Corn Products Refining Company v. Commissioner of Internal Revenue

PETITIONER:Corn Products Refining Company
RESPONDENT:Commissioner of Internal Revenue
LOCATION:Pittsburgh Party Headquarters

DECIDED BY: Warren Court (1955-1956)
LOWER COURT: United States Court of Appeals for the Second Circuit

CITATION: 350 US 46 (1955)
ARGUED: Oct 18, 1955
DECIDED: Nov 07, 1955

Facts of the case


Audio Transcription for Oral Argument – October 18, 1955 in Corn Products Refining Company v. Commissioner of Internal Revenue

Earl Warren:

Number 20 on the docket, Corn Products Refining Company versus Commissioner of Internal Revenue.

Mr. Kramer.

Jay O. Kramer:

May it please the Court.

We’ve asked the marshal to bring in an easel and a chart which we will use during the course —


— of this case to illustrate certain points.

This case comes before the Supreme Court on certiorari to the Second Circuit.

It involves income and excess profits taxes for the years 1940 and 1942.

The actions for both those years were previously consolidated and it appears as one proceeding here.

The order of certiorari has limited the review by this Court to two points.

The first point, which I will discuss, involves the following question where petitioner’s transactions in commodity futures, which are not true hedges, subject to the capital gain and loss treatment of Section 117 (a) of the Internal Revenue Code of 1939.

Well, were they are ordinary gains and losses and to be treated the same.Point two which Mr. McCain will discuss is an entirely distinct point.

That point is — are commodity futures securities within the meaning of Section 118 of the Internal Revenue Code of 1939 and subject to the so-called wash sales provisions thereof.

As I have stated, I will address myself solely to the first point.

The facts with respect to this issue are conceded.

They start or are caused by the great drought of 1934 and 1936.

These severe droughts caused a great shortage of corn in our midwestern farming areas.

The result of that was that the price of corn rose substantially during the years 1934, 1935, 1936 and 1937.

Now, the petitioner here is a nationally known processor of raw corn, perhaps the largest in the country.

Petitioner’s main products consist primarily of starch, corn syrup, and cerelose, which is a refined corn sugar.

Its byproducts are feed and corn oil.

Now, cerelose, the refined corn sugar competes with cane and beet sugar.

It is used in canning, candy and other commercial uses.

The great droughts of 1934 and 1936 as I have stated caused the price of corn to rise and therefore the price of petitioner’s product, cerelose.

The result was that petitioner actually lost money during 1937 on every sale of cerelose.

It had risen out of line with the price of cane sugar and beet sugar because Your Honors will recognize that the same area affected by the drought with respect to corn was not necessarily affected with respect to raising of cane sugar or beet sugar.

Petitioner was faced with a serious situation.

Its annual grind in those years about 35 million bushels and rose gradually during the years here in question to almost — to over 60 million bushels in 1942.

Petitioner could only store 2,300,000 bushels in its facilities.

This is equivalent to about three weeks grind.

Jay O. Kramer:

The problem then faced petitioner’s officers what to do about it.

They envisaged a plan or a program whereby they would buy corn futures up to the amount of 11 or 12 millions bushels during the year when they were sure in July or fairly certain that there would be no great shortage of corn.

Their plan was to liquidate that position and thereupon pick it up again in the following year.

Now, this plan didn’t quite work out the way the petitioner had envisaged it.

The petitioner had always established for itself a corn futures position but as I say during these years it became considerably larger.

When the Commodity Exchange Authority received reports from the petitioner and the petitioner is required to file such reports weekly, the Commodity Exchange Authority objected to the size of petitioner’s position and proceeded to bring an action against this petition.

By the time the action was commenced however and discussions were under way, the war had broken out.

The price of all sugars, cane sugar, beet sugar and this cerelose rose rapidly.

The need for any protection had vanished.

The result was, as seen on the chart which appears at page 8 of the brief, petitioner’s position in futures, which is represented by this stippled area, dropped very rapidly.

Petitioner, in other words, liquidated the largest part of its futures position.

I might say at the beginning that it wasn’t easy for petitioner to obtain 12 million — a position of 12 million bushels overnight.

It had to work its way up gradually and that you will see in this line at the beginning of the chart 7138 as you can see gradually reaching the peak position there.

And I further state that this chart is cumulative.

The storage capacity is represented by the lowest stippled area.

The inventory is added to that in this second area and again the futures are imposed cumulatively on top of the stock to show the total long position of the petitioner at any given time during the period in 7138 through to the end of 1942.

Stanley Reed:

Here were your words when you said that lawfully storage capacity which I think it is the yellow line.

Jay O. Kramer:

That is correct.

Stanley Reed:

What — what’s the next —

Jay O. Kramer:

That is the inventory on hand of finished goods and above that the futures position.

It represents, in other words, a total long position of the petitioner — of the — of reason for mentioning that at this time will be brought out later in the argument.

Now, during these years, petitioner had a constant sales policy.

This includes the years 1936, right through 1942 and that was this and it is brought out in Exhibit 10 in the record at page 104.

The customer ordering any of petitioner’s products will always receive the lower of the contract price or the market price on the date of delivery.

The lower of the two and this is important in considering the question of hedging which we will get to a little later.

Petitioner also had the policy of permitting its customers to cancel unfilled orders at any time.

Cancellations were frequent and unpredictable as the record will show.

I believe the — the record, it appears at page 68 and 69 on that point.

The Commodity Exchange, as I have stated, brought a proceeding against the petitioner in 1939 to — charging it with excessive speculation in corn futures.

When the war broke out, as this chart shows, petitioner liquidated its position.

Jay O. Kramer:

The result was that the matter became moot and was dismissed.

There was no opinion on the merits.

This is brought out by the later facts after the taxable years that after the war when petitioner resumed its buying of corn futures, a similar proceeding was brought against this petitioner and resulted in an order against it.

That order is recorded in 13 agricultural decisions on page 1117.

That case is now on appeal before the Second Circuit.

The — the Secretary of Agriculture held in that case that petitioner was not hedging and even though as in later years it was brought out, certain additional things were done despite that and I’ll bring that out later in the argument, the Court or rather the Commission of the Agriculture Department held that the petitioner was not hedging.

That —

Harold Burton:

When you say that he — when you say that he was not hedging, that means he had some other reason in his — in the course of his business to do or to do what he was doing other than just to protect the price?

Jay O. Kramer:

In effect, the decision was — was that they were speculating in excess of a two million bushel position, which was allowable under the rules of — of the department.

Felix Frankfurter:

Meaning by that, meaning in future there is such.

Jay O. Kramer:


Buying and selling.

Earl Warren:

Well, what is your position, Mr. Kramer, to the petitioner in this case as to whether that was hedged or not in the — in the case that’s on appeal?

Jay O. Kramer:

The petitioner in that case points to a different definition of hedging contained in the Commodity Exchange Act which says a reasonable hedge.

The facts in that case were dissimilar than in the present case for the reason that after the war, the petitioner developed a method of predicting what its sales would be within an accuracy of 5% as brought out in that case.

Also, petitioner sold short cane sugar futures and cottonseed oil futures so that it maintained a balanced position.

I’m getting a bit ahead of myself in defining the hedge.

But the — the effect is that the situation there was quite different than in the tactical years.

So as —

Stanley Reed:

What — what was the amount of bushels that — the highest purchase a bushel?

Jay O. Kramer:

About 11 million, almost 11 million bushels.

Stanley Reed:

And your annual consumption?

Jay O. Kramer:

Our annual consumption ran from 35 million bushels in 1936 or 1937 to over 60 million bushels in 1942.

Now, this case came before the Tax Court of the United States which held that the corn futures program of petitioner, this area that you see, March futures on the chart, was an integral part of its manufacturing process and that even though this petitioner was not technically hedging, nevertheless, the transaction was subject to ordinary gains and loss treatment.

The Court of Appeals in affirming went on to say that while petitioner was not hedging, the property was used for essentially the same purposes and should be treated in the same fashion as if it were hedging and accorded ordinary gain and loss treatment.

