*265 Decision will be entered under Rule 50.
1. Deduction -- Expense -- Compensation. -- Reasonable allowances determined for salaries or other compensation for personal services rendered to a corporation by its officers.
2. Deduction -- Expense -- Royalties. -- A corporation is entitled to deduct reasonable amounts representing fair compensation paid or accrued to two of its controlling stockholders for the use of their invention, in spite of their having granted the corporation a royalty-free license, where the parties contemplated and intended to agree upon such compensation after a trial period.
3. Deduction -- Unpaid Expense -- Notes as Payment. -- Certain expenses of a corporation on an accrual basis were "paid within the taxable year or within two and one-half months after the close thereof" within the meaning of section 24 (c) (1), relating to items not deductible, where the corporation duly issued interest-bearing negotiable demand notes to its stockholder in payment of the expenses.
4. Failure to File Return -- Addition to Tax. -- The imposition of an addition to the excess profits tax of a corporation for failure to make and file an excess profits tax return for 1941*266 sustained. P. Dougherty Co., 5 T. C. 791; affd., 159 Fed. (2d) 269; certiorari denied, 331 U.S. 838">331 U.S. 838, followed.
*332 The Commissioner determined deficiencies in the tax of the petitioner and imposed*267 a 25 per cent addition to its excess profits tax as follows:
| Declared value | 25% addition | |||
| Year | Income tax | excess profits | Excess profits | to excess |
| tax | tax | profits tax | ||
| 1940 | $ 546.79 | $ 503.95 | $ 636.26 | |
| 1941 | 5,337.66 | 4,568.24 | 9,613.33 | $ 2,403.33 |
| 1942 | 13,432.18 | 73,443.49 |
The issues are:
(1) Whether the Commissioner erred in disallowing portions of the deductions claimed by the petitioner in 1940, 1941, and 1942 as compensation for services rendered by its officers;
*333 (2) Whether amounts paid or incurred by the petitioner in 1941 and 1942 as royalties are deductible as ordinary and necessary expenses of carrying on the business within section 23 (a) (1) (A);
(3) Whether, in the alternative, portions of the deductions claimed by the petitioner for compensation and royalties in those years are nondeductible under section 24 (c), relating to items not deductible; and
(4) Whether the Commissioner erred in imposing a 25 per cent addition to the excess profits tax of the petitioner for 1941 for its failure to file a return for that year.
FINDINGS OF FACT.
The petitioner, a Massachusetts corporation, filed its returns with the collector of internal*268 revenue for the district of Massachusetts. It used an accrual method of accounting.
The petitioner was organized to take over the business of "The Heatbath Corporation" (hereinafter called the predecessor). The predecessor was a Massachusetts corporation, organized in 1923, and was engaged in the manufacture and sale of materials and equipment to be used to impart a surface color to metals. The principal reason for the formation of the petitioner was to obtain larger corporate powers than those possessed by the predecessor.
Ernest A. Walen was a stockholder and an employee of the predecessor from the date of its incorporation. Fowler W. Wilbur began working for the predecessor in 1934. Walen and his wife, Isabel, had owned a majority of the stock of the predecessor since November 1, 1925, and they became owners of all of its stock on March 16, 1939. Walen transferred 40 per cent of the stock to Wilbur on June 1, 1939. The record does not show the consideration for that transfer. Those three were thereafter the officers of the predecessor.
The predecessor originally manufactured salts used in bluing metals by a heat process. Walen and his associates later discovered a compound*269 which would produce a black finish on steel when heated at high temperatures, but that process lessened the hardness of the steel, rendering it unsuitable for many uses. They began experimenting in 1930 on a process for producing a black finish on steel at lower temperatures. Walen and Wilbur, during the period from 1934 through 1939, developed a process for imparting a protective black finish to the surface of ferrous metals and a soluble bath composition, called Pentrate, to be used in that process. Relatively low temperatures were used in the process. Both men made substantial contributions to the development of the process, of Pentrate, and of the equipment used in the practice of the process. They agreed that each would own one-half of any patent obtained. They made applications on January *334 20, 1939, and on April 3, 1939, for patents on their invention, but no patents were issued on those applications. An assignment of the invention to the predecessor, dated January 20, 1939, was executed by Walen and Wilbur, but was never delivered to the predecessor or intended to become effective. A license of April 14, 1939, referring to the second patent application, was*270 executed by Walen and Wilbur and delivered to the predecessor. However, the license was not intended by them to remain in effect in the event that letters patent were not granted on the second application. Letters patent were not granted to Walen and Wilbur on their second application, but were granted on a later and substantially different application. The license of April 14, 1939, did not remain in effect.
