Bibb Mfg. Co. v. Secretary of War

Bibb Manufacturing Company, Petitioner, v. The Secretary of War, Respondent Bibb Mfg. Co. v. Secretary of War Docket No. 87-R United States Tax Court 12 T.C. 665; 1949 U.S. Tax Ct. LEXIS 216; April 29, 1949, Promulgated *216 1. Renegotiation -- Constitutionality. -- The Renegotiation Act is constitutional as applied to the petitioner for the fiscal year 1942. 2. Renegotiation -- Jurisdiction. -- The Court has jurisdiction to consider sales subject to renegotiation in an amount greater than that determined by the Secretary, for purposes of redetermining the amount of excessive profits derived therefrom by a subcontractor. 3. Renegotiation -- Final Payment -- Section 403 (c) (6). -- The entire sales under subcontracts on which deliveries were made and payments therefor were received by a subcontractor both prior to and subsequent to April 28, 1942, are subject to renegotiation, since final payment pursuant to such subcontracts was not made prior to April 28, 1942. 4. Renegotiation -- Sales -- Seconds and Shorts. -- Sales made by a subcontractor to other subcontractors and contractors representing seconds and shorts produced by them and sold by them for non-warend use without charge to the Government are not subject to renegotiation. 5. Renegotiation -- Sales -- Waste. -- Sales made by a subcontractor to other subcontractors and contractors representing waste produced by them and charged by them into*217 the cost of their goods sold to the Government are subject to renegotiation. 6. Renegotiation -- Deduction -- State Tax. -- A state tax on income paid or accrued within the renegotiable fiscal year 1942 is deductible in determining the profits on the sales subject to renegotiation made by a subcontractor during that year. 7. Renegotiation -- Excessive Profits -- Amount. -- The amount of excessive profits determined. Richard B. Barker, Esq., and C. Baxter Jones, Esq., for the petitioner. William T. Becker, Esq., and Paul L. Muilenburg, Esq., for the respondent. Murdock, Judge. MURDOCK *666 The Secretary of War made a unilateral determination that the petitioner had realized excessive profits of $ 1,400,000 from sales subject to renegotiation made during the fiscal period ended August 31, 1942. The issues for decision are: (1) Whether the Renegotiation Act of 1942, as amended, is constitutional; (2) Whether the Tax Court has jurisdiction to start with any larger amount representing renegotiable sales for the period in controversy than the amount of such sales as determined by the Secretary; (3) Whether the amount of $ 1,597,413 representing sales upon which*218 deliveries were made and payment was received prior to April 28, 1942, is subject to renegotiation; (4) Whether sales of seconds and shorts which did not find a warend use are subject to renegotiation; (5) Whether waste should be eliminated from renegotiable sales; (6) Whether income taxes paid to the State of Georgia are deductible in determining the profits from renegotiable sales; and (7) The amount of excessive profits for the period in controversy. FINDINGS OF FACT. 1. The petitioner is a Georgia corporation, with its principal place of business in Macon, Georgia. It is, and for many years has been, engaged in the business of manufacturing cotton textile goods. 2. The petitioner began operations as a textile manufacturer in Macon, Georgia, in 1876. Its business grew until in 1941 it owned and operated a total of ten mills in Georgia, five of which are located in or near Macon, three at Porterdale, one at Reynolds, and one at Columbus. 3. Over the period of 1922 to 1929, inclusive, 1 the petitioner's sales averaged over $ 22,000,000 annually. More than 50 per cent of these sales consisted of tire fabric and cord, and the balance of yarns, twines, *667 braids, and hosiery. *219 The tire fabric and cord sales declined sharply in 1929, falling off from approximately $ 17,200,000 in that year to $ 7,100,000 in 1930, and to as low as $ 1,600,000 in 1932. That decline was due principally to the fact that the large tire manufacturers which the petitioner had been supplying began to manufacture their own tire fabrics and cords. The petitioner then began manufacturing a number of other products, including printed cloth, sheetings, shirtings, and laundry nets. During the period 1930 to 1940, inclusive, its total annual sales averaged approximately $ 14,123,000. About half of those sales consisted of yarns and twines, about one-fourth of tire fabric and cords, and the balance of miscellaneous products. 4. About 1935 the petitioner began an intensive research program to develop a tire fabric and cord that would*220 meet the demands for a more heat-resistant and long-wearing tire. It succeeded in developing such a process, which it patented in 1937, and by 1940 it had recaptured a large portion of its business in that field. In that year its tire fabric and cord sales amounted to approximately $ 6,700,000. 