Docket No. 51225.

26 T.C. 622 (1956)


United States Tax Court.

Filed June 21, 1956.

Attorney(s) appearing for the Case

Arthur McGregor, Esq., Charles J. Higson, Esq., and Stafford R. Grady, Esq., for the petitioner.

John J. Burke, Esq., for the respondent.

Respondent has determined deficiencies and additions to tax in petitioner's income tax as follows:

                                        |            |             Additions to tax
                 Year                   | Deficiency |-----------------------------------------
                                        |            | Sec. 291 |      Sec.       |     Sec.
                                        |            |          | 294 (d) (1) (A) | 294 (d) (2)
1948 ---------------------------------- |    $202.22 |   $50.56 | --------------- | -----------
1949 ---------------------------------- |  10,597.05 | -------- |       $1,688.69 |   $1,013.22
1950 ---------------------------------- |  23,652.56 | -------- | --------------- |    1,379.86

All but one issue have been settled by the parties. The sole issue remaining is whether certain payments to petitioner in the above taxable years were taxable as ordinary income, as determined by respondent, or as capital gain, as contended by petitioner.


A stipulation filed by the parties is incorporated by this reference as a part of our findings.

Petitioner is an individual who has resided at all times material subsequent to June 23, 1949, at Los Angeles, California. Prior thereto she was a resident of Canada. She filed individual income tax returns for the calendar years 1948, 1949, and 1950 with the then collector of internal revenue at Los Angeles, California.

During the 1930's petitioner became convinced that swimsuits then available lacked proper style and structural support for the female figure and were generally unsatisfactory. In 1937 she began designing and making swimsuits for her friends. She was urged to make them commercially, and thereafter designed several swimsuits and employed 16 women to make swimsuits in their homes.

The suits so made were sold in Canada under petitioner's name. Gross sales were made in 1937 in the amount of approximately $10,000, upon which petitioner realized a profit of approximately $2,500. During 1937, she also received national and international publicity as a result of the use of her product by female participants in the British Empire Games in Australia.

The swimsuits manufactured and sold by petitioner contained structural innovations which petitioner later patented in Canada. Some were also patented in the United States. These innovations made petitioner's swimsuits different from and superior to other available products.

In 1938 petitioner formed a Canadian corporation to manufacture and sell her swimsuits. Its original name was Reid's Holiday Togs, Limited, but the name was thereafter changed to Rose Marie Reid, Limited (hereinafter called Canadian).

Canadian met with immediate and growing success. Annual sales grew from $32,000 in 1938 to $834,000 in 1946. Its products were sold throughout Canada by more than 500 retail outlets. All of its swimsuits bore the name Rose Marie Reid or Rose Marie Reid Originals, and contained one or more of petitioner's patented features. By 1946 Canadian had captured about 50 per cent of the swimsuit market in Canada. Its competitors for that market included many leading United States firms.

In 1938 petitioner entered into a licensing agreement with a large sportswear manufacturer in the United States located in Baltimore, Maryland, which sold its products nationally and internationally. The agreement provided that the licensee would manufacture and sell swimsuits in the United States for 1 year using petitioner's name and patents. Petitioner was to receive a royalty of 10 per cent of sales. Accordingly, swimsuits utilizing petitioner's patents were manufactured and sold throughout the United States during 1938 under the name Rose Marie Reid. The suits were advertised in magazines of national circulation and in newspapers throughout the country. Sales were made in the amount of $110,000, and petitioner received royalties in the amount of $11,000. This arrangement was not continued because of the difficulties and inconveniences experienced by petitioner in traveling between Vancouver, Canada, and Baltimore, Maryland, and because the licensee wanted her to leave Canada and come to the United States. Petitioner did not feel free to do so because of her enterprise in Canada.

During the period 1938 through 1945 petitioner also sold to United States retailers a relatively small number of swimsuits manufactured by Canadian. There were many inquiries from others in the United States in the industry wishing to purchase her product. Wherever sold, her suits met with general consumer acceptance and were highly successful. They were highly regarded by many large United States retailers, including recognized leaders in the fashion world. Petitioner was unable, however, to meet the full demand in the United States because of tariff restrictions and wartime scarcities. By 1946 her name had a distinct value and advantage in the industry in the United States. Her patents were valuable at all times.

