Supply Division, Inc. v. War Contracts Price Adjustment Board

Supply Division, Inc., Petitioner, v. War Contracts Price Adjustment Board, Respondent Supply Division, Inc. v. War Contracts Price Adjustment Board Docket No. 199-R. United States Tax Court 9 T.C. 1103; 1947 U.S. Tax Ct. LEXIS 14; December 15, 1947, Promulgated *14 1. Petitioner is a subcontractor within the meaning of the Renegotiation Act, and the act is not unconstitutional as applied to petitioner. 2. Petitioner, whose aggregate renegotiable sales were in excess of $ 500,000, is subject to renegotiation, notwithstanding its subcontracts were in amounts of less than $ 100,000 each. 3. Held, petitioner's excessive profits for the fiscal year ended December 31, 1943, were in the amount determined by the respondent, petitioner not having sustained its burden of proving the original determination was in error and the respondent not having sustained its burden of proving that petitioner had additional excessive profits. Carl J. Batter, Esq., and James C. Thompson, C. P. A., for the petitioner. William V. Crosswhite, Esq., and Paul L. Muilenburg, Esq., for the respondent. Arundell, Judge. ARUNDELL *1104 The respondent determined that petitioner's profits on contracts subject to renegotiation during the year ended December 31, 1943, were excessive to the extent of $ 60,000, within the meaning of the Renegotiation Act, and that after adjustment for state taxes the net amount to be eliminated was $ 59,562.34. The respondent has now affirmatively alleged that petitioner's excessive profits for the period in question amounted to $ 75,000. FINDINGS OF FACT. The petitioner is a corporation, organized under the laws of *16 Missouri on January 19, 1934. Its principal place of business for the period here involved was at Lambert Field, St. Louis, Missouri. In 1943 petitioner maintained a branch office at Oklahoma City, Oklahoma. The petitioner is now and during the year under review was engaged in the business of maintaining, acquiring, and offering for sale to the aircraft industry parts and accessories for the manufacture or repair of aircraft, and also pilots' supplies. Petitioner maintained a well stocked warehouse at Lambert Field, buying from manufacturers and selling as principal at wholesale and retail. The business was started in 1933 by W. F. Scott, who is the vice president of petitioner. Scott had been engaged in various phases of the aviation industry for a period of about 16 years. In 1937 H. W. Draughon joined the organization and became petitioner's president. Scott and Draughon were the only executive officers of petitioner. In 1943 Scott was 39 years old and Draughon 43. Scott was responsible for all details of purchases and sales and for the detailed management of the entire organization. Draughon determined and defined its long range policies, arranged the financing, negotiated*17 contracts with sources of supply, and solicited new manufacturing accounts for the petitioner to represent. The petitioner started its business in a very small room at the airport. It continued to expand its rented facilities there until it could no longer find space. Thereupon, it approached the city of St. Louis, banks, loan companies, and construction companies in an attempt to acquire land and to build larger quarters, but met with difficulties on account of the single purpose nature of the building. In 1940 Mrs. Draughon, the wife of the petitioner's president, had money of her *1105 own she wanted to invest. She financed the construction of a building, which was leased to petitioner for a 10-year period at a rental of $ 175 per month. This new building gave the petitioner warehousing space which it had not previously had. Petitioner's sales were in two distinct classifications, dealer and factory. The dealer accounts were composed of the itinerant flier who flew his own plane, the fixed base operators who repaired and rented planes and sometimes taught flying, the larger fixed base operators who taught flying, and competitors. The factory accounts were composed of*18 producers of airplanes. The trade discounts on dealer accounts averaged 20 to 25 per cent, whereas those on factory accounts were 50 per cent or more. In March or April 1943 petitioner was requested by the Government to send a representative to Wright Field at Dayton, Ohio. Draughon responded to the call and was advised that petitioner had been selected by a poll of aircraft manufacturers as one of three concerns to carry a stock of earmarked hardware to supply the various aircraft manufacturers in emergencies, in order to prevent shutdown of plants because of shortages. Petitioner was asked to carry a $ 600,000 inventory of materials selected by the Government, from which 10 per cent of any particular item could be delivered to any one manufacturer in a single month. The petitioner informed the Government officials that it was not in a financial position to undertake the assignment, that it did not have sufficient space to segregate the material, and that it would first have to ascertain whether it could borrow enough money to handle the transaction. On or about May 26, 1943, satisfactory arrangements having been made, petitioner was awarded an Army Air Force contract under which*19 it agreed to maintain a stock of specific earmarked parts for sale to airplane