
    KVP SUTHERLAND PAPER COMPANY v. THE UNITED STATES
    [No. 303-60.
    Decided April 16, 1965.
    Plaintiff’s motion for rehearing denied July 16, 1965]
    
      
      Walter J. dimmings, Jr., for plaintiff. Harlowe E. Bowes, Robert R. Frei and 8idley, Austin, Burgess <& Smith of counsel.
    
      8. Lawrence Shaiman, with whom was Assistant Attorney General Louis F. Oberdorfer, for defendant. O. Moxley Featherston, Lyle M. Turner, and Philip R. Miller were on the brief.
    Before CoweN, Chief Judge, Lakamore, Dtjrfee, Davis and ColliNS, Judges.
    
   CoweN, Chief Judge,

delivered the opinion of the court:

Plaintiff, successor to the Kalamazoo Vegetable Parchment Company, is engaged in the production and sale of paper, with its principal offices and plant located in Kalamazoo, Michigan.

In 1943, plaintiff purchased a long-idle pulp and paper mill in Española, Ontario, Canada, for 1,000,000 Canadian dollars. In order to place the facilities (which included a townsite adjoining the mill property, a dam and hydroelectric plant serving the mill and the town, and certain timber rights) in a state whereby full self-sustaining production could be achieved, plaintiff spent over 8,000,000 dollars in Canadian funds on the physical plant and inventories of pulpwood and supplies. Some 321,334.55 Canadian dollars worth of machinery, equipment and supplies, costing plaintiff $292,106.50 in United States currency, was purchased in the United States, shipped to Española and charged to the project. For the rest of the Canadian currency expenditures made on behalf of Española, plaintiff purchased Canadian dollars on the United States market.

In 1946, when the Española mill was ready to begin production, a Canadian subsidiary called the KYP Company Limited was incorporated under the laws of Canada, pursuant to a plan approved by the Canadian authorities. All of the Española properties were then transferred to the subsidiary for a consideration equal to the cost of the properties in Canadian funds. Plaintiff received notes of KVP Limited in the aggregate principal amount of 9,333,599.44 Canadian dollars and 450,000 shares of no-par capital stock of KVP Limited having a stated value of one Canadian dollar per share. The notes were made payable in Canadian dollars only because' the Canadian -Foreign Exchange Control Board would not permit payment "in United States currency.- ■ .Plaintiff secured a .ruling from the Commissioner óf Internal Revenue-to .the effect that the transfer of assets to KVP Limited was not a transfer-having as one of its .principal purposes the avoidance of federal income- taxes within the meaning of Section- 112 (i) of the Internal Revenue Code of 1939. Plaintiff reported no gain or loss with respect to the transíer.in its 1946 income tax return. • ■ '

The cost to plaintiff for the 9,333,599.44 Canadian dollars was only $8,455,113.81 in United States currency, due to the fa'ct that the Canadian dollar was selling at an average of 91 cents in United States currency during the time plaintiff made its-purchases.-

The notes were payable serially on the .last day of each-calendar quarter beginning March' 31, 1947.- Through' a series of transactions the maturity dates were extended,, and some 6,000,,000 more Canadian dollars were loaned tó'KVP Limited, which issued notes therefor payable in Canadian dollars to plaintiff. • ■ •

. < In order to finance ‘ the transaction, plaintiff borrowed $9,000,000 from the Chase National Bank of the City of New York, issuing its promissory notes to Chase in return. -To secure the loan and a subsequent one obtained from the Chase National Bank, .all securities, issued by KVP Limited to plaintiff were deposited with the bank.- ' ' ■. ’

To provide. Canadian distribution for pulp and paper products produced by KVP Limited, plaintiff also purchased in 1945 all of the outstanding capital stock of Appleford Paper.Products Limited, which was engaged in the business of converting paper. Plaintiff then loaned Appleford $900,000 to-provide for plant expansion and working capital, and Appleford issued a .series of notes .payable to plaintiff-in Canadian dollars in installments commencing-December 31, 1953.

The repayment by its subsidiaries of the principal due on the notes was made to plaintiff in two ways. Part of the indebtedness was repaid in Canadian dollars, by check, to plaintiff. It immediately converted these Canadian dollars into United States dollars. The remainder was repaid by means of intercompany credits affected by offsetting the Canadian dollars due to plaintiff against amounts due by it to KVP Limited for pulp purchases made by plaintiff from KVP Limited. Plaintiff’s open-account indebtedness for pulp purchases was credited by an amount equal to the value of the Canadian dollar indebtedness in United States currency at the then prevailing exchange rate. This procedure was followed in order to avoid the conversion fees which would have otherwise been payable on the conversion of the foreign currency into domestic currency. For the purposes of the decision in this case, we have treated these intercom-pany credits as if they were actually repayments to plaintiff in Canadian dollars which it then converted into United States currency. See Seaboard Finance Co. v. Commissioner, 225 F. 2d 808 (9th Cir. 1955). The notes were redeemed in installments in the years of 1949, 1951, 1952, 1953, 1954, 1955, and 1956, inclusive.

While the debts were reflected in the records of the subsidiaries, they did not maintain transfer books with respect to the notes. No transfer agent was appointed by the subsidiaries, and no agreement of any kind between the subsidiaries and plaintiff required notification of the issuer of the notes in order to make a transfer of the notes effective. None of the notes had interest coupons attached.

The interval between the dates of repayment of the notes in Canadian dollars and the conversion thereof into United States currency was less than 6 months in each instance. As a result of the repayments and the conversion of the Canadian dollars, plaintiff realized a gain of more than $700,000 in excess of its cost of the Canadian dollars repaid. The gain was entirely due to the fact that when the Canadian dollars were repaid and converted, the Canadian dollar was more valuable in terms of the United States dollar than it had been on the various dates when plaintiff purchased such Canadian dollars it loaned to its subsidiaries. In its federal income tax returns for the taxable periods involved, plaintiff reported the gain realized as long-term capital gain.

