1946 U.S. Tax Ct. LEXIS 214">*214 Decision will be entered under Rule 50.
Where under the terms of a contract the taxpayer, by the exercise of an option, acquired the "exclusive" and "perpetual" right to manufacture and sell alcoholic malt beverages under the trade names "Rainier" and "Tacoma" in a limited territory for a consideration of $ 1,000,000, held, (1) the right to use the trade name in connection with the manufacture and sale of alcoholic malt beverages is property which the owner thereof could license or assign to another; (2) the grant of an exclusive and permanent right in a limited territory was an assignment of such right; (3) the taxpayer acquired a capital asset and the transaction was a sale and not a license.
69 U.S.P.Q. (BNA) 266">*267 6 T.C. 856">*856 This proceeding involves deficiencies in income and excess profits taxes and penalties thereon as follows:
| Income tax | Excess profits | |||
| Calendar year | deficiency | Penalty | tax | Penalty |
| deficiency | ||||
| 1940 | $ 19,056.59 | $ 9,528.30 | $ 12,688.61 | $ 6,344.30 |
| 1941 | 24,565.15 | 12,282.58 | 86,175.87 | 43,087.93 |
It was alleged in the petition that the respondent erred:
(a) In disallowing as a deduction royalty expenses amounting to the sum of $ 56,498.13 for the year 1940 and $ 142,821.04 for the year 1941.
6 T.C. 856">*857 (b) In disallowing as a deduction officers' salaries of $ 19,000 for the year 1940, and officers' salaries of $ 12,833.33 and other salaries of $ 7,483.33 for the year 1941
(c) In failing to allow for the year 1941 as an additional deduction the sum of $ 4,125 representing additional capital stock tax.
At the hearing petitioner conceded issue (b) relating to officers' salaries and bonuses, with respect to both years, and the respondent stipulated that petitioner's claim for capital stock tax deductions should be allowed in the sum of $ 1,125 for 1940 and $ 3,000 for 1941.
The petitioner further conceded that, for the purposes of this1946 U.S. Tax Ct. LEXIS 214">*216 case only, if any deficiency is determined with respect to the taxable years 1940 and 1941 the penalty under section 293(b) of the Internal Revenue Code may be imposed.
The only remaining issue for our decision is whether petitioner is entitled to deduct from income for the years 1940 and 1941 certain amounts claimed as royalty expenses in connection with its contract with Rainier Brewing Co.
The case was submitted on oral and documentary evidence and under certain concessions and stipulations made by counsel at the hearing.
FINDINGS OF FACT.
Petitioner is a corporation, organized under the laws of the State of Washington. Its Federal income and excess profits tax returns for 1940 and 1941 were filed with the collector of internal revenue at Tacoma, Washington. Its returns were filed on the accrual basis.
Petitioner was incorporated in 1933 as Century Brewing Association, and it established a plant and began the manufacture of beer at Seattle, Washington. Many years prior to the incorporation of petitioner, and prior to the amendment of the Constitution establishing national prohibition, which was ratified in 1919,69 U.S.P.Q. (BNA) 266">*268 another corporation, known as the Seattle Brewing & Malting Co., 1946 U.S. Tax Ct. LEXIS 214">*217 was engaged in the manufacture of beer in Seattle, and in 1933 its assets were held or controlled by Rainier Brewing Co., hereinafter called Rainier, a corporation with headquarters at San Francisco, California. Among these assets were certain properties in Seattle which were not then being used, except as a distributing warehouse, and the trade name "Rainier," which was applicable to beer then being distributed and marketed in certain western states, including Washington, and Alaska, by Rainier Brewing Co., which also had acquired the trade name "Tacoma" in order to prevent confusion in the labels which carried a picture of Mt. Rainier (sometimes called Mt. Tacoma).
The trade name "Rainier" had a well established and recognized value by reason of its use and development, and petitioner was desirous of acquiring the right to use it in connection with the manufacture 6 T.C. 856">*858 and sale of its own beer. The trade name "Tacoma" was less used and not so valuable. Rainier was approached with the suggestion of a merger, but would not sell any part of its business. Later petitioner appointed a committee of four of its directors to negotiate with Rainier. After some negotiation a contract1946 U.S. Tax Ct. LEXIS 214">*218 was entered into between petitioner and Rainier on April 23, 1935, under which the petitioner purchased certain property and equipment located at Seattle and certain personal property, and secured a right to use the trade names "Rainier" and "Tacoma" in the State of Washington and the Territory of Alaska, in consideration for the payment of certain sums to be determined on a production basis or a minimum royalty specified therein. No other consideration was provided or required for the "perpetual right and license" granted.
The contract of April 23, 1935, after reciting the mutual desire of Rainier to sell and petitioner to purchase the physical property and of petitioner to secure and Rainier to grant the right to use the trade names within the State of Washington and the Territory of Alaska, and after providing in detail for the sale of the physical properties, continues with the following provision:
Licensing Agreement
Seventh: Rainier hereby grants to Century the sole and exclusive perpetual right and license to manufacture and market beer, ale and other alcoholic malt beverages within the State of Washington and the Territory of Alaska under the trade names and brands of "Rainier" 1946 U.S. Tax Ct. LEXIS 214">*219 and "Tacoma" together with the right to use within said State and Territory any and all copyrights, trademarks, labels, or other advertising media adopted or used by Rainier in connection with its beer, ale, or other alcoholic malt beverages.
