AMERICAN INTERNATIONAL GROUP, INC. - DETERMINATION - 06/20/03

In the Matter of AMERICAN INTERNATIONAL GROUP, INC.

TAT(H) 00-36(GC) - DETERMINATION

NEW YORK CITY TAX APPEALS TRIBUNAL

ADMINISTRATIVE LAW JUDGE DIVISION_

GENERAL CORPORATION TAX – AS ADMINISTRATIVE CODE §11-602.8(b)(6) APPLIES ONLY TO

EXPENSES THAT ARE ATTRIBUTABLE TO SUBSIDIARY CAPITAL, IT COULD NOT BE USED TO

DISALLOW LOSSES ARISING FROM FOREIGN CURRENCY CONTRACTS THAT PETITIONER

ENTERED INTO TO STABILIZE ITS FOREIGN CURRENCY EXPOSURE W ITH RESPECT TO ITS

SUBSIDIARY CAPITAL. MOREOVER, DISALLOW ING THE LOSSES FROM SUCH CONTRACTS

W HILE TAXING THE GAINS W OULD RESULT IN TAX BEING IMPOSED ON SUCH CONTRACTS

EVEN W HERE THERE IS NO ECONOMIC GAIN, AND W HERE NO POTENTIAL EXISTS FOR A

DOUBLE TAX BENEFIT. HOW EVER, AS THE FOREIGN CURRENCY CONTRACTS HEDGE THE

STOCK OF THE SUBSIDIARIES, UNDER THE "MATCHING APPROACH" ADOPTED IN THE

INVESTMENT CAPITAL REGULATIONS, THOSE CONTRACTS SHOULD BE CATEGORIZED AS

SUBSIDIARY CAPITAL W ITH BOTH THE LOSSES AND GAINS FROM THOSE CONTRACTS BEING

EXCLUDED FROM ENTIRE NET INCOME UNDER CODE §11-602.8(a)(1). SINCE THE ADOPTION OF

THE MATCHING APPROACH IN THE INVESTMENT CAPITAL REGULATIONS OCCURRED AFTER

THE TAX YEAR AND CHANGED THE PRIOR INTERPRETATION OF THE STATUTE, THE RULING

THAT THE MATCHING APPROACH REQUIRES THE FOREIGN CURRENCY CONTRACTS TO BE

CATEGORIZED AS SUSBISIDARY CAPITAL W AS NOT APPLIED RETROACTIVELY TO THE TAX

YEAR.

JUNE 20, 2003

For ease of reference, Code provisions are referenced in accordance with1

their current designations rather than the designations that existed during the

Tax Year. Similarly, the regulations thereunder are referenced by their current

designations rather than the designations that existed when they were first

promulgated. Any material changes have been noted.

The Petition was filed in the name of “American International Group,2

Inc. and Combined Subsidiaries.” The “Combined Subsidiaries” were those of AIG’s

subsidiaries with which it filed a combined New York City (“City”) General

Corporation Tax (“GCT”) return. Although the workpapers of the City Department

of Finance (the “Department”) indicate that the audit included Petitioner and the

Combined Subsidiaries, the Petition specifically protests a November 4, 1999

Notice of Disallowance that only lists “American International Group Inc.” Since

AIG is the only corporation to which that notice was sent, it is the only entity

with standing to petition this forum to review that notice. See, Code §11-

680(3)(c)(2). Therefore, the Petition is dismissed as to the “Combined

Subsidiaries.”

NEW YORK CITY TAX APPEALS TRIBUNALADMINISTRATIVE LAW JUDGE DIVISION_ : In the Matter of the Petition : : DETERMINATION of : : TAT(H) 00-36(GC)AMERICAN INTERNATIONAL GROUP, INC.:

:__________________________________:

Gombinski, C.A.L.J.:

Petitioner, American International Group, Inc. (“AIG”),

filed a Petition for Hearing, dated September 28, 2000 (the

“Petition”), for redetermination of a disallowance of a claim for

refund of General Corporation Tax (“GCT”) paid pursuant to former

Title R of Chapter 46 (now Chapter 6 of Title 11) of the City

Administrative Code (the “Code”) for the 1984 calendar year (the1

“Tax Year”).2

By letters dated July 11 and 16, 2001, respectively, Stanton

Alan Young, Esq., Petitioner’s Senior Tax Counsel and

2

representative, and Martin Nussbaum, Esq., Assistant Corporation

Counsel and the representative of the City Commissioner of

Finance (“Commissioner”), agreed to have this matter determined

on submission without a hearing pursuant to the City Tax Appeals

Tribunal (“Tribunal”) Rules of Practice and Procedure, 20 RCNY

§1-09(f).

The parties filed a joint Stipulation of Facts, dated July

13, 2001, with exhibits. Petitioner filed a Memorandum of Law

dated October 3, 2001. Respondent filed a Brief dated January

11, 2002. Petitioner and Respondent filed Reply Briefs dated

February 6, 2002 and April 8, 2002, respectively.

As the Administrative Law Judge who initially presided over

this matter retired from the Tax Appeals Tribunal, this case was

assigned to me for determination. By letter dated October 2,

2002, I afforded the parties the opportunity to submit

supplemental briefing regarding two legal issues that had not

previously been briefed. Those issues are whether foreign

currency forward contracts that are designed to reduce the impact

of foreign currency fluctuations on the U.S. dollar value of the

stock of subsidiary corporations (which, for convenience, are

referred to in this determination as “foreign currency

contracts”) should be deemed to constitute subsidiary capital by

analogy to 19 RCNY §11-37(g) which deals with investment capital;

and, if so, whether such treatment could be applied

retroactively. Petitioner had previously raised and summarily

dismissed the possibility that foreign currency contracts could

be categorized as subsidiary capital, but did so without

reference to the investment capital regulations.

Those issues are whether the disallowance made by the Commissioner3

pursuant to Code §11-602.8(b)(6) was required to prevent a double tax benefit

since future foreign currency fluctuations could (a) reduce or eliminate any

potential for double taxation by their impact on the U.S. dollar value of the

stock of Petitioner’s subsidiaries, and (b) result in taxable gains being

realized on similar future foreign currency contracts; whether deductions that

are not for expenses but are for losses that arise from business capital (the

gain on which would be taxable as business income) should be disallowed under

Code §11-602.8(b)(6) as being deductions directly attributable to another type

of capital (i.e., subsidiary capital); and whether the disallowed Loss was the

total amount of losses from Petitioner’s foreign currency contracts relating to

subsidiaries or the net loss from such contracts (i.e., the total of all losses

less all gains from such contracts), and whether it is proper to net gains and

losses from such foreign currency contracts during the same tax year.

3

At the request of the Commissioner’s representative, a

telephone conference addressing my letter was held on October 4,

2002. During that conference, as I confirmed in a letter dated

October 7, 2002, the scope of the supplemental briefing was

expanded to include several additional concerns that I raised

during that conference which had not previously been addressed. 3

Petitioner and Respondent filed Supplemental Briefs dated,

respectively, November 25, 2002 and November 26, 2002.

Petitioner and Respondent each filed a Reply Supplemental brief

dated December 12, 2002. Respondent, however, amended its Reply

Supplemental Brief without leave of this forum, and in doing so,

addressed issues raised in Petitioner’s Reply Supplemental Brief.

Consequently, Petitioner was permitted to file a Reply

Memorandum, dated December 20, 2002. Robert Firestone, Esq.,

Assistant Corporation Counsel, participated in the Commissioner’s

supplemental briefing.

Unless otherwise indicated, all statements herein refer to the Tax Year.4

4

ISSUES

Whether the loss arising from foreign currency contracts

that Petitioner entered into to stabilize its foreign currency

exposure with respect to its subsidiary corporations was properly

disallowed as either a deduction directly attributable to

subsidiary capital under Code §11-602.8(b)(6) or as a loss from

subsidiary capital under Code §11-602.8(a)(1) and, if so, whether

such a disallowance represents a change in policy that should not

be applied retroactively.

FINDINGS OF FACT

The facts set forth below are based upon the stipulated

facts and submitted exhibits.4

1. Petitioner, whose principal office was located in the

City, is a Delaware corporation and the parent of a group of

corporations that were engaged in a broad range of insurance and

insurance–related businesses in the United States. Petitioner’s

subsidiary corporations operated in approximately 130

jurisdictions worldwide.

2. Petitioner and the Combined Subsidiaries timely filed a

combined City GCT return on Form NYC-3A and timely paid the tax

shown as due thereon.

3. Petitioner’s consolidated financial statements: (a)

included its subsidiaries; (b) were filed with the Securities and

Exchange Commission; (c) were published in Petitioner’s Annual

Shareholders Report; and (d) were denominated in U.S. dollars.

The Stipulation of Facts also provides that Petitioner had the option5

of reducing its translation exposure by using forward exchange contracts and

purchase options where their cost was reasonable and the markets were

sufficiently liquid.

5

4. During the Tax Year, much of Petitioner’s subsidiaries’

revenue and expenses were earned and incurred in foreign

currencies. Similarly, a significant portion of the assets owned

and liabilities owed by Petitioner’s foreign subsidiaries and

U.S. subsidiaries with foreign branches (the “Subsidiaries”) were

denominated in foreign currencies.

5. Since the foreign business operations were conducted in

the currencies of the local operating environment, when

Petitioner’s foreign currency net investment was affected by

changes in the foreign exchange rates relative to the U.S.

dollar, exchange gain or loss occurred from one reporting period

to the next.

