Brown v. Comm'r , 25 B.T.A. 814 ( 1932 )

BERENICE BROWN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Brown v. Comm'r

Docket Nos. 24667, 36637.

United States Board of Tax Appeals

25 B.T.A. 814; 1932 BTA LEXIS 1468;

March 8, 1932, Promulgated

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">*1468 Held: (1) Applications for patents were acquired by petitioner by gift;

(2) Applications for patents are property subject to valuation which may be recovered by depreciation allowances over the lives of the patents;

(3) These applications having been acquired by gift prior to December 31, 1920, the basis for depreciation thereof is their fair market value as of date of acquisition;

(4) Which value is herein determined; and

(5) Annual depreciation based thereon allowed over the lives of the patents.

Lawrence A. Baker, Esq., for the petitioner.

T. M. Mather, Esq., for the respondent.

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GOODRICH

">*814 In these proceedings, which were consolidated, petitioner contests deficiencies asserted by the respondent of $61.28 for the year 1923, and $3,494.80 for the year 1925. These deficiencies result from respondent's disallowance of deductions claimed by petitioner on account of depreciation of patent rights.

">*815 FINDINGS OF FACT.

During the years before us, petitioner was the wife of Charles Henry Brown. In the period from 1910 to 1915 Brown, after considerable study and experiment, developed certain new and original principles">*1469 in the making and fitting of shoes. His ideas were based upon a new method for the measuring of the foot and practical devices carrying them out were perfected. The product manufactured in accordance with these principles and embodying his devices is marketed as the "Arch Preserver" shoe. During the time Brown was working on these developments he ran short of funds and would have been forced to return to the business in which he had formerly engaged had not petitioner and her mother contributed to him from their resources. Brown then agreed to assign the patents, when issued, to petitioner. Patents were applied for, assigned to petitioner and granted as follows:

Patent No.	Description	Applied for	Applications assigned to petitioner	Patent granted
1237464	Last	Dec. 1, 1915	Nov. 26, 1915	Aug. 21, 1917
1249318	Shoe	Jan. 11, 1916	Jan. 11, 1916	Dec. 11, 1917

In November, 1913, Brown entered into an informal contract with the Rickard Shoe Company of Lynn, Massachusetts, whereby the company agreed to manufacture a line of women's shoes in accordance with his ideas and he undertook to establish agencies and secure orders from retail dealers. There">*1470 was reserved to Brown a commission of 6 per centum of the wholesale price of shoes sold through his efforts. Because of unfavorable business conditions this agreement was abandoned by mutual consent.

Shortly thereafter Brown entered into negotiations with the E. T. Wright Company of Rockland, Massachusetts, makers of men's shoes, which, prior to January 3, 1914, resulted in a temporary working arrangement between them. The company agreed to prepare sample lines for its salesmen under Brown's supervision. Brown agreed to instruct the salesmen concerning the special features of the new shoe and to assist in making sales by his personal efforts and demonstrations. He was to receive $100 per month for three months. At the end of that time the parties were to agree on a royalty basis, having in mind the possibilities of future sales development as indicated by results during this try-out period. At that time there were approximately 2,000 retail stores, located in various parts of the country, selling the products of the Wright Company. The officers of that company believed that the shoe industry was ">*816 then in need of new ideas and developments upon which to build up">*1471 business and that the majority of the dealers handling the Wright Company products would successfully undertake the sale of the Arch Preserver shoe. They estimated that in 1916 they could make and market 50,000 pairs of Arch Preservers; in 1917, 75,000 pairs; in 1918, 100,000 pairs; and in each year thereafter a number increased by ten per centum of the previous year's business.

