9 T.C. 495">*496 The petitioner appears before this Court under favor of section 403 of the Sixth Supplemental National Defense Appropriation Act, 1942, as amended, and challenges the right of the Secretary of War and the Undersecretary of War to redetermine, as excessive, profits aggregating $ 70,000 realized by the petitioner during its fiscal year ended December 31, 1942, under its contracts and subcontracts subject to renegotiation pursuant to the provisions of the act. The determination was made on May 31, 1944, and the petition was filed on August 18, 1944.

The petition alleges that:

1. The Renegotiation Act is unconstitutional;

2. If constitutional, it is not applicable to the petitioner since it had no contracts or subcontracts with the Departments amounting to $ 100,000;

3. The petitioner had no excessive profits;

4. No proper consideration was given to price reductions and competitive prices of the petitioner's product, to its efficiency in reducing costs, to its economy in the use of raw materials, to its use of facilities and its conservation of manpower, to the quality of its production, to the rate of delivery and turnover, to inventive and development1947 U.S. Tax Ct. LEXIS 81">*83 contribution to war products, to the comparative percentage of profits, to the petitioner's guarantee of the quality of its products and their servicing, and to the petitioner's investment and reasonable rental value of its building and equipment.

FINDINGS OF FACT.

Certain facts were stipulated. In so far as they are material to the issues, the stipulated facts are as follows:

The petitioner is a partnership, consisting of Benjamin Grob and Theodore Grob, general partners, and Anna Grob, Mavis Grob, and Robert P. Zaun, trustee, limited or special partners, organized under the partnership laws of the State of Wisconsin, with principal offices in the village of Grafton, Ozaukee County, Wisconsin.

It is engaged in the manufacture, sale, design, invention, and distribution of machine tools, accessories, and allied lines, and in the owning, operating, and managing of real estate.

On or about May 31, 1944, the Undersecretary of War of the War Department of the United States made a unilateral determination that $ 70,000 of the profits realized by the petitioner during its fiscal year ended December 31, 1942, under its contracts and subcontracts subject to renegotiation pursuant to the provisions1947 U.S. Tax Ct. LEXIS 81">*84 of section 403 of the Sixth Supplemental National Defense Appropriation Act of 1942 (the Renegotiation Act) were excessive.

The product of the petitioner consists chiefly of metal-cutting hand saws, butt-welders and continuous band filing machines. Such products are primarily used in machine shops and tool and die shops. The products manufactured by the petitioner are the same now as they 9 T.C. 495">*497 were at the time of the inception of its business in 1929 and the same in 1942 as they were in 1929.

During the full year ended December 31, 1942, the petitioner had sales from all sources of $ 635,130.79. For the period April 29 to December 31, 1942, there were sales in the amount of $ 450,567.31. Of the $ 450,567.31, the sum of $ 48,553.19 represents sales made to the Defense Plant Corporation and the balance represents sales made to private concerns wherein the end use was designated by the purchaser as being either for the Army or the Navy.

During the full year ended December 31, 1942, the petitioner had costs and expenses of $ 473,011.92 in connection with income from all sources. Included in this amount of $ 473,011.92 is the sum of $ 20,000 representing an allowance in lieu 1947 U.S. Tax Ct. LEXIS 81">*85 of $ 10,000 annual salary each to Benjamin Grob and Theodore Grob, general partners. No allowance was made for rental of plant and equipment. The petitioner owns its plant and equipment outright. Included in the amount of $ 473,011.92 is the sum of $ 9,318.72 representing the annual depreciation on plant and equipment.

The reasonable expenses properly allocable to the above sales of $ 450,567.31 amount to $ 336,611.93, leaving a net profit of $ 113,955.35, before state or Federal income taxes. The net worth (per books) of the petitioner's business on January 1, 1942, was $ 84,278.26.

