Hoover Co. v. Comm'r of Internal Revenue, Docket Nos. 2697-77

• Decision Date: 24 April 1979
• Docket Number: Docket Nos. 2697-77,9646-77.
• Citation: 72 T.C. 206
• Parties: THE HOOVER COMPANY, PETITIONER v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

72 T.C. 206

THE HOOVER COMPANY, PETITIONER
v.
COMMISSIONER of INTERNAL REVENUE, RESPONDENT

Docket Nos. 2697-77

9646-77.

United States Tax Court

Filed April 24, 1979.

Petitioner entered into 18 forward sale agreements to offset (1) a potential decline in the value of its investment in certain foreign subsidiaries, whose home currencies may be or are devalued relative to the U.S. dollar, and (2) exchange losses required to be reported on petitioner's consolidated financial statement. Petitioner suffered losses on the closing of 16 of the sale agreements and realized gains on the sale of one contract and satisfaction of the remaining contract. Held:

1. The forward sale agreements do not constitute bona fide hedging transactions in commodity futures and the gains and losses realized from them are not ordinary gains and losses but capital gains and losses.

2. The Corn Products Refining Co. v. United States, 350 U.S. 46 (1955), doctrine is not applicable to these transactions. The rationale of International Flavors & Fragrances Inc. v. Commissioner, 62 T.C. 232 (1974), revd. and remanded524 F.2d 357 (2d Cir. 1975), T. C. Memo. 1977-58, not followed.

3. The losses incurred by petitioner on certain forward sale agreements do not constitute ordinary and necessary business expenses.

4. The currency purchased by petitioner to satisfy its obligations under certain forward sale agreements constitutes a capital asset in petitioner's hands.

5. Petitioner was not released from its obligations under certain forward sale agreements.

6. Sec. 1233(a), I.R.C. 1954, is applicable to these forward sale agreements.

7. Short-term or long-term treatment of the capital gains and losses determined.

[72 T.C. 207]

Charles J. Kerester and Wallace M. Wright, for the petitioner.

Robert A. Roberts, John R. Dorocak, and Raymond W. McKee, for the respondent.

DAWSON, Judge:

In these consolidated cases respondent determined the following deficiencies in petitioner's Federal income taxes:

+------------------------------+
                ¦TYE Dec. 31— ¦Deficiency ¦
                +-----------------+------------¦
                ¦ ¦ ¦
                +-----------------+------------¦
                ¦1968 ¦$192,775.71 ¦
                +-----------------+------------¦
                ¦1969 ¦101,508.22 ¦
                +-----------------+------------¦
                ¦1970 ¦60,005.53 ¦
                +------------------------------+
                

The primary issue presented for our decision is whether gains and losses from short sales in foreign currency engaged in by petitioner to offset (1) a potential decline in the value of its investment in certain foreign subsidiaries, whose home currencies may be or are devalued relative to the U.S. dollar, and (2) exchange losses required to be reported on petitioner's consolidated financial statement, constitute ordinary losses or business expenses, and gains, or capital losses and gains. If the gains and losses are capital in nature, we must also determine whether they are short-term or long-term gains and losses.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference.

Hoover Co. (hereinafter referred to as petitioner) is a Delaware corporation with its principal place of business in North

[72 T.C. 208]

Canton, Ohio. Petitioner filed United States corporate income tax returns for the years in issue with the Internal Revenue Service Center, Cincinnati, Ohio.

Petitioner is, and has for many years been, a publicly held corporation. Its shares, which are traded over the counter, were held by more than 9,000 stockholders as of June 30, 1977. Directly, and through subsidiaries in foreign countries, during the taxable years in question, petitioner was engaged in the business of manufacturing and distributing electric vacuum cleaners and accessories, floor polishers, laundry equipment, automatic washers and dryers, as well as smaller appliances such as irons, toasters, and heaters, and certain other products such as die castings.

Petitioner maintained its books and records and filed its returns for the years in issue on the accrual method of accounting.

In the taxable years 1968, 1969, and 1970, petitioner owned approximately 55 percent of the outstanding shares of Hoover Ltd., a British corporation. The balance of the shares of Hoover Ltd., was publicly held, mostly in the United Kingdom. In such taxable years, Hoover Ltd., had wholly owned subsidiaries in Australia, Austria, Denmark, Finland, Norway, Sweden, and South Africa. Petitioner also owned a 50-percent interest directly, and an additional 27.5-percent interest indirectly (an aggregate of 77.5-percent) in Hoover (Holland) N. V., a Dutch corporation. The latter in turn had active, wholly owned subsidiaries in Belgium, France, Germany, Holland, Italy and Switzerland. In addition, petitioner had wholly owned subsidiaries in Canada and Panama. The Panamanian corporation in turn owned subsidiaries in Panama, Colombia, Brazil, and Mexico. Petitioner directly or indirectly exercised a majority of the voting power of, and thus controlled, all of the subsidiaries.

The corporate structure denominated above can be graphically shown as on p. 209.

