*

The Honorable Thomas A. Wiseman, Jr., United States District Judge for the Middle District of Tennessee,

sitting by designation.

RECOMMENDED FOR FULL-TEXT PUBLICATION

Pursuant to Sixth Circuit Rule 206

File Name: 05a0361p.06

UNITED STATES COURT OF APPEALS

FOR THE SIXTH CIRCUIT _________________

VISION INFORMATION SERVICES, L.L.C.,

Petitioner-Appellant,

v.

COMMISSIONER OF INTERNAL REVENUE,

Respondent-Appellee.

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No. 04-2110

On Appeal from the United States Tax Court.

No. 1750-01—David Laro, Tax Court Judge.

Argued: July 26, 2005

Decided and Filed: August 22, 2005 

Before: MOORE and COLE, Circuit Judges; WISEMAN, District Judge.*

_________________

COUNSEL

ARGUED: Robert M. Jackson, HONIGAN, MILLER, SCHWARTZ & COHN, Detroit, Michigan,

for Appellant. Steven W. Parks, UNITED STATES DEPARTMENT OF JUSTICE, Washington,

D.C., for Appellee. ON BRIEF: Robert M. Jackson, Roger Cook, James H. Combs, HONIGAN,

MILLER, SCHWARTZ & COHN, Detroit, Michigan, for Appellant. Steven W. Parks, Richard

Farber, UNITED STATES DEPARTMENT OF JUSTICE, Washington, D.C., for Appellee.

_________________

OPINION _________________

KAREN NELSON MOORE, Circuit Judge. This is an appeal from a decision of the United

States Tax Court holding that certain sums received by the Petitioner-Appellant, Vision Information

Services, L.L.C. (“Vision” or the “taxpayer”), during tax years 1995 and 1996 were license fees and

therefore taxable as ordinary income under the Internal Revenue Code. The legal issue presented

in this case is whether the agreement between the taxpayer and Twentieth Century Fox Home

Entertainment L.L.C. (“FoxVideo”) was a sale of intellectual property and thus a capital transaction,

or rather a license permitting FoxVideo to use Vision’s software solution. Upon review, we

conclude that the agreement was an outsourcing arrangement and software license and therefore the

Tax Court did not err in finding the payments to Vision were taxable as ordinary income.

Accordingly, we AFFIRM the Tax Court’s judgment.

1
No. 04-2110 Vision Information Services v. Commissioner Page 2

I. BACKGROUND

Vision Information Services, L.L.C. is a limited liability company headquartered in Royal

Oak, Michigan. For federal tax purposes, Vision is treated as a partnership and its members are

treated as partners. Vision was formed in February 1995 by Correia Vision, L.L.C. and Nordic

Group, L.L.C., an affiliate of Nordic Information Systems, Inc. (“Nordic”), to market and provide

inventory information management services to manufacturers, distributors, and retailers, allowing

them to better manage the flow of product inventory. Vision provides these services through the use

of a software package entitled MVPS/MVPR (the “Nordic Software”) developed by Nordic. The

Nordic Software “assists users in tracking the shipment, purchase, retail replenishment, and return

of consumer goods between manufacturers and retailers.” Joint Appendix (“J.A.”) at 168 (Nordic

Software License Agreement at 1).

On the same day that Vision was formed, Nordic and Vision entered into a software license

agreement (the “Nordic Software License”). The Nordic Software License states:

2. LICENSE GRANT AND RESTRICTIONS.

2.1 License. Subject to the terms and conditions of this Agreement, Nordic

grants to Vision, and Vision accepts, an exclusive perpetual worldwide license to

use, copy, modify and enhance the Software, Source Materials and Manuals: (i) to

provide Third-Party Service Bureau Services to various third parties . . .; and, (ii) to

sub-license the Software to FoxVideo to enable FoxVideo to use the Software to

process its own data and the data of its affiliates provided, however, FoxVideo’s

rights to exercise its rights under such sublicense shall not arise until there is a

termination of the service agreement between Vision and FoxVideo for reasons other

than a FoxVideo breach or election by FoxVideo to terminate due to a prohibited

assignment by Vision. . . . . . .

