William M. Bailey Co. v. Commissioner

William M. Bailey Company, Petitioner, v. Commissioner of Internal Revenue, Respondent William M. Bailey Co. v. Commissioner Docket No. 22615 United States Tax Court 15 T.C. 468; 1950 U.S. Tax Ct. LEXIS 69; October 10, 1950, Promulgated *69 Decision will be entered under Rule 50. 1. Royalties on patented blast furnace specialties paid under licensing agreements by petitioner corporation to its president held deductible in year of payment. 2. Deposits of insurance premiums by petitioner with trustees under a stock bonus plan creating forfeitable beneficial interests in the officer-beneficiaries, held not deductible. Section 23 (p) (1) (D), Internal Revenue Code. 3. Amount for which liability was recognized and evidenced by accrual in tax year, held properly accruable. 4. Petitioner, having received net abnormal income in tax years partially attributable to research or development extending over period of more than 12 months in designing and improving some of its blast furnace specialties, held entitled to refund of excess profits tax. Section 721 (a) (2) (C), Internal Revenue Code. William Wallace Booth, Esq., and Sidney B. Gambill, Esq., for the petitioner. Kalman A. Goldring, Esq., for the respondent. Opper, Judge. OPPER *469 By this proceeding petitioner claims a refund, under Internal Revenue Code section 721 (a) (2) (C), of excess profits tax for 1942 and 1943, and challenges respondent's determination*71 of deficiencies in declared value excess profits tax and excess profits tax as follows: Declared value Excess profits Year excess profits tax tax [1942] $ 7,177.63 [1943] $ 2,795.26 13,909.19 Some adjustments are not contested, and the only questions, in addition to the 721 issue, are the deductibility of "royalties" paid in each year to petitioner's president, 1 premiums paid in 1943 on an endowment policy insuring his life, and amounts entered on petitioner's books in 1943 as liabilities owing to subcontractors, where settlement was not made until 1945. An issue raised by petitioner with respect to the disallowance of a claim for relief under section 722 was dismissed at the hearing for lack of jurisdiction. The parties have filed stipulations of fact. Other evidence was adduced at the hearing. FINDINGS OF FACT. The stipulated facts are hereby found. Petitioner filed its returns for the years in question with the collector of internal*72 revenue for the twenty-third district of Pennsylvania at Pittsburgh. Petitioner is a Pennsylvania corporation organized in 1920 as Bailey-Lewis, Incorporated. Its name was changed to William M. Bailey Co. in 1921. From 1921 to 1926 it was engaged in selling the products of New York Blower Co., Chicago, and Vulcan Iron Works, Wilkes-Barre, Pennsylvania. Since 1926 petitioner has specialized in designing and selling its own line of steel products used in and around blast furnaces and known as "blast furnace specialties." Petitioner does no manufacturing. All of its products are manufactured by other companies. *470 Petitioner's principal products, their inventors, and the patents protecting each, are as follows: Patent Date Product number issued Inventors Thermal expansion goggle valve 1,506,021 8-26-24 Frank R. McGee. Do 1,678,867 7-31-28 Do. Mechanical goggle valve 2,125,253 7-26-38 Andrew Bowland. Goggle valve plate 1,947,453 2-20-34 William M. Bailey. Electric plunger clay gun 1,726,068 8-27-29 Hopkins and Osolin. Do 1,726,070 8-27-29 Do. Do 1,774,373 8-26-30 Do. Do 1,780,485 11-4-30 Do. Do 2,248,434 7-8-41 Osolin and Ferree. Open joint checker 1,986,737 1-1-35 Frank R. McGee. Steel stove bottom 1,983,017 12-4-34 Andrew Bowland. Pig casting machine 2,167,883 8-1-39 Jay W. Ferree. Cinder notch stopper Alfred Osolin. Pug mill 1,557,123 10-13-25 George W. Vreeland. *73 Facts Relating to Deduction of Royalties. William M. Bailey, hereinafter called Bailey, has been president and a majority stockholder of petitioner since its organization. He is not an engineer or a college graduate. From 1900 to 1915 he was employed by Carnegie Steel Co. as office boy, stenographer, and secretary to the president, and from 1915 to 1919 by Midvale Steel Co. as secretary and assistant to the president. Petitioner was authorized to issue 9,000 shares of $ 50 par value common stock. As of the dates indicated, its outstanding stock was held by the following persons: Shares Relationship to Stockholder Bailey 3-27-42 5-5-43 9-1-49 Bailey [763] 2,601 Viola M. Bailey Wife [500] Anne Louise Bailey Daughter [275] Kathryn B. Hull do [275] Frank H. Bailey Brother [25] Harry E. Bailey do [2] Arthur R. Schulze [550] Andrew Bowland (employee) [400] Jay W. Ferree (employee) [80] John C. Hopkins (employee) [40] Other Employees [437] Other Persons [815] Total 1,520 1,520 6,000 A schedule comparing for each year in question the percentage of*74 royalties paid with the percentages of stock held and of compensation for services as employees paid to the recipients of the royalties is as follows: *471 [1942] Per cent of Per cent of compensation stock held for services Bailey 50.198 22.17 Andrew Bowland 6.578 7.63 Jay W. Ferree 1.316 7.40 John C. Hopkins .329 12.13 Estate of Frank R. McGee 10.527 Arthur R. Schulze 9.868 Others 20.526 50.67 Total 100.00 [1943] Bailey 50.198 25.55 Andrew Bowland 6.578 9.00 Jay W. Ferree 1.316 8.62 John C. Hopkins .658 13.45 Estate of Frank R. McGee 10.527 Arthur R. Schulze 9.868 Others 20.420 43.38 Total 100.00 [1942] Per cent of Per cent of total compensation royalties and royalties Bailey 11.66 18.86 Andrew Bowland 21.14 11.90 Jay W. Ferree 3.34 6.12 John C. Hopkins 5.12 9.92 Estate of Frank R. McGee 30.81 9.72 Arthur R. Schulze 7.51 2.37 Others 20.42 41.11 Total 100.00 100.00 [1943] Bailey 13.01 20.41 Andrew Bowland 15.97 11.86 Jay W. Ferree 10.99 9.59 John C. Hopkins 3.60 9.42 Estate of Frank R. McGee 34.18 13.99 Arthur R. Schulze 9.41 3.85 Others 12.84 30.88 Total 100.00 100.00 *75 Of royalties paid by petitioner in the aggregate amounts of $ 74,187.09 and $ 114,140.77 in 1942 and 1943, respectively, Bailey received the following: Product [1943] Plate -- Thermal Valve $ 1,277.47 $ 3,796.23 Plate -- Mechanical Valve 4,303.25 7,647.36 Checker 3,070.86 3,402.06 Total 8,651.58 14,845.65 Royalties on the plate paid by petitioner to Bailey from 1934 through 1948 were as follows: Goggle Valve Plate Year Thermal Mechanical valve valve [1934] $ 53.50 [1935] 17.83 [1936] 474.03 $ 869.84 [1937] 1,107.05 992.75 [1938] 262.20 1,305.03 [1939] 377.80 143.17 [1940] 956.84 539.96 [1941] 937.26 3,129.55 [1942] 1,277.47 4,303.25 [1943] 3,796.23 7,647.36 [1944] 1,406.12 2,781.54 [1945] 1,465.53 664.07 [1946] * 1,576.03 * 3,660.73 [1947] 3,414.99 4,652.16 [1948] 2,762.30 10,929.85 Total 19,885.18 41,619.26 *472 Royalties have been regularly paid to McGee and