*2998 1. Reduction of closing inventory taken by the petitioner in computing net income for the year 1920 on account of certain goods claimed to have been obsolete at the close of that year, disallowed.
2. The petitioner is entitled to have its profits-tax liability for the year 1920 computed under section 328 of the Revenue Act of 1918.
*225 This proceeding is for the redetermination of deficiencies in income and profits taxes asserted by the respondent in the amounts of $1,475.16 for the year 1919, and $21,133.80 for the year 1920. The issues raised by the pleadings are:
1. Whether the petitioner is entitled to have its profits tax liability for the year 1919 computed under section 328 of the Revenue Act of 1918.
2. Whether the petitioner is entitled to have its profits tax liability for the year 1920 computed under section 328 of the Revenue Act of 1918.
3. Whether there should be excluded from the petitioner's closing inventory for 1920 certain casing elevators which cost $37,373.34, and which the petitioner claims were obsolete and worthless*2999 at that time.
At the trial of this case it was agreed by the parties that the question of the proper comparatives to be used in computing the petitioner's profits-tax liability for 1919 and 1920, in the event the Board should hold that the petitioner is entitled to special assessment for those years or either of them should be left for a subsequent determination under Rule 62 of the Board's rules of practice.
*226 FINDINGS OF FACT.
The petitioner is a California corporation with its principal office and place of business at Oxnard, Calif. It was organized in 1911 with a capital stock of $113,750, of which $75,000 was issued to W. L. Dunn for certain patents; $35,000 to the Oxnard Merchandising Co. for certain other assets; and the remainder was sold for cash. It is and has been since it was organized engaged in manufacturing and selling oil-well tools. For several years prior to 1921 it also sold automobiles and motor trucks.
During the years 1911 to 1918, inclusive, the petitioner employed several men who were engaged exclusively in improving and developing the patents the petitioner acquired upon its organization and in improving and developing other patents*3000 that it purchased subsequent thereto. In this improvement and development work the petitioner expended a large amount of money, all of which was charged to expense. The exact amount of money so expended is not known, but it was at least $100,000. More than two-thirds of the petitioner's income for 1919 and practically all of its income for 1920 was derived from the sale of oil-well tools manufactured under the patents mentioned.
For several years prior to 1918 the petitioner was experimenting with a casing elevator, but had not been successful in developing a market for it. In the year 1918, however, the oil "boom" in the Midcontinent field, particularly in Texas and Oklahoma, created a demand for this type of elevator. The petitioner received orders for its elevators and manufactured and sold many of them in 1919 and the early part of 1920. Sales of the elevators decreased greatly after the first few months of 1920, due to the collapse of the oil "boom," although there were some sales made throughout the remainder of the year. The elevator manufactured by the petitioner was not a tool that could be successfully sold in ordinary competition with other tools of a similar nature, *3001 but the demand for drilling equipment and tools was so great in 1919 that any tool could be sold that would do the work. On December 31, 1920, the petitioner had on hand casing elevators which cost $37,373.34 to manufacture, and they were included in the closing inventory at that amount. The petitioner still has the elevators on hand. Its inventories were all taken at cost. No part of the petitioner's income for 1919 and 1920 was from Government contracts.
The respondent upon audit of the petitioner's income and profits-tax returns for the years 1919 and 1920 determined that for the year 1919 its net income was $224,207.11 and its invested capital $250,455.13; that for the year 1920 its net income was $231,306.72 and its invested capital $423,639.88, and that there are deficiencies in tax in the amounts of $1,475.16 for 1919, and $21,133.80 for 1920.
*227 OPINION.
MARQUETTE: It is the contention of the petitioner that in its closing inventory for the year 1920 there were included certain casing elevators which had cost $37,373.34, but which were in fact obsolete and of no value, and that the inventory should now be adjusted by excluding the elevators therefrom, *3002 and the petitioner's net income for 1920 reduced accordingly. On the record we are unable to agree with the petitioner's contention. It may be that in the light of events occurring since 1920 the elevators in question were worthless at that time, but if they were obsolete and worthless, it does not appear that they were so known to be or considered by the petitioner's officers. While sales of the elevators had fallen off materially since the spring of 1920, some sales had been made throughout the year. The inventory was taken by one of the petitioner's officers and he included the elevators therein at their cost. The only explanation of his action in including the elevators in inventory is his statement made at the hearing of this case that "Well, I overlooked it, I guess that is all." This appears to be a belated claim for a deduction from 1920 income on account of goods on hand at that time which have since proved to be unsalable. On the evidence we hold that the cost should not be excluded from the closing inventory.
The only other question is whether the petitioner is entitled to have its profits taxes for 1919 and 1920 computed under section 328 of the Revenue Act of*3003 1918. The evidence relative to this issue shows that the petitioner on its organization acquired certain patents covering oil-well tools in consideration of the issuance of its capital stock; and that it subsequently acquired other patents by purchase. In order to render the devices covered by the patents of commercial value, it was necessary to develop the patents and make improvements thereon. The petitioner for a number of years prior to 1919 employed several men for that purpose, and as the result thereof perfected certain oil-well tools, from the sale of which it derived the greater part of its income for 1919 and 1920. The cost of this experimental and development work, which resulted in acquisition of capital assets of great value, was at least $100,000, but the exact amount can not now be ascertained. The expenditures were properly capital expenditures, but were charged by the petitioner to expense. We have heretofore held in , that expenditures for the development of patents, processes, etc., may be restored to surplus, on a clear showing that they were in fact capital expenditures, even though they had been charged to expense*3004 and deducted from gross income for income-tax purposes in the year in *228 which they were made. See also, . The expenditures we are here considering were, we think, clearly capital expenditures, and if the amount thereof were known they could properly be restored to the petitioner's invested capital. They can not now, however, be definitely ascertained, and we are therefore confronted with the situation that the cost of certain valuable assets which the petitioner had in 1919 and 1920 and which produced a large part of its income, must be excluded from its invested capital. In view of these facts we are of opinion that the petitioner's invested capital can not be determined, and that it is entitled to have its profits tax computed under section 328 of the Revenue Act of 1918.
Reviewed by the Board.
Further proceeding may be had under Rule 62.