*35 Decision will be entered for the respondent.
1. Income from the sale of tangible property resulting from research and development, held, not abnormal within the meaning of section 456(a)(2)(B), I.R.C. 1939.
2. Deductible interest on 1942 and 1943 income tax deficiencies which arose out of excess profits tax relief for same years, held, related to interest credited on excess profits tax refund within the meaning of section 456(a)(3), I.R.C. 1939.
*289 Respondent determined deficiencies in petitioner's income and excess profits tax of $ 87,935.72, $ 220,260.07, and $ 261,682.44 for the years 1951, 1952, and 1953, respectively. He disallowed petitioner's claim for refund of income and excess profits tax of $ 193,908.85 for the year 1951.
The issues to be decided are (1) whether petitioner received abnormal income within the meaning of section 456, I.R.C. 1939, during *290 any of the years in issue from the sales of either (a) stereo products, or (b) the Polaroid Land equipment, or both; and (2) whether interest credited to petitioner on a refund of excess profits tax for the years 1942 and 1943 must be reduced by interest charged on deficiencies in income tax for those same years under section 456 (a)(3), I.R.C. 1939, in computing petitioner's "net abnormal income" for 1951.
FINDINGS OF FACT.
The stipulated facts are*37 found.
Petitioner is a Delaware corporation with its principal office in Cambridge, Massachusetts. It filed an original return for 1951 with the collector of internal revenue for the district of Massachusetts. It filed an amended return for 1951 and original returns for 1952 and 1953 with the director of internal revenue, Boston, Massachusetts.
Petitioner was incorporated in 1937 and from that date to late in 1948 it engaged primarily in the business of research and development and the exploitation of research and development by manufacturing and selling a variety of optical products in the field of light polarization, such as polarizing sunglasses and visors, polarizing camera filters, polarizing day-driving visors, and variable density windows.
In 1952 and 1953, 3-dimensional (3-D) motion pictures were exhibited. The audience viewed the picture through viewers incorporating the Polaroid synthetic light polarizer which were necessary to give the 3-D illusion. Edwin H. Land, petitioner's president and director of research, invented the synthetic polarizer used in these viewers. Petitioner owned three patents which covered this polarizer, hereafter referred to as stereo. The *38 exhibition of the 3-D motion pictures would not have been commercially practicable had petitioner's synthetic polarizer not been available. No noninfringing material for this purpose was on the market.
Petitioner's sales of stereo products during 1946 through 1950 were:
| Year | Sales |
| 1946 | $ 25,141 |
| 1947 | 7,077 |
| 1948 | 55,867 |
| 1949 | 9,850 |
| 1950 | 15,385 |
Its sales, expenses, and net income from these sales in 1951, 1952, and 1953 were:
| Year | Sales | Expenses | Net income |
| 1951 | $ 39,543 | $ 21,726 | $ 17,817 |
| 1952 | 85,443 | 82,558 | 2,885 |
| 1953 | 6,310,201 | 717,671 | 1,592,530 |
*291 The expenses incurred by petitioner in the invention and development of its stereo products during 1943 through 1953 were:
| Year | Expenses |
| 1943 | $ 60,695 |
| 1944 | 86,819 |
| 1945 | 172,640 |
| 1946 | 22,806 |
| 1947 | 9,040 |
| 1948 | |
| 1949 | |
| 1950 | 17,203 |
| 1951 | 22,773 |
| 1952 | 51,602 |
| 1953 | 143,953 |
Petitioner's income from the sales of stereo products during the years 1946 through 1953 was income from sales of tangible property arising out of research and development which extended over a period of more than 12 months.
On February 21, 1947, at a meeting of the Optical Society of America, Land first publicly*39 announced and demonstrated his invention of a camera and photographic film which produced a finished dry positive print directly from the camera within 60 seconds after the picture was snapped. The camera and photographic film are known respectively as the Polaroid Land camera and Polaroid Land picture roll, and together they constitute the Polaroid Land equipment. The Optical Society program referred to the equipment as "a new kind of photography as revolutionary as the transition from wet plates to daylight-loading film."
