Opinion
Docket No. 9030.
1948-05-27
THE CLEVELAND GRAPHITE BRONZE COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
William B. Cockley, Esq., for the petitioner. Howard M. Kohn, Esq., for the respondent.
1. Taxpayer entered into an agreement with two underwriters covering the purchase by them of its 30,000 shares of newly authorized preferred stock at $100 per share, the underwriters to be paid $3,50 per share for their services. Although a public offering of such shares at $100 per share was made, the amount of $2,895,000, and not $3,000,000, is the amount of ‘daily capital additions,‘ as defined in section 713(g)(3), I.R.C., for the purpose of computing the excess profits credit based on income, there being no evidence that the stock was actually sold to the public and certificates therefor issued direct to the purchasers thereof.
2. The amounts of $67,145 and $36,138 paid by petitioner in 1942 for 680 and 364 shares of its preferred stock represent the ‘daily capital reduction‘ as defined in section 713(g)(4), I.R.C., on the respective dates of retirement thereof for the purpose of computing the excess profits credit based on income.
3. The agreement executed by petitioner in 1938 with respect to certain British letters patent did not constitute an assignment of such patents, but merely a license, and the aggregate amount of royalties received by petitioner in 1941 and 1942 was ordinary income and not long term capital gain excludible from excess profits net income under section 711(a)(1)(B), I.R.C.
4. The petitioner is not entitled in 1941 and 1942 to the credit under section 131(a)(1), I.R.C., of the amounts of royalties retained by its British licensee as British taxes, as ‘taxes paid or accrued during the taxable year to any foreign country.‘ William B. Cockley, Esq., for the petitioner. Howard M. Kohn, Esq., for the respondent.
The Commissioner determined deficiencies in excess profits taxes of $4,170.08 for 1941 and $7,560 for 1942. In his amended answer the Commissioner claimed additional deficiencies of $674,68 for 1941 and $2,410.39 for 1942. Petitioner claims overpayment of excess profits taxes of $24,641.91 in 1941 and $60,681.96 in 1942.
The questions to be determined are: (1) Whether, for the purpose of computing petitioner's excess profits credit based on income, the daily capital addition resulting from the sale of 30,000 shares of preferred stock in 1941 is $3,000,000, the amount received by petitioner from its underwriters, or that amount less commission of $105,000 paid to the underwriters as compensation for services rendered in such sale; (2) whether, for the same purpose, the daily capital reduction resulting from the retirement of 680 and 364 shares of such stock on June 25 and August 22, 1942, is the par value thereof of $100 a share, or the amounts of $67,145 and $36,138 paid therefor by petitioner; (3) whether the royalties received by petitioner in 1941 and 1942 are ordinary income, or long term capital gains and, as such, excludible in determining excess profits net income; and (4), in the alternative, whether petitioner is entitled to a credit against tax under section 131(a)(1), Internal Revenue Code, of the amounts of royalties retained as British taxes by the Vandervell Products Ltd., of England.
FINDINGS OF FACT.
Most of the facts were stipulated in form substantially as follows:
The petitioner is a corporation, organized and existing under the laws of Ohio, with its principal office in Cleveland, Ohio. Its books and accounts for the calendar years 1941 and 1942 were kept, and its tax returns for such years filed, on an accrual basis.
The petitioner filed its excess profits tax return for the calendar year 1941 with the collector of internal revenue for the eighteenth district of Ohio on March 13, 1942. On January 9, 1945, petitioner signed an agreement (Treasury Department Form 872) extending the period of limitation for assessment of income and excess profits taxes for the year 1941 to June 30, 1946. This agreement was signed on behalf of the respondent on January 12, 1945. Petitioner filed with the collector of internal revenue, on October 2, 1946, a claim for refund of excess profits tax for the year 1941, on the ground that amounts received from Vandervell Products Ltd., London, England, were improperly included in computing excess profits net income for such year.
The petitioner filed its excess profits tax return for 1942 with the collector of internal revenue for the eighteenth district of Ohio on May 14, 1943. It filed with the collector of internal revenue, on October 2, 1946, a claim for refund of excess profits tax for the year 1942 on the ground that amounts received from Vandervell Products Ltd., London, England, were improperly included in computing excess profits net income for such year.
The petitioner entered into an underwriting agreement with two underwriters, F. Eberstadt & Co. and Prescott, Jones & Co., dated February 4, 1941, as modified by agreement of February 25, 1941, covering the purchase of shares of a newly authorized issue of preferred stock by such underwriters from the petitioner. The pertinent provisions of this underwriting agreement are as follows:
4. The Company will:
(a) Pay to F. Eberstadt & Co. Incorporated, for the account of the Underwriters, a commission for your services hereunder of $3,50 per share for each share of Preferred Stock which the Underwriters purchase from the Company pursuant to the terms hereof. Such payment shall be made in New York or Cleveland funds.
(b) Grant to the Underwriters the right and privilege of purchasing, jointly and severally, at the price of $100 per share, plus accrued dividends to the time of delivery, all or any part of 5,000 shares of the Preferred Stock, being in addition to the 25,000 shares hereinafter mentioned; provided, however, that such right and privilege may be exercised only by written notice or notices delivered by the Underwriters to the Company on or prior to the seventh day after the effective date of the Registration Statement. Each such notice shall state the number of shares to be purchased thereunder and the desired date and place of delivery of such shares, which place and date shall be later than the fifteenth day after the effective date of the Registration Statement. If by the time of closing provided in Section 5(a) hereinafter the Underwriters shall not have purchased and paid for the 25,000 shares of Preferred Stock as provided in such Section, the Company shall be under no obligation to sell or deliver any shares pursuant to this provision.
