38 T.C. 677">*677 The respondent, by order dated December 23, 1957, determined that 1962 U.S. Tax Ct. LEXIS 94">*95 Joan V. Beets and Marjorie C. Yeckel, copartners, d.b.a. The Thorson 38 T.C. 677">*678 Company, realized excessive profits for the year ended December 31, 1954, in the amount of $ 15,000 (reduced to $ 14,862, after proper adjustment on account of taxes measured by income, other than Federal taxes), derived from contracts and subcontracts subject to renegotiation pursuant to the Renegotiation Act of 1951, as amended. The general question presented is to what extent, if any, the Thorson Company realized excessive profits during the year 1954.

FINDINGS OF FACT.

Some of the facts have been stipulated and are found as stipulated.

Joan V. Beets (nee Joan V. Thorson) and Marjorie C. Yeckel (nee Marjorie C. Thorson) are daughters of C. J. Thorson and sisters of George O. Thorson. During the period beginning January 1, 1952, and extending beyond the year under review, 1954, Joan and Marjorie were copartners in a partnership that did business under the name of The Thorson Company, hereafter sometimes referred to as Thorson or the second partnership. Its address was 1644 North Orange Grove Avenue, Los Angeles, California, the same as C. J. Thorson's residential address, but the business was conducted1962 U.S. Tax Ct. LEXIS 94">*96 in a building separate from the home. Thorson, organized on January 1, 1952, was a successor to a partnership that operated under the same name, The Thorson Company, sometimes referred to herein as the first partnership or the Thorson Company. It had operated from the aforesaid address. The first partnership was organized about September 1949, and consisted of C. J. Thorson, hereafter referred to as C. J., and his son, George O. Thorson, hereafter referred to as George, each owning a 50-percent interest. They had no formal partnership agreement.

Each partnership operated as a manufacturer's representative and in connection therewith rendered sales-engineering services.

Prior to the formation of the first partnership, C. J. had had legal and financial experience and George had had experience in aviation engineering.

C. J. received a law degree from the University of Colorado Law School in 1914 and was admitted to practice law in Colorado. Thereafter, he taught classes at the university and practiced corporate law. The parties have stipulated that at some time during 1914 to 1922, C. J. did some engineering work for the United States Government and during the war worked in Washington. 1962 U.S. Tax Ct. LEXIS 94">*97 He was treasurer of California Bank, Los Angeles, from 1922 to 1928. He was a consultant and financial adviser from 1928 to 1941. From 1941 to 1945, he was vice president of San Diego Trust & Savings Bank, and from 1945 to 1947, served as contract termination negotiator for the United States Air Force.

George, during 1940 and 1941, was employed as a final assembly inspector by Lockheed Aircraft Corporation. During the years 1942 38 T.C. 677">*679 to 1946 he was a United States Air Force pilot. He attended the Air Force Flight Engineering School, serving as a flight engineer and as an engineering check or test pilot. He also served as an instructor in the Flight Engineering School and the Flight School. He served 21 months overseas (Pacific area) with bombers and fighters. During the period 1946 through 1948, he served in Alaska as flight captain and chief test pilot, and as sales and traffic manager of the Wein Alaska Airline, the oldest airline in Alaska with a full schedule. He returned from Alaska in January 1949, and for 6 months attended the University of California at Los Angeles, studying courses in economics and business and receiving a B.A. degree.

Little business, if any, 1962 U.S. Tax Ct. LEXIS 94">*98 was done by the partnership in 1949. In January 1950, it undertook nationwide aircraft sales representation of the Meletron Corporation, a manufacturer in Los Angeles of all types of pressure switches. Meletron's stock was owned by the president of the corporation and his wife. Arrangements were made for George to receive a token part of the common stock and to become the corporation's third officer. As of August 1, 1950, he became vice president and aircraft sales manager, and on the same date entered into an agreement with Meletron on a commission basis. He had no particular duties as vice president but under his contract handled sales and sales engineering of products for airborne application. Active continued participation in the ownership and operation of the Thorson Company was specifically included in the agreement covering George's association with Meletron. George was permitted to apply his time to both organizations as long as he got his work done for Meletron and handled no sales for the Thorson Company in competition with Meletron. He had no daily working hours at Meletron or the Thorson Company, allocating his time as he thought best, one month giving 60 percent1962 U.S. Tax Ct. LEXIS 94">*99 of his time to one and 40 percent to the other, and the next month reversing the allocation. Meletron was kept informed of George's work for the Thorson Company.

During the period George was associated with Meletron he negotiated at least four agreements under which the Thorson Company or Thorson became manufacturer's representative of firms which continued to be principals of Thorson during 1954.

On March 1, 1950, George, as an individual, entered into an agreement with Allen Aircraft Products, Inc., Ravenna, Ohio. It was on a "Standard Form of Agreement with Manufacturers' Agent," an extensive document which recited that various items were covered in attached exhibits, entitled "Territory," "List of Products," "Prices and Terms," "Commission Schedule," and several other designations. This principal manufactured valves of various kinds from approximately an inch cube up to a 12-inch cube. They were primarily used 38 T.C. 677">*680 in a plane's fuel system, but also were used in low-pressure pneumatic systems, lubricating oil systems, and the heat and vent systems.

The sales made for this principal in 1954 were Thorson's second highest sales.

In August 1950, the Thorson Company, through1962 U.S. Tax Ct. LEXIS 94">*100 George, became the representative of Acromark Company, Elizabeth, New Jersey. Thorson's sales for this principal in 1954, all renegotiable, amounted to only $ 963.10, on which Thorson received commissions of $ 141.12.

On or about April 4, 1951, the Thorson Company became "Manufacturers' Agent" of the Electronic Specialty Company, Los Angeles, California, hereafter referred to as Elsco. On April 16, 1951, C. J., on behalf of the Thorson Company, wrote a letter to Elsco, in which it confirmed their understanding to the effect that the agent was to represent the principal for the development of applications and procurement contracts for the principal's intervalometer in the west coast area (including the Wichita plant of the Boeing Airplane Company), for which the agent was to receive "a sales engineering fee of 10% upon all sales made within the aircraft industry for the territory herein covered, for the period of our exclusive representation of your Company, and upon all business realized thereafter which had its inception during such period of exclusive representation." It was also understood that the exclusive representation was to continue without further affirmative action of1962 U.S. Tax Ct. LEXIS 94">*101 either party, until terminated by mutual consent or by 90 days' written notice from either party. The above arrangement was accepted by the manager of the contract division of Elsco on April 17, 1951.

