The IRS has concluded in a legal memorandum (ILM 2012-38-025) that a taxpayer was considered a dealer in securities under Section 475(c) because it purchased debt and subsequently sold such debt as part of its securitization activity.
The taxpayer addressed in the ILM was an investment bank that purchased trust preferred securities (the Trups) from various regional banks. The Trups were treated as debt for U.S. federal tax purposes. The taxpayer would hold and warehouse the Trups until there was a sufficient number and dollar amount of these securities to form a securitization vehicle to issue collateralized debt obligations (CDOs). Once the taxpayer had arranged enough buyers for the CDOs, the taxpayer sold the Trups to the trusts, which were disregarded entities from the taxpayer.
Section 475(a) requires dealers in securities to mark-to-market securities with certain exceptions provided under Section 475(b). For Section 475(a) purposes, the term "mark to market" means that a dealer must treat a security that is held on the last day of its taxable year as if it had been sold on the last business day of the taxable year for an amount equal to its fair market value, and the appropriate gain or loss must be recognized.
Section 475(c)(1)(A) provides that a dealer in securities is a taxpayer who regularly purchases securities from or sells securities to customers in the ordinary course of a trade or business. Debt is a security under Section 475(c)(2)(C).
In the facts of the ILM, the taxpayer both purchased debt from the regional banks and sold debt to the trusts. Thus, the IRS concluded the taxpayer met the requirement of Section 475(c)(1)(A) if either the regional banks or the trusts constituted "customers" to the taxpayer.
The IRS based its analysis on whether the taxpayer was being paid for making a market (as a dealer would be) rather than profiting from a rise in values of the underlying assets during the time between a purchase and resale (as an investor or trader would).
Because the taxpayer was in the securitization business and held itself out as a market-maker looking to buy Trups from regional banks to create securitization vehicles, the IRS viewed the regional banks as customers of the taxpayer.
In addition, because the taxpayer sold debt to the trusts, the IRS considered the taxpayer to be acting as a middleman between the regional banks and the trusts by buying the Trups, warehousing them until ready to repackage them as a new type of debt and making sure the debt was available when needed. The IRS viewed the trusts as customers of the taxpayer.
Furthermore, the IRS considered the warehousing fee to be consistent with a fee for being a market-maker for the first part of the securitization transaction and to constitute remuneration for the taxpayer's acting as a middleman, bringing together buyers and sellers and performing the usual services of a retailer or wholesaler of goods.
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