# Newton Insert Co. v. Commissioner

> United States Tax Court · January 30, 1974 · 61 T.C. 570

URL: https://www.frixlaw.com/law-library/cases/4482599

## Case

- **Full name:** Newton Insert Company, Transferor, and Tridair Industries, Transferee v. Commissioner of Internal Revenue
- **Court:** United States Tax Court
- **Decided:** January 30, 1974
- **Citations:** 61 T.C. 570; 61 T.C. No. 62; 1974 U.S. Tax Ct. LEXIS 159
- **Precedential status:** Published
- **Opinion:** Opinion of the court by Scott
- **Judges:** Scott
- **Cited by:** 9 later opinions in the Frix Law Library

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## Opinion text

OPINION
Scott, Judge: Respondent determined that Tridair Industries was liable as transferee for a deficiency of $444,779 for the taxable year ended October 31, 1967, of its transferor, Newton Insert Co. (hereinafter Newton). Newton was dissolved and its assets transferred to Tridair Industries on October 31,1967, in liquidation under the provisions of section 332 (b), I.R.C. 1954, 1 to which section 334 (b) was applicable.
The sole issue for decision is whether percentage payments made by Newton to Robert Neuschotz, City of Hope, and Marvin Best under 1961 and 1966 licensing agreements represent depreciation of patents acquired thereunder which amounts are subject to recapture under section 1245.
All of the facts have been stipulated and are found accordingly.
■ Tridair Industries (hereinafter petitioner) is a California corporation with its principal office in Redondo Beach, Calif. Petitioner is engaged in the design, manufacture, and sale of aircargo handling equipment, specialty fasteners, and inserts for original equipment manufacturers and consumers, and in the fabrication of fiberglass products.
Newton was a California corporation with its principal office in Los Angeles, Calif. Newton was engaged in the manufacture of threaded bushing inserts and studs used in structural applications. The primary function of inserts is to provide a strong thread in a soft or weak material (called a carrier), i.e., steel inserts are generally used in aluminum or magnesium parts to enable these parts to be joined to other parts by bolts. On July 10, 1967, petitioner purchased all the outstanding stock of Newton, consisting of 10 shares, from Marvin Best for $3,750,000 in cash. On October 31, 1967, Newton was liquidated into petitioner under section 332(b), and thereafter was operated as a division of petitioner. The basis to petitioner of the assets received from Newton was arrived at by allocating the adjusted basis to petitioner of the Newton stock, proratable to all Newton’s assets, pursuant to section 334 (b) (2).
Petitioner has executed a Form 2045 Transferee Agreement in which it became a transferee within the meaning of section 6901 to the extent of the deficiency at issue plus statutory interest.
On January 4,1961, Robert Neuschotz was the president of Newton and owned 39.5 percent of the outstanding shares of common stock in his own name. He also owned 37.17 percent of the stock as trustee under the will of Lily Neuschotz, his deceased wife. In addition, 10.5 percent of the stock of Newton was owned by each of his two daughters and 2.33 percent of the shares was owned by City of Hope, a California nonprofit corporation.
On January 4, 1961, Neuschotz and City of Hope executed a document entitled “Grant and Agreement,” which provided for the transfer to City of Hope of certain patents and patent applications relating to inventions developed by Neuschotz. The pertinent parts of the agreement read as follows:
Whereas, Neuschotz is the inventor of certain products, a list of which is hereby appended, marked Exhibit “A” and herein incorporated by reference, on which Letters Patent of the United States have heretofore issued or for which application has heretofore been made; and,
Whereas, it is the desire of Grantee to acquire and of Neuschotz to sell the said inventions (hereinafter referred to as “Patents” whether or not the patents have been issued thereon) ;
* ⅜ # * * * &
2. Grant. Neuschotz does hereby give, grant, assign and transfer to Grantee the said Patents and each of them, including without limiting the foregoing, all of his right to make, use and sell in the United States of America, all products and to practice all processes utilizing or otherwise embodying the Patents.
3. Consideration. As consideration for the grant set forth in paragraph 2 hereof, the Grantee agrees to pay to Neuschotz, his transferees, licensees or assigns, payments computed in accordance with the following schedule:
An amount equal to five percent (5%) of the “net sales”, as that term is hereinafter defined.
