author: Trammell: Phillips,

text:
    Appeal of The Ottawa Park Realty Co.
    Docket No. 5907.
    Decided November 12, 1926.
    Interest and taxes paid during tbe period of development of real estate for subdivision and sale may not be capitalized and treated as a part of the cost of such property.

      Bay E. Zaehman, Esq., for the petitioner.

      Arthur H. Fast, Esg., for the Commissioner.
    Petitioner appeals from the determination of a deficiency of $4,746.04 in income and profits taxes for 1919. It alleges that the Commissioner committed error in refusing to permit the taxpayer to treat as a capital expenditure interest and taxes paid during the period of development of a real estate project. The appeal was submitted upon the pleadings, the answer admitting the allegations of fact contained in the petition.
    FINDINGS OF FACT.
    The taxpayer is an Ohio corporation with its principal office at Toledo. In 1915 and 1916 it piirchased certain lands for the purpose of development, subdivision and sale. From the time ox purchase until the year 1922 these lands were being improved and placed in shape to market, as subdivision property.
    During the year 1916 comparatively few sales were made because the land was in a raw condition. During the years 1916,1917, and 1918, the sales were slow as the property was not in proper shape to sell readily. During the year 1919 the sales greatly increased.
    During the four years mentioned, the taxpayer was required to pay interest and taxes on all unsold lots. The taxpayer adopted an accounting system as follows:

      The sale of each lot was considered to be a separate transaction and was treated as such. Prior to the sale of any lot, certain amounts of interest and taxes were paid by the taxpayer, which were not deducted from income but were carried into asset accounts known as “ deferred interest ” and “ deferred taxes.”
    Upon the sale of the lot, which in nearly all cases was upon the installment plan, the accumulated interest and taxes were deducted from the income over the period during which monthly payments on the sale price were received.
    The Commissioner, in computing the deficiency, refused to capitalize such payments for taxes and interest, and deducted the total amount of interest and taxes paid and accrued on all lots, sold or unsold, from the income realized each year.
    Interest and taxes were carried into the accounts known as “ deferred interest ” and “ deferred taxes ” during the years 1916 to 1919, inclusive, in accordance with the following table:

    In 1919 the amount of interest received was $1,715.61 in excess of the amount paid.
    The total net profit for each of said years, as finally determined by the Commissioner, is as follows:
    Year. Net profit.
    1916_$4,001.40
    1017-' 7, 919. 45
    1918- 1, 435.17
    1919_:_ 30, 521.09
    At the beginning of the year 1919 the accounts known as “deferred interest” and “deferred taxes” totaled $42,383.02, which amount the taxpayer included in invested capital in determining its taxes for the year 1919. In the deficiency letter the Commissioner excluded this amount from invested capital.
    The amounts of interest and taxes carried into the asset accounts “ deferred interest ” and “ deferred taxes ” exceeded the total net income of the taxpayer from all sources as follows:
    Year. Excess.
    1916_ $738. 29
    1917_ — _ 6, 220.10
    1918_ 23,062.51
    Total_ 30, 020. 90

      Taxes on unsold lots during the year 1919 were carried to the “ deferred taxes ” account in the amount of $2,865.15. During said year interest was taken from the “ deferred interest ” account and deducted as an expense in the amount of $1,715.61. In computing the deficiency, the Commissioner disapproved the taxpayer’s handling of both of these items, deducted the tax item as an expense, and held that the deferred interest adjustment was to be disregarded in computing the income, thereby decreasing the net income for said year in the amount of $1,049.54.
   OPINION.

Trammell:

The taxpayer, which was engaged during the year in question in developing a tract of land for the purpose of subdivision and sale, contends that it is entitled to add, as a part of the cost of each lot, mortgage interest and taxes paid upon each lot prior to its sale. The adjustments made by the Commissioner arise from his contention that such interest and taxes are deductions which are to be taken annually in computing income and can not be treated as additional cost of such property or as an investment of capital.

Under the statute interest and taxes are deductions which are to be taken annually in computing net income. The statute does not leave the question open to taxpayers and permit them to decide whether such payments are to be treated as capital expenditures or as deductible expenses, but provides that such payments shall be allowed as deductions from gross income in determining net income. They can not be treated as capital expenditures and added to the cost of the property in determining gain or loss from the sale thereof. Westerfield v. Rafferty, 4 Fed. (2d) 590; Appeal of Columbia Theatre Co., 3 B. T. A. 622.

Judgment will be entered on 10 days’ notice under Rule 50.

Phillips,

dissenting: Taxpayer insists that it is a company producing articles for sale, is closely analagous to a manufacturing concern, and is entitled to treat interest and taxes paid on lots in process of development as part of the cost of such lots, and, therefore, as an increase in the cost of its inventory. It points out that during the years of development the interest and taxes were in fact paid out of its capital funds and represented a capital investment in the property.

Income has been defined to be “‘gain derived from capital, from labor, or from both combined,’ provided it be understood to include-profit gained through a sale of conversion of capital assets.” Merchants Loan & Trust Co. v. Smietanka, 255 U. S. 509; Eisner v. Macomber, 252 U. S. 189. In Goodrich v. Edwards, 255 U. S. 527, the court says:

Tlie statute imposes the income tax on the proceeds of the sale of personal proxierty to the extent only that gains are derived therefrom by the vendor. (Italics ours.)

