Sanchez, Pedro v. Comm.

Decision will be entered under Rule 50.

Harry L. Gutter, Esq., for the petitioner. Walt Mandry, Esq., for the respondent.

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The Commissioner determined a deficiency in petitioner's income tax for the calendar year 1940 in the amount of 9,563.53. Petitioner conceded the correctness of the Commissioner's action in including in his taxable income the amount of 3,686.67 representing salary, but contends the respondent erred in including royalties in the amount of 8,678.30 as income from sources within the United States and royalties in the amount of 7,642.60 which petitioner contends were constructively received by him in 1939. FINDINGS OF FACT.

Petitioner is and was during the taxable year a nonresident alien. He resides in Havana, Cuba, and his income tax return for 1940 was filed with the collector of internal revenue for the second district of New York.

Petitioner is the inventor of certain processes of treating and clarifying sugar solutions, and of an improved chemical reagent, called Sucro-Blanc, containing a hypochlorite as an element, which inventions are covered and described by certain patents and patent rights referred to in the agreements hereinafter mentioned. On January 24, 1934, petitioner entered into a written contract at

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Buffalo, New York, with the Buffalo-Electro-Chemical Co. (therein and hereinafter referred to as "Becco"), a New York corporation, whereby petitioner granted to that company the full and exclusive world-wide right and license to employ the inventions covered by the patents then in existence and any other patents which he might thereafter secure, and any continuations, extensions, reissues, or improvements relating thereto, and the exclusive rights and licenses in all countries of the world to make, use, and sell products of all kinds embodying or utilizing the said inventions. The agreement provided that, in full compensation for all rights granted thereunder, Becco should pay to petitioner a royalty of 50 percent of its net profits resulting from the sale of the products involved in the inventions, royalties or license fees received from sublicensees, the proceeds of the sale of any patent or interest therein, and moneys recovered from infringers. The contract further provided that Becco should render quarterly statements not more than 45 days after the close of the quarter, showing appropriate receipts and disbursements, and should therewith pay to petitioner the royalties due him. Minimum royalties of 25,000 per year were provided for, and Becco was given the right to reimburse itself for any difference paid by it between the earned and minimum royalties out of the earned royalties in excess of the minimum in any other year. The agreement contained a termination clause exercisable by Becco at the end of any calendar year upon written notice as provided.

On July 1, 1936, a written agreement was entered into at Buffalo, New York, between Sanchez, Becco and Sucro-Blanc, Inc., a New York corporation organized by Becco as a vehicle for the development of the use and sale of Sucro-Blanc. By the terms of this contract, Becco sold and assigned to Sucro-Blanc, Inc., all Becco's right, title, and interest under the 1934 agreement with the same force and effect as if Sucro-Blanc, Inc., had been named as a party of the second part in said agreement. Becco transferred to petitioner 550 shares of nonvoting and 150 shares of voting stock in Sucro-Blanc, Inc., and retained enough shares of voting stock to assure itself of control. Sucro-Blanc, Inc., accepted the transfer and agreed to perform all things required by the earlier agreement of Becco, and agreed to pay to each of Becco and petitioner the sum of 30 per short ton on all sales, and 37 1/2 percent of the proceeds of any sale, assignment, sublicense, or other disposition of any patent or patent right. The earlier provision for minimum royalties was modified to provide for minimum payments to petitioner of salary, dividends, or royalties of 12,000 per year. Except for the modifications thereof specifically set forth, the agreement of January 24, 1934, was continued in effect.

On September 18, 1937, a written agreement was entered into at New York City among petitioner, Becco, and Sucro-Blanc, Inc., because

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of a proposed change in the manner of preparing and selling the products manufactured by Sucro-Blanc, Inc., modifying the July 1, 1936, agreement by providing for the payment by Sucro-Blanc, Inc., to each of Becco and petitioner, of an amount equal to 10 percent of the selling price of all sales of "Sucro-Blanc" made by Sucro-Blanc, Inc., f. o. b. Wyandotte, Michigan, payable quarterly, instead of 30 per short ton as previously provided.

