*182 Decision will be entered under Rule 50.
Held, an amount received in compromise of a suit for damages under the Federal antitrust laws not shown to have constituted restoration of capital; held, further, that the Commissioner erred in allowing deduction of a part of the recovery as unamortized cost of patents involved in a licensing arrangement between the parties to the action.
*952 The respondent determined deficiencies of $ 46,894.24 and $ 15,772.64 in the petitioner's income tax and excess profits tax, respectively, for its fiscal year ending May 31, 1938.
The sole original issue is the taxability of the sum of $ 350,000 received by the petitioner from the Radio Corporation of America as a part of the amount paid in settlement of litigation between it and the petitioner.
By an amendment to his answer the respondent has raised two additional issues:
(1) His alleged error in failing to include in gross income the sum of $ 26,949.03 representing unamortized cost of patents.
(2) His alleged error in failing to disallow*183 the sum of $ 60,000 paid for professional services rendered in connection with the litigation mentioned in the first issue.
FINDINGS OF FACT.
The petitioner is a corporation organized under the laws of Delaware. It filed its income and excess profits tax return for the fiscal *953 year ending May 31, 1938, with the collector of internal revenue for the district of Massachusetts.
The American Appliance Co., hereinafter called Appliance, was incorporated under Massachusetts laws in 1922. It later changed its name to Raytheon Manufacturing Co., hereinafter called Raytheon, then to Raytheon, Inc., and then to Thenos, Inc.
Raytheon was a pioneer manufacturer of a rectifying tube which made possible the operation of a radio receiving set on alternating current instead of on batteries. In 1926 and 1927 it was doing a large and profitable business. In 1926 the profits were about $ 450,000, in 1927 about $ 150,000, and in 1928, $ 10,000. In 1926 the volume of business of Raytheon was well over half of the total business of all conpetitors in its field.
The Radio Corporation of America, hereinafter called RCA, had many patents covering radio circuits and claimed control over almost*184 all of the practical circuits. Cross-licensing agreements had been made among several companies, including RCA, General Electric Co., Westinghouse, and American Telephone & Telegraph Co. RCA had developed a competitive tube which produced the same type of rectification as the Raytheon tube but which was considered by Raytheon to be inferior thereto. Early in 1927 RCA began to license manufacturers of radio sets and in the license agreement it incorporated "Clause 9," which provided that the licensee was required to buy its tubes from RCA. In 1928 practically all manufacturers were operating under RCA licenses. As a consequence of this restriction Raytheon was left with only replacement sales, which soon disappeared.
In 1927 or 1928 Raytheon brought a suit for patent infringement against the Q. R. S. Corporation, hereinafter called QRS. In May 1928 the suit was settled by an agreement under which the Raytheon Manufacturing Co., hereinafter sometimes called Manufacturing Co., was organized under the laws of Delaware with capital stock of 75,000 shares of no par value. QRS received 17,000 shares thereof in exchange for $ 25,000 in cash and its radio business, including patents, *185 inventories, machinery, and contracts.
On May 23, 1928, Raytheon paid some cash and conveyed all of its property (except patents) to the Radio Conduction, Inc., a Massachusetts corporation, hereinafter called Conduction, in exchange for the latter's stock. Good will in the radio business was included in the conveyance, also the right to sue for any property or rights conveyed. Raytheon agreed to change its name to Raytheon, Inc. Thereafter it was engaged in research and development work. On May 29, 1928, Conduction transferred to Manufacturing Co. all of the property acquired from Raytheon in exchange for 38,000 shares of Manufacturing Co. stock. The board of directors of Raytheon *954 determined that the fair value of the assets acquired from Conduction, less the obligations assumed, was in excess of $ 190,000 and that such excess should be received as paid-in surplus.
