Petition for a Writ of Certiorari — Harrison v. United States

Supreme Court brief1963

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“FILED

DEC 21 1982

. 8 JOHN F. DAVIS, CLERK

IN THE wea BS i:

Supreme Court of the United States

OCTOBER TERM, 1962

O. D. HARRISON and wife JENNIE L. HARRISON;

“ ADDISON O. WOOD and wife JOANNA G. WOOD; and

EDWARD H. JACKSON and wife MARGARET J. JACKSON,

Petitioners,

versus f

‘ 15

UNITED STATES OF AMERICA,

Respondent.

PETITION FOR WRIT OF CERTIORARI TO THE UNITED *

STATES COURT OF APPEALS FOR THE FIFTH CIRCUIT.

LEON O’QUIN,

Fifth Floor, First

National Bank Building

ShrewWport, Louisiana

Attorney for : Petitioners.

THOMAS A. HARRELL,

Fifth Floor, First

National Bank Building,

Shreveport, Louisiana,

Of Counsel

‘ Shreveport, Louisiana, December 18, 1962.

LECOMTE, SHREVEPORT, LOUISIANA * ft

ces I OOO

— —

——

TABLE OF CONTENTS

Page

— P ———ͤ — — 2

JuRISDIC Tics 1

QUESTION PRESENT E

STATUTES ixVvo b 3

__ STATEMENT OF THE CASE g 5

SUMMARY OF ARGUMENT eas 6

ARGUMENT 2... 3 9

I. The Decisions of the Circuit —

of Appeals are Conflieting. n „ Se

II. The Statute in Issue Clearly Provides

that Gain from Amounts Received in

Retirement of Registered Corporate N

Bonds is Capital Gain. .. 2

III. Tne Legislative History of the Statute

Unqualifiedly Corroborates the Views

Expressed in the Case of Commissioner

vs. Caulkins, 144 F. 2d 482. (C. A. 6,

1944) ..... 2 — 15

IV. Contemporaneous Judicial nnn

is in Accord with the Caulkins — — 17

V. Contemporaneous Administrative and

Legislative Construction is in Accord

with the Caulkins Case. ie

. , 25

VI. Conclusion

— 1 8 8 4

APPENDIX

OPINION OF THE COURT OF APPEALS .

CON epson OPINION

J UDGMENT

DECISION ON REHEARING .

——

—

OPINION OF DISTRICT COURT

ati

TABLE OF AUTHORITIES

„„ ZSututes Page

Revenue Acts, 3 a

1934, Section 117 (d. — —. 17

Section 117 (f) — — 8, 15, 17

1100 Becton 170060 ——.—7—rð＋, — .

1938, Section 117 (f) ...........- 88 sities = a

Internal Revenue Code of 1939, ; : .

Section 117 (f). By 6, 7, 10, 16, 22

Internal Revenue Code of 1954,

Section 1232 (a) (1) eee —— 3, 7, 10, 28, 27

Section 1232 (a) (2) 27

Adolph Klein, 15 T. C. 26 (1950) 15

Commissioner V. Caulxins, 144 F. 2d 482 55

(C. S 2x. —— 7, 9, 12, 15, 23

Commissioner v. Morgan, 272 F. 2d 936

(GA 9th; 10 >: 10, 16, 25, 27

Driscoll v. Commissioner, 306 F. 2d =: . .

(C.A. 7th, r 5 21

Eli D. Goodstein, 30. T.C. 1178 (1958), ‘

affd.; 267 F. 2d 127 (C. A. Ist, 1959) ........... 15

Fairbanks v. U. S., 306 U.S. 436, 59

S.Ct. 607, 83 L. Ed. 855 (1939) 8, 9, 18, 25

Hanover Bank v. Commissioner, 369 U.S.

672, 82 S. Ct. 2080 S. Ct. 1080, 8 L. Ed. 2d

187 (1962) 7, 11°

” Howard C. Avery, 13 T. C. 351 (1949) 15

iv.

Lurie v. Commissioner, 156 F. 2d 436

1 10, 23

‘McClain v. Commissioner, 311 U.S. 527, ‘

61 S.Ct. 373, 85 L. Ed. 319 (1941) . 8,9, 19, 21, 25

Rieger v. Commissioner, 139 F. 2d 618

e 10,23

Rosen v. U.S. 288 F. 2d 658 (C. A. 3rd, 1961) . 10, 11

Steven W..Kormendy, 18 T. C. M. 353 (1959) — 1

Timkin, 6 T. C. 483 (1946) . g 15

U.S. v. Fairbanks, 95 F. 2d 794 (C. A. 9th, 1938) —. 17

Administrative Regulations and Rulings

Regulations, I. R. C. 1954, Sec. 1.1282(a)-2

Tb 6258, 1957-2 C. B. 556

2⁴

I. T. 2846, XIV - 1 C. B. 112 (1935) .... 22

Acquiescence Noted, C. I. R. v. Caulkins,

Bey SE pce aoe

Rev. Ruling 56-299, 1956-1 C. B. 603

Reports of Congressional Committee

8 House Committee on Ways and Means on Revenue

Act of 1934, 1939-1 C. B. (Part 2) 577 16, 26

House Committee on Ways and Means on I. R. C.

of 1954, 1954 U.S. Code, Congressional and

and Administrative News, Vol. 3, p. 4110

(1954) —— — : 23

* Miscellaneous

Janin, The Israeli Bond Ruling: Legiglation by

Administrative Fiat? 33 Taxes (March :

1955) 191 (1955) ...... 25

* * 8 a

IN THE

Supreme Court of the United States

OCTOBER TERM, 1962

O., D. HARRISON and wife JENNIE L. HARRISON ;

ADDISON O. WOOD and wife JOANNA G. WOOD; and

EDWARD H. JACKSON and wife MARGARET J. JACKSON,

, | * Petitioners,

versus

UNITED STATES OF AMERICA,

Respondent.

PETITION FOR WRIT OF CERTIORARI TO THE UNITED

STATES COURT OF APPEALS FOR THE FIFTH CIRCUIT.

Petitioners, O. D. HARRISON and,JENNIE L.

HARRISON (husband and wife), ADDISON O. WOOD

g and JOANNA G. WOOD (husband and wife) and ED-

= WARD H. JACKSON and MARGARET J. JACKSON

. (husband and wife) respectfully pray that a writ of

certiorari issue to review a judgment of the United States

Court of Appeals for,the Fifth Circuit entered June 22,

1962, and made finafby denial of a petition for rehearing

on Septeniber 27, 1962, reversing a decision of the United -

‘States District Court for the Western District of Louisi-

ana. a 3

OPINIONS BELOW

The opinion of the Court of Appeals is reported at

304 F.2d 835 (C. A. 5th 1962) and is reproduced at Page

I of the Appendix hereof. It also appears at Page 121

of the Transcript. The decision of the District Court is

not Feported, but is found at Page 66 of the Transcript.‘

This opinion has also been reproduced at Page 12 * the

Appendix hereof.

‘J —

The joigment of the Court. f Appeals (Tr. p. 129,

App. p. 9) was entered June 22, 1962. Application for

rehearing was timely filed by petitioners (Fr. p. 130),

and on September 27, 1962 an order \was entered denying

the petition for rehearing (Tr. p- 145, App., p. 11 >. thus

making final the judgment of the Court of Appeals. Juris- ae

diction is conferred upon this Court bef * U.S. C. A. Sec- _

tion 1254 (1).

” QUESTION *

The question “presented for decision in this case

is whether for the purpose of the Federal income tax, and

under the terms of Sections 117 (f) I. R. C. 1939 and 1232 (a)

(1) LR. C. 1954, petitioners are entitled to treat the gain

from amounts received by them in retirement of corporate

a It also appears at the same page of the Record of the

proceedings before the Court of Appeals, nine copies of

which are filed with this application. Pages 1 through

119 of the Transcript and Pages 1 * 119 of the

Record are identical.

— en —

me NS

bonds issuꝶl in oe form and purchased for less

than their face amount as gain from the sale or exchange 5

of capital assets, or whether the difference between the

cost of such bonds to them and the amount received upon

retirement of the bands constitutes ordinary indome. -

Although the \question is simpie, it has given rise,

‘within the past few years, to considerable litigation in

the various circuits and in the Tax Court with conflicting

decisions hereinafter discussed. >

STATUTES 8

N * The question presented requires an interpretation

of I. RC. 1939 Section 117 (f) and I. R. C. 1954 Section

1232 (a) (1), which provide as follows:

\ 3117. Capital gains and losses

“*(f). ‘Retirement of bonds, ete. For the purposes of

this chapter, amounts received by the holder upon

the retirement of bonds, debentures, notes, or cer-

tificates or other evidences of indebtedness issued

by any corporation (including those -issued by a

government or political subdivision thereof), with

interest coupdns or in registered form, shall be con-

sidered as amounts received in exchange therefor.”

