Opinion
Docket No. 38640.
1955-06-30
PORTABLE INDUSTRIES, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
I. W. Sharp, Esq., for the petitioner. Stanley W. Ozark, Esq., for the respondent.
I. W. Sharp, Esq., for the petitioner. Stanley W. Ozark, Esq., for the respondent.
1. Petitioner gave X corporation a license under which petitioner received royalties. A separate so-called service agreement was executed which provided that X would pay petitioner $30,000 per year for 2 years for petitioner's services in improving the patented devices and expanding their use. In each taxable year, X paid petitioner $30,000. The question is whether all or part of the $30,000 constituted personal holding company income. Held, that a portion represented personal holding company income; a portion was compensation for services rendered; the total amount of personal holding company income received in each taxable year was as large as the prescribed percentages in section 501(a)(1) and petitioner was a personal holding company.
2. Petitioner failed to file personal holding company returns for its fiscal years 1949 and 1950. Held, on the facts, petitioner's failure to file such returns was due to reasonable cause and not due to willful neglect.
The Commissioner determined deficiencies for the taxable years ended March 31, 1949 and 1950, in personal holding company surtaxes under section 500 of the 1939 Code, and in additions to tax under section 291(a) as follows:
+--------------------------------------+ ¦Year ¦Deficiency¦Sec. 291 (a)¦ +--------------+----------+------------¦ ¦March 31, 1949¦$45,176.99¦$11,294.25 ¦ +--------------+----------+------------¦ ¦March 31, 1950¦55,883.88 ¦13,970.97 ¦ +--------------------------------------+
The questions are whether petitioner was a personal holding company within section 501(a) of the 1939 Code, subject to surtax under section 500, in either or both of the taxable years, and whether petitioner's failure to file a personal holding company surtax return was due either to reasonable cause or to willful neglect. The parties are in agreement with respect to several adjustments determined by the respondent.
FINDINGS OF FACT.
The facts which have been stipulated are found according to the stipulation. The stipulation of facts, together with the annexed exhibits, is incorporated herein by reference.
Petitioner was incorporated on February 6, 1948, under the laws of the State of Ohio. Its principal office is located at 12117 Berea Road, Cleveland, Ohio. Petitioner's books of account have been kept and its income tax returns have been prepared and filed on an accrual basis. Petitioner filed its income tax returns for the fiscal years ended March 31, 1949 and 1950, with the collector of internal revenue for the eighteenth district of Ohio, at Cleveland, Ohio. The returns showed liability for income tax in the following amounts which were duly paid on or before their due dates:
+--------------------------------------------+ ¦For the year ended March 31, 1949¦$33,619.90¦ +---------------------------------+----------¦ ¦For the year ended March 31, 1950¦40,281.36 ¦ +--------------------------------------------+
On February 24, 1947, the Stemco Corporation, hereinafter referred to as Stemco, was incorporated under the laws of Ohio for the purpose of engaging in the manufacture and sale of explosive-operated tools, among other things. Soon thereafter, it began to assemble and sell explosive-operated tools under patents or applications for patents owned by an engineer named Stanley Temple.
On October 1, 1947, Jesse E. Williams, president of Stemco, purchased Temple's patent rights and applications for patents for $24,155. Stemco continued to sell the explosive-operated tools under these patents and applications for patents. Stemco had not paid royalties to Temple for the use of these inventions, and did not pay royalties to Williams after he had acquired them from Temple.
Stemco did not manufacture the devices it sold. The component parts were ordered from various manufacturers, and Stemco assembled, packaged, sold, and shipped the finished product.
In 1947, several claims were asserted against Stemco for personal injuries growing out of the use of Stemco's products. In addition, Stemco was unable to obtain adequate liability insurance coverage. Williams desired to protect himself and his family from any personal injury claims which might otherwise be asserted against him as owner of the patents. Accordingly, he organized petitioner on February 6, 1948, for the purpose of holding and licensing the patent rights he had acquired from Temple and such other patent rights as might be secured by virtue of engineering and development work which he intended petitioner would perform. Williams preferred that a new corporation, rather than Stemco, should hold the patents and perform the developmental work, inasmuch as there existed a possibility that personal injury judgment creditors might gain control of Stemco's assets.
