Kueneman v. Comm'r of Internal Revenue
| Decision Date | 26 July 1977 |
| Docket Number | Docket No. 9858—74. |
| Citation | 68 T.C. 609,196 U.S.P.Q. 431 |
| Parties | DON AND IRENE KUENEMAN, JOHN R. KUENEMAN, AND EDMUND W. AND ELLA M. HARRELL, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
A group of individuals, including some of the petitioners, jointly owned patents covering certain rock-crushing machines. The group transferred all of their patent rights within a specified geographical area to P corp. No evidence was presented as to the value of the patent rights retained in all other geographical areas. Held: A transfer of all patent rights within a specified geographical area does not automatically qualify as a transfer of ‘all substantial rights' to patent within the meaning of sec. 1235, I.R.C. 1954. Rodgers v. Commissioner, 51 T.C. 927 (1969), and Estate of Klein v. Commissioner, 61 T.C. 332 (1973), revd. 507 F.2d 617 (7th Cir. 1974), cert. denied421 U.S. 991 (1975), to the extent they hold to the contrary, will no longer be followed. Held, further, the petitioners have failed to establish as a matter of fact that their geographical transfer disposed of ‘all substantial rights' to their patents; consequently, the royalty income they received is taxable as ordinary income. Joseph L. Strabala, for the petitioners.
James H. Ross, Jr., for the respondent.
The Commissioner determined the following deficiencies in the petitioner's Federal income taxes:
+----------------------------------------------------------+
¦ ¦ ¦Deficiencies ¦ ¦
+-----------------------------+------+--------------+------¦
¦Petitioners ¦1971 ¦ ¦1972 ¦
+-----------------------------+------+--------------+------¦
¦ ¦ ¦ ¦ ¦
+-----------------------------+------+--------------+------¦
¦Don and Irene Kueneman ¦$1,933¦ ¦$1,898¦
+-----------------------------+------+--------------+------¦
¦John R. Kueneman ¦2,344 ¦ ¦1,911 ¦
+-----------------------------+------+--------------+------¦
¦Edmund W. and Ella M. Harrell¦287 ¦ ¦290 ¦
+----------------------------------------------------------+
As a result of a concession by the Commissioner, the sole issue for decision is whether the petitioners are entitled to report as long-term capital gains royalty payments received from an exclusive transfer of patent rights within a specified geographical area. That issue turns on whether such a transfer disposed of ‘all substantial rights' to the patents within the meaning of section 1235(a) of the Internal Revenue Code of 1954.1
All of the facts have been stipulated, and those facts are so found.
All of the petitioners—Don and Irene Kueneman (husband and wife), John R. Kueneman, and Edmund W. and Ella M. Harrell (husband and wife)—resided in Oakland, Calif., when they timely filed the petition herein. For the years 1971 and 1972, Mr. and Mrs. Kueneman and Mr. and Mrs. Harrell filed joint Federal income tax returns, and John R. Kueneman filed individual Federal income tax returns. All such returns were filed with the District Director of Internal Revenue, Fresno, Calif.
The petitioners Don Kueneman and John R. Kueneman were the principal inventors of a type of rock-crushing machine for which they obtained patents (the patents) in the 1940's. By agreement dated August 27, 1946, the ownership of such patents was altered so that John R. Kueneman, Don Kueneman, Alma B. Harrell, and Cyril P. Kenville each acquired a specified undivided ownership interest in them. In addition, the agreement provided that John R. Kueneman was authorized to act on behalf of all the owners of the patents in connection with any sale, lease, or other arrangement affecting the patents.
On November 1, 1948, John R. Kueneman entered into a licensing agreement with Pennsylvania Crusher Co. (Crusher), a New York corporation. Under the licensing agreement, Crusher was granted the exclusive right to make, vend, and use the patents throughout Puerto Rico, eastern Canada, and all of the United States east of North Dakota, South Dakota, Nebraska, Kansas, Oklahoma, and Texas during the lives of such patents. In return for the transfer, Cursher agreed to make specified royalty payments to the undivided owners in accordance with their ownership interests in the patents, as set forth in the licensing agreement.
