Blake v. Comm'r of Internal Revenue
| Decision Date | 06 October 1976 |
| Docket Number | Docket No. 8235—74. |
| Parties | DAVID R. BLAKE AND BETTY H. BLAKE, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
1. Petitioner owned a patent on a leveling device. He granted an exclusive license to American in 1954, limited to the public seating field, and an exclusive license to Ever-Level in 1960, limited to the restaurant field. He received royalties under both licenses as well as damages for patent infringement by others. Held, petitioner retained valuable rights at the time of the American license and is not entitled to capital gain treatment of royalties received thereunder under sec. 1235, I.R.C. 1954. Fawick v. Commissioner, 436 F.2d 655 (6th Cir. 1971), revg. 52 T.C. 104 (1969), followed under the doctrine of Jack E. Golsen, 54 T.C. 742 (1970), affd. on the substantive issue 445 F.2d 985 (10th Cir. 1971). Held, further, on the facts of this case, the Ever-Level license constituted a transfer by petitioner of all substantial rights to his patent and he is entitled to the benefit of sec. 1235 with respect to royalties and infringement damages attributable thereto. Fawick v. Commissioner, supra, distinguished.
2. Petitioner, an accrual basis taxpayer, brought suit against an alleged infringer. The District Court held his patent infringed, the Court of Appeals affirmed, and certiorari was denied in 1968. In 1970, a special master issued a proposed report fixing damages. The case was settled in that year. Held, the amount of damages could not be determined with reasonable accuracy prior to 1970 and was not income prior to that year.
3. Held, petitioner is not entitled to a deduction or an addition to cost with respect to the surrender in 1969 of a right to additional royalties. David R. Blake, pro se.
Thomas R. Ascher, for the respondent.
Respondent determined deficiencies of $1,447.20 and $26,177.38 in the petitioners' Federal income taxes for 1969 and 1970, respectively. The issues now presented for decision are:
(1) Whether amounts received with respect to certain patent licensing agreements are taxable as long-term capital gain under section 12351 or as ordinary income;
(2) Whether a portion of damages received in 1970 in settlement of a patent infringement suit should have been accrued as income in 1968;
(3) Whether the surrender in 1969 of the right to receive certain royalties gave rise to a deduction or addition to cost in that year.
Some of the facts are stipulated and are found accordingly. The stipulation of facts and attached exhibits are incorporated herein by this reference.
Petitioners, husband and wife, resided in Detroit, Mich., at the time their petition was filed. They filed joint Federal income tax returns, amended joint returns, Federal partnership returns of income, and amended partnership returns for the years 1969 and 1970. At all material times, petitioners and their partnership have reported their income on the accrual basis. The events in question relate to the activities of David R. Blake, who will hereinafter be referred to as petitioner.
On July 24, 1948, petitioner applied for a United States patent on a leveling device (hereinafter referred to as a glide) for tables and chairs. A patent was issued with respect to this application on March 22, 1955. On June 24, 1954, petitioner entered into a ‘license agreement’ with the American Seating Co. (hereinafter American or American Seating). Under that license, American was entitled to make, have made, use, and sell glides during the life of the patents. The license was limited to the public seating field, i.e., ‘furniture and equipment for schools, churches, chapels, courtrooms, hospitals, theaters, auditoriums, and vehicles used in transportation’ but excluding ‘furniture designed primarily for restaurant and cafeteria use.'2 It provided for a royalty of eight-tenths of 1 cent (adjusted annually to reflect fluctuations in the consumer price index) on each glide sold by American. American agreed, among other things, not to compete with petitioner in the sale of glides per se (not incorporated in manufactured articles) outside the public seating field. The license could be made nonexclusive or canceled by petitioner if minimum royalties were not paid. It could also be canceled by either party on the other's default. In the event the patents were infringed by a competitor of American, petitioner undertook to take action against the infringer at his own expense. If he did not do so, American could take action in his name ‘and for the account of the parties as their interests may appear.’ American was authorized to withhold royalties during such proceedings and to apply them to defray the cost of a successful action. Petitioner had no liability for costs in excess of royalties.
