37 T.C. 52">*52 The respondent determined deficiencies in petitioners' income tax as follows:

1961 U.S. Tax Ct. LEXIS 55">*56 The question for decision is whether amounts received in April 1955 and December 1956 in retirement of notes qualify for treatment as amounts received in exchange for said notes under section 1232(a)(1) of the Internal Revenue Code of 1954.

FINDINGS OF FACT.

Some of the facts have been stipulated and they are found accordingly.

Petitioners J. Francis Driscoll, Jr., and Ann K. Driscoll, Arthur Edelstein and Marian L. Edelstein, and Lawrence I. Cohen and Myra L. Cohen are husbands and wives who filed their joint Federal income tax returns for the years 1955 and 1956 with the district director of internal revenue at Chicago, Illinois.

Ellis Brothers of Illinois, Inc., was an Illinois corporation chartered in January 1948. Its principal place of business was at Chicago and it operated as a wholesale dealer in wines and liquors. Its principal shareholders were Julius and Albert E. Ellis. In July 1953 the corporation, for value received, executed and delivered its 4-percent demand promissory note in the sum of $ 49,736.61 to Julius and Albert 37 T.C. 52">*53 Ellis. The note did not have interest coupons nor was it in registered form.

South Shore Liquors, Inc., was an Illinois corporation chartered1961 U.S. Tax Ct. LEXIS 55">*57 in February 1946. Its principal place of business was Chicago and it operated as a wholesale dealer in wines and liquors. J. Francis Driscoll, Jr., was secretary and a director of South Shore and owned 375 shares of its stock; Arthur Edelstein was president and a director and owned 750 shares of its stock; and Myra L. Cohen was a director and owned 750 shares of its stock as nominee for Lawrence Cohen. South Shore had 2,380 shares of stock outstanding.

On December 15, 1953, South Shore acquired all of the outstanding capital stock of Ellis Brothers of Illinois, Inc., for about $ 800. On the same day Driscoll, Edelstein, and Cohen purchased the outstanding note from Julius and Albert Ellis for $ 3,500. The Ellises endorsed said note as follows: "Without Recourse pay to the order of" Driscoll, Edelstein, and Cohen. The petitioners are not related to the Ellises.

On February 1, 1954, South Shore and Ellis Brothers of Illinois, Inc., entered into a "Plan and Agreement of Merger" which became effective on March 1, 1954. Under the provisions of the plan the surviving corporation assumed all of the liabilities of each of the constituent corporations. The surviving corporation was1961 U.S. Tax Ct. LEXIS 55">*58 to be Ellis Brothers of Illinois, Inc., which, as of the date of the merger, was renamed South Shore Liquors, Inc. As of this time the original Ellis Brothers of Illinois, Inc., had operating losses of about $ 25,000.

On February 28, 1955, the note was surrendered to new South Shore and it issued three separate notes dated February 28, 1955, payable on demand with interest at 4 percent. The notes were issued to Driscoll, Edelstein, and Cohen and were each in the amount of $ 16,578.87, i.e., one-third of $ 49,736.61, the face amount of the old note.

The net worth of new South Shore at the close of business February 28, 1955, was $ 1,157,646.91.

From July 1953 to July 1954 petitioners did not receive interest on the old note. From July 1954 to February 28, 1955, they received interest at the rate provided. Each received interest on the new notes at the rate provided from February 28, 1955, until the date of retirement of the notes.

On April 7, 1955, new South Shore paid $ 6,578.87 on each of the notes. The unpaid balance of $ 10,000 on each was retired on December 28, 1956, and the notes were canceled. On their 1955 tax returns petitioners reported $ 6,115.84 ($ 6,578.77 less 1961 U.S. Tax Ct. LEXIS 55">*59 $ 462.93 cost basis) as long-term capital gain; in 1956 they reported $ 9,296.27 ($ 10,000 less $ 703.73 cost basis) in the same manner.

Respondent determined the deficiency in question as to each of the petitioners by including in income in 1955, $ 15,412.20 (one-third of 37 T.C. 52">*54 $ 49,736.61 less one-third of $ 3,500). In explanation of his determination respondent explained that the exchange of the old note for the three new ones constituted a "taxable exchange as the result of which you realized gain * * * taxable as ordinary income."

OPINION.

Capital gain and loss provisions apply only where there has been a sale or exchange of a capital asset, section 1222, I.R.C. 1954. Ordinarily payment and discharge of an obligation is neither sale nor exchange within the commonly accepted meaning of the words. Fairbanks v. United States, 306 U.S. 436">306 U.S. 436, 306 U.S. 436">437. However, since the Revenue Act of 1934, provision has been made for capital gains treatment of amounts received upon the retirement of certain corporate and Government obligations. The statutory provision for this treatment, first enacted by the Revenue Act of 1934, appeared in the 1939 Code as section1961 U.S. Tax Ct. LEXIS 55">*60 117(f), which provided:

(f) Retirement of Bonds, Etc. -- For the purposes of this chapter, amounts received by the holder upon the retirement of bonds, debentures, notes, or certificates or other evidences of indebtedness issued by any corporation (including those issued by a government or political subdivision thereof), with interest coupons or in registered form, shall be considered as amounts received in exchange therefor.

Litigation developed as to whether the registration and coupon requirement meant the obligation had to be in that form at the time of original issue or only at the time of retirement. In Lurie v. Commissioner, 156 F.2d 436 (C.A. 9, 1946), reversing Babette G. Lurie, 4 T.C. 1065">4 T.C. 1065, a corporate note when issued was neither registered nor coupon-bearing. Later the note was returned to the corporation and altered to registered form. The Ninth Circuit held the registration requirement of section 117(f), I.R.C. 1939, was satisfied: The note "must be in registered form at the time of its retirement, but it need not be in registered form at the time of its issuance."

We followed Lurie v. Commissioner, supra,1961 U.S. Tax Ct. LEXIS 55">*61 in Carl Oestreicher, Trustee, 20 T.C. 12">20 T.C. 12 (1953), and more recently (1959) in Victor A. Miller, 32 T.C. 954">32 T.C. 954, reversed on another issue 285 F.2d 843.

The 1954 Code changed the law as it appeared in section 117(f) of the 1939 Code by enacting section 1232(a)(1), which provides as follows:

SEC. 1232. BONDS AND OTHER EVIDENCES OF INDEBTEDNESS.

(a) General Rule. -- For purposes of this subtitle, in the case of bonds, debentures, notes, or certificates or other evidences of indebtedness, which are capital assets in the hands of the taxpayer, and which are issued by any corporation, or government or political subdivision thereof --

(1) Retirement. -- Amounts received by the holder on retirement of such bonds or other evidences of indebtedness shall be considered as amounts 37 T.C. 52">*55 received in exchange therefor (except that in the case of bonds or other evidences of indebtedness issued before January 1, 1955, this paragraph shall apply only to those issued with interest coupons or in registered form, or to those in such form on March 1, 1954).