The case came before this Court on certiorari because what appeared to be a conflict with the Third, Fifth and I believe the Sixth Circuits, which had held that unless a true hedge were established, a taxpayer could not claim an ordinary loss.

The Court will recognize it once that we’re dealing with the other side of the picture and we will point out empathically I hope at a later point that where the Government is dealing with losses, where the Commissioner is dealing with losses, insist on the test of a true hedge.

Therefore, limiting the taxpayer to a capital loss, whereas in this case, the situation is the reverse where it’s dealing with a profit, he will say that it’s ordinary and — and forget about the test of — of the true hedge.

Incidentally and fairly on the side, the case because of peculiarity of the excess profits tax law finds the petitioner and the Government in the reversed positions of that which would ordinarily be expected.

In this case, the Government is contending in effect that petitioner’s losses were ordinary losses fully deductible without limit by saying that their gains are ordinary income because there were some years in which we had losses.

Jay O. Kramer:

The reason for that is in the computation of our excess profits credit for the — is 1936 through 1939, we had substantial losses and ordinary losses would have the effect of reducing our excess profits credit.

On the second issue, the Government is also taking a unusual position.

They are saying that the wash sales provisions do not apply to commodity transactions.

Now, my argument with respect to point one is divided into two separate and distinct propositions.

The first proposition is that Section 117 (a) in defining capital assets does not make any exception for assets used in hedging, although it makes specific exceptions in a number of other cases.

I will develop the statutory history of Section 117 to show the specific exclusions to the definition of capital assets.

Our position is there is no statutory justification or any exception in the nature of hedging to any unwritten or implied exception.

Our second position, our second line of defense is that even if there is a hedging exception, petitioner’s transactions do not fall with any — within any such unwritten exception to Section 117 (a).

And therefore, unless it is established that the petitioner was engaging in true hedging operation, its transactions must be treated as capital transactions and the result in gain or loss computed accordingly.

I would like to read if I may because it is so important here, Section 117 (a) because as the Court will see, there’s a missing phrase in — in that Section.

When I say a missing phrase, I mean that it was never once mentioned either in the Tax Court’s opinion, in the Court of Appeals opinion or in respondent’s brief except in the appendix when the Section was printed.

Capital assets are defined at page 53 of our brief and — and we are reading from the Internal Revenue Code of 1939, “The term capital assets means property held by the taxpayer.”

The next phrase is the missing phrase, “It’s parenthetical whether or not connected with his trade or business, but does not include stock and trade of the taxpayer or other property of a kind which properly would be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business, or property, used in the trade or business, of a character which is subject to an allowance for depreciation provided in Section 23 (l).”

I would like to go far back into the history of the Internal Revenue statutes and pick up the ancestor of that Section and point out that in 1921, the — essentially the same definition appeared in the law, we have quoted that definition at page 4 of our reply brief, “The term capital assets as used in this Section means property and acquired — acquired and held by the taxpayer for profit or investment for more than two years whether or not connected with his trade or business.”

Again, the missing clause, “But does not include property held for personal use or consumption of the taxpayer or his family or stock and trade of the taxpayer or other property of a kind which would be properly includable in inventory of the taxpayer if on hand at the close of the taxable year.”

Right at the start, the definition of capital asset was any assets held by the taxpayer for over two years.

This was changed as we will see in 1934.

But right at the very start, Congress sought that to state that they were capital assets whether or not connected with his trade or business and Congress saw fit to make specific exceptions or exclusions thereto.

And so this concept continued with slight modifications in the Revenue Acts of 1924, 1926, 1928 and 1932.

This is a statement about personal use or consumption was dropped from the statute very shortly.

In 1934 —

Stanley Reed:

Was your reply brief — was it filed —

Jay O. Kramer:

I’m very sorry, Your Honor, I thought that our reply brief was available to the Court.

Stanley Reed:

I — I have a reply brief filed January 5th.

Jay O. Kramer:

I think that’s on the certiorari application.

Stanley Reed:

Where is this?

Jay O. Kramer:

Sorry, sir.

In 1934, Congress in enacting Section 117 (b) defined capital assets in substantially the same manner as it now appears in the present code, it says, “Definition of capital assets for this purpose, the term capital assets means property held by the taxpayer and again whether or not connected with his trade or business.”

I’m reading from page 5 of the reply brief, “But does not include stock and trade or other property of a kind which would be includable in inventory of the taxpayer if on hand at the close of the taxable year or property held by taxpayer primarily for sale to customers in the ordinary course of his trade or business.”

Now, there’s one thought I think I should set at rest at the very beginning and that is this.

Jay O. Kramer:

These futures were not sold to our customers in the regular course of business.

They were sold through brokers on the exchange.

We never knew the name of the customer.

The — our regular products were sold to our regular customers.

These futures were merely disposed of on the exchange.

There never has been any assertion by respondent that we were dealers in futures or anything like that.

Now, what I would like to do —

Harold Burton:

Were they still being used in some way in lieu of storage in the way you spoke of in the first instance?

Jay O. Kramer:

I — I understand that petitioner still maintains a position in corn futures.

He — they are permitted so to do under the Commodity Exchange Act to the extent of two million bushels and the commodity exchange proceeding now pending as to determine if anything above that may be maintained.

Now, the first point of law that we would like to make is this, that where Congress sets up a general definition that assets are capital assets and provides for a series of exclusions that there is no room for any other exclusion to be implied.

This is all the more true in the present case because Congress has given this Section a tremendous amount of attention from 1921 right through to 1954.

And wherever shoe was pinched, wherever Congress has thought it necessary, it has added additional exclusions.

I need only refer to the so-called Eisenhower Amendment with respect to artistic works where a — an author no longer receives capital gain treatment for his artistic efforts.

But Congress, not the Commissioner, required that result.

Our point then is further emphasized by the fact that Congress was not unaware of the existence of hedging as a concept.

If the Court will recall, Section 502 of the Internal Revenue Code with respect to the definition of personal holding company income specifically excludes profits from hedging transactions.

In 1954, when Congress passed the new Internal Revenue Code, they specifically provided that in Section 1233 that — that hedging transactions would not come within the short sale rule.

But the Congress did not at the same time amend Section 1231, which is the successor to Section 117 (a), to provide that assets used in hedging were to be an exception to Section 117 (a).

Felix Frankfurter:

What is the history or what you called the designated exception?

Jay O. Kramer:

I will come to that at once, sir.

Felix Frankfurter:

Just take your time.

Jay O. Kramer:

In 1934, Congress abolished the two-year rule defining capital assets and thereafter said all assets are capital assets.

The Commissioner’s regulations echoed that provision.

Now, before 1934, this question of commodity futures was academic because commodity futures by their nature matured in less than two years and therefore, no commodity future prior to that time was a capital asset.

After 1934, there was no such situation.

Accordingly in 1936, the Treasury issued General Counsel’s Memorandum 17322, and this for the first time expounded the theory of hedging as insurance and therefore that losses in hedging would result in any ordinary losses in the nature of an insurance or business deduction.

Significantly, this General Counsel’s Memorandum was never promulgated into regulation.

The normal course of events in many General Counsel’s Memorandum is to promulgate it into regulation and then if there is a statutory reenactment at a later date, it is deemed to have received legislative sanction, such is not the case here.

Now, following the enactment or — or the promulgation of this regulation which never — I’m sorry, I misspoke myself, following the issuance of this General Counsel’s Memorandum, a series of cases began to arise in the courts in which hedging as an exception to 117 (a) first became apparent.

Jay O. Kramer:

Those cases are detailed at page 22 of our initial brief.

They start as the Court will see in 1940 and in 1941.

I’m getting a bit ahead of myself, unfortunately, because I will have to develop those — those cases a little further when I —

Felix Frankfurter:

Based in the words that they rest on the General Counsel’s Memorandum?

Based on — on —

Jay O. Kramer:

Many of them —

Felix Frankfurter:

— administrative factors?

Jay O. Kramer:

Many of them did so.

Many of them cited the General Counsel’s Memorandum directly.

