Case Name: (Patrick) P. T. Clary, Petitioner, v. Commissioner of Internal Revenue, Respondent
Court: United States Board of Tax Appeals
Jurisdiction: United States
Decision Date: 1940-11-05
Citations: 42 B.T.A. 1142
Docket Number: Docket No. 96496
Parties: (Patrick) P. T. Clary, Petitioner, v. Commissioner of Internal Revenue, Respondent.
Judges: Black, Arhold, Hill, and Opper agree with this dissent.
Reporter: Reports of the United States Board of Tax Appeals
Volume: 42
Pages: 1142–1150

Head Matter:
(Patrick) P. T. Clary, Petitioner, v. Commissioner of Internal Revenue, Respondent.
Docket No. 96496.
Promulgated November 5, 1940.
John J. Dougherty, G. P. A., for the petitioner.
B. D. Daniels, Esq., for the respondent.

Opinion:
OPINION.
Mellott :
Respondent contends that the royalties applied during the taxable years by Swanson Brothers to the payment of the Dukane indebtedness "were royalties from the taxpayer's property — constructively received by him and appropriated to the use of another." He argues that the question is simply: To whom is the income from proceeds arising and derived from patents at the initial stage attributable — not whose income it may be after other steps are taken. He urges that, even if it be assumed, for the purpose of discussion, that Swanson Brothers would not have entered into the contract without the agreement to liquidate the account of the Dukane Coffee Corporation, still the royalties accrued to the taxpayer first before they could be applied to other purposes, and hence that the income (royalties) was not divested until after it (they) had been earned. He also denies petitioner's various contentions, hereinafter set out.
Petitioner contends that he never had the unrestricted choice of taking, or refraining from taking, possession of the income in question, and, therefore, that he never constructively received it; that the instrument which created the income destroyed it as far as he was concerned; that he waived the right to receive it as part of the consideration for the contract; that the contract would never have been executed if he had not consented to the waiver; and that, if the waiver can he considered to be an assignment, it constituted an assignment of a property right, and any income accruing thereunder was taxable to the assignee.
The question is a difficult one and the right answer is elusive. Petitioner assumed the burden of attempting to overturn the presumptive correctness of the respondent's determination and, for reasons which will be pointed out, we think he has succeeded in doing so.
The facts set out in the findings need not be repeated. Suffice it to note at this juncture that petitioner acceded to what appears to have been rather harsh terms — in the language of our findings— "because he felt it was the best arrangement that he could make and that the royalties to be received by him after the indebtedness was liquidated would adequately compensate him for the use of his; patent." He testified that it was merely a question of giving "something to get something bigger. ⅛ I had to do it to get them for the whole term of the patent." "That was just for a bargain; the best I could take." Under cross-examination he expressed the same idea when he likened the transaction to giving "a sardine for a salmon." Eespondent, upon brief, points out that it was a rather large "sardine" which he gave up, since it amounted to more than $50,000. It can not be gainsaid that there is considerable substance to this argument; but in this connection reference may appropriately be made to the fact that petitioner anticipated that the royalties would be sufficient to liquidate the Dukane obligation' in approximately two and one-half years, leaving him free to collect royalties at an estimated rate of $20,000 a year for approximately fifteen years. When these facts are kept in mind the terms of the contract are not so shockingly harsh as they first appear to be.
No attempt will be made to summarize all of the evidence. It indicates, however, that the Dukane Corporation was having financial difficulties. One faction of its management was urging that it be placed in bankruptcy, while petitioner and his nephew — the latter owning about 20 percent of its stock — wished to save it, if possible. Swanson Brothers naturally wanted to collect the account, which was long past due. The situation was such that a hard bargain could be driven. Whether it was a wise one or not, from the standpoint of the petitioner, need not be decided. It is sufficient for the present purposes to advert to the fact, which is amply shown by this record and set out in our findings, that petitioner had not guaranteed the Dukane indebtedness to Swanson Brothers, had not been responsible for the granting of the credit under which it had been created, and was not personally liable for the payment of any part of it. He, therefore, was not discharging any personal obligation of his own in consenting that a portion of the royalties be applied upon the Dukane indebtedness. He was not a stockholder or financially interested in the Dukane Coffee Co.
