Philbrick
v.
Comm'r of Internal Revenue

Tax Court of the United States.Nov 26, 1956
27 T.C. 346 (U.S.T.C. 1956)
27 T.C. 346T.C.

Docket No. 53780.

1956-11-26

F. H. PHILBRICK AND FLORENCE PHILBRICK, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Harold R. Burnstein, Esq., John W. Hughes, Esq., and John E. Hughes, Esq., petitioners. John E. Owens, Esq., for the respondent.


Harold R. Burnstein, Esq., John W. Hughes, Esq., and John E. Hughes, Esq., petitioners. John E. Owens, Esq., for the respondent.

One of the petitioners, an inventor, granted an exclusive license to a corporation to make, use, and sell, throughout the world, machines embodying the inventions set forth in certain letters patent and applications for letters patent, and also any and all improvements and inventions relating to such machines which he might devise or acquire during the term of such license agreement. Held, that the transfer of patent rights effected by such license agreement must, under the provisions of section 117(q) of the 1939 Code, be considered the sale or exchange of capital assets held for more than 6 months; and that gains derived by the petitioner from the payments received pursuant to such license agreement are taxable as long-term capital gains. Held, further, that an issue, which respondent raised for the first time on brief, was not adequately or timely raised, and therefore is not property before the Court.

The respondent determined deficiencies in the income taxes of the petitioners for the calendar years 1951 and 1952, in the respective amounts of $9,025.53 and $14,059.87.

The issue for decision is whether payments of $33,526.65 and $44,920.28, which petitioner Frank H. Philbrick received in the taxable years 1951 and 1952, respectively, under the terms of an exclusive patent license agreement, are taxable as long-term capital gains, or as ordinary income from ‘royalties.’

FINDINGS OF FACT.

Certain facts have been stipulated, and the stipulation with attached exhibits is incorporated herein by reference.

Petitioners are husband and wife; and for each of the years involved they filed a joint income tax return with the director of internal revenue at Chicago, Illinois.

Petitioner Frank H. Philbrick (hereinafter called Philbrick) is an engineer. In about 1926 he and one Jackson organized a corporation known as Power Ballaster Company, for the purpose of selling machines used in the maintenance of railroad rights-of-way. Jackson had a patent on a ballast tamping machine, which had been issued to him in October 1925; and, in June 1931, he obtained another patent on a machine for digging ballast from between railroad ties. The above-mentioned corporation sold machines covered by these Jackson patents until about 1933, when Philbrick bought all of Jackson's shares of stock, dissolved the corporation, and agreed to pay Jackson royalties for continued use of the latter's patents.

After thus acquiring Jackson's interest in the business, Philbrick and his wife, petitioner Florence Philbrick, organized a partnership under the name of Power Ballaster Company to carry on the business which had theretofore been operated by the corporation, and to sell machines covered by the Jackson patents. This partnership had no manufacturing facilities; and arranged to have the machines which it sold manufactured by other parties.

Philbrick found, however, that machines made under the Jackson patents were inadequate to meet competition; and he began to develop improved machines and to obtain patents on the same. His first invention was an improved machine for digging ballast, for which he filed an application for letters patent on November 18, 1935, and in respect of which United States Patent No. 2.082.594 was issued to him on June 1, 1937. Prior to this, he had made no inventions and had obtained no patents. In subsequent years, he originated several other improved machines used in the maintenance of railroad rights-of-way; and by March 1947, he had obtained 5 United States patents and 1 Canadian patent, had an application pending for another United States patent, and had other inventions on which he was about to file applications for patents.

Philbrick was the owner of the entire right, title, and interest in and to all of the above-mentioned inventions, patents, and patent applications; and they all were used by him solely in connection with the machines sold by the Power Ballaster partnership. Prior to the exclusive license agreement of March 21, 1937, which is hereinafter mentioned, he made no attempt to sell any of them, or to license anyone to manufacture under them. None of said inventions, patents, and patent applications were at any time held by Philbrick, or by the Power Ballaster partnership, primarily for sale to customers in the ordinary course of his or its trade or business.

In 1946 the New York Central Railroad Company, which had been using certain of the improved machines that Philbrick had developed, placed an order for several of these machines with the Power Ballaster partnership. The railroad was concerned, however, as to whether the partnership could, with its limited facilities, deliver a sufficient number of these machines; and therefore, with Philbrick's consent, it contacted other equipment supply companies with the idea of arranging with someone else to do the manufacturing. Among the companies which it so contacted was Pullman-Standard Car Manufacturing Company (hereinafter called the Pullman Company). This company investigated the machines, without Philbrick's knowledge; and, early in March 1947, it proposed to Philbrick that it would buy his several inventions and patents, and also that it would buy from the Power Ballaster partnership certain of its physical assets and unfilled orders, including the order from the New York Central Railroad Company.

Philbrick was then 65 years of age, and he was desirous of getting out of the strenuous business in which he was engaged. Accordingly, on March 21, 1947, he, the Power Ballaster partnership, and the Pullman Company executed a memorandum of agreement (hereinafter called the exclusive license agreement), which provided, so far as here material, as follows:

MEMORANDUM OF AGREEMENT Made and entered into this 21st day of March, 1947, by and between FRANK H. PHILBRICK of Chicago, Illinois (hereinafter referred to as the ‘Licensor’), party of the first part, FRANK H. PHILBRICK and FLORENCE G. PHILBRICK, copartners doing business under the name and style of POWER BALLASTER COMPANY, party of the second part, and the PULLMAN-STANDARD CAR MANUFACTURING COMPANY, a corporation organized and existing under the laws of the State of Delaware (hereinafter referred to as the ‘Licensee’), party of the third part.

WITNESSETH: THAT WHEREAS the Licensor is owner of the whole right, title and interest in and to the following letters patent and applications for letters patent, viz.:

U.S. Patent No. 2082594 dated June 1, 1937, entitled IMPROVEMENT IN MACHINES FOR DIGGING BALLAST;

U.S. Patent No. 2107639 dated February 8, 1938, entitled RAILWAY BALLASTING MACHINE;

U.S. Patent No. 2242793 dated May 20, 1941, entitled IMPROVEMENT IN DIGGING TOOLS;

U.S. Patent No. 2272429 dated February 10, 1942, entitled IMPROVEMENT IN BALLAST CLEANING APPARATUS;

U.S. Patent No. 2309719 dated February 2, 1943, entitled IMPROVEMENT IN APPARATUS FOR HANDLING BALLAST IN ROADBEDS;

Letters Patent of the Dominion of Canada No. 408777 dated November 24, 1942, entitled IMPROVEMENT IN BALLAST CLEANING APPARATUS;

An application for Letters Patent of the U.S. filed October 1, 1945, serially numbered 619,585, entitled IMPROVEMENT IN BALLAST TAMPING MACHINE;

Certain improvements in ballast tamping machines upon which applications for Letters Patent of the United States are about to be filed;

and

WHEREAS, Power Ballaster Company, a copartnership composed of Frank H. Philbrick and Florence G. Philbrick, has been engaged in the manufacture and sale of machines or equipment embodying the improvements of some of the foregoing patents and applications; and

WHEREAS, the Licensee is desirous of engaging in the business relating to the manufacture and sale of machines and devices embodying the improvements set forth in the aforesaid Letters Patent and applications and is desirous of acquiring from the Licensor and the aforesaid copartnership certain assets hereinafter more particularly defined and also is desirous of acquiring an exclusive license, together with the right to grant sublicenses, to make, to use, and to sell, and to have made for it, machines and devices embodying the aforesaid improvements;

NOW, THEREFORE, in consideration of the premises and the mutual considerations hereinafter set forth, the parties hereto have agreed and do hereby agree as follows:

1. The Licensor hereby grants the Licensee an exclusive license, together with the right to grant sublicenses, to make, to use, and to sell, and to have made for it, throughout the world, machines, apparatus and devices embodying the inventions set forth in the aforesaid Letters Patent and applications and any and all improvements therein and all other inventions relating to machines for tamping or for digging or for cleaning ballast which the Licensor may devise or acquire during the term of this Agreement, subject to the terms and conditions hereinafter set forth.

