American Home Products Corp. v. United States

• Decision Date: 13 June 1979
• Docket Number: No. 422-75.,422-75.
• Parties: American Home Products Corporation v. The UNITED STATES.
• Court: U.S. Claims Court

601 F.2d 540

American Home Products Corporation v. The UNITED STATES.

No. 422-75.

United States Court of Claims.

June 13, 1979.

COPYRIGHT MATERIAL OMITTED

William M. Chanson, New York City, Atty. of Record, for plaintiff.

Bruce W. Reynolds, Washington, D.C., with whom was Asst. Atty. Gen. M. Carr Ferguson, Washington, D.C., for defendant; Theodore D. Peyser and Robert S. Watkins, Washington, D.C., of counsel.

Before DAVIS, KASHIWA and KUNZIG, Judges.

ON DEFENDANT'S MOTION FOR SUMMARY JUDGMENT AND PLAINTIFF'S CROSS-MOTION FOR SUMMARY JUDGMENT

DAVIS, Judge:

This case involves the tax effects of certain forward sale contracts of foreign currency. We must first determine the proper amount of dividends declared in British pounds when the American taxpayer immediately applied most of the dividends it received to cover two of its forward sale contracts of pounds into dollars. We conclude that the dividends must be measured by the prevailing exchange rate at the time of distribution to taxpayer, not the better rate contractually mandated by the forward sale agreements. The second issue involves characterization of taxpayer's gain from the assignment of two other foreign currency futures contracts. Each contract was held more than six months, the then prevailing long term holding period. We decide that the assignment was a bona fide transaction, that the gain was long term, and that the special rule of Internal Revenue Code section 1233 governing short sales is inapplicable.

Both parties have moved for summary judgment on the following stipulated facts: Plaintiff American Home Products ("taxpayer" or "American Home") is a domestic corporation which produces a variety of foods, ethical and non-prescription drug products, and housewares. In 1967 it had a controlling interest in five foreign subsidiaries located in the United Kingdom.¹ Taxpayer expected to receive (late in 1967 or in 1968) substantial dividends payable in pounds sterling from its British subsidiaries, but was concerned about the effects on its income from the dividends of a possible devaluation of the pound. After some planning and study, plaintiff (in September and early October of 1967) entered into four futures contracts with two large American banks (which we shall call Continental and Manufacturers Hanover), each promising to sell one year later a specified amount of pounds at approximately $2.80 per pound (which was then the dollar value of the pound). Plaintiff in effect made a "short sale" of pounds — promising to deliver currency it did not have at the time.² Plaintiff's concern over the course of the pound was well-founded. A little more than a month after it signed the last of the four futures contract, the British Government devalued the pound from about $2.80 to about $2.40 per dollar. American Home then had four contracts enabling it to sell pounds in September and October 1968 at a rate considerably higher than the post-devaluation exchange rate.

As projected, taxpayer received very substantial dividends of sterling from its British subsidiaries. For relatively small dividends plaintiff exchanged the pounds into dollars at the lower post-devaluation exchange rate. However, plaintiff used most of the pounds received from these dividends to cover (partially) its obligation under two of the futures contracts with Continental. The procedure was this: After receiving advance notice of an impending dividend declaration, American Home would make arrangements with Continental to accept the pounds as an early delivery on the futures contracts. The bank was not contractually required to accept early delivery, and a separate agreement was reached for each one. Upon declaration of the dividend and requisite export clearance from British authorities, American Home ordered the subsidiary to pay the pounds directly to Continental. The latter in turn paid American Home an amount in dollars at approximately the contractually-mandated rate of $2.80 per pound. Although the precise time lag between declaration of a dividend in pounds and translation into dollars is not clear, we can assume it was done quickly. It is stipulated that American Home never held any pounds in its possession or subject to its control for greater than six months.

For federal income tax purposes, taxpayer valued its British dividends (and the British taxes paid thereon) at the contractual exchange rate of $2.80 per pound, producing a larger total dividend income than if the pound dividends were valued in dollars at the prevailing post-devaluation exchange rates.³ The larger dividend value produced a net tax advantage to American Home under the foreign tax credit provisions of the Internal Revenue Code because the British income taxes (which were creditable under the tax credit provisions) were enlarged if translated at $2.80 rather than $2.40.⁴

On audit the Internal Revenue Service adopted the lower prevailing exchange rate to value the sterling dividends and the British taxes. The Service also characterized the exchange gain realized on the two futures contracts as ordinary income. These adjustments produced a substantial deficiency which taxpayer paid and for which it now seeks a refund.

