18 T.C. 361">*361 The respondent determined deficiencies in the income and victory tax of petitioners for the year 1943 as follows: Kibbey W. Couse, $ 502,027.12; Murray Thompson, $ 38,276.98. Because of the provisions of the Current Tax Payment Act of 1943, the year 1942 is also involved.

The principal issue is whether certain war contracts performed by a partnership, in which petitioners were partners, had a cost or 18 T.C. 361">*362 other basis which it was entitled to recover through depreciation allowances.

Petitioner Couse claims an overpayment of tax for the year 1943.

FINDINGS OF FACT.

Some of the facts were stipulated.

Murray Thompson, a resident of New York City, filed his returns for the years 1942 and 1943 with the collector of internal revenue for the fourteenth collection district of New York. Kibbey W. Couse filed his returns for these years with the collector of internal 1952 U.S. Tax Ct. LEXIS 191">*192 revenue for the fifth collection district of New Jersey.

Couse, a mechanical engineer, was graduated from Stevens Institute of Technology in 1918. In 1922 he opened a machine shop in Elizabeth, New Jersey, to manufacture special types of machines embodying original types of design and invention. In 1930 he moved his machine shop to Taos, New Mexico, and utilized it to repair road building equipment. In 1932 he decided that the business would have a better credit standing if incorporated, and organized Couse Laboratories, Inc., under the laws of New Mexico. When the road building work in the vicinity of Taos was finished, Couse built a mobile machine shop so that he could follow the work being done in other sections of the state and repair damaged road building equipment.

In 1936 Couse wrote an article on mobile machine shops which was published in the American Machinists Magazine. This created such an interest in these shops that Couse decided to move to Newark, New Jersey, and attempt to market them.

In 1937 Couse became acquainted with procurement officers attached to the Signal Corps of the United States Army who were interested in obtaining a mobile radar mount for long range1952 U.S. Tax Ct. LEXIS 191">*193 airplane interception. During that year he designed a mobile signal tower and the corporation received its first order from the Signal Corps.

The New Mexico corporation operated on a very small scale until 1940 and was at all times in dire financial straits, being unable to obtain bank financing or any other type of customary financing. In 1938 the corporation received $ 5,000 from Maud Dale, who had known Couse for many years, and he transferred to her 5 per cent of the stock of the corporation. At this time, Murray Thompson, who was her son and had been instrumental in getting her to make this investment, became an employee of the corporation.

The corporation experienced its first profitable year in 1940, when it received a substantial order for signal towers from the Signal Corps.

On February 16, 1941, Couse Laboratories, Inc., was organized under the laws of the State of New Jersey. It acquired all of the assets 18 T.C. 361">*363 and assumed all of the obligations of Couse Laboratories, Inc., the New Mexico corporation, and the latter was dissolved. Couse acquired 95 per cent of the stock of the New Jersey corporation and Maud Dale 5 per cent.

During the year 1941, the corporation1952 U.S. Tax Ct. LEXIS 191">*194 adapted its mobile machine shop for use by the Engineer Corps of the Army. It continued to manufacture signal towers (with mounts) for the Signal Corps, but orders for these towers and radar equipment to be attached thereto were as a matter of expediency placed by the Signal Corps with Westinghouse Electric and Manufacturing Company, which manufactured the radar equipment. The Signal Corps required Westinghouse to buy the towers from the corporation because those supplied by it in prior years had been satisfactory. With the advent of large-scale mobilization for World War II, it began to obtain substantial orders.

All of the engineering and development work in connection with the products manufactured by the corporation was done by Couse personally. He applied for and received patents on certain features of both the mobile machine shop and the signal tower, and permitted the corporation to use these patents without the payment of any royalties. The corporation originally acquired contracts for the machine shops and signal towers because of Couse's "know-how" in manufacturing them.

The mobile machine shop consisted of a truck chassis and cab purchased directly by the corporation1952 U.S. Tax Ct. LEXIS 191">*195 from the Ford Motor Company or other truck manufacturers. The corporation installed a body upon the chassis which constituted the outer portion of the machine shop. Inside the shop there were installed various items of equipment, such as a welder, lathe, and other items of machinery generally found in a complete machine shop. These items were purchased from various manufacturers. The essential part of the shop which made it different from shops produced by other companies was the power take-off, designed and patented by Couse. The power take-off transferred the power of the truck engine to a generator or compressor which was used to operate the machines in the shop. This eliminated the necessity of having an additional machine mounted on the truck to run a dynamo or welding machine.

The signal tower was a large folding mast which, when extended, reached 53 feet into the air. The corporation installed this tower on a large semi-trailer purchased from the Kingham Trailer Company, upon which it built a large circular table for a base. It did not manufacture any of the electrical or radar equipment. This was done by the Westinghouse Electric and Manufacturing Company.

During 1952 U.S. Tax Ct. LEXIS 191">*196 the period January 1 through October 31, 1942, the corporation filled orders received from the War Department and Westinghouse 18 T.C. 361">*364 in the aggregate amount of $ 3,514,960.37. On October 31, 1942, it had on hand unfilled orders aggregating $ 8,416,746.43.

The books of Couse Laboratories, Incorporated, as of October 31, 1942, disclosed the following assets and liabilities:

Couse Laboratories, Inc. (New Jersey), was dissolved on October 31, 1942, and all of its assets subject to its liabilities were distributed to its stockholders in redemption of the stock held by them. Couse and Maud Dale acquired 1952 U.S. Tax Ct. LEXIS 191">*197 an undivided interest in the assets of 95 per cent and 5 per cent, respectively. Maud Dale transferred her 5 per cent to her son, Murray Thompson. He was to pay her therefor only out of his share of the profits of a partnership to be formed.

On November 2, 1942, a partnership agreement was entered into between petitioners Couse and Thompson. This agreement provided in part that the partnership would carry on the business theretofore conducted by Couse Laboratories, Inc.; that the firm name of the partnership would be Couse Laboratories; that the capital of the business would consist of the assets which the parties might receive or be entitled to receive as a result of the liquidation of the corporation; that the books of the partnership should be kept on the basis of a fiscal year expiring on November 30 of each year; and that the net profits or net losses should be divided among the partners in the proportions of 95 per cent to Couse and 5 per cent to Thompson.

On November 8, 1942, a meeting was held of the trustees in dissolution of Couse Laboratories, Inc. The trustees, Kibbey W. Couse, Murray Thompson and M. Raymond Riley, adopted a resolution, which provided in part as follows:

1952 U.S. Tax Ct. LEXIS 191">*198 WHEREAS, Couse Laboratories, Incorporated, has been dissolved by the unanimous consent of its stockholders; and

WHEREAS, the Directors of the said corporation are now Trustees in Dissolution, and as such are required to wind up the company's affairs and divide the monies and other properties among the stockholders; and

WHEREAS, Kibbey W. Couse owns and holds 1,900 shares of the capital stock of the company, and is entitled to 95% of its net assets; and

18 T.C. 361">*365 WHEREAS, Maud Dale, the owner of the remaining 100 shares of capital stock of the company, has, by an agreement in writing filed with the company, assigned and transferred to Murray Thompson all of her undivided pro rata share in the net assets of the company, under which said assignment Murray Thompson is entitled to 5% of such net assets; and

WHEREAS, Kibbey W. Couse and Murray Thompson have entered into an agreement of partnership under which they have agreed to continue the business formerly conducted by the corporation, and have agreed to contribute their respective shares of said net assets to the capital of the said partnership, and individually and as partners to assume and pay the company's debts, and

WHEREAS, said1952 U.S. Tax Ct. LEXIS 191">*199 Kibbey W. Couse and Murray Thompson have requested the Trustees in Dissolution not to sell the property of the company, but instead to distribute the same to them, in kind, on their agreement to assume and pay the company's debts;

* * * *

BE IT RESOLVED, by the Trustees in Dissolution of Couse Laboratories, Incorporated, as follows:

* * * *

3. That any two of the Trustees be and they hereby are directed, authorized and empowered, in the name of the corporation to assign, transfer and set over unto Kibbey W. Couse and Murray Thompson, partners trading as Couse Laboratories, all of the corporation's right, title and interest in and to the contracts and purchase orders hereinafter set forth, and all monies now due or hereafter payable under the said contracts and purchase orders, to wit:

* * * *

BE IT FURTHER RESOLVED, that the effective date of the dissolution of the company be and the same is hereby fixed as of October 31, 1942.

