*2842 1. Values of patent and a license agreement determined.
2. Petitioner is entitled to a deduction for exhaustion of the foregoing patent and license agreement computed upon the remaining life thereof when acquired.
3. The petitioner's invested capital for the years in question with respect to the patent and license agreement should be recomputed upon the basis of the values herein determined.
4. Respondent's action in reducing invested capital by the amount of income and profits taxes for preceding taxable years approved under section 1207 of the Revenue Act of 1926.
5. For failure to adduce evidence as to the insufficiency of the rate of depreciation used by the respondent, his rate is approved.
6. Respondent's action in reducing petitioner's invested capital for 1921 by the accrual of the tentative tax in computing earnings available for dividends were erroneous.
*522 These proceedings, which were, upon motion of counsel, consolidated for hearing and decision, are for the redetermination of deficiencies*2843 in income and profits taxes for the calendar years 1919 to 1921 and income taxes for the year 1922, in the following amounts:
| 1919 | $10,980.56 |
| 1920 | 15,270.15 |
| 1921 | 7,111.61 |
| 1922 | 1,921.74 |
The allegations of error upon which the parties have joined issue are:
1. Disallowance of the value of a patent, good will and organization, paid in for stock in the computation of invested capital;
2. Failure on the part of the respondent to allow exhaustion for each of the taxable years in controversy on a certain patent paid in for capital stock of the par value of $200,000, based upon the remaining life of said patent at the date of acquisition;
3. Failure and refusal of the respondent to allow the petitioner to include in the computation of invested capital the value of a license agreement acquired by it from the Aetna Fire Sprinkler Co. for its capital stock, or to allow it to deduct an amount in each of the taxable years for exhaustion thereof;
4. The action of the respondent in reducing invested capital by the amount of income and profits taxes for preceding taxable years;
5. The action of the respondent in computing depreciation upon furniture and fixtures*2844 and factory equipment at a rate of 15 per cent instead of 25 per cent;
6. The action of the respondent in reducing the petitioner's invested capital for 1921 by the accrual of the so-called tentative tax in computing the amount of earnings available for dividends; and in the alternative,
7. Failure and refusal of the respondent to compute petitioner's excess-profits taxes for the years 1918, 1919, and 1921 under the provisions of sections 327 and 328 of the Revenue Acts of 1918 and 1921.
FINDINGS OF FACT.
Petitioner is a corporation organized and incorporated under the laws of the State of Delaware on November 26, 1917, with authorized capital stock of $1,000,000, to acquire the assets of the Aetna Fire Sprinkler Co., Independent Sprinkler Co., and the Allis Fire Extinguisher Co., and to engage thereafter in the manufacture, sale, and erection of fire-protection devices. At the beginning of each of the taxable years here in controversy, the par value of its outstanding capital stock was $1,000,000.
*523 On November 26, 1917, William A. Pope, owning or controlling all of the capital stock of the Aetna Fire Sprinkler Co., an Illinois corporation, entered into an*2845 agreement to transfer to the petitioner certain specified property belonging to him or to the said Aetna Fire Sprinkler Co., agreeing, that he would "cause the said Aetna Fire Sprinkler Company forthwith, upon the execution and delivery of this instrument, to proceed to complete all its contracts in process, collect its accounts and bills receivable, discharge all its obligations, liquidate its affairs, [and] terminate its existence, * * *." The said Pope further agreed to execute and deliver all necessary papers required by the petitioner to carry into effect the intent and purpose of that agreement, to vest in the petitioner all of the property conveyed thereby, "or intended so to be," and that his company would be dissolved forthwith, in consideration of payment by the petitioner to him of $140,000 par value of its capital stock. The property specifically set forth in that agreement consisted of 9,984 Lapham and Niagara heads, 4,188 Grinnell heads, and certain valves, fittings, tank heaters, pipe, tools, and office furniture and fixtures inventoried at $24,736.06, and $5,263.94 in cash, making the total amount of assets received $30,000.
On the same day and date of the agreement*2846 aforesaid, an instrument in writing, purporting to be a receipt, signed by said Pope, acknowledged receipt of 1,400 shares of capital stock of the petitioner, aggregating $140,000 par value, which instrument recited:
The foregoing is intended to cover all of the tangible property of Aetna Fire Sprinkler Company as the same was on October 25th, 1917, together with all contracts for the sale and installation of sprinkler equipment made by said Aetna Fire Sprinkler Company since October 25, 1917, inclusive, together with all moneys due or to become due thereon on such contracts.
