Lehmann Machine Co. v. Reconstruction Finance Corp. Price Adjustment Board

Lehmann Machine Company, a Corporation, Petitioner, v. Reconstruction Finance Corporation Price Adjustment Board, Respondent Lehmann Machine Co. v. Reconstruction Finance Corp. Price Adjustment Board Docket No. 158-R. United States Tax Court 10 T.C. 350; 1948 U.S. Tax Ct. LEXIS 259; February 24, 1948, Promulgated *259 Decision will be entered in accordance with the above opinion. 1. The Renegotiation Act of 1942, as amended July 1, 1943, held applicable to Defense Plant Corporation contracts fully performed and paid for after date of original enactment and prior to date of amendment. 2. As so applied, Renegotiation Act of 1942, as amended, held not unconstitutional. Stein Brothers Mfg. Co., 7 T. C. 863; Ring Construction Corporation, 8 T. C. 1070; National Electric Welding Machines Co., 10 T. C. 49. 3. The amount of petitioner's excessive profits from the manufacture and sale of lathes on the contracts with Defense Plant Corporation determined on the evidence. Milton Yawitz, Esq., for the petitioner. Robert H. Winn, Esq., for the respondent. LeMire, Judge. LEMIRE *350 The Reconstruction Finance Corporation Price Adjustment Board made a unilateral determination that $ 83,000 of the $ 263,201 of profits which the petitioner realized in 1942 from certain contracts with the Defense Plant Corporation were excessive profits within the meaning of section 403 of the Sixth Supplemental National Defense Appropriation *351 Act, 1942, as amended. The contracts on which these profits were realized comprised approximately one-third of petitioner's total business for the taxable year. In its original petition in this proceeding the petitioner sought to contest the determination*261 only upon the grounds of constitutionality. It raised no question as to the correctness of the determination with respect to the amount of the alleged excessive profits. The respondent filed an answer traversing the allegations contained in the petition. By an amended answer subsequently filed, the respondent affirmatively alleged that the petitioner's total profits from the contracts in dispute amounted to $ 270,865 and that $ 187,000 of such profits was excessive. The petitioner filed a reply denying those allegations. A further issue raised in the pleadings as to the timeliness of the institution of the renegotiation proceedings by the Reconstruction Finance Corporation Price Adjustment Board has been abandoned by the petitioner. The issues remaining for our determination are: (1) Is the Renegotiation Act of 1942, as amended on July 1, 1943, unconstitutional? (2) Is the act, as amended, to be given retroactive application to the profits on the Defense Plant Corporation contracts here involved which were fully completed and on which full payment had been received before the enactment of the amendment? (3) What was the amount, if any, of the petitioner's excessive profits in*262 1942 from the Defense Plant Corporation contracts here in question? FINDINGS OF FACT. The parties have submitted two separate stipulations of facts; one dealing principally with the petitioner's organization and operations, and the other with the history and functions of the Reconstruction Finance Corporation Price Adjustment Board and other Government agencies and their relation to the contracts under consideration. These stipulations of fact are incorporated herein by reference. The following statement of facts contains a summary of such of the stipulated facts, as well as those established by evidence adduced at the hearing, as we deem essential to the determination of the issues presented. The petitioner is a Missouri corporation, organized in 1907, with its principal place of business in St. Louis, Missouri. Since 1915 it has been engaged in the manufacture and sale of metal turning lathes and other machine tools. In 1935 the petitioner began the manufacture and sale of a new improved type of lathe, known as the "hydratrol lathe." In this type of lathe the driving power is transmitted from the motor to the lathe chucks through oil, rather than through a driving shaft. The*263 hydratrol *352 lathe was developed by the petitioner's engineers at its plant in St. Louis, and at its own expense. The development work was begun in 1934. There were eight basic patents issued to L. A. Carter, petitioner's chief engineer. These patents were acquired by the petitioner in 1940. The petitioner sold its first hydratrol lathe in 1935 at a price of $ 3,281. During the years 1936 to 1941, inclusive, the petitioner's sales of hydratrol lathes, its total sales, and its profits or losses, after the deduction of all expenses and costs, were as