6. Since fluctuations arising from foreign exchange rates

could result in a reduction in the U.S. dollar value of the

Subsidiaries’ foreign currency denominated assets, undistributed

earnings, and contributed capital, AIG had foreign currency

exposure from its investments in the Subsidiaries.

7. Petitioner’s Foreign Exchange Operating Committee

evaluated each of its worldwide consolidated foreign currency net

asset or liability positions and managed Petitioner’s translation

exposure to adverse movement in currency rates, including

Petitioner’s foreign currency exposure from its investments in

the Subsidiaries. 5

Petitioner has not asserted that it is entitled to any part of the6

denied refund as a result of the Commissioner’s concession regarding this issue.

6

8. To stabilize its foreign currency exposure, Petitioner

entered into foreign currency contracts, primarily forward

contracts, in which it agreed to deliver or receive a set amount

of a specific foreign currency at a future date at a fixed price

in U.S. dollars (the “Foreign Currency Contracts”).

9. During the Tax Year, Petitioner realized a net loss of

$3,590,460 on the Foreign Currency Contracts (the “Loss”). The

Loss was deducted on Petitioner’s City GCT return.

10. Petitioner requested a refund for the Tax Year. The

Department granted Petitioner most of the requested refund but

denied $94,716.97 of the amount requested in a Notice of

Disallowance, dated November 4, 1999. The bases for the

disallowance were that: (a) the Loss (which the Notice of

Disallowance described as: “Capital Loss disallowed Re:

Subsidiary Capital hedging transactions”) was a deduction

directly attributable to subsidiary capital; and (b) the

computation of Petitioner’s insurance company subsidiary issuer

allocation percentage should be based on a ratio of City premiums

to total premiums. Respondent no longer asserts the second

issue, leaving the deductibility of the Loss as the only basis

for the disallowance.6

11. The schedule of the Department’s auditor entitled

“Computation and allocation of entire net income – 1984,” shows a

total combined entire net income, as adjusted, of $15,793,660 and

allocated taxable income of $8,039,660.

Although Respondent states on p. 2 of her brief that the Losses “were7

offset by, corresponding increases in the dollar equivalent amount of

Petitioner’s investments in its subsidiaries,” an exact correlation would be

highly unlikely. See, Shoup, The International Guide to Foreign Currency

Management (Glen Lake Pub. Co., 1998), which states that due to the inherent

imprecision of hedging transactions, the offsetting of gains and losses will

“hardly ever result. . . in complete offsets.” Id. at 190.

7

12. On January 26, 2000, Petitioner timely filed a Request

for Conciliation with the Department’s Conciliation Bureau in

which it requested a refund of City GCT in the amount of

$94,716.97.

13. On August 3, 2000, the Department’s Conciliation Bureau

issued a Conciliation Decision to Petitioner discontinuing the

conciliation proceeding.

14. Petitioner timely filed a Petition for Hearing with the

Tribunal, dated September 28, 2000, requesting a refund of City

GCT of $94,716.97 for the Tax Year.

POSITIONS OF THE PARTIES

The Commissioner asserts that the Loss is directly

attributable to subsidiary capital since the Foreign Currency

Contracts would not have been entered into but for Petitioner’s

holding of the stock of the Subsidiaries. She asserts that

allowing the Loss would create a double tax benefit since the

same foreign currency fluctuations that resulted in the Loss

generated a concomitant increase in the net worth (book value) of

the Subsidiaries’ stock as translated into U.S. dollars. 7

Petitioner counters that the Loss was not directly

attributable to the stock of the Subsidiaries and did not result

in a double tax benefit because the Foreign Currency Contracts

The Commissioner states on page 14 of her Supplemental Brief that:8

The taxpayer reported the net loss on the tax return, and

. . . that was the amount that was picked up by the auditor and

disallowed. . . . It is the City’s position that this was

incorrect, although it is conceded that it might have been

administratively feasible and expeditious to handle it in this

way. The reasoning supplied in this brief would support taxing

the gains as business income in full, and disallowing the

losses, the excess basis of which has absolutely nothing to do

with the taxable gains on the other contracts.

The information needed to assert a deficiency attributable to the gross amount

of gain from the Foreign Currency Contracts is not in the record and the

Commissioner has not sought to assert such a deficiency.

8

were separate assets that generated their own independent gains

and losses and, thus, had no impact on the value of the stock of

the Subsidiaries.

In the additional briefing, both parties asserted that the

Foreign Currency Contracts constitute business capital and cannot

be categorized as subsidiary capital by analogy to the investment

capital regulations. The Commissioner also asserted, in response

to my inquiry, that gains from foreign currency contracts should

be taxable as income from business capital, and that losses from

such contracts should be disallowed as being attributable to

subsidiary capital, even where the gains and losses from those

foreign currency contracts arise in the same taxable year.8

CONCLUSIONS OF LAW

The GCT imposes a tax on every corporation doing business in

the City upon the greatest of: (1) entire net income (“ENI”)

allocable to the City; (2) total business and investment capital

allocable to the City; (3) modified (30% of) ENI, plus

compensation paid to officers and greater than 5% shareholders

(subject to certain adjustments); or (4) a minimum tax of $125.

Code §§11-603.1 and 11-604.1.E. For the Tax Year, Petitioner and

9

the Combined Subsidiaries computed their GCT liability based on

ENI.

ENI is a taxpayer’s total net income from all sources. Code

§11-602.8. It is computed by modifying federal entire taxable

income. Id. One such modification is that income and gains from

subsidiary capital are excluded from ENI to the extent that they

were included in federal taxable income. Code §11-602.8(a)(1).

Subsidiary capital is defined Code §11-602.3 as “investments in

the stock of subsidiaries and any indebtedness from subsidiaries”

exclusive of certain accounts receivable. A corporation is a

subsidiary if the taxpayer owns over 50% of its voting stock.

Code §11-602.2.

As a necessary corollary to the exclusion of gains and

income from subsidiary capital, losses from subsidiary capital

are excluded from ENI under Code §11-602.8(a)(1). In addition,

the Commissioner has the discretion, under Code §11-602.8(b)(6),

to exclude from ENI interest and other expenses directly

attributable to subsidiary capital and interest expenses

indirectly attributable to subsidiary capital. After the Tax

Year, in 1988, Code §11-602.8(b)(6) was amended to expand the

Commissioner’s discretionary authority to include expenses

indirectly related to subsidiary capital.

The purpose of Code §11-602.8(b)(6) is to prevent a parent

corporation from obtaining a double tax benefit by taking a

deduction relating to its investment in its subsidiaries while,

at the same time, any income derived from such investment would

be tax-free. Matter of Playboy Enterprises, Inc., TAT(E) 93-

879(GC), et. al. (City Tribunal, December 11, 2002). See, also,

Matter of F.W. Woolworth Co. v. State Tax Comm’n., 126 A.D.2d 876

Business income is allocated to (and thus taxable by) the City in9

accordance with the taxpayer’s business allocation percentage, which is a

percentage determined by comparing its property, payroll and receipts within the

City to its total property, payroll and receipts. Code §11-604.3(a). Investment

income, on the other hand, is allocated to (and thus taxable by) the City in

accordance the issuer’s allocation percentage of the issuer or obligor of the

investment capital. Code §11-604.3(b). Due to the more favorable allocation,

and thus tax treatment, that is generally attendant to income from investment

capital, the Commissioner has also been granted discretionary authority to

allocate “any deductions allowable in computing entire net income which are

directly or indirectly attributable to investment capital or investment income.”

Code §11-602.5(a). For brevity, references in this determination to deductions

attributable to subsidiary or investment capital also include deductions

attributable to the income and gains from such capital.

10

(3 Dept. 1987), aff’d mem., 71 N.Y.2d 907 (1988), whichrd

addressed Tax Law §208.9(b)(6), the New York State (“State”)

counterpart to Code §11-602.8(b)(6); Statement of Audit Procedure

96-1-GCT (January 29, 1996) (“SAP 96-1”), which states:

Consistent with New York City’s longstandingtradition as a center of corporateheadquarters, under the GCT, . . . investmentincome generally is allocated to the City ata lower percentage than business income, and,for GCT purposes, income, gains and lossesfrom subsidiary capital are excluded fromentire net income. There is, however, a taxon subsidiary capital, but it is imposed at avery low rate. The purpose of expenseattribution is to avoid a double tax benefitresulting from giving favorable tax treatmentto income from investment and subsidiarycapital while simultaneously allowing adeduction against business income forexpenses related to investment or subsidiarycapital.9

The parties agree the Loss only can be excluded from ENI if

its allowance could give rise to a double tax benefit.

Petitioner asserts that the Loss could not give rise to a double

tax benefit because the Foreign Currency Contracts could not have

directly affected the value of the Subsidiaries and thus their

Petitioner supports this assertion by referencing a factual finding in10

Hoover Co. v. Commissioner, 72 T.C. 206, 242 (1979), nonacq., 1980-2 C.B. 2,

nonacq. withdrawn in part and acq. in part, 1984-2 C.B. 1. There, the taxpayer

argued, in an attempt to obtain an ordinary loss deduction for losses arising

from similar foreign currency contracts, that such contracts were either a form

of insurance or that they hedged the ordinary business assets of their

subsidiaries (vis-a-vis hedging the stock of the subsidiaries which would have

resulted in a capital loss). The Tax Court found that the foreign currency

contracts were not related to (and could not be characterized in the same manner

as) the ordinary income generating assets of the subsidiaries since they did not:

(1) provide capital for the subsidiaries which increased their earnings capacity

and hence their (non-taxable) dividend payments to their parent; (2) finance the

acquisition of a subsidiary that could be sold tax free; or (3) directly affect

the value of any subsidiary since each of the subsidiaries would be sold at the

same gain or loss regardless of whether petitioner entered into such contracts.