Also the good will, trademarks and trade names of the said Aetna Fire Sprinkler Company.
The intangible assets acquired from the Aetna Fire Sprinkler Co. were recorded in the petitioner's books of account as "organization and good will," $110,000, and the remaining sum of $30,000, representing the cost of the tangible assets was charged to the appropriate asset accounts, the value of which has never been disputed. The item of "organization and good will" was not segregated in the books of account.
On November 26, 1917, the petitioner entered into an agreement with the Independent Sprinkler Co., then*2847 engaged in the business of manufacturing and installing fire-extinguishing apparatus, for the acquisition of certain specified property, consisting of $20,442.72 in cash, accounts receivable, investments on contract work, sprinklers, tools, valves, fittings, machinery, and office equipment, in the aggregate *524 inventory sum of $68,460.60, also certain contracts for supplying or installing equipment listed at $63,655, against which there were certain liabilities that were assumed by the petitioner, amounting to $11,135.43. Included in that same agreement were certain Letters Patent No. 1,191,919, to which no specific value was assigned, issued to W. W. Hawkins and John M. Duncan on July 18, 1916, assigned to the Independent Sprinkler Co. April 25, 1916, and transferred to the petitioner on the records of the United States Patent Office on December 12, 1917, covering improvements in the "fusible link." It was agreed that the petitioner pay John M. Duncan the sum of $35,000 for the account of the said Independent Sprinkler Co., said amount to be credited upon the purchase price to be paid by the petitioner under that agreement. The Independent Sprinkler Co. agreed to terminate*2848 its existence under the law and to execute further instruments in order to carry into effect the intent and purpose of that agreement and to invest the petitioner with all the property conveyed by that instrument "or intended so to be" and "including particularly the assignment of patent rights, so that the same may be recorded in the patent office." In addition to the foregoing consideration, the petitioner agreed to pay $350,000 par value of its capital stock.
On the same day and date of the foregoing agreement an instrument was executed by the secretary and treasurer of the Independent Sprinkler Co., acknowledging the receipt of 3,500 shares, par value of the capital stock of the petitioner, and also the receipt of $35,000 for the payment of three notes made by the Independent Sprinkler Co. to the order of John M. Duncan, and endorsed by him without recourse. The president of that company, by an instrument in writing, on the same day aforesaid, ordered the petitioner to issue stock certificates, aggregating 3,500 shares, to the following persons in the amounts set opposite their names:
| Shares | |
| John M. Duncan | 1,739 |
| W. E. Pratt | 700 |
| C. E. Johnson | 350 |
| John W. Huxley, Jr | 711 |
*2849 The assets received by the petitioner under the above mentioned agreement were recorded in the books of account; $200,000 as the cost of Patent No. 1,191,919, $3,000 for a certain leasehold, $81,671.65 as good will, and the remaining sum, or $65,328.35, was attributed to tangible assets and recorded in the appropriate tangible asset accounts, the value of which had never been disputed. Patent No. 1,191,919 was issued July 18, 1916, and on the date acquired by the petitioner had 15 years and almost 8 months to run.
*525 The value of the foregoing patent, when acquired, was $200,000.
On November 26, 1917, the petitioner entered into an agreement with the National Protection Co., a corporation of the State of New Jersey, owning or controlling all of the capital stock and assets of the Allis Fire Extinguisher Co., for the acquisition of those said assets, consisting of patterns and tools, by which instrument it was agreed that the Allis Fire Extinguisher Co. should be liquidated and its existence terminated. In consideration of the sale of those assets to the petitioner, to which no specific values were attached by the vendor, and the issuance by petitioner of $510,000*2850 par value of its capital stock to the National Protection Co., the said company agreed to pay into the treasury of the petitioner the sum of $170,000 in cash, or its equivalent.
On the same day and date of the foregoing agreement the vice president of the National Protection Co. aforesaid requested, by an instrument in writing, that 5,100 shares of capital stock of the petitioner, pursuant to that agreement, be issued to:
| Shares | |
| Francis T. Sargent | 1,250 |
| Edgar W. Shaw | 3,838 |
| Albert E. Maves | 3 |
| William W. Allis | 3 |
| Paul M. Kuder | 3 |
| Roger H. Anderson | 3 |
A receipt was signed by the president of the petitioner as having received the $170,000 provided for in the foregoing agreement and a receipt was also signed by the vice president of the National Protection Co. for the 5,100 shares of capital stock of the petitioner.
