Court Opinion

ID: 4592091
Source: CourtListenerOpinion
Date Created: 2020-11-20 19:07:12.304662+00
Date Added: 2024-06-11T07:50:48.344208
License: Public Domain

Kraft Foods Company (Formerly Kraft Cheese Company and Theretofore Kraft-Phenix Cheese Corporation), Petitioner, v. Commissioner of Internal Revenue, RespondentKraft Foods Co. v. CommissionerDocket Nos. 4160, 5574United States Tax Court21 T.C. 513; 1954 U.S. Tax Ct. LEXIS 310; January 25, 1954, Promulgated 1954 U.S. Tax Ct. LEXIS 310">*310 Decisions will be entered under Rule 50.  1. National Dairy, in a lump-sum purchase, acquired the assets and business of Kraft-Phenix Cheese Corporation, an Illinois corporation paying therefor $ 78,338,412.84 in common stock, bonds, and cash, plus the assumption of liabilities of $ 2,801,148.72.  Except for a minor portion of the assets not exceeding $ 13,051,179.77 in value or cost, National Dairy immediately thereafter transferred the Kraft assets and business to petitioner, receiving in return 20,000 shares, $ 2,000,000 par value, of petitioner's stock, which shares were and continued to be all of petitioner's outstanding shares.  Among the assets so purchased by National Dairy and transferred to petitioner, were 31 patents and applications for patents, which patents were not shown as book assets by the Illinois corporation and were not immediately set up as assets on petitioner's books.  The parties agree that the basis of the patents and applications for patents to petitioner for amortization or depreciation purposes was the amount of their cost to National Dairy.  Held, that the cost of the patents and applications for patents to National Dairy was $ 8,000,000.2. In1954 U.S. Tax Ct. LEXIS 310">*311  1934, after the privilege of filing consolidated returns had been eliminated by the Revenue Act of 1934, the petitioner's board of directors adopted resolutions increasing the book value of goodwill, patents and trade-marks by $ 13,120,151.26, declaring a dividend of $ 30,000,000, chargeable to book surplus, and authorizing and directing that the dividend be paid in "6% debentures of the corporation due February 1, 1948." Pursuant to the resolutions, $ 30,000,000 of the claimed debentures was issued by petitioner to National Dairy, its sole stockholder, and in each of the taxable years petitioner paid to National Dairy amounts equaling 6 per cent on the said debentures and on its income tax returns claimed deductions of the amounts so paid, as interest.  On the evidence of record and the facts drawn therefrom, held, that there was no intent to create a debt or establish a debtor-creditor relationship between petitioner and National Dairy by reason of the issuance of the debentures and that the respondent did not err in disallowing the claimed interest deductions.  John F. Dooling, Jr., Esq., Norris Darrell, Esq., John G. Dorsey, Esq., and Erwin P. Snyder, Esq., for the petitioner.Harold D. Thomas, Esq., and William A. Schmitt, Esq., for the respondent.  1954 U.S. Tax Ct. LEXIS 310">*312 Turner, Judge.  Arundell, J., dissents on the interest deduction issue.  Van Fossan, J., dissents.  Opper, J., concurring.  TURNER 21 T.C. 513">*514  The respondent determined deficiencies in income tax and declared value excess-profits tax against the petitioner for the years 1934, 1935, 1936, 1937, and 1938, as follows:Declared valueYearIncome taxexcess-profits tax1934$ 358,533.561935482,995.43$ 137,408.711936840,890.5449,756.881937934,875.2630,193.911938753,042.944,537.17It is the claim of the petitioner that it has 1954 U.S. Tax Ct. LEXIS 310">*313  overpaid its income tax for the years in question as follows: 1934, $ 28,232.28; 1935, $ 165,932.38; 1936, $ 73,671.96; 1937, $ 55,101.40; and 1938, $ 3,494.17.Two questions are presented for determination, one being the basis to petitioner of patents acquired by it in 1930, for purposes of amortization, for each of the taxable years 1934 to 1938, inclusive; and the other, whether the respondent erred in disallowing deductions of $ 900,000 for 1934 and $ 1,800,000 for each of the years 1935 to 1938, inclusive, claimed as payments of interest on debentures issued to stockholders of record on June 29, 1934, in payment of a dividend of $ 30,000,000.FINDINGS OF FACT.The facts have been stipulated in part and are found as stipulated.The petitioner is a Delaware corporation originally organized under the name Kraft-Phenix Cheese Corporation.  On January 2, 1940, its name was changed to Kraft Cheese Company, and on August 31, 1945, to Kraft Foods Company.  The principal executive offices of the petitioner are at Chicago, Illinois.  Its returns for the years involved were filed with the collector of internal revenue for the second district of New York.  The petitioner keeps its books of1954 U.S. Tax Ct. LEXIS 310">*314  accounts and makes its returns on an accrual basis.  For the years 1934 through 1938, and on the basis of the returns filed, the petitioner paid income tax as follows:1934$ 28,232.281935165,932.381936166,216.691937$ 161,188.111938281,098.82Timely and proper waivers extending the time within which the respondent might assess additional taxes were executed by the petitioner and the respondent, and were in full force and effect when the notices of deficiency herein were mailed.On March 17, 1930, National Dairy Products Corporation, a Delaware corporation, sometimes hereafter referred to as National Dairy, entered into an agreement with Kraft-Phenix Cheese Corporation, an Illinois corporation, sometimes hereafter referred to as Kraft (Ill.), to acquire all of the business, property, and assets of the latter, in 21 T.C. 513">*515  consideration of the delivery by National Dairy to Kraft (Ill.) of (a) 665,287 full paid and nonassessable shares, without par value, of National Dairy common stock, exclusive of right to regular dividend payable April 1, 1930; (b) $ 33,264,500 principal amount of National Dairy 5 1/4 Per Cent Gold Debentures, due in 1948, with interest thereon1954 U.S. Tax Ct. LEXIS 310">*315  from April 1, 1930; (c) cash in the amount of $ 6,182,000 plus an additional sum in cash to equal the amount of the accrued dividends on the Kraft (Ill.) preferred stock to the date of dissolution and liquidation of that company; and (d) the assumption by National Dairy of all of the liabilities and contracts of Kraft (Ill.).  Under the agreement, Kraft (Ill.) was obligated to dissolve and distribute its remaining assets to its stockholders immediately after the consummation of the above sale.In the agreement, Kraft (Ill.) represented, among other things, that its consolidated net sales, including those of its wholly owned subsidiaries exclusive of intercompany transactions, after the deduction of all returns, deductions, and charges of proper character, all in accordance with good accounting practice, were not less than $ 86,500,000 for the calendar year 1929.  It also represented that its consolidated net earnings, together with its portion of the undistributed net earnings of controlled subsidiaries and the net earnings for the full year of wholly owned subsidiaries, were not less than $ 5,000,000 for the calendar year 1929.  One of the conditions precedent to the obligation of1954 U.S. Tax Ct. LEXIS 310">*316  National Dairy under the agreement, was that the certificate of a designated accounting firm should show to the satisfaction of National Dairy that all of the representations and statements of Kraft (Ill.) contained therein with reference to its assets, liabilities, sales, and earnings and of the wholly owned subsidiaries, the controlled subsidiaries, and Southern Dairies, Inc., and its subsidiaries were correct; that the financial positions of Kraft (Ill.) and the wholly owned subsidiaries and of Southern Dairies and its subsidiaries were in compliance with the agreement; and that the consolidated balance sheets attached to the agreement were correct.  Thereafter the agreement was modified by letters and further agreements, ranging in date from March 15 through May 12, 1930.  By the terms of these modified agreements, National Dairy waived the right to terminate the agreement because of variances in the financial position of Kraft (Ill.) and its subsidiaries or Southern Dairies, Inc., and its subsidiaries.On May 12, 1930, the stockholders of Kraft (Ill.) approved the sale of all the property of the company of every kind to National Dairy, on the terms set forth in the agreement 1954 U.S. Tax Ct. LEXIS 310">*317  above, as amended.  On May 13, 1930, Kraft (Ill.) changed its name to Kraphene Corporation.21 T.C. 513">*516  On May 21, 1930, performance of the agreement, as amended, was consummated by the delivery by Kraft (Ill.) of a general bill of sale embracing all of its properties of every kind to National Dairy (or its nominee), against receipt of (a) 665,287 full paid and nonassessable shares, without par value, of National Dairy common stock; (b) $ 33,264,500 principal amount of National Dairy 5 1/4 Per Cent Gold Debentures, due in 1948, and entitled to interest as from April 1, 1930; (c) cash in the amount of $ 6,182,000; (d) an instrument evidencing the assumption by National Dairy of all of the liabilities of Kraft (Ill.); and (e) the undertaking of National Dairy to deliver to a named trust company, as distribution agent, the additional sums in cash required to pay dividends accrued on the preferred stock of Kraft (Ill.).  April 30, 1930, was the accounting date as of which the transfer was made.The earnings of Kraft (Ill.) as per books for the year 1929; the restatement of such earnings called for under the provisions of the contract dated March 17, 1930, for the sale of its assets to National1954 U.S. Tax Ct. LEXIS 310">*318  Dairy; the restated income as adjusted by Price, Waterhouse and Company, named in the contract to certify as to the correctness of the representations and statements of Kraft (Ill.) with respect to its assets, liabilities, sales, and earnings; and the earnings of Kraft (Ill.) for 1929, as set forth by National Dairy in its New York Stock Exchange listing application for the shares of National Dairy common stock issued in the transactions, were respectively as follows: $ 3,514,839.86, $ 5,016,450.25, $ 4,545,241.63, and $ 4,622,839.75.  The difference between these various figures arose out of differences in computing the net dividends from an equity in undistributed earnings of subsidiary corporations of Kraft, differences in classification of extraordinary expense, and differences in interest added back.On June 4, 1930, the stockholders of Kraft (Ill.) voted to dissolve the corporation and to distribute to its stockholders all of its assets, paying in the case of preferred stock $ 110 per share, plus accrued dividends to June 14, 1930, or with an earlier date of payment thereon, at the rate of 6 1/2 per cent per annum from April 1, 1930.  On the same day, notice was sent to all 1954 U.S. Tax Ct. LEXIS 310">*319  of the Kraft stockholders of the action and of the availability for immediate distribution of the debentures, stock, and cash supplied by National Dairy and receivable by them on their stock in Kraft (Ill.).The liabilities of Kraft (Ill.) (excluding liabilities to its wholly owned subsidiary corporations) assumed by National Dairy on May 21, 1930, amounted to $ 2,801,148.72.Apart from the liabilities assumed, as shown in the preceding paragraph, the consideration paid by National Dairy for the assets of Kraft (Ill.) was as follows: 21 T.C. 513">*517 665,287 shares National Dairy common stock, fair marketvalue, $ 57,875 per share$ 38,503,485.13National Dairy 5 1/4% Gold Debentures at par33,264,500.00Interest on above debentures -- April 1, 1930 toApril 30, 1930145,532.19Cash paid at closing on May 1, 19306,182,000.00Accrued dividends on Kraft (Ill.) preferred stock71,248.51Purchase of Kraft (Ill.) scrip outstanding438.99Other capital costs of acquisition171,208.02Total$ 78,338,412.84The journal entries on the books of National Dairy covering the above transaction were as follows:DescriptionDebitCreditAssets acquired less liabilities assumed fromKraphene Corporation (formerly Kraft-PhenixCheese Corporation$ 47,432,927.77Common stock$ 5,322,296.00Unissued common stock, 665,287 shares 5 1/4 per cent golddebentures due 194833,264,500.00Accounts payable (Kraphene Corporation)6,182,000.00Interest paid on 5 1/4 Per Cent Gold Debentures due 1948145,532.19Initial surplus2,518,599.58$ 47,432,927.771954 U.S. Tax Ct. LEXIS 310">*320  In one of the explanatory statements appearing on the journal voucher, it was stated that the above transaction was authorized by the board of directors, it being resolved that the capital liability of National Dairy with respect to each of the 665,287 shares of common stock so issued was conclusively limited and deemed to be $ 8.The assets acquired by National Dairy from Kraft (Ill.), as shown by the books of the latter, were as follows:Current assets:Cash in banks and on hand$ 4,700,089.58Notes and accounts receivable, less reservefor doubtful notes and accounts2,793,365.83Accounts receivable from employees27,741.72Inventories4,887,481.17Intercompany accounts wholly ownedsubsidiaries7,049,598.08Intercompany accounts partly ownedsubsidiaries1,870,983.86Total current assets$ 21,329,260.24Investments:In wholly owned subsidiaries$ 12,676,276.62In partly owned subsidiaries1,394,009.79Southern Dairies, Inc1 8,453,190.90Mortgages receivable67,073.73Other915,034.84Total investments$ 23,505,585.88Property, plant and equipment, less reservefor depreciation$ 4,101,030,08Deferred charges, prepaid taxes, insurance andsundry300,549.55Leasehold2 750,000.00Goodwill, etc3 1,219,206.37Total assets$ 51,205,632.121954 U.S. Tax Ct. LEXIS 310">*321 21 T.C. 513">*518  The liabilities of Kraft (Ill.), as shown on its books as at April 30, 1930, exclusive of capital and surplus, were as follows:Current liabilities:Notes payable$ 1,295,000.00Accounts payable and accrued liabilities$ 1,129,885.16Provision for Federal income tax376,263.56Intercompany accounts wholly ownedsubsidiaries2,617,732.37Total current liabilities$ 5,418,881.09Reserves for investments and intercompany accounts:Wholly owned companies571,300.88Party owned companies288,800.05Total liabilities per books, exclusive of capital and surplus$ 6,278,982.021954 U.S. Tax Ct. LEXIS 310">*322  At April 30, 1930, Kraft (Ill.) had 36 wholly owned subsidiary companies, its investment in which was carried on its books at $ 12,676,276.62.  It also carried among its assets intercompany accounts receivable from such wholly owned subsidiaries in the amount of $ 7,049,598.08.  Its liabilities to such companies, as shown on its balance sheet, were $ 2,617,732.37.  Except as to 4 corporations, the figure at which the investment of Kraft (Ill.) in each of the wholly owned subsidiary corporations was shown, was equal to the sum of the stated capital and surplus of the subsidiary corporation as reflected by its separate books of account at April 30, 1930.  In the case of the 4 corporations mentioned, Bradley Cheese Company, Food Specialties Distributing Company, Kraft-Phenix Cheese Corporation of the South, and Miller-Richardson Company, the investment of Kraft (Ill.) was carried on its books at $ 2, $ 1, $ 1, and $ 69,294.50, respectively.  The stated capital and surplus of each such corporation, as per its books, was a minus amount.At April 30, 1930, Kraft (Ill.) owned controlling interests in 10 additional corporations.  Its investment in those corporations was carried on its books1954 U.S. Tax Ct. LEXIS 310">*323  as of that date at $ 1,394,009.79.  It also carried 21 T.C. 513">*519  among its assets intercompany accounts receivable from such corporations in the amount of $ 1,870,983.86.  Its balance sheet as of April 30, 1930, showed no liabilities to such companies by petitioner.  Southern Dairies, Inc., sometimes referred to herein as Southern Dairies, another corporation in which petitioner owned a controlling interest, is covered hereafter.The consolidated sales and net income of Kraft (Ill.) and predecessor corporations, including foreign and domestic subsidiaries, for the period November 1, 1924, to May 1, 1930, as disclosed by their books of account, were as follows:Year or periodTotal net salesTotal net income5 Months ended March 31, 1925$ 15,072,221.32$ 602,857.31Year ended March 31, 192636,720,076.901,500,432.929 Months ended December 31, 192629,350,631.311,104,757.03Year 192737,593,104.91824,979.37Year 192875,648,426.331,848,258.04Year 192986,393,675.413,514,839.864 Months ended April 30, 193025,664,997.421,483,724.99When its stock transfer books were closed May 24, 1930, Kraft (Ill.) had 3,185 common stockholders of record.  Immediately1954 U.S. Tax Ct. LEXIS 310">*324  prior to the closing, National Dairy had approximately 31,000 common stockholders. Immediately prior to the issuance of common stock of National Dairy to Kraft (Ill.), there were 5,291,079 shares (exclusive of scrip) of National Dairy common stock outstanding.  Immediately after the issuance of the shares to Kraft (Ill.), there were 5,956,366 shares of common stock outstanding.  The shares issued to Kraft (Ill.) constituted 11.169 per cent of the National Dairy common stock outstanding after the issuance of those shares.  Neither Kraft (Ill.) nor its stockholders, nor both, acquired an interest in or control of National Dairy of 50 per cent or more.Petitioner was incorporated under the laws of the State of Delaware on May 3, 1930.  On May 7, 1930, National Dairy subscribed for 100 shares of the $ 100 par value capital stock of the petitioner, at $ 100 per share.  No shares of the petitioner's capital stock were issued to anyone other than National Dairy.On May 21, 1930, National Dairy entered into an agreement with petitioner, whereunder it transferred to petitioner all the property, business, and assets acquired from Kraft (Ill.), except $ 1,942,255.65 in cash and accounts receivable, 1954 U.S. Tax Ct. LEXIS 310">*325  and all shares acquired from Kraft (Ill.) of the stock of Southern Dairies, Inc., Purity Creamery Products, Inc., Oakdale Dairy, Inc., and National Cheese Company.  In consideration therefor, petitioner assumed the liabilities of Kraft (Ill.), issued and delivered the remaining 19,900 shares of its capital stock to National Dairy, and paid $ 10,000 in cash.  The transfer of the Kraft (Ill.) assets was made by National Dairy to petitioner by a general deed 21 T.C. 513">*520  and bill of sale dated May 21, 1930, and certain supplemental assignments.Immediately after the transfer of the above property and assets from National Dairy to petitioner, National Dairy owned, and has since continued to own, 100 per cent of the stock of petitioner.A summary of the journal entries indicates that the assets acquired from Kraft (Ill.) which were retained by National Dairy and not transferred to petitioner, were carried onto the books of National Dairy, as follows:Cash$ 1,638,755.37Accounts receivable:National Cheese Company$ 100,000.00 Purity Creamery Products, Inc200,000.00 Southern Dairies, Inc3,500.28 303,500.28Total cash accounts receivable1 $ 1,942,255.65Investment in Southern Dairies, Inc10,959,468.57Equity investment, other companies:National Cheese Company$ 48,166.31 Oakdale Dairy Company, Inc.(102,661.73)Purity Creamery Products Company, Inc260,673.69 206,178.27$ 13,107,902.49Less: Reserve for intercompany inventory loss formerlycarried on the books of Kraft (Ill.)55,722.72Net assets retained by National Dairy per books$ 13,051,179.771954 U.S. Tax Ct. LEXIS 310">*326 The amount at which the stock of Southern Dairies was entered on the books of National Dairy was the same amount at which the stock had been carried on the books of Kraft (Ill.) prior to the write-down as of April 30, 1930.  The fair market value of the stock of Purity Creamery Products Company, Inc., when acquired by National Dairy from Kraft (Ill.) was $ 260,673.69.  Similarly the fair market value of the stock of the National Cheese Company was $ 48,166.31.  The value of the stock of Oakdale Dairy Company, Inc., when acquired by National Dairy from Kraft (Ill.) was zero.  1Southern Dairies, Inc., was incorporated in 1925, to take over and operate1954 U.S. Tax Ct. LEXIS 310">*327  a group of companies operating principally from Washington, D. C., through the South Atlantic States.  Its outstanding stock consisted of 250,000 shares of class A stock, and 235,000 shares of class B.  National Dairy acquired from Kraft (Ill.) 227,120 shares 21 T.C. 513">*521  of class A stock and 132,500 shares of class B stock. The class A stock was entitled to a noncumulative preference of $ 4 per share per annum in dividends over the class B stock. When the $ 4 a share had been distributed on both classes of stock in any year, both classes participated equally per share in further dividends. On dissolution both classes participated equally per share.  Each share of both issues had one vote at corporate meetings.  Both the class A and the class B shares were listed on the New York Stock Exchange.According to its published financial statement, Southern Dairies had net sales in 1929 of $ 10,438,149.98 and a net income of $ 836,952.58.  Its surplus at December 31, 1929, was $ 643,010.44.  According to its balance sheet, its current assets at December 31, 1929, amounted to $ 2,208,105.61.  Its other assets, including land, buildings and equipment, and good will, brought its total assets1954 U.S. Tax Ct. LEXIS 310">*328  to $ 14,475,391.29.  Its land, buildings and equipment were shown at $ 7,828,139.11, and good will at $ 3,629.704.81.  Its current liabilities were shown at $ 477,411.67 and its total liabilities, other than capital and surplus, amounted to $ 3,564,528.77.As shown by its books, the net sales of Southern Dairies for the 4 months ended April 30, 1930, were $ 2,850,806.41.  Its net income was $ 78,979.31.  According to its balance sheet at April 30, 1930, its current assets were $ 1,874,129.65.  Its other assets, including property, plant and equipment, and goodwill, brought its total assets to $ 14,318,758.46.  Its property, plant and equipment were shown at $ 7,678,135.25, and good will at $ 3,629,704.81, the same as shown for good will at December 31, 1929.  Its current liabilities were shown at $ 461,336.39 and its total liabilities, other than capital and surplus, amounted to $ 3,545,973.88.  Surplus was shown at $ 493,145.10.From February 1 through June 1930, 3,100 shares of Southern Dairies class A stock were sold on the New York Stock Exchange, in lots ranging from 100 to 500 shares.  The prices ranged from a high of 27, on March 6 and 7 and June 3, to a low of 20, on May 21954 U.S. Tax Ct. LEXIS 310">*329  and 5 and June 19.  For March the high was 27 and the low was 25 1/8.  For April the high was 23 5/8 and the low was 22.  For May the high was 20 1/4 and the low was 20.From February 1 through June of 1930, 14,000 shares of Southern Dairies class B stock were sold on the New York Stock Exchange, in lots ranging from 100 to 1,900 shares.  The prices ranged from a low of 5, on February 3 and 10, to a high of 9, on March 3 and June 3.  For March the high was 9 and the low was 6 1/4.  For April the high was 7 3/4 and the low was 6.  For May the high was 6 7/8 and the low was 5 1/2.The book value of the class A and class B shares of Southern Dairies, at December 31, 1929, was $ 22.50 per share, and at April 30, 1930, $ 22.30 per share.21 T.C. 513">*522  From April 30, 1927, until December 1929, no dividends were paid on the Southern Dairies class A stock. Dividends of 37 1/2 cents per share were paid on the said stock on December 30, 1929, and March 30, 1930.  As of May 21, 1930, no dividends had ever been paid on Southern Dairies class B stock.The assets acquired by National Dairy from Kraft (Ill.) and transferred to petitioner for its capital stock and other undertakings, as reflected by1954 U.S. Tax Ct. LEXIS 310">*330  a summary from journal entries on the books of National Dairy, were as follows:Total capital and surplus on Kraft (Ill.) books atApril 30, 1930$ 44,926,650.10Write up stock Southern Dairies, Inc., National Dairy'sbooks, May 1, 19301 2,506,277.67Total of assets acquired by National Dairy$ 47,432,927.77Cash paid to petitioner for incorporators'shares$ 10,000.00Net assets acquired from Kraft (Ill.) andinvested by National Dairy in petitioner34,371,748.00Total investment in petitioner per books34,381,748.00Net assets retained by National Dairy2 $ 13,051,179.77A summary of petitioner's assets, as shown by its opening balance sheet as of May 1, 1930, was as follows:Current assets:Cash in banks and on hand$ 4,700,089.58Notes and accounts receivable, less reservefor doubtful notes and accounts2,789,865.55Accounts receivable from employees27,741.72Inventories4,944,203.89Intercompany accounts -- wholly ownedsubsidiaries6,749,598.08Intercompany accounts -- partly ownedsubsidiaries1,696,639.80Total current assets$ 20,908,138.62Investments:In wholly owned subsidiaries$ 12,367,436.62In partly owned subsidiaries1,432,938.62Mortgages receivable67,073.73Other915,034.84Total investments$ 14,782,483.81Property, plant and equipment, less reserve for depreciation4,101,030.08Deferred charges$ 300,549.55Valuation of leasehold1 750,000.00Goodwill, etc2 1,219,206.37Total assets$ 42,061,408.431954 U.S. Tax Ct. LEXIS 310">*331 21 T.C. 513">*523  The liabilities of petitioner as shown by its opening balance sheet as of May 1, 1930, were as follows:Current liabilities:Notes payable -- banks and brokers$ 1,295,000.00Accounts payable and accrued liabilities1,129,885.16Provision for Federal income tax376,263.56Intercompany accounts -- National Dairy1,504,040.14Intercompany accounts -- wholly ownedsubsidiaries2,617,732.37Total current liabilities$ 6,922,921.23Reserves for investments and intercompany accounts:Wholly owned companies571,300.88Partly owned companies185,438.32Total liabilities per opening balance sheet,exclusive of capital and surplus7,679,660.43Capital and surplus:Capital stock2,000,000.00Earned surplus at acquisition32,381,748.0034,381,748.00Total liabilities$ 42,061,408.431954 U.S. Tax Ct. LEXIS 310">*332  In determining petitioner's depreciation allowances on buildings and equipment, and gains and losses in dispositions of land, buildings, and equipment in taxable periods following April 30, 1930, respondent has used substantially the book figures of petitioner as adjusted bases.In determining, in the case of petitioner's wholly owned subsidiary companies, their depreciation allowances on buildings and equipment, and their gains and losses on dispositions of land, buildings, and equipment in taxable periods following April 30, 1930, respondent has used substantially the book figures of petitioner's wholly owned subsidiary companies as adjusted bases therefor.National Dairy acquired from Kraft (Ill.) and transferred to petitioner, on the date of National Dairy's acquisition of them, inter alia, the following patents, applications for patent which later resulted in the issuance of patents, license under Patent No. 1,634,410, invention (later patented under United States Patent No. 2,005,996), and claim against N. L. Simmons for assignment of Patent No. 1,763,633, as follows: 21 T.C. 513">*524 ApplicationIssueApplicationInventorPatent No.No.datedateJ. L. Kraft1,186,52486,7646/6/163/25/16Reissue 14,777331,72112/23/1910/18/19Nusbaum1,258,438170,1263/5/185/22/17J. L. Kraft1,323,869282,64512/2/193/14/19J. L. Kraft1,350,870331,6328/24/2010/18/19Garstin1,368,624418,3202/15/2110/28/20Eldredge1,374,141326,0384/5/219/24/19Reissue 15,648615,3687/10/231/27/23Carpenter, et al1,389,09535,4778/30/216/21/15222,3123/14/18Carpenter, et al1,389,57735,4779/6/216/21/15222,5143/14/18J. L. Kraft1,400,171446,67412/13/212/21/21Hill1,484,945585,3292/26/248/30/22Wyner1,500,478531,5997/8/241/25/22Hunter1,500,494534,6347/8/242/6/22Hill1,508,019585,3309/9/248/30/22Schaefer, et al1,522,793656,7141/13/258/10/23Schaefer, et al1,522,794662,0531/13/259/11/23Coon1,579,19691,2623/30/262/27/26Eldredge1,607,0649,70811/16/262/16/25Eldredge(license) 1,634,410727,0587/5/277/19/24Robinson1,678,167646,9217/24/286/21/23Eldredge1,693,025167,36611/27/282/10/275/18/28Eldredge1,693,026198,69711/27/286/13/27Martin1,748,781231,3942/25/3011/5/27Simmons1,763,633418,1576/10/301/2/30Vesey1,767,193203,2856/24/307/5/27Bell1,810,898280,7016/23/315/26/28Bell, et al1,816,202292,8497/28/317/14/28Bell1,862,563292,8506/14/327/14/28N. Kraft1,916,515362,1627/4/335/11/29Eldredge1,923,427339,7458/22/332/13/29N. Kraft1,965,769362,1627/10/345/11/29N. Kraft2,005,996541,1636/25/356/1/311954 U.S. Tax Ct. LEXIS 310">*333  Of the above patents, the following were acquired by Kraft (Ill.) or predecessor companies after the dates of their issue from other companies in connection with the acquisition of such companies or of the assets of such companies:Owning company which or assets of which wereDate of acquisitionPatent No.acquired by Kraft (Ill.)by Kraft (Ill.)1,258,438P. E. Sharpless CompanyNov. 1, 1924.1,522,793Velveeta Cheese CompanyAug. 12, 1927.1,522,794SameSame.1,368,624Phenix Cheese CorporationFeb. 10, 1928.1,374,141SameSame.Reissue   15,6481,389,095SameSame.1,389,577SameSame.1,484,945SameSame.1,500,478SameSame.1,500,494SameSame.1,508,019SameSame.1,748,781SameSame.(applicationpending)1,579,196E. W. CoonNov. 1, 1928.The Kraft cheese business was originally begun in Chicago, Illinois, as the individual enterprise of J. L. Kraft.  He had formerly been 21 T.C. 513">*525  a partner in the Shefford Cheese Company, in Buffalo, New York.  In 1954, he withdrew from that partnership and started his individual operations in Chicago.  The business was a "little one-horse business, with one horse and a wagon." He brought one of his brothers1954 U.S. Tax Ct. LEXIS 310">*334  from the Buffalo area to run his factory.In 1909, he was joined by another brother, and on November 26, of that year, the business was first incorporated, under the laws of Illinois, as J. L. Kraft and Bros. Company.  On May 1, 1918, Kraft Brothers Cheese Company was incorporated under the laws of Wisconsin, to which J. L. Kraft and Bros. Company transferred certain of its Wisconsin assets and then distributed the stock received therefor among its own stockholders. In 1921, J. L. Kraft and Bros. Company and certain of its stockholders acquired interests in Jacob Marty Company, a Wisconsin corporation.  Jacob Marty Company was a cheese assembling company and also manufactured swiss cheese. In 1920, Penn-Kraft Cheese Company was incorporated under the laws of Pennsylvania, the stockholders of J. L. Kraft and Bros. Company taking approximately 86 per cent of its common stock.On September 20, 1924, Kraft Cheese Company was organized under the laws of Illinois, and into it were consolidated the businesses and assets of J. L. Kraft and Bros. Company, Kraft Brothers Cheese Company, Jacob Marty Company, and Penn-Kraft Cheese Company, the stock of the Kraft Cheese Company being issued 1954 U.S. Tax Ct. LEXIS 310">*335  to the stockholders of the consolidated companies on the basis of their shares in such companies.  