Opinion
Docket No. 25753.
1951-02-19
HALSEY W. TAYLOR, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Lewis L. Guarnieri, Esq., for the petitioner. Thomas V. Lefevre, Esq., for the respondent.
Lewis L. Guarnieri, Esq., for the petitioner. Thomas V. Lefevre, Esq., for the respondent.
1. INCOME, CAPITAL GAINS.— Held, that assignments of letters patent and an invention constituted a sale of capital assets, and payments denominated ‘royalties‘ constituted the purchase price in periodic payments and, further, that the payment received in the taxable year constituted a long-term capital gain, taxable at capital gain rates.
2. DEDUCTION, ALIMONY.— Premiums paid on insurance policy which was merely security for alimony payments, held not deductible under section 23(u), Internal Revenue Code.
This proceeding involves an income tax deficiency in the amount of $50,740.43 for the calendar year 1947.
Petitioner assigns error in the respondent's determination: (1) that the amount of $100,220.44 received in the taxable year constituted ordinary derived from royalties rather than a long term capital gain derived from a sale of patents, and (2) that the amount of $499.50 paid in taxable year as premiums on life insurance payable to petitioner's divorced wife, is not an allowable deduction under section 23(u) of the Internal Revenue Code.
FINDINGS OF FACT.
The stipulated facts are so found and incorporated herein by reference.
The petitioner, a resident of Warren, Ohio, filed his income tax return for the calendar year 1947 with the collector of internal revenue for the eighteenth district of Ohio.
Over a long period of years petitioner has obtained numerous patents on his inventions relating to drinking fountains and water cooling apparatus. Since prior to 1926 petitioner has been the major stockholder, the president, and a director of The Halsey W. Taylor Company, an Ohio corporation doing business at Warren, Ohio, (hereinafter sometimes referred to as the corporation), engaged in manufacturing drinking fountains and water cooling equipment. On January 4, 1926, petitioner owned 996 of the corporation's 1000 shares of common stock. On February 7, 1945, that stock was owned: 706 shares by petitioner; 240 shares by a voting trustee to whom they were transferred by gift in December 1944 for the benefit of petitioner's daughters and grandchildren; 44 shares by members of petitioner's family, transferred to them by gift, and 10 shares by one L. O. Wurternberger, acquired by purchase.
On January 4, 1926, the petitioner as owner of letters patent and patents pending and the corporation as licensee, entered into a written agreement for a nonexclusive ‘License To Use Patents‘ which provided, in part, as follows:
FIRST: The owner hereby licenses and empowers the LICENSEE to manufacture or to procure to be manufactured, to the end of the term for which said LETTERS PATENT were granted, or will be granted, or any of them, fixtures or devices containing the patented improvements, and to sell the same.
SECOND: The LICENSEE agrees, on its part, to make full and true returns to the owner upon the first day of each year of the total sales derived hereunder, either directly or indirectly and further agrees to pay to the first party five per cent (5%) of the total net sales.
That agreement specifically enumerated seven patents, but by mutual consent of the parties and by actual practice, its provisions were applied to the corporation's use of and payment of royalties on several additional patents obtained by petitioner at various times during the years between January 4, 1926, and February 7, 1945.
On February 7, 1945, the petitioner and the corporation entered into the following written agreement:
This Agreement made and concluded at Warren, Ohio, this 7th day of February, 1945 by and between HALSEY W. TAYLOR, Party of the First Part, and the HALSEY W. TAYLOR COMPANY, Party of the Second Part, WITNESSETH:
WHEREAS the Party of the First Part entered into an agreement entitled ‘License to Use Patents‘ with the Halsey W. Taylor Company, on January 4, 1926, a copy of which agreement is attached hereto and marked ‘Exhibit A‘, and
WHEREAS the Party of the First Part is desirous of assigning to the Party of the Second Part all patents now owned by the Party of the First Part, or which may be later acquired by him, to the Party of the Second Part, upon condition that the royalties stipulated in ‘Exhibit A‘ continue only during the lifetime of the Party of the First Part. And
WHEREAS the Party of the First Part is desirous of terminating the payment of royalties by the Party of the Second Part to the Party of the First Part, or his estate, at the time of the death of the Party of the First Part.