Petitioner's books of account record the $170,000 cash received pursuant to the foregoing agreement with the National Protection Co. The assets received in addition to the $170,000 cash, were recorded as "organization and good will," $340,000.
After these transactions the "organization and good will" account in petitioner's books showed*2851 a balance of $566,671.65, made up of the following items:
| Nov. 26, Stockholders Allis F. E. Co | $340,000.00 |
| Nov. 26, Ind. Spr. Co. Loan a/c | 35,000.00 |
| Nov. 26, Stockholders Aetna F. S. Co | 110,000.00 |
| Dec. 31, Stockholders Ind. Spr. Co | 81,671.65 |
Contemporaneously with the execution of the three agreements hereinbefore discussed, on the same day and date thereof, to wit, November 26, 1917, John M. Duncan, being then the record assignee in the United States Patent Office of Letters Patent No. 1,210,757, granted January 2, 1917, covering "improvement in value mechanisms," and No. 1,239,878, granted September 11, 1917, covering "improvement in fusible links," assigned those two letters patent to the petitioner, for which it paid Duncan $70,000 in cash on November *526 26, 1917. This amount was recorded in the books of account as a cash payment for those patents.
Early in 1917, either in the month of March or April, Alfred F. Fritzsche, vice president of the General Fire Extinguisher Co., just prior to petitioner's inception discussed with Duncan the matter of licensing Patents Nos. 1,191,919, 1,210,757, and 1,239,878 to that company, and as a result*2852 of those discussions a license agreement was entered into, terminable at the will of either party at the end of any one year, which provided for the payment of $35,000 per annum by the said General Fire Extinguisher Co. The license agreement was reduced to writing and signed by Duncan for the Independent Sprinkler Co., but was never executed by the General Fire Extinguisher Co. The initial sum of $35,000 was paid by that company, however, pursuant to the existing oral agreement entered into, and the contract remained in force, but the United States entered the World War shortly thereafter and the General Fire Extinguisher Co. was taken over by the Government and nothing further was done with respect to the contract, nor did that company ever operate under the license. The Independent Sprinkler Co. retained the right to manufacture under those patents, otherwise the General Fire Extinguisher Co. had exclusive right to manufacture thereunder. Although there were three patents involved in this license agreement, it was the so-called Hawkins patent, or Patent No. 1,191,919, that the General Fire Extinguisher Co. was vitally interested in.
While competition in the automatic sprinkler*2853 industry was rather keen in 1917, it was limited, and the outlook for the sprinkler industry at the time the company was organized was decidedly good. There were ten approved sprinkler heads on the market in 1917, other than the one covered by petitioner's Patent No. 1,191,919. All of them, however, differed from the petitioner's in their mechanical operations. They were all in the hands of only seven competitors.
The most important considerations entering into the value of a patent covering sprinkler head parts are that they are protected by patent and also that they have been approved and accepted by the Underwriters Laboratories. Where sprinkler heads have been approved by the Underwriters Laboratories, and by the insurance companies, fire insurance premiums are materially reduced and the assured is enabled to purchase larger amounts of fire insurance at reduced cost, due to the safety offered by those devices. If, on the other hand, they have not been approved by the Underwriters, no reduction in rate can be secured. Patent No. 1,191,919, acquired by the petitioner as hereinbefore mentioned, was approved by the Underwriters Laboratories on or about October 17, 1916, and*2854 had such approval on November 26, 1917, when acquired by the petitioner.
*527 The Aetna Fire Sprinkler Co. paid dividends during the period August, 1914, to July, 1917, as follows:
| August, 1914 | $1,500 |
| February, 1915 | 1,800 |
| August, 1916 | 3,000 |
| July, 1917 | 4,500 |
The assets and liabilities of that company as of January 1, 1916, January 1, 1917, and December 31, 1917, were:
| Jan. 1, 1916 | Jan. 1, 1917 | Dec. 31, 1917 | |
| ASSETS | |||
| Cash | $3,583.07 | $16,241.45 | $42,793.60 |
| Accounts and bills receivable | 28,030.33 | 30,848.11 | 25,399.42 |
| Inventory | 12,887.18 | 21,433.82 | 23,896.53 |
| Total assets | 44,500.58 | 68,523.38 | 92,089.55 |
| LIABILITIES | |||
| Accounts payable | 9,889.15 | 15,873.94 | 757.65 |
| Other payables | 371.63 | ||
| Accrued taxes | 98.72 | ||
| Reserves | 3,775.73 | 3,842.00 | 1,260.53 |
| Capital stock | 30,000.00 | 30,000.00 | 30,000.00 |
| Surplus | 736.98 | 18,435.81 | 60,071.37 |
| Total liabilities | 44,500.58 | 68,523.38 | 92,089.55 |
The net income of the Aetna Fire Sprinkler Co. for the year 1916 was $20,698.83 and for 1917, $44,838.43. The earnings prior to 1916 could not be evidenced, because of the loss of the books and records of that company recording its affairs*2855 for the year 1913, the year of its incorporation, and for 1914 and 1915.
