Starbuck v. Commissioner

*796 This is a proceeding for the redetermination of a deficiency in income taxes for the calendar year 1919, in the amount of $62,050.01. The amount in controversy is $59,668.49.

The errors assigned are (1) the action of the respondent in disallowing as a deduction from gross income fo 1919, $93,823.18 of the amount of depreciation claimed by the petitioner on patents, and (2) the failure of the respondent to allow as a deduction from gross income for the year 1919, depreciation on applications for United States patents filed by petitioner prior to March 1, 1913, and for which United States patents Nos. 1057423 and 1057828 were issued to petitioner on April 1, 1913.

FINDINGS OF FACT.

The petitioner is the administrator of the estate of Elwood Haynes, who died April 13, 1925.

Elwood Haynes in his lifetime was engaged*3178 in making investigations in alloys of nickel, chromium, cobalt, tungsten, molybdenum and other metals as far back as 1907.

*797 In the fall of 1912 Haynes built a small factory of cement blocks in which Stellite, an alloy invented by the deceased, was manufactured, beginning in December, 1912. The building did not cost over $2,500. The main difficulty at first in the manufacture of satellite was to obtain crucibles and refractory materials that would stand the heat required. Dixon graphite crucibles were used, which had to be lined with fire clay or bauxite in order to keep out carbon. The only persons employed in the factory were Elwood Haynes, his son, March Haynes, who devoted only part time, a Mr. Lanternman, and a stenographer. Lanternman was paid a salary of $18 per week. Haynes continued manufacturing satellite up to March 1, 1913, and was selling all he could manufacture at $5 per pound. At or about March 1, 1913, the production varied from 5 to 20 pounds per day. At this time the capacity of the plant was 100 pounds or more per day. This capacity could have been increased by the further addition of equipment.

The crucibles used cost about $1 each. They*3179 were about 9 or 10 inches high, would hold about 15 pounds of stellite and would last for two meltings. The fire clay cost at that time about $20 per ton. Natural gas and air blast were used and it took 1 1/2 hours to melt a crucible of the mixture. Gas cost 25 cents per 1,000 cubic feet. Molds were used which would last on an average of 12 casts and would then have to be machined at a cost of $1 each. A mold would hold 5 pounds of stellite. The melting cost would not run over 10 cents per pound.

Two different grades of stellite were manufactured. The ternary alloy was composed as follows:

In 1912 and 1913, the cost of the material was as follows:

No. 3 grade stellite contained twice as much tungsten and cost 4 cents per pound more to manufacture. Both grades sold for $5 per pound. The manufacture of stellite required no expert metallurgist, but required only accuracy in mixing the ingredients. Haynes just cast the metal and sold it in bar form. It was used for making machine tools and lathe tools for turning iron and steel.

Prior to March 1, 1913, Elwood*3180 Haynes began to widely advertise stellite. He advertised in trade magazines, inserted articles in magazines and made addresses before various manufacturing organizations. *798 An advertisement of stellite was placed in the February, 1913, issue of the trade magazine, "Machinery."

Stellite is resistant to acid and to heat and will not rust. Its coefficient of expansion is the same as that of glass.

Elwood Haynes had been successful in 1907 in making an alloy composed of nickel and chromium and had obtained from the United States Patent Office patent No. 873746, dated December 17, 1907, covering the same. He had also received United States patent No. 873745, dated December 17, 1907, covering an alloy of cobalt and chromium. On the two patents obtained in 1907, the respondent has allowed their fair market value on March 1, 1913, of $200,000.

On July 20, 1912, Haynes filed an application in the United States Patent Office for a patent on the alloy "stellite" which included a ternary alloy of cobalt, chromium and tungsten or molybdenum, and a quationary alloy of cobalt chromium tungsten and molybdenum. The application was afterwards divided into two applications, the*3181 original application covering the ternary invention bearing serial No. 710598. The new application was filed in the United States Patent Office August 16, 1912, under serial No. 715326, covering the quationary alloy.

Notice was given to Haynes by the United States Patent Office on September 5, 1912, that application No. 710598 was allowed, and that the patent would issue upon the payment of the final fee. On September 6, 1912, Haynes received notice that application serial No. 715326 had been allowed and that a patent would be issued upon the payment of the final fee.

Final fees were paid on February 28, 1913, and the United States Patent Office issued receipts therefor on which there was stamped notice that the patent would be issued in each instance on April 1, 1913. Patent No. 1057423 was issued to Haynes on April 1, 1913, covering the ternary alloy and on the same date patent, No. 1057828 was issued to him covering the quationary alloy.

