Opinion
Docket No. 59449.
1957-07-31
FRANKLIN S. SPEICHER AND ELEANOR SPEICHER, HUSBAND AND WIFE, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
C. Walter Smith, Esq., for the petitioners. Gerald Backer, Esq., for the respondent.
C. Walter Smith, Esq., for the petitioners. Gerald Backer, Esq., for the respondent.
1. In each of the taxable years petitioner Franklin S. Speicher received percentage payments from a corporation to which he had transferred complete ownership of an invention which he had perfected, but not patented, prior to the date of transfer. Petitioners on their joint returns reported these payments as capital gains. The Commissioner has determined that the payments were royalty income and taxable in full. Held, the payments were made as part of the purchase price of an invention which petitioner assigned to the corporation and the payments were properly treated as long-term capital gain under section 117, I.R.C. 1939.
2. In 1951, petitioner did not file a declaration of estimated tax. However, on March 15, 1951, he deposited with the collector of internal revenue at Pittsburgh a check for $151.74. This check was ultimately applied to petitioners' income tax for 1951 and on December 13, 1951, the collector filed a ‘dummy declaration of estimated tax’ in the name of Frank S. Speicher. The Commissioner determined additions to the tax for 1951 under section 294(d)(1) (A) and (d)(2), I.R.C. 1939. Held, the Commissioner is sustained. Petitioner has not proved that he ever filed a declaration of estimated tax for 1951. Even if the ‘dummy’ declaration filed by the collector in petitioner's name December 13, 1951, be regarded as filed by petitioner, it was filed long after the time for filing required by law and was ineffective to stay the penalty for failure to file.
This is a proceeding for the redetermination of deficiencies of the petitioners as follows:
+-----------------------------------------+ ¦ ¦ ¦Additions to tax ¦ +----+----------+-------------------------¦ ¦Year¦Income tax¦Sec. 294 (d)¦Sec. 294 (d)¦ +----+----------+------------+------------¦ ¦ ¦ ¦(1) (A) ¦(2) ¦ +----+----------+------------+------------¦ ¦ ¦ ¦ ¦ ¦ +----+----------+------------+------------¦ ¦ ¦ ¦ ¦ ¦ +----+----------+------------+------------¦ ¦1951¦$3,627.92 ¦$683.10 ¦$455.40 ¦ +----+----------+------------+------------¦ ¦1952¦4,543.64 ¦ ¦ ¦ +----+----------+------------+------------¦ ¦1953¦5,429.54 ¦ ¦ ¦ +----+----------+------------+------------¦ ¦ ¦ ¦ ¦ ¦ +-----------------------------------------+
The deficiency for 1951 is due to one adjustment which the Commissioner made to the net income reported by petitioners on their joint return. That adjustment was ‘(a) Royalty income $8,253.27.’ The adjustment is explained in the deficiency notice as follows:
(a) It is determined that the payment in the amount of $16,506.55 received by Franklin S. Speicher from M. E. Cunningham Company in 1951, which was reported as a long-term capital gain in your Federal income tax return for that year, constitutes for income tax purposes, royalty income, taxable in full.
The deficiencies for 1952 and 1953 are due to the same type of adjustment as (a) above, and the explanation in the deficiency notice is the same as the explanation given above. The only differences are as to amounts.
Petitioners by appropriate assignments of error contest the correctness of these adjustments. The petitioners also contest the correctness of the additions to the tax for the year 1951 under section 294(d)(1)(A) and (d)(2), Internal Revenue Code of 1939.
FINDINGS OF FACT.
Part of the facts was stipulated and the stipulation of facts is incorporated herein by reference.
The petitioners are husband and wife, residing in Pittsburgh, Pennsylvania. The return for the calendar year 1951 was filed with the collector of internal revenue for the twenty-third district of Pennsylvania, and the returns for the calendar years 1952 and 1953 were filed with the district director of internal revenue at Pittsburgh.
Issue 1.