The foregoing convinced petitioner that a great opportunity existed in the United States, and she decided to come to this country to manufacture swimsuits soon after the end of the war. With that idea in mind she kept in touch with suppliers of fabrics and sewing machine manufacturers, so as to be better able to secure her expected future needs.

In order to protect her inventions in the United States petitioner applied for five patents, all of which were ultimately granted. She also filed an application for registration of the name Rose Marie Reid.

About 1938 in the course of her business in Canada petitioner met Jack Kessler (hereinafter called Kessler) and his wife, Nina, both of whom then resided in Seattle, Washington. Kessler was interested in buying petitioner's swimsuits, and he and his wife encouraged her to come to the United States and enter the market in a larger way. During the war years the Kesslers visited petitioner several times, and purchased swimsuits for Nina and many of her friends.

In 1946 petitioner felt ready to come to the United States, and so advised Kessler. He evinced a desire to go into business with her, and informal discussions were had with that end in mind. They decided to form a California corporation.

Accordingly, in the spring of 1946, petitioner and Kessler met in Los Angeles, California, in the office of a man named Mitchell, Kessler's attorney. They orally agreed to form a California corporation to be called Rose Marie Reid (hereinafter called Californian). Petitioner and Kessler were each to receive 50 percent of its stock.

The agreement so made was never reduced to writing. The only written evidence thereof consisted of notes made by Mitchell, which are no longer available. Petitioner's understanding of the substance of the agreement was that Kessler was to pay $50,000 in cash for his stock, and was also to provide a sufficient line of credit to finance the operations of the company. Petitioner, as consideration for her stock, was to surrender to Californian United States rights to her patents, patent applications, and trade name. Kessler was to act as business manager and petitioner was to act as designer. No salaries were to be paid to either of them until the corporation should begin to show a profit.

Petitioner was not at that time represented by counsel. She assumed that she would be dealt with honestly and fairly by Kessler and Mitchell. She was unfamiliar with legally complicated matters. She in fact turned over all documents relating to her patents and applications at that time.

Subsequently, Kessler claimed that the foregoing oral agreement was to the effect that each party was to supply Californian with cash in the amount of $25,000, and that he, in putting up $50,000, was lending petitioner $25,000, to be repaid by her out of earnings to be realized from the business. No consideration was provided for, in respect of petitioner's trade name, patents, and patent applications.

Petitioner at no time had such understanding of their arrangement. Her conception was at all times as above stated. She accordingly refused to sign a note in the amount of $25,000 when requested by Mitchell to do so several months after the oral agreement had been reached in his office. Petitioner was neither offered nor did she receive as a result of the 1946 agreement any consideration for the use of her name, and for her patents and patent applications other than stock of Californian as claimed by her. The substance of the 1946 agreement was as claimed by petitioner, and we so find it as a fact.

On September 4, 1946, Californian issued 500 shares of stock, of which 250 were issued in the name of Kessler and 250 in the name of petitioner. A permit was issued by the Commissioner of Corporations of California under date of September 4, 1946, indicating that Californian was authorized to issue 500 shares at par for cash.

Although as above stated petitioner at first refused to sign a note in the amount of $25,000, she ultimately agreed orally to pay that amount to Kessler at some future date, but only out of earnings of the business, and without interest or fixed date of payment. She so agreed only because she felt that she was too far committed to withdraw and seek other financial backing. Californian had already begun production at that time.

Californian prospered and its business grew rapidly. It is today one of the world's largest manufacturers of women's swimsuits. Petitioner's name and patents were an important factor in this success. Various competitors have attempted from time to time to simulate, without infringing on petitioner's patents, the unique features of her swimsuits, but have not succeeded. Others who were thought to be infringing upon the patents desisted upon the threat of legal proceedings. Petitioner's name and structural innovations embraced by the patents were vital in winning retailer and consumer acceptance in the United States.

