Rev. Rul. 1978-414
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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