Raytheon Prod. Corp.. v. Comm'r of Internal Revenue

• Decision Date: 15 April 1943
• Docket Number: Docket No. 110380.
• Citation: 1 T.C. 952
• Parties: RAYTHEON PRODUCTION CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

1 T.C. 952

RAYTHEON PRODUCTION CORPORATION, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 110380.

Tax Court of the United States.

Promulgated April 15, 1943.

Held, an amount received in compromise of a suit for damages under the federal antitrust laws not shown to have constituted restoration of capital; held, further that the Commissioner erred in allowing deduction of a part of the recovery as unamortized cost of patents involved in a licensing arrangement between the parties to the action. Edward C. Thayer, Esq., for the petitioner.

James T. Haslam, Esq., for the respondent.

The respondent determined deficiencies of $46,894.24 and $15,772.64 in the petitioner's income tax and excess profits tax, respectively, for its fiscal year ending May 31, 1938.

The sole original issue is the taxability of the sum of $350,000 received by the petitioner from the Radio Corporation of America as a part of the amount paid in settlement of litigation between it and the petitioner.

By an amendment to his answer the respondent has raised two additional issues:

(1) His alleged error in failing to include in gross income the sum of $26,949.03 representing unamortized cost of patents.

(2) His alleged error in failing to disallow the sum of $60,000 paid for professional services rendered in connection with the litigation mentioned in the first issue.

FINDINGS OF FACT.

The petitioner is a corporation organized under the laws of Delaware. It filed its income and excess profits tax return for the fiscal year ending May 31, 1938, with the collector of internal revenue for the district of Massachusetts.

The American Appliance Co., hereinafter called Appliance, was incorporated under Massachusetts laws in 1922. It later changed its name to Raytheon Manufacturing Co., hereinafter called Raytheon, then to Raytheon, Inc., and then to Thenos, Inc.

Raytheon was a pioneer manufacturer of a rectifying tube which made possible the operation of a radio receiving set on alternating current instead of on batteries. In 1926 and 1927 it was doing a large and profitable business. In 1926 the profits were about $450,000, in 1927 about $150,000, and in 1928, $10,000. In 1926 the volume of business of Raytheon was well over half of the total business of all competitors in its field.

The Radio Corporation of America, hereinafter called RCA, had many patents covering radio circuits and claimed control over almost all of the practical circuits. Cross-licensing agreements had been made among several companies, including RCA, General Electric Co., Westinghouse, and American Telephone & Telegraph Co. RCA had developed a competitive tube which produced the same type of rectification as the Raytheon tube but which was considered by Raytheon to be inferior thereto. Early in 1927 RCA began to license manufacturers of radio sets and in the license agreement it incorporated ‘Clause 9,‘ which provided that the licensee was required to buy its tubes from RCA. In 1928 practically all manufacturers were operating under RCA licenses. As a consequences of this restriction Raytheon was left with only replacement sales, which soon disappeared.

In 1927 or 1928 Raytheon brought a suit for patent infringement against the Q.R.S. Corporation, hereinafter called QRS. In May 1928 the suit was settled by an agreement under which the Raytheon Manufacturing Co., hereinafter sometimes called Manufacturing Co., was organized under the laws of Delaware with capital stock of 75,000 shares of no par value. QRS received 17,000 shares thereof in exchange for $25,000 in cash and its radio business, including patents, inventories, machinery, and contracts.

On May 23, 1928, Raytheon paid some cash and conveyed all of its property (except patents) to Radio Conduction, Inc., a Massachusetts corporation, hereinafter called Conduction, in exchange for the latter's stock. Good will in the radio business was included in the conveyance, also the right to sue for any property or rights conveyed. Raytheon agreed to change its name to Raytheon, Inc. Thereafter it was engaged in research and development work. On May 29, 1928, Conduction transferred to Manufacturing Co. all of the property acquired from Raytheon in exchange for 38,000 shares of Manufacturing Co. stock. The board of directors of Raytheon determined that the fair value of the assets acquired from Conduction, less the obligations assumed, was in excess of $190,000 and that such excess should be received as paid-in surplus.