Walen and Wilbur made application on May 16, 1939, for a United States patent on a soluble bath composition and a process of using the composition for imparting a black finish to the surfaces of ferrous metals. The application made claims for both a product and a process. The process differed in certain details from that described in the prior applications. Walen and Wilbur executed a license on December 18, 1939, providing in part as follows:
I. Whereas, we * * * have jointly invented a "Process for Imparting Color Finish to Ferrous Metal Articles, and Product Used Therefor" for which we have filed application for United States Letters Patent, Serial No. 273,964, filed May 16, 1939, andII. Whereas, The Heatbath Corporation, * * * is desirous of acquiring a license under*271 any patent or patents which may be granted on said invention,
III. Now, Therefore, in consideration of a valuable sum of money and other valuable considerations, the receipt of which is hereby acknowledged, we * * * hereby grant said The Heatbath Corporation a non-exclusive, non-transferable, non-revocable, and royalty free license under any patent or patents that may be granted in the United States on said application, to use and practice said invention; the above license being for the full term of any patent or patents granted on said application.IV. In view of the foregoing consideration, said Walen and said Wilbur further agree that they or either of them will grant no further license under the aforesaid patent or patents, except with the written consent of The Heatbath Corporation.The license of December 18, 1939, was recorded in the United States Patent Office on December 21, 1939.
United States Patent No. 2,192,280, on a "Process for Imparting Color Finish to Ferrous Metal Articles," was granted on March 5 1940, to Walen and Wilbur on their application of May 16, 1939. The patent allowed claims for a process, but not for a product.
The stockholders and directors of the*272 predecessor voted on November 24, 1939, to liquidate the corporation and to cease doing business on December 31, 1939. The incorporators and stockholders of the petitioner voted on December 8, 1939, to accept the following offer and to commence operations on January 2, 1940:
*335 The Heatbath Corporation
Springfield, Mass.,
December 7, 1939.
To the Stockholders of Heatbath Corporation.
The Directors of "The Heatbath Corporation" acting under instructions voted by the Stockholders at a Special Meeting November 24, 1939, to liquidate "The Heatbath Corporation" hereby make the following offer to the Stockholders of "Heatbath Corporation" for their action.
1. As far as the authority of the Directors of "The Heatbath Corporation" extends, to allow said "Heatbath Corporation" the exclusive use of the Term "Heatbath" in the corporate name, and the words "Heatbath," "Penetrate" and any and all other trade names either now or formerly used in connection with the products of "The Heatbath Corporation".
2. To sell the following assets of "The Heatbath Corporation" to said "Heatbath Corporation" on January 2, 1940 at the book value of said items less depreciation as they show on the books*273 of "The Heatbath Corporation" at the close of business Dec. 31, 1939.
a. All factory equipment including electric furnaces and their equipment complete.
b. Demonstration outfit complete.
c. All tools and supplies.
d. All office furniture, equipment and supplies.
e. Automobile.
f. Inventory of Raw Material, and finished products at cost.
3. To turn over all uncompleted contracts that are on hand at the close of business Dec. 31, 1939, "The Heatbath Corporation" to be reimbursed by said "Heatbath Corporation" for all costs for material and labor that have been expended on said contracts.
The predecessor was liquidated at the end of 1939 and all of its assets, except any rights which it had to the patented process, were transferred to the petitioner by the predecessor stockholders in full payment for the stock of the petitioner. A court order dissolving the predecessor was obtained in 1941.
The authorized capital of the petitioner consisted of 500 shares of no par value common stock, all of which was issued on January 1, 1940. Its stockholders and officers were as follows during 1940, 1941, and 1942:
| Shares | |
| Ernest A. Walen, president | 48 |
| Fowler W. Wilbur, vice president and general manager | 200 |
| Isabel L. Walen, treasurer | 250 |
| Irving T. Norton, clerk and (from 4/11/41) assistant treasurer | 2 |
*274 The record does not show the circumstances of or the consideration for the issuance of two shares of stock to Norton. The original directors of the petitioner were Wilbur and the two Walens, and the record does not show any subsequent change in the board.
The predecessor executed the following assignment on March 7, 1940:
*336 Whereas, by an instrument in writing dated December 18, 1939, Ernest A. Walen and Fowler W. Wilbur, joint inventors of a "Process for Imparting Color Finish to Ferrous Metal Articles," for which they applied for Letters Patent of the United States, Serial No. 273,964, filed May 16, 1939, and issued March 5, 1940, No. 2,192,280, granted a non-exclusive, non-transferable, nonrevocable, and royalty free license under said Letters Patent to The Heatbath Corporation * * * and
Whereas, said The Heatbath Corporation has by due process of law changed its name and identity to Heatbath Corporation * * *.
Now, Therefore, in consideration of the premises and other valuable considerations, receipt of which is hereby acknowledged, said The Heatbath Corporation hereby assigns and transfers unto the said Heatbath Corporation all the right, title and interest in the aforesaid*275 license formerly held by The Heatbath Corporation; the same to be held and enjoyed by the said Heatbath Corporation for its own use and behoof and for its legal representatives, as fully and entirely as the same would have been held by The Heatbath Corporation had this assignment not been made.
The assignment was "approved and confirmed" by Walen and Wilbur, and was recorded in the United States Patent Office on March 8, 1940.
Walen and Wilbur acted on the advice of their patent attorneys in all matters involving the patent. The entire expense of obtaining the United States patent on the process was paid by the predecessor and the petitioner. Neither Walen nor Wilbur was employed or paid by the predecessor with the understanding that his compensation was for labor in developing the patented process.
