12 T.C. 760">*761 The Commissioner determined deficiencies in declared value excess profits tax and excess profits tax for the fiscal year ended April 30, 1946, in the amounts of $ 1,890.64 and $ 97,868. The issues are: (1) Was petitioner entitled to deduct as a business expense the sum of $ 7,942.04 expended during the taxable year by the Midwest Research Institute out of the total of $ 20,000 paid by petitioner to the institute to carry on certain research and development work for petitioner pursuant to contract? (2) Did money borrowed by petitioner, 1949 U.S. Tax Ct. LEXIS 204">*206 represented by notes and used by petitioner to buy United States obligations during war loan drives, constitute borrowed investment capital under section 719 of the Internal Revenue Code?

Some of the facts have been stipulated. The written stipulation is incorporated herein by reference.

FINDINGS OF FACT.

Petitioner is a corporation, organized on August 15, 1907, under the laws of the State of Missouri. During all of the time material herein it was and now is engaged in the business of buying, selling, and storing grain and selling feed in the States of Missouri, Kansas, Nebraska, Oklahoma, Iowa, South Dakota, and Colorado, and during all of said time it maintained and it now maintains its principal place of business in Kansas City, Missouri.

Petitioner has always kept its books and filed its income tax, declared value excess profits tax, and excess profits tax returns on the basis of a fiscal year ending April 30 and upon the basis of the accrual method 12 T.C. 760">*762 of accounting. The returns for the period here involved were filed with the collector of internal revenue for the sixth district of Missouri.

Midwest Research Institute is a corporation organized on December 10, 1943, 1949 U.S. Tax Ct. LEXIS 204">*207 under the statutes of the State of Missouri relating to nonprofit corporations. During all of the time material herein, it was and now is engaged in carrying on and conducting scientific research in latent industrial and agricultural potentialities of the midwest area. Its initial capital consisted of contributions made by corporations and persons interested in the future of the Midwest. Paul D. Bartlett, petitioner's president, was one of the Midwest Research Institute's nine incorporators.

On October 31, 1945, petitioner, as the "Sponsor," and Midwest Research Institute entered into a contract which provided in part as follows:

2. The Sponsor hereby engages the Institute to carry on research and development work for the Sponsor relating to Chemicals, Excepting Enzymes and Antibiotics, Derivable From Grain by Fermentation Processes     for a period of Two Years, Beginning October 23, 1945.

* * * ^*

3. The Sponsor agrees to appropriate a total sum not to exceed Twenty Thousand Dollars on this project, and the Institute shall not expend more than said sum without first securing the specific written approval of the Sponsor to do so.

* * * *

6. Invoices shall be rendered by the1949 U.S. Tax Ct. LEXIS 204">*208 Institute or on about the first of each month for the charges and expenses specified in the preceding paragraphs 5 (a) through 5 (d) incurred on behalf of Sponsor prior to the date of the invoice. The Sponsor agrees to pay the invoices of the Institute so rendered within 15 days after receipt thereof. * * *

* * * *

9. Any and all patentable inventions, applications for patent and patents thereon, relating to the subject matter of the project as herein defined which may be hereafter made by staff members employed by the Institute on this project, during the term of this project and as a result thereof, shall become the property of the Sponsor, subject to the terms and conditions of this agreement. * * *

10. The Institute shall cause to be kept complete and systematic memoranda in writing, including notes on all experimental and research work, descriptions, diagrams, and other data pertaining to the work done on said project, which memoranda shall be available at all times to the Sponsor. The Institute agrees to preserve and retain all such memoranda for at least five years from date hereof, it being understood that the Institute, at its option, may deliver such memoranda to the1949 U.S. Tax Ct. LEXIS 204">*209 Sponsor and thereby be relieved of its obligation to preserve and retain the same. In the event the Sponsor desires to keep secret any new process, device, machine, or composition of matter, relating to the project and resulting from the research investigations and activities under this agreement, the Institute shall use its best efforts to maintain the same secret and not to disclose the same to any third party without the consent of the Sponsor.

* * * *

12 T.C. 760">*763 14. The Institute agrees that it will not conduct investigations relating to this project for any other party during the period it is performing work on this project.