follows: Hydratrol lathes sold Year Total sales Profit or (loss) Units Sale price [6] $ 23,411 $ 119,328 ($ 10,178) [22] 81,994 201,287 (3,774) [9] 64,527 142,046 (6,413) [12] 62,811 136,929 (4,171) [50] 372,717 780,118 181,761 [130] 1,218,612 1,595,602 447,994 The petitioner sold 196 hydratrol lathes in 1942 for $ 2,091,880. Of such sales, $ 976,688 were made under contracts with the Defense Plant Corporation (hereinafter referred to as DPC), acting at the request of either the War Department or the Navy Department or the Maritime Commission, whereby the*264 petitioner furnished lathes to be installed in plants being constructed and equipped under DPC leases known as "plancors." DPC was a governmental corporation, created by the Reconstruction Finance Corporation Price Adjustment Board (hereinafter referred to as RFC) on August 22, 1940, pursuant to section 5 (d) of the Reconstruction Finance Corporation Act, as amended. DPC's stock was wholly owned by RFC. DPC was dissolved on June 30, 1945, and its duties, functions, powers, and assets were transferred to RFC. During its existence DPC built, equipped, and operated various plants for the production of war materials. Such plants were leased by DPC to various private corporations and other persons. On its DPC sales of $ 976,688 in 1942 the petitioner realized profits of $ 263,201. The petitioner's total sales in 1942, including the DPC sales, other Government sales, and other nonwar business amounted to $ 2,851,494.13. Its nonwar sales in 1942 were $ 477,900, on which it realized profits of $ 129,681. The other Government sales are not in issue in this case. The petitioner had made delivery and received full payment on substantially all of its 1942 DPC sales prior to July 1, 1943, *265 the date of the enactment of the above mentioned amendment to the Renegotiation Act of 1942. *353 The Office of Price Administration fixed ceiling prices on the petitioner's hydratrol lathes in February 1941 at the prices shown in the petitioner's published price list, dated February 25, 1941. All of petitioner's sales during 1942 were made at ceiling prices. All of the lathes which the petitioner supplied under its DPC contracts were manufactured by the petitioner at its own plant, with its own equipment, and at its own cost. The petitioner did not borrow any money or receive any financial aid from the United States Government. Petitioner's net worth on December 31, 1941, was $ 332,702. The business of manufacturing and selling lathes, such as those produced by the petitioner, is subject to business cycles, as is the entire machine tool industry to which it belongs. The experience of the industry as a whole is that there are periods of several years of prosperity, when there is a large demand for machine tools and when operations are profitable, followed by similar or longer periods of slack demand and diminishing profits, or even losses. The lathes of all types sold by *266 the petitioner each year over the period 1936 to 1942, inclusive, numbered 21 in 1936, 38 in 1937, 26 in 1938, 19 in 1939, 106 in 1940, 198 in 1941, and 240 in 1942. There have been recent sales of hydratrol lathes manufactured by the petitioner through Government surplus channels at prices of less than one-half their list prices. During the year 1942 the petitioner operated its plant with two full shifts of 10 hours each for 5 days a week and 8 hours each on Saturdays. Some of the critical machines in the plant were operated on a 24-hour basis, 7 days a week. The petitioner's employees increased from about 135 in 1940 to 225 in 1941 and reached a high of about 300 in 1942. Its factory costs in 1942 increased 10 1/2 per cent over 1941, while at the same time its administrative expenses decreased from 6.95 per cent to 4.24 per cent of sales. The cost of goods sold rose from 51.5 per cent of sales in 1941 to 61.9 per cent in 1942. In prior years the cost percentages in relationship to sales were considerably higher, reaching 80 per cent or over in 1937, 1938, and 1939. After 1942 the petitioner's sales of lathes of all types fell off to 158 in 1943 against 240 in 1942, 136 in 1944, *267 207 in 1945 and 86 in 1946. The Government continued to accept delivery of lathes on some of its contracts after the close of the war. One hundred seventy-six of the lathes sold by the petitioner in 1945 and 43 of those sold in 1946 were on Government contracts. With a few minor repairs and replacements of working parts, the hydratrol lathes manufactured by the petitioner and other similar lathes have a normal useful life of many years and probably will not be replaced or discarded until they have become obsolete. The hydratrol lathes are adaptable to peace-time