Comm'r of Internal Revenue

Tax Court of the United States.Oct 31, 1956
27 T.C. 265 (U.S.T.C. 1956)
27 T.C. 265T.C.111 U.S.P.Q. 315

Docket No. 55207.



Richard H. MacCracken, Esq., for the petitioners. Richard W. Janes, Esq., for the respondent.

Richard H. MacCracken, Esq., for the petitioners. Richard W. Janes, Esq., for the respondent.

In 1945, petitioner assigned his full right, title, and interest in an invention, subsequently patented, to his employer in consideration of a percentage of the sales price of the item when marketed. The invention had been perfected on his own time but work on a pilot model thereof had been done on the employer's premises with its material and with the help of two other employees. In 1951 and 1952, petitioners reported payments received under the 1945 agreement as long-term capital gains from the sale of a patent. Held, such shop rights as petitioner's employer had in the invention did not dilute petitioner's ‘substantial rights' in his patent within the meaning of section 117(q) of the 1939 Code, and the amounts received in 1951 and 1952 were properly reported by him as long-term capital gains.

This proceeding involves deficiencies in income tax for the years 1951 and 1952 in the respective amounts of $12,343.28 and $9,560.42.

The sole issue is whether amounts which petitioner, Hans Jordan, received during the years in issue were the proceeds from the sale of a patent and, therefore, taxable as long-term capital gains under the provisions of section 117(q) of the 1939 Code.

This case was first submitted to the Court sitting at Los Angeles, California, on January 30, 1956, on a full stipulation of the facts. On joint motion of the parties, the case was reopened on April 9, 1956, to receive the testimony of petitioner, Hans Jordan, and one other witness.

Some of the facts were stipulated.


The stipulated facts are so found and are incorporated herein by this reference.

Hans Jordan (hereinafter referred to as the petitioner) and his wife, Trudy Jordan, were residents of Los Angeles, California, during the years in issue and filed their joint income tax returns for such years with the former collector of internal revenue for the sixth district of California.

Petitioner is an electrical engineer and was educated in Germany.

Early in 1941, petitioner was employed by the Given Machinery Company, a partnership, to make drawings of a variable drive device to be used on machine tools. In the fall of 1941, he was employed temporarily by another firm, but late in 1941 returned to the employment of the Given Machinery Company. From that time to the end of World War II, his duties with Given Machinery Company were in connection with its various contracts for war production. During the course of his employment he became the chief engineer for the company.

In 1942, petitioner began thinking of his future after the termination of the war. He approached Bert Given, the managing partner of the machinery company, with the proposition that if he, petitioner, conceived of an invention which could be profitably manufactured, Given Machinery Company would undertake to manufacture the invention and pay him a royalty thereon.

In the summer of 1943, petitioner conceived of the idea of a waste disposal unit. Bert Given thought the idea a good one, and suggested that petitioner develop it. Petitioner did so on his own time and toward the end of 1943, with the help of two other Given Machinery Company employees who were paid by Given, made a pilot model on the company's premises from materials which it bought. The model was tested in Bert Given's home and proved to be successful. The parties stipulated that the basic invention had been reduced to actual practice by the petitioner in the latter part of 1943, and more than 6 months prior to August 22, 1945.

On such latter date, petitioner entered into an agreement with Given Machinery Company, assigning to it his full right, title, and interest in the patent on the waste disposal unit. The pertinent provisions of the agreement are set forth below:

WHEREAS, JORDAN has invented a garbage disposal device on which an application for United States Letters Patent has been prepared * * * ; and

WHEREAS, JORDAN invented the subject matter of said application as a part of his duties while employed by GIVEN and at GIVEN'S direction and expense; and

WHEREAS, GIVEN desires to acquire and JORDAN is willing to part with the full right, title, and interest in and to said JORDAN PATENT RIGHTS upon the terms set forth hereinafter,

NOW, THEREFORE, in consideration of the mutual covenants contained herein, the parties agree as follows:

1. JORDAN hereby agrees to assign currently herewith to GIVEN the full right, title, and interest in and to the JORDAN PATENT RIGHTS, and to execute now or in the future any and all legal documents which are in the opinion of GIVEN reasonably necessary to convey the same to GIVEN or establish his right thereto, and to take any and all lawful oats in connection with said JORDAN PATENT RIGHTS which are in the opinion of GIVEN reasonably necessary to secure the filing, granting, or protection of the JORDAN PATENT RIGHTS or any of them.

2. GIVEN hereby agrees to pay to JORDAN on each and every complete garbage disposal device sold by GIVEN which embodies any invention disclosed and claimed in the JORDAN PATENT RIGHTS, or any of them, and which claim has been allowed by the United States Patent Office, an earned royalty of One percent (1%) of the net selling price received by GIVEN therefore. * * *

4. In the event that GIVEN fails to offer for sale on the open market prior to January 1, 1947, garbage disposal devices disclosed or claimed in the JORDAN PATENT RIGHTS, JORDAN within sixty (60) days thereafter may by written notice thereof delivered to GIVEN terminate this agreement, and in such event GIVEN agrees to promptly reassign all of the JORDAN PATENT RIGHTS to JORDAN, * * *

On December 18, 1947, the Given Machinery Company assigned its exclusive right to make, use, and sell petitioner's invention to the Given Manufacturing Company, a corporation, which undertook to pay petitioner the payments to which he was entitled under the agreement of August 22, 1945.

Petitioner was granted a patent on June 8, 1948.