The Tax Court in Hoover thus found that the foreign currency contracts did not

hedge the ordinary business operations of the subsidiaries. However, the court

further stated that those contracts (which hedged the stock of the subsidiaries)

were sufficiently related to the stock of the subsidiaries that a loss from those

contracts should have the same capital tax character as would a gain or a loss

from such stock.

Therefore salary paid to a parent corporation’s employee to monitor the11

parent’s investment in the subsidiary (such as stewardship expenses which do not

benefit the subsidiary’s ability to earn income) is as attributable to subsidiary

capital as is salary paid by the parent to that same individual to directly

assist in the business operations of the subsidiary (which would directly benefit

the subsidiary). See, 19 RCNY §11-69(c)(2); SAP 96-1.

11

ability to generate additional exempt gain or income.10

Attribution, however, does not apply only to deductions that

impact a subsidiary’s ability to earn income and generate gain.

It also applies to deductions that directly relate to a taxpayer

carrying or maintaining its investment in a subsidiary.

Otherwise, expenses incurred by a corporation, solely in its

capacity as a shareholder of a subsidiary, which do not further

the subsidiary’s generation of income, would be included in the

computation of ENI and result in a double tax benefit.11

Had the Loss been an expense, the only gain or income to

which it could properly be attributed would be gain or income

arising from the stock of the Subsidiaries and it would be clear

that a double tax benefit exists. The Loss, however, arose from

the Foreign Currency Contracts which the Commissioner asserts

Essentially, foreign currency hedges give a parent corporation the right12

to purchase U.S. dollars in the foreign currency in which the subsidiary operates

at a set price and time. If the value of the subsidiary declines because the

12

constitute business capital. Normally, losses from business

capital are included in determining ENI. The Commissioner

nevertheless claims that because the Foreign Currency Contracts

hedged the stock of the Subsidiaries, the Loss is directly

attributable to subsidiary capital and must be disallowed.

If the Loss is attributed only to the Foreign Currency

Contracts from which it arose, and those hedges are, as the

Commissioner asserts, business capital, then no double tax

benefit would arise from the Foreign Currency Contracts since

both the gains and losses from those hedges would be included in

ENI. The Commissioner, however, claims on page 18 of her Brief

that allowing the Loss can nonetheless result in a double tax

benefit since the Loss offsets a corresponding increase in the

value of the stock of the Subsidiaries:

losses on the currency contracts were offsetby corresponding increases in the net worth(book value) of the subsidiary stocktranslated into U.S. dollars. If Petitioneropts to sell off these subsidiaries ratherthan carry them, or repatriate some of itssubsidiaries’ earnings to fund dividendpayments to its shareholders, the resultinggains [or income] would be excludable fromPetitioner’s income as income from subsidiarycapital. (First emphasis added, footnoteomitted.)

The Commissioner is correct in her analysis. “By

definition, the [foreign currency] hedge reduces the effect of

possible value change by creating an opposite change in value to

counterbalance it.” Shoup, supra at p. 188. Thus, the Loss12

value of that foreign operating currency declines vis-à-vis the U.S. dollar, the

hedges will produce a gain that will offset the decrease in the value of the

subsidiary. However, foreign currency hedges also require that the taxpayer

purchase U.S. dollars in that foreign currency even if the value of that foreign

currency increases. Therefore, if the value of the subsidiary increases because

the value of the foreign operating currency increases vis-à-vis the U.S. dollar,

the hedges will produce an offsetting loss. Consequently, the “reduction of risk

[from hedging] comes at a price: the loss of opportunity to realize a gain on the

exposure.” Shoup, supra, at p. 190.

To warrant the exclusion of a deduction under Code §11-602.8(b)(6),13

there need not exist a guarantee that a double tax benefit will arise. All that

is necessary is that there exist a sufficient relationship between the deduction

and the subsidiary capital to warrant attributing the deduction to any gain or

income that might arise from subsidiary capital. Thus, expenses relating to

subsidiary capital are properly disallowed even though the subsidiary may never

generate income or gain equal to the amount of the deductions that are disallowed

as being attributable to subsidiary capital.

13

could only have occurred if, during the period covered by the

Foreign Currency Contracts, there had been an increase in the

value of the foreign currencies, and thus the U.S. dollar value

of the Subsidiaries and the amount of potentially exempt gain

from subsidiary capital. Therefore, if the stock in the13

Subsidiaries had been sold on the last day of the Tax Year, an

increased amount of exempt gain from subsidiary capital could

have arisen as a result of the same foreign currency fluctuations

that generated the Loss.

A necessary corollary to the Commissioner’s position is that

if foreign currency hedges on subsidiary capital generate gains

(instead of losses), then the value of the subsidiaries and, thus

the amount of potentially exempt gain or income from subsidiary

capital, would decrease. Thus, taxpayers would be subject to a

double tax detriment if the gains on such hedges are, as the

Commissioner asserts, taxable as income from business capital.

See, f.n. 12, supra. Consequently, where foreign currency

contracts produce a loss, taxpayers would have the possibility of

receiving a double tax benefit, and where foreign currency

For federal income tax purposes, a financial instrument will constitute14

a bona fide hedge (and thus not be classified as a capital asset) if there is:

(1) a risk of loss by unfavorable changes in the price of something expected to

be used or marketed in one’s business; (2) a possibility of shifting such risk

to someone else, through the purchase or sale of futures contracts; and (3) an

intention and attempt to so shift the risk. Muldrow v. Commissioner, 38 T.C. 907

(1962). While under federal law, the primary characterization issue is whether

a loss or gain is ordinary or capital, under City law the primary

characterization issue is whether assets constitute business, subsidiary, or

investment capital. Thus, the question of whether the Foreign Currency Contracts

constitute a hedge for City tax characterization purposes is whether they shift

the risk of loss of a decline in the value of subsidiary capital. As the Foreign

Currency Contracts limit the negative impact of foreign currency fluctuations on

the value of the stock of the Subsidiaries, they are hedges. This conclusion was

reached by the Department of Finance whose Notice of Disallowance describes the

disallowance of the Loss as: “Capital Loss disallowed Re: Subsidiary Capital

hedging transactions” (see, Finding of Fact 10, supra). Moreover, neither party

has asserted in their briefs that the Foreign Currency Contracts were anything

other than bona fide hedges.

A “surrogate” or “substitute” is a financial instrument which behaves15

economically like the property being hedged. FNMA, supra at p. 569.

14

contracts produce a gain, taxpayers would be subject to the

possibility of a double tax detriment.

The Commissioner’s desire to match the character of the Loss

from the hedge (the Foreign Currency Contracts) with the

character of any potential gain from the stock of the

Subsidiaries that are being hedged is supported by the current

federal tax treatment of such “integrally related” assets.14

See, Federal National Mortgage Ass’n. (FNMA) v. Commissioner, 100

T.C. 541, 579 (1993), where the United States Tax Court adopted a

“surrogate” approach to find that futures contracts and other15

hedge positions that were taken to protect against interest rate

risk mortgages that were exempt from capital asset treatment

under IRC §1221(a)(4) had a close enough connection to those

mortgages to warrant their receiving conforming tax

characterization:

The hedging positions that FNMA took in thesecurities market in order to protect itsinterest position made these hedging

Corn Products Refining Co. v. Commissioner, 350 U.S. 46 (1955) is16

discussed in f.n. 20, infra.

The federal statute references ordinary property because the critical17

categorization question under federal law is whether a hedge constitutes an

ordinary or a capital asset. See, f.n. 14, supra. Consequently, although the

Internal Revenue Service considers requests for private letter rulings on the

income tax consequences of hedges not covered in the regulations under IRC §988,

“the IRS will not rule on ‘hedges of taxpayer’s investment in a foreign

subsidiary,’ so-called Hoover hedges.” 3 Bittker and Lokken, supra at ¶74.10.1,

f.n. 1. The Tax Court’s decision in Hoover, supra, is discussed in f.n. 10,

supra, and f.n. 34, infra.

This rule also exempts hedging transactions as defined under IRC18

§1221(b)(2)(A), including foreign currency hedges, from IRC §1256 which otherwise

would annually “mark to market” such contracts, requiring gains and losses be

recognized as if the contracts were sold for their then fair market value with

40% of the gain or loss being treated as a short-term capital gain or loss and

15

securities the “surrogates” for the mortgagesit was committed to buy . . . in the samesense that corn futures were surrogates forcorn in Corn Products. The transactions weresurrogates and the income or loss from eachtransaction should have the same character.Thus, we conclude that the petitioner’shedging transactions bear a close enoughconnection to its section 1221[a](4)mortgages to be excluded from the definitionof capital asset.16

In response to FNMA, the IRS changed its position regarding

hedges, promulgating hedging regulations entitled “Transactions

that manage risk.” See, Treas. Reg. §1.1221-2(d); 2 Bittker and

Lokken, Federal Taxation of Income, Estates and Gifts, 3d Ed.

(Warren, Gorham & Lamont, 1999), at ¶57.5.3. Thereafter,

Congress amended IRC §1221 by P.L. 106-170, §532 (the Tax Relief

Extension Act of 1999) to exclude clearly identified hedging

transactions from the definition of a capital asset. IRC

§1221(a)(7). Included in the definition of a hedging transaction

is a “transaction entered into by the taxpayer in the normal

course of trade or business primarily . . . (i) to manage risk of

price changes or currency fluctuations with respect to ordinary

property . . ..” IRC §1221(b)(2)(A). 17 18

60% of the gain or loss being treated as a long-term capital gain or loss.

