11 T.C. 584">*585 By this proceeding petitioner seeks a redetermination of a deficiency for 1940 in excess profits tax of $ 1,703.81 and a deficiency in income tax for 1941 in the1948 U.S. Tax Ct. LEXIS 63">*64 amount of $ 478.54.

Petitioner has now conceded all of the adjustments made by respondent except one, which presents the only remaining issue. It is whether petitioner is entitled to special relief on its excess profits tax, as having received net abnormal income in 1940 which is attributable to other years under section 721 of the Internal Revenue Code.

FINDINGS OF FACT.

Petitioner is a Wisconsin corporation, organized January 17, 1917, with its principal office at Manitowoc, Wisconsin. Its tax returns for 1940 and 1941, prepared on a cash receipts and disbursements basis were filed with the collector of internal revenue for the district of Wisconsin.

During 1940, and for many years prior thereto petitioner had been continuously engaged in the real estate, insurance, and bonding business. In the conduct of its bonding business petitioner had acted as agent of various surety companies in the procuring of performance bonds, payment bonds, and other types of surety bonds. It had acted as agent for Fidelity & Deposit Co. of Maryland since 1933, and a substantial portion of its bonding business was effected through that company. Petitioner's business was well established, and there1948 U.S. Tax Ct. LEXIS 63">*65 were no substantial changes in the method of operation of the business in 1940 or prior thereto.

Pursuant to the Naval expansion program, Manitowoc Shipbuilding Co. of Manitowoc, Wisconsin, on or about September 9, 1940, entered into a contract with the United States, through the Acting Secretary of the Navy, for the construction of 10 submarines of about 1,500 tons each. The estimated construction cost of the 10 submarines was in the aggregate amount of $ 28,500,000. Under the contract, the first submarine was to be completed within 34 months from September 9, 1940, the tenth submarine was to be completed within 59 months from that date, and the remaining 8 submarines were to be completed at periodic intervals between these two. The contract also provided for a guaranty period of 6 months after the preliminary acceptance by the Navy Department. The last of the 10 submarines covered by the contract scheduled for completion on August 9, 1945, was delivered by the shipbuilding company to the Navy Department on October 26, 1943, and the 6-month guaranty period began to run at that time, terminating in 1944.

A separate supplemental contract was executed on or about the same date (September1948 U.S. Tax Ct. LEXIS 63">*66 9, 1940) by the shipbuilding company and the Acting Secretary of the Navy on behalf of the United States, relating to the 11 T.C. 584">*586 acquisition and installation of special additional plant equipment and facilities required to expedite the national defense program. The estimated cost of such equipment and facilities was in the amount of $ 1,000,000. The facilities contract contained a clause by which the shipbuilding company granted the Navy Department an option for a period not to exceed 90 days after the date of preliminary acceptance of the last of the 10 submarines, or after the cancellation of the contract, to require the shipbuilding company to maintain and preserve the facilities for shipbuilding not to exceed 5 years after the exercise of the option, the cost of the maintenance and preservation to be provided for by a subsequent agreement.

In connection with the submarine contract, the shipbuilding company was requested by the Navy Department to procure two separate surety bonds, each in the amount of $ 2,500,000, to guarantee performance of the submarine and facilities contracts and the payment by the shipbuilding company of all claims for labor, material, etc., involved1948 U.S. Tax Ct. LEXIS 63">*67 in carrying out the contracts.

At the request of the shipbuilding company and on its behalf, petitioner in 1940 procured the execution of the performance and payment bonds. Petitioner obtained as sureties on the bonds 13 separate companies engaged in the bonding, surety, and insurance business. The principal surety on each of the bonds was Fidelity & Deposit Co. of Maryland, which assisted in obtaining the execution of the bonds by the other 12 companies.

On or about October 17, 1940, each of the sureties executed a document designated "Assent of Sureties," under which they consented to the amendments and additions covered by the facilities contract and agreed that the bonds would cover all such amendments and additional obligations assumed thereunder.

The premium charged the shipbuilding company for the issuance of the bonds was $ 73,750.

On December 10, 1940, the shipbuilding company paid the $ 73,750 premium to petitioner, and petitioner on December 14, 1940, remitted the amount of $ 55,312.50 to Fidelity & Deposit Co. of Maryland, retaining 25 per cent of the premium or $ 18,437.50 as its commission. The entire amount of the commission was received by petitioner in 1940, and1948 U.S. Tax Ct. LEXIS 63">*68 petitioner included the entire amount in its income tax return for that year.

On December 10, 1940, petitioner wrote a letter to the shipbuilding company which stated that it was written and delivered by the authority of H. W. Pripps, representing the Milwaukee branch of the Fidelity & Deposit Co. of Maryland. The letter stated:

* * * *

Bond premiums are payable within ninety days after date of the contract which the bond guarantees. This contract with the Navy Department, as to 11 T.C. 584">*587 which bonds were furnished by the Fidelity and Deposit Company of Maryland and other surety companies, bears date September 9, 1940, although it is our understanding that it did not actually become binding by the signatures of the parties until considerably later than that.

In view of the date carried by the contract, we request that you pay the premium on the bonds at this time, and we confirm Mr. Pripps's statement that if hereafter your contract or the bonds should be cancelled for any reason, you will be entitled to have the amount of the premium returned to you, diminished by (a) the earned premium for the time during which the bonds were in force and (b) a reasonable handling charge.

This1948 U.S. Tax Ct. LEXIS 63">*69 agreement was in accord with the prevailing practice in the bonding business.

According to that same practice, petitioner was expected to and did "service" the bonds while the construction work proceeded on the submarine and facilities contracts. Servicing the bond in this instance included the making of progress reports on construction to the bonding companies, eliminating difficulties between the contractor and the principals, and the like. And, in the event of cancellation of the contracts before completion, petitioner would have to handle the refund to the contractor of the unearned portion of the premium, plus a proportionate part of the petitioner's commission. However, the submarine and facilities contracts were not canceled or terminated, but were duly performed in accordance with their terms, and none of the 13 sureties, which were carefully selected companies of the highest integrity and responsibility, withdrew from the bonds or failed to comply with their obligations. Petitioner was not required to arrange for substitute sureties or to refund any part of its commission of $ 18,437.50.

The total amount of bonds procured by petitioner in the regular course of its business1948 U.S. Tax Ct. LEXIS 63">*70 during each of the years 1936 to 1940, inclusive, and the aggregate premiums paid on the bonds were as follows:

Petitioner's total receipts from commissions on bond premiums for each of the years 1930 to 1940, inclusive, were as follows:

11 T.C. 584">*588 Petitioner's total receipts from commissions on bond premiums for the taxable year 1940 consisted of the $ 18,437.50 as the commissions on the foregoing performance bond, and the amount of $ 890.75 as commissions from other bond premiums.

The premium rate for most of the bonds procured by petitioner prior to January 1, 1940, was computed on the basis of the total amount of the penalty specified in the bond. The combined premium rate on the foregoing performance bond executed in 1940 was computed on the basis of $ 2.50 per thousand dollars of the aggregate1948 U.S. Tax Ct. LEXIS 63">*71 estimated costs of the construction contract and the facilities contract ($ 29,500,000), and was not based on the penalty specified in the bonds. The aggregate amounts of bonds and premiums for the year 1939 included a bond in the amount of $ 1,970,260, issued to Manitowoc Shipbuilding Co. in connection with the construction of a car ferry, on which the premium was in the amount of $ 9,851.50. The bond on the car ferry construction covered a period of over one year, although usually the period on the bonds procured by petitioner was not over a year.

The aggregate construction costs of naval ships under contracts executed by the United States Navy Department for each of the years 1936 to 1940, inclusive, were as follows:

Prior to 1940 petitioner had no business with respect to bonds executed in connection with the United States Navy ship construction contracts. After 1940 the shipbuilding company obtained a further contract from the Navy calling for the construction of 20 additional submarines, but no bond was required for that contract.

Although petitioner maintained an ordinary 1948 U.S. Tax Ct. LEXIS 63">*72 bookkeeping system, including a ledger, journal, and commission book, petitioner's books and records contained no record of any services performed by petitioner in the years subsequent to 1940 with respect to the bonds and they did not reflect any expenses paid by petitioner during those years in connection with the bonds. There was no entry in petitioner's books at any time as to services or expenses connected with the bonds, but such services were performed during the years 1940 to 1944, inclusive, without any assignment of dollar value thereto.

In its excess profits tax return for 1940 petitioner claimed that the bond commission of $ 18,437.50 was abnormal income, and stated that the amount of average annual income in the same class during the years 1936 through 1939 was $ 2,240.18. Petitioner reported as abnormal 11 T.C. 584">*589 income attributable to the four succeeding years a portion of the commission in the amount of $ 14,750 and eliminated that amount from its excess profits net income for 1940. It made that allocation in view of the fact that under the terms of the submarine contract the delivery date specified for the last submarine was a date approximately five years from 1948 U.S. Tax Ct. LEXIS 63">*73 the date of the contract. The statement attached to petitioner's return relating to its claim of abnormal income attributable to other years stated:

We submit a schedule showing by years the amount of income of the same class during the 4 taxable years, immediately preceding the taxable year:

Our commission on Bond premiums for the year 1940 amounted to $ 19,303.12, disclosing an abnormality in excess of 125 per centum of the average amount of commissions on bonds for the 4 previous taxable years. The year 1940 shows bond commission in amount of $ 865.62 exclusive of the abnormal item of $ 18,437.50 mentioned above.