From the time of the inception of Californian in 1946 and continuing until 1949, petitioner did all designing for both Californian and Canadian. She resided during this time in Canada with her children, but her duties necessitated frequent travel between Canada and the United States.

All capital stock of Canadian was owned by petitioner and her estranged husband, each owning 50 per cent thereof. In 1947 the opportunity arose to purchase the 50 per cent interest owned by petitioner's husband. Petitioner was concerned at the time that Kessler might become apprehensive because she was devoting some of her time to Canadian, and might feel that she was doing so to the prejudice of Californian. She believed that any such disquietude on Kessler's part could be avoided if he should acquire the interest in Canadian then for sale.

Kessler reacted favorably to the idea. He purchased the stock at a price of $50,000, the price for which the shares had been made available to petitioner. This price was substantially lower than the fair market value of the shares, and Kessler was able to effect the purchase at such advantageous terms only because petitioner decided to forego taking advantage of the opportunity herself. Kessler borrowed $25,000 from a bank in Seattle for the downpayment, and the remaining $25,000 from a bank in Toronto. He executed a note and permitted the shares of Canadian thus purchased by him to be held as security for the latter loan. Petitioner signed Kessler's note as guarantor, and permitted the bank to hold her stock in Canadian as well as that of Kessler as security. In return for petitioner's permitting Kessler to effect the purchase of stock in Canadian it was agreed that she need no longer pay him the sum of $25,000 to which she had orally agreed at Mitchell's insistence.

Shortly thereafter, Canadian became involved in financial difficulties, the details of which are not relevant to this proceeding. As a result, Kessler constantly harassed petitioner in attempts to be relieved of his obligations connected with the purchase of the stock in Canadian. He also represented to petitioner that those obligations endangered the business of Californian. In order to relieve herself of harassments with which she was unable to cope, petitioner agreed to surrender a part of her interest in Californian, so that Kessler might sell it and raise funds necessary for operation of its business. She also agreed to assume his obligations to the Toronto bank on account of the loan and to repay him the downpayment of $25,000, which he had borrowed from the bank in Seattle. She accordingly endorsed to Kessler the stock certificate representing 250 shares issued in her name. That certificate and all other papers and documents relating to Californian, as well as all documents relating to petitioner's patents and applications, had been at all times since the formation of Californian in the possession of Kessler and Mitchell.

At the behest of Kessler and his father-in-law, one Iflin, petitioner signed a letter agreement dated January 2, 1948, and addressed to Californian. It recited, inter alia, that petitioner had assigned to Kessler 150 shares in Californian, leaving 100 shares in herself; that Kessler assigned his shares in Canadian to petitioner; that petitioner was to assume the entire indebtedness of Kessler to the Toronto bank outstanding on account of the purchase of the stock in Canadian; and that petitioner was to pay Kessler the sum of $31,000, $25,000 of which represented the amount Kessler had borrowed from the Seattle bank.

Thereafter, in September of 1948, and without the knowledge or consent of petitioner, Kessler caused Californian to issue to himself an additional 500 shares of stock. As a result thereof, petitioner's holdings, consisting of 100 shares, were diluted from 20 per cent to 10 per cent of all outstanding shares.

At some time during the latter part of 1948 or the early part of 1949, petitioner became suspicious that representations made to her by Kessler upon which she had relied in signing the foregoing letter agreement and performing various actions to her detriment were untrue. She was also of the opinion that Kessler had in general failed to deal honestly with her, and that he had not in fact sold the stock which he had received from her on the strength of various representations that such sale was necessary and was the purpose for which he required her stock.

Early in 1949 petitioner retained legal counsel for the first time. Petitioner's counsel contacted Kessler and Californian. Petitioner asserted that her understanding of the original oral agreement was correct, and that Kessler was to contribute $50,000 and she was to contribute only her name, patents, and patent applications, for which each was to receive 50 per cent of the stock of Californian. As a result of discussions with Kessler and Mitchell and independent investigation, petitioner's counsel concluded that under the laws of the State of California petitioner had available to her various legal remedies, including the right of equitable rescission, whereby she could enjoin Californian from the use of her name and recover her patents and patent applications. This latter was the remedy decided upon as the most feasible, and Kessler and Californian were advised that unless a settlement was reached suit would be commenced for such purpose.