See, footnote 8, supra. 19

16

Thus, a foreign currency hedge entered into with respect to

property used in a taxpayer’s business that would generate

ordinary income would, in turn, also generate ordinary income or

loss under the Internal Revenue Code. Moreover, IRC §988(d)(1),

which is part of the Internal Revenue Code section that deals

with foreign currency transactions, provides that all

transactions which are part of a “988 hedging transaction” shall

“be integrated and treated as a single transaction or otherwise

treated consistently.” (Emphasis added.) A “988 hedging

transaction” includes any transaction entered into by the

taxpayer primarily to manage risk of currency fluctuations with

respect to property it holds. IRC §988(d)(2)(A)(i).

The Commissioner, however, does not seek to categorize the

Foreign Currency Contracts in the same manner as the stock of the

Subsidiaries that they hedge. Instead, she seeks to match only

the character of losses from foreign currency hedges with the

subsidiary stock being hedged. The Commissioner thus would

exclude all losses from foreign currency hedges from ENI as being

attributable to subsidiary capital, while including all gains

from those same hedges in ENI as constituting gain from business

capital, even where such gains and losses occur in the same tax

year. This approach would effectively treat foreign currency19

hedges as subsidiary capital where there are losses and as

business capital where there are gains.

Bifurcating the character of gains and losses from foreign

currency hedges, or any other asset, is contrary to fundamental

tax policy. While it is usually taxpayers, rather than the

In Corn Products, the Supreme Court had found that the taxpayer had20

ordinary income and loss on sales of corn futures, even though those future

contracts appeared to constitute capital assets since those contracts were

acquired to hedge inventory purchases for the taxpayer’s business of

manufacturing products from corn.

17

taxing authority, who seek to manipulate the tax consequences by

categorizing gains and losses from the same type of asset

differently, the need to avoid such impermissible whipsawing

applies equally to both. The importance of avoiding the type of

mismatching the Commissioner seeks to employ in this case was

clearly enunciated by the United States Supreme Court in Arkansas

Best Corp. v. Commissioner, 485 U.S. 212 (1988), when it limited

the scope of its seminal decision in Corn Products, supra.20

Having found no case which held that gain from the sale of stock

constituted ordinary income because the stock (a capital asset)

had been held for a business purpose, the Supreme Court was

unwilling to foster the abuse that would occur were taxpayers

permitted to manipulate the character of gains and losses by

characterizing the loss on the sale of stock as ordinary based

upon the taxpayer’s purported business purpose for holding that

stock.

The Supreme Court, however, indicated that Corn Products

should still be read as standing for the proposition that, under

the matching approach, hedges of inventory can be treated as

constituting inventory for purposes of applying the Internal

Revenue Code provision that exempts inventory from capital gain

treatment: “Corn Products is properly interpreted as standing

for the narrow proposition that hedging transactions that are an

integral part of a business’ inventory-purchase system fall

within the inventory exclusion of [IRC] § 1221.” Arkansas Best

at 222 (footnote omitted). “[A]lthough the corn futures were not

‘actual inventory,’ their use . . . led the court to treat them

The two hypotheticals presented on pp. 10 and 11 of the Commissioner’s21

Supplemental Brief are not analogous for they discuss the treatment of expenses

and gains relating to and arising from the same asset, rather than losses and

gains arising from the same asset. Moreover, while the expenses involved in the

hypotheticals relate solely to the subsidiary’s business operations, the gains

relate solely to intangible assets owned by the parent which bore the attendant

economic cost of the asset from which gain was realized; i.e., the parent was the

tenant responsible for lease payments under a bargain lease and the parent paid

the additional premiums that would have been required for it to obtain a “cash

surrender value” in an insurance policy.

18

as substitutes for the corn inventory so that they came within a

broad reading of ‘property of a kind which would properly be

included in the inventory of the taxpayer’ in § 1221.” Id. at

221.

The conclusion that losses and gains from the same asset

should be categorized consistently is further supported in Treas.

Reg. §1.865-2(a)(1), which addresses the issue of how to “source”

or allocate the income of foreign (i.e., alien) taxpayers to the

United States. This regulation provides that a loss recognized

with respect to stock should be allocated to the class of gross

income that would have included gain from that transaction had

there been a gain rather than a loss. See, also, Treas. Reg.

§1.865-1(a)(1). The Commissioner (who cited to the federal

sourcing regulations to support her analogy regarding stewardship

expenses), has offered no cogent explanation why losses should

not similarly follow gains in this instance. Nor has she

demonstrated any instance in which it would be appropriate to

characterize gains and losses from the same type of asset

differently. 21

The whipsawing that would occur here would be particularly

egregious. The categorization of a loss as capital under federal

law primarily effects the timing and value of such loss (as a

corporation’s capital losses can only offset its capital gains

19

under IRC §1211(a) and those gains are taxed more favorably than

ordinary income under IRC §1201(a)). However, categorizing

losses from foreign currency contracts as being losses

attributable to subsidiary capital under Code §11-602.8(b)(6)

(rather than being losses from subsidiary capital under Code §11-

602.8(a)(1)), would result in such hedges being taxed on a gross

basis. Taxing gains and income from assets and activities on a

gross basis is highly disfavored under the tax law. Other than

for limited public policy concerns (such as the disallowance of

deductions for illegal bribes, kickbacks, and other similar

payments under IRC §162(c)), even generally disallowed losses are

permitted to offset the gains from similar assets and activities

under the Internal Revenue Code. See, IRC §§1211 and 1212,

capital losses are allowed to the extent of a corporation’s

capital gains; IRC §183(b), the “hobby loss rule,” under which

deductions relating to activities which were not engaged in for

profit are nevertheless allowed to the extent of the gross income

derived from such activity; and IRC §165(d), gambling losses are

allowed to the extent of gambling gains.

The same concept applies with regard to hedges under federal

law. IRC §1256(e)(4)(A) provides that even as to limited

partners and limited entrepreneurs, a hedging loss will be

allowed to the extent of the taxable income of such taxpayer that

is attributable to the trade or business in which the hedging

transactions were entered into. IRC §1256(e)(4)(B) further

provides that hedging losses can even be taken in excess of

taxable income described in IRC §1256(e)(4)(A) where and to the

extent that there is an “economic loss.” IRC §1256(e)(4)(B).

The inequity of taxing gross (rather than net) gain is

exacerbated by the nature of foreign currency hedges. For

By illustration, the Federal Reserve Statistical Release regarding G522

Foreign Exchange rates indicates that the British pound sterling was worth

approximately U.S. $1.51 in April of 1996 and was again worth the same amount in

September of 2002, over six years later. In the interim, the pound appreciated

to $1.65, before proceeding to decline as low as $1.40. Therefore, in a six

year period, the pound rose over 9%, then dropped by of over 15%, before again

rising by 7.8% to return to the rate of exchange against the dollar that had

existed in April 1996. Moreover, within each broad increase and decline,

numerous smaller but similarly profound fluctuations occurred. Had a series of

foreign currency contracts been entered into regarding these currencies during

this six year period, they likely would have resulted in both significant gains

and losses even though the foreign currency exchange rate between the pound

sterling and the dollar would have had no impact on the value of subsidiary

corporations.

20

foreign currency contracts are far more likely than other assets

(such as publicly traded stock) to give rise to significant

amounts of gross gains and losses. This occurs because foreign

currency fluctuations are not linear and trend in both

directions. Moreover, foreign currency hedges are usually not

long-lived, particularly in comparison to the hedged stock of

subsidiaries which are often held for long periods since they

conduct integrally related business operations that otherwise

would be conducted directly by the parent. Thus, foreign

currency hedges of subsidiary capital are likely to yield gross

gains that greatly exceed the amount of the net gain, if any,

from such hedges. 22

Under the Commissioner’s position, not only would all gross

gains from foreign currency hedges on subsidiary capital be taxed

with no benefit being afforded the losses from those same hedges,

but this would occur even where the foreign currency exchange

rate has not changed over the period at issue and, therefore,

there is no potential for any double tax benefit. For example,

assume that over a ten-year period a foreign exchange rate

fluctuated in both directions but returned to its original

position. If, as a result of such fluctuations, a taxpayer

realized $50 million of gross gains and $50 million of gross

Losses arise when the amount realized from the sale or other exchange23

of a capital asset is less than the taxpayer’s adjusted tax basis in the asset;

e.g., the cost of acquiring that asset less the applicable depreciation

deductions. See, IRC §§165(b), 165(f), 1001(a), and 1011.

The term expense is defined in Smith, West’s Tax Law Dictionary, 200324

Ed., at pp. 327-328: “In general, the term [expenses] refers to the currentcosts of carrying on an activity . . . [and] do[es] not include capital

expenditures. Capital expenditures are recovered, if at all, through

depreciation and amortization of the asset.” A capital expense that is not

recovered is a loss. See, also, 1 Bittker and Lokken, supra at ¶20.4.1 (the

basic difference between business expenses and capital expenditures is that

expenses are deducted when paid or incurred, while capital expenditures are

written off over a period of time).

This is because: (A) business income is defined Code §11-602.7 as entire25

net income minus investment income; (B) entire net income is defined under Code

§11-602.8 as total net income from all sources, which is presumed to be the same

as the entire taxable income the taxpayer is required to report to the United

States Treasury Department, subject to certain modifications; (C) taxable income

is defined in §63(a) of the Internal Revenue Code of 1954, amended (“IRC”), as

gross income minus deductions allowed by Chapter 1 of the IRC (§§1 through 1399);

and (D) deductions are allowed under IRC §§165(a) and 165(f) for losses that are

not compensated for by insurance, including capital losses, but only to the

extent of capital gains due to the restrictions provided in IRC §§1211 and 1212.

