*298 Decision will be entered under Rule 50.
Credits at a New York bank to the account of petitioner, a Swiss corporation, made pursuant to a contract between it and the foreign owner of patents to pay a percentage of United States license fees for use of the patents, in which petitioner had no interest, held not to constitute petitioner a holding company as "royalty" income from United States sources.
*151 *38 *299 This proceeding is brought for a redetermination of deficiencies in income and personal holding company taxes as follows:
| Income | Personal holding | |
| Year | tax | company |
| surtax | ||
| 1940 | * $ 3,490.30 | |
| 1941 | $ 31.07 | 17,042.22 |
| 1942 | 29,703.14 | |
| 1943 | 112.51 | 23,824.71 |
| 1944 | 75.00 | 28,093.08 |
| 1945 | 75.00 | 22,302.25 |
The only question is whether amounts credited to petitioner, a foreign corporation, on the books of a New York bank were "gross income from sources within the United States" and taxable to it as personal holding company income.
The parties have filed a stipulation of facts.
*39 FINDINGS OF FACT.
The stipulated facts are hereby found accordingly.
Petitioner, a Swiss corporation, was organized on January 20, 1941, as the successor to a Luxemburg corporation, hereinafter called Hopa, which was *300 organized on May 3, 1938. Petitioner's principal office is at Mendrisio, Switzerland. Neither petitioner nor Hopa has ever had an office or place of business in the United States. The outstanding stock of both corporations was at all times during the years in question owned by nonresident aliens.
The "Association Privee pour l'Industrie et le Commerce," hereinafter called Apic, was a French corporation organized in 1930 for the purpose of exploiting industrial inventions. In 1932 Bernard Salomon, a French engineer, interested Apic in promoting his patented invention of a motor vibration damper. Apic induced 17 individuals, 16 of whom were residents of France and one of Brazil, to invest an aggregate of 500,000 francs in forming "Association en Participation des Volants-Filtres d'Oscillation Brevets Bernard Salomon," hereinafter called the association. Salomon himself invested 19,000 francs, and was one of the 17 members of the association. The object of the association was to promote Salomon's inventions. The articles named Apic and Salomon as comanagers, fixed the situs of the association "at the situs of A. P. I. C. at Paris," and further provided, in part:
9 - Sale of sub-licenses. *301 The present Association is especially authorized by Salomon to sell or to grant in the name of Salomon, in whatever form or manner, in France as well as abroad, sub-licenses of exploitation of the Salomon patents.
The monies derived from these sales shall be put in reserve in contemplation of the organization of the corporation hereinafter mentioned in Article 10.
10 - Transformation into a corporation. When the present Association shall have realized by the sale of sub-licenses a net amount equal to the amount of capital which shall be subscribed by the members, the transformation into a corporation shall be realized as soon as the managers shall jointly adjudge opportune.
Salomon will then contribute to this corporation the exclusive license for the entire world to * * * all * * * patents and additions which he shall have taken out relative to vibration-dampers.
* * * *
12 - Substitution. Notwithstanding anything in the present * * * [articles] relative to the rights and duties of Salomon he shall he shall always have the right to substitute for himself at any time any other individual or French or foreign company to which he shall have transferred his industrial and commercial*302 rights in respect of all of his present and future patents and inventions in the field of vibration-dampers.
On May 3, 1937, Salomon assigned to Apic his United States patent rights in order to facilitate deals then in prospect with American manufacturers. The assignment stipulated that Apic would restore *40 the patent rights to Salomon by July 10, 1937, subject to any licensing contracts executed prior to that date, and that Apic would turn over such contracts to the association. Pursuant to the assignment, on July 1, 1937, Apic entered into a written licensing agreement with Wright Aeronautical Corporation, hereinafter called Wright, a New York corporation with an office at Paterson, New Jersey. Under the agreement, Apic granted Wright "a limited exclusive license to manufacture, * * * use and sell throughout the United States * * * all devices * * * relating or pertaining to vibration dampers * * * covered by * * * any patent * * * owned or controlled by APIC, * * * exclusively * * * for engines in the aviation and hydro-aviation fields only * * *." Wright agreed to pay Apic*152 $ 30,000 down and "royalties" measured by the number of engines manufactured. Paragraph 24 of *303 the agreement provided:
24. In case APIC changes its place of residence or its status, or for any other reason loses control of the Salomon patents made the subject of this agreement, it is understood and irrevocably agreed that the present agreement is to be automatically and completely assigned with maintenance of all rights in the sole name of Salomon, wherefor the present agreement is duly signed not only by APIC, but by Salomon as well, who accepts and gives his acceptance of all the requirements, terms and conditions of this agreement.
