United States Mineral Prods. Co.
v.
Comm'r of Internal Revenue

This case is not covered by Casetext's citator
Tax Court of the United States.May 5, 1969
52 T.C. 177 (U.S.T.C. 1969)
52 T.C. 177162 U.S.P.Q. 480

Docket No. 4733-66.

1969-05-5

UNITED STATES MINERAL PRODUCTS COMPANY, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Arnold J. Zurcher, Jr., David W. Feeney, and John M. Fedders, for the petitioner. Julius M. Jacobs and Denis M. Neill, for the respondent.


Arnold J. Zurcher, Jr., David W. Feeney, and John M. Fedders, for the petitioner. Julius M. Jacobs and Denis M. Neill, for the respondent.

Petitioner is a United States corporation engaged in the manufacture and sale within this country of sprayed-insulation products. Prior to 1959 its products were sold to a distributor in Canada who applied the products, petitioner organized a wholly owned subsidiary under Canadian law and transferred to it in March 1959 certain rights relating to patents, trademarks, and know-how which comprised the collective technical and production knowledge essential to petitioner's business. Through its own manufacturing and marketing facilities the subsidiary then began to operate independently the entire business within Canada. Held: (1) Petitioner transferred a going business consisting of several assets whose taxable nature must be individually determined. (2) The trademarks and know-how constituted ‘property’ within the meaning of sec. 1221, I.R.C. 1954. (3) The payments to petitioner are attributable wholly to the sale of capital assets and are taxable at capital gains rates.

DAWSON, Judge:

Respondent determined deficiencies in petitioner's Federal income tax for its taxable years ended March 27, 1960, and March 26, 1961, in the respective amounts of $12,575.32 and $17,952.92.

The issue for decision is whether amounts received by petitioner during the years in issue from its Canadian subsidiary as payments for the transfer by it to the Canadian subsidiary of certain rights relating to patents, trademarks, and know-how are taxable as long-term capital gains or as ordinary income.

FINDINGS OF FACT

Some of the facts have been stipulated and are found accordingly.

Petitioner is a corporation organized under the laws of the State of New Jersey on April 10, 1937, and having its principal office and place of business in Stanhope, N.J. It uses the accrual method of accounting and reports its Federal income tax on the basis of a fiscal year ending the last Sunday in March. Federal income tax returns for its fiscal years ended March 27, 1960, and March 26, 1961, were filed with the district director of internal revenue at Newark, N.J.

Petitioner is engaged generally in the manufacture and marketing of mineral wool based products for insulation, fireproofing, and acoustical treatment. Prior to 1954, petitioner manufactured and supplied mineral wool to a company headed by James Louis Kempthorne (herein referred to as Kempthorne) which blended the miner wool with asbestos and other products to produce an insulating material which was applied by spraying devices. Although the company had a marketable product and applicators throughout the United States, it experienced financial difficulties which led to bankruptcy in 1952 or 1953. Petitioner's officers, in their efforts to recover on the bankruptcy as a creditor of the company, became acquainted with Kempthorne and his business.

Kempthorne a graduate engineer, began a career in the business of sprayed insulation in 1929 utilizing a product composed of ground newsprint and emulsified asphalt. In 1942 he developed a straight asbestos material, but during World War II when the supply of asbestos became scarce he formulated a more efficient product for use in Government construction in consisting of rock wool, asbestos, and cementitious material. In addition, he developed an adhesive material which was sprayed on a surface to prepare it to securely hold the insulating material. Kempthorne then constructed a plant to manufacture the product and acquired for it an Underwriters' Laboratories, Inc., label certifying its uniformity and performance. On April 17, 1950, in connection with a U.S. Government Atomic Casualty Commission project which tested sprayed insulating material, he was certified by the U.S. Government as an expert in the field of sprayed insulation. He presently holds approximately 30 patents in the sprayed-insulation industry. His business flourished until a Government-imposed freeze on asbestos in 1952 predicted the ultimate bankruptcy.

Three of Kempthorne's former employees and his former foreman organized in 1950 a competing company, Asbestos Spray, utilizing Kempthorne's product formulations and his manufacturing, sales, and application procedures.

At the bankruptcy sale of Kempthorne's company, Smith and Kanzler purchased Kempthorne's trademark ‘Spray Kraft,‘ his fiber formulations, his raw material specifications, his adhesive formulas, and his list of approved suppliers.

After extensive discussions with Kempthorne, petitioner's officers decided to enter the sprayed-insulation industry via his connections and know-how. As a result, on February 24, 1954, petitioner organized a wholly owned subsidiary, Columbia Acoustics & Fireproofing Co. (herein referred to as CAFCUS), under the laws of the State of New Jersey for the purpose of marketing the insulation materials which were to be developed and manufactured by petitioner. No formal written agreement was entered into between petitioner and CAFCUS. On the same day, CAFCUS entered into an agreement with Kempthorne (herein sometimes referred to as the Kempthorne agreement) which provided, inter alia:

WHEREAS, Kempthorne represents that he has invented, developed, tested, publicized and promoted certain formulae, processes, procedures, machinery and materials used and useful in the field of sprayed insulation for fire retarding, insulating and acoustical purposes, and has knowledge and a reputation in said field, all of which he desires to make available on an exclusive basis to Company, and

WHEREAS, Trustee (Kempthorne) is the owner by virtue of assignment from said Kempthorne of Letters Patent and Application for Letters Patent heretofore issued to and applied for by said Kempthorne, said assignment having been made pursuant to a certain Agreement bearing date March 26th, 1952, copy of which is annexed hereto and Marked Schedule 1, and Trustee desires to authorize Company to manufacture, sell and otherwise act exclusively under said letters Patent and under such Letters Patent as may be issued hereafter pursuant to such Applications; and

WHEREAS, all of the parties hereto desire to enter into an arrangement upon the terms hereinafter set forth;

NOW THEREFORE, in consideration of the sum of One Dollar by each of the parties unto the other paid, receipt of which is hereby acknowledged, and in further consideration of the keeping and performing of the several covenants and conditions hereinafter contained to be kept and performed, the parties hereto have agreed and by these Presents do agree as follows:

1. Kempthorne and Trustee grant to Company and its assigns for the period from the date of this Agreement to April 1, 1959, full, sole and exclusive rights, privileges and licenses to manufacture and to have others manufacture for it. the blended fibers, slurry mix, binder material and other ingredients, devices, equipment, machinery and apparatus used or useful in sprayed insulation applications, as prescribed in Kempthorne's formulae and processes or under the Letters Patent or Applications for Patents pending, owned by Trustee (said Letters Patent and Applications for Patents pending being set forth in Schedule A, part of Schedule 1, annexed hereto), and as prescribed or defined in any improvement, development, Letter Patent or Application for Patent hereinafter developed, granted or applied for by or on behalf of Kempthorne or Trustee during said period; and the sole and exclusive right, privilege and license to sell and distribute throughout the world, except in the Metropolitan New York City area, as hereinafter defined, all of the said blended fibers, slurry mix, binder material, other ingredients, devices, equipment, machinery and apparatus for the said period.

