
    ROYCE KERSHAW AND MIRIAM KERSHAW v. THE UNITED STATES
    [No. 413-58.
    Decided January 20, 1960]
    
      
      Mr. Fred 8. Ball, Jr., for the plaintiffs.
    
      Miss June A. Murray, with whom was Mr. Assistant Attorney General Charles E. Biee, for the defendant. Messrs. James P. Garland and Lyle M. Turner were on the brief.
   Jokes, Chief Judge,

delivered the opinion of the court:

This case presents the question whether royalty payments received by the taxpayer as the result of a sale of a patent by him to a corporation of which 100 percent of the stock was owned by him, his wife, and his minor children, are entitled to capital gains treatment under section 117 of the Internal Revenue Code of 1939 or section 1239 of the Internal Revenue Code of 1954.

The plaintiff, Royce Kershaw, had spent many years in the railroad construction business. On January 22, 1952, he obtained a United States patent covering a ballast regulator, a machine useful for spreading, distributing, and dressing the ballast between the rails and on the sides of railroad tracks. He was not a professional inventor, has no other inventions that produce income, .and did not hold the patent for sale in the ordinary course of his business.

On January 31, 1952, Mr. Kershaw sold and transferred all of his patent rights in the ballast regulator to the Ker-shaw Manufacturing Company, Inc., in consideration of the corporation’s agreement to pay him five percent of the retail sales price received from the sale of the ballast regulators. On the date the patent was transferred, Mr. Kershaw, his wife, and two minor children, owned all of the common and preferred stock of the corporation. In the joint Federal income tax returns which plaintiffs filed for the calendar years 1952, 1953, 1954, and 1955, they reported as ordinary income the royalties which they received from the Kershaw Manufacturing Company, Inc., pursuant to the sale contract of January 31, 1952.

Thereafter and within the time required by law, they filed claims for refund, asserting that the royalty payments which they had received from the corporation had been erroneously reported in their tax returns for the years mentioned as ordinary income and contending that such royalties were taxable as long-term capital gains.

It is the defendant’s position that plaintiffs are precluded from recovering anything in this action by the terms of-section 328 of the Internal Revenue Act of 1951, which1 added section 117 (o) to the Internal Revenue Code of 1939.-In substance, and to the extent here pertinent, section 117 (o) provides that any gain realized from the sale or exchange of a capital asset shall be treated as ordinary income rather than as a capital gain if the following circumstances exist:

(1) The sale or exchange is between an individual and a corporation more than 80 percent in value of the outstanding stock of which is owned by the individual, his spouse, and his minor children;

(2) the property in the hands of the transferee is of the character that is subject to depreciation under the provisions of the Internal Revenue Code, and

(3) the sale occurred after May 3, 1951.

It is undisputed here that Mr. Kershaw sold his patent to a corporation, all of the outstanding stock of which was owned by him, his wife, and his minor children, and that the sale occurred after May 3, 1951. It is also too clear for argument that a patent is a form of intangible property which is subject to depreciation under the provisions of section 23(1) of the Internal Revenue Code of 1939 and section 167(a) of the Internal Revenue Code of 1954. American Chemical Paint Co. v. Commissioner, 66 F. 2d 381 (1933).

Section 1239 of the Internal Revenue Code of 1954 is, in all material respects, a reenactment of section 117 (o) and, although section 117 of the Internal Revenue Code of 1939 was amended retroactively by the Act of June 29, 1956 (70 Stat. 404), to authorize capital gains treatment with respect to the transfer of patent rights under certain circumstances, both parties concede that the 1956 amendment has no application in this suit.

The issue is thus narrowed to the single point whether section 117(o) (added by the 1951 amendment) applies to the sale or transfer by an inventor of his patent rights.

Plaintiffs argue that in view of a favorable congressional attitude toward inventors as reflected in tbe 1954 Senate Committee Report relating to section 1235 of the 1954 Internal Revenue Code and the fact that no mention is made ■of patents in section ll7(o), Congress intended that the 1951 amendment should not apply to the transfer of patent rights. They place great reliance on H. Rep. No. 586, 82d Cong., 1st Sess., p. 26, which states that the purpose of the amendment was to forestall the practice of selling depre-ciable assets to controlled corporations in order to obtain the substantial tax benefits available under existing law. The practice referred to was illustrated in the committee report by the sale by a husband and wife of a building, which has a current value well in excess of its depreciated basis, to a corporation engaged in the retail trade and in which they own more than 80 percent of the outstanding stock.