Couse Laboratories, Inc., had on October 31, 1942, eight unfilled purchase orders of the Westinghouse Electric & Manufacturing Company. The aggregate purchase price of the materials in these purchase orders which had not been delivered on October 31, 1942, 1952 U.S. Tax Ct. LEXIS 191">*200 was $ 2,802,396.99. Each purchase order contained, among others, the following provisions:

Westinghouse Electric & Manufacturing Company reserves the right to cancel this purchase order at any time. In the event of cancellation, reimbursement for labor and materials already used on this order will be made and the materials so paid for will be shipped to the Westinghouse Company.

This order is neither assignable nor transferable without our written approval.

On November 21, 1942, Couse Laboratories, Inc., acting by and through and with the consent of its trustees in dissolution, Kibbey W. Couse, Murray Thompson and M. Raymond Riley, "assigned, transferred and set over" to Kibbey W. Couse and Murray Thompson, partners trading as Couse Laboratories, all right, title and interest in and to eight purchase orders of the Westinghouse Electric & Manufacturing Company.

On November 27, 1942, the Westinghouse Electric & Manufacturing Company executed a consent to the "assignment."

On March 24, 1942, Couse Laboratories, Inc., entered into a contract with the War Department under the terms of which it was to furnish 18 T.C. 361">*366 the Government 112 sets of mobile repair shop equipment and instruction1952 U.S. Tax Ct. LEXIS 191">*201 books for $ 4,319,349.44. A "supplemental agreement" was entered into on October 31, 1942, between the United States Government, and Couse Laboratories, Inc., and Kibbey W. Couse and Murray Thompson, partners trading as Couse Laboratories, called assignor and assignee, respectively. The agreement, after reciting that no units had been completed and delivered, that the Government had paid nothing to the assignor, and that it was advantageous and in the best interests of the United States to modify the contract because the assignor was dissolving as a corporate entity and the assignee desired to assume all rights and liabilities under the contract, to which the assignor was agreeable, stated that the contract was modified in the following particulars:

1. Assignor hereby waives all rights and claims against the Government under contract No. W 978-eng-4869, as hereby amended.

2. Assignee hereby assumes all of the obligations and liabilities of assignor under contract No. W 978-eng-4869, as hereby amended, and agrees to complete performance in accordance with the terms thereof, and assignee shall be entitled to all of the rights and benefits accruing from completion of performance of1952 U.S. Tax Ct. LEXIS 191">*202 such contract.

3. The parties hereto agree that the Government shall make all further payments that may be due or become due under said contract, as amended, to assignee from and after the date of this agreement.

Couse Laboratories, Inc., also had at the time of its dissolution a contract with the War Department under the terms of which it was to furnish the Government 32 sets of mobile repair shop equipment and instruction books for $ 1,296,000. A "supplemental agreement" was entered into as of October 31, 1942, by and between the United States Government and Couse Laboratories, Inc., and Kibbey W. Couse and Murray Thompson, partners trading as Couse Laboratories, called assignor and assignee, respectively. The recitals in this agreement and the three paragraphs describing the particulars in which the contract is modified, are the same as those contained in the supplemental agreement attached to the March 24, 1942, contract except that contract No. W 1128-eng-469 is inserted in place of contract No. W 978-eng-4869.

