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"If a corporation purchased a patent and paid for it in stocks or securities, its cost is the fair market value of the stocks or securities at the time of the purchase." (Art. 167, Reg. 45, Rev.)

"Where the patent has been purchased for a cash consideration, the amount would represent the cost. Where the corporation has purchased a patent and made payment therefor in stocks or other securities, the actual cash value of such stocks or other securities at the time of the purchase will represent the cost of the patent to the corporation." 137, Reg. 33, Rev.)

(Art.

3. Where a patent was in force on March 1, 1913, the fair market value of the patent at that date can be substituted for the cost price, and the difference between this value and the price received for the patent when subsequently sold is the amount to be rendered as profits in the Income Tax return.

"In the case of property acquired before March 1, 1913, the fair market price or value of such property as of that date." (Sec. 202.)

"A taxpayer disposing of patents or copyrights by sale shall determine the profit or loss arising therefrom by computing the difference between the selling price and the value as of March 1, 1913, if acquired prior to that date." (Art. 40, Reg. 45, Rev.)

(The method of obtaining the value of a patent as of March 1, 1913, is explained in the chapter on Valuation of Patents, etc., page 77.) To illustrate the computations of the costs under these rules and the entry of profits on the tax return, the following examples are cited: If an inventor obtains a patent after March 1, 1913, its cost value (for tax purposes) to him is the sum of:

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(a) The cost of obtaining the patent, including all fees paid to the Government, his attorneys, draftsmen, etc.

(b) The cost of developing the invention, including bills for materials used, amounts expended for labor, use of machinery, etc., in building experimental models. (It would appear that there should also be included a reasonable amount to recompense the inventor for the time he himself has spent in developing the invention, but the Regulations do not appear to provide for this, limiting their ruling as to cost to the amount actually expended.)

If he then sells the patent for a cash amount greater than its cost value, he must include as profits in his Gross Income Statement of his tax return for the year of the sale the amount whereby the sales price exceeds the cost value, and pay income tax (normal and surtax) upon this amount.

If, instead of selling for a cash amount, he receives in payment for the patent shares of stocks, bonds, and the like, his profits shall be based on the difference between the cost value of his patent and the market value of the stocks or bonds on the day received by him; and he must include as profits in his Gross Income Statement of his tax

return for the year of the sale the amount whereby the market value of the intangibles received exceeds the cost value, and pay income (normal and surtax) upon this amount.

If he receives in payment for his patent part cash and part stocks, bonds, and the like, the market value of the stocks, bonds, etc., received should be calculated and added to the cash received to represent the taxable amount received by him. From this amount the cost value is deducted and the difference included in his tax return for the year.

To the purchaser of a patent the cost value to him (for tax purposes) is the amount paid out for the patent, and this figure should be entered on his books and used for calculating depreciation of the patent during the remaining years of its life. (See Chapter X on Depreciation.) Thus, if the patent purchased has ten years to run after the date of purchase, 1/10th of the purchase price should be written off as depreciation each year during the next ten years. If the patent purchased has seventeen years to run after the date of purchase, 1/17th of the purchase value should be written off as depreciation each year, and so on.

If a corporation purchased a patent and paid for it in stocks or securities, its cost value to the corporation is the fair market value of the stocks or securities at the time of the purchase (not necessarily the par value thereof); and this figure should be entered on the books and used for calculating depreciation of the patent during the remaining years of its life.

Where a patent is purchased for a mixed amount of cash and securities, its cost value is the sum of the cash and the fair market value. of the stocks or securities at the time of the purchase, and the sum should be entered on the books for purposes of depreciation.

If the purchaser of a patent subsequently sells it, his profit or loss on the transaction must be figured as the difference between the sales price received and the amount originally paid for the patent, less all depreciation charged off during the interim.

Chapter IX.

MONEYS RECOVERED BECAUSE OF INFRINGEMENT.

Another well-recognized method of obtaining financial returns from patents, copyrights, etc. is to sue an infringer and recover from him judicially-determined amounts in settlement for the infringement.

