The respondent determined deficiencies of $46,894.24 and $15,772.64 in the petitioner's income tax and excess profits tax, respectively, for its fiscal year ending May 31, 1938.
The sole original issue is the taxability of the sum of $350,000 received by the petitioner from the Radio Corporation of America as a part of the amount paid in settlement of litigation between it and the petitioner.
By an amendment to his answer the respondent has raised two additional issues:
(1) His alleged error in failing to include in gross income the sum of $26,949.03 representing unamortized cost of patents.
(2) His alleged error in failing to disallow the sum of $60,000 paid for professional services rendered in connection with the litigation mentioned in the first issue.
FINDINGS OF FACT.
The petitioner is a corporation organized under the laws of Delaware. It filed its income and excess profits tax return for the fiscal
The American Appliance Co., hereinafter called Appliance, was incorporated under Massachusetts laws in 1922. It later changed its name to Raytheon Manufacturing Co., hereinafter called Raytheon, then to Raytheon, Inc., and then to Thenos, Inc.
Raytheon 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 and 1927 it was doing a large and profitable business. In 1926 the profits were about $450,000, in 1927 about $150,000, and in 1928, $10,000. In 1926 the volume of business of Raytheon was well over half of the total business of all conpetitors in its field.
The Radio Corporation of America, hereinafter called RCA, 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 RCA, General Electric Co., Westinghouse, and American Telephone & Telegraph Co. RCA had developed a competitive tube which produced the same type of rectification as the Raytheon tube but which was considered by Raytheon to be inferior thereto. Early in 1927 RCA 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 RCA. In 1928 practically all manufacturers were operating under RCA licenses. As a consequence of this restriction Raytheon was left with only replacement sales, which soon disappeared.
In 1927 or 1928 Raytheon brought a suit for patent infringement against the Q. R. S. Corporation, hereinafter called QRS. In May 1928 the suit was settled by an agreement under which the Raytheon Manufacturing Co., hereinafter sometimes called Manufacturing Co., was organized under the laws of Delaware with capital stock of 75,000 shares of no par value. QRS received 17,000 shares thereof in exchange for $25,000 in cash and its radio business, including patents, inventories, machinery, and contracts.
On May 23, 1928, Raytheon paid some cash and conveyed all of its property (except patents) to the Radio Conduction, Inc., a Massachusetts corporation, hereinafter called Conduction, in exchange for the latter's stock. Good will in the radio business was included in the conveyance, also the right to sue for any property or rights conveyed. Raytheon agreed to change its name to Raytheon, Inc. Thereafter it was engaged in research and development work. On May 29, 1928, Conduction transferred to Manufacturing Co. all of the property acquired from Raytheon in exchange for 38,000 shares of Manufacturing Co. stock. The board of directors of Raytheon
Manufacturing Co. sold its remaining 20,000 shares to Harry C. Watts & Co. for $20 per share. Harry C. Watts & Co. also bought 5,000 of such shares from QRS for $20 per share. It later sold all 25,000 shares to the public at $27.50 and up per share. Manufacturing Co. entered on its books the transaction involving the exchange of its 38,000 shares of stock by itemizing the receipt of cash, $25,000; inventory, $60,174.27; permanent assets, $181.970 (as appraised), or a total of $267,144.27, less current assumed liabilities of $35,000, or a net value of $232,144.27. The books of Raytheon did not show the claim against RCA as an asset; and the books of Manufacturing Co. indicated the 38,000 shares as issued for the tangible assets of Conduction. No notation was made on the books of Manufacturing Co. that any shares were issued for intangibles, and no intangible value was set up on the opening balance sheet.
When Manufacturing Co. found it impossible to market its tubes in the early part of 1929 it obtained a license from RCA to manufacture tubes under the latter's patents on a royalty basis. The license agreement contained a release of all claims of Manufacturing Co. against RCA by reason of the illegal acts of the latter under clause 9, but by a "side agreement" such claims could be asserted if RCA should pay similar claims to others.