During the years in issue, the petitioners received the following payments from the exclusive geographical patent rights granted to Crusher:
+--------------------------------------------------------------+
¦ ¦ ¦Royalty payments ¦ ¦
+-----------------------------+------+------------------+------¦
¦Petitioners ¦1971 ¦ ¦1972 ¦
+-----------------------------+------+------------------+------¦
¦ ¦ ¦ ¦ ¦
+-----------------------------+------+------------------+------¦
¦John R. Kueneman ¦$7,814¦ ¦$7,910¦
+-----------------------------+------+------------------+------¦
¦Don and Irene Kueneman ¦7,814 ¦ ¦7,910 ¦
+-----------------------------+------+------------------+------¦
¦Edmund W. and Ella M. Harrell¦2,293 ¦ ¦2,322 ¦
+--------------------------------------------------------------+
On their Federal income tax returns for the years in issue, the petitioners treated such royalties as long-term capital gains. In his deficiency notices, the Commissioner determined that such royalty income was ordinary income.
We must decide whether the petitioners are entitled to report the income received from their patent transfers as long-term capital gains or whether it is ordinary income. The petitioners contend they are entitled to capital gain treatment under section 1235 and make no argument for capital gain treatment outside such provision. They argue that their exclusive geographical transfers disposed of ‘all substantial rights' in such patents within the meaning of section 1235(a).2 In two prior decisions, Rodgers v. Commissioner, 51 T.C. 927 (1969), and Estate of Klein v. Commissioner, 61 T.C. 332 (1973), revd. 507 F.2d 617 (7th Cir. 1974), cert. denied 421 U.S. 991 (1975), this Court held that such a transfer automatically meets that statutory requirement and qualifies for capital gain treatment. In so holding, we overturned a Treasury regulation to the contrary.3 The action of the Seventh Circuit in reversing our decision in Estate of Klein clearly calls for a reconsideration of our position with respect to geographically limited transfers of patent rights. Moreover, the rationale on which we relied in the Rodgers and Estate of Klein cases has been rejected by the Ninth and Sixth Circuits. Mros v. Commissioner, 493 F.2d 813 (9th Cir. 1974), revg. per curiam a Memorandum Opinion of this Court;4 Fawick v. Commissioner, 436 F.2d 655 (6th Cir. 1971), revg. 52 T.C. 104 (1969). In view of such general criticism of our position, we have carefully reexamined the basis for our decision in Rodgers.
Prior to the enactment of section 1235, there was no specific statutory provision prescribing the tax consequences resulting from a transfer of patent rights; instead, taxpayers seeking capital gains for the proceeds of such transfers had to meet the general requirements relating to capital gains contained in section 117 of the Internal Revenue Code of 1939. Thus, it was necessary for a taxpayer to show that the patent rights transferred by him were in his hands a ‘capital asset'5 and that he disposed of them in a transaction that qualified as a ‘sale or exchange.'6 In understanding the approach we took in Rodgers, it is helpful to discuss the rationale by which exclusive geographical transfers had qualified as a ‘sale.’
Originally, when the courts were confronted with the necessity of deciding when a transfer of patent rights constituted a ‘sale’ for tax purposes, they turned to Federal patent law for guidance as to the recognized and divisible property interests in a patent. If a patent transfer represented under patent law a disposition of an identifiable and distinct piece of property, then a ‘sale’ could be found; otherwise, the transfer did not amount to a ‘sale.’ The patent law already recognized such a distinction with respect to the transfer of patent rights by use of the concepts of ‘assignment’ and ‘license.’ For patent law purposes, certain legal consequences flowed from whether one achieved the status of the distinction was merely a licensee. The classic exposition of the distinction between such concepts appears in the Supreme Court's opinion in Waterman v. MacKenzie, 138 U.S. 252, 255 (1891), wherein it was said:
Every patent issued under the laws of the United States for an invention or discovery contains ‘a grant to the patentee, his heirs and assigns, for the term of seventeen years, of the exclusive right to make, use and vend the invention or discovery throughout the United States and the Territories thereof.’ Rev. Stat. $4884. The monopoly thus granted is one those laws. The and cannot be divided into parts, except as authorized by those laws. The patentee or his assigns may, by instrument in writing, assign, grant and convey, either, 1st, the whole patent, comprising the exclusive right to make, use and vend the invention throughout the United States; or, 2d, an undivided part or share of that exclusive right; or, 3d, the exclusive right under the patent within and throughout a specified part of the United States. Rev. Stat. s 4898. A transfer of either of these three kinds of interests is an assignment, properly speaking, and vests in the assignee a title in so much of the patent itself, with a right to sue infringers; in the second case, jointly with the assignor; in the first and third cases, in the name of the assignee alone. Any...
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