Opinion
Docket No. 20975.
1951-03-8
BREEZE CORPORATIONS, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Sydney A. Gutkin, Esq., and David Beck Esq., for the petitioner. Francis X. Gallagher, Esq., for the respondent.
Sydney A. Gutkin, Esq., and David Beck Esq., for the petitioner. Francis X. Gallagher, Esq., for the respondent.
The petitioner filed claim for relief as to excess profits taxes under section 721(a)(2)(C) of the Internal Revenue Code, on the ground that income for 1941 was abnormal in amount. Held, claim denied for the reason that the claimed net abnormal income for 1941 was the result of increased physical volume of sales due to increased demand, and therefore under Regulations 112, section 35.721-3, was not attributable to earlier years.
Petitioner seeks a review of the disallowance by the respondent of its claim for refund of excess profits tax for the year 1941, in the amount of $480,121.79. The only question for our consideration is whether the petitioner received during the taxable year 1941 from the sale of rotating antenna mounts and armor plate net abnormal income that was attributable to any previous taxable year or years so as to be entitled to relief for the taxable year 1941 within the meaning of section 721(a)(1) and (a)(2)(C) of the Internal Revenue Code.
The case was submitted in part upon a stipulation of facts. The facts stipulated are so found and incorporated by this reference. Such part as is considered necessary to set forth is included with other facts found from the evidence adduced in our findings of fact.
FINDINGS OF FACT.
The petitioner is a corporation, organized under the laws of the State of New Jersey, with in its principal office at Newark, New Jersey. The excess profits tax return for the period herein involved was filed with the collector of internal revenue for the fifth district of New Jersey. The return was prepared on an accrual basis of accounting and involves the taxable year ended December 31, 1941. Claim for refund of the excess profits taxes in controversy was filed by the petitioner on June 29, 1943. The Commissioner's letter rejecting the petitioner's claim was dated August 20, 1948. In the years immediately following its formation in 1926 as the result of the consolidation of three companies, petitioner manufactured automotive parts, including machinery, bumpers, flexible hose for heaters, carburetor heaters, and push and pull controls. Subsequently, and in or about 1929, petitioner began to manufacture aircraft parts and accessories for the aviation industry, including metal hose, shielding and bonding for aircraft, disconnect plugs, tie-rods, flow meters, fuel gauges, gun starters, and gun mounts. It also manufactured doors and hatches for the united States Government from light gauge stainless steel. Petitioner commenced a program of research and development with respect to antenna mounts November 1938 and face-hardened armor plate in August 1939. During the taxable year herein involved, petitioner was engaged in the manufacture and sale of radio shielding conduits and fittings, electrical connectors, tubings, cases and shafts, tie-rods, antenna mounts, and armor plate. During the years 1938 to 1941, inclusive, the United States Government, either directly or indirectly, was petitioner's largest customer, although Western Electric, Sperry Gyroscope, and Bell Telephone laboratories were likewise its customers during those years.
From 1938 on, petitioner occupied a number of plants and an office building, part of which it owned and part of which it rented, located in Newark, East Orange, and Elizabeth, New Jersey. Petitioner's personnel included unskilled, semi-skilled, and skilled labor, as well as professional engineers, sales engineers, draftsmen, and the customary clerical help.
The mobile antenna mount is a mechanism intended to support radar equipment with its antenna in such a way as to permit complete operation thereof in horizontal and vertical positions. The horizontal rotation is on a 360 degree plane and the vertical plane is 180 degrees, so that the entire sky can be scanned by the antenna. Operation also requires instantaneous determination of the exact position of the exact position of the antenna in space, and mobility is obtained by having the mount on a trailer or truck. The general category of product within which the antenna mount falls is radio and radar end equipment, which means that it is a final end product.
During all years in question, with respect to both the antenna mount and armor plate, petitioner kept the usual engineering records, written laboratory reports, sketches, blue prints, and tracings of all tests, experimentation, research, and development as well as photographs of the products at various stages of development.
On March 13, 1939, the Signal Corp gave petitioner an order for one rotating antenna mount. This unit was not mobile. The sales price was $1,350. During the remainder of March and throughout April and May 1939, petitioner's engineering department engaged in translating the basic concepts into details for manufacturing, making modifications where necessary, and culminating in a final assembly drawing, dated May 1, 1939. At about this time, the mount assembly was approximately six feet high, made of weldments, and because of the importance of accuracy, difficulty was experienced with distortions due to welding heats. Because of the unfeasability of performing later straightening operations, petitioner developed a sequence of welding operations resulting in automatic adjustments of the metal to heating applications, thereby obviating the straightening operations. The first unit was shipped by petitioner on May 25, 1939, and was delivered to the Signal Corps in June 1939.