“1232. Bonds and other evidences of indebtedness

(2) In addition to the reported cases, involving the uestion,

which are discussed in the argument below, petitioners

believe that following cases presently pending upon

the docket of the Tax Court involve substantially simi-

lar issues: Raymond F. and Nathryn. Custithe, Docket

No. 1363-62; Thomas E. Wood, Docket No. 3014-62.

„(a) General Rule. — For purposes of this subtitle,

in the case of bonds, debentures, notes ox cer-

tificates or other “evidences of. indebtedness, which

are capital assets in the hands of the taxpayer, and

which are issued by any corporation, or government .

or political subdivision’ thereof —

“(1) Retirement. — Amounts received by the holder

on retirement of such bonds or other evidences of

- indebtedness shall be considered as amounts receiv-

ed in éxchange therefor (except that in the case of

bonds or other evidences of indebtedness issued be-

fore January 1, 1955, this paragraph shall apply

only to those issued with interest coupons or in reg-

istered form, or to those in such form on March 1,

1954). 70

STATEMENT OF THE CASE

This action involves three consolidated suits filéd

- by each husband and wife party hereto for the recovery

of Federal income taxes erroneously assessed and paid

by them for the years 1953 through 1957.0 The facts

are uncontradicted, were compietely stipulated in the

trial court and can be summarized as follows:

The Washington Youree Hotel Company (herein-

after simply referred to as the “Hotel Company” ).~oper-

ates the Washington Youree Hotel in Shreveport, Louis-

iana (Tr. p. 36). On April 29, 1952, petitioners purchased

(in varying amounts) from the Hotel Company sixty (60)

_ serially numbered, non-interest bearing bonds in regis-

(3) The year 1954 is not involved in the case of ee

Addison O. Wood and his wife.

. ‘

5 ‘

* ¢

tered form having a, face amount of $404,850 (Tr. pp. 36,

57%. The purchase price was $300,000 cash (Tr. p. 37).

The bonds, although non-negotiable, were fully transferr-

able and were secured by a second mortgage on the Hotel

Company property with The First National Bank of

Shreveport serving as Trustee under the mortgage (Tr.

pp. 36, 59). Petitioners had no other interests in the

Hotel Company (Tr. p. 38). The bonds were registered

with the Trustee and were. held by petitioners until ma-

turity (Tr. p. 38: The bonds maturing during the years 1952

through 1956 were duly paid and retired by the Hotel

Company (Tr. p. 38). Those maturing in 1957 were not

retired in full, a partial retirement being made of them

with an extension agreed to for the payment of the

balance (Tr. p. 38).

In their returns for the years 1953 through 1957,

petitioners reported the difference between the cost of

the bonds and the amounts received upon their retirement

as amounts received from the sale or exchange of capital

assets dnd included the gain from the transaction in their

returns as long-term capital gain. The Commissioner of

Internal Revenue determined that the difference between

the cost of bonds to petitioners and the amount received

upon, the retirement of the bonds constituted ordinary

income and assessed a deficiency which was paid. Claims

for refund were timeiy filed by petitioners and rejected

by the Commissioner (Tr. pp. 19, 22, 26). These suits

for refund were then timely filed against the United States

a 6

in the United States District Court for the Western Dis-

trict of Louisiana (Tr. pp. 2, 7, 12). 0

The cases were consolidated for all purposes by the

District Court (Tr. p. 33). The District Court held that

the amounts received upon retirement of the bonds con-

stituted amounts received upon retirement of bonds in

registered form within the meaning of Section 117(f)

I. R. C. 1939 (as to the year 1953) and within the meaning

of Section 1232 (a) (1) I.R.C. 1954 (as to the later years)

and that, accordingly, the gain upon the transaction con-

stituted long-term capital gain (App. p. 12)

Upon. appeal by the Government, the Fifth Circuit

Court of Appeals reversed the lower court’s decision and

held that the transaction was not within the intendment

- of the sections in question and that the gain from the

transaction constituted ordinary income to petitioners. It

is the review of this decision that is here sought.

There is no dispute as to the amount involved, the

parties having agreed that if petitioners are correct in

their contentions the judgment rendered in the lower court

is correct (Tr. pp. 62, 64).

SUMMARY OF ARGUMENT ‘

I. The question presented is whether the differ-

ence between the face amount received upon their retire-

ment and the cost of registered corperäte bonds issued

at a discount comes within the purview of Sections 117

(4) Petitioners.- were, at all times relevant hereto, residents

of Shreveport, Louisiana, in the Western Distrieg of

Louisiana,

“ail

‘

(f) IR. C. 1939 and 1232 (a) (1) I. R. C. 1954, both of

which provide in part: “amounts received by the holder

upon the retirement of bonds. . . in registered form

shall be considered as amounts received in exchange there-

for.“ There is a clear conflict between the decision of

the court below and that of the Sixth Circuit in Commis-

sioner v. Caulkins, 144 F. 2d 482 (C. A. 6th, 1944). The

court below held that although the gain in question came

within the literal terms of the act, it did not come within

its intention and the gain from the transaction not being

capital in nature was ordinary income. The Sixth Cir-

cuit in the Caulkins case held that the provisions of the

law were clear, that the amounts in question fell within

the terms of the act and that the gain was gain from the

exchange of a capital asset.

II. This Court has held in a number of cases, in-

cluding a very recent one, Hanover Bank v. Commissioner,

369 U.S. 672, 82 S. Ct. 1080, 8 L.Ed. 2d 187 (1962), that

the wörds of statutes including the revenue acts should

be interpreted in their ordinary, everyday sensesand that

where the statute is clear resort should not be had to

supposed Congressional intention to effect a purpose which

does not appear from a fair reading of the language of

the act. The ordinary sense of the statute involved is

to treat the amount paid upon retirement of a bond as

gain from the sale or exchange of the bond. The Sixth

Circuit in the Caulkins case, after reviewing the history

of the act, arrived at precisely the same conclusion using

the principles set forth in the Hanover Bank case. The

Caulkins decision is completely in accord with the juris-

”

prudence from the date of the adoption of Section 117

(f) in the Revenue Act of 1934 until the year 1959.

III. The legislative history of the statute cléarly

‘shows that Section 117 (f) was enacted to convert what

had formerly been considered as caus of a debt to a

capital transaction.

. IV. This Court in the case of Fairbanks v. LU. S.,

306 U.S. 436, 59 S. Ct. 607, 83 L. Ed. 855 (1939), agreed

‘with the Ninth Circuit when, in. referring to Section 117

(f) as it appeared in the Revenue Act of 1934, it stated:

“When Congress determined as it did in 1934 to treat

as capital gains, gains resulting from the retirement of

bonds issued by a government or corporation, it had no

difficulty in expressing its intent in clear and unambiguous

language.” This Court in McClain v. Commissioner, 311

U.S. 527, 61 S. Ct. 373, 85 L. Ed 319 (1941), found this

to be the purpose of Section 117 (f) and asserted that

if there were any inadequacies or inconsistencies in this,

it was the function of Congress to change them, not the

Courts’.

V. The Treasury Department apparently consider-

ed Section 117 (f) clear since no regulations were issued

interpreting it, and in 1935, shortly after the adoption

of the Revenue Act of 1934, the Commissioner ruled that

the act clearly made the retirement of bonds a capital

transaction even though the transaction might not be in

fact capital by its nature and even though as to the issuer

of the bonds it remained a debt transaction. Section

117 (f was re-enacted several times while this ruling

was in effé&t.

VI. Although the Internal Revenue Code of 1954

in Section 1232 (a)(1) changed prospectively an interpre-

tation of Section 117(f) by a circuit court dealing with

the question of whether the bonds had to be initially issued

in registered form, it continued and re-enacted the balance

of the section interpreted by the Caulkins case as extend-

ing capital gains treatment to a situation such as that

involved in this case. i

VII. Accordingly, the opinion of the court below

is contrary to the Caulkins case, and to the opinions of

this Court and is unsupported either by the plain langu-

age oi the act, its legislative history or its administrative

construction. iJ 3 a

ARGUMENT

I. The Decisions of the Circuit Courts of Ap-

peals are Conflicting.

The decision of the Court of Appeals is incorrect

and is in direct and irreconcilable conflict with the decision

of the Court of Appeals for the Sixth Circuit in the case

of Commissioner v. Caulkins, 144 F.2d 482 (C.A. 6th

1944). It is alse/contrary to the interpretation given to

the statute involved by this Court in the cases of Fairbanks

v. U. S., 306 U.S. 436, 59 S. Ct. 607, 83 L. Ed. 855 (1939)

and McClain v. C. I. R., 311 U.S. 527, 61 S. Ct. 373, 85

L. Ed. 319 (1941).

Prior to the instant case, the question at issue ws

considered by three separate Circuit Courts of Appeals,

the Sixth Circuit in Commissioner v. Caulkins, 144 F.2d .