But this General’s — the General Counsel’s Memorandum never had before as an effective law.

However, the regulation with respect to 117 (a) which specifically states, the term capital assets includes all classes of property not specifically excluded by Section 117 (a).

That regulation has appeared in every regulation in connection with every Act since 1934, 1934, 1936, 1938, the Internal Revenue Code of 1939, the amendments thereto in 1942 and again the Internal Revenue Code of 1954.

I say that that regulation by statutory reenactment has received legislative sanction and that is the point that we are here making.

First, that there is no statutory justification for any implied exception in the form of hedging and that this is confirmed by repeated reenactment of law without making any specific exception for “assets used in hedging”, four words could have changed the problem but they did not do so.

The second point which I would like to make is that even if there is a hedging reception — exception and we do not concede that there is, the test is whether or not taxpayer was engaging in true hedging operations and not something akin to it.

The words of the Tax Court that petitioner’s transactions were an integral part of its manufacturing process can be accepted as correct.

If you say that everything that a taxpayer does as part of its business, but Congress had specifically stated that assets remain capital assets whether or not used in the taxpayers business.

So I would say that the Tax Court’s opinion simply disregards that missing phrase.

The Court of Appeals in its decision said these assets were used in the same manner as in hedging and therefore we’re going to treat them the same way.

And once again, never mentions the fact that the definition of capital assets says whether or not used in the taxpayer’s business.

Felix Frankfurter:

Did the Tax Court elucidate what it meant by method of authority (Inaudible)

Jay O. Kramer:

Unfortunately, the Tax Court’s opinion in this case which appears in the record at page 203 — I’m sorry, 201 and following, is very cryptic.

At 211, this particular issue is decided in two fairly short paragraphs.

It would almost be worthwhile reading it if the Court wishes.

The key sentence is right at the beginning.

It says although perhaps, not conforming technically to the definition of a hedge, it seems indisputable as our finding show that petitioner’s practice of purchasing corn futures was as an integral part of its manufacturing business.

No mention of Section 117 (a) in the particular phrase which I call the missing phrase.

It would hence be anomalous to view them as purely speculative transactions of a capital nature and so on.

The Tax Court —

Felix Frankfurter:

Do you agree with the next thing especially considering this was largely in effect of (Inaudible), do you agree with that?

Jay O. Kramer:

I don’t think the courts have treated this as a factual situation at any point.

They have held you’re either hedging as matter of law or you’re not.

And if you’re not, the results are that you have capital gain and if you are, you have ordinary income.

Felix Frankfurter:

I suppose younger lawyers in the courts (Inaudible)

Jay O. Kramer:

Well, the phrase hedging has many connotations including hedging on —

Felix Frankfurter:

To determine whether it is or it isn’t (Inaudible) hedges —

Jay O. Kramer:

I —

Felix Frankfurter:

— has made a question of loss.

Jay O. Kramer:

Well, the cases so treat it.

The whole series of cases, all — all turned on the point, is this a true hedge?

If — if it isn’t, you will not receive the ordinary deductions.

Hugo L. Black:

Unless there must be a (Inaudible)

Jay O. Kramer:

I am going to endeavor to do so.

We try to reach the definition of hedging in a series of statements made in our brief outlining the principles of what hedging is.

Hedging is essentially the maintenance of a balanced position which eliminates the risk of the market.

At page 24 of our initial brief, we make a series of statements which will help define what hedging is as far as tax cases are concerned.

This Court has had occasion to define hedging on several occasions.

The initial attempt to define it was in Chicago Board of Trade versus Christie Stock — Grain & Stock Company.

There, the Court said, hedging as it is called is a means which collectors and exporters of grain or other products and manufactured, who make contracts in advance for the sale of their goods, secure themselves against the fluctuations of the market by counter contracts for the purchase or sale as a case maybe of an equal quantity of the product or the material of manufacture.

Now, during the statement of facts, I laid some emphasis on the undisputed fact that petitioner had no fixed prices on the sale of its merchandise.

Petitioner took the risk when it sold that its costumer would receive the lower of two prices, either the contract price or the market price if it went down.

Petitioner also allowed its costumers to cancel their contracts wherever they so desired.

Consequently, when we examine this chart here, these red lines or columns indicating orders are orders in name only, they are not fixed as to price, they are not fixed as to quantity because a costumer finding that the market has dropped may cancel.

He may also take at the lower price and it is for that reason that the Tax Court said, “We are not technically hedging.”

The Court of Appeals agreed, it says, “We — that we are not engaging in true hedging.”

The respondent himself in his brief admits that we are not true — I am not truly hedging.

But the Court of Appeals and the respondent says it makes no difference.

It’s immaterial.

We are doing something in connection with our business here and therefore it’s going to be taxed at ordinary income rates and losses are ordinarily deductible, completely disregarding that initial trade in Section 117 (a) which says, “Whether or not connected with taxpayers business.”

I see that my time is fast expiring.

Jay O. Kramer:

I would like to turn to just one further point.

Felix Frankfurter:

Well, what that does mean, that phrase, because if you were ( or engaged in cottons, especially it’s a profitable (Inaudible) would that be a capital asset in relation to (Inaudible) as hedging?

Jay O. Kramer:

In the same Supreme Court case, it defined hedging that Christie Grain case.

This Court defined people who deal in futures in three categories.

One, speculators, two, legitimate capitalist and I hope that that’s not a word of the program as I would get, to gather from my opponent’s brief.

I think it would be —

Jay O. Kramer:

In my opponent’s brief.

And three, hedges.

We claim that we fall within the legitimate capitalist class.We have taken a position, a long position —

Felix Frankfurter:

With reference to your business.

Jay O. Kramer:

True, it — it is in reference —

Felix Frankfurter:

Therefore my cotton assumption would — would be out, isn’t it?

Jay O. Kramer:

They differ —

Felix Frankfurter:


Jay O. Kramer:

I would be inclined to say it was probably out, but I wouldn’t be too certain because the line has never been —

Felix Frankfurter:

Well, there wouldn’t be any difference from (Inaudible) just sitting and looking at the board in his brokerage office in dealing with futures.

Jay O. Kramer:

Well, who is an investor and who is a speculator is a question that would require better brains and mind to answer.

It may be a —

Felix Frankfurter:

(Voice Overlap) —

Jay O. Kramer:

— question of degree.

Felix Frankfurter:

— of law, is it?

If it is then I should like to invoke the shade of the doctrine about it.

Jay O. Kramer:

[Laughs] I — I understand you at this point.

The situation with respect to whether somebody is a capitalist — I’m sorry, I misstated myself.

This Court has defined the person who is head — who is engaging in futures transaction in these three categories and I am — before I sit, compelled to accept that as being the — the law even though it was not issued in a tax case.

I would like to make one further —

Felix Frankfurter:

How about in Christie?

Jay O. Kramer:


Felix Frankfurter:

It might make a lot of difference.

The Christie-Board case is unrelated —

Jay O. Kramer:

Oh, completely.

Felix Frankfurter:

— to this problem.

Jay O. Kramer:


This Court has never had a case involving hedging in a tax matter before and I’m about to point out if I may that what the taxpayer intends to do is immaterial in every one of the cases which the Government won cited at pages 22 of our brief.

The taxpayers conscientiously thought they were hedging.

Nevertheless, the courts ruled against them and said, “You are not engaged in a true hedge and therefore you are subject to a capital loss.”

This Court momentarily did have this question before it but only on an application for certiorari.

In Commissioner versus Farmers & Ginners Cotton Oil Company, certiorari was denied in 314 U.S.683.

And I have taken perhaps unfair advantage of my opponent in quoting liberally from the respondent’s brief in that case in which the respondent there took the position that unless it was a true hedge, capital gain treatment would be accorded or capital loss treatment would be accorded and not ordinary deduction because that was the issue in that case.

I’d — I’d like to point out that inconsistent position which appears at page 17 of our reply brief.

Felix Frankfurter:

That is getting to be a rather recurring custom of counsel on both sides, the Government has repudiated and I read that that was (Inaudible) the people, the lawyers take the position with reference to a case and write whatever they felt in the (Inaudible) except you might say, that its — perfectly, this is a good argument.

