*2547 1. Deduction for depreciation in the year 1923 of a patent issued in November, 1913, allowed on the basis of the March 1, 1913, value of the patent application then pending.
2. Value of patent application at March 1, 1913, for depreciation purposes determined.
3. Increase in net loss deduction for 1923, representing the excess of net loss in 1921 over net income in 1922 allowed, where it is shown that the Commissioner in computing the net loss deduction for 1923 did not make proper allowance for depreciation in 1921 and 1922.
*617 This proceeding is for the redetermination of a deficiency in income tax for the fiscal year ended June 30, 1923, in the amount of $3,600.02. Petitioner claims an overpayment for said year in respect of taxes previously assessed in the amount of $50,432.72. It is alleged that the respondent erred in failing to allow a deduction in the taxable year 1922 on account of the exhaustion of a patent issued to the petitioner in November, 1913, *2548 based upon the March 1, 1913, value of the patent application prorated over the life of the patent, and in failing to make proper allowance in computing the net loss deduction for 1923 for depreciation of the patent in the years 1921 and 1922.
FINDINGS OF FACT.
The petitioner is an Illinois corporation with its principal place of business at Peoria. During the taxable year 1923 and for many prior years it was engaged in the business of manufacturing woven wire fence, wire, nails, and other similar products. It was one of the first manufacturers of woven wire fence.
*618 Since about the year 1907 the petitioner has owned and used in its business an invention for the manufacture of a certain type of wire fence known under the trade name of the Square Deal fence. The invention had been perfected in the petitioner's plant by one of its officers and owners. Application for a patent was filed July 12, 1907, involving 42 claims. Additional claims were made later, bringing the total to 112. On June 12, 1912, all of these claims were declared allowable by the Patent Office examiner, subject to interference proceedings involving three of the claims which had been begun*2549 by two an award was made to the petitioner by forfeiture. On April 15, 1913, the patent was formally declared allowable and on November 18, 1913, Letters Patent No. 1,078,702 was issued to the petitioner as assignee of the inventor.
The patent as issued covered various parts and mechanisms of the machine for manufacturing the Square Deal fence. It did not cover the type of fence or the method of making the fence.
The Square Deal fence is characterized by the staple lock or knot with which the horizontal or strand wires are fastened to the vertical or stay wires. The stay wires consist of a single piece of wire extending from the upper to the lower strand wires and fastened to the intermediate strand wires with staples. The principal feature of the invention is the fastening of the staples or ties by operation of dies and other mechanisms. The staple is pressed down tightly over the strand wire at the point of intersection with the stay wire and each of the ends wrapped tightly around the stay wire, forming a compact knot that prevents slipping. This type of fence is known as the stiff stay or staple lock tie fence. The other of the two leading types of wire fence is known*2550 as the wrapped stay or hinge joint fence, in which type the vertical or stay wires consist of separate pieces the ends of which are wrapped to the strand wires.
At the time the patent in question was issued to the petitioner, and at March 1, 1913, there were other manufacturers making both the stiff stay type and the hinge joint type of fence under patents covering several different methods. The leading manufacturer was the American Steel & Wire Co. This company had acquired, about the year 1898, a patent, known as the Bates patent, covering a machine for the manufacture of a wrap tie or hinge joint type of fence known as the American fence. This machine operated at a rapid rate of speed and gave the American Steel & Wire Co. an advantage over other competitors. The American Steel & Wire Co. also manufactured a staple tie fence similar to the Square Deal fence on a machine known as the Anthony machine, on which it owned the patent. The Anthony machine operated at a slow rate of speed *619 and for that reason could not be operated as profitably as the Bates machine. It was in an effort to meet this competition that the petitioner developed the Square Deal machine.
