W. Tip Davis Co. v. Patterson

W. Tip Davis Company, Petitioner, v. Robert P. Patterson, Under Secretary of War, Respondent W. Tip Davis Co. v. Patterson Docket No. 52-R United States Tax Court 12 T.C. 335; 1949 U.S. Tax Ct. LEXIS 255; March 10, 1949, Promulgated *255 1. Renegotiation -- Sales to Post Exchanges, Etc. -- Sales to post exchanges, ship service stores, officers' clubs, company funds and the like are not subject to renegotiation, since they do not involve funds appropriated by Congress. 2. Id. -- Purchase Orders. -- Direct sales to Army and Navy on purchase orders are subject to renegotiation, since purchase orders are contracts. 3. Id. -- Allocation of Costs and Expenses. -- Costs and expenses allocated between renegotiable and nonrenegotiable sales on basis of sales where petitioner had used no accurate method of allocation. 4. Id. -- Excessive Profits -- Amount. -- Amount of excessive profits determined. Urban E. Wild, Esq., and Milton Cades, Esq., for the petitioner. Frederick N. Curley, Esq., for the respondent. Murdock, Judge. MURDOCK *335 The Under Secretary of War determined that profits in the amount of $ 35,000 realized by the petitioner during the fiscal period from April 1 to December 31, 1942, on sales subject to renegotiation were excessive. The issues are (1) whether the petitioner had sales subject to renegotiation during the fiscal period ended December 31, 1942, in the amount of $ 185,689.61, and, if its renegotiable sales exceeded $ 100,000, (2) whether it realized excessive profits of $ 35,000 on those sales. FINDINGS OF FACT. The petitioner was a partnership, with its principal place of business in Honolulu, Territory of Hawaii. It was organized on April*257 1, 1942, *336 to take over the business formerly conducted by W. Tip Davis as a sole proprietorship. The partners were W. Tip Davis (hereinafter referred to as Davis), S. C. Davis, F. T. Davis, W. E. Hunter, and F. Y. Murai. Davis had started the business in Honolulu in 1931 as a sales agent for mainland manufacturers of office supplies. He sold various types of metal office desks, files, and chairs. He had thirteen employees prior to Pearl Harbor, included among whom were the four persons who later became his partners in the petitioner. It became difficult to obtain commercial shipments from the United States after Pearl Harbor. Therefore, Davis in February 1942 instituted a policy of having the products which he sold manufactured in Honolulu. The organization of the petitioner on April 1, 1942, effected no change in the nature of the business which had theretofore been conducted by Davis. The petitioner was able to obtain some shipments of supplies on priorities from the United States during the renegotiable period. It acted as sales agent for mainland manufacturers to that extent as had Davis prior to the war. The petitioner also continued the policy of having equipment*258 manufactured locally. It furnished the designs and materials for the products to independent shops which contracted to manufacture and sell the products to the petitioner. It obtained the greater part of the equipment which it sold during the renegotiable period in that manner. The petitioner sold office desks, files, and chairs during the renegotiable period. Those products which were manufactured locally were made of wood and were modeled after the equipment which Davis had previously supplied in steel. The petitioner experienced no difficulty in making sales during the renegotiable period. The sales of the petitioner during the renegotiable period were as follows: Direct sales to Government: Army and Navy purchase orders $ 121,549.67 Contracts 47,447.51 Sales to war end use contractors 12,365.82 Sales to Army post exchanges, officers' clubs, Navy ship service stores, etc 4,326.61 Sales to nonwar end use contractors and to Government completed and paid for prior to April 28, 1942 28,517.31 Total 214,206.92 The petitioner had sales of $ 181,363 during that period which were subject to renegotiation. The sales to Army post exchanges, officers' *259 clubs, Navy ship service stores, etc., were made up of the following: *337 Army post exchanges $ 3,491.80 Ship service stores 341.45 Control stores C. P. F., Naval Air Station 59.00 Post signal fund, Fort Shafter 9.00 Post recreation fund, Camp Malakole, Ewa 21.45 Recreation fund, Kahuku Navy Air Base 33.95 Post recreation fund, Fort Shafter 17.46 Battery "A", 305th Coast Artillery 15.30 Regimental fund, 19th Infantry 7.00 Company "I", 106th Infantry 4.50 Battery "M", 98th Coast Artillery 9.40 Battalion fund, 90th Field Artillery, Schofield 65.00 Schofield Post library 3.20 Officers' Club, Fort Shafter 52.50 Receiving Station B. O. Q., U. S. Navy Yard 4.50 Noncommissioned Officers' Club, Hickam 12.00 Officers' messes 179.10 Total 4,326.61 The petitioner did not sign any agreement in connection with the sales made under Army and Navy purchase orders. A unit or branch of the Army or Navy would orally give the petitioner a purchase order number and the place of delivery. The petitioner, upon delivery, would receive from the inspecting officer a written authorization to bill for the merchandise. The petitioner signed nothing and received no written*260 evidence of the transaction prior to delivery. It usually billed the unit for the merchandise upon delivery and received payment in 60 to 120 days. Davis was the lessee of property at the corner of Alakea and Queen Streets in Honolulu. He paid an annual rent of $ 4,500 under his lease and sublet the property during the renegotiable period to the petitioner and others for a total rental of $ 3,690, of which the petitioner paid $ 1,800. The rent which the petitioner paid Davis for the premises which it occupied during the renegotiable period was low. The petitioner had only one employee in addition to the partners during the renegotiable