Rev. Rul. 71-564

The Internal Revenue Service has been asked to explain the phrase "in perpetuity" as used in Revenue Ruling 64-56, C.B. 1964-1 (Part 1), 133.

Revenue Ruling 64-56 discusses whether technical "know-how" (trade secrets) constitutes property that can be transferred, without recognition of gain or loss, in exchange for stock or securities under section 351 of the Internal Revenue Code of 1954. Revenue Ruling 64-56 states, at page 135:

* * * Where the property right in the secret formula consists of both the composition and the method of making it, the unqualified transfer in perpetuity of the exclusive right to use the formula, including the right to use and sell the products made from and representing the formula, within all the territory of the country will be treated as the transfer of all substantial rights in the property in that country. (Emphasis supplied).

The unqualified transfer in perpetuity of the exclusive right to use a secret process or other similar secret information qualifying as property within all the territory of a country, or the unqualified transfer in perpetuity of the exclusive right to make, use and sell an unpatented but secret product within all the territory of a country, will be treated as the transfer of all substantial rights in the property in that country. (Emphasis supplied).

Secret information is sufficiently akin to patents to warrant the application, by analogy, of some of the principles of law relating to the transfer of patent rights. Pickren v. United States, 378 F. 2d 595 (1967), E. I. DuPont de Nemours and Company v. United States, 288 F. 2d 904 (1961); Commercial Solvents Corporation v. Commissioner, 42 T.C. 455 (1964), acquiescence, C.B. 1965-2, 4. The grant of patent rights to a corporation will constitute a transfer of property within the meaning of section 351 of the Code only if the grant of these rights in a transaction, which would ordinarily be taxable, would constitute a sale or exchange of property rather than a license for purposes of determining the character of gain or loss. Revenue Ruling 69-156, C.B. 1969-1, 101.

In order for a grant of patent rights to constitute a sale or exchange, the grant must consist of all substantial rights to the patent. One substantial right which must be transferred is the right of the transferee to use the patent for its full life, i.e., the remaining statutory length of the patent. Waterman v. Mackenzie, 138 U.S. 252 (1891). Thus, the transferor cannot retain a remainder interest in the patent by giving the transferee the use of the patent for a period less than the remaining statutory length of the patent and be deemed to have transferred all substantial rights in the patent. Likewise, in order for all substantial rights in a trade secret to be transferred, the transferor must transfer to the transferee the use of the trade secret for its full life. Pickren v. United States.

Trade secrets, however, have useful periods which may last for an indefinite period of time, that is until they become public knowledge. Once a trade secret becomes public knowledge it is no longer protectible under the applicable law of the country in which the rights have been granted to the transferee. At this point, the property interest in the trade secret ceases.

Accordingly, it is held that an unqualified transfer of the exclusive right to use a trade secret until it becomes public knowledge and no longer protectible under the applicable law of the country where the transferee is to operate is a transfer of property for purposes of Revenue Ruling 64-56.

Revenue Ruling 64-56 is amplified.