Opinion
No. 32658
Decided December 5, 1951.
Taxation — Intangible — "Investments" construed — Percentage of employer's profits paid to employee for work — Whether percentage payments an "investment" or "commission" — Determined by nature of employment contract — Not "royalties" defined as "investments" — Section 5323, General Code.
1. Where a person under a contract of employment to use his technical knowledge and inventive skill in the solution of problems and the development for his employer of ideas submitted by the employer, or ideas which the employee may have relating to machinery and equipment, receives as part of his compensation for his work a percentage of the profits of his employer which are due to such person's efforts, such percentage payments are not royalties defined as investments in Section 5323, General Code, but they constitute commissions or other incorporeal rights derived from the employment contract.
2. Whether a pro rata remuneration to an employee, in the form of a percentage of profits derived from the work and efforts of such employee, constitutes an investment as defined by Section 5323, General Code, or commissions or other incorporeal rights derived from a contract of employment, is determinable by the nature of the contract between the employer and employee, the work of the employee and the relations between the employer and employee rather than by the mere name by which the percentage remuneration is designated in the employment contract.
APPEAL from the Board of Tax Appeals.
In this opinion appellant will be referred to as applicant, appellee as commissioner, and the Board of Tax Appeals as the board.
The commissioner issued a preliminary assessment certificate whereby he levied an assessment of intangible tax for the years 1941 to 1948, inclusive, on various sums of money as taxable royalties, which sums were paid to applicant by The McNeil Machine Engineering Company of Akron, hereinafter referred to as McNeil.
On January 29, 1949, applicant filed an application with the commissioner for a review and redetermination of the assessment, which was denied. Applicant thereupon appealed to the board, which affirmed the order denying the application for review and redetermination, and the cause is before this court on an appeal taken from the decision of the board.
The cause was heard by the board upon a stipulation of facts and from that stipulation it appears that in 1937 McNeil felt a need for the employment of some person with a talent for developing new ideas and products for sale by McNeil.
Applicant was suggested to the president of McNeil as a man of considerable inventive and development ability although his experience had been in the field of dry cleaning machinery.
The president of McNeil contacted applicant, became convinced that he was possessed of considerable ability and would probably be able to develop and improve machinery and products for McNeil, and that he would be of value to McNeil as an employee both in improving existing production methods and products and in developing new machinery and products.
It was considered that, although a flat salary per month would adequately compensate applicant for a part of his services, his true value to the company could be measured only in terms of the actual results of his services and that he should be compensated by being paid both a flat salary and a share in the profits of McNeil's business derived from his efforts. Thereupon a written contract was entered into by McNeil and applicant whereby McNeil agreed to employ applicant for a period of two years, commencing January 16, 1938, at a salary of $5,400 per year for the first year, $6,000 per year for the second year, and, in addition, a sum equal to 10 per cent of the net profit realized by McNeil from the manufacture and sale of all machinery and equipment invented or developed solely by applicant and five per cent from machinery and equipment invented or developed by applicant in conjunction with others. The payments were to be made during the life of any patents issued upon applicant's inventions or developments or for a like period as to such on which patents were not taken.
The contract provided further that if at any time during its operation applicant should terminate his employment with McNeil, the 10 per cent paid would be reduced to five per cent, but, if McNeil terminated the employment, applicant's percentage would remain at 10 per cent.
The contract provided that the percentages payable might be assigned by applicant and that in the event of his death they would continue to be payable to his heirs, executors or administrators.
The contract provided further that all inventions and developments made by applicant during its duration would be and remain the exclusive property of McNeil and that applicant would never disclose to any person other than McNeil any trade secrets, secret inventions, discoveries, improvements, methods of manufacture or any information relating to same.
On February 19, 1941, a new agreement in writing was made between applicant and McNeil to the same effect as the first agreement, except as to changes in compensation. This latter contract provided for a salary of $500 per month plus certain dollar payments for presses developed by applicant and sold by McNeil, one per cent of the gross sales price on applicant's sole inventions and developments, and one-half of one per cent on developments made in conjunction with others.
On August 1, 1942, by written contract applicant's compensation was again changed by providing that if in any year the amount payable to applicant under the terms of his contract of February 19, 1941, should not total the sum of $11,000, McNeil would make up the difference between $11,000 and the amount payable to applicant.
On October 9, 1947, the minimum of $11,000 per year was raised to $12,000.
In the various contracts between applicant and McNeil the percentages to be paid applicant were designated royalties, but in the stipulation of facts it was agreed that the word, royalty, was used in the agreement as a convenient description and there was no actual intent on the part of applicant or McNeil by the use of the word, royalty, to consider the payments made to applicant as royalties in the true sense as distinguished from additional compensation.
The payments to applicant by McNeil, in addition to applicant's flat salary, included the percentage of profits made upon applicant's developments and a single payment of $1,522.50 paid in January 1944 to make up the deficit under his minimum guaranty.
McNeil has expanded immensely and its operations have been profitable due in a large measure to the efforts of applicant, and applicant would not have continued working exclusively for Mcneil if his total compensation had been his flat salary. The stipulation of facts narrates that this latter fact was known to McNeil and the right to additional compensation was retained throughout all the contracts up to and including the present time, both as additional compensation for applicant's exclusive services as an employee of McNeil in order to retain him as such employee and also to provide incentive for his continued efforts.
Applicant furnished the commissioner with photo-static copies of his employment contracts with McNeil and with a statement of the payments made thereunder. The sum upon which the commissioner assessed the intangible tax was $118,188 which, by application of the formula prescribed by Section 5389, General Code, resulted in an income yield, from the percentage payments to applicant, of $24,322.57, to which a penalty of $3,652.14 was added, and the total being taxed at five per cent an additional assessment of $1,339.98 was made.
In one of the years involved stock owned by applicant and yielding an income of $25 was included in the assessment. However, there is no question as to its taxability under the Intangible Tax Act.
Messrs. Wise, Roetzel, Maxon, Kelly Andress and Mr. John M. Ulman, for appellant.
Mr. C. William O'Neill, attorney general, and Mr. J. Ralston Werum, for appellee.
The sole question presented to this court in the present case is whether the percentage payments to applicant by McNeil, which were derived from the contracts of employment between applicant and McNeil, constituted royalties subject to the intangible tax, within the meaning of the provisions of Section 5323, General Code. If those payments were the result of investments they are taxable. If, however, they constituted compensation under a contract of employment they are not taxable.
So far as relevant to the issue presented to us, Section 5323, General Code (115 Ohio Laws, 548; 120 Ohio Laws, 112), then provided:
"The term `investments' as used in this title includes the following:
"* * *
"Annuities, royalties and other contractual obligations for the periodical payment of money and all contractual and other incorporeal rights of a pecuniary nature whatsoever from which income is or may be derived, however evidenced, excepting * * * (2) contracts of employment or partnership and salaries, wages, commissions, seniority and other incorporeal rights derived from any such contract * * *."
Were the percentage payments to applicant salaries, wages, commissions or other incorporeal rights derived from a contract of employment, or did they constitute taxable royalties?
It is true that in the various contracts between applicant and McNeil the payments were designated as royalties and the board held them to be taxable. However, we are of the opinion that the nature of the payments must be determined from all the circumstances under which they were made rather than by the name by which they were called. As Shakespeare so aptly said, "What's in a name?"
There can be no question that applicant has been in the exclusive employment of McNeil during all the time with which this case is concerned and that he has been subject at all times to the direction and control by McNeil's officers in the manner and details of his employment. Such facts are stipulated. Likewise, according to the stipulation, there was no actual intent upon the part of applicant or McNeil to consider the percentage payments to applicant as royalties in the true sense as distinguished from additional compensation.
It seems to us that the foregoing stipulated facts dispose of any uncertainty as to the percentage payments not being royalties or investments as defined in Section 5323, General Code. If they were not true royalties but were additional compensation, they must be considered as commissions or other incorporeal rights derived from a contract of employment. If that is true, the percentage payments come squarely within the exception to investments as defined in the statute.
This court decided the case of French, Exrx., v. Glander, Tax Commr., 146 Ohio St. 225, 65 N.E.2d 61, at a time when the exception clause in Section 5323, General Code, contained only the language, "employment and partnership contracts and salaries and wages derived therefrom." That case concerned one French who was the author of several books and who entered into five separate contracts during a period of 16 years with a publishing company for the publication and sale of books. With one exception the books were copyrighted in the publisher's name and French was to receive certain stated royalties computed upon the number of books sold. French claimed that he was not liable for intangible taxes on the royalties paid him by the publisher, on the ground that they constituted salary or wages under a contract of employment. This court held that such a contract was not a contract of employment and that the sums of money paid French were royalties or income yield from an investment which was subject to intangible personal property tax.
In the opinion in the French case it is stated that the word, "royalty," is one of varying meanings.
It seems clear that in the French case, as was said in the opinion, there was no employment contract between French and his publisher since the publisher had no right of control over the manner of doing the work by the author.
The French case involved a true royalty which constitutes an investment taxable under the Intangible Tax Act.
In the present case applicant was employed full time to invent and develop machinery under the direction and control of his employer and his compensation under the contract of employment consisted largely of a percentage of the profits made from his developments. Such an arrangement made the percentage compensation more in the nature of a commission than a true royalty and thus came within the exception in the definition of investment.
It is a matter of common knowledge that there are innumerable contracts whereby a salesman receives a flat salary and a percentage of the profits of his employer brought about by the salesman's efforts, and no one could validly contend that such a percentage was taxable as an investment.
The board seemed to be impressed by the fact that the word, royalty, was used so frequently in the contracts between applicant and Mcneil and was concerned with the definition of that word. However, no one involved in this controversy seems to consider the definition of "commissions."
In the Oxford English Dictionary the word, "commission," is defined as "a remuneration for services or work done as agent, in the form of a percentage on the amount involved in the transactions; a pro rata remuneration to an agent or factor."
In the case of Ralston v. Admr. of Kohl, 30 Ohio St. 92, 98, it is stated in the court's opinion:
"The term `commission,' as here used, legally imports a sum allowed as compensation to a servant, factor, or agent, who manages the affairs of others, in recompense for his services. The right to such allowance may either be the subject of a special contract, or it may rest upon an implied contract to pay quantum meruit."
Assuredly the percentage payments to applicant in the present case were a pro rata remuneration to an agent for services or work done as such agent.
It is true that applicant's percentage remuneration was to continue in the event his employment contract with McNeil ceased and was to be payable to his heirs, executors, or administrators in the event of his death, and that applicant had a right to assign such percentage remuneration. However, no one of those events has occurred, and during all the time with which this controversy is concerned applicant remained in the employ of McNeil under the contracts, and, therefore, the percentage payments made to him were derived from a contract of employment. If in the future those payments should continue after the severance of the employment or the death of applicant, or to an assignee of applicant, a different question might be presented, but that question is not before us now.
We hold that the percentage payments to applicant constituted commissions or other incorporeal rights derived from a contract of employment, and, therefore, did not constitute investments. Consequently, the decision of the Board of Tax Appeals must be and is reversed.
Decision reversed.
WEYGANDT, C.J., ZIMMERMAN, MIDDLETON, TAFT, MATTHIAS and HART, JJ., concur.