*2316 1. During the taxable year, petitioner created, by appropriate instruments, two trusts for the payment of pensions to former employees and officers. Held that the net income of the trusts is not taxable to petitioner, and that the securities and cash contributed to the funds held in trust are deductible from gross income as ordinary and necessary business expenses.
2. Where an inventory of goods in process and finished goods on hand at the close of a taxable year is taken at cost, it should include the amount of bonuses paid to employees who participated in the production of the goods composing the inventory.
3. No error was committed by respondent in allowing as a deduction from gross income instead of as a credit against taxes due the United States, certain income taxes assessed by Great Britain.
4. Special assessment allowed.
*340 This proceeding was instituted for the redetermination of a deficiency of $112,019.98 in income and profits taxes for*2317 the fiscal year ended April 30, 1919, arising out of the rejection in part of a claim in abatement. The issues are whether the respondent erred in:
1. Adding to net income the sum of $5,886.30, representing net income of pension funds created by petitioner.
2. Refusing to allow as a deduction from gross income the amount of contributions of petitioner to the trustees of its pension funds.
3. Adding to the cost of inventories of merchandise in process and finished, a portion of the amount of bonuses paid to employees during the year.
4. Failing to increase invested capital by the amount of money expended to develop and construct capital assets.
5. Refusing to allow a deduction for the exhaustion of Patent No. 1,020,832 based upon its March 1, 1913, value.
6. Refusing to allow a deduction for the exhaustion of Patent No. 1,096,304 based upon the March 1, 1913, value of the patent application.
7. Declining to allow as a credit against income and profits taxes, the amount of certain income taxes assessed by Great Britain.
8. Refusing to assess petitioner's profits taxes under the provisions of section 328 of the Revenue Act of 1918.
FINDINGS OF FACT.
*2318 The petitioner is an Illinois corporation with its principal office in Chicago. During the taxable year, and for many years prior thereto, it was engaged in the manufacture and sale of watch movements.
On September 3, 1918, the board of directors of petitioner adopted a resolution approving rules and regulations for the establishment, operation, and termination of a pension fund for the benefit of its officers and employees. The rules and regulations provided for (1) the creation of the fund; (2) the appointment of five trustees for the fund, consisting of the president, two directors, the factory superintendent and an employee of the petitioner; (3) the election of the trustees; (4) the organization of the board of trustees; and (5) for *341 meetings of the trustees. In addition, the rules and regulations contained the following provisions as amended by the trustees on February 7, 1919, and April 18, 1919, with the approval of petitioner's directors:
SECTION IV - ORGANIZATION OF BOARD OF TRUSTEES
As soon as the full Board of Trustees for said Pension Fund has been elected as herein provided, said Board of Trustees shall meet and organize by electing from their*2319 number a President, Vice-President and a Secretary. The Comptroller of the Elgin National Watch Company shall be ex-officio treasurer of said Pension Fund. The President, Vice-President and Secretary of said Pension Fund shall hold their respective offices for one year, or until their successors are elected.
The duties of the several officers so elected shall be such as usually appertain to their respective offices.
Said Treasurer shall have the custody of all moneys, securities and obligations belonging to said Pension Fund, but he shall at all times deposit any cash coming to his hands in such bank in the City of Elgin, Kane County, Illinois, as shall be designated by said Board of Trustees. Said Treasurer shall also at all times deposit all securities of every kind or character belonging to said Pension Fund in some safety deposit vault to be designated by said Board of Trustees of said Pension Fund, and such securities belonging to said Pension Fund shall only be withdrawn from said safety deposit vault upon the written order of the Board of Trustees of said Pension Fund, or a majority thereof. If the securities and obligations belonging to said Pension Fund are left*2320 in the custody of said Treasurer, access to such securities and obligations may be had according to rules and regulations to be adopted from time to time by the Board of Trustees with the written approval of the President of the Elgin National Watch Company; or, if deemed advisable, upon the vote of the Board of Trustees, with the approval of the Board of Directors of the Elgin National Watch Company, any or all securities and obligations belonging to said Pension Fund may be deposited with some trust company located in Chicago, Illinois, as custodian. In the event of such securities and obligations being deposited with some trust company such trust company shall pay over to said Treasurer the income from such securities. The Treasurer shall deposit all moneys belonging to said Pension Fund in the name of "The Elgin Watch Company's Pension Fund."
All checks drawn upon said Elgin National Watch Company's Pension Fund shall be signed by the Treasurer and the Secretary of the Board of Trustees, or in the absence or inability to act of the Treasurer shall be signed by the Secretary and the President of the Board of Trustees, or in the absence or inability to act of the Secretary shall*2321 be signed by the Treasurer and the President of the Board of Trustees. Payments from said Pension Fund shall only be made after they have been approved by the Board of Trustees and ordered paid.
Said Trustees shall serve without compensation, but all necessary expenses incurred by any of the trustees in attending the meetings of said Board shall be paid out of said Pension Fund.
Three Trustees shall constitute a quorum of the Board for the transaction of business, and it shall require at least three affirmative votes to pass any motion or resolution voted upon by said Board.
*342 SECTION VI - TITLE AND POWER OF BOARD OF TRUSTEES IN RELATION TO FUND.
At least three affirmative votes cast at a regular or special meeting of the Board of Trustees shall be required for the assignment, sale, or transfer of any real or personal property belonging to said fund.
The title, management, and distribution of the fund created hereby shall vest in said Board of Trustees, and said trustees are hereby vested with full power and authority to sell, transfer, invest and reinvest any and all securities or funds belonging to said fund and generally to manage and control the same, *2322 subject only to the limitations in these Rules and Regulations contained.
SECTION VII - CONTRIBUTIONS TO THE FUND.
Officers and employees of the Elgin National Watch Company shall contribute two per cent (2%) of the amount of their several salaries or wages in installments to be deducted by said Elgin National Watch Company at the time of their regular pay days, but no contributions shall be made on any portion of a salary or wage in excess of $4,000 and no pension shall be based or computed on any portion of a salary or wage exceeding $4,000.
Admission to the benefit of this fund shall be optional with those officers and employees who have reached the age, in the case of males, of twenty-one years, and in the case of females, of eighteen years, and who are in the service of the Elgin National Watch Company on the date this fund becomes operative, but all persons thereafter entering the service of the Elgin National Watch Company shall be obliged to join and contribute to the fund when they shall have reached the age, in the case of males, twenty-one years, and in the case of females, eighteen years, as herein provided, and their term of service for computation of pension*2323 shall be considered to commence at the time of their first contribution to the fund. The Board of Trustees is hereby empowered to waive the obligation to join and contribute to the fund in the case of persons of advanced age entering the service of the Company.
SECTION VIII - CONTRIBUTIONS BY ELGIN NATIONAL WATCH COMPANY TO PENSION FUND.
In order to enable the Board of Trustees of said Pension Fund hereby created to successfully carry out the plan of pensioning employees, as herein provided for, the Elgin National Watch Company will, as soon as said Board of Trustees for said Fund shall have been elected and shall have organized by the election of officers, turn over to said Board of Trustees $100,000.00, par value, of Liberty Bonds; and said Elgin National Watch Company will also, Commencing one year from the date of the said initial payment to said Fund. contribute annually to said Fund an amount equal to the aggregate of the contributions thereto of the officers and employees of the Elgin National Watch Company who are contributors to said Fund.
The annual contributions above provided to be made by the Elgin National Watch Company to said Fund may be made at any time*2324 during any current year within which said payment should be made.
The provisions of this Section as to contributions to said Fund by said Elgin National Watch Company is made, however, subject to the right hereby expressly reserved by said Elgin National Watch Company, to discontinue said contributions at any time hereafter at its option, upon declaring said Fund terminated and providing for the liquidation thereof as herein provided.