5. The Underwriters hereby, jointly and severally, agree with the Company as follows:
(a) To purchase from the Company at $100 per share plus dividends, if any, accrued to the time of closing, 25,000 shares of the Preferred Stock referred to above, and to pay for such shares, and for such of the additional 5,000 shares which the Underwriters elect to purchase from the Company under the right hereinabove granted, in New York or Cleveland funds, as the Underwriters may elect. Payment for the 25,000 shares shall be made at such time and place (hereinafter respectively referred to as the time of closing and place of closing) as the Underwriters may select, which time shall be not later than the tenth day after the effective date of the Registration Statement. Such payment shall be made against delivery to the Underwriters or upon their order of certificates for such shares in such names and denominations as the Underwriters may request, provided that the Underwriters shall give the Company not less than forty-eight hours written or telegraphic notice of said time and place of closing provided in this paragraph. The time of closing provided in this paragraph may be extended from time to time by agreement between the Company and the Underwriters.
(c) That the Underwriters will initially offer the Preferred Stock to the public at not in excess of $100 per share.
In connection with the purchase of such shares, the steps as set forth in paragraphs (a) to (e), inclusive, were taken concurrently on March 4, 1941.
(a) F. Eberstadt & Co. delivered to petitioner a letter dated March 4, 1941, reading as follows:
Pursuant to the Underwriting Agreement dated February 4, 1941, between you and the Underwriters named therein, modified by agreement dated February 25, 1941, there is handed to you herewith, on behalf of ourselves and Prescott, Jones & Co., a certified check, constituting New York funds, payable to your order, in the sum of $1,551,500 in payment, at $100 per share, for 15,515 shares of your 5% Cumulative Preferred Stock.
Pursuant to the Underwriting Agreement, as modified, kindly deliver to the undersigned, against our receipt duly issued certificates for said 15,515 shares of Preferred Stock. Please also deliver to Prescott, Jones & Co., against its receipt and payment, duly issued certificates for 14,485 shares of your 5% Cumulative Preferred Stock.
The certified check for $1,551,500, duly endorsed, was delivered by petitioner to the Bank of New York for deposit in its account with that bank.
(b) The petitioner delivered to F. Eberstadt & Co. its certified check constituting Cleveland funds in the amount of $105,000, with a letter, dated March 4, 1941, as follows:
In accordance with the Underwriting Agreement between the undersigned on the one hand and you and Prescott, Jones & Co. on the other, dated February 4, 1941, and modified on February 25, 1941, the undersigned herewith delivers to you its certified check in the sum of $105,000, constituting Cleveland funds, and being an amount equal to $3.50 for each share of 5% Cumulative Preferred Stock of the undersigned which you and Prescott, Jones & Co. have purchased from the undersigned. This payment is for the account of you and Prescott, Jones & Co. for services pursuant to the Underwriting Agreement. Will you kindly acknowledge receipt.
(c) Certificates for 15,515 shares of preferred stock were delivered by petitioner with a letter dated March 4, 1941, acknowledging receipt of the check for $1,551,500 of F. Eberstadt & Co.
(d) Prescott, Jones & Co. delivered to petitioner a letter, dated March 4, 1941, in form similar to the above quoted letter of F. Eberstadt & Co., transmitting a certified check constituting Cleveland funds in the amount of $1,448,500. Petitioner delivered such check duly endorsed to the Cleveland Trust Co., Cleveland, Ohio, for deposit in its account with that trust company.
(e) Certificates for 14,485 shares of preferred stock were delivered by petitioner to Prescott, Jones & Co. with a letter dated March 4, 1941, acknowledging receipt of the check for $1,448,500 of Prescott, Jones & Co.
The 30,000 shares of petitioner's preferred stock were publicly offered on February 26, 1941, at $100 per share.
A registration statement with respect to such shares of preferred stock was filed by petitioner with the Securities and Exchange Commission and became effective on February 26, 1941. The following table was included in such registration statement as item 24, in accordance with instructions governing the preparation of such statement as indicated:
24. Give the information required by the following table (estimate, if necessary.)
+-------------------------------------------+ ¦ ¦Price to ¦Underwriting¦Proceeds to¦ +--------+---------+------------+-----------¦ ¦ ¦Public ¦Discounts or¦Registrant ¦ +--------+---------+------------+-----------¦ ¦ ¦ ¦Commissions ¦ ¦ +--------+---------+------------+-----------¦ ¦Total ¦$3,000,00¦$105,000 ¦$2,895,000 ¦ +--------+---------+------------+-----------¦ ¦Per Unit¦100 ¦3.50 ¦96.50 ¦ +-------------------------------------------+
In its excess profits tax returns for the calendar years 1941 and 1942, the petitioner, in determining the net capital additions for such years in the computation of its excess profits credit based on income, treated the sum of the amounts of $1,551,500 and $1,488,500 as the daily capital addition effective March 4, 1941.
On June 25, 1942, petitioner retired 680 shares of its preferred stock which it had purchased from the holders thereof for an aggregate amount of $67,145, and on August 22, 1942, it retired an additional 364 shares of the same stock which it had purchased from the holders thereof for an aggregate amount of $36,138. In its excess profits tax return for the year 1942 petitioner computed the net capital addition for such year in determining its excess profits credit based on income by treating the amount of $68,000 as the daily capital reduction resulting from retirement of such preferred stock effective June 25, 1942, and by treating $36,400 as the daily capital reduction resulting from retirement of such additional preferred stock effective September 25, 1942. The effective date of this last capital reduction was erroneously given in petitioner's return as September 25, 1942, when the stock was actually delivered for retirement on August 22, 1942. This was corrected in the revenue agent's report of July 26, 1944.
