26 T.C. 634">*635 The Commissioner determined deficiencies in income tax for the calendar years 1951 and 1952 in the amounts of $ 21,092.88 and $ 16,457.16, respectively. Petitioners contest the entire deficiencies and claim further that there is overpayment of $ 7,202.40 for 1951 and $ 3,564.76 for 1952.

The questions are: (1) Whether either or both of two transfers of rights in patents constituted sales or merely licensing agreements. The Commissioner has determined that only licensing agreements were made so that payments of $ 53,739.84 and $ 38,367.54, in 1951 and 1952, respectively, by National Air Sander, Inc., constituted royalties for the use of patents and are1956 U.S. Tax Ct. LEXIS 145">*147 taxable as ordinary income rather than long-term capital gain. (2) Whether the rates of payments under the agreements were excessive in part.

FINDINGS OF FACT.

Roy J. Champayne, hereinafter referred to as Champayne, and Gladys Champayne, husband and wife, are residents of Rockford, Illinois. Petitioners filed joint returns for 1951 and 1952 in the first collection district of Illinois.

During 1951 and 1952, Champayne received $ 53,739.84 and $ 38,367.54, respectively, from National Air Sander, Inc., under the terms of two exclusive license agreements which are referred to hereinafter. These receipts were reported by petitioners as long-term capital gains.

From 1931 to 1945, petitioners owned an automobile body and fender repair shop in Rockford, Illinois. During the 1930's and until about October 23, 1940, when National Air Sander, Inc., was organized, Champayne devoted his entire time to the operation of the shop.

Champayne is not an engineer, either by training or education. He is not a machinist, although he can do a limited amount of machine work, and he is not skilled in machine design. His occupation is that of a businessman-mechanic who was engaged in the auto body repair1956 U.S. Tax Ct. LEXIS 145">*148 business until he became affiliated as an executive with National Air Sander, Inc.

In the 1930's, when Champayne was operating his repair shop, doing body and fender repair work, he found that the pounding out of dents in and the sanding of surfaces of automobile bodies, which was done by hand, was time consuming and expensive. In order to make his work easier, Champayne experimented on the design of a pneumatic hammer to use on automobile bodies. He worked on the development of this tool in his spare time in a workshop at his home. 26 T.C. 634">*636 In 1934, he applied for a patent on the air hammer, and a patent was issued to him in 1939. Later, in 1940 and 1943, Champayne received patents on improvements on the invention.

While developing the air hammer, Champayne obtained the help of Max E. Dayton who operated a machine shop near Champayne's repair shop. Dayton made parts for about 500 hammers, he did various jobs for Champayne, and later the two became business associates.

In 1939, Champayne undertook to develop another tool, a power-operated sanding machine for body and fender work, but because of his lack of mechanical skill he was not entirely successful. He asked Dayton to 1956 U.S. Tax Ct. LEXIS 145">*149 help him, promising to give Dayton a 25 per cent interest in a corporation to be formed for the purpose of making and selling the pneumatic sanding machine. Dayton agreed to help Champayne. In May 1940, a pneumatic sander, known as the A-S (Air-Sander) model, was completed. They built 100 A-S sanders and promptly sold them. Champayne received a patent on the A-S sander.

Prior to October 1940, Champayne had received four or five patents for which he did not give any assignment or exclusive license.

On October 23, 1940, Champayne and Dayton organized under Illinois laws, National Air Sander, Inc. (hereinafter called National), the primary purpose of which was to make and sell air sanding machines. The authorized capital of the corporation was 3,000 shares of common stock having a par value of $ 5 per share. The stock was initially issued and held as follows:

Dayton received his 750 shares of stock solely in exchange for the work he had done in assisting Champayne in developing the A-S sanding machine. Champayne received1956 U.S. Tax Ct. LEXIS 145">*150 1,500 shares in exchange for his assignment to National of all of his right, title, and interest in the patent on the A-S sanding machine, and for certain inventory and equipment. Gladys Champayne received 750 shares for her interest in certain machines and equipment which were transferred to the corporation by virtue of her having been in partnership with her husband.

