§1235 — Sale or exchange of patents
73 citing cases
Statute Text — 26 U.S.C. §1235
A transfer (other than by gift, inheritance, or devise) of property consisting of all substantial rights to a patent, or an undivided interest therein which includes a part of all such rights, by any holder shall be considered the sale or exchange of a capital asset held for more than 1 year, regardless of whether or not payments in consideration of such transfer are—
payable periodically over a period generally coterminous with the transferee’s use of the patent, or
contingent on the productivity, use, or disposition of the property transferred.
For purposes of this section, the term “holder” means—
any individual whose efforts created such property, or
any other individual who has acquired his interest in such property in exchange for consideration in money or money’s worth paid to such creator prior to actual reduction to practice of the invention covered by the patent, if such individual is neither—
the employer of such creator, nor
related to such creator (within the meaning of subsection (c)).
Subsection (a) shall not apply to any transfer, directly or indirectly, between persons specified within any one of the paragraphs of section 267(b) or persons described in section 707(b); except that, in applying section 267(b) and (c) and section 707(b) for purposes of this section—
the phrase “25 percent or more” shall be substituted for the phrase “more than 50 percent” each place it appears in section 267(b) or 707(b), and
paragraph (4) of section 267(c) shall be treated as providing that the family of an individual shall include only his spouse, ancestors, and lineal descendants.
For special rule relating to nonresident aliens, see section 871(a).
Treasury Regulations
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Treas. Reg. §1.1235-1Sale or exchange of patents
(a) General rule. Section 1235 provides that a transfer (other than by gift, inheritance, or devise) of all substantial rights to a patent, or of an undivided interest in all such rights to a patent, by a holder to a person other than a related person constitutes the sale or exchange of a capital asset held for more than 1 year (6 months for taxable years beginning before 1977; 9 months for taxable years beginning in 1977), whether or not payments therefor are:
(1) Payable periodically over a period generally coterminous with the transferee's use of the patent, or
(2) Contingent on the productivity, use, or disposition of the property transferred.
(b) Scope of section 1235. If a transfer is not one described in paragraph (a) of this section, section 1235 shall be disregarded in determining whether or not such transfer is the sale or exchange of a capital asset. For example, a transfer by a person other than a holder or a transfer by a holder to a related person is not governed by section 1235. The tax consequences of such transfers shall be determined under other provisions of the internal revenue laws.
(c) Special rules—(1) Payments for infringement. If section 1235 applies to the transfer of all substantial rights to a patent (or an undivided interest therein), amounts received in settlement of, or as the award of damages in, a suit for compensatory damages for infringement of the patent shall be considered payments attributable to a transfer to which section 1235 applies to the extent that such amounts relate to the interest transferred. For taxable years beginning before January 1, 1964, see section 1304, as in effect before such date, and § 1.1304A-1 for treatment of compensatory damages for patent infringement.
(2) Payments to an employee. Payments received by an employee as compensation for services rendered as an employee under an employment contract requiring the employee to transfer to the employer the rights to any invention by such employee are not attributable to a transfer to which section 1235 applies. However, whether payments received by an employee from his employer (under an employment contract or otherwise) are attributable to the transfer by the employee of all substantial rights to a patent (or an undivided interest therein) or are compensation for services rendered the employer by the employee is a question of fact. In determining which is the case, consideration shall be given not only to all the facts and circumstances of the employment relationship but also to whether the amount of such payments depends upon the production, sale, or use by, or the value to, the employer of the patent rights transferred by the employee. If it is determined that payments are attributable to the transfer of patent rights, and all other requirements under section 1235 are met, such payments shall be treated as proceeds derived from the sale of a patent.
(3) Successive transfers. The applicability of section 1235 to transfers of undivided interest in patents, or to successive transfers of such rights, shall be determined separately with respect to each transfer. For example, X, who is a holder, and Y, who is not a holder, transfer their respective two-thirds and one-third undivided interests in a patent to Z. Assume the transfer by X qualifies under section 1235 and that X in a later transfer acquires all the rights with respect to Y's interest, including the rights to payments from Z. One-third of all the payments thereafter received by X from Z are not attributable to a transfer to which section 1235 applies.