On July 8, 1937, Apic complied with the terms of the assignment by restoring to Salomon his rights and by turning over the licensing agreement to the association.
Although the association's financial condition had become such, as a result of the licensing agreement with Wright and agreements in other countries, that transformation into a corporation was in order under its articles, Salomon would not agree to the change. Instead, on February 12, 1938, he independently formed at Luxemburg a corporation named "Societe Holding des Reducteurs Dynamiques d'Oscillations et Volants-Filtres," hereinafter called Redynam. Its 250 shares were subscribed *304 by 7 individuals, 6 of whom were residents of France and one of Switzerland. Salomon, who held 82 shares, was the only subscriber who was also a member of the association. The articles of incorporation contained no reference to the association. They stated Redynam's object to be "the acquisition and the realization of value upon rights on patents taken out by" Salomon.
Salomon assigned to Redynam all the commercial and industrial rights on his patents. Wright approved the substitution of Redynam for Apic as a party to the licensing agreement of July 1, 1937, and on July 1, 1938, entered into a new agreement with Redynam and Salomon, replacing and supplementing the former one. Apic was dissolved and by December 22, 1938, had ceased to function. Under the new agreement, Wright agreed "to pay Redynam, on vibration *41 dampers covered by one or more issued Salomon U. S. Patents," royalties measured by the number of engines manufactured. Paragraph 21 provided:
Redynam represents that it has appointed as its agent in the United States Mr. George A. Rubissow, 425 Riverside Drive, New York City, New York; and additionally Redynam has granted to said Rubissow an irrevocable assignment*305 of thirty-five percent (35%) of all moneys due to Redynam by Wright pursuant to the terms of this agreement, and Redynam authorizes and directs Wright to pay over to the said Rubissow thirty-five percent (35%) of the sums payable to Redynam hereunder and to pay the remaining sixty-five percent (65%) to Redynam.
The new agreement contained a joint warranty by Redynam and Salomon "that Redynam is the owner, unencumbered of the entire right, title and interest in, to and under the" Salomon patents. The only reference to either petitioner or Hopa was in a recital as follows:
Whereas, Redynam agreed with "Societe Holding de Participation et de Gestion de Brevets Industriels [Hopa] * * * that it, Redynam, would not grant exclusive license under any Salomon patents without the approval of said Holding Company * * *.
When the members of the association were notified of the formation of Redynam, they dissolved and on May 3, 1938, created Hopa, a Luxemburg corporation with capital of 750,000 francs. The articles of incorporation, signed by Redynam's president, recited that 525,000 of the 750,000 francs were contributed to Redynam in return for its commitment to pay over to Hopa 25 per*306 cent of the gross revenues derived from exploitation of Salomon's patents. The 25 per cent was to be net to Hopa, which was expressly excluded from connection with promotion of the inventions and from responsibility for expenses. Distribution of the agreed percentage was to be accomplished by a "mandatary" designated by Redynam and Hopa. Out of the shares representing the 525,000 francs, Redynam was to remit to the members of the association in proportion to their interests therein an aggregate of shares representing 350,000 francs. Article 3 stated Hopa's object to be:
* * * the taking of participations in whatever form, in all Luxembourg or foreign enterprises and especially the acquisition and the management of rights deriving from patents, including all financing or other operations, directly or indirectly connected with the object above stated, subject always to the limits of the law of July 31, 1929, as to holding companies.
The articles provided that Redynam "shall not need the previous authorization of" Hopa "except to grant exclusive *153 licenses or licenses containing the authority to grant sub-licenses, or for the partial or total sale of the patents above referred to or*307 their perfections." Redynam was required within fifteen days of the execution of "each new license option contract, or the like" to furnish Hopa with a copy thereof.
