Appeal from the Board of Tax Appeals.
Before MANTON, AUGUSTUS N. HAND, and CHASE, Circuit Judges.
The petitioner is the inventor of a process for making desiccated soluble products of coffee and other substances. In 1910, desiring to keep his process secret while manufacturing and selling its product on a commercial scale, he organized a New York corporation called G. Washington Coffee Refining Company, and made an arrangement with it to supply him with the materials which he needed to exploit his process himself and to sell the product he made. He was to receive for what he did an agreed amount based upon the quantity of the product with which he provided the corporation and which was sold by it. This was called a royalty. It will be convenient to speak of his income from this arrangement as his royalty. When the corporation was organized, it had common stock of the par value of $500,000 and preferred stock of $100,000 in par value.
The petitioner became president of the corporation and owned all of the preferred and $300,000 of the common stock. Capital necessary for operation was obtained for the corporation by selling the remainder of the common stock to the public largely, if not wholly, through the efforts of a friend, Mr. Arkell, who will be mentioned later in connection with one of the questions raised. The business was successful. In 1918 petitioner made a contract with the corporation in terms much like the previous arrangements he had had with it, but providing for monthly payments of royalty to him for furnishing it the product of his process. He had previously been paying Mr. Arkell, in appreciation of his former assistance, an agreed amount per unit of product out of the royalties he received. Arkel had been connected with the corporation, but these payments had not been for his current services. In 1918 Arkell retired, and, instead of paying him as before, it was agreed that petitioner would pay him $2,000 a month so long as Arkell lived. Having so arranged his affairs, the petitioner wrote a letter on December 30, 1918, to his wife and three children, the youngest of whom was then twenty years old, which read as follows:
"To my dear wife, Lina, to my dear children, Louise, Irene and George:
"Pursuant to our conversations on the subject, in consideration of the devoted care and valuable assistance you have given me, in the past, and other valuable consideration, I, hereby, sell and assign to each of you a one-fifth interest in all my real and personal property, except my shares of the Capital Stock of the G. Washington Coffee Refining Company of New York, but, including the contract I have with said Company by virtue of which they pay me a royalty. However, in view of your inexperience in business matters, I want it distinctly understood that I reserve, for myself, the exclusive right to alter or modify said contract, as well as the amount of royalties payable thereunder, from time to time, as in my judgment may best serve the interests of the business.
"Providing, first: That any financial obligations I now have shall be liquidated out of the herewith assigned assets to the extent of one-fifth by each of you; the balance to be used absolutely.
"Secondly: That while we live together and as long as we do so, we shall each equally share in the general expense of doing so.
"For your convenience, I will inform the company of your interest in my contract and authorize them to pay to each of you, directly, your share of the Royalties upon your request to them to do so.
"Realizing that this may not be the best form of an Assignment I will, in the near future, cause a formal document to be prepared and executed.
"[Signed] G. Washington."
The corporation was notified of the letter, and on March 3, 1919, the petitioner followed out his intention so expressed by executing four formal assignments of "an undivided one-fifth part or share of all my right, title and interest in and to any and all royalties or other sums of money which may at any time hereafter become due and payable to me" from the corporation under his royalty agreement. One of these assignments, none of which covered anything but a one-fifth interest in his royalties to become due, was delivered to his wife and one to each of his children. All of the assignments were made upon the express condition, to which the assignee by acceptance assented, that the petitioner's ...