Raytheon Production Corp. v. Commissioner of Int. Rev.

• Decision Date: 20 November 1944
• Docket Number: No. 3956.,3956.
• Citation: 144 F.2d 110
• Parties: RAYTHEON PRODUCTION CORPORATION v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — First Circuit

144 F.2d 110 (1944)

RAYTHEON PRODUCTION CORPORATION v. COMMISSIONER OF INTERNAL REVENUE.

No. 3956.

Circuit Court of Appeals, First Circuit.

July 28, 1944.

Writ of Certiorari Denied November 20, 1944.

Edward C. Thayer, of Boston, Mass., for petitioner.

Newton K. Fox, Sp. Asst. to Atty. Gen. (Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key and J. Louis Monarch, Sp. Assts. to Atty. Gen., on the brief), for respondent.

Before MAGRUDER, MAHONEY, and WOODBURY, Circuit Judges.

Writ of Certiorari Denied November 20, 1944. See 65 S.Ct. 192.

MAHONEY, Circuit Judge.

This case presents the question whether an amount received by the taxpayer in compromise settlement of a suit for damages under the Federal Anti-Trust Laws, 15 U.S.C.A. § 1 et seq., is a non-taxable return of capital or income. If the recovery is non-taxable, there is a second question as to whether the Tax Court erred in holding that there was insufficient evidence to enable it to determine what part of the lump sum payment received by the taxpayer was properly allocable to compromise of the suit and what part was allocable to payment for certain patent license rights which were conveyed as a part of the settlement.

Petitioner, Raytheon Production Corporation, came into existence as a result of a series of what both parties as well as the Tax Court have treated as tax free reorganizations. Since we think such is the proper treatment, we shall simplify the facts by referring to any one of the original and successor companies as Raytheon. The original Raytheon Company was a pioneer manufacturer of a rectifying tube which made possible the operation of a radio receiving set on alternating current instead of on batteries. In 1926 its profits were about $450,000; in 1927 about $150,000; and in 1928, $10,000. The Radio Corporation of America had many patents covering radio circuits and claimed control over almost all of the practical circuits. Cross-licensing agreements had been made among several companies including R.C.A., General Electric Company, Westinghouse, and American Telephone & Telegraph Company. R.C.A. had developed a competitive tube which produced the same type of rectification as the Raytheon tube. Early in 1927, R.C.A. began to license manufacturers of radio sets and in the license agreement it incorporated "Clause 9", which provided that the licensee was required to buy its tubes from R.C.A. In 1928 practically all manufacturers were operating under R.C.A. licenses. As a consequence of this restriction, Raytheon was left with only replacement sales, which soon disappeared. When Raytheon found it impossible to market its tubes in the early part of 1929, it obtained a license from R.C.A. to manufacture tubes under the letters patent on a royalty basis. The license agreement contained a release of all claims of Raytheon against R.C.A. by reason of the illegal acts of the latter under Clause 9 but by a side agreement such claims could be asserted if R.C.A. should pay similar claims to others. The petitioner was informed of instances in which R.C.A. had settled claims against it based on Clause 9. On that ground it considered itself released from the agreement not to enforce its claim against R.C.A. and consequently, on December 14, 1931, the petitioner caused its predecessor, Raytheon, to bring suit against R.C.A. in the District Court of Massachusetts alleging that the plaintiff had by 1926 created and then possessed a large and valuable good will in interstate commerce in rectifying tubes for radios and had a large and profitable established business therein so that the net profit for the year 1926 was $454,935; that the business had an established prospect of large increases and that the business and good will thereof was of a value of exceeding $3,000,000; that by the beginning of 1927 the plaintiff was doing approximately 80% of the business of rectifying tubes of the entire United States; that the defendant conspired to destroy the business of the plaintiff and others by a monopoly of such business and did suppress and destroy the existing companies; that the manufacturers of radio sets and others ceased to purchase tubes from the plaintiffs; that by the end of 1927 the conspiracy had completely destroyed the profitable business and that by the early part of 1928 the tube business of the plaintiff and its property and good will had been totally destroyed at a time when it had a present value in excess of $3,000,000, and thereby the plaintiff was injured in its business and property in a sum in excess of $3,000,000. The action against R.C.A. was referred to an auditor who found that Clause 9 was not the cause of damage to the plaintiff but that the decline in plaintiff's business was due to advancement in the radio art and competition. The auditor, however, also found that if it should be decided that Clause 9 had turned the development of the radio art away from plaintiff's type of tube, then the damages would be $1,000,000.

