*220 Decisions will be entered under Rule 50.
Petitioners acquired a 2-State master franchise for Dairy Queen freezers in April 1947. They intended organizing with others five or six regional corporations to develop and operate Dairy Queen stores. Commencing in December 1947 petitioners granted numerous territorial subfranchises by different types of agreements. Held:
1. Petitioners effected the sale of territorial rights in one instance, but the remainder of the transactions constituted sublicenses, payments for which produced ordinary income.
2. Petitioners did not hold the rights which they sold in the one instance mentioned in paragraph 1 above primarily for sale to customers in the ordinary course of business, and are entitled to treat the gains on the sale as long-term capital gains.
3. In computing the amount of gain on the one sale which was made, petitioners are entitled to have taken into account their adjusted cost basis of tangible personal property sold and also to have allocated a part of the cost of the master franchise which they acquired in 1947 to the subfranchise which was sold in 1948.
*500 *773 Respondent determined deficiencies in the income taxes of petitioners for the taxable years 1948, 1949, and 1950, as follows:
| Docket | Petitioners | Year | Deficiency |
| No. | |||
| 1948 | $ 12,525.90 | ||
| 47880 | Theodore E. Moberg and Pauline Moberg | 1949 | 11,828.98 |
| 1950 | 3,047.02 | ||
| 47925 | Vern H. Moberg and Reta N. Moberg | 1948 | 12,535.16 |
| 1949 | 11,537.78 |
*501 The issues presented for decision are:
(1) Whether the transfer by petitioners of rights held under a master franchise for the use of Dairy Queen freezers constituted sales giving rise to long-term capital gains, or licenses giving rise to ordinary income.
(2) If the transfers were sales, whether petitioners held their rights*222 primarily for sale to customers in the ordinary course of business.
(3) If the transfers were sales, whether petitioners have established a reasonable method of allocating their basis in the rights sold.
*774 FINDINGS OF FACT.
Stipulations of facts filed by the parties are incorporated herein by this reference.
Petitioners Theodore E. Moberg and Pauline Moberg, husband and wife residing in Tacoma, Washington, timely filed joint income tax returns for the years 1948, 1949, and 1950 with the collector of internal revenue at Tacoma. Petitioners Vern H. Moberg and Reta N. Moberg, husband and wife residing in McAllen, Texas, timely filed joint income tax returns for 1948 and 1949 with the collector of internal revenue, Austin, Texas.
During the years in issue, Vern and Theodore, hereinafter referred to as petitioners, each owned a one-half interest in a partnership they had orally formed, effective April 10, 1947, and known as Dairy Queen Stores.
On May 18, 1937, Harry M. Oltz secured patent No. 2080971 on a "Freezing and Dispensing Machine" which later became known, and is hereinafter referred to, as the Dairy Queen machine. In 1940 Oltz sold, assigned, and transferred the whole*223 right, title, and interest in the patent to Ar-Tik Systems, Inc., hereinafter referred to as Ar-Tik.
By September 7, 1946, Oltz and Ar-Tik had granted to Hugh A. McCullough the exclusive right to use, manufacture, sell, and distribute Dairy Queen machines in all of the States west of the Mississippi River, and Illinois and Wisconsin. The right to sublicense others was also granted.
In the spring of 1947 petitioners became interested in securing a territorial franchise for Dairy Queen machines. They contacted McCullough and negotiated an agreement. Petitioners wanted to secure the franchise for the State of Washington. McCullough stated the price of the franchise was computed on the basis of 1 cent per person in the territory based on the 1940 census. He said, however, that if petitioners took both Washington and Oregon the price would be $ 24,000, rather than approximately $ 28,000 based on population.
On April 10, 1947, the petitioners and Hugh A. and John F. McCullough entered into a "Freezer and Territory Agreement," hereinafter referred to as the master franchise. The agreement recited that:
(1) The McCulloughs are the registrants of the trade name "Dairy Queen" in the States*224 of Washington and Oregon.
(2) The patent No. 2080971 covering Dairy Queen freezers was held by Ar-Tik, and that the McCulloughs hold all rights under the patent in several States, including Washington and Oregon.
(3) The McCulloughs desire to sell, and petitioners to purchase, "the exclusive right to the use of" Dairy Queen freezers in Washington and Oregon.
*775 The parties agreed that:
(1) The McCulloughs grant to petitioners the exclusive right to use the freezers with the understanding that any freezers so purchased not be moved outside of Washington and Oregon for operation.
(2) Petitioners purchase all needed freezers from the McCulloughs "at a cost not to exceed the manufacturing cost F.O.B. Factory."