2. Kempthorne agrees forthwith to reduce to writing and deliver to Company, and to explain to and instruct Company's designated employees in the correct use of, all formulae, processes and procedures now known to him, or invented, improved upon or developed by him during the term of this agreement, used or useful in the businesses of manufacturing and applying blended fibers, slurry mix, or other materials or combinations thereof to structures or to portions thereof or to products of every nature whatever, for the purposes of strengthening the same or imparting to them fire-retardant, insulating or acoustical properties.

3. Kempthorne agrees to make available to Company or to such person or firm as it may designate, promptly on Company's request, his services as a consultant on problems within the scope of his knowledge or talents.

4. Kempthorne agrees to communicate and disclose promptly to Company full and complete information concerning any new inventions or improvements discovered or developed by him, including the disclosure of the method of manufacture, the formulae and all other information required to enable Company under its said full, sole and exclusive right, privilege and license, to manufacture and have others manufacture for it according to such new processes, or such new products, as the case may be, and to sell and to distribute the products of such manufacture, all without payment of compensation or charges other than as specified herein during the term hereof or any renewal or extension.

5. Kempthorne agrees to cooperate fully forthwith, upon request of Company, in arranging for, conducting, writing up and publicizing, under Company's direction and control, such tests of materials and products manufactured, sold and distributed under said licenses as Company shall desire to have made, at Company's expense; and agrees further that the said tests and reports thereof shall be the property of Company. Further, upon Company's request and payment by it of the expense of patent proceedings relating thereto, Kempthorne and Trustee agree to take such action as may be required to assign, transfer and vest in Company for the term hereof and all renewal periods sole control of all rights derived from and proceedings with respect to applications for patents or inventions concerned with any phase of the sprayed insulation field, now or hereafter pending or owned or otherwise held or controlled by Kempthorne, Trustee or either of them. Further, said parties agree that if this contract is not renewed at the end of said term or any renewal period, thereafter either Kempthorne or Trustee (whichever may be so entitled) or Company, or both, may license others upon a non-exclusive basis to use such patents or rights as may then exist concerning such inventions, and shall share equally the royalties or other proceeds derived from such licenses.

7. Company agrees that Kempthorne shall have the sole and exclusive rights to purchase from Company for distribution, sale and installation in the Metropolitan New York City area, hereinafter defined, the products manufactured, sold and distributed by Company under the Licenses herein granted, upon the following terms and conditions:

(f) Company grants Kempthorne, for himself and for any corporation controlled by him aforesaid, in connection with his said business in the Metropolitan New York City area, the privilege of using the reports of tests hereinbefore mentioned and agrees to make available to him the products, machinery and equipment manufactured, sold or distributed by it pursuant to the rights, privileges and licenses granted it by this Agreement, including those products, machinery and equipment prepared according to Kempthorne's and Trustee's present formulae, processes and patents and presently pending applications for patents, and also those developed or improved by Kempthorne or by Company during the term of this Agreement and any extension or renewal thereof.

Pursuant to this agreement, Kempthorne gave to CAFCUS the product formulations for the insulating materials, known as SprayDon Standard and SprayDon Type I, which he had developed In addition, he gave it it his list of approved suppliers, his list of applicators throughout the country, and his list of completed jobs along with pictures of the jobs and testimonials from satisfied customers.

Kempthorne began to exercise his exclusive marketing rights under the agreement in the New York metropolitan area through Sprayon Insulation & Acoustics, Inc., which he had reorganized on April 13, 1953.

Within a short time after the Kempthorne agreement was formalized the amiable and cooperative relationship between the parties began to deteriorate. Petitioner's officers had some difficulty in acquiring the precise product formulations from Kempthorne, and the mixed product did not perform as well as anticipated. As a result, petitioner manufactured and CAFCUS marketed very little of the product during the ensuing year.

The basic formulation developed by Kempthorne was used by petitioner to manufacture the insulation material first marketed by it. ‘Factory Inspection and Label Service Procedures' were issued to Sprayon Insulation & Acoustics, Inc., on July 21, 1954, authorizing the use of Underwriters' Laboratories, Inc., labels on the product called ‘SprayDon Fire Test Fiber’ and to CAFCUS on August 5, 1954, authorizing the use of such labels on the product called ‘Cafco Spray Fiber.’ The procedures contained the same specifications since the products were identical and were both manufactured by petitioner. Underwriters' Laboratories, Inc., is an independent testing agency whose label is required to meet the specifications for fireproofing materials of most construction contracts in the United States. The results of all tests conducted by it are set out in its listing books which are distributed to all fire-rating organizations, insurance companies, building officials, and municipalities having a building code related to these tests.

A test by Underwriters' Laboratories, Inc., of the product manufactured in accordance with Kempthorne's basic formulation (referred to in the report as Cafco Spray Type 1), as applied to a structural steel column, which was conducted on October 29, 1954, and reported on October 27, 1955, indicated that the product was capable of acting as a fire retardant for more than 2 hours. The test report had little commercial value because a 3- or 4-hour rating is required in the industry for the protection of columns.

The report of October 27, 1955, did not mention the SprayDon product marketed by Kempthorne, as Kempthorne understood that it would. After a protest by Kempthorne, CAFCUS wrote to him certifying that its product was identical to his and that the test results were properly applicable to both.

The principal machine developed by Kempthorne for applying his insulation product was known as the model A machine. The machine sprayed approximately 5 pounds of fiber per minute through a maximum hose length of 50 feet, which was reduced to 15 feet when the hose was in a vertical position. Consequently, the machine and the sprayed product had to be elevated on scaffolding and moved frequently, which required considerable labor, to do high ceilings and multistory buildings. The machine operated on the centrifugal blower principle by which the fiber came into direct contact with the blades of the blower as it was propelled into and through the hose in its dry state, causing the blades to be worn out within 2 weeks of operation.

A problem of excessive dust was incurred in the use of any machine which propelled the mineral fiber through a hose in a dry state. Under the terms of the Kempthorne agreement, Kempthorne delivered to petitioner a patented device consisting of a spray nozzle with pipes for air and water by which water was injected into the model A machine near the end of the blower causing the fiber to be moistened as it entered the hose. The dust control device proved to be impractical because it wetted the fiber excessively causing a buildup and clogging in the spray hose.

Petitioner and CAFCUS determined that a considerable research effort was required before a sprayed-insulation product could be marketed under the CAFCO trade name. Consequently, in November 1954, petitioner employed Frank M. Stumpf (herein referred to as Stumpf), a graduate chemical engineer with experience in the sprayed-insulation field, to head its research department. In consideration of his employment, Stumpf agreed that all inventions, developments or improvements discovered by him relating to mineral wool manufacturing and application would become the property of petitioner.

