National Piano Mfg. Co. v. Commissioner

NATIONAL PIANO MANUFACTURING CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. National Piano Mfg. Co. v. Commissioner Docket Nos. 3333, 20486. United States Board of Tax Appeals 11 B.T.A. 46; 1928 BTA LEXIS 3868; March 20, 1928, Promulgated *3868 1. Evidence that instruments were signed by the Commissioner or a duly authorized agent, and evidence as to time of such signing held not necessary to constitute valid consents, and 1917 tax held not barred. 2. Since the petitioner was not organized until May 1, 1917, the respondent erred in including as its income for 1917 the income of the predecessor corporation from January 1, 1917, to May 1, 1917. 3. Upon the facts, held that the petitioner and another corporation were affiliated. 4. In the absence of evidence as to the worthlessness in 1921 of the stock of a corporation which the petitioner purchased in 1917, deduction because of alleged loss not allowed. 5. Payment by petitioner of the income tax of another corporation held not a deductible item from petitioner's income. 6. Held that respondent erred in reducing invested capital of petitioner by use of a "tentative tax." L. S. Ayers & Co.,1 B.T.A. 1135, followed. 7. Special assessment under section 210 of the Revenue Act of 1917 allowed petitioner, where the value of a patent application at acquisition can not be determined, and where amounts expended for development*3869 of patents can not be determined. 8. Prewar credit determined. 9. Values of patents at time of acquisition determined for purposes of depreciation. 10. Application of loss in 1921 against subsequent income allowed. Frank E. Seidman, C.P.A., and Jacob S. Seidman, Esq., for the petitioner. Orris Bennett, Esq., and John F. Greaney, Esq., for the respondent. SIEFKIN *47 These are proceedings for the redetermination of deficiencies in income and profits taxes for the years 1917, 1922, and 1923 in the amounts, respectively, of $27,103.10, $4,812.18, and $404.05. The proceedings involve the valuation of certain patents as of May 1, 1917, for the purpose of computing the allowance for exhaustion, wear and tear, and as of July 8, 1909, for purposes of invested capital. The petition in Docket No. 3333, involving the year 1917, was amended to raise further issues with respect to the prewar credit, the inclusion of the petitioner's predecessor corporation's income and invested capital in computing the taxable net income of petitioner and affiliation of the petitioner with the Sparta Manufacturing Co. from May 1, 1917, to December 31, 1917. *3870 By further amendment the petitioner alleged error in Docket No. 3333 in that the respondent erroneously reduced invested capital by decreasing the earnings available for the payment of dividends in 1917 by the amount computed by him as an accrued tentative tax for the current year; that the respondent erred in failing to compute the excess-profits tax under section 210 of the Revenue Act of 1917; and that assessment and collection of the deficiency are barred by the statute of limitations. An issue peculiar to Docket No. 20486 is that respondent, in arriving at the taxable income of petitioner for the calendar years 1922 and 1923, failed to deduct an alleged net operating loss sustained by the petitioner during the year 1921. At the hearing the petitioner further amended its petition in Docket No. 20486 by alleging that the respondent failed to include as a deduction from gross income in the year 1922 the amount of $22,048.76 representing income taxes required to be paid by the petitioner on behalf of another corporation in accordance with a contract, or, in the alternative, if such amount is a *48 proper deduction from 1921 income instead of 1922 income, that respondent*3871 failed to consider such amount in computing the net loss sustained in that year. The proceedings were consolidated for hearing and decision. FINDINGS OF FACT. The petitioner in this proceeding is an Arizona corporation having its principal office at Grand Rapids, Mich., and was organized May 1, 1917, to succeed a corporation of the same name organized under the laws of the State of Illinois in 1909. The Illinois corporation was engaged in the manufacture of automatic pianos under a patent termed the Kingsley-Carlson patent, and other patents. Its authorized capital stock was $400,000. In 1911 net income was realized in the amount of $2,036; in 1912, $21,570.24; and in 1913, $28,039.65. The rights in the Kingsley-Carlson patent application had been obtained by the corporation on July 8, 1909, from C. L. Pierce for $50,000 par value of preferred stock and $140,000 par value of common stock, and the opening journal entry of the Illinois corporation dated July, 1909, showed a value assigned to it of $190,000. On January 1, 1911, there was outstanding capital stock and surplus in the amount of $198,000; on January 1, 1912, $201,020; and on January 1, 1913, $226,390.20. *3872 The net income and invested capital of the petitioner's predecessor corporation, excluding any amount on account of the patent application during the prewar period was as follows: Year Invested capital Net income [1911] $8,000.00 $2,036.00 [1912] 11,020.00 21,570.24 [1913] 36,390.20 28,439.65 Total 55,410.20 52,045.89 Average 18,470.17 17,348.63 On May 1, 1917, the petitioner acquired the assets of the National Piano Manufacturing Co. of Illinois, among which were the following patents: Patent Date of Date of issue Description on letters patent No. Application 1071640 Mar. 3, 1909 Aug. 26, 1913 Coin operated automatic piano. 