*2974 1. Value of patents acquired for stock disallowed in computing invested capital on account of lack of proof of value.
2. Exhaustion of patents based on March 1, 1913, value disallowed for lack of proof of value.
*1202 In this proceeding petitioner seeks a redetermination of its tax liability for the year 1919, for which the Commissioner has determined a deficiency of $1,623.47. Petitioner alleges error on the part of the Commissioner (a) in disallowing the amount of $4,367.01 of a deduction of $12,218.07 taken by the petitioner for depreciation of machinery, furniture, fixtures, drawings, tools, etc.; (b) in refusing to allow any depreciation on patents protected by letters patent of the United States or applications therefor acquired by the petitioner for stock; (c) in holding that the net loss of the National Stamp Vending Co. was $3,268.50 for the period from March 16, 1919, to December 31, 1919, and that only $1,280.44 thereof was applicable to the period of affiliation between that company and the petitioner, *2975 which period was from September 9, 1919, to December 31, 1919, and in consequence holding that $1,280.44 only was deductible as a loss from the consolidated net income of the petitioner and its affiliated corporations; (d) in failing to allow as a deduction certain bad debts of the National Stamp Vending Co. in the amount of $3,776.53, which were ascertained to be worthless and charged off during the period of affiliation from September 9, 1919, to December 31, 1919; (e) in failing to allow as a deduction a total loss of useful value due to obsolescence of certain property of the National Stamp Vending Co. consisting of patents costing $5,000, patterns and dies costing $16,500, stamp vending machines costing $6,875, and die-cutting photos costing $300; (f) in failing to allow as a deduction an amount of $2,865.42, representing the net loss of the Altis Finance Co.; (g) in refusing to include in invested capital any part of the value of certain patents and applications for patents acquired by the petitioner for stock in 1911; (h) in reducing the invested capital of the petitioner by the amount of an additional assessment of income tax for 1917 which was not determined until after the*2976 taxable year in question, and the amount of which remained in the business of the petitioner during the taxable year; (i) in reducing the invested capital of the National Stamp Vending Co. *1203 by $596.65 and in failing to allow as its invested capital the sum of $30,546.47, and in failing to allow as the invested capital of the Altis Finance Co. the sum of $1,700.
FINDINGS OF FACT.
Petitioner is a corporation organized under the laws of the State of Illinois, with its principal office at Chicago, Ill.
Since the organization of the petitioner in 1901 its business has been the manufacture and sale of optical projection instruments, apparatus, accessories and supplies, including motion picture projection machines, stereopticons, and magic lanterns. Its moving picture projection machine is known to the trade as Motiograph De Luxe. About 90 per cent of the manufactured articles of the petitioner were protected by letters patent.
On July 1, 1911, the petitioner had an actual earned surplus of $147,913.71 in addition to its capital stock of $5,000. On or about that date A. C. Roebuck, then practically the sole owner of the stock of the petitioner, subscribed for an*2977 increase of capital stock in the amount of $245,000 par value consisting of $120,000 par value of common stock and $125,000 par value of preferred stock. On July 21, 1911, A. C. Roebuck in consideration of $1 and other valuable considerations assigned to the petitioner all his right, title and interest in and to the following described letters patent:
Letters for Lens Boxes for Stereopticons, etc., dated March 28, 1905;
Letters for Lime Light Fixtures, dated May 2, 1905;
Letters for Lime Light Fixtures, dated June 27, 1905;
Letters for Film Reeling Mechanisms, dated May 15, 1906;
Letters for Stands or Tripods, dated July 9, 1907;
Letters for Separator Strips for Slide Racks, dated July 7, 1908;
Letters for Shutter Mechanisms, dated January 12, 1909;
Letters for Film Reeling Mechanisms, dated April 27, 1909;
Letters for Kinetoscopes, dated July 13, 1909;
Letters for Kinetoscopes, dated November 9, 1909;
Letters for Kinetoscopes, dated April 19, 1910;
Letters*2978 for Film Reeling Mechanisms, dated June 14, 1910;
Application filed August 20, 1906, Serial No. 331,258, for Slide Changers;
Application filed, February 11, 1909, Serial No. 477,436 for Optical Projection Apparatus;
Application filed April 21, 1909, Serial No. 491,310 for Optical Projection Apparatus;
Application filed April 21, 1909, Serial No. 491,311, for Kinetoscopes;
Application filed October 14, 1909, Serial No. 522,676, for Kinetoscope Safety Shutters, being a renewal of application filed November 27, 1907, Serial No. 404,091;
Application filed May 26, 1910, Serial No. 563,438, for Kinetoscopes;
Application filed May 22, 1911, Serial No. 628,837, for Rewinding Mechanism;
*1204 As a result of this assignment petitioner canceled the stock subscriptions for the additional capital stock of a par value of $245,000 and canceled a personal account amounting to $2,204.50, and issued to A. C. Roebuck such additional stock fully paid and nonassessable.