Upon audit of the returns, the Commissioner of Internal Revenue determined that the gains reported were taxable as ordinary income and disallowed plaintiff’s computation of its tax at the lower capital gains rates. A deficiency assessment was made for the additional amounts of income tax, excess profits tax and interest due pursuant to the Commissioner’s determination. Plaintiff paid the deficiency, amounting to $256,530.40 and, after it had filed timely claims for refund, brought this suit to recover the amount paid, plus statutory interest.

It is agreed that each of the notes was held for morei than 6 months between the dates of its issuance and redemption.

Two issues are presented for our decision: (1) whether the gain realized by plaintiff during the taxable years in suit constituted long-term capital gain, short-term capital gain, or ordinary income, and (2) whether plaintiff’s gain was realized upon its receipt of the payments in Canadian currency in discharge of the notes or at the time the Canadian currency was converted into United States dollars.

The first five taxable periods involved here are covered by the provisions of the Internal Revenue Code of 1939, while the 1954 Code is applicable to the last 2 years. For the purposes of this action, there is no material difference between the pertinent sections of the two Codes. The statutory provisions of each Code sets forth a three-fold test for the determination of whether gain realized by the taxpayers is to be classified as a long-term capital gain. The gain must be realized from a “sale or exchange” of property. The property sold or exchanged must be a “capital asset” in the hands of the seller, and the property sold or exchanged must have been held for more than 6 months prior to the transfer.

We shall first discuss defendant’s contention that the gains realized by plaintiff in the transactions before us were ordinary income in that plaintiff’s loans to its subsidiaries were made in the normal course of its business. Defendant concedes that foreign currency is property and, as such, is not specifically excluded from treatment as a capital asset by Section 117 (a) of the 1939 Code and Section 1221 of the 1954 Code.. However, defendant maintains that the transactions in which plaintiff engaged fall within the rationale of Corn Products Co. v. Commissioner, 350 U.S. 46 (1955) and Booth Newspapers, Inc. v. United States, 157 Ct. Cl. 886 (1962). We do not agree with this contention because of the significant factual distinctions between those cases and the action before us. In Corn Products, the taxpayer, who Consumed millions.'of bushels of corn annually in its manufacturing processes, dealt in corn futures .as an integrated and functional part of its business to -hedge -against price rises in raw material inventories and to Insure against scarcity. In Booth Newspapers, taxpayers were users of newsprint who bought a newsprint manufacturing 'facility at a time when there was an extreme shortage as a hedge against commercial sources :and as a principal supplier in times of need. The court treated the purchase of the paper plant as an acquisition of a vital source of inventory. • Plaintiff here was not a dealer in Canadian currency. It says, and we agree, that plaintiff had a substantial investment in the stocks of the subsidiaries and that the loans were made to provide the capital needed in the conduct -of their businesses, thereby enhancing plaintiff’s investment in the stocks' of the two companies. The notes which plaintiff received as- a-creditor were capital assets, Paine v. Commissioner, 236 F.2d 398 (8th Cir. 1956) and Conrad N. Hilton, 13 T.C. 623 (1949).

In its view of the dealings with its subsidiaries, plaintiff claims that its holding period for the Canadian currency commenced when plaintiff purchased such currency it loaned to the subsidiaries and, in the case of property transferred to KVP Limited, when plaintiff agreed to accept Limited’s purchase price notes, payable in Canadian currency. ' Plaintiff further claims that its holding period ended in each instance when the Canadian money plaintiff received in discharge of the notes was converted into United States dollars. The interval in each instance was more than 6 months. We cannot accept this characterization of the facts as a basis for a decision in this case. -First, it collides with the undisputed -fact that plaintiff disposed of the Canadian currency it had purchased by loaning it to the subsidiaries and receiving their notes in exchange therefor. Second, plaintiff’s treatment of the situation ignores the fact that the transactions in this case involve three taxable events, each Of which must be examined separately to determine its taxable consequences.

Plaintiff’s investment in the Canadian dollars was short-lived. Plaintiff’s acceptance of the notes in exchange- for the Canadian dollars transferred'full title'to such currency to the subsidiaries. Plaintiff retained none of the elements of ownership. It is interesting to note that in its brief plaintiff argues that the notes-were capital assets in its hands and cites cases in support of that statement. Such a ■ recognition is, of course, inconsistent with plaintiff’s general contention that it held the Canadian currency it acquired for the subsidiaries for periods in excess of 6 months. - If the dollar value of the Canadian currency purchased by plaintiff had increased'between the dates of purchase and the dates it was transferred to the subsidiaries, plaintiff would have realized a gain .as a result" of the disposition. No' gain or loss was reported and the question is now moot.

Plaintiff’s basis for the Canadian money loaned was the cost in United States dollars at the exchange rate prevailing at the time of purchase. At maturity, when the subsidiaries paid the notes in Canadian currency, another taxable event occurred.- At that time plaintiff acquired property which had a value in excess of the cost basis of the notes and it then realized a gain measured in terms of the difference between the dollar cost of the Canadian currency and its value in dollars when the notes were paid. Section 111 of the 1939 Code (26 U.S.C. 1952 Ed., § 111) and Section 1001 of the 1954 Code (26 U.S.C. 1958 Ed., § 1001) provide that the gain from any disposition of property is the excess of the amount realized therefrom over its adjusted basis. The amount realized is the amount of money received, plus the fair market value of property received. When an obligation is discharged by a payment in property, the gain to the recipient is measured by the difference between the fair value of the property and the basis of the obligation. Bingham v. Commissioner, 105 F. 2d 971 (2d Cir. 1939) Felin, v. Kyle, 102 F. 2d 349 (3d Cir. 1939).

