*1773 March 1, 1913, value of a group of patents determined for the purpose of computing annual allowance for exhaustion based upon the average life of the group.
*865 The respondent determined deficiencies in income tax against the Merrell-Soule Co. for the years and in amounts as follows:
| Year | Docket No. | Deficiency |
| 1920 | 40316 | $6,748.80 |
| 1923 | 3,739.88 | |
| 1924 | 40195 | 8,515.15 |
| 1925 | 6,311.48 |
The issues are (1) respondent's failure to allow adequate deductions for exhaustion of patents; (2) respondent's failure to allow a deduction for 1923 for the entire New York State franchise tax accrued in that year; and (3) whether the respondent's determination of deficiency for 1920 was made in respect of a taxable period or the calendar year. All other issues were abandoned by the petitioner at the hearing. In the brief filed subsequent to the hearing the respondent concedes that the petitioner is entitled to a further deduction of $15,423.47 for 1923 on account of the New York franchise taxes, and that petitioner's tax liability*1774 for 1920 should be determined upon the calendar year basis, thus disposing of the second and third issues in conformity with the contentions of the petitioner and leaving only the first issue for decision by the Board. Upon motion of the respondent, to which no objection was raised by the petitioner, the name of the petitioner was changed from Merrell-Soule Co. to Syracuse Food Products Corporation. The proceedings were consolidated for hearing and decision.
FINDINGS OF FACT.
Petitioner, a New York corporation with its principal office at Syracuse, was organized in 1893, for the purpose of taking over the business of the partnership of Merrell and Soule. Trufood, Limited, was incorporated under the laws of New York, on November 23, 1907. On December 3, 1907, the petitioner and Trufood, Limited, were consolidated under the provisions of section 671 of the New York corporation laws of 1895, pursuant to which the petitioner *866 became vested with all of the rights, franchises, property and obligations of the consolidated companies. On February 21, 1928, the name of the corporation was changed to Syracuse Food Products Corporation.
The partnership of Merrell & Soule*1775 was formed in 1868 by G. L. Merrell and O. F. Soule, for the purpose of engaging in the business of canning foods, Soule investing $1,200 and Merrell his skill and experience in canning corn. During the term of the partnership Merrell devised and patented an improved apparatus and process for canning corn; and it is by this process, still known as the Merrell-Soule process, that most corn and vegetables are canned today. Merrell also obtained patents on other inventions of canning machinery, and eventually the partnership engaged in the manufacture of this patented machinery, which was sold outright or leased on a royalty basis to competitors in the canning business. Between 1884 and 1886 the partnership commenced the manufacture of mince meat. This product was marketed under the trade brand "None Such," originally in tin cans and later in paper packages.
On May 30, 1899, United States Letters Patent No. 625,880 was issued to William B. Gere, assignor to the Merrell-Soule Co. This is a product and process patent for the manufacture of vegetable soup powder, consisting of cooked green vegetables, starch, and soup stock.
On December 25, 1900, United States Letters Patent No. *1776 664,458 was issued to Charles H. Brooks, assignor to the Merrell-Soule Co. This patent related to an invention of a machine for making paper boxes for mince meat.
On January 1, 1901, United States Letters Patent No. 665,323 was issued to William B. Gere, assignor to the Merrell-Soule Co., covering a method of preparing vegetable soup powders.
On May 5, 1903, United States Letters Patent No. 727,173 was issued to G. L. Merrell, assignor to the Merrell-Soule Co. This patent covered a mask, suitable for the amusement of children, intended to be used for advertisement purposes.
On January 12, 1904, United States Letters Patent No. 749,211 was issued to G. L. Merrell, assignor to the Merrell-Soule Co., covering the invention of a machine for soldering tin cans.
On February 9, 1904, United States Letters Patent No. 751,714 was issued to Charles H. Brooks, assignor to the Merrell-Soule Co., covering the invention of a machine for closing the ends of paper boxes.
On June 12, 1906, United States Letters Patent No. 823,477 was issued to Irving S. Merrell, assignor to the Merrell-Soule Co., covering the invention of a conveyor system for use in preserving plants and similar manufactories.
*1777 *867 On June 11, 1907, United States Letters Patent No. 856,356 was issued to Irving S. Merrell, assignor to the Merrell-Soule Co., covering the invention of a pea-separating machine.
On June 11, 1907, United States Letters Patent No. 856,894 was issued to Irving S. Merrell, assignor to the Merrell-Soule Co., covering a corn-silking machine.
On December 31, 1907, United States Letters Patent No. 875,092 was issued to Irving S. Merrell, assignor to the Merrell-Soule Co., covering the invention of a machine for marking tin cans.
On September 13, 1910, United States Letters Patent No. 969,969 was issued to Irving S. Merrell, assignor to the Merrell-Soule Co., covering the invention of an apparatus for treating dried fruit.
In 1890 the partnership acquired the manufacturing rights, on a royalty basis, of an infant food invented by Dr. John A. Just, which was then in the laboratory stage of development. This food was a malt dextrine product, and selling soon proved difficult because it required the addition of fresh milk before feeding to infants, and the latter was not always available in many places. Dr. Just was retained as a consulting chemist to discover some*1778 way to put milk into his infant food.
During the period of Dr. Just's experiments and about 1896, the petitioner, having succeeded in the interim to the partnership business, began the drying of pumpkin for pie-making. The prepared liquid pumpkin was placed in a pan on the underside of a steamheated cylinder and as the cylinder rotated it carried a film of the product upward, where it was scraped off. Dr. Just tried to dry milk with this same apparatus, but it would not adhere to the cylinder. William B. Gere, petitioner's general manager, and Irving S. Merrell, petitioner's mechanical engineer, then developed an improved machine for drying vegetables, particularly pumpkins, between two cylinders placed horizontally and close together. The material to be dried was fed into place above the joint of the two cylinders. A thin film of the material adhered to the surface of the cylinders as the adjacent sides were rotated downward together, and it was completely dried and scraped off as it passed about three-fourths of the rotation. Dr. Just endeavored to dry milk on a smaller machine of the same type, but after the product was subjected to laboratory analysis, he reported that*1779 it was unsatisfactory and not fit for use. Shortly thereafter, Dr. Just left the petitioner's employ, and two or three months later a patent appeared in his name, covering a process for drying milk in this manner. Further experiments were then made by the petitioner with the process patented by Dr. Just, but it was found that the milk was boiled while between the heated cylinders - the albumen and casein *868 were cooked and fat globules ruptured - the product was only soluble in hot water and there was a considerable precipitation when the water cooled.
Further experiments were carried on by the petitioner in search of a process for obtaining a satisfactory dry milk product; many methods were tried, but none proved successful. Finally, Irving and Lewis Merrell, who were in charge of this experimental work, decided that the milk area exposed for drying must be enlarged, and that a small sphere would expose the greatest area in proportion to volume, and this suggested an effort to dry a spray or mist. On Thanksgiving Day, 1904, the Merrells subjected their theories to test. Using an apparatus containing a heated chamber with a large flat pan on the bottom, milk was sprayed*1780 into the warm air of the chamber with a perfumery atomizer. The experiment was believed to be unsuccessful, because no powder could be seen in the bottom of the pan, but when the pan was being washed it was observed that the water took on a faint white shade. The experiment was repeated and about a teaspoonful of white powder obtained. A larger apparatus was then made, a greater quantity of the powder produced, and the powder was sent to Professor George W. Cavanaugh of the chemistry department of Cornell University for analysis.