manufacturers up to a value of $ 600,000. This inventory was to be in addition to petitioner's regular stock, and the Government agreed to repurchase on termination of the contract any unsold portion of the earmarked inventory up to $ 600,000. A certificate of necessity in the amount of $ 81,269.40 was issued to petitioner for a warehouse building to house the earmarked inventory. The building was constructed by December 1, 1943. A banking arrangement was made with the Mercantile-Commerce Bank & Trust Co. of St. Louis for a million dollar revolving credit fund, which the Government guaranteed, agreeing to make good any deficiency. Petitioner was required to pledge as collateral the assignment of accounts receivable arising out of the earmarked stock, the earmarked inventory itself, $ 46,600 of U. S. Treasury notes, the assignment of the Government stock-piling contract, and a deed of trust to the building erected to house the earmarked stock. From June to December 1943, petitioner proceeded to recruit and *1106 train an organization to handle the earmarked stock and to contact sources of supply*20 to accumulate it. The 1943 sales of the earmarked inventory amounted to $ 45,616.37, on which a profit of $ 4,170 was realized: The earmarked stock had a concentrated weight load, and in order to keep operating costs within control it was necessary to provide for a 1,200 to 1,500 pound per square foot load in the construction of the building. The construction of the new warehouse was a severe drain on petitioner's working capital. At the end of 1942 its current assets amounted to $ 229,939.03 and current liabilities were $ 186,844.77, resulting in net current assets of $ 43,094.26. By the end of 1943, although surplus had increased by $ 52,345.81, petitioner's current position was changed so that current liabilities of $ 439,557.67 exceeded current assets of $ 438,427.13 by $ 1,130.54. Of the two other concerns chosen by the Government to maintain a stock of earmarked parts, one was on the east coast and the other was on the west coast. Late in 1943 and early in 1944 petitioner faced a declining market, but it continued to function under its stock-piling contract and absorbed the loss. The west coast concern declined to absorb the loss and ceased operations under its contract. *21 The east coast concern continued to function, but not nearly to the extent that petitioner did. The stock-piling contract was terminated in July 1944, and the materials were inventoried and paid for by the Government. The earmarked stock was left with the petitioner for sale as the agent of the Metals Reserve Co. under a contract calling for compensation of 30 per cent on sales. In October 1945 the rate of compensation was raised to 40 per cent, when the Reconstruction Finance Corporation acquired the stock and appointed petitioner as its sales agent. Sixty per cent of the surplus earmarked inventory in the possession of the petitioner was unsalable merchandise. Over-all gross profits on sales of such surplus property averaged about 30 per cent. For the years 1936 to 1943, inclusive, petitioner's sales, net profits before taxes, number of employees at the end of the year (exclusive of the two officers), officers' salaries, and percentage of profit on sales, were as follows: Net profit Number of Officers' Per cent of Year Sales before taxes employees salaries profit on sales [1936] $ 33,893.74 ($ 847.48) [3] $ 1,750.00 Loss [1937] 59,008.36 144.27 [2] 4,540.00 0.24 [1938] 81,983.21 51.25 [4] 6,625.00 .06 [1939] 85,012.04 5,044.58 [4] 5,021.15 5.93 [1940] 154,942.41 6,196.23 [6] 15,400.00 3.98 [1941] 336,872.28 7,467.38 [14] 24,250.00 2.22 [1942] 903,318.12 85,407.74 [36] 24,000.00 9.45 [1943] 1,989,037.20 196,353.12 [45] 24,000.00 9.87 *22 *1107 The petitioner's average profit on sales in the years 1936 to 1939, inclusive, was about 1.69 per cent. Petitioner's inventory turn-over was rather rapid. In the period 1936 to 1943, inclusive, inventory turnover was between 5 and 10 times a year. The following schedule shows petitioner's closing inventory and year end net worth for the period 1936 to 1943, inclusive: Closing Closing Year inventory net worth [1936] $ 5,000.29 $ 4,259.65 [1937] 9,718.21 5,629.90 [1938] 9,318.18 6,253.30 [1939] 14,534.70 13,022.66 [1940] $ 37,082.89 $ 18,186.67 [1941] 63,355.82 33,256.23 [1942] 68,103.65 59,616.56 [1943] 243,840.22 112,162.67 Of the petitioner's total net sales in the amount of $ 1,989,037.20 for 1943, $ 1,692,243.98 were of renegotiable nature and $ 296,793.22 were not renegotiable. Total costs and expenses on all sales were $ 1,792,684.08, of which $ 1,537,799.03 (including cost of materials, $ 1,402,688.55) was allocable to renegotiable sales and $ 254,885.05 (including cost of materials, $ 216,444.52) was allocable to nonrenegotiable sales. Total profits before taxes for the year 1943 were $ 196,353.12, of which $ 154,444.95 were allocable to renegotiable*23 sales and $ 41,908.17 to nonrenegotiable sales. The profit on renegotiable sales was 9.13 per cent and that on nonrenegotiable sales was 14.12 per cent. Petitioner's sales for 1943 were numerous and in small amounts. It issued over 27,000 invoices, averaging less than $ 100 each. Petitioner made no direct sales to the United States Government and held no contracts with the Government, except for the stock-piling