Section 263 provides in part:

SEC. 263. CAPITAL EXPENDITURES.

(a) General Rule. -- No deduction shall be allowed for --

(1) any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate. * * *

Included in those1975 U.S. Tax Ct. LEXIS 194">*205 expenses to be capitalized are those that are for the acquisition or disposition of capital assets. Woodward v. Commissioner, 397 U.S. 572">397 U.S. 572, 397 U.S. 572">575 (1970); United States v. Hilton Hotels, 397 U.S. 580">397 U.S. 580 (1970); secs. 1.212-1(n) and 1.263(a)-2(a), Income Tax Regs. These expenditures are included in "the basis of the capital asset with respect to which they are 186 U.S.P.Q. (BNA) 57">*60 incurred, and are taken into account for tax purposes either through depreciation or by reducing the capital gain * * * when the asset is sold." 397 U.S. 572">Woodward v. Commissioner, supra at 574-575; sec. 1001.

Petitioner's primary contention is that these legal fees were incurred to enforce a fully executed contract complete as to its terms. As such the expenditures plainly qualify as incurred in the collection of income within the terms of section 212(1). Respondent disputes this point arguing that the expenses were 63 T.C. 513">*518 incurred to arrive at a fair price to compensate petitioner in accordance with American's policy. As such these expenses were incurred in disposing of a capital asset and must be capitalized.

Respondent points to the terms1975 U.S. Tax Ct. LEXIS 194">*206 of the March 1953 employment contract which stated that such compensation was discretionary and the provisions of circular No. 605 which were subject to withdrawal or change without notice. Respondent argues then that petitioner's contract was not complete until final settlement was reached on petitioner's law suit initiated as a result of American's unilateral amendment to the circular.

The facts are in large part uncontested. Petitioner worked for many years for American. In March 1953 he became chief engineer of copper development, a division of American's research and development department. At this time petitioner entered into an employment contract with American. Under this contract petitioner was required to assign to American all rights to any patents developed by him. American was then authorized to license these patents to other corporations. In return petitioner was to receive a percentage of the net proceeds from the licensing arrangements. The terms of these payments were established by circular No. 605 which was incorporated into the terms of the employment contract. However, American reserved the right to change or withdraw the circular without notice.

In 19611975 U.S. Tax Ct. LEXIS 194">*207 petitioner was partly responsible for reducing to practice a new production process. Before the patent was finally obtained and assigned to American, it was thought that this patent would produce substantial benefits for American. Correspondingly, American would be required to make substantial payments to petitioner.

In May 1962 American withdrew circular No. 605 and adopted circular No. 995, which was similar in all material respects to the earlier circular with the important exception that the payments American would make to petitioner would be limited to $ 20,000 per year and would be made only while petitioner was actively employed. American also requested petitioner to sign a new employment contract which was similar to the one signed in March 1953 saving it incorporated the terms of circular No. 995.

Petitioner objected to the terms of the new employment contract and circular and hired an attorney to protect his interests. A suit was brought against American requesting the terms of the original employment contract and circular be 63 T.C. 513">*519 upheld. Before a judicial decision, an agreement was reached that marked a complete settlement of petitioner's rights with respect to1975 U.S. Tax Ct. LEXIS 194">*208 the payments petitioner was to receive from the licensing of this patent.

Petitioner has received payments from American under the terms of the settlement. It is agreed by the parties that these amounts have been properly reported on petitioner's tax returns as long-term capital gain, during the years in question, since they have been deemed to fall within section 1.1235-1(c)(2), Income Tax Regs. Petitioner's attorney was retained on a contingent fee basis, consisting of a percentage of the payments made by American to petitioner. These legal fees have been deducted on petitioners' tax returns, during the years in question, as a miscellaneous ordinary expense.

Legal fees are not automatically deductible under the Internal Revenue Code. See 372 U.S. 39">United States v. Gilmore, supra at 48. An examination must be made into the nature of the claim that gave rise to the fees. The Supreme Court, in 372 U.S. 39">United States v. Gilmore, supra at 49, said:

we resolve the conflict among the lower courts on the question before us * * * in favor of the view that the origin and character of the claim with respect to which an expense was incurred, 1975 U.S. Tax Ct. LEXIS 194">*209 rather than its potential consequences upon the fortunes of the taxpayer, is the controlling basic test * * *

The Supreme Court has recently applied this test to the statutory provisions in issue in this case, when it said in 397 U.S. 572">Woodward v. Commissioner, supra at 577:

In our view application of the latter regulation [1.263(a)-2(a), Income Tax Regs.] to litigation expenses involves the simpler inquiry whether the origin of the claim litigated is in the process of acquisition itself.