Shortly after Stumpf was employed by petitioner, Kempthorne was denied free access to petitioner's plant and was directed to deal exclusively with petitioner's president, James P. Verhalen (herein called Verhalen). Kempthorne did not participate in any research projects conducted by Stumpf but made numerous suggestions to Verhalen relating to the projects.

Within a year, petitioner's research staff under Stumpf's direction developed a product capable of fire retarding, soundproofing, and thermal insulating first called ‘CAFCO Spray Standard’ (and later marketed as ‘CAFCO Blaze-Shield’) which consisted of the same materials as Kempthorne's original product but in significantly different proportions. The average variance in the percentages of the three ingredients (or groups of ingredients) common to both products was approximately 23 percent. The ingredients in Kempthorne's product had not been blended in any particular order and with only a general direction as to time. CAFCO Spray Standard was blended according to a particular receipt for a more exact period of time. For a period from 3 to 9 months after its development, the product was field tested and found to be dependable. A test by Underwriter's Laboratories, Inc., on CAFCO Spray Standard was conducted on October 4, 1955, and, as a consequence, the product was given a 3-hour rating as protection for structural steel beams in a report issued on February 17, 1956. Two later tests utilizing greater thicknesses of the product which were reported on May 8, 1958, gave it 4- and 5-hour ratings. A report issued by Underwriters' Laboratories of Canada on September 8, 1958, gave CAFCO Spray Standard a 3-hour rating.

In September 1956, Underwriters' Laboratories, Inc., revised its Factory Inspection and Label Service Procedure of August 5, 1954, for the product then called CAFCO Spray Fiber, substituting the name ‘CAFCO Spray Type 1’ and altering the formulation greatly, principally by increasing the percentage of cementitious material by over 600 percent. CAFCO Spray Type 1 was later marketed as ‘CAFCO Sound-Shield’ to function principally as an acoustical finishing product.

A third product first called CAFCO Spray Industrial, and now marketed as CAFCO Heat-Shield, was developed by petitioner's research department. It consists of the same basic materials combined in different proportions resulting in a less expensive product with lesser fireproofing capacity.

The registration of the trade names was obtained by petitioner in the U.S. Patent Office and in the Canadian Trade Marks Office as follows:

+------------------------------------+ ¦Date ¦Trademark ¦Country ¦ +--------+------------+--------------¦ ¦ ¦ ¦ ¦ +--------+------------+--------------¦ ¦5/10/55 ¦CAFCO ¦United States.¦ +--------+------------+--------------¦ ¦12/21/56¦CAFCO ¦Canada. ¦ +--------+------------+--------------¦ ¦3/24/59 ¦Sound-Shield¦United States.¦ +--------+------------+--------------¦ ¦11/3/59 ¦Blaze-Shield¦United States.¦ +--------+------------+--------------¦ ¦11/3/59 ¦Heat-Shield ¦United States.¦ +------------------------------------+

As part of its efforts to maintain quality control and to avoid variances from the specifications in the Underwriters' ‘Laboratories Factory Inspection and Label Service Procedures,‘ petitioner's research department under Stumpf's direction tried unsuccessfully to break down samples of the CAFCO products from completed jobs into their component parts and determine the percentages of the various raw materials. It determined that consistency could be maintained only by careful observation of the mixing process to determine that the raw materials were included in the proper proportions and in the proper mixing order.

Soon after becoming an employee of petitioner, Stumpf, at the urging of petitioner's officers and Kempthorne, set out to develop a dependable dust control device for the model A machine. After considerable research during which 25 different nozzles were tested, a successful design was arrived at which consists of two fine tubes, one inside the other, through which water (or other liquid) and air under pressure pass causing a finely atomized moisture to emanate from the joint orifice. The tubelike nozzle is positioned inside the rigid hose leading from the blower through which the dry fiber passes at high speeds causing it to be moistened. A length of flexible tube, called a flapper tube, is situated immediately in front of the nozzle and between two sections of rigid hose causing a vibration which prevents the wet fibers from building up and thus self-cleans the system.

A patent application was submitted on the device listing Kempthorne and Stumpf as joint inventors. A patent was issued in their joint names noting the assignment of Stumpf's rights to petitioner.

Because of the unsatisfactory performance of the A Machine for certain types of jobs and its inefficiency, Stumpf began research which resulted in the development of the model H machine which uses a positive pressure blower that propels fiber materials through a feeder without the materials coming into contact with the blower. The model H machine can apply 20 to 25 pounds of fiber per minute with hose lengths in excess of 200 feet. These features along with its capacity to propel the spray to great vertical heights often allow the completion of an entire building without moving the machinery or the fiber materials. A U.S. patent application was submitted on the machine on July 1, 1958. Patents were subsequently issued on it in the United States, Canada, and Australia listing Stumpf as inventor and petitioner as owner by assignment.

Richard L. Kempthorne, son of James L. Kempthorne, was employed on a full-time basis by CAFCUS from April 1954 until June 1956. In his first few months with the company he helped spray the product developed by his father for certain tests. Thereafter, his duties were confined to sales of the CAFCO products and to the preparation of a sales manual. He was not authorized to have access to the CAFCO product formulas.

Approximately 6 months before he left the full-time employ of CAFCUS, Richard L. Kempthorne notified the company of his decision to leave. At about that time, he wrote the formulas for CAFCO Spray Type 1 and CAFCO Spray Standard on the back of his desk calendar pad at CAFCUS, and he took the information with him when he left.

CAFCO products were purchased from petitioner by CAFCUS, then sold to distributors throughout the country, outside of the Metropolitan New York area, who were licensed to use the patented machinery and certain sales and application know-how. The distributors received expansive manuals containing technical and practical information helpful in sales and application. They were required to use the proper equipment, to train their supervisory personnel, and to apply and sell the CAFCO products in accordance with the manuals.

The sprayed-insulation products of petitioner's competitors contained basically the same raw materials as the CAFCO products but in varying qualities and quantities. Some competitors prepared sales manuals which were generally less comprehensive than petitioner's. Sometimes contractors would substitute a competing product when the specifications called for ‘CAFCO or equal.’

On June 1, 1957, CAFCUS entered into a license agreement with E. T Sampson & Co., Ltd. (herein referred to as Sampson), a Canadian corporation having its principal place of business in Montreal, Canada, granting to it the exclusive rights for 3 years to sell, distribute, and apply CAFCO products in all of Canada. CAFCUS agreed to sell to Sampson its requirements of CAFCO sprays and application equipment and to keep it informed of the latest technical developments. In return, Sampson agreed to purchase all necessary materials from CAFCUS. At the outset, Sampson operated primarily as an application contractor but later developed more of a distributor function, sublicensing others to apply CAFCO products.

As a result of the election as Canada's Prime Minister in 1957 of John Diefenbaker, a member of the Conservative Party who had campaigned on the slogan of ‘Buy Canadian,‘ products manufactured in Canada were given a 10-percent preference in Government contracts. In order to bid competitively on several large Canadian Government contracts, petitioner organized in April 1958 a wholly owned Canadian subsidiary, Columbia Acoustics & Fireproofing Co. (Canada), Ltd. (herein referred to as CAFCAN), to manufacture the CAFCO products in Canada.