William A. Pope, who in 1913 had the right to manufacture a sprinkler head known as the Lapham, entered into an agreement on May 6, 1913, with the Ohio Automatic Sprinkler Co., which provided that Pope execute a license to that company to manufacture and sell the Lapham sprinkler head and that the said sprinkler company should manufacture and keep on hand sufficient sprinkler heads until April 30, 1927, to fill promptly, and at all times, the orders which Pope might place with it, Pope agreeing to purchase not less than 5,000 and not more than 50,000 sprinkler heads a year, to be used in his business of installing sprinkler systems. The pertinent provisions of that agreement, which mentions the Ohio Automatic Sprinkler Co. as party of the first part and Pope as party of the second part, are as follows:
FOURTH: The price at which the party of the first part shall sell said sprinkler heads, whether the Lapham or any other kind, and the price which the party of the second part shall pay for the sprinkler heads ordered and delivered, shall be thirty-two and one-half (32 1/2) cents each, properly packed, boxed*2856 and loaded for *528 shipment f.o.b. cars Youngstown, Ohio; terms sixty (60) days from date of bill of lading unless other terms are hereafter agreed upon from time to time; but it is expressly agreed that said price for each sprinkler head is based upon the present market price of copper, which is now fifteen and one-half (15 1/2) cents per pound, New York; and should the market price of copper at New York advance or decline during the term of this contract, then the price of said sprinkler heads, shall, upon the request of either party, at intervals of not less than six months, be increased or decreased for any succeeding six months (but not for any preceding period) equally with such decline or advance in the market price of copper at New York.
FIFTH: It is further agreed between the parties hereto that the party of the first part shall and will, during said terms of this contract, sell and deliver to the party of the second part all the valves hereinafter in this Article described that the latter may require and order in connection with said business of the party of the second part, and for use in his own works as hereinafter limited, and the latter shall and will during*2857 said term buy all such valves required in said business from the party of the first part; and that the valves hereinafter in this Article described ordered by and delivered to the party of the second part are to be sold by the party of the first part and paid for by the party of the second part at the prices set opposite the same, subject always, however, to the provisions in Article Seventh hereof,
| For each 6" automatic wet alarm check valve | $34.00 |
| For each 5" automatic wet alarm check valve | 30.45 |
| For each 4" automatic wet alarm check valve | 26.25 |
| For each 6" automatic dry pipe valve complete with trimmings | 125.00 |
| For each 5" automatic dry pipe valve complete with trimmings | 115.00 |
| For each 4" automatic dry pipe valve complete with trimmings | 100.00 |
all packed, boxed and loaded for shipment f.o.b. cars Youngstown, Ohio; Terms, sixty (60) days from date of Bill of Lading unless other terms are hereafter agreed upon from time to time.
* * *
SEVENTH: It is further agreed that the prices on valves and automatic sprinkler heads are based on those manufactured by the party of the first part and approved by the Insurance Companies as of the date of the signing*2858 of this contract, and should the Laboratories or Insurance Companies demand any change in design, workmanship or material, which will increase or decrease the cost of producing the said valves or automatic sprinkler heads, then it is agreed that the prices shall be increased or decreased accordingly.
EIGHTH: It is further understood and agreed by and between the parties hereto that if for any reason the party of the second part shall deem it necessary or proper to install at any time and from time to time sprinkler heads that are approved by the Associated Factory Mutual Fire Insurance Companies of New England or any other insurance companies which do not approve the Lapham Sprinkler, that in every such case the party of the first part, subject to the limitation as to quantity hereinbefore mentioned, will furnish and deliver to the party of the second part, at and for the prices and upon the terms herein stated, other sprinkler heads, provided, always, that in every such case the sprinkler heads so sold and delivered by the party of the first part and purchased by the party of the second part shall be of a type which the party of *529 the first part is supplying or manufacturing*2859 for the Automatic Sprinkler Company of America.
