*292 Decision will be entered under Rule 50.
1. Cost basis of patents used in the petitioner's business determined for purpose of computing equity invested capital and depreciation deductions.
2. Certain capital expenditures relating to the development and procurement of patents held proper additions to the cost basis thereof.
3. Expenditures relating to the procurement of royalty producing licenses for the use of patents held capital expenditures recoverable through amortization deductions spread ratably over the life of the licenses.
4. Legal fees paid with petitioner's capital stock at a valuation agreed upon by the parties held deductible as ordinary and necessary business expenses of the year when so paid.
*153 *1178 This proceeding involves deficiencies in income tax for the years 1939, 1940, and 1941 in the amounts of $ 1,458,80, $ 918.66, and $ 7,498.13, a deficiency in declared value excess-profits tax for 1942 in the amount *1179 of $ 323.03 and a deficiency in excess profits tax for 1942 in the amount of $ 104,176.69. Petitioner claims that there are overpayments of income taxes for all of the years 1939 to 1942, inclusive.
The issues are (1) the basis, both for the purpose of determining equity invested capital and for depreciation of certain patent rights and inventions acquired by the petitioner at the time of its organization, (2) whether the basis for such patents and inventions should be increased by reason of certain capital expenditures relating thereto, (3) whether the costs of acquiring lease agreements for the use of the patents and inventions were capital expenditures subject to amortization deductions or were ordinary and necessary business expenses, (4) whether petitioner is entitled to the deduction of legal fees paid in 1942 for services rendered during 1936 to 1941, inclusive, and (5) *294 whether petitioner is entitled to a net operating loss and excess profits credit carry-overs from 1940 and 1941 to 1942.
FINDINGS OF FACT.
Petitioner is a Delaware corporation. Its returns for the years involved were filed with the collector of internal revenue for the first district of New York. The returns were prepared on an accrual basis and for a calendar year.
Petitioner was organized in August 1931 for the purpose of exploiting certain inventions and patents pertaining to the manufacture of Diesel engines. Its organizers were Franz Lang and Albert Wielich. The inventions in question had been owned by Lang. They will be referred to hereinafter generally as the Lang inventions. Lang had formerly been associated with Rudolf Diesel, principal inventor of the Diesel engine. Wielich was an attorney and financier who had had previous business connections with Lang.
Prior to petitioner's organization and in September 1930 Lang and Wielich had organized another corporation under the laws of the Principality of Liechtenstein, *154 city of Vaduz. This corporation, hereinafter referred to as Vaduz, was capitalized at 100,000 Swiss francs, approximately $ 20,000 at the then rate of exchange, *295 which was paid by Wielich in exchange for 60 per cent of the corporation's stock. Lang paid in to Vaduz all of his Diesel patents, including those presently owned and any later to be acquired, in exchange for the remaining 40 percent of the corporation's stock. In addition Vaduz agreed to reimburse Lang for his expenses of developing his patents to the extent of $ 18,000.
At the time of petitioner's organization Vaduz transferred to it an exclusive right to the use of the Lang inventions in the United States and other countries in North and South America for a stated consideration of $ 4,000,000, payable in part or in whole in petitioner's *1180 capital stock at par value. Petitioner immediately issued to Vaduz all of its capital stock consisting of 40,000 shares of a par value of $ 25 each and three promissory notes for $ 1,000,000 each, payable on demand either in cash or, at petitioner's option, in petitioner's capital stock. Within one year after organization the three notes were taken up and paid as permitted by the option by the issuance of capital stock of the par value of $ 3,000,000. The so-called Lang inventions were then covered by three applications for patents*296 pending in the United States Patent Office numbered 499,222, 499,223, and 499,224. Of these three basic patent applications one (No. 499,222) was abandoned in 1932 and the other two, at the direction of the Patent Office, were broken down into several divisional applications on which seven separate patents were finally issued.