period. The partners devoted all their time to the business of the petitioner and worked long hours. Davis was the managing partner and general manager of the business. He also handled financial matters and made catalogs for the petitioner. His wife, S. C. Davis, was bookkeeper, secretary, and stenographer. F. T. Davis, their son, did selling, handled incoming shipments and priorities, helped develop equipment, and made deliveries. Hunter developed ideas for furniture, wrote specifications on the merchandise sold, hauled incoming shipments, *261 organized and supervised the subcontracted manufacturing, and helped in selling by introducing the new wooden products to customers. Murai kept track of shipments, *338 handled priorities, and kept account of the costs and charges on incoming shipments. The four men also scouted for materials and did manual labor, repairing and assembling furniture. The partnership agreement of April 1, 1942, provided that the monthly salaries of the partners could not exceed the following amounts: W. Tip Davis $ 450 S. C. Davis [300] F. T. Davis [250] Hunter [250] Murai [200] The terms of the partnership agreement were not changed during 1942. The above amounts were charged to the salary account of the petitioner as salaries to partners in each of the nine months of the renegotiable period. The partners made withdrawls of cash, some of which were called "advances," during that period as follows: Total withdrawals Advances W. Tip Davis $ 6,050 $ 2,000 S. C. Davis 3,700 1,000 F. T. Davis 4,700 2,500 Hunter 4,250 2,000 Murai 2,300 [500] Total 21,000 8,000 A reasonable allowance in lieu of salaries or other compensation to the partners for services actually *262 rendered to the petitioner during the renegotiable period would be $ 22,500. The assets of the partnership were shown on the books at $ 17,415.11 on April 1, 1942, and at $ 81,807.70 on December 31, 1942. The fixed assets during that period amounted to about $ 2,300. The increase in total assets was due mostly to an increase of $ 39,752.90 in accounts receivable and one of about $ 22,000 in cash. The partners' accounts increased during that period from $ 8,000 to $ 59,793.51. The records of the petitioner do not show accurately the costs of goods applicable to sales subject to renegotiation. A profit and loss statement for the renegotiable period, with costs and expenses properly allocated to renegotiable sales, is as follows: Renegotiable Total sales sales Sales $ 214,207 $ 181,363 Cost of sales 129,417 109,357 Gross profit 84,790 72,006 Expenses 12,062 10,192 Salaries to partners 22,500 19,013 Net profit * 50,228 42,801 *339 The respondent determined that the petitioner realized excessive profits of $ 35,000. The petitioner realized excessive profits of $ 27,500 during the*263 renegotiable period from sales subject to renegotiation. OPINION. The first point for decision under issue (1) is whether sales made by the petitioner during the period here in question to Army post exchanges, officers' clubs, Navy ship service stores, and numerous armed forces organizations were subject to renegotiation. The evidence on this point is extremely limited. It shows that sales in the total amount of $ 4,326.61 were made to Army post exchanges, ship service stores and various military organizations and clubs, and were paid for after April 28, 1942. The parties, in discussing this point, make no distinction between the sales made to Army post exchanges and the relatively smaller sales made to other organizations. Section 403 (c) (1) of the Renegotiation Act of 1942, as amended, provided for renegotiation of any contract with a Department to eliminate excessive profits, and Department was defined to include the War Department. Sec. 403 (a) (1). The respondent relies upon Standard Oil Co. of California v. Johnson, 316 U.S. 481, in which the Court stated that post exchanges "are integral parts of the War Department." That case did not*264 involve renegotiation and is not determinative of the point here under consideration. Although a post exchange may be regarded as a part of the War Department for some purposes, nevertheless, it is not like the Quartermaster Corps, the Signal Corps, or other parts of the War Department for which Government funds are appropriated and spent. The Court also said in the Johnson case, supra, that "The Government assumes none of the financial obligations of the exchange." Appropriated funds have been used by the War Department to provide suitable buildings for post exchanges, but post exchanges have no appropriated funds with which to make purchases of merchandise or equipment. Standard Oil Co. v. Johnson, supra; 27 Stat. 178; 10 U. S. C. A., Sec. 1335; Opinion of the Judge Advocate General, Feb. 20, 1943; Army Regulations 210-65 (19 Mar. 1943) para. 33 (h). Post exchanges and the other organizations to which the sales in question were made buy with their own funds, which belong to the share-holding units of which each exchange consists. This matter of the source and ownership of funds used to purchase the goods is vital in renegotiation. *265 The statutes providing for renegotiation were not intended to prevent excessive profits from contracts on which the Government was not obligated. The legislative history of those provisions shows that it was "Government" appropriated" funds which had "been taken *340 from the taxpayers" which were to be "returned to the Treasury thereafter to be reappropriated by Congress." Congressional Record, Senate 4/7/42, p. 3481; same, p. 3495; Senate 10/10/42, p. 8312; House 4/21/42, p. 3697. The renegotiating authorities issued manuals stating that contracts such as those involved herein were not subject to renegotiation. The Joint Renegotiation Manual, covering fiscal years ended before July 1, 1943, secs. 332.5 and 332.6; Renegotiation Regulations, War