The petitioner Franklin S. Speicher, sometimes hereinafter referred to as petitioner, had been experimenting in his spare time with the possibility of making steel stamps mechanically or by machine, since 1908, and early in 1923 he hit upon what he thought was the answer. He made drawings and models and, after discussing the manufacture of steel stamps with two of his friends, E. F. Waller, hereinafter referred to as Waller, and W. W. Hague, hereinafter referred to as Hague, he finally entered into an agreement with them, dated May 20, 1924, under which the three of them were to incorporate for the purpose of manufacturing steel stamps, using the machine which petitioner had designed.
The agreement entered into on May 20, 1924, between petitioner, Waller, and Hague was later destroyed by fire when the offices of M. E. Cunningham Company, hereinafter sometimes referred to as the company, were destroyed by fire, and no copies of it are available.
However, the minutes of a meeting of the stockholders and board of directors of the company held on May 21, 1938, described such agreement as follows:
MAY 21, 1938
A special meeting of the Board of Directors of the M. E. Cunningham Company, was called to order by the President, F. S. Speicher, to discuss placing in the minutes, a record of the loss in our fire of 1936, the lost agreement entered into between E. F. Waller, W. W. Hague and F. S. Speicher, who had purchased the controlling interest in the M. E. Cunningham Company. Said agreement was entered into under date of May 20th, 1924 and stipulated a five (5%) Per cent Royalty payment to F. S. Speicher, of all sales of Steel Stamps each year (profits permitting) but not to accrue if any year has shown no profit. In return, F. S. Speicher agrees to assign ownership of the special machine for the manufacture of Steel Stamps and Dies and also agrees to assign any future improvements to said machine or patents that he may develop while he was part owner or employee of the M. E. Cunningham Company without necessarily being paid any further royalty payments.
Before petitioner, Waller, and Hague had an opportunity to carry out their plan, they discovered that they could buy the majority interest in the company, which company was then making rubber stamps and hand-lettered steel stamps. Sometime during 1924 petitioner and his relatives purchased 40 shares out of a total of 147 outstanding of the company. This was 27.2 per cent of the total stock outstanding. Hague purchased 16 shares or 10.9 per cent of the total stock outstanding of the company, and the Waller family purchased 20 shares, or 13.6 per cent of the total stock outstanding of the company, giving the three of them 51.7 per cent of the total outstanding stock of the company.
Immediately after the purchase of the stock by the three men, petitioner, Waller, and Hague, the design for the machine which petitioner owned was turned over to the company and the first machine was built under the supervision of petitioner. No new agreement was entered into between petitioner and the company but it was understood that the company was taking over the agreement, which had been entered into between the three men, petitioner, Hague, and Waller, and it accepted the responsibility or obligation of making payments to petitioner under this agreement.
Petitioner developed a new idea in 1939. The first experimental machine carrying out this new idea was developed in 1940 and 1941, and shortly thereafter 5 machines were built. No patent was ever obtained in connection with the machines.
The payments made by the company to the petitioner under the agreement above referred to were based upon the agreed percentage of the company's sales of steel stamps. Such payments were made in the years we have before us and in the amounts as follows:
+------------------+ ¦Year ¦Amount ¦ +------+-----------¦ ¦1951 ¦$16,506.55 ¦ +------+-----------¦ ¦1952 ¦18,707.07 ¦ +------+-----------¦ ¦1953 ¦21,347.96 ¦ +------------------+
These amounts were reported by petitioners as long-term capital gain in the respective taxable years.
In the joint returns filed by petitioners the following amounts were reported as salary received by petitioner from the company:
+------------------+ ¦Year ¦Amount ¦ +------+-----------¦ ¦1951 ¦$15,261.60 ¦ +------+-----------¦ ¦1952 ¦15,243.40 ¦ +------+-----------¦ ¦1953 ¦15,355.44 ¦ +------------------+
These amounts were reported by petitioners as ordinary income and no issue has been raised with respect to them. Their taxability as ordinary income is conceded.
