Opinion
No. 47736.
June 6, 1949.
Action by David M. Williams against the United States to recover income tax wrongfully collected, wherein the defendant filed a counterclaim.
Order in accordance with opinion.
This case having been heard by the Court of Claims, the court, upon the evidence and the report of a commissioner, makes the following
Special Findings of Fact
1. Plaintiff is an individual residing in New Haven, Connecticut.
2. Plaintiff was born in 1900 and until 1939 resided in Godwin, North Carolina, where he was engaged in the occupation of farming. In May 1939, he became a salaried employee at New Haven, Connecticut, of the Winchester Repeating Arms Company, a division of Western Cartridge Company, hereinafter referred to as "Winchester," at an annual salary of $5,000, which was later increased to $5,500 or $6,000. His duties as an employee of Winchester were to develop new guns and new gun mechanisms. Under the terms of his employment any patentable inventions which he might develop would belong to Winchester. At the time of the trial of this case on September 8, 1948, plaintiff had ceased to be a salaried employee of Winchester and was then known as an outside contractor.
3. During the years he was engaged in farming, plaintiff earned very little income and filed no income tax returns. After becoming a salaried employee, plaintiff filed income tax returns for the years 1939 to 1943, inclusive, with the Collector of Internal Revenue for the District of Connecticut. He has been married and living with his wife at all times since about 1919. He has one son who was eight or nine years old at the time of the trial on September 8, 1948. He had no other dependents in any of the years in question.
4. During young manhood, plaintiff became interested in firearms as a hobby. Thereafter and until work on firearms became his vocation, he devoted all the time he could spare from his farm work, including work at night and on Sundays, to this hobby. About 1925 plaintiff conceived the idea for an invention of a short stroke piston device or vibrator as the operating mechanism of automatic firearms. About that time, 1925, using hand tools and the equipment of a country blacksmith shop, he first made a shooting device or fixture to test out the principle of his invention. He was unable fully to develop the idea until he obtained additional tools such as a lathe and milling machine, which he acquired in 1928. After the acquisition of these machines, he continued with experimental work on his invention until he finished working models, which was shortly prior to the time when he filed his patent application on his invention on February 7, 1931.
5. About two or three months prior to the filing of the application on February 7, 1931, plaintiff employed a patent attorney and he worked with this attorney and a draftsman in preparing drawings and the patent application itself. The invention, as shown in the drawings in the patent application, was complete at the time the application was filed on February 7, 1931.
6. That patent application was permitted to lapse but was renewed on August 19, 1933, and a patent, United States Patent No. 2,090,656, covering the invention was issued to plaintiff on August 24, 1937.
7. By agreements of November 11, 1931, and March 14, 1932, plaintiff granted a license to the United States Government to make and use or have made and used on .22-caliber machine guns the short stroke piston device or vibrator, a form of which is described in United States Patent No. 2,090,656, in exchange for royalty payments. On April 30, 1934, plaintiff granted an exclusive license to the Colt Patent Fire Arms Manufacturing Company to manufacture, use, and sell automatic pistols with right to sublicense others to manufacture, use, and sell automatic pistols containing the invention covered by Patent No. 2,090,656 in exchange for royalty payments. By agreement of November 1, 1939, plaintiff granted an exclusive license to Remington Arms Company, Inc., to make, use, and sell sporting shoulder rifles embodying the invention covered by Patent No. 2,090,656 in exchange for royalty payments.
8. On September 9, 1940, plaintiff granted an exclusive license to Winchester, except for rights previously granted by plaintiff as shown in the preceding finding, to make, use, sell, have made, and rights to license others for certain specified types of military and sporting firearms containing a vibrator or actuator in the form of a short stroke piston, as described in Patent No. 2,090,656, in exchange for a royalty payable to plaintiff on the basis of the value of each gun manufactured containing plaintiff's invention.