(d) Payor's treatment of payments in a transfer under section 1235. Payments made by the transferee of patent rights pursuant to a transfer satisfying the requirements of section 1235 are payments of the purchase price for the patent rights and are not the payment of royalties.
(e) Effective date. Amounts received or accrued, and payments made or accrued, during any taxable year beginning after December 31, 1953 and ending after August 16, 1954, pursuant to a transfer satisfying the requirements of section 1235, whether such transfer occurred in a taxable year to which the Internal Revenue Code of 1954 applies, or in a year prior thereto, are subject to the provisions of section 1235.
(f) Nonresident aliens. For the special rule relating to nonresident aliens who have gains arising from a transfer to which section 1235 applies, see section 871 and the regulations thereunder. For withholding of tax from income of nonresident aliens, see section 1441 and the regulations thereunder.
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Treas. Reg. §1.1235-1(a)General rule.
General rule. Section 1235 provides that a transfer (other than by gift, inheritance, or devise) of all substantial rights to a patent, or of an undivided interest in all such rights to a patent, by a holder to a person other than a related person constitutes the sale or exchange of a capital asset held for more than 1 year (6 months for taxable years beginning before 1977; 9 months for taxable years beginning in 1977), whether or not payments therefor are:
(1) Payable periodically over a period generally coterminous with the transferee's use of the patent, or
(2) Contingent on the productivity, use, or disposition of the property transferred.
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Treas. Reg. §1.1235-1(b)Scope of section 1235.
Scope of section 1235. If a transfer is not one described in paragraph (a) of this section, section 1235 shall be disregarded in determining whether or not such transfer is the sale or exchange of a capital asset. For example, a transfer by a person other than a holder or a transfer by a holder to a related person is not governed by section 1235. The tax consequences of such transfers shall be determined under other provisions of the internal revenue laws.
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Treas. Reg. §1.1235-1(c)Special rules—(1) Payments for infringement.
Special rules—(1) Payments for infringement. If section 1235 applies to the transfer of all substantial rights to a patent (or an undivided interest therein), amounts received in settlement of, or as the award of damages in, a suit for compensatory damages for infringement of the patent shall be considered payments attributable to a transfer to which section 1235 applies to the extent that such amounts relate to the interest transferred. For taxable years beginning before January 1, 1964, see section 1304, as in effect before such date, and § 1.1304A-1 for treatment of compensatory damages for patent infringement.
(2) Payments to an employee. Payments received by an employee as compensation for services rendered as an employee under an employment contract requiring the employee to transfer to the employer the rights to any invention by such employee are not attributable to a transfer to which section 1235 applies. However, whether payments received by an employee from his employer (under an employment contract or otherwise) are attributable to the transfer by the employee of all substantial rights to a patent (or an undivided interest therein) or are compensation for services rendered the employer by the employee is a question of fact. In determining which is the case, consideration shall be given not only to all the facts and circumstances of the employment relationship but also to whether the amount of such payments depends upon the production, sale, or use by, or the value to, the employer of the patent rights transferred by the employee. If it is determined that payments are attributable to the transfer of patent rights, and all other requirements under section 1235 are met, such payments shall be treated as proceeds derived from the sale of a patent.
(3) Successive transfers. The applicability of section 1235 to transfers of undivided interest in patents, or to successive transfers of such rights, shall be determined separately with respect to each transfer. For example, X, who is a holder, and Y, who is not a holder, transfer their respective two-thirds and one-third undivided interests in a patent to Z. Assume the transfer by X qualifies under section 1235 and that X in a later transfer acquires all the rights with respect to Y's interest, including the rights to payments from Z. One-third of all the payments thereafter received by X from Z are not attributable to a transfer to which section 1235 applies.
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Treas. Reg. §1.1235-1(d)Payor's treatment of payments in a transfer under section 1235.
Payor's treatment of payments in a transfer under section 1235. Payments made by the transferee of patent rights pursuant to a transfer satisfying the requirements of section 1235 are payments of the purchase price for the patent rights and are not the payment of royalties.