15. In the event the project sum is expended prior to the expiration of this agreement, then this project shall terminate unless the Sponsor in writing authorizes the Institute to continue this project. Should the solution of the problem covered by this agreement be obtained to the satisfaction of the Sponsor or the steering committee before the project sum is expended, the Sponsor reserves the right to terminate this agreement but agrees to give thirty (30) days' written notice of its election to do so to the Institute.

Pursuant to the aforesaid contract, 1949 U.S. Tax Ct. LEXIS 204">*210 petitioner paid to the Midwest Research Institute $ 5,000 on November 3, 1945, and $ 15,000 on December 17, 1945, of which the institute has spent $ 7,942.04 by April 30, 1946.

In entering into the contract petitioner's officers hoped that something useful might be developed in connection with grain that would either benefit the farmer or petitioner's business, or both, but they had no specific process or commodity in mind. The project was established without qualification by petitioner as to the particular field in which the research would be made. Midwest Research Institute was told to decide that for itself. The scientists working on the project attempted to develop a new product from agricultural material, using biological processes. They did research on acetic acid, muriatic acid, and humuric acid. Nothing of commercial value or of a patentable nature was developed by the end of the taxable year on April 30, 1946. Subsequently, this biological research was dropped and on November 1, 1946, the scientists working on the project shifted into the riboflavin field.

In its income tax return for the period ended April 30, 1946, petitioner deducted the entire $ 20,000 which had1949 U.S. Tax Ct. LEXIS 204">*211 been paid to Midwest Research Institute as above stated. Respondent disallowed the deduction and determined that the $ 20,000 was a capital expenditure. In its petition petitioner contested the disallowance of the $ 20,000 deduction in its entirety. However, at the hearing and on brief petitioner contended on this issue only that it was entitled to deduct the $ 7,942.04 actually spent by Midwest Research Institute during the taxable year.

In connection with its business of buying, selling, and storing grain, petitioner owns and operates grain elevators in some fifty-five towns and cities throughout the area in which it does business. It buys grain from farmers and sells it to grain merchants, flour millers, speculators, and other storers of grain. During normal times the largest percentage of grain is sold to flour millers.

Petitioner's elevators were run by employees who lived in the communities where the elevators were located. The buying end of the grain business was highly competitive, and to obtain local good will it was a policy of petitioner that these employees should participate in 12 T.C. 760">*764 local affairs, such as joining chambers of commerce and taking part in community1949 U.S. Tax Ct. LEXIS 204">*212 chest, Red Cross, and other similar drives. During the war years petitioner's elevator managers were requested by local committees to purchase their respective quotas of bonds or other United States obligations and these requests were passed on to the home office. Similar requests were made of petitioner itself.

During the war years, the War Finance Committee of the United States Treasury Department conducted campaigns or "drives" for the sale of United States obligations. Pursuant to instructions of the War Finance Committee, a purchaser of bonds in such campaigns or drives would submit to a bank or banks a purchase form designating the amount and the type of obligation for which the subscription was made. If the purchaser so desired, there could be attached to said purchase order a request to the appropriate Federal Reserve Bank for allocation of geographical credit in which there could be set out instructions for the allocation of the subscription among one or more cities or counties of the United States.

The petitioner did not participate in the first three war loan drives. After informal discussion among its officers, but without formal action by its board of directors, 1949 U.S. Tax Ct. LEXIS 204">*213 petitioner participated in all the succeeding war loan drives, as follows:

1949 U.S. Tax Ct. LEXIS 204">*215 12 T.C. 760">*765 In every instance the borrowings were evidenced by notes and the notes were secured by the obligations purchased with those borrowings. When the obligations were sold, the notes which they secured were retired with the proceeds. These purchases of United States obligations during the various war loan drives were allocated by petitioner for quota purposes to some fifty-four towns in which petitioner did business.

Petitioner's assets and liabilities as of April 30, 1945 and 1946, were as follows:

In all of its taxable years to which the excess profits tax applied prior to the taxable year ended April 30, 1946, involved herein, petitioner used an excess profits credit based on the income method in computing its excess profits tax liability. In its excess profits tax return for the taxable year involved, it used an excess profits credit based on the invested capital method in computing its liability.