Schulze on the thermal valve and to Bowland on the mechanical valve. The royalties on the thermal valve were paid*76 under a written agreement dated March 27, 1926, in which McGee and Schulze as "licensors" granted Bailey as "licensee" the "exclusive right to make, use and sell" the valves protected by three patents issued to the licensors. Bailey assigned the agreement to petitioner on November 5, 1927, in exchange for $ 25,000 worth of petitioner's stock. The royalties on the mechanical valve were paid under a written agreement between petitioner and Bowland dated October 6, 1936, providing in part: In lieu of the assignment of the Patent Application of Andrew Bowland and patent when it is granted on the design of our American Mechanical Goggle Valve, The William M. Bailey Company agrees to pay Andrew Bowland 3% on the net selling price of each and every valve of this design as long as it is necessary to pay F. E. Kling on his patent * * *. After this patent is run out in 1937, The Bailey Company agrees to pay Andrew Bowland 5% on the net selling price on this valve. A written agreement of September 29, 1937, after the Kling patent had expired, repeated petitioner's undertaking to pay royalties of 5 per cent. The patent on the mechanical valve was issued to petitioner on July 26, 1938. Petitioner*77 has never attempted to enforce "shop rights" to inventions of its employees. Petitioner has a mutual understanding with its employees that it will pay them royalties of 5 per cent on any inventions it markets. Payment in the taxable years of royalties on the plate by petitioner to Bailey, the sums in dispute, were made under one oral and two written agreements. Royalties from 1934 to 1943 on plates installed in thermal valves were paid under the oral agreement reached at an undisclosed date subsequent to June 1933. Royalties on plates installed in mechanical valves were paid under a written agreement between petitioner and Bailey dated May 1, 1936, obligating petitioner * * * to pay William M. Bailey Three (3%) per cent Royalty on the net selling price on each and every Mechanical Goggle Valve manufactured in which the Goggle Plate as covered by the above patent is used. This agreement to hold good during the life of the patent or as long as the plate is used on the Mechanical Goggle Valves and sold by the William M. Bailey Company. A "Memorandum agreement" between the same parties dated April 8, 1943, provided: The William M. Bailey Company agrees to pay William M. Bailey, Five*78 (5%) per cent Royalty on the net selling price of each and every Goggle Plate manufactured in accordance with his design as shown on above patent. This agreement *473 to hold good during the life of the patent or as long as this Plate is manufactured and is sold by The William M. Bailey Company. This royalty has been paid since the patent was issued but no formal agreement was ever signed. It is now felt that some form of agreement should be prepared and signed as a protection both to the Patentee and the Company. By an agreement dated November 8, 1945, Bailey as "licensor" granted to petitioner as "licensee," in consideration of royalties, * * * the sole and exclusive right and license to make, use and sell apparatus embodying the inventions described and claimed in the aforesaid letters patent to the full end of the terms for which such patents are granted. Either party was authorized to terminate the 1945 agreement after 1 year on 60 days' notice "for sufficient cause, such as lack of development of designs of the Licensor to keep pace with competition, or improper conduct or neglect of business by the Licensee." The three agreements between petitioner and Bailey dated*79 May 1, 1936, April 8, 1943, and November 8, 1945, were each signed twice by Bailey: as president of petitioner and in his individual capacity. In his Federal income tax return for the year 1946, Bailey reported the royalties received in that year as long term capital gain on sale of the plate patent held for more than six months. In its returns for 1942 and 1943, petitioner deducted in full the royalties paid, in the respective amounts of $ 74,187.09 and $ 114,140.77. Respondent allowed the deduction of royalties paid to Bailey on the checker; royalties paid to McGee, Schulze and Bowland on the valves; and all the other royalties except those paid to Bailey on the plate. In his notice of deficiency respondent determined that $ 5,580.72 and $ 11,443.59 in 1942 and 1943, respectively, * * * allegedly representing royalty payments made to William M. Bailey, your President and principal stockholder, and taken as a deduction in your return under the caption "other deductions," * * * [are] not a proper deduction from your gross income. Facts Relating to Deduction of Insurance Premiums. In addition to Bailey, petitioner's officers during the years in question were as follows: Officer Office John C. Hopkins Vice President Fred W. Kusserow Secretary and Treasurer Jay W. Ferree Sales Manager Andrew Bowland Chief Engineer *80 Petitioner paid compensation to its officers and other employees in 1942 and 1943 as follows: *474 [1942] Compensation Bailey $ 35,655.96 Hopkins 19,505.76 Bowland 12,271.51 Ferree 11,903.11 Kusserow 11,332.13 $ 90,668.47 The 17 other employees 70,127.92 Total $ 160,796.39 [1943] Compensation Bailey $ 42,058.75 Hopkins 22,136.08 Bowland 14,817.36 Ferree 14,192.75 Kusserow 13,393.08 $ 106,598.02 The 17 other employees 58,040.70 Total $ 164,638.72 On December 17, 1941, petitioner entered into a trust agreement with its five officers, naming William Wallace Booth and Union Trust Co. of Pittsburgh (now Mellon National Bank and Trust Co.) as trustees. The agreement recited that petitioner was presently carrying insurance on the lives of Bailey, Bowland, Ferree, and Kusserow, with petitioner as beneficiary, for the joint purpose of providing petitioner with funds to purchase its stock upon their deaths and to compensate petitioner for loss caused thereby. Pursuant to the trust agreement, all insurance policies on the lives of the four officers, in the following aggregate face amounts, were deposited with the trustees: Face amount Insured of policies Bailey $ 175,000 Bowland 20,000 Ferree 20,000 Kusserow 4,500 *81 Premiums on the above policies were paid by the trustees with funds furnished by petitioner. No deduction for those premiums has been claimed in any year by petitioner. The agreement further recited: WHEREAS, the company [petitioner] now desires to apply for and will take out additional insurance of the endowment type * * * on the life of the said Bailey for the two-fold purpose of establishing a bonus plan for said employee beneficiaries and for the purpose of making further funds available for the purchase of the company's stock, which said policy