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Treas. Reg. §1.1235-1(e)Effective date.
Effective date. Amounts received or accrued, and payments made or accrued, during any taxable year beginning after December 31, 1953 and ending after August 16, 1954, pursuant to a transfer satisfying the requirements of section 1235, whether such transfer occurred in a taxable year to which the Internal Revenue Code of 1954 applies, or in a year prior thereto, are subject to the provisions of section 1235.
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Treas. Reg. §1.1235-1(f)Nonresident aliens.
Nonresident aliens. For the special rule relating to nonresident aliens who have gains arising from a transfer to which section 1235 applies, see section 871 and the regulations thereunder. For withholding of tax from income of nonresident aliens, see section 1441 and the regulations thereunder.
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Treas. Reg. §1.1235-2Definition of terms
For the purposes of section 1235 and § 1.1235-1:
(a) Patent. The term patent means a patent granted under the provisions of title 35 of the United States Code, or any foreign patent granting rights generally similar to those under a United States patent. It is not necessary that the patent or patent application for the invention be in existence if the requirements of section 1235 are otherwise met.
(b) All substantial rights to a patent. (1) The term all substantial rights to a patent means all rights (whether or not then held by the grantor) which are of value at the time the rights to the patent (or an undivided interest therein) are transferred. The term all substantial rights to a patent does not include a grant of rights to a patent:
(i) Which is limited geographically within the country of issuance;
(ii) Which is limited in duration by the terms of the agreement to a period less than the remaining life of the patent;
(iii) Which grants rights to the grantee, in fields of use within trades or industries, which are less than all the rights covered by the patent, which exist and have value at the time of the grant; or
(iv) Which grants to the grantee less than all the claims or inventions covered by the patent which exist and have value at the time of the grant.
The circumstances of the whole transaction, rather than the particular terminology used in the instrument of transfer, shall be considered in determining whether or not all substantial rights to a patent are transferred in a transaction.
(2) Rights which are not considered substantial for purposes of section 1235 may be retained by the holder. Examples of such rights are:
(i) The retention by the transferor of legal title for the purpose of securing performance or payment by the transferee in a transaction involving transfer of an exclusive license to manufacture, use, and sell for the life of the patent;
(ii) The retention by the transferor of rights in the property which are not inconsistent with the passage of ownership, such as the retention of a security interest (such as a vendor's lien), or a reservation in the nature of a condition subsequent (such as a provision for forfeiture on account of nonperformance).
(3) Examples of rights which may or may not be substantial, depending upon the circumstances of the whole transaction in which rights to a patent are transferred, are:
(i) The retention by the transferor of an absolute right to prohibit sublicensing or subassignment by the transferee;
(ii) The failure to convey to the transferee the right to use or to sell the patent property.
(4) The retention of a right to terminate the transfer at will is the retention of a substantial right for the purposes of section 1235.
(c) Undivided interest. A person owns an undivided interest in all substantial rights to a patent when he owns the same fractional share of each and every substantial right to the patent. It does not include, for example, a right to the income from a patent, or a license limited geographically, or a license which covers some, but not all, of the valuable claims or uses covered by the patent. A transfer limited in duration by the terms of the instrument to a period less than the remaining life of the patent is not a transfer of an undivided interest in all substantial rights to a patent.
(d) Holder. (1) The term holder means any individual:
(i) Whose efforts created the patent property and who would qualify as the original and first inventor, or joint inventor, within the meaning of title 35 U.S.C., or
(ii) Who has acquired his interest in the patent property in exchange for a consideration paid to the inventor in money or money's worth prior to the actual reduction of the invention to practice (see paragraph (e) of this section), provided that such individual was neither the employer of the inventor nor related to him (see paragraph (f) of this section). The requirement that such individual is neither the employer of the inventor nor related to him must be satisfied at the time when the substantive rights as to the interest to be acquired are determined, and at the time when the consideration in money or money's worth to be paid is definitely fixed. For example, if prior to the actual reduction to practice of an invention an individual who is neither the employer of the inventor nor related to him agrees to pay the inventor a sum of money definitely fixed as to amount in return for an undivided one-half interest in rights to a patent and at a later date, when such individual has become the employer of the inventor, he pays the definitely fixed sum of money pursuant to the earlier agreement, such individual will not be denied the status of a holder because of such employment relationship.