In 1928, the Kraft Cheese Company acquired the assets of Phenix Cheese Corporation and on February 28, 1928, changed its name to Kraft-Phenix Cheese Company.Kraft-Phenix Cheese Corporation, generally referred to herein as Kraft (Ill.), was organized under the laws of Illinois, on November 10, 1928, and took over the business and assets of Kraft-Phenix Cheese Company, as well as the business and assets of certain other companies acquired, or the acquisition of which was completed, during the latter part of 1928.  The Kraft-Phenix Cheese Company continued in existence under the name of "K-P-C Company" until it was dissolved on June 25, 1931, but did not function after its properties were transferred to Kraft (Ill.) in 1928.Prior to the sale of its business and assets to National Dairy on May 21, 1930, Kraft (Ill.) or its predecessor companies had acquired the stock or assets and business of various companies, as follows: 221 T.C. 513">*526 Nature ofconsideration paidDate ofacquisition orName of corporation or business acquiredCommoncompletion ofstock atacquisitioncurrentmarket value11/1/24P. E. Sharpless Co3/31/25Kraft MacLaren Cheese Co. Ltd$ 1,039.610.006/17/25C. D. Reynolds Co26,656.008/31/25Burton Creamery Co5/20/26C. A. Straubel Co8/12/27Velveeta Cheese Co5/12/27H. F. Laabs Cheese Co2/26/27Maltoa Products Co2/3/28A. E. Wright Co722,112.002/10/28Phenix Cheese Corporation4,725,000.002/11/28Milani Company83,850.003/10/28Brodhead Cheese & Cold Storage Co186,534.0012/31/28Badger Cheese Co90,000.0011/20/28Companies combined into1,225,546.88Miller-Richardson Company, Inc.:B. B. Miller & SonRichardson & CoT. W. McGrath & SonLowville Cheese CoJohn S. Martin & CoW. J. Peach & SonJacob VogtR. J. ChandlerW. J. Benjamin & SonW. H. McCadam & SonCompanies combined intoKarlen-Bickelhaupt Co.:Adam BickelhauptJ. Karlen Cheese Co., IncLowville Cold Storage Co12/31/28Birnamwood Wittenberg Milk Co39,375.0012/31/28Chicago National Cheese Co256,308.6812/31/28E. W. Coon656,250.0012/31/28Sheboygan Cheese Co116,640.0012/31/28Peacock Cheese Co55,125.0012/31/28S. J. Stevens Co36,750.0012/31/28Lexington Purity Creamery74,970.0012/31/28F. N. Mills24,000.0012/31/28Potsdam Creamery Co18,000.0012/31/28St. Lawrence County Dairies, Inc60,000.006/29/29Ward Dry Milk Co895,312.507/31/29Cloverleaf Creameries, Inc512,000.009/30/29Gilbert J. Easton, Inc2,800,000.009/27/29Buflolac Corp191,272.2510/21/29Crawford Farms, Inc69,500.0010/30/29Henard Mayonnaise205,537.5010/30/29Atlas Dry Milk Co27,268.0010/30/29Sauquoit Valley Dairy Co., Inc260,500.0011/30/29Gelfand Mfg. Co664,125.0012/31/29Missoula Creamery, Inc8,600.0012/31/29Red Rock Dairy430,000.004/21/25International Wood Products Co245,428.5011/30/29International Wood Products Co824,400.0012/31/29Sentinel Creamery, Inc30,100.001929John E. Cain193,200.003/31/30Tuttle Cheese Co214,000.001954 U.S. Tax Ct. LEXIS 310">*336 Nature ofconsideration paidDate ofacquisition orName of corporation or business acquiredcompletion ofCashacquisition11/1/24P. E. Sharpless Co$ 208,000.003/31/25Kraft MacLaren Cheese Co. Ltd300,300.006/17/25C. D. Reynolds Co8/31/25Burton Creamery Co70,000.005/20/26C. A. Straubel Co402,000.008/12/27Velveeta Cheese Co24,825.005/12/27H. F. Laabs Cheese Co83,000.002/26/27Maltoa Products Co249,725.002/3/28A. E. Wright Co2/10/28Phenix Cheese Corporation2,397,422.002/11/28Milani Company3/10/28Brodhead Cheese & Cold Storage Co12/31/28Badger Cheese Co38,500.0011/20/28Companies combined intoMiller-Richardson Company, Inc.:B. B. Miller & SonRichardson & CoT. W. McGrath & SonLowville Cheese CoJohn S. Martin & CoW. J. Peach & SonJacob VogtR. J. ChandlerW. J. Benjamin & SonW. H. McCadam & SonCompanies combined intoKarlen-Bickelhaupt Co.:Adam BickelhauptJ. Karlen Cheese Co., IncLowville Cold Storage Co12/31/28Birnamwood Wittenberg Milk Co12/31/28Chicago National Cheese Co1 200,000.0012/31/28E. W. Coon76,733.2512/31/28Sheboygan Cheese Co12/31/28Peacock Cheese Co12/31/28S. J. Stevens Co12/31/28Lexington Purity Creamery12/31/28F. N. Mills12/31/28Potsdam Creamery Co12/31/28St. Lawrence County Dairies, Inc6/29/29Ward Dry Milk Co7/31/29Cloverleaf Creameries, Inc9/30/29Gilbert J. Easton, Inc9/27/29Buflolac Corp10/21/29Crawford Farms, Inc10/30/29Henard Mayonnaise10/30/29Atlas Dry Milk Co10/30/29Sauquoit Valley Dairy Co., Inc11/30/29Gelfand Mfg. Co82,000.0012/31/29Missoula Creamery, Inc12/31/29Red Rock Dairy4/21/25International Wood Products Co11/30/29International Wood Products Co12/31/29Sentinel Creamery, Inc1929John E. Cain3/31/30Tuttle Cheese Co1954 U.S. Tax Ct. LEXIS 310">*337 Nature ofconsideration paidDate ofacquisition orName of corporation or business acquiredcompletion ofTotalacquisition11/1/24P. E. Sharpless Co$ 208,000.003/31/25Kraft MacLaren Cheese Co. Ltd1,339,910.006/17/25C. D. Reynolds Co26,656.008/31/25Burton Creamery Co70,000.005/20/26C. A. Straubel Co402,000.008/12/27Velveeta Cheese Co24,825.005/12/27H. F. Laabs Cheese Co83,000.002/26/27Maltoa Products Co249,725.002/3/28A. E. Wright Co722,112.002/10/28Phenix Cheese Corporation7,122,422.002/11/28Milani Company83,850.003/10/28Brodhead Cheese & Cold Storage Co186,534.0012/31/28Badger Cheese Co128,500.0011/20/28Companies combined into1,225,546.88Miller-Richardson Company, Inc.:B. B. Miller & SonRichardson & CoT. W. McGrath & SonLowville Cheese CoJohn S. Martin & CoW. J. Peach & SonJacob VogtR. J. ChandlerW. J. Benjamin & SonW. H. McCadam & SonCompanies combined intoKarlen-Bickelhaupt Co.:Adam BickelhauptJ. Karlen Cheese Co., IncLowville Cold Storage Co12/31/28Birnamwood Wittenberg Milk Co39,375.0012/31/28Chicago National Cheese Co456,308.6812/31/28E. W. Coon732,983.2512/31/28Sheboygan Cheese Co116,640.0012/31/28Peacock Cheese Co55,125.0012/31/28S. J. Stevens Co36,750.0012/31/28Lexington Purity Creamery74,970.0012/31/28F. N. Mills24,000.0012/31/28Potsdam Creamery Co18,000.0012/31/28St. Lawrence County Dairies, Inc60,000.006/29/29Ward Dry Milk Co895,312.507/31/29Cloverleaf Creameries, Inc512,000.009/30/29Gilbert J. Easton, Inc2,800,000.009/27/29Buflolac Corp191,272.2510/21/29Crawford Farms, Inc69,500.0010/30/29Henard Mayonnaise205,537.5010/30/29Atlas Dry Milk Co27,268.0010/30/29Sauquoit Valley Dairy Co., Inc260,500.0011/30/29Gelfand Mfg. Co746,125.0012/31/29Missoula Creamery, Inc8,600.0012/31/29Red Rock Dairy430,000.004/21/25International Wood Products Co11/30/29International Wood Products Co1,069,828.5012/31/29Sentinel Creamery, Inc30,100.001929John E. Cain193,200.003/31/30Tuttle Cheese Co214,000.001954 U.S. Tax Ct. LEXIS 310">*338 The total net tangible assets of the corporations and businesses listed in the foregoing paragraph, as described by their respective books of account at the accounting date next preceding their acquisition by Kraft (Ill.), was $ 10,967,802.36.  The total price paid by Kraft (Ill.) to acquire these businesses exceeded said aggregate book value by $ 10,172,674.20, indicating that such aggregate book value was approximately 52 per cent of the total net consideration paid.  Five of those businesses owned some patent rights, namely, P. E. Sharpless Company, Velveeta Cheese Company, Phenix Cheese Corporation, 21 T.C. 513">*527  E. W. Coon, and Ward's Dry Milk Company.  Excluding those businesses, the total net consideration paid was $ 12,156,033.81, of which $ 6,531,165.981954 U.S. Tax Ct. LEXIS 310">*339  equaled the book value of net tangible assets.The assets of the Phenix Cheese Corporation at December 31, 1927, approximately 6 weeks prior to acquisition by Kraft Cheese Company, as shown by its consolidated balance sheet, amounted to $ 5,325,536.25.  Its liabilities, exclusive of common and preferred stock and earned and capital surplus, were $ 2,363,619.85.  Among its assets, were cash, $ 208,272.92; notes and accounts receivable, $ 1,154,800.64; inventories, at cost, $ 2,548,621.50; land, buildings, machinery, and equipment, at cost, less provision for depreciation, $ 1,273,945.61.  The balance sheet showed no amount for patents and carried no item designated as goodwill.Generally, the term "cheese" when used in the United States without descriptive or qualifying words means cheddar cheese. It is quite commonly referred to as American cheese.In the manufacture of cheddar cheese, the cheese maker starts with milk received from the farmers.  The milk may or may not be standardized to reach a definite predetermined fat content and it may or may not be pasteurized.  The better the milk, the better the cheese. Due to the fact that the milk delivered to cheese factories is not 1954 U.S. Tax Ct. LEXIS 310">*340  uniform, great skill and knowledge on the part of the cheese maker is required.  The usual tests are "the metal and blue tests, the acid test and usually and probably the most accurate one is just the smell." An acid or sour smell usually indicates a milk which will have a bad effect on the quality of the cheese.The milk is placed in a large vat and at or shortly thereafter a starter is stirred into the milk. The starter, which has been grown in sterilized milk, is a bacterial culture of organisms which will develop acid.As soon as the starter-induced acid development has taken place to the desired degree, usually after 30 minutes to 1 hour, a water solution of rennet is added.  Rennet is an enzyme extract taken from the stomachs of young calves and used to coagulate milk.If it is desired to market the cheddar cheese as a yellow cheese rather than a white cheese, coloring matter is added to the milk before coagulation.After approximately 30 to 40 minutes the milk is coagulated and forms a semisolid mass, with a consistency something like custard.  After the curd has coagulated, it is cut into cubes approximately a quarter to three-eighths of an inch on a side.  This is done by1954 U.S. Tax Ct. LEXIS 310">*341  pulling knives with horizontal and vertical wires lengthwise of the vat so that the curd is in long, slender ribbons.  The curd is then cut crosswise with the vertical knives.21 T.C. 513">*528  Up to this point, the milk and curd have been kept at a temperature of approximately 86 to 88 degrees Fahrenheit.  Soon after the curd particles are formed, additional heat is applied slowly and the acid development is watched to determine when the curd reaches the proper degree of firmness.  At this stage the curd is floating in liquid whey, and after the particles thereof have settled to the bottom of the vat and have been pushed to the sides of the vat, the whey is drawn off.When the separation of the curd from the whey is completed and the curd particles have matted together or adhered to each other, the curd is cut from side to side of the vat in strips 12 to 16 inches wide and piled on top of each other at the sides of the vat.  This piling is an important stage in the manufacture of cheese and is referred to as the cheddaring operation.  Strips of curd are piled, turned, and repiled, during which operation the acid development continues.When the curd has developed the proper body, it is milled, 1954 U.S. Tax Ct. LEXIS 310">*342  by placing the slabs into a mill which reduces the curd to small pieces approximately 1/2 by 1/2 by 2 inches in size.  After the curd has been milled, it is agitated or forked and salt is added.  The salt is sprinkled on and allowed to dissolve and work its way into the curd.In a comparatively short time, the curd is ready to go into hoops, which are metal containers shaped somewhat like buckets and lined with cheesecloth.  The hoops containing the curd are fitted together and placed in a press, where pressure is applied.  After being pressed, usually over night, the curd or cheese is removed from the press and from the metal hoops and is placed upon shelves for drying.  The cheesecloth adheres to the cheese. The drying period usually lasts for 3 or 4 days.  After the cheese has dried, it may be sold to an assembler.  Otherwise it is usually coated with paraffin and placed on shelves or in wooden or cardboard cheddar boxes for curing.  The paraffin is applied by immersing the cheese, with the cheesecloth still around it, in melted paraffin.  Sometimes the cheese is placed on the shelves for curing before the paraffin is applied.  In such cases it is dipped in paraffin when it has1954 U.S. Tax Ct. LEXIS 310">*343  cured to the desired degree.  The curing actually starts as soon as the curd is coagulated.  The primary purpose of the 4 or 5 days of drying is to get the surface of the cheese dry so that the paraffin will stick to it.In milk, casein is in a colloidal form and butterfat is present in minute globules floating inside the milk. When rennet is added, the colloidal proteins, primarily casein, form a gelatinous mass and the fat globules are trapped in the body of the coagulated mass.  When acid is developed and heat is applied, the coagulated casein contracts with a resultant expulsion of whey. The cheese mass itself is made up primarily of casein, with entrapped butterfat and approximately 36 21 T.C. 513">*529  or 37 per cent moisture.  The whey which has been expelled is approximately 93 1/2 per cent water.  The remaining 6 1/2 per cent consists of solids made up of soluble proteins -- mostly albumens -- milk sugar or lactose, and certain soluble milk minerals.The coating of cheese with paraffin reduces the shrinkage and loss of moisture on the surface of the cheese and thus inhibits rind formation.At and prior to the beginning of the Kraft cheese business by J. L. Kraft in Chicago, in 1954 U.S. Tax Ct. LEXIS 310">*344  1904, the cheese business was generally a bulk cheese business and there was practically no packaged cheese of the cheddar variety on the market.  J. L. Kraft, while a partner in the Shefford Cheese Company, had devised a cylindrical 4-ounce package of cheddar cheese. This was nothing more than ground-up cheddar cheese, formed into a roll.  It was sold under the name of "Shefford's Snappy Cheese."In 1904 and for some years afterwards, the bulk cheese business was handled in the main by the large meat packing concerns.  They used the cheese as a leader in their line of merchandise and sold it at a low gross profit.  They distributed their products through branch houses and by car routes.  The car route method involved the use of refrigerator cars on railroad lines which were stopped at small towns long enough to sell to a few retail merchants, after which the car would be moved on to the next town.  Since the cheese was very perishable, it was necessary to use refrigerator cars, particularly in the summer.The natural cheddar cheese was produced and sold in a number of different sizes.  The Young American weighed approximately 10 pounds, the Longhorn weighed from 12 to 13 pounds, 1954 U.S. Tax Ct. LEXIS 310">*345  the Daisy 20 pounds, the Flat 30 pounds, and the traditional Cheddar approximately 60 pounds.The wheels of natural cheese were generally placed on the counter in the grocery store.  If the weather was warm, the cheese would melt or oil off.  If the weather was cold, the cheese would dry up, so that the grocer almost invariably would have to cut off the dry slice and throw it away before cutting a piece for the customer.  Some grocers kept the cheese under a glass bell.  While this protected the cheese from the flies, it did not protect it from the variable weather conditions.  Some of the stores had ice refrigerators, but natural cheese would still dry out, even when kept in such a refrigerator.  In the refrigerator, it also had a tendency to develop a mold more quickly than if it had been kept outside.  In cutting a wedge from a wheel of natural cheese, the grocer was faced with the difficulty of estimating the weight desired.  If he cut more than the amount requested, the customer normally expected to receive the surplus without paying for it.  If he cut less, the customer was likely to be displeased.21 T.C. 513">*530  Natural cheese, as it comes from the factory, is not uniform in quality. 1954 U.S. Tax Ct. LEXIS 310">*346  No two manufacturers make cheeses identical in quality, and no single factory would normally produce cheeses identical in quality on 2 successive days.  This is due, to a substantial extent, to the variation in the milk. Cheese made in the period from June until the end of October is normally referred to as grass cheese and is generally regarded as being of better quality than cheese made during the winter months, which is referred to as fodder cheese. As a result, many of the cheese factories would close in the autumn and would not reopen until May of the following year.  Grass cheese commanded a higher price than fodder cheese.At or following incorporation of its business in 1909 Kraft, in addition to bulk cheese, was selling packaged cheese, which included cream cheese, Neufchatel cheese, a variety called Appetitos, Tasty cheese, Hand cheese, and one or two other specialties of lesser importance.  The cream cheese was a 3-ounce, tin-foil-wrapped package. The Neufchatel was a 3-ounce round package. Tasty cheese was comparable to Shefford's Snappy Cheese and was put in both 3-ounce and 4-ounce rolls.  Appetitos was a ground-up mixture and might include Limburger, brick cheese, 1954 U.S. Tax Ct. LEXIS 310">*347  or certain types of American cheese, together with spices and caraway seeds to give it a strong flavor.The packaged cheeses were very perishable and during the summer months sales were practically impossible because of their rapid deterioration and the lack of adequate refrigeration facilities in the retail stores.  They were not ordinarily shipped more than an 18-hour distance from Chicago, and the maximum period for which they would keep was about 2 weeks under refrigeration.  The margin of profit on packaged cheese ran about 25 per cent to 30 per cent gross.  In the summertime, the volume of packaged cheese was perhaps about 20 per cent of the wintertime volume, and during the summer months salesmen were frequently called upon to pick up and take back cheese which had spoiled, become oily or rancid, or had blown up.In the early period the dollar volume and tonnage of sales of J. L. Kraft and Bros. Company consisted of approximately two-thirds bulk cheese and one-third natural packaged cheese. Of the bulk cheese business, approximately two-thirds consisted of buying and selling on its own account.  The other one-third was handled on consignment from country factories.  Both operations1954 U.S. Tax Ct. LEXIS 310">*348  required a particular knowledge of the needs of the particular customer.  When bulk cheese was received at the Chicago plant, substantial reconditioning was necessary, such as waxing and frequently reboxing.  The customers for the bulk cheese were generally the larger and better type of retailers and a few small jobbers in or near Chicago.  The cheese was customarily delivered to out-of-town customers by freight.  On certain days 21 T.C. 513">*531  of the week refrigerated pool cars were available to most of the big markets.  At other times, particularly for the short hauls in winter and on certain days in the summer, the company would ship by ordinary freight.The perishable nature of natural cheese being one of the drawbacks and major difficulties to the development and operation of a cheese business, J. L. Kraft and Bros. Company, and J. L. Kraft in particular, devoted considerable attention to the problem of improving the keeping qualities of cheese. Due to the growth of bacteria in cheese, a continuous change is taking place, first bringing about improvement in the cheese and subsequently its deterioration.  Such action of bacteria could be arrested by pasteurization or sterilization, 1954 U.S. Tax Ct. LEXIS 310">*349  but the application of heat to a mass of cheese or ground cheese generally resulted in oil separation and upon cooling the mass would not revert to a state resembling its natural state prior to the application of the heat.  A process to overcome this difficulty was developed, and on June 6, 1916, United States Patent No. 1,186,524, covering that process, was issued to J. L. Kraft.  The patent was reissued as United StatesReissue No. 14,777, on December 23, 1919.  The life of a patent and its reissue is 17 years from the date of issue of the original patent. One of the claims of this patent was that it destroyed all bacteria.  The process covered the grinding of the cheese, the heating thereof, its agitation while being so heated and the placing of the heated mass in sealed containers.  The heating arrested the curing of the cheese at the state it was in at the time the heat was applied and prevented further changes from taking place.  The continuous agitation prevented the separation of oil or fat from the mass, or worked the oil or fat back into the mass, leaving flavor and texture substantially the same as it was before treatment.  This product was first introduced to the trade1954 U.S. Tax Ct. LEXIS 310">*350  in 1915.  The containers used were tin.Large quantities of cheese were processed by Kraft for the United States Army during World War I, and placed in 8-pound tins.While the putting of the cheese in tins was an expensive process and some difficulty with the keeping quality of the smaller size tins was met, the product had a popular reception in the trade, particularly in more remote areas, such as mining camps and other out-of-the-way places, and in the South.  This was due to the fact that the product would not spoil, but would keep indefinitely.  There was a wider margin of profit on tinned cheese than on bulk cheese.On January 31, 1917, L. E. Carpenter and E. E. Eldredge filed an application for a patent on the sterilization of cheese. Phenix Cheese Corporation, sometimes referred to as Phenix, was owner by assignment of the application.  On July 30, 1919, there was pending in the Patent Office an interference proceeding between the said application 21 T.C. 513">*532  and the original KraftPatent No. 1,186,524 involving the priority of invention of that process.  On July 30, 1919, J. L. Kraft and J. L. Kraft and Bros. Company entered into an agreement with Phenix under which Phenix1954 U.S. Tax Ct. LEXIS 310">*351  conceded priority to J. L. Kraft and agreed to file such a concession in the Patent Office.  Under that agreement, Phenix received a royalty-free license to practice the Kraft invention, including unlimited rights under all reissues, extensions, and divisions of patents growing out of the Kraft patent or under all inventions and improvements in sterilizing cheese which Kraft3 might thereafter own or control.  Phenix granted Kraft like license rights under all applications then owned by Phenix relating to the art of sterilizing cheese.On August 24, 1920, a second patent, No. 1,350,870, covering the sterilization of cheese by "retorting," was issued to J. L. Kraft.  This method differed from the prior method in that the cheese was heated twice.  The first heating was at a lower temperature for the purpose of placing it in the sealed containers.  The cheese was then sterilized by1954 U.S. Tax Ct. LEXIS 310">*352  subjecting the tins or other containers in which it had been placed to substantially higher temperatures than were applied at first.  Fat or oil separation did not occur when the containers were subjected to the higher temperature.One of the difficulties with the tinned cheese was its lack of uniformity, which was due to a comparable lack of uniformity in the natural cheeses which were processed. On December 2, 1919, Patent No. 1,323,869 was issued to J. L. Kraft to cover a process for the blending of natural cheeses from two or more batches of such natural cheeses. Under this process the manufacturer could select from the inventory of natural cheese on hand the proper quantities of each, so as to result in a processed cheese that would be uniform throughout the year.  A uniform product with a uniform flavor resulted.  Operation under this process required great skill in the selection of the various grades of bulk cheese and the proportions thereof, which, upon melting, mixing, and blending, would produce an end product of constant flavor and texture.  The work of selecting the various cheeses to be used in a single batch and the proportions therefor required the talent of a master1954 U.S. Tax Ct. LEXIS 310">*353  blender.After 1921, the putting of cheese in tins was substantially reduced.  This came about by the development of a new packaging method and the packaging of the cheese at a different point in the course of its processing. The first of these new packages has been commonly denominated the 5-pound loaf.  It was packaged in a wooden box, lined with foil. The loaf was what might have been termed the sandwich bread size, and was approximately 11 1/4 inches by 3 1/2 inches.21 T.C. 513">*533  The development of the processed loaf came from taking the cheese at various intervals from a batch which was being processed for packaging in tins and observing the body and pull of the cheese at the earlier stages.  In processing cheese for packaging in tins, the heat was carried to the point where the body would be broken and the cheese would become "spready and soft." "It would pour instead of string." A good blend of cheese would have more or less of a taffy consistency.  The result was that when a batch of tinned cheese was completed it had no strand at all.  It would spread somewhat like cream cheese; it could not be sliced.  The 5-pound loaf was packaged before it reached that state in its processing. 1954 U.S. Tax Ct. LEXIS 310">*354  Also, over the years of testing a check would be made back over the raw material to see what batches produced the particular strand.  The result was a loaf of cheese which could be sliced; it would not stick to the knife blade.  In the course of processing, the time for packaging the 5-pound loaf was determined by the appearance and temperature of the mass and by the body and texture of the product in the kettle.  If it still had some body or string and would not flow off the paddle, that was a good indication.Before the filling of the box with cheese, the box was lined with the main body foil, with ends of this foil folded back over the sides.  Smaller pieces were similarly placed in the ends of the box, with enough length to lap over the top of the loaf and seal with the main body foil. As the cheese cooled after being placed in the box, the foil adhered to the cheese, giving a complete foil-to-foil seal.  This afforded added protection, since the air did not come in direct contact with the cheese itself.  After the box was filled and the foil folded over the top, the wooden cover was then nailed on.During the early operations and for the purpose of packaging the 5-pound loaf1954 U.S. Tax Ct. LEXIS 310">*355  the kettle was elevated over a belt or conveyor, along which the boxes which had already been lined with foil would move.  The cheese being packaged having a more or less heavy body, would permit a man stationed below the kettle to catch a batch of the cheese in his hands and flip it into the box.  After the box moved on, each box would be weighed and the quantity of cheese necessary to bring the loaf to the 5-pound weight would be put in or taken out.  An experienced operator could so nearly determine the amount of cheese needed to make 5 pounds that there was very little adjusting to do.  Subsequently, however, a dough divider, built in Ohio by a bread equipment company, was used until a better device was provided.  A patent, United States Patent No. 1,400,171, covering the processing of cheese as used in the 5-pound loaf, was issued to J. L. Kraft on December 13, 1921.21 T.C. 513">*534  The 5-pound loaf was introduced to the trade in the autumn of 1920, and was a successful product from the beginning.  Starting in November of 1921, it was advertised on a nationwide scale.  It was a long-keeping cheese and did not have to be kept under refrigeration.  It was not characteristically a consumer1954 U.S. Tax Ct. LEXIS 310">*356  package of cheese, but was essentially a package for the retailer.  For him, the difficulties of spoilage, shrinkage, rancidity, and mold inherent in natural bulk cheese were avoided.  It minimized the loss theretofore incurred upon cutting slices, since the foil wrapper was marked so that he could judge the weights when cutting off a piece or slice for a consumer.  Under normal conditions, the cheese did not form a rind.The 5-pound loaf was subject to competition by manufacturers who cut out blocks of natural cheese, wrapped them in foil, and used various methods to attempt to make the foil adhere to the cheese. Although these blocks of natural cheese were marketed at a price much lower than the Kraft 5-pound loaf, they were not a successful product because they were subject to all the drawbacks of the old perishable and variable natural bulk cheeses. Some manufacturers, finding competition with the 5-pound loaf difficult, conducted a program of attacks on the product, attempted to obtain discriminatory legislation against it and by publicity campaigns assailed its quality.On July 5, 1927, an application for patent on a machine for lining boxes was filed by Wayne E. Vesey, assignor1954 U.S. Tax Ct. LEXIS 310">*357  to Kraft.  The end purpose sought was an automatic method of inserting foil liners in the 5-pound loaf cheese box.  Under the Vesey application, United States Patent No. 1,767,193 was issued on June 24, 1930.  The mechanism covered placed the main body foil in the box, but the side pieces of foil were still inserted by hand.  Only 2 machines were built.  They were used for about a year, were not successful, and all work on them was stopped in 1930.  Kraft was never able to devise a machine to insert foil liners satisfactorily in the 5-pound box.It was not possible to process swiss cheese commercially by heat and agitation alone.  When heat was applied the cheese would oil off and the agitation would not work the oil back into the protein mass, so as to result in a product resembling natural cheese in texture and quality.  This was also true of American cheese, which was very young or had an extremely high acid body.  It was discovered that by using various chemical salts as emulsifiers this difficulty could be overcome.  The use of the salts made it possible to process swiss cheese for the first time, and in the processing of American cheese, to use in the blends young cheese and1954 U.S. Tax Ct. LEXIS 310">*358  highly acid cheese which could not theretofore be used.  Processing by the use of emulsifiers was first covered by United States Patent No. 1,368,624, issued on February 15, 1921, to G. H. Garstin.  A second patent, providing for the use of emulsifier 21 T.C. 513">*535  salts, was issued as United States Patent No. 1,374,141 on April 5, 1921, to Eldredge.  This latter patent was given a Reissue No. 15,648 on July 10, 1923.  It was later found that 5 of the claims in the Garstin patent had been anticipated by Eldredge.  Both patents, however, were assigned to and became the property of Phenix Cheese Corporation.  Two other patents relating to the processing of cheese by the use of emulsifiers were issued in 1921.  These patents were issued to Eldredge and Carpenter, United States Patent No. 1,389,095, on August 30, 1921, and United States Patent No. 1,389,577, on September 6, 1921.  Phenix likewise became the assignor of these patents.The actual chemical reaction which takes place where emulsifiers are used is not known, but the effect is to aid in making the cheese homogeneous when heat is applied.  