This Board and the courts have held that an owner of property who contracts to sell it or lease it to another can not escape tax on the income resulting from the sale or lease by designating in the contract that the selling price or rental shall be paid to a third party. Samuel V. Woods, 5 B. T. A. 413; J. T. Browning, 16 B. T. A. 485; John Shirley Ward et al., Executors, 22 B. T. A. 352; affd., 58 Fed. (2d) 757; certiorari denied, 287 U. S. 656; rehearing denied, Dec. 5, 1932; W. L. Shore, 26 B. T. A. 389. The reason for this holding is well stated in Samuel V. Woods, supra, relied upon by the respondent. There an owner leased property and in the lease agreement directed that the lessee pay to his wife and daughter portions of the rents and royalties as they became due. In holding that the amounts paid to the wife and daughter constituted income of the lessor, this Board said:
The petitioner, the parties agree, was the owner of the property from which the income was derived. As such owner he had the right to the income or the right to dispose of it. In the enjoyment of this right, he ordered it paid directly to another until otherwise ordered. He might have taken it, or he might have ordered it sent to his hank, paid directly to a creditor, or held by the lessee. Whichever of these courses he took was an exercise of his enjoyment of the fruits of his ownership inherent in such ownership. Such a voluntary act in anticipation of actual receipt and before the income exists can only affect the income when it actually arises, and in our opinion it may properly be treated as coming to him and immediately disposed of. See Ormsby McKnight Mitchel, 1 B. T. A. 143.
In our opinion the facts relating to the royalties applied by Swanson Brothers during the taxable years to the payment of the indebtedness of the Dukane Coffee Corporation call for the application of a different rule than that applied in Samuel V. Woods, supra, and related cases. Petitioner, as has been pointed out above, never had the right to acquire this income or to dispose of it as he saw fit. It can not be said, therefore, that he ever, either actually or constructively, received it. Moreover, the agreement did not provide that it be paid to a third party, although it is true that its application to the indebtedness of the Dukane Coffee Corporation did unquestionably benefit that corporation, which was not a party to the agreement. However, the primary purpose of the provision was not so much to benefit Dukane as it was to benefit Swanson Brothers; and it had its inception in the desire of that concern to liquidate one of its bad accounts. It was inserted at the insistence of Swanson Brothers and to induce it to enter into the contract.
It is apparent from what has been said that we are of the opinion the Commissioner erred in including the amounts in controversy in petitioner's income. But such holding need not be predicated entirely upon the ground discussed. Under the contract Swanson Brothers acquired not only an interest in petitioner's patent — the exclusive right to use it in a specified territory, which vested "pro tanto title to the patent itself in the grantee" (Claude Neon Lights, Inc., 35 B. T. A. 424, 427, and cases cited) — hut also the right to the income from such property to the extent of the Dukane indebtedness. Swanson Brothers thus acquired two valuable property rights in exchange for its promise to pay petitioner all royalties accruing after the Dukane debt had been liquidated. A taxpayer may transfer or assign property or property rights and any income subsequently arising therefrom is not taxable to him, as transferor or assignor. Nelson v. Ferguson, 56 Fed. (2d) 121; certiorari denied, 296 U. S. 555; Blair v. Commissioner, 300 U. S. 5; Hall v. Burnet, 54 Fed. (2d) 443; certiorari denied, 285 U. S. 552; Commissioner v. O'Donnell, 90 Fed. (2d) 907.
We are of the opinion and hold that the respondent erred in including the amounts in controversy in petitioner's gross income.
Reviewed by the Board.
Judgment will ~be entered for the petitioner.