*93 Decision will be entered under Rule 50.
The petitioner from the time of its organization has been engaged in the manufacture of woodworking machinery, and though its plant and tools were old and its machinery designs were generally outmoded, it was able to do a very profitable business for the years immediately following World War II. The machines of woodworking companies had become worn and needed to be replaced and petitioner was able to take advantage of the great demand for such machinery. During the year 1946 and through the years herein, petitioner built up from earnings a very substantial surplus, which it did not distribute to its stockholders. As the postwar demand for woodworking machinery was satisfied, the competition in the manufacture of such machinery became intense and it became apparent that petitioner would have to expand and improve its plant very substantially and design and produce modern and efficient machines, if it was to continue successfully in that business. The accumulated and undistributed earnings for the taxable years were needed for that purpose. Held, that petitioner, by permitting its earnings and profits to accumulate, was not availed*94 of for the purpose of preventing the imposition of the surtax upon its shareholders, within the meaning of section 102 of the Internal Revenue Code of 1939.
*1031 Respondent determined deficiencies in income tax against petitioner as follows:
| Docket No. | Year | Deficiency |
| 44379 | 1949 | $ 104,732.73 |
| 52020 | 1950 | 73,487.08 |
| 1951 | 62,538.32 |
The sole issue is whether petitioner was subject to the surtax imposed by section 102 of the Internal Revenue Code of 1939.
FINDINGS OF FACT.
Some of the facts have been stipulated and*95 are found as stipulated.
Petitioner is a North Carolina corporation, with its principal place of business in Greensboro, North Carolina. It filed its income tax returns for the taxable years involved with the collector of internal revenue for the district of North Carolina. Its income is computed on a calendar year basis and under an accrual method of accounting.
Petitioner was incorporated in 1934, by George F. Newman, Sr., H. L. Newman, and M. F. Douglas, and, since its organization, it has been engaged in the business of manufacturing woodworking machinery, principally planers and matchers, and related equipment used in the lumber industry, some of which are automatic feed tables, hand jointers, tenoners, ripsaws, and knife sharpening devices. Petitioner's principal product is sold to planing mills which process lumber for the building of houses. However, some of petitioner's customers are manufacturing plants which construct their own packing crates from lumber.
There had been an earlier Newman Machine Company, which had been organized in 1906, under the name of Wyland-Newman Machine Company, by George F. Newman, Sr., and others and had been in the same business as that of*96 the petitioner. It was placed in receivership and liquidated in 1932, the stockholders losing all their investment and the creditors making only a small percentage of recovery. Thereafter, and until petitioner was organized, Newman, Sr., individually, dealt in some secondhand machinery.
In 1934, Newman, Sr., interested William M. York, an attorney, in reestablishing the business and York not only did the legal work in organizing the petitioner but also became one of its active officers, serving as vice president, treasurer, and director. During the taxable years involved he supervised the financial affairs of petitioner, the office, general, and cost accounting, and collection of notes and accounts receivable.
The petitioner was incorporated in 1934, its authorized capital consisting of 1,000 shares of stock without nominal or par value. No shares were issued until 1935, when 896 shares were issued for cash or other property with an aggregate value of $ 25,338.60. The two *1032 principal stockholders were George F. Newman, Sr., and William M. York, who received respectively 562 and 315 shares of stock. One additional share was issued sometime prior to 1944, but there was*97 no change in capital investment. By the end of 1946, all but one of the shares issued to George F. Newman, Sr., had been transferred to his son, George F. Newman, Jr. York still retained his shares. Newman, Sr., died on May 2, 1948.
Newman, Jr., had worked for the old company after school hours and during vacation. He started working for petitioner in 1936. After working for a time as a salesman, he became petitioner's first sales manager. Later he became a director and vice president of the company, continuing, however, as sales manager. He has been its president since the death of his father.
In 1935 petitioner purchased the machine tools, inventory, and personal property, and rented the land and building, all of which had been owned by the defunct company and had been acquired by a bank creditor. Petitioner's total fixed assets, as of December 31, 1935, were carried on the books at $ 6,875 before depreciation. In 1937 the land and building were purchased from the bank creditor by George F. Newman, Sr., and William M. York and then leased to petitioner at a monthly rental of $ 700. After leasehold improvements had been made, and during the tax years involved, the rental*98 was $ 1,000 per month.
A manufacturer of woodworking machinery usually maintains an engineering department, headed by an engineer who is a designer of woodworking machinery and who supervises the improvement of the machines currently in production and the designing of new ones. It is through such a department that the manufacturer's product is improved and its costs lowered, factors to which the department gives its attention at all times.
The defunct Newman Machine Company had had such an engineering department, and from November 1925 to February 1929, it was headed by T. C. Mann. During the period of his employment Mann redesigned most, if not all, of the woodworking machines being manufactured by the company. The major objective in such redesigning was to substitute ball bearings for babbitt roller bearings in the various machines. The use of ball bearings would greatly increase the speed of the machines, thereby permitting substantially greater productivity by the machine when installed and in use. Mann left the old company in 1929, because he anticipated the financial difficulties which later brought an end to its operations and existence.
When petitioner was first organized, *99 it was unable financially to employ a designing engineer or to finance an engineering program. Its work at first consisted of the manufacture of repair parts for machines which had been produced and sold by the old company and *1033 of the rebuilding of used machines. Using the designs of the old company, petitioner did manufacture and sell some new machines in the late 1930's.
In 1938 petitioner employed Jack Best to head its engineering department. Best had at one time worked for petitioner, or the old company, and was capable of designing some types of woodworking machinery, more particularly the belt-driven type. His qualifications for the job were limited but he was the best qualified man petitioner could then afford. In the course of his employment, he designed a ball-bearing planer and matcher as a new item in petitioner's line of machinery, but the machine so designed proved to be incapable of meeting competition. Best retired in 1943 or 1944 and moved to Florida, leaving petitioner without an engineer of any designing experience.
The machine tools which petitioner had acquired upon organization were old and badly worn. Most of them were driven by belts off a line*100 shaft. They were not accurate and the parts manufactured by their use required much hand work before they could be properly assembled in a machine.
When the United States entered World War II, petitioner's prospects for business were not good. Through considerable effort on the part of Newman, Jr., it obtained an order from the Government for some single surfacers, machines which surface one side of lumber. Other orders were received during the war period from the armed services; they were for surfacers, hand jointers, and tenoners. Petitioner also manufactured some planers and matchers for members of the industry who were able to obtain Government priorities for the purchase thereof. It had operated at a loss for each of the years 1935 through 1939, and had realized small profits in 1940 and 1941. During the war years, particularly 1942, 1943, and 1944, its profits increased substantially.
By the end of the war, the woodworking machines then in use had become worn and needed to be replaced, and with the release of restrictions on materials and credit, there was a ready sale for the new equipment which could be produced. Petitioner was able to take advantage of the great demand*101 for such machinery, and beginning with 1946, entered upon a most profitable period of operations.
Prior to World War II petitioner's usual policy had been to accept trade-ins and to allow credit on terms of 25 per cent down, with the balance payable on notes extending over a period of 12 to 24 months. Because of the heavy demand for woodworking machinery after the war, petitioner was able to adopt a stricter credit policy with its customers. It did not accept trade-ins, and 10 per cent of the sales price was to accompany the order, with the balance to be paid when the machinery was delivered.
The building which petitioner occupied was not in good shape or *1034 suitable for the use of machine tools. The wooden floor prevented the machines from maintaining the levelness which was necessary for accuracy in the manufacturing operation. This condition was remedied somewhat, late in 1945 or early in 1946, by the erection of some lean-tos to the building, the scrapping of the old basement, and the construction of a new basement with a cement floor, thereby providing a more suitable foundation for the machine tools.
With the growing demand for woodworking machinery, following the*102 war, it was necessary for petitioner to improve its tools and plant if it was to take care of the backlog of orders which began building up. Few, if any, new tools were to be had, but a supply of better used tools did become available, and petitioner entered upon a program of upgrading its machine tools by the replacement of worn parts and machines and by the addition of other machines by purchases, usually at auction sales of Government surpluses.
During 1946 and until the latter part of 1949, petitioner had no difficulty in disposing of all of the equipment it could manufacture. Its designs were outmoded, or rapidly becoming so, however, and if it was to maintain a competitive position or even survive in the woodworking machinery field, it was essential that its designs be brought up to date.
From 1929 through the depression and war years, there had been no widespread changes or improvements in the designs of woodworking machinery and in 1944 some manufacturers set about the improving of their lines of machines by instituting active designing programs. In 1946, 1947, and 1948, the redesigning of woodworking machines became a general trend in the industry.
A common change was *103 from the slower belt-driven machines to direct electrically driven machines. These machines were heavier and the feed speeds were at least doubled. Some such direct electrically driven matchers had been brought out possibly as early as 1939 or 1940.
Most, if not all, of the machines being produced by petitioner were still of the slower belt-driven type and as the production of the newer, faster machines would catch up with the demand there would be little, if any, market for petitioner's machines among the quantity woodworking operators. Its market would largely be restricted to smaller plants which were so situated that they were not in competition with the larger operators.
Noting the situation, petitioner in 1947 undertook to reemploy Jack Best, but Best did not wish to return to full-time duty. He did agree to design a new moulder for petitioner, in his garage in Florida. The design was for a belt-driven machine, however, and the machine did not prove to be satisfactory. The pilot model of the machine was first shown at a machinery show held in Greensboro, in March of 1950, *1035 and the dealers suggested so many changes that petitioner junked the model and decided to*104 start anew on another moulder design.