Petitioner's stock consisted of 250 shares of no-par common stock of which 248 shares, or 99.2 per cent, were owned by Williams throughout the years in controversy. During the years 1948 through 1950, Williams also owned 248 shares of the 250 outstanding shares of Stemoc's no-par common stock. Williams was the president and a director of each corporation.
During the calendar and fiscal years 1948 and 1949, the principal offices of both corporations were located at the same place. The books of petitioner and Stemco were kept in the same office and by the same person during the years in question.
On April 2, 1948, Williams transferred to petitioner for $150,000 the ownership of the patent rights and applications he had acquired from Temple. On the same day, the board of directors of each corporation authorized the execution of two agreements between the corporations.
The following is found in the minutes of a meeting on April 2, 1948, of petitioner's board of directors:
It was then regularly resolved that the president and secretary be authorized to enter into a contract with Stemco Corporation by the terms of which Stemco Corporation would be granted an exclusive license to manufacture and sell powder-operated tools, studs, pins and accessories within the United States , its territories and dependencies for a term of ten (10) years, Stemco Corporation to pay Portable Industries, Inc. a royalty of ten (10%) per cent of the manufacturer's net sales up to a total of One Million Dollars and five (5%) per cent on manufacturer's net sales thereafter.
It was also regularly resolved that the president and secretary be authorized to contract with Stemco Corporation for the rendering of engineering, development and research services to Stemco Corporation to improve the safety, use and sales appeal of the tools and the accessories; said engineering services to be done in cooperation with the Employees of Stemco Corporation and Stemco Corporation to charge Portable Industries for any and all amounts expended by Stemco Corporation in connection with the research and development covered by such agreement.
The following is found in the minutes of a meeting on April 2, 1948, of the board of directors of Stemco Corporation:
Mr. Williams presented to the board a copy of the agreement which had been prepared. The terms of this agreement were thoroughly discussed after which it was regularly resolved that the officers be authorized to execute such agreements on the part of the company, one agreement calling for employing Portable Industries, Inc. as sales and development engineer at a fee of $30,000 per year for a two year period, to work in cooperation with Stemco Corporation in designing and developing a safer, more effective and more saleable tool and appliances, and providing that Stemco Corporation be reimbursed by Portable Industries for any materials, labor and engineering and for a prorata portion consumed in such research and developing work by any of Stemco's employees; the other agreement providing for an exclusive right to manufacture the tool and accessories within the United States for a ten year period at a royalty of ten (10%) per cent on the first million dollars net sales and five (5%) per cent thereafter, with a minimum royalty of $25,000.00 per year.
The two agreements were executed as of April 2, 1948.
The exclusive license agreement between petitioner, as licensor, and Stemco Corporation, as licensee, contained the following provisions:
(1) Licensor hereby grants to Licensee under any patent or patents that may be issued upon the applications aforesaid and and (sic) under all patents relating thereto which may be owned or controlled by Licensor during the period of this agreement shall remain in effect an exclusive license to manufacture, use and sell powder-operated tools, studs, pins and accessories, and any and all developments and improvements thereon within the United States, its territories and dependencies.
(2) Said license shall continue in effect for a term of ten (10) years unless sooner terminated under the provisions hereof.
(3) It is the essence of this agreement that Licensor shall furnish to Licensee engineering research, development and other services, not only to enable licensee to use the inventions aforesaid and obtain the best results therefrom but to considerably improve said inventions; to overcome any and all dangers in the use of said tools and accessories; to improve the effectiveness and expand the uses for said tools and accessories; to improve the efficiency, effectiveness and quality of said tool by metallurgic and other scientific and engineering research.
For the services so to be rendered by Licensor to Licensee, Licensor shall be compensated in accordance with separate agreement entered into by and between the parties and the entering into of said separate agreement for said services and the consideration therein expressed is a part of the inducement to Licensor to enter into this agreement.
