*93 Decision will be entered under Rule 50.
In 1942 and 1943 petitioner obtained from Defense Plant Corporation six purchase orders for an equipment pool of machine tools. Pursuant to the terms of the orders Defense Plant Corporation advanced to the petitioner 30 per cent of the total purchase price. Upon sale of the machine tools to substituted purchasers petitioner returned the advances to Defense Plant Corporation. Held, the advance payments did not constitute a part of petitioner's borrowed capital under section 719, Internal Revenue Code, and the repayment thereof did not constitute a reduction of petitioner's indebtedness for purposes of credit for debt retirement under section 783.
*456 The respondent here*94 has determined deficiencies in petitioner's excess profits tax for the calendar years 1942 and 1943 in the respective amounts of $ 37,257.73 and $ 46,445.16. Petitioner claims an overpayment.
Certain of the issues raised in the pleadings have been settled by agreement of the parties, to which effect will be given in the recomputation under Rule 50. The remaining issues are whether certain moneys which petitioner received from the Defense Plant Corporation in the taxable years in connection with purchase orders for machine tools constituted a part of its borrowed capital under section 719 of the Internal Revenue Code, and whether the repayment thereof entitles petitioner to a credit for debt retirement under section 783 for the year 1943.
FINDINGS OF FACT.
Petitioner is a corporation, organized under the laws of New Jersey in 1900, with its principal office in Irvington, New Jersey. Its returns for the years here involved were filed with the collector of internal revenue at Newark.
During 1942 and 1943 and for many years prior thereto petitioner was engaged in the business of manufacturing large machine tools such as shapers, gear hobbers, and gear cutters. These machines cost *95 a great deal to manufacture, and from 6 to 18 months are required in their production. They sell at prices ranging from $ 3,000 to $ 145,000.
In normal times petitioner employed about 300 to 320 skilled employees. At the beginning of the war period, machine tools were urgently needed to equip factories for war production; and to produce the necessary tools, expansion of machine tool manufacturing was essential. At the request of the Office of Production Management, petitioner enlarged its production facilities, subcontracted part of its work, and increased its force to about 750 employees. It operated a night shift in addition to the day shift.
To expand its facilities and produce the great number of machine tools needed, petitioner required considerably more capital than it had or could borrow from its bankers. It discussed its financial problems with representatives of the Office of Production Management, who informed it that at the start of the war the War and Navy Departments and the Defense Plant Corporation had adopted a policy of making 30 per cent advance payments under purchase orders. This policy was adopted in recognition of the need of the machine tool industry for*96 financial assistance and for working capital to enable it to maintain expanded production.
Defense Plant Corporation, hereinafter referred to as DPC, was an instrumentality of the United States. It was created under authority *457 of statute by the Reconstruction Finance Corporation, hereinafter referred to as RFC, on August 22, 1940, "to aid the Government of the United States in its national defense program." DPC was entirely owned by RFC, and all of the funds used by DPC were received from RFC and were returnable to RFC upon the dissolution of DPC. Similarly, all of the funds used by RFC are funds of the United States Government and are returnable to the Government upon dissolution of RFC.
Under its charter, as amended, DPC was empowered to produce, acquire, carry, sell, or otherwise deal in strategic and critical materials of war. It was authorized to purchase or lease land, to build and expand plants, to purchase and produce equipment and machinery, to use, lease, sell, or otherwise arrange for the use of such plants and facilities for war production, and to take such other action as the President and the Federal Loan Administrator might deem necessary to expedite the*97 National defense program.
In addition to direct purchase orders, DPC and the War and Navy Departments issued pool purchase orders. The purpose of the latter was to create a reservoir of machine tools for subcontractors and vendors of war materials in order to avoid production delays.
In 1941 and 1942 petitioner consulted with officials of the War Production Board with reference to the existing and potential demands for various types of machine tools. From time to time during that period petitioner submitted to WPB definite proposals for pool purchase orders from DPC. In these proposals petitioner usually stated that it had orders on hand or prospective customers for a certain number or percentage of the machines covered by the proposals.
