July 9, 1941
COMMISSIONER OF INTERNAL REVENUE
Before L. HAND, AUGUSTUS N. HAND and CHASE, Circuit Judges.
AUGUSTUS N. HAND, Circuit Judge.
The taxpayer through his agent, Piedmont Financial Co. of New York, which we shall call the management company, conducted various short sale transactions in stocks of a company known as Drug, Inc. To effect these sales he borrowed 27,700 shares of stock of Drug, Inc. He sold 34,800 shares of Drug, Inc., to various purchasers during the years 1932 and 1933 and purchased a like amount, of which 7,100 shares were used to make deliveries upon his total sales of 34,800 shares, and the balance was returned to the lenders. These 7,100 shares, at the time of purchase, were intended to cover pro tanto his obligations to return the borrowed stock, and were so entered in account No. 18 kept by the management company as a short account. But they were in fact used to make deliveries to persons to whom he later sold stock of Drug, Inc.After these deliveries there was insufficient stock to make good his borrowings and it was necessary to purchase additional stock of Drug, Inc., in order to fulfill his obligations, which was finally accomplished by deliveries during June and July, 1933.
The taxpayer argues that gain or loss was realized when the acts that determined gain or loss had been completed, that this occurred when he bought the 7,100 shares and they were placed in an account with the intention of using them for delivery to the lender. In this connection it should be observed that he followed a consistent practice of matching the first purchases with the first sales. The difficulty with the contention of the taxpayer is that he is not shown to have made and entered in his account No. 18 these alleged covering purchases of 7,100 shares under any agreement or understanding with the lender or to have otherwise placed himself in a position where he was not entitled to treat the shares as long stock and sell them for his own account. As we have already said, he in fact never used these shares to cover his obligations but only to make sales in a market thought to present an opportunity for future purchases at a lower price. We think that his unfulfilled intention to make a covering purchase did not result in a completed transaction on which gain or loss was realized. In our opinion gain or loss was only realized when the borrowed stock was delivered, or at least not before the lender acquired an equitable interest in specific shares.
The definition of a "short sale" made by the Securities and Exchange Commission under the authority of the Securities Exchange Act, 15 U.S.C.A. § 77b et seq., warrants the result we have reached. The definition promulgated by the Commission is as follows:
"The term 'short sale' means any sale of a security which the seller does not own or any sale which is consummated by the delivery of a security borrowed by, or for the account of, the seller."
Rule X-3B-3. (CCH. Securities Law Service, par. 22, 244.)
According to the above definition the 7,100 shares were not short sales which the taxpayer covered by subsequent purchases but were long sales of his own stock. The cost of the subsequent purchases which he used to return borrowed stock had to be matched against the amounts realized for the original short sales of stock in that amount.
The taxpayer says that even if the short sale transactions were closed by the deliveries in June and July, 1933, some of the shares then delivered were purchased in 1932 and the gain or loss qua these shares was fixed when they were purchased, irrespective of the time of delivery. Yet they remained under control of the taxpayer and up to the time of actual delivery could have been sold and replaced by other purchases in the absence of prior agreement with the lender to use them to make restitution. Such a shifting intent to cover a short sale ought not to be the critical event which would determine gain or loss under a tax statute. It would leave the whole matter of fixing the event to the taxpayer's own will. We hold that the time of delivery was the time at which the covering transactions must be regarded as closed.
Such decisions as Ruml v. Commissioner, 2 Cir., 83 F.2d 257, and Commissioner v. Dashiell, 7 Cir., 100 F.2d 625, are not adverse to our conclusion. In each case stock belonging to the seller, but inaccessible at the time of sale, was not turned over to his broker until the next year after the sale. In the meantime the broker had loaned stock to that amount to carry out the selling orders.Because the seller's own stock was inaccessible, he had to borrow, but he had agreed with his broker to use his own stock as soon as he could to cover the transaction. In other words, the seller's shares at the time the stock was loaned by the broker belonged in equity to the latter and no delivery was required to fix the gain or loss on the transaction.
A majority of the Board held that the gain or loss incurred through the short sales was determined by what the taxpayer paid for the shares actually delivered, and that there was no gain or loss until 1933 when the shares were actually returned. We think that the Board was right in computing the tax upon this basis.
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