(4) Licensee agrees to pay Licensor, in addition to the payment for services as above set forth, a sum equal to ten (10%) per cent of Licensee's net sales as a royalty upon the first million ($1,000,000.00) dollars of such net sales and five (5%) per cent of licensee's net sales above said figure, annually.
The license agreement is incorporated herein by reference.
The second agreement executed by petitioner and Stemco Corporation on April 2, 1948, was a service agreement which contained the following provisions:
(1) Portable agrees to use its best efforts, technical knowledge and skill to continuously improve the tools, studs, pins and accessories therefore above referred to, and to furnish engineering, research, development and other service to Stemco in order to improve said inventions, to overcome any dangers connected with the use of such; to improve the efficiency and expand the uses of said tools and accessories and to aid in sales engineering.
(2) Stemco agrees to pay to Portable for said services the sum of Thirty Thousand ($30,000.00) Dollars per year during the life of this agreement.
(3) It is understood and agreed that certain engineering and technical employees of Stemco Corporation will assist Portable's officers and engineers in such research and development to an extent which does not interfere with the needs of Stemco. For such services Stemco shall be reimbursed by Portable upon the presentation of invoices for the time actually spent by such employees upon Portable's business. In no event shall Portable be held liable for any claims for any product liability or defect.
This agreement shall continue in full force and effect for a period of two years from the date hereof, and shall be renewable for a like period upon such terms as shall be agreed to by the parties.
The service agreement is incorporated herein by reference.
On April 2, 1948, when petitioner and Stemco entered into the exclusive license and service agreements, the basic invention required substantial improvement and development to render the devices less hazardous and to enlarge their utility. At this time, petitioner owned no facilities and employed no engineers. Stemco employed engineers, Rowland J. Kopf, Frank Svekric, Rudy Witt, and Stanley Temple, who were familiar with the devices and the problems involved in their use. In the year ending March 31, 1949, petitioner reimbursed Stemco $15,066.86 for the time devoted by these engineers to what Williams considered as petitioner's activities. These engineers were paid by Stemco and remained employees of Stemco during the periods for which Stemco was reimbursed by petitioner. During the year ending March 31, 1949, the only engineers employed by petitioner were Evor S. Kerr, a naval engineering officer, who was paid a retainer of $400 for the 4 months from December 1, 1948, to March 31, 1949, and Kopf and Svekric, who were employed for the month of March 1949, at salaries of $500 and $350, respectively. Williams received an annual salary from petitioner of $6,000.
The work performed by the engineers in the year ending March 31, 1949, consisted primarily of designing a safer and more efficient tool and developing a line of accessories to enhance the use of the tool. This developmental work was performed for petitioner, which obtained the property rights to all innovations. For the $30,000 fee specified in the service agreement, Stemco received from petitioner the use of these new developments and improvements, and certain services, such as the training of Stemco's customers and salesmen, the investigation of accidents, and the preparation of sales, service, and price literature.
In the year ending March 31, 1949, $20,000 of the $30,000 paid by Stemco to petitioner was paid for the use of the new accessories for and improvements to the original Temple device. Stemco paid $10,000 for the services it received in training customers and salesmen, investigating accidents, and preparing literature.
In the year ending March 31, 1949, petitioner's gross income did not exceed $127,895.84. In this year, the petitioner received royalties from Stemco in the total amount of $116,482.98.
More than 80 per cent of petitioner's gross income for the year ending March 31, 1949, and more than 70 per cent of petitioner's gross income for the year ending March 31, 1950, consisted of personal holding company income.
Petitioner was a personal holding company in the years ending March 31, 1949, and March 31, 1950.
Petitioner did not file personal holding company surtax returns for the years ending March 31, 1949, or March 31, 1950. Petitioner's failure to file the returns was due to reasonable cause and not due to willful neglect.
OPINION.