9. In March 1942, Winchester granted royalty free to the United States Government a nonexclusive, irrevocable right to manufacture and use, or to cause to be manufactured and used by others for Government purposes, a light weight military carbine officially designated Carbine Caliber .30M1 which included plaintiff's invention covered by Patent No. 2,090,656 in consideration of payment by the Government to Winchester of a lump sum of $886,000. On March 19, 1942, plaintiff entered into an agreement with Winchester consenting to the foregoing contractual arrangement between Winchester and the United States and agreeing to accept 26.411 percent of the lump-sum payment of $886,000 provided therein in lieu of all royalties to which he would otherwise be entitled under the license agreement of September 9, 1940, referred to in the preceeding finding.
10. With the exception of Patent No. 2,090,656, the patents and patent applications listed under the name of Williams in the contract between Winchester and the United States Government and attached to the contract between Winchester and plaintiff dated March 19, 1942, all belonged to Winchester. Plaintiff, however, is still owner of Patent No. 2,090,656 subject to the manufacturing rights granted to others under licenses.
11. Pursuant to the agreement of March 19, 1942, referred to in finding 9, Winchester paid plaintiff the sum of $234,001.46 in the year 1942, which sum represented a royalty payment for the use of plaintiff's device covered by Patent No. 2,090,656. That sum had no connection with plaintiff's duties as an employee of Winchester. In addition to the foregoing amount of $234,001.46, plaintiff received royalty income under the licenses granted to use his invention covered by Patent No. 2,090,656 as follows:
------------------------------------------------------ Year Source Amount ------------------------------------------------------ 1939 Colt Patent Firearms Manufacturing Co. .............................. $250.00 1940 .... do ............................ 250.00 Winchester ....................... 3,090.00 1941 Colt Patent Firearms Manufacturing Co. .............................. 329.60 Ordnance Department, U.S. Army ............................. 534.00 Remington Arms Company ............. 3,297.78 1942 War Department, U.S. Army ......... 3,474.00 Remington Arms Company ............. 8,074.59 Colt Patent Firearms Manufacturing Co. .............................. 589.20 ------------------------------------------------------
From the date of the receipt of the lump sum payment of $234,001.46 in 1942 to September 8, 1948, the date of the trial of this case, plaintiff received no royalty income from the invention covered by Patent No. 2,090,656.
12. In developing his invention and obtaining Patent No. 2,090,656, plaintiff incurred expenses of approximately $6,000. In addition, plaintiff incurred expenses of $26,000 in connection with the foreign rights under that patent, which he paid in 1942.
13. In his income tax return filed March 15, 1943, for the year 1942, plaintiff, in addition to other income including other royalties in the amount of $12,137.79, reported the sum of $234,001.46, referred to in finding 11, but deducted therefrom $26,000, the expense item of that amount referred to in finding 12, leaving the net amount of $208,001.46 as taxable income. In that return plaintiff, using a forty-one month period, apportioned that sum to the respective years 1939 to 1942, inclusive, purporting to act in accordance with Section 139(a) of the Revenue Act of 1942, amending Section 107(a) of the Internal Revenue Code. That method of reporting income produced additional taxes for the years 1939, 1940, and 1941 in a total amount of $63,780.27 which, together with the tax shown due for the year 1942 of $35,079.09, resulted in a total reported tax liability for the year 1942 of $98,859.36. In his income tax return filed for 1943, plaintiff did not report the receipt of any royalty income from the invention covered by Patent No. 2,090,656, the income reported for that year being his salary from Winchester.
Plaintiff paid amounts on account of the tax liability shown on his income tax returns for 1942 and 1943 as follows:
Apr. 1, 1943 ............................ $24,714.84 Aug. 4, 1943 ............................ fn124,714.84 Oct. 14, 1943 ........................... 24,335.45 Dec. 29, 1943 ........................... 24,335.44 Through withholding of income and victory tax by his employer during 1943 ....... 791.06 --------- Total ............................. 98,891.63
These payments made on account of tax for the taxable year 1942 were considered as payment of the estimated tax for 1943 pursuant to Section 6(e) of the Current Tax Payment Act of 1943.