Jay O. Kramer:

May I —

Felix Frankfurter:

And we have contradiction.

I think (Inaudible)

Jay O. Kramer:

Well —

Felix Frankfurter:


Jay O. Kramer:

Well, the only reason, if I may answer Your Honor —

Felix Frankfurter:

Then answer it.

Is this addressed to (Inaudible)

Jay O. Kramer:


The only reason I would even mention that if I may use this time just to answer Your Honor’s question is subsequent to this case, the bureau has — the — the Internal Revenue Department has gone back to the same position that it took in the earlier cases in Fulton Bag & Cotton Mills, 22 T.C. 1044 which is cited at the bottom of page 22.

So this is not a position which the Government has taken just once.

It has taken it, it is abandoned it in this case because it involves gains and then gone back to it in the next case involving losses.

Felix Frankfurter:

That’s a relevant argument, I might say.

Jay O. Kramer:

May I ask Mr. McCain to continue with point two.

Earl Warren:

Mr. McCain.

Samuel A. McCain:

Mr. Chief Justice, Justices of the Court.

If this — if this Court determines that any other corn futures transactions in this case, other transaction from this — this long futures position are capital asset transactions then this Court has before it the issue of whether or not Section 118 of the Revenue Code is applicable where petitioner sold the corn future of one maturity and purchased a corn future of a later maturity.

Petitioner has a support of a direct holding by the Court of Appeals for the Sixth Circuit and Section 118 is applicable to the sale of a commodity future and the contemporaneous purchase of a later maturity.

This is in the case of Trenton Cotton Oil Co. v. Commissioner, reported in 147 F.2d 33.

Samuel A. McCain:

In the case at bar, the Court of Appeals for the Second Circuit in a dictum, not necessary to the decision, stated we find ourselves unable to agree with that decision, referring to the Trenton Cotton Oil case.

That’s in the record at page 297.

The issue turns mainly on whether corn futures contracts are securities within the meaning of Section 118 of the Internal Revenue Code.

The irrelevant portion of which reads as follows, this is at page 68 of our main brief, Section 118 loss from wash sales of stock or securities.

In the case of any loss claimed to have been sustained from any sale or other disposition of shares of stock or securities where it appears that within a period of 30 days before the date of such sale or disposition and ending 30 days after such date, the taxpayer has acquired substantially identical stock or securities, then no deduction for the loss shall be allowed under, in this case, Section 23 (l).

The evidence in this case shows that the corn futures contract is a document and the contract as Exhibit 14 reproduced at page 151 of the record, evidencing an agreement to buy 5000 bushels of corn or some multiple thereof at a stated price upon delivery during a stated month.

The record shows that large numbers of these contracts were outstanding.

Petitioner alone purchased 824 contracts calling for over 19 million bushels of corn in 1938 and 593 contracts calling for about 14.5 million bushels in 1939.

This appears in the record at page 37.

Mr. Dobie Henry, a member of the Board of Trade of Chicago testified, at pages 90 and 91 and 94 of the record, as to the character of corn futures contracts.

All these contracts are identical in a wording, differing only as to maturity date, price and quality and the quantity is always a multiple of 5000 bushels.

Contracts are traded regularly on the Chicago Board of Trade being fully negotiable and transferable.

There is no essential difference in the trading of stock and bonds and in the trading of futures contracts.

Now, this Court in the case of S. E. C. against Joiner Corporation, reported at 320 U.S.344, looked particularly at the fact that the documents there before the Court which incidentally were leases of particular pieces of real estate that mineral leases are the particular pieces of real estate, whether the documents were widely offered or dealt in on their terms or in a course of dealing which established their character as securities.

Now, we contend here that the — that the course of dealing the characteristics of the — of a corn futures do establish them as security.

At this point I would like to look at the purpose of the statute which was in the words of the Committee Reports of both Houses of Congress to prevent evasion, that’s what they said, of taxes by taking of losses where the economic position of the taxpayer was not altered.

Now, the — the Court of Appeals for the Sixth Circuit having in mind this — this purpose of Congress adopted the definition in Webster’s New International Dictionary of securities as applicable in the case of commodity futures.

This definition is that a security is an evidence of debt or a property as a bond, stock, certificate or other instrument, etc., a document giving the right to demand and receive property not in his possession.

That Court then held that when the taxpayer had the Court — the cottonseed oil future yet in the words of the Court, it had no more than a document giving it the right to demand and receive property not in its possession.

This, said the Court, is a security.

He went on to say that unless commodity futures losses are within the statute, the bearing under the statute has weakened pointing out that commodity dealings are almost as extensive as dealings in stocks and bonds.

The Government argues first that securities mean corporate securities because in most of the definitions in the Internal Revenue Code, the subject matter is only corporate securities.We submit that this argument has no weight in view of the purpose of the statute.

It’s this Court to look at.

The Government also argues that the ordinary dictionary definition is an unusual meaning to give the word securities.

It seems to me, Your Honors, that the statement of this proposition has its own answer.

At this point, I would like to call the attention of the Court to the fact that the statute is designed to protect the revenue and if the Government’s position is sustained, it will mean a loss of revenue.

The real question was, was it Congress’ intention to close the loophole only partly as to corporate stocks and bonds or did it mean to close the loophole entirely as to all securities regularly traded including commodity futures?

We think the answer is clear.

The only other issue involved under Section 118 is whether a futures contract of one maturity is substantially identical to a succeeding maturity.

The wording of the contracts is identical which appear at the record 90.

Samuel A. McCain:

Normally, the only difference in — in price between a future of one maturity and the next succeeding maturity is the cost to a storage of corn.

It appears in the record at page 51 and this is around one-and-a-half cents of bushel a month for the intervening months.

This is not really an economic difference.

If — if the buyer took delivery on his future of one maturity and held the product until the next maturity, assuming that’s when he was going to use it, he would have that storage expense so that his economic position on one maturity is really, we say, substantially identical to his position on a — on the next succeeding maturity.

Stanley Reed:

Either these sales of repurchasing the (Inaudible), were they all sell — selling at one month and they’re buying at the — of a different future?

Samuel A. McCain:

Yes, sir, in general.

Now, the record shows, Your Honor, that we did take delivery on the actual corn on some of these futures and of course that one entire inventory at — that’s what we paid for it.

But as a general rule, the futures were disposed of and a — and a subsequent maturity bought or the futures were disposed of and cached corn was bought at — at the same time.

And the reason for that is that on a corn future, any — any grade of corn can be delivered as a — as a — declare a different price.

Stanley Reed:

(Voice Overlap) — because in Section 118 —

Samuel A. McCain:

Yes, sir.

Stanley Reed:

— as I understand.

Samuel A. McCain:

Yes, sir.

Stanley Reed:

And whether that — that’s when there’s a motor sale and of course to adopt the General Motor stock — suppose General Motor stock in December and bought in January and you have precisely the same thing.

Samuel A. McCain:

That’s what we contend, Your Honor.

Stanley Reed:

Now, if you sold September corn and there is the September corn and bought in December, is that your point and then you’re buying different things?

Samuel A. McCain:

That you’re buying substantially identical appliance.

That the September is —

Stanley Reed:

Even though the delivery date is different.

Samuel A. McCain:

Even though the — the delivery date is different.

Stanley Reed:

When you — when you sell, what month?And within 30 days, buy back a different product or the same product, then your — your (Voice Overlap) —

Samuel A. McCain:

Our contention is that that’s substantially identical property.

In other words, and that’s reflected the economics.

The finding I think is reflected in the prices.

The price say on August to the September future will be —

Stanley Reed:

A different (Inaudible)

Samuel A. McCain:

The only difference between the September and the December is — is the — is the storage.

As a matter of fact, those prices, the Government has set them forth at page 50 of its brief and I think that makes it clear that economically there’s not — not any difference to speak of.

There is just one other point — there is just one other point in the Government’s brief that I would — I would like to discuss and that is where the Government attempts to identify wash sales under the Commodity Exchange Act with wash sales under the Internal Revenue Code.