Tanks and other equipment specially designed for use in the patented process were developed by employees of the petitioner, including Walen and Wilbur, and were sold by it. They were not patented. The tanks and most of the equipment, including attachments, were manufactured by others. The petitioner assembled the tanks in its plant and installed on them various attachments and instruments*276 which were intended to regulate the operation of the patented process and to insure the safety of the operator.
Pentrate was manufactured and sold by the petitioner for use in the patented process. The name Pentrate was a registered trademark of the predecessor and of the petitioner. The product Pentrate was not patented. The petitioner manufactured Pentrate during the taxable years at a cost of 5.81 cents per pound from two common chemicals which were easily obtainable by anyone. It sold Pentrate during those years at a price of 33 to 35 cents per pound, depending upon the quantity sold. Virtually the same product could be purchased from others at about one-third of that price.
The petitioner had sales representatives throughout the United States and in Canada during the taxable years. It paid them commissions of 20 per cent on the selling price of Pentrate and 10 per cent on the selling price of the equipment used in the patented process.
*337 The petitioner treated metal by the patented process during the taxable years only for the purpose of demonstrating the process to its customers. It provided services to its customers without charge, including demonstration of *277 the process, aid in the installation of the equipment which it sold, maintenance of the equipment, and technical advice for solving special problems arising in the operation of the process. Both the petitioner and its predecessor dealt in many products and processes used in various treatments of metal, in addition to Pentrate and the patented process. Sales of other products amounted to about three-tenths of total sales in 1940, one-fifth in 1941, and one-ninth in 1942.
The petitioner granted permission to use the patented process to purchasers of Pentrate and to purchasers of the equipment designed for use in the patented process. It placed the following notice in its literature and inside each container of Pentrate sold after March, 1940:
NOTICE
"Pentrate" is the registered trade mark of Heatbath Corporation, and is applied to a particular salt mixture compounded and sold by Heatbath Corporation especially for use in the process covered by its United States Patent No. 2,192,280.
A formal license to practice the process of said patent is not necessary for users of "Pentrate." Others may obtain such a license under said patent at established and uniform rates of royalty, particulars*278 of which will be furnished upon request.
Other concerns negotiated with the petitioner during the taxable years for license agreements under the patent to provide for royalties based upon the quantity of salts used in the operation of the process, but no agreements were consummated prior to 1945. Walen and Wilbur executed an agreement with Remington Arms Co. in 1945, granting to the latter a nonexclusive license to practice the patented process and requiring it to pay them a royalty of 5 cents per pound of salt mixtures used in the practice of the process. However, Remington has never availed itself of the privileges granted by the license and has paid no royalties. No royalties from others for the use of the patented process have ever been received by Walen, Wilbur, or the petitioner.
Competitors of the petitioner sold products similar to Pentrate and used processes similar to the patented process. Pentrate might have been used in those other processes, but not with complete success. Its use was required on many Government contracts during World War II.
Walen and Wilbur had an understanding between themselves that they would allow the corporations to authorize their customers*279 to use the patented process, in connection with Pentrate and process equipment sold by the corporations, until the value of the process was demonstrated, *338 after which they would require the corporations to pay them a fair amount for such continued use of the process.
Walen and Wilbur presented the following request, drafted by Norton, to the petitioner on June 5, 1941:
We, Ernest A. Walen and Fowler W. Wilbur, having jointly and individually developed, improved and perfected a low cost process for imparting color finish to ferrous metal articles for which we have been granted and hold United States and Canadian patents, and further developed, improved and perfected the equipment necessary for the operation of this process, all of which was done at our own time, effort and expense and all of which Heatbath Corporation is using and capitalizing to its advantage, hereby request Heatbath Corporation to change the arrangement under which they are now and have been using this process and manufacturing of equipment necessary for the operation of this process and substitute therefor the following basis, which is the same basis on which we are now negotiating with other parties for*280 use of this process and the manufacture of the equipment necessary for the operation of this process.
1. Heatbath Corporation pay a royalty of 6 cents per pound on all material manufactured under our patents, one-half or 3 cents per pound to be paid to Ernest A. Walen, and one-half or 3 cents per pound to be paid to Fowler W. Wilbur.
2. Heatbath Corporation pay Ernest A. Walen and Fowler W. Wilbur each 5 per cent of the sales price of all equipment designed, manufactured, and sold for the operation of this process.
The directors of the petitioner voted on June 20, 1941, to accept the requested basis of operation, effective as of July 1, 1941.
