EI DuPont de Nemours and Company v. United States

• Decision Date: 13 October 1970
• Docket Number: No. 17948.,17948.
• Parties: E. I. du PONT de NEMOURS AND COMPANY v. UNITED STATES of America, Appellant.
• Court: U.S. Court of Appeals — Third Circuit

432 F.2d 1052 (1970)

E. I. du PONT de NEMOURS AND COMPANY v. UNITED STATES of America, Appellant.

No. 17948.

United States Court of Appeals, Third Circuit.

Argued February 16, 1970.

Decided October 13, 1970.

William Friedlander, U. S. Dept. of Justice, Tax Division, Washington, D. C. (Johnnie M. Walters, Asst. Atty. Gen., Meyer Rothwacks, Jeanine Jacobs, Attys., Dept. of Justice, Washington, D. C., F. L. Peter Stone, U. S. Atty., on the brief), for appellant.

Karl R. Price, Ivins, Phillips & Barker, Washington, D. C. (Roy A. Wentz, Jr., John F. Palmer, Wilmington, Del., on the brief), for appellee.

Before KALODNER and VAN DUSEN,^* Circuit Judges, and FULLAM, District Judge.

OPINION OF THE COURT

FULLAM, District Judge:

This appeal raises two unrelated tax issues: (1) whether funds received by the taxpayer in exchange for the assignment of certain Brazilian patents were taxable as ordinary income or as capital gain; and (2) whether certain legal expenses incurred in connection with the reorganization of a Canadian subsidiary of the taxpayer were deductible as ordinary business expenses, or were capital expenditures. The District Court, 296 F.Supp. 823, decided both questions in favor of the taxpayer, and the government appeals.

I The Brazilian Patents Issue

The taxpayer was the owner of eight Brazilian patents relating to the manufacture of nylon fibers. All were process patents, but four also covered apparatus used in the manufacture of the fibers and four included claims having applicability to dacron as well.¹

In January 1954, the taxpayer entered into two related agreements with a French chemical corporation, Societa Rhodiaceta (hereinafter Rhodiaceta) and its Brazilian affiliate, Companhia Brasileira Rhodiaceta (hereinafter CBR), the effect of which was to transfer rights in all of these eight Brazilian patents to CBR, for a consideration of $5,500,000, so that CBR could engage in the manufacture of nylon in Brazil. Of the agreed payment, $4,094,000 was paid during 1954, and in its tax return for that year, the taxpayer included this amount as ordinary income. Thereafter, a timely claim for refund was filed, on the theory that this payment should have been treated as a capital gain. When the refund was refused, the taxpayer brought suit in the court below and recovered judgment in its favor.

The record discloses the following background to this transaction: In 1946, the taxpayer had assigned to Rhodiaceta its nylon patents in France, Belgium, Spain and Switzerland, and had made available to Rhodiaceta its current nylon technology; and in exchange Rhodiaceta had agreed to pay the taxpayer a continuing royalty. In 1948, Rhodiaceta had licensed the taxpayer under its cellulose acetate yarn patents in the United States and Canada, in exchange for which the taxpayer had agreed to pay Rhodiaceta a continuing royalty. In 1950, Rhodiaceta sought to obtain from the taxpayer nylon rights for CBR under the taxpayer's Brazilian nylon patents. On March 20, 1952, after extended negotiations, these rights were granted to CBR by a non-exclusive license, under which CBR immediately paid a security deposit of $250,000 and agreed to pay a continuing royalty through 1974. On the same date, the taxpayer executed a separate agreement with Rhodiaceta under which the taxpayer agreed, inter alia, to make available to Rhodiaceta the taxpayer's entire nylon technology up to September 30, 1952, and authorized its use by Rhodiaceta and its licensees, including CBR; and Rhodiaceta agreed to cancel the taxpayer's continuing royalty obligation under the 1948 cellulose acetate yarn agreement.

Insofar as Rhodiaceta was concerned, the agreement was carried out, but the provisions of the 1952 license agreement with CBR could not be carried because the Brazilian government refused to approve the agreement and to make available the necessary foreign exchange. It further appeared that the Brazilian government opposed in principle any nonexclusive licensing arrangement, particularly one which would be likely to produce a recurring drain on its dollar reserves.

Thereafter, negotiations continued with a view toward obviating these difficulties. It was the position of Rhodiaceta and CBR that they were interested only in exclusive nylon rights in Brazil, and that, for foreign exchange reasons, it would be helpful to channel the transfer through Rhodiaceta. The taxpayer was willing to grant exclusive nylon rights, on a fixed-price basis, payable over a very short period. Moreover, the taxpayer felt constrained by the terms of a recent antitrust decree to reserve the right to import into Brazil nylon lawfully manufactured in the United States.