1052427 Jan. 10, 1910 Feb. 10, 1910 Operating contact for automatic player pianos. 1070698 May 4, 1910 Aug. 9, 1913 Self-setting mechanism for player pianos. 1068217 Aug. 7, 1912 July 22, 1913 Automatic player piano having self- setting device. 1141549 do June 1, 1915 Coin-operated automatic piano player. 1152787 July 8, 1913 Sept. 7, 1915 Automatic musical instrument with magazine. 1152852 July 18, 1913 do Automatic player piano. 1217271 do Feb. 27, 1917 Automatic musical instrument with magazine. 1203348 Feb. 7, 1914 Oct. 31, 1916 Roller for player pianos. 1152806 May 5, 1914 Sept. 7, 1915 Multiple coin chute. 1154919 Jan. 7, 1915 Sept. 28, 1915 Coin detector. 1207022 Feb. 21, 1916 Dec. 5, 1916 Dancing toy. *3873 *49 On May 1, 1917, when the petitioner was organized, no new books were opened, but at the time of closing the books as of December 31, 1917, the patents were put on the books at a balancing figure of $764,953.93. The new corporation took over all properties of the old, and made an exchange of stock with the stockholders of the Illinois corporation. The authorized capital stock of the new corporation was increased to $1,200,000 of which $50,000 was preferred. The whereabouts or present existence of individuals connected with the predecessor corporation are now unknown to the petitioner. The plant continued to produce automatically selective pianos. The following is a list of automatic pianos produced by the petitioner and its predecessor: Year Number Total [369] 1,348 [58] 1,406 [173] 1,579 [444] 2,023 [768] 2,791 [345] 3,136 [496] 3,632 [520] 4,152 All of these had been distributed in various States by December 31, 1924, except 148 which were lost by obsolescence or fire. On December 31, 1916, there*3874 were 979 pianos in distribution in 8 States and on December 31, 1924, there were 4,152 in 24 States. This patented piano was vitally different from any other in the field in 1909 and nothing of its kind his since been produced. There were other mechanical pianos which were worked upon the slot principle, but they had no automatic selectivity. There was one piano which contained a dial, which, if turned, would select a tune, but the piano manufactured by the National Piano Manufacturing Co. was operated by simply inserting a coin in a slot opposite the name of the tune desired. The quality of the piano of the National Piano Manufacturing Co. was such that it was possible to put it in restaurants and other public places. The quality of the music was also an improvement over that of the other types. Despite the fact that there were other large businesses of the same general nature, the National Piano Manufacturing Co. withstood all competition and did not general advertising. In the early days one man placed pianos as fast as the company could produce them. The company borrowed no money for purposes of producing pianos. The National Piano Manufacturing Co. did not manufacture*3875 pianos, but purchased them and then installed its patented devices, which consisted of some 3,000 parts. *50 On June 3, 1913, the National Piano Manufacturing Co. of Illinois entered into an agreement with the National Automatic Music Co., the pertinent portions of which are set forth below: WITNESSETH: 1. First party [petitioner] is the owner of certain rights to manufacture automatic pianos and proposes to sell such pianos to the party of the second part under the terms of the agreement. 2. The party of the second part agrees to purchase automatic pianos from the first party and the parties hereto agree that the first party shall sell and deliver to the party of the second part all of the pianos manufactured by it up to $1,000,000 and that the party of the second part will pay and deliver to the party of the first part, so long as it has capital stock in its treasury for such purposes, the sum of Seven Hundred and Fifty dollars for each piano so sold to it, said payment to be in capital stock of the party of the second part at par. (a) The party of the first part will procure the installation of all pianos manufactured by it in favorable public places under*3876 contracts with the owners thereof whereby a portion of the gross earnings of such pianos shall be accepted by the owners as and for a rent and compensation to them for permitting the pianos to be installed and maintained upon their premises. The exact proportion of such gross earnings to be paid to each of said owners to be determined by the party of the first part from time to time. The balance of the earnings of each of such pianos, less the amount of 20% paid to the first party for maintenance as hereinafter provided, hereafter called the net earnings shall be paid to the party of the second part. (b) Out of the net earnings from the pianos, the party of the second part shall distribute among the holders of its stock, as often as once a month, a dividend of not less than one per cent on its