*343 SECTION IX - COMPUTATION OF PENSIONS, AND PAYMENT
When an officer or employe shall have been in the service of the Elgin National Watch Company continuously for twenty years, or upwards, and shall have attained the age of sixty-five years if male; or fifty-five years if female; and has contributed to said fund for ten years, or more, continuously, he or she as the case may be, shall be entitled to a pension hereunder, computed in accordance with the provisions of this section.
The pension allowed an officer or employe who has contributed to this fund shall be computed on the average annual salary or wage (not to exceed $4,000) which he or she received during the ten years immediately preceding the date of his or her superannuation. *2325 One-fiftieth (1-50th) of which average salary or wage, multiplied by the number of years, (not exceeding twenty-five) he or she has been in the service of the Elgin National Watch Company, plus one-half of one per cent (1/2 of 1%) for each year more than ten during which he or she has contributed continuously to the fund, shall constitute his or her snnual pension.
Pensions will be paid monthly during the continuance of this fund; the first payment to be made on the last day of the month following the date when pension is ordered paid by the Board of Trustees, and the first payment will cover the proper portion of the broken period, and thereafter the pension will be paid monthly on the last day of each month following the awarding of such pension.
Pensions allowed under the provisions of this section, as well as all other pensions or allowances made pursuant to these rules and regulations, are subject to be terminated and said fund liquidated as provided in these regulations.
No other pension or temporary allowance shall be made by said Board of Trustees except as provided in this Section: PROVIDED, HOWEVER, That in any case arising where in equity and good conscience it*2326 may seem to the Board of Trustees that a temporary pension or allowance should be made to any officer or employe who is a contributor to said Fund, but not entitled to a pension under the provisions hereof, in such case the Board of Trustees of said Pension Fund may, in its discretion, recommend to the Board of Directors of the Elgin National Watch Company that such temporary pension or allowance should be made, stating the amount thereof.
In case the Board of Directors of the Elgin National Watch Company should approve such recommendation and order the same paid then said Board of Trustees may award such temporary pension or allowance and pay the same, but said Board of Trustees of said Pension Fund shall have the right to discontinue and stop payment of any such temporary pension or allowance at any time in their discretion, and the Board of Directors of the Elgin National Watch Company expressly hereby reserves the right to order any temporary pension or allowance discontinued, and payment thereof stopped at any time after the same may have been made.
SECTION X - ALLOWANCE TO WIDOW OR CHILDREN OF PENSIONER
For the period of five years following the death of any male pensioner*2327 to whom a pension had been awarded in his lifetime, under the provisions of Section IX of these Regulations, an allowance equal to one-half of his pension shall be paid to his widow, but this allowance shall cease on her remarriage.
If the deceased pensioner leaves no widow or if leaving a widow and said widow dies within a period of five years following the death of the pensioner, then one-half of such pension shall be paid to and divided equally among the *344 children of the pensioner who are under eighteen years of age and unmarried, if such there be, the portion of such pension due to each child shall cease as he or she reaches the age of eighteen years, or in the event of the marriage of any such child prior thereto.
No pension provided for in these Rules shall be continued to either the widow or to her children beyond the period of five years beyond the death of the pensioner.
For the period of five years following the death of a female to whom a pension has been awarded under the provisions of Section IX of these Regulations, leaving a child or children under the age of eighteen years and unmarried, an allowance equal to one-half of her pension shall be paid*2328 to such surviving child or children equally, but that portion of such pension due to each child shall cease as each child reaches the age of eighteen years, or in case of the marriage of any such child prior thereto, and no pension shall continue beyond the period of five years after the death of the pensioner.
SECTION XI - ALLOWANCE TO SIDOW, WIDOWER, OR CHILDREN OF DECEASED CONTRIBUTOR WHO HAS SERVED LESS THAN TWENTY YEARS
In all cases of the death of an officer or employe who has not been in the service of the Elgin National Watch Company continuously for twenty years, or who has not contributed to said Pension Fund continuously for ten years, said Board of Trustees may, at its discretion, recommend to the Board of Directors of the Elgin National Watch Company that a temporary pension be granted to the surviving widow, or widower, of such deceased officer or employe, or in case there shall be no surviving widow or widower, to the children of such deceased officer or employe who are under eighteen years of age and unmarried, which pension shall in no case exceed one-half of the pensions provided for in Section IX hereof.
In case the Board of Directors of the Elgin National*2329 Watch Company approve said recommendation, then and in that event the Board of Trustees of said Pension Fund may grant such temporary pension or allowance, but not otherwise.
In case the Board of Directors of the Elgin National Watch Company shall not approve said recommendation, then the Board of Trustees of said Pension Fund shall direct that all moneys contributed to said fund by said deceased officer or employe with interest at four per cent per annum, less any sum which such officer or employe may owe to the Elgin National Watch Company at the time of his or her death, shall be paid to the widow or widower of such deceased officer or employe, as the case may be, or if there shall be no surviving widow or widower, then to the person designated in writing by such deceased officer or employe, or to his or her legal representatives.
SECTION XII - ALLOWANCE TO CONTRIBUTOR PHYSICALLY INCAPACITATED
Where an officer or employe of the Elgin National Watch Company who has contributed to such fund over five years and who has been in the employ of said Elgin National Watch Company for over ten years, but has not attained the age of sixty-five years, if a male, or fifty-five years, *2330 if a female, shall become incapacitated by ill health or affliction, and such employe shall submit evidence of his or her physical incapacity satisfactory to the Board of Trustees of said Fund, such officer or employe may be permitted to retire from the service of the Elgin National Watch Company and the Board of Trustees of said Pension Fund may recommend to the Board of Directors of the Elgin National Watch Company that a temporary pension or allowance be made to such retiring officer or employe as in their judgment shall seem just and equitable, but in no *345 event shall the amount thereof exceed one-half of the pension provided for in Section IX of these Rules and Regulations. In case said Board of Directors of said Elgin National Watch Company approve said recommendation, then such Board of Trustees may order the same paid.
In the event of an officer or employe being allowed a pension on the ground of ill health before the age of sixth-five, if a male, or fifty-fiveIf a female, such pensioner shall, on the first day of January and July of each year, furnish a certificate of his or her state of health from some physician, satisfactory to the board of Trustees of said*2331 Pension Fund. And in the event that it shall appear that the health of said pensioner has been reestablished, such pensioner shall be liable to be called upon to reenter the service of the Elgin National Watch Company, and in that event such pension shall immediately cease.
The Board of Trustees shall at all times have power to annual or discontinue any such pension when, in the judgment of the Board it is just and proper to do so, such action to be at all times subject to the approval of the Board of Directors of the Elgin National Watch Company.
SECTION XIII - TEMPORARY ABSENCE FROM SERVICE
When an officer or employe of the Elgin National Watch Company who has been a contributor to this fund is out of service of the Company on account of the existing regulations of the factory, by which service terminates after thirty (30) days continuous absence, such absence shall not be considered a break in the continuity of service in the event that such officer or employe shall reenter the service of the Company within six months thereafter, but in such case such absence shall be deducted in computing the length of service of such officer or employe, or in computing his time of service*2332 and contributions to said Pension Fund hereunder:
PROVIDED, HOWEVER, That where equity and good conscience would seem to indicate in any particular case that an absence from service and a failure to contribute for over six months should not be considered as a break in service, the Board of Trustees of said Pension Fund may so recommend to the Board of Directors of the Elgin National Watch Company, and the action of the Board of Directors of said Elgin National Watch Company upon such recommendation shall be final and conclusive.