Accepting this as the test, it becomes necessary to determine whether interest and taxes paid 'upon land during the period such land is being developed for the market are properly a part oí the cost of the finished product which must be recovered before any taxable gain results. It is not a sufficient answer merely to say that the statute permits such items to be taken as deductions in computing net income. Deductions are allowed by statute in computing taxable net income because the Congress saw fit to allow them, but the right to take such deductions does not affect the concept of what constitutes income in the first instance. Within the meaning of the Constitution, cost must be recovered before there is any taxable gain. If carrying charges are in fact a part of the cost, they are none the less so because allowed as a deduction in computing net income subject to tax. For example, let us assume that Congress had provided that a limited amount expended in purchasing Liberty bonds should be allowed as a deduction in computing net income. Would any one contend that when such bonds were sold the entire proceeds must be included in gross- income as taxable gain ? If a debt created by a loan of money is ascertained to be worthless and charged off in one year and collected in a subsequent year, has income been realized when the amount loaned is collected? In such a case does it make any difference whether the debt was claimed as a deduction from income for the year in which it was ascertained to be worthless and charged off ? And what is the situation if the debt was in fact ascertained to have been worthless but never charged off and never claimed as a deduction ? If it is income in the year when collected, because allowed as a deduction in a prior year, is it any the less income because not charged off or deducted in the prior year if, in fact, it was ascertained to have been worthless in the prior year ? It would seem that income in any year can not be determined by examining the returns of prior years to see whether certain deductions allowed by statute have been taken, or by examining the facts to see whether they should have been taken. Income, as applied to the instant appeal, can include only the amo'unt realized from the sale of each lot in excess of the cost of such lot. Whether or not carrying charges were or could have been deducted annually, it becomes necessary to determine whether such carrying charges were in fact a part of the cost of the property sold.

It appears that this taxpayer purchased undeveloped real estate for the purpose of improvement, subdivision, and sale as building lots. There is no question that the amounts expended for physical improvements in converting the acreage into suitable building lots are a part of the cost of the property. In my opinion, the amounts expended in carrying property during the period of such improvement are also a part of the cost of the finished product. Taxpayer may be compared with a manufacturer who purchases raw cotton to manufacture into fabric. The cost of the finished product is not merely that of the raw material and labor entering into the article. Many other items, such as transportation and warehousing of the raw material, must be considered. Yet these add nothing to the capital value and, if the statute is to be literally construed, are deductible as ordinary and necessary expenses of the business. So with the taxes here involved. They add nothing to the capital value, but so long as they are paid out in connection with the production of the finished article they are properly a part of the cost of that article.

Aside from the general principles involved, legislative history convinces me that it was the intention of Congress that such items should constitute a part of the cost of the goods sold. Section 202(b) of the Revenue Act of 1924 provides in part:

(b) In computing tbe amount of gain or loss under subdivision (a) proper adjustment should be made for (1) any expenditure properly chargeable to capital account.

In submitting the draft of the 1924 Act, the Committee on Ways and Means of the House of Representatives said with reference to this section:

The rule laid down therein is substantially the same as the construction placed upon the existing law by the Treasury Department. It provides that in computing gain or loss from the sale or other disposition' of property, the cost or other basis of the property shall be increased by the amount of items properly chargeable to capital account and decreased by the depreciation and similar deductions allowed with respect to the property. Under this provision capital charges, such as improvements, and betterments, and carrying charges, such as taxes on unproductive property, are to be added to the cost of the property in determining the gain or loss from its subsequent sale * * *.

Tbe Revenue Act of 1918 does not contain the provisions quoted, but there would seem to be no doubt that if “carrying charges, such as taxes on unproductive property,” are “ properly chargeable to capital account ” under the 1924 Act, as the Committee considers to be the case, they must likewise be chargeable to capital account under constitutional requirements, as laid down by the Supreme Court, that capital invested must be recovered before any income is realized. Merchants Loan & Trust Co. v. Smietanka, supra; Eisner v. Macomber, supra; and Goodrich v. Edwards, supra.

In passing it might be noted that article 231 of Regulations 62, issued under the Revenue Act of 1921, provides:

In the case of a timber property held for future operation .* * * all expenditures for administration, protection, and other carrying charges prior to production on a normal basis, shall be charged to capital account; after such a property is on a normal production basis such expenditures shall be treated as current operating expenses.

There would seem to be no doubt that any prudent business man entering upon a project such as is described in this article of the regulations looks forward to the carrying charges as a part of the cost of the production of timber which is to take place and arranges his finances accordingly. It has been said that the Constitution is to be interpreted in the light of the common understanding existing at the time of its adoption and, if we are right in believing that carrying charges are, as the regulations must indicate, ordinarily considered as a part of the cost of the article produced, they should be considered as part of the cost within the definition of the word “ income.” It is impossible to distinguish in principle between timber property held for future operations and acreage held for subdivision. If the decision in the present appeal is correct, the article of the regulations quoted can not be justified.

There is the further consideration that the accounts kept by the taxpayer have consistently capitalized the expenditures for interest and taxes. They correctly reflect income in accordance with the best accounting practice used in such business, and under section 212(b) of the Revenue Act of 1918 should be accepted as the basis for determining income. Appeal of Amalgamated Sugar Co., 4 B. T. A. 568.

For the reasons stated I must dissent from the conclusion reached.

Tkussell concurs in this dissent.


source: Caselaw Access Project

author: Littleton :

license: Public Domain

text:
    Appeal of Automatic Sprinkler Company of America.
    Docket No. 4987.
    Decided November 12, 1926.

      Irving Smith, Jr., Esq., for the petitioner.

      Thomas P. Dudley, Jr., Esq., for the Commissioner.
   Littleton :

This is an appeal from the determination of deficiencies for the years 1918 and 1919 in the amounts of $32,802.85 and $7,800.80, respectively, of which amounts approximately $2,100 is in dispute.

The controversy arises from the reduction by the Commissioner from $50,000 to $25,000 of invested capital, representing alleged value of patents and license agreements.

FINDINGS OF FACT.

The taxpayer is a Delaware corporation with principal office in New York City. During the taxable years it was affiliated with the Sypho-Chemical Sprinkler Corporation. On February 6, 1916, the Sypho-Chemical Sprinkler Corporation acquired for $200,000 par value of its capital stock certain patents and license agreements covering a certain automatic fire extinguishment system, which patents and license agreements had an actual cash value at the time acquired for stock of $50,000.

