Thomas Flexible Coupling Co. v. Commissioner

Thomas Flexible Coupling Company, Petitioner, v. Commissioner of Internal Revenue, Respondent

Thomas Flexible Coupling Co. v. Commissioner

Docket Nos. 12579, 15188, 15753, 17378

United States Tax Court

14 T.C. 802; 1950 U.S. Tax Ct. LEXIS 202;

May 15, 1950, Promulgated

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Decisions will be entered under Rule 50.

1. Petitioner is a corporation, engaged in the business of manufacturing and selling flexible couplings. For the years 1942, 1943, and 1944 petitioner, pursuant to an agreement of November 26, 1939, and a supplemental agreement of November 26, 1943, made payments designated as royalties on patents to one of its stockholders. This stockholder, together with her husband, president of petitioner, controlled the majority of petitioner's stock. The decision in Thomas Flexible Coupling Co. v. Commissioner, 158 Fed. (2d) 828, affirmed our decisions denying the deduction of similar payments made in 1939, 1940, and 1941, pursuant to the agreement of November 26, 1939. Held, that our decisions in the former proceedings affirmed by the Third Circuit are not res judicata as to the present proceedings; held, further, that the royalties paid in 1942, 1943, and 1944 to the extent of $ 80,000 in each year are deductible as ordinary and necessary business expenses under section 23 (a) (1) (A), I. R. C.

2. The amount of deduction to which petitioner is entitled in each taxable year because of payment of Pennsylvania corporate net income tax depends upon petitioner's net income as determined in these proceedings and will be settled under Rule 50.

3. Issues concerning petitioner's excessive profits which have been determined by the renegotiation authorities under the provisions of the Renegotiation Act can not be determined in these proceedings. Petitioner's tax liability in the present proceedings must be determined without regard to whether petitioner's excessive profits as already determined by the renegotiation authorities are increased or decreased in the renegotiation proceedings now pending before us in other docket numbers.

Frank A. Moorshead, Esq., Richard D. Case, Esq., and Richard E. Crook, C. P. A., for the petitioner.

Louis A. Boxleitner, Esq., for the respondent.

Black, Judge. Disney, J., dissenting. Kern, Harron, Opper, and LeMire, JJ., agree with this dissent.

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BLACK

These proceedings have been consolidated.

In Docket No. 12579, the Commissioner has determined deficiencies as follows:

Deficiency in income tax for 1943	$ 5,743.10
Deficiency in excess profits tax for 1942	144,297.94
Deficiency in excess profits tax for 1943	290,848.14

The deficiency in petitioner's excess profits tax for 1942 is due to certain adjustments which the Commissioner made to the net income disclosed on petitioner's return for that year. These adjustments are disclosed in the deficiency notice as follows:

Adjustments to Net Income
Net income as disclosed by return		$ 713,849.47
Unallowable Deductions and Additional Income:
(a) Royalties	$ 170,833.16
(b) Patent application fees	60.00
(c) Pennsylvania income tax	5,586.96	176,480.12
Total		$ 890,329.59
Nontaxable Income and Additional Deductions:
(d) Federal capital stock tax	$ 15,000.00
(e) Pennsylvania capital stock tax	673.94
(f) Taxes increased	2,705.57
(g) Depreciation	289.09
(h) Renegotiation adjustment	625,000.00	643,668.60
Net income as adjusted		$ 246,660.99

Not all of the foregoing adjustments are in issue. Those which are in issue are explained in the deficiency notice as follows:

(a) It is determined that the amount of $ 170,833.16 claimed in your income tax return for the year 1942 for royalties paid Bertha E. Thomas is not an allowable deduction from your gross income.

* * * *

(c) The amount of $ 10,375.39 claimed as a deduction in your income tax return for Pennsylvania corporate net income tax is determined to be excessive to the extent of $ 5,586.96, computed as follows: [Here follows the computation.]

* * * *

(h) The amount of $ 625,000.00 refunded the United States Government under a renegotiation agreement in connection with war contracts, is determined to be an allowable deduction from your gross income.

The deficiencies in petitioner's income tax and excess profits tax for the year 1943 are due to certain adjustments which the Commissioner made to the net income disclosed on petitioner's return for that year.

These adjustments are disclosed in the deficiency notice as follows:

Adjustments to Net Income
Net income as disclosed by return		$ 984,643.20
Unallowable Deductions and Additional Income:
(a) Royalties	$ 276,323.73
(b) Patent application fees	169.10
(c) Federal capital stock tax	27,500.00
(d) Pennsylvania loans tax	76.00
(e) Pennsylvania capital stock tax	1,234.63
(f) Pennsylvania income tax	24,356.17	329,659.63
Total		$ 1,314,302.83
Nontaxable Income and Additional Deductions:
(g) Depreciation	$ 289.09
(h) Renegotiation adjustment	938,274.69	938,563.78
Net income as adjusted		$ 375,739.05

Not all of the foregoing adjustments are in issue. Those which are in issue are explained in the deficiency notice as follows:

(a) It is determined that the amount of $ 276,323.73 claimed in your income tax return for the year 1943 for royalties paid Bertha E. Thomas is not an allowable deduction from your gross income.

* * * *

(f) The amount of $ 39,385.73 claimed as a deduction in your return for Pennsylvania corporate net income tax is determined to be excessive to the extent of $ 24,356.17, computed as follows: [Here follows the computation.]

* * * *

(h) The amount of $ 938,274.69 refunded the United States Government under a renegotiation agreement in connection with war contracts is determined to be an allowable deduction from your gross income.

The petitioner assigns errors as to 1942 as follows:

(a) The Commissioner erroneously excluded from Petitioner's cost of goods sold, $ 170,833.16 representing royalties paid to Bertha E. Thomas. Further he erroneously increased taxable net income by that amount.

(b) The Commissioner erred in his determination of the proper amount of the deduction for the interdependent Pennsylvania Corporate Net Income tax.

(c) The Commissioner erred in treating as final and conclusive, the amount of $ 625,000.00 refunded to the United States, in compliance with order of the Secretary of the Navy (symbol NOd-6383u) dated May 28, 1945, and made pursuant to the provisions of the Renegotiation Act.

The petitioner's assignments of error as to 1943 are the same as those above for 1942, except as to amounts.

