The Timken Roller Bearing Co. v. Commissioner, 3 T.C. 1036 (1944)

The amount of money paid in for stock, used to calculate the “daily capital addition” for excess profits tax purposes, is the net amount received by the corporation after deducting underwriting commissions, unless the evidence shows the stock purchasers paid the full amount directly to the corporation.

Summary

Timken Roller Bearing Co. sold preferred stock through underwriters and sought to include the gross amount received before underwriting commissions in its “daily capital addition” for calculating excess profits tax. The Tax Court held that the net amount received after deducting underwriting commissions was the correct amount, as the evidence did not demonstrate the public investors directly paid the gross amount to Timken. The court also determined the proper treatment of preferred stock retirements and royalty income from British patents, classifying the latter as ordinary income, not capital gains.

Facts

In 1941, Timken sold 30,000 shares of preferred stock. The agreed purchase price was $3,000,000, but after paying $105,000 to underwriters as commission, Timken netted $2,895,000. Timken also retired some of its preferred stock in 1942. Timken received quarterly payments from Vandervell Products Ltd. related to British patents.

Procedural History

Timken petitioned the Tax Court to challenge the Commissioner’s determination of its excess profits tax liability. The dispute centered on the calculation of the “daily capital addition,” the treatment of preferred stock retirements, and the characterization of royalty income. The Tax Court rendered a decision based on the evidence presented.

Issue(s)

1. Whether the “daily capital addition” under Section 713(g)(3) of the Internal Revenue Code is the gross amount received from the sale of stock before underwriting commissions or the net amount received after deducting such commissions.

2. Whether the amount of daily capital reduction resulting from preferred stock retirement is the par value of the stock or the amount the company actually paid to retire the stock.

3. Whether royalty payments received from Vandervell Products Ltd. constitute long-term capital gains or ordinary income.

Holding

1. No, because the evidence showed the underwriters, not the public, purchased the stock, and the statute refers to “money paid in for stock.”
2. The amount the company actually paid to retire the stock is the correct amount.

3. Ordinary income, because the 1938 agreement with Vandervell Products Ltd. constituted a license, not an assignment, of the British patents.

Court’s Reasoning

The court reasoned that the “daily capital addition” should reflect the amount of money actually received by the corporation for its stock. Since the underwriters purchased the stock and the evidence didn’t demonstrate the public investors directly supplied the funds to Timken, the commission was appropriately deducted. The court followed the principle that invested capital cannot be increased by commissions paid for selling stock. Regarding the preferred stock retirement, the court sided with the Commissioner’s concession that the amounts actually paid should be used. As to the British patents, the court determined that the 1938 agreement, when read in conjunction with a 1932 letter agreement, granted Vandervell only an exclusive license to make and sell products covered by Timken’s patents, not an assignment of all rights under the patents. Quoting Waterman v. Mackenzie, 138 U.S. 252, the court emphasized that a transfer of patent rights must include the rights to make, use, and sell to be considered an assignment. The court also noted, “An assignment gives the transferee the right to sue for infringement, while a license gives a transferee merely immunity from suit for infringement. ‘The first gives positive rights, the second negative rights.’”

Practical Implications

This case clarifies how to calculate the “daily capital addition” for excess profits tax, emphasizing the importance of demonstrating that the corporation directly received the full purchase price of stock from investors. It also provides a detailed analysis of the distinction between patent assignments and licenses, underscoring the need for a clear and unambiguous transfer of all rights (make, use, and sell) for a transaction to be considered an assignment. The decision highlights the importance of examining the substance of a transaction over its form, particularly when dealing with complex financial arrangements. Later cases would cite this when determining whether proceeds are capital gains or ordinary income. The importance of demonstrating that the investor directly paid proceeds to the company is crucial in supporting the taxpayer’s claimed tax treatment.