21 T.C. 696">*697 The respondent has determined deficiencies in the petitioner's income and excess profits taxes as follows:

The issues for decision are whether the respondent, in his determination of the deficiencies herein, erred (1) in disallowing as deductions in 1942 and 1943, expenditures1954 U.S. Tax Ct. LEXIS 295">*299 made in 1941 but deducted in the years stated as deferred development and pre-operating expense; (2) in disallowing $ 1,264.18 of the deduction claimed by petitioner on its 1942 return as covering repairs; (3) in disallowing a portion of the deductions claimed by petitioner on its 1942 and 1943 returns as compensation paid to J. W. Nunamaker, Sr.; (4) in disallowing a portion of the deductions claimed by petitioner on its 1942, 1943, 1944, and 1945 returns for depreciation; (5) in disallowing a portion of a deduction claimed by petitioner on its 1944 return for engineering services; (6) in disallowing a deduction claimed by petitioner on its 1945 return as an "item of expense covering a payment of $ 35,000 made to James J. Motycke"; and (7) in failing to determine that petitioner was entitled to the application of section 3806 (a) (2) of the Internal Revenue Code in a determination of its income for 1944 and 1945, due to disallowances of reimbursable costs by the Commodity Credit Corporation.

FINDINGS OF FACT.

Part of the facts have been stipulated and are found as stipulated.

The petitioner is an Illinois corporation, with its principal office 21 T.C. 696">*698 in Indianapolis, Indiana. 1954 U.S. Tax Ct. LEXIS 295">*300 Formerly, its name was Mid-State Frozen Egg Corporation. Its income and excess profits tax returns for the years herein were prepared from books kept on an accrual basis, and were filed with the collector of internal revenue for the district of Indiana.

The petitioner was organized in March 1941, to engage in the business of purchasing shell eggs and selling frozen eggs. Its capital stock was $ 25,000, divided into 250 shares of a par value of $ 100 each, all of which were outstanding through the years involved herein. Upon organization, the 250 shares of authorized stock were issued, 150 shares to J. W. Nunamaker, Jr.; 25 shares to J. W. Nunamaker, Sr., and Blanche Nunamaker; 55 shares to James J. Motycke; and 20 shares to Ray Elster. The 25 shares issued to J. W. Nunamaker, Sr., and Blanche Nunamaker were transferred on October 10, 1942, to John W. Nunamaker, Jr.

"Deferred Development and Pre-Operating Expense."

On May 12, 1941, a meeting of petitioner's board of directors was held, at which the chairman stated that one of the purposes of the meeting "was to consider enlarging the operations of the corporation by engaging in the business of dried eggs." He stated further1954 U.S. Tax Ct. LEXIS 295">*301 that there seemed to be a potential market for dried eggs and "that his information was to the effect that the United States Government was or might be interested in purchasing dried egg powder." After discussion, a resolution was adopted authorizing and directing J. W. Nunamaker, Jr., and Motycke, the president and secretary of the corporation, to investigate the desirability and feasibility of entering the business of drying eggs and selling dried egg products and to report their findings with reference to the possible market for such products and the availability of physical plant facilities. They were to keep a true and accurate account of the time spent and the expenses incurred by each of them in connection with the said investigations.

As the possible location of its dried egg business, the petitioner thereafter acquired an option to purchase certain property in Greensburg, Indiana, paying $ 500 for the option. Nunamaker and Motycke learned, or were aware, of a dried egg purchasing program of the Surplus Marketing Administration of the Department of Agriculture. They made some trips to Washington to explore the matter, in the course of which they made certain representations, 1954 U.S. Tax Ct. LEXIS 295">*302 including the plan for the dried egg plant in Greensburg, and on July 11, 1941, petitioner received a letter from the Surplus Marketing Administration, reading as follows:

This will confirm our understanding concerning the construction of facilities at Greenburg [sic], Indiana, to dry approximately 3,000,000 pounds of dried whole eggs per annum.

21 T.C. 696">*699 This Department will purchase during the fiscal year ending June 30, 1942, as large a quantity of dried whole eggs as can be obtained at reasonable price levels up to 100,000,000 pounds. Should you construct your facilities, as part of the purchase program referred to above, this Department will purchase from you, at reasonable price levels in accordance with our normal offer and acceptance procedure and provided that prices at which you offer eggs are competitive with other offers we receive, your entire plant's production up to 3,000,000 pounds.

Although it is clearly understood that no commitments are made for any period beyond June 30, 1942, should the dried egg purchase program be continued, your concern will receive equitable consideration with all other firms producing dried eggs.

On some undisclosed date, the petitioner1954 U.S. Tax Ct. LEXIS 295">*303 learned that a desirable property located in Indianapolis might be available. This property was a 4-story, brick building, which at one time had been used for the manufacture of school supplies, but currently was being used for storage purposes.

At a meeting of petitioner's board of directors on August 18, 1941, a resolution was adopted to the effect that the option to purchase the Greensburg property be not exercised and that negotiations for the lease of the Indianapolis property, with an option to purchase, be initiated. The resolution directed that the $ 500 paid for the option on the Greensburg property be charged to an account on petitioner's books to be known and captioned as "Deferred Development and Pre-Operation Expense." ¹ The president and secretary were directed "to attempt to effect the transfer of the letter of intent, certificate of necessity and project priority rating" to the property petitioner hoped to procure in Indianapolis. At the same meeting, the directors authorized increases in the salaries of J. W. Nunamaker, Jr., and Motycke and directed that until the first calendar month in which the petitioner should produce dried egg powder, 90 per cent of the 1954 U.S. Tax Ct. LEXIS 295">*304 increase should be charged to the account "Deferred Development and Pre-Operation Expense" and 10 per cent to the cost of construction of the improvements to be made on the Indianapolis property.

On some date not shown, but presumably prior to September 15, 1941, a lease, with an option to purchase, was acquired on the Indianapolis property. Remodeling of the building was then begun, to make it suitable for the processing and drying of eggs.

Under date of September 15, 1941, the petitioner received a letter from the Surplus Marketing Administration, the body of which in all respects was identical with that of the letter of July 11, except that it referred to the construction of facilities for drying eggs at the Indianapolis location, instead of 1954 U.S. Tax Ct. LEXIS 295">*305 Greensburg.

21 T.C. 696">*700 Under date of October 15, 1941, the petitioner received from the appropriate agency of the United States Government a certificate of necessity covering the Indianapolis property and specified facilities and equipment.

At a meeting of petitioner's board of directors on December 15, 1941, the president was authorized to instruct the accountants preparing "the fiscal statements" for the period ending November 30, 1941, that (1) in addition to the increased compensation for J. W. Nunamaker, Jr., and Motycke, authorized on August 18, an amount equal to one-half of the compensation of the said individuals be set aside as having been attributable to the "development and pre-operating classification," and that 90 per cent of this amount be charged to "Deferred Development and Pre-Operation Expense" and 10 per cent to the cost of the construction of the physical plant; (2) the travel expenses incurred for the corporation by the said individuals subsequent to May 31, 1941, and prior to November 30, 1941, be charged in like manner and in like proportions to "Deferred Development and Pre-Operation Expense" and cost of the physical plant; (3) $ 69.12 expended for office supplies, 1954 U.S. Tax Ct. LEXIS 295">*306 and $ 758.71 in long distance tolls be similarly charged; and (4) "that the Deferred Development and Pre-Operation Expense be charged to operating expenses of the company on a per pound basis beginning in the first month in which this corporation is equipped to produce dried egg powder and extending over the first six million pounds of dried egg powder sold" by petitioner.

At December 15, 1941, the date of the above directors' meeting, the petitioner had received 3 contracts or orders for dried eggs from the Surplus Marketing Administration, one on October 14 for 50,000 pounds, to be delivered during December; a second on October 30 for 200,000 pounds, also for delivery in December; and a third on December 11 for 150,000 pounds, for delivery in January. The petitioner began the production of dried egg powder in December 1941, and made its first delivery, in the amount of 24,046 pounds, under the contract of October 14, on January 12, 1942.

At a meeting of petitioner's board of directors on February 9, 1942, an accountant, representing the accounting firm doing petitioner's accounting business, reported that, due to the fact that petitioner's income tax return for the period ended1954 U.S. Tax Ct. LEXIS 295">*307 November 30, 1941, would have to be filed prior to February 15, 1942, and to the fact that petitioner's books of account had been considerably in arrears when the preparation of the data for the return was begun, "certain analysis work primarily concerning the fixed assets account" would have to be deferred until after the rush of Federal income tax work. He recommended that an account be set up to be known and captioned as "Construction 21 T.C. 696">*701 Account" and that such items as were known to be part of the purchase and addition to fixed assets be posted thereto, and that other items which had been ordered by the board to be set up in an account to be known as "Deferred Development and Pre-Operation Expense," be also set up in the Construction Account, because of lack of time in which to segregate those items from others which logically would be placed in the Construction Account.