2.3 Additional License. In addition to the license rights granted in Section 2.1

and in consideration for an eleven (11%) percent payment described more fully

below, Nordic hereby automatically grants Vision a more extensive license

including, without limitation, a broader grant of exclusivity than stated in Section

2.2. . . . . . .

For example, and without limiting the foregoing, if a Manufacturer of cosmetics

and Vision agree that for an additional $1 million, such Manufacturer shall have

exclusive rights to the Software in its industry, then this license shall be deemed

automatically broadened. . . . . . . 4. OWNERSHIP, CONFIDENTIALITY AND PROTECTION OF SOFTWARE AND

OTHER TRADE SECRETS.

4.1 Nordic Ownership of Software. This license is not a sale. Except as

otherwise provided herein, title and all proprietary rights (patents, trade secrets,

copyrights and trademarks) to the Software, and any copy made by Vision are held

by Nordic. The Software is copyrighted and is protected by United States and

International Copyright Laws.

J.A. at 171, 173-74, 177 (Nordic Software License at 4, 6-7, 10). Thus, the Nordic Software License

authorized Vision to sub-license the Nordic Software to FoxVideo, and also envisioned potential

sub-licensing opportunities in other industries as well.
No. 04-2110 Vision Information Services v. Commissioner Page 3

Also on that same day, Vision and FoxVideo entered into a Distribution Information Services

Agreement (the “Vision Agreement”) which set forth the “preliminary binding agreement” between

the two parties. J.A. at 200 (Deal Mem. at 1). The purpose of the agreement was to enable

FoxVideo to sell its products directly to retail stores and thereby eliminate the need for a distributor.

To accomplish this goal, Vision significantly enhanced the Nordic Software (the enhanced version

hereinafter referred to as the “Vision Software”) to track the sale of FoxVideo products in retail

stores, to determine the necessary product replenishment, and to handle product returns. Rather than

simply running the program itself, FoxVideo outsourced the operation to Vision. Bennett Means

(“Means”), FoxVideo’s vice president for information technology and distribution, testified that

“when we had Vision deal directly with our clients, they represented themselves as 20th Century

Fox, as agents on our behalf.” J.A. at 456 (Trial Tr. at 26). Means explained that “the concept of

Vision was to develop a capability without their clients having to invest heavily into technology and

processes, and to amortize this capability, perhaps across, in the future, many customers, in many

different areas.” J.A. at 456 (Trial Tr. at 26).

To effectuate this relationship, FoxVideo and Vision signed the Vision Agreement which

states that “Vision shall provide Information Services with respect to the distribution of any product

distributed by FoxVideo.” J.A. at 211 (Deal Mem. at 7). In exchange for providing these

“Information Services,” FoxVideo agreed to pay Vision according to a fee schedule attached to the

Vision Agreement. The initial term of the Vision Agreement was for five years, but could be

extended by FoxVideo for additional five-year terms without additional payment. The Vision

Agreement also contains an exclusivity provision which requires that “FoxVideo shall procure

Information Services for use in direct-to-store distribution of videocassettes in the United States and

Canada exclusively from Vision.” J.A. at 212 (Deal Mem. at 8). By contrast, however, the Vision

Agreement also states that “Vision shall have the right to provide services, including Information

Services, to other entities throughout the Territory” except to Good Times Video and the home video

division of any major studio with respect to video products. J.A. at 212 (Deal Mem. at 8).

In addition to the provision of services, the Vision Agreement also contained a conditional

license to FoxVideo for the Vision Software. Paragraph seven of the Vision Agreement explains

the terms of FoxVideo’s conditional license, which is at the heart of this tax case. Paragraph seven

of the Vision Agreement states:

7. VISION SOFTWARE LICENSE/FEE:

(a) Vision Software License:

(i) Vision’s License from Nordic: The continuing existence and validity

of Vision’s license of the Nordic Software from Nordic (including all

maintenance and related agreements) (collectively, the “Nordic Agreements”)

shall be of the essence of the Vision Agreement. Maintenance of the exclusivity

contemplated hereunder at all times during the Term shall also be of the essence

of the Vision Agreement. Any material breach by Nordic of its exclusivity

obligations under the Nordic Agreements as contemplated hereunder, or any

agreement by Vision to eliminate, modify or otherwise limit Nordic’s exclusivity

obligations under the Nordic Agreements as contemplated hereunder, shall

constitute a default under the Vision Agreement. . . .