Eighth: In consideration of said perpetual right and license, Century agrees to pay to Rainier in cash, lawful money of the United States, a royalty amounting to Seventy-five cents (75 cents) per barrel (consisting of 31 gallons) for every barrel of beer, ale, or other alcoholic malt beverages sold or distributed in the State of Washington and the Territory of Alaska under the said trade names or brands of "Rainier" and "Tacoma" up to a total of one hundred twenty-five thousand (125,000) barrels annually, and eighty cents (80 cents) per barrel for all such products distributed within said territory annually in excess of said amount of one hundred twenty-five thousand (125,000) barrels; provided, however, that the minimum annual amount to be paid by Century to Rainier shall be the sum of Seventy-five Thousand Dollars ($ 75,000.00), which said amount is herein termed "minimum annual royalty". Said payments shall be made in lawful money of the 1946 U.S. Tax Ct. LEXIS 214">*220 United States as follows:
* * * *
Century further agrees that annually on the 1st day of August of each year, commencing with the 1st day of August, 1936, it will deliver to Rainier a statement prepared by Price, Waterhouse & Co., or other Certified Public Accountants acceptable to Rainier, showing the sales of beer, ale and other alcoholic malt beverages under the trade names or brands of "Rainier" and "Tacoma" for the contract year commencing July 1st and ending June 30th immediately preceding the date of such statement.
6 T.C. 856">*859 Rainier shall have the right, at its own cost and expense, to examine the books, records and accounts of Century for the purpose of verifying any such statement so submitted to determine the accuracy thereof.
Ninth: Rainier agrees that during the period of time this agreement remains in force, it will not manufacture, sell or distribute, within the territory herein described, directly or through or by any subsidiary company or instrumentality wholly owned or substantially controlled by it, beer, ale, or other alcoholic malt beverages, or directly or indirectly enter into competition with Century in said territory. It is understood and agreed, however, 69 U.S.P.Q. (BNA) 266">*269 1946 U.S. Tax Ct. LEXIS 214">*221 that Rainier shall have the sole and exclusive right to manufacture, sell, and distribute non-alcoholic beverages within said territory under said trade names or brands of "Rainier" and "Tacoma" and any and all other trade names or brands that it owns and desires to use.
Rainier agrees that during the period of time this agreement remains in force it will maintain in full force and effect Federal registrations of said trade names or brands, "Rainier" and "Tacoma" and will likewise maintain in full force and effect the present registration of said trade names or brands within the State of Washington and Territory of Alaska. Should Rainier fail to so maintain its rights under said trade names or brands, then and in that event Century shall have the right to pay any and all amounts necessary to so maintain said trade names or brands for and in the name of Rainier, and shall be entitled to deduct any and all amounts so paid from the royalties then due or thereafter becoming due under this agreement.
Tenth: Century agrees that any and all beer, ale, or other alcoholic malt beverages manufactured by it pursuant to this agreement and marketed under said trade names and brands of "Rainier" 1946 U.S. Tax Ct. LEXIS 214">*222 and "Tacoma" shall at all times be of a quality at least equal to the quality of similar products then manufactured and marketed under said trade names and brands by Rainier; and shall be manufactured under the same formulae used in the manufacture of similar products by Rainier, which formulae Rainier shall make available to Century.
Eleventh: It is understood and agreed by and between the parties hereto that should Century at any time be prevented from manufacturing, selling, and distributing beer, ale, or other alcoholic malt beverages due to strikes, boycotts, fires, earthquakes or acts of God, for periods of time in excess of three (3) months, and as a result thereof Century shall fail to earn a sufficient amount from the operation of its entire business to enable it to pay the royalty next due and payable under this agreement, then and in that event, the time of payment of such royalty shall be deferred for a period of time equal and equivalent to the period during which such cause shall continue, but in no event beyond a date upon which Century has available sufficient funds to pay royalty payments that have accrued; provided, however, that during any such period when royalty1946 U.S. Tax Ct. LEXIS 214">*223 payments, shall be so deferred, Century shall apply all of its monthly net income derived from the operation of its entire business toward the payment of any royalties so due.
Should the citizens residing in any portion of the territory covered by this agreement elect to adopt local prohibition laws prohibiting the manufacture, sale, and distribution of beer, ale, or other alcoholic malt beverages in such community, and should Century, due to such laws, be unable to sell and distribute within the territory described in this agreement, beer, ale, and other alcoholic malt beverages manufactured under the trade names and brands of "Rainier" and "Tacoma" in a quantity at least equal to Fifty-Two Thousand (52,000) barrels annually, then and in that event, the minimum royalty payable hereunder shall be reduced during the continuance of the operation of such laws 6 T.C. 856">*860 by the percentage that the sales of such products under such trade names and brands of "Rainier" and "Tacoma" sold within that particular community bear to the total sales of such products by Century under such brands within the entire territory covered hereby, which percentage shall be based upon the average sales of 1946 U.S. Tax Ct. LEXIS 214">*224 such products theretofore made hereunder.
It is further understood and agreed by and between the parties hereto that should Century at any time be prevented from manufacturing, selling and distributing beer, ale, or other alcoholic malt beverages under the brands and trade names of "Rainier" and "Tacoma," in a quantity at least equal to fifty-two thousand (52,000) barrels annually, due to governmental action, war regulation, or general prohibitory laws adopted by the United States of America or the State of Washington, then and in that event Century shall have the option of terminating this agreement or submitting to arbitration, in the manner hereinafter provided, the question of adjusting the minimum royalties payable hereunder during the continuance of such restriction upon the operation of its business. In the event that Century elects to submit the matter to arbitration, it agrees to abide by any decision rendered by the arbiters, and to pay the minimum royalties so fixed, in the manner and at the times herein provided. Rainier agrees, in the event of such arbitration, to accept the royalties so fixed in satisfaction of the obligation of Century for such period.
69 U.S.P.Q. (BNA) 266">*270 Twelfth: Century1946 U.S. Tax Ct. LEXIS 214">*225 agrees that upon acquiring title to the real property herein agreed to be sold to it by Rainier, it will, in addition to executing the mortgage provided in paragraph Third hereof, execute and deliver to Rainier such document or documents as Rainier shall deem necessary to cause said real property to stand as security for the prompt and faithful compliance by Century of all of its obligations under this agreement, to the end that should Century default in the performance of its obligations under this agreement and should Rainier elect to terminate this agreement, then and in that event, title to said real property shall pass to Rainier, free and clear of all liens and encumbrances, as and for liquidated damages due to such default.