In Docket No. 15753, the Commissioner has determined a deficiency of $ 247,949.08 in petitioner's excess profits tax for the year 1944. This deficiency is due to certain adjustments which the Commissioner made to the net income disclosed in petitioner's return for that year. These adjustments are disclosed in the deficiency notice as follows:

Adjustments to Net Income
Net income as disclosed by return		$ 867,229.39
Unallowable Deductions and Additional Income:
(a) Patent application fees	$ 1,322.30
(b) Royalties	80,000.00
(c) Pennsylvania capital stock tax	963.11
(d) Pennsylvania income tax	19,571.37	101,856.78
Total		$ 969,086.17
Nontaxable Income and Additional Deductions:
(e) Depreciation	$ 289.09
(f) Renegotiation adjustment	584,399.71
(g) Taxes increased	6,452.26	591,141.06
Net income as adjusted		$ 377,945.11

Not all of the foregoing adjustments are in issue. Those which are in issue are explained in the deficiency notice as follows:

* * * *

(b) It is determined that the amount of $ 80,000.00 claimed in your income tax return for the year 1944 for royalties paid Bertha E. Thomas is not an allowable deduction from your gross income.

* * * *

(d) The amount of $ 34,689.17 claimed as a deduction in your return for Pennsylvania corporate net income tax is determined to be excessive to the extent of $ 19,571.37, computed as follows: [Here follows the computation.]

* * * *

(f) The amount of $ 584,399.71 has been allowed as a deduction for renegotiation in connection with war contracts representing an amount of $ 775,510.00 less an amount of $ 191,110.29 which is unpaid.

Petitioner assigns errors as to the foregoing adjustments as follows:

(a) The Commissioner erroneously excluded from Petitioner's cost of goods sold $ 80,000.00 representing royalties paid to Bertha E. Thomas. Further he erroneously increased taxable net income by that amount.

(b) The Commissioner erred in his determination of the proper amount of the deduction for the interdependent Pennsylvania Corporate Net Income tax.

(c) The Commissioner erred in treating as final and conclusive, the amount of $ 775,510.00 determined to be excessive profits by the War Contracts Price Adjustment Board. Further the Commissioner erred in allowing a renegotiation adjustment of only $ 584,399.71 instead of the $ 775,510.00 determined to be excessive profits by the War Contracts Price Adjustment Board, thereby erroneously including in his taxable net income the amount of $ 191,110.29.

In Docket No. 15188 the Commissioner has determined a deficiency of $ 31,052.13 in petitioner's declared value excess profits tax for the year 1942. In his deficiency notice he stated, among other things, as follows:

This statutory notice is issued solely for the purpose of protecting the revenue against the tolling of the statute of limitations in the event the Commissioner prevails in the proceeding now pending before The Tax Court of the United States at Docket No. 12579, and the petitioner prevails in the proceeding now pending before The Tax Court at Docket No. 256-R both involving related matters which you are litigating.

As to the action of the Commissioner in determining a deficiency in petitioner's declared value excess profits tax for 1942, petitioner assigns errors as follows:

(a) The Commissioner erroneously excluded from Petitioner's cost of goods sold, $ 170,833.16 representing royalties paid to Bertha E. Thomas. Further he erroneously increased Petitioner's taxable net income by that amount.

(b) The Commissioner erred in his determination of the proper amount of the deduction for the interdependent Pennsylvania Corporate Net Income Tax.

(c) The Commissioner erred in not taking in account and giving effect, in his computation of Declared Value Excess Profits Net Income, of the amount of $ 625,000.00 refunded to the United States, in compliance with an order of the Secretary of the Navy dated May 28, 1945, and made pursuant to the provisions of the Renegotiation Act.

In Docket No. 17378 the Commissioner has determined a deficiency of $ 15,871.57 in petitioner's declared value excess profits tax for the year 1944. In his deficiency notice he stated, among other things, as follows:

This statutory notice is issued solely for the purpose of protecting the revenue against the tolling of the statute of limitations in the event the Commissioner prevails in the proceeding now pending before The Tax Court of the United States at Docket No. 15753, and the petitioner prevails in the proceeding now pending before The Tax Court at Docket 639-R, both involving related matters which you are litigating.

As to the action of the Commissioner in determining a deficiency in petitioner's declared value excess profits tax for 1944, petitioner assigns errors as follows:

(a) The Commissioner erroneously excluded from Petitioner's cost of goods sold $ 80,000 representing royalties paid to Bertha E. Thomas. Further he erroneously increased taxable net income by that amount.

(b) The Commissioner erred in his determination of the proper amount of the deduction for the interdependent Pennsylvania Corporate Net Income Tax.

(c) The Commissioner erred in his determination of the proper amount of the deduction for the Pennsylvania Capital Stock tax.

(d) The Commissioner erred in not taking into account and giving effect to, in his computation of net income, of the amount of $ 775,510.00 determined to be excessive profits by the War Contracts Price Adjustment Board.

FINDINGS OF FACT.

The facts which were stipulated are so found. Other facts are found from the evidence.

Petitioner, a Pennsylvania corporation, located at Warren, Pennsylvania, is engaged in the business of manufacturing and selling flexible couplings. Petitioner keeps its books and files its Federal tax returns on the accrual basis and its taxable period is the calendar year. For the years here involved petitioner filed its tax returns with the collector of internal revenue at Pittsburgh, Pennsylvania.

During the years 1942, 1943, and 1944 petitioner paid the following amounts to Bertha E. Thomas as alleged "royalties," which amounts were paid in accordance with the terms of certain "agreements" between her and petitioner executed on November 26, 1939, and November 26, 1943, as hereinafter set out:

		Amount
Year paid	"Agreements" dated	paid
1942	Nov. 26, 1939	$ 170,833.16
1943	Nov. 26, 1939, and Nov. 26, 1943	276,323.73
1944	Nov. 26, 1939, and Nov. 26, 1943	80,000.00

On May 31, 1944, we entered our memorandum findings of fact and opinion and our decisions in Thomas Flexible Coupling Co., Dockets Nos. 110799 and 257, determining certain deficiencies in petitioner's excess profits liability under the Vinson Act for the year 1939 and in petitioner's income and declared value excess profits taxes and excess profits taxes for the years 1940 and 1941. In those proceedings we examined the contracts between petitioner and Bertha E. Thomas and interpreted those contracts as giving petitioner a right to the patents under which the alleged royalties were paid. We held that the payments made by petitioner to Bertha E. Thomas in 1939, 1940, and 1941 as alleged "royalties" were not deductible from petitioner's gross income in those years as ordinary and necessary business expenses because "petitioner was under no legal obligation to make the payments to Bertha E. Thomas as set out in the agreement of November 26, 1939." The patents in those proceedings are the identical patents involved in these proceedings, and the contracts between petitioner and Bertha E. Thomas are identical, except for the contract of November 26, 1943, which was not before us in the prior proceedings.

