1930 BTA LEXIS 2546">*2546 1. An application for a patent is intangible property and regardless of its actual cash value when paid in for the stock of a corporation, Subsequent to March 3, 1917, can be included in the computation of invested capital only as subject to the limitations of section 326(a)(5) of the Revenue Acts of 1918 and 1921.
2. Appreciation of assets after acquisition may not be included in the computation of invested capital.
18 B.T.A. 1003">*1003 The respondent has asserted deficiencies in income and profits taxes for the years 1920 and 1921, in the respective amounts of $3,476.88 and $1,064.60. The profits taxes involved were computed under the provisions of section 328 of the Revenue Acts of 1918 and 1921. For its cause of action the petitioner asserts that the tax liabilities so ascertained are excessive and asks that its profits taxes for each of the years under review be assessed under section 301 of the Revenue Acts applicable and that its invested1930 BTA LEXIS 2546">*2547 capital be computed on the basis of a value for a patent application paid in for stock which is much greater than the respondent concedes.
FINDINGS OF FACT.
The petitioner is a Nebraska corporation, with its principal office at Omaha. It was organized in 1917 and at that date stock of the par value of $20,000 was issued.
Prior to 1917 Benjamin S. Elrod, a practical printer of many years experience, spent considerable time in devising and experimenting with a device for casting rules and slugs for use in the printing trade. By July 1, 1917, this device was so far developed that Elrod was convinced of its great potential value and marketability. He was 18 B.T.A. 1003">*1004 without means for further experimentation or to build machines for test under actual working conditions. He took the matter up with Lee Hurdman, and James E. Rait, who were practicing attorneys in Omaha. For the purpose of financing the further development and perfection of the device, Elrod, Hurdman, and Rait organized the petitioner about August 1, 1917, with authority to issue common stock of the par value of $20,000. Upon incorporation Elrod received shares of common stock of the par value of $10,200 in1930 BTA LEXIS 2546">*2548 exchange for the device and his application for patent thereon. The remaining shares of stock of the par value of $9,800 were issued in equal amounts to Hurdman and Rait, who paid cash therefor in the amount of the par value thereof.
About a year and six months after the incorporation of the petitioner, the device had been so far developed and tested that the inventor and his associates regarded its successful operation as assured. Thereupon the Nebraska State Railway Commission was duly asked for permission to sell preferred stock of the par value of $100,000. After hearing, such Commission promulgated its finding of facts and opinion thereon and made an order in respect thereto, which, so far as it may be material to this proceeding was as follows:
OPINION AND FINDING.
By The Commission:
This matter came on to be heard upon the sworn written application of the Elrod Slug Casting Machine Company asking authority to sell $100,000 of its preferred participating 8% stock and to assign to Messrs. Benjamin S. Elrod, Lee Hurdman, and Jas. E. Rait such a sum as the Commission finds them entitled to for the assignment of the device and for bringing the machine to its present1930 BTA LEXIS 2546">*2549 state of perfection and for their services, and was heard upon said sworn application, the testimony offered before the Commission and the report of the Examiner as to the operation of the machine as seen at the World Herald Building in Omaha.
And the Commission being fully advised in the premises finds that the company holds the patent rights to an apparently valuable machine for use in the printing trade and that the object of the company is legitimate and that Messrs. Elrod, Hurdman and Rait are entitled to have assigned to them $100,000 of the common stock of said company provided such fact is known to the purchasers of stock who purchase same for cash and further that said stock assigned shall be held in escrow until the stock of the company is all worth par. The Commission further finds that the permit issued to applicant company should provide the usual safe-guards to purchasers and provide for full showing of the changes to be made in its incorporation.
ORDER.
IT IS THEREFORE ORDERED by the Nebraska State Railway Commission that the Elrod Slug Casting Machine Company of Omaha, Nebraska, be and the same is hereby permitted to sell $100,000 of its 8% preferred participating1930 BTA LEXIS 2546">*2550 stock of the par value of $100 per share at par, and to assign to Messrs. Benjamin S. Elrod, Lee Hurdman and Jas. E. Rait $100,000 of the common stock of said 18 B.T.A. 1003">*1005 company in payment for the assignment to said company of the patent rights to the Elrod machine and in payment for their services in developing the device and bringing it to its present development, all of which is subject to the following conditions:
1. That upon all the stock sold by said company any upon its stock selling contracts and the advertising used by it to further its stock sales, it shall plainly appear that $100,000 of the stock of said company has been assigned to Messrs. Benjamin S. Elrod, Lee Hurdman and Jas. E. Rait in exchange for the assignment of the patent rights to the Elrod Slug Casting Machine to the company and in payment for the services of said gentlemen in developing and perfecting said machine. Further the said stock so assigned to Messrs. Elrod, Hurdman and Rait shall be deposited in escrow with some reputable bank or trust company in the state of Nebraska for delivery to said three men upon a finding by the Commission that all of the stock of the corporation has a market value1930 BTA LEXIS 2546">*2551 of not less than par and upon the order of the Commission to re-deliver the stock in accordance with such finding. The applicant company is to furnish to the Commission proof that said stock has been so placed in escrow and setting out a copy of the escrow agreement with the bank or trust company in which said stock is deposited.
2. That applicant company shall at once take all necessary legal steps to amend its articles of incorporation for increasing its authorized capital stock to at least $200,000 of stock and proof of the steps so taken shall be made to the Commission within ninety days from this date including proof of publication of the notice of amending its articles of incorporation.
