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The agreement indicated that the specific patents covered were
contained in Exhibit A. Exhibit A, however, was not created until
1996, and was first provided to respondent during March 1996.
The first amendment to the agreement, effective June 1, 1989,
reduced the royalty rate to 12 � percent and obligated Powertex to
assume full financial responsibility for the costs of defending and
litigating patent infringement claims. The second amendment to the
agreement required the Podds to disclose improvements or further
inventions embodying the ideas covered by the licensed property to
Powertex, and if the improvements were dominated by the licensed
patents, the Podds would disclose to Powertex the method of making
and using the improvements and allow it to make, use, and sell
products containing such improvements royalty free. The amendment
also allowed the Podds to apply for patents concerning the
improvements in other countries at Powertex's expense and
discretion.
II. Issue 1: Whether Powertex Is Entitled To Deduct Royalty
Payments, or Whether an Adjustment Under Section 162 or Section
482 Is Warranted
FINDINGS OF FACT
1. Respondent's Notices of Deficiency
In the notices of deficiency, respondent disallowed deductions
claimed by Powertex for royalty expenses on its Federal income tax
returns for the years ending May 31, 1989, and May 31, 1990, in the
amounts of $686,034 and $531,082, respectively. Respondent
determined that such amounts were not ordinary and necessary
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