5. In 1933 the petitioner launched a program of reequipping and modernizing its mills. It had a survey made by engineers representing the machinery manufacturers, with whom it worked out an over-all improvement and modernization plan to extend over a number of years. In carrying out this plan the petitioner replaced a great deal of its machinery with the most modern machines obtainable, redesigned some of its factory buildings, and rearranged the floor plans for the most efficient and economical operation. Most of these expenditures were for new machines. The expenditures for capital improvements for each of the years 1936 to 1942, inclusive, were as follows: [1936] $ 536,000 [1937] 1,275,000 [1938] 495,000 [1939] 257,000 [1940] 533,500 [1941] 2,100,000 [1942] 670,000 6. With the completion of its improvement program the petitioner became one of the best equipped and most efficient mills*221 of its type in the country. Consequently, the heavy demand on the textile industry for wartime production found the petitioner in a highly favorable position. Without any expansion of plant facilities, but with a change to 24-hour operation, it was able to increase production from approximately 70,500,000 pounds of goods in 1939 to 118,600,000 pounds in 1942. The petitioner would have been unable to achieve this large production without the improved equipment and trained operators to work it. Neither new equipment nor trained labor was readily available after our entry into the war. *668 7. The successful operation of a textile-manufacturing business such as the petitioner's requires the use of a large number of complicated machines and trained workmen to operate them. The process of manufacturing cotton into usable goods consists of a series of separate but integrated operations, such as mixing, cleaning, picking, carding, drawing, twisting, and spinning the yarn, and, finally, weaving it into cloth. After the mixing and cleaning the small fibers of lint must first be paralleled and then drawn out and twisted into yarn. The size, strength, and other requirements of the*222 yarn are determined by the type of goods for which it is to be used. The machines operate at a high speed and require delicate adjustments in order not to overdraw, overtwist, or break the fiber. Each step in the process must be carefully supervised and correlated. 8. The articles which the petitioner manufactured for the Government, or for Government use, and which are included in the stipulated unadjusted net renegotiable business (see paragraph 19), consisted of duck, drills, yarn, seine twine (used for camouflage), parachute cord, and other lesser items, of which the duck and drills, in about equal quantities, comprised more than one-half. They were among the most critical war materials. The petitioner was not manufacturing either duck or drills at the outbreak of the war. Its looms were not designed for such materials. However, by making adjustments in the mechanisms, which it did at its own expense, the petitioner was able to put them to such uses. 9. Approximately $ 1,360,000 of the approximate total of $ 3,851,000 of duck which the petitioner produced for the Government in 1942 was manufactured on looms which had been fully depreciated in prior years. The petitioner*223 had last used these looms to manufacture duck for the Government during the first world war. Since that time it had kept them stored in a warehouse which it had built for that purpose. The petitioner spent about $ 50,000 of its own funds repairing and reconditioning these looms for use in World War II. 10. All goods manufactured by the petitioner for Government use were of good quality and met Government specifications. Out of its total stipulated unadjusted net renegotiable sales of over $ 13,000,000 in 1942, the petitioner had practically no rejects. 11. Because of its efficient methods of operation, its general knowledge of cotton textiles, and its long experience in manufacturing cotton goods, the petitioner was able to use lower grades of less expensive cotton for certain products, without lessening their quality or serviceability, than were commonly used by the industry. In most of the products of the type manufactured by the petitioner there is used a mixture of raw cotton consisting of several different grades of lint, classified according to the length, weight, texture, color, and other conditions of the fiber, as found in each separate bale of cotton. *669 12. A*224 standard bale of cotton contains 500 pounds of lint. Each bale is sampled and graded separately and is priced accordingly. Generally, the length and texture of the fiber and the quantity of trash and discoloration determine its selling price. These conditions depend upon the variety of cotton, the locality in which it is grown, weather conditions, and other factors. The longer staple has a greater tensile strength and is more desirable for certain uses than the shorter staple. Fine white goods require a clean, white grade of lint. 13. By using the lower grade mixtures the petitioner was able not only to reduce the cost of its products as compared with other mills, but was able to conserve the limited supply of better grades and staples for other uses. This practice resulted in savings to the petitioner of nearly a half million dollars in 1942. 14. The petitioner maintains a force of trained cotton buyers who visit the cotton-producing areas during the harvest season and purchase cotton for the petitioner's use directly from the producers. 