For the purposes of this agreement “net sales” and “net sales of the Patents”, as those terms are used herein, shall mean the “gross sales” by the Grantee and any of its Licensees (such sales by Licensees being included in accordance with the provisions of paragraph 8), excluding all sales taxes and manufacturers’ excise taxes, and minus a deduction of sales and returns and allowances credited in lieu of cash payments on returned merchandise.
* ⅜ * # ⅝ Sf« *
6. Trademarks. Should any Trademark be adopted by any licensee for any Patent covered hereby, such Trademark shall not become the property of Neuschotz, nor need the Grantee contract for ownership of the same.
⅜ ⅞: * * ⅜ * ⅜
8. Licenses. Grantee contemplates that it may license others to make, use and sell all products and to practice all processes utilizing or otherwise embodying the Patents. In the event Grantee grants any such license, a sale by any licensee shall be considered a sale by Grantee for the purpose of computing payments owing to Neuschotz; provided, however, that Grantee shall contractually obligate each such licensee to make periodic accountings and payments to Grantee not less frequently than required by the provisions of paragraph 4 of this Agreement, and Grantee shall account and pay to Neusohotz, his transferees, licensees or assigns, on the basis of such accountings. No royalty-free license or foreign licenses shall or may be issued hy Grantee without the written consent of Neuschotz.
9. Warranty. Neuschotz warrants and represents that the Patents, and each of them, referred to on Exhibit “A”, are his alone, and no other person, firm or corporation has any right, title or interest therein. Neuschotz agrees to and does hereby indemnify and hold harmless the Grantee from all loss, liability, cost or expense incurred by the Grantee by reason of the untruthfulness of any representation or warranty in this paragraph contained, or by reason of any claim made by any third person that the Patents, or any of them, infringe the patents of others.
The agreement further provided, that Neuschotz would pursue all patent applications at his own expense and such patents when issued would be deemed transferred under the agreement to City of Hope.
The grant and agreement covered seven patents and four patent applications, one of the patents being a principal Newton product known as a “Keensert.” The unique feature of a Keensert is that after insertion into the carrier it can be locked into place by the use of locking keys which will prevent further rotation.
On the same day and covering the same patents as the grant and agreement above set forth in part City of Hope and Newton executed a document entitled “Agreement” (hereinafter 1961 license agreement) which provided in part as follows:
Whereas, the Licensor [City of Hope] is the owner of certain patents and/or patent applications, a list of which is attached hereto, marked Exhibit “A”, and herein incorporated by reference, and
Whereas, it is the desire of the Licensee [Newton] to secure an exclusive license to make, use and sell products and to utilize processes referred to in or covered by said patents or patent applications, as the case may be. For convenience the patents and patent applications will be generically referred to hereinafter as “Patents”.
The Parties Agree as follows:
1. GRANT. The Licensor hereby grants to the Licensee an exclusive right to make, use and sell products and to utilize the processes disclosed in the Patents, for the full term of the last maturing patent referred to on Exhibit “A”. The Licensee agrees that any modifications, changes, improvements or additions to the said Patents, or any of them, made or acquired by the Licensor during the life of this Agreement shall come under all of the terms of this Agreement, and title thereto shall pass to the Licensor. In this connection Licensee agrees to execute such further and other assignments thereof as may be appropriate in the circumstances.
2. CONSIDERATION. In consideration for the foregoing, the Licensee will pay to the Licensor an amount equal to six percent (6%) of the net sales of each of the patents, for the term hereinabove described.
For the purposes of this agreement “net sales” and “net sales of the Patents”, as those terms are used herein, shall mean the “gross sales” by the Licensee, excluding all sales taxes and manufacturers’ excise taxes, and minus a deduction of sales returns and allowances credited in lieu of cash payments on returned merchandise.
3. CERTAIN DUTIES OF LICENSEE. Licensee agrees to use its best efforts to promote the use and sale of products manufactured under or pursuant to the Patents, to keep true and accurate books of account, and to render reports for each month within thirty (30) days after the end of each calendar month for which any payment is due. Such report will be accompanied by the remittance of tie amount siown due thereby. Licensee agrees that it will keep true and accurate books of account reflecting all sales of and under tie Patents, and tie Licensor shall have the right and may authorize others to utilize the right to examine such books and records at all reasonable times, but not oftener than four times per year, for the purpose of verifying the accountings hereunder.