482 (1944) and Rieger v. C. I. R., 139 F. 2d 618 (1943);

the Ninth Circuit in Commissioner v. Morgan, 272 F. 2d

936 (1959) and Lurie v. C. I. k., 156 F. 2d 436 (1946),

and the Third Cireuit in Rosen v. United States, 288

F.2d 658 (1961). The Sixth Circuit held that under the

plain language of the statute the holder of the bonds was

entitled to report the gain as capital gain. The Ninth

Circuit in, Lurie held the gain from such a transaction

was capital gain even though the bonds were not registered

until shortly before they were retired. In Commissioner

v. Morgan, supra, the Ninth Cireuit held the gain to be

ordinary ineome without mentioning its prior deeision

in Lurie. The Third Cireuit followed the Morgan ease in

Rosen v. United States, supra. The court below rejected

the Caulkins case and followed that of Morgan and Rosen

without mentioning either Rieger or Lurie. In its opinion,

the Fifth Circuit summarized the matter as follows:

“They [petitioners] rely on Section 117 (f) of the

Internal Revenue Code of 1939 and Section 1232

(a) of the 1954 Code which provide that ameunts

received by the holder upon the retirement of bonds

shali be considered as ‘amounts received in exchange

therefor.’ The Government “asserts: that this pro-

vision does not reguire capital gains treatment of

amounts received on the redemption of bonds but

merely permits it; that the gain received by the

taxpayers is in the nature of accrued interest on the

capital invested and is taxable as regular income.

Courts of Appeals in three circuits have ruled on

this question. Commissioner v. Cauikins, 6 Cir.,

1944, 144 F.2d 482 held that the statute compelled

capitals gains treatment of the amounts received on

,°

the redemption of a bond. Commissioner v. Morgan,

9 Cir., 1959, 272 F.2d 936 and Rosen v. United

States, 3 Cir., 1961, 288 F.2d 658 rejected the re-

sult reached in Caulkins, held that capital gains

taxation is not compulsory under the statute, and

imposed regular income taxes on the gains in ques-

tion We agree with the Morgan and Rosen

interpretation and hold that the portion of the tax-

payers’ receipts representing the original issue

discount must be taxed as regular income.” [App.

pp. 2 (Footnotes omitted)

Implicit in the opinion of the Court is the fact that

under the ordinary language of the acts the amounts re-

ceived by petitioners would constitute amounts received

in exchange for the bonds.® Notwithstanding this, how-

ever, the Court held: “In the light of its historical setting

and pertinent tax principles, the natural reading of ‘in

exchange therefor’ is to permit capital gains treatment,

not compel it.“ (Emphasis supplied.) The Court then

conelud. in the instant case the gain must be taxed as

ordinary income.

II. The Statute in Issue Clearly Pro that

Gain from Amounts Received in Ret

of Registered Corporate Bonds is Capital Gain.

In the very recent case of Hanover Bank v. Com-

missioner, 369 U.S. 672, 82 S.Ct. 1080, 8 L. Ed 2d 187

(1962), this Court, in a case dealing with the amortiza-

tion of bond premiums and in replying to an argument

(5) It seems fair to state that this is also true of the

opinions in Morgan and Rosen. '

(6) App. p. 5.

by the Government which bears great similarity to that

accepted by the Court of Appeals in this case, held:

“A firmly established principle of statutory inter-

pretation is that ‘the words of statutes — including

revenue acts — should be interpreted where pos-

sible in their ordinary, everyday senses.’ Crane v.

Commissioner, 331 US 1, 6, 91 L ed 1301, 1306, 67

S Ct 1047. The statute jg issue here, in plain

ordinary language, evidences a clear congressional

intent to allow amortization with reference to any

call date named in the indenture. Under such cir-

cumstances we are not at liberty, notwithstanding

the apparent tax-saving windfall bestowed upon

taxpayers, to add to or alter the words employed to

effect a purpose which ddes not appear on the face

of statute.” ö

What is the ordinary sense of the statute involv-

ed“? When a bond is issued and is retired at maturity,

what other amount could be received in its retirement

if it is not the face amount of the bond? This is what

petitioners received; this is what they claimed they re-

ceived upon retirement; this is what they contended should

be used in oe the gain received from the exchange

of the bonds.

The Sixth Circuit in the Caulkins case, which was

rejected by the court below, used precisely the same reason-

ing in arriving at its decision, as will appear from the

following :

“The decisive question is whether the amount re-

ceived by the taxpayer falls within § 117(f), which

provides that amounts received by the holder upon

2 >

retirement of the securities named shall be con-

sidered as amounts received in exchange therefor.

If it does, the decision of the Tax Court is correct.

As pointed out in Fairbanks v. United States, 306

U.S. 436, 59 S.Ct. 607, 83 L.Ed. 855, a case in-

volving a profit received on the redemption of cor-

porate bonds prior to the enactment of § 117(f) in

1934, the redemption before maturity of corporate

bonds is not a sale and exchange of capital assets

within the commonly accepted meaning of the

words. The gain realized prior to 1934, the court

held, was not a capial gain. Similarily, prior to

1934 losses on bonds were deducted in full,. under

the bad debt provisions of the statutes. Lebanon

National Bank v. Commissioner, 3 Cir., 76 F.2d -

792; Pacific National Bank v. Commissioner, 9

Cir., 91 F.2d 103. The Revenue Act of 1934 made

a radical change in the prior law when it provided

§ 117(f) that amounts received on retirement of the

securities listed should be calculated as capital gain

or capital loss. Fairbanks v. United States, supra.

1 „ „3

“While granting that the security held by the tax-

payer is an evidence of indebtedness of the character

described in §117(f), the Commissioner contends

that that section was not inténded to cover the gain

from interest, but only capital gain.. The

Commissioner hence urges that the increment in

value of the certificate constitutes compensation

for the use of the taxpayer’s money, which the

Supreme Court has recently stated to be interest,

Cf. Deputy v. DuPont, 308 U.S. 488, 60 S.Ct. 363,

84 L.Ed. 416, and that as such it must be taxed

in its entirety as ordinary income under §22(a).

Congress might well have made the differentiation

urged by the Commissioner, since it is difficult to

perceive any practical reason for taxing increment

of the type involved here differently from ordinary

income. The fact that-the contract does not pro-

vide for equal amounts of interest to be set aside

each year, available to the holder, does not affect

the question. The increment is. “consideration paid

for the use of the amounts paid in. Unfortunately

? for the Commissioner’s contention, Congress has

not made the differentiation.

“Where statutory standards are lacking, statutory

language is to be read in its natural and common

meaning.“ Helvering v. William Flaccus Oak

Leather Co., 313 U.S. 247, 249, 61 S.Ct. 878, 85

L.Ed 1310; Kales v. Commissioner, 6 Cir., 101

F.2d. 35. In the present case, the promise was

to pay $20,000 at the expiration of the ten-year

period. Clearly $20,000 was the amount received.

on the retirement of the certificate, and undef the

plain’ wording of § 117(f), it was taxable as a

capital gain. A provision that the increment in

such cases should be taxable under § 22(a) might

or might not have been wise and fair; but Congress

has not enacted it; and the courts cannot supply it

by judicial legislation. Because of the application

of the capital gains tax to securities which on their

retirement may not result in capital gain, incon-

sistencies and inequalities may well result from the

application of § 117(f). If this is so, the correc-

tion of this defect in the operation of the statute

is for Congress and not for the courts. McClain |

v. Be ng gl 811 US. 527, 530, 61 S. Ct. 373,

85 L. Ed. 319. . :

This case is completely in accord with the juris-

prudence interpreting Section 117 (f) from the date it was

adopted in 1934 until che Morgan case was decided in 1959.

See, in addition to the cases already cited:

Timkin v. C. I. R., 6 T.C. 483 (1946), (aeg.

noted 1946-2 CB. 5); .

Howard C. Avery, 13 T. C. 351 (1949) (aeg.

noted 1950-1 C. B. 1);

Adolph Klein, 15 T. C. 26 (1950) (acg. noted

1950-2 C. B. 3);

Steven W. Kormendy, 18 T. C. M. 353 (1959) ;

and

Eli D. Goodstein, 30 T. C. 1178 (1958) (af.

firmed 267 F. 2d 127 (1959) ).7

Ill. The Legislative History of the Statute Un-

qualifiedly Corroborates the Views Expressed

in the Case of Commissioner v. Caulkins, 144

F. 2d 482 (C. A. 6, 1944).

Although petitioners believe the law is clear and

there. is no necessity for resorting: to its legislative his-

tory, an examination of this history and of the circum-

» stances surrounding the adoption of Section 117 (f) com-

pletely affirms the Sixth n opinion. 8

ls. hee tiie

tion 117 (f), is found in a corres; ndingly numbered

tion of the Revenue Code of 1934. Prior to that time

(7) Appeal by taxpayer on other points. ‘The Court of

Appeals did not pass upon the point in question because

the Commissioner apparently did not urge it.

