S.C. Johnson & Son, Inc. v. Comm'r of Internal Revenue
| Decision Date | 31 March 1975 |
| Docket Number | Docket No. 1821-72. |
| Citation | 63 T.C. 778 |
| Parties | S. C. JOHNSON & SON, INC., PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Karl R. Price, for the petitioner.
James F. Kidd and Denis J. Conlon, for the respondent.
Petitioner entered into two forward sales contracts with respect to the British pound. After devaluation of the pound in November 1967, these contracts had substantially appreciated in value. Petitioner contributed the contracts to a charitable organization which subsequently entered into negotiations and sold the contracts to an unrelated third party. Held, petitioner did not realize income as a result of the contribution and subsequent sale of the forward sales contracts.
Respondent determined deficiencies in petitioner's Federal income tax as follows:
+---------------------------+
¦TYE ¦Deficiency ¦
+-------------+-------------¦
¦ ¦ ¦
+-------------+-------------¦
¦June 30, 1967¦$2,037,317.76¦
+-------------+-------------¦
¦June 28, 1968¦2,768,400.26 ¦
+---------------------------+
Other issues having been settled, the only issue remaining for decision is whether petitioner realized unreported income in the amount of $555,427.50 from the contribution of two foreign exchange contracts to a charitable organization and the subsequent sale of those contracts by the charitable organization and, if so, whether the income realized on the sale of the contracts is taxable as ordinary gain or as capital gain.
Petitioner S. C. Johnson & Son, Inc., is a Wisconsin corporation engaged in the manufacture and sale of various wax products and other chemical specialties. Its manufacturing plants, as well as its principal offices, are located in Racine, Wisc. In reporting its income, petitioner uses a fiscal year ending on the Friday nearest June 30.
During its fiscal year 1968, petitioner had 27 foreign subsidiaries which were engaged in the manufacture and sale or the purchase and sale abroad of products similar to the ones petitioner manufactured and sold in the United States. Most of the subsidiaries were wholly owned, directly or indirectly, by petitioner. Petitioner did not make sales in any substantial amounts to its foreign subsidiaries, but it provided them with technical assistance and the use of certain intangibles for which it received service fees and royalties, paid monthly or quarterly.
One of petitioner's wholly owned subsidiaries in 1968 was S. C. Johnson & Son, Ltd. (presently named Johnson Wax Ltd.), a British corporation, which was engaged in the manufacture and sale of wax products and chemical specialties in the United Kingdom. Johnson Wax Ltd. was one of petitioner's largest and most profitable subsidiaries. At the end of its fiscal year 1967 (June 30), the subsidiary had net assets with a British currency equivalent of about $2,600,000.
In July 1967, petitioner's management became concerned over the possibility that the British pound sterling would be devalued. Such a devaluation would reduce the value of Johnson Wax Ltd.‘s assets in terms of United States dollars, as reflected on petitioner's consolidated financial statements. Petitioner itself carried no sterling balances and owned no other British assets.
One of the measures considered by petitioner's management to protect against the effects of possible devaluation of the British pound sterling was a forward sale of pounds, i.e., a contract to sell pounds on a designated future date at an agreed price. Since the seller can meet its obligation under such a contract by buying pounds at any time between the date of the contract and 2 days prior to its maturity. petitioner's management reasoned that petitioner could make a profit from a forward sale and thereby offset whatever loss was caused by the devaluation. Petitioner's management had not previously handled such forward sales. It was aware, however, that the foreign exchange departments of the major metropolitan banks, acting as dealers, frequently buy and sell foreign currencies for both immediate and future deliveries and that price quotations were published in the daily press.
Petitioner decided to make a forward sale of British pounds. Accordingly, July 26, 1967, it entered into contracts (hereinafter the contracts) with two New York City banks, one with First National City Bank and the other with Morgan Guaranty Trust Co. Under each contract, petitioner agreed to sell and the bank agreed to buy 750,000 British pounds at $2.765 each, for delivery on July 29, 1968. Each bank sent petitioner a written confirmation of the terms of the contract on a standard form used by the bank, a duplicate copy of which petitioner executed and returned to the bank.