Century further agrees that should it sell said property, it will, under written agreements satisfactory to Rainier, impound the proceeds received from such sale to the extent of Two Hundred Fifty Thousand Dollars ($ 250,000.00), or such sums as shall be realized on said sale, which said impounded funds shall thereafter stand as security for the prompt and faithful compliance by Century of all of its obligations under this agreement, and in the event of 1946 U.S. Tax Ct. LEXIS 214">*226 default, be transferred and delivered to Rainier as and for liquidated damages.
It is understood and agreed by and between the parties hereto that in the event of the default of Century hereunder, the termination of this agreement by Rainier, and the transfer or delivery to Rainier of said real property, or such impounded proceeds as liquidated damages, Rainier shall, in addition thereto, be entitled to recover any and all royalties due and payable under this agreement at the time of the termination thereof, which said amounts Century agrees to pay upon demand.
Thirteenth: It is understood and agreed by and between the parties hereto that at any time after this agreement has been in force for five (5) years, Century shall have the right and option of electing to terminate all royalties thereafter payable hereunder by notifying Rainier of its election so to do, and by executing and delivering to Rainier the promissory notes of Century aggregating in principal amount the sum of One Million Dollars ($ 1,000,000.00) dated as of the date of the exercise of such option, bearing interest from date at the rate of five per cent (5%) per annum, which said promissory notes shall be 6 T.C. 856">*861 1946 U.S. Tax Ct. LEXIS 214">*227 divided into five (5) equal maturities and shall be payable respectively on or before one (1), two (2), three (3), four (4), and five (5) years after the dates thereof.
Paragraphs fourteenth to twenty-fifth were headed "Miscellaneous Provisions." In paragraph fourteenth petitioner agreed to purchase from Rainier at prevailing market prices all malt required in the manufacture of beer, ale, and other alcoholic malt beverages under the trade names and brands of "Rainier" and "Tacoma." In paragraph fifteenth petitioner agreed to use its best efforts to increase the sales of alcoholic malt beverages within its territory and to expend in advertising amounts equal to those expended in advertising all other beverages manufactured and sold by it under other brands in Washington and Alaska. In paragraph seventeenth Rainier agreed to cause the old Seattle Brewing & Malting Co., the West Virginia corporation, to change its name to the end that petitioner might adopt the name Seattle Brewing & Malting Co. Paragraph twenty-second provided that if petitioner should fail to fully and promptly carry out the terms and provisions of the agreement or to make payments according thereto after proper 1946 U.S. Tax Ct. LEXIS 214">*228 notice by Rainier such failure should be considered an event of default and Rainier might cancel the agreement by written notice to petitioner, in which event all the rights of petitioner should terminate and liquidated damages as specified in paragraph twelfth would accrue to Rainier. It was further provided in paragraph twenty-fourth that the agreement should be binding upon and inure to the benefit of the parties and their respective successors and assigns, provided, however, that no rights of Century should be assigned by it without the written consent of Rainier first had and obtained.
The contract was carried into execution. In pursuance of paragraph seventeenth of the agreement petitioner changed its name from Century Brewing Association to Seattle Brewing & Malting Co. Rainier withdrew from the sales and distribution of its products in Washington and Alaska. The Seattle plant was deeded by Rainier to petitioner and petitioner conveyed the Seattle plant to a bank as trustee and executed its trust indenture with Rainier as beneficiary, all in accordance with the terms of the agreement. From time to time thereafter various amendments were made to the contract of April 23, 1946 U.S. Tax Ct. LEXIS 214">*229 1935, none of which substantially affected the provisions respecting the use of the trade names.
69 U.S.P.Q. (BNA) 266">*271 Thereafter petitioner operated under the licensing agreement until July 1, 1940, and royalties paid pursuant thereto were claimed and allowed as deductions for income tax purposes. During the period from June 30, 1935, to July 1, 1940, the petitioner sold alcoholic malt beverages in Washington and the Territory of Alaska under the 6 T.C. 856">*862 name of "Rainier" in the quantities set out below and paid "royalties" thereon as follows:
| Year ended June 30 -- | Barrels sold | Royalties paid |
| 1936 | 60,171.51 | $ 75,000.00 |
| 1937 | 82,881.50 | 75,000.00 |
| 1938 | 114,308.16 | 85,731.12 |
| 1939 | 112,538.17 | 84,403.63 |
| 1940 | 131,355.59 | 98,834.47 |
| Total | 501,254.93 | 418,969.22 |
In the spring of 1940 it became apparent that with increased production and sales the payments at the barrelage rate for the next five years would closely approximate, if not exceed, $ 1,000,000, and at a meeting held April 10, 1940, petitioner's directors considered the advisability of exercising the election provided in paragraph thirteenth of the contract of April 23, 1935. At a subsequent meeting of the board of directors, 1946 U.S. Tax Ct. LEXIS 214">*230 held June 18, 1940, the matter was again discussed and the following resolution was adopted:
Be It Resolved, that the President and Secretary of this corporation be and they hereby are authorized to execute promissory notes in the aggregate sum of $ 1,000,000.00 dated as of July 1, 1940, payable respectively on or before one, two, three, four and five years after date, with interest at the rate of five (5%) per cent per annum, and payable to Rainier Brewing Company, Inc., and that the President of this corporation be and he hereby is authorized to exercise the right and option given to this corporation by its agreement of April 23, 1935, to terminate the payment of royalties to Rainier Brewing Company, Inc., by the delivery to them of said promissory notes.