9 ‘

‘the ‘retirement of a bond was not considered a sale or ex

) 16

oF pa |

change but was simply treated as the payment of a debt.

Any profit realized by the holder of the bond was at that

time treated as ordinary income. Similarly, the loss suffer-

ed upon such a retirement was treated as a loss from

a bad debt.

Section 117 (f) was enacted to change this. Al-

though the legislative history of the provision ‘s some-

what meager, it clearly demonstrates that the interpreta-

tion of the Sixth Circuit is correct. The House Committee

reporting the bill simply stated:

“Subsection (f) referring to Section 117(f) pro-

vides that amounts received upon the retirement

of corporate bonds and similar evidences of in-

debtedness shall be considered as amounts received

in exchange therefor.“ .

It appears that the provision was inserted partly

at the insistence of,a Committee of the American Bar

Association. As noted by the Ninth Circuit in the Morgan

case® the Committee urged Congress to extend capital

gain and loss benefits to this type transaction. There is

certainly no intimation in the history of the act that the

section was intended to mean anything’other than what is

clearly states—that, amounts received upon the ‘retire-

ment of a bond are considered to be as amounts received

in exchange for it. te

(8). 1939-1 C.B. (Part 2), 577.

(9) At 272 F. 2d 936.

It also might be noted in passing that an exception

to this general rule was inserted at the same time in Sec-

tion 117 (d) of the Revenue Act of 1934 in dealing with

losses from the sale or exchange of identical securities in

the case of banks. This limitation clearly shows Congress,

in enacting Section 117 (f), was aware of the fact that

the basis of bonds of the type dealt with in that section

might be more or less than the face amount thereof and

specifically restricted or limited the applicability of such

provisions in the case of banks. If any such limitation

or qualification had been generally intended by Section

117 (f) surely Congress would have so provided.

IV. Contemporaneous Judicial Construction is in

Accord with the Caulkins Case.

Shortly after the enactment of the Revenue Act

of 1934, it was contended that Sectio® 117 (f/ was merely

declaratory of the pre-existing law, and accordingly that

gain of the nature involved in this case should, for years

prior to 1934, be taxed at capital gain rates. In U. S. v.

Fairbanks, 95 F. 24 794 (C. C. K. 9th 1938), the Ninth Gir-

cuit ‘rejected this view, held that the addition of Section

117(f) was intended to radically change the law, and

made the following comments pertaining to it:

“The question now to be decided is whether the gain

so realized by defendant was a ‘capital gain.“ a:

We think not. Between the redemption of a bond

and the sale or exchange thereof, there is a clear

distinction. Such redemption is merely the pay-

ment of an obligation according to its terms. It is

a’

he 4 * a *

in no wise a sale or exchange. Watson v. Commis-

sioner, 27 B. T. A. 463, 465; Braun v. Commissioner,

29 B. T. A. 1161, 1177...

. This doubtless, is the reason why prior to 1934

gains resulting from such redemption were_never

included in the definition of ‘capital gain.’ What-

ever the reason, such gains were not so included,

and the definition should not, we think, be —

by judicial construction.

“When Congress determined, as it did in. 1934, to N

treat as ‘capital gains’ gucns resulting from the

retirement of bonds issued by a government or cor-

poration, it had no difficulty in expressing its in-

tent in clear and unambiguous language. Revenue

Act of 1934, § 117(f), 48 Stat. 715, 26°U.S.C.A.

101 (f). If such intent had existed prior to 1934,

it could and, we think, would have found similar

expression.” (Emphasis supplied)

Certorari was granted by this Courtio which ap-

proved not only the holding and interpretation of the law

as made by the Circuit Court, but its eonstruetion of the

Revenue Act of 1934. See Fairbanks v. U. S., 306 U.S.

436, 59 S.Ct. 607, 83 L.Ed. 855 (1939). 4

Section 117 (f) also had the effect of converting

what had formerly been considered a loss from a bad debt

to a capital loss. Several cases were instituted by tax- -

payers who found their deductions for losses upon regis-

tered bonds limited by Section 7 (f). To resolve con-

flicting cases with respect to this matter, this Court grant-

(10) 305 U.S. 667, 59 S.Ct. 66, 83 L. Ed. 433 (1939).

19 an

ed certiorari in two of them. In these cases, the tax-

payers contended that Section 117 (f) was not “intended”

by Congress to make the loss a capital loss. They argued

a bond is “obviously” merely evidence of a debt. The

failure of a debtor to pay his debt is “obviously” not a

‘capital transaction. Accordingly, it was not “reasonable,” i

they said, to conclude Congress: would have “intended” to

treat the loss from a bad debt as a capital transaction.

: >

The Government on the other hand argued:

“The taxpayer’s surrender of his bonds for cash con-

stituted a yetirement of the obligations within the

meaning of § 117(f) 26 USCA Int. Rev. Acts, 1940

ed. p. 708, and the loss thereby sustained was a

capital loss . Se

“Section 117 7 covers all transactions hereby

bonds or other evidence of indebtedness of a cor-

poration or of a government are surrendered ct .

cash and the debt is thereby —

(Emphasis supplied) :

Mr. Justice Roberts delivered the opinion of this

Court in which it agreed with the goverament for the

following reasons:

“The earlier revenue acts contained sections similar

to 23 (K) of the Act of 1934. They also embodied

provisions for calculation of taxes on — net

(11) McClain v. C. I. R., 310 U.S. 620, 60 S.Ct. 1079, 84 1. Ed.

1393 (1939); Helvering v. Thomson, 310 U. 620, 60

S8. Ct. 1079, 84 L. Ed 1393 (1939).

(12) Summaries of these arguments are found at 85 L. 3

319-320.

= °

‘

gains. None of them included any section like

117(f). Prior to the adoption of the 1934 Act it

had been held that the phrase ‘sale or exchange’ of

. Capital assets, employed in those Acts, was not de-

scriptive of the redemption or call for repayment

of corporate securities, and hence gain thereby oc-

casioned was to be treated as ordinary income, and

loss so arising was to be deducted from gross in-

come as a bad debt. 0

The Rovenke Act 01 1934, by subsection (f) of

§ 117, provided that for the purposes of the title

dealing with capital gains and losses, ‘amounts re-

ceived by the holder upon the retirement’ of such

securities as are here involved, ‘shall be considered

ast amounts received in exchange therefor.’

“It is plain that Congress intended by the new sub-

section (f) to take out of the bad debt provision

certain transactions and to place them in the cate-

gory of capital gains and losses,

* *# #& @

“The taxpayer in number 8 urges that to hold sub-

section (f) applicable in his case would give the

provision an unjust effect, since, if he had refused

to surrender his debentures for the trifling consider-

ation offered, he could have charged off their whole

cost as a bad debt under § 23 (k).

“The answer is that we must apply the’ statute ‘as

we find it, leaving to Congress the correction of

asserted inconsistencies and inequalities in its op-

eration.” (Emphasis supplied)

McClain v. C. I. R., 311 U.S. 527, 529, 61

S.Ct. 373, 85 L. Fd. 319, 322 (1941).

That this Court considered the enactment of See-

tion 117 (f) to evidence a clear expression by Congress

of its purpose to convert a transaction previously regarded

as involving a debtor-creditor relationship to a capital

transaction is clearly established.

V. Contemporaneous Administrative and Legis-

tive Construction is in Accord with the

Caulkins Case.

Surely had Congress meant to restrict the provis-

ions to losses suffered, it could have simply stated that

losses from the redemption of jbor: ds shall be treated as

capital losses. Had it intended to exclude “original issue

discount” from the gain provisions, it could have simply

qualified the section by saying that amounts received from

the retirement of bonds in excess of their issue price shall

not be considered as being received in exchange for them.

It did neither. The Treasury Department apparently

found no such limitations inherent in Section 117 (f)

either, since during the twenty years the seetion remained

in effect no regulations were issued interpreting the sec-

tion — indicating the section to be plain and unambiguous.

° In spite of the Government’s prese ~ assertions as

to Congress’ intentions, the Commisssioner ruled, within

(13) The McClain case was recently relied upon by the

Seventh Circuit Court of Appeals in granting capital

gain treatment to the retirement of evidences of in-

debtedness issued after January 1, 1955, under the prov-_

isions of Section 1232 (a) (1). The Court found the

section to be clear and unambiguous. See Driscoll v.