outstanding capital stock, if same has been earned, and the balance of said net earnings shall be paid into a surplus fund to be used as hereinafter provided. (c) The party of the first part will maintain all such pianos in repair and change the music thereon as often as in its judgment may be required and will change the location thereof whenever in its judgment it may be necessary, *3877 paying all the expenses of operation and maintenance of such pianos, including the expenses of weekly collections, and shall receive as compensation twenty per cent (20%) of the net returns, after payment of percentage to location lessee. * * * (e) The surplus fund of the party of the second part may be invested in new pianos which shall be sold to the party of the second part by the party of the first part for cash at Seven Hundred and Fifty dollars each. At least twenty-five per cent (25%) of the net earnings of all pianos shall be paid into the surplus fund and all earnings for the pianos acquired from the surplus fund after payment of twenty per cent (20%) for maintenance has been paid to the party of the first part, and twenty-five per cent (25%) placed in the surplus account for investment in additional pianos, the balance of the earnings shall be available for additional dividends to the stockholders, until such time as the surplus amounts to the entire capital stock outstanding, and thereafter, all earnings of the pianos may become available for dividends as may be directed by the Board of Directors of said National Automatic Music Company. No stock of the party of the*3878 second part shall be issued against pianos purchased from surplus. 3. The party of the first part agrees to sell all pianos manufactured by it to the party of the second part until such time as the capital stock of the party *51 of the second part shall have been fully issued in payment for pianos so sold and until then the second party shall have the exclusive right to purchase the pianos manufactured by the first party. * * * 6. This contract shall remain in force and be binding upon the parties hereto for a period of ten years from date hereof. The National Piano Manufacturing Co. made money upon the sales of pianos, but lost money under the servicing agreement. The above agreement was in force on May 1, 1917. In 1917, prior to May 1, a good deal of stock of the National Piano Manufacturing Co. was dealt in by the stockholders, at prices of from $300 to $400 per share. There were several hundred stockholders in May, 1917. In 1917 and subsequent thereto about 5,000 or 6,000 shares of stock were sold. Prior to 1917 substantial profits had been made and dividends declared, some of this being stock which had been obtained as payment for pianos. In 1917, *3879 after May, the stock of the National Automatic Music Co. was selling for $15 per share, par value being $10. The war did not affect the petitioner's business until the United States Government, in 1918, restricted the manufacture of pianos as nonessentials, when the plant of the petitioner was closed. From 1913 to 1917 the average tangible assets of the National Piano Manufacturing Co. of Illinois were about $62,000. During this period a profit of about $300 per piano was realized. The valuable life of patents issued subsequently would expire on August 26, 1930, the expiration date of the basic patent, by reference to the basic patent. The president of the National Piano Manufacturing Co. of Illinois was also president of the Sparta Manufacturing Co. in 1917, which latter company produced a coin-operated peanut machine which was distributed in the same manner as automatic pianos. The Sparta Manufacturing Co. did not manufacture all of the machine, its business being mainly installing the patented coin slot device. During 1917 the employees of the National Manufacturing Co. often worked in the Sparta Manufacturing Co. along mechanical or engineering lines. The National*3880 Piano Manufacturing Co. made loans to the Sparta Manufacturing Co. from time to time and the Sparta Manufacturing Co. account on the ledger of the National Piano Manufacturing Co. showed the following: Debit Credit Balance [1915] $3,697.59 $2,966.39 $731.20 [1916] 2,011.68 284.33 1,727.35 [1917] 11,444.09 315.00 11,129.09 *52 On May 1, 1917, the Sparta Manufacturing Co. consolidated with the petitioner, the latter purchasing the stock of the former. On June 21, 1921, the working assets of the Sparta Manufacturing Co. were sold for $6,000. The taxable net income of the National Piano Manufacturing Co. of Illinois from January 1 to April 30, 1917, was $16,822.38, and the taxable net income of the petitioner for the period May 1, 1917, to December 31, 1917, was $59,390.68. From May 1, 1917, to December 31, 1917, the Sparta Manufacturing Co. sustained a net loss of $19,044.80. The income and profits-tax return of the petitioner for the year 1917 was filed on March 30, 1918. The petitioner's returns were prepared on an accrual basis. The patent legal service account in the books of the petitioner and its predecessor contained entries*3881 during the period from November 13, 1912, to July 1, 1922, crediting patent legal service on account of expenses in a total amount of $5,414.40, $2,103 of