125 U.S.P.Q. (BNA) 601">*601 34 T.C. 385">*386 Respondent determined deficiencies in income tax as follows:

1960 U.S. Tax Ct. LEXIS 145">*146 The sole issue is whether payments of $ 67,681.95, $ 70,828.88, and $ 63,065,95 to petitioners' decedent, hereinafter called Laurent, and petitioner Ruby Sandoz Laurent in 1951, 1952, and 1953, respectively, under a licensing agreement, are taxable as long-term capital gains or as ordinary income.

The parties agree that no deficiencies remain and that any overpayments will be given effect under Rule 50.

FINDINGS OF FACT.

The stipulated facts are found.

Petitioners' decedent, Milton P. Laurent, Sr., died on November 6, 1955. Petitioners are Laurent's wife and his estate, by its independent executors.

Laurent and his wife filed joint returns on a cash method of accounting with the collector (or director) of internal revenue for the first collection district of Texas for the controversial years.

Subsequent to April 15, 1941, Laurent invented a closure joint. Part of this invention involved an improved seal. On July 6, 1943, Laurent filed Patent Application Serial No. 493,673 for a patent on this invention which was titled "Closure Joint" and which related to a plug and joint structure and had for its general object the provision of an improved plug and joint arrangement for sealing1960 U.S. Tax Ct. LEXIS 145">*147 pressure vessels. This application was granted on January 22, 1952, resulting in the issuance of Patent No. 2,582,995. The "closure joint" as disclosed in Patent Application Serial No. 493,673 and Patent No. 2,582,995, will sometimes hereafter be called Patent 995. Patent 995 contained 17 claims.

On December 21, 1953, Laurent filed Patent Application Serial No. 399,647 for the reissue of Patent 995. This application was granted and on March 23, 1954, Patent 995 was reissued as Patent No. Re.23,805. The reissued patent contained two additional claims and did not extend the life of the original patent.

The closure joint (Patent 995) was intended to have wide application in all types of pressure vessels and pipelines including but not limited to gate valves, check valves, handholes, manholes, cleanout 34 T.C. 385">*387 openings, as well as in return bends and other special fittings subjected to internal pressure.

On March 2, 1945, Laurent filed Patent Application Serial No. 580,552 which was titled "Seal for Gate Valve Bonnets." Laurent filed this application to cover more specifically the gate valve bonnet construction which was disclosed in Patent 995. This application was granted on1960 U.S. Tax Ct. LEXIS 145">*148 January 22, 1952, resulting in the issuance of Patent No. 2,582,996. The patent stated, in part:

The invention relates to a seal for valve bonnets or caps which close the valve chamber.

* * * ^*

The present invention therefore contemplates an improvement in providing a simple and economical connection for the bonnet or cap to the valve body with greater safety factor and less weight of material used.

* * * *

The present invention relates generally to the invention disclosed in my prior copending application Serial Number 493,673, filed July 6, 1943, for Closure Joint, and is a continuation in part thereof.

The "seal for gate valve bonnets," as disclosed in Patent Application Serial No. 580,552 and Patent No. 2,582,996, will sometimes hereafter be called Patent 996. Patent 996 contained 1 claim. Each of the 17 claims set forth in Patent 995 and each of the 19 claims set forth in Patent No. Re.23,805 "reads upon" the structural device illustrated or typified in Patent 996. Patent 996 disclosed, and claimed the use of, the seal of Patent 995 in a gate valve.

On October 20, 1947, Laurent filed Patent Application Serial No. 780,987 which was titled "Closure." This application was 1960 U.S. Tax Ct. LEXIS 145">*149 granted on January 22, 1952, resulting in the issuance of Patent No. 2,582,997. The patent stated, in part:

The invention relates generally to the type of plug and joint structure disclosed in my co-pending application, * * * [for closure joint]; a combination seal and load ring disclosed herein is retained by the pressure which is being sealed and is entitled to the filing date of such earlier application as to all common subject matter.

