*41 Decision will be entered for the respondent in Docket No. 108342 and under Rule 50 in Docket No. 108343.
1. Pursuant to an agreement between the petitioners, brothers, that Henry Rose would pay Jack Rosenzweig one-half of any amount recovered upon a suit for infringement of a copyright in consideration of the latter bearing the expense of the suit, Henry Rose in 1939 paid his brother $ 25,000. Held, that the amount is a legal deduction from the gross income of Henry Rose under section 23 (a) of the Internal Revenue Code, as amended by section 121 of the Revenue Act of 1942.
2. In their income tax returns for 1939 the brothers each accounted for his share of the net proceeds, but claimed that the amounts received constituted "compensation * * * for personal services rendered" within the meaning of section 107 of the Internal Revenue Code, added by section 220 of the Revenue Act of 1939. Held, that the net proceeds from the settlement of the suit did not constitute "compensation * * * for personal services rendered" and that the petitioners are not entitled to the benefits of section 107.
3. The petitioners claim that, if they are not entitled to the benefits of section*42 107, they are entitled to consider the amounts received by them in the settlement of the suit as capital gain under section 117. Held, that, since the net amount received by each was not from a "sale or exchange" of a capital asset, the amount received did not constitute capital gain.
*25 These proceedings, consolidated for hearing, are for the redetermination of deficiencies in income tax for 1939 of the petitioners Jack Rosenzweig and Henry Rose in the amounts of $ 2,182.60 and $ 11,098.55, respectively. The points in issue are:
(1) Whether Henry Rose is liable to income tax upon the full amount of $ 58,500 received as the net proceeds from the compromise of an infringement suit or upon only $ 33,500, which was the amount received and enjoyed by him.
(2) Whether the amounts received by each of the petitioners constituted "compensation * * * for personal services rendered" within the meaning of section 107 of the Internal Revenue Code, added by section 220 of the Revenue Act of 1939.
(3) Whether, if those amounts did not constitute "compensation * * * for personal services*43 rendered," the amounts constitute capital gain under section 117 of the Internal Revenue Code.
FINDINGS OF FACT.
1. The petitioners, brothers, reside in New York, New York, and filed their income tax returns for 1939 with the collector of internal revenue for the second district of New York.
2. Jack Rosenzweig was married in 1939 and had two dependents. He has been since about 1920 the superintendent of a branch post office in New York City. He filed income tax returns for the years 1935 to 1939, inclusive. The returns for years prior to 1939 were nontaxable returns, since legal deductions and exemptions were in excess of taxable income received.
3. Henry Rose is a single person. He had no taxable income for years prior to 1939 and filed no income tax returns.
4. Jack Rosenzweig was a member of a political club. In 1925 he invited his brother to go with him to one of the meetings of the club. Later they attended several meetings. As a result of such attendance Henry Rose conceived the idea of writing a political play based upon what he had observed at the meetings. He discussed this project with his brother, who encouraged him in it. Rose told his brother that if he ever *44 got anything out of the writing of such a play he would give his brother one-half.
*26 5. Rose started making notes for his play in 1928 or prior thereto. In 1930 or 1931 he completed a final synopsis. He commenced writing the dialogues at the end of 1931 or the beginning of 1932. There were many discussions between the brothers regarding the play and, although the actual writing was done by Rose, his brother made many helpful suggestions. The play was completed in 1934 and was given the name "Burrow, Burrow." On July 3, 1934, it was copyrighted in the name of Henry Rose.
6. Rose then took the play to several producers and agents in an attempt to have it produced. One of the agents thought that the Metro-Goldwyn-Mayer Corporation might be interested in it and sent it to that organization for its perusal. After a time it was returned to Rose. Rose then took it to two theatres in New York City, where he tried to have it produced. It was placed on the recommended list of the Federal Theatre, but no production of it was ever effected.
