Trace v. United States

C. H. Trace, Petitioner, v. United States of America, Respondent Trace v. United States Docket Nos. 406-R, 547-R, 748-R. United States Tax Court 25 T.C. 538; 1955 U.S. Tax Ct. LEXIS 19; December 16, 1955, Filed *19 War Contracts Price Adjustment Board determined that petitioner, a manufacturer's representative, realized excessive profits of $ 65,000 for the year 1943 and $ 10,000 for each of the years 1944 and 1945. Held: (1) That salary allowance should be made for one person who negotiated sales in 1943 and that the petitioner's profits for that year were excessive to the extent of $ 55,000; (2) that the Board did not err in refusing to make allowance for compensation to the petitioner in lieu of salary; (3) that no error has been shown in the Board's determinations for the years 1944 and 1945. C. H. Trace, pro se. Harlan F. Leathers, Esq., for the respondent. Atkins, Judge. ATKINS *538 In these proceedings the petitioner contests determinations by the War Contracts Price Adjustment Board that he realized excessive profits in the calendar years 1943, 1944, and 1945. These proceedings were once dismissed for lack of jurisdiction. 21 T. C. 303. After appeal of the decision of dismissal, the Congress extended the time for substitution of the United States as a party defendant and the petitioner having timely moved for substitution, the appeal was dismissed and the cases remanded. They are now before us for consideration on the merits. The War Contracts Price Adjustment Board issued unilateral orders in which it determined that the petitioner had realized excessive profits for the calendar year 1943 in the amount of $ 65,000, and for each of the years 1944 and 1945 in the amount of $ 10,000. The pleadings raise the issues that the Adjustment Board erred in (a) treating commissions as profits realized by the petitioner alone rather than as a co-owner*21 of a business in which only one-half of the profits were those of the petitioner; (b) in not allowing as deductions amounts *539 paid by the petitioner to others for personal services rendered; and (c) in not determining a reasonable compensation to the petitioner in lieu of salary in determining profits of the joint venture. The proceedings were consolidated for purposes of trial and briefing. FINDINGS OF FACT. The petitioner is an individual with his principal place of business at Detroit, Michigan. His income tax returns for the calendar years 1943, 1944, and 1945 were filed with the collector of internal revenue for the district of Michigan. In and prior to the years involved herein, the petitioner was engaged in trade or business as a manufacturer's representative. Among the companies that he represented were National Grinding Wheel Sales Company, Detroit, Michigan, and the Lehmann Machine Company of St. Louis, Missouri. In the years 1943, 1944, and 1945, the petitioner represented the National Grinding Wheel Sales Company and the Lehmann Machine Company and others in procuring orders from and making sales to the United States Navy, on which the commissions received by *22 the petitioner were as follows: [1945] Nat'l. Grinding Wheel Sales Company $ 58,900.63 $ 45,351.38 $ 27,623.46 Lehmann Machine Company 130,056.55 54,040.45 40,664.56 Subtotal $ 188,957.18 $ 99,391.83 $ 68,288.02 Others 39,462.64 26,032.35 45,172.16 Total $ 228,419.82 $ 125,424.18 $ 113,460.18 Of the above amounts of commissions, the amounts subject to renegotiation were not less than $ 184,835 for 1943, $ 96,217 for 1944, and $ 58,546 for 1945. The petitioner's expenses with respect to both renegotiable and nonrenegotiable sales (but not including salaries paid or split commissions allowed to others) were as follows: 1943, $ 11,754.58; 1944, $ 10,794.19; 1945, $ 14,151.22. In the years here involved there were associated with the petitioner three men; namely, a twin brother, Claude J. Trace; a younger brother, Keith B. Trace; and George F. Boos. Claude J. Trace was a full-time employee of the Ford Motor Company. He had been associated with the petitioner in some of the latter's business deals since about 1928. His principal activity on behalf of the petitioner was to introduce the petitioner to persons who had businesses for sale. Some*23 of such introductions led to others which in turn resulted in bringing in business to the petitioner. The petitioner and Claude met frequently at night to discuss deals in *540 which the petitioner was interested. Under an arrangement entered into between the petitioner and Claude in 1934, the petitioner paid to Claude 50 per cent of the net profits of any business deals that were concluded by the petitioner. The amounts paid to Claude for the years 1943, 1944, and 1945, were, respectively, $ 65,598.53, $ 34,656.65, and $ 36,507.19. Prior to World War II, the petitioner interested Keith, his younger brother, in the sale of lathes produced by the Lehmann Machine Company. The petitioner made the first sale to an automobile manufacturer and thereafter Keith sold to other automobile manufacturers and to the Navy Department. The petitioner agreed to pay to Keith one-third of all commissions on sales of lathes after the