*159 Decision will be entered for the respondent.
The amount by which petitioner's indebtedness for royalties was reduced, pursuant to prolonged negotiations conducted under a contractual provision therefor, was not a gift to the debtor of the amount agreed upon as excessive, and having been deducted in prior years as business expenses, resulted in realization of taxable income to petitioner.
*505 *371 This proceeding involves a deficiency of $ 14,635.70 in income tax for the fiscal year ended March 31, 1948. The sole issue is whether cancellation by the creditor of accruals in the amount of $ 34,715.48 for royalties payable under a written contract resulted in realization of taxable income.
FINDINGS OF FACT.
The stipulated facts are so found.
The petitioner, a Texas corporation with its principal place of business in Port Arthur, Texas, filed its return for the taxable year with the collector of internal revenue for the first district of Texas. It kept its books and reported its income for tax purposes on the accrual method.
The Sandusky Foundry & Machine Company*160 (hereinafter referred to as Sandusky) is an Ohio corporation. Neither it nor petitioner is an affiliate or subsidiary of the other.
In 1940 petitioner was producing cylindrical castings and bearings for the petroleum industry and shipyards in its area by the static method, which involved the use of sand for making molds. It was difficult to make perfect castings in sand. Petitioner desired to improve *372 the quality of its castings by use of centrifugal casting machines, which were developed and being manufactured by Sandusky.
On February 23, 1940, petitioner and Sandusky entered into a written contract by the terms of which Sandusky granted to petitioner an exclusive license, subject to an exception not material here, under all of its United States patents and applications for patents, covering the centrifugal casting of metals, to manufacture and sell nonferrous, cast iron and iron alloy castings in the states of Texas, Oklahoma, and Louisiana. In addition to $ 10,000 cash for the contract and instruction in the use of the machines, petitioner agreed to pay to Sandusky on all products produced and sold under the license a royalty of 3 cents a pound on nonferrous castings*161 and 1 cent a pound on iron or alloy iron castings, commencing 2 years after the installation by petitioner of the first machine, provided, however:
that at the expiration of two years after the installation of the first centrifugal casting machine and at the expiration of each two-year period thereafter the basis of royalties shall be adjusted in accordance with competitive and economic conditions then existing, such adjustment to be arranged through consultation and agreement between Standard and Sandusky, and if the contract parties can not agree the royalty rate shall be fixed by arbitration through the facilities and according to the rules of the American Arbitration Association; provided further that the maximum royalty during the life of this agreement shall be three cents per pound on non-ferrous castings and one cent per pound on iron or alloy castings. No royalties shall be payable by Standard after the expiration of seventeen years from the installation of the first centrifugal casting machine.
Another provision of the contract appointed petitioner exclusive selling agent in Texas, Oklahoma, and Louisiana of specified castings produced by Sandusky, for which services *162 Sandusky agreed to pay petitioner certain commissions. Petitioner did not make any sales for Sandusky under the agency contract.
All payments of royalties and commissions were to be made on a quarterly basis. Any disputes arising under the contract that could not be settled by the parties by negotiation were to be settled through the facilities and according to the regulations of the American Arbitration Association. Each party was to furnish the other with any information it acquired which would be helpful to the other in the production of castings of the nature licensed by the agreement. The agreement was to be effective as long as petitioner remained in the business of producing castings of the nature covered by the license. Its provisions prohibited petitioner from manufacturing the licensed centrifugal castings under any other patents or applications therefor, or acting as agent for the sale of centrifugal castings of any other company.*506 During the life of the contract authorized agents of either party were to be freely admitted to the plant of the other.
Installation of the first machine under the license was completed in January 1941 and the first accrual of royalties on*163 petitioner's books *373 was made for the first quarter of 1943. The accrual and all others made thereafter until March 1948 were made at the rates set forth in the licensing agreement. The amounts of the accruals were:
| Fiscal year ended | |
| Mar. 31 | Amount |
| 1943 | $ 6,133.60 |
| 1944 | 12,968.88 |
| 1945 | 17,096.88 |
| 1946 | 3,068.22 |
| 1947 | 715.59 |
| 1948 | 912.63 |
| Total | $ 40,895.25 |
An entry in the amount of $ 7.22 made for March 1948 was computed at the rate of $ 10 a ton for nonferrous castings and $ 5 a ton for iron and alloy iron castings.
The first payment made by petitioner for accrued royalties was in June 1945 in the tentative amount of $ 5,548.49. All payments made thereafter were at the rate of $ 10 a ton for nonferrous castings and $ 5 a ton for ferrous castings. As of March 31, 1948, the account had a credit balance of $ 34,715.48 due Sandusky. The amounts comprising the balance were deducted as expenses by petitioner in income tax returns filed for years during which the accruals were made.
Immediately after petitioner started to use the first machine installed in its plant it learned that while the process produced high quality castings, the cost of production was greatly*164 in excess of the sand method and that the royalties agreed upon were excessive. Thereafter petitioner's president, Henry J. LeBlanc, discussed with the president of Sandusky the matter of reducing the rates of royalty but without success, even though Sandusky's president agreed that the royalty rates were too high. Subsequent discussions until 1945 were likewise unsuccessful to petitioner. The attitude of Sandusky changed when it elected Frank Buckingham president of the corporation.
