Dyer Engineers, Inc. v. Commissioner

Dyer Engineers, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent Dyer Engineers, Inc. v. Commissioner Docket No. 10385 United States Tax Court 10 T.C. 1265; 1948 U.S. Tax Ct. LEXIS 141; June 29, 1948, Promulgated *141 Decision will be entered under Rule 50. 1. Petitioner is engaged in the business of installing an incentive wage system in manufacturing plants. Due to the antagonism and hostility of labor toward the plan during the base period, petitioner's average base period net income did not reflect adequately its normal earnings and resulted in an excessive and discriminatory excess profits tax based upon a comparison of its normal earnings with its earnings during the excess profits tax period. Petitioner is entitled to relief under the provisions of subsections (b) (1) and (2) of section 722, I. R. C., as amended. 2. Upon the evidence, determination made of an amount representing normal earnings to be used as constructive average base period net income in computing excess profits tax for the years 1941 and 1942. Edwin W. Brouse, Esq., for the petitioner. Lawrence R. Bloomenthal, Esq., for the respondent. Van Fossan, Judge. VAN FOSSAN *1265 The respondent determined a deficiency of $ 2,599.79 in the petitioner's income tax for the year 1941 and deficiencies of $ 290.25 and $ 6,816.73 in its excess profits tax for the years 1941 and 1942, respectively. The single issue is whether or not the petitioner is entitled to relief from excess profits tax for the taxable years, under the provisions of section 722 of the Internal Revenue Code. FINDINGS OF FACT. The petitioner is a corporation, organized under the laws of Ohio, and has its principal office in Cleveland, Ohio. It filed its income tax and excess profits tax returns for the taxable years with the collector of internal revenue for the eighteenth district of Ohio. *143 The petitioner is engaged in the business of industrial engineering. It specializes in the installation of incentive wage systems and pay roll and manufacturing controls in manufacturing plants. C. D. Dyer, Jr., a graduate engineer, is the president of the petitioner and has been such officer since January 1, 1906. The petitioner employed 11 or more engineers and various persons and office assistants. The number of such employees in 1932 was 24. In its capacity as expert investment engineer, the petitioner surveys the plant of its customer or "client" and determines the proper amount of production representing a standard hour's performance by labor. The wage corresponding to such standard performance is paid to labor whether or not such a standard or unit so fixed is accomplished by the *1266 laborer. When a laborer produces work in excess of the standard or unit he is paid a proportionate share of the basic rate. For example, if the basic rate is $ 1 per hour for 100 units of production and the worker produces 150 units in an hour, he is paid $ 1.50 per hour. If he produces less than 100 units he is still paid $ 1 per hour. The system is most favorable to labor because*144 of the guaranteed day rate. The standard unit is established by the petitioner after a careful survey of the plant, a reasonable determination of the average worker's rate and speed, and a consultation with the workers themselves, giving them a full explanation of the system. The base rates are practically the same for any given class of work. During the period from 1926 to 1933, incentive systems were installed by the petitioner in the metalwork, rubber, steel, and paper industries, with the unqualified cooperation of labor and management. The petitioner installed its system in the plants of the Otis Elevator Co., Cincinnati Milling Co., Worthington Pump Co., S. S. White Dental Manufacturing Co., Phillip Carey Co., Procter & Gamble Co., Morrison Steel Products Co., Hewitt Rubber Co., De Laval Separator Co., Goodyear Tire & Rubber Co., Hammermill Paper Co., Vick Chemical Co., and many other similar manufacturers. To gain the best results from the installation of incentive systems devised by Dyer Engineers, Inc., it is essential that there be cooperation of management and labor. Prior to 1935 there were no large scale unions in the mass production industries such as metalworking, *145 rubber, steel, and paper. Craft unions affiliated with the American Federation of Labor represented workers in a few of the plants in which Dyer systems were installed prior to 1933. Prior to 1933 Dyer Engineers, Inc., had unqualified cooperation of management and labor in introducing the system, and it enjoyed profitable operation. With the advent of the National Industrial Recovery Act of 1933, which legalized the selection by employees of bargaining agents of their own choice, the unionization of workers in mass industry began. The National Industrial