The initial tests disclosed the necessity for many modifications in the mount, due primarily to the incomplete type of data received from the Signal Corps and the latter's continual expansion of requirements. The Signal Corps made no suggestion as to the method of correcting the problems.
By letter, dated September 28, 1939, addressed to the Director of the Signal Corps Laboratories, petitioner furnished certain specifications in regard to the antenna mount units, covering such items as the trailer, road clearance, rotation, gear, dust proof covers, backlash, lubrication fittings, paint, weight, and capacity to withstand wind velocity, and stated that the project was secret.
The petitioner received its second order from the Signal Corps under date of October 16, 1939, for two special mobile antenna mounts which included the specifications enumerated in the letter above mentioned. The total contract price was $25,722. One of the mounts was delivered on March 1, 1940, and the other on May 20, 1940. The petitioner had some problems that remained to be worked out in 1940. Two of them were the clearing up of the difficulty of too much backlash and the installation of a light hoist. On June 20, 1940, petitioner booked an order for thirty additional antenna mounts, two of which were shipped in December 1940 and the remainder at various dates in 1941 up to July 30, 1941. In early September 1940, petitioner received an order for 201 mounts which was cancelled and superseded by an order, dated November 6, 1940, for 406 mounts from Western Electric. Under this contract, petitioner was to furnish to Western Electric 406 completed mounts for specialized work by the latter (having nothing to do with the mount itself) and transmission of the entire unit to the Signal Corps. The first mount of this Western Electric order was shipped on February 26, 1941, and the 359th mount of said order was shipped on December 30, 1941. A further order was received on May 13, 1941, by petitioner from the Signal Corps for nine mounts, only five of which were shipped in 1941, starting on August 7, 1941, and ending on December 12, 1941. A total of 394 mounts was shipped and billed in 1941.
The petitioner has not manufactured antenna mounts since 1945.
The petitioner became interested in face-hardened armor plate for use in aircrafts as a result of a report rendered during 1937 by the brother of its president. The general type of armor plate in use in August 1939 was homogeneous armor plate wherein the hardness and strength of the steel throughout the thickness of the plate were uniform. In face-hardened armor plate only the face of the steel was hardened in order that the entire hardness was outward to the approach of the projectile with the remainder of the plate relatively ductile and soft to cushion the shock. Petitioner secured steel plates from various steel companies and experimented with different methods from August 1939 through the remainder of that year and most of 1940. The petitioner used the firing range at Cedar Gove, New Jersey, as a testing ground for its product during the early part of 1940. Later it maintained a firing range on its own premises. Petitioner also sent many plates to Aberdeen Proving Grounds for inspection by the Army. The petitioner had a product that was acceptable by the close of the year 1940 (about November 1940). Petitioner obtained orders for armor plate October 9 and 24 and November 15, 1940. It made a few minor shipments of armor plate in 1940. Its first shipment of consequence was January 20, 1941.
Prior to development of petitioner's face-hardened armor plate, none was ever used on aircraft in this country. Prior to petitioner's production thereof, no company in this country produced such light armor for use on aircraft.
