Paine v. Comm'r of Internalrevenue
| Decision Date | 30 November 1954 |
| Docket Number | Docket Nos. 46036,46237. |
| Citation | 23 T.C. 391 |
| Parties | F. RODNEY PAINE AND ANNA H. PAINE, PETITIONER, V. COMMISSIONER OF INTERNALREVENUE, RESPONDENT. CECIL B. MYERS TRUST U/W LUCY N. MYERS, DECEASED, CECIL B. MYERS, JAMES S. MATTESON, AND NORTHERN MINNESOTA NATIONAL BANK, TRUSTEES, PETITIONERS, V. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Lawrence R. Graving, C.P.A., and H. A. Dancer, Esq., for the petitioners.
Merl B. Peek, Esq., for the respondent.
Petitioners sold, 10 days prior to maturity, certain non-interest-bearing notes which had been issued originally on a discount basis for substantially less than face value. As a result of the sales just before maturity, petitioners realized an increment or profit representing the excess of sales price over basis. Held, that the increment or profit so realized was in fact interest and was taxable as ordinary income notwithstanding the fact that the transactions resulting in the realization of such increment or profit constituted sales.
The respondent determined deficiencies in income taxes of petitioners as follows:
+---------------------------------------------------------------+
¦ ¦1947 ¦1948 ¦1949 ¦
+---------------------------------+---------+---------+---------¦
¦F. Rodney Paine and Anna H. Paine¦ ¦$4,845.02¦$3,431.04¦
+---------------------------------+---------+---------+---------¦
¦Cecil B. Myers Trust ¦$1,548.14¦2,070.87 ¦ ¦
+---------------------------------------------------------------+
After hearing, these cases were consolidated for decision, and, by stipulation, testimony taken in Docket No. 46036 was received as evidence in Docket No. 46237.
The fundamental question presented for our consideration is whether the increment or profit realized upon the sale, 10 days prior to maturity, of certain non-interest-bearing notes originally issued on a discount basis for substantially less than their face value, is taxable as ordinary (interest) income, or as capital gain.
Other issues in the case have been resolved by agreement between the parties.
The facts are largely stipulated by the parties and to that extent are found accordingly.
Petitioners F. Rodney Paine and Ann H. Paine, during the years in question, were residents of Duluth, Minnesota, and filed joint income tax returns for the years 1948 and 1949 with the collector of internal revenue for the district of Minnesota. Petitioner Cecil B. Myers Trust, established under the will of Lucy N. Myers, is represented by Cecil B. Myers, James S. Matteson, and Northern Minnesota National Bank, Duluth, Minnesota, as trustees with their principal office at Duluth, Minnesota. Timely income tax returns for the years 1947 and 1948 were filed on behalf of the Cecil B. Myers Trust with the collector of internal revenue for the district of Minnesota.
On May 1, 1902, the Niles Land Company, a Wisconsin corporation (hereinafter called Niles), leased certain mineral lands in St. Louis County, Minnesota, to the Chemung Iron Company, a Minnesota corporation (hereinafter called Chemung), for 50 years. Chemung agreed to pay a royalty of 25 cents per ton on all iron ore removed from the land. The lease also provided for certain annual minimum payments. Subsequently, Chemung assigned its lease to the Oliver Iron Mining Company, a Minnesota corporation (hereinafter called Oliver).
On July 2, 1917, Niles (in Docket No. 46036), and Niles and the Toledo Investment Company (hereinafter called Toledo) (in Docket No. 46237) which owned certain mineral lands adjacent to those owned by Niles alone, each sold to Oliver 120 acres (a total of 240 acres) of iron ore-bearing lands. The total sales price for each of the properties was computed on the basis of the number of tons of ore estimated to exist in the land at 25 cents per ton, less the royalties paid previously. (The actual cash figures involved in the transaction are deemed irrelevant to this proceeding). The balance of the purchase price was agreed to be paid by Oliver to Niles, and to Niles and Toledo in the form of promissory notes. All of the promissory notes issued by Oliver were secured by purchase money mortgages from Oliver to Niles, and from Oliver to Niles and Toledo.