In 1951, petitioner received $43,309.53 under the provisions of the 1945 agreement and in 1952 he received $32,251.87. On the joint income tax returns filed for those years, the petitioners reported such sums as the proceeds from the sale of the patent, taxable as long-term capital gains.

The respondent determined that such sums constituted the receipt of ordinary income.

On or about the 17th day of February 1955, and subsequent to the filing of the petition herein, petitioners paid to the district director of internal revenue at Los Angeles the sum of $12,000 for the year 1951 and the sum of $9,500 for the year 1952 to apply on the deficiencies determined by the respondent in his notice of deficiency.


RICE, Judge:

Section 117(q) of the 1939 Code provides that the transfer of all substantial rights to a patent shall be considered as the sale or exchange of a capital asset held for more than 6 months. That subsection of section 117 was added by Public Law 629, 84th Congress, 70 Stat. 404 (1956). Its provisions are substantially identical to section 1235 of the 1954 Code. Section 117(q) is applicable to taxable years beginning after May 31, 1950. The question before us here is whether the petitioner transferred ‘all substantial rights' in his patent within the meaning of the statute.

SEC. 117. CAPITAL GAINS AND LOSSES.(q) TRANSFER OF PATENT RIGHTS.—(1) GENERAL RULE.— A transfer (other than by gift, inheritance, or devise) of property consisting of all substantial rights to a patent, or an undivided interest therein which includes a part of all such rights, by any holder shall be considered the sale or exchange of a capital asset held for more than 6 months, regardless of whether or not payments in consideration of such transfer are—(A) payable periodically over a period generally coterminous with the transferee's use of the patent, or(B) contingent on the productivity, use, or disposition of the property transferred.(2) ‘HOLDER’ DEFINED.— For purposes of this subsection, the term ‘holder’ means—(A) any individual whose efforts created such property, or(4) APPLICABILITY.— This subsection shall apply with respect to any amount received, or payment made, pursuant to a transfer described in paragraph (1) in any taxable year beginning after May 31, 1950, regardless of the taxable year in which such transfer occurred.

See S. Rept. No. 1941, 84th Cong., 2d Sess. (1956).

The respondent contends that petitioner did not transfer all substantial rights because, by virtue of that clause in the agreement of August 22, 1945, which reads:

WHEREAS, JORDAN invented the subject matter of said application as a part of his duties while employed by GIVEN and at GIVEN'S direction and expense;

he possessed no substantial patent rights to transfer. We think that argument without merit.

When this case was reopened, the Court heard the testimony of petitioner and of Bert Given. Both witnesses made it clear that there was no agreement that the Givens would have any legal interest in any invention which petitioner might perfect and patent. Neither remembered why the clause on which respondent bases his argument was included in the agreement. Bert Given testified that the lawyer who drew the agreement probably inserted it on his own initiative. Petitioner testified that had his English been as good in 1945 as it was at the time of the hearing, he would have insisted that the clause be eliminated. He testified further that the only provision in the agreement in which he was vitally interested at the time was the one guaranteeing to him the return of his patent rights if the Givens failed to offer the disposal device for sale on the open market prior to January 1, 1947. Both witnesses also testified that petitioner invented the device on his own time.

The only interest which the Givens could have possessed in petitioner's invention was a so-called shop right; and that right we think insufficient to dilute petitioner's ‘substantial rights to a patent,‘ within the meaning of the statute. As the Supreme Court said in United States v. Dubilier Condenser Corp., 289 U.S. 178, 187-189 (1933):

One employed to make an invention, who succeeds, during his term of service, in accomplishing that task, is bound to assign to his employer any patent obtained. The reason is that he has only produced that which he was employed to invent. His invention is the precise subject of the contract of employment. A term of the agreement necessarily is that what he is paid to produce belongs to his paymaster. Standard Parts Co. v. Peck, 264 U.S. 52. On the other hand, if the employment be general, albeit it cover a field of labor and effort in the performance of which the employee conceived the invention for which he obtained a patent, the contract is not so broadly construed as to require an assignment of the patent. Hapgood v. Hewitt, 119 U.S. 226; Dalzell v. Dueber Watch Case Mfg. Co., 149 U.S. 315. * * *

The reluctance of courts to imply or infer an agreement by the employee to assign his patent is due to a recognition of the peculiar nature of the act of invention, * * *

* * * Recognition of the nature of the act of invention also defines the limits of the so-called shop-right, which shortly stated, is that where a servant, during his hours of employment, working with his master's materials and appliances, conceives and perfects an invention for which he obtains a patent, he must accord his master a non-exclusive right to practice the invention. McClurg v. Kingsland, 1 How. 202; Solomons v. United States, 137 U.S. 342; Lane & Bodley Co. v. Locke, 150 U.S. 193. This is an application of equitable principles. Since the servant uses his master's time, facilities and materials to attain a concrete result, the latter is in equity entitled to use that which embodies his own property and to duplicate it as often as he may find occasion to employ similar appliances in his business. But the employer in such a case has no equity to demand a conveyance of the invention, which is the original conception of the employee alone, in which the employer had no part. This remains the property of him who conceived it, together with the right conferred by the patent, to exclude all others than the employer from the accruing benefits. These principles are settled as respects private employment.

We are satisfied that at the time petitioner assigned his patent rights in the waste disposal unit, he had ‘substantial rights' to transfer within the meaning of section 117(q). It, therefore, follows that the amounts received by him during the years in issue were taxable as capital gains and not as ordinary income.

Decision will be entered for the petitioners.