Court Opinion

ID: 4615535
Source: CourtListenerOpinion
Date Created: 2020-11-21 02:32:33.657969+00
Date Added: 2024-06-11T07:59:52.758517
License: Public Domain

Victor Rakowsky and Ella J. Rakowsky, Husband and Wife, Petitioners, v. Commissioner of Internal Revenue, RespondentRakowsky v. CommissionerDocket No. 29509United States Tax Court17 T.C. 876; 1951 U.S. Tax Ct. LEXIS 29; November 28, 1951, Promulgated 1951 U.S. Tax Ct. LEXIS 29">*29 Decision will be entered for the respondent.  Petitioner acquired in 1941, ownership of a contract for patent royalties and agreed to pay for such rights and for other property acquired at the same time, $ 50,000 to American Cyanamid Company.  Petitioner executed his promissory note for this $ 50,000 payable to Cyanamid and due October 15, 1947.  On May 1, 1942, petitioner assigned to Cyanamid his royalty contract as security for the $ 50,000 which he owed Cyanamid.  On January 10, 1944, petitioner assigned to his daughter, Janis Velie, all of his right, title and interest in the patent royalty contract which he owned, subject, however, to the assignment which he had previously made to Cyanamid as security for his debt due Cyanamid.  Janis Velie did not, either directly or indirectly, assume and agree to pay the note which petitioner owed to Cyanamid.  Held, that the patent royalties in the taxable year 1944 which were paid to Cyanamid and applied by it to petitioner's debt evidenced by his promissory note were taxable to petitioner and not to his daughter. The Commissioner is sustained.  Paul E. Bradley, Esq., for the petitioners.Frank M. Cavanaugh, Esq., for the 1951 U.S. Tax Ct. LEXIS 29">*30  respondent.  Black, Judge.  Raum, J., concurs in the result.  BLACK 17 T.C. 876">*876  The Commissioner has determined a deficiency in petitioners' income tax for the year 1944 of $ 2,228.35.  The deficiency is due to one adjustment made by the Commissioner which is explained in the deficiency notice as follows:(a) Your taxable net income for 1944 is increased as follows:Royalty income received and applied to your credit byAmerican Cyanamid Company$ 10,380.44Less: Amortization of patent cost2,761.24$ 7,619.20Less: Portion of royalty income applied as payment ofinterest on your indebtedness to the AmericanCyanamid Company1,406.88Net increase$ 6,212.32Your contention that the above-mentioned royalties represent income which is taxable to your daughter, Janis Velie, now Janis Reid, is denied.17 T.C. 876">*877  It is petitioners' contention that prior to the taxable year he assigned the royalties to his daughter, Janis Velie, and that she has returned the income in question on her own income tax return and that the Commissioner erred in taxing the same income to petitioners.FINDINGS OF FACT.Most of the facts have been stipulated 1951 U.S. Tax Ct. LEXIS 29">*31  and we adopt the facts which have been stipulated as part of these findings and incorporate them by reference.The petitioners, husband and wife, are now and were during the year 1944 residents of Joplin, Missouri.  They filed a joint income tax return for the year 1944 with the collector of internal revenue at Kansas City, Missouri.  Petitioner Victor Rakowsky will sometimes hereinafter be referred to as petitioner.Under date of October 15, 1941, American Cyanamid Company, sometimes hereafter referred to as Cyanamid, entered into a written agreement with petitioner under which Cyanamid sold to petitioner for the sum of $ 50,000 to be paid on or before October 15, 1947, one-third of the issued and outstanding stock of a corporation known as Wuensch Hetero Concentration Process Company, herein for convenience referred to as WHCP, and also one-third of certain promissory notes of said WHCP.  At the time of the sale by Cyanamid to petitioner of the one-third notes and one-third stock of WHCP, petitioner gave to the seller, American Cyanamid Company, his personal promissory note in the face amount of $ 50,000, bearing interest at 4 per cent, payable monthly until the debt was paid on 1951 U.S. Tax Ct. LEXIS 29">*32  or before October 15, 1947.On March 31, 1942, Cyanamid and petitioner entered into another written agreement under which they agreed to dissolve WHCP and distribute its assets, approximately one-third to petitioner and two-thirds to Cyanamid.  The agreement recites that, inasmuch as it was not practical upon dissolution to distribute the assets of WHCP to the stockholders pro rata petitioner should receive in dissolution 40.833 per cent of the royalty income under a certain license agreement dated July 10, 1937, as amended October 27, 1941, between WHCP and American Zinc, Lead & Smelting Company, under which WHCP granted to American Zinc, Lead & Smelting Company the exclusive right to use and to sublicense others to use certain inventions.  