* * *
In conformity with the order set forth above the petitioner duly obtained permission to increase its capital and issue common stock of the par value of $100,000 and 8 per cent preferred stock in the same amount. Thereafter Elrod, Hurdman, and Rait surrendered the common stock allocated to them at date of incorporation and in exchange change therefor received common stock of the par value of $100,000 ratably with their original holdings. Preferred stock was sold to the public1930 BTA LEXIS 2546">*2552 at par for $32,000.
In due course letters patent covering the Elrod device were issued by the United States, Argentine, Australia, Belgium, Canada, Denmark, France, Germany, Great Britain, Italy, Japan, New Zealand, Norway, Sweden, and Switzerland. The parties agree that all such patents were either issued or assigned to the petitioner. At one time the petitioner gave an option to a man named Reade to purchase all the foreign patents for $150,000, but such option lapsed and at a later date all foreign patents were sold to Reade for $50,000. In 1923 the Ludlow Typograph Co. was authorized to sell the petitioner's patents issued by Great Britain and six other European countries for any amount in excess of $200,000.
After the increase of its capital stock the petitioner began the manufacture of the machine invented by Elrod and before July 5, 1920, had realized a gross amount of $90,000 from the sales thereof. 18 B.T.A. 1003">*1006 On July 15, 1920, it licensed the Lodlow Typograph Co. of Chicago to manufacture and sell the Elrod machine in the United States on a royalty basis of $300 per machine, with net minimum annual royalties of $54,000.
Shortly after the royalty contract was1930 BTA LEXIS 2546">*2553 made, an action at law alleging infringement of patents was brought against the petitioner by the Lanston Monotype Co. of Philadelphia. On the trial of such action in the Federal District Court the petitioner prevailed, but on appeal to the United States Circuit Court of Appeals the decision of the court below was reversed. Thereafter a compromise was effected and all adverse litigation in the United States ceased. By the terms of the compromise the petitioner was to receive $100 per machine, up to $12,000 per year, during the remaining life of the patent, and the Lanston Co. $250 per machine, without limit.
In its income and profits-tax returns for each of the taxable years the petitioner included the par value of its outstanding common stock in the computation of its invested capital. Upon audit of such returns the respondent disallowed $80,000 of the amount so included, but held that certain abnormalities in the situation of the petitioner entitled it to relief and computed its profits taxes under the provisions of section 328 of the Revenue Acts of 1918 and 1921, respectively. A part of the deficiency so determined is in controversy in this proceeding.
OPINION.
LANSDON: 1930 BTA LEXIS 2546">*2554 This proceeding is an appeal from the respondent's determination of profits-tax liabilities for the years 1920 and 1921, under the provisions of section 328 of the Revenue Acts of 1918 and 1921. The petitioner contends that it should be allowed to include at least the par value of its outstanding stock in the computation of its invested capital and that such inclusion would enable the respondent to determine its profits-tax liability for each of the taxable years under the provisions of section 301 of the applicable revenue acts. As the basis of its contention the petitioner avers that the application for a patent paid in by Elrod in exchange for stock of the par value of $10,200 had an actual each value of at least $100,000 at the date its was acquired for stock.
Under the law patents are intangible property (section 325(a), Revenue Act of 1918). An application for a patent we think must be classified as "other like property" and, therefore, as an intangible. The question here, then, is to determine the value for invested capital purposes of intangibles paid in for stock at date of the incorporation of the petitioner. That part of section 326 of the Revenue Acts of 1918 and1930 BTA LEXIS 2546">*2555 1921 applicable here is as follows:
18 B.T.A. 1003">*1007 (5) Intangible property bona fide paid in for stock or shares on or after March 3, 1917, in an amount not exceeding (a) the actual cash value of such property at the time paid in, (b) the par value of the stock or shares issued therefor, or (c) in the aggregate 25 per centum of the par value of the total stock or shares of the corporation outstanding at the beginning of the taxable year * * *.
The record discloses that the petitioner was incorporated about August 1, 1917, and that at date of incorporation the application for a patent on the device invented by Elrod was paid in for common stock of the par value of $10,200. Without more, this fact, under the law, limits the value of such application for invested capital purposes to the par value of the stock then received therefor. The petitioner contends, however, that the effect of the increase of capital stock about a year and a half after incorporation was to substitute the transaction in connection therewith for the original issue of stock for cash and intangible property. Its theory seems to be that it dates as a corporate entity from the reorganization rather than from the1930 BTA LEXIS 2546">*2556 time of original incorporation. There is very little basis for this assumption. The corporation first chartered still exists. The only change is in the amount of authorized capital. It is true that Elrod received stock of the par value of $51,000 upon surrender of the shares originally issued to him, but we fail to see how it can be said that he paid in his patent application for such shares. So far as the common stock is concerned the increase thereof seems to have been in the nature of a stock dividend. If so, and it represented value that existed at date of incorporation, the petitioner can not benefit here, since the fact remains that the patent application was paid in for shares of the par value of $10,200 and, entirely regardless of the value of such application, that is the maximum amount that can be allowed under the law for invested capital purposes. If it was a stock dividend representing appreciation of the value of the application for a patent between the date of incorporation and the issue thereof, it avails the petitioner nothing. Beginning with 1930 BTA LEXIS 2546">*2557 , the courts and this Board have many times held that appreciation of values after acquisition may not be considered as an element in the computation of statutory invested capital. ; .
In the light of the statute and the authorities above cited, it is not necessary to discuss the evidence adduced by the petitioner for the purpose of showing that the patent application had an actual cash value of at least $100,000 when paid in for stock in 1917.
Decision will be entered for the respondent.