21

losses on foreign currency hedges relating to subsidiary capital,

the Commissioner would disallow the entire $50 million of losses

and tax the entire $50 million of gain even though the taxpayer

would have had no net profit and there would have been no

potential whatsoever for a double tax benefit.

The reason that impermissible gross taxation arises under

the Commissioner’s position is that Code §11-602.8(b)(6) was

never intended to apply to losses, since losses from subsidiary

capital are already disallowed under Code §11-602.8(a)(1).23

Instead, Code §11-602.8(b)(6) was only intended to apply to

expenses. While Code §11-602.8(b)(6) disallows deductions,24

which technically includes deductions for losses, a deduction25

can only be disallowed under Code §11-602.8(b)(6) if it

constitutes a “carrying charge or otherwise” for the stock of the

Subsidiaries.

The Commissioner’s representative cogently argued at conference that26

economic realities suggest that foreign currency contracts have an inherent

administrative cost. If such a cost could be separately quantified as an

independent charge or fee, an argument could be made that it is an expense that

could be attributable to subsidiary capital and thus disallowed. There is,

however, no evidence in the record as to whether such a cost could be

ascertained.

22

The term “carrying charge” is defined in West’s Tax Law

Dictionary, supra at p. 124 (emphasis added), as an “expense

incident to ownership of property,” and the Loss clearly is not

an expense. The words “or otherwise” do imply a broader

statutory construction than would apply if only the words

“carrying charge” were used. McKinney’s Statutes 231 (“In the

construction of a statute, meaning and effect should be given to

all its language, if possible, and words are not to be rejected

as superfluous when it is practicable to give each a distinct and

separate meaning”). However, the term “or otherwise” was never

intended to be read so broadly as to include losses, and neither

the Commissioner nor her State counterpart has ever read that

term so broadly.26

The question of how attribution should be made has been a

difficult and significant issue in State and City taxation over

the past two decades. Yet nowhere in the numerous State and City

regulations, revised regulations, and pronouncements (including

GCT Policy Bulletin 2-84 (April 2, 1984), New York State

(“State”) TSB-M-88(5)C (October 14, 1988), Statement of Audit

Procedure AP/GCT 2 (March 22, 1991), Statement of Audit Procedure

93-1-GCT (March 1, 1993), and SAP 96-1 (collectively, the

“Pronouncements”)) is there any indication that discretionary

authority can be exercised to attribute deductions for losses

arising from business capital to subsidiary (or, for that matter,

investment) capital. The Commissioner has not cited a single

authority or commentary that even hints at the possibility of

23

attributing losses from business capital to subsidiary capital,

let alone suggests it would be warranted.

The Pronouncements and Playboy, supra, address only the

allocation of deductions for “expenses” and the Commissioner’s

most recent guidance concerning the attribution of deductions

under Code §§11-602.8(b)(6) and 11-602.5(a), SAP 96-1, is

entitled “NONINTEREST EXPENSE ATTRIBUTION” (emphasis added).

Moreover, SAP 96-1’s reference to attribution under those Code

sections as “expense attribution” rather than “deduction

attribution” is how such attribution is colloquially referred to

in the tax nomenclature. Similarly, although Code §11-602.5(c)

provides that “in the discretion of the commissioner of finance,

any deductions allowable in computing entire net income which are

directly or indirectly attributable to investment capital or

investment income” will be taken into account in determining

investment (vis-a-vis business) income, 19 RCNY §11-69 appears to

limit the scope of the statute to the deduction of expenses:

(c) Deduction of expenses. (§11-602(5) ofAdministrative Code). (1) Investment income must bereduced by any deductions, allowable in computingentire net income, which are directly or indirectlyattributable to investment capital or investmentincome. Deductions allowable in computinginvestment income are not taken into account incomputing business income. (Emphasis added.)

Nor is there a need to read Code §11-602.8(b)(6) to broadly

encompass deductions for losses. For losses, unlike expenses, do

not need to be attributed to a class of capital. Since losses

arise from property, by statute, they are inherently attributed

to the type of capital and income of the asset from which they

arise. Thus, losses from subsidiary and investment capital are,

Code §§11-602.7 and 11-602.8(a)(1) provide that ENI is computed without27

taking into account losses from subsidiary capital.

Code §§11-602.7 and 11-602.5(a), when read in conjunction with IRC28

§1211(a), provide that losses from investment capital do not reduce ENI. That

occurs because Code §11-602.7 provides that business income means ENI minus

investment income; Code §11-602.8(a)(1) provides that ENI shall not include

income, gains and losses from subsidiary capital; Code §11-602.5 provides that

investment income [which is excluded from ENI under Code §11-602.7] is the sum

of income, including capital gains in excess of capital losses, from investment

capital; and IRC §1211(a) provides that in the case of a corporation, losses from

sales or exchanges of capital assets are allowed only to the extent of the gains

from such sales or exchanges.

24

under the Code, per se treated as losses from subsidiary and

investment capital and there is no need for the Commissioner to

exercise her discretionary authority under Code §11-602.8(b)(6)27

and 11-602.5(a). In fact, had the Commissioner sought to28

attribute a loss arising from investment capital to subsidiary

capital under Code §11-602.8(b)(6), such attribution would have

been in direct contradiction to the Code’s explicit directive

that losses from investment capital offset investment income

under Code §11-602.5.

Since losses from subsidiary and investment capital are per

se attributable to subsidiary and investment capital, only losses

from business capital could possibly be attributed to subsidiary

capital under Code §11-602.8(b)(6). Moreover, it is only because

business capital is defined by what remains after investment and

subsidiary capital are ascertained, that losses from business

capital are not per se required by statute to be attributed to

business income. Code §11-602.6. Regardless, both by default

and economic reality, losses from business capital arise from,

and thus relate to, business capital. Thus, there is no need for

the attribution of losses (which arise from an asset) as there is

for expenses (which do not arise from an asset).

This is the State’s standard as set forth in TSB-M-88(5)C.29

As there is no reference to “loss attribution,” the only standard that30

could be applied is the standard for “expense attribution.”

25

Even if losses were subject to attribution under Code §11-

602.8(b)(6), the attribution rules in effect during the Tax Year

would preclude attribution here. As stated by this Tribunal’s

Appeals Division in Playboy, supra, the standard for determining

whether an expense should be attributed to subsidiary capital for

years prior to 1988 (which includes the Tax Year) is that the

expense must be “directly traceable” to subsidiary capital to29

be attributed to subsidiary capital under Code §11-602.8(b)(6)

(emphasis added). 30

The term “direct” has the definite connotation of immediacy.

See, Webster’s Seventh New Collegiate Dictionary, p. 235, which

defines the word “direct” as:

1: proceeding from one point to another . . .without deviation or interruption : STRAIGHT2 a: stemming immediately from a source . . .5 a: marked by absence of an interveningagency, instrumentality, or influence . . ..

The immediacy in the word “direct” precludes the

indisputable, but one-step removed, causal relationship between

the Loss and the stock of the Subsidiaries to take precedence

over the immediate and uninterrupted relationship between the

Loss and the Foreign Currency Contracts from which they arose.

Given the unambiguous meaning of the word “direct,” the only

possible conclusion is that the Loss is directly traceable to,

and only to, the assets that generated the Loss; namely the

Foreign Currency Contracts.

This determination does not preclude the possibility that a loss might31

be sufficiently similar to an expense as to be properly treated as an expense and

thus be deemed to be subject to Code §11-602.8(b)(6). For example, standard

administrative practice allows assets with a short useful life to be expensed;

e.g., a pencil. A similar result might apply with respect to losses arising from

essentially “wasting” assets used with respect to subsidiary capital, such as a

personal computer and other assets that are unlikely to ever yield a material

gain and thus give rise to a double tax detriment.

Since the value of a taxpayer’s subsidiaries will increase if the32

foreign currency hedges generate losses and decrease if they generate gains,

gains and losses from the foreign currency hedges must be netted not only to

determine the economic effect of those contracts (i.e., whether there has been

a gain or a loss), but also to determine whether the value of the subsidiaries

has decreased or increased (and thus whether there exists a double tax benefit

or a double tax detriment).

26

In sum, the term “carrying charge or otherwise” in Code §11-

602.8(b)(6), should not be expanded to include losses. Since31

any increase in the value of the Subsidiaries (the predicate for

finding a double tax benefit) will far more closely correlate to

the amount of the net loss from foreign currency contracts than

to the amount of the gross loss from such contracts, the32

Commissioner’s position of disallowing the gross loss from

foreign currency contracts is far more likely to result in an

unnecessary and substantial double tax detriment than it is to

prevent an unwarranted double tax benefit. Imposing a cure that,

more often than not, will be unnecessary and result in a litany

of probable side-effects that are more deleterious than the

problem it seeks to redress is not a reasonable or proper

exercise of discretion. See, Barney’s Inc. v. Dept. of Finance,

93 A.D.2d 642 (1 Dept. 1983), aff’d, 61 N.Y.2d 786 (1984).st

Having decided that the Loss cannot be attributed so

subsidiary capital under Code §11-602.8(b)(6), the issue becomes

whether the Foreign Currency Contracts themselves should be

categorized as subsidiary capital. Petitioner argues that the

Foreign Currency Contracts cannot be treated as subsidiary

capital under Code §11-602.3 because they are not “stock of

27

subsidiaries.” Instead, it asserts that the Foreign Currency

Contracts should be treated as business capital and that the Loss

(as well as gains from foreign currency contracts) should be

included in ENI.

