The Internal Revenue Code of 1954

to show that failure to include the right to use was inadvertent and not controlling.

Pike v. U. S. (101 F. Supp. 100, D. C. Conn., decided Aug. 15, 1951).

The agreement expressly stated that the parties contemplated only a license and not a sale, but this language was not held controlling.

Kronner v. U. S. (110 F. Supp. 730, U. S. Court of Claims, decided Mar. 3, 1953). This was an exclusive license in which the licensor was obligated to defend infringement suits against the licensed subject matter and was required to hold the licensee and its customers harmless.

The following decisions do not follow the Myers case:

Bloch v. U. S. (200 F. (2d) 63 C. A. 2, decided Nov. 21, 1952).

Suit to recover taxes withheld on royalties under sections 143 and 211. The nonresident alien taxpayer granted an exclusive license to a United States corporation.

The agreement called for a fixed price of $75,000, $40,000 down and royalties to make up the balance, plus royalties thereafter at reduced percentages. The $40,000 initial payment was taxed as ordinary income since the Revenue Act of 1934 then in effect made no distinction between license royalties and the proceeds of a sale. The Revenue Act of 1936 exempted from tax the proceeds of a sale of personal property by a nonresident alien. If the taxpayer's position had been sustained, he would have paid no tax on any of the royalty payments. The court held that the transaction was a mere license and not a sale. The basis of the decision is that no sale took place because of "the retention of an interest in the profitable exploitation of the patented articles by a receipt of a percentage of the sales price or a stated amount for each article sold." The court expressly disagrees with the Myers and Kimble Glass Co. cases. Eterpen Financiera Sociedad v. United States (108 F. Supp. 100, U. S. Court of Claims, decided Nov. 4, 1952)

Suit by a foreign corporation taxpayer to recover taxes withheld on royalties under section 143. The taxpayer granted an exclusive license to two United States corporations, jointly, with the usual exclusive license provisions including royalties based on a percentage of sales. The parties executed an option simultaneously with the agreement, under which either or both of the United States corporations could purchase the entire right, title, and interest in the patents for a stipulated amount. As in the Bloch case, if the agreement was held to be a sale, no taxes of any kind would be paid. The agreement was held to be a license and not a sale on the ground that if the license was actually an assignment or sale, the option would be meaningless, and therefore the intent of the parties was to grant a license only. The court also relied upon the fact that the licensees were not only expressly given the right to sue in their own names and upon the use of the words "license" and "royalties" in the agreement. A dissenting opinion was filed. The court distinguished the fact situation from that presented in the Myers case. The same court followed the Myers case in the subsequent case of Kronner v. U. S. (110 F. Supp. 730).

Mr. BALLUFF. I would like to say a few words at this time.

Section 1235 proposes for the first time in the tax code special tax consideration of patent rights by the inventor, if and only if the seller retains no interest whatsoever in the property transferred, except to the extent that the purchase price may be related to the productive use or disposition of the property transferred within a period of 5 years from the date of sale or exchange; and, secondly, if the entire proceeds from the sale are received or payable within a period of 5 years from the date of the sale or exchange.

With reference to this section, the House Ways and Means Committee, in its report to the House, stated that it would provide a larger incentive to all inventors to contribute to the welfare of the Nation and, also, that this section would obviate the distinction under present tax law between amateur and professional inventors with respect to capital gains treatment from the sale of the patent right.

The Special Committee on Taxation of the American Patent Law Association endorses the policy of offering greater incentive to all inventors to contribute to the welfare of the Nation. But it has serious doubts that the section, as worded, would contribute to this policy. And, therefore our committee has voted to disapprove this section in its present form.

Because of the difficulty of fixing the fair value of most patent rights for the purposes of sale, it is a common practice for an inventor, and a prospective buyer who desires to exploit the invention, to enter into an exclusive license arrangement. Exclusive license arrangements generally have been held by the courts to be tantamount to a sale, for tax purposes. Under the usual exclusive license arrangement, the inventor retains legal title to the patent rights, but grants the licensee the enjoyment and use of the invention for a consideration, usually depending upon the productivity or use of the invention during the life of the patent, which is 17 years.