The petitioner's sales of Pentrate and of the equipment designed for use in the patented process, and the amounts paid or accrued on its books as royalties to Walen and Wilbur, were as follows during the taxable years:
| Pentrate sales | ||||
| Equipment | Royalties paid | |||
| Period | Pounds | Dollars | sales | or accrued |
| 1940 | $ 61,561.16 | $ 16,572.25 | ||
| 1941 Jan.-June | 235,175 | 25,082.82 | ||
| July-Dec | 244,385 | 30,817.35 | $ 17,745.02 | |
| Total | 479,560 | 157,546.59 | ||
| 1942 | 1,224,665 | 385,982.96 | 180,221.59 | 91,515.12 |
"Royalty Accounts" *281 for Walen and Wilbur were set up on the books of the petitioner as of September 30, 1941. Monthly credits were made to those accounts in 1941 and 1942 as the royalties became payable. The royalties credited to the account of Walen in 1941 were paid to him in cash during the year, except for the following amounts, which were paid to him by negotiable notes, payable "On demand Ninety Days after date" and bearing interest at 3 per cent per annum, as follows: *339
| Date of note | Amount |
| Dec. 1, 1941 | $ 3,729.21 |
| Dec. 31, 1941 | 569.43 |
| Dec. 31, 1941 | 2,425.50 |
Those three notes were issued to Walen during 1941 or within two and one-half months after the close of 1941, and they were all paid in full by check of the petitioner by March, 1944, except that a balance of $ 812.37 due on the note for $ 2,425.50 has never been paid. The petitioner was solvent and had sufficient cash on hand to pay those notes at all times during 1941 and 1942. It debited the amounts of the three notes to Walen's royalty account and credited them to its notes payable account as the notes were issued. Walen included the three notes at their face value in his gross income on his return for 1941, *282 using the cash basis of accounting.
The petitioner claimed $ 17,745.02 and $ 91,515.12 as deductions for royalties on its returns for 1941 and 1942. The Commissioner disallowed the deductions on the ground that "Information on file indicates that these royalties were paid without legal obligation and that they were, therefore, not ordinary and necessary expenses within the meaning of Section 23 (a) of the Internal Revenue Code."
$ 12,219.52 of the amount claimed for 1941 and $ 61,233.25 of the amount claimed for 1942 were ordinary and necessary expenses paid or incurred by the petitioner during those years in carrying on its business.
Walen and Wilbur were both well qualified in their field. Wilbur was employed by the predecessor only part time during 1934 to help solve specific problems of installation. Thereafter he worked full time for the predecessor and participated in all phases of the business. Walen and Wilbur handled most of the predecessor's manufacturing, selling, shipping, service to customers, designing of equipment, financial problems, and development of various heat treatment products and processes. They developed Pentrate and the patented process. The predecessor*283 had only one employee, in addition to Walen and Wilbur, engaged in the operation of the business. They worked long hours for the predecessor. Walen's salary increased from $ 1,497.65 in 1933 to $ 3,257.59 in 1938 and $ 6,000 in 1939. Wilbur's salary was $ 3,800 in 1939 and about $ 1,200 prior thereto.
The business expanded rapidly after 1939. Walen and Wilbur continued to handle or supervise all of the activities and problems of the petitioner that they had handled for the predecessor. Their duties increased during the taxable years because of the additional problems, such as financial and personnel problems, related to the expansion of the business and to the advent of war. The personnel employed by the petitioner increased to 30 or 35, exclusive of salesmen. *340 Walen and Wilbur devoted their full time to the business during the taxable years, except that Walen took short vacations.
Isabel Walen was treasurer of the predecessor from 1932 on. She visited the office of the predecessor almost every day to bring Walen his lunch and to do some clerical work such as signing and mailing checks. She did the same kind of work for the petitioner and spent one to four hours *284 at the office three or four times a week during the taxable years. She had never had any other experience or training in business affairs. She often discussed business matters with Walen. She received no compensation for her services prior to 1937. Her salary was $ 1,820 for 1937, $ 1,800 for 1938, and $ 4,500 for 1939.
Irving T. Norton has been a full time employee of the Commonwealth of Massachusetts since 1922 and at all times material hereto. He worked during spare time for the predecessor from 1935 on, supervising the keeping of its accounting and corporate records. He prepared its tax returns from 1937 on. Norton, without legal aid, prepared the papers and saw that the various steps were taken to incorporate the petitioner. He supervised the keeping of its records, prepared its tax returns, and handled the details in connection with the execution of its war contracts during the taxable years. He consulted with Walen and Wilbur frequently from 1935 on. He spent more time working for the petitioner than he had for the predecessor. He prepared individual tax returns for Walen and Wilbur and their wives from 1937 through the taxable years, and he also did similar work *285 for other individuals during those years. He received no compensation from the predecessor or the petitioner prior to 1941, and he never received any compensation from Walen, Wilbur, or their wives.
The directors of the petitioner voted on July 11, 1940, as follows:
* * * that the salaries of the officers of the corporation be established as follows: provided the earnings of the corporation are sufficient to pay them, and in the event that the earnings of the corporation are insufficient to pay those amounts, these salaries shall be scaled down pro-rata on the following basis: and that in no case shall these salaries be paid from any other source than earnings, so as not to impair or decrease the value of the capital stock: and any portion of these salaries that remain unearned and unpaid at the end of the year, shall not become an account payable or a liability of the corporation.
| President, Ernest A. Walen | $ 48,000.00 |
| Vice-President and General Manager, Fowler W. Wilbur | 60,000.00 |
| Treasurer, Isabel L. Walen | 12,000.00 |
The directors voted on January 24, 1941, that the authorized salaries of the officers would be the same and subject to the same conditions for 1941 as for*286 1940. The directors voted on April 11, 1941, that Norton's salary would be $ 15,600 if the earnings were sufficient to pay that amount without impairing the capital of the petitioner, and if the earnings were not sufficient to pay that amount, his salary would *341 be reduced to $ 10,400. The directors voted on February 26, 1942, that "the salaries of all officers be continued on the same basis and subject to the same restrictions as in the preceding year."