(ii) Grant of License: Vision shall grant or cause to be granted to

FoxVideo a worldwide, non-exclusive, non-transferable license (“Vision

Software License”) to use, on its own hardware or otherwise, the Vision

Software. The Vision Software License shall have a term coextensive with the

Term of the Vision Agreement, including all extensions. . . . In all respects, the
No. 04-2110 Vision Information Services v. Commissioner Page 4

terms granted to FoxVideo under the Vision Software License shall be no less

favorable than the terms granted to Vision in the Nordic Agreements. . . . Vision

shall retain the right to license (or sub-license) all or any part of Vision Software,

subject to restrictions contained herein, in the Vision Agreement and in the

Vision Software License. . . .

(iii) Scope of Use: FoxVideo shall not have the right to exercise its rights

under the Vision Software License (except with respect to interface and other

activities contemplated under the Vision Agreement) for so long as the Vision

Agreement is in effect (including all extensions). Immediately upon any

termination of the Vision Agreement except termination resulting from (A) an

uncured breach by FoxVideo, or (B) FoxVideo’s election to terminate pursuant

to Paragraph 8., FoxVideo shall have the right to fully exercise its rights under

the Vision Software License . . . .

(b) License Fee:

(i) Payment of Fee: Except as provided below, FoxVideo shall pay a

License Fee to Vision in the aggregate amount of $10 million, payable as

follows: (A) $3 million payable on signature of the Vision Agreement; plus (B)

$1.75 million payable on each of the first four anniversary dates of the signing

of the Vision Agreement. . . .

J.A. at 214-15 (Deal Mem. at 10-11). Thus, paragraph seven indicates that Vision was to provide

inventory management services to FoxVideo through the use of the Vision Software, which in turn

was built upon the Nordic Software. Vision granted FoxVideo a license to the Vision Software

which FoxVideo could only exercise upon termination of the outsourcing agreement between the

parties. In exchange for the conditional license, FoxVideo agreed to pay Vision $10 million over

five years.

During 1995 and 1996, FoxVideo paid Vision $3 million and $1.75 million pursuant to the

terms of the Vision Agreement. On its partnership tax returns for those years, Vision reported the

payments as an installment “sale of exclusive rights & know how.” J.A. at 110, 125. Vision treated

the FoxVideo payments as a long-term capital gain (with the exception of $429,802 of the $1.75

million received in 1996 which was treated as interest from portfolio income). The Commissioner

of the Internal Revenue Service (the “Commissioner”) determined that the amounts from FoxVideo

were “license fee income” and therefore taxable as ordinary income. J.A. at 143 (Notice of Final

Partnership Admin. Adjustment 7 (Nov. 20, 2000)). The taxpayer challenged the Commissioner’s

ruling and filed a petition for readjustment in the United States Tax Court. On March 8, 2004, the

Tax Court ruled in favor of the Commissioner, upholding the classification of the FoxVideo

payments as license fees and therefore taxable as ordinary income. The court stated that its holding

turned on the intent of the parties in signing the Vision Agreement, which it interpreted as a software

license. The taxpayer appeals from this ruling.

II. ANALYSIS

The sole question in this case turns on the proper characterization of the Vision Agreement.

The taxpayer argues that despite the fact that the Vision Agreement refers to the payments from

FoxVideo as a “license fee,” the payments were instead “a sale of exclusive rights & know how”

to the direct-to-retail business model and therefore should be treated as a capital gain. We have

stated that “[t]he question of whether the language of an agreement is ambiguous is a question of

law. Once the language of a contract has been held to be ambiguous, the interpretation of such

language is a question of fact that turns on the intent of the parties.” United States v. Donovan, 348
No. 04-2110 Vision Information Services v. Commissioner Page 5

F.3d 509, 512 (6th Cir. 2003). The Tax Court found the language of the Vision Agreement to be

clear. Accordingly, we review the Tax Court’s legal findings de novo. N. Am. Rayon Corp. v.