NOW, THEREFORE, in consideration of the sum of $10.00, Ten, paid by the Party of the Second Part to the Party of the First Part, the receipt of which is hereby acknowledged, the Party of the First Part agrees as follows:
(1) That all patents now owned by the Party of the First Part, or which may hereafter be acquired by the Party of the First Part, shall be assigned by the Party of the First Part to the Party of the Second Part, and the same shall be accomplished as soon as practicable.
(2) That the payment of royalties due the Party of the First Part under ‘License to 'use Patents‘, Exhibit ‘A‘ attached hereto, shall cease and absolutely terminate upon the death of the Party of the First Part; and that thereafter the Party of the Second Part shall be under no obligation whatsoever to pay royalties as set forth in Exhibit ‘A‘ to the estate of the Party of the First Part, his representatives, or to any other person, firm or corporation.
On May 22, 1945, and pursuant to the agreement of February 7, 1945, petitioner executed three assignments to the corporation of his entire right, title, and interest in thirteen letters patent and in a certain invention and application for patent thereon. Each assignment was recorded in the United States Patent Office on May 24, 1945. The first assignment embraced ten solely owned letters patent issued to petitioner during the years 1928 to 1942 and provided, in part, as follows:
Now, therefore, in consideration of the sum of one dollar ($1.00) the receipt of which is hereby acknowledged, I. Halsey W. Taylor, by these presents do sell, assign, and transfer unto the said The Halsey W. Taylor Company, the whole right, title and interest in and to the said letters patents therefor aforesaid; the same to be held and enjoyed by the said The Halsey W. Taylor Company, for its own use and behoof, and for its legal representatives, to the full end of the term for which said letters patents are granted, as fully and entirely as the same would have been held by me had this assignment and sale not been made.
The second assignment, containing similar provisions as to sale and transfer, embraced three letters patent issued jointly to petitioner and the corporation during 1928 to 1933. The third assignment, also in consideration of one dollar, sold and transferred to the corporation the full and exclusive rights in and to an invention described in a certain application for patent filed on April 27, 1945, and any letters patent subsequently issued thereon. That application for patent was filed within but approximately at the end of one year after the invention was first reduced to practice and/or use. Also, pursuant to the agreement of February 7, 1945, the petitioner executed during 1948, 1949, and 1950, additional assignments to the corporation of his entire right, title, and interest in certain inventions and applications for patents filed thereon.
Immediately prior and leading up to the agreement of February 7, 1945, the corporation's accountant and its officers and directors, including petitioner, had numerous discussions concerning the corporation's unfavorable position as a nonexclusive licensee under the agreement of January 4, 1926, in the event of petitioner's death and the possibility that his patents might be disposed of, by his estate, to competitor concerns. As a result of those discussions, petitioner decided that it would be a fair proposition to sell to the corporation the patents then owned or subsequently applied for by him and to terminate, at his death, the 5 percent of net sales royalty payments which the corporation was then obligated to pay him. The petitioner's offer and the corporation's acceptance thereof as set forth in the minutes of a meeting of the corporation's board of directors on February 6, 1945, were as follows:
Halsey W. Taylor, President of the Company, advised the Board that a royalty agreement dated January 4, 1926 existed between the corporation and himself and that he was of the opinion that the patents now owned by him and patents which may later be acquired by him upon which the royalties are based, should be assigned by him to the corporation and that the royalty agreement should continue in force and effect until Mr. Taylor's death, at which time the royalty agreement should terminate and the corporation should cease paying royalties, and that some nominal consideration should be paid Halsey W. Taylor in consideration of the agreement to terminate the royalty agreement upon his death.