It is also quite common in an exclusive license arrangement to provide conditions subsequent that permit the licensee to cancel, or the licensor.

As section 1235 is now worded, it would exclude such exclusive license arrangement from its benefits because of the 5-year rule, and because of the prohibition against retention of interest on the part of the seller.

While the courts now generally accord capital gains-tax treatment to exclusive license arrangements, the report of the House Ways and Means Committee leaves the impression that such is not the case. And accompanying the report of the special committee, I have attached a list of recent cases dealing with this subject, which shows that all of the courts, except one, have accorded capital-gains treatment to exclusive license arrangements.

I want to point out, however, that the Bureau of Internal Revenue, in 1950, adopted an opposite policy and has been following that policy since that time.

The report of the House Ways and Means Committee, in referring to the elimination of distinction for tax purposes between so-called amateur and professional inventors, also leaves the impression that under existing law professional inventors cannot obtain capital gainstax treatment, whereas such is not the case, as may be determined by consideration of the cases cited in the memorandum attached to our report.

Section 1235, as worded, is inapplicable to exclusive license arrangements and would, as a practical proposition, eliminate most sales or exclusive licensing arrangements from its benefits. Certainly, for those inventors who can now qualify for capital gains-tax treatment under the Myers case, which is a leading case on the subject, section 1235 represents less favorable tax treatment than they now enjoy.

Since section 1235 deals specifically with patents, but is applicable only to inventors, it leaves the following two possibilities:

1. By implication it excludes assignees from capital gains-tax treatment, which many can now qualify for under section 117 (a) of the present Internal Revenue Code.

2. Section 1235 leaves assignees free to qualify under the new section 1221, which corresponds with section 117 (a), and it would thus leave assignees in a position to get capital gains treatment on

more favorable terms than are available to an inventor under section 1235.

If the latter possibility is true, and there are many members of our profession who feel that this is the case, it follows that section 1235, which is supposed to provide a larger incentive to all inventors to contribute to the welfare of the Nation, actually provides less favorable tax treatment than many now enjoy, and less favorable tax treatment than would be enjoyed by assignees under section 1221 of the new code.

Investors are benefactors of the public, because after the expiration of a patent, the invention is available for free use of the public, and the protection afforded by patented inventions for a limited time makes possible the establishment of businesses and industries which are vitally important to the economic welfare of the country.

For the reasons pointed out, section 1235 is inadequate to encourage incentive activity and the expenditure of funds to support the same. It is our belief that to be effective section 1235 should have eliminated therefrom the 5-year limitation and also the rule against the retention of any interest in the patent rights sold.

It is also our recommendation that, so modified, section 1235 should be applicable to all gain from the sale, exchange, or licensing of patent rights, and that assignees should also be accorded the same favorable consideration.

I thank you.

The CHAIRMAN. Thank you very much. I hope the staff will consider this very carefully. There have been a lot of complaints on it.

Mr. Jackman, we are glad to see you.

STATEMENT OF WILLIAM JACKMAN, PRESIDENT, INVESTORS

LEAGUE, INC.

Mr. JACKMAN. I am William Jackman, president of the Investors League, with headquarters at 175 Fifth Avenue, New York. The league that I represent is the oldest and most successful organization of investors, with thousands of members residing throughout every State in the Union. It is an organization of investors, both large and small, who make up the backbone of our national economy.

The CHAIRMAN. Do you want to put your written statement into the record?

Mr. JACKMAN. Yes, sir.

The CHAIRMAN. We will include it.

Mr. JACKMAN. I will only deal with the conclusion of my statement, Senator.

First, I would like to thank the committee for allowing me to present the views of the individual investor on H. R. 8300, the tax bill presently under consideration. Since I have but a limited time allotted to me, I will confine my remarks to those sections of the bill which are of immediate concern to investors, namely, the sections dealing with dividend income (secs. 34 and 116).

Gentlemen, in my estimation H. R. 8300 represents a milestone in Federal tax legislation. Among the many provisions designed to overhaul and simplify the Internal Revenue Code, one alone will prove to be of immense importance to our present economic situation.