Judgment will he entered for the petitioner upon the issue raised on 15 days’ notice, under Rule 50.


author: Tp.ttssell :

text:
    Appeal of Bert K. Smith, Mrs. Bert K. Smith, and James A. Simons, Jr., and Wife.
    Docket No. 5329.
    Decided November 12, 1926.
    1. Bad debts. — Evidence respecting three certain accounts receivable and two items of bills receivable examined, and held tbat tbe same were ascertained to be worthless and charged off against the gross income of the year 1919 and should be allowed as a deduction in redetermination of deficiencies.
    2. Railkoad claims. — Claims of a shipper of merchandise made against railroad carriers for alleged losses and damages in transit, growing out of transactions occurring within the taxable period, should, under the evidence submitted, be given the same treatment as other accounts receivable growing out of the same year’s business in the computation of gross income. Similar claims resulting from the business and transactions of prior years, although still unsettled and carried on the taxpayers’ books as accounts receivable, should not be considered in arrriving at the gross income of the taxable year.

      H. E. Ketner, Esq., and Charles Kershenhamn, C. P. A., for the petitioners.

      B. E. Saunders, Esq., for the Commissioner.
    This is a joint appeal from the determination of deficiencies in income tax for the year 1919 as follows: Bert K. Smith, $3,021.34; Mrs. Bert K. Smith, $3,265.44; James A. Simons, Jr., and wife (joint return) $400.79, a total of $6,687.57. The petitioners allege error on the part of the Commissioner in his refusal to allow as deductions from the gross income of their partnership business, bad debts, $1,530.85; railroad claims receivable, $5,082.99; and bills receivable, $481.64 — a total deduction of $7,095.48.

      At the hearing the petitioners were granted leave to amend their petition claiming a deduction of $12,311.52 as railroad claims receivable, or a total deduction of $14,324.01.
    FINDINGS OF FACT.

    Bert K. Smith and James A. Simons, Jr., both residents of Fort Worth, Tex., were, during the year 1919, members of the partnership of Smith Brothers Grain Co., of Fort Worth, hereinafter referred to as the partnership. Smith owned a five-sixths interest and Simons owned a one-sixth interest in the partnership, and the profits therefrom were distributed in that ratio. The individual income-tax returns were filed on a community-property basis, Mr. and Mrs. Smith filing separate returns, and Mr. and Mrs. Simons filing a joint return.
    In January, 1920, a fire destroyed the Santa Fe Elevator, partnership property, and also resulted in the loss or destruction of the partnership books of account and records, except certain financial statements which were in the possession of a bank.
    On or about the 14th day of April, 1920, there was made and filed a partnership income return of the partnership of Smith Brothers Grain Co., which showed gross income $2,784 and net income $2,784, and that Bert K. Smith owned a five-sixths interest and James A. Simons, Jr., a one-sixth interest in said partnership. Upon their original individual income-tax returns, Bert K. Smith was assessed a tax in the amount of $636.56; Mrs. Bert K. Smith was assessed a tax in the amount of $940.08; and James A. Simons and wife, making a joint return, were assessed a tax in the amount of $181.61. Thereafter one of the Commissioner’s field agents made a report of an investigation of the Smith Brothers Grain Co. for the year 1919 in which he reported that the net income of said partnership for that year was $68,415.67. The petitioners immediately protested against this report and claimed that the said amount should be reduced by various deductions aggregating $35,-569.11. A reinvestigation was thereupon made by another field agent who recommended the allowance of items claimed by the petitioners aggregating $27,500.87, and the disallowance of items as follows:
    Railroad claims-«$6,155. 76.
    Accounts receivable_ 1, 530. 85
    Bills receivable--- 381.63
    Total. 8,068.24

      Thereafter, on May 8, 1925, the Commissioner issued a letter to the partnership, a part of which is as follows:
    The Solicitor has held that the following deduction cannot he allowed as the evidence presented is insufficient to warrant this office in making any change from the previous audit:
    Bad debts_$1, 530. 85
    Railroad claims_ 0,155.76
    Bills receivable_ 481. 64
    Total_ 8,168. 25
    These adjustments result in a corrected net income of $40,913.80 * * *.
    The individual returns of the partnership have been adjusted accordingly and made the subject of a separate communication of even date.
    On the same date there were issued the three deficiency letters to the petitioners herein.
    As practically all of the accounting records of the partnership had been destroyed by fire in January, 1920, the examining revenue agents used as a basis for ascertaining the gross income of the partnership a trial balance sheet which they found in the possession of one of the banks with which the partnership did business. In this trial balance there appeared an asset item, designated as railroad claims, in the amount of $12,311.52, which was carried as accounts receivable. This total of railroad claims included not only those claims growing out of the business of the year 1919, but also all unsettled claims growing out of the business of the years 1918 and 1917. Under its regular accounting practice, the partnership, whenever a claim for loss or damage was about to be or was made against a carrier, credited merchandise for the amount of the claim and charged the carrier. These claims were carried as accounts receivable for the amount of their face value until a settlement or adjustment was made with the carrier, at which time the amount received in settlement of a claim was charged to cash and any part of the claim that was not paid by the carrier was charged to profit and loss. No collections or settlements on any railroad claims were made during the year 1919. In the trial balance found in possession of the petitioners’ bank the item of railroad claims was shown as $12,311.52, but this figure was carried into the total of assets only at 50 per cent of its face value. During the years following 1919 there has been collected upon these old claims the amount of $7,228.53, and the balance of $5,082.99 has not been collected. The larger portion of these settlements was made in the year 1923.
    The partnership had shipped to E. E. Anderson, of Memphis, Tenn., a carload of grain and a draft for the amount of the grain was charged to his account. Anderson refused to accept the grain and a broker in Memphis was employed to resell the grain. The proceeds from the sale were $503.69 less than the amount charged to Anderson’s account. In 1919 the partnership determined Anderson’s debt of $503.69 to be worthless and charged it oif. No part of the said debt has ever been collected.
    The partnership had shipped to E. H. Jones, at Grosebeck, Tex., a carload of grain, and the circumstances surrounding the transaction were the same as in the Anderson account. The proceeds from the resale were $558.34 less than the amount charged to Jones’ account. In 1919 the partnership determined Jones’ debt of $558.34 to be worthless and charged it off. No part of the said debt has ever been collected.
    The partnership had a contract with E. M. Rogers involving the purchase and sale of grain and out of this contract grew a claim by Rogers against the partnership for $468.82. The partnership denied its liability under this contract and the matter was settled in Rogers’ favor by arbitration before the National Grain Dealers Association of which both were members. In order to appeal from the award it was necessary for the partnership to put up a certified check for $468.82, which it did, charging that amount to Rogers’ account. The claim was finally determined in Rogers’ favor in 1919. No part of the $468.82 was ever returned to the partnership. The National Grain Dealers Association returned to the partnership $45, which represented a part of the arbitration fee advanced by it, but this was no part of the said $468.82.
    The Edwards Grain & Elevator Co. became indebted to the partnership in the amount of $400 through contract obligations and gave the partnership its 60 day promissory note. The note matured prior to December 31, 1919, but was not paid at maturity nor at any time since. The Edwards Grain & Elevator Co. went out of business during 1919, and the partnership determined the debt to be worthless and charged off the $400 in 1919.
    The partnership’s transaction with the Dalhart Grain & Coal Co. was similar to that with the Edwards Grain & Elevator Co. The promissory note which was given for $81.64 matured during 1919 but was not paid at maturity nor at any time since. The Dalhart Grain & Coal Co. went out of business during 1919, and the partnership determined its debt to be worthless and charged off the $81.64 in 1919.
   OPINION.