Upon the recommendation of petitioner's proposals by WPB, DPC issued and petitioner accepted six separate "Purchase Orders," stated to be "For Equipment Pool," as shown in the following schedule:
| DPC | Quantity | Purchase | |
| Date order accepted | order | of tools | price |
| No. | |||
| 7/11/42 | 127 | 447 | $ 3,719,150 |
| 2/24/42 | 198 | 1 | 58,500 |
| 2/3/42 | 471 | 72 | 1,117,522 |
| 7/18/42 | 472 | 230 | 652,545 |
| 10/8/42 | 584 | 54 | 531,216 |
| 1/11/43 | 666 | 366 | 1,178,729 |
*98 Each of the orders provided that petitioner should make every effort through its regular sales organization to sell the machines covered by the order; and as any such machine was ordered by or invoiced and shipped to others than DPC, to whom delivery should be approved by the governmental agency having jurisdiction over priorities, it was to be eliminated from the DPC order. Each of the orders also provided that upon its acceptance by petitioner and upon written request *458 DPC would "advance to you (petitioner) 30% of the total purchase price of this order outstanding." Petitioner agreed "to use the proceeds of the advance payment exclusively for labor and materials required to manufacture the equipment covered by this order." Upon the completion, cancellation, or termination of the order, petitioner was to repay the amount of the advance payment immediately; also, upon invoicing or shipment to a substituted purchaser of any machine covered by the pool order, petitioner was immediately required to pay to DPC "an amount equal to 30% of the unit price stipulated in this order for such item." Repayment of any advance payment made under the order could be effected by DPC by*99 means of deductions from any moneys owing from DPC to petitioner for storage and insurance charges on completed machines or as payment for completed machines invoiced to DPC.
DPC had the right to audit petitioner's records as to the use petitioner made of the advances. It also at any time had the right to require petitioner to furnish it with adequate or additional security for the advance payments. Any assignment of moneys due or to become due under the several orders was to be subordinate to the rights and claims of DPC under the orders.
DPC reserved the right to cancel the orders by written notice to petitioner. In such event, in the case of order Nos. 127 and 198, machines which were within 30 days of completion were to be completed by petitioner and DPC would pay for them. On all items not within 30 days of completion, DPC agreed to pay petitioner on the basis of actual cost of labor, materials, overhead, etc., plus 12 per cent, but not in excess of 90 per cent of the quoted price of such items. In the event of cancellation of the other 4 orders, Nos. 471, 472, 584, and 666, petitioner was to discontinue production and transfer to DPC title to all completed and uncompleted*100 machines and materials. DPC was to reimburse petitioner for its actual expenditures for labor, materials, and supplies, overhead and administrative expense, and for costs of settling or discharging petitioner's outstanding obligations under noncancelable subcontracts.
In the case of machines not sold to substituted purchasers before the time for delivery under the orders, DPC would pay for the machines and either take delivery thereof or request petitioner to store them for DPC.
In accepting each pool purchase order petitioner requested DPC to send the advance of 30 per cent of the total price of the machines stated in the order. In 1942 and 1943 DPC made the requested 30 per cent advance payments in the amounts and on the dates shown in the following table: *459
| D. P. C. | Purchase | |
| Date received | No. | price |
| 3/6/42 | 198 | $ 17,550.00 |
| 4/10/42 | 127 | 626,202.00 |
| 5/28/42 | 120 | 489,543.00 |
| 7/17/42 | 471 | 418,932.00 |
| 8/14/42 | 472 | 200,862.00 |
| 10/21/42 | 584 | 159,364.80 |
| 1,912,453.80 | ||
| 1/20/43 | 666 | 353,618.70 |
| Total | 2,266,072.50 |
Upon receipt of each advance, petitioner, in accordance with the terms of the orders, deposited it in a separate, special bank account in*101 its own name. From time to time petitioner withdrew various amounts from these bank accounts to cover the cost of labor and materials in manufacturing machines covered by each purchase order.
Petitioner manufactured all of the machines covered by the six pool orders except five machines the order for which was canceled. Petitioner also manufactured under orders from other persons many other machines of equivalent types.
Petitioner for many years has had standard form agreements with about 30 persons or firms who act as its dealers, having the exclusive sales rights for its machine tools, each in a designated territory throughout the United States. During the war, rather than have a large number of contracts with the War and Navy Departments running to 25 or 30 different dealers, petitioner at times made direct contracts with the Army or Navy. Upon shipping machines into a dealer's territory to factories operated by the War and Navy Departments, petitioner would receive direct payment for the machines from such Departments and would then send to its dealers the commissions they would otherwise have been entitled to had the orders been received directly by them. An undisclosed *102 number of the machines covered by the purchase orders in controversy went to the War and Navy Departments. Petitioner sold 6 of the machines direct to DPC or to agents acting for DPC at a time when petitioner had no dealer operating in the particular territory involved. Its dealers sold the rest of the machines.