Recovery Act was declared unconstitutional by the Supreme Court in 1935, but the section dealing with the right to engage in collective bargaining was not affected. By the Act of July 5, 1935, generally known as the Wagner Act (ch. 372, 49 Stat. 449; ch. 7, Title 29 U.S.C.A.) Congress set up a system of national labor relations which provided, among other things, that employees would have the right to self-organize, to form, join, or assist labor organizations; to bargain collectively through representatives of their own choosing; and to engage in concerted activities for the purpose of collective bargaining or other mutual aid*146 or protection. When the National Industrial Recovery Act was passed, labor was not qualified to take advantage of its provisions. Theretofore the *1267 labor unions had very little or no experience in organizing mass industry. Resistance to their accomplishing such organization sprang up among the operating executives of industry, who did not want labor unions in their plants and who believed that their prerogatives were being usurped by the unions. Labor had few trained organizers with the proper temperament and capacity to deal in collective bargaining. The unions' agents effected their organization in a roughshod way so that they antagonized the operating executives. During the period from 1933 to 1939, inclusive, the United Automobile Workers and the United Electrical Workers, both affiliated with CIO, were opposed to the installation of incentive systems, and the United Automobile Workers Union is still opposed to it. During that period the labor leaders were concerned with securing a maximum number of members and were not interested in developing and training men to cooperate with management in adopting or continuing wage incentive systems. The plant executives were*147 not receptive to the system under such disturbing conditions. During 1940 labor changed its attitude toward the wage incentive plan and began to develop and train men of a business type to represent the workers in the installation and operation of the petitioner's system. The decision of the Supreme Court of the United States in upholding the unionization of the Ford Co. contributed to the receptivity of both management and labor to the introduction of the petitioner's plan in the various plants. The petitioner had done educational work with the unions, thus assisting in changing their attitude toward its system, but the results therefrom did not appear until after 1939. Subsequent to 1940 the unions in certain of the petitioner's clients have been putting pressure on the management to obtain more coverage for the workers; that is, to extend the Dyer plan to departments in which it was not in effect. From 1933 to 1939 the lack of acquiescence of the unions in the establishment of the petitioner's system and their failure to cooperate in its operation rendered the petitioner's business unprofitable. During the early part of 1940 the attitude of labor became more friendly to the*148 petitioner and its wage incentive system. By the end of that year the petitioner had begun many negotiations which immediately or eventually led to restoration of its business. In the companies in which the Dyer system had been previously established and discontinued and in the plants of new or potential clients of the petitioner, the opposition thereto subsided during the years 1940 and 1941, so that with the active cooperation of labor and with the same wholehearted approval and support of its plan which the petitioner had enjoyed prior to 1934, the petitioner's income began *1268 to resume its normal rate of growth, apparent prior to the depression period. When the Dyer system is initially installed in a manufacturer's plant, completely and with the cooperation of both management and labor, the petitioner has finished most of its work. However, whenever new operations are introduced and new methods of production are established, the petitioner's services are required to survey the jobs, set standards, and adapt the system to the new conditions. Often the plan is not installed in all departments and units of the plant. The petitioner is thus asked to return to the plant*149 to make additional installations and to bring its system up to date. The petitioner makes a flat rate of charge for its services. The number of its clients varies, within a very limited range, from year to year. The petitioner's gross income, total expenses, and adjusted net operating income for the years 1926 to 1944, inclusive, were as follows: Taxable year Gross income Total expenses Adjusted net income — 1926 — $ 185,806.91 $ 136,926.81 $ 48,880.10 — 1927 — 213,524.69 166,579.38 46,945.31 — 1928 — 372,426.09 239,548.12 132,877.97 — 1929 — 479,365.22 311,565.30 167,799.92 — 1930 — 275,194.30 234,944.61 40,249.69 — 1931 — 327,173.43 242,728.32 84,445.11 — 1932 — 179,578.31 172,616.64 6,961.67 — 1933 — 139,348.08 127,175.38 12,172.70 — 1934 — 78,237.38 102,361.96 (24,124.58) — 1935 — 49,543.67 72,597.21 (23,053.54) — 1936 — 77,299.72 94,870.56 (17,570.84) — 1937 — 123,703.84 103,828.56 19,875.28 — 1938 — 70,963.87 91,202.66 (20,238.79) — 1939 — 84,392.34 90,821.58 (6,429.24) — 1940 — 53,055.73 59,631.54 (6,575.81) — 1941 — 174,912.52 140,876.47 34,036.05 — 1942 — 171,338.34 137,288.71 34,049.63 — 1943 — 194,482.08 158,165.59 36,316.49 — 1944 — 238,446.26 190,524.18 47,922.08 *150 (The figures showing gross income include minor items of interest.) The following tables reflect the petitioner's income for various periods: Table A For the period from 1926 to 1933 the petitioner's gross $ 2,172.417.03 income was or an average for each year of 271,552.13 The total net income for these eight years was 540,332.47 or an average net income for these eight years of 67,541.56 Table B For the period from 1926 to 1935, inclusive, the gross income of petitioner was $ 2,300,198.05 or an average for each year of 230,019.80 For the same period the net income totaled 493,154.35 or average annual net income for this period of 49,315.43 (This table includes two loss years of 1934 and 1935.) Table C The base years of 1936, 1937, 1938, and 1939 show: The gross income for these base years was $ 356,359.77 with an average gross income for these base years of 89,089.94 For the four base period years there was a net loss of (24,363.59) or an average loss per year for each of the base years (6,090.89) Table D For the five years from 1940 to 1944, inclusive, the total gross income was $ 832,234.93 or an average gross income for these years of 164,646.98 The total net income for the five years was 145,748.44 or an average net income per year of 29,149.68 *151 *1269 The petitioner's president computed its constructive average base period net income as follows: Average amount per annum Gross receipts from engineering services -- based on billing rate of $ 2,250 per engineer per month for 11 engineers and allowing 1 month for idle time (excluding receipts for special work of supervisors billed at daily rates) $ 272,250.00 Salaries: President $ 30,000.00 Vice president 4,800.00 Supervisors -- 2 at $ 3,600 per annum 7,200.00 Engineers -- 11 at $ 3,000 per annum 33,000.00 Office -- 2 at $ 2,400 per annum 4,800.00 Engineering commissions -- at 25% of gross receipts 68,062.50 Sales commissions -- at 8% of gross receipts 21,780.00 Total salaries and commissions 169,642.50 Bonus -- at 15% of salaries and commissions 25,446.38 Traveling and miscellaneous expenses -- at 10% of gross receipts 27,225.00 Rent 2,280.00 Taxes -- at 1.2% of gross receipts 3,267.00 Contributions -- at .2% of gross receipts 544.50 Total expenses $ 228,405.38 Constructive average base period net income 43,844.62 The corporation income and declared value excess profits tax return*152 filed by the petitioner for the calendar year 1941 reported a normal tax net income of $ 8,012.25 and an adjusted net income of $ 9,114.06. The total income and declared value excess profits taxes due in the amount of $ 1,742.82 were paid to the collector of internal revenue on or before March 19, 1942. The corporation excess profits tax return filed by the petitioner for the calendar year 1941 reported an excess profits net income computed *1270 under the income credit method of $ 22,617.50. It also reported excess profits net income computed under the invested capital credit method of $ 22,915.17. Excess profits tax for the calendar year 1941 in the amount of $ 4,357.18 was paid to the collector of internal revenue on March 16, 1942. Since the excess profits credit based on invested capital in the amount of $ 2,706.09 was greater than the excess profits credit computation under the income method, the former figure was used in computing excess profits tax liability for 1941. The corporation income and declared value excess profits tax return filed by the petitioner for the calendar year 1942 reported an adjusted net income in the amount of $ 35,481.63. After subtracting *153 income subject to excess profits tax in the amount of $ 25,443.52 and a dividends received credit of $ 1,217.20, the normal tax net income amounted to $ 8,820.91. Total income and declared value excess profits taxes due were computed in the amount of $ 2,281.64. The corporation excess profits tax return filed by the petitioner for the calendar year 1942 reported excess profits net income in the amount of $ 34,271.08. The excess profits credit for 1942 based on invested capital was computed as the amount of $ 3,827.56. After deducting the specific exemption of $ 5,000 and the foregoing excess profits credit, the petitioner reported an adjusted excess profits net income for 1942 of $ 25,443.52. The excess