Samueli v. Comm'r of Internal Revenue, s. 13953–06
| Decision Date | 16 March 2009 |
| Docket Number | Nos. 13953–06,14147–06.,s. 13953–06 |
| Citation | 132 T.C. 37,132 T.C. No. 4 |
| Parties | Henry and Susan F. SAMUELI, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentThomas G. and Patricia W. Ricks, Petitioners v. Commissioner of Internal Revenue, Respondent. |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Ps–S purchased an approximate $1.64 billion of securities from F in October 2001 and simultaneously transferred the securities back to F pursuant to F's promise to transfer identical securities to Ps–S on Jan. 15, 2003. The agreement between Ps–S and F allowed Ps–S to require an earlier transfer of the identical securities only by terminating the transaction on July 1 or Dec. 2, 2002. Ps–S did not require an earlier transfer and sold the securities to F on Jan. 15, 2003. Ps treated the transaction as a securities lending arrangement subject to sec. 1058, I.R.C., and Ps–S reported an approximate $50.6 million long-term capital gain on the sale. Ps also deducted millions of dollars of interest related to the transaction. R determined that the transaction was not a securities lending arrangement subject to sec. 1058, I.R.C. Instead, R determined that Ps–S purchased the securities from and immediately sold the securities to F in 2001 at no gain or loss and then repurchased from (pursuant to a forward contract) and immediately resold the securities to F in 2003 realizing an approximate $13.5 million short-term capital gain. R also disallowed all of Ps' interest deductions because the corresponding debt that Ps claimed was related to the transaction did not exist.
Held: The transaction is not a securities lending arrangement subject to sec. 1058, I.R.C., because the ability of Ps–S to cause F to transfer the identical securities to Ps–S on only three of the approximate 450 days during the transaction period reduced their “opportunity for gain * * * in the transferred securities” under sec. 1058(b)(3), I.R.C. The substance of the transaction was the purchases and sales that R determined.
Held, further, Ps are not entitled to their claimed interest deductions because the debt Ps claimed was related to the transaction did not exist.
Nancy L. Iredale, Jeffrey G. Varga, and Stephen J. Turanchik, for petitioners.
Miles B. Fuller and Louis B. Jack, for respondent.
These consolidated cases are before the Court on petitioners' motion for summary judgment and respondent's cross-motion for partial summary judgment. Respondent determined a $2,177,532 deficiency for 2001 and a $171,026 deficiency for 2003 in the Federal income taxes of Henry and Susan F. Samueli (collectively, Samuelis). Respondent determined a $6,126 deficiency for 2001 in the Federal income tax of Thomas G. and Patricia W. Ricks (collectively, Rickses). Each deficiency relates to petitioners' participation in a leveraged securities transaction (Transaction).1 Petitioners treated the Transaction as a securities lending arrangement subject to section 1058, 2 the provisions of which we set forth in an appendix.
These cases present an issue of first impression on the interpretation of section 1058(b)(3). Specifically, we decide whether the agreement (Agreement) underlying the Transaction did “not reduce the * * * opportunity for gain of the transferor of the securities in the securities transferred” within the meaning of section 1058(b)(3). We agree with respondent's primary determination that the Agreement did reduce the Samuelis' opportunity for gain in the securities (Securities) transferred in the Transaction. Accordingly, we hold that the Transaction did not qualify as a securities lending arrangement under section 1058. We also decide whether petitioners may deduct interest claimed paid with respect to the Transaction. We hold they may not because the debt that petitioners claimed was related to the Transaction did not exist.
I. Preliminaries
The parties filed an extensive stipulation of facts with accompanying exhibits. We treat the facts set forth in this background section as true solely for purposes of deciding the parties' motions, not as findings of fact for these cases. See Fed.R.Civ.P. 52(a); P & X Mkts., Inc. v. Commissioner, 106 T.C. 441, 442 n. 2, 1996 WL 323680 (1996), affd. without published opinion 139 F.3d 907 (9th Cir.1998).
II. Individuals and EntitiesA. Overview of Petitioners
Petitioners are two couples, each husband and wife, who filed joint Federal individual income tax returns for the relevant years. Each petitioner resided in California when his or her petition was filed with the Court.
B. Mr. Samueli
Henry Samueli (Mr. Samueli) is a billionaire who co-founded Broadcom Corporation, a publicly traded company listed on the NASDAQ Exchange.
C. H & S Ventures
H & S Ventures, LLC (H & S Ventures), was a limited liability company that was treated as a partnership for Federal tax purposes. Mr. Samueli owned 10 percent of H & S Ventures, Susan Samueli owned 10 percent of H & S Ventures, and the Samuelis' grantor trust (Shiloh) owned the remaining 80 percent of H & S Ventures.3 H & S Ventures was the primary entity through which the Samuelis conducted their business affairs.