Up to June 30, 1942, the petitioner had received 21 contracts or orders from the Surplus Marketing Administration, for a total of 5,600,500 pounds of dried eggs, and from July 1, 1942, to November 30, 1942, the end of its fiscal year, it received 6 additional orders, for a total of 410,350 pounds, bringing1954 U.S. Tax Ct. LEXIS 295">*308 the over-all total of orders at November 30, 1942, to 6,010,850 pounds. Under those contracts it delivered 5,396,980 pounds in its fiscal year 1942, and 549,810 pounds in its fiscal year 1943. In the latter year, it received 2 additional orders, for a total of 214,925 pounds of dried egg powder, under which, in the same year, it delivered 214,925 pounds.

In the years 1944, 1945, 1946, and 1947, the petitioner received further orders for dried eggs from the Surplus Marketing Administration or its successors, the Federal Surplus Commodities Corporation and the Commodity Credit Corporation.

The books and records of petitioner show that $ 16,890.35 actually expended in 1941 was capitalized as part of the Construction Account; that on June 30, 1942, $ 15,239.39 of that amount was transferred to an account called "Deferred Development and Pre-Operating Expense"; that the balance of $ 1,650.96 was certified as emergency facilities; that out of the $ 15,239.39, the sum of $ 13,837.01 was charged to expenses in 1942, and the balance of $ 1,402.38 was charged to expenses in 1943. An analysis of the $ 15,239.39 expended in 1941 and so entered and charged off on petitioner's books as set up1954 U.S. Tax Ct. LEXIS 295">*309 by the accounts, shows the following:

21 T.C. 696">*702 1941 Expenditures Deducted on 1942 Return as Repairs.

On its 1942 return, the petitioner deducted $ 1,264.18 under the heading of repairs, which amount was made up of various expenditures which had actually been made in 1941.

In his determination of the deficiency for 1942, the respondent disallowed the deduction of the said amount1954 U.S. Tax Ct. LEXIS 295">*310 as claimed by petitioner.

According to an itemization by the petitioner, the said 1941 expenditures were as follows:

The item designated legal expenses was made up of $ 166.17 paid to Harry C. Partlow, then a practicing attorney and later an employee or official of the petitioner, and $ 350 paid to the law firm of Hammond, Buschmann, Roll and Alexander. Partlow had rendered some services to petitioner in connection with its negotiations with the Surplus Marketing Administration and other matters, and had made a trip to Washington. The $ 350 payment was for services rendered by the above-named law firm in connection with the financing by petitioner of the setting up of its dried egg business.

Of the $ 700 described as "Costs of expired option," $ 200 had been paid by petitioner in procuring the option to purchase the property in Greensburg, Indiana, ² which option was not exercised by reason of the decision of its board of directors, at their meeting on August 17, 1941. The remaining $ 500 represented a payment made by petitioner in1954 U.S. Tax Ct. LEXIS 295">*311 1941 for a lease on property adjacent to its main property in Indianapolis, with an option to purchase, and known as the Solotkin property. A part of the Solotkin property was not needed immediately in connection with petitioner's operations and was leased or 21 T.C. 696">*703 subleased to the S. & S. Body Company. In 1942 it was needed by petitioner and $ 500 was paid to the Body Company for termination of its lease.

Compensation of J. W. Nunamaker, Sr.

To convert and adapt the Indianapolis property to the purposes for which it was acquired, extensive remodeling was necessary. Among other things, a substantial addition was made at the end of the building to house an egg drying unit. The addition was approximately the same height as the main building but without floors. To supervise and direct this work, petitioner employed J. W. Nunamaker, Sr., the father of its president. J. W. Nunamaker, Sr., was then engaged1954 U.S. Tax Ct. LEXIS 295">*312 in farming, but prior to the farming venture had been engaged in the building and contracting business. At one time he had been president of the Brick Contractors Association in Indianapolis.

In addition to supervising the remodeling of the main building and the construction of the addition thereto, J. W. Nunamaker, Sr., also supervised the installation of the egg processing and drying equipment, and after production began, he had charge of alterations, changes, rearrangements, and replacements, and of general maintenance and upkeep of the plant. Numerous alterations and changes were necessary from time to time in order to make the operations more efficient. The egg breaking room was rearranged. The canning room was changed from one floor to another. Some partitions which had been damaged by equipment and the floors in two freezers had to be replaced. Various doors and partitions were changed.

In connection with his services to petitioner, J. W. Nunamaker, Sr., furnished a 3-horsepower hoist, a one-half bag concrete mixer, a hand derrick of 1-ton capacity, scaffolding, ropes and blocks, pulleys, and wheelbarrows, all of which belonged to him and had been retained from his contracting1954 U.S. Tax Ct. LEXIS 295">*313 business. He regularly devoted 48 hours or more each week to his employment during the fiscal year ended November 30, 1942, and approximately 44 hours a week during the fiscal year ended November 30, 1943.

For the fiscal year 1942, the salary of J. W. Nunamaker, Sr., was $ 1,000 a month, or $ 12,000 for the year. For the fiscal year 1943, his salary was $ 1,000 for the month of December 1942, and $ 500 a month for the remaining 11 months, or $ 6,500 for the year. The foregoing amounts constituted compensation for his services and for the use of his equipment.

The petitioner paid its president a salary of $ 7,690.40 for 1942, and a salary of $ 7,800 for 1943.

At the end of the fiscal year 1942, $ 2,900 of the above compensation of J. W. Nunamaker, Sr., for that year, was unpaid. On January 31, 21 T.C. 696">*704 1943, that amount and his compensation of $ 1,000 for December 1942, and $ 500 for January 1943, or a total of $ 4,400, was unpaid. On January 31, 1943, the petitioner executed and delivered to him its negotiable promissory note, due 1 year after date, in the amount of $ 4,500, which, by mistake, was for $ 100 more than was due him at that time. The petitioner made the following1954 U.S. Tax Ct. LEXIS 295">*314 payments on the note: June 8, 1943, $ 1,000; September 7, 1943, $ 500; December 13, 1943, $ 1,500; or a total of $ 3,000. For the unpaid balance of $ 1,500, the petitioner on January 31, 1944, executed and delivered to him a new negotiable promissory note, due 1 year after date, for $ 1,500. This note was paid by the petitioner on March 17, 1944.

At the end of the fiscal year 1943, the above compensation of J. W. Nunamaker, Sr., for the last 10 months of the year, or $ 5,000, was unpaid. On January 31, 1944, that amount and his compensation of $ 500 for each of the months December 1943, and January 1944, or a total of $ 6,000, was unpaid. On January 31, 1944, the petitioner executed and delivered to him its negotiable promissory note, due 1 year after date, in the amount of $ 6,000. The note was paid by the petitioner as follows: August 29, 1944, $ 2,500; December 22, 1944, $ 3,500.

On its returns for the fiscal years 1942 and 1943, the petitioner took deductions of $ 12,000 and $ 6,500, respectively, as compensation to J. W. Nunamaker, Sr. The respondent disallowed $ 2,900 and $ 6,400 of the deductions so claimed, on the ground that they were not deductible under the provisions1954 U.S. Tax Ct. LEXIS 295">*315 of section 24 (c) of the Internal Revenue Code and on the further grounds that they were excessive under the provisions of section 23 (a) of the Code.

For the fiscal years 1942 and 1943 the amounts of $ 12,000 and $ 6,500 constituted reasonable compensation to J. W. Nunamaker, Sr., for his services and the use of his equipment in those years.

Depreciation.

Under dates of October 15, 1941, ³ and November 10, 1942, the petitioner received necessity certificates from the War Production Board covering facilities acquired and installed for the purpose of its dried egg operation, and on its returns for the years 1942, 1943, and 1944, it elected to amortize its facilities, under section 124 of the Internal Revenue Code, over a period of 60 months and took deductions in accordance therewith. Pursuant to subsection (d) of section 124, a nonnecessity certificate was issued on December 11, 1945, by the Civilian Production Administration, certifying that the facilities in question had ceased on April 25, 1945, to be necessary in the interest of national defense during the emergency period. Thereafter the petitioner filed 21 T.C. 696">*705 applications for adjustment with respect to amortization1954 U.S. Tax Ct. LEXIS 295">*316 deductions for the said years to conform with the shorter period ending April 25, 1945. As to the facilities covered, adjustments were made by the respondent and increased amortization deductions were allowed by him in his determination of the deficiencies herein.