Petitioner's notes payable as of April 30, 1946, totaled $ 7,093,000. Of that amount $ 1,930,000 was unsecured and bore interest at 1 1/2 per cent per annum and $ 210,000 was secured by warehouse receipts and bore interest at 1 1/4 per cent per annum. These amounts were borrowed for the purpose of and were used in carrying on petitioner's business of buying, selling, and storing1949 U.S. Tax Ct. LEXIS 204">*217 grain. The daily average of 12 T.C. 760">*766 these borrowings for the taxable year ended April 30, 1946, was $ 2,286,753.42. Petitioner included this amount in borrowed invested capital in its excess profits tax return for this period, and respondent concedes that it was correctly so included.

The balance of $ 4,953,000 of petitioner's notes payable as of April 30, 1946, consists of $ 4,170,000 bearing 7/8 per cent per annum interest and $ 500,000 bearing 3/4 per cent per annum interest, secured by U. S. 7/8 per cent certificates of indebtedness, $ 200,000 bearing 7/8 per cent interest secured by U. S. Treasury 2 1/4 per cent bonds, and $ 83,000 bearing 9/10 per cent interest secured by U. S. Treasury 9/10 per cent notes. The borrowings represented by these notes were all used for the purpose of acquiring the United States obligations which secured the notes. The daily average of these borrowings for the taxable year ended April 30, 1946, was $ 3,198,032.58 ($ 5,484,786-$ 2,286,753.42). Petitioner also included this amount in borrowed invested capital in its excess profits tax return for this period. Respondent determined that it should not have been so included, and petitioner disputes1949 U.S. Tax Ct. LEXIS 204">*218 this determination.

OPINION.

It has consistently been held that expenses incurred in the experimentation and development of patents, formulas, and processes are capital expenditures. Claude Neon Lights, Inc., 35 B. T. A. 424; Hazeltine Corporation, 32 B. T. A. 110; Forest Products Chemical Co., 27 B. T. A. 638; Goodell-Pratt Co., 3 B. T. A. 30; Gilliam Mfg. Co., 1 B. T. A. 967; see Reliable Incubator & Brooder Co., 6 T.C. 919, 929; John F. Canning, 29 B. T. A. 99, 107; Ward v. United States, 32 Fed. Supp. 743, 746 (Dist. Ct. Mass. 1940).

Here, however, petitioner maintains that the expenditure of $ 7,942.04 by the Midwest Research Institute during the taxable year did not develop anything of commercial value for petitioner and was not even directed to a particular patent, formula, or process which afforded a reasonable expectation of commercial success. It contends that this money was expended on an exploratory line of research that1949 U.S. Tax Ct. LEXIS 204">*219 was subsequently abandoned and that it should accordingly be deductible as a business expense.

As noted in our findings, the agreement between petitioner and Midwest Research Institute provided that the Institute was to "carry on research and development work for the Sponsor [petitioner] relating to chemicals, excepting enzymes and antibiotics, derivable from grain by fermentation processes for a period of two years, beginning October 23, 1945." Petitioner was "to appropriate a total sum not to exceed $ 20,000 on this project." "Any and all patentable inventions, applications for patents and patents thereon, relating to the subject matter of the project" and resulting from the project were to 12 T.C. 760">*767 become the property of petitioner, and the institute was not to disclose to any third party without petitioner's consent any "new process, device, machine, or composition of matter" growing out of the project.

It is obvious from a reading of these provisions that it was at least within the contemplation of petitioner's officers that research in regard to chemicals derivable from grain might develop something of permanent value to petitioner. It is not determinative of the issue here1949 U.S. Tax Ct. LEXIS 204">*220 that nothing of a capital nature was developed during the taxable year in question or that the particular line of research which the institute was following during that year subsequently proved fruitless. It is clearly the very nature of an experimental project that many lines of approach must be tried and many abandoned before results are obtained.

