Opinion
No. 33517
Decided December 9, 1953.
Taxation — Annual payments for assignment of patents — Consideration for transfer of capital investment — Not income yield from royalties — Section 5638, General Code.
Annual payments of a percentage of the net sales of a corporation to an owner of patents during his lifetime for the assignment of such patents to the corporation constitute the consideration for the transfer of a capital investment, and not income yield from royalties or investments; and such patents are not, under the provisions of Section 5638, General Code, subject to taxation against such former owner.
APPEAL from the Board of Tax Appeals.
This case involves the validity of certain tax assessments predicated on claimed royalties paid to one Halsey W. Taylor of Warren, Ohio, for the tax years 1948 to 1951, inclusive.
In 1926, Taylor, was the owner of 996 of the 1,000 issued shares of the Halsey W. Taylor Company, an Ohio corporation organized in 1912 and engaged in the manufacture of ice and electric cooled drinking fountains.
On January 4, 1926, Taylor entered into a written contract with the corporation whereby it was given a nonexclusive license to manufacture certain devices, in connection with its business, under favor of seven patents then owned by Taylor and for which he was to receive annually as royalties five per cent of the total net sales of the corporation, to the end of the term for which such patents were granted, provided the license was not sooner terminated for failure in the payment of the royalties.
Subsequent to 1926, thirteen additional patents were obtained by Taylor and a working arrangement was entered into whereby the corporation was permitted to manufacture the devices covered by the patents and whereby the corporation paid Taylor as royalties five per cent on all sales of such manufactured devices. This arrangement continued until February 7, 1945.
On such latter date, Taylor entered into a new agreement in writing with the corporation by the terms of which he agreed to assign to the corporation, for a stated consideration of $10, all patents which he then owned and all patents which he might later acquire and for which the corporation agreed to pay him each year thereafter until his death five per cent of its total net sales. Pursuant to the terms of this contract, Taylor executed seven separate assignments of patents and patents pending which he owned at the time of the agreement or acquired subsequently thereto, all but one of which assignments were recorded in the United States Patent Office. By the terms of such assignments, all Taylor's right, title and interest in the patents and patents pending were sold, assigned, and transferred to the corporation to the full end of the term for which they were granted.
Thereafter, the corporation made payments to Taylor, under the agreement of 1945, in the following amounts: In 1947, $100,220.44; in 1948, $93,489.75; in 1949, $83,365.74; and in 1950, $110,225.38.
The Tax Commissioner made increased assessments, including penalties, against Taylor for the several tax years as follows: For 1948, $7,516.53; for 1949, $7,524.63; for 1950, $6,564.43; and for 1951, $8,750.72.
These assessments were made on claimed income-yielding investments as royalties which Taylor did not list in his personal property tax return for the respective years, he claiming that the payments so made to him by the corporation were payments on the sale of a capital investment to it, and not payments as income from capital investments or royalties owned by him.
An appeal was taken by Taylor to the Board of Tax Appeals, which affirmed the order of the commissioner. From the decision of the board, Taylor perfected his appeal to this court.
Messrs. Guarnieri Secrest, for appellant.
Mr. C. William O'Neill, attorney general, Mr. Hugh A. Sherer, Mr. Thomas R. Lloyd and Mr. Larry H. Snyder, for appellee.
The facts in this case are not in dispute. The controversy arises out of the interpretation of such facts, as related to the assessment of the taxes. The question is whether the payments made to Taylor by the corporation in the years 1948 to 1951, inclusive, constituted income yield from investments or royalties as defined by Section 5323, General Code (Section 5701.06, Revised Code), or whether such payments were made to him as the purchase price on the sale of capital investments.
The term, "royalties," had its origin in the designation of the payments made to a monarch or sovereign by his subjects for privileges granted by the former and enjoyed by the latter. Hence, in modern usage, the term signifies sums paid to the owner of a patent for its use or for the right to operate under it, and may also refer to the obligation giving rise to the right to such sums.
Clearly, the payments to Taylor by the corporation, under the original agreement, were income from royalties. However, under the contract of 1945, Taylor transferred his entire interest in the patents to the corporation and his ownership ceased. The payments under this contract could not be income from royalties but clearly represented the purchase price paid by the company, not for the use, but for the ownership of the patents in question. The nature of the contract constituted a sale of capital assets, and the sums received by Taylor represented installment payments of the consideration for the complete transfer of title.
If a patent or copyright is a capital asset and it is sold or exchanged rather than licensed, the gain or loss is a capital gain or loss. This rule applies even though the consideration is in the form of periodic payments that are in many respects like royalties. Commissioner of Internal Revenue v. Hopkinson, 126 F.2d 406.
The remaining question is whether the patents as investments are subject to taxation measured by the payments to Taylor under the contract of 1945. The Tax Commissioner claims they are taxable as income-producing investments, under Sections 5323 and 5638, General Code (Sections 5701.06 and 5707.04, Revised Code).
Section 5323, General Code (120 Ohio Laws, 112), provided:
"The term `investments' as used in this title, includes the following:
"* * *
"Annuities, royalties and other contractual obligations for the periodical payment of money and all contractual * * * rights of a pecuniary nature whatsoever from which income is * * * derived * * *.
"All equitable interests, life or other limited estates and annuity interests in any investment hereinbefore described * * *."
Section 5638, General Code, provides in part:
"Annual taxes are hereby levied on the kinds and classes of intangible property, hereinafter enumerated * * * at the following rates, to wit:
"Investments, five per centum of income yield or of income as provided by Section 5372-2 of the General Code * * *."
The Tax Commissioner claims that, since the payments to Taylor were based on a percentage of net sales derived from the use of the patents, such payments were income from investments. The commissioner concedes that the conveyance of 1945 "did indicate an outright sale," but claims that, inasmuch as the consideration was designated as a percentage of sales under the patents for the lifetime of Taylor and inasmuch as Taylor was dealing with his corporation, the whole transaction constituted a gift of a part interest in the patents and that such payments constituted income from taxable investments.
It is the opinion of this court that the contract of 1945 here under consideration constituted an outright sale of the patents, by reason of which Taylor ceased to have any interest in them, and that the payments were necessarily the consideration for such transfer and constituted the purchase payments for the sale of capital assets, and could not be income from taxable investments.
The decision of the Board of Tax Appeals is reversed.
Decision reversed.
MIDDLETON, TAFT, ZIMMERMAN and STEWART, JJ., concur.
LAMNECK, J., not participating.