uses without any changes. *354 The petitioner was before this Court in a prior proceeding, Lehmann Machine Co., Docket No. 393, involving a claim for relief under section 721, Internal Revenue Code. That proceeding was settled by stipulation in which the parties agreed that a portion of petitioner's income for 1941, amounting to 7 1/2 per cent of sales, was attributable to the prior years during which the hydratrol lathe was in process of development. A similar adjustment was made in the petitioner's tax liability for the year 1940. OPINION. The petitioner's contentions are that, since its contracts with DPC, which*268 gave rise to the profits in dispute, were fully performed and paid for before the enactment of the July 1, 1943, amendment to the Renegotiation Act of 1942, they are not subject to renegotiation. It contends that the amendment can not be given retroactive application and, if so construed, it is unconstitutional because it results in the taking of private property for public use without just compensation, in contravention of the Fifth Amendment of the Constitution. Prior to July 1943 the Renegotiation Act did not provide for renegotiation of contracts with DPC. Section 403 (a) of the Sixth Supplemental National Defense Appropriation Act, 1942, as amended by section 801 (a) of the Revenue Act of 1942, provided that: "The term 'Department' means the War Department, the Navy Department, the Treasury Department, and the Maritime Commission, respectively." As further amended on July 1, 1943, the item "Department" was defined as the: * * * War Department, the Navy Department, the Treasury Department, the Maritime Commission, the War Shipping Administration, Defense Plant Corporation, Metals Reserve Company, Defense Supplies Corporation, and Rubber Reserve Company, respectively. The question*269 of the applicability of the Renegotiation Act, as amended, to DPC contracts such as those here involved and the constitutionality of the act as so applied, has been ruled upon in several cases previously decided by this Court and need not be discussed at great length here. See Stein Brothers Mfg. Co., 7 T. C. 863; Ring Construction Corporation, 8 T. C. 1070; National Electric Welding Machines Co., 10 T. C. 49. The arguments made by the petitioner here are much the same as those made in the decided cases. National Electric Welding Machines Co., supra, perhaps bears the closest factual evidence to the instant case. Some of the profits there involved were from DPC contracts fully performed and paid for after enactment of the original Renegotiation Act, but prior to the July 1, 1943, amendment. We held that the act, as amended, is applicable to such contracts and as so applied is not unconstitutional. *355 We therefore hold that the contracts under consideration are subject to renegotiation and that as applied to such contracts the statute is not unconstitutional. *270 The more difficult problem here is to determine the amount of excessive profits, if any, which the petitioner realized under its DPC contracts. It will be noted that the sales under those contracts comprised a little more than one-third of petitioner's total sales for the taxable year 1942, or $ 976,688 out of a total of $ 2,851,494.13. The parties have stipulated that the profits on these sales amounted to $ 263,201. The RFC made a unilateral determination that $ 83,000 of the $ 263,201 was excessive profits. The petitioner in its petition filed in this proceeding challenged the constitutionality of the Renegotiation Act, but did not question the determination as to the amount of excessive profits. However, in an amended answer the respondent affirmatively alleged that the petitioner's excessive profits from the DPC contracts were $ 187,000 instead of $ 83,000, as determined by the RFC. As to the proposed increase in the amount of excessive profits, the burden of proof rests upon the respondent, while the burden of showing that the original determination is erroneous rests upon the petitioner. Nathan Cohen v. Secretary of War, 7 T. C. 1002. *271 It is our opinion that the evidence of record does not afford any basis for setting aside the determination of excessive profits made by the RFC. Section 403 (a) (4) (A) of the statute enumerates certain factors which are to be taken into consideration in determining excessive profits. These are: (1) Efficiency of contractor; (2) reasonableness of costs and profits; (3) amount and source of public and private capital employed and net worth; (4) extent of risk assumed; (5) nature and extent of contribution to the war effort; (6) character of business; and (7) such other factors as should be considered for the public's interest and for fair and