At least since
Gregory v. Helvering,
FACTS
In 1970 taxpayer Robert DeMartino, a long-time commodities trader, and Robert E. McDonnell formed Commodity International (“Cl”), a partnership dealing in a broad range of commodities on all of the New York and Chicago exchanges and on certain London exchanges. Cl was a member of the National Futures Association, was registered with the Commodity Futures Trading Commission (“CFTC”), and was a clearing member of the Commodity Clearing Corporation, which clears all trades on the New York Cotton Exchange (“NYCE”). The trades involved here were executed on behalf of Cl at the NYCE between September 17, 1975, and January 21, 1976.
Commodity futures contracts are exec-utory contracts representing commitments to deliver or receive a specified quantity and grade of a commodity during a specified month in the future at a price designated by the trading participants. One who commits to deliver pursuant to a futures contract is a “seller” and has a “short position” in the futures market, while one who commits to receive is a “buyer” and has a “long position” in the futures market. Trading of commodity futures contracts takes place in so-called trading pits or trading rings on the floor of the NYCE. The trades must take place by “open outcry,” which involves vocal expressions and ritualized hand signals indicating the position, quantity, and price at which the floor broker or trader is willing to trade; this practice was vividly described in Frank Norris’s The Pit, a 1903 novel about Chicago’s grain market. Contracts do not remain bilateral between buyers and sellers. Once cleared, they exist only between the buyer or seller and the clearing house for the exchange, so that the clearing house stands as buyer to every seller and as seller to every buyer. Only a small percentage of futures contracts are satisfied by delivery. The bulk of them are terminated prior to delivery by offsets, that is, by the execution of an equal and opposite transaction.
A straddle, or spread, position is established by simultaneously holding a long position in one delivery month and a short position in another delivery month with respect to the same commodity. For example, if one buys a contract in March 1990 *403 crude oil and sells a contract in June 1990 crude oil, he establishes a straddle long March 1990 crude and short June 1990 crude. The two months are called the legs of the straddle. Profit or loss is based not on absolute price movements in the legs, but rather on the increase or decrease in the price differential between the long and the short contracts. Thus, if the short leg loses more value than the long leg gains, the differential changes and the value of the entire straddle position diminishes. By comparison, profit or loss on the trading of an “outright position” — solely short or long — is determined by the difference in price between the opening trade and the offsetting trade.
Open commodity futures positions are “marked to market” by the clearing house at the close of each trading day. This is done by comparing the actual prices paid for the futures contracts to settlement prices that the exchange fixes daily, and the market price is generally somewhere in the range of prices traded near the close of trading. Trading in commodity futures contracts has been regulated since April 1975 by the CFTC under the Commodity Futures Trading Commission Act of 1974, Pub.L. No. 93-463, 88 Stat. 1389, codified as per note following 7 U.S.C. § 2 (1982).
Trading of crude oil futures contracts at the NYCE began on September 10, 1974, and ended on July 2, 1976. A standard NYCE crude oil futures contract specified 5,000 barrels of crude oil for delivery at Rotterdam, Holland, and four delivery months were utilized — March, June, September and December. During the first month this market existed, only five cоntracts were traded. During the entire operation of the NYCE crude oil market only about 55,000 trades were executed, of which approximately 37,000 were straddle trades. There was virtually no trading in the nearby months in the crude oil market, unlike other commodity markets.
The rules covering trading in crude oil futures contracts at the NYCE provided that, with few exceptions, “[n]o transaction that is not made competitively by open outcry in the trading ring of the Exchange shall be permitted, reported or recorded in the records of transactions,” Crude Oil ByLaws and Rules of the Petroleum Associates of the New York Cotton Exchange, Inc., Delivery Rule C14(5), and that “[m]is-leading or ambiguous bids, offers or acceptances, as well as those of a frivolous nature, are strictly prohibited,” id. Rule C14(6). The rules further provided for straddle trades:
These orders are to be executed competitively by public outcry in the ring with at least one side of the straddle at the market price prevailing at the time of the trade. In inactive futures in which there are no prevailing market prices because there have been no trades, bids or offers in either future, the price must bear a reasonable relаtionship to the prevailing market prices of active futures.
Id. Rule C14(15). When a single broker had orders representing both sides of the same trade, the rules permitted him to place such orders only if they were “first offered openly and competitively by open outcry in the trading ring”; if “[n]either the future commission merchant receiving nor the member executing such orders [had] any interest therein, directly or indirectly, except as a fiduciary”; and if the broker met certain observation, reporting and recording requirements. Id. Rule C27.