2. The Licensor and said Power Ballaster Company jointly and severally agree to deliver to the Licensee possession of and title to the physical assets of the aforesaid Power Ballaster Company, a copartnership, such assets to include the patterns, jigs, drawings and files now in the possession of the said Power Ballaster Company.

3. The Licensee agrees to pay the Licensor concurrently with the execution and delivery of this Agreement the sum of Fifty Thousand Dollars ($50,000.00).

4. The Licensee agrees:

(a) To pay the Licensor a royalty of Twelve Hundred Dollars ($1200.00) upon each of the first fifty (50) ballast tamping machines manufactured and sold by the Licensee as and when payment is received by Licensee, and a royalty of five per cent (5%) on the net selling price as and when payment is received by the Licensee, less transportation charges and all sales, occupation, use and excise taxes if and to the extent included in such price, of all other and additional machines, apparatus or devices and repair or replacement parts therefor manufactured and sold under the foregoing license. * * *

5. The Licensor and the Power Ballaster Company jointly and severally have heretofore transferred and conveyed to the Licensee orders from The New York Central Railroad Company for twenty (20) tamping machines, which orders are to be executed by Licensee. * * *

8. It is understood and agreed that the foregoing license includes machines for digging ballast, machines for tamping ballast and machines for cleaning ballast, and that the Licensee shall use reasonable efforts in the manufacture and sale of each of said types of machines. It is further understood and agreed that in the event the Licensee fails to use reasonable efforts in the manufacture and sale of any one or more of the said types of machines, and in the event no sublicense is outstanding upon which royalties are accruing to Licensor on such type or types of machines, and no reasonably based claim for liability for alleged patent infringement by such type or types is pending, and such failure shall continue for a period of ninety (90) days after notice thereof in writing from the Licensor to the Licensee, the the exclusiveness of the license herein granted will respect to such type or types of machines shall cease and be determined and thereafter the Licensor shall have the right, upon thirty (30) days' notice in writing to the Licensee, to manufacture, use and sell, and to grant licenses to others to manufacture, use and sell such type or types of machines.

11. In the event of a breach or default by either party in the performance of this Agreement, the aggrieved party shall have the right to terminate this Agreement upon ninety (90) days' notice in writing to the other, provided that the default shall not be cured or the breach remedied within said ninety (90) day period. Unless terminated as hereinbefore provided, this Agreement shall remain in force during the life of the patents which have been or may be granted covering the inventions embraced by the foregoing license.

12. The Licensor agrees to prosecute the aforesaid applications for Letters Patent of the United States, and also applications for Letters Patent of the United States upon all additional improvements covered by the foregoing license, to a conclusion. Licensor further agrees to apply for and prosecute applications for patents on the licensed improvements in such foreign countries as the Licensee may from time to time elect, provided that the Licensee shall pay the costs of obtaining and maintaining such foreign patents, which costs are to be deducted from royalties accruing to the Licensor from the manufacture and/or sales in such foreign countries, respectively.

15. The Licensor represents and warrants that no license or right such as to be in conflict with the provisions hereof has heretofore been granted or agreed to be granted.

Also on March 21, 1947, Philbrick and the Pullman Company executed another agreement (hereinafter called the employment contract), which provided, so far as here material, as follows:

1. Pullman hereby employs Philbrick for the term commencing on the first day of April, 1947, and ending on the 30th day of September, 1948, and from month to month thereafter, subject, however, to the termination provisions hereinafter set forth. Throughout the term of this Agreement Philbrick shall devote his entire time and energy in the performance of such services and functions in connection with the development, manufacture, sale and servicing of machines for tamping ballast, machines for digging ballast and machines for cleaning ballast, as Pullman may from time to time direct.

2. Philbrick hereby accepts said employment and agrees, during the term of this Agreement, faithfully and to the best of his ability to devote his entire time and energy in discharging the duties which may from time to time devolve upon him hereunder.