During the fiscal years 1936-1941, inclusive, the petitioner had gross sales and net profits (before any allowance for partners' salaries and before state or Federal income taxes) as follows:

It was stipulated that the testimony taken in Stein Brothers Manufacturing Co. v. Secretary of War, 7 T.C. 863, appearing at pages 615 to 764 of the transcript therein, 1947 U.S. Tax Ct. LEXIS 81">*86 should be received in evidence in the case at bar and that, with certain specified exceptions, the witnesses would testify in the present case as they did in the Stein case. The said testimony is incorporated herein by reference.

The record discloses the following additional facts:

The petitioner began business in 1928 in West Allis, Wisconsin, and moved to its present site at Grafton, Wisconsin, in 1936. During the period from 1936 to 1942, inclusive, its business was managed and controlled by the same individuals.

9 T.C. 495">*498 Benjamine Grob completed his work in an engineering school in Switzerland in 1923, when he came to the United States and was employed as a designer by the Allis-Chalmers Manufacturing Co. and A. O. Smith, from that year until 1928. He designed for the Allis-Chalmers Manufacturing Co. special machinery on which patents were obtained.

When Grob started the petitioner's business, the firm made tools and dies for others. He then discovered the need for a continuous motion filing machine, which he designed. In 1930 he developed the open-end band saw and improved it in 1939. He also designed and patented a briquetting machine, a butt-welder, and other special1947 U.S. Tax Ct. LEXIS 81">*87 machinery. He designed a machine to file the gas turbine wheel used in the Pontiac Torpedo Plant. The work on one wheel was done by his machine in 27 minutes, whereas it had formerly required 40 hours of skilled labor.

He also designed special tools for use in the petitioner's operations, such as an automatic milling machine, a cut-off machine for filing chains, a sand blast machine, hardening jigs, etc. No other engineering services were hired, or required, by the petitioner except those of Benjamin Grob and his brother, who assisted in all operations.

During the period of inventing, developing, and improving the petitioner's machines it made radical changes therein, resulting in the saving of material and man-hours. Examples of such changes were the substitution of pressed steel for cast iron frames and the use of concrete to fill machine bases instead of cast iron in order to give them weight, reinforcement, and rigidity.

In 1942 the petitioner's plant was first set up for, and adapted to, mass production.

The average life of the petitioner's band saws and filing machines was over 25 years, since the parts that wear out are quickly replaceable.

The petitioner services the machines1947 U.S. Tax Ct. LEXIS 81">*88 itself. Its machines are designed to accelerate the work of the tool maker.

In 1936 the petitioner erected its first factory building in Grafton at a cost of about $ 14,000. Benjamin Grob supervised the work, erected the steel work, and did much of the labor thereon. A second building was constructed in 1931, a third in 1940, and a fourth in 1941. The plant was erected on approximately 4 acres of land and contained over 30,000 feet of floor space. Its value on September 1, 1942, was $ 150,000. No Government aid was asked or required for the construction of the building, or for any other purpose.

The partners of the firm left in the business all the money not needed for taxes and living expenses.

9 T.C. 495">*499 The prices for the petitioner's products were not changed materially during 1942. They were lower than those of the petitioner's nearest competitor, the Do-All Co., of Minneapolis. The competitor's machine was a dual purpose machine which necessitated a mechanical change-over for separate filing and sawing operations, while the petitioner's machines were single purpose machines.

In December 1941 the partners of the petitioner formed trusts and paid to the trustee $ 65,0001947 U.S. Tax Ct. LEXIS 81">*89 from the funds of the petitioner as the corpora of such trusts. The petitioner then borrowed that sum from the trustee for capital use and gave its notes as evidence thereof. Such sum of $ 65,000 was in addition to the stipulated sum of $ 84,278.26 representing the petitioner's net worth (per books) on January 1, 1942.