Each of the contracts with the War Department contained a provision that should conditions arise which, in the opinion of the Secretary of War, made it desirable to 1952 U.S. Tax Ct. LEXIS 191">*203 terminate the contract, the Government could terminate it in whole or in part. In the event of such termination, the Government was obligated to pay the contractor the contract price of all materials completed in accordance with the provisions of the contract, reimburse the contractor for actual expenditures made with respect to the uncompleted portion of the contract and for expenditures made with the prior written approval of the contracting 18 T.C. 361">*367 officer in settling or discharging that portion of the outstanding obligations or commitments of the contractor which had been incurred or entered into with respect to the uncompleted portion of the contract. The Government was also obligated, in the event it terminated the contract, to pay the contractor a profit on the uncompleted portion of the contract to be determined as provided in the contract.

An accountant employed by Couse Laboratories, Inc., made a detailed "projection" as of October 31, 1942, to determine the amount of profit which would have been realized had the corporation retained and completed the aforementioned Westinghouse purchase orders and War Department contracts. He arrived at a profit of $ 1,314,506.21 as1952 U.S. Tax Ct. LEXIS 191">*204 follows:

The actual shipments under these contracts totaled $ 8,653,060.37. Had the "projection" been prepared upon the actual shipments, the projected cost of sales would have been $ 7,175,818, divided as follows:

18 T.C. 361">*368 The actual cost of sales attributable to the shipments of $ 8,653,060.37 was $ 7,387,186.51, 1952 U.S. Tax Ct. LEXIS 191">*205 divided as follows:

Of the projected cost of sales of $ 6,979,858.79, there was on hand inventory at the date of dissolution of the corporation of $ 2,649,486.53, divided as follows:

There were also on hand purchase orders for material of $ 1,503,064.11, which had been accepted by the suppliers.

Shipments made by the partnership upon the aforementioned Westinghouse and War Department contracts totaled $ 82,744.09 during the fiscal year ending November 30, 1942, and $ 8,203,706.44 during the fiscal year ending November 30, 1943. The remainder of the shipments under these contracts was made during the fiscal year ending November 30, 1944. During the year ending November 30, 1943, the partnership made shipments of $ 2,974,830.49 on new contracts which it had obtained without cost.

For the fiscal year ended November 30, 1943, the profits1952 U.S. Tax Ct. LEXIS 191">*206 of the partnership on all its shipments were renegotiated to the extent of $ 475,000 which it was required to repay to the United States.

The partnership acquired nothing of value from the petitioners in relation to the war contracts of Couse Laboratories, Inc., that it could not or did not obtain itself without cost.

From 1937 through 1949, inclusive, the only products manufactured by Couse Laboratories and its predecessor companies were mobile machine shops and signal towers. The company continued to make mobile machine shops after World War II on a very reduced scale, but all orders for signal towers ceased.

From 1936 through 1949, the net earnings of Couse Laboratories and its associated enterprises were as follows: 18 T.C. 361">*369

1952 U.S. Tax Ct. LEXIS 191">*207 In his income tax return for 1942, petitioner Couse reported the amount realized by him upon dissolution of Couse Laboratories, Inc., to be $ 1,377,479.49, ² and he reported this amount less cost of stock of $ 2,375, or $ 1,375,104.49 as a long term capital gain, of which 50 per cent, or $ 687,552.25 was included in income. Petitioner Thompson did not realize any income when the corporation was liquidated as he was not a stockholder and none of its assets were distributed by the corporation to him.

In determining the deficiencies, the respondent did not reduce the amount of capital gain reported by Couse, on the ground that the amount included by him as the value of uncompleted contracts represented the value of good will.

In the partnership return for the period November 2, 1942, to November 30, 1942, opening inventory was stated to be $ 2,649,486.53. 1952 U.S. Tax Ct. LEXIS 191">*208 This was also the closing inventory of Couse Laboratories, Inc. In this return "amortization" or depreciation of cost of contracts in the amount of $ 11,388.75 was deducted as part of the cost of sales. The closing inventory of the partnership for this period was stated to be $ 3,364,180.29.

In the partnership return for the taxable year ending November 30, 1943, opening inventory was stated to be $ 4,667,297.75, or an increase of $ 1,303,117.46. This latter amount represents the "amortization" or unexhausted "cost of contracts" which was taken as a deduction in computing the net income of the partnership for its fiscal year ending November 30, 1943.