Professor Cavanaugh was specializing in the chemistry of milk products, but he had never seen milk in powder form before. He tested the powder sent to him by the petitioner for the presence of dry starch, but found none. He then made a number of analyses of the powder and found that when distilled water was added to the powder, in the same proportion in which it existed in the natural milk, there was complete solubility without any precipitation and the reconstructed milk contained all of the constituents, in the same proportions as the natural milk; that though the desiccating process had subjected the milk to heat above the boiling point, no cooking*1781 or curdling of the albumen had taken place, nor was there any separation of the casein by a natural acid which develops in milk under heat; that no change had taken place in the milk sugar, the solubility of the albumen, or in the physical form and quantity of the milk fat; that cream would rise on the reconstituted milk in the same manner and quantity as on the natural milk; that certain enzymes existing in natural milk, and ordinarily destroyed at temperatures of about 175 degrees Fahrenheit, persisted in the reconstituted milk; and that Vitamin "C," present in milk produced from the green pastures of summer, was preserved in the powder and present in the milk reconstituted therefrom iv the winter, although fresh winter milk was deficient in that respect.
*869 Following Professor Cavanaugh's examination and conclusions, a sample of the reconstituted milk was sent to the New York State chemist, who was told that the petitioner had reason to suspect it and that a complete examination and report was desired. The written report of that official stated that the milk submitted was absolutely all right; that he could find nothing wrong with it; and that the petitioner need have*1782 no fear of using it.
The results of the examination of the milk powder by Professor Cavanaugh, and of the examination of the reconstituted milk by the New York State chemist, convinced the petitioner that it had something more than a powdered milk to put into an infant food. The matter was taken up with a patent attorney and a patent application was prepared covering the process. It was during the latter proceeding that discovery was made of the Stauf process patent which described just what the petitioner had been doing.
The Stauf process was an invention of Robert Stauf, a government slaughter house inspector of Posen, Germany. Stauf conceived the idea that if fresh blood could be dried and preserved in its raw state, it would be a wonderful medicinal product - there being in vogue at that time the practice of feeding blood to tubercular people. Stauf applied for a patent for his invention of a "Method of desiccating blood, &c.," on October 3, 1900, and United States Letters Patent No. 666,711 was issued to him on January 29, 1901. Stauf's claim as set forth in the Letters Patent is:
The process of obtaining the solid constituents of liquids such as blood, milk, and*1783 the like, in the form of powder, said process consisting in converting the liquid into a fine spray, bringing such spray or atomized liquid into a regulated current of heated air so that the liquid constituents are completely vaporized, conveying the dry powder into a suitable collecting-space away from the aircurrent, and discharging the air and vapor separately from the dry powder.
On June 15, 1905, the petitioner, acting through Frank and Oscar Soule, purchased the Stauf patent (No. 666,711) for $10,000, and also secured options, which were later exercised, to purchase all of the Stauf foreign patents for $40,000.
The petitioner continued experiments trying to perfect an apparatus to make the Stauf process commercially successful. An experimental plant was built at Fayetteville, N.Y., in the summer of 1905, and during the same season the petitioner dried what now would be considered a comparatively small amount of milk. Another plant was constructed at Arcade, N.Y., early in 1906, solely for the milk powder business. This plant was designed to handle 20,000 quarts of milk a day in eight machines operated under the Stauf patent. The process proved to be very expensive and*1784 commercially unprofitable, because of the high cost of heating the air, which was the evaporating medium for taking the water out of the milk. The *870 required heat ranged from 185 to 300 degrees Fahrenheit; and 150 pounds of coal were required to dry 50 quarts of milk.
With the view to finding some cheaper way of taking out at least a portion of the water without impairing or changing the properties of the several constituents of the milk, further consultations were had with Professor Cavanaugh of Cornell University. There was conceived the idea of concentration of the solids of the milk by evaporation of a portion of the water through a vacuum pan as a preliminary step to the Stauf process. The concentrated milk was not the ordinary condensed milk of commerce, because the latter requires the addition of constituents not contained in natural milk, to make it keep. The addition of this preliminary step to the Stauf process resulted in several improvements; there was a saving in labor; 50 quarts of milk could be dried with 50 pounds of coal; the same weight of product could be packed in 25 per cent less space; and the product was more soluble in water and had a longer*1785 life.
On August 29, 1906, Lewis C. and Irving S. Merrell and William B. Gere applied for patents covering their inventions of a "Process of separating the moisture from the constituent solids of liquids" and of an "Apparatus for recovering the constituent solids of liquids and semi-liquids"; and on July 23, 1907, and August 15, 1911, respectively, United States Letters Patent Nos. 860,929 and 1,000,931, covering said process and apparatus, respectively, were issued to them as assignors to the Merrell-Soule Co.
The claims as set forth in the Merrell-Merrell-Gere process patent (No. 860,929) are:
The process of obtaining the solid constituents of liquids and semi-liquids, in the form of powder, which process consists in concentrating the substance by removing a large percentage of the water therefrom, converting the concengas mass into a fine spray, bringing such spray into a current of dry air or gas having an avidity for moisture so that substantially all the remaining liquid constituents are separated thereby, conveying the dry powder into a suitable collecting space away from the air or gas current, and discharging the air or gas separately from the dry powder.
The process*1786 of obtaining the solid constituents of liquids and semi-liquids, in the form of powder, which process consists in concentrating the substance by removing a large percentage of water therefrom, converting the concentrated mass into a spray, bringing such spray into a current of dry heated air or gas having an avidity for moisture of the substance treated, retaining the moisture momentarily in said current so that substantially all the remaining moisture is converted into vapor and the product is prevented by the cooling effect of such evaporation from undergoing chemical change, conveying the dry powder into a suitable collecting space away from the vaporizing current, and discharging the air or gas separately from the dry powder.
The separation and recovery of the solid constituents of milk by the Merrell-Merrell-Gere process is accomplished in a much more economical manner than by the Stauf process. Skimmed milk is *871 normally about 8 per cent solids, and the preliminary step of concentration according to the Merrell-Merrell-Gere process reduced the water content, so that the milk subjected to the Stauf spray had about 40 per cent solids. In other words, if 100 pounds*1787 of skimmed milk was subjected to the Stauf spray, 92 pounds of water had to be removed through evaporation in the heated chamber, whereas the concentrated milk produced by the Merrell-Merrell-Gere process required the removal of only 60 pounds of water in the heated chamber. This enabled the drying of as much milk in one Merrell-Merrell-Gere apparatus and one Stauf drying apparatus as could be dried in approximately six and one-half Stauf drying units working alone.
The characteristic feature of the Merrell-Merrell-Gere apparatus patent (No. 1,000,931), is embodied in most of the claims, and covers the collection of the milk powder as it is produced. The powder is dried in a current of heated air which passes through a screen to prevent the loss of the dried powder. In order to clean the screen, which becomes clogged up from time to time, without discontinuing operation of the unit, provision is made for a dust collector of at least two chambers which are alternately brought into cooperative action. While one chamber is being used the screen on the other chamber is being cleaned, permitting the continuous operation of the apparatus.
With the acquisition by the petitioner*1788 of the Merrell-Merrell-Gere process and apparatus patents, the petitioner was advised by a qualified patent attorney that ownership of those patents and the Stauf process patent composed a monopoly on the involved processes. Foreign patents were obtained on the Merrell-Merrell-Gere process, and steps were taken toward manufacturing abroad, particularly in England, where actual manufacturing was required to hold patents.