shall be in the amount of $ 32,000.00 and the beneficiary thereof shall be the Trustees under this agreement * * * On November 5, 1941, petitioner and Bailey had jointly applied for a 10-year endowment policy for $ 32,000 on Bailey's life, naming petitioner as beneficiary. The policy, being the $ 32,000 endowment policy referred to in the trust agreement, was issued on December 27, 1941, and was assigned by petitioner to the trustees under the agreement on January 30, 1942. In connection with the $ 32,000 endowment policy on Bailey's life, the trust agreement further provided, in part: Fourth: Upon the maturity of said endowment*82 policy otherwise than by the death of Bailey, the Trustees shall collect the proceeds of the policy and will *475 purchase from Bailey and/or his wife, Mrs. Viola M. Bailey, and Bailey and/or Mrs. Bailey will sell to the Trustees, the number of shares of stock of the company which the insurance proceeds, less payment of the Trustees' expenses of collection, will purchase at a price to be determined as hereinafter provided; provided, however, that Bailey shall not be required to sell more than 162 shares, it being the intent hereof that Bailey and his wife shall at all times during his life own more than 50% of the outstanding stock of the company. Should such proceeds of endowment insurance amount to more than the purchase price of said 162 shares of stock, then and in that event the Trustees shall hold the balance of such proceeds for the respective employee beneficiaries in the following proportions: Andrew Bowland, 24/64ths or 37.5 per cent. Jay W. Ferree, 13/64ths or 20.3125 per cent. John C. Hopkins, 16/64ths or 25 per cent. Fred W. Kusserow, 11/64ths or 17.1875 per cent; invest the same in stock of the company if possible, and, if not possible, in legal investments, *83 collect the income therefrom and accumulate it for the same purpose. Upon the death of Bailey, the Trustees shall use such excess of endowment insurance proceeds and accumulated income, if not already invested in stock of the company, to purchase stock of the company from the Bailey estate at a price to be determined as hereinafter provided. Fifth: The stock of the company so purchased by the Trustees, as provided in paragraph Fourth hereof, shall (1) to the extent purchased from Bailey and/or Mrs. Bailey on the maturity of said endowment policy and as soon after purchase as possible, be assigned, transferred and delivered to the said employee beneficiaries in proportion to their interest as hereinbefore provided, and (2) to the extent purchased subsequent thereto, be assigned, transferred and delivered after the death of Bailey to the same employee beneficiaries in the same proportion. Sixth: The death, discharge, resignation or retirement of an employee beneficiary, except forced retirement on account of ill health or physical or mental disability, of which the company shall be the sole judge, shall terminate his interest herein and destroy his right to share in any future*84 distribution of said stock so purchased by the Trustees and distributable as provided in paragraph Fifth hereof, and his proportion thereof shall be distributed to the remaining employee beneficiaries in proportion to their respective interests; provided, however, that upon the happening of any such events the company may substitute another employee or employees hereunder and/or appoint the deceased employee's wife or children as beneficiary hereunder, so that at no time shall there be a failure of beneficiaries. Seventh: In the event of the death of Bailey prior to maturity of said endowment policy, the Trustees shall collect the proceeds thereof and shall purchase from the heirs, executors or administrators of said Bailey or from his Trustee in the event he has assigned all or any part of said shares in trust, and the said heirs, executors, administrators or Trustee of said Bailey shall sell to the Trustees at a price to be determined as hereinafter provided, stock of the company to the full extent of such proceeds, less expenses of collection; and thereupon the Trustees will immediately distribute said stock of the company to the said employee beneficiaries in proportion to*85 their respective interests in such insurance proceeds as hereinbefore provided. * * * * *476 Ninth: In the event Bailey sells all or any part of his stock in the company so that there is no stock of his or Mrs. Bailey's available for purchase by the Trustees with the proceeds of said endowment insurance, or not sufficient stock to exhaust said proceeds, the proceeds or any excess thereof shall, upon maturity, by death of Bailey or otherwise, be immediately distributable to the employee beneficiaries who would then be entitled to distribution of stock and in the same proportions as heretofore provided in paragraphs Fifth, Sixth and Seventh hereof. In general, shares of stock purchased according to the agreement but not transferred to employee beneficiaries were to be assigned by the trustees to petitioner and held as treasury stock; but "no stock purchased with the proceeds of endowment insurance shall ever be transferred to the company or held for its benefit." While the agreement could be amended by consent of petitioner, the employee beneficiaries, and the trustees, "no amendment thereof shall be made so that the proceeds of the endowment insurance policy or any income *86 therefrom may at any time be diverted or appropriated for the use or benefit of the company or for any purpose other than for the benefit of the employee beneficiaries." A supplemental agreement dated September 11, 1943, between the same parties, designed to meet an objection raised by the Commissioner of Internal Revenue that petitioner had power to change beneficiaries and allow some of the endowment policy proceeds to Bailey or his family, provided in part: WHEREAS, the question has arisen whether it would be possible under said paragraph Sixth for the share of any of said parties of the second part, or some other benefit, to inure to the benefit of William M. Bailey, his wife or children, or the Company, and it is the desire of the parties hereto to make certain that no such share or benefit shall ever inure to the benefit of said William M. Bailey, his wife or children, or the Company; NOW, THEREFORE, THIS AGREEMENT WITNESSETH, that the parties hereto, intending to be legally bound hereby, covenant and agree that neither William M. Bailey, his wife, his children, nor the Company shall ever be designated as beneficiaries of said trust entitled to receive distribution of any shares*87 of stock of the Company purchased by the Trustees from the proceeds of the aforesaid endowment policy or otherwise become entitled thereto or to any benefit arising therefrom. The percentages of beneficial