Rev. Rul. 59-332

Advice has been requested concerning the adequacy of the procedures used by a dealer in securities in identifying investment securities for the purpose of section 1236 of the Internal Revenue Code of 1954.

In the instant case, the M company, a dealer in securities, is a member of the New York Stock Exchange and participates with other firms in a securities pilot operation being carried on by the N corporation. The operation was formed to reduce the floating supply of stocks being carried by brokerage firms in their own names and to avoid as far as possible the necessity for daily deliveries among brokerage firms of the stock certificates which must be handed about in settlement as a result of the clearance operation.

Under the pilot operation, certificates for a limited number of stocks listed on the New York Stock Exchange for which a bank acts as transfer agent are held by the bank in the name of the O company, a nominee partnership. Such partnership has been registered by each of the participating firms as its nominee for purposes of Federal stock transfer tax exemption requirements. The stock certificates are in large denominations and the respective interests of the participating firms therein are reflected on the bookkeeping records maintained by the N corporation.

Transfers out of the nominee partnership are made only as necessary to make delivery subsequent to a sale to a nonparticipant firm or its customer or to a customer of a participant firm who wishes to take down certificates in its own name. Additional stock may be registered from time to time in the nominee's name as there are purchases by the participant firms for the accounts of their customers or additions by customers to their accounts of stock owned by them. The ability to identify through reference to certificate numbers is lost when the participating firms deposit with the bank stock held for investment along with customers' securities and securities held as dealers; however, M company's bookkeeping records clearly designate that a certain number of shares are held for investment, and purchases as made are so categorized within a 30-day period.

Section 1236 of the Code provides, in part, as follows:

(a) CAPITAL GAINS.-Gain by a dealer in securities from the sale or exchange of any security shall in no event be considered as gain from the sale or exchange of a capital asset unless-

(1) the security was, before the expiration of the 30th day after the date of its acquisition, clearly indentified in the dealer's records as a security held for investment or if acquired before October 20, 1951, was so identified before November 20, 1951; and

(2) the security was not, at any time after the expiration of such 30th day, held by such dealer primarily for sale to customers in the ordinary course of his trade or business.

The provisions of section 1236(a) of the Code were also contained in section 117(n)(1) of the Internal Revenue Code of 1939 and were added to the 1939 Code by section 327 of the Revenue Act of 1951, effective with respect to sales or exchanges made after November 19, 1951.

For the purpose of explaining section 327 of the Revenue Act of 1951, Senate Report No. 781, 82d Cong., C.B. 1951-2, 458, at 482, makes the following statements:

Under existing law, dealers in securities are permitted to hold some securities as a personal investment. Gains or losses on those securities which are held by the taxpayer in his capacity as a dealer are treated as ordinary income. Capital gain or loss treatment is accorded the results of the transfer of securities which the taxpayer holds as an investor. Existing law also permits the transfer of securities from such a taxpayer's investment account to his inventory account and vice versa with corresponding changes in tax liabilities. These transfers increase the difficulty of determining in which portfolio specific securities are actually held, and facilitate the manipulation of the taxpayer's accounts so as to obtain ordinary loss treatment on securities sold at a loss and capital gains treatment on those sold at a gain.

To forestall this practice, section 327 of this bill * * * provides that in the case of a dealer in securities capital gains treatment be available only under certain specific conditions. The security in question must have been clearly identified in the dealer's records as `a security held for investment' within a period of 30 days after the date of its acquisition or after the date of enactment of the Revenue Act of 1951, whichever is later, and must not at any time thereafter have been held by the taxpayer `primarily for sale to customers in the ordinary course of his trade or business.' Unless these terms are complied with, the gain on the sale of the security is to be taxed as ordinary income.

The motivating purpose for the creation of the pilot operation is to increase the business efficiency of the participating brokerage firms with respect to stocks sold in the ordinary course of their business. Whether each of the various securities sold was held primarily for sale in the ordinary course of the dealer's business or held for investment cannot be determined since the securities are commingled with the securities of all the other firms participating in the experimental pilot operation.

On the basis of the foregoing, it is held that where investment securities of the brokerage firm are deposited in accordance with a securities pilot operation with the bank as transfer agent, to be held in the name of the nominee partnership, together with similar securities of that firm and other participating firms held for sale to customers in the ordinary course of business, such securities do not qualify as clearly identifiable investment securities within the meaning of section 1236 of the 1954 Code. Accordingly, any gain on the sale of such securities is taxable as ordinary income.