## Facts

- An author wrote a novel and a play based on the life of Toulouse-Lautrec.
- The author and José Ferrer entered a dramatic production contract granting Ferrer exclusive rights to produce the play on the U.S. and Canadian stage for a term with renewal features.
- The contract gave Ferrer an exclusive, transferable interest in stage production rights and an effective ability to block competing stage exploitation during the term.
- The contract also provided Ferrer a contingent contractual interest in proceeds from any motion picture based on the story, while the author retained the copyright.
- A film producer sought to make a motion picture based on the story and wanted Ferrer to star.
- Ferrer agreed to abandon stage production and to release/transfer his contractual rights in exchange for (i) a salary for acting services and (ii) additional contingent payments tied to the film’s financial performance.
- Ferrer reported his acting salary as ordinary income and reported the contingent film-related payments as long-term capital gain.
- The Commissioner determined a deficiency, treating the contingent payments as ordinary income.

## Issues

1. Whether payments received in connection with Ferrer’s relinquishment of rights under the dramatic production contract were capital gain from the sale or exchange of a capital asset or ordinary income.
2. Whether Ferrer’s distinct contractual interests (exclusive stage rights/negative control versus film-proceeds participation and service-related compensation) required different tax characterization and allocation.

## Decision

- The court reversed the Tax Court’s single-character treatment and held that the transaction required separation of the rights surrendered and allocation of consideration.
- Consideration attributable to Ferrer’s exclusive/leasehold-type stage production rights and related negative control could qualify as capital gain.
- Consideration attributable to compensation for Ferrer’s acting services, or to income-like participation not tied to disposition of a capital asset, constituted ordinary income.
- The case was remanded for the Tax Court to determine the proper allocation between capital gain and ordinary income.

## Legal Principles

- Tax characterization turns on the nature of the specific rights transferred or terminated; composite entertainment transactions may contain both capital and ordinary components.
- An exclusive, transferable interest in stage production rights, including an enforceable power to exclude others, can constitute a capital asset; gain from its sale or surrender may be capital gain.
- Payments that are, in substance, compensation for personal services are ordinary income even if negotiated alongside transfers of contractual rights.
- Contingent profit-based payments must be analyzed to determine whether they are consideration for disposition of a property interest (capital) or a substitute for expected income/compensation (ordinary), and amounts must be allocated accordingly.

## Conclusion

The Second Circuit held that Ferrer’s film-related payments could not be classified under a single tax label; the Tax Court had to allocate the consideration between capital gain for surrender of Ferrer’s proprietary stage-rights interest and ordinary income for service-based or income-substitute components.


Commissioner v. Ferrer, 304 F.2d 125 (2d Cir. 1962)