The sodium phosphates, the citrates, and the tartrates are all of the salts commercially used1954 U.S. Tax Ct. LEXIS 310">*359  in the processing of bulk cheese and the phosphates are the salts most generally used.On December 12, 1922, J. L. Kraft and Bros. Company and Phenix executed a new patent agreement modifying and superseding the licensing agreement executed on July 30, 1919.  The new agreement recited that Kraft and Phenix, respectively, were the owners of the following patents:Kraft CompanyPhenix CompanyReissue No. 14,777No. 1,368,624No. 1,323,869No. 1,374,141No. 1,350,870No. 1,389,095No. 1,400,171No. 1,389,577By that agreement each company in substance granted the other a license to make and sell royalty-free the product covered by each and all of its patents, including all reissues, extensions, and divisions, together with like rights under any and all patents thereafter acquired or controlled covering the remaking, pasteurizing, or sterilization of bulk cheese by any process involving the heating of cheese above ordinary atmospheric temperature, the stated intent being that the parties would give and take license rights which were "reciprocal and equal in scope, duration and extent."Many other manufacturers from 1922 on began to produce processed bulk cheese in 1954 U.S. Tax Ct. LEXIS 310">*360  violation of the above patents. On March 6, 1923, an infringement suit was instituted by Kraft against Swift and Company, and about that time Kraft and Phenix publicly advertised their ownership of the 6 patents covering the production of sterilized or pasteurized cheese and warned the trade against infringing products.  Prior to May 21, 1930, Kraft and Phenix instituted 12 infringement lawsuits involving various of the said patents, plus United States Patent No. 1,678,167, issued on June 24, 1928, to Sanford K. Robinson, Kraft-Phenix Cheese Company being assignor.  This patent provided for 21 T.C. 513">*536  the addition of a small quantity of an alkali metal tartrate to cheese in the melting process.  The emulsifiers specified did not prove satisfactory and were little used.  Eight or more infringement suits involving most of the above patents have been filed by the petitioner herein subsequent to May 21, 1930.About 1925, Kraft and Phenix decided that it would be good business policy to license certain of the processing patents to responsible manufacturers, some of whom were already producing processed cheese and infringing those patents. Kraft did not have the manufacturing, sales or 1954 U.S. Tax Ct. LEXIS 310">*361  delivery capacity, access to sufficient raw material, or the capital to take over and retain for itself the potential market for processed cheese products.  Furthermore, the processing operations under the patents were simple enough to invite widespread infringement.  In addition, a number of natural cheese manufacturers and dealers were displaying open and strong hostility toward the new products.  They were carrying on campaigns to convince the consumers that processed cheese was not a good food.  They also attempted to procure the enactment in various States of laws stigmatizing and taxing processed cheese. They advocated labels which would indicate to the housewife that such cheese was unhealthy.  In the circumstances, it was the thought of Kraft and Phenix that by bringing in a substantial group of other manufacturers who had the necessary facilities to process and market cheese under the patents, it would aid in popularizing and winning public approval of processed cheese and help combat the opposition to that product which had developed on the part of certain food officials and manufacturers and dealers in natural cheese. Except for the royalty requirements, the concerns licensed1954 U.S. Tax Ct. LEXIS 310">*362  were, by the license agreements, placed on an equal footing competitively with Kraft and Phenix insofar as the processing of cheese under the patents was concerned.On October 17, 1925, there was pending in a Federal court a suit by Kraft against Brookshire Cheese Company for the infringement of Patents Nos. Reissue 14,777, 1,323,869, and 1,400,171.  There was also pending a suit brought by Phenix against the Brookshire Company for infringement of Patents Nos. 1,389,095, 1,389,577, and Reissue 15,648.  By an agreement made in October 1925, Kraft granted a license to Brookshire under the three Kraft patents, and Phenix granted a license to Brookshire under Patent No. 1,389,095 (referred to in the agreement as the Phenix Swiss Cheese patent) to make and sell processed bulk cheese, but only by the continuous method and apparatus then employed by Brookshire.  The agreement also provided that, so far as the general method and apparatus then used by Brookshire were concerned, the licenses would extend to all United States patents which might be owned or controlled by Kraft and 21 T.C. 513">*537 Phenix.  As consideration for the licenses, Brookshire paid $ 10,000 to Kraft and Phenix jointly and 1954 U.S. Tax Ct. LEXIS 310">*363  was released from all claims for infringement up to and including December 31, 1925, after which it agreed to pay a royalty of 12 1/2 cents per 100 pounds of processed cheese produced.  The agreement also provided for an annual minimum royalty of $ 10,000.  The Brookshire Company was succeeded by Lakeshire Cheese Company, which, in 1928, was acquired by the Borden Company.On May 8, 1926, Kraft and Phenix executed an agreement providing that royalties received under the license agreement involving the above patents, including the license to Brookshire, should be divided 55 per cent to Kraft and 45 per cent to Phenix.On June 4, 1924, Kraft and Phenix filed separate suits for infringement against Pabst Corporation.  On February 23, 1927, the validity of J. L. KraftPatents Nos. Reissue 14,777, 1,323,869, and 1,400,171 was sustained by a decision of the United States District Court for the Eastern District of Wisconsin.  On April 20, 1927, a decree was entered by the same court sustaining the validity of 3 patents owned by Phenix, namely, Nos. 1,389,095, 1,389,577, and Reissue 15,648.  On May 16, 1927, Kraft and Phenix, as licensors, granted a license to Pabst under the patents involved1954 U.S. Tax Ct. LEXIS 310">*364  in the above decisions, and, in addition, Kraft granted a license to Pabst under Patent No. 1,350,870, and Phenix granted a license to Pabst under No. 1,368,624.  Under the licenses so granted, Pabst obtained the right to practice the processes of the said patents, except as to the manufacture of cheese products packaged in hermetically sealed metal cans.  In consideration therefor, Pabst agreed to pay after February 23, 1927, a royalty of 25 cents per 100 pounds of cheese products produced, a minimum royalty of $ 10,000 per year, and $ 250 for each private brand other than that of Pabst which the licensee might elect to use.  Pabst agreed that its plant, facilities, and products could be inspected by experts designated by the licensors for the purpose of maintaining the quality of the cheese products produced.  The licensee agreed not to use a cheddar or American cheese ingredient which contained less than 50 per cent butter fat.  The parties agreed that if the licensors should thereafter grant any license under any of the said patents at terms more favorable than those granted to Pabst, such terms, upon demand, would also be granted to Pabst.On August 31, 1927, Kraft and Phenix1954 U.S. Tax Ct. LEXIS 310">*365  granted a license to Swift and Company under the following patents:KraftPhenixReissue 14, 7771,389,0951,323,8691,389,5771,400,171Reissue 15,64821 T.C. 513">*538  The license granted to Swift and Company the right to practice the processes of the patents, except as to the manufacture of cheese products packaged in hermetically sealed metal cans.  The agreement provided for a sliding scale of yearly royalties of 25 cents per 100 pounds on the first 10,000,000 pounds; 12 1/2 cents per 100 pounds on the next 10,000,000 pounds; and 6 1/4 cents per 100 pounds on production over 20,000,000 pounds. Provisions as to the minimum royalty and the use of the patents were the same as those in the licenses to Pabst.  The licensors agreed to prosecute vigorously suits against infringers and to attempt to maintain a substantial monopoly under the patents licensed.  They also agreed that the total number of licenses to be granted, including the license to Brookshire and the license to Swift, but exclusive of licenses to subsidiary or controlled companies of licensors and to educational institutions, would not exceed ten in number.  The agreement took effect on June 6, 1927, and was1954 U.S. Tax Ct. LEXIS 310">*366  to continue throughout the life of the patents, but could be terminated by breach or default, or cessation of use by the licensee.  The license could be canceled by the licensee on June 6, 1930, by payment of 1 year's royalties measured by the average royalties of the 3 preceding years; and on June 6, 1933, without additional payment and for any reason whatsoever.  Prior to June 6, 1933, the licensee could not dispute the validity of any of the 6 patents. It also had the right to demand license terms as favorable as any granted to any other licensee, except as to the terms granted to Brookshire Cheese Company.By agreement made on or about April 20, 1928, between Kraft and Pabst, a new license was substituted for that entered into between Kraft and Phenix and Pabst on May 16, 1927.  The revised agreement was effective as of September 1, 1927, and in all material respects was the same as the license which had been granted to Swift.Other licenses which were substantially the same in all material respects were granted by Kraft to Anona Cheese Company, as of April 20, 1928, Ladysmith Cheese Company, as of June 1, 1928, and Breakstone Brothers, Inc., as of September 1, 1928.  On or about1954 U.S. Tax Ct. LEXIS 310">*367  February 15, 1928, Kraft and Phenix granted a license under the same 6 patents to Shefford Cheese Company, Inc., and Kingan & Company, Inc.  The royalty rate in the license was one-fourth cent per pound, but in all other material respects the provisions of that agreement were the same as those contained in the license granted to Swift.On May 21, 1930, seven license agreements were outstanding and in force.  Five agreements, namely, those granted to Pabst, Swift, Ladysmith, Anona, and Breakstone, were substantially uniform in their provisions and carried the same sliding scale royalty rates.  The 21 T.C. 513">*539  royalty rate payable by Brookshire and its successors, Lakeshire and Borden, was one-eighth cent per pound, the license being limited to a continuous method of processing. The royalty rate in the Shefford-Kingan agreement was one-fourth cent per pound. None of the licensees was permitted to grant a sublicense.Prior to May 1, 1930, the number of pounds of processed bulk cheese on which royalties were earned and the amount of royalties earned, including amounts payable in respect of past infringements and the amounts payable for the use of private labels, were as follows:YearPoundsAmount1925$ 10,000.00192614,790,19918,487.76192759,616,308139,743.43192857,049,931128,026.52192967,426,373134,719.161930 -- to May 124,779,74644,956.461954 U.S. Tax Ct. LEXIS 310">*368  Except for the provision limiting Brookshire's use of emulsifying salts to the processing of swiss cheese, none of the licenses in effect on May 21, 1930, contained any limitation on the quantity of processed bulk cheese which could be produced by the licensees.  None of the licenses contained any limitation on the size or type of package in which the product could be packed, except that the use of a hermetically sealed metal can was prohibited.  No license agreement then in effect contained any provision permitting the licensors or their agents to inspect the premises of the licensees or their methods of manufacturing.The production of processed bulk cheese by Kraft and its domestic subsidiaries for 1929 was 68,354,151 pounds. The weighted average rate of royalty earned by Kraft in that year from its licenses was $ 0.002002 per pound.As of May 21, 1930, it was reasonable to assume that the royalties from the licensees would continue until December 13, 1938, at a weighted average rate of one-fifth cent per pound of production.  Except for cases in which a licensee was acquired by petitioner or another licensee, or came under common ownership with petitioner, all the licenses continued, 1954 U.S. Tax Ct. LEXIS 310">*369  with some amendments, until the expiration of the boxing patent, No. 1,400,171, in December 1938.In the case of Swift and Company, the license agreement was superseded as of June 6, 1933, by a new license. This new license added the Norman H. Kraft Patent No. 1,965,769.  This patent, which was issued on July 10, 1934, related to a package structure, covered hereafter.  The license to this patent took effect as of July 6, 1933.On July 29, 1935, a license agreement between the petitioner and Borden's Cheese Company, Inc., was substituted for the license which had been granted to Brookshire Cheese Company on October 17, 1925.  Borden's Cheese Company, Inc., was the successor of Lakeshire Cheese 21 T.C. 513">*540  Company, which was formerly Brookshire Cheese Company.  As in the case of the new license to Swift, the Norman H. Kraft Patent No. 1,965,769 was included.In the same manner as in the case of Swift and Borden, the license previously granted to the Shefford-Kingan companies was revised as of June 6, 1933.On July 22, 1936, petitioner granted a license on Patents Nos. 1,323,869, 1,400,171, 1,389,095, 1,389,577, and Reissue No. 15,648 to Nestles Milk Products, Inc., limited to the manufacture1954 U.S. Tax Ct. LEXIS 310">*370  and sale of processed swiss cheese, but not packaged in the block form or rectangular package issued by petitioner.  The royalty rate was 25 cents per 100 pounds and the license ran to December 13, 1938.After May 21, 1930, petitioner instituted infringement suits on Patent Nos. 1,323,869, 1,389,577, 1,400,171, and 1,678,167 and Reissues Nos. 14,777 and 15,648, against Independent Cheese Company et al., Pure Cheese Corporation et al., Southern Gold Cheese Company et al., Tasty Cheese, Inc., and another, Challenge Cream and Butter Association, Cumberland Valley Cheese Company et al., Middle States Cheese & Butter Manufacturing Company et al., and Hygrade Food Products Corporation.  The suits were instituted at dates varying from July 18, 1931, to August 19, 1938.  Some of the defendants ceased to manufacture and vend the products covered; others received licenses or made payments for past infringements.Subsequent to April 30, 1930, the following royalties were earned by petitioner on processed cheese produced by licensees and on private brands used by licensees:YearPoundsRoyaltiesRate perearnedpound1930-8 mos51,214,625$ 100,519.92$ 0.00196193158,662,194104,521.510.00178193259,097,470112,473.760.00190193359,396,93992,073.350.00155193464,398,43582,386.980.00128193571,767,96289,709.970.00125193682,029,175102,749.040.00125193785,788,374116,351.820.00136193893,577,281117,574.500.001261954 U.S. Tax Ct. LEXIS 310">*371  Except as generally stated above, no licenses on which royalties were payable were granted by petitioner, Kraft (Ill.), or their predecessor companies under any patents relating to the processing of bulk cheese or the machinery, apparatus, or packages used in the production of processed bulk cheese. No royalties were earned on any such patents after December 13, 1938.United States Patent No. 1,607,064 was issued November 16, 1926, to E. E. Eldredge.  It was designated "Method of Pasteurizing Cheese." The emulsifiers indicated in the claim were ammonium 21 T.C. 513">*541  tartrate and ammonium chloride.  The emulsifiers indicated have not been used by petitioner from 1934, on.  The extent to which they were used prior to that time, if at all, does not appear.Kraft made a practice of processing bulk cheese for distribution and sale by other parties.  This business was known as the private label business, and in 1929 was carried on only with Armour and Company.  Armour supplied Kraft with the bulk cheese of the necessary type and specified the kind of processed product and size of packaged desired.  Kraft processed the cheese for a fee and the products were distributed and sold by Armour 1954 U.S. Tax Ct. LEXIS 310">*372  to its own customers in its own trade channels and under its own brands.  The processing and packaging charge made by Kraft varied in 1929 from 3 1/2 cents per pound for the American 5-pound loaf, to 6 1/2 cents for certain 1/2-pound packages, the variation in rates being due to the type of processed bulk cheese, the size of the package, and the location of the Kraft plant.  After its organization, the petitioner continued this type of business and, except for 1936, Armour continued as the chief customer in this field.  From 1930 through 1936, cheese was similarly processed in lesser amounts for other concerns.  The cheese so processed by Kraft and its wholly owned subsidiaries, group 1, 4 and by petitioner and its wholly owned subsidiaries, group 1, and the total gross profits, exclusive of Federal taxes, for the years 1929 through 1940, were as follows: 21 T.C. 513">*542 YearPoundsTotal feesGross profit(sales)192911,844,359$ 457,864.42$ 164,201.131930 4 mos4,125,124157,214.0364,435.728 mos9,266,415386,921.88172,632.23193113,813,638487,363.88189,547.34193212,922,175401,293.72148,496.11193312,293,386365,943.11131,603.49193413,125,942444,516.84188,258.7119356,334,522202,133.49100,022.1119361,651,73646,138.5613,403.97193710,878,988370,096.4691,987.42193820,622,411690,469.61183,387.45193917,306,169483,779.32115,402.3019401,131,03832,764.032,977.291954 U.S. Tax Ct. LEXIS 310">*373 1954 U.S. Tax Ct. LEXIS 310">*374  In addition to the private label business, the petitioner and its wholly owned subsidiaries, group 1, made net trade sales of processed cheese to Armour and Company, as follows:Pounds1932170,2111933369,5131934724,58919356,541,334193612,391,47119375,898,235Except for a small amount of sales in cans, the amount of which is unknown, the sales of processed bulk cheese by Kraft (parent company only) and Phenix (parent company only) in 1927 amounted to 60,826,292 pounds. Similar sales by Kraft in 1928 amounted to 57,289,027 pounds, and for 1929, 55,787,232 pounds.The quantity of processed bulk cheese sold by Kraft and its wholly owned domestic subsidiary companies, group 1, and the quantity of such cheese sold by petitioner and its wholly owned domestic subsidiary companies, group 1, the gross profit per pound and the total gross profit thereon, as shown by the books, for the years 1929 through 1938, were as follows:YearPoundsGross profitCents of grossprofit per pound192968,354,151$ 4,667,676.946.83193067,398,2954,838,376.797.18193169,244,6784,058,868.905.86193266,468,4673,010,355.254.53193367,749,6823,266,629.794.82193490,900,7564,162,495.584.581935107,070,9124,734,270.814.421936125,442,0385,909,608.644.711937131,003,8266,088,237.984.651938147,502,1526,386,550.614.331954 U.S. Tax Ct. LEXIS 310">*375  The sales in pounds, total dollar amount of sales, and gross profit from sales of processed American bulk cheese in tins by Kraft and its group 1 subsidiaries, and by petitioner, after it was organized, and its group 1 subsidiaries, for the years 1929 through 1938, were as follows: 21 T.C. 513">*543 YearSales in poundsSales in dollarsGross profit1929221,264$ 115,409.90$ 29,239.641930152,91979,375.0225,298.831931105,84349,988.8417,662.98193258,61126,898.9210,651.36193316,5587,858.043,401.45193430,94320,488.917,276.26193526,39011,470.164,411.23193627,49012,983.535,201.81193722,55820,678.003,389.05193821,68210,382.163,231.17The quantity of unprocessed bulk cheese (other than Kay Natural) sold by Kraft and its group 1 subsidiaries and later by petitioner and its group 1 subsidiaries, the gross profit per pound, and the total gross profit thereon, for the years 1929 through 1938, were as follows:YearSales in poundsCents of grossGross profitprofit per pound192981,098,8241.19$ 963,349.06193075,236,8551.541,159,165.43193179,565,4491.911,520,390.19193284,001,9801.661,395,243.76193387,919,7051.671,470,877.17193488,000,7271.711,505,074.59193591,670,8002.111,938,263.70193689,258,1531.531,367,129.47193795,949,5411.601,533,933.63193899,221,0381.301,293,476.551954 U.S. Tax Ct. LEXIS 310">*376  Under a contract consummated on December 31, 1928, but effective as of December 31, 1927, Kraft (Ill.) purchased the assets and business of Edward W. Coon for a total consideration of $ 732,983.25, of which $ 76,733.25 was paid in cash and $ 656,250 in Kraft stock at the current market value.  The net worth of the business so acquired, as shown by Coon's books of account at December 31, 1927, was $ 834,374.73.  Except for a fire loss claim, and a few small items such as warehouse supplies, automobile and office furniture, a mortgage, and two small prepaid items, the assets shown by Coon's books consisted of real estate, accounts receivable, cheese inventories, and machinery and equipment.  No amount appeared on Coon's books as representing the cost or value of patents.Among the assets acquired from Coon was United States Patent No. 1,579,196, issued to William Edward Coon on March 30, 1926.  The patent covered a process for curing cheddar cheese at specified ranges of temperature and humidity.  By the Coon method cheese could be cured in a substantially shorter time than by the methods commonly used.  Cheese so cured is known in the trade as Coon cheese. In curing cheese under the1954 U.S. Tax Ct. LEXIS 310">*377  Coon patent, paraffin is not applied prior to the curing.  As the curing progresses a greenish black mold forms on the surface of the cheese and when the curing is completed the cheese is 21 T.C. 513">*544  uniformly coated with such a mold.  The cheese is then paraffined over the mold.After acquisition of the Coon business and assets, Kraft cured cheese by the Coon method both for use in the processing of bulk cheese and for sale in its natural state.  While Coon cheese is fairly well known, it is not a very popular cheese when compared with other cheeses. The Coon patent was never licensed and no infringement suits were ever brought based upon it.The general practice of Kraft prior to 1928 or 1929 in cooking cheese for processing purposes was by use of a steam or water-jacketed upright kettle equipped with rotating stirring blades operated by a central shaft and with a valve at the bottom of the kettle whereby the melted cheese could be drawn off.  Where steam was used, the heat was intense and would cause the cheese nearest the walls of the kettle to burn.  The burned cheese would adhere to the kettle walls, forming an insulation which would progressively lengthen the cooking time of1954 U.S. Tax Ct. LEXIS 310">*378  the cheese. It was the practice to clean the cookers after processing every third batch of cheese. The finished cheese would at times contain spots of burned cheese and have a mottled appearance, due to the fact that some of the burned cheese would become dislodged from the walls of the kettle and enter the general mass.  The excessive heat at the walls of the cookers resulting from the use of steam could be overcome, to some extent, by the use of water jackets.  In that case, however, the heat being reduced, the period of time required for the processing of a batch of cheese was substantially extended.The area at and around the valve at the bottom of the kettle was not subjected to the same heat as the rest of the kettle wall and the cheese near the valve would not be cooked as rapidly as the main body of cheese. For that reason, it was necessary, from time to time, during the cooking operation, to withdraw a quantity of cheese from the bottom of the kettle and transfer it back to the top of the cooker, in order to accomplish a complete cooking operation.On August 12, 1927, Kraft acquired all of the stock of Velveeta Cheese Company in a cash transaction of $ 24,825.  At December1954 U.S. Tax Ct. LEXIS 310">*379  31, 1926, the books of account of Velveeta had reflected a total net worth of $ 92,756.97, of which $ 38,205.37 represented patents and $ 54,551.60 net tangible assets.  Velveeta was liquidated on April 1, 1928, at which time its books disclosed a net worth of $ 30,960.79, of which $ 26,509.38 was represented as covering patents, while the remaining $ 4,451.41 was cash.  The company had operated at a net loss for 1926, 1927, and 1928.Among the assets of Velveeta when its stock was acquired by Kraft in 1927 were 2 patents issued to Schaefer and Frey, No. 1,522,793 and No. 1,522,794, both issued on January 13, 1925.  These patents provided 21 T.C. 513">*545  for heating the cheese by the direct injection of steam into the cheese mass.  The cooker utilized was an upright cooker with stirring devices attached to a central vertical shaft.  The steam was injected through three nozzles in the lid of the cooker. Upright cookers utilizing the direct injection of dry steam into the cheese mass were in use by Velveeta.  Some or all of these cookers were moved by Kraft to its Chicago plant, but, so far as appears, they were never used by Kraft.On July 14, 1928, Arthur W. Bell, an employee of Kraft, 1954 U.S. Tax Ct. LEXIS 310">*380  applied for a patent on a horizontal cooking machine, in which agitation was provided by a screw or worm in a trough.  The application as filed contained 10 claims, all relating to a combination of parts.  All claims were rejected as anticipated by prior patents or as not constituting an invention, but merely aggregations of parts which functioned separately.  On July 15, 1929, 2 claims were amended, by inclusion of language relating to a mixing action within the trough, and 2 additional claims were made.  On June 14, 1932, Patent No. 1,862,563 was issued to petitioner as assignee of Bell, covering only the 2 claims as amended.  The claims allowed described an apparatus for treating cheese, with a trough and cover forming a cooking chamber, a heating jacket on the trough, and a rotatable spiral extending lengthwise of the trough and covering only a portion thereof cross section, thereby providing a passageway in the trough above the spiral for permitting a flow of the cheese back along the upper portion of the trough, and with a discharge opening at the end of the trough, it being stated that said trough is adapted to be substantially filled with cheese or to receive a predetermined1954 U.S. Tax Ct. LEXIS 310">*381  load of cheese, the load subjected to heat and circulated longitudinally the trough as an incident to the operation of the rotatable spiral.  The cooker covered by this patent has been referred to as the Bell laydown cooker. In May 1930, Kraft (Ill.) had at most one or two of the Bell cookers in use.In 1890, a patent, No. 430,652, covering an apparatus designed to steam and dry grain, had been issued to George L. Jarrett.  The apparatus included a longitudinal chamber containing a feed-in opening or hopper at one end and a discharge opening at the other.  A tubular conveyor-shaft had a spiral flange and was provided with an opening at one end to admit steam and perforations at its central portion to emit the steam from the shaft into the chamber.  The end result claimed was that the grain would be partially cooked and dried as it passed through the machine and thoroughly prepared for packing, shipping, and storing.Under an application filed September 24, 1923, Patent No. 1,639,8285 was issued on August 23, 1927, to John H. Wheeler and Henry Murray 21 T.C. 513">*546  Scott.  The patent was denominated a "Process For Treating Cheese." It contemplated the use of either the horizontal or 1954 U.S. Tax Ct. LEXIS 310">*382  upright cooker, and provided for the direct introduction of steam into the cheese mass through small jets near the bottom of the vertical shaft in the upright cooker, and through steam inlet ports along the sides of the cylindrical, horizontal cooker, preferably below the longitudinal center line.  The horizontal cooker contained a worm or screw for agitating and moving the cheese mass toward the discharge end of the cylinder, while the upright cooker was equipped with mixing blades attached to the vertical shaft and with an outlet for the processed cheese at the bottom of the kettle.  The process consisted generally of exposing successive particles of cheese momentarily to a flowing jet of steam having sufficient temperature to substantially liquefy the particles during such exposure.Another longitudinal cooker for processing cheese was the Parsons patent, No. 1,522,384, 1954 U.S. Tax Ct. LEXIS 310">*383  issued June 6, 1925, Swift and Company, assignor.  In this cooker the ground cheese was conveyed by a screw filled with vertical tubes containing hot water or some other heating element.At some undisclosed date after the first Bell laydown cooker was built, Kraft began experimenting with ways and means of melting or cooking cheese in such cookers by the direct injection of steam into the cheese mass.  The injection of steam through the lids of the cookers, from the bottom and through the sides, was tried.  Some laydown cookers with injection from the side walls were installed.  One of the difficulties was that burnt cheese would pile up or accumulate on the face of the steam nozzle or valve.  Subsequently, on some date not shown, Norman H. Kraft devised a means whereby the steam could be injected into the cheese mass through radial steam jet nipples mounted on or connected with a hollow shaft journaled in and lengthwise of the cooking chamber.  It is possible that some cookers with the device of so injecting the steam into the cheese mass had been installed by May 1930.  At that date, Kraft was still using upright cookers, to some extent.On June 1, 1931, Norman H. Kraft filed an1954 U.S. Tax Ct. LEXIS 310">*384  application for a patent to cover a cooker in which the steam was injected through radial steam jet nipples mounted on or connected with a hollow shaft, as described above.  The application contained 14 claims, 3 of which were for a method and the remainder for a combination of parts.  The Patent Office required division as to the 3 method claims, and they were canceled by the applicant.  Six other claims were rejected as anticipated by prior patents or as lacking invention.  The applicant added an additional claim on August 15, 1933, and on June 25, 1935, Patent No. 2,005,996 was issued to Norman Kraft, assignor to petitioner.  In 21 T.C. 513">*547  issuing the patent, 5 claims were allowed, which in general provided for the direct injection of steam into the cheese mass through radial steam jet nipples on or connected with a hollow shaft journaled in and lengthwise an elongated cooking chamber, said nipples having closed outer ends and lateral discharge apertures.  The stirring means comprised a worm on and coextensive lengthwise with the shaft.By 1932, the laydown cooker wherein the steam was injected into the cheese mass through nipples on a hollow horizontal shaft, as described in Patent1954 U.S. Tax Ct. LEXIS 310">*385  No. 2,005,996, was in general use in most, if not all, of petitioner's cheese processing plants.  