* * * *

It is * * * a primary object of the present invention to provide a closure assembly for an opening in return bends, pipe lines, or pressure vessels which is capable of withstanding high pressures and maintaining a seal to prevent leakage of internal pressure from such opening.

The "closure," as disclosed in Patent Application Serial No. 780,987 and Patent No. 2,582,997 will sometimes hereafter be called Patent 997. Patent 997 contained 8 claims.

On March 3, 1953, Laurent filed Patent Application Serial No. 340,119 which was titled "Pressure Tightened Joint." This application was granted on August 24, 1954, resulting in the issuance of 34 T.C. 385">*388 Patent No. 2,687,229. The "pressure tightened joint," as disclosed in Patent Application Serial1960 U.S. Tax Ct. LEXIS 145">*150 No. 340,119 and Patent No. 2,687,229, will sometimes hereafter be called Patent 229. Patent 229 contained 8 claims.

Patent 995 is the basic, dominant, or primary patent in the following group of patents: Patent 995 (Reissued 23,805); Patent 996; Patent 997; and Patent 229.

W-K-M Manufacturing Co., Inc., hereafter called W-K-M, experimented with Laurent's closure joint. On October 31, 1944, after the completion of these experiments, W-K-M and Laurent entered into an agreement which provided, in part:

Whereas, Laurent is the inventor and owner of a new and useful invention in a Closure Joint, application for United States Letters Patent on which were filed July 6, 1943, being Serial No. 493,673.

Whereas, W-K-M * * * desires to acquire the exclusive right to utilize the above identified invention so far as the invention may be applied to gate valves.

* * * *

1.

LAURENT hereby grants to W-K-M * * * a license to make, use, and sell devices embodying the [closure joint] invention disclosed in his application for United States Letters Patent, Serial No. 493,673 [Patent 995], and any improvements thereon for the life of any patent or patents which may issue. The license granted herein 1960 U.S. Tax Ct. LEXIS 145">*151 is non-exclusive as to the entire invention, but is exclusive in so far as the invention can be applied to gate valves of the type manufactured by the W-K-M * * *. This agreement * * * shall remain in full force and effect throughout the life of any patent or patents heretofore or hereafter issued on said invention or improvements thereon or substitutes therefor.

2.

W-K-M * * * for and in consideration of the above grant and license, agrees to pay over to Laurent a royalty of five per cent (5%) which five per cent is based upon the normal current sales price to the consumer of A.P.I. blind flange units of the nearest like series, said five per cent to apply on complete units and parts thereof. It is understood that an A.P.I. blind flange unit consists of "a welding neck flange, a blind flange, a ring, and bolts and nuts." For example, a 2" -- 3000# W.P. W-K-M gate valve requires a 4" opening through the bonnet end to enter the gate. Therefore, in this instance a 4" A.P.I. 3000# W.P. blind flange unit is used as a basis for figuring royalty. Smaller size or larger size valves are to be figured on a comparable basis. A schedule for the computation of royalties on valve bonnets and1960 U.S. Tax Ct. LEXIS 145">*152 parts therefor is attached hereto.

* * * *

4.

W-K-M * * * agrees to proceed with reasonable diligence with marketing the devices embodying the invention in accordance with its present facilities * * *. W-K-M * * * agrees to employ the new bonnet design on all new types and sizes of gate valves hereinafter designed whenever it is feasible and practicable to do so and to effect changes to embody the new design on its present line of gate valves within one year from the date hereof; provided, however, that failure to do so within said period of time will not be cause for cancellation but 34 T.C. 385">*389 will obligate W-K-M * * * to pay to Laurent the royalty hereinbefore provided for on this feature on all sizes and types of gate valves sold by it subsequent to said one year period.

* * * *

6.