The formidable and well-reasoned authority arrayed against our position requires a thorough reanalysis by the Court. Unless we can state a clearly articulated and compelling rationale for our position, a tenacious adherence to our prior views will serve only to promote further uncertainty.
In fact, a compelling rationale for the Court's position cannot be stated, since a review of the legislative history underlying section 1235 makes it quite clear that we are in error. Section 1235 was added to the Code in 1954. The House version provided capital gains treatment for a sale or exchange of a patent, an application for a patent, or an undivided interest therein, provided that the ‘seller retains no interest whatsoever’ in the patent.3
Effective in November 1954 petitioner granted a 10-year license under the same patent to Ever-Level Glides, Inc. (hereinafter Ever-Level). Under their agreement, Ever-Level was to pay royalties of 7 percent of the net selling price of glides it sold. However, the royalty was limited to 5 percent until Mason & Parker Manufacturing Co., an alleged infringer, ceased (voluntarily or through legal action by petitioner) to manufacture or sell devices similar to the glides. The additional 2-percent royalty on sales made in the meantime was to be paid once the stated condition was satisfied. Petitioner did not commence any action against Mason & Parker under this agreement and never received the additional 2-percent royalty.
On April 6, 1960, petitioner and Ever-Level executed a ‘patent royalty agreement’ which superseded the 1954 license. The 1960 agreement gave Ever-Level an exclusive license to make, have made, use, and sell glides throughout the United States and Canada for the life of the patents, subject to the American Seating license. Royalties were set at 5 percent of the net selling price of glides sold by Ever-Level. Should annual royalties with respect to sales in fields outside the ‘restaurant trade’ not reach a specified minimum, the license would become nonexclusive with respect to those fields. The restaurant trade was defined as sales ‘for use in establishments offering food and/or drink to the public.’ There was no minimum royalty on sales in the restaurant field. Ever-Level never paid the minimum royalty on non-restaurant sales, and its license became nonexclusive as to such sales in 1963.
The 1960 license provisions regarding suits against alleged infringers were similar to those contained in the American Seating license. In addition, petitioner was obligated to defend infringement suits brought against Ever-Level at his own expense. Any net profit resulting from a suit by Ever-Level against an infringer was to be divided equally between it and petitioner.
Petitioner again agreed that he would ‘commence and vigorously and in good faith prosecute’ an infringement action against Mason & Parker. If that action was unsuccessful, royalties would be reduced by half and, if unfavorable on the merits, Ever-Level had the right to cancel. If petitioner did not commence such an action promptly, Ever-Level could pay royalties into escrow pending the outcome of a suit. In the event of a successful action, petitioner would be entitled to the escrowed royalties plus one-half of the royalties which had previously been withheld under the 1954 agreement.
Ever-Level could cancel the agreement on 60 days' notice, and petitioner could cancel in the event of default. Both parties' rights were subject to a binding arbitration provision. The agreement would terminate on bankruptcy or similar event affecting Ever-Level. It was binding on both parties and their successors and could be assigned by either with the consent of the other. If petitioner desired to sell his patents, Ever-Level had a right of first refusal.
Petitioner thereafter attempted unsuccessfully to find a business willing to purchase rights under his patent outside the fields covered by the American Seating and Ever-Level licenses. He was told by those he contacted that it would not be commercially worthwhile to manufacture and sell glides in a market that excluded the public seating and restaurant fields.
Following acrimonious dispute between them, petitioner and Ever-Level canceled all previous agreements on May 1, 1969, and executed a settlement agreement. This agreement granted Ever-Level a royalty-free nonexclusive license limited to the restaurant field. Petitioner agreed to pay certain legal fees, and a promissory note issued by petitioner to an officer of Ever-Level was canceled. Ever-Level assigned to petitioner all rights to recover damages for infringement of petitioner's patents.
An infringement action by petitioner against Mason & Parker was begun in 1968 and successfully concluded in 1969. As an inducement for Ever-Level to enter into the May 1, 1969, settlement agreement, petitioner released any claim for the additional 2-percent royalty provided in the 1954 agreement. Ever-Level did not reduce, withhold, or pay into escrow any royalties under the 1960 agreement.
Petitioner and Ever-Level sued Bassick Co. and Stewart-Warner Corp. ...
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