⅞; ⅜ }'¿ ⅝ ⅜ ⅜ ⅜
5. INDEMNITY ON ACCOUNT OF DEFECTIVE PRODUCTS. Licensee agrees to and does hereby indemnify and save harmless the Licensor of and from any loss, cost, damage, liability or expense, including attorney’s fees, arising out of or connected with any claim made by any person, firm or corporation, that the products manufactured pursuant to this license, and/or any of them, is defective. Licensee further agrees to indemnify and save harmless the Licensor of and from any claims made by others that any of the products manufactured pursuant to the license herein granted, shall and do constitute an infringement of letters patent issued to others, it being understood and agreed in this connection that any actions instituted by the Licensee on account of any claimed violation by others of any patent rights
(a) May be at Licensee’s sole cost and expense and in the name of Licensor, or otherwise;
(b) May be solely at Licensee’s cost and expense; and
(c) Licensee may keep and retain for its own use and benefit all recoveries, if any, made in any such action or proceeding.
Under the 1961 license agreement, Newton utilized three of the seven patents, in manufacturing products between January 1, 1962, and October 31,1967. Of the four patent applications, two were abandoned and two matured into patents, one issued on April 28, 1964, and the other issued on December 1, 1964. One of these covered the manufacture of the “Speedsert,” which is a self-threading device that can be inserted into an unthreaded hole in the carrier. The Speedsert is another principal Newton product.
On February 16, 1962, Neuschotz sold 10 shares of Newton stock to Marvin Best. Subsequently, on October 19,1965, all shares of stock except those owned by Marvin Best were redeemed by Newton for $332,500.
In 1965 an audit of Neuschotz’s Federal income tax returns for the years 1961, 1962, and 1963 was made by an internal revenue agent. The agent questioned Neuschotz’s reporting of royalties received by him under the 1961 license agreement as capital gain, on the grounds that the transfer of the patent rights to City of Hope and subsequent license given Newton was in substance an “indirect” transfer from Neuschotz to Newton within the meaning of section 1235(d). Neu-schotz and representatives of the Internal Revenue Service settled this issue on March 16, 1965. The settlement provided that amounts received by Neuschotz for the years 1961 through 1963 as transferor of the patents were to be treated as ordinary income, while amounts received, by him for those years as income beneficiary of the “Trust under the Will of Lily Neuschotz,” his deceased wife, were entitled to capital gains treatment. The basis for capital gains treatment of part of the payments was that Lily Neuschotz was deemed to have had a one-half community property interest in ;a pending patent application which after her death in 1956 developed into the basic Keensert patent. This interest passed under her will to the aforementioned trust, and payments made in consideration of its transfer to City of Hope were received by Neuschotz as sole income beneficiary under the trust.
On January 28, 1966, Newton and City of Hope in a letter agreement which was made effective retroactively to January 4, 1961, amended the grant and agreement which the parties had executed on that earlier date to provide that:
1. Tou [City of Hope] shall have the right at the expiration of any calendar year hereafter ensuing to render the license agreement non-exclusive unless we [Newton] shall have paid you within said calendar year minimum royalties aggregating not less than $25,000.00.
2. Should you elect to render such license agreement non-exclusive pursuant to the option hereinabove given to you, we shall be released from any duty to indemnify or save you harmless in consequence of any claims made by others that the products manufactured pursuant to such license agreement constitute an infringement of Letters Patent issued to others.
Oi^tme 30,19fifiiCity of HopejuuDJarvin Best executed an agree-rfMPwnich prolsHfd in part as falPmR ■;
Whereas, it is the desire of City of Hope to sell and of Best to buy all right, title and interest of City of Hope in and to its rights under said Grant, including, without being limited to, the patents referred to in said Grant,
Now, Therefore, the Parties Agree as Follows :
1. City of Hope hereby transfers, sets over and assigns to Best all and the entire right, title and interest heretofore acquired by it in, to and under the Grant, expressly subject, however, to the following:
(i) The rights of Newton Insert Company, as licensee under a Patent License Agreement between Newton Insert Company and City of Hope, executed on or about January 4,1961, and
(ii) The rights of Robert Neuschotz, the grantor named in said Grant.
2. As full and final consideration for the conveyance herein made, Best agrees to pay to City of Hope the sum of $80,000.00 in 120 equal monthly installments commencing on the first day of July, 1966.