Although it is hard put to find any provision in the Internal Revenue Codes in support of its argument, plaintiff asserts that no gain in fact was realized when the notes were paid because it had not converted the Canadian dollars into United States currency; that its investment in the Canadian dollars was still subject to fluctuations on the market; and that in transactions involving foreign currency, no taxable event occurs until the transaction is closed by conversion of the foreign money.

Plaintiff relies principally on B. F. Goodrich Company, 1 T.C. 1098 (1943) and Foundation Company, 14 T.C. 1333 (1950). In Goodrich the taxpayer borrowed 11,000,000 francs from a French bank and loaned the francs to its French subsidiary. In 1936, after the franc had declined in value, the taxpayer purchased francs at a lower price and repaid the bank loan before its subsidiary paid its notes. The court held that the taxpayer realized no income on the discharge of the debt to the bank because the entire transaction, including that with the bank and the loan to the subsidiary, had not been closed. With respect to the loan by the bank and its repayment, the court stated “No real gain or loss could result from the mere borrowing and return of fungible property”.

In Foundation Company, the taxpayer had, prior to 1928 and in the regular course of its business, performed construction work for a country club in Peru. The debt, which was payable in Peruvian soles, was accrued on the taxpayer’s books at its value in United States dollars and reported as gross receipts in its federal income tax return for 1928. In the period 1937 to 1941, after the dollar value of the Peruvian sol had declined, the debt was paid and the taxpayer immediately converted the soles into dollars. The court held that the taxpayer sustained an ordinary loss in the amount of the difference between the accrued value of the soles and their value at the time of receipt and conversion. The court did not decide whether the losses occurred when the soles were received or when they were converted into dollars, but it did state that “the exchange of each group of soles for United States dollars marked a clearly identifiable event and constituted a closed transaction with respect to those soles”.

As defendant has correctly pointed out in its brief, the facts in Goodrich and Foundation Company are so dissimilar to those before us that the cases have little bearing on the issues in this case. To the extent, however, that the quoted statements from the two cases may be construed as holding that the payment of a loan in foreign currency is not an event which gives rise to a taxable gain or loss without the necessity of converting the foreign currency into United States dollars, we decline to follow them. Although it recognizes foreign currency as property, the Tax Court treats it, without explanation, quite differently from other commodities which can be used in payment of an obligation, such as gold, wheat, or diamonds. We see no basis for this exception, and the court gives none. We think the question involved in such a situation was correctly decided in Waterman's Estate v. Commissioner, 195 F. 2d 244 (2d Cir. 1952). There, an estate claimed an ordinary loss 'as the result of the receipt of payment of a bill of exchange for 10,000 English pounds. The bill of exchange had been valued for estate tax purposes at a sum which, at the current rate of exchange, was more than $16,000 less than the value of the obligation in dollars at the time of the decedent’s death. The pounds received were not converted into dollars because they were contained in a blocked sterling account throughout the year in which the payment was made. Despite that fact, the Second Circuit held that “the taxpayer sustained a loss when the note was so paid and that fixed the time as of which the loss' was allowable”.

Since we have decided that the notes, which plaintiff held for more than 6 months, were capital assets, the only question remaining is whether plaintiff’s receipt of the Canadian currency in payment of the notes was a “sale or exchange” within the meaning of Section 117(a) of the Internal Kevenue Code of 1939 and Section 1222 of the 1954 Code. This decision turns on the provisions of Section 117 (f) of the 1939 Code and Section 1232 of the 1954 Code.

The receipt of payment on ordinary notes or debts (other than securities with interest coupons or notes in registered form) is not a sale or exchange which is accorded treatment as a capital gain or loss. Fairbanks v. United States, 306 U.S. 436 (1939); Felin v. Kyle, supra. The application of this general rule is hot altered by the fact that the notes, paid in the currency received by-plaintiff, were themselves received in exchange for property. Osenbach v. Commissioner, 198 F. 2d 235 (4th Cir. 1952) and Bingham v. Commissioner, supra.

The sections of the Codes last cited are a congressional abrogation of the general rule and are to be narrowly applied. Corn Products Co., supra. The note or other indebtedness must show on its face that it is registered. Victor A. Miller, 32 T.C. 954 (1959).

It is undisputed that the notes involved here were not in registered form on or prior to March Í, 1954, and were issued prior to January 1, 1955. However, in an effort to avoid the plain statutory requirement, plaintiff contends that the purpose of the limitation was simply to prevent original issue discount in the nature of interest from receiving capital gain treatment. Plaintiff points to Senate Report No. 1622, 83rd Cong., 2d Sess. 112, and argues that the validity of its position is demonstrated by the fact that Section 1232 of the 1954 Code, treats, all promissory notes alike on retirement and provides new rules to insure that gain attributable to original issue discount is taxed as ordinary income. The report cited indicates quite clearly that the problem of original discount arose after enactment of the 1939 Codé and that new provisions were inserted in Section 1232 of the 1954 Code to eliminate questions which had arisen under the 1939 Code as to whether the increment received on a registered bond or note issued at a discount should be. treated as a capital gain or as interest income. But the question discussed is unrelated to the changes in the 1954 Code which treat unregistered notes issued after January 1, 1955, in the same manner as registered notes. The Committee Report simply gives no clue ás to why the change was made. In the absence of clear and unmistakable evidence of a congressional .intention to the contrary, the statutory language must be read in its common and natural meaning. '