National rented a small building on West State Street in Rockford shortly after incorporation and immediately went into production of the A-S model sanding machine. Such production was small, however, due to the limited capital available and the nature of the venture. Neither Champayne nor Dayton devoted full time to National during this initial period. In the spring of 1941, National enlarged its shop 26 T.C. 634">*637 by renting space in an adjoining building. In March 1941, Dayton terminated his employment at a machine company and began to devote his entire time to National; Champayne continued to devote part of his time to his repair shop business. Before National was able to get into large production of the A-S sander, our country entered World War II and National had to discontinue, nearly, production of the sander. 1956 U.S. Tax Ct. LEXIS 145">*151 National did subcontract work for other concerns engaged in war production.

In the summer of 1941, Champayne began experimenting with a new model of a lighter and smaller sanding machine. He conceived the idea of this device at his home workshop away from National's shop. Champayne worked on the model in his home workshop. Dayton gave him some assistance. Some work on parts for the model was done in National's shop, but not enough to give National "shop rights" in the device eventually developed, and the making of the parts which were worked on at National's shop did not constitute an element in the conception of the invention itself.

In April 1942, Dayton left National and went to work for another firm as its chief engineer, but he continued to hold the office of vice president of National, and to hold stock.

By November 1942, Champayne had completed a new sander model. On December 11, 1942, he applied for a patent. On January 23, 1945, the patent, No. 2,367,668, was granted to Champayne.

The new sander was given the name Mity Midget. This machine had a power-driven rubbing element with a positive gyratory motion; it differed substantially from the A-S sander; and it was 1956 U.S. Tax Ct. LEXIS 145">*152 considerably lighter in weight. National was permitted to manufacture on an experimental basis a limited number of the Mity Midget sanding machines in 1942 because Champayne wanted to put a few on the market as "trial horses." The Mity Midget was well received but war restrictions on materials limited or prevented production.

On January 25, 1945, Champayne granted National an exclusive license to manufacture, sell, and use the Mighty Midget, or Mity Midget (each name referring to the sander covered by patent No. 2,367,668) for which National was to pay up to 5 per cent of net sales. The board of directors of National approved the license agreement and authorized National to procure the exclusive license. The license agreement provided, inter alia, as follows:

LICENSE

Agreement between ROY J. CHAMPAYNE, of Rockford, Illinois, as "Licenser", and NATIONAL AIR SANDER, INC., a corporation, of Rockford, Illinois, as "Licensee", made and entered into January 25, 1945;

* * * *

Whereas, licensee desires to obtain a license to make, sell, use and embody the inventions, sanding machines.

26 T.C. 634">*638 Now, Therefore, in consideration of the premises herein and other good considerations, the1956 U.S. Tax Ct. LEXIS 145">*153 parties agree as follows:

1. Licenser does hereby give and grant to licensee an exclusive right and license to manufacture, sell and use sanding machines to be known as "Mighty Midget", embodying the inventions described and claimed in my application for United States Letters Patent, Serial No. 468,726 filed December 11, 1942, and the patent issued thereon, No. 2367668, January 23, 1945, for the full term thereof, and the like license under any United States patents which may hereafter be granted to me covering improvements in the same subject matter, together with a right to grant sub-licenses thereon, said license to be world-wide and for the life of the patent or of this agreement, if sooner terminated as herein provided.

2. In consideration of said license, I shall be paid royalties upon each Mighty Midget Sanding Machine manufactured as follows: For the calendar year 1945, none; For the calendar year 1946, one-half (1/2) of one (1%) per cent of the net sales price received by the NATIONAL AIR SANDER, INC.; For the calendar year 1947, one (1%) per cent of the net sales price received by the NATIONAL AIR SANDER, INC.; For the calendar year 1948, two (2%) per cent of the net sales1956 U.S. Tax Ct. LEXIS 145">*154 price received by the National Air Sander, Inc.; For the calendar year 1949, three (3%) per cent of the net sales price received by the NATIONAL AIR SANDER, INC.; For each calendar year after 1949, five (5%) per cent of the net sales price received by the NATIONAL AIR SANDER, INC.; said royalties to be paid on or before the 60th day following the end of each calendar year.

