Court Opinion

ID: 4630195
Source: CourtListenerOpinion
Date Created: 2020-11-21 03:06:58.880798+00
Date Added: 2024-06-11T07:57:30.192570
License: Public Domain

THE JOHN DOUGLAS COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.John Douglas Co. v. CommissionerDocket No. 38726.United States Board of Tax Appeals23 B.T.A. 1308; 1931 BTA LEXIS 1731; August 25, 1931, Promulgated 1931 BTA LEXIS 1731">*1731  Value of patents and patent applications determined.  J. Marvin Haynes, Esq., W. C. Magathan, Esq., and S. Lester McCormick, Esq., for the petitioner.  Eugene Harpole, Esq., and E. M. Niess, Esq., for the respondent.  VAN FOSSAN 23 B.T.A. 1308">*1308  This proceeding was brought to redetermine deficiencies in the income tax of the petitioner for the years 1923, 1924 and 1925 in the sums of $2,009.49, $643.95 and $562.25, respectively.  Several errors were alleged, but all were waived except the single issue relating to depreciation on certain inventions and patent applications existing thereon on March 1, 1913.  The petitioner asserts that the respondent erred in not allowing deductions from taxable income for exhaustion of the value of such patents owned and used by it, granted upon patent applications owned by the petitioner on March 1, 1913.  If the said inventions and patent applications are depreciable, the petitioner requests a determination of the fair market value thereof on March 1, 1913.  FINDINGS OF FACT.  The petitioner, The John Douglas Company, is a corporation organized under the laws of the State of Ohio on June 10, 1890, with its1931 BTA LEXIS 1731">*1732  principal office and plant at Cincinnati.  It is engaged in the manufacture and sale of sanitary plumbing fixtures and plumbing supplies.  The business of the petitioner was started by John Douglas, a plumber, who invented and patented the Douglas rubber-ball 23 B.T.A. 1308">*1309  valves used in flush tanks.  Prior to 1905 the principal products of the petitioner were wooden tanks and wooden seats for water closets.  The water closet bowel was purchased from factories in and near Trenton, N.J.  It and other fixtures were assembled at the petitioner's plant and sold as a unit.  The flush tank was made of wood and lined with zinc, copper, lead or tin.  Wooden tanks are unsatisfactory because of warping and cracking.  Iron and enamel tanks are subject to rust.  In 1905 or 1906 vitreous china tanks came into use.  They were manufactured by hand in potteries located in the Trenton district.  Labor was highly organized and thoroughly unionized and assumed an arrogant attitude toward employers.  The production of each worker was limited to five tanks a day.  He was fined if he exceeded that number.  Consequently, the petitioner could not secure sufficient tanks to meet the demands of its trade. 1931 BTA LEXIS 1731">*1733  John Douglas thereupon commissioned D. W. McNeil, an employee of the petitioner and later its general superintendent for many years, to develop a machine and process for manufacturing vitreous chinaware, particularly those articles used in the sanitary plumbing business.  McNeil was a machinist, an engineer, a designer and a toolmaker.  He took a special course in ceramics at Illinois University and made an intensive study of the problem.  He also was instructed in the practical phases of vitreous china manufacture by the superintendent of the Elite Pottery Company at Trenton, a concern owned by Douglas.  McNeil then proceeded to experiment and to develop a machine and method of manufacture which constituted a revolutionary step in the pottery industry.  It incorporated an exclusive basic principle and device theretofore unknown.  The new method necessitated further experimentation and research in order to develop a clay mixture adapted to machine use.  By 1912 the machine-made tank was commercially producible, but certain manufacturing difficulties had to be overcome.  The problem was successfully solved and on March 1, 1913, the petitioner was manufacturing about 70 tanks per day. 1931 BTA LEXIS 1731">*1734  The method of manufacture by machine was unique and distinctly different from hand processing.  The length of time required to produce a finished article was materially shortened.  Only one firing was necessary instead of the two required by the hand method.  The cost of labor and materials of a tank made by hand was $3.09 as against $1.396 for one manufactured by the Douglas machine.  Common labor could be used with the machine operations, while expert labor was essential in hand operation.  The Douglas machine used domestic clays and produced better results than were obtainable by the hand process with the use of English clays, French flint and English china clays which were more expensive raw materials than 23 B.T.A. 1308">*1310  domestic clays.  The Douglas machine occupied less floor space than a hand labor unit.  The machine produced an article more exact in measurement and more beautiful in lustre and color than could be made by the hand process.  Sanitary fixtures other than tanks were made by the Douglas machine, such as lavatory legs and pedestals, sinks, backs, etc.  All such plumbing equipment was produced at much less cost by the machine method than by the hand process.  On1931 BTA LEXIS 1731">*1735  February 9, 1910, McNeil applied for a patent on apparatus for pressing and molding clay or similar materials, and on September 13, 1910, he made a further application for a patent on methods for pressing or molding clay or similar materials.  