Our findings of fact in the prior proceedings may be summarized as follows: On January 6, 1920, petitioner entered into a contract with one of its stockholders, Bertha E. Thomas, the wife of its principal stockholder and president, Millard T. Thomas, for the assignment to it by her of one of the United States patents on coupling devices which she owned. Petitioner agreed to pay her therefor 450 shares of its capital stock and 10 per cent of the total amount of gross sales of couplings for the life of the patent. Petitioner also agreed that she should participate in any future increase of its stock to the extent of 50 per cent thereof. On March 20, 1920, petitioner entered into a further agreement with Mrs. Thomas whereby, in consideration for the assignment of the other two patents on couplings which she owned, and all improvements upon the inventions therein described, as well as for other good and valuable consideration, it granted her an exclusive license to manufacture and sell or have manufactured and sell flexible couplings to be used in connection with or on automobiles, trucks, and tractors only. The license applied to all patents which petitioner owned or might thereafter acquire. Petitioner issued to Mrs. Thomas the 450 shares of stock provided for in the January 6, 1920, agreement and paid to her the 10 per cent of the gross sales price of the couplings it manufactured and sold under the agreement during the life of the patent and thereafter until early 1939, after which a different arrangement was made. On September 2, 1939, Mrs. Thomas applied for a patent on an improvement on the couplings, and on August 8, 1939, she applied for a patent on another improvement, the first being granted on December 5, 1939, and the second on August 8, 1941. On October 26, 1939, she assigned these two inventions to the petitioner and on November 26, 1939, the petitioner entered into an agreement to pay her $ 3,500 in cash and 6 per cent royalty of the invoicing price on all couplings, 20 per cent of the invoicing price of coupling discs sold as repair parts, and 33 1/3 per cent of the invoicing parts of all coupling discs sold separately where the customer manufactured the other parts of the couplings. Pursuant to the assignment, the two patents were issued to petitioner.

Based upon the foregoing findings of fact in the former proceedings, we held that, when the November 26, 1939, agreement was entered into, petitioner was already the owner of the two improvement patents by virtue of the October 26, 1939, assignment to which it was entitled by reason of the March 20, 1920, contract; that, being already entitled thereto by the contract, the petitioner was under no legal obligation to make additional payments therefor; and that, consequently, the payments provided for in the contract of November 26, 1939, were voluntary payments made in the absence of an existing obligation and were not "ordinary and necessary expenses paid or incurred * * * in carrying on a trade or business." We found that any license to make or sell under letters patent on the flexible couplings to be used in connection with or on automobiles, trucks, and tractors was without value on October 26, 1939, and on November 26, 1939.

Following a denial for a rehearing by us, there was a declaratory judgment proceeding as to the November 26, 1939, and November 26, 1943, agreements brought in the Warren County, Pennsylvania, Common Pleas Court by Bertha E. Thomas against petitioner. Plaintiff prayed for a determination that she was entitled to retain all royalties paid her under the agreements of November 26, 1939, and November 26, 1943; that these agreements were valid, bona fide, and subsisting; that she was entitled to all royalties accrued under the agreement of November 26, 1943, and for other determination and relief. Defendant answered the above petition and prayed for a declaratory judgment in its own favor. The purpose of this proceeding was to settle the rights and obligations of the parties under the royalty agreements. Petitioner hoped, in case these agreements were sustained, to deduct such royalty payments from its gross income under section 23 (a) (1) (A) of the Internal Revenue Code. In that state court proceeding petitioner admitted an oral agreement to cancel the contracts with the exception of the continuance of the obligation to pay Mrs. Thomas 10 per cent royalties. It also admitted an informal contract of January, 1939, which was the basis of the October 26, 1939, assignment and that the contract of November 26, 1939, was only a formal confirmation of the January, 1939, contract. The case was heard on complaint and answer. The Common Pleas Court sustained plaintiff's claims and entered its decree in accordance therewith. The decree of the Common Pleas Court was as follows:

And now, to-wit: this 11th day of July, A. D. 1945, it is hereby ordered, adjudged and decreed:

(1) That the contract of November 26, 1939, between Bertha E. Thomas and Thomas Flexible Coupling Company, providing for the payment of royalties under United States Applications No. 162,205 and No. 289,058, and the supplementary contract thereto dated November 26, 1943, are valid and subsisting agreements.

(2) That the aforesaid contracts dated November 26, 1939 and November 26, 1943, are supported by valid, adequate and legal consideration.

(3) That the contracts of November 26, 1939 and November 26, 1943, between the parties, were entered into in good faith and were and are of substantial benefit to the Defendant.

(4) That the Plaintiff was entitled to receive and is entitled to retain the royalties originally paid under the agreement of November 26, 1939.

(5) That the Plaintiff was entitled to receive and is entitled to retain the royalties paid under the supplementary agreement of November 26, 1943.

(6) That the Plaintiff is the present owner of United States Patent 2,182,711, dated December 5, 1939, covered by United States Application No. 162,205 and United States Patent 2,251,722, dated August 5, 1941, covered by Application No. 289,058, together with all rights under pending Application, Serial No. 478,267 filed March 6, 1943.

(7) That Defendant is not entitled to demand or receive reassignments of United States Patents No. 2,182,711 and No. 2,251,722, nor Patent Application, Serial No. 478,267.

(8) That Defendant is indebted to Plaintiff under the agreements of November 26, 1939 and November 26, 1943, for the accrued royalties up to and including May 31, 1945, in the sum of Thirty-four Thousand One Hundred Eighty-three Dollars and Eight Cents ($ 34,183.08).

(9) That Plaintiff is entitled to receive from the Defendant, under the terms of the agreements of November 26, 1939 and November 26, 1943, royalties accruing thereunder subsequent to May 31, 1945.

(10) That judgment be entered in favor of the Plaintiff and against the Defendant in the sum of Thirty-four Thousand One Hundred Eighty-three Dollars and Eight Cents ($ 34,183.08).

By the Court,

FINAL JUDGMENT

July 11, 1945, Judgment is entered in favor of Plaintiff and against Defendant for Thirty-four thousand one hundred eighty-three and 08/100 Dollars, in accordance with Order of Court filed.

Addison White,

Prothonotary.