In the notice of deficiency the respondent disallowed the amount of $ 14,750 reported as abnormal income attributable to other years. He determined that no portion of the income was attributable to other years, and also held that petitioner had failed to establish that it had realized during the taxable year any net abnormal income within the meaning of section 721 of the code.

In the taxable year 1940, one-fifteenth of petitioner's1948 U.S. Tax Ct. LEXIS 63">*74 net abnormal income ¹ was attributable to each of the years 1941, 1942, 1943, and 1944.

OPINION.

The present difficulty does not arise because of any question that some part of petitioner's income was "abnormal" within the meaning of section 721. It was abnormal in size, ² and that suffices. Geyer, Cornell & Newell, Inc., 6 T.C. 96. The reason given for attributing 11 T.C. 584">*590 it to other years, which is also necessary, Harris Hardwood Co., 8 T.C. 874, 882, namely, the duration of the bond liability for a period of more than 12 months, is related to a class of income which may itself be abnormal, ³1948 U.S. Tax Ct. LEXIS 63">*76 but we take it that that would merely fortify petitioner's position, not as a ground of abnormality, but as a ground of attribution ⁴ -- which is also necessary, Regulations 109, sec. 30.721-3, as amended1948 U.S. Tax Ct. LEXIS 63">*75 by T. D. 5045, 1941-1 C. B. 69, 86, on the theory that "other years" must always be involved when a contract lasts more than one, and that Congress so recognized.

The problems at hand are, to the contrary, practical, not theoretical. It is quite evident that, to some extent at least, this extraordinary income was, in fact, the result of increased demand, improved business, higher prices, or some combination of all three. Not only do the figures ⁵ make this clear, but these conditions were a direct consequence of the very aspect of the economy which motivated the excess profits tax -- the existence of the European war and the domestic armament program. See Eitel-McCullough, Inc., 9 T.C. 1132, 1148.

1948 U.S. Tax Ct. LEXIS 63">*77 If all of the abnormal income could be thus characterized, its abnormality would not suffice to justify special relief. Precisely such increases over the base period were the objective and the rationale of the tax.

* * * It is seen from this history and from the provisions of the act that the profits of a taxpayer for the base period years were to be regarded as normal in most cases and the tax was to be applied, generally, to the excess of the profits of the tax year over the prior normal profits. Congress anticipated that business for many taxpayers would improve because of external changes and it intended the tax to apply in those cases. * * * [Soabar Co., 7 T.C. 89, 96.]

On the other hand, even the respondent's regulations do not eliminate all abnormal income, but limit the exclusion for this cause "to the extent that any items of abnormal income in the taxable year are the result of high prices, * * * increased demand * * * or decreased competition * * *." (Emphasis added.) Regulations 109, sec. 30.721-3. We take this to authorize relief when to some extent, even if not wholly, the abnormality is due to other causes, see W. B. 11 T.C. 584">*591 ., 6 T.C. 519, 531,1948 U.S. Tax Ct. LEXIS 63">*78 at least when the basis for allocation to other years consists, as it does here, of the circumstance that we are dealing with a contract requiring several years for its performance; although to be sure that may be merely another way of saying that improved business does not account for all of the increased income.

We are hence not persuaded that either extreme of the views advanced can be approved here. We need not, on the one hand, agree that the income was due entirely to improved business, Geyer, Cornell & Newell, Inc., supra, nor, on the other, that it is attributable entirely to the chronological span of the service. See Ramsey Accessories Manufacturing Corporation, 10 T.C. 482. When all is said, there consequently remains to be ascertained what constitutes the source of the income, and, if necessary, to what extent it seems to be the one or the other. And merely because some work remains to be done under a contract, an equal division among all the years of its performance is not necessarily called for. The justification advanced for the present annual allocation, that the earning of the income coincides with 1948 U.S. Tax Ct. LEXIS 63">*79 the passage of time, certainly does not dispose of the probability that the procurement of the business in the first instance was the most potent factor in the earning of the commissions. Since that occurred in the tax year in issue, it seems necessary to place upon that year the greatest emphasis.