The respondent disallowed the deduction of $ 11,388.75 claimed for the period ending November 30, 1942, and the deduction of $ 1,303,117.46 claimed for the fiscal year ending November 30, 1943. The effect of these disallowances was to decrease the loss sustained by the partnership from $ 15,152.44, as reported in the partnership return for the period ending November 2, 1942, to $ 4,902.45, and to increase the income of the partnership, from $ 91,000.52, as reported in the 18 T.C. 361">*370 partnership return for the year ending November 30, 1952 U.S. Tax Ct. LEXIS 191">*209 1943, to $ 933,303.31. Couse's share of the latter amount was determined to be $ 869,328.14 and Thompson's share $ 63,975.17.

OPINION.

Petitioner Couse owned 95 per cent of the stock of Couse Laboratories, Inc., and dominated its affairs. At the time of its dissolution on October 31, 1942, it had uncompleted contracts calling for the production and delivery of war goods for an aggregate price of $ 8,416,746.13. Petitioner Couse had designed and developed the mobile machine shops and signal towers which were the subject matter of the contracts, and these contracts had been awarded to the corporation originally by reason of the know-how possessed by petitioner Couse, in whom the War Department had confidence. It was estimated as of October 31, 1942, that the completion of these contracts would result in a profit of $ 1,314,506.21.

Upon dissolution of the corporation, Couse reported as capital gain, the excess of the value of his share of the corporation's net assets distributed to him over his basis ($ 2,375) in the stock of the corporation. However, he included in the value of the assets thus received his proportionate share of an alleged value of $ 1,314,506.21 applicable to 1952 U.S. Tax Ct. LEXIS 191">*210 the war contracts, which he treated as having been distributed by the corporation on dissolution. Thus, he in effect paid a capital gains tax on his portion of the profits which were anticipated from the uncompleted war contracts, and now contends that since he contributed his share of the contracts to the partnership subsequently formed the value of these war contracts must be "amortized" or depreciated in the hands of the partnership.

The consequence of this contention is that the profits earned by the partnership on the war contracts could not be taxed unless and only to the extent that they exceeded the "basis" thus attributed to them. In substance, the effort is made to avoid paying taxes at ordinary rates on income earned from the performance of the war contracts by attempting to pay a capital gain tax with respect thereto at the dissolution of the corporation. ³ We think the effort must fail.

1952 U.S. Tax Ct. LEXIS 191">*211 Petitioners contend that the uncompleted war contracts were distributed to the corporation's stockholders upon dissolution; that the 18 T.C. 361">*371 distributees or their successors (Thompson having succeeded to the minority interest of Maud Dale) then contributed these contracts to the partnership formed by Couse and Thompson; and that the partnership acquired the contracts at a basis, recoverable through depreciation or "amortization," equal to their market value at that time. At the trial petitioners attempted to prove, through expert witnesses, that the contracts "distributed" by Couse Laboratories, Inc., had a fair market value of about $ 750,000 or $ 800,000. We do not pause to consider certain basic difficulties which would be inherent in accepting such valuations of the contracts, for we are satisfied that the corporation did not and could not distribute or transfer any valuable interest in these contracts, and that the partners did not contribute such an interest to the partnership.

Section 3737 of the Revised Statutes (41 U.S. C., sec. 15), dealing with Government contracts, provides as follows:

No contract or order, or any interest therein, 1952 U.S. Tax Ct. LEXIS 191">*212 shall be transferred by the party to whom such contract or order is given to any other party, and any such transfer shall cause the annulment of the contract or order transferred, so far as the United States are concerned. All rights of action, however, for any breach of such contract by the contracting parties, are reserved to the United States.

The Westinghouse contracts contained a provision that they could not be assigned without the consent of Westinghouse.

