Connecticut Marine Boiler Works
Sec'y (Chairman) Mar. Comm'n

This case is not covered by Casetext's citator
Tax Court of the United States.Feb 15, 1951
16 T.C. 339 (U.S.T.C. 1951)

Docket No. 447-R.



Benjamin A. Mahler, Esq., for the petitioner. John F. Wolf, Esq., and James H. Prentice, Esq., for the respondent.

1. Held, that renegotiation of petitioner's war contracts completed during its fiscal year ended December 31, 1942, was commenced within one year thereafter within the meaning of section 403(c)(6) of the Renegotiation Act of 1942.

2. Held, that the portion of petitioner's gross sales for 1942 which was received from subcontracts not completed until 1943 was part of petitioner's renegotiable business for 1942.

3. Reasonable compensation for petitioner's two officers in 1942 determined.

4. The amount of excessive profits realized by petitioner in 1942 determined. Benjamin A. Mahler, Esq., for the petitioner. John F. Wolf, Esq., and James H. Prentice, Esq., for the respondent.

Respondent made a unilateral determination on January 10, 1946, that petitioner had realized excessive profits in the amount of $32,000 from sales subject to renegotiation in its fiscal year ended December 31, 1942. This determination was made pursuant to section 403 of the Sixth Supplemental National Defense Appropriation Act, as amended (hereinafter referred to as the Renegotiation Act of 1942). The following questions are presented for our determination in this proceeding:

1. Was renegotiation of petitioner's war contracts completed during its fiscal year ending December 31, 1942, commenced within one year thereafter within the meaning of section 403(c)(6) of the Renegotiation Act of 1942?

2. Did $68,415.60 of petitionerS gross receipts for 1942, received as part payment under five subcontracts not completed until 1943, constitute part of its renegotiable business for 1942?

3. What constituted reasonable compensation for petitioner's two officers in 1942?

4. Were petitioner's net profits from renegotiable business in 1942 excessive, and if so, to what extent?


Part of the facts were stipulated and are so found except for the stipulation that officers' salaries totaling $30,000 reported by petitioner for the year 1941 constituted compensation paid to William Wilson only.

Petitioner was a corporation organized under the laws of the State of Connecticut in January ,9,. to engage in the business of designing and manufacturing various kinds of marine equipment. Its principal place of business was at Stratford, Connecticut. Its outstanding capital stock consisted of 270 shares of stock with a par value of $100 each. In 1942 William G. Wilson, president of the company, owned 150 shares, while his son Donald G. Wilson, vice-president, owned the remaining 120 shares of stock. In 1943 petitioner was succeeded by a partnership.

William Wilson had been in the structural steel business designing and manufacturing parts for ships long before the formation of petitioner in 1931. After serving his apprenticeship, he worked as an engineer for various companies engaged in building ships, high pressure boilers for plants, steel-constructed buildings, oil storage tanks, submarine hulls and other similar products from 1909 until 1918. In the latter part of 1918 Wilson went into business for himself, operating an individual proprietorship under the name of Connecticut Marine Boiler Works. He fabricated hatches, watertight doors, and boilers for ships and repaired ship parts.

Upon incorporation of petitioner in 1931, Wilson took a great deal of time from the regular activities of the company to experiment with the watertight door then in use to improve its design and make it more efficient. By 1939 he perfected a door called the Wilson-type water-tight door which proved satisfactory under the most exacting tests. The new door had fewer parts than the old door, its component parts were welded rather than riveted together, it stayed watertight over a longer period, and was more cheaply and efficiently constructed.

Petitioner was able to put the door on the market and produce it commercially for the first time in the early part of 1940. In that year a naval architect building ships for the Maritime Commission at Tampa, Florida, was impressed with the efficiency of the Wilson-type door, and included it in a plan submitted to the Maritime Commission for approval. When the plan was approved, petitioner thereupon received an order for production of watertight doors for those ships at Tampa. Thereafter a major portion of petitioner's work was the manufacturer of watertight doors for shipbuilders throughout the nation. Wilson never attempted to patent the door he developed.

During the years 1941 and 1942 petitioner's business consisted primarily of producing marine doors, ship hatches and skylight lifting gears for cargo ships pursuant to orders received from concerns which were constructing or repairing ships. It had no prime contracts with any of the Government agencies, but supplied such articles either to or on behalf of prime contractors or other subcontractors. The manufacturing process by which the watertight door were constructed commenced with the purchase of sheet steel by a subcontractor. The latter pressed it into panels of various dimensions and sent them to petitioner's plant where they were cut and trimmed to the desired shape. Dogs, which were to be attached to the doors, were produced by a subcontractor by drop-forging and then were transferred to another subcontractor which machined them. These dogs were then transferred to petitioner's plant where they were attached to the doors. Petitioner also purchased steel bars which it cut, bent to proper shape and fitted and attached to the doors by welding. It then purchased rubber and inserted it in the groove made up by the bars which had been placed on the doors. Hinges were produced by petitioner from steel bars and welded to the door. After all parts had been attached, the door was then aligned, tested, and delivered to the customer. This procedure was followed in the production not only of the standard type watertight door, but also of the watertight Dutch-type door and ‘quick-action‘ door. The Dutch-type door used at the entrance to ship galleys was divided in two halves. The ‘quick-action‘ type door could be shut with the mere turn of a wheel.

