New Mexico Timber Co. v. Comm'r of Internal Revenue
| Decision Date | 17 June 1985 |
| Docket Number | Docket No. 24199-82. |
| Citation | 84 T.C. 1290,84 T.C. No. 70 |
| Parties | NEW MEXICO TIMBER COMPANY, A NEW MEXICO CORPORATION, T. P. GALLAGHER AND BARBARA GALLAGHER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
JAMES E. POLK, for the respondent.
Respondent determined deficiencies in Federal income tax against petitioners as follows:
The only issue for us to decide is whether the amount of ‘gross receipts,‘ within the meaning of section 1372(e)(5), 1 realized by a small business corporation trading in commodity futures contracts, equals the total amount realized, or whether such receipts are taken into account only to the extent of the gains from such transactions, unreduced by any fees or commissions.
This case was submitted to the Court under the provisions of Rule 122, upon a set of stipulated facts and exhibits. The stipulation of facts, supplemental stipulation of facts, and joint exhibits attached thereto are incorporated herein by this reference and form the basis of our findings of fact.
New Mexico Timber Company (hereinafter ‘NMT‘) was, during the years in issue, a New Mexico corporation, with principal offices in Albuquerque, New Mexico.
T.P. Gallagher (hereinafter ‘T.P.‘) and Barbara Gallagher were husband and wife and residents of Albuquerque, New Mexico, at the time the petition herein was filed. T.P. was the sole shareholder, president, and chief executive officer of NMT at all times material hereto.
In 1959, T.P. purchased 100,000 acres of standing timber in the Valle Grande in Sandoval County, New Mexico (hereinafter the ‘Baca location‘) and 116,000 acres of standing timber in Sandoval County, New Mexico, in the San Diego Land Grant (hereinafter the ‘San Diego location‘). T.P. also purchased a saw mill, logging equipment, a planing mill, dry kilns, and other equipment used in the production of lumber, the inventory and receivables of NEMTICO, Inc., and a tract of real property located in Bernalillo, Sandoval County, New Mexico (hereinafter the ‘Bernalillo land‘). The timber and the other assets were then transferred to NMT's predecessor, 2 of which T.P. was the sole shareholder, and later to NMT. The latter was engaged in various activities, including the sale of standing timber, lumber manufacturing, and the wholesale purchase and sale of manufactured timber. NMT acquired equipment and other operating assets, from time to time, in connection with its various businesses.
In 1963, NMT sold the San Diego location. The Baca location was sold, in a transaction qualifying for reporting under the installment method of section 453, in 1972; the last installment payment was received by NMT in June 1981.
NMT decided to cease its lumber business and to liquidate the equipment on May 1, 1976. As of May 1, 1976, and at all times until April 30, 1978, NMT was an electing small business corporation. No voluntary revocation of NMT's small business corporation election was filed by its shareholders during the years in issue.
In November 1978, NMT sold the Bernalillo land, in a transaction qualifying for the installment method of reporting of section 453.
Between 1976 and 1979, T.P. discussed the possibility of liquidating and dissolving NMT with his accountants. T.P. was advised that a liquidation would have unfavorable income tax consequences resulting from the disposition of the installment obligations received by NMT in the sale of the Baca location and the Bernalillo land, pursuant to the provisions of section 453(d). T.P. was also advised that in order for NMT to avoid the automatic termination provisions of section 1372(e)(5) and return its status as an electing small business corporation, its gross receipts from passive income sources, viz, royalties, dividends, interest, and gains from the sales or exchanges of stock or securities, had to be less than 20 percent of its gross receipts. Gross receipts from passive investment income sources did not equal or exceed 20 percent of total gross receipts of NMT during its taxable years 1976 through April 30, 1978.
In 1978, NMT was approached by Hanseatic Commodities Advisors (hereinafter ‘Hanseatic‘), a commodity futures consulting firm, concerning trading in commodity futures. NMT decided to attempt to make profits by trading in commodity futures contracts.