Manufacturing Co. sold its remaining 20,000 shares to Harry C. Watts & Co. for $ 20 per share. Harry C. Watts & Co. also bought 5,000 of such shares from QRS for $ 20 per share. It later sold all 25,000 shares to the public at $ 27.50 and up per share. Manufacturing Co. entered on its books the transaction*186 involving the exchange of its 38,000 shares of stock by itemizing the receipt of cash, $ 25,000; inventory, $ 60,174.27; permanent assets, $ 181.970 (as appraised), or a total of $ 267,144.27, less current assumed liabilities of $ 35,000, or a net value of $ 232,144.27. The books of Raytheon did not show the claim against RCA as an asset; and the books of Manufacturing Co. indicated the 38,000 shares as issued for the tangible assets of Conduction. No notation was made on the books of Manufacturing Co. that any shares were issued for intangibles, and no intangible value was set up on the opening balance sheet.
When Manufacturing Co. found it impossible to market its tubes in the early part of 1929 it obtained a license from RCA to manufacture tubes under the latter's patents on a royalty basis. The license agreement contained a release of all claims of Manufacturing Co. against RCA by reason of the illegal acts of the latter under clause 9, but by a "side agreement" such claims could be asserted if RCA should pay similar claims to others.
In 1929 Manufacturing Co. entered into a complicated agreement with the National Carbon Co., hereinafter called Carbon, whereby Manufacturing*187 Co. manufactured tubes and Carbon sold them as its exclusive sales agent. In order to execute the contract the petitioner was organized and all of the assets, business, privileges (except corporate franchise) good will, trade-marks, patents, licenses, personal property, plant and equipment, choses in action, contracts, etc., of Manufacturing Co. were transferred to petitioner in return for petitioner's capital stock and bonds in the amount of $ 500,000. The cause of action against RCA was not set up as an asset on the books of Production. The petitioner manufactured the tubes and sold them to Manufacturing Co., which in turn sold them to Carbon. The contract was terminated in 1933.
The petitioner was informed of instances in which RCA had settled claims against it based on clause 9. On that ground it considered itself released from the agreement not to enforce its claim against RCA and consequently, on December 14, 1931, the petitioner caused Raytheon to bring suit against RCA in the District Court of Massachusetts, alleging that the plaintiff had by 1926 created, and then possessed, a large and valuable good will in interstate commerce in rectifying tubes for radios, and had*188 a large and profitable established business therein, so *955 that the net profits for the year 1926 was $ 454,935; that the business had an established prospect of large increase and that the business and the good will thereof was of a value of exceeding three million dollars; that by the beginning of 1927 the plaintiff was doing approximately 80 percent of the business in rectifying tubes of the entire United States; that the defendant conspired to destroy the competition of the plaintiff and others, by a monopoly of such business, and did suppress and destroy the existing competition; that manufacturers of radio sets and others ceased to purchase tubes from the plaintiffs; that by the end of 1927 the conspiracy had completely destroyed the profitable business and that by the early part of 1928 the tube business of the plaintiff and its property and good will had been totally destroyed, at a time when it had a present value in excess of three million dollars, and thereby the plaintiff was injured in its business and property in a sum in excess of three million dollars. The suit was brought in the name of Raytheon for its benefit and the benefit of Manufacturing Co., petitioner's*189 predecessor in interest, for damages up to May 28, 1928, the day prior to transfer of Conduction's assets to Manufacturing Co.
In May 1933 Manufacturing Co. acquired all of the remaining assets of Raytheon, Inc. (formerly Raytheon (Massachusetts)) in exchange for stock. The value of such assets in excess of the par value of the stock was received as paid-in surplus. The assets consisted of cash, contracts, machinery, laboratory equipment, rights, patents, licenses, etc.
The action against RCA was referred to an auditor, who filed his report on February 14, 1938. Referring to the licensing arrangement involved in the conspiracy and monopoly of which the plaintiff complained, the report reads:
The patents covering the circuits so licensed were owned by the defendant, or the General Electric Company, or the Westinghouse Electric & Manufacturing Company, or the American Telephone & Telegraph Company. The General Electric Company and the Westinghouse Company joined with the defendant as licensors in these license agreements, and the approval of the American Telephone and Telegraph Company was given. Prior to 1927 these companies had entered into certain so-called cross licensing agreements, *190 by which radio patents owned or acquired by each were for certain purposes made available to each. In addition to claiming that clause 9 was illegal, the plaintiff also claims that these cross licensing agreements created an illegal monopoly in the defendant, the General Electric Company, the Westinghouse Company and The Telephone Company; and that this also has a bearing upon the issues in this case.
