Wiseman v. Halliburton Oil Well Cementing Company, 6563.

• Decision Date: 05 April 1962
• Docket Number: No. 6563.,6563.
• Citation: 301 F.2d 654
• Parties: Earl R. WISEMAN, District Director of U. S. Treasury Department, Internal Revenue Service, Appellant, v. HALLIBURTON OIL WELL CEMENTING COMPANY, a corporation, Appellee.
• Court: U.S. Court of Appeals — Tenth Circuit

301 F.2d 654 (1962)

Earl R. WISEMAN, District Director of U. S. Treasury Department, Internal Revenue Service, Appellant, v. HALLIBURTON OIL WELL CEMENTING COMPANY, a corporation, Appellee.

No. 6563.

United States Court of Appeals Tenth Circuit.

April 5, 1962.

John B. Jones, Jr., Atty., Dept. of Justice, Washington, D. C. (Louis F. Oberdorfer, Asst. Atty. Gen., Lee A. Jackson and John J. Pajak, Attys., Dept. of Justice, Washington, D. C., and Paul W. Cress, U. S. Atty., Oklahoma City, Okl., and Leonard L. Ralston, Asst. U. S. Atty., Oklahoma City, Okl., on the brief), for appellant.

Duke Duvall, Oklahoma City, Okl. (Robert O. Brown and Robert E. Rice, Duncan, Okl., on the brief), for appellee.

Before MURRAH, Chief Judge, and PICKETT, LEWIS, BREITENSTEIN and HILL, Circuit Judges.

PICKETT, Circuit Judge.

After payment of a deficiency assessment for 1955 income taxes, Halliburton Oil Well Cementing Company brought this action for a refund. The question presented is whether payments received under a contract pursuant to which Halliburton agreed to the termination of an exclusive license to use and to grant sublicenses for the use of a patented process in exchange for a non-exclusive license and one-third of the royalties received from third party licensees shall for income tax purposes be treated as ordinary income or as gain from the sale or exchange of a capital asset as contemplated by the Internal Revenue Code of 1954, 26 U.S.C.A. §§ 1201-1202, 1221-1223. The trial court found that the income from the transaction was a capital gain, and entered judgment for Halliburton.

In a 1949 agreement Stanolind Oil and Gas Company granted to Halliburton the right to develop and use commercially, under the trade name "Hydrafrac Process," an unproven method, known as hydraulic fracturing, which it had invented for the creation and stimulation of production from oil and gas wells. Except for use by Stanolind and its affiliates, the agreement granted to Halliburton a non-transferrable right to use the Hydrafrac Process in the United States and foreign countries and, subject to the approval of Stanolind, to issue sublicenses to others for its use.¹ Halliburton agreed to pay Stanolind a $100 royalty for each Hydrafrac job performed by Halliburton, its affiliates or sublicensees. The license was exclusive throughout the term of the agreement if, by March 1, 1951, the royalties paid and payable to Stanolind should total $300,000. This date was later changed by an amendment to the agreement.

At the time of the execution of the agreement, the process was in its experimental stages and had not been commercially developed and tested in the field. Under the terms of the agreement both Stanolind and Halliburton were to continue the development and improvement of the process, and Halliburton was to promote its use in the industry. Each party agreed to furnish the other with all technical information and data which would be of assistance to the other. The agreement was to remain in effect until the expiration of any patents issued to Stanolind relating to the process. Halliburton immediately entered into extensive laboratory work, developed special mechanical equipment, trained personnel, and devised safety methods. In the course of its operations, and through interchange of information, resulting from joint meetings of technicians and other means, Halliburton accumulated a great amount of technical ability with respect to the use of the process. Some of its work led to patents of its own. All of Halliburton's knowledge, including patents, was, by the terms of the agreement, available to Stanolind.

Within a comparatively short time the demand of the oil and gas industry for the use of the process exceeded all expectations. This demand became so great that Halliburton was unable to manufacture equipment and train personnel sufficient to meet the requests for the service. This situation induced a growing demand among Halliburton's oil well servicing competitors for a right to use the process. Halliburton doubted that it would be good business practice for it to license its own competitors, and did not desire to institute infringement proceedings against any of them. The situation became acute in 1952, and, at the request of Stanolind, the parties explored the possibility of Halliburton relinquishing its right to grant sublicenses thus permitting others to be licensed by Stanolind.²

After extended negotiations an agreement was reached on June 10, 1953. By this agreement Halliburton terminated its right to an exclusive license under the 1949 agreement and accepted a non-exclusive license. It was agreed that Stanolind should have the irrevocable right to supply other licensees with the technical information and data relating to the use of the process which had previously been available only to Stanolind from Halliburton. In addition to the non-exclusive license, Halliburton was to receive a sum equivalent to one-third of the royalties which Stanolind received from licenses granted to third parties. In the year 1955, the tax year in question, this amount totaled more than $400,000, and in its income tax return for that year Halliburton reported this sum as proceeds from the sale or exchange of a capital asset. The Commissioner determined that these receipts should be treated as ordinary income, and assessed a deficiency. This action followed payment of the deficiency and the denial of a claim for refund.

The trial court was of the opinion that the transaction "was a sale and transfer of a substantial and valuable property right and capital asset, which had been developed from the crude stage into a perfected process with a great demand for it, and was at the time of the transfer substantially different from the original process and with a demand increased from practically zero to one almost universal in the oil fields." The trial court concluded that the 1953 transaction was not the mere cancellation or extinguishment of a contract right, and did not constitute a conversion of future income into present income.

Although third party licenses were contemplated by the terms of the 1949 agreement none had been issued. Consequently the 1953 agreement, except for permitting competition from others, had little or no effect upon Halliburton's situation as it then existed. In its argument, Halliburton assumes that it had no sublicensing rights at the time of the 1953 contract. The contract provisions and the testimony of its officers are to the contrary. It is true that sublicenses were subject to the prior approval of Stanolind, but it was Halliburton's own decision, "rightfully or wrongfully", not to grant them. The parties were in agreement that Halliburton could not satisfy the demand of the industry and that it was preferable that Stanolind issue the licenses. They recognized Halliburton's right to participate in the income from licenses issued to third persons. There was no way of estimating with any degree of accuracy the amount of this income in future years. This led to the provision that the receipts from this source should be divided on a percentage basis. The resulting change in the two contracts was that instead of Halliburton paying Stanolind $100 royalty for Hydrafrac jobs performed by Halliburton's sublicensees, Halliburton was to receive one-third of the royalty receipts of Stanolind under licenses it issued.

Admittedly all sums received by Halliburton from the use of the process in furnishing services under the 1953 license were ordinary income. Had Halliburton received any income from the granting of third party licenses under the 1949 agreement, that would have been ordinary income. It contends here, however, that the right to control the issuance of sublicenses was a property right, and that when it relinquished that right to Stanolind and accepted a percentage of the royalties which Stanolind received from third party licensees, the income resulted from a sale or transfer of a capital asset. No method is suggested by which a basis for the right transferred could be computed. The record indicates that substantially all costs of development were treated as expense rather than as capital investment made with the expectation of earning income in the future. The amount which Halliburton was willing to accept as royalty necessarily was based on what it could earn in the future under the...