Case Name: Estate of Ernest Gustav Hoffman, Deceased, William D. Sporborg, as Administrator, c. t. a., Petitioner, v. Commissioner of Internal Revenue, Respondent
Court: United States Board of Tax Appeals
Jurisdiction: United States
Decision Date: 1927-11-07
Citations: 8 B.T.A. 1272
Docket Number: Docket No. 7914
Parties: Estate of Ernest Gustav Hoffman, Deceased, William D. Sporborg, as Administrator, c. t. a., Petitioner, v. Commissioner of Internal Revenue, Respondent.
Judges: Considered by Morris, Murdock, and Siefkin.
Reporter: Reports of the United States Board of Tax Appeals
Volume: 8
Pages: 1272–1276

Head Matter:
Estate of Ernest Gustav Hoffman, Deceased, William D. Sporborg, as Administrator, c. t. a., Petitioner, v. Commissioner of Internal Revenue, Respondent.
Docket No. 7914.
Promulgated November 7, 1927.
Thomas F. J. Connolly, Esq., for the petitioner.
L. L. Sight, Esq., for the respondent.

Opinion:
OPINION.
TRAmmell :
The issues involved in this proceeding are sufficiently set out in our preliminary statement above. The first two issues relating to a mathematical error and the life of the patents after March 1, 1913, have been admitted by the respondent and further reference thereto is unnecessary.
With reference to the third issue, the petitioner contends that the royalties received from the patents involved herein should be allocated in part to income and in part to capital, in the manner provided in the decree of the Supreme Court of the State of New York dated June 19, 1920. The respondent urges that the decision of a state court determining what is income and what is capital as between tenants for years and remainderman can not affect the character of a receipt as income under the laws of the United States.
Royalties, like rent, are inherently income and have been commonly so considered. Appeal of Nelson Land & Oil Co., 3 B. T. A. 315; Arthur H. Fleming v. Commissioner, 6 B. T. A. 900, Appeal of Mary E. McCahill, 2 B. T. A. 875. In Arthur H. Fleming v. Commissioner, supra, we said:
That royalties from mining ore are income and not the return of capital has been settled ever since the decisions in Stratton's Independence v. Howbert, 231 U. S. 399; 34 Sup. Ct. 136; and Von Baumbach v. Sargent Land Co., 242 U. S. 503 .
Royalties received from licenses to use patents are no less income than royalties received by lessors of ore deposits. The entire amount thereof constitutes gross income. The patents were not sold. The licenses merely provided for the right to use the patents and to manufacture articles thereunder. No part of the royalties represents, under the Revenue Act in question, a return of capital. The Revenue Act, however, does make provision for deductions from the royalties received of such amounts during the life of the patents so that their value on March 1, 1913, or their cost if subsequently acquired, is returned to the taxpayer by the time the patents have become exhausted. Appeal of Union Metal Manufacturing Co., 1 B. T. A. 395. Deduction for the exhaustion of the patents has been allowed. It is only by virtue of the deduction by statute that the entire amount thereof is not subjected to tax. Von Baumbach v. Sargent Land Co., supra; Stratton's Independence v. Howbert, supra.
There remains for consideration only the question of the fair value of the patents at March 1, 1913. Petitioner contends that the value of the patents was greatly in excess of that determined by the respondent, and presented the testimony of two witnesses who were qualified by training and experience to express their opinions. One of them testified that in his opinion the value of the patents at the basic date was $60,000, and the other testified to a value of $65,000. The respondent took as the basis for determining the value of the patents, the minimum annual royalty of $2,500, which he capitalized, at 15 per cent, and thus fixed the value of $16,666.66.
In determining the value of assets, such as patent rights, the valuation should be based upon the facts known at the time as of which the valuation is being determined. Subsequent earnings can not be used in the determination, unless from past experience or known facts such future earnings might reasonably have been anticipated. Appeal of Dwight & Lloyd Sintering Co., 1 B. T. A. 179.
We are satisfied that the minimum royalty basis, under all the facts and circumstances of this case, is not the proper basis upon which to determine the value. We have evidence as to the superiority of the bearings made under these patents as compared to any in use at the time. The improvements made by these patents largely corrected defects which had existed in bearings made by others. It had been sought for some time to make more perfect and more endurable bearings. The sale of these bearings increased very rapidly from the time their manufacture commenced in March, 1911. For the remaining 9 months of that year 15,349 bearings were manufactured, while for the year 1912 the number increased to 161,321, more than ten times as many. In 1913 the number manufactured increased nearly three times over the number for 1912. There was a constant material increase each year. In 1916 the number reached 1,112,334. The continuing increase in the demand for these improved bearings, according to the testimony, could be reasonably anticipated on March 1,1913.
In view of all the evidence, it is our opinion that the patents had a value on March 1, 1913, of $40,000, which amount should be spread over the life of the patents.
Judgment will be entered on 15 days' notice, wider Rule 50.
Considered by Morris, Murdock, and Siefkin.