One of the purposes of section 3737 of the Revised Statutes was to give the United States the assurance that it would have the attention and services of the contractor with whom it undertook to do business. See Francis v. United States, 11 Ct. Cl. 638">11 Ct. Cl. 638, 11 Ct. Cl. 638">640, affd., 96 U.S. 354">96 U.S. 354. A contractor cannot avoid a contract or thrust a substitute party upon the United States merely by "transferring" it to someone else. See 16 Ops. Atty. Gen. 277, 279; 18 Ops. Atty. Gen. 88. This does not mean, however, that the Government may not enter into a new contractual relationship with a purported transferee. And the ruling1952 U.S. Tax Ct. LEXIS 191">*213 of the Comptroller General (9 Comp. Gen. 72), relied upon by petitioners, goes no further than that. The Comptroller General stated that where the contractor sells his entire business "as distinguished from merely an assignment of the Government contract," a transferee "may be recognized" by the United States in certain circumstances as the lawful successor in interest of the contractor. The petitioners urge that this ruling permits the transfer of Government contracts in connection with the sale or transfer of an entire business.

We do not agree with the petitioners' interpretation of the Comptroller General's ruling. It does not in any way modify or change the prohibition contained in section 3737 against the transfer of Government contracts or any interest therein. It differentiates between the sale of the entire business of a contractor, and a transfer or assignment 18 T.C. 361">*372 of the contract itself. It authorizes, but does not require, a Government department to recognize a transferee as the lawful successor in interest of the contractor where the transferee acquires the contractor's entire business. The Comptroller General's ruling does not authorize1952 U.S. Tax Ct. LEXIS 191">*214 a corporation which sells its entire business to sell or transfer to the purchaser the right to fill uncompleted Government contracts which it had at the time of sale. And it is important that any new arrangement entered into by the Government be not obscured by nomenclature. For, whether the arrangement be viewed as a "novation," or the approval of an "assignment," or a "substitution" of parties, the fact is that it derives vitality only from a new contractual relationship established between the United States and the new party.

Thus, the original contracts had no ascertainable fair market value, because the corporation was powerless to make an assignment that would effectively substitute the assignee for it as the party to perform the contracts, and because there was no assurance that any prospective purchaser would satisfy the Government of its capacity to perform, and thereby procure new contracts in place of the old. Particularly is this true in the present case, where the corporation obtained the original contracts by reason of the special skills and know-how of petitioner Couse who controlled the corporation's affairs. Whether petitioner Couse would continue his personal1952 U.S. Tax Ct. LEXIS 191">*215 efforts in relation to these contracts if they were "sold" to some "willing buyer" is a matter of pure conjecture, and we cannot say that any successor in interest would have been acceptable to the Government.

Any transfer of the uncompleted contracts and orders which the corporation had at the time of its dissolution would not confer upon the transferee the right to fill them, and this is true even though the transfer is denominated an "assignment," the corporation the "assignor," and the transferee the "assignee." Petitioner Couse and Maud Dale may have acquired physical possession of the contracts when the corporation was dissolved, but they never became entitled to and never acquired from it the right to complete them and be paid. Never having acquired this right or any interest therein, Couse could not transfer to the partnership a 95 per cent interest in the contracts and Maud Dale could not transfer a 5 per cent interest to Thompson which he in turn could transfer to the partnership. It, therefore, cannot treat the contracts and orders and the right to fill them as property contributed by the petitioners in arriving at a "basis," for "amortization" or depreciation. It acquired1952 U.S. Tax Ct. LEXIS 191">*216 that right as the result of new contractual relations entered into with the War Department and Westinghouse and it paid nothing therefor. It could have and subsequently did obtain similar war contracts without cost. Having received nothing of value from the partners in relation to the uncompleted 18 T.C. 361">*373 war contracts, and paid nothing for the right to complete them, it has no basis to recover through depreciation or "amortization" allowances.

In view of the conclusion reached above, it becomes unnecessary to consider whether unfilled contracts and orders such as those here involved would otherwise qualify as depreciable assets. Cf. U. S. Industrial Alcohol Co., 42 B. T. A. 1323, affd. (C. A. 2) 137 F.2d 511.

Decisions will be entered under Rule 50.