1996 WL 33658420 (1st Cir.)

 

For opinion see 93 F.3d 26

 

United States Court of Appeals, First Circuit.

 

Carlos J. and Jean M. QUIJANO, Appellants,

v.

UNITED STATES OF AMERICA, Appellee.

 

No. 96-1053.

April 27, 1996.

 

On Appeal from a Judgment of the District Court for the District of Maine

 

Reply Brief for the Appellants

 

Paula N. Singer, BBO # 464700, Robert S. Grodberg, BBO # 212360, Vacovec, Mayotte & Singer, Two Newton Place, 255 Washington Street, Suite 340, Newton, MA 02158, (617) 964-0500.

 

*i TABLE OF CONTENTS TO THE REPLY BRIEF

 

TABLE OF AUTHORITIES ... ii

 

ARGUMENT ... 1

 

A. TAXPAYERS WERE TAXED ON AN UNREALIZED EXCHANGE GAIN WHERE NO DOLLARS WERE EXCHANGED FOR POUNDS TO PURCHASE THE TAXPAYERS' RESIDENCE ... 1

 

B. THE SEPARATE TRANSACTION PRINCIPLE APPLIED TOGETHER WITH THE COMMISSIONER'S APPLICATION OF REV. RUL. 54-105 RESULTS IN THE IMPOSITION OF AN UNCONSTITUTIONAL TAX ON THE TAXPAYER'S SALE OF THEIR RESIDENCE ... 5

 

CONCLUSION ... 9

 

EXHIBIT A ... 10

 

EXHIBIT B ... 12

 

CERTIFICATE OF SERVICE ... 13

 

*ii TABLE OF AUTHORITIES

 

CASES:

 

Bennett's Travel Bureau, Inc. v. Commissioner, 29 T.C. 350 (1957) ... 10

 

Bernuth Lembcke Co. v. Commissioner, 1 B.T.A. 1051 (1925) ... 10

 

Church's English Shoes, Ltd. v. Commissioner, 229 F.2d 957 (2d Cir. 1957), aff'd 24 T.C. 56 (1955) ... 10

 

Commissioner v. Glenshaw Glass, 348 U.S. 426 (1955) 4

 

Eisner v. MaComber, 252. U.S. 189 (1920) ... 4

 

Federal National Mortgage Ass'n v. Commissioner, 100 T.C. 541 (1993) ... 7, 10

 

G.M. Trading Corp. v. Commissioner, 103 T.C. 59 (1994) ... 10

 

Gillin v. United States, 423 F.2d 309 (Ct. Cl. 1970) ... 10

 

Joyce-Koebel Co. v. Commissioner, 6 B.T.A. 403 (1927) ... 10

 

KVP Sutherland Paper Co. v. United States, 344 F.2d 377 (Ct. Cl. 1965) ... 10

 

Puttkammer v. Commissioner, 66 T.C. 240 (1976) ... 10

 

Seaboard Finance Co. v. Commissioner, 225 F.2d 808 (9th Cir. 1955) ... 10

 

Willard Helburn, Inc. v. Commissioner, 214 F.2d 815 (1st Cir. 1954) ... 5, 6, 8, 10

 

MISCELLANEOUS:

 

III J. Isenbergh, International Taxation (1996) ... 3, 4

 

D. Ravenscroft, Taxation and Foreign Currency (1973) ... 3, 6, 7

 

Rev. Rul. 54-105, 1954-1 C.B. 12 ... 10

 

Rev. Rul. 71-134, 1971-1 C.B. 75 ... 11

 

*1 ARGUMENT

 

A. TAXPAYERS WERE TAXED ON AN UNREALIZED EXCHANGE GAIN WHERE NO DOLLARS WERE EXCHANGED FOR POUNDS TO PURCHASE THE TAXPAYERS' RESIDENCE

 

The Commissioner acknowledges the well-established principle that foreign currency is treated as property. (Br. p. 7.) When taxpayers engage in buying or selling assets denominated in a foreign currency with U.S. dollars, a gain or a loss may result from the currency conversions. Taxpayers agree that had they converted U.S. dollars to pounds to purchase the residence or paid for the residence with equivalent U.S. dollars, they would have had a gain *2 derived from the change in the value of the pound relative to the U.S. dollar between the date of purchase and the date of sale. To use the Commissioner's example (Br. p. 19), had the taxpayers purchased an asset valued at £100,000 for $150,000 and subsequently sold the property for £100,000 when that amount of pounds was worth $175,000, the taxpayers would have had an exchange gain of $25,000.