Now, wash sale is known for trade under the Commodity Exchange Act, it’s a fictitious sale.

Samuel A. McCain:

For instance, in the case where a person sells through one broker and buys from himself through another broker for the purpose of establishing a published quotation as he may use to a regular market.

Of course, there’s no sale.

The sale is fictitious and that’s a crime under — under the Act.

The wash sale under the Internal Revenue Code is entirely a different sales, a real sales to a third person that the — the seller repurchases and so he retains his economic possession, his loss is an actual realized loss that it’s merely a paper loss because he has the property he always had.

On the other hand, the gains on wash sales of the Internal Revenue Code are real gains and are both recognized in tax and the Valley Waste Mills case and Harriss against Commissioner referred to in our brief.

It is — it is submitted at the Government’s semantics on the identity of these two types of wash sales is not a valid point.

In closing, I want to say that the Court of Appeals and the Tax Court and the Government in its brief cite the Valley Waste Mills case and the Harriss case.

Now, the Government — the Court of Appeals for the Second Circuit merely refers to them and the Government’s brief seems to imply that these cases were decided under Section 112 (b) (1) relating to exchange as a property used in trade or business and that there was some holding about whether they were property of a like kind.

Now, we have studied these cases as — there’s no reference to Section 112 (b) (1), maybe one of them in the Valley Waste Mills case, the Court merely said that the exchange has been recognized under Section 112 (a) which says that (Inaudible) are recognized.

There is a discussion at 112 (b) (1) where in the Trenton Cotton Oil case where the Court held that — that the gains were — were recognized because it was a sale and a purchase and not an exchange.

Thank you.

Earl Warren:

Mr. Rice.

Charles K. Rice:

If the Court please.

As Mr. Kramer has said there are two questions in this case.

First is whether or not certain transactions of the petitioner in commodity futures should be considered as capital gains or income — or losses or ordinary income or losses.

And the second question is one which is reached only if the Court decides the first question adversely to the Government and that is the point just covered by Mr. McCain as to whether or not the transactions in question were subject to the wash sales provisions of Section 118 of the code.

Now, Mr. Kramer has given you the factual background in this matter and I think there is not too much dispute as to the basic facts involved.

He has, however, hurried over somewhat the manner in which this case arises and because we think the setting is particularly important in this case to an understanding of the problem.

I would to review briefly the — the manner in which the question arises.

In significant part, what we are trying to determine here is what were the average annual earnings of this taxpayer during the so-called base period of 1936 to 1939 which was taken by Congress as a period of normal earnings for use in the application of the excess profits tax laws.

Now, the excess profits tax laws, I did not, as Your Honors know, apply to all earnings of a company during the war.

The purpose of that Act was to capture those profits which were in excess of normal or average annual earnings during a normal peacetime period which was — which purpose is 1936 to 1939 was taken as normal.

And in excluding or in arriving at that definition of average annual earnings, Congress was seeking to limit the — or to stabilize the earnings that the normal operating profit of a corporation and to exclude from that concept all things which were abnormal and non-recurrent or which were not related to their ordinary business.

And thus, as a part of the concept, it excluded capital gains and losses.

Now, in this particular case, the taxpayer is interested in having this particular transactions treated as capital gains or losses because for that — for that reason they would be excluded from the computation of its credit under the excess profits tax laws, and hence, less of their income in the wartime period would be subject to excess profits taxes.

In other words, if these were not ordinary losses to be deducted from ordinary income of the taxpayer during the base period, the taxpayer’s base period net income is that much higher and therefore it’s credit when it comes into the wartime excess profits tax period is substantially greater.

But we think that selling is important because we believe that Congress in enacting the excess profits tax law was seeking to exclude as a credit or was seeking to allow as a credit base only those earnings which were normal, regular operating profit of the company.

And therefore, when it chose to eliminate capital gains and losses from the computation of average annual earnings, it were doing so in the belief that what it was excluding was not a normal part of the business activity of the particular taxpayer and therefore, it shouldn’t be charged with — with such items as included in their credit in computing the excess profits tax.

Felix Frankfurter:

How does that general principle help us to determine what is and what is not (Inaudible)

Charles K. Rice:

Well, that’s — that’s —

Felix Frankfurter:

Suggesting to you that the ordinary — the case itself —

Charles K. Rice:

It’s a suggestion —

Felix Frankfurter:

— hold — hold against it.

Charles K. Rice:

It’s — it’s a suggestion, Your Honor, that — that Congress thought of capital gains and losses in the manner in which we contend the statute could be construed as relating primarily to investment properties and not something which is an integral part of the manufacturing process, the integral part of operating profit recurring from day-to-day and from year-to-year.

It is really a — our argument here is really a double barrel proposition.

In other words, we would contend for the construction of Section 117 along the lines that we do even if there were no question of excess profits tax law involved.

But as it happens, there is a question of excess profits tax law involved and we believe that Congress when it took into that law or when it excluded under that law capital gains and losses from the determination of average annual income, it was thinking of capital gains and losses just as we are thinking of them for purposes of this particular case.

Now, as Your Honors know, the outset of our income tax laws, the capital gains were treated as ordinary income, capital gains and losses were treated as ordinary income or losses in contradistinction to the British system under which they were not treated as income at all.

And that created a great deal of dissatisfaction in this country because it was felt that capital gains were not the same as ordinary income.

They represented profit which had been appreciated over a number — period of years and that the taxation of capital gains and ordinary income rates was a deterrent to the conversion of — of capital assets into income.

And so in 1921, the first capital gains law was enacted which was a sort of a compromise between the previous American concept of them and the British concept and that they were treated as a class apart, as — as taxable but not as taxable as the same as ordinary income and special rates were applicable to gains which fell in that category.

The definition of capital assets contained in that law is, as our brief points out, rather unique and that it is specific only in what is excluded from the statute and not as to what is covered.

It specifically excludes stock in trade, inventory, property on hand primarily for sale to customers in the ordinary force of trade or business and depreciable property used in the trade or business.

Now, it was early recognized by this Court and by others that this definition of capital assets and the granting of capital gain or a preferential capital gain treatment was to be given a strict construction.

This Court had the question before it in 20 or more years ago when Burnet against Harmel, which the question was as to the status of royalties and bonuses received in the sale of oil leases.

And there it was contended that the oil leases were property and that they didn’t fall within any of the four exceptions here and that the income received by the lessor must constitute capital gain to him.

And this Court in reviewing the history of the capital gains taxation found that it wasn’t the sort of thing that Congress had in mind when they were granting this preferential treatment, that it was not the sort of hardship that Congress was seeking to avoid when they enacted the capital gains law.

There wasn’t in that case any particular transaction such as you have in the normal sale, any one isolated transactions such as you have in a normal sale or exchange.

And the — though the title to the gas or oil might have passed as result of the lease, it was but an incident of the manufacturing operation.

And consequently, although the — a literal application of the statute might have produced a favorable result for the taxpayer, this Court held that — to hold that the taxpayer was entitled to capital gains treatment would defeat, rather than further, the purpose of the Act.

And so in subsequent decisions, both here and in the courts below, there have been numerous cases in which superficially the transaction in question appeared to qualify for capital gains treatment.

But the Court involved found that it wasn’t the sort of thing that Congress had in mind and it didn’t represent an appreciation of profit over substantial period of years and that to permit that kind of preferential treatment, it would not be in accord with the — with the spirit of the Act.

We’ve had it in the case of — of payments as a part of a lump sum condemnation award which represented compensation for the delay in the — in the payment.

You had it in the case — in this Court in the case of lump sums paid in the cancellation of a lease and we have had it in court — in the courts below in connection with the sale of rights to receive a legal fee for past due services or sale of bond interest overdue.

And then in a variety of other circumstances, we have had situations which if you gave the statute a literal application to follow the language with federal fidelity, you would’ve arrived at a result in favor of the capital gains treatment.

