33 T.C. 289">*289 Respondent determined deficiencies in petitioner's income and excess profits tax of $ 87,935.72, $ 220,260.07, and $ 261,682.44 for the years 1951, 1952, and 1953, respectively. He disallowed petitioner's claim for refund of income and excess profits tax of $ 193,908.85 for the year 1951.

The issues to be decided are (1) whether petitioner received abnormal income within the meaning of section 456, I.R.C. 1939, during 33 T.C. 289">*290 any of the years in issue from the sales of either (a) stereo products, or (b) the Polaroid Land equipment, or both; and (2) whether interest credited to petitioner on a refund of excess profits tax for the years 1942 and 1943 must be reduced by interest charged on deficiencies in income tax for those same years under section 456 (a)(3), I.R.C. 1939, in computing petitioner's "net abnormal income" for 1951.

FINDINGS OF FACT.

The stipulated facts are1959 U.S. Tax Ct. LEXIS 35">*37 found.

Petitioner is a Delaware corporation with its principal office in Cambridge, Massachusetts. It filed an original return for 1951 with the collector of internal revenue for the district of Massachusetts. It filed an amended return for 1951 and original returns for 1952 and 1953 with the director of internal revenue, Boston, Massachusetts.

Petitioner was incorporated in 1937 and from that date to late in 1948 it engaged primarily in the business of research and development and the exploitation of research and development by manufacturing and selling a variety of optical products in the field of light polarization, such as polarizing sunglasses and visors, polarizing camera filters, polarizing day-driving visors, and variable density windows.

In 1952 and 1953, 3-dimensional (3-D) motion pictures were exhibited. The audience viewed the picture through viewers incorporating the Polaroid synthetic light polarizer which were necessary to give the 3-D illusion. Edwin H. Land, petitioner's president and director of research, invented the synthetic polarizer used in these viewers. Petitioner owned three patents which covered this polarizer, hereafter referred to as stereo. The 1959 U.S. Tax Ct. LEXIS 35">*38 exhibition of the 3-D motion pictures would not have been commercially practicable had petitioner's synthetic polarizer not been available. No noninfringing material for this purpose was on the market.

Petitioner's sales of stereo products during 1946 through 1950 were:

Its sales, expenses, and net income from these sales in 1951, 1952, and 1953 were:

33 T.C. 289">*291 The expenses incurred by petitioner in the invention and development of its stereo products during 1943 through 1953 were:

Petitioner's income from the sales of stereo products during the years 1946 through 1953 was income from sales of tangible property arising out of research and development which extended over a period of more than 12 months.

On February 21, 1947, at a meeting of the Optical Society of America, Land first publicly1959 U.S. Tax Ct. LEXIS 35">*39 announced and demonstrated his invention of a camera and photographic film which produced a finished dry positive print directly from the camera within 60 seconds after the picture was snapped. The camera and photographic film are known respectively as the Polaroid Land camera and Polaroid Land picture roll, and together they constitute the Polaroid Land equipment. The Optical Society program referred to the equipment as "a new kind of photography as revolutionary as the transition from wet plates to daylight-loading film."

New basic principles of photographic processing were evolved by Land in his conception of the Polaroid Land equipment. There had never previously existed any photographic process in which a positive print was obtained simultaneously with the development of the negative by the application to the negative and positive receiving sheets of both the silver halide developer and the silver halide solvent. There had been no prior recognition of the possibility of simultaneously introducing the silver halide developer and the silver halide solvent and so controlling their intensitives and speed of operation that the developer could perform its function in the presence1959 U.S. Tax Ct. LEXIS 35">*40 of the solvent before the solvent could act upon the silver halide in the negative. The four separate steps in the prior art -- the developing and fixing of the negative and the printing and fixing of the positive -- were compressed in the Polaroid Land equipment into one step, the developing and fixing of the negative and contemporaneous formation on a positive sheet of a positive print from the dissolved silver halide of the negative. In the Polaroid Land picture roll all materials required for the developing and printing are part of the film assembly. The camera in which the film is processed remains dry throughout.

33 T.C. 289">*292 There were at least two major basic developments involved in the Polaroid Land equipment. One was a means by which high concentrations of developer and silver halide solvents were introduced simultaneously, after having been stored in a capsulating agent to keep them from oxidizing through contact with the air. The second was the process of catalyzing the precipitation of silver from the silver halide solvent onto the surface of the positive receiving sheet in such a way as to obtain a silver image with relatively minute quantities of silver.