The Patent Office rule in 1912 was that payment of final fees should be applied on the Thursday following payment, and that the patent date would be that of the fourth Tuesday following the Tuesday next after the Thursday on which payment*3182 was applied.

Haynes filed application in the Canadian Office for patents on both the ternary and quationary alloys on January 23, 1913. In accordance with the Canadian Government requirements, this application was divided so that it became the original application only for the ternary alloy which was the same invention covered by United States Patent No. 1057423. Upon this application the Canadian Patent Office on December 23, 1913, granted a patent to the petitioner, No. 152710. Canadian patent No. 154134, covering the quationary *799 alloy, was issued March 3, 1914, for the same invention covered by United States Patent No. 1057828.

As early as 1900 manufacturers of tools and machinery in metal working plants found that carbon steel tools would not do the work demanded by manufacturers of tools and lathes. There was, therefore, developed a "high-speed steel," an alloy made of iron or steel with chromium, vanadium, and other ingredients. The automobile trade and other industries were rapidly increasing and new shops were starting all over the country. There was a great demand for high-speed production and there was a consequent demand for highspeed steel. High-speed*3183 steel had power to withstand greater heat when being used ant to turn and cut metal faster than the ordinary steel tools. In the year 1912 there were produced and sold about 10,000,000 pounds of high-speed steel and the increase in its use thereafter has been perceptible. The increase in the use of highspeed steel had been from 20 per cent to 50 per cent per annum from 1904 to March 1, 1913.

Prior to March 1, 1913, experiments made with stellite tools for use on lathes had shown that "stellite" tools would turn metals from two to five times faster than the high-speed steel tools. Stellite being a nonferrous alloy requires no tempering and will not lose its hardness when subject to the heat generated when cutting metals at high speeds. It would keep an edge longer than and would not require being reground as often as high-speed steel. In some machines where one tool governs others, it is expensive and laborious to remove tools to resharpen them and stellite might be used to advantage in them. Stellite is brittle but may be used to advantage in making tools by welding it as a cutting edge to a steel shank. Sometimes tools composed of stellite entirely were used and sometimes*3184 only a part was stellite, but even in the latter case considerable stellite was used. The properties of stellite were known to manufacturers engaged in making tools in various parts of the country. Stellite was not advantageous in all cases where high-speed steel was used. It was not good as a finishing tool but was most advantageous for turning, roughing and heavy cutting. It was, however, expected that it would supplant between 1 and 2 per cent of the total amount of high-speed steel used.

It was understood that in the year 1912 the amount of high speed steel used for the same purpose for which stellite was being used was 600,000 pounds per year. The domestic steel was being sold at 60 cents to 75 cents per pound and some imported steel sold for as high as $1.45 per pound, while stellite was selling at $5 per pound, but it was expected that stellite would take the place of at least 20 per cent of this amount and would thereafter increase in use.

*800 In 1911 Elwood Haynes entered into negotiations with the Deloro Mining & Production Co., afterwards known as the Deloro Smelting & Refining Co., at Deloro, Ontario, Canada, producers of oxide of cobalt, and agreed to*3185 allow this company to manufacture stellite upon a royalty basis. Definite arrangements were subsequently made and the actual manufacture of stellite by this company began in the year 1915. The Deloro Smelting & Refining Co. in 1919 paid Haynes royalties on patents for stellite in the amount of $35,750.40.

In the year 1915 Haynes formed a corporation for the purpose of Manufacturing stellite at Kokomo, Ind. This corporation was known as the Haynes Stellite Co. Haynes owned one-half of the stock of this company and entered into a contract with the company giving it the sole right to manufacture and sell stellite under United States Patents Nos. 1057423 and 1057828, and for such right the corporation agreed to pay Haynes a royalty of 10 per cent on the gross sales of stellite manufactured. Under this contract Haynes received for the year 1919, royalties amounting to $172,861.96

The following is a summary of the patents owned by Elwood Haynes throughout the year 1919:

United States Patent No. 873746, dated December 17, 1907. A metal alloy composed of nickel and more than 30 per cent of metal of the chromium group.

United States Patent No. 873745, dated December 17, 1907. *3186 A binary alloy consisting of cobalt and chromium, or other metal of the chromium group allied with chromium, or having properties like those of chromium, such metals of the chromium groups embracing in addition to chromium, tungsten, molybdenum, and uranium.