ELEVENTH: It is expressly understood and agreed that the party of the second part may, at any time during the year 1913, assign this contract and all his right, title and interest therein and thereunder to a corporation now or hereafter organized under the laws of Illinois, satisfactory to the party of the first part, and upon such assignment to a corporation, which shall in writing assume and agree to be bound by all of the said covenants and agreements of said William A. Pope in this agreement, then such corporation shall immediately thereupon succeed to and then and thereafter have all of the rights of said William A. Pope in and under said agreement, and said corporation shall thereafter be the party of the second part therein and thereby, and the said William A. Pope shall ipso facto, upon making said assignment, forthwith and thereafter be released and forever discharged of and from the said agreement, and of and from all liabilities and obligations of any and every kind arising therefrom, but otherwise this agreement shall not be further assignable or transferable on the part of the party of the second part or the aforesaid*2860 corporation assignee except with the consent in writing first had and obtained of the party of the first part.
By communication dated April 29, 1913, from the Ohio Automatic Sprinkler Co. to Pope, that company expressly acknowledged the Aetna Fire Sprinkler Co. as the assignee of the agreement aforesaid entered into between those parties. Thereafter, to wit, on November 26, 1917, when the petitioner acquired the assets of the Aetna Fire Sprinkler Co., it succeeded to the rights of that company under the agreement dated May 6, 1913, and on January 22, 1918, the Ohio Automatic Sprinkler Co. expressly acknowledged the petitioner as the assignee and, as such, entitled to all of the benefits and rights arising thereunder. Petitioner operated under the foregoing agreement during the years 1918 to 1922, inclusive. The communication from the Ohio Automatic Sprinkler Co., dated January 22, 1918, acknowledging the petitioner as assignee, was dated subsequently to the actual transfer of the agreement to the petitioner and was for the purpose of filling out the technical requirements of the agreement.
The value of the foregoing contract at the date of acquisition was $50,000.
The open*2861 market prices of the products covered by the contract aforesaid, that is, the contract of May 6, 1913, with the Ohio Automatic Sprinkler Co., were considerably higher than the contract prices.
Petitioner's balance sheet as of January 1, 1918, exclusive of patents, leaseholds, organization and good will here in controversy, is as follows:
| Assets | |
| Cash | $97,027.71 |
| Contracts in process | 9,432.44 |
| Accounts receivable | 19,714.45 |
| Office furniture and fixtures | 625.00 |
| Factory and office equipment | 8,180.92 |
| Office supplies | 150.00 |
| Organization and good will | 35,000.00 |
| Patents acquired for cash | 70,000.00 |
| Road tools | 6,317.63 |
| Sprinkler products finished and in process | 12,002.27 |
| Warehouse stock, Philadelphia | 2,215.45 |
| Warehouse stock, Chicago | 20,211.06 |
| Total | 280,876.93 |
| Liabilities | |
| Capital stock | $1,000,000.00 |
| Advance payments against contracts | 2,466.66 |
| Accounts payable | 10,600.62 |
| Reserved for loss on contracts | 2,481.30 |
| Deficit | 734,671.65 |
| Total | 280,876.93 |
*530 Net earnings according to petitioner's books before depreciation of the patents in issue are as follows:
| 1919 | $77,029.47 |
| 1920 | 100,014.57 |
| 1921 | 62,903.00 |
| 1922 | 48,315.76 |
*2862 The following are petitioner's balance sheets for the four full years beginning with December 31, 1918, which do not include the intangible assets here in controversy:
| Dec. 31, 1918 | Dec. 31, 1919 | Dec. 31, 1920 | Dec. 31, 1921 | Dec. 31, 1922 | |
| ASSETS | |||||