In addition to the above, other items were acquired and installed by the petitioner which were not covered by necessity certificates and in respect of which petitioner did not claim amortization under section 124. These items were classified by petitioner on its books under the headings "Buildings," "Machinery and Equipment," and "Furniture and Fixtures." The category "Machinery and Equipment" has been subdivided into Dryer Equipment, Supplemental Equipment to Dryer, General Equipment, Rolling Equipment, and Miscellaneous, the only item under Miscellaneous being "70 baskets for egg cleaner," for a total of $ 70.

Among the items classified under General Equipment are a Frick Air Cooling Unit, which had cost1954 U.S. Tax Ct. LEXIS 295">*317 $ 1,965, and a Frick Cooling Unit, which had cost $ 6,584. A cooling unit consisted of 2 principal parts: A fan, which was replaceable, and a coil. The useful life of the coil was 15 years and that of the fan 10 years. The cooling units were used in the cooling rooms.

Among the items classified under Rolling Equipment were 4 Mobilifts, 1 having a cost of $ 1,722.50 and 3 having an aggregate cost of $ 5,020. The Mobilifts were motor driven vehicles for picking up, moving, and stacking heavy objects and materials. They were used by petitioner in its egg merchandising business, and had a useful life of not less than 10 years.

The plant capacity for the production of dried eggs in the United States had been multiplied many times by 1944, over what it had been at the time the petitioner entered the field. ⁴

1954 U.S. Tax Ct. LEXIS 295">*318 There was no demand for dried eggs for war purposes after April 1945, and the petitioner thereafter used its plant for producing dried egg powder only during the periods when the Commodity Credit Corporation made purchases to support the price of eggs to egg producers. During the period from March 1, 1946, through August of that year, the petitioner sold to the Commodity Credit Corporation, under 13 contracts, 1,963,120 pounds of dried whole eggs for $ 2,192,073.10. From January 15 to April 17, 1947, the petitioner sold to the same Corporation, under 8 contracts, 1,157,100 pounds of dried whole eggs for $ 1,421,397.30. From June 30, 1945, to September 21 T.C. 696">*706 30, 1951, the petitioner used its plant less than 14 months in the production of dried egg products. The equipment remains installed as when regularly operated and the plant is in condition to be operated at any time.

The petitioner regularly conducts an egg merchandising business, buying and selling shell eggs, in its plant, but uses less than 15 per cent of the entire plant for that purpose. In the operation of that business, the cooling and refrigeration rooms and the general equipment are used, to some extent.

On its1954 U.S. Tax Ct. LEXIS 295">*319 returns for the taxable years 1942, 1943, and 1944, the petitioner took depreciation on various classes of property, other than those covered by the necessity certificates, on the basis of the composite lives of the various classes: 20 years for buildings acquired in 1941, 60 months for machinery and equipment, and 60 months for furniture and fixtures. For buildings acquired in 1942, it took depreciation on the basis of a composite life of 60 months. On its return for the taxable year 1945, it did not show the life or lives used in computing the depreciation on the foregoing classes of property, but in answer to the question as to the life used, merely stated "Various" with respect to buildings and machinery and equipment. It left blank the space for showing the life used in the depreciation on furniture and fixtures.

For the years 1942 through 1945, the respondent determined depreciation on the above mentioned classes of property on a composite life basis, determining a life of 20 years for buildings, 15 years for machinery and equipment, and 15 years for furniture and fixtures. He disallowed all depreciation deducted by petitioner with respect to those classes of property in1954 U.S. Tax Ct. LEXIS 295">*320 excess of that computed on the basis of the composite life determined by him.

Payments for Engineering Services.

In 1944, the petitioner employed H. S. Boles, an engineer, to prepare a plan and specifications for the construction of a rotary table for egg breakers. Boles prepared the plan and specifications and delivered them to petitioner. However, the table was not built in 1944, because the petitioner was unable at that time to obtain the materials necessary therefor. The petitioner paid Boles $ 3,000 for his services.

During 1944 Boles also prepared for the petitioner plans and specifications for the construction of a dried egg conveyor which was necessary in the operation of the petitioner's dried egg plant. The conveyor was built and was operated in 1944 and 1945. The petitioner paid Boles $ 2,000 for his services in preparing the plans and specifications.

21 T.C. 696">*707 In determining the deficiency for 1944, the respondent disallowed a deduction of $ 5,000 taken for the payment to Boles for his services and determined that the amount should be capitalized.

Payment to James J. Motycke.

Misunderstandings arose between John W. Nunamaker, Jr., and Motycke respecting the1954 U.S. Tax Ct. LEXIS 295">*321 affairs of the petitioner and on April 29, 1943, they entered into a contract wherein Motycke agreed to sell his stock to John W. Nunamaker, Jr., at such fair value of the stock as of April 30, 1943, as might be determined by an arbitrator to be agreed upon by them. The contract provided that the arbitrator should fix and determine the fair value of the stock within 30 days after his selection. Motycke and Nunamaker selected J. Dwight Peterson, of Indianapolis, as arbitrator. The 30-day period provided in the agreement, within which his determination was to be made, expired before Peterson completed his valuation. However, when completed, his valuation was $ 225 a share, or $ 12,375 for the 55 shares. A dispute arose between Nunamaker and Motycke as to whether the time in which Peterson was to make his valuation had fully expired and the transaction contemplated by the agreement of April 29, 1943, did not materialize.

On November 16, 1943, Motycke, as a stockholder of the petitioner, filed a suit in the Superior Court of Marion County, Indiana, naming Nunamaker and petitioner as defendants. In his complaint he alleged that Nunamaker, as president and majority stockholder of 1954 U.S. Tax Ct. LEXIS 295">*322 the petitioner, had improperly diverted profits of the petitioner to himself and members of his family, had improperly made other payments, and should be required to account to the petitioner therefor. He also alleged that by reason of Nunamaker's wrongful and unlawful acts as alleged therein the petitioner was in imminent danger of insolvency and that waste and loss of its assets could only be prevented by the appointment of a receiver for its assets located within the State of Indiana. He asked that Nunamaker be enjoined and also that the petitioner be enjoined from disbursing its funds in the manner alleged in the complaint; that a receiver be appointed for all the business and assets of the petitioner located within the State of Indiana and that the receivership be authorized by the court to operate the business or to liquidate it, as the court should deem to the best interests of petitioner's creditors and stockholders; that Nunamaker be ordered to account for the money, property, and assets of the petitioner illegally diverted from it to himself; that judgment be rendered in favor of the petitioner and against Nunamaker for the amount found to be due; and that Nunamaker be 1954 U.S. Tax Ct. LEXIS 295">*323 held liable and ordered to pay to the petitioner 21 T.C. 696">*708 all damage or injuries resulting to it on account of his misfeasance or malfeasance in the office of president and manager.

After the filing of various pleadings and two changes of venue, the Superior Court of Marion County, Indiana, on May 18, 1945, directed the petitioner and Nunamaker to permit Motycke to inspect designated books and records of the petitioner and directed Nunamaker to permit Motycke to inspect designated books and records of Nunamaker, doing business under the name of Mid-State Egg Company.

In October 1944, Nunamaker filed suit against Motycke in the Superior Court of Marion County, Indiana, for a specific performance of the contract of April 29, 1943, and, on motion, Motycke was enjoined from selling or pledging his stock to anyone except Nunamaker. Motycke removed the case to the United States District Court for the Southern District of Indiana. Pleadings were filed. Motycke moved for judgment on the pleadings. On May 14, 1945, the court entered an order dismissing the suit without prejudice, rendering judgment for Motycke, and dissolving the injunction. Thereupon, Nunamaker filed notice of appeal1954 U.S. Tax Ct. LEXIS 295">*324 to the United States Court of Appeals for the Seventh Circuit.

Subsequent to the court order permitting him to inspect books and records of the petitioner and Nunamaker, Motycke employed a firm of accountants. They and he made an audit of petitioner's books. He also obtained copies of the petitioner's income tax returns for 1943 and 1944. On its return for 1943 the petitioner reported a net income of $ 47,118.39 for the year. On its return for 1944 the petitioner reported a net income for the year of $ 535,969.21. It also showed earned surplus and undivided profits at the end of 1944 of $ 213,347.88, or an amount equal to approximately $ 853.40 a share for the petitioner's outstanding 250 shares of stock. On the basis of the copies of the returns and the audit reports, Motycke placed a value of $ 1,000 a share on his 55 shares of stock in the petitioner. During negotiations that subsequently developed for a settlement of the 2 suits, Motycke instructed his attorneys that he was asking $ 55,000 for his stock, and that he did not care whether the amount was split up or how it was split up, that he would be satisfied if he received $ 55,000.

