*2111 1. Affiliation allowed.
2. Notes given petitioner covering the amount of an indebtedness that had been charged off as worthless held not to be accruable as taxable income under the facts in this case.
3. Value and useful life of certain rights to manufacture and sell shipbuilding machinery determined for exhaustion purposes.
4. Amount advanced for experimental work on inventions to acquire the manufacturing and selling rights thereto, allowed as a loss.
5. Debt ascertained to be worthless and charged off in the taxable year allowed as a deduction.
6. Amount paid an employee upon the termination of his services held to be deductible as compensation for services rendered.
*450 Proceeding for the redetermination of a deficiency of $3,569.87 in income and excess-profits taxes for 1920. The issues are: (a) Whether petitioner was affiliated with the Shipbuilder's Machinery Company from January 1, 1920, to September 14, 1920, inclusive; (b) whether certain notes of the Groton Iron Works constitute*2112 taxable income; (c) the amount of depreciation allowable on rights for the manufacture and sale of shipbuilding machinery; (d) whether amounts advanced for experimental work on inventions are deductible as losses; (e) whether the balance in an account covering loans made is deductible as a bad debt, and (f) whether an amount paid an employee is deductible as compensation for services rendered.
*451 FINDINGS OF FACT.
The petitioner, a Washington corporation with its principal office in Seattle, Wash., prior to and during 1920 was engaged in the manufacture and sale of machinery.
The Shipbuilder's Machinery Company, A Washington corporation, was organized by the stockholders of petitioner on May 21, 1918, with a capital stock of $50,000, divided into 500 shares each of the par value of $100. All of its capital stock was issued to H. B. Perine, S. W. Fuertel, S. H. Borrow, and C. D. Buchner. Borrow sold his stock in 1919 to the Shipbuilder's Machinery Company.
On May 28, 1918, the petitioner assigned to the Shipbuilder's Machinery Company certain rights, patterns, machines and other personal property for the manufacture and sale of certain shipbuilding machinery, *2113 together with orders amounting to about $10,000 for such machinery. The assignment gave the assignee the exclusive manufacturing and selling rights on all of the machines except the angle beveling machine.
The capital stock of the two corporations from January 1, 1920, to September 14, 1920, was owned as follows:
| Perine Machinery Company | Shipbuilder's Machinery Company | |||
| Shares | Per cent | Shares | Per cent | |
| H. B. Perine | 340 | 68 | 166 | 33 1/3 |
| S. W. Fuertel | 160 | 32 | 167 | 33 1/3 |
| C. D. Buchner | 167 | 33 1/3 | ||
| Total | 500 | 100 | 500 | 100 |
The stock owned by Buchner was acquired by the petitioner September 15, 1920, without consideration.
Perine was president of petitioner, and treasurer and a trustee of the Shipbuilder's Machinery Company. Fuertel was president and a trustee of the Shipbuilder's Machinery Company and secretary and treasurer of petitioner. For nine or ten years prior to 1920 and in that year until about April, when he voluntarily left its service, Buchner devoted all of his time to his duties of salesman for petitioner. He was also vice president and a trustee of the Shipbuilder's Machinery Company until he left the employ of*2114 petitioner. The sales department of the Shipbuilder's Machinery Company was managed by Fuertel, and Perine had charge of the corporation's construction and repair work. They managed and directed all of the affairs of the Shipbuilder's Machinery Company. Buchner never took part in the management of the affairs of that corporation.
*452 For some undisclosed time prior to the organization of the Shipbuilder's Machinery Company the petitioner was doing a large volume of business, and the manufacture and sale of shipbuilding machinery was interfering with the operation of other branches of its business. The Shipbuilder's Machinery Company was incorporated for the purpose of eliminating this interference and acting as a selling agent of petitioner. In 1920 it did act as a selling agency for petitioner. It had no plant or equipment other than models and patterns, transacted its business from the office of petitioner, never paid any dividends, and its minute book reflects no meetings of its stockholders and trustees after the organization meeting on May 28, 1918, other than a meeting of the trustees held on September 27, 1918. The records and accounts of both corporations*2115 were kept by the same bookkeeper. Such funds as the Shipbuilder's Machinery Company required to conduct its business were advanced by the petitioner.
In 1919 the Groton Iron Works was indebted to the Shipbuilder's Machinery Company for machinery. The Shipbuilder's Machinery Company charged off the account as worthless in 1919 after its president had been verbally advised by the receiver for the Groton Iron Works that the debtor would never be able to liquidate the indebtedness. In 1920 the Groton Iron Works was reorganized, and thereafter in 1920 it paid the Shipbuilder's Machinery Company $602 in cash and gave it two notes, each in the amount of $1,205.15. In 1921 the debtor made a further cash payment of $200 on the account and gave its note for the balance. No further payments have been made on the account. In December, 1921, the debtor was declared a bankrupt. The Shipbuilder's Machinery Company reported the cash payment of $602 as taxable income in 1920. It did not place any value on the notes received and did not include them in its gross income for 1920.
Machinery manufactured by the Shipbuilder's Machinery Company under the rights assigned to it by petitioner*2116 on May 28, 1918, was sold by the former to shipbuilders throughout the world. Its sales of the machines in 1918 amounted to $267,000. At the time the rights to manufacture and sell the machines were acquired the rights had a value of $50,000, and a useful life of five years.
