*36 Decision will be entered under Rule 50.
1. Petitioner made certain payments to Best Yeast in 1943 and 1944 pursuant to a contract between petitioner and Best Yeast, under which Best Yeast rendered technical assistance and know-how services to petitioner in the course of and in connection with petitioner's development of a technique and process for the manufacture of active dry yeast. Held, that the payments constituted a capital expenditure and that petitioner could not elect to expense or capitalize the expenditure as one for research and development. Held, further, that petitioner failed to establish a loss thereon in either 1945 or 1946.
2. Petitioner's plant was located on a bluff adjacent to Lake Michigan. By 1944, the lake bank had substantially deteriorated. Petitioner sought advice from two professional engineers and thereafter constructed two permeable groins extending into the lake, certain drains in the lake bank, since washed away, and a new sewer running down the lake bank onto the end of one of the permeable groins. Certain of the advice of one of the engineers was not followed by petitioner. Petitioner attributed all of these items of cost to the construction*37 of permeable groins and deducted the total amount in 1944 as an ordinary and necessary business expense. Held, that the costs of constructing permeable groins, drains and a new sewer constituted capital expenditures for improvements and betterments having a life of more than 1 year. Held, further, that petitioner did not show in what year the drains washed away and thus is not entitled to a deduction therefor in 1944. And held, further, that petitioner is entitled to deduct as an ordinary and necessary expense the cost of the professional advice which was not followed.
*322 The respondent determined deficiencies in the corporate income taxes of petitioner for the taxable years 1943 and 1945, in the amounts of $ 20,371.22 and $ 32,184.99, respectively. The deficiency for 1945 is, in part, a consequence of adjustments made by respondent for the taxable year 1944, including the carryback of a net operating loss sustained by petitioner in 1946.
The questions presented for our consideration are: (1) Whether certain payments made by petitioner in 1943 and 1944 pursuant to a contract between petitioner and Best Yeast, under which Best Yeast was required to render certain technical assistance services on the basis of the Best experience, know-how, techniques, and processes in the manufacture of active dry yeast, are to be capitalized or whether they were deductible currently either as ordinary and necessary business expenses or otherwise; (2) alternatively, *39 if such payments are considered capital in nature, whether they are deductible under 23 (f) as losses from abandonment in either 1945 or 1946; and (3) whether certain expenditures for the construction of permeable groins, a new sewer, drains which have since washed away, and for professional advice which has never been followed are properly deductible as ordinary and necessary business expenses in the year in which made.
FINDINGS OF FACT.
Petitioner is a corporation organized under the laws of the State of Wisconsin, with its principal office and place of business in Milwaukee, Wisconsin. Petitioner's business consists mainly of manufacturing yeast and other related products. Petitioner maintains two plants, one in the city of Milwaukee, located on North 27th Street, and the other in Cudahy, Wisconsin, a suburb of Milwaukee. In addition, it maintains distribution branches in various other cities in the United States. Petitioner is an accrual basis taxpayer and files its Federal tax returns for the calendar year. For the taxable years here involved petitioner filed its Federal corporate income and excess profits tax returns with the then collector of internal revenue for the district*40 of Wisconsin.
Best Yeast Payments.
Petitioner's business in the main consists of manufacturing and selling yeast.
Yeast is a fungus which grows in liquid solutions of carbohydrates, proteins, and oxygen. Commercially, it is grown by placing in a large fermenter a dilute solution of nutritive material, consisting of a base of either grain or molasses to supply the necessary carbohydrates and inorganic (ammonium sulfate) and organic substances to supply the *323 required protein (nitrogen). The fermenter is equipped with an aerating device which blows air through the solution. A starting batch of seed yeast is placed in the fermenter, aeration begun, temperature controlled and during growth additional amounts of nutritive materials added. After fermentation the yeast is harvested in a type of centrifuge machine. This product is then put through a filer press and the resultant product is a solid cake of fresh compressed yeast.
Such fresh compressed yeast is comprised of 70 per cent water and 30 per cent active solids which induce fermentation. Yeast in this state is bulky and highly perishable and must be kept under refrigeration. Certain types of fresh compressed yeast*41 can be dehydrated and thereby become a substance known as active dry yeast which has a moisture (water) content of approximately 8 per cent and a solid content of approximately 92 per cent. In this state the yeast is considered dormant. In contrast to fresh compressed yeast, active dry yeast is compact and has an extended shelf life; it is capable of being kept without appreciable deterioration for periods as long as 6 months without refrigeration. In order to utilize active dry yeast water must first be added back and the substance returned to essentially its original active state as compressed yeast. Various techniques, formulas and secret processes are used by manufacturers of active dry yeast both to produce compressed yeast suitable for drying and in dehydration.
In 1940, petitioner began to consider the problem of producing active dry yeast, and incident to its general research activity at that time, carried on certain negotiations with the Northwestern Yeast Company of Chicago and the Mellon Institute, mainly in relation to the development of a process for the production of active dry yeast. Both Mellon and Northwestern were then engaged in work in the field.
About June*42 1942, petitioner was requested by the Quartermaster Corps Subsistence Research Laboratory, United States Army, (hereinafter referred to as Quartermaster Research), to develop a process for the production of active dry yeast, and to produce active dry yeast for sale to the United States Army for use by combat troops overseas. The Army was interested in having petitioner become a supplier of active dry yeast both because of the Army's large demand for the product and because the existence of only a single supplier prior to petitioner's entry into the field, was not, from the Army's point of view, a satisfactory situation in regard to either price or quantity.
Largely in accordance with this request, petitioner shortly thereafter undertook to develop a process for the production of active dry yeast. Petitioner's research and experimentation in this respect was conducted under the supervision of Robert Irvin, a research chemist. Irvin's work actually began in the early part of the summer of 1942 with his reading of all of the available literature on the subject of *324 active dry yeast and later by collecting apparatus and equipment considered necessary to the conduct of the research. *43 Irvin's first laboratory experiment was conducted on October 13, 1942, and related solely to the drying of yeast. Thereafter, further experiments were conducted both with respect to the drying of yeast and with respect to making petitioner's commercial compressed yeast suitable for dehydration.
During the period from January 19 to 21, 1943, petitioner conducted a group of experiments known as the F-80 series. In these experiments commercial compressed yeast produced in petitioner's plant was subjected to an "after-treat," which is a secondary fermentation applied to finished yeast in order to render it more suitable to withstand drying. Irvin considered the active dry yeast produced as a result of these experiments to be good, testing well as to gassing power and showing a good probable stability in storage. Samples of this product were sent in January to the Department of Agriculture, Beltsville Laboratory, Baltimore, Maryland, for testing and were approved as meeting that department's specifications.
Shortly thereafter, petitioner submitted a number of samples of active dry yeast produced in its laboratory to Quartermaster Research for testing. The samples submitted were found*44 to be satisfactory as to moisture content and ability to raise bread. Quartermaster Research then had no facilities for testing the keeping qualities of the samples. Because of the limited number of personnel attached to Quartermaster Research at that time most of the reporting on the tests of these samples was done verbally, by phone or in person.
In the period February to April 1943, petitioner was contacted on several occasions respecting when and to what extent it might be able to supply active dry yeast to the Armed Forces. On March 11, 1943, in response to one such inquiry from the United States Department of Agriculture, Food Distribution Administration, dated February 25, 1943, petitioner by its vice president, R. D. L. Wirth, replied, in part, as follows:
We have been and are presently conducting a research program to work out methods that will enable us to produce a dried yeast to meet the specifications of the United States Army. At present, however, we are not in a position to answer all the questions contained in your letter of the 25th. More particularly those questions concerning the amount of dried yeast we could produce with type of equipment and priorities*45 needed for this production, as our results to date have not advanced to the point where we know exactly what process and equipment we will ultimately use.
Irvin continued his experiments and on April 22, 1943, (in series F 134) produced an active dry yeast in petitioner's laboratory which was stored by petitioner until June 18, 1943, at a temperature of 70 degrees Fahrenheit without deterioration. On April 29, 1943, petitioner *325 submitted to Quartermaster Research samples of the yeast dried by Irvin on April 22. Under date of May 17, 1943, Quartermaster Research wrote petitioner that the results of the moisture and baking tests conducted on the samples submitted were satisfactory and met Army standards. Quartermaster Research's principal standard of judgment then was whether the yeast submitted would produce a nice, high loaf of bread. The report indicated that all but one of the samples produced very good bread. At that date Quartermaster Research still had no facilities for testing the keeping quality of active dry yeast, and it was expected that the producer would run his own keeping quality tests by exposure to high temperatures. Properly interpolated, such exposure*46 would be indicative of the keeping quality of yeast at different temperatures for different periods. It was not until January 8, 1944, that Quartermaster Research had available equipment for testing the keeping quality of active dry yeast.