interests of Bowland, Ferree, Hopkins, and Kusserow, as provided under the trust agreement, were not based on stock ownership or compensation but were fixed by Bailey. Petitioner deposited the following amounts with the trustees for payment of premiums on the $ 32,000 endowment policy: Date deposited Amount Dec. 30, 1942 $ 3,676.80 Dec. 15, 1943 3,663.68 Dec. 14, 1944 3,649.92 *477 In its returns for 1942 and 1943, petitioner deducted the $ 3,676.80 and $ 3,663.68, respectively, under "Other Deductions," with the explanation "Insurance, life (held in trust for employees)." In his notice of deficiency, respondent disallowed the deduction for 1943, determining * * * that the amounts of $ 3,663.68 consisting of premiums on life insurance held in trust for your employees, is not a proper deduction from your gross income under the provisions of the law. Facts Relating to Deduction of Accrued Liabilities. On May 9, 1942, petitioner received an order for the design*88 and construction of 8 hot blast stoves, at a price of $ 1,317,099.48, from Defense Plant Corporation acting by and through Koppers Co., Pittsburgh. Petitioner immediately placed unconditional orders on its own behalf with 3 subcontractors: Paulsen Engineering Co., Pittsburgh-Des Moines Steel Co., and A. P. Green Fire Brick Co. On June 19, 1942, Koppers Co., agent for Defense Plant Corporation, ordered all work stopped, and, on July 16, 1942, placed a revised order for the same stoves reduced to one-half size for a price of $ 946,526. Petitioner and its subcontractors immediately redesigned all parts of the stoves and prepared to fill the revised order. On July 24, 1942, Koppers Co., agent for Defense Plant Corporation, orally advised petitioner to cancel all material covered by the order of May 9, 1942, and in a letter to petitioner dated July 27, 1942, stated: Superseding the verbal instructions previously given to you, do not cancel this order, but arrange to hold up all work on same, and let us know as promptly as convenient the present status of the work, the amount of cancellation charge, and if any material has already been fabricated, where it is located so that it may be*89 inspected by a representative of the Defense Plant Corporation. Your statement of cancellation charges must be in detail as it will be subject to inspection and approval by the Defense Plant Corporation. Petitioner immediately notified its 3 subcontractors, who submitted "cancellation charges or bills for services, expenses, and material costs" to the date of the receipt of the stop-work order, as follows: Subcontractor Date of invoice Amount A. P. Green Fire Brick Co 8/20/42 $ 3,916.14 Pittsburgh-Des Moines Steel Co 9/19/42 12,750.00 Paulsen Engineering Co 7/8/43 2,016.00 The Pittsburgh-Des Moines Co. bill was not satisfactory, and petitioner refused to recognize it or enter it on its books as a proper account payable. The Green Co. and Paulsen Co. bills were entered on petitioner's books on December 31, 1943, as a liability. The Green Co. claim was subsequently reduced by $ 50, representing salvage of material. *478 By a letter dated April 19, 1945, Koppers Co. advised petitioner that total cancellation charges of $ 25,455.90, based on negotiations between petitioner and auditors of Defense Plant Corporation and including cancellation charges of the 3 subcontractors*90 in question, had been approved for payment. Petitioner paid the claims of the subcontractors as follows: Subcontractor Date of payment Amount Paulsen Engineering Co 1/16/45 $ 2,016.00 A. P. Green Fire Brick Co 5/22/45 3,866.14 Pittsburgh-Des Moines Steel Co 5/22/45 3,035.70 The Paulsen Co. bill became a fixed obligation of petitioner in 1943. In its returns for 1943, prepared on an accrual basis, petitioner deducted $ 5,882.14, being the charges of Green Co. ($ 3,866.14) and Paulsen Co. ($ 2,016). Petitioner now contends that the amounts are properly deductible either in 1942 or 1943. In his notice of deficiency respondent disallowed the deduction because "not a proper accrual for the year 1943." Facts Relating to Section 721 Issue. In its returns for the period in question petitioner described its "Kind of business" as "Commission Merchants, Manufacturers' Agents, dealing in mill and mine equipment." As a "Note" to "Schedule A -- Cost of Goods Sold" in its 1943 return petitioner stated that its "Merchandise is shipped generally by vendor-manufacturer direct to customer." Since 1927 petitioner has had an English representative which handles all of the Bailey*91 products except the checker and stove bottom and pays petitioner 15 per cent "royalties" on sales. The number of petitioner's employees has increased from 2 in 1921 to 22 in the years at issue, including the 5 officers, 5 or 6 regular draftsmen, and 10 or 11 temporary draftsmen hired for one job only. As disclosed by its balance sheets, petitioner's assets, liabilities, and capital as of December 31, 1941, and 1942, were as follows: *479 Assets Dec. 31, 1941 Dec. 31, 1942 Current Assets Cash $ 57,234.05 $ 52,080.11 Accounts Receivable 71,720.01 297,045.39 Inventories 6,347.64 528.14 Prepaid Expense 2,364.59 Total 135,301.70 352,018.23 Investments, Permanent Common Stock 750.00 750.00 Bonds 5,165.64 Life Insurance 28,924.49 35,055.03 Total 29,674.49 40,970.67 Equipment Patterns 6,611.68 14,370.52 Office Furniture & Fixtures 2,577.76 4,594.94 Automobiles 3,277.44 1,866.14 Total 12,466.88 20,831.60 Patents Patents at Amortized value 14,616.03 10,224.22 Total assets 192,059.10 424.044.72 Liabilities Current Liabilities Notes Payable 50,000.00 Accounts Payable & Accrued Liabilities 72,204.74 241.587.04 Total 72,204.74 291,587.04 Capital Stock and Surplus Capital Stock Outstanding 76,000.00 76,000.00 Surplus 43,854.36 56,457.68 Total 119,854.36 132,457.68 Total liabilities & capital 192,059.10 424,044.72 *92 Valves and Plate. The first product which petitioner undertook to have manufactured and sell as its own was the thermal expansion goggle valve invented and patented by McGee and Schulze, employees of Carnegie Steel Co. The purpose of the valve was to control the flow of gas in the hot gas main between blast furnace and dust catcher. As originally patented in 1924, the valves contained 4 tubes. Steam entering the tubes caused them to expand and move 2 flanges apart to permit operation of a steel plate. Petitioner did not sell any of the valves with 4 tubes. Bowland prepared drawings redesigning the valve to contain 3 tubes, and changing the movement of the plate, previously vertical, to a swing from a point of suspension. Bowland's drawings were shown to McGee, who on July 31, 1928, was granted a patent on the improvements. The plates in the first thermal valves sold by petitioner were rolled from solid steel. They varied from 48 to 108 inches in diameter, and