Under paragraph 3 of the agreement, the cash of WHCP on hand was distributed one-third to petitioner and two-thirds to Cyanamid.  In pursuance of the last mentioned agreement, WHCP executed an assignment to petitioner of 40.833 per cent of the royalty income under the license agreement theretofore made between WHCP and American Zinc, Lead & Smelting Company.17 T.C. 876">*878  As security for the payment of the purchase price of $ 50,000, with interest, 1951 U.S. Tax Ct. LEXIS 29">*33  petitioner under date of May 1, 1942, executed an agreement with Cyanamid assigning to it all sums thereafter becoming due and payable to petitioner under the agreement between WHCP and American Zinc, Lead & Smelting Company, so long as any part of the purchase price of $ 50,000, with interest, remained unpaid.On January 10, 1944, petitioner entered into an agreement with his daughter, Janis Velie, wherein and whereby he did convey and assign unto Janis all of his right, title and interest in the royalty income purchased by him from Cyanamid.  This instrument which was signed by both petitioner and his daughter reads as follows:THIS CONTRACT, made and entered into this 10th day of January, 1944, by and between VICTOR RAKOWSKY, as first party, and JANIS VELIE, as second party,WITNESSETH:WHEREAS, by agreement dated October 15, 1941, first party became indebted to American Cyanamid Company (hereinafter sometimes called CYANAMID) in the sum of Fifty Thousand Dollars ($ 50,000), to be paid on or before October 15, 1947, with interest at the rate of four percent (4%) per annum, payable monthly, said indebtedness being the purchase price agreed to be paid by first party to CYNAMID for1951 U.S. Tax Ct. LEXIS 29">*34  the property sold to him as in said contract described, and,WHEREAS, under date of the 31st day of March, 1942, the said first party and CYNAMID did make and enter into a certain written contract wherein and whereby division of the property of said WUENSCH HETERO CONCENTRATION PROCESS COMPANY (hereinafter called WHCP) mentioned and described in said contract of October 15, 1941, was agreed upon, and thereafter, under date of the 30th day of April, 1942, there was assigned to first party, in pursuance of the aforementioned contracts, forty and eight hundred thirty three thousandths per cent (40.833%) of the royalty income accruing under that certain agreement dated July 10, 1937, as amended October 27, 1941, between said WHCP, as first party, and American Zinc, Lead & Smelting Company, as second party (hereinafter called the Hetero License), said unsignment being subject in all respects to the terms and provisions of said contract of March 31, 1942, between first party and CYANAMID and further subject to all of the liabilities and obligations referred to in said agreement, and,WHEREAS, under date of the 1st day of May, 1942, first party, as security for the payment of the above mentioned1951 U.S. Tax Ct. LEXIS 29">*35  sum of $ 50,000, together with interest thereon, did assign and transfer to CYANAMID all sums thereafter becoming due and payable to him, the said first party, under said Hetero license, for the period and subject to the stipulations therein contained, and,WHEREAS, first party now desires to transfer and assign unto second party all of his rights and property under the aforementioned contracts,NOW, THEREFORE, in consideration of love and affection and the sum of One Dollar ($ 1.00) this day paid by second party to first party, the receipt of which is hereby acknowledged, first party does hereby transfer, convey and assign unto second party, her heirs, legal representatives and assigns, all the right, title and interest of the said first party in and to said 40.833% of the royalty income under said Hetero license, subject in all respects to the terms and provisions of the aforementioned assignments and contracts, and second party hereby accepts 17 T.C. 876">*879  said assignment subject to the conditions aforesaid and agrees to fulfill and comply with the terms and provisions of the aforementioned contracts and agreements and each thereof.EXECUTED by the parties hereto the day and year first1951 U.S. Tax Ct. LEXIS 29">*36  above written.(Signed) Victor RakowskyFirst Party(Signed) Janis VelieSecond PartyThe conveyance made by petitioner to his daughter Janis was a gift and was so reported by him in February 1945.  