Our holding on this point is supported by the Tax Court decision in Columbia Sand and Gravel Company, Inc., 11 CCH Tax Ct. Mem. 794 (1952), in which the court held that losses on bonds which were within the limitations of section 117(f), were capital:

.Since the purchase and redemption of the bonds was a capital matter, section 117, Internal Revenue Code, petitioner’s entire loss was a capital loss, * * *

See. also the discussion of this section in Bailey, Creditors' Losses on Foreign Currency Loans, 31 Taxes 476, 479 (June 1953), wherein Mr. Bailey states:

In its simplest form the problem may be illustrated by reference to a case where an American corporate taxpayer, for sound business reasons, loans 1,000 imaginary pesos worth 1,000 United.States dollars to a foreign affiliate. The loan may be evidenced by a promissory note, by a bond, or merely by a book entry. As part of the loan transaction, the American taxpayer purchases pesos and transmits those pesos to the borrower. At a later date, and after a decline of 50 per cent in the value of the peso, the borrower returns 1,000 pesos to the lender. Thereafter the lender converts the 1,000 pesos into 500 United States dollars.
*****
If the [foreign currency] loan is evidenced by a corporate obligation bearing interest coupons or in registered form, the loss should be deemed a capital loss deductible to the extent that it may be offset against capital gains. On the other hand, if the obligation is evidenced only by a book entry or an ordinary promissory note, no sale or exchange is presumed from the fact of repayment and the loss is an ordinary one deductible under Section 23(f) of the [1939] Code.

Accordingly, we hold that the repayment of the notes held by plaintiff for over 6 months was not a sale or exchange and that the gain plaintiff realized upon repayment of the notes is taxable as ordinary income.

Since the Canadian currency received by plaintiff in discharge of the notes was not held for 6 months but immediately converted into United States dollars, any gain which plaintiff realized in this separate transaction was a short-term gain.

For the reasons stated plaintiff’s petition is dismissed.

FINDINGS OF FACT

The court, having considered the stipulation of the parties, and the briefs and arguments of counsel, makes findings of fact as follows:

1. Plaintiff, KYP Sutherland Paper Company, is a Delaware corporation with its principal office at Kalamazoo, Michigan. Effective January 4,1960, Kalamazoo Vegetable Parchment Company (hereinafter referred to as “KYP”), a Michigan corporation, was merged into plaintiff under the applicable state corporation laws. As the successor of KYP, plaintiff brought this action under Section 1491(2) of the Judicial Code for refund of federal income and excess profits taxes, and interest thereon, paid by KVP for taxable years prior to the merger. In its answer, defendant denies liability to make such refunds.

2. At all times here relevant, KYP was engaged in manufacturing, converting and selling paper. Its principal manufacturing facilities were located in Kalamazoo, Michigan. In January 1943, KVP purchased a pulp and paper mill property in Española, Ontario, Canada, for 1,000,000 Canadian dollars. Included in the property so acquired was a townsite adjoining the mill property, a dam and hydroelectric plant serving the mill and the town, and certain timber rights and woodcutting rights in the area around Española.

3. At the time of the purchase of the properties the mill had been idle for a number of years, and it was planned to develop the property to the point where it constituted a complete industry in Española. It was contemplated that substantial expenditures and considerable time would be required to develop the property before the commencement of operations. Also, from the outset it was intended that when the Española installation was ready to commence the manufacture of wood pulp, all of the assets located at Espa-ñola would be transferred to a newly formed Canadian corporation to be operated as a subsidiary of KVP. Preliminary discussion with the various official departments of the Dominion of Canada and the Province of Ontario from which licenses or clearances were required to be obtained were carried on with the understanding that a Canadian corporation would be formed to hold and operate the Espa-ñola properties.

4. KVP expended between January 1943 and April 1, 1946, over 8 million dollars' in Canadian funds for new construction, improvements and additions to the property, inventories of pulpwood and supplies, establishment of woods camps, building of woods roads, and other deferred costs, relating to the cutting of pulpwood.

5. The Canadian currency expended was acquired by KVP through purchases on the United States market. Detailed records were kept of the cost in United States currency of the Canadian funds. In addition, machinery, equipment and supplies costing $292,106.50 were purchased in the United States and shipped to Española, and the Española project was charged $821,334.55 in Canadian currency therefor. This amount was based on the exchange rate prevailing at) the time of purchase.

6. A Canadian subsidiary called the KVP Company Limited (hereinafter referred to as “Limited”) was incorporated under the laws of Canada in March 1946. As of April 1, 1946, KVP transferred to Limited all of the properties at or near Española or related to the business to be carried on at Española for a consideration, payable in stock and notes of Limited, equal to the cost of the properties in Canadian funds, which was 9,783,599.44 Canadian dollars. KVP received notes of Limited in the aggregate principal amount of 9,333,599.44 Canadian dollars and 450,000 shares of no-par capital stock of Limited having a stated value of one Canadian dollar per share. The Canadian Foreign Exchange Control Board had stated that it would not permit Limited to issue securities payable in United States currency.

7. By ruling letter dated May 1, 1946, the Commissioner of Internal Revenue concluded, on the basis of the facts submitted by KVP in letters dated March 13, 1946, and March 26, 1946, that the transaction described in the paragraph above was not “in pursuance of a plan having as one of its principal purposes the avoidance of Federal income taxes within the meaning of Section 112 (i) of the Internal Revenue Code.” The Commissioner expressed no opinion with respect to the applicability of any other provision of the Internal Revenue Code. No gain or loss was reported with respect to the transfer in KVP’s 1946 income tax return.