Tp.ttssell :

While the record shows that the petitioners’ books of account for 1919 and prior years have been destroyed and the testimony concerning the method of keeping such accounts has some elements of uncertainty, there appears to be no reason to doubt that, in respect to the handling of claims for losses and damages against carriers, it is definitely established as set forth in the findings of fact. There also appears to be no reason to doubt that the examining revenue agent found the asset item of railroad claims in the amount of $12,311.52 and that they treated this item the same as other accounts receivable in arriving at gross income for the year 1919. The testimony received at the hearing establishes that this total of railroad claims was the result of’ accumulations covering three years. Under the petitioners’ method of accounting, claims made against railroads for losses and damages growing out of the business for the year 1919 were included among the accounts receivable in ascertaining the gross income for that period.

The Commissioner held that the total of the claims outstanding in 1919 constituted income for that year. We have no evidence to show that these claims were not correctly treated as income by the Commissioner, and, in these circumstances, that portion of the claims which grew out of business for the year 1919 should remain in gross income for that year. Upon final determination of the deficiencies under Rule 50 the petitioners and the Commissioner should compute such deficiencies, in so far as such railroad claims are concerned, by eliminating such amount of those claims as grew out of business for the years prior to the year 1919.

Respecting the three items of the so-called bad debts, aggregating $1,530.85, we find that the evidence supports the contentions of the petitioners and that that amount should be allowed as a deduction from partnership gross income.

With reference to the bills receivable aggregating $481.64, we are equally satisfied that the same were debts ascertained to be worthless and charged off in the year 1919, and if they have not already been allowed by the Commissioner in computing the partnership net income they should now be allowed.

Order of redetermination will he entered on 80 days’ notice, u/nder Rule 50.


author: Tbits sell :

text:
    Appeal of Nice Ball Bearing Co.
    Docket No. 2109.
    Decided November 12, 1926.
    1. Patent values. — For the purposes of invested capital and allowance for exhaustion, the values of patents acquired by a corporation for stock at some prior date determined upon the evidence of earnings produced by the use of such patents in the hands of their former owners, the opinion evidence of men experienced in the business using such patents, and comparison with the profits produced by the purchasing corporation in subsequent years.

      2. Good wild. — The good will of a going business based exclusively upon the manufacture and sale of articles protected by patent monopoly and transferred to a successor corporation for stock can not be determined in the absence of specific testimony distinguishing the value of the good will as separate from the value of the patent monopoly.
    3. Losses ; deduction. — No part of the amount paid in 1921 in compromise of litigation can be an allowable deduction from gross income for the years 1918 and 1919 although the cause of the litigation arose in those years but no liability was then acknowledged or accrued.
    4. Jurisdiction. — Under both the Revenue Acts of 1924 and 1926 the Board has jurisdiction of an appeal involving an alleged deficiency in tax, the assessment of which was made prior to June 2, 1924, and a claim for abatement of such assessment was rejected during 1925.
    5. Statute or limitations. — A deficiency for the calendar year 1916 was not discovered until July, 1920, and was not assessed until subsequent to December 23, 1924. Held, that the statute of limitations had run against any alleged deficiency for the year 1916.

      Andrew R. McCown, Esq., and Okas. S. Rochey, G. P. A., for the petitioner.

      A. R. Marts, Esq., for the Commissioner.
    The taxpayer brought this proceeding for the purpose of a rede-termination of alleged deficiencies as follows: For the year 19 L6, $1,884.08; .for the year 1917, $16,253.32, being the amount for which a claim for abatement of $17,374.73 was rejected by the Commissioner; for the year 1918, $11,861.31; for the year 1919, $24,787.04, aggregating $54,785.75.
    The issues presented for determination are:
    (1) The value of certain patents acquired by the taxpayer for stock.
    (2) The value of the good will of two predecessor businesses acquired by the taxpayer for stock.
    (3) The taxpayer’s claim that the sum of $100,000 paid in 1921 in settlement of litigation should be prorated over the years 1918, 1919, L920, and 1921, during which the subject of the litigation was in controversy.
    At the hearing the Commissioner moved to dismiss the petition as to the year 1917, claiming that the Board had no jurisdiction over an appeal for that year. At the same time the taxpayer claimed the benefit of the statute of limitations as regards the year 1916, but proceeded nevertheless to the trial of the issues on the merits for all of the years 1916 to 1919, inclusive.