Cl engaged in two series of crude oil futures straddle trades in 1975 and 1976, the first a June 1977-Deeember 1977 straddle and the second a December 1977-March 1978 straddle. The Tax Court found that all of the trades involved were pre-ar-ranged outside of the trading ring in contravention of CFTC regulations. Joseph R. Hamilton, the broker who executed all of CPs trades, had so testifed. There was testimony to the contrary from one Norman Turkish, but the Tax Court found Turkish’s testimony unreliable, especially in light of his conviction of tax evasion and conspiracy to defraud the United States, which resulted from his involvement in a conspiracy to fix commodity futures transactions in a similar tax deferment straddle scheme in the NYCE сrude oil market.
See United States v. Turkish,
The Tax Court also found that the trades were not executed at free market prices because Hamilton, who was a broker for 98% of the trades executed in the NYCE crude oil market, testified that on several occasions he controlled the market and artificially moved prices downward. Some 67% of all the trades on the NYCE in the crude oil market were straddles. Almost all of the remaining trades were wash sales, purchases and sales of the same contract at the same time for the same price that resulted in no profit or loss to the trader. The wash sales apparently were made to inflate artificially the volume of contracts in order to make the market more attractive to investors. While the taxpayer argues that no one could have prevented outsiders from entering the market to capitalize on unrealistic prices, there was testimony from Hamilton that he moved market prices gradually in a successful effort to discourage outside investors from entering the. market.
Third, the Tax Court found that the differentials in Cl’s crude oil straddles stayed virtually the same throughout the entire life of the straddles. Both Cl straddle differentials varied on only one day throughout the time the straddles were maintained, even though the prices in the legs of the straddles changed. The Tax Court found that Hamilton set the crude oil settlement prices and that it was important to make the prices of the legs of the straddles fluctuate, to achieve the desired tax results, while keeping the settlement prices making up the differential at a constant price, to avoid margin calls. Specifically, there was evidence that on the June 1977-December 1977 straddle, the price of each of the two legs of the straddle varied up tо $2.49 while the straddle differential was a constant $.08 throughout the life of the straddle, except for September 23, 1975, when the differential was $.09. Similarly, the straddle differential for the December 1977-March 1978 straddle was the same on each day the straddle was maintained except for December 11, 1975. Because the differential did not change, Cl’s account equity remained at zero throughout the trading period, and it was not called upon to pay any maintenance margins.
Finally, the Tax Court found that the crude oil market was a “thin” market and that Hamilton was the only broker who was continuously in the crude оil ring. On the basis of these findings, the Tax Court concluded that these were sham transactions and that the losses sustained therein could not be recognized for federal tax purposes.
As a result of the trades, one Cl house account lost $4,208,860 in 1975 and gained $4,091,035 in 1976 for a net crude oil futures transaction loss of $117,825. Another Cl house account gained $57,500 in 1976. For all of its crude oil futures trading, Cl was net out of pocket $60,125. On its 1975 partnership income tax return, it claimed a $4,208,860 short-term capital loss from crude oil futures, income of approximately $4,000,000 from other transactions, and a net loss of $286,293 for the year.
The Commissiоner issued a notice of deficiency disallowing as sham the short-term capital loss claimed for 1975, and he eventually determined that Cl had realized a short-term capital gain in excess of $4,000,-000, of which DeMartino’s distributive share was $2,140,850. The Commissioner also asserted a tax for negligence or intentional disregard of the rules and regulations pursuant to section 6653(a) of the Code, supra note 4. Taxpayers then sought a redetermination of the deficiency in the Tax Court.
DISCUSSION
A. The Sham “Losses”
The primary issue in this appeal turns on section 165, the general loss provision of the Internal Revenue Code, and section 108(a)
5
of the Tax Reform Act of
*406
1984, which governs the deductibility of losses from commodity straddles claimed for tax years prior to 1982. The basic rule of law is that taxation is based upon substance, not form.
Gregory v. Helvering,
The taxpayer argues first that the transactions were not sham. The Commissioner’s findings were presumptively correct and the burden was on the taxpayer to demonstrate that the purported trades were bona fide.
