Affiliated Enterprises, Inc. v. Commissioner

MURRAH, Circuit Judge. The question presented by this appeal is whether 80 per cent of the taxpayer’s income for the taxable year 1937 was derived from “royalties” or “other like property”, and consequently taxable as personal holding company income within the meaning of Section 351(b) of the Revenue Act of 1936, c. 690, 49 Stat. 1648, as amended by Section 1 of the Revenue Act of 1937, c. 815, 50 Stat. 813.1 The answer depends on whether the principles an [648] nounced by this court in a former case involving the taxpayer’s income for the taxable years 1934, 1935 and 1936 is applicable to and controlling of the instant facts. Commissioner v. Affiliated Enterprises, Inc., 10 Cir., 123 F.2d 665, certiorari denied 315 U.S. 812, 62 S.Ct. 796, 86 L.Ed. 1211. The Tax Court held the facts here insufficiently different on principle to warrant a contrary result, and that accordingly the taxpayer fell within the statutory definition of a personal holding company for the taxable year 1937. By this appeal, the taxpayer does not attack the former holding as applied to those facts, but does contend that these facts, when applied to the principles announced there, requires a different result. Affiliated Enterprises, Inc. (taxpayer and herein called Affiliated), was organized in 1933 to promote the sale of a plan or scheme called “Bank Night” to theater owners throughout the country. The plan was> designed to stimulate theater business by encouraging attendance in the following manner: Any person over sixteen years of age who registered in the lobby of a theater using the plan was given a number. These numbers were placed in a box, and on an appointed night a number was drawn from the box on the stage of the theater, and the holder of the number drawn, if present, received a sum of money which had been placed in a special account in a local bank. “Bank Night” was advertised by means of cards, posters, and film trailers which Affiliated sold to the theater owners. The plan was immediately successful, and was used extensively throughout the country. Between 1933 and 1938, Affiliated made repeated attempts to obtain a patent on the “means for conducting prize drawings”,. but it was denied on the grounds that the art was not patentable. It did succeed however in securing copyrights on certain film trailers and instruction sheets which described the system, and the name “Bank Night” was registered as a trade-mark name in most of the states. The plan was originally sold to theater owners throughout the country under a written agreement labelled “Bank Night License Agreement”, which recited that Affiliated was the owner of the copyrighted and trade-marked name “Bank Night”, and of certain copyrights and patents pending, together with other accessories such as cards, posters, registers, film trailers, record books, and instruction sheets used in the operation of “Bank Night”. The theater operator was called a licensee, and the agreement recited that the licensee desired to acquire a limited license to use the “Bank Night” system in his theater. The licensee acknowledged Affiliated’s ownership of the trade-marks, copyrights, patents pending, and further acknowledged that it was purchasing only the right to use that which Affiliated owned, and agreed to pay damages of $100 per day if it used the system or any modification thereof after the termination of the license agreement. Affiliated reserved the right to defend in the name of the licensee any attack upon the right to exercise the license or any phase thereof, and it paid legal retainers throughout the country to thirty or more attorneys for the purpose of defending various attacks upon the system. By the terms of the license agreement, the theater owners agreed to pay a stipulated fee of from $5 to $10 per week for the right to use the system. Affiliated also sold the theater owners all of the accessories and equipment used in the operation of the plan, but more than 80 per cent of its income for the taxable years 1934, 1935 and 1936 was derived directly from the sale of “Bank Night License Agreements.” On December 3, 1936, this court in Affiliated Enterprises, Inc., v. Gantz, 86 F.2d 597, 599, held that the trade-mark [649] registration of the term “Bank Night” afforded Affiliated no protection of the plan or system employed. It further held that Affiliated had no property right in the plan or system called “Bank Night”; that it was “too closely akin [to a lottery]” to “have the protection * * * of a court of equity.” On December 18, 1936, the First Circuit in Affiliated Enterprises, Inc., v. Gruber, 86 F.2d 958, likewise held that Affiliated had no property right in the plan or system capable of protection in a court of equity.2 Thereafter, the Commissioner determined that Affiliated fell within the statutory definition of a personal holding company with respect to its tax liability for the taxable years 1934, 1935 and 1936, and assessed a deficiency accordingly. On redetermination, the Board of Tax Appeals (now the Tax Court) held that since Affiliated had no property right in its idea or system which it could protect, or “on which it could give licenses to others”, the income from the sale of the license agreements was not royalty or “other like property”, and consequently Affiliated was not a personal holding company within the meaning of the Act. Affiliated Enterprises v. Commissioner, 42 B.T.A. 390. The Board thought that the income was in reality derived from a sales promotion scheme, which those purchasing same believed worth the payment of the fee charged under the written agreement. On appeal (123 F.2d 665, 667). this court held that the test was not whether the system was patentable or capable of protection in a court of equity, but rather “whether the idea is new or novel and has value.” The court stated, “it is apparent from the record that respondent [Affiliated] in its dealings with theater operators treated the transaction as one involving the payment of royalty for the use of a creative, novel idea possessing utility”; that since the parties at the time of the