Plaintiff claimed a refund of $254.42 on his income tax return for 1943. That sum was refunded to him and was the only refund made to plaintiff on account of his income taxes for the years 1942 and 1943.
14. Plaintiff's income tax returns for the years 1942 and 1943 correctly reflected the amount of income which plaintiff received in those years.
15. On March 15, 1945, plaintiff filed a claim for refund of income taxes for the year 1942 in the amount of $45,252.60 on the ground that "Patents sold in 1942 should have been considered as Capital Gain instead of Ordinary Income." On March 15, 1946, plaintiff filed a claim for refund of income taxes for the year 1943 in the amount of $68,977.66, amending and supplementing the claim filed for 1942, on the ground that the gross income received by plaintiff in 1942 from his invention should be apportioned ratably over the period of thirty-six months prior to February 7, 1931, when the period of work on the invention terminated and the tax computed at the rates in effect during those years, and that the overstatement of tax for the taxable year 1942 resulted in overstatement of the tax for the taxable year 1943 under the Current Tax Payment Act of 1943. In the alternative, claim was made for any resulting refund should it be determined that the income was attributable to the sale or exchange of a capital asset. More than six months elapsed between the filing of such claims for refund and the filing of the petition in this proceeding.
16. In a ninety-day letter dated June 25, 1948, the Commissioner of Internal Revenue notified plaintiff that the claims for refund referred to in the preceding finding would be disallowed. In connection with that disallowance, the Commissioner reduced the royalty payment of $234,001.46 received by plaintiff from Winchester in 1942 by $26,000 expenses in connection with foreign rights and further by expenses incurred in obtaining the patent, thus determining $201,601.46 as the net amount received by plaintiff for the use of his invention covered by Patent No. 2,090,656. In addition, the Commissioner, purporting to act in accordance with the provisions of Section 107(b) of the Internal Revenue Code, 26 U.S.C.A. § 107(b), allocated that net amount of $201,601.46 in equal installments to the thirty-six months immediately preceding the close of the calendar year 1942. Through his application of Section 107(b), the Commissioner determined plaintiff's total tax liability for the years 1940, 1941, and 1942, in the amount of $114,783.32. To that tax the Commissioner added an unforgiven part of plaintiff's 1943 tax liability as provided in Section 6(b) of the Current Tax Payment Act of 1943, 26 U.S.C.A. § 1622 note, making a total tax due as determined by him of $115,005.47. Since plaintiff's income tax return filed March 15, 1944, for the year 1943, reported a tax liability of only $98,637.21, the Commissioner determined a deficiency in income and victory tax against plaintiff for 1943 of $16,368.26, which tax has not been paid by plaintiff.
Conclusion of Law
Upon the foregoing special findings of fact, which are made a part of the judgment herein, the court concludes as a matter of law that the plaintiff is entitled to recover. Entry of judgment will await the filing of a stipulation by the parties showing the amount due, including interest as provided by law.
Lawrence J. Bernard, Washington, D.C., for the plaintiff. George E. McMurray, Jr., Washington, D.C., was on the brief.
H.S. Fessenden, with whom was Theron Lamar Caudle, Assistant Attorney General, for the defendant. Ellis N. Slack and Andrew D. Sharpe, Washington, D.C., were on the brief.
Before JONES, Chief Judge, and MADDEN, HOWELL, WHITAKER and LITTLETON, Judges.
This suit is to recover $68,977.66, which is a part of the income tax paid by the plaintiff in 1943. The income in question was received by the plaintiff in 1942, and the tax was paid in 1943 pursuant to Section 6(e) of the Current Tax Payment Act of 1943. The source of the income was a patent, United States Patent No. 2,090,656, for a short stroke piston device or vibrator which should serve as the operating mechanism of automatic firearms.