See Welch v. Helvering,
The taxpayer’s more persuasive argument is based оn section 108 of the 1984 Tax Reform Act, supra note 5. In 1984, section 108 created a rebuttable presumption that the pre-1982 straddle trading losses of commodities dealers and those who regularly invested in commodity contracts were incurred in transactions engaged in for profit and thus were deductible. The taxpayer argues, however, that the Service saw the rebuttable presumption as an invitation to rebut and litigation continued. In *407 section 1808(d) of the Tax Reform Act of 1986, Congress amended section 108 to provide that “any loss incurred by a commodities dealer in the trading of commodities shall be treated as a loss incurred in a trade or business” and as such an allowable deduction. Congress removed from section 108 the provision that a straddle loss should be allowed “if such position is part of a transaction entered into for profit” and inserted instead the words “if such loss is incurred in a trade or business, or if such loss is incurred in a transaction entered into for profit though not connected with a trade or business.”
The words of the statute are so unambiguous, according to the taxpayer, that it is inappropriate to resort to the legislative history to interpret the statute.
See Miller v. Commissioner,
On the other hand, the same House Report stated that the per se deductibility of section 1808(d) would not apply “where the trades were fictitious, prearranged, or otherwise in violation of the rules of the exchange.” H.R.Rep. No. 99-426 at 911. The amendment was intended to overrule the sharply divided Tax Court’s decision in
Miller v. Commissioner,
We agree with the Commissioner that it is appropriate to apply here the basic rule of statutory interpretation that а statute should not be interpreted to produce an absurd or unreasonable result.
Haggar Co. v. Helvering,
B. The Taxpayer’s Liability for 5% Addition to Tax Upon Underpayment Due to “Negligence or Intentional Disregard of Rules and Regulations”
Under section 6653(a) of the Internal Revenue Code,
supra
note 4, a taxpayer’s “negligence or intentional disregard of rules and regulations” exposes him to a penalty of 5% of the underpayment.
See Neely v. United States,
C. The Retroactive Application of Section 6621 of the Internal Revenue Code, as Amended
For certain types of underpayments listed in section 6621,
supra
note 2, interest is calculated at 120% of the usual rate of interest. This occurs when a “substantial underpayment” of tax is “attributable to tax motivated transactions.” The statute has always listed straddles as “tax motivated transactions,” but, as previously noted, Judge Korner originally held that section 6621 was inapplicable to DeMartinо. He held that DeMartino’s straddles didn’t meet the technical definition of “straddle”
because
they were sham. The Tax Reform Act of 1986 added shams to the list of tax motivated transactions,
6
and Congress indisputably intended to make the amendment retroactive. The Conference Committee Report named Judge Korner’s first opinion in this case and
Forseth v. Commissioner,
Its application, the taxpayer argues, gives effect to an unconstitutional congressional assumption of judicial power and unconstitutionally imposes a retroactive penalty. First, relying on
Marbury v. Madison, 5
U.S. (1 Cranch) 137, 178,
We approve the Tax Court’s application of the penalty. One can certainly agree with the conferees that the Tax Court’s holdings in
Forseth
and the original
De-Martino
were “anomalous” in that “a genuine transaction (lacking the proper profit motive) would be subject to a higher interest rate, while a sham transaction, which is significantly more abusive, would escape the higher interest rate simply because it is a sham.”
See
H.R.Conf.Rep. No. 99-841 at 796, 1986 U.S.Code Cong. & Admin.News p. 4884. Beyond this, Congress added sham or fraudulent transactions to the list of transactions subject to the higher interest rate regardless of the taxpayer’s identity. Congress did not simply aim its arrow of increased interest penalty at the individual taxpayers in
Forseth
and
DeMartino,
and it indicated that the clarification did not apply “to any Underpayment with respect to which there was a final court decisiоn (either through exhausting all appeals rights or the lapsing of the time period within which an appeal must be pursued) before the date of enactment of this Act.”
Id.
Here, no final decision had been entered under the Tax Court rules, so application of the amendment was proper.
See Temple Univ. v. United States,
*409
That the legislation was retroactive does not make it unconstitutional.
Pension Benefit Guar. Corp. v. R.A. Gray & Co.,
Nor was the 1986 amendment viola-tive of the ex post facto clause of the Constitution, as this is a civil, not a criminal case.
Harisiades v. Shaughnessy,
JUDGMENT AFFIRMED.
Notes
. This decision was summarily affirmed as to DeMartino’s partner in
McDonnell
v.