contract mentioned above. It sold its merchandise to manufacturers and users of airplanes. Petitioner paid Missouri state income taxes in the amount of $ 1,678.90 on its 1943 profits as reported to the state. These profits did not reflect an adjustment for the amount of excessive profits determined by the respondent. The wartime business of petitioner was of the same general nature as its peacetime business, except that the variety of products which petitioner could handle was considerably more limited, and except that its volume increased during 1943 over 30 times its average sales in the period from 1936 to 1939, inclusive. Petitioner's wartime business was simple wholesaling, a procurement and resale operation, of the type of articles with which a high rate of turnover*24 was possible. The amount of capital employed and net worth were small in relation to the volume of business during 1943. The efficiency of the petitioner for 1943 was very good. Petitioner did not furnish any data or information to any price adjustment board during 1943 with respect to its 1942 business, and it *1108 was not renegotiated for excessive profits for the year 1942. Petitioner was renegotiated for 1944 and 1945 and given clearance, after having reported to the War Department Price Adjustment Board that its profits on over-all sales during those years were between 3 and 4 per cent of sales. The respondent's action in determining petitioner's excessive profits for 1943 was not arbitrary, capricious, or unreasonable. Due consideration was given to the efficiency of the petitioner; to the reasonableness of its costs and profits, with regard to the volume of business; to its prewar earnings, with little weight given to the fact that they were low; to a comparison of the wartime and peacetime products which petitioner handled and to the fact that the wartime variety of products was more limited; to the amount and source of capital employed in petitioner's business; *25 to the extent of the risk assumed by petitioner, particularly in connection with the expansion of its facilities toward the end of 1943; to the risks incident to petitioner's pricing policies and to those incident to a possible shrinkage in value of inventory; to the nature and extent of petitioner's contribution to the war effort, with emphasis upon the fact that it was one of three contractors selected to carry out the airplane supplies stock-piling program; to the character of petitioner's business and the fact that no manufacturing was done; to the rate of inventory turnover; and to the ability and experience of petitioner's officers. Petitioner's profits on renegotiable business in 1943 were excessive to the extent of $ 60,000 within the meaning of the Renegotiation Act, or in a net amount of $ 59,562.34 after adjustment for state income taxes. OPINION. Petitioner first contends that the Renegotiation Act as applied to it is unconstitutional. It attempts to distinguish ; , on the ground that those cases involved prime contractors*26 who had contractual relations with the Government. However, what we said in those cases with reference to the constitutionality of the act in general is equally sufficient to sustain the act as applied to the petitioner, a subcontractor. In any event, we have since specifically held the act constitutional as applied to a subcontractor, . See also ; ; affd., ; certiorari granted, ; ; affd., ; certiorari granted, ; ; affirmed per curiam, ; certiorari granted, . We need not, therefore, further belabor this issue. *1109 Petitioner next argues that*27 it is not subject to renegotiation because it is neither a contractor nor a subcontractor within the purview of the Renegotiation Act. It makes the point that it had no contracts involving an amount of more than $ 100,000 and calls attention to the provision in section 403 (b) of the act requiring the insertion of a provision for renegotiation in each subcontract involving an estimated amount of more than $ 100,000. A similar argument was made, but without success, in As we there pointed out, the statutory definition of a subcontract is extremely broad, 1 and the obvious intent of Congress was to limit profits derived from war production by both contractors and subcontractors. The question whether subcontracts in amounts of less than $ 100,000 are subject to renegotiation was also raised in the Lichter and Pownall cases, supra, although the decisions turned on other grounds. *28 Section 403 (b) also provides that: * * * Whether or not there is inserted in a contract with a Department or subcontract, to which subsection (c) is applicable, the provisions specified in this subsection, such contract or subcontract, as the case may be, shall be considered as having been made subject to such subsection in the same manner and to the same extent as if such provisions had been inserted. [Italics added.] But subsection (c) rather than (b) is the one dealing with the limitations on the power to renegotiate, and nothing in subsection (c) limits renegotiable subcontracts to those involving amounts of more than $ 100,000. Under paragraph (1) of that subsection, the Board is given power to renegotiate whenever in its opinion the amounts received or accrued under subcontracts may reflect excessive profits, and the Board "shall exercise its powers with respect to the aggregate