      FINDINGS OF FACT.
    1. The taxpayer is a corporation organized under the laws of Pennsylvania, having its principal place of business at Philadelphia. It was incorporated on January 18, 1916. At or about the time of its organization it acquired all the properties and the going business, including good will, of the Pressed Steel Manufacturing Co., a corporation. At the same time it acquired all the properties and the going business, including good will, of one Budd G. Nice, doing business under the name and style of Nice Ball Bearing Co. For all of these properties and businesses it paid, or undertook to pay, a small amount of cash, assumed some then outstanding obligations, and issued a large portion of its authorized capital stock. Shortly thereafter it acquired from Frank Beemer two certain patents for which it issued $100,000 of its common stock, and at the same time it acquired from Budd G. Nice two certain patents for which it issued $50,000 par value of its authorized capital stock.
    The Pressed Steel Manufacturing Co. -was incorporated in the year 1902 and had been continuously in business from that time to the transfer of its business to the taxpayer. It had acquired the ownership of a number of patents and some tangible properties. Its principal business, however, was that of a selling organization. In connection with its merger with the taxpayer it submitted a written offer of sale of its property and business, the pertinent parts of which are as follows:
    We do hereby agree to sell, assign and transfer unto the Nice Ball Bearing Company, Incorporated, our entire business now being carried on by us in Philadelphia, Penna., consisting of the promotion and sale of Ball Bearings, now being made for us by other concerns under contract, and for which we own very valuable and exclusive patents, consisting of the following assets:
    Tools-$12,109.54
    Insurance- 1, 971. 00
    Cuts and electros- 469. 52
    Drawings- 867. 00
    Merchandise, finished_ 14, 684. 56
    Stationery and office supplies- 346.57
    Office furniture_ 2, 938.25
    Cash- 421. 59
    Accounts receivable_ 21,748. 92
    Patents and trade-mark- 178,335. 63
    Good will — based inter alia on a total of approximately $90,000 of unfinished orders on our books for redelivery during the year 1916, on which the estimated profit is $50,000; as well as on the volume of profit obtained on the amount of business we transact, and by the trade name we have built up at great expense and care during the past fourteen years_ 271,109.35
    505, 061.93

      This offer was accepted by the taxpayer and payment was ordered made therefor as follows:
    690 shares common stock, par yalue $100_$69, 000
    690 shares preferred stock, par value $100_ 69, 000
    1,750 shares common stock, par value $100 (after increase of capitalisation)_ 175,000
    1,750 shares preferred stock, par value $100 (after increase of capitalization)_ 175,000
    - $488,000. 00
    Assumption of outstanding indebtedness_ 17, 061. 93
    Total_=_ 505, 061.93
    The patents purchased by the new corporation upon its incorporation as of January 18, 1916, the serial numbers, the dates of issue, and the par value of stock of such new corporation issued therefor are as follows:

    The earnings before amortization of patents, except as to 1915, and net tangibles of the Pressed Steel Manufacturing Oo. over the five-year period from 1911 to 1915 were as follows:

    Said earnings for 1915, namely, $14,294.02, are the net earnings after claimed amortization of patents in the amount of $17,838.56. The earnings for 1915, therefore, before amortization of patents, amounted to $32,127.58, and the total of the column of earnings upon this basis is $117,635.86.
    All the patents transferred to the taxpayer with the exception of three, for which a nominal amount of stock was issued, played an important part in the business of the taxpayer.
    Serial No. 859,099, for which $10,000 stock was issued, was a patent for a ball bearing wheel. This was issued for invalid chairs and other various small vehicles. This wheel was also used in trans-veyor trucks.
    Serial No. 953,433, for which $1,000 stock was issued, was a pressed steel carpet fastener for use on stairways. The use of this patent, however, was discontinued after 1912.
    Serial Nos. 735,529 and 811,152, for which $50 stock was issued for each, were not used.
    Serial No. 887,265, for which $100,000 stock was issued, was a stamped thrust bearing. This was next to the most important patent used by the taxpayer. It was used in the hinge and sash bearing business, stearing gears, marine motor thrust bearing, king pin, tractor thrust, elevator thrust, revolving doors and ceiling fans.
    Serial No. 859,083, for which $65,000 stock was issued, was a radial thrust bearing. This was sold to street car manufacturers. It was also used for baby carriages, radiator fans, washing machines, electric fans, electric flasher signs and ship windlass bearings.
    Serial No. 871,518, for which $2,235.63 of stock was issued, was a ball bearing roller skate patent. This was a combined unit of five distinct parts into a single wheel.
    The business of Budd Gr. Nice, trading as Nice Ball Bearing Co., was first established in or about May, 1914. At the time of the merger of this business with the taxpayer, Nice submitted a written offer of sale of all of his properties and business, the pertinent parts of which are as follows:
    I hereby agree to sell, assign and transfer to the Nice Eall Bearing Company, incorporated, the entire business now carried on by myself, trading as Nice Ball Bearing Company, located at the northwest corner of 25th and Lombard Streets, Philadelphia, Penna., for the manufacture of ball bearings, their parts and accessories, consisting of the following:
    Machinery_ $34,311.30
    Tools (finished)-2, 573. 84
    Tools (unfinished)-258.10
    Factory equipment-194. 85

    Merchandise-12, 9G0.34
    Insurance (unexpired) 108. 77
    Office furniture-568.54
    Cash_ 37. 85
    Factory improvements- 1,310.75
    Good will — which is based on a total of approximately $138,000 of unfinished orders on my boots for delivery during the first nine months of the year 1916, on which the estimated profit is approximately $60,000- 89, 518.21
    141, 842. 55
    This offer was accepted by the taxpayer and payment was ordered made therefor as follows:

      660 shares common stock, par value $100-$56, 000.00
    560 shares preferred stock, par value $100_ 56, 000.00
    112, 000. 00
    Assumption of outstanding obligations_ 7, 603.23
    Cash payment within two years_ 22,239.32
    Total_ 141,842.55
    On or about March 16, 1916, the taxpayer acquired from Frank Beemer and Budd G. Nice four other patents, in payment for which it issued its stock. The patent serial numbers, the dates of issue, and the par value of stock issued therefor are as follows:

    Foreign rights were likewise acquired at the same time and patents were immediately procured in England, France, Italy, and Canada.
    Serial No. 1,149,889 was secured from Frank Beemer. This patent was known as the annular roller hearing. This was used in heavy machinery, such as concrete machinery, bait overhead cranes, propeller shafts, and other heavy machinery.
    Serial No. 1,242,911 was a patent also secured from Beemer and was known as the diamond ball retainer patent. For these two patents $100,000 stock was issued.
    Serial No. 1,147,116 covered a thrust steel annular bearing and was secured from Bndd G. Nice. This was used in washing machines, cream separators, oil separators, and floor surfacing machines.
    Serial No. 1,177,046 was a patent also secured from Budd G. Nice. For the two latter patents $50,000 stock was issued. This latter patent was a single row type ball bearing wheel used mostly in overhead traction work, in overhead conveyers, sliding doors, etc. The most valuable patent used by the taxpayer was the one secured from Frank Beemer.
    Budd G. Nice transferred his bearing patent and an application for a patent on an anti-friction wheel to the taxpayer corporation for stock of the par value of $50,000. During the years 1914 and 1915 the predecessors, under a shop license, manufactured through others and sold bearings and wheels to the amount of $11,240, of which the profit was $6,925, which was a sales profit only as the predecessors had their manufacturing done by others; book and unfilled orders, requiring material made under this patent and application therefor, taken over by the taxpayer from the Pressed Steel Manufacturing Co., amounted to $9,166, on which the estimated profit was $5,210, which profit was made thereon by the taxpayer.
    Frank Beemer transferred an annular rolling bearing patent and an application for a pressed or stamped ball retainer patent to the taxpayer corporation for stock of the par value of $100,000. During the years 1914 and 1915 the business of Budd G. Nice, trading as Nice Ball Bearing Co., was increased from approximately $27,000 in 1914 to $75,000 in 1915, largely because of the use of such ball retainer invention. The amount of business booked for 1916 in which the said retainer was used exceeded $140,000 and the total sales on the said inventions of Beemer in the year 1915 amounted to $11,300. The predecessors had a shop license for such inventions but had no title thereto, and the patents were not included in the original transfer and sale of the assets of the two predecessor businesses to the taxpayer in January, 1916.
    The earnings of the taxpayer corporation and the net tangibles for the five-year period subsequent to its acquisition of the patents and other assets upon its organization in January, 1916, to wit, from 1916 to 1920, inclusive, as shown by its tax returns (and as adjusted by the Commissioner of Internal Revenue with respect to the years 1916 to 1919, inclusive) before amortization of patents, are as follows:

    The amortization charge in each of said years was $28,967.02.
    The taxpayer never manufactured or sold any articles except under its said patents or patent applications. The gross sales under the patents or patent applications transferred to the taxpayer corporation by Budd G. Nice and Frank Beemer and the Pressed Steel Manufacturing Go. for the five-year period subsequent to the acquisition of them by the taxpayer was as follows:

      At the time of the acquisition by the taxpayer of the said seven patents from the Pressed Steel Manufacturing Co., of said patent and application for patent from Budd G. Nice, and of said patent and application for patent from Frank Beemer, and of the other assets acquired P’om the predecessor businesses, the taxpayer (purchaser) and the sellers knew from statistical records the percentage of the bearing business had by the predecessors under said patents and patent applications, with respect to the total business in the bearing industry, for the year prior to said acquisition, and as well the probable increase of such business by the taxpayer. The position of the taxpayer and/or its predecessors in the bearing industry, as to twenty-two different kinds of bearings, as shown by the percentage of business had by taxpayer and/or its predecessors with respect to the total business in the industry, for the years 1915 to 1919, inclusive, is as follows:

    As to the above items marked (a) the table shows percentage of total particular units manufactured which used bearings, such as steering gears, etc.; the remainder in percentage of such units did not employ bearings therein so that taxpayer supplied all of such business where bearings were used, as to steering gears, radiator fan bearings, transveyor truck bearings, electric flasher bearings, elevator thrust bearings, hinge and sash bearings, revolving door bearings, ship windlass bearings, electric and other coffee grinder and feed mill bearings, ceiling fan bearings, and conveyor system wheel bearings.
    As to the above items marked (b), the table shows the percentage of total particular units which used bearings manufactured by taxpayer so that taxpayer did not supply all of such business where bearings were used but only the percentage thereof indicated.
    During the years 1911 to 1916, inclusive, the net tangible assets employed in the business of the Pressed Steel Manufacturing Co., the net profits produced before amortization of patents, the amount of 8 per cent of return on net tangibles, and the balance of profits were as follows:

    During the years 1911 to 1915, inclusive, the net tangible assets employed in the business of the taxpayer, the net profits produced before amortization of patents, the amount of 8 per cent of return on net tangibles, and the balance of profits were as follows:

    2. The Pressed Steel Manufacturing Co., one of the predecessors, had been in business for fourteen years at the time all of its assets were transferred to the taxpayer. It owned at such time the trademark “ Nice,” which was registered in the United States Patent Office, and which was transferred to the taxpayer upon its incorporation. It was a successful, going concern and at such time it had on its books $90,000 of unfilled orders on which the estimated profit was $50,000, and which were likewise then transferred to the taxpayer. Such orders were consummated by the taxpayer and the profits thereon exceeded said estimated profit. Said business at the time of the transfer thereof to the taxpayer was transferred at the value of $505,061.93, of which $271,109.35 was good will, $178,-335.63 was for patents, and the balance of $55,619.95 was for tangible assets at the book value which was the cost value.
    The business of Budd G. Nice, trading as the Nice Ball Bearing Co., at the time of its transfer to the taxpayer, included no patent account, but did. include $138,000 of unfilled orders on which the estimated profit was $60,000. Such orders were consummated by the taxpayer and the profits thereon exceeded said estimated profit. Three months prior to the transfer of said business said Budd G. Nice had received an offer for said business from a responsible party in the amount of $175,000. Said business at the time of the transfer thereof to the taxpayer was transferred at the value of $141,842.55, of which $89,518.21 was good will and the balance, $52,323.79, consisted of tangible assets at cost, and the business at the time of the receipt of the offer of purchase therefor of $175,000 was the same business and consisted of the same assets.
    3. On or about the 13th day of April, 1917, a contract was entered into with William Steel & Sons Co. for the erection of a one-story steel and concrete building which was finished on or about September 1, 1917. This building was built on the “ cost plus ” basis. The estimated cost was $187,000. The final cost was $290,000. The contractor had agreed to finance the construction to a large extent by mortgage, but was unable to place the mortgage on account of the Liberty Loan drives and finance conditions at that time. The contractor brought a suit for the unpaid balance of $230,000. An attempt to adjust this suit by a deed of the real estate to the contractor was objected to by the bank and by merchandise creditors of the taxpayer. The creditors entered into an agreement but the contractor refused to enter with them and threatened to proceed with the suit. Thereupon, the taxpayer secured one Kirkbride, the president of the so-called “bearing trust,” to purchase the contractor’s building debt, taking an assignment of the taxpayer’s real estate. A voting trust was created, by the terms of which the voting stock of the taxpayer corporation was transferred to the said Kirkbride. There was litigation with Kirkbride as to the final payments and the return of stock and a number of suits were pending in various courts. Finally, a compromise was effected for $100,000 and suits between all the parties were settled, discontinued and entered of record. Final agreement was made December 1,1921, $50,000 cash was paid in December, 1921, and a note for the remaining $50,000 was given, which was paid January 2, 1923. These payments were confirmed by the stockholders and directors of the taxpayer. This $100,000 was allowed as a deduction from the gross income of the taxpayer for the year 1921, but the taxpayer claimed that said sum should have been allocated to tlie years 1918 to 1921, inclusive. The books of the taxpayer -were kept on the accrual basis.
    4. For the year 1917, upon the basis of original and amended income-tax returns made by the Commissioner and a report made by an examining agent, the Commissioner made original and additional assessments aggregating $25,924.62. Against the total of these assessments the taxpayer at some time prior to December 23, 1924, made and filed with the Commissioner a claim for the abatement of $17,374.73. The deficiency letter dated December 23, 1924, recites the allowance of said claim in the amount of $1,121.41 and its rejection in the amount of $16,253.32.
    5. For the year 1916 the taxpayer’s original income-tax return, made February 21, 1917, was filed in the office of the collector of the first district of Pennsylvania on February 22, 1917, showed a net taxable income in the amount of $35,633.77, and computed the amount of tax due as $712.68. Thereafter, and on or about July 28, 1920, a revenue agent investigated the taxpayer’s books and records and concluded that there was an additional tax of $1,884.04. At his suggestion the president of the taxpayer signed an amended return prepared by the agent for the calendar year 1916, which showed a taxable income in the amount of $129,838.23 and a total apparent tax for that year of $2,596.76. This return was forwarded by the agent to the Commissioner with his report of July 21, 1920. Thereafter, the Commissioner considered the question of tax liability for the year 1916, and on December 23, 1924, mailed to the taxpayer a notice of deficiency, registered, advising it of his determination of a deficiency of $1,884.04. No assessment of the deficiency for that year was made' prior to December 23,1924.
    At the trial of this proceeding and for the purpose of supporting the taxpayer’s claims to patent values, the earnings and profits as shown in the above-mentioned amended return have been used by taxpayer as part of a proposed basis for computing values of the taxpayer’s intangible properties consisting of both patents and good will.
    In making his adjustments of invested capital and allowances for exhaustion of patent values, the Commissioner found that all the patents acquired by the taxpayer for stock had at the date acquired a cash or fair market value in the amount of $86,000 and allowed no value whatever for the good will of the predecessor businesses taken over. The Board finds that the group of seven patents acquired by the taxpayer from the Pressed Steel Manufacturing Company had a cash or fair market value at the date acquired in the amount of $178,335.63 and that the four patents and inventions acquired from Budd G. Nice and Frank Beemer had a value at the date acquired in the amount of $150,000.
   OPINION.

Tbits sell :

In view of the evidence we are of the opinion that the statute of limitations had run against the year 1916 and that there is no deficiency for that year.

The Commissioner urged, in support of his motion to dismiss the appeal for the year 1917, the fact that an assessment of the claimed deficiencies had been made prior to June 2, 1924. This motion was denied at the time of the hearing on the basis of the Board’s decision in the Appeals of E. J. Barry, 1 B. T. A. 156, and Hickory Spinning Co., 1 B. T. A. 409, and that conclusion is now affirmed in accordance with section 283(f) of the Revenue Act of 1926.

In the case of the Malleable Iron Range Co. v. United States, 62 Ct. Cls. 425, the Court of Claims had under consideration a situation where the plaintiff sought in its income-tax return for the year 1918 to deduct the amount of the judgment rendered against it during that year but in respect to which the plaintiff then took an appeal which was not finally determined and settled until the year 1920, and the court held that, inasmuch as the plaintiff in that case never acknowledged the liability until the appeal was determined, it could not accrue any amount on account of said judgment while its appeal was pending and unsettled. The record in the instant case does not show when the litigation which was compromised and settled in 1921 was actually begun. It does show, however, that the taxpayer never recognized its liability in any amount until it sought to and effected a compromise. This is not exactly parallel with the Malleable Iron Range Co. case, supra, but the reasoning of the court in that case seems to’be applicable here.

Section 234(a) (4) of the Revenue Act of 1921 contains these words:

Losses sustained during the taxable year and not compensated for by insurance or otherwise; unless, in order to clearly reflect the income, the loss should in the opinion of the Commissioner be accounted for as of a different period.