At some undetermined date a plan of operation for the partnership was executed so that after January 1, 1952, Joan and Marjorie would be the two general partners and C. J. and George would operate the business. It was recited in the document that C. J. and George as partner-owners of the first partnership were employed on a full-time basis elsewhere and were, therefore, not in a position to devote sufficient time to operate the business successfully; that C. J. was employed by the Los Angeles Regional Office of the Renegotiation Board and George was employed by the Meletron Corporation; that because of their employment conflicts and criticisms could arise if they actively participated in the operation or continued as owners of the business; that as partner-owners, any compensation they realized from their services would1962 U.S. Tax Ct. LEXIS 94">*102 not be deductible in the partnership's tax returns, and that their financial liability for the operation of the business should be limited and defined.

38 T.C. 677">*681 The instrument then recited that the partnership interests of C. J. and George be transferred to Joan and Marjorie so that each would own a 50-percent interest in the business as general partners; that Thorson would employ a full-time secretary and office manager, and an additional sales engineer to supervise sales operations; that George would continue as sales manager, without compensation, but would be entitled to reimbursement for direct and indirect expenses incurred by him on behalf of Thorson, computed on the basis of 1 1/2 percent of gross annual income; that C. J. would continue to handle all financial matters and supervise all operations on a consulting basis, and would be reimbursed for direct cash outlay incurred on behalf of Thorson.

It was further recited that since it was contemplated that George might eventually terminate his association with the Meletron Corporation and the first partnership had originally been organized to provide him with a vehicle for his future business career, no consideration was being1962 U.S. Tax Ct. LEXIS 94">*103 paid by Joan and Marjorie for the partnership business and George had agreed to assume the accrued and subsequent deficits and liabilities of the business, it being understood and agreed by the parties that George could acquire, at any later time, all or any percentage of Thorson by payment to the proprietary interest involved, an amount, in cash or its equivalent in accordance with a designated computation. It was provided that C. J. could acquire at any time prior to the exercise by George of his option, the 50-percent interest originally owned by C. J. (but assigned to Joan pursuant to the plan) upon payment to her in cash or its equivalent of the value of the 50-percent partnership interest, determined in accordance with the designated computation.

It was further provided that when and if either C. J. or George, or both, were in a position to render services to the partnership which would be productive of valuable and profitable results, reasonable compensation would be paid therefor as an operating expense of the partnership.

Under the plan C. J. was granted full authority and a general power of attorney to represent, commit, and obligate any of the parties to whatever extent1962 U.S. Tax Ct. LEXIS 94">*104 might be necessary to consummate the plan as contemplated.

On January 1, 1952, C. J. and George executed assignments under which they transferred their respective 50-percent interests in their partnership to Joan and Marjorie, respectively. The assignments were made without consideration, it being recited in each assignment that no profits had been realized and the future profit prospects were questionable, which eliminated any basis for a valuation or market for the interest involved; and that the tangible assets of the partnership were not of sufficient market value to liquidate the liabilities which were assumed by George.

38 T.C. 677">*682 In C. J.'s assignment it was further recited that Thorson might eventually develop some nominal profits, that each of C. J.'s other three children were reasonably well established financially, that the youngest daughter, Joan Vesta, would benefit more from such profits, if realized, than any other members of the family, she having no financial resources or prospects, "being a sophomore student at U.C.L.A.," and C. J.'s action would favorably affect her morale. It was also recited that C. J. was employed on a full-time basis by the United States Government; 1962 U.S. Tax Ct. LEXIS 94">*105 that he was unable to contribute actively and substantially to the development and operations of the partnership which would result in the necessity of employing others to operate the business.

In George's assignment it was recited that George was employed by the Meletron Corporation and was unable to contribute actively and substantially to the development and operations of the partnership which would result in the necessity of employing others to operate the business.

On January 1, 1952, Joan and Marjorie signed a printed form of articles of copartnership in which it was recited that they had agreed to and did become copartners in business under the name of "The Thorson Co." No contribution was shown to have been made by either partner toward the copartnership, nor was it shown what kind of business the copartners were to conduct.

On January 31, 1952, within the month after formation of the second partnership, George wrote a letter to the manager of the contract division of Elsco confirming "our understanding of amendments to our letter of April 161962 U.S. Tax Ct. LEXIS 94">*106 which is the basis of representation" of Elsco by Thorson. The amendments were stated as follows:

1. The coverage is to be expanded to include, in addition to the Intervalometer, all products manufactured by the Electronic Specialty Company which are ultimately airborne in their application.

2. This contract is to be extended to also include the Chance Vought Plant in Dallas, Texas, for the sale of all airborne items.

3. This contract is to be further amended to specifically include any sales of the "Sensitometer" regardless of where sold and specifically includes General Electric Corporation and/or any of the various plants producing North American designed airplanes, either in the United States or Canada.

Acceptance of the above was acknowledged by Elsco on February 2, 1952.

Elsco received its first order for the sensitometer in 1952 from North American Aviation, Inc., and subsequently General Electric became the primary customer.

Thorson's highest sales in 1954 were for this principal and the sensitometer comprised the great majority of such sales.