(3) Petitioners pay to the McCulloughs consideration in the amount of $ 24,000 and 4 cents "a gallon in the nature of royalty" on mixes used in all freezers in Washington and Oregon, computed and payable monthly.
(4) Petitioners maintain records available to the McCulloughs showing the serial numbers and locations of all freezers, so identify the freezers on all reports, and maintain records of all mix sold or used, keeping such available to inspection by the McCulloughs *225 or Ar-Tik or their agents.
(5) Neither the McCulloughs nor petitioners should bear any responsibility to defend the patent.
(6) In the event of default in payment the McCulloughs may give written notice to the Mobergs, and if payment were not made within 30 days, the agreement should terminate.
(7) Petitioners have the right to grant sublicenses upon approval of the McCulloughs for any portion of the territory granted by the agreement.
(8) Petitioners pay to the McCulloughs one-half of amounts received for sales of territory or sublicenses granted by petitioners.
(9) All sublicensees be obligated:
(a) to keep a record of the serial numbers and location of all freezers, to which the McCulloughs would have access, and*502 to so specify in all monthly reports of mix used;
(b) not to move the freezers outside the sublicensed territory;
(c) to pay a 4-cent-per-gallon royalty on all mixes used so long as the freezer is used;
(d) to suffer inspection of mix records at any time by the McCulloughs or Ar-Tik, or their agents; and
(e) to give in writing to the McCulloughs or Ar-Tik the serial numbers and locations of any and all freezers upon request.
(10) Both petitioners and the McCulloughs reserve*226 the right to assign the agreement.
(11) The McCulloughs are not involved in or liable for the operations of either petitioners or their sublicensees.
At the time they acquired the master franchise, petitioners planned to attract investment capital from others with which to establish five or six corporations to operate Dairy Queen stores on a regional basis. They hoped to be able to make arrangements with investors whereby the investors would contribute capital to these corporations and the *776 petitioners would contribute regional subfranchises, and possibly cash or other property, in return for capital stock. Whether petitioners would secure controlling stock interests in these regional corporations would depend on what arrangements could be made with investors. Petitioners realized that they would have to grant some subfranchises for cash in order to raise sufficient capital to execute their plan, and were prepared to do so.
Petitioners first decided to build a Dairy Queen store in Tacoma, Washington. The store was opened on July 12, 1947, but was not an immediate success. Difficulties with refrigeration and in securing a satisfactory mix forced the store to close temporarily. *227 It was not until sometime in September 1947 that the store was functioning properly.
The delay in getting the store functioning properly created some financial difficulties for the petitioners. A payment of $ 1,000 was due on the contract with the McCulloughs on October 1, 1947, and payments were due in repayment of a loan in the amount of $ 12,000 borrowed to establish the business.
In August or September of 1947, Bertrum J. Dunn, advertising salesman for a radio station, approached Theodore (often called and hereinafter sometimes referred to as Ted) for the purpose of selling radio advertising for the Dairy Queen store. Dunn became interested in the business, and after observing the operations of the Tacoma store over a period of time entered into negotiations with Ted to secure a territorial franchise from petitioners.
On December 17, 1947, petitioners and Dunn and his wife executed an "Agreement Relating to Dairy Queen Franchise," (hereinafter referred to as the 10-paragraph contract). By the agreement petitioners (referred to in the contract as "Sellers") granted to the Dunns (referred to as "Buyers") petitioners' rights under the agreement with the McCulloughs in Yakima *228 County, Washington. Petitioners specifically granted the buyers the right to transfer or sell the agreement and to procure the mix for the Dairy Queen machines from sources the buyers deemed proper. The grants were subject to the following limitations and restrictions:
(1) Assignment or transfer of the agreement is subject to the approval of petitioners.
(2) The buyers must furnish to petitioners the names of suppliers of mix.
(3) Petitioners, the McCulloughs, and Ar-Tik shall have the right to inspect the books of the buyers for the purpose of computing royalties.
(4) The buyers are to maintain the freezers, building, and equipment in a high state of repair, and to keep the premises clean.
(5) The buyers are to furnish to the McCulloughs or Ar-Tik the serial numbers and locations of freezers upon request.
*777 (6) The buyers may not move the freezers outside the territory granted for purposes of operation.
(7) The buyers must report the amount of mixes used monthly giving the serial number and location of the freezers covered by the report.
(8) The buyers must purchase all freezers through petitioners at manufacturing cost f.o.b. factory.
(9) If the buyers fail to make required*229 payments as due, petitioners may give written notice, and if the buyers do not make the required payments within 30 days of the notice, petitioners may terminate the agreement.