On April 19, 1937, Vaduz assigned to petitioner outright the following 14 patents and 10 patent applications:
| Patent No. | Date of issue |
| 1,937,655 | Dec. 5, 1933 |
| 1,941,805 | Jan. 2, 1934 |
| 1,941,806 | Jan. 2, 1934 |
| 1,944,352 | Jan. 23, 1934 |
| 1,944,605 | Jan. 23, 1934 |
| 1,954,082 | Apr. 10, 1934 |
| 1,954,083 | Apr. 10, 1934 |
| 1,954,084 | Apr. 10, 1934 |
| 1,964,667 | June 26, 1934 |
| 1,994,000 | Mar. 12, 1935 |
| 1,998,725 | Apr. 23, 1935 |
| 2,001,535 | May 14, 1935 |
| 2,001,536 | May 14, 1935 |
| 2,004,631 | June 11, 1935 |
| Patent | |
| Application | |
| No. | Date of filing |
| 499,223 | Dec. 1, 1930 |
| 109,896 | Nov. 9, 1936 |
| 742,068 | Aug. 30, 1934 |
| 20,029 | May 6, 1935 |
| 20,030 | May 6, 1935 |
| 39,427 | Sept. 6, 1935 |
| 39,428 | Sept. 6, 1935 |
| 46,990 | Oct. 28, 1935 |
| 53,541 | Dec. 9, 1935 |
| 87,137 | June 25, 1936 |
The 14 above listed patents and the following four additional patents thereafter assigned to petitioner by Vaduz comprise the patents involved*297 in this proceeding:
| Patent No. | Date of issue |
| 2,080,139 | May 11, 1937 |
| 2,097,492 | Nov. 2, 1937 |
| 2,103,423 | Dec. 28, 1937 |
| 2,105,662 | Jan. 18, 1938 |
During the period August 31, 1933, to December 31, 1938, petitioner expended a total of $ 9,494.84 in fees to patent counsel and other expenses relating to the acquisition of patents. Of this amount $ 5,936.16 was attributable to the Lang inventions and the balance to another group of patents known as the Fischer patents. There were four of the Fischer patents having the following numbers and dates of issue:
| Patent No. | Date of issue |
| 2,119,781 | June 7, 1938 |
| 2,153,618 | Apr. 11, 1939 |
| 2,157,658 | May 9, 1939 |
| 2,157,659 | May 9, 1939 |
Petitioner's principal source of income is the royalties which it receives from its licensees of the Lang inventions. It licenses engine *1181 manufacturers to make and sell Diesel engines manufactured under the Lang inventions. The customary procedure is to enter into a preliminary agreement with the manufacturer for the conversion of its conventional gasoline engine to a Diesel, or Lanova, engine. Petitioner undertakes to make the necessary changes in the design of the engine. The basic changes are*298 the substitution of a Lanova type cylinder head for the conventional gasoline cylinder head and the substitution of a Diesel fuel injection system for the ignition and carburetor systems. If after these changes the engine performs satisfactorily a working license agreement usually results.
Following is a partial list of petitioner's licensees with the dates of the various licenses:
| The Buda Company | Sept. 29, 1934 |
| Apr. 30, 1940 | |
| July 1, 1942 | |
| July 1, 1942 | |
| Mack Manufacturing Company | Jan. 22, 1935 |
| July 7, 1936 | |
| Apr. 25, 1939 | |
| June 14, 1940 | |
| Chrysler Corporation | July 12, 1937 |
| Atlas Thornburg Company | Jan. 6, 1938 |
| Mar. 1, 1938 | |
| Stover Manufacturing Engine Company | Apr. 15, 1940 |
| The Kohler Company | Mar. 15, 1939 |
*155 The license agreements continue in effect until the expiration date of the latest patent involved.
In addition to specific projects of conversion, the petitioner also engaged in laboratory research and development calculated to produce improvements in its system and to enlarge its patent structure. Some expenses also were incurred in the protection of patents already owned or controlled by the petitioner.