Plaintiff assigned its two remaining futures contracts (one with Continental and the other with Manufacturers Hanover) to the Canadian Imperial Bank of Commerce. The assignment was made some two weeks before the delivery dates, and Canadian Imperial paid plaintiff about $336,000 for the two contracts. This sum was the difference between the contract rate (approximately $2.80 per pound) and the prevailing exchange rate in 1968 (about $2.40), adjusted for Canadian Imperial's commission expenses and interest charges. Both Continental and Manufacturers Hanover accepted the assignments. American Home and Canadian Imperial were completely independent companies at the time of assignment. The terms of both assignment agreements specify that American Home assigned all "right, title, and interest" in the futures contracts, and the agreement assigning the contract made with Manufacturer's Hanover specifically stated that the assignment was "without recourse."

Taxpayer characterized the $336,000 gain as a long term capital gain. The Service treated the gain as ordinary income,⁵ producing a deficiency which was paid, and which plaintiff seeks to recover in the second part of this suit.

I.

The first problem is whether the sterling dividends are properly valued at the regular exchange rate prevailing on the date of declaration (defendant's view) or whether the special contractual rate at which the pounds were actually converted controls (plaintiff's view).

The underlying rules form the common ground for this contest. Section 301(b) of the Internal Revenue Code states that the amount of dividends of property other than cash is determined (in this setting) by the fair market value of the property. I.R.C. § 301(b)(1)(C). For these purposes, moreover, foreign currency is deemed "property" other than cash. See 31 U.S.C. § 451-463 (1976) (defining "legal tender" of the United States); Gillin v. United States, 423 F.2d 309, 311, 191 Ct.Cl. 172, 177 (1970) (foreign currency frequently treated as "property or a commodity"); Costello, Tax Impact of Currency Exchange Rate Fluctuations, 26 Tax Law'y 399, 420 & n. 85 (1973) (cases consistently treat foreign currency as commodity) hereinafter Costello, Tax Impact; cf. I.R.C. § 317(a). And section 301(b)(3) requires that the fair market value of such property be determined "* * * as of the date of the distribution."⁶

None of this is overtly disputed. The clash narrows to the proper method of determining in this case the value of the dividends (and taxes) paid in British currency. Defendant rests on the proposition that fair market value of a foreign currency must be measured by the prevailing exchange rate (if one exists). Plaintiff, as we have suggested, parries that the prevailing rate is irrelevant in this case where the taxpayer made an actual conversion at a different rate under its futures contracts. We agree with defendant.

Where, as here, foreign currency regularly and normally exchanges at a "free" rate — unimpeded by blocking or other significant currency restrictions⁷ — that rate necessarily measures the fair market value of the alien money at the time of conversion. This follows from the general test in tax law for fair market value as the price of exchange "between a willing buyer and a willing seller, neither being under any compulsion to buy or sell ..." Treas. Reg. § 1.170-1(c)(1) (adopting test for measuring fair market value of property in charitable contribution); Treas. Reg. § 20.2031-1(b) (adopting test for measuring value of property includable in decedent's gross estate); see Jack Daniel Distillery v. United States, 379 F.2d 569, 574, 180 Ct.Cl. 308, 315-16 (1967) quoted in Bankers Trust Co. v. United States, 518 F.2d 1210, 1219, 207 Ct.Cl. 422, 437 (1975), cert. denied, 424 U.S. 966, 96 S.Ct. 1461, 47 L.Ed.2d 733 (1976); Knapp King-Size Corp. v. United States, 527 F.2d 1392, 1400 n. 4, 208 Ct.Cl. 533, 548 n. 4 (1975). Under this test, it is clear that no willing buyer would have purchased plaintiff's pounds at a price some $548,000 higher than the regular exchange rate, without the compulsion (as Continental had) of a futures contract.⁸

Similarly, taxpayer's $2.80 rate fails the test that the foreign dividend be given its fair market value at the time of distribution. Let us assume that American Home translated its pounds into dollars the same day as each dividend was declared.⁹ Even so, the $2.80 rate was, as the facts show, clearly not the fair market value for those dates in late 1967 or in 1968, though it may have been for the pre-devaluation period earlier in 1967. Yet section 301(b)(3) and the implementing regulations require measurement of fair market value "as of the date of distribution." See Treas. Reg. § 1.301-1(b); cf....