Eickmeyer v. Comm'r of Internal Revenue
| Decision Date | 19 April 1976 |
| Docket Number | Docket No. 6756-73. |
| Citation | 66 T.C. 109,190 U.S.P.Q. 31 |
| Parties | ALLEN G. EICKMEYER AND MARJORIE L. EICKMEYER, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
A. Glenn Sowders, Jr., for the petitioners.
George T. Morse III, for the respondent.
Petitioner, pursuant to eight separate agreements, received amounts in return for allowing the transferees to use his patented ‘Catacarb Process.’ Under three of these agreements, petitioner transferred an ‘undivided interest’ in the patent rights and, under the remaining five agreements, he transferred an ‘undivided 1% interest’ in such rights. Held, for purposes of sec. 1235, in determining whether there has been a transfer of an ‘undivided interest’ in ‘all substantial rights' to a patent, the proper focus should be on the substantiality of the rights transferred and retained and not on the size or extent of the ‘undivided interest’ so transferred. Held, further, under each of the eight agreements, petitioner transferred all and retained none of the substantial rights to the ‘Catacarb Process' and is entitled under sec. 1235 to capital gains treatment on the amounts received.
*
Respondent has determined deficiencies in petitioners'1 income tax for taxable years 1968, 1969, and 1970 in the following amounts:
+----------------+
¦1968¦$48,148.43 ¦
+----+-----------¦
¦1969¦115,363.38 ¦
+----+-----------¦
¦1970¦92,842.58 ¦
+----------------+
Concessions having been made, the only issue remaining for our decision is whether, pursuant to eight separate agreements concerning use of his ‘Catacarb Process,‘ the amounts received by petitioner constitute ordinary income or whether such amounts should be characterized as long-term capital gain under section 1235.2
All of the facts have been stipulated and are so found.
Petitioners Allen G. and Marjorie L. Eickmeyer were residents of Prairie Village, Kans., at the time the petition herein was filed. Petitioner filed his 1968 and 1970 income tax return with the District Director, Austin, Tex. There is no indication in the record as to where he filed his 1969 return.
Petitioner is an engineer by profession and, during the years 1968, 1969, and 1970, he operated a sole proprietorship under the name of Eickmeyer & Associates using the cash basis method of accounting.
At least as early as 1960, petitioner began work on a process (hereinafter referred to as the Catacarb Process) for the removal of acid gases, such as carbon dioxide and hydrogen sulfide, from gaseous mixtures. The Catacarb Process has wide application in the oil refining, petrochemical, and fertilizer processing industries.
As early as 1962, petitioner filed a patent application with the United States Patent Office covering the Catacarb Process. From 1962 to 1971, petitioner filed a series of patent applications covering said process, and on November 26, 1974, a copy of letters patent No. 3,851,041 covering the Catacarb Process was issued to petitioner. Petitioner is the only record holder of an interest in the patent applications filed between 1962 and 1971, and is the only record owner of the letters patent issued November 26, 1974.
Between January 1, 1960, and December 31, 1970, petitioner entered into 12 separate agreements with unrelated business entities concerning the use of the Catacarb Process. Payments received pursuant to these agreements inured solely to the benefit of petitioner. However, under only 8 of these 12 agreements did petitioner receive any payments during the years at issue.
For purposes of the instant case, the eight contracts at issue can be divided in two groups: three contracts executed prior to 1968,3 and five contracts executed after that year.4
Each of the three pre-1968 contracts provide that petitioner, in consideration for a specified fee, grants an ‘exclusive license’ in the Catacarb Process to the transferee corporations. In two of these contracts (Bechtel Corp. and Sun Oil Co.) the term ‘exclusive license’ is defined as, ‘the sale and transfer of an irrevocable, undivided interest in the complete Catacarb Process and Patent Rights.’ In the third contract (Atlantic Richfield Co.), the term is defined as ‘the sale and transfer of an irrevocable undivided interest to make, use and sell the complete process defined by Letters Patent and/or patent applications.’
In each of the three contracts, the terms ‘license’ and ‘license fee’ are used to characterize the rights granted therein and the fees paid therefor.
None of these contracts specifically reserve to petitioner the right to make, use, or sell the patent rights to the Catacarb Process. In each, the patent rights transferred thereunder extend for 10 years or for the life of the patent, whichever period is longer.