During discussions and correspondence LeBlanc had with Buckingham, the former alleged that certain misrepresentations had been made to petitioner at the time the licensing agreement was negotiated, informed Sandusky that the high rates provided for in the existing agreement prevented it from meeting competition, and requested a release from the contract. Buckingham advised him that it would be necessary to present the matter to the board of directors of the corporation for consideration and that it would consent to a reduction of the rates. On May 3, 1944, Buckingham informed petitioner by letter that Sandusky would not consent to a cancellation of the agreement but would consider any request for*165 adjustment on more equitable grounds.
*374 Further discussion of the matter between LeBlanc and Buckingham resulted in an understanding between them, subject to approval of Sandusky's directors, to reduce the royalty to $ 10 a ton for bronze castings and $ 5 on cast iron castings. Buckingham was then of the opinion that the directors would authorize a reduction of the rates. On January 10, 1945, Buckingham suggested to petitioner that it accrue liability on that basis to the end of 1944 and suggested another conference to discuss the subject in general. On March 6, 1948, Sandusky informed petitioner by letter, which was received about 2 days later, that royalties would be charged at the rate of $ 10 a ton on bronze castings and $ 5 on iron castings, retroactive to the time of execution of the licensing agreement.
During the period in which negotiations were conducted for a reduction of the rates of royalty petitioner was operating with very little cash. It was not discounting its bills and if it had paid royalties at the original rates, it would have been necessary to reduce payments to other creditors by a like amount. Petitioner's loss during the taxable year on sales *166 of castings produced by the machines was about 3.75 per cent of sales. Losses of a like percentage were sustained in some of the prior years.
During the years 1943 to 1948, inclusive, petitioner paid dividends as follows:
| Year | Amount |
| 1943 | $ 33,000 |
| 1944 | 33,000 |
| 1945 | 27,500 |
| 1946 | 22,000 |
| 1947 | 5,500 |
| 1948 | 22,000 |
At the close of the taxable year petitioner's capital stock was $ 275,000, all of which was common, and surplus, $ 601,397.46.
In March 1948, after Sandusky consented to the reduction in royalty rates, petitioner credited the balance of $ 34,715.48 in the account to surplus. In his determination of the deficiency respondent held that the release from liability to pay the amount resulted in realization of taxable income of $ 34,715.48.
At all times material petitioner was solvent.
*507 OPINION.
The amount of $ 34,715.48 in controversy represents the difference between the original license rates and the ones agreed upon in March 1948, retroactive to the time of execution of the agreement. Royalties at the original rates were accrued each year, except for March 1948, for which period the accrual was on the basis of the adjusted rates, and the amounts so accrued were claimed*167 as expense deductions in the year of accrual. No contention is made that the accruals were disallowed as deductions by the respondent.
*375 Petitioner's contention in general is that the balance due Sandusky on its books was gratuitously forgiven by its creditor and, therefore, did not result in realization of taxable income, as determined by the respondent. Respondent's position is that the transaction was a settlement made under the contract in the exercise of sound business judgment, and, accordingly, no gift was made.
A like question, under different facts, was considered in . There the Court held that "The forgiveness was gratuitous, a release of something to the debtor for nothing, and sufficient to make the cancellation here gifts within the statute." The decision must be viewed in the light of , "which tells us that there can be a gift only when the intent to make a gift is present"; , affd. . "* * * The*168 income taxed is described in sweeping terms and should be broadly construed in accordance with an obvious purpose to tax income comprehensively. The exemptions, on the other hand, are specifically stated and should be construed with restraint in the light of the same policy. * * *" , in which the Court also said that the question is factual and "turns upon whether the transaction is in fact a transfer of something for the best price available or is a transfer or release of only a part of a claim for cash and of the balance 'for nothing,'" and that intent to make a gift must be present to escape tax on the transaction. 1180 .
The lack of intent of Sandusky to make a gift is evident from the facts. The contract, executed in February 1940, made express provision for adjustment of the royalty rates every 2 years commencing 2 years after the installation of the first machine "in accordance with competitive and economic conditions then existing," the adjustment, if necessary, to be made by the American Arbitration Association. The first*169 machine was installed in January 1941 and royalties were not chargeable under the contract until January 1943.
Promptly after the machine was placed in operation petitioner realized that the royalty rates were excessive and while the then president of Sandusky agreed with the conclusion, he declined and thereafter continued to refuse to make a downward adjustment. Negotiations conducted with Buckingham, a new president of Sandusky, resulted in an understanding at some undisclosed time between May 1944 and January 1945, subject to approval of Sandusky's directors, to reduce the rates to the figures ultimately agreed upon. Settlement involved other matters covered by the contract, a conference to discuss which was suggested by Buckingham in January 1945, when he suggested also that liability for royalty be accrued at the rates finally made official. *376 The royalty rates informally fixed by Buckingham were accepted by Sandusky's directors in March 1948, retroactive to all prior years. In the meantime, petitioner accrued liability and took deductions therefor at the original rates but paid to Sandusky amounts computed on the basis of royalty fixed by the settlement.
It thus*170 appears that the adjustment of liability resulted from orderly negotiation of rights and obligations arising from contract, a situation anticipated by the parties when the licensing agreement was executed. Instead of giving up something for nothing, which is an essential element of a gift (; , affd. ), Sandusky merely acknowledged a contractual right of petitioner to a reduction of the rates of royalty, a strictly business transaction containing none of the characteristics of a gift.
From consideration of all of the facts we find no error in the determination of respondent that the settlement resulted in realization of income by petitioner in the amount of $ 34,715.48.
Decision will be entered for the respondent.