*4287 1. Payments on stock subscriptions may be included in invested capital from the time paid in.
2. Petitioner is not entitled to include in invested capital subscriptions to capital stock until paid.
3. Amount allowable as a deduction on account of the exhaustion of a patent determined.
4. The patent can not be included in invested capital at a value in excess of the cost to the previous owner under section 331 of the Revenue Act of 1918.
5. The evidence is insufficient to show that certain parts of expenditures originally estimated as overhead expense applicable to the manufacture of tools and other shop equipment were not applicable to the manufacture of such tools and shop equipment.
*1161 This is a proceeding for the redetermination of a deficiency in income and profits taxes of $2,193.19 for 1920. The deficiency results in part from the respondent's refusal to allow as part of invested capital $78,400 representing a patent paid in for stock and $65,580 representing unpaid subscriptions to capital*4288 stock. The petitioner also claims a reasonable deduction on account of the exhaustion of the patent.
FINDINGS OF FACT.
The petitioner is a Massachusetts corporation organized on September 17, 1919, having its principal office at Attleboro. It is engaged in the manufacture and sale of a patented article known as the "Mosspeed Braider Carrier" and certain other textile mill equipment known as beam heads.
The authorized capital stock provided for at the time of organization was $325,000 divided into 1,250 shares of 8 per cent cumulative preferred stock and 2,000 shares of common stock. The shares of each class of stock had a par value of $100 each and were entitled to one vote.
The articles of agreement in addition to providing for the issuance and delivery of the preferred stock when paid for in cash also provided for the sale of such stock on terms of 20 per cent cash and payments of 20 per cent each 60 days thereafter until fully paid. The stock, however, when sold on the installment plan was not issued until paid for in full. During 1919 and 1920 the common stock was *1162 issued as a bonus with preferred stock. At first one-half share of common stock was*4289 given with the sale of one share of preferred and later a whole share was given.
At a meeting of the organizers of the petitioner corporation on September 17, 1919, it was "Voted that the amount of capital stock now to be issued is two thousand shares of common stock and three shares of preferred stock, to be paid for as follows: Three shares preferred to be paid for in cash, two thousand shares common stock to be paid for in patent rights."
Preferred stock having a total par value of $9,900 had been subscribed for and paid for in full prior to January 1, 1920. Prior to that date, the petitioner had received subscriptions on the installment basis to preferred stock of a total par value of $99,050. On such subscriptions cash payments totaling $33,470 had been received, leaving unpaid subscriptions of $65,580 on January 1, 1920.
During the petitioner's taxable year 1920 it received additional subscriptions to preferred stock of a par value totaling $66,000 and the additional collections on preferred stock subscriptions amounted to $142,825, of which $10,200 represented cancellations and corrections. The difference between these amounts, or $132,625, when prorated for the portion*4290 of the year the respective collections were a part of the capital of the petitioner corporation gives an average amount of $52,228.08.
On August 27, 1920, preferred stock of a par value of $5,000 and common stock of a par value of $2,500 was issued to Frank Mossberg, a stockholder. Of the preferred stock $4,000 was issued for the payment of a note for that amount owing by the company and the remaining $1,000 of preferred stock was issued for the partial payment by him of invoices of goods received by it. The common stock was given as a bonus with the preferred.
On February 25, 1919, there was issued to Frank Mossberg letters patent No. 1295565, relating to a carrier for braiding machines. On September 24, 1919, he assigned it to the petitioner corporation, together with any other patents that might be issued to him while in the employment of the petitioner, for shares of its common stock as hereinafter set out. On September 29, 1919, Mossberg executed an instrument wherein he acknowledged the receipt by him of 2,000 shares of the common stock of the petitioner and stated "that 750 shares were received by me in consideration of my transfer of all my letters-patent covering*4291 all patents which I now own in whole and all patent rights applied for and all future improvements and inventions that I may make while in the employment of the Mossberg Pressed Steel Corporation, and that the remaining 1,250 shares of common stock of said corporation, I hold as trustee for said corporation same to be disposed of by me as directly by the directors of said *1163 corporation from time to time." The 1,250 shares of common stock were put in the treasury of the petitioner to be issued as and were issued as a bonus to purchasers of preferred stock as and when the preferred stock was issued. While the issuance of 2,000 shares of common stock for patent rights was authorized on September 17, 1919, the patent rights assigned to the corporation on September 24, and the instrument acknowledging receipt of the shares by Mossberg executed on September 29, no stock was issued to him until September 30, 1919, when 750 shares of the common stock were issued to him for the patent. On April 23, 1920, there were issued to him as a bonus an additional 75 shares of common stock which he received in connection with his subscription for 150 shares of preferred stock also issued*4292 to him on that date.