+---------------------------------------------------------+
                ¦ ¦ ¦HOOVER COMPANIES 1 ¦ ¦ ¦
                +---------------+---+--------------------+----+-----------¦
                ¦ ¦ ¦(1968) ¦ ¦ ¦
                +---------------+---+--------------------+----+-----------¦
                ¦BRITISH ¦ ¦ ¦ ¦ ¦
                +---------------+---+--------------------+----+-----------¦
                ¦PUBLIC ¦ ¦The Hoover Co. ¦ ¦ ¦
                +---------------+---+--------------------+----+-----------¦
                ¦ ¦ ¦U.S. ¦100%¦ ¦
                +---------------+---+--------------------+----+-----------¦
                ¦45% ¦55%¦ ¦ ¦canada ¦
                +---------------+---+--------------------+----+-----------¦
                ¦ ¦ ¦77.5% ¦ ¦ ¦
                +---------------+---+--------------------+----+-----------¦
                ¦ ¦ ¦ ¦ ¦ ¦
                +-------------------+--------------------+----+-----------¦
                ¦ ¦ ¦ ¦ ¦
                +-------------------+--------------------+----+-----------¦
                ¦Hoover Ltd. ¦Hoover N.V. ¦ ¦Hoover Inc.¦
                +-------------------+--------------------+----+-----------¦
                ¦United Kingdom ¦Holland ¦ ¦(Panama) ¦
                +-------------------+--------------------+----+-----------¦
                ¦ ¦ ¦ ¦ ¦
                +-------------------+--------------------+----+-----------¦
                ¦100% ¦ ¦100% ¦ ¦100% ¦
                +---------------+---+--------------------+----+-----------¦
                ¦ ¦ ¦ ¦ ¦ ¦
                +---------------+---+--------------------+----+-----------¦
                ¦Australia ¦ ¦Belgium ¦ ¦Panama ¦
                +---------------+---+--------------------+----+-----------¦
                ¦Austria ¦ ¦France ¦ ¦Colombia ¦
                +---------------+---+--------------------+----+-----------¦
                ¦Denmark ¦ ¦Germany ¦ ¦Brazil ¦
                +---------------+---+--------------------+----+-----------¦
                ¦Finland ¦ ¦Italy ¦ ¦ ¦
                +---------------+---+--------------------+----+-----------¦
                ¦Norway ¦ ¦Netherlands ¦ ¦ ¦
                +---------------+---+--------------------+----+-----------¦
                ¦South Africa ¦ ¦Switzerland (2) ¦ ¦ ¦
                +---------------+---+--------------------+----+-----------¦
                ¦Northern Branch¦ ¦ ¦ ¦ ¦
                +---------------+---+--------------------+----+-----------¦
                ¦Sweden ¦ ¦ ¦ ¦ ¦
                +---------------+---+--------------------+----+-----------¦
                ¦ ¦ ¦ ¦ ¦ ¦
                +---------------------------------------------------------+
                

Petitioner did not actively export its finished products to Hoover Ltd., or its other subsidiaries in Europe. Rather, petitioner sold its products primarily in the United States, Canada, and the Caribbean. Hoover Ltd., was the major source of supply to the subsidiaries in Europe and South Africa. Hoover Ltd., manufactured finished products in three plants in the United Kingdom and shipped 40 percent of this production to

[72 T.C. 210]

other Hoover subsidiaries. The subsidiaries on the European continent and in South Africa did not actively engage in manufacture, but were essentially sales corporations.

Over the years, petitioner has received dividends from some of its foreign subsidiaries. In addition, it also receives under so-called “Pro-Rata Agreements” payments from certain subsidiaries for “benefits derived” by the subsidiaries from petitioner's research and development activities. Finally, petitioner receives “other foreign income,” consisting of interest from some of its foreign subsidiaries, and royalties and management fees from its wholly owned subsidiary in Canada.

The following table sets forth for the years 1963 through 1970 the dividends, pro rata payments, and “other foreign income” received by petitioner from its foreign subsidiaries:

+---------------------------------------------------------+
                ¦ ¦ ¦ ¦Other ¦ ¦
                +------+-----------+--------------+------------+----------¦
                ¦ ¦ ¦Pro rata ¦foreign ¦ ¦
                +------+-----------+--------------+------------+----------¦
                ¦Year ¦Dividends ¦payments 1 ¦income 2 ¦Total ¦
                +------+-----------+--------------+------------+----------¦
                ¦ ¦ ¦ ¦ ¦ ¦
                +------+-----------+--------------+------------+----------¦
                ¦1963 ¦$3,385,841 ¦$1,158,842 ¦$52,650 ¦$4,597,333¦
                +------+-----------+--------------+------------+----------¦
                ¦1964 ¦3,328,585 ¦1,312,377 ¦55,404 ¦4,696,366 ¦
                +------+-----------+--------------+------------+----------¦
                ¦1965 ¦3,291,620 ¦1,331,014 ¦120,462 ¦4,743,096 ¦
                +------+-----------+--------------+------------+----------¦
                ¦1966 ¦2,814,287 ¦1,418,396 ¦116,993 ¦4,349,676 ¦
                +------+-----------+--------------+------------+----------¦
                ¦1967 ¦2,993,891 ¦1,576,356 ¦542,314 ¦5,112,561 ¦
                +------+-----------+--------------+------------+----------¦
                ¦1968 ¦2,918,582 ¦1,744,802 ¦518,774 ¦5,182,158 ¦
                +------+-----------+--------------+------------+----------¦
                ¦1969 ¦3,615,446 ¦1,886,306 ¦416,049 ¦5,917,801 ¦
                +------+-----------+--------------+------------+----------¦
                ¦1970 ¦3,499,908 ¦2,090,475 ¦333,437 ¦5,923,820 ¦
                +------+-----------+--------------+------------+----------¦
                ¦ ¦ ¦ ¦ ¦ ¦
                +---------------------------------------------------------+
                

The income received by petitioner as shown in the preceding schedule was received from its subsidiaries during the years 1967 through 1970 as follows:

+----------------------------------------------+
                ¦ ¦ ¦Pro rata ¦Other ¦

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