From this judgment and decree of the Common Pleas Court, the Thomas Flexible Coupling Co. appealed to the Supreme Court of Pennsylvania. On March 25, 1946, the Supreme Court affirmed the decree and judgment of theCourt of Common Pleas of Warren County, Pennsylvania, and rendered its opinion, from which one justice dissented and filed a dissenting opinion. Thomas v. Thomas Flexible Coupling Co., 353 Pa. 591">353 Pa. 591; 46 Atl. (2d) 212. Both the Court of Common Pleas and the Supreme Court of Pennsylvania held that the agreements of November 26, 1939, and November 26, 1943, were supported by good legal consideration; that the agreements were valid, binding, and enforceable; and that defendant company was legally obligated to pay the royalties set forth therein. Justice Jones, in his dissenting opinion, stressed the view that there was no controversy between the plaintiff and the defendant with respect to the alleged contracts and the rights of the parties thereunder. It was his view that the declaratory judgment proceeding did not present "an actual controversy and that the lower court should be reversed," with directions to dismiss the proceeding for want of jurisdiction.

Both the majority opinion by Mr. Justice Stern and the dissenting opinion by Mr. Justice Jones are incorporated herein by this reference.

Petitioner appealed our prior decisions in Dockets Nos. 110799 and 257 and we were affirmed by the Circuit Court of Appeals for the Third Circuit in Thomas Flexible Coupling Co. v. Commissioner, 158 Fed. (2d) 828. Petitioner thereafter petitioned the United States Supreme Court for writ of certiorari, and certiorari was denied at 329 U.S. 810">329 U.S. 810. In the appeal from our decisions in Dockets Nos. 110799 and 257 to the Circuit Court of Appeals for the Third Circuit, the subsequent decisions by the courts of Pennsylvania referred to above were brought to the attention of the Third Circuit, but were not a part of the record before the court.

After the 450 shares of stock of the company were issued to Bertha E. Thomas pursuant to the agreement of January 6, 1920, M. T. Thomas and Bertha E. Thomas held the majority of the voting stock of the company continuously through 1944, except during the year 1942, when their combined holdings fell slightly below an absolute majority.

On September 2, 1937, an application for letters patent was filed in the name of Bertha E. Thomas in the United States Patent Office, which application was assigned serial No. 162,205. Patent No. 2,182,711, sometimes called the "cross-graining patent" or the "dialing patent," was issued on said application on December 5, 1939.

On August 8, 1939, an application for letters patent was filed in the name of Bertha E. Thomas and serial No. 289,058 was assigned to said application. Patent No. 2,251,722 was issued on this application on August 5, 1941, and has as a claimed patent feature an emergency support for flexible couplings which is intended to prevent damage upon failure of a flexible coupling when the coupling is used in connection with a single bearing generator. The emergency support for flexible couplings, also known as the safety feature, was developed to overcome sales resistance, which existed by reason of the fact that the coupling did not have such a feature.

On October 26, 1939, Bertha E. Thomas, for good and valuable consideration, sold, assigned, and transferred to the petitioner her full and exclusive rights in and to the inventions covered by patent applications Nos. 162,205 and 289,058 and in any patent or patents issued therefor or thereon. The instrument of assignment was recorded in the United States Patent Office on October 27, 1939.

Bertha E. Thomas and petitioner, by its president, M. T. Thomas, on November 26, 1939, entered into an "agreement" wherein it was agreed that petitioner would pay her 6 per cent of the invoice price of all complete couplings sold by petitioner, 20 per cent of the invoice price of all coupling discs sold as repair parts by the petitioner, and 33 1/3 per cent of the invoice price of all coupling discs sold separately by petitioner where the customer made the other parts of the coupling.

After the conclusion of the last hearing before this Court on June 9, 1943, in Thomas Flexible Coupling Co. v. Commissioner, Dockets Nos. 110799 and 257, while that case was under consideration by this Court, a special meeting of the stockholders of the petitioner was held. This meeting was held on November 11, 1943, and the agreement of November 26, 1939, between petitioner and Bertha E. Thomas was considered in light of the proceedings then before this Court. After discussing the status of this litigation "with respect to the attempt of the Internal Revenue Bureau to eliminate payments of royalties as an operating expense," the stockholders authorized the directors of the company to amend the agreement so as to place a ceiling on the amount of royalties which could be paid in any one year. Of the 1,778 shares of stock voted at this meeting in favor of the resolution, M. T. Thomas voted 675 shares of his own and 990 shares on proxies, including 350 shares on a proxy from his wife.

On November 26, 1943, Bertha E. Thomas and petitioner, by its president, M. T. Thomas, executed a "Supplemental Agreement" which purported to modify the terms of the agreement of November 26, 1939. In this "Supplemental Agreement" the parties recognized the unreasonableness of the payments which had been made to Bertha E. Thomas under the 1939 instrument and provided that the terms of this "Supplemental Agreement" should be retroactively effective as of July 1, 1943. This 1943 agreement further provided, inter alia, as follows:

(a) That petitioner would immediately sell, assign and transfer to Bertha E. Thomas all of its title, right and interest in the letters patent [Nos. 2,182,711 and 2,251,722], which had been assigned to it by Bertha E. Thomas on October 26, 1939.

(b) That concurrent with the assignment of said patents to Bertha E. Thomas, she would grant petitioner an exclusive, non-assignable and non-transferable personal license to make, use and/or sell flexible couplings or parts thereof under said patents and under a pending patent application filed March 6, 1943 and having the Serial No. 478,267.

(c) That in lieu of the royalties called for in the November 26, 1939 agreement, petitioner would pay Mrs. Thomas a royalty of 6% of the invoice price of all couplings and parts thereof manufactured and/or sold by it.

(d) That the maximum royalties payable by petitioner to Bertha E. Thomas in any one calendar year should not exceed $ 80,000.

Of the amount of $ 170,833.16 paid to Bertha E. Thomas in 1942 by petitioner, $ 63,630.79 was paid at the rate of 6 per cent, $ 5,890.72 was paid at the rate of 20 per cent, and $ 101,311.65 was paid at the rate of 33 1/3 per cent of the invoice price of the products sold during that period. During the first six months of 1943 petitioner paid to Bertha E. Thomas as alleged "royalties" the sum of $ 236,323.73, of which amount $ 48,578.15 was paid at the rate of 6 per cent, $ 2,398.41 was paid at the rate of 20 per cent, and $ 185,347.17 was paid at the rate of 33 1/3 per cent of the invoice price of the products sold during that period. In the last six months of 1943 petitioner paid Bertha E. Thomas the sum of $ 40,000 as alleged "royalties," that amount being one-half of the maximum annual "royalties" payable to her under the terms of the modification of November 26, 1943. In 1944 petitioner paid Bertha E. Thomas the sum of $ 80,000, which was the maximum amount payable to her under the terms of the November 26, 1943, instrument. The "royalties" paid to Bertha E. Thomas in the taxable years 1942, 1943, and 1944 amounted to 38.8 per cent, 37.97 per cent and 23.2 per cent, respectively, of all deductions claimed by petitioner in its income and declared value excess profits tax returns for the respective years.