In 1918 the petitioner and W. F. Watkins entered into an agreement wherein the latter agreed to give the former the exclusive manufacturing and selling rights on certain prescribed inventions and patented articles, together with such other devices as he might thereafter develop, in consideration of the payment to him, among other amounts, of the sum of $40 per week as advance royalty and his expenses in developing other inventions. Pursuant to the terms *453 of this contract, in 1920 petitioner paid to Watkins the sum of $3,743.21 for experimental work on inventions. None of such work produced any valuable articles and in 1920 the inventions were abandoned by the petitioner. The inventions worked on in 1920 were different from those on which experiments were conducted by Watkins in 1919. Petitioner has never recovered any part of the cost of the experimental work.
In 1920 H. G. Nordeen was indebted*2117 to the petitioner in the amount of $851.32 for loans. In that year Nordeen had no property. The account was ascertained to be worthless and charged off in 1920.
The employment contract of C. D. Buchner with petitioner provided for the payment of a bonus in addition to a salary and commissions. Pursuant to this agreement, on September 15, 1920, petitioner paid to Buchner the sum of $1,500 representing bonuses and commissions due him for services rendered. No part of the sum was paid for stock of the Shipbuilder's Machinery Company.
OPINION.
ARUNDELL: The respondent held that the petitioner was affiliated with the Shipbuilder's Machinery Company for the period in 1920 after September 15, but denied affiliation from January 1, 1920, to that date.
It is apparent from the evidence that the Shipbuilder's Machinery Company was organized to serve, and during the period in controversy did serve, merely as a department or branch of petitioner. For some time prior to its incorporation the shipbuilding machinery branch of petitioner's business was interfering with the efficient operation of its other activities. To correct this undesirable situation, the stockholders of petitioner*2118 organized the Shipbuilder's Machinery Company, and the petitioner promptly assigned to it the exclusive manufacturing the selling rights on certain shipbuilding machinery. All of the corporation's authorized capital stock was issued to Perine, Fuertel, Buchner, and Borrow, and it does not appear that any of them paid any consideration for the stock. Borrow disposed of his stock in 1919. From January 1 to September 15, 1920, Perine and Fuertel, the sole stockholders of petitioner, each owned one-third of the outstanding capital stock of the Shipbuilder's Machinery Company, the remainder of the stock being held by Buchner, an employee.
The stockholders of petitioner managed and controlled the activities of the Shipbuilder's Machinery Company. The petitioner financed the business of the Shipbuilder's Machinery Company without *454 any interference by Buchner. The two corporations did business from the same office and used the same bookkeeper and otherwise conducted their affairs as a business unit. Buchner left the employ of the Shipbuilder's Machinery Company in April, 1920, and in September of that year, when a settlement was made under his employment contract, he assigned*2119 his stock to his employer without consideration.
We think the corporations are entitled to affiliation for the period in question. See ; ; ; .
In determining the proposed deficiency the respondent included the Groton Iron Works notes in the gross income of the Shipbuilder's Machinery Company at their face value. The account was charged off as worthless in 1919, based upon information received from the debtor's receiver that nothing ever would be paid on the account. The small cash payment made in 1920 was not expected and thereafter only $200 was paid on the indebtedness. In our opinion, in 1920 the prospects of ultimately collecting the indebtedness were not such as to require the Shipbuilder's Machinery Company to accrue the notes on its books as taxable income. Accordingly, this issue is decided in favor of petitioner.
The uncontradicted evidence here is that the manufacturing and selling rights assigned to the Shipbuilder's Machinery Company in 1918 had a value for exhaustion*2120 purposes of $50,000, and that their useful life was not in excess of five years. In computing the consolidated net income of the two affiliated corporations for 1920 there should be allowed as a deduction for exhaustion of these assets, the sum of $10,000. .
The advances made to Watkins in 1920 were made with the expectation that the experiments would result in the acquisition of valuable manufacturing and selling rights on the inventions. The experimental work, however, did not result in the creation of any asset of commercial value, and the inventions on which the work was performed were abandoned in 1920 as worthless. Petitioner's entire outlay of capital, amounting to $3,743.12, produced no valuable results and no part of the expenditure has been recovered. The amount advanced represents a loss sustained in 1920.
We have found as a fact that the indebtedness due petitioner by Nordeen in the sum of $851.32 was ascertained to be worthless and charged off in 1920. In that year petitioner not only pressed Nordeen for payment of the account, but definitely ascertained that he had no property out of which a judgment for the amount*2121 due could be collected. The respondent admits in his answer that the account *455 was charged off as of December 31, 1920, and the testimony of petitioner's witness is that the entry charging off the amount was made in 1920. The account is deductible as a bad debt ascertained to be worthless and charged off in 1920.
Respondent contends that a portion of the $1,500 paid to Buchner in September, 1920, was in payment for his stock in the Shipbuilder's Machinery Company and a portion for services. The evidence is that all of the amount was in payment of bonuses and commissions for services rendered. Accordingly the whole sum is deductible in 1920 as compensation paid for services rendered by Buchner to petitioner.
Reviewed by the Board.
Decision will be entered under Rule 50.
MORRIS, TRAMMELL, and MURDOCK dissent on the question of affiliation.