The hatches were produced in the same manner as were the watertight doors. The lifting gears were designed according to each particular location on a ship. In connection with the skylight lifting gears, various steel bars were purchased, and cut to size by petitioner. Some of these were sent to a subcontractor's machine shop to be machined and others were machined by petitioner itself. The machined parts were then assembled, tested, and delivered.

Such an extensive amount of subcontracting was necessary because petitioner did not have a plant equipped to do heavy pressing or machine work. Petitioner leased its only plant from William Wilson's wife. The plant covered an area of about 7,000 square feet in which was housed all of petitioner's equipment consisting of three drill presses, a small bench drill, six to eight portable drills, six to eight portable sanding and polishing machines, two heavy grinding machines, four acetylene cutting and welding machines, and a crane.

In 1941 and 1942 petitioner employed an average of eighteen men to do the shop work of machining, drilling, burning, welding, and assembling. Their tasks required such men to be skilled. The steel panels received at petitioner's plant had to be examined carefully on receipt. Though the panels were pressed out by means of a die, they were far from identical. It was quite normal to find plates with bent or twisted flanges, with short and long flanges, and with corners of different sizes. Petitioner's employees had to sort these panels, match them up, and often trim them. Where the panels were too uneven, it was necessary to reject them. Furthermore, each panel had to be laid out separately and lines drawn and marked for the proper location of parts. The dogs machined for petitioner had to be inspected to see that the tolerance was not too great. Care and skill was also required in welding the various parts of the watertight doors together. The workmen were under the direct supervision of a shop foreman. They acquired their various skills through a company training program.

Petitioner never hired a sales staff to obtain orders for its products.

William and Donald Wilson were the only executives employed by petitioner in meeting the expanded needs of the shipbuilding industry in 1941 and 1942, the former on a full time basis and the latter on a part time basis. The duties of William Wilson, as president in these years were many and varied. He was shop superintendent in full charge of production at petitioner's plant. Training programs essential to teach the constantly changing personnel the necessary skills were set up by him. As an engineer he designed the jigs and other apparatus needed in the machine work done both outside and inside the plant. He helped install and put into operation the equipment necessary to machine the dogs. He submitted sketches to the steel company producing the steel panels for petitioner's doors, showing the dimensions necessary for the production of standard-sized watertight doors. In addition William Wilson worked with them in achieving the proper dies. He submitted drawings of dogs to the subcontractor forging them for the doors and assisted it in getting a satisfactory die. He drew up plans to meet the requirements of shipbuilders and worked with the naval architects where necessary. As a draftsman he made many of the sketches involved in his engineering work. He was both purchasing agent obtaining materials needed at petitioner's plant and an expediter helping to get priorities in steel for subcontractors and hastening the flow of door parts to petitioner's plant. Finally, he did all the company bidding for orders and made the estimates necessary for the submission of bids. In these years William Wilson worked night and day, seven days a week, for petitioner. His responsibilities in 1942 increased slightly over those of 1941 due to the great increase in petitioner's orders.

Donald Wilson first started working part time for his father at petitioner's plant in 1935, while he was still in school. In the period 1935-1939 Donald made drawings and sketches to help his father in improving the design of the watertight door. He also designed a method of making Dutch-type doors watertight and obtained a patent thereon. In 1939 Donald received an engineering degree from Rensselaer Polytechnic Institute. Thereafter he received both a master's degree and a doctor's degree from Harvard.

In 1942 Donald was 25 years old and spent most of his time that year teaching engineering first at Rensselaer and later at M.I.T. Throughout 1942 he made it a practice to spend Saturdays and Sundays working at petitioner's plant. On these weekends he helped his father by designing and drafting work. He also studied and digested the constantly changing government regulations on war materials and priorities, and kept his father informed on how to operate under these directives. Even when he was away from the plant, Donald spent a portion of his spare time designing things for petitioner's business. In 1942 he designed a ‘quick-action‘ type watertight door, which allowed petitioner to fill orders for such doors. The great rise in petitioner's business in 1942 only slightly increased his duties over the prior years.