If any of said patents on said new invention are infringed or the rights of either of the parties hereto as herein set forth adversely affected in any way, W-K-M * * * may, if it elects to do so and not otherwise, take such action as it may consider necessary or desirable to protect the rights of the parties hereto to said patents and the proper enjoyment thereof by suit or otherwise in the name of 1960 U.S. Tax Ct. LEXIS 145">*153 either or both of the parties hereto; * * *

Fred M. McManis was president of W-K-M on October 31, 1944. He negotiated the October 31, 1944, agreement on behalf of W-K-M.

Laurent was not an employee of W-K-M and neither he nor his family owned more than 1 per cent of its capital stock.

Laurent and W-K-M clarified and interpreted the October 31, 1944, agreement as follows: (1) In a letter dated March 4, 1947, Laurent acknowledged the fact that he had "granted to the W-K-M * * * a license under pending patent application bearing Serial No. 493673 [Patent 995]." In this letter the parties agreed to change the manner of computing the royalty payments by using as a basis 0.019785 of total valve sales which had been the average royalty-type payment made under the agreement. In addition, the parties agreed that no payment would be made to cover the use of the seal in the bonnets of 15,000-pound test valves and over because such seal was not used therein and it was improbable that it would ever be so used. Laurent agreed to return royalties paid on the 15,000-pound test valves. (2) In a letter dated February 16, 1950, which corrected a letter dated January 5, 1950, the parties agreed to1960 U.S. Tax Ct. LEXIS 145">*154 eliminate retroactively the words "of the type manufactured by the W-K-M Company, Inc.," in section 1, second sentence, of the October 31, 1944, agreement. (3) On July 8, 1954, Laurent consented to W-K-M's assignment of its rights in the October 31, 1944, agreement by an agreement which provided, in part:

Whereas, said W-K-M * * * is the owner of a license dated October 31, 1944 and subsequently amended February 16, 1950, to make, use and sell devices embodying the [closure joint] invention disclosed in * * * [Patent 995] and any improvements thereon for the life of any patent or patents which may issue, said license being nonexclusive to W-K-M * * * as to the entire invention, but exclusive in so far as the invention can be applied to Gate Valves.

Whereas, the aforesaid limited exclusive license agreement was subsequently extended to include the following Letters Patent granted to said M. P. Laurent and the inventions covered thereby:

34 T.C. 385">*390 Whereas, the aforesaid limited exclusive license agreement was subsequently extended to include further1960 U.S. Tax Ct. LEXIS 145">*155 inventions and improvements in closure joints made by said Laurent for which an application for United States Letters Patent was filed March 3, 1953, Serial No. 340,119 [Patent 229], in so far as those inventions can be applied to the bonnet construction of gate valves; and

Whereas, the said W-K-M * * * desires to assign its full interest in, to and under said license agreement and in, to and under said Letters Patent and applications for Letters Patent.

Now, Therefore * * *

* * * Laurent hereby consents to an assignment by W-K-M * * * of all the rights and benefits flowing to said W-K-M * * * out of the said limited, exclusive license agreement with the said Laurent dated October 31, 1944 and subsequently modified in a supplemental agreement dated February 16, 1950.

W-K-M could not, without infringement, manufacture gate valves as disclosed in Patent 996 unless it had rights under Patent 995.

W-K-M sold gate valves to various industries including oil, gas, coal, and chemical industries. The term "gate valve" has a precise and specific meaning in the valve industry. It is a pressure vessel retaining fluid by means of and under its own pressure.

In 1945 and 1948, Laurent entered 1960 U.S. Tax Ct. LEXIS 145">*156 into the following licensing agreements relating to his closure joint (Patent 995):

None of these agreements conveyed any rights to the seal in gate valve bonnets (Patent 996).

Prior to March 24, 1945, Thornhill-Craver Company experimented with the closure joint and manufactured two closure devices which did not involve gate valves.

Laurent's March 24, 1945, agreement with Thornhill-Craver Company provided, in part:

[Laurent] is the owner of the entire right and interest in and to * * * [Patent 995].