Comm’r, 12 F.3d 583, 586 (6th Cir. 1993). Applying this standard, we conclude that the Tax Court

did not err in concluding that the contract was unambiguous and that FoxVideo’s payments were

ordinary income.

We begin our analysis by noting that “[t]he cardinal rule in the interpretation of contracts is

to ascertain the mutual intention of the parties and then, so far as it is possible so to do consistently

with legal principles, give effect to that intention.” Pickren v. United States, 378 F.2d 595, 599 (5th

Cir. 1967). We have explained that “[t]he intent of the parties is best determined by the plain

language of the contract.” Donovan, 348 F.3d at 512; see also 11 Samuel Williston & Richard A.

Lord, A Treatise on the Law of Contracts § 31:4 (4th Ed. 1999) (noting that “primary importance

should be placed upon the words of the contract”). “It is clear, therefore, that it is not the real intent

but the intent expressed or apparent in the writing which is sought; it is the objective, not the

subjective, intent that controls.” Williston & Lord, supra § 31:4. Thus, our first inquiry is whether

the language of the Vision Agreement is ambiguous or unclear. We have noted that “[a] court,

however, may not use extrinsic evidence to create an ambiguity; the ambiguity must be apparent on

the face of the contract.” Donovan, 348 F.3d at 512 (internal citation omitted).

Applying these principles to this case, we conclude that the unambiguous language of the

Vision Agreement reveals the parties’ primary intention was both to enter into an outsourcing

arrangement and to grant a conditional license of the Vision Software to FoxVideo. First, the Vision

Agreement establishes that the taxpayer will provide distribution information services to FoxVideo

for a five-year period. In connection with those distribution information services, FoxVideo agreed

to pay the taxpayer for the services as outlined in Exhibit A to the Vision Agreement.

In paragraph seven of the Vision Agreement, titled “Vision Software License/Fee,” the

taxpayer granted a conditional license of the Vision Software to FoxVideo to continue with the

direct-to-retail program using the Vision Software in the event that Vision ever terminated the

outsourcing agreement. J.A. at 214 (Deal Mem. at 10). Thus, FoxVideo did “not have the right to

exercise its rights under the Vision Software License (except with respect to interface and other

activities contemplated under the Vision Agreement) for so long as the Vision Agreement is in effect

(including all extensions).” J.A. at 215 (Deal Mem. at 11, ¶ 7(a)(iii)). If the outsourcing agreement

was ever terminated by Vision, however, FoxVideo could “fully exercise its rights under the Vision

Software License, including the right to full access to all material escrowed thereunder.” J.A. at 215

(Deal Mem. at 11, ¶ 7(a)(iii)). The clear import of these words establishes that the taxpayer granted

a conditional software license to FoxVideo. In exchange for this conditional license, FoxVideo was

obligated to “pay a License Fee to Vision in the aggregate amount of $10 million,” payable as $3

million at signing and $1.75 million each of the next four years. J.A. at 215 (Deal Mem. at 11,

¶ 7(b)(i)) (emphasis added). The unambiguous language of the Vision Agreement confirms the Tax

Court’s interpretation that the payments by FoxVideo were license fees taxable as ordinary income.

The taxpayer argues that despite the clear language of the Vision Agreement, the transaction

was actually a sale of trade secrets and know-how of the direct-to-retail business model to

FoxVideo. We find this argument to be wholly without merit. There is simply nothing in the

language of the Vision Agreement to support this characterization. The Vision Agreement outlines

a service agreement between the parties and grants FoxVideo a conditional license to the Vision

Software. There is no mention of a sale of a trade secret or know-how anywhere in the document.