The contract with the First National City Bank recited:
We confirm having today BOUGHT from you the foreign exchange described hereunder. subject to the conditions set forth on the reverse side hereof.
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¦Amount ¦£ 750,000-0-0¦Tenor¦Cable London¦
+--------+-------------+-----+------------¦
¦Delivery¦July 29, 1968¦Rate ¦2.7650 ¦
+-----------------------------------------+
The reverse side set forth the following conditions:
I. Should the New York market price of the foreign exchange be more at any time than the rate we are to pay you therefor, you shall, upon our request at any time, promptly deposit with us at this office, as security for your obligation, cash or its equivalent in an amount sufficient to cover the amount of the increase. In default thereof, we may, in our discretion at any time thereafter, cancel the purchase, whereupon you will be indebted to us for, and shall pay us upon demand, an amount equal to any excess of the said market price of such foreign exchange on the date of cancellation over the purchase price.
II. Unless the purchase is cancelled as provided above, the foreign exchange shall be delivered by you in free and unrestricted funds, and in the manner indicated on the reverse side hereof. If delivery is to be made by a MAIL or CABLE TRANSFER, delivery shall be made to such one of our foreign Branches or Correspondents, for credit to our account, as shall have been specified to you by us and confirmed in writing; if by a CABLE TRANSFER, such delivery shall be made not later than the due date specified on the reverse side hereof; if by a MAIL TRANSFER, by delivery to us not later than the date specified on the reverse side hereof of a copy of your order instructing the transfer, and delivery must be effected pursuant thereto in due course; if by a CHECK or DRAFT, by delivery to us not later than the date specified on the reverse side hereof of such an item payable in a country where the foreign exchange is the usual medium of exchange and it must be accepted or paid (as the case may be) on presentation.
III. In event of any of the conditions set forth in ‘II’ hereof not being fulfilled, you will, upon demand at any time thereafter, pay us: (a) any United States Dollar amount which we may have paid you on account of the foreign exchange, together with interest thereon at such rate as we may determine to be effective at the time in the aforesaid country for loans or advances to us of the foreign currency, and for the period between the time when such payment was made by us to you and the date when such reimbursement shall have been received by us from you, and (b) any excess of the United States Dollar equivalent of the amount of the foreign exchange (at our selling rate for cable transfers of such foreign exchange on the date of reimbursement) over the purchase price. Should the foreign exchange for which we shall have been thus reimbursed, and/or any relative documents (or the proceeds thereof), be at the time of such reimbursement or thereafter in the possession of our Branch, Correspondent or otherwise under our control, the same will be held for your account without responsibility therefor on the part of this Bank or its Correspondent.
IV. As security for the prompt payment of any indebtedness or liability for which you may be or become obligated hereunder, we shall have a lien upon any and all of your funds and/or other property which is (are) now or may at any time(s) hereafter come into our possession or under our control.
In November 1967, the British Government devalued the pound, reducing its par value from.$2.80 to $2.40. In the months immediately preceding the devaluation, the pound had traded, in spot transactions, between $2.78 and. $2.80; in the months immediately following, it traded between $2.38 and $2.42. The rates on forward transactions ranged from 0.5 cent to 4 cents under the spot rate.1
The owner of a forward sale contract with respect to a foreign currency can close out his position, in an economic sense, at any time by making a forward purchase of an equivalent amount of the same currency for delivery on the same maturity date. The sale contract can then be performed at maturity by delivering the funds acquired under the purchase contract. Alternatively, the owner can achieve the same basic objective by selling the contract to a third party, although to make the sale without recourse, he must obtain the consent of the bank (i.e., the bank's approval of the purchaser under the forward sale contract). On the other hand, if he wishes to maintain his forward position as long as possible, he may perform at maturity by purchasing the currency on the spot market at any time until 2 banking days in advance of the maturity date.
After the November 1967 devaluation, petitioner's contracts had substantial value. Petitioner's management gave considerable attention to the question of what should be done with the contracts.
In 1959, petitioner had organized a Wisconsin nonprofit corporation, the Johnson's Wax Fund, Inc. (hereinafter the Wax Fund), which was ruled by the Internal Revenue Service to be exempt from Federal...
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