Contracts Price Adjustment Board, applicable to fiscal years ending after June 30, 1943, secs. 332.6 and 332.7. The respondent's brief does not suggest a valid reason for subjecting these particular sales to renegotiation. It is held that the sales in the amount of $ 4,326.61 were not subject to renegotiation. The petitioner made sales of $ 121,549.67 to the Army and Navy upon purchase orders. Another question under the first issue*266 is whether sales on purchase orders are subject to renegotiation. Section 403 of the Renegotiation Act provides that contracts with the Departments are subject to renegotiation. The petitioner contends that a purchase order is not a contract within the meaning of that word as used in section 403. It argues that Congress, in enacting laws, has always distinguished between contracts and purchases or purchase orders and, when it mentioned contracts but did not mention purchase orders in section 403, it intended that the latter should not be subject to renegotiation. Congress did not define contracts as used in that section. A subcontract is defined in section 403 (a) (5) to include a purchase order. The petitioner argues that this specific inclusion under subcontracts indicates an intention to exclude when the purchase order comes directly from a Department. Section 403 (a) (5) was enacted to show that the act was broad in its scope rather than to limit its application, Supply Division, Inc., 9 T. C. 1103, and does not support the petitioner's argument. The purpose and legislative history of renegotiation indicate a Congressional intention that *267 purchase orders, which are a type of contract and could result in excessive profits just as readily as any other kind of direct contract, be subject to renegotiation. Cf. Report of the Special Committee Investigating the National Defense Program, 78th Cong., 2d sess., Rept. No. 10, part 16, p. 60; part 5, p. 231; National Electric Welding Machines Co., 10 T. C. 49. The purpose of renegotiation was to prevent war profiteering from the expenditure of Government funds necessary in the prosecution of the war. There would be no reason to limit the profits derived through a direct sale to a Department of the Government evidenced by one type of contract but not to limit similar profits derived from a sale evidenced by a purchase order. It is held that the sales made on purchase orders are subject to renegotiation. The renegotiable sales of the petitioner for the period here involved were *341 in excess of $ 100,000, the renegotiable minimum fixed in section 403 (c) (6). The second issue relates to the amount, if any, of excessive profits realized by the petitioner during the nine-month period ended December 31, 1942, on its renegotiable sales in the*268 amount of $ 181,363. The parties disagree as to two alleged expenses. The petitioner paid rent of $ 1,800, or $ 200 a month, for the premises which it occupied. It contends that this rent was low, a reasonable rental for the space would have been $ 600 a month, and the difference of $ 400 should be allowed as an additional deduction in computing profits. There is no authority in the statute for allowing a deduction for rent in excess of the amount actually paid. However, if a low rental were to be shared with the Government through low prices or a return of some of the profits, it might be considered as a "favorable factor." Albert & J. M. Anderson Manufacturing Co., 12 T. C. 132. The renegotiators have determined that reasonable salaries to the partners for the period here in question would amount to $ 13,050, and the respondent recognizes that a reasonable amount should be allowed for partners' salaries in accordance with Joint Renegotiation Manual, sec. 352.1, and sec. 403 (d). The petitioner contends that the allowance should be $ 38,880. All of the evidence on this point has been considered and the conclusion has been reached that $ 22,500*269 would be a reasonable allowance for partners' salaries during the period in question. The parties agree that the petitioner had total sales of $ 214,206.92, cost of sales in the amount of $ 129,416.53, and expenses of $ 12,062.13, not including any allowance for salaries to partners, during the last nine months of 1942. They disagree, however, on the method of allocating those costs and expenses between renegotiable and nonrenegotiable sales. The petitioner maintains that the allocation should be made in accordance with the method of accounting which it used, whereas the respondent contends that the accounting method used by the petitioner was neither complete nor accurate and, accordingly, the allocation should be made on the basis of sales. The difference in results is not great. The accounting method used by the petitioner to allocate cost of goods sold was not accurate. It had no method of allocating expenses. Both cost of goods sold and expenses have been allocated upon the basis of sales. The petitioner contends that its profits from renegotiable sales were not excessive, whereas the respondent contends that they were excessive to the extent of $ 35,000. The sales to *270 post exchanges and similar organizations were included in renegotiable sales and only $ 13,050 was allowed for partners' salaries in arriving at the determination that profits were excessive to the extent of $ 35,000. This Court, after *342 considering all of the evidence, including the nature of the business, the risks assumed, the investment involved, the performance, the difficulties overcome, and all evidence bearing on any other factor which might be considered, has come to the conclusion that the profits of the petitioner from renegotiable sales during the last nine months of 1942 were excessive in the amount of $ 27,500. An order will issue in accordance herewith. Footnotes *. Before allowance for Federal and territorial income taxes.↩