C. I. R., 306 F. 2d 35 (C. A. 7, 1962).

—

a few months after the adoption of Section 117 (f), that

capital gain was realized to the holder of bonds. upon their

retirement not because of the nature of the gain, but

because Section 117 (f) made it so even though from the

viewpoint of the obligor or issuer of the bonds it remained

a debt transaction:

—

* a

“Under the Revenue Act of 1934, it is clear as to

the holder of bonds which are retired that the gain

derived or loss sustaindd must be treated asa capital

gain or capital loss in view of the provisions of

section 117(f) of that Act, which provides that

amounts received by the holder upon the retirement

of bonds shall be considered as amounts received

in exchange therefor. Such a gain or loss is a cap-

tial gain or capital loss, as the case may be, not by

reason of the nature of the transaction itself but be-

cause of the specific provisions of section 117/f),

supra. However, the statute does not contain any

such provision with respect to the transaction as

viewed from the standpoint of the obligor cor-

poration. There is no sale or exchange by the cor-

poration in such a case as required by the statute in

order for a transaction to result in a capital gain

or a capital loss.” (Emphasis partially supplied)

I. T. 2846, XIV +" 112 (1935).

Congress re-enacted Section 117 (f) at least three times

while this ruling was in effect.'4

In 1953 when the Internal Revenue Code Wag under

revision the House Committee which prepared the Revenue

— |

(14) See Section 117 (f) Revenue Acts of 1936, 1938, ‘and

I. R. C. 1939.

—

23 *

Act of 1954 inserted in their bill what is now Section 1232.

In addition to the decisions of this Court just mentioned

expressing its views as to the meaning of the act, there

were at that time three Courts of Appeals cases directly

construing the provisions of Section 117 (f) the Caulkins,

Rieger. and Lurie cases, cited above. The Caulkins and

Rieger cases held, as we have mentioned, that the differ-

ence between the cost and the face amounts of the certif-

icates of indebtedness when received upon retirement con-

stituted amounts received in excharfge for the certificates.

The Lurie case further held that this was true even though

the bonds or certificates of indebtedness had only been

registered shortly before they were retired. The Revenue

Act of 1954 expressly changed the rule of the Lurie case

in Section 1232 (a) (1) and left unchanged the rest of the

provisions of 117 (f).

<>? g $

In the Report of the House Committee which drew

the Revenue Act of 1954, it is stated:

“(E) Bonds and other debt (sec. 1232)

(15) The change was accomplished by the parenthetical

clause added to the end of Section 1232 (a) (1). Such

a change would have been meaningless if the opinion

of the court below were correct since the registration

of the bonds would have had no effect in the Lurie case

unless capital gains would result upon the retirement

of registered (as distinguished from unregistered)

„ bonds.

(16). Report of House Committee on Ways and Means on I.R.C.

of 1954, 1954 U.S. Code, Congressional and Adminis-

trative News, Vol. 3, p. 4110 (1954).

5 he .

“Under existing law any gain realized from a cor-

porate or Government bond in registered form or

ith coupons attached is treated as a capital gain

either if the bond is held to retirement or if it is

sold or exchanged. Part or all of this gain, how-

ever, may represent discount on original issue

which is a form of interest income and in fact is

deductible as an interest payment by the issuing

corporation.

“Effective with respect to bonds issued after Decem-

ber 31, 1954, the committee bill provides that any

gain realized by the holder of a bond attributable —

to the original issue discount will be taxed as ordi-

nary income. This discount is apportioned over

the entire period to the’matlirity of the bond and

if the bond is sold prior to maturity only a pro rata

“portion of this discount is attributed to the gain

realized by the seller. Any excess gain over the

amount considered as ordinary income Wil be taxed

as a capital gain. This rule is not applied to State

and local government securities since interest in-

come on these securities is free of tax. Rules for

determining the original issue price are provided

by the bill.”

In the — issued by the Secretary of Treas-

ury shortly after the 1954 Code was adopted, it was stated:

“Section 1232 (a) (1) provides that any amount

received by the holder upon the retirement of an

obligation shall be considered as an amount re-

ceived in exchange therefor.” [Regs. 1954, §

1.1232 (a)-2] |

The history of the administrative interpretation of

Section 117 (f) by the Commissioner of Internal Revenue \

lends further support to the petitioners’ position ;. how-

ever, rather than unduly lengthen this argument, petition-

ers refer the Court to an article by Mr. Harry Janin

in the March 1955 issue of Commerce Clearing House’s

magazine “Taxes” at page 191, entitled “The Israeli Bond

Ruling: Legislation by Administrative Fiat?” which com-

pletely discusses the matter.

VI. CONCLUSION

_ Until the Morgan case was decided, there was ab-

solutely nothing in the jurisprudence, regulations cr rul-

ings which would indicate that there was any limitation

upon the plain meaning of Section 117 (f. The Ninth

Circuit in two cases prior to the Morgan case clearly

thought that gains such as are involved in this case were

made capital gains by Section 117 (f. This Court in

approving the Fairbanks case, and in the McClain ease,

considered the statute to do the same thing. The Commis-

sioner of Internal Revenue in 1935, the year following the

enactment of Section 117 (f., considered the law clear.

The Treasury Department undoubtedly considered the law

clear, or it would have issued regulations interpreting it.

The Tax Court prior to the Morgan case thought the law

was clear. The Sixth Circuit thought it was clear; and

the Commissitner, until shortly before the 1954 act Was

(17) It is interesting to note that the Ninth Circuit in

Morgan did not repudiate the Fairbanks case, and

indeed, in effect. held that had the Fairbanks case arisen

after Section 117 (f) was enacted capital gain would

have occurred. See 272 F. 2d 938.

adopted, apparently was satisfied with the Caulkins cage

since he acquiesced in the decision in 1944 (1944 C.B. 5.)

and this acquiescence continued until 1956 (Rev. Ruling

56-299, 1956-1 C.B. 603). :

Furthermore, the taxation of the gain derived from

the purchase of a bond at a dis bunt and realized upon its

retirement is entirely consistent with the purposes and

intention of Congress in 1934 when the section was origin-

ally adopted. It is significant, we think, that in 1934

Congress was still grappling with the basic approach to

be used in the taxation of capital gains and Section 117

of the Revenue Act of that year was a new and admittedly

experimental approach to the problem. The basic premise

upon which Sec m 117 was based was that income which

is earned over a period of time but realized in one trans-

action should be taxed differently from income which

ordinarily accrues annually or on a regular basis. Thus,

the Committee said: *

“Subsection (a) provides for all taxpayers other

than ‘corporations a series of percentages which

must be used in arriving at the amount of the

recognized gain or loss which shall be taken into ac-

count in computing net income. The theory is that

the gain or loss shall be somewhat reduced in pro-

portion to the time for which the capital asset has

been held.”

[1939-1 (part 2) C.B. 577]

The taxation of gain such as is here involved is

entirely consistent with this since it cannot be realized

until the a is retired.

—

It is perhaps true that in recent years the philos-

ophy underlying the taxation of capital gains has changed

and Congress and the courts have adopted a more sophistic-

ated approach to the subject in light of current economic

thought. Thus, it appears fair to state that the length of

time over which the income accrues is no longer the con-

trolling factor in determining whether income should be

taxed at capital gain rates, but it is whether the income

essentially represents a conversion of capital. Whether,

in light of this changing concept, gain from bonds pur-

chased at a discount should be taxed at capital gain rates

may be debatable and it may well have caused Congress to

restate and partially restrict the applicability of the capit-

al gain provisions to discount realized upon the retirement

of bonds in Section 1232 (a) (2) with respect to bonds

issued after 1954. Such a decision is the function of

Congress. It is not the function of the Commissioner or

the courts. ö f

Petitioners submit that this case simply presents

a situation wherein the court below and the Government

has been unwilling to accept the fact that Congress, for

reasons which it felt best, chose to treat as a capital trans-

action what the Commissioner now feels should be treated

as a debtor-creditor relationship. The Government’s en-

tire argument, we believe, and the rationale of the Morgan

case which was relied upon by the court below as controll-

ing may be summarized simply in the statement that See-

tion 117 (f and its present counterpart, Section 1232

(a) (1), cannot mean what they say, because Congress

couid not have intended to do what it obviously did. This

e 28 0

& 8 . gee

arguinent has been properly answered in the McClain case

and in the Fairbanks case by this Honorable Court and in

the Caulking case by the Sixth Circuit. a

Petitioners respectfully submit that the. opinion

of the court below is incorrect and the writs of certiorari

should be granted and thereafter that the decision of the

Court of Appeals for the Fifth Circuit should be reversed. »

Respéctfully submitted,

g LEON O’QUIN,

* Fifth Floor, First

National Bank Building

Shreveport, Louisiana

N : Attorney for Petitioners.