During each of the years 1931-1941 the gross sales, gross profits from sales, administrative expenses, salaries paid officers, and net income or loss of petitioner were as follows:

+-------------------------------------------------------------------+ ¦ ¦Sales ¦Gross profit¦Administrative¦Salary ¦Net income¦ +----+----------+------------+--------------+------------+----------¦ ¦ ¦ ¦ ¦and overhead ¦officers * ¦ ¦ +----+----------+------------+--------------+------------+----------¦ ¦1931¦18,877.50 ¦2,930.56 ¦5,447.46 ¦1,778.90 ¦(4,295.80)¦ +----+----------+------------+--------------+------------+----------¦ ¦1932¦11,100.81 ¦255.79 ¦4,707.37 ¦1,581.16 ¦(6,032.74)¦ +----+----------+------------+--------------+------------+----------¦ ¦1933¦10,145.13 ¦4,388.40 ¦2,727.78 ¦1,829.64 ¦(169.02) ¦ +----+----------+------------+--------------+------------+----------¦ ¦1934¦9,725.53 ¦2,485.65 ¦2,602.42 ¦ ¦(116.77) ¦ +----+----------+------------+--------------+------------+----------¦ ¦1935¦10,212.38 ¦4,150.61 ¦2,876.86 ¦1,371.52 ¦(98.77) ¦ +----+----------+------------+--------------+------------+----------¦ ¦1936¦17,802.19 ¦3,930.46 ¦3,482.10 ¦915.07 ¦(466.71) ¦ +----+----------+------------+--------------+------------+----------¦ ¦1937¦17,947.34 ¦6,577.46 ¦5,177.60 ¦1,800.00 ¦(400.14) ¦ +----+----------+------------+--------------+------------+----------¦ ¦1938¦16,263.63 ¦7,601.59 ¦5,539.17 ¦2,810.78 ¦(748.36) ¦ +----+----------+------------+--------------+------------+----------¦ ¦1939¦14,831.28 ¦8,265.72 ¦4,849.14 ¦3,661.49 ¦(244.91) ¦ +----+----------+------------+--------------+------------+----------¦ ¦1940¦32,716.83 ¦11,169.40 ¦5,944.31 ¦5,503.13 ¦(278.04) ¦ +----+----------+------------+--------------+------------+----------¦ ¦1941¦111,283.27¦49,776.27 ¦15,111.45 ¦30,000.00 ¦4,664.82 ¦ +-------------------------------------------------------------------+

FN* “Salary officers” in each year constitutes compensation paid only to William Wilson, except in the year 1941 when $12,000 of the $30,000 represents compensation received by Donald Wilson.

During the years 1931-1940 when petitioner was losing money, William Wilson was not paid a salary commensurate with his duties and abilities, but he expected when the watertight door was developed, he would be repaid for his earlier financial sacrifices.

A meeting of petitioner's board of directors was held April 6, 1942. The directors present at this meeting were William Wilson, his son Donald, and his daughter. A resolution was adopted as follows:

RESOLVED: — That the salaries of William G. Wilson and Donald G. Wilson, as such officers aforesaid, shall be computed by taking ninety (90%) per cent of the net profits of the company for the calendar year 1942 and allocating sixty (60%) per cent thereof to William G. Wilson for his salary for said year for both of said offices and forty (40%) per cent to Donald G. Wilson as his salary for said year as such Vice-President.

This resolution arose out of an agreement between William and Donald Wilson. Pursuant to the resolution petitioner paid William Wilson a salary of $63,000 and Donald Wilson a salary of $42,000 in the year 1942 based on its net income before salaries of $117,178.77. Such salaries were unreasonable and excessive in amount and constituted in part a distribution of profits.

In the year 1942 petitioner kept its books and filed its returns on the accrual basis. Included in its total sales for that year of $345,127.37 was $68,425.60 received for products having a war-end use under five subcontracts which were not fully completed in 1942. As to each of these subcontracts petitioner made a partial shipment and received part payment in 1942, while it completed shipment and received the balance on the contract price in 1943. On its tax return for 1942 petitioner included the $68,425.60 in its gross receipts. The amount of $68,425.60 is includible in petitioner's renegotiable sales for the year 1942.

It is stipulated that if it is found that these sales totaling $68,425.60 were part of petitioner's renegotiable business for 1942, then petitioner's non-renegotiable and renegotiable sales, costs of sale, expenses, and net income before officers' salaries for 1942 were as follows:

+-----------------------------------------------------------------------------+ ¦ ¦Non-renegotiable ¦Renegotiable ¦Total ¦ +-----------------------------+------------------+--------------+-------------¦ ¦Sales ¦$85,913.86 ¦$259,213.51 ¦$345,127.37 ¦ +-----------------------------+------------------+--------------+-------------¦ ¦Percentage of sales ¦24.9% ¦75.1% ¦100% ¦ +-----------------------------+------------------+--------------+-------------¦ ¦Cost of subcontract work ¦$30,160.00 ¦$90,964.50 ¦$121,124.50 ¦ +-----------------------------+------------------+--------------+-------------¦ ¦Other cost of goods sold ¦16,427.50 ¦49,546.38 ¦65,973.88 ¦ +-----------------------------+------------------+--------------+-------------¦ ¦Total cost of goods sold ¦$46,587.50 ¦$140,510.88 ¦$187,098.38 ¦ +-----------------------------+------------------+--------------+-------------¦ ¦Gross profit on sales ¦$39,326.36 ¦$118,702.63 ¦$158,028.99 ¦ +-----------------------------+------------------+--------------+-------------¦ ¦Plant and general expense ¦10,171.71 ¦30,678.51 ¦40,850.22 ¦ +-----------------------------+------------------+--------------+-------------¦ ¦Net income before salaries ¦$29,154.65 ¦$88,024.12 ¦$117,178.77 ¦ +-----------------------------------------------------------------------------¦ ¦Note: Petitioner kept no separate records of costs for the performance of ¦ ¦each contract, and it is stipulated that all costs and expenses are to be ¦ ¦prorated to renegotiable business in the ratio that renegotiable sales bear ¦ ¦to total sales. ¦ +-----------------------------------------------------------------------------+

The tremendous jump in petitioner's sales and in its net profits experienced in 1942 was due to the nation's wartime economy rather than the services of its two officers.

