36 T.C. 1043 (1961), 32629, Sprague Elec. Co. v. C.I.R.

Docket Nº:32629.
Citation:36 T.C. 1043
Opinion Judge:MULRONEY, Judge:
Attorney:Hugh C. Bickford, Esq., Henry II. Elliott, Esq., Nicholas Kapnistos, Esq., and Arthur G. Connolly, Esq., for the petitioner. Donald W. Geerhart, Esq., Paul G. Wilson, Esq., and Irene F. Scott, Esq., for the respondent.
Case Date:September 19, 1961
Court:United States Tax Court

Page 1043

36 T.C. 1043 (1961)




No. 32629.

United States Tax Court.

September 19, 1961

Hugh C. Bickford, Esq., Henry II. Elliott, Esq., Nicholas Kapnistos, Esq., and Arthur G. Connolly, Esq., for the petitioner.

Donald W. Geerhart, Esq., Paul G. Wilson, Esq., and Irene F. Scott, Esq., for the respondent.

Petitioner has been an electronic components manufacturer since about 1926. During the years 1941 through 1945 it primarily manufactured condensers, resistors, and filters. Held, on the record presented petitioner has shown that some part of the income received from these items can be attributed to research and development in prior years within the meaning of section 721(a)(2)(C), I.R.C. 1939.


The respondent determined deficiencies and overassessments in income, declared value excess profits tax, and excess profits taxes for the calendar years 1941 through 1945. The petition raised 20 issues on the basis of said determinations. Issues 2 through 20 relating to adjustments of gross income and deductions have been settled and the net tax effect of such settlement has been stipulated by the parties. The deficiencies determined by respondent and the overassessments claimed by petitioner are stipulated to remain in dispute as follows:

Year Tax liability Tax previously Deficiency Overassessment
1941 $108,829.20 $107,375.59 $1,453.61
1943 74,091.43 360,290.00 $286,198.57
1944 75,958.18 463,020.39 387,062.21
1945 88,874.43 265,748.52 176,874.09
1946 296,864.29 345,352.54 48,488.25
Total 644,617.53 1,541,787.04 1,453.61 898,623.12
1942 $8,224.77 $8,591.54 $366.77
1944 50,407.12 47,232.45 $3,174.67
1945 6,946.50 6,946.50
Total 65,578.39 55,823.99 10,121.17 366.77
1941 $84,508.09 $79,820.82 $4,687.27
1942 520,726.14 525,397.54 $4,671.40
1943 1,117,163.37 477,430.30 639,733.07
1944 1,741,240.36 1,223,339.66 517,900.70
1945 1,790,791.52 1,270,862.85 [1]
Total 5,254,429.48 3,576,851.17 1,682,249.71 4,671.40
Grand total 5,964,625.40 5,174,462.20 1,693,824.49 903,661.29
Net deficiency without regard to section 721, I.R.C. 1939 790,163.20

