value of the property repossessed to be taxable income solely in the year of repossession.

When the failure to recoup the advanced royalties or the lapse of the lease are due to inefficient operation, lack of capital by the lessee or similar reasons other than the content, availability, etc., of the mine and the allowance in previous years for depletion, which never actually accrued, has resulted in real income not yet reported, amended returns should be made by the lessor. Also, if advanced royalties become unrecoverable because minerals have not been removed during a definite period stipulated in the lease within which advanced or minimum royalties may be recovered, there may be some additional income of the lessor for previous years for which amended returns should be made.

Royalties from Copyrights

An author should report in gross income all sums received from copyright privileges. He is entitled to claim as deductions all expenses, except ordinary living expenses, incurred in producing the income.

REGULATION. . . . Amounts expended for securing a copyright and plates which remain the property of the person making the payments, are investments of capital. (Art. 293.)

However, deductions can be made for depreciation, and conservative accounting calls for rates of depreciation on assets of this kind up to 100 per cent per annum.

The method prescribed for computing the profit, if any, from the sale of copyrights is the same as that for patents. The British practice as to copyrights is of interest:

BRITISH PRACTICE. (1) Annual payments of fixed amount, or being a fixed share of profits, are assessed on the person making the payment in the same way as interest.

'See Chapter XXIX, "Depreciation." 'Reg. 45, Art. 40, page 398.

(2) An author, playwriter, or artist selling copyrights, etc., to publishers is chargeable on the amount received less his expenses; if sold on royalty, the whole amount of the royalty is chargeable.

(3) No charge is made upon a person who has an isolated transaction of such a nature; the profit is looked upon as capital. (Murray and Carter, Income Tax Practice, page 247.)

Royalties and Profits from Patents

Income from the sale of patents above cost or from royalties, when such royalties include profit over and above the return of capital, is taxable. The general principle of a return of capital must be followed, however. No tax can be imposed on receipts from the sale of patents or patent rights unless the owner has made full provision to reimburse himself for the cost or value of them. If the patents were owned on or before March 1, 1913, their actual value at that date is their capital value. If acquired after that date, the cost is considered the capital value."

[Former Procedure] The following ruling was made at a time when the Treasury was attempting to tax capital as well as income, and should not be relied upon without giving consideration to the allowable depreciation deduction and fair value at March 1, 1913.

RULING. "This office is in receipt of your letter of January 19, 1916, reading, in part, as follows:

"No. 1. In 1900 A made a written contract with B whereby A sold to B the right to manufacture and sell a certain machine under A's patent in consideration where for B agreed to pay A $100 royalty for each machine sold. Are royalties so payable income or principal under the provisions of the Federal Income Tax Act?' [Answer.] In reply you are advised that the office holds that the amount of royalties received by A is income which is subject to tax under the provisions of the Federal Income Tax Law and that the amount thereof should be included in any personal return A is required to render for the year during which the royalties were received.

"No. 2. In 1915 A sold his rights under said contract to C for the lump sum of $500,000. Is said sum of $500,000 income or principal under the provisions of said Act?' [Answer.] The office also holds that if A in consideration of the $500,000 received from C surrendered all his right and title to the patent in addition to his rights under the contract with B, the difference between the $500,000 so received and the aggregate amount expended by him in perfecting the invention and obtaining the patent was net income to him and its amount should be included in any personal return he is required to render for the year 1915. (Letter to Edwin R. Leavitt, 99 Nassau Street, New York, signed by Deputy Commissioner L. F. Speer, and dated January 24, 1916.)"

Reg. 45, Art. 1561, page 342.

Damages received from infringements of patents.-Collections of damages arising from infringements may be income or capital or both, depending on the fair value March 1, 1913, and the nature of the damages collected. If no injury to the capital value has resulted, the entire collection, less expenses, is income.

If the capital value has been diminished by the infringement the amount collected or any part thereof should be applied in reduction of the book value of the patents.