Negotiations between the parties were undertaken. All interested parties were represented by counsel. Petitioner offered to license Californian to use her name and inventions for a period of 5 years. This was rejected, because Kessler insisted upon complete ownership by Californian of petitioner's trade name and inventions. The negotiations culminated in the execution of two contracts on April 20, 1949, each designated "Agreement of Settlement."

One such agreement was between petitioner and Californian, and provided in part as follows:

1. Corporate Name and Design Patents.

Reid hereby grants to the corporation the exclusive and continuing right to use her name as its corporate name in the United States of America, and to allow the corporation the right, exclusive in the United States of America, to utilize her design patents and/or process patents, now existing or hereafter obtained, in the manufacture and sale of the corporation's products. In consideration thereof the corporation agrees to pay to Reid, her heirs, executors, administrators and assigns an annual royalty which shall be equal to one per cent of the corporation's net sales for each year commencing September 1, 1948. This royalty shall not be diminished by the expiration or judicially determined invalidity of any such patent or patents, and the obligation to pay such royalty shall continue so long as the corporation continues to do business in the said name or under any name similar thereto, and shall likewise continue as an obligation of any person, firm or corporation to whom the business of the corporation or a substantial part thereof shall be sold or transferred and which shall use said name as a trademark or corporate name. This paragraph shall be severable from and independent of any provision of this contract hereinafter set forth.

2. The corporation hereby employs Reid in the sole capacity of designer effective as of September 1, 1948, and Reid hereby accepts such employment and agrees to carry out her duties thereunder to the best of her ability, devoting thereto such time as shall reasonably be required of her. Such employment shall continue to and including August 31, 1954 unless sooner terminated by her resignation, death or other contingency permanently incapacitating her to perform such duties. As Reid's compensation for her performance hereunder the corporation promises to pay her annually a sum which shall be equal to an aggregate of the following percentages based upon its net sales for each year of the term:

a. Two percent of the corporation's net sales for such year up to and including $1,000,000.00. b. One and one-half per cent of the corporation's net sales for such year in excess of $1,000,000.00.

Against such compensation Reid shall have a drawing account of $1500.00 per month which sum shall be paid by the corporation to Reid on the first day of each month of said term commencing September 1, 1949.

The second agreement was between petitioner and Kessler and provided, inter alia, that Kessler was holding 100 shares, representing 10 per cent of the outstanding stock of California, which belonged to and was owned by petitioner, and that petitioner was indebted to Kessler in the amount of $24,800. This agreement recited the simultaneous execution of the settlement with Californian in the following language:

3. Reid has coincidentally herewith executed a contract with the said corporation wherein, among other things, the corporation has agreed to pay her as consideration for services heretofore rendered, and hereinafter to be rendered a percentage on the corporation's net sales amounting to two per cent on the first $1,000,000.00 thereof in each year, and one and one-half per cent on all net sales in excess of $1,000,000.00 in such year, said portion of said contract to run for the term of six years from September 1, 1948, and in another and severable clause in said contract has agreed to pay Reid a continuing royalty not limited to said term for the use of Reid's name as its corporate name, and for other privileges therein granted to the corporation, said royalties to be equal to one per cent of all yearly net sales of the corporation. Said contract further provides that Reid shall have a drawing account with the corporation amounting to the sum of $1500.00 per month against the percentages hereinabove referred to. Any excess of moneys accruing to Reid in any one year over and above the yearly aggregate of said drawing account shall be for brevity referred to as the excess. Reid agrees to pay her said indebtedness to Kessler of $24,800.00 out of said excess, if, as, and when received by her, and without interest, at the rate of $5000.00 per year, and Kessler agrees that he will look only to said excess for payment of said indebtedness and only at the times and in the amounts hereinbefore referred to. [Italics supplied.]