The sales, gross profit, and net income (or loss) of the predecessor and the petitioner were reported as follows on their returns from 1933 through 1942:
| Year | Sales | Gross profit | Net income or |
| (loss) | |||
| 1933 | $ 8,297.14 | $ 2,424.19 | ($ 89.93) |
| 1934 | 10,532.18 | 2,798.91 | (322.84) |
| 1935 | 11,142.51 | 2,809.99 | (326.37) |
| 1936 | 15,334.94 | 3,494.79 | (252.05) |
| 1937 | 26,936.89 | 5,800.78 | (17.14) |
| 1938 | 32,461.18 | 19,315.19 | (169.84) |
| 1939 | 56,636.06 | 38,132.26 | (94.62) |
| 1940 | 111,341.37 | 73,651.47 | 11,514.92 |
| 1941 | 266,800.81 | 166,621.06 | 1,726.98 |
| 1942 | 635,729.78 | 396,851.15 | 87,231.04 |
The petitioner paid or accrued compensation to its officers and claimed deductions therefor on its returns, and the Commissioner allowed*287 the deductions in part and disallowed the excess as "unreasonable and excessive" in the following amounts for the taxable years:
| Year | Walen | Wilbur | Isabel | Norton | Total | |
| Walen | ||||||
| 1940 | Deducted | $ 13,202.24 | $ 15,102 | $ 3,890 | $ 32,194.24 | |
| Allowed | 13,202.24 | 15,102 | 1,000 | 29,304.24 | ||
| Disallowed | 2,890 | 2,890.00 | ||||
| 1941 | Deducted | 25,560.00 | 32,375 | 6,450 | $ 11,700 | 76,085.00 |
| Allowed | 17,500.00 | 20,000 | 1,000 | 5,200 | 43,700.00 | |
| Disallowed | 8,060.00 | 12,375 | 5,450 | 6,500 | 32,385.00 | |
| 1942 | Deducted | 20,800.00 | 26,000 | 5,200 | 15,600 | 67,600.00 |
| Allowed | 20,800.00 | 26,000 | 1,000 | 5,200 | 53,000.00 | |
| Disallowed | 4,200 | 10,400 | 14,600.00 |
Reasonable allowances for salaries or other compensation paid or incurred by the petitioner in 1940, 1941, and 1942 for personal services actually rendered by the officers mentioned are not in excess of the amounts allowed by the Commissioner for those years.
The petitioner has never filed an excess profits tax return for 1941. Norton prepared its income tax return for 1941. He concluded that its 1941 excess profits net income, for the purpose of determining the necessity for its filing an excess profits tax return, was $ 1,726.98, *288 and that there was therefore no necessity for its filing an excess profits tax return for 1941. He advised the petitioner to that effect. Walen relied upon Norton's advice regarding the necessity for filing an excess profits tax return for 1941.
The record does not show that Norton was either an attorney or an accountant, that he was otherwise qualified as a Federal tax advisor, or that he considered the deductibility under the code and the regulations of the royalty and salary items in arriving at the petitioner's excess profits net income for 1941.
*342 The Commissioner imposed a 25 per cent addition to the petitioner's excess profits tax for 1941 in the amount of $ 2,403.33 under sections 729 (a) and 291 of the Internal Revenue Code on the ground that it "failed to file an excess profits tax return for the year 1941 and no reasonable cause has been shown for such failure."
The record does not show that the petitioner's failure to file an excess profits tax return for 1941 was due to reasonable cause and not due to willful neglect.
The stipulation of facts is incorporated herein by this reference.
OPINION.
It was incumbent upon the petitioner to show that the total salaries*289 paid and claimed as deductions, or at least some amounts larger than those allowed, represent reasonable compensation for the services rendered by the officers. Careful consideration has been given to all of the evidence that appears in the record but it does not justify a finding that reasonable compensation for any of the officers was in excess of the amount allowed by the Commissioner. There is evidence of the services performed by the four persons, of the earnings and profits, and of the salaries paid in prior years. There is no evidence of what the officers might have earned elsewhere or of what it would have cost the petitioner to obtain their equals, and no adequate test by comparison is afforded. The petitioner argues that a part of the salaries in question were to make up for the fact that the four persons were underpaid in prior years by the predecessor corporation. That could raise an interesting question, but it does not appear that these persons were underpaid to any great extent by the predecessor and the amounts allowed by the Commissioner seem ample to make up for all services, past and current.
Wilbur and the two Walens were the directors of the petitioner and*290 the owners of practically all of its stock. They authorized enormous, contingent salaries to themselves in such a way that Wilbur's salary for any year would exactly equal the total salaries paid to Walen and his wife. That circumstance is not without significance, particularly when the question of a reasonable salary of Isabel Walen is considered. The Commissioner allowed a deduction of $ 1,000 for each year as reasonable compensation for her, although she was paid much larger amounts. Her services to the predecessor and also to the petitioner were minor in importance, being clerical in nature and on a part time basis. Her title was an empty one. Walen and Wilbur handled the financial affairs of the petitioner. Isabel and the other officers appeared on the witness stand. The evidence indicates that she was amply paid by the predecessor and that her services to the petitioner were not worth more than $ 1,000 a year.