In the meantime, however, it was found that the difficulties previously encountered with the steam nozzle or valve in the side wall of the cooker could be overcome by placing the steam valve in and flush with the side of the trough, so that the blades of the revolving worm or screw would scrape across the end of the valve and keep the surface free of cheese. At or about 1935, the petitioner began replacing the cookers whereby the steam was injected through the central horizontal shaft with the cookers having the steam valves in the side of the trough, as just described.  The changeover was gradual, however, and a few of the old cookers were in use in Canada at the time of the trial herein.All of the above cookers were batch cookers, in that each batch of cheese was completely processed and removed before more natural cheese was inserted for cooking.  The laydown cookers using the direct injection of steam resulted in an improved quality for the finished product.  It had a better color, a better body, and a better texture.  The cooking time for a single batch of cheese was greatly reduced. 1954 U.S. Tax Ct. LEXIS 310">*386  The laydown cookers did not have to be cleaned except at the end of a day's operation.Although the licensees of Kraft under the processing patents produced large amounts of processed bulk cheese, they were not licensees of Kraft under the so-called cooker patents and, insofar as appears, either owned or had rights to use other devices or apparatus for processing bulk cheese.In keeping with the advancing trend in the food industry toward small consumer packages, Kraft introduced a 1-pound package of processed cheese in 1924, and a 1/2-pound package in 1925.  These packages avoided the previous possibilities of product substitution, provided greater convenience for both the retailer and the consumer, and lent themselves to display in grocery stores outside of refrigerators.The first of the small packages described above were packaged in a square cardboard foil-lined box known as a butter print carton.  The package was lined, formed, and closed by a machine made by Peters Machinery Company in such a way that the top side and end flaps of the outer carton were interleaved with corresponding flaps of the inner 21 T.C. 513">*548  liner.  This package did not produce a close seal of the cheese1954 U.S. Tax Ct. LEXIS 310">*387  contained therein and some spoilage resulted from mold and deterioration.  Efforts were made to eliminate the various drawbacks to the packaging of the cheese by the method described.  The shape of the outer carton was changed and a die-cut foil liner devised of such shape that when the formed package was filled, the cheese was completely incased in the foil and was contained within but separate from the outer carton.  The package thus formed was rectangular or oblong in shape.  It was a substantial improvement over the prior package. This package was first placed in production by Kraft in 1927 or 1928.As a result of these experiments and improvements, Norman Kraft filed an application for patent on May 11, 1929, for a "Package and Machine for Making Same." The application contained 20 claims.  By Patent Office action dated February 27, 1930, division was required between the claims directed to an article or package and those directed to a machine. On March 14, 1930, the applicant canceled the 11 claims directed to the machine. On March 26, 1930, the remaining 9 claims directed to a package structure were rejected by the Patent Office as lacking invention over prior patents. 1954 U.S. Tax Ct. LEXIS 310">*388  By amendments dated September 9, 1930, and July 31, 1931, 5 of the 9 claims were canceled.  The 4 claims remaining and 1 of 4 additional claims were allowed.  On July 10, 1934, Patent No. 1,965,769 was issued to Norman Kraft, assignor to Kraft.  The principal objects of the invention were stated to be "to provide a package structure especially adapted to the formation of an impervious wrapper on products which, while in a liquid or soft plastic state, are poured or deposited in the package; to provide an improved package structure which will effectively preserve the contents of the package over long periods of time; and to provide a simple and efficient package structure which adapts itself to forming, filling and closing by automatic means." These objects were to be accomplished by means of a specially designed die-cut foil inner wrapper, with much of the portion which in the conventional wrapper would be folded over the top of the final package cut away, so that in the end the inner wrapper completely lined the bottom, sides and ends of the outer carton, with the front flap of the inner wrapper being of sufficient width to completely cover the top of the cheese when packaged and 1954 U.S. Tax Ct. LEXIS 310">*389  leave thereafter a small portion to be doubled back.  The back flap of the inner wrapper and the end flaps were much narrower comparatively and were only wide enough to make sure of a connecting seal with the wide front flap of the wrapper when folded over the top.  The design of the outer carton was also changed, to some extent, from that of the butter type carton, to the end that the end flaps would in no way interfere with the overlapping, sealing edges of the inner wrapper, and so that neither of the end flaps of the outer carton was interleaved with any part of the inner wrapper which incased the packaged cheese.21 T.C. 513">*549  On May 26, 1930, Norman Kraft filed an application with the United States Patent Office for a patent to cover the 11 claims directed to a machine which had been divided out and canceled from the application under which Patent No. 1,965,768, covering the die-cut foil and carton, was issued.  Under this application, Patent No. 1,916,515 was issued to Norman Kraft, assignor to petitioner, on July 4, 1933.  The main object was to provide a machine for closing filled receptacles embodying the features of the packaging patent, No. 1,965,769.  In working out the features1954 U.S. Tax Ct. LEXIS 310">*390  of the finished machine covered by this patent, the inventor started with the Peters packaging machine. The new features consisted of changes which enabled the finished machine to handle the particular carton and inner wrapper covered by the package patent, No. 1,965,769.  The Peters machine as it could be bought would not handle that package.The die-cut foil package and machine covered by Patent Nos. 1,916,515 and 1,965,769, when introduced, were extended to all the production of pasteurized and processed cheese of Kraft in sizes of 1 pound and under.  The changeover was effected as rapidly as the machines could be converted and the die-cut foil obtained.  After the changeover, the die-cut foil was used continuously by Kraft and petitioner until the discovery of a transparent wrapper. The changeover to the transparent wrapper began in 1940.The die-cut foil package overcame the difficulties experienced with the butter print carton.  It eliminated almost completely the difficulties with mites.  The overlapping fold prevented contamination or deterioration at the edges both in the back and on the sides.  The excessive foil on top was eliminated so that the package could be more 1954 U.S. Tax Ct. LEXIS 310">*391  easily sliced.  There was also a slight saving in the cost of foil because the excess foil cut out remained with the foil company and the credit Kraft received for this salvage more than offset the cost of die-cutting.By agreement with Swift and Company dated December 29, 1934, but effective June 6, 1933; an agreement without date with Shefford Cheese Company, Inc., but effective June 6, 1933; 6 an agreement dated July 29, 1935, but effective June 1, 1935, with Borden's Cheese Company, Inc.; and an agreement dated October 11, 1937, with Challenge Cream & Butter Association, the petitioner licensed its hard cheese processing patents and its package patent, No. 1,965,769.  The agreements provided for a payment of royalty of 12 1/2 cents on each 100 pounds of cheese processed and packaged under the patents. Except in the case of Challenge Cream & Butter Association, a minimum royalty 21 T.C. 513">*550  of $ 5,000 per year was provided to cover all patents, except as otherwise provided.  From and after December 13, 1938, royalties were payable only under unexpired patents and if used.  The agreement with Challenge Cream & Butter Association was the result of a settlement of infringement proceedings1954 U.S. Tax Ct. LEXIS 310">*392  brought by petitioner.  Under that agreement, a minimum royalty of $ 10,000 up to December 13, 1938, was required.  After December 13, 1938, the royalty required was 12 1/2 cents per 100 pounds on all products manufactured by Challenge "according to any of the inventions described and claimed in Letters Patent No. 1,965,769."Cream cheese is a fresh, soft, unripened product made from milk, with the addition of cream.  It has a delicate flavor and is very perishable, being a dairy product with low acid development.  There is no inhibiting action of lactic acid, as in cheddar cheese. In the making of natural cream cheese a culture of lactic acid organisms is added to develop acidity and coagulate the curd. The curd is then placed in a mesh bag, which allows the whey to drain off, after which the curd is salted and formed1954 U.S. Tax Ct. LEXIS 310">*393  into cakes.  This product is sometimes referred to in the trade as coldpack cream cheese. Rennet is sometimes used in very small quantities, but if used in lieu of a lactic acid culture, a tough, flavorless curd would be the result.  Under present day methods, the milk and cream are pasteurized before the starter is added.  Cream cheese must be kept under refrigeration.Prior to 1900 cream cheese was made by the Empire Cheese Company at South Edmeston, New York.  It marketed this cheese under the name Philadelphia Cream Cheese. About 1900, the factory burned and Phenix Cheese Company was formed to carry on the business at the same location.In the early days, cream cheese was packaged by hand.  In the course of the operation the cheese would adhere to the hands, would be smeared on the outside of the wrappers and would have to be wiped from the outside of the packages by cloths.  The manually wrapped packages were uneven in size and shape.  Cheese would be caught between folds of the wrapper, the cake was often marked with fingerprints, and mold would develop within a short time.  It had a trade life of not much over 7 or 8 days.By 1914, Phenix was using a machine for the purpose1954 U.S. Tax Ct. LEXIS 310">*394  of forming the cakes of cream cheese packaged by it.  The cream cheese was extruded from the machine in the form of a ribbon, on to a belt which ran down the middle of the table.  The ribbon was cut into pieces by wire which was actuated by the movement of the belt.  Girls seated on the two sides of the table then picked up the pieces of cheese and wrapped them by hand.  Each girl had a pile of sheets of foil in front of her, and because gloves were too cumbersome for the operation, 21 T.C. 513">*551  the girls handled both the cheese and the foil wrappers with their bare hands.  The wire cutting device was inaccurate.  Cakes varied by an eighth to a quarter of an inch in length.  To assure at least the minimum weight, many of the packages were overweight.  All of the 3-ounce cream cheese packages were formed and wrapped in the manner stated.Prior to its acquisition of Phenix Cheese Company in 1928, Kraft manufactured a 3-ounce package of cream cheese under the name "Blue Ribbon." The cream cheese so packaged and sold was hand wrapped.Breakstone Brothers, Inc., also packaged cream cheese by hand.  It used a Doering butter machine to extrude a ribbon of cream cheese. The ribbon was cut into1954 U.S. Tax Ct. LEXIS 310">*395  cakes or sections by a manually operated bar, to which a number of cutting wires were attached.  The interior sections cut by the wires were of uniform size, but the end pieces were usually off-size and were picked up and thrown back into the worm of the machine. After being cut, the cheese moved on a belt in a cogged track set in a table and was hand wrapped by girls seated along the table.  Breakstone packaged its cream cheese by this method in the 1920's.During the early 1920's, cream cheese was made and sold commercially in the United States by Phenix, Kraft, F. X. Baumert Company in the East, P. E. Sharpless Company in the Philadelphia area, and Blue Label Cream Cheese Company in Illinois.  No other concerns, with the possible exception of one or two small ones, made and sold cream cheese commercially in the United States at that time.  In the late 1920's and afterward, Sodus Cooperative Creamery Company of Walcott, New York, manufactured and sold cream cheese in a 3-ounce foil-wrapped package. The packaging was done by hand.Among the assets of Phenix acquired by Kraft on February 10, 1928, were 4 patents, Nos. 1,484,945, 1,500,478, 1,500,494, and 1,508,019.  These patents1954 U.S. Tax Ct. LEXIS 310">*396  were directed to parts of machines for wrapping small cakes of material such as cream cheese. The cheese would enter the machine through a vertical hopper, in which sections of a worm revolved and which also contained stationary spiral-shaped blades.  The movement of the worm in the hopper forced the cream cheese into a mold which shaped the cake, which was then ejected downward by means of a plunger onto a foil-covered platform carried by a circular turntable.  The turntable carried 6 of such platforms and revolved intermittently, making 6 stops per revolution.  Each of the platforms was perforated and connected with a vacuum.  A vacuum pickup device transported a sheet of tinfoil from a pile and deposited it upon a platform of the turntable in its first position.  At the second position, the formed cake of cream cheese was dropped upon the foil on the platform.  While the turntable was moving to the third position, 21 T.C. 513">*552  2 moving arms acting successively folded the foil over the sides and the top of the cake.  During the movement to the fourth position, 4 folding fingers tucked in the foil at the ends of the cake.  No action took place at the fourth position.  At the fifth 1954 U.S. Tax Ct. LEXIS 310">*397  position, 2 blades moving downward, followed by 2 blades moving upward, smoothed down the end portions of the wrapper. At the sixth position, the wrapped cake was pulled from the platform.  The machine wrapped the small cakes of cream cheese automatically, required the services of only 1 attendant, and produced a more attractive, more accurate size and longer keeping cake of cream cheese than when wrapped by hand.Patent No. 1,484,945 relates to a feed hopper for plastic materials and was issued to Herbert M. Hill on February 26, 1924.  Application for the patent was filed on August 30, 1922.  The claims under this patent were directed to a vertical hopper containing an interrupted spiral thread or worm.  Three sections of the thread revolved and two were stationary.  The purpose of the device was to force plastic cream cheese into a mold.On January 25, 1922, Felix Wyner filed an application with the United States Patent Office for a patent on a folding mechanism.  All claims were rejected on January 28, 1923, as anticipated by earlier patents. Wyner thereafter filed 6 amended claims, 5 of which, after some further amendments, were allowed.  On July 8, 1924, United States Patent1954 U.S. Tax Ct. LEXIS 310">*398  No. 1,500,478 was issued to Wyner on these 5 claims.  Encompassed in the allowed claims were a package wrapping platform on a turntable, folder arms, and the means as described for actuating the folder arms, one at a time, as an incident to the rotation of the turntable through pinions mounted on rocking shafts.On February 6, 1922, an application was filed in the United States Patent Office by Lewis B. Hunter for a patent covering a claimed invention relating "to packaging machines for plastic materials such as cream cheeses, butter, lard, and the like." The specifications set forth described substantially all of the Phenix cream cheese wrapping machine. The application contained 20 claims, and 3 others were later added.  Thirteen claims were rejected as anticipated by prior patents. One of the claims rejected as old in the art was directed to the inclusion of a Geneva wheel to produce intermittent motion.  On July 8, 1924, United States Patent No. 1,500,494 was issued to Hunter allowing the 10 remaining claims.  Claims allowed had to do with a turntable, means for turning it step-by-step, a package wrapping platform mounted on the turntable, a pneumatic holdfast carried by the1954 U.S. Tax Ct. LEXIS 310">*399  turntable and connected to the wrapping platform to secure a wrapper thereon, and a pipe connected to the holdfast and extending away from the turntable to maintain partial vacuum.  Also described were the mechanisms, the arms and pipes, and other parts 21 T.C. 513">*553  having to do with the folding of the wrapper, both longitudinally and at the ends of the cake of plastic material, and the manner in which the various parts operated, the action of the various parts being controlled by or coacting with the movement of the turntable.On August 30, 1922, the same date on which application was filed for the patent later issued as No. 1,484,495, Herbert M. Hill also filed an application which resulted in the issuance to him, on September 9, 1924, of United States Patent No. 1,508,019.  The specification set forth in the application described the complete machine for packaging cream cheese used by Phenix, including the feed mechanism, cake forming and displacing mechanism, the turntable and accessories, the package wrapping platform and ejector mechanism, folding mechanism consisting of 3 separate sets of arms, fingers, and blades, and a pneumatic holdfast for a wrapper. The application as filed1954 U.S. Tax Ct. LEXIS 310">*400  contained 30 claims.  The Patent Office, under date of June 15, 1923, required that the first 11 claims, directed to a molding apparatus, "be divided out," also holding that the molding apparatus claimed was old.  The applicant acquiesced therein and canceled the 11 claims.  By action dated February 9, 1924, the Patent Office required further division of 7 claims pertaining to sheet feeding mechanisms and rejected 4 other claims pertaining to a combination of sheet feeding and wrapping as an exhausted combination.  The applicant, on April 1, 1924, canceled these 11 claims.  The claims as allowed described a turntable rotating step-by-step and a wrapping platform carried by the turntable, so arranged as to stop in a predetermined position; stationary guides upon the framework adjacent to the stop position of the platform; a plunger in the guides; and a pair of blades movable by the plunger so as to engage, fold, and smooth protruding portions of the wrapper, at the stop position of the platform.  Also described were the means of arresting the platform in the predetermined position, folder mechanism carried by the platform for partial wrapping of the package thereon, a pair of blades1954 U.S. Tax Ct. LEXIS 310">*401  carried by the platform for folding down some of the protruding wrapper portions, and a pair of blades supported by the framework and so positioned as to be proximate to the platform when it stopped in predetermined position, these latter blades being movable in relation to the platform, so as to fold other protruding portions of the wrapper; also means for causing the latter blades to follow the movement of the first mentioned blades.In 1921, 1922, and 1923, machines embodying the various items or devices later covered by the Hill, Wyner, and Hunter patents had been delivered to Phenix Cheese Company, and by the spring of 1923, all of the 3-ounce cream cheese of Phenix was being packaged on these machines. The machines were called Potter machines, after the name of the company that built them.21 T.C. 513">*554  The packaging of the cream cheese on the above machines had the following advantages over the packaging of the cheese by hand: (a) It greatly increased the production per man hour, and thus reduced the unit cost of labor; (b) the cake was formed accurately, so that the weight could be closely controlled; (c) the closure of the package was very much better than in the hand-wrapped1954 U.S. Tax Ct. LEXIS 310">*402  package, and the foil adhered closely to the surface of the cheese; (d) there was no cheese smeared on the outside of the package, to pick up bacteria and cause deterioration; (e) because the foil wrappers were not handled by the hands of wrappers, they were not subject to the same contamination as in the case of hand-wrapped packages; (f) the keeping quality or shelf life of the cheese package was more than doubled; and (g) the manufacturer was able to advertise that the cheese was untouched by human hands.No other machine suitable for the packaging of cream cheese was available on the market at the time of the development of the Potter machine, or for many years thereafter.  During the period 1920 to 1930, Phenix, Kraft-Phenix, and Kraft (Ill.) investigated other packaging machines, but found no satisfactory substitute for the Potter machine.Phenix, Kraft-Phenix, Kraft (Ill.), and for sometime after its organization the petitioner, packaged all their 3-ounce cream cheese on the Potter machines. The maximum number of machines in use was in the early 1930's, at which time 22 to 24 were in operation.  Four or five of the machines were in operation at the New Jersey plant of the 1954 U.S. Tax Ct. LEXIS 310">*403  petitioner until December 31, 1949.Late in 1938 or 1939, petitioner first acquired certain Swiss machines, called Kustner machines, for packaging 3-ounce cream cheese in the United States.  The Kustner machine is more rapid than the Potter machine.After the introduction of the packaging machines, the 3-ounce foil wrapped cream cheese business of Phenix increased rapidly.  In 1927, Phenix sold 4,616,703 pounds of 3-ounce foil wrapped cream cheese. In the same year Kraft sold 1,254,067 pounds. The Kraft product was hand wrapped.The savings effected in the packaging of cream cheese by the use of the Potter machine, over the packaging by hand, in both material and cost were sustantial.About 1925, Kraft began to produce a product containing cream cheese mixed with relishes and packed in glass jars.  Due to its perishable nature, it was successfully handled only in the winter months.  About 1927 Kraft, in an effort to improve the keeping quality of the product, installed a Reed sterilizer, by which the cream cheese spreads, after being placed in 6-ounce screwcap glass jars, were immersed on 21 T.C. 513">*555  traveling belts for 30 or 40 minutes in a hot water bath.  Sterilization by this method1954 U.S. Tax Ct. LEXIS 310">*404  was not wholly satisfactory, since the heat caused synerisis or watering-off of the whey or water from the cheese. The cheese pulled back from the walls of the glass containers and, due to its unsightly appearance, customers were of the impression that it was spoiled.To overcome the above difficulties, various experiments and studies were made.  The emulsifying salts and the agitation which had been successful in the processing of cheddar cheese did not produce the desired results in cream cheese. It was then found that the mixing of a vegetable gum substance with cream cheese while it was being heated would prevent synerisis or watering-off.  The resulting product was sometimes referred to in the trade as hotpack cream cheese or as processed cream cheese. In 1927 Kraft succeeded in producing a long-keeping processed cream cheese spread.  The gum or stabilizing colloid used was pectin.  Later tragacanth was used.  After the cheese was processed, it was packaged in jars and subjected to heat treatment in the Reed sterilizer.On February 10, 1927, Eldredge, assignor to Kraft (Ill.), filed an application for a patent for the processing of cream cheese by the use of pectin and heat. 1954 U.S. Tax Ct. LEXIS 310">*405  The patent was issued November 27, 1928, as United States Patent No. 1,693,025.  On June 13, 1927, Eldredge filed an application, the claims of which were directed to colloids or gums generally and to tragacanth specifically.  The patent was issued on November 27, 1928, as United States Patent No. 1,693,026.  Kraft (Ill.) was also assignor of this patent.The vegetable gums or stabilizing colloids do not act as preservatives of cream cheese; their function is to prevent synerisis.  A long-keeping processed cream cheese cannot be produced without using a vegetable gum or stabilizing colloid.  When considered in connection with the heat treatment of cream cheese, all edible vegetable gums are stabilizing colloids.  The exact physical or chemical nature of the action of a stabilizing colloid is not understood and is a controversial point.In April 1927, Kraft published its first national advertisment for Kay, a cream cheese spread with spices and relish added.  Kay relish, sold in a 6-ounce screwcap jar, was successful from the beginning.  A number of varieties of cream cheese spreads were subsequently added to the line.  The merchandising development of the product moved from the 6-ounce1954 U.S. Tax Ct. LEXIS 310">*406  jar to 4-ounce paper cups, called "Kleen Kups," and in 1933, to vacuum-capped decorated reusable drinking glasses called "Swanky Swigs." In all 3 containers, the product has not required refrigeration and could be sold in the same way as processed cheddar and other hard cheeses.21 T.C. 513">*556  As the production of processed cream cheese advanced to the use of the more efficient gums or stabilizing colloids, the manufacturing process was changed so that the heating and the mixing were done in the same processing machine or cooker. The additional step of sterilizing the finished product in its sealed containers was discontinued.  The agitation during the mixing of the cheese and the gum is simply to effect a thorough mixture and bring about a uniform product.On November 5, 1927, Erwin S. Martin applied for a patent covering the homogenization or viscolization of cheese or a mass consisting principally of cheese in connection with the pasteurization or heat treatment of that mass.  This application became the property of Kraft in its acquisition of the business and assets of Phenix in February 1928, and a patent thereunder, United States Patent No. 1,748,781, was issued February 25, 1930. 1954 U.S. Tax Ct. LEXIS 310">*407  The effect of homogenizing cream cheese, as described in the Martin patent, is to produce a smoother bodied product.  Homogenization is accomplished by forcing the heated cream cheese with gum mixed therein through very small openings under pressure.  The minute subdivision of the mass results in a more stable and better textured product.  Homogenization has been used by Kraft in the processing of cream cheese since the acquisition of Phenix.  Locust bean gum has been used since about the same time.In the acquisition of P. E. Sharpless Company, in November 1924, Kraft acquired United States Patent No. 1,258,438, issued March 5, 1918, to Joseph Nusbaum.  The patent covered a process of producing a blended mixture of cream cheese and Roquefort in approximately an 8 to 1 ratio.  On January 8, 1923, the United States Court of Appeals for the Second Circuit had held 1 claim under the patent valid and infringed, and 2 claims invalid.  After Kraft purchased the business and assets of the Sharpless Company, it manufactured and sold Ancre cheese, made according to the Nusbaum patent. Although petitioner makes and sells a cream cheese spread called Roka, consisting of a blend of cream cheese1954 U.S. Tax Ct. LEXIS 310">*408  and Roquefort in approximately the same ratio as specified in the Nusbaum patent, it stated to the Bureau of Internal Revenue, on September 12, 1941, that the Nusbaum patent was not in use on May 20, 1930, that it had no ascertainable value at that time, and had not proved of any value to petitioner since that time.  In acquiring the business and assets of the Sharpless Company, Kraft's purpose was the acquisition of the distributing facilities of that company in the Philadelphia area.Late in 1926 or early in 1927, Sodus Cooperative Creamery Company conducted experiments whereby gelatin was mixed with cream cheese. The experiment was not successful, and tragacanth was tried, 21 T.C. 513">*557  which was a little better than gelatin.  Later in 1927, it began using carob or locust bean gum and found that much better.  A process was developed in 1927 in which the cheese and gum were heated to a semifluid state and put through a viscolizer, and packed hot in containers.  Cream cheese so processed was thereafter sold by the Sodus Company in considerable quantities in New York City, Long Island, New Jersey, and in several cities in New York State.Beginning in 1931 and continuing to the date of1954 U.S. Tax Ct. LEXIS 310">*409  the trial herein, Columbia Cheese Company, of Newark, New Jersey, has processed, with a gum ingredient, and sold hotpack cream cheese. This cheese was viscolized.  During the same period, that company has made and sold cream cheese spreads or blends containing condiments and relishes made by the hotpack process and packed in jars, boxes, and packages. No one has attempted to prevent Columbia Cheese Company from making and selling these products on the ground that the use of gums or the pasteurizing and viscolizing operations were controlled by patents.In 1937, Rosedale Dairy Company began processing a hotpack cream cheese. In the process, the cheese was heated, viscolized, and the gum mixed therein.  The product was made in the conventional way and was known and sold as cream cheese.About 1935, Newark Cheese Company began, and has since continued, to produce a hotpack cream cheese by heating and viscolizing and the mixing of gum therein.On March 6, 1928, United States Patent No. 1,661,601 was issued to Arthur C. Dahlberg, assignor to the people of the United States of America.  This patent covered a process for producing a dairy product which in many respects resembles hotpack1954 U.S. Tax Ct. LEXIS 310">*410  cream cheese. It is a smooth, acid-flavored product which will spread more or less like butter, will also slice, and has many of the characteristics of a poor grade hotpack cream cheese. None of the standard dairy laboratory tests is capable of showing the difference between a poor grade cream cheese and the product produced in accordance with the process covered in the Dahlberg patent, although there is a difference of opinion between individuals experienced in the cream cheese field as to whether in some manner they are capable of distinction one from the other.The processed cream cheese produced and sold, as shown above, by Sodus, Rosedale, Columbia, and Newark Cheese companies was a true hotpack cream cheese and was not made by the Dahlberg process.During 1928, 1929, and 1930, Federal officials charged with the enforcement of the food laws and the prevention of adulteration discovered a trend toward a decrease in butter fat content and an increase in the water content of cream cheese being sold to the public.  Good quality cream cheese, such as the Philadelphia brand, contained about 21 T.C. 513">*558  35 per cent butter fat and about 51 to 55 per cent moisture, but during the 1930's1954 U.S. Tax Ct. LEXIS 310">*411  cream cheese was being sold with a butter fat content of 23 to 25 per cent and a moisture content of 65 per cent.  