Pursuant to this resolution petitioner notified Rainier of its election to exercise the option as of July 1, 1940, and of the execution of promissory notes in the amount of $ 1,000,000, bearing interest at 5 percent and payable on five equal maturity dates of one, two, three, four, and five years, respectively, thereafter. These notes were made payable to Rainier, Inc. Note No. 1, in the amount of $ 200,000, was paid at its due1946 U.S. Tax Ct. LEXIS 214">*231 date July 1, 1941. Notes Nos. 2 and 3, for $ 200,000 each, payable on July 1, 1942, and July 1, 1943, respectively, were paid in 1942, and in consideration for the advanced payment Rainier granted to petitioner, subject to all the terms and conditions of the contract of April 23, 1935, the "sole and perpetual right and license" to manufacture and market alcoholic malt beverages within the State of Idaho under the trade names and brands of "Rainier" and "Tacoma" without any payment therefor other than the payment of the remaining promissory notes given by petitioner in settlement of all royalty payments under the agreement of April 23, 1935.
In the fall of 1942 petitioner arranged to pay in advance the notes of July 1, 1944, and July 1, 1945, in the principal amount of $ 200,000 each, together with interest thereon, less $ 10,000 of such interest, in 6 T.C. 856">*863 consideration of Ranier (1) releasing the properties held by the First National Bank of Seattle as trustee from the lien thereof and directing the conveyance of such property to petitioner; (2) releasing the provisions in the contract of April 23, 1935, for the purchase of malt from Rainier, and (3) extending the right to manufacture1946 U.S. Tax Ct. LEXIS 214">*232 and sell beer under the trade names of "Rainier" and "Tacoma" to any plant or plants owned or controlled by petitioner within the States of Idaho and Washington and the Territory of Alaska without the necessity of securing the written consent of Rainier in connection therewith.
Aside from the changes indicated above, as consideration for advance payments of the notes and accrued interest thereon, no changes were made in the contract of April 23, 1935, after the election by petitioner to exercise the right to "terminate the payment of royalties" by the payment of $ 1,000,000.
Upon the exercise of the option granted in paragraph thirteenth of the contract and execution and delivery to Rainier of its promissory notes aggregating $ 1,000,000, petitioner acquired the perpetual and exclusive right to manufacture and market beer, ale, and other alcoholic malt beverages within the State of Washington and the Territory of Alaska, without any further payments and without regard for the amount of alcoholic malt beverages so manufactured and sold.
After the execution of the contract of April 23, 1935, petitioner spent large sums in advertising the name "Rainier." The sums spent for advertising1946 U.S. Tax Ct. LEXIS 214">*233 increased very substantially after 1940 and the volume of the sales of "Rainier" beer expanded steadily from 112,538 barrels in the fiscal year beginning July 1, 1935, to 232,316 barrels in the fiscal year beginning 69 U.S.P.Q. (BNA) 266">*272 July 1, 1944. The amount of beer marketed under the trade name "Tacoma" was insignificant.
In petitioner's income tax return for the calendar year 1940 it claimed a deduction of $ 104,488.59 as "Selling expense, royalty." In its income tax return for the calendar year 1941 petitioner claimed a deduction of $ 142,821.04 as "Amortization of prepaid royalty for use of Rainier trade-name."
During the year 1941 and subsequent years payments on account of the $ 1,000,000 were treated on petitioner's books in the following manner: The amounts paid were written off and charged against income based on the same barrelage rate as formerly applied prior to the exercise of the option on July 1, 1940.
Under date of April 9, 1943, petitioner mailed to the collector of internal revenue for the district of Washington two claims for refund covering the years 1940 and 1941 in amounts as follows: Year 1940, $ 10,440.40; year 1941, $ 37,339.66. The claims state, among other things, that 1946 U.S. Tax Ct. LEXIS 214">*234 in making its return for 1940 the taxpayer deducted as expenses the sum of $ 56,498.15, being the amount computed at barrelage 6 T.C. 856">*864 rates on production during the last half of that year, and for 1941 the sum of $ 142,821.04, being an amount computed at barrelage rates for that year. The basis of both claims is that the deduction for royalties should be at the rate of $ 200,000 per year, beginning July 1, 1940.
OPINION.
The only remaining issue for decision is whether petitioner is entitled to deduct from its income for the years 1940 and 1941 any portion of the $ 1,000,000 which it agreed on July 1, 1940, to pay to Rainier upon the exercise of the option of electing to terminate all royalties payable under the contract of April 23, 1935. None of the $ 1,000,000 was paid by petitioner in 1940. Two hundred thousand $ 200,000) dollars, with interest, was paid in 1941 and $ 800,000, with interest, was paid in 1942.
The petitioner contends that Rainier did not sell to it the right to use its trade names, copyright, labels, etc., but granted the right to use such property on a royalty basis; that its election to terminate all royalties thereafter payable by the execution and delivery1946 U.S. Tax Ct. LEXIS 214">*235 to Rainier in 1940 of its promissory notes aggregating $ 1,000,000 did not convert the existing contract from a royalty basis to a capital transaction, but simply substituted a lump sum payment for payments on a barrelage basis for the use of another's property right; that the transaction was a license, since it did not convey full title to the trade name and the payment was in the nature of rent or royalty and should be considered a prepayment of future operating or production expenses. The petitioner does not contend that the amounts in controversy are deductible as amortization or exhaustion of a capital asset, but recognizes that such an asset is not subject to periodic exhaustion and that if capitalized there would be no recognizable basis for writing it off.
The respondent contends that by exercising the option in 1940 the petitioner converted the existing contract from a royalty basis to a transaction under which it acquired exclusive and perpetual rights of a capital nature to manufacture and sell alcoholic malt beverages under the trade names of "Rainier" and "Tacoma," the cost of which may not be deducted as an expense or otherwise. The respondent further contends, in 1946 U.S. Tax Ct. LEXIS 214">*236 the alternative, that in the event the Court should determine that the amount of the obligation to Rainier by reason of the exercise of the option by petitioner may be deducted as an expense, the entire $ 1,000,000 would be deductible in 1940, since petitioner was on the accrual basis.