As bearing upon the issue of capital gain involved in this proceeding, the following excerpts from the minutes of the company are contained in the stipulation of facts:
JUNE 21st, 1941
A special meeting of the Board of Directors of the M. E. Cunningham Company, was called to order for the purpose of discussing the building of more modern steel stamp machine, designed primarily for the manufacturing of intricate symbol inspection stamps as well as complicated designs or trade-marks and after a lengthy discussion, it was to (sic) decided to proceed with the designing and building of said machine, thereby permitting the cost of production to be reduced at least 50%.
SEPTEMBER 25, 1946
Stockholders Meeting
A discussion was held in which the present Officers explained their plan to extend more time and capital in developing improved designs in the processing machines. All present Stockholders agreed that these progressive plans met with their approval and would prove their value over the future years.
APRIL 20, 1950
Stockholders Meeting
A report was made by F. S. Speicher, Sr. that the manufacture and replacement of the pantograph die setups for production of steel stamps on our special stamp processing machines were now nearly completed and were already proving their value in the production of stock and standard items and also in the production of many special orders. He outlined the wide possibilities of the benefits to be gained from the expenditure made for this new die setup. A motion was made and unanimously approved to continue this program in developing dies and improved models of the stamp processing machines.
JULY 27, 1953
Board of Directors Meeting
A discussion was held on the proposed changes in management duties to provide for more efficient handling of this work. Increased production and personnel and the development of the new marking machines had created a problem for efficient management of the many details involved. F. S. Speicher, Sr. requested that he be relieved of his duties as president so that he could exert his full efforts in the development of new patterns, fixtures, dies and other products.
Issue 2.
On or about March 15, 1951, petitioner deposited with the collector of internal revenue for the twenty-third district of Pennsylvania a check in the amount of $151.74. On or about October 5, 1951, petitioner received a letter from the collector for the twenty-third collection district of Pennsylvania relative to this check. The letter reads as follows:
This office is in receipt of your remittance in the amount of $151.74. It is evident that this payment was intended in payment of an installment on your Estimated Income Tax. However, our office records fail to disclose an Estimated Income Tax return having been filed by you.
In the event you have any data in reference to this account, please indicate in the space provided below. Form 1040 ES is enclosed in case you have failed to file a form for the period in question.
Please give this matter immediate attention, as we are endeavoring to make proper disposition of this remittance.
On or about December 13, 1951, a ‘dummy’ declaration of estimated tax for the year 1951 (Form 1040-ES) based upon the aforementioned check was prepared by the office of the collector of internal revenue for the twenty-third collection district of Pennsylvania. The amount of such check was applied against petitioners' 1951 income tax liability.
Petitioners offered no proof that they had filed a declaration of estimated tax for the year 1951.
OPINION.
BLACK, Judge:
There are two issues involved in this proceeding. They are: (1) Were the percentage payments received by petitioner from M. E. Cunningham Company for the calendar years 1951, 1952, and 1953 capital gains from the sale of an invention of a steel stamping machine which he had perfected but not patented prior to its assignment to the company, or royalties, taxable as ordinary income; and (2) are the petitioners subject to additions to tax for failure to file a declaration of estimated tax for 1951 and for underestimation of their tax for 1951? No additions to tax have been determined for 1952 and 1953.
We shall take up these issues in their order.
Issue 1.
There is no controversy as to the amounts which petitioner received in 1951, 1952, and 1953 as percentage payments from the company under the agreement which has been set out in our Findings of Fact. Petitioners returned these amounts as long-term capital gain and paid tax thereon as provided in section 117. The joint returns of petitioners for each of the 3 taxable years also reported a salary, which petitioner received from the company in each year, of somewhat in excess of $15,000 for his general services to the company. Petitioners returned this salary as ordinary income. As to this salary there is no controversy. It is respondent's contention, however, that the percentage payments which petitioner received should also be returned in the same way because they were essentially compensation payments which petitioner received for his services and were not payments received as part of the selling price of an invention. Section 117, which provides for capital gains treatment of profits from the sale of capital assets, is a familiar statute and it is not believed that it is necessary to print it here.
