Acme Prods. Co. v. Commissioner

*194 The Commissioner determined a deficiency in the petitioner's income-tax liability of $9,925.66 for 1925 and one of $20,365.80 for 1926, but now confesses error as to the computation of net losses for 1923 and 1924 which may change the above deficiencies. The only issue is as to whether or not the Commissioner erred in disallowing a deduction of $79,835.51 for 1926 alleged to represent the cost of experimental work on two processes which failed to materialize and were abandoned in that year.

FINDINGS OF FACT.

The petitioner is a Louisiana corporation now located in New Orleans. Prior to 1927 it had its place of business in De Quincy, La. It was organized in 1920 for the purpose of engaging in the manufacture, sale and distribution of turpentine, pine oil and other forms of naval stores. About November, 1919, experimental work on the development of certain processes was begun on its behalf. About the same time the construction*1683 of its plant at De Quincy was begun. The experimental work continued throughout the petitioner's entire period of operation.

The parties entered into a stipulation as follows:

On December 14, 1920, the petitioner completed construction of its plant and during the period from December 15, 1920 to October 31, 1922, petitioner manufactured no products for sale or which might be included in its inventory. During the said period petitioner incurred certain expenses totalling $181,154.81. Petitioner began manufacturing operations on November 1, 1922 and continued said operations up to and including the years involved in this proceeding. During the said period, November 1, 1922 to December 31, 1924, the petitioner incurred certain expenses totaling $37,647.72. The total of said expenses amounts to $218,802.53.

In its 1925 income tax return, petitioner took an amount of $147,404.32 of above expenses as a deduction designated "organization expenses" and in its 1926 return it took the balance of said items, in the sum of $71,398.21 as "organization expenses," which deductions were disallowed by the respondent in the deficiency letter.

*195 Petitioner admits that $99,815.02*1684 of said items making up the said sum of $181,154.81 incurred from December 15, 1920 to October 31, 1922 is an ordinary and necessary expense, deductible during said period.

The balance $81,339.79 of said sum of $181,154.81 represents the following expenses incurred from December 15, 1920 to October 31, 1922:

Respondent admits said $34,105.94 of said amount of $37,647.72 was incurred during 1923 and that the 1923 net loss of $77,874.15 allowed in the deficiency letter should be increased by said amount of $34,105.94 and that $3,541.78 the balance of said sum of $37,647.72 was incurred in 1924 and that the 1924 net loss of $108,676.29 allowed in the deficiency letter should be increased by said amount of $3,541.78, thus increasing pettioner's 1923 net loss to $111,780.09 and its 1924 net loss to $112,218.07.

Included in the salaries for the period December 15, 1920, to October 31, 1922, is the salary of W. B. Logan, at $15,000 per annum, and that of*1685 a research man and his assistant at $300 and $150 per month, respectively. There are also included the total salaries or wages of eleven other regular employees such as electricians, mechanics, and two accountants who were put to work assisting in the experiments when needed and not busy at their regular work. The only other employees during this period were a watchman and two firemen. The plant was idle and the only work being done was experimental work. Most of the experimental work during this period was done in an unsuccessful attempt to discover and patent a process for making pale wood resin and to discover a commercially practical means of manufacturing ester-gum by a known process. This work continued intermittently after this period until the petitioner's officers decided in 1926 to do no further work on these processes because Logan had patented another different process under which the company was manufacturing a product. The data obtained in this work has never been used, but is still available. During this period $12,331.13 was spent for the purchase of materials used in the experimental work.

W. B. Logan was vice president and manager of the petitioner from*1686 its organization until December, 1928. He managed the company, directed the research work, and spent time in connection with the erection of the petitioner's plant buildings. The research man and his assistant gave all of their time to the experimental work on pale wood resin and ester-gum.

The petitioner sustained a loss of $30,331.13 in 1926 on its experiments on the pale wood resin and ester-gum processes.

*196 OPINION.

MURDOCK: The items in controversy wre deducted as organization expenses and disallowed as such. It is now claimed that they are deductible on an entirely different basis as expenditures made in an unsuccessful effort to develop a secret formula and a patentable process. Such expenditures, if made as contended, would be of a capital nature and would not be deductible as ordinary and necessary expenses. While additional work was being done in an effort to succeed and while hope for ultimate success was not unreasonable, there was no occasion to deduct any part of the expenditures as a loss. Some of the expenditures would have entered into the cost of the process if any had been discovered. Here the effort was a complete failure and the expenditures*1687 represented a loss to the petitioners in so far as they can be properly allocated to the experimental work on these processes. ; cf. .

The cost of materials and the salaries of the research man and his assistant are clearly a part of such loss. Logan and the other regular employees had other regular duties, were not employed for the purpose of carrying on these experiments, spent only part of their time on the work, and did this only as a makeshift. Officers' salaries and wages are specifically deductible as expense where they are paid or incurred in carrying on a business. The total amount claimed includes some such items that are not part of the loss. We can not accurately determine how much of the time of these officers and employees was spent in the work or what would have been reasonable compensation for the performance of the services they rendered in the experimental work. Less expensive labor would have sufficed and the difference in compensation is not properly a part of the loss.