*4309 Value of patents as of March 1, 1913, determined.
*1030 This is a proceeding for the redetermination of income taxes for the year 1919 in the sum of $62,499.06. Two questions are presented for decision: (1) The valuation of certain letters patent as of March 1, 1913, the petitiner claiming a value of $250,000, the respondent having allowed $20,000; and (2) whether respondent erred in reducing the amount of $20,000 by $7,253.87 for exhaustion between March 1, 1913, and the date of sale in 1919.
FINDINGS OF FACT.
On May 26, 1919, petitioner sold letters patent serial No. 1010556, applied for April 8, 1911, and issued to him on December 5, 1911, and serial No. 1022452, applied for October 24, 1911, and issued to him on April 9, 1912, to the Kalamazoo Loose Leaf Binder Co., a corporation, hereinafter referred to as the Company, for the sum of $139,150.
The respondent determined that the said two patents which were owned by petitioner on March 1, 1913, had a then fair market value of $20,000. He reduced this value by deducting depreciation based*4310 on the life of the patents remaining after March 1, 1913, and held that the depreciated value of the patents on the date of sale was $12,746.13 ($20,000 less $7,253.87) and that the net gain from the sale of said patents was $126,403.87, which he added to petitioner's net income and computed thereon the deficiency contested in this proceeding.
The facts concerning the invention and use of the two patents and the profits therefrom are as follows:
*1031 George P. Wigginton was employed by the Company in February, 1907, as superintendent of its plant. In 1909 he invented the binder upon which the first patent was issued, and later made improvements thereon on which the latter patent was issued.
56, issued to George P. Wigginton on December 5, 1911, reads in part as follows:
This invention relates to improvements in temporary binders.
The main objects of this invention are: First, to provide in a temporary binder or loose sheet holder, an improved adjusting mechanism. Second, to provide an improved binder or loose sheet holder of the binding core or strip type in which the tension on the binding strips is not materially varied by the opening or closing*4311 of the binder, or the swinging of the covers. Third, to provide in a temporary binder, an improved leaf clamping bar. Fourth, to provide an improved temporary binder by which any number of leaves up to the maximum may be effectively clamped and one in which the binder mechanism is so constructed that the covers may be made very thin. Fifth, to provide an improved binding mechanism which is particularly adapted for embodiment in light or small binders. Sixth, to provide in a temporary binder, an improved cover structure. Seventh, to provide an improved temporary binder which is very economical in structure and simple and easy to manipulate.
Letters 52, issued to George P. Wigginton on April 9, 1912, reads in part as follows:
This invention relates to improvements in temporary binders.
My present invention is an adaptation and in some respects an improvement upon the apparatus shown in Letters , issued to me on the 5th day of December, 1911.
The main objects of this invention are, first, to provide in a temporary binder or loose sheet holder, an improved adjusting mechanism. Second, to provide an improved temporary binder or loose sheet*4312 holder which is capable of very rapid manipulation to permit the insertion or removal of sheets or leaves, and one in which the sheets may be securely clamped, the mechanism at the same time being simple and compact, so that it may be embodied in small binders. Third, to provide an improved temporary binder or loose sheet holder having a back strip or piece which is automatically adjusted upon the adjusting of the binder.
Prior to the time of the aforesaid invention by Wigginton the Kalamazoo Loose Leaf Binder Co. was making a thong binder of heavy record type. At that time the binders on the market besides this heavy thong binder were a metal-back binder, a heavy record binder, post binders and ring binders.
The binder covered by the said patents was known as the "Kalamazet Binder," and it differed from the binders which were on the market prior to its invention, among other things, in that it held the sheets by compression between the so-called clamping bars; it had no projecting posts; it would hold one sheet or many, the sheets could be removed easily by separating the sheet body, and it had an adjustable *1032 back which adjusted itself to the number of sheets in*4313 the binder; it had greater durability than other binders and was neater in appearance; it was suitable for binding such things as price lists, catalogues, small sheets used for chronological case records, cash receipt and disbursement and sales records; it was cheaper to make than the other binders, and sold for less; the only machinery necessary to manufacture the Kalamazet binder was a punch press. Such a punch press cost approximately $150 and each press would make many thousands of binders. On March 1, 1913, a considerable amount of machinery was required to make the other binders then on the market, including stickers, wood-working machines of various kinds, including special machines, drill presses, punch presses, screw machine parts, special screw machine ends, dies and generally all wood-working machines and tools.
When the Kalamazet binder was first put on the market it excited great interest among consumers and found a ready market. Of the total sales price of the Kalamazet binder on March 1, 1913, approximately 60 per cent thereof was net profit to the Company. On the sale of sheets and indexes the net profit was 10 per cent of the selling price.
