I think it is pretty clear that section 1235 of this present bill will have substantially the same effect on the inventor and small and independent business as would have the provision in the 1950 tax bill which your committee caused to be stricken out. If it was wrong then, it is equally wrong now, we believe, especially, at this period of readjustment when many small companies are being forced out of business and we are in one of those downward turns when inventors need to be encouraged rather than harassed and discouraged.

In the name of the individual inventor who forms the base upon which our gigantic industrial system has been built, and in the name of small and independent businessmen throughout the Nation, and to preserve and foster the inventive genius that has made this Nation. the greatest on earth, we respectfully and urgently request you to delete the words "if and only if" of paragraph (a) as well as its subparagraphs (1) and (2) in their entirety, lines 35 through 47 on page 259. section 1235, of H. R. 8300.

Thank you very much.

The CHAIRMAN. Thank you. We will give that very careful consideration.

(The prepared statement of Mr. McGregor follows:)

TESTIMONY OF FRANK R. MCGREGOR, EXECUTIVE VICE PRESIDENT, COUNCIL FOR INDEPENDENT BUSINESS, WASHINGTON 5, D. C.

Mr. Chairman and members of the committee, my name is Frank R. McGregor. I am executive vice president of the Council for Independent Business. I also operate a public relations business of which I am the head and I am on the board of directors of a couple other corporations.

Small and independent businessmen and women in this country who operate in whole or in part under the protection of our patent system are very much alarmed because of section 1235 of this tax bill (H. R. 8300). If enacted into law, it would operate to practically deny an inventor any chance to profit from his patent as a capital asset.

May I read the new restrictions fastened on the inventor as set forth in this bill.

"SECTION 1235. SALE OR EXCHANGE OF PATENTS BY THE INVENTOR. “(a) GENERAL. Gain from the sale or exchange of property consisting of a patent or application therefor, or an undivided interest therein which includes a part of all rights in such patent or application, by any person whose efforts created such property shall be deemed gain from the sale or exchange of a capital asset if and only if—

"(1) the seller retains no interest whatsoever in the patent, application, or undivided interest therein so transferred, except to the extent that the purchase price may be related to the productivity, use, or disposition of the property transferred within a period of 5 years from the date of such sale or exchange; and

"(2) the entire proceeds of such sale or exchange are received by the seller within a period of 5 years from the date of such sale or exchange. For purposes of this paragraph, any proceeds due and payable within such period which are received thereafter solely by reason of failure of the purchaser (or any successor in interest of such purchaser) to fulfill a contractual obligation shall be deemed to have been received within such period."

You will remember that the tax bill of 1950 (H. R. 8920) contained a provision that "a patent or copyright; an invention or design" could not be held or sold as a capital asset while it was "held by a taxpayer whose personal efforts created such property." You will also remember probably that Mr. C. E. Earle (now deceased), and I appeared before your committee to urge the deletion of that provision and that this committee did cause that provision to be stricken from the bill. The Senate so voted and the House conferees concurred and the bill was so passed.

I submit to you that the section I refer to is in effect the same philosophy dressed up in different words. Let us not be deceived by the 5 years allotted to the inventor to collect payment for his invention under a capital gains status. It is common knowledge that inventors do not as a rule have the money to develop, merchandise and practice their patents. In order to profit from his patent the inventor must either sell it or license its use-usually an exclusive license which the courts have held is equivalent to a sale.

There are very few if any inventors who get any recovery within the first 5 years after the issuance of a patent. It is easy to see that the inventor would collect little or nothing during the 5 years the patent was being developed and would then be in the melancholy position during the remaining 12 years of the life of the patent of watching the purchaser of his patent reap the harvest of the inventor's creation. The result then, would be the same under this provision as it would have been under the provision which your committee struck out 4 years ago.

Let me give you an example that I happen to know about. In 1942 a chemical engineer, after many years of work and experimentation, developed a process of combining lithium with lubricating grease. This gave the grease a viscosity beretofore unknown and enabled our planes in World War II to take off from airbases in the South Pacific in temperatures of 100 degrees or higher and fly into high altitudes where the temperature is as low as 40 degrees below zero, without the lubricating grease becoming thin as water in the hot temperature or solidifying into a mudlike consistency in the cold temperature. The process is equally valuable for trucks and automobiles and it is in wide use in industry today. This is one of the very few cases where an inventor sold his patent for $1 million, as the patent was sold to a company that specializes in buying and developing patents for something in excess of that amount payable over the remainder of the life of the patent and based on the anticipated earnings from it. But let us see how the inventor would have fared under section 1235. The first 5 years there were no profits or royalties to the inventor. The second 5 years the patent earned a total of around $170,000 of which the inventor received a part. The patent now has 5 years to run and, based on the rate at which the lithium grease is increasing in use in industry, it is estimated that the patent will. during that time, earn well over the million dollars to be paid to the ventor. It will be seen that if section 1235 had been in effect when this patent was obtained, the inventor would have received absolutely nothing for his very important contribution to our national defense and welfare; while the purchaser of the patent would have made well over $1 million on which he would have had to pay only a capital gains tax.

This case is exceptional only in the fact that the patent will earn such a large sum of money. Most inventors do not achieve anywhere near this high figure for their patents. In fact not 1 inventor in 100,000 ever gets within hailing distance of $1 million.

We Americans believe that the great advantage our economic system has over the Communist philosophy is that we operate under an incentive philosophy whereby a man profits in accordance with his contribution to the wealth of the Nation. This, we believe, is the motivating force which has spurred our people on to make us the greatest industrial nation on earth.

It is a fundamental belief then in this country that a man who creates wealth for this Nation by inventing something new and useful should be rewarded by Society for that contribution. The idea that a bill could be passed depriving the inventor of a large part of the fruits of his labor is so foreign to our conception of what is right and fair, that the American people just cannot believe it could happen here. None of us can understand the philosophy behind the type of thinking that has injected such limitations into this bill.

The Founding Fathers believed so strongly in the importance of rewarding the creator of new things, that they put it in the Constitution. Article 1, section 8 of the Constitution declares

The Congress shall have the power to promote the progress of science and useful arts, by securing for limited times to authors and inventors, the exclusive right to their respective writings and discoveries. And the Congress of the United States has exercised this power to the great benefit of the people of America by setting up a patent system for this purpose. Now it appears there are those who want us to turn our backs upon the philosophy of the Founding Fathers and penalize inventors, rather than reward them.

Let there be no doubt as to who is the target-for, it says, and I quote "a patent *** (held by)' any person whose efforts created such property.” This applies then to the creator of the invention.

Under this provision, the man who buys an invention from the inventor is priv ileged to treat it as a capital asset. If, after buying a patent from the inventor, the money man sells it at a fat profit, he can take advantage of the capital gains tax as set forth in this act. In other words, the entrepreneur who buys a patent can treat it as a capital asset, but the man who created the patent by his own thinking and personal efforts is prohibited from so doing, unless he collects his payment in the first 5 years-if indeed there is any money to collect during that 5 years.

None of us can understand how a patent, a piece of property which is not held for sale to regular customers in the ordinary course of business, can be in one man's hands a capital asset, yet in another man's hands, not a capital assetexcept under such restrictive conditions that it would effectively deny him the fruits of his labor.

Our patent system is responsible, to a large degree, for the tremendous and rapid growth of the industrial phase of our economy. Although the individual inventor has rarely been properly rewarded for his advanced thinking, vision, and personal efforts, he deserves the major part of the credit for this great progHis type of thinking should be encouraged rather than discouraged. Invention does not thrive on adversity. The old notion that great discoveries are made by starving geniuses in a garret is romantic, but it is just not true. Invention increases as the prosperity of the country increases and it fades and diminishes in bad times and during war periods.

ress.

Attached hereto is a graph entitled “Trend of Inventive Thinking in the United States, 1840-1951."

It shows graphically the effect of depressions and wars on our inventive capacity. It also shows the trend of our inventive ability during the last 90 years. The graph is based upon the annual number of patent applications for each 10,000 of population in the United States. It also shows patents granted and the relationship between the two. For example we see that toward the close of the 19th century, when the population was from 60 to 70 million, patent applications ran as high as six and a half for each 10,000 of population, falling off of course during the depressions or "panics" (as they were called then) of the eighties and nineties.

