Kentucky Elec. Lamp Co. v. Commissioner , 14 B.T.A. 603 ( 1928 )

KENTUCKY ELECTRIC LAMP CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Kentucky Elec. Lamp Co. v. Commissioner

Docket No. 14337.

United States Board of Tax Appeals

14 B.T.A. 603; 1928 BTA LEXIS 2955;

December 6, 1928, Promulgated

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Certain additional royalties provided for in a license contract held to be ordinary and necessary business expenses of the licensee in the years in which obligation to pay was incurred.

W. P. Sandidge, Esq., for the petitioner.

Frank W. Gibbs, Esq., for the respondent.

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LANSDON

The respondent asserts deficiencies for the fiscal years ended October 31, 1920, 1921, and 1922, in the respective amounts of $383.18, $1,078.98, and $210.61. The only issue involved is whether the petitioner properly accrued certain additional royalties due the General Electric Co. on account of sales in the taxable years as ordinary and necessary business expenses incurred and paid in such years.

FINDINGS OF FACT.

The petitioner is a Kentucky corporation, with its principal office and place of business at Owensboro, where it is engaged in the manufacture of electric light lamps, commonly designated as tungsten lamps, under a license from the General Electric Co., which is the owner of a large number of patents covering such lamps.

The license agreement authorizes the petitioner to manufacture a stated quota of lamps each year. This quota is not uniform and is based on a certain percentage of lamps sold in each year by the licensor company. At the beginning of any fiscal year, the petitioner can only estimate the number of lamps which it may sell in such year. Each month it pays 5 per cent royalties on sales of the preceding month. After the close of each calendar year, in conformity with the terms of the license agreement, auditors examine the books of the licensee and, if the sales for the year exceed the quota by more than 5 per cent, additional royalty must be paid on such excess sales.

The auditors selected for that purpose duly examined the books of the petitioner and certified that for the calendar years 1921 and 1922 sales of lamps exceeded the quota in the respective amounts of $53,397.72 and $118,230.40. On March 21, 1922, and March 28, 1923, the General Electric Co. invoiced the petitioner for additional royalties in the respective amounts of $10,679.60 and $23,648.08. Adjusted to the petitioner's fiscal year accounting basis the additional royalties for the years ended October 31, 1921 and 1922, were in the respective amounts of $8,899.66 and $19,705.07, and were determined by an examination of the sales records of the petitioner for each of such years.

The petitioner accepted liability for the additional royalties for 1921 and 1922 and, upon receipt of invoices from the General Electric Co., accrued the amounts thereof on its books as expenses for such respective years.

The petitioner keeps its books and makes its income-tax returns on the accrual basis. In its income and profits-tax returns for the fiscal years ended October 31, 1921, and October 31, 1922, it deducted the regular or monthly royalties from its income for each of such years, but failed to make a deduction for the additional royalties for which it was liable on account of sales in excess of its quota under the terms of the license contract. In amended returns for the years involved it deducted the respective amounts of $8,899.66 and $19,705.07, representing additional royalties for such years as ordinary and necessary expenses. Upon audit of the amended returns the Commissioner disallowed such deductions and, after making other minor adjustments, asserted the deficiencies here in question.

OPINION.

LANSDON: The only question here is whether the petitioner in the circumstances set forth in our findings of fact had the right to accrue the additional royalties for which, under its license contract, it became liable in the respective taxable years as ordinary expenses for such years. The respondent disallowed such accruals as deductions because from the nature of the transaction it was impossible to reduce the liability to figures at the close of each of such respective years, and because there was no proof that the petitioner had accepted liability for such royalties.

The petitioner admits the invoices for additional royalties were not paid until some time after their receipt. It proves to our satisfaction, however, that such delay in payment was not based on any doubt or dispute over its liability for the accrued amounts, but was for other reasons which need not be recited here. The additional royalties were obligations of the petitioner under its contract with the General Electric Co. and were expenses incident to the production of income in the years in which the quota of sales was exceeded. The amounts of such royalties were determined shortly after the close of the respective years and when ascertained were properly accrued on the books of the petitioner as ordinary and necessary business expenses for such year. Cf. . On this point the respondent is reversed.

At the hearing the petitioner abandoned its appeal as to the year 1920 and we, therefore, approve the determination of the respondent as to that year.

Decision will be entered under Rule 50.