After reviewing the evidence heard, and summarizing previous detailed findings, the auditor concludes: "I find that clause 9 was not the cause of damage to the plaintiff."
In the spring of 1938 the Raytheon affiliated companies began negotiations for the settlement of the litigation with RCA. In the meantime, *956 a suit brought by RCA against the petitioner for the nonpayment of royalties resulted in a judgment of $ 410,000 in favor of RCA. Certain credits were agreed to be due to the petitioner. RCA and the petitioner finally agreed on the payment by RCA of $ 410,000 in settlement of the antitrust action. A written plan of settlement was carried out. Paragraph 9 thereof recites: "RCA shall pay Raytheon $ 410,000.00 upon execution of the agreement for the releases and patent*191 rights referred to in items 2, 5 and 6."
Items 2, 5, and 6 read as follows:
2. RCA will grant to the several Raytheon Companies, and the several Raytheon Companies will grant to RCA, GE, Westinghouse and AT&T, full and complete releases from all claims of whatsoever nature on account of past acts of the parties except the royalties specified in Item 1 hereof, and current bills for merchandise, etc., and also except for claims for infringement outside of the radio field, provided, however, that the existing license agreement between RCA and Raytheon shall continue in force until December 31, 1938. The side agreement entered into concurrently therewith shall be cancelled or suitably modified.
* * * *
5. Raytheon shall grant to RCA non-exclusive licenses in all countries under its present patents, applications and inventions for vacuum tubes (as distinguished from gas tubes) for use in the fields of radio purposes as defined in Agreement A-1, and for tubes for use in all fields of the types designed and intended primarily for use in the fields of radio purposes or similar thereto. A tentative list of U. S. patents relating to vacuum tubes is attached hereto, subject to later correction*192 as to completeness and accuracy.
6. Raytheon shall grant to RCA the non-exclusive right to grant sub-licenses to others under Raytheon's present U. S. patents, applications and inventions for vacuum tubes (as distinguished from gas tubes) for use in the fields of radio purposes as defined in Agreement A-1, and for tubes for use in all fields of the types designed and intended primarily for use in the fields of radio purposes or similar thereto.
RCA issued its check for $ 410,000 payable to Raytheon, Manufacturing Co., and Production. RCA declined to allocate the amount paid. Mutual releases were executed. Raytheon, Manufacturing Co., and the petitioner each separately executed the same form of release, releasing RCA, General Electric Co., Westinghouse Electric & Manufacturing Co., and American Telephone & Telegraph Co., and all of their respective subsidiary and affiliated companies therein referred to as the "Licensor Group" of and from "all manner of actions, causes of action, suits, debts * * *, claims and demands whatsoever [with exceptions not here material] in law or in equity," which the undersigned corporation "ever had, now has, or hereafter can, shall, or may have * * *193 * whatsoever from the beginning of the world to and including the day of these presents; and including (but without in any way limiting the generality of the foregoing) all causes of action * * * by virtue of the anti-trust or other laws * * * and further including" the action then pending.
*957 As provided in section 2 of the plan of settlement, the "side agreement" was amended by eliminating and canceling paragraph 3 thereof (which gave any licensee injured the right to sue if other licenses should be paid). The agreement so canceling section 3 was signed by RCA, General Electric Co., Westinghouse, Production, Manufacturing Co., and Raytheon. It recites the execution of the "side agreement" by RCA, General Electric, Westinghouse, Raytheon, and Manufacturing Co., and that Raytheon, Manufacturing Co., and Production have "as of this date resolved certain differences that have heretofore existed with RCA and others," that in connection with such settlement the parties desire to modify the side agreement, and that, in consideration of the premises and of the several covenants and agreement set forth, the side agreement is canceled as to paragraph 3. On the same day an agreement*194 was executed by Raytheon, Manufacturing Co., Production (referred to therein as the "Raytheon Group"), and RCA, reciting the simultaneous delivery of the three releases to RCA, for itself and the "Licensor Group," General Electric, Westinghouse, American Telephone & Telegraph Co., and inter alia relating: "Raytheon Group acknowledges receipt of a sum of money constituting fully adequate consideration for the execution of said releases, and this agreement," and, further, that the Raytheon group, jointly and severally, warrant and guarantee all claims released to be owned by one or more members of the Raytheon group, and will save the licensor group harmless. The agreement for judgment, filed in court, was signed by attorneys on behalf of Raytheon, Manufacturing Co., Production, and the defendant.