The ultimate outcome of these negotiations was the transaction now under scrutiny. The taxpayer entered into the two agreements referred to above, one with Rhodiaceta dated January 4, 1954, and the other with CBR dated January 19, 1954, the net effect of which was to transfer to Rhodiaceta and CBR the exclusive right to make, use and sell nylon in Brazil, and to license others to do so, for the full life of the patents, subject to the taxpayer's reserved right to import, for a total consideration of $5,500,000, part of which was to be paid by CBR and part by Rhodiaceta.

It is undisputed that the taxpayer had held the patent rights in question for more than six months prior to the transfer, and had not held them for sale to customers. Accordingly, the only question is whether the transfer constituted a sale of such rights within the meaning of sections 1222 and 1231 of the Code. Neither the Code itself, nor treasury regulations define what constitutes a sale for capital gains purposes.²

Patent rights are intangible property rights, the transfer of which may qualify as a sale for capital gain purposes. The precise form and terminology of the transfer are not controlling, so long as it transfers exclusive rights for the full life of the patent. Lockhart v. Commissioner of Internal Revenue, 258 F.2d 343 (3rd Cir. 1958); Merck & Co., Inc. v. Smith, 261 F.2d 162 (3rd Cir. 1958); General Aniline & Film Corp. v. Commissioner of Internal Revenue, 139 F.2d 759 (2d Cir. 1944). As stated by this Court in Merck & Co., Inc. v. Smith, supra, at page 164 of 261 F.2d:

"* * * a transfer of all of the substantial rights in a patent is deemed an assignment and qualifies the transferor for capital gains treatment. A transfer of anything less is called a license with a resultant assessment of the tax at ordinary income rates."

To determine whether the taxpayer did transfer all of the substantial rights in the patents in question, the key question is whether the transferor retained any rights which, in the aggregate, have substantial value. See Allied Chemical Corp. v. United States, 370 F.2d 697 (2d Cir. 1967); Merck & Co., Inc. v. Smith, supra; Schmitt v. Commissioner of Internal Revenue, 271 F.2d 301 (9th Cir. 1959).

In the present case, the government contends that the taxpayer retained the following valuable rights in connection with the transfer:

1. The right to import into Brazil nylon lawfully manufactured elsewhere;

2. The right to control any subsequent licensing or assignment of the rights granted Rhodiaceta and CBR with respect to the use of the patented process and apparatus in making nylon;

3. The right to make any use it saw fit (including manufacturing under its own auspices, licensing, sale, etc.) of the patent rights in connection with dacron; and

4. The right to manufacture for sale the apparatus covered by the patent or to license others to manufacture the apparatus for use, in connection with the manufacture of fibers other than nylon (especially dacron).

The District Court carefully analyzed all of the rights retained by the taxpayer, and specifically found that they were of no substantial value. On appeal, the government contends that each of these findings was erroneous, and that, in any event, the District Court erred in treating each right individually and in failing to make a finding that, in the aggregate, the retained rights had substantial value.

In our view, this latter argument represents a too narrow reading of the District Court opinion. After analyzing each of the rights individually, and finding it valueless, the District Court concluded that the taxpayer had not retained substantial rights in the patents, and that the transfer qualified for capital gains treatment. Indeed, at the conclusion of his discussion of the various retained rights, Chief Judge Wright expressly stated:

"No substantial rights in the eight patents transferred having been retained, the 1954 transactions constituted a sale of those patents, the proceeds of which are entitled to capital gains treatment." (296 F.Supp. 833).

Accordingly, the only issue before this Court is whether the District Court findings are clearly erroneous. We have concluded that the record adequately supports the findings of the District Court.

1. Right to import. There was ample evidence in the record to justify the conclusion that the reservation by the taxpayer of the right to import nylon into Brazil, and to license others to do so, preserved nothing of value to the taxpayer. The parties contemplated that the government of Brazil would adhere to its policy of excluding such imports, once a Brazilian company entered the market. Subsequent events have borne out the accuracy of this assumption.

In this connection, we note, but need not pass upon, taxpayer's further argument that this reservation was included in the agreement because it was believed to be required by the provisions of an antitrust decree; hence, the argument goes, the taxpayer lacked the legal capacity to transfer a right to preclude imports, so that this right should be deemed non-existent rather than retained.

Moreover, it is by no means clear that the (theoretical) right to import into Brazil nylon lawfully manufactured in the United States (presumably, under...