In determining the net capital addition for the years 1941 and 1942, the Commissioner in the notice of deficiency herein treated only the net amount of $2,895,000 (after deduction of $105,000 as the ‘amount paid underwriters for selling the stock‘) as the daily capital addition resulting from the sale of the aforementioned preferred stock on March 4, 1941. The Commissioner has treated as the daily capital reductions resulting from retirement of petitioner's preferred stock, effective June 25, 1942, and August 22, 1942, the amounts of $68,000 and $36,400, respectively.
In 1932 the petitioner owned certain British patents and patent applications on inventions which were also covered by United States letters patent owned by petitioner.
Prior to November 1932, O. & S. Bearing Co., Ltd., a British corporation, entered into negotiations at Cleveland, Ohio, with petitioner. As a result of such negotiations, on November 28, 1932, the petitioner delivered a letter to the American representative of O. & S. Bearing Co., Ltd., reading in part, as follows:
Confirming the outcome of our various conferences with you on the subject of an arrangement between your Company and ours, under which your Company would be licensed to manufacture and sell, in England, various products covered by our English patents and by our patent applications, both pending and proposed:
During the course of our conferences, it became evident that neither you nor we are at this time in possession of all of the facts necessary to the working out of a long-time contract on a basis which would be certain to be fair to both parties as time goes on.
If we were considering bronze bushings, alone, our problem would be materially simplified. However, you are desirous of including our various bimetal products which include main bearings, camshaft bearings, connecting rod liners, bushings, etc.
While both you and we feel that there is a large potential market in England for these various bimetal products, in view of their wide adoption in this country, and while we both feel that the business in England should prove highly profitable, neither of us is in a position at this time to forecast what the volume and profits may be.
On our side, we are of course anxious to make the best possible connection for the manufacture of our products in England; a connection that can do the best possible job of manufacturing, of selling and of rendering satisfactory service to every customer; a connection that has, or can readily secure, the finances necessary to take on new business as rapidly as new business is available; and, most important of all, a connection that will at all times deal fairly and honestly with us and with everybody else.
As our share of the profits growing out of our contribution to the business, we desire only what is fair to both parties. We have discussed royalties, a share of the profits above cost, or a stockholding interest. At this time, neither of us has sufficient data upon which to determine which of these plans would prove best for both of us.
On your side, you have urged that a connection with your Company would be the best connection for us and that you can meet all of the qualifications we desire, as hereinbefore set forth, you have conceded the difficulties which now confront us in attempting to work out a long-time contract, and have suggested that we work out a temporary plan which would give you an opportunity to prove to us that your Company is the logical connection for us in England and which would also give us both an opportunity to learn more as to the potential volume of business and the potential profits. As you have put it, you are willing to ‘take a sporting chance‘ to prove your contentions, provided we will agree that if the temporary arrangement is not continued we will take off your hands the special broaching and shaving machines at their cost to you less proper depreciation.
In view of the fact that Vauxhall is now asking for quotations on thin-wall main bearings and connecting rod liners for a motor which is to go into production at an early date, and in view of the further fact that this offers immediate business in England for these new products, this opportunity should not be lost.
We are therefore agreeable to your suggestion that a temporary arrangement be worked out with you along the lines we have discussed with you, to-wit:
I— This arrangement shall continue for the period beginning on December 1st, 1932 and ending on October 31st, 1933;
II— During that period you shall pay us a royalty of:
(a) Five per cent (5%) of the Net Selling Price of all Plain Bronze Bushings covered by our English patents. A list of these patents will be furnished to you;
(b)— Ten per cent (10%) of the Net Selling Price of all bimetal products,—main bearings, camshaft bearings, connecting rod liners, bushings, etc.
(c)— Ten per cent (10%) of the Net Selling Price of all Graphited Bronze Bushings;
(d)— Such royalty as may hereafter mutually be agreed upon as to our rubber bushings; All royalties shall be payable quarterly and shall be deposited to our credit in such Bank as we shall nominate. The usual procedure as to keeping accurate records and rendering certified statements as to the sales each month shall be followed.
III— We agree to supply you with all technical information, drawings, specifications and other date to enable you to manufacture; also such data as you may require to solicit and quote on new business;
IV— We agree to supply you with samples for new installations at agreed prices;
V— We agree to supply you with duplicates of any of our plant tools, dies, fixtures or equipment, at agreed prices;
VI— We agree to supply you with completed bushings or bearings, or with any component part thereof, at agreed prices;
VII— It is understood, of course, that we are under no obligation to extend this temporary agreement beyond the date of its expiration (October 31st, 1933) but, in the event no new arrangement is worked out with you, we agree to take off your hands all special shaving and broaching equipment you may have purchased from us, at the purchase price thereof less proper depreciation. Naturally, we are hopeful that our connection with you will continue beyond the period of this agreement. If we did not feel that you could do a good job for us, it would be a grave mistake on our part to enter into a temporary agreement with you. If you should do a poor job on our new products the products themselves would become discredited and it would be most difficult to regain favor for them. In addition, if we thought it would become necessary to make a new connection within a year, we would prefer to do nothing with you at this time, since any change of connection would necessarily be most annoying and costly. I can assure you that if you will work closely with us and work efficiently we shall make every effort we consistently can to work out with you an extension of this agreement on a basis that will be fair to both of us.