Manifestly, the initial unsuccessful experiments, as well as the final successful ones, would have entered into the cost of any capital asset that had been developed. There was no occasion for saying at the close of the taxable year that no capital asset would be developed and for isolating the portion of the project sum expended by the institute up until that time and deducting it as a business expense of petitioner. Clearly, the project sum, which had been paid in toto by petitioner to the Midwest Research Institute shortly after the contract was executed, should be treated as a unit, like the project. As of the end of the taxable year on April 30, 1946, only slightly more than one-third of that project sum had been expended and only slightly more than one-fourth of the project time had elapsed. Only when the complete project had1949 U.S. Tax Ct. LEXIS 204">*221 resulted in failure and there had been a definite abandonment or termination could the expenditures have been deducted, and then as a loss. Acme Products Co., 24 B. T. A. 194; H. B. Perine, 22 B. T. A. 201. As the Board said in Acme Products Co., supra (p. 196):

It is claimed that * * * the items in controversy * * * are deductible * * * as expenditures made in an unsuccessful effort to develop a secret formula and a patentable process. Such expenditures, if made as contended, would be of a capital nature and would not be deductible as ordinary and necessary expenses. While additional work was being done in an effort to succeed and while hope for ultimate success was not unreasonable, there was no occasion to deduct any part of the expenditures as a loss.

The cases cited by petitioner are clearly distinguishable from the case at bar. In Duesenberg, Inc. of Delaware v. Commissioner, 84 Fed. (2d) 921 (C. C. A., 7th Cir., 1936), the taxpayer was not allowed to capitalize certain development and experimental costs which it had already deducted as business1949 U.S. Tax Ct. LEXIS 204">*222 expenses in prior years with the approval of the Commissioner. No such question is involved here. In Homer L. Strong, 14 B. T. A. 902, the taxpayer was allowed to deduct sums expended by him in a futile effort to make marketable an already patented machine. There was no indication that the experimentation was to extend beyond the taxable year, as here.

12 T.C. 760">*768 In Dresser Manufacturing Co., 40 B. T. A. 341, the syllabus of the opinion reads:

During the years 1931, 1932, and 1933, taxpayer made expenditures, which it capitaized, for the purpose of developing a gas compressor engine known as "Engine No. 1." In 1933 it abandoned its efforts to develop and perfect "Engine No. 1." * * * Held, petitioner is entitled to deduct as a loss sustained in 1933 the amount of the capital expenditures made in connection with "Engine No. 1" * * *.

In a former proceeding of the Dresser Manufacturing Co., before the Board of Tax Appeals the taxpayer had sought to reduce its taxable income for 1932 by the amount of its experimental expenditures made in 1932. The opinion of the Board in the earlier case was quoted in the opinion of1949 U.S. Tax Ct. LEXIS 204">*223 the Board set forth in 40 B. T. A. 341, supra, and in that quotation the Board is reported to have decided that the expenditures of 1932 should be capitalized during 1932, inasmuch as the experimental project had not been abandoned in 1932 and was not abandoned until the following year.

In the case at bar we have a very similar situation. At the end of the taxable year, April 30, 1946, petitioner herein was still promoting its research. It had no means of knowing whether the money expended prior to April 30, 1946, would develop into a valuable asset or not. The fact that it continued such expenditures until November 1946 would indicate that at the close of the fiscal year now before the Court it had reasonable hope of success. Therefore at the end of the fiscal year 1946 it could only consider its development expenditures as capital investments. The manner in which such expenditures should be handled for tax purposes during the year in which the experiments were finally abandoned is not now before us.

We accordingly hold that the amount of $ 20,000 paid by the petitioner to Midwest Research Institute to carry on research and development work as 1949 U.S. Tax Ct. LEXIS 204">*224 per contract was a capital expenditure, as determined by respondent, and that no part of that amount can be deducted from petitioner's income for the taxable year ended April 30, 1946.

The second question is whether sums borrowed by petitioner which it used to purchase United States obligations during war loan drives constitute borrowed invested capital under section 719 of the Internal Revenue Code. ¹1949 U.S. Tax Ct. LEXIS 204">*225 Respondent maintains that these sums do not come within the intent of the statute. He cites Regulations 112, section 12 T.C. 760">*769 35.719-1, ² and contends that the indebtedness here in question was not incurred for business reasons as required by this regulation.