This holding of the Supreme Court has been held to favor "an expansive application,186 U.S.P.Q. (BNA) 57">*61 rather than a narrow circumscription, of the phrase 'incurred in the * * * disposition of a capital asset.'" Helgerson v. United States, 426 F.2d 1293, 1298 (C.A. 8, 1970). See also Beerman v. United States, 390 F.2d 638 (C.A. 6, 1968); Anchor Coupling Co. v. United States, 427 F.2d 429 (C.A. 7, 1970); Stass Reed, 55 T.C. 32">55 T.C. 32, 55 T.C. 32">40 (1970); Vincent Boagni, Jr., 59 T.C. 708">59 T.C. 708, 59 T.C. 708">713 (1973).

63 T.C. 513">*520 To determine the origin of the questioned 1975 U.S. Tax Ct. LEXIS 194">*210 legal expenses we must examine all of the facts involved. ² We must consider "the issues involved, the nature and objectives of the litigation, the defenses asserted, the purpose for which the claimed deductions were expended, the background of the litigation, and all the facts pertaining to the controversy." 59 T.C. 708">Vincent Boagni, Jr., supra at 713. We are mindful of the opinion expressed in Justice Jackson's dissent, joined by Justice Frankfurter, in Lykes v. United States, 343 U.S. 118">343 U.S. 118 (1952), in which he feared this test, applied in a "but for" sense, could produce ludicrous results. ³

1975 U.S. Tax Ct. LEXIS 194">*211 After a careful review of the record we believe that petitioner's legal action and the resulting legal expenses have their origin in the disposition of a capital asset and must be capitalized. Although it was American's policy to reward those employees who developed patentable processes, the March 1953 employment contract and circular No. 605 clearly state that such rewards were discretionary and subject to withdrawal without notice. Under these terms American had the right to amend the manner in which petitioner was to be rewarded.

When petitioner refused to accept the new terms, disagreement arose with respect to the manner and amount of petitioner's benefits. The law suit was instituted to determine petitioner's rights under the March 1953 contract pursuant to which petitioner was required to assign this patent to American. When a capital asset is disposed of, expenses incurred to fix the sales price are clearly in the process of disposition and must be used to produce the resulting gain realized. Woodward v. Commissioner, 63 T.C. 513">*521 397 U.S. 572">397 U.S. 572 (1970). Or to put it as the Third Circuit did in Munson v. McGinnes, 283 F.2d 333, 3351975 U.S. Tax Ct. LEXIS 194">*212 (C.A. 3, 1960):

If the problem is to reach mutually satisfactory or binding terms of sale, the problem is one of disposing of the property, not of collection, and the question of capitalization must be faced.

Petitioner also argues that section 1.263(a)-2(a), Income Tax Regs., does not apply in this case since it was written with reference to sections 1221 and 1222(3) which historically have not included patents within their provisions. He argues that the "intrinsic nature of the transfer of a patent is not such that it falls within section 1221, defining capital assets and thus such a transfer was dealt with in a separate Section, * * * [sec. 1235] as a matter of congressional largesse."

Petitioner's argument is ingenious and we compliment him on it; however, we must reject it. Before the adoption of section 1235 a taxpayer could qualify the proceeds from the sale of a patent for capital gain treatment if he could prove he was not in the trade or business of being an inventor. If he could not prove that, then the patent, in his hands, was an item held for sale in the taxpayer's trade or business. One of the purposes of section 1235 was to remove the fuzzy distinction between1975 U.S. Tax Ct. LEXIS 194">*213 an amateur and professional inventor. Historically the capital asset status of a patent, like any other property, rested on a determination of the nature of the property in the taxpayer's hands. H. Rept. No. 1337, to accompany H.R. 8300 (Pub. L. No. 591), 83d Cong., 2d Sess., pp. 82, A279 (1954); S. Rept. No. 1622, to accompany H.R. 8300 (Pub. L. No. 591), 83d Cong., 2d Sess., pp. 113, 438 (1954). 186 U.S.P.Q. (BNA) 57">*62 We also note that the Income Tax Regulations promulgated under both the 1939 and 1954 Internal Revenue Codes exclude a patent from the term "similar property" that appears in section 117(c), I.R.C. 1939, as amended, and section 1221(3). Sec. 29.117-1, Regs. 111; sec. 1.1221-1(c), Income Tax Regs.

Under section 1235(a) "A transfer * * * of property consisting of all substantial rights to a patent, * * * by any holder shall be considered the sale or exchange of a capital asset held for more than 6 months." Since petitioner has met the provisions of section 1235, as amplified in section 1.1235-1(c)(2), Income Tax Regs., a qualifying transfer has taken place. Under the circumstances the property involved is considered to be a capital asset. Since we believe that the legal fees in question1975 U.S. Tax Ct. LEXIS 194">*214 were incurred as 63 T.C. 513">*522 part of the transfer, all the expenses incurred in the transfer of a capital asset must be capitalized. 397 U.S. 572">Woodward v. Commissioner, supra.The fact that the component parts of the transfer -- the assignment of the patent rights and the establishment of the sales price -- were separated by several years is not relevant. Munson v. McGinnes, supra.