The question, therefore, turns on whether the sum of $ 1,000,000 is to be regarded as an expense in the nature of prepaid royalties, or whether it is to be regarded as a capital expenditure. This is not a case of accelerated income taxable as ordinary income.
6 T.C. 856">*865 The contract of April 23, 1935, was divided into three parts, headed "Purchase Agreement," "Licensing Agreement," and "Miscellaneous Provisions." The purchase agreement provided for the purchase of certain real property in or adjacent to the city of Seattle, Washington, including the old brewery then dismantled and used as a cold storage plant and warehouse, together with certain specified personal property, including beer containers, cardboard cases, beer on hand, and office fixtures and equipment. Under the licensing agreement Rainier granted to petitioner, its successors, and permitted assigns "the sole and exclusive perpetual right1946 U.S. Tax Ct. LEXIS 214">*237 and license" to market and manufacture alcoholic malt beverages within the State of Washington, and the Territory of Alaska under its trade names and brands "Rainier" and "Tacoma," together with the right to use within the territory any and all copyrights, trade marks, labels, or other advertising media adopted or used by the grantor in connection with its beer, ale, or other alcoholic malt beverages. The consideration for this grant was to be determined at least during the first five years on the barrelage basis, 69 U.S.P.Q. (BNA) 266">*273 i.e., a specified amount for each barrel of alcoholic malt beverage sold or distributed within the territory, payable annually. There was also a provision for a minimum annual royalty of $ 75,000 and a provision for the reduction of the minimum royalty in the event of local option in a part of the territory covered by the agreement, or governmental action preventing the manufacture and sale of alcoholic malt beverages in the assigned territory. There is a further provision that the real property purchased or, in the event of its sale, $ 250,000, should stand as security for the performance of petitioner under the contract. It further provided (paragraph thirteenth, which1946 U.S. Tax Ct. LEXIS 214">*238 is the important paragraph here) that at any time after the agreement had been in force for five years petitioner "shall have the right and option of electing to terminate all royalties thereafter payable hereunder" by executing and delivering to Rainier its five promissory notes of $ 200,000 each, aggregating the sum of $ 1,000,000 and bearing interest at the rate of 5 percent per annum payable, respectively, in 1, 2, 3, 4, and 5 years after the date hereof. The miscellaneous provisions provided:
1. For the purchase by petitioner of malt from Rainier.
2. That petitioner would use its best efforts to increase the sales of "Rainier" and "Tacoma" beer by advertising within the territory assigned to it.
3. That it would sell Rainier at cost malt manufactured under the trade names for distribution outside of the territory assigned.
4. Termination of the contract upon default of petitioner.
5. That no assignment of its contract rights could be made by petitioner without the consent of Rainier.
Petitioner argues that Rainier did not transfer to it the entire title to the trade name, but reserved certain rights, including the right to use the trade name in the manufacture and sale of the1946 U.S. Tax Ct. LEXIS 214">*239 nonalcoholic 6 T.C. 856">*866 beverages within the territory and to require petitioner to do certain other things set out above "during the period of time that this agreement remains in force." Petitioner relies on Clifford H. Goldsmith, 1 T.C. 711; affd., 143 Fed. (2d) 466; certiorari denied, 323 U.S. 774">323 U.S. 774; Rafael Sabatini, 32 B. T. A. 705; affd., 98 Fed. (2d) 753, and related cases. The facts of these cases distinguish them from the case before us and are not controlling here. The Sabatini case involved the question of whether the income involved was from sources within or without the United States. The question of whether the transaction granting motion picture rights to copyrighted works was a license or a sale was incidental thereto. The Board of Tax Appeals held that the exclusive world-wide right to motion picture rights for a limited period was a sale, since the contract was made in England. In reversing the Board on this point the Court of Appeals for the Second Circuit said "We cannot agree that what occurred was a sale. It was1946 U.S. Tax Ct. LEXIS 214">*240 instead but a granting of a right to produce motion pictures from the works for a limited time." This case did not involve a situation where an exclusive and perpetual right was granted. The Goldsmith case, supra, involves a formal assignment of exclusive world-wide motion picture rights to a play. The question was whether the money received from the assignment and transfer was from the sale of a capital asset as defined in section 117 of the Revenue Act of 1938. The Commissioner contended that the assignment amounted to a license and, therefore, there was no sale of a capital asset and, in the alternative, that the property involved was property used in petitioner's trade or business of a character subject to an allowance for depreciation, and, therefore, excluded from the term "capital assets" as defined in section 117. In affirming respondent's determination on both grounds, this Court cited Witmark & Sons v. Pastime Amusement Co., 298 F. 470; affd. per curiam, 2 Fed. (2d) 1020, and Rafael Sabatini, supra.In the Witmark case, as in the Sabatini case, the grant1946 U.S. Tax Ct. LEXIS 214">*241 was for a limited term and the court held that under such conditions the grantor did not part with all interest in the copyright and could sue for infringement.
The Goldsmith case was affirmed. Judge Chase, who wrote the main opinion, held, on the authority of the Witmark and Sabatini cases, that the assignment was a license and the income was from royalties. In a concurring opinion, in which he was joined by Judge Swan, Judge L. Hand held that Goldsmith was in business as a playwright; that the license granted was "property" within section 117(a)(1); the grant was a "sale"; and the licensee was a customer in the ordinary course of business.