equitable dealing. Petitioner's position with respect to most of the enumerated factors is favorable. The evidence indicates that it operated with normal efficiency; that its costs were held within reasonable bounds; that it furnished its own facilities and capital, using no public capital; and that it contributed to the war effort by supplying vital machine tools of superior quality and in fair quantity, according to its productive capacity. It assumed no unusual risks. The petitioner urges that among the principal factors to be considered*272 in determining its excessive profits, if any, are: (1) The return of capital expended in the development of the hydratrol lathe; (2) the cyclical incident of the machine tool industry; and (3) the risk of saturation. The petitioner points out that its comparatively large percentage of business, and correspondingly large profits, in *356 the taxable year 1942 were due in a large part to the sales of the hydratrol lathe which it had recently brought into quantity production. In the evidence before us, however, there is no showing or even an estimate of the cost to the petitioner of developing the hydratrol lathe. We know that for the years 1940 and 1941 the Commissioner of Internal Revenue allowed the petitioner, on its claim for relief under section 721, Internal Revenue Code, to reallocate to prior years a portion of its 1940 and 1941 earnings amounting to 7 1/2 per cent of sales. However, we do not know on what figures or factors that allowance was made. It is evident that the petitioner did not suspend other operations while it was developing and introducing the hydratrol lathe to the trade, since, as the facts show, it had sales of approximately $ 119,000 in 1936, when*273 it sold only 6 hydratrol lathes, for $ 23,411; approximately $ 201,000 in 1937, when it sold 22 lathes, for $ 81,994; and over $ 142,000 in 1938, when it sold 9 lathes, for $ 64,527. At the same time, consideration must be given to the fact that petitioner's 1942 profits were due in substantial part to the manufacture and sale of this new improved type of lathe. Some consideration, perhaps not measurable in dollars and cents, must also be given to the fact, which the respondent recognizes, that the petitioner's business, along with the machine tool industry as a whole, is subject to business cycles in which prosperous periods of one or more years are followed by longer periods of small profits or even losses, depending upon management in each individual case. The peak production period for the petitioner began about 1940, when it sold a total of 106 lathes of all types, against 19 for 1939. It sold 198 in 1941; 240 in 1942; 158 in 1943; 136 in 1944; 207 in 1945; and 86 in 1946. Whether in 1942 there were any indications or reasonable expectations of an approaching "valley" in the petitioner's business cycle which would have justified the petitioner in setting aside any substantial*274 portion of its profits in that year in a contingent reserve; whether in 1942 the industrial demand for the type of lathes manufactured by the petitioner was approaching saturation point; whether the petitioner then had any reasonable grounds for belief that it was facing a prolonged business depression which would absorb a substantial portion of its profits of the war years, and post-war years, are questions that we can not answer on any evidence before us. The respondent produced two qualified witnesses who, in response to hypothetical questions embodying the essential facts pertaining to petitioner's operations as agreed to by the parties in their stipulations, expressed their opinions as to what portion of petitioner's 1942 profits from the DPC contracts was fair and reasonable. One of the witnesses gave it as his opinion that from $ 100,000 to $ 110,000 and the other that from $ 100,000 to $ 120,000 of the $ 263,201 of profits would be *357 fair and reasonable. A witness testifying on behalf of the petitioner named a much higher figure of from 33 1/3 per cent to 35 per cent of sales. The respondent tacitly concedes on brief that the increased excessive profits of $ 187,000*275 proposed in the amended answer are not supported by the evidence of record, but urges that we find that at least $ 145,000 of the $ 263,201 of profits was excessive. As indicated above, we have been unable to find in the evidence before us any convincing proof that the amount of the petitioner's excessive profits from the DPC contracts was either more or less than the amount determined in the renegotiation made by the RFC. We therefore find that the petitioner's excessive profits on these contracts were $ 83,000. Decision will be entered in accordance with the above opinion.