The company began*4314 to manufacture the Kalamazet binder in 1910. By March 1, 1913, no further expense was needed to have a commercial article. Before it began to make this binder it was doing practically a local business, but immediately after the patent license hereinafter referred to was procured, it began to establish national business and now its business extends over the entire country.
Wigginton allowed the Company to manufacture the binder without paying him any royalty or compensation from 1910 to the date of the contract of May 26, 1913, hereinafter referred to, in order to get the device on the market and to establish some indication of its value. Whenever the Kalamazet binder was sold on and prior to March 1, 1913, and at the present time, there is and was, as a general rule, incidental to the sale of this binder a sale of sheets and indexes to be contained in it. The prices obtained from the sales of sheets incidental to the sale of the binders averages two-thirds of the gross selling price of the binders. The company's sales of the Kalamazet binder and the profits thereon for the years from 1910 to and including 1912 and for the first three months of 1913 were as follows:
| Year | Sales | Profit |
| Year ended Dec. 31: | ||
| 1910 | $2,541.70 | $1,525.02 |
| 1911 | 14,384.20 | 8,630.52 |
| 1912 | 33,891.89 | 20,335.13 |
| First 3 months of 1913 | 15,219.05 |
*4315 *1033 The sales of this binder continued to increase until in 1925 they amounted to $237,772.88, and for the first five months of 1926 amounted to $130,577.41.
The net profits of the company from the year 1910 to and including the year 1918 were as follows:
| 1910 | $15,124.91 |
| 1911 | 19,874.22 |
| 1912 | 33,558.49 |
| 1913 | 66,333.48 |
| 1914 | 44,254.62 |
| 1915 | $38,397.26 |
| 1916 | 103,277.82 |
| 1917 | 273,697.15 |
| 1918 | 305,322.73 |
Late in 1912 and early in 1913 the company began negotiations with Wigginton, its superintendent, for the purchase of the said patents from him. At that time he owned $500 worth of stock in the company. He owned the same amount when he sold these patents to the company in 1919. John J. Knight, who had been president of the company and was then chairman of its board of directors, offered Wigginton $150,000 for the two patents in January, 1913. Wigginton declined the offer, stating he would sell them for $250,000. Knight then discussed the matter with Frank W. Blowers, who was then president of the company. Blowers was authorized by the board of directors of the company to negotiate with Wigginton for the acquisition of the patents. He was*4316 advised of the offer made to purchase the patents for $150,000 and of its rejection, and discussed it with Wigginton. He negotiated with Wigginton a contract which was entered into on February 24, 1913, and is as follows:
MEMORANDUM OF AGREEMENT made and entered into between the Kalamazoo Loose Leal Binder Company, a Corporation organized and existing under the Laws of the State of Michigan and George P. Wigginton of No. 1409 Sherwood Avenue, in the City of Kalamazoo, Michigan.
WHEREAS the said George P. Wigginton, is employed as General Manager of the Kalamazoo Loose Leaf Binder Company, at a salary of three thousand five hundred dollars per annum:
AND WHEREAS the said George P. Wigginton has invented certain new and useful improvements in Temporary Binders or Loose Sheet Holders for which Letters Patent of the United States have been issued as follows:
Serial Number 1010556 issued December 5th, 1911.
Serial Number 1022452 issued April 9, 1912.
The said Letters Patent being issued in the name of said George P. Wigginton and no other person, firm or corporation having any right, title or interest therein or thereto:
AND WHEREAS the said Kalamazoo Loose Leaf, Binder*4317 Company desires to acquire the full and exclusive right to the said inventions as fully set forth and described in the several Letters Patent of the United States above specified, and to any other new and useful improvements in Temporary Binders or Loose Holders that the said George P. Wigginton may now own or may hereinafter invent or acquire:
*1034 AND WHEREAS the said George P. Wigginton in consideration of his assigning all his title and interest in the above-mentioned inventions and Letters Patent, to the said Kalamazoo Loose Leaf Binder Company, desires some remuneration over and above the salary paid to him as General Manager.