3. In the event that the royalties hereunder shall be less than $ 5,000.00 for the calendar years, 1946, 1947, and 1948, or shall be less than $ 7,500.00 for the year 1949, or $ 10,000.00 for each year after the year 1949, then the licenser shall have the option to terminate the exclusiveness of the license herein granted by delivering a 30 day notice of such termination period.

4. Licensee shall have the right to terminate this agreement at any time after December 31, 1949 by delivering to licenser a 60 day written notice and the payment to him of the sum of $ 25,000.00. Thereupon, the license herein shall terminate and said license shall automatically terminate upon the expiration of all letters patent.

In Witness Whereof, I have hereunto set my hand and seal this day and year first above written.

[s] Roy J. 1956 U.S. Tax Ct. LEXIS 145">*155 Champayne [SEAL]

The exclusive license agreement was not signed by National.

Instead of asking for a 5 per cent rate of payment over the life of the patent of Mity Midget, Champayne agreed to accept a reduced, graduated rate on the Mity Midget sales for the first 5 years, up to 5 per cent, so as to permit National to establish itself financially.

In 1945, Champayne sold the body and fender repair shop and retired from that business. Thereafter, he devoted full time to National.

In 1946, National moved from West State Street into a garage on Kishwaukee Street in Rockford, which new space provided about 2 1/2 times the space formerly occupied.

During the period 1942 to 1946, Champayne worked on and developed another sander model which employed two sanding pads operating in a circular motion. It could be used chiefly in the furniture manufacturing industry and only to a minor extent in the automobile industry. This model eventually was given the name Two Pad 26 T.C. 634">*639 sander. Champayne conceived the idea for this device at his home workshop where he worked on this model. He did some of the work on parts for this model in National's shop but not enough to give National "shop rights" 1956 U.S. Tax Ct. LEXIS 145">*156 in the device eventually developed, and the making of the parts which were worked on at National's shop did not constitute an element in the conception of the invention itself.

On April 30, 1945, Champayne submitted rough drawings of the Two Pad sander to his patent attorney. On February 1, 1946, he applied for a patent, and on December 9, 1952, Champayne was granted a patent on the Two Pad sander, patent No. 2,620,775.

The Two Pad sander was a much more costly tool to develop than the Mity Midget; it is a more costly tool to produce than the Mity Midget; a greater percentage of profit could be realized on its sale than on the sale of a Mity Midget; its market is not as extensive as that of the Mity Midget, because its sales are limited, almost exclusively, to furniture manufacturers and there are not as many furniture manufacturing concerns as there are automotive body and repair shops.

Champayne's conceptions of the mechanical sander devices came to him through his automobile body repair work and in the course of his thinking of means of making the work easier.

Champayne, not being an engineer, was incapable of making the drawings which are required for patent purposes to set forth1956 U.S. Tax Ct. LEXIS 145">*157 an invention. He was not professional in his procedures. For example, he did not recognize the importance of keeping a diary or other record with respect to the developments of his inventions. He was a "tinkering type" of inventor. It was Champayne's practice to approach his patent attorney with either extremely crude sketches or a crude model of the device he had developed, and a draftsman in his patent attorney's office actually prepared and worked up, from Champayne's crude sketches or models, the drawings that were required to be submitted with patent applications to the United States Patent Office.

Champayne has never solicited the sale or licensing of the Mity Midget, the Two Pad sander, or any other of his inventions. Champayne was not in the business of making inventions.

In 1946, Champayne and Dayton entered into negotiations with respect to one buying the other's stock interest in National Air Sander, Inc. As a result of their negotiations, National purchased Dayton's 750 shares on December 20, 1946, for $ 163,750. Thereafter, the petitioners were National's sole stockholders. The 750 shares acquired from Dayton were held by National as treasury stock until September1956 U.S. Tax Ct. LEXIS 145">*158 15, 1947, at which time these shares of stock were canceled.