Petitioner's argument that the $ 1,000,000 which it became bound to pay upon the exercise of the option should be deducted, according 6 T.C. 856">*867 to the best accounting practice, by applying the barrelage rates which had existed theretofore or, in the alternative, over a five-year period at $ 200,000 per year, in order to properly reflect income, is, we think, unsound. In Coca-Cola Bottling Co., 6 B. T. A. 1333, the grantee had a contract granting it 69 U.S.P.Q. (BNA) 266">*274 exclusive bottling and selling rights in a certain1946 U.S. Tax Ct. LEXIS 214">*242 territory, for which it paid $ 100,000. The contract had no fixed term, but was subject to termination by either party if the other failed to perform its obligations thereunder, or by the grantor if the grantee failed to properly push the sale of bottled Coca-Cola. The grantee contended that the contract should be treated as a ten-year contract because the amount paid for the right would probably be returned within that time. This contention was denied, because, under the terms of the contract, there was no exhaustion of the capital investment by the lapse of time and the useful life of the contract could not be determined. Cf. International Textbook Co. v. United States, 44 Fed. (2d) 254; Jefferson Gas Coal Co., 16 B. T. A. 1135; affd., 52 Fed. (2d) 120; Clark Thread Co., 28 B. T. A. 1128; affd., 100 Fed. (2d) 257. In the Coca-Cola case the opinion of the Board referred to the expenditure as a capital investment and we think it was, notwithstanding the fact that it might be canceled upon the happening of certain conditions. 1946 U.S. Tax Ct. LEXIS 214">*243 In our judgment, these conditions were subsequent and did not affect the character of the transfer.
Royalties are often characterized as rents and where, as in the contract here under consideration, they are based on an amount required to be paid each year for the total quantity of goods produced during the year, there is no question but that they are deductible as an expense incident to such product. The mere fact that there was a payment of $ 1,000,000 in a lump sum is not in itself determinative whether the transaction was a license or a sale. Cf. Sax Rohmer, 5 T.C. 183; affd., 153 Fed. (2d) 61; Sabatini v. Commissioner, supra. We must look to the extent of the rights granted and the finality of the grant. It is the nature of the transaction that is the controlling factor. Cf. Moore v. Marsh, 7 Wall. 515.
The parties agree that for the contract period prior to the exercise of the option on July 1, 1940, the transactions were tantamount to a license and the payments based on barrelage were deductible as an expense. This may be true, and in fact it makes no difference whether1946 U.S. Tax Ct. LEXIS 214">*244 we designate it as a license or as tantamount to a perpetual assignment of a right of use with a condition subsequent which might defeat it upon the happening of the event specified. In any event, there was a definite term measured from year to year when the expenditure applicable to income for the period could be definitely determined and exhausted. Cf. Philip W. McAbee, 5 T.C. 1130.
6 T.C. 856">*868 On July 1, 1940, the petitioner had the option of continuing to operate under the contract on a barrelage or royalty basis, or to end payments based upon the quantity of beer produced and to acquire the right to operate indefinitely upon the payment of a fixed sum of $ 1,000,000, regardless of the amount of beer produced thereafter. The payment of the fixed sum had no relation to production or sales or to the quantum of use of the trade name. Since petitioner's production had increased to the point that it was apparent that payment on a barrelage basis would soon approach $ 200,000 a year, which it would be required to pay under the option agreement, and since petitioner did not want to pay royalties indefinitely, it was considered good business to exercise1946 U.S. Tax Ct. LEXIS 214">*245 the option. This the petitioner did on July 1, 1940. After the payment of $ 1,000,000 the rights of the parties were very different, as were also their obligations. Rainier no longer had the right to call the contract breached and take over the trade name for failure to pay the price. By the same token, there was no longer any object in having petitioner hold the real property purchased from Rainier, or its equivalent in value, as security for the performance of its contract. Prior to the exercise of the option petitioner's right, although designated perpetual in the contract, was not in fact perpetual. It was perpetuated so long as the petitioner continued to pay royalties and was subject to being forfeited by a breach as provided in the contract. After the exercise of the option the right became perpetual in a real sense. Thereafter there was no further payment to be made and the forfeiture clause became inoperative. The exclusive right to use the trade name in the designated territory became perpetual and the liability of having it revoked by the happening of a subsequent condition no longer existed in a real sense. Provisions such as the maintenance of quality, advertising, 1946 U.S. Tax Ct. LEXIS 214">*246 and the purchase of malt were for the mutual benefit of both parties, and the agreement to protect the licensee against infringement was no different than one to protect title. The most important provision in the contract was the payment of the price, and, when payment had been made in full, provisions for the mutual benefit of the parties became of relative minor importance.
The right to use a trade name is a monopoly, as is a copyright or a patent. It carries with it the right to control its use in connection with a manufactured article and to prevent any competition that might destroy its value. It is a property right and the trade name is 69 U.S.P.Q. (BNA) 266">*275 property, no less so because it is intangible. The right of alienation is one of the essential incidents of a right of property. Whatever right the owner may have to protect the control over the trade name beyond his own sales must depend upon agreement. He can not divide his property in the name, but he may assign or transfer a property 6 T.C. 856">*869 right thereto by grant in a limited territory. If such grant is exclusive and perpetual, its characteristics more resemble a sale than a license, and this is particularly true where all the consideration1946 U.S. Tax Ct. LEXIS 214">*247 has been paid. In Goldsmith v. Commissioner, supra, Judge L. Hand said "It does not unduly strain the meaning of a sale to make it include an exclusive license." But see Rohmer v. Commissioner, supra, where the court thought the fact that the time was unlimited was immaterial, due to the very limited scope of the grant.
It is true under this agreement that petitioner could not assign the rights granted to it without the consent of Rainier, but we do not regard this provision as controlling here. Neither could Rainier assign the right to another or use it itself. The exclusive grant to petitioner resulted in the retention by Rainier of the naked legal title in the interest granted for the benefit of the grantee. Moreover, by the grant of an exclusive right and the agreement not to compete, Rainier transferred to petitioner its business in alcoholic malt beverages sold under the trade name in the limited territory.