On June 18, 1945, the petitioner's 1954 U.S. Tax Ct. LEXIS 295">*325 board of directors adopted a resolution which authorized settlement of the suit brought by Motycke against Nunamaker and the petitioner, by petitioner paying Motycke $ 35,000 and the dismissal of the suit by Motycke, and authorized the petitioner's president and secretary to execute a written contract of settlement on that basis and make payment of the $ 35,000. On June 19, 1945, a contract of settlement on the basis thus authorized was entered into between Motycke and the petitioner. Payment of the $ 35,000 was made by petitioner and the suit was dismissed.

21 T.C. 696">*709 On the same day, June 19, 1945, a settlement contract was entered into by Motycke and Nunamaker. In this contract, reference was made to the agreement of April 29, 1943, between the parties, wherein Motycke agreed to sell to Nunamaker his 55 shares of stock in the petitioner at their fair value on April 30, 1943, and to Nunamaker's suit for specific performance of that agreement. Then it was recited that "in order to settle said suit and all other litigation, matters, and controversies between the parties hereto, First Party [Motycke] is willing to sell said Fifty-five (55) shares of the capital stock of said corporation1954 U.S. Tax Ct. LEXIS 295">*326 to Second Party [Nunamaker] or such party as he may designate at its fair value on April 30, 1943, which is hereby agreed to be the sum of $ 20,000.00, if Second Party will dismiss said appeal * * * to said United States Circuit Court of Appeals of the Seventh Circuit." The contract provided for the immediate transfer of the stock to Nunamaker and for his payment of $ 20,000, by 12 promissory notes executed by him and secured by the pledge of 95 shares of stock in the petitioner then owned by him. Of the $ 20,000 of notes, $ 5,000 was payable on November 1, 1945, February 1, 1946, March 1, 1946, and April 1, 1946, respectively. Motycke transferred his stock to Nunamaker and the latter dismissed his suit against Motycke.

On its return for 1945, the petitioner took as a deduction the $ 35,000 it paid to Motycke, as set out above. In determining the deficiency for that year, the respondent disallowed the deduction.

The payment of $ 35,000 by petitioner to Motycke was on behalf of Nunamaker and was in part payment for the stock of petitioner acquired by Nunamaker from Motycke.

Disallowances by Commodity Credit Corporation.

On March 16, 1944, the petitioner entered into contract1954 U.S. Tax Ct. LEXIS 295">*327 FSC (F) 34483 with the Federal Surplus Commodities Corporation for the sale of dried eggs, with deliveries to be made from April 5 through August 30, 1944. On March 24, 1944, the petitioner entered into contract FSC (F) 35686 with that Corporation for the sale of dried eggs, with deliveries to be made during September 1944. These contracts provided for payment at a specified price per pound.

On April 21, 1944, the Federal Surplus Commodities Corporation sent to petitioner and to other egg driers a telegram pointing out that contracts for future delivery of dried eggs had been entered into on the assumption that producers of eggs would receive support prices for their eggs and that driers would receive a reasonable return; and that conditions had developed where it was apparent that egg driers in many instances had procured eggs at prices substantially below 21 T.C. 696">*710 the support level, which afforded egg driers holding future contracts an opportunity to make profits larger than those originally anticipated. The telegram also stated that it was the desire of the Federal Surplus Commodities Corporation to procure dried eggs in quantities sufficient to meet its requirements and in1954 U.S. Tax Ct. LEXIS 295">*328 that procurement, to return to egg driers their costs of raw materials, their reasonable operating costs, and a reasonable profit. By the telegram, the Federal Surplus Commodities Corporation amended all contracts between it and egg driers for delivery of dried eggs after May 1, 1944. The amendment changed the name of the purchaser from Federal Surplus Commodities Corporation to Commodity Credit Corporation and provided that the price to be paid for dried whole eggs should be the actual cost of the eggs to the producer, plus conversion charges, as set forth in the telegram. The amendment further provided that in presenting claim for payment covering dried eggs the vendor should attach thereto a sworn statement of his costs computed in accordance with the method provided in the amendment and that the vendor should permit representatives of the Commodity Credit Corporation to examine his plant, equipment, processing materials, books, records, and accounts to the extent necessary to determine his compliance with the provisions of the amendment.

On April 29, 1944, the Commodity Credit Corporation wrote a letter to all egg driers, including the petitioner, clarifying the amendment and1954 U.S. Tax Ct. LEXIS 295">*329 answering certain questions that had arisen. The letter stated how the drier was to compute the cost that was to be shown in the sworn statement or affidavit to accompany his claim for payment for dried eggs. Respecting shell eggs acquired through affiliates, the letter provided that the statement or affidavit should show the price received by the producer of the eggs, loose basis, plus 2 cents per dozen, plus 10 cents per case for case obsolescence, plus transportation, if any, from point of purchase to storage or drying plant, plus cost of carrying until used.

Contracts as thus amended and contracts made subsequent to the date of the amendment provided for prompt payment of the bills of driers upon delivery of dried eggs, but subject to subsequent audit and refund by the driers of any sums found to have been overpaid under their bills.

On June 6, 1944, the petitioner sent a telegram to the Commodity Credit Corporation in which it confirmed the amendments made to its above mentioned contracts.

In 1944, the Commodity Credit Corporation paid the petitioner $ 2,396,493.89 for deliveries under contract FSC (F) 34483 from May 1 through August 30, 1944, and $ 586,623.84 for deliveries1954 U.S. Tax Ct. LEXIS 295">*330 under contract FSC (F) 35686 from September 6 through September 30, 1944.

21 T.C. 696">*711 On September 22, 1944, petitioner entered into contract Aw-f (F) 14978 with the Commodity Credit Corporation for the sale of dried eggs on a cost-plus-a-fixed-fee basis, with deliveries to be made during October 1944.

On March 9, 1945, the petitioner entered into contract Aw-f(F) 23951 with the Commodity Credit Corporation for the sale of dried eggs on a cost-plus-a-fixed-fee basis, with deliveries to be made during March 1945.

In April 1945, auditors of the Commodity Credit Corporation called at the petitioner's plant and informed the petitioner that they did not agree with the method it used in arriving at costs for billing dried eggs on the cost-plus contracts made in 1944. On February 15, 1946, petitioner and the Commodity Credit Corporation entered into a written contract which recited the execution of contract FSC (F) 34483, and its subsequent amendment, changing the price from a fixed price per pound to a price based on cost of material, plus a fixed processing fee, and the dispute as to whether the Commodity Credit Corporation had overpaid petitioner, based upon the appropriate method of determining1954 U.S. Tax Ct. LEXIS 295">*331 costs of dried eggs for May 1944 deliveries. The contract provided that after an audit to determine costs and alleged overpayment and formal written demand upon petitioner for repayment, the Commodity Credit Corporation could withhold one-half cent per pound on all dried eggs, one-seventh cent per pound on all frozen eggs, and one-sixth cent per dozen on all shell eggs, which might be delivered to the Commodity Credit Corporation in 1946 or 1947 by petitioner under new contracts, until an amount was withheld which, when added to the amount of the $ 25,000 performance bond of the petitioner already on deposit with the Commodity Credit Corporation, would constitute 100 per cent security for the amount alleged to be due from the petitioner under the 1944 contract. The contract further provided that the Commodity Credit Corporation would pay to petitioner the amount withheld as above provided, and release the petitioner's $ 25,000 performance bond, if the Department of Justice was not requested within 1 year from the date of the contract, February 15, 1946, to institute action against petitioner in the above mentioned dispute and the petitioner was so notified in writing of such request. 1954 U.S. Tax Ct. LEXIS 295">*332 The contract also provided that the Commodity Credit Corporation, upon presentation to it of a bond acceptable by it as to form and surety and in the amount of the funds withheld, would pay to the petitioner any funds withheld under that contract. Neither party otherwise waived or altered any rights it had under the amended contract FSC (F) 34483, nor did the Commodity Credit Corporation waive any lawful remedy available to it for the enforcement of any debt arising thereunder. So far as appears, the Department of Justice 21 T.C. 696">*712 was never requested at any time to bring suit against the petitioner with respect to the controversy.

On April 24, 1946, the petitioner was advised by letter that a preliminary audit indicated that approximately $ 71,719.58 was due from petitioner on the 4 contracts mentioned above.

By letter of November 7, 1946, the petitioner was notified that the final audit showed total overpayments of $ 64,399.34 under the said 4 contracts and that $ 10,215 had been withheld under the contract of February 15, 1946. On August 1, 1947, the Commodity Credit Corporation notified the petitioner that in lieu of withholding one-half cent per pound from its various contracts, 1954 U.S. Tax Ct. LEXIS 295">*333 payment of 2 of its claims of $ 25,236.75 each, or $ 50,473.50, was being withheld. The total amount actually withheld was $ 65,476.50. This was more than the amount of $ 64,004.94 disallowed as items of cost paid the petitioner in 1944 under contracts FSC (F) 34483, FSC (F) 35686, and Aw-f (F) 14978, and $ 394.40 disallowed as items of cost paid the petitioner in 1945 under contract Aw-f (F) 23951.

