Rev. Rul. 69-156

Advice has been requested whether the transaction described below is a transfer of property within the meaning of section 351 of the Internal Revenue Code of 1954.

X, a domestic corporation, proposes to grant certain patent rights in a chemical compound to Y, its foreign subsidiary, in exchange for Y's stock. The patent rights to be granted are the exclusive rights to import, make, use, sell, and to sublicense others under patents owned and registered by X in the country in which Y is organized and operated, covering the manufacture of the chemical compound. However, Y will agree not to assert these rights to prevent X and its subsidiaries from importing, using, and selling the chemical compound in Y's country of operation. The rights to import, use, and sell the chemical compound in Y's country of operation are substantial rights.

Section 351 of the Code provides that gain or loss will not be recognized if property is transferred to a corporation by one or more persons in exchange for stock or securities in such corporation and immediately after the exchange such person or persons are in control of the corporation.

The grant of patent rights to a corporation will constitute a transfer of property within the meaning of section 351 of the Code only if the grant of these rights in a transaction which would ordinarily be taxable, would constitute a sale or exchange of property rather than a license for purposes of determining gain or loss. In order for such a grant of patent rights to Y to constitute a sale or exchange, the grant must consist of all substantial rights to the patent. See section 1.1235-1 of the Income Tax Regulations; Carroll Pressure Roller Corp. v. Commissioner, 28 T.C. 1288 (1957), acquiescence, C.B. 1958-2, 4; and A. E. Hickman, et ux. v. Commissioner, 29 T.C. 864 (1958), acquiescence, C.B. 1958-2, 6. See also Revenue Ruling 64-56, C.B. 1964-1 (Part 1), 133, at 135, requiring that "all substantial rights" to secret processes and formulas be transferred to constitute a transfer of property under section 351 of the Code.

The substance and overall effect of a transaction rather than the formal steps will determine whether all substantial rights have been granted. This position is analogous to the purpose of section 1235 of the Code, which is outlined by the Senate Finance Committee in S. Rept. No. 1622, Eighty-third Congress, 2d Session, 440 (1954), wherein it is stated that "the entire transaction, regardless of formalities, should be examined in its factual context to determine whether or not substantially all rights of the owner in the patent property have been released to the transferee, rather than recognizing less relevant verbal touchstones." Thus, in determining whether a taxpayer has transferred all substantial rights, an agreement that the transferee shall not assert certain rights against the taxpayer will be taken into account where the agreement is executed contemporaneously with the initial transfer of rights or pursuant to prearrangement.

In the pesent case, the overall effect of the transaction is that X will retain for itself and its subsidiaries the substantial rights to import, use, and sell the chemical compound in the country in which Y is operated.

Accordingly, since Y will not have all substantial rights in the patent, the grant of the patent rights will not constitute a transfer of property within the meaning of section 351 of the Code, and the receipt of stock of Y by X will result in ordinary income to X.

Revenue Ruling 57-317, C.B. 1957-2, 909, holds that a sale occurred where the transferor granted the exclusive right to make, use, and sell the patented article in the United States, but reserved the right to license foreign manufacturers to export to the United States machinery equipped abroad with the patented device. In support of this holding the Revenue Ruling cites General Aniline & Film Corporation v. Commissioner, 139 F. 2d 759 (1944), in which a sale was held to have occurred where the United States grantee agreed not to assert its right to prevent the foreign grantor or its licensees from importing products covered by the patents into the United States.

Revenue Ruling 57-317 is modified to remove therefrom the conclusion that the rights reserved by the transferor through the nonassertion agreement did not detract from the exclusiveness of the rights granted to the transferee and also to remove therefrom the implication that a sale of patent rights can occur in instances in which the grantor through the nonassertion agreement has retained substantial rights in the patent. Therefore, in view of the provisions of the nonassertion agreement in that case, the transaction constituted a grant of a nonexclusive license and not a sale.