Mossberg has been president and general manager of the petitioner since its incorporation.
At the time of the incorporation of the petitioner, Mossberg had applications pending for letters patent, He also subsequently made application for others. He is an inventor to whom have been issued more than 200 American patents and 50 foreign patents. Prior to inventing the Mossberg braider carrier, which is the invention covered by letters patent No. 1295565, he had been associated with another company engaged in manufacturing a braider carrier patented by one Troxtell of Rome, N.Y. The principle of the Troxtell carrier was different from that of the old style braider carrier then being manufactured by about ten other companies. Braiding machines are used in the manufacture of insulated wire, shoe laces, flat braid, elastic braid, etc. The yarn used for making the insulation is placed on spools which rotate in an irregular circular track (maypole style). This causes an overlapping of the yarns, which is necessary to the process of braiding. As each spool approaches the center of the irregular circle it is necessary that the resulting slack in the yarn unwinding*4293 from that spool be taken up in order to prevent tangling or breaking the yarn. In the old style braider carriers the slack was taken up by the gravitation of a weight through which the yarn was passed. The effect of centrifugal force limited the speed with which the old style carriers took up the slack in the yarns, and this in turn limited the speed at which the whole braiding machine could be operated efficiently.
The braider carrier patented by Troxtell involved the principle of taking up the slack in the yarns by the use of a spring instead of by the use of a weight, thereby eliminating the effect of centrifugal force on the speed of operation. Mossberg, in manufacturing the Troxtell carrier had observed its faults and his patent represented a spring control of tension on yarn with the defects of the Troxtell *1164 carrier eliminated. Mossberg's patented carrier has a new system for threading the carrier involving two simple loops, while the old style carrier involves threading the yarn through two holes. This results in a saving of time in manufacturing.
The Mossberg carrier may be attached to all braiding machines except one, the Wardwell machine. The Wardwell*4294 is the only braiding machine and carrier that operates at a higher speed than other machines equipped with the Mossberg carrier. The Wardwell invention, which was patented and produced about the same time as the Mossberg carrier, consists of an entire braiding machine, including carriers. Its carriers could not be attached to any other braiding machine then in existence. A Wardwell unit sells for $260 and occupies twice as much space as other braiding machines, which equipped with the Mossberg carrier sell for about $100.
As braider carriers wear out faster than other parts of braiding machines, there was in 1919 a possible replacement market in the wire industry of 5,000,000 carriers and 2,500,000 carriers in the textile industry. About 84,000 carriers are required annually to equip new braiding machines being added to those in use in the wire industry. In manufacturing the Troxtell carrier, Mossberg had an opportunity to ascertain the probable cost of making his carrier. He originally estimated that it would cost 72 cents to manufacture a No. 2 carrier which would sell for $1.15. Experience has shown that the carriers can be manufactured for 60 cents each while they sell*4295 for $1.15 each. The old style carriers sell for 54 cents each. The useful life of the Mossberg carrier is from 6 to 7 years, while that of the old style carrier varies from 2 to 20 years.
By the use of the Mossberg carrier, speed of operation is increased 50 per cent with no increase in operators. This results in a saving of approximately 33 per cent in the cost of goods manufactured. One company manufacturing insulated wire found that by the use of the Mossberg carrier on all of its machines the direct labor cost per 1,000 feet of wire was reduced from 7 cents to 2 1/2 cents and the production of its plant increased by approximately 9,000 feet per week. The production per hour with the old type weight tension carrier was 110 feet. With the Mossberg carrier it was increased to 158 feet per hour. The braid produced was more uniform and the wear and tear of the braiding machinery was less. The increased speed at which braiding machines equipped with Mossberg carriers may be operated does not result in any greater wear to the machinery than when equipped with the old style carriers.
In 1919, the Mossberg carrier was offered to the New England Butt Co., which is the largest*4296 manufacturer of the old style weight *1165 tension braider carriers and braider machines. The carrier was not adopted by that company, however, until on July 1, 1926, when it entered into a contract whereby it advertises the Mossberg carrier as an optional equipment on its braiding machines.