*42 Prompted by the international situation, on April 19, 1939, Hopa assigned all its assets to Paul Baillard and an alternate on condition that, upon instructions from Hopa, a substitute corporation would be formed to take over the assets. In response to instructions from Hopa, Baillard organized petitioner on January 20, 1941, and transferred to it all of Hopa's assets and liabilities. For similar reasons Redynam also was succeeded by a Swiss corporation of the same name. Redynam's contract to pay Hopa 25 per cent of its gross receipts from exploitation of Salomon's patents was confirmed and continued as between Redynam and petitioner.
Until a few months before the German invasion, all remittances due from licensees in the United States and elsewhere were credited to Redynam's account in banks at Luxemburg and Paris. Amounts representing Hopa's share were then paid to it upon Redynam's instructions. During the winter of 1939-1940, due to war conditions, Redynam and Hopa made arrangements with Irving Trust *308 Co. of New York City to receive the license fees due from Wright and to credit Hopa's account with the amounts due under the contract.
As disclosed by correspondence between Hopa and Redynam, Hopa was not satisfied with the method of payment. In a letter to Redynam dated October 12, 1939, the president of Hopa's board of directors stated:
When, in the new Wright contract you allocated 35% of the license fees to Mr. Rubissow, you should have, logically, likewise committed 25% to our company * * *.
* * * *
When you write us that we seem to forget that our company has only to collect the fruits of the labors of Mr. Salomon and of the great efforts of Redynam, we find ourselves obliged to remind you that it was thanks to the capital which was put at the disposal of Mr. Salomon for 6 years, and to the cooperation which was given to him by the members of the Participating Association, that his invention has been able to be perfected and applied.
* * * *
The amounts of license fees actually paid over to Hopa thus represent the fair remuneration for the capital committed by Mr. Salomon's backers.
On May 7, 1940, Redynam and Hopa instructed Irving to hold all remittances for Redynam's account, *309 and to cease crediting any amounts to Hopa's account. No credits to the account of either Hopa or petitioner were entered in the year 1941.
By a letter to Irving dated March 10, 1942, Redynam gave "irrevocable" instructions "to transfer on the account of the said Hopag S. A. [petitioner] 25/65 of every amount you will receive from the Wright Aeronautical corporation for our account."
The following sums were transferred to the account of petitioner or Hopa during the calendar years 1940 to 1945, inclusive, and for purposes *43 of this proceeding they represent all moneys received by them in the United States:
| 1940 | $ 4,570.71 |
| 1942 | 49,094.28 |
| 1943 | 25,068.85 |
| 1944 | 26,974.64 |
| 1945 | 41,558.16 |
No United States taxes were withheld from amounts credited to petitioner, but were in each instance withheld by the respective licensees from their gross remittances.
In a letter to Irving, dated April 14, 1945, petitioner stated:
As we have verified through our account statements we lately received from you, you have only credited us our royalty shares on the Wright Aeronautical Corporation, while you haven't shared the amounts of the other licencers [sic].
Conforming the instructions*310 of the Redynam S. A. in the letter of March the 24th, we beg you to revise the matter and to ask for the necessary licenses in order to transfer us the already due amounts.
As a result of a cable from Redynam dated February 25, 1946, instructing Irving to cease crediting license fee remittances to Redynam's account, and to hold them in a suspense account pending further instructions, petitioner's account received no credits after October 26, 1945.
During the period in question, more than 50 per cent in value of petitioner's outstanding stock was owned by fewer than five individuals; and the amounts credited to its account at Irving constituted at least 80 per cent of its gross income for each year.
In his notice of deficiency, respondent *154 increased petitioner's income by the following amounts, as representing "Royalty income from sources within the United States":
| Source | 1940 | 1941 | 1942 |
| Wright | $ 5,386.02 | $ 28,535.33 | $ 47,979.52 |
| Cummins Engine Co | 250.00 | 399.70 | |
| Fairbanks Morse | 32.37 | 20.17 | |
| General Machinery | |||
| Worthington Pump | 125.00 | ||
| Total | 5,386.02 | 28,817.70 | 48,524.39 |
| Source | 1943 | 1944 | 1945 |
| Wright | $ 35,576.72 | $ 38,583.43 | $ 31,015.62 |
| Cummins Engine Co | 732.41 | 644.29 | 657.38 |
| Fairbanks Morse | 3,282.82 | 7,696.54 | 5,538.76 |
| General Machinery | 375.00 | 250.00 | 250.00 |
| Worthington Pump | 250.00 | 250.00 | 250.00 |
| Total | 40,216.95 | 47,444.26 | 37,711.76 |
*311 Respondent allowed credits for "the amounts representing tax paid at the source on the aforementioned income," and determined:
* * * that you are subject to the surtax imposed by section 500 of the Internal Revenue Code for the years 1940, 1941, 1942, 1943, 1944, and 1945.