*2551 The chief value of the Square Deal machine was the saving which it effected in material. The length of the wire for the staple used in making the Square Deal knot varied from about three-quarters of an inch to two inches, according to the size of the wire used, while the knots or joints for corresponding fences made by competing manufacturers required from about one and one-half inches to three and three-quarters inches of wire. The Square Deal knot was the shortest method of fastening together the strand wires and stay wires then known to the trade. A patent embodying the electric weld as a means of making the joint was in use at that time by the Pittsburgh Steel Co., but this type of fence had been found unsatisfactory in some respects and was not a strong competitor of the Square Deal fence. On the basis of the petitioner's production of Square Deal fence for the year ended June 30, 1913, and at the prevailing cost prices of wire for that year it had a saving in wire alone, due to the use of the Square Deal invention, as compared with the production cost of the type of fence sold by its leading competitors, which has been variously estimated at from approximately $56,500 to*2552 $87,500. At or about March 1, 1913, the Square Deal machine operated at an average speed of about 90 stays per minute, while most of the other staple tie machines operated at about 40 stays per minute, and the average hinge joint type machine operated at about 60 stays per minute. The Bates machine operated at about the same speed as the Square Deal machine. The Square Deal machine compared favorably with competing machines in the cost of its construction and operation.
Up to and including the year 1913 considerably more of the hinge joint type of fence was sold to the trade than of the stiff stay type. This was largely due to the advertising and promoting efforts of some of the large manufacturers who were producing the hinge joint type of fence. At March 1, 1913, the petitioner was manufacturing about 10 per cent of the woven wire fence sold in the United States.
The Square Deal machine was put into commercial use by the petitioner immediately after it was perfected. There were installed in petitioner's plant seven machines at June 30, 1908; 19 at June 30, 1912, and 22 at June 30, 1913. At March 1, 1913, the petitioner had not sold or leased, or offered for sale or lease, *2553 any of the Square Deal machines. During that time the petitioner was abandoning the manufacture and sale of the Keystone fence, which previously had been its principal product, in favor of the Square Deal fence.
*620 For the fiscal year ended June 30, 1912, petitioner's gross sales of Square Deal fence amounted to nearly a million dollars, which was over 75 per cent of its total gross sales. It had gross profits of nearly $275,000, about 94 per cent of which was attributable to the Square Deal fence. The proportion of profits from sales of Square Deal fence remained substantially the same in the year ended June 30, 1913, with total gross sales of over a million and a half dollars.
Petitioner's net income and investment in tangibles for the years 1908 to 1913, and 1914 to 1918, inclusive, were as follows:
| Fiscal years ending June 30 | Income for year | Investment at beginning of year |
| 1908 | $ 116,050.68 | $488,919.01 |
| 1909 | 153,624.64 | 551,596.92 |
| 1910 | 88,782.68 | 607,106.96 |
| 1911 | 170,957.23 | 565,578.82 |
| 1912 | 117,051.35 | 697,462.27 |
| 1913 | 130,691.21 | 774,271.88 |
| Average, 1908-1913 | 129,526.30 | 614,155.98 |
| 1914 | $131,118.29 | $854,574.24 |
| 1915 | 186,753.17 | 1,109,549.90 |
| 1916 | 288,571.70 | 1,225,736.51 |
| 1917 | 374,787.85 | 1,714,415.24 |
| 1918 | 391,583.67 | 3,488,257.25 |
| Average, 1914-1918 | 274,562.94 | 1,678,506.63 |
*2554 There have been no material changes or improvements made in the Square Deal machine since it was first put in use by the petitioner in 1907. There has never been an infringement suit involving the patent or any infringement thereof brought to the petitioner's attention. At March 1, 1913, the woven wire fence industry was on an upward trend. Wire fence was rapidly replacing the old type rail and board fences for farm uses. The petitioner was firmly established and had a favorable position in the industry. It had been steadily expanding for several years and might reasonably have expected a further increase in the volume of its business.
The patent application in question had a fair market value at March 1, 1913, of $200,000.
The petitioner operated at a net loss for the fiscal year ended June 30, 1921, exclusive of any deduction on account of the exhaustion of its patent on the Square Deal machine of $502,922.34. Its net income for the fiscal year ended June 30, 1922, exclusive of any deduction on account of the exhaustion of its patent on the Square Deal machine, was $48,572.46.