The proposal contained in the above letter was duly accepted on behalf of O. & S. Bearing Co., Ltd., on January 12, 1933. Subsequently O. & S. Bearing Co., Ltd., changed its name to ‘Vandervell Products Limited.‘
On or about July 28, 1938, an instrument dated July 28, 1938, was executed by petitioner, as ‘Licensors‘ and Vandervell Products Ltd. as ‘Licensees‘ and certain named trustees. On its cover page the instrument is designated as ‘Exclusive Licence‘ and in its opening statement of execution and parties it is designated as ‘Deed of Licence.‘ It is, in part, as follows:
* * * WHEREAS the Licensors are the beneficial owners of the Letters Patent short particulars whereof are set out in the first and second parts of the schedule hereunto annexed and are the registered proprietors of the Letters Patent short particulars whereof are set out in the first part of the said schedule AND WHEREAS one or other of the Trustees as appears from the said schedule is the registered proprietor of each of the Letters Patent short particulars whereof are set out in the second part of the said schedule but the Trustees as they do hereby acknowledge hold their interest in the said Letters Patent upon trust for the Licensors AND WHEREAS the Licensors have agreed with the Licensees for the grant to the Licensees of a sole and exclusive licence under each and everyone of the said Letters Patent upon the terms and conditions set out in a letter dated the Twentyeighth day of November One thousand nine hundred and thirty two addressed to the Managing Director of the Licensees and signed by the President of the Licensors AND WHEREAS the Licensors have requested and directed the Trustees to joint in this Deed of Licence NOW THIS DEED WITNESSETH that in pursuance of the said agreement the Licensors as beneficial owners and the Trustees at the request and by the direction of the Licensors DO HEREBY grant unto the Licensees the sole and exclusive licence under the said Letters Patent and each of them To HOLD the same unto the Licensees for their own benefit for the remainder of the term for which the said Letters Patent were respectively granted and any extension or renewal thereof upon and subject to the terms and conditions set out in the said letter dated the Twentyeighth day of November One thousand nine hundred and thirty two IN WITNESS WHEREOF the Licensors have caused this Deed to be executed under their Corporate Seal by their thereunto duly authorized officers the Trustees have hereunto set their respective hands and seals and the Licensees have caused their Common Seal to be hereunto affixed this day and year first before written.
+--------------------------------+ ¦THE SCHEDULE ABOVE REFERRED TO ¦ +--------------------------------¦ ¦FIRST PART ¦ +--------------------------------¦ ¦ ¦ ¦ ¦ +--------------------------------+
Number Date Grantee 320943 27th July 1928 William Klocke 336333 30th July 1929 William Henry Klocke 340776 28th December 1929 William Henry Klocke 371479 28th January 1931 James Lawrence Myers 409239 7th January 1932 the Licensors 474981 20th February 1936 the Licensors
SECOND PART
Number Date Registered Proprietor 426770 13th October 1934 Conrad Arnold 437199 23rd April 1934 Conrad Arnold 438789 23rd April 1934 Conrad Arnold 440258 23rd April 1934 Conrad Arnold 441467 23rd April 1934 Conrad Arnold 457151 21st January 1936 Alfred Augustus Thornton [Signatures omitted]
The British patents listed in the above instrument were all beneficially owned by petitioner and covered inventions which were likewise covered by United States letters patent owned by petitioner. Such British patents had been granted for definite terms from the dates of filing of the applications therefor. All the rights of petitioner in the inventions covered by such patents had been held by it for more than 18 months prior to July 28, 1938.
During the period from July 28, 1938, to and including the taxable years here involved, petitioner acquired other British patents covering inventions which were likewise covered by United States letters patent owned by it. During that period, petitioner paid the annual fees required under British patent law to maintain patents in effect for their terms, both with respect to the patents listed in the instrument dated July 28, 1938, and with respect to the British patents acquired after July 28, 1938.
For the years 1941 and 1942 the petitioner received net amounts quarterly from Vandervell Products Ltd., calculations of which were set forth in letters from Vandervell Products Ltd. to petitioner. Such calculations in dollars, the net amounts received by petitioner, and the dates when and periods for which received, are as follows:
+-----------------------------------------------------------+ ¦Quarter ended—¦Percentage¦British tax¦Net amounts¦Date ¦ +--------------+----------+-----------+-----------+---------¦ ¦ ¦of sales ¦ ¦due and ¦received ¦ +--------------+----------+-----------+-----------+---------¦ ¦ ¦ ¦ ¦received ¦ ¦ +--------------+----------+-----------+-----------+---------¦ ¦3-31-41 ¦$14,833.68¦$6,304.31 ¦8,529.37 ¦May 1941 ¦ +--------------+----------+-----------+-----------+---------¦ ¦6-30-41 ¦22,425.16 ¦11,212.58 ¦11,212.58 ¦Aug. 1941¦ +--------------+----------+-----------+-----------+---------¦ ¦9-30-41 ¦33,904.72 ¦11,452.36 ¦11,452.36 ¦Nov. 1941¦ +--------------+----------+-----------+-----------+---------¦ ¦12-31-41 ¦22,377.20 ¦11,188.60 ¦11,188.60 ¦Feb. 1942¦ +--------------+----------+-----------+-----------+---------¦ ¦Total, 1941 ¦82,540.76 ¦40,157.85 ¦42,382.91 ¦ ¦ +--------------+----------+-----------+-----------+---------¦ ¦3-31-42 ¦34,639.34 ¦17,319.67 ¦17,319.67 ¦May 1942 ¦ +--------------+----------+-----------+-----------+---------¦ ¦6-30-42 ¦36,830.60 ¦18,415.30 ¦18,415.30 ¦Aug. 1942¦ +--------------+----------+-----------+-----------+---------¦ ¦9-30-42 ¦37,565.26 ¦18,782.63 ¦18,782.63 ¦Nov. 1942¦ +--------------+----------+-----------+-----------+---------¦ ¦12-31-42 ¦46,597.04 ¦23,298.52 ¦23,298.52 ¦May 1943 ¦ +--------------+----------+-----------+-----------+---------¦ ¦Total, 1942 ¦155,632.24¦77,816.12 ¦77,816.12 ¦ ¦ +-----------------------------------------------------------+
The amounts shown in the above schedule as ‘British tax‘ were deducted and retained by Vandervell Products Ltd. under the provisions of the British income tax law authorizing such deduction and retention.
