1929 BTA LEXIS 2560">*2560 The respondent's determination that a certain patent involved herein had no actual cash value when acquired by the petitioner, approved.
16 B.T.A. 545">*545 This proceeding is for the redetermination of deficiencies in income and profits taxes asserted by the respondent in the amounts of $41,202.61 for the year 1917, and $250.11 for the year 1918. The petitioner alleges that the respondent erred (1) in disallowing a deduction from gross income for 1917 in the amount of $50,000 taken on account of a patent claimed to have become worthless in that year; (2) in excluding from invested capital for 1917 the amount of $50,000, representing the value of said patent, which the petitioner claims to have acquired in exchange for its capital stock, and the amount of $28,644.86, representing dividends paid in 1917 in excess of current earnings reduced by a tentative tax theoretically set aside out of such earnings; (3) in reducing invested capital for 1918 by the amount of $22,576.78, representing additional income and profits taxes for 1917 averaged in accordance with article1929 BTA LEXIS 2560">*2561 845 of Regulations 45, and by the amount of $8,821.56, representing a dividend paid during the year 1918 in excess of current earnings reduced by a tentative tax theoretically set aside out of such earnings; and (4) in denying the petitioner's application for special assessment for the years 1917 and 1918 under section 210 of the Revenue Act of 1917 16 B.T.A. 545">*546 and section 328 of the Revenue Act of 1918. The hearing was limited to the issues other than special assessment.
FINDINGS OF FACT.
The petitioner is a corporation organized under the laws of West Virginia in the year 1902, with a capital stock of $100,000, divided into 1,000 shares of the par value of $100 each, and it is and has been since its organization, engaged in manufacturing and selling malleable iron castings.
Prior to 1914 the petitioner's product consisted principally of a locking device or corner post fastener for metal beds, which it produced without the use of any patent rights or licenses, and which was known as a box type malleable casting. The device sold for about 75 cents per set. At that time the larger manufacturers used a chilled cast locking device to connect the heads, sides and feet of the1929 BTA LEXIS 2560">*2562 metal beds they manufactured, and they continued to use such castings until 1917. While these chilled castings were inferior to the malleable castings produced by the petitioner, in that they weighed 20 pounds per set and were more easily broken, they could be produced for 40 cents per set, and because of that fact the petitioner was unable to secure the business of the larger manufacturers. However, the petitioner prior to 1914 had sold several hundred thousand of the box type malleable castings.
When the petitioner was organized in 1902 it employed, as general superintendent of its foundry, one E. H. Woelffel, who was then and had been for some time connected with the Columbus Malleable Iron Co. Woelffel was made general manager of production by the petitioner in 1905 or 1906. As manager of production he traveled extensively over the eastern half of the United States and sold the petitioner's product and fixed its prices. His duties did not include the development of any patents or improvements of the petitioner's product.
In the year 1912 Woelffel invented a new type malleable locking device or corner post fastener for metal beds, which was superior to the locking device1929 BTA LEXIS 2560">*2563 then manufactured by the petitioner, and also superior to the chilled cast device then used by the larger manufacturers. This new locking device weighed only 6 pounds per set for the regular type of bed and 12 pounds per set for the hospital type of bed, and the regular type could be sold for about 21 cents per set whereas, as above stated, the chilled castings used by the larger manufacturers cost 40 cents per set to manufacture. The new device was also superior to the chilled castings, in that it was practically unbreakable; and it could be more easily produced than the box type malleable casting then being manufactured by the petitioner and at a lower cost per pound.
16 B.T.A. 545">*547 On January 27, 1913, Woelffel made application to the United States Patent Office for letters patent on the new locking device mentioned. Some time thereafter he took up with the officers of the petitioner the matter of the purchase by the petitioner of the rights to him invention. They agreed that, if he could show them by actual sales after making up the pattern that the device had merit, they would consider the matter of purchasing it. On September 7, 1913, and before a patent had issued on said1929 BTA LEXIS 2560">*2564 invention, Woelffel assigned to the petitioner all his rights therein for a stated consideration of $1. On October 7, 1913, the United States issued a patent to the petitioner covering said invention. In 1913 said patent was registered in Canada.
On March 18, 1914, at a general meeting of the stockholders of the petitioner, action was taken as shown by the minutes of said meeting, as follows:
* * *
RESOLVED, That the authorized capital stock of the West VirginiaMalleable Iron Company be increased from one thousand (1000) shares of the par value of one hundred dollars ( $100) each, to two thousand (2000) shares of the par value of one hundred dollard ( $100) each, so that the authorized capital stock of said corporation shall hereafter be two hundred thousand ($200,000) dollars instead of one hundred thousand ($100,000) dollars, as heretofore.
On Motion of Mr. C. R. McCulloch, seconded by Mr. T. Stribling, the following resolution was unanimously adopted:
WHEREAS, E. H. Woelffel obtained patent No. 1074919 for corner post fasteners used by manufactures of beds; and,
WHEREAS, said patent is of great value to this Company by reason of the business in which it is engaged; 1929 BTA LEXIS 2560">*2565 and,
WHEREAS, Pursuant to a prior understanding and agreement between the officers of this Company and W. H. Woelffel that in consideration of the assignment of this patent to this Company he was to receive fifty thousand ($50,000) dollars of the fully paid and non-assessable stock of this Company in payment of same; and,
WHEREAS, This patent has been assigned to this Company and this Company Considers the price to be paid therefor to be fair and reasonable;
RESOLVED, That this Company hereby approves and ratifies the said understanding and agreement between the officers of this Company and the said E. H. Woelffel, and hereby agrees to have issued to the said E. H. Woelffel for the said patent fifty thousand ($50,000) dollars of the fully paid and nonassessable stock of this Company.