transaction “certainly thought they were dealing with reference to an idea subject to protection by patent or copyright, and that the transaction involved royalty payments”, the' income derived from the sale of the contracts constituted royalty or other like property for income tax purposes. Whether Affiliated falls within the arbitrary statutory definition of a personal holding company for the taxable year 1937 depends upon the peculiar facts applicable for that year, and not upon its taxable status in any other year. See Mertens Law of Federal Income Taxation, Vol. 7, Sec. 39.01, p. 70. With the beginning of the year 1937, the Gantz and Gruber cases had been given wide publicity by means of trade journals and general newspaper comments. Theater owners and managers were given to understand that Affiliated could no longer claim any exclusive right to the use of the “Bank Night” system, and Affiliated also realized that it had nothing to sell capable of protection as a patentable or copyrightable idea. It was faced with the necessity of changing its “mode of operation” if it were to stay in business. Consequently, to meet this exigency, it devised what it called a “Bank Night Theater Service”, which, by means of a manual published early in 1937, it advertised a comprehensive and complete theater service designed to give the independent theater owner specialized advice for the operation of a theater in the most efficient and economical manner. The “Bank Night Theater Service” was advertised through the manual to the theater owners as a “Department of Affiliated Enterprises, Inc., owner of the trade-name, trade-mark, copyrights and/or patents pertaining to Bank Night”. Twenty-two items 3 were listed as subjects for specialized advice and counsel. Included in the service offered was the “Bank Night” plan as a “business stimulator”, but no exclusive rights in the “Bank Night” idea was claimed, and the accessories and supplies used in connection with the system were furnished without extra cost to the purchasers of the service. Of the total gross income of the taxpayer for the year 1937, 58.32 per cent was realized from the sale of written “License Agreements” identical to those used in prior years, some of which were sold in 1936 prior to the Gantz and Gruber [650] decisions, and others in 1937. With respect to this income, Affiliated concedes that it is controlled by the earlier decision of this court, and that it is to be classified as royalty or other like property for the purposes of this case. But 41.30 per cent of the total gross income of Affiliated for the year 1937 was realized from the sale of the “Bank Night Theater Service” to theater operators who did not sign any contract or agreement, but orally agreed to pay a stipulated amount for the service, with the privilege of termination at will. In other words, 41.30 per cent of the taxpayer’s income was derived from sources which cannot be said to be attributable to any written agreements wherein the parties by contract “treated the transaction as one involving the payment of royalty for the use of a creative, novel idea possessing utility.” The parties did not treat the idea as one subject to protection by patent, copyright, or otherwise. The Commissioner concedes of course that if the 41.30 per cent of the taxpayer’s income was realized for services rendered, having no relation to royalties or other like property, it does not come within the statutory definition of a personal holding company for the taxable year 1937. To hold that the income derived from the oral contracts constituted royalties or other like property is pushing the rule announced in the earlier case beyond the practical and common sense interpretation accorded that term. It follows that Affiliated does not fall within the statutory definition of a personal holding company for the taxable year 1937, and the order of the Tax Court is accordingly reversed. Footnotes [1] The applicable portion of the Act provides: “Sec. 351. Surtax on Personal Holding Companies. There shall be levied, collected, and paid, for each taxable year (in addition to the taxes imposed by Title I), upon the undistributed adjusted net income of every personal holding company a surtax equal to the sum of the following: * « S:» “Sec. 352. Definition of Personal Holding Company, (a) General Rule. — For the purposes of this title and of Title I the term ‘personal holding company’ means any corporation if — (1) Gross income requirement. — At least 80 per centum of its gross [648] income for the taxable year is personal holding income as defined in section 353; * * * and (2) Stock ownership requirement. — At any time during the last half of the taxable year more than 50 per centum in value of its outstanding stock is owned, directly or indirectly, by or for not more than five individuals.” “Sec. 353. Personal Holding Company Income. For the purposes of this title the term ‘personal holding company income’ means the portion of the gross income which consists of: (a) Dividends, interest, royalties (other than mineral, oil, or gas royalties), annuities.” 26 U.S.C.A. Int. Rev.Acts, pages 973, 974. Personal bolding company income is defined by Treasury Regulations 94, promulgated under the Revenue Act of 1936, Art. 353-1, as follows: “The term ‘personal holding company income’ means the portion of the gross income which consists of the following: * * * (3) Royalties — The term ‘royalties’ includes amounts received for the privilege of using patents, copyrights, secret processes and formulas, good will, trade-marks, trade-brands, franchises, and other like property. * * *” [2] Affiliated discontinued operations in 1938 when a fraud order was issued against it by the Post Office Department on the grounds that its system constituted a lottery. [3] Electrical survey, power costs, heating analysis, accounting, advertising and exploitation, architecture, business stimulators, discounts, decorating, electricity, equipment, financing, insurance, laboratories, library, heating and cooling, modernization, physical operation, projection and sound, purchasing advice, valuation, and summary.