to be gas tight, machining was required to a uniform thickness not varying more than 15/1000 of an inch. Difficulty was experienced in obtaining gas tight plates from the manufacturers. The plate *480 finally*93 found satisfactory, and presently installed in petitioner's valves, was invented by Bailey in 1931. Bailey's invention of the plate resulted from his chance observation at Vulcan Iron Works in 1931 of the manufacture of parts for lime kilns. A machine rolled a steel "T" section into a circle, forming the track on which the kilns revolve. Bailey was informed by Vulcan's superintendent that the same machine could roll a two-inch steel bar into a circle. Applying that method to the plate, uniform machining to within 2/1000 of an inch was obtained, and a gas tight valve resulted. The thermal valve being unsatisfactory for gas mains smaller than 48 inches in diameter, Bowland worked from 1931 to 1938 designing a mechanical valve for that purpose and applied for a patent on October 14, 1936. The patent, reciting that Bowland was "assignor to WILLIAM M. BAILEY COMPANY," was issued to petitioner on July 26, 1938. The plate invented by Bailey is installed in both the thermal and mechanical valves. Clay Gun. A clay gun is used to stop the flow of molten pig iron through the tapping hole of the blast furnace by shooting clay into the hole. In 1926 or 1927 petitioner began redesigning*94 the first electric clay gun which was invented by Hopkins who at that time was employed by another company. The first gun, built by Hopkins, was crudely constructed of scrap metal, and was designed to hang on a crane attached to the furnace column. Petitioner spent about two years designing an independent pedestal with carriage for the gun, which was believed to be a safer arrangement. Petitioner sold the first gun in 1929, and in the next 3 years sold about twenty-two guns. Because of many complaints from its customers concerning the high operating cost, due to unreasonable wear on two intermeshing screws driving the clay through the barrel, petitioner became discouraged and in 1930 or 1931 Hopkins took the gun to another company. As of January 1, 1938, petitioner again included Hopkins' clay gun among its products, with the understanding that it would be redesigned. Bailey, Hopkins, Bowland, Ferree and Alfred Osolin worked on the gun and completely redesigned it, replacing the intermeshing screws with a piston propelled by a protected screw. Osolin is not associated with petitioner as officer, employee, or stockholder. A patent covering the improved clay gun, application *95 for which was made on March 26, 1938, was granted to Ferree and Osolin on July 8, 1941. The gun was marketed by 1939 and since that time there has been no change in its construction. Cinder Notch Stopper. A cinder notch stopper is used to close automatically the cinder notch, a 2-inch hole in the blast furnace for drainage of slag. Petitioner *481 sold its first cinder notch stopper in 1927, paying royalties to Osolin as inventor. At that time the stoppers were installed on the bustle pipe of the blast furnace. Expansion and contraction of the bustle pipe threw the stopper out of alignment, causing it to miss the cinder notch. Petitioner remedied this deficiency in about 1933, by changing the stopper so that it could be fastened directly to the furnace front. Steel Stove Bottom and Checker. In the operation of a blast furnace, hot gases are run downward from the top of the furnace through a "stove," a steel shell full of fire bricks which absorb heat from the gases. Cold air passing through the stove is heated by the bricks and blown into the bottom of the furnace where it is essential to successful operation. In common language a "checker" is a brick. A checker*96 first designed and patented in 1935 by McGee, featuring a straight brick, was not commercially successful. Due to dirty gas a large flue was required. Bowland redesigned the checker, changing it from the straight brick to a variation of three types: "Inlet," "top," and "ribbed." The "inlet" checker was pointed so that dirt from the gas would not accumulate on the top of the stove. The "top" checker of 10 to 12 feet in height was made heavier to gather and hold more heat. The next lower section of brick continued to use the original McGee checker, and the "ribbed" checker was installed in the bottom section. Through this arrangement, cross ventilation is created and a much larger heating surface of brick is provided. In 1937 or 1938 the two top bricks were eliminated because use of gas cleaners in the stoves rendered them unnecessary. The checker sold by petitioner during the years in question was the same as that sold in 1937. Prior to 1934 stoves were constructed with brick arch bottoms which were not satisfactory for installation of petitioner's checker because of its greater weight and size. In about 1930 Bowland began designing a steel stove bottom to accompany petitioner's*97 checker, and was granted a patent on December 31, 1934. Petitioner sold its first steel stove bottom in 1934, and has paid Bowland royalties thereon under a written agreement of June 27, 1933. Pug Mill. Flue dust passing from the blast furnace through a dry gas cleaner and into the dust catcher is about 50 per cent metallic iron. Prior to 1925 dust was dumped from the dust catcher into an open freight car. Being a very fine powder, some of the hot dust in the dumping process would be spread throughout the plant causing personal injuries. In 1921 George W. Vreeland, an employee of Carnegie Steel Co., conceived *482 the idea of attaching a "pug mill" to the dust catcher, "pugging" the dust with about 60 per cent of the moisture required for "sintering," and delivering it to the sintering plant or stock pile sufficiently cool to handle. Pursuant to his application of October 13, 1921, Vreeland was granted a patent on the pug mill on October 13, 1925. Petitioner "took over" Vreeland's pug mill in 1927. As originally designed, the mill was driven by a worm gear inside the dust box, which became easily damaged through contact with the dust. Between 1930 and 1934, Bowland*98 completely redesigned the mill to contain an independent drive outside the dust box. The improvements were not patented. Petitioner paid Vreeland royalties until his patent expired. No improvements have been made in the pug mill since 1934. Pig Casting Machine. Hot molten iron from the blast furnace is poured into molds which travel slowly on the chains of a pig casting machine and, when the iron has cooled and hardened, are dumped into a car. Pig casting machines constructed prior to 1936 contained two chains which moved over sprocket wheeels and supported the molds between them. The design resulted in excessive wear on the wheels because of high