Commissioner,
. Section 6621 provides that:
In the case of interеst payable under section 6601 with respect to any substantial underpayment attributable to tax motivated transactions, the rate of interest established under this section shall be 120 percent of the underpayment rate established [elsewhere in section 6621].
26 U.S.C. § 6621(c)(1) (Supp. IV 1986) (as amended in 1986); see also 26 Ú.S.C. § 6621(d)(1) (Supp. Ill 1985) (substantially identical subsection that replaced subsection (c)(1) in 1984). Since 1984, it has also provided that:
For purposes of this subsection, the term "tax motivated transaction" means—
(i) any valuation overstatement (within the meaning of section 6659(c)),
(ii) any loss disallowed by reason of section 465(a) and any credit disallowed under section 46(c)(8),
(iii) any straddle (as defined in section 1092(c) without regard to subsections (d) and (e) of section 1092), and
(iv) any use of an accounting method specified in regulations prescribed by the Secretary as a use which may result in a substantial distortion of income for any period.
26 U.S.C. § 6621(d)(3)(A) (Supp. Ill 1985). In 1986, Congress added a fifth definition of the term “tax motivated transaction” in a "Clarification of Treatment of Sham or Fraudulent Transactions.” The term now is also defined to mean "(v) any sham or fraudulent transaction.” 26 U.S.C. § 6621(c)(3)(A) (Supp. IV 1986). The amendment adding subsection (v) "shall apply to interest accruing after December 31, 1984; except that such amendment shall not apply in the case of any underpayment with respect to which there was a final court decision before the date of the enactment [of the 1986 Act].” Pub.L. No. 99-514, § 1535(b), 100 Stat. 2085, 2750 (1986). See section C of this opinion for a discussion of the effect of this amendment.
. Section 6621 imposes additional interest for a straddle “as defined in section 1092(c).” 26 U.S.C. § 6621(c)(3)(A)(iii) (Supp. IV 1986). Section 1092(c) provides in pertinent part:
Straddle Defined
For purposes of this section—
(1) In general
The term "straddle" means offsetting positions with respect to personal property.
(2) Offsetting Positions
(A) In general
A taxpayer holds offsetting positions with respect to personal property if there is a substantial diminution of the taxpayer’s risk of loss from holding any position with respect to personal property by reason of his holding 1 or more other positions with respect to personal property (whether or not of the same kind).
26 U.S.C. § 1092(c) (1982). Judge Korner held that the taxpayer’s transaction was not a section 1092(c) "straddle” because offsetting positions do not diminish risk in a sham.
. The version of section 6653 that is applicable to tax liability for the 1975 tax year provided:
If any part of any underpayment ... of any tax ... is due to negligence or intentionаl disregard of rules or regulations (but without intent to defraud), there shall be added to the tax an amount equal to 5 percent of the underpayment.
26 U.S.C. § 6653(a)(1) (1982), codified as amended at 26 U.S.C. § 6653(a)(1) (Supp. IV 1986).
. The original version of section 108 of the Tax Reform Act provided as follows:
SEC. 108. TREATMENT OF CERTAIN LOSSES ON STRADDLES ENTERED INTO BE *405 FORE EFFECTIVE DATE OF ECONOMIC RECOVERY TAX ACT OF 1981.
(a) GENERAL RULE. — For purposes of the Internal Revenue Code of 1954, in the case of any disposition of 1 or more positions—
(1) which were entered into before 1982 and form part of a straddle, and
(2) to which the amendments made by title V of the Economic Recovery Tax Act of 1981 do not apply,
any loss from such disposition shall be allowed for the taxable year of the disposition if such position is part of a transaction entered into for profit.
(b) PRESUMPTION THAT TRANSACTION ENTERED INTO FOR PROFIT. — For purposes of subsection (a), any position held by a commodities dealer or any person regularly engaged in investing in regulated futures contracts shall be rebuttably presumed to be part of a transaction entered into for profit.
(c) NET LOSS ALLOWED WHETHER OR NOT TRANSACTION ENTERED INTO FOR PROFIT. — If any loss with respect to a position described in paragraphs (1) and (2) of subsection (a) is not allowable as a deduction (after applying subsections (a) and (b)), such loss shall be allowed in determining the gain or loss frоm dispositions of other positions in the straddle to the extent required to accurately reflect the taxpayer's net gain or loss from all positions in such straddle.
