Comm'r of Internal Revenue

Tax Court of the United States.Dec 7, 1954
23 T.C. 441 (U.S.T.C. 1954)
23 T.C. 441T.C.103 U.S.P.Q. 416

Docket No. 31244.



Adam Y. Bennion, Esq., and Stafford R. Grady, Esq., for the petitioner. James Powers, Esq., for the respondent.

Adam Y. Bennion, Esq., and Stafford R. Grady, Esq., for the petitioner. James Powers, Esq., for the respondent.

The taxpayer, a motion picture director, purchased a literary property, expecting to sell it to an independent motion picture producer and to direct a picture based upon the story. He was not a dealer in literary properties. Held, petitioner did not hold the literary property ‘primarily for sale to customers in the ordinary course of his trade or business' within the meaning of section 117(a)(1)(A) of the Internal Revenue Code of 1939, and the gain derived by him upon sale of the story must be treated as capital gain. Fred MacMurray, 21 T.C. 15.

The respondent determined a deficiency in the income tax of petitioner for the year 1947 in the amount of $50,525.94. The sole issue is whether the gain realized by petitioner upon the sale of the motion picture rights in and to a literary property entitled ‘Sorry, Wrong Number’ constituted long-term capital gain or ordinary income.


Petitioner is an individual currently residing in Paris, France, but who resided during the taxable year 1947 in Pacific Palisades, California. His income tax return for the taxable year was filed with the collector of internal revenue for the sixth district of California.

Petitioner was born in Russia, where he worked at an early age as an actor in a theater and later in motion pictures. He left Russia in 1924 and from then until 1929 was engaged in various capacities in the motion picture business in Germany and France. He directed his first motion picture in 1929, in Germany, and between then and 1936 he directed eight or nine pictures in Germany, France, and England, some of which were distributed in the United States. Because of the prominence he thus attained he was invited to the United States in 1936 to direct a motion picture. He decided to remain in this country, applied for citizenship papers, and became a United States citizen in 1940. He directed a motion picture for R.K.O. and then signed a contract with Warner Brothers for which he directed several pictures from 1937 until the outbreak of World War II. On September 29, 1941, he entered into a contract with Twentieth Century-Fox Film Corporation to direct three motion pictures at a salary of $60,000 per picture. After only one of these pictures had been directed, petitioner, on June 8, 1942, was granted a leave of absence under the contract so that he might serve in the armed forces of the United States. The leave of absence was terminated on February 17, 1947.

When the United States entered World War II petitioner went to Washington to ascertain if he could contribute in some way to the war effort. He was initially employed by the War Department as a civilian and then in April 1942 he received a commission as major in the United States Army, being assigned to the Motion Picture Division of the Signal Corps. He at first worked as director in the production of educational pictures for the soldiers. In November 1942, he asked for overseas duty and was assigned to the photographic unit of the Western Task Force which accompanied General Patton's army in the invasion of North Africa. He later was in charge of all photographic units in the Normandy landings, and accompanied the first shuttle bomb mission from England which landed in Russia. He went on terminal leave about the end of 1945 and was discharged from the Army in March 1946.

On July 31, 1946, petitioner entered into an agreement with Lucille Fletcher under which she granted and conveyed to petitioner the exclusive motion picture rights in and to a literary property entitled ‘Sorry, Wrong Number’ which had been written for and produced as a radio program under the name of ‘Suspense.’ Negotiations for the purchase had been commenced prior to May 28, 1946, and on that date petitioner made a down payment of $1,500 on the purchase price. Lucille Fletcher agreed in the contract of July 31, 1946 (as amended by a supplemental letter agreement of the same date), to write a screen treatment, which is usually a short synopsis of the literary work, on or before September 1, 1946. If petitioner accepted the screen treatment, as he did by letter dated December 30, 1946, the total purchase price was to be $15,000. This sum was paid by petitioner to Lucille Fletcher. The agreement provided that if he had rejected the screen treatment, the purchase price of the literary property itself, without the screen treatment, would have been $10,000, or, at his option, petitioner might have canceled the contract, in which event the literary property would revert to Lucille Fletcher and she could retain the $1,500 consideration originally paid.

Prior to the war, when the petitioner was under contract with major motion picture studios, he had little to say about the stories for his pictures, or the casting of them, or the manner in which they were directed. He was many times required to direct pictures which he did not want to direct. During the war the petitioner acquired a different perspective and concluded that this situation was detrimental to his career and that the important thing from the point of view both of his personal satisfaction and his future career was to make pictures which he thought were good ones. He therefore decided to deal with independent producers where he could be his own ‘boss' and could choose his own stories and cast and direct his pictures the way he liked. It was for this reason that he began negotiations with Charles Einfeld, hereinafter mentioned.