CAFCAN began operations in August 1958 under an oral license from petitioner. The ‘basic element,‘ a mixture of specific amounts of portland cement, bentonite clay, and asbestos, of the CAFCO products continued to be manufactured by petitioner and was sold to CAFCAN to be mixed with rock wool and asbestos to form the final products. CAFCAN then sold the final products to Sampson, the sole Canadian distributor, which, in turn, sold them to applicators throughout Canada. CAFCAN paid petitioner 3 cents for every pound of CAFCO product it mixed.

In a contract dated October 10, 1958, CAFCUS agreed to sell to two Australian companies (herein referred to as the Bowsers) the CAFCO Spray basic element and granted to them ‘an exclusive license * * * to sell, distribute and apply CAFCO Spray’ for the mainland of Australia, New Zealand, and two other Pacific islands. The Bowsers were authorized to mix, in those areas, the basic element with the other ingredients required to constitute CAFCO Spray, provided that they buy all the basic element and spray equipment from CAFCUS, that they comply with its standards of quality, and that they pay royalties quarterly at the rate of 3 cents per pound of all CAFCO Spray mixed by them. CAFCUS agreed to furnish all the Bowsers' requirements of the basic element and spray equipment and to make available to them the latest research information and technical advice.

By late 1958 the increasingly fractious relationship between petitioner and Kempthorne had reached the breaking point with each party completely dissatisfied with the performance of the other under the Kempthorne agreement. Petitioner felt that Kempthorne did not have the technical know-how that he purported to have and that sales in the New York area had not been as great as they should have been. Kempthorne, in turn, felt that petitioner's officers had not fully cooperated with him, that they had unjustifiably denied him access to their research facilities, and that as a result of their failure to include his SprayDon products in Underwriters' Laboratories, Inc., test reports and labeling procedures, he was precluded from bidding on many large jobs in the New York area. He adamantly maintained throughout that all CAFCO products were essentially the same in formula as the products whose formulas he originally revealed to petitioner in 1954.

In late 1958, however, petitioner offered to renew the Kempthorne agreement for a 5-year period at a reduced royalty if he would relinquish his rights to market in the New York area. Kempthorne rejected the terms of the offer, and the agreement was permitted to expire on March 31, 1959.

On March 18, 1959, CAFCUS sent letters to all of its customers informing them that the Kempthorne-CAFCUS relationship would expire, that the CAFCO products were developed solely by the research department of petitioner and were the sole property of petitioner, and that after the termination date CAFCUS would commence sales in the New York area.

Thereafter Kempthorne issued a notice to the trade affirming the termination of the Kempthorne agreement and denying that the CAFCO product formulations were developed solely by petitioner's research department.

Subsequently, in 1961, Kempthorne, individually and as trustee, and Sprayon Insulation & Acoustics, Inc., instituted a suit against CAFCUS, petitioner, and Stumpf in the Superior Court of New Jersey, Chancery Division, Essex County. The complaint generally alleged that (1) by the terms of the Kempthorne agreement, CAFCUS was to provide Kempthorne with certain test reports which it refused to give him and which refusal caused Kempthorne severe damage, (2) CAFCUS had refused to account to Kempthorne for the full amount of royalties owed to him under the agreement, and (3) the patent for the dust-control device should be the sole property of Kempthorne or that he should receive royalties resulting from any license of suchpatent.

In the answer, the defendants (1) alleged that Kempthorne had the privilege of using the test reports only during the term of the agreement and only within the Metropolitan New York City area, (2) denied that CAFCUS refused to render an accounting to Kempthorne or refused to permit him or anyone designated by him to examine its books to determine the accuracy of the payments, and (3) denied that Kempthorne was the sole inventor of the dust-control device patented by him and Stumpf jointly.

CAFCUS, petitioner, and Stumpf counterclaimed for an order restraining Kempthorne and Sprayon Insulation & Acoustics, Inc., from misrepresenting that any of their products were the same as those of CAFCUS or petitioner or were manufactured by them, and from misrepresenting that Stumpf was in their employ. Kempthorne and Sprayon Insulation & Acoustics, Inc., answered the counterclaim with a general denial.

On April 11, 1963, the parties settled the suit and a final order was entered. The defendants paid Kempthorne $5,000, and Kempthorne and Sprayon Insulation & Acoustics, Inc., were ordered to ‘refrain from representing in any manner that products manufactured or sold by them are manufactured by defendants or any of them, or are the same as products manufactured or sold by defendants or any of them,‘ and to refrain from representing that Stumpf was employed by them.

With respect to the patents on the dust-control device issued jointly to Stumpf and Kempthorne and any patents covered by the Kempthorne agreement, the order stated that CAFCUS and petitioner could use the patents as they desired without compensating Kempthorne or Sprayon Insulation & Acoustics, Inc., and that they could license others to use the patents on a nonexclusive basis.

On April 22, 1959, two agreements were simultaneously executed whereby Sampson ceased to be the exclusive distributor in Canada of the CAFCO products and equipment for CAFCUS and became the exclusive distributor of the products for CAFCAN. Sampson retained the equipment delivered to it by CAFCUS under terms and conditions which survived the termination of their earlier contract, and CAFCUS agreed to continued to make new research information available to Sampson through CAFCAN. All of the Kempthorne patents and patent applications, including the joint patent of Kempthorne and Stumpf issued in the United States and in Canada, were listed in the agreement between CAFCAN and Sampson. Also listed were the United States and Canadian patents issued to petitioner, as assignee of Stumpf, on the model H machine and the Canadian trademark applications of Blaze-Shield, Heat-Shield, and Sound-Shield (which were thereafter issued to CAFCAN).

In September 1960, petitioner and CAFCAN executed an agreement (sometimes referred to herein as the Canadian agreement) dated March 16, 1959, which granted:

to Cafco, Canada, the following exclusive rights, licenses and privileges, to be exercised solely within the territorial limits of Canada, and subject only to the conditions set forth in this agreement.

(a) To manufacture, use and sell, and to grant to others sub-licenses to manufacture, use and sell, products embodying the inventions described in the patents listed on Schedule 1 annexed hereto; and

(b) to use and to grant to others the right and privilege to use the trademarks listed on Schedule 1 annexed hereto; and

(c) to use and to grant to others the right and privilege to use the manuals, reports and other documents listed on Schedule 2 annexed hereto.

In return, CAFCAN agreed to pay petitioner quarter-annually 3 cents per pound of blended fibers mixed by it. The Canadian patents listed in schedule 1 covered, with one exception, the same inventions which were the subjects of the grant in the Kempthorne agreement. The exception was the dust-control device for which a Canadian patent was issued on July 23, 1957, listing Kempthorne and Stumpf joint inventors. Schedule 1 also listed a Canadian patent application filed November 21, 1958, on the model H machine which resulted in the issuance of Canadian patent No. 628,135 to petitioner, as assignee of Kempthorne, on September 26, 1961. The trademarks referred to in the agreement consisted of one issued Canadian trademark (CAFCO) and three Canadian trademark applications (Sound-Shield, Blaze-Shield, and Heat-Shield) which were issued in October and December 1960.