(2) Although a partnership cannot be a holder, each member of a partnership who is an individual may qualify as a holder as to his share of a patent owned by the partnership. For example, if an inventor who is a member of a partnership composed solely of individuals uses partnership property in the development of his invention with the understanding that the patent when issued will become partnership property, each of the inventor's partners during this period would qualify as a holder. If, in this example, the partnership were not composed solely of individuals, nevertheless, each of the individual partners' distributive shares of income attributable to the transfer of all substantial rights to the patent or an undivided interest therein, would be considered proceeds from the sale or exchange of a capital asset held for more than 1 year (6 months for taxable years beginning before 1977; 9 months for taxable years beginning in 1977).
(3) An individual may qualify as a holder whether or not he is in the business of making inventions or in the business of buying and selling patents.
(e) Actual reduction to practice. For the purposes of determining whether an individual is a holder under paragraph (d) of this section, the term actual reduction to practice has the same meaning as it does under section 102(g) of title 35 of the United States Code. Generally, an invention is reduced to actual practice when it has been tested and operated successfully under operating conditions. This may occur either before or after application for a patent but cannot occur later than the earliest time that commercial exploitation of the invention occurs.
(f) Related person. (1) The term related person means one whose relationship to another person at the time of the transfer is described in section 267(b), except that the term does not include a brother or sister, whether of the whole or the half blood. Thus, if a holder transfers all his substantial rights to a patent to his brother or sister, or both, such transfer is not to a related person.
(2) If, prior to September 3, 1958, a holder transferred all his substantial rights to a patent to a corporation in which he owned more than 50 percent in value of the outstanding stock, he is considered as having transferred such rights to a related person for the purpose of section 1235. On the other hand, if a holder, prior to September 3, 1958, transferred all his substantial rights to a patent to a corporation in which he owned 50 percent or less in value of the outstanding stock and his brother owned the remaining stock, he is not considered as having transferred such rights to a related person since the brother relationship is to be disregarded for purposes of section 1235.
(3) If, subsequent to September 2, 1958, a holder transfers all his substantial rights to a patent to a corporation in which he owns 25 percent or more in value of the outstanding stock, he is considered as transferring such rights to a related person for the purpose of section 1235. On the other hand if a holder, subsequent to September 2, 1958, transfers all his substantial rights to a patent to a corporation in which he owns less than 25 percent in value of the outstanding stock and his brother owns the remaining stock, he is not considered as transferring such rights to a related person since the brother relationship is to be disregarded for purposes of section 1235.
(4) If a relationship described in section 267(b) exists independently of family status, the brother-sister exception, described in subparagraphs (1), (2), and (3) of this paragraph, does not apply. Thus, if a holder transfers all his substantial rights to a patent to the fiduciary of a trust of which the holder is the grantor, the holder and the fiduciary are related persons for purposes of section 1235(d). (See section 267(b)(4).) The transfer, therefore, would not qualify under section 1235(a). This result obtains whether or not the fiduciary is the brother or sister of the holder since the disqualifying relationship exists because of the grantor-fiduciary status and not because of family status.
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Treas. Reg. §1.1235-2(a)Patent.
Patent. The term patent means a patent granted under the provisions of title 35 of the United States Code, or any foreign patent granting rights generally similar to those under a United States patent. It is not necessary that the patent or patent application for the invention be in existence if the requirements of section 1235 are otherwise met.
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Treas. Reg. §1.1235-2(b)All substantial rights to a patent.
All substantial rights to a patent. (1) The term all substantial rights to a patent means all rights (whether or not then held by the grantor) which are of value at the time the rights to the patent (or an undivided interest therein) are transferred. The term all substantial rights to a patent does not include a grant of rights to a patent:
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Treas. Reg. §1.1235-2(c)Undivided interest.