D. Mr. Ricks and Mr. Schulman
Thomas Ricks (Mr. Ricks) was the chief investment officer for H & S Ventures and an investment adviser to the Samuelis. Michael Schulman (Mr. Schulman) was the managing director of H & S Ventures and the Samuelis' personal attorney.
E. TFSC
Twenty–First Securities Corporation (TFSC) was a brokerage and financial services firm specializing in structuring leveraged securities transactions for wealthy clients. TFSC structured the Transaction for the Samuelis. TFSC was unrelated to the Samuelis.
III. Genesis of the Transaction
TFSC had forecast in 2001 that interest rates would decline. Katherine Szem (Ms. Szem), then a tax partner with Arthur Andersen LLP, discussed with Thomas Boczar (Mr. Boczar), Director of Marketing for Financial Institutions at TFSC, the pricing and mechanics of a leveraged securities transaction for the Samuelis. Ms. Szem suggested to Mr. Schulman that the Samuelis consider entering into a leveraged securities transaction.
Mr. Boczar forwarded to Mr. Ricks hypothetical leveraged transactions using fixed-income securities including U.S. Treasury STRIPS and agency STRIPS, 4 such as those from the Federal Home Loan Mortgage Corporation (Freddie Mac). The profitability of these transactions hinged on a fluctuation of market interest rates favorable to the investor; i.e., an investor would borrow money at a variable interest rate to invest in fixed-income securities and could realize a gain from the investment if market interest rates then declined. Two days later, Mr. Ricks recommended to Mr. Schulman that the Samuelis invest in a proposed leveraged securities transaction. Shortly after that, the Samuelis decided to make such an investment.
IV. The TransactionA. Investors in the Transaction
The Samuelis, the Rickses, and Mr. Schulman invested in the Transaction. The Samuelis held a 99.5–percent interest in the Transaction. The Rickses and Mr. Schulman collectively held the remaining one-half-percent interest. The Rickses' interest was .2 percent, and Mr. Schulman's interest was .3 percent.
B. Documents Underlying the Transaction
The Transaction was governed by five written documents entered into by and between the Samuelis and their securities broker, Refco Securities, LLC (Refco). These documents were a(n): (1) Master Securities Loan Agreement (MSLA); (2) Amendment to Master Securities Loan Agreement (Amendment); (3) Addendum to the Master Securities Loan Agreement (Addendum); (4) Client's Agreement/Margin Agreement (Client Agreement); and (5) Refco Statement of Interest Charges Pursuant to the “Truth–In–Lending” Rule 10(b)–16. The MSLA, the Amendment, and the Client Agreement were each entered into on or about October 11, 2001. The Addendum was dated October 17, 2001.
C. Specifics of the Transaction
The Samuelis and Refco entered into the MSLA and the Amendment approximately a week after the TFSC's marketing director contacted the Samuelis' trusted adviser. Both the MSLA and the Amendment were on standard forms used by the Bond Market Association.5 The MSLA and the Amendment required the Samuelis to acquire the Securities from Refco through the use of a margin loan and then to “loan” the Securities to Refco. The MSLA and the Amendment allowed the Samuelis to terminate the Transaction (and thus cause Refco to transfer to the Samuelis securities identical to the Securities) by giving notice to Refco before the close of business on any “business day.” 6 The Client Agreement allowed Refco to hold the Securities as security for the margin loan and to subject the Securities to a general lien and right of setoff for all obligations of the Samuelis to Refco.
Refco and the Samuelis also entered into the Addendum. Unlike the MSLA and the Amendment, the Addendum was customized and provided that the Samuelis' “ loan” of the Securities to Refco would terminate on January 15, 2003 (and thus require Refco on that date to provide the Samuelis with the Securities). The Addendum also allowed the Samuelis to terminate the Transaction earlier on July 1 or December 2, 2002 (early termination dates). Refco could purchase the Securities from the Samuelis at a price established under a LIBOR-based formula set forth in the Addendum if the Transaction was terminated on either early termination date.7
D. The Samuelis' 2001 Purchase
The Samuelis purchased the Securities from Refco in October 2001.8 The Securities consisted of a $1.7 billion principal STRIP of the $5.7 billion principal on an unsecured fixed-income obligation issued by Freddie Mac. The maturity date of the obligation was February 15, 2003, and the yield to maturity on October 17, 2001, at which the Securities accrued interest, was fixed at 2.581 percent.
The Samuelis purchased the Securities at a price of $1,643,322,000 ($1.64 billion). The Samuelis paid the $1.64 billion by...
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