In the petitioner's income and excess profits tax returns for the calendar years 1941 and 1942 there was included in petitioner's gross income and its excess profits net income for such years a portion of the net amounts received by the petitioners from Vandervell Products Ltd., viz., $42,194.31 and $73,206.20 for 1941 and 1942, respectively. This disparity between these amounts and the net amounts actually received by petitioner from Vandervell Products Ltd. in such years resulted from the difference between the final quarter payments and the estimated amounts accrued therefor.
The record discloses additional facts, as follows:
The balance sheets in schedule L in petitioner's income and declared value excess profits tax return for 1941 show that petitioner's capital stock as of the beginning and the end of the year was as follows:
+---------------------------------------------------------+ ¦ ¦Beginning¦ ¦ +-----------------------------------+---------+-----------¦ ¦Capital stock ¦of 1941 ¦End of 1941¦ +-----------------------------------+---------+-----------¦ ¦(a) 5 per cent cumulative preferred¦$0.00 ¦$3,000.00 ¦ +-----------------------------------+---------+-----------¦ ¦(b) Common stock ¦321,920 ¦321,920 ¦ +---------------------------------------------------------+
Schedule M, ‘Reconcilement of Net Income and Analysis of Earned Surplus and Undivided Profits,‘ of the same return shows a charge to earned surplus of the amount of $127,627.39 designated as ‘Expenses in connection with sale of 5% cumulative preferred shares.‘
The balance sheets in schedule L in petitioner's income and declared value excess profits tax return for 1942 show that its 5 per cent cumulative preferred stock of $3,000,000 at the beginning of the year 1942 was reduced at the end of the year to $2,895,600, a reduction of $104,400.
Ever since its incorporation in 1919, the petitioner has been engaged in the manufacture and sale of bushings and bearings, principally for the automotive trade. From the beginning the business was conducted in the United States.
After its organization in 1919, the petitioner from time to time obtained United States letters patent on processes and products used in its business. Such patents were secured principally for the protection of both petitioner's own United States manufacturing business and the business of its customers. In accordance with customary automotive industry practice, licenses covering its principal and other competitors in order to furnish additional sources of supply to petitioner's customers. A general license covering all petitioner's products was granted to Ford Motor Co. for a nominal sum and also to General Motors Corporation in consideration for a portion of its business for one year. Another license was issued to a refining company for $1,000 for the use of tellurium in refining babbitt metal. This license was continued from year to year. In addition, the petitioner had general cross license agreements with other bearing manufacturers during the war.
About 1920 petitioner first commenced taking out British letters patent on its major inventions covered by its United States patents, principally for the protection of its customers who exported their products to Great Britain. If petitioner had not taken out these patents, someone else could readily have done so and barred petitioner's United States customers from reselling their products in the British export market. From 1920 until 1932, petitioner made no efforts to manufacture or sell its products in England, to sell the British patents, or to grant licenses to others under the British patents. During this period the only development with reference to these patents was the unsuccessful attempt of one English distributor to secure petitioner's American manufactured products for resale in England.
In 1932 petitioner's consulting engineer visited England and there met G. A. Vandervell, managing director of O. & S. Bearing Co., Ltd., a British corporation. It was found that the O. & S. Bearing Co., Ltd., was manufacturing bearings covered by petitioner's British patents. Upon discovering this fact, G. A. Vandervell promptly came to the United States and entered into negotiations with petitioner in Cleveland with a view to obtaining a license under petitioner's British patents. As a result of these negotiations, petitioner and the O. & S. Bearing Co., Ltd., entered into the letter agreement dated November 28, 1932, heretofore referred to.
The letter agreement of November 28, 1932, was initially merely a temporary arrangement and was made in that form because the British company was relatively inexperienced in the manufacture of bearings and petitioner had little basis for assessing its prospects for success. The agreement, however, was not canceled after its expiration date, but was continued in effect until 1938 by mutual agreement of the parties, without any formal renewal. During the period from 1932 to 1938 the British company, the name of which was changed in this period to ‘Vandervell Products Limited,‘ continued to manufacture and sell in England products covered by petitioner's British patents.
By 1938 the business of Vandervell Products Ltd. had grown steadily and rapidly and more capital was required for its further development. In addition, it was discovered that an ‘infringer‘ had begun to manufacture bearings. For these reasons, Vandervell Products Ltd. asked for a change of the informal license arrangement to a more definite form. After many conversations and attempts by petitioner to prepare a suitable license, Vandervell Products Ltd. submitted a form of agreement prepared by its own patent counsel. After some discussion, such agreement was accepted by petitioner. The agreement accepted is the one dated July 28, 1938, hereinafter referred to.
The letters patent taken out after the execution of the 1938 agreement covered improvements, mostly of a minor nature, of the inventions on which petitioner had obtained patents prior to 1938. As and when any new British patents were obtained after the execution of the letter agreement of 1932, the petitioner made such patents available to Vandervell Products Ltd. without requiring any new written agreement. After the execution on the 1938 agreement the petitioner continued its practice of making available in a similar manner to Vandervell Products Ltd. any British patents acquired by it. These also covered improvements of products or process related to previous patents.