15. One of the critical war materials was parachute cord. Originally, it was made of flax, due to the great tensile strength of that fiber, *225 which is imported from Ireland and Scotland. With the drastic curtailment of imports from those countries after our entry into the war, the Government's need for parachute cord became acute. To meet this situation the petitioner's engineers developed a chemically treated cotton cord that proved a highly satisfactory substitute for the linen cord. During 1942 the petitioner manufactured and sold to the Government over 1,000,000 pounds of such cord, at a total sale price of approximately $ 985,000. Later, other cotton textile manufacturers began making parachute cord by processes differing somewhat from the process developed by the petitioner. 16. Early in its history the petitioner organized its own sales department, instead of selling its products through commission merchants, as was the custom in most of the industry. With the growth of its business the petitioner established sales offices in a number of leading cities in the country, including New York, Philadelphia, Chicago, and Boston. The customary commissions paid on the sale of cotton textiles ranged from 2 1/2 per cent to about 5 per cent, depending upon the type of goods handled. Through the utilization of its own *226 sales department the petitioner was able to hold its selling costs in 1942 to approximately $ 260,000 on sales of over $ 49,000,000, or slightly more than one-half of 1 per cent of sales. The petitioner's combined selling, general, and administrative expenses for 1942 were $ 922,153.88, or approximately 1.87 per cent of sales; as against an average of over 5 per cent for the industry as a whole. 17. The petitioner financed all of its operations with its own capital. It never had the use of any public capital or had any grant from the Government. *670 18. The petitioner has always maintained a high rate of earnings as compared with the textile industry as a whole. Its records show earnings in every year of its operations, even during the depression periods when many of the cotton textile manufacturers were operating at a loss. 19. It is stipulated that for the fiscal year 1942 the petitioner's net sales, costs, and profits, of both renegotiable and nonrenegotiable business, without any adjustment of renegotiable business on account of goods shipped and paid for prior to April 28, 1942, or for seconds, shorts, and waste, or for State or Federal income taxes, were as follows: Renegotiable Total business business Net sales $ 49,359,806.75 $ 13,889,604.66 Costs 36,188,961.16 10,981,121.37 Profits 13,170,845.59 2,908,483.29 *227 20. The petitioner's net sales and profits, before taxes on income, either state or Federal, for the period 1922 to 1941, inclusive, were as follows: Fiscal year ended Net sales Profits Aug. 31 -- [1922] $ 18,475,341.42 $ 3,790,851.42 [1923] 22,140,810.13 4,461,140.94 [1924] 22,365,880.41 2,310,177.33 [1925] 24,099,097.49 2,790,665.77 [1926] 22,039,040.71 1,939,404.11 [1927] 19,600,903.27 2,602,629.26 [1928] 22,456,368.05 3,218,391.88 [1929] 26,652,192.44 4,472,209.80 [1930] 15,379,934.65 204,419.28 [1931] 9,544,437.98 797,283.76 [1932] 6,076,634.56 268,142.94 [1933] 9,113,581.10 1,088,736.77 [1934] 12,399,723.64 1,007,830.62 [1935] 12,828,990.66 209,092.78 [1936] 15,419,682.45 1,262,754.08 [1937] 20,689,198.90 1,506,035.48 [1938] 12,177,579.15 959,097.39 [1939] 16,951,311.78 1,404,176.51 [1940] 18,872,630.77 2,618,742.23 [1941] 27,075,301.19 5,208,810.67 21. The petitioner paid $ 605,369.34 income taxes to the State of Georgia for the year 1942. 22. The petitioner's stipulated unadjusted net renegotiable sales in 1942 were all indirect Government sales; that is, the goods were sold to other manufacturers who finished or converted them into articles for Government use. *228 All of such sales were made at open, competitive prices and were in line with the general prices prevailing throughout the industry. The petitioner never asked for or received from the Government any premium prices for any of its products. 23. All of the petitioner's 1942 sales were made in accordance with established trade rules of the industry known as "Worth Street Rules," as applied to cloth, and "Cotton Yarn Rules of 1938," as applied to yarns. The contracts between the petitioner and its vendees on which the above sales were made called for deliveries of goods not in a single *671 lot, but in installments, some monthly, some weekly, and some on other specified schedules. They were of the type generally referred to as "blanket contracts." The vendees were obligated to pay for each separate shipment of goods upon its receipt, or, if an f. o. b. shipment, as most of them were, upon its delivery to the carrier. Prices were based on the yard unit for cloth goods and on the pound unit for yarns. When a shipment of goods was received and accepted by the vendee and payment therefor made to the vendor neither party was under any further obligation with respect to such shipment, *229 and to that extent the contract was deemed fully performed. Of the 1942 stipulated unadjusted net renegotiable sales, $ 9,552,028 were on contracts which had been entered into before April 28, 1942, and $ 1,597,413 were for goods which had been shipped and paid for before April 28, 1942, although these were not the final shipments on the contracts. 