As the 20th century began to unfold, you will observe the number of creative technological ideas considered worth patent application increased until war broke out in Europe when they declined slightly. When the United States entered the war in 1917, you can see what happened to the inventive mind. With the close of World War I, inventive thinking rose until we hit the recession of 1921.

After this recession was weathered, inventors again were on the march until we hit the big depression in 1929. You will remember that things started to get better in 1934 and 1935 and so did the creative production of inventors.

When Hitler moved into the Rhine, Austria, and Czechoslovakia, and we had an undeclared war in Europe, the effect of this disturbance on the inventive genius of America is shown here, and the negative curve reaches its depth in the midst of World War II. Here it starts to rise again, probably due to the increase in technology of war developments and production. So we were well on our way again until the cold war and Korea. Now we find ourselves again on the downward path. It is now proposed to pass a bill that will undoubtedly accelerate the speed of this descent.

The attached graph definitely establishes that technical creation does not flourish in barren soil. Observe, if you will, what happens whenever the economy is disturbed either by wars, rumors of wars, or other factors. The inventor is discouraged and inhibited so that his creative impulses cease to function normally. The inventor flourishes and brings forth fruit when he feels that he is being nurtured in an atmosphere of freedom and a soil rich in opportunity. In other words the inventor, like we other human beings, does his best thinking when he does not have to worry about getting the money to pay his rent, when he and his family have enough to eat and he can afford to buy decent shoes for his children to wear to school.

1 The parentheses are mine.

The experts who wrote this provision call it "plugging up a loophole." Permitting an inventor to get a good reward for his invention is not our idea of a loophole. As for "plugging up" we believe it will effectively plug up the inventor's desire to create new and better things for our people to enjoy. In addition, it will accelerate the further establishment of corporate control of inventions, thus encouraging monopoly and penalizing the small-business man, for the only company that could afford to pay, within a 5-year period, a reasonable portion of what the patent would earn over its 17-year life, would be a corporation with very great assets.

It is estimated by the tax experts that this capital asset provision will yield a maximum of a few hundred thousand dollars a year. For this comparatively picayune sum, we would discourage our individual inventor by putting a ceiling over his opportunities, thus inhibiting his desire to create by depriving him of the major part of the reward which is already pretty small in most cases. So the end result will be to deny the economy of this Nation, many inventions potentially worth hundreds of millions of dollars, to say nothing of the loss of potent stimuli to our industrial developments.

I think it is pretty clear that section 1235 of this present bill will have substantially the same effect on the inventor and small and independent business as would have the provision in the 1950 tax bill which your committee caused to be stricken out. If it was wrong then, it is equally wrong now we believe, especially, at this period of readjustment when many small companies are being forced out of business and we are in one of those downward turns when inventors need to be encouraged rather than harassed and discouraged.

In the name of the individual inventor who forms the base upon which our gigantic industrial system has been built, and in the name of small and independent businessmen througout the Nation, and to preserve and foster the inventive genius that has made this Nation the greatest on earth, we respectfully and urgently request you to delete the words "if and only if" of paragraph (a) as well as its subparagraphs (1) and (2) in their entirety-lines 35 through 47 on pages 259, section 1235 of H. R. 8300.

The CHAIRMAN. Congressman Davis, we are glad to have you here. Make yourself comfortable.

STATEMENT OF HON. CLIFFORD DAVIS, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF TENNESSEE

Representative DAVIS. Mr. Chairman, I shall not ask to impose upon the committee, but I will be very grateful, if you will permit me to file for the purposes of the record a very short statement on a bill that I introduced in the other body, relating to tax-exempt organizations.

The CHAIRMAN. It will be put in the record. And we are very glad to have you here.

Representative DAVIS. Thank you very, very much, Mr. Chairman. (The statement of Representative Davis follows:)

STATEMENT WITH REGARD TO H. R. 8300 BY REPRESENTATIVE CLIFFORD DAVIS

My statement is directed particularly to subchapter F, Exempt Organizations; part III; section 521, Exemption of Farmers' Cooperatives From Tax, and section 322, Tax on Farmers' Cooperatives.