OPINION.
VAN FOSSAN, Judge:
The first question presented is the amount of ‘daily capital addition‘ to be used in the computation of excess profits credit pursuant to section 713.
In computing its excess profits credit under that section, a taxpayer is entitled to include an amount equal to (A) 95 per centum of its average base period net income, plus (B) an additional amount equal to 8 per centum of the ‘net capital addition‘ as defined in subsection (g), or minus (C) 6 per centum of the ‘net capital reduction‘ as defined in subsection (g). The ‘daily capital addition‘ which enters into the computation of ‘net capital addition‘ is defined in subsection (g)(3) as ‘the aggregate of the amounts of money * * * paid in for stock, or as paid-in surplus, or as a contribution to capital, after the beginning of the taxpayer's first taxable year under this subchapter * * * .‘
In 1941 the petitioner sold 30,000 shares of its preferred stock. The question to be determined as to this transaction is whether ‘daily capital addition‘ is $3,000,000, the agreed purchase price received by petitioner for the 30,000 shares, or $2,895,000, the net amount after payment by petitioner of $105,000 to the underwriters as commission for service. More directly stated, the question is whether $3,000,000 or $2,895,000 is, under the statute, the amount ‘of money * * * paid in for stock.‘ The petitioner contends that the daily capital addition under the statute is the amount of $3,000,000, whereas the respondent contends it is the amount of $2,895,000. The petitioner relies upon Simmons Co., 8 B.T.A. 631; affd. (C.C.A., 1st Cir.), 33 Fed. (2d) 75; certiorari denied, 280 U.S. 588; Magee Furnace Co., 11 B.T.A. 1216, and Finance Corporation of New England, 16 B.T.A. 763. The respondent relies primarily upon Corning Glass Works, 9 B.T.A. 771; affirmed and reversed in part (App. D.C.), 37 Fed.(2d) 798; certiorari denied, 281 U.S. 742.
It is argued by petitioner that, pursuant to normal financial practice, a public offering of the 30,000 shares at $100 a share was accomplished through the mechanics of a sale to the underwriters on March 4, 1941, after the public offering had been made, with all or a substantial portion of the funds paid by the underwriters to petitioner having been supplied by the public investors in the stock, and that while in legal form at the moment of the consummation of the sale the underwriters were the legal purchasers of the stock, they had already sold the stock to the public and were in fact merely conduits through which the ownership of the stock passed from petitioner to the ultimate purchasers.
Invested capital under section 718(a)(1) of the Internal Revenue Code consists in part of ‘(1) Money previously paid in for stock, or as paid-in surplus, or as a contribution to capital.‘ Factor (1) entering into the computation of the excess profits credit based on invested capital is essentially comparable to the factor ‘daily capital addition‘ entering into the computation of the excess profits credit based on income. The statutory definition of each factor is the same, i.e., money paid in for stock, or as paid-in surplus, or as a contribution to capital.
The question presented in American Business Credit Corporation, 9 T.C. 1111, was whether the amount paid in by stockholders for taxpayer's stock or the net amount of cash made available to the taxpayer (its broker agent having retained certain commissions for making the sale of such stock) was ‘money * * * paid in for stock‘ under section 718(a)(1). Therein it is stated:
We think it clear that the question before us is to be approached and answered from the viewpoint of the stockholder, i.e., ‘money previously paid in for stock.‘ So approached, the conclusion is obvious that the full amount which the stockholder paid for his stock is to be included in equity invested capital, as contemplated by the statute. The stockholder paid one sum, viz., the purchase price of the stock.
Comparable reasoning is apt in the instant case.
It is to be noted, however, that in American Business Credit Corporation, supra, it was expressly found that the broker did not purchase the shares involved, but in each case found purchasers for the stock and caused the taxpayer to issue shares of stock against payment of the purchase price therefor by the purchasers thereof. Similar findings were made in Simmons Co., supra; Magee Furnace Co., supra, and Finance Corporation of New England, supra, i.e., that the amounts involved had been paid in by the persons to whom the stock was issued.
The facts as disclosed by the record herein are that petitioner entered into an underwriting agreement with two underwriters in February 1941, covering the purchase by them of 30,000 shares of a newly authorized issue of preferred stock from the petitioner at $100 per share, petitioner to pay the underwriters a commission for their services of $3,50 per share, or a total of $105,000. The agreement required that the underwriters initially offer the stock to the public at not in excess of $100 per share. The shares were publicly offered on February 26, 1941, at $100 a share. On March 4, 1941, the underwriters paid petitioner $3,000,000 and the petitioner paid the underwriters $105,0-0, and at the same time delivered to one underwriter certificates for 15,515 shares and to the other certificates for 14,485 shares, or a total of 30,000 shares.
Although it appears that the stock was offered to the public at $100 a share, there is no evidence that the 30,000 shares or any of them were actually sold to the public. In so far as the record shows, the 30,000 shares were purchased by the underwriters and the certificates therefor were delivered to them. The record is silent as to whom such certificates were issued. There is no evidence to sustain petitioner's argument that the funds paid to it by the underwriters had been supplied by public investors in the stock. The petitioner has failed to bring the transaction within the ambit of the cases relied upon by it.
It is stated in Simmons Co., supra, that ‘under no circumstances can invested capital be increased by the amount of commission which a corporation pays for the sale of its stock to those who thereby become stockholders.‘
It is our conclusion, therefore, that the amount of ‘daily capital addition‘ as defined in section 713(g)(3) is $2,895,000, and that the Commissioner did not err in reducing the amount of $3,000,000 received by petitioner from the underwriters by the commission of $105,000 paid by petitioner to the underwriters for services rendered.