This product was made possible by the use of gums and the hotpack process.  A Foods Standards Committee held a hearing in 1934 for the purpose of developing information on the use of gums and formulating a proper composition of cream cheese. Existing statutes did not authorize the formulation of a standard until passage of the Food and Drug Act of 1938.  Under that act, hearings were held, beginning in 1939, the purpose being to establish definitions and standards of identity of cream cheese. Representatives of the cream cheese manufacturing industry, including petitioner, voluntarily appeared at the hearing and testified, under oath, as to the processes used by them in making cream cheese, the use of gums in the processes, and gave opinions as to the compositions they favored.  As a result of this hearing, proposed standards of identity of coldpack and hotpack cream cheese were promulgated on December 23, 1942.  At the time of that hearing, no manufacturer claimed the use of pectin in the hotpack process and it was not included by the Food and Drug Administration in1954 U.S. Tax Ct. LEXIS 310">*412  the proposed regulation in the list of gums allowed to be used in that process.  The final regulation was not changed in that respect.At the 1939 hearing by the Food and Drug Administration, witnesses, other than those representing petitioner, testified that their companies were and had been making and selling pasteurized cream cheese containing a gum and viscolized.  No question was raised that such a process violated or infringed any patent. Petitioner at no time ever brought any proceedings in court or took any steps to exert any monopoly under the Eldredge and Martin patents.The quantity of foil-wrapped natural cream cheese in pounds sold by Kraft and its group 1 subsidiaries and later by petitioner and its group 1 subsidiaries, the gross profit in cents per pound and the gross profit in dollars, for the years 1929 through 1940, were as follows:YearNet salesCents of grossGross profitpoundsprofit per pound19297,260,30919.3$ 1,403,90519307,556,85919.21,447,93819317,828,52219.41,519,62519328,333,89915.21,266,86619338,717,59912.11,055,335193410,010,2389.0895,95219359,094,54511.21,018,300193610,259,9949.91,010,662193711,831,28410.01,186,588193812,300,46713.41,646,179193913,253,56211.41,506,503194013,737,76813.01,790,2591954 U.S. Tax Ct. LEXIS 310">*413 21 T.C. 513">*559   The natural cream cheese loaf, in pounds, sold by Kraft and later by petitioner and their group 1 subsidiaries, the total sales in dollars, and the gross profit thereon, for the years 1929 through 1940, were as follows:YearPoundsSalesGross profit19294,479,792$ 1,420,480.12$ 113,396.0719303,851,0941,225,511.48343,565.9919314,486,7931,038,345.93374,578.7119323,777,676818,797.69259,892.7719333,762,572747,103.75180,313.9719343,279,263691,450.08146,219.4319353,170,422773,245.29144,107.5719362,967,692728,820.32145,096.5719372,584,683653,254.01123,168.0919382,419,438586,662.69179,587.1319392,013,161462,620.76124.854.9319401,420,193347,956.3994,720.92The total sales in pounds of processed cream cheese in jars, glasses, cups, and other packages and in loaf size by Kraft and later by petitioner and their group 1 subsidiaries, for the years 1929 through 1940, were as follows:YearIn jars, etc.Loaf size19293,466,8882,526,99119303,447,3062,607,84719312,996,6492,544,67119323,630,1391,617,01919333,327,5991,380,06119348,814,3413,542,02219357,557,5152,385,22919369,106,7532,129,99719378,404.8152,105,61019388,911,4551,640,88719397,483,849742,63819407,295,287634,6131954 U.S. Tax Ct. LEXIS 310">*414  In 1927 and prior thereto, Pabst Corporation produced a processed bulk cheese product known as Pabst-ett, which was a product made from blended cheddar cheese, with the addition, among other things, of condensed or concentrated whey during the sterilizing or pasteurizing operation.  A product of that type is called cheese food.  On July 19, 1924, Eldredge, assignor to Pabst, had filed an application for a patent which included the mixing of whey concentrate with cheese during the sterilizing or pasteurizing operations.  Under this application, United States Patent No. 1,634,410 was issued on July 5, 1927.  The sterilizing or pasteurizing operation used in the production of Pabst-ett was covered by and infringed the Kraft and Phenix processing patents heretofore set forth.  Following the licensing of Pabst on May 16, 1927, by Kraft and Phenix, under the processing patents, Pabst on May 25, 1927, granted to Kraft a royalty-free nonexclusive license for the United States and Canada under the application later 21 T.C. 513">*560  issued as Patent No. 1,634,410.  In return, Kraft granted Pabst Corporation a royalty-free nonexclusive license to manufacture Pabst-ett in Canada under four Canadian 1954 U.S. Tax Ct. LEXIS 310">*415  patents owned by Kraft or a subsidiary company.  The Canadian patents were declared invalid in Canada prior to May 1930 for nonpayment of fees.In 1927 Kraft began the production of a processed cheese food called Nukraft, to compete with Pabst-ett.  It was a combination of cheddar cheese, whey, skimmed milk solids, and cream, and was packaged in a round, flat cardboard package lined with foil. The introduction of Nukraft was supported by an ambitious national advertising campaign.  A special rack was developed for its display on the counters of retail stores.  The public did not respond to the new product and it was not a success.At or about the same time, Phenix Cheese Company had a cheese food product.  This product was called Chateau, and was on the market in Canada.Late in 1928, after more research, Kraft changed the Nukraft formula and brought out a cheese food under the name "Velveeta." Velveeta was made of selected cheddar cheese, skimmed milk powder, whey solids, butter fat, and emulsifying salts.  It could not be made without a whey product.  The exact formula is a trade secret.  Velveeta has been very successful since the time of its introduction.  More than $ 250,000 1954 U.S. Tax Ct. LEXIS 310">*416  was spent annually in advertising Velveeta in 1929 and for several years thereafter.The first Velveeta was made in November of 1928.  Its manufacture was conducted as follows: Cheddar cheese was selected for its body and flavor, was cleaned and ground and emptied into cooking kettles equipped with agitators.  At the same time condensed whey (whey concentrate), emulsifying salts, and other ingredients were added.  When the cooking was completed the batch was transferred to the hopper of a filling machine through which it flowed into the die-cut foil packages which thereafter were handled in the same manner as the 1/2-pound die-cut packages of processed cheese.In 1929 and 1930 condensed whey was used in the manufacture of Velveeta.  After 1930, petitioner at various times and in various locations has used either condensed whey or whey powder. When whey powder is used water is added so that it is in the form of a concentrate or paste at the time it is mixed with the cheese.The sales of Velveeta, insofar as they are ascertainable from an analysis of petitioner's records, for the years 1929 through 1940, have been as follows: 21 T.C. 513">*561 Sales poundsSales poundsSales poundsYearin half-poundin otherin loaf formpackagepackages19296,158,79019308,242,9346,62019317,289,51017,8082,18419326,893,92713,69272119335,941,0977,32327419346,063,6952463019357,423,76519369,266,633400,318193710,002,077647,36018,067193811,206,956885,174162,83819399,947,838789,4876,543,17819409,815,594865,83315,106,2391954 U.S. Tax Ct. LEXIS 310">*417  On May 26, 1928, Arthur W. Bell filed an application which resulted in the issuance of United States Patent No. 1,810,898 on June 23, 1931.  Bell was assignor to petitioner.  The patent was on a sheet feeding mechanism.  On July 14, 1928, Bell and Eldredge filed an application which resulted in the issuance of United States Patent No. 1,816,202 on July 28, 1931, on a packaging method and apparatus.  The mechanism and apparatus had been developed for the packaging of Nukraft and were used only in the production of that product.  Nukraft was not a success and Kraft has not used the mechanism and apparatus on any other product.Whey is the product which results from the removal of substantially all the fat and casein from milk. It is the residual fluid from the manufacture of natural cheese. In 100 pounds of liquid whey approximately 94 pounds are water and the 6 pounds remaining are solids.  The solids contain about 70 to 74 per cent lactose, also known as milk sugar, about 12 per cent protein and about 8 per cent mineral ash.In the early days of the cheese making industry in the United States, it was customary for the cheese factories to return the whey to the farmer who supplied1954 U.S. Tax Ct. LEXIS 310">*418  the milk so he could feed his pigs and calves with it.  As cheese factories grew in size, whey disposal became a serious problem.  Most cheese makers simply pumped the whey into a wooden tank outside the factory and made no attempt to take any particular care of it.  It turned sour, fermented, foamed over, attracted flies, and gave off a bad odor.  If the whey was emptied into running streams, it polluted the streams and brought on lawsuits against the cheese makers.  These and similar problems caused Kraft to conduct research regarding the use and disposal of whey. In 1927 it established a fellowship at Rutgers University to study the utilizable nutritional values, if any, to be found in whey if it could be processed into a commercial form.Under the heading "Food Compound," United States Patent No. 515,736 had been issued to John J. Angus, on March 6, 1894.  The object of the invention was stated to be "to increase the wholesome and nutritious 21 T.C. 513">*562  product obtained from milk in the manufacture of cheese, which object is attained by combining the completed cheese product, obtained from the milk, with the product obtained by evaporating the whey produced from the milk during1954 U.S. Tax Ct. LEXIS 310">*419  the process of manufacturing cheese. The whey product used to be as a paste or a powder." The claim was stated "as a new article of manufacture a food product consisting of cheese in its ripened or mellow state having incorporated therewith evaporated whey."Lactose exists in two forms: Anhydrous, that is, without water of crystalization, and hydrated, that is, with a full complement of water of crystalization.  Whey powder containing anhydrous lactose is hygroscopic, that is, it attracts moisture from the atmosphere.  Nonhygroscopic whey powder is that in which the lactose contained therein is in equilibrium with the atmosphere and has no marked affinity for water.  The hygroscopic or nonhygroscopic condition of whey powder is traceable solely to the lactose and not to any other ingredient of the whey.The whey powder produced by Kraft in and about 1927 was hygroscopic.  It would absorb water of crystalization from the air and the process of crystalization so interlocked the mass that it became a solid, which was very hard and tough and not reasonably adaptable to commercial uses.In 1929, Nicholas Simmons, an employee of Kraft and a vice president of one of its wholly owned subsidiaries, 1954 U.S. Tax Ct. LEXIS 310">*420  was working on a program in an attempt to produce a nonhygroscopic whey powder, and in that year he devised the method later covered by United States Patent No. 1,763,633.  He was instructed to file an application for a patent for the benefit of Kraft and through Kraft's regular patent counsel.  Without informing the Kraft executives, Simmons, on January 2, 1930, filed an application for a patent in his own name and Patent No. 1,763,633 was issued on June 10, 1930.In the summer of 1930 Simmons' acts came to the attention of petitioner, which demanded that the patent be turned over to it.  A lawsuit was begun in 1931 to establish petitioner's title to the patent and to require transfer thereof by Simmons.  Prior to the end of 1931, the suit was settled by a payment of $ 7,500 by petitioner to Simmons and the assignment by Simmons of the patent to petitioner.  Petitioner's total expenses, inclusive of the $ 7,500, was $ 38,266.11.On February 13, 1929, Elmer E. Eldredge, assignor to petitioner, applied for a patent on a process designed to prepare nonhygroscopic whey powder. A patent under this application, No. 1,923,427, was issued on August 22, 1933.  Under the Eldredge process, 1954 U.S. Tax Ct. LEXIS 310">*421  liquid whey was dried to the point where it was a hygroscopic whey powder, in which the lactose was in an anhydrous form.  Water was then added back until the anhydrous lactose had absorbed its quota of water of 21 T.C. 513">*563  crystalization.  At this point the whey powder would be ground into a powder. The product was a free-flowing powder.At some time during the period beginning with 1927 and ending prior to May 20, 1930, the Eldredge process for producing a nonhygroscopic whey powder was commercially used by Kraft.  The product was sold under the name "Kraco." The process was expensive, was not in use on May 20, 1930, and had no ascertainable value at that time.  The patent thereafter issued covering the process has not proved to be of any value to petitioner.Under the Simmons process, the whey was not reduced to a hygroscopic state.  It would be dried to the point where it was composed of approximately 60 per cent to 70 per cent solids, the rest being water.  The mass was then allowed to stand until the lactose crystallized into a pasty mass.  The mass of hydrated crystals was then broken up and dried in a hot air tunnel.  The Simmons patent prescribed a temperature range for the1954 U.S. Tax Ct. LEXIS 310">*422  first drying step so that some of the water would form hydrated lactose crystals and the rest would be given off to the atmosphere.  The temperature was kept below the temperature which would completely drive off the water of crystalization and result in the production of an anhydrous powder. The process did not involve the reintroduction of water.By an agreement executed by Kraft and other parties on dates varying from July 17, 1931, to August 3, 1931, it was recited that David D. Peebles, Paul D. V. Manning, and Western Condensing Company, known as the California parties, were the owners of four applications for patent having to do with a process or processes for making whey powder, and further recited possible interference between the said applications and the application of Eldredge, under which Patent No. 1,923,427 was later issued, and that interference would probably be declared between one of the applications and the Simmons patent, No. 1,763,633.  On the basis of these recitations, the right to use the processes covered by the applications for patent of the California parties was granted to Kraft.  No minimum or guaranteed royalty was provided.  It was provided, however, 1954 U.S. Tax Ct. LEXIS 310">*423  that a reasonable royalty not exceeding 1 cent per pound of finished product would be payable by Kraft on shipments subsequent to the date of issuance of a patent containing a claim covering the Peebles process, apparatus or product and resulting from the four applications or any application which was a continuation or division thereof.  All parties to the agreement were mutually to cooperate and use their best efforts to assist each other, to the end that priority of invention of any of the subject matter involved in the agreement should be awarded to the party or parties to the agreement according to fact and not to third parties outside the agreement.21 T.C. 513">*564 Patent Nos. 1,928,135, 2,126,807, and 2,088,206 were subsequently issued to Peebles and Manning under dates of September 26, 1933, August 16, 1938, and August 3, 1937, respectively.  United States Patent No. 2,016,592, in the same general field, of which Western Condensing Company became the owner, was issued to Chuck on August 8, 1935.On April 29, 1937, cross-licensing agreements were entered into between the petitioner and Western Condensing Company covering the patents and applications for patent above recited and including, 1954 U.S. Tax Ct. LEXIS 310">*424  in addition, patents and applications for patent owned by petitioner, designated Patent No. 2,076,400, issued April 6, 1937, to Clickner; Application No. 745,289, filed September 24, 1934, by Clickner; and Application No. 13,925, filed March 30, 1935, by George H. Kraft.  By these agreements, each of the parties licensed the patents owned by it to the other nonexclusively and free of royalty throughout the United States and all territory subject to the jurisdiction of the patent laws of the United States.  In addition, however, Western agreed to pay to Kraft contemporaneously with the execution of the agreement whereby Kraft licensed its patents and applications to Western, the sum of $ 2,500 for release by Kraft from any and all claims on account of any and all infringements by Western of Simmons Patent No. 1,763,633 prior to the date of the agreement.Subsequently, on the first day of July 1945, Kraft and Western executed further cross-licensing agreements whereby Kraft granted a nonexclusive license free of royalty throughout the United States and all territory subject to the jurisdiction of the patent laws of the United States, to Patent Nos. 1,763,633, 1,923,427, and 2,118,252, 1954 U.S. Tax Ct. LEXIS 310">*425  the latter having been issued on May 24, 1938, to G. H. Kraft.  By cross agreement, Western similarly licensed Patent Nos. 1,928,135, 2,016,592, 2,126,807, and 2,088,606 to Kraft.  Patent No. 1,126,807 had been issued to Peebles August 16, 1938.  Patent No. 2,088,606 had been issued to Peebles and Manning August 3, 1937.Under date of April 16, 1936, petitioner entered into an agreement with Roberts Dairy Company in settlement of a suit whereby petitioner charged infringement of Patent Nos. 1,763,633 and 1,923,427.  Under the agreement, petitioner licensed Roberts Dairy Company to manufacture, not to exceed 500,000 pounds in each calendar year, dried whey for bird or animal feed, for sale to petitioner only, and petitioner agreed to buy from Roberts Dairy Company not less than 80,000 pounds of such product in each calendar year.  The agreement excepted dried whey produced from the byproduct of cottage cheese.Under date of February 28, 1937, the petitioner granted a nonexclusive and nonassignable license under Patent No. 1,763,633 to Stella 21 T.C. 513">*565  Cheese Company, to manufacture dried whey for sale to one of petitioner's subsidiaries only.  Under date of April 8, 1943, the petitioner1954 U.S. Tax Ct. LEXIS 310">*426  and Western Condensing Company granted licenses to Stella Cheese Company to produce dried whey or dried mixtures for animal consumption under the above patents and patents heretofore described which belonged to Western.  The agreement provided that Stella should pay to petitioner specified royalties for division between petitioner and Western.  On the same date, petitioner entered into a further agreement with the Stella Cheese Company covering the marketing of the dried whey so produced.  Under date of May 10, 1946, petitioner licensed Patent Nos. 1,763,633 and 2,181,146 to Stella Cheese Company for specified royalties.In settlement of an infringement suit against Hercules Powder Company, petitioner and Western Condensing Company, effective as of July 1, 1937, granted licenses to the Hercules Powder Company for the manufacture of dried whey. Under the agreement, Hercules agreed to pay specified royalties to petitioner for division between petitioner and Western as they should see fit.Including the $ 2,500 received from Western Condensing Company under the agreement of April 29, 1937, the petitioner, from 1937 to 1947, inclusive, received royalties under license agreements for 1954 U.S. Tax Ct. LEXIS 310">*427  producing dried whey aggregating $ 100,675.39.  Except for the $ 2,500 payment from Western Condensing Company in 1937, and $ 2,704.97 from Stella Cheese Company in 1945, all of the royalties were received from Hercules Powder Company.The principal whey powder products manufactured by petitioner have been Kraco, Belyn, and DML, all produced as animal feeds, and Krafen, a dried whey for human consumption.  Petitioner has also produced a cream cheese whey powder, under the name of "Flox." All of these products were and are nonhygroscopic whey powders. The largest selling product of the group has been Kraco.From 1934 to 1948, inclusive, the sales in pounds of whey powder by petitioner and its wholly owned domestic subsidiaries increased from 7,661,632 to 26,194,971 pounds. During the same period, the sales in dollars increased from $ 382,381.14, in 1934, to $ 1,910,481.36, in 1948.  71954 U.S. Tax Ct. LEXIS 310">*428  The rise of Kraft in the cheese producing and marketing field to the position it occupied during the 1920's and at the time of the purchase by National Dairy in 1930 really began with the developing and patenting of the methods for processing cheese, the first of these patents being No. 1,186,524, issued June 6, 1916, which was followed 21 T.C. 513">*566  later by a so-called blending patent, No. 1,323,869, issued on December 2, 1919.  With the advent of processed cheese, Kraft was of the opinion that the volume of available or potential business was such that it could not possibly acquire either sufficient raw material, manufacturing capacity, or sales and delivery capacity to supply the demand, and decided to license, among others, its processing, blending, and 5-pound loaf boxing patents, at a very favorable rate, to leading cheese manufacturers who would maintain the quality of and help to popularize the product, relying chiefly for its advantage, not on the complete monopoly afforded it by its patents, but on its conviction that through its acumen and operating ability it could attain and hold a dominant position in the cheese manufacturing and marketing field.  Kraft had in mind the 1954 U.S. Tax Ct. LEXIS 310">*429  doubling of the per capita consumption of cheese in the United States which, when compared with the per capita consumption of cheese in Europe, was very low.Kraft's business grew so rapidly it had difficulty in obtaining an adequate cheese supply.  It acquired a number of cheese assemblers who also had several cheese factories.  Among the inducements for acquiring the Phenix Cheese Corporation in 1928 were the bulk cheese factories owned by Phenix and the fact that there would be a consolidation of production efforts and the operating costs of the two companies could be cut.  Through the purchase of the business and assets of Edward W. Coon in 1927, Kraft acquired added facilities for storing and curing natural cheese as well as the Coon patent covering a method for curing cheese in a substantially shorter time than under standard or normal methods.Kraft established a practice of promoting the dairy industry generally and the working out of plans for building cheese factories in various parts of the country.  In placing factories, it would secure the cooperation of 4-H groups, the Future Farmers of America, and farm organizations of every type.  It published for them a farm paper1954 U.S. Tax Ct. LEXIS 310">*430  which it distributed free of charge.  It assisted dairy farmers in procuring pure bred stock with which to start and build up their herds.  An outstanding example of such promotional work was its participation in the establishment of dairy farming in the State of Idaho in 1921, and thereafter by assuring the bankers and farmers of Idaho that it would take all of the cheese the State could produce for 10 years.Another purpose served by the acquisition of Phenix by Kraft was the consolidation of the advertising and sales efforts of the two companies.  Phenix also brought with it the label "Philadelphia Cream Cheese" under which it packaged and sold its cream cheese, which was and ever since has been the largest selling packaged cream cheese in the world.  Previously, in 1924, Kraft had acquired the P. E. Sharpless 21 T.C. 513">*567  Company primarily because Sharpless had distributing facilities which gave Kraft an immediate outlet in the Philadelphia market.During the 1920's Kraft developed a system whereby its products were delivered to and sold at the retail stores.  It had four and later five divisional headquarters established in geographical centers and depots at other key cities from1954 U.S. Tax Ct. LEXIS 310">*431  which refrigerator truck service was operated.  This method of distribution continued into the early 1930's, and the service was expanded until it covered the entire country.  The trucks were painted a particular design and color, were recognizable everywhere as Kraft trucks, and reached to every crossroad where the road was good.  In 1928 this delivery service required more than 2,000 trucks and delivery to the stores averaged about once per week.  The service was performed chiefly by independent distributors who owned the trucks and sold Kraft products to the retail stores.  This system of selling and distributing Kraft merchandise was an element of great value as a part of the going business on May 21, 1930.At the time of the sale of its business to National Dairy on May 21, 1930, Kraft owned 49 registered United States trade-marks and 5 foreign trade-marks.  It also had one application for a trade-mark pending in the United States.  One of the most valuable of the trade-marks was that covering the name "Philadelphia Cream Cheese." Another valuable trade-mark was the name "Velveeta" on which the advertising expenses exceeded $ 250,000 annually.  Advertising was designed to popularize1954 U.S. Tax Ct. LEXIS 310">*432  the various trade-marks, brands, products, and the name "Kraft" in the minds of consumers.  The name "Phenix" had a wide acceptance in the Chicago area and the eastern part of the country and was included in the company's name after its acquisition in 1928 and in the name of petitioner for some time after its organization.  The name "Kraft" was pretty close to a magical word in the cheese business.  It had great publicity value.  The name "Kraft" and that of "Kraft-Phenix," their products and brands were extensively advertised in magazines, such as The Saturday Evening Post, Ladies Home Journal, and Woman's Home Companion, which had wide national circulations.  These names were also kept before the public by displays in retail stores and on delivery trucks.  Radio advertising was also widely used.  If a new product did not bring in what was regarded as a sufficient gross profit after a period of a year to allow for the advertising charges, the advertising allotment for that product was discontinued.Kraft conducted its cheese business in England, Germany, Belgium, Holland, Cuba, Australia, Argentina, and Canada.  On May 21, 1930, Kraft owned and petitioner acquired all or a part of1954 U.S. Tax Ct. LEXIS 310">*433  the capital stocks of the following foreign corporations:21 T.C. 513">*568 Kraft Cheese Company, Ltd. (England)Kraft Cheese Company, G. m. b. h. (Germany)Kraft-Phenix Company, Ltd. (Canada)Phenix Cheese Company, Ltd. (England)Betz & Jay (Holland)Kraft-Phenix Cheese Company of Cuba (Cuba)Kraft-Walker Cheese Company Pty. Ltd. (Australia)Kraft attempted to obtain patents in England covering its methods for sterilizing or processing cheese, but its applications or claims were disallowed by the House of Lords.  Regardless of that fact, however, Kraft became the largest manufacturer and dealer in processed cheese in Great Britain.  In Australia it built its business to a point where it was doing better than 50 per cent of the Australian processed cheese business.After petitioner was organized and had acquired the business and assets of Kraft, as above set forth, it continued Kraft's policy of expanding through the acquisition of corporations and businesses engaged in the production and sale of cheese and cheese products.  After May 21, 1930, it acquired the following cheese manufacturing corporations or businesses: 8ConsiderationDate ofName of company or(all wereacquisitionbusinessacquiredfor cash)Feb.   3, 1931Ladysmith Cheese Company$ 314,097.68Oct.  31, 1933Pabst cheese assets868,597.43Mar.  30, 1937Mansfield Cheese Company18,250.00Apr.   1, 1938American Cheese Company16,334.05Sept.  1, 1939Alexandria Cheese Company15,000.00Nov.   1, 1939Martin Cheese Company17,702.37Nov.   1, 1939Walnut Cheese CompanyJune  16, 1941M. J. Schneider79,212.69Dec.  13, 1941D. J. and Ida Bender14,438.83Aug.  20, 1943Mar-Lin Dairies20,463.77Sept. 18, 1943B. E. and Hazel M. Scott35,828.27Apr.  20, 1944J. F. Maddox21,977.45June  15, 1944Mills Cheese, Inc4,640.36July  31, 1944A. and C. A. Madsen136,680.82Jan.   1, 1945Fred and Elisa Glauser$ 28,414.85Jan.   1, 1945Cedar Valley CheeseFactory14,085.54Jan.  17, 1945Gerhardt H. Riedel8,000.00Sept. 10, 1945Frank and Emma Swetz23,187.56Nov.  11, 1945Everett and Nora Miller13,827.78Apr.  16, 1946Dallas Cheese Company7,500.00July   8, 1946Magnolia Dairy Products Co17,500.00Sept.  5, 1946Brickheimer CheeseFactory7,858.89Sept. 27, 1946Lecker Cheese Factory19,570.97Oct.  22, 1946Galena Cheese Factory14,000.00Nov.   1, 1946Parishville Creamery Co15,025.00Mar.  24, 1947J. B. and Beatrice Wann89,900.081954 U.S. Tax Ct. LEXIS 310">*434 Included among the assets of Premier-Pabst Corporation acquired in 1933, as set forth above, was United States Patent No. 1,634,410, a license under which had been acquired by petitioner on May 21, 1930, through the purchase by National Dairy of the assets and business of Kraft.In addition to cheese and cheese products, Kraft and its subsidiaries and later petitioner and its subsidiaries sold substantial quantities of 21 T.C. 513">*569  other products, including mayonnaise and dressings, malted milk products, butter, liquid milk and cream, ice cream and frozen confections, milk and whey powders, and other dairy products.  The sales in pounds, sales in dollars, and the gross profit realized by Kraft and petitioner, as the case may be, and their wholly owned domestic subsidiary companies, group 1, for cheese and cheese products and other products indicated, for the years 1929 through 1936, were as follows:1929Sales in poundsSales in dollarsGross profitCheese181,570,035$ 53,558,396.08$ 8,601,792.02Mayonnaise, milk, etc128,743,35716,548,385.912,126,616.401930Cheese172,788,55946,126,562.379,606,534.70Mayonnaise, milk, etc131,685,22219,906,935.033,710,297.451931Cheese179,153,25839,357,546.559,190,571.83Mayonnaise, milk, etc106,874,56016,582,562.943,360,806.251932Cheese184,365,32032,439,537.137,415,900.05Mayonnaise, milk, etc107,400,84612,826,614.822,753,815.891933Cheese181,411,18232,179,658.067,249,297.83Mayonnaise, milk, etc108,048,54512,449,044.192,964,525.741934Cheese212,317,76640,769,240.418,441,747.73Mayonnaise, milk, etc153,500,84018,618,630.754,260,982.411935Cheese230,926,47748,765,896.239,594,209.92Mayonnaise, milk, etc167,810,92423,300,116.855,673,736.931936Cheese252,290,73257,119,374.7810,383,002.05Mayonnaise, milk, etc203,443,61629,925,049.077,471,595.251954 U.S. Tax Ct. LEXIS 310">*435  For all of the years 1929 through 1936, mayonnaise and dressings constituted much the largest single item in the products sold other than cheese, and for the years 1933 through 1936, the sales thereof were more than the sales of all such other items combined.  