Eastern Machinery Co. v. Under Secretary of War

The Eastern Machinery Company, Petitioner, v. Under Secretary of War, Respondent Eastern Machinery Co. v. Under Secretary of War Docket No. 63-R United States Tax Court 12 T.C. 71; 1949 U.S. Tax Ct. LEXIS 292; January 27, 1949, Promulgated *292 1. The action of the Bureau of Internal Revenue in determining the reasonableness of salaries for petitioner's officers is not binding in a renegotiation case. 2. The petitioner's excessive profits are here redetermined in the amount originally determined by the respondent, the petitioner having failed to sustain its burden to show that they were less in amount and the respondent having failed to sustain his burden to show that they were greater in amount. Elden McFarland, Esq., C. Chester Guy, Esq., and Harold W. Walker, Esq., for the petitioner. William V. Crosswhite, Esq., and John F. Wolf, Esq., for the respondent. Arundell, Judge. ARUNDELL *72 The respondent determined that petitioner's profits from renegotiable sales for the fiscal year ended September 30, 1942, were excessive in the amount of $ 143,000. Petitioner, in the petition, raised several constitutional questions and challenged the applicability of the Renegotiation Act to sales to Defense Plant Corporation during the year involved. In view of the intervening decisions of the Supreme Court in Lichter v. United States, 334 U.S. 742, 92 L. Ed. 1694, 68 S. Ct. 1294, and of this Court in National Electric Welding Machines Co., 10 T.C. 49,*293 petitioner does not press these questions on brief. It does, however, contend that at all events its profits were not excessive to the extent determined by the respondent. By amended answer, filed after the taking of evidence was concluded, respondent asks that we find petitioner's profits excessive to the extent of at least $ 250,000. FINDINGS OF FACT. Petitioner is a corporation, organized under the laws of Ohio, having its offices at Cincinnati. Since September 22, 1925, petitioner has been engaged in the second-hand machine tool business. For the fiscal year ended September 30, 1942, petitioner's total sales were $ 1,674,280.60. Its gross profit thereon was $ 949,199.91. Petitioner had interest income of $ 187.56. Its total expenses per books, including compensation of $ 204,900 paid to its officers, amounted to $ 316,558.05. Net income per books was $ 632,829.42. After an agent of the respondent had spent several days at petitioner's offices in August or September 1943 examining petitioner's records and discussing renegotiable business with petitioner's officers, petitioner reported to the renegotiating authorities that its renegotiable sales for the year ended September*294 30, 1942, amounted to $ 406,691.65. In making his determination herein, respondent used that figure as representing the gross amount of petitioner's renegotiable sales. The amount of $ 406,691.65 for renegotiable sales was determined in the following manner. The respondent's agent and the petitioner's officers together went over the petitioner's orders and came to an understanding with respect to total renegotiable sales. Sales to the United States Government were included by mutual agreement. Sales to Defense Plant Corporation in the amount of $ 117,785 were included at the insistence of the respondent's agent, but over the objection of the petitioner's officers. All other sales subsequent to April 27, 1942, which carried priority certificates were included. Certain sales to *73 other second-hand dealers for stock and resale by them were not included. It was recognized that not all the included sales were fully renegotiable, but they were included at 100 per cent in order to offset other excluded sales which might be partially renegotiable. Petitioner paid its three officers, George, Fred, and Robert Bierbaum, $ 204,900 compensation during the year involved. They managed*295 the business, worked long hours, traveled considerably, and did all the buying and selling. The respondent allowed $ 125,000 as reasonable compensation for the officers in determining the petitioner's excessive profits. The revenue agent who audited petitioner's tax returns for that year likewise allowed but $ 125,000 as reasonable compensation for the officers. Upon the determination of tax deficiencies, the petitioner filed a proceeding in this Court involving, among other issues, the question of compensation. Subsequently the case was settled and a decision was entered pursuant to stipulation of the parties as to the amounts of the deficiencies due. Among the questions disposed of in this settlement was the adequacy of the salary allowance. Petitioner's business during the year in issue was of the same general character as its business during the prewar period. It carried its own inventory risks, and its operations involved the use of large sums of money. Petitioner's sales were made at or less than OPA ceiling prices. Petitioner performed reconditioning operations on the machines which it bought and resold. The second-hand machine tool business is subject to cycles. *296 Skill and experience in buying are required to succeed in the business. Petitioner's sales during the prewar period were small in comparison with