On November 17, 1947, the authorized capital stock of National was increased to 250,000 shares of common stock of a par value of $ 5 per share. On December 12, 1947, a stock dividend of 25 shares of 26 T.C. 634">*640 common stock for each share of outstanding stock was declared and made. Thereafter, and through the years 1951 and 1952 here involved, the stockholders of National and their respective stock interests were as follows:

On June 7, 1948, Champayne, at a meeting of National's directors, advised the directors that he was willing to enter into a license agreement covering the Two Pad sander of the same type as the license agreement covering the Mity Midget, except that the royalty rate would be 20 per cent. The directors, on June 7, 1948, approved the exclusive license agreement.

On June 7, 1948, Champayne granted National an exclusive license to manufacture, use, and sell the Two Pad sander, also called Model No. 300. The license agreement was almost identical with 1956 U.S. Tax Ct. LEXIS 145">*159 the license agreement of January 25, 1945, covering the Mity Midget, and it provided, inter alia, as follows:

Now, Therefore, in consideration of the premises herein and other good considerations, the parties agree as follows:

1. Licenser does hereby give and grant to licensee an exclusive right and license to manufacture, sell and use sanding machines to be known as the "Model #300" two pad reciprocating sander, embodying the inventions described and claimed in my application for United States Letters Patent, Serial No. for the full term thereof, and the like license under any United States patents which may hereafter be granted to me covering improvements in the same subject matter, together with a right to grant sub-licenses thereon, said license to be world-wide and for the life of the patent or of this agreement, if sooner terminated as herein provided.

2. In consideration of said license, I shall be paid royalties upon each Model #300 two pad reciprocating sander manufactured as follows: Twenty (20%) per cent of the net sales price received by the NATIONAL AIR SANDER, INC., said royalties to be paid on or before the 60th day following the end of each calendar year.

3. In 1956 U.S. Tax Ct. LEXIS 145">*160 the event that the royalties hereunder shall be less than $ 5,000.00 for the calendar years 1948, 1949 and 1950, or shall be less than $ 7,500.00 for the year 1951, or $ 10,000.00 for each year after the year 1951, then the licenser shall have the option to terminate the exclusiveness of the license herein granted by delivering a thirty day notice of such termination period.

4. Licensee shall have the right to terminate this agreement at any time after December 31, 1951 by delivering to licenser a sixty day written notice and the payment to him of the sum of $ 25,000.00. Thereupon, the license herein shall terminate and said license shall automatically terminate upon the expiration of all letters patent.

In Witness Whereof, I have hereunto set my hand and seal this day and year first above written.

[s] Roy J. Champayne [SEAL]

26 T.C. 634">*641 National did not sign the above instrument.

The exclusive license agreements were not filed in the Patent Office.

During the years 1950 and 1951, National's sales of the Mity Midget sanding machine amounted to $ 496,179.01 and $ 458,671.77, respectively. National accrued the payments due under the agreement, and it made payment thereof to Champayne1956 U.S. Tax Ct. LEXIS 145">*161 in the years 1951 and 1952 in the amounts of $ 24,808.95 and $ 22,933.59, respectively.

During the years 1950 and 1951, National's sales of the Two Pad sanding machine amounted to $ 144,654.46 and $ 96,715.48, respectively. National accrued the payments, and it made payment thereof to Champayne in 1951 and 1952 in the amounts of $ 28,930.89 and $ 15,433.95, respectively.

The sales of the Mity Midget and the Two Pad sanders by National during the years 1945 through 1952, and the amounts it accrued on its books during those years as the payments due and owing thereon to Champayne, were as follows:

Sales of parts and service by National in connection with the Mity Midget and the Two Pad sanders for the years 1946 through 1952, upon1956 U.S. Tax Ct. LEXIS 145">*162 which National made no payments to Champayne, aggregated $ 815,000.

During 1951 and 1952, National Air Sander, Inc., declared and paid dividends to its two stockholders, the petitioners, as follows:

The exclusive license agreements of January 25, 1945, and June 7, 1948, were bona fide agreements and they were made at arm's length and in good faith. They were not sham, fiction, or tax avoidance arrangements. National is a bona fide corporation having a real entity separate and distinct from its stockholders.

It was Champayne's desire and intent that National should have the whole interest in his two inventions, Mity Midget and Two Pad 26 T.C. 634">*642 sanders, for the entire life of each invention if National so desired. He intended each agreement to be an exclusive license agreement.