At the time petitioner purchased ‘Sorry, Wrong Number’ he hoped to be able to direct a motion picture based upon it. He commenced negotiations about the end of 1945 with Charles Einfeld (formerly director of advertising and exploitation at Warner Brothers) and David Loew (who had been connected with the motion picture industry), who were in the course of organizing an independent motion picture producing company. The negotiations progressed to the point that the attorneys for Einfeld and Loew prepared a draft of a 36-page contract which was submitted to petitioner in about April 1946. By that time Einfeld and Loew had caused the organization of a corporation known as Enterprise Productions, Inc. Petitioner owned no stock in that company. The draft of the contract contemplated that a producing company would be organized by petitioner, to be owned by petitioner and others whom he might care to bring in, and that during a period of 4 consecutive years the producing company would produce three motion pictures, which would be directed by petitioner. He would receive a salary of $100,000 per picture and the net profits from each picture would be divided equally between the producing company contemplated to be formed by petitioner and Enterprise Productions, Inc. Enterprise Productions, Inc., would supply the cost of the story material for the three photoplays and also provide the financing for the motion picture productions. The original negotiations were for the production of a series of pictures but in the draft of the contract the number was reduced to three.

The negotiations with Enterprise Productions, Inc., continued until the latter part of 1946. On May 26, 1946, prior to the purchase of ‘Sorry, Wrong Number,’ the petitioner purchased the motion picture rights to a book known as ‘Snake Pit’ for $75,000. The petitioner had become enthusiastic about this story and was determined to make a motion picture of it. At the time of this purchase the representatives of Enterprise Productions, Inc., had not decided whether they would be willing to make a picture based on this book. Petitioner purchased ‘Sorry, Wrong Number’ during the period when he was negotiating with Enterprise Productions, Inc., but he did not inform that company that he was purchasing the story because at the time of the purchase he felt that he was not far enough along in his negotiations to reveal that fact. On September 29, 1946, Enterprise Productions, Inc., bought the motion picture rights to a story known as ‘Coup de Grace.’ The petitioner was given to understand that this property had been purchased in anticipation of the parties' ultimately reaching an agreement and that he was morally responsible for their acquisition of it. The representatives of Enterprise Productions, Inc., liked ‘Coup de Grace’ but did not care much about ‘Sorry, Wrong Number’ or ‘Snake Pit,‘ particularly the latter. Petitioner intended that these three stories would form the basis of motion pictures to be directed by him under his anticipated agreement with Enterprise, if that agreement were consummated. Petitioner intended that ‘Sorry, Wrong Number’ and ‘Snake Pit’ would be transferred to the new producing company at petitioner's cost.

The agreement with Enterprise Productions, Inc., however, was never consummated, the principal reasons being that petitioner insisted upon ‘Snake Pit’ being one of the three motion pictures and when it came to a final decision Enterprise Productions, Inc., refused to produce it because of apprehension over the subject matter (it being the story of an insane asylum); and, also, Enterprise Productions, Inc., in the meantime had become involved with other interests in a large production under the name of ‘Arch of Triumph’ starring Ingrid Bergman. Accordingly, negotiations with petitioner fell through and were terminated in the latter part of 1946.

Petitioner was therefore faced with the necessity of making other arrangements with respect to ‘Snake Pit’ and ‘Sorry, Wrong Number.’ He tried to interest various producers in ‘Snake Pit’ and in the same type of an arrangement, i.e., an agreement whereby he would recover his cost of the story, direct the motion picture for his usual salary, and have an interest in the profits of the production. Each time the other party to the negotiations, although enthusiastic about the story, because fearful of the subject matter and refused to go through with the program, until petitioner finally despaired of being able to do anything with the story. Finally, he contacted Darryl Zanuck, who was in charge of production at Twentieth Century-Fox. Zanuck agreed to buy the story, ‘Snake Pit,‘ but insisted that it be an outright sale and refused to permit petitioner to have an interest in the profits. They therefore negotiated a sales price and petitioner sold the story, ‘Snake Pit,‘ to Twentieth Century-Fox at a profit on December 16, 1946.

With respect to the story, ‘Sorry, Wrong Number,‘ petitioner talked to Hal Wallis, whom he had known and worked with as the executive in charge of production at Warner Brothers and who had left Warner Brothers to form an independent production company known as Hal Wallis Productions, Inc. Hal Wallis liked the story and agreed to buy it. At that time both parties hoped that petitioner would be able to direct the picture; but petitioner was then engaged in directing another picture and had a commitment to direct still another for Twentieth Century-Fox. Hence, petitioner could not promise Wallis when he would be able to direct ‘Sorry, Wrong Number,‘ and Wallis then inquired whether petitioner would sell the story outright, even if he could not direct it and whether he would sign an employment contract to direct a motion picture for Hal Wallis Productions, Inc., which might not be ‘Sorry, Wrong Number.’ Petitioner replied that he would be willing to sell the story under such circumstances if a satisfactory price could be agreed upon, although he was greatly interested in the story and hoped it would work out that he could direct the picture to be based upon it.