3. It is understood and agreed that all inventions and improvements relating to machines for tamping ballast or for digging ballast or for cleaning ballast, developed by Philbrick during said term, shall be the property of Philbrick, that any and all such inventions and improvements shall be included in and shall be subject to the aforesaid exclusive license, and that all other inventions and improvements he may devise during his employment which either relate to devices or machines dealt in by Pullman or which are developed in the course of his employment, shall be the property of Pullman.

4. Pullman agrees to pay Philbrick for his said services at the rate of One Thousand Dollars ($1,000) per month, payable in equal semi-monthly instalments on the 15th and last days of each month of said term.

5. It is also understood and agreed that this Agreement is for the personal services of Philbrick and is not subject to assignment by him.

Subsequent to the execution of the two above-mentioned agreements, Philbrick obtained additional patents covering the following improvements on his original inventions, all of which were subject to the exclusive license agreement with Pullman:

+-----------------------------------------------------------------------------+ ¦ ¦Application ¦Patent ¦ +------------------------------------------------+-------------+--------------¦ ¦ ¦filed ¦issued ¦ +------------------------------------------------+-------------+--------------¦ ¦Machines to tamping ballast ¦Aug. 13, 1947¦Sept. 20, 1949¦ +------------------------------------------------+-------------+--------------¦ ¦Ballast tamping machines (application mentioned ¦ ¦ ¦ +------------------------------------------------+-------------+--------------¦ ¦in license agreement) ¦Oct. 1, 1945 ¦Jan. 2, 1951 ¦ +------------------------------------------------+-------------+--------------¦ ¦Ballast digging machines ¦Nov. 17, 1947¦Nov. 4, 1952 ¦ +------------------------------------------------+-------------+--------------¦ ¦Machines for tamping railway ballast ¦Mar. 24, 1950¦Dec. 14, 1954 ¦ +------------------------------------------------+-------------+--------------¦ ¦Cushioning mechanism for drop-head of displacing¦ ¦ ¦ +------------------------------------------------+-------------+--------------¦ ¦machine ¦Feb. 4, 1952 ¦Jan. 6, 1955 ¦ +-----------------------------------------------------------------------------+

Also subsequent to the execution of the above agreements, Philbrick obtained another patent on a machine which did not progress beyond the experimental stage; and he purchased a patent known as the Donovan patent. No payments in respect of either of these two latter patents are here involved. Likewise, no portion of the amounts here involved was paid in respect of either of the above-mentioned Jackson patents, one of which had expired prior to the execution of the exclusive license agreement.

During the taxable year 1951, the Pullman Company paid Philbrick $33,526.65 pursuant to the terms of the exclusive license agreement; and during the year 1952, it paid him $44,920.28 pursuant to said license agreement. In addition, the Pullman Company paid Philbrick $12,000 in each of said years, pursuant to the above-mentioned employment contract. The parties have stipulated that said sums of $33,526.65 and $44,920.28 were paid pursuant to the provisions of paragraph 4(a) of said exclusive license agreement.

Philbrick, in the joint income tax returns which he filed with his wife for the years 1951 and 1952, reported the sums received under the exclusive license agreement as long-term capital gains, without claiming any cost basis; and he reported the amounts received pursuant to the employment contract as ordinary income, representing compensation for personal services. The respondent, in his notice of deficiency, made no adjustment with respect to the income from personal services; but he determined that each of the sums received pursuant to the exclusive license agreement constituted ‘royalties' which were taxable as ordinary income.

OPINION.

PIERCE, Judge:

The notice of deficiency herein was issued prior to the enactment of Public Law 629, approved on June 29, 1956, which amended section 117 of the Internal Revenue Code of 1939 (relating to capital gains and losses) by adding at the end thereof a new subsection (q), relating to transfer of patent rights. Also the trial of the present case was had, and the briefs of both parties were filed, prior to such enactment. The petitioners have, however, now invoked said amendatory statute, by letter addressed to the Court with a copy mailed to respondent's counsel. The respondent has not advised the Court of his position respecting the same.

