1930 BTA LEXIS 1773 | B.T.A. | 1930
Lead Opinion
In view of the respondent’s admission of the errors charged in the second and third issues, the petitioner’s tax liability and the deficiency, if any, for 1920, should be redetermined upon the basis of the calendar year 1920, and the net income determined by the respondent for 1923, should be reduced by $15,423.47 on account of Hew York State franchise taxes.
The lone issue remaining for decision by the Board is the March 1, 1913, value of 22 patents, as the basis for the computation of the annual deductions for exhaustion. There is no dispute as to the
The 22 patents owned by this petitioner on March 1, 1913, have been divided for convenience into two groups. The 11 patents comprising the “ Milk Powder Group ” are regarded by the petitioner as of the greater importance and value to its business. It is with this group of patents that the great mass of evidence is chiefly concerned. The 11 patents comprising the “ Miscellaneous Group ” have been given but scant consideration by the petitioner in the presentation of its case.
Besides the great amount of testimony, the evidence includes more than 100 exhibits of historical matter, graphs, ledger accounts, statistical data, and tax returns. On the whole, the evidence relating to the patents comprising the “ Milk Powder Group ” covers in a broad and comprehensive fashion tlie state of the art of reducing milk to a dried form and the improvements effected by the inventions covered by petitioner’s patents; the security and comprehensiveness of the patent protection; the economic advantages resulting from the patented inventions; the superiority of the product obtained by the use of the patents; the growth of the patent-protected business to the basic date; and the future prospects which on the basic date might have been reasonably anticipated. All of these are covered in much detail in the findings of fact, and we shall not burden the opinion by their repetition. There is also in the record the testimony of pei'sons having intimate knowledge of the patented inventions and in intimate contact with the pátent-protected business; evidence as to negotiations carried on by the petitioner with a prospective purchaser of the petitioner’s milk powder business; and expert testimony as to the value of the patents at the basic date. To attempt an analytical discussion of all of this evidence and to balance the weight to be given to the testimony of the several witnesses would carry this opinion far beyond the bounds of reasonable limitations and add but little to the certainty of its conclusion.
It has long been recognized that questions of value and estimates thereof involve matters of opinion upon which minds are prone to differ. An opinion as to value is generally based upon a prior determination of extrinsic facts. Disagreement as to these facts often results in differences of opinion as to value. Common experience indicates that agreement upon these extrinsic facts offers no assurance of agreement upon the ultimate question of value. The difficulties inherent in the problem are increased when an attempt
Nor has the problem been made easier by the inconsistent statements of the petitioner, made under oath in its tax returns. The highest patent value returned by the petitioner for the purpose of the capital stock tax was $116,169.15 in the return for 1921. In the capital stock tax return for 1917, filed four years after the basic date, the patent value returned was but $55,000. In the capital-stock-tax returns for 1923 and 1925, the patent values returned were $107,192.44 and $69,286.54, respectively; while in its income tax returns for the same years the petitioner claimed a March 1, 1913, patent value, as the basis for the deduction claimed for exhaustion of patents, of $1,269,408.80 in excess of cost. If the book value of patents, as disclosed by the balance sheets for 1923 and 1925, correctly reflects the cost of the patents, the highest March 1, 1913, patent value was claimed in the return for 1925, and amounts to $1,328,107.56. As
On March 1, 1913, we find the petitioner reducing milk and other liquids and semiliquids to the form of a dry powder containing all of the constituent solids of the original milk or other liquids in their natural state, and from which the original milk or other liquid could be reconstituted at will, with all of its original characteristics, by simply mixing the powder with water in proper proportions. At the basic date the pioneering work in this new field, which was actually commenced by Stauf in 1900 in an endeavor to preserve the blood of slaughtered animals for feeding to tuberculars, had been completed, and the uncertainties enveloping the experimental and development work had been left more than four years behind. The addition to the Stauf process in 1907, of the preliminary step of preconcentration, of liquids by vacuum in the Merrell-Merrell-Gere process, had converted a basic and practicable, but expensive and unprofitable, method into a commercially profitable and successful process. The addition in 1907, through acquisition of the patent rights, of the Bevenot-debTeveu process of injecting the spray into the heated chamber under hydraulic pressure brought further improvements in the product and substantial economies in manufacture; and additional improvements in the product resulted by the addition of the Glas process of homogenization, in 1912. A substantial market for the patented products had already been developed. From a small beginning of 390,000 pounds production in 1906, by 1912 the production and sales had risen more than 1,300 per cent. The production and sales for 1908 showed an increase of 16.22 per cent over 1907; for 1909, 41.83 per cent over 1908; for 1910, 10.42
However, looking backward from March 1, 1913, it may be fairly said that the history of the business presents a picture of consistent and expanding development, with the dropping off of the profits in 1912 as the only high light to indicate that there was anything sporadic in its nature. With this history back of it, the business might reasonably be expected to grow; its future must be judged
Dyer’s testimony was devoted almost entirely to an attack upon the validity of the most important patents and it is clear that his opinion of invalidity was the predominating influence in his valuation of the patents. On the other hand, the witness, Frank Soule, standing on the threshold at March 1, 1913, would prophesy that the time was coming “ when powdered milk, whole milk, sold in cans, the same as condensed milk is now sold, we will say, but in a larger package, would be the sanitary milk supply of the large cities, like New York, Washington, and other places.” All litigation since March 1, 1913, as far as it has gone, has sustained the validity of the petitioner’s patents at March 1, 1913, and so Dyer’s opinion that they were invalid must fall. It is true that some time after 1913 there was a decision by a United States District Court which was adverse to the petitioner, and though this was reversed on appeal, Dyer points to it as corroborating his view that a question of doubtful validity existed at March 1, 1913. But long before 1913 this petitioner had been advised by one whom the respondent admits to be a highly qualified patent attorney that these patents were valid. We have no reason to believe that the question of doubtful validity would have been present in the mind of a prospective purchaser of these patents to any greater degree than might be reasonably anticipated in any ordinary case of purchase and sale of patents. Soule’s forecast was unquestionably overly optimistic.
