109 U.S.P.Q. (BNA) 300">*300 26 T.C. 138">*138 The Commissioner determined deficiencies in the petitioners' 1956 U.S. Tax Ct. LEXIS 211">*212 income tax as follows:

The only question presented is whether the sums of $ 48,510 and $ 53,814.99 received by the petitioner Arthur C. Ruge, hereinafter referred to as Ruge, in 1951 and 1952, respectively, from the Baldwin Locomotive Works constituted ordinary income or long-term capital gain from the sale of a patent.

FINDINGS OF FACT.

The petitioners are husband and wife and reside at Lexington, Massachusetts.

Petitioners filed joint income tax returns on the cash basis on Form 1040 for the calendar years 1951 and 1952, the period here involved, with the collector and the director of internal revenue for the district of Massachusetts, respectively.

Ruge was formerly employed as a research associate and later as a professor of engineering seismology at the Massachusetts Institute of Technology, hereinafter referred to as M. I. T.. While so employed and prior to 1940, he made a certain invention known as a strain gage. As required by the terms of his employment with M. I. T., he offered the invention to that institution. M. I. T. waived its right to the invention and Ruge then applied for patents in his own name which1956 U.S. Tax Ct. LEXIS 211">*213 were later issued. On September 3, 1940, Ruge and Alfred V. deForest, with whom Ruge had formed a partnership, licensed the patents on the strain gage invention to the Baldwin Locomotive Works, hereinafter referred to as Baldwin.

By 1942 the invention had developed such commercial possibilities that Ruge got informal leave of absence from M. I. T., which in 1943 26 T.C. 138">*139 was made a formal leave of absence. He and deForest moved into a small factory of their own, and by 1947 the invention had developed such potentialities that Ruge resigned from M. I. T.

The agreement of September 3, 1940, between the Ruge-deForest partnership and Baldwin was a license to Baldwin of Ruge's inventions relating to electrical strain-sensitive gages and various applications and embodiments thereof and any improvements thereof or inventions relating thereto or embodying a strain-sensitive wire, made either by Ruge or deForest. At Baldwin's request the 1940 agreement was terminated and another agreement, under which the payments now in question were made, was entered into, dated June 14, 1944.

Under the terms of the 1944 agreement (paragraph 2), Ruge and deForest assigned to Baldwin their entire right, 1956 U.S. Tax Ct. LEXIS 211">*214 title, and interest in and to all inventions theretofore made or conceived by them and falling within the scope of the 1940 agreement. Also they undertook that they or a representative of theirs would give Baldwin a certain number of man-days consulting service per year if requested, but not to exceed 60 days per year. The purpose of this service was to assist Baldwin in the "establishment, or subsequent control, of its manufacturing operations of electrical strain gages or applications thereof or of rendering consulting services relating to or embodying strain responsive apparatus." Certain percentage payments provided for by paragraph 4 of this agreement were to be made "In consideration of Ruge and deForest assigning said inventions to Baldwin and of giving a109 U.S.P.Q. (BNA) 300">*301 certain number of days consulting service per year." Ruge and deForest by paragraph 6 also agreed for an additional consideration of 2 per cent of the gross dollar sale volume "to give Baldwin the benefit of their best efforts and thoughts for promoting and developing the strain gage business and also to assign to Baldwin and hereby do assign their entire right, title and interest in and to all developments and inventions, 1956 U.S. Tax Ct. LEXIS 211">*215 whether patentable or not, hereafter made by them during the term of this agreement, relating to or useful in connection with electrical strain measurements or electrical strain responsive apparatus, together with all instrumentation and products used in connection therewith." By paragraph 13 of the agreement Ruge and deForest agreed to give Baldwin for 5 years certain consulting time in addition to that referred to in paragraph 4, in return for which Baldwin guaranteed that their receipts during the 5-year period would not be less than $ 20,000 per year.

After the agreement of June 14, 1944, had been made, Baldwin was unable immediately to manufacture enough products covered by the agreement to satisfy the demand, and under a number of interim agreements Ruge and deForest, during deForest's lifetime, and, after deForest's death in 1945, Ruge or the corporation Ruge-deForest, Inc., 26 T.C. 138">*140 formed by him for that purpose in January 1949, manufactured such articles and sold them to Baldwin at an agreed price. Upon the articles so manufactured and sold no payments under the agreement of June 14, 1944, were made and Ruge's and deForest's profits upon such articles were all manufacturing1956 U.S. Tax Ct. LEXIS 211">*216 profits. These interim agreements did not bear at all upon the payments made to petitioner in 1951 and 1952, which payments were made under the provisions of the agreement of June 14, 1944, without any modification whatsoever.