SECTION XIV - VOLUNTARY RESIGNATION OR DISMISSAL
In case of the voluntary resignation, or dismissal, of any officer or employe from the service of the Company, all payments made by him or her to the Pension Fund, less any amount which such employe may owe to the Elgin National Watch Company, shall be returned to the person so resigning or dismissed, without interest.
The question of cause for dismissal of such officer or employe shall rest entirely with the Board of Directors of the Elgin National Watch Company, and the action of said Board in this respect shall be conclusive, both at law and in equity, that the officer or employe in question has*2333 been properly and legally dismissed.
SECTION XVIII - NO ASSIGNMENT OR ANTICIPATION OF BENEFITS ALLOWED
It is hereby expressly provided that the title to all contributions to said pension fund shall vest in the Board of Trustees of said fund, and no officer or employe who has contributed thereto shall be capable of assigning or transferring any interest in said fund, or of in any manner anticipating by assignment or otherwise the payment of any pension herein or hereunder provided to be *346 made, or of assigning, transferring, or in any manner anticipating the payment of any sum which the Borad of Trustees may order repaid to any contributor of said fund as herein provided.
SECTION XIX - TREASURER OF PENSION FUND TO KEEP ACCURATE BOOKS OF ACCOUNT
The Treasurer of said Pension Fund shall at all times keep accurate books of account of said Pension Fund in which shall be entered all contributions to said fund from every source, and all payments from said fund shall be entered.
The Board of Trustees will cause an annual statement of the condition of said fund to be made and presented to the Board of Directors of the Elgin National Watch Company at the end of each fiscal*2334 year during the life of said fund, and shall cause a copy of said statement to be posted on the bulletin board of each department at the factory.
SECTION XX - POWER OF BOARD TO ORDER AUDIT OF PENSION FUND
SaidBoard of Trustees shall have the power from time to time to order examinations to be made of the condition of said Pension Fund, and all matters connected therewith, and to pay therefor from said Pension Fund.
SECTION XXII - AMENDMENTS
It is hereby expressly agreed by and between the Elgin National Watch Company, a corporation, and the Trustees of the Pension Fund hereby created, and with each and every subscriber to said fund, that these Rules and Regulations do not constitute a contract between the Elgin National Watch Company and the employes there who shall hereafter contribute to said fund, but it is expressly agreed and understood by all concerned that these Rules and Regulations may be altered, amended or changed at any regular or special meeting of the Board of Trustees of said Pension Fund by a majority vote of the Trustees of said Pension Fund and the action of the Board of Trustees of said Pension Fund in that regard shall be subject only to the approval*2335 of the Board of Directors of the Elgin National Watch Company.
PROVIDED, HOWEVER, That said Rules shall not be so amended or altered as to cancel the obligation of the Trustees of said Pension Fund to return to the officers and employes of the Elgin National Watch Company who have contributed to said Pension Fund all money which said officers or employes shall have paid into said Pension Fund in case of the termination and liquidation of said fund with interest thereon at the rate of four per cent per annum, less any payments made to any subscriber or subscribers to said fund on account of pensions or allowances paid to any such subscriber or subscribers and less any sum of money which any subscriber or subscribers may owe to the Elgin National Watch Company at the time of the Termination and liquidation of said fund.
SECTION XXIII - POWERS RESERVED BY THE ELGIN NATIONAL WATCH COMPANY
The Elgin National Watch Company hereby expressly reserves to itself the right:
(a) To terminate the Pension Fund herein and hereby created, and to order the liquidation thereof at any time hereafter throught the Board of Trustees of said Eigin National Watch Company's Pension Fund as herein*2336 provided;
(b) To approve or disapprove, through its Board of Directors, of any pension or allowance recommended to be made by the Board of Trustees of said Pension Fund in any case where such pension or allowance so recommended by the *347 Board of Trustees of said Pension Fund is not provided for by Section IX of these Rules and Regulations.
(c) To determine absolutely at all times and under all circumstances when an employe shall be considered permanently out of service of the Elgin National Watch Company, whether by reason of dismissal, voluntary withdrawal, or otherwise.
(d) To discharge any officer or employe of said Elgin National Watch Company when it shall appear to be in the best interest of the Company so to do.
SECTION XXIV - TERMINATION AND LIQUIDATION OF FUND
The said Elgin National Watch Company hereby expressly reserves to itself the right to terminate said Pension Fund and to liquidate the same at its option at any time hereafter.
In case said Elgin National Watch Company shall elect to terminate said fund and liquidate the same, it shall do so in the following manner:
(a) The Board of Directors of the Elgin National Watch Company shall pass*2337 a resolution notifying the Trustees of said Fund that it has terminated said Fund, and that the same shall be liquidated, and thereupon the Secretary of the Board of Trustees of said Pension Fund shall immediately notify all contributors to said fund that the same has been terminated and is in the process of liquidation, and said Board of Trustees and its officers shall not thereafter receive any further contributions to said Fund from any source whatever.
(b) SaidBoard of Trustees of said Pension Fund shall thereupon, by appropriate action, direct its treasurer to audit or cause to be audited, the account of every officer and employe who has contributed to said fund whose interest therein has not previously been forfeited, paid or adjusted in accordance with these Rules and Regulations.
(c) SaidBoard of Trustees of said Pension Fund shall thereupon direct its treasurer to pay to every officer or employe who has contributed to said Pension Fund and whose interest therein has not been forfeited, paid, or adjusted under these regulations, all sums of money which such officers or employes have respectively contributed thereto with interest thereon at the rate of four per cent, *2338 per annum, less any payments on account of pensions, allowances, or otherwise, made to any such contributor or contributors, and less also any sum, if any, which any such contributor or contributors may at said time be owing to the Elgin National Watch Company.
(d) As soon as all officers and employes who have contributed to said Pension Fund shall have been paid the several amounts respectively found to be due to such contributors, the Board of Trustees shall immediately assign, transfer, and deliver to the Elgin National Watch Company all securities of every kind, name or nature, together with any cash on hand, belonging to said Pension Fund hereby created, and shall thereupon declare said Pension Fund finally terminated and liquidated.
At a meeting held on October 22, 1918, the petitioner's board of directors authorized the president and secretary of petitioner to execute an agreement with the trustees of the pension fund for continuing the payment of certain pensions aggregating $1,075.08 monthly, which the petitioner had been voluntarily paying to 17 former employees. The provisions of the agreement partinent to the questions here are:
NOW, THEREFORE, In consideration*2339 of the premises, The Elgin National Watch Company agrees with said Board of Trustees of said Elgin National Watch *348 Company's Pension Fund that in case said Board of Trustees shall assume and take over the payment of said voluntary pensions hereinbefore referred to, and the management of a fund to be created, to provide an income from which to pay said voluntary pensions, that the Elgin National Watch Company will assign, transfer and turn over to said Board of Trustees $50,000.00, par value, Chicago & Northwestern Railroad Company 4% Extension Bonds and $50,000.00, par value, Chicago, Burlington & Quincy Railway Company General Mortgage Bonds and also 1274 shares of the American Watch Case Company of Toronto, the denominations and serial numbers of said bonds and said shares of stock being attached hereto, and the sum of $39,970.39 in cash upon the following terms and conditions, namely:
(1) SaidBoard of Trustees of said Pension Fund shall have the power to sell and assign said securities on the approval of the Board of Directors of the Elgin National Watch Company, and shall invest and reinvest the cash belonging to said Fund and the income thereof and generally to manage*2340 the same.
(2) SaidBoard of Trustees of said Pension Fund shall keep said fund so to be turned over to it, as a separate and distinct fund.
(3) Shall collect all interest, dividends and income arising therefrom:
(4) Shall apply the interest, dividends and income arising therefrom, so far as the same will extend, to the payment of said voluntary pensions herein mentioned.