Manufacturing Co. sold its remaining 20,000 shares to Harry C. Watts & Co. for $20 per share. Harry C. Watts & Co. also bought 5,000 of such shares from QRS for $20 per share. It later sold all 25,000 shares to the public at $27.50 and up per share. Manufacturing Co. entered on its books the transaction involving the exchange of its 38,000 shares of stock by itemizing the receipt of cash, $25,000; inventory, -,174.27; permanent assets, $181,970 (as appraised), or a total of $267,144.27 less current assumed liabilities of $35,000, or a net value of $232,144.27. The books of Raytheon did not show the claim against RCA as an asset; and the books of Manufacturing Co. indicated the 38,000 shares as issued for the tangible assets of Conduction. No notation was made on the books of Manufacturing Co. that any shares were issued for intangibles, and no intangible value was set up on the opening balance sheet.

When Manufacturing Co. found it impossible to market its tubes in the early part of 1929 it obtained a license from RCA to manufacture tubes under the latter's patent on a royalty basis. The license agreement contained a release of all claims of Manufacturing Co. against RCA by reason of the illegal acts of the latter under clause 9, but by a ‘side agreement‘ such claims could be asserted if RCA should pay similar claims to others.

In 1929 Manufacturing Co. entered into a complicated agreement with the National Carbon Co., manufactured tubes and Carbon sold them as its exclusive sales agent. In order to execute the contract the petitioner was organized and all of the assets, business, privileges (except corporate franchise) good will, trade-marks, patents, licenses, personal property, plant and equipment, choses in action, contracts, etc., of Manufacturing Co. were transferred to petitioner in return for petitioner's capital stock and bonds in the amount of $500,000. The cause of action against RCA was not set up as an asset on the books of Production. The petitioner manufactured the tubes and sold them to Carbon. The contract was terminated in 1933.

The petitioner was informed of instances in which RCA had settled claims against it based on clause 9. On that ground it considered itself released from the agreement not to enforce its claim against RCA and consequently, on December 14, 1931, the petitioner caused Raytheon to bring suit against RCA in the District Court of Massachusetts, alleging that the plaintiff had by 1926 created, and then possessed, a large and valuable good will in intestate commerce in rectifying tubes for radios, and had a large and profitable established business therein, so that the net profit for the year was $454,935; that the business had an established prospect of large increase and that the business and the good will thereof was of a value of exceeding three million dollars; that by the beginning of 1927 the plaintiff was doing approximately 80 percent of the business in rectifying tubes of the entire United States; that the defendant conspired to destroy the competition of the plaintiff and others, by a monopoly of such business, and did suppress and destroy the existing competition; that manufacturers of radio sets and others ceased to purchase tubes from the plaintiffs; that by the end of 1927 the conspiracy had completely destroyed the profitable business and that by the early part of 1928 the tube business of the plaintiff and its property and good will had been totally destroyed, at a time when it had a present value in excess of three million dollars, and thereby the plaintiff was injured in its business and property in a sum in excess of three million dollars. The suit was brought in the name of Raytheon for its benefit and the benefit of Manufacturing Co., petitioner's predecessor in interest, for damages up to May 28, 1928, the day prior to transfer of Conduction's assets to Manufacturing Co.

In May 1933 Manufacturing Co. acquired all of the remaining assets of Raytheon, Inc. (formerly Raytheon (Massachusetts)) in exchange for stock. The value of such assets in excess of the par value of the stock was received as paid-in surplus. The assets consisted of cash, contracts, machinery, laboratory equipment, rights, patents, licenses, etc.

The action against RCA was referred to an auditor, who filed his report on February 4, 1938. Referring to the licensing arrangement involved in the conspiracy and monopoly of which the plaintiff complained, the report reads:

The patents covering the circuits so licensed were owned by the defendant, or the General Electric Company, or the Westinghouse Electric & Company and the Westinghouse Company joined with the defendant as licensors in these license agreements, and the approval of the American Telephone and Telegraph Company was given. Prior to 1927 these companies had entered into certain so-called cross licensing agreements, by which radio patents owned or acquired by each were for certain purposes made available to each. In addition to claiming the clause 9 was illegal, the plaintiff also claims that these cross licensing agreements created an illegal monopoly in the defendant, the General Electric Company, the Westinghouse Company and The Telephone Company; and that this also has a bearing upon the issues in this case.

After reviewing the evidence heard, and summarizing previous detailed findings, the auditor concludes: ‘I find that clause 9 was not the cause of damage to the plaintiff.‘

In the...