The price under the agreement was a fixed sum, partially payable in a lump sum upon execution of the agreement and partially on the basis of 15 cents per gallon of mix used, plus a continuing royalty of 14 cents per gallon of mix used.
Subsequently, petitioners executed other 10-paragraph contracts, similar to the one executed with the Dunns, granting*503 franchises in different areas to other persons. The dates, names of "Buyers," territories granted, total fixed prices, and populations of all territories granted under 10-paragraph agreements are as follows:
| Date | "Buyers" | Territory | Total | Population |
| price | ||||
| Dec. 17, 1947 | Bertrum J. Dunn and | Yakima County, Wash | $ 4,000 | 99,019 |
| Ruth V. F. Dunn. | ||||
| Jan. 2, 1948 | Dean T. Mohler and | Clark County, Wash | 2,500 | 49,852 |
| Kenneth Lindberg. | ||||
| Jan. 2, 1948 | Dean T. Mohler and | Cowlitz County, Wash | 2,000 | 40,155 |
| Kenneth Lindberg. | ||||
| Jan. 2, 1948 | Dean T. Mohler and | Thurston County, Wash | 1,800 | 37,285 |
| Kenneth Lindberg. | ||||
| Mar. 20, 1948 | Wilson P. Highly | Marion County, Oreg | 3,750 | 75,246 |
| May 5, 1948 | Bernice Rhodes | Kitsap County, Wash | 2,200 | 44,387 |
| June 5, 1948 | Harold F. Martret | Chelan County and East | 1,700 | 34,680 |
| Wenatchee, Wash. | ||||
| June 16, 1948 | Raleigh Sligar | Kittitas County, Wash | 1,500 | 20,230 |
| June 19, 1948 | C. William | Lewis County, Wash | 2,000 | 41,393 |
| Elmquist and | ||||
| James C. Snead. | ||||
| June 26, 1948 | Edward Thompson | Snohomish and Whatcom | 7,400 | 149,109 |
| Countries, Wash. | ||||
| July 14, 1948 | F. W. Sullivan | Grays Harbor County, Wash | 1,300 | 53,166 |
| and Norman | ||||
| Sullivan. |
*230 During 1949 and 1950, petitioners received no lump-sum payments on the fixed prices under the 10-paragraph contracts. Petitioners received total lump-sum payments in 1948, gallonage payments on the fixed prices, and royalties for the years 1948, 1949, and 1950 under the 10-paragraph contracts as follows:
| Fixed price payments | |||
| Year | Royalty | ||
| Lump sum | Gallonage | ||
| 1948 | $ 9,750 | $ 8,292.09 | $ 5,982.04 |
| 1949 | 6,533.93 | 20,393.81 | |
| 1950 | 663.48 | 26,051.14 |
*778 In May 1948, representatives of A. & M. Concessions, Inc. (hereinafter referred to as Concessions), approached Ted about securing the subfranchise for Pierce County, in which the partnership's store in Tacoma was located. On June 7, 1948, petitioners and Concessions entered into an agreement. The provisions of this agreement, among other things, provide:
That the sellers have this day sold to the buyer the following described personal property, to-wit:
The Business and Equipment of the Dairy Queen Drive-In Store, at #4816 Pacific Avenue, Tacoma, Washington; and
Dairy Queen Franchise for Pierce County, Washington, under United States Patent No. 2080971, and all extensions and renewals thereof, and as more*231 particularly described in a subsequent paragraph of this agreement; and
* * * *
In addition to the purchase price the buyer shall pay to the sellers at the time of the signing of this agreement the sum of Four Hundred Eighty and 00/100 Dollars ($ 480.00), which represents the amount the sellers have deposited with F. R. Zaugg under their lease, and which should be repaid to the sellers and thus entitle the buyer to the rights of the sellers under such lease.
That the buyer shall pay to the sellers the amount of the inventory at the above Dairy Queen Drive-In Store at the time of taking possession thereof under this agreement.
The buyer agrees to pay any tax that may hereafter be levied against the goods or chattels sold under this agreement.*504
In a stipulation filed at the hearing the parties agreed that the partnership's basis for the tangible assets of the store sold to Concessions was in the amount of $ 6,535.89. Concessions agreed to pay $ 12,500, 25 cents per gallon of mix used for 48,000 gallons, $ 480 for the deposit on the lease, and a continuing royalty of 14 cents per gallon of mix.
The territorial rights which petitioners granted under the Concessions agreement were not *232 held by them primarily for sale to customers in the ordinary course of business.