OPINION.
SMITH: We have heretofore decided that a patent application is property and*2555 that a taxpayer under circumstances similar to those obtaining in the instant proceeding is entitled to a deduction on account of the exhaustion of a patent issued in a subsequent year based upon the March 1, 1913, value of the patent application prorated over the remaining life of the patent. Individual Towel & Cabinet Service Co.,5 B.T.A. 158">5 B.T.A. 158; Hartford-Fairmont Co.,12 B.T.A. 98">12 B.T.A. 98; Hershey Manufacturing Co.,14 B.T.A. 867">14 B.T.A. 867.
*621 The petitioner contends that the fair market value at March 1, 1913, of the application for patent on the Square Deal machine was at least $1,000,000. In support of that value it has adduced with other evidence the testimony of its president, the patent attorney who assisted in securing the patent, and of two individuals connected with other companies engaged in manufacturing woven wire fence. We think that the estimate of value placed on the patent application by these witnesses is far too high. It appears that their opinions were based largely on the assumption that the petitioner's savings in the amount of materials due to the use of the invention, estimated at between $50,000 and $85,000 annually, *2556 would extend over the entire life of the patent. In view of the facts shown we do not think that this is a proper basis for the determination of the fair market value of the patent application at March 1, 1913. The patent, or patent application, here did not ocver the type of fence manufactured by the Square Deal machine or the method of making the knot, but merely the machine for making the fence. We do not find that the patent obtained was a basic or a generic one, or that it gave the petitioner any monopoly in the production of any type of wire fence. The evidence shows that the Anthony machine, patent on which was owned by the American Steel & Wire Co., produced a fence very similar to the Square Deal fence but that it operated at a slower rate of speed. Improvements in the Anthony machine rendering it equally as desirable as the Square Deal machine might have been made without infringement on the petitioner's patent.
We are of the opinion that the estimates of value made by witnesses for the petitioner were based largely upon hindsight rather than upon foresight; that it could not be foreseen at March 1, 1913, that the petitioner would enjoy over a period of years the*2557 advantage which it then enjoyed in the economic utilization of wire used in the manufacture of the fence. The patent was not infringed. There was never a demand, so far as the record shows, for a license of the patent and there was never any offer made to the petitioner for the purchase of it. The estimates of value were, we think, colored by the subsequent prosperity of the company. Cf. The Conqueror,166 U.S. 100">166 U.S. 100; W. S. Bogle & Co.,5 B.T.A. 541">5 B.T.A. 541; affd., 26 Fed.(2d) 771. Upon consideration of all of the evidence, we are of the opinion that the fair market value at March 1, 1913, of the application for patent on the Square Deal machine was not in excess of $200,000. A reasonable allowance for exhaustion of the patent for the taxable year ended June 30, 1923, is one-seventeenth of that amount.
The petitioner had a net loss for the fiscal year ended June 30, 1921, of $502,922.34, and net income for the fiscal year ended June *622 30, 1922, in the amount of $48,572.46, without any allowance for exhaustion of its patent on the Square Deal machine in either year. Section 204(b) of the Revenue Act of 1921 provides as follows:
*2558 If for any taxable year beginning after December 31, 1920, it appears upon the production of evidence satisfactory to the Commissioner that any taxpayer has sustained a net loss, the amount thereof shall be deducted from the net income of the taxpayer for the succeeding taxable year; and if such net loss is in excess of the net income for such succeeding taxable year, the amount of such excess shall be allowed as a deduction in computing the net income for the next succeeding taxable year; the deduction in all cases to be made under regulations prescribed by the Commissioner with the approval of the Secretary.
We think that the petitioner is entitled to have its tax liability for the taxable year 1923 recomputed with due allowance for the depreciation of the patent in question in the years 1921 and 1922, to be reflected in the allowable net loss deduction, as well as in the year 1923, in accordance with the foregoing opinion.
Judgment will be entered under Rule 50.