In addition, since a valid transfer has taken place there has been a "sale or exchange of a capital asset held for more than 6 months." Sec. 1235(a). This is the exact language used to define a long-term capital gain in section 1222(3) which is the section petitioner has used to characterize his gain. Since petitioner admits that section 1.263(a)-2(a) applies to section 1222(3), his argument must fail for this reason also.

Petitioner urges us to follow Commissioner v. Doering, 335 F.2d 738 (C.A. 2, 1964), affirming 39 T.C. 647">39 T.C. 647 (1963), in which legal expenditures were held to qualify as ordinary deductions under section 212(1). Although that case was decided before 397 U.S. 572">Woodward v. Commissioner, supra,1975 U.S. Tax Ct. LEXIS 194">*215 and United States v. Hilton Hotels, 397 U.S. 580">397 U.S. 580 (1970), we believe it is still consonant with those decisions.

In that case the taxpayer was a shareholder in a corporation that was engaged in producing motion pictures. It contracted with another corporation for the latter to distribute and exhibit motion pictures which it was to produce. The taxpayer's corporation was to receive a percentage of the receipts from the distribution and exhibition activities. A dispute arose over the amount that was due.

Before the dispute was settled, the taxpayer's corporation was dissolved. The claim which had no ascertainable fair market value at dissolution, was distributed to the shareholders. Ultimately the claim was settled and the taxpayer reported his share of the proceeds as long-term capital gain under section 331(a)(1). The legal fees incurred in connection with the settlement paid by the taxpayer were deducted as an ordinary and necessary expense under section 212(1).

The circuit court in upholding the taxpayer said that the critical determination was "what the stockholders were trying to get, not the rate at which Congress chose to tax what they got." 1975 U.S. Tax Ct. LEXIS 194">*216 Commissioner v. Doering, supra at 741. What was being pursued was the proceeds from the grant of the right to distribute and exhibit the corporation's films. Such receipts would have been 63 T.C. 513">*523 taxable to the corporation (if it had remained in existence) as ordinary income. This claim did not arise from the sale of a capital asset. The taxpayer was able to report his proceeds as long-term capital gain because of the intervening dissolution and the fact that the claim could not be valued at dissolution which held the liquidation open for tax purposes. This fact was entirely unrelated to the origin of the taxpayer's lawsuit.

Both petitioner and respondent rely on Munson v. McGinnes, supra, a decision by the circuit court in which appeal in this case would lie. Jack E. Golsen, 54 T.C. 742">54 T.C. 742 (1970), affd. 445 F.2d 985 (C.A. 10, 1971), certiorari denied 404 U.S. 940">404 U.S. 940 (1971). In Munson v. McGinnes, supra, there was a successful effort to reopen the original terms of a sale due to underlying fraud. The legal1975 U.S. Tax Ct. LEXIS 194">*217 fees incurred were deducted under section 212(1).

The court characterized the legal claim as being from "the seller's position, an expense of modifying [the] terms of sale, incurred as an essential incident of a capital transaction in the disposition of property." Munson v. McGinnes, supra at 335. The court went on to hold that these legal fees exhibited the characteristics of selling expenses and belonged in the category of capital expenditures.

Petitioner seeks to distinguish that case by arguing that in the case at bar the legal claim was to enforce a contract whose terms were final. As noted earlier we do not believe the terms of the employment contract were final with respect to the disposition price. Petitioner's grounds for distinction are inapplicable.

Finally petitioner argues that a decision for respondent will effectively strip section 212 of its vitality when the income to be collected is capital gain income. We do not 186 U.S.P.Q. (BNA) 57">*63 believe this will be true. See Munson v. McGinnes, supra; cf. Beerman v. United States, 390 F.2d 638 (C.A. 6, 1968). Under section 1.212-1(b), Income Tax Regs., 1975 U.S. Tax Ct. LEXIS 194">*218 "The term 'income' for the purpose of section 212 includes not merely income of the taxable year * * * but applies as well to gains from the disposition of property." However, section 1.212-1(n) clearly states that "capital expenditures are not allowable as nontrade or nonbusiness expenses." See sec. 263 and sec. 1.263(a)-2(a), Income Tax Regs.

We concede that on occasion distinctions between these provisions may be difficult to draw. We take note, however, of the Supreme Court's statement in 397 U.S. 572">Woodward v. Commissioner, supra at 578, to the effect that: "The standard here pronounced may, 63 T.C. 513">*524 like any standard, present borderline cases, in which it is difficult to determine whether the origin of particular litigation lies in the process of [disposition]." (Fn. omitted.)

Having found that the legal expenses involved in this case have their origin in the disposition of an asset that is capital in nature, we believe the respondent's determination must be upheld.

Decision will be entered for the respondent.