The Pennsylvania corporate net income tax is measured by the net income of a corporation as reported to, and ascertained by, the Federal Government. Sec. 2, Pennsylvania Corporate Net Income Tax Act of May 16, 1935, P. L. 208, as amended.

Renegotiation determinations involving petitioner and proceedings now pending in the Tax Court of the United States for redetermination thereof, covering the years in question, are as follows:

			Amount	Tax Court
			determined	Docket
Year	Determination by --	Date	to be	No.
			excessive
1942	Secretary of Navy	5/28/45	$ 625,000	256-R
1943	Secretary of Navy	9/4/45	1,070,097	338-R
1944	War Contracts Price Adjustment Board	10/4/46	775,510	639-R

The following were the net profits for the three taxable years here involved as shown by the books of petitioner after payment of all expenses and after payment of royalties to Bertha E. Thomas:

	Net profits	Royalties	Net profits of
Year	before	paid Bertha	company after
	royalties	E. Thomas	royalties
1942	$ 884,682.63	$ 170,833.16	$ 713,849.47
1943	1,260,966.93	276,323.73	984,643.20
1944	947,229.39	80,000.00	867,229.39
Total	3,092,878.95	527,156.89	2,565,722.06

Of the amounts of royalties which petitioner paid Bertha E. Thomas during the year 1942 and the first half of the year 1943 under the agreement of November 26, 1939, and of the amounts which petitioner paid her during the last half of 1943 and the whole of the year 1944 under the supplemental agreement of November 26, 1943, $ 80,000 represents a reasonable amount in each taxable year as royalties paid to her for the use of her rights under the patents. Of the amounts claimed by petitioner as deductions for royalties paid in 1942, 1943, and 1944, $ 80,000 was ordinary and necessary expense paid or incurred by the petitioner during each of these years in carrying on its business.

OPINION.

The first issue in these proceedings for our decision is whether certain "royalty" payments made by petitioner to Bertha E. Thomas are allowable deductions from petitioner's gross income under section 23 (a) (1) (A) of the Internal Revenue Code. ¹

In our findings of fact we have summarized the litigation concerning the deduction of similar payments for the years 1939, 1940, and 1941. Respondent contends that the same issue is involved in the present proceedings as was litigated in the prior proceedings; that, a court of competent jurisdiction having passed on this issue, our adherence to the former decisions as res judicata is required. If respondent's contention is correct, we shall not reach the merits of the present controversy as to the deductibility as ordinary and necessary business expense of alleged royalties paid.

The most recent pronouncement of the Supreme Court on the problem of res judicata is found in Commissioner v. Sunnen, 333 U.S. 591">333 U.S. 591. As stated therein, each tax year presents a new cause of action, therefore:

* * * the parties are free to litigate points which were not at issue in the first proceeding * * *. But matters which were actually litigated and determined in the first proceeding cannot later be relitigated. Once a party has fought out a matter in litigation with the other party, he cannot later renew that duel. In this sense, res judicata is usually and more accurately referred to as estoppel by judgment, or collateral estoppel. See Restatement of the Law of Judgments, §§ 68, 69, 70; Scott, "Collateral Estoppel by Judgment," 56 Harv. L. Rev. 1">56 Harv. L. Rev. 1.

* * * *

* * * It must be confined to situations where the matter raised in the second suit is identical in all respects with that decided in the first proceeding and where the controlling facts and applicable legal rules remain unchanged. * * * As demonstrated by Blair v. Commissioner, 300 U.S. 5">300 U.S. 5, 9, a judicial declaration intervening between the two proceedings may so change the legal atmosphere as to render the rule of collateral estoppel inapplicable. * * *

Petitioner contends that the decisions of the Pennsylvania state courts described in our findings of fact represent an intervening decision within the meaning of Blair v. Commissioner, 300 U.S. 5">300 U.S. 5, and Commissioner v. Sunnen, supra. In this contention we think petitioner must be sustained.

In Blair v. Commissioner, supra, to which the Supreme Court recently referred with evident approval in its opinion in the Sunnen case, the Commissioner ruled that the income distributed in the taxable year 1923 to assignees of interests in a trust was taxable to the assignor petitioner. The Board of Tax Appeals held to the contrary. The Circuit Court of Appeals reversed the Board, holding that the trust was a spendthrift trust and the assignments were invalid. The Supreme Court of the United States denied certiorari. The trustees then brought suit in the courts of Illinois to determine the validity of the assignment. Upon review, an intermediate appellate court of Illinois decided that the trust was not a spendthrift trust, and upheld the assignments. The record of the state court proceedings was then received in evidence by the Board of Tax Appeals in proceedings involving the income of the trust for 1924, 1925, 1926, and 1929. The Board thereupon overruled the Commissioner's determination of petitioner's liability. The Circuit Court again reversed the Board. The Supreme Court granted certiorari, followed the state court decision, reversed the decision of the Circuit Court, and affirmed the decision of the Board. The Government first contended then, as it does in the instant proceedings, that the judgment relating to the income for 1923 was conclusive in the subsequent proceedings as res judicata. In disposing of this contention, the Supreme Court held that "the opinion and decree of the state court created a new situation" and could not "justly be ignored."

In the instant case, the judgments of the state courts of Pennsylvania were not before the United States Court of Appeals for the Third Circuit in Thomas Flexible Coupling Co. v. Commissioner, supra, as a part of the record in that case and they have not been a part of the record before the Tax Court until now. This, we think, creates a "new situation" and can not "justly be ignored," to use the language of the Supreme Court in the Blair case.