Pub. L. 629, 84th Cong., 2d Sess., ch. 464 (H.R. 6143 , 70 Stat. 404.Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled, That section 117 of the Internal Revenue Code of 1939 (relating to capital gains and losses) is hereby amended by adding at the end thereof a new subsection as follows:(q) TRANSFERS 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(B) any other individual who has acquired his interest in such property in exchange for consideration in money or money's worth paid to such creator prior to actual reduction to practice of the invention covered by the patent, if such individual is either—(i) the employer of such creator, nor(ii) related to such creator (within the meaning of paragraph (3)).(3) EXCEPTIONS.— This subsection shall not apply to any transfer described in paragraph (1)—(A) by a nonresident alien individual, or(B) between an individual and any related person.For purposes of this paragraph, the term ‘related person’ means a person, other than a brother or sister (whether of the whole or half blood), with respect to whom a loss resulting from the transfer would be disallowed under section 24(b).(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.

I.

Prior to considering the application of this new section 117(q), it is necessary to define the nature and scope of the issue here presented. In the notice of deficiency, the respondent made only one adjustment to the petitioners' returns: He determined that the amounts of $33,526.65 and $44,920.28, which Philbrick received from the Pullman Company, pursuant to paragraph 4(a) of the exclusive license agreement, constituted ‘royalties' taxable as ordinary income, rather than long-term capital gains as reported in the petitioners' returns. The respondent has made it clear, both in the opening statement of his counsel at the trial and also in his briefs, that this is the basic issue presented. More specifically, he has taken the position that the exclusive license agreement did not effect a ‘sale’ of capital assets for income tax purposes; and that insofar as the decision of this Court in Edward C. Myers, 6 T.C. 258, is in conflict with such position, the opinion in the Myers case should be overruled.

On brief, however, the respondent has attempted to raise a new and additional issue. He has pointed out that applications for patents on three of Philbrick's improvement inventions, which concededly became available to the Pullman Company under the terms of the exclusive license agreement, were not filed until after the execution of said license agreement, and until after the employment contract had become operative; and hence he contends that, even assuming that such improvement inventions were capital assets in Philbrick's hands, all royalties attributable to them should be taxed as ‘additional compensation for personal services' under the employment contract.

This new and additional issue was not raised in the notice of deficiency, or pleaded by respondent in his answer to the petition, or suggested by respondent's counsel during his opening statement at the trial. To the contrary, the stipulation of facts was prepared, and the evidence was presented, without notice either to the Court or to petitioners' counsel that such issue was present. In this situation, we sustain the objection and contention of the petitioners, that such additional issue was not adequately or timely raised and therefore is not properly before this Court. As was stated by the Supreme Court in General Utilities & Operating Co. v. Helvering, 296 U.S. 200, at page 206:

Always a taxpayer is entitled to know with fair certainty the basis of the claim against him. Stipulations concerning facts and any other evidence properly are accommodated to issues adequately raised.

This Court has held frequently that issues raised for the first time on brief will not be considered. Sangston Hettler, 16 T.C. 528, 535; Maurice P. O'Meara, 8 T.C. 622, 628; Wentworth Manufacturing Co., 6 T.C. 1201, 1208.

Thus, the issue is limited to the question raised by the deficiency notice: Whether the amounts received by Philbrick in 1951 and 1952, pursuant to paragraph 4(a) of the exclusive license agreement, are taxable as long-term capital gains, or as ordinary income from ‘royalties.’

II.

We turn now to a consideration of section 117(q), as added by Public Law 629. A review of the circumstances which gave rise to the enactment of this statute is helpful in determining its purpose and applicability.

In 1946 this Court held in the above-mentioned case of Edward C. Myers, supra, that where an inventor had, in consideration of certain annual payments or ‘royalties' to be made to him, granted an exclusive license to another party to use, manufacture, and sell an invention which he had theretofore held for more than 2 years but in respect of which he had not filed an application for a patent, such exclusive license should be regarded for income tax purposes as a sale by him of his invention; and that gains thereafter derived from payments under such license agreement were taxable as long-term capital gains. The Commissioner of Internal Revenue, at first, published his acquiescence in the Myers decision (1946-1 C.B. 3), which meant, as stated in an accompanying announcement, that the decision should be relied upon by officers and employees of the Bureau of Internal Revenue as a precedent in the disposition of other cases.