While the Petitioner’s methodology does not eliminate all

potential for a double tax benefit, over time, it is far less

problematic and troubling than the Commissioner’s methodology

since: (1) being computed on a net basis it more fairly reflects

the economics of foreign currency contracts, thus substantially

reducing the potential amount of double tax benefit and

detriment; (2) the possibility of being benefitted or harmed is

not one that can be controlled and thus manipulated by taxpayers;

(3) the risk or benefit falls similarly and more fairly on the

City and taxpayers alike; and (4) given the constant fluctuations

in the numerous foreign currencies that City taxpayers are likely

to hedge, this methodology could have little impact on the City’s

fisc.

However, the preferable approach would be to categorize

foreign currency contracts as subsidiary capital. In such

instance, both gains and losses from such hedges would be

excluded from ENI under Code §11-602.8(a)(1) and, thus, no double

tax benefit or double tax detriment could occur. The

Commissioner’s reasonable goal of precluding an unintended double

tax benefit would be effectuated, while avoiding the unfairness

of taxing hedges on a gross basis. Moreover, adopting the

matching approach to catagorize foreign currency hedges of

subsidiary capital as subsidiary capital would effectuate the

business purpose of those contracts, which is to prevent foreign

currency fluctuations from affecting taxpayers’ investments in

their subsidiaries; i.e., it would avoid subjecting taxpayers to

As the Commissioner notes in fn 2 on page 8 of her brief, “TSB-A33

advisory opinions are not binding precedent for other taxpayers . . ., even for

New York State.”

As the Commissioner asserts, the Morgan Opinion misapplied the Tax34

Court’s decision in Hoover, supra. See, footnote 10, supra. For the Tax Court

in Hoover, held that the foreign currency contracts did not hedge the ordinary

business operations of the subsidiaries and thus was not an ordinary loss. The

foreign currency contracts, however, economically hedged the subsidiaries’ stock

which was the raison d’être for the Tax Court’s conclusion that gains and losses

from foreign currency forward contracts must be afforded the identical capital

treatment that would attach to the disposition of the subsidiary stock to which

they related: “The only ‘asset’ that Petitioner can possibly protect is its

investment, as expressed in stock ownership, in the foreign subsidiary. That

investment, except in limited circumstances, is a capital asset in petitioner’s

hands.” Id. at p. 237. See, also, Nalco Chemical Co. v. U.S., 561 F.Supp. 1274

(N.D.Ill. 1983); Wool Distributing Corp. v. Commissioner, 34 T.C. 323 (1960).

28

the double tax benefits and detriments that would arise were

foreign currency hedges categorized differently from the stock

they hedge. See, Matter of C. Czarnikow, Inc., Nos. 802174 and

806000 (State Tax Appeals Tribunal, April 25, 1991), which held

that in applying the test for determining whether a security

qualifies as investment capital, “it is appropriate to look at

the function of the security, and search for substance over form

with emphasis on economic reality . . ..” (Emphasis added.)

Petitioner asserts that the holding in Morgan Guaranty

International Finance Corporation (Advisory Opinion), TSB-A-

87(3)C (January 15, 1987) (the “Morgan Opinion”), precludes

foreign currency contracts from being categorized as subsidiary

capital. Having been decided by the former State Tax Commission,

the Morgan Opinion does not constitute binding precedent. 33

However, nothing else has been referenced that addresses the

issue of whether foreign currency contracts should be categorized

as subsidiary capital. Moreover, the Commissioner agrees with

the Morgan Opinion’s conclusion that foreign currency forward

contracts do not constitute subsidiary capital, although she

disagrees with parts of its analysis. 34

The same language is contained in Code §11-602.3. 35

29

The result in the Morgan Opinion is predicated on the

conclusion that forward contracts do not come within the

definition of either stock or indebtedness “as such terms are

ordinarily understood.” The Morgan Opinion thus adopted a

literal interpretation of the definition of subsidiary capital in

State Tax Law §208.4. It did so, however, at a time when the35

administrative policy in both the State and the City, which was

upheld by the courts, was to narrowly construe the statutory

definitions of capital even though the statute was sufficiently

ambiguous to allow for rational alternative interpretation. See,

Matter of Carret & Company, Inc., 148 A.D.2d 40 (3 Dept. 1989);rd

Matter of Pohatcong Investors, Inc., TSB-D-88(9)C (Dec. 1, 1988),

aff’d., 156 A.D.2d 791 (3d Dept. 1989).

In 1991, both the State and the City abandoned their prior

policy which had employed a strict statutory construction

approach to literally interpret the definition of investment

capital. They did so by amending their regulations to provide

that options on assets that are investment capital will

themselves be characterized as investment capital unless “the

options are purchased primarily to diminish the taxpayer’s risk

of loss from holding one or more positions in assets that

constitute business or subsidiary capital.” Rule §11-37(c)(4).

By using an approach that determines an option’s tax

characterization by matching it to the character of the hedged

asset, the amended regulations changed the prior, judicially

sanctioned, interpretation of the law that had automatically

See, Commissioner’s Supplemental Brief, p. 3: “The amended investment36

capital regulations were the product of long negotiations with the securities

industry, negotiations which culminated in a policy to materially change the

[interpretation of the] definition of investment capital and to grant certain

concessions to that industry, such as the treatment of certain financial

instruments as investment capital that prior decisions interpreting the statute

had held not to be investment capital.”

As the Basis and Purpose of Proposed Amendments states: “These37

amendments differ substantively from the State regulations in treating futures

and forward contracts as investment or business capital . . ..” See, 20 NYCRR

§3-3.2(a)(2)(vi), which provides that investment capital does not include futures

contracts and forward contracts. Contra its City counterpart, 19 RCNY §11-

37(a)(4)(v), which states that investment capital does not include “assets

reflected in the taxpayer’s books and records in connection with futures

contracts and forward contracts except as provided in subdivision (g) of this

section.” Thus, unlike the State, forward and futures contracts are only

categorized as business capital for City GCT purposes if they do not come within

the terms of 19 RCNY §11-37(g).

30

excluded all options from being considered investment capital

regardless of their function: 36

The current rules were promulgated prior tothe development or widespread use of avariety of financial instruments that haveentered the marketplace in recent years.. . .

The amendments . . . eliminate the currentregulatory requirement that securities be “ofa like nature as stock and bonds . . .”

Basis and Purpose of Proposed Amendments, signed by Carol

O’Cleireacain, Commissioner of Finance, February 20, 1991.

The City also adopted the matching approach with respect to

futures and forward contracts, although the State did not follow

suit. The Commissioner promulgated 19 RCNY §11-37(g) which37

provides:

Investment capital shall include assetsreflected in the taxpayer’s books and recordsin connection with futures or forwardcontracts if such contracts substantially

It would make no sense for 19 RCNY §11-37(c)(4) to have adopted the38

matching approach to hold that options are not investment capital because they

relate to subsidiary capital, if the matching approach were then rejected in

order to find that such options do not constitute subsidiary capital but instead,

by default, constitute business capital. Had a different result been desired,

at the very least, 19 RCNY §11-37(c)(4) would have been drafted using language

similar to 19 RCNY §11-37(g) which makes no mention of subsidiary capital.

31

diminish the taxpayer’s risk of loss fromholding one or more positions in assets thatconstitute investment capital or if suchcontracts substantially diminish thetaxpayer’s risk of loss from making shortsales of assets that constitute investmentcapital. If the taxpayer holds morepositions in futures or forward contractsthan are reasonably necessary tosubstantially diminish its risk of suchlosses, assets attributable to the excesspositions in futures or forward contracts arenot included in investment capital.(Emphasis added.)

Under this regulation, identical forward contracts can be

treated as either constituting or not constituting investment

capital depending upon whether they were necessary to hedge

investment capital (i.e., were bona fide hedges). When this

regulation is viewed in conjunction with RCNY §11-37(c)(4),

(which strongly suggests that options relating to subsidiary

capital be categorized as subsidiary capital), it is clear that

the investment capital regulations have adopted the matching

approach to categorize bona fide hedges not as a separate

investment vehicle, but in accordance with the character of the

asset being hedged. See, also, 19 RCNY §11-69(b)(i)(B):38

“Investment income also includes gain (or loss) from closing out

a position in a futures or forward contract if such contract

substantially diminishes the taxpayer’s risk of loss from holding

one or more positions in assets that constitute investment

capital.”

Moreover, taxpayers do have an essential element of control over39

investment capital which allows them to time their income from such capital:

their ability to sell such capital.

32

Although investment and subsidiary capital are defined

differently, the statutory language is sufficiently similar to

warrant the conforming tax treatment of hedges. As the

Commissioner stated when citing 19 RCNY §11-69(c)(2) of the

investment capital regulations for the proposition that

stewardship expenses should have the same treatment with respect

to subsidiary capital as they do with respect to investment

capital: “Although these regulations deal with investment

capital, their rationale applies equally to investments in

subsidiary capital.” Commissioner’s Brief, p. 14. Only when the

issue arose as to whether the Foreign Currency Contracts could be

treated as subsidiary capital by analogy to the investment

capital regulations did the Commissioner change her position and

argue that the investment capital regulations were not applicable

by analogy.

