The opinion
Western Precipitation Corporation, Petitioner, v. Charles B. Henderson, Henry A. Mulligan, Howard J. Klossner, Sam H. Husbands, Charles T. Fisher, Jr., Constituting the Board of Directors of the Reconstruction Finance Corporation, Respondents
Western Precipitation Corp. v. Henderson
Docket No. 192-R.
United States Tax Court
9 T.C. 877 ; 1947 U.S. Tax Ct. LEXIS 40 ;
October 31, 1947 , Promulgated
*40 Since the petitioner has failed to carry its burden of establishing error in the determined amount of its excessive profits for 1942, and respondents have likewise failed to carry their burden of establishing the factual basis upon which they rely for an increase therein, the amount of such excessive profits is found as so determined. Nathan Cohen , 7 T.C. 1002 ; Aircraft Screw Products Co ., 8 T.C. 1037 .
George Bouchard, Esq ., for the petitioner.
Julian R. Wilheim, Esq ., for the respondents.
Leech, Judge .
LEECH
*877 The petitioner asks redetermination of its excessive profits, if any, derived during its fiscal year ended December 31, 1942, from contracts subject to renegotiation under the Renegotiation Act of 1942 as amended, the Reconstruction Finance Corporation Price Adjustment Board having determined under that act that such profits were excessive in the amount of $ 10,000. Petitioner contends that it had no excessive profits. Respondents, by amended answer, ask that we find excessive profits in the increased amount of $ 15,000.
FINDINGS OF FACT.
The petitioner was organized under the laws of California *41 in November 1936 and began business December 1, 1936. It is the successor of a corporation known as Western Precipitation Co., which was organized *878 in 1908. Its office and principal place of business are in Los Angeles, California.
Petitioner's business is that of engineering and building industrial equipment, primarily Cottrell electrostatic precipitators, mechanical dust collecting equipment, and spray drying equipment. It designs equipment for a specified purpose in a customer's plant, selecting the type of equipment to be used and specifying the size equipment to accomplish the desired result. Petitioner then secures the fabrication of such equipment. Some of this fabrication is done in petitioner's own shop, but more than 50 per cent is done for petitioner by other firms according to its specifications. In some instances petitioner merely delivers the equipment to its customer. In other instances it erects and installs the equipment in its customer's plant and puts it into operation. On some occasions when petitioner does not install equipment for a customer it furnishes engineering services to supervise the installation and to conduct and/or supervise its placing *42 in operation. Petitioner's customers are primarily industries producing essential materials or industrial materials such as steel, cement, and chemical plants and various metallurgical industries.
During its fiscal year ended December 31, 1942, petitioner had overall sales, including both renegotiable and nonrenegotiable sales, in the total amount of $ 1,628,234; costs attributable thereto in the sum of $ 1,531,675; and profits derived therefrom in the total amount of $ 96,559. During its fiscal year ended December 31, 1942, petitioner had renegotiable sales within the meaning of the Renegotiation Act of 1942 as amended, in the total amount of $ 533,631; costs attributable thereto in the sum of not more than $ 493,172; and profits derived therefrom of not less than the amount of $ 40,459, and petitioner's renegotiable profit therefrom was not less than 7.58 per cent of renegotiable sales before renegotiation.
During its fiscal year ended December 31, 1942, petitioner had nonrenegotiable sales in the total amount of $ 1,070,990; costs attributable thereto of not less than $ 1,014,890; and profits derived therefrom in the amount of not more than $ 56,100, and its profit on such nonrenegotiable *43 business for that fiscal year was not more than 5.24 per cent of its total nonrenegotiable sales for that year.
For each of its fiscal years ended December 31, 1937, to and including December 31, 1945, petitioner had the following total gross sales and total net profits: Year Sales Profits
1937 $ 662,082 $ 46,061
1938 523,200 8,825
1939 674,608 64,778
1940 933,959 37,597
1941 1,110,403 20,554
1942 $ 1,628,234 $ 96,559
1943 1,632,228 59,509
1944 1,905,561 61,695
1945 1,638,886 63,102
*879 The percentage of net profit to gross sales which petitioner realized in each of its fiscal years ended December 31, 1937, to and including December 31, 1945, is as follows: 1937 6.96%
1938 1.69%
1939 9.60%
1940 4.02%
1941 1.85%
1942 5.93%
1943 3.64%
1944 3.23%
1945 3.85%
Petitioner's net worth for each of its fiscal years ended December 31, 1937, to and including December 31, 1942, as of January 1 of each year, was as follows: 1937 $ 196,939
1938 225,331
1939 227,448
1940 $ 279,327
1941 294,425
1942 309,902
Petitioner's net worth as of December 31, 1942, was $ 330,924.
During its fiscal years ended December 31, 1937, to and including *44 December 31, 1945, petitioner paid the following annual salaries to its three officers, namely, president, vice president and secretary-treasurer, as follows: Vice
Year President president Secretary-treasurer
1937 $ 12,330 $ 4,212 $ 5,136
1938 16,500 4,200 5,400
1939 18,825 4,992 6,247
1940 18,000 4,200 5,400
1941 18,000 4,200 5,975
1942 19,800 4,620 6,600
1943 19,800 4,620 6,600
1944 19,800 4,620 6,600
1945 19,900 4,720 6,690
By a resolution dated December 16, 1942, petitioner's board of directors authorized and directed petitioner to pay a bonus, for petitioner's fiscal year ended December 31, 1942, to the following officers and directors in the following amounts: President and member of board of directors $ 10,000
Vice president and member of board of directors 2,500
Secretary-treasurer and member of board of directors 2,500
Engineer and member of board of directors 2,500
Bonuses in the identical respective amounts were authorized and directed by petitioner's board of directors to be paid to each of the above mentioned officers and members of the board of directors for each of petitioner's fiscal years ended December 31, *45 1940, to and including December 31, 1945. There is included in the renegotiable costs of not more than $ 493,172, $ 5,735 which is the maximum amount, if any, of the above mentioned bonuses for petitioner's fiscal year ended December 31, 1942, allocable to petitioner's renegotiable business for that fiscal year. It is stipulated that if the Court should find *880 that all, or any part, of the above mentioned bonuses for petitioner's fiscal year ended December 31, 1942, are not allocable to petitioner's renegotiable business for said fiscal year, then the renegotiable profits of not less than $ 40,459 shall be increased by such amount of those bonuses as the Court finds is not allocable to petitioner's renegotiable business for that fiscal year, not exceeding, in any event, the total amount of $ 5,735.
