## Facts

- Midland-Ross Corporation purchased noninterest-bearing promissory notes at prices discounted below their face amounts (original-issue-discount notes).
- With one exception, Midland-Ross held each note for more than six months and, in the year of purchase, sold it before maturity for more than its issue price but less than its face amount.
- The economic gain on each sale to the extent of the discount was functionally equivalent to interest for the use of money up to the sale date.
- Midland-Ross reported the gains as long-term capital gains under the Internal Revenue Code of 1939.
- The Commissioner of Internal Revenue determined the discount-related gains were ordinary income (interest in another form) and assessed deficiencies.
- After paying, Midland-Ross sued for a refund; the district court ruled for Midland-Ross, and the Sixth Circuit affirmed.
- The Supreme Court granted certiorari to resolve a conflict among circuits on the proper tax treatment.

## Issues

1. Whether, under the Internal Revenue Code of 1939, gain attributable to earned original-issue discount realized on the sale of noninterest-bearing notes is taxable as capital gain or as ordinary income.

## Decision

- The Supreme Court reversed the Sixth Circuit.
- Earned original-issue discount was held not entitled to capital-gains treatment under the 1939 Code.
- The gain attributable to the discount was taxable as ordinary income.

## Legal Principles

- The statutory term “capital asset” under the 1939 Code is construed narrowly to confine capital-gains treatment to gains typically reflecting appreciation accrued over time, rather than ordinary income items.
- Property that represents income items, or accretions properly attributable to income, may be excluded from capital-asset treatment even if it is “property” in a general sense.
- Original-issue discount that has been earned serves the same economic function as stated interest; when predictable and not a product of market appreciation, it is ordinary income.
- Later statutory provisions expressly addressing original-issue discount do not establish that such discount was otherwise intended to receive capital-gains treatment under prior law.

## Conclusion

The Court held that Midland-Ross’s gain attributable to earned original-issue discount on the sold notes was ordinary income, not capital gain, because the discount functioned as interest rather than appreciation in a capital asset’s value.


United States v. Midland-Ross Corp., 381 U.S. 54 (1965)