National desired and intended to receive from Champayne an exclusive license to make, use, and sell the Mity Midget sanding machine and the Two Pad sanding machine.

The Mity Midget sanding machine sold for $ 79.50 each. It was a valuable invention because of a counterbalancing1956 U.S. Tax Ct. LEXIS 145">*163 arrangement incorporated in the device which enabled the weight of the tool to be reduced considerably and which also increased the efficiency and perfection of its abrasive action. It was a valuable invention because it also gave the user of the tool an advantage over competitors. The Mity Midget is operated by compressed air pressure requiring 50 to 75 pounds. It operates with great speed and its speed can be varied from 4,000 to 6,000 revolutions per minute, depending on the surface desired and the abrasive being used. It has interchangeable pads for wet and dry sanding; has an instant starting trigger on a top which fits the palm of the hand for close work; it has a handle on the side for 2-hand operation; it weighs only 4 pounds, it can be used on metal, wood, leather, plastic, and composition surfaces; it is a high speed, all purpose tool; it has an orbital action. The patent related to a special clamp on the machine which fastened the abrasive material used, such as pads of sandpaper, felt, sponge rubber, or neoprene; the pads are interchangeable.

Champayne wanted to receive as the consideration for his transfer of the patent of the Mity Midget the normal rate of payment, 1956 U.S. Tax Ct. LEXIS 145">*164 but in its beginning years National had a small amount of capital and it needed to become financially established. Because of that need, Champayne believed that during the first 5 years of production of Mity Midget it was fair and practical to ask for a low and gradually increasing rate of payment. Accordingly, it was satisfactory to him and to National that in the first year of the exclusive license agreement, no payments would be made; that in each of the succeeding 4 years the rates of payments would be, respectively, 1/2 of 1 per cent; 1 per cent; 2 per cent; and 3 per cent; and that thereafter during each year of the life of the patent or of the agreement the rate of payment would be 5 per cent of the net selling price per unit sold. This arrangement had a legitimate business purpose.

A reasonable and normal rate of payment for the rights transferred to National under the Mity Midget exclusive license agreement was 5 per cent of the net selling price during the life of the patent or of the agreement. The payments under the Mity Midget agreement for the taxable years 1951 and 1952 were reasonable.

The Two Pad sander sold for from $ 100 to $ 125 depending upon the types of 1956 U.S. Tax Ct. LEXIS 145">*165 sanding shoes on the tool. It is a valuable invention 26 T.C. 634">*643 and was the first rubbing machine adapted to wood polishing. It was designed to hold various types of sanding shoes and pads for use in "sanding" or finishing wood surfaces to give the surface a fine finish. As in the case of the Mity Midget, the patent on the Two Pad related to a special clamp on the machine which fastened the abrasive material used, such as pads of fine sandpaper, felt, natural rubber, or neoprene, to a sanding shoe. The Two Pad is a straight-line action, two pad air sander with a built-in water spray for wet sanding. Nine different pads and two sizes of pad shoes are available for the Two Pad sander each of which is designed for a special finishing operation, and pads and shoes are easily and quickly interchanged. There was a market for the Two Pad sander in Rockford, Illinois, because it is a furniture manufacturing center.

A reasonable rate of payment for the rights transferred to National under the Two Pad exclusive license agreement was 5 per cent of the net selling price during the life of the patent or the agreement.

Champayne's proposal that National make payments under the Two Pad exclusive1956 U.S. Tax Ct. LEXIS 145">*166 license agreement at the rate of 20 per cent of the net sales price per unit was a bona fide arrangement based upon his understanding that such rate was not lacking in the practice of negotiating for payments for patent rights and was justified by the sales price of the tool, the fact that it was an entirely new tool for use in the furniture industry, the extent of the market for the tool, and other business reasons. The agreement that the rate of payments would be 20 per cent of net sales price was not a tax avoidance scheme and did not make the exclusive license agreement one made in bad faith, or a fiction, or a sham.