The basis for the Commissioner’s assertion that 19 RCNY §11-

37(g) should not apply by analogy with respect to subsidiary

capital is that “taxpayers control the subsidiary and the

reinvestment of its earnings or its repatriation as a dividend, a

level of control that is absent from assets which meet the

definition of investment capital.” Commissioner’s Supplemental

Brief, p. 4. Control, however, can only affect the timing of

income of the hedged asset, and not the proper categorization of

income from either that asset or the hedge. 39

Of greater relevance is the Commissioner’s analysis of the

function of a foreign currency hedge:

While the Commissioner asserts on p. 7 of her Supplemental Brief that40

the investment capital regulations address “no counterpart to these concerns,”

they address the identical concern. See, RCNY §11-37(c)(4).

Characterizing the foreign exchange hedges as subsidiary capital is the41

functional equivalent of attributing the gains (as well as losses) from those

contracts to subsidiary capital.

33

the parent is not purchasing the [foreigncurrency] contract to diminish its risk withrespect to any currency the parent isholding, nor to idle speculation in theparticular currency. Rather, the parent ispurchasing that contract for but one purpose,to diminish the risk of the foreign currency-denominated value of its investment in thesubsidiary. Id. at p. 7.

This statement by the Commissioner cogently summarizes why

the matching approach found in the investment capital regulations

should also be applied to categorize bona fide hedges of

subsidiary capital in the same manner as the asset being hedged

(rather than as business capital).40

Moreover, since the Commissioner based her disallowance

under Code §11-602.8(b)(6) on the offsetting relationship between

the Loss and the value of the stock of the Subsidiaries, she has

effectively adopted the matching approach with respect to foreign

currency hedges of subsidiary capital. While she applied the

matching approach only where those contracts produced a loss,

there is no conceptual difference between disallowing a loss as

being attributable to subsidiary capital and disallowing a loss

as being from subsidiary capital. There is, however, a41

substantial practical difference between the two. For

disallowing the Loss as being attributable to subsidiary capital

would allow the Commissioner to bifurcate gains and losses from

foreign currency hedges and tax them on a gross basis, which is

contrary to fundamental principles of tax policy and fairness.

See, f.n. 38, supra. This is of particular concern in this case for42

while it was stipulated that the Foreign Currency Contracts were mainly forward

contracts, they could also have been comprised, in part, of options contracts.

See, Finding of Fact 8, supra; f.n. 5, supra.

34

In view of the interdependency of the definitions of

business, investment and subsidiary capital, applying the

matching rule with respect to hedges of one type of capital

(investment) but not another (subsidiary) would undermine the

purpose of a rule that was designed to foster conformity. There

is no apparent reason why a bona fide hedge of investment capital

should be treated as investment and not business capital, whereas

a bona fide hedge of subsidiary capital should be treated as

business but not subsidiary capital. See, RCNY §11-37(c)(4)

which references all three types of capital and implies that

options relating to subsidiary capital should be characterized as

subsidiary capital.42

Were the matching approach not a rational interpretation of

the statute, then the investment capital regulations would be

invalid with respect to options and futures contracts. However,

the matching approach is not only a valid interpretation of the

law, but is a materially better interpretation than the prior

literal interpretative approach. For the matching approach

categorizes gains and losses from forward contracts in a manner

that more accurately reflects the nature and consequence of such

hedges, whose function is to modify the amounts of financial gain

and loss on the underlying capital to which they relate. Thus

the change in tax policy (from applying the definition of capital

literally to applying it in accordance with the economic purpose

and substance of option and forward contracts) is a reasonable

policy decision that was warranted under general principles of

statutory construction. See, McKinney’s Statutes §112: “The

construction of various particular statutes illustrate the

35

principle that literal language of an enactment is not always

controlling and that the courts may depart from a literal

construction in order to carry out the legislative intent.”

Since the Commissioner appropriately adopted the matching

approach with respect to investment capital, the same approach

must be applied consistently with respect to all categories of

capital, including subsidiary capital, unless there is a

compelling reason to do otherwise. Otherwise, conflicting

principles of attribution would apply with respect to different

types of capital, whose definitions are interrelated, without

there being a rational basis for such a distinction. As the

Appellate Division held in Matter of Exxon Corp. v. Board of

Standards and Appeals, 128 A.D.2d 289, 296 (1 Dept. 1987):st

While an administrative agency is accordedbroad regulatory authority, “[discretionary]power is not absolute; it is subject to thelimitation that it cannot be exercisedarbitrarily”. (Matter of Freidus vGuggenheimer, 57 AD2d 760, 761.) Thus, anadministrative agency may not rule or act insuch a way as to result in inconsistenttreatment of similarly situated parties.(See, Matter of Society of N.Y. Hosp. vAxelrod, 116 AD2d 426; Matter of Freidus vGuggegnheimer, supra; see also, R-C MotorLines v United States, 350 FSupp 1169, 1172,affd 411 U.S. 941 [“Although the doctrine ofstare decisis does not apply to decisions ofadministrative bodies, consistency ofadministrative rulings is essential, for toadopt different standards for similarsituations is to act arbitrarily.”]

The Commissioner has not presented a cogent argument why

bona fide hedges of subsidiary capital should be treated as

business capital when bona fide hedges of investment capital are,

36

under the matching approach, properly treated as investment

capital. Nor has she presented a cogent argument why forward

contracts should be treated differently than options contracts

under the investment capital regulations. See, the discussion in

f.n. 38, supra, regarding RCNY §11-37(c)(4).

I therefore find that the matching approach adopted in the

investment capital regulations with respect to the categorization

of forward contracts, must also apply, by analogy, with respect

to subsidiary capital.

Both parties nevertheless assert that the Foreign Currency

Contracts still cannot be treated as subsidiary capital as they

are not the type of forward contracts covered under 19 RCNY §11-

37(g). The Commissioner argues that 19 RCNY §11-37(g) only

addresses hedges that offset market risk and Petitioner suggests

that the regulation requires that the hedge eliminate any further

speculative element in the hedged asset. The parties have not,

however, cited any authority supporting their interpretation of

19 RCNY §11-37(g).

The language of 19 RCNY §11-37(g) includes forward contracts

which “substantially diminish the taxpayer’s risk of loss from

holding one or more positions in assets that constitute

investment capital.” By describing the risk as “the” risk of

loss (rather than “a” risk of loss), the regulation can be viewed

as suggesting that the hedge relate to market risk.

However, the regulation does not explicitly provide that the

forward contract “substantially eliminate market risk” or that it

“substantially eliminate all risk.” Instead, it merely requires

that the forward contract “substantially diminish the taxpayer’s

37

risk of loss.” Had the Commissioner desired to limit the

applicability of the regulation to only those contracts that

“substantially eliminate market risk,” she could have done so

explicitly by using such terms. Instead, she only required that

such contracts “substantially” reduce risk.

The question then becomes whether the term “substantially”

requires that the risk being hedged have substance or whether it

requires the risk to be substantial in comparison to the total

risk. While the term is commonly used to imply “virtually all,”

it is defined quite differently. See, Webster’s Third New

International Dictionary, Unabridged (1993), p. 2280 (the term

“substantial” means having “substance or actual existence,” or

“an important or material, thing or part”). See, also, Black’s

Law Dictionary, p. 1428 (substantial evidence is “evidence

possessing something of substance and relevant consequence and

which furnishes substantial basis of fact from which issues

tendered can be reasonably resolved”).

Under federal tax law, the term substantial has been used to

mean material or significant. IRC §751(b)(3) defines

“substantial appreciation” as inventory items of a partnership

whose fair market value exceeds 120% of the adjusted basis to the

partnership of such property. Congress’ use of a 20% increase in

value to indicate substantial appreciation indicates that they

intended the term “substantial” to mean having substance or

materiality, rather than be trivial or de minimis.

Although the risk of loss arising from the conduct of the

business operations of the Subsidiaries is likely to be greater

than the translation exposure attendant to the foreign currency

value of the stock of the Subsidiaries, foreign currency exposure

38

is a significant and material risk. This risk induced Petitioner

to form an operating committee to manage its foreign currency

translation exposure and to enter into the Foreign Currency

Contracts to protect against that risk. Moreover, the Foreign

Currency Contracts generated a net Loss of $3,590,460 in the Tax

Year alone, which was over 22% of the $15,793,660 of adjusted

total combined net income of Petitioner and the Subsidiaries.

Given the magnitude of the Loss in comparison to the total

adjusted combined net income of Petitioner and the Combined

Subsidiaries, it can hardly be said from the record before me

that the foreign currency risk attendant to the stock of the

Subsidiaries was not s significant or material risk.

Given the ambiguity in the phrase “substantially diminish

risk of loss,” it is also important to examine its intended

purpose. The purpose of that phrase, however, may vary depending

upon the context in which it is used. The concept of

substantially diminished risk of loss is used in another tax

provision, IRC §355, which sets forth the requirements for a

corporate division to qualify as a tax-free reorganization. IRC

§355(d)(6) provides that the 5-year holding period for

determining what constitutes disqualified stock will be suspended

for any period during which “the holder’s risk of loss with

respect to such stock or securities is (directly or indirectly)

substantially diminished.” Due to the purpose of this provision,

which is to toll a measuring period by the amount of time that

the holder of a security does not bear the economic risk of

holding that security, it seems that this provision was intended

only to include hedges or similar devices that reduce market risk

of loss.

See, Basis and Purpose of Proposed Amendments, supra: “These amendments43

differ substantively from the State regulations in treating futures and forward

contracts as investment or business capital . . ..”