*343 The salaries of Walen and Wilbur are involved only for the year 1941, since the Commissioner allowed the full amount paid to them for 1940 and 1942. They were the two principal officers and were largely responsible for the success of the petitioner, *291 although there were, apparently, some subordinate executives who received relatively high salaries. The Commissioner disallowed a part of the amounts claimed as salary for each for 1941, but still he allowed substantial amounts. The Commissioner allowed salary deductions for these two men in increasing amounts as the business increased, which seems logical. The sales and earnings figures do not show that their services fairly entitled them to larger shares of the earnings than the amounts allowed by the Commissioner as deductions for 1941. The petitioner is claiming larger salary deductions for these two men for 1941 than were claimed and allowed in full for 1942, although sales and income for 1942 far exceeded those for 1941, and there is no reason to believe that the officers put forth greater efforts in 1941 than in 1942. They put in full time and did their best in each year. It does not appear that the predecessor underpaid these men to any great extent, and it must be remembered in that connection that they spent a part of their time working upon a valuable invention for which they are claiming royalties under another issue. It is easy enough to conclude that these two *292 men were entitled to large salaries for 1941, but the Commissioner has allowed them large salaries and the evidence as a whole, including portions not discussed herein, does not justify a finding that the amounts allowed were less than reasonable compensation for their services for 1941.
Norton's salary presents a little different situation in that he owned only two shares of stock, excessive payments to him could not represent dividends, and the reason for paying him an excessive salary is not so apparent. However, the evidence shows that he was overpaid. He testified to his amazement when he first heard of the amount of his 1941 salary. He received no salary for 1940, $ 11,700 for 1941, and $ 15,600 for 1942, a total of $ 27,300 during the taxable years. The Commissioner allowed as a deduction $ 5,200 of the amount paid him for each of the years 1941 and 1942. He had full time employment elsewhere and devoted only such spare time as he had available to the affairs of the petitioner, its chief officers, their wives, and others. The Wilburs and the Walens paid him nothing for services rendered to them. It is not clear just how much time he devoted exclusively to the affairs *293 of the petitioner, but the deductions allowed represent ample compensation for any services which this record shows he rendered, taking into account past services as well as those performed in 1941 and 1942.
Wilbur and Walen first applied for a United States patent on their process for imparting a black finish to the surface of ferrous metals *344 on January 20, 1939. No claim for a product was made in that application. They executed on the same date an instrument purporting to assign their entire interest in the invention to the predecessor corporation, but the assignment was never delivered and never became effective and no patent was granted on the application. They made another application for a United States patent on April 3, 1939, in which they claimed both a process and a product. They gave the predecessor corporation a license on April 14, 1939, in which they recited that application for a patent had been filed on April 3. No patent was ever granted on the application of April 3, 1939. The Commissioner argues that the predecessor, at the time of its dissolution, still had rights acquired under the assignment of January 20, 1939, and the license of April 14, 1939, *294 and the petitioner acquired those rights. The intent of the parties as shown by their entire course of action is controlling. DeForest Co. v. United States, 273 U.S. 236">273 U.S. 236; Baldwin Rubber Co. v. Paine & Williams Co., 107 Fed. (2d) 350; certiorari denied, 309 U.S. 676">309 U.S. 676. Walen and Wilbur never intended the assignment to become effective and never delivered or recorded it, and, as a consequence, nothing was transferred by it. Also, the parties did not intend the license dated April 14, 1939, to remain in effect in the event that letters patent were not granted on the application of April 3, and, since no letters patent were granted on that application, the petitioner, at least, never acquired any rights under that particular license. The predecessor did not transfer to the petitioner any rights acquired under those documents. Furthermore, those documents can be disregarded for the reason that the later assignment of March 7, 1940, gave rights as complete as any actually given theretofore.