During the years 1936 to 1942, inclusive, the petitioner expended*299 a total of $ 80,911.66 for the purposes described above. Of this amount $ 47,823.77 was expended in connection with the conversion of engines of manufacturers from whom license agreements were ultimately obtained, and $ 18,988.25 was expended for the conversion of engines of manufacturers from whom no license agreements were obtained. The balance of approximately $ 14,000 was expended for general development of the Lanova Combustion System, and for the protection of patents owned by the petitioner. Petitioner capitalized all of such expenses in its books and did not deduct them as ordinary and necessary business expenses in its returns.
The amounts expended by the petitioner in obtaining license agreements ($ 47,823.77), the years in which these expenditures were made, the amounts expended in each such year, the date of acquisition of the *1182 latest issued patent, and the length of time such patent had to run from the beginning of each such year were as follows:
| Calendar year (or fiscal | Date of acquisition | Remaining | |
| year, or period) ended | Amounts | of | life of latest |
| expended | latest issued | issued patent | |
| patent | [months] | ||
| Aug. 31, 1937 | $ 4,530.28 | May 11, 1937 | 212 |
| Aug. 31, 1938 | 7,240.85 | June 7, 1938 | 213 |
| Dec. 31, 1938 | 1,493.18 | June 7, 1938 | 201 |
| Dec. 31, 1939 | 4,090.62 | May 9, 1939 | 208 |
| Dec. 31, 1940 | 15,755.26 | May 9, 1939 | 196 |
| Dec. 31, 1941 | 8,324.55 | May 9, 1939 | 184 |
| Dec. 31, 1942 | 6,389.03 | May 9, 1939 | 172 |
| (Total | $ 47,823.77) |
*300 At the time of petitioner's organization American engine manufacturers were showing increasing interest in the development of Diesel engines. They were particularly interested in the development of light high speed engines for a variety of uses. Many of them were conducting their own research in this field.
For the first 3 years of its existence, 1932, 1933, and 1934, petitioner reported no income or losses. For the years 1935 to 1939, inclusive, it reported losses ranging from $ 12,000 to over $ 40,000. For the years 1940, 1941, and 1942, it reported profits in the respective amounts of $ 575.19, $ 11,727.23, and $ 34,100.72. The total royalties received by petitioner up to the middle of 1950 amounted to nearly $ 1,500,000, exclusive of approximately $ 443,000 of royalties recaptured by the United States Government during 1943, 1944, and 1945.
In its returns for the years involved petitioner claimed an unadjusted basis of $ 160,000 for its property rights in the Lang patents, both for invested capital and for depreciation purposes. On that basis, increased, however, by the amount of $ 7,278.41 representing the additional cost of obtaining patents, the annual depreciation deductions*301 claimed on the patents amounted to $ 9,839.88. The respondent eliminated the $ 160,000 from invested capital and disallowed all of the exhaustion deductions claimed on the patents. Petitioner now contends that the proper unadjusted basis for the patents for invested capital purposes as well as for depreciation is $ 500,000, with adjustment for the additional capital expenditures amounting altogether to $ 9,494.84.
On April 14, 1942, petitioner transferred to Cadwalader, Wickersham & Taft 8,200 shares of its newly issued stock in payment of legal fees of $ 24,600. The bill for such fees was first rendered to the petitioner on April 1, 1942, and covered legal services from June 1, 1936, to December 31, 1941. The shares of stock were accepted by Cadwalader, Wickersham & Taft at a valuation of $ 3 a share pursuant to an agreement between that firm and the petitioner approved *156 by the *1183 petitioner's directors at a meeting held April 9, 1942. The firm entered the shares in its books at $ 3 per share and reported that amount as income in its income tax return.
The rights which petitioner acquired in the Lang inventions at the time of its organization had a cost basis in the hands*302 of its transferor, Vaduz, of $ 31,333.33.