In accordance with petitioner's practice, when it deems a process to be sufficiently developed at the laboratory stage to indicate commercial feasibility, experimentation and production is shifted from the laboratory scale to that of the pilot plant, a somewhat larger operation. On May 21, 1943, after receipt of the report from Quartermaster Research in respect to the moisture and baking qualities of the April 22 samples of active dry yeast produced by Irvin, petitioner, under the supervision of Oswald Freund, director of petitioner's fermentation laboratory, using Irvin's laboratory product as developed under the F-80 series of experiments, undertook to produce active dry yeast on a pilot plant scale.
On June 18, 1943, petitioner submitted to the Special Commodities Branch of the Department of Agriculture a sample of the yeast dried by Irvin on April 22 and from that time stored in an oven at 70 degrees Fahrenheit. By letter, dated July 30, *47 1943, the petitioner was informed of the results of the Special Commodities Branch tests, that the samples produced bread that was equal in loaf volume and crumb color to bread with 2 per cent compressed yeast and thus met the standard basis for judging test samples.
Meanwhile, on May 21, 1943, the same day on which Freund first began his experiments (numbered 104), and undertook the first pilot plant run, petitioner entered into a contract with Best Yeast, Ltd. of Canada (hereinafter called Best) for the purpose of securing certain aid from Best, hereinafter described.
For some time since January 1943, when the F-80 series of experiments proved successful, petitioner believed that its work on the production of active dry yeast was being conducted along the proper lines. Ultimate success and conversion to commercial production, however, involved certain substantial risks, considering that petitioner had never before produced active dry yeast on a commercial scale. Some *326 uncertainty existed, therefore, as to the usability of its laboratory and pilot plant processes and techniques for producing active dry yeast on a commercial scale. Accordingly, Irvin suggested that before*48 the company spend a great deal of money for specially designed manufacturing equipment, petitioner obtain such aid and information as it could to assist in guiding the necessary conversion and expansion. Irvin suggested specifically that petitioner contact Best to learn about its manufacturing procedures. Colonel Rohland Isker of Quartermaster Research, who was particularly anxious for petitioner to go into production as soon as possible, also suggested that petitioner contact Best in this regard.
No one then doubted that within a reasonable length of time petitioner could perfect to an even greater degree the technique and process it had developed for producing active dry yeast, or that further pilot plant experiments would satisfactorily assure the feasibility of producing active dry yeast on a commercial scale in accordance with such technique and process. Petitioner, however, in an endeavor to assure itself of the probable cost of production, to accelerate conversion over to production on a commercial scale, to confirm the adequacy or inadequacy of its own technique and process from a standpoint of economic feasibility, and if necessary, to learn of or to develop an economical*49 process and technique for producing active dry yeast, decided to seek the aid and technical assistance and advice of a commercial producer such as Best, as suggested by both Irvin and Isker.
By entering into an agreement for such assistance petitioner hoped to glean whether the process and the technique it had thus far developed were superior or inferior to those currently employed by a producer of dry yeast, and to study such a producer's techniques. Petitioner also hoped to obtain data on the costs of production and thus be able to better evaluate its prospective costs for producing dry yeast in accordance with its then perfected laboratory process.
Accordingly, on May 21, 1943, petitioner and Best entered into a contract which provided, in pertinent part, as follows:
Whereas, BEST represents that for some time past under its exclusive patent rights it has been making compressed yeast from a sulphite liquor base and, in the process thereof, has developed certain knowledge and information concerning types of yeast suitable for dehydration and has been producing a compressed yeast with constituent elements suitable for effective dehydration and has been dehydrating such yeast and*50 selling the same in dry form on a commercial basis in the Dominion of Canada; and
Whereas, RED STAR and BEST are of the opinion that the dried yeast of BEST'S manufacture meets the present requirements of the United States Government as per Exhibit A attached, and BEST is of the opinion that with the knowledge and information now possessed by it on this subject, and the skills, methods or processes used by it in the making of its compressed yeast for drying, it is able to adapt the same to compressed yeast made from a molasses base and prepare such yeast suitable for dehydration and marketing *327 in the dry form, and that such dried yeast will likewise meet the requirements of the United States Government, Exhibit A attached; and
Whereas, RED STAR for many years has made and sold throughout the United States compressed yeast made from a molasses base, and is desirous of obtaining knowledge of the processes, methods, skills and ways and means of producing such yeast for dehydration that it may engage in the commercial manufacture and sale of dried yeast, and to such end is desirous of acquiring from BEST detailed and complete knowledge and information of its skills and methods*51 or processes and in adapting the same to the making of a molasses base compressed yeast (hereinafter referred to as "Red Star type") suitable for drying and to the drying of such yeast, together with the right and license to make, use and sell the same;
Now, Therefore, for and in consideration of the premises and of the mutual covenants and agreements hereinafter expressed to be performed, the parties hereto have agreed and do hereby agree as follows:
1. RED STAR agrees to pay to BEST concurrently with the execution of this agreement the sum of Twenty Five Thousand ($ 25,000.00) Dollars in United States funds.
2. Promptly following the signing of this agreement, and at a time mutually agreeable to both parties, representatives of the technical staffs of BEST and RED STAR shall meet together at the plant of RED STAR in Milwaukee, Wisconsin, and at such meeting RED STAR shall disclose fully to BEST all information concerning RED STAR'S present commercial yeast production methods as may be necessary or helpful in applying or adapting BEST'S knowledge, information, skills, methods and processes to the working out of the problems of producing a compressed yeast of the RED STAR type suitable*52 for dehydration; and RED STAR, through its technical staff, in ccoperation [sic] with the representatives of the technical staff of BEST, shall thereupon proceed to apply or adapt to RED STAR'S type of yeast and procedure, BEST'S knowledge, information, technique, skills, methods or processes which BEST shall fully divulge to RED STAR in order to produce a compressed yeast of the RED STAR type suitable for dehydration and which, when dried at BEST'S Liverpool plant will meet the United States Government requirements as per Exhibit A attached. In the event that BEST decides at this stage of performance that yeast of the RED STAR type suitable for dehydration cannot be produced as aforesaid, BEST agrees to refund forthwith to RED STAR Twenty thousand ($ 20,000.) Dollars of the Twenty five thousand ($ 25,000.) Dollars initial payment, retaining for itself Five thousand ($ 5,000.) Dollars thereof.
3. Immediately following the production at the Milwaukee plant of RED STAR of fresh compressed yeast, pursuant to the foregoing paragraph, the technical staffs of BEST and RED STAR shall meet together at the Liverpool Nova Scotia plant of BEST where said RED STAR fresh compressed yeast *53 shall be dehydrated by BEST in the presence of the representatives of RED STAR'S technical staff on the drying equipment now in operation at BEST'S Liverpool Nova Scotia plant, and said dehydrated yeast shall thereupon be tested to ascertain whether it will probably meet the requirements of the United States Government as per Exhibit A attached. If, as a result of such tests, such yeast appears to be satisfactory, samples thereof shall be promptly delivered to the Chicago Quartermasters Depot, No. 1819 West Pershing Road, Chicago, Illinois, U. S. A. for further examination, analysis and test, to determine whether or not such product meets the Government requirements as per Exhibit A attached, and in the event said Depot finds that said product meets said requirements, RED STAR agrees to make a further payment to BEST of Twenty Five Thousand ($ 25,000.00) Dollars in United States funds within thirty (30) days of such finding. (It is *328 understood and agreed that, at RED STAR'S option, BEST will, during the stay of RED STAR'S technical staff at the Liverpool plant, permit inspection of its commercial operation in making compressed yeast and will disclose and furnish to RED STAR*54 detailed and complete information concerning BEST'S skills, processes or methods, procedure, technique, formulae, materials, controls, and all other data concerning BEST'S present commercial operations employed in the production of its compressed yeast for dehydration).
4. Time is of the essence in respect to the foregoing, and BEST agrees that it will dehydrate such compressed yeast of the RED STAR type and test the same at its Liverpool plant and deliver such tested samples to the Quartermasters Depot, as aforesaid, within ninety (90) days from the date hereof, provided RED STAR will, at all times, promptly and fully cooperate with BEST with respect to the procedure contemplated under the foregoing paragraphs "2" and "3" and comply with the requests of BEST in connection therewith, and will furnish all necessary facilities, equipment (including a pilot plant) and materials for the carrying out, adapting and perfecting BEST'S knowledge, skills, processes and methods in and to the production of such yeast. This RED STAR agrees fully and unreservedly to do, and in consideration thereof BEST binds itself to deliver such dried yeast to the said Quartermasters Depot within said ninety*55 (90) day period, failing which this agreement shall be cancellable at the option of RED STAR on ten (10) days' written notice to BEST, and in the event of such cancellation BEST agrees forthwith to refund to RED STAR Fifteen Thousand ($ 15,000.00) Dollars of the initial payment (Paragraph "I" hereof) made by RED STAR hereunder, retaining for itself Ten Thousand ($ 10,000.00) Dollars thereof.
5. In the event the said Chicago Quartermasters Depot finds that the yeast delivered to it by BEST as aforesaid does not meet said requirements, this agreement shall also be cancellable at the option of RED STAR on ten days' written notice to BEST, and in the event of such cancellation BEST agrees forthwith to refund to RED STAR one-half ($ 12,500.00) Dollars of the initial payment (Paragraph "I" hereof) made by RED STAR hereunder, retaining for itself the balance thereof ($ 12,500.00). If RED STAR does not cancel as aforesaid, BEST agrees to continue its cooperation with RED STAR to produce a yeast of the RED STAR type suitable for drying and to test the same as aforesaid. At any time thereafter, and before obtaining success in producing yeast of the RED STAR type according to the aforesaid*56 conditions, RED STAR shall have the right to cancel this agreement, and BEST shall likewise have the right to cancel this agreement. In either event BEST shall forthwith refund to RED STAR one-half ($ 12,500.00) of the initial payment (Paragraph "I" hereof) made by RED STAR hereunder.
6. In the event compressed yeast of the RED STAR type suitable for drying is produced pursuant to the provisions of paragraph "2" hereof, and such yeast as dehydrated at Best's Liverpool plant meets the Government requirements as per Exhibit A attached, all in compliance with the foregoing, RED STAR agrees, subject to the provisions of paragraph "11" hereof, and further subject to its ability to obtain equipment and materials, to promptly and diligently proceed with the design, purchase and installation of drying equipment at its Milwaukee plant for the commercial production of such yeast and shall, within sixty (60) days from the date of the initial operation of its said drying equipment, pay to BEST the further sum of Fifty Thousand ($ 50,000.00) Dollars in United States funds.
7. On RED STAR'S request, BEST agrees to furnish to RED STAR full information and knowledge based upon its experience in *57 the dehydration of yeast at its Liverpool plant as concerning the design, development and installation of commercial drying equipment in the plant of RED STAR to the end that such *329 equipment may operate and function economically and to the best possible advantage in the dehydration of such yeast.
8. It is understood and agreed that in the event RED STAR enters upon the commercial manufacture and sale of dried yeast pursuant to the provisions hereof, RED STAR shall have the exclusive right, so far as BEST is concerned, throughout the United States and the territories and possessions thereof, in, to and under the knowledge, skills, methods and processes and technique pertaining to the subject matter hereof made known to RED STAR by BEST during the workings of this agreement and BEST agrees not to sell the same or divulge any information or knowledge pertaining thereto to any person, firm or corporation engaged or for use in the manufacture or sale of yeast made from a molasses base.
9. BEST agrees that should RED STAR desire to file application for Letters Patent in the United States on any of BEST'S knowledge, skills, processes or methods and technique pertaining to the subject*58 matter of this agreement made known to RED STAR by BEST during the workings of this agreement, BEST will at any time upon request and without further compensation, but at the expense of RED STAR, execute, acknowledge and deliver, or cause to be executed, acknowledged and delivered, all such papers, including applications for patent, as may be necessary to obtain patents thereon in the United States and to vest title thereto in RED STAR, its successors or assigns. In the event Letters Patent are granted to RED STAR as aforesaid, there shall be granted to BEST, or to an assign owning a majority of its common shares, a paid up and unlimited license thereunder. BEST does not, however, represent that it is a pioneer in the art of producing compressed yeast from a molasses base suitable for drying, or the drying thereof, or that its knowledge, skills, processes and methods with respect thereto are patentable.
10. It is understood and agreed that following the production hereunder of a compressed yeast of the RED STAR type suitable for drying pursuant to paragraph "2" hereof, RED STAR may proceed to cause a patent infringement investigation to be made in respect of the product and process*59 or method of producing the same. Said patent infringement investigation must, however, be concluded and RED STAR'S election (as provided in the next succeeding paragraph) announced to BEST within sixty (60) days from the date of delivery of yeast by BEST to the said Chicago Quartermasters Depot pursuant to paragraph "4" hereof.
11. Should RED STAR conclude, upon the results of said infringement investigation, that there is infringement, RED STAR shall have the right to elect not to proceed with the development and installation of drying equipment and the manufacture and sale of dried yeast, and in such event RED STAR shall be relieved of all obligation to make further payments hereunder; provided, however, that in the event the Chicago Quartermasters Depot finds that the yeast delivered to it by BEST meets the said Government requirements and RED STAR at any time within a period of three (3) years from the date hereof engages upon the manufacture and sale of a dried yeast under any process, the provisions of paragraphs "3" and "6" shall apply and RED STAR shall pay to BEST the full amounts as and when herein provided.
12. In the event, however, that the Chicago Quartermasters Depot*60 rejects the yeast delivered to it by BEST, and RED STAR by reason thereof cancels this agreement pursuant to the provisions of paragraph "5" hereof, but neverthless [sic] RED STAR, at any time within three (3) years from the date hereof, proceeds with the manufacture and sale of a dried yeast which, when tested by the same methods and under the same conditions as employed by the Chicago Quartermasters Depot in testing the said rejected yeast, shall show a moisture *330 content the same as or higher than, and baking and keeping qualities the same as or lower than, the corresponding findings of the said Chicago Quartermasters Depot in respect of said rejected yeast, then only the additional payment of $ 50,000.00 provided by paragraph "6" hereof shall be made by RED STAR to BEST, the refund under paragraph "5" ($ 12,500.00) and the second payment under paragraph "3" ($ 25,000.00) being forgiven. If, despite the aforesaid rejection by the Chicago Quartermasters Depot, RED STAR sells said dry yeast to the United States Government within eighteen (18) months of said rejection, then the entire $ 100,000.00 as provided for herein shall be paid.
13. BEST represents that it has the*61 unrestricted right to make and enter into this agreement and that the knowledge, skills, methods, processes and technique developed by it in the production of its compressed yeast which, when dried at its Liverpool plant, meets (as agreed by BEST and RED STAR) the requirements of the United States Government test as per Exhibit A attached hereto, are the result of its own independent efforts and development work and constitute part of its own knowledge and skill acquired in the course of the manufacture by it of fresh or compressed yeast at its yeast plant; that it is free to transfer to RED STAR full and complete information and knowledge thereof, and the right to use the same in connection with the manufacture of dried yeast made from a molasses base within and throughout the United States, its territories and possessions, to the full extent herein contemplated, and that there are no outstanding licenses, interests or agreements inconsistent herewith, or which will impair or restrict BEST in the performance of its obligations or RED STAR in the enjoyment of its rights hereunder.
14. In consideration of the knowledge and skills to be imparted hereunder by BEST to RED STAR, RED STAR*62 agrees for the period of two years after it has commenced commercial production of dried yeast not to manufacture or sell dried yeast within the Dominion of Canada or Newfoundland, except sales of dried yeast to the Government of the United States, or its authorized agencies.
15. The provisions of this agreement shall not be construed as granting any rights to RED STAR to manufacture, dehydrate and sell yeast made from a sulphite liquor base in any part of the territories mentioned herein, or likewise as prohibiting BEST from such manufacture, dehydration and sales, if such yeast is made from a sulphite liquor base.
Exhibit A attached thereto provided, as follows:
GRANULAR DEHYDRATED YEAST: Shall be clean cultures of bread yeast (Saccharomyces cerevisae) of good commercial quality, grown on a clean nutrient medium, from which separation is effected and dehydration executed, all under modern sanitary conditions, to the end that the final product shall be capable of producing a vigorous and a well-risen dough.
Shall be composed only of yeast cells which have been dehydrated to a mositure [sic] content of not more than 8 per cent. Shall contain sufficient live yeast cells to do*63 the work of compressed yeast under standard conditions when used at the rate of 1 part of granular dehydrated yeast in lieu of 2 parts of compressed yeast. Shall be in prime condition at the time of delivery and shall not be appreciably affected as to its baking time after storage for six (6) weeks at 70 deg. F. and only slightly affected after three months' storage at such temperature. Shall not require cold storage, but shall not be affected adversely by storage for six months at 38 deg. to 42 deg. F. and on removal from such storage, shall be in as good condition as when placed in storage. Shall be free from mold, dirt, grit, starch, or other extraneous or added matter. The rope spore count shall not exceed 200 per gram.
*331 In accordance with the provisions of the contract with Best, Sidney Breese, managing director of Best, and Felix Block, a research chemist with Best, came to Milwaukee on June 15, 1943. They stayed at first for about 10 days, returning thereafter to Canada, once again coming to Milwaukee early in July and remaining for about three weeks, and then again coming back from Canada on August 12 for Breese and August 26 for Block, finally returning to Canada*64 at the end of August. While in Milwaukee Breese worked with Irvin on methods for drying yeast and Block worked with Freund on the development of a process for producing compressed yeast suitable for drying. Duplicate records of work carried on by either Irvin or Freund during Block's or Breese's absence were furnished them upon their return from Canada.
Breese and Irvin conducted their first joint experiment on June 18, 1943. Breese proposed the conditions for drying. These were different from those previously employed by Irvin in respect to both temperature range and humidity, Breese using low temperatures, while Irvin had previously dried his yeast samples at relatively higher temperatures. The finished yeast produced in accordance with Breese's first suggested drying procedure ranged from poor to only commercially acceptable, and utilization of the process commercially would have been quite costly. Subsequently, Breese and Irvin used a higher temperature level in their joint experiments and were able more efficiently to produce a good dry yeast.
