E. I. Du Pont de Nemours & Co. v. United States
200 Ct. Cl. 391, 471 F.2d 1211, 177 U.S.P.Q. (BNA) 14 (1973)
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Rule of Law:
The transfer of a non-exclusive license to use a patent in exchange for stock in a controlled corporation qualifies for non-recognition of gain under Internal Revenue Code § 351. The “sale or exchange” requirement for capital gains treatment, which requires the transfer of all substantial rights, is not applicable to § 351's “transfer...in exchange” language.
Facts:
- E. I. Du Pont de Nemours and Company (Du Pont) owned French patents for urea herbicides it manufactured in the U.S. and sold in France.
- French law required that products patented in France be manufactured there within three years of the patent's issuance to avoid being compelled to license the patent to a French producer.
- To comply with this law and protect its market, Du Pont organized a wholly-owned French subsidiary, Du Pont de Nemours (France) S.A., in October 1959.
- In December 1959, Du Pont granted the subsidiary a royalty-free, non-exclusive license to make, use, and sell the herbicides under its French patents for the remaining life of the patents.
- In consideration for this license, Du Pont received stock in the French subsidiary valued at $411,500.
- Through the license, Du Pont gave up its right to sue the subsidiary for patent infringement but retained the right to license other manufacturers.
Procedural Posture:
- Prior to the transaction, Du Pont requested a ruling from the Internal Revenue Service (IRS).
- The IRS ruled that the proposed grant of a non-exclusive license would not be a transfer of 'property' within the meaning of § 351 because not all substantial rights to the patents were being transferred.
- Despite the adverse ruling, Du Pont proceeded with the transaction and did not include the $411,500 value of the subsidiary's stock as income on its 1959 tax return.
- Du Pont later sued the United States in the U.S. Court of Claims for tax refunds for 1959 and 1960 on unrelated matters.
- In that litigation, the government asserted a setoff defense, arguing Du Pont owed tax on the $411,500 of stock received in the 1959 transaction.
- Both parties filed cross-motions for partial summary judgment in the Court of Claims to resolve the § 351 issue.
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Issue:
Does the transfer of a non-exclusive, royalty-free, perpetual license to use a patent to a wholly-owned subsidiary, in exchange for that subsidiary's stock, qualify as a 'transfer of property...in exchange for stock' for non-recognition of gain under Internal Revenue Code § 351?
Opinions:
Majority - Davis, Judge
Yes, the transfer of a non-exclusive license to a controlled subsidiary for stock is a transaction eligible for non-recognition of gain under § 351. The court rejected the government's argument that the 'transfer...in exchange' language of § 351 is equivalent to the 'sale or exchange' standard required for capital gains, which necessitates a transfer of all substantial rights. The court reasoned that the purposes of the capital gains provisions and § 351 are fundamentally different. The capital gains provisions require a complete divestiture of control to qualify for preferential tax rates, whereas § 351 is specifically designed to provide tax deferral for transactions where the transferor retains control over the transferred assets through ownership of the transferee corporation. Such a transfer is merely a change in the form of ownership, not a substantive disposition. The court held that 'property' under § 351 has a broad meaning and includes a valuable, non-exclusive patent license. Since Du Pont simply rearranged its assets by placing the license in a corporate entity it controlled, the transaction falls within the purpose of § 351 to defer taxation until a true disposition to an outside party occurs.
Analysis:
This decision significantly broadens the scope of what constitutes 'property' and a 'transfer...in exchange' for purposes of tax-free corporate formation under § 351. By delinking the § 351 analysis from the more stringent 'all substantial rights' test used for capital gains, the court provided greater flexibility for taxpayers, particularly multinational corporations, to structure their operations by contributing intangible assets like non-exclusive licenses to controlled subsidiaries without triggering immediate taxation. The ruling reinforces the foundational principle of § 351: non-recognition is appropriate for transactions representing a mere continuity of investment and control, regardless of whether the transfer constitutes a complete disposition of the underlying asset.