In June of 1940 another written agreement was entered into at New York City among the three parties, in which the agreements of June 1, 1936, and September 28, 1937, were clarified. It recited that those agreements had failed to indicate and this agreement supplied that deficiency, that the moneys to be paid petitioner and Becco were to be calculated on the selling price of all sales of "Sucro-Blanc," and further that the moneys payable to petitioner constituted royalties, and that the method of computing such royalties was merely a gauge in determining so much of the consideration as is based on royalties for the granting of the exclusive license under the foreign patents and the United States patents. The agreement further required Sucro-Blanc, Inc., to keep and maintain separate accounts in its books setting forth the sales made by virtue of the exclusive license granted under foreign patents and those under the exclusive license granted under the United States patents.

The chemical known as Sucro-Blanc was manufactured at Wyandotte, Michigan, and during 1940 Sucro-Blanc, Inc., sold 274.35 short tons of the product to customers located in the United States and its possessions, and the amount due petitioner based thereon was 12,620.10. During the same year, it sold 188.55 short tons to customers for use in other countries, and the amount due petitioner based thereon was 8,673.30, which is the item now in controversy.

The amount of Sucro-Blanc sold for use in other countries in 1940, calculated in pounds, was as follows:

             Pounds

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requirements of the product Sucro-Blanc from Sucro-Blanc, Inc., and if it purchased at least one hundred fifty (150) tons of said product in each calendar year after 1938. This agreement was executed in New York. In all sales of Sucro-Blanc to W. R. Grace & Co. the shipping papers were delivered to it and payments were made by it in New York.

During the year 1940 there was in effect a nonexclusive license agreement between Sucro-Blanc, Inc., and the Florida Sugar Co. Under this agreement, which was to be construed in accordance with the laws of the State of New York, Sucro-Blanc, Inc., gave to the Florida Sugar Co. the nonexclusive right and license to use in its sugar refining plant in Cuba the chemical reagent Sucro-Blanc. The licensee, however, was only permitted the use of such chemical reagent if it were purchased from the licensor, Sucro-Blanc, Inc. Attached to this license agreement was a "Sales Agreement for Sucro-Blanc." This agreement between Sucro-Blanc, Inc., and the Florida Sugar Co. provided that the price of Sucro-Blanc to the Florida Sugar Co. was to be 15 cents per pound f. o. b. Philadelphia, Pennsylvania; that the terms should be "cash against delivery of complete shipping documents in New York"; that the contract should not be altered except by "an instrument in writing executed by an officer of the seller at seller's office in New York City"; and that the contract should be governed and construed under the laws of the State of New York. This contract and agreement were typical of the other nonexclusive license agreements entered into by Sucro-Blanc, Inc.

Sucro-Blanc, Inc., made no charge to its licensees for the use of the patented process. Practically all of its income was derived from the sale of the product Sucro-Blanc. The payments made by Sucro-Blanc, Inc., to petitioner which are here in question were calculated upon such sales and were paid from the proceeds thereof.

Petitioner also received from Sucro-Blanc, Inc., in 1940 a check dated January 3, 1940, in the amount of 7,642.60 representing royalties on sales made by Sucro-Blanc, Inc., during the year 1939. Sucro-Blanc, Inc., had a cash balance on December 31, 1939, of 59,250.81. Petitioner was an officer of Sucro-Blanc, Inc., and, as such, was authorized to sign checks, which required the signatures of two authorized signers. The sum of 7,642.60 was not credited to any account of petitioner on the books of Sucro-Blanc, Inc., or otherwise set apart for him. Petitioner reported his income for the years 1939 and 1940 on a cash basis. He reported the item of 7,642.60 for taxation in 1939. The amount of 7,642.60 was actually received by petitioner in 1940. OPINION

The first issue which we have to decide is whether certain payments, designated as royalties, received by petitioner in

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1940 from Sucro-Blanc, Inc., a New York corporation, constituted income from sources within the United States, as respondent contends, or from sources without the United States, as petitioner contends.

Petitioner is the inventor of what we shall call the Sucro-Blanc process for refining sugar, a patent for which, in 1934, had been issued in Cuba, and applied for in the United States, which involves the use of a hypochlorite called Sucro-Blanc. In 1934 he granted the exclusive world-wide license for its use to the Buffalo Electro-Chemical Co., called Becco, to which we have referred in our findings.

The consideration for this transfer was Becco's promise to pay to petitioner a percentage of its net profit from the sale or use of the process or the product, or a minimum of 25,000 a year. Approximately two years later, Becco transferred all its rights to another New York corporation, called Sucro-Blanc, Inc. Petitioner received one-half of the stock of Sucro-Blanc, Inc., numerically (although Becco received a majority of the voting stock), and agreed to modify his contract by accepting from Sucro-Blanc, Inc., in lieu of the consideration specified in his contract with Becco, 30 for each short ton of Sucro-Blanc sold, and 37 1/2 percent of the proceeds of any sale, assignment, license or other disposition of the patent or patent rights, or a minimum of 12,000 a year. Becco was to receive a like amount from Sucro-Blanc, Inc. The amount of the payments based on sales was later reduced to 10 percent of the sale prices f. o. b. Wyandotte, Michigan, of all the Sucro-Blanc sold, and this was the contract in effect in the tax year.

After the original transfer, patents were secured in the United States and many other countries, including those specifically concerned in the situation before us.

During 1940 petitioner received and reported the income which he received, based on sales for use in the United States and its possessions. During the same year 188.55 tons were sold for use in other countries, as set out in our findings, and petitioner received 8,673.30 based on such sales. It is as to this item that the dispute revolves. Petitioner contends it was income from sources without the United States, and hence not taxable to him.

We do not believe that sales of Sucro-Blanc made in this country by Sucro-Blanc, Inc., even though for use in other countries, give a foreign origin to the payments made to petitioner by Sucro-Blanc, Inc., the amount of which was measured by the sales of the product.

It is the petitioner's contention that the exclusive license granted by him covered not only the product, but the process, which is true; and that the sublicenses granted by Sucro-Blanc, Inc., similarly covered both process and product. From this he argues that, although no charge was allocated to the process, as distinguished from the product,

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either in his contract with the corporation or the corporation's contract with its licensees, nevertheless, all the corporation's income arising from the sale of the product, and all of petitioner's income derived from the corporation and measured by such sales, was received for the use of both process and product, and, to the extent that the process and product were used in foreign countries, was income from without the United States. Since he thus denies that the income arises wholly from the sales, he contends the place of sale is immaterial.

In this argument petitioner minimizes the salient fact that he himself had no relationship whatsoever with any person using the process or product in foreign countries. His contractual relationship out of which his income here in question was derived was with an American corporation, Sucro-Blanc, Inc., which disposed of the use of the process in this country and made the product necessary to the process in this country. By reason of his contract, executed in the United States by himself and an American corporation, he was entitled to and received certain payments made to him in the United States from funds held in the United States by a New York corporation. The fact that the New York corporation received a part of these funds from sales made by the corporation to its customers doing business in foreign countries or from sublicenses which it had the right to make, granted by the corporation to persons who used the process licensed in foreign countries, can not affect the characterization of the income derived by petitioner from the New York corporation.

Even if we were of the opinion that the source of the payments to Sucro-Blanc, Inc., would be determinative of the source of the income derived from Sucro-Blanc, Inc., by petitioner, we would still be of the opinion that petitioner's income here in question would be from sources within the United States.

The evidence is far from satisfactory, but it is sufficient to establish that the corporation chose not to charge anything for the installation and use of the patented process by its licensees, looking to the sales of the product for its remuneration. The corporate income, therefore, was, by design, derived from the sales, not the installation or use of the process, and, consequently, the source of the payments to petitioner here in question, upon the hypothesis that the source of the income of the corporation is controlling, would be the sales of Sucro-Blanc. Therefore, the place where the sales of the product were consummated would determine the source of petitioner's income. See East Coast Oil Co., 31 B. T. A. 558.

Petitioner introduced in evidence an exclusive license and a nonexclusive license, executed by Sucro-Blanc, Inc., presumably as typical examples of the type of licenses which it granted.