38 T.C. 677">*683 On November 25, 1952, the Safe Flight Instrument Corporation, White Plains, New York, addressed a letter to Thorson "Attention: 1962 U.S. Tax Ct. LEXIS 94">*107 Mr. George O. Thorson," acknowledging the letter of the latter of November 7, 1952, in which Thorson had offered to act as exclusive agent for the principal in certain western States and pursuant to certain conditions. The principal made a counteroffer, designating Thorson as its exclusive agent for all the sales and service engineering of Prestall Warning Systems, Life Instrumentation Systems, and Instrument Panel Vibrators made and rendered to airframe manufacturers in the States of Washington, Oregon, California, Arizona, Nevada, Idaho, and Montana, and to Western Airlines, Inc., throughout the United States. The commission was designated as 7 1/2 percent of the net sales, whether the sales were accomplished by the principal, the agent, or by and through the combined efforts of both. It was also provided that the agreement could be terminated by either party at any time after a period of 6 months upon a written 30 days' notice. The counteroffer was approved by C. J. on behalf of Thorson on November 29, 1952.

During 1952 Thorson put on its books gross sales of $ 727,381.77, was paid commissions on gross sales of $ 487,400, and received gross commissions of $ 37,269.01.

During1962 U.S. Tax Ct. LEXIS 94">*108 the years 1950 through 1952, Thorson and its predecessor had at least one graduate engineer as a full-time employee who rendered engineering sales service.

In January 1953, C. J. started devoting his full time to Thorson as its general manager. On December 1, 1953, after his association with Meletron had been terminated, George became Thorson's full-time sales manager. He was also employed as a sales representative and sales engineer. During 1954, other full-time employees were Donald E. Hughes and Kenneth C. Stone, sales representatives and sales engineers, and Dorothy Matthews, the exact nature of her duties not being shown. During the year Thorson employed four "part-time secretaries." Hughes and Stone paid their own local expenses.

Hughes had graduated in mechanical engineering at Purdue University in 1936. He was sales engineer for Crane Company from 1936 to 1941. During 1940 to 1945, he was a colonel in the United States Air Force. In 1947, he obtained a masters degree in business administration at Stanford University. From 1947 through 1949, he was sales engineer for the Standard Oil Company of California. He served as sales engineer for Owens Corning Fiberglass Corporation1962 U.S. Tax Ct. LEXIS 94">*109 from 1949 to 1952. He was sales engineer for Thorson from January 1952 to May 1959. ¹

38 T.C. 677">*684 Stone was a United States Navy electronics technician from 1942 through 1945. In 1950 he graduated with honors in electrical engineering at the University of Nevada. From 1950 through 1953, he was application and sales engineer for Westinghouse Electric Corporation. From 1953 through December 1955, he was a sales engineer for Thorson.

During 1954 Joan was a schoolteacher and unmarried, and Marjorie was a housewife. Each spent approximately 5 hours a week in connection with Thorson's business, conducting some correspondence and helping in the office at times of peak workloads. Neither of them engaged in any sales representative1962 U.S. Tax Ct. LEXIS 94">*110 work for Thorson. One or the other, or both, signed documents that were necessary for the operation of the business, consisting of tax returns, establishing a bank account, and obtaining business licenses. They were not involved in the specific details of the day-to-day running of the business, which were handled by their father and brother, who kept them informed.

Marjorie and Joan made withdrawals during the years 1952 through 1954 as follows:

The Internal Revenue Service disallowed $ 3,150 sales promotion expense for 1954, and in the adjustment treated it as partner withdrawal, making the total withdrawals for the year $ 21,158.19. Of the $ 3,150 disallowed as promotion expense, $ 2,525 represented payments of $ 1,350 and $ 1,175 to C. J. and George, respectively. Neither reported such payment in his individual income tax return for the year 1954.

During the years 1950 through 1954, George received compensation in various amounts from employers, as follows:

In his 1954 income tax return, George deducted as business expenses the sum of $ 16,955.11 expended during 1954 in behalf of Thorson. His 1954 return has been audited by the Internal Revenue Service and a total of $ 15,519.28 of said expenses was allowed as a deduction. The net salary George received from Thorson in 1954 amounted to $ 9,480.72.

38 T.C. 677">*685 During the years 1949 through 1954, C. J. received compensation in various amounts from employers and other income, as follows:

1962 U.S. Tax Ct. LEXIS 94">*112 On February 1, 1955, Marjorie and Joan signed a document in letter form addressed to C. J., as manager of Thorson, in which it was stated that they were pleased with the report rendered by C. J. as to the operations of Thorson for the fiscal year 1954, together with its financial condition and prospects for 1955, and further statements were made as follows:

1. We confirm our verbal request made to you during April 1954 and ratify the action which you took during the year 1954 in compliance with our request that you should continue to withdraw your salary of $ 1,000.00 per month, at least for the balance of 1954 (although it was apparent at the time the request and authorization was made by us that you might not be able to devote the full amount of time and effort for The Thorson Company as you had been doing previously on account of the change which had taken place in your state of health). Such continuance of your salary was to constitute a discretionary voluntary "wage continuation plan" which we as partners had determined upon for the benefit of any of The Thorson Company employees in our discretion as to the individual employee and the nature and extent of benefits thereunder.

1962 U.S. Tax Ct. LEXIS 94">*113 2. You are hereby authorized and instructed to pay George O. Thorson and yourself each $ 10,000.00 as "1954 discretionary profit participation compensation."

3. You are hereby authorized and instructed to distribute to each of the undersigned as the proprietary partners of The Thorson Company, 50% of all remaining profits of the partnership as of January 1, 1955, which we understand totals $ 32,846.39.

4. You are also authorized and instructed to continue withdrawals from the partnership for your own account in the amount of $ 1,000.00 monthly for the year 1955 as sickness benefit to you under the "wage continuation plan" referred to in paragraph 1 above.

5. We hereby confirm and ratify all official action taken by you during 1954 as Manager of The Thorson Company (regardless as to whether or not such action was specifically authorized by us, verbally or otherwise, as the proprietary partners).

On April 12, 1955, C. J. and his wife signed a joint return for the year 1954, reporting "Total Wages Etc." as having been received from Thorson in the amount of $ 22,000, "Less excludable portion received under wage continuation plans for sickness or injury" in the amount of $ 3,903, and showing1962 U.S. Tax Ct. LEXIS 94">*114 a balance of $ 18,097.

Most of Thorson's representations were limited to aircraft equipment which in general was procured by the Government under defense spending.