RESOLVED FURTHER, That the Board of Directors of this Company be, and they are hereby authorized, empowered and directed to do everything necessary to carry the foregoing resolution into effect, as of this date, when, and as soon as the certificate from the Secretary of the State of West Virginia is received authorizing the increase of the capital stock of this Company from one hundred thousand1929 BTA LEXIS 2560">*2566 to two hundred thousand dollars pursuant to the resolution for that purpose passed at this meeting of the stockholders.
There being no further business, on motion, the meeting adjourned.
(Signed) C. R. MCCULLOCH,
Secretary.
(Signed) J. A. SPENCER,
President.
16 B.T.A. 545">*548 Pursuant to said resolution of the stockholders of the petitioner adopted on March 18, 1914, the capital stock of the petitioner was increased from $100,000 to $200,000. Fifty thousand dollars par value of the additional stock was immediately distributed to the then stockholders and the remaining $50,000 of additional stock was issued to Woelffel. On the same date Woelffel assigned and transferred said $50,000 par value of stock received by him for said patent rights to the stockholders of the petitioner, and it was divided among them in proportion to their then holdings. At that time Woelffel was the owner of 90 shares of the 1,500 shares outstanding.
The balance sheet of the petitioner on December 31, 1913, as shown by its books, was as follows:
| Resources | |
| Real estate | $ 2,500.00 |
| Buildings | 54,500.00 |
| Heating plant | 1,800.00 |
| Machinery | 16,000.00 |
| Furnace equipment | 30,000.00 |
| Furniture and fixtures | 1,300.00 |
| Insurance unearned | 290.00 |
| Material on hand | 33,256.72 |
| Accounts receivable | 22,921.74 |
| Bills receivable | 21,000.00 |
| Cash | 2,706.53 |
| 186,274.99 | |
| Liabilities | |
| Capital stock | $100,000.00 |
| Bills payable | 18,000.00 |
| Accounts payable | 6,112.52 |
| Profit and loss | 62,162.47 |
| 186,274.99 |
1929 BTA LEXIS 2560">*2567 The petitioner's sales during the years 1913 to 1917, inclusive, were as follows:
| 1913 | $213,735.62 |
| 1914 | 117,436.46 |
| 1915 | 141,600.81 |
| 1916 | 242,502.98 |
| 1917 | 425,337.35 |
In the year 1913 the petitioner sold 2,939.3 tons of castings at a net profit of $15.05 per ton. The capacity of the petitioner's plant in 1913 was 16 tons of castings per day, and production was between 8 and 9 tons per day.
During the years 1914 to 1917 the new device mentioned was manufactured and sold by the petitioner. In the year 1917, however, there was placed upon the market by a competitor of the petitioner, a steel hook device, very simple in design and inexpensive to manufacture, which had the effect of rendering obsolete the patented device of the petitioner. After said steel hook was introduced on the market the petitioner was able to make only occasional sales of its malleable locking device, which sales were made only to one concern that had a few customers who still preferred the malleable lock. By the year 1919 the steel hook device was in general use throughout the entire metal bed industry.
16 B.T.A. 545">*549 In its income and profits-tax returns for the years 1917 and 1918, 1929 BTA LEXIS 2560">*2568 the petitioner included in invested capital the amount of $50,000 on account of the patent, or patent rights it acquired from Woelffel in exchange for $50,000 par value of its capital stock, and in its return for 1917 it deducted from gross income the amount of $50,000 as a loss on said patent. The respondent disallowed said deduction, and also excluded from invested capital in each of the years 1917 and 1918 any amount on account of said patent. The respondent also reduced invested capital for the year 1917 by the amount of $28,644.86 and for the year 1918 by the amount of $8,821.56, representing dividends paid during those years in excess of current earnings reduced by a tentative tax theoretically set aside out of such earnings. The respondent also reduced invested capital for the year 1918 by the amount of $22,476.78, representing the additional tax asserted for the year 1917 prorated to the due dates thereof.
OPINION.
MARQUETTE: The first contention of the petitioner is that in 1914 it acquired from Woelffel a patent of the fair market value of $50,000, for which it issued its capital stock in the same amount, and that it is entitled to include in invested capital $50,0001929 BTA LEXIS 2560">*2569 on account thereof, and to deduct that amount as a loss in 1917, when the patent became valueless. The respondent has determined that the patent had no fair market value when the petitioner acquired it, and that no amount should be included in invested capital or deducted from income.
It may be pointed out that even if the patent was worth the amount claimed by the petitioner, there could only be deducted in 1917, assuming that the patent became worthless in that year, the depreciated cost or value at that date. However, in the light of the evidence, we are unable to agree with the petitioner that the patent had any fair market or actual cash value on or prior to March 18, 1914. If it had, the burden is upon the petitioner to establish that fact, and it has failed to meet that burden. The evidence shows that some six months after the right to the patent was assigned to the petitioner, it issued $50,000 par value of its stock to Woelffel, after declaring a stock dividend so as practically to eliminate the then surplus accounts, and that Woelffel and the petitioner's officers entertained hopes that the invention would prove profitable, but it fails to establish any fair market1929 BTA LEXIS 2560">*2570 or actual cash value. On the record we decline to disturb the respondent's determination.
The second question is whether the respondent erred in reducing invested capital for 1917 and 1918 by the amount of dividends in excess of current earnings as reduced by the amount of a tentative 16 B.T.A. 545">*550 tax theoretically set aside out of such earnings, prorated over the taxable years. On this issue our decision is in favor of the petitioner.
L. S. Ayers & Co.,1 B.T.A. 1135">1 B.T.A. 1135.
At the hearing the petitioner conceded that invested capital for 1918 should be reduced by the correct amount of the 1917 taxes, prorated to the due dates thereof.
Further proceeding will be had under Rule 62(b).