profits tax due was computed in the amount of $ 22,899.17. Of the excess profits tax due per return, $ 7,556.73 was deferred by reason of the application of section 710 (a) (5) of the Internal Revenue Code. The balance of excess profits tax then due was computed as the amount of $ 15,342.44, less credit for debt retirement of $ 1,534.24, leaving excess profits tax due in the amount of $ 13,808.20, which was paid in full. On or about March 15, 1943, the petitioner filed an application*154 for relief under section 722 on Form 991 with respect to the excess profits tax taxable year 1942. Schedule A-6-b attached to the Form 991 claim for 1942 set forth a summary of net income as adjusted for computation of constructive average base period net income covering the calendar years 1926 to 1942, as above set forth. On or about September 15, 1943, an application for relief under section 722 for the excess profits tax taxable year 1941 was filed on Form 991 by the petitioner herein. The information set forth in the schedules attached to the Form 991 for the calendar year 1942 was incorporated by reference and made a part of the Form 991 pertaining to the year 1941. On or about June 11, 1945, the petitioner herein filed a claim for refund on Form 843 with the collector of internal revenue for the *1271 eighteenth district of Ohio, claiming a refund of excess profits tax for the calendar year 1942 in the amount of $ 10,356.15. The reasons stated in support of its claim were as follows: On March 12, 1943, the taxpayer filed an application for relief (Form 991) under Code section 722 which showed net relief from excess profits tax of $ 15,342.44 before debt retirement credit*155 of $ 1,534.24. Such application constituted a claim for refund to the extent of $ 3,452.05, the amount of excess profits tax paid on March 12, 1943. Therefore, the taxpayer is required to file this claim for the portion of relief claimed ($ 10,356.15) covered by payments of excess profits tax after March 12, 1943. Details regarding the relief claimed are given in Forms 991 and 1121 filed for the year 1942 and in further data furnished in connection with hearings at the office of the Internal Revenue Agent, Cleveland, Ohio, all of which are thereby incorporated herein by reference. On January 14, 1946, a statutory notice of deficiency was sent by registered mail to the petitioner herein, advising that a determination of its income tax liability for the calendar year 1941 disclosed a deficiency of $ 2,599.79; that the determination of its excess profits tax liability for the years ended December 31, 1941 and 1942, disclosed deficiencies of $ 290.25 and $ 6,816.73, respectively, and that the determination of its income tax liability for the year ended December 31, 1942, disclosed an overassessment of $ 5.22. Such statutory notice also advised the petitioner herein that it had not*156 established its right to relief under section 722 as requested in its applications for relief filed May 27, 1943, and September 15, 1943, and notice was given in accordance with the provisions of sections 272 and 732 of the Internal Revenue Code of the deficiencies mentioned above and of the disallowance of a claim for refund asserted in the applications for relief under section 722 and in the related claim on Form 843 filed with the collector of internal revenue, Cleveland, Ohio, on June 11, 1945. Petitioner's average base period net income is an inadequate standard of normal earnings. Petitioner's excess profits tax for the years 1941 and 1942, computed without the benefit of section 722, results in an excessive and discriminatory tax. The business of the taxpayer was depressed in the base period because of temporary economic circumstances unusual in the case of this taxpayer. The sum of $ 30,000 is the fair and just amount representing the normal earnings of the petitioner to be used as a constructive average base period net income for the purpose of computing its excess profits taxes for the taxable years. OPINION. The single issue is whether or not the petitioner is entitled *157 to relief for the taxable years under the provisions of section *1272 722 of the Internal Revenue Code, as amended. It predicates its claim to relief on subsections(a), (b) (2), and (b) (5). 