In Vincent A. Marco, 25 T.C. 544, 547-548, we stated the general rule, which governs in the decision of such an issue as we have here, as follows:
It is now well established by the weight of authority that the grant of the exclusive right to manufacture, use, and sell a patented article constitutes a sale of the patent rights with the proceeds taxable as long-term capital gain, provided (1) the invention constitutes a capital asset in the hands of the grantor, and (2) it was held by the grantor for the required period. Proceeds from such a grant constitute long-term capital gain income whether payment is made in a lump sum or over a period of years based on the use of the invention by the grantee. This was what we held in Edward C. Myers, 6 T.C. 258. That case has been frequently cited and followed by us. In our decision in that case, we based it largely on the Supreme Court's decision in Waterman v. Mackenzie, 138 U.S. 252. This latter case was not a tax case but did deal with the question as to when a patent agreement amounted to a mere license and when it amounted to a sale.
In Kimble Glass Co., 9 T.C. 183, we emphasized that the agreement, in order for it to be an assignment rather than a mere license, must provide for the assignment for all three of the rights of the inventor to wit, ‘to make, use and vend.’ In the instant case, did the agreement provide for the assignment of all three of these rights? We do not have the text of the agreement before us. It was lost in a fire which occurred in the factory of the company in 1936. However, it was stipulated that the minutes of a meeting of the board of directors of the company of May 21, 1938, described the agreement as follows:
Said agreement was entered into under date of May 20th, 1924 and stipulated a five (5%) Per cent Royalty payment to F. S. Speicher, of all sales of Steel Stamps each year (profits permitting) but not to accrue if any year has shown no profit. In return, F. S. Speicher agrees to assign ownership of the special machine for the manufacture of Steel Stamps and Dies and also agrees to assign any future improvements to said machine or patents that he may develop while he was part owner or employee of the M. E. Cunningham Company without necessarily being paid any further royalty payments.
It will be noted from the above agreement that it does not provide in specific language that the assignee, the M. E. Cunningham Company, shall have the exclusive right to make, use, and vend the invention. However, the agreement does specify that petitioner is to assign ownership of the machine and any future improvements of the machine that may be developed by him in his research. The petitioner testified at the hearing that he did not retain any right of ownership in the invention. The following questions and answers occur in his testimony at the trial and in the former trial of M. E. Cunningham Co., Docket Nos. 11783 and 27720, the record of which has been made a part of this proceeding:
Q. Did you at the time you turned over this machine, did you retain any right of ownership in connection with the machine?
A. No.
Q. Can you give us the substance of that agreement?
A. Oh, yes; I can pretty nearly the exact words. It was just an agreement that any machine or things that I developed in my work belonged to the Company, anything that I developed would belong to the Company along with this machine that is the steel stamp work.
Q. In other words, your understanding was that when you turned this machine in, it belonged to the Company?
A. Yes.
Q. And your understanding under that agreement of 1924 was that each of those machines or any of them— and it meant the 1939 improvements and this new thing in 1941, all belonged to the Company?
A. All belonged to the Company, that is right.
Although the transfer agreement in this case evidently did not use the words ‘to manufacture, use and vend,‘ yet it did clearly transfer petitioner's ownership of his invention and that is just as effective as if the customary language ‘to manufacture, use and vend’ is used. See Halsey W. Taylor, 16 T.C. 376; Arthur C. Ruge, 26 T.C. 138.
We sustain petitioner's contention that there was an assignment of his invention and that the percentage payments received by him ‘n the taxable years were payments to him by the corporation as part of the purchase price of his invention. The Commissioner argues that this cannot be so because petitioner's invention was not patented by him at the time of the purported assignment. In Edward C. Myers, 6 T.C. 258, 265, we said:
Petitioner's invention was not patented at the time of sale. In fact application for a patent had not at that time been filed. The application for patent was filed by petitioner January 25, 1932, and the patent was granted December 31, 1935. But petitioner's invention and improvement of the rubber-covered flexible steel track was completely conceived prior to January 1, 1930. Petitioner has proved, clearly enough we think, the completed conception of his invention prior to January 1, 1930, by drawings made, signed, and dated by him, which drawings set forth the invention in sufficient detail to enable those skilled in the art to manufacture the invention and improvement without further application of the inventive act. * * *
In the instant case we think the evidence shows that petitioner had a completed conception of his invention and had actually expressed it in the form of drawings and a machine manufactured under his direction prior to the agreement of May 20, 1924. Respondent's argument that petitioner did not assign the ownership of his invention because it had not been patented is not sustained.