In 1929 Manufacturing Co. entered into a complicated agreement with the National Carbon Co., hereinafter called Carbon, whereby Manufacturing Co. manufactured tubes and Carbon sold them as its exclusive sales agent. In order to execute the contract the petitioner was organized and all of the assets, business, privileges (except corporate franchise) good will, trade-marks, patents, licenses, personal property, plant and equipment, choses in action, contracts, etc., of Manufacturing Co. were transferred to petitioner in return for petitioner's capital stock and bonds in the amount of $500,000. The cause of action against RCA was not set up as an asset on the books of Production. The petitioner manufactured the tubes and sold them to Manufacturing Co., which in turn sold them to Carbon. The contract was terminated in 1933.
The petitioner was informed of instances in which RCA 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 RCA and consequently, on December 14, 1931, the petitioner caused Raytheon to bring suit against RCA 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
In May 1933 Manufacturing Co. acquired all of the remaining assets of Raytheon, Inc. (formerly Raytheon (Massachusetts)) in exchange for stock. The value of such assets in excess of the par value of the stock was received as paid-in surplus. The assets consisted of cash, contracts, machinery, laboratory equipment, rights, patents, licenses, etc.
The action against RCA was referred to an auditor, who filed his report on February 14, 1938. Referring to the licensing arrangement involved in the conspiracy and monopoly of which the plaintiff complained, the report reads:
The patents covering the circuits so licensed were owned by the defendant, or the General Electric Company, or the Westinghouse Electric & Manufacturing Company, or the American Telephone & Telegraph Company. The General Electric Company and the Westinghouse Company joined with the defendant as licensors in these license agreements, and the approval of the American Telephone and Telegraph Company was given. Prior to 1927 these companies had entered into certain so-called cross licensing agreements, by which radio patents owned or acquired by each were for certain purposes made available to each. In addition to claiming that clause 9 was illegal, the plaintiff also claims that these cross licensing agreements created an illegal monopoly in the defendant, the General Electric Company, the Westinghouse Company and The Telephone Company; and that this also has a bearing upon the issues in this case.
After reviewing the evidence heard, and summarizing previous detailed findings, the auditor concludes: "I find that clause 9 was not the cause of damage to the plaintiff."
In the spring of 1938 the Raytheon affiliated companies began negotiations for the settlement of the litigation with RCA. In the meantime,
Items 2, 5, and 6 read as follows:
2. RCA will grant to the several Raytheon Companies, and the several Raytheon Companies will grant to RCA, GE, Westinghouse and AT&T, full and complete releases from all claims of whatsoever nature on account of past acts of the parties except the royalties specified in Item 1 hereof, and current bills for merchandise, etc., and also except for claims for infringement outside of the radio field, provided, however, that the existing license agreement between RCA and Raytheon shall continue in force until December 31, 1938. The side agreement entered into concurrently therewith shall be cancelled or suitably modified.
* * * * * *
5. Raytheon shall grant to RCA non-exclusive licenses in all countries under its present patents, applications and inventions for vacuum tubes (as distinguished from gas tubes) for use in the fields of radio purposes as defined in Agreement A-1, and for tubes for use in all fields of the types designed and intended primarily for use in the fields of radio purposes or similar thereto. A tentative list of U. S. patents relating to vacuum tubes is attached hereto, subject to later correction as to completeness and accuracy.
6. Raytheon shall grant to RCA the non-exclusive right to grant sub-licenses to others under Raytheon's present U. S. patents, applications and inventions for vacuum tubes (as distinguished from gas tubes) for use in the fields of radio purposes as defined in Agreement A-1, and for tubes for use in all fields of the types designed and intended primarily for use in the fields of radio purposes or similar thereto.
RCA issued its check for $410,000 payable to Raytheon, Manufacturing Co., and Production. RCA declined to allocate the amount paid. Mutual releases were executed. Raytheon, Manufacturing Co., and the petitioner each separately executed the same form of release, releasing RCA, General Electric Co., Westinghouse Electric & Manufacturing Co., and American Telephone & Telegraph Co., and all of their respective subsidiary and affiliated companies therein referred to as the "Licensor Group" of and from "all manner of actions, causes of action, suits, debts * * *, claims and demands whatsoever [with exceptions not here material] in law or in equity," which the undersigned corporation "ever had, now has, or hereafter can, shall, or may have * * * whatsoever from the beginning of the world to and including the day of these presents; and including (but without in any way limiting the generality of the foregoing) all causes of action * * * by virtue of the anti-trust or other laws * * * and further including" the action then pending.