Some time after the issuance of the increased capital stock of A. C. Roebuck a journal entry was made as of July 1, 1911, as follows:
| Patents and Copyrights | $99,290.79 | |
| Surplus Account | 147,913.71 | |
| To Subscription Account | $247,204.50 |
*2979 Entry to show payment of increased capitalization of $245,000 as subscribed for.
Surplus account of the petitioner from July 1, 1911, to January 1, 1919, as taken from its books, is as follows:
| ENTERPRISE OPTICAL MFG. CO. | |||
| Surplus account | |||
| Dr. | Cr. | Net cumulative additions to surplus | |
| July 1, 1911, balance | $147,913.71 | ||
| July 1, 1911 1 | $147,913.71 | ||
| Dec. 31, 1911, profit and loss | 14,081.21 | $14,081.21 | |
| Dec. 31, 1912, profit and loss | 5,236,96 | 19,318.17 | |
| Dec. 31, 1913, profit and loss | 992.73 | 20,310.90 | |
| Dec. 31, 1914, profit and loss | 6,489.87 | 26,800.77 | |
| Dec. 31, 1914 dead accounts J 344 | 2,916.23 | 15,666.77 | |
| Dec. 31, 1914, dead stock J 345 | 8,217.77 | ||
| Dec. 31, 1915, profit and loss | 18,887.38 | ||
| Dec. 31, 1915, bonus to A.C.R., J 390 | 1,748.93 | ||
| Dec. 31, 1915, bonus to O.F.S. 390 | 1,105.87 | ||
| Dec. 31, 1915, special tools - Depreciation, J 390 | 1,400.00 | 30,299.38 | |
| May 31, 1916, A. C. Roebuck - Bonus J 403 | 1,748.93 | ||
| Dec. 31, 1916, profit and loss | 26,766.28 | 58,814.56 | |
| Dec. 31, 1916, Premium - Capital stock 2 J 451 | 10,000.00 | 48,814.56 | |
| Dec. 31, 1917, profit and loss | 13,103.60 | 61,918.16 | |
| Dec. 31, 1917, balance | 61,918.16 | ||
| 235,220.67 | 235,220.67 | ||
| Jan. 1, 1918, balance | 61,918.16 | ||
| Dec. 31, 1918, profit | 703.61 | ||
| 62,622.77 | |||
| Jan. 1, 1919, balance of surplus | 62,622.77 |
Subsequent to the assignment of patents and applications for patents certain patents were granted as follows:
granted July 18, 1911.
granted June 10, 1913.
granted April 29, 1913.
granted March 11, 1913.
granted October 17, 1911.
granted September 3, 1912.
granted April 30, 1912.
These patents became the property of the petitioner.
*1205 Prior to July 1, 1911, A. C. Roebuck permitted the petitioner to manufacture articles covered by the patents and applications for patents owned by him. Such permission, however, was upon sufferance only. A. C. Roebuck was practically the sole stockholder of the petitioner at that time, owning $4,800 par value of the $5,000 par value stock outstanding; the remaining two shares being held as qualifying shares only.