8. KVP’s cost for the properties transferred to Limited for the notes of Limited referred to in paragraph 6 hereof was 9,333,599.44 Canadian dollars, the same as the face amount of the notes. KVP’s cost for the properties so transferred was $8,455,113.81 in United States currency. The difference between the Canadian dollar cost of the properties and KVP’s cost for the properties in United States currency was attributable to the fact that, throughout the period during which KVP was acquiring the Canadian dollars used to purchase the properties, the Canadian dollars were selling at an average of approximately 91 cents in United States currency, and KVP bad accordingly paid only $8,455,113.81 for the 9,333,599.44 Canadian dollars.

9. Twenty-three separate notes were issued by Limited representing the aggregate indebtedness of 9,333,599.44 Canadian dollars. Thirteen notes were in the principal amount of 500,000 Canadian dollars and matured serially on the last day of each calendar quarter commencing March 31, 1947 and ending March 31, 1950. Nine notes were in the principal amount of 300,000 Canadian dollars and matured serially on the last day of each calendar quarter commencing June 30, 1950 and ending June 30, 1952. The remaining note was in the principal amount of 133,599.44 Canadian dollars and matured on September 30,1952. Each note was dated April 1,1946, was payable to KVP or order in Canadian funds and bore interest at 4% payable quarter-annually in Canadian funds.

10. Limited commenced the manufacture of wood pulp in May 1946. However, the original concept of the Española project had in the meantime been expanded to provide not only for the production of wood pulp but for the development of an integrated Canadian pulp and paper manufacturing business at Española. In order to finance the additional capital requirements of the expanded program, KVP lent an additional 3,900,000 Canadian dollars to Limited in 1946 and Limited issued 13 additional promissory notes which matured serially in amounts of 300,000 Canadian dollars quarter-annually commencing March 31, 1952 and ending on December 31, 1955, which notes were in all material respects identical with those previously issued by Limited to KVP.

11. In order to finance the development at Española, KVP borrowed $9,000,000 from The Chase National Bank of the City of New York (hereinafter referred to as “the Chase”) between June 1944 and November 1946, and issued serial promissory notes to the Chase evidencing this indebtedness. The loan agreements required that KVP use the proceeds for carrying out the Española project. The original loan agreement dated June 23,1944, provided that when the Española properties were transferred to a Canadian subsidiary, the indebtedness to the Chase might be assumed by the Canadian subsidiary with KVP remaining liable only as a guarantor. However, by letter dated July 18,1944, the Canadian Foreign Exchange Control Board advised KYP that it would not approve the assumption of the indebtedness to the Chase by the Canadian subsidiary to be formed. As previously stated, the Canadian Foreign Exchange Control Board also refused to allow Limited to issue notes to KVP payable in United States currency. Foreign exchange controls were eliminated in Canada in December 1951.

12. By agreement dated December 23,1946, between KVP, the Chase and The Penn Mutual Life Insurance Company (hereinafter referred to as “the Insurance Company”), KVP’s outstanding indebtedness to the Chase was reduced by partial prepayments to $8,000,000 and the Insurance Company lent $4,000,000 to KVP. In conjunction therewith the $9,000,000 of notes previously issued to the Chase by KVP, which matured in quarterly amounts of $250,000 from June 30,194V to and including March 31,1956, were replaced by $12,000,000 of new notes in the amount of $200,000 each which matured serially on the last day of each quarter commencing March 31,1947 and ending December 31,1981. On the same date the maturity dates of the indebtedness from Limited to KVP in the amount of 13,233,599.44 Canadian dollars were adjusted by memorandum agreement between KVP, Limited and the Chase. In general, the memorandum agreement provided that the indebtedness should mature at the rate of 250,000 Canadian dollars quarterly commencing March 31, 1947 and ending March 31, 1960, the only exceptions being that the amount due on September 30,1952, was 133,599.44 Canadian dollars and the last two quarterly payments were 300,000 Canadian dollars each. New notes were not issued by Limited. The extended maturities were reflected by endorsement on the previously issued notes. The loan agreement of December 23, 1946, required, as did the earlier loan agreements between KVP and the Chase, that all securities issued by Limited to KVP be deposited with the Chase 'as security for KVP’s indebtedness, and the stock and notes of Limited were accordingly deposited with the Chase.

13. During 1947 Limited issued to KVP seven additional promissory notes in the aggregate amount of 2,100,000 Canadian dollars evidencing loans of a like amount of Canadian dollars made by KVP to Limited in 1947. These notes matured in amounts of 300,000 Canadian dollars quarter-annually commencing on June 30, I960,, with two notes being dne on March 31, 1961. The notes, which were in all material respects identical with the notes previously issued by Limited to KVP, were deposited by KVP with the Chase as additional security for KVP’s indebtedness.

14. 4,420,221.93 of the Canadian dollars lent by KVP to Limited subsequent to April 1, 1946, were purchased by KVP for this purpose from United States banks. A portion of the 1,579,778.07 Canadian dollar balance of the loans stemmed from disbursements made by KVP on Limited’s behalf in United States currency, such disbursements being charged by KVP to Limited in the amount of Canadian dollars equivalent under the then prevailing exchange rate to the amount disbursed. These disbursements included disbursements for equipment and supplies such' as salt, pumps, chemicals, coal, machinery and sulphur purchased in the United States and shipped to Limited in Canada. The remainder of the Canadian dollars loaned were amounts collected as interest on the indebtedness of Limited to KVP which KVP then loaned back to Limited.

