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150 - Raytheon Production v. CIR
150 - Raytheon Production v. CIR
150 - Raytheon Production v. CIR
CIR
July 28, 1944| Mahoney, Circuit Judge | When is Income Taxable?
Digester: Lopez, Katrina Isabel
SUMMARY: Raytheon was a pioneer manufacturer of rectifier
tubes which are used in radio receiving sets. The Radio
Corporation of America (RCA) developed a competitive tube. As
RCA owned many patents covering radio circuits, its license
agreements with radio set manufacturers included a clause which
required them to buy their tubes only from RCA. Soon, Raytheons
sales gradually declined. Raytheon brought an action against RCA
for violating anti-trust laws, as well as for the destruction of
Raytheons profitable business and goodwill. Both parties agreed
on a $410,000 settlement of the anti-trust case wherein RCA
acquired patent license rights and sublicensing rights. In
Raytheons tax return, it only counted the $60,000 from the
amount as income from patent licenses maintaining that the
remaining $350,000 was as a realization from a chose in action
(damages) and not as taxable income. The Commissioner posited
that since there is no clear evidence as to how the total amount
was divided between consideration for the patent rights
transferred to RCA and for damages, the amount of $350,000
should be treated as taxable income. The appellate court held that
compensation for the loss of Raytheon's good will in excess of its
cost is gross income and since Raytheon could not establish the
cost basis of its good will, its basis will be treated as zero and thus
the whole amount is treated as income and therefore taxable.
DOCTRINE: If the damages were for loss of profits due to an
injury on your business, then the damages are a substitute for lost
profit and are taxable as gross income. On the other hand, if the
damages were for loss of a capital item, then the damages are to
replace what you lost, and are not taxable as gross income.
However, tax law does not exempt compensatory damages just
because they are a return of capital exemption applies only to
the portion that recovers the cost basis of that capital, any excess
damages serve to realize prior appreciation, and should be taxed
as income.
FACTS:
The Raytheon Company was a pioneer manufacturer of a
rectifying tube which made possible the operation of a radio
receiving set on alternating current instead of on batteries.
The test is not whether the action was one in tort or contract
but rather the question to be asked is "In lieu of what were the
damages awarded? Where the suit is not to recover lost profits
but is for injury to good will, the recovery represents a return
of capital and, with certain limitations to be set forth below, is
not taxable.
The allegations in the anti-trust suit were that the illegal
conduct of RCA "completely destroyed the profitable interstate
and foreign commerce of the plaintiff and thereby the said
tube business of the plaintiff and the property good will of the
plaintiff therein had been totally destroyed at a time when it
then had a present value in excess of three million dollars and
thereby the plaintiff was then injured in its business and
property in a sum in excess of three million dollars." This antitrust suit was not merely for loss of profits.
Since the suit was to recover damages for the destruction of
the business and good will, the recovery represents a return of
capital. The fact that the suit ended in a compromise
settlement does not change the nature of the recovery; "the
determining factor is the nature of the basic claim from which
the compromised amount was realized."
NOTES: