Before: Mayer, Chief Judge, Rich and Rader, Circuit Judges.
The opinion of the court was delivered by: Mayer, Chief Judge.
Appealed from: United States Court of Federal Claims Judge John P. Wiese United States Court of Appeals for the Federal Circuit
Cenex, Inc. appeals the judgment of the United States Court of Federal Claims, No. 92-CV-97, which granted the United States' motion for summary judgment that losses associated with Cenex's investment in Energy Cooperative, Inc. are capital losses and that Cenex's payments to Northern Tier Pipeline Company for shutdown costs were contributions to capital that deserve capital loss treatment. Because the court correctly characterized these losses as capital ones, we affirm.
Cenex, Inc. is an agricultural cooperative corporation that sells, inter alia, petroleum products to farmers and ranchers. In 1975, in order to obtain an assured supply of refined petroleum products, Cenex and eight other regional cooperatives established a corporation, ultimately named Energy Cooperative, Inc. ("ECI"), to operate an oil refinery. ECI's corporate structure was set up so that ownership of ECI stock was required to purchase ECI's petroleum products and ECI's output was allocated among its owners based on the number of shares each held. Between 1975 and 1981, Cenex purchased $14,615,701 of ECI preferred stock and $1,000 of common stock, and received "$129,600 of ECI stock as part of its patronage dividend distribution." Each share of stock had a par value of $100.00. The preferred stock had no voting rights and was not entitled to dividends, but had preference over common stock upon liquidation.
ECI did not have a long-term supply of crude oil, its refinery was old and had a limited capacity to produce unleaded products, and its product prices were not competitive. As a result of these handicaps and other factors, ECI filed for bankruptcy under Chapter 11, 11 U.S.C. §§ 1101-1174, in May 1981, but converted this proceeding to a liquidation under Chapter 7, 11 U.S.C. §§ 701-766, in 1984, which rendered its stock worthless. Cenex's 1984 tax return listed a loss of $14,745,301 attributable to its investment in ECI, which it characterized as ordinary under I.R.C. § 165(a). After an audit, the Internal Revenue Service ("IRS") determined that the loss was a capital one, deductible only in accordance with I.R.C. §§ 165(f), 1211(a), and 1212(a). This characterization is significantly less desirable for Cenex because its ordinary losses are deductible from ordinary gain, whereas its capital losses offset only capital gain, which is generally taxed at a lower rate than ordinary gain. See I.R.C. § 1211(a); compare I.R.C. § 1201(a)(2) with § 11(b).
During the audit of Cenex's 1984 return, the IRS also determined that Cenex had mischaracterized a loss stemming from Cenex's ownership in Northern Tier Pipeline Co. ("Northern Tier"), which was established to construct and operate a pipeline from Washington state to Minnesota. Cenex purchased stock in and made loans to Northern Tier in 1979. In 1982, Cenex and the other owners entered into an agreement ("the 1982 Agreement") that modified the terms of previous loan notes issued to Northern Tier and established liability for shutdown costs in the event that the company abandoned its plan to construct the pipeline. In 1983, Northern Tier abandoned the pipeline project and made "cash calls" to its owners to cover the costs of shutting down. In 1983 and 1984, Cenex made shutdown payments to Northern Tier of $75,465 and $184,762, respectively. On its 1983 and 1984 tax returns, Cenex deducted these payments as bad debt, which is deductible as an ordinary loss under I.R.C. § 166(a)(1). The IRS ruled that the shutdown payments were not loans, but capital contributions which give rise to capital losses. See Treas. Reg. § 1.166-1(c) ("A . . . contribution to capital shall not be considered a debt for the purposes of section 166.").
Cenex sued for a tax refund resulting from these two losses. In response to the parties' cross motions for summary judgment directed to the interpretation of the relevant provisions of the Internal Revenue Code and the 1982 Agreement, the Court of Federal Claims held that Cenex's stock in ECI was a capital asset and that its shutdown payments to Northern Tier were capital contributions. Cenex appeals.
"Summary judgment is appropriate when there is no genuine issue as to any material fact and the moving party is entitled to judgment as a matter of law." Barseback Kraft AB v. United States, 121 F.3d 1475, 1479 (Fed. Cir. 1997). In light of the absence of a genuine issue of material fact here, our focus is whether the Court of Federal Claims properly construed provisions of the Internal Revenue Code and the 1982 Agreement. Accordingly, our review is de novo. See id.; Gump v. United States, 86 F.3d 1126, 1127 (Fed. Cir. 1996) ("We review the summary judgment of the Court of Federal Claims, as well as its interpretation and application of the governing law, de novo.").
We first address whether the inventory exception of I.R.C. § 1221(1) applies to Cenex's ownership of ECI stock. Section 1221 defines capital assets as all "property held by the taxpayer (whether or not connected with his trade or business)" except for five types of property enumerated in the section. Id. These five "listed exceptions are exclusive." Arkansas Best Corp. v. Commissioner, 485 U.S. 212, 218 (1988). The first one includes "stock in trade of the taxpayer or other property of a kind which 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 his trade or business." I.R.C. § 1221(1). Cenex argues that its ownership of stock in ECI qualifies as "other property of a kind which would be properly included in the inventory of the taxpayer if on hand at the close of the taxable year." Recognizing that its ECI stock is not actually inventory, *fn1 Cenex argues that it should be considered an inventory substitute because it was purchased in order to obtain a supply of petroleum products, which are actual inventory in its business.
The legislative history of section 1221 sheds no light on the type of property qualifying as "other property of a kind which would be properly included in the inventory of the taxpayer if on hand at the close of the taxable year." The Supreme Court has interpreted this phrase broadly, however, to include substitutes for inventory, such as "hedging transactions that are an integral part of a business' inventory-purchase system." Arkansas Best, 485 U.S. at 222. The Court offered no guidance on the kind of business arrangement or asset that qualifies as this type of transaction except that the corn futures in Corn Products Refining Co. v. Commissioner, 350 U.S. 46 (1955), did so.
In Corn Products, the taxpayer was a manufacturer of products made from corn, such as starch, syrup, sugar, feed, and oil. The taxpayer's storage capacity could handle only a three week supply of corn. After experiencing sharp increases in the price of spot corn as a result of droughts, the taxpayer began buying corn futures to stabilize its inventory costs. "At harvest time each year it would buy futures when the price appeared favorable. It would take delivery on such contracts as it found necessary to its manufacturing operations and sell the remainder in early summer if no shortage was imminent. If shortages appeared, however, it sold futures only as it bought spot corn for grinding. In this manner it reached a balanced position with reference to any increase in spot corn prices. It made no effort to protect itself against a decline in prices." Corn Prods., 350 U.S. at 48-49 (footnote omitted). The taxpayer opted to characterize the gains and losses on its futures transactions as capital ones. "Both the Tax Court and the Court of Appeals found [the taxpayer's] futures transactions to be an integral part of its business designed to protect its manufacturing operations against a price increase in its principal raw material and to assure a ready supply for future manufacturing requirements." Id. at 50. Based on this integral relationship between the futures and the taxpayer's manufacturing enterprise, the Treasury's consistent treatment of bona fide hedging transactions as a ...