About 1908 the petitioner began to feel the market effect of infringers of its patents. Some thirty infringers were operating and producing approximately one-half as much milk powder as the petitioner. These infringers were known to the petitioner. In 1911 the petitioner brought suit against the Powdered Milk Co. of America for infringement of the Stauf process patent. This suit was brought to trial in 1914, the validity of the Stauf process patent was sustained by the court, and the decision of that court was affirmed upon appeal to the United States Circuit Court of Appeals for the Second Circuit, on March 9, 1915. Between 1919 and 1924 a large number of suits were brought by petitioner against alleged infringers of the Merrell-Merrell-Gere process patent. *1789 Only one of such suits was brought to a final decision - the District Court holding *872 that that patent was so narrow as to be invalid, but that court was reversed on appeal to the United States Circuit Court of Appeals. Subsequent to March 1, 1913, the petitioner collected damages for infringements prior to that date.
On February 11, 1908, United States Letters Patent No. 878,977 was issued to Lewis C. and Irving S. Merrell and William B. Gere, assignors to the Merrell-Soule Co., covering their invention of a "Process for separating the moisture from the constituent solids of milk." This patent is an alternative process to the Merrell-Merrell-Gere process (Patent No. 860,929). In accordance with this patent the liquid to be dried, of which milk is given as one example, is rendered viscous by the addition of some other material, such as flour, sugar, dried milk, or the like, that being referred to as a compatible material in the claims. This patent was one of several which were solicited in order to "close any loop-holes which might have been left in the claims" of the Stauf and Merrell-Merrell-Gere process patents. The process covered by this patent was not used to*1790 any considerable extent prior to March 1, 1913, but it was used more or less successfully after that date in connection with the drying of fruit juices.
In 1908 plans were made for an additional factory at Little Valley, N.Y., which was completed in 1909. The demand for the milk powder grew rapidly, and one year after completing the Little Valley plant the petitioner built another plant at Frewsburg, N.Y.
On May 10, 1906, Paul Bevenot, a citizen of Paris, France, and Edward de Neveu, a citizen of Asnieres, France, applied for a patent covering their invention of a "Desiccating process," and United States Letters Patent No. 1,020,632 was issued to them on March 19, 1912. This patent is characterized by three features. In the first place, the conversion of the milk into a spray is effected by means of hydraulic pressure, that is to say, the milk is subjected to a very high pressure, 150 to 200 atmospheres (approximately 2,250 to 3,000 pounds) being mentioned in the specifications, with the result that the milk is sprayed at a very much greater speed than with the air sprays theretofore employed in connection with the Stauf and Merrell-Merrell-Gere processes.
The second characteristic*1791 of the Bevenot-deNeveu process is that the spray is an exceedingly fine one. The orific through which the milk is forced is very small, about the size of a pin point, so that the milk is ejected in the form of a very fine mist. The result is that there is a much more intimate contact brought about between the liquid and the air with consequent rapied drying, and at the same time the milk solids are brought into a fine condition, approximating that known as homogenizing milk.
*873 The third characteristic of the Bevenot-deNeveu process is that the spray is whirled as it is ejected from the spray nozzles, thus contributing to the distribution of the mist or atomized milk, and thus aiding in bringing it into more intimate contact with the heated air.
Prior to 1909 the petitioner had experimented with the Bevenot-deNeveu process in conjunction with the Stauf and Merrell-Merrell-Gere processes and found two marked results. One was economy in making the spray. It reduced the horsepower necessary to make the spray for one drying unit from about 35 to 3 1/2. The process made possible a better and more even distribution of the fat particles in the spray than had ever been*1792 made with the combined Stauf and Merrell-Merrell-Gere processes. The result was a more even treatment of all of the particles, because particles of the same size and content dry in the same time.
By subjecting milk to certain processes, the already small fat particles may be subdivided into such a fine state that cream will not rise on the milk. This is what is known as homogenization. The advantage of homogenization is that the smaller fat particles are more thoroughly and completely covered and surrounded by the other dry constituents of the milk, affording better protection against rancidity or decomposition when in contact with the air. The Stauf and Merrell-Merrell-Gere processes made no change in the constituent parts of the milk; but there was some change in the fat globules when the Bevenot-deNeveu process was added, because a pressure of 150 to 200 atmospheres was used to force the vacuumcondensed milk through the small orific involved in the Bevenot-deNeveu process. While that process, when applied to natural milk, did not completely homogenize the product, when joined with the Stauf and Merrell-Merrell-Gere processes employing a preconcentrated milk, it did split*1793 some of the fat globules into smaller particles which still retained their spherical condition, and a product of better keeping properties resulted.
The success of the experiments with the Bevenot-deNeveu process led to the formation of a company known as Trufood, Limited, of London, which took over petitioner's foreign patents and the rights of Bevenot and deNeveu in their then pending patent application, and the United States rights in the latter were turned over to the petitioner. The patent, as previously stated, was issued to Bevenot and deNeveu on March 19, 1912, and by them, assigned to the petitioner on April 26, 1912.
On February 12, 1907, United States Letters Patent No. 843,938 was issued to Adolf Glas, of Berlin, Germany, covering his invention of the "Manufacture of milk-powder." This is a patent on the milk powder itself rather than on the method of making it, although *874 the patent described both the method and the powder. It would homogenize the milk as a preliminary step, by breaking up the butterfat into very fine particles, commingled with the other solids of the milk. Then, having thus homogenized the milk, it is subjected to the spraying or drying*1794 process so as to reduce the homogenized milk to the powdered form. The first claim is directed to the method, consisting of those steps of first homogenizing and then converting into a dry powder, and the second claim is the milk powder produced in this way. When the Stauf, Merrell-Merrell-Gere and Bevenot-deNeveu processes were combined, the petitioner observed that it accomplished in a large degree what Glas claimed, although not in the same manner; and to avoid any trouble through possible infringement of the Glas patent, the petitioner acquired that patent on January 5, 1912.
After the purchase of the Glas patent, the petitioner's process was a combination of the Stauf patent, by drying milk in a regulated current of heated air, of the Merrell-Merrell-Gere patent, by first preconcentrating the milk before drying, of the Bevenot-deNeveu patent, by injecting the milk into the heated-air chamber under pressure, and of the Glas patent, by producing a milk powder in which the fat globules had been more or less homogenized; and that was the process employed on March 1, 1913, and as long thereafter as they were in business.
On April 12, 1910, United States Letters Patent No. 954,451*1795 was issued to Irving S. Merrell, assignor to the Merrell-Soule Co. This patent covers a desiccating apparatus for converting liquids, such as milk and other liquids containing a large amount of moisture, into powder, and contains inventions embodied in the drying machinery used by the petitioner.
On February 28, 1911, United States Letters Patent No. 985,271 was issued to Lewis C. Merrell, assignor to the Merrell-Soule Co. This patent is directed to a whey powder, both of the claims being directed to the powder itself, which is produced with the method of the Stauf patent.
On February 28, 1911, United States Letters Patent No. 985,747 was issued to Irving S. Merrell, assignor to the Merrell-Soule Co. This is an apparatus patent dealing with the milk powder collector used prior to March 1, 1913.
On August 15, 1911, United States Letters Patent No. 1,000,686 was issued to Lewis C. Merrell, assignor to the Merrell-Soule Co. This patent is for the production of an acid milk powder, and the three claims of the patent are directed to this powder. Claim No. 1 is directed to a milk powder containing lactic acid and so soluble in water as to approximate the original acid liquid*1796 milk. The next *875 claim specifies the percentage of lactic acid, and the next is for an acid milk powder wholly soluble in water. The patent contemplates producing the acid milk powder by subjecting the natural milk to the Stauf process.