New basic principles of photographic processing were evolved by Land in his conception of the Polaroid Land equipment. There had never previously existed any photographic process in which a positive print was obtained simultaneously with the development of the negative by the application to the negative and positive receiving sheets of both the silver halide developer and the silver halide solvent. There had been no prior recognition of the possibility of simultaneously introducing the silver halide developer and the silver halide solvent and so controlling their intensitives and speed of operation that the developer could perform its function in the presence*40 of the solvent before the solvent could act upon the silver halide in the negative. The four separate steps in the prior art -- the developing and fixing of the negative and the printing and fixing of the positive -- were compressed in the Polaroid Land equipment into one step, the developing and fixing of the negative and contemporaneous formation on a positive sheet of a positive print from the dissolved silver halide of the negative. In the Polaroid Land picture roll all materials required for the developing and printing are part of the film assembly. The camera in which the film is processed remains dry throughout.
*292 There were at least two major basic developments involved in the Polaroid Land equipment. One was a means by which high concentrations of developer and silver halide solvents were introduced simultaneously, after having been stored in a capsulating agent to keep them from oxidizing through contact with the air. The second was the process of catalyzing the precipitation of silver from the silver halide solvent onto the surface of the positive receiving sheet in such a way as to obtain a silver image with relatively minute quantities of silver.
Prior to*41 the conception of the Polaroid Land equipment, no photographic equipment existed whereby the picture was taken, the negative developed, and a positive print obtained directly from the camera by a 1-step dry process. Land's new inventions in photographic equipment were novel.
Petitioner's first patent in its "Picture in a Minute" field issued in 1948, and at the end of 1953, 118 patents had issued and 91 additional applications were pending. At the end of 1958, 238 patents had issued and 202 additional applications were pending. In 1954, the United States Patent Office created a separate subclass to handle, exclusively, patent applications in the Polaroid Land equipment field.
The Polaroid Land equipment was first marketed by petitioner in November 1948. The camera is not usable with any film other than the Polaroid Land picture roll and the picture roll is not usable with any camera other than the Polaroid Land camera. The photographic accessories marketed by petitioner, such as flashguns, light meters, filters, and copy makers, have been specifically designed for the Polaroid Land camera and have had no market apart from their use with that camera. There have been no products*42 on the market directly competitive with the Polaroid Land equipment since its introduction. In addition to its use in producing a picture in a minute, the Polaroid Land equipment is used to make instantaneous X-rays and in devices for the detection of the extent of exposure to radiation.
Petitioner's sales of Polaroid Land cameras, photographic packs, and photographic accessories during 1948 through 1950 were:
| Year | Sales |
| 1948 | $ 39,155 |
| 1949 | 5,379,023 |
| 1950 | 5,057,908 |
*293 Its sales, expenses, and net income from these sales in 1951, 1952, and 1953 were:
| Year | Sales | Expenses | Net income |
| 1951 | $ 7,394,385 | $ 6,164,973 | $ 1,229,412 |
| 1952 | 11,076,969 | 9,611,657 | 1,465,312 |
| 1953 | 17,212,784 | 14,727,692 | 2,485,092 |
The expenses incurred by petitioner in the invention and development of Polaroid Land cameras, photographic packs, and photographic accessories during 1944 through 1953 were:
| Year | Expenses |
| 1944 | $ 7,150 |
| 1945 | 96,943 |
| 1946 | 388,667 |
| 1947 | 300,369 |
| 1948 | 365,332 |
| 1949 | 267,425 |
| 1950 | 267,733 |
| 1951 | 143,986 |
| 1952 | 213,776 |
| 1953 | 243,936 |
No expenses were incurred by petitioner in the invention and development of Polaroid Land cameras, photographic*43 packs, or photographic accessories prior to 1944.
The sales of the Polaroid Land equipment during the years 1948 through 1953 resulted entirely from its capacity to produce a picture in a minute. If this equipment had not made an instantaneous positive print there would have been no demand for the camera or photographic pack during that period.
Petitioner's income from the sales of the Polaroid Land equipment and photographic accessories during 1948 through 1953 was income from the sales of tangible property arising out of research and development which extended over a period of more than 12 months.
The income received by petitioner in 1951, 1952, and 1953 from the sales of stereo products and the Polaroid Land equipment and accessories does not constitute abnormal income under section 456.
In 1951, petitioner's claims for relief under section 722, I.R.C. 1939, for the years 1942 and 1943 were settled, and as a result, interest of $ 74,864.93 on the overassessments was computed to June 13, 1951. As a further result of this settlement on the same claims, interest on deficiencies in income tax for those years of $ 34,075.11 was computed to June 13, 1951. The interest charged on the*44 deficiencies in income tax for the years 1942 and 1943 in the amount of $ 34,075.11 is a deduction relating to the interest of $ 74,864.93.
OPINION.
The issues in this case are essentially questions of statutory construction. Respondent does not dispute the facts produced by petitioner.
*294 The income 1 which petitioner contends is abnormal under section 456, I.R.C. 1939, 2*45 was earned by the sale of tangible property which arose out of research and development 3 extending over a period of more than 12 months. Respondent's regulations 4 provide that such income is not abnormal and may not constitute a class of income under section 456. This provision in respondent's regulations is squarely in accord with congressional intent as manifested by the legislative history of section 456.
*46 Basically, the Korean War excess profits tax was patterned after the World War II excess profits tax. There was, however, a general attempt to simplify the administration of the tax and to eliminate potential inequities. The World War II tax described one class of abnormal income as follows:
*295 SEC. 721 [I.R.C. 1939]. ABNORMALITIES IN INCOME IN TAXABLE PERIOD.
(a) Definitions. -- For the purposes of this section --
* * * *
(2) Separate classes of income. -- Each of the following subparagraphs shall be held to describe a separate class of income:
* * * *
(C) Income resulting from exploration, discovery, prospecting, research, or development of tangible property, patents, formulae, or processes, or any combination of the foregoing, extending over a period of more than 12 months; or
Congress reported with regard to the Korean War (sec. 456) counterpart of this class of abnormal income:The equivalent provision in the World War II law (sec. 721) also permitted adjustments with reference to certain other types of income, particularly that resulting from the sale of tangible property arising out of research and development which extended over a period of more*47 than 12 months. This provision in the old law was a potential loophole of major dimensions. Because there appeared to be no means of restricting such an adjustment to truly meritorious cases other than by the introduction of a large degree of administrative discretion of the type required by the general relief clause of the World War II law (sec. 722), and because the need for a reallocation of such income seemed to be materially less than in the other classes of income described above, this item has been omitted from the list of abnormal types of income for which a reallocation can be made under this bill. [H. Rept. No. 3142, 81st Cong., 2d Sess. (1950), p. 13. Emphasis added.]
Petitioner contends that its income is "otherwise properly includible within a class of income to which * * * [sec. 456, I.R.C. 1939] is applicable" and therefore qualifies under the exception contained in the regulation. It contends that the income resulted from a "discovery" within the meaning of section 456(a)(2)(B), and that although the term "discovery" as used in that section may not encompass all inventions it does include new basic inventions of "revolutionary proportions" such as the Polaroid*48 Land equipment and the stereo products. For purposes of this case we assume that petitioner's inventions may have been new, startling, or even revolutionary.