38 T.C. 677">*686 Products sold by Thorson on a commission basis included electronic controls for electrical systems, aircraft fuel system accessories, environmental test cabinets, vibration test machines, aircraft stall warning indicators, lift detectors and panel vibrators, self-locking aircraft turn buckles, aircraft component test panels, and flexible metal hose. During 1954, all principals were represented on an exclusive basis. Generally the territory covered by Thorson for its principals were the States of Washington, Oregon, and California, except for the Electronic Specialty Company, in which instance the territory covered the entire United States. As a general rule, commissions were due Thorson under its contracts on the 30th of the month following the month in which the principal received payment from its customers. The only compensation Thorson received was a commission on sales it made. The rate of commission payable to Thorson by the principals ranged from 5 percent to 25 percent.

The principals did the detail1962 U.S. Tax Ct. LEXIS 94">*115 designing of their products or equipment and it was their responsibility to service and subsequently to provide maintenance on such products and equipment. Testing of an engineered device was done by both the principal and the customer. Thorson collected data and information from the principals which it provided the customers, along with drawings, circuit diagrams, schematics, and manuals. For some of its principals it made up and prepared sales brochures and catalogs at its own expense. One function Thorson performed for principals was to expedite shipments to customers.

At all times material hereto Thorson employed the cash method of accounting. Costs and expenses were allocated to renegotiable business on the basis of commissions earned.

During 1954 Thorson realized a total of $ 120,895.35 in renegotiable income, within the meaning of section 103(g)(3) of the Renegotiation Act of 1951, as amended.

The following schedule shows the principals Thorson represented during the year 1954, the referable sales, and the rate of commission:

1962 U.S. Tax Ct. LEXIS 94">*116 38 T.C. 677">*687 The following schedule based on the above sales, shows the renegotiable commissions and rate, and the nonrenegotiable sales, commissions, and rate:

The term "referable sales" as used herein means the amount of the principals' sales upon which Thorson received commission income, as well as the sales related thereto in which no commissions were payable in the given fiscal years. The actual amount of sales on which Thorson received commissions during the year 1954 was $ 1,475,048.11, which figure includes $ 24,510.67 of sales made by Thorson's principals on which Thorson received no commission. The term "sales booked" as used herein means the amount of sales made by Thorson for its principals in a given accounting period.

During 1954, as shown above, the greater part of the sales by Thorson were for the contract1962 U.S. Tax Ct. LEXIS 94">*117 division of the Electronic Specialty Company at Los Angeles, referred to as Elsco. The contract division dealt exclusively with military products. The division had been discontinued between 1946 and 1950, and was reestablished in late 1950 or early 1951, partly because of increased activity during the Korean war period.

Elsco maintained an active research and development program through its Research and Development Laboratory, which insured quality control of all its products. The laboratory was equipped with modern precision mechanical and electrical measuring and testing equipment, data recording equipment, environmental test chambers, and other equipment for research, design, and testing of products.

During 1954 the major product on which Thorson did some work and for which it received commissions was the voltage sensitometer, a product of its principal Elsco. The sensitometer is a voltage sensing and time delay electronic device used in the electronic control system of the jet engine.

The sensitometer was developed in the latter part of 1951 or early in 1952. It was the result of a problem that grew out of the incapabilities of the airplane know as the F-86 D interceptor 1962 U.S. Tax Ct. LEXIS 94">*118 with a jet engine, 38 T.C. 677">*688 J-47. It was after the airplane was in production by North American Aviation Company for the United States Air Force that it was found that the power supply systems of the aircraft would drop dangerously low in voltage and power at crucial moments of the aircraft's takeoff. The problem was first posed to George Thorson by the engineers of North American. George felt that the voltage sensing and time delay constituted the basic problem and that the problem was within the capabilities of Elsco. George worked with the engineers of both concerns, obtaining the specific requirements from North American and taking them to the principal whose design department worked out some basic ideas for solving the problem, which were then discussed with North American, after which Elsco made up a breadboard or a device, which was circuitwise, able to solve the problem. The term "breadboard" is used to describe the first model of an electronic device. It usually consists of a large board on which the component parts are spread out and connected with wires. By this means the parts can be changed or hooked up differently and through testing prove out the circuit refinement1962 U.S. Tax Ct. LEXIS 94">*119 and later develop the finished product. The breadboard was made up and demonstrated to North American in 1951 or 1952. Then, because of the severity of the problem and the time factor, the solution of the problem was transferred to the engine manufacturer, the General Electric Company, in Cincinnati, Ohio. General Electric had the problem in 1951 or early 1952.

George demonstrated the breadboard unit to the group of engineers who were concerned with the problem at General Electric. By working with them he was able to get complete defense figures of the problem, make suggestions to the principal's design group, and coordinate the latter's efforts to meet the requirements of General Electric.

The original model of the sensitometer was designated T-162 and as it was improved a change in the model was shown by a letter which was attached to the basic part number. The first device delivered was T-162 A. The device was improved by changes that went from "A" to "F", "F" being the final development, which was put into production in 1953. From the time the first production order was received by Elsco in 1952, several changes were made in the device without reflecting a change in the1962 U.S. Tax Ct. LEXIS 94">*120 letter of the basic number. The Elsco model was chosen as the best offered, there being two other models offered by competitors. One competitor was the division of General Electric at Schenectady, New York, which manufactured the entire electronic system of the airplane. During the production of the models George served as a liaison between the principal and General Electric and coordinated a great volume of engineering data between the two. He provided engineering services, and attended and took notes on engineering 38 T.C. 677">*689 tests. Except for more complex engineering matters, which were handled by the engineers of the two concerns, George was the main contact with General Electric and its chief engineer regarded him very highly. The chief engineer dealt occasionally with other engineers of Thorson but most of his dealings with Thorson were through George.

Elsco's overall sales amounted to approximately $ 350,000 in 1952, $ 700,000 in 1953, and a little over $ 1 million in 1954. The contract division's sales for the respective years were approximately $ 50,000, $ 575,000, and $ 880,000, and the contract division's sales of the sensitometers for the respective years were in1962 U.S. Tax Ct. LEXIS 94">*121 the approximate amounts of $ 50,000, $ 560,000, and $ 775,000. The sale of sensitometers constituted approximately 88 percent of the sales of the contract division in 1954.

