Tygart Valley Glass Co. v. Comm'r of Internal Revenue, Docket No. 25258.

• Decision Date: 02 May 1951
• Docket Number: Docket No. 25258.
• Citation: 16 T.C. 941
• Parties: TYGART VALLEY GLASS COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

16 T.C. 941

TYGART VALLEY GLASS COMPANY, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 25258.

Tax Court of the United States.

Promulgated May 2, 1951.

Norman D. Keller, Esq., for the petitioner.

Albert J. O'Connor, Esq., for the respondent.

In 1936 petitioner in settlement of litigation brought by Hartford for infringement of patents surrendered certain patents, equipment, and cash to Hartford and agreed to pay royalties to Hartford as licensee of such property. In 1939 action was filed by the United States against Hartford for violation of the anti-trust laws. A receiver was appointed and royalties payable from 1942 from petitioner and many other licensees from Hartford were impounded. In the course of the litigation evidence indicated that petitioner's settlement with Hartford in 1936 was induced by fraud. In 1945 the anti-trust litigation was settled pursuant to opinion therein by the Supreme Court, and Hartford was released from liability by many but not all of the licensees, each participating licensee, including petitioner, receiving an amount equal to 60 per cent of the impounded royalties paid in by it. Held the money was received by petitioner in settlement of claim for royalties, and not in settlement of claim for restitution because of fraud in the 1936 settlement, and is taxable as ordinary income, not capital gain.

This proceeding involves deficiencies in corporate income and excess profits taxes for the fiscal year ending September 30, 1946, in the amounts of $10,669.10 and $51,878.16, respectively.

The only question for our determination is whether the amount of $241,973.34 received by petitioner under a settlement agreement is taxable as ordinary income or as a long term capital gain.

The case was submitted on a stipulation of facts and oral and documentary evidence. The facts as stipulated are hereby found accordingly and the stipulation filed is incorporated herein by reference.

FINDINGS OF FACT.

The petitioner, Tygart Valley Glass Company, is a corporation organized under the laws of the State of West Virginia and is engaged in conducting a glassware manufacturing business, having its office and principal place of business in Washington, Pennsylvania.

Petitioner kept its books and filed its income tax returns on an accrual basis of accounting and on a basis of a fiscal year ending September 30. It filed its income and excess profits tax returns for the tax period here in question with the collector of internal revenue for the twenty-third district of Pennsylvania, at Pittsburgh.

Hartford-Empire Company (hereinafter referred to as Hartford) is a corporation organized and existing under the laws of the State of Delaware, and since its organization has engaged in the business of manufacturing glassworking machinery and of licensing machinery and methods for the manufacture of glassware.

On June 6, 1928, Hartford instituted suit against Hazel-Atlas Glass Company in the United States District Court for the Western District of Pennsylvania, alleging that the operations of Hazel-Atlas Glass Company infringed the Peiler patent owned by Hartford for a method of and apparatus for feeding molten glass. On February 28, 1930, the District Court dismissed Hartford's bill of complaint, the opinion being reported as Hartford-Empire Co. v. Hazel-Atlas Glass Co., 39 F.2d 111. Upon appeal the Circuit Court of Appeals for the Third Circuit reversed the judgment of the District Court with instructions to enter a decree holding Hartford's patent valid and the claims sued on infringed, the opinion being reported as Hartford-Empire Co. v. Hazel-Atlas Glass Co., 59 F.2d 399.¹

On May 1, 1933, Hartford instituted suit against Shawkee Manufacturing Company and certain other defendants in the United States District Court for the Western District of Pennsylvania, alleging that the operations of the defendants infringed the Peiler patent owned by Hartford. The District Court granted a preliminary injunction from which appeal was taken to the Circuit Court of Appeals for the Third Circuit by Shawkee Manufacturing Company and the other defendants. The Circuit Court of Appeals held that infringement had occurred and remanded the case for proceedings in due course, its opinion being reported as Shawkee Mfg. Co. v. Hartford-Empire Co., 68 F.(2d) 726.²

On November 12, 1935, Hartford instituted suit against petitioner in the United States District Court for the Western District of Pennsylvania, alleging that petitioner's operations had infringed Hartford's Peiler patent. On the same date Hartford instituted three additional suits against petitioner in the same court, alleging that petitioner's operations infringed a number of other patents of Hartford relating to the feeding and shearing of molten glass. Petitioner's patent counsel advised petitioner that it need not fear any of Hartford's patents except the Peiler patent but that, by virtue of the opinion of the Circuit Court of Appeals, petitioner was in serious danger of having a preliminary injunction granted unless the suits were settled.