(d) OTHER RULES. — Except as otherwise provided in subsections (a) and (c) and in sections 1233 and 1234 of such Code, the determination of whether there is recognized gain or loss with respect to a position, and the amount and timing of such gain or loss, and the treatment of such gain or loss as long-term or short-term shall be made without regard to whether such position constitutes part of a straddle.
(e) STRADDLE. — For purposes of this section, the term "straddle” has the meaning given to such term by section 1092(c) of the Internal Revenue Code of 1954 as in effect on the day after the date of the enactment of the Economic Recovery Tax Act of 1981, and shall include a straddle all the positions of which are regulated futures contracts.
(f) COMMODITIES DEALER. — For purposes of this section, the term "commodities dealer” has the meaning given to such term by section 1402(i)(2)(B) of the Internal Revenue Code of 1954 (as added by this subtitle).
(g) REGULATED FUTURES CONTRACTS. —For purposes of this section, the term "regulated futures contracts" has the meaning given to such term by section 1256(b) of the Internal Revenue Code of 1954 (as in effect before the date of enactment of this Act).
(h) SYNDICATES. — Subsection (b) shall not apply to any syndicate (as defined in section 1256(e)(3)(B) of the Internal Revenue Code of 1954).
Pub.L. No. 98-369, § 108, 98 Stat. 494, 630 (1984).
As amended in 1986, section 108 now provides:
(a) GENERAL RULE. — For purposes of the Internal Revenue Code of 1986 [formerly I.R. C. 1954], in the case of any disposition of 1 or more positions—
(1) which were entered into before 1982 and form part of a straddle, and
(2) to which the amendments made by title V of the Economic Recovery Tax Act of 1981 ... do not apply,
any loss from such disposition shall be allowed for the taxable year of the disposition if such loss is incurred in a trade or business, or if such loss is incurred in a transaction entered into for profit though not connected with a trade or business.
(b) LOSS INCURRED IN A TRADE OR BUSINESS. — For purposes of subsection (a), any loss incurred by a commodities dealer in the trading of commodities shall be treated as a loss incurred in a trade or business.
(c) NET LOSS ALLOWED. — If any loss with respect to a position described in paragraphs (1) and (2) of subsection (a) is not allowable as a deduction (after applying subsections (a) and (b)), such loss shall be allowed in determining the gain or loss from dispositions of other positions in the straddle to the extent required to accurately reflect the taxpayer’s net gain or loss from all positions in such straddle.
(d) OTHER RULES. — Except as otherwise provided in subsections (a) and (c) and in sections 1233 and 1234 of such Code, the determination of whether there is recognized gain or loss with respect to a position, and the amount and timing of such gain or loss, and the treatment of such gain or loss as long-term or short-term shall be made without regard to whether such position constitutes part of a straddle.
(e) STRADDLE. — For purposes of this section, the term "straddle” has the meaning given to such term by section 1092(c) of the Internal Revenue Code of 1986 as in effect on the day after the date of the enactment of the Economic Recovery Tax Act of 1981 [Aug. 13, 1981], and shall include a straddle all the positions of which are regulated futures contracts.
(f) COMMODITIES DEALER. — For purposes of this section, the term "commodities dealer" means any taxpayer who—
(1) at any time before January 1, 1982, was an individual described in section 1402(i)(2)(B) of the Internal Revenue Code of 1986 [formerly I.R.C. 1954] (as added by this subtitle), or
(2) was a member of the family (within the meaning of section 704(e)(3) of such Code) of an individual described in paragraph (1) to the extent such member engaged in commodities trading through an organization the members of which consisted solely of—
(A) 1 or more individuals described in paragraph (1), and
*406 (B) 1 or more members of the families (as so defined) of such individuals.
(g) REGULATED FUTURES CONTRACTS. —For purposes of this section, the term “regulated futures contracts” has the meaning given to such term by section 1256(b) of the Internal Revenue Code of 1986 (as in effect before the date of enactment of this Act [July 18, 1984],
(h) SYNDICATES. — For purposes of this section, any loss incurred by a person (other than a commodities dealer) with respect to an interest in a syndicate (within the meaning of section 1256(e)(3)(B) of the Internal Revenue Code of 1986 [formerly I.R.C. 1954]) shall not be considered to be a loss incurred in a trade or business.
Section 108 of Pub.L. No. 98-369, as amended by Pub.L. No. 99-514, § 1808(d), 100 Stat. 2085, 2817 (1986), reprinted at 26 U.S.C. § 1092 note (Supp. IV 1986).
. See note 2, supra.