Payments under the Two Pad exclusive license agreement for 1950 sales, paid to Champayne in 1951, and for 1951 sales, paid to him in 1952, based upon the rate of 5 per cent of net sales in the respective amounts of $ 7,232.72 and $ 3,858.49 constituted reasonable payments under the license agreement.

Payments under the Two Pad exclusive license agreement for 1950 and 1951 sales, paid to Champayne in 1951 and 1952, were excessive to the extent of $ 21,698.17 and $ 11,575.46, respectively, and represented distributions of earnings of National, i.e., dividends, to Champayne1956 U.S. Tax Ct. LEXIS 145">*167 in 1951 and 1952.

Upon audits of petitioners' returns for 1951 and 1952, an agent proposed deficiencies, prior to the issuance of the statutory notice of deficiency, in the amounts of $ 7,202.40 and $ 3,564.76, respectively, which amounts were paid by petitioners on July 21, 1954, and were duly assessed by the district director for the Chicago district. Thereafter, on Feburay 23, 1955, petitioners filed claims for refund (Treasury Form 843).

26 T.C. 634">*644 The facts which have been stipulated which are not set forth above are found as stipulated and the entire stipulation of facts is incorporated herein by this reference.

OPINION.

In the joint returns of the petitioners for 1951 and 1952, receipts from National under the two exclusive license agreements were reported in the total amounts of $ 53,739.84 and $ 38,367.54, respectively, and were treated as long-term capital gains of which 50 per cent was taxable. The Commissioner determined in the statutory deficiency notice that the above receipts were not long-term capital gains within the purview of section 117, subsections (a), (b), and (c), 1939 Code, and that therefore the entire amounts of the receipts were subject to tax.

The respondent1956 U.S. Tax Ct. LEXIS 145">*168 contends that either the two exclusive license agreements were a fiction, a sham, and not what they purported to be, or that they were only licensing agreements as distinguished from sales of all of the substantial rights of Champayne in the two patents involved. If either of the Commissioner's contentions is correct, it would follow that the payments under both agreements, which Champayne received in the taxable years 1951 and 1952, would be taxable in full. The respondent's first contention, if sustained, will result in a determination that the payments in question represented distributions of earnings of National, taxable as dividends.

Respondent makes another contention which is related to his contention that both agreements were a fiction and should not be recognized as what they purport to be. This additional contention is that the 20 per cent rate of payments prescribed in the Two Pad sanding machine agreement was excessive. This contention must be considered along with the question whether either both agreements were or the Two Pad sander agreement was a fiction and a sham. If, however, it is held that the Two Pad sander agreement was a bona fide, arm's-length agreement, 1956 U.S. Tax Ct. LEXIS 145">*169 respondent's additional contention takes on another aspect which is that the 20 per cent rate was excessive to the extent of 15 per cent which part, respondent argues, represented a distribution of earnings of National taxable as dividends.

We shall first consider the question whether either or both of the exclusive license agreements was or were a fiction and lacking in bona fides.

The owner of the patent on the Mity Midget and of the patent applications on the Two Pad sander, Champayne, owned 50 per cent of National's stock, his wife owned 25 per cent, and Dayton owned 25 per cent at the time the Mity Midget agreement was executed by Champayne. When the Two Pad agreement was executed, Champayne 26 T.C. 634">*645 owned 66.67 per cent, and his wife owned 33.33 per cent of National's stock. There was, therefore, at both times control of National through stock owned by either Champayne and his wife or by Champayne. This relationship of the owner of the patent and patent application (which are referred to hereinafter, for convenience, as the patents) to National requires close scrutiny of both agreements and the circumstances under which they were made. In deciding this question both the1956 U.S. Tax Ct. LEXIS 145">*170 bona fides of the transactions and the reasonableness of the amounts of the payments to Champayne under the agreements require consideration. Cf. Granberg Equipment, Inc., 11 T.C. 704; Differential Steel Car Co., 16 T.C. 413.

Respondent's arguments have been carefully considered together with the entire record. It is recognized that in a situation such as the one before us, where the principal stockholder of a corporation also owns a patent and receives payments out of the sales of the patented article, it is possible for a transaction involving such payments to give rise to suspicion. But, as has been said before, tax issues cannot be decided on suspicion; they must be decided on the facts of each particular case, taking into account the burden of proof, if any, which may be upon the taxpayer or upon the respondent, as the case may be.