In the case of the exclusive license agreement, the licensee was W. R.

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Grace & Co., a Connecticut corporation, which held the exclusive license for Bolivia, Peru, and Chile, in South America. Petitioner's witness testified that, as to all sales made to W. R. Grace & Co., shipping papers were delivered to it in the United States, and payment was made and received in this country. The contract itself was entered into in New York. Where one domestic corporation sells and delivers to another domestic corporation a product manufactured in the United States, pursuant to a contract entered into in the United States, for which payment is received in the United States, it can scarcely be argued that the shipment of the product thereafter for use in a foreign country makes the money paid for it income arising from a source outside of the United States.

With respect to the sales under the nonexclusive licenses, all the above facts are true, except that the licensee was a foreign corporation. The contract provided that it was to be governed by the laws of New York State. The product was sold f. o. b. Philadelphia, and the shipping papers were delivered and payments were made in New York. We are equally unable to find a foreign source of the income resulting from these sales.

A majority of the so-called foreign sales made in 1940 appear to have been made under these two contracts. If they are not typical of all the sales made during that year, as petitioner suggests in his brief, and if other sales were made providing for the transfer of title elsewhere than in the United States, we have before us no evidence from which we can determine the number or identity of such sales.

Upon this issue and the record before us we decide in favor of respondent.

The second issue involved is the correctness of respondent's action in including in petitioner's taxable income for 1940 royalties in the amount of 7,642.60 which petitioner received in 1940, the check therefor having been issued by Sucro-Blanc, Inc., on January 3, 1940. The royalties were earned in 1939. Petitioner was on a cash basis of accounting.

Petitioner contends that he constructively received these royalties in 1939. Section 19.42-2 of Regulations 103 provides:

Income which is credited to the account of or set apart for a taxpayer and which may be drawn upon by him at any time is subject to tax for the year during which so credited or set apart, although not then actually reduced to possession. To constitute receipt in such a case the income must be credited or set apart to the taxpayer without any substantial limitation or restriction as to the time or manner of payment or condition upon which payment is to be made, and must be made available to him so that it may be drawn at any time, and its receipt brought within his own control and disposition. * * *

Ordinarily, a taxpayer who employs the cash basis must actually receive the income before he is taxable on it. To constitute constructive

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receipt, the income must be credited to the account of the taxpayer without restriction, or so set aside for the taxpayer's use that it is under his unrestricted control.

There is no evidence here that the corporation credited the royalties on its books to petitioner, or that the amount thereof was or could have been computed or finally determined before the close of business on December 31, 1939. The contract provided the royalties should be paid quarterly on all sales for which payment had been received during the previous quarter. The evidence indicates that the first entry on the books of Sucro-Blanc, Inc., reflecting the item in dispute was made on January 3, 1940, and was described as a disbursement of royalties due December 31, 1939. It was further shown that the corporation's books showed a balance of 59,250.81 as of December 31, 1939, that the corporate checks required two signatures, and that petitioner was one of the persons authorized as a cosigner of such checks, as an officer of the corporation.

In the case entitled In re John A. Brander, 3 B. T. A. 231, and its companion case, Chester M. Curry, 3 B. T. A. 237, the taxpayers controlled the corporation, which is not true of the petitioner here. The amounts due were credited to their accounts on the books of the corporation, which is not true here. The taxpayers' failure to receive the amounts due resulted from their deliberate refusal to take them. Here, where the amount was not determinable until the close of the year, petitioner, having received them on January 4, can hardly be said to have willfully declined to receive them in the earlier year.

We have frequently had occasion to reiterate the rule that the doctrine of constructive receipt will be sparingly applied. William A. Hines, 38 B. T. A. 1061; Samuel Keller Jacobs, 22 B. T. A. 1166; William H. C. Plety, 43 B. T. A. 140; Hal E. Roach, 20 B. T. A. 919. In the latter case, we said the doctrine would be invoked "only in unique circumstances and a clear case."

The facts here fall short of presenting such a case. We conclude, therefore, that the respondent did not err in his determination that the amount involved in this issue is taxable to petitioner in 1940.

Decision will be entered under Rule 50.