After negotiations between the parties and their attorneys the following agreements were entered into and carried into execution:

a. On March 1, 1947, an employment agreement was entered into under which Hal Wallis Productions, Inc., employed petitioner to direct a motion picture for a salary of $110,000, which at that time was the highest salary he had ever received for directing a motion picture. The employment agreement did not designate the picture that would be directed by petitioner and there was no tie-in between the employment agreement and the sale of the story, ‘Sorry, Wrong Number.’

b. On March 31, 1947, an agreement of sale was entered into under which petitioner sold to Hal Wallis Productions, Inc., for the sum of $96,500 the motion picture rights in and to the literary property, ‘Sorry, Wrong Number,’ together with the agreement of July 31, 1946, by which he had acquired such literary property from Lucille Fletcher. Petitioner received the selling price of $96,500 on April 8, 1947. This was a fair price for the literary property.

c. On March 31, 1947, petitioner sold to Hal Wallis Productions, Inc., for the sum of $3,500 the screen treatment which Lucille Fletcher had written for ‘Sorry, Wrong Number.’

d. Under the agreement of July 31, 1946, petitioner had the right to employ Lucille Fletcher at $500 per week to write a screenplay based upon ‘Sorry, Wrong Number’; and on March 31, 1947, petitioner granted Hal Wallis Productions, Inc., an option to acquire from him the screen play thus to be written upon repayment to petitioner of the salary he may have paid Lucille Fletcher for writing it, but not to exceed $7,500. The screenplay was thereafter written by Lucille Fletcher for a salary of $5,500, and on July 31, 1947, Hal Wallis Productions, Inc., exercised its option to acquire the screenplay and reimbursed petitioner for the amount of $5,500.

e. On March 31, 1947, petitioner agreed within 60 days to procure Lucille Fletcher's approval of two letters of clarification of the basic agreement of July 31, 1946, failing which Hal Wallis Productions, Inc., could rescind the purchases of the literary property and the screen treatment and petitioner would be obliged to refund the $100,000 consideration. On May 19, 1947, the 60-day period was extended to 90 days (or to June 30); and the approval of Lucille Fletcher was finally obtained.

f. It finally worked out that petitioner was able to and did direct the motion picture, ‘Sorry, Wrong Number,‘ under his employment contract with Hal Wallis Productions, Inc.

Enterprise Productions, Inc., after its negotiations with petitioner had fallen through, attempted to do something with the story, ‘Coup de Grace,’ which had been purchased with the intent that it be one of the three pictures to be directed by petitioner. Failing in this attempt, it asked petitioner if he would take the story off its hands and he felt morally obligated to do so. Believing that Cary Grant would be a good actor for the male lead in the picture, petitioner inquired whether he would be interested in purchasing a half interest in ‘Coup de Grace.’ After reading the story, Grant was interested; and he and petitioner each contributed one-half of the $28,000 for which they purchased the story from Enterprise Productions, Inc., on February 15, 1947. Grant was very busy at that time, as was petitioner, and they had an indefinite hope that at some time within the next 12 or 16 months their respective schedules would work out so that they could make a motion picture based upon ‘Coup de ?grace.’ Sometime in 1947 Charles Vidor, a director at Columbia Pictures Corporation, heard of the story and asked petitioner whether he intended to do anything with it. Petitioner talked the matter over with Grant and they came to the conclusion that it might be 3 years before they could get around to doing anything with it and at that time the story might not be timely. Hence, they concluded to sell it and they negotiated the best price they could for the story. Grant insisted that petitioner receive a little more than half of the sales price, inasmuch as he had initiated the transaction. The story was sold to Columbia at a profit on January 8, 1948, and neither petitioner nor Grant had any further connection with the story.

The foregoing transactions were the only purchases and sales by petitioner of literary properties except for the following circumstances: Petitioner was acquainted with a French newspaperman and novelist by the name of Joseph Kessell. In a period from 1935 to 1937 petitioner had made loans to Kessell in the aggregate amount of about $3,000, which the latter found difficult to repay. Petitioner happened to meet Kessell in London in 1943. Kessell was embarrassed about never having repaid the debt. Kessell had written on a few sheets of paper five ideas for short stories and petitioner accepted the ideas in cancellation of the indebtedness. Later, in 1944, petitioner was in need of money, the Government having filed an income tax lien on his property, and he interested Jack Benny in one of the five short stories. Petitioner sold the short story on May 29, 1944. The motion picture to be based on that story fell through and was never made. In 1946, just after he had been discharged from the Army, and again in need of money, petitioner directed a motion picture, ‘Long Night,‘ which was a remake of a French picture. While he was directing this picture, it became apparent that the picture needed a new ending, and petitioner interested the producers in another of the five short short stories, to be used as the ending. They agreed and petitioner sold them the story on July 1, 1946.