(5) When said fund is terminated either by the death of the pensioners named or by the affirmative action of the Eigin National Watch Company, the Board of Trustees of said Pension Fund shall immediately assign and deliver all securities, cash, and accretions to said fund to whomsoever the board of Directors of the Elgin National Watch Company shall direct.
(6) SaidBoard of Trustees of said Pension Fund will at all times hereafter, during the life of the special fund hereby created, pay only to such pensioners and in such amount as the Elgin National Watch Company may from time to time direct.
(7) The pension paid to any pensioner or pensioners herein named shall automatically lapse at the death of any such pensioner or pensioners.
(8) That it will pay said voluntary pensions monthly on the last*2341 day of each month.
Said Elgin National Watch Company further agrees with said Board of Trustees of the Elgin National Watch Company's Pension Fund that in case the income from the fund hereby created is insufficient to pay the voluntary pensions herein provided to be paid from time to time as directed by it, that it will furnish to said Board of Trustees from time to time sufficient money to pay such voluntary pensions as the same become due and payable.
Said Board of Trustees of the Elgin National Watch Company's pension fund in consideration of the agreements of the Elgin National Watch Company herein contained, hereby agrees to receive said funds and securities;
To carefully keep the same invested; to collect the interest, dividends and income arising therefrom; to pay the voluntary pensions hereinbefore mentioned as directed by the Elgin National Watch Company, and to pay any additional voluntary pensions that said Elgin National Watch Company may direct to be paid, and to keep the fund hereby created as a separate special fund, and to observe all the conditions herein set forth relative to the care and management of said fund.
IT IS FURTHER AGREED Between the parties*2342 hereto that the said Board of Trustees of said Pension Fund shall not receive any compensation for their *349 services in administering the fund hereby created, but said Board of Trustees may pay any items of expense which are actually necessary incident to the management of said fund, but no such items of expense shall be paid until the same have been approved by said Board of Trustees and ordered paid.
Said Board of Trustees shall keep, or cause to be kept, accurate books of account in which shall be set down all receipts on behalf of said fund and all expenditures therefrom for whatever purposes made.
IT IS FURTHER AGREED BETWEEN THE PARTIES HERETO, That the Elgin National Watch Company hereby expressly reserves to itself the right to terminate and discontinue said special fund at any time hereafter at its option, and in the event of said Elgin National Watch Company electing to terminate said fund, it shall formally notify the Board of Trustees of said Elgin National Watch Company's Pension Fund in writing of its election so to do, and thereupon the said Board of Trustees of said Elgin National Watch Company's Pension Fund shall immediately cease payment of any such*2343 pensions and shall order an audit of said special fund.
IT IS FURTHER EXPRESSLY AGREED Between the parties hereto that when the voluntary pensions above mentioned shall expire, either by the death of the pensioners, or by the affirmative action of the Board of Directors of the Elgin National Watch Company discontinuing the same, then the Board of Directors of the Elgin National Watch Company hereby specifically reserves to itself the right -
First: To direct that said special fund with its accretions be retained by the Board of Trustees of the Elgin National Watch Company's Pension Fund and added to its general pension fund.
Second: Or to direct that said fund and all its securities and accretions be properly assigned, transferred and delivered to the treasurer of the Elgin National Watch Company at its option.
Third: And in either event to declare said fund fully liquidated.
On October 24, 1918, the petitioner, in accordance with section VIII of the rules and regulations for the management of the general pension fund, and the provisions of the agreement entered into with the trustees for the management of its special pension fund, transferred the following*2344 securities to the trustees:
$100,000 par value 4 1/4% U.S. Liberty bonds
$50,000 per value 4 1/4% external bonds of the Chicago & Northwestern R.R. Co.
$50,000 par value 4% general mortgage bonds of the Chicago, Burlington & Quincy R.R. Co.
1,274 shares of common stock of the American Watch Case Co. of Toronto, of the par value of $127,400.
The cost of the securities, and the fair market value of the bonds on the date of their transfer, were as follows:
| Cost | Market value | |
| Liberty bonds | $100,000.00 | $96,800 |
| C N.W.R.R. Co | 50,000.00 | 41,250 |
| C., B. & Q.R.R. Co | 50,000.00 | 41,750 |
| Am. Watch Case Co | 70,029.61 |
*350 The securities transferred to the pension funds were deposited in a safe-deposit box by the trustees in the name of the Elgin National Watch Co.'s pension fund, and were always kept apart from securities owned by petitioner. The first dividend paid on the American Watch Case Co. stock after the transfer was paid to the petitioner, the record holder of the stock. The dividend, amounting to $7,644, was paid to the trustees by the petitioner on January 22, 1919. On November 19, 1923, the stock was reissued in the name of the trustees. *2345 The books of account kept by the trustees for the pension funds were separate and distinct from the books of the petitioner.
During the taxable year the petitioner contributed the sum of $39,970.39 to the special pension fund as provided for in the agreement approved by its directors on October 22, 1918. On April 30, 1919, the petitioner accrued the sum of $25,000 on its books on account of the general pension fund. The amount accrued was paid to the trustees in the following fiscal year. During the taxable year the petitioner kept its books on the accrual basis of accounting.
During the fiscal year ended April 30, 1919, the petitioner paid its employees salaries and wages totaling $3,393,170.52.
All of the aforementioned contributions to the pension funds, including the item of $25,000, were claimed as deductions from gross income for the taxable year and were disallowed by the respondent.
The parties have stipulated that the respondent increased petitioner's net income for the taxable year by $5,886.30, this figure being the amount of net income of the pension funds during the year.
Petitioner's inventory of goods in process and finished at the close of the taxable*2346 year was taken on the basis of cost. During the taxable year, petitioner paid to its employees bonuses totaling $614,937.65, under the following notices signed by petitioner's president:
May 27, 1918. A war bonus of 10% placed on the earnings during March, April and May will be paid as soon after June 11 as the rolls can be made up to all persons in the employ of this company on the date said payment is made. Also beginning on July 21 and continuing until further notice a monthly war bonus of 10% based on the earnings of the previous month will be paid on the second pay day in each month to all persons in the employ of this company on that date.
July 1, 1918. On July 21 an extra war bonus of 2% of their earnings for the first six months of the current year will be paid to all persons now in our employ and who remain in our employ until that date; also an extra war bonus of 6% of their earnings for the last six months of the year 1918 will be paid on January 21, 1919, to all persons who are now or within one month hereafter become our employees and remain continuously in our employ until that date. The above payments are additional to the regular monthly war bonus of*2347 10% established by our notice of May 27, 1918.
August 23, 1918. The regular monthly war bonus announced in our notice of May 27, 1918, has been increased from 10% to 15%, which is payable in *351 accordance with the terms of that notice on all salaries and wages earned since July 31 last. We take advantage of this opportunity to impress on employees the importance to themselves of keeping up the number and efficiency of the factory personnel. Our ability to continue to pay these additional wages depends on our having a large production to sell and that can only come from a permanent force of trained workers constantly employed.
November 27, 1918. The present regular monthly war bonus of 15% will continue to be paid up to February 21, 1919, on which date it will be increased to 25% based in every case on the earnings of the previous month and will continue at that rate for a period of six months thereafter. We are unable to guarantee it for a longer period on account of the uncertainties with regard to future general business conditions. After the payment on January 21, 1919, of the extra 6% war bonus announced in our notice of July first last no extra war bonuses*2348 will be paid. Attention is called to the fact that war bonuses are payable only to those who are in our employ on the date such bonuses are paid.
In computing the cost of goods in process and finished goods on hand April 30, 1919, the petitioner did not include any part of the bonuses paid to its employees during the taxable year.