The plaintiff began to work on the invention which resulted in the patent in about the year 1925, and continued work on it until February 7, 1931, on which date he filed his application for a patent. The patent was not actually issued until August 24, 1937. In 1940 the plaintiff granted an exclusive license to the Winchester Repeating Arms Company for the use of his patent, subject to exceptions not material here, and that company agreed to pay the plaintiff a royalty upon each gun manufactured which used the plaintiff's invention. On March 19, 1942, the Winchester Company and the plaintiff liquidated the royalty agreement by Winchester's agreeing to pay the plaintiff $234,001.46 in lieu of all payments to which he would otherwise have been entitled under the royalty agreement. The named sum was paid to the plaintiff in 1942. It constituted much more than 80%, of all the income which the plaintiff received from his patent at any time before, during, or since 1942.
Section 107(b) of the Internal Revenue Code reads as follows:
"Sec. 107. Compensation for services rendered for a period of thirty-six months or more and back pay.
* * * * * *
"(b) Patent, copyright, etc. For the purposes of this subsection, the term `artistic work or invention', in the case of an individual, means a literary, musical, or artistic composition of such individual or a patent or copyright covering an invention of or a literary, musical, or artistic composition of such individual, the work on which by such individual covered a period of thirty-six calendar months or more from the beginning to the completion of such composition or invention. If, in the taxable year, the gross income of any individual from a particular artistic work or invention by him is not less than 80 per centum of the gross income in respect of such artistic work or invention in the taxable year plus the gross income therefrom in previous taxable years and the twelve months immediately succeeding the close of the taxable year, the tax attributable to the part of such gross income of the taxable year which is not taxable as a gain from the sale or exchange of a capital asset held for more than 6 months shall not be greater than the aggregate of the taxes attributable to such part had it been received ratably over that part of the period preceding the close of the taxable year but not more than thirty-six calendar months."
The plaintiff says that this statute entitles him to compute his taxes upon the income received by him in 1942 from his patent as if that income had been received ratably during the thirty-six months ending on February 7, 1931, the date when he finished his work on his invention, and had been taxed at the income tax rates then in force. The Government says that the tax should be computed as if the income actually received in 1942 had been received ratably during the thirty-six months ending December 31, 1942, and had been taxed at the rates in force in 1940, 1941, and 1942. Since the applicable rates in the latter years were much higher than those which the plaintiff would use, the difference is large.
The obvious hardship of taxing a person who received, all or mostly in one year, income which he had worked many years to earn, and thus subjecting him to high surtax rates, was first dealt with by Congress in Section 220 of the Revenue Act of 1939, Section 107 of the Internal Revenue Code. It provided:
"Sec. 107. Compensation for services rendered for a period of five years or more.
"In the case of compensation (a) received, for personal services rendered by an individual in his individual capacity, or as a member of a partnership, and covering a period of five calendar years or more from the beginning to the completion of such services, (b) paid (or not less than 95 per centum of which is paid) only on completion of such services, and (c) required to be included in gross income of such individual for any taxable year beginning after December 31, 1938, the tax attributable to such compensation shall not be greater than the aggregate of the taxes attributable to such compensation had it been received in equal portions in each of the years included in such period."
Subsections (a) and (b) of Section 107 of the Internal Revenue Code in their present form were enacted in Section 139 of the Revenue Act of 1942, which, prior to its passage was H.R. 7378, 77th Congress, 2nd Session. By Section 139, Section 107 was amended and became Section 107(a) which reads as follows:
"Sec. 107. Compensation for services rendered for a period of thirty-six months or more * * *.
"(a) Personal services. If at least 80 per centum of the total compensation for personal services covering a period of thirty-six calendar months or more (from the beginning to the completion of such services) is received or accrued in one taxable year by an individual or a partnership, the tax attributable to any part thereof which is included in the gross income of any individual shall not be greater than the aggregate of the taxes attributable to such part had it been included in the gross income of such individual ratably over that part of the period which precedes the date of such receipt or accrual."