And then again, we have another series of cases in the Circuit Courts in which the Courts have held that the profits involved were directly related to the manufacturing or — or business operations of the taxpayer in such a way that Congress couldn’t be deemed to have intended that they should receive the preferential treatment granted to capital gains.

Only recently in the Second Circuit, in the Bagley & Sewall case, the taxpayer under a contract for the Government of Finland for the manufacture of paper equipment was required to purchase a very large amount of government bonds, place them in escrow for the performance of the contract.

It didn’t have any bonds on hand and it had to borrow the money with which to buy the bonds and when the contract was performed satisfactorily and the bonds could be released from escrow where they were sold at a loss, which the taxpayer claimed it was an ordinary loss being intimately connected with its business operation.

And in that case, the Second Circuit held that the property in question couldn’t be divorced from its background or from the nature of the contract pursuant to which it was bought and that the reason for which it was bought was a business reason.

And that therefore, it was not the sort of thing that Congress had in mind in — in setting up the — a favored capital gains treatment, so the ordinary loss was allowed.

Charles K. Rice:

We’ve had the same sort of thing in the liquor stock cases where to obtain purchase of liquor in favorable terms.

Taxpayers have purchased the stock from companies so that they could get the rights to buy the liquor.

And thereafter, sold the stock at a loss and has been allowed ordinary losses because again, the — the purchase of the loss was a part of their normal recurring day-to-day business activity.

And so again, we have had it in the case of the purchase of the stock of a company in order to get out of an unfavorable contract which the taxpayer — the purchaser-taxpayer have.

And there again, it was held that the purpose of the transaction was so intimately connected with the normal business with the operating activity of the purchaser that should be treated as an ordinary loss and not a capital loss.

Earl Warren:

Doesn’t make any difference if these purchasers of futures were brokers and they are not (Inaudible)

Charles K. Rice:

Well, no, I don’t think it makes any difference to the theory of our case, Your Honor.

So with that background seeing as we do that the — the capital gains statute is not to be applied literally and — and so to speak in vacuo without regard to the circumstances of the particular case, we turn to the hedging exception.

Now, the hedging exception as Mr. Kramer or the hedging question as Mr. Kramer pointed out, it didn’t become significant in the earlier revenue acts because under those acts, the capital asset had to be one which was held for two years or more or as by definition, the commodity futures are held for a substantially lesser period than that, less than a year.

But in 1934, when that two-year limitation was taken off the statute, the question did become important.

And in 1936, the Treasury Department issued its General Counsel’s Memorandum which Mr. Kramer referred to and which is the — the background — furnishes the background for most of the litigation as followed.

And in that General Counsel’s Memorandum, the Treasury said as follows, “Such hedges which eliminates speculative risks due to fluctuations in the market price of cotton and therefore tend to assure ordinary operating profits are common trade practices and are generally regarded as a form of insurance.

The only kind available as protection against such risks necessary to conservative business operation, where future contracts are entered into only to ensure against the above mentioned risks inherent from the taxpayers business.

The hedging operations should be recognized as a legitimate form of business insurance, as such, the cost thereof which includes losses sustained therein is an ordinary and necessary expense deductible under Section 23 (a) of the Revenue Act of 1934 and corresponding provisions of prior revenue acts.”

Well, that General Counsel’s Memorandum laid down the general principle that those hedges which were a form of price protection and — or a form of price insurance were to be regarded as regular business practices of the taxpayer and not to qualify for capital gains treatment.

Now, this rule which was laid down in the General Counsel’s Memorandum has been on the books ever since 1936, nearly 20 years and never, as far as I know prior to this case, has it been challenged.

Now, there have been — there has been litigation in the lower courts involving the application of the principle and in particular cases, it was contended that the transactions involved there either were or weren’t price insurance and that they were or weren’t speculation or exchange of risks or something other than hedging.

Hugo L. Black:

What kind of evidence did you find?

Charles K. Rice:

The evidence is largely factual, Your Honor.

Is that what you had in mind?

Hugo L. Black:


Charles K. Rice:

Well, the issue is whether or not the particular person or company is protecting itself against fluctuations in the market, against the rise and fall of prices.

Felix Frankfurter:

They would buy futures of another commodity in order to offset against the losses for that time?

Charles K. Rice:

No — no, Your Honor, that’s not —

Felix Frankfurter:

Although the — although the (Inaudible)

Charles K. Rice:

Yes, Your Honor.

Hugo L. Black:

Well, but here they were buying the kind of (Inaudible)

Charles K. Rice:

Well, the basis of proof is whether or not they were guarding themselves against rises in the — in this case and rises against in the prices of corn.

Hugo L. Black:

And that’s decided.

What kind of evidence did the Government include (Inaudible)

Charles K. Rice:

Well, it would be offered by the testimony of — of the company’s officials as to why the — pardon?

Hugo L. Black:

As to their purpose?

Charles K. Rice:

As to why they purchased it.

Hugo L. Black:

As to their purpose?

Charles K. Rice:

As to why they purchased it and by relevant statistics as to fluctuations in the price which occurred then and which had — had them occurring previously and technical testimony of that nature.

Hugo L. Black:

Is it a question of determining what their motive was or —

Charles K. Rice:

Well, it’s a question —

Hugo L. Black:

— (Inaudible)

Charles K. Rice:

It’s a question primarily a fact as to whether or not they were guarding themselves against price changes that would be adverse to them.

Felix Frankfurter:

Mr. Rice, is there any — any established, factual, or any deciding consideration in the Treasury as to grain, the pronouncements of General Counsel’s incorporated in the regulations and under that (Inaudible) General Counsel’s own ways?

Charles K. Rice:

Well — and we rely on the decisions holding that whether there’s been a settled administrative practice, the — the courts will accept that practice where Congress has reenacted the law numerous times in the phase of that settled administrative practice.

Now, it is true that the General Counsel’s Memorandum doesn’t have the force of a Treasury regulation, but it — it has established a — a settled administrative pattern which —

Felix Frankfurter:

I was wondering whether it’s chance or is there some — some established reason for purchasing, when they do and when they don’t (Inaudible) the counsel’s legal opinion into (Inaudible) —

Charles K. Rice:

Well, I don’t think, Your Honor, that an answer —

Felix Frankfurter:

Is there a chance of —

Charles K. Rice:

I don’t think an answer could be given which would cover all of the reasons or all of the situations in which questions become part of the Treasury regulations and — and those which haven’t.

Felix Frankfurter:

Suppose that they could resist, the Government did not assign (Inaudible) prosecution.

Charles K. Rice:

I think that’s probably it.

Now, as I said there has been litigation in the courts as to the application of the rule but never until now has this rule itself had been challenged.

And referring to the canon of construction which I just recited, namely, that where a settled administrative practice is then inherent to for many years and Congress has as it has here reenacted the Internal Revenue Code several times during that period.

The courts will recognize that as indicative of the congressional will.

Now, we have more than that in this particular case because in 1954, in the new Internal Revenue Code, when Congress was amending the provisions in regard to short sales of property, it — it provided that gain or loss in the short sale of property other than a hedging transaction in commodity futures is to be treated as a gain or loss from a sale of a capital asset to the extent that the property including a commodity future used to close the short sale constitutes a capital asset in the hands of the taxpayer.

And in the Committee Report with respect to that —

Which section?

Charles K. Rice:

That’s 1233 (a) of the 1954 Code.

In the Committee Report with respect to that Section, it was said that under existing law of bona fide hedging transactions do not result from capital gains or losses.

This result is based upon case law and regulations.

To continue this result hedging transactions in commodity futures have been specifically excepted from the operation of this subsection.

So there we have a recognition, after some 20 years of experience, 20 years that the problem existed, by Congress that that had been the law all the time.

In other words, that short sales do not — that hedging transactions do not result from capital gains and losses.

Charles K. Rice:

Now, on this particular case, the petitioner which was one of the largest consumers of corn, if not, the largest in the United States had, as the record shows, a twin purpose in — in the purchase of corn futures.

They wanted to — it had a limited as Mr. Kramer pointed out, a limited storage capacity something like three-week supply and it wanted to assure itself without the expense of additional storage facilities which they — the petitioner’s officials testified would be very expensive.