its 1942 sales, and it suffered losses in two of those years. In the fiscal year ended September 30, 1942, the aliquot portion of petitioner's over-all net profits attributable to its renegotiable sales in the amount of $ 406,691.65, after adjusting deductions to reflect a salary allowance of $ 125,000 to its officers, was approximately $ 173,000. Petitioner's profits were excessive in the amount of $ 143,000 for the fiscal year ended September 30, 1942. OPINION. Except for the includibility of sales to the Defense Plant Corporation, there was apparent agreement between the petitioner and the respondent, in the administrative stage of this proceeding, as to the gross amount of petitioner's renegotiable sales. Petitioner now concedes that, under National Electric Welding Machines Co., 10 T.C. 49, Defense Plant sales are renegotiable, and it is therefore willing to stand by the figure of $ 406,691.65 as representing its renegotiable sales. The respondent admits in his answer that he used that figure in making*297 his determination, but he denies the correctness *74 of the figure and now contends that petitioner's total renegotiable sales greatly exceeded that amount. The manner in which the amount of $ 406,691.65 was determined -- a sort of compromise between the respondent's agent and the petitioner's officers -- is set out in our findings and need not be repeated here. At that time both sides recognized that not all the included sales would be renegotiable to the extent of 100 per cent because the machines were probably not used by the vendees entirely on war production work; that the excess amount would offset some omitted sales which might, to a small extent, be renegotiable; and that, collectively, $ 406,691.65 fairly represented the gross amount of petitioner's renegotiable sales. Accepting the amount of the renegotiable sales to be $ 406,691.65, as originally determined by the respondent and now agreed to by the petitioner, we proceed with the consideration of the reasons advanced by petitioner in support of its contention that its excessive profits were a sum very much less than $ 143,000. Petitioner contends that the respondent's salary allowance is too low, and that this Court*298 should allow either the full amount of $ 204,900 actually paid the officers or, at least, the amount of $ 188,400, which one of petitioner's officers testified to as the amount finally allowed by the Bureau of Internal Revenue in settlement of the tax deficiencies. We find no warrant in the present record for disturbing the respondent's allowance of $ 125,000 compensation, which, under the circumstances appears to us to be reasonable. While the Renegotiation Act, section 403 (c) (3), provides for the allowance of deductions of the character allowed under the Internal Revenue Code, it does not, as the petitioner recognizes, make the determination of the Bureau of Internal Revenue binding as to the amount of any particular deduction. Furthermore, as indicated in our findings, the tax case involved other issues and was settled by stipulation of the parties. We have taken note of the fact that petitioner's business is speculative and subject to cycles, that risk is involved in its buying and selling operations, that considerable capital is employed in the business, and that petitioner carries its own inventory risk. We think, however, that the determination of the respondent allows*299 the petitioner an adequate return to compensate it for these factors. While the profits remaining to the petitioner after deducting the excessive portion might appear somewhat small, percentagewise, by prewar standards, in view of the tremendous volume induced undoubtedly by the war preparedness program, we think the net return on sales, after renegotiation, is fair. Taking the record as a whole, we conclude that petitioner has failed to prove that its excessive profits were less in amount than those determined by the respondent. *75 The respondent contends that the petitioner's renegotiable sales were greater than the amount determined by him, viz., $ 406,691.65, and he therefore asks that the excessive profits be determined in the amount of $ 250,000. It is incumbent upon respondent to prove the facts in support of his claim for an increased amount of excessive profits, a burden which he has failed to sustain. Nathan Cohen, 7 T.C. 1002. Petitioner finally contends for an adjustment on account of accelerated amortization under section 124 (d) of the Internal Revenue Code. One of its officers testified that in connection with the compromise*300 of the tax deficiencies there was an additional allowance of $ 10,517.49 attributable to accelerated amortization. Assuming without deciding that this is a matter to be considered by this Court, the record fails to contain a certificate from the Bureau of Internal Revenue of any official action in that regard, such as is required to obtain a renegotiation rebate. The petitioner should follow the procedure provided by section 403 (a) (4) (D) of the Renegotiation Act, paragraphs 383.2 and 383.3 of the Renegotiation Regulations, and Mim. 6023, 1946-2 C. B. 187, by filing claim for a net renegotiation rebate. An order will issue in accordance herewith.