THOMAS A. HARRELL,

Fifth Floor, First *

National Bank Building,

Shreveport, Louisiana,

Of Counsel

Shreveport, Louisiana

December 18, 1962.

— 2

CERTIFICATE

I, Leon O’Quin, attorney for the petitioners herein

and a member of the Bar of the Supreme Court of the

United States hereby certify that on the-18th day of

December, 1962, I served copies of the foregoing petition

for certiorari to the Supreme Court of the United States

on the defendant, the: United States, as follows:

1. By mailing a copy in a duly addressed envelope

with air mail postage pre-paid to the Solicitor General,

Department of Justice, Washington 25, D. C.

2. By mailing a copy in a duly addressed envelope

with postage pre-paid to Edward J. Shaheen, Esq., United

States Attorney for the Western Distriet of Louisiana,

Federal Building, Shreveport, Louisiana; and

3. By mailing a copy in a duly addressed envelope

with . postage pre-paid to Louis F. Oberdorfer,

Esq., Assistant Attorney General, Department of Justice,

Washington, D. C. N

a °

LEON O’QUIN,

„. Fifth Floor, First National Bank

Building.

Shreveport, Louisiana,

Attorney for Petitioners.

5 Appendix Page 1

IN THE

UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

* e

No. 19059

le UNITED STATES OF AMERICA,

Appellant,

versus

O. D. HARRISON and wife JENNIE L. HARRISON;

ADDISON O. WOOD and wife JOANNA G. WOOD;

and EDWARD H. JACKSON and wife MARGARET J.

JACKSON

Appellees.

Appeal from the United States District Court for the

Western District of Louisiana.

(June 22, 1962)

Before RIVES, BROWN, and WISDOM, Circuit Judges.

WISDOM, Circuit Judge: This action for tax re-

funds presents the question whether amounts of original

issue discount or interest received upon retirement of cor-

porate bonds are taxable as capital gain or ordinary in-

come. |

In 1952 the taxpayers purchased original issue

9 ,9

Appendix Page 2

discount bonds due to mature in series over the next five

years. As the bonds were redeemed, the taxpayer reported

their gain as long-term capital gain. They rely on Section

117 (f) of the Internal Revenue Code of 1939 and Section

1232 (a) of the 1954 Code which provide that amounts re-

ceived by the holder upon ti retirement of bonds shall be

considered as “amounts received in exchange therefor.”

The Government asserts’ that this provision does not

require capital gains treatment of amounts received on

the redemption of bonds but merely permits it; that the

gain received by the taxpayers is in the nature of accrued

Internal Revenue Code of 1939:

SEC. 117. CAPITAL GAINS AND LOSSES.

(f) Retirement of Bonds, Etc. For the purposes of this

chapter, amounts received by the holder upon the retire-

ment of bonds, debentures, notes or certificates or other

evidences of indebtedness issued by any corporation

(including those issued by a government or political

subdivision thereof), with interest coupons or in register-

-ed,form, shall be considered as amounts received in ex-

change therefor.

(26 U.S.C. 1952 ed., Sec. 117.)

Internal Revenue Code of 1954:

— 1232. BONDS AND OTHER vibe OF INDEBTED-

(a) General Rule. — For purposes of this sub-title, in

the case of bonds, debentures, notes or certificates or

other evidences ‘of indebtedness, which are capital assets

in the hands of the taxpayer, and which are issued by

ony a or government or political subdivision

ereof — - ö

(1) Retirement. — Amounts received by the

holder on retirement of such bonds or other evi- =

dence of indebtedness shall be considered as

amounts received in exchange therefor (except

that in the case Uf bonds or other evidences of

indebtedness issued before January 1, 1955, this

paragraph shall apply only to those issued with

interest coupons or in registered form, or to those

in su¢h-form on March 1, 1954). s

(26 US.C. 1958 ed., Sec. 1232.)”

8 &

‘or ee 0

8 ease *

- Appendix Page 3 5

interest on the capital invested and is taxable as regular

income. Courts of Appeals in three circuits have ruled on

this question. Commissioner v. Caulkins, 6 Cir.; 1944, 144

F. 2d 482 held that*the statute compelled capital gains

treatment of the amounts received on the redemption of a

bond. Commissioner v. Morgan, 9 Cir., 1959,.272 F. 2d

936 and. Rosen v. United States, 3 Cir., 1961, 288 F. 2d 6658

rejected the result reached in Caulkins, held that capital

gains taxation is not compulsory under the statüte, and

imposed regular income taxes on the gains in questior. See

also Jaglom v. Commissioner, 2 Cir., June 4, 1962, F..2d,

citing Morgan and Rosen with approval, and holding that

the portion of the proceeds from the flat“ sale of.defaulted

bonds which is allocable to interest accrued while the tax-

payers held the bonds is taxable as ordinary income. We

agree with the Morgan and Rosen interpretation? and

hold that the portion of the tax-payers’ receipts represent-

ing the original issue discount must be taxed as regular

income. 3

The facts of the case are not disputed. The taxpayers

purchased second mortgage bonds with a face value of

$404,850. They paid 7300,000, leaving an original issue

discount of $104,850, or 25.9 per cent of the face value. The

discount represented a purchasd bonus of $50,000 and, in-

terest at three and three-quarters per cent until maturity.

The purchase agreement provided that if the corporation

did not redeem the bonds at maturity it would’ pay

interest at the rate of five per cent. None of the taxpayers

had any interest in the corporation other than their if-

vestment in the bonds. They held the bonds until maturity,

and the bonds were redeemed as they matured until 1957

when the parties, agreed to postpone the redemption of a

— oo B. Gibbons, 37 T.C. No. 57; David Leavin, 37 T.C.

o. 73.

Appendix Page 4

i) ‘

portion of the bonds maturing that year. The corporation

amortized the original issue discount over the life of the

bonds and deducted the amount allocated to each year as an

interest expense. —

The taxpayers hitch their wagon to a literalistic eon-

struction a the statutory term, “in exchange therefor“.

Under Section 1222 (3) (of the 1954 Code) a long-term

capital gain is defined as the “gain from the sale or ex-

change of a capital.asset held for more than 6 months, if

and to the extent such gain is taken into account in com-

puting gross income.” To qualify as a capital gain income

must be received not merely in an “exchange” but “in ex-

change for a capital asset.“ The fact that a gain is receiv- .

ed in an “exchange” is a prerequisite to capital gains treat-

ment, but it does nꝗt by itself insure such treatment. When

the right to receive ordinary income is sold, the proceeds

from that exchange do not qualify for capital gains. treat-

ment. Commissioner v. Lake, 1958, 356 U.S. 260, 78 S. Ct.

691, 2 L. Ed. 2d 743. The weight of the taxpayers’ argu-

ment therefore, rests on the word “therefor” rather than on

the words “in exchange“ they would maintain that the

statute requires all the proceeds from the retirement of a

The defiition of capital asset’ is considerably broader than is

justified by the rationale fur capital gains and if read literally

would encompass income which Congress did not intend to give

the benefit of the lower capital gains tax rate. Consequently,

‘the courts = narrowly interpreted the definition of capital

assets. See, e.g., Corn Products Refining Cc. 5 ey ag ms 350

U. S. 46, 52, 35.54 (1955); Commissioner v. P. G. Lake, Inc., 356

U. S. 260, 265 (1958). A distinction has arisen between an

income-producing capital asset and the income which it produces.

Gains arising from the sale of such an asset which has appreciat-

ed in value are capital gains, but gains flowing from the sale

of an accrued right to collect the income from such afi asset are

not. Thus the right to collect ordinary income is not transmuted

into 8 20, 1 by its sale. See, e.g., Hort v. Commissioner,

313. (1941); Commissioner v. P.-G. Lake, supra, at

266. 11 — the income producing asset and the right to accrued

income from the assct are sold together, the purchase price must

be allocated between ine two, only the former =e capital

asset. Jaglom v. Commissioner, 2 Cir., June 4, 1962

a Appendix Page 5

bond to be treated as received in exchangé for the bond

which is a capital asset. This would conflict with the well

- established and soundly reasoned rule that when property

is sold any portion of the proceeds that represents a right :

to receive ordinary income is taxed as such, even though the

principal asset transferred is a capital asset. Commis-

sioner v. Phillips, 4 Cir., 1969 275 F. 2d 33; Tunnell v.

United States, 3 Cir., 1958, 259 F. 2d 916.