While Breese's and Irvin's joint experiments ultimately produced an active dry yeast which was commercially acceptable as to quality, *65 Irvin considered the product no better than that he had previously obtained in the F-80 series of experiments. At the conclusion of the joint experiments, in August, Irvin reported to Wirth that he thought petitioner's staff had learned nothing from the Best people and that he thought petitioner's staff knew more about drying yeast than Best.
During the conduct of the joint drying experiments by Breese and Irvin, Block and Freund worked together in petitioner's pilot plant. The first pilot plant experiment was conducted on June 16, 1943, upon instruction of Block. It consisted of an after treat (or secondary fermentation) of petitioner's commercial compressed yeast. The resultant yeast was poor in quality, because the amount of air supplied in the fermentation was in the wrong proportion; the recovery of raw material was only about 45 per cent, whereas 70 per cent or better is considered normal. Block indicated to Freund that since the Best experience was with a sulphite liquor base and petitioner used a molasses base, it would be necessary for him to feel his way. After further experimentation and substantial changes in the original Best procedure, Block and Freund were able*66 to produce in petitioner's pilot plant a satisfactory compressed yeast suitable for drying. For this *332 they employed instead of commercial finished yeast a different type of compressed yeast, especially adapted to respond more readily to an after-treatment. This latter type of yeast was, on an average, a yield in weight of approximately 62 per cent of the weight of the nutrients used in the special process. Since the pilot plant experiment looked promising, it was decided to conduct a semi-commercial run. On August 6, 1943, petitioner used this process (under label of D C-27 and D C-28) successfully on a commercial scale at its Cudahy plant, producing a compressed yeast suitable for drying. This final process and technique was the result of a joint effort, including close consultation and exchange of views between Block and Freund.
Petitioner dehydrated the yeast produced by Block and Freund on August 6 on the pilot plant driers, borrowed from the company from whom it intended to purchase similar equipment. On August 25, 1943, in accordance with its contract with Best, petitioner submitted samples of the resultant active dry yeast (D C-28 (5) series) to Quartermaster*67 Research, the Office of the Quartermaster General at Washington, and the Department of Agriculture at Washington. All of the samples met United States Government standards, and petitioner was so informed in writing by the several authorities.
Freund did not consider the process and technique developed jointly with Block as an economical one and consequently did not think that it would be very practical from a commercial standpoint for petitioner to produce yeast for drying in accordance therewith.
After conclusion of the various joint experiments conducted by petitioner's and Best's representatives, petitioner continued to experiment in both its laboratory and pilot plant. Irvin, himself, conducted several hundred experiments during the period from August 20, 1943, to January 9, 1945. This further experimentation was carried on particularly to develop an economical process for the production of a satisfactory active dry yeast. Petitioner did not feel that it was possible to so produce commercially on the basis of the processes and techniques developed in conjunction with the Best representatives.
On October 22, 1943, Irvin conducted experiments in the 173 series. Samples of the*68 product were submitted to Quartermaster Research and to the War Food Administration at Washington and were found to meet Government standards. The 173 series of experiments were based upon the original F-80 series under which Irvin had originally produced a satisfactory active dry yeast on January 19, 1943. The active dry yeast process of the 173 series was basically the type of process used by petitioner in 1944 when it first began to produce active dry yeast for sale to the Army.
Following the departure of the Best people from Milwaukee, Freund also returned to experimenting somewhat along those lines established before beginning the series of joint experiments with *333 Block. The Freund-Block process, developed jointly, required two separate fermentations, necessitating a separation and washing of each fermentation. During this two-part separation and washing a certain amount of raw material was lost. Freund's further experiments in the 105 series, after the Best people had left, resulted in a process which combined two fermentations in a single synchronized step. This technique produced a maximum yield from raw material (yield of compressed yeast equal in weight to*69 a percentage of the weight of the nutrients used in the process) of 81.25 per cent, with an average yield of approximately 70 per cent, as compared with a yield of only 62 per cent from the D-28 pilot plant experiments made by Freund and Block, utilized less equipment, water, time, and labor, and was thus less costly and more efficient than that evolved with Best. Consequently the process and technique for making active dry yeast evolved in joint effort by petitioner's staff with the Best representatives was never utilized by petitioner for commercial production. The process used by petitioner for commercial production in August 1944 was that of Freund, developed in the 105 series of experiments.
In November 1943, Freund visited the Best plant at Liverpool, Nova Scotia, Canada. In accordance with the contract between petitioner and Best, Freund was permitted to observe Best's method of producing active dry yeast by the sulphite liquor process. Freund considered this process complicated and the raw material difficult to work from. He also concluded that the expense of utilizing Best's process of manufacture would be prohibitive for petitioner, since petitioner's plant was not *70 located very near a paper mill. It was, therefore, not feasible for petitioner to consider employing Best's particular methods and procedures in the production of active dry yeast.
In each of the years 1943 and 1944, petitioner paid $ 50,000 to Best in accordance with the contract of May 21, 1943. Petitioner determined to make the payments to Best because it believed that Best had fully complied with its obligations under the agreement. Best's representatives in conjunction with petitioner's technical staff had conducted a series of joint experiments which yielded samples of dry yeast meeting Army standards. To carry on this work, Breese and Block, in accordance with the contract, had drawn upon Best's experience and technical know-how, formulas, processes, and methods in the making of dry yeast using a sulphite liquor base and had adapted that knowledge and skill to the production of a satisfactory dry yeast from petitioner's product. Further, Best had disclosed to petitioner everything that Best did to produce dry yeast commercially, its costs and selling price. Finally, having produced satisfactory samples of dry yeast, such payment had to be made if petitioner, under the *71 terms of the contract, was to be permitted to sell yeast to the Army or to *334 any trade for given periods of time, regardless of the process employed to produce yeast for sale.
At the conclusion of World War II, petitioner was unable successfully to sell for commercial trade the active dry yeast product it had developed for sale to the Army, since commercial trade required a yeast product with faster baking quality and longer shelf or storage life. Consequently, petitioner was required to develop another active dry yeast suitable for its commercial peacetime trade.
Petitioner's program of experiment and research in the development of active dry yeast began in 1942 and has continued without interruption through the years 1943 to 1946, inclusive (here material).
During the years in question petitioner regularly maintained a research department, in which experiments were constantly conducted to improve petitioner's manufacturing processes and its products, and to develop such new processes and products. In accordance with its established method of accounting, petitioner charged to laboratory and experimental expense accounts on its books the costs for salaries, insurance, taxes, *72 supplies, repairs, and other expenses incurred in the operation of the research department, including certain amounts not exceeding $ 2,866.64 in any year paid to the University of Wisconsin under a fellowship grant. The total of these expenditures for the years prior to 1943 was not more than $ 26,000 per year. For the years 1943, 1944, and 1945, these expenditures totaled approximately $ 34,000, $ 45,000, and $ 71,000, respectively. Petitioner deducted these amounts as business expenses for the years 1939 to 1945, inclusive. For the years 1943 and 1944 petitioner charged the two $ 50,000 payments to Best to a separate expense account for "dry yeast." Petitioner claimed these amounts as a deduction in its returns for the years 1943 and 1944, as "Non-Apportionable Expense" for "Professional Services." Respondent disallowed the deductions and determined that the payments to Best were capital expenditures.
We find as an ultimate fact that the $ 50,000 paid by petitioner to Best in each of the years 1943 and 1944, pursuant to the contract between them, was a capital expenditure.
Permeable Groins.
Petitioner's Cudahy plant, consisting of a number of buildings, is situated on a*73 bluff immediately adjacent to the shore of Lake Michigan, approximately 112 feet above the level of the lake. Running from part of petitioner's plant at the top of the bluff, down the bluff, to the lake, and emptying into the lake was a sewer, built as an open drainage pipe, employed by petitioner to discharge pure waste water used in the course of its manufacture. During the late 1930's and early 1940's, *335 the lake bluff, a substantial portion of the side of which had been covered with trees and foliage, began to erode and deteriorate. As a consequence the sewer was left without necessary support and was damaged.
In 1942, petitioner's director of engineering undertook to construct a wharf consisting of three 40-foot long 14 x 14's placed one on top of another and threaded by bolts to old boiler flues which were filled with concrete and rock, extending back onto the beach for 18 feet. The sewer pipe was placed on top of this wharf. For a short time the sewer remained stable. After a series of storms, however, the rocks began to fall underneath the 14 x 14's and to wash out into the lake, ultimately causing the flues and the 14 x 14's also to wash out into the lake. *74 The sewer was then discharging on the lake bed.
Petitioner consulted two engineers, Charles Whitney and Sidney Makepeace Wood, in connection with the erosion of the bluff. Whitney recommended that a flat rock be built out into the lake and up onto the beach and shore, with sand underneath to act as a filter. Wood, on the other hand, recommended that permeable groins (sometimes called jetties) be constructed. Whitney's recommendation was not followed. His fee of $ 1,381.65 was paid by petitioner in 1944 and a portion thereof, in the amount of $ 1,106.43, was charged to the construction of two permeable groins, described below. Whitney's advice had no relation to such groins, construction of which was suggested by Wood.