During the year 1942 petitioner's president, vice president, and secretary-treasurer held, respectively, 52, 6, and 5 per cent of its outstanding stock. These officers were also members of its board of directors. Petitioner's president, Walter A. Schmidt, is a chemical engineer by profession and a graduate of the University of California. He has been the president of the petitioner *46 and its predecessor company since 1909. Petitioner's vice president, Alfred W. Knight, is a chemical engineer and a graduate of the California Institute of Technology. He is also a patent attorney and has been with petitioner and its predecessor since 1924.
During the year 1942 petitioner's employees numbered approximately 125, of which about 50 were engineers. Its business is highly technical. It has a number of competitors who manufacture and sell other types of apparatus constructed for the same use and purpose as that of the petitioner.
Petitioner's work during the war years, including 1942, was of the same character as in prior years. It did not increase its facilities during the war period. It was organized for a peacetime business and required no change to continue production under wartime conditions. It used only private capital during the year 1942. Its products sold in its 1942 renegotiable sales and nonrenegotiable sales were substantially identical. Petitioner in 1942 carried no regular inventories of its products and had no inventory risks. During that year its risks in labor and/or price fluctuations were little. During that period its regular business risks *47 did not differ from its prewar normal business risks and such risks did not differ as between its renegotiable and nonrenegotiable sales. Petitioner faced no reconversion problem at the end of the war.
Petitioner during the fiscal year ended December 31, 1942, realized excessive profits upon its renegotiable sales in the amount of $ 10,000.
OPINION.
The burden is upon petitioner to establish that the profits it realized in 1942 upon its renegotiable sales were not excessive, or excessive in an amount less than $ 10,000. Nathan Cohen , 7 T.C. 1002 ; Aircraft Screw Products Co ., 8 T.C. 1037 . Upon careful consideration of the evidence, it is our conclusion that it has failed to carry that burden.
*881 The record shows clearly to our satisfaction that petitioner's risks from its war business were no more than those it faced in normal prewar times, and that its risks with respect to its renegotiable business were no greater than those faced with respect to its regular nonrenegotiable business. Notwithstanding these facts as stipulated, we have found that petitioner's profits upon its nonrenegotiable sales were not more *48 than 5.24 per cent of such sales, whereas its profits upon its renegotiable sales were not less than 7.58 per cent of such sales. Petitioner has given no satisfactory explanation as to why its prices quoted to the Government or to Government contractors were such that it derived a considerably higher profit than that realized by it from sales it made to other customers of products substantially identical in character and produced at similar costs and under similar risks. Its first attempted explanation of this difference was that the renegotiable sales were mainly of small jobs upon which the prices quoted are higher. However, the record does not support this explanation. Petitioner's vice president admitted upon cross-examination that one of the probable causes for a higher profit on renegotiable sales was that, in the case of these sales, there was an excessive estimate of the cost which was anticipated.
Respondents ask, however, that petitioner's profits be redetermined to be excessive to the extent of $ 15,000. This $ 5,000 increase is based upon the allegation in the answer, and denied in the reply, that a bonus of $ 17,500 paid by petitioner at the close of 1942 to its *49 three executive officers and its engineer did not represent reasonable compensation for services rendered by the recipients, but was in the nature of a dividend distribution to them as stockholders.
Of the total bonus of $ 17,500 paid, $ 5,735 was allocated to petitioner's renegotiable business and was accepted and allowed by respondents as an expense of that business in computing the net profit upon which an excessive profit of $ 10,000 was determined.
The burden is accordingly upon the respondents to establish that these bonuses were in fact distributions of earnings or unreasonable compensation for services. Nathan Cohen, supra ; Aircraft Screw Products Co., supra . We think they have failed to carry this burden.
There is no proof in the record even tending to show that the bonuses in question do not represent reasonable compensation. The only evidence is to the contrary. All the recipients of the bonuses are men of high technical knowledge and experience and are directing the activities of a very successful business. The amounts of the bonuses were not in proportion to the stockholdings of the recipients. The payment *50 of these bonuses was not unusual in the history of the company. They were paid under a fixed policy of the company. Bonuses in these identical amounts were paid to these same individuals *882 in each of the six years from 1940 to 1945, inclusive. Moreover, the Government, through the Commissioner of Internal Revenue, in computing net income of petitioner for 1942 for income tax purposes, allowed the deduction of the payments in that year to these officers, including the bonuses, as ordinary and necessary business expenses.
It is accordingly our conclusion that the bonuses in question represent reasonable compensation. Of the total of $ 17,500, the sum of $ 5,735 allocated to petitioner's renegotiable business represents an allowable expense subject to deduction in computing the net profits subject to renegotiation.
Thus, respondents have failed to carry their burden in establishing the basis of fact upon which they rely for the increase of $ 5,000 in the disputed excessive profits. The increase is, therefore, denied.
An order will issue in accordance herewith .