Respondent made an allowance of $24,000 for officers' salaries in 1942 of which $18,024 was allocated to renegotiable business, leaving as net income from renegotiable business $70,000.12. Respondent determined that $32,000 of this total constituted excessive profits.

Reasonable compensation for the services performed by petitioner's officers in 1942 totaled $32,000, of which $24,032 is allocable to renegotiable business. petitioner's net income from renegotiable business in 1942 was $63,992.12.

Approximately $275,000 of petitioner's total sales of $345,127.37 in 1942 were attributable to the sale of standard watertight doors. Sale of dogs amounted to about $20,000. The manufacture of watertight Dutch doors produced about $6,000, while the sale of ‘quick-action‘ doors accounted for approximately $12,000. Contracts for skylight lifters and hatch covers amounted to $3,000 and $18,000, respectively. Miscellaneous sales were about $4,000.

Petitioner's operations at its plant in 1942 were relatively simple, involving light machine shop, welding and assembly work. The fabricating work done at petitioner's plant did not involve any complicated manufacturing technique or require any specialized engineering skill. Any reasonably competent machine shop operator could fabricate the doors and other products, while the welding and assembly processes were not unduly difficult. The largest single operation in connection with making the doors and hatches was pressing the steel panels, and this work was subcontracted by petitioner. Another major operation in connection with the making of these products, the forging and machining of ‘dogs,‘ was also subcontracted by petitioner. Of petitioner's total cost of good sold in 1942 which amounted to $187,098.38, the cost of the subcontract work, including raw materials procured and used by the subcontractors, totaled $121,124.50. Petitioner subcontracted approximately 50 per cent of the manufacture of the watertight doors and hatches.

Petitioner obtained no loans or other financial assistance from public sources to enable it to carry on business operations during 1942. Necessary additional capital was provided by borrowing from banks, which loans William Wilson personally guaranteed.

Petitioner's business operations entailed no unusual business risk, due to the fact the plant was rented, the number of machines and employees was small, and there was a lack of complicated production problems. In relation to sales its net worth of $29,228.81 on January 1, 1942, turned over many times during the course of the year. Petitioner did not have procurement and inventory risks to the extent of a company conducting an integrated manufacturing operation. Because of its subcontracting petitioner did not bear any risk in connection with the cost of dies used in pressing the door and hatch panels. These dies cost the subcontractor approximately $30,000. The subcontractor amortized their cost by charging petitioner and other purchasers of the panel $7 apiece until the full cost of the dies was recovered. Petitioner's shop could readily be converted to peacetime pursuits.

Petitioner made no significant inventive or developmental contribution to the production of an improved watertight door, nor was there any problem in procuring watertight doors during the war years. The only vital difference between the manufacture of watertight doors in 1931 and 1941 was the use of welding rather than riveting. While the Wilson-type door was approved by the Maritime Commission, it was never submitted for approval as such, and such approval was by no means unique. During the war various prime contractors submitted at least fifteen watertight door plans similar to that of Wilson and they were approved. While the typical door plan drawn up by the Maritime Commission in 1942 as a basis for checking the plans and specifications coming in from contractors was identical to the Wilson-type door, yet it had been used on ships long before then. The Commission never adopted the Wilson door as its standard watertight door. Donald Wilson's patented method of making the center break in a Dutch door watertight had only a limited application, for it was not a common requirement that such doors be watertight. There was nothing new about the ‘quick-action‘ doors designed by Donald Wilson.

Petitioner's profits from its renegotiable business in 1942 were excessive in the amount of $20,000.

Facts in Respect of Statute of Limitations

On October 25, 1943, Major W. Howard Dilks, Jr., Clearance and Assignment Officer, Departmental Price Adjustment Boards, wrote to petitioner requesting it to furnish certain information regarding its renegotiable business in 1942 on a mimeographed ‘Standard Form of Contractor's Report‘ which was enclosed. The letter stated in part as follows:

The above Government Departments and Agencies have established Price Adjustment Boards to conduct the renegotiation of contracts and subcontracts as provided under Section 403 of the Sixth Supplemental National Defense Appropriation Act, 1942, as amended, to determine whether or not excessive profits have been or are likely to be realized under such contracts and subcontracts.

The purpose of this information is to facilitate a determination of whether or not further action need be taken in regard to statutory renegotiation proceedings with your company.

On November 17, 1943, petitioner received a telegram from Major Dilks asking that the information requested in his letter of October 25, be submitted without delay. Thereupon petitioner executed and mailed to Major Dilks the ‘Standard Form of Contractor's Report,‘ setting forth therein detailed facts relating to its business during its fiscal years ended December 31, 1941 and 1942. The report stated that William Wilson received a salary of $18,000 and Donald Wilson a salary of $12,000 in 1941.