temperatures and unsatisfactory lubrication. In 1930 Ferree, petitioner's sales manager, first thought of making the wheels stationary, thus reducing their temperature and permitting the use of roller bearings and proper lubrication. He applied on April 26, 1936, for a patent which was granted August 1, 1939. Petitioner sold the first pig casting machine, as designed by Ferree in 1936. Subsequently 9 machines were sold by petitioner's English representative. The next machine built in this country was sold by petitioner in 1941. *99 There has been no change in basic construction of its pig casting machines sold since 1939. Petitioner's receipts, cost of sales, gross profit or loss, compensation paid, and net income or loss for the period 1930 through 1943 were as follows: Gross profit Compensation Net income Year Receipts Cost of sales or (loss) paid or (loss) [1930] $ 250,837 $ 144,848 $ 105,364 $ 61,750 $ 13,739 [1931] 82,129 53,793 27,843 24,073 (8,644) [1932] 7,064 7,527 (534) 9,662 (19,131) [1933] 47,149 32,533 14,595 10,544 (5,217) [1934] 70,451 44,874 22,042 11,439 5,197 [1935] 79,652 48,852 30,799 15,769 4,795 [1936] 150,749 85,918 63,769 34,876 12,302 [1937] 266,703 116,685 149,987 67,001 48,275 [1938] 151,956 70,288 81,390 46,567 14,163 [1939] 138,246 60,960 76,970 42,599 10,771 [1940] 294,911 177,114 117,510 65,159 24,163 1941 * 549,240 78,528 [1942] 1,883,135 1,492,709 385,098 160,796 83,676 [1943] 2,147,854 1,529,948 617,905 164,638 256,858 *483 The "direct cost" of producing the products sold by petitioner was about 72 per cent of gross receipts*100 in 1940, 69 per cent in 1941, 86 per cent in 1942, and 80 per cent in 1943. During the same years, the percentages of "indirect costs" to gross profits were about 71, 54, 68, and 39, respectively. Notwithstanding the rise in "direct costs," the selling price of petitioner's products was not increased until after the war. From 1926 to 1940 some of petitioner's officers and employees devoted part of their time in research and development to design and improve petitioner's blast furnace specialties. Hundreds of engineering drawings were made, and are still preserved for use in replacement jobs. A drawing is made for every installation. Bailey and Bowland devoted about 25 and 75 per cent, respectively, of their time to that work. Bailey can read and understand drawings, but never made a drawing in his life. Petitioner carried on research and development, in years prior to 1940, and extending for each product over a period in excess of 12 months in connection with the thermal valve, mechanical valve, clay gun, and pug mill. Petitioner received "net abnormal income" in 1942 and 1943 from each of the above products, "before applying any adjustment for increases or decreases due to demand*101 or other factor changes," as follows: Net abnormal income Product [1943] Thermal Valve $ 37,480.57 Mechanical Valve $ 7,528.33 32,979.41 Clay Gun 3,923.27 17,395.99 Pug Mill 7,627.13 15,605.28 Total 19,078.73 103,461.25 Petitioner subscribes to and advertises in Metal Statistics, an annual publication of The American Metal Market Co., New York, and advertises in the following magazines: Blast Furnaces, Steel Plant, Iron and Steel Engineer, Steel, Iron Age, and Safety First. All of petitioner's products are sold to plants operating blast furnaces. At petitioner's request, its advertisement in Metal Statistics appears in the section devoted to pig iron statistics. The average annual production of pig iron in the period 1936 to 1939 was 33,368,125 net tons; the production for 1942 and 1943 was 60,903,304 and 62,769,946 net tons, respectively. The business improvement factors for pig iron production were 1.825194 for 1942 and 1.881135 for 1943. Application of these factors to the total "net abnormal income" for 1942 and 1943 results in the figure constituting *484 net abnormal income attributable to improvement in business conditions. The*102 balance of the net abnormal income was attributable to research and development in years prior to 1940. Petitioner filed claims under section 721, Internal Revenue Code, for refund of excess profits tax for 1942 and 1943. In his notice of deficiency, respondent stated: In accordance with the requirement of Section 732 of the Internal Revenue Code, notice is given of the disallowance of the claims for refund (Form 843) filed pursuant to Section 721 of the Internal Revenue Code. OPINION. Under the first issue petitioner contends it is entitled to deduct royalties or depreciation allowances, see Associated Patentees, Inc., 4 T. C. 979, depending upon whether the transactions with Bailey under which the amounts were paid resulted in a "license" or "sale" of his plate patent. Although in an agreement for exploitation of patents the parties call themselves "licensor" and "licensee" and the consideration "royalties," the transaction may nevertheless constitute a sale. W. B. Davis & Son, Inc., 5 T. C. 1195, 1204. But "where he [the patentee] transfers less than all three rights to make, use, and vend for the term of the patent, *103 or transfers them nonexclusively, the transfer is a mere license and does not convey any title in the patent itself." Kimble Glass Co., 9 T. C. 183, 190. In our view -- and apparently respondent does not now seriously contend otherwise -- none of the three agreements effective during the period in question amounted to a sale of the plate patent. Evidence of the terms of the initial oral agreement, under which the 1942 thermal valve payments were made, is not entirely satisfactory. But our conclusion that it conveyed less than the "exclusive" right to "make, use, and vend" for the term of the patent is consistent with the agreement of 1943 reducing the oral agreement to writing. As in the case of the 1936 agreement covering the mechanical valve payments, it purported to be neither exclusive nor unconditionally for the life of the patent. Respondent contends that the payments were without consideration because petitioner owned or had "shop rights" in the patent from the start, see Heckett Engineering, Inc. v. Commissioner (CA-3), 173 Fed. (2d) 572; Thomas Flexible Coupling Co. v. Commissioner (CCA-3), 158 Fed. (2d) 828,*104 certiorari denied, 329 U.S. 810, and that the payments were disguised dividends, see W. N. Thornburgh Manufacturing Co., 17 B. T. A. 29. But the evidence is conclusive to the contrary, and in fact demonstrates substantially an inverse ratio *485 between stock ownership and royalties for each year. 2 See Louise K. Aprill, 13 T. C. 707, 712. This failure of any other explanation for the payments*105 satisfactorily disposes of respondent's theory. Even the possibility that petitioner had "shop rights" disappears, in the light of the mutual understanding, illustrated by the present instance and consistently