On December 24, 1912, United States Letters Patent No. 1,048,463 was issued to Lewis C. and Irving S. Merrell, assignors to the Merrell-Soule Co. This patent calls for the reduction of the moisture content of the liquid in a vacuum and the drying of the product by forcing between two rotating heated cylinders, and involves the preconcentrated process employed in the Merrell-Merrell-Gere process patent.
The petitioner's policy with relation to patent protection was directed toward two cooperative results, the "hedging" of its inventions through the purchase of all patents that would close loopholes which might have been left in the claims on patents already owned, and the patenting of all essential apparatus and equipment as soon as it was perfected.
The milk powder manufactured by the petitioner on March 1, 1913, by the use of the Stauf, Merrell-Merrell-Gere, Bevenot-deNeveu, and Glas processes, and by the use of the Merrell-Merrell-Gere*1797 apparatus, was a new product resulting from a new process, which had been originated in 1904. When water was added to the powder produced by these combined processes, the resulting milk had all of the meritorious qualities of the original milk. It was and is the only processed milk which will answer to that specification. Compared with different forms of condensed or evaporated milk, powdered milk stored in less space, kept better than either of the others, and was much easier to handle in a bakery or manufacturing plant. It could be dissolved or mixed directly with other dry ingredients, and water put in where milk was called for. It would not adhere to utensils, and the flavor and resulting product was better. Depending upon certain conditions of season, the whole milk powder produced by the petitioner would keep from two to six months without deterioration, whereas skim milk powder could be stored for approximately a year.
At March, 1, 1913, the petitioner was producing, by the combined Stauf, Merrell-Merrell-Gere, Bevenot-deNeveu, and Glas processes, powder from cream, whole milk, skim milk, half and whole skimmed, and from any combination thereof, accordingly as wanted*1798 by the trade. Powdered whey was produced for food in special formulae for hospitals and for infant feeding.
Petitioner's first market was for skim milk powder. The development of the demand for whole milk powder was slower than for skim milk powder. The production of skim milk powder made it necessary to purchase whole milk and dispose of the cream as butterfat, *876 because skim milk could not be purchased in sufficient quantity or quality to warrant operating a powder plant for it alone. Petitioner's cream and butter business was the development of a byproduct. It was never the primary business, but was always secondary and was engaged in only because it was a necessary by-product in the operation of the powdered milk plants.
Prior to 1913 the petitioner's milk powders were tested at Johns Hopkins University, and were found to meet all of the required tests of a satisfactory food for infant and convalescent adult feeding. As a result of the recommendations of Dr. McCullough of that institution, such powders were largely used in hospitals and public institutions, and by the State institutions of Massachusetts for their regular milk supply.
On March 1, 1913, petitioner's*1799 milk powder was used extensively in the baking industry. It was also used in the manufacture of ice cream and confectionery. It was looked to in domestic use, including uses in the Army and Navy, on shipboard, in ocean travel, and particularly in parts of the world where the milk supply was short or inadequate - as in the southern States of this country and in the tropics - as a supplement to or substitute for liquid milk. On the world cruise of the United States Naval Fleet, large supplies of powdered milk and eggs were carried as substitutes for the fresh products. During periods of milk shortage, there were sales of milk powder to milk distributors, and this powder was dissolved and mixed with other fresh bottled milk for delivery to customers of such distributors. During a milk shortage in Detroit, Mich., the petitioner shipped 2,000 pounds of milk powder a day, which was dissolved and mingled with the regular fresh milk supply. The dry product was frequently sold back to farmers for feeding their young calves. Sales were also made to manufacturers of poultry feed as a constituent to be mixed in poultry rations.
Prior to 1913 it was apparent that the petitioner's processes*1800 and devices could be applied to many things besides milk. Experiments were made with powdered fruit juices and eggs. Powders were made from raspberries, strawberries, bananas, pineapples, etc., which retained the natural flavor and color and could not be distinguished from raw fruit juices. In 1910 the petitioner constructed a large plant at Des Moines, Iowa, where it produced considerable quantities of powdered eggs. After 1913 the petitioner's processes were used for the production of powdered eggs in China, where there is no patent protection and eggs are cheaper than in any other market, and the petitioner being unable to meet with competition from that source discontinued its operations at Des Moines.
The production of petitioner's plants was not sufficient to meet the growing demand for its products, and the petitioner found it *877 necessary to purchase milk powder from the factory operated at Wrenbury, England. Later, but before March 1, 1913, the petitioner imported milk powder produced in Australia under its processes, to supply the increasing demand in this country. The powder was in first-class condition upon arrival in this country. The packages were different*1801 from petitioner's and the contents were repackaged in this country.
The petitioner's sales and net profits for 1906 to 1912, inclusive, were as follows:
| Year | Pounds of powder sold | Powdered food products | |||
| Skim powder | Other powder | Total | Sales | Net profits | |
| 1906 | 390,500 | $48,421.42 | 1 $19,066.87 | ||
| 1907 | 1,305,550 | 155,125.94 | 19,643.31 | ||
| 1908 | 1,517,368 | 224,776.40 | 40,359.78 | ||
| 1909 | 1,623,738 | 528,293 | 2,152,031 | 362,731.37 | 19,162.24 |
| 1910 | 2,023,209 | 352,939 | 2,376.148 | 406,993.90 | 81,171.82 |
| 1911 | 3,046,363 | 439,049 | 3,485,311 | 535,082.67 | 101,458.17 |
| 1912 | 4,841,766 | 835,404 | 5,677,170 | 784,924.23 | 88,196.09 |
| Year | Powder-plant by-products | Total powdered food products and powder-plant | ||
| Sales | Net profits | Sales | by- products Net profits | |
| 1906 | $71,464.24 | 1 $4,196.02 | $119,885.66 | n1 $23,262.89 |
| 1907 | 229,829.23 | 1 10,500.40 | 384,955.17 | 9,142.91 |
| 1908 | 324,431.53 | 9,832.55 | 549,207.93 | 50,192.33 |
| 1909 | 298,250.24 | 9,788.02 | 660,981.61 | 28,950.26 |
| 1910 | 808,611.65 | 14,941.06 | 1,215,605.55 | 96,112.88 |
| 1911 | 704,177.66 | 11,687.91 | 1,239,260.33 | 113,146.08 |
| 1912 | 708,442.24 | 26,835.47 | 1,493,366.47 | 115,031.56 |
| Year | Other food products | Miscellaneous | ||
| Sales | Net profits | Income | Total net profits | |
| 1906 | $874,139.96 | $108,570.43 | $1,521.51 | $86,829.05 |
| 1907 | 736,529.85 | 29,092.39 | 199.69 | 38,434.99 |
| 1908 | 727,613.93 | 72,142.18 | 1 754.49 | 120,938.02 |
| 1909 | 845,380.26 | 132,302.72 | 1 6,909.86 | 154,343.12 |
| 1910 | 764,023.49 | 45,339.19 | 1 7,522.47 | 133,929.60 |
| 1911 | 840,047.48 | 53,099.98 | 16,088.61 | 182,334.67 |
| 1912 | 827,844.20 | 50,230.63 | 1 2,308.84 | 162,953.35 |