As pointed out in the Morgan and Rosen opinions,

Section 117 (f) was enacted in response to Watson v. Com-

missioner, 1932, 27 B.T.A. 463. Watson held that since the

capital gains provisions were tied to the term sale or ex-

change”, a bond retirement could not qualify. The ruling

blocked capital gains treatment in cases where by the un-

derlying tests it would be appropriate; for example; the

gain received when a bond purchased at a depressed market

price is redeemed at par. The gain realized from such a

transaction is a form of capital appreciation that resembles

the capital gain received when stock or real estate is pur-

chased and later sold at a profit, in contrast to an original

issue discount gain which represents the interest or compen-

sation paid for the use of the money loaned. In the light of

its historical setting and pertinent tax principles, the

natural reading of “in exchange therefor” is to permit

capita] gains treatment, not compel it. It is implausible that

Congress intended by use of this language to discard other

tests that regularly must be met before a gain qualifies for

capital gains treatment under Section 1222 (3). As we 2

Sections 117 (f) and 1232 (a), the critical words are i

exchange”. “Therefor” is a, filler word necessary to ee

plete the grammatical st®ucture of the sentence. We can-

not believe that Congress intended to give “therefor” the

drastic effect contended for by the appellants. Had it wish-

ed to achieve that result it doubtless would have provided

expressly for capital gains treatment. The structure of the

—

Appendix Page 6

provision as it stands indicates a purpose to liken a bond

retirement to a sale or exchange and subject it to the same

tax treatment that a sale or exchange would entail. ‘The

reasons pointing to this conclusion are more fully discussed

in the Morgan and Rosen decisions. We believe that their

reasoning i¥ sound, and we follow their lead. The proceeds

in question in this litigation represent regular income and

should be taxed as such.. —

The judgment is 5

REVERSE.

BROWN, Circuit Judge, concurring specially:

I concur but not without some misgivings. I would

emphasize that we are not here dealing with the status of

proceeds received upon an ordinary commercial market

sale of such bonds subsequent to the time of original issu-

ance. From the interplay of economic laws which may even

_ defy judge-made laws, the price will fluctuate, up and

down, above or below the normal par (face) value de-

pending on the supply of money, the demand for it, and

other economic factors. See The Hanover Bank, Executor

v. Commissioner, 1962, — U. S. —, S. Ct. —, — L. Ed.

2d — [May 21, 1962, 30 L. W. 4385].

This pinpoints the difficulty with any broad state-

ments such as the Court makes about a well established

and soundly reasoned rule that when property is sold and

a portion of the proceeds that represents a right to receive

ordinary income is taxed as such, even though the principal

asset transferred is a capital asset. Commissioner v. Phil-

lips, 4 Cir., 1960, 275 F. 2d 33; Tunnell v. United States, 8.

Appendix Page 7

- other one at odds with our consistent statement recently

reiterated in Sherlock v. Commissioner, 5 Cir., 1961, 294 F.

2d 863, that this Court, in contrast to some others, follows’

the aggregate, not the entity, theory so that taxability is

not to depend on chopping up into little‘ bits something

which is whole and sold (or exchanged) as a whole.

At what stage does the original-issue-discount cease

to have the operative effect of additional interest for the

use of money? Does a poftion of it, ‘somehow like some

marine life incrust itself permanently as a barnacle on the

bond? When the original-issue-holder No. 1 sells, he sells all.

As between him⸗and his vendee (Holder No. 2), would it

not (except for current accrued interest) all be capital

gains just as would be the sale of an ordinary promissory

note? Certainly as to the next transaction — ‘the sale be-

tween Holder No. 2 and Holder No. 3 — all Holder No. 2

can ever hope to get is the face of the bond (and interést

accruir, during his ownership). If Holder No. 2 can treat

it as a capital gain oma sale to Holder No. 3, why is it so

implausable (as the Court says) that Congress could have

intended that Holder No. 1 may treat it the same way on

the redemption as he.would have on a sale to No. 2 at which

time he gets the same, no more, no less. The effort to look?

at the “real” or “original” nature of the gain, i. e., the dif-

ference, leads to. metaphysical dialectic when one considers

successive transactions in whi ch, say between the time

Holder No. 4 acquires it and Holder No. 7 sells it~at par),

the market price at which No. 6 bought it was at the level

of the face value less original issue discount. What changes

the character of the very Same number of dollars arising

out of the very same contract? Indeed, as I read it; the

Court in effect says the answer should be the same. “The

structure of the provision as it stands indicates a purpose

to liken a bond retirenient to a sale or exchange and sub-

8 N ‘

3 6

Appendix Page 8

jeet it to the same tax treatment that a sale or exchange

would entail.“

These seemingly internal contradietions and the

problems I have just barely sketched cause me to have these

considerable misgivings — our effort to make sense

really makes much.

Appendix Page 9

UNITED STATES COURT. OF APPEALS

FOR THE FIFTH CIRCUIT °

OCTOBER TERM, 1962

No. 19,059

b. C. Docket Nos. 7340, 7347, 7366

UNITED STATES OF AMERICA,

3 Appellant, .

b. D. HARRISON and wife JENNIE L. HARRISON;

ADDISON O. WOOD and wife JOANNA G. WOOD;

and EDWARD H. JACKSON and wife MARGARET J.

JACKSON °

_ Appellees.

: ö

Appeal froin the United States District Court for the

Western District of Louisiana.

Before Rives, Brown and Wisdom, Circuit Judges.

JUDGMENT

This cause came on to be heard on the “transcript

of the record from the United States District Court for

RO A

—

Appendix Page 10

the Western District of Louisiana, and was argued by |

counsel ;

ON CONSIDERATION WHEREOF, It is now

here ordered and adjudged by this Court that the judg-

ment of the said Distrigt Court in this cause be, and the

same is hereby, reversed.

“Brown, Circuit J udge, Concurs Specially”

- June 22, 1962

Issued :

Appendix Page 11

IN THE UNITED STATES COURT OF APPEALS

FOR THE’ FIFTH CIRCUIT

No. 19,059 6, N

UNITED STATES OF AMERICA,

* Appellant,

versus

O. b. HARRISON and wife JENNIE L. HARRISON ;

ADDISON O. WOOD and wife JOANNA G. WOOD;

and EDWARD H. JACKSON and wife MARGARET J.

es.

* ©

Appellees.

Appeal from the United States District Court for the

Western District of Louisiana.

(September 27, 1962)

ON PETITION FOR REHEARING

Fefore RIVES, BROWN, and WISDOM, Circuit Judges.

PER CURIAM:

It is ORDERED that the petition for rehearing

filed in the above styled and numbered cause be, and the

same is hereby

DENIED.

—

* 9 3 2

— Appendix Page 12 ‘

IN THE

UNITED STATES DISTRICT COURT FOR THE

WESTERN DISTRICT OF LOUISIANA

SHREVEPORT, DIVISION

CIVIL ACTION NO. 7340

ADDISON O. WOOD AND WIFE

JOANNA G. WOOD

VS.

UNITED STATES OF AMERICA

—

2 CIVIL ACTION NO. 7347

: EDWARD H. JACKSON AND WIFE

MARGARET J. JACKSON

VS.

UNITED STATES OF AMERICA

CIVIL ACTION NO. 7366

O. D. HARRISON AND WIFE

JENNIE L. HARRISON

VS. ;

UNITED STATES OF AMERICA

HUNTER, JUDGE:

These actions were instituted by the taxpayers for

the recovery of income and interest assessed and

collected for the calendar years 1953 through 1957 in the

total sum of $11,222.23. On taxpayers’ motion these cases

were consolidated for trial before the Court.

. Se

Appendix Page 13

QUESTION PRESENTED

Whether the original issue discount on second mort-

gage bonds of the -Washington-Youree Hotel Company,

Inc., when realized by the taxpayers at retirement, con-

stituted interest taxable at ordinary income rates within

the meaning of Section 22 (a) of the Internal Revenue

Code of 1939 and Section 61 (a) (4) of the Internal Rev-

enue Code of 1954, or, whether it constitued “amounts

received * * * at retirement” within the meaning of Sec-

tion 117 (f) of the Internal Revenue Code of 1939 and

Section 1232 (a) of the Internal Revenue Code of 1954.

STATUTES INVOLVED -

5 Internal Revenue Code of 1939;

SEC. 22. GROSS INCOME.

(al [ss amended by Section 1 of the Public

Salary Tax Act of 1939, c. 59, 53 Stat. 574] Gen-

eral Definition. — Gross income“ includes gains,

profits, and income derived from salaries, wages,

or compensation for personal service (ineluding.

personal service as an officer or employee of a

State, or any political subdivision thereof, or any

agency or instrumentality of any one, or more of

the foregoing), of whatever kind and in whatever

form paid, or from professions, vocations, trades,

businesses, commerce, or sales, or dealings in prop-

erty, whether real or personal, growing out of the

ownership or usé of or interest in such property; °

also frum: interest, rent, dividends, securities, or

the transaction of any business carried on for

gain or profit, or gains or profits and income de-

N — * J

Appendix Page 14

rived from any source whatever, 9 (26 U.S.C.