*2981 A correct statement of the assets and liabilities of the petitioner as of June 30, 1911, before the increase in capitalization referred to, is as follows:
| Trial balance after closing, June 30, 1911 | |||
| Inventory accounts: | Dr. | Cr. | |
| Circular advertising | $78.50 | ||
| Sundry advertising | 74.75 | ||
| Camera | 237.70 | ||
| Copyrights | 270.00 | ||
| Cuts and catalogue sundries | 3,509.91 | ||
| Drawings | 3,280.63 | ||
| Office furniture and fixtures | 2,863.05 | ||
| Shop furniture and fixtures | 3,297.76 | ||
| Insurance | 325.00 | ||
| Machinery | 21,929.24 | ||
| Merchandise | 61,232.02 | ||
| Models | 5,532.28 | ||
| Motiograph catalogue account | 345.44 | ||
| Negatives | 2,920.35 | ||
| Office supplies and stationery | 266.75 | ||
| Patterns | 7,740.34 | ||
| Patents cost account | 1,934.50 | ||
| Postage | 65.00 | ||
| Taxes | 82.51 | ||
| Special tools, dies, jigs, etc | 22,225.11 | ||
| Small tools | 1,764.54 | ||
| $139,975.38 | |||
| Accounts receivable: | |||
| Customers' accounts | 32,336.83 | ||
| F. A. Clerk | 100.00 | ||
| E. A. Schultz | 50.00 | ||
| A. C. Roebuck | 14,220.25 | ||
| H. Wallance | 400.00 | 47,107.08 | |
| Cash on hand | 169.30 | ||
| J. A. King - Note account | 207.84 | ||
| Adjustment account | $1,094.41 | ||
| Bank | 1,127.86 | ||
| Bills payable | 12,500.00 | ||
| Capital stock | 5,000.00 | ||
| Accounts payable | 19,823.62 | ||
| Surplus and undivided profit | 147,913.71 | ||
| 187,459.60 | 187,459.60 |
*2982 *1206 The following table shows the basis of the rates of depreciation used by the Commissioner in computing the depreciation allowance for the items in schedule (a)(18) of the return filed by the petitioner for 1919 and the correct rates and amount of depreciation:
| Correct depreciation | Deduction allowed by Commissioner | ||||
| Items | Cost | Rate | Amount | Rate | Amount |
| Per cent | Per cent | ||||
| 1. Cuts, Electros, etc.: | |||||
| Balance Jan. 1, 1919 | $2,566.59 | 25 | $641.65 | 25 | $641.65 |
| Additions 1919 | 152.67 | 12 1/2 | 19.08 | ||
| 2. Drawings: | |||||
| Balance Jan. 1, 1919 | 124.39 | 50 | 62.20 | 25 | 31.10 |
| Additions 1919 | 1.44 | 25 | .36 | ||
| 3. Furniture and fixtures: | |||||
| Balance Jan. 1, 1919 | 3,342.57 | 10 | 334.26 | 10 | 334.26 |
| Additions 1919 | 299.50 | 5 | 14.97 | ||
| 4. Machinery: | |||||
| Balance Jan. 1, 1919 | 17,914.26 | 10 | 1,791.43 | 10 | 1,791.43 |
| Additions 1919 | 2,283.28 | 5 | 114.16 | ||
| 5. Models: | |||||
| Balance Jan. 1, 1919 | 1,009.48 | 50 | 504.74 | 25 | 252.37 |
| Additions 1919 | 235.13 | 25 | 58.78 | ||
| 6. Patterns: | |||||
| Balance Jan. 1, 1919 | 3,433.95 | 50 | 1,716.98 | 25 | 858.49 |
| Additions 1919 | 695.74 | 25 | 173.93 | ||
| 7. Small tools: | |||||
| Balance Jan. 1, 1919 | 1,583.20 | 25 | 395.80 | 25 | 520.80 |
| Additions, 1919 | 1,125.50 | 12 1/2 | 140.68 | ||
| 8. Special tools, dies, jigs, etc.: | |||||
| Balance Jan. 1, 1919 | 3,704.50 | 50 | 1,852.25 | 25 | 926.13 |
| Additions 1919 | 30.52 | 25 | 7.63 | ||
| 9. Designs and patent: | |||||
| Investigation expense - Balance Jan. 1, 1919 | 1,905.00 | 50 | 952.50 | 25 | 476.25 |
| 10. Development: | |||||
| Balance Jan. 1, 1919 | 4,000.00 | 50 | 2,000.00 | 50 | 2,000.00 |
| 11. Models on safety razor: | |||||
| Balance Jan. 1, 1919 | 74.34 | 25 | 18.58 | 25 | 18.58 |
| Additions 1919 | 90.43 | 12 1/2 | 11.30 | ||
| Total | 45,072.49 | 10,811.28 | 7,851.06 | ||
| Depreciation allowed by commissioner | 7,851.06 | ||||
| Additional amount allowed | 2,960.22 |