HARRON, Judge:
The issue to be decided is whether during the taxable years ended March 31, 1949, and March 31, 1950, petitioner was a personal holding company as defined by section 501 of the 1939 Code. Petitioner met the stock ownership requirement of section 501(a)(2). The issue is restricted to whether the required percentage of gross income of petitioner in each taxable year was personal holding company income within sections 501(a)(1) and 502. The required percentage would be at least 80 per cent for the year ended March 31, 1949, and the percentage for the year ended March 31, 1950, would be the same, unless petitioner should have been found to be a personal holding company with respect to the year ended March 31, 1949, in which event the required percentage for the year ended March 31, 1950, would be 70 per cent. The provisions of section 501(a)(1) are set forth in the margin.
SEC. 501. DEFINITION OF PERSONAL HOLDING COMPANY.(a) GENERAL RULE.— FOR the purposes of this subchapter and chapter 1, the term ‘personal holding company’ means any corporation if—(1) GROSS INCOME REQUIREMENT.— AT least 80 per centum of its gross income for the taxable year is personal holding company income as defined in section 502; but if the corporation is a personal holding company with respect to any taxable year beginning after December 31, 1936, then, for each subsequent taxable year, the minimum percentage shall be 70 per centum in lieu of 80 per centum * * * ; and(2) STOCK OWNERSHIP REQUIREMENT.— AT any time during the last half of the taxable year more than 50 per centum in value of its outstanding stock is owned, directly or indirectly by or for not more than five individuals.
The petitioner also admits that some of its income in each taxable year consisted of ‘royalties' (other than mineral, oil, or gas royalties), and interest. See sec. 502 of the 1939 Code. That is to say, apart from income in the amount of $30,000, the income which is in dispute, petitioner received royalties during the taxable year ended March 31, 1949, in an amount which was approximately 75.6 per cent of gross income. Also, during the taxable year ended March 31, 1950, petitioner received royalties in an amount which was approximately 75.6 per cent of gross income. If it is found that all or part of the $30,000 in dispute which was received during the year ended March 31, 1949, represented ‘royalties' under section 502, in an amount which would increase the admitted ‘personal holding company income’ from 75.6 per cent to 80 per cent, then, of course, it must be held that petitioner was a personal holding company subject to the surtax in the year ended March 31, 1949. It will follow from that holding that petitioner was a personal holding company subject to the surtax in the succeeding year, the year ended March 31, 1950, because more than 70 per cent of its gross income for the latter year was admittedly from ‘royalties.’
From the foregoing it is clear that the issue to be decided relates to the fiscal year ended March 31, 1949.
In the deficiency notice, the respondent stated his reason for his determination that there were deficiencies in personal holding company surtax in the following way:
it is held that during the years ended March 31, 1949 and March 31, 1950, you were a ‘personal Holding Company’ as defined in Section 501(a) of the Internal Revenue Code and subject to the surtax imposed by Section 500 thereof.
In its petition, the petitioner set forth among alleged facts upon which it would rely that on April 2, 1948, it entered into a ‘Service Agreement’ with Stemco under which Stemco agreed to pay petitioner $30,000 per year for 2 years for engineering, research, development, and other services to be rendered by petitioner ‘to improve said inventions, to overcome any dangers connected with their use, and to improve the efficiency and expand the uses of said tools and accessories and to aid in sales engineering’; and that the alleged engineering service fees were not ‘personal holding company income.’
The respondent contends first that at least 80 per cent of petitioner's gross income for the taxable year ended March 31, 1949, was personal holding company income within the meaning of section 502 because the so-called service agreement between petitioner and its licensee, Stemco, lacked substance and was designed to avoid personal holding company surtax liability of petitioner by disguising royalties as engineering fees. He asserts that royalties include compensation for the use of not only the basic invention or patent but also any improvements and developments thereof; that the evidence as to the services petitioner claims it rendered to Stemco under the service agreement is that such services actually consisted of the use of improvements and developments of the basic invention or patent; and that the $30,000 specified in the service agreement was consideration for such use and, therefore, constituted additional royalties. Respondent relies upon Lane-Wells Co., 43 B.T.A. 463, affirmed as to this question 134 F.2d 977, certiorari denied 320 U.S. 741; Warren Browne, Inc., 14 T.C. 1056; Anton Dolenz, 41 B.T.A. 1091 (acq. 1940-2 C.B. 2); Hugh Smith, Inc., 8 T.C. 660, affd. 173 F.2d 224, certiorari denied 337 U.S. 918; and Commissioner v. Affiliated Enterprises, Inc., 123 F.2d 665, certiorari denied 315 U.S. 812.