The respondent determined the cost of petitioner's inventory of goods in process and finished goods on hand at the close of the taxable year by including an undisclosed portion of the bonuses paid during the year as being allocable to the cost of such goods.
On March 1, 1913, the petitioner owned, and during the taxable year it used in its business, United States Patent No. 1,020,832, issued March 19, 1912, covering a gauge designated to measure the width of the opening of a single and double roller fork in watches so as to enable a jeweler to select the proper size jewel pin without damaging the fork. Prior to March 1, 1913, the petitioner manufactured and sold about 1,000 of the gauges.
On July 23, 1912, G. E. Hunter, an employee of petitioner, filed an application with the United States Patent Office for a patent on an invention relating*2349 to certain improvements in the winding mechanism of watches. On May 12, 1914, Letters Patent No. 1,096,304 were issued to G. E. Hunter, assignor to petitioner, for the invention.
On March 31, 1904, the petitioner (designated as the party of the first part) entered into a written agreement with the Keystone Watch Case Co. of Philadelphia, Pa., by the terms of which the petitioner agreed to confine its sale of watch movements and materials for export trade to the latter. The agreement contained, among other things, a clause providing maximum prices at which the movements to be furnished by the petitioner under the contract were to be taken in fixing the export prices for complete watches, and the following provisions:
11. All losses by reason of bad debts, non-payment of accounts, &c., are to be borne by the parties hereto in the proportion that their respective goods, to wit: the movements and watch cases bear to the total amount.
*352 12. The expenses incurred in the conduct of the export business including the maintenance of the foreign offices, &c., shall be borne by the parties hereto in the proportions that their respective goods, to wit: the movements and materials*2350 and the cases bear to the total amount of the sales. A monthly statement of said expenses shall be furnished by the party of the second part to the party of the first part, and settlement thereof shall be promptly made. $16. The party of the first part will further so regulate the prices of the
16. The party of the first part will further so regulate the prices of the them in foreign markets at the same price or below the price at which movements of corresponding or competing grades are sold in the domestic markets.
Pursuant to the provisions of section 12 of the agreement, at some undisclosed time the petitioner paid to the Keystone Watch Case Co. the sum of $18,526.90 to reimburse it for taxes paid to Great Britain upon income earned therein under the contract during the fiscal year ended April 30, 1919.
In determining the deficiency in controversy, the respondent allowed the sum as a deduction from gross income and declined to allow it as a credit against income and profits taxes due the United States for the fiscal year ended April 30, 1919.
The invention covered by Patent No. 1,020,832 was invented by Lewis K. Malvern, an employee of petitioner, with the assistance*2351 of other employees. The invention was under consideration for a long period of time. Sometime prior to March 19, 1912, the date of the issue of the patent, the inventor assigned his right, title and interest in and to the invention to the petitioner. Malvern did not keep a record of the time spent by him in developing the invention and did not receive any compensation for inventing the article, other than his regular salary for performing his ordinary duties. The time cards prepared by Malvern during the period the invention was being developed did not include any capital charge for work done on the invention.
On October 31, 1916, the United States Patent Office issued Letters Patent No. 1,202,925 to Frank D. Urie, director of petitioner's observatory, for an invention relating to the receiving, recording and comparing of radio time signals. It took the inventor about eight months to develop the invention. The device was invented on the petitioner's time and with the help of its facilities. The inventor did not have an agreement with petitioner requiring him to assign his invention to the petitioner in case a patent was issued therefor. Several months after the patent was*2352 issued, the inventor assigned the patent to the petitioner for a recited consideration of $1, which consideration was never paid. The patent was used by the petitioner during and prior to the taxable year for comparing radio time signals sent from Washington with its time signals. The device enabled petitioner to record radio time signal variations of *353 one one-hundredth of a second. The petitioner is unable to determine the amount of time the inventor spent working on the invention.
During the taxable year the petitioner used in the conduct of its business, shipping boxes for watch movements manufactured under Patent No. 1,331,263 issued by the United States Patent Office on February 17, 1920, to George E. Hunter, an employee of petitioner, under an application for patent filed June 27, 1917. The boxes constructed under the patent enabled petitioner to transport watch movements to jobbers and retailers without scratching the dials thereof or otherwise damaging the movements.
The petitioner did not pay anything to George E. Hunter for developing Patents Nos. 1,096,304 and 1,331,263 other than his regular salary for performing his customary work. No charge was made*2353 for overhead for inventing the patents and no part of the cost of either patent was capitalized.
The petitioner's capital account for patents had a balance on December 31, 1900, of $138,727.06, after deducting credits thereto of $45,449.23 for royalties. Prior to that date it had trade-marks and trade names but did not have any capital accounts therefor. The patent account was charged off the books May 1, 1916. Between May 23, 1899, and October 23, 1917, the petitioner registered a total of 20 trade-marks and trade names with the United States Patent Office, none of which expired prior to the taxable year. Some of its trade names were also registered in various foreign countries. The employees of petitioner who developed the foregoing trade-marks did not receive any compensation for their services other than their regular salary.
On January 1, 1901, the petitioner made effective a policy of charging to expense, instead of capitalizing, all expenditures made in connection with the acquisition of patents, trade-marks and trade names, including the fees of governments for registering, and the fees of attorneys for procuring the registration of such assets. The petitioner's*2354 books did not in the years 1919 and 1921, and do not now, contain any capital accounts for intangible assets, including patents, trade-marks and trade names. It is impossible to determine from petitioner's books the amounts it expended for the acquisition and registration of trade-marks and trade names.
In connection with the operation of its business prior to and in the taxable year, the petitioner was required to, and did, because of market conditions, design and construct machinery for manufacturing watch movements as well as machines to build such machines. About 10 per cent of the machinery used by petitioner in *354 the taxable year was acquired by purchase and the remainder was built by it. Such records as were kept of the cost of constructing a machine were confined to the cost of the machine itself, which did not include any amount for drafting, experimenting, developing, or "tuning up" work. The cost of the "tuning up" work was charged to expense or repairs. The petitioner did not always make a record of the cost of rebuilding machines constructed by it.
The machinery cost records kept by the head of petitioner's machine department and delivered by him to*2355 petitioner's factory superintendent, in charge of finished machinery, did not include any charge for overhead, experimental work, or wages paid to draftsmen for designing the machines. The cost figures turned in by the machine department were increased 23 per cent at the close of the year, when the machinery inventory was taken. Of the 23 per cent by which the cost figures were increased, 13 per cent was to cover overhead in the machine department and the balance of 10 per cent was to cover general expense items in the department. Nothing was added to the cost figures for taxes, depreciation, insurance or salaries of general officers. At the close of the taxable year petitioner's factory superintendent prepared, in accordance with the above described method, and submitted to petitioner's Chicago office the following inventory:
| Used or in use | |||
| Watch machinery: | |||
| Manufactured | $1,720,978.74 | ||
| Bought | 108,206.59 | ||
| $1,829,185.33 | |||
| Factory machinery: | |||
| Manufactured | 301,501.09 | ||
| Bought | 72,677.21 | ||
| Shafting: | |||
| Manufactured | 59,094.00 | ||
| Bought | 35,121.47 | ||
| 468,393.77 | |||
| Patterns | 100,334.26 | ||
| Expense: | |||
| Manufactured | 280,735.66 | ||
| Bought | 29,671.69 | ||
| 310,407.35 | |||
| Factory fixtures: | |||
| Manufactured | 128,206.58 | ||
| Bought | 18,511.88 | ||
| 146,718.46 | |||
| Watch tools: | |||
| Manufactured | 76,563.91 | ||
| Bought | 2,038.76 | ||
| 78,602.67 | |||
| $2,933,641.84 | |||
| New - Unused | |||
| Watch machinery: | |||
| Manufactured | $38,882.64 | ||
| Bought | |||
| Factory machinery: | |||
| Manufactured | $4,898.06 | ||
| Bought | 1,255.84 | ||
| Shafting: | |||
| Manufactured | 2,677.52 | ||
| Bought | 4,568.32 | ||
| 13,399.74 | |||
| Expense: | |||
| Manufactured | 133,490.40 | ||
| Bought | 452.14 | ||
| 133,942.54 | |||
| Factory fixtures: | |||
| Manufactured | 2,946.77 | ||
| Bought | 824.22 | ||
| 3,770.99 | |||
| Watch tools: | |||
| Manufactured | 96.09 | ||
| Bought | 293.27 | ||
| 389.36 | |||
| Supplies | 8,526.98 | ||
| $198,912.25 | |||
| 3,132,554.09 |
*2356 *355 The figures were entered on the books as submitted, with the exception that the amount for used factory and watch machinery was reduced 5 per cent, and the figure for petterns was decreased 75 per cent.