Walen and Wilbur were employees of the predecessor, but there was no understanding between them and*295 the predecessor that any inventions which they might perfect while in the employ and working on the time of the predecessor would belong absolutely to the predecessor. The process which they eventually patented was developed upon the time of the predecessor in its shop and at expense to it. The predecessor, in the absence of any agreement, would have acquired "shop rights" to the invention, but not ownership. United States v. Dubilier Condenser Corporation, 289 U.S. 178">289 U.S. 178. However, Walen and Wilbur, after making the application for a United States patent on which their patent was subsequently granted, entered into a written agreement dated December 18, 1939, with the predecessor under which they granted to the predecessor "a non-exclusive, non-transferable, non-revocable, and royalty free license under any patent or patents that may be granted in the United States on said application [filed May 16, 1939] to use and practice said invention; the above license being for the full term of any patent or patents granted on said *345 application." The petitioner argues that the predecessor did not acquire, under the assignment or under any shop rights*296 to which it may have been entitled, the right to authorize others than itself to use the patented process, but only acquired for itself the right to use and practice the patented process. The Commissioner takes the position that the predecessor, both through shop rights and through the license of December 18, acquired a royalty-free right or license under which those persons who bought salts and equipment from it to be used in the patented process could put those salts and equipment to use by processing ferrous metals under the patented process. He points out that the predecessor had never been engaged in the business of actually processing ferrous metals to give them a colored finish, but had been engaged only in the business of selling salts and equipment to others who desired to process their own metals. He further points out that there was no intention to change the business of the predecessor so as to make it a processor, rather than a seller of salts and equipment for processing. He cites cases to the effect that a shop right is necessarily coextensive with the business requirements of the employer, which has the right to use the patent in such a way and to such extent as*297 may be necessary to benefit it in the business which it is carrying on. He also cites cases to show that a license must be interpreted reasonably to give effect to the intention of the parties in the light of the objects which they must have had in mind in making it. He concludes that neither the shop rights nor the license would have been of any benefit to the predecessor unless it could sell its merchandise with the right on the part of the purchasers to use that merchandise in practicing the patented process. Actually the predecessor, without objection from Walen and Wilbur, did just what the Commissioner says it was entitled to do, and it is our conclusion that that is what the parties intended under the license of December 18, 1939.
The predecessor, on March 7, 1940, transferred to the petitioner its rights under the license of December 18, 1939. The petitioner, prior to that time and thereafter, without objection from Walen and Wilbur, sold its merchandise with the understanding that the purchasers could use the patented process in connection with their use of the merchandise. Walen and Wilbur at all times material hereto had full control of the predecessor and of the petitioner, *298 which were mere tools to carry out their wishes. The conclusion seems inescapable that Walen and Wilbur intended the petitioner to do under the license what it actually was doing.
The question remains, nevertheless, of whether under these and other circumstances now to be mentioned, Walen and Wilbur had any right to ask and receive from the petitioner some payment for this use of their invention. It seems proper to bear in mind, in connection *346 with all of the steps taken, that these two men were not astute, experienced business men, familiar with corporate affairs, and also that their advisors were not too meticulous in carrying out their purposes. They have testified, without contradiction of any kind, that their intention and understanding had been to have the predecessor, and later the petitioner, make sales of Pentrate and of the equipment, and to permit the purchasers to use those salts and equipment in the patented process, until such time as Walen and Wilbur could determine from the sales and use just how valuable the process would be in the business, after which they would enter into an agreement giving them some fair compensation or reward for that particular *299 use of their patented process. That was a reasonable and sensible way to proceed. Meanwhile, they negotiated unsuccessfully with others in an effort to profit thereby from the invention. It was apparent by 1941 that the petitioner, with the aid of the invention, was able to carry on its business successfully. No doubt, as the Commissioner contends, there were other factors which contributed to the success of that business. Nevertheless, the patented process was one of the more important factors.
The request made by Walen and Wilbur to the petitioner on June 5, 1941, which became a binding contract when agreed to by the petitioner, was inartificially drawn by Norton, who had had no training in law. Walen and Wilbur were in position at that time to have the petitioner agree to almost anything and, consequently, this particular agreement may properly be closely scrutinized to determine its effect for Federal tax purposes. The Commissioner argues that Walen and Wilbur could not demand royalties from the petitioner as provided in the contract of June 5, 1941, and there was no consideration from Walen and Wilbur flowing to the petitioner for the agreement because the petitioner already*300 had a royalty-free right to do what it was doing. Cf. Thomas Flexible Coupling Co. v. Commissioner, 158 Fed. (2d) 828, in which the patentee had assigned patents, together with future interests, and, as a consequence, royalties paid her by the assignee under a subsequent contract assigning later improvements were without consideration. Since Walen and Wilbur were in complete control and had an understanding all along that they were to be paid for the use of their process after its value had been established, that understanding modified the royalty-free provision of the license and left room for the June 5, 1941, agreement. That agreement was not a sham or entirely lacking in legal requirements, and was not without effect for Federal tax purposes. Cf. W. N. Thornburgh Manufacturing Co., 17 B. T. A. 29; Ingle Coal Corporation, 10 T.C. 1199">10 T. C. 1199; affd., 174 Fed. (2d) 569; Granberg Equipment, Inc., 11 T. C. 704; Wall Products, Inc., 11 T. C. 51.
*347 A constant effort has been made, in reaching the*301 above conclusions, to determine, from all of the evidence and from observing the witnesses, the intentions of two men unskilled in drafting legal documents and in corporate affairs. Some of the conclusions are not strictly in accordance with the words of the documents used. However, it might be appropriate to point out that the case for the Commissioner would be no stronger if the precise words of the license of December 18, 1939, and the assignment of March 7, 1940, were followed. They gave to the corporations a royalty-free, "non-transferable" license "to use and practice said invention." They, therefore, give force to the petitioner's argument that the corporations had no right to transfer to others, that is, to their customers, the right to use and practice the invention, but could only use and practice the invention by treating metals in their plant. If that was what the parties intended, then there was ample consideration for the agreement of June 5, 1941.