The partners of the petitioner paid $ 17,382 as income taxes due to the State of Wisconsin. The petitioner filed an application for a certificate of necessity for the amortization of its plant and facilities with reference to the year 1942. The application was rejected, as shown in the following communication:

Jan 7 1944

SPPDT

Grob Brothers,

Grafton, Wisconsin

Subject: Application for Necessity Certificate File Number WD-N-28385

Gentlemen:

Your application for a Necessity Certificate, bearing the above file number, has been carefully considered by this office, but has been denied on the ground that the facilities sought to be certified are not necessary in the interest of National Defense within the meaning of Section 124 of the Internal Revenue Code, and the Regulations issued pursuant thereto.

Very truly yours,

[Signed] Moe Neufeld

Major, A. U. S.

For 1947 U.S. Tax Ct. LEXIS 81">*90 George H. Foster,

Chief, Tax Amortization Branch.

The net profits subject to renegotiation amounted to $ 113,955.35.

The sum of $ 25,000 would have been a reasonable allowance in lieu of salary for the full year 1942 and should have been used in the computation incident to renegotiation.

The petitioner's profits were excessive in the amount of $ 60,505.56.

OPINION.

The constitutionality of the Renegotiation Act was considered and discussed at length by this Court in Stein Brothers Manufacturing Co., 7 T.C. 863, and Ring Construction Corporation, 9 T.C. 495">*500 8 T.C. 1070. On the facts and arguments presented in those cases we held that the act is constitutional. In the case at bar the petitioner has challenged its constitutionality on several grounds, all of which were presented, considered, and discussed in Stein Brothers Manufacturing Co., supra, and Ring Construction Corporation, supra.The petitioner has suggested no new theories nor advanced any new grounds for supporting its contention. In Spalding v. Douglas Aircraft Co., 154 Fed. (2d) 419,1947 U.S. Tax Ct. LEXIS 81">*91 the court also passed on similar questions relating to the constitutionality of the act and declared that it violated no constitutional provisions. We see no reason to depart from our conclusions in the Stein and Ring cases and, therefore, hold that the petitioner has failed to show that the Renegotiation Act is unconstitutional.

The petitioner next presents the issue that it had no contracts or subcontracts with the Departments amounting to $ 100,000. The statutory definition of a subcontract is found in section 403 (a) (5) (i) and is as follows:

Sec. 403 (a). For the purposes of this section --

* * * *

(5) The term "subcontract" means

(i) 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.

* * * *

The petitioner maintains that it had no subcontracts for war work and challenges the existence of a "purchase order or agreement" defined in the statute to be a subcontract. However, the petitioner stipulated that during the period from April 29 to December 31, 1942, it had made sales amounting to $ 48,553.19 to the Defense Plant Corporation and that the balance1947 U.S. Tax Ct. LEXIS 81">*92 of the total sales of $ 450,567.31 made therein (or $ 402,014.12) represented "sales made to private concerns wherein the end use was designated by the purchaser as being either for the Army or Navy."

There is no question that the phraseology used meant that the articles furnished by the petitioner were required for the performance of a conract or subcontract with the Army or Navy. Otherwise, there would have been no reason to incorporate that language in the stipulation. Notwithstanding the stipulation, the petitioner seeks to place on the respondent the burden of producing formal orders or agreements supporting the sales. This the respondent was not required to do. The burden of proof rested on petitioner.

The intent of Congress patently was to limit profits derived from war production by prime contractors and subcontractors. The statutory 9 T.C. 495">*501 definition of a subcontract is extremely broad. It contains no requirement of the manner of making a purchase order or agreement or the form which such obligation must take. The petitioner sold its products understanding that they were destined for war-end use. By the terms of its stipulation, the petitioner thus brought itself1947 U.S. Tax Ct. LEXIS 81">*93 within the purview of the statute.

The petitioner points to the rejection of its application for a certificate of necessity as proof that it was not a subcontractor. Many factors may conceivably have entered into the action of the War Department (taken, incidentally, on January 7, 1944, long after the period at issue), pursuant to a statute unrelated to the Renegotiation Act and under conditions not set forth in the record. We do not see its pertinence to the issue at hand.