Machinery built by petitioner was installed by its employees. The wages paid to employees for installing machinery were charged to an expense account designated as "Factory Machinery Repair." None of such expense was ever capitalized. The time cards kept for work done repairing machinery in use and installing new machinery did not differentiate between the two classes of work. All of the pay-roll cards kept by petitioner for the years from 1909 to 1921 or 1922, with the exception of a few cards for the year 1909, were destroyed by petitioner in the years 1922 or 1923. The cost of installing the machinery can not be determined at the present time.
Petitioner's employees also constructed several small factory buildings, erected and installed electrical, fire and power equipment and constructed other property designated as factory and ground fixtures. Prior to 1919 the petitioner designed, and in that year used in its business, an undisclosed number of plates for*2357 various kinds of watch dials. The cost of making these plates was charged to expense and can not be determined at this time. No overhead was ever charged to the cost of any of this property.
In addition to drawing all of the designs for the machinery built by petitioner, the employees of petitioner's drafting department, *356 numbering about eight men in the taxable year, drew designs for watches, small factory buildings and for the installation of ground fixtures and factory equipment. The time cards kept for the employees of the drafting department did not show the amount of time spent by them on particular jobs. The wages of the draftsmen, amounting to $166,025.70 in the years 1908 and 1916, inclusive, were charged to expense.
The petitioner sold its watch movements exclusively to jobbers. In 1870, and between 1876 and 1918, inclusive, petitioner expended a total of $2,255,977.33 for advertising. Petitioner has no record of the amount spent for advertising between 1871 and 1875, both inclusive. Petitioner also employed men to call on retail jewelers for the purpose of interesting them in its product. The salaries and other expenses of these employees from 1880*2358 to 1916, amounting to about $525,000, were charged to expense. A great deal of this advertising had for its purpose the building up of future business rather than of making immediate sales. Prior to the taxable year petitioner also gave away an indeterminable number of watches as prizes for window displays.
For about 20 years prior to the taxable period it was the policy of petitioner to repair watches of its manufacture without cost upon complaint of an owner that his watch was not performing satisfactorily. Petitioner's books do not disclose the cost of making such repairs. The petitioner also replaced an undisclosed number of watches damaged beyond repair by the San Francisco fire or earthquake and certain floods in Massachusetts and at Dayton, Ohio. The object of performing this service for the public wsas to enhance the standing of petitioner's watches.
In February or March, 1925, all of petitioner's books of account up to January 1, 1925, including cash books and journals, were, with the exception of general ledgers, voluntarily destroyed.
The sales and net income of petitioner for the years from 1886 to 1917, were:
| Year ended Apr. 30 | Sales | Net income |
| 1886 | $1,975,880.83 | $497,744.50 |
| 1887 | 2,430,306.08 | 597,069.48 |
| 1888 | 2,513,744.53 | 792,486.58 |
| 1889 | 2,780,684.62 | 843,291.86 |
| 1890 | 3,061,638.43 | 925,604.06 |
| 1891 | 3,421,440.02 | 1,241,921.30 |
| 1892 | 3,338,035.32 | 902,083.91 |
| 1893 | 3,053,635.32 | 732,801.60 |
| 1894 | 1,358,331.40 | 267,695.19 |
| 1895 | 1,399,184.16 | 274,104.91 |
| 1896 | 1,743,157.31 | 318,481.87 |
| 1897 | 1,443,326.50 | 140,053.38 |
| 1898 | 2,251,241.91 | 354,775.85 |
| 1899 | 2,155,542.68 | 315,481.77 |
| 1900 | 2,336,334.02 | 499,921.02 |
| 1901 | 3,181,514.32 | 1,001,556.49 |
| 1902 | $3,293,225.10 | $1,106,375.18 |
| 1903 | 3,183,467.95 | 974,899.22 |
| 1904 | 3,428,728.55 | 995,849.41 |
| 1905 | 3,259,645.67 | 964,368.60 |
| 1906 | 3,562,718.89 | 894.318.57 |
| 1907 | 3,861,195.49 | 793,224.38 |
| 1908 | 3,669,120.40 | 639,631.76 |
| 1909 | 3,342,513.80 | 661,881.17 |
| 1910 | 3,744,657.22 | 666,529.99 |
| 1911 | 3,449,590.58 | 527,928.06 |
| 1912 | 3,085,852.70 | 556,789.66 |
| 1913 | 3,844,386.83 | 439,688.22 |
| 1914 | 4,027,570.66 | 361,424.19 |
| 1915 | 3,135,843.93 | 237,916.48 |
| 1916 | 4,070,597.10 | 603,124.23 |
| 1917 | 5,689,997.26 | 1,137,186.36 |
*2359 *357 The total sales, net income and amount expended for advertising during the years 1903 to 1909, both inclusive, and 1910 to 1916, inclusive, were:
| Sales | Net income | Advertising | |
| 1903 to 1909 | $24,307,390.75 | $5,925,173.11 | $595,924.89 |
| 1910 to 1916 | 25,358,499.02 | 3,393,400.83 | 996,659.56 |
The sales price of watch movements increased 20 per cent from 1910 to 1916.
The sales were, for 1919, $8,096,849.94; 1920, $9,599,784.89; and 1921, $9,537,801.72.
The petitioner's factory at Elgin, Ill., is situated on a plot of ground of about 22 acres donated by the citizens of Elgin in or about the year 1865.
In his computation of invested capital for the taxable year respondent did not include any amount for intangible assets.
OPINION.
ARUNDELL: In his determination of petitioner's tax liability for the taxable year, the respondent not only taxed it on the net income of the two pension funds, amounting to $5,886.30, but disallowed as deductions for ordinary and necessary business expenses the cost of the securities assigned to the trustees of the funds, totaling $270,029.61; the cash payment of $39,970.39 to the special fund; and the item*2360 of $25,000 accrued on its books April 30, 1919, for liability as a contributor to the general fund. The respondent's action in each instance was based upon the ground that the instruments establishing the funds created not a taxable entity separate from the petitioner, but merely an agency forming a part of its business.