Under the provisions of section 291 of the Internal Revenue Code made applicable by section 508 of said Code, a 25% penalty for the year 1940 has been added to the surtax imposed by section 500 for failure to file a return of personal holding company since it has been determined that the failure to file said return was not due to reasonable cause.
*44 OPINION.
Whether petitioner was a personal holding company and thus liable to the corresponding surtax depends as the case is presented upon whether the income it received was from "royalties," 1 under section 502, Internal Revenue Code, and from "sources within the United States," 2*313 under section 119. Cf. Porto Rico Coal Co., 44 B. T. A. 221; affd. (C. C. A., 2d Cir.), 126 Fed. (2d) 212. This in turn reduces to a more limited question -- whether petitioner had an "interest" in the Salomon patents for*312 the use of which the payments in question were made. Both the definition under section 119 and the regulations under section 502 deal with the meaning of royalties as payment "for the use of or for the privilege of using * * * patents * * * and other like property." Section 119 (a) (4) refers to "rentals or royalties from property located in the United Statesor from any interest in such property." 3 (Emphasis added.)
Consideration of all the circumstances, and particularly of the underlying agreement of the parties and their course of conduct, satisfies us that no such interest resided in petitioner. The contract itself demonstrates rather that the petitioner was not a joint owner of the patents, than the reverse. Had it been such, the careful provision for protecting it against certain conduct on the part of Redynam would have been unnecessary. That Redynam's legal right to deal with the patents as its own property was absolute, except as limited by its contractual *314 obligations to petitioner, is the reasonable inference to draw from that document.
The patents were in the first instance the property of the inventor, Salomon, and not of petitioner's predecessor. His title apparently passed directly to Redynam and not to petitioner, which acquired by the contract no more than a right to share in the profits. Had petitioner *45 owned any interest in the patents it could presumably have taken depreciation on its cost. A. R. M. 35, 1920 (2) C. B. 142. Yet we doubt whether such a claim could possibly be approved on these facts. MacCallum Gauge Co., 32 B. T. A. 544.*155
And when the Wright Aeronautical Co., the American licensee, was permitted to use the patents, it was represented, with the consent of petitioner's predecessor, that Redynam was their sole owner. What the latter received from Wright were thus royalties based on this ownership; what petitioner became entitled to under the contract was a right to share in Redynam's income, and not any part of the Wright royalties as such. See Kiesau Petroleum Corporation, 42 B. T. A. 69.
Since the parties have agreed that the sole issue*315 is whether petitioner's connection with these transactions constituted an "interest" in the patents, and since we conclude it did not, the issue must be disposed of in petitioner's favor.
Decision will be entered under Rule 50.
Footnotes
*. Also a 25 per cent penalty for 1940 of $ 872.58. No explanation is offered as to why this antedates the formation of petitioner.↩
1. "SEC. 502. * * *
"For the purposes of this subchapter the term 'personal holding company income' means the portion of the gross income which consists of:
"(a) Dividends, interest (other than interest constituting rent as defined in subsection (g)), royalties (other than mineral, oil, or gas royalties), annuities."↩
2. Regulations 111, Section 29.500-1:
"* * * The term 'personal holding company,' as used in subchapter A of chapter 2, does not include a foreign corporation if (1) its gross income from sources within the United States for the period specified in section 119 (a) (2) (B)↩ is less than 50 percent of its total gross income from all sources and (2) all of its stock outstanding during the last half of the taxable year is owned by nonresident alien individuals, whether directly or indirectly through other foreign corporations."
3. "SEC. 119. * * *
"(a) Gross Income From Sources in United States. -- The following items of gross income shall be treated as income from sources within the United States;
* * * *
"(4) Rentals and Royalties. -- Rentals or royalties from property located in the United States or from any interest in such property, including rentals or royalties for the use of or for the privilege of using in the United States patents, copyrights, secret processes and formulas, good will, trade-marks, trade brands, franchises, and other like property; * * *"↩