The grant of patents, patent applications, and trade name was in perpetuity with no provision for reversion, or forfeiture for any reason, and covered the entire United States. No formal assignments were executed at the time because it was the understanding of petitioner's counsel that all necessary documents were in the possession of Californian, and that the latter had prepared and filed such papers as were necessary or could do so at any time in the future. Californian had used the name Rose Marie Reid as its corporate and trade name since its inception in 1946, and had in that year retained an attorney to register the name with the United States Patent Office. This work was finally completed in 1951. All fees and expenses thereof were borne by Californian.

Subsequent to the execution of the agreements of April 20, 1949, Californian brought new registration proceedings, and the trade name Rose Marie Reid was actually registered in its name as owner. Under date of November 1, 1950, petitioner executed a written consent to such application for registration, and executed formal assignments of her patents and patent applications to Californian.

In 1946 there was a transfer by petitioner of all United States rights in respect of her trade name, patents, and patent applications. A disagreement thereafter arose with respect to the existence and nature of the consideration therefor, and a serious question existed as to whether petitioner could rescind, and in so doing prevent further use by Californian of her name and, in addition, recover her patents and patent applications. Petitioner was advised by her counsel and believed in good faith that she could. Neither Kessler nor Californian nor their legal counsel were sufficiently confident that she could not that they were willing to risk legal proceedings and a court adjudication of the issue, if it could be avoided. Under the agreements of April 20, 1949, this misunderstanding was resolved, and the consideration for the transfer, previously in doubt, was definitely fixed.

The patents and trade name were not property held by petitioner for sale to customers in the ordinary course of her trade or business.

The amounts in question received as part of the purchase price of capital assets are taxable to petitioner as capital gains.


RAUM, Judge:

The Agreement of Settlement of April 20, 1949, between petitioner and the corporation provided for two series of payments. By paragraph 1 petitioner purported to grant to the corporation the exclusive and continuing right to use her name and patents in the United States in consideration of payments equal to 1 per cent of net sales. This provision was not limited as to time and in no way was contingent upon rendition of services by petitioner. On the other hand, paragraph 2 provided for the employment of petitioner as a designer, with annual compensation equal to 2 per cent of net sales up to $1,000,000 and 1½ per cent of net sales in excess of that amount. The payments required by paragraph 2 were plainly compensation and were geared to the rendition of services. However, the payments in paragraph 1 were entirely independent of any services to be rendered, and were to continue regardless of petitioner's performance of any services. The paragraph 2 payments are not involved herein. The only question before us is whether the payments called for by paragraph 1 are to be treated as ordinary income rather than as capital gain. Two issues are presented in this regard, first, whether the payments were in fact made in respect of petitioner's name and patents rather than for services, and second, whether, assuming that they were made in respect of the name and patents, they represented the proceeds of a sale entitled to capital gains treatment.

1. We are satisfied that petitioner in fact received the payments in question in respect of her trade name and patents, and not for personal services rendered. Despite the testimony of respondent's witnesses to the contrary the weight of the evidence is overwhelming to the effect that petitioner's name as well as her rights in her inventions were of considerable value both in 1946 and 1949.

Respondent would have us find, in effect, that petitioner, both in 1946 and 1949, freely permitted Californian to use her name and deal with her patents as it deemed in its own best interests, without compensation of any kind. First, with respect to 1946, respondent would have us believe that petitioner agreed to pay the same amount of cash for her 50 per cent stock interest as did Kessler, and at the same time either completely surrendered her name and patents or permitted Californian to deal with them with a free hand. The only conceivable offsetting consideration for this would be the undertaking by Kessler to arrange whatever financing should prove necessary. Then, in 1949, believing herself to have been the victim of a fraud, and represented by counsel protecting her interests, she again gratuitously surrendered title or at least a substantial part of her rights in her trade name and patents in the United States. The record satisfies us that nothing of the sort occurred.

