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November 1, 1963

W. Palmer DIXON et al., Plaintiffs,
UNITED STATES of America, Defendant

The opinion of the court was delivered by: LEVET

These are cross motions for summary judgment in an action for refund of federal income taxes paid by the plaintiffs for the taxable year 1952 in the sum of $ 369,329.65 plus interest. Jurisdiction is based upon 28 U.S.C. § 1346(a). The parties agree, except for one fact, which will be dealt with later, that there are no issues as to any material facts.

The facts surrounding this claim for refund are as follows:

During the year 1952, the plaintiffs were partners in the investment firm of Carl M. Loeb Rhoades & Co. (hereinafter 'partnership'), a member of the New York and American Stock Exchanges. The principal sources of income of the partnership are from commissions earned on sales of customers' securities, the underwriting and selling of securities and from trading and investing on its own account.

 During 1952, the partnership acquired 33 short-term non-interest bearing notes, commonly known as commercial paper. All of the notes were issued at a discount which ranged from 2 3/8 to 3 3/4% On the face value of the notes. The notes were purchased either directly from the issuing obligor corporation or through agents or dealers on the original date of issue. The notes had maturity dates between 190 and 272 days from the date of issue. All of these notes were either sold subsequent to six months after their purchase or were retained, unmatured, at the close of the taxable year 1952.

 Plaintiffs reported the distributive share of the profit realized from the sale by the partnership of 20 of the notes during the year 1952 as long-term capital gain. The Internal Revenue Service disallowed capital gain treatment and computed the discount earned per day for each note by dividing the number of days between issuance and maturity into the total discount. The earned discount per day, multiplied by the number of days the notes were held during 1952, either before sale or as of December 31, was considered as 'discount earned.' The Internal Revenue Service treated the amount of 'discount earned' as ordinary income. Deficiencies were assessed against the plaintiffs. The deficiencies were paid, a claim for refund was duly filed, and this action was thereafter commenced.

 The parties differ as to the treatment which should be accorded to the original issue discounts. The plaintiffs claim that the amounts so realized are long-term capital gains, while the Internal Revenue Service held them to be interest, therefore, ordinary income. In addition, the plaintiffs urge the Commissioner of Internal Revenue's prior acquiescence in 1944 in the case of Commissioner of Internal Revenue v. Caulkins, 144 F.2d 482 (6 Cir. 1944), affirming 1 T.C. 656 (1943), estops the Internal Revenue Service from now claiming that original issue discounts should be treated as interest since they relied on the Caulkins' acquiescence when they purchased the securities in 1952.

 Thus, the issue is squarely before the court: Aside from any consideration of reliance or estoppel, when short-term non-interest bearing notes are purchased at a discount, is the amount of such discount when realized in the nature of interest or a capital gain?



 There are two sections of the Internal Revenue Code of 1939 which must be considered in determining this action. They are Sections 22 and 117(a)(1). Section 22 provides:

 ' § 22. Gross income

 '(a) General definition 'Gross income' includes gains, profits, and income derived from salaries, wages, or compensation for personal service (including 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 property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever. * * *'

 Section 117(a)(1) provides:

 ' § 117. Capital gains and losses

 '(a) Definitions. As used in this chapter --

 '(1) Capital assets. the term 'capital assets' means property held by the taxpayer (whether or not connected with his trade or business), but does not include --

 '(A) stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to ...

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