Halsey W. Taylor, then presented to the Board the form of agreement supplementing the royalty agreement and providing for the transfer of the patents now owned or later to be acquired to the corporation and the termination of the payment of royalties by the corporation at the time of Mr. Taylor's death. The supplemental agreement was read by the Secretary whereupon Mr. Paul H. Taylor moved that the offer made by Halsey W. Taylor be accepted by the corporation in consideration of the payment to Mr. Taylor of the sum of $10.00 and that the corporation accept title to the various patents held by Mr. Taylor, and that the officers of the corporation to (sic) authorized and empowered to execute the supplemental agreement with Halsey W. Taylor. The motion was seconded by Thomas R. Rose and unanimously carried.
The intention of the parties to the agreement of February 7, 1945, and the intention of petitioner in executing the assignments dated May 22, 1945, was that the corporation should thereby acquire the petitioner's entire right, title, and interest in the designated patents and an invention then owned by petitioner for varying periods of time in excess of six months.
Prior to the February 7, 1945, agreement the corporation's payments to petitioner in connection with its use of patents developed by petitioner, were entered on its books in a ledger account entitled ‘Royalty.‘ Subsequently, throughout the years 1945, 1946, and 1947 the corporation continued to use the same entitled account and the entires therein of payments to petitioner during 1947 totalled $100,220.44. As of January 1, 1948, the title of that ledger account was changed to 'Installment payment on purchase of Patents.‘ The corporation's tax return for 1947, filed in March 1948, reported the amount of $100,220.44 as cost of patents.
The petitioner's original income tax returns for 1945 and 1946 reported as royalties taxable as ordinary income. the payments received from the corporation in connection with patents developed by him, but subsequently petitioner filed amended returns claiming those payments as long term capital gains. The petitioner's income tax return for 1947, filed March 15, 1948, reported a taxable gain of $50,110.22 representing 50 per cent of a long term capital gain in the amount of $100,220.44 derived from the corporation as an installment payment on the sale of patents on February 7, 1945.
The respondent determined that the above-mentioned amount of $100,220.44 received by petitioner from the corporation in 1947, constituted royalties taxable in full as ordinary income. Respondent increased petitioner's reported net income by the amount of $50,110.22 and thereby determined the income tax deficiency of $50,740.43 involved in this proceeding.
Sometime in or about the year 1933 in an action before the Court of Common Pleas of Trumbull County, Ohio, the petitioner was divorced from his wife, Nelle, whose maiden name of Nelle E. Lammiman was restored. The divorce decree approved and incorporated a property settlement agreement of the parties, dated January 30, 1933, which provided, inter alia, that petitioner pay Nelle $150 per month during her natural life subject to specified conditions; that, to secure those monthly payments, petitioner procure and pay premiums on a $10,000 insurance policy on his own life made payable, in full and exclusively, to Nelle in complete settlement of the provision for monthly payments in the event he predecease her, and, further, that in the event of Nelle's remarriage the monthly payments shall cease and Nelle shall surrender the insurance policy to petitioner and assist him in securing a change of beneficiary.
On July 22, 1933, petitioner procured a change of beneficiary on his $10,000 life insurance policy with the Mutual Benefit Life Insurance Company, thereby making the policy payable ‘to Nelle E. Lammiman, my former wife, if living at my decease, otherwise to me, my executors, administrators, or assigns‘. At the same time petitioner relinquished the right to further change the beneficiary without her consent, but retained the dividend rights prior to maturity of the policy. The policy was delivered to and has remained in the hands of petitioner's former wife Nelle.
Pursuant to the divorce decree petitioner paid the sum of $499.50 as premium due on the above-mentioned insurance policy during 1947. On his 1947 income tax return, petitioner claimed a deduction of $1,800 for alimony payments to his divorced wife Nelle, but claimed no deduction for the $499.50 life insurance premium. Petitioner made a supplemental claim for a deduction of the $499.50 premium and in his deficiency notice for the year 1947 respondent disallowed that claimed deduction under section 23(u) of the Internal Revenue Code.
OPINION.
TIETJENS, Judge:
The first issue presents the question of whether the payments in the amount of $100,220.44 received by petitioner from the corporation in 1947 constituted royalties taxable as ordinary income as determined by respondent or a long-term capital gain from the sale of capital assets taxable at capital gain rates as contended by petitioner.