The manuals and reports listed in schedule 2 of the Canadian agreement consisted of a manual of manufacturing methods for blended fibers, raw material specifications, finished-product specifications, quality-control procedures and devices for measurement, design specifications for mixing plant and material handling system, all test data for acoustical, insulating, and fireproofing properties of blended fiber products, applications and sales material (setting forth procedures and cautions with respect to application of CAFCO products. recommended methods of selling, promoting, and estimating costs of application), and research reports concerning uses and properties of CAFCO products.

The manuals and reports contained specific data concerning every aspect of petitioner's successful operations. This data included the product formulations for the three basic CAFCO products, precise quality specifications for raw materials comprising the CAFCO products (which were of equal importance with the formulas relating to the quantity of each material), specifications for liquid CAFCO Adhesive (a priming material) and CAFCO Sealer (a plastic finishing material) references to acceptable sources of supply, tests exclusively applicable to the CAFCO products which enable the applicator to determine whether the finished product will perform satisfactorily, fire-test reports to aid in marketing the product, and techniques developed by experience relating to sales, cost estimating, and application. Although the information was constantly updated, the great bulk of the materials was compiled more than 6 months prior to March 16. 1959. Some portion of this material was accessible to petitioner's competitors, but most was not generally known in the industry or was uniquely applicable to the CAFCO products.

The exclusive grant of rights, licenses, and privileges under the Canadian agreement was to remain effective for the periods during which the various patents and trademarks were in force unless sooner terminated by petitioner as a result of CAFCAN's default in the performance of any of its obligations. Petitioner could terminate CAFCAN's rights upon 30 days' notice if CAFCAN's remittance to petitioner for any year totaled less than $5,000, or if CAFCAN became insolvent. CAFCAN covenanted to keep complete books and records of the accounts of its business and to make periodic reports to petitioner.

Conferences held by petitioner's attorney regarding the drafting of the formal agreement occurred intermittently from April 28, 1960, to September 27, 1960. The final agreement provided that its provisions related back to, and were effective commencing, June 15, 1958.

From 1959 through 1961 all of the officers of CAFCAN were officers or employees of petitioner or CAFCUS, or both, and the boards of directors were substantially the same. None of them were stationed at the Canadian office but all were stationed at the main offices of petitioner and CAFCUS in Stanhope, N.J. The Canadian office and factory of CAFCAN was located in Montreal, Canada, and was in charge of a manager who was a Canadian national and who had an average of three employees working under his supervision. He took care of filling Sampson's orders for CAFCO products after confirmation by petitioner; he supervised the final mixing stage of the CAFCO Spray basic element with asbestos and the rock wool purchased from petitioner and, after March 1959, supervised the entire mixing process; he supervised the bagging of the CAFCO products; and he took care of shipping them to their ultimate destination. CAFCAN has its own bank accounts, payroll, and personnel and is operated independently from petitioner. Petitioner does supply certain administrative and bookkeeping services to CAFCAN.

During its fiscal years ended March 29, 1959, March 27, 1960, and March 26, 1961, petitioner received from CAFCAN, in payment of the 3 cents per pound of CAFCO products it had mixed in those years, the amounts of $26,686.20, $46,575.30, and $71,872.20, respectively (expressed in U.S. dollars). In its Federal income tax return for the fiscal year ended March 29, 1959, petitioner reported the $26,686.20 received from CAFCAN as ordinary income; in its Federal income tax returns for the fiscal years ended March 27, 1960, and March 26, 1961, the 2 years involved herein, it reported the respective amounts of $46,575.30 and $71,872.20 as ‘Payments received on exclusive assignments of patents and trademarks' taxable as capital gains from the sale of property held for more than 6 months.

In its Canadian income tax returns covering the years in issue herein, CAFCAN deducted as expenses the payments made to petitioner of the 3 cents per pound of the CAFCO product it mixed. In addition, it withheld and remitted to the Receiver General of Canada 15 percent of such payments as withholding tax on nonresidents.

During the years in issue CAFCUS filed separate Federal income tax returns and did not file any consolidated return with petitioner.

Upon audit of petitioner's income tax returns for the fiscal years ended March 27, 1960, and March 26, 1961, respondent, among other adjustments, disallowed the capital gains treatment of the respective amounts of $46,575.30 and $71,872.20 and determined that they were taxable as ordinary income.

ULTIMATE FINDINGS OF FACT

The Canadian agreement was a bona fide recordation of an oral contract entered into by petitioner and CAFCAN on or about March 16, 1959.

As of March 16, 1959, the formulas for the CAFCO products constituted trade secrets.

OPINION

Respondent's position that the payments in issue are taxable as ordinary income is based upon four principal arguments: (1) The Canadian agreement was not a bona fide agreement of sale but rather a paper transaction set up between a parent corporation and its wholly owned subsidiary to alter the tax consequences of a preexisting licensing arrangement; (2) petitioner did not own the patents listed in the Canadian agreement but had only the right to grant CAFCAN a nonexclusive license to manufacture and to license others to use the patents in Canada; (3) the CAFCO formulas and ‘know-how’ did not have the quality of exclusivity so as to constitute ‘property’ within the purview of sections 1221 or 1231, I.R.C. 1954; (4) where an entire business is sold in a ‘package deal,‘ it does not constitute a single capital asset but several individual assets, among which the sales price must be allocated to determine tax consequences; and to the extent that any part of the intangibles transferred under the Canadian agreement constituted section 1221 or section 1231 property, petitioner failed to prove a portion of the entire consideration allocable to it.

All statutory references are to the Internal Revenue Code of 1954 unless otherwise indicated.SEC. 1221. CAPITAL ASSET DEFINED.For purposes of this subtitle, the term ‘capital asset’ means property held by the taxpayer (whether or not connected with his trade or business), but does not include—(1) stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business;(2) property, used in his trade or business, of a character which is subject to the allowance for depreciation provided in section 167, or real property used in his trade or business;(3) a copyright, a literary, musical, or artistic composition, or similar property, held by—(A) a taxpayer whose personal efforts created such property, or(B) a taxpayer in whose hands the basis of such property is determined, for the purpose of determining gain from a sale or exchange, in whole or in part by reference to the basis of such property in the hands of the personal efforts created such property;(4) accounts or notes receivable acquired in the ordinary course of trade or business for services rendered or from the sale of property described in paragraph (1); or(5) an obligation of the United States or any of its possessions, or of a State or Territory, or any political subdivision thereof, or of the District of Columbia, issued on or after March 1, 1941, on a discount basis and payable without interest at a fixed maturity date not exceedingone year from the date of issue.SEC. 1231. PROPERTY USED IN THE TRADE OR BUSINESS AND INVOLUNTARY CONVERSIONS.(a) GENERAL RULE.— If, during the taxable year, the recognized gains on sales or exchanges of property used in the trade or business, plus the recognized gains from the compulsory or involuntary conversion (as a result of destruction in whole or in part, theft or seizure, or an exercise of the power of requisition or condemnation or the threat or imminence thereof) of property used in the trade or business and capital assets held for more than 6 months into other property or money, exceed the recognized losses from such sales, exchanges, and conversions, such gains and losses shall be considered as gains and losses from sales or exchanges of capital assets held for more than 6 months. * * *