To support its argument, the taxpayer relies solely on oral testimony of the parties presented to the

Tax Court. Because we find the language of the Vision Agreement to be clear and unambiguous,

reliance on extrinsic evidence of the parties’ intent is unnecessary. Schachner v. Blue Cross & Blue

Shield of Ohio, 77 F.3d 889, 893 (6th Cir.) (holding that “in this circuit, before a district court can
No. 04-2110 Vision Information Services v. Commissioner Page 6

1

In support of its argument, the taxpayer cites several cases from the United States Claims Court which held

that “[t]he nomenclature and labels employed by the parties, however, are not decisive; the substance of the transaction

governs whether it is a sale or a license.” Liquid Paper Corp. v. United States, 2 Cl. Ct. 284, 290 (Cl. Ct. 1983); see also

Hooker Chems. & Plastic Corp. v. United States, 591 F.2d 652, 658 (Ct. Cl. 1979); Bell Intercont’l Corp. v. United

States, 381 F.2d 1004, 1011 (Ct. Cl. 1967). The taxpayer’s reliance on these cases is misplaced however.

All three of these cases dealt with the issue of “whether the granting clause in the patent agreement is so broad

that in legal effect it is an assignment even though the parties call it a license and the payments thereunder royalties.”

Redler Conveyor Co. v. Comm’r, 20 T.C.M. (CCH) 371 (T.C. 1961), aff’d 303 F.2d 567 (1st Cir. 1962). By contrast,

the issue in this case is not whether the license to use the Vision Software was so broad as to constitute a sale of the

Vision Software, but rather whether the plain language of the Vision Agreement detailing the Vision Software License

instead should be read as a sale of the direct-to-retail trade secret. None of these cases support the taxpayer’s argument

that language indicating the license of one product actually reveals the sale of another one.

consider extrinsic evidence of the parties’ intent, it must find an ambiguity on the face of the

contract”), cert. denied, 519 U.S. 865 (1996). In reviewing a similar case, the First Circuit stated:

The agreements show every evidence of careful and skillful draftsmanship. And they

are licenses in form in that the parties are described as licensor and licensee and the

payments to be made under them are called royalties. Substance controls words to

be sure, but when parties obviously skilled in the business at hand use words of art

in formal documents carefully drawn we can only assume that the words used were

intended to mean what they say. We can hardly assume that their use was

inadvertent or the product of bumbling draftsmanship.

Redler Conveyor Co. v. Comm’r, 303 F.2d 567, 569 (1st Cir. 1962); see also Grace Bros. v.

Comm’r, 173 F.2d 170, 177 (9th Cir. 1949). We agree with the First Circuit’s reasoning in Redler

and similarly find that the parties’ repeated reference to the term “license” throughout paragraph

seven of the Vision Agreement as well as use of the term “License Fee” to describe FoxVideo’s

payments was intentional. Accordingly, we decline the taxpayer’s invitation to rely on oral

testimony in the face of clear, contradictory written intent.1

Moreover, even were we to accept the taxpayer’s invitation to look beyond the plain

language of the Vision Agreement, we agree with the Commissioner’s contention that FoxVideo’s

payments to Vision would most likely be considered additional revenue for Vision’s outsourcing

services, and thus taxable as ordinary income. The underlying purpose of the Vision Agreement was

for the taxpayer to use its know-how and the Vision Software to provide direct-to-retail services on

FoxVideo’s behalf. While the Vision Agreement states that the taxpayer is to be compensated for

these distribution information services pursuant to the prices set forth in Exhibit A, J.A. at 213 (Deal

Mem. at 9, ¶ 6(a)), the schedule in Exhibit A reveals that the vast majority of these services were

provided to FoxVideo free of charge. See J.A. at 224 (Exhibit A at 4) (noting that the information

management services “are required and are provided without specific charge to the customer”).

Exhibit A of the Vision Agreement only provides for additional payment to the taxpayer for its

professional services as well as its field merchandising services management. Forty-eight other

services identified in the Vision Agreement are provided by the taxpayer to FoxVideo but not

specifically charged. Thus, were we to construe the payments to the taxpayer without reliance on

the licensing language of the Vision Agreement, we would conclude that the evidence demonstrates

that the payments were consideration to the taxpayer for the forty-eight other services rendered.