The Wright Company was satisfied with the results obtained during the test period and, although no formal contract was made until 1921, continued the manufacture and sale of these shoes upon a royalty basis of 5 cents per pair and assisted Brown, who, meantime was continuing his demonstrations and sales efforts at various places, in making a contract with the Selby Shoe Company of Portsmouth, Ohio, manufacturers of women's shoes. By contract of June 20, 1921, petitioner and Brown granted to the Wright Company the exclusive license to use the patents which had been granted in the meantime, in the manufacture of men's and boys' boots and shoes, and likewise the trade-mark "Arch Preserver" which had been registered on October 24, 1916. The licensee reserved the right to grant sublicenses to other manufacturers">*1472 of men's and boys' shoes and, upon certain conditions, to sell its license. A royalty of 5 cents per pair on all shoes manufactured and sold under the license or any sublicense, with a minimum royalty of $416.66 per month, was reserved to petitioner. The parties also agreed to an assignment of the patents and to a declaration of trust hereinafter described.

The Wright Company's production since its first agreement with Brown has been as follows:

Year	All shoes (pairs)	Arch Preserver shoes (pairs)
		1914	475,000	than
		1,000
1915	488,000	1 6,000
1916	584,617	25,725
1917	560,823	43,621
1918	344,252	22,683
1919	557,544	31,546
1920	490,559	30,205
1921	478,970	72,883
1922	441,005	44,905
1923	502,642	119,630
1924	381,352	165,273
1925	342,476	182,288
1926	359,459	229,720
1927	326,561	267,826
1928	382,594	269,350
1929	374,480	276,276
1930	382,346	217,061

War conditions were largely responsible for the failure of the company to reach the production anticipated, since during that time the company was engaged in the manufacture of Army and Navy shoes and promotion of the Arch Preserver">*1473 shoes was interrupted.

On May 20, 1915, after negotiations continuing over a period of several months, petitioner and Brown entered into a contract with ">*817 the Selby Shoe Company, under which the company was licensed to use the patents and trade-mark here involved, in the manufacture and sale of women's and misses' shoes. Brown undertook to supervise the preparation of samples; to instruct the salesmen; and to render assistance in creating a market by his demonstrations and sales efforts, particularly for a period of two years. The company undertook to use its best efforts to promote the sale of this product; to pay Brown $1 per annum as compensation for his efforts; and to pay petitioner a royalty of 5 cents per pair for all shoes manufactured and sold under the license, the minimum royalty being $150 per month. The licensee was given the right to grant sublicenses, but was required to demand a royalty thereunder of not less than 5 cents per pair, of which one-half was to be remitted to petitioner. By the contract the parties also agreed to an assignment of the patents and trade-mark and to a declaration of trust, under which the Selby Company was to have "a one-half">*1474 interest in the patents and trade-mark so far as they affect the women's and misses' branch of the Arch Preserver shoe and name."

When the contract was signed with the Selby Shoe Company it was marketing its products through approximately 2,500 retail stores, selling directly to the stores. The directors and officers of the company believed that the product could be exploited successfully and they could reach an output of five hundred thousand pairs a year in five years, and a million pairs a year in ten years by means of a ratable and consistent annual increase in production. They expanded the company's sales force to put the product before the public, believing they would have a particular advantage in the selling of this product because of the fact that the shoe, although special in construction, looked like any ordinary shoe and had no conspicuous eccentric appearance which would attract attention to the wearer. It was recognized by the trade that about five pairs of women's shoes are consumed annually as against one pair of men's shoes.

The production of the Selby Shoe Company for all shoes and Arch Preserver shoes, has been as follows:

Year	All shoes	Arch Preserver shoes
1916	1,695,171	41,077
1917	1,620,150	6,084
1918	1,289,583	78,662
1919	1,506,338	149,854
1920	1,711,126	272,667
1921	1,245,703	529,540
1922	1,506,942	614,948
1923	1,520,222	659,314
1924	1,566,373	536,199
1925	Unknown.	534,158
1926	Unknown.	1,276,931

">*1475 War conditions were largely responsible for the failure of the company to reach the production anticipated by the end of five years, but during the war period approximately 15,000 pairs of Arch Preserver ">*818 shoes were sold to the Government for nurses. In addition, many requisitions for nurses' shoes were filled by retail stores handling this product, about three pairs of Arch Preservers being thus sold as against one pair of ordinary shoes.