Undivided interest. A person owns an undivided interest in all substantial rights to a patent when he owns the same fractional share of each and every substantial right to the patent. It does not include, for example, a right to the income from a patent, or a license limited geographically, or a license which covers some, but not all, of the valuable claims or uses covered by the patent. A transfer limited in duration by the terms of the instrument to a period less than the remaining life of the patent is not a transfer of an undivided interest in all substantial rights to a patent.
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Treas. Reg. §1.1235-2(d)Holder.
Holder. (1) The term holder means any individual:
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Treas. Reg. §1.1235-2(e)Actual reduction to practice.
Actual reduction to practice. For the purposes of determining whether an individual is a holder under paragraph (d) of this section, the term actual reduction to practice has the same meaning as it does under section 102(g) of title 35 of the United States Code. Generally, an invention is reduced to actual practice when it has been tested and operated successfully under operating conditions. This may occur either before or after application for a patent but cannot occur later than the earliest time that commercial exploitation of the invention occurs.
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Treas. Reg. §1.1235-2(f)Related person.
Related person. (1) The term related person means one whose relationship to another person at the time of the transfer is described in section 267(b), except that the term does not include a brother or sister, whether of the whole or the half blood. Thus, if a holder transfers all his substantial rights to a patent to his brother or sister, or both, such transfer is not to a related person.
(2) If, prior to September 3, 1958, a holder transferred all his substantial rights to a patent to a corporation in which he owned more than 50 percent in value of the outstanding stock, he is considered as having transferred such rights to a related person for the purpose of section 1235. On the other hand, if a holder, prior to September 3, 1958, transferred all his substantial rights to a patent to a corporation in which he owned 50 percent or less in value of the outstanding stock and his brother owned the remaining stock, he is not considered as having transferred such rights to a related person since the brother relationship is to be disregarded for purposes of section 1235.
(3) If, subsequent to September 2, 1958, a holder transfers all his substantial rights to a patent to a corporation in which he owns 25 percent or more in value of the outstanding stock, he is considered as transferring such rights to a related person for the purpose of section 1235. On the other hand if a holder, subsequent to September 2, 1958, transfers all his substantial rights to a patent to a corporation in which he owns less than 25 percent in value of the outstanding stock and his brother owns the remaining stock, he is not considered as transferring such rights to a related person since the brother relationship is to be disregarded for purposes of section 1235.
(4) If a relationship described in section 267(b) exists independently of family status, the brother-sister exception, described in subparagraphs (1), (2), and (3) of this paragraph, does not apply. Thus, if a holder transfers all his substantial rights to a patent to the fiduciary of a trust of which the holder is the grantor, the holder and the fiduciary are related persons for purposes of section 1235(d). (See section 267(b)(4).) The transfer, therefore, would not qualify under section 1235(a). This result obtains whether or not the fiduciary is the brother or sister of the holder since the disqualifying relationship exists because of the grantor-fiduciary status and not because of family status.
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Treas. Reg. §1.1235-2(i)Whose efforts created the patent property and who would qualify as the original and first inventor, or joint inventor, within the meaning of title 35 U.
Whose efforts created the patent property and who would qualify as the original and first inventor, or joint inventor, within the meaning of title 35 U.S.C., or
(ii) Who has acquired his interest in the patent property in exchange for a consideration paid to the inventor in money or money's worth prior to the actual reduction of the invention to practice (see paragraph (e) of this section), provided that such individual was neither the employer of the inventor nor related to him (see paragraph (f) of this section). The requirement that such individual is neither the employer of the inventor nor related to him must be satisfied at the time when the substantive rights as to the interest to be acquired are determined, and at the time when the consideration in money or money's worth to be paid is definitely fixed. For example, if prior to the actual reduction to practice of an invention an individual who is neither the employer of the inventor nor related to him agrees to pay the inventor a sum of money definitely fixed as to amount in return for an undivided one-half interest in rights to a patent and at a later date, when such individual has become the employer of the inventor, he pays the definitely fixed sum of money pursuant to the earlier agreement, such individual will not be denied the status of a holder because of such employment relationship.