which was up to May, 1917. In 1922 this account was transferred to the patent account. Between 1913 and 1917 expenditures in connection with the patents and experimental work had been incurred and charged to expenses in an unknown amount. The dividends paid by the National Piano Manufacturing Co. of Illinois were as follows: Year Preferred stock Jan. 1 Amount of dividend Common stock Jan. 1 Amount of dividend [1912] $50,000 $3,500 [1913] 50,000 3,500 [1914] 50,000 3,500 $177,400 $42,640 [1915] 50,000 3,500 177,800 53,340 [1916] 50,000 3,500 170,000 53,700 [1917] 50,000 1,750 183,000 36,800 The following is a schedule of the fixed assets of the National Piano Manufacturing Co. of Illinois after deducting depreciation: [1913] $5,923.58 [1914] 7,332.81 [1915] 8,814.42 [1916] 10,343.40 [1917] 15,445.72 The petitioner filed its income-tax return for the year 1922 on March 15, 1923. An item of $22,948.76, tax for the year 1921 paid in 1922 by the petitioner on account*3882 of the National Automatic Music Co., under an alleged agreement, was not deducted on the return. The following schedule shows the net profit, loss on service contracts, tangible net worth, and net worth of the petitioner and its *53 predecessor from 1913 to 1924, as reflected by the books of the two corporations: Year Net profits per books Loss on service contracts Tangible net worth Jan. 1 Net worth per books Jan. 1 [1913] $28,039.65 $9,264.47 $25,003.96 $226,390.20 [1914] 76,423.24 17,338.24 48,875.85 251,879.85 [1915] 52,706.91 23,487.86 77,241.49 281,873.28 [1916] 64,711.06 28,942.06 72,610.41 278,940.19 [1917] 66,517.70 33,581.45 87,327.39 294,051.08 [1918] 1 74,707.47 45,678.62 292,240.88 1,071,308.35 [1919] 1 10,568.21 54,706.47 102,291.37 881,495.88 [1920] 63,778.43 80,231.64 81,862.63 785,794.17 [1921] 51,850.62 119,381.31 53,484.60 835,845.35 [1922] 72,071.43 109,656.01 2 17,507.59 666,562.33 [1923] 77,051.25 89,443.56 2 3,453.40 553,663.36 [1924] 58,635.34 68,362.45 79,121.01 736,071.28 The following instruments in writing were executed by the petitioner: *3883 WAIVER National Piano Mfg. Co., a corporation organized under the laws of the State of Arizona, in consideration of the assurance given it by officials of the Income Tax Unit of the Bureau of Internal Revenue that its liability for all Federal taxes imposed by the Act of Congress, approved September 8, 1916, as amended by the Act of Congress approved October 3, 1917, for the year ended December 31, 1917 on its net income received from all sources in said year, shall not be determined except after deliberate, intensive and thorough consideration, hereby waives any and all statutory limitations as to the time within which assessments based upon such liability may be entered. It is understood, however, that the above corporation does not, by the execution of this waiver admit in advance the correctness of any assessment which may be made against it for said year by the officials of the Income Tax Unit. Executed this 4th day of February 1921. (Signed) NATIONAL PIANO MFG. CO., Corporation. By JOSEPH RENIHAN, Vice President. APPROVED Feb. 7, 1923. D. H. BLAIR, Commissioner of Internal Revenue. Corporate Seal: Attest: S. D. THOMPSON Secretary *3884 FEBRUARY 26, 1924. INCOME AND PROFITS TAX WAIVER In pursuance of the provisions of subdivision (d) of Section 250 of the Revenue Act of 1921, the National Piano Mfg. Co., of Grand Rapids, Michigan and the Commissioner of Internal Revenue, hereby consent to a determination, *54 assessment and collection of the amount of income, excess-profits, or warprofits taxes due under any return made by or on behalf of the said National Piano Mfg. Co. for the years 1917 under the Revenue Act of 1921, or under prior income, excess-profits, or war-profits tax Acts, or under Section 38 of the Act entitled "An Act to provide revenue, equalize duties, and encourage the industries of the United States, and for other purposes", approved August 5, 1909. This waiver is in effect from the date it is signed by the taxpayer and will remain in effect for a period of one year after the expiration of the statutory period of limitation, or the statutory period of limitation as extended by any waivers already on file with the Bureau, within which assessments of taxes may be made for the year or years mentioned. NATIONAL PIANO MFG. CO., Taxpayer. By S. D. THOMPSON, Secy. D. H. BLAIR, *3885 Commissioner. JANUARY 30, 1925 INCOME AND PROFITS TAX WAIVER (For taxable years ended prior to March 1, 1921) In pursuance of the provisions of existing Internal Revenue Laws National Piano Manufacturing Company, a taxpayer of Grand Rapids, Michigan, and the Commissioner of Internal Revenue hereby waive the time prescribed by law for making any assessment of the amount of income, excess-profits, or war-profits taxes due under any return made by or on behalf of said taxpayer for the year(s) 1917, under existing revenue acts, or under prior revenue acts. This waiver of the time for making any assessment as aforesaid shall remain in effect until December 31, 1925, and then expire except that if a notice of a deficiency in tax is sent to said taxpayer by registered mail before said date and (1) no appeal is filed therefrom with the United States Board of Tax Appeals then said date shall be extended sixty days, or (2) if an appeal is filed with said Board then said date shall be extended by the number of days between the date of mailing of said notice of deficiency and the date of final decision by said Board. NATIONAL PIANO MFG. CO. Taxpayer. By S. D. THOMPSON *3886 Sec'y.