Petitioner's position is that the statute is categorical and that under the statute, as a corporation computing its excess profits tax credit on the basis of invested capital, it was entitled to include in its invested capital one-half of all its indebtedness evidenced by notes, regardless of the reason for which the indebtedness was incurred. Petitioner contends that the regulation cited by respondent is not valid, being a delimitation of the clear words of the statute.

We may state at this juncture that, in our opinion, the cited portion of Regulations 112, sec. 35.719-1 is valid. It is entirely in accord with the spirit of the excess profits tax legislation. As this Court said in West Construction Co., 7 T.C. 974 (at 978):

* * * Underlying the whole plan of the statute is the assumption that invested capital may consist * 1949 U.S. Tax Ct. LEXIS 204">*226 * * of borrowed capital as well. Internal Revenue Code, secs. 717-719. But it is equally reasonable to infer that what was intended was an investment as to which the business in question assumes some risk. We must never lose sight of the fundamental purpose of the legislation, which was to establish a measure by which the amount of profits which were "excess" could be judged. Thus capital funds placed at the risk of the business might be regarded as entitled to an adequate return * * *.

In Player Realty Co., 9 T.C. 215, this Court said:

We are therefore of the opinion that by the use of outstanding indebtedness the statute contemplates the inclusion in invested capital of outstanding indebtedness, in the form required, for capital borrowed and invested in the business of the taxpayer * * *. [Italics supplied.]

The cited regulation is not in conflict with the statutory intent, nor is it a delimitation of the meaning of the statute, as contended by petitioner. It merely expresses the well settled rule that transactions must have a business purpose and not be mere formal devices, to be effective taxwise. Higgins v. Smith, 308 U.S. 473">308 U.S. 473 (1940);1949 U.S. Tax Ct. LEXIS 204">*227 Gregory v. Helvering, 293 U.S. 465">293 U.S. 465 (1935).

It is not questioned that the borrowings in question were evidenced by notes, nor that they constituted indebtedness of petitioner. They therefore meet the bald requirements of the statute. The question then is simply whether or not these sums qualify as borrowed invested capital within the intent of the statute and under the disputed regulation.

Petitioner maintains that, even if it concedes for the sake of argument the validity of the regulation, the sums here in question qualify under it as borrowed invested capital. Petitioner does not contend that the transactions whereby it bought securities with borrowed funds were entered into by it for the sake of any profit 12 T.C. 760">*770 to be derived in the form of interest on the securities, since in almost all cases it paid out the same rate of interest on the notes evidencing the borrowings as it received on the securities. On the contrary, it merely contends that by participating in war loan drives in the communities where it had grain elevators it obtained local good will essential to its business, and that therefore the sums here in question were borrowed1949 U.S. Tax Ct. LEXIS 204">*228 for business reasons, as required by the regulation, and thus qualify as borrowed invested capital.

However, whatever the fears of petitioner's officers, they certainly did not suppose that it was incumbent on any business to subscribe for Government obligations to an extent where it had to borrow millions in order to finance the subscriptions, as petitioner did here. And it is worthy of notice that petitioner sold all the securities and retired the notes which they secured after the close of the fiscal year, April 30, 1946, when the excess profits tax (terminated by the Revenue Act of 1945, effective as to taxable years beginning after December 31, 1945) was no longer in effect and the tax benefits of a large amount of borrowed invested capital could no longer be obtained. Also, it is not amiss to inquire why any good will which petitioner might have obtained by the gesture of the purchases was not lost when it unloaded the securities the following year. The facts clearly do not support a view that the borrowings were a proper "measure by which the amount of profits which were excess could be judged," in the phrase of West Construction Co., supra.1949 U.S. Tax Ct. LEXIS 204">*229

It is therefore our conclusion that the sums here in question were not borrowed for business reasons and they were not subject to business risks. We hold that they may not be included in petitioner's borrowed invested capital under section 719 of the Internal Revenue Code.

Decision will be entered under Rule 50.