In Orr v. Yates,209 Ill. 222">209 Ill. 222; 70 N.E. 731">70 N.E. 731, the Supreme Court applied the following test for determining whether the instrument before it created a trust:
It may be conceded that the declaration of a trust must be reasonably certain in its material terms, and that this requisite of certainty includes, first, the subject-matter of property embraced within the trust; second, the beneficiaries or persons in whose behalf the trust is so created; third, the nature and quantity of interests which they are to have; and, fourth, the manner in which the trust is to be performed. If the language is so vague, general, or equivocal that any one of these necessary elements of the trust is left in real uncertainty, the trust must fail, or, if any one of the three things necessary to constitute a trust is wanting (that is, first, sufficient*2361 words to raise it; second, a definite subject; and, third, a certain or ascertained object), the trust will fail. It is not practicable to adopt any specific definition of a trust which can be applied in all cases. Many attempted definitions are to be found in *358 the textbooks and decided cases, but is unimportant here to accept one rather than another. All must agree that it is not necessary to the validity of a trust that every element necessary to constitute it must be so clearly expressed in detail in the instrument creating it that nothing can be left to inference or implication. No particular form of words are necessary, but, language of the instrument and the terms employed, such intention will be supported by the courts. Fisher v. Fields, 10 Johns, 495; 2 Story's Eq. Jur. § 980; Hagan v. Harney,147 Ill. 281">147 Ill. 281, 35 N.E. 219">35 N.E. 219.
The court in Osborn v. Rearick,325 Ill. 259">325 Ill. 259; 156 N.E. 802">156 N.E. 802, said:
Any agreement or contract in writing made by a person having the power of disposal over property, whereby such person agrees or directs that a particular parcel of property or a certain fund shall*2362 be held or dealt with in a particular manner for the benefit of another, in a court of equity raises a trust in favor of such other person against the person making such agreement. 1 Perry on Trusts, § 82; Whetsler v. Sprague,224 Ill. 461">224 Ill. 461, 79 N.E. 667">79 N.E. 667; Fox v. Fox,250 Ill. 384">250 Ill. 384, 95 N.E. 498">95 N.E. 498. If the writing makes clear the existence of a trust, if it states a definite subject and object, it is not necessary that every element required to constitute it must be so clearly expressed that nothing is left to inference or implication. Orr v. Yates,209 Ill. 222">209 Ill. 222, 70 N.E. 731">70 N.E. 731. "If the writing makes clear the existence of a trust, the terms may be supplied aliunde." Kingsbury v. Burnside,58 Ill. 310">58 Ill. 310, 11 Am. Rep. 67">11 Am.Rep. 67; Cagney v. O'Brien,83 Ill. 72">83 Ill. 72.
To the same general effect see the citations in Hibbard, Spencer, Bartlett & Co.,5 B.T.A. 464">5 B.T.A. 464.
Each of the instruments creating the pension funds provides that the contributions of the contributors are to be held by the trustees under definite conditions for the benefit of certain specified persons. Petitioner ceased to*2363 have any beneficial interest in amounts contributed by it as soon as it made a payment except the possibility of a reversion upon the liquidation of the trusts at some indefinite time in the future.
Throughout the taxable year the trusts functioned in accordance with the terms of the instruments. The trustees received the income from the securities and cash held by them, paid sums to pensioned officers and employees of petitioner as provided for in the trust agreements, and sold some of the securities at a loss.
The respondent cites N. H. Boynton,11 B.T.A. 1322">11 B.T.A. 1322, as being a case having facts more analogous to those obtaining here than the Hibbard case, supra, relied upon by petitioner. We not only think the Boynton case has many distinguishing facts, but are of the opinion that the reasons for holding here that valid trusts exist are as persuasive, if not more persuasive, than they were in the Hibbard case.
Applying the rules of law applicable to the creation of trusts to the facts before us, we conclude that all the requisites of a valid trust are present. From this conclusion it necessarily follows that the *359 respondent erred*2364 in taxing petitioner on the net income of the two trusts. Hibbard, Spencer, Bartlett & Co., supra.
The respondent contends that in case we hold that valid trusts exist we should not allow a deduction for the securities contributed to the funds or the accrued item of $25,000. As to the initial contributions of $100,000 par value of Liberty bonds to the general pension fund, the respondent argues that it should be treated as in the nature of a capital expenditure, and as to the securities contributed to the special fund, his contention against their deductibility is based upon the theory that petitioner did not part with any right or title in the principal of the assets.
We are unable to agree with the view expressed that the contribution of Liberty bonds to the general pension fund should be considered a capital expenditure and not a business expense. The transfer to the securities to the trustees of the fund operated to divest the petitioner of all its right, title and interest in the bonds except a reversionary interest. Thereafter the trustees had the custody and control of the securities and were entitled to receive the profits therefrom for the purposes*2365 of the trust. The transaction did not result in the acquisition of an asset for use in petitioner's business for several years, but actually reduced its resources. While it can not be doubted that the petitioner derived a benefit from the expenditure, it is not one which should be capitalized.
In Hibbard, Spencer, Bartlett & Co., supra, we held that the payment made to a fund for the purpose of paying pensions to retired employees was reasonably connected with the taxpayer's business, and it having been stipulated that the payment did not make the total compensation of each employee unreasonable in amount, the contribution was allowed as a business expense. No contention is being made here that the contributions of Liberty bonds when added to the wages and salaries paid during the taxable year made the total compensation to petitioner's employees unreasonable in amount, and because of the small amount involved in comparison with the total wages and salaries paid to active employees during the taxable year, the figure being about 3 per cent, we see no reason to question it.
What we have said concerning the contribution of Liberty bonds to the general pension*2366 fund applies to a considerable extent to the payments of securities to the special fund, created and managed for the benefit of employees to whom petitioner had been paying pensions. As we have heretofore pointed out, the only interest the petitioner retained in any of the securities transferred was a reversionary interest. Until the liquidation of the trust in the manner provided for, the trustees were entitled to receive the benefits of the securities free from any interest therein of the petitioner.
*360 In addition to the cost of the securities and cash paid to the trustees, the petitioner is claiming as a deduction from gross income, the sum of $25,000 accrued on its books at the close of the taxable year under its liability to contribute annually to the general fund an amount equal to the payments of its officers and employees. By the provisions of section VIII of the rules and regulations adopted for the operation of the fund the liability of the petitioner to make annual contributions was not to commence until one year from the date of the initial payment and could be paid any time within the current year. The initial payment of Liberty bonds was made on October 24, 1918, less*2367 than one year prior to April 30, 1919, the date on which the liability was accrued on the corporate books. It is quite obvious that since the petitioner's liability to make annual contributions to the general fund was not to become effective until October 24, 1919, no part of the amount in question accrued during the taxable year.
There remains for decision under this issue the question of whether the deduction for the securities should be on the basis of cost or market value at the time of their transfer, there being proof that the market values of the bonds were less than their cost. The petitioner failed to prove the market value of the stock.
The issue as presented to us for decision is broad enough to allow the petitioner a loss on such of the securities as had a market value of less than cost and to increase its income by the amount of any excess of market value over cost. Because of this condition it is not necessary for us to decide whether the deduction should be measured by the cost or market value of the securities, since the final result would be the same, regardless of the basis we adopted to compute the deduction.
*2368 The cost of the securities transferred to the funds, amounting to $270,029.61, and the cash payment of $39,970.39, a total of $310,000, are deductible from gross income in the taxable year as ordinary and necessary expenses. See Hibbard, Spencer, Bartlett, & Co., supra, and Live Stock National Bank,7 B.T.A. 413">7 B.T.A. 413.
In fixing the cost of petitioner's inventory of goods in process and finished goods on hand at the close of the taxable year, the respondent included an undisclosed portion of the bonuses paid during the year as being allocable to the cost of such goods. It appears that there is no dispute about the actual amount included. Petitioner contends that since in many instances the labor for which the bonuses were paid had played its part in the production of goods prior to the issuance of the several bonus announcements, no part of the bonuses should be included in the cost of the inventory.
The bonus announcements introduced into the record clearly show that part of the bonuses paid in the taxable year was for services *361 performed by employees during that period in the production of the goods in the inventory, and no evidence was*2369 offered to show that the amount paid for such services was different from that determined by the respondent. On this issue the respondent is sustained.
While a great deal of evidence was introduced into the record to show the expenditure of large sums of money prior to the taxable year for the development and construction of capital assets, such as good will, trade-marks, patents, small factory buildings, etc., it fails to prove that any specific amount charged to expense should be restored to capital. In their brief counsel for the petitioner do not claim to have proved the exclusion from invested capital of any definite sum. In these circumstances we decline to disturb respondent's determination of invested capital.
Two of the three witnesses whose depositions petitioner introduced into the record expressed the opinion that Patent No. 1,020,832 had a fair market value on March 1, 1913, of $150,000. The other witness testified that the patent had a value on that date of not less than $100,000. The latter witness failed to show sufficient experience in the valuation of property of this character to entitle his opinion to weight. Another witness, G. V. Dickinson, an officer*2370 of the petitioner corporation for many years, frankly admitted that if he had been called upon on March 1, 1913, to value the patent as of that date, he could not have done so. The remaining witness on this question displayed some experience in the sale of patents of an undisclosed character. This valuation of the patent was, however, predicated almost entirely upon the sales of watch parts and movements after March 1, 1913, and the use of the patented device by 5,000 jewelers in connection with the repair of watches of Elgin and other manufacture. The evidence is that not more than 1,000 of the gauges were distributed prior to March 1, 1913. No proof was made that there were 5,000 of the gauges in use at any time after the basic date or that all or any portion of the sales of watch parts and movements were directly attributable to the patent, and, if so, that they could have been reasonably anticipated on March 1, 1913. On the record as made it is our opinion that the respondent must be sustained on this point.
Petitioner is claiming exhaustion on Patent No. 1,096,304, issued May 12, 1914, on an application therefor filed July 23, 1912, based upon a March 1, 1913, value of*2371 the application of $50,000. The opinion of the witness, Hansen, who testified to this value is not supported by any facts as to the effect the invention would have, or had, on future sales of watch movements; the extent to which the invention was an improvement in the art; public demand for watch movements covered by the application; whether the invention enabled petitioner to reduce the production cost of its product, and, if so, the *362 amount, or any other pertinent facts to enable us to test the accuracy of his judgment. Furthermore, the witness has not shown any special knowledge of the watch business, such as the petitioner is engaged in, or any particular knowledge of values to be attached to improvements in the mechanism of watch movements. Under these circumstances we must decline to accept the witness' opinion as proof of the value on March 1, 1913, of the patent application.
The petitioner's argument in favor of the allowance of the sum of $18,526.90 paid to the Keystone Watch Case Co. on account of income taxes assessed by Great Britain as a credit against income and profits taxes due the United States, instead of as a deduction from gross income, is based*2372 upon the theory that the latter company paid the taxes as its agent.
Section 238(a) of the Revenue Act of 1918 provides, in part, that there shall be credited against taxes imposed by its provisions, the amount of any income, war-profits and excess-profits taxes paid to a foreign country upon income derived from sources therein. Section 200 of the same act provides that the term "paid" for the purpose of credits, means "paid or accrued" or "paid or incurred."
The petitioner made no attempt to prove the foreign law under which the taxes were assessed or the time of payment of the taxes. Without proof of these facts we are unable to determine whether the taxes accrued or were paid in the taxable year so as to bring the item within the provisions of section 238(a) of the taxing act.
We are unable to agree with the conclusion of petitioner that the contract of March 31, 1904, pursuant to the terms of which the taxes were paid, appointed the Keystone Watch Case Co. as agent for the sale of complete watches in foreign countries. The purpose of the instrument was to create an arrangement for the sale in foreign countries of watch movements manufactured by petitioner and watch cases*2373 manufactured by the Keystone Watch Case Co., combined as a complete watch, by the latter company, the selling expenses to be borne by the respective parties according to the proportions set forth in the agreement. That this business was to be carried on by the Keystone Watch Case Co. in its individual capacity and not as agent for the petitioner seems clear from a provision in the preamble to the agreement that "the export business wherein the product of both of the parties to this agreement combined as complete watches should be conducted exclusively by the party of the second part." The statement attached to the deficiency letter shows that the taxes were not assessed against either the petitioner or the Keystone Watch Case Co., but against the Keystone Watch Case Co., Ltd., a foreign corporation, the stock of which was owned by the latter company. It therefore appears that the taxes were paid in the first instance by the Keystone Watch Case Co., Ltd., a corporation whose business connection, *363 if any, with the petitioner has not been shown. We find no error in the respondent's treatment of the item as a business expense instead of a credit.
The remaining issue is*2374 whether petitioner is entitled to special assessment.
Proof was made that in the year 1870 and for the years from 1876 to 1918, inclusive, there being no record of the amount spent during the years 1871 to 1875, petitioner expended in its business a total of $2,255,977.33 for advertising to bring about immediate as well as future sales, and in addition thereto expended about $525,000 from 1880 to 1916, inclusive, for salaries and expenses of traveling men engaged in calling upon retail jewelers, not for the purpose of making direct sales, as the petitioner sold its watch movements exclusively through jobbers, but to acquaint them with the advantages of handling Elgin watches as compared with watches of other manufacture, and otherwise inform them of its product. Prior to the taxable year, the petitioner also replaced, free of charge, watches damaged beyond repair by the San Francisco fire and earthquake, and certain floods at Dayton, Ohio, and in Massachusetts. All these advertising and watch replacement costs were charged to expense.
There can be little, if any, doubt that these expenditures, representing a substantial sum, resulted in the acquisition of an intangible asset*2375 from which the petitioner reaped a benefit in future years. This fact is illustrated by the sales of petitioner, which, in 1917, were considerably in excess of those for any prior year.
There is no competent evidence before us from which to determine what part of the total amount expended to create current sales and future business should be treated as a capital expenditure, and accordingly included in invested capital. This condition brings the case within the rule announced in Northwestern Yeast Co.,5 B.T.A. 232">5 B.T.A. 232. See, also, Mead Cycle Co.,10 B.T.A. 887">10 B.T.A. 887, and George W. Casewell Co.,14 B.T.A. 15">14 B.T.A. 15.
During the taxable year the petitioner owned and used in the conduct of its business, four valuable patents. The cost of developing these patents was charged to expense and because of the manner in which petitioner kept its books, it is not possible to make an accurate determination of the amount of such cost.
No consideration other than their regular salary for performing their customary duties was paid to employees for developing trade-marks and trade names. These costs, as well as the fees charged by attorneys for registering*2376 the trade-marks and trade names, were charged to expense after January 1, 1901, and their amount can not now be determined.
*364 About 90 per cent of the machinery used by the petitioner was designed, constructed, and installed by its employees. The portion of the total cost capitalized did not include any charges for drafting, or for experimenting, developing, installing, or "tuning up" work, or overhead. The cost of installing the machinery can not be determined, and because of the absence of this cost, there is no basis for fixing the amount of overhead properly chargeable thereto. Inability to determine accurately the cost of machinery used, as here, in the production of a material part of income, is, as we held in Akron Rubber Mould & Machine Co.,12 B.T.A. 1252">12 B.T.A. 1252, ground for allowing special assessment. All or part of the cost of many other capital items, including plates for making watch dials, factory fixtures and small factory buildings, was charged to expense. A large part of the cost of acquiring these capital assets, all of which had their part in producing income, can not be determined.
From a consideration of all the facts of record we*2377 are of the opinion that petitioner's invested capital can not be determined under the provisions of section 326 of the Revenue Act of 1918 and that it is entitled to have its tax liability determined under the provisions of section 328.
Reviewed by the Board.
Further proceeding will be had under Rule 62(c).