7. In 1936 or the early part of 1937 Rose noticed that the Metro-Goldwyn-Mayer Corporation was showing a picture called "Man of the People." *45 Upon seeing it he perceived that it was based upon his own play, although it had a different title and different names for the characters. He claimed it was a plagiarism of his play. He immediately called this fact to the attention of his brother, who advised consulting an attorney. They did so. The attorney wrote to Metro-Goldwyn-Mayer Corporation and demanded redress, which was refused. The brothers then considered bringing suit against the corporation for the infringement of the copyright. Rose told his brother that he had no money for the bringing of a suit and that a lot of expense would be involved. Rosenzweig said that he would bear the expenses of a suit (he had been paying Rose's living expenses since 1930). The brothers agreed that if they got anything from the suit above expenses Rosenzweig should get one-half. This oral understanding was put in writing by Henry Rose under date of August 16, 1937, in the following language:
I, Henry Rose, hereby assign one-half of any monies I receive from my claim against Metro-Goldwyn-Mayer to my brother, Jack Rosenzweig, in consideration of payment by him of the expenses of this action.
This was signed by Henry Rose and sworn*46 to before a notary public on the date thereof.
8. A summons and bill of complaint against Metro-Goldwyn-Mayer Corporation and associated companies was instituted on August 11 or 12, 1937, for infringement of the copyright. The plaintiff in this suit was Henry Rose. Rosenzweig paid the cost of the summons and complaint and other incidental expenses in the prosecution of the suit of an aggregate amount of between $ 500 and $ 600. The suit was finally compromised in January 1939, upon payment by the defendants to Henry Rose of $ 80,000.
*27 9. After the payment of the attorneys' fees $ 58,500 was left to be divided between the brothers. By reason of the fact that Rose had written the play Rosenzweig agreed that his brother should receive a larger share of the net proceeds than he received. He accordingly accepted $ 25,000 as his share. This left $ 33,500 for Rose.
10. In their income tax returns for 1939 each of the petitioners reported his share of the net proceeds from the settlement of the suit, but claimed the benefits of section 107 of the Internal Revenue Code, added by section 220 of the Revenue Act of 1939. They claimed that the amount received by each constituted*47 "compensation * * * for personal services rendered" over a period of five years; that the tax liability of each was the 1939 tax computed upon one-fifth of the amount received by each plus the additional tax due for the preceding four years computed by considering one-fifth of the net proceeds as taxable income of each of such years.
11. In the determination of the deficiencies the respondent has rejected the contentions of the petitioners that each is taxable upon his distributive share of the net proceeds; has held that the entire amount of $ 58,500 constitutes taxable income of Henry Rose and that $ 25,000 constitutes taxable income of Jack Rosenzweig; has denied that these amounts constitute "compensation * * * for personal services rendered" over a period of five years, and, consequently, that they are not entitled to the benefits of section 107 of the Internal Revenue Code added by section 220 of the Revenue Act of 1939.
OPINION.
The first question for consideration is whether Henry Rose is liable to income tax for 1939 upon the entire amount of $ 58,500 net proceeds received upon the settlement of a suit brought by him against the Metro-Goldwyn-Mayer Corporation and associated*48 companies, or on only that amount less the $ 25,000 paid to his brother, Jack Rosenzweig, upon the settlement of the suit.
Section 23 (a) (1) of the Internal Revenue Code was amended by section 121 of the Revenue Act of 1942. By the amendment taxpayers are permitted to deduct from gross income not only "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business," but also:
* * * Non-Trade or Non-Business Expenses. -- In the case of an individual all the ordinary and necessary expenses paid or incurred during the taxable year for the production or collection of income, or for the management, conservation, or maintenance of property held for the production of income.
By subdivision (d) of section 121 the amendment is made applicable to taxable years beginning after December 31, 1938.
*28 The evidence shows that petitioner Henry Rose had no money with which to institute a suit against the Metro-Goldwyn-Mayer Corporation for the infringement of his copyright. He therefore agreed with his brother that if he would bear the expenses of the infringement suit he would pay him one-half of any amount which might be recovered*49 over and above attorneys' fees. When it came to a settlement between the brothers Jack Rosenzweig agreed to accept $ 25,000 instead of $ 29,250. Henry Rose therefore paid his brother $ 25,000 and kept $ 33,500.
It is clear that there was no element of a gift in the payment of this $ 25,000. It was, we think, an ordinary and necessary expense paid in the collection of income. As such it is a legal deduction from the gross income of Henry Rose. He is therefore taxable upon net income of only $ 33,500.
The second question involves the proper construction of section 107 of the Internal Revenue Code added by section 220 of the Revenue Act of 1939. That section in full reads as follows:
SEC. 220. COMPENSATION FOR SERVICES RENDERED FOR A PERIOD OF FIVE YEARS OR MORE.
