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purchase the workstations from Sun rather than manufacturing them
itself, as did the reverse royalty arrangement with Sun. Under
the terms of the purchase agreement, CV would reach the dollar
volumes of business with Sun at which the second warrant would
become exercisable more rapidly if it purchased workstations from
Sun rather than manufactured them itself. If Sun became
successful by virtue of CV’s purchasing workstations manufactured
by Sun, Sun’s value would be enhanced, and CV could benefit from
the increased value through the exercise of the warrants. The
warrants CV received from Sun were intended to, and did in fact,
lower the cost to CV of purchasing workstations from Sun.19
Additionally, in their 1987 income tax return, petitioners
treated the net proceeds of the sale of the second warrant as a
reduction of cost of goods sold to the extent of the proceeds
that would have been realized on the sale of the second warrant
had it been disposed of when it first became exercisable
19
Petitioners, in an effort to bolster their argument that the
second warrant was a capital asset of CV, suggest that the
warrant represented “partial compensation to Computervision for
the below-market interest rate on the loans” CV made to Sun as
part of the workstation purchase transaction. If in fact the net
proceeds of the sale of the second warrant constituted additional
interest income to CV with respect to its loan to Sun, the
proceeds would be taxable as ordinary income and not long-term
capital gain. See Comtel Corp. v. Commissioner, 376 F.2d 791,
796-797 (2d Cir. 1967), affg. 45 T.C. 294 (1965); Green v.
Commissioner, 367 F.2d 823, 825 (7th Cir. 1966), affg. T.C. Memo.
1965-272. Accordingly, accepting petitioners’ suggestion would
not cause us to adopt petitioners’ characterization of the second
warrant as a capital asset.
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