The petitioner's first milk powder plant, erected at Arcade, N.Y., in 1906, was of frame construction, but the later plants were of permanent hollow tile construction, with concrete floors and side walls. On March 1, 1913, the petitioner owned and operated plants at Arcade, Frewsburg, and Little Valley, N.Y., and one was under construction at Union City, Pa. During the years prior to 1913 the petitioner made unusual replacements in the equipment used in the various powdered milk plants, and suffered unusual losses *878 through depreciation and repairs, due to experimental and development work. The following statement shows, for the years 1907 to 1912, inclusive, the petitioner's*1803 investment in patented desiccating process plants at the beginning of each year, and the amount charged to profit and loss, in each year, for depreciation and repairs:
| Year | Investment | Repairs and | Percentage |
| depreciation | |||
| 1907 | $73,195.46 | $17,533.40 | 23.95 |
| 1908 | 107,946.78 | 22,351.47 | 20.71 |
| 1909 | 112,517.07 | 33,406.39 | 29.69 |
| 1910 | 179,707.47 | 35,844.77 | 19.95 |
| 1911 | 260,881.06 | 68,409.46 | 26.22 |
| 1912 | 288,827.54 | 60,000.96 | 20.77 |
The net working assets employed in the business, at the beginning of each of the years 1907 to 1912, inclusive, were as follows:
| 1907 | $170,866.63 |
| 1908 | 133,562.86 |
| 1909 | 197,988.89 |
| 1910 | $322,593.92 |
| 1911 | 391,139.14 |
| 1912 | 423,051.18 |
The petitioner's net tangible assets, exclusive of patents and other intangibles, at the beginning of each of the years 1907 to 1912, inclusive, were as follows:
| 1907 | $470,036.93 |
| 1908 | 468,592.26 |
| 1909 | 1 782,771.14 |
| 1910 | 2 $986,501.84 |
| 1911 | 2 1,144,625.24 |
| 1912 | 3 1,215,460.35 |
*1804 On March 1, 1913, the petitioner was the owner of the following-described patents:
| Patent No. | Description | Date of issue |
| Powdered Milk Group | ||
| 666,711 | Stauf milk powder process | Jan. 29, 1901 |
| 843,938 | Glas milk powder process | Feb. 12, 1907 |
| 860,929 | Merrell-Merrell-Gere milk powder process | July 23, 1907 |
| 878,977 | Merrell-Merrell-Gere milk powder process | Feb. 11, 1908 |
| 954,451 | Improvements in desiccating apparatus | Apr. 12, 1910 |
| 985,271 | Process for manufacturing powdered whey | Feb. 28, 1911 |
| 985,747 | Improvements in desiccating apparatus | Do. |
| 1,000,686 | Process for manufacturing acid milk powder | Aug. 15, 1911 |
| 1,000,931 | Merrell-Merrell-Gere desiccating apparatus | Do. |
| 1,020,632 | Bevenot-deNeveu desiccating process | Mar. 19, 1912 |
| 1,048,463 | Preconcentrated milk dried between rollers | Dec. 24, 1912 |
| Miscellaneous Group | ||
| 625,880 | Soup powder process | May 30, 1899 |
| 664,458 | Paper box machine | Dec. 25, 1900 |
| 665,323 | Vegetable soup powder process | Jan. 1, 1901 |
| 727,173 | Advertising mask | May 5, 1903 |
| 749,211 | Soldering machine | Jan. 12, 1904 |
| 751,714 | Machine to close ends of paper boxes | Feb. 9, 1904 |
| 823,477 | Conveyor system | June 12, 1906 |
| 856,356 | Pea separator | June 11, 1907 |
| 856,894 | Corn silking machine | Do. |
| 875,092 | Can marking machine | Dec. 31, 1907 |
| 969,969 | Treating dried fruit | Sept. 13, 1910 |
*1805 *879 During the month of July 1913, the following correspondence, omitting salutations, closings, etc., took place between Frank C. Soule, president of petitioner, and F. S. Taylor, president of the Borden Condensed Milk Co.:
Taylor to Soule on July 8, 1913:
Herewith find the third copy of the paper which Mr. Nichols inadvertently put in his pocket, not knowing that you wanted it returned.
Regarding the matter, would say that the subject has been very carefully considered by our Board of Directors, today, and a full discussion of the situation confirms the decision given by our informal committee in meeting with yourself and associates last Wednesday; the Board also considering that the proposition last submitted by us through Mr. Milburn and the writer at that time, which yourself and associates did not feel could be accepted, was as liberal as circumstances warranted.
We regret exceedingly that we are so far apart as to be unable to agree, therefore, under the circumstances, there seems apparently nothing to do but to drop the subject from further consideration, which we do with regret.
We appreciate very much the spirit which has been exhibited on your side*1806 during the whole discussion, but realize that our view points would naturally be different as to certain fundamental matters.
Soule to Taylor on July 10, 1913:
I am in receipt of your letter of July 9th.
Since the first proposition presented by you was somewhat modified during our interview, I wish you would let me know whether I am not correct in stating it as follows:
That you would pay us $1,500,000, $1,000,000 thereof in cash and $500,000 in a series of five notes, $100,000 maturing annually, with five per cent interest payable semi-annually; that you would also furnish $1,000,000 of new capital to the Company which it is proposed to organize to take over our powdered milk business; that $500,000 of the $1,000,000 new capital be used in purchasing our powdered milk plants, and that the new company should also purchase our merchandise on hand at inventory value; that we should also receive as part of the purchase price one-half of the net profits of the business above $150,000 for a period of five years.
If I am correct in this understanding, I think that possibly with some modifications as to the length of time in which we would participate in the profits, say ten*1807 years, some agreement satisfactory to both parties might be worked out.
Taylor to Soule on July 11, 1913:
Replying to your letter of July 10th I would say that you correctly state the plan we suggested at our recent interview, except that it was our intention that the payment of $1,500,000 to you should include your entire milk powder business, plants, trading assets, goodwill, etc. In the light of your letter, however, I would say that I believe our Board would be willing to consider again the plan we suggested even though it had to be modified, in an attempt to meet your views, to the extent of requiring us to pay an additional amount for your working and trading assets over and above the $1,500,000, and to the further extent of extending the period in which you would participate in the profits, as indicated in your letter. If your thoughts are along these lines, it might *880 well be worth while for you to suggest such a plan and I shall promptly bring the matter to the Board's attention.
P. S. As one of the important members of the Committee sails for Europe on Tuesday, would appreciate your reply by Monday if practicable.
In its capital-stock-tax returns for*1808 the years 1917 to 1925, inclusive, the petitioner stated the fair values of its patents to be as follows:
| 1917 | $55,000.00 |
| 1918 | 39,651.48 |
| 1919 | 48,817.06 |
| 1920 | 113,172.40 |
| 1921 | 116,169.15 |
| 1922 | $112,542.03 |
| 1923 | 107,192.44 |
| 1924 | Not stated |
| 1925 | 69,286.54 |
No deduction was claimed by the petitioner in its income-tax returns for 1920, 1921, and 1922, for exhaustion of patents. In its income-tax returns for the years 1923 to 1927, inclusive, petitioner claimed deductions for exhaustion of patents, based upon the March 1, 1913, value. In each of said returns, it was alleged that the patents had a fair market value at March 1, 1913, of $1,269,408.80 in excess of cost. The book values of patents at the close of each of the years 1923 to 1927, inclusive, as disclosed by balance sheets attached to the income-tax returns for said years, were as follows:
| 1923 | $55,747.92 |
| 1924 | 55,782.75 |
| 1925 | 58,698.76 |
| 1926 | 56,868.55 |
| 1927 | 50,129.53 |
The respondent has held that the March 1, 1913, value of the 22 patents owned by the petitioner was $436,396.87, and has allowed deductions from income for exhaustion of said patents based upon that value and a*1809 remaining average life of 11.0095 years from March 1, 1913.
The fair market value as of March 1, 1913, of the 22 patents owned by the petitioner was $1,750,000. The average remaining life of these patents at March 1, 1913, was 11.0095 years.