First, we believe to be true the version of petitioner rather than that of Kessler as to the substance of the 1946 agreement. We are convinced that in fact petitioner was to receive 50 per cent of the stock of Californian solely in respect of her name, patents, and patent applications. And second, we cannot but be convinced that the arrangement entered into in 1949 was to the effect that, as provided in the agreement between petitioner and Californian, petitioner was to receive the sums at issue here in respect of the foregoing property. The agreement so states and we believe it to be in accord with the substance of the actual understanding of the parties. We do not find credible the testimony of respondent's witnesses to the contrary. We are convinced that in 1949 petitioner, represented by counsel, was asserting a bona fide claim of a right to cut off Californian completely from any rights with respect to valuable property interests. We do not believe that she would or did surrender such claim gratuitously. For the foregoing reasons, and our evaluation of the evidence before us, we conclude that the amounts in question were received not as compensation for services, but as consideration for rights granted, surrendered, or transferred by petitioner in her name and inventions, the nature of which we shall discuss in greater detail hereinafter.

2. In order for petitioner to prevail she must establish three things. First, she must prove that the property in question constituted capital assets. Second, the property must have been held for over 6 months prior to the transaction in question. And third, that transaction must be shown to have constituted a "sale or exchange" within the meaning of section 117 of the Internal Revenue Code of 1939. Kronner v. United States, 110 F.Supp. 730 (Ct. Cl.).

Our finding that petitioner's trade name and patents were not held by her for sale to customers in the ordinary course of her trade or business establishes that such property constituted capital assets in her hands within the meaning of section 117 (a). Cf. Seattle Brewing & Malting Co., 6 T.C. 856, affirmed 165 F.2d 216 (C. A. 9); Rainier Brewing Co., 7 T.C. 162, affirmed 165 F.2d 217 (C. A. 9); Kronner v. United States, supra. It is also abundantly clear from the record that the property in question was held by her well in excess of the holding period required by section 117 (a) (1) (4).

In view of the foregoing the only question remaining is whether there was a "sale or exchange" of that property, as contended by petitioner, or a mere license thereof, as urged by respondent.

An exclusive perpetual grant of the use of a trade name, even within narrower territorial limits than the entire United States, is a disposition of such trade name falling within the "sale or exchange" requirements of the capital gains provisions of the 1939 Code. Seattle Brewing & Malting Co., supra, at p. 873; Rainier Brewing Co., supra. And the grant of the exclusive right to make, use, and sell an invention throughout the United States or a specified area therein constitutes an assignment of the patent and not a mere license. Waterman v. Mackenzie, 138 U.S. 252, 256; Watson v. United States, 222 F.2d 689 (C. A. 10); Arthur C. Ruge, 26 T.C. 138; Kimble Glass Co., 9 T.C. 183; Vincent A. Marco, 25 T.C. 544, on appeal (C. A. 9).

Nor is the question governed by the use of particular words of art. The transaction suffices as a sale or exchange if it appears from the agreement and surrounding circumstances that the parties intended that the patentee surrender all of his rights in and to the invention throughout the United States or some part thereof, and that, irrespective of imperfections in draftsmanship or the peculiar words used, such surrender did occur. Arthur C. Ruge, supra; Commissioner v. Celanese Corp., 140 F.2d 339 (C. A., D. C.); Halsey W. Taylor, 16 T.C. 376, 383; Watson v. United States, supra; Allen v. Werner, 190 F.2d 840 (C. A. 5); Claude Neon Lights, Inc., 35 B. T. A. 424, 427. Even the fact that an agreement may be termed a "license" or the parties thereto "licensor" and "licensee" has been denied determinative effect. Kronner v. United States, supra, at p. 734; Watson v. United States, supra; Kimble Glass Co., supra.