It is petitioner's contention that under the Canadian agreement which became effective on or about March 16, 1959, it transferred all substantial rights in certain patents, trademarks, applications, and know-how, which it had possessed for more than 6 months, to a separate entity, its wholly owned Canadian subsidiary, giving rise to capital gains treatment of the proceeds of the ‘sale’ under sections 1221 and 1231. Petitioner argues that the principal portion of the know-how was secret and was a requisite to the profitable utilization of the patents and trademarks; the remainder was an incident of the patents and trademarks and assumed their nature. Petitioner does not contend that it was a ‘holder’ of the property rights within the meaning of section 1235.

This Court has held that ‘if a transfer is not one described in subsec. (q) (of sec. 117, I.R.C. 1939, which was the progenitor of sec. 1235, I.R.C. 1954), 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.’ F. H. Philbrick, 27 T.C. 346, 355 (1956). See also Leonard Coplan, 28 T.C. 1189 (1957).

We first consider respondent's contention that petitioner and CAFCAN did not in fact make a bona fide agreement of sale on March 16, 1959, the date appearing on the subsequently drafted Canadian agreement. It is well established that ‘an agreement between a corporation and its sole stockholders (or, it follows a fortiori, its wholly owned subsidiary) is valid and enforceable, if the arrangement is fair and reasonable, judged by the standards of the transaction entered into by parties dealing at arm's length.’ Stearns Magnetic Mfg. Co. v. Commissioner, 208 F.2d 849, 852 (C.A. 7, 1954); Leonard Coplan, 28 T.C. 1189 (1957).

Two key factors convince us of the bona fides of the transaction between petitioner and CAFCAN. First, the location of the entire manufacturing process for the Canadian market within Canada was motivated by business considerations. The Canadian Government began in 1958 granting a 10-percent preference in Government contracts to products manufactured in Canada. CAFCAN would have lost a substantial portion of its business if it had been compelled to compete at this disadvantage. In addition, the location of the manufacturing facilities in Canada caused a reduction in raw material costs since the asbestos used in the CAFCO products comes from Canadian sources. Secondly, the sales price of 3 cents per pound of fiber mixed by CAFCAN was reasonable in comparison with payments made by other companies located outside the United States which distributed the CAFCO products. See Stearns Magnetic Mfg. Co. v. Commissioner, supra.

Respondent refers to the Canadian agreement as ‘window-dressing,‘ citing the predating as an attempt to retroactively alter tax consequences. Clearly, however, it ‘is competent for the parties to agree that a written contract shall take effect as of a date earlier than that on which it was executed, and when this is done, the parties will be bound by such agreement.’ Brewer v. National Surety Corporation, 169 F.2d 926, 928 (C.A. 10, 1948). After a careful review of the evidence before us, we hold that the facts comport to the form of the transaction, i.e., the existing licensing arrangement between petitioner and CAFCAN was transformed into a complete sale of petitioner's Canadian operations to CAFCAN on or about March 16, 1959. We note that the agreement provides that its terms relate back to June 15, 1958; the parties concede that CAFCAN did not begin operations until August 1958, and the evidence indicates that it operated as a licensee for a few months. See Rose Marie Reid, 26 T.C. 622 (1956).

In essence, what we have here is the transfer of a going business in Canada carried on by a U.S. corporation with the marketing aid of a Canadian distributor to a wholly owned Canadian subsidiary formed for the purpose of carrying on the entire operation within the bounds of Canada. We decline, however, to great the business as a single asset and determine whether it is essentially capital in nature, as petitioner would have us do, but instead we shall categorize the various assets transferred and determine their taxable nature individually. Redman L. Turner, 47 T.C. 355 (1967); Watson v. Commissioner, 345 U.S. 544 (1953); Williams v. McGowan, 152 F.2d 570 (C.A. 2, 1945). See also Brainerd, ‘Income From Licensing Patents Abroad,‘ 38 Taxes 209 (1960).

Sec. 1249 specifically covers transactions such as the one in issue here consummated after Dec. 31, 1962.SEC. 1249(a). GENERAL RULE.— Gain from the sale or exchange after December 31, 1962, of a patent, an invention, model, or design (whether or not patented), a copyright, a secret formula or process, or any other similar property right to any foreign corporation by any United States person (as defined in section 7701(a)(30) which controls such foreign corporation shall, if such gain would (but for the provisions of this subsection) be gain from the sale or exchange of a capital asset or of property described in section 1231, be considered as gain from the sale or exchange of property which is neither a capital asset nor property described in section 1231.With respect to whether this section constitutes a codification or a change in preexisting legal principles, we note the Senate Finance Committee explanation of the purpose of the section:‘Your Committee recognizes that the transfer of U.S. developed patent and similar rights by a U.S. corporation to a controlled foreign corporation causes a diversion of income from U.S. sources. It believes that taxing any gain on such transfer as ordinary income will, however, correct this situation as to such transfers in the future.’ (S. Rept. No. 1881, 87th Cong., 2d Sess. (1962).)

Five Canadian patents listing Kempthorne as inventor covering spray equipment (relating to the model A machine) and processes and one Canadian patent issued in the joint names of Stumpf and Kempthorne were granted to CAFCAN under the Canadian agreement ‘to manufacture, use and sell, and to grant to others sub-licenses to manufacture, use and sell, products embodying the inventions' within the territorial limits of Canada.

A patent is intangible property whose value is protected by a Government-imposed monopoly for a period of time over which its development costs are normally depreciable. Sec. 1.167(a)-3, Income Tax Regs. Because it constitutes depreciable property when used in the operation of a business, it does not qualify as a capital asset under section 1221, but, if held for more than 6 months, its sale or exchange may result in capital gain under section 1231. See 3B Mertens, Law of Federal Income Taxation, secs. 22.126 and 22.133 (1966 rev.).

SEC. 1231(b). DEFINITION OF PROPERTY USED IN THE TRADE OR BUSINESS.— For purposes of this section—(1) GENERAL RULE.— THE term ‘property used in the trade or business' means property used in the trade or business, of a character which is subject to the allowance for depreciation provided in section 167, held for more than 6 months, and real property used in the trade or business, held for more than 6 months, which is not—(A) property of a kind which would properly be includible in the inventory of the taxpayer if on hand at the close of the taxable year,(B) property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business, or(C) a copyright, a literary, musical, or artistic composition, or similar property, held by a taxpayer described in paragraph (3) of section 1221.