15. In order to provide Canadian distribution for pulp and paper products produced by Limited at Española, KVP acquired in December 1945 all of the outstanding stock of Appleford Paper Products Limited (hereinafter referred to as “Appleford”), a Canadian corporation engaged in the business of converting paper at Hamilton, Ontario. Apple-ford’s operations were expanded following its acquisition, and a new plant, additional capital equipment and additional working capital were required. In order to meet these capital requirements, KVP loaned 750,000 Canadian dollars to Appleford in 1947, 1948 and 1949, and the latter issued to KVP thirty promissory notes in the amount- of 25,000 Canadian dollars each. The notes were payable to KVP or order in Canadian funds and bore interest at. 5.per-cent payable in Canadian funds quarter-annually. The notes matured serially on March 31 of each year commencing on March 31, 1949. The notes were pledged by KVP with the Chase as required by the loan agreement of December 23, 1946. 725,000 Canadian dollars of the funds so loaned were Canadian dollars which had become due on the indebtedness of Limited to KVP and which were delivered by Limited to Appleford at the direction of KVP. The remaining 25,000 Canadian dollars were purchased by KVP for the purpose of lending them to Appleford. 0'n June 30, 1952, KVP loaned an additional 250,000 Canadian dollars to, Appleford in order to provide the latter with additional working capital. Appleford .issued a 5 percent interest-bearing promissory note to KVP in the amount of 250,000 Canadian dollars. On- September 30, 1953, all of Appleford’s then outstanding notes to KVP, which totaled 900,000 Canadian dollars, were cancelled and Appleford issued to KVP in lieu thereof 60 notes in the principal amount of 15,000 Canadian dollars each. The new notes bore interest at 5 percent payable in- Canadian dollars and matured in amounts .of 15,000 Canadian dollars quarter-annually on the last, day of each calendar quarter commencing on December 31, 1953. In all other material re-, spects the new notes were identical with the Appleford notes cancelled. The new notes were pledged by KVP with the Chase as required by the loan agreement of December 23,1946. ,

16. All of the notes issued by Limited and Appleford to KVP, as described in paragraphs 9, 10, 13 and 15, were identical in all respects except as to the name of the payor, due date, amount and purpose of the loan. Following is the text of one of the notes issued by Limited to KVP;- .

Española, Ontario, April 1,1946
500,000.00
On March 31, 1949, the undersigned THE KVP COMPANY LIMITED (a corporation organized and existing under the Companies Act of the Dominion of Canada), for value received, hereby promises to pay to KALAMAZOO VEGETABLE PARCHMENT COMPANY, of Parchment, Kalamazoo, Michigan, U.S.A., or order, at the main office of The Royal Bank of Canada, in the City of Toronto, Province of Ontario, Canada, in lawful money of the Dominion of Canada,
FIVE HUNDRED THOUSAND . . . DOLLARS
and to pay interest thereon at said office, in like funds, quarter-annually on the last days of March, June, September and December in each year, at the rate of 4% per annum.
This note is one of a series of notes to be issued by the undersigned to evidence indebtedness incurred for the purchase and construction of a pulp and paper mill and repayable in conformity with the terms of such notes (commencing March 31, 1947), in principal amounts of $500,000 quarter-annually to and including March 31, 1950, and thereafter in principal amounts of $300,000 quarter-annually until this series is retired.
_ If the undersigned shall default in the payment of either the principal of or interest on this note or any such notes of this series, and such default shall have continued unremedied for a period of ninety days, the holder of the note, at his election, may declare that the principal of this note is due and payable at any time specified by him, and. thereupon the principal shall become due at such time.
The undersigned may also prepay this note and any of such other notes at any time, either in inverse order of the maturity thereof or ratably of each maturity thereof at such time outstanding, upon endorsement of such notes with the amounts so prepaid on account thereof (if prepaid in part) or the surrender of such notes (if prepaid in full), with interest on all notes so prepaid in full.
THE KVP COMPANY LIMITED
By R. A. Hayward
President
E. Norval Hunter
Secretary

17. During 1949 Limited repaid to KVP 1,000,000 Canadian dollars of the total indebtedness of 9,333,599.44 Canadian dollars represented by the promissory notes issued by Limited on April 1,1946. 900,000 of the Canadian dollars so repaid were converted by KYP during the taxable year into United States currency. Limited’s checks payable in Canadian funds were delivered to the Chase and converted by the latter, at the direction of KVP, into United States currency for KVP’s account at the prevailing exchange rate. The amount credited to KVP’s account for the Canadian dollars so converted was $821,125. The 100,000 Canadian dollars repaid by Limited but not converted by KVP into United States currency were loaned by KVP to Appleford in 1949, as described in paragraph 15.

18. During 1951 Limited repaid to KVP 1,000,000 Canadian dollars in discharge of the indebtedness maturing quarterly during 1951. During 1951 Appleford repaid to KVP 50,000 Canadian dollars in discharge of the indebtedness maturing March 31,1951, and of the indebtedness originally maturing March 31, 1949, which had been extended. Limited and Appleford made their respective payments by checks payable in Canadian dollars which were forwarded by KVP to the Chase and converted by the latter, at the direction of KVP, into United States currency for KVP’s account at the prevailing exchange, rate. The amount credited to KVP’s account for the Canadian dollars so converted was $1,006,154.74.

19. During the taxable period January 1, 1952 to September 30, 1952, KVP received repayment of 275,000 Canadian dollars in discharge of the indebtedness of its Canadian subsidiaries maturing on March 31,1952. Of this amount, 250,000 Canadian dollars were paid by Limited and the balance by Appleford. The payments by Limited were effected by offsetting the Canadian dollars due to KVP against amounts due from KVP to Limited for pulp purchases made by KVP from Limited. Limited invariably invoiced its pulp shipments to KVP in United States currency pursuant to the normal practice of Canadian producers on shipments to United States customers. As payments on Limited’s indebtedness to KVP became due, KVP authorized Limited to effect the payment by crediting KVP’s open-account indebtedness for pulp purchases by an amount equal to the value of the Canadian dollar indebtedness in. United 'States currency at the then prevailing exchange rate. The payment made by Appleford was effected by Appleford’s remitting Canadian dollars to Limited, which then credited KVP’s open-account indebtedness to Limited for pulp purchases in the same manner. KVP was credited with $285,425 in United States currency for the Canadian dollars so applied. Payments were effected by intercompany credits in the manner described in order to save the conversion fees which would otherwise have been paid by both KVP and Limited to convert the foreign currency received into their respective domestic currencies.