On July 29, 1944, pursuant to petitioner's request, the War Department issued a permit to petitioner for the erection of four concrete permeable groins in the lake opposite its property, extending from 100 to 150 feet in length. Thereafter, in 1944, in accordance with Wood's recommendations, petitioner erected two concrete permeable groins, 200 feet apart, extending into the lake from the shore line perpendicular to petitioner's property, one to the north, 68 feet*75 in length, and the other to the south, 100 feet in length. The groins, an open type, were precast on the bank of the lake, then slid down and threaded on concrete piles which had been sucked into the lake bottom by hydraulic pressure. The two groins were constructed at a cost of $ 12,911.50, exclusive of the $ 1,106.43 attributed thereto by petitioner for the cost of Whitney's services.
Wood's recommendations also included the construction of drains in the lake bank for the purpose of draining surface water and thus to keep the bank from being washed away. The drains were built at a cost of $ 3,543.61, but their operation was not successful, since the bank constantly crumbled and fell as a result of the winter freeze and spring *336 thaw, and it was therefore impossible for the drains to be held in the bank. The drains were finally washed into the lake and no longer exist.
Wood further advised petitioner to build a new sewer opposite one of the groins, to be supported at one end by the groin. The old sewer could not be moved because of the then present condition of the portion of the bank upon which the old sewer rested. In 1944, petitioner had constructed a new sewer of*76 6-inch copper pipe, at a cost of $ 1,860.06. This sewer is presently in operation.
In respect to the benefits that might be expected from construction of the two permeable groins, it was Wood's view that the jetties might build a beach for petitioner for some 200 feet between the two jetties, and that it could be expected that petitioner's shore line would be stabilized in the vent of the jetties. Such would be the consequence of the jetties which would trap sand and other material carried in suspension by the current along the shore line. However, it was not expected that erosion of the bluff would cease. To the contrary, Wood indicated that erosion of the lake bank would continue despite the construction of the jetties. Wood also indicated that the probable useful life of the jetties, if constructed, would be 10 years or more.
Erosion of the lake bank has continued to date as expected and the distance between the lake bank and petitioner's buildings is constantly diminishing. At certain points not protected by the jetties, the bluff has receded considerably, perhaps some 90 feet, between April 1944 and June 1954. In 1946, as a consequence of this continued erosion, petitioner*77 was forced to tear down a 1-story building used as a machine shop. The permeable groins, however, have maintained the lake bank at the point at which the new sewer rests on the bank.
On the other hand, since the erection of the jetties, some beach has formed at the foot of the bluff in the area between the jetties. There has been practically no erosion at the site of the long jetty for approximately 35 to 40 feet about the site of the jetty. This is the point at which the new sewer is located.
Petitioner deducted $ 19,421.60 as a business (repair) expense in 1944, consisting of $ 1,106.43 paid to Whitney for advice which was not followed and charged by petitioner to the cost of building the permeable groins, $ 3,543.61 attributable to the construction of drains in the lake bank, since washed away, $ 1,860.06 representing the expense of constructing the new sewer, and $ 12,911.50 expended in the construction of the two permeable groins. The compensation paid to Wood was allocable to and included as a part of the last three items. Respondent capitalized $ 19,253.56 of the entire amount and allowed such amount to be depreciated over a 50-year life basis.
*337 OPINION.
Best*78 Yeast Payments.
In each of the years 1943 and 1944 petitioner paid $ 50,000 to Best Yeast under an agreement with that company, dated May 21, 1943. These amounts were deducted by petitioner in 1943 and 1944 as ordinary and necessary business expenses under section 23 (a) of the Internal Revenue Code of 1939. Respondent has capitalized both payments and has not allowed any deduction for depreciation in either of the years 1943 or 1944, or in any of the subsequent years involved in this proceeding.
Petitioner's main contention is that the expenditure in question was not made to acquire, develop, or improve a capital asset, but was incurred only for certain technical assistance and know-how services rendered to petitioner by Best Yeast in connection with petitioner's undertaking to engage in the manufacture of dry yeast. Petitioner argues that in the circumstances of the instant case such expenditure should be considered currently deductible as an ordinary and necessary business expense. We cannot agree.
In January 1943, some 4 months before Red Star entered into a contract with Best, petitioner had developed a laboratory technique and process (described generally in our Findings*79 of Fact, supra) for producing active dry yeast. Samples so produced had tested well, satisfying the standards and specifications of both the Department of Agriculture and Quartermaster Research. Subsequent to the January F-80 series of experiments, petitioner continued its research, conducting further experiments along these same lines, and was able to produce additional samples of active dry yeast which also tested satisfactorily. In view of these successful experiments, petitioner, on May 21, 1943, the same date on which the contract with Best Yeast was entered into, stepped up its scale of operation and undertook to produce active dry yeast in its pilot plant, in accordance with the basic process and technique developed in the F-80 series of experiments.
Clearly, for some time prior to entering into the contract with Best Yeast in May 1943, petitioner knew it had a satisfactory laboratory technique and process for producing active dry yeast, meeting Army standards. But conversion from the laboratory to commercial production in accordance with the technique and process so developed would involve a large expenditure of money for special equipment. Red Star's management, *80 considering that petitioner had never before produced dry yeast commercially, appears to have been somewhat apprehensive of the substantial risks inherent in such conversion. Moreover, petitioner was being pressed by the Army to get into production as quickly as possible to supply the large Army demand for active *338 dry yeast. Accordingly, petitioner, upon the suggestion and advice of Irvin and Isker, proceeded to contact a commercial producer of dry yeast with which petitioner was not and would not be in competition, with a view to obtaining technical assistance to guide the necessary conversion and to confirm the adequacy or inadequacy of its own technique and process by comparing it with the techniques and processes then being employed by a commercial producer of dry yeast, and if necessary, to learn of or to develop an economical process and technique for producing active dry yeast. On May 21, 1943, petitioner entered into a contract with Best Yeast of Canada, hoping thereby to perhaps accelerate conversion from its laboratory scale to commercial production, to glean whether the process and the technique it had thus far developed were superior or inferior to those currently*81 employed by a producer of dry yeast and thus be better able to evaluate the quality and economic feasibility of utilizing the process it had already developed, to study such a producer's production techniques and methods, and to obtain cost and other production data.
We have carefully reviewed the circumstances under which the services of Best were sought and employed by petitioner, the terms of the contract with Best Yeast, and the services rendered to petitioner by the representatives of Best Yeast, and we think that petitioner did not intend to and never did acquire everything possessed by Best in the way of knowledge, skills, methods, techniques, formulas, processes, materials, and other data relating to the commercial production of dry yeast, somewhat in the nature of a unitary process, for use as such. Petitioner only intended to obtain certain technical assistance from an experienced producer of dry yeast. The contract with Best clearly recognized that the Best techniques and processes could not and would not be simply transferred in whole for production of active dry yeast by petitioner with its molasses base compressed yeast product, since the Best processes and techniques*82 were developed for production of dry yeast from a sulphite liquor base. Thus it was provided that both parties contemplated and believed that Best could "with the knowledge and information * * * possessed by it * * * and the skills, methods or processes used by it in the making of its compressed yeast for drying, * * * adapt the same to compressed yeast made from a molasses base and prepare such yeast suitable for dehydration and marketing in the dry form * * *." Best, therefore, was engaged to render technical assistance in adapting its experience as a commercial producer of dry yeast to the particular requirements of petitioner's product. These services were to be based on the total of Best's experience and know-how in such manufacture, not with the aim of introducing or converting petitioner to the sulphite liquor process but with the purpose of adapting such techniques, skills, processes, *339 and know-how possessed by Best to the manufacture of dry yeast on the basis of petitioner's product.
Our view that petitioner contracted with Best for technical assistance services is further supported by the undertakings of the parties' representatives in their actual work together*83 during July and August. The Best people and Red Star people worked closely together during that period on adapting the Best experience to petitioner's product, eventually producing satisfactory samples of active dry yeast. The process and technique ultimately developed was essentially different from any previously employed by Best and neither Best nor petitioner had any prior knowledge of the final process and technique.
From the beginning of their joint work, it was obvious to both groups that the Best experience could not be transferred in whole to production of active dry yeast with petitioner's type of compressed yeast. The first experiments undertaken on the advice of the Best representatives, based on Best's experience, were not successful and indicated clearly that the petitioner's basic product required a different process and technique for producing dry yeast. Block, who worked with Freund on the production of a compressed yeast suitable for drying, indicated that since his experience was with the sulphite liquor process he would have to feel his way with petitioner's molasses base product. Subsequently, Block and Freund, by working closely together, did evolve jointly*84 a process and technique for producing a compressed yeast suitable for drying, samples of which tested satisfactorily. This process, however, was costly, and after the Best people left Milwaukee, Freund continued his experiments, ultimately developing a single-step synchronized process, described briefly and somewhat generally in our Findings of Fact. It was this later developed process that was finally employed by petitioner in its manufacture of active dry yeast in 1944.
