The opinion of the court was delivered by: MARIS
These are suits against the former acting collector of internal revenue for the First collection district of Pennsylvania brought by two residents of the district to recover income taxes alleged to have been erroneously collected for the calendar year 1932. The cases were tried together and will be disposed of in one opinion. From the evidence I made the following special findings of fact:
The trust agreement entered into between the Lumber & Millwork Company of Philadelphia and the Provident Trust Company of Philadelphia, as trustee, under which the aforesaid notes were issued, provided that the Lumber & Millwork Company expressly reserved the right to pay off and redeem all or any part of the notes at any time outstanding prior to maturity on any interest payment date. A sinking fund was provided under which $35,000 par value of the notes were required to be redeemed and paid off on each semiannual interest payment date. Prior to the transaction involved in this case Mr. Felin executed and filed with the trustee a written instrument waiving any and all requirements as to notice prior to redemption of the notes as required by the trust agreement.
In 1932 Messrs. Erny and Nolen were heavily indebted to the Lumber & Millwork Company and were unable to reduce their indebtedness unless they could sell certain first mortgages which they held on properties which they had built. The president of the Lumber & Millwork Company accordingly early in July, 1932, requested Mr. Felin to purchase certain mortgages from Messrs. Erny and Nolen in order that they might liquidate their account, and in this connection, in order to provide the funds required to purchase the mortgages, offered to anticipate the redemption of $28,000 of bonds which normally would have been redeemable on January 1, 1933. Mr. Felin thereupon agreed to purchase the mortgages.
On July 20, 1932, the Lumber & Millwork Company transmitted the sum of $28,951.22 to the Provident Trust Company of Philadelphia, as trustee, $28,000 thereof representing the par value of twenty-eight notes for $1,000 each and the balance being the interest and premium computed to be due upon the redemption of said notes. On July 22, 1932, $23,000 of the notes belonging to Mr. Felin and $5,000 of the notes belonging to Mrs. Felin, which had been in the custody of the Provident Trust Company for safe-keeping, were canceled by it as trustee, and the sum of $28,951.22 was paid by the said trustee to Mr. Felin, who on the same day deposited $23,777.21 thereof in his personal bank account and $5,168.96 thereof in the personal bank account of Mrs. Felin.
On July 22, 1932, pursuant to instructions from Mr. Felin, the Provident Trust Company, as agent, transmitted to the North Philadelphia Trust Company the sum of $23,000 from his account and the sum of $4,700 from the account of Mrs. Felin. The North Philadelphia Trust Company used these funds for the purchase from Messrs. Erny and Nolen on July 22, 1932, of three mortgages aggregating $13,800 for Mr. Felin and one mortgage for $4,700 for Mrs. Felin, on July 27, 1932, of one mortgage for Mr. Felin for $4,500, and on July 28, 1932, of one mortgage for Mr. Felin for $4,700. The aggregate amount of the mortgages so purchased by Mr. and Mrs. Felin was $27,700.
The sum of $27,700 was paid by Messrs. Erny and Nolen to the Lumber & Millwork Company on account of their indebtedness to it, $14,000 being paid on July 22, 1932, $9,000 on July 29, 1932, and $4,700 on August 5, 1932.
On or before March 15, 1933, the plaintiffs each filed their income tax returns for the calendar year 1932. In the case of Mr. Felin the return showed an income tax liability of $2,939.91 and in the case of Mrs. Felin $1,877.55, which amounts were paid in 1933.
Thereafter, upon an audit of the returns, the Commissioner of Internal Revenue determined a deficiency of tax for 1932 of $3,745.34 in the case of Mr. Felin and $146.83 in the case of Mrs. Felin, said deficiencies being based in part upon the ruling of the Commissioner that the sum of $17,842.02 reported by Mr. Felin and $4,597.90 reported by Mrs. Felin as capital gains derived from the sale or exchange of the ten-year 6 1/2 per cent. notes of the Lumber & Millwork Company redeemed on July 22, 1932, were not capital gains but rather ordinary income subject to normal and surtax rates. The notes in question cost Mr. Felin $254.56 per bond and Mrs. Felin $114.20 per bond. Subsequent to the audit, but before the deficiency assessment above referred to, the plaintiffs on July 21, 1934, each paid additional taxes for the year 1932.In the case of Mr. Felin the additional tax amounted to $663.54 with interest of $53.73 and in the case of Mrs. Felin $69.82 with interest of $5.65.
On November 17, 1934, Mr. Felin paid the deficiency assessment above referred to, amounting to $3,745.34, with interest of $374.53, or a total of $4,119.87. On November 30, 1934, Mrs. Felin paid the deficiency assessment above referred to amounting to $146.83, with interest of $14.68, or a total of $161.51. On January 16, 1935, each of the plaintiffs filed claims for the refund of the additional taxes and interest so paid, and these claims were rejected by the Commissioner on June 19, 1935.
Other facts which may be material appear in the agreed statements of facts filed by the parties which are incorporated herein by reference.
The question which these cases raise is whether the gain admittedly derived by the plaintiffs from their Lumber & Millwork Company notes was a capital gain and taxable as such or an ordinary gain subject to normal tax and surtax. The notes had been held by the plaintiffs for more than two years and were admittedly capital assets. The answer to this question, therefore, depends upon whether the transaction involved a sale or exchange of capital assets within the meaning of section 101(c) (1) of the Revenue Act of 1932, 26 U.S.C.A. § 101 note, which defines "capital gain" as meaning "taxable gain from the sale or exchange of capital assets consummated after December ...