-Treas. D. H. BLAIR Commissioner INCOME AND PROFITS TAX WAIVER For taxable years ended prior to January 1, 1922 GRAND RAPIDS, MICH., Nov. 19, 1925 In pursuance of the provisions of existing Internal Revenue Laws National Piano Manufacturing Co. of Grand Rapids, a taxpayer of Grand Rapids, Michigan, and the Commissioner of Internal Revenue hereby waive the time prescribed by law for making any assessment of the amount of income, excessprofits, or war-profits taxes due under any return made by or on behalf of said taxpayer for the year (or years) 1917 under existing revenue acts or under prior revenue acts. *55 This waiver of the time for making any assessment as aforesaid shall remain in effect until December 31, 1926, and shall then expire except that if a notice of a deficiency in tax is sent to said taxpayer by registered mail before said date and (1) no appeal is filed therefrom with the United States Board of Tax Appeals then said date shall be extended sixty days, or (2) if an appeal is filed with said Board then said date shall be extended by the number of days between the date of mailing of said notice of deficiency and the date of final*3887 decision by said Board. NATIONAL PIANO MFG. CO. Taxpayer By S. D. THOMPSON Sec'y. D. H. BLAIR Commissioner In 1925 the petitioner and the National Automatic Music Co. consolidated and the new company was called the Automatic Musical Instrument Co. As of December 31, 1925, the patents were put upon the books at a value of $1,399,285. In its return for 1917 the petitioner entered the patents at book value for invested capital purposes, but did not deduct any exhaustion thereof in computing income. The respondent disallowed the entire amount claimed as invested capital and made no deduction from income for patent exhaustion. For the years 1921 to 1923 the petitioner deducted exhaustion on $191,300, the amount at which the patents appeared on the books of its predecessor, upon a basis of a 17-year life for the patents. On May 1, 1917, the patents had a fair market value of $250,000 and a life ending August 26, 1930. In its return for 1917 the petitioner did not compute its predecessor's prewar income and invested capital, but took the 7 per cent minimum deduction, which rate the respondent used in arriving at the deficiency. For the year 1917 the*3888 respondent computed the tax as if the petitioner had been in existence during the whole year and determined that its taxable income was $76,213.01. In computing the deficiency for 1917 the respondent set up a tentative income and excess-profits tax for 1917 of $36,791.49, on the basis of an income of $76,213.01 and invested capital of $91,291.31. Pro rata earnings available for dividends were then decreased by him to the extent of the proportionate amount of the accrued tentative tax. A subpoena duces tecum was served upon the respondent requiring him to produce certain data as to comparatives. He failed to comply with this. OPINION. SIEFKIN: This proceeding raises questions as to - 1. Whether assessment and collection of taxes for the year 1917 are barred by the statute of limitations; *56 2. The inclusion of income of the petitioner's predecessor in the petitioner's income for the year 1917; 3. Affiliation of petitioner and the Sparta Manufacturing Co.; 4. Respondent's failure to deduct from taxable income in 1922 and 1923 an alleged net operating loss sustained by petitioner in 1921; 5. The deduction from income of petitioner of $22,948.76, *3889 which was the amount of income tax of the National Automatic Music Co. for the year 1921 which the petitioner paid in 1922 under an alleged agreement; 6. Deduction of tentative tax in the computation of earnings available for dividends; 7. The value on July 8, 1909, of an application for a patent, for purposes of invested capital for each of the years in controversy; 8. Relief under section 210 of the Revenue Act of 1917; 9. Prewar credit; 10. Patent values as of May 1, 1917, for purposes of calculating exhaustion, wear and tear on patents for each of the years in controversy; 11. Application of 1921 net loss against 1922 and 1923 income, in the event that application of exhaustion, if allowed, results in a net loss during that year. 1. The return for the year 1917 was filed on March 30, 1918, and the deficiency letter was dated February 20, 1925. On February 4, 1921, the petitioner executed an instrument in writing designated a waiver, by the terms of which the time for assessment of 1917 taxes was extended indefinitely. This "waiver" was signed on behalf of the respondent on February 7, 1923. Another instrument, bearing date of February 26, 1924, extended*3890 the time for determination, assessment and collection of taxes for 1917 for one year. No date of approval by the respondent appears upon the instrument. On January 30, 1925, another instrument was executed by the petitioner extending the time for assessment of 1917 