Hansen, an expert witness called by the petitioner, estimated, upon the basis of experience prior to the basic date, there would be an annual increase in sales, to and including 1923, equivalent to 35 per cent of the sales of the next preceding year. The production for 1912 is the starting point for his computation. The witness Merrell, also called by the petitioner, is but little more conservative. The average increase in business for the period 1908 to 1912 was 37.61 per cent. Two of the five years in that period show an increase over the preceding year’s business of more than 40 per cent and the year 1912 shows an increase of nearly 63 per cent over 1911. But that five-year period was one of rapid development and expansion, such as might be expected of any new business producing a product as satisfactory and meritorious as the petitioner’s. Such rapid development and expansion can not reasonably be expected to continue indefinitely; sooner or later, any healthy business reaches and passes
The testimony of Oscar Soule presents two methods of valuation. The first of these is based upon an annual increase in production equivalent to 20 per cent of the next preceding year’s production, the production for 1912 being used as a starting point, and results in an estimated production to the end of 1923 of 189,614,000 pounds. He estimates the future profits on this production at 2 cents per pound, or a total profit for the eleven years of average patent life of $3,792,280. This estimated profit, he says, justifies a patent valuation, as of the basic date, of $3,500,000. The second method assumes the same rate of growth in production and profits, and results in an estimated profit for 1923, the last whole year of patent life, of $720,000. This estimated profit, Soule points out, represents a return of 10 per cent upon a capital investment of $7,200,-000, which, according to “ a rule of thumb,” should be allocated one-half to tangibles and one-half to intangibles. The trouble with the first method is that it assumes that a prospective purchaser of the patents will pay a price therefor equal to the entire income which he could expect, under the most favorable circumstances, to receive during the remaining life of the patents. It may not be assumed that a prudent business man will invest his funds in a hazardous proposition, such as patents, without any expectation of a fair retui'n on his investment; and the greater the risks and hazards, the more will he discount the future and pay a price that seemingly assures him against loss while yielding him a fair return. The-second method assumes that during the period of patent monopoly, an intangible structure, a sort of going business value or good will, of $3,600,000, will be built up; and that at the end of the patent monopoly, the profits will continue to be substantially the same as for 1923, in perpetuity. Granting the assumptions, which
The basis for Donahoe’s valuation of $260,000 was substantially as follows: He took the production for 1912, which was the highest for any year prior to 1913, determined how much of that was skim milk powder and how much was whole milk powder. He estimated that the maximum royalties which the petitioner might expect to receive under license agreements, though there were no such agreements prior to, or until two years after, March 1, 1913, were 1 cent per pound for skimmed milk and 2 cents per pound for whole milk. Assuming that the estimated royalties represented the maximum profits attributable to the patents, he determined that the 1912 profits directly attributable to patents amounted to $65,000. He assumed an annual growth in the business equivalent to 20 per cent of the next preceding year’s production. He found upon investigation that the American Brass Co. and the General Electric Co; were enjoying approximately the same rate of growth, about 1913, and that the earnings of those companies represented an average return of 10 per cent on the 1913 market prices of their stocks. He then determined that if 7.4 per cent of the purchase price was set aside each year to accumulate with interest, at the end of the average life of the patents a prospective purchaser would have returned to him his investment. He therefore assumed that the proper rate of capitalization of the future earnings should be 17.4 per cent which, he says, is equivalent to a purchase of 5.74 years earnings; but he reduces the factor to 4, to reflect “ the effect the buyer and seller would give to the uncertainties.” Multiplying $65,000, the maximum profits which he attributed to patents for 1912, by 4, he concluded that the value of the patents, at the basic date, was $260,000. His valuation is not nearly as complex as his statement of it makes it appear. Strip it of all of its dressing, and you find that after all it amounts to the capitalization, at the rate of 25 per cent of assumed earnings of $65,000 per year, for 10 years, or total earnings of