The petitioner purchased from the holders thereof 680 shares and 364 shares of its preferred stock which it retired on June 25, 1942, and August 22, 1942, respectively. It paid for such stock the aggregate amounts of $67,145 and $36,138, respectively. Both the petitioner and respondent used the par value of such shares of $68,000 and $36,400 as the daily capital reductions in computing net capital addition for the purpose of determining the excess profits credit.
Section 713(g)(4) provides that:
The daily capital reduction for any day of the taxable year shall be the aggregate of the amounts of distributions to shareholders, not out of earnings and profits, after the beginning of the taxpayer's first taxable year under this subchapter * * *
The respondent on brief concedes that only the amounts actually paid by the petitioner should be treated as the daily capital reductions resulting from the retirements of its preferred stock. This, in our opinion, is in accord with the statute. See Simmons Co., supra.
The next question to be considered is whether the aggregate amounts of quarterly payments of $42,382.91 and $77,816.12 received by petitioner in 1941 and 1942 from Vandervell Products Ltd. are ordinary income or long term capital gains, excludible from excess profits net income under section 711(a)(1)(B) of the Internal Revenue Code.
It is contended by petitioner that the amounts received by it were installments of the agreed sale price of its British patents and therefore representing long term capital gains, to be excluded in determining excess profits net income. The respondent contends that the 1938 agreement did not constitute a sale of petitioner's British patents.
Whether a transfer of an interest or right under a patent is an assignment or only a license does not depend upon the name by which the agreement is called, ‘but upon the legal effect of its provisions.‘ Waterman v. Mackenzie, 138 U.S. 252. No particular form is required for an assignment, ‘but the instrument of transfer must be unambiguous and show a clear and unmistakable intent to part with the patent.‘ Kenyon v. Automobile Instrument Co., 160 Fed.(2d) 878, 882. A transfer, to constitute an assignment, must be a grant of either (1) the whole patent, comprising the exclusive right to make, use, and vend an invention throughout the United States, or (2) an undivided part or share of that exclusive right, or (3) the exclusive right under the patent within and throughout a specified part of the United States. Waterman v. Mackenzie, supra; United States v. General Electric Co., 272 U.S. 476, 489; Kenyon v. Automobile Instrument Co., supra, and Federal Laboratories, Inc., 8 T.C. 1150. As stated in the leading case of Waterman v. Mackenzie, supra:
* * * Any assignment or transfer, short of one of these is a mere license, giving the license no title in the patent, and no right to sue at law in his own name for an infringement. * * * In equity, as at law, when the transfer amounts to a license only, the title remains in the owner of the patent; and suit must be brought in his name, and never in the name of the licensee alone, unless that is necessary to prevent an absolute failure of justice, as where the patentee is the infringer, and cannot sue himself. Any rights of the licensee must be enforced through or in the name of the owner of the patent, and perhaps, if necessary to protect the rights of all parties, joining the licensee with him as a plaintiff. * * * the grant of an exclusive right under the patent within a certain district, which does not include the right to make, and the right to use, and the right to sell, is not a grant of a title in the whole patent right within the district, and is therefore only a license. * * * So is an instrument granting ‘the sole right and privilege of manufacturing and selling‘ patented articles, and not expressly authorizing their use, because, though this might carry by implication the right to use articles made under the patent by the licensee, it certainly would not authorize him to use such articles made by others.
An assignment gives the transferee the right to sue for infringement, while a license gives a transferee merely immunity from suit for infringement. ‘The first gives positive rights, the second negative rights.‘ Ridsdale Ellis, Patent Assignments and Licenses (2d Ed.), Sec. 57, p. 63.
Under the agreement dated July 28, 1938, petitioner granted to Vandervell Products Ltd., hereinafter referred to as Vandervell, ‘the sole and exclusive license‘ under the letters patent involved to be held by Vandervell for its own benefit for the remainder of the term for which such letters patent were respectively granted and any extension or renewal thereof ‘upon and subject to the terms and conditions‘ set out in the letter agreement of November 28, 1932. This requires reference to the letter agreement of 1932.
Such letter agreement is a confirmation of an arrangement, arrived at after various conferences between the parties, under which Vandervell ‘would be licensed to manufacture and sell, in England, various products ‘ covered by petitioner's English patents and patent applications, both pending and proposed. This arrangement was to be effective from December 1, 1932, to October 31, 1933, but was continued in effect until 1938 without any formal renewal. During that period Vandervell was required to pay quarterly to petitioner certain royalties on various products manufactured by Vandervell, as specified in the letter agreement.
The 1938 agreement granted an exclusive license without any enumeration of the rights to be exercised thereunder. Construing the 1938 agreement in conjunction with the 1932 letter agreement, as we must, and applying the principles heretofore set forth, the 1938 agreement was no more than an exclusive license to make and sell various products covered by petitioner's English patents. The transfer was not a grant of the whole of the English patents. One of the three rights comprising the whole thereof, i.e., the right to use, -as not expressly included in the grant. A grant of an exclusive right under a patent within a certain district which does not include the right to make, the right to use, and the right to sell, is only a license. Waterman v. Mackenzie, supra.
All but two of the 12 patents listed in the 1938 agreement were held by trustees. It is conceded by petitioner on brief that as to such patents ‘legal title remained in the trustees.‘ If the agreement did not effect a transfer of legal title as to the patents held by the trustees, it did not effect a transfer of legal title of the patents in the name of petitioner. It retained title to the patents and after the execution of the 1938 agreement it continued to pay the annual fees required under British patent law to maintain patents in effect, on all patents listed in the agreement and those acquired thereafter.