But Congress intentionally excluded income from the sale of property resulting from research, whether or not constituting invention, as a potential class of abnormal income when it enacted section 456, and it did so regardless of the dynamic effect of an invention. Although the meanings of the terms "discovery" and "invention" may overlap in the field of patent law, see 35 U.S.C. sec. 100, we do not read the section before us as indicating that Congress intended the term "discovery" to include what is normally thought of as patentable *296 inventions. 5 Cf. sec. 456(a)(2)(C), supra at footnote 2. Respondent's suggestion that "discovery" was used to refer to the gas, oil, and mining industries has some merit inasmuch as it is interposed between "exploration" and "prospecting" which are normally thought of in connection with those industries. This, however, is a question we need not decide. The narrower interpretation of section 456 is necessary if we are to give effect to the*49 action taken by Congress in changing the language of the predecessor of that very section to exclude income resulting "from the sale of tangible property arising out of research and development which extended over a period of more than 12 months." Searle & Co. v. Jarecki, (N.D. Ill.) F.Supp. (May 11, 1959).
*50 Petitioner further contends that although its income may not fall within one of the classes enumerated in section 456, it is entitled under respondent's regulations 6 to group this income in such classes "as are reasonable in a business of the type which * * * [it] conducts, and as are appropriate in the light of * * * [its] business experience and accounting practice." Although this regulation provides that such a grouping is subject to respondent's approval, petitioner contends that the provision in section 456(a)(2) that "the classification of income of any class not described * * * shall be subject to regulations prescribed by the Secretary" was intended to broaden the classes and that the respondent has no right to refuse approval to petitioner's classification. That section does not require respondent to classify all income. He did not approve of petitioner's classification and, furthermore, his regulation specifically excludes the type of income in question with an exception which we have found not applicable to petitioner. Petitioner's income earned in 1951, 1952, and 1953, was not abnormal within the meaning of section 456.
*51 The second issue is whether the interest with which petitioner was credited in 1951 upon its successful claim for an excess profits tax refund, and which was admittedly abnormal income, must be reduced *297 in computing petitioner's net abnormal income under section 456(a)(3)7 by the interest which it was charged on income tax deficiencies which were attributable to the reduced excess profits tax. In the words of the statute, the question is whether the interest on the income tax deficiency is a cost or deduction "relating" to the interest on the excess profits tax refund.
*52 Although the corporate income tax and the excess profits tax are separate and distinct types of taxes, Babcock & Wilcox Co. v. Pedrick, (C.A. 2) 212 F. 2d 645, certiorari denied 348 U.S. 936">348 U.S. 936, they are related in some aspects. The net dollar return to petitioner from its excess profits tax refund claim was reduced by a corresponding income tax deficiency, because as petitioner was successfully able to reduce its adjusted excess profits net income its normal tax net income increased. Sec. 26(e), I.R.C. 1939, applicable to the relevant years 1942 and 1943. There was, at least to that extent, a relationship between the World War II excess profits tax and the income tax.
It is not necessary to say that income tax and excess profits tax are not different taxes in order to say that they are "related." Computation of one is reciprocal to that of the other, and it is this arithmetic relationship which led automatically and inevitably to the deficiency in income tax upon reduction of and determination of overassessment in the excess profits tax. Morrisdale Coal Mining Co., 21 T.C. 393">21 T.C. 393; Ambassador Hotel Co. of Los Angeles, 32 T.C. 208">32 T.C. 208.*53
Interest on the one was due to the petitioner by reason of the same fact that caused interest on the other to be due from petitioner, namely, allowance of petitioner's claim under section 722. We think it would hence be totally illogical to say that the two payments are not "related." And that the interest payable by petitioner was a "deduction" cannot be questioned. Sec. 23(b), I.R.C. 1939. It need not also be a "cost." We conclude that respondent did not err on either ground urged.
Decision will be entered for the respondent.