The findings which have been made dispose of this question. Upon the entire record, we would not be justified in disregarding the separate entity of the corporation, National, which is legally recognized as distinct from the individuals who are the stockholders, simply because Champayne1956 U.S. Tax Ct. LEXIS 145">*171 was dealing with a corporation in which he and his wife, or he alone, owned the controlling shareholdings. "An agreement between a corporation and its sole stockholders is valid and enforceable, if the arrangement is fair and reasonable, judged by the standards of a transaction entered into by parties dealing at arm's length." Stearns Magnetic Mfg. Co. v. Commissioner, 208 F.2d 849, 852. Furthermore, it was entirely permissible for Champayne to grant to a corporation which was equipped to manufacture the items, either exclusive licenses or mere licenses, provided the transactions were bona fide. Such transactions are common in business and commercial practice. We are satisfied that the agreements with National had a business purpose. Both of the patented tools were valuable; they incorporated original conceptions worthy of receiving patents, they were items requiring manufacture and sale. Champayne had the right to transfer the patents to the manufacturing and selling corporation if he desired to do so, as he did.

We do not have here a great disparity between the dividends paid by the corporation, National, and the amounts of the payments under1956 U.S. Tax Ct. LEXIS 145">*172 the agreements. For example, the total amount of dividends paid in 1951 and 1952 amounted to $ 32,175 in each year; and the total payments 26 T.C. 634">*646 under the two agreements amounted to $ 53,739.84 and $ 38,367.54 in 1951 and 1952, respectively. The evidence establishes clearly that the 5 per cent rate of payments under the Mity Midget agreement was a normal rate for the type of tool involved, and that it was a reasonable rate. The evidence shows also that there was a good business reason for the lower, graduated rates under this agreement during its first 5 years, namely, a forbearance on Champayne's part to enable National to become financially established. We are satisfied that the graduated rates, up to 5 per cent, did not constitute a device for distributing earnings of National to Champayne in the guise of "royalties."

With respect to the 20 per cent rate under the Two Pad sander agreement, there is evidence that rates as high as 20 and 22 per cent are adopted in exclusive license agreements. Later, we shall consider the question of the reasonableness of the 20 per cent rate, but in connection with its relationship to the bona fides of the agreement, it is concluded that1956 U.S. Tax Ct. LEXIS 145">*173 the adoption of a rate of 20 per cent is not sufficient reason for concluding that the Two Pad sander agreement was not an arm's-length, bona fide agreement. Champayne believed that because of the value of his invention, the rate of 20 per cent of net sales was a reasonable rate.

Other arguments of the respondent are of little merit. For example, we are satisfied that National did not have "shop rights" in either invention, but, if it did, that factor would not prevent the granting of greater rights to National under the agreements in question, and would not make the agreements a sham and fiction. Also, the fact that National did not sign the agreements does not make them lacking in bona fides or ineffective. It is readily apparent from each "exclusive license" that the contract of the parties was not dependent on mutual promises. The terms of Champayne's offer were clearly spelled out in the "exclusive license." National accepted these terms when it made use of the inventions, and it became obligated to pay the royalties when it was paid in full by its customers. Cf. 1 Restatement, Contracts sec. 52.

It is concluded that both of the exclusive license agreements were bona fide1956 U.S. Tax Ct. LEXIS 145">*174 and arm's-length agreements. Under this issue, respondent's contentions are rejected.

The next issue is whether the payments received under the agreements are payments for the patents and taxable as long-term capital gains. Respondent does not contend that the patents were not capital assets of Champayne at the time each agreement was executed.

The petitioners rely primarily upon Waterman v. Mackenzie, 138 U.S. 252">138 U.S. 252, and also upon the following: Edward C. Myers, 6 T.C. 258; Kimble Glass Co., 9 T.C. 183; Halsey W. Taylor, 16 T.C. 376; Vincent A. Marco, 25 T.C. 544; Kronner v. United States, 110 F. Supp. 730">110 F. Supp. 730; 26 T.C. 634">*647 Commissioner v. Hopkinson, 126 F.2d 406; Commissioner v. Celanese Corp., 140 F.2d 339; Allen v. Werner, 190 F.2d 840; United States v. Carruthers, 219 F.2d 21.

In Vincent A. Marco, supra,1956 U.S. Tax Ct. LEXIS 145">*175 this Court said:

It is now well established by the weight of authority that the grant of the exclusive right to manufacture, use, and sell a patented article constitutes a sale of the patent rights with the proceeds taxable as long-term capital gain, provided (1) the invention constitutes a capital asset in the hands of the grantor, and (2) it was held by the grantor for the required period. Proceeds from such a grant constitute long-term capital gain income whether payment is made in a lump sum or over a period of years based on the use of the invention by the grantee. This was what we held in Edward C. Myers, 6 T.C. 258. That case has been frequently cited and followed by us. In our decision in that case, we based it largely on the Supreme Court's decision in Waterman v. Mackenzie, 138 U.S. 252">138 U.S. 252. This latter case * * * did deal with the question as to when a patent agreement amounted to a mere license and when it amounted to a sale.

The principle stated in the Marco case has been restated recently in Watson v. United States, 222 F.2d 689, 690:1956 U.S. Tax Ct. LEXIS 145">*176

It is a firmly accepted principle of law that if the patentee conveys by an instrument in writing the exclusive right to make, use, and vend the invention throughout the United States, or an undivided part or share of that exclusive right, or the exclusive right under the patent within a specified area within the United States, the conveyance constitutes an assignment of the patent, complete or partial as the case may be; and that a transfer short of that is not an assignment but a license. Waterman v. Mackenzie, 138 U.S. 252">138 U.S. 252, 11 S. Ct. 334">11 S. Ct. 334, 34 L. Ed. 923">34 L. Ed. 923; United States v. General Electric Co., 272 U.S. 476">272 U.S. 476, 47 S. Ct. 192">47 S. Ct. 192, 71 L. Ed. 362">71 L. Ed. 362; Doherty Research Co. v. Vickers Petroleum Co., 10 Cir., 80 F.2d 809, certiorari denied 299 U.S. 545">299 U.S. 545, 57 S. Ct. 9">57 S. Ct. 9, 81 L. Ed. 401">81 L. Ed. 401; Broderick v. Neale, 10 Cir., 201 F.2d 621. * * *

The reasoning in support of this principle is that by the terms of a United States patent a patentee receives, for a term of 17 years, the exclusive1956 U.S. Tax Ct. LEXIS 145">*177 right to make, use, and vend the invention in the United States, and when the patentee "transfers all of these rights exclusively to another, even though he calls the instrument a license rather than an assignment, he transfers all that he has by virtue of the patent and the transfer amounts to a sale of the patent." Kimble Glass Co., supra, pp. 189, 190.

The evidence establishes that Champayne intended to give National and National wanted exclusive licenses to make, use, and sell both of the patented tools. We disagree with respondent's argument to the contrary.

Applying the principles enunciated in the authorities cited above, it is held that each agreement was an exclusive license agreement under which Champayne transferred his "whole" right in each patent to National; the agreements amounted to sales of the patents involved. It follows that the payments by National under the agreements were payments of the purchase prices and that they constituted long-term 26 T.C. 634">*648 capital gains to Champayne. Switzer v. Commissioner, 226 F.2d 329, on which respondent relies is distinguishable.

On the matter of the 5 per cent1956 U.S. Tax Ct. LEXIS 145">*178 payments under the Mity Midget agreement, we find that the rate was reasonable and normal. Respondent actually does not contend to the contrary.

There remains the question whether the 20 per cent rate under the Two Pad agreement was a reasonable rate. Under this question petitioner has the burden of proof. He has failed in part in his burden of proof. We are satisfied from the evidence that 5 per cent of net sales is a reasonable rate of payment for the patent rights, and have so held. It is held that 15 per cent of National's payments under this agreement represented distribution of earnings of National which are taxable to Champayne as dividends.

Decision will be entered under Rule 50.