The number of competent and experienced designing engineers of woodworking machines was quite limited. Design engineering with particular reference to woodworking machinery is not taught in college, and so far as appears, there is only one book on the subject. A graduate engineer just out of college may, through training and experience in the shop and in the field, eventually become a good designer, but such a course for obtaining a competent designer of woodworking machinery is both prolonged and uncertain. The only other course open to petitioner at the time was to obtain a designing engineer from a competitor, by outbidding the competitor for his services. It might be possible to attract such an engineer by offering better prospects for the future.
Early in 1948, petitioner undertook to employ T. C. Mann, who had done designing work for the old company. Mann at that time was chief engineer for one of petitioner's competitors, but in May of 1948, he visited petitioner's plant to study the setup in connection with the offer of employment. He found that there had been practically no improvement in the machinery designs from the time he had*105 left the old company in 1929. The major machines, which included planers, matchers, and moulders, had not been touched. As to petitioner's plant, it was his opinion that the machine tools were not adequate to carry out a highly progressive program. A designing program to cover a period of approximately 5 years was outlined to him and a salary offer was made, but the offer was not accepted.
The designing of a new woodworking machine and the putting of it into production is a rather lengthy and costly operation. In designing a machine, detailed drawings are made of the various parts, which in some machines may amount to several hundred. When the drawings are finished and the assembly of the parts is laid out and checked on paper, blueprints are made and the production department is directed to proceed with making the patterns and parts that are called for. When the parts so produced have been assembled, the resulting machine is referred to as the pilot model. It is then put through a series of tests to determine its effectiveness in production and whether it measures up to anticipation. After the tests, the necessary and indicated changes are made, and when the results are satisfactory*106 and the model is approved, the engineering department next proceeds to design the jigs and fixtures which will be required for the manufacture of the machine for the trade. After the drawings have been completed and the jigs and fixtures have been made, the work of the engineering department is concluded and the machine is ready to go into production.
A general rule, or "rule of thumb," for estimating such engineering costs is that the design, development, and production of the pilot model *1036 of a machine will run from 6 to 7 times the price at which the machine will be sold. Under immediate consideration at the time of Mann's visit to petitioner's plant in 1948, were a new line of matchers and a new line of moulders. It was Mann's opinion at that time that the development costs of the two lines of machines would amount to $ 350,000 and possibly as much as $ 450,000. The development cost of a planer and matcher through the building of the pilot model, but not including the costs of the necessary jigs and fixtures to put the machine into production, would approximate $ 35,000.
It was anticipated by petitioner that as the postwar demand for woodworking machinery became satisfied*107 and the designs of modern and improved machines were in production, the competition would become quite intense and would require substantial changes not only in its plant and its machine designs, but in its selling program as well. At a special meeting of the board of directors on December 7, 1948, Newman, Jr., outlined some views with respect to petitioner's operations and its financial and capital needs in light of existing and anticipated conditions, and made recommendations with respect thereto. It was his stated view that many of the tools needed to be replaced at once, and he advised that he was in process of placing orders for 7 tools as replacements for tools which, according to the plant foreman, had to be replaced immediately if the company was to maintain its production. The total cost of these tools would be between $ 50,000 and $ 60,000. He also expressed the view that the "rather abnormal sales policy for the past few years" could not continue; that under normal operations accounts receivable on the 1948 volume of business would range from $ 250,000 to $ 350,000, whereas under the current policy they amounted to $ 50,000 or less; that at times when cash was not so*108 plentiful, the company would have to sell on terms and would then need between $ 300,000 and $ 500,000 with which to carry installment sales; that an additional $ 50,000 to $ 100,000 would represent the anticipated inventory of finished machines; that $ 100,000 to $ 175,000 would be required to finance the floor planning and consignment of machines to dealers; and that, all told, the permanent capital of the petitioner should be increased to at least $ 1,000,000 and that a surplus of at least $ 250,000 should be accumulated, in order for petitioner to have adequate working capital. Until about 1947, petitioner had been able to borrow money at the local bank only on the personal endorsement of York, and in obtaining small loans it had been required from time to time to pledge its accounts and notes receivable.
In a resolution adopted at the meeting, the directors agreed with Newman, Jr.'s analysis of the financial needs of petitioner and voted an immediate increase of $ 627,900 in its capital, this increase to be effected by the transfer of the said amount from surplus and undivided profits to the capital account and the distribution of 6,297 shares of *1037 stock as a stock *109 dividend, each stockholder of record on December 10, 1948, to receive 7 additional shares for each share then owned. This increase brought petitioner's total capital and paid-in surplus to $ 719,718.40. Immediately prior thereto, its paid-in capital had been $ 25,263.60 and its paid-in surplus $ 66,554.80.
In January of 1949, petitioner was in need of additional space at its plant. At that time, it occupied, in addition to its original or main building, an old foundry building across the street. It was proposed to remodel the old foundry building and to erect across the dead end of the street a building to be used as a shipping room, and to the rear thereof a metal storage or warehouse building, which buildings would connect petitioner's main building with the building across the street. By April of 1949, an arrangement had been worked out with the City of Greensboro for such use of the dead end of the street, and petitioner's officers were directed