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Rev. Rul. 1978-414 Document Info Printer

Revenue Rulings
Internal Revenue Service
 Revenue Ruling

Rev. Rul. 78-414

1978-2 C.B. 213

Sec. 1221

IRS Headnote

Commodity futures; Treasury bills. Commodity futures contracts on Treasury
bills that are purchased as an investment rather than as a hedge or for
sale to customers in the ordinary course of business are capital assets in
the hands of the purchaser. Gain on the sale of such contracts held for
more than six months is long-term capital gain. Rev. Rul. 77-185 amplified.


Full Text

Rev. Rul. 78-414 

Advice has been requested whether gain realized on the sale of a commodity
future contract on Treasury bills, under the following circumstances, is a
long-term capital gain. 

On January 4, 1977, A purchased a commodity future contract on a
three-month (13-week) Treasury bill on the International Monetary Market of
the Chicago Mercantile Exchange, for delivery in January 1978 of a Treasury
bill maturing 90 days from the delivery date. Under the rules of the
Exchange, delivery of the Treasury bill that is the subject of the contract
will be made three business days following the original issuance of the
Treasury bill. In August 1977, A sold the contract at a gain. A purchased
the contract as an investment and did not hold the contract primarily for
sale to customers in the ordinary course of A's trade or business. A did
not purchase the contract as a "hedge." Treasury bills are sold by the
Treasury Department of the United States Government on a discount basis and
are redeemed at par at maturity. 

Section 1221(1) of the Internal Revenue Code of 1954 excludes from the
definition of the term "capital asset," stock in trade of the taxpayer or
other property of a kind that would properly 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 the trade or business. 

Section 1221(5) of the Code excludes from the definition of capital asset
an obligation of the United States or any of its possessions, or of a State
or any political subdivision thereof, or of the District of Columbia,
issued on or after March 1, 1941, on a discount basis and payable without
interest at a fixed maturity date not exceeding one year from the date of
issue. 

Section 1222 of the Code provides, in effect, that gain from the sale or
exchange of a commodity future that is traded subject to the rules of a
board of trade or commodity exchange is long-term capital gain if the
future is a capital asset and has been held for more than six months, if
and to the extent such gain is taken into account in computing gross
income. 

The Supreme Court of the United States noted in United States v. New York
Coffee & Sugar Exchange, 263 U.S. 611 (1924), that individuals who deal
in commodity futures contracts are divided into three classes: those who
use the futures to "hedge," i.e. to ensure themselves against loss by
unfavorable changes in price at the time of actual delivery of what they
have to buy or sell in their business; investors who buy or sell for future
delivery with a view to profit based on the law of supply and demand; and
"gamblers" or irresponsible speculators. 

In Corn Products Refining Company v. Commissioner, 350 U.S. 46 (1955), Ct.
D. 1787, 1955-2 C.B. 511, the Supreme Court considered whether the
purchases and sales of certain corn futures, that were in the nature of
hedges, resulted in ordinary gain or loss, or in capital gain or loss. The
taxpayer purchased corn futures in order to protect itself against an
increase in the price of corn, its major raw material. Both the Tax Court
and the Court of Appeals found that the futures transactions were an
integral part of its business designed to protect its manufacturing
operations against a price increase in corn. The Supreme Court held that
since Congress intended profits and losses arising from the everyday
operation of a business be considered as ordinary income or loss rather
than capital gain or loss, any gains or losses the taxpayer sustained in
its futures transactions were ordinary gains or losses. 

Rev. Rul. 72-179, 1972-1 C.B. 57, concludes that hedges, which eliminate
speculative risks due to fluctuation in the market price of commodities and
thereby tend to assure ordinary operating profits, are not in the nature of
capital asset transactions. 

In Faroll v. Jarecki, 231 F.2d 281 (7th Cir. 1956), a taxpayer made
numerous sales of commodity futures contracts. The court determined that
the taxpayer did not hold the commodity futures contracts primarily for
sale to customers in the ordinary course of the trade or business, and that
the Corn Products decision was not applicable. The court, in concluding
that the losses realized by the taxpayer were capital losses, recognized
that transactions in commodity futures contracts are transactions in rights
to the commodity rather than in the commodity itself. See, also, the
concurring opinion of Judge Holmes in Commissioner v. Covington, 120 F.2d
768 (5th Cir. 1941), wherein he stated that traders in commodity futures
acquire rights to the specific commodity rather than the commodity itself.
Thus, the purchase of the commodity future contract for future delivery of
Treasury bills as described above is the acquisition of rights to Treasury
bills and not the acquisition of Treasury bills. Since A did not hold the
commodity future contract primarily for sale to customers in the ordinary
course of A's trade or business or purchase the contract as a "hedge", the
commodity future contract is a capital asset in A's hands. The fact that
Treasury bills, pursuant to section 1221(5) of the Code, are not capital
assets does not affect the conclusion that the above commodity future
contract on Treasury bills is a capital asset. Accordingly, the gain
realized by A on the sale of the commodity future contract is long-term
capital gain. 

See, however, Rev. Rul. 77-185, 1977-1 C.B. 48, which described the tax
consequences to a taxpayer who entered into a "commodity futures spread"
transaction in silver futures consisting of a long and a short position,
subsequently closed out the long position and immediately replaced it with
another long position. The conclusion of Rev. Rul. 77-185 would be equally
applicable to a spread transaction in commodity futures contracts on
Treasury bills. 

Rev. Rul. 77-185 is amplified.

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