In the preparation of the agreements of September 3, 1940, June 14, 1944, and the subsequent interim agreements, Ruge and deForest and Ruge-deForest, Inc., were not represented by attorneys, but Baldwin was.

The actual amount of time rendered by Ruge or his approved representative in giving consulting service to Baldwin at Baldwin's request in the years in question was slight, not exceeding a few days of each year. Ruge, of course, was interested in developing the potentialities of the invention, as its success would result in an increase in his receipts under the June 14, 1944, agreement. Under the terms of the provision which called for an additional 2 per cent for Ruge's best efforts and thoughts in developing the strain gage, some 99 United States and Canadian patents, patent applications, and ideas were assigned to Baldwin.

Petitioner, or the partnership, at June 14, 1944, had owned the invention and patents assigned much longer than 6 months.

During1956 U.S. Tax Ct. LEXIS 211">*217 the calendar years 1951 and 1952 Ruge received the following payments from Baldwin under the agreement of June 14, 1944, as amended:

The petitioners reported these payments as long-term capital gain in the taxable years. The Commissioner determined that these payments were royalty payments and should be reported and taxed as ordinary income.

The stipulated facts are incorporated herein by this reference.

26 T.C. 138">*141 OPINION.

The sole question before this Court is whether payments under an agreement between Baldwin and Ruge constituted ordinary income or capital gains. The petitioners claim that this agreement dated June 14, 1944, was an agreement for the sale of inventions and patents only, and that all the amounts in question here were the payments in consideration1956 U.S. Tax Ct. LEXIS 211">*218 of that sale and are taxable as long-term capital gains under section 117 of the Internal Revenue Code of 1939. Edward C. Myers, 6 T.C. 258, and Commissioner v. Hopkinson, 126 F.2d 406, are cited to us by the petitioners as controlling on the proposition that the agreement here constituted a sale. In the deficiency notice the respondent determined that the payments in question here were 109 U.S.P.Q. (BNA) 300">*302 "deemed to be royalty income and recommendation [was therein] made that such payments be returned as ordinary income for the current year, in the nature of royalty payments." In his opening statement at the hearing herein respondent's counsel explicitly stated his further contention that the agreement was a contract for Ruge's personal services, and that the payments in dispute were compensation for services and taxable as ordinary income under section 22 (a) of the Internal Revenue Code of 1939. In his brief counsel for respondent for the first time advanced a third theory of why the payments were taxable as ordinary income. He argued that if there were sales of patents by the agreement, the transaction was a sale of property 1956 U.S. Tax Ct. LEXIS 211">*219 held for sale in the ordinary course of business by a professional inventor.

We first consider the question of whether the June 14, 1944, agreement accomplished a sale or a licensing of Ruge's inventions to Baldwin. It is well established that an assignment of the exclusive right to manufacture, use, and sell a patented article amounts to a sale of the patent rights and that the consideration therefore is taxable as long-term capital gain provided that (1) the invention is a capital asset in the hands of the inventor, and (2) that it was held by the grantor for the required period. And it makes no difference whether payment is made in a lump sum or over a period of time in amounts based on the use or sale of the invention by the grantee. Vincent A. Marco, 25 T.C. 544; Edward C. Myers, supra;Commissioner v. Hopkinson, supra;Waterman v. Mackenzie, 138 U.S. 252">138 U.S. 252. In 138 U.S. 252">Waterman v. Mackenzie, supra, the Supreme Court held that if anything less than the exclusive right to manufacture, use, and sell was transferred, then there was1956 U.S. Tax Ct. LEXIS 211">*220 only a license and not a sale. Here Ruge "assigned to Baldwin his entire right, title, and interest" in his invention. We have held before that a transfer in these words constituted a sale within section 117. Halsey W. Taylor, 16 T.C. 376; Carl G. Dreymann, 11 T.C. 153.