A year ago, I reintroduced in the 83d Congress a bill which I had offered and urged in previous sessions. It is numbered H. R. 5598 and it is entitled "A bill to provide tax equity through the taxation of cooperative corporations and to provide tax credits for recipients of dividends from genuine cooperatives." I shall file with the clerk of the committee copies so that every member may see it. This is a proposal which would accomplish a number of very highly desirable results. In the first place, it would do away with the utterly unfair competitive situation that now exists between fully taxpaying companies and companies of identically the same kind that enjoy the Federal Government's subsidy of tax exemption, either in whole or in part. In the second place, it would eliminate the disastrous effects of the provision of the 1951 Revenue Act under which co

operatives are required to report patronage dividends paid to farmer members, so the Internal Revenue Service may hound the farmers and make them pay individual income tax on dividends which they have not received in cash money and may never receive. Third, it would put cooperative corporations and their members and stockholders on a single-tax basis, instead of the double tax that other corporations and their stockholders are now required to pay. And fourth, this proposal would bring into the Treasury of the United States at least $400 million of new revenue.

The members of the Senate Finance Committee are fully aware of the tremendous growth in volume of cooperative business; of its expansion into practically all lines of enterprise, many of them far removed from the farmer's needs for marketing or purchasing; and of the complaint of businessmen and other taxpayers because of the tax privileges which are granted to cooperative competitors.

Now, while the revenue code is being rewritten, is the time to correct this situation. H. R. 5598 is, in the opinion of many persons, the fairest and best way to do it. Sections 521 and 522 of H. R. 8300 are, to all intents and purposes. identical with subsections 12 and 13 of section 101 of the present Internal Revenue Code. My bill, H. R. 5598, proposes that these sections be eliminated from the code, thereby doing away with the present legal exemption of cooperative corporations from payment of Federal income tax on their earnings. Further, I would insert at the proper place in the code a definition of the cooperative corporation as a taxable entity, and, to the end that there could be no misinterpretation of the intent of the new law, I would explicitly terminate the present deduction of patronage dividends from the net income of the cooperative corporation.

In other words, a cooperative corporation would then be treated, for tax purposes, in exactly the same manner as any other corporation.

I have gone further, however, in suggesting a provision that is, I am convinced, highly desirable as a measure of just and additional relief for our farmers. Treasury regulations have always insisted that the farmer-members of cooperatives should report their patronage dividend receipts and pay income tax on them. Until 1951, however, there was no effort to enforce this regulation and consequently it was, I believe, generally ignored. In 1951 Congress wrote into law a binding requirement that co-ops report the patronage dividends paid to members so the Internal Revenue Service can check up on our farmers' individual income-tax returns and force them to pay income tax whether they have received their dividends in cash, in stock, in scrip, in merchandise, by book allocation, or by any other so-called constructive method. All this means that in probably 9 cases out of 10 the farmer will have to dig down into his pants pocket for money earned by the sweat of his brow to pay the tax on patronage dividends that he may never get in cash so long as he lives.

That, I insist, is an evil conception of taxation. It should be corrected so that the farmer may be freed from this unwarranted burden and the cooperative corporation be made to pay the tax and give a credit to the farmer or city mem ber. Then, instead of an addition to his tax, he might well have a subtraction. That is just what H. R. 5598 proposes to do. That primarily is why it should be included in the Senate's version of H. R. 8300. The farmer is being hurt. He should be given relief-but the tax should be paid nevertheless. The cooperative corporation should pay it-no one else.

The revenue to come from enactment of legislation such as I propose would be a very considerable sum. My own figure of $400 million or more would go some way toward making up the losses resulting from other features of the bill as it stands.

My proposal will bring justice to competitive businesses, relief to farmers. and new revenue to the Treasury. I urge its immediate consideration and its inclusion in H. R. 8300.

The CHAIRMAN. All right, Mr. Balluff.

STATEMENT OF E. J. BALLUFF, CHAIRMAN, SPECIAL COMMITTEE ON TAXATION, AMERICAN PATENT LAW ASSOCIATION Mr. BALLUFF. Mr. Chairman, my name is Edwin J. Balluff. I am a patent lawyer. I have my offices in the city of Detroit, Mich. I am appearing here as chairman of the special committee on taxation of