(a) The Internal Revenue Code is amended by inserting after section 106 the following new section:
"SEC. 107. COMPENSATION FOR SERVICES RENDERED FOR A PERIOD OF FIVE YEARS OR MORE.
"In the case of compensation (a) received, for personal services rendered by an individual in his individual capacity, or as a member of a partnership, and covering a period of five calendar years or more from the beginning to the completion*50 of such services, (b) paid (or not less than 95 per centum of which is paid) only on completion of such services, and (c) required to be included in gross income of such individual for any taxable year beginning after December 31, 1938, the tax attributable to such compensation shall not be greater than the aggregate of the taxes attributable to such compensation had it been received in equal portions in each of the years included in such period."
(b) The amendment made by subsection (a) shall be applicable to taxable years beginning after December 31, 1938.
So far as we have been able to determine, this provision of the law has never been judicially construed. The petitioners have interpreted it as applying to them, and in accordance with their interpretation of it each has computed his income tax for 1939 as being the amount of the tax which would be due for 1939 by considering one-fifth of his share of the proceeds as taxable income of 1939 plus the additional tax which would be due for the four prior years if one-fifth of each share of the net proceeds received on the settlement of the suit in 1939 was taxable income of each of such prior years.
The respondent denies that this*51 section of the law is applicable to the cases of these petitioners. He says that they were in no sense employees *29 at any time of the Metro-Goldwyn-Mayer Corporation; that the money paid by that corporation in the settlement of the suit was not paid as compensation for personal services rendered, but was paid as damages for the infringement of a copyright; also that the copyrighted play was completed prior to 1935 and that there is no basis for spreading the net proceeds of the infringement suit over the five years 1935 to 1939.
Petitioners, on the other hand, contend that section 107 of the Internal Revenue Code was intended to give relief to writers and inventors who realized the profits of their labors over a period of five years or more in one year, and that that is their situation. In support of this argument they cite the Report of the Senate Finance Committee upon section 220 of the Revenue Act of 1939, H. R. 6851, p. 7, as follows:
It has been considered a hardship to tax fully the compensation of writers, inventors, and others who work for long periods of time without pay and then receive their full compensation upon the completion of their undertaking. Under existing*52 law, such persons have their income for the whole period aggregated into the final year. This results in two inequities: First, only the deductions, expenses, and credits of the fiscal year are chargeable against the compensation for the full period; second, under our graduated surtax, the taxpayer is subjected to a considerably greater burden because of the aggregation of his compensation.
The important question here is whether the net proceeds of the settlement of the litigation constituted "compensation * * * for personal services rendered" by the petitioners. It is quite clear that it was not paid as such by the Metro-Goldwyn-Mayer Corporation or considered as having been received as such by the petitioners at the time of receipt. They were never employees of the Metro-Goldwyn-Mayer Corporation. The suit was not for the recovery of wages or salaries owed to them or for the recovery of money for services performed. It was a suit for infringement of a copyright. After the suit was settled Henry Rose still was the owner of his copyrighted play and by the settlement was not precluded from producing it, selling it, or instituting other suits against any other infringers of the*53 copyright.
In E. Phillips Oppenheim, 31 B. T. A. 563, the question for decision was whether the taxpayer was entitled to earned income credit. Oppenheim had made an agreement with his publishers by which he was to furnish them with two novels each year. They were to publish the novels and he was to receive royalties upon the sales. The Board held that the amounts received by him were not compensation received for personal services rendered. We do not think that the petitioners stand in any better position than did Oppenheim in contending that the amounts received by them in 1939 constituted compensation for personal services.
The action of the respondent in taxing the entire amounts received by each petitioner upon the settlement of the litigation in 1939 as taxable *30 income of that year without the benefit of section 107 of the Internal Revenue Code is approved.
The petitioners contend, in the alternative, that the amounts received by them should be considered as capital gain under section 117 of the Internal Revenue Code. That section applies only to sales or exchanges of capital assets. It is quite obvious that the petitioners did not*54 sell or exchange anything. Even if the sum had been received as a license, it would not have been received as the result of a sale or exchange. See Sabatini v. Commissioner (C. C. A., 2d Cir.), 98 Fed. (2d) 753; Irving Berlin, 42 B. T. A. 668.
Decision will be entered for the respondent in Docket No. 108342 and under Rule 50 in Docket No. 108343.