Subsequently however, in 1950, the Commissioner reversed his position with respect to the Myers case; and in a ruling (Mim. 6490, 1950-1 C.B. 9), he withdrew his acquiescence, substituted a nonacquiescence, and held in substance that royalties under exclusive license agreements, received for taxable years beginning after May 31, 1950, would be regarded as ordinary income. This action resulted in the renewal of litigation respecting the proper tax treatment of such royalties.

At the time when the Internal Revenue Code of 1954 was being drafted, the Congress took note of the above situation; and it included in section 1235 of said Code, certain new provisions relating to the transfer of patent rights. These new provisions are substantially the same as those subsequently enacted as the first section of Public Law 629. The report of the Senate Finance Committee regarding section 1235, discloses that the purpose of these provisions was: ‘To obviate the uncertainty caused by this mimeograph (Mim. 6490) and to provide an incentive to inventors * * * (by giving) statutory assurance to certain patent holders that the sale of a patent (whether as an ‘assignment’ or ‘exclusive license’) shall not be deemed not to constitute a ‘sale or exchange’ for tax purposes solely on account of the mode of payment.'

S. Rept. No. 1622, 83d Cong., 2d Sess., p. 439.

Section 1235 applies, under the terms of the 1954 Code, only to payments described therein which are received in taxable years beginning after December 31, 1953, and ending after August 16, 1954. Shortly after the section was enacted, the Commissioner announced (Rev. Rul. 58, 1955-1 C.B. 97) that, as regards any such payments received in taxable years beginning after May 31, 1950 (the effective date of his Mim. 6490), and prior to the effective date of the 1954 Code, he would continue to adhere to the position stated in his mimeograph. Thus, there arose the anomalous situation that payments of the type described in section 1235 would be regarded by the Commissioner as proceeds from the sale of a capital asset, if they were received during taxable years beginning either before May 31, 1950, or after the effective date of section 1235 of the 1954 Code; but that such payments, even though they arose out of the same transfer of patent rights, would be regarded as ordinary income if they were received in any intervening taxable year.

It was to correct this situation that Public Law 629 was enacted. Its practical effect was to render inoperative, both Mimeograph 6490 and Revenue Ruling 58, supra, insofar as they relate to transfers described in the new subsection (q); and to make benefits like those provided by section 1235 of the 1954 Code available for any taxable year beginning after May 31, 1950.

S. Rept. No. 1941, 84th Cong., 2d Sess., p. 4.

III.

Section 117(q) of the 1939 Code, as added by Public Law 629, provides, in part, as follows:

(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.

It should be observed that this new subsection (q) relates only to transfers described therein; and that it does not, by its terms, repeal any of the other subsections of section 117. Thus, if a transfer is not one described in subsection (q), the provisions of this subsection have no application in determining whether or not such transfer constitutes a sale or exchange of a capital asset; and the tax consequences of such transfer must be determined under other provisions of the internal revenue law. Conversely, if the transfer is one described in subsection (q), then the tax consequences thereof must be determined in accordance with the provisions of this new subsection, so as to give effect to the policy of Congress reflected therein.

The meaning of the phrase ‘all substantial rights to a patent,‘ used in said subsection (q), is explained in the report of the Senate Finance Committee on the cognate provisions of section 1235 of the 1954 Code, as follows:

S. Rept. No. 1622, 83d Cong., 2d Sess., pp. 439-440.

The section does not detail precisely what constitutes the formal components of a sale or exchange of patent rights beyond requiring that all substantial rights evidenced by the patent (other than the right to such periodic or contingent payments) should be transferred to the transferee for consideration. This requirement recognizes the basic criteria of a ‘sale or exchange’ under existing law, with the exception noted relating to contingent payments, which exception is justified in the patent area for ‘holders' as herein defined. To illustrate, exclusive licenses to manufacture, use, and sell for the life of the patent, are considered to be ‘sales or exchanges' because, in substantive effect, all ‘right, title, and interest’ in the patent property is transferred (irrespective of the location of legal title or other formalities of language contained in the license agreement). Moreover, the courts have recognized that an exclusive license agreement in some instances may constitute a sale for tax purposes even where the right to ‘use’ the invention has not been conveyed to the licensee, if it is shown that such failure did not represent the retention of a substantial right under the patent by the licensor. It is the intention of your committee to continue this realistic test, whereby the entire transaction, regardless of formalities, should be examined in its factual context to determine whether or not substantially all rights of the owner in the patent property have been released to the transferee, rather than recognizing less relevant verbal touchstones. The word ‘title’ is not employed because the retention of bare legal title in a transaction involving an exclusive license may not represent the retention of a substantial right in the patent property by the transferor. Furthermore, retention by the transferor of rights in the property which are not of the nature of rights evidenced by the patent and which are not inconsistent with the passage of ownership, such as a security interest (e.g., a vendor's lien) or a reservation in the nature of a condition subsequent (e.g., a forfeiture on account of nonperformance) are not to be considered as such a retention as will defeat the applicability of this section. On the other hand, a transfer terminable at will by the transferor would not qualify.

The phrase ‘rights to a patent,‘ appearing in said subsection (q), appears also in section 1235 of the 1954 Code. The reports of the Senate Finance Committee and of the Conference Committee on this latter section indicate that such phrase was substituted, in lieu of a previously suggested phrase reading ‘rights evidenced by a patent,‘ in order to make clear that the section applied, even though the patent itself might not have been issued at the time of the transfer, and even though an application for the patent might not then have been made.

Conference Report No. 2543, 83d Cong., 2d Sess., pp. 16, 70; S. Rept. No. 1622, supra, p. 439.

The term ‘holder,‘ as used in subsection (q), is defined therein to include ‘any individual whose efforts created such property.’ The Senate Finance Committee, in its above-mentioned report on section 1235 of the 1954 Code, states on page 440 thereof, that such term embraces ‘all qualifying individuals, whether amateur or professional, regardless of how often they may have sold their patents.’ Thus, subsection (q) eliminates, in the case of a transfer described therein, not only the distinction between an amateur and a professional inventor, but also the problem as to whether the property transferred was held by the transferor primarily for sale to customers in the ordinary course of a trade or business.

Finally, subsection (q) provides that a transfer described therein ‘shall be considered the sale or exchange of a capital asset held for more than 6 months * * * .’ The Conference Committee, in its report on the cognate provision of section 1235 of the 1954 Code, states, on page 70 thereof, that ‘the requirement of a 6-month holding period is dropped.’ It follows therefore, that where payments are received pursuant to a transfer described in subsection (q), any gains or losses derived therefrom shall be treated as long-term capital gains or losses, irrespective of the actual period for which the property transferred may have been held.

In the instant case, Philbrick was the individual whose efforts created all of the rights to patents here involved; and he transferred such rights to the Pullman Company by means of an exclusive license ‘to make, to use, and to sell, and to have made for it, throughout the world, machines, apparatus and devices embodying the inventions set forth in the aforesaid Letters Patent and applications and any and all improvements therein and all other inventions relating to (such) machines * * * which the Licensor may devise or acquire during the term of this Agreement, * * * .’ In our opinion, Philbrick was a ‘holder,‘ and his said transfer was, with respect to each of the properties involved, ‘A transfer (other than by gift, inheritance, or devise) of property consisting of all substantial rights to a patent,‘ within the meaning of section 117(q)(1).

The parties in the instant case have stipulated that all payments here involved were received by Philbrick pursuant to the agreement for said exclusive license; and that they all were received during the years 1951 and 1952. Section 117(q) provides in substance, in paragraph (4) thereof, that its provisions shall apply if the amount received or the payment made pursuant to a transfer described in paragraph (1) thereof falls within any taxable year beginning after May 31, 1950, ‘regardless of the taxable year in which such transfer occurred.’

We hold that, under the facts here present, the provisions of section 117(q) are applicable; and that, in accordance with said statute, the payments here involved are taxable as long-term capital gains.

Reviewed by the Court.

Decision will be entered for the petitioners