In Masterson v. Commissioner, 141 Fed. (2d) 391, the sequence of events was somewhat similar to those in the instant case. The Board of Tax Appeals first held that the taxpayer had a full life estate in the property. Pending the appeal to the United States Circuit Court of Appeals, the taxpayers obtained a contrary decision by the state court and then offered it in evidence in the Circuit Court of Appeals. That court refused to enlarge the record so as to admit the state court judgment in evidence. However, it considered the decision and then declined to follow it. In subsequent proceedings in the Tax Court involving the same parties, taxpayer pleaded and proved the state court judgment. The Tax Court nevertheless held that the Circuit Court's decision was res judicata as to such proceedings. The Fifth Circuit reversed and held that its former decision in the case was not res judicata as to the proceedings because the state court judgment had not been before it as part of the record proper on the first appeal. In deciding the issue of res judicata against the Commissioner in the Masterson case, the court said:

The situation here then is in legal effect the same as it was in Blair's case. There the Federal Court made its first decision without having the State Court judgment before it. It made its second decision on a record in which the State Court proceedings appeared as pleaded and proved. Here, when the first decision was made, the record of the State Court proceedings was not before the court. When the second decision was made, they were. Res adjudicata is a principle of peace, and should be applied to bring litigation to an end where it is correct and just to do so. It is without application here. * * *

The respondent strongly contends that the judgments of the Pennsylvania state courts were in nonadversary proceedings and, therefore, should be given no weight here in determining the issue of res judicata. If, in giving effect to the judgments of the Pennsylvania state courts, we had to be guided and controlled by the dissenting opinion of Justice Jones in Thomas v. Thomas Flexible Coupling Co., supra, we would, doubtless, sustain respondent's contention that these Pennsylvania judgments were in nonadversary proceedings and we are not bound by them. However, it is to the majority opinion of the Supreme Court of Pennsylvania that we must look for the character of the proceedings and not to the dissenting opinion of Justice Jones, regardless of what we might think as to its merits.

In Gerrard E. Kelly Trust No. 2 v. Commissioner, 168 Fed. (2d) 198, it was held that the Tax Court erred in not following a judgment by an appellate state court on the question of whether each of three trust deeds established but a single trust, even though in that particular case the proceedings in the lower state court were nonadversary, the complaint was amended to include the question only after the proceedings raising that question were begun in the Tax Court, "all the parties to the state-court suit were in accord with one another before the entry of the judgment therein," and the appeal to the higher state court was taken only after the Tax Court had indicated in another case that a lower court judgment might be inconclusive unless there was an appeal. The Second Circuit stated:

We think the Tax Court erred. Whatever may have been the nature of the state-court suit in its inception, the appeal made it adversary, within the meaning of Freuler v. Helvering, 291 U.S. 35">291 U.S. 35, and Blair v. Commissioner, 300 U.S. 5">300 U.S. 5, especially as, on appeal from the state-court judgment, one judge dissented. The fact that the appeal was considered shows that the judgment was not by consent, for a consent judgment by its nature precludes an appeal.

The doctrine of the Freuler and Blair cases has been criticised. There may be good sense in the criticism, but rejection of the doctrine is not within our province.

In view of the foregoing authorities, we hold against respondent's plea of res judicata. We hold that the decision of the Supreme Court of Pennsylvania that Bertha E. Thomas was not legally obligated in 1939 to assign the patents in question to petitioner, that their assignment was legal consideration for petitioner's promise to pay the royalties provided under the contract, and that petitioner was thereby legally obligated to make the payments which were made in the years 1942, 1943, and 1944, is determinative on these points in the present proceedings. But while we fully recognize the power and authority of the Supreme Court of Pennsylvania to determine "who owes what and to whom" under Pennsylvania law and that its decisions as to legal liability of petitioner to pay under the agreements of November 26, 1939, and November 26, 1943, are binding upon us, that is not to say that such decisions are binding upon us as to whether the amounts so paid or any part thereof in pursuance of the legal liability decreed in such decisions are deductible from gross income as ordinary and necessary business expenses. The Pennsylvania state courts had not the power to decide that a single dollar of such payments was deductible as ordinary and necessary business expense. That is a question of Federal law and is within our jurisdiction in the present proceedings.

As the Supreme Court said in Blair v. Commissioner, supra, after deciding that the decision of the Illinois court that the testamentary trust there involved was not a spendthrift trust and that the beneficiary's assignment of income was valid: "The question remains whether treating the assignments as valid, the assignor was still taxable upon the income under the federal income tax act. That is a federal question." And in the same way in the instant proceedings, whether the royalties paid by petitioner to Bertha E. Thomas, or any part thereof, are deductible as ordinary and necessary business expense is a Federal question.

We shall now examine that question. Section 23 (a) (1) (A) of the code specifically permits the deduction of rentals or "other payments" required to be made as a condition of the continued use of property. This provision covers patent royalties paid in a proper case. Cf. Wall Products, Inc., 11 T. C. 51; Heatbath Corporation, 14 T. C. 332.

Petitioner argues that it is entitled to deduct from its gross income in each of the taxable years the entire amount of royalties which it paid to Bertha E. Thomas as a business expense because the amounts paid were reasonable. Respondent, on the other hand, while arguing strongly that the royalties paid were not legal obligations of petitioner and that the decision of the Third Circuit in Thomas Flexible Coupling Co. v. Commissioner, supra, affirming our memorandum opinion is res judicata as to the present proceedings, contends in the alternative that, if this Court should determine that petitioner was obligated to pay royalties to Bertha E. Thomas during the taxable years 1942, 1943, and 1944, the payments made to her were unreasonable in amount and that to the extent that such payments were unreasonable they are not deductible as ordinary and necessary business expenses under section 23 (a) (1) (A) of the code. In support of this alternative contention respondent argues in his brief as follows:

It is not necessary to look far for support of respondent's contention as to the unreasonableness of royalties claimed. At their meeting of November 11, 1943, petitioner's stockholders in acting on the resolution offered by Ernest Hagenlocher, petitioner's vice-president, specifically recognized that the royalty payments to Bertha E. Thomas had become entirely unreasonable in amount. Then M. T. Thomas, as president of the petitioner, and Bertha E. Thomas entered into the supplemental agreement of November 26, 1943 wherein they recited that the royalties then being paid to her were "in excess of the amount contemplated by the parties when the said agreement [of November 26, 1939] was executed." In this agreement petitioner and Mrs. Thomas recognized that any royalties in excess of $ 80,000 were unreasonable in amount and placed a ceiling of $ 80,000 per annum on all future royalty payments.

As we pointed out in the recent case of Heatbath Corporation, supra:

Ordinarily the amounts which a corporation must pay under an agreement for the use of a patent would be deductible in their entirety as ordinary and necessary expenses, and neither the Commissioner nor the Court would have any authority to rewrite the agreement of the parties. But where, as here, the parties contracting with the corporation and the wife of one of those parties hold practically all of its stock, and, as a consequence, make the decisions for the corporation, the terms of their agreement may be examined to see whether the amounts to be paid may fairly be regarded as compensation for the use of the patent or represent, to some extent, dividends in disguise. Cf. L. Schepp Co., 25 B. T. A. 419; Granberg Equipment, Inc., supra; Atlantic Monthly Co., 5 T.C. 1025">5 T. C. 1025. * * *

We then went on to hold in the Heatbath Corporation case, supra, that only part of the royalties paid in that case to the taxpayer's principal stockholders, Walenn and Wilbur, was deductible as ordinary and necessary business expense.