On February 18, 1936, petitioner and Hartford entered into two agreements in settlement of the suits above described. Pursuant to the terms of the settlement agreements, petitioner in the year 1936 paid to Hartford the sum of $30,000 and transferred to Hartford its interest in certain patents and title to 13 glass feeding machines, known as Tygart feeders.

Subsequent to the transfer of the aforesaid Tygart feeders to Hartford, petitioner paid royalties to Hartford for the use thereof and for the use of certain Hartford feeders substituted from time to time for Tygart feeders. The aggregate royalties paid by petitioner to Hartford for the use of Tygart feeders from March 1, 1936, to August 31, 1942, amounted to $550,263.59. The aggregate royalties paid by petitioner to Hartford for the use of substituted Hartford feeders up to August 31, 1942, amounted to $81,131.77.

In 1939, the United States instituted a civil action (hereinafter referred to as the anti-trust action) in the United States District Court for the Northern District of Ohio, Western Division, in which Hartford and certain other defendants, not here involved, were ultimately held to have violated the Federal anti-trust laws. The opinion, dated August 25, 1942, is reported as United States v. Hartford-Empire Co., 46 F.Supp. 541. By order of the District Court a receiver was appointed to take possession of all the property and assets of Hartford including all patents, and to collect and receive the income of Hartford. The effect of the order was to require the various lessees and licensees of Hartford, including petitioner, to pay to the receiver all rental and royalty payments which were due or became due on or after September 1, 1942, under any agreement for the leasing of machinery or licensing of patents owned by Hartford. The order of the District Court further provided:

* * * Receipts from licensees are to be set aside and specially earmarked as coming from each licensee, and, upon confirmation by the Supreme Court of the decree to be entered herein, such receipts so collected and set aside are to be returned, without interest, to the various licensees.

Pursuant to the provisions of the order appointing a receiver, petitioner made certain rental and royalty payments to the receiver. The aggregate royalties paid by petitioner to Hartford for the use of Tygart feeders from September 1, 1942, to October 31, 1945, amounted to $256,947.60. The aggregate royalties paid by petitioner to Hartford for the use of substituted Hartford feeders during the same period amounted to $142,659.85. In its corporate income and excess profits tax returns for each of the taxable years 1942 through 1946, inclusive, petitioner included the rental and royalty payments made to the receiver as a part of the cost of goods sold, and these amounts were duly allowed by respondent as an exclusion from gross income.

Upon appeal taken by the defendants in the anti-trust action, the United States Supreme Court on January 8, 1945, affirmed the judgment of the District Court to the extent of finding violations of the anti-trust laws but modified the District Court's decree in many respects. The opinion of the Supreme Court is reported as Hartford-Empire Co. v. United States, 323 U.S. 386.

Upon petition of the United States for clarification of the Supreme Court's opinion, that Court handed down a second opinion on April 2, 1945, which is reported as Hartford-Empire Co. v. United States, 324 U.S. 570.

Subsequent to the second opinion of the Supreme Court, a committee was formed, representing the licensees of Hartford which were non-defendants in the anti-trust action, to negotiate a program in conformity with the CourtS opinion which could be recommended to the Court as a reasonable and equitable basis of relationship for the future between Hartford and its licensees. The committee held meetings with the various licensees and with representatives of Hartford. Some of the companies stated that they had no claims against Hartford other than the refund claim (claim for the return of rents and royalties). Some companies, including petitioner, contended that they had ‘outside claims‘ against Hartford, i.e., claims other than claims arising out of the receivership. One of such companies was The Knox Glass Co. The ‘outside claims‘ were not discussed as such in the negotiations between Hartford and the committee. During the negotiations Hartford made an offer to the committee which embodied certain objectives, terms, conditions, and a summary. The objectives enumerated that Hartford sought to make available to the entire glass container industry a comprehensive program of engineering, research and development to enable the industry to meet the post-war competition of other types of containers, and asked, in return, reasonable financial resources with which to serve the...