A comparison made by the New England Butt Co. showed that a unit of 20 of the Wardwell braiding machines costing $5,310, had an operating efficiency of 80 per cent, and occupied the same floor space as a unit of 50 of its own machines equipped with the Mossberg carrier costing $3,916 and having an operating efficiency of 92 per cent.
The letters patent No. 1295565 assigned by Mossberg to the petitioner corporation on September 24, 1919, had an actual cash value of $40,000 on that date. A reasonable allowance for the exhaustion of the patent in 1920 is $2,352.94.
Before it could begin manufacturing the Mossberg carrier, it was necessary for the petitioner to make certain tools that would be needed in manufacturing the carrier. This work was done by the petitioner during 1920. The direct labor and material cost of making such tools was charged direct to the tool or machinery asset*4297 accounts. An estimate of the amount of "overhead expenses" applicable to the making of such tools was made by the treasurer of the company by taking 200 per cent of the direct labor cost. On this basis the net charges to the tool or machinery asset accounts were made in 1920 in the amount of $38,858.92 and the net credits of the same amount were made to the profit and loss account.
In its 1920 income and profits-tax return, the petitioner took deductions as follows:
| Ordinary and necessary expenses | $87,485.69 |
| Compensation of officers | 9,073.86 |
| Repairs | 6,620.42 |
| Interest | 1,286.23 |
| Taxes | 1,231.10 |
| Exhaustion wear and tear | 20,859.37 |
| Total | 126,556.67 |
As an offset to the foregoing deductions, the petitioner reported in its return as income the amount of $38,858.92. This amount represented that part of the deductions totaling $126,556.67 which it was estimated was applicable to the making of tools and other shop equipment and not properly a part of expenses.
In an audit of the petitioner's return the respondent increased the net income reported from $15,353.84 to $15,721.46 and eliminated from invested capital as computed by the petitioner $78,400 representing*4298 patent paid in for stock, and $65,580 representing unpaid subscriptions for capital stock.
*1166 OPINION.
TRAMMELL: In its original petition the corporation claims that the respondent erred by refusing to allow as part of its invested capital unpaid subscriptions for capital stock. In an amended unpaid subscriptions for capital stock; In an amended petition filed at the hearing the petitioner claims that the respondent erred by not including in invested capital (1) all the actual cash paid in by stockholders, (2) that portion of stock subscriptions made by stockholders prior to January 1, 1920, which had not been collected by petitioner but which had been accrued as accounts receivable due from subscribers, and (3) $40,000 representing the actual cash value of patents bona fide paid in for stock of the corporation having a par value of $75,000. In the amended petition it is also claimed that the respondent erred by failing to allow a reasonable allowance or one-seventeenth of the patent's actual cash value for exhaustion, and that the respondent further erred by failing to determine that the petitioner had no net income for the calendar year 1920 due to erroneous credits*4299 to profit and loss representing excessive overhead charges as cost of manufacture of tools and other shop equipment.
The respondent denies that error was committed by him in the determination of the petitioner's tax liability.
We have found that prior to January 1, 1920, the petitioner, besides having received $9,900 as payment in full for preferred stock subscribed, had also collected $33,470 on unpaid subscriptions to preferred stock. In addition to the $33,470 collected during 1919, the petitioner collected $132,625 during 1920, which, when prorated for the portion of the year in which the respective collections were paid, gives an average amount of $52,228.08 to be included in invested capital. We have heretofore held that payments on stock subscriptions may be included in invested capital from the time paid in. Central Consumers Wine & Liquor Co.,1 B.T.A. 1190">1 B.T.A. 1190; Barker-Jennings Hardware Corporation,4 B.T.A. 20">4 B.T.A. 20; Meadows & Co.,5 B.T.A. 241">5 B.T.A. 241. There should therefore be included in petitioner's invested capital, on account of collections for stock, $95,598.08, composed of the amounts of $9,900, $33,470, and $52,228.08.
*4300 With respect to petitioner's contention that there should be included in invested capital amounts of subscriptions made prior to January 1, 1920, for stock not issued and which had not been collected by petitioner, we are of the opinion that such amounts can not be included in invested capital until paid. Central Consumers Wine & Liquor Co., supra;Forge Coal Mining Co.,2 B.T.A. 975">2 B.T.A. 975; Barker-Jennings Hardware Corporation, supra;Meadows & Co., supra. The decisions in those cases are applicable and controlling here.