20. During the taxable year October 1, 1952 to September 30, 1953, KVP received repayment of 2,158,599.44 Canadian dollars in discharge of an equivalent amount of the indebtedness of its Canadian subsidiaries. Of this amount 2.133.599.44 Canadian dollars were paid by Limited, and the balance by Appleford. All but one of the payments by Limited were effected by offsetting the Canadian dollars due to KVP against amounts due from KVP to Limited for pulp purchases made by KVP from Limited. This was done in the manner described in paragraph 19 hereof for the reason therein stated. The other payment by Limited was made by delivering 250,000 Canadian dollars to the Chase for the account of KVP, which funds were then converted by the Chase, at the direction of KVP, into United States currency for KVP’s account at the prevailing exchange rate. The payment by. Appleford was made in the manner described in paragraph 19 hereof for the reason therein stated. The total amount of the credits received by KVP from Limited and the Chase with respect to the 2.158.599.44 Canadian dollars thus repaid to KVP in the taxable year was $2,197,389.66 in United States currency.

21. During the taxable year October 1, 1953 to September 30, 1954, KVP received repayment of 1,810,000 Canadian dollars in discharge of an equivalent amount of the indebtedness of its Canadian subsidiaries. Of this amount 1,750,000 Canadian dollars were paid by Limited, and the balance by Appleford. The payments by Limited and Appleford were made in the manner described in paragraph 19 hereof for the reason therein of the credits received by KVP from Limited with respect to the 1,810,000 Canadian dollars thus repaid to KVP in the taxable year was $1,852,448.03 in United States currency.

22. During the taxable year October 1, 1954 to September 30, 1955, KVP received repayment of 1,060,000 Canadian dollars in discharge of an equivalent amount of the indebtedness of its Canadian subsidiaries. Of this amount 1,000,000 Canadian dollars were paid by Limited, and the balance by Áppleford. The payments by the two subsidiaries were made in the mariner described in paragraph 19 hereof for the reason therein stated. The total amount of the credits received by KVP from Limited with respect to the 1,060,000 Canadian dollars thus repaid to KVP in the taxable year was $1,081,261.09 in United States currency.

23. During the taxable year October 1, 1955 to September 30, 1956, KVP received repayment of 545,000 Canadian dollars in discharge of an equivalent amount of the indebtedness of its Canadian subsidiaries. Of this amount 500,000 Canadian dollars were paid by Limited and the balance by Appleford. The payments were made in the manner described in paragraph 19 hereof for the reason therein stated. The total amount of the credits received by KVP from Limited with respect to the 545,000 Canadian dollars thus repaid to KVP in the taxable year was $545,384 in United States currency.

24. The interval between the repayment of the Canadian dollars to KVP by its Canadian subsidiaries and the conversion by KVP of the Canadian dollars repaid into United States currency, as described in paragraphs 17 to< 23, inclusive, was in each case an interval of less than 6 months. The interval between the making of each particular Canadian dollar loan- and the conversion by KVP of the Canadian dollars into United States currency following, or in conjunction with, repayment of the particular Canadian dollar loan, as described in paragraphs 6, 10, 13, 15 and 17 to 23,'inclusive, was in each case an interval'of more than 6 months.

25. The notes issued and repaid by KVP’s subsidiaries as herein described were at no time held by KVP for sale to customers or to anyone else.

26. KVP at no time subsequent to 1941, or at any time during or prior thereto to the best of the knowledge of the present management of KVP, ever engaged in any transactions involving Canadian dollars or any other foreign currency except for Canadian dollar transactions entered into in connection with the acquisition of and the financing of its Canadian subsidiaries, Limited and Appleford, as herein described.

27. The interest accruing from time to time on the notes issued and repaid by KVP’s Canadian subsidiaries as described herein was reported as taxable income by KVP in its tax returns. The amount so reported was the value in United States currency of the Canadian dollar amount of the interest, based on the then prevailing exchange rate.

28. The indebtedness from time to time outstanding from the Canadian subsidiaries to KVP was reflected ini the records of the subsidiaries as indebtedness to KVP. The subsidiaries did not maintain transfer books with respect to the notes, no transfer agent was appointed by the subsidiaries, and no oral or written agreement between Limited or Appleford and KVP required notification of the issuer of the notes in order to make a transfer of the notes effective. None of the notes had interest coupons attached.

29. KVP, Limited and Appleford had the following common officers during the years in question: B,. A. Hayward was the chief executive officer of KVP at all times herein described until his death in 1951, and also served as chief executive officer of Limited and of Appleford from the respective dates on which those companies became subsidiaries of KVP until Ms death. A. Southon was chief executive officer of all three corporations in 1951 and 1952. Dwight L. Stocker has been chief executive officer of all three corporations since 1953. Thomas W. Peck was cMef financial officer of KVP, Limited and Appleford at all times herein described until his retirement in 1951. E. N. Hunter was also a principal executive officer of all three corporations. In addition, eight individuals were directors of both KVP and Limited and six individuals were directors of both KVP and Appleford.

30. KVP’s cost of the 0,333,599.44 Canadian dollars owed to it by Limited and represented by the notes issued on April 1, 1946, as described in paragraphs 6 and 9 hereof, was the $8,455,113.81 paid by KVP for the 9,333,599.44 Canadian dollars used to acquire the properties transferred to Limited on April 1,1946.