Oil July 1,1966, Neuschotz and Newton executed a document entitled “Exclusive License Agreement” (hereinafter referred to as 1966 license agreement), which agreement was further amended on July 2, 1966. The final agreement granted the licensee, Newton, “the exclusive right, license and privilege to manufacture, use, sell, and lease, and to grant sublicenses to manufacture, use, sell, and lease, throughout the world, products, apparatus, and processes,” covered by 15 new patents and 18 new patent applications. Included among these was a patent issued on November 3, 1970, which related to the manufacture of Keenserts with an improved barb-type key. Thereafter, most Keenserts were manufactured under this new patent. Newton paid amounts under this agreement to Neuschotz on all products and apparatus which it sold or leased under the agreement, in the amount of 6 percent of the net selling price or net leasing price. The 1966 license agreement provided also for minimum royalties, at the rate of $75,000 per year for each of the first 5 years following the execution of the agreement, and at the rate of $60,000 per year thereafter until the date of expiration of the last-to-expire letters patent already issued at the time of the execution of the agreement or until the total of all payments received by Neuschotz under the agreement reached an aggregate of $1,095,000, at which time Newton would be relieved of the responsibility for minimum royalties. During the period January 1,1962, to October 31,1967, Newton paid the following sums under the licensing agreements:
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The following percentages represent that portion of the total royalties paid by Newton under the 1961 license agreement deemed to pass through the trust established under the will of Lily Neuschotz:
Year Percentages Year Percentages
1962_ 50. 6 1965_ 36. 2
1963_ 42.9 1966_ 36. 8
1964_ 36. 2 1967_ 41. 5
Newton did not treat the license agreements or underlying patents and patent applications as capital assets in its books, nor did it record on its 'books or claim as a deduction on its Federal income tax returns any depreciation attributable to such patents and patent applications. Newton at no time capitalized research and experimental expenses in connection with the patents or patent applications as permitted under section 174(b). On its Federal income tax returns for fiscal years ending October 31, 1962, through October 31, 1967, Newton deducted the amounts due and paid under the license agreements for each respective year as “royalties,” carrying the expenses under the heading of “Other Deductions.” Newton’s Federal income tax return for the fiscal year ended October 31,1965, was audited by an agent of the Internal Revenue Service and accepted as filed by tbe Internal Revenue Service.
The patents used in products manufactured by Newton during the period January 1,1962, through October 31,1967, which fall under the 1961 license agreement, had an aggregate fair market value as of November 1,1967, of $569,500. Patents not used in products manufactured by Newton during this period and covered by the 1961 license agreement had an aggregate fair market value of $103,000.
The fair market value of the patents and other inventions covered by the 1966 license agreement was $1,514,000 as of November 1,1967.
The projected sales figures used in arriving at the above fair market values of the license agreements would have generated required payments under the license agreements of approximately $1,754,000 through October 1,1972.
Respondent in his computation of Newton’s tax liability in his notice of transferee liability to petitioner determined that Newton had income for its fiscal year ended October 31,1967, from “depreciation recapture” of $926,623. On brief respondent concedes that any depreciation recapture is limited to $569,500 with respect to the patents covered by the 1961 agreement and $100,047.67 as to the patents covered by the 1966 agreement.
Section 1245 2 provides that if personal property of a taxpayer of a character subject to depreciation or amortization is disposed of during a taxable year beginning after December 31, 1962, the excess of (1) the recomputed basis of the property, or (2) in case of a sale, exchange, or involuntary conversion, the amount realized, or (3) in the case of any other disposition, the fair market value of the property over the adjusted basis of the property shall be treated as gain from the sale or exchange of property which is neither a capital asset nor property described in section 1231.
Section 1.1245-3 (b), Income Tax Regs., 3 includes within the definition of personal property, intangible personal property. Petitioner does not contest the validity of this regulation but accepts the fact that if Newton owned the patents covered by the 1961 and 1966 agreements so that those patents were intangible personal property subject to depreciation in Newton’s hands, they are personal property within the provisions of section 1245. The parties agree that the disposition of Newton’s rights in the patents to petitioner upon Newton’s liquidation in accordance with the provisions of section 332(b) is a disposition of property to which section 1245 is applicable because petitioner’s basis for Newton’s assets was not a carryover basis but a basis determined under section 334(b) (2).
Petitioner concedes that the 1966 license agreement constituted a sale of the patents covered thereby to Newton and therefore those patents were depreciable assets in Newton’s hands, but takes issue with respondent’s determination of the amount of this depreciation which is recapturable.