24. The stipulated unadjusted net renegotiable sales included $ 677,089.56 sales dollar value of "shorts" and "seconds" produced by petitioner's vendees, who were direct contractors with the Government, which were not sold to, or delivered to, the Government. These goods were sold to non-Government use. In respect of such goods the petitioner's vendees charged $ 4,385.15 into their cost of goods sold to the Government as "firsts." 25. Approximately $ 6,440,000 of the stipulated amount of the petitioner's renegotiable sales were of yarns which it sold to vendees who were subcontractors with the Government. The vendees of these subcontractors, who were direct contractors with the Government, produced seconds and shorts, from the yarns purchased from the petitioner, which did not find their way into Government use, of $ 303,960.71 sales*230 dollar value. 26. The direct customers of the petitioner produced waste on the contracts included in the stipulated unadjusted net renegotiable sales of a sales dollar value of $ 124,240.99. This amount of waste was all charged into the cost of the goods sold to the Government. 27. The petitioner's property and plant account, as of August 31, 1941, shows a total of $ 28,969,651.15, including land, buildings, machinery, and other equipment and improvements. 28. The Secretary of War determined, unilaterally, that the net renegotiable business of the petitioner for the fiscal year ended August 31, 1942, was $ 12,547,814; the net profit thereon was $ 2,488,400; and $ 1,400,000 of that amount constituted excessive profits which should be returned to the Government. 29. The petitioner's renegotiable sales were $ 12,912,939.54, its profits thereon were $ 2,579,687.51, and its excessive profits were $ 850,000, for the fiscal year ended August 31, 1942. *672 30. The facts contained in the several stipulations filed by the parties are incorporated herein by reference. OPINION. This is the first case in which a Commissioner of this Court conducted the hearing and made findings of fact. *231 That procedure was adopted upon motion of the petitioner, to which the respondent said he had no objection. His findings were served upon the parties and they were given an opportunity to object. The petitioner had no substantial objections to the findings, but counsel for the respondent filed a number of objections, all of which have been carefully considered. The findings set forth above, except for the ultimate finding of the amount of excessive profits and a few minor changes and additions, are the findings of Commissioner Davis. He did not decide and did not intend to decide any of the issues hereinafter discussed, including the ultimate question of the amount of excessive profits. His findings included one of the amount of excessive profits, assuming certain amounts to represent renegotiable sales and net profits from those sales. That finding represented his judgment or conclusion based upon the evidence. But it did not, of course, represent the judgment or conclusion of the Court. The question of the amount of excessive profits, the ultimate question in this proceeding, the Court can not avoid, but must decide itself. It has made a finding deciding that question, *232 which is one on which opinions can differ widely, as this proceeding clearly demonstrates. The pleadings raise a question of the constitutionality of the Renegotiation Act, but that issue has not been argued and might properly be regarded as abandoned. However, the point is decided against the petitioner upon authority of , and . The Secretary determined that the net amount of renegotiable sales of this petitioner for the period ended August 31, 1942, was $ 12,547,814. He eliminated an estimated $ 1,400,040 to represent sales of seconds and shorts in arriving at the above amount. The petitioner contends that this Court must start with the figure of $ 12,547,814 to represent the renegotiable sales, since it does not have jurisdiction to consider any larger amount than that determined by the Secretary. Section 403 (e) (2) gives any subcontractor aggrieved by a determination of the Secretary as to the existence of excessive profits for any period ended before July 1, 1943, the right to file a petition with the Tax Court. The filing of that petition*233 gives the Court jurisdiction to determine in a de novo proceeding the correct amount of excessive profits for the period involved. One of the things to be proved in a proceeding before the Tax Court is the amount of profits of the fiscal year which is *673 subject to renegotiation. The Court may even determine a greater amount of excessive profits than that determined by the Secretary if put in issue. There is nothing in the law supporting the petitioner's contention that the Tax Court must start with the same figure to represent renegotiable sales for the period under renegotiation as that determined by the Secretary. The petitioner contends that $ 1,597,413 should be