During the years 1948, 1949, and 1950, petitioners received under the agreement with Concessions lump-sum and gallonage payments on the fixed price, and royalties, as follows:
| Fixed price payments | |||
| Year | Royalty | ||
| Lump sum | Gallonage | ||
| 1948 | $ 12,480 | $ 3,667.60 | |
| 1949 | $ 6,266.68 | 2,092.25 | |
| 1950 | 5,733.32 | 7,832.74 |
On June 10, 1948, petitioners entered into an "Agreement Relating to Dairy Queen Franchise" for a portion of Portland, Oregon. The other parties to the agreement, which was of a type hereinafter referred to as a 34-cent contract, were Harold E. Spears and Ruth C. *779 Spears. During 1948, 1949, and 1950, petitioners executed agreements with other individuals similar to those executed with the Spears. A 34-cent contract provided that petitioners (referred to in some of the agreements as "Seller") granted to the other parties to the contract (referred to in some of the agreements as "Buyer"):
(1) The exclusive right to use Dairy Queen freezers (or a specified number of freezers per store opened) and the name "Dairy Queen" for the life of the freezer patent within *233 a described territory.
(2) The right to assign or transfer the contract.
(3) Aid in opening the first store the buyer should establish.
These grants were subject to the following restrictions and limitations:
(1) The freezer remained the property of petitioners.
(2) The buyer is to install and maintain the freezers at his expense.
(3) The bookkeeping system employed by the buyer is subject to approval by petitioners.
(4) The buyer is to maintain such records on the store premises and to make them available to inspection by petitioners, the McCulloughs, and Ar-Tik.
(5) The buyer is to report mix used and pay royalty thereon monthly, giving the serial numbers and locations of freezers.
(6) The buyer is to erect a store according to blueprints supplied by petitioners on a suitable lot with drive-in space available for "a large number of automobiles," construction to commence not later than a specified date.
(7) "All mixes and supplies, including cones, cups, containers, topping, flavoring, coloring and like supplies and materials" must meet "standards of quality and specifications approved" by petitioners.
(8) The buyer is to paint and maintain the store in "a high state of repair and*234 cleanliness," and to maintain the premises by "standards of quality and cleanliness now or hereafter set up by" the petitioners.
(9) The buyer may sell no product other than Dairy Queen without approval of petitioners.
(10) The buyer is to maintain no less than a specified number of stores for no less than a specified number of months each year.
(11) The buyer may not use any type of ice cream or ice milk freezer or equipment except Dairy Queen.
(12) Default by the buyer in any of its obligations entitles petitioners to terminate the agreement without notice.
In consideration for the subfranchise, the buyer agreed to pay petitioners a fixed amount, payable partially in a lump-sum payment and partially on a royalty basis, and a continuing 34-cent royalty on all mix used.
*780 Some of the 34-cent contracts contained the provisions additional or alternative to those set forth above, as follows:
(1) That the buyer might select a mix supplier as he saw fit, but if the buyer failed to use high quality mix, petitioners might give him 30 days' notice to improve the mix, and failing such, might designate the mix supplier.
(2) That, upon request, the buyer shall give to the McCulloughs*235 or Ar-Tik the serial numbers and locations of freezers.
(3) That the buyer shall have the right to assign the contract subject to the approval of petitioners and the McCulloughs.
(4) That upon any default by the buyer petitioners may give 30 days' notice to terminate the default, and upon*505 the buyer's failure so to do, petitioners might terminate the contract.
(5) That if the buyer fails to establish stores or make proper use of all of the territory granted, such unused territory shall revert to petitioners.
