Rev. Rul. 57-317

Advice has been requested whether payments received after December 31, 1935, by a nonresident foreign corporation from a disposition within the United States in 1929 of certain United States and Canadian patents are subject to Federal income tax.

X , a nonresident foreign corporation, not engaged in business in the United States and not having an office or place of business therein, was sole owner of certain United States and Canadian patents. In 1929, X entered into an agreement with Y , a domestic corporation, whereby X granted to Y the exclusive right and license, and the right to sublicense others, to manufacture, use, and/or sell certain devices under such patents in the United States and Canada during the term of the patents. X reserved the right to license foreign manufacturers to export into the United States and Canada machinery equipped abroad with the patented mechanisms, but not to sell such mechanisms for machinery manufactured in the United States or Canada. The agreement granted Y the right to dispose of machinery manufactured in the United States or Canada and equipped with the devices, anywhere in the world, and the right to cancel the agreement in the event that it ceased to manufacture the mechanisms. Y was further granted the right, at its own expense, to prosecute infringers in its own name or in the name of X , or both, and to retain any damages recovered. X reserved the right to terminate the agreement in the event of default by Y . A total consideration was to be paid under the agreement, represented by an initial payment as an `advance on royalties,' and subsequent annual payments based on each device manufactured during the year but not less than a specified annual amount. All annual payments were made except those payments for the years 1940 to 1943 which could not be paid to X because of military occupation of its country by enemy forces. Payments due for those years were accrued by Y on its books, and were subsequently paid to X in 1953.

The specific question in this case is the income tax treatment of the payments received by X in 1953. The answer, however, is dependent upon the nature of the payments (whether purchase payments for the sale of patents or payment of royalties), and the income tax treatment of payments to a nonresident foreign corporation before and after the changes in section 231(a) of the Revenue Act of 1934, 48 Stat. 680 made by the Revenue Act of 1936, 49 Stat. 1648, at 1717, and which were carried forward in the Revenue Act of 1938 and the Internal Revenue Code of 1939.

Section 231(a) of the Revenue Act of 1934, supra , provides that, in the case of a foreign corporation, gross income includes only the gross income from sources within the United States.

Section 231(a) of the Revenue Act of 1936, supra , provides, in part, as follows:

(a) NONRESIDENT CORPORATIONS.-There shall be levied, collected, and paid for each taxable year, in lieu of the tax imposed by sections 13 and 14, upon the amount received by every foreign corporation not engaged in trade or business within the United States and not having an office or place of business therein, from sources within the United States as interest * * *, dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, or other fixed or determinable annual or periodical gains, profits, and income, a tax of 15 per centum of such amount, * * *.

Section 143 of both the 1934 and 1936 Revenue Acts, with respect to nonresident alien individuals not engaged in business in the United States and not having an office or place of business therein, provides that a withholding of tax is required on income received by them from sources within the United States. Such income is specified therein as dividends, rent, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, or other fixed or determinable annual or periodical gains, profits, and income. Article 143-2 of both Regulations 86 and Regulations 94, relating to the Revenue Acts of 1934 and 1936, respectively, provide that the term `fixed or determinable annual or periodical income' includes royalties but not income derived from the sale in the United States of personal or real property.

Section 114 of the Revenue Act of 1934, supra , provides as follows:

In the case of foreign corporations subject to taxation under this title not engaged in trade or business within the United States and not having any office or place of business therein, there shall be deducted and withheld at the source and in the same manner and upon the same items of income as is provided in section 143 a tax equal to 13 3/4 per centum, and such tax shall be returned and paid in the same manner and subject to the same conditions as provided in that section: * * *.

Section 144 of the 1936 Act is identical to section 114 of the 1934 Act, except for certain changes in the tax rate not material here.

The provisions of sections 143, 144, and 231, as amended by the Revenue Act of 1936, supra , or their counterparts in later acts, insofar as material to this case and except for subsequent changes in the tax rate, are applicable to taxable years beginning after December 31, 1935, and to taxable years governed by the Revenue Act of 1938, 52 Stat. 447, and by the Internal Revenue Code of 1939.