None of the contracts restrict the transferees' patent rights to any geographical area nor do they limit such rights to particular fields of use within certain trades or industries.
None of the contracts reserve to petitioner the right to sue third parties for infringement of the patent, and none provide that petitioner has the right to terminate the transfer at will, or for any reason.
Two of the three contracts (Atlantic Richfield Co. and Sun Oil Co.) are silent as to the rights of the respective transferees to sublicense or subassign the patent rights granted thereunder. The third (Bechtel Corp.), however, provides that the transferee can sublicense if the transferee (1) notifies petitioner and (2) pays and accounts to petitioner ‘for all royalties herein provided.’
The five post-1968 contracts are, in many respects, quite similar to those executed prior to that year. However, certain differences merit discussion.
The post-1968 contracts do not refer to the granting of a ‘license’ nor do they characterize the payments to petitioner as ‘license fees.’ Instead, these documents generally use terminology more associated with the ‘assignment’ of patent rights, such as ‘assignee,’ ‘owner,‘ and ‘purchase price.’
Four of the five contracts either clearly provide or imply that the transferee may sublicense or subassign its rights to the Catacarb Process, and the fifth (Dawood Hercules Chemicals Ltd.) contains no statement to the contrary.
Four of the contracts provide that the agreement can be terminated by petitioner if the transferee corporation is in default on any obligations under the contract. The contract with Tenneco Oil Co., however, contains no such provision.
Three of the five contracts are silent as to the right of the transferee to sue third parties for infringement of the patent, but the contracts with J. F. Pritchard & Co. and the M. W. Kellog Co. specifically state that these companies may sue for infringement in their own name.
All five of the post-1968 contracts provide that, in consideration of the payments specified therein, petitioner ‘hereby sells an undivided 1% interest in the Patent Rights,‘ such rights to extend for the life of the patent.
OPINIONThe issue in the instant case involves the proper characterization of the amounts received by petitioner during the years at issue pursuant to the eight contracts discussed, supra. Petitioner contends that such amounts should be characterized as long-term capital gain under section 1235. Respondent argues that section 1235 is not applicable and that the amounts received by petitioner should be treated as ordinary income.
Section 12355 provides that, under certain conditions, a transfer of ‘all substantial rights' to a patent (or an undivided interest therein which includes a part of all such rights) will result in long-term capital gain to the transferor. An ‘undivided interest’ in all substantial rights to a patent is defined in the regulations as the ownership of the same fractional share of each and every substantial right. Sec. 1.1235-2(c), Income Tax Regs. 6
In the three pre-1968 contracts, petitioner received payments in return for transferring an ‘undivided interest’ in the patent rights to the Catacarb Process. In the five post-1968 contracts the payments were in consideration of transferring an ‘undivided 1% interest’ in the patent rights.
Although the capital gains benefits of section 1235 pertain to a transfer of an ‘undivided interest’ in patent rights, respondent argues that, looking at all the circumstances of each transaction, section 1235 is not applicable because petitioner failed to transfer an undivided interest which included ‘all substantial rights' to the Catacarb Process. We disagree and hold for petitioner.
The questions of whether all substantial rights to a patent have been transferred is generally resolved by examining the substantiality of the rights, if any, that the transferor has retained. Donald C. MacDonald, 55 T.C. 840, 859(1971); Taylor-Winfield Corp., 57 T.C. 205, 219(1971).
In his regulations pertaining to section 1235, respondent has specified certain limited or incomplete transfers which respondent regards as transfers of less than ‘all substantial rights.’ Sec. 1.1235-2(b)(1) and (4), Income Tax Regs.7 Respondent also sets forth certain rights which, if retained by the transferor, may or may not be considered ‘substantial,‘ depending on the circumstances of the whole transaction. Sec. 1.1235-2(b)(3), 8 Income Tax Regs.
Our holding in the instant case is based on our finding that, with respect to each of the eight transfers at issue, petitioner transferred an undivided interest in the right to make, use, and sell the patent rights to the Catacarb Process.9 Further, petitioner did not limit or restrict the rights transferred in any significant manner nor did he retain any rights which we have found to be ‘substantial.’ In short, petitioner made transfers within the ambit of section 1235 and should be entitled to the benefits provided therein. 10
At the outset, we note that respondent does not rely on any of the incomplete transfers or retained rights set forth in his regulations...
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