During the taxable years in issue, petitioners granted subfranchises by 34-cent contracts on dates, to "Buyers," covering territories, and for fixed prices, as follows:
| Date | "Buyers" |
| June 10, 1948 | Harold E. Spears and Ruth C. Spears |
| July 14, 1948 | Melvin J. Harper |
| Aug. 26, 1948 | N. M. Krueger, James E. Fitzgerald, and |
| Don H. Kroker. | |
| Mar. 1, 1949 | N. M. Krueger, James E. Fitzgerald, and |
| Don H. Kroker. | |
| Mar. 1, 1949 | Roy W. Taylor |
| Mar. 1, 1949 | Harold E. Spears and Ruth C. Spears |
| Mar. 1, 1949 | D. D. Baker |
| Apr. 5, 1949 | Charles C. Libby and Leona H. Libby |
| May 3, 1949 | Oliver J. Parkhurst and Ethel A. Parkhurst |
| July 19, 1949 | Verna M., Betty, Brent A., and Sumner |
| Deitrick. | |
| Jan. 23, 1950 | Earl E. Reinhart and Mildred J. Reinhart |
| Mar. 6, 1950 | Clarence Boyd and Genevieve A. Boyd |
| Mar. 17, 1950 | Ben F. Conklin and Florence B. Conklin |
| May 15, 1950 | Clarence A. Boyd and Genevieve A. Boyd |
| June 17, 1950 | James M. Ellery and Jennie M. Ellery |
| July 27, 1950 | George J. Kenagy, Jr., and Marie G. Kenagy |
| Aug. 23, 1950 | Earl E. Reinhart and Mildred J. Reinhart |
| Date | Territory | Fixed |
| price | ||
| June 10, 1948 | Portland, Oreg | $ 3,000 |
| July 14, 1948 | Kenniwick, Wash | 3,000 |
| Aug. 26, 1948 | Spokane, Wash | 3,000 |
| Mar. 1, 1949 | Spokane Co., Wash | 9,000 |
| Mar. 1, 1949 | Franklin Co., Wash | 3,000 |
| Mar. 1, 1949 | Part of Multnomah Co., Oreg | 9,000 |
| Mar. 1, 1949 | Part of Multnomah Co., Oreg | 9,000 |
| Apr. 5, 1949 | Lebanon, Oreg | 3,500 |
| May 3, 1949 | Albany, Oreg | 3,500 |
| July 19, 1949 | Bend, Oreg | 3,500 |
| Jan. 23, 1950 | Coos Bay, Oreg | 3,500 |
| Mar. 6, 1950 | Prineville, Oreg | 3,500 |
| Mar. 17, 1950 | Baker, Oreg | 3,500 |
| May 15, 1950 | La Grande, Oreg | 3,500 |
| June 17, 1950 | Coquille, Oreg | 3,500 |
| July 27, 1950 | Redmond, Oreg | 3,500 |
| Aug. 23, 1950 | Empire, Oreg | 3,500 |
During 1948, 1949, and 1950, the partnership received under the 34-cent contracts total lump-sum and gallonage payments on the fixed prices and royalties, as follows:
| Fixed price payments | |||
| Year | Royalty | ||
| Lump sum | Gallonage | ||
| 1948 | $ 4,400 | $ 7,600 | $ 324.74 |
| 1949 | 16,250 | 19,000 | 28,380.28 |
| 1950 | 15,750 | 16,000 | 55,452.71 |
On July 10, 1948, petitioners executed an agreement, of a type hereinafter referred to as a 14-cent contract, with Norman A. Williams. *781 During 1948 and 1949, petitioners*237 executed agreements with other individuals similar to those executed with Williams. By a 14-cent contract, petitioners (referred to in some of the agreements as "Seller") granted to the territorial grantees (referred to in some of the agreements as "Buyer") the exclusive right to use two Dairy Queen freezers for each store opened and to use the trade name Dairy Queen in the specified territory. The grants were subject to the following limitations and restrictions:
(1) The buyer's bookkeeping system is subject to the approval of petitioners.
(2) The buyer's selection of a mix*506 supplier, and any change thereof, is subject to approval of petitioners.
(3) The buyer is to report the amount of mix used, and pay the per gallon royalty thereon, monthly.
(4) The buyer is to erect a Dairy Queen store according to blueprints supplied by petitioners on a suitable lot large enough to accommodate a large number of cars.
(5) "All mixes and supplies, including cones, cups, containers, topping, flavoring, coloring and like supplies and materials" must meet "standards of quality and specifications approved" by petitioners.
(6) The buyer may not use any type of ice cream or ice milk freezer or equipment*238 except Dairy Queen.
(7) The buyer is to paint and maintain the store in "a high state of repair and cleanliness," and to maintain the premises by "standards of quality and cleanliness now or hereafter set up by" the petitioners.
(8) The buyer may sell no product other than Dairy Queen without approval of petitioners.
(9) The buyer is to maintain no less than at least one store for no less than a specified number of months each year.
(10) Upon default by the buyer petitioners may, without notice, declare the agreement terminated.
Some of the 14-cent contracts contained the following additional or alternative provisions:
(1) That the buyer shall require his mix supplier to furnish petitioners with a monthly record of sales of mix to the grantee.
(2) That upon any default by the buyer petitioners may give 30 days' notice to terminate the default, and upon the buyer's failure so to do, petitioners might terminate the contract.
(3) That if the buyer fails to establish stores or make proper use of all of the territory granted, such unused territory shall revert to petitioners.
