General Foods Corp. v. United States

• Decision Date: 28 January 1976
• Docket Number: No. 70-73.,70-73.
• Citation: 530 F.2d 923
• Parties: GENERAL FOODS CORPORATION v. The UNITED STATES.
• Court: U.S. Claims Court

530 F.2d 923

GENERAL FOODS CORPORATION v. The UNITED STATES.

No. 70-73.

United States Court of Claims.

January 28, 1976.

David I. Granger, Washington, D.C., atty. of record, for plaintiff. Harold D. Murry, Jr. and Clifford, Warnke, Glass, McIlwain & Finney, Washington, D.C., of counsel.

Richard F. Treacy, Jr., Washington, D.C., with whom was Asst. Atty. Gen. Scott P. Crampton, Washington, D.C., for defendant. Theodore D. Peyser and Donald H. Olson, Potomac, Md., of counsel.

Before LARAMORE, Senior Judge, and DAVIS, SKELTON, NICHOLS, KASHIWA, KUNZIG and BENNETT, Judges.

OPINION

KASHIWA, Judge.

This action comes before us on a stipulation of facts. The essential facts stipulated are recited below. Each of the parties claims that it is entitled to judgment on said stipulated facts. We hold for the defendant and against the plaintiff for reasons hereafter stated.

This is an action arising under the Internal Revenue Code of 1954 for the taxable year 1959, beginning April 1, 1958, and ending March 31, 1959. Since Section 1232 of the Internal Revenue Code of 1954 is the center of discussion, we shall first quote by footnote its relevant portions.¹

Plaintiff, General Foods Corporation, is a corporation duly organized and existing under the laws of the State of Delaware, with its principal place of business, at White Plains, New York. The stipulation shows that General Foods Corporation's principal business is the production and sale of a wide variety of food and grocery products, many in package form under nationally advertised brand names. General Foods Corporation is not now, nor has it ever been, a dealer in securities. During the taxable year 1959, plaintiff held promissory notes with no stated interest issued by various corporations. The notes, commonly referred to as commercial paper, were non-registered bearer instruments containing an unconditional promise to pay a specified amount on a specified date at a specified place. Plaintiff purchased each of the notes from the issuer or from Goldman, Sachs & Company, a dealer in securities, at an amount less than its face value. The notes were held by plaintiff for periods ranging from 43 days to 181 days. The plaintiff held each note for a period less than six months and at maturity received the face amount from the issuer. Plaintiff retired all of the notes in the taxable year 1959. The notes were purchased by the plaintiff for investment and were not property of a type that would be held in inventory or for sale to customers in the normal course of business. All of the notes involved in this case were issued after December 31, 1954, and before May 27, 1969. The amount received by the plaintiff on retirement of each of the notes which exceeded the amount paid by plaintiff for the note was original issue discount; no part of that amount was attributable to market fluctuations as opposed to the passage of time.

On its Federal income tax return for the taxable year 1959, beginning April 1, 1958, and ending March 31, 1959, plaintiff reported short-term capital gains of $608,598.99. This was the amount received over and above the purchase prices from the retirement at maturity of the total of $90,750,000 non-interest-bearing corporate notes purchased by the plaintiff at a discount and held for less than six months. During the taxable year 1959 plaintiff had net capital loss carryovers from the prior years in the amount of $518,840.74. There is no dispute as to this loss carryover. Plaintiff claims that it is entitled to deduct the loss carryover from the above-mentioned gain of $608,598.99 because the gain is short-term capital gain.

On October 29, 1965, the Commissioner of Internal Revenue mailed to the plaintiff a statement of tax due, assessing a deficiency in income taxes for the taxable year 1959 in the amount of $345,638 plus interest. Plaintiff paid this amount plus interest on November 8, 1965. The amount of $208,291 of this deficiency assessment resulted from the Commissioner treating as interest income rather rather than as short-term capital gain the amount of $608,598.99 received by plaintiff over and above the purchase prices on the retirement at maturity of the non-interest-bearing corporate notes purchased by the plaintiff at a discount for investment and held for less than six months. On November 6, 1967, plaintiff filed a claim for refund of this amount of $208,291 plus the interest paid thereon together with interest as provided by law, representing that part of the assessed deficiency attributable to treating as interest income rather than short-term capital gain the amounts over and above the purchase prices, received by plaintiff on the retirement of the corporate notes. On March 1, 1971, the Commissioner of Internal Revenue disallowed in its entirety plaintiff's claim for refund. This action for refund was filed in this court on February 27, 1973.