Edward C. Myers, 6 T.C. 258, cited by petitioner, is distinguishable. Therein the agreement granted an exclusive license, together with the right to grant sublicenses, to make, use, and sell through the United States, its territories and possessions. All three rights were expressly granted. The agreement in Parke, Davis & Co., 31 B.T.A. 427, also cited by petitioner, was a grant of an undivided part or share of the three exclusive rights, i.e., to make, to use, and to sell. In Commissioner v. Celanese Corporation of America, 140 Fed.(2d) 339, and Commissioner v. Hopkinson, 126 Fed.(2d) 406, both cited by petitioner, the owners of United States letters patent not only executed agreements containing language showing a clear and unmistakable intent to part with the whole of the patents, but also executed assignments of each of the patents which were recorded in the United States Patent Office.
Clearly, under the laws of the United States the 1938 agreement was but a license and not an assignment. Neither, as we shall see, was it an assignment of the patents under English law.
Petitioner's expert witness as to British patent law testified that, in his opinion, the 1938 agreement was irrevocable and an effective transfer of all the rights of petitioner under the patents involved and that petitioner's only remaining right thereunder was the collecting of royalties as provided in the letter agreement of 1932. His opinion was entirely based upon certain English cases which, however, in our judgment, do not support his opinion. Guyot v. Thomson, 11 R.P.C. 541, a leading British patent case which he cited as supporting his opinion, was an action brought by the exclusive licensee against the patentee and licensor. By written instrument the patentee had granted an ‘exclusive license to manufacture, use and vend the inventions ‘ during the unexpired terms of the patents, with the right to grant sublicenses. The agreement, among other things, provided that the patentee should not commence proceedings for infringement without the consent in writing of the licensee. Upon appeal, the question involved was whether the exclusive license granted by the instrument involved was revocable by the patentee. The patentee had attempted by written notice to revoke the license on account of alleged breaches of the licensee of certain conditions. He contended that the agreement was a mere license, not a grant. The court held that the license was not revocable because ‘on the face of the document, there is an implied covenant not to revoke.‘ The court pointed out that the agreement contained several clauses which were inconsistent with the right to revoke. Although the license granted was an exclusive license to make, use, and vend the inventions, with the right to sublicense, the court stated:
* * * They (licensees) are not assignees of the patent. We were asked to construe this— or it was suggested that we might construe this: as amounting to an assignment of the patent, but the clause that the right to sue for an infringement is in the patentee excludes that view. It is not, therefore, quite an assignment of the patent. There is not very much difference in it, but that clause prevents us from holding that it is an assignment of the patent.
Neither does the case of Heap v. Hartley, 6 R.P.C. 495, also cited by petitioner's expert witness, support his opinion. In that case the patentee of a machine granted an exclusive license to use and exercise his invention within a certain district for four years and the deed conferring the license was registered at the Patent Office. The licensee brought an action to restrain the use by a third party of certain machines purchased outside of his district but taken within his district and used there. The court held that, since the license was a simple license and not a grant, the licensee was not entitled to sue in his own name without the joinder of the patentee. It stated, in part, as follows:
* * * An exclusive license is only a license in one sense. That is to say, the true nature of the exclusive license is this. It is a leave to do a thing, and a contract not to allow anybody else to do a thing. But it confers no more than any other license any interest or property in the thing. A license may be, and often is, coupled with a grant, and that? grant then may convey an interest in property, but the license pure and simple, and by itself, never conveys an interest in property. It only enables a person to do lawfully what he could not otherwise do, except unlawfully.
Furthermore, petitioner's expert witness conceded that the 1938 agreement contained no provision granting to Vandervell the right to assign any of the patents to third parties, that the license granted was personal to, and exercisable only by, Vandervell, and that if Vandervell desired to bring suit for infringement it would have to join petitioner as either party plaintiff or defendant.
Thus, under British law, as under the laws of the United States, a transfer which gives to the licensee no title to the patents and no right to sue in his own name for infringement is but a license and not an assignment. The 1938 agreement, therefore, did not effect a sale of the patents. Accordingly, the respondent did not err in treating the royalties received in 1941 and 1942 as ordinary income.
It is contended by petitioner that, if the amounts received as royalty are determined to be ordinary income, then the total amounts of royalty under the agreement should be included in income and a credit against taxes of the amounts retained as British taxes by Vandervell should be allowed under section 131(a)(1) of the Internal Revenue Code. A similar question was considered by this court in Irving Air Chute Co., 1 T.C. 880; affd. (C.C.A., 2d Cir.), 143 Fed.(2d) 256. In that case a British company also retained a certain amount of royalties due under an agreement to the taxpayer. It was held that the British tax was levied upon, assessed against, and paid by the English company, was not the taxpayer's tax within the meaning of our statute, and, hence, the taxpayer was not entitled to the credit under section 131(a)(1).
Wisconsin Gas & Electric Co. v. United States, 322 U.S. 526, and International Harvester Co. v. Wisconsin Department of Taxation, 322 U.S. 435, involving the Wisconsin privilege dividend tax, cited by petitioner, are not applicable.
It was stipulated that the allowance by respondent in his amended answer of additional deductions of $4,227.26 for 1941 and $224,132.95 for 1942 for amortization of emergency facilities as a result of petitioner's election to terminate amortization under the provisions of section 124(d) of the Internal Revenue Code was proper and that the amounts so allowed may be accepted as correct and given effect in the computation under Rule 50.
It is conceded by petitioner that it is not entitled to the deduction from gross income for 1942 of the amount of $172.67 as a loss sustained upon the disposal of certain emergency facilities as claimed by it.
Decision will be entered under Rule 50.