31. KVP’s cost of the Canadian dollars owed to it by Limited and Appleford and represented by notes issued subsequent to April 1, 1946, as described in paragraphs 10, 13 and 15 hereof, was KVP’s cost of the Canadian funds loaned to KVP’s subsidiaries as described in said paragraphs. In the case of Canadian dollars purchased by KVP with United States funds, KVP’s cost was the purchase price. In cases where the Canadian dollar loans stemmed from expenditures made by KVP in United States funds for equipment and supplies shipped to Limited and charged to Limited in Canadian dollars, KVP’s cost for the Canadian dollars was the amount expended for the equipment and supplies. In cases where Canadian dollars paid or payable as interest on the Canadian dollar indebtedness were loaned to Limited, KVP’s cost was the United States currency equivalent of the Canadian dollar interest under the exchange rate prevailing on the date the interest became payable.

32. The amounts realized by KVP upon the repayment of the Canadian dollar indebtedness of its subsidiaries and conversion of the Canadian funds into United States funds, as described in paragraphs 17 to 23 hereof, was more than KVP’s cost of the Canadian dollar indebtedness so repaid. The differences were due entirely to the fact that upon the dates when the Canadian dollars repaid to KVP were converted into their United States currency equivalent, the Canadian dollar was more valuable in terms of the United States dollar than it had been on the dates of the various transactions which established KVP’s cost of the Canadian currency loaned to its subsidiaries.

33. KVP reported the gains realized as long term capital gain in its returns for the taxable periods involved, as follows:

Amount of Taxable Period Gain Ended Reported
December 31, 1949_ $5, 506. 30
December 31, 1951_ 54, 599. 59
September 30,1952_ 36,208.18
September 30,1953_ 241,174. 03
September 30,1954_ 212,148.22
September 30,1955_ 123,910. 66
September 30,1956_ 49,930. 00

34. Upon audit of KVP’s returns the Commissioner of Internal Kevenue determined that the gains reported by KVP were taxable as ordinary income rather than as long term capital gains. As a result of such determination, the Commissioner computed the income tax on such gains at the rates applicable to ordinary income rather than at the lower rates applicable to long-term capital gains. Also as a result of such determination, the Commissioner added the amount of the gains for the taxable year 1951 and the taxable periods ending on September 30, 1952, 1953 and 1954, to KVP’s excess profits net income for each of the respective periods. For the taxable year 1951 and the taxable periods ending September 30, 1952 and 1953, KVP’s excess profits credit and unused excess profits credit adjustment were more than sufficient to offset its excess profits net income as increased by the Commissioner. However, the Commissioner’s addition of the gains to KVP’s excess profits net income for the taxable year 1951 and the taxable periods ending September 30, 1952 and 1953 resulted in a $331,981.80 reduction in KVP’s unused excess profits credit carryover to the taxable period ending September 30, 1954. This reduction, together with the addition of the gain of $212,148.22 to KVP’s excess profits net income for the period ending September 30, 1954, produced adjusted excess profits net income for that period in the amount of $381,702.29 upon which the Commissioner imposed an excess profits tax. The above-described adjustments by the Commissioner resulted in the assessment of deficiencies pins interest 'thereon which were paid by KVP. The amounts of the increases in tax liability for the several taxable periods attributable to the determination that the gains were taxable as ordinary income for both income and excess profits tax purposes, including the interest paid by KVP as a result of such increases, were as follows:

Excess Income Profits Tax Tax Interest Total
1949_ $715.81 $323.88 $1,039.69
1951_ 14,059.40 6,497.81 20,557.21
1952_ 9,414.12 2,627.84 12,041.96
1953_ 62,705.25 13,512.55 ' 76,217.80.
1954_ 55,158.53 $28,862.97 13,064.78 97,086.28
1955_• 33,455.88 _ 1,649.19. 35,105.07
1956_13,481.10 _ 1,001.29 14,482.39
Total- $188,990.09 $28,862,97 $38,677:34 $256",530.40

35. KVP filed timely claims for refund of the amounts set forth in paragraph 34 upon the ground that the gains involved were taxable as long-term capital gains. More than 6 months and less than 2 years after the filing of the claims, plaintiff brought this suit on the claims for refund.

36. No action on this claim has been taken by Congress or by any department of the government or in any judicial proceeding.

37. Plaintiff is the owner of this claim and no assignment or transfer of the claim has been made except as a result of the merger of KVP into plaintiff described in paragraph 1.

CONCLUSION OE LAW

Upon the foregoing findings of fact which are made a part of the judgment herein, the court concludes as a matter of law that plaintiff is not entitled to recover, and the petition is therefore dismissed. 
      
       Section 1221 of the 1954 Code (26 U.S.C. 1958 Ed. § 1221) defines a capital asset as follows:
      For purposes of this subtitle, the term “capital asset” means property held by the taxpayer (whether or not connected with his trade or business), but does not include— .
      (1) stock in trade of the taxpayer or other property of a kind which would properly he 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. sale1 to customers in the ordinary course of .his trade or business;
      - (2) property, used in his trade or business, of a character which is.
      subject-to-the allowance for depreciation provided in section 167, or real property used in his trade or business. ' '
      ■ (4) accounts or .notes receivable acquired in the ordinary course of trade or business for services rendered or from the sale of property described in paragraph (1). .
      Subsection-117(a) (1) of the 1939 Code (26 U.S.C. 1952 Ed. § 117(a)) .defines a capital asset in the same terms, except that it does not contain any counterpart to paragraph (4) of Section 1221 of the 1954 Code.
     
      
       26 U.S.C. 1952 Ed. § 117(f) provides:
      (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. • •
      26 Ü.S.C. 1958 Ed., § 1232 provides:
      (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 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).
     