Ordinarily the amounts which a corporation must pay under an agreement for the use of a patent would be deductible in their entirety as ordinary and necessary expenses, and neither the Commissioner nor the Court would *302 have any authority to rewrite the agreement of the parties. But where, as here, the parties contracting with the corporation and the wife of one of those parties hold practically all of its stock and, as a consequence, make the decisions for the corporation, the terms of their agreement may be examined to see whether the amounts to be paid may fairly be regarded as compensation for the use of the patent or represent, to some extent, dividends in disguise. Cf. L. Schepp Co., 25 B. T. A. 419; Granberg Equipment, Inc., supra;Atlantic Monthly Co., 5 T. C. 1025. The Commissioner contends that the payments are entirely distributions of profits. It is extremely difficult, if not impossible, to determine from the record just what would represent reasonable compensation for the use which the petitioner made of the process during the latter part of 1941 and all of 1942, bearing in mind how the process was developed. Walen and Wilbur had not been able to make any arrangement with outside parties for the use of the process prior to 1945. However, the evidence as a whole has some tendency to show that*303 about 5 to 6 cents per pound of Pentrate sold might be a fair measure of reasonable compensation for the petitioner's indirect use of the patented process. The petitioner was able to sell Pentrate for 33 to 35 cents per pound. The cost of manufacture was about 6 cents. Salesmen received about 7 cents per pound. Similar salts could be obtained elsewhere for 12 cents. Obviously, the petitioner had something valuable to offer with Pentrate. Five to six cents for the process would leave a substantial amount for the service given by the petitioner and other factors. Walen and Wilbur had asked but had not gotten 6 cents from strangers. Five cents was *348 the amount agreed upon with Remington. The petitioner here claims more than 6 cents, i. e., it claims in addition 10 per cent on equipment sales. No basis for a claim by these two men for a commission on the sales of equipment separate from a claim based upon the use of their process appears. The equivalent of payments up to 5 cents per pound of Pentrate may be deducted and those in excess disallowed, following the principle of Cohan v. Commissioner, 39 Fed. (2d) 540.
The Commissioner *304 raises an alternative contention under section 24 (c). However, he concedes in his brief that the issue does not require decision as to salaries unless larger deductions than he has allowed are allowed by the Court. Nevertheless, the question does arise as to a part of the amounts due to Walen for 1941 on account of the use of the patent. The entire amount of the so-called royalties accrued in favor of Walen for 1941 and deducted by the petitioner on its return was paid either by check or by note of the petitioner delivered to Walen during 1941 or within 2 1/2 months thereafter and Walen included the full amount in his gross income for 1941. $ 6,724.14 of the total was paid in 3 negotiable notes payable on demand 90 days after date, with interest at 3 per cent, given to Walen in December, 1941. With the possible exception of a balance of $ 812.37, the principal of the notes was paid in 1943 and 1944. The $ 812.37 is not material here, due to the disallowance above of a part of the deduction claimed. The petitioner debited the amounts of the notes to Walen's royalty account and credited them to its notes payable account in December, 1941. The petitioner was solvent at all times*305 and had sufficient cash on hand to pay the notes. The present case is not distinguishable from the following cases which held that the issuance of demand and time notes constituted payment within the meaning of section 24 (c) (1). Akron Welding & Spring Co., 10 T. C. 715; Musselman Hub-Brake Co. v. Commissioner, 139 Fed. (2d) 65, reversing T. C. Memo., Nov. 10, 1942; Celina Manufacturing Co. v. Commissioner, 142 Fed. (2d) 449, reversing 47 B. T. A. 967; Anthony P. Miller, Inc. v. Commissioner, 164 Fed. (2d) 268, reversing 7 T. C. 729; certiorari denied, 333 U.S. 861">333 U.S. 861; Commissioner v. Mundet Cork Corporation, 173 Fed. (2d) 757, affirming T. C. Memo., June 30, 1948. Decision on this point will be for the petitioner and no part of the deduction already allowed under section 23 (a) need be disallowed because of section 24 (c).
The petitioner has not proven that its failure to make and file an excess profits tax return for 1941 was due *306 to reasonable cause and not to willful neglect, and it follows that the imposition of a 25 per cent addition to the excess profits tax for 1941 can not be disturbed. This case, on that point, is not distinguishable from, and is no stronger for the petitioner than, the case of P. Dougherty Co., 5 T.C. 791">5 T. C. 791; affd., 159 Fed. (2d) 269; certiorari denied, 331 U.S. 838">331 U.S. 838, which established *349 the law of this Court, despite an able dissent. Home Guaranty Abstract Co., 8 T.C. 617">8 T. C. 617. Thus, the petitioner is not saved by the fact that its income tax return for 1941 disclosed less income than that which makes the filing of an excess profits tax return necessary. Nor is it saved by the fact that it relied upon Norton, who knew that no excess profits tax return was required unless the excess profits net income amounted to $ 5,000 or more. The evidence does not disclose that he was in any way qualified to give competent advice upon Federal tax matters or that any responsible person would have had reason to believe that he was. Furthermore, it does not appear that he considered*307 the possible nondeductibility of a part of the salaries and royalties.
Decision will be entered under Rule 50.