It wanted to assure itself of a satisfactory supply of corn to meet its requirements.

And at the same time, it wanted to guard against rises in the price of corn when it came to honor it’s — or to carry out its contracts.

Now, its contracts were entered into on either the basis of the contract price or the market price, the lower of those two would prevail, so that the taxpayer in this particular case was seeking by the purchase of these commodity futures to protect itself against increases in the price of — of the raw corn which might occur during the time that it was necessary to manufacture the product and deliver it to the customer to whom it had a contract.

Now, we have in this case — we do not have, well, the so-called true hedge and that the — there is not protection against both a rise and a fall in — in the price of corn, the protection only against the rise in the price of a corn.

But that was a result of the taxpayers of the type of contract for which it entered into with its customers.

In other words, those in which they — the customer could have the benefit of either the market price or the contract price at the date of delivery.

So that in effecting this form of price insurance, it is true that the taxpayer did not have complete insurance.

It didn’t have the — what is sometimes, I think perhaps unfortunately referred to as the true hedge which would be a hedge against either a rise or a fall in the price of the commodity.

But the true — the term true hedge is we think somewhat misleading, it connotes as it’s opposite the false hedge or some hedge which other than a partial or incomplete one such as we have here.

The — a more correct terminology I think would be a — a complete hedge in which the hedge guarded against a rise or a fall in the price of — of goods or a partial or incomplete hedge such as we have here where the protection was only against the rise in the price of the goods.

But it is our position, nevertheless, that — that it doesn’t make any difference whether the hedge is complete or partial as long — as long as it forms — as long as it performs the function of price insurance.

Now, the taxpayer here got all the protection that it was able to get under the formal contract which it utilized.

It’s true that it didn’t get — it didn’t get the protection of a complete hedge but that was impossible under the nature of its contract, so that to say that it is not a hedge merely because it did not guard against any — every possible loss.

It would be like saying that insurance, which guarded against only the risks of — of fire and tornado and not against hurricane was not insurance because it was not complete insurance.

And so here, the — the hedge guarded against or was partial insurance and we think that was — that that is enough to bring it within the hedging exception.

In a case of this magnitude where the taxpayer was dealing in such vast quantities of corn, it’s impossible of course to match item per item to prove that for every purchase of a commodity future, the taxpayer had a corresponding commitment for a forward sale.

But when you compare the orders which the taxpayer had and the futures which it bought, we submit that there is a broad correspondence between its orders and futures particularly for the years 1940 and 1942 which are the tax years here involved.

And in any event, the testimony of the court below or in the court below was — by the taxpayer’s own officers was to the effect that we need the corn that we have bought.

And in — and in the proceeding under the — before the Department of Agriculture involving the Commodity Exchange Act, it stated that the futures it bought represented only corn which was expected to use within a relatively short period.

In other words, it forecast what its business would be and bought futures of corn accordingly.

The taxpayers has put considerable emphasis on the fact that its customers had the right to cancel contracts if they so desire.

And to us that feature is of no great significance here because that right of cancellation was in the opposite party and if it were to the other party’s advantage, the price of corn should rise, it would be to the other party’s advantage to exercise their — to hold the taxpayer to its contract so that we don’t — do not see that that particular feature has any significance here.

In the — it is our position that essentially this is a factual question which in this case has been resolved against the taxpayer by concurrent findings of the two courts below in which under the principles laid down by this Court will be accepted as final here except in the case of showing of exceptional error.

Now, there are various definitions of the term hedging but one thing is basic to it and that is that in some way it guards against — gives protection against price fluctuations.

Accepting that general principle, you can find variations which range from the — from the broad definition in the New York Commodity Exchange market in which it is indicated clearly that commodity futures purchased in anticipation of sales, believed regarded as hedging, to a narrow and restricted definition under the Commodity Exchange Act where the purpose being to guard against unnecessary fluctuations in the price of commodities, hedging is very, very strictly construed.

For purposes of the tax laws, bearing in mind what Congress had intended with respect to the capital — favored capital gains treatment and bearing in mind the particular background of this case and which we’re trying to determine what earnings would be normal to this taxpayer, we think that the hedging exception should be given a broad and wide definition.

In other words, it should not be restricted as in the manner of the Commodity Exchange Act but should be considered to cover all transactions in which there is some form of insurance prices, whether it be complete or whether it should be partial.

A taxpayer in this proceeding is in a particularly awkward position for the reason that in this Court, it is contending that its transactions are those of a — the so-called independent capitalist, whatever that maybe.

Charles K. Rice:

And at the same time in the proceeding before the Department of Agriculture, it is contending that the — that it is engaging in hedging transactions so that — while here it contends that it is not hedging and that its transactions were those of an independent capitalist in the agriculture proceeding.

It is contending that it didn’t buy futures in excess of what it estimated its needs would be.

They have the technique to forecast what its needs would be and that purchases of futures of that kind were hedges against possible price increases.

So in — in conclusion of this point, it is our position that this case turns not on any precise definition of hedging but on the meaning of — of the capital gains transactions and the tax laws, particularly with the background of the excess profits tax laws which are involved here.

We believe that these — that these transactions were an integral part of the normal day-to-day business of the taxpayer that they form part of their operating profits and losses that they would not be considered among the class of property which Congress would intend to exclude from the definition of capital assets.

And that when the Congress enacted the excess profits tax law and excluded capital assets from the definition or from the computation of average annual earnings, it had no idea that it was excluding computation of losses of this sort from the average annual earnings of the taxpayer.

Now, the second question involved in this case is whether or not — and this question is reached only if the first question is decided adversely to the Government.

The second question is whether or not the — the transactions here in question fall within Section 118 of the Code relating to the wash sales provisions.

And the first question there is whether or not these commodity futures constitute stock or securities within the meaning of that Section.

And first of all, we point out that in the Internal Revenue Code, Congress has referred to stock or securities a half a dozen times in various contexts throughout the statute and in none of those instances were it has used the terms stock and securities or securities alone as it included commodity futures within the definition of the term commodity — within the definition of the term securities.

On the other hand and then several instances within the Code and the citations to these sections are in the briefs, it has specifically referred to commodity futures.

For example, in the definition of personal holding company income and foreign personal holding company income, it refers to stock and securities in — as one type of personal holding company income.

And then it refers to income from transactions in commodity futures as another type of personal holding company income.

So that the history of the Code shows that Congress when it has intended to include commodity futures, it has specifically referred to them.

It has not included them in its definitions of stock and securities where it used elsewhere within the Code.

We find the same thing is true in the — in the trade practice in the Chicago Board of Trade, the rules and regulations also distinguished between stock and securities on the one hand and commodity transactions on the other.

There are differences as to commissions and brokerage fees and the places in the pit where the transactions must take place and so forth.All of which we think tends to emphasize that in using the word stock — word stock or securities, Congress did not intend to include the commodity futures.

The Committee Reports under Section 118 are completely silent as to any intention to cover commodity futures and the words throughout those reports, the word stock and securities are used interchangeably so that we think that it’s clear that what Congress had in mind was the ordinary shares of stock and notes, bonds, the ventures and other evidences of indebtedness and not commodity futures.

In addition to those matters of statutory construction, we think that commodity futures of such a nature that they do not — lend themselves to evil which Congress was intending to prevent in Section 118.

They are held for a short duration, 11 months or less whereas with your ordinary stocks and securities, it’s possible to build up a portfolio of gains over a substantial period of time and then Section 118 more than in existence to make some sales at a loss, buy back the securities in short time and thereby establish a fictitious loss which could be used to offset against the gains.

The commodity futures transaction are of a different nature because it’s a recurring process with the futures, a very short duration in the process or working forward in the market and via selling futures and buying new ones, delivery at a later date to replace the ones sold.

Furthermore, as the record indicates below, it would be a costly operation to — to engage in transactions of this nature solely for the purpose of establishing tax law — tax losses.