 

Central to the taxpayers' argument is the fact that no U.S. dollars were exchanged for pounds to purchase the taxpayers' residence. [FN1] Taxpayers argue that, without converting U.S. dollars to pounds for the purchase of their residence, they received no economic benefit resulting from the change in the value of the pound from the date of purchase to the date of sale. The taxpayers' argument is incorrectly reiterated throughout the Commissioner's brief. According to the Commissioner, "the taxpayers argue that because they did not convert pounds into dollars [emphasis added] in purchasing their residence, the increase in the value of the pound between the date they purchased the residence and the date they sold the residence should be ignored in computing the gain on the sale." (Br. p. 7. See also Br. p. 19, p. 20 and p. 21 fn4.) This significantly *3 misstates the taxpayers' argument as described above and in the taxpayers' brief. (Br. p. 6, I.) The Commissioner states that the taxpayers' argument is based on the fact that they did not convert pounds to U.S. dollars. In fact, the taxpayers' argument is based on the fact that "no U.S. dollars were exchanged for pounds." (Br. p. 6.) The Commissioner's misstatement of the taxpayers' argument by reversing the currency conversions suggests, at the very least, some confusion as to the actual economic benefit realized by the taxpayers. [FN2]

 

FN1. This argument would apply to all sales of assets denominated in foreign currency by U.S. taxpayers who must use the U.S. dollar as their functional currency. Such sales would include the sale of assets, such as foreign real estate inherited by U.S. taxpayers and foreign real estate and other foreign currency-denominated assets by U.S. taxpayers who are foreign nationals but who acquired the assets before becoming U.S. tax residents.

 

FN2. In fact, the conversion of pounds to U.S. dollars following the sale of the residence is not relevant when determining the gain on the sale. The taxpayers could have continued to reside in the U.K. and to hold the proceeds in pounds. Nevertheless, they would have been required to compute the gain on the sale in U.S. dollars for purposes of determining the applicable tax on their U.S. income tax return. It is the formula used to determine this gain in U.S. dollars which is at issue in this case.

 

Taxpayers argue that the Commissioner cannot use a rule of translation to create an economic benefit. "Translation means simply the statement of the equivalent value in one currency of a given amount of another currency. In contrast to the term conversion, translation does not refer to the actual exchange of an amount of one currency for its equivalent in another; translation is only a statement of valuation." D. Ravenscroft, Taxation and Foreign Currency p. xxi. (1973), Most courts, commentators, and the Commissioner use the term foreign currency transaction to refer to a foreign currency *4 conversion. See III J. Isenbergh, International Taxation ¶51.3 (1996), D. Ravenscroft, Taxation and Foreign Currency (1973).

 

The Commissioner relies on case law distinguishable from the facts in this case. The Commissioner identifies no cases imposing a tax on income resulting from a mere translation. The cases cited by the Commissioner are developed from facts involving foreign currency transactions (i.e. conversions of U.S. dollars to foreign currency or foreign currency to U.S. dollars or both) and not translations. (See Exhibit A.)

 

Where there is no economic gain there can be no tax. Eisner v. MaComber, 252 U.S. 189 (1920). Absent case law on point, the taxpayers argue that they did not receive "income" as that term has been defined in the Sixteenth Amendment from the translation. The court in Commissioner v. Glenshaw Glass, 348 U.S. 426 (1955), defined gross income in terms of "accessions to wealth, clearly realized, and over which the taxpayers have complete dominion." Id. at 431. Although, courts and commentators point out that Eisner v. MaComber has lost some of its vitality, it has not been specifically overruled and still stands for the principle that where there is no economic gain there can be no tax.

 

The facts of this case do not include a foreign currency transaction. The taxpayers real estate transaction involved the purchase of a U.K. residence with pounds. The *5 taxpayers did not purchase pounds with U.S. dollars in order to purchase the residence. Neither did they use U.S. dollars to purchase the pound-denominated residence. The taxpayers paid, and do not dispute, the tax on the approximately $200,000 of actual economic gain realized on the sale of their residence. (See Exhibit B.) The taxpayers argue that the imposition of a tax by the Commissioner on the unrealized exchange gain of approximately $100,000 resulting from the Commissioner's application of Rev. Rul. 54-105 is unconstitutional. [FN3]

 

FN3. Had the exchange rates been reversed, the taxpayers' unrealized loss of approximately $100,000 on the exchange would have reduced the realized appreciation gain of approximately $200,000 to a taxable gain of approximately $100,000 based on the Commissioner's rule. Taxpayers no doubt benefit without protest from the application of this rule in such situations.

 

B. THE SEPARATE TRANSACTION PRINCIPLE APPLIED TOGETHER WITH THE COMMISSIONER'S APPLICATION OF REV. RUL. 54-105 RESULTS IN THE IMPOSITION OF AN UNCONSTITUTIONAL TAX ON THE TAXPAYERS' SALE OF THEIR RESIDENCE.