1 *158 The purpose and plan of section 722 were discussed at length in Monarch Cap Screw & Manufacturing Co., 5 T. C. 1220, and subsequent cases, and need not be repeated here. It is sufficient to emphasize the fact that the section is a relief measure, calculated to help those taxpayers that can bring themselves within the scope of its provisions. The burden so to do is, of course, on them. The facts in the case at bar are comparatively simple. The petitioner contends and has proved that during its base period of 1936 to 1939, inclusive, labor was vigorously antagonistic to the introduction and maintenance of the Dyer wage incentive system in manufacturing plants. At the same time management resisted the inroads that labor was making in the control and operation of the plants and consequently was hostile to labor. It is essential to the successful application and operation of the system that management and labor be harmoniously cooperative. The Dyer wage incentive system is neither complex nor hard to understand and to apply. Briefly, it rewards the worker for his *1273 efforts in producing more than the average or normal amount of output -- hence*159 the pertinence of the word "incentive." Excepting the years 1934 and 1935, and the base period of 1936 to 1939, inclusive, the petitioner had, throughout the years, enjoyed a consistently satisfactory net income, giving due regard to periods of business depression. By reason of the altered attitude of labor toward its employers and toward the use of the Dyer system during its base period and for two years prior thereto, the petitioner's income was reduced drastically. In fact, for the years 1936, 1938, and 1939 the petitioner suffered an operating loss. Looking at petitioner's entire prior history, however, it seems at once apparent that the base years were not normal. Thus it is that at the first glance the facts in this case appear to bring the petitioner precisely within the scope and intendment of the statute The respondent undertakes to controvert this conclusion on several grounds. The respondent first asserts that the enactment of legislation giving labor a more prominent position in determining the rates and methods of fixing wages did not constitute a temporary economic circumstance unusual in the experience of the petitioner. We agree that the mere enactment of legislation*160 in itself produced no event unusual and peculiar in the petitioner's experience. It was the reaction of labor in the premises that brought about the changed condition. The respondent confuses the legislation itself with labor's immediate reaction to its own newly created position in the economic status of the Nation. It was not the passage of the National Industrial Recovery Act and the Wagner Act that interrupted and diminished the petitioner's normal output. The Wagner Act is still law. But, since 1940 management and labor have adjusted themselves thereto and have gradually reassumed a cooperative attitude toward the establishment and maintenance of industrial programs such as petitioner's incentive plan. The system, if sympathetically received and properly installed and operated, benefited labor and management alike even under new conditions, as both came to realize later. The respondent next argues that, "since union approval of wage rates was necessary, unions in reality were competitors of petitioner in setting wage standards," and cites Fish Net & Twine Co., 8 T. C. 96, and Lamar Creamery Co., 8 T. C. 928, in*161 support of the principle that competition is not an unusual, peculiar, or temporary event in business experience. We can see no element of competition between the petitioner and labor in any respect. It was a matter of complete indifference to the petitioner what wage the manufacturer paid his workers. That was a question that had to be settled by management and labor. After the wage rate was fixed, management, labor, and the petitioner collaborated in determining a standard production unit *1274 and applied that rate to it. Therefore, we may disregard the respondent's argument based on the theory of competition between labor and the petitioner. As a consequence, the cited cases are not in point in the instant case. The respondent further argues that the petitioner had dealt with management alone in introducing its plan and that at December 31, 1939, it had no assurance that labor would ever agree to the use of the Dyer plan. We do not find this argument supported by the record. On the contrary, in its earlier experience we note that the petitioner received complete cooperation of both management and labor upon the adoption and installation of its system. Later, when*162 labor assumed its attitude of antagonism and hostility, the petitioner "did educational work" to convince labor leaders that their position was detrimental to the best interests of the workers themselves. The fruits of the petitioner's labor became evident in 1940 and thereafter, so that most classes of labor which have had experience with it are now friendly to the Dyer plan. The respondent next states that no event or condition occurring or existing after December 31, 1939, should be considered in determining the adequacy of the average base period net income as a standard of normal earnings. We agree with this contention and we have not considered post base period earnings in establishing what we believe to be