39

However, §355(d)(6)(B) further requires that the risk of

loss must be substantially diminished by “(i) an option, (ii) a

short sale, (iii) any special class of stock, or (iv) any other

device or transaction.” Although foreign currency forward

contracts could arguably qualify as an “other . . . transaction,”

it would not appear that such contracts were intended to come

within the four defined categories of assets. Thus, it might be

argued, that the purpose of listing the four categories was to

insure that contracts that do not come within one of those

categories, but which substantially reduce risk other than market

risk (e.g., foreign currency contracts), do not toll the 5-year

holding period.

The purpose of 19 RCNY §11-37(g), by contrast, was to match

the character of forward contracts with the character of the

asset being hedged. Notably, the City chose to go beyond the

State to extend the matching concept beyond options primarily

purchased as hedges (which are governed under 19 RCNY §11-

37(c)(4)) to also include forward contracts that serve a similar

purpose. Thus, the Commissioner, having apparently perceived no

reason for distinguishing between the two types of hedges,

attempted to apply the matching approach broadly, rather than

narrowly, even though that created a conflict between the State

and City approaches regarding forward contracts.43

No evidence has been presented that would suggest that the

expansion of the matching approach in 19 RCNY §11-37(g) was

intended in any way to be limiting, rather than inclusive. It is

possible that the issue of foreign currency contracts was not

40

considered when the regulation was promulgated. However, the

regulation was not made instrument specific. Instead, it

deliberately was written broadly to include a variety of

financial instruments. Contra the limiting language found in

§355(d)(6)(B)(i) to (iv). While the Commissioner’s brief

attributes this result to negotiations with the securities

industry, any interpretation of the statute by the Commissioner,

regardless of its motivation, cannot be arbitrarily applied in

such a manner as to result in inconsistent treatment. Exxon,

supra at p. 296.

Interpreting the statutory definition of subsidiary capital

literally was held to be rational by the courts. Interpreting

the statutory definition of subsidiary capital broadly to

effectuate its intent by adopting the matching approach is also

rational and the clear trend in the tax law. It would not,

however, be rational to interpret the definition of subsidiary

capital literally with respect to bona fide hedges of foreign

currency risk but broadly with respect to bona fide hedges of

market risk. Under the matching approach, there is no rational

basis for distinguishing between two hedges, both of which are

equally valid and necessary from a business standpoint, and both

of which serve the identical purpose of materially reducing risk

with respect to the holding of an asset that, absent utilization

of the matching approach, would have a different categorization

for tax purposes. That is why, under federal law, foreign

currency contracts can constitute a hedge and give rise to

ordinary gain and loss even though they only reduce one element

Even a hedge of a foreign stock that would close out a taxpayer’s44

position and thus exposure would have two components: a market component measured

in the local operating currency and a foreign currency component. Under the

parties’ position, were that hedge bifurcated into a hedge of stock denominated

in the foreign currency and a corresponding foreign currency hedge, only the

former hedge could qualify for matching categorization even though both hedges

were integral to the elimination of market or total risk.

41

of risk and (being contracts for currency) do not involve the

same property being hedged (stock). IRC §1221(b)(2)(A)(i).44

Since 19 RCNY §11-37(g) is not being applied literally, and

the parties have not proffered a rational reason why the matching

approach adopted therein should not be applied consistently and

uniformly to include bona fide foreign currency hedges, I find

that bona fide hedges of foreign currency that materially reduce

a taxpayer’s foreign currency exposure with respect to subsidiary

capital must be treated as subsidiary capital by analogy to 19

RCNY §11-37(g).

As neither party disputes that the Foreign Currency

Contracts are bona fide hedges as described in the Notice of

Disallowance being protested, I find that the contracts

constitute subsidiary capital under the current law. However,

the question remains whether this holding should be applied on a

retroactive basis to exclude the Loss from ENI under Code §11-

602.8(a)(1) during the Tax Year. Both parties agree that this

holding should not be applied retroactively to the Tax Year. I

agree.

Judicial opinions, like administrative regulations only

interpret and apply the statute. Therefore, like regulations,

judicial rulings are generally applied retroactively from the

See, Gurnee v. Aetna Life & Cas. Co., 55 N.Y.2d 184 (1982), where the45

Court of Appeals held, with respect to its holding in another case, that changes

in decisional law are normally applied retroactively to all cases that are in the

litigating process.

Section 14 of the Amendments to Rules Relating to the City GCT, which46

became effective April 1, 1991, provides that “amendments made by these

regulations . . . which classify as investment income . . . the income from

certain . . . forward contract transactions, . . . shall apply only to positions

taken during taxable years beginning on or after January 1, 1990.”

See, Matter of Dominion Textile (USA) Inc., DTA No. 812248, 1997 NYTC47

T-555 (State Tax Appeals Tribunal, April 10, 1997), which held that tax

regulations are applied prospectively unless they specifically provide otherwise,

effect a change in policy, or the meaning of the statute they interpret is

ambiguous.

42

inception of a statute. Although the holding that the Foreign45

Currency Contracts constitute subsidiary capital would generally

apply retroactively, this is an unusual circumstance. For here,

a new valid statutory interpretation was administratively

substituted for another valid but conflicting statutory

interpretation after the Tax Year.

Under the earlier long-standing statutory interpretation

that was in effect during the Tax Year, the definition of

subsidiary capital was interpreted literally and the Loss would

have been allowed as a loss from business capital. The change of

that policy in the 1991 investment capital regulations upon which

this determination relies, was made applicable only with respect

to positions taken on or after January 1, 1990. The46

Commissioner has specifically asserted that the investment

capital regulations, having constituted a change in policy, were

made applicable on a prospective only basis out of concern that

the City could be harmed by their retroactive application.

Just as the application of regulations can be made

prospective only where they implement a change in existing

policy, the same is true with respect to judicial and quasi-47

43

judicial determinations and decisions. See, Hilton Hotels Corp.

v. Commissioner, 219 A.D.2d 470 (App. Div. 1 Dept. 1995), wherest

the Appellate Division of the Supreme Court held that a ruling of

the Appeals Division of this Tribunal while correct, had been

improperly applied on a retroactive basis. The Appellate

Division reached this conclusion by applying the following three-

pronged analysis that is based on the standards set forth by the

United States Supreme Court in Chevron Oil Co. v. Huson, 404 U.S.

97, 106-107 (1971):

Pursuant to such test, a decision must beapplied prospectively (1) if it establishes anew principle of law, either by overrulingclear past precedent on which litigants mayhave relied or by deciding an issue of firstimpression whose resolution was not clearlyforeshadowed, (2) the merits of each casemust be weighed by viewing the prior historyof the rule in question, its purpose andeffect, and whether retroactive operationwill further or retard its operation, and (3)the inequity imposed by retroactiveapplication must also be weighed, for wheresuch decision could produce substantialinequitable results if applied retroactively,there is ample basis for avoiding theinjustice or hardship by a holding ofnonretroactivity. Hilton, supra at 477.

As the law was interpreted during the Tax Year, the Loss

would have been allowed. Thus this determination could not have

been foreshadowed at that time. It was the 1991 regulatory

change that first adopted the matching approach with respect to

investment capital that is the predicate of this determination.

Since the holding in this case relies on the Commissioner’s

fundamental change of a prior, but also valid policy, and the

Commissioner properly made that change prospective only from 1990

Petitioner might be harmed if it had net gains from foreign currency48

hedges that it included in ENI as being attributable to business (rather than

subsidiary) capital in subsequent tax years and the period for claiming refunds

with respect to the tax imposed on those gains has expired. Similarly, the

Commissioner could get whipsawed if taxpayers claim refunds with respect to the

tax imposed on gains on foreign currency contracts that were included in ENI, but

the statute of limitations for asserting a deficiency for other tax years in

which losses from such hedges were deducted has expired. In determining the

potential for whipsawing, consideration must be given to the fact that the City

and large corporate taxpayers often enter into agreements which extend the

statute of limitations for asserting a deficiency and claiming a refund for

prolonged periods, as occurred in this case.

The implications of treating the Foreign Currency Contracts as business49

capital are discussed on p. 27, supra.

44

forward, applying this holding retroactively to 1984 would make

the investment capital regulations applicable by analogy with

respect to subsidiary capital before they are applicable by their

terms to investment capital. This would not be an equitable

result. Of additional concern, both parties could possibly be

whipsawed by the retroactive application of this determination.48

Consequently, the holding that the Foreign Currency Contracts

constitute Subsidiary Capital is not applied retroactively during

the Tax Year and those contracts are therefore treated as

business capital. 49

ACCORDINGLY, IT IS CONCLUDED THAT:

A. The Commissioner’s exercise of discretion under Code §11-

602.8(b)(6) to disallow the Losses was improper because the

provision was intended to apply only to expenses and not losses.

Were this provision extended to losses, foreign currency

contracts would be taxed on a gross basis even where there is no

potential for a double tax benefit.

B. The matching approach adopted in the investment capital

regulations applies by analogy to categorize foreign currency

45

contracts as subsidiary capital and the loss therefrom as a loss

from subsidiary capital which is excluded from ENI.

C. As the adoption of the matching approach in the

investment capital regulations after the Tax Year changed the

prior valid literal interpretation of the statute, this ruling is

not applied retroactively to the Tax Year.

Since the Loss was improperly attributed to subsidiary

capital under Code §11-602.8(b)(6), and the Foreign Currency

Contracts cannot be treated as subsidiary capital during the Tax

Year as that would constitute an inappropriate retroactive

application of an unforeseen change in tax policy, the Notice of

Disallowance, dated November 4, 1999, denying a refund of City

GCT, is hereby cancelled and Petitioner is granted the refund

requested in the Petition.

Dated: June 20, 2003 New York, New York

_______________________________ STEVEN J. GOMBINSKI

Chief Administrative Law Judge