Other items which were sold in comparably large quantities were butter, liquid milk and cream, and milk and whey powder. Also in the years 1929 through 1936, more than half of the gross profit in the "Mayonnaise, milk, etc." group was from sales of mayonnaise and dressings.  For the years 1932, 1933, 1934, and 1935, the ratable sales in liquid milk and cream were noticeably less than in the other years designated.  Included in the sales in dollars were the fees received by petitioner for processing cheese under private label contracts, as heretofore set forth.  For each of the years shown, there was an adjustment in comparatively 21 T.C. 513">*570  small amounts between cost of sales and gross profits, resulting in a slight decrease in gross profits for 1930 and a slight increase for other years.  What part of these adjustments was due to sales of cheese and what part to mayonnaise and other items is not shown.The total production 1954 U.S. Tax Ct. LEXIS 310">*436  of American or cheddar cheese, the total production of swiss, brick, Munster, Limburger, cream and Neufchatel, and other varieties of cheese, exclusive of cottage, pot, and bakers' cheese, in the United States, and the total of American and other such cheese produced in the United States and the per capita civilian consumption of such cheese, excluding further American cheddar cheese made from full skimmed milk, all in pounds, for the years 1924 to 1936, inclusive, as reported by the United States Department of Agriculture, were as follows:Per capitaYearAmerican orSwiss, brick,Totalconsumptioncheddaretc.(in pounds)1924373,056,00096,642,000469,698,0004.51925394,167,000100,606,000494,773,0004.61926377,787,00096,816,000474,603,0004.71927345,968,000103,476,000449,444,0004.41928375,287,000105,940,000481,227,0004.41929378,879,000108,321,000487,200,0004.61930383,138,000117,229,000500,367,0004.61931378,172,000114,207,000492,379,0004.41932374,287,000109,816,000484,103,0004.41933415,649,000128,086,000543,735,0004.51934441,150,000137,972,000579,122,0004.81935475,788,000145,168,000620,956,0005.21936493,367,000149,184,000642,551,0005.31954 U.S. Tax Ct. LEXIS 310">*437  The net operating profit and the net income, as per books and as taken from audit reports, of J. L. Kraft & Bros. Co. from May 1, 1915, until October 31, 1924, the date of the unification of the Kraft constituent companies in Kraft Cheese Company (of Illinois), predecessor of Kraft (Ill.), were as follows:PeriodNet operatingNet incomeprofitYear ended Apr. 30, 1916$ 1,013.19 $ 698.19 Year ended Apr. 30, 191730,728.43 23,690.66 8 mos. ended Dec. 31, 19171 20,478.30 1 12,980.49 Year ended Dec. 31, 19181 94,637.91 1 88,906.87 3 mos. ended Mar. 31, 1919225,584.61 9 mos. ended Dec. 31, 19193,297.43 26,413.70 Year ended Dec. 31, 1920(12,543.36)(4,124.88)Year ended Dec. 31, 1921175,872.85 170,841.89 Year ended Dec. 31, 1922549,876.49 501,809.61 3 mos. ended Mar. 31, 1923146,867.37 101,176.53 Year ended Mar. 31, 19241,443,394.46 1,056,226.21 7 mos. ended Oct. 31, 1924445,979.90 299,854.51 The net operating1954 U.S. Tax Ct. LEXIS 310">*438  profit and the net income, as per books and as per audit reports, of Kraft Bros. Cheese Company from May 1, 1918, to 21 T.C. 513">*571  October 31, 1924, when it was united with the other Kraft companies in Kraft Cheese Company (of Illinois), the predecessor of Kraft (Ill.), were as follows:PeriodNet operatingNet incomeprofit8 mos. ended Dec. 31, 1918$ 20,736.72$ 21,590.12Year ended Dec. 31, 191989,555.6979,938.74Year ended Dec. 31, 192070,673.7183,380.37Year ended Dec. 31, 192125,393.3033,806.55Year ended Dec. 31, 1922303,409.93235,463.063 mos. ended Mar. 31, 192313,975.029,994.18Year ended Mar. 31, 1924290,877.96219,752.967 mos. ended Oct. 31, 1924191,219.34142,216.12The net operating profit and the net income, as shown by Federal tax returns, of Jacob Marty Company for the period from April 1, 1920, to March 31, 1923, were as follows:Year ended March 31Net operatingNet incomeprofit1921($ 71,720.96)($ 67,964.39)19223,627.11 5,307.41 192323,527.93 26,880.13The net operating profit and the net profit before Federal income tax of Penn-Kraft Cheese Company for the year ended December 31, 1922, as shown1954 U.S. Tax Ct. LEXIS 310">*439  by Federal income tax records, were as follows:Net profit beforeNet operating profitFederal income tax$ 6,613.62$ 7,641.88The net operating profit and the net income of Kraft Cheese Company (of Illinois) and subsidiaries and of Kraft (Ill.) and subsidiaries for the period from the formation of Kraft Cheese Company (of Illinois) on November 1, 1924, to December 31, 1928, as shown by audit reports and as per books for 1929, were as follows:PeriodNet operatingNet incomeprofit5 mos. ended Mar. 31, 1925$ 1,064,932.96$ 602,857.31Year ended Mar. 31, 19261,702,529.961,500,432.929 mos. ended Dec. 31, 19261,028,523.291,104,757.03Year ended Dec. 31, 1927909,485.91824,979.37Year ended Dec. 31, 19282,902,244.491,848,258.04Year ended Dec. 31, 19294,299,502.783,514,839.86The net operating profit and the net income of Phenix Cheese Corporation as per its books for the period January 1, 1923, to December 31, 1927, were as follows: 21 T.C. 513">*572 Year endedNet operatingNet incomeDecember 31profit1923$ 784,858.10$ 723,002.801924524,448.44467,074.811925312,324.14232,997.211926$ 734,063.73$ 615,859.141927256,043.43272,425.251954 U.S. Tax Ct. LEXIS 310">*440  The net operating profit and the net income per books of petitioner and wholly owned subsidiary companies for the period from May 1, 1930, to December 31, 1940, were as follows:PeriodNet operatingNet incomeprofit8 mos. ended Dec. 31, 1930$ 3,129,929.02$ 3,233,720.98Year ended Dec. 31, 19313,968,121.313,383,669.24Year ended Dec. 31, 19322,590,927.752,302,274.50Year ended Dec. 31, 19332,664,176.632,688,427.71Year ended Dec. 31, 19343,348,816.812,400,455.45Year ended Dec. 31, 19356,100,631.613,964,680.51Year ended Dec. 31, 19366,697,783.874,221,344.09Year ended Dec. 31, 19376,802,706.063,849,930.58Year ended Dec. 31, 19387,380,556.204,199,640.35Year ended Dec. 31, 19399,213,448.705,021,464.84Year ended Dec. 31, 19408,671,459.174,610,243.91The gross profit, net operating profit, and net income of the parent company, Kraft or petitioner, as the case may be, and wholly owned domestic subsidiary companies, group 1, for the years 1929 through 1940, were as follows:YearGross profitNet operatingNet incomeprofit1929$ 10,753,055.19$ 3,150,274.66$ 2,536,735.08193013,239,865.663,856,451.843,927,013.98193112,578,238.443,786,994.703,553,205.14193210,216,656.352,696,888.872,463,128.46193310,238,472.482,324,073.222,358,102.24193412,704,866.242,738,121.271,699,500.48193515,280,060.565,418,502.393,235,085.57193617,896,452.265,905,331.763,355,817.96193719,521,132.256,050,010.183,149,243.20193823,637,994.216,510,679.903,386,878.15193927,214,232.828,080,868.123,805,513.91194028,254,657.547,763,841.063,844,651.811954 U.S. Tax Ct. LEXIS 310">*441  In the negotiations leading up to the purchase of the business and assets of Kraft, National Dairy was represented by its president, Thomas E. McInnerney.  National Dairy was interested in acquiring the Kraft business and assets as a unit, not in acquiring parts thereof, and in the negotiations and the purchase thereafter the business and assets were not broken down into the component parts.  McInnerney was generally familiar with the growth of Kraft and the nature of its products.  He was thoroughly familiar with its earnings.  He knew of the patents, and had discussed the patent value "as a commercial 21 T.C. 513">*573  proposition" with Kraft's counsel, Irwin P. Snyder.  On behalf of National Dairy, however, he did not consult with or seek the advice of any patent expert.  He did not concern himself with particular patents, other than two or three "that were outstanding, that were being licensed." He "knew about the ones that expired in about three years, and the one in about eight years, but that is about all." He could not put a value on the patents, but had attached a great deal of value to them.  He thought they gave Kraft "a little edge against competition."From February 1923 through1954 U.S. Tax Ct. LEXIS 310">*442  1930, National Dairy had acquired by purchase, for cash, stock debentures, and the assumption of liabilities, a total of 53 companies and businesses engaged in the dairy and ice cream business, exclusive of Kraft (Ill.).  Most of the companies were acquired in 1927, 1928, and 1929.  Three such transactions occurred after May 21, 1930.  The total consideration paid for the businesses by National Dairy was $ 273,934,831.32.  9 The aggregate gross tangible assets acquired at book value as of the accounting date of the acquisition amounted to $ 139,580,733.44, or approximately 51 per cent of the aggregate consideration paid.  The excess of the consideration paid over gross tangible assets per books was $ 134,354,098.38, or 49 per cent of the aggregate consideration.  The aggregate earnings before Federal taxes of the 53 companies in the year preceding their acquisition amounted to $ 19,664,726.93.  Of the above 53 companies, one was a cheese company, one an egg company, one a meat products company, two were butter companies, and two were milk and whey companies, while all the rest were milk and ice cream companies.  Ordinarily dairy and food companies do not have patents.1954 U.S. Tax Ct. LEXIS 310">*443  The following 9 patents covering the process of cooking, pasteurizing, and blending bulk cheese, and the emulsifier salts used in connection therewith, constituted a functionally related group of patents:No. 1,186,524No. 1,374,141ReissueReissue14,77715,648No. 1,323,869No. 1,389,095No. 1,350,870No. 1,389,577No. 1,368,624No. 1,400,171No. 1,678,167The average life of these 9 patents was 8.08 years from May 21, 1930.Patent Nos. 1,484,945, 1,500,478, 1,500,494, and 1,508,019 form an integrated group of patents covering associated mechanisms and parts of a wrapping machine adapted for wrapping cakes of cream cheese. 21 T.C. 513">*574  The average life of the patents in this group at May 21, 1930, was 11.08 years.As of May 21, 1930, the patents acquired by National Dairy in its acquisition of the business and assets of Kraft on that date, had a total of 141,160 days of remaining unexpired patent life.In the consolidated tax returns made with National Dairy and its affiliates, petitioner claimed deductions for amortization of cost of patents for the years 1930 through 1933, as follows:1930$ 690,804.5719311,555,322.591932$ 1,557,875.8019332,594.431954 U.S. Tax Ct. LEXIS 310">*444  The amount deducted for 1933 was for amortization of a cost of $ 38,266.11 incurred in litigating title to Patent No. 1,763,633.In connection with the closing of the taxable years 1928 to 1933, both inclusive, of National Dairy and its affiliated corporations, involving deductions for depreciation and property losses aggregating $ 54,439,046.67, the deductions for depreciation and property losses so claimed, including the $ 3,806,597.39 claimed for the years 1930 through 1933, as covering amortization of the cost of patents, were permitted to stand without prejudice to the undecided contentions of the petitioner and the Government with respect to the May 21, 1930, cost basis and the January 1, 1934, adjusted cost basis of petitioner's patents.As of January 1, 1934, the patents, acquired by National Dairy from Kraft and transferred by National Dairy to petitioner under the agreement of the same date, had a total of 107,057 days of remaining unexpired patent life.Of the total number of remaining days of unexpired patent life as of January 1, 1934, the number of days of remaining life expiring in each year and the percentage which that figure for each year is of the total number 1954 U.S. Tax Ct. LEXIS 310">*445  of days of remaining unexpired life as of January 1, 1934, was as follows:Percentage ofdays of expiringDays oflife in eachYearexpiringyear to totallifedays of unexpiredlife as ofJan. 1, 1934Per cent193410,3949.708847193510,4739.782639193610,5859.887256193710,0929.42675419389,0098.41514319398,0307.50067719408,0527.52122719417,2576.77863219425,8665.47932419435,5195.15519819444,9444.61810019454,5174.21924819463,6503.40939919472,9472.75273919482,2152.06899119491,6251.51788319501,1491.0732601951556.5193501952177.165333107,057100.00000021 T.C. 513">*575  The cost to National Dairy of the patents acquired from Kraft (Ill.) on May 21, 1930, and transferred to petitioner by National Dairy under an agreement bearing the same date, was $ 8,000,000.On its returns for the years involved, the petitioner claimed deductions for depreciation or amortization of patents, which deductions were disallowed by the respondent in determining the deficiencies herein.  The deductions as disallowed by respondent, the deductions as claimed by petitioner in its petitions, 1954 U.S. Tax Ct. LEXIS 310">*446  and the deductions now claimed by petitioner on brief are as follows:YearRespondent'sClaimed inOn briefdeterminationpetitions1934$ 1,500,000.00$ 2,900,000$ 1,572,192.6819351,500,000.002,900,0001,584,142.1219362,000,000.002,900,0001,601,083.1719372,000,000.002,800,0001,526,512.2319382,054,119.192,400,0001,362,697.99Interest Deduction Issue.The minutes of a special meeting of the petitioner's board of directors, on May 21, 1930, show the acceptance of an offer from National Dairy to sell and convey to petitioner all the properties and assets it had acquired from Kraft (Ill.), excepting a specified amount of cash and the stock of certain corporations, in consideration of the assumption by petitioner of the liabilities of Kraft (Ill.), the issuance of 19,900 shares of its capital stock to National Dairy, and the payment of $ 10,000 in cash.  The minutes also show the adoption of a resolution finding that the assets so acquired had an actual value of at least $ 31,500,000 in excess of the liabilities assumed; and further, "that $ 1,990,000.00 in value of said business, properties and assets so to be received * * * shall be1954 U.S. Tax Ct. LEXIS 310">*447  taken as capital with respect to said 19,900 shares and the remainder in value of such properties and assets over and above the total amount of liabilities to be assumed and the sum of $ 10,000.00 to be paid as part of the purchase price shall be taken as surplus." 10 As of May 1, 1930, petitioner opened an account designated "Surplus -- Initial," with a credit entry of $ 32,381,748.  For the years 1931, 1932, 1933, and 1934 up to June 30, this account was designated "Surplus at Date of Acquisition." Separate and apart from the Surplus at Date of Acquisition account, petitioner, in May of 1930, also opened an account designated "Surplus -- Earned," which account was maintained currently with the Surplus at Date of Acquisition account.1954 U.S. Tax Ct. LEXIS 310">*448 21 T.C. 513">*576   The minutes of the meeting of petitioner's board of directors, held on June 26, 1934, show the following:The Chairman presented the balance sheet of the Corporation as of May 31, 1934, prepared by the Corporation's officers and accountants showing a surplus per books of $ 31,324,384.14.  11The Chairman suggested that a dividend be declared and paid by the Corporation to the stockholders of the Corporation out of such surplus. He stated, however, that it was desirable to conserve the cash position of the Corporation for the present and recommended that the dividend be paid in 6% debentures of the Corporation due February 1, 1948.  He presented a form of such debenture as prepared by counsel to the Corporation and pointed out that the interest was payable monthly, and that the entire principal amount thereof become due on default by the Corporation or the occurrence of certain other events.After due consideration, on motion duly made, seconded and unanimously carried, it wasRESOLVED, That the Board of Directors of this Corporation hereby declares out of the surplus of this Corporation a dividend of $ 30,000,000.00 on the issued and outstanding capital stock of the 1954 U.S. Tax Ct. LEXIS 310">*449  Corporation payable on June 30, 1934, to stockholders of the Corporation of record on the 29th day of June, 1934; and furtherRESOLVED, That such dividend be paid in 6% debentures of the Corporation due February 1, 1948, such debentures to be substantially in the form as presented to this meeting and to be paid to the stockholders of the Corporation entitled thereto in such amount or amounts as may be requested by such stockholders, but not in excess of the amounts to which such stockholders may be entitled; and furtherRESOLVED, That the Officers of this Corporation be and hereby are authorized and directed to do any and all acts and things, including the execution and delivery of such debentures in the proper amounts, as, with the advice of counsel, they may deem necessary or advisable in order to facilitate the payment of the aforesaid dividend and the issuance of the aforesaid debentures.The Chairman then referred to the transactions in 1930 in connection with the sale by this Corporation's predecessor, Kraft-Phenix Corporation (Illinois), of its entire assets and business as a going concern to National Dairy Products Corporation, and the subsequent transfer to this Corporation1954 U.S. Tax Ct. LEXIS 310">*450  of the entire assets and business, except for shares of stock of Southern Dairies, Inc., Purity Creamery Products, Inc., Oakdale Dairy Co., Inc., and National Cheese Co.  The Chairman also referred to the earnings record of the Corporation and to the value of its assets and business as a going concern.  He further called attention to the fact that the assets and business had been entered on the books of this Corporation at the time of acquisition at the amount of $ 34,371,748.00, being in substance the mere transfer of the book values of the properties from the books of the predecessor Illinois corporation to the books of this Corporation.After due consideration, on motion duly made, seconded and unanimously carried, it was21 T.C. 513">*577  RESOLVED, That in the judgment of this Board of Directors, the assets of this Corporation exclusive of goodwill, trade marks and patents, are worth not less than the values at which such assets are now carried on the books; and furtherRESOLVED, That in the judgment of this Board of Directors, the goodwill, trade marks, and patents of this Corporation are worth at least $ 17,500,000; and furtherRESOLVED, That the goodwill, trade marks and patents1954 U.S. Tax Ct. LEXIS 310">*451  of this corporation be entered on its books at $ 17,500,000 and that the surplus account of the corporation be adjusted accordingly.Pursuant to resolution adopted, as shown by the above minutes, debentures 12 were issued and delivered by petitioner to National Dairy in the principal amount of $ 30,000,000 on June 30, 1934.  Thirty debentures, each in the amount of $ 1,000,000, were so issued and delivered on that day, and were in form and words as follows: No.    $ 1,000,000KRAFT-PHENIX CHEESE CORPORATION6% DEBENTUREDUE FEBRUARY 1, 1948KRAFT-PHENIX CHEESE CORPORATION, 1954 U.S. Tax Ct. LEXIS 310">*452  a corporation organized and existing under the laws of the State of Delaware (hereinafter called the Company), for value received, hereby promises to pay to NATIONAL DAIRY PRODUCTS CORPORATION, or order, on the first day of February, 1948, at the principal office of the Company in the City of Chicago, State of Illinois, the sum of    ONE MILLION DOLLARS ($ 1,000,000)    lawful money of the United States of America, and to pay interest thereon from the 30th day of June, 1934, at the rate of six per cent, per annum, in like money, at said office of the Company, in the City of Chicago, State of Illinois, on the 1st day of each month in each year, but only until maturity.This Debenture is designated as a 6% Debenture of the Company due February 1, 1948 and is one of a duly authorized issue of Debentures of the Company, all of like tenor, limited to an aggregate principal amount of $ 30,000,000 (hereinafter called the Debentures), all dated as of June 30th, 1934.If default shall be made in the payment of any interest due on any Debenture of this issue, and such default shall continue for sixty days, or if the Company shall be adjudicated insolvent or a bankrupt, or file1954 U.S. Tax Ct. LEXIS 310">*453  a petition for voluntary bankruptcy, or make an assignment for the benefit of its creditors, or consent to the appointment of a receiver of all or any substantial part of its property, or admit in writing its inability to pay its debts generally as they become due, or if an order, judgment or decree shall be entered by any court of a competent jurisdiction appointing a receiver or trustee of the Company or of the whole or a substantial part of its property without the consent of the Company on the ground of its 21 T.C. 513">*578  insolvency or because of its inability to pay its debts or obligations and such receiver or trustee shall not be removed or discharged within ninety days from the date of the qualification of such receiver or trustee, or if final judgment for the payment of money shall be rendered against the Company and shall not be discharged within sixty days from entry thereof or a stay of execution secured pending appeal therefrom, the Debentures of this series then outstanding may be declared and shall forthwith become due and payable at their principal amount and accrued interest by declaration to the Company in writing by the holders of fifty per cent, in principal amount 1954 U.S. Tax Ct. LEXIS 310">*454  of the Debentures outstanding or their duly authorized agents.No recourse shall be had for the payment of the principal of or interest on this Debenture or for any claim based hereon or otherwise in respect hereof, against any incorporator, stockholder, director or officer, past, present or future of the Company or of any successor or predecessor corporation, either directly or through the Company or any such successor or predecessor corporation, whether for amounts unpaid on stock subscriptions or by virtue of any constitution, statute or rule of law or by the enforcement of any assessment, penalty or otherwise, all such liability, whether at common law, in equity, by any constitution or statute or otherwise, of incorporators, stockholders, directors or officers, being released by every holder hereof by the acceptance hereof and as part of the consideration for the issue hereof.IN WITNESS WHEREOF, KRAFT-PHENIX CHEESE CORPORATION has caused this Debenture to be executed in its corporate name by its President thereunto duly authorized, as of the 30th day of June, 1934.ATTEST:SecretaryKRAFT-PHENIX CHEESE CORPORATIONBy    PresidentTreasurer(Reverse side)FOR VALUE1954 U.S. Tax Ct. LEXIS 310">*455  RECEIVEDhereby sell, assign, endorse and transfer untothe within debenture ofKRAFT-PHENIX CHEESE CORPORATIONand hereby irrevocably authorize said Corporation to transfer said debenture on the books of said Corporation.    Dated   In respect of the issue of this Debenture United States Documentary stamps have been affixed to a memorandum placed in the minute book of the Corporation, and duly cancelled.On the issuance of such debentures, documentary stamp tax was paid in the amount of $ 30,000.At December 31, 1933, the Surplus at Date of Acquisition account stood at $ 29,752,461.38.  Net credits to the account for the first 6 21 T.C. 513">*579  months in 1934 amounted to $ 245,841.53, representing appreciation of investments, bringing the balance1954 U.S. Tax Ct. LEXIS 310">*456  in the account at June 30, 1934, to $ 29,998,302.91.  The Earned Surplus account stood at $ 573,632.86 at both December 31, 1933, and June 30, 1934.  On June 30, 1934, both of these accounts were closed out and an account designated "Surplus" was set up, with an opening entry of $ 30,077,986.79, being the aggregate, less $ 493,948.98, 13 of the closing balances in the Surplus at Date of Acquisition account and the Earned Surplus account.  On the same date, June 30, 1934, there was also credited to the new Surplus account $ 13,120,151.26, bringing the aggregate credits as of that date to $ 43,198,138.05.  The item of $ 13,120,151.26 represented the carrying out of the second above resolution of the board of directors adopted on June 26, 1934, being the amount necessary to bring the "appreciation of good will, patents and trade marks" up to $ 17,500,000.  Also under date of June 30, 1934, the first charge to the new Surplus account was $ 30,000,000, representing the issuance of the above debentures in that aggregate face amount.  Credit entries were thereafter made to cover dividends received in the amount of $ 932,091.02 and 1934 profit and loss of $ 1,295,381.10.  Charges to cover1954 U.S. Tax Ct. LEXIS 310">*457  a $ 1,000,000 cash dividend, provision for bad debts, loss on worthless investments, investments written down, and investments written off, left a credit balance in the account at December 31, 1934, of $ 14,352,209.The net income of petitioner per books, after provision for Federal income tax, for the years 1931 through 1936, inclusive, was as follows:1931$ 3,394,481.7419322,308,395.8519331,953,484.5219341 $ 1,294,693.0219351 2,503,418.4019361 2,621,409.05The net income of petitioner and its wholly owned subsidiaries per books, after provision for Federal income tax, for the 8-month period ended December 31, 1930, and for the calendar years 1931 to 1936, inclusive, was as follows:1930 -- 8 months$ 3,233,720.9819313,683,669.2419322,302,274.5019332,688,427.7119341 $ 2,400,455.4519351 3,964,680.5119361 4,221,344.091954 U.S. Tax Ct. LEXIS 310">*458 The consolidated balance sheets of petitioner and its wholly owned subsidiaries as at December 31, 1933, and December 31, 1934, reflect cash on hand of $ 1,558,225.15 and $ 1,964,784.79, respectively.  The cash balances at the end of the preceding year were not materially different.  Marketable securities were carried in insignificant amounts.  21 T.C. 513">*580  Notes and accounts receivable at the end of the years 1933 and 1934 were in the amounts of $ 4,741,791.51 and $ 4,327,305.44, respectively.  As at the close of the 3 preceding years notes and accounts receivable varied from approximately $ 6,200,000 to $ 6,600,000.  No other quick assets are disclosed as at December 31, 1933, and December 31, 1934.  Current liabilities on such dates were $ 2,399,181.39 and $ 3,228,429.22, respectively.The earnings of National Dairy consist, for the most part, of dividends from its subsidiaries or other companies.  Its net profits for the years 1930 to 1933, inclusive, amounted to $ 14,918,230.32, $ 21,977,898.46, $ 12,680,574.67, and $ 10,319,410.54.For the years 1930 to 1933 inclusive, 1954 U.S. Tax Ct. LEXIS 310">*459  National Dairy and its affiliated companies, including petitioner, filed consolidated returns of income.  On each of said returns net consolidated taxable income was reported, on which a tax was paid.  The net losses of National Dairy used in arriving at the net consolidated taxable income of National Dairy and its affiliated companies for said years, were as follows:1930$ 3,582,510.3519311,445,177.731932$ 3,630,138.6719334,151,212.67For the years 1934 and 1935, National Dairy filed separate returns, on which it reported net losses of $ 1,483,155.88 and $ 523,070.59, respectively.  On its 1934 return, $ 64,041,588.38 was reported as dividends on the stock of domestic corporations, and under deductions was the same amount as dividends on domestic corporations.  On the 1935 return, National Dairy reported $ 18,937,403.65 as dividends on the stock of domestic corporations, and under deductions for dividends, the same amount was claimed as a deduction.Petitioner paid interest to National Dairy on the 30 debentures above described for the years 1934 to 1940, inclusive, as follows:1934$ 900,00019351,800,00019361,800,00019371,800,0001938$ 1,800,00019391,800,00019401,800,0001954 U.S. Tax Ct. LEXIS 310">*460  From 1930 to 1938, inclusive, the following dividends were paid by petitioner in cash and demand notes:1930 Cash$ 1,750,0001931 Cash4,000,0001932 Cash3,500,0001933 Cash2,000,0001934 Cash1,000,0001935 Cash5,300,0001936 Demand Notes (6%)3,850,0001937 Cash400,000Demand Notes (4 1/2%)2,583,0001938 Demand Notes (4 1/2%)4,000,00021 T.C. 513">*581  Under date of January 21, 1941, J. L. Kraft, president of the petitioner, wrote the following letter to National Dairy:January 21, 1941.National Dairy Products Corporation,230 Park Avenue,New York, N. Y.Dear Sirs:You hold $ 30,000,000 of our debentures. At the time our debentures were issued and the interest rate on them fixed, your outstanding debentures bore interest at 5 1/4% per annum.  Subsequently, by refunding operations, you have substantially diminished your long term funded debt interest rate.We respectfully request that you consent to a reduction in the interest rate on our debentures held by you from 6% per annum to 4% per annum, effective January 1, 1941, such consent to be evidenced by appropriate endorsement on said debentures.Yours very truly,Kraft Cheese Company.By J. L. Kraft1954 U.S. Tax Ct. LEXIS 310">*461 President.The action of the board of directors of National Dairy on the matter covered in the January 21, 1941, letter from petitioner is shown by the minutes of the meeting of the board of directors of National Dairy for January 23, 1941, as follows:Indebtedness from SubsidiariesThe Chairman presented letters dated January 21, 1941, received from Kraft Cheese Company, Sheffield Farms Company, Inc., General Ice Cream Corporation and Hydrox Corporation requesting a reduction in the rate of interest carried by the 6% Debentures due 1948 of those companies held by the Corporation.  The Comptroller, at the request of the Chairman, made a report as to the principal amount of other indebtedness due from subsidiaries to the Corporation and the rate of interest being charged on such loans.  The Chairman reported that, including all costs in connection therewith, the cost of the Corporation of the twenty-year long term funded debt now outstanding was approximately 3 1/2% per annum and the cost of its funded debt maturing serially over ten years averaged about 1.83%.After full consideration, the Board of Directors authorized a reduction in the rate of interest on the debentures 1954 U.S. Tax Ct. LEXIS 310">*462  of Kraft Cheese Company, Sheffield Farms Company, Inc., General Ice Cream Corporation and Hydrox Corporation held by this Corporation from 6% to 4% per annum; a reduction in the rate of interest on loans from the Corporation to its subsidiaries, classed as storage loans or inventory loans to be paid in the ordinary course of business within one year from the date thereof, from 4% to 3% per annum; and a reduction in the rate of interest on other loans from the Corporation to its subsidiaries from 4 1/2% to 4% per annum all effective as of January 1, 1941.Effective January 1, 1941, by agreement between petitioner and National Dairy, typewritten on the face of each debenture and signed by National Dairy, the rate of interest was reduced from 6 per cent per annum to 4 per cent per annum and the interest thereafter paid annually by petitioner was $ 1,200,000.21 T.C. 513">*582  The 30 debentures matured February 1, 1948, and were at that time replaced by a new issue of debentures bearing interest at 4 per cent per annum.  