Petitioner's capital stock had a value on April 14, 1942, of not less than $ 3 per share.
OPINION.
The value, or cost basis, of the Lang inventions both for the purpose of invested capital and the computation of exhaustion deductions is the first and principal issue for consideration.
Respondent's position is that petitioner acquired its rights in the inventions from Vaduz in a nontaxable transaction in exchange solely for its capital stock; that Vaduz in turn acquired them from Lang in a similar transaction; and that, therefore, the cost basis to petitioner is the cost of the rights to Lang, the original transferor. He argues that neither the cost of the inventions to Lang nor their value when acquired by Vaduz has been proven by competent evidence and that, therefore, no basis can be allowed for the patents in petitioner's hands either for invested capital or for amortization purposes.
Petitioner argues that its basis for invested capital purposes under section 718, Internal Revenue Code, is either the cost of the inventions to itself or the cost to Vaduz; that in either case this cost was the market value of its shares of stock or the *303 shares of Vaduz which were paid in exchange for them; and that these shares had a fair market value equal to the value of the inventions, which was not less than $ 500,000.
We think that the respondent is correct in his contention that petitioner acquired its interest in the Lang inventions at the time of its organization in exchange solely for its stock. The agreement between petitioner and Vaduz called for payment to Vaduz by petitioner of $ 4,000,000 for the inventions, including all of petitioner's capital stock at a valuation of $ 1,000,000 and promissory notes for $ 3,000,000. However, it was agreed that the whole amount of $ 4,000,000 might be paid in petitioner's capital stock and within less than a year the three notes were redeemed with petitioner's newly issued stock at par value. These notes we think represented an equity interest in the petitioner corporation rather than a bona fide obligation of the petitioner. See Swoby Corporation, 9 T.C. 887">9 T. C. 887. Petitioner does not now contend that its rights in the inventions had a value or cost basis to it in excess of $ 500,000.
Petitioner's acquisition of the rights in the inventions from Vaduz *304 being a nontaxable exchange under section 112 (b) (5) its basis is *1184 the basis in the hands of its transferor, Vaduz. Section 113 (a) (8), (12), (16). Vaduz acquired the patent applications from Lang in exchange for 40 per cent of its capital stock plus $ 18,000 which it agreed to pay Lang as reimbursement for its expenses in developing the inventions. This was not a 112 (b) (5) transaction in which the property was exchanged solely for stock and the transferor remained in control of the transferee corporation. Wielich, who received 60 per cent of the stock of Vaduz, had no interest in the Lang inventions while Lange, the transferor, acquired only a 40 per cent stock interest in Vaduz. It is, therefore, the cost to Vaduz that must be used as the starting point in determining petitioner's basis for its interest in the Lang inventions.
The cost to Vaduz was $ 18,000 plus the value of the stock issued to Lang. Since Vaduz had no net assets except the patent applications and $ 2,000 paid in capital ($ 20,000 paid in by Wielich less the $ 18,000 pledged to Lang), the value of its shares depends largely upon the value of the patent applications at that time. No patents had*305 yet been issued to Lang but the inventions were covered by eight German patent applications then on file, and under its agreement with Vaduz the petitioner was entitled to any and all patents which might thereafter be issued relating to those inventions and patent applications. The patent applications were property capable of valuation and assignment. See Hershey Manufacturing Co., 14 B. T. A. 867, affd. (on this issue) 43 F. 2d 298; Ida I. McKinney, 32 B. T. A. 450, affd. 87 F. 2d 811. While the evidence as to value is not too satisfactory, we are convinced from the record as a whole that the inventions did have value and that the respondent erred in not allowing petitioner any basis whatever either for invested capital or for exhaustion purposes. On the other hand we think that the value sought by the petitioner of $ 500,000 is much too high. Other than the opinion of petitioner's expert witness there is not much in the record to support such a value.