Petitioner (through CAFCUS) was in the business of selling products, not patents. See Albright v. United States, 173 F.2d 339 (C.A. 8, 1949). Therefore, the patents and patent application, which were the subject of the transfer of CAFCAN, did not constitute petitioner's stock in trade or inventory, nor were they ‘property held by (petitioner) primarily for sale to customers in the ordinary course of (its) trade or business.’ The determinative question remains, however whether the transfer in question constituted a ‘sale’ or a ‘license.’ If it was in the nature of a license, the consideration paid for it constituted a royalty and is taxable as ordinary income. Sec. 61(a)(6); Redler Conveyor Co. v. Commissioner, 303 F.2d 567 (C.A. 1, 1962), affirming a Memorandum Opinion of this Court. Whether the payment is made in a lump sum or over a period of time in amounts based upon the use of the invention by the grantee is immaterial to this determination. Arthur C. Ruge, 26 T.C. 138 (1956); Vincent A. Marco, 25 T.C. 544 (1955).

To determine the quantum of interest in the five Kempthorne patents transferred to CAFCAN under the Canadian agreement, we must look first to the legal relationships established by the Kempthorne agreement. Kempthorne granted to CAFCUS the exclusive right to manufacture, and the exclusive right to sell throughout the world except in the Metropolitan New York area, the sprayed-insulation materials and equipment developed by him for the period from February 24, 1954, to April 1, 1959. Upon the termination of that period without renewal, both Kempthorne and CAFCUS were to have the right to license others upon a nonexclusive basis to use the patents and invention rights. It is clear from the terms of the agreement that Kempthorne retained ownership of his patents and inventions. The most critical factor was the limitation of the contract period to approximately 5 years, a period not coterminous with the lives of the patents. See Redler Conveyor Co., supra; Thomas D. Armour, 22 T.C. 181 (1954); Lynne Gregg, 18 T.C. 291 (1952), affd. 203 F.2d 954 (C.A. 3, 1953). Since CAFCUS received limited rights in the patents, less than the whole interest which Kempthorne possessed and could have transferred to it, the transfer constituted a license, not a sale. Waterman v. Mackenzie, 138 U.S. 252 (1891).

Plainly, petitioner transferred under the Canadian agreement all substantial rights it may have possessed in the patents to CAFCAN. The grant was for the lives of the patents and embodied the magic language ‘manufacture, use and sell’ (Waterman v. Mackenzie, supra); the right of petitioner to terminate upon certain conditions subsequent did not constitute the retention of ‘substantial rights.’ Allen v. Werner, 190 F.2d 840 (C.A. 5, 1951), Commissioner v. Celanese Corp. of America, 140 F.2d 339 (C.A.D.C. 1944). Petitioner could, however, convey to CAFCAN no greater rights than it possessed. CAFCUS received a license in patents from Kempthorne and could, in turn, grant to others no more than a sublicense. Federal Laboratories, Inc., 8 T.C. 1150 (1947). It should be noted that nowhere in this record do we find direct evidence that CAFCUS transferred its rights under the Kempthorne agreement to petitioner. CAFCUS operated as a separate legal entity and filed its Federal income tax returns as such during the years in issue. We hold that any amounts received by petitioner as a consequence of the transfer of its rights in the five Kempthorne patents listed in the Canadian agreement constituted royalty income.

We likewise conclude that, to the extent of Kempthorne's interest, CAFCAN received a sublicense in the Canadian patent on the dust-control device issued jointly to Kempthorne and Stumpf. We are not persuaded on this record by petitioner's argument that Kempthorne had no valid interest in the patent because Stumpf did the final development of the invention. Since Stumpf's interest was assigned absolutely to petitioner, petitioner was in a position to, and did in fact, sell that interest to CAFCAN.

Petitioner possessed, through assignment from Stumpf, all property rights in the model H machine, which had been reduced to practice more than 6 months prior to the date of the Canadian agreement. The Canadian patent application, which constituted a manifestation of these rights, was assigned absolutely for its life to CAFCAN under the Canadian agreement. A patent application is an assignable property right (Saunders v. Commissioner, 29 F.2d 834 (C.A. 3, 1928)), but not a depreciable asset. When the patent is issued depreciation may be taken over its life. Hershey Manufacturing Co., 14 B.T.A. 867 (1928), affd. 43 F.2d 298 (C.A. 10, 1930). We hold that the application constituted a capital asset which was sold. See Samuel E. Diescher, 36 B.T.A. 732 (1937), affd. 110 F.2d 90 (C.A. 3, 1940), certiorari denied 310 U.S. 650 (1940).

The second category of assets transferred under the Canadian agreement consisted of the Canadian trademark and trademark applications, the exclusive use of which was granted to CAFCAN for all of Canada for the lives of the trademarks. The common-law right to prevent unfair competition and the statutory right permanently to exclude others from the use of a registered name certainly are valuable property rights which may be assigned. Those rights with respect to the names referred to in the Canadian agreement constituted capital assets which were sold under the agreement. Seattle Brewing & Malting Co., 6 T.C. 856 (1946), affd. 165 F.2d 216 (C.A. 9, 1948); see also Norwich Pharmacal Co., 30 B.T.A. 326 (1934). The Canadian trademark ‘CAFCO’ was issued on December 21, 1956; the trade names for which Canadian trademark applications had been made were first used in September 1958.

The third category of assets transferred may be loosely termed ‘know-how’ and is represented by the manuals, reports, and other documents. Petitioner argues, and respondent denies, that the ideas reduced to tangible from in these papers possess the attributes of ‘property’ within the meaning of section 1221.

See generally Brainerd, ‘Income From Licensing Patents Abroad,‘ 38 Taxes 209, 229-234 (1960).

An inventor's property right in his invention exists at the time of its reduction to actual practice; a patent later granted for the invention merely creates an additional monopoly right to exclude others from its use for a period of years. Samuel E. Diescher, supra. The right of property in industrial knowledge has long been recognized by this Court. George S. Mepham, 3 B.T.A. 549 (1926). Similarly, we have held that a secret formula used in a manufacturing business constitutes property. Wall Products, Inc., 11 T.C. 51 (1948). Neither the fact that the formula is simple and may be broken down into its constituent parts by a competent chemist nor that a patent for the formula has not been applied for negatives the property right. Wall Products, Inc., supra.

Respondent has shown in this case no more than that it is theoretically possible to break the CAFCO products down into their component parts after a complicated and costly laboratory process.

Without question, the formulas for the CAFCO products were the heart of petitioner's business. The parties agree that if they were ‘secret,‘ they constituted ‘property’ within the meaning of section 1221. This record is replete with conflicting testimony on this point, largely as a result of the apparent ill will between Kempthorne and petitioner's officers. Concrete evidence relating to competitor's formulas was made available and the exact formulation of the various CAFCO products as compared to SprayDon formulas developed by Kempthorne prior to 1954 is far from clear. But, on the preponderance of the evidence, we have found as a fact that the Kempthorne formulas were changed substantially without the aid or knowledge of Kempthorne after Stumpf became an employee of petitioner and were, at the time of the transfer to CAFCAN, trade secrets.