* * * *

This license [to make, use, and sell devices embodying the closure joint] does not convey to the Licensee [Thornhill-Craver Company] the right to embody this invention in any product or products other than * * * [couplings; couplings with blanking plugs; couplings, hose; couplings, ball joint; crosses; tees; ells; chokes, positive and adjustable; return bends; return bends with cleanout plugs; return bends, box type, with cleanout plugs; return bends, H and Y types, with cleanout plugs; manifold1960 U.S. Tax Ct. LEXIS 145">*157 headers with cleanout plugs]. This license to use this invention shall be exclusive as to the [aforementioned] enumerated products of Licensee and the specified closure units, and shall not extend to any other application of this invention as, for example, a valve bonnet.

34 T.C. 385">*391 Thornhill-Craver Company printed an advertising brochure which included the closure joint, acquired under the March 24, 1945, agreement, in its line of products. The advertising brochure stated, in part:

Flex-O-Ring Self Sealing Closure

Here is an entirely original design in header closure. Its mechanical features are so simple yet so sound that it can be used economically in a wide range of operating conditions. Its simplicity, eliminating mule ears, horse shoes, bull nuts, dogs, screws, etc., makes for compact design and reduced weight. * * * Flex-O-Ring self-sealing closures are available for hand-hole plates, man-ways, cylinder ends, boiler wash-out plugs, inspection ports, etc.

On February 28, 1952, in accordance with his privilege under the contract, Laurent notified Thornhill-Craver Company that its rights under the March 24, 1945, agreement would be terminated in 30 days.

Laurent's June 14, 1960 U.S. Tax Ct. LEXIS 145">*158 1945, agreement with Kelley Manufacturing Company provided, in part:

* * * LAURENT is the inventor and owner of a new and useful invention in a Closure Joint [Patent 995] * * *

* * * *

Laurent hereby gives and grants to Kelley a non-exclusive right as to the [closure joint] invention, but an exclusive right and license to make, sell, and use devices embodying the invention * * * in boiler hand hole cap assemblies and boiler man hole cap assemblies, * * *

On January 12, 1948, Laurent wrote a letter to J. A. Rossiter, which stated, in part:

With further reference to our conversation regarding the use of my "closure design" in connection with your separator: --

This letter will be your authority to use the "closure design" as an integral part of your unit * * *

This arrangement is non-exclusive since your production is not, as yet, large enough to warrant an exclusive contract. I am not making exclusive contracts with anyone under $ 1,000.00 yearly minimum. However, anyone using this design, under a non-exclusive basis, will be given four months' notice should an exclusive contract be made with another in a competitive field.

Closure units to be attached to vessels by welding, flanging, 1960 U.S. Tax Ct. LEXIS 145">*159 rolling * * * can be procured thru Thornhill-Craver Co., who have an exclusive contract for manufacturing and selling Closures as complete units.

In 1949 and 1950, Laurent and his wife created four trusts and one foundation and transferred to their respective trustees, by deeds of gift and instruments of assignment, certain property interests. Each of the respective trustees for the four trusts and one foundation received (1) an undivided one-eighth interest in the closure joint (Patent 995), seal for gate valve bonnets (Patent 996) and closure (Patent 997), and any division, reissue, and improvements thereon for the life of any patent or patents which may have issued on any of the respective subjects; (2) an undivided one-eighth interest 34 T.C. 385">*392 in and to certain licensing agreements made by Laurent with W-K-M (October 31, 1944), Thornhill-Craver Company (March 24, 1945), and Kelley Manufacturing Company (June 14, 1945), including an undivided one-eighth interest in any royalty to be earned under the respective licensing agreements.

In his assignments of the closure joint (Patent 995), seal for gate valve bonnets (Patent 996), and closure (Patent 997) to each of the respective1960 U.S. Tax Ct. LEXIS 145">*160 trustees, Laurent stated:

[In] consideration of One Dollar ($ 1.00) * * * [I] do sell, assign, and transfer unto the aforesaid Trustees an undivided one-eighth (1/8) interest in and to the full and exclusive right for the territory of the United States in and to said [inventions] * * *; said [inventions], [applications], and letters patent [respectively] to be held and enjoyed as to one-eighth (1/8th) thereof by the said Trustees for the benefit of the aforesaid [Trusts and one foundation] to the full end of the term for which said letters patent may be granted as fully and entirely as the same would have been held by me had * * * [these] [assignments] and [sales] not been made.