In accordance with paragraphs 5 and 6 of the plan of settlement, a license agreement was executed between Production and Manufacturing Co., therein called "Raytheon Group," and RCA. As a part thereof, the Raytheon group granted certain nonexclusive licenses and rights to grant sublicenses as to tubes, and released RCA and its subsidiaries from all claims for profits or damages with respect*195 to infringement of certain patent rights prior to the date of the agreement; and RCA granted, and the Raytheon group agreed to accept, certain licensing arrangements as to radio receiving tubes for a period to January 1, 1945; and RCA released the Raytheon group and its subsidiaries jointly and severally from all claims for profits or damages with respect to infringement of patents as to radio tubes.
The patents under which RCA acquired licenses were a small part of those owned by the Raytheon group. Very few of them were being used by the Raytheon affiliates and no royalties were being derived from them. The officers of the Raytheon companies ascribed $ 60,000 *958 of the $ 410,000 received from RCA as the proper cost of development of the patents.
Officials of the Raytheon companies allocated $ 350,000 of the $ 410,000 received from RCA as a credit to surplus and $ 60,000 thereof to the value of the patent rights. Of the latter sum, $ 40,000 was credited to the patent account of the petitioner and $ 20,000 as payment to Manufacturing Co. for its patent rights. In its income tax return the petitioner treated the $ 350,000 as a realization from a chose in action and not as*196 taxable income. It noted the payment of $ 20,000 to Manufacturing Co. and charged itself with taxable income of $ 13,050.97, designating the remaining $ 26,949.03 as unamortized cost of patents and license rights.
The Commissioner determined that the $ 350,000 constituted income on the following ground, contained in the statement attached to his notice of deficiency:
It is the opinion of this office that the amount of $ 350,000 constitutes income under section 22 (a) of the Revenue Act of 1936. There exists no clear evidence of what the amount was paid for so that an accurate apportionment can be made as to a specific consideration for patent rights transferred to Radio Corporation of America and a consideration for damages. The amount of $ 350,000 has therefore been included in your taxable income.
The petitioner claimed and was allowed a deduction of $ 60,000 in payment of legal services rendered in connection with the suit against RCA. By his amendment to his answer, the respondent seeks (1) to include in the petitioner's income the item of $ 26,949.03 representing the unamortized cost of patents and license rights, and (2) the $ 60,000 paid and deducted as legal fees, in case*197 the $ 350,000 payment is held to be nontaxable.
OPINION.
The primary issue before us is whether or not $ 350,000 of the $ 410,000 paid to the petitioner by RCA is taxable income. The notice of deficiency recognizes that the remaining $ 60,000 was properly allocated to the payment for patent and license rights.
The petitioner contends that the amount in controversy was not income, but was compensation for damages caused by the tortious acts of RCA -- specifically, the inclusion in its contracts with licensees of clause 9 and the enforcement of such clause. It asserts that the money so recovered was merely reimbursement for the injury sustained by its business and its capital assets and serves partially to restore its assets to their former value.
The question before us, in last analysis, is: For what did the petitioner receive the $ 410,000? It must, in order to show nontaxability of the amount as income demonstrate that it was received as replacement of capital lost. After reviewing the voluminous record, we *959 think that clearly the best guide to the answer is found in the instruments of settlement. The essential details thereof have been set forth in the findings. The*198 plan of settlement informs us definitely that the $ 410,000 was paid "for the releases and patent rights referred to in items 2, 5 and 6." Reviewing those items, we find that it was specifically paid in consideration of the fact that "the several Raytheon Companies will grant to RCA, GE, Westinghouse and AT&T, full and complete releases from all claims of whatsoever nature on account of past acts of the parties except * * * [matters not here pertinent]"; also in consideration of the fact that "The side agreement entered into concurrently therewith shall be cancelled or suitably modified"; also the grant by "Raytheon" to RCA of nonexclusive licenses in all countries under its present patents, applications, and inventions for vacuum tubes for use in the fields of radio purposes and for tubes for use in all fields of the same type; also, the grant by "Raytheon" to RCA of nonexclusive right to grant sublicenses to others, with reference to the same patents, applications, and inventions for vacuum tubes, and release of past damages for infringement.