Even if this might be construed to authorize the Commissioner to allocate losses actually sustained in 1921 to prior years, it does not seem to be applicable in the present case for the reason that there is nothing in the record which seems to connect this loss in any way with the production of gross income in the years 1918, 1919, or 1920. We have-therefore arrived at the conclusion that no part of that loss may be properly deducted from gross income for any of the years here under consideration.

While we are generally ready to concede that a going business conducted successfully for a number of years, which has produced profits, and which shows a comparatively steady growth, develops a good will and that such good will when transferred to a successor must have a capital value. Such capital value, however, must be established by evidence segregating and distinguishing good will value from the values inherent in other assets, both tangible and intangible. The business of the two predecessor concerns which were taken over by the taxpayer was built up entirely upon the basis of manufacturing and selling articles protected by patent monopoly, and the testimony in the present case does not clearly distinguish between the intangible capital values inherent in the patent monopoly and any values pertaining to good will. We are, therefore, of the opinion that neither the good will values claimed by the taxpayer nor any part thereof has been established by the evidence.

The value of patents at any given date is, like the value of other property, a question of fact Avhich must be determined upon the evidence. In the Appeals of Dwight & Lloyd, Sintering Co., 1 B. T. A. 179; Gamon Meter Co., 1 B. T. A. 1124, and J. J. Gray, Jr., 2 B. T. A. 672, the Board has laid down the rule that in determining the value of patents at any basic date it would take into consideration the history and the volume of profits produced by the use of patents, the opinion testimony of men experienced in dealings in patents and in the products protected by the patent monopoly and Avould also consider the subsequent history of such patents, together with the volume of profits produced by their use in the business, and upon the basis of such evidence determine the value at the basic date.

In the instant case the Commissioner took the average profits produced by the predecessor enterprises during the period of 5 years immediately preceding January, 1916, when the group of seven patents had an average remaining life of 7 years and the group of four patents had an average remaining life of almost their whole term of 17 years, and that the two groups together had an average life of approximately 11 years and, applying a well known annuity formula, produced a value of $86,000 at the basic date, January 18, 1916. If the Commissioner had taken the average profits of the 5 subsequent years when the first group of 7 patents had a remaining life of approximately 4 years, the group of four patents had a remaining life of approximately 12 years, and the average remaining life of all of the two groups was approximately 7 years, and had applied the same formula, he would have found that these patents in January, 1921, had a value of $423,000. It is no doubt entirely possible that there may be cases in which a group of patents on one date might be worth $86,000 and that five years later the same patents might be worth $423,000, but under all the facts appearing in the record of this case we are convinced that so wide a spread between the values at two different dates must produce a doubt as to the application of the formula adopted by the Commissioner.

In the instant case the record contains the testimony of two business men who were also inventors and had produced part of the patents here in question. These men have lived with these patents and the business in which they are used for a number of years. Their private fortunes and their life work are staked upon the successful outcome of a business devoted entirely to the production and sale of articles protected by these patent monopolies. On January 18, 1916, the group of seven patents had been tried and proven by years of successful operation, and on that date these men in reorganizing their business determined that this group of seven patents had a value of $178,335.63. The group of four patents were new and little tried. They were, however, related to the same general character of business as the preceding group of seven patents. They evidenced improvements along the same general lines of manufacture of patented articles. At the time of the transfer of these four patents and inventions to the taxpayer these men were not only conversant with all the past history of the business using such patents but they were also cognizant of the then present conditions of the industries using ball bearings. They knew the industrial field within which such articles as they had produced and proposed to produce could be used. They already controlled a considerable percentage of the business in twenty-two separate lines of industry. They knew the history of these industries and, on the basis of such history, they could estimate the probable growth and expansion of such industry and, therefore, of the increased demand for ball bearings. They were able at that time to sense the future of the properties which they owned and which they transferred to the taxpayer corporation, and they then in the exercise of their experienced judgment as business men placed a valuation on these four patents and inventions in the amount of $150,000. That they were capable appraisers of such values we believe must be accepted without question.

Now, let us see whether subsequent events as disclosed by this record tend to support or to disprove the appraisal then made by them. During the five years of 1916 to 1920, inclusive, the taxpayer corporation carrying on the manufacture and sale of articles protected by these eleven patents produced net gains and profits aggregating $628,013.74. If, then, we assume that this taxpayer had, at or near the beginning of the year 1916, purchased this group of patents for a cash consideration of $328,335.63, and had acquired the business in which such patents were used and had conducted such business during the following five years with the same results as to profits, it could have disposed of such pi’ofits as follows:

Total profits produced_$628, 013. 74
Amount necessary to pay 8 per cent on average cost of tangible properties employed in business_ 105,457.93
Balance_ 522, 555. 81
Amount necessary to repay or amortize cost of patents- 328, 335. 63
194, 220.18

This balance is equal to an annual average of $38,844.04,.which will pay an 8 per cent annual dividend on $485,550. The total increase of tangible assets during the 5 years was $407,720.52. The company could have issued and sold stock for this amount and more and paid an annual dividend of 8 per cent thereon. It thus appears that during these 5 subsequent years the purchasers of these patents could have amortized their entire cost and still have had possession of the patent monopoly inherent in the group of seven patents for the further period of 4 years and in the group of four patents for the further period of approximately 12 years. We are thus convinced that the estimate of values placed upon these patents in 1916 was conservative and safe and that if the patents had been in the market a prudent buyer could have safely offered to pay the values claimed by the taxpayer. We have, therefore, found that the group of seven patents had a value on January 18, 1916, in the amount of $178,335.63, and that the group of four patents and inventions had a value on the date they were transferred to the taxpayer in the amount of $150,000. In the computation of a deduction for the exhaustion of these capital values, the total values found for the group of seven patents should be distributed and assigned to the several patents in the amounts shown in the findings of fact, and the total of $150,000 found to be the value of the group of four patents and inventions may be segregated and assigned to each patent or invention in the amounts elected by the taxpayer.

Order of redetermination of deficiencies in accordance with the foregoing findings of fact and opinion will be made on 15 days’ notice, pursuant to Bule 50.