In accordance with paragraphs 5 and 6 of the plan of settlement, a license agreement was executed between Production and Manufacturing Co., therein called "Raytheon Group," and RCA. As a part thereof, the Raytheon group granted certain nonexclusive licenses and rights to grant sublicenses as to tubes, and released RCA and its subsidiaries from all claims for profits or damages with respect to infringement of certain patent rights prior to the date of the agreement; and RCA granted, and the Raytheon group agreed to accept, certain licensing arrangements as to radio receiving tubes for a period to January 1, 1945; and RCA released the Raytheon group and its subsidiaries jointly and severally from all claims for profits or damages with respect to infringement of patents as to radio tubes.
The patents under which RCA acquired licenses were a small part of those owned by the Raytheon group. Very few of them were being used by the Raytheon affiliates and no royalties were being derived from them. The officers of the Raytheon companies ascribed $60,000
Officials of the Raytheon companies allocated $350,000 of the $410,000 received from RCA as a credit to surplus and $60,000 thereof to the value of the patent rights. Of the latter sum, $40,000 was credited to the patent account of the petitioner and $20,000 as payment to Manufacturing Co. for its patent rights. In its income tax return the petitioner treated the $350,000 as a realization from a chose in action and not as taxable income. It noted the payment of $20,000 to Manufacturing Co. and charged itself with taxable income of $13,050.97, designating the remaining $26,949.03 as unamortized cost of patents and license rights.
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 section 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 petitioner claimed and was allowed a deduction of $60,000 in payment of legal services rendered in connection with the suit against RCA. By his amendment to his answer, the respondent seeks (1) to include in the petitioner's income the item of $26,949.03 representing the unamortized cost of patents and license rights, and (2) the $60,000 paid and deducted as legal fees, in case the $350,000 payment is held to be nontaxable.
The primary issue before us is whether or not $350,000 of the $410,000 paid to the petitioner by RCA is taxable income. The notice of deficiency recognizes that the remaining $60,000 was properly allocated to the payment for patent and license rights.
The petitioner contends that the amount in controversy was not income, but was compensation for damages caused by the tortious acts of RCA—specifically, the inclusion in its contracts with licensees of clause 9 and the enforcement of such clause. It asserts that the money so recovered was merely reimbursement for the injury sustained by its business and its capital assets and serves partially to restore its assets to their former value.
The question before us, in last analysis, is: For what did the petitioner receive the $410,000? It must, in order to show nontaxability of the amount as income demonstrate that it was received as replacement of capital lost. After reviewing the voluminous record, we
The instruments executed in accordance with the above described plan show that the word "Raytheon" refers to the original Massachusetts corporation, to Raytheon Manufacturing Co. of Delaware, and to Raytheon Production Co., the petitioner, and to those companies RCA executed its check and its release, while the petitioner on its part executed a release to RCA. General Electric, Westinghouse Electric & Mfg., and American Telephone & Telegraph; and releases identical therewith were executed by the Massachusetts corporation and by Raytheon Manufacturing Co. of Delaware. Each of these releases forever releases and discharges RCA and the other corporations just above named in the most general terms from all actions, causes of action, suits, and debts in law or in equity, including "but without in any way limiting the generality of the foregoing," all causes of action arising under the antitrust laws of the United States or any state and in the action then pending. (Certain exceptions stated, specifically listed, are not material here.)
RCA declined to allocate the amount paid, apparently either as to payees or as to matters for which paid.
We think it obvious from a review of the facts just above stated that it is impossible to designate the recovery as capital replacement. All things between plaintiff and defendant, since Genesis, were settled, as well as matters with other parties. 15 Corpus Juris Secundum 776, on Compromise and Settlement, recites the general rule:
A general settlement will be presumed to include all existing demands between the parties, imposing on the party claiming that certain items were not included, the burden of proving that fact.