The instruments executed in accordance with the above described plan show that the word "Raytheon" refers to the original Massachusetts corporation, *199 to Raytheon Manufacturing Co. of Delaware, and to Raytheon Production Co., the petitioner, and to those companies RCA executed its check and its release, while the petitioner on its part executed a release to RCA, General Electric, Westinghouse Electric & Mfg., and American Telephone & Telegraph; and releases identical therewith were executed by the Massachusetts corporation and by Raytheon Manufacturing Co. of Delaware. Each of these releases forever releases and discharges RCA and the other corporations just above named in the most general terms from all actions, causes of action, suits, and debts in law or in equity, including "but without in any way limiting the generality of the foregoing," all causes of action arising under the antitrust laws of the United States or any state and in the action then pending. (Certain exceptions stated, specifically listed, are not material here.)
RCA declined to allocate the amount paid, apparently either as to payees or as to matters for which paid.
We think it obvious from a review of the facts just above stated that it is impossible to designate the recovery as capital replacement. All things between plaintiff and defendant, since Genesis, *200 were settled, as well as matters with other parties. 15 Corpus Juris Secundum 776, on Compromise and Settlement, recites the general rule:
A general settlement will be presumed to include all existing demands between the parties, imposing on the party claiming that certain items were not included, the burden of proving that fact.
*960 Petitioner not only released and settled any claim for capital damage, but all other claims it had against RCA in addition to which for the consideration received it executed releases to other companies. It likewise executed a release and cancellation of its contractual right to recover under the side agreement -- not only for damages done in the past, but for any for which it might have recovered in the future. This is not damage already done to capital structure. Furthermore, it is plain that the other members of the "Raytheon Group" released various matters and rights for the same consideration. The consideration can not fairly or logically all be ascribed to a certain claim of the petitioner alone. In addition to all of this, the petitioner here, for the same consideration, granted RCA nonexclusive licenses in all countries for vacuum*201 tubes and the right to grant sublicenses, and released RCA and its subsidiaries from all claims for past infringement of certain patent rights.
Under such a record the item of alleged damage or injury to capital, good will, and reputation of business must be seen as merely one of a series of matters, involving both past and future, settled or conveyed for the same consideration, and we are unable to allocate any portion of the settlement to nontaxable capital recovery in the face of the presumption that the Commissioner's determination to the opposite effect is correct. In , we had before us this precise question, involving a settlement of two suits for $ 50,000 each, one, in effect, for damage to business and the other for breach of contract. We said:
The amount in question was paid to the petitioner in compromise and settlement of two suits, and there is no evidence to indicate in what proportion the amount could be allocated between the actions. Also, there is no evidence to establish the specific purpose for which the money was paid, other than that it was paid as a lump sum in compromise and settlement*202 of the litigation. Whether the amount represented damages for wrongful injury to the petitioner's good will, or whether it represented damages for loss of profits, or indeed whether the amount was simply paid by the defendants to avoid further expense and harassment resulting from long continued litigation, does not definitely appear.
Although in that case we concluded that the suits involved did not involve damage to capital, nevertheless the criterion suggested is sound, and, in the absence of any means of ascertainment or allocation of any amount of capital injury, it is our opinion that, even if we assume the suit against RCA to have charged damage to the capital of plaintiff, the petitioner has failed to show error in the determination by the Commissioner. , does not require the impossible.