During the war DPC built and equipped a number of plants for the production of war materials. It would lease these plants and equipment to a private company at a nominal rental, such as $ 1 a year, for the company to use in producing war materials for which it had a Government contract or subcontract. Typical of the sales made by the petitioner's dealers was one to the Eastern Aircraft Division of General Motors at Linden, New Jersey, which had such a lease from DPC. General Motors, acting for and on behalf of DPC, ordered a *460 certain machine tool from a dealer of petitioner; and the dealer, in turn, sent his order for the machine to petitioner, with instructions to make shipment to General Motors as agent for DPC. Petitioner billed its dealer for the machine at list price, less dealer's commission, and the dealer sent his own check to petitioner for the net amount. *103 Upon shipment of the machine, General Motors sent the invoice to the Federal Reserve Bank of New York, which, upon instructions of DPC, sent a check to petitioner's dealer in payment of the machine. When the machine arrived at the General Motors plant, a metal tag was attached to it, stating that it was the property of DPC.
On or about the 1st and 15th of each month petitioner reported to DPC on the number of orders it had received from substituted purchasers for machine tools covered by the six pool purchase orders. For the year 1942 it thus reported orders for machines on which DPC had advanced a total of $ 1,727,722.20 and for the year 1943, orders for machines on which DPC had advanced a total of $ 486,685.80.
The total advances received by petitioner from DPC were repaid in full by petitioner to DPC by checks mailed in New Jersey between August 17, 1942, and June 30, 1944. During the years 1942 and 1943 total repayments by petitioner to DPC were $ 388,982.40 and $ 1,707,000.90, respectively. No interest was paid by petitioner on any of the advance payments.
By reason of these advance payments petitioner claims it is entitled to include in its average borrowed capital for*104 the years 1942 and 1943 the respective amounts of $ 496,883.60 and $ 417,769.17. Respondent, in determining the deficiencies, held that the DPC advances did not constitute borrowed capital.
Upon its 1943 excess profits tax return petitioner elected to claim credit for debt retirement. By reason of bona fide bank loans evidenced by its ordinary promissory notes and as a result of various repayments thereof, petitioner's lowest indebtedness during the period September 1 to December 31, 1942, was $ 335,946.48, and the indebtedness so evidenced on December 31, 1943, was $ 229,344.60, thereby resulting in a net reduction in indebtedness of $ 106,601.88 for the year 1943. In the deficiency notice respondent allowed petitioner a credit for debt retirement in the amount of 40 per cent of that sum, or $ 42,640.75. Petitioner claims it is entitled to a credit for debt retirement in the amount of $ 583,993.63 by reason of treating the DPC advances as indebtedness and the repayments thereof as a reduction of indebtedness.
The stipulation of facts and the exhibits accompanying the same are hereby adopted by this reference as fully as if set forth herein.
*461 OPINION.
Here we have a somewhat*105 different facet of the basic problem involved in Canister Co., 7 T. C. 967, and West Construction Co., 7 T.C. 974">7 T. C. 974, that is, whether advance payments on Government contracts may be considered a part of the contractor's borrowed capital within the meaning of section 719 of the Internal Revenue Code1 for purposes of computing the excess profits credit based on invested capital.
*106 In the Canister case there were contracts with the Navy Department and in the West Construction Co. case, with the War Department. In this case the contracts were with the Defense Plant Corporation, likewise an instrumentality of the United States Government.
The petitioner makes an earnest effort to distinguish those cases, and it may be conceded that there are some factual differences; some differences, for example, in the mechanics of carrying out the respective transactions. It is urged that the advance payments on the six DPC purchase orders here involved amount to loans. And then it is contended that the purchase orders themselves and the checks issued for the advance payments qualify either as notes, bills of exchange, debentures, or mortgages -- the types of evidence of indebtedness specified in the statute. This latter question we need not reach unless it first be determined that the advance payments constitute outstanding indebtedness within the scope and purpose of the statute.
The six purchase orders which petitioner accepted from DPC covered a large number of machine tools and provided in terms for the advance payment by DPC of 30 per cent of the total contract*107 price of the machines. DPC was authorized under its enabling legislation and its charter to acquire critical war materials, plants, and equipment, and to use, lease, or otherwise arrange for the use of such plants and facilities for war production. It was not engaged in the business of making loans -- a function which belonged to its parent, the RFC. In making *462 advance payments on critical machines and equipment ordered by it, it was doing what it was created and authorized to do. See section 5d (3), (4), Reconstruction Finance Corporation Act, as amended, 15 U. S. C. § 606b (3), (4). The purchase orders provided that petitioner should make efforts through its own sales organization to sell the machines to others approved by the Government agency having charge of priorities and upon such sales to repay to DPC the moneys advanced by it on those machines. DPC was obligated to take any machines covered by the orders which were not thus sold.