The evidence shows that prior to February 24, 1947, Stanley Temple had invented an explosive-operated device capable of driving metal studs and other fasteners into steel and concrete objects. On February 24, 1947, Williams organized Stemco to subcontract the manufacture of the component parts of the device under an informal arrangement with Temple, and to assemble the parts, and package and sell the completed product. On October 1, 1947, Williams personally purchased from Temple the patent rights and applications covering the tool. In 1947, its first year of operation, Stemco earned $31,340.55, after provision for Federal income taxes. The device was comparatively new and proved extremely dangerous to its users. Safety improvements and the development of additional accessories were urgently required to reduce the hazards involved in the use of the device and to enlarge its utility. In addition, in 1947, a number of claims were asserted against Stemco for injuries allegedly resulting from the new device. Williams feared that claims would be asserted against him personally, as patent owner. On February 6, 1948, he organized petitioner. Throughout the years in question Williams owned 248 shares of each corporation's 250 outstanding shares of no-par common stock. On April 2, 1948, he conveyed his patent rights and applications to petitioner, intending that petitioner would also acquire all other patents subsequently obtained with respect to these tools. These patent rights were not conveyed to Stemco inasmuch as Stemco was experiencing considerable difficulty in obtaining liability insurance, and its assets were exposed to tort claims and judgments. On the same day, April 2, 1948, the two corporations entered into two agreements. In the first, or license agreement, petitioner granted to Stemco a 10-year exclusive license to manufacture, use, and sell within the United States any tools or accessories covered by any patent rights then owned by petitioner or which might be issued to petitioner in the future. Stemco agreed to pay petitioner annual royalties equal to 10 per cent of Stemco's net sales on the first million dollars of sales and 5 per cent of annual sales in excess of one million dollars. The second agreement, or service agreement, is the basis of this controversy. The service agreement was to last for 2 years, and provided that petitioner was to use ‘its best efforts, technical knowledge and skill to continuously improve the tools, studs, pins and accessories therefor,’ and to furnish ‘engineering, research, development and other service to Stemco,‘ in return for which Stemco agreed to pay the sum of $30,000 per year. At this time petitioner had been in existence for less than 2 months, had no facilities, and employed no engineering or technical staff, with the possible exception of Williams, who was president of both corporations and who, although not a graduate engineer, claimed to have had considerable experience with engineering problems. Stemco, on the other hand, employed a staff of engineers who had been working on the devices for Stemco for more than 1 year. The Stemco engineering staff included Temple, the inventor. The service agreement contained the following provision relating to the assistance to be given to petitioner by Stemco:
It is understood and agreed that certain engineering and technical employees of Stemco Corporation will assist Portable's officers and engineers in such research and development to an extent which does not interfere with the needs of Stemco. For such services Stemco shall be reimbursed by Portable upon the presentation of invoices for the time actually spent by such employees upon Portable's business. In no event shall Portable be held liable for any claims for any product liability or defect.
In the year ending March 31, 1949, Rowland J. Kopf, Rudy Witt, Frank Svekric, and Temple were engineers employed by Stemco. Pursuant to the paragraph of the service agreement quoted above, petitioner paid Stemco $15,066.86 for the portion of their working time which Williams considered as having been devoted to ‘Portable's business.’ During this year, petitioner employed the following engineers: Evor S. Kerr, a naval engineering officer, who was paid a retainer of $100 per month for 4 months beginning December 1948, and Kopf and Svekric, who were employed only during the month of March 1949, at a total salary of $850.