The petitioner asserts that it made no excessive profits and that, in any event, the respondent failed to consider various pertinent factors in making the determination. The petitioner had profits subject to renegotiation in the amount of $ 113,955.35. The respondent found petitioner's profits excessive by $ 70,000. Our question is, Has petitioner shown this to be erroneous?

The Court said in the Stein case:

* * * Congress, in section 403 (c) (3), indicated some guides to be used. Factors deemed relevant were already known by Congress to be in use in voluntary renegotiations when the act here in question was enacted. The Secretaries directed the renegotiating authorities to use those same factors and1947 U.S. Tax Ct. LEXIS 81">*94 their use as to subsequent years was later required by an amendment to the Renegotiation Act. See section 403 (a) (4) (A) as provided in section 701 of the Revenue Act of 1943. They are the factors which any reasonable person would naturally use in determining the amount of excessive profits. * * *

These factors are as follows:

(i) efficiency of contractor, with particular regard to attainment of quantity and quality production, reduction of costs and economy in the use of materials, facilities, and manpower;

(ii) reasonableness of costs and profits, with particular regard to volume of production, normal prewar earnings, and comparison of war and peacetime products;

(iii) amount and source of public and private capital employed and net worth;

(iv) extent of risk assumed, including the risk incident to reasonable pricing policies;

(v) nature and extent of contribution to the war effort, including inventive and developmental contribution and cooperation with the Government and other contractors in supplying technical assistance;

(vi) character of business, including complexity of manufacturing technique, character and extent of subcontracting, and rate of turn-over;

(vii) such other1947 U.S. Tax Ct. LEXIS 81">*95 factors the consideration of which the public interest and fair and equitable dealing may require, which factors shall be published in the regulations of the Board from time to time as adopted.

9 T.C. 495">*502 We also said in the Stein case:

Section 403 (c) (3) of the Renegotiation Act, applicable hereto, provides for recognition of deduction allowed for income tax purposes. A partnership is not allowed any deduction for income tax purposes on account of compensation of active partners, but the renegotiating authorities have recognized that allowance should be made for reasonable compensation for services actually rendered by them. * * *

Appreciating fully the inherent difficulties of the burden placed on the petitioner in these cases, we are nonetheless limited in our considerations by the proof adduced. The burden of proof rests on the petitioner and our decision is circumscribed by the record made.

The record is convincing that in Benjamin Grob the petitioner partnership enjoyed the services of a man whose value to the firm and, consequently, whose contribution to its success and to the war effort were not adequately compensated by the salary of $ 10,000. This fact reduced petitioner's1947 U.S. Tax Ct. LEXIS 81">*96 costs. E contra, had adequate recognition been given to this fact, petitioner's proper costs would have been greater and the amount of profits subject to renegotiation would have been less. This modest amount was in line with the petitioner's policy of leaving the profits in the business. It did not fix the amount of Grob's contribution. The sum of $ 25,000 would have been a reasonable allowance in lieu of salary for the full year 1942 and should have been used in the computation incident to renegotiation.

All of the factors prerequisite to forming a judgment, such as amount and source of capital employed, percentage of profits, return of investment, and similar elements have been weighed and tested as best we can with the record marked by paucity of specific proof. It will be conceded that petitioner did a good job and contributed substantially to the war effort. Such a concession, however, is not enough. The proof must be such as to bring to this Court a conviction that respondent has not dealt fairly with the petitioner, i. e., that his determination is not justified by the facts.

We have found that the sum of $ 25,000 would have been a reasonable allowance in lieu of1947 U.S. Tax Ct. LEXIS 81">*97 salary for Benjamin Grob for the entire year 1942. An allocable part of this sum was chargeable to renegotiable business. Total sales of petitioner for 1942 amounted to $ 635,130.79. Sales subject to renegotiation amounted to $ 402,014.12. Applying the ratio existing between these two sales figures to $ 15,000 (the increase found by us in the salary allowance) results in the sum of $ 9,494.44. The net result is that petitioner's profits were excessive in the amount of $ 60,505.56.

An order will issue in accordance herewith.