Petitioner contends, however, that the 1961 license agreement was a license and did not amount to a sale of patent rights1 and therefore Newton acquired no depreciable intangible property under the 1961 agreement but that the payments by Newton to Neuschotz under this agreement were merely for the use of a capital asset and are deductible business expenses. Sec. 162(a) (3).
The 1961 license agreement granted Newton the “exclusive right to make, use and sell the products and to utilize the processes disclosed in the Patents for the full term of the last maturing patent.” These terms are identical in impact to the language stated in Waterman v. MacKenzie, 138 U.S. 252 (1891), to be necessary to effect a sale of a patent. There, the Supreme Court found that a patent was composed of the “exclusive right to make, use and vend an invention,” and “the granting of an exclusive right under the patent * * * which does not include the right to make, and the right to use, and the right to sell, is not the grant of a title in the whole patent * * * and is therefore only a license.” However, a transfer of the rights to make, use, and vend amounts to a transfer of all substantial rights to a patent, and has consistently been deemed to be a sale. Edward C. Myers, 6 T.C. 258 (1946); Lockhart v. Commissioner, 258 F. 2d 343 , 349 (C.A. 3, 1958), affirming in part and reversing in part a Memorandum Opinion of this Court. Whether there has been a transfer of all substantial rights depends upon the facts and circumstances of each case. Rose Marie Reid, 26 T.C. 622 , 632 (1956). The use of the terms “licensor” and “licensee” in the agreement is not controlling. Rose Marie Reid, supra, and Edward C. Myers, supra.
The 1961 license agreement unequivocally granted to Newton the three substantial rights necessary to a sale of a patent. City of Hope did not reserve any right which might preclude our finding a sale of the patents.
Examples of substantial rights retained by a transferor include’the right to terminate the agreement with or without cause, Bell Intercontinental Corporation v. United States, 381 F. 2d 1004, 1020-1021 (Ct. Cl. 1967); rights to grant a nonexclusive license to another firm and to compel the transferee to sublicense another, Allied Chemical Corporation v. United States, 370 F. 2d 697 (C.A. 2, 1967); and the right to prohibit assignment of the agreement without the transferor’s written consent. Oak Manufacturing Co. v. United States, 301 F. 2d 259, 262 (C.A. 7, 1962).
The provisions of the 1961 license agreement clearly did not reserve any such right to City of Hope. The obligation which the agreement imposed on Newton to use its best efforts to promote the sale of products manufactured under the patents and the requirement that Newton utilize appropriate accounting methods and allow City of Hope access to Newton’s books of account, were simply provisions included to protect City of Hope’s right to compensation under the agreement. Such provisions provide security for the transferor, but do not cause there to be no transfer of ownership.
Petitioner makes some argument that even though there was no retention of a substantial right in the patents by City of Hope, since there was no affirmative statement in the agreement that City of Hope granted Newton the right to sublicense others to utilize the patents, this right was not granted to Newton by the agreement. In our view an unlimited transfer of the exclusive rights to use, manufacture, and sell for the life of the patent would automatically include the right to authorize others to use, manufacture, and sell. Furthermore, even if the agreement could be interpreted as not granting to Newton the right to sublicense, the failure to grant Newton the right to sublicense does not result in the reservation of a substantial right to City of Hope, since City of Hope was foreclosed from granting other licenses by the exclusiveness of Newton’s license.
The case of Harrison v. Schaffner, 312 U.S. 519 (1941), relied on by petitioner, which deals with the right of a life beneficiary of a testamentary trust to assign income, is clearly distinguishable. Oak Manufacturing Co. v. United States, supra, also relied on by petitioner, is likewise distinguishable on its facts from this case. The facts in that case showed that the parties had intended to establish an agency relationship for the distribution of the taxpayer’s products, rather than to sell the patents.
Finally, even were we to find that the failure to grant permission to sublicense others meant that Newton had to obtain the consent of City of Hope before doing so, this alone has been held not to amount to the reservation of a substantial right so as to preclude a sale. Watson v. United States, 222 F. 2d 689, 691 (C.A. 10, 1955).
Petitioner further contends that the 1961 license agreement was not a sale because some of the patents later covered by the agreement were not in existence in 1961. However, we have held that it is not significant in determining whether an agreement constitutes a sale of a patent that a patent has not been issued or even applied for at the time that all substantial rights are transferred. Estate of Milton P. Laurent, Sr., 34 T.C. 385 (1960).
