Shepard v. Comm'r of Internal Revenue

• Decision Date: 09 February 1972
• Docket Number: Docket No. 3194-69.
• Citation: 57 T.C. 600,173 U.S.P.Q. 34
• Parties: FRANCIS H. SHEPARD, JR., AND MARGARET R. SHEPARD, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

173 U.S.P.Q. 34

57 T.C. 600

FRANCIS H. SHEPARD, JR., AND MARGARET R. SHEPARD, PETITIONERS

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 3194-69.

United States Tax Court

Filed February 9, 1972.

David Beck, for the petitioners.

John James O'Toole, for the respondent.

The petitioner, an inventor, developed a high-speed printer for use in conjunction with electronic computers. Therefore he and the National Cash Register Co. entered into an agreement and two supplemental agreements under which such company obtained from him both a nonexclusive license with respect to two patents which related to certain aspects of the printer, and the technological know-how which was necessary to the manufacture of the printer. Held, that the amounts received by petitioner from the National Cash Register Co. during the years in question related solely to the technological know-how rather than to any license under patents. Held, further, that the petitioner conveyed all the substantial rights of ownership in the technological know-how to such company and, accordingly, is entitled to treat such amounts as capital gain.

ATKINS, Judge:

The respondent determined deficiencies in income tax for the taxable years 1965, 1966, and 1967 in the respective amounts of $20,532.32, $17,012.64, and $44,736.44. The only issue for decision is whether amounts received by Francis H. Shepard, Jr., during the above taxable years from National Cash Register Co. represented royalty payments made by such company pursuant to a nonexclusive license under patents owned by Shepard or a nonexclusive license to use certain technology and, hence, ordinary income to him, or whether such amounts represented proceeds from the sale by Shepard of such technology to such company so as to entitle him to treat such amounts as long-term capital gain.

FINDINGS OF FACT

Some of the facts have been stipulated and are incorporated herein by this reference.

Francis H. Shepard, Jr., and Margaret R. Shepard, husband and wife, filed joint Federal income tax returns for the taxable years 1965 through 1967 with the district director of internal revenue, Newark, N.J. At the time they filed their petition herein they resided in Summit, N.J. Inasmuch as Margaret R. Shepard is a party herein only because of having filed joint returns for the years in issue, Francis H. Shepard, Jr., will hereinafter be referred to as the petitioner.

The petitioner is a professional engineer. After his graduation from college he was employed as an engineer by Sperry Development Co. and, subsequently, by Radio Corp. of America. Since 1939 he has served as a consulting engineer for clients which have included DuPont, Bristol Instruments, Glenn L. Martin, United Shoe, and various agencies of the U.S. Government. During the course of his work for various clients petitioner developed patentable inventions while working on his own behalf and, accordingly, owned the patents which issued with respect thereto. Prior to the year 1955 he had never sold or offered to sell any of the patents which he owned.

By the middle of 1954 the petitioner had completed the development of a high-speed, alpha-numeric line printer for use in conjunction with computers. The purpose and function of such printer, known as the Model 190 High Speed Typer and hereinafter referred to as the typer, was to convert the electrical impulses produced by a computer into hard copy. The petitioner's typer accomplished such conversion with an output potential of up to 190 columns of print at a rate in excess of 20 lines per second. At that time its output potential far exceeded the output which could be obtained by the closest available art, namely, some 80 columns of print at a rate of about 1 1/2 lines per second.

Incorporated into the petitioner's typer was a cylindrical drum which was rotated by a synchronous motor. Around the periphery of the drum were columns of raised type, each such column containing a complete alphabet, numbers, and punctuation marks. Beneath the drum were hammers, the function of which was to strike the type on the rotating drum so as to produce the desired character on inked paper which was positioned between the drum and the hammers. Inasmuch as the drum was rotated at speeds of about 1,800 revolutions per minute (that is, about 30 revolutions per second), the peripheral speed or speed at which the type passed the hammers was very high. Thus, the hammers had to be timed exactly to enable them to strike the desired character and get away in a very short time in order to produce a clear impression of the character without blurring or smearing.