One of petitioner's contentions is that engineers Kopf, Witt, Svekric, and Temple were part-time employees of petitioner during the year ending March 31, 1949, to the same extent that petitioner reimbursed Stemco for their assistance. The evidence does not support petitioner. These engineers were employed by Stemco before petitioner was organized, were always paid by Stemco, and continued to be so paid after the service agreement was executed. Neither the resolutions of the respective boards of directors which authorized the service agreement, nor the agreement itself purport to change the existing employer-employee relationships, but on the contrary, specifically classify as Stemco employees the engineering and technical personnel for whose services petitioner was required to reimburse Stemco.
The status of these engineers as employees of Stemco pertains more, however, to the construction to be accorded the service agreement than to our primary inquiry concerning the nature of the benefits received by Stemco, in return for which the $30,000 was paid to petitioner.
The evidence concerning the nature of the services purportedly rendered to Stemco consisted primarily of testimony and of an exhibit which Williams identified as ‘a record of many details of engineering and service work that was rendered by Portable Industries' personnel’ up to September 29, 1949. The exhibit lists 42 descriptive phrases of ‘Details Completed and Completed Problems' accomplished by the engineers, and is incorporated herein by reference.
Except for a few items such ‘Sales and Service Bulletins,’ ‘Accident records file up to date,’ ‘New type of Multigraph print forms,‘ and ‘Dimensional and price catalogue,‘ petitioner admits that each entry describes the completion of a design or redesign of a part of the device or of an accessory.
The petitioner secured the patent applications for these improvements and new accessories, pursuant to Williams' plan to have petitioner own all patent rights touching on the devices invented by Temple, and to have Stemco perform the assembling and selling.
We find from this evidence that the greatest part of the engineers' efforts were devoted to the most urgent problem created by the device, namely, the design or redesign of safer and more efficient parts for the tool and the development of accessories to enhance its use. We also find that this improvement and development was done for the benefit of petitioner, which was the patent holder.
That petitioner itself considered that the improvement and development work was performed on its behalf, as the patent owner, is also indicated by its sworn protest to respondent, executed by Williams on May 1, 1951, in which the reimbursement to Stemco for the assistance of the Stemco engineers is characterized as ‘wages and salary payments paid or accrued by the taxpayer in connection with engineering, research and exploration of present and future products to be manufactured by whatever business organizations which may be interested in obtaining such rights from the taxpayer.’
Stemco obtained the rights to incorporate the improvements and new accessories in the parts which it ordered from its subcontractors and in the finished product it sold. We find no merit in petitioner's contention that the improvement and development work on its inventions constituted ‘engineering services' to Stemco. We think it quite clear in this case that the engineering services involved in improving petitioner's patents were rendered to petitioner, as owner-licensor of the basic patents and of the improvements, and not to Stemco, which, as a licensee, obtained only the use of the new developments.
The respondent properly determined that the principal benefit obtained by Stemco under the service agreement was the right to use petitioner's new accessories for, and improvements to, the basic Temple patents. It is concluded from all the evidence that $20,000 of the $30,000 paid by Stemco in the year ended March 31, 1949, was paid for the use of these new developments. This $20,000 constituted royalties. Lane-Wells Co., supra; Warren Browne, Inc., supra. The allocation of two-thirds of the total payment is amply supported by a consideration of the nature of the work accomplished by the engineers and of the urgent need for the development of safety features and accessories which existed at the time the service agreement was executed. On the other hand, the evidence, viewed in its most favorable aspect for the petitioner, namely, that certain services were rendered to Stemco by petitioner in the year ended March 31, 1949, nevertheless fails to establish that Stemco paid any more than one-third of the $30,000 for such services. These services consisted of the training of Stemco customers and salesmen, the investigation of accidents purportedly caused by the devices, and the preparation of Stemco's sales, service, and price literature. When compared to the benefits obtained by Stemco from the use of the improvements developed for petitioner, it is apparent that these services accounted for but a small portion of the $30,000. It is concluded that Stemco paid $10,000 for these services during the year ended March 31, 1949. U.S. Universal Joints Co., 46 B.T.A. 11.