We are, for other reasons, of the opinion that the petitioner has not demonstrated receipt of capital replacement. The petitioner was organized in 1929. The suit for damages against RCA was particularly *961 limited to damage done to May 28, 1928, the day before conveyance of the assets of Conduction*203 (including any right of action) to Manufacturing Co. The suit charged, and the facts indicate, that the tube business enjoyed by Raytheon in 1926 and 1927 was virtually dead long before organization of the petitioner and the issuance of its stock and bonds for the assets of Manufacturing Co., including any right of action against RCA. It was not until the latter part of 1929 that any evidence of right of action was discovered, and not until 1931 that the right to recover was actually proven and action instituted. The petitioner, in effect, purchased no business consisting of the claim against RCA, but merely a possible chose in action. We think it may not soundly be said that such chose in action is of the same nature in petitioner's hands as it had in those of Raytheon. ; certiorari denied, , in our opinion, does not call for that conclusion. The question here is the nature of income to the petitioner, whether capital or no. Even if we assume Raytheon to have had a claim for capital damage, petitioner merely had an investment in a chose in action, to set against*204 a recovery thereon. The parties have both taken the view that the various steps by which the petitioner acquired the claim -- from Raytheon to Conduction to Manufacturing Co. to petitioner -- were all reorganizations. If we so assume, and therefore assume the petitioner to have a basis the same as that of Raytheon, we have no evidence as to amount of that basis. Even Raytheon, had it received and retained the compromise money, would have had to show what capital it had invested in what it received. Demonstration of capital recovery necessarily entails determination of the amount of capital involved. In , and , where we sustained a contention of capital recovery in amounts received in settlements, it is apparent that the amount of capital invested was an element considered in the conclusion. Recoveries for property taken in condemnation proceedings offer clear analogy to the instant situation; and, though by way of replacement of capital lost, they are free from tax only above the basis of cost. So here, if we assume that capital recovery is involved*205 and contained in the compromise moneys, only that portion above basis may be left untaxed. The cost or other basis of Raytheon's good will and business is not shown. The record is merely that that corporation was doing a profitable business, $ 450,000 in 1926 and $ 150,000 in 1927, which diminished to $ 10,000 in 1928. If it were assumed that the steps by which petitioner acquired the cause of action against RCA were not reorganizations, no facts appear upon which to value the basis of the right when acquired by petitioner upon its organization in 1929. In the absence of evidence of the basis of the business and good will of Raytheon, the amount of any nontaxable *962 capital recovery can not be ascertained, and the determination of the respondent must be sustained.
In the light of the above conclusion and of the fact that the respondent alleges his error in allowing $ 60,000 for expenses for attorneys' fees only in the alternative in case the recovery was held to be for capital replacement, it is unnecessary to consider that allegation of error.
This leaves for consideration respondent's contention that he erred in allowing deduction of $ 26,949.13 as unamortized cost of*206 patents transferred to RCA. He relies, upon brief, solely upon the testimony that no patents were transferred to RCA. The petitioner concedes that legal title did not pass, but argues that practically all rights under the patents were transferred, so that the control by RCA was for practical purposes equivalent to ownership. This argument overlooks the fact that what the petitioner granted to RCA was nonexclusive licenses and the nonexclusive right to grant sublicenses to others. Such non-exclusive rights are by no means a practical equivalent of ownership. The petitioner not having transferred the patents in the taxable year, did not therein change its previous position with reference to annual amortization of cost of such patents. The Commissioner erred in allowing the deduction of $ 26,949.13.
Decision will be entered under Rule 50.
Van Fossan, J., dissenting: The prevailing opinion holds, in effect, that the payment in compromise of the suit for damages under the Federal antitrust laws has not been shown to constitute a restoration of capital. I can not agree.
The injury to Raytheon was tortious. There was no contract, express or implied, between Raytheon*207 and RCA. The pleadings in the suit brought under the Sherman and Clayton Acts charge only the tortious conduct of the defendant. They neither claim nor suggest as a measure of damage the loss of profits, nor is there any indication in the record that the compromise settlement was predicated on such basis. The charge was based on the illegal injury to plaintiff's business and property, specifically its good will. The case thus comes squarely within the decision of the court in . That case was cited with approval by the Board of Tax Appeals in , and . See also ; .
The cases in which damages have been held to be includible in income seem to rest on the fact that the suits in question were based on loss *963 of profits. ; ;*208 ; affd., .
I am likewise unable to concur in the conclusion that the case involves a question of basis. The character of the item, the treatment thereof by petitioner and the respondent, in my judgment, raise no such question.
In my judgment the record amply demonstrates that the payment here involved constituted a restoration of petitioner's capital and did not constitute income to recipient. I would reverse respondent's action.