In the spring of 1938, after the auditor's report and just prior to the time for the commencement of the trial before a jury, the Raytheon affiliated companies began negotiations for the settlement of the litigation with R.C.A. In the meantime a suit brought by R.C.A. against the petitioner for the non-payment of royalties resulted in a judgment of $410,000 in favor of R.C.A. R.C.A. and the petitioner finally agreed on the payment by R.C.A. of $410,000 in settlement of the anti trust action. R.C.A. required the inclusion in the settlement of patent license rights and sublicensing rights to some thirty patents but declined to allocate the amount paid as between the patent license rights and the amount for the settlement of the suit. The agreement of settlement contained a general release of any and all possible claims between the parties.

The officers of the Raytheon companies testified that $60,000 of the $410,000 received from R.C.A. was the maximum worth of the patents, basing their appraisal on the cost of development of the patents and the fact that few of them were then being used and that no royalties were being derived from them. In its income tax return the petitioner returned $60,000 of the $410,000 as income from patent licenses and treated the remaining $350,000 as a realization from a chose in action and not as taxable income. The Commissioner determined that the $350,000 constituted income on the following ground contained in the statement attached to his notice of deficiency: "It is the opinion of this office that the amount of $350,000 constitutes income under § 22(a) of the Revenue Act of 1936. There exists no clear evidence of what the amount was paid for so that an accurate apportionment can be made as to a specific consideration for patent rights transferred to Radio Corporation of America and a consideration for damages. The amount of $350,000 has therefore been included in your taxable income."

The pertinent sections of the statute are set out in the margin.¹

Adverting to the question of whether that part of the $410,000 which was paid by R.C.A. to Raytheon to settle the anti trust suit was a return of capital or ordinary income, we must observe that the auditor's report is immaterial on that issue. Despite the fact that the auditor found that the loss was not caused by Clause 9, it was open to the jury to come to a different conclusion on the question of liability, and to avoid this R.C.A. settled the suit by compromise.

Damages recovered in an antitrust action are not necessarily nontaxable as a return of capital. As in other types of tort damage suits, recoveries which represent a reimbursement for lost profits are income. Swastika Oil & Gas Co. v. Commissioner, 6 Cir., 1941, 123 F.2d 382, certiorari denied 1943, 317 U.S. 639, 63 S.Ct. 30, 87 L.Ed. 515; H. Liebes & Co. v. Commissioner, 9 Cir., 1937, 90 F.2d 932; Sternberg v. Commissioner, 1935, 32 B.T.A. 1039. The reasoning is that since the profits would be taxable income, the proceeds of litigation which are their substitute are taxable in like manner.

Damages for violation of the anti-trust acts are treated as ordinary income where they represent compensation for loss of profits. Commercial Electrical Supply Co. v. Commissioner, 1927, 8 B.T.A. 986; see Park v. Gilligan, D.C.S.D.Ohio 1921, 293 F. 129, 130.

The test is not whether the action was one in tort or contract but rather the question to be asked is "In lieu of what were the damages awarded?" Farmers' & Merchants' Bank v. Commissioner, 6 Cir., 1932, 59 F.2d 912; Swastika Oil & Gas Co. v. Commissioner, supra; Central R. Co. of New Jersey v. Commissioner, 3 Cir., 1935, 79 F.2d 697, 101 A.L.R. 1448. See United States v. Safety Car Heating & Lighting Co., 1936, 297 U.S. 88, 98, 56 S.Ct. 353, 80 L.Ed. 500. Plumb, "Income Tax on Gains and Losses in Litigation" (1940) 25 Cornell L. Q. 221. Where the suit is not to recover lost profits but is for injury to good will, the recovery represents a return of capital and, with certain limitations to be set forth below, is not taxable. Farmers' & Merchants' Bank v. Commissioner, supra. Plumb, supra, 25 Cornell L. Q. 221, 225. "Care must certainly be taken in such cases to avoid taxing recoveries for injuries to good will or loss of capital". 1 Paul and Mertens Law of Federal Income Taxation § 6.48.

Upon examination of Raytheon's declaration in its anti-trust suit we find nothing to indicate that the suit was for the recovery of lost profits. The allegations were that the illegal conduct of R.C.A. "completely destroyed the profitable interstate and foreign commerce of the plaintiff and thereby, by the early part of 1928, the said tube business of the plaintiff and the property good will of the plaintiff therein had been totally destroyed at a time when it then had a present value in excess of three million dollars and thereby the plaintiff was then injured in its business and property in a sum in excess...