Next, we have for consideration, for whatever light it may throw on the problem, the correspondence between Frank O. Soule, in behalf of the petitioner, and F. S. Taylor, in behalf of the Borden Condensed Milk Co., which took place in July, 1913, and in which negotiations were carried on with a view to the purchase of petitioner’s business, by the Borden Co. The most that can be gathered from this correspondence is that the Borden Co. offered to purchase the petitioner’s business, lock, stock and barrel, for $1,500,000 plus one-half of the profits of the business above $150,000 for a period of five years; and a suggestion on the part of Taylor that the board of directors of the Borden Co. might be willing to modify the offer “ to the extent- of requiring us to pay an additional amount for your working and trading assets over and above the $1,500,000, and to the further extent of extending the period in which you would participate in the profits ” from five to ten years. Whether the Borden Co. actually went so far as to modify its first offer to the extent indicated in Taylor’s last letter does not appear. Apparently the negotiations ended with Taylor’s last letter, for there is nothing-further of record until the sale of the business to the Borden Co. 15 years later. There is nothing in the correspondence from which we can deduce that the patents were of the high value claimed by the petitioner.
In an attempt to support the value of $3,500,000 which he placed upon the petitioner’s patents, as of March 1,1913, one of the witnesses testified that the entire business was sold to Borden Co. in 1928 for 54,000 shares of capital stock, which had a value, at the date of transfer of $159 per share. Aside from the unsupported statement of the witness as to the fair value of the Borden Co. stock, at the date of the transfer, we wish to point out that this transaction took place
Our conclusion, which has been reached only after a careful study and weighing of all of the evidence, is that the March 1, 1913, value of the 22 patents owned by the petitioner on that date was $1,750,000.
This brings us to the consideration of a matter very earnestly pressed upon us by the respondent in the brief. There he contends that the allowance for exhaustion must be computed separately for each patentj and that since the petitioner has not proven the separate value of each patent, so as to permit the computation in such fashion, the petitioner’s case must fail. We can not subscribe to that view. In the deficiency notice, the respondent determined the value of the patents as a group and computed the allowances for exhaustion accordingly. The petitioner accepted that situation. All of the witnesses for the petitioner and the respondent testified to the value of the patents as a group. Aside from these facts, the evidence is clear and unmistakable that it would not only be impossible, but highly improper, to place a separate value on each of the patents comprising the “Powered Milk Group.” The important patents in the powdered milk group are the Stauf patent, the Merrell-Merrell-Gere patent, the Bevenot-deNeveu patent, the Glas patent, and the Merrell-Merrell-Gere apparatus patent. The other six patents might be called “ hedging ” patents, since they were obtained almost solely for the purpose of closing any loopholes which might have been left in the claims of the more important patents. It is doubtful that any one of the five important patents, standing alone, had more than a nominal value. The Stauf patent, which is the basic one, covered a process which proved to be very expensive and commercially unprofitable. Only the addition to the Stauf process of the preliminary step of preconcentration of liquids by vacuum in the Merrell-Merrell-Gere process, made the Stauf process commercially profitable and successful. The addition of the Bevenot-deNeveu and the Glas processes brought further economies in manufacture and improvements in the product. The witness Brown, called by the petitioner and admitted by the respondent to be a highly qualified patent attorney, testified that the Merrell-Merrell-Gere process patent could not be operated by other than the owner of the Stauf process patent without infringing the latter, and ownership of both patents gave the petitioner a monopoly on the process of spray-drying milk, precondensed by the vacuum process; that the Bevenot-deNeveu process patent invoked a process which could not have been carried to fruition without infringing the Stauf process patent; that the Glas process patent was being infringed, when acquired by the petitioner, by the product at that time pro
All of the patents in the “ Powdered Milk Group ” were interdependent. In the hands of separate owners, they would be of little value. Collectively, under a single ownership, they represent a valuable property right, and it is this right which is being gradually exhausted. Under less compelling circumstances, the Board has not found any obstacle to determining the allowances for exhaustion of patents upon the basis of a group value and the average life of the group. See Union Metal Mfg. Co., 4 B. T. A. 287; Owens Bottle Co., 8 B. T. A. 1197; and Western Wheeled Scraper Co., 14 B. T. A. 496.
The petitioner is entitled to annual deductions for exhaustion of its patents based upon a March 1, 1913, value of $1,750,000 and an average life of 11.0095 years.
Judgment will he entered under Rule 50.