deduction of expenses attributable to such sales. The amounts paid by the petitioner to Keith under that arrangement were $ 46,831.44 for 1943, $ 22,030.46 for 1944, and $ 12,000 for 1945. George F. Boos was introduced to the petitioner at a time when the petitioner*24 was attempting to secure for a third party the right to transport automobiles for the Ford Motor Company. Boos had some acquaintance with someone in the Ford Motor Company and was able to make the arrangements that the petitioner sought. Boos was instrumental in getting the Ford Motor Company to try out the grinding wheels that were marketed by the National Grinding Wheel Sales Company. In the course of time the Ford Motor Company purchased a substantial portion of its grinding wheels from the National Grinding Wheel Sales Company. The petitioner arranged with Boos to have Boos handle the sales for the National Grinding Wheel Sales Company and agreed to pay to Boos one-half of the commissions on sales. Under that arrangement, the petitioner paid to Boos the sums of $ 39,269.94 for 1943, $ 23,286.23 for 1944, and $ 14,294.57 for 1945. In determining the amount of excessive profits for the year 1943, an allowance should be made for reasonable compensation for services rendered by Claude J. Trace in the amount of $ 10,000. For the year 1943 the petitioner's profits on renegotiable business were excessive to the extent of $ 55,000. For each of the years 1944 and 1945 the petitioner's*25 profits on renegotiable business were excessive to the extent of $ 10,000. OPINION. The petitioner was a manufacturer's representative whose compensation consisted of commissions on sales of his principals' products. As such, any excessive fees earned on sales of commodities to the Government for war-end use are recoverable under the Renegotiation Act. French v. War Contracts Price Adjustment Board, 13 T. C. 276. *541 The War Contracts Price Adjustment Board has determined that the petitioner's profits, which consisted of commissions on renegotiable sales, were excessive in the amounts of $ 65,000 for the year 1943 and $ 10,000 for each of the years 1944 and 1945. The amounts of commissions realized by the petitioner for those years, subject to renegotiation, were at least $ 184,835 for 1943, $ 96,217 for 1944, and $ 58,546 for 1945. The petitioner's primary contention as raised by the pleadings was that the Adjustment Board erred in failing to reduce the amounts of his commissions by the amounts that he paid to his brother, Claude J. Trace, his theory being that Claude was a co-owner of the business and was entitled to one-half the profits. *26 However, on briefs no mention is made of this contention, leading us to believe that he no longer relies upon that ground. In any event, the record does not establish that the petitioner and Claude were co-owners of the business or that Claude was in any way entitled to one-half the commissions. The contract between the petitioner and Claude is not in evidence, nor does the testimony show the precise arrangement between them. Upon the record, we hold that the petitioner has not sustained his burden of showing error on the part of the Board in holding that all the commissions were, in the first instance, income of the petitioner. The alternative contention, and the one which the petitioner urges on brief, is that the Board erred in not allowing as deductions the amounts paid to his brothers, Claude and Keith, for personal services rendered. The Renegotiation Act provides that items estimated to be allowable under chapter 1 (the income tax sections) of the Internal Revenue Code shall "be allowed as items of cost" under renegotiable contracts. The same section of the Renegotiation Act further provides that no item of cost shall be charged to renegotiable contracts "to the extent*27 that in the opinion of the [Price Adjustment] Board or, upon redetermination, in the opinion of The Tax Court of the United States, such item is unreasonable * * *." Sec. 403 (a) (4) (B), Renegotiation Act of 1943. Salaries, of course, are allowable deductions under the income tax section of the Internal Revenue Code in determining net income, and, by the cited provision of the Renegotiation Act, are allowed as part of the cost of performing renegotiable contracts. The Internal Revenue Code provision as to salaries is to permit the deduction from gross income of "a reasonable allowance for salaries or other compensation for personal services actually rendered; * * *." Sec. 23 (a) (1) (A), I. R. C. 1939. This provision of the Code as to "reasonable compensation" and the further provision of the Renegotiation Act requiring the disallowance of any item determined *542 to be "unreasonable" make it clear that the establishment of the reasonableness of any amount claimed on account of a salary payment is an essential element to its allowance. The demonstration of reasonableness is a part of the petitioner's burden of proof to show error with respect to the determination of the Adjustment*28 Board. Nathan Cohen v. Secretary of War, 7 T. C. 1002. As to the salary allowable for Claude J. Trace, the petitioner relies heavily on provisions of income