For the years 1949 and 1950, Laurent and his wife filed separate gift tax returns. The following statement appeared in the returns for 1950 dated March 13, 1951:

Of the three patent applications forming the bases of these gifts * * * [i.e., the closure joint (Patent 995) seal for gate valve bonnets (Patent 996) and closure (Patent 997)] claims have been allowed by the United States Patent Office on the application for Closure Joint * * *. An appeal on this application to the United States Court of Customs1960 U.S. Tax Ct. LEXIS 145">*161 and Patent Appeals for additional claims was denied January 27, 1951. All claims for patent * * * [in the seal for gate valve bonnets (Patent 996)] have been rejected in their entirety. * * * [In the closure (Patent 997)], three claims have been allowed and the application is still pending in the Patent Office.

Of the three contracts also forming the bases of these gifts * * * only one has produced revenue and it is believed that the others will not produce any revenue. It relates to * * * [the closure joint (Patent 995)]. Royalties have been received and are being received under the W-K-M * * * contract, dated October 31, 1944. * * *

A review of Patent Appeal Docket #5727 * * * will reveal that this [closure joint] invention is by no means a basic invention, and the claims allowed are restricted to the structure, in view of existing patents in this art. For this reason, a licensing agreement was entered into with * * * W-K-M * * * which was manufacturing a patented article, as such a procedure tends to strengthen a patent by its becoming one of a group. The other two applications were filed in an attempt to strengthen the original application.

After the transfers to the four1960 U.S. Tax Ct. LEXIS 145">*162 trusts and one foundation, Laurent and his wife were entitled to only three-eighths of the amounts payable under the October 31, 1944, agreement with W-K-M.

From 1953 through 1957 Laurent (or his executors) and the trustees of the four trusts and one foundation entered into the following licensing agreements: 34 T.C. 385">*393

With respect to these agreements, each stated that Laurent and the trustees owned the patents specifically referred to therein, and none conveyed any rights to the seal in gate valve bonnets (Patent 996).

On January 12, 1952, Laurent and the respective trustees of the four trusts and one foundation granted to W-K-M International Corporation, a New York corporation, hereafter called International, the exclusive license to make, use, and sell gate valves embodying the closure joint (Patent 995), seal for gate valve bonnets (Patent 996), and closure (Patent 997) in certain foreign countries. International agreed to pay Laurent and the trustees a 2 per cent royalty based on the selling price of gate valves. In addition, the agreement stated, in part:

LAURENT is the sole inventor and co-owner with the above * * * trustees of a new and useful invention in a Closure Joint, applications for * * * Patents * * * bearing Serial No. 493,673 [Patent 995], * * * Serial No. 580,552 [Patent 996], and * * * Serial No. 780,987 [Patent 997] * * *

On March 16, 1955, Laurent and the respective trustees1960 U.S. Tax Ct. LEXIS 145">*164 of the four trusts and one foundation entered into a licensing agreement with W-K-M Manufacturing Company, Inc. (successor in interest to W-K-M and International), a Delaware corporation, hereafter called W-K-M of Delaware. The agreement designated Laurent and the trustees as licensors and W-K-M of Delaware as licensee. The agreement was executed for the purpose of combining into a single instrument the rights previously granted to W-K-M by Laurent under the October 31, 1944, agreement, to clarify some questions which had been raised by the parties as to those rights, and to reflect changed conditions and present agreements. It provided, in part:

Whereas, LICENSORS are the owners of Letters Patent * * * listed in Appendix A attached hereto and made a part hereof; and

Whereas, LICENSORS have heretofore granted to predecessors of LICENSEE certain limited exclusive rights in the United States under the inventions of the aforesaid * * * [patents], as originally set forth in a certain agreement, executed the 31st day of October 1944, between * * * LAURENT and W-K-M 34 T.C. 385">*394 * * * and in various subsequent amendments made to said agreement, said exclusive rights being limited to the1960 U.S. Tax Ct. LEXIS 145">*165 employment of said inventions of said * * * [patents] in so far as the inventions may be applied to the bonnet sections of Gate Valves; * * *

* * * *

1.