And finally, payment for the transfer need not be in the form of a lump sum in order to constitute capital gain, but may take the form of a percentage of sales or profits, or an amount per unit manufactured or sold, or any combination of the foregoing. Kenyon v. Automatic Instrument Co., 160 F.2d 878 (C. A. 6); Kronner v. United States, supra; Commissioner v. Hopkinson, 126 F.2d 406 (C. A. 2); Halsey W. Taylor, supra, at p. 384; Watson v. United States, supra; Allen v. Werner, supra; Edward C. Myers, 6 T.C. 258; Carl G. Dreymann, 11 T.C. 153; United States v. Carruthers, 219 F.2d 21 (C. A. 9); Hofferbert v. Briggs, 178 F.2d 743, 744 (C. A. 4); Massey v. United States, 226 F.2d 724, 727 (C. A. 7); Vincent A. Marco, supra, at p. 548.

The record satisfies us that the parties intended that petitioner should assign all of her United States rights in her trade name, patents, and patent applications to Californian and that she in effect did just that. Although the 1949 agreement does not expressly include the word "use," a reading of the entire agreement, together with the facts surrounding the transactions, amply convinces us that a complete assignment was intended and made, and that the exclusive right to "use" petitioner's name and patents throughout the United States for the full period of their existence was transferred to Californian. Cases cited by respondent are distinguishable in that it was there thought that the owner's rights had not been completely transferred. Cf. Broderick v. Neale, 201 F.2d 621 (C. A. 10); Ernest E. Rollman, 25 T.C. 481; Lynne Gregg, 18 T.C. 291, affirmed 203 F.2d 954 (C. A. 3); Cleveland Graphite Bronze Co., 10 T.C. 974, affirmed 177 F.2d 200 (C. A. 6).

We do not deem it important that petitioner transferred her interests in 1946, whereas the agreement giving rise to the payments in question was executed in 1949. Even in the absence of any dispute as to whether Californian's rights to petitioner's trade name and inventions were perfected or indefeasible, the payments in question were made in respect of the transfer of such rights. Whether they be viewed as payments for finally perfecting those rights, or additional consideration for that to which Californian was already entitled, they were in consideration of the transfer of the trade name and inventions, and not for personal services, and represent capital gains to petitioner. Hofferbert v. Briggs, supra.

In the instant proceeding, however, it is clear that there was in fact a serious dispute as to the perfection of Californian's title, or as to its rights to retain title as against petitioner. Respondent has attempted to discuss the merits of petitioner's claim of a right to rescind the 1946 agreement and recover her assets. He argues that she could not. In our opinion, it is of no moment whether petitioner would have prevailed had she litigated the matter to final judgment. We cannot say, despite respondent's arguments, that it is manifestly clear that she could not. The determinative factor is that petitioner believed in good faith that she could, and was so advised by counsel. Her claim was certainly not frivolous, and was taken seriously enough by Kessler and Californian. Had she commenced litigation seeking rescission and settled her suit for the payments in question, we would have no doubt that those payments would be entitled to treatment as capital gains. Albert J. Goldsmith, 22 T.C. 1137; Margery K. Megargel, 3 T.C. 238. Here commencement of an action to rescind was rendered unnecessary by the willingness of the parties to settle their differences shortly after retention of counsel by petitioner. Nevertheless, the underlying claim remained the same, i. e., title to the trade name and patents, and amounts received by petitioner in settlement thereof must be held referable thereto. Cf. Lyeth v. Hoey, 305 U.S. 188.

The final contention of respondent with which we must deal is that in California a trade name may not be sold separately from the business. Whatever the soundness of such argument under California jurisprudence, it can have no effect upon our result here. First, it has no applicability to the transfer of patents and patent applications. And with respect to the trade name itself, the fact is that petitioner did transfer to Californian a right hitherto held by her alone, the sole right to use her name in the swimsuit industry in the United States and reap the benefit thereof. Californian has at all times used such name as its own and has registered it as its property with the United States Patent Office. California rules respecting the transfer of a trade name cannot change the nature of the payments into payments for services for Federal income tax purposes, when they were not in fact made for services rendered. Whatever the defects or incapacities of such transfer (we do not intend here to rule upon that question) we are convinced that she received the payments in respect of such transfer, and not for personal services. Hence, respondent erred in determining the amounts thereof to be taxable as ordinary income.

Decision will be entered under Rule 50.


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