(4) That the buyer shall purchase all freezers through petitioners at cost of manufacturing f.o.b. factory.
(5) *239 That any assignment of the agreement by the buyer is subject to approval of petitioners.
*782 Consideration under the 14-cent contract was a fixed sum, payable partially in a lump-sum payment and partially on a gallonage basis, and a 14-cent-per-gallon royalty on all mix used.
During the taxable years in issue, petitioners granted subfranchises by 14-cent contracts on dates, to "Buyers," covering territories, and for fixed prices, as follows:
| Date | "Buyer" |
| July 10, 1948 | Norman A. Williams |
| Aug. 17, 1948 | C. William Elmquist and Harry E. Elmquist |
| Aug. 17, 1948 | Everett H. Kastner, Adam Rott, and H. C. |
| Garey. | |
| Aug. 17, 1948 | Everett H. Kastner, Adam Rott, and H. C. |
| Garey. | |
| Aug. 17, 1948 | Everett H. Kastner, Adam Rott, and H. C. |
| Garey. | |
| Aug. 17, 1948 | Earl B. Pyeatt and Ruth Elaine Pyeatt |
| Aug. 24, 1948 | Walter Mix and Madge Mix |
| Aug. 28, 1948 | Jack A. Holder |
| Nov. 17, 1948 | Carl J. Schmitz |
| Nov. 27, 1948 | Ray R. Kelley |
| Jan. 7, 1949 | Wells H. Aldrich and Martha Mae Aldrich |
| Mar. 1, 1949 | Glynn Price and George W. Slyter |
| Mar. 7, 1949 | Owen E. Lawrence and Marie M. Lawrence |
| Mar. 20, 1949 | Otto W. Segrin and Alva G. Segrin |
| Date | Territory | Fixed price |
| July 10, 1948 | Umatilla Co., Oreg | $ 1,500 |
| Aug. 17, 1948 | Lane Co., Oreg | 3,500 |
| Aug. 17, 1948 | Benton Co., Oreg | 1,500 |
| Aug. 17, 1948 | Jackson Co., Oreg | 1,800 |
| Aug. 17, 1948 | Josephine Co., Oreg | 1,500 |
| Aug. 17, 1948 | Skagit Co., Wash | 1,800 |
| Aug. 24, 1948 | Mason Co., Wash | 1,500 |
| Aug. 28, 1948 | Douglas Co., Oreg | 1,500 |
| Nov. 17, 1948 | Klamath Co., Oreg | 2,000 |
| Nov. 27, 1948 | Walla Walla Co., Wash | 1,500 |
| Jan. 7, 1949 | Yamhill Co., Oreg | 1,500 |
| Mar. 1, 1949 | Clallam Co., Wash | 1,500 |
| Mar. 7, 1949 | Clatsop Co., Oreg | 1,500 |
| Mar. 20, 1949 | Clackamas Co., Oreg | 2,000 |
*507 *240 In 1950, petitioners received no lump-sum payments on the fixed prices under the 14-cent contracts. Petitioners received total lumpsum payments in 1948 and 1949, and gallonage payments on the fixed prices and royalties in 1948, 1949, and 1950, as follows:
| Fixed price payments | |||
| Year | Royalty | ||
| Lump sum | Gallonage | ||
| 1948 | $ 8,300 | $ 947.00 | $ 1,088.40 |
| 1949 | 4,250 | 8,569.90 | 17,972.90 |
| 1950 | 2,534.10 | 27,700.87 |
On July 23, 1948, petitioners executed an agreement with Thompson's Freeze Incorporated (hereinafter referred to as Freeze). The agreement, in which petitioners are referred to as the "Sellers" and Freeze as the "Buyer," recites that petitioners held certain Dairy Queen rights and that "the Sellers desire to sell to the Buyer and the Buyer desires to purchase from the Sellers said Sellers' exclusive rights in King County," Washington. Petitioners granted to Freeze the exclusive right to use Dairy Queen freezers in King County and agreed not to grant such rights to any other person. The grant was subject to the following provisions:
(1) The freezers purchased by Freeze may not be moved outside King County.
(2) Any assignment of the agreement by Freeze is *241 subject to approval by petitioners, the McCulloughs, and Ar-Tik.
*783 (3) If the mix used by Freeze is not of high quality, petitioners may give Freeze 30 days' notice to improve the quality, failing which, they may require Freeze to select and use another supplier of mix.
(4) Petitioners, the McCulloughs, and Ar-Tik may inspect the records of all Dairy Queen stores established by Freeze.
(5) Freeze is to maintain the freezers, building, and equipment in a high state of repair, and to keep the premises clean.