In the gift tax return petitioner described the gift as follows:Under date of January 10, 1944, Victor Rakowsky conveyed to his daughter, Janis Velie, in consideration of love and affection, 40.835% of the royalty income accruing under the agreement dated July 10, 1937, as amended October 27, 1941, between Wuensch Hetero Concentration Process Company, as first party, and American Zinc, Lead & Smelting Company, as second party, subject in all respects to the contract of March 31, 1942 between Victor Rakowsky, as first party, and American Cyanamid Company, as second party, said interest being 40.835% of 15% of Domestic Gross Royalties for the use of the MBI Heavy Media Separation Process.Valued at$ 46,941.05Less: Balance of purchase price due American Cyanamid Co39,340.17$ 7,600.88Petitioner's daughter accounted for the receipt of the earnings on the royalty conveyed to her by petitioner for the year 1944 in her tax return for that year.  This return showed1951 U.S. Tax Ct. LEXIS 29">*37  a royalty income in the gross amount of $ 10,380.44 and a net income of $ 6,202.32 on which she paid income tax in the sum of $ 2,056.28.  She has filed a protective claim for refund.  The royalty income reported by Janis Velie for the year 1944 is the same royalty income that respondent has asserted against petitioner.Cyanamid was not a party to the agreement dated January 10, 1944, between petitioner and his daughter, Janis Velie, which has been set out in full above.  No showing has been made that Cyanamid was ever notified anything about it.The royalty income mentioned above was paid during 1944 by American Zinc, Lead & Smelting Company to Cyanamid in accordance with the agreement by which petitioner assigned his royalty contract to Cyanamid as security, of which American Zinc, Lead & Smelting Company had been advised, and such receipts were applied by Cyanamid in payment of interest on and in reduction of said purchase price of $ 50,000.All payments received by Cyanamid from American Zinc, Lead & Smelting Company under the provisions of the assignment to Cyanamid were applied as credits against said purchase price until the full amount thereof was liquidated, at which time1951 U.S. Tax Ct. LEXIS 29">*38  petitioner's personal 17 T.C. 876">*880  promissory note was canceled.  This occurred in a year subsequent to the one which we have before us.  Thereafter, the royalty payments were made by American Zinc, Lead & Smelting Company directly to petitioner's daughter, Janis Velie.OPINION.The only issue in this proceeding is whether petitioner is taxable on net royalties of $ 6,212.32 which were paid to Cyanamid in the taxable year and applied by Cyanamid to the payment of indebtedness which petitioner owed Cyanamid, or whether such income is taxable to petitioner's daughter, Janis, to whom he had, on January 10, 1944, assigned his contract for royalties, subject to Cyanamid's prior right to them until petitioner's indebtedness to Cyanamid was fully paid.We think the facts sustain the Commissioner's determination that the income in question is taxable to petitioner. There is really no dispute between the parties as to the facts.  Their differences are as to the legal interpretation which is to be given to these facts.Briefly stated these facts are: Petitioner by written contract dated October 15, 1941, purchased a one-third interest in a corporation, giving the seller in payment therefor his1951 U.S. Tax Ct. LEXIS 29">*39  personal promissory note for $ 50,000 due 6 years from purchase date and bearing 4 per cent interest payable monthly. Subsequent thereto, on May 1, 1942, he pledged this income from patent royalties by written assignment to his creditor as security for payment of the balance of his debt.  He therein by contract assigned certain royalties theretofore payable to him as a licensee of a basic patent and stipulated that the income so assigned or pledged would remain payable by the distributing agent direct to his creditor so long as any part of the $ 50,000 note obligation, plus interest, remained unpaid. Thereafter payments were again to be made direct to petitioner.  The agreement of May 1, 1942, provided further that in so far as the creditor was concerned, the assignment of the royalties as security could in no sense be construed as payment of petitioner's debt "except to the extent that any sums may be paid to and received by Cyanamid hereunder." Payments were thereafter applied on petitioner's debt by the distributing agent and reported for tax purposes by petitioner until January 10, 1944, when a gift assignment to his daughter was made expressly subject to all prior arrangements1951 U.S. Tax Ct. LEXIS 29">*40  and contracts.  