Letters patent were issued on both applications on June 8, 1915, under Patent Nos. 1142341 and 1142342, respectively.  McNeil's interest in the invention and patent applications was assigned to the petitioner on February 7, 1910.  The cost of developing the Douglas machine and the clay mixture is not determinable from the petitioner's records, but is conservatively estimated to be $150,000.  The production of flush tanks in 1913 was between 700,000 and 750,000, gradually increasing to a present output of about 1,400,000 per year.  A fair royalty charge for the use of the Douglas machine would have been from 20 cents to 75 cents per tank.  The Douglas machine was never licensed to other manufacturers, because Douglas was opposed to that procedure.  No other machine has been invented to accomplish the same purposes as the Douglas machine although a casting process was developed about 1921.  However, tanks produced by the Douglas machine are manufactured1931 BTA LEXIS 1731">*1736  for 50 per cent less than those made by the casting process.  The fair market value of the invention known as the Douglas machine and the patent applications thereon, on March 1, 1913, was $1,750,000, and it was at least that sum on June 15, 1915.  OPINION.  VAN FOSSAN: The first question presented for our consideration in this case is whether or not applications for patents, maturing into patents, are subject to depreciation or exhaustion.  The respondent's counsel had devoted himself almost exclusively to the theory that they are not, but we have frequently decided to the contrary.  Individual Towel & Cabinet Service Co.,5 B.T.A. 158">5 B.T.A. 158; Hartford-Fairmont Co.,12 B.T.A. 98">12 B.T.A. 98; Hershey Manufacturing Co.,14 B.T.A. 867">14 B.T.A. 867; Keystone Steel & Wire Co.,16 B.T.A. 617">16 B.T.A. 617; Empire Machine Co.,16 B.T.A. 1099">16 B.T.A. 1099. The petitioner is entitled to an allowance for exhaustion of its patent based on the March 1, 1913, value of the invention and the application for patent thereon and a seventeen-year life of such patent dated from June 8, 1915, its issuance date.  1931 BTA LEXIS 1731">*1737 Stephens-Adamson Manufacturing Co.,16 B.T.A. 41">16 B.T.A. 41. 23 B.T.A. 1308">*1311  Our next problem, therefore, is to determine the value of the petitioner's inventions and applications and patents therefor as of March 1, 1913.  The petitioner introduced as its principal witness Daniel W. McNeil, a former machinist, who for many years had been engaged in various phases of the manufacturing plumbing business.  He showed a thorough familiarity with the machine and hand processes of manufacturing vitreous china.  His qualifications as an expert were not challenged.  The value of his testimony was strengthened by cross-examination.  He fixed the value of the inventions and of applications for patents thereon as of March 1, 1913, at from $1,750,000 to $2,000,000.  He based his judgment on the savings in the cost of production due to the decreased amount of time, labor and floor space required and the use of cheaper materials, on the general demands of the industry at the time, on the unique character of the invention, on the peculiar need of the industry for machine production and on the amount of royalties obtainable through licensing the use of the invention.  The petitioner also presented1931 BTA LEXIS 1731">*1738  as a witness A. M. Maddock, vice president of the Standard Sanitary Manufacturing Company, which produces 27 per cent of the present output of the sanitary plumbing industry.  Maddock is a man of large experience and training in manufacturing pottery ware.  In 1913 he was general manager of Thomas Maddock & Sons Company, at that time the outstanding concern in the pottery industry.  He testified that in about the year 1913 he had offered Douglas $1,000,000 for his entire rights to the invention and that the offer was only a "feeler" preparatory to further negotiations.  Douglas was not interested in such a sale and Maddock then suggested the manufacture of vitreous china articles on a royalty basis.  Douglas rejected that proposition also.  Both McNeil and Maddock testified that a reasonable royalty for the use of the Douglas machine would have been between 50 cents and 75 cents per tank.  It is uncontroverted that the production of tanks and other vitreous china articles can be accomplished much more economically and satisfactorily by machine manufacture than by the hand process.  Hence, it is proper to assume that many other manufacturers in the industry would have been licensees1931 BTA LEXIS 1731">*1739  of the Douglas patents had Douglas chosen to grant licenses for such use.  The respondent did not attempt to rebut the fair market valuation of the invention and patent applications established by the petitioner, nor did he discredit the testimony of the witness, McNeil.  As we said in Anita M. Baldwin,10 B.T.A. 1198">10 B.T.A. 1198: * * * if the evidence adduced by one party in support of a proposed valuation is clear, convincing and uncontradicted and no reason for disbelieving or discounting such evidence is present, and if the adverse party neither weakens the testimony by cross-examination nor produces any evidence on his own behalf, the party producing the evidence should prevail.  23 B.T.A. 1308">*1312  The evidence in this case convinces us that the fair market value of the inventions and applications for patents therefor maturing into Patents Kos. 1142341 and 1142342 and $1,750,000 on March 1, 1913.  Judgment will be entered under Rule 50.