Irvin and Breese also conducted their first experiments upon the instruction of Breese, but it was clear that his instructions, based on Best's experience, were not adequate for dehydrating petitioner's product and producing satisfactory samples of dry yeast. Irvin, drawing on his own experience with drying from January through April of 1943, prior to the contract with Best, and Breese, both working closely together, were finally able to produce a satisfactory product. But Irvin concluded that the Best people did not know as much about drying as petitioner's technicians and, after the Best people left, he returned to further experimenting along the lines he had previously followed, ultimately developing a technique*85 and process which was different from that worked out jointly with Breese. This latter process and technique was finally employed by petitioner in its manufacture.
*340 We think it is clear from the record that the experimentation carried on jointly by the representatives of both petitioner and Best during a 2-month period was not merely incidental to the acquisition by petitioner of a unitary process from Best. The experimentation carried on was contemplated by the contract between petitioner and Best, and was an essential and important part of the services to be rendered to petitioner, if the Best knowledge, experience, skills, techniques, processes, formulas, and other materials were to be adapted satisfactorily to the requirements of petitioner's basic type of yeast.
We think that the Best services, and the cooperative experimentation and research carried on by the representatives of Best and Red Star must be considered in connection with, and as an integral part of, the general program of research and experimentation undertaken by petitioner to develop a process and technique for the manufacture of active dry yeast.
Petitioner was engaged for some time in research, study, *86 and experimentation in an effort to develop a process and technique for the successful manufacture commercially of active dry yeast. Whether the payments to Best Yeast constituted a cost incident to the development of that technique and process depends on whether the technical assistance and advisory services rendered to petitioner by Best were a part of and incident to the conduct by petitioner of its experimental research for development of a satisfactory commercial technique and process for the manufacture of dry yeast. It is our view that the services of Best are not significantly separable from the conduct by petitioner of its research and experimentation in development of a technique and process for the manufacture of dry yeast. The services contracted for and rendered by Best were primarily aid in research to adapt the Best experience and know-how to producing dry yeast from petitioner's molasses base compressed yeast product. It is clear, therefore, that the expenditure was really for development or in the course of development of a technique and process for the manufacture of dry yeast. It is true that further experimentation was carried on after the Best people left*87 Milwaukee and that such experimentation and research was somewhat outside of the scope of the Best assistance. But from this perspective we think that the services rendered may be likened to a series of unsuccessful experiments conducted in the course of research and development of a process and obviously incident to and part of that development. While the information and services of Best were, perhaps, not otherwise beneficial in a practical sense, petitioner was at least heartened thereby and was confirmed in its confidence in the technical competence of its own research staff and in its reliance upon the commercial value and feasibility of the product resulting from their work. Upon consideration of the whole picture, we think that the expenditure here in issue was a capital expenditure *341 incurred in the course of and in connection with the development of a technique and process for the manufacture of active dry yeast, and was incident to and a part of petitioner's research and experimental activity undertaken to develop such a process and technique. Hart-Bartlett-Sturtevant Grain Co., 12 T. C. 760 (1949), affd. (C. A. 8, 1950) 182 F. 2d 153;*88 Claude Neon Lights, Inc., 35 B. T. A. 424 (1937); Hazeltine Corporation, 32 B. T. A. 110 (1935), affirmed on this issue (C. A. 3, 1937) 89 F.2d 513">89 F. 2d 513; John F. Canning, 29 B. T. A. 99 (1933).
Homer L. Strong, 14 B. T. A. 902 (1928), relied on by petitioner, is distinguishable from the instant case. There the taxpayer acquired a certain machine which had many mechanical imperfections. The taxpayer expended the amounts there in issue in an attempt to perfect the machine. However, the attempted improvements were not successful and the machine was considered to be imperfect and "an absolute failure" in the year of acquisition. We held that the expenditure did not result in the acquisition, development, or improvement of a capital asset having a useful life beyond the taxable year in which the outlay was made and permitted deduction of such amounts as losses sustained (or alternatively as expenses incurred) in that year. Such is not the instant case. Here the Best services were a part of petitioner's whole course of development of a *89 technique and process for the manufacture of dry yeast, which program was ultimately successful, causing creation for petitioner of a process and technique subsequently used in commercial manufacture. Any lack of usefulness to petitioner of the particular services performed by Best under the contract would not render the expenditure therefor a business expense, but only in the proper circumstances a loss in a particular year upon proof of discard by petitioner of that process and technique in the development of which this expenditure and service was only a part. W. B. Harbeson Lumber Co., 24 B. T. A. 542 (1931), also cited by petitioner, is distinguishable for essentially the same reasons.
Petitioner contends alternatively that the Best Yeast payments, if in the nature of a capital expenditure, as decided above, are nevertheless deductible as business expenses in the year in which made, in accordance with the respondent's publicly expressed policy regarding development and research expenditures. Petitioner argues that a statement of the position of the Internal Revenue Service by former Commissioner Dunlap to the Joint Committee on Internal Revenue*90 Taxation, authorizes deduction of the payments as business expenses, if such deduction is consistent with petitioner's established method of accounting.
The criteria for expensing certain research and development costs as set forth by Commissioner Dunlap are, in part, as follows:
It is the policy of the Bureau, where the taxpayer under its established method of accounting has elected to adopt the practice of charging to expense research *342 and development costs, to allow such costs as deductions in computing net income. Such costs, however, may include only such expenditures as would normally be considered to represent research and development costs in the experimental or laboratory sense. Thus, in the case of experimental airplanes, the salaries of engineers working on development of the planes, the cost of materials which enter into the construction of the planes, the cost of test flights and similar expenditures is deductible as expense items. However, amounts paid out for new buildings and equipment including tools which have a substantial life beyond the taxable year, or which are adaptable for use other than the particular research or development project for which *91 they were constructed or acquired, must be capitalized even though such buildings or equipment are necessary for the particular research or development project.
Petitioner argues that the payments to Best are such research and development costs as contemplated thereby and are properly deductible as business expenses in the year in which they are incurred. Respondent, on the other hand, contends that the circumstances of the payments to Best are not such as to bring petitioner within the purview of the policy set forth in the Commissioner's statement. Respondent contends mainly that the Best payments were not such expenditures as would normally be considered research and development costs in the experimental or laboratory sense. While we agree largely with petitioner's over-all conception of the nature of the Best expenditure, we must, nevertheless, disagree with its ultimate conclusion that the capital expenditure here in issue is currently deductible as a business expense because of the respondent's apparent administrative practice.
Neither the Internal Revenue Code nor the regulations provide any general definition for determining what constitutes research and development costs. *92 Such determination, therefore, must be made in each case upon the particular circumstances involved therein. In some measure, the research and development costs which the Service contemplated were particularized and qualified in terms of such costs in an "experimental or laboratory sense," and related mainly to the constant carrying on of laboratory and research operations. Petitioner points out that it has consistently for many years deducted as business expenses the various costs of operating its laboratory and research facilities, and in particular indicates that it properly so expensed those costs incurred over a period of about 4 years in converting from a grain base to a molasses base in the production of fresh compressed yeast. Petitioner argues that the Best Yeast payments should be treated in the same manner. It should be noted that petitioner has consistently in its accounting deducted currently its research and experimental expenses and that this practice has been allowed by the Commissioner except for such treatment by petitioner of the Best expenditure.
We think that the payments to Best were essentially research and development costs in a laboratory or experimental*93 sense. The contract *343 between petitioner and Best is complex, but in essence it provided that Best make available to petitioner all of Best's knowledge, skills, techniques, formulas, etc., regarding its processes for manufacturing dry yeast and adapt such experience and know-how as Best had acquired in such manufacture to the development of a technique and process for manufacturing dry yeast from petitioner's molasses base compressed yeast product. This was to be accomplished by representatives of the technical staffs of both Best and petitioner meeting together at petitioner's plant in Milwaukee and there engaging in the necessary laboratory and pilot plant research and experimentation. The record indicates that the representatives of both companies met and worked together in accordance with the agreement. They jointly undertook a series of experiments for the production of a compressed yeast suitable for drying and in the dehydration of such yeast to produce an active dry yeast. These experiments were carried on intermittently over a period of approximately 6 weeks over the summer of 1943. After utilization and adaptation of each of the parties' knowledge and skills*94 in respect to the production and drying of yeast, the joint experiments ultimately produced a satisfactory product meeting the Government's standards as tested in accordance with the terms of the contract. On the basis of the foregoing, we think that the Best payments should be considered research and development costs in the laboratory or experimental sense as such terms were employed by Commissioner Dunlap. Accordingly, we think that the expenditure incurred by petitioner for payments to Best Yeast was such as would qualify for deduction as a business expense in accordance with the policy statement of Commissioner Dunlap.