eliminated from renegotiable sales because deliveries and payments on sales in that amount were made prior to April 28, 1942. Section 403 (c) (6) of the Renegotiation Act provides that subsection (c) shall apply to all contracts and subcontracts theretofore made unless "final payment pursuant to such contract or subcontract was made prior to April 28, 1942." The petitioner entered into the contracts prior to April 28, 1942, and continued to make deliveries and receive payments under those contracts after*234 April 28, 1942. The $ 1,597,413 represents goods shipped under those contracts and paid for prior to April 28, 1942, but the payments were in no case the final payments on the contracts and in every case additional shipments and additional payments occurred after April 28, 1942. The petitioner argues that those contracts were divisible, so that the goods shipped and paid for prior to April 28, 1942, were sales completed prior to that date and were not subject to renegotiation. The statute mentions contracts on which final payment had been made, not merely shipments under such contracts. The findings clearly show that final payment pursuant to the contracts or subcontracts involved herein was in no case made prior to April 28, 1942. Renegotiation was intended to apply to the entire contracts in such cases. The petitioner did not make any sales directly to the Government. It sold yarn and cloth to others. Those others further processed the material, for example, by dyeing, weaving, or manufacturing in some way, and ultimately some of the yarn and cloth sold by the petitioner was sold to the Government. The Government*235 rejected some of the material offered to it which had originally come from the petitioner. The rejections were for various reasons, including unsatisfactory variations in the colors and shrinkage. Material rejected by the Government was then sold for civilian use and did not involve the use of any appropriated Government funds. Such sales of seconds and shorts in the amount of $ 976,665.12 2 were included in the stipulated figure of $ 13,889,604.66. This Court held in the case of , that only sales of material paid for out of appropriated Government funds are subject to renegotiation. The Secretary, in determining the excessive profits in this case, took the same position and held that sales of seconds and shorts were not subject to renegotiation. Now the opposite is urged. It is held that the sales of seconds and shorts in the amount above stated are not subject to renegotiation. *236 The petitioner contends that waste in the amount of $ 124,240.99 should likewise be eliminated in determining the net amount of renegotiable sales. The record is not clear as to what, if anything, was done with the waste. However, finding of fact 26 shows that waste in this amount was charged into the cost of goods sold to the Government. Thus, the material represents sales for which the petitioner received full payment and for which the Government was charged. There is no occasion under such circumstances to eliminate the amount of the waste from the renegotiable sales of the petitioner. The same is true of a small amount of seconds and shorts for which the Government was charged. See finding of fact 24 and footnote 2. The next contention of the petitioner is that income taxes paid to the State of Georgia in the total amount of $ 605,369.34 are deductible in determining the profits on the petitioner's renegotiable sales. This Court held in , that similar taxes were deductible for 1942, as contended by the petitioner. The ultimate question is the amount of excessive profits. The Secretary of War, *237 after considering the evidence submitted in the renegotiation, determined that $ 1,400,000 of total profits of $ 2,488,400 on $ 12,547,814 of sales were excessive. The petitioner concedes that $ 550,000 of those profits were excessive. The Commissioner concluded that $ 750,000 would be the amount of excessive profits, assuming total profits of $ 2,908,483.29 on sales of $ 13,889,604.66. It is incumbent upon this Court to make its own determination of excessive profits. It has done so after carefully considering all of the evidence and arguments. The prior history and record of the petitioner, the plant, equipment, capital, and trained employees used by it, the relationship between renegotiable and nonrenegotiable business, its use of fully depreciated machinery, its efficiency, the savings which it effected, the changes and adjustments which it had to make, the valuable contributions made by it to the war effort, the prices charged and the quality and quantity of its goods, its position in the industry, these and all other "factors" have been considered and given such weight as seemed appropriate under the circumstances in arriving at the determination that the profits were excessive*238 in the amount of $ 850,000. An order will issue in accordance herewith. Footnotes 1. The accounting period of the petitioner at all times material hereto was a fiscal year ended August 31. All years referred to herein, including 1942, are the fiscal years ended August 31.↩ 2. See findings 24 and 25. $ 677,089.56 + 303,960.71 = 981,050.27 - 4,385.15 = 976,665.12↩