In Commissioner v. Pelham G. Wodehouse , 337 U.S. 369, Ct. D. 1722, C.B. 1949-2, 62, involving the taxability of lump sum advance payments made in 1938 and 1941 to a nonresident alien author for exclusive rights to only one of the bundle of rights under a copyright, the Court stated that what was determinative of the issue was whether such payments would have been subject to withholding under section 143 of the Revenue Act of 1934 prior to the amendment of section 211(a) by the Revenue Act of 1936. In discussing the effect of the changes made in the 1936 Act, the Court stated as follows:

* * * under the Act of 1934, Congress sought to tax (and withhold all or part of the tax on) the income of a nonresident alien individual insofar as it was derived from payments for the use of or for the privilege of using copyrights in the United States. It also sought to tax (although it could not generally withhold the tax on) any gain which the taxpayer derived from the sale of personal property produced by him without the United States but sold within the United States. Accordingly, if the receipts now before us had been received by the respondent under the Act of 1934, they would have been taxable whether they were treated as payments in the nature of royalties for the use of copyrights under section 119(a) or were treated as payments of a sale's price for certain interests in copyrights under section 119(e). * * * The regulations showed that, while both forms of income were taxable, yet it was only the royalty payments (and not the sales' proceeds) that were subject to the withholding procedure . * * * (Page 68.)

The Revenue Act of 1936 * * * did, however, amend section 211(a) materially in its description of the taxable income of nonresident alien individuals. * * * By thus restricting the income tax to those specific kinds of income to which the withholding procedure has previously applied, Congress automatically relieved nonresident alien individuals from taxation of their income from certain sales of real or personal property, previously taxed. This amendment, on the other hand, retained and increased the tax on the very kind of income that is before us. * * * (Page 69.)

* * * Therefore, after the 1936 amendments, it became equally clear that these receipts in the nature of royalties and previously withheld at their source were included in the source of income specified in section 211(a) but that profits from sales of property were not included in the sources of income specified in section 211(a) . * * * (Page 71, emphasis added.)

The Wodehouse case does not suggest that the Court intended to determine more than the issue which was before it, or to overturn the well-settled rule that the exclusive grant of all the rights under a copyright or a patent was a sale of the copyright or patent with the tax consequences attendant upon the sale of any personal property by a nonresident alien. In its determination, the Court distinguished between the sale of all the rights under a patent or copyright, which would be exempt from tax after the 1936 amendment to section 211(a), and the transfer of less than all such rights which would be subject to tax whether it be called a sale or a license. Regardless of whether the grant of less than all of the rights under the copyright or patent was a sale or a license, payments therefor were subject to withholding under section 143 before the 1936 amendment to section 211(a), and were subject to taxation thereafter.

The interpretation made by the Court of the 1936 amendment of section 211(a) is equally applicable to the 1936 amendment of section 231(a), dealing with the tax on foreign corporations. Article 231-1 of Regulations 94 provides that every nonresident foreign corporation is liable to tax upon gross income from sources within the United States which is fixed or determinable annual or periodical gains, profits, and income. Specific items of such income are enumerated therein as interest, dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other fixed or determinable annual or periodical gains, profits, and income, as, for instance, royalties. Article 231-3 of Regulations 94 provides that the taxable income of a nonresident foreign corporation does not include profits derived from the sale within the United States of personal property or real property located therein. See also Mimeograph 4471, C.B. XV-2, 112 (1936).

In the instant case, the agreement which granted the exclusive right to make, use, and sell the patented article in the United States was a grant of all that the patentee possessed under the patent, and thus amounted to a sale of the patent. See Commissioner v. Celanese Corp. of America , 140 Fed.(2d) 339; General Aniline & Film Corporation v. Commissioner , 139 Fed.(2d) 759; Kimble Glass Company v. Commissioner , 9 T.C. 183, acquienscence C.B. 1947-2, 3. The rights which both parties retained to terminate the agreement under certain conditions have been held to be mere conditions subsequent, not interfering with the passage of ownership from the patentee to the other contracting party or negating the existence of a sale of the patent. See Commissioner v. Celanese Corp. of America, supra; Kimble Glass Company v. Commissioner, supra . Likewise, the right which X retained to license foreign manufacturers to export to the United States machinery equipped abroad with the patented devices would not detract from the exclusiveness of the right granted to Y to make, use, and sell the patented articles under the United States patents. See General Aniline & Film Corporation v. Commissioner, supra . Furthermore, the instant case is distinguishable from Franz G. Block v. United States , 200 Fed.(2d) 63, cert. denied 345, U.S. 935, as it can hardly be said that an economic interest in the successful exploitation of a patent has been retained where there is a total consideration to be paid not dependent in any way upon the volume of sales or production. As no economic interest is retained, the instant transaction is a sale with periodic payment of the purchase price, in the nature of an installment sale.

Accordingly, it is held that gain resulting from payments received after December 31, 1935 by a nonresident foreign corporation not engaged in business in the United States and not having an office or place of business therein, from a sale of a patent in the United States in 1929, is not subject to Federal income tax for taxable years governed by the Revenue Acts of 1936 and 1938, and the 1939 Code. Gain resulting from payments received on or before December 31, 1935, is subject to Federal income tax but not to withholding of such tax. The gain for taxable years ending on or before December 31, 1935, should be determined with reference to the provisions of Regulations 86 prescribed for the allocation of costs.