petitioner's proper constructive average base period net income. In East Texas Motor Freight Lines, 7 T. C. 579, we said, among other things: Under the statute petitioner must establish (1) that the tax computed without the benefit of section 722 results in an excessive and discriminatory tax and (2) a fair and just amount representing normal earnings to be used as a constructive average base period net income. * * * In determining (2) *163 no regard shall be had to events or conditions affecting petitioner, the industry of which it is a member, or taxpayers generally occurring or existing after December 31, 1939, with certain exceptions not material here. [Emphasis supplied.] In our finding that the sum of $ 30,000 is the fair and just amount representing the normal earnings of the petitioner to be used as a constructive average base period net income for the purpose of computing its excess profits taxes for the taxable years, we have observed the rule of the statute as referred to above in East Texas Motor Freight Lines, supra. These cases must be decided on the record made. Under the facts before us, the petitioner has demonstrated under subsection (b) (2) that it is entitled to relief. No specific "factor" not comprehended in these two sections has been shown to exist and, therefore, subsection (b) (5) does not apply. Finally, the respondent contends that the petitioner has not established the fair and just amount representing normal earnings, to be *1275 used as a constructive average base period net income. The petitioner submitted evidence for the purpose of showing that*164 such constructive average base period net income was $ 43,844.62. It also submitted much other pertinent and helpful evidence. Though we have not accepted petitioner's figure, we find ample proof in support of the figure found by us. Giving due weight to all the facts and circumstances developed in the record and properly to be considered under the statute, we consider the sum of $ 30,000 to be such fair and just amount, and we so hold. Reviewed by the Special Division. Decision will be entered under Rule 50. Footnotes 1. SEC. 722. GENERAL RELIEF -- CONSTRUCTIVE AVERAGE BASE PERIOD NET INCOME. (a) General Rule. -- In any case in which the taxpayer establishes that the tax computed under this subchapter (without the benefit of this section) results in an excessive and discriminatory tax and establishes what would be a fair and just amount representing normal earnings to be used as a constructive average base period net income for the purposes of an excess profits tax based upon a comparison of normal earnings and earnings during an excess profits tax period, the tax shall be determined by using such constructive average base period net income in lieu of the average base period net income otherwise determined under this subchapter. In determining such constructive average base period net income, no regard shall be had to events or conditions affecting the taxpayer, the industry of which it is a member, or taxpayers generally occurring or existing after December 31, 1939, except that, in the cases described in the last sentence of section 722 (b) (4) and in section 722 (c), regard shall be had to the change in the character of the business under section 722 (b) (4) or the nature of the taxpayer and the character of its business under section 722 (c) to the extent necessary to establish the normal earning to be used as the constructive average base period net income. (b) Taxpayers Using Average Earnings Method. -- The tax computed under this subchapter (without the benefit of this section) shall be considered to be excessive and discriminatory in the case of a taxpayer entitled to use the excess profits credit based on income pursuant to section 713, if its average base period net income is an inadequate standard of normal earnings because -- (1) in one or more taxable years in the base period normal production, output, or operation was interrupted or diminished because of the occurrence, either immediately prior to, or during the base period, of events unusual and peculiar in the experience of such taxpayer, (2) the business of the taxpayer was depressed in the base period because of temporary economic circumstances unusual in the case of such taxpayer or because of the fact that an industry of which such taxpayer was a member was depressed by reason of temporary economic events unusual in the case of such industry, * * * * (5) of any other factor affecting the taxpayer's business which may reasonably be considered as resulting in an inadequate standard of normal earnings during the base period and the application of this section to the taxpayer would not be inconsistent with the principles underlying the provisions of this subsection, and with the conditions and limitations enumerated therein.↩