practiced through the years, that petitioner would pay royalties of 5 per cent to employees for their inventions. "It is scarcely necessary to add that estoppel [shop rights] cannot be based upon the fact * * * that the company [petitioner] bore the expense of reducing * * * [Bailey's] invention to practice, since this, as well as * * * [Bailey's] disclosure of his invention to the company, was in pursuance of a proved understanding that the rights of the parties should be fixed by a subsequent written contract; it might be conceded that in the absence of this distinct condition the company would have been entitled to an implied license, a shop right * * *." Hazen Manufacturing Co. v. Wareham (CCA-6), 242 Fed. 642, 648. Respondent erred in disallowing the deduction of royalties. If the disputed payments to the trust in 1943 were "contributions * * * paid by an employer to or under a stock bonus * * * plan," or pursuant to a "method of employer*106 contributions" having "the effect of a stock bonus * * * plan," their deductibility is controlled exclusively by section 23 (p) (1). 3*107 Tavannes Watch Co., 10 T. C. 544, 549, *486 reversed (CA-2), 176 Fed. (2d) 211; Times Publishing Co., 13 T. C. 329. Deduction under section 23 (a) (1) (A)4 of payments to the same trust in 1942, antedating section 23 (p) as amended, were not disallowed. Cf. Phillips H. Lord, 1 T. C. 286, and Gisholt Machine Co., 4 T. C. 699, with Draper & Co., 5 T. C. 822. We agree with petitioner that the plan under which it paid the amounts in question as insurance premiums "would be considered to be a stock bonus plan within the generally accepted meaning of that term." And the words of the statute are to be given their generally accepted meanings. But to warrant deduction, either the sums must have been "paid * * * into a trust * * * exempt under section 165 (a)," 5section 23 (p) (1) (C); or "the employees' rights to or derived from such employer's contribution" must have been "nonforfeitable at the time the" payments were made. Section 23 (p) (1) (D). *108 Petitioner does not suggest that the payments "do not discriminate in favor of employees who are officers, shareholders, persons whose principal duties consist in supervising the work of other employees, or highly compensated employees," as required by section 165 (a). Cf. Volckening, Inc., 13 T. C. 723. The opposite is obviously true. See H. S. D. Co. v. Kavanagh (Dist. Ct., Mich.), 88 Fed. Supp. 64, 69: Where, as here, it appears that an employer's stock bonus, pension and profit-sharing plan is not operated for the exclusive benefit of the employees, but as a mere subterfuge to build up the employer's capital reserves and to provide what are in effect benefits which discriminate in favor of executive officers who are shareholders, * * * contributions to such a plan are not exempt under Section 165 (a), Internal Revenue Code, so as to be deductible in the year paid under Section 23 (p) (1), (A) (B) (C), and ( 3), Internal Revenue Code. As the case is presented, deductibility under section 23 (p) (1) (D) depends upon whether the "employees' rights" required by that section to be "nonforfeitable" at the time of payment*109 refers to the rights of each named employee beneficiary or of all "employees" as a class. Under the agreement, rights of each named beneficiary terminated upon his "death, discharge, resignation, or retirement"; and petitioner could, as it chose, distribute "his proportion" of stock to the remaining original beneficiaries, to substituted employees, or, in case of death, *487 to the deceased employee's wife or children. Under petitioner's theory, restriction of the benefits to "employees" as a class, or their families, would meet the nonforfeitability requirement of the statute. However, Times Publishing Co., supra, 333-4, indicates that "employees' rights" refers to the rights of specific beneficiaries: * * * the employees' rights to the payments must be nonforfeitable at the time the contributions or deferred compensation is paid. * * * * * * * Since * * * an employee was entitled to receive only the bare refund of his own contributions in the event of death, termination of employment, or default in making payment * * *, the employees did not have a nonforfeitable right in petitioner's contributions. * * * We hold, therefore, that the*110 payments by petitioner are not an allowable deduction under section 23 (p). [Emphasis added.] In H. S. D. Co. v. Kavanagh, supra, 69, the Court found that The rights of the employees under this plan were forfeitable at the time the taxpayer contributed thereto for the reason that the Employees' Trust agreement provided that when an employee, voluntarily or involuntarily, left his employment with the company for any reason, except cause * * * he would receive 10% of the contributions standing to his account for each year of service, up to five years, and 5% * * * for each year over five years, and 100% * * * only at or after ten years * * *. Stressing the requirement that an individual beneficiary must have received rights to the contribution when made, the Court concluded, (p. 69): * * * if not so exempt, [under section 165 (a)] such contributions are deductible in the year paid only in the case of an employee whose beneficial interest in such contribution is nonforfeitable at the time made. Section 23 (p) (1) and (3) * * *. * * * * 5. Where, as here, an employer's contributions to a trust are not exempt under Section 165 (a), Internal*111 Revenue Code, such contributions are not deductible by the employer in the year paid where there is no employee whose beneficial interest in such contribution is nonforfeitable at the time the contribution is made * * *. [Emphasis added.] See Wooster Rubber Co., 14 T. C. 1192. This result is consistent with the legislative plan that, in any year, "the contribution cannot be both nontaxable and deductible." Eisenstein, "A Case of Deferred Compensation," 4 Tax L. Rev. 391, 416 (May 1949). Under section 165 (c), an employer's contribution to a trust not exempt under section 165 (a) "shall be included in the gross income of an employee for the taxable year in which the contribution is made to the trust in the case of an employee whose beneficial interest in such contribution is nonforfeitable at the time the contribution is *488 made." [Emphasis added.] See George Von Hoffmann, 10 T. C. 314, 317; section 22 (b) (2) (B). 