And then again if Section 118 applied in this situation where the hedgers are working forward continually in the market selling and buying and buying and selling, it would mean in many situations that the computation of any gain or loss would be postponed indefinitely, perhaps several years as — as the new commodity futures were purchased to replace those sold and this is contrary to the general principles of tax accounting that transactions are to be accounted for in the year in which they took place.

In view of the statutory construction and these practical principals which illustrate that the reasons were not present in the case of commodity futures, which were present in the case of stocks and securities, we believe that Congress did not intend to include commodity futures within the meaning of the term stock — stock and securities.

There is another reason, a separate and independent reason why commodity futures are not subject to the provisions of Section 118 and that is that the commodity futures — that the purchase of another commodity future is not substantially identical to the one which it replaces.

You have differences as to seller, as to price, as to delivery date and — and these commodity futures, the seller has the right with a certain price adjustment to make a delivery of a different grade commodity so that the commodity future may result in the delivery of even a different grade than that contemplated in the future just sold.

The delivery date, of course, the difference in the delivery date is the most important feature indicating that they are not substantially identical because delivery dates are the keystone of the futures transaction, the most important, probably the most important feature of them and the differences in those dates we think alone may prevent them — prevent a new one from being substantially identical to the one sold.

Congress has recognized this when in the Revenue Act of 1950 in Section 211 in determining the holding period of short sales.

It specifically provided that a commodity future requiring delivery in one calendar month shall not be considered as property — property substantially identical to another commodity future requiring delivery in a different calendar month.

So there we have the congressional recognition that one — that a commodity future requiring delivery in — in a different month is not substantially identical with the commodity future sold.

Charles K. Rice:

Furthermore —

Earl Warren:

Is that — where could that be found, Mr. Rice?

Charles K. Rice:

That’s at page 49 of our brief, Your Honor.

Furthermore, as our brief indicates, there are important price differentials or have been in the commodity markets.

We give an illustration of that at page 50 of our brief, which refute the taxpayer contention that there is only a small economic difference in the value of the different maturities.

And finally under — in connection with this point, the — we call attention to the fact that the Commodity Exchange Act itself prevents the — prevents or prohibits wash or fictitious sales.

And while the petitioner has made some attempt to indicate that the sales under the tax laws is referred to as wash sales are real sales whereas the — those under the Commodity Exchange Act are fictitious sales.

Actually, the reason that the loss is disallowed under the tax laws is because there is no economic change.There is no — no real sale under — under those laws either.

And we submit that it is not to be assumed that the taxpayer was conducting transactions here in violation of the Commodity Exchange Act.

In connection with the taxpayer’s chart or graph, which it has in its brief and is blown up as an exhibit here, we would like to call attention to our own chart appearing at the — as an appendix to our brief in which — which we believe gives a more accurate picture of the situation as it existed during the years in question.

The taxpayer’s chart is pyramided in one category upon another whereas ours has leveled them out and we think that from this chart — chart number one of ours, it is possible to gain a more accurate picture of the situation as it existed in the years in question.

We also have added a chart two showing a comparison between futures owned and the carry over in the terminal market, which was the amount of corn which was available for — for commercial consumption.

In other words, what the — the amount of corn which the taxpayer was able to buy at any particular time.

So in summary of our position here with respect to the — to the first point, we contend that the transactions in question fall within the hedging exception under the Internal Revenue Code, then first of all that the capital asset statute is not to be read as the taxpayer would have us do with a literal exactness and without regard to the facts of the particular circumstance or without regard to the fact that Congress intended to cover a particular type of hardship in enacting this Act.

Stanley Reed:

Where — where is the hedging exception in the Internal Revenue Code?

Charles K. Rice:

There — it isn’t — it isn’t literally expressed, Your Honor.

That — that’s the point I’m making that — that over the years in — in different circumstances, the statute has been read as — as not to be taken entirely literally.

And this Court beginning in Burnet against Harmel and running on through many decisions in the — in the lower courts, there have been decisions —

Stanley Reed:

Well, I understand that.

I’m just using that phrase to know whether (Voice Overlap) —

Charles K. Rice:

Well, I — I refer to a hedging exception as one established by administrative construction and by judicial precedent.

We contend that there is in this case — are in this case the elements of a hedge of — of price protection against price increases.

But that was the only form of protection which under the particular type of contract in which the taxpayer engaged, but the only type of protection which was available to the taxpayer.

Thereby, achieved a form of partial insurance which comes within the hedging exception and that this was so integrated to its business form, so normal a part of its business that it should be held to be an exception to the capital gains statute.

And on the second point, we contend both that the commodity futures were not stock and — or securities within the meaning of the statute and that they were not — those purchased were not substantially identical to those sold and therefore do not come within the wash sales of the Act.

Earl Warren:

Mr. Kramer.

Jay O. Kramer:

I believe I have six minutes to reply, the marshal has so informed me.

I waited with some impatience, I will admit, to find out whether the respondent at last was going to utter the missing phrase which the courts below had never paid any attention to which has appeared in every statute since 1921 and that is the definition of capital assets includes all assets whether or not connected with taxpayers trade or business.

The respondent has — the Court will see that explained what that phrase means and I submit that it means just what it says.

Number two, respondent — I would like to turn this proceeding into a question of fact.

Jay O. Kramer:

Both courts below have held that we were not engaged in true hedging operations.

Other courts have held that that is the test.Is this a true hedge or not?

If it is not a true hedge, then as a matter of law, you must have capital treatment.

Otherwise, you have ordinary loss.

So it is not a question of fact, it is a question of law.

Number three, I produced this chart blown up in this fashion for one purpose, to show that there is no correlation between our orders and our futures position.

On 7141, when our orders were at their highest, we had the smallest future position.

At 7138, when our orders were at their lowest point, we had our largest futures position accumulative.

In fact, there we had five — we had almost 10 billion — 10 million bushels of futures.

All our futures position was — was a calculated risk that we were going to have a — that we were going to have a rise in the corn market rather than a fall.

All we did is shift the risk from a risk that corn would rise to a risk that corn might go down.

In Commissioner versus Farmers & Ginners Cotton Oil Company, Fifth Circuit 1941, reported at 120 F.2d 722, the Court said that there was no hedge when a taxpayer who manufactured crude cottonseed oil which it sold for refined cottonseed futures, it thereby merely shifted the risk, the Court said, that refine might go down in price.

All we did by establishing our futures position here to take the risk that the price of corn would go down.

That has been denominated as partial insurance but it is not insurance at all.

It’s the taking of a position.

If I buy real estate, I shift the risk from the risk that that real estate might go up in price to the risk that it might go down in price.

That is not insurance.

It is merely the taking of a position.

Now —

Felix Frankfurter:

What do you take the position for?

You have to take a position.

Jay O. Kramer:

We are entitled to take a position.

We contend there is a purpose if we wish to we can get the delivery of raw corn by buying futures and where we have done so, we have correctly reported it as part of our inventory.

But there’s no contention here and the court below has held that these futures were not part of our inventory.

The Tax Court so found.

Furthermore, I would like to point out there’s an obvious inaccuracy in that Committee Report which was read to the Court appearing at page 29 of the brief.

We have all admitted the Section 730 — that General Counsel’s Memorandum 17322 never became part of regulations and yet the Committee Report said this result is based on case law and regulations.

Actually, the only regulation here which has any force or effect is the regulation which states all assets are capital assets unless specifically excluded and that has appeared in every regulation since 1934.

It has had repeated reenactment and judicial sanction arising therefrom.

With respect to the 118 point, the fact that Congress in 1951, I believe, changed the law and required — and stated that the holding period would not include where there had been a shift in — in futures positions from one future to another — from one maturity to another I should I say.

Jay O. Kramer:

It indicates very clearly to me that that was not the law before that time and therefore cannot be taken as indicative of anything.

I believe that that covers all of the points which we wish to — to make except to say in summary that what the respondent wants this Court to do is to disregard specific language in the statute, to disregard repeated enactment of that statute, to disregard his own regulations and to disregard the repeated statement of those regulations year after year, code after code and that is the position the respondent — the petitioner respectfully submits is incorrect.