All amounts due on dried egg contracts in its fiscal years 1944 and 1945 were accrued by petitioner in those years, reported as taxable income on its income and excess profits tax returns for those years, and taxes paid accordingly. On its income and excess profits tax returns for its fiscal year 1946, the petitioner reported as taxable income all amounts billed in that year for dried egg shipments to the Commodity Credit Corporation, less $ 10,015.15 withheld by the Corporation on prior year contracts, and taxes were paid accordingly. On its income tax return for its fiscal year 1947, the petitioner reported as taxable income all amounts billed for dried egg shipments in that fiscal year to the Commodity Credit Corporation, plus said amount of $ 10,015.15, and taxes were paid accordingly. 1954 U.S. Tax Ct. LEXIS 295">*334 The $ 10,015.15 was included in fiscal year 1947 income because the petitioner had been informed that the amount should not have been deducted from its income for the fiscal year 1946.

On September 3, 1947, the petitioner filed suit against the Commodity Credit Corporation in the United States District Court for the Eastern District of Illinois. In its complaint, petitioner set out all contracts made in 1946 and 1947 between it and that Corporation, alleged a breach thereof by the Corporation in failing to pay the full amount due the petitioner under the contracts, and prayed for a judgment against the Corporation in the total amount of $ 65,476.50, with interest.

The Commodity Credit Corporation filed an answer, in which it admitted petitioner's performance of said contracts. However, in a counterclaim, the Corporation alleged that during 1944 and 1945 the 21 T.C. 696">*713 parties entered into certain cost-plus-a-fixed-conversion-charge contracts for the sale of whole dried eggs, that the petitioner billed and collected during 1944 and 1945 for items of cost amounts which were more than should have been charged, that when the true cost was ascertained, it was found that the Corporation1954 U.S. Tax Ct. LEXIS 295">*335 had overpaid the petitioner $ 47,199.25 under contract FSC (F) 34483, $ 16,646.09 under contract FSC (F) 35686, and $ 159.60 under contract Aw-f (F) 14978 (the 1944 contracts), or a total for 1944 of $ 64,004.94, and $ 394.40 under contract Aw-f (F) 23951 (the 1945 contract), or a total overpayment for both years of $ 64,399.34, which, with interest, exceeded the sum of $ 65,476.50, as alleged in the complaint had been withheld from subsequent deliveries under subsequent contracts.

In its reply to the counterclaim of the Commodity Credit Corporation, the petitioner denied that it had improperly charged the costs and denied any over-billing or any overpayment under the contracts. The petitioner also made a counterclaim, alleging, in the alternative, that the amendments to the contracts made in 1944 and 1945 were obtained by economic duress exercised by the Commodity Credit Corporation, were null and void and should be canceled, and that the petitioner should have judgment against the Corporation for $ 101,200.03, being the balance due under the terms of the original contracts, with proper interest, in addition to judgment for the sum of $ 65,476.50, with interest, as prayed for in1954 U.S. Tax Ct. LEXIS 295">*336 the complaint. The Corporation filed a reply denying the allegation of the petitioner's counterclaim. A trial was had on the petitioner's counterclaim and the Corporation's reply thereto. The court dismissed petitioner's counterclaim and entered a decree accordingly. On petitioner's appeal to the United States Court of Appeals for the Seventh Circuit, the action of the District Court was affirmed, at 196 F.2d 416.

OPINION.

"Deferred Development and Pre-Operating Expense."

Our first question is as to the deductibility of $ 15,239.39 expended by the petitioner during its fiscal year ended November 30, 1941, and capitalized on its books under the heading "Construction Account" and then in an account styled "Deferred Development and Pre-Operating Expense," from which, during the fiscal years 1942 and 1943, it was charged as cost or expense in producing the first 6,000,000 pounds of dried eggs sold to the Surplus Marketing Administration. The expenditures in question were generally in the nature of salaries and compensation for services, traveling expenses, telephone, telegraph, 21 T.C. 696">*714 office supplies, automobile expense, and the like. As an alternative1954 U.S. Tax Ct. LEXIS 295">*337 claim, the petitioner contends that if it was in error in capitalizing the amounts in question and writing them off in the fiscal years 1942 and 1943 against the first 6,000,000 pounds of powdered eggs produced, then the amounts were deductible as ordinary and necessary expenses in the fiscal year 1941, the year in which they were actually paid or incurred.

In our disposition of the case, we do not reach the petitioner's alternative claim. The respondent agrees with petitioner that the expenditures made in 1941, in setting up the powdered egg business, were capital items, and even though they are of a type which ordinarily is deductible currently as ordinary and necessary expenses, we are of the view that the facts of record justify the respondent's concurrence. In Goodell-Pratt Co., 3 B. T. A. 30, where the question was whether certain expenditures should be regarded as capital expenditures, we quoted with approval from Applied Theory of Accounts, page 226, by Paul J. Esquerre, as follows:

When subjected to a theoretical analysis, this term appears to apply to such expenses as, in the aggregate, represent the cost of the increased earning capacity1954 U.S. Tax Ct. LEXIS 295">*338 of the enterprise as a whole or of particular parts thereof, which has been secured over the earning capacity known to exist before the said expenses were incurred.

Here the expenditures were designed and intended to increase the earning capacity of petitioner beyond that of the shell egg business, for which it was organized and in which it was engaged, by setting up and establishing a new and additional business, namely, that of producing and selling dried eggs in which operations actually began in the next succeeding year.

In the absence of recovery through a sale or exchange of a capital item, capital costs, if recoverable tax-wise, are recovered through depreciation, obsolescence, amortization, or loss deductions. Not all capital items are wasting assets, however, and it does not follow that depreciation or amortization deductions with respect thereto begin or are allowable upon their acquisition and utilization in the taxpayer's business. X-Pando Corporation, 7 T.C. 48; Mills Estate, Inc., 17 T.C. 910; Duesenberg, Inc. of Delaware, 31 B. T. A. 922. See and compare A. Finkenberg's Sons, Inc., 17 T.C. 973;1954 U.S. Tax Ct. LEXIS 295">*339 Ralphs-Pugh Co., 7 T.C. 325; and Charley J. Bradley, 41 B. T. A. 152.

In support of its action in charging the expenditures against the first 6,000,000 pounds of dried eggs produced and sold, the petitioner cites and relies on United Profit-Sharing Corporation v. United States, 66 Ct. Cl. 171">66 Ct. Cl. 171. Whatever may be said of the ruling in that case, it is not authority for the petitioner's claim here. There the Court of Claims found the facts to be that the expenditures in an advertising 21 T.C. 696">*715 campaign represented the costs of certain designated contracts and that those costs were to be allocated to the various contracts according to the volume and lives thereof. Here, even though it be said that the items in question were expended in procuring dried egg contracts with the Surplus Marketing Administration, no factual basis is shown for choosing the first contracts up to 6,000,000 pounds and excluding all later contracts. The Surplus Marketing Administration did state in its letter of September 15, 1941, that it would purchase dried eggs from petitioner, if it should construct its facilities, 1954 U.S. Tax Ct. LEXIS 295">*340 but the amount specifically mentioned was 3,000,000 pounds, not 6,000,000, and there was no unqualified commitment as to any amount, but only that it would purchase dried eggs from petitioner up to 3,000,000 pounds at "reasonable price levels in accordance with our [Surplus Marketing Administration's] normal offer and acceptance procedure and provided that prices at which you [petitioner] offer eggs are competitive with other offers we [Surplus Marketing Administration] receive." Furthermore, the commitment, if it may be called a commitment, did not extend beyond June 30, 1942, after which petitioner was to "receive equitable consideration with all other firms producing dried eggs." Just why petitioner decided to charge the items in question against the first 6,000,000 pounds of dried eggs sold to the Surplus Marketing Administration, is not clear, since at the time the decision was made on December 15, 1941, the total orders from that agency amounted to only 400,000 pounds; and beyond the fact that petitioner did then have the facilities for drying eggs and the indication that it had met its competition as to that 400,000 pounds, there is no proof of record that at that time the 1954 U.S. Tax Ct. LEXIS 295">*341 prospective orders of the Surplus Marketing Administration did represent the 3,000,000 pounds suggested in the letter of September 15, or some other widely divergent amount. Furthermore, if the charge-off were to be made according to the formula followed in the United Profit-Sharing Corporation case, the determination would, as in that case, be made on a hindsight basis and would require a spread to include at least all orders received from the Government up to April 15, 1945, when the nonnecessity certificate was issued by the Civilian Production Administration, and probably would have to be extended to cover orders from the Commodity Credit Corporation in 1946 and 1947, which would have been far beyond the 6,000,000 pound limit which petitioner seeks to have allowed here. The practical difficulties which would be attendant upon such a course are obvious, particularly when regard is had for the requirements of the statute as to the annual reporting of income and the paying of the tax thereon. It is also to be noted that petitioner has asked for no such deductions beyond fiscal year 1943.

