Before HASTINGS, Chief Judge, and KILEY and MAJOR, Circuit Judges.
J. Francis Driscoll, Jr. and Ann K. Driscoll, Arthur Edelstein and Marian Edelstein, and Lawrence I. Cohen and Myra L. Cohen (petitioners herein) are husbands and wives who filed their joint income tax returns for the years 1955 and 1956 with the appropriate District Director of Internal Revenue. The Tax Court, after making certain adjustments in the Commissioner's determination, held that petitioners had deficiencies in their income taxes for the years 1955 and 1956. Since the deficiencies in each instance stemmed from the same transaction, the three proceedings have been consolidated. The wives being joined as parties only because they filed joint returns with their husbands, the latter are referred to as the taxpayers.
Taxpayers realized gains on the retirement of certain corporate notes. In their returns these gains were treated as longterm capital gains, relying on Sec. 1232(a)(1) of the Internal Revenue Code of 1954. (Title 26 U.S.C.A. § 1232(a)(1).) Respondent denied them this treatment on the premise that such gains were taxable as ordinary income.
The Tax Court (37 T.C. 52) decided in favor of respondent's position. The cases are here on petitions by the taxpayers for a review of that decision. The findings of fact as made by the Tax Court are not in dispute. A brief statement of such facts will suffice to bring into focus the issue for decision.
Ellis Brothers of Illinois, Inc. and South Shore Liquors, Inc. were Illinois corporations, the former chartered in January 1948, and the latter in February 1946. Both had their principal places of business in Chicago and operated as wholesale dealers in wines and liquors.
In July 1953, Ellis Brothers for value received executed and delivered its 4% demand promissory note in the sum of $49,736.61, to two of its principal stockholders, Julius and Albert E. Ellis. This note had no interest coupons attached nor was it in registered form. On December 15, 1953, the three taxpayers purchased the note for $3,500, which was endorsed by the Ellises, "Without Recourse pay to the order of" Driscoll, Edelstein and Cohen.
The outstanding capital stock of Ellis Brothers of Illinois, Inc. was acquired on December 15, 1953, by South Shore Liquors, Inc., and on March 1, 1954, pursuant to a statutory merger, Ellis Brothers survived and was then renamed South Shore Liquors, Inc. (sometimes called new South Shore Liquors, Inc.).
On February 28, 1955, the note for $49,736.61 was surrendered to new South Shore Liquors, Inc., which in turn issued three separate notes, one to each of the taxpayers, all dated February 28, 1955 and each in the amount of $16,578.87, payable on demand with interest at 4% per annum. The face amount of each of these new notes represented one-third of that of the surrendered note.
On April 7, 1955, new South Shore paid $6,578.87 on each of the new notes. The remaining balance of $10,000 on each was paid December 28, 1956, when all were retired and cancelled. The gains realized from these payments are those involved in the controversy before us.
In brief summary, we have a situation where a note was issued in July 1953 by one corporation payable to Julius and Albert Elis, purchased by the three taxpayers on December 15, 1953, and after certain corporate mergers surrendered to a new corporation which, on February 28, 1955, issued three separate notes, each in one-third of the amount of the old note and each payable to one of the three taxpayers.
Respondent, in his statement of contested issues and at other places in his brief, characterizes the transaction as a "substitution" of the new notes for the old. While this terminology may or may not be important, it is well to point out that the Tax Court found:
"On February 28, 1955, the note [referring to the old note] was surrendered to new South Shore and it issued three separate ...