Relying upon the Heatbath Corporation case, supra, and the rule therein stated, and after a careful consideration of the evidence, we have found that $ 80,000 in each of the years 1942, 1943, and 1944 of the amounts paid to Bertha E. Thomas as royalties was royalties and deductible by petitioner in each of the taxable years as ordinary and necessary business expense under section 23 (a) (1) (A) of the code. The remainder of the amounts paid in 1942 and 1943 in excess of $ 80,000 must be regarded as in the nature of a distribution of profits.

It is true, of course, as respondent argues in his brief, that under our memorandum opinion in the former proceedings, affirmed in Thomas Flexible Coupling Co. v. Commissioner, supra, petitioner was not allowed to deduct anything because of similar royalties paid to Bertha E. Thomas in the years 1939, 1940, and 1941, but that was because we held in those proceedings that there was no legal obligation resting upon petitioner to make such payments, that they were mere voluntary payments and, as such, were not deductible as ordinary and necessary business expense. That such was the basis of the Third Circuit's affirmance of our decision is shown, we think, by the following language of the court:

The Tax Court obviously labored under no misapprehension of law in its decision. Under the facts before it and passing upon the credibility of the witnesses it found that there was no consideration for the royalty agreement, that the royalty payments by the company were actually voluntary and that they were not ordinary and necessary business expenses. * * *

The Third Circuit, in affirming our decision in that case, pointed out that the subsequent judgment of the Supreme Court of Pennsylvania to which we have already referred could not hamper the Tax Court's right to determine what were and what were not deductible under the statute as ordinary and necessary expenses. That, of course, was true, as we have already said, and, inasmuch as the records of the proceedings of the Pennsylvania courts were not before us in the former proceedings, they had no effect in those proceedings in determining legal liability to pay the royalties. Cf. Masterson v. Commissioner, supra.

In the instant proceedings we do have in evidence the records of the proceedings in the Pennsylvania state courts and, as has already been pointed out, the Pennsylvania courts have held that the payments made by petitioner to Bertha E. Thomas were not voluntary payments made by petitioner without any legal obligation to make them, but, on the contrary, represented obligations which petitioner was legally bound to pay. This, as we have endeavored to point out, presents an entirely different situation from what we had in the former proceedings and imposes upon us the function of deciding under the evidence which we have in the instant proceedings what, if any, of the amounts so paid by petitioner to Bertha E. Thomas in 1942, 1943, and 1944 are deductible as ordinary and necessary business expenses. In discharge of that duty we have determined that $ 80,000 of such amounts in each of the taxable years is deductible as ordinary and necessary business expense.

Much of respondent's argument is to the effect that the patents in question were of no value to petitioner and that petitioner could have done all of its manufacturing of flexible couplings just as well without the right to use the patents as with them. But there is much testimony in the record from witnesses having far more technical knowledge in such matters than we have, who testified that the right to use such patents and the ideas which they represented had great value to petitioner. There is too much of this testimony for us to discuss it in detail in this opinion. Suffice it to say that our finding that $ 80,000 represents a reasonable amount to allow petitioner as a deduction in each of the taxable years as ordinary and necessary business expense is based upon a consideration of this testimony, taking also into consideration petitioner's own realization that the royalties, on account of swollen war business, were amounting to far more than the parties had originally contemplated under their contract of November 26, 1939, and should be reduced and were, in fact, reduced as we have detailed in our findings of fact.

Having reached our conclusions as stated above on the issue of res judicata and as to how much petitioner is entitled to deduct in each of the taxable years as ordinary and necessary business expense on account of the royalties paid, we have two more issues to consider. The next of these is, What is the proper amount of the deduction for Pennsylvania corporate net income tax which is allowable in computing petitioner's taxable net income for each of the taxable years 1942, 1943, and 1944? The Pennsylvania corporate net income tax is measured by the net income of a corporation as returned to and ascertained by the Federal Government. Both parties agree that the amounts which petitioner will be entitled to deduct on account of the Pennsylvania corporate net income tax are dependent upon the conclusions reached by this Court on the main issues and can be settled under Rule 50. Therefore, it is unnecessary for us to further discuss that issue.

The last and final issue presented to us is with reference to the determination by the renegotiation authorities of the amount of excessive profits realized by petitioner upon its war contracts. Petitioner's assignments of error as to these renegotiation determinations have been stated in detail in our preliminary statement and need not be repeated here. Respondent in his brief discusses the matters raised by these assignments of error as follows:

The Secretary of the Navy and the War Contracts Price Adjustment Board have made determinations as to the amounts of excessive profits realized by petitioner in the calendar years 1942, 1943 and 1944. Petitioner has petitioned this Court for redetermination of the amounts of excessive profits which have been determined by the above-mentioned renegotiation authorities. These renegotiation proceedings are now pending before this Court under Docket Nos. 256-R, 338-R and 639-R. The adjustments to be made in petitioner's gross income for each of the taxable years here involved so as to eliminate therefrom petitioner's excessive profits during said years, will depend upon the final disposition of the proceedings now pending before this Court under Docket Nos. 256-R, 338-R and 639-R. See section 3806 (a), Internal Revenue Code.

Petitioner, in its briefs, does not argue to the contrary of the foregoing position taken by respondent. Petitioner in its brief states:

There are other issues, as set forth in the pleadings, pertaining to the deduction for the Pennsylvania Corporate Net Income Tax, and deductions for renegotiation in connection with war contracts. However, as the solution of these issues is believed to follow as a consequence from the decision on the main issue and as it appears that they can therefore be disposed of in the computation under Rule 50, the discussion in this Brief will be limited for the sake of simplicity to the basic issue stated above.

Our decision in National Builders, Inc., 12 T.C. 852">12 T. C. 852, with reference to the renegotiation payments is controlling in the instant proceedings. In that case we said:

The correct tax liability of a taxpayer is, in the first instance, to be determined with complete disregard of the fact that the taxpayer may have repaid amounts representing excessive profits to the Government incident to renegotiation and in making the payments received the benefit of the credit provided for by section 3806 (b) (1). Petitioner's tax liability for 1943 should be computed on the basis of the gross income, deductions, and net income as shown on the return, and such other adjustments as may be required, including any resulting from the instant redetermination, so that the tax as finally computed meets the requirements of the statute. It follows that under this method the full amount of taxes paid by the petitioner should be applied against the total tax liability in determining the amount of any deficiency or overpayment, and the respondent should not, in this computation, treat the credits previously computed under section 3806 (b) (1) as rebates within the definition contained in section 271 (b) (2). It is not until the tax liability as such has been correctly determined that we have a basis for the computation of the credit under section 3806, and if a credit has been allowed for renegotiation purposes prior to the final determination of the tax liability as such, then the credit must be regarded as tentative and must necessarily fluctuate up or down, dependent upon what is finally determined to be the petitioner's correct tax liability.