Petitioner thereafter failed to report this income for tax purposes but the amount of this income appears on the return of the daughter.The essence of petitioner's contention is that under the terms of the assignment which petitioner made to his daughter, she agreed to assume and pay the debt which petitioner owed to Cyanamid and 17 T.C. 876">*881  thereafter she became the primary debtor to Cyanamid, and that petitioner was no longer the primary debtor.  If that were so, there might be merit in petitioner's contention that the income in question was taxable to his daughter and not to him.  However, we do not think it is so.A reading of this assignment agreement makes it clear to us that Janis took the property subject to all the outstanding agreements which her father had made and agreed "to fulfill and comply with the terms and provisions of the aforementioned contracts and agreements." She, in no manner as we read the agreement, assumed and agreed to pay any part of the indebtedness which petitioner owed to Cyanamid and which was evidenced by petitioner's promissory note for $ 50,000 due on or before October 15, 1947.  This note remained in the hands of Cyanamid until1951 U.S. Tax Ct. LEXIS 29">*41  fully paid. There is nothing to show that Janis assumed and agreed to pay any part of this note.Petitioner argues in his brief that the holder of the note against petitioner, American Cyanamid Company, could have recovered directly from Janis for the payment of the note if the use of the patents had failed to produce income.  Petitioner says in his brief: "Assume for the moment that immediately after the transfer had been made by petitioner to his daughter that petitioner had become insolvent and that the use of the patents produced no income, then under the law * * * American Cyanamid Company could have proceeded directly against petitioners' transferee." If such circumstances had happened as those which petitioner assumes and Cyanamid had brought suit against Janis as the debtor, we think that such a suit would have completely failed because she was not the debtor and had never entered into any agreement, either express or implied, that she would assume and agree to pay petitioner's promissory note.We think our decision in the instant case is controlled by our decision in J. Gregory Driscoll, 3 T.C. 494. In that case the shoe was on the other foot1951 U.S. Tax Ct. LEXIS 29">*42  from what it is here.  In that case the Commissioner was seeking to tax income to the assignor of property where the income had already been committed to the payment of another's debt and was so used in the taxable year and where the assignor had not assumed and agreed to pay such debt of another.  In that case we held for the taxpayer, and in so doing, we said:We think the petitioner's position is impregnable.  In acquiring the interest in the lease, subject to the mortgage and the assignment, she acquired no interest whatever in the oil which produced the income here in dispute.  That oil had been validly assigned before she acquired her interest in the lease. The oil to which she was entitled under her assignment was the oil to be produced after the obligation to the bank was fully satisfied.  Until that time, she was not entitled to any oil produced from the premises in question, or to its proceeds.  She never received the income, nor any benefit from it.  It was not at her disposal or subject to her dominion or control.  She could not successfully have 17 T.C. 876">*882  demanded its payment to her.  The indebtedness upon which it was applied was not incurred by her, nor was it ever1951 U.S. Tax Ct. LEXIS 29">*43  assumed by her as a personal liability.  See P. T. Clary, 42 B. T. A. 1142.About the same thing as we said above in the Driscoll case, supra, could be said in the instant case if Janis were the taxpayer, and not her father, Victor Rakowsky.The facts clearly convince us that petitioner was the debtor to Cyanamid.  The royalties in question were collected by Cyanamid and in accordance with the agreement executed in 1942 were applied to petitioner's debt to Cyanamid and thereupon such debt was canceled to the extent of such payment.  Under the doctrine of the Driscoll case, supra, this income is taxable to petitioner and not to his daughter, Janis.  We sustain respondent's determination.Decision will be entered for the respondent.