Elsco has followed the policy of rewarding the ingenuity and inventiveness of its engineers by paying them additional compensation based in general on the sales success of the devices in the development of which they have participated. In accordance with this policy, Elsco paid to William D. Gibbs, vice president and director of engineering of Elsco, in addition to his salary, an amount equal to 5 percent of the net sales of sensitometers, for the development of which he was largely responsible.

Another product of Elsco on which Thorson worked and for which it received commissions in 1954, was a device called regulometer. It was a voltage-regulating device used to control the input voltage into the transistor portion of the MA-2 bombing and navigation system used on the B-52 airplane being built by Boeing Airplane Company at Seattle, Washington. The problem arose in 1952 when the system was in flight status. Elsco, working through Thorson, developed the regulometer for the International Business Machines Corporation. 1962 U.S. Tax Ct. LEXIS 94">*122 Thorson had become aware of the problem as a result of its contact with the flight test group and the engineering groups at Boeing. The product was developed through 1952 and 1953, and the first production contract was received in March of 1954. Deliveries under the production contract did not commence until approximately June 1954. Thus, approximately 1 year and 4 months elapsed between the time Thorson began working on the regulometer and the time the first purchase order was received. An additional 3 months elapsed before Thorson received any commissions on the project.

Elsco kept an inventory of its nonmilitary products and on orders for such products it usually made immediate shipments. In the case of aircraft component sales shipments would be made within 6 weeks if the particular device "had been previously engineered." If it had not been engineered, the time lag between receipt of the order and shipment would be 3 to 4 months.

38 T.C. 677">*690 The number of sales made by Elsco in 1954 of the regulometers on which Thorson received commissions are included in the 12 percent of sales that cover products other than sensitometers.

The Thorson Company, from April through December1962 U.S. Tax Ct. LEXIS 94">*123 1951, and its successor partnership, from January 1952 through December 1954, and their principal Elsco had sales projects in the aggregate number of 155 for approximately 40 customers. In addition, there were other purchase orders.

Elsco rated Thorson as a highly qualified application engineering firm in rendering a number of very valuable contributions to the solution of problems for it and its customers and considered that the money paid Thorson for the services it rendered during 1954 resulted in full value received both by it and its customers with which Thorson was working.

In October 1955, Elsco and Thorson entered into a new agreement, under which commissions would be paid on net selling prices excluding freight, handling charges, direct Government business, qualification testing, and miscellaneous extra charges, as follows: 10 percent on all commercial and nonrenegotiable business, and 5 percent on Government contract, subcontract, and renegotiable sales.

The seller's products were described as follows:

Aircraft electrical, electronic and electro-mechanical devices for control or regulation of voltage, frequency or time, such as voltage regulators, timers, time delay relays, 1962 U.S. Tax Ct. LEXIS 94">*124 sequencing controls, voltage sensitometers; flashers, keyers, intervalometers, control boxes, amplifiers, test equipment, power supplies, relays, RF systems and components such as automatic antenna matching devices, VHF through microwave antennas and associated units, RF switching mechanisms.

The representative's territory was stated to be the States of California, Nevada, Arizona, and the States of Washington and Oregon as long as a representative was maintained in Seattle.

A major product manufactured by Safe Flight Instrument Corporation and on which Thorson received commissions during 1954 was a lift coefficient measuring system or aircraft warning indicator, which was developed for North American Aviation Company.

In 1953, the chief of flight tests of North American had the problem of a high sink rate on the F-100 plane, the first of a new series of supersonic airplanes, known as the Century Series. For supersonic speed, it was necessary to design a wing with an aspect ratio between the wing area and the span, the sweepback and other factors. Consequently, a sacrifice in the low-speed range had to be made and this caused trouble to the pilot in the approach or landing. To 1962 U.S. Tax Ct. LEXIS 94">*125 retain the high-speed advantage, the best solution to the problem was to provide the pilot with some warning so that he would not enter the low-speed range, particularly for younger and inexperienced 38 T.C. 677">*691 pilots. The chief flight test engineer knew George Thorson, who had worked with him on the F-86 plane of an earlier Saber series, normally referred to as fighter planes, a so-called subsonic aircraft in which the level flight speed was below the speed of sound, and who had discussed a device for a similar problem. He knew George represented the Safe Flight Instrument Company, which had a stall warning device that might, with considerable changes, solve the problem. The engineering services consisted of establishing the type of device that could solve the problem, engineer it, install it on the aircraft, and put it through tests at Edwards Air Force Base. The device was affected by speed brakes which are deflected underneath the fuselage, by the wing flaps, by the turning bank angle, and by other factors, and the choice of the location of the device on the aircraft's wing was the essential thing. It was first worked out by North American and Thorson, and then modified by 1962 U.S. Tax Ct. LEXIS 94">*126 the testing program. George rendered service as liaison of engineering data between the principal and North American and attended the tests of the device at Edwards Air Force Base, an aircraft-testing facility in California, operated by the Air Force.

In a comparatively short time, by the fall of 1953, the problem was solved and the device was on the aircraft that was produced in 1954. The result of the efforts of the principal, Thorson, North American and of the tests was a small device that has a tiny vane which projects from the leading edge of the wing and senses the direction of the airflow around the wing. There is a so-called stagnation point in the leading edge of each wing above which the airflow flows around the top of the wing and below which it flows around the bottom. By choosing the right location for the vane, one can approximate how much lift is on the wing. To select the location, it is necessary to have a knowledge of aerodynamics for the airflow, the pilot's problems as to what he should be warned of and in what manner, and some knowledge of structure. The device was a new application of an old idea.

The chief flight test engineer had dealt with many other 1962 U.S. Tax Ct. LEXIS 94">*127 engineering representatives and, compared with their services, he found Thorson's performance to be "Every bit as good."