The petitioner had gross income in the year ended March 31, 1949, in the amount of $127,895.84. It had personal holding company income, in the form of royalties from Stemco, in the total amount of $116,482.98, of which $96,482.98 was paid under the license agreement and $20,000 was paid under the service agreement. Petitioner's personal holding company income exceeded 80 per cent of its gross income, and, accordingly, it is concluded that petitioner was a personal holding company, under the provisions of section 501(a) of the 1939 Code, in the year ended March 31, 1949. Petitioner's personal holding company income in the year ended March 31, 1950, admittedly exceeded 70 per cent of its gross income, and, accordingly, petitioner was a personal holding company in the year ended March 31, 1950. See sec. 501(a)(1) of the 1939 Code.
The petitioner makes an alternative contention to its argument that the $30,000 was paid by Stemco for engineering services. The petitioner's argument is that a patent owner, while receiving royalties from a licensee, is under no obligation to the licensee to improve the patents or inventions, and that the $30,000 should be viewed as compensation or reimbursement paid by Stemco to induce petitioner to continue development of its patents and of the inventions on which they are based.
Petitioner cites no authority to support this theory of a patent owner-licensee relationship. In any event, we do not think it applicable to the facts of this case. On April 2, 1948, petitioner had no facilities or technical employees and owned only patent rights which required substantial improvement. Williams desired petitioner to hold not only the Temple patents, but also any related patent rights which subsequently would be acquired. We construe the service agreement not as an inducement for petitioner to act, but on the contrary, as substantially an arrangement for giving petitioner the use of Stemco's engineers and facilities, and the rights to whatever inventions would be developed by these engineers. That the service agreement was required primarily for petitioner's benefit is expressly revealed in the companion license agreement, which states that ‘the entering into of said separate agreement for said services and the consideration therein expressed is a part of the inducement to Licensor to enter into this agreement.’ We therefore reject petitioner's argument that the $30,000 fee specified in the service agreement was paid to induce it to improve its patent rights.
We hold that respondent did not err in determining that the petitioner was liable for personal holding company surtax in the years ended March 31, 1949, and March 31, 1950. Because of our finding that $10,000 received by petitioner from Stemco in the year ended March 31, 1949, did not constitute personal holding company income, it will be necessary to recompute the deficiency in surtax for this year under Rule 50.
In view of the conclusions reached, it is unnecessary to consider an alternative contention of the respondent.
An additional problem is raised by petitioner's failure to file personal holding company returns for either of its fiscal years in controversy, as a consequence of which the Commissioner has determined additions to tax under section 291(a) of the Code.
Williams admitted that he had been a certified public accountant since 1935. The evidence indicates, however, that until 1940, he was controller of the Cleveland operations of an industrial manufacturing firm and from 1940 to 1948 general manager of their Cleveland plant. There is also uncontradicted testimony that Williams consulted with Jules Eshner, a Cleveland attorney, concerning whether petitioner was required to file a personal holding company return for each year in question. Eshner had been engaged in the practice of law in Cleveland for over 30 years and was admitted to practice before The Tax Court of the United States and before the Treasury Department. He was conversant with petitioner's operations, and advised Williams that petitioner was not a personal holding company and that no additional return was required. The return for the year ending March 31, 1950, was prepared by a firm identified as certified public accountants, with whom Eshner testified he consulted at length concerning petitioner's status and the necessity for filing a personal holding company return. We find, on the basis of the foregoing, that the failure to file personal holding company returns for the years ending March 31, 1949, and March 31, 1950, was due to reasonable cause and not due to willful neglect. Haywood Lumber & Mining Co. v. Commissioner, 178 F.2d 769, reversing 12 T.C. 735; O. Falk's Department Store, Inc., 20 T.C. 56; Rev. Rul. 172, 1953-2 C.B. 226. Respondent's determination on this issue is disapproved.
Decision will be entered under Rule 50.