FACTS:
constitutes income under 22(a) of the Revenue
Raytheon (original company) was a pioneer
manufacturer of rectifier tubes which are used
in radio receiving sets (using alternating
current instead of batteries). The Radio
Corporation of America developed a capital or income.
competitive tube, with the same effect as the
Raytheon tube. RCA owned many patents
covering radio circuits. In the early of 1927, it
entered into cross licensing agreements with
radio set manufacturers and in their agreement
it includes a clause particularly clause 9, which
required the manufacturers to buy their tubes
only from RCA. Later on those manufacturers
were operating under RCA and as a result,
Raytheon’s sales gradually declined.
It decided to enter into RCA but in the
condition that Raytheon will drop the case
against the latter for the illegal acts on the
ground of clause 9 and Raytheon shall pay
royalty basis.
However, Raytheon (new company that bought
original company) brought an action against
RCA for violating anti-trust laws, as well as for
destruction of Raytheon’s profitable business
and goodwill alleging that due to the acts of
RCA, Raytheon sales decline, which result to its
downfall and that CIR here conspired to
destroy its business.
Both parties finally agreed on a $410,000
settlement of the anti-trust case, with RCA
acquiring patent license rights and sublicensing
rights. Raytheon counted the $60,000 from the
amount as income from patent licenses, while
the remaining $350,000 were counted as
damages, and therefore not subject to income
tax. The income from patents was determined
from the cost of the development of such
patents, and the fact that few of them were
being used and none were earning royalties.
Thus, the value of patents and the goodwill
was backed by evidence during trial.
CIR opposed and alleged that the $350,000
Act of 1936 and thus a taxable income.
However, compensation for the loss of goodwill
in excess of its cost is gross income. The law
ISSUE: Whether or not damages for loss of does not exempt compensatory damages just
business good will are a nontaxable return of because they are a return of capital. The tax
exemption applies only to the portion that
recovers the cost basis of that capital; any
HELD: No. They are not taxable in general.
excess damages serve to realize prior
 Damages for violation of the anti-trust acts appreciation, and should be taxed as income.
are treated as ordinary income where they In addition, evidence must be produced to
represent compensation for loss of profits. establish the value of the goodwill and
Jurisprudence provides that Damages for business.
violation of anti- trust acts are treated as an
In this case, Raytheon was not able to
ordinary income in which this represent the
establish the value of its goodwill and
compensation for loss of profits.
business. It did not produce enough evidence
The test is not whether the action was one in to such effect. The amount of nontaxable
tort or contract but rather the question to be capital cannot be ascertained. Since Raytheon
asked is "In lieu of what were the damages could not establish the cost basis of its good
awarded?" Where the suit is not to recover lost will, its basis will be treated as zero. The Court
profits but is for recovery in injury to good will, concludes that the $350,000 of the $410,000
the recovery represents a return of capital and, attributable to the suit is thus taxable income.
with certain limitations (necessity of
proof/evidence), is not taxable.
In the case at bar, the suit by Raytheon was
not one of recovering lost profits (business
completely destroy and likewise the property
good will of Raytheon because of the illegal
acts of RCA). From its allegations, Raytheon’s
suit was for the destruction of its goodwill. The
presentation of evidence of profits was merely
used to establish the value of good will and the
business, since such value is derived by a
capitalization of profits. Therefore, a recovery
on goodwill and business represents return of
capital.
The fact that the case ended in settlement is of
no moment. The determining factor is the
NATURE of the basic claim from which the
compromised amount was realized.