During the course of developing his typer the petitioner filed two applications for patents, each dated January 22, 1953. One such application, No. 332-712, related to an intermittent motion device which, as stated in such application, is a device ‘for obtaining a dwell or a series of dwells in the motion of an output shaft from a continuously rotating input shaft.’ The other application, No. 332,711, related to a hammer-impelling means in high-speed printers or, as stated in such application, ‘more particularly to a hammer assembly for high-speed printers.’ Two of the objects of such hammer assembly were, as stated in such application, ‘to provide a hammer assembly for high-speed printers for cooperation with a continuously relating type drum’ and ‘to provide a hammer assembly for a high-speed printer in which the time of dwell of a hammer can be accurately controlled to within narrow limits.’

As heretofore indicated the development of petitioner's typer was not completed until the middle of 1954. It was not until that time that the technology incorporated in the final design of the typer had been fully developed, namely, the technology involved in controlling the hammers and type drum, in advancing the paper without tearing, and in inking the originals and copies. Knowledge of the mere information contained in the above-described patent applications would not have been sufficient to enable one to manufacture petitioner's typer.

The National Cash Register Co., hereinafter referred to as NCR, wished to acquire a typer similar to petitioner's for us in connection with its Model 304 Electronic Data Processor. In July 1955, NCR purchased two typers from petitioner.¹ Shortly before the two typers were purchased Carl Beust, then the head of NCR's patent department, received an interdepartment correspondence of NCR which stated in part as follows:

Our negotiations with Dr. Shepard of the Shepard Laboratories, Summit, New Jersey, in the matter of the procurement of two of his Model 190 Typers for use with the forthcoming Model 304 Electronic Date Processor, has reached the stage where purchase orders are being written for these units. We expect to place the orders early next week. * * *

It seems to us that to satisfy the high speed printing requirements for the 304 Data Processor and probably also for later improved Processors, it will be necessary to employ printers of the so-called ‘Synchronous' type similar in principle to the Model 190 Typer made by Shepard. Since the urgency associated with the development of the 304 precludes the development of a Synchronous Printer here, we intend to use the Model 190 Typer in the 304 system production.

The purpose of this letter is to acquaint you with the engineering planning in this matter so that you in turn can formulate your plans as to how you will proceed to clear our future course, in the matter of synchronous printers, with possible controlling interested parties in this field. It may be necessary, due to Shepard's inability to deliver sufficient machines, once we are in production, or due to excessively high costs in Shepard's production, to tool and manufacture these printers in Dayton. In fact, it seems to me that we should at least be ready with a design based on a conversion of Shepard's drawings to our standards and process specifications, at an early date, so as to insure a supply of printers from our factory, should for some reason or another Shepard purchased printers become unavailable.

One of the typers purchased by NCR was to be used by its Electronics Division in conjunction with the engineering prototype of its data processor. The other typer purchased was, as stated in an interdepartmental correspondence of NCR, for use—

in the Electronic Production Engineering Department at Dayton on which exhaustive tests (not simply acceptance tests) can be performed with a view to improving the printer to be supplied hereafter by Shepard, and also as an educational unit to be studied by our design engineers for the later development of our own synchronous type printer. We also intend to use it at Dayton as a guide in preparing factory working drawings of the Shepard printer so that this particular printer can be manufactured at Dayton should Shepard fail to adequately produce or should the Shepard Laboratories be purchased by some third party. In this regard, Mr. Beust has been requested to clear our course for the manufacture of the Shepard printer and/or a printer of the synchronous type of our own design.

Such correspondence also contained the following reasons why NCR felt it desirous to acquire the petitioner's typer rather than to design their own:

1. Design and design studies at NCR showed that conventional approaches employing start-stop mechanisms would not yield an alphanumeric printer of high enough speed (in lines per second) to compete with printers already offered with Electronic Data Processing Systems. Additionally, because of the large numbers of parts in the start-stop approach, it seemed likely that production costs per unit would be higher than the synchronous approach. Print quality would be good, however, as compared to the synchronous printer. Tooling costs would also likely be higher for the start-stop printer.

2. It was then thought that we should set about to design a...