Harvey v. Commissioner of Internal Revenue

• Decision Date: 03 January 1949
• Docket Number: No. 11823.,11823.
• Citation: 171 F.2d 952
• Parties: HARVEY et al. v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Ninth Circuit

171 F.2d 952 (1949)

HARVEY et al. v. COMMISSIONER OF INTERNAL REVENUE.

No. 11823.

United States Court of Appeals Ninth Circuit.

January 3, 1949.

Charles H. Carr and Bryant R. Burton, both of Los Angeles, Cal., for petitioners.

Theron LaMar Caudle, Asst. Atty. Gen., Ellis N. Slack, A. F. Prescott, Sumner M. Redstone and L. W. Post, Sp. Assts. to Atty. Gen., for respondent.

Before DENMAN, Chief Judge, ORR, Circuit Judge, and HARRISON, District Judge.

ORR, Circuit Judge.

Petitioners, as husband and wife, made income tax returns for the years 1939, 1940 and 1941. The Commissioner of Internal Revenue determined a deficiency and the Tax Court was petitioned for a redetermination. That court sustained the Commissioner's determination.

Petitioner, Leo M. Harvey, to whom we will hereinafter refer as petitioner, is an inventor. He has been successful in the round wire tying and flat band strapping and tying fields.

Beginning with the year 1930 and continuing to March 21, 1938, the Gerrard Company was licensed to manufacture wire tying machines under petitioner's domestic and foreign patents, paying him the sum of $30,000 a year royalty. Petitioner carried on a business of manufacturing machinery under the name of Harvey Machine Company. The expenses of the inventive activity of petitioner were deducted as a business expense of the Harvey Machine Company and the royalty income was included in the income of that company.

On March 21, 1938, petitioner sold to the Gerrard Company his patents to the tying machines for the sum of $425,000. He was given $25,000 cash and ten notes of $40,000 each, maturing annually in sequence for ten consecutive years.

Petitioner reported the gain from the sale of the patents to the Gerrard Company on the installment basis under § 44(b) of the Internal Revenue Code, 26 U.S.C.A. § 44(b). For the years in question the actual cash due and received from the vendee was returned as capital gain. The Commissioner determined the gain to be ordinary income on the finding that the patents were "property, used in the trade or business, of a character which is subject to the allowance for depreciation provided in section 23(l)". Section 117(a) (1), Internal Revenue Code, 26 U.S.C.A. § 117(a) (1).

Petitioner began the developing of a wire tying device in 1924 or 1925. His earliest patent for the flat band wire tying machine was issued in 1928. A large number of patents relating to and concerning the same idea and as improvements thereon were secured during the ensuing years. The licensing of the patent to Gerrard carried the stipulation that petitioner would finish certain work he had started.

Petitioner argues that the patents involved here were not used in his trade or business; that in order to be so classified under § 117(a) (1) they must have been so used at the time of sale and that such was not the case because in 1938 when he sold his flat band patents to Gerrard he was with respect to such patents a mere passive recipient of minimum royalties under the license granted by him to Gerrard in 1930. The Tax Court rejected this contention on the ground that it saw "no reason or necessity for limiting the scope of petitioner's business carried on in the name of Harvey Machine Company to the making of machinery on special order and excluding therefrom the inventive activity that did in fact co-exist in the making of machinery. The expenses of this inventive activity were deducted as a business expense of Harvey Machine Company and the royalty income was included as income of the Harvey Machine Company. Nor do we consider it realistic to look only at the receipt of royalties divorced from the efforts and accomplishments leading up to such receipt and to say such passive receipt does not constitute a business. We conclude therefore that the patents in question were used by petitioner in his business and were subject to depreciation. It follows that they were not capital assets and that the gain from their sale constituted ordinary income as respondent determined."

We think the evidence supports the finding of the Tax Court. The petitioner held his patents for the production of royalty income in his business as an inventor up to the time of sale. The patents were depreciable property, the use of which he licensed and from which he received taxable income and hence was property used by him in trade or business.¹

It is not essential to the finding of the Tax Court that the particular trade or business relating to the patents be the only occupation from which petitioner earned his livelihood, nor that it was one to which the majority of his time was devoted. Fackler v. Com'r, 6 Cir., 133 F.2d 509. The inventive activities of petitioner co-existed with his machine shop, trade or business; both were profitable occupations.

There were a large number of inventions other than the wire tying patents to which petitioner devoted some of his time. These activities added to those resulting in the procurement of patents support the conclusion that a very considerable portion of petitioner's time was thus engaged.

Petitioner moved for judgment on the pleadings in the Tax Court. The grounds of the motion were:

That petitioner had alleged that he had elected in the year 1938 to report the gain from the sale of the patents on the installment plan under § 44(b) of the code; that this allegation was admitted in the answer; that it was alleged that the patents were not used in petitioner's trade or business, which allegation was denied in the answer. The Commissioner, according to petitioner, thus assumes an inconsistent position, and results in an admission that he has no basis for levying the tax.

It is contended that in order to assess a tax for the years 1939, 1940 and 1941, the...