| Cash | $108,167.64 | $102,460.09 | $114,030.52 | $150,067.48 | $102,181.84 |
| 4th Lib. bond | 10,000.00 | 10,000.00 | 10,000.00 | ||
| U.S. Treas. Cert | 65,000.00 | 85,000.00 | |||
| Accounts receivable | 57,723.49 | 123,346.25 | 159.955.03 | 62,964.18 | 66,299.53 |
| Notes receivable | 14,304.10 | 53,514.64 | 21,275.87 | ||
| Work in process | 102,651.86 | 300,783.17 | 1,802.92 | ||
| Contracts in process | 126,982.80 | 122,172.54 | |||
| Inventories | 50,808.45 | 44,788.84 | 72,990.46 | 39,578.85 | |
| Advances | 1,210.24 | 978.81 | 580.20 | ||
| Miscellaneous investments | 794.44 | 751.89 | |||
| Suspense | 88.74 | ||||
| Furniture and fixtures | 1,665.51 | 2,218.75 | 3,742.27 | 4,132.98 | 4,529.09 |
| Factory equipment | 7,035.70 | 7,948.66 | 8,674.16 | 8,780.12 | 8,915.12 |
| Org. and good will | 35,000.00 | 35,000.00 | 35,000.00 | 35,000.00 | 35,000.00 |
| Patents | 70,000.00 | 70,000.00 | 70,000.00 | 70,000.00 | 70,000.00 |
| Road tools | 4,738.02 | 5,477.78 | 5,242.56 | 1,404.60 | 2,433.70 |
| Finished goods | 43,013.77 | ||||
| Warehouse stock | 119.75 | ||||
| 345,138.81 | 504,011.98 | 795,932.51 | 619,287.64 | 563.956.47 | |
| LIABILITIES | |||||
| Accounts payable | 34,199.82 | 48,522.84 | 43,545.85 | 18,879.48 | 20,161.78 |
| Accrued items | 8,136.18 | 2,719.32 | 2,619.06 | ||
| Reserves for taxes | 7,500.00 | 5,000.00 | 4,000.00 | ||
| Reserve for loss on contracts | 2,117.50 | 2,105.49 | 436.40 | 436.40 | |
| Accrued insurance | 2,131.67 | ||||
| Accrued taxes | 1,000.00 | ||||
| Reserves for cont. claims and adj | 3,502.63 | 1,669.21 | 612.62 | 844.15 | |
| Reserve income tax | 7,000.40 | 9,958.77 | |||
| Depreciation on patents | 6,802.58 | ||||
| Capital stock | 1,000,000.00 | 1,000,000.00 | 1,000,000.00 | 1,000,000.00 | 1,000,000.00 |
| Depreciation reserve | 12,335.38 | 18,146.82 | 24,164.20 | 30,261.64 | |
| Suspense account | 15.00 | 13.26 | |||
| Reserve for contingencies | 6,200.00 | 10,500.00 | |||
| Advances on contracts | 113,300.49 | 351,185.98 | |||
| Unearned discount | 10,088.25 | ||||
| Surplus (deficit) | 713,617.27 | 685,886.92 | 637,944.84 | 627,065.29 | 618,124.01 |
| Accrued wages | 3,201.36 | ||||
| Liability on contract | 174,052.92 | 107,448.47 | |||
| Reserve for loss on contingencies | 10,500.00 | 436.40 | |||
| Reserve, taxes and insurance | 1,855.02 | ||||
| Reserve for unearned interest | 3,358.40 | ||||
| 345,138.81 | 504,011.98 | 795,932.51 | 619,287.64 | 563,956.47 |
*2863 *531 Dividends paid by the petitioner from August, 1918, until November, 1922, on its outstanding capital stock are as follows:
| 1918 | $ 40,000 |
| 1919 | 40,000 |
| 1920 | 40,000 |
| 1921 | 40,000 |
| 1922 | 40,000 |
The net profit for the year 1918, after deduction for exhaustion of patents, $14,000, and $1,000 for exhaustion of leaseholds, amounted to $50,602.34.
In the computation of petitioner's net income the respondent has allowed no deduction for exhaustion of the contract acquired from the Aetna Fire Sprinkler Co.
The book value for the three years ended December 31, 1919, 1920, and 1921, of leaseholds, organization and good will, and patents, and the amounts allowed and disallowed by the respondent, are as follows:
| Books | Asamended by respondent | Reduction | |
| Dec. 31, 1919: | |||
| Leasehold | $2,000.00 | $2,000.00 | |
| Organization and good will | 566,671.65 | $35,000.00 | 531,671.65 |
| Patents | 232,200.00 | 70,000.00 | 162,200.00 |
| Dec. 31, 1920: | |||
| Leasehold | 1,000.00 | 1,000.00 | |
| Organization and good will | 566,671.65 | 35,000.00 | 531,671.65 |
| Patents | 213,300.00 | 70,000.00 | 143,300.00 |
| Dec. 31, 1921: | |||
| Leasehold | |||
| Organization and good will | 566,671.65 | 35,000.00 | 531,671.65 |
| Patents | 194,400.00 | 70,000.00 | 124,400.00 |
*2864 The respondent refused to allow a greater patent valuation than $70,000 for the purpose of invested capital and exhaustion.