tax regulations and court decisions to the effect that, generally, contingent compensation paid under a contract made before the services are rendered should be allowed as a deduction even though in the working out of the contract the amount may be greater than the amount which would ordinarily be paid. Sec. 29.23 (a)-6, Regs. 111; Draper & Co., 5 T. C. 822; William S. Gray & Co. v. United States, (Ct. Cl.) 35 F. 2d 968. However, the cited regulations go further than the general statement referred to, and point out that "in any event the allowance for the compensation paid may not exceed what is reasonable under all the circumstances." In the cases cited by the petitioner, which allow deductions for contingent compensation, the evidence detailed the services that were rendered and the allowances were made in the light of that evidence. For example, in the William S. Gray case, supra, the Court of Claims made detailed*29 findings of fact as to the duties of and services performed by each of the employees of the taxpayer whose compensation was questioned by the Commissioner of Internal Revenue. The petitioner also refers to that part of the above regulations which provides that in judging salary allowances the circumstances to be taken into consideration are those existing at the date the contract for services was made, not those existing at the time the contract is questioned. On this point he cites Robert Rogers, Inc. v. United States, 93 F. Supp. 1014. In the cited case of Rogers, Inc., the question concerned the reasonableness of a salary paid under a contingent contract entered into prior to the taxable year. The court in that case found on the evidence that at the time the salary arrangement was agreed upon "it appeared to be a reasonable one." The petitioner's meager evidence fails to meet the tests prescribed by the regulations he cites, and fails to show that the amount paid to Claude for 1943 constituted reasonable compensation. We are not informed in any detail as to what services were expected of Claude or what services he performed; we do not know*30 the extent of his responsibility for bringing to fruition the deals on which he worked with the petitioner; and there is no evidence of how his compensation compared with others performing similar services in like businesses. *543 Although the evidence lacks the details that the petitioner might normally be expected to show as to services rendered by Claude, the record as a whole affords support for allowing some compensation to Claude, which should be taken into consideration in determining the amount of excessive profits realized in the year 1943. There is evidence that he did render services that were valuable to the petitioner in producing the commissions that constituted the renegotiable profits. To refuse to make any allowance for the value of Claude's services distorts the amount of such profits. Considering all of the facts and circumstances that the record contains concerning Claude's services, we have concluded that the amount of $ 10,000 represents reasonable compensation therefor. See L. Schepp Co., 25 B. T. A. 419, 429. That amount is an allowable item of the cost in determining the extent to which the petitioner's profits were *31 excessive for the year 1943. The petitions filed assign error in the Adjustment Board's disallowance of part of the salary claimed on behalf of Claude for the years 1944 and 1945. It appears that the Board did make an allowance for a salary to Claude in each of those years. For the same reasons that we have set out in regard to the year 1943, we cannot say, on the record before us, that the Board erred in not allowing larger amounts. As to Keith B. Trace, there is evidence that he also performed services that were valuable to the petitioner in 1943 in producing the renegotiable profits; that petitioner claimed $ 47,000 as an allowable cost item for such services, and the Adjustment Board allowed $ 30,000. Here again, the petitioner's evidence is quite general and fails to give details that he no doubt was in a position to produce. On the record, we cannot find that the Adjustment Board erred in not allowing a larger amount for Keith's services. Although the petitioner adduced evidence as to the activities of George F. Boos, he does not urge any specific error in the Adjustment Board's allowance in regard to payments to Boos. Upon the record, we find no error by the Adjustment *32 Board in this respect. There was no error in the refusal of the Adjustment Board to make an allowance for compensation in lieu of salary for the petitioner. Where income is due to personal efforts, the profits realized measure the value of the services, and no separate allowance for salary is to be made. Greaves v. War Contracts Price Adjustment Board, 10 T. C. 886. It follows from what we have said, and it is our conclusion, that for the year 1943, the petitioner's profits from renegotiable business were excessive to the extent of $ 55,000 instead of $ 65,000, as determined by the Adjustment Board. We find no error in the Board's determinations for the years 1944 and 1945. Orders will be entered in accordance herewith.