This argument was presented in skillful fashion, but it immediately collides with the language of the Senate Report on the same bill (S. Rep. No. 781, 82d Cong., 1st Sess., p. 670) in which the practice to be prevented by the amendment under consideration was illustrated by a taxpayer’s transfer of a patent owned by him. A careful reading of the House Report makes it abundantly clear that the reference therein to the sale of a depreciated building was intended to be no more than the label which was placed on it in the report; namely, an illustration of the kind of transfers to be deprived of capital gains treatment by section 117 (o). There is nothing in the legislative history to indicate that Congress intended to exclude patents from the 1951 amendment. When this is considered in connection with the clear and explicit language of section 117 (o), we must conclude that this section controls the sale involved in this suit and that the plaintiffs are not entitled to recover.

It follows that plaintiffs’ petition will be dismissed.

It is -so ordered.

Reed, Justice (Bet.), sitting by designation; LittletoN, Judge, {Bet.); Laramoke, Judge/ and MaddeN, Judge, concur.

Whitaker, Judge, took no part in the consideration and decision of this case.

FINDINGS OF FACT

The court, having considered the evidence, the report of Trial Commissioner Wilson Cowen, and the briefs and arguments of counsel, makes findings of fact as follows:

1. Plaintiffs Royce Kershaw and Miriam Kershaw are husband and wife and reside in Montgomery, Alabama. He is the president of the Kershaw Manufacturing Company, Inc., a family corporation.

2. The Kershaw Manufacturing Company, Inc., was organized in 1946 as an equipment company dealing in railroad construction equipment. Sometime later it began the manufacture of equipment for railroad track maintenance and has since been continuously engaged in that business,

3. Prior to the organization of the corporation, Mr. Ker-shaw had spent his life in the railroad construction business. While he was performing a railroad ballast job in 1945, he conceived the idea of building a ballast regulator for spreading, distributing, and dressing the ballast between the rails and on the sides of railroad tracks. After building one of these machines, he applied for and obtained a United States patent for it on J anuary 22, 1952.

4. By written agreement entered into on J anuary 31, 1952, between Mr. Kershaw and the Kershaw Manufacturing Company, Inc., he sold and assigned to the corporation all his patent rights in the ballast regulator. As a consideration for the transfer of all rights in the patent, including the exclusive right to manufacture and sell the machines, the corporation agreed to pay Mr. Kershaw 5 percent of the retail sales price received from the sale of such machines covered by patents issued, pending, or applied for.

5. In the joint Federal income tax returns which plaintiffs filed for the calendar years 1952, 1953, 1954, and 1955, they reported as ordinary income the following amounts received as royalties from the Kershaw Manufacturing Company, Inc., pursuant to the contract of January 31, 1952:

Year Amount
1952_$13,413. 65
1953_ 20, 684. 50
1954_ 32,024.75
1955_ 48,560.14

6.Plaintiffs timely filed claims for refund for the following years and in the amounts stated:

Tear Amount
1952_ $323. 53
1953_ 7, 685.43
1954_ 8,449.60
1955_ 14,320.58

In their claims for refund, plaintiffs stated that the royalties which Mr. Kershaw had received purauant to the contract entered into with the corporation on January 31, 1952, had been erroneously reported in plaintiffs’ tax returns as ordinary income and contended that such royalty payments were taxable as long-term capital gains. All the claims were duly rejected by defendant by registered letters dated October 30, 1957.

7. Royce Kershaw was not and is not a professional inventor and has no other inventions that produce income. He did not hold the patent on the ballast regulator for sale in the ordinary course of his business. '

8. From April 26, 1948, until the present time, all of the common stock of the Kershaw Manufacturing Company, Inc., has been owned by Royce Kershaw, Miriam Kershaw, and their two minor children. At various times since April 30, 1947, employees of the Kershaw Manufacturing Company, Inc., have owned shares of the preferred stock of the corporation, but on January 31, 1952, when Mr. Kershaw transferred his patent to the Kershaw Manufacturing Company, Inc., the Kershaw family owned all of the common and preferred stock of the corporation.

CONCLUSION OK LAW

Upon the foregoing findings of fact, which are made a part of the judgment herein, the court concludes as a matter of law that the plaintiffs are not entitled to recover and the petition is dismissed.  