By instrument of June 20, 1921, recorded in the Patent Office on December 17, 1921, the patents here in question, subject to the licenses, were assigned by petitioner and her husband to Charles H. Brown, Mark W. Selby and James A. Munroe, as trustees. The trustees were to hold the letters patent subject to the licenses existing in favor of the Selby and Wright Company; to issue further licenses as requested by the petitioner and the then licensees; to conduct legal proceedings for the protection of the patents; and, subject to the written consent of the petitioner and licensees, to sell the patent rights, the net proceeds to be distributed to petitioner and the licensees according to such an agreement as they then might make. The">*1476 Selby Company was not assigned a one-half interest in the patents as stipulated in the agreement of May 20, 1915, but by agreement supplemental to that of June 20, 1921, and dated the same day, it was provided that in case of dissolution of the trust there should be transferred to the Selby Shoe Company a one-half interest in the letters patent so far as they related to women's and misses' shoes, and all remaining rights and interests in the letters patent and trade-marks should be transferred to the licensors.

Petitioner has received royalties under the licenses granted to the Selby and Wright Companies and payments made under the initial contracts which were deposited to her account by Brown as follows:

1914	$1,200.00
1915	2,700.00
1916	3,853.85
1917	4,344.20
1918	5,733.10
1919	9,292.70
1920	16,273.35
1921	31,477.00
1922	$35,747.00
1923	39,447.20
1924	44,573.60
1925	59,255.05
1926	75,611.61
1927	75,873.05
1928	88,154.62

The total value of the applications for patents, as of final dates of acquisition by petitioner was $376,234.96.

OPINION.

GOODRICH: Petitioner claims a value of her patent rights as of the date of acquisition">*1477 by her of $700,000, and contends that she is entitled to recover that value by means of deductions on account of depreciation thereof over the lives of the patents. Respondent advances several contentions in opposition. He urges, first, that petitioner acquired these patent applications not by gift, but for a consideration, in which case the basis for depreciation is the original ">*819 cost thereof, which is not disclosed by this record. Next, he contends that, regardless of the basis, petitioner is not entitled to depreciation, because during the years here involved she was not the owner of the patents, since they had been transferred to trustees and no allowance on account of the exhaustion of trust property may be made to a beneficiary of a trust. Finally, he disputes the value of the patent applications as claimed by petitioner, contending that it was not in excess of about $25,000

Respondent's contention, that petitioner's acquisition of these patent applications was not by gift, it bottomed solely upon the following testimony by Brown:

At the time I was working out the development of this shoe proposition I had given up a very lucrative engagement in the line which">*1478 I had been working, and there came a time when it was necessary for me to have more funds to operate with or give up the idea, and go back into my old business. Mrs. Brown and her mother had resources, and they agreed to contribute the funds necessary to carry on everything to have me proceed with the shoe proposition rather than go back into the old business. Their belief and enthusiasm was such that they were willing to take the chance, and on the strength of that I agreed to assign the patents when issued to Mrs. Brown.

As we consider this case we become convinced that in agreeing to transfer to petitioner his patent applications, Brown was motivated not by the money advanced by Mrs. Brown and her mother, but by the fact that they had given their support to an endeavor which had, for him, become of great interest and were willing to assist him in every possible way, even to drawing upon their own financial resources, to bring his labors to a successful culmination. Brown had abandoned a lucrative connection in the advertising business to enter a field to which his interest led him. Through his observations, his studies and experiments he had become convinced that ordinary">*1479 footwear was largely responsible for most of the foot trouble from which so many people suffer and that, in turn, such trouble was responsible for much ill health and misery. He had experimented considerably with devices designed to cure individual cases of foot malformation and defects and came to believe that the majority of such cases could have been avoided had the sufferers worn shoes so scientifically modeled as to permit the foot to perform its natural functions, free from the restrictions and damages caused by ordinary footwear. The development of his ideas, therefore, became for him more than a commercial proposition. He made it his life's work and he believed that to accomplish it would be to confer a benefit upon mankind. There is no doubt but that to have the members of his family believe in his ideas and their ultimate development, and to wish him to continue in his endeavors, meant much to him. Judging him as he appeared before us, we are convinced that he is a person who would respond generously to the ">*820 loyalty offered him by these members of his family and that reaction, we believe, motivated him in making the assignments. The amounts advanced by petitioner">*1480 and her mother are not disclosed. We infer from the record that they were small; that they met only the living expenses of the family and some traveling expenses for Brown while engaged in his demonstrations and in making his contracts with the manufacturers who later entered into contracts with him and petitioner. Brown testified that the advances in nowise represented a selling price of the patents; that he would not have assigned to any outsider upon these terms; and that "love and affection" as recited in the assignment, was an important item in connection therewith. We conclude that the assignments made by Brown to petitioner were gifts.