In Parke, Davis & Co., 31 B. T. A. 427, the contract recited that in consideration of certain payments to be made the licensor sells and grants unto the licensee the exclusive right, license, and privilege to manufacture 1946 U.S. Tax Ct. LEXIS 214">*248 and have manufactured for its exclusive use and to use, but not to sell, the invention covered by the patents subject to certain conditions. The question before the Board was whether the transaction was a license or a sale. The respondent's contention that the transaction was only a license was based on the fact that the petitioner did not part with all of its rights and that the licensee did not receive, among other things, the right to sell or the right to improvements, or the right to grant license to others without the consent of the licensor. The question was entirely different from that presented in Waterman v. Mackenzie, 138 U.S. 252">138 U.S. 252, and similar cases where the right to sue was in question and was denied because the right to sell or license the use had been retained by the assignor. In its opinion the Board said:
* * * Here we have a question of income tax liability where legal title is of little consequence and the inquiry is as to the ownership of the beneficial interest. We are not to determine whether petitioner or Eli Lilly & Co. could maintain a suit for infringement in its own name, but merely whether petitioner, under its 1946 U.S. Tax Ct. LEXIS 214">*249 contract with Eli Lilly & Co., divested itself irrevocably of certain capital investments in consideration of the payment made to it by the latter company. If this is the fact, then the transaction for income tax purposes is no more than a conversion of capital.
* * * Legal title alone, without beneficial ownership, and held for the interest of another, is without value. [Italics supplied.]
The fact that in the contract the parties were termed licensor and licensee was of no consequence, A. B. Watson, 24 B. T. A. 466; affd., 6 T.C. 856">*870 62 Fed. (2d) 35. It was held that the rights granted or surrendered determine the character of the instrument to have been an absolute conveyance of a one-half beneficial interest in the patents involved.
In Commissioner v. Celanese Corporation, 140 Fed. (2d) 339, the question was whether certain payments under a contract were royalties or income subject to the withholding clause, or whether the parties had effected a purchase and sale and not a royalty contract. The Commissioner's case was based on the theory that there were in the contract restrictions and1946 U.S. Tax Ct. LEXIS 214">*250 limitations which indicated that it was no more than a licensing agreement, since, as a result of these provisions, the user might lose the patents and the vendor might recover them. In regard to this the court said:
* * * We find no merit in the claim. Most of the language * * * embraces precautionary provisions in the protection of the rights of the parties, respectively, under the contract. None of it affects the intent and purpose of the contract to vest immediately in the Purchaser absolute title to the patents.
The court held that the transaction was a sale.
In Jefferson Gas Coal Co., supra, a so-called lease was held to be a sale of coal in place rather than a lease, the intent of the parties as disclosed in the instrument being a purchase and sale. The sum and substance of the agreement was that the grantor sold all the coal in place for a consideration on a deferred payment basis. If the petitioner had not mined or moved any coal by the end of the term it would have paid the entire 69 U.S.P.Q. (BNA) 266">*276 stipulated price in annual installments, irrespective of the total quantity of coal recovered. The Board held that such provisions are foreign to an actual1946 U.S. Tax Ct. LEXIS 214">*251 lease and disclosed the true nature of the agreement to be a sale rather than a lease.
In the case before us the $ 1,000,000 was paid, irrespective of the total quantity of beer manufactured. Thereafter it was of no consequence whether the petitioner manufactured a quantity of beer which at the royalty rate produced a lesser or a greater sum over any given period. It, therefore, makes no difference what terminology is applied to the payment. Regardless of the language used, it was the intention of the parties that upon the payment of $ 1,000,000 the petitioner should have the exclusive and perpetual use of the trade name "Rainier," regardless of the quantity of beer manufactured and for all future time. These provisions, we think, are inconsistent with the theory of a lease or license and are more consistent with the idea of a sale. Other provisions in the contract giving Rainier the right to require petitioner to do certain things, such as keeping the quality of the malt and beer manufactured equal to Rainier quality, were but conditions subsequent, primarily applicable to the period during which payment was made annually on a barrelage basis, and were for the benefit of both1946 U.S. Tax Ct. LEXIS 214">*252 parties, both before and after the exercise of the 6 T.C. 856">*871 option. Whether or not Rainier could have enforced these provisions after the exercise of the option is immaterial, our question being the character of the transaction incident to the option under which the petitioner paid $ 1,000,000 in consideration for the exclusive and unlimited right to manufacture and sell alcoholic malt beverages within a designated territory for an indefinite future time. Since the right was exclusive and unlimited as to time within the assigned territory, we think it very doubtful after the payment of $ 1,000,000 that Rainier could have interfered with petitioner in the exercise of that right. It is significant that immediately after giving the notes Rainier was willing to cancel the security which it held under the contract and the requirement that petitioner purchase malt from it. The real consideration throughout was the payment of the price, and once that was paid in full Rainier had no ground upon which to base a cancellation of the contract under which it might have received liquidated damages, and petitioner lost its right to have the payments reduced in the event of a decrease in sales1946 U.S. Tax Ct. LEXIS 214">*253 through local option or national prohibition. Nor can it be said that, Rainier having assigned an exclusive right, it was thereafter interested more than petitioner in the quality of the alcoholic malt beverages manufactured and sold by petitioner under the trade name "Rainier" in the exclusive territory designated. All of these facts are consistent with the idea of a sale, but not consistent with the idea of a license. We see no inhibition, where a corporation owns a trade name, to its assigning a right to use that name in a designated territory for a price, and if the right to use is perpetual and exclusive it is more consistent with the idea of a sale than a lease, particularly where it is not dissociated from the business or merchandise with which it has been used. Cf. Green v. LeClair, 24 Fed. (2d) 74. In 138 U.S. 252">Waterman v. Mackenzie, supra, it is said:
Whether a transfer of a particular right or interest under a patent is an assignment or a license does not depend upon the name by which it calls itself, but upon the legal effect of its provisions.