On November 24, 1943, Major Dilks mailed a letter to petitioner stating that on the basis of information contained in the form filed by it that further consideration of the renegotiation of its contracts was being referred to the Maritime Commission. On the same day Major Dilks assigned petitioner to the Price Adjustment Board of the Maritime Commission for renegotiation.

On December 10, 1943, petitioner's president, William Wilson, received a telephone call from Edward W. Burnham of the Maritime Price Adjustment Board requesting him to come to the Board's offices at 45 Broadway, New York City, New York, on December 14, 1943, to further breakdown and explain the figures previously submitted by petitioner regarding its business in 1942.

On December 14, 1943, William Wilson and the company auditor, 3. P. Levine, held a conference with Burnham, regarding renegotiation of petitioner's war contracts for the year 1942. Later that same day Burnham executed an interoffice memorandum of the conference, setting forth specific, detailed information disclosed at the conference by the company representatives concerning petitioner's financial history up to and including 1942. The memorandum noted that in discussing petitioner's renegotiable business for 1942, the conference agreed that certain additional facts concerning such business desired by the Board would be supplied by petitioner.

No further communication between petitioner and the Board occurred prior to the close of 1943.

On August 11, 1944, Burnham sent petitioner a letter stating that in the opinion of the Maritime Commission Price Adjustment Board the amount of excessive profits realized from renegotiable business in 1942 was $47,000. Attached to the letter was a summary of profit and loss for the year 1942 with adjustments for purposes of renegotiation, upon which summary the opinion of the Board as to excessive profits was based. This communication further asked whether petitioner desired to enter into an agreement providing for the elimination of excessive profits.

Further correspondence between petitioner and respondent took place in 1944 and 1945.

On January 10, 1946, the Board executed and sent to petitioner by registered mail notification of a unilateral order entered by it that day determining t at petitioner had realized excessive profits in the amount of $32,000 from its renegotiable business in 1942.

Renegotiation proceedings were commenced prior to December 31, 1943.


HILL, Judge:

The first question for our determination is whether respondent commenced renegotiation of those war contracts of petitioner completed during petitioner's fiscal year ended December 31, 1941, within one year from that date in accordance with the provisions of section 403(c)(6) of the Renegotiation Act of 1942. It is respondent's contention that renegotiation commenced with the conference held between the representatives of petitioner and respondent on December 14, 1943, and therefore it complied with section 403(c)(6). On the other hand, petitioner asserts that renegotiation did not begin until August 11, 1944, when respondent wrote to petitioner stating that in its opinion petitioner had realized excessive profits of $47,000 from renegotiable business during 1942. In any event petitioner contends that renegotiation did not commence before the close of 1943.

SEC. 403(c)(6). No renegotiation of the contract price pursuant to any provision therefor, or otherwise, shall be commenced by the Secretary more than one year after the close of the fiscal year of the contractor or subcontractor within which completion or termination of the contract or subcontract, as determined by the Secretary, occurs.

Since the question is whether there was a commencement of renegotiation during the year ended December 31, 1943, we need only determine whether upon the occurrence of the conference on December 14 of that year renegotiation proceedings had commenced.

In petition‘er's view the purpose of this conference was merely for the production of further information to enable respondent to determine whether or not it should begin renegotiation, and thus the meeting constituted simply a step preliminary to the start of renegotiation. It points out that the telephone call from respondent on December 10, 1943, requested a meeting to provide a further breakdown of the initial figures submitted by petitioner in The ‘standard Form of Contractor's Report‘ regarding the year 1942. Petitioner asserts that it was never specifically notified at the conference that this was the commencement of renegotiation or that a review of its profits from renegotiable business was being made to determine the extent that they were excessive. Moreover the mere fact a Price Adjustment Board was asking for further information about profit figures for 1942 did not in itself warrant a conclusion that renegotiation had begun. Petitioner states that it was incumbent on respondent to give some fair, unequivocal and unmistakable notice its intention to commence renegotiation, citing Sessions & Son v. Secretary of War, 6 T.C. 1236, and concludes such notice was never given it before the close of 1943.

It is well settled that a contractor or subcontractor must receive clear notification of a Secretary's intent to commence renegotiation before it can be held that such proceedings commenced within the meaning of section 403(c)(6). Such notification may well be in the form of an oral or written notice by the Secretary stating that renegotiation is commencing. The evidence in this proceeding falls short of proving that in any of its communications with petitioner in 1943 respondent ever gave petitioner such an express warning. But such notification to a contractor may also arise indirectly from the nature of the actions taken by the Secretary. Thus we said in the Sessions case, page 1233: ‘It (renegotiation) could not commence until the Secretary had done something to indicate to a reasonably intelligent contractor that it was to commence at that point.‘

At review of the communications between petitioner and the renegotiating authorities leading up to the conference of December 14, 1943, as well as the discussions at that conference, can lead only to the conclusion that on that date it should have been unmistakably clear to an intelligent contractor that renegotiation had commenced. Major Dilks' letter of October 25, 1943, requesting data concerning petitioner's renegotiable business in 1942, stated that the purpose of this information was to permit a determination of whether or not further action need be taken in regard to renegotiation. Such further action was taken. On November 24, 1943, Major Dilks mailed to petitioner a letter stating that on the basis of information submitted further consideration of the renegotiation of its contracts was being assigned to respondent. On December 10, 1943, petitioner was requested by phone to come to respondent's offices to further break down figures it had previously submitted. Burnham's memorandum of that conference states that renegotiation of petitioner's war contracts in 1942 was discussed. In support of this conclusion the memorandum sets out details of petitioner's financial history up to and including 1942 which were disclosed by its representatives. It also notes that petitioner agreed to submit further specific data regarding its renegotiable business in 1942 requested by respondent. We have no reason from the evidence to doubt the veracity of this memorandum. Moreover, Levine admits that he realized at the time of the conference that the information requested was in connection with renegotiation of petitioner's war contracts. To paraphrase the language of the Court in Spray Cotton Mills v Secretary of War, 9 TC. 824, we are convinced that this conference constituted unmistakable notice from respondent of its decision to renegotiate and a demand upon petitioner for the specific information upon the basis of which a determination of excessive profits could be made. Thereby petitioner was brought in as a party to a proceeding which would lead to a determination respecting excessive profits. The conference between petitioner and respondent plainly indicated that the machinery of renegotiation was in motion. We thus found as a fact and now hold that respondent commenced renegotiation before December 31, 1943.

In the event we found that renegotiation commenced before the end of 1943 under the authority of the Spray Cotton Mills case, petitioner then argues that Congress intended entirely different standards for determining the start of renegotiation than were set forth in that case. We can find no authority for the standards petitioner suggests either in the statute or the court decisions interpreting it, and therefore we reject this alternative contention.

We now come to the question whether the net profits realized by petitioner from its renegotiable business in 1942 were excessive and, if so, to what extent. But before we can consider this question, we must deal with two preliminary questions determinative of the amount of net profits petitioner realized from renegotiable business in that year. The first preliminary question we must decide is whether $68,415.60 of petitioner's total sales of $345,127.37 in 1942 constituting part payment received on five war contracts not completed until 1943, is includible in petitioner's renegotiable sales for 1942. Petitioner contends that since these five contracts were not completed until the following fiscal year, receipts arising therefrom were not part of its renegotiable business for 1942. The basis for this argument lies in petitioner's interpretation of the last sentence of section 403(c)(6) of the Renegotiation Act of 1942, requiring a Secretary to commence renegotiation of war contracts within one year after the close of the fiscal year of the contractor within which the contracts were completed. It interprets this language to mean that renegotiation of contracts in any fiscal year may not include receipts received from contracts which are not completed until the following fiscal year. In support of this contention petitioner quotes sentences taken from our decisions in Sessions & Son, supra, and Louis H. Abramson, 11. T.C. 122, interpreting section 403(c)(6). It also cites Stein Brothers Manufacturing Co. v Secretary of War, 7 T.C. 863, and Bibb Manufacturing Co. v. Secretary of War, 12 T.C. 665, for the proposition that war contracts are not divisible between fiscal years for renegotiation purposes.

Petitioner's contention so obviously results from a misinterpretation of section 403(c)(6) and the cases it cites that no extended discussion is necessary in rejecting that proposition. In the Sessions and Abramson cases, we merely pointed out that in renegotiating war contracts of a contractor for any given fiscal year, renegotiation of such of those contracts as were completed in that year must commence within a year thereafter. We emphatically did not say that renegotiation could encompass only those contracts completed in the fiscal year under consideration. That the opposite is true is borne out by two quotations from the Sessions case itself. At page 1239 we said: ‘The gross receipts for the accounting year might include receipts on contracts which were not fully completed within that year. The receipts from such contracts for the subsequent year would be considered in the renegotiation of that later year. The law does not limit renegotiation to completed contracts * * * /‘ On page 1240, we said: ‘But (section 403(c)(6) can serve to cut off renegotiation only on contracts completed or terminated within that period * * * .‘ (Emphasis added.) In both the Sessions and Spray Cotton Mills cases we determined the amount of excessive profits received in 1942 from contracts which were not completed until 1943.

As to the divisibility of petitioner's five war contracts, we note that petitioner's income tax return for 1942 included the $68,425.60 received on these contracts in that year in gross receipts, so that petitioner clearly did not deal with them on a completed contract basis. Furthermore neither the Stein nor Bibb Mfg. Co. cases holds that war contracts may not be divided between fiscal years for renegotiation purposes. Our holdings in those two cases are limited to their special facts which brought them within the language of section 403(c)(6) of the Renegotiation Act of 1942, expressly excluding from renegotiation contracts on which final payment was made before April 28, 1942. In those cases payments were made on war contracts both prior and subsequent to April 28, 1942. Due to the statutory provision, we held in both cases that the entire receipts, not merely those received on and after April 28, 1942, were subject to renegotiation. Our holdings in these two cases as to the non-divisibility of contracts before and after April 28, 1942, afford petitioner no support in the instant case. We therefore found as a fact and now hold that the $68,415.60 is includible in petitioner's renegotiable business for 1942.

The second preliminary question we must determine is what constituted reasonable compensation for petitioner's two officers, William Wilson and Donald Wilson, in 1942. While section 403(c)(3) of the Renegotiation Act of 1942 authorizes an allowance for salaries paid by a contractor to its officers in determining excessive profits, section 403(d) makes it clear that no allowance shall be made for salaries in excess of a reasonable amount. It is petitioner's contention that the $63,000 paid to William Wilson and the $42,000 paid to Donald Wilson in 1942 were reasonable salaries and should be allowed in full. Respondent, however, argues that officers' salaries totaling $105,000 constitutes a distribution of profits and that a reasonable compensation for both men should not exceed $24,000.

It is well settled that what is reasonable compensation is essentially a fact question to be resolved in the light of the special facts of each case. Miller Mfg. Co. v Commissioner, 149 Fed.(1d) 421. Other cases involving this question are of little aid as precedents. Other cases involving this question are of little aid as precedents. Wood Roadmixer Co., 8 T.C. 247. Where, as here, the compensation was contingent in nature, all circumstances must be considered, both those existing at the time the compensation was agreed upon and those present at the time the compensation was paid, and no one factor is determinative. Hoffman Radio Corp. v. Commissioner, 177 Fed.(2d) 264, and Mayson Mfg. Co. v Commissioner, 178 Fed.(2d) 115.

We shall first consider whether the compensation arrangement for the Wilsons voted by petitioner's board of directors on April 6, 1942, was fair and reasonable in view of the conditions existing at that time. It is once obvious that the resolution passed by petitioner's board of directors was not the result of an arm's length transaction between petitioner and the Wilsons. No interest adverse to the Wilsons represented petitioner at the meeting. The terms of the resolution were the result of an agreement solely between the Wilsons, who between them owned all the stock of this small, closely held family corporation. They constituted petitioner's only two officers and two of the three members of its board of directors at the time the resolution was passed. The third board member present at the meeting was William Wilson' daughter. Thus no one was present at the meeting whose financial interest was opposed to the payment of excessive compensation to the Wilsons. Under such circumstances the contingent compensation arrangement must be closely scrutinized to see whether it is fair and reasonable.

We are convinced that provision in the resolution for the division between petitioner's two officers of 90 per cent of petitioner's net profits for 1942 as compensation for their services was entirely unreasonable and excessive in the light of circumstances on April 6, 1942. At the outset we note that the allocation of a large percentage of company profits to officers' salaries is customary only in personal service companies and not in a fabricating and assembly business, where plant equipment and labor force play such a vital role in the realization of income. Furthermore, it was clearly foreseeable in the fourth month of 1942 that 90 per cent of petitioner's net profits for the year would far exceed anything previously paid its officers. The $30,000 received by the Wilsons in 1941 constituted slightly less than 90 per cent of the company's net profits in 1941 and they could be sure in April 1942 that receipts and net profits would double or triple in petitioner's field due to the vast increase in shipbuilding required by the entry of this nation into war in December 1941. It was equally evident at that time that while such increased business might add somewhat to the duties and working hours of petitioner's officers, yet it would cause no major change in their responsibilities. Moreover it was clear that the expected jump in petitioner's income would be due to the war economy rather than founded on services performed by William and Donald Wilson.

Turning to the provision in the resolution for the allocation of compensation to the two officers on a 60-40 basis, we find this division bears no relationship to the value of their respective services. Allocation of 40 per cent of the total compensation to such a young, inexperienced engineer as Donald Wilson at a time when his services at petitioner's plant were being limited to weekends is completely out of balance with the value of his services.

When we couple all the above circumstances with the fact that the two Wilsons held all of petitioner's stock, that petitioner had never paid a dividend, that compensation was based on petitioner's net profits, that the 60-40 ratio of compensation between William and Donald Wilson roughly approximated the proportion of stock each held, we are led to the inevitable conclusion that the compensation authorized by the resolution of April 6, 1942, represented an attempt by the Wilsons to distribute company profits in the guise of compensation for services.

Consideration of the circumstances existing at the close of 1942 when William and Donald Wilson were paid $63,000 and $42,000 confirms our view that the compensation paid was excessive and constituted in part a distribution of profits. A comparison of these figures with the salaries received in the prior year strikingly illustrates the tremendous boost in their compensation. We have found as a fact, despite the stipulation to the contrary, that petitioner paid William Wilson $18,000 and Donald Wilson $12,000 in 1941. We made this finding in conformity with the schedule furnished Major Dilks by petitioner which shows that $12,000 of the$30,000 compensation paid in 1941 was received by Donald. Thus in the case of William Wilson, his salary was increased over three times in 1942. We recognize his ability and skill, his years of experience, the myriad duties he performed at petitioner's plant and with subcontractors, and the long hours of work he put in during 1941 and think that his services were fully worth the $18,000 he was paid. We further think that William Wilson was entitled to a moderate increase in salary in 1942 due to the extension of his responsibilities caused by the upsurge in the company's business in that year. But the great jump in compensation he received in 1942 was out of all proportion to the value of the services he performed. In valuing his services, we were not sufficiently convinced by petitioner that the Wilson-type watertight door was a patentable article to require us to conjecture what royalties William Wilson gave up by waiving patent rights on the door.

Turning to Donald Wilson, while the evidence does not make clear his services in 1941, we can only assume that they were similar in nature to those performed in 1942. We consider the part-time designing and drafting work of this inexperienced young engineer completely out of proportion to the $12,000 paid him in 1941, the first year he was on a salary basis. In our view such compensation in large part represented a distribution of profits to him. Therefore the $42,000 paid Donald in 1942 appear grossly excessive, even conceding that his responsibilities increased slightly over those of the past years due to the large influx of war business.

Petitioner raises the point that while William Wilson was experimenting to improve the design of the watertight door during the years 1933-1939, he received a salary far beneath the value of his services. Petitioner also notes that Donald Wilson assisted his father in this development work to an increasing extent over these years and yet never received any compensation for these services. Therefore it argues that the high salaries paid in 1942 were in part to compensate for the inadequate remuneration of the Wilsons in earlier years. The evidence does not support this assertion. The resolution of April 6, 1942, makes absolutely no reference to past services, but rather expressly states that the 60-40 division between the Wilsons of 90 per cent of the net profits constitutes their salaries for 1942. See Wood Roadmixer Co., supra. Furthermore, there is no evidence of any obligation, express or implied, on petitioner's part to pay William Wilson further compensation or to pay Donald Wilson any compensation for work performed in past years. It is only logical to imply that as sole stockholders of a company struggling to stay in existence, they were willing to work for practically nothing in order to reap their full reward when the watertight door was fully developed. In fact William Wilson stated that he was willing to accept a low salary during the 1930's because he felt he would be repaid for his financial sacrifices in later years when petitioner was a success. As owners of the corporation it would be only natural that the Wilsons would not expect a salary reflecting the value of their services until petitioner was financially able to pay such amounts. See Lucilla deV. Whitman, 12 T.C. 324. We therefore reject this contention by petitioner.

In considering the value of the services of the Wilsons to petitioner in 1942 we are also influenced by the fact that petitioner's operations in that year were relatively simple ones involving primarily machining, welding and assembling parts provided by subcontractors. At least 50 per cent of the operations necessary for petitioner to produce a finished product were carried out by subcontractors. Thus the extent of the work performed by the Wilsons was limited by the nature of petitioner's business.

One of numerous tests in determining reasonableness of an officer's salary is its relationship to the gross receipts and net income of the company employing him. In the instant situation total salaries of $105,000 are out of proportion with petitioner's gross sales of $345,127.37 and net income of $117,178.77 before salaries in 1942. The evidence fails to reveal circumstances justifying allocation of such a large proportion of profits to officers' salaries. It is also significant that in 1942 when petitioner's salary payments were so high, no dividend was declared.

While both petitioner and respondent introduced expert testimony on the issue of reasonable compensation, we are able to place little reliance on the opinions expressed. The testimony of petitioner's witness that the services of William Wilson were worth $50,000 in 1942 is too full of discrepancies to be of great value. Moreover he admitted that company whose gross sales were only $345,000 could not afford to pay such a salary. We can assign equally little probative force to the testimony of respondent's witness that the total reasonable compensation for petitioner's officers in 1942 would be $24,000. Respondent's witness was a business analyst, who was never connected with a steel fabricating plant such as petitioner, nor in touch with the customary salaries paid for responsibilities such as William and Donald Wilson undertook in 1942. In reaching our determination we have not had the benefit of evidence showing the prevailing rates of compensation concerns.

Under all the circumstances enumerated we found as a fact that the compensation paid to both Wilsons was excessive and constituted in part a distribution of profits. On the other hand, we are convinced that respondent's figure of $24,000 is too low to represent reasonable compensation for both men. We found as a fact and now hold that $32,000 constituted reasonable compensation for petitioner's officers.

After allocating such compensation allowance between renegotiable and non-renegotiable business, we now come to the question whether petitioner's net profits of $63,992.12 on its renegotiable business in 1942 were excessive in amount and, if so, to what extent. We have considered all relevant factors, including the character and nature of the business, the nature and extent of contribution to the war effort, business risks assumed, the amount and source of capital employed, net worth, the volume of production, pre-war earnings, and reconversion to peacetime production. There was insufficient evidence to properly judge the efficiency and economy of petitioner's production. Petitioner submitted no expert testimony on this issue. While respondent's expert testified that a reasonable profit would not exceed $36,000 we do not attach much weight to this opinion. Even respondent himself has refused to follow it. It is our conclusion that petitioner realized excessive profits in the amount of $20,000 from its renegotiable business in 1932, and we so hold.

An order will issue in accordance herewith.