Now, in consideration of the sum of one dollar in hand paid by each of the parties hereto to the other, the receipt of which is hereby mutually confessed and acknowledged,
The Kalamazoo Loose Leaf Binder Company does hereby agree to pay to the said George P. Wigginton in addition to the salary of three thousand five hundred dollars per annum before mentioned, additional annual compensation during the term of this Agreement, the amount of such additional compensation for any one year to be based upon the Net Profits of the Company for the*4318 year immediately preceding and to be equivalent in amount to Ten per centum of such Net Profits of the preceding year, said Net Profits to be computed from the same items of revenue and expenses, including proper charges for depreciation of the Company's plant, equipment, machinery, tools stocks of materials and supplies, etc., as are used to determine the Net Income as reported to the United States Internal Revenue Department under Section 38 Act of Congress approved August 5th, 1909, the said items of Revenue, Expenses and Depreciation and the Inventories of all property, machinery, tools, materials and stocks on hand, us ed in determining the amount of such Net Income or Profit shall be audited and approved by the Board of Directors of the said Company or by a Committee of said Board of Directors or by a competent Auditor or in such other way as may be directed by said Board: It being understood and agreed that the amount of said additional compensation charged to Expense in any one year shall be excluded from the expense items used in computing the amount of Net Profits for that year on which to base the additional compensation for the succeeding year. And the said Kalamazoo Loose*4319 Leaf Binder Company agrees that the said George P. Wigginton shall continue to manage the business of the said Company during the term of this agreement subject to the direction of the President and the Board of Directors as required by the By-laws of the Company.
The said George P. Wigginton does hereby agree to immediately assign to the Kalamazoo Loose Leaf Binder Company all of his right, title and interest in the inventions and Letters Patent issued for same as hereinbefore specified, and the said George P. Wigginton does hereby agree to assign to the Kalamazoo Loose Leaf Binder Company all of his right, title and interest in any and all other new and useful improvements in Temporary Binders or Loose Sheet Holders that he may now own or may invent or acquire, and in the Applications for Letters Patent and Letters Patent of the United States that may be obtained therefor during the term of this Agreement, and the said George P. Wigginton further agrees to devote his whole time and energy to the development and furtherance of the Kalamazoo Loose Leaf Binder Company's business during the term of this Agreement.
It is hereby mutually agreed that in the event of the death of the*4320 said George P. Wigginton during the term of this Agreement that the said Kalamazoo Loose Leaf Binder Company shall pay to the Estate of the said George P. Wigginton a sum equal to the value of all such Patents as shall have been assigned to the said Company by the said George P. Wigginton under the Terms of this Agreement, as the value of said Patents may appear at the time of said death; such value to be determined by three Arbitrators, one of whom shall be named by the Estate of said George P. Wigginton, one to be named by the said Kalamazoo Loose Leaf Binder Company, and these two arbitrators to select the third arbitrator. It is agreed that in determining the value of said Patents *1035 the value of each as an independent invention shall be considered, together with the value of said invention as forming a part of the business of the said Kalamazoo Loose Leaf Binder Company and the necessity and use of said invention in the manufacture of the Company's devices and in the operation of said Company's business. The decision of said Arbitrators to be final.
It is hereby mutually agreed that in the event of the Kalamazoo Loose Leaf Binder Company desiring to sell out to*4321 or consolidate with some other Company during the term of this Agreement that the said Kalamazoo Loose Leaf Binder Company shall pay to the said George P. Wigginton a sum equal to the value of all such Patents as shall have been assigned to the said Company under the terms of this Agreement, such value to be determined by three arbitrators selected as provided for above in the case of said Wigginton's demise and the value of such patents to be determined in a similar manner and upon the same basis.
It is hereby mutually agreed that this Agreement shall take effect as of the First day of January, A.D. 1913, and shall continue in full force and effect for a period of Five years from said date, at which time it may be renewed at the option of the said Kalamazoo Loose Leaf Binder Company for a further period of five years under the same terms and conditions as hereinbefore set forth, it being mutually understood and agreed that at the expiration of any five year renewal the said Kalamazoo Loose Leaf Binder Company may at its option renew this agreement for a further period of five years under the same terms and conditions as herein set forth:
Provided further, that in the event of*4322 the said Kalamazoo Loose Leaf Binder Company not renewing this agreement for a further period as provided above, then the Kalamazoo Loose Leaf Binder Company will re-assign such applications for Letters Patent and Letters Patent as may have been assigned by the said George P. Wigginton to said Company under the terms of this Agreement, back to the said George P. Wigginton.
It is further mutually agreed that the amount of the additional compensation provided herein for each year shall be paid to the said George P. Wigginton in two equal payments during such year, one half of the total amount being payable on the first day of February and the remaining half being payable on the first day of August.
In witness whereof we have hereunto set our hands and seals this 25th day of February, 1913.
KALAMAZOO LOOSE LEAF BINDER COMPANY,
By F. W. BLOWERS, [L.S.]
President.
And By H. S. HUMPHREY,
Vice-President.
GEORGE P. WIGGINTON.
It was understood by the parties to this contract that $3,500 was compensation for the services of Wigginton and the balance was royalty for the use of the patents. The corporation never charged off any depreciation on the patents on its*4323 books, and Wigginton returned the annual payments in excess of $3,500 under the heading of "Royalties" in his income-tax returns for the years during which they were received.