Without information as to the applicable data, the customary "earned premium" or "handling charge," the respective costs, the experience of petitioner and its competitors in the trade, the views of other qualified brokers, the impact of generally improved conditions on petitioner's line of business, and other bases for allocation, we have somewhat arbitrarily, see Cohan v. Commissioner (C. C. A., 2d Cir.), 39 Fed. (2d) 540, apportioned one-third of the "net abnormal income" to improved business and have divided the remaining two-thirds equally between procurement and servicing. See Ramsey Accessories Manfacturing Corporation, supra. In our findings we have accordingly spread only the latter one-third over the five years of the life of the contract and the services rendered thereunder, ⁶ allocating to each year one-fifteenth1948 U.S. Tax Ct. LEXIS 63">*80 of the total.

We have not, however, attempted to compute or to require of petitioner, any figures for the "direct costs" covered by the statute. ⁷ It 11 T.C. 584">*592 seems to be agreed that no such items appear on petitioner's books, which would be their most likely source, and the finding made at respondent's request so implies. If, in spite of this, it is claimed that such costs were incurred, the burden of going forward with evidence of their existence, if not of their amount, seems to us to have shifted to respondent. See Soabar Co., supra, 94. Other figures for the computation of "net" abnormal income having now been agreed to, all of the necessary material is available for the recomputation.

1948 U.S. Tax Ct. LEXIS 63">*81 Decision will be entered under Rule 50.

Arundell, J., dissenting: I agree with the majority opinion in its holding that the commissions received for the taxable year 1940 by petitioner in connection with the writing of the five-year performance bonds constituted net abnormal income, and that petitioner is therefore entitled to special relief on its excess profits tax for 1940, under the provisions of section 721 of the Internal Revenue Code. I do not agree, however, that the relief granted is adequate. The majority have attributed one-third of the income to increased demand, improved business, and higher prices; one-third of the income is attributed to the procuring and writing of the bonds; and only one-third of the income is allocated to the succeeding five years which the bonds would run and during which they were to be serviced by petitioner. In my opinion, there is no evidence in the record whatever to support the majority holding that one-third of the income is attributable to "increased demand, improved business, and higher prices." The evidence makes clear that the large commissions received in 1940 were due to the fact that the bonds were written1948 U.S. Tax Ct. LEXIS 63">*82 for a five-year term and not for the usual one-year term. The rate of commission was no greater for the year 1940 than in past years.

I agree that a greater sum should be attributable to the first year by reason of the fact that the work incident to the securing and writing of the bonds was performed in that year. But, it seems to me, based on this record, that if one-third of the income is attributed to 1940, this sum is sufficiently liberal to cover the matter of securing the business and writing the bond and also to cover any amount that could be attributed to that year by reason of improved business. I would, therefore, attribute to the year 1940 not more than one-third of the income and spread the remaining two-thirds, not over the original five-year period of the bond, but over the period that the risk actually extended.

11 T.C. 584">*593 Murdock, J., dissenting: Section 30.721-3 of Regulations 109 was considered in Soabar Co., 7 T.C. 89, 95, and the conclusion reached that no portion of net abnormal income of a tax year is to be attributed to other years where the excess of the income of this class for the tax year over 125 per cent of the average1948 U.S. Tax Ct. LEXIS 63">*83 of this class for the four years was due solely to an improvement in business conditions. Obviously, this improvement means improvement generally, not improvement just in the taxpayer's business. If it were to be measured only by improvement in the taxpayer's business, there never could be any relief under section 721. This very mistake is made in the majority opinion through footnote 5, where reference is made to figures which show, not a general improvement in business conditions, but an increase in the commissions which this particular taxpayer realized in 1940 over those realized by it in the four preceding years.

The increased commissions of this taxpayer in 1940 may have been due to some extent to an improvement in business conditions generally. Any failure of proof there must bear heavily upon the taxpayer. A large part of the 1940 commissions should be attributed to 1940 because that was the year in which the business was obtained and the subsequent servicing of the contracts was not at all comparable in importance to the obtaining of the business. Therefore, I would attribute a large part of the commissions to 1940, including enough to take care of any improvement in1948 U.S. Tax Ct. LEXIS 63">*84 business conditions generally. However, I would not assign two-thirds of the net abnormal income to 1940. Two-fifths would be sufficient.

I disagree with the report in attributing any of the net abnormal income to periods beyond those during which the contracts were actually being performed. Hindsight can be used in attributing a part of the net abnormal income for 1940 to other years in which it was actually earned. The report falls into error in allocating it equally over a five-year period when the evidence shows that it was actually earned in a shorter period.