OPINION.
ARUNDELL: In view of the respondent's admission of the errors charged in the second and third issues, the petitioner's tax liability and the deficiency, if any, for 1920, should be redetermined upon the basis of the calendar year 1920, and the net income determined upon the respondent for 1923, should be reduced by $15,423.47 on account of New York State franchise taxes.
The lone issue remaining for decision by the Board is the March 1, 1913, value of 22 patents, as the basis for the computation of the annual deductions for exhaustion. There is no dispute as to the *881 average remaining life of these patents from the basic date; the respondent determined that to be 11.0095 years, and that is not contested by the petitioner. The respondent determined the fair market value of the patents, as of the basic date, to be $436,396.87. The petitioner contends that their fair market value was not less than $4,100,000.
*1810 The 22 patents owned by this petitioner on March 1, 1913, have been divided for convenience into two groups. The 11 patents comprising the "Milk Powder Group" are regarded by the petitioner as of the greater importance and value to its business. It is with this group of patents that the great mass of evidence is chiefly concerned. The 11 patents comprising the "Miscellaneous Group" have been given but scant consideration by the petitioner in the presentation of its case.
Besides the great amount of testimony, the evidence includes more than 100 exhibits of historical matter, graphs, ledger accounts, statistical data, and tax returns. On the whole, the evidence relating to the patents comprising the "Milk Powder Group" covers in a broad and comprehensive fashion the state of the art of reducing milk to a dried form and the improvements effected by the inventions covered by petitioner's patents; the security and comprehensiveness of the patent protection; the economic advantages resulting from the patented inventions; the superiority of the product obtained by the use of the patents; the growth of the patent-protected business to the basic date; and the future prospects which*1811 on the basic date might have been reasonably anticipated. All of these are covered in much detail in the findings of fact, and we shall not burden the opinion by their repetition. There is also in the record the testimony of persons having intimate knowledge of the patented inventions and in intimate contact with the patent-protected business; evidence as to negotiations carried on by the petitioner with a prospective purchaser of the petitioner's milk powder business; and expert testimony as to the value of the patents at the basic date. To attempt an analytical discussion of all of this evidence and to balance the weight to be given to the testimony of the several witnesses would carry this opinion far beyond the bounds of reasonable limitations and add but little to the certainty of its conclusion.
It has long been recognized that questions of value and estimates thereof involve matters of opinion upon which minds are prone to differ. An opinion as to value is generally based upon a prior determination of extrinsic facts. Disagreement as to these facts often results in difference of opinion as to value. Common experience indicates that agreement upon these extrinsic facts*1812 offers no assurance of agreement upon the ultimate question of value. The difficulties inherent in the problem are increased when an attempt *882 is made to determine values as of a distant date, either past or future. The case at bar clearly demonstrates the truth of these things. Confronted with the same identical facts as to conditions existing at March 1, 1913, - the state of the art, the improvements effected by the inventions, the security and comprehensiveness of the patent protection, the economic advantages resulting from the patented inventions, the superiority of the product obtained by use of the patents, and the growth of the patent-protected business to the basic date - the opinions of the two groups of witnesses, as to the fair value of the patents at the basic date, are so substantially different as to seem wholly irreconcilable. An appreciation of the difficulty of reconciling the differing values of the witnesses may be indicated by stating that Donahoe and Dyer, who testified for the respondent, fixed the value of the patents as of March 1, 1913, at $260,000 and $200,000, respectively, while the four witnesses called by the petitioner valued the patents*1813 as of the same date at $3,500,000 to $4,000,000. Three of the witnesses called by the petitioner had spent their entire business lives in the development of the petitioner's patents and the business accruing from operations under protection of those patents; the fourth is an engineer and practicing patent attorney with a wide and varied experience in the valuation of patents. The witness Dyer, called by the respondent, is a patent expert of extensive experience in the valuation, purchase and sale of patents; while Donahoe, also called by the respondent, is an engineer with a large experience in the valuation of real and personal property. All of these witnesses are intelligent men of affairs, possessing such qualifications as to entitle their opinions to great weight and respect. We believe that they are honest in their convictions, and that each endeavored to give the Board a frank and sincere analysis of conditions existing at the basic date, as they observed them, and of the premises upon which they based their conclusions.
Nor has the problem been made easier by the inconsistent statements of the petitioner, made under oath in its tax returns. The highest patent value returned*1814 by the petitioner for the purpose of the capital stock tax was $116,169.15 in the return for 1921. In the capital stock tax return for 1917, filed four years after the basic date, the patent value returned was but $55,000. In the capital-stock-tax returns for 1923 and 1925, the patent values returned were $107,192.44 and $69,286.54, respectively; while in its income tax returns for the same years the petitioner claimed a March 1, 1913, patent value, as the basis for the deduction claimed for exhaustion of patents, of $1,269,408.80 in excess of cost. If the book value of patents, as disclosed by the balance sheets for 1923 and 1925, correctly reflects the cost of the patents, the highest March 1, 1913, patent value was claimed in the return for 1925, and amounts to $1,328,107.56. As *883 late as 1928, a year and a half before this proceeding was heard, the petitioner claimed a March 1, 1913, patent value of $1,319,538.33 in its income-tax return for 1927. The petitioner must find it difficult to explain this discrepancy between the March 1, 1913, value of its patents, as disclosed by the income tax returns, on the one hand, and the capital stock tax returns on the other. *1815 There is no explanation in the record and it is doubtful that a satisfactory one may be found, in the light of the testimony of one of the petitioner's chief witnesses to the effect that one-half of the consideration received by the petitioner in 1928, upon the sale of its business and assets to the Borden Co. was for intangibles, and that the whole consideration was 54,000 shares of the capital stock of the Borden Co., which shares, at the date of the transfer, had a fair market value of $159 per share. All of these returns, both capital stock tax and income tax, were executed under oath by two officers who, as witnesses in this proceeding, testified that the March 1, 1913, value of the petitioner's patents was at least $3,500,000 and $3,600,000, respectively. To say the least, these facts cast some shadow of doubt upon the judgment of these two witnesses as to the value of the patents at the basic date.