1952 ed., Sec. 22). 52

00 O 00

SEC. 117. CAPITAL GAINS AND ‘LOSSES.

Af) Retirement of Bonds, ete. For the pur-

of this chapter, amounts received by the hold-

upon the retirement of bonds, debentures, notes,

or certificates or other evidences of indebtedness

issued by any corporation (including thcse issued

by a government or political subdivision thereof),

with interest coupons or in registered form, shall

be considered as amounts received in exchange

therefor. (Emphasis ours) (26 U.S.C. 1952 ed., Sec.

117.) *

Internal Revenue Code of 1954: 0

SEC. 61. GROSS INCOME DEFINE D.

(a) General Definition. — Except as other-

wise provided in this subtitle, gross income means

all income from whatever source derived, includ-

ing (but not limited to) the following items:

(4) Interest; * * (26 JS. C. 1958 ed.,

Sec. 61) :

SEC. 1232. BONDS AND OTHER EVIDENCES

OF INDEBTEDNESS.

(a) General Rule—For purposes of this sub-

title, in the case of bonds, debentures, notes or

certificates or other evidences of indebtedness,

which are capital assets in the hands of the tax-

Appendix Page 15

payerf and which are issued by any corporation,

or government or political subdivision’ thereof—

(1) Retirement. — Amounts received by

the holder on retirement of such bonds or

other evidences of indebtedness shall be con-

sidered as amounts received in exchange there-

for (except that in the case of bonds or other

evidences of indebtedness issued before Janu-

ary 1, 1955, this paraſſſs ph shall apply only

to those issued with interest coupons or in

registered form, or to those in such form on

March 1, 1954). * (26 U.S.C. 1958 ed.,

Sec. 1232)

THE FACTS

he facts in this case are not in dispute and have

been completely stipulated. In 1952 petitioners purchased

$404,850 of second mortgage bonds of the Washington-

Youree Hotel Company, Inc. for $300,000. They held the

bonds until they matured (at various times during 1953-

1957) and were retired by the Washington-Youree Hotel

Company, Inc. at their face value. It is clear that the

difference between the face amount of the bonds and their

selling price was computed on the basis of a bonus for

their purchase in the amount of $50,000, with interest

upon cash and bonus at the rate of 3-3/4th per cent per

annum. ‘Petitioners claimed the gain they had realized

upon retirement, of the bonds was taxable as long-term

capital gain because the amount had been received in

exchange of the bonds under Section 117(f) of the In-

ternal Revenue Code öf 1939 and Section 1232 (a) of the

Internal Revenue Code of 1954. The Commissioner of

Internal Revenue denied the amounts received from the

bonds constituted the amounts received upon retirement

of a bond and assessed tax at ordinary income rates upon

®%

Appendix Page 16

the gain. The assessment was paid, a elaim for refund

was filed by petitioners and rejected by defendant, and

petitioners instituted this suit.

Relying on Morgan, the Government insists that the

difference between the purchase price to the taxpayers

and the maturity value plainly constituted compensation

for the use of the taxpayer's’ money, and thus this dif-

ference is taxable as ordinary interest. Petitioners, rely-

ing on Caulkins,? argue that they are entitled to treat

the amounts which they received in retirement of the

bonds as amounts received in exchange for them under

Sections 117(f) and 1232 (a) of the Codes of 1939 and

1954, and accordingly, that the = is taxable as a long-

term capital gain. ,

THE LAW

Two forums have passed on this exact problem. The

Sixth Circuit Cour of Appeals decided the Caulkins case,

supra, and adopte . the taxpayers’ theory. Last year, the

Court of Appeal or the Ninth Circuit handed down its

opinion in Commissioner v. Morgan, ‘supra, which adopted

the Gavernment’s position. The two decisions are irre-

concilable and this Court is faced with the task of choos-

ing the one which it feels better effectuates the scheme of

taxation as framed by the Congress.

We believe that much can be said for the Govern-

ment’s description of the taxpayers’ position as a tedious

one that interest under the facts (Stipulation, Paragraph

8) is not interest under the law (Sec. 117(f), but we

must apply the statute as we find it, leaving to Congress

'Commissioner v. loan 272 F. 24 936 9 C. C. A. 1959.

a Commissioner of Internal Revenue v. Caulkins, 144 F. 2d 482, 6

C. A. 1944. ; 1 a

Appendix Page 17

the correction of asserted inconsistencies. Perhaps it

would be well to add here that in the 1954 Code, Congress

included a provision to correct and clarify the precise

problem now presented. The 1954 Code includes a pro-

vision relating to original issue discount bonds. issued

after December 31, 1954, which expressly makes such

ga realized by the holder subject to ordinary income

rates (Internal Revenu2 Code of 1954, Sec. 1232 (a) (2)).

The new law clearly and concisely separates the interest

element (which we admittedly have here) from the capi-

tal gain element. But, lest it be argued that this effected

a change in prior law, we quote the Senate Committee’s

comment relative to this new section:

„S. Rep. No. 1622, 83d Cone, 2d Sess., p. 112 (3

U.S. C. Cong. & Adm. News (1954 4621, 4745):

“Under Section 117(f) of the present law,

when a corporate or Government bond in reg-

istered form or with coupons attached is re-

tired the. 3 is treated as a sale or

exchange. There is some uncertainty as to

the status of proceeds in these transactions,

i. e., as capital gain or as interest income

where the bond or other evidence of indebted-

ness has been issued at a discount (see I. T.

3486, 1941-2, C. B. p. 76, as compared with

Comm. v. Catilkins, 144 F. 2d 482). In these

cases, that part of the amount received on a

sale or exchange wl. ich may represent a par-

tial recovery of discount on original issue is

a form of interest income and in fact is de-

corporation..

“Effective with respect td bonds issued

after December 31, 1954, the House bill re-

wae

Appendix Page 18

moves doubt in this area@by providing that

any sale realized by the holder of a bend at-

tributable to the original issue discount will

be taxed as ordinary income. This is, of

course, not intended to have any effect with

respect to bonds issued before that date.

“Thus, the Congress chose to, leave to the

courts settlement of the question as to evidencg¢s

of indebtedness issued before January 1, 1955.7.

We agree with Caulkins and it is completely con-

sistent with the jurisprudence of the Section which, ex-

cept for Morgan, has uniformly accorded capital gain

treatment to the retirement of bonds under Section 117(f),

Reiger v. C. I. k., 139 F. 2d 618 (1943); Timkin v. C k.,

6 T. C. 483 (1946), Acq. noted 1946-2 C.B. 5; Howard

C. Avery, 13 T.C. 351 (1949), acq. noted 1950-1 C.B. 1;

Adolph Klein, 15 T.C. 26 (1950), acq. noted 1950-2 C.B.

3; Steven W. Kormendy, 18 T.C.M. 353 (1959); and Eli

D. Goodstein, 30 T.C. 1178 (1938), affirmed 267 F. 2d

127 (1959). N :

There is absolutely no warrant for the conclusion

that in enacting Section 117 6f Congress intended any-

thing other than wnat is clearly said that the retire-

ment of ea bond is equivalent to its exchange; that any

amount received in excess of its cost would be capital

gain; and that upon receipt of Jess than its cost a capital

loss will ensue. Whether it should or should not have

done this, or whether Congress made a mistake which

they have now fetified, is a matter over which this

Court has no centrol. Certainly, there-is nothing in the

teens by taxpayer on other points. The Court of Appeal did not

pass upon the —_ in question; * the Commissioner did not urge it.

Appendix Page 19 mA N

legislative history of the Act to indicate that the con-

gressional intention was to limit Section 117 (f to losses,

and it would be surprising if Congress defined a loss

from a transaction as a capital loss and then were to

treat a gain theref rom, as an ordinary gain.

The whole matter involved in this law suit, inelud-

ing the jurisprudence, legislative history, and adminis-

trative interpretation of Section 117 (f of the Internal

Revenue Code of 193“ and Section 1232 (a) of the In-

ternal Revenue Code of 1954 has been completely analyzed

in an article by Harry Janin, found in 33 Taxes 191,

March 1955, “The Israeli Bond Ruling; Legaglation by

Fiat.“

Judgment for plaintitte Counsel will present to the

Court a formal judgment and this deeision is not to be

effective until the signing of that formal judgment.

THUS DONE AND SIGNED in Chambers at Lake

Charles, Louisiana on this the 12th day~ef November,

1960.

: E. F. N., JR,

a UNITED STATES vis ric

5 JUDGE —

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