Up to the date of the sale of the patents to the company on May 26, 1919, Wigginton received under the said contract $76,000, which he returned as royalties in his income-tax returns.
*1036 Prior to March 1, 1913, the company decided, in anticipation of future business to be procured for the sale of the patented articles, to construct a new building, partly for the purpose of taking care of the orders which it anticipated getting for the patented articles and the sheet business incidental thereto. This building increased the company's capacity about 100 per cent. In 1913 it expended the money for these enlargements. The building was at that time so constructed that two additional stories might be added to it.
In 1911 or 1912 a board of officers was appointed by the Navy Department to examine the light-binder market in order to ascertain if a light, quick-operating binder could be found for the purpose of placing the naval regulations in loose leaf. The Weather Bureau also conducted such an*4324 inquiry, and it was not until the Kalamazet binder was brought to their attention that they were able to find such a binder. Prior to March 1, 1913, the Navy Department had adopted the Kalamazet binder as the standard binder for holding loose-leaf regulations; the Quartermaster Corps of the Army and other Government departments had purchased this binder. These events led the company to reasonably anticipate large future sales to the Government departments, which anticipations were fully realized.
On March 1, 1913, there was no similar binder on the market. There was no competition in the sale of the Kalamazet binder, but there was keen competition in the sale of other binders. The binders manufactured up to that time were so heavy that their use was restricted to a very limited field. with the introduction of the Kalamazet binder the field widened greatly, and by means of the sale of the Kalamazet binder the company was enabled to sell other devices manufactured by it. The Kalamazet binder was the controlling factor in building up the business of the company from a local organization to a national organization extending from coast to coast and from the Canadian border to the*4325 Mexican Gulf. The company has never been troubled by infringers.
Wigginton sold the patents to the company for $139,150 on May 26, 1919. As an incentive to induce him to sell the patents his salary was increased to $12,000 a year, and he was given an option to purchase stock of the company at its par value for $139,500, which option he exercised.
The fair market value of the two patents on March 1, 1913, was $175,000.
OPINION.
SIEFKIN: The question of the March 1, 1913, value of two patents is presented by the parties. On that date petitioner had, by contract, granted an exclusive license for five years with privileges of further *1037 renewals for further five-year periods, covering the two patents and improvements thereon which should be made. The considerations flowing to petitioner by the contract were the payment of a royalty of 10 per cent of the net profits of the company, petitioner's employment by the company at a stated salary as manager, and an agreement that in case of his death the company should pay to his estate the value of the patents at the time of death. A similar clause provided for payment to the petitioner of the value of the patents in*4326 the event that the company sold out or consolidated. The contract provided that petitioner should assign the patents to the company but should have them reassigned to him should the company not renew the agreement.
Petitioner thus had, on March 1, 1913, his patent rights largely merged in, or at least limited by, his rights and duties under the contract, effective January 1, 1913. The patents had been granted late in 1911 and in 1912 and neither petitioner nor the company had developed the market for the patented articles to the extent that the earnings therefrom up to March 1, 1913, standing alone, were any fair indication of a fair market value on that date. All of the other circumstances affecting the patents must be considered. One such circumstance is an offer to purchase the patents for $150,000 early in 1913, which offer the prospective purchaser was able and willing to carry out. Others are testimony of witnesses familiar with the devices covered by the patents as to the probable market as it existed on March 1, 1913, the steps taken by the company which acquired the rights to manufacture under the patents in enlarging its plant, the acceptance of the devices by various*4327 purchasing agencies of the Federal Government and numerous sales made to such agencies before March 1, 1913, as well as the opinions of experienced witnesses and the subsequent history of the earnings to petitioner. When we consider all this evidence, we are led to the conclusion that the fair market value of petitioner's interest in the patents on March 1, 1913, was far in excess of the amount determined by respondent. However, the subsequent history of the company and the earnings from the patents fully justified the expectations of petitioner, yet, even under such favorable conditions, the patents yielded him in royalties and sales price the total sum of $215,150 in a period of six years. Under such circumstances we believe the facts show the estimates of the witnesses to be unduly optimistic and that $175,000 more nearly represents the value. In computing the gain or loss on the sale in 1919, that amount should be reduced by the deductions for exhaustion allowable to petitioner, based upon an expiration date of December 11, 1928, the expiration date of the earlier patent, since we have no information showing that *1038 after that date the other patent will maintain the*4328 monopoly held by both up to that time.
Judgment will be entered on 15 days' notice, under Rule 50.
Considered by TRAMMELL, MORRIS, and MURDOCK.