We must, nevertheless, hold for respondent. The statement of policy by Commissioner Dunlap is not in any way binding, absent provision for this view in the Internal Revenue Code or the regulations appropriate to and promulgated thereunder. We need indicate only briefly that under the applicable provisions of the Internal Revenue Code and regulations no election exists with respect to the treatment to be accorded to expenditures which are capital in nature. If challenged by the Commissioner, they must be capitalized. Gilliam Manufacturing Co., 1 B. T. A. 967 (1925);*95 Hazeltine Corporation, supra;Claude Neon Lights, Inc., supra;Hart-Bartlett-Sturtevant Grain Co., supra.See also Goodell-Pratt Co., 3 B. T. A. 30 (1925); John F. Canning, supra.
At one time article 168 of Treasury Regulations 45, 62, and 65, permitted taxpayers incurring expenses of an experimental nature calculated to result in improvement of their facilities or products to elect to deduct such expenses currently from income in the year in which incurred or to capitalize such expenditures. Subsequently, in *344 Gilliam Manufacturing, supra, we held that under the then applicable revenue act a taxpayer had no option to treat expense items as capital or capital expenditures as ordinary and necessary expenses of carrying on a trade or business. In 1926, the Treasury deleted from article 168 of Regulations 69 the previously permitted option. Thereafter, the then Internal Revenue Bureau, nevertheless, permitted taxpayers to deduct expenses incurred in conducting regular and continual research activities. *96 For the most part, the courts, however, have constantly held that experimentation and research expenditures incurred in the development of new processes, formulas, or patents are capital expenditures and that no option exists for the taxpayer to capitalize or expense such items in accordance with its particular established method of accounting period. Ultimately the service policy was publicly stated in the expression by Commissioner Dunlap heretofore discussed. 1
In view of the long-standing and well-settled position taken by this Court in these respects, we think that, having determined petitioner's expenditure to be capital in nature, we must find that it is not free to deduct such amounts as business expenses. Accordingly, we hold that respondent was justified in capitalizing the payments to Best Yeast.
Petitioner further argues that whatever it acquired from Best was discarded or abandoned within the year of*97 acquisition, and, therefore, that the entire cost is currently deductible "whether the expenditure be designated as expense or capital." W. B. Harbeson Lumber Co., supra. Petitioner, however, has not by appropriate pleading raised a claim for loss deduction under section 23 (f) for either of the years 1943 or 1944, and, therefore, such contention is not properly before us. Even if the issue had been properly raised, however, we think its determination would have been controlled by the views expressed infra in connection with petitioner's like claim of loss grounded upon abandonment in 1945 or 1946.
As indicated above, petitioner has, by appropriate pleading, raised a similar contention in respect to the taxable years 1945 and 1946. Petitioner argues that if the Best Yeast payments were properly capitalized by respondent and are not deductible as business expenses or otherwise during the years in which incurred, such amounts are nevertheless deductible as a loss in either the taxable year 1945 or 1946, under section 23 (f) of the Internal Revenue Code of 1939. Petitioner's position is that such loss was from discard and abandonment of that for *98 which it made the payments to Best and that such abandonment occurred either in 1945, when sales of active dry yeast to the *345 Army ceased, or in 1946, when petitioner adapted its process and product to the requirements of the commercial trade.
If the payments to Best were segregable and deductible on the theory of abandonment as items separate and distinct from other capital outlays covering the research and experimental activities of petitioner in relation to the development of a technique and process for manufacture of active dry yeast, the deduction should have been claimed for a year or years not later than 1944. Cf. Dresser Manufacturing Co., 40 B. T. A. 341 (1939). As already indicated, however, petitioner has not raised this issue by appropriate pleading.
Petitioner argues on brief, however, that its development of processes to make active dry yeast, including the payments to Best, was undertaken for the sole purpose of being able to supply active dry yeast to the Army for war purposes; that sales to the Army ceased in 1945, and that when such sales were resumed in 1946, they were on a limited basis. It further argues that, except for*99 the urgency of war conditions, it would have been able to take its time in developing its processes to make active dry yeast, and would never have entered into the contract with Best.
Petitioner further argues on brief as follows:
At the termination of World War II, petitioner, unlike other manufacturers of yeast, was not satisfied to drop the sale of active dry yeast even though the demand from the United States Army ceased. Accordingly, petitioner began selling active dry yeast in commercial channels. The result of such attempts at commercial sale proved unsuccessful, but petitioner still would not give up on the matter of selling active dry yeast in commercial channels, and petitioner's research staff set out to produce an active dry yeast that would be acceptable to the bakers' trade and the housewife. Petitioner then realized that in order for active dry yeast to be sold in commercial channels it would have to have a faster baking quality and a better (longer) shelf life or storage life. Petitioner proceeded to change its processes of making active dry yeast that were in existence at the conclusion of World War II so as to permit the production of active dry yeast that *100 had a faster baking quality and a better (longer) shelf life or storage life, and then experienced such success in commercial sales of active dry yeast that other companies followed its lead in selling active dry yeast to the commercial trade.
We do not think that the events occurring in 1945 or 1946 amounted to an abandonment or gave rise to circumstances warranting a loss deduction. The record establishes that petitioner, in 1942, embarked upon a program of research and experimentation looking to the development and manufacture of an active dry yeast product. The contract with and the payments to Best were incident to and a part of that program. The immediate objective was to manufacture for and sell to the Army an active dry yeast suitable for its purposes. This objective was achieved, but the market for the particular product ceased (as no doubt was anticipated) when war activities ceased. Petitioner continued its program of research and its experiments in *346 order to develop a product which would meet the requirements of the commercial trade for a faster baking quality and a longer shelf life. The product, however, continued to be active dry yeast. The research program*101 was continuous and developing. It began prior to any of the years here material and has continued to the present day. The Army was an easier customer than the housewife or baker, and when the Army ceased to be a good customer, a process was developed to satisfy the commercial trade. The process developed with Best's representatives differed from that ultimately used to meet Army requirements, and the latter differed from the process used to meet the requirements of the commercial trade. It is our view, however, that the various steps were merely parts of a whole experimental, research, and development program which began with the objective of producing active dry yeast, achieving one of its objectives in selling active dry yeast to the Army and another in adapting the active dry yeast product for sale to the commercial trade. We find nothing in the record which establishes an abandonment of the program at any of these stages and the affirmative evidence appears rather to support a contrary view.
Accordingly, we hold that petitioner is not entitled to deduct the amount of the payments to Best as a loss upon discard or abandonment in either of the years 1945 or 1946, the only years*102 in respect to which such issue was raised by appropriate pleading.
Deduction for Permeable Groins.
The respondent has determined that of an amount of $ 19,421.60 deducted by petitioner on its 1944 corporate income tax return as an ordinary and necessary repair expense, $ 19,253.56 should be capitalized and that such amount should be depreciated over a period of 50 years. Petitioner, in its amended petition, segregated the $ 19,421.60 amount, previously deducted as a single expenditure without segregation, into four separate elements of cost composed of the following four items: (1) $ 1,106.43 paid by petitioner to Whitney for certain advice which was not followed; (2) $ 3,543.61 attributable to the construction of certain drains in the lake bank (and including $ 275.22 of a total of $ 1,381.65 paid to Whitney, representing the allocable portion of that amount paid for advice concerning such drains); (3) $ 1,860.06 representing the expense of constructing a new sewer; and (4) $ 12,911.50 expended in the construction of two permeable groins. We will consider whether any or all of such cost items were properly capitalized by respondent.
The largest expenditure in issue is that *103 incurred in the actual construction of two permeable groins. Respondent contends that the expenditure was capital in nature. He argues that the permeable groins constituted permanent improvements or betterments having a useful *347 life of more than 1 year and prolonging the beneficial life of the property so improved. Petitioner, on the other hand, contends that construction of the permeable groins was a repair made only to keep petitioner's plant in its ordinarily efficient operating condition. Petitioner argues that the groins did not add to the value of petitioner's property or prolong its useful life. We hold for respondent for the reasons set out below.
Questions concerning the capital or expense nature of an item have often been before the Court, and though in broad application the legal principles are well settled, it nonetheless remains in each particular case for us to determine whether in the circumstances of that case the expenditure was in fact a repair expense or a capital improvement or betterment, an issue which is frequently a matter of degree. We think that the construction involved in this case, namely, two permeable groins, was capital in nature. The*104 groins represented new and permanent construction and had a useful life extending beyond the one year in which the expenditure was incurred. We think the record indicates that the groins improved and bettered petitioner's property, in some measure successfully stabilizing a portion of petitioner's shore line and building a beach within the immediate area of the groins. The existence of the groins has also enabled petitioner to construct a new sewer opposite one of them. Admittedly the groins have only to a degree prevented further erosion of petitioner's lake bank, and obviously have not prolonged the useful life of petitioner's property beyond that for which it would have been useful had no erosion taken place, but we nevertheless think that they have added to the value of petitioner's property for use in its business. See Hotel Sulgrave, Inc., 21 T. C. 619 (1954), where it was held that installation of a sprinkler system did not represent a repair but was an improvement or betterment which, while it did not increase the value of the hotel property, did render such property more valuable for use in the taxpayer's business, and accordingly, that *105 the cost of such installation was properly added by respondent to petitioner's capital investment in the building and depreciated over the life of the building. Cf. Black Hardware Co., 16 B. T. A. 551 (1929), affd. (C. A. 5, 1930) 39 F. 2d 460, certiorari denied 282 U.S. 841">282 U.S. 841; International Building Co., 21 B. T. A. 617 (1930); Difco Laboratories, Inc., 10 T. C. 660 (1948).