*2983 The deficiency asserted by the respondent is based on a computation of the consolidated net income of three corporations, consisting of the petitioner, the Amusement Supply Co. and the National Stamp Vending Co., which the Commissioner properly held to be affiliated within the meaning of section 240 of the Revenue Act of 1918. In computing the consolidated net income a deduction of $4,087.65 is allowable representing the net loss sustained by the National Stamp Vending Co. instead of the sum of $1,868.30 as set forth in the Commissioner's letter of August 29, 1924.
OPINION.
TRAMMELL: Issues (d), (e), (f), (h), and (i) were abandoned by the petitioner at the hearing. Therefore, the action of the Commissioner in respect to those issues is approved. Issue (a) was settled as set forth in the findings of fact, by stipulation. The petitioner is, accordingly, allowed as a deduction for depreciation an *1207 amount of $10,811.28 in lieu of $7,851.06 allowed by the Commissioner. Issue (c) was also settled by stipulation. Therefore, the petitioner is entitled to a deduction of $4,087.65, representing the net loss sustained by the National Stamp Vending Co. instead of the*2984 amount of $1,886.30 as set forth in the Commissioner's letter of August 29, 1924.
There remain but two issues - (1) the amount to be included in invested capital with respect to the patents acquired in 1911, and (2) the deduction allowable on account of the exhaustion thereof.
In determining the amount of invested capital with respect to the patents, we must first decide whether they were acquired for stock or were acquired for something else, that is, the cancellation of an indebtedness. The petitioner treated the transaction on its books as amounting to the capitalization of the earned surplus to the extent of $147,913.71, and valued the patents and copyrights at $99,290.79. Roebuck was for all practical purposes the sole owner of the stock of the corporation. He had certain patents and applications which he desired to transfer to the corporation. The transaction took the form of a stock subscription for the additional stock, which represented not only consideration for the patents, but also the surplus of the corporation.
In his opening statement counsel for the petitioner stated that they were not able to determine the value of the patents, but had to measure it by*2985 the stock issued therefor. While the transaction took the form of a cancellation of indebtedness for stock, the substance of the transaction was that the stock was issued in part for patents and applications. It appears that the entire transaction was pursuant to a plan of Roebuck, the sole stockholder. On the other hand, if we look only to the form, we have no evidence as to the terms of the subscription agreement. We do not know whether there was a definite and fixed liability to pay for the stock in cash. We are convinced that it was the plan to issue stock to Roebuck for his patents or, in any event, to satisfy his subscription agreement by the transfer of the patents.
In view of our conclusion that the patents were acquired for stock, it is necessary to determine the value thereof at the time acquired. On this question we think the evidence is insufficient. The only facts we have before us consist of the book entries in which patents and copyrights were entered at $99,290.79 and the surplus account, together with the trial balance on June 30, 1911. We are unable to determine a valuation of the patents from this evidence.
On the question of the valuation of patents*2986 for purposes of depreciation, there is the same situation. The evidence presented is wholly insufficient. We must, therefore, affirm the action of the respondent on these issues.
Judgment will be entered under Rule 50.