Thorson also supplied services to Safe Flight, which pioneered a type of panel vibrator that imposed an artificial vibration on the instruments in jet aircraft in order to prevent them from sticking during operation of the aircraft.

The quantity of sales of the lift detectors and of the vibrators, and the commissions Thorson received on them, are included in the total sales made for the principal and the total commissions paid to Thorson, as shown above.

Thorson's third highest sales were for its principal Tenney Engineering Inc., Newark, New Jersey. On February 13, 1953, Robert 38 T.C. 677">*692 H. Brown, on behalf of the principal, wrote a letter to C.J. Thorson, in which the following statements concerning commissions were made:

we will go along on the basis of standard equipment (definition of standard equipment meaning standard size TSA, TH, TR, STR as well as S chambers and Servo units as given in the bulletins) in an amount of 10% of sales price. Any allowance made for freight or any freight prepaid would be deducted from the total sales price before commissions1962 U.S. Tax Ct. LEXIS 94">*128 figured.

This sales commission does not apply, however, to what we consider special deviation from standard equipment or walk-in chambers of any sort. On these latter items, it will be a fluctuating figure that can vary from job to job as we feel the dollar value which can be absorbed in the sale price. As a result, it may be a flat dollar figure or it may be on a percentage figure ranging anywhere from 2 to 10%.

On February 19, 1953, Brown further wrote to C. J. concerning commissions as follows:

Relative to our recent letter on the above subject, please understand that on items such as the Industrial Salt Fog Chambers, or any dealer items such as that, the former 5% commission applies. This is strictly a resale deal and we do not have any room for the 10%.

Also, in the event that it should come through, on the California Electronic Service proposition, this was a very special deal in which I allowed them a tremendous price reduction in order to charge it against advertising and you must bear with me on 5% on that particular job, as well as the order that is now in process for Electronic Manufacturing Corp. (our Job #1815)

* * * *

If we make special deals on standard equipment1962 U.S. Tax Ct. LEXIS 94">*129 in the future, you may have to bear with us to some extent.

On February 25, 1953, C. J. wrote to Brown acknowledging receipt of the two letters, and stated, in part:

We will assume, as implied in the two memoranda above referred to, that the 10% commission will apply to all quotations and purchase orders except those upon which you have personally notified us of a deviation from the 10%, and indicated at the time of quote or acceptance of a purchase order a commission which, in your judgment, is made necessary in order to meet competition, and your specific reasons therefore. [sic] * * *

On March 3, 1953, Brown acknowledged receipt of C. J.'s letter and agreed to C. J.'s suggestion.

This principal manufactured a line of environmental test equipment which was used to test aircraft equipment under simulated conditions that would be encountered in service, such as high and low temperature, sand and dust, salt spray, humidity, rain, 1962 U.S. Tax Ct. LEXIS 94">*130 and sunshine, or any type of environmental condition except vibration.

38 T.C. 677">*693 The sales Thorson made during 1954 for the five other principals aggregated a little over $ 62,000. The largest sales of the five were for Avica Corporation, which pioneered a new and different approach to the problem of flexible fluid lines and gaslines on aircraft. The only contract of record concerning flexible metal hose was with the Flexible Metal Hose Mfg. Company, Costa Mesa, California, a principal for which Thorson made its least amount of sales (less than $ 1,000). The contract, in letter form, dated January 8, 1954, was written by the principal to Thorson, "Att: C. J. Thorson," and was accepted by C. J. on behalf of Thorson on the same date. Under the agreement, Thorson became the principal's exclusive agent for the sale of Cal Flex Stainless Steel Bellows, Cal Flex Removable Hose Fittings, Stainless Steel Hose, and Assemblies manufactured by the principal. The commission was fixed at 10 percent of the net sales price. The territory was given as California, Oregon, Washington, and Arizona. The agreement could be terminated by either party upon 60 days' notice.

Thorson provided services1962 U.S. Tax Ct. LEXIS 94">*131 to L.A.B. Corporation, Summit, New Jersey, under a letter written by the principal to Thorson, "Attention: C. J. Thorson," on August 7, 1953, in reply to letters written by C. J. to L.A.B. on June 1, 1953, and July 16, 1953. Thorson became L.A.B.'s exclusive representative on the Pacific coast as of August 15, 1953, at a 5-percent commission on all orders of standard equipment, as cataloged, originating in the territory, with the exception of 19 designated firms, the majority of which had been customers of L.A.B. for some time and some of which were then in active negotiation for equipment. The commission on nonstandard equipment or specially engineered projects was fixed at 10 percent. Upon 60 days' notice by either party, the agreement could be terminated. Thorson provided services to L.A.B. on the equipment it produced to simulate the vibration that aircraft components would encounter in service in order to learn ahead of time of any weaknesses or failures which might develop in such components when actually in service.

During 1954, Thorson made a comparatively small amount of sales for the Impact-o-Graph Corporation of Cleveland, Ohio. In a letter dated August 10, 1953, to1962 U.S. Tax Ct. LEXIS 94">*132 Thorson, "Att'n. -- Mr. C. J. Thorson -- Manager," the principal acknowledged C. J.'s letter of August 6, concerning the matter of marketing the Impact-o-Graph. It was recited, inter alia, that under separate cover literature which would be helpful to Thorson was being sent; that a complete list would soon be mailed, giving the names of persons on the west coast who had contacted the principal and also a list of customers; that a copy of a letter was enclosed which was addressed to a person from whom Thorson was to obtain a model instrument and who would assist Thorson in its work; that the instrument could be used in demonstrating different models; 38 T.C. 677">*694 that a commission equivalent to 25 percent of the net proceeds would be paid on sales of recorders, batteries, or tapes; that during any calendar month in which three or more instruments were sold, an additional 5 percent covering all instruments sold during that period would be paid; and that the arrangement would cover a 3-month period, and for a 6-month period if Thorson desired.

Leach Corporation, formerly Leach Relay Company, Los Angeles, manufactured component parts for relays, which are electrical and mechanical 1962 U.S. Tax Ct. LEXIS 94">*133 and are components of electronic devices. The relay is actually a switch and also has numerous industrial applications from pinball machines to all types of electrical circuits. Relays constituted a specialty market and appeared of high performance demand on newer aircraft. Because of the necessity of making new designs, no finished relays were kept in stock, only components for circuits being stocked. Leach also manufactured motor generator sets and ground support equipment.