All products in the sprayed-insulation field are composed of essentially the same basic ingredients. Not all, however, have the same heat or flame retarding or acoustical properties, as a result of a variance in the quality and quantity of the various ingredients and the method by which they are mixed. This is reflected by the great weight afforded the Underwriter's Laboratories, Inc., tests and factory label procedures throughout the industry. Consistency in performance and economy in application are the most essential attributes of a successful product and depend entirely upon a precise formulation.

‘CAFCO Spray Standard’ developed by Stumpf differed from Kempthorne's basic formulation, ‘SprayDon Fire Test Fiber’ (and initially called CAFCO Spray Fiber by petitioner), in at least three material respects: (1) The average variance in the percentages of the three ingredients (or groups of ingredients) common to both products was approximately 23 percent; (2) CAFCO Standard was mixed according to a precise receipt controlling both the order and time of mixing, while Kempthorne mixed his product without order and for imprecise periods of time; and(3) CAFCO Standard contained a single (alternative) grade of Canadian asbestos while the Kempthorne product contained a blend of three particular grades of Canadian asbestos. The formulation for CAFCO Spray Type 1 differed from the SprayDon formulation to even a greater extent. A ‘Factory Inspection Procedure’ issued September 21, 1956, on ‘CAFCO Spray Type 1’ revising an earlier procedure on ‘CAFCO Spray Fiber’ (which, again, was identical to SprayDon Fire Test Fiber) set out a formulation in which the percentage of the various ingredients varied greatly, with over a 600-percent increase in the percentage of cementitious materials. It is clear that the formulas were ‘so substantially improve(d) that (petitioner) became invested with the ownership.’ Reynolds Metals Co. v. Skinner, 166 F.2d 66, 76 (C.A. 6, 148). And it appears from this record that, as a corollary to this change in formula, the performance of the CAFCO products was substantially changed.

It follows, therefore, that the formulas acquired from Kempthorne by Asbestos Spray in 1950 and Smith & Kanzler in 1953, two of petitioner's competitors, were not the same formulas transferred by petitioner to CAFCAN. Petitioner carefully protected its formulas from becoming known in the trade, particularly in its dealings with its licensee in Australia and with CAFCAN before the final ‘sale’ was made. The ‘basic ingredient’ was mixed by petitioner and was then shipped to the licensees who, within their own territories, blended it with the other ingredients to form the final products. By keeping the formula for the basic ingredient secret, petitioner was able to prevent the overall formulas from becoming known in the trade. They were no less trade secrets because of a breach of confidence by Richard L. Kempthorne, the son of James Kempthorne, in copying them before leaving the employ of petitioner. Petitioner's interest in the formulas was sufficient to evoke injunctive relief to prevent Richard L. Kempthorne from using them or disclosing them to others. Club Razor & Blade Mfg. Corporation v. Bindzsus, 131 N.J. Eq. 283, 24 A.2d 31 (1942); Nelson v. Commissioner, 203 F.2d 1 (C.A. 6, 1953), reversing a Memorandum Opinion of this Court. We hold that the formulas constituted ‘property’ as that term is used in section 1221.

In other contexts, it has been held that the term ‘property’ within the tax laws should not be given a narrow or technical meaning. See, e.g., United States v. Graham, 96 F.Supp. 318 (S.D. Cal. 1951), affirmed sub nom. 195 F.2d 530 (C.A. 9, 1952), certiorari denied 344 U.S. 831 (1952); Citizens State Bank of Barstow, Tex. v. Vidal, 114 F.2d 380 (C.A. 10, 1940).

The design of a special device created by petitioner to measure the bulk density of fibers was transferred to CAFCAN as part of the ‘know-how.’ The evidence indicates that it was not known to the trade, and respondent does not contend otherwise. Accordingly, we hold that it constituted a capital asset.

By granting to CAFCAN the exclusive right within the territorial limits of Canada to use and to grant to others the right to use the formulas and the design, petitioner conveyed its most important property right in them, viz, the right to prevent unauthorized disclosure. See E. I. Du Pont De Nemours and Co. v. United States, 288 F.2d 904 (Ct. Cl. 1961). Consequently, we hold that they were the subject of a ‘sale’ rendering the gain realized taxable at capital gains rates.

The finished product specifications, quality-control procedures, and the test data and research reports relating to the properties of the CAFCO products constituted technical information unique to the CAFCO products and necessary for the effective utilization of the transferred formulas. The formulas for CAFCO adhesive and sealer were essential to CAFCAN in order to obtain a supply for its distributors. Without these products a proper application of the CAFCO products would have been difficult or impossible. This information was an incident of the patents and assumed their nature as capital assets. Heil Co., 38 T.C. 989 (1962).

Our conclusion is the same with respect to the bulk of the other materials contained in the manuals which dealt principally with sales, cost estimating, and application techniques. Even though much of the material was available to competitors, it constituted valuable marketing information, developed through practice, which was oriented toward the particular properties of the CAFCO products and which could be obtained from no other source. Assuming arguendo that this information was tantamount to consulting services, as respondent contends, we find that it was of the type usually called for to implement the sale of highly technical inventions and, thus, was ancillary and subsidiary to the assignments of the formulas and the patent application. Arthur C. Ruge, 26 T.C. 138 (1956); see also Rev. Rul. 55-17, 1955-1 C.B. 388.

The vast majority of the materials comprising the ‘know-how’ transferred to CAFCAN was compiled and dated before March 16, 1959. The remainder we consider de minimis with respect to our conclusion that the ‘know-how’ constituted a capital asset held by petitioner for more than 6 months prior to its transfer to CAFCAN.

Finally, we must allocate the sales price in accordance with our comminution of the bundle of rights transferred into its fragments. Williams v. McGowan, supra. There is no question that the deferred payments should be included in income when received. See C. W. Titus, Inc., 33 B.T.A. 928 (1936).

The only patent transferred by Kempthorne under the Kempthorne agreement which proved to be of substantial value to petitioner was the model A machine patent. After the development of the model H machine, the model A machine became impractical for all but a very limited number of jobs and was not manufactured thereafter. The only patent transferred under the Canadian agreement, then, which had any significant value as of March 16, 1959, was the patent issued jointly to Stumpf and Kempthorne for the dust-control device. The patent application on the model H machine and the secret formulas and incidental know-how represented the lion's share of the value transferred to CAFCAN. Accordingly, we conclude on this record that the entire 3 cents per pound constitutes consideration paid for the sale of capital assets and section 1231 assets owned by petitioner. See Arthur C. Ruge, supra; cf. Redman L. Turner, 47 T.C. 355 (1967); Rev. Rul. 55-17 1955-1 C.B. 388.

In order to reflect certain adjustments not contested by petitioner,

Decision will be entered under Rule 50.