Then Congress added Section 107(b) which we have quoted above, and the meaning of which is the question before us.
Section 107(a) concededly permits the taxpayer, if his work extended over a period of thirty-six months or more, to compute his taxes as if he had been paid monthly concurrently with his work, no matter when the work was done. If then, the plaintiff had been a lawyer who worked for more than three years and finished his work in 1931, but did not receive his fee until 1942, he could have computed his taxes at the rates in force in the years ending in 1931.
The Government says that the plaintiff, whose income was from a patent, and therefore covered by Section 107(b) cannot do as it admits that the lawyer could do, but must compute his tax as if the income received in 1942 had been earned in 1940, 1941, and 1942. In fact it was not earned in those years. To attribute to Congress an intention to relate the income of e.g., a lawyer, to the time when he did the work for which he was ultimately paid, but, in the next subdivision of the same section of the Code to relate the income of an inventor, not to the period when he did the work but to another period arbitrarily specified for the purpose, although nothing relevant occurred in two of the three years of that period, would be to attribute to Congress a lack of consistency.
Section 107(b) in its first sentence speaks of, inter alia, a patent "the work on which by such individual covered a period of thirty-six calendar months." In the second sentence it provides that the tax should not be more than it would have been if the income had "been received ratably over that part of the period preceding the close of the taxable year but not more than thirty-six calendar months." The expression "the period" in the second sentence refers, grammatically and logically, to the period referred to in the first sentence, which is the period when the work was done. The fact that the period referred to in the second sentence must precede the close of the taxable year suggests that it should immediately precede it, but the suggestion is not so strong as to enable the interpreter of the language to completely change the reference in the second sentence to "the period" from its grammatical and logical meaning and make it refer to a wholly different period.
We have said that Section 107(b) was, before enactment, contained in H.R. 7378, 77th Congress, 2nd Session. As enacted by the House of Representatives, its last sentence said perfectly plainly what the Government says is its meaning, as enacted, and as applied in this case. It said "the tax attributable (to the part of the income received in the taxable year) shall not be greater than the aggregate of the taxes attributable to such part had it been received ratably over the period of thirty-six calendar months ending with the close of the taxable year." We recognize that the change made in the language of the bill in the Senate, and in the bill as enacted may have been made primarily to limit the period of computation to the actual time of work on the invention preceding the close of the taxable year, in a case where in fact some of the necessary thirty-six months of work took place after the taxable year, yet the change also had, we think, the effect of eliminating the requirement of the House of Representatives' version which would have plainly fixed the period for computation as the months immediately preceding the close of the taxable year. The Committee on Finance of the Senate reported to the Senate, S. Rep. No. 1631, 77th Cong., 2nd Sess., pp. 108-109 (1942-2 Cum.Bull. 504, 586) that it had changed the House version so that the tax would be computed as if the income had been received "ratably over (1) the part of the period of the work which preceded the close of the taxable year, or (2) a period of 36 calendar months, whichever of such periods is the shorter." Here the reference to the "period of the work" is unmistakable, and it was this Committee's revision which was enacted into Section 107(b).
It may well be that Congress did not foresee the unusual situation which this case presents, and, for that reason did not clearly answer the question here presented. We think however, that if it had foreseen the situation, it would have answered it as we have, by relating the income and the tax to the time when the work which produced the income was done, and not to some other arbitrarily fixed and otherwise irrelevant period.
The plaintiff may recover upon his claim and the Government may not recover on its counterclaim, which is based upon the same contentions upon which it seeks to defeat the plaintiff's claim. Entry of judgment will be suspended to await the filing by the parties of a stipulation showing the amount, including interest as provided by law, which the plaintiff is entitled to recover.
It is so ordered.
JONES, Chief Judge, and HOWELL, WHITAKER and LITTLETON, Judges, concur.