Said new debentures were outstanding at the time of the trial herein.The principal amount of funded debt obligations of National Dairy outstanding in the hands of the public 1954 U.S. Tax Ct. LEXIS 310">*463  and in banks at the end of each year from 1933 through 1940, the rates of interest payable thereon and the due dates, were as follows:Year endedNaturePrincipalRate ofDueDecember 31amountinterest1933Debentures$ 69,623,500.005 1/4%19481934Debentures68,214,500.005 1/4%19481935Debentures67,070,500.005 1/4%19481936Debentures62,545,500.003 3/4%1951Bank loans6,300,000.002 1/2%1937-19411937Debentures60,539,000.003 3/4%1951Bank loans4,900,000.002 1/2%1937-19411938Debentures58,775,500.003 3/4%1951Bank loans3,500,000.002 1/2%1937-19411939Debentures56,899,000.003 3/4%19511940Debentures55,000,000.003 1/4%1960Serial debentures15,000,000.003/8%-2.10% 11941-1950On June 20, 1934, Sheffield Farms Company, Inc., all of the stock of which had been owned by National Dairy from October 31, 1925, declared and paid to National Dairy a dividend of $ 22,165,712.32, payable in 6 per cent debentures of said Sheffield Farms Company, Inc., 1954 U.S. Tax Ct. LEXIS 310">*464  due February 1, 1948.  Said debentures were debited to surplus and said Sheffield Farms Company, Inc., had at the time of such said declaration and payment of dividends earnings and profits for Federal income tax purposes, accumulated since March 1, 1913, in excess of the principal amount of such debentures. The separate taxable net income of Sheffield Farms Company, Inc., for 1930 to 1933, included in the consolidated returns of National Dairy and its affiliated corporations was as follows:1930$ 4,794,845.8219314,723,372.181932$ 4,690,390.8619332,680,594.55In determining the tax liability of Sheffield Farms Company, Inc., for 1934 and later years, respondent did not disallow as deductions interest paid to National Dairy on such debentures.Insofar as appears of record, the sole purpose of issuing the 30 debentures herein on June 30, 1934, was to permit the petitioner to take tax saving deductions, while at the same time the tax liability of National Dairy under existing law was not affected by receipt of the interest.In its returns for the years herein, the petitioner claimed deductions of $ 900,000 for 1934 and $ 1,800,000 for the remaining years as interest1954 U.S. Tax Ct. LEXIS 310">*465 21 T.C. 513">*583  paid to National Dairy on the above 30 debentures. The respondent in his determination of deficiencies for those years disallowed the deductions so claimed.OPINION.The first question is the basis to petitioner for depreciation or amortization of the patents and applications for patents which were among the assets acquired by it from National Dairy in exchange for its capital stock. The parties are agreed that the basis therefor in the hands of petitioner is the cost to National Dairy of the patents and applications for patents in the transaction whereby National Dairy, in a lump-sum or package deal, acquired the business and assets of Kraft (Ill.).  The facts show that the consideration so paid by National Dairy in the acquisition of the assets and business of Kraft (Ill.) consisted of the assumption of liabilities in the amount of $ 2,801,148.72, and other consideration consisting of stock, debentures, and cash amounting to $ 78,338,412.84.  In short, our first question is to determine what part of the consideration stated properly represented the cost to National Dairy of the Kraft patents and applications for patents.In its petitions the petitioner alleged that the1954 U.S. Tax Ct. LEXIS 310">*466  cost of the patents herein to National Dairy was $ 31,373,716.25.  On brief, its claim now is that such cost was at least $ 20,000,000.  It is the claim of the respondent that the amount allocable as the cost of the patents did not exceed $ 2,530,000.The record is replete with evidence covering the manufacture, processing, and marketing of cheese and cheese products, the growth of Kraft in that business, the introduction on the market of processed cheese, as contrasted with natural cheese, the development and improvement of the methods of processing, the machinery required and utilized therein, as well as the equipment for the packaging of the product for the retail trade.  The history of the patents and the dates and manner of their procurement are quite fully shown.  There is also of record, on behalf of the petitioner, a detailed computation made by its comptroller, showing the conclusions as to unit costs, unit sales, and unit net profits of the various products produced and sold by Kraft and by petitioner, both patented and unpatented, for the years 1929 through 1948.  In making these computations, the witness started with book figures and then exercised his own judgment as 1954 U.S. Tax Ct. LEXIS 310">*467  to the proper allocation to the particular products of administrative and other costs not theretofore taken into account in arriving at gross profit.  The books themselves contained no entries designed to reflect such allocations or the unit net profits.In the course of the trial, the petitioner called numerous witnesses, beginning with J. L. Kraft, the founder of the original Kraft business, 21 T.C. 513">*584  designed to show the growth and development of the business and the role of the patented processes and apparatus in that growth and in the conduct of the business at the time of the sale to National Dairy.  Thereafter, it called one witness as an expert to give his opinion as to the portion of the total lump-sum price paid by National Dairy for the Kraft business and assets which should be regarded as the amount paid for the patents and applications for patents.In addition to several witnesses who gave testimony as to the manufacture and production of cheese, largely with respect to cream cheese, the respondent's testimony was from four witnesses.  The first of these was an employee of the Bureau of Internal Revenue, in its engineering and auditing section, who had prepared schedules, 1954 U.S. Tax Ct. LEXIS 310">*468  first from the balance sheet of Kraft (Ill.), and second according to the consolidated balance sheet of Kraft (Ill.) and its subsidiaries. The first was to show the assets of Kraft (Ill.) according to its books, both tangible and intangible, and finally its net tangible assets; and the second was to show similarly the assets of Kraft (Ill.) and subsidiaries on a consolidated basis.  He also presented his tabulation of the lump-sum cost to National Dairy of the Kraft assets and business by taking bonds and debentures at par plus interest, cash and other amounts paid in cash at the stipulated figures, and the stock at the high and low for sales made on the date of the sale herein.The second of respondent's witnesses was a practicing patent attorney, a former naval officer, who, during the recent World War, had devoted his time and attention to patent problems encountered by the Navy in the prosecution of the war.  In his testimony, he gave his analyses of many of the Kraft patents, most of his testimony being directed to the mechanical patents, which included the cheese cookers, so-called, and the packaging machinery patents. In the course of his testimony and by referring to what1954 U.S. Tax Ct. LEXIS 310">*469  he termed the carrying phrases in the various patents, he pointed out that many of the patents were what are sometimes referred to as patents in combination, wherein various of the elements are not novel but their use in combination is novel to the extent that they present an apparatus or device regarded by the United States Patent Office as patentable and upon which patents are issued.  As to a number of these patents and on the basis of his analyses thereof, he expressed the opinion that they were of limited value, in that as to many of them the use in combination was such as to give the patents what he termed merely a defensive value, which value from a comparative standpoint was negligible.  As to others, he found what he termed to be an assertive value.  This value was attributable to something more than a mechanical combination of elements, the use in combination being such as to give affirmative value to the patents.21 T.C. 513">*585  The third witness was called as an expert to present the results of a study made by him of acquisitions by food companies of similar or comparable concerns during the years 1928 and 1929 and the first 6 months of 1930, and to testify with respect thereto. 1954 U.S. Tax Ct. LEXIS 310">*470  In his studies, made on the basis of available statistics, he gave particular attention to the consideration paid in the course of such acquisitions for tangible and intangible assets.The respondent's fourth witness was an engineer of long service in the Bureau of Internal Revenue, who, on the basis of his opinion of their similarity "in nature," divided the patents into nine groups.  By way of illustration, the first group contained the processing and blending patents. The fourth group contained the patents relating to cooking apparatus.  In group seven were the patents relating to the cream cheese wrapping machine. Schedules showing his tabulation or mathematical computation of the remaining lives of the patents by groups were placed in evidence.  He also presented a schedule which in his opinion disclosed the value of the patents in group one on the basis of the royalties under the licensing agreements covering those patents.Relying heavily on the testimony of his witness called as an expert on patents, and on the valuation of the so-called processing or group one patents, arrived at by computations based on the royalties paid under licensing agreements covering those patents, 1954 U.S. Tax Ct. LEXIS 310">*471  the respondent makes his claim that the amount allocable as the cost of the patents and applications for patents did not exceed $ 2,530,000.  The objective here, however, is not to analyze the patents in combination in order to find and determine the relative technical merits of the separate or individual parts, nor to arrive at the value of such individual parts separately.  Neither is it our purpose to determine what the value of the patents might have been if the owner had been limited in their use to mere licensing for the purpose of collecting such royalties as might have been obtainable.  Here, the patents were part and parcel of the assets of the Kraft enterprises, a going business, and it is with them in that posture that we are concerned.  Furthermore, we are interested in the fair market value of the patents at the time of purchase only insofar as such fair market value may be indicative of the portion of the lump-sum purchase price of Kraft's business and assets as may reasonably and properly be regarded as having been paid for the patents. The respondent has not, in our opinion, given due regard to the problem in that aspect, and we are unable to conclude that the amount1954 U.S. Tax Ct. LEXIS 310">*472  properly to be regarded as the cost of the patents did not exceed the $ 2,530,000, as he contends.The $ 20,000,000 figure now claimed by petitioner is an acceptance of the opinion of its witness, called as an expert, as to the portion of 21 T.C. 513">*586  the lump-sum price paid by National Dairy for the Kraft business and assets which should be regarded as the amount paid for the patents and applications for patents. This witness was the only witness for petitioner testifying to any fixed or dollar amount which should be regarded as the amount so paid.While we have no doubt that the above witness was a man of wide experience in his field, namely, that of acting as business consultant, his testimony here was not impressive or convincing.  He had listened to the testimony of J. L. Kraft, and of McInnerney who had acted for National Dairy in the above purchase, and had reviewed "a good many documents" and the record of the trial which had been made prior to his appearance on the stand and when he was not present.  He arrived at his opinion of value by what might be termed a process of elimination.  He noted that in the contract of purchase "an earnings base of $ 5,000,000 was agreed upon1954 U.S. Tax Ct. LEXIS 310">*473  for the purpose of that transaction." He concluded on the basis of his studies of the business and the book assets that a value of 12 times earnings, or $ 60,000,000, was reasonable.  He noted, however, that the price actually paid was approximately $ 80,000,000, and looking for something to which he might attribute the $ 20,000,000 of the purchase price over and above the $ 60,000,000, arrived at as indicated, he decided that the patents, which were not among the book assets, accounted for the additional $ 20,000,000 of the purchase price.  He had heard or reviewed certain of the testimony, as indicated above, but he had made no study of the patents personally, or arrived at any conclusion as to the use or device of the patents in the Kraft business.  He had skimmed through them, but they meant nothing to him particularly.  And, when being questioned on cross-examination with respect to his choosing of the ratio of earnings to value, he testified that in 1929 and the early part of 1930 "very many" food companies were being purchased at amounts exceeding 12 times their earnings.  He also testified that he had had occasion to look at food companies and dairy companies and was of the1954 U.S. Tax Ct. LEXIS 310">*474  view that ordinarily they did not have patents. Having carefully observed the witness, listened to, examined and considered his testimony, we are unable to conclude that it supplies an adequate basis for finding that $ 20,000,000 of the total purchase price paid by National Dairy for the business and assets of Kraft (Ill.), or any other particular amount, is the amount properly allocable as the cost to National Dairy of the patents and applications for patents acquired in the transaction.In the circumstances stated, we are left to determine as best we may, from the background evidence, whether the cost of the patents to National Dairy was reasonably the $ 20,000,000 contended for, or some lesser amount.  Certainly we find no justification in the testimony 21 T.C. 513">*587  of McInnerney, president of and negotiator for National Dairy, for any conclusion that the amount properly allocable as the cost of the patents was anything like $ 20,000,000.  While he did testify at one point that he knew of the patents, attached a great deal of importance to them, and would not have bought the business if the patents had been excluded, his concluding statement on direct examination was more revealing, 1954 U.S. Tax Ct. LEXIS 310">*475  we think, of what he had in mind.  It was that the patent rights played an important part because they gave, or would give, the business "a little edge against competition." We are satisfied that he did regard the ownership of the patents as being important; but his testimony, as we heard it from him, falls far short of justifying a conclusion that $ 20,000,000, or, to put it differently, that approximately 25 per cent of the total purchase price of the business and assets of Kraft (Ill.), was paid for the patents.While there can be no question, we think, that the patents constituted an important part of the Kraft assets as they were acquired by National Dairy, we are of the view that the respondent is justified in his position that the patents themselves were a much lesser factor in the Kraft business and operations and in the purchase thereof by National Dairy than the petitioner claims.  The evidence of record very definitely shows that the development and advent of effective and successful methods of processing and blending natural cheese practically revolutionized the cheese business, but a patent and the rights thereunder are not synonymous with the method or process covered1954 U.S. Tax Ct. LEXIS 310">*476  thereby.  See Patterson v. Commonwealth of Kentucky, 97 U.S. 501">97 U.S. 501, 97 U.S. 501">507, wherein the Supreme Court quoted with approval from an opinion of the Supreme Court of Ohio as follows:Although the inventor had at all times the right to enjoy the fruits of his own ingenuity, in every lawful form of which its use was susceptible, yet, before the enactment of the statute, he had not the power of preventing others from participating in that enjoyment to the same extent with himself; so that, however the world might derive benefit from his labors, no profit ensued to himself.  * * * The sole operation of the statute is to enable him to prevent others from using the products of his labors except with his consent.  But his own right of using is not enlarged or affected. * * *Along the same line, Chief Justice Taney, in Bloomer v. McQuewan, 14 Howard 539">14 Howard 539, at page 548, had previously said:The franchise which the patent grants, consists altogether in the right to exclude every one from making, using, or vending the thing patented, without the permission of the patentee.  This is all that he obtains by the patent. * * *With few exceptions, the patents1954 U.S. Tax Ct. LEXIS 310">*477  here covered processes and apparatus which were of value or important because they were improvements or expansions of the methods covered by the processing and blending patents or supplied practical and economical devices and apparatus 21 T.C. 513">*588  for their exploitation.  14 For instance, the cookers and the packaging device for hard cheeses would have had little apparent utility but for the discovery and development of the method whereby the cheese, when heated, would remain in a homogeneous, cheese-like mass during and after the processing. Such dominance over the group of patents as a whole by the early processing and blending patents, the first of which was to expire in 1933, is, therefore, a very important factor in arriving at the role played by the patents in the Kraft operations and in determining their cost to National Dairy.  In that connection, the testimony of J. L. Kraft was quite revealing.  From his testimony, it is reasonable to conclude that Kraft was never so much interested in a substantial or full exercise of its rights under the patents, as it was in getting the resulting commodities to the consuming public.  In the first place, the processing operations, according1954 U.S. Tax Ct. LEXIS 310">*478  to his testimony, were simple enough to invite widespread infringement, and very shortly controversy arose between Kraft and Phenix, which were then separate enterprises, as to who was infringing whose patents. This altercation was settled by agreements providing for cross-licensing.  By 1925, Kraft and Phenix decided that it would be good business policy to license the processing patents 15 to responsible manufacturers, not with the revenue to be derived from the royalty as the moving factor, but for the purpose of obtaining the support of such manufacturers for the processed products and for the purpose of educating the public to the qualities thereof through wider distribution.  This course was feasible in the opinion of J. L. Kraft for several reasons.  The volume of available and potential business was such that Kraft could not possibly have acquired either sufficient raw material, manufacturing capacity, or sales or delivery capacity to supply the demand.  He was also of the view that, even with the competition that such a plan would afford, Kraft had the ability and capacity to attain and hold a dominant position in the cheese producing and marketing field to the extent that1954 U.S. Tax Ct. LEXIS 310">*479  it could develop sources of raw material, finance and expand its manufacturing capacity, and build up and improve its sales, 21 T.C. 513">*589  delivery, and other marketing operations.  J. L. Kraft himself quite aptly illustrated the soundness of the course taken, when he pointed out that even though Kraft had failed in its efforts to obtain patent protection in England for its cheese processing methods it nevertheless became the largest manufacturer and dealer in processed cheese in Great Britain, and in Australia its business progressed to such a point that it was doing better than 50 per cent of the Australian processed cheese business.1954 U.S. Tax Ct. LEXIS 310">*480  As being indicative of great value in the processing, blending, and boxing patents and in the Eldredge Patent No. 1,634,410, the petitioner puts great emphasis on Velveeta.  Velveeta is what is commonly referred to as a cheese food, and results from the processing of carefully selected cheddar cheese and, in the course of such processing, the addition of condensed whey and other ingredients.  It was introduced to the trade in 1928 and became one of Kraft's, and thereafter one of petitioner's, most popular and profitable products.The development of Velveeta followed the procuring in 1927 of a license under the above Eldredge patent from Pabst Corporation.  Pabst had been producing a processed bulk cheese product known as Pabst-ett, which was made from blended cheddar cheese, with the addition, among other things, of condensed or concentrated whey, and had been sued by Kraft for infringing its processing, blending, and boxing patents. The court held that the Kraft patents had been infringed and handed down a decision to that effect.  Thereafter, following the decision of the court, Kraft and Phenix granted licenses to Pabst under the above Kraft patents and under the blending and 1954 U.S. Tax Ct. LEXIS 310">*481  processing patents then belonging to Phenix, and Pabst granted a license to Kraft and Phenix under the Eldredge Patent No. 1,634,410.  Following the licensing of the patent, Kraft produced and brought out a cheese food by the name of "Nukraft," purportedly under the Eldredge patent, to compete with Pabst-ett.  Nukraft, although widely advertised, was a failure as a commercial product, and its production was discontinued.  After further research Kraft changed the Nukraft formula and brought out the cheese food Velveeta.In the light of the court decision above, we think it reasonable to conclude that the processes and devices covered by the above Kraft patents and most likely the methods of processing covered by the Phenix patents were and are utilized in the production of Velveeta.  Furthermore, to the extent that we may assume that the addition of whey and other ingredients, whatever they may be, is covered by the Eldredge patent, the processing of Velveeta is within the scope of that patent. We are unable to conclude, however, that the full value to be drawn from Velveeta is attributable solely to the patents in question.  As indicated, the record is plain and definite that Velveeta1954 U.S. Tax Ct. LEXIS 310">*482  is produced 21 T.C. 513">*590  according to a secret formula.  A secret formula or trade secret is quite the opposite from a process covered by a patent and to the extent that value is attributable to the secret formula, it may not be attributed to the patent. And in the absence of a showing that the success of Velveeta was due wholly to the use of the patented processes, as against its manufacture under the secret formula, we are unable to attribute value to the patents involved from the production of Velveeta to the extent claimed by the petitioner.  Nukraft, insofar as appears, was wholly within the Eldredge patent but, as indicated, was not a success and was abandoned.  Velveeta, at least insofar as the end product was concerned, was apparently something different, in that it was brought out after further research following the failure of Nukraft.  The formula was a new formula which was and has continued to be secret.With respect to the whey processing patents, we have encountered a somewhat comparable difficulty.  At May 21, 1930, Kraft had rights in processes covered by the applications for patents by Eldredge and Simmons, although the rights in Simmons' application had to be settled1954 U.S. Tax Ct. LEXIS 310">*483  thereafter by litigation.  At or about the same time, Peebles, Manning, and Western Condensing Company were likewise applying for patents covering methods for processing whey. In 1931 petitioner, on the one hand, and the parties mentioned, on the other, entered into a cross-licensing agreement.  If we have read the petitioner's argument aright, it is that the process covered by the Simmons patent dominated the whey processing field and the Simmons application for patent at May 21, 1930, when the rights thereto were acquired by National Dairy, is to be valued accordingly.  For corroboration, it points to the subsequent growth of petitioner's whey processing business.  We have been unable to conclude that the record is as definite and clear in that respect as petitioner's argument indicates.  There is testimony that during some of the time, if not all of the time, whey processing was carried on by petitioner under the method covered by the Peebles patent. The record is not clear as to the extent to which the petitioner's whey processing operations as were thereafter carried on, were under the Simmons, as against the Peebles, processing method.The above is not to say, however, that1954 U.S. Tax Ct. LEXIS 310">*484 Kraft, in its efforts to popularize its product by a rather free and liberal licensing policy 16 under its patents, surrendered, or had any intention of surrendering, the patents to public use, as in the case of the Dahlberg patent, or that it did not profitably utilize its patents or rights thereunder in its business.  As previously noted, one of the rights under a patent is the right of 21 T.C. 513">*591  choosing those who may be licensed and the extent of the use granted.  In the main, at least, Kraft granted its licenses to the more responsible cheese manufacturers, namely, those who could best further its purposes.  Furthermore, there can be no question that its prior ownership and continued ownership of the patents were factors which contributed substantially to its development ahead of its competitors, and at the time of the sale was contributing to its maintenance of that dominant position in the cheese manufacturing and marketing field.  While we have set forth much of the background or foundation facts, it has not been feasible to recite many such facts.  We have carefully studied and considered all of the evidence of record as presented by both the petitioner and the respondent, 1954 U.S. Tax Ct. LEXIS 310">*485  and after such consideration, it is our opinion, and we conclude that of the lump-sum purchase price paid by National Dairy for the Kraft business and assets, $ 8,000,000 was the amount paid for the patents and applications for patents.The remaining difference between the parties as to patents is over the method of computing the annual allowance for depreciation or amortization thereof.  Both parties apparently agree that where the cost or other basis of a patent is known, or may reasonably be determined, the correct method would be to prorate or spread such basis over the remaining life of the patent. Neither seeks to use that method here, however, since they are also in apparent agreement1954 U.S. Tax Ct. LEXIS 310">*486  that the cost basis of each patent individually cannot be determined.The petitioner, although making some computations of value for various patents or groups of patents upon the basis of amounts constructed by it as the earnings attributable thereto, argues that the patents were such an integrated part of the business and assets of Kraft, and later of petitioner, that there is no practical or sound method of finding and determining the value of the patents individually; and in the absence thereof, the best or most reasonable method is to compute the number of days of unexpired patent life at the beginning of the taxable years for all patents and the number of days of remaining life expiring in each taxable year for all patents and then apply the precentage which the latter figure is of the former to the basis for all patents, to arrive at the amount of the deduction.  It points out that this method was approved and followed by this Court in disposing of a similar question in Simmons Co., 8 B. T. A. 631. It argues further that such a method is within the scope of the respondent's regulations and sound accounting principles.  171954 U.S. Tax Ct. LEXIS 310">*487  The respondent, on the other hand, while criticizing the petitioner's method for computing the annual depreciation or amortization allowance, and pointing out that the correct method is by spreading the cost 21 T.C. 513">*592  or other adjusted basis of each particular patent over the years of its remaining life, has in principle adopted a method which is open to the same criticism he has directed toward petitioner.  Instead of making a determination of the adjusted basis for each individual patent and computing the depreciation allowance over the remaining life thereof, he contends for a determination of basis of the patents by groups and for a depreciation allowance over the remaining period representing the average of the lives of the patents in the particular group.  Theoretically there is some justification for grouping the patents as the respondent seeks to do, in that such a course would be one step closer to a determination of the depreciation or amortization allowance on the patents individually, and further, the patents in at least two of the groups, and petitioner so admits, do constitute functionally related groups.  The difficulty is, however, that in the instant case we find 1954 U.S. Tax Ct. LEXIS 310">*488  no better basis for determining the cost of the patents by groups than for determining their costs individually, which latter determination respondent, on brief, states cannot be done.The statute, section 23 (l) of the Revenue Acts of 1934, 1936, and 1938, goes no further than to provide for the deduction of "a reasonable allowance for exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence." A taxpayer is not restricted to any specific method of computing the depreciation allowance, however, the only requirement being that the allowance, when computed, be a reasonable allowance.  With reference to patents, article 23 (l)-7 of Regulations 86, 94, and 101 states that the allowance "should be computed by an apportionment of the cost or other basis of the patent" over its life.  With respect to the method of computation, article 23 (l)-5 of the said regulations provides, "Whatever plan or method of apportionment is adopted must be reasonable and must have due regard to operating conditions during the taxable period.  The reasonableness of any claim for depreciation shall be determined upon the conditions known to exist at1954 U.S. Tax Ct. LEXIS 310">*489  the end of the period for which the return is made.  * * * The deduction for depreciation in respect of any depreciable property for any taxable year shall be limited to such ratable amount as may reasonably be considered necessary to recover during the remaining useful life of the property the unrecovered cost or other basis."On the facts here, we think that the method of computing the depreciation or amortization allowance contended for by the petitioner is the most reasonable advanced, and we have been unable to discover any method which is more reasonably applicable to this case.  