United States Court of Appeals for the Second Circuit commissioner of internal revenue, Petitioner, V

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United States Court of Appeals for the Second Circuit






Docket No. 27232

Date of Decision: June 5, 1962


Tax Analysts Citation: 1995 TNT 38-116

Principal Code Reference: Section 1221


Provided by Tax Analysts. Copyright 2000 Tax Analysts. All rights reserved.


In 1951, actor Jose Ferrer contracted with an author to produce

a play based upon a book by the author. Ferrer purchased three interests

relevant to this case: a "lease" of the right to make a play; the power to

prevent the author from disposing of the motion picture rights for a

certain period; and a 40-percent share of the author's motion picture

proceeds if Ferrer produced the play.

The play was subsequently abandoned in favor of a motion

picture, in which Ferrer agreed to perform. As compensation for his

surrender of the three rights mentioned above and his services in the

motion picture, Ferrer received $50,000 for the first twelve weeks of

acting, deferred compensation to be taken out of net receipts in the amount

of $50,000 plus $10,416 per additional week of acting, and a percentage of

the motion picture profits. If Ferrer's services were interrupted by his

willful refusal or neglect to perform, he would not receive a percentage of

the profits. Ferrer treated his share of the film's profits as long-term

capital gain under former section 117. The IRS treated it as ordinary

income, but the Tax Court ruled in favor of Ferrer.

The Second Circuit ruled that the portion of Ferrer's share of

the profits allocable to his sale of the "lease" to make the play and his

right to prevent the author from disposing of the motion picture rights

were capital gain. Circuit Judge Friendly explained that the lease created

an equitable interest in the copyright of the play, which allowed Ferrer to

enjoin any other person from making such a production. His role as producer

did not create the property interest in the copyright.

The court found no basis for denying capital gain treatment

because the receipts from the play would have been ordinary income or

because Ferrer was paid in a lump sum what might otherwise have been spread

over a number of years. Nor was there any direct relation between what

might have been derived from the play and what was realized by its

surrender. The right to prevent disposal of the motion picture rights

clouded the author's title, which the court analogized to a tenant's

release of a right to prevent his landlord from leasing to another tenant

in the same business, a capital asset.

The court ruled, however, that the release of the contingent

right to a percentage of the motion picture proceeds produced ordinary

income. The original contract, Judge Friendly noted, emphasized that the

author retained title to the motion picture rights and restricted Ferrer's

recourse to arbitration against the author. Ferrer never had an affirmative

equitable interest in the motion picture rights; if he had produced the

play, his profits derived from the motion picture, regardless of whether

they were sold for a lump sum or not, would have been ordinary income.

The appeals court rejected the contention of the IRS that,

because the payments were contingent on Ferrer performing services, all the

payments were compensation for services and, thus, ordinary income. Ferrer,

Judge Friendly reasoned, accepted a contingent percentage of the profits

instead of a fixed sum payable for his rights. The case was remanded to the

Tax Court for a determination of what portion of the payments were

attributable to each of the three rights sold.
US-CT-APP-2, [62-2 USTC ¶9518], Commissioner of Internal Revenue, Petitioner v. José Ferrer, Respondent , Capital gains and losses: Sale of rights under dramatic production contract: Divisible rights.--, (June 05, 1962)

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