Gilson v. Commissioner
| Decision Date | 21 August 1984 |
| Docket Number | Docket No. 3801-78. |
| Citation | 1984 TC Memo 447,48 TCM (CCH) 922 |
| Parties | Channing W. Gilson and Marie K. Gilson v. Commissioner. |
| Court | U.S. Tax Court |
Craig C. Alexander and Robert M. Barton, for the petitioner. Charles O. Cobb, for the respondent.
Memorandum Findings of Fact and Opinion
Respondent has determined the following deficiencies in petitioners' Federal income taxes:
Year Amount
1971 ................ $8,417
1972 ................ 4,505
1973 ................ 9,244
1974 ................ 9,411
The sole issue is whether payments that petitioner Channing W. Gilson received during the years in issue constituted compensation for services, taxable as ordinary income, or payments for all substantial rights to patents, qualifying for capital gains treatment under section 1235.1
Some of the facts have been stipulated and are so found. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference.
Petitioners Channing W. Gilson and Marie K. Gilson,2 husband and wife, resided in Los Angeles, California at all times relevant to this case. Petitioners, cash-basis taxpayers, filed joint Federal income tax returns for their calendar years 1971, 1972, 1973, and 1974 with the Internal Revenue Service Center at Fresno, California.
Since 1951, petitioner Channing W. Gilson (hereinafter petitioner) has been a professional inventor of industrial designs, designing the external surfaces of manufactured articles so that these articles are both aesthetically pleasing and easier to use. Petitioner has won numerous awards for the excellence of his industrial designs.
During the years in issue, petitioner conducted his business as a sole proprietor under the name "Channing Wallace Gilson, Industrial Design." During these years, petitioner had a few large clients such as Hughes Aircraft, North American Rockwell, and Bell & Howell and many clients that were smaller manufacturing companies. During the years in issue, petitioner had 82 contracts with 53 different clients. Petitioner was an independent contractor and not an employee of any of his clients.
Typically,3 a potential client would contact petitioner proposing that petitioner undertake the industrial design of a new product the client had developed and hoped to manufacture and market. Next, petitioner would meet with the client's management and engineering personnel at the client's plant or office to be shown the client's new development or research work and to discuss with the client its product design requirements. Petitioner was never retained to make drawings of a design the client had already created but was always retained to create a new and original design. Petitioner would then return to his office and draw up a letter outlining the steps involved in completing an industrial design and proposing a flat fee or price for the design.4 Petitioner set his fees or prices on the basis of a number of factors, including the difficulty involved in completing the design, the budget of the client (if known to petitioner), petitioner's knowledge of the customer's size and ability to pay, and, occasionally, petitioner's estimate of possible bids by his competitors. Prior to the years in issue, petitioner had charged his clients by the hour. However, he abandoned that practice because he found that his customers were not interested in the number of hours he expended and instead wanted a design for a flat fee.
Typically, a client would accept petitioner's proposal through a form purchase order or form contract the client had prepared. Some of the form purchase orders or form contracts described petitioner's contractual obligation as "industrial design work," "industrial design services," "consulting services," or similar terms suggesting performance of services. Other contracts referred to "Industrial Design," "Cost of Design," or similar terms suggesting the sale of designs. Some of the contracts also reproduced part of petitioner's proposal letter. A few of petitioner's design contracts during these years were oral.
Following the acceptance of his proposal, petitioner would carefully research the appearance of products manufactured by the client's competitors. Petitioner maintained an extensive library of catalogs, professional and trade magazines, directories, and advertising materials regarding products and product designs that he used to ascertain competing products and prior art. Petitioner's clients also furnished him with data about their competitors' products. Petitioner would also research possible materials for use in the finished product. After completing his research, petitioner would prepare rough sketches of two or three different design proposals and would present the drawings at a meeting with the client's engineering, management, and sales personnel. The client's representatives would screen the proposals and usually discard one or more of the proposed designs.
Following this meeting, petitioner would return to his office and prepare a more detailed design proposal. Petitioner would then take the drawings of his revised proposal to another meeting with his client's representatives. The number of meetings and proposed revisions varied from client to client. These meetings with the clients, however, represented only a small part of the time required to create the design. Eventually, petitioner would prepare and present to the client the final, detailed design drawings from which the client's engineers could make production drawings. Petitioner would usually receive his fee in installments as he presented design drawings to the client. Petitioner would receive the final installment upon his completion of the project by delivery of the final design drawings to the client. Petitioner was not required to account to his clients for the time he spent on a design.
The industrial designs petitioner created for his clients were unique, innovative, attractive, and functional, and were quite different from the designs of his clients' competitors. Petitioner had many satisfied clients who returned to him for additional projects. Generally, petitioner's clients were very pleased with his designs.5 Each of the designs represented petitioner's own creative effort; the designers petitioner employed merely made more detailed drawings of the designs petitioner himself conceived. Many of the articles or products for which petitioner created designs were never produced or marketed by the clients for various business reasons unrelated to the quality of petitioner's designs.
Designs like those created by petitioner in this case may be patented if they are new, original, and ornamental. Determination of this question involves examination of existing design patents and of unpatented prior art more than one year old. A patent attorney advising a client of patentability would normally examine (or have an agent examine) the records of issued patents at the U.S. Patent & Trademark Office (Patent Office). Because of some uncertainty over prior art, even with a search at the Patent Office, a patent attorney would always hedge or qualify his advice to his client concerning the patentability of a design. The only way to be absolutely certain that a design is patentable is to submit a patent application and await acceptance or rejection. However, the patent attorney could examine prior art in many ways — he could examine (or have an agent examine) a library of various catalogs, professional and trade magazines, directories, and advertising materials at the Patent Office, or his own library of such materials, or rely upon the inventor-client's examination of the client's own library of such prior art reference materials. If a patent attorney or his inventor-client had an adequate library covering prior art, the attorney might qualifiedly advise that a design was patentable without a formal search at the Patent Office. A highly qualified professional inventor of industrial designs with over 30 years' experience in the field, such as petitioner, could reasonably search prior art as petitioner did in this case.
Many owners of patentable designs will make a business decision not to patent their designs, for various reasons. Between 1955 and 1978, petitioner had been issued 21 design patents, all of which he assigned. One of them was the design patent for a smoke detector that petitioner created under one of the contracts involved in this case; that smoke detector was manufactured and marketed. Petitioner has never had an application for a design patent denied. None of petitioner's designs under the contracts here in issue have ever been claimed to have infringed any patented design belonging to someone else.
During the years in issue, petitioner's proposal letters to prospective clients generally contained the following paragraph or a similar paragraph:
We will cooperate fully in assigning design rights to you in consideration of full remuneration from you, whether patent or not, however, this is to be done at your expense.
Petitioner and each of his clients understood this language to clarify that petitioner was transferring to the client all rights to the design, including the right to apply for a design patent, but that it was up to the client to pursue a patent at its own expense.
Petitioner generally would represent to each client that his design would be unique and patentable. Generally, petitioner's clients considered the patentability of the designs as an important and valuable aspect of their contracts with petitioner. Many clients would not have contracted with petitioner had he not relinquished his rights to patent his designs. The clients wanted the right to obtain the design patent because such right could become quite important in the event of business success in manufacturing and marketing the article or product. Petitioner's...
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