The aforesaid original agreement executed the 31st day of October 1944 and the aforesaid licensee agreement executed the 12th day of January 1952 [with International], including all subsequent amendments made thereto in writing, orally or otherwise are hereby terminated fully and entirely in all their respective provisions * * *

2.

LICENSORS hereby grant to LICENSEE, * * * a right and license to make, have made, use and sell in the United States of America, its territories and possessions, and in all foreign countries in which LICENSORS now or hereafter may have the right to grant such licenses, the inventions * * * [listed in Appendix A] and any improvements thereon or substitutes therefor made or acquired by Laurent or acquired by the aforesaid Trusts and Foundation. The right and license herein granted is limited specifically to the application of said inventions only to the bonnet sections of Gate Valves and replacement parts therefor and as so limited is exclusive to LICENSEE and includes the right by LICENSEE to grant similar1960 U.S. Tax Ct. LEXIS 145">*166 rights and licenses to others under the same terms and conditions as herein contained.

For the purpose of this Agreement, the term "bonnet sections" is defined as the closure through which the operating mechanism is assembled or to which it is attached, as typefied [sic] by * * * [Patent 996].

* * * *

3.

LICENSEE * * * agrees to pay to LICENSORS a royalty for each and every Gate Valve manufactured and sold by or for LICENSEE * * * which employs any of said inventions in the bonnet section thereof and for replacement parts therefor covered by claims in said patents or by allowed claims in patent applications coming within the terms of this Agreement. The amount of royalty shall be the Net Sales Price in dollars of the Gate Valve multiplied by the decimal fraction 0.019785. * * *

Gate valves subject to royalty hereunder shall mean a complete gate valve comprising all parts required for its normal functioning including parts necessary for normal hand operation. No royalty shall be payable for any attachment or accessory, termed "Auxiliary Elements," not an integral part of the gate valve nor required for its normal function. * * *

* * * *

5.

On or before the twentieth (20th) 1960 U.S. Tax Ct. LEXIS 145">*167 day of each month during the term of this Agreement, LICENSEE shall furnish to LICENSORS a statement of all sales made by it or its licensees during the preceding month of Gate Valves and replacement parts embodying any of the inventions licensed hereunder. * * *

* * * *

8.

LICENSEE agrees that it will continue, throughout the life of this Agreement, to employ said inventions in the bonnet sections of its present lines of 34 T.C. 385">*395 Gate Valves and that it will incorporate said inventions in any other lines of Gate Valves hereafter manufactured and sold by or for LICENSEE wherever it is feasible and practicable to do so * * *

* * * *

* * * *

After Laurent's death in 1955, there were filed for his estate an "Inventory, Appraisement and List of Claims" in the1960 U.S. Tax Ct. LEXIS 145">*168 Probate Court of Harris County, Texas, and a Federal estate tax return. Among the assets listed in both the probate inventory and the Federal estate tax return were the following:

Flex-Ring and Float-Ring Patent Group, non-exclusive to W-K-M Co., and other companies:

(1) * * * [Patent] 995 * * * Re 23,805

* * * (Flex-Ring Closure Joints)

(2) * * * [Patent] 996 * * *

(Seal for Gate Valve Bonnets)

(3) * * * [Patent] 997 * * *

(Closure [Flex-Ring])

(4) * * * [Patent] 229 * * *

(Pressure Tightened Joint)

(5) #2,760,673, issued 8-28-56

(Seal for Vacuum Vessels [Flex-Float])