United States v. Midland-Ross Corp., 381 U.S. 54 (1965)

United States v. Midland-Ross Corp.

No. 628

Argued March 31, 1965
Decided May 3, 1965
381 U.S. 54

Syllabus

Respondent taxpayer, in 1952-1954, bought noninterest-bearing promissory notes at prices discounted below the face amounts and held them over six months. Before maturity and in the year of purchase, it sold each below the face amount, but for more than the issue price. The gains, concededly the economic equivalent of interest, were reported as capital gains. The Commissioner of Internal Revenue determined that the gains attributable to original discount were but interest in another form, and therefore taxable as ordinary income. After paying the deficiencies, respondent brought this refund action, which both the District Court and the Court of Appeals decided in its favor.

Held: Earned original issue discount is not entitled to capital gains treatment under the 1939 Internal Revenue Code. Pp. 56-67.

(a) Although capital gains treatment is to be accorded to the sale of a "capital asset," defined in § 117(a)(1) of the Internal Revenue Code of 1939 as "property" held by the taxpayer, the term "capital asset" is to be construed narrowly so as to apply only where there has been realization of appreciation in value accrued over a substantial period of time. Pp. 56-57.

(b) "Capital asset" does not include an item like earned original issue discount, which serves the same function as stated interest, the earning of which is predictable and does not represent market appreciation. Pp. 57-58.

(c) In specifying ordinary income treatment for original issue discount in § 1232(a)(2) of the Internal Revenue Code of 1954 and in special provisions of the 1939 Code, Congress did not indicate any understanding that such discount would be entitled to capital gains treatment in the absence of such provisions. Pp. 58-63.

(d) A case in which the Tax Court allowed capital gains treatment of the full amount the taxpayer received upon retirement of an "Accumulative Installment Certificate" -- Caulkins v. Commissioner, 1 T.C. 656, acq., 1944 Cum.Bull. 5, aff’d, 144 F.2d 482 (C.A. 6th Cir.), acq. withdrawn, 1955-1 Cum.Bull. 7 -- did not unambiguously establish that original issue discount was itself a "capital asset" entitled to capital gains treatment, and what little other administrative practice dealt with the question appears contrary to its holding. Pp. 63-66.

(e) This Court has often recognized the economic function of discount as interest. Pp. 66-67.

335 F.2d 561 reversed.