In support of his contention that, regardless of the manner in which acquired, petitioner may not have a deduction on account of depreciation because she was not the owner of the patents during the years here involved, but was only the beneficiary of a trust, respondent cites the cases of ; ; and ">*1481 . The Baltzell case arose under the Revenue Act of 1918 and deals with income of a trust described by section 219(a)(4) as follows in part:

"(4) Income which is to be distributed to the beneficiaries periodically whether or not at regular intervals * * *." The Detroit Trust Company case arose under a similar provision of the 1921 Act and was controlled by the Baltzell decision, as was the Sharpe case, arising under a similar provision of the 1924 Act. These decisions, and the many other decided cases bearing on the same issue, manifest the rule that a beneficiary of a trust is not entitled to deduct from his distributable share of the trust income an allowance for the exhaustion of the trust property. But this issue does not arise in the case at bar. Here, there are no distributions from the trust, periodic or otherwise, for the trust has no income. It was created by petitioner for purposes of management and protection of her patents. Under it, the trustees may grant licenses of the patents, or sell or dispose of them only upon petitioner's assent and direction. She retained the power to terminate the trust; ">*1482 she remained the veritable owner of the patents. True, the agreement provided that upon termination of the trust petitioner should convey to the Selby Shoe Company a one-half interest in the patents so far as they relate to the women's and misses' shoe business and, in case of sale of the patents, should make a settlement with the licensees, but the rights of these parties are vague, indefinite and dependent upon future agreements. There is nothing to indicate that the trust will be terminated within the lives ">*821 of the patents and we regard these possible interests as too contingent to effect such a substantial derogation of petitioner's ownership as to bar her from a deduction representing the exhaustion of the patents and allowed her under section 214(a)(8) of the Revenue Acts of 1921 and 1924. Again, we point out that all royalties arising under the licenses granted under these patents are paid directly to petitioner, not to the trust. It is manifest that this fact makes here inapplicable the statutory provisions treated in the cases cited. Cf. ">*1483 .

We have held that the patent applications were acquired by petitioner by gift, prior to December 31, 1920. Therefore, under section 204(a)(4) of the Revenue Act of 1924, the basis for depreciation thereof is their fair market value as of date of acquisition. . Applications for letters patent are property subject to valuation which may be recovered by depreciation allowances over the life of the patents. ; ; ; ; .

Our determination of the total value of these patent applications when acquired by petitioner we have set out in our findings of fact. In determining this value we have relied largely upon the testimony of two witnesses of outstanding qualifications. Both had long been connected and were in positions of responsibility with long established and leading shoe manufacturers, one a maker">*1484 of women's and misses' shoes; the other a maker of men's and boys' shoes. That these witnesses were familiar with the shoe business in all its phases and were competent to judge of the importance in the trade of Brown's developments and the future commercial possibilities of those ideas can not be questioned. At the time Brown presented his proposition to their concerns and both decided to take it up, each of these witnesses made estimates as to what future business his concern could develop with the Arch Preserver shoe. Upon these estimates we rely, for they were made by persons who were in a position to gauge the future as well as that could be done with respect to this proposition and their accuracy has been borne out well by subsequent production, except during a war period which they could not have foreseen. Since the estimates of future production had been made, and the royalty fixed prior to the assignment of the applications to petitioner, we base our determination of value upon those factors. Based upon that valuation, an annual deduction should be allowed petitioner during the lives of these patents.

Judgment will be entered under Rule 50.

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Footnotes

• 1. Estimated. ↩