Petitioner's profit and loss statements for the calendar years 1937 to 1941, inclusive, were as follows:
+-------------------------------------------------------------------------------------+ ¦ ¦1937 ¦1938 ¦1939 ¦1940 ¦1941 ¦ +--------------+-------------+-------------+-------------+-------------+--------------¦ ¦Sales ¦$1,521,665.64¦$2,631,124.78¦$2,695,160.85¦$4,489,545.44¦$15,525,288.66¦ +--------------+-------------+-------------+-------------+-------------+--------------¦ ¦Less returns ¦ ¦ ¦ ¦ ¦ ¦ ¦discounts, ¦40,864.14 ¦58,326.50 ¦94,778.46 ¦35,611.18 ¦80,024.48 ¦ ¦etc. ¦ ¦ ¦ ¦ ¦ ¦ +--------------+-------------+-------------+-------------+-------------+--------------¦ ¦Less excess ¦ ¦ ¦ ¦ ¦ ¦ ¦profits on ¦ ¦ ¦ ¦ ¦700,000.00 ¦ ¦renegotiation ¦ ¦ ¦ ¦ ¦ ¦ +--------------+-------------+-------------+-------------+-------------+--------------¦ ¦Net sales ¦1,480,801.50 ¦2,572,798.28 ¦2,600,382.39 ¦4,453,934.26 ¦14,745,264.18 ¦ +--------------+-------------+-------------+-------------+-------------+--------------¦ ¦Less cost of ¦ ¦ ¦ ¦ ¦ ¦ ¦sales, direct ¦ ¦ ¦ ¦ ¦ ¦ ¦costs and ¦962,612.74 ¦1,853,639.35 ¦1,777,545.62 ¦2,832,978.05 ¦9,531,756.52 ¦ ¦unabsorbed ¦ ¦ ¦ ¦ ¦ ¦ ¦burden ¦ ¦ ¦ ¦ ¦ ¦ +--------------+-------------+-------------+-------------+-------------+--------------¦ ¦Engineering ¦ ¦ ¦ ¦ ¦ ¦ ¦and ¦146,321.21 ¦140,749.60 ¦157,109.29 ¦206,455.79 ¦379,639.11 ¦ ¦development ¦ ¦ ¦ ¦ ¦ ¦ ¦expenses ¦ ¦ ¦ ¦ ¦ ¦ +--------------+-------------+-------------+-------------+-------------+--------------¦ ¦Royalty ¦8,991.40 ¦13,819.65 ¦19,436.77 ¦55,610.63 ¦53,034.37 ¦ ¦expenses ¦ ¦ ¦ ¦ ¦ ¦ +--------------+-------------+-------------+-------------+-------------+--------------¦ ¦Total cost of ¦1,117,925.35 ¦2,008,208.60 ¦1,954,091.68 ¦3,095,044.47 ¦9,964,430.00 ¦ ¦sales ¦ ¦ ¦ ¦ ¦ ¦ +--------------+-------------+-------------+-------------+-------------+--------------¦ ¦Gross profit ¦362,876.15 ¦564,589.68 ¦646,290.71 ¦1,358,889.79 ¦4,780,834.18 ¦ ¦on sales ¦ ¦ ¦ ¦ ¦ ¦ +--------------+-------------+-------------+-------------+-------------+--------------¦ ¦General ¦ ¦ ¦ ¦ ¦ ¦ ¦selling and ¦158,220.88 ¦317,137.19 ¦256,023.41 ¦392,460.84 ¦562,894.84 ¦ ¦administrative¦ ¦ ¦ ¦ ¦ ¦ ¦expenses ¦ ¦ ¦ ¦ ¦ ¦ +--------------+-------------+-------------+-------------+-------------+--------------¦ ¦Profit from ¦204,655.27 ¦247,452.49 ¦390,267.30 ¦966,428.95 ¦4,217,939.34 ¦ ¦operations ¦ ¦ ¦ ¦ ¦ ¦ +--------------+-------------+-------------+-------------+-------------+--------------¦ ¦Other income ¦31,095.92 ¦20,683.19 ¦5,169.21 ¦342,866.37 ¦69,022.72 ¦ +--------------+-------------+-------------+-------------+-------------+--------------¦ ¦Total ¦235,751.19 ¦268,135.68 ¦395,436.51 ¦1,309,295.32 ¦4,286,962.06 ¦ +--------------+-------------+-------------+-------------+-------------+--------------¦ ¦Other expenses¦819.77 ¦386.50 ¦6,652.36 ¦22,757.12 ¦28,355.39 ¦ +--------------+-------------+-------------+-------------+-------------+--------------¦ ¦Net income ¦234,931.42 ¦267,749.18 ¦388,784.15 ¦1,286,538.20 ¦4,258,606.67 ¦ ¦corrected ¦ ¦ ¦ ¦ ¦ ¦ +-------------------------------------------------------------------------------------+
The following is a schedule of sales by years (dollars volume) by products for the years 1937-1941, inclusive, and allocation of cash discounts to claimed ‘class‘ sales as shown on the books of petitioner:
+--------------------------------------------------------------------+ ¦ ¦Prepared by E. J. Hoses¦Date 10/27/49¦ +------------------------------+-----------------------+-------------¦ ¦Breeze Corporations, Inc. ¦ ¦ ¦ +------------------------------+-----------------------+-------------¦ ¦721 Claim ¦ ¦ ¦ +------------------------------+-----------------------+-------------¦ ¦Sales by Years—(Dollar Volume)¦ ¦ ¦ +------------------------------+-----------------------+-------------¦ ¦ ¦ ¦ ¦ +--------------------------------------------------------------------+
(Source: Data taken from clients' reports)
+-----------------------------------------------------------------------------+ ¦ ¦Year ended December 31 ¦ +---------------+-------------------------------------------------------------¦ ¦Products ¦ ¦ +---------------+-------------------------------------------------------------¦ ¦ ¦1937 ¦1938 ¦1939 ¦1940 ¦1941 ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦Radio ¦$398,935 ¦$427,010 ¦$613,492 ¦$1,377,622 ¦$3,951,803 ¦ ¦shieldings ¦ ¦ ¦ ¦ ¦ ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦Conduit and ¦310,452 ¦239,318 ¦343,301 ¦1,127,069 ¦2,553,042 ¦ ¦fittings ¦ ¦ ¦ ¦ ¦ ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦Electrical ¦74,282 ¦116,229 ¦204,154 ¦557,718 ¦849,977 ¦ ¦connections ¦ ¦ ¦ ¦ ¦ ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦Gun starters ¦66,105 ¦203,662 ¦124,310 ¦211,046 ¦791,597 ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦Tubing ¦42,528 ¦26,973 ¦32,136 ¦41,912 ¦73,643 ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦Case and shaft ¦39,348 ¦31,557 ¦32,695 ¦70,492 ¦86,334 ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦Molding ¦47,432 ¦21,202 ¦13,398 ¦18,813 ¦53,269 ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦Aircraft ¦ ¦33,879 ¦197,975 ¦479,152 ¦210,647 ¦ ¦miscellaneous ¦ ¦ ¦ ¦ ¦ ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦Brake lining ¦8,390 ¦7,656 ¦6,303 ¦4,118 ¦3,693 ¦ ¦machine ¦ ¦ ¦ ¦ ¦ ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦Gas and oil ¦22,088 ¦8,634 ¦7,513 ¦9,501 ¦ ¦ ¦line ¦ ¦ ¦ ¦ ¦ ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦Tie rod ¦22,613 ¦26,275 ¦21,380 ¦39,131 ¦56,347 ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦Library book ¦154,021 ¦1,169,193 ¦670,621 ¦ ¦ ¦ ¦shelf ¦ ¦ ¦ ¦ ¦ ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦Gun mounts ¦ ¦ ¦172,832 ¦264,155 ¦933,558 ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦Tab control ¦ ¦ ¦ ¦ ¦574,677 ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦Miscellaneous ¦43,002 ¦(6,303) ¦1,182 ¦42,956 ¦13,778 ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦Total sales, ¦ ¦ ¦ ¦ ¦ ¦ ¦other than ¦ ¦ ¦ ¦ ¦ ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦class below(A) ¦1,229,196 ¦2,305,285 ¦2,441,292 ¦4,243,685 ¦10,152,365 ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦Bulb ¦ ¦ ¦10,108 ¦16,821 ¦163 ¦ ¦thermometer ¦ ¦ ¦ ¦ ¦ ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦Fuel analyzer ¦55,623 ¦16,001 ¦118,006 ¦125,392 ¦61,724 ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦Stainless steel¦205,343 ¦260,420 ¦42,913 ¦76,853 ¦126,944 ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦Secret devices ¦ ¦ ¦ ¦ ¦ ¦ ¦(antenna ¦ ¦ ¦ ¦28,194 ¦4,644,403 ¦ ¦mounts) ¦ ¦ ¦ ¦ ¦ ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦Armor plate ¦ ¦ ¦ ¦ ¦534,014 ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦Flow meter ¦ ¦ ¦ ¦ ¦5,676 ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦Total sales ¦ ¦ ¦ ¦ ¦ ¦ ¦resulting ¦ ¦ ¦ ¦ ¦ ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦from ¦260,966 ¦276,421 ¦171,027 ¦247,260 ¦5,372,924 ¦ ¦development (B)¦ ¦ ¦ ¦ ¦ ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦Gross sales ¦1,490,162 ¦2,581,706 ¦2,612,319 ¦4,490,945 ¦15,525,289 ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦Less cash ¦9,360 ¦8,908 ¦13,337 ¦35,611 ¦80,025 ¦ ¦discounts ¦ ¦ ¦ ¦ ¦ ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦Net sales (A ¦1,480,802 ¦2,572,798 ¦2,598,982 ¦4,455,334 ¦15,445,264 ¦ ¦and B)(C) ¦ ¦ ¦ ¦ ¦ ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦Ratio of cash ¦ ¦ ¦ ¦ ¦ ¦ ¦discount to ¦ ¦ ¦ ¦ ¦ ¦ ¦sales ¦ ¦ ¦ ¦ ¦ ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦(D)(percent) ¦0.6281 ¦0.3450 ¦.0.5105 ¦0.7930 ¦0.5154 ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦Cash discount ¦ ¦ ¦ ¦ ¦ ¦ ¦applicable to ¦ ¦ ¦ ¦ ¦ ¦ ¦class ¦ ¦ ¦ ¦ ¦ ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦sales (E) ¦$1,639.13 ¦$953.65 ¦$873.09 ¦$1,960.77 ¦$27,692.05 ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦Net sales ¦ ¦ ¦ ¦ ¦ ¦ ¦resulting from ¦ ¦ ¦ ¦ ¦ ¦ +---------------+-----------+-----------+-----------+-----------+-------------¦ ¦development ¦$259,326.87¦$275,467.35¦$170,153.91¦$245,299.23¦$5,345,231.95¦ ¦(B-E) ¦ ¦ ¦ ¦ ¦ ¦ +-----------------------------------------------------------------------------+
In its claim for refund, the petitioner contends that the class herein referred to as ‘research or development‘ included the last six above named products. Petitioner did not develop the gun mounts and gun starter, included in the 21 products shown in the schedule of sales above.
The following schedule shows the net sales, cost of goods sold and gross profit on sales of antenna mounts, armor plate and all other products and net income for the year 1941:
+-----+ ¦¦¦¦¦¦¦ +-----+
Total Antenna Armor Other mounts plate products Sales $15,525,289 $4,644,403 $534,014 $10,346,872 Less: Cash discounts (0.5154% sales) 80,025 23,940 2,752 53,333 Net sales 15,445,264 4,620,463 531,262 10,293,539 Less: Excessive profits on renegotiation 1 700,000 2,062 16,045 681,893 Net sales after elimination of designated excessive profits on renegotiation 14,745,264 4,618,401 515,217 9,611,646 Less: Cost of sales: Per books (with unabsorbed burden allocated) 9,495,461 2,601,248 379,804 6,514,409 Adjustments 1 2 Schedule M of Return $10,838 R.A.R. 6/26/42 (40,101) R.A.R. 12/9/42 9,590 Liquidating damages 10,242 Adjustments allocated (9,431) (2,584) (377) (6,470) Revenue agent's report—8/16/44 property taxes 39,675 10,871 1,587 27,217 Revenue agent's report—4/2/46 Accelerated amortization 6,051 1,658 242 4,151 Adjusted cost of sales before royalties or engineering and development expenses 9,531,756 2,611,193 381,256 6,539,307 Royalties 53,034 53,034 Engineering and development expenses 2 379,639 104,021 15,186 260,432 Cost of sales 9,964,429 2,715,214 396,442 6,852,773 Gross profit on sales 4,780,835 1,903,187 118,775 2,758,873 Less: General and administrative expenses 2 562,895 154,233 22,516 386,146 Profit from operations 4,217,940 1,748,954 96,259 2,372,727 Other income $69,022 Other expenses 28,355 Other income net 40,667 Net income 4,258,607 FN2 Allocated in ratio of cost of sales per books.
The following schedule shows the development cost of antenna mounts and armor plate as charged to expense accounts and as recorded on petitioner's books for the years 1938, 1939, 1940 and 1941:
+----+ ¦¦¦¦¦¦ +----+
1938 1939 1940 1941 Antenna mount: Selling expense $200.00 $1,200.00 $3,050.00 $5,375.00 Engineering and drafting 480.00 9,903.25 18,866.08 12,814.21 Factory charges 116.34 .96 Total 680.00 11,103.25 22,032.42 18,190.17 Armor plate: Selling expense 2,004.00 7,674.99 13,468,73 Engineering and drafting 1,100.00 3,808.75 4,920.00 Factory overhead 240.00 240.00 Development and experimental 4,422.18 22,077.33 2,242.23 Total 7,766.18 33,801.07 20,630.96
OPINION.
DISNEY, Judge:
BLACK, J., dissenting: I dissent from the majority opinion wherein it holds that none of petitioner's net abnormal income can be attributable to prior years when research and development took place because petitioner's production of rotating antenna mounts and armor plate went into supplying the United States Government's armament program. It seems to me that the holding of the majority opinion that none of such net abnormal income can be attributable to prior years under the Treasury regulation relied upon does violence to such cases as Keystone Brass Works, 12 T.C. 618, and Pantasote Leather Co., 12 T.C. 635.
I, therefore, respectfully record my dissent.