taxes to December 31, 1925, provided that if a notice of deficiency in tax was sent before that date, the time should be extended 60 days, or if an appeal was filed with the Board of Tax Appeals, the time should be extended by the number of days between the mailing of the notice of deficiency and the date of final decision of the Board. This instrument bears no date of approval by the respondent. On November 19, 1925, the petitioner executed another instrument whereby time for assessment was extended to December 31, 1926, with the same provisions as the preceding "waiver." This instrument bore no date of approval by the respondent. All of these instruments bear the name of the respondent, but only one bears the date of approval by him. The petitioner contends *57 that since it is not shown whether they were signed by the respondent or a duly authorized agent, and no date of signing is shown, they do not*3891 constitute valid consents. In ; ; and , we held that it is not necessary for the Commissioner to personally sign consents. In , we stated: * * * It is a general principle to presume that public officials act correctly, in accordance with the law and their instructions, until the contrary appears. , citing , and . * * * Even if it could be assumed, from the mere showing that the consents were not personally signed by the Commissioner of Internal Revenue, that they did not then become effective so as to suspend the running of the statute, the record is sufficient to show that the Commissioner's office considered the consents valid and that the Commissioner himself, even if he had not done so before, ratified and approved that which had been done when he made his final*3892 determination of the deficiencies and mailed notices thereof to the petitioners. We are of the opinion that these instruments, constituted valid consents to extensions of the time for determination, assessment and collection of taxes for 1917, to February 26, 1926, and under section 277(b) of the Revenue Acts of 1924 and 1926, assessment and collection is not now barred, since this proceeding is now pending and since, under the Revenue Act of 1926, the Commissioner is prohibited from making an assessment while such proceeding is pending. See sections 277(b), 274(a) and 283(b), (c) of the Revenue Act of 1926. 2. The respondent, in computing the tax liability of the petitioner for 1917, considered its net income as $76,213.01. It is stipulated between the parties that $59,390.68 was the true, net income of the petitioner from May 1, 1917, to December 31, 1917, and that the balance was income to the petitioner's predecessor in 1917 prior to May 1, 1917. The petitioner was organized on May 1, 1917. It is clear that it is not liable in this proceeding for taxes of another corporation. 3. The officers of the Sparta Manufacturing Co., which produced a peanut machine, and the*3893 petitioner were the same. Both concerns produced a coin-operated slot machine, each installed only the slot mechanism instead of manufacturing the whole machine, each distributed its product in the same manner over the same general field, and the employees of the petitioner often worked in the plant of the Sparta Manufacturing Co. along mechanical or engineering lines. On May 1, 1917, the petitioner consolidated with this company, buying all its stock. It is stipulated between the parties that *58 if the petitioner and the Sparta Manufacturing Co. were in closely related businesses since May 1, 1917, the other facts necessary for consolidation are present. It is further stipulated that from May 1, 1917, to December 31, 1917, the Sparta Manufacturing Co. sustained a taxable net loss of $19,044.80. The evidence shows that these companies were in closely related businesses and the tax liability of both companies should, therefore, be determined upon a consolidated basis. 4. Petitioner alleges that the respondent, in computing the taxable income of the petitioner for the calendar years 1922 and 1923, erred in failing to deduct an alleged net operating loss sustained during*3894 the year 1921. This was stated in the petitioner as being in the amount of $83,840.00, and alleged to be due to the worthlessness of the stock of the Sparta Manufacturing Co., which the petitioner purchased on May 1, 1917. The respondent admits in his answer that the working assets of the Sparta Manufacturing Co. were sold on June 21, 1921, for $6,000, but in its brief the petitioner has apparently abandoned this point. An exhibit introduced in evidence indicates that petitioner paid $81,190 for stock of the Sparta Manufacturing Co. No evidence was introduced to show that the stock of the Sparta Manufacturing Co. became worthless, or if so, when, and it is therefore impossible to determine whether a loss was sustained or not, even if a loss could be sustained on stock of an affiliated company. See ; . 