The amounts of depreciation and exhaustion claimed by the petitioner and finally allowed by the respondent, together with the amounts disallowed by him, are as follows:
| Year | Claimed | Allowed | Disallowed |
| 1919 | $22,439.60 | $5,532.80 | $16,906.80 |
| 1920 | 22,369.22 | 5,811.44 | 16,557.78 |
| 1921 | 21,876.07 | 6,017.38 | 15,858.69 |
| 1922 | 20,514.83 | 6,097.44 | 14,417.39 |
The amounts allowed are based upon patent valuation of $70,000 and furniture and fixtures and factory equipment, etc., in the following amounts:
| Year | $ 70,000 of | Furniture and fixtures | Factory equipment | Total |
| patent value | (15 per cent rate) | (15 per cent rate) | ||
| 1919 | $4,117.65 | $ 291.32 | $1,123.83 | $5,532.80 |
| 1920 | 4,117.65 | 447.08 | 1,246.71 | 5,811.44 |
| 1921 | 4,117.65 | 590.65 | 1,309.08 | 6,017.38 |
| 1922 | 4,117.65 | 649.65 | 1,330.14 | 6,097.44 |
*532 The respondent reduced invested capital for 1919 by $5,054, for 1920 by $8,440.59, and for 1921 by $12,462.65, which sums represent taxes for the preceding taxable year as prorated by him. He has*2865 further reduced invested capital for 1920 by $5,259.69, additional taxes for 1918; for 1921 by $18,447.93, additional taxes for 1918; and 1919, and for 1921 by the use of the so-called tentative tax computation in determining the earnings available for dividends as of March 15, 1921.
OPINION.
MORRIS: The first, second, and third allegations of error urged by the petitioner relate to the inclusion in invested capital of the value of a patent, the value of what is denominated "good will and organization," and the value of a so-called license agreement and the deductibility of exhaustion on said patent and agreement, based upon the remaining life thereof at the date of acquisition by the petitioner. The respondent contends that the petitioner has failed to establish the values contended for.
The petitioner alleges in its petition that it is entitled to a value of $200,000, as the cost of Patent No. 1,191,919, and $50,000 as the cost of the contract acquired from the Aetna Fire Sprinkler Co.
We have the testimony of a designing engineer, engaged in the automatic sprinkler industry for 20 years, who testified that he himself had invented over 80 appliances for automatic sprinkler*2866 devices, over 20 of which were in active use, and that he considered Patent No. 1,191,919, with which he was thoroughly familiar, to be worth not less than $250,000 on November 26, 1917. We also have the benefit of the testimony of a man who has been in the sprinkler business for 16 or 17 years, who testified that he made the original plans and designs for the fusible link covered by Letters Patent No. 1,191,919; that he handled the patent from the actual making of the sprinkler for the laboratory tests and approval, both in the Underwriters Laboratories in Chicago and the Mutual Laboratories in Boston, and that he considered the value thereof as of November 26, 1917, to be between $250,000 and $300,000. Having considered the testimony of those witnesses, together with other factors in corroboration thereof, and convinced, as we are, that the patent in question had a value equal to the amount attributed thereto and contended for by the petitioner, as recorded in its books of account, we have found in our findings of fact herein a value of $200,000 therefor.
With respect to the value of the agreement acquired by the petitioner from the Aetna Fire Sprinkler Co. for capital stock, *2867 we are convinced, and have found as a fact, that that agreement had a value when acquired in November, 1917, of $50,000. William A. Pope, vice president and director of the petitioner, who has been in the contracting *533 and sprinkler business since 1899, stated that the average prevailing prices in November, 1917, to those not so fortunate as to have a contract for the purchase of equipment were considerably higher than those in the contract, and furthermore, that said contract was worth not less than $100,000 at that time.
The respondent's counsel contends that the foregoing license agreement was not assigned to the petitioner until January 22, 1918 (the
Having determined the values of Patent No. 1,191,919 and the Ohio Automatic Sprinkler Co.), and consequently no value could be ascribed thereto on November 26, 1917, when the petitioner acquired the assets of the Aetna Fire Sprinkler Co. With respect to this we have only to say that the direct testimony of witnesses is to the effect that the petitioner acquired its rights under that contract on November 26, 1917, and furthermore that it operated thereunder during the years 1918 to 1922, inclusive. We have heretofore*2868 held in The Hub, Inc.,3 B.T.A. 1259">3 B.T.A. 1259, that an oral assignment of a leasehold interest in real estate is voidable, not void, and where the parties have recognized said assignment as valid and subsisting, it can not be collaterally attacked by third parties. From the record before us, as we have said, the assignment took place on November 26, 1917, and we infer, in the absence of testimony to the contrary, that the parties regarded themselves as bound thereby from that date, and we must so treat them.