Petitioner's position is that, with the exception of six machines which it sold direct to DPC or to DPC agents and an undisclosed number of machines sold by it to the War and Navy Departments, its*108 regular dealers sold the machines to their customers; that petitioner sold the machines to its dealers in the first instance and it was not concerned with what the dealers thereafter did with the machines; that it had nothing to do with the transactions between its dealers and their customers. Actually, however, the respondent's evidence shows that in typical instances of such sales by the petitioner's dealers DPC was the ultimate purchaser of the machines; that it held title to the machines and leased them to manufacturers of war materials for a nominal rental. But, in any event, we are not prepared to say that, even if others than DPC and the War and Navy Departments were the ultimate purchasers and owners of some of the machines, that fact would serve to convert into loans what were advance payments against the purchase price of the machines.
In West Construction Co., supra, we held that what Congress had in mind in making allowance for borrowed capital was capital as to which the business assumes some risk. Here, we are unable to conclude that petitioner assumed any risk whatever with respect to the advance payments. It stood to lose nothing. *109 If risk there was, it would seem to be a risk assumed by DPC rather than by petitioner.
We also observed in the West case that the fact that Congress in section 719 (a) (2) had made specific provision for the allowance of borrowed capital credit in the case of advance payments on certain contracts with foreign governments and nowhere made any reference to such payments on contracts with our own Government, was indicative of a purpose to exclude the latter from the scope of borrowed capital. That same reasoning applies with equal force in this case. Basically, the purchase orders here involved were United States Government contracts and the moneys in question were advance payments thereon. Such payments do not partake of the character of indebtedness to any greater degree than those involved in the West case. In one respect, at least, the facts in that case would seem to be even more *463 favorable to the taxpayer's position than are the facts here. There the contractor paid a regular rate of interest to the War Department on its advance payments.
We conclude that, despite some factual differences, the principles of the West case govern here and that petitioner*110 is not entitled to include the advances in its borrowed capital.
There remains the question whether the advance payments should play any part in the computation of petitioner's credit for debt retirement under section 783 of the code. 2 That section differs slightly from section 719 with respect to the type of evidence of indebtedness required. However, the first step in this instance, as in the other, is to determine whether the advance payments amounted to "indebtedness" within the meaning of the statute. On brief, petitioner advances the same arguments on this point under both sections, and we see no good reason why the scope of the term "indebtedness" should be any different in the one section than in the other, so far as the present problem is concerned. We therefore hold that no account should be taken of the advance payments in computing petitioner's credit for debt retirement.
*111 Decision will be entered under Rule 50.
Footnotes
1. SEC. 719. BORROWED INVESTED CAPITAL.
(a) Borrowed Capital. -- The borrowed capital for any day of any taxable year shall be determined as of the beginning of such day and shall be the sum of the following:
(1) The amount of the outstanding indebtedness (not including interest) of the taxpayer which is evidenced by a bond, note, bill of exchange, debenture, certificate of indebtedness, mortgage, or deed of trust, plus,
(2) In the case of a taxpayer having a contract (made before the expiration of 30 days after the date of the enactment of the Second Revenue Act of 1940) with a foreign government to furnish articles, materials, or supplies to such foreign government, if such contract provides for advance payment and for repayment by the vendor of any part of such advance payment upon cancellation of the contract by such foreign government, the amount which would be required to be so repaid if cancellation occurred at the beginning of such day, but no amount shall be considered as borrowed capital under this paragraph which has been includible in gross income, plus,
* * * *
(b) Borrowed Invested Capital. -- The borrowed invested capital for any day of any taxable year shall be determined as of the beginning of such day and shall be an amount equal to 50 per centum of the borrowed capital for such day.↩
2. SEC. 783. CREDIT FOR DEBT RETIREMENT.
(a) General Rule. -- An amount equal to 40 per centum of the amounts paid during the taxable year in repayment of the principal of indebtedness shall, at the election of the taxpayer made in its return for such year, be allowed as a credit against the tax for such year imposed by this subchapter.
* * * *
(d) Definition of Indebtedness. -- For the purposes of this section the term "indebtedness" means any indebtedness of the taxpayer or for which the taxpayer is liable evidenced by a bond, note, debenture, bill of exchange, certificate, or other evidence of indebtedness, mortgage, or deed of trust.↩