On March 1, 1913, we find the petitioner reducing milk and other liquids and semiliquids to the form of a dry powder containing all of the constituent solids of the original milk or other liquids in their natural state, and from which the original milk or other liquid could*1816 be reconstituted at will, with all of its original characteristics, by simply mixing the powder with water in proper proportions. At the basic date the pioneering work in this new field, which was actually commenced by Stauf in 1900 in an endeavor to preserve the blood of slaughtered animals for feeding to tuberculars, had been completed, and the uncertainties enveloping the experimental and development work had been left more than four years behind. The addition to the Stauf process in 1907, of the preliminary step of preconcentration of liquids by vacuum in the Merrell-Merrell-Gere process, had converted a basic and practicable, but expensive and unprofitable, method into a commercially profitable and successful process. The addition in 1907, through acquisition of the patent rights, of the Bevenot-deNeveu process of injecting the spray into the heated chamber under hydraulic pressure brought further improvements in the product and substantial economies in manufacture; and additional improvements in the product resulted by the addition of the Glas process of homogenization, in 1912. A substantial market for the patented products had already been developed. From a small beginning*1817 of 390,000 pounds production in 1906, by 1912 the production and sales had risen more than 1,300 per cent. The production and sales for 1908 showed an increase of 16.22 per cent over 1907; for 1909, 41.83 per cent over 1908; for 1910, 10.42 *884 per cent over 1909; for 1911, 46.68 per cent over 1910; and for 1912, 62.89 per cent over 1911. The average annual increase in production and sales of patented products for 1908 to 1912, inclusive, was 37.61 per cent. Three plants were being operated in New York State in the production of the patented products, but these were unable to cope with the increasing demand for these products and the petitioner found it necessary to make importations from England and Australia. The patented products were being used extensively in the baking, confectionery and ice cream industries; they were being furnished to hospitals and State institutions, in various formulae and combinations, in large quantities; they were used by the United States Naval Fleet in its cruise around the world as substitutes for fresh milk; and had been sent into and used in localities when shortages existed in the regular supply of fresh milk. The average book profit*1818 per pound of food products produced, for the period 1908 to 1912, exclusive of profits from sales of by-products, was 2 cents. This the respondent concedes was low, due to excessive charges for depreciation of plant facilities. If the profits were corrected to exclude depreciation charges in excess of 10 per cent of plant investment, a rate which respondent admits to be fair, the average profit amounts to 3 cents per pound. These profits were produced on an average plant investment of 6 cents per pound and an average investment in net working or current assets of 3 cents per pound. While the production for 1912 exceeded that for 1911 by 62.89 per cent and the sales for 1912 were a quarter of a million dollars more than for 1911, there was a recession in net profits for 1912, a fact for which there is no explanation in the record. The average book profit on the production of powdered food products for 1912 was 1.5 cents per pound as compared with 3 cents per pound for 1911; and if the profits are corrected to exclude excessive depreciation charges, the average profit for 1912 is 2 cents as compared with 4 cents for 1911. This recession in profits for 1912, which are not only below*1819 the average profit for 1911 but are also below the average for the five-year period, is a matter which no doubt would have been weighed very seriously by a prospective purchaser of the patents and must be reckoned as an important factor in an attempt to determine the value of the patents at the basic date. Johnson v. United States, 44 Fed.(2d) 244.
However, looking backward from March 1, 1913, it may be fairly said that the history of the business presents a picture of consistent and expanding development, with the dropping off of the profits in 1912 as the only high light to indicate that there was anything sporadic in its nature. With this history back of it, the business might reasonably be expected to grow; its future must be judged *885 in the light of what has transpired in the past. Here is the point where the two groups of witnesses, so to speak, part company. Their opinions as to the future growth of the patent-protected business differ materially and this is their substantial difference which leads to widely separated values of the patents at the basic date.
Dyer's testimony was devoted almost entirely to an attack upon the validity of*1820 the most important patents and it is clear that his opinion of invalidity was the predominating influence in his valuation of the patents. On the other hand, the witness, Frank Soule, standing on the threshold at March 1, 1913, would prophesy that the time was coming "when powdered milk, whole milk, sold in cans, the same as condensed milk is now sold, we will say, but in a larger package, would be the sanitary milk supply of the large cities, like New York, Washington, and other places." All litigation since March 1, 1913, as far as it has gone, has sustained the validity of the petitioner's patents at March 1, 1913, and so Dyer's opinion that they were invalid must fall. It is true that some time after 1913 there was a decision by a United States District Court which was adverse to the petitioner, and though this was reversed on appeal, Dyer points to it as corroborating his view that a question of doubtful validity existed at March 1, 1913. But long before 1913 this petitioner had been advised by one whom the respondent admits to be a highly qualified patent attorney that these patents were valid. We have no reason to believe that the question of doubtful validity would have*1821 been present in the mind of a prospective purchaser of these patents to any greater degree than might be reasonably anticipated in any ordinary case of purchase and sale of patents. Soule's forecast was unquestionably overly optimistic.
Hansen, an expert witness called by the petitioner, estimated, upon the basis of experience prior to the basic date, there would be an annual increase in sales, to and including 1923, equivalent to 35 per cent of the sales of the next preceding year. The production for 1912 is the starting point for his computation. The witness Merrell, also called by the petitioner, is but little more conservative. The average increase in business for the period 1908 to 1912 was 37.61 per cent. Two of the five years in that period show an increase over the preceding year's business of more than 40 per cent and the year 1912 shows an increase of nearly 63 per cent over 1911. But that five-year period was one of rapid development and expansion, such as might be expected of any new business producing a product as satisfactory and meritorious as the petitioner's. Such rapid development and expansion can not reasonably be expected to continue indefinitely; sooner*1822 or later, any healthy business reaches and passes *886 the point of rapid growth incident to its infancy and settles down to a much less substantial but normal growth. Herein lies the fallacy in the estimates of Hansen and Merrell, for they have assumed a future growth, throughout the average life of the patents, approximately equal to the years in which the most rapid expansion would naturally be expected. All things considered, we believe that Oscar Soule and Donahoe, witnesses for the petitioner and the respondent, respectively, just about struck a fair average when they fixed the future growth of the business from March 1, 1913, at an annual increase of 20 per cent. That conclusion of Oscar Soule is based upon almost a lifetime of observation, as a partner in the predecessor partnership and an executive officer of the petitioner, of the development and growth of the business. Certainly, he is in a far better position to pass judgment on the matter than Hansen, who, for all the record shows, never heard of this petitioner or its business until called as a witness in this proceeding.
The testimony of Oscar Soule presents two methods of valuation. The first of these*1823 is based upon an annual increase in production equivalent to 20 per cent of the next preceding year's production, the production for 1912 being used as a starting point, and results in an estimated production to the end of 1923 of 189,614,000 pounds. He estimates the future profits on this production at 2 cents per pound, or a total profit for the eleven years of average patent life of $3,792,280. This estimated profit, he says, justifies a patent valuation, as of the basic date, of $3,500,000. The second method assumes the same rate of growth in production and profits, and results in an estimated profit for 1923, the last whole year of patent life, of $720,000. This estimated profit, Soule points out, represents a return of 10 per cent upon a capital investment of $7,200,000, which, according to "a rule of thumb," should be allocated one-half to tangibles and one-half to intangibles. The trouble with the first method is that it assumes that a prospective purchaser of the patents will pay a price therefor equal to the entire income which he could expect, under the most favorable circumstances, to receive during the remaining life of the patents. It may not be assumed that a prudent*1824 business man will invest his funds in a hazardous proposition, such as patents, without any expectation of a fair return on his investment; and the greater the risks and hazards, the more will he discount the future and pay a price that seemingly assures him against loss while yielding him a fair return. The second method assumes that during the period of patent monopoly, an intangible structure, a sort of going business value or good will, of $3,600,000, will be built up; and that at the end of the patent monopoly, the profits will continue to be substantially the same as for 1923, in perpetuity. Granting the assumptions, which *887 we do not, the whole of the accretion in going business value can not be attributed to the patents or the patent monopoly. On the contrary, much of it will accrue in sheer spite of the patents and may be fairly attributed to capable management and organization to conduct the promotion, exploitation, development and operation of the business, and to the good will of patrons. Of course, the patent monopoly provides the opportunity for building up a value of this sort, and gives the business a great advantage over its competitors when the monopoly*1825 terminates; but the returns which it will yield, and that is the lone basis for the claim of value, will be entirely dependent upon a continuance of capable management and organization and the same business policies conducive to the retention of the good will of its patrons. Returns of this sort can not be attributed to the patents.