*1167 We have also found that on August 27, 1920, preferred stock to the amount of $5,000 was issued to Mossberg in consideration for his paying a note for $4,000 owing by the company and the partial payment by him of invoices of goods received by it and that common stock amounting to $2,500 was issued to him as a bonus with the preferred. Inasmuch as the payment of the note extinguished a liability of the company amounting to $4,000, that amount should be included in the petitioner's invested capital. Since the evidence does not show the amount of that portion of the invoices paid by Mossberg, *4301 we have no basis for determining the amount to be included in the petitioner's invested capital as a result of this transaction.
Relative to the patent assigned by Mossberg to the petitioner on September 24, 1919, we have found that with the exception of one carrier the carrier produced under the Mossberg patent was in several respects superior to the old style carriers then being manufactured. While no carriers had been manufactured under the patent there was at the time the petitioner acquired it an established market for braider carriers. There were at least five million then in use and a portion of them had to be replaced either with the old style carrier or with the Mossberg carrier, which was a superior article. A witness for the petitioner, who is an employee of the New England Butt Co. and who was familiar with the various types of carriers manufactured and sold in 1919, expressed his opinion as to an actual cash value of $40,000 on September 24, 1919, of the patent. Mossberg, who had had long experience in obtaining and disposing of patents, testified as to a value of $50,000. In view of all the evidence in the case we are of the opinion that the patent had an actual*4302 cash value of at least $40,000 at the time it was assigned to the corporation.
Of this value, the petitioner is entitled to a deduction against income of one-seventeenth of the amount or $2,352.94, representing a reasonable allowance for exhaustion of the patent.
We have found the value of the patent for the purpose of an exhaustion allowance to be $40,000. The respondent contends, however, that section 331 of the Revenue Act of 1918 will prevent the patent being included in petitioner's invested capital at a greater amount than its cost to Mossberg.
This contention is correct if Mossberg acquired an interest or control of 50 per cent or more of the petitioner corporation.
The petitioner began business with an authorized capital stock of $325,000 divided into $200,000 common stock and $125,000 preferred stock. Each share of both classes of stock had a par value of $100 and the right to one vote. Mossberg assigned to the petitioner for $200,000 par value of its common stock the patent here under consideration, together with such others as he might obtain while "in the employment" of the petitioner. Of the $200,000 of common *1168 stock the evidence shows that*4303 $75,000 was issued to Mossberg for the patent. The evidence does not show that the $125,000 of the common stock was actually issued to him. While in the instrument executed September 29, 1919, he acknowledges having received the stock, he testified that he had no recollection of this portion of the stock actually being issued to him nor did he remember ever voting it, but that this portion of the stock was placed in the treasury of the corporation and later was issued from time to time as a bonus. The books were introduced in evidence and they do not show that the $125,000 par value of the common stock was issued to Mossberg.
Whether the $125,000 par value of stock was actually issued to Mossberg or was held in the treasury of the company or remained as unissued stock the effect insofar as the question in controversy is concerned, is the same. If it was actually issued to him he held it as a trustee for the corporation. It was the corporation's stock. In effect it was treasury stock, or unissued stock, and should not be considered in determining the amount of outstanding stock. The $75,000 par value of stock held by Mossberg in his own right was immediately after the transfer*4304 of the patent to the corporation more than 50 per cent of the outstanding stock. On the other hand, even if it be held that the $125,000 par value of stock was actually issued to Mossberg and it be held to be effective outstanding stock, it was controlled by Mossberg, as trustee, who owned in his own right the balance of the common stock. In any event, the situation is one coming within the scope of section 331 of the Revenue Act of 1918, and the petitioner is not entitled to include in invested capital the patent at a value in excess of the cost to Mossberg. Since the evidence does not show the cost to Mossberg, the action of the respondent with respect to the patent is affirmed.
The petitioner's last contention is that the respondent erred by failing to determine that the corporation had no net income for 1920 due to erroneous credits to profit and loss representing excessive overhead charges in cost of manufacture of tools, and other shop equipment. In regard to this issue, the petitioner contends that instead of $38,858.92, which represented the amount of overhead expenses originally estimated as being applicable to the manufacture of tools and other shop equipment, being*4305 eliminated from its total expenses and capitalized, only $12,146.88 should have been so eliminated from its total expenses and capitalized. In support of this the petitioner offered no legal or admissible evidence. On the basis of the evidence before us, we are unable to hold that this contention of the petitioner is correct.
Reviewed by the Board.
Judgment will be entered on 10 days' notice, under Rule 50.