OPINION.
Smith
: Moneys paid for patents or for the exclusive right to use designs and inventions, whether patented or not, have been so generally recognized as capital expenditures that any argument or citation of authority in support thereof would seem to be superfluous. In 1911 the petitioner acquired by written contract exclusive license to use certain unpatented designs and inventions and agreed to pay and apparently did pay royalties for such use. In 1915 it acquired title to such inventions then held under applications fór' patents and paid therefor a purchase price of $25,000, together with counsel fees in connection with the acquirement of such title in the amount of $500. It appears that no one can question the fact that these payments, aggregating $25,500, are capital expenditures and immediately upon such payments being made become a part of the invested capital of the petitioner.
The payment of $15,000 by the petitioner to the Welded Steel Products Co., at or about the same time that it purchased title to the inventions, appears from the record to have been the sum of three payments made in settlement of the petitioner's obligations under the contract of 1911 for the payment of roj^alties. It is not clear why the petitioner capitalized this amount. It may be that this $15,000 represents royalties upon manufactured articles which proved to be defective and were 'therefore junked, and if such facts were shown the petitioner's assignment of these payments as capital expenditures might under the circumstances have been warranted, but the testi mony offered does not prove that the $15,000 was anything other than the usual royalty payments under the contract of 1911. We are, therefore, of the opinion that that amount can not under the circumstances be treated as a capital expenditure.
The petitioner, who had up to 1909 been engaged in the manufacture of school desks and seats with cast iron frames, determined in 1909 to substitute steel frames for the cast iron frames. This was a new and at that time untried business venture. The petitioner was in possession of no designs, patterns,, tools, .or machinery fitted for the manufacture of such steel frames and it could not procure them from other manufacturers. It was therefore under the necessity of employing skilled engineers and mechanics to develop designs, patterns, tools, and machinery, and, according to the testimony in this case, such development covered a transition period from 1909 until after the close of 1912. By the close of the period the petitioner had an established business of comparatively large proportions and had had a number of years experience in such business. Apparently, its management was in the hands of business men of experience and ability and its engineers and accountants were as capable as the going rates of wages and salaries could command. It had a thoroughly efficient cost accounting system by means of which it was able at all times to keep itself informed -as to the true cost of every article manufactured and sold. When it determined to venture into the field of manufacturing steel frames for school desks and seats it set up, in accordance with approved accounting methods, a capital account in which it entered material, labor, and overhead cost of developing the new business of making such desks and seats with steel frames. It is universally recognized in such cases that much capital must be put into development costs, and the record in this proceeding shows that in this case thousands of dollars worth of material and labor were expended in the production of designs, patterns, tools, and machinery which failed at first to produce results; that in the early days in the production of desks and seats with steel frames many such articles manufactured were found to be defective and were necessarily junked. The charging of all of these costs of experimentation, of materials lost, and of labor employed, as capital expenditures was apparently done in accordance with sound business judgment and approved accounting methods. So far as the record shows, the three items of development cost capitalized by the petitioner and eliminated by the Commissioner were just as much entitled to classification as capital expenditures as were the items which the Commissioner has allowed as capital expenditures.
In the ordinary conduct of a manufacturing business the differentiation of capital expenditures and operating expense disburse ments is largely a matter of sound discretion and experienced business judgment. The dividing line between the two classes can not be defined by statute and, so far as has come to our attention, no court has ever yet attempted to make a definition that can apply to any case except the one under review. We are thus led to the conclusion that on December 31, 1912, the amount of the petitioner's capital which had been expended in developing and perfecting the business of producing school desks and seats with steel frames was the sum of $396,884.13, and that that amount, constituting a part of $398,934.39, was then properly carried on its books as a capital asset.
The, taxpayer has continued to manufacture school desks and seats with steel frames. Its expenditures during the years 1910 to 1912, inclusive, in the development of a process of such manufacture were as much a capital item in 1920 as they were in 1913 or 1914. The taxpayer has lost none of the benefit of its capital outlay during these years. The charging off of the capital outlay in 1914 to surplus did not change the character of the expenditure so far as the computation of invested capital is concerned. Invested capital does not depend upon the manner in which the taxpayer's books are kept. At most the books are only evidentiary. We conclude that the taxpayer is entitled to reinstate in its surplus account $396,884.13 of the $398,934.39 charged off to surplus in 1914. The Commissioner has allowed the reinstatement in surplus of $198,167.16. The balance of the $396,884.13 should also be restored. Appeal of Goodell-Pratt Co., 3 B. T. A. 30.
Judgment will he entered on 15 days1 notice, vmder Rule 50.