The petitioner's primary intention in acquiring ‘Snake Pit,’ ‘Sorry, Wrong Number,‘ and ‘Coup de Grace’ was to obtain material for his duties as a director. With respect to the five stories obtained for cancellation of the debt of Joseph Kessell, he merely ‘hoped for the best.’ As matters actually worked out, one of these stories was sold to a studio and used as material for his duties as a director, and one other was sold to a producing company but was never made into a picture and the petitioner had no further connection with it.

For the years 1946, 1947, and 1948 the petitioner reported on his income tax return, salary from his occupation as a director, such salary after deduction of business expenses, and gain from the sale of story rights being as follows:

+----------------------------------------+ ¦ ¦ ¦Salary less¦Gain from sale¦ +----+--------+-----------+--------------¦ ¦ ¦Salary ¦business ¦of story ¦ +----+--------+-----------+--------------¦ ¦ ¦ ¦expense ¦rights ¦ +----+--------+-----------+--------------¦ ¦1946¦$105,000¦$66,174.58 ¦$89,000.00 ¦ +----+--------+-----------+--------------¦ ¦1947¦111,000 ¦61,729.54 ¦ FN1 Before application of 50 per cent.FN2 Includes $35,000 of proceeds from sale of “Snake Pit,” sold in 1946, which was returned in 1947 but eliminated from 1947 income in the statutory notice.

125,500.00¦ +----+--------+-----------+--------------¦ ¦1948¦114,250 ¦71,119.29 ¦27,777.78 ¦ +----------------------------------------+

In the notice of deficiency respondent determined that the gain realized by petitioner on the sale of the literary property, ‘Sorry, Wrong Number,’ constituted ordinary income and not a long-term capital gain as reported by petitioner in his return for the year 1947.

The literary property, ‘Sorry, Wrong Number,‘ was held by petitioner for more than 6 months. It was not held by petitioner primarily for sale to customers in the ordinary course of his trade or business.


RAUM, Judge:

The question for decision is whether petitioner derived capital gain, rather than ordinary income, upon the sale of the literary property, ‘Sorry, Wrong Number.’ The only statutory provision relied upon by the Commissioner is section 117(a)(1)(A) of the Internal Revenue Code of 1939, which defines ‘capital assets' to mean ‘property held by the taxpayer (whether or not connected with his trade or business),‘ but not to include ’ * * * property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.' At the end of the trial, the Court indicated its conclusions that, although the literary property in question had been held by petitioner in connection with his trade or business of being a director, it was not held by him primarily for sale to customers in the ordinary course of trade or business. The Court also announced its conclusion that the literary property had been held for more than 6 months. Thereafter, respondent requested permission to file a brief. Briefs have been filed by both parties, and they have been considered.

Respondent's brief does not challenge the findings of fact that were announced or were implicit in the conclusions announced by the Court at the end of the trial. Respondent does not now appear to contest the conclusion that the literary property was held for more than 6 months, or that petitioner was not engaged in the business of dealing in literary properties, either as a separate business, or as an adjunct to his being a director. Respondent's position is a legal one, based upon his interpretation of section 117(a)(1)(A), that since petitioner admittedly held the literary property, intending to sell it in connection with his trade or business of being a director, it was not a capital asset within the meaning of the provisions quoted above, because, in respondent's view, the provisions dealing with property held primarily for sale to customers in the ordinary course of trade or business were intended to have a limiting effect only in the case of speculators or traders in securities.

Respondent's brief does indeed persuasively show that Congress was preoccupied with the problems of speculators and traders in securities when these provisions finally took form, and there appears much to be said in favor of limiting the provisions to speculators and traders. However, the statutory language is not so limited, and we do not see how we would be justified in rewriting the statute to attain that objective. The problem is a legislative one. As the statute is now written, it would require a distortion of the statutory language to read the words ‘held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business' so as to mean merely held for sale in connection with trade or business except in the case of speculators or traders, where the statute is to be given its normal interpretation.

The issue here is not different from the comparable issue in Fred MacMurray, 21 T.C. 15, and we reach the same result in this case. The Commissioner has announced his acquiescence in the MacMurray decision. 1954-1 C.B. 5.

Decision will be entered under Rule 50.