Having determined the values of Patent No. 1,191.919 and the license agreement acquired from the Aetna Fire Sprinkler Co., the petitioner is entitled to exhaust those values over the remaining life of the assets.
The respondent strongly contends that section 331 of the Revenue Acts of 1918 and 1921 is controlling and that even though the values claimed by the petitioner were determined by the Board for exhaustion purposes, they should not be included in invested capital. The petitioner contends, on the other hand, that the case is not controlled by that section for the reason that the respondent did not so find at the outset and the pleadings do not raise that question, *2869 and furthermore, that the proof shows that it is inapplicable for the reason that an interest or control of 50 per cent or more in no prior trade, business or property here at issue, remained in the same persons or any of them. In our view of the case it is unnecessary to pass upon the question of the pleadings. The assets, the inclusion of the value of which in invested capital is in controversy, were owned by the Aetna and Independent companies prior to the reorganization, and these companies received in exchange therefor, 14 per cent and 35 per cent, respectively, of the petitioner's stock. Section 331 is therefore not applicable to those assets. R. H. Perry & Co.,12 B.T.A. 328">12 B.T.A. 328. In that case we said:
* * * Section *534 331 * * * applies to instances of individual acquirement of "a trade or business" or individual "change of ownership of property" in the sense that the business or property, as the case may be, is acquired from one owner or several joint owners. It is clear to us that Congress by this provision intended to restrict those reorganizations or consolidations effected, or transfers of property made, with the intent of capitalizing*2870 unrealized appreciation in asset values, and provided, in effect, the test for such intent to be the retaining of an interest or control of 50 per cent or more in the property conveyed. In those cases where the former owner or owners of the particular property was willing to surrender the interest or control of 50 per cent or more which he or they theretofore held in the property, the limitation on invested capital would not apply.
Having found that the patent acquired from the Independent Sprinkler Co. and the license agreement acquired from the Aetna Fire Sprinkler Co. in exchange for stock had actual values of $200,000 and $50,000, respectively, at the date of acquisition, the petitioner's invested capital should be computed upon that basis.
If the petitioner acquired any good will of value in 1917, we can safely eliminate the assets acquired from the Independent Sprinkler Co. and the Allis Fire Extinguisher Co. from our consideration, as there is no evidence in the record from which we may find a value. Therefore, we shall consider the evidence offered in substantiation of the value of good will acquired from the Aetna Fire Sprinkler Co. The petitioner contends that, *2871 because of the fact that that company operated successfully since 1913 and paid dividends during the period of its operations, and based upon its earnings of $20,698.83 in 1916 and $44,838.43 in 1917, we should find the value of good will by the use of a formula. We have as evidence bearing upon this subject the testimony of a witness that in his opinion the Aetna Fire Sprinkler Co. had a good will on or before November 26, 1917. We have the dividend record of that company from 1914 to 1917 inclusive, balance sheets for three years, and the amounts of net income for 1916 and 1917. The witness who testified that in his opinion that company had a good will did not venture an opinion as to the amount thereof, nor was the basis for his opinion given. Even assuming that the existence of good will has been satisfactorily proven, we are of the opinion that good will can not be properly determined by the use of the average net income and net tangibles for a period of only two years. We must hold, therefore, that the evidence is not sufficient to establish the value of good will on November 26, 1917, acquired from either of the three companies at that time.
Since it does not appear*2872 from the record that the respondent's action complained of in the fourth allegation of error herein was contrary to the regulations in force for the various taxable years, as provided in section 1207 of the Revenue Act of 1926, we must sustain his determination in that particular.
*535 The petitioner having offered no evidence in support of the fifth allegation of error, we must approve the action of the respondent in applying a 15 per cent rate to furniture and fixtures and factory equipment in determining deductible depreciation for the years in question.
Following L. S. Ayers & Co.,1 B.T.A. 1135">1 B.T.A. 1135, the respondent's action in reducing petitioner's invested capital for 1921 by the accrual of the tentative tax in computing earnings available for dividends, was erroneous. See also Commissioner v. Pittsburgh Knife & Forge Co., 30 Fed.(2d) 522.
As the seventh and last issue raised by the pleadings is in the alternative, a discussion thereof is unnecessary in view of our decision on other issues.
Judgment will be entered under Rule 50.