In Boesch v. Graff, 133 U.S. 697">133 U.S. 697,1946 U.S. Tax Ct. LEXIS 214">*254 there was a provision in the contract of assignment that under certain circumstances the title to the patent should revert to the assignor. The Supreme Court held that the title had already vested, but was liable to be defeated in the future on the failure of the conditions subsequent. In Rude v. Westcott, 130 U.S. 152">130 U.S. 152, there was an assignment with a provision that the net profits arising from sales, royalties, settlements, or other source were to be divided between the parties to the assignment so as to give the patentees one-fourth thereof. The Court held that this did not limit or modify the absolute transfer of title. Where such a provision reserves to the grantor no control over the patents or other use or disposal, or any power to interfere with the management of the business growing out 6 T.C. 856">*872 of their ownership, it is not material. In Littlefield v. Perry, 88 U.S. 205">88 U.S. 205, there was an assignment of the patentee's interest in the patent and a provision voiding the assignment upon the failure of the assignee to do certain things. The Court held that neither the agreement to account and pay royalties 1946 U.S. Tax Ct. LEXIS 214">*255 nor the clause of forfeiture for nonperformance reduced the transferees to the position of licensees.
In the appeal of Dwight & Lloyd Sintering Co., 1 B. T. A. 179, the license agreements to make and use certain patented machines for refining ores acquired by a corporation for stock was intangible property for invested capital purposes.
69 U.S.P.Q. (BNA) 266">*277 In LaBelle Iron Works v. United States, 256 U.S. 377">256 U.S. 377, the laying out of money by a concern in acquiring something of permanent use in the business is defined as a capital transaction.
In Coca-Cola Bottling Co. v. Coca-Cola Co., 269 F. 796, it was held that the right to a trade-mark is a property right which may be sold in connection with the good will of the business, since it is a symbol of part or all of the good will; but it can not be sold wholly dissociated from the business or merchandise with which it has been used. In this case there was a contract whereby the manufacturer of a syrup for soda fountain drinks granted the exclusive right to bottle and sell beverages under its trade-mark within a specified territory to a corporation which agreed1946 U.S. Tax Ct. LEXIS 214">*256 to establish a bottling plant sufficient to meet demand for the product in the territory and to purchase syrup for such drinks from the manufacturer. It was held that the contract was a perpetual contract and not a contract at will, and that it granted and conveyed property rights in and to a business which the manufacturer had never developed, and that all the provisions of the contract were adapted to carry out that intention.
In Griggs, Cooper & Co. v. Erie Preserving Co., 131 F. 359, the instrument recited that F grants, licenses, assigns, and sets over to G and its successors in business the absolute and exclusive use of certain trade-mark in and to certain states, such absolute and exclusive use to be held and enjoyed by G for its own use, but during such time only as it and its successors shall continue in business; provided, however, that G shall not use any label which shall imitate or conflict in color or design with the label used by F; and provided that the agreement shall not prevent F or its successors from using such trade-marks in said states, provided it shall not adopt any new label which shall imitate or conflict in color or1946 U.S. Tax Ct. LEXIS 214">*257 design with the label of G. On these facts the court held that the contract did not give G a mere license, but assigned the exclusive ownership and good will in the trade-marks within the specified states, merely reserving to F certain permissive rights of personal use.
In Andrew Jergens Co. v. Woodbury, Inc., 273 F. 952; affd. per curiam, 279 F. 1016; certiorari denied, 260 U.S. 728">260 U.S. 728, it was held that 6 T.C. 856">*873 where the owner of a trade-mark gave an exclusive license with certain exceptions and the transaction disclosed a purpose to transfer the rights therein, it was not a mere license, but in legal contemplation constituted an assignment, notwithstanding the use of the word "license."
As we interpret the contract here in question, it was obviously the intention of the parties that Rainier grant to petitioner all of the right which it had to use the trade names "Rainier" and "Tacoma" in the manufacture and sale of alcoholic malt beverages in the State of Washington and the Territory of Alaska. It was also the intention of the parties that this grant was to be exclusive not only as 1946 U.S. Tax Ct. LEXIS 214">*258 to third parties, but as to Rainier itself. We know of no reason why one who is the owner of the right to use a trade name may not grant to another its exclusive use in a limited territory for all future time upon the payment of a price. Cf. Coca-Cola Bottling Co. v. Coca-Cola Co., supra.Such a grant, while not disposing of the entire property in the grantor, is the equivalent of such disposition within the limited territory granted. Clearly such a grant would be a capital transaction and the amount paid by the grantee could not be exhausted because it was perpetual. Cf. Coca-Cola Bottling Co., supra;International Textbook Co. v. United States, supra;Charles P. Limbert Co., 9 B. T. A. 1390; Andrew Jergens Co., supra.The fact that the amount paid by the grantee was an expenditure incident to production does not change the situation.
Finally the petitioner argues that it was not the intention of the parties to change the agreement from a royalty basis to a capital transaction by the exercise of the option, and that paragraph1946 U.S. Tax Ct. LEXIS 214">*259 thirteenth should not be so construed. We find no ambiguity in the contract and the language in paragraph thirteenth is clear. It provided that at any time after five years petitioner "shall have the right and option of electing to terminate all royalties thereafter payable hereunder" by executing and delivering to Rainier its promissory notes in the principal sum of $ 1,000,000. Obviously, it was intended that after the execution of the notes all royalty payments as such should cease. The agreement admits of no other construction. Thereafter Rainier must look for payment to the promissory notes and not to the contract. The execution and delivery of the notes put an end to the payment of royalties on a barrelage basis and was the consideration for the exclusive and perpetual use of such rights thereafter. It is our opinion that upon the exercise of the option petitioner acquired a capital asset for which it paid $ 1,000,000. This was a capital transaction and the amounts payable thereunder are not deductible from income. The action of the respondent is sustained.
Decision will be entered under Rule 50.