Immediately following the issuance of the notes by Oliver, on July 20, 1917, Frederic W. Paine, father of petitioner F. Rodney Paine, acquired a number of the notes in a distribution by Niles to its stockholders. Similarly, Henry H. Myers, husband of Lucy N. Myers, acquired several of the notes prior to his death on September 13, 1931, upon a partial liquidation of Niles and Toledo, in proportion to his ownership of stock in each company. Each stockholder in Niles and Toledo received his share in notes maturing every 6 months in equal amounts for the period during which the lease would have remained in effect had the property not been purchased by Oliver.
Except for amounts and maturity dates each note was the same, as follows:
Duluth, Minnesota, July 20th, 1917
$ . . .
On or before . . . after date the OLIVER IRON MINING COMPANY, a Minnesota corporation, promises to pay to the order of THE NILES LAND COMPANY . . . at THE FIRST NATIONAL BANK OF DULUTH, Duluth, Minnesota, without interest until after maturity, Value received.
Payment of each note was guaranteed by the United States Steel Corporation.
Among the notes received by Frederic W. Paine, one matured on July 20, 1948, and another on January 20, 1949. On December 30, 1935, Frederic W. Paine transferred the two notes by gift in trust irrevocably, to be held respectively in two separate trusts for the benefit of his son, petitioner F. Rodney Paine, and for the benefit of his daughter-in-law, petitioner Anna H. Paine. The trust instrument in each trust provided that the trustee ‘agrees to use reasonable diligence in the care and custody of the same (the note) until said note is paid and in the collection thereof at maturity and upon its payment or collection to pay over the proceeds there * * * ‘ to the beneficiary. These notes have at all times been the only property subject to the two trusts.
The Northern Minnesota National Bank, Duluth, Minnesota, as successor trustee, on July 10, 1948, and on January 10, 1949, transferred the notes due on July 20, 1948, and January 20, 1949, respectively, to the Northwestern State Bank, Duluth, Minnesota, receiving for each note the amount of $31,916.40. This amount was computed by reducing the face amount of each note by 3 per cent for the 10 days until the maturity date of the note. These transactions were reflected on the records of the transferee bank as follows:
The trustee of the trust for the benefit of F. Rodney Paine deducted $239.57 as its fee, and on July 21, 1948, remitted the balance of $31,676.83 to petitioner F. Rodney Paine. The basis of the note maturing July 20, 1948, to the trustee was $12,526.63 (this was also the basis to Frederic W. Paine and was computed on July 20, 1917, by applying a 5 per cent simple discount rate to the face of the note),1 resulting in realization of a profit of $19,150.20 upon disposition. Petitioners, both cash basis taxpayers, reported 50 per cent of $19,150.20, or $9,575.10 as long-term capital gain on their joint income tax return for 1948.
The trustee of the trust for the benefit of Anna H. Paine deducted $239.57 as its fee, and on January 21, 1949, remitted the balance of $31,676.83 to petitioner Anna H. Paine. The basis of the note maturing January 10, 1949, to the trustee was $12,405.05, resulting in realization of a profit of $19,511.35 upon disposition. Petitioners deducted the trustee's fee of $239.57 from 50 per cent of the profit of $19,511.35 ($9,755.67 minus $239.57) and reported $9,516.10 as long-term capital gain on their joint income tax return for 1949.
Lucy N. Myers (hereinafter referred to as decedent), who died on July 28, 1938, was the owner by inheritance from her husband, Henry H. Myers, of a group of Oliver notes at the time of her death. These notes were made the subject of the Cecil B. Myers Trust on March 3, 1940, under the will of the decedent.
During the taxable years 1947 and 1948, petitioner Cecil B. Myers Trust transferred the notes as follows:
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