Prior to1959 U.S. Tax Ct. LEXIS 35">*41 the conception of the Polaroid Land equipment, no photographic equipment existed whereby the picture was taken, the negative developed, and a positive print obtained directly from the camera by a 1-step dry process. Land's new inventions in photographic equipment were novel.

Petitioner's first patent in its "Picture in a Minute" field issued in 1948, and at the end of 1953, 118 patents had issued and 91 additional applications were pending. At the end of 1958, 238 patents had issued and 202 additional applications were pending. In 1954, the United States Patent Office created a separate subclass to handle, exclusively, patent applications in the Polaroid Land equipment field.

The Polaroid Land equipment was first marketed by petitioner in November 1948. The camera is not usable with any film other than the Polaroid Land picture roll and the picture roll is not usable with any camera other than the Polaroid Land camera. The photographic accessories marketed by petitioner, such as flashguns, light meters, filters, and copy makers, have been specifically designed for the Polaroid Land camera and have had no market apart from their use with that camera. There have been no products1959 U.S. Tax Ct. LEXIS 35">*42 on the market directly competitive with the Polaroid Land equipment since its introduction. In addition to its use in producing a picture in a minute, the Polaroid Land equipment is used to make instantaneous X-rays and in devices for the detection of the extent of exposure to radiation.

Petitioner's sales of Polaroid Land cameras, photographic packs, and photographic accessories during 1948 through 1950 were:

33 T.C. 289">*293 Its sales, expenses, and net income from these sales in 1951, 1952, and 1953 were:

The expenses incurred by petitioner in the invention and development of Polaroid Land cameras, photographic packs, and photographic accessories during 1944 through 1953 were:

No expenses were incurred by petitioner in the invention and development of Polaroid Land cameras, photographic1959 U.S. Tax Ct. LEXIS 35">*43 packs, or photographic accessories prior to 1944.

The sales of the Polaroid Land equipment during the years 1948 through 1953 resulted entirely from its capacity to produce a picture in a minute. If this equipment had not made an instantaneous positive print there would have been no demand for the camera or photographic pack during that period.

Petitioner's income from the sales of the Polaroid Land equipment and photographic accessories during 1948 through 1953 was income from the sales of tangible property arising out of research and development which extended over a period of more than 12 months.

The income received by petitioner in 1951, 1952, and 1953 from the sales of stereo products and the Polaroid Land equipment and accessories does not constitute abnormal income under section 456.

In 1951, petitioner's claims for relief under section 722, I.R.C. 1939, for the years 1942 and 1943 were settled, and as a result, interest of $ 74,864.93 on the overassessments was computed to June 13, 1951. As a further result of this settlement on the same claims, interest on deficiencies in income tax for those years of $ 34,075.11 was computed to June 13, 1951. The interest charged on the1959 U.S. Tax Ct. LEXIS 35">*44 deficiencies in income tax for the years 1942 and 1943 in the amount of $ 34,075.11 is a deduction relating to the interest of $ 74,864.93.

OPINION.

The issues in this case are essentially questions of statutory construction. Respondent does not dispute the facts produced by petitioner.

33 T.C. 289">*294 The income ¹ which petitioner contends is abnormal under section 456, I.R.C. 1939, ²1959 U.S. Tax Ct. LEXIS 35">*45 was earned by the sale of tangible property which arose out of research and development ³ extending over a period of more than 12 months. Respondent's regulations ⁴ provide that such income is not abnormal and may not constitute a class of income under section 456. This provision in respondent's regulations is squarely in accord with congressional intent as manifested by the legislative history of section 456.

1959 U.S. Tax Ct. LEXIS 35">*46 Basically, the Korean War excess profits tax was patterned after the World War II excess profits tax. There was, however, a general attempt to simplify the administration of the tax and to eliminate potential inequities. The World War II tax described one class of abnormal income as follows:

33 T.C. 289">*295 SEC. 721 [I.R.C. 1939]. ABNORMALITIES IN INCOME IN TAXABLE PERIOD.

(a) Definitions. -- For the purposes of this section --

* * * *

(2) Separate classes of income. -- Each of the following subparagraphs shall be held to describe a separate class of income: