*1340 1. Petitioner and a corporation in which it owned all the stock after May 16, 1926, filed separate income tax returns for the year 1926. Held, that such filing constituted an election to make separate returns under the provisions of section 240(a) of the Revenue Act of 1926 and thereafter it was necessary to obtain permission from the Commissioner to authorize a change to a consolidated returns basis.
2. Amounts spent in the investigation of processes for the manufacture of chemical products from destructive distillation of wood are not deductible in the years expended as ordinary and necessary expenses.
3. Certain payments of bonuses to employees for services rendered in the taxable years, together with regular salaries, were reasonable compensation for services rendered in such years.
*638 The respondent has asserted a deficiency in income tax for the year 1927 in the amount of $2,913.51. Three questions are raised by the pleadings, viz., (1) whether the petitioner was entitled to have its tax liability for the taxable year determined on the*1341 basis of a consolidated return; (2) whether it is entitled to deduct from its gross income for the year certain traveling expenses incurred by its officers and paid by it as ordinary and necessary expenses, and (3) whether it is entitled to deduct from its gross income in such year certain amounts paid as bonuses to its employees.
FINDINGS OF FACT.
The petitioner is a Tennessee corporation, with its principal office at Memphis. It was incorporated in 1911 to engage in the business *639 of destructive wood distillation. The Mississippi Chemical Company, with its principal office at Charleston, Mississippi, was incorporated prior to 1926 to engage in the same business. On May 14, 1926, petitioner acquired all the stock of the Mississippi Chemical Company and thereafter the two corporations were affiliated.
The petitioner and the Mississippi Chemical Company filed separate income tax returns for the year 1926. Beginning January 1, 1927, the two corporations were operated as a unit and their accounts were consolidated in a single set of accounting records. Prior to March 15, 1928, the assistant secretary-treasurer of the petitioner had several conversations with a*1342 revenue agent at Memphis in connection with an income tax return for 1927 and was informed that petitioner had the right to file a consolidated return for such year for itself and its wholly owned subsidiary corporation. Such agent advised that a request be made to the collector's office at Nashville for the necessary forms, which was done. On March 15, 1928, petitioner filed a consolidated return which included all the information necessary to determine its tax liability. Petitioner was never advised that permission from the Commissioner to file a consolidated return was necessary. It made no application for such permission other than in the conversation with the revenue agent and received no such permission in writing either from the Commissioner or any agent of the Bureau of Internal Revenue. Upon audit of the consolidated return the Commissioner rejected the same and held that, having elected to make separate returns for 1926, such election was effective until permission to change to a consolidated basis was received in conformity with section 240(a) of the Revenue Act of 1926.
In the year 1927 the president of the petitioner and a chemical engineer employed by it went*1343 to Europe for the purpose of investigating the production of acetic acid by the so-called Suide process. The expenses of this trip, including salary of the engineer for one month, were paid by the petitioner in the amount of $4,236.82, were taken into its accounts as "deferred charges" and were not claimed as a deduction from income in its income tax return for that year.
The president of the petitioner hoped to make an arrangement for the exclusive use of the Suide process in America. This was not done, but the petitioner installed a so-called pilot plant at its works for the purpose of manufacturing acetic acid. This plant was only partially successful. In 1929 petitioner obtained a license on a royalty basis for the use of the patented Suide process during the life of the patent, which expires some time in 1944. This license is not exclusive and any improvements of the process developed in the petitioner's plant becomes the property of the licensor.
*640 On January 12, 1926, the petitioner by proper corporate action authorized its president to pay bonuses in stock to certain of its employees. Acting upon such authority the president authorized such bonus payments*1344 in the respective amounts of $5,000 and $500 to be made for the year 1927 to H. N. Brisen, Jr., sales manager and T. C. Albin, chemical engineer, whose regular salaries for that year were $5,000 and $6,000, respectively. The total compensation so authorized for such employees was reasonable compensation for services rendered in the taxable year. The corporate authorization specified that bonus arrangements with employees should be evidenced by contracts, but this was not done except by verbal agreements between the employees and the president in conformity with which the bonuses in question were credited on the books of the petitioner as of December 31, 1927, by order of the president and later discharged by the issue of shares of common stock which had a value at the date of such audit of $100 per share.
OPINION.
LANSDON: The petitioner's contention that for the year 1927 it was entitled to file a consolidated return for itself and a 100 per cent owned subsidiary is without merit. Affiliation after May 14, 1926, is admitted by the respondent, but the record shows that for that year each of the affiliated corporations filed a separate income tax return. That procedure was*1345 an election to file separate returns as provided in section 240(c) of the Revenue Act of 1926 1 and article 632 of Regulations 69. 2 Petitioner's sole contention on this issue is that through conversations between one of its employees and a revenue agent it satisfied the requirements of the statute and the regulations. This is not sufficient. The Commissioner was never asked to grant the necessary permission to change to the consolidated basis, nor did he even delegate his discretion or authority to the revenue agent. On this issue the determination of the respondent is affirmed. *641 ; certiorari denied, ; . Cf. ; ; .
*1346 On the second question it is clear that in the taxable year the petitioner spent the amount of $4,236.82 in an investigation of the Suide method of manufacturing acetic acid. It is equally clear that in subsequent years it erected a plant for the use of that method and that it eventually secured a license from the patentee of such method, permitting its use during the life of the patent. The cost of this investigation, of the plant additions and any other expenses incurred in securing such license and in the installation of machinery and equipment for the production of acetic acid were all capital expenditures which we think are deductible ratably from income during the term of the license. ; ; ; . We are of the opinion that this amount was properly accounted for on the books of the petitioner as deferred charges and that it is not deductible from income in the taxable year, as is now contended.
Upon the record we are convinced that the bonus credits of*1347 $500 and $5,000 made to Albin and Boisen in the taxable year were duly authorized and were corporate obligations at December 31 of such year. The officer authorized to make the contracts with the employees ordered the credits. The total amount received by each employee was reasonable compensation for services rendered in 1927. The fact that the stock certificates were not issued until some time in 1928 is not material, since the petitioner was on the accrual basis. Moreover, the credit made as of December 31, 1927, vested the ownership of the specified amount of common stock in the employees as of that date, regardless of the time at which the certificates, which are no more than evidence of stock ownership, were issued. The uncontradicted evidence indicates that the stock was worth $100 per share when the credits were made. On this issue the determination of the respondent is reversed.
Decision will be entered under Rule 50.
Footnotes
1. For the purpose of this section two or more domestic corporations shall be deemed to be affiliated (1) if one corporation owns at least 95 per centum of the voting stock of the other or others, or (2) if at least 95 per centum of the voting stock of two or more corporations is owned by the same interests. This subdivision shall be applicable to the determination of affiliation for the taxable year 1925. ↩
2. Consolidated returns.↩ - Affiliated corporations as defined in section 240(d), irrespective of the basis upon which returns were filed prior to 1926 under section 240(a) of the Revenue Acts of 1924 and 1926, may for 1926 elect to make separate returns or file a consolidated return in which will be reported the consolidated net income of the affiliated group. If return is made upon either of these bases, all subsequent returns must be made upon the same basis except as permission to change may be granted by the Commissioner. In applying for permission to change from one basis to the other there should be submitted a statement in the form of an affidavit executed by a person or persons qualified to sign the returns (see section 239) setting forth completely the reasons for making the request.