(6) Freeze shall give to the McCulloughs or Ar-Tik the serial numbers and locations of freezers upon request, and give petitioners access to such records and supply same with monthly reports of mix used.
(7) Freeze is to order all freezers it requires through petitioners at manufacturing cost f.o.b. factory.
(8) Freeze shall establish and commence operation of two stores on or before each of three specified dates.
(9) If Freeze fails to make required payments as due, petitioners may give written notice, and if Freeze does not make the required payments within 30 days of the notice, petitioners may terminate the agreement.
During the years 1948, 1949, and 1950, petitioners*242 received under the agreement with Freeze lump-sum and gallonage payments on the fixed price and royalties, as follows:
| Fixed price payments | |||
| Year | Royalty | ||
| Lump sum | Gallonage | ||
| 1948 | $ 10,000 | $ 73.00 | $ 204.40 |
| 1949 | 6,164.25 | 8,212.42 | |
| 1950 | 12,973.25 | 14,044.84 |
OPINION.
The principal issue presented is whether the agreements by which petitioners granted subfranchises under their master Dairy Queen franchise for Washington and Oregon were sales or some lesser disposition. Petitioners contend the agreements effected sales giving rise to long-term capital gain under the provisions of section 117(a) of the Internal Revenue Code of 1939. 1 Respondent *784 contends that petitioners did not sell the subfranchises; that they retained controls over the rights granted which were inconsistent with sales; and that they merely granted sublicenses, payments for which constitute ordinary income.
*243 Under the agreement with the McCulloughs, petitioners received the exclusive right to use Dairy Queen machines in Washington and Oregon. The right was subject to the limitations and restrictions set forth in our Findings of Fact. By implication, the agreement also accorded petitioners the right to use the trade name "Dairy Queen" in the 2-State area. It seems clear to us that under the agreement petitioners were*508 territorial licensees of the McCulloughs' right to use the machines and trade name and not purchasers of the patent rights to make, use, and vend Dairy Queen machines. Cf. Edward C. Myers, 6 T.C. 258">6 T.C. 258.
It does not follow, however, that because petitioners were but licensees the disposition of their rights is of necessity something less than a sale. No doubt is raised by the parties on that score and we are satisfied that the territorial franchise rights which petitioners held under the agreement with the McCulloughs constituted property susceptible of sale. Jones v. Corbyn, 186 F. 2d 450; United States v. Jones, 194 F.2d 783">194 F. 2d 783. The question then becomes one of determining*244 whether petitioners did in fact so divest themselves of all substantial rights under the franchise in a certain geographic area as to accomplish a sale, rather than a lesser transfer. We must look then to the agreements into which petitioners entered.
In our Findings of Fact we have given the substance of the provisions of the different contract agreements involved in this proceeding. Manifestly, it would not be practical to set out in this report the different contract agreements in full. We have carefully examined and considered the different provisions in these contracts and have summarized the provisions of the several contracts in the Findings of Fact. We are convinced that all these Dairy Queen franchises, with the exception of the one entered into in June 1948 with A. & M. Concessions, were sublicenses rather than sales due to the many restrictions and controls reserved by petitioners in the agreements. Therefore, we conclude that the proceeds therefrom are in the nature of royalties and constitute ordinary income rather than capital gains. We shall discuss later in this opinion the agreement entered into in June 1948 by petitioners with Concessions.
We had a similar *245 issue to the one we have here in Dairy Queen of Oklahoma, Inc., 26 T.C. 61">26 T.C. 61 (1956), and we decided the issue in favor of the Commissioner and against the taxpayers. We were reversed in that case on this issue by the Tenth Circuit in Dairy Queen of Oklahoma, Inc. v. Commissioner, 250 F. 2d 503 (1957). Needless to *785 say, we have great respect for the views of the United States Court of Appeals for the Tenth Circuit and we have reexamined the question involved carefully and we conclude that we must adhere to the views on this issue which we expressed in Dairy Queen of Oklahoma, Inc., supra.