The letter amendment of January 28, 1966, to the 1961 agreement, effective as of January 4, 1961, which amendment provided that the license granted would become nonexclusive if minimum royalties of $25,000 were not paid to City of Hope annually does not cause the 1961 agreement not to be a sale of the patents. Assuming the retroactive effectiveness of the amendment, this clause merely established a condition subsequent, which does not negate a sale. Allen v. Werner, 190 F. 2d 840 (C.A. 5, 1951); Commissioner v. Celanese Corp., 140 F. 2d 339 (C.A.D.C. 1944), affirming a Memorandum Opinion of this Court.
Having reviewed the transaction both from the standpoint of what was transferred, as well as what was retained, we find that the broad and unlimited language contained in the 1961 license agreement shows that the parties thereto intended a sale of the patents. Watson v. United States, supra, and Rose Marie Reid, supra.
Petitioner contends tliat if we find from the terms of the agreement that there was a sale, Newton was nevertheless entitled to treat the transaction as a mere license because the amounts paid under the license agreements were contingent and not fixed. This argument of petitioner is without merit. The Court has stated that a taxpayer which was paying a percentage of sales for use of a patent was entitled to deduct the percentage payments either 'because the sums were ordinary and necessary expenses paid for the use of the invention or because they represented depreciation allowable on the purchased invention. 4 This statement was merely a recognition that it was unnecessary to determine in the particular case whether the amounts are deductible as royalties or as depreciation since the licensee was entitled to a deduction for the amount as a business expense if the agreement between the parties was a mere license or to a deduction of the same amount as depreciation of a capital asset if the agreement was the sale of the invention. This statement in no way indicates that where there has been a sale of the patents, the purchaser has the choice of characterizing the deduction of the percentage payments made as royalties deductible under section 162 or as depreciation deductible under section 167. We have held to the contrary. In Associated Patentees, Inc., 4 T.C. 979 (1945), we held that since a transfer of patents in return for 80 percent of the income generated by their use was found to be a purchase of capital assets with a determinable useful life, the purchaser was entitled to deduct the percentage payments, but only as depreciation of the cost of the patents.
Petitioner relies on the case of McCullough Tool Co., 33 T.C. 743 (1963), affirmed on another issue 318 F. 2d 790 (C.A. 9, 1963), acq. 1964- 1 C.B. 5 , to support its contention that in the absence of a fixed cost for the patent, a licensee under an exclusive license may deduct percentage payments as business expenses under section 162. The Court in McOullough found that the agreement there involved, as modified, was a sale of the patents for a fixed price and, in light of that determination, saw no basis for denying the taxpayer a depreciation deduction on the assets purchased. Tire Court was not required to pass on the argument of the Government that depreciation could not be taken on assets purchased on a percentage of sales or production basis since under such circumstances the patents had no fixed cost susceptible of depreciation.
Petitioner contends that the 1966 agreement between City of Hope and Marvin Best, which transferred the former’s rights under its 1961 agreement with Neuschotz to Best for $80,000 shows that City of Hope could not have intended in 1961 to transfer ownership of the patents to Newton. The agreement ‘between City of Hope and Best does not support petitioner’s position. City of Hope transferred its interest to Best subject to Newton’s rights. In our view the agreement transferred to Best only City of Hope’s 1-percent royalty interest in the patents and in no way affected Newton’s ownership of all rights in the patents.
Petitioner’s final argument is that the provisions of section 1285 preclude the possibility that the 1961 license agreement could effect a sale of the underlying inventions.
•Section 1235, enacted in 1954, deals with the tax treatment of payments received by a “holder” as consideration for his transfer of all substantial rights to a patent, where the payments are contingent upon the productivity of the patent or payable periodically over the period the patent is used by the transferee. 5 Prior to the enactment of section 1235, the Government had contended, generally unsuccessfully, in certain cases that transactions transferring patents for contingent rather than fixed amounts were licenses and not sales, and that trans-ferors of patents on such terms were not entitled to treat the payments which they received as capital gains. See Leonard Coplan, 28 T.C. 1189, 1191 (1957), for a discussion of changes in the positions taken by the Government in this regard.
Section 1235 was enacted to clarify the tax treatment of percentage payments to inventors and their financial backers, and to allow persons whose efforts led to the development of valuable inventions capital gains treatment on the sale or assignment of the underlying patents, regardless of the mode of payment involved and whether the inventor was in the business of inventing. The substance of the provisions is that a transfer shall be deemed a sale or exchange of a capital asset held for more than 6 months — and, consequently, result in long-term capital gain — where enumerated conditions are met.