6 *112 Respondent's disallowance of premium payments to the trust is sustained. Accrual of the Paulsen Co. charge in 1943 was proper because by entering the amount on its books in the same year the invoice was received petitioner effectively demonstrated its contemporaneous acceptance of the bill as a fixed obligation. Associated Gas & Electric Co., 2 B. T. A. 263, 265. That petitioner continued to consider the Paulsen Co. bill as an unconditional liability, not contingent upon settlement through Defense Plant Corporation, is illustrated by its payment several months prior to any reimbursement. But nothing occurred in 1943 to warrant accrual of the Green Co. bill in that year, and petitioner's failure to treat it as a liability in 1942, when invoiced, puts it on no more favorable footing than the Pittsburgh Co. charge as to which accrual in neither year is claimed. Respondent's disallowance of the Green Co. bill as a proper accrual in either 1942 or 1943 is therefore sustained. Our ultimate findings for each year of petitioner's net abnormal income from its blast furnace specialties, and of the appropriate business improvement factors, dispose of the only*113 questions raised by the section 721 issue. Since no contention is made for other adjustments, cf. Ramsey Accessories Manufacturing Corp., 10 T. C. 482, Rochester Butter Co., 7 T. C. 529, the net abnormal income attributable to prior years can be computed under Rule 50 by applying the business improvement factors to net abnormal income. Because the parties have stipulated the amounts of net abnormal income, we have only the narrow question whether, for each product, petitioner in prior years conducted "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." *489 Section 721 (a) (2) (C), Internal Revenue Code. 7 With respect to all products except the cinder notch stopper, steel stove bottom, and pig casting machine, proof of the requisite research for at least 12 months is adequate, and our findings have been made accordingly. See W. B. Davis & Son, Inc., supra, 1195. *114 The remaining question concerns the choice of an appropriate index to reflect the portion of net abnormal income due not to research and development but to improved business conditions. W. B. Knight Machinery Co., 6 T. C. 519, 534; Regulations 112, section 35.721-3. We have chosen the factors for pig iron production. While not themselves pig iron, each of the products in question was employed exclusively in operation of blast furnaces for the production of pig iron. An increased demand for the iron therefore inevitably accounted for some portion of petitioner's increased sales. It is not shown that application of different business improvement factors would change the result. See Rochester Button Co., supra, 554. Reviewed as to Section 721 (a) (2) (C) by the Special Division. Decision will be entered under Rule 50. Footnotes 1. Who is petitioner in a related proceeding in Docket No. 22972.↩ *. To be compared with total 1946 royalties of $ 3,533.40, stipulated as paid to Bailey for purposes of the proceeding in Docket No. 22972.↩ *. Missing figures for 1941 do not appear in the record.↩ 2. Thus, for each 1 per cent of total stock owned, Bailey with about 50 per cent of the total stock received only about .2 per cent of the total royalties in each contested year, whereas for each 1 per cent of total stock owned by them, the smaller stockholders, Estate of Frank R. McGee, Schulze, Bowland, Ferree, and Hopkins, with about 10 to .3 per cent of the total stock, in that order, received about 3, .8, 3, 2.5, and 15 per cent of the royalties, respectively, in 1942, and about 3, .9, 2, 8, and 5 per cent, respectively, in 1943.↩ 3. SEC. 23. DEDUCTIONS FROM GROSS INCOME. In computing net income there shall be allowed as deductions: * * * * (p) Contributions of an Employer to an Employees' Trust or Annuity Plan and Compensation Under a Deferred-Payment Plan. -- (1) General rule. -- If contributions are paid by an employer to or under a stock bonus, pension, profit-sharing, or annuity plan * * *, such contributions * * * shall not be deductible under subsection (a) but shall be deductible, if deductible under subsection (a) without regard to this subsection, under this subsection but only to the following extent: * * * * (C) In the taxable year when paid, if the contributions are paid into a stock bonus or profit-sharing trust, and if such taxable year ends within or with a taxable year of the trust with respect to which the trust is exempt under section 165(a). * * * (D) In the taxable year when paid, if the plan is not one included in paragraphs (A), (B), or (C), if the employees' rights to or derived from such employer's contribution * * * are nonforfeitable at the time the contribution or compensation is paid. * * * *↩ If there is no plan but a method of employer contributions * * * has the effect of a stock bonus * * * plan, * * * this paragraph shall apply as if there were such a plan. 4. (a) Expenses. -- (1) Trade or business expenses. -- (A) In General. -- All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business * * *↩ 5. SEC. 165. EMPLOYEES' TRUSTS. (a) Exemption From Tax. -- A trust forming part of a stock bonus, pension, or profit-sharing plan of an employer for the exclusive benefit of his employees or their beneficiaries shall not be taxable under this supplement * * * -- * * * * (4) if the contributions or benefits provided under the plan do not discriminate in favor of employees who are officers, shareholders, persons whose principal duties consist in supervising the work of other employees, or highly compensated employees.↩ 6. SEC. 22. GROSS INCOME. * * * * (b) Exclusions From Gross Income. -- The following items shall not be included in gross income and shall be exempt from taxation under this chapter: * * * * (2) Annuities, etc. -- * * * * (B) Employees' Annuities. -- If an annuity contract is purchased by an employer for an employee under a plan with respect to which the employer's contribution is deductible under section 23 (p) (1) (B), or if an annuity contract is purchased for an employee by an employer exempt under section 101 (6), the employee shall include in his income "the amounts received under such contract for the year received * * *. In all other cases, if the employee's rights under the contract are nonforfeitable except for failure to pay future premiums, the amount contributed by the employer * * * on or after such rights become nonforfeitable shall be included in the income of the employee in the year in which the amount is contributed↩ * * *. [Emphasis added.] 7. SEC. 721. 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 includible in the gross income of the taxpayer for any taxable year under this subchapter if it is abnormal for the taxpayer to derive income of such class, or, 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 125 per centum of the average amount of the gross income of the same class for the four previous taxable years, or, if the taxpayer was not in existence for four previous taxable years, the taxable years during which the taxpayer was in existence. (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. * * *↩