Both parties agree that the sole issue presented is whether gain attributable to original issue discount on evidences of indebtedness issued after December 31, 1954, and before May 28, 1969, and held by plaintiff for periods of not more than six months is taxable as short-term capital gain on the retirement of the indebtedness.

The decision in this case rests, as we shall hereafter show, upon Section 1221 but since plaintiff's arguments center on Section 1232, we shall first examine Section 1232. Plaintiff claims that Section 1232 gives capital treatment to the gain in this case. Defendant, on the other hand, states that Section 1232 is not relevant to the original issue discount herein since Section 1232 only deals with notes which are capital assets in the hands of the taxpayer and since original issue discount under case law is not a capital asset, Section 1232 does not apply.

We shall first discuss the history of Section 1232. Section 206(a)(1) of the Revenue Act of 1921, c. 136, 42 Stat. 227, 232, defined the term "capital gain" as "taxable gain from the sale or exchange of capital assets * * *." This provision, without material change, was reenacted by Section 208(a)(1) of the Revenue Act of 1924, c. 234, 43 Stat. 253, 262; by Section 208(a)(1) of the Revenue Act of 1926, c. 27, 44 Stat. 9, 19; by Section 101(c)(1) of the Revenue Act of 1928, c. 852, 45 Stat. 791, 811; and by Section 101(c)(1) of the Revenue Act of 1932, c. 209, 47 Stat. 169, 191.

The question arose as to whether, under these statutes, a redemption (retirement) of bonds constituted a sale or exchange within the meaning of that provision and successor statutes. A conflict of judicial decisions² on the matter led Congress to enact Section 117(f) of the Revenue Act of 1934, c. 277, 48 Stat. 680, 715, which is the predecessor of Section 1232(a)(1). The addition of that provision assured that the retirement of notes would constitute an exchange.

While Section 117(f) served to resolve the question of whether the retirement of a note constituted a "sale or exchange," it created a new round of litigation as to whether gain attributable to original issue discount was an amount received in exchange for a capital asset and, consequently qualified for long-term capital gain treatment. In Commissioner of Internal Revenue v. Caulkins, 144 F.2d 482 (6th Cir. 1944), the Sixth Circuit read Section 117(f) to permit long-term capital gain treatment for the $5,000 gain realized, functionally, as original issue discount. The court noted (at 484) that if the application of Section 117(f) resulted in inconsistencies and inequalities, "the correction of this defect in the operation of the statute is for Congress and not for the courts." The Supreme Court in United States v. Midland-Ross Corp., 381 U.S. 54, 85 S.Ct. 1308, 14 L.Ed.2d 214 (1965), subsequently disagreed with the holding of Caulkins that the proceeds received upon a face-amount certificate cannot be divided into separate increments which represent interest income and capital gain after other courts, including this court, refused to follow the rationale of the Sixth Circuit. See Pattiz v. United States, 311 F.2d 947, 160 Ct.Cl. 121 (1963); Commissioner of Internal Revenue v. Morgan, 272 F.2d 936 (9th Cir. 1959); Rosen v. United States, 288 F.2d 658 (3d Cir. 1961); United States v. Harrison, 304 F.2d 835 (5th Cir. 1962), cert. denied, 372 U.S. 934, 83 S.Ct. 881, 9 L.Ed.2d 765 (1963).

The legislative history of the revised version of Section 117(f) (Section 1232) indicates that Congress chose to heed the admonition of the court in Caulkins to correct, at least partially, a possible defect in the statute which, under the holding of Caulkins, allowed the issuing corporation an interest deduction for original issue discount, but taxed the holder at more favorable long-term capital gain rates if the notes were held more than six months. The following language of the Senate Report accompanying the enactment of Section 1232 of the 1954 Code graphically illustrates the situation which Congress faced at the time (S.Rep.No.1622, 83d Cong., 2d Sess. 112 (1954), U.S.Code Cong. & Admin.News 1954, pp. 4629, 4745):

(C) Bonds and Other Debt (sec. 1232)

(1) House changes accepted by committee

Under section 117(f) of present law, when a corporate or Government bond in registered form or with coupons attached is retired the transaction 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 indebtedness has been issued at a discount (see I.T. 3486, 1941-2, C.B. p. 76, as compared with Comm. v. Caulkins 6 Cir., 144 F.2d 482). In these cases, that part of the amount received on a sale or exchange which may represent a partial recovery of discount on original issue 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 December 31, 1954, the House bill removes doubt

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