During 1954, Leach had a standard rate of commission it paid all of its representatives, 5 percent on renegotiable business and 10 percent on nonrenegotiable business. Its reason for the difference was because the majority of electronic business was of high performance and was in a military market where the customers were fewer than those that would normally be solicited in establishing an industrial market. The sensitometer developed by Elsco was a much more complicated device which performed functions in addition to those performed by the normal relay.

The following schedule is a summary of Thorson's profit and loss for the year 1954 broken down between renegotiable business (as previously defined) and1962 U.S. Tax Ct. LEXIS 94">*134 nonrenegotiable business as shown by Thorson's books and records and as reported on its partnership tax returns, incorporating the adjustments made therein by the Internal Revenue Service:

38 T.C. 677">*695 The following schedule is a detailed statement of Thorson's costs and expenses during 1954 as shown on the books and records and as reported on its partnership tax returns, incorporating therein the adjustments made by the1962 U.S. Tax Ct. LEXIS 94">*135 Internal Revenue Service:

The following schedule is a summary of the copartners' capital accounts, net income, and withdrawals for Thorson and its predecessor partnership for the years 1951 through 1954, as shown on the books and records and as reported on the partnership1962 U.S. Tax Ct. LEXIS 94">*136 income tax returns, incorporating therein the adjustments made by the Internal Revenue Service:

1962 U.S. Tax Ct. LEXIS 94">*137 38 T.C. 677">*696 A revised summary for year ending Dec. 31, 1954, incorporating Internal Revenue disallowances (with no adjustment for $ 14,862 refund) would be as follows:

During the year 1954 the Thorson Company realized excessive profits on its renegotiable net income of at least $ 15,000.

OPINION.

Respondent determined that the Thorson Company realized $ 15,000 excessive profits in 1954. Petitioners have instituted this proceeding alleging that no part of the profits realized by the partnership in 1954 was excessive within the meaning of the Renegotiation Act of 1951, as amended. Respondent makes no claim that the profits in excess of $ 15,0001962 U.S. Tax Ct. LEXIS 94">*138 were excessive.

This is a de novo proceeding and the Court, from the evidence of record, guided by the Renegotiation Act, the rules and regulations promulgated by the respondent pursuant to the Act, and the Court's own decisions, is to determine to what extent, if any, the Thorson Company realized excessive profits in the year in question. Boeing Co. v. Renegotiation Board, 37 T.C. 613">37 T.C. 613; Finnie Co. v. United States, 31 T.C. 1182">31 T.C. 1182; Vaughn Machinery Co. v. Renegotiation Board, 30 T.C. 949">30 T.C. 949; Trace v. United States, 25 T.C. 538">25 T.C. 538.

The "person" subject to the Renegotiation Act is defined in section 103 (j) as "an individual, firm, corporation, association, partnership, and any organized group of persons whether or not incorporated." The renegotiable profits of a partnership are, therefore, subject to renegotiation, that is, the partnership entity is to be renegotiated and not the individual partners. We do not understand respondent contends otherwise.

The phrase "profits derived from contracts with the Departments and subcontracts" as used in section1962 U.S. Tax Ct. LEXIS 94">*139 103 (e) of the Renegotiation Act is defined in section 103(f) as "the excess of the amount received or accrued under such contracts and subcontracts over the costs paid or incurred with respect thereto and determined to be allocable thereto." It thus appears that all and not a segment of the partnership's renegotiable profits are renegotiable. While the partnership was rendering its services to different manufacturers under separate contracts, respondent is not contending that each contract should be renegotiated.

38 T.C. 677">*697 In their endeavor to show that the partnership did not realize $ 15,000, or a lesser amount, in excessive profits during 1954, petitioners have produced quite a bit of testimony relating to the technical services rendered by the partnership and the development of certain devices that were engineered by both the manufacturers and their particular customers. In relation to the time of the services and the development of many articles or devices to which services were rendered by the partnership, the testimony is, in the main, of a general nature extending over periods of time other than the year under review and not specific as to actual services rendered during1962 U.S. Tax Ct. LEXIS 94">*140 the year in question. The facts as shown from the evidence are set forth in our Findings of Fact, and need not be related again. It is not necessary, as we are of the opinion that petitioners have failed to prove that all profits realized by their partnership were reasonable.

The evidence shows that the technical services rendered by the partnership were performed by persons employed by the partnership for such purposes, not the partners; that the partners not only performed no personal and technical services for the manufacturers the partnership represented, but rendered very little clerical assistance, working an average of only 1 hour a day for 5 days a week; that the petitioners contributed little, if any, financial aid to the partnership; and that the renegotiable commissions, the renegotiable costs, and the renegotiable profits of the partnership for 1954 were respectively $ 120,896.35, $ 84,473.03, and $ 36,423.32.

Ordinarily, where partners are engaged in the business of representing manufacturers they render personal services themselves, and expect to receive as compensation for their services a share of the profits realized by the partnership from such services, which 1962 U.S. Tax Ct. LEXIS 94">*141 profits, to the extent they are not excessive, are the value of the partners' services. Edell v. United States, 28 T.C. 601">28 T.C. 601; 25 T.C. 538">Trace v. United States, supra; Greaves v. War Contracts Price Adjustment Board, 10 T.C. 886">10 T.C. 886.

In the instant case, the evidence shows that the petitioners, as partners of the Thorson partnership, rendered no technical or personal services to the principals on behalf of Thorson. The only services they rendered consisted of a small amount of clerical assistance which, if placed on a salary basis, would justify only a small amount of compensation.