(2) Although a partnership cannot be a holder, each member of a partnership who is an individual may qualify as a holder as to his share of a patent owned by the partnership. For example, if an inventor who is a member of a partnership composed solely of individuals uses partnership property in the development of his invention with the understanding that the patent when issued will become partnership property, each of the inventor's partners during this period would qualify as a holder. If, in this example, the partnership were not composed solely of individuals, nevertheless, each of the individual partners' distributive shares of income attributable to the transfer of all substantial rights to the patent or an undivided interest therein, would be considered proceeds from the sale or exchange of a capital asset held for more than 1 year (6 months for taxable years beginning before 1977; 9 months for taxable years beginning in 1977).
(3) An individual may qualify as a holder whether or not he is in the business of making inventions or in the business of buying and selling patents.
73 Citing Cases
-32- [*32] However, section 1235(a) does not apply if the transferee is a related person.
; Schank v. Commissioner, T.C. Memo. 2015-235, at *16. II. Classification ofIncome We must decide whether any ofthe payments under the 2006 addendum were in exchange for Pipeline IP or were owed to Mr. Meggs under his broker agreement. We start with section 1235. A. Section 1235 Section 1235(a) provides that the "transfer * * * ofproperty consisting ofall substantial rights to a patent * * * by any holder shall be considered the sale or exchange ofa capital asset held for more than 1 year". This
The question we must decide is whetherpetitioner transferred "all substantial rights" to the relevant technology, such that the royalties he received are eligible for capital gain treatment under section 1235.¹ Finding as we do that petitioner retained valuable rights in the technologythat was the subject ofthe transfer, we sustain respondent's determination that section 1235 does not apply and that the royalties constituted ordinary income.
1235(a); see also Juda v. Commissioner, 90 T.C. 1263, 1281 (1988), aff'd, 877 F.2d 1075 (1st Cir. 1989). For purposes ofsection 1235, the term "all substantial rights"29 means "all rights * * * which are ofvalue at the time the rights * * * are transferred." Sec. 1.1235-2(b)(1), Income Tax Regs.3° The retention ofthe right to terminate the transfer at will is the retention ofa substantial right under section 1235.3' Sec. 1.1235-2(b)(4), Income Tax Regs. 28Generally, an assignment is a transfer o
After concessions, the issues for decision are: (1) whether royalties petitioner James Cooper received during 2006, 2007, and 2008 qualified for capital gain treatment pursuant to section 1235; (2) whether petitioners may deduct professional fees paid during 2006 that were attributable to expenses charged by Holmes Development for work performed with respect to U.S.
payments he received from -Cardinal. Health constitute long-t;erm capital gain, not" ordinary income Generally, income a patent holder receives from the transfer of substantiallys all rights to a patent .shall be treated as long- term capital gain.« Sec. 1235 (a) . The parties agree that petitioner transferred all of, his rights in the needleless syringe patents to Cardinal Health and that any income -petitioner received for the transfer of the patents constitutes -long-term capital gain. The pa
For purposes - 26 - of section 1235, the term "all substantial rights" means "all rights * * * which are of value at the time the rights * * * are transferred ." Sec .
For purposes - 26 - of section 1235, the term "all substantial rights" means "all rights * * * which are of value at the time the rights * * * are transferred ." Sec .
For purposes - 26 - of section 1235, the term "all substantial rights" means "all rights * * * which are of value at the time the rights * * * are transferred ." Sec .
For purposes - 26 - of section 1235, the term "all substantial rights" means "all rights * * * which are of value at the time the rights * * * are transferred ." Sec .
OPINION Petitioners contend that, pursuant to section 1235, income reported by petitioners in the amounts of $247,977, $224,962, and $339,560 relating to 2000, 2001, and 2002, respectively, qualifies .
(2) Whether the Leas may report the payments as capital gain income under section 1235.1 Respondent's position on this issue 1Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
(2) Whether the Leas may report the payments as capital gain income under section 1235.1 Respondent's position on this issue 1Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.