A commodity futures contract is a firm commitment to deliver or to receive a specified quantity and grade of a commodity during a designated month in the future (the delivery month) at a specified price. All the terms and provisions of a futures contract are fixed by the bylaws and rules of the commodity exchange on which the contract is traded, except for the price and the delivery month, which are agreed upon at the time a trade is made on the floor of the exchange. A person entering into a commodity futures contract to sell a commodity, viz, to deliver the commodity, is obligated to deliver the commodity in the delivery month, unless he has disposed of the contract in the meantime; this is known as taking a ‘short position.‘ A person buying a commodity futures contract to purchase a commodity, viz, to accept delivery of the commodity, is obligated to accept delivery of the commodity in the delivery month and pay for the commodity at the specified contract price, unless he has disposed of the contract in the meantime, although his liability for the payment of such money on any day before the delivery date is limited to the margin call on that particular day; 3 this is known as taking a ‘long position.‘ If the price of the underlying commodity falls, the trader must either satisfy the margin call requirements or liquidate his position at a loss.
The holders of both long and short positions can close out their contracts, without making or taking delivery of the commodity, by entering into offsetting purchases or sales of futures contracts on the exchange. 4 Pursuant to the rules of the various exchanges, the offsetting purchase or sale cancels the obligation to accept or deliver the underlying commodity. Thus, the holder of a long commodity futures contract can cancel or offset his obligation to purchase and pay for the commodity by acquiring from another the promise to purchase and pay for the same commodity on the same exchange for the same delivery month, that is, by entering into an offsetting short contract, and vice versa.
NMT established a commodities futures trading account with Merrill Lynch Pierce Fenner and Smith, Inc. (hereinafter ‘Merrill Lynch‘), a brokerage firm, pursuant to the terms of a commodity account agreement. Under the terms of the aforesaid agreement, NMT agreed that:
(a) Any and all transactions would be subject to the constitution, rules and regulations, customs and usages of the exchange or market where any transaction was to be executed;
(b) Any and all securities or commodities or contracts relating thereto, held by Merrill Lynch, were to be held as security for the payment of any of NMT's liabilities to Merrill Lynch;
(c) Merrill Lynch would have the right, whenever in its discretion it considered it necessary for its protection, to sell any of the commodities or contracts related thereto or to close out any standing commodities or contracts related thereto on the open market or on any exchange, without notice, demand, or advertisement;
(d) NMT would be at all times liable for deficiencies remaining in its account after sales by Merrill Lynch or NMT.
NMT also executed a power of attorney constituting and appointing Hanseatic as NMT's agent for the purpose of buying, selling, and trading in commodities. As a condition for buying, selling, and trading in commodities, Merrill Lynch required that NMT deposit $100,000 in cash with it. This was a margin 5 requirement to protect Merrill Lynch and the various commodity exchanges from losses in NMT's commodities account. 6 NMT opened a Ready Asset account with Merrill Lynch, with an initial deposit of $100,000. NMT authorized Merrill Lynch, in writing, to transfer funds from its Ready Asset account to its commodity account.
During its taxable year ended April 30, 1979, NMT, acting as a commodities trader, effected a number of futures transactions in commodities that included lumber, gold, hogs, copper, sugar, soybean oil, silver, soybeans, cotton, wheat, foreign currency and cattle. NMT entered into commodities futures contracts with an aggregate cost price of $880,882. In order to close its positions, NMT entered into offsetting commodity futures contracts with respect to the same underlying commodities in the same delivery months with an aggregate selling price of $909,471.60. NMT realized total gains, before fees or commissions, of $28,590 from its commodity futures transactions. NMT did not engage in any straddle transactions. 7 At no time during its taxable year ended on April 30, 1979 did NMT have possession, nor did it take delivery of any underlying commodities in connection with its commodity futures...
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