Page 1044 The only issue remaining for consideration is the correctness of section 721(a)(2)(C) of the Internal Revenue Code of 1939. [1]. FINDINGS OF FACT. Some of the facts have been stipulated. In addition, evidence in this case was presented before a commissioner of this Court. He made proposed findings of fact which were served upon the parties who made certain objections and requests for additional findings. The stipulated facts are found and the commissioner's findings of fact which were not objected to are adopted for the purposes of this opinion. Where, in our Findings of Fact we relate facts objected to or requested by the parties, our inclusion of such facts will be deemed rulings on the objections or requests without specifically noting each such objection or request. Sprague Electric Company, hereinafter sometimes called petitioner, is a corporation incorporated under the laws of Massachusetts in June 1926 under the name of the Sprague Specialties Company, which name was changed in 1944 to its present one. Petitioner's principal office is in North Adams, Massachusetts, and its income, declared value excess profits tax and excess profits tax returns for the years here involved were filed with the collector of internal revenue at Boston, Massachusetts. Petitioner filed timely claims for refund of excess profits tax, claiming the applicability of section 721(a)(2)(C), for each of the years 1941 through 1945. Page 1045 During these years petitioner was an electronic components manufacturer. Its major products were condensers, resistors, and filters. A condenser is a device for accumulating and making available a charge of electricity. In its simplest form it consists of two conducting plates separated by a nonconductor known as a dielectric. Condensers are now commonly referred to as ‘ capacitors'[2] since the capacity of the unit to store electricity is its primary characteristic. The conducting plates are made of some conducting metal such as aluminum. The nonconductor, or dielectric, between the plates, may be simply air (a space between the plates), mica, or paper, cellophane, and other materials impregnated with oil or wax. It is also possible to utilize a thin oxide film on the surface of the conductor as the dielectric. A microfarad is the common measure of capacitance of a condenser. The metric measure of energy in a capacitor in relation to size is measured in joules. Capacitors remained relatively unchanged from the original Leyden Jars, invented in the 17th century when crude paper-type capacitors were first constructed. During the period from 1920 until the present, great increases in voltage stress, microfarad capacity and energy density of capacitors have resulted from research and development in the electronics industry. This, coupled with the lessening in size of capacitors, known as miniaturization, has made possible electrical and electronic end products which would not otherwise have been practical or commercially feasible. The important commercial characteristics of capacitors are size, stability, and price. Resistors are devices in which a conducting material or coil opposes the passage of current, causing the electrical energy to be transformed into heat. The selectivity of current by such devices is an essential part of most electronics equipment. There are two kinds of resistors: (1) The carbon composition resistor in which particles of carbon are compressed with an inert insulating filling material to produce a solid unit having certain resistance value. They are cheap to make and widely used; and (2) the coil or wire-wound resistor in which a conducting wire is wound around a core and the wire fixed into position by some sealer, usually ceramic in nature. These may be simple or very complicated in some applications. In the 1920's and early 1930's the two types of resistors in common use were the carbon, or carbon pile, resistors and the vitreous enamel resistors. In the carbon type, finely pulverized carbon was mixed with binders to obtain the resistance gradients desired, and these were pressed into discs or into cylindrical pellets, or deposited on glass or ceramic materials in various configurations to get the desired resistance Page 1046 value. In the vitreous enamel resistor, a small high-resistance core, with each turn of the wire separated so that it would not touch the next turn and cause a short circuit. The entire wound core was then dipped in a solution and fired to give it a vitreous enamel coating moisture. The factors relating to resistors that were commercially important were the comparative size and cost in relation to power-rating wattage and resistance value and the ability to stand a heating and cooling cycle without significant change in resistance value. Filters are combinations of components (including condensers and resistors). The filter selects out of an aggregate of currents only the desired frequency, and thus eliminates from the apparatus undesirable frequencies of ‘ static.’ The use of filters has increased with the development of electronic devices. Many electrical devices, such as electric razors, motors, and automobile ignition systems, act as transmitters of energy in the radio spectrum, causing ‘ static.’ This causes interference with other devices such as radio, television, radar, and other sensitive electronic equipment. Filters are attached to the annoying device for the purpose of bypassing the electric circuit for undesirable frequencies and preventing the broadcasting of the unwanted transmission. The important commercial characteristics of filters are that they perform the specific function for which they are designed and that they be relatively small in size and low in cost. Petitioner, engaged during the years here in issue in the primary business of manufacturing and selling condensers, resistors, and filters for electrical apparatus, was originally formed to manufacture and market a radio tone control device invented by its founder, Robert C. Sprague, who is now chairman of the board and treasurer of the petitioner. This unit was not commercially successful, and shortly thereafter the petitioner began the manufacture of the Midget condenser, which was a redesigned form of the wax impregnated condenser that had formed a part of the unsuccessful tone control device. The midget condenser was constructed in many sizes ranging from 0.00025 to 0.25 microfarads and tested at 1,500 volts. It was smaller and less expensive than any bypass condensers then available, which were generally of a mica type or bulky and expensive paper condensers. In 1929 the petitioner established a research department headed by Preston Robinson, and as a result of the work of its research laboratory the petitioner was able to market a wet electrolytic condenser by 1931, a dry electrolytic condenser in 1932, and a two-paper aluminum wax tubular condenser in 1932. The difference between a wet and a dry electrolytic condenser is the substitution in the latter type of a Page 1047 wet electrolyte (a solution of boric acid or ammonium borate) with a paste electrolyte. The condensers were somewhat smaller in size and cheaper than those then used in the industry. As a result, petitioner's competitive position was enhanced and these condensers...

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