United States Patent No. 1057423, applied for July 20, 1912, allowed in September 5, 1912, all final fees paid February 28, 1913, issued April 1, 1913. A metal alloy composed of cobalt, chromium, tungsten or molybdenum.

United States Patent No. 1057828, applied for July 20, 1912, allowed September 6, 1912, all final fees paid February 28, 1913, issued April 1, 1913. A quationary alloy of cobalt, chromium, tungsten, and molybdenum.

United States Patent No. 152710, dated December 23, 1913. A metal alloy composed of cobalt, chromium, and one other metal of the chromium group.

Canadian Patent No. 152710, dated December 23, 1913. A metal alloy composed of cobalt, chromium and one other metal of the chromium group.

Canadian Patent No. 154134, dated March 3, 1914. A metal alloy composed of cobalt, chromium, tungsten, and molybdenum. A metal alloy composed of cobalt, chromium and two other metals of the chromium group, *3187 a metal alloy composed of cobalt, chromium and a plurality of the other metals of the chromium group.

English Patent No. 2487. Date of application January 30, 1913. Accepted January 29, 1914. An alloy consisting of cobalt, chromium, and one or more other metals of the chromium group.

English Patent No. 100434, January 5, 1918. An alloy consisting of cobalt, chromium with iron or nickel.

Italian Patent No. 161169 (471/81). An alloy composed of cobalt, chromium, tungsten and molybdenum, or alloy of the chromium group.

*801 Austrian Patent No. 66714, April 1, 1914 (15 years). An alloy composed of cobalt, chromium, tungsten, or an alloy composed of cobalt, chromium, tungsten, and molybdenum, or an alloy composed of cobalt, chromium, and molybdenum, or other metal of the chromium group.

Belgian Patent No. 253653 dated February 8, 1913. An alloy composed of cobalt, chromium and tungsten, or an alloy composed of cobalt, chromium and molybdenum, or an alloy composed of cobalt, chromium, tungsten and molybdenum.

Hungarian Patent No. 64711, dated February 5, 1913. An alloy composed of cobalt, chromium and tungsten, or an alloy composed of cobalt, chromium and*3188 molybdenum, or an alloy composed of cobalt, chromium, tungsten and molybdenum.

French Patent No. 454064, issued April 19, 1912. An alloy composed of cobalt, chromium, and tungsten, or an alloy composed of cobalt, chromium, and molybdenum, or an alloy composed of cobalt, chromium, tungsten, and molybdenum, or other metals of the chromium group.

French Patent No. 389424, dated April 18, 1908, granted June 27, 1908 - Published September 9, 1905. An alloy composed of cobalt and a metal of the chromium group notably chromium.

The petitioner claimed on his 1919 tax return a March 1, 1913, value of $1,800,000 for all of his patents owned in 1919 which had been allowed (whether or not issued) prior to March 1, 1913, and claimed as a deduction for depreciation thereof one-seventeenth of $1,800,000, or $105,882. The respondent allowed a March 1, 1913, value of $200,000 on patents issued prior to March 1, 1913, allowed the cost of $5,000 on all patents (including the Canadian and United States stellite patents) issued after March 1, 1913, and disallowed all depreciation claimed on stellite patents except $294.11 allowed on the $5,000 cost. The amount of depreciation allowed by the*3189 respondent was as follows:

The patents owned by petitioner in 1919, including those issued both prior to and subsequent to March 1, 1913, had a total March 1, 1913, value of at least $1,800,000.

*802 OPINION.

SIEFKIN: The questions in this proceeding find their answer in the valuation of patents and inventions on which applications for patents had been made on March 1, 1913. The subject matter consists of certain nonferrous alloys. There was abundant testimony of well-qualified experts in metallurgy as to the physical characteristics and value of the product. *3190 There was also sufficient evidence, in our opinion, of a demand for the product which could reasonably be expected to yield a considerable income over the life of the patents. From all the evidence we conclude that the value was at least the amount claimed by the petitioner and that a deduction can be taken for exhaustion based upon the values we have found.

The respondent's counsel, although he does not cite the case of Individual Towel & Cabinet Service Co.,5 B.T.A. 158, in effect makes the same contention which was made for the respondent in that case and which was rejected by the Board. Although the argument is made in different terms, we regard it as essentially the same position. In any event, we see no merit in it.

Judgment will be entered under Rule 50.