21 T.C. 696">*716 The answer, we think, is that the expenditures here may not reasonably be regarded1954 U.S. Tax Ct. LEXIS 295">*342 as the cost to petitioner of the Surplus Marketing Administration orders for 6,000,000 pounds of dried eggs, 3,000,000 pounds, or some other amount, but are more nearly comparable to the cost of surveys preliminary to the organization of any business corporation or venture and the costs attendant upon the organizing and launching of the business. The direction to the petitioner's president and secretary, for whose salaries and expenses most of the $ 15,239.39 was paid, was that they investigate the "desirability and feasibility" of petitioner entering into "the business of drying and selling dried egg products." The basis therefor, as stated by the chairman of the board of directors, was "that there seemed to be a potential market for dried eggs and that his information was to the effect that the United States Government was or might be interested in purchasing dried egg powder." They were to look into the possible market for such products and the availability of physical plant facilities. According to the testimony of petitioner's president, the plant capacity in the United States for dried eggs at or about the time the petitioner began the production thereof was only approximately1954 U.S. Tax Ct. LEXIS 295">*343 10,000,000 pounds per annum, as against 320,000,000 pounds a year or two after.

It is, of course, true that in 1941 the attitude and plans of the Government were very potent influences in most lines of industrial and business endeavor, but there is no proof or indication that the entry of petitioner into the dried egg field was to be determined by the contingency that the United States should become and, if so, continue to be the major buyer in the dried egg market. The possibility of the Government as a prospective buyer was one factor for investigation, just as were other possible or probable influencing factors. At or about that time, the attitude of the Government in relation to the national defense program was a very real and far reaching force which had to be considered in most plans for launching an enterprise and in procuring the physical facilities therefor, even though the Government might or might not be a potential customer. The petitioner has made no showing with respect to the detail of the expenditures or the purposes thereof beyond their characterization on its books of account, and such detail of expenditures as appears was, according to the minutes of the directors' 1954 U.S. Tax Ct. LEXIS 295">*344 meeting and statement of petitioner's accountants, made to fit a prior determination that the deferred items were to be charged against the first 6,000,000 pounds of dried eggs sold to the Surplus Marketing Administration, which, as shown above, was not justified on the facts, even under petitioner's theory and application of the rule in the United Profit-Sharing case.

21 T.C. 696">*717 Conceivably, there could have been some costs which, in reason, could properly have been chargeable to specific orders or contracts for dried eggs, as contrasted with the costs considered and discussed above, which were made preliminary to and in the setting up of petitioner's dried egg enterprise and which, so far as they did relate to the Government orders, tended to put petitioner in a position where it could compete for orders along with any and all other dried egg producers in the country. But, even so, the orders were still to be obtained by petitioner only by meeting that competition. There is also some suggestion of record that certain of the costs had to do with the obtaining of priorities, presumably for materials and equipment for the setting up of petitioner's plant and possibly some such1954 U.S. Tax Ct. LEXIS 295">*345 costs might, in reason, have been chargeable as cost of the plant and thereby have become subject to amortization, under section 124, supra. The record indicates, however, that in transferring the items herein from the Construction Account to the "Deferred Development and Pre-Operating Expense Account," petitioner's accountants gave attention to those items which might properly be regarded as the cost of emergency facilities and they were so certified. Insofar, therefore, as the proof shows, the expenditures were preliminary to the entry of petitioner into its dried egg operations and were made in acquiring a capital benefit which, insofar as its life is concerned, is somewhat comparable to organization costs, the corporate franchise, good will, and other nonwasting items which continue through the life of the enterprise. There was no termination or end thereof in any of the years before us. See and compare X-Pando Corporation, supra, and other cases there cited.

1941 Expenditures Deducted on 1942 Return as Repairs.

The petitioner has submitted no evidence and has made no argument with reference to the items of office supplies, machinery, 1954 U.S. Tax Ct. LEXIS 295">*346 repairs, and supplies, and it will be assumed that it has abandoned its claim of error on the part of the respondent with respect thereto.

The $ 516.17 labeled "legal expenses" is made up of two items, a fee of $ 166.17 paid to Partlow, a practicing attorney, and $ 350 paid to Hammond, Buschmann, Roll and Alexander. There is every indication that these expenditures were made generally for the same purpose as those heretofore covered in the discussion under the heading of "Deferred Development and Pre-Operating Expense," and there is no proof that they were not. For the reason heretofore stated, it is concluded and held that the respondent did not err in disallowing the deduction of that item for petitioner's fiscal year 1942.

The $ 700 item labeled "Costs of expired option" is made up of $ 200 paid out in 1941 in acquiring the option to purchase the property in 21 T.C. 696">*718 Greensburg, Indiana, which option was abandoned in the same year, and $ 500 paid in acquiring a lease on the Solotkin property, with an option to purchase, which property was adjacent to the property on which petitioner's main plant was located in Indianapolis. Just why $ 200 of the $ 500 expended in 1941 for the1954 U.S. Tax Ct. LEXIS 295">*347 option to purchase the Greensburg property was entered on petitioner's books as repairs and deducted as such on its return for its fiscal year 1942, while the remaining $ 300 was deducted on the return for the fiscal year 1941 in the category "Other Deductions" and described as "Building Option Loss (Greensburg)," does not appear. Regardless of such varied treatment, however, we think it apparent that the $ 200 to be dealt with here was not deductible for 1942 as repairs or under any other classification. The Greensburg option was abandoned in petitioner's fiscal year 1941 and was a closed transaction in that year, leaving nothing to be carried over to 1942.

The petitioner admits that its claim of deduction under Repairs of the $ 500 paid in acquiring the lease and option on the Solotkin property in 1941 was in error. In its petition, however, it alleged that the deduction is now claimed to cover $ 500 actually expended in petitioner's fiscal year 1942, the reasons back of the claim being that petitioner had leased a portion of the Solotkin property to an outside party, on the theory that it would not be needed in connection with its dried egg operations, but that in the fiscal1954 U.S. Tax Ct. LEXIS 295">*348 year 1942 the property so sublet was needed and the $ 500 now claimed was expended in buying back the lease. The respondent did not err in disallowing the amount nor in refusing in this proceeding to agree to the allowance of the amount now claimed. The item so expended, if deductible, should be spread over the life of the lease on the property. The petitioner has made no claim for such an allowance and has submitted no proof thereon.

Compensation of J. W. Nunamaker, Sr.

After careful consideration of the evidence of record as to the services rendered to petitioner by J. W. Nunamaker, Sr., during the fiscal years 1942 and 1943 and with respect to the use of equipment owned by him, it is our conclusion, and we have found as a fact that compensation of $ 12,000 for the fiscal year 1942 and $ 6,500 for the fiscal year 1943 was reasonable.

Without argument or citation of authorities, the respondent, on brief, states a further objection to the allowance of the deductions claimed to the extent of $ 2,900 for the fiscal year 1942 and $ 6,400 for the fiscal year 1943, which is, that the deduction of the salaries to the extent disallowed is barred by section 24 (c) of the Internal Revenue1954 U.S. Tax Ct. LEXIS 295">*349 21 T.C. 696">*719 Code, ⁵ in that they were not paid within the taxable years, or within 2 1/2 months thereafter, as required by that section.

1954 U.S. Tax Ct. LEXIS 295">*350 The facts show that within the period prescribed in section 24 (c) (3), the petitioner, for each of the years in question, issued its negotiable promissory notes for the balances due J. W. Nunamaker, Sr. The respondent makes no claim that the petitioner was not solvent at all times, or that it did not have sufficient cash on hand to pay the notes, and while his brief was filed as an answering brief and the petitioner had cited and relied upon Musselman Hub-Brake Co. v. Commissioner, 139 F.2d 65; Anthony P. Miller, Inc. v. Commissioner, 164 F.2d 268; and Akron Welding & Spring Co., 10 T.C. 715, no effort was made to show wherein the decisions in the cases mentioned are not controlling. We think that they are. It is true that in those cases the notes were demand notes, whereas in the instant case the due date of each note was more than 2 1/2 months after the close of the taxable year, but the decisions were not made to rest on that fact. The controlling consideration was that they were given in payment of the compensation obligation and accepted as such. Here, the notes were 1954 U.S. Tax Ct. LEXIS 295">*351 negotiable and, as in the cases cited and relied on by petitioner, they were given and accepted as payment of the remainder of the compensation due and owing. See and compare Heatbath Corporation, 14 T.C. 332, where the facts show that the notes did not become demand notes until 90 days after issue, which, as to 2 notes, was more than 2 1/2 months after the close of the taxable year, and it was held that the above cases were controlling, and that section 24 (c) did not apply. Our conclusion is the same in the instant case.