Wielich paid to Vaduz 100,000 Swiss francs, approximately $ 20,000 cash, for 60 per cent of its stock. This would*306 indicate that the total value of petitioner's stock was, in exact figures, $ 33,333.33, and the value of the shares issued to *157 Lang in exchange for his inventions, 40 per cent, $ 13,333.33. This amount plus the $ 18,000 of cash which Vaduz agreed to pay to Lang making a total of $ 31,333.33 represents the cost, so computed, of the inventions to Vaduz.
It is argued that the capital structure of Vaduz did not reflect the value of the Lang inventions, but was merely an arbitrary figure which Lang and Wielich adopted for their own convenience. However, the evidence before us does not support this contention and does not offer any other means of determining the cost of the Lang inventions to *1185 Vaduz. We have, therefore, found that the cost of the inventions to Vaduz and, therefore, their unadjusted basis in petitioner's hands was $ 31,333.33. That figure is the amount to be included in petitioner's invested capital under section 718, Internal Revenue Code, and is the starting point for determining the adjusted basis to be used in computing exhaustion deductions on the patents under sections 113 (b) and 114 (b) (1).
No issue has been raised in this proceeding as to the proper*307 method to be used in computing the depreciation on the patents involved, in the event that a proper basis should be established. An approved method of computing the deductions on an interdependent group of patents is to spread the cost or value of the group over the average life of the patents. See Union Metal Manufacturing Co., 4 B. T. A. 287; Simmons Co., 8 B. T. A. 631; Syracuse Food Products Corporation, 21 B. T. A. 865; Prophylactic Brush Co., 25 B. T. A. 676.
The additional capital expenditures properly allowable to the patents should be included in the cost basis for the purpose of computing the exhaustion deductions. These expenditures amounted to $ 9,494.84, of which $ 5,936.16 related to the Lang patents and $ 3,558.68 to another group of patents pertaining to certain features of the Lanova engine known as the Fischer patents.
The next issue involves a question of petitioner's right to the deduction of the expenditures made in securing the agreements with its licensees. These expenditures fall into two classes: Those resulting in working contracts*308 which actually produced royalties and those which did not result in producing contracts. There was $ 47,823.77 of the former and $ 18,988.25 of the latter class of expenditures during the years 1937 to 1942, inclusive.
The costs of acquiring license agreements such as petitioner had with its licensees are capital expenditures recoverable through amortization deductions spread ratably over the life of the agreements. Halbert K. Hitchcock, 4 B. T. A. 273. Since the agreements here were all coextensive with the life of the patents, the amortization deductions should be spread over the same period as the depreciation deductions on the patents.
The expenditures for research and experimental work which did not result in consummated license agreements, amounting to $ 18,988.25, cannot be capitalized since no equitable asset was acquired. The respondent now concedes that those expenditures are deductible currently as ordinary and necessary business expenses.
The next issue is the deductibility of the legal fees of $ 24,600 claimed as a deduction in 1942. Respondent's position is that petitioner has not proved the value of the shares of stock which it issued*309 in payment of the fees or established its right to the deduction under section 23 (a).
*1186 The evidence before us, although meager, supports petitioner's claim to the deduction. Ordinary legal expenses incidental to the conduction of a business are deductible when paid or accrued. The fact that the legal services here were performed in part in prior years does not prevent the deduction in the year when the fees were actually paid. The evidence is that the firm first presented its bill to the petitioner in April 1942 for services rendered over the period June 1, 1936, to December 31, 1941. There is nothing to indicate that the fees were either payable or allowable prior to that time. In his brief respondent suggests that the fee may have been in part for services in connection with a recapitalization in 1942, and, therefore, a capital expenditure, but the evidence is to the effect that the bill covered services up to December 31, 1941.
The final issue, whether petitioner is entitled to net operating loss and unused excess profits credit carry-overs, depends upon the computation to be made under our disposition of the above issues and will be settled under Rule 50 computation.
*310 Decision will be entered under Rule 50.