In Joe L. Schmitt, Jr., 322">30 T.C. 322 (1958), affd. 271 F. 2d 301 (C.A. 9, 1959), we decided a somewhat similar issue to the one we have here and we decided it in favor of the Commissioner and against the taxpayer. In doing so, after reciting the several provisions of the contract agreements, we said:
We are of the opinion that the foregoing aspects of petitioner's relationship to the territorial franchise holder and the franchise itself are*246 inconsistent with the position that he had disposed of all his substantial rights in the Exact-O-Matic System within each territorial area. It is important to note that we do not rest our conclusion upon any one of petitioner's retained interests or powers, and, without doubt, there are cases in which the reservation of some similar powers and rights has been held not to be fatal. We hold that all of the rights, powers, and continuing interests reserved by petitioner, taken in combination, are of such character as to be inconsistent with a "sale or exchange" of property by petitioner, and that Congress did not intend to confer the special benefits relating to sales of capital assets in such situations. It is no answer to say that a number of the rights reserved by petitioner were merely to protect his interest in the system or to insure full payment for the assignments. That reason may explain why such reservations were made, but it does not detract from the conclusion that petitioner did not in fact dispose of all his substantial interest in the system by reason of such reserved rights when taken together with all other reserved rights, powers, and interests.
Our decision*247 in the Schmitt case was affirmed by the Ninth Circuit as we have stated above. Both our decision in the Schmitt case (1958) and its affirmance by the Ninth Circuit (1959) were subsequent to the Dairy Queen of Oklahoma, Inc., case.
The facts in the instant case are so similar to those present in Dairy Queen of Oklahoma, Inc., that we feel we would not be able to draw a valid distinction between the facts in the instant case and those which were present in that case. Therefore, for the reasons stated in our opinion on this issue in Dairy Queen of Oklahoma, Inc., and of our decision in Joe L. Schmitt, Jr., decided since the Dairy Queen case, we decide the first issue in favor of respondent, except as to the contract of sale entered*509 into by petitioners and Concessions in June 1948.
We hold, except as noted, that the lump-sum payments, the gallonage payments, and the royalties are taxable as ordinary income and not as long-term capital gains.
Now as to the contract of sale entered into by petitioners with Concessions in June 1948, we hold that that was a sale. The facts with reference to this sale are set out in our Findings of Fact and need not *786 *248 be repeated here. We also found as a fact that the territorial rights which petitioners sold to Concessions were not property which petitioners held primarily for sale in the ordinary course of their business. Therefore, petitioners are entitled to receive long-term capital gains treatment for whatever gain resulted to them from this sale to Concessions. As to this particular transaction, we hold in favor of petitioners.
The next question presented is whether, for the purpose of determining the gain upon the sales of subfranchises, petitioners are entitled to an allocation of their basis in the rights in the proportion which the 1940 population of each subfranchised area bears to the total 1940 population of Washington and Oregon. The evidence is clear and uncontroverted that in petitioners' negotiations with the McCulloughs, the basis used in arriving at the price for the master franchise was 1 cent per person living in those States, based on the 1940 census. The total figure thus computed was discounted from in excess of $ 28,000 to $ 24,000 because petitioners were taking a franchise for two rather than one State.
The petitioners point out in their brief that the Commissioner*249 in his notice of deficiency did not allow the petitioners any cost basis whatsoever for the sales of sublicenses made by them in the years 1948, 1949, and 1950 in determining petitioners' gain on such sales. The Commissioner's answer to this contention of petitioners is that inasmuch as the subfranchises granted by petitioners were mere licenses and not sales of property, there was no occasion to allocate cost between the cost of petitioners' master franchise and the several subfranchises or licenses which they granted to others. We agree with this general contention of respondent. However, as has already been stated, we have held that one of the agreements in issue, namely, the one between petitioners and Concessions dated June 1948, was a sale. In reference to this sale, the parties have stipulated as follows:
The tangible assets sold by the partnership, Dairy Queen Stores, Inc. to the A & M Concessions, Inc., on June 9, 1948 * * * had a remaining basis to the said partnership on the date of said sale in the amount of $ 6,535.89.
In view of this stipulation, in computing gain or loss on the sale made by petitioners to Concessions, the remaining basis of the tangible assets*250 as stipulated should be used. Also, in allocating a portion of the cost of the master franchise which was $ 24,000 to the subfranchise which petitioners sold to Concessions, embracing all of Pierce County, Washington, the population formula contended by petitioners should be used. It seems to us that this formula is reasonable and fair, and should be used in a computation under Rule 50.
Decisions will be entered under Rule 50.
Footnotes
1. SEC. 117. CAPITAL GAINS AND LOSSES.
(a) Definitions. -- As used in this chapter --
(1) Capital assets. -- The term "capital assets" means property held by the taxpayer (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business, or property, used in the trade or business, of a character which is subject to the allowance for depreciation provided in section 23(1) * * *.
* * * *
(4) Long-term capital gain. -- The term "long-term capital gain" means gain from the sale or exchange of a capital asset held for more than 6 months, if and to the extent such gain is taken into account in computing net income;↩