Depreciation.

The petitioner contends that it is entitled to depreciation allowances for each of the years 1942 through 1945 in excess of those determined by respondent. In support of the contention, the petitioner urges that certain assets in each of the property classifications here involved had expected useful lives that were shorter than the composite life determined by the respondent for their respective classifications and 21 T.C. 696">*720 that as to them depreciation should be allowed on the basis of their respective expected lives. The respondent takes the position that the petitioner has failed to show that the composite 1954 U.S. Tax Ct. LEXIS 295">*352 lives determined by him for the various property classifications were erroneous, or that it was otherwise entitled to any greater allowances for depreciation than he has allowed.

So far as appears, the respondent has classified the petitioner's property into the same classifications employed by petitioner in computing and deducting depreciation on its returns. The only apparent difference between the method employed by the petitioner and that used by the respondent is that the respondent has used longer composite lives with respect to the various classifications. The burden is upon the petitioner to show error in the respondent's action and it can discharge that burden only by showing that the composite lives, as determined by respondent, for the assets included in the respective classifications were erroneous. The burden is not discharged by merely showing that certain assets had shorter lives than determined by respondent for the classification in which they were included. Southern California Freight Lines, Ltd., 36 B. T. A. 328, affd., 99 F.2d 104, certiorari denied, 306 U.S. 632">306 U.S. 632; Union Co., 14 B. T. A. 1310.1954 U.S. Tax Ct. LEXIS 295">*353

In connection with this issue, the petitioner put into the record an exhibit, exhibit 42, purporting to show the various assets in each classification, the date of their acquisition, their cost, the estimated life the petitioner claims herein for them and the life determined by respondent, the amount of depreciation allowable on the petitioner's claimed life, and the amount allowed by respondent for each of the petitioner's taxable years 1942 through 1945. The respondent conceded that the exhibit correctly showed the assets on which he had allowed depreciation, their cost, their estimated life as determined by him, and the amounts of depreciation he had allowed with respect to them in the various taxable years involved. Beyond the foregoing, the respondent made no concession as to the correctness of the matters contained in the exhibit.

Listed in the above mentioned exhibit, under the classification of buildings, are the items "Protective Fence," "Improvements to Solotkin Building," and "Improvements to Lumbermen's Building." On brief, the petitioner contends that the useful lives of these assets were 3 1/2, 19 1/2, and 19 years, respectively, instead of a composite life of 20 years1954 U.S. Tax Ct. LEXIS 295">*354 allowed by respondent with respect to these and all other assets included in the classification of buildings. The record contains no evidence as to the nature or character of these items or their useful life, nor as to the composite life of the property in the buildings classification. Under these circumstances, we are unable to find that the 21 T.C. 696">*721 respondent erred in determining a composite life of 20 years for petitioner's properties included in the buildings classification.

In the petitioner's Exhibit 42, part of the items listed under the classification of furniture and fixtures are listed as new when acquired by petitioner and the remainder are listed as used when it acquired them. With the exception of 2 desks, which are assigned lives of 20 years in the exhibit, the petitioner assigns estimated lives ranging from 3 years to 15 years to all items in the furniture and fixtures classification.

On brief, the petitioner contends that no proof should be required to show that used equipment would have a shorter life than new equipment. Relying on certain average useful lives shown in respondent's Bulletin F for items of mechanical office equipment, the petitioner contends 1954 U.S. Tax Ct. LEXIS 295">*355 that the estimated life assigned in its exhibit to the various items in the furniture and fixtures classification is more nearly correct than the composite life of 15 years determined by respondent for the classification.

To the extent the respondent's determination here is at variance with what is contained in his Bulletin F, it must be concluded that he determined that what is contained there is inapplicable here. As to petitioner's contention respecting the comparative lives of used and new equipment, it is to be observed that the petitioner has submitted no evidence to show that the items listed in its exhibit as used properties at the time of acquisition by it were in fact used properties. Furthermore, if they had been such at the time acquired, that fact alone, and without a showing as to the extent of their use, would not be conclusive that for all practicable purposes their useful life was substantially shorter than new property of like kind.

Since the petitioner not only has not submitted any evidence from which the useful life of any item of property contained in its furniture and fixtures classification might be determined, but also has not submitted any evidence as to1954 U.S. Tax Ct. LEXIS 295">*356 the composite useful life of the property in that classification, we sustain the respondent's determination of a composite life of 15 years for the property contained in that classification.

Constituting a part of the petitioner's machinery and equipment were certain dryer equipment and supplementary equipment to dryer. These items were used for drying purposes in the manufacture of the petitioner's dried egg product and comprised component parts of the machinery used for that purpose. In its Exhibit 42 the petitioner assigns to the various items of the dryer equipment and that supplementary thereto lives ranging from 1 1/12 to 3 7/12 years and proposes exhaustion allowances over the taxable years 1942 through 1945 sufficient to completely exhaust the cost of the equipment during 1945. 21 T.C. 696">*722 The petitioner urges that the lives so assigned are proper because of the absolescence sustained over the years in addition to the normal physical exhaustion of the equipment.

In support of its position as to obsolescence, the petitioner contends that after the wartime demand for its product ceased, the equipment lost its economic value and usefulness, that this occurred not later than 1954 U.S. Tax Ct. LEXIS 295">*357 June 30, 1945, and that thereafter the equipment was worthless and without salvage value and accordingly it should not be determined to have had any life beyond June 30, 1945, for purposes of depreciation.

The evidence does not show that the equipment in question was obsolete and worthless after June 30, 1945, as petitioner contends. The substantial production of its plant in 1946 and 1947 indicated by the sales made in those years to the Commodity Credit Corporation shows that the equipment was usable and was used for the purpose for which acquired. According to the petitioner's exhibit, the equipment was acquired over the years 1941 through 1944, and, so far as shown, was of the latest design when acquired. This equipment, along with the remainder of the machinery and equipment in the petitioner's egg drying plant, has been continued in place and in operating condition and had been operated as and when the petitioner was again producing dried eggs.

In general, obsolescence is a process whereby property, as a result of external causes as distinguished from deterioration in its physical condition, becomes obsolete by losing its economic usefulness for the purpose for which it was1954 U.S. Tax Ct. LEXIS 295">*358 acquired, and by being useless for any other purpose. In Real Estate-Land Title & Trust Co. v. United States, 309 U.S. 13">309 U.S. 13, the Supreme Court enumerated some of the external causes resulting in obsolescence as being changes in the art, loss of trade, inadequacy, supersession, and prohibitory laws. The Court further said, "But in general, obsolescence under the Act connotes functional depreciation, as it does in accounting and engineering terminology. More than non-use or disuse is necessary to establish it."

Examining the petitioner's position in the light of the facts and of the foregoing, it is clear that the equipment was not obsolete and worthless after June 30, 1945. While the petitioner lost trade by reason of the termination of the wartime demand for its product, it sold substantial amounts of its production in 1946 and 1947 to the Commodity Credit Corporation. Worthless equipment could not have produced such substantial quantities of the petitioner's product. There is nothing of record to indicate that during the period over which the petitioner claims obsolescence, or since, there has been any change in the art of manufacturing the 1954 U.S. Tax Ct. LEXIS 295">*359 petitioner's product or any development which rendered the petitioner's equipment outmoded for the purpose for which it was acquired. The most that has been shown is that since 21 T.C. 696">*723 1945 the equipment has not been used to an extent comparable to that in 1945 and earlier years. However, the equipment has been retained in place, ready for use, if there should be a demand for its use. Neither petitioner nor its officers appear at any time to have contemplated its abandonment prior to the expiration of its normal life. As said by the Supreme Court, more than nonuse or disuse is necessary to establish obsolescence.

A proper basis for an allowance for obsolescence has not been shown, and petitioner's claim therefor is denied.

In its Exhibit 42, the petitioner showed 3 Mobilifts acquired in 1942 and 1 in 1943, and assigned a life of 4 years to them. It showed the Frick Air Cooling Unit as acquired in 1943 and the Frick Cooling Unit as acquired in 1944, and assigned a life of 10 years to them. We have found that the Mobilifts had a life of not less than 10 years, that the fans of the cooling units had a life of 10 years and the coils 15 years. The depreciation deductions claimed1954 U.S. Tax Ct. LEXIS 295">*360 by petitioner on its returns were based, not on the individual lives of the various items of machinery and equipment, but on the composite life of the group, and the respondent used the same method in his determination of the deficiencies herein. In the absence, therefore, of a showing that the life of the remainder of the property contained in the classification as well as the life of the above items was such as to bring the composite life of the whole group below 15 years, the determination of the respondent is sustained.