The petitioner was the owner of certain letters patent and an invention at the time of the execution of the agreements and assignments involved herein. There is no dispute as to those letters patent and the invention constituting capital assets of petitioners, i.e., ‘property held by the taxpayer’ (and not held primarily for sale to customers in the ordinary course of his trade or business) within the meaning of section 117(a)(1), Internal Revenue Code, as amended by section 151(a) of the Revenue Act of 1942.
Further, there is no dispute as to those capital assets having been ‘held for more than 6 months ‘ as provided in section 117(a)(4), Internal Revenue Code, so that if a sale thereof was made in 1945, then only ‘50 per centum‘ of the 1947 installment payments recognized as gain ‘shall be taken into account‘ in computing petitioner's net income for 1947, as provided in section 117(b), Internal Revenue Code, both as amended by section 150 of the Revenue Act of 1942. Also, if there was a sale, petitioner makes no contention as to any unrecovered cost basis. On this first issue as presented by the parties, they are in agreement as to the foregoing matters and, under the facts herein, such agreement is in accord with prior decisions. Se Carl G. Dreymann, 11 T.C. 153; Edward C. Myers, 6 T.C. 258; Commissioner v Hopkinson, 126 Fed.(2d) 406, affirming 42 B.T.A. 580; and Samuel E. Diescher, 36 B.T.A. 732 affirmed on other points, 110 Fed.(2d) 90.
SEC. 117. CAPITAL GAINS AND LOSSES.(a) DEFINITIONS.— As used in this chapter—(1) CAPITAL ASSETS.— The term ‘capital assets‘ means property held by the taxpayer (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business, or property, used in the trade or business, of a character which is subject to the allowance for depreciation provided in section 23(1). * * *
The evidence herein and more particularly the agreements entered into, present conflicting inferences and although the parties are in agreement as to certain factual circumstances surrounding the transactions involved they disagree as to the ultimate conclusions of fact and law to be drawn therefrom and the resulting tax consequences.
The respondent raises no question as to the transactions being bona fide and for a business purpose. Further, he raises no question as to the assignments of May 22, 1945, effectively transferring ownership of the letters patent and invention from petitioner to the corporation. However, he contends that such transfer was not a sale for an adequate consideration, but was a gift or contribution of capital to the corporation which petitioner controlled as president and majority stockholder and, further, that the 1947 payments to petitioner were royalties under the January 4, 1926, agreement which continued in full force and effect.
Respondent advances the following arguments in support of his position: That by mutual consent of the parties thereto the nonexclusive license agreement of January 4, 1926, was extended to embrace all drinking fountain and water cooling equipment inventions developed by petitioner during an indefinite period of years including the taxable year and by its terms petitioner was entitled to receive royalties in the sum of 5 per cent of the corporation's net sales of devices incorporating inventions developed by petitioner; that the January 4, 1926, agreement was not superseded by but was merely attached as an exhibit to a supplemental agreement of February 7, 1945, which latter agreement was by its terms, for the purpose of terminating ‘the payment of royalties due‘ under the earlier agreement upon the death of the petitioner; that since the corporation had a pre-existing and continuing obligation to pay royalties to petitioner the latter's assignment to the corporation of his valuable right, title, and interest as owner of letters patent and inventions under the terms of the February 7, 1945, agreement, was not supported by any new obligation of the corporation to pay royalties or by any adequate consideration and therefore was not in substance a sale, but instead constituted transfers by gift for the special purpose of terminating, at petitioner's death, the corporation's obligation to make royalty payments under the agreement of January 4, 1926. In short, respondent contends that under the circumstances herein and without disregarding the actuality of the assignments of May 22, 1945, the amount of $100,220.44 income in question for the year 1947 was not received as consideration for a sale of patents and thus was not a capital gain.