5. In 1922 the petitioner paid the 1921 income tax of the National Automatic Music Co., amounting to $22,048.76. In preparing its return for 1922 the petitioner made no deduction for this, but now claims that the payment of this tax was deductible as part of the cost incurred*3895 in deriving the income from servicing the pianos sold to the National Automatic Music Co. The pertinent portion of the contract is as follows: (c) The party of the first part will maintain all such pianos in repair and change the music thereon as often as in its judgment may be required and will change the locations thereof whenever in its judgment it may be necessary, paying all the expenses of operation and maintenance of such pianos, including the expense of weekly collections, and shall receive as compensation twenty per cent (20%) of the net returns after payment of percentage to location lessee. Nothing in the contract indicates that the petitioner assumed the obligation of paying the income tax of the National Automatic Music Co. and petitioner has, therefore, not shown that its payment thereof is a deductible item. 6. In computing the deficiency for 1917, the respondent set up a tentative tax of $36,791.49, which was deducted by him on a pro rata accrual basis from earnings available for dividends. The petitioner contends that the computation is erroneous because the earnings and dividend figures include the earnings and dividends *59 of the predecessor*3896 company, and further contends that the use of an accrued tentative tax is improper. We must hold that the respondent has erred in this respect, since, in , we held that the invested capital of a corporation may not be reduced, in determining the extent to which a dividend is paid from current earnings of a year, by a "tentative tax" theoretically set aside out of such earnings pro rata over such year. 7 and 8. On July 8, 1909, the petitioner's predecessor obtained from C. L. Pierce, the rights in the Kingsley-Carlson patent application for $140,000 par value of its common stock and $50,000 par value of its preferred stock. At a meeting on this day, the board of directors stated that they believed that the patent application had a fair cash value of $190,000. There was also received for the $190,000 stock, besides the rights in the application, the right to any application which might afterwards be made by Pierce or the inventors, Kingsley and Carlson, covering the invention or any improvements thereon. The whereabouts or existence of the parties to the transfer of the patent application are now unknown to the petitioner. *3897 The petitioner asks that we determine, if possible, the value on July 8, 1909, of this application for purposes of invested capital. Section 207(a) of the Revenue Act of 1917, provides: (3) * * * (b) * * * but good will, trade-marks, trade brands, franchise of a corporation or partnership, or other intangible property, bona fide purchased, prior to March third, nineteen hundred and seventeen, for and with interest or shares in a partnership or for and with shares in the capital stock of a corporation (issued prior to March third, nineteen hundred and seventeen), in an amount not to exceed, on March third, nineteen hundred and seventeen, twenty per centum of the total interests or shares in the partnership or of the total shares of the capital stock of the corporation, shall be included in invested capital at a value not to exceed the actual cash value at the time of such purchase, and in case of issue of stock therefor not to exceed the par value of such stock. Since the statute defines patents as intangible property we assume that an application for a patent is also intangible property and may be included as invested capital subject in amount to the actual cash value thereof, *3898 not to exceed the par value of stock issued therefor. See . The invested capital value is not affected by the 20 per cent limitation of the Act, as 20 per cent of the capital stock outstanding on March 3, 1917, was more than the stock issued for the application. The patent legal service account in the books of the petitioner and its predecessor contained entries crediting patent legal services on account of expenses in the amount of $2,103 from November 13 1912, to May 1, 1917. Between 1913 and 1917 expeditures in connection *60 with the patents and experimental work had been incurred and charged to expenses in an unknown and substantial amount. The petitioner submits that because it can not be definitely ascertained whether other value besides the patent application was obtained for the $190,000 stock, and because it is impossible to determine the amount which was expended for developing the patents and charged to expense, which should be included in invested capital, the petitioner is entitled to relief under section 210 of the Revenue Act of 1917. At the hearing the petitioner moved that if the*3899 taxpayer is entitled to relief under section 210 of the Revenue Act of 1917, the petitioner be afforded an opportunity to show cause why any comparatives applied by the Commissioner ought not to be used and in the affirmative that it be allowed to submit evidence under Rule 50 as to the proper comparatives. This motion was overruled at the time, but was to be considered in deciding the case if necessary. It is settled that the cost of developing patents is a capital expense. ; . In , special assessment was allowed where development costs over a long period of time were charged to expense and the accounting method used precluded the restoration of such costs to invested capital. While it seems clear