Rev. Rul. 55-377

Advice has been requested whether certain increases in redemption prices of noninterest-bearing obligations issued at a discount, under the circumstances set forth below, constitute abnormal income attributable to other years within the meaning of section 456 of the Internal Revenue Code of 1939.

The corporation keeps its books and records and files its Federal income tax returns on the cash receipts and disbursements basis. Pursuant to an election under section 42(b) of the 1939 Code, the increases in the redemption prices of certain noninterest-bearing obligations occurring in the taxable year 1950 and prior years were treated as income received in 1950. The amount reported in 1950 was 100 x dollars of which 75 x dollars represented the accumulated increases in value of such obligations prior to 1950.

Section 42 of the 1939 Code provides in part:

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(b) NONINTEREST-BEARING OBLIGATIONS ISSUED AT DISCOUNT.-If, in the case of a taxpayer owning any noninterest-bearing obligation issued at a discount and redeemable for fixed amounts increasing at stated intervals * * * the increase in the redemption price of such obligation occurring in the taxable year does not (under the method of accounting used in computing his net income) constitute income to him in such year, such taxpayer may, at his election made in his return for any taxable year beginning after December 31, 1940, treat such increase as income received in such taxable year. If any such election is made with respect to any such obligation, it shall apply also to all such obligations owned by the taxpayer at the beginning of the first taxable year to which it applies and to all such obligations thereafter acquired by him and shall be binding for all subsequent taxable years, unless upon application by the taxpayer the Commissioner permits him, subject to such conditions as the Commissioner deems necessary, to change to a different method. In the case of any such obligations owned by the taxpayer at the beginning of the first taxable year to which his election applies, the increase in the redemption price of such obligations occurring between the date of acquisition * * * and the first day of such taxable year shall also be treated as income received in such taxable year.

Section 456 of the 1939 Code provides in part:

(a) DEFINITIONS.-For the purposes of this section-

(1) ABNORMAL INCOME.-The term `abnormal income' means income of any class described in paragaph (2) includible in the gross income of the taxpayer for any taxable year under this subchapter if it is abnormal for the taxpayer to derive income of such class, * * *

(2) SEPARATE CLASSES OF INCOME.-Each of the following subparagraphs shall be held to describe a separate class of income:

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(D) Income includible in gross income for the taxable year rather than for a different taxable year by reason of a change in the taxpayer's method of accounting.

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(b) AMOUNT ATTRIBUTABLE TO OTHER YEARS.-The amount of the net abnormal income that is attributable to any previous * * * taxable year or years shall be determined under regulations prescribed by the Secretary. * * *

It is abnormal for a taxpayer to derive income of any class only if the taxpayer received no gross income of that class for the four previous taxable years. Section 40.456-1(a) of Regulations 130. In the instant case the taxpayer had no gross income within the class described in section 456(a)(2)(D) supra , in the 4 years preceding 1950.

Section 40.456-3 of Regulations 130 provides in part:

AMOUNT ATTRIBUTABLE TO OTHER YEARS.-(a) The mere fact that an item includible in gross income is of a class abnormal either in kind or amount does not result in the exclusion of any part of such item from excess profits net income. It is necessary that the item be found attributable under these regulations in whole or in part to other taxable years. Only that portion of the item which is found to be attributable to other years may be excluded from the gross income of the taxpayer for the year for which the excess profits tax is being computed.

(b) Items of net abnormal income are to be attributed to other years in the light of the events in which such items had their origin, and only in such amounts as are reasonable in the light of such events * * *

In view of the above, it is held that the increases in redemption prices of the noninterest-bearing obligations, purchased by the taxpayer, accrued up to the time of the election under section 42(b) of the Internal Revenue Code of 1939 constitute a separate class of abnormal income within the meaning of section 456(a)(2)(D) of the Code and are attributable to the taxable years in which they had their origin. Accordingly, 75 x dollars of the total increases is attributable to the years prior to 1950 and the balance to the taxable year 1950.

Section 40.456-9 of Regulations 130 provides that the class of income may include such items of income as are includible in gross income for the taxable year by reason of a change from the installment method to the straight accrual method of accounting, a change in inventory method, or a change from the reserve method to the specific charge-off method for the treatment of bad debts. This section also provides that the method of allocating items of net abnormal income includible in gross income for the taxable year rather than for a different year by reason of changes in accounting method, other than a change from the installment to the accrual method, is to be determined in each particular case upon consideration of all the facts in the case.

Section 42(b) of the 1939 Code was enacted by the Revenue Act of 1941. H.R. Report No. 1040, 77th Congress, C.B. 1941-2, 413, at page 445, in discussing the applicability of such section, stated in part:

* * * Therefore, with respect to such noninterest-bearing United States defense bonds, the effect of this section is to extend, at the election of the taxpayer, the accrual method to a taxpayer on the cash basis, but only for the limited purpose of reporting the increment in value of such bonds as it accrues.

Thus, it would appear that it was the intent of Congress that an election under section 42(b) of the 1939 Code be considered a change in the method of accounting for a limited purpose