Briefly stated, petitioner contends that while the agreement of February 7, 1045, does not use the word sale, it does provide for the assignment of patents theretofore licensed to the corporation and that agreement coupled with the actual assignments of May 22, 1945, evidence the intention of petitioner to sell and of the corporation to purchase the entire rights in and to those patents. Petitioner further contends that the prescribed payments denominated royalties in reality constitute installment payments of the purchase price for his sale of patents and thus the $100,220.44 payment in question herein was a capital gain realized in the taxable year 1947.
In our opinion the character of the income involved herein, i.e., whether ordinary income or a capital gain, must be determined by viewing the transactions of the parties as a whole in order properly to assess the real intent and substance thereof rather than by looking to the form of the separate transactions.
Under the January 4, 1926, agreement, as extended by mutual consent, the corporation had a nonexclusive license to use patents and petitioner, as licensor, had a right to royalties determinable in a specified manner. In 1045 the interested parties determined that for the protection of the business of the corporation it should be the owner rather than the nonexclusive licensee of the patents developed by petitioner. To accomplish that business purpose, the agreement of February 7, 1945, and the assignments of May 22, 1945, were executed. The agreement did not employ words of purchase and sale, but did provide for assignments by petitioner to take effect immediately. The assignments executed did use words of purchase and sale to transfer to the corporation the petitioner's entire right, title, and interest as owner of specified letters patent and an invention. Both the agreement and each of the assignments mentioned only a nominal cash consideration paid in hand, but the agreement further provided that the assignments be made ‘upon condition‘ that, during petitioner's lifetime, the corporation continue payment of the royalties specified in the license agreement of January 4, 1926. It is clear that the continued payments so provided, constituted the real consideration for the assignments and since those continued payments were to be determined in amount in the same manner specified in the earlier license agreement they were denominated as the ‘royalties stipulated‘ and again as the ‘royalties due‘ under the attached agreement of January 4, 1926.
Prior to the agreement of February 7, 1945, and the assignments of May 22, 1945, the letters patent and an invention were owned by petitioner who was entitled to royalties from his nonexclusive licensee, but thereafter the corporation was the absolute owner thereof and perforce the petitioner was no longer a licensor. Accordingly, the continued payments which the corporation was obligated to make to petitioner as a ‘condition‘ for its acquisition of the patents and invention must be deemed to be the purchase price thereof. The salient facts herein are wholly incompatible with the respondent's contention that petitioner made a gift of his patents in 1945 and thereafter, despite transfer of ownership, was still entitled to royalties under a prior licensing agreement.
We have heretofore held that where the owner of a patent transfers his entire interest in the patent itself, the transaction constitutes a sale as distinguished from a mere license regardless of whether the instrument is termed a license agreement or whether the consideration is termed a royalty on the basis of a percentage of sales over a period of years. See Edward C. Myers, supra, and cases therein cited; Carl G. Dreymann, supra; and Kimble Glass Co., 9 T.C. 183. Cf. Cleveland Graphite Bronze Co., 10 T.C. 974, affd., 177 Fed.(2d) 100; and Philip W. McAbee 5 T.C. 1130.
We conclude that petitioner made a sale of letters patent and an invention to the corporation in 1945 and that the payment of $100,220.44 received by him in 1947 was part of the periodic payments which constituted the purchase price. Since petitioner sold capital assets held for more than six months he realized therefrom in 1947 a long term capital gain of $100,220.44 of which only 50 per cent is to be taken into account in computing his net income for the taxable year 1947. We hold that respondent erred in his determination as to the first issue herein.
The second issue involves a claimed deduction, under section 23(u), Internal Revenue Code, of $499.50 premiums paid in 1947 on an insurance policy as directed in a separation agreement incorporated in a decree of divorce of petitioner and his wife Nelle. On the facts, we conclude that the insurance policy was merely security for alimony payments to the divorced wife and accordingly upon authority of Meyer Blumenthal, 13 T.C. 28, affd., 183 Fed.(2d) 15; Lemuel Alexander Carmichael, 14 T.C. 1356; and William J. Gardner, 14 T.C. 1445, appealed to CCA-6 September 30, 1950, the claimed deduction is not allowable. In this issue the respondent is sustained.
Decision will be entered under Rule 50.