Securities Transfer Is Not a Securities Lending Arrangement

By James Beavers, J.D., LL.M., CPA

In a case of first impression, the Tax Court held that a billion dollar–plus securities transaction was not a securities lending arrangement under Sec. 1058 because its terms reduced the opportunity for gain to the transferor of the securities in the transaction for almost the entire transaction period.


Henry Samueli, billionaire co-founder of Broadcom Corporation, and his wife purchased approximately $1.64 billion of securities from a securities broker, Refco Securities, in October 2001. The Samuelis simultaneously transferred the securities back to Refco per Refco’s promise to transfer identical securities to the Samuelis on January 15, 2003. Refco also transferred $1.64 billion to the Samuelis as “cash collateral” for the securities. Under the agreement, the Samuelis were required to pay Refco a fee for the use of the cash collateral.

The agreement between the Samuelis and Refco allowed the Samuelis to require an earlier transfer of the identical securities only by terminating the transaction on July 1 or December 2, 2002. The Samuelis did not require an earlier transfer and sold the securities to Refco on January 15, 2003. The Samuelis treated the transaction as a securities lending arrangement subject to Sec. 1058 and reported an approximate $50.6 million long-term capital gain on the transaction in 2003. They also deducted as interest their portion of the almost $8 million in fees paid for the use of the cash collateral during the transaction period.

The IRS determined that the transaction was not a securities lending arrangement subject to Sec. 1058. Instead, it ruled that the Samuelis purchased the securities from and immediately sold them to Refco in 2001 at no gain or loss and then repurchased the securities from Refco (under a forward contract) and immediately sold them back in 2003, realizing an approximate $13.5 million short-term capital gain. The IRS also disallowed all of the Samuelis’ interest deductions because, under its characterization of the transaction, the debt that the Samuelis claimed the agreement created never existed.

Sec. 1058(b)

If an agreement to transfer securities qualifies as a securities lending arrangement under Sec. 1058, the transfer will not result in gain recognition to the transferor. Under Sec. 1058(b), an agreement qualifies as a securities lending arrangement if it:

  • Provides for the return to the transferor of securities identical to the securities transferred;
  • Requires that payments be made to the transferor of amounts equivalent to all interest, dividends, and other distributions that the owner of the securities is entitled to receive during the period beginning with the transfer of the securities by the transferor and ending with the transfer of identical securities back to the transferor;
  • Does not reduce the risk of loss or opportunity for gain of the transferor of the securities in the securities transferred; and
  • Meets such other requirements as the IRS may prescribe by regulation.

The Tax Court’s Decision

The Tax Court held that the Samuelis’ agreement was not a securities lending arrangement under Sec. 1058 because its terms reduced the Samuelis’ opportunity for gain in the securities transferred in the transaction for almost all of the transaction period. It also held that the IRS had properly recharacterized the securities transfers as two separate sales and that the Samuelis had a short-term capital gain in 2003 and were not entitled to the interest deductions they claimed related to the agreement.

The Tax Court focused on Sec. 1058(b) (3), which requires that to be considered a securities lending arrangement, a securities transfer agreement must “not reduce the risk of loss or opportunity for gain of the transferor of the securities in the securities transferred.” It concluded that the Samuelis’ transfer agreement reduced the opportunity for gain in the securities transferred for purposes of Sec. 1058(b)(3) because the agreement prevented the Samuelis from causing Refco to transfer the securities to them on all but three days of the approximately 450-day transaction period.

Absent the agreement, the Samuelis could have sold the securities and realized an inherent gain whenever they wanted to simply by instructing their broker to execute a sale. According to the Tax Court, the agreement severely reduced the Samuelis’ ability to realize such an inherent gain because the Samuelis could realize such a gain only if the gain existed on one or more of the three stated days, instead of being able to sell the securities whenever there was an opportunity for a profitable sale.

In their defense, the Samuelis argued that the transaction agreement did not reduce their opportunity for gain because they retained the opportunity for gain at the end of the loan period. The Tax Court rejected this argument, stating that the statute does not speak to whether the opportunity for gain was “retained,” merely whether it was “reduced.”

The Samuelis further argued that the Tax Court should consider the effect of the financing agreement tied to the loan of the securities or the fact that the Samuelis could have locked in a gain on the transfer by purchasing an option to sell the securities at a fixed price in a separate transaction. Noting that Sec. 1058 refers to an “opportunity for gain of the transferor of the securities in the securities transferred,” the Tax Court refused to consider anything other than the opportunity for gain on the transferred securities.

Having determined that the transaction was not a securities lending arrangement, the Tax Court considered the IRS’s recharacterization of the transaction. It found that, as the IRS argued, the economic reality of the transaction was that it was two separate sales of the securities without any debt obligation being created. Treating the transaction as such, it held that the Samuelis had no gain or loss on the first sale of the securities in 2001 and a short-term capital gain on the second sale in 2003 and that the Samuelis were not entitled to an interest deduction from the transaction because no debt obligation had existed.


According to Senate Committee Report 95-762, Congress enacted Sec. 1058 to encourage owners of securities to engage in securities lending transactions with brokers to enable them to make deliveries of securities to purchasers within the time required by the relevant market rules. At the time of Sec. 1058’s passage, although the IRS had been treating securities lending transactions as nontaxable dispositions of the loaned securities, there was some uncertainty about the correct tax treatment of these transactions. Therefore, in order to reassure potential lenders who otherwise might be reluctant to enter into securities lending transactions, Congress felt it was necessary to enact a provision that specifically provided that the transactions would not be taxable.

Samueli, 132 T.C. No. 4 (3/16/09)

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