Footnotes
1. The parties have drawn no distinction between the income earned from the sales of the Polaroid Land equipment and that earned from the sales of the stereo products. Accordingly, we treat them as being similar in nature for purposes of this issue.↩
2. SEC. 456. ABNORMALITIES IN INCOME IN TAXABLE PERIOD.
(a) Definitions. -- For the purposes of this section --
(1) Abnormal income. -- The term "abnormal income" means income of any class described in paragraph (2) includible in the gross income of the taxpayer for any taxable year under this subchapter if * * * the taxpayer normally derives income of such class but the amount of such income of such class includible in the gross income of the taxable year is in excess of 115 per centum of the average amount of the gross income of the same class for the four previous taxable years * * *
(2) Separate classes of income. -- Each of the following subparagraphs shall be held to describe a separate class of income:
(A) Income arising out of a claim, award, judgment, or decree, or interest on any of the foregoing; or
(B) Income resulting from exploration, discovery, or prospecting, or any combination of the foregoing, extending over a period of more than 12 months; or
(C) Income from the sale of patents, formulae, or processes, or any combination of the foregoing, developed over a period of more than 12 months; or
(D) Income includible in gross income for the taxable year rather than for a different taxable year by reason of a change in the taxpayer's method of accounting.
All the income which is classifiable in more than one of such subparagraphs shall be classified under the one which the taxpayer irrevocably elects. The classification of income of any class not described in subparagraphs (A) to (D), inclusive, shall be subject to regulations prescribed by the Secretary.↩
3. Petitioner cannot and does not deny this, but insists that the "tangible" properties would have been valueless except for the process they embodied. This seems to us irrelevant.↩
4. Regs. 130. Sec. 40.456-2. [As amended by T.D. 6026, 2 C.B. 235">1953-2 C.B. 235, 236]
Classification of income. * * *
(b) Other income, not within a class described in subparagraphs (A)-(D) of section 456(a)(2), to which section 456 is applicable may be grouped by the taxpayer, subject to approval by the Commissioner on the examination of the taxpayer's return, in such classes similar to those specified in subparagraphs (A)-(D) of section 456(a)(2) as are reasonable in a business of the type which the taxpayer conducts, and as are appropriate in the light of the taxpayer's business experience and accounting practice. Income from the sale of tangible property arising out of research and development which extended over a period of more than 12 months is not included in the list of abnormal types of income to which section 456 is applicable, and such income may not constitute a class of income for purposes of that section. However, section 456 is applicable to such income if the income is otherwise properly includible within a class of income to which such section is applicable, for example, the class described in section 456(a)(2)(D)↩.
5. "Webster's New Collegiate Dictionary defines 'exploration' as '[act] of exploring, as for geographical discovery,' and in discussing the word 'discover' the same work says: 'Discover presupposes exploration * * *.' It also defines 'discovery' as '1. Act of discovering,' and the verb 'prospect' as '[to] explore or examine for something.' We consider that Congress in using the words 'exploration, discovery, or prospecting' meant acts leading up to and antedating the finding of the thing discovered, which in this case, according to the hypothesis made by both parties, was the oil pool here in question. A factor leading us to this conclusion is the deliberate omission by Congress in enacting section 456(a)(2)(B) of the word 'development,' which had appeared in the predecessor statute. We consider that Congress did not mean the words 'exploration, discovery, or prospecting' to include acts seeking information about the thing already discovered, performed as incidents to its development and exploitation after it was discovered." ( Big Four Oil & Gas Co., 29 T.C. 31">29 T.C. 31, 41↩.)
6. See footnote 4, supra↩.
7. SEC. 456. ABNORMALITIES IN INCOME IN TAXABLE PERIOD.
(a) Definitions. -- For the purposes of this section --
* * * *
(3) Net abnormal income. -- The term "net abnormal income" means the amount of the abnormal income less, under regulations prescribed by the Secretary, * * * (B) an amount which bears the same ratio to the amount of any costs or deductions relating to such abnormal income, allowable in determining the normal-tax net income for the taxable year, as the excess of the amount of such abnormal income over 115 per centum of such average amount bears to the amount of such abnormal income.↩