Rev. Rul. 59-120

Advice has been requested whether ordinary income is recognized to a corporation using the cash receipts and disbursements method of accounting upon its sale of discounted promissory notes during a period of liquidation under a plan adopted pursuant to section 337 of the Internal Revenue Code of 1954.

A corporation adopted a plan of complete liquidation in accordance with section 337 of the Code. Within the 12-month period commencing on the date of adoption of the plan, it sold all of its assets in bulk to another corporation. The taxpayer employed the cash receipts and disbursements method of accounting.

Among the assets transferred to the buyer were promissory notes held by and payable to the taxpayer, evidencing loans (and the obligation to repay them) made by the taxpayer to certain of its customers. Income from the notes which had been earned before the date of sale had not yet been collected. It was the taxpayer's customary business practice, for example, to receive a $1,000 note, payable one year from the date of the loan (in a lump sum and not by installments), in return for a loan of $950, the $50 difference representing advance interest at five percent per annum. The taxpayer did not report interest on the note until it was received at the date of maturity by payment in full.

Since the buyer of these notes from the taxpayer will only be required to report interest income accruing from the date of his purchase, any interest income earned prior to the date of sale will escape taxation to the extent that it is not reported as income by the seller. However, interest income earned before the date of sale would have been taxed had the taxpayer employed the accrual method of accounting.

Under the method of accounting used by the taxpayer, interest income resulted to the taxpayer upon the sale of the notes to the extent of the interest accrued at the date of sale. See section 1.61-7(d) of the Income Tax Regulations. The fact that the taxpayer is in liquidation at the time of the sale is immaterial since, here, an actual cash sale took place.

Section 337 of the Code provides, in effect, that no gain or loss will be recognized to a corporation from its sale or exchange of property within a 12-month period after it adopts a plan of complete liquidation. However, section 337(b)(1) of the Code excludes from the term `property' stock in trade of the corporation which would properly be included in its inventory, property held primarily for sale to customers in the ordinary course of its trade or business, and installment obligations, except if substantially all of its inventory is sold or exchanged to one person in one transaction. The term `property' includes property so sold or exchanged or installment obligations acquired in respect of such sale or exchange. Essentially, section 337 applies to all assets except those specifically excluded in section 337(b)(1) of the Code. To the same effect, section 1.337-3(a) of the regulations states, in part, that: `With the exceptions listed above, the term `property' includes all assets owned by a corporation.'

Thus, section 337 of the Code is intended to exclude gain resulting from the unrealized appreciation of business property. However, the notes in question were not sold for more than their cost because of any appreciation in their value. On the contrary, the notes were sold for their original cost plus interest. Thus, in part, the sale of the above items is in reality the assignment of the claim for interest. In the case of an accrual method taxpayer, no problem arises since the accrued interest would have been included in income as it accrued. However, in the case of a cash method taxpayer, the interest is included in income when it is converted into cash or paid by the assignee of the claim, in other words, when the note is sold.

In view of the foregoing, it is held that ordinary income is recognized to the selling corporation within the meaning of section 61 of the Code upon its sale of discounted notes to the extent of the interest income earned but not collected pursuant to its sale of such items during complete liquidation under the provisions of section 337 of the Code.