To justify petitioners' contention that the profits of the partnership are reasonable, we look to see what other contributions the partners made to the partnership. It may be that large financial contributions at great risks would justify, in the circumstances, greater profits for the partners, regardless of the small amount of personal services they rendered. The evidence shows, however, that petitioners made no contributions to the partnership's capital and very little, if any, of their profits were retained in the1962 U.S. Tax Ct. LEXIS 94">*142 partnership. In fact, they paid no 38 T.C. 677">*698 consideration for their respective partnership interests and were protected from any liability by their brother George assuming all liabilities, both the liabilities of the prior partnership and the subsequent liabilities of the petitioners' partnership.

The evidence shows that at the end of 1951, the last year of the first partnership, there was a deficit in the capital account of $ 722.72, and at the beginning of the year 1952, the first year of the second partnership, the capital account was shown to be the aggregate amount of $ 1,277.28, or $ 635.64 for each partner. It thus appears that $ 2,000 was advanced in order to pay the deficit of the first partnership and to leave the remainder for the capital account of the second partnership. The evidence does not indicate who contributed the $ 2,000, but it does indicate that the petitioners did not. It could be that George made the advancement, since he was a partner of the first partnership which had incurred the deficit and in the creation of the second partnership he agreed to pay all liabilities of both partnerships.

The partnership's ordinary net income for 1952 is shown in the1962 U.S. Tax Ct. LEXIS 94">*143 aggregate amount of $ 17,625.04, or $ 8,812.52 for each partner, and it is further shown that there were withdrawals during the year of $ 1,000 by each partner, or a total of $ 2,000, the equivalent of the capital put up at the beginning of the year. The capital account at the end of the year and at the beginning of 1953, is shown as $ 8,451.16 for each partner, or an aggregate amount of $ 16,902.32. The partnership's ordinary net income for 1953 aggregated $ 16,105.86, or $ 8,052.93 for each partner. Withdrawals totaling $ 15,000, or $ 7,500 for each partner, were made during 1953, leaving to the capital account at the end of the year the aggregate amount of $ 18,008.19, or $ 9,004.09 for each partner, which amounts were also shown as the partnership's capital account at the beginning of 1954, the year under review, and which amounts were withdrawn by the partners during the year. The books of the partnership show that the ordinary net income for 1954 aggregated $ 32,846.39, or $ 16,423.20 for each partner, which amounts were also shown to be the capital account of the partnership at the end of the year and which amounts were withdrawn on or about February 1, 1955. It is apparent1962 U.S. Tax Ct. LEXIS 94">*144 that by February 1955, all profits realized by the partnership during the 3 years of its operation had been withdrawn; that petitioners had no investment in the partnership; and that to them there was no investment risk.

It thus appears that petitioners having contributed so little personally and financially to the partnership, the value of their services is correspondingly little. On the other hand, it appears that the value of the partnership's services to the principals by the employees may be measured by the costs of their services. Both parties agree that the renegotiable costs of $ 84,473.03 are reasonable, particularly with respect to the compensation paid those rendering sales-engineering 38 T.C. 677">*699 services, which included the "discretionary profit participation compensation" in the aggregate amount of $ 20,000 paid to George and C. J. The partnership and the employees apparently agreed that the compensation paid and received was reasonable. Respondent does suggest that C. J. did not earn the $ 22,000 he received as compensation, as he was ill during the last 9 months of the year and for which period he received "sickness salary" and for which period he claimed "salary1962 U.S. Tax Ct. LEXIS 94">*145 exclusion" on his return. Respondent suggests that C. J. was paid more for services he rendered during the first 3 months of 1954 than he was paid for 12 months of service during 1953. However, no issue is raised, respondent merely pointing out its liberal action in allowing the full amount of C. J.'s compensation as part of the partnership's costs. Also, no issue is raised as to the compensation paid to George. The evidence shows that he received compensation of $ 25,000 for his services during 1954, but it also shows that he expended over $ 15,000 for expenses of the partnership for which he was not reimbursed. Why an employee should pay such a large amount of the partnership's expense and not be reimbursed is not explained, but it is shown that on audit of George's 1954 income tax return the Internal Revenue Service allowed as a deduction the amount of expense George paid personally on behalf of the partnership. The net aggregate of approximately $ 32,000 received by C. J. and George as compensation is considerably more than the aggregate of approximately $ 16,000 received as compensation by the two other sales engineers for their services.

Petitioners state that limiting1962 U.S. Tax Ct. LEXIS 94">*146 the value of the partnership's services to the amount of cost of the services would result in not permitting the partnership to have a profit, when the Renegotiation Act and respondent's own regulations expect a contractor to realize a profit; that all that would have to be determined would be the reasonableness of salaries; that the petitioners should be treated as stockholders of a corporation who render little or no service to the corporation, and that they should be permitted to retain the profits of the partnership earned, whatever was the contribution of the individual partners to the partnership.

There is a difference in the entity of a partnership and that of a corporation, just as there is a difference in the entity of both to an individual, but whether a renegotiable contractor is an individual, a partnership, or a corporation, he is not permitted to realize excessive profits. That is the purpose of the Renegotiation Act. In determining whether profits are excessive or not, there may be occasions to determine if salaries are reasonable, though the contractor be an individual, a partnership, a corporation, or any other entity. See 25 T.C. 538">Trace v. United States, supra; 1962 U.S. Tax Ct. LEXIS 94">*147 Waltham Screw Co. v. Renegotiation Board, 31 T.C. 227">31 T.C. 227; Stein Brothers Mfg. Co. v. Secretary of War, 7 T.C. 863">7 T.C. 863. 38 T.C. 677">*700 But, as shown in these cases, a determination that salaries are unreasonable does not deprive the contractor of all profits. Nor is the respondent contending here that the Thorson partnership is entitled to no profits.

Our question does not concern reasonableness or unreasonableness of salaries. The parties are in agreement that all costs, including salaries, of the partnership during the year in question were reasonable.

The Renegotiation Act sets forth factors that are to be considered in determining excessive profits and to the extent that such factors can be applied to a business such as that of the Thorson partnership, they have been taken into consideration.

After careful consideration of all evidence of record, we conclude, as we have found as a fact, that of the $ 36,423.32 renegotiable net income realized by the Thorson Company during the year 1954, at least $ 15,000 represented excessive profits.

An order will be issued in accordance herewith.