of the amounts received or accrued during the fiscal year * * * by a * * * subcontractor under * * * subcontracts." Under the terms of paragraph (6), subsection (c) is applicable to all contracts and subcontracts to the extent of amounts received or accrued thereunder in any fiscal year*29 ending after June 30, 1943, regardless of whether they contain the provisions required under subsection (b), unless "the aggregate of the amounts received or accrued in such fiscal year * * * do not exceed $ 500,000." Here the aggregate of the amounts received or accrued was $ 1,692,243.98, which clearly exceeds the $ 500,000 limitation. Moreover, nothing in subsection (a), which defines the terms used in the act, restricts renegotiable subcontracts to those involving amounts of more than $ 100,000. We think it quite clear that the provisions of section 403 (b) are not *1110 a limitation on the definition of subcontract in section 403 (a) (5) (A). Such was the administrative interpretation early adopted by the renegotiating authorities, and we think rightly so. See J-PAB-2 (e), Joint Statement by the War, Navy, and Treasury Departments and the Maritime Commission, March 31, 1943. Nor are the provisions of section 403 (b) a limitation on the Board's power to renegotiate under section 403 (c). See We hold that there is no merit in petitioner's argument on this point, and that the petitioner is subject*30 to renegotiation. On the merits, the question is whether petitioner realized excessive profits on its renegotiable business and, if so, in what amount. The War Contracts Price Adjustment Board determined that petitioner's profits were excessive to the extent of $ 60,000, and in the answer respondent has asked for a determination that the excessive profits were at least $ 75,000. We held in , that the petitioner has the burden of proof with respect to any amount up to that originally determined as excessive, and respondent has the burden with respect to any additional amount. We find no merit whatever in petitioner's contention that the determination of the Board was arbitrary, unreasonable, and capricious, but think that the record amply demonstrates the contrary. The evidence shows that the various statutory factors 2 were taken into consideration in determining that petitioner's profits were excessive to the extent of $ 60,000. The remaining net profits on renegotiable sales, after deducting those determined to be excessive, allow the petitioner a margin of between 5 1/2 per cent and 6 per cent on sales -- approximately*31 equivalent to its best prewar year, 1939, and in excess of its average prewar experience. And certainly the petitioner is in no position to complain of the return on net worth which the remaining profits give it. In arguing that it had no excessive profits, petitioner relies on certain information and tables relating to renegotiated 1943 cases submitted by the chairman of the War Contracts Price Adjustment Board to the Select Committee on Small Business of the House of Representatives and published in the Congressional Record. 3 We think such information is of very little assistance for comparative purposes. While the average percentage of profits to sales after renegotiation in the cases there considered was larger than in petitioner's case, the return on net worth after renegotiation was very much less. If any weight is to be given to such statistical information, the net result appears to be that the factors therein favorable to petitioner's contentions are about equally*32 balanced by the unfavorable factors. It can not be doubted that petitioner's efficiency was good and that *1111 it assumed some risks, particularly in connection with the construction of the building to house the earmarked stock; and its undertaking in connection with the stock-piling contract was undoubtedly a contribution to the war effort. However, we are convinced that the profits remaining to petitioner, after deduction of the amount determined by the Board to be excessive, give it adequate compensation for those factors. Petitioner's operations were relatively simple wholesaling. It did no manufacturing, and there is no evidence that it made any inventive or developmental contribution. Its wartime business was of the same general character as its peacetime business, except that the variety of products it could obtain was more limited and the volume of business much greater. Its nonrenegotiable business in 1943 was greater than its average peacetime business. Its inventory*33 turnover was high. Upon a careful consideration of the entire record, we can only conclude that petitioner has not proved it had less than $ 60,000 excessive profits. On the other hand, we do not think the respondent has justified its claim for an increased amount. We have accordingly found that petitioner had excessive profits of $ 60,000, or a net amount, after adjustment for state taxes, of $ 59,562.34. ;; . An order will be issued in accordance herewith. Footnotes 1. Sec. 403. (a) For the purposes of this section -- * * * * (5) The term "subcontract" means -- (A) Any purchase order or agreement to perform all or any part of the work, or to make or furnish any article, required for the performance of any other contract or subcontract * * * * * * *↩ 2. Sec. 403 (a) (4) (A), Renegotiation Act.↩ 3. 91 Cong. Rec. 6145-6149.↩