## Facts

- Spiridon Spireas, a pharmaceutical scientist, developed “liquisolid” drug-delivery technology and held numerous patents and applications relating to that technology.
- In 1997, Spireas and Sanford Bolton formed Hygrosol Pharmaceutical Corp., an S corporation, to commercialize the technology; each owned 50%.
- In 1998, Spireas and Bolton/Hygrosol entered into an agreement granting Mutual Pharmaceutical Company, Inc. rights to use the liquisolid technology to develop and commercialize only certain pharmaceutical products selected by the parties.
- The agreement was limited to mutually selected drug products and excluded other uses, including products Spireas was developing with others and contemplated non-pharmaceutical applications (e.g., nutritional supplements).
- In 2000, the parties selected three drugs for development; Mutual paid royalties based on sales of products developed under the agreement, and those royalties flowed through Hygrosol to Spireas.
- On their 2007 and 2008 joint returns, Spireas and Amalia Kassapidis‑Spireas reported his share of the royalty income as long-term capital gain, asserting the agreement qualified under I.R.C. § 1235.
- The IRS issued deficiency notices for 2007 and 2008, recharacterizing the royalties as ordinary income and asserting additional tax of $4,083,264 (2007) and $1,745,701 (2008).

## Issues

1. Whether the 1998 agreement transferred “all substantial rights” to the relevant patents within the meaning of I.R.C. § 1235, so that payments received in consideration of the transfer were taxable as long-term capital gain.
2. If § 1235 did not apply, whether the payments were properly treated as ordinary income royalties for 2007 and 2008.

## Decision

- The Tax Court held that Spireas did not transfer “all substantial rights” in the patents and technology to Mutual within the meaning of § 1235.
- The court found that the agreement was a limited, product-specific license rather than a transfer of the entire patent monopoly.
- Because § 1235 did not apply, the payments were taxable as ordinary income royalties.
- The court sustained the IRS’s deficiency determinations for 2007 and 2008.

## Legal Principles

- I.R.C. § 1235 grants capital-gain treatment only when a qualifying holder transfers “all substantial rights” to a patent; the transaction is tested by the rights conveyed, not by labels such as “license” or “royalty.”
- Retention of rights that are economically meaningful, rather than minor or formal, prevents a finding that “all substantial rights” were transferred.
- A field-of-use or product-limited grant that leaves the transferor free to exploit or license the same patented technology for other products or uses generally does not constitute a transfer of all substantial rights.
- Absent a qualifying § 1235 transfer, payments received for use of patented technology under a license are generally taxed as ordinary income royalties.

## Conclusion

Because the agreement granted Mutual rights only for selected drug products while Spireas retained commercially significant rights to use and license the underlying technology outside that limited scope, the transfer failed § 1235’s “all substantial rights” requirement, and the royalties were ordinary income for 2007 and 2008.


Spireas v. Comm’r, T.C. Memo. 2016-163 (2016)