26 T.C. 138">*142 Nevertheless, the Commissioner contends that Ruge retained several important incidents of ownership which are inconsistent with an assignment of patent rights and that, therefore, the agreement was merely a licensing arrangement. By the 1944 agreement Ruge and deForest retained "the exclusive rights in and to such inventions or suggestions for fields outside of the field of strain responsive application and apparatus" and also "the right to consult for others than Baldwin and to use, but not to sell, loan, or otherwise dispose of for use by others, apparatus embodying any Ruge-deForest inventions for their own personal use in their consulting work."

However, the first-quoted retention of rights applied only to inventions which might be made by Ruge subsequent to 1944 under the provisions of paragraph 6 of the agreement, and did not refer 1956 U.S. Tax Ct. LEXIS 211">*221 to the inventions and patents sold and assigned to Baldwin by the 1944 agreement, and consequently did not affect the completeness of their assignment. The second quoted retention of rights is minor in character and should be considered as a license back not detracting from the validity of the sale of the inventions. See Lamar v. Granger, 99 F. Supp. 17">99 F. Supp. 17. We see nothing in either of the reservations by Ruge that would prevent the conclusion that there was a sale to Baldwin of Ruge's right, title, and interest in the inventions covered by paragraph 2 of the assignment of 1944. The agreement by its terms contemplates a sale and we agree that it is such. Evans v. Kavanagh, (E. D., Mich.) 86 F. Supp. 535">86 F. Supp. 535, affd. (C. A. 6, 1951) 188 F.2d 234.

In his opening statement counsel for respondent contended for the first time that these payments were in part compensation for Ruge's personal services. While there were no amended pleadings, counsel for petitioners neither objected nor claimed surprise at the hearing when the trial proceeded on the assumption that this was an issue. On the contrary, 1956 U.S. Tax Ct. LEXIS 211">*222 he dealt with this question in his brief as though it were in issue. In view of these circumstances, we are of the opinion that this question is before the Court, and that the payments received by Ruge under paragraph 6 of the agreement constituted compensation for personal services and are thus taxable to him as ordinary income.

In Kimble Glass Co., 9 T.C. 183, an inventor was required to further develop his inventions in the field covered by the sale agreement, to disclose to the buyer any inventions made by him and covered by the agreement, to use his best efforts to keep the buyer informed as to any developments in the corresponding field by others, and to submit any propositions he might obtain for sale or licensing of such inventions in the United States or Canada. We held that such an agreement called for the inventor's personal services and that a portion of the 109 U.S.P.Q. (BNA) 300">*303 consideration paid was compensation for personal services.

26 T.C. 138">*143 In the instant case we are of the opinion that the services called for by paragraph 6 of the agreement of 1944 are similar to those held to be personal services in Kimble Glass Co., supra,1956 U.S. Tax Ct. LEXIS 211">*223 and that the compensation paid therefor, the "additional two percent" provided for in that paragraph, constitutes ordinary income.

However, we agree with petitioner that the 5 per cent payments called for under paragraph 4 of the agreement constitute consideration paid for the sale of the inventions and patents owned by Ruge in 1944, and are, therefore, to be considered as capital gains. The consulting services of Ruge and deForest referred to in that paragraph were ancillary and subsidiary to the assignments of the inventions accomplished by paragraph 2 of the agreement, and are of the type and kind usually called for to implement the sale of highly technical and intricate inventions.

To recapitulate, we hold that the payments to Ruge during the taxable years under the agreement of 1944 were neither all capital gain nor all compensation for personal services, but that the payments made to him under paragraph 6 of the agreement were for personal services, and the payments of 5 per cent under paragraph 4 constituted consideration for the sale to Baldwin of the inventions referred to in paragraph 2, and are, therefore, taxable as capital gains.

Even if we could properly consider the1956 U.S. Tax Ct. LEXIS 211">*224 contention made by respondent's counsel for the first time on brief to the effect that if the agreement of 1944 accomplished sales of inventions the remuneration, therefore, constituted ordinary income, since Ruge was in the business of making and selling inventions, we would conclude that this contention was without merit. The record indicates that in 1944 Ruge was not engaged in the business of making and selling inventions and, consequently, the respondent's contention is without validity with reference to the inventions transferred by paragraph 2 of the agreement for which payments were made to him under paragraph 4. With regard to the payments made to him under paragraph 6, we have already concluded that these constituted ordinary income, and it, therefore, becomes moot whether as to inventions made and transferred subsequent to 1944 pursuant to paragraph 6 Ruge was engaged in the business of making and selling inventions.

Decision will be entered under Rule 50.