that the only thing which was received for the $190,000 stock was the right in the Kingsley-Carlson patent application, the fact that the board of directors of the company stated that the application had a value of $190,000 is not conclusive evidence of its value, and we do not have sufficient evidence to permit us to determine*3900 what the value was. The testimony shows that the cost of development of patents was charged to expense in an unknown and substantial amount. In view of the foregoing, the petitioner is entitled to have its tax computed under the provisions of section 210 of the Revenue Act of 1917, and is herewith allowed to submit evidence under Rule 62 as to the proper comparatives to be used. 9. The net income and invested capital of the predecessor corporation (excluding any amount of account of patent application), during the prewar period was as follows: Year Invested capital Net income Percentage [1911] $8,000.00 $2,036.00 [1912] 11,020.00 21,570.24 [1913] 36,390.20 28,439.65 Total 55,410.20 52,045.89 Average 18,470.17 17,348.63 93.87 *61 Section 203 of the Revenue Act of 1917 provides: That for the purposes of this title the deduction shall be as follows, except as otherwise in this title provided - (a) in the case of a domessic corporation, the sum of (1) an amount equal to the same percentage of the invested capital for the taxable year which the average amount of the annual net income of the trade or business during the prewar period*3901 was of the invested capital for the prewar period (but not less than seven or more than nine per centum of the invested capital for the taxable year), and (2) $3,000. Section 204 of the same Act prescribes the same method where a business "is substantially a continuation." When the petitioner filed its 1917 return it took the minimum deduction of 7 per cent, and this was accepted by the respondent in his calculations. From the above facts we find that 9 per cent is the proper percentage to use. 10. The evidence shows that of the 12 patents which the petitioner acquired on May 1, 1917, the majority were related to the Kingsley-Carlson patent, which was the basic patent, and that their valuable life would end at its expiration date, August 26, 1930. These patents were the very foundation of the petitioner's business, and as they covered the manufacture of an automatic coin selective piano which was superior to any other on the market, it is apparent that they had considerable value. The petitioner, under contract, was to deliver pianos to the National Automatic Music Co. at a price of $750 par value of the stock of the Music Company. This stock, in 1917, was selling for*3902 50 per cent over its par value. There was a large field for the sale of this type of piano. It was not until 1918 that the Government restricted the manufacture of pianos. A witness testified that at the time of incorporation of the petitioner a profit of $300 for each piano preduced could have been realized an that about 1,500 pianos could be produced each year. This testimony as to production must be largely discounted, however, in view of the number of pianos actually manufactured and in the light of the evidence showing that at all times the instruments were being sold as fast as they could be produced. In 1917 more pianos were manufactured than ever before and the number was only 369. In the prior 9 years of its existence the petitioner and its predecessor had produced 1,348 pianos. On an average investment in fixed assets of about $8,100 and an average tangible investment of about $62,000 during the period from 1913 through 1916, the National Piano Manufacturing Co. of Illinois realized a profit of about $75,000 per year on the sales of pianos. During this period about 200 pianos were being produced per year. The $75,000 does not actually represent the net income of*3903 the company, as losses were sustained on the servicing agreement. The company, was conservative in its exploitation of the patents. It borrowed no money nor did it do any advertising. Based upon all the evidence *62 we are of the opinion that on May 1, 1917, the patents had a fair market value of $250,000. Section 12(a) of the Revenue Act of 1916 provides: In the case of a corporation, joint-stock company or association, or insurance company, organized in the United States, such net income shall be ascertained by deducting from the gross amount of its income received within the year from all sources - * * * Second. All losses actually sustained and charged off within the year and not compensated by insurance or otherwise, including a reasonable allowance for the exhaustion, wear and tear of property arising out of its use or employment in the business or trade; * * * Exhaustion should be allowed for each of the years in question based upon a value of $250,000 and a life of the patents to be terminated August 26, 1930. 11. If, as a result of the allowance for exhaustion on the patents in 1921, a net loss is shown, such loss should be applied against subsequent*3904 net income as provided by section 204 of the Revenue Act of 1921. Reviewed by the Board. Judgment will be entered on 15 days' notice, under Rule 50. GREEN did not participate. Footnotes 1. Losses. ↩ 2. Deficit. ↩