## Facts

- Thomas L. Fawick, an inventor and patent holder, developed patented flexible brakes/couplings/clutches.
- On February 23, 1937, Fawick entered into an agreement granting Falk Corporation an exclusive license under his patent applications and resulting patents, but only for marine use of the patented driving clutches.
- In 1938, Fawick formed Fawick Corporation to manufacture and sell the patented driving clutches for non-marine uses.
- Fawick assigned to Fawick Corporation all remaining patent rights, excluding the marine-use rights licensed to Falk.
- For the tax years at issue, Fawick reported royalties received from Falk as long-term capital gain under I.R.C. § 1235.
- The IRS determined the royalties were ordinary income and assessed deficiencies; the Tax Court ruled for the taxpayers; the Commissioner appealed.

## Issues

1. Whether an exclusive patent license restricted to a specific field of use (marine use) constitutes a transfer of “property consisting of all substantial rights to a patent” under I.R.C. § 1235, permitting capital-gain treatment for royalties.

## Decision

- The Sixth Circuit reversed the Tax Court.
- The court held that the marine-only exclusive license did not transfer “all substantial rights” in the patent within the meaning of § 1235.
- Because § 1235 did not apply, the payments from Falk were ordinary income rather than long-term capital gain.
- The case was remanded for proceedings consistent with treating the royalties as ordinary income.

## Legal Principles

- I.R.C. § 1235 applies only when a patent holder transfers “all substantial rights” in the patent, meaning substantially the entire patent interest (or an undivided fractional interest), not a segmented grant.
- A field-of-use restriction that leaves the transferor with substantial exploitation rights in other fields is a retention of substantial rights inconsistent with § 1235 treatment.
- An agreement labeled or functioning as a license, coupled with retained rights in significant fields of use, is not treated as a qualifying sale-like transfer under § 1235.
- Taxpayer-favorable statutory exceptions granting capital-gain treatment are construed narrowly, and the taxpayer bears the burden to show the transaction fits the statute’s requirements.

## Conclusion

An exclusive license confined to marine use, where the patent holder retains and exploits other fields of use through another entity, is not a transfer of all substantial patent rights under I.R.C. § 1235; royalties paid under such a license are taxed as ordinary income.


Fawick v. Commissioner, 436 F.2d 655 (6th Cir. 1971)