We have been able, on the evidence, to determine the cost of the patents as a group and we agree with the parties that it is not possible to determine the cost of each patent separately.  It is undoubtedly true, 21 T.C. 513">*593  as the respondent suggests, that some of the patents are worth more than others, and, such being the case, those patents would be regarded as having a greater cost than others and having a greater cost, the depreciation or amortization allowance would be correspondingly greater.  In the circumstances here, however, it is not possible to determine within the group, particularly those1954 U.S. Tax Ct. LEXIS 310">*490  which are functionally related, where the scope of one patent ends and the other begins.  Rather obviously, there is an overlapping and the second or third patent would not have been what it was except for matters covered by those which preceded it.We are accordingly of the opinion that the computation of the depreciation or amortization allowance on the patents as a group is fair and proper and that the life of the group in each particular year is fairly and reasonably shown according to the method advanced by the petitioner and covered in our Findings of Fact.  Noting, however, the provisions quoted above from article 23 (l)-5 of the regulations, that the allowance shall be determined upon the conditions known to exist at the end of the taxable period, the parties are directed in their computations to eliminate Patent No. 1,258,438, since the findings show that although included among the patents, title to which passed to National Dairy on May 20, 1930, this patent had no value and had proved of no value since that time.The remaining issue is as to the correctness of the respondent's disallowance of interest deductions claimed by petitioner.  It is the petitioner's contention 1954 U.S. Tax Ct. LEXIS 310">*491  that the amounts in question represented interest paid annually pursuant to $ 30,000,000 of valid and subsisting debentures or evidences of indebtedness outstanding in each of the taxable years.  If we read them aright, the respondent's claims in substance are that the issuance of the said instruments did not create a debtor-creditor relationship, that the interest of National Dairy in petitioner was, and continued to be a stock interest, and that the payments in question, although made under the guise of interest, represented the distribution of petitioner's earnings and profits to its one stockholder, namely, National Dairy.Subject to an exception, not here pertinent, section 23 (b) of the Internal Revenue Code provides for the deduction of "all interest paid or accrued within the taxable year on indebtedness." With respect to the words "interest" and "indebtedness" as used in that section, the Supreme Court, in Deputy v. Du Pont, 308 U.S. 488">308 U.S. 488, had the following to say:We are dealing with the context of a revenue act and words which have today a well-known meaning.  In the business world "interest on indebtedness" means compensation for the 1954 U.S. Tax Ct. LEXIS 310">*492  use or forbearance of money.  In the absence of clear evidence to the contrary, we assume that Congress has used these words in that sense. * * *21 T.C. 513">*594  Unlike many of the decided cases, we do not have here a case in which the instruments involved had some of the characteristics of both debentures and certificates of stock and the problem has been to determine which they were.  In the instant case, all of the requirements of form and ritual necessary to make the instruments debentures were meticulously met.  They were either evidences of indebtedness and effective as such, or, being purely ritualistic and without substance, were futile and ineffective to make the annual payments interest.  See and compare John Kelley Co. v. Commissioner and Talbot Mills v. Commissioner, 326 U.S. 521">326 U.S. 521; Commissioner v. Hood & Sons, Inc., 141 F.2d 467; Ruspyn Corporation, 18 T.C. 769; Lansing Community Hotel Corporation, 14 T.C. 183; New England Lime Co., 13 T.C. 799; Toledo Blade Co., 11 T.C. 1079;1954 U.S. Tax Ct. LEXIS 310">*493 Swoby Corporation, 9 T.C. 887; 1432 Broadway Corporation, 4 T.C. 1158; Clyde Bacon, Inc., 4 T.C. 1107; Proctor Shop, Inc., 30 B. T. A. 721, affd.  82 F.2d 792; and O. P. P. Holding Corporation, 30 B. T. A. 337, affd.  76 F.2d 11.Relying heavily on the fact that the issuance of the debentures was a transaction between a parent company and its wholly owned subsidiary and the further fact that the debentures brought no new money into the business, and contending that their issuance served no business purpose but that the sole purpose was a tax-saving purpose, whereby petitioner could distribute its earnings to its sole stockholder in the guise of interest, that the ratio of the so-called debentures to capital stock was so disproportionate as to make the transaction unrealistic, and further, that there is no evidence here of a genuine intention to create a debt, the respondent concludes that the transaction did not result in the creation of an indebtedness, but that, for all 1954 U.S. Tax Ct. LEXIS 310">*494  practical purposes, the interest of National Dairy in petitioner remained the same as before the issuance of the debentures.As proof of its claimed indebtedness to National Dairy, the petitioner, for all practical purposes, rests its case on the resolution of its board of directors that it "hereby declares out of the surplus of this Corporation a dividend of $ 30,000,000.00," and on the terms of the debentures issued thereunder, its argument with respect to the latter being that the terms "of the debentures so clearly demonstrate that petitioner intended to create and did create true indebtedness that those terms alone are more than enough to satisfy petitioner's burden of proof." The remainder of its argument, in the main, is negative in character, such as, the debentures were not invalid because petitioner had only one stockholder; 18 the debentures were not invalid because simple in form; the debentures were not invalid because assets were not distributed pursuant to the declaration of the "dividend"; 1921 T.C. 513">*595  the debentures were not invalid because they were charged to paid-in surplus; 20 they were not invalid because they brought no new capital into the business; 21 they1954 U.S. Tax Ct. LEXIS 310">*495  were not invalid because a tax advantage "may have accrued from their issuance"; 22 and whether their issuance served a business purpose, is not a test of the deductibility of interest thereunder.  231954 U.S. Tax Ct. LEXIS 310">*496 While it may be sound law that the declaration of a dividend creates a debt and gives rise to a debtor-creditor relationship between a corporation and its stockholders, as petitioner argues, the declaration, to be effective, must be supported by an intent that it be so and that the dividend be paid.  The formality of declaration alone is insufficient.  See the discussion in Maverick-Clarke Litho Co., 11 T.C. 1087, as to the declaration and payment of a dividend by a corporation whose stock was closely held.As to the dividend in the instant case, we agree with the respondent that the only purpose shown for its declaration or the issuance of the debentures which followed was a tax-saving purpose.  Petitioner does make some argument that a business purpose was indicated in the issuance of the debentures and that substance was imparted to the transaction by the fact that National Dairy, in its acquisition of the Kraft business and assets some 4 years earlier, had paid $ 33,264,500 of the purchase price in its 5 1/4 per cent gold debentures, which debentures were still outstanding.  From this, it is argued that since the business and assets so acquired 1954 U.S. Tax Ct. LEXIS 310">*497  by National Dairy from Kraft had become the business and assets of petitioner, a business purpose was served by having petitioner similarly obligated to National Dairy in a somewhat comparable amount.  Aside from the argument itself, the record is devoid of any proof showing that the situation described prompted or brought about the issuance of the debentures herein; or, if so, the reason why they were not issued some 4 years before they were.  Furthermore, it is not readily apparent just how the issuance of the debentures by petitioner, merely because its parent company had debentures outstanding, would serve a business purpose for petitioner.  The petitioner's minutes show only that the chairman of petitioner's board of directors presented a balance sheet as of May 31, 1934, showing a surplus, according to the books, of $ 31,324,384.14 and suggested that a dividend be declared and paid to its stockholder out of such surplus, and that he then stated that it was desirable to conserve 21 T.C. 513">*596  the cash position of the corporation and recommended that the dividend be paid in 6 per cent debentures, due February 1, 1948.  In that connection, we agree with respondent that any matter appearing1954 U.S. Tax Ct. LEXIS 310">*498  in the minutes which might convey the thought that there was ever any idea that such a dividend would be paid in cash, was purely "window dressing." Except for the comparatively small amount of accumulated earnings and profits, the dividend would have had to be paid from surplus paid in at the time of petitioner's organization, which surplus was and had continued to be in the form of assets regularly used and required in the business.  To have paid the dividend in cash, without borrowing substantially the full amount, would have required the liquidation of a very substantial portion of the Kraft enterprises, and the possibility or probability that the Kraft business would have been liquidated for that purpose or money actually borrowed therefor, is, in our opinion, too remote for serious consideration.On the other hand, there is ample indication of a tax motive and, so far as appears, a purpose or motive to save taxes was the only purpose served.  Until the tax situation changed in 1934 and National Dairy and its subsidiaries were no longer permitted to file returns on a consolidated basis, the then existing capital structure of the petitioner had, so far as shown of record, adequately1954 U.S. Tax Ct. LEXIS 310">*499  and satisfactorily served its purposes.  During all of the years of petitioner's existence, up to and including 1933, the operations of National Dairy, after the exclusion of dividends received by it from domestic corporations, disclosed large net losses, which were available in the consolidated returns to substantially absorb the taxable income of petitioner and other subsidiaries. When the filing of consolidated returns was outlawed in 1934, there was no such advantage, since the dividends paid to National Dairy were not deductible by petitioner on its returns and National Dairy's net loss could not be availed of as theretofore.  To the extent, however, that the character of petitioner's distributions to National Dairy should be changed from dividends to interest, it would have a deduction in computing its net income; and any interest received by National Dairy, even though taxable to it, could be absorbed to the extent of the loss which National Dairy would otherwise report on its return.It does not follow, of course, that the presence of a tax-saving purpose and the absence of a business purpose in the issuance of the claimed debentures requires or leads to the conclusion that1954 U.S. Tax Ct. LEXIS 310">*500  a debtor-creditor relationship evidenced by valid and subsisting debentures did not arise between the parties.  Commissioner v. Hood & Sons, Inc., supra;Lansing Community Hotel Corporation, supra;Toledo Blade Co., supra; and Cleveland Adolph Mayer Realty Corporation, supra. See also what was said in our opinion in John Kelley Co., 21 T.C. 513">*597 1 T.C. 457. That is not to say, however, that they are not factors to be considered in the over-all picture for the purpose of determining whether the creation of a debt was actually intended and whether a debt in truth did arise.  And while we do agree that the petitioner had the legal right to rearrange its capital structure in the manner set forth, and as we have already noted, the instruments in question did meet the formal requirements of evidences of indebtedness and the facts further show that petitioner had ample and adequate surplus to supply the consideration for the issuance of the debentures, the answer to the question whether a debtor-creditor relationship did arise may not, on the1954 U.S. Tax Ct. LEXIS 310">*501  record here, be so readily and simply derived.  There was not, for instance, an arm's-length transaction wherein the parties were unrelated or strangers, but a corporation-stockholder transaction.  Furthermore, we do not have a case where the corporate stock was widely held, but that of a parent corporation and its wholly owned subsidiary, in which, as stated in Commissioner v. Transport Trading & Terminal Corporation, 176 F.2d 570, the will of the parent is also the will of the subsidiary. What was said in 1432 Broadway Corporation, 24supra, where the same question was presented, is equally to the point in this case.  We there said:The debentures are in approved legal form, and, if their legal attributes alone were determinative of the character of the interest accruals, there would be little room for doubt that they were the indebtedness they purport to be.  Cf.  Clyde Bacon, Inc., 4 T.C. 1107. But, for tax purposes, their conformity to legal forms is not conclusive.  Although a taxpayer has the right to cast his transactions in such form as he chooses, and the form he chooses will generally be respected, 1954 U.S. Tax Ct. LEXIS 310">*502  the Government is not required to acquiesce in the taxpayer's election of form as necessarily indicating the character of the transaction upon which his tax is to be determined.  "The Government may look at actualities and upon determination that the form employed for doing business or carrying out the challenged tax event is unreal or a sham may sustain or disregard the effect of the fiction as best serves the purposes of the tax statutes." Higgins v. Smith, 308 U.S. 473">308 U.S. 473. * * *Even where new money or property is needed in the business and is paid in to a closely held corporation, and where the book entries and the terms of the written instruments, because made or1954 U.S. Tax Ct. LEXIS 310">*503  determined at or about the time the money or property was actually paid in, might more reasonably be expected to reflect the true character of the transaction, it has been found that such entries or writings may or may not be indicative of the character of the payments or advances as loans and that a debtor-creditor relationship has arisen with respect thereto.  There must have been an intention that a debt should be created and that a debtor-creditor relationship, rather than a stockholder 21 T.C. 513">*598  or proprietor relationship, should arise.  Wilshire & Western Sandwiches, Inc. v. Commissioner, 175 F.2d 718; Maloney v. Spencer, 172 F.2d 638; Van Clief v. Helvering, 135 F.2d 254; Erard A. Matthiessen, 16 T.C. 781; Isador Dobkin, 15 T.C. 31; Edward G. Janeway, 2 T.C. 197; and Daniel Gimbel, 36 B. T. A. 539.We have carefully examined and considered the evidence of record and the facts which may fairly be drawn therefrom, and we are not convinced that the1954 U.S. Tax Ct. LEXIS 310">*504  creation of a debt or of a debtor-creditor relationship between National Dairy and petitioner under the claimed debentures was ever intended.  To the contrary, we are persuaded by the evidence and the facts drawn therefrom that their relationship continued to be a stockholder-corporation relationship and that that relationship was not changed by the adoption of the dividend resolution and the issuance of the debentures thereunder.  Aside from the fact that there was ample substance in petitioner's assets to support the debentures, there is in our opinion the showing of nothing more than an indulgence in formalities, which include the dividend resolution, the form and formal issuance of the debentures, and the recording of the annual payments of 6 per cent on the books of the 2 companies as interest.  There was, it is true, an actual payment by petitioner to National Dairy each year of the amount called for under the debentures as interest, but the payment could be taken or left, as National Dairy, the parent, saw fit.  Furthermore, as long as consolidated returns were not permitted and it continued to disclose a net loss on its operations, exclusive of the dividends it received from1954 U.S. Tax Ct. LEXIS 310">*505  domestic corporations, it was the same to National Dairy whether it took the payment as interest or as dividends. Subject to change in the situation, it could, so to speak, turn on the dividend tap or the interest tap, as expediency indicated.  There is some corroboration of these conclusions in certain events occurring after the claimed debentures were issued.  In 1941, when it became desirable to reduce the annual payments from 6 to 4 per cent, the reduction was accomplished by the formality of a simple written request by petitioner's officers to National Dairy therefor.  It is true that the request was purportedly bottomed on the fact that National Dairy had managed to procure a lower interest rate on its outstanding bonds and debentures and that petitioner accordingly considered it was entitled to a comparable reduction.  It is to be noted, however, that National Dairy had for approximately 5 years been enjoying interest rates ranging from 3 3/4 per cent down to 2 1/10 per cent, whereas petitioner had continued to pay the full 6 per cent, and then received a reduction down to only 4 per cent.  Furthermore, no payments were ever made on principal, either during the stated life1954 U.S. Tax Ct. LEXIS 310">*506  of the instruments or on their 21 T.C. 513">*599  maturity date.  In 1948, when, by their terms, they were to be paid, they were simply replaced by a new issue of debentures with a stated interest rate of 4 per cent.  Also, as we said in 1432 Broadway Corporation, supra, "It is idle to argue that the debentures were transferable and must therefore be judged separately from the shares." No such transfer was ever made, and we are not in doubt that it was intended that no transfers would be made so long as National Dairy should own petitioner's outstanding stock.In Prudence Securities Corporation v. Commissioner, 135 F.2d 340, where the question was as to the accrual of interest on the bonds of a subsidiary corporation standing in the name of its parent, the United States Court of Appeals for the Second Circuit said:A corporation, ordinarily, cannot in a real sense become a creditor of one of its own incorporated departments.  The situation here is substantially the same as if the taxpayer were seeking to deduct accrued interest on its own unissued bonds because it had set them aside in an envelope in its vault.  While there1954 U.S. Tax Ct. LEXIS 310">*507  are perhaps conceivable circumstances in which accruing interest on bonds of a wholly-owned subsidiary held by its parent company might be deductible from the subsidiary's gross income, certainly when the government chooses to assail the transaction such a deduction cannot be permitted. Higgins v. Smith, 308 U.S. 473">308 U.S. 473.While the facts in that case appear to present a more obvious situation than in the instant case, and we are not certain that it was intended, as a matter of law, that where the transaction is assailed by the Government, a subsidiary corporation is in no case entitled to deduct amounts paid as interest on its bonds where the bonds stand in the name of the parent company, we are of the opinion that on the facts here the petitioner, for all practical purposes, was a department of National Dairy, even though incorporated, and that National Dairy did not in a real sense become a creditor of petitioner.  See and compare 326 U.S. 521">Talbot Mills v. Commissioner, supra; Wetterau Grocer Co., Inc. v. Commissioner, 179 F.2d 158; Commissioner v. Schmoll Fils Associated, Inc., 110 F.2d 611;1954 U.S. Tax Ct. LEXIS 310">*508 Swoby Corporation, supra; 1432 Broadway Corporation, supra; and Charles L. Huisking & Co., 4 T.C. 595. In our opinion, the ratable annual payments were distributions of corporate earnings under the guise of interest and there was not a forbearance of money or property in the business sense, such as would be required to make the payments deductible as interest under section 23 (b) of the Code.  John Kelley Co. v. Commissioner, supra,Commissioner v. Hood & Sons, Inc., supra,Lansing Community Hotel Corporation, supra,Toledo Blade Co., supra, and Cleveland Adolph Mayer Realty Corporation, supra, presented situations which, in our opinion, were factually different.  Of those cases, Toledo Blade Co. is most nearly comparable on the facts.  In that case, however, the creation of a debt and of a creditor-debtor relationship between 21 T.C. 513">*600  the parent corporation and its subsidiary was obviously intended, whereas in the instant case the presence1954 U.S. Tax Ct. LEXIS 310">*509  of such an intent has not been established.Decisions will be entered under Rule 50.  OPPEROpper, J., concurring: While I am in agreement with the result now being reached I view it as inconsistent with Lansing Community Hotel Corporation, 14 T.C. 183, affd. (C. A. 6) 187 F.2d 487. I thought and still think that case was erroneously decided but in the light of the present result it should in my opinion be expressly overruled.  See Mullin Building Corporation, 9 T.C. 350, 358, affd. (C. A. 3) 167 F.2d 1001. Footnotes1. This amount reflects a write down of stock of Southern Dairies, Inc., on the books of Kraft (Ill.) as of April 30, 1930, in the amount of $ 2,506,277.67, which write down was intended to bring the carrying figure of the stock on the books of Kraft (Ill.) to its equity in the stated capital and surplus shown by the books of Southern Dairies, Inc.↩2. This was a 99-year lease, commencing January 1, 1924, on land and buildings at 400 Rush Street, Chicago, Illinois.  The value of the leasehold interest on May 21, 1930, was not greater than $ 35,000.↩3. On the consolidating balance sheet of Kraft (Ill.) and its wholly owned subsidiary companies as of April 30, 1930, goodwill, etc., was shown at $ 7,174,657.14.↩1. This amount in cash, though not "sold" by National Dairy to petitioner, did in fact go to petitioner and was carried as an open account obligation of petitioner to National Dairy.↩1. The zero value for the stock of Oakdale Dairy Company, Inc., was stipulated, with the explanation by petitioner's counsel to the effect, "We do not contend that it was a minus value."↩1. This is the same amount by which the stock of Southern Dairies was written down by Kraft (Ill.) on its books as of April 30, 1930.↩2. This amount includes $ 1,942,255.65 in cash not sold by National Dairy to petitioner but allowed to remain as open account obligation of petitioner to National Dairy.↩1. This was a 99-year lease, commencing January 1, 1924, on land and buildings at 400 Rush Street, Chicago, Illinois.  The valuation of the leasehold interest on May 21, 1930, was not greater than $ 35,000.↩2. On the consolidating balance sheet of petitioner and its wholly owned subsidiary companies as of May 1, 1930, goodwill, etc., was shown at $ 7,174,657.14.↩2. The following list includes only businesses engaged in the production and sale of products and does not include acquisitions or formations of Kraft distributor organizations.↩1. Notes of Kraft (Ill.) paid in cash and capital stock in approximately one year.↩3. For the sake of brevity, the name Kraft will sometimes be used in referring to Kraft (Ill.) or the appropriate predecessor corporation.↩4. Group 1 companies constitute a category set up by petitioner for the purposes of the instant case.  Generally, the group purports to cover the production, sale, and profits experiences of Kraft, and then of petitioner and their wholly owned domestic subsidiaries and to exclude all wholly owned foreign subsidiary companies and domestic subsidiaries engaged in business unrelated to cheese and cheese products.  One difficulty is that, even assuming a proper grouping of the companies, neither Kraft nor petitioner in their books of account or statistical records kept records showing net operating profits by product groups, and while petitioner has placed in the record a schedule showing a computation by its comptroller of such net profits by products made for the purposes of this case and showing allocations of general expenses according to his judgment, we have not deemed it desirable to further extend our recitation of facts by setting out herein the results of such exercise of judgment by him.  We have accordingly limited our recitation here to gross profits as shown by the books of account.  It is also noted that some companies were included which were engaged in business unrelated to cheese or cheese products, while other such companies were excluded.  It is said that this was necessary because the companies included were later dissolved and their operations taken over by the parent company or another subsidiary in some later year.  Also, with the exception of the inclusion of the results of the operations of Phenix for 1927, as shown above, the data covers acquired companies only from and after the date of acquisition, which, of course, may or may not result in a distortion of the conclusions of fact sought to be drawn.  With respect to foreign companies, no reason for their exclusion is indicated, other than that they were foreign.  Other companies were excluded because it was said that Kraft dealt with them at arm's length.  In the case of such companies, however, it is not possible to determine and find that part of the over-all operating costs of Kraft, and later of petitioner, were not, to some extent, occasioned by such supervision of these particular subsidiaries as was given by Kraft and petitioner.↩5. This patent or some interest therein was apparently assigned to Brookshire Cheese Company, later Lakeshire Cheese Company, and afterwards Borden's.↩6. This agreement also covered rights to Kingan & Company, Inc., as well as Shefford Cheese Company, Inc., and each and all of the present and future wholly owned subsidiaries of Kingan & Company, Inc.↩7. There is no showing of record as to profits on such sales prior to 1943.  The gross profits were $ 197,182.94 for 1943, and $ 467,322.95 for 1948.↩8. This list does not include acquisitions or formations of Kraft distributor organizations.↩1. A different audit report gives net income (net operating profit not being separately computed) for the year ended December 31, 1917, of $ 30,261.97 and for the year ended December 31, 1918, of $ 56,739.27.↩9. This includes stock at current market values and debentures at principal amounts.↩10. Apparently the $ 10,000 was in satisfaction of the subscription by National Dairy for 100 shares of petitioner's stock at the time of organization.  The par value of petitioner's stock was $ 100 per share.  On its opening balance sheet petitioner's capital stock was shown as common stock $ 2,000,000.↩11. The source of this figure has not been demonstrated.  At June 30 and prior to their consolidation, the balances in the Surplus at Date of Acquisition account and the Earned Surplus account were $ 29,998,302.91 and $ 573,632.86, or a total of $ 30,571,935.77.  No entries were made in either account between May 31 and June 30.  Of the above June 30 total, $ 30,079,986.79 was transferred to and became the opening entry in the new Surplus account.↩12. With respect to this issue, the parties have stipulated that the terms "Debenture" or "Debentures" and the term "Interest" are used for convenience and without prejudice to respondent's contention that the debentures represented a capital interest.↩13. The disposition on petitioner's books of this amount is not demonstrated.↩1. These amounts are after deduction for interest on $ 30,000,000 of debentures issued in 1934 to National Dairy.↩1. These amounts are after deduction for interest on $ 30,000,000 of debentures issued in 1934 to National Dairy.↩1. These serial debentures, maturing semiannually, bore various interest rates ranging from 3/8% for the earliest maturity to 2.10% for the latest maturity.↩14. Possible exceptions include the cream cheese packaging machine, the Coon process for curing cheese, and probably to some extent, the methods for processing whey.↩15. Among the patents first licensed were the reissue of the first processing patent, the blending patent, and the 5-pound loaf boxing patent. It is to be noted, also, that when the Norman Kraft patent, covering the die-cut foil lining packaging device and for which application was pending at May 21, 1930, was issued, it was included in various, if not all, of the licensing agreements, one of which was to Borden which had become or was to become one of Kraft's stronger competitors.  None of the patents covering the "cookers" were included in the license agreements appearing of record but since the licensees processed large amounts of cheese annually they apparently owned or had rights to use other effective devices or apparatus.  According to the record, there was no licensing of the cream cheese processing patents nor any effort on the part of Kraft or the petitioner to protect any rights they may have had thereunder, even though in later years, at least, the processing of cream cheese through the use of carob or other gums was rather commonly practiced.↩16. So far as appears, the patents covering the Potter or cream cheese packaging machine were never licensed.  This machine, we think, was a very great if not the greatest factor in giving Kraft a quite dominant position in the cream cheese field.  Another important factor, however, was the trade name "Philadelphia Cream Cheese."↩17. The petitioner cites Paton, Advanced Accounting (1941), Paton, Accountants' Handbook (3d Ed. 1943), and Finney, Principles of Accounting -- Intermediate (3d Ed. 1936).↩18. Citing Toledo Blade Co., 11 T.C. 1079↩.19. Citing T. R. Miller Mill Co., 37 B. T. A. 43↩.20. Citing Delaware Corporation Law, sec. 34 (Del. Rev. Code 1935, sec. 2066); Lansing Community Hotel Corporation, 14 T.C. 183; and Toledo Blade Co., supra↩.21. Citing, among other cases, United States v. Guinzburg, 278 F. 363">278 F. 363; Lansing Community Hotel Corporation, supra; and T. R. Miller Mill Co., supra↩.22. Citing Commissioner v. Hood & Sons, Inc., 141 F.2d 467; Toledo Blade Co., supra; and Lansing Community Hotel Corporation, supra↩.23. Citing Toledo Blade Co., supra;Clyde Bacon, Inc., 4 T.C. 1107; and Cleveland Adolph Mayer Realty Corporation, 6 T.C. 730↩.24. It is to be noted that while the affirmance of this case, at 160 F.2d 885, was apparently under the rule in Dobson v. Commissioner, 320 U.S. 489">320 U.S. 489↩, the court added "that, if the questions were open to us we should reach the same result as did the Tax Court."