Under the Internal Revenue Code, all payments should be treated as ordinary income unless an

exception applies, such as a sale of a capital asset. In this case, however, there is simply nothing in

the record which supports the taxpayer’s contention of a sale of a capital asset. Accordingly, we

conclude that, if we were to look beyond the language of the Vision Agreement, the payments by

FoxVideo were for services rendered, and therefore, would be treated as ordinary income for tax

purposes.
No. 04-2110 Vision Information Services v. Commissioner Page 7

Finally, even assuming arguendo, that the Vision Agreement could be read as a sale of a

trade secret or know-how, we conclude that FoxVideo’s payments would not be considered a sale

of a capital asset pursuant to I.R.C. § 1235. Section 1235 states that “[a] transfer . . . of property

consisting of all substantial rights to a patent . . . by any holder shall be considered the sale or

exchange of a capital asset held for more than 1 year.” I.R.C. § 1235. Courts have held that

“[s]ecret formulas and trade names are sufficiently akin to patents to warrant the application, by

analogy, of the tax law that has been developed relating to the transfer of patent rights, in tax cases

involving transfers of secret formulas and trade names.” Pickren, 378 F.2d at 599. In order to

qualify for capital gain treatment for tax purposes under § 1235 however, the sale must be of “all

substantial rights” to the trade secret or know-how. The term “all substantial rights” has been

defined as all rights “which are of value at the time” of the transfer. 26 C.F.R. § 1.1235-2(b). Thus,

where the rights granted are limited in geographic scope or to a specific field of use, the transfer is

not a sale of a capital asset under § 1235 absent a showing of no commercial value to the rights in

other geographic areas or other fields of use. We have held that the term “all substantial rights”

means that “the transfer must cover all practical fields-of-use for the invention.” Fawick v. Comm’r, 436 F.2d 655, 662 (6th Cir. 1971); see also Mros v. Comm’r, 493 F.2d 813, 816 (9th Cir. 1974)

(holding that a transfer was not a capital asset sale where the patent had potential value in other

fields not subject to the transfer agreement). In Fawick, we concluded that because the transfer of

rights to a patent was to one specific industry and the patents had known value outside that one

industry, the transaction failed to qualify as a sale of a capital asset under § 1235. Fawick, 436 F.2d

at 663.

Applying these principles to this case, we conclude that the taxpayer would not be entitled

to capital gain treatment even assuming the Vision Agreement was a sale of the direct-to-retail trade

secret. By the terms of the Vision Agreement, the taxpayer may not provide distribution information

services to either Good Times Video or the home video division of any major studio, defined as

seven of FoxVideo’s competitors. The exclusivity provision specifically covers only the videoproducts field however. Under the Vision Agreement, the taxpayer could sell its business model to

major studios so long as their use of the model is limited to the sale of “CD/ROM’s, interactive

software, audio products, cartridge-based videogame software or other products that are not Video

Products.” J.A. at 212 (Deal Mem. at 8, ¶ 5(b)(i)). Moreover, nothing in the Vision Agreement

prevents the taxpayer from selling its direct-to-retail model to smaller studios which do not compete

with FoxVideo. Likewise, nothing in the Vision Agreement prevents the taxpayer from selling its

direct-to-retail model to other industries.

Vision’s business model seeks to revolutionize the relationship between the manufacturer

and the retailer by eliminating the traditional distributor. The taxpayer has presented no evidence

why this solution is only effective with regard to home videos. Indeed, the Nordic Software License

specifically envisions the taxpayer utilizing the Nordic Software to implement a direct-to-retail

model in other industries, specifically suggesting the cosmetics industry. See J.A. at 174 (Nordic

Software License at 7). Thus, even assuming that the Vision Agreement could be considered a sale

of a trade secret, we conclude that the sale did not cover all practical fields-of-use for the invention

and accordingly, was not a sale of all substantial rights under § 1235. Thus, the transaction fails to

qualify as a sale of a capital asset and would be treated as ordinary income even under the taxpayer’s

strained reading of the Vision Agreement.

III. CONCLUSION

For the foregoing reasons, we AFFIRM the Tax Court’s judgment holding that the FoxVideo

payments were license income and taxable as ordinary income.