Under such a record the item of alleged damage or injury to capital, good will, and reputation of business must be seen as merely one of a series of matters, involving both past and future, settled or conveyed for the same consideration, and we are unable to allocate any portion of the settlement to nontaxable capital recovery in the face of the presumption that the Commissioner's determination to the opposite effect is correct. In Armstrong Knitting Mills, 19 B. T. A. 318, we had before us this precise question, involving a settlement of two suits for $50,000 each, one, in effect, for damage to business and the other for breach of contract. We said:
The amount in question was paid to the petitioner in compromise and settlement of two suits, and there is no evidence to indicate in what proportion the amount could be allocated between the actions. Also, there is no evidence to establish the specific purpose for which the money was paid, other than that it was paid as a lump sum in compromise and settlement of the litigation. Whether the amount represented damages for wrongful injury to the petitioner's good will, or whether it represented damages for loss of profits, or indeed whether the amount was simply paid by the defendants to avoid further expense and harassment resulting from long continued litigation, does not definitely appear.
Although in that case we concluded that the suits involved did not involve damage to capital, nevertheless the criterion suggested is sound, and, in the absence of any means of ascertainment or allocation of any amount of capital injury, it is our opinion that, even if we assume the suit against RCA to have charged damage to the capital of plaintiff, the petitioner has failed to show error in the determination by the Commissioner. Helvering v. Safe Deposit & Trust Co., 316 U.S. 56, does not require the impossible.
We are, for other reasons, of the opinion that the petitioner has not demonstrated receipt of capital replacement. The petitioner was organized in 1929. The suit for damages against RCA was particularly
In the light of the above conclusion and of the fact that the respondent alleges his error in allowing $60,000 for expenses for attorneys' fees only in the alternative in case the recovery was held to be for capital replacement, it is unnecessary to consider that allegation of error.
This leaves for consideration respondent's contention that he erred in allowing deduction of $26,949.13 as unamortized cost of patents transferred to RCA. He relies, upon brief, solely upon the testimony that no patents were transferred to RCA. The petitioner concedes that legal title did not pass, but argues that practically all rights under the patents were transferred, so that the control by RCA was for practical purposes equivalent to ownership. This argument overlooks the fact that what the petitioner granted to RCA was nonexclusive licenses and the nonexclusive right to grant sublicenses to others. Such nonexclusive rights are by no means a practical equivalent of ownership. The petitioner not having transferred the patents in the taxable year, did not therein change its previous position with reference to annual amortization of cost of such patents. The Commissioner erred in allowing the deduction of $26,949.13.
Reviewed by the Court.
Decision will be entered under Rule 50.
VAN FOSSAN, J., dissenting:
The prevailing opinion holds, in effect, that the payment in compromise of the suit for damages under the Federal antitrust laws has not been shown to constitute a restoration of capital. I can not agree.
The injury to Raytheon was tortious. There was no contract, express or implied, between Raytheon and RCA. The pleadings in the suit brought under the Sherman and Clayton Acts charge only the tortious conduct of the defendant. They neither claim nor suggest as a measure of damage the loss of profits, nor is there any indication in the record that the compromise settlement was predicated on such basis. The charge was based on the illegal injury to plaintiff's business and property, specifically its good will. The case thus comes squarely within the decision of the court in Farmers & Merchants Bank of Catlettsburg, Ky. v. Commissioner, 59 Fed. (2d) 912. That case was cited with approval by the Board of Tax Appeals in Edward H. Clark, 40 B. T. A. 333, and Highland Farms Corporation, 42 B. T. A. 1314. See also Strother v. Commissioner, 55 Fed. (2d) 626; Henri Chouteau, 22 B. T. A. 850.
The cases in which damages have been held to be includible in income seem to rest on the fact that the suits in question were based on loss
I am likewise unable to concur in the conclusion that the case involves a question of basis. The character of the item, the treatment thereof by petitioner and the respondent, in my judgment, raise no such question.
In my judgment the record amply demonstrates that the payment here involved constituted a restoration of petitioner's capital and did not constitute income to recipient. I would reverse respondent's action.