The amounts so received by the owner of the patent must be included as income in his tax return. But, granting this broad proposition, many difficult questions arise in administering it—for example:

In the return for what year should the amount received be included? Can the infringer deduct the amount paid as a necessary business expense?

If so, in what year?

Can the expenses (legal fees, etc.) of recovering the damages be deducted as necessary business expenses?

Can the legal expenses of defending the suit be deducted by the infringer as necessary business expenses?

If the suit is terminated adversely to the plaintiff, so that he would be called upon to pay not only his own expenses but also the defendant's court costs, would such expenditures still be deductible as necessary business expense?

Many such questions have been passed upon by the Treasury Department Officials, and the following decisions are cited as illustrative of the views taken by the Internal Revenue Officials in determining analogous cases:

That the total amount of the award should be entered as income in the year in which it is recovered on the judgment in the case of the owner of the patent, and as a deductible expense in the year in which the amount to be paid is judicially determined in the case of the infringer, is set forth in the following:

"A person may sue in one year on a pecuniary claim or for property, and money or property recovered on a judgment therefor rendered in a later year would be income in that year, assuming that it would have been income in the earlier year if then received. This is true of a recovery for patent infringement." (Art. 52, Reg. 45, Rev. April 17, 1919.)

"A report of a master of chancery, appointed by an interlocutory decree in a suit for alleged infringement of a patent, assessing damages against the taxpayer, which report was filed during the taxable year, but was not confirmed until the following year when judgment was entered on

the report, cannot be regarded as a determination of the amount of the claim, and no deduction for the earlier taxable year is permissible in regard to the judgment referred to." (Sec. 923. 1-19-94.)

That the infringer is entitled to deduct as a business expense the entire amount of the award is specified in the following:

"The amount which a plaintiff should report as income or a defendant may deduct as an expense in the case of an award for damages on account of patent infringement is not affected by the amount of federal taxes which have been paid by the defendant. The amount to be reported or deducted is the total amount awarded by the courts." (O. D. 26. 1-19-38.)

"Any amount paid pursuant to judgment or otherwise on account of damages is deductible from gross income to the extent of, and when the amount is actually paid, less any amount of such damages as may have been compensated for by insurance." (Art. 158, Reg. 33, Rev.)

That the owner of the patent may deduct as business expense the expenses expended in litigation is decided in the following:

"The M Company expended a certain amount in litigation, defending its right, title and interest in a patent after the patent had been issued by the Government.

HELD, that the amounts expended are not a part of the cost of the patent for the reason that such amounts do not add to or prolong the life of the patent in question and cannot be considered as an improvement or betterment. The title and ownership of the patent was in the corporation and the amounts expended were not made in perfecting its title to the patent already owned and used by the company. The con clusion of the Committee is that the amount spent in litigation should be allowed as a necessary operating expense." (A. R. R. 98. 20-20-934.)

No decision has been found that unqualifiedly states that the legal expenses of a corporation held to be an infringer may be deducted as necessary business expense. It would appear, however, that where no bad faith is shown on the part of the defending company, its legal expenses should be deducted just as are those of the owner of the patent. In the majority of disputed questions of infringement, the defendant in good faith believes it is not infringing and supports its belief and contention through hired legal talent. Because the court decides that it actually does infringe should not negative the legitimacy of the expense and place it without the pale of allowable business expenses.

Similarly, if the decision in the suit is adverse to plaintiff, and he is called upon to pay defendant's court costs as well as his own expenses, the situation as regards the legitimacy of such expenses is not altered (unless bad faith is shown). It is thought that such expenditures are still to be classed as allowable deductions in the year

they are paid out. Sound business policy demands that the prescribed method of enforcing one's patent rights (suit for infringement) be employed whenever it is believed that another is trespassing on such rights. One's patent or copyright would soon become valueless if not enforced. When the decision is made in good faith that suit should be brought the expenditures incidental thereto should be regarded as deductible expenses made in the proper conduct of the business, regardless of the outcome of the suit.

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