Petitioner argues further, on the basis of Illinois Merchants Trust Co., Executor, 4 B. T. A. 103 (1926) and American Bemberg Corporation, 10 T. C. 361 (1948), affirmed per curiam (C. A. 6, 1949) 177 F. 2d 200, that the two permeable groins merely restored its property to its ordinarily efficient operating condition and did not otherwise constitute an improvement or betterment in the nature of a capital item. We think that both cases are readily distinguishable on their facts.
*348 In Illinois Merchants Trust, a sudden lowering of the water level in the south branch of the*106 Chicago River left the upper ends of certain wood piles upon which the taxpayer's building rested exposed to the air, causing that part of the piles to decay from dry rot. As a consequence, the wall on the river side of the taxpayer's building settled to a point where it was likely that the entire building would collapse. In order to maintain the building in serviceable condition it was necessary to saw off the rotted piles at a point below the new water level and to insert concrete supports between the ends of the submerged piles in the floor of the building, thus raising the river wall. This wall was also considerably shored up. We held that the taxpayer was entitled to deduct the cost of this work as a business expense for repairs. Regarding the distinction between a repair expense and a capital expenditure we said:
In determining whether an expenditure is a capital one or is chargeable against operating income, it is necessary to bear in mind the purpose for which the expenditure was made. To repair is to restore to a sound state or to mend, while a replacement connotes a substitution. A repair is an expenditure for the purpose of keeping the property in an ordinarily*107 efficient operating condition. It does not add to the value of the property, nor does it appreciably prolong its life. It merely keeps the property in an operating condition over its probable useful life for the uses for which it was acquired. Expenditures for that purpose are distinguishable from those for replacements, alterations, improvements or additions which prolong the life of the property, increase its value, or make it adaptable to a different use. The one is a maintenance charge, while the others are additions to capital investment which should not be applied against current earnings. * * *
It is clear that in Illinois Merchants Trust the expenditure did not prolong the useful life of the building beyond its probable normal life, even though it did extend the life of the building beyond what it would have been had the piles not been repaired. But the critical basis for permitting the taxpayer to deduct the expenditure currently was that there was a restoration of "damaged fabric" in order to keep the property in operating condition and that the work did not represent a complete replacement of any sizable unit or totally new construction such as is involved in*108 the instant case. See Buckland v. United States, (D. Conn., 1946) 66 F. Supp. 681">66 F. Supp. 681.
Similarly, American Bemberg is also a case of repairs. There several large cave-ins occurred in the taxpayer's plant, caused by the condition of the soil and bedrock. In order to prevent having to abandon the plant, the taxpayer undertook certain drilling and grouting operations. Relying somewhat on Illinois Merchants Trust, we held that consideration should be given to the physical nature of the work, the effect of the work undertaken, whether something new was created, and whether the work afforded permanent relief or merely maintained the level of operation of the plant. We concluded in that case that the purpose of the work was to enable the taxpayer *349 to continue the plant in operation on the same scale as before, and was not to rebuild or replace the plant. We pointed out that neither the drilling nor the grouting was a work of construction nor did it create anything new, and that only the intermediate consequences of the original geological defect had been dealt with. Accordingly, we held that the expenditures were for repairs and were*109 not capital expenditures. Such circumstances obviously are quite different from those of the instant case where there was no damage to petitioner's plant to which the construction of permeable groins related. (In this respect the expenditure was wholly anticipatory.) The construction was entirely new and, as is apparent from the record, did substantially more than merely maintain petitioner's plant in its ordinarily efficient operation.
The second item of expense to be considered is that incurred for construction of a new sewer of 6-inch copper pipe. In large measure for the same reasons heretofore expressed in respect to the groins, we think that the cost of constructing the sewer was a capital expenditure. However, petitioner argues further in respect to this item that the sewer was merely a replacement of one already in existence and therefore that such expenditure should not be considered a capital expenditure. Petitioner urges that it should not be required to capitalize an expenditure for duplicating a facility which was still in existence and which physically was still in usable condition, but which for other causes was not usable. The old sewer apparently was not deteriorated*110 but because of the washing away of the lake bank it could not be moved from its position along the side of the bluff to the location of the present (new) sewer along an end of one permeable groin.
In Illinois Merchants Trust we distinguished a repair expense from a capital expenditure by considering expenditures for replacement which prolong the life of property or increase its value as capital expenditures. The expenditure here was such a capital replacement expenditure. There was no restoration of the old facility but construction of a completely new one. It is evident that the distinction between the terms "repair" and "replacement" is one of fine degree. However, we think that a repair involves something more in the nature of a substitution of new parts or restoration of certain parts of a given whole, whereas in the instant case the entire structural unit was replaced and a new one substituted therefor without relation to the original physical facility. See Russell Box Co. v. Commissioner, (C. A. 1, 1953) 208 F. 2d 452, affirming a Memorandum Opinion of this Court, holding that the cost of constructing a steel fence to provide protection*111 against sabotage and to replace an old wooden fence was a capital expenditure. Cf. Hoyt B. Wooten, 12 T. C. 659 (1949), affirmed per curiam (C. A. 6, 1950) 181 F. 2d 502.
*350 We hold that respondent has properly capitalized the expenditure incurred in construction of a new sewer.
The third item in issue is the cost of constructing certain drains in the lake bank adjacent to petitioner's plant. The drains proved unsuccessful and, at a time not disclosed in the record, were washed into the lake. Petitioner argues that the expenditure for drainage did not result in the acquisition of a capital asset and therefore that such amount should be allowed as a deductible expense in 1944 under section 23 (a) of the Internal Revenue Code of 1939. It is our view, based upon consideration of the entire record, that the expense incurred by petitioner for construction of these drains was capital in nature. The drains appear to have had a useful life of more than 1 year and certainly represented new construction as distinguished from the repair or restoration of an existing facility. Also, in some measure, they doubtless increased*112 the value of petitioner's property for the period of their existence. Subsequent destruction or loss of the drains does not in any way reflect on the nature of the original expense. The issue in this respect would have to be drawn in terms of a deduction for loss under section 23 (f) of the Internal Revenue Code. Our examination of the pleadings does not reveal any claim on such basis and the record discloses no evidence from which we might infer such a claim. Consequently, we must sustain the respondent's determination in respect to this item.
The last item in issue is the fee paid to Whitney for certain advice which was not subsequently acted upon by petitioner. Petitioner's contention in respect thereto is essentially the same as that urged in regard to the expenditure for drains, namely, that the payment in question constituted a business expense for the reason that there was no acquisition by petitioner of a capital asset as a consequence of the expenditure and to which the expenditure could properly be attributed.
Petitioner sought advice from both Whitney and Wood in connection with deterioration of the lake bluff. Ultimately petitioner followed some of the recommendations*113 of Whitney and Wood in respect to the construction of drains, but followed only the recommendations of Wood in respect to the construction of permeable groins. Petitioner did not follow or otherwise utilize the recommendation of Whitney respecting the construction of certain stone filters. It is the portion of the fee that is attributable to this latter advice which is now in issue.
We think that while the single same circumstance prompted petitioner to seek the advice of both Whitney and Wood, Whitney's advice concerning construction of stone filters is clearly separable from and has no relation to that advice of Wood concerning the construction of permeable groins. Accordingly, we agree with petitioner that the *351 expenditure did not result in the acquisition of an asset to which the fee may be attributed as a cost factor. It would obviously not be proper to attribute this fee to the cost of permeable groins since the advice for which the fee was paid had nothing at all to do with construction of permeable groins, except in an extreme causal sense in which it might be considered that both cost factors (and also the cost of drains) related to preservation of the lake bank. *114 This does not seem to us to be a case where the cost of architectural or engineering services is related to construction of some kind and consequently attributable thereto. We think that in the circumstances of this case the amount is properly deductible as a fee for professional services in the year in which it was incurred and is not to be considered as a capital expenditure.
At several points during the course of the hearing and on brief, petitioner appears to contend alternatively that should the $ 19,421.60 expenditure have been properly capitalized in any amount by respondent depreciation is properly calculable over a lesser period than that of 50 years as determined by respondent. Petitioner offered no proof in respect to this matter, only challenging respondent's expert witness' expertise regarding the probable useful life of permeable groins located in Lake Michigan. And a careful review of the pleadings discloses no assignment of error in regard to this portion of respondent's determination. Accordingly, no such issue is before us and respondent's determination is sustained.
Decision will be entered under Rule 50.
Footnotes
1. Certain Congressional action has since been taken in the 1954 Internal Revenue Code, section 174↩.