The basis for Donahoe's valuation of $260,000 was substantially as follows: He took the production for 1912, which was the highest for any year prior to 1913, determined how much of that was skim milk powder and how much was whole milk powder. He estimated that the maximum royalties which the petitioner might expect to receive under license agreements, though there were no such agreements prior to, or until two years after, March 1, 1913, were 1 cent per pound for skimmed milk and 2 cents per pound for whole milk. Assuming that the estimated royalties represented the maximum profits attributable to the patents, he determined that the 1912 profits directly attributable to patents amounted to $65,000. He assumed an annaul growth in the business equivalent to 20 per cent of the next preceding year's production. He found upon investigation that the*1826 American Brass Co. and the General Electric Co. were enjoying approximately the same rate of growth, about 1913, and that the earnings of those companies represented an average return of 10 per cent on the 1913 market prices of their stocks. He then determined that if 7.4 per cent of the purchase price was set aside each year to accumulate with interest, at the end of the average life of the patents a prospective purchaser would have returned to him his investment. He therefore assumed that the proper rate of capitalization of the future earnings should be 17.4 per cent which, he says, is equivalent to a purchase of 5.74 years earnings; but he reduces the factor to 4, to reflect "the effect the buyer and seller would give to the uncertainties." Multiplying $65,000, the maximum profits which he attributed to patents for 1912, by 4, he concluded that the value of the patents, at the basic date, was $260,000. His valuation is not nearly as complex as his statement of it makes it appear. Strip it of all of its dressing, and you find that after all it amounts to the capitalization, at the rate of 25 per cent of assumed earnings $65of,000 per year, for 10 years, or total earnings of*1827 *888 $650,000. Suffice it to point out, that had Donahoe followed through his own assumed rate of growth of the business and his own assumed profits of 1 cent per pound on skimmed milk and 2 cents per pound on whole milk, he would have arrived at estimated gross earnings from March 1, 1913, to the end of 1923, of approximately $2,750,000, instead of $650,000. We are satisfied that the figure of $2,750,000 more nearly represents the gross earnings which this petitioner might reasonably have anticipated, at March 1, 1913, over the remaining average life of its patents. While we are perfectly willing to believe that a prospective purchaser of these patents, at March 1, 1913, would gladly have taken advantage of any opportunity to purchase them at a price of $260,000, with the prospects that they would yield gross earnings of between $2,500,000 and $3,000,000 over the next 10 years, we are as equally reluctant to believe that the petitioner would have willingly made the sacrifice.
Next, we have for consideration, for whatever light it may throw on the problem, the correspondence between Frank C. Soule, in behalf of the petitioner, and F. S. Taylor, in behalf of the Borden*1828 Condensed Milk Co., which took place in July, 1913, and in which negotiations were carried on with a view to the purchase of petitioner's business, by the Borden Co. The most that can be gathered from this correspondence is that the Borden Co. offered to purchase the petitioner's business, lock, stock and barrel, for $1,500,000 plus one-half of the profits of the business above $150,000 for a period of five years; and a suggestion on the part of Taylor that the board of directors of the Borden Co. might be willing to modify the offer "to the extent of requiring us to pay an additional amount for your working and trading assets over and above the $1,500,000, and to the further extent of extending the period in which you would participate in the profits" from five to ten years. Whether the Borden Co. actually went so far as to modify its first offer to the extent indicated in Taylor's last letter does not appear. Apparently the negotiations ended with Taylor's last letter, for there is nothing further of record until the sale of the business to the Borden Co. 15 years later. There is nothing in the correspondence from which we can deduce that the patents were of the high value claimed*1829 by the petitioner.
In an attempt to support the value of $3,500,000 which he placed upon the petitioner's patents, as of March 1, 1913, one of the witnesses testified that the entire business was sold to Borden Co. in 1928 for 54,000 shares of capital stock, which had a value, at the date of transfer of $159 per share. Aside from the unsupported statement of the witness as to the fair value of the Borden Co. stock, at the date of the transfer, we wish to point out that this transaction took place *889 15 years after the basic date, and at a time when every one of the 22 patents had expired. This transaction can hardly be accepted as throwing any light upon the problem.
Our conclusion, which has been reached only after a careful study and weighing of all of the evidence, is that the March 1, 1913, value of the 22 patents owned by the petitioner on that date was $1,750,000.
This brings us to the consideration of a matter very earnestly pressed upon us by the respondent in the brief. There he contends that the allowance for exhaustion must be computed separately for each patent; and that since the petitioner has not proven the separate value of each patent, so as to*1830 permit the computation in such fashion, the petitioner's case must fail. We can not subscribe to that view. In the deficiency notice, the respondent determined the value of the patents as a group and computed the allowances for exhaustion accordingly. The petitioner accepted that situation. All of the witnesses for the petitioner and the respondent testified to the value of the patents as a group. Aside from these facts, the evidence is clear and unmistakable that it would not only be impossible, but highly improper, to place a separate value on each of the patents comprising the "Powered Milk Group." The important patents in the powdered milk group are the Stauf patent, the Merrell-Merrell-Gere patent, the Bevenot-deNeveu patent, the Glas patent, and the Merrell-Merrell-Gere apparatus patent. The other six patents might be called "hedging" patents, since they were obtained almost solely for the purpose of closing any loopholes which might have been left in the claims of the more important patents. It is doubtful that any one of the five important patents, standing alone, had more than a nominal value. The Stauf patent, which is the basic one, covered a process which proved*1831 to be very expensive and commercially unprofitable. Only the addition to the Stauf process of the preliminary step of preconcentration of liquids by vacuum in the Merrell-Merrell-Gere process, made the Stauf process commercially profitable and successful. The addition of the Bevenot-deNeveu and the Glas processes brought further economies in manufacture and improvements in the product. The witness Brown, called by the petitioner and admitted by the respondent to be a highly qualified patent attorney, testified that the Merrell-Merrell-Gere process patent could not be operated by other than the owner of the Stauf process patent without infringing the latter, and ownership of both patents gave the petitioner a monopoly on the process of spray-drying milk, precondensed by the vacuum process; that the Bevenot-deNeveu process patent invoked a process which could not have been carried to fruition without infringing the Stauf process patent; that the Glas process patent was being infringed, when acquired by the petitioner, by the product at that time produced *890 from whole milk by the combined Stauf, Merrell-Merrell-Gere, and Bevenot-deNeveu processes; and that the Merrell-Merrell-Gere*1832 apparatus patent could not be operated without ownership or infringement of the Merrell-Merrell-Gere process patent. This witness was thoroughly acquainted with petitioner's patents, since he had solicited the Stauf process patent, had prosecuted the United States application for patent on the Bevenot-deNeveu process; and had been associated with the petitioner in all litigation, since 1907 in which the petitioner enjoined and eventually collected damages from infringers of its patents.
All of the patents in the "powdered Milk Group" were interdependent. In the hands of separate owners, they would be of little value. Collectively, under a single ownership, they represent a valuable property right, and it is this right which is being gradually exhausted. Under less compelling circumstances, the Board has not found any obstacle to determining the allowances for exhaustion of patents upon the basis of a group value and the average life of the group. See Union Metal Mfg. Co.,4 B.T.A. 287">4 B.T.A. 287; Owens Bottle Co.,8 B.T.A. 1197">8 B.T.A. 1197; and *1833 Western Wheeled Scraper Co.,14 B.T.A. 496">14 B.T.A. 496.
The petitioner is entitled to annual deductions for exhaustion of its patents based upon a March 1, 1913, value of $1,750,000 and an average life of 11.0095 years.
Judgment will be entered under Rule 50.
Footnotes
1. Loss. ↩
1. Includes an investment of $247,946.55 in Trufood, Limited. ↩
2. Includes investments of $247,946.55 and $10,000 in Trufood, Limited, and Canadian Milk Products, Limited, respectively. ↩
3. Includes investments of $247,946.55 and $11,250 in Trufood, Limited, and Canadian Milk Products, Limited, respectively. ↩