In S. Rept. No. 1622, to accompany H.R. 8300 (Pub. L. No. 591), 83d Cong., 2d Sess., p. 441, the statement is made that:
It is the intention of your committee that, if the mode of payment is as described in subsection (a) [of See. 1235] * * * the sale of a patent by any “holder1’ must qualify under the section in order for such “holder” to obtain capital gain treatment. [Emphasis supplied.]
In Myron C. Poole, 46 T.C. 392 (1966), cited by petitioner, the issue was whether Poole, an inventor, was entitled to capital gains treatment. Poole was a “holder” under section 1235, and he transferred his rights to a patent to an intermediary corporation, which then granted an exclusive license to a corporation controlled by him. Both transfers were for consideration contingent upon production of the inventions under the patent. We found that Poole had made an indirect transfer of all substantial rights to the patent to his controlled corporation, a “related” entity within the meaning of section 1235(d). Accordingly, we held that Poole was not entitled to treat the payments he received as capital gains undersectionJl)35, andttaip ay ments which he received MÜ». transf
(1) Tangible personal property (as defined in paragraph (c) of § 1.48-1, relating to the definition of “section 38 property” for purposes of the investment credit), and
(2) Intangible personal property.
Petitioner relies on M. E. Cunningham Co., T. C. Memo. 1951-81 .
SEC. 1235. SALE OR EXCHANGE OF PATENTS.
(a) General. — 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—
(1) payable periodically over a period generally coterminous with the transferee’s use of the patent, or
(2) contingent on the productivity, use, or disposition! of the property transferred.
(b) “Holder” Defined. — For purposes of this section, the term “holder” means—
(1) any individual whose efforts created such property, or
(2) 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 neither — ■
(A) the employer of such creator, nor
(B) related to such creator (within the meaning of subsection (d)).
(c) Effective Date. — This section shall be applicable with regard to any amounts received, or payments made, pursuant to a transfer described in subsection (a) in any taxable year to which this subtitle applies, regardless of the taxable year in which such transfer occurred.
(d) Related Persons. — Subsection (a) shall not apply to any transfer, directly or indirectly, between persons specified within) any one of the paragraphs of section 267(b) ; except that, in applying section 267)(b) and (c) for purposes of this section—
(1) the phrase “25 percent or more” shall be substituted for the phrase “more than 50 percent” each place it appears in section 267(b), and
(2) paragraph (4) of sectiom 267 (c) shall be treated as providing that the family of an individual shall include only his spouse, ancestors, and lineal descendants.
There is nothing in this record to indicate that any of the payments made by Newton to City of Hope, Best, or Neuschotz were with respect to patent applications before issuaruce of the patent and therefore there is no issue with respect to the treatment of payments made for use of a process or manufacture of a product covered by a patent application prior to issuance of the patent.
Sec. 1.1245-4(c) (8), Income Tax Regs.:
(;3) Complete liquidation of subsidiary. In the case of a distribution in complete liquidation of an 80-percent-or-more controlled subsidiary to which section 832 applies, the limitation provided in section 1245(b)(3) is confined to instances in which the basis of the property in the hands of the transferee is determined, under section 334(b)(1), by reference to its basis in the hands of the transferor. * * * section 1245(b)(3) may apply in respect of a liquidating distribution of section 1245 property by an 80-percent-or-more controlled corporation to the parent corporation, but does not apply in respect of a liquidating distribution of section 1245 property to a minority shareholder. Section 1245(b)(3) does not apply to a liquidating distribution of property by an 80-percent-or-more controlled subsidiary to its parent if the parent’s basis for the property is determined, under section 334(b)(2), by reference to its basis for the stock of the subsidiary.
SEC. 1016. AnjuSTMENTS TO BASIS.
(a) (General Rule. — ¿Proper adjustment in respect of the property shall in all cases be made—
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(2) in respect of any period since February 28, 1913, for exhaustion, wear and tear, obsolescence, amortization, and depletion, to the extent of the amount—
(A) allowed as deductions in computing taxable income under this subtitle or prior income tax laws, * * *
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but not less than the amount allowable under this subtitle or prior income tax laws. Where no method has been adopted under section 167 (relating to depreciation deduction), the amount allowable shall be determined under section 167(b)(1). * * *

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Source: Frix Law Library, https://www.frixlaw.com/law-library/cases/4482599. Public record. Not legal advice.