 

If the court agrees with the taxpayers' argument that the imposition of the tax on the unrealized gain resulting from the Commissioner's application of Rev. Rul. 54-105 is unconstitutional, it is unnecessary to address the separate transaction rule as it applies to this transaction. Otherwise the court must review the separate transaction rule as it applies to the taxpayers' purchase and sale of the residence and the underlying mortgage obligation.

 

*6 The Commissioner argues that the district court correctly applied the principles set out in Willard Helburn, Inc. v. Commissioner., 214 F.2d. 815 (1st Cir. 1954), and states that its decision should be affirmed. (Br. p.7.) Under those principles, "where a United States taxpayer purchases property with borrowed foreign currency, a gain or loss arises upon repayment of the loan, as a result of fluctuation in exchange rates between the time of the borrowing and the repayment, and that such gain or loss is independent of any gain or loss realized on the disposition of the property purchased with the borrowed funds." (Br. p. 7.)

 

The taxpayers are not suggesting that the separate transaction rule as set out in Willard Helburn, Inc. be overruled. Rather the taxpayers argue that the alternative analysis considered in Willard Helburn, Inc. can be applied to the taxpayers' transaction to reach a constitutional result. "The court said that Helburn might have treated the transaction in either of two ways. The purchase of lambskins and the various financial arrangements could have been treated as a single, integrated transaction, in which case the inventory value would have been reduced by the gain from the devaluation of the pound; or, the purchases could have been viewed as separate from the financial arrangements, the inventory cost determined at the dollar equivalent at the accrual date exchange rate, and the gain or loss on the financial arrangements taken separately. By *7 taking the lambskins into inventory at the accrual rate of 4.04, Helburn chose to treat the financial arrangement as separate from the purchase of merchandise." D. Ravenscroft, Taxation and Foreign Currency 59 (1973).

 

In adopting the separate theory, the court was motivated by the fact that Helburn had an opportunity to minimize U.S. income taxes by its treatment of the transaction. The court rightfully found that Helburn 'could not have its cake and eat it too'. It could not both use the high cost basis for the lambskins and exclude the exchange-rate-change gain from gross income. The Helburn court did not suggest that the integrated transaction method was improper in other factual circumstances.

 

Taxpayers argue that the integrated transaction rule can and should be applied to the taxpayers' sale transaction in order to reach a constitutional result. The taxpayers' underlying borrowing is irrevocably tied to the foreign currency-denominated asset. [FN4] The taxpayers' purchased the U.K. residence with a 100 percent purchase money mortgage; there were no principal payments other than the periodic refinancings of the residence in pounds. The taxpayers had no opportunities to use the proceeds of the pound-denominated mortgage for any other purpose. Therefore, the *8 taxpayers had no opportunity to minimize their tax obligation as a result of their pound-denominated mortgage borrowing. [FN5]

 

FN4. In applying the separate transaction rule to the facts in National-Standard Co. v. Commissioner, 80 T.C. 551 (1983), aff'd 749 F.2d 369 (6th Cir. 1984), Justice Dawson notes in footnote #2 of the concurring opinion that the court did not know whether or not the borrowings were irrevocably invested in the assets.

 

 

FN5. Had the taxpayers borrowed U.S. dollars instead of pounds to finance the purchase, the taxpayers could have incurred, depending on the exchange rate fluctuations, U.K. income taxes on U.S. dollar borrowings and payoffs.

 

 

There is no reason to apply the separate transaction rule to the taxpayers' transaction. To treat the purchase, sale, loan borrowing, and payoff as an integrated transaction is a more reasoned application of Willard Helburn, Inc. [FN6] Otherwise the taxpayers will be taxed on an unrealized exchange gain without the amelioration of the net exchange loss on the borrowings. Taxpayers argue that the integrated transaction analysis of Helburn can and should be applied to reach a constitutional result for the taxpayers. [FN7]

 

FN6. The Commissioner argues that, as explained in Willard Helburn, Inc., by purchasing property with foreign currency, taxpayers "necessarily involved [themselves] in a speculation on foreign exchange." (Br. p. 12, 13) Webster's dictionary defines speculate as: "to assume a business risk in hope of gain; to buy or sell in expectation of profiting from market fluctuations." It is a stretch to suggest that individuals living and working in a pound-denominated economy are involved in foreign currency speculation when they buy a house for a pound-denominated value with a pound-denominated mortgage. It is also inconsistent with the Commissioner's argument that this is a personal transaction to which I.R.C. § 165 applies to disallow the unrealized exchange loss on the borrowings.

 

FN7. U.S. taxpayers not before the court, who have assets originally acquired in the foreign currency for which there is no irrevocable borrowing, would not be similarly situated. Appellant-taxpayers suggest that the more rational approach to on-going litigation of such matters would be the promulgation of Regulations by the Commissioner as allowed by Congress pursuant to I.R.C. § 985(a).

 

*9 CONCLUSION

 

For the foregoing reasons, the judgment of the district court should be overruled.

 

Appendix not available.