* * * *

Whether the determination of excessive profits made by the Under Secretary of War is increased or decreased by the decision of this Court in the renegotiation proceedings, it will in no way affect the petitioner's tax liability for 1943 which we have here finally determined. Any finding as to excessive profits different from that initially made by the Under Secretary of War will be given final effect by a recomputation of the credit under section 3806. As we have previously stated, until that time, any credit allowed the petitioner under section 3806 will necessarily be tentative, a final credit being determinable only at such time as a final determination of the excessive profits is made.

At any rate, it is clear that the renegotiation cases which are pending before the Tax Court under other docket numbers are not before us in these proceedings. Just what effect our decision on the issues which have herein been decided will have in the renegotiation proceedings, we do not attempt to decide. Certainly, whether the amounts of petitioner's excessive profits are increased or decreased in the renegotiation proceedings which are now pending before us under other docket numbers can have no effect here.

Decisions will be entered under Rule 50.

DISNEY

Disney, J., dissenting: On the res judicata question reflected in the first headnote I think we have erred. The state judgment decision relied upon to prevent the application of res judicata was, as the majority opinion and findings of fact show, not an adversary proceeding, but one based upon agreement. The pertinent allegations of the petition there were admitted by the answer, that is, the petition alleged and the defendant's answer admitted the oral agreement to cancel exising contracts. There was no actual controversy between the parties. Freuler v. Helvering, 291 U.S. 35">291 U.S. 35, indicates that a decree of a state court to be relied upon as conclusive here can not be one "in any sense a consent decree" and can not be "collusive in the sense that all the parties joined in a submission of the issues and sought a decision which would adversely affect the Government's right to additional income tax." We have followed and applied this principle so many times that I do not see how we can fail to do so here. In First-Mechanics National Bank of Trenton, Executor, 40 B. T. A. 876, we declined to recognize a decree where there was no contest, but consent. We relied on the First-Mechanics National Bank case in Charles S. McVeigh, 3 T. C. 1246, cited the Freuler case, and declined to be bound by a judgment which we considered collusive in the sense used in the Freuler case. We there cited a number of cases, including Otto C. Botz, 45 B. T. A. 970. In Tatem Wofford, 5 T. C. 1152, we held that a state court's adjudication of ownership of property on the basis of an admission thereof was not binding upon the Tax Court and that there must be a real controversy and in no sense a consent decree. The suit was in a circuit court, but was affirmed by the Supreme Court of Florida. In Francis Doll, 2 T. C. 726; affd., 149 Fed. (2d) 239, we followed the Freuler case in that matter. After respondent's determination and the filing of the petition and answer in this Court, a decree was entered by a Missouri court as to partnership. The petition in that court asked for a construction of a writing as to partnership and the answer admitted the material allegations. We held that such judgment was not controlling, saying that the answer had admitted the material allegations. It is to be noted that the judgment in the state court in the Doll case was a declaratory judgment. In Leslie H. Green, 7 T. C. 263, 274; affd., 168 Fed. (2d) 994, the situation was that after the filing of the petitions before this Court proceedings were instituted in a Michigan state court to obtain a decree construing the trust instruments in question. Notice was served upon the Commissioner of Internal Revenue. There was no controversy in issue and no object other than the purpose of obtaining the state court's interpretation of the instruments. Relying upon the Freuler, Wofford, and Doll cases, and noting that the pleadings in the state court presented no real controversy, and that, although the answer purported to put plaintiff on proof of many allegations, there was no evidence of proof being introduced, we concluded that the proceeding was collusive and not binding. To the same effect see Erik Krag, 8 T. C. 1091; Estate of Mary Clare Milner, 6 T. C. 874; and James S. Reid Trust, 6 T.C. 438">6 T. C. 438. In the last named case an Ohio court, after controversy had arisen between the parties and the Treasury Department of the United States as to taxation of income, was asked to construe a trust agreement. The General Counsel for the Commissioner of Internal Revenue was notified. It did not appear whether answers were filed, but it was stipulated that the matter was not briefed. We found it to be collusive under the Freuler case and that there was no "real trial." I note also Loggie v. Thomas, 152 Fed. (2d) 636, wherein it was held that the fact that the state court had rendered a declaratory judgment with reference to the legal title to property as between trustee and cestuis que trust "does not foreclose an inquiry as to the liability of the trustee for taxes on the income from the same property involved in the state court judgment"; also Sewell v. Commissioner, 151 Fed. (2d) 765, where, after decision here and appeal to the Circuit Court of Appeals, Fifth Circuit, petitioners in that court moved to remand the case to the Tax Court for consideration by the Tax Court of a declaratory decree of the state court of Georgia rendered since the decision of the Tax Court. The Circuit Court held that, though the decision of the state court was binding between the parties in the settlement of their legal rights inter sese, it was not so between the parties and the United States over income taxes.

I can find no reason for not adhering to these repeated decisions in this matter. Blair v. Commissioner, 300 U.S. 5">300 U.S. 5; Commissioner v. Sunnen, 333 U.S. 591">333 U.S. 591; and Masterson v. Commissioner, 141 Fed. (2d) 391, relied upon by the majority, do not touch this question of nonadversary or consent judgment. Gerrard E. Kelly Trust v. Commissioner, 168 Fed. (2d) 198, does not touch it, but is based upon the fact that there was appeal from the state court judgment and a dissent in the appellate court. With all respect, I can not conceive why an appeal from a consent or nonadversary matter renders it less so -- for, of course, the appeal could be pro forma and without real contest, as much as the original judgment. I note that in the Tatem Wofford case, supra, the state court judgment was affirmed by the Supreme Court of Florida, yet, as above stated, we declined to give effect thereto because it was an adjudication on the basis of an admission. We have therefore, apparently passed upon this question. In any event, I would follow the numerous decisions above and decline to give effect to a state court decision, even though appealed, which was obviously nonadversary and equally obviously intended to be collusive in the sense of the language expressed in the Freuler case. I therefore dissent.

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Footnotes

• 1. SEC. 23. DEDUCTIONS FROM GROSS INCOME.

  In computing net income there shall be allowed as deductions:

  (a) Expenses. --

  (1) Trade or business expenses. --

  (A) In General. -- All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including * * * rentals or other payments required to be made as a condition to the continued use or possession for purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity.↩