Respondent further argues that even though it be assumed that petitioner made a completed transfer of his invention, nevertheless the percentage amounts which he received in the taxable year would not be entitled to capital gains treatment under section 117 because that section provides that the words ‘capital assets' do not include '(A) * * * property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.’ It is respondent's contention that petitioner was a professional inventor and that as such the particular invention involved here was one which he held ‘primarily for sale to customers in the ordinary course of his trade or business.’ We think the evidence is contrary to what respondent contends. We think our language in Edward C. Myers, supra, is appropriate here, wherein we said (6 T.C.,at 266):
Petitioner, during this time, conceived an invention and thereby acquired a property right thereto. He might have made an effort to manufacture and sell the invention and improvement himself. In fact he testified that at one time he considered doing so but decided that his financial resources were not adequate. Instead, he chose to convert his property right by transferring it to Goodrich in exchange for a contract providing payment of determinable annual sums. By thus transferring his one and only invention to Goodrich, petitioner was not transferring property held primarily for sale to customers in any trade or business conducted by him. * * *
We so hold in the instant case. Respondent's contention in this respect, we think, is without merit.
Respondent also contends that, even assuming that petitioner's invention was a capital asset under section 117, nevertheless, petitioner had not held the property for more than 6 months prior to the time of sale. In Edward C. Myers, supra, we held that the holding period begins when the invention is completely conceived and drawings made sufficient to make its manufacture possible, and not when a patent is issued. On the facts therein we held that the taxpayer had held his invention for more than 24 months, which was the holding period required under the statute then in force.
In the instant case we think the facts show that petitioner had been working in his spare time for 15 years to discover a method of making multiple copies of steel stamps, and early in 1923 he ‘fell on and figured out the exact movement,‘ as he expressed it in his testimony at the trial. He proceeded to make drawings and models during 1923 and on May 20, 1924, he entered into the agreement for the sale of his invention. On these facts, we hold that petitioner has proved that he held his invention for more than 6 months prior to its sale under the agreement of May 20, 1924, the holding period required under section 117.
We sustain petitioner on the capital gains issue and reverse the Commissioner in his determination that the percentage payments were ordinary income under section 22 of the Code. See F. H. Philbrick, 27 T.C. 346 (1956).
Issue 2.
In his determination of the deficiency for the year 1951, the Commissioner has made additions to the tax of $683.10 under section 294(d)(1)(A) and $455.40 under section 294(d)(2). The petitioner disputes the correctness of these additions.
The facts show that petitioners deposited a check with the collector's office and that the amount of this check was ultimately applied against petitioners' 1951 income tax liability. However, this check, upon receipt thereof, could not be identified by the collector's office since it was not accompanied by a declaration for 1951. In such circumstances, it was the policy of the collector's office to communicate with the taxpayer so that unidentified remittances, such as the instant check, could be identified and credited to the proper account. A communication was sent to petitioners on October 5, 1951, and a ‘dummy’ declaration of tax for 1951 was prepared by the collector on December 13, 1951. Both of these dates were subsequent to March 15, 1951, so that a declaration for 1951 could not possible have been timely filed under the provisions of section 58(d)(1). In section 294(d)(1)(A), it is explicitly stated that the declaration must be filed ‘within the time prescribed.’ A declaration for 1951 was not filed within the time prescribed and, therefore, the petitioner is liable for the additions to tax under section 294(d)(1)(A). The failure to file gives rise also to the addition to the tax under the provisions of section 294(d)(2).
We sustain respondent as to Issue 2. However, respondent, in computing the additions to the tax, has done so on the basis of taxing the percentage payments received by petitioner in 1951 as ordinary income, instead of capital gain as petitioners had reported them on their returns. We have reversed the Commissioner as to Issue 1. The additions to tax should, therefore, be recomputed under Rule 50 in the light of our decision on Issue 1.
Decision will be entered under Rule 50.