REGULATION. a person may sue in one year on a pecuniary claim or for property, but 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.)

The foregoing regulation may be applicable to most cases of recoveries arising from judgments, but there are many exceptional cases which must be decided according to other sections of the law and according to the decisions of the courts which define taxable income.

As stated above, the fair value of a claim on March 1, 1913, is an important consideration. If a taxpayer was entitled to property in 1912, but did not recover it until 1918, it cannot be held that he received any taxable income in 1918.

If he became entitled to property in 1914, but did not return it in that year because he did not know its actual value, it is not reasonable to claim that if he collected the claim or received the property in 1918 the entire amount would be income in 1918. The courts would probably hold that the income arose in 1914 and would require the taxpayer to file an amended return for that year.

When further infringement was made impossible by a judgment of a United States circuit court of appeals it is obvious that no income can accrue after the date of judgment, unless interest accrues and is paid.

As late as 1917 (see Chapter XXIV) the Treasury held

that when a corporation was compelled in 1916 to pay damages arising out of an infringement case and the period of infringement ended in 1912, no part of the sum paid was deductible as an expense in 1916, but that it should all be deducted (by amended returns) in the period prior to 1912.

Patent development costs.-The cost of developing a patent is of the same nature as carrying charges on real estate. One has the option of capitalizing the items or of charging them off as current expenses. Frequently it is difficult to determine which course should be pursued, even at the time. It may be obvious after a period that the experiments under way are not yielding satisfactory results. In such event the cost is a clear expense. More often the result is doubtful, in which case it is permissible to elect whether to capitalize or to charge off the amount.

Conservative accounting methods call for charging off, but the owner may be penalized for so doing if current profits are not large. The subsequent sale of the patent for a considerable profit would result in a tax on the entire purchase price, if the development costs were all claimed as deductions and written off.

REGULATION.

The cost of defending or perfecting title to property constitutes a part of the cost of the property and is not a deductible expense.

(Art. 293.)

The foregoing regulation cannot always be applied to patent litigation. If the litigation does not clearly add to the value of the patent, the expenses should be charged off as incurred.

Method of valuing patents.-Owing to the great uncertainty which often exists as to the commercial (that is, the market or income-producing) value of a patent, it is difficult to arrive at a fair taxable value when a sale or transfer is made for a consideration other than cash before the patent is fully developed.

In ascertaining the net taxable income of an inventor or owner to be assessed as of a year when a transfer takes place, there should be taken into consideration the stage of the patent's commercial development, the degree of prosperity attained by the concern manufacturing it and any other facts which would serve to fix a fair value. Some of the information might appear to be of a later date, but it would be valuable in spite of that fact.

Royalties subject to depreciation charges.-The following ruling, which appeared in the 1918 edition of the regulations, explains the extent to which royalties subject to depreciation charges are taxable.10

REGULATION. Royalties received by a corporation in accordance with a contract by which it has assigned the patent rights to manufacture machines, etc., are income and should be so accounted for. The owner of the patent may deduct from gross income each year, until the capital invested therein11 is extinguished, a sum ascertained by dividing the cost of the patent by the number of years constituting its life or by a number representing the years of its life remaining after the date of acquirement. (Reg. 33, 1918, Art. 113.)

Profits from sale of patents-how determined.—

REGULATION. A taxpayer disposing of patents or copyrights by sale should determine the profit or loss arising there from by computing the difference between the selling price and the value as of March 1, 1913, if acquired prior to that date, or between the selling price and the cost, if acquired subsequently to that date. The profit or loss thus ascertained should be increased or decreased, as the case may be, by the amounts deducted on account of depreciation of such patents or copyrights since February 28, 1913, or since the date of acquisition if subsequently thereto. . . . . (Art. 40.)

It is important to note that "cost" may include the cost of patent litigation if such expenses have been capitalized.

10See Chapter XXIX for a full discussion of the depreciation of patents.

"To the words "capital invested therein" there should be added "or fair market value March 1, 1913."