In addition to its claim for added allowances for depreciation for 1943, 1944, and 1945, the petitioner contends that it is entitled to deductions for losses of $ 864.26 and $ 573.53, on account of property discarded, junked, or stolen in those years. The parties have stipulated that the respondent disallowed the "charge-off of remaining book values of certain items of machinery and equipment which were junked or discarded." They did not stipulate nor has petitioner submitted any proof as to the amounts thereof or the years involved. Presumably there was no dispute as to the amounts and years affected and it was understood that proper effect would be given thereto1954 U.S. Tax Ct. LEXIS 295">*361 in computations under Rule 50. Otherwise there would have been no point to the stipulation.

Payments for Engineering Services.

The petitioner contends that the respondent erred in disallowing the deduction of $ 3,000 paid to Boles for preparing the plan and specifications for the rotary table. The respondent contends that the petitioner has failed to show that there was an abandonment of the plan and specifications by petitioner or of the petitioner's plan to build the table in either 1944 or 1945.

21 T.C. 696">*724 Ordinarily, for there to be an abandonment, there must be an intention to abandon, evidenced by some act. Such intention and act are to be ascertained from the facts and surrounding circumstances. Nonuser alone is not sufficient. Minneapolis, St. Paul & Sault Ste. Marie Railway Co., 34 B. T. A. 177, and W. B. Davis & Son, Inc., 5 T.C. 1195. It has been held, however, that an act of abandonment alone is sufficient. Mine Hill & Schuylkill Haven Railroad Co. v. Smith, 184 F.2d 422. While the evidence shows that the table was not built in 1944, because the required materials1954 U.S. Tax Ct. LEXIS 295">*362 were not obtainable then, there is nothing in the record to indicate that in that year or any subsequent year the petitioner or its officers decided to drop the plan to build the table and determined that it would never be built. In Murphy Transfer & Storage Co., 7 B. T. A. 1148, cited and relied on by petitioner, it was shown that the building plans there involved were discarded in the year in which abandonment was claimed. Such a showing is not made here. Apparently the petitioner has continued to preserve intact the plan and specifications involved here. It introduced in evidence an exhibit which was identified as the plan for the table prepared by Boles. So far as appears, the only reason the petitioner has not built the table is that the demand for dried eggs has not been great enough to warrant its construction. From the facts presented, we are unable to find that at any time there has been an abandonment by petitioner of the table plans. The most that appears is a nonuser of the plan and specifications prepared by Boles. That is not enough to sustain the allowance of the deduction sought by petitioner. In Continental Trust Co., 7 B. T. A. 539,1954 U.S. Tax Ct. LEXIS 295">*363 also cited and relied on by petitioner, abandonment of the plans in the year the deduction was claimed was established.

The petitioner concedes the correctness of the respondent's determination that the $ 2,000 paid Boles for preparing plans and specifications for the dried egg conveyor should be capitalized, but contends that the respondent should have made allowance for the exhaustion thereof on the basis proposed in its Exhibit 42, considered under Issue (4), supra. Since the conveyor is included in Exhibit 42 as supplementary equipment to dryer, which was part of the machinery and equipment classification of petitioner's properties, and since by our holding under Issue (4) we have disposed of the question here raised by petitioner, no further consideration is required as to exhaustion allowances to be made with respect to the conveyor.

Payment to James J. Motycke.

We are not in doubt as to the facts relating to this issue, nor as to the over-all result. Motycke disposed of or sold his stock in petitioner and J. W. Nunamaker, Jr., acquired it. The fact that J. W. Nunamaker, Jr., and Motycke agreed in the course of settlement of their 21 T.C. 696">*725 disputes and lawsuits that1954 U.S. Tax Ct. LEXIS 295">*364 $ 35,000 of the consideration flowing to Motycke for the stock should be paid for Nunamaker by petitioner, does not make it otherwise. Neither is its character or substance changed by the wording or formalities of the documents used in the settlement. The payment by petitioner to Motycke was not an ordinary and necessary expense incurred by it in the operation of its business. The respondent's disallowance of the deduction claimed is accordingly sustained.

Disallowances by Commodity Credit Corporation.

The issue here is whether the petitioner's income for the taxable years 1944 and 1945 is, under the provisions of section 3806 (a) (2) of the Internal Revenue Code, ⁶ to be reduced by the amounts of $ 64,004.94 and $ 394.40, respectively, as representing the amounts for which petitioner had been reimbursed under contracts with the Commodity Credit Corporation on a cost-plus-a-fixed-fee basis, but which were subsequently disallowed by that Corporation and applied by it as offsets against amounts due the petitioner under other contracts. In support of its position that it is entitled to such reductions, the petitioner relies on our holding in Cramp Shipbuilding Co., 17 T.C. 516,1954 U.S. Tax Ct. LEXIS 295">*365 affirmed sub nom. Harriman Ripley & Co., Successor, 202 F.2d 280. While conceding that the amounts in question were withheld by the Commodity Credit Corporation, the respondent contends that there has been no disallowance of any amounts by the Corporation, nor any offset or repayment within the meaning of section 3806. He urges that the amounts withheld were held by the Corporation merely as security for the payment of sums claimed by it to be due from the petitioner, but that the petitioner is contesting the correctness of that claim by suit against the Corporation.

1954 U.S. Tax Ct. LEXIS 295">*366 In Cramp Shipbuilding Co., supra, we considered at length the provisions of section 3806 (a) (2), and their legislative history. We concluded that with respect to cases coming within those provisions, Congress intended that repayments by contractors under cost-plus-a-fixed-fee contracts are to be related back to the year in 21 T.C. 696">*726 which reimbursable cost items became reportable as income, and that to that extent Congress had changed the general rule of requiring taxpayers to account for each year's operations on the basis of facts known or ascertainable at the end of the year, regardless of what occurred in subsequent years. We further concluded that Congress did not intend by section 3806 (a) (2) to keep a prior year open for eventual reimbursement to a contractor of items previously disallowed and repaid by him. In accordance with those conclusions, we held that where the Navy Department had recouped reimbursable sums from the taxpayer, effect was to be given the provisions of section 3806 (a) (2), even though the taxpayer had instituted suit in the Court of Claims for their recovery.

In the instant case, certain of the petitioner's reimbursable1954 U.S. Tax Ct. LEXIS 295">*367 costs for 1944 and 1945 were disallowed. With respect to the disallowances relating to contract FSC (F) 34483, the Commodity Credit Corporation, under its contract with petitioner of February 15, 1946, was authorized to make withholdings from payments due petitioner on deliveries in 1946 and 1947 by petitioner under new contracts, until an amount was withheld which, when added to the amount of the petitioner's performance bond of $ 25,000, would constitute 100 per cent security for the amount alleged to be due from the petitioner by reason of disallowances relating to contract FSC (F) 34483. The contract of February 15, 1946, provided that the Corporation would pay to the petitioner the amount so withheld and release petitioner's performance bond, if the Department of Justice was not requested within a year from February 15, 1946, to institute suit against the petitioner in the controversy. So far as appears, the only agreement between the petitioner and the Corporation with respect to withholding involved only disallowances relating to contract FSC (F) 34483. However, the Corporation appears to have made withholding not only with respect to disallowances relating to that contract, 1954 U.S. Tax Ct. LEXIS 295">*368 but to two others made in 1944, and one made in 1945. Whether, or to what extent, this was done under other agreements between the petitioner and the Corporation is not clear from the record. Since the record does not show whether the Department of Justice was or was not requested to bring suit against the petitioner within the year prescribed, or during any other period, the reason why the Corporation did not, pursuant to the contract of February 15, 1946, return the withholdings made as to disallowances relating to contract FSC (F) 34483, is not clear. On the state of the record, it is not clear whether the amounts in controversy here were held by the Corporation as security for the repayment by the petitioner of the items disallowed with respect to the contracts made in 1944 and 1945.

21 T.C. 696">*727 Whatever may have been the purpose of the Commodity Credit Corporation in making the withholdings, we think it is clear that they were accomplished by reason of the disallowed items having been, by the Corporation, "applied as an offset against other amounts due the taxpayer." We do not see anything in the provisions of section 3806 (a) (2) to indicate that the circumstances under which1954 U.S. Tax Ct. LEXIS 295">*369 such offsets are made, whether by agreement of the parties or unilaterally by a Government agency, and over the objection of the contractor, affect the application of the provisions. They appear to be equally applicable in either instance. From the facts before us, we think the offsets made by the Corporation fall within the intendment of the section, and we so hold.

National Builders, Inc., 12 T.C. 852, relied on by the respondent, is without application here. That case, as was pointed out in Cramp Shipbuilding Co., supra, involved a question of renegotiation under section 3806 (a) (1) of the Code.

Decision will be entered under Rule 50.