Internal Revenue Service
Revenue Ruling

TaxLinks.com   sm

 Rev. Rul. 60-37

1960-1 C.B. 309

Sec. 61

Sec. 1232

IRS Headnote

The fact that non-interest bearing bonds, which were issued at a discount, are exchanged for new ten-year debentures in a tax-free exchange does not change the character of the original issue discount. Such discount represents ordinary interest income.

Full Text

Rev. Rul. 60-37

Advice has been requested regarding the Federal income tax consequences of an exchange of certain debenture bonds under the circumstances described below.

In 1952, the taxpayer, who is not a broker, trader, or dealer in securities, acquired directly from a corporation (the issuing company) certain nondefaulted noninterest-bearing debentures at a cost of 20 x dollars. These debentures are redeemable at stated intervals prior to maturity at varying prices and have a value at maturity of 30 x dollars. In the current year, the corporation issued, in exchange for the old bonds, new ten-year debentures of an equal principal amount 30 x dollars, pursuant to a plan of reorganization qualifying under section 368(a)(1)(E) of the Internal Revenue Code of 1954. The exchange was tax-free under the provisions of section 354 of the Code.

Section 1232 of the Code provides, in part, as follows:

(a) GENERAL RULE.-For purposes of this subtitle, subtitle A 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).

(2) SALE OR EXCHANGE.-

(A) GENERAL RULE.-Except as provided in subparagraph (B), upon sale or exchange of bonds or other evidences of indebtedness issued after December 31, 1954, held by the taxpayer more than 6 months, any gain realized which does not exceed-

(i) an amount equal to the original issue discount (as defined in subsection (b), * * * shall be considered as gain from the sale or exchange of property which is not a capital asset. Gain in excess of such amount shall be considered gain from the sale or exchange of a capital asset held more than 6 months.

*

(b) DEFINITIONS.-

(1) ORIGINAL ISSUE DISCOUNT.-For purposes of subsection (a), the term `original issue discount' means the difference between the issue price and the stated redemption price at maturity. If the original issue discount is less than one-fourth of 1 percent of the redemption price at maturity multiplied by the number of complete years to maturity, then the issue discount shall be considered to be zero. For purposes of this paragraph, the term `stated redemption price at maturity' means the amount fixed by the last modification of the purchase agreement and includes dividends payable at that time.

Since, in the instant case, the reorganization is tax-free under section 354 of the Code, the basis of the new debentures received by the taxpayer is the same as the basis of the property exchanged. See section 358(a) of the Code. Thus, the taxpayer is in the same relative position immediately after the exchange as he was immediately before the exchange.

Accordingly, in the instant case, where the new debentures are redeemed at maturity, that part of the redemption value which represents the original issue discount constitutes interest and is taxable as ordinary income. To the same effect, where the new debentures are redeemed prior to maturity, that part of the redemption value which represents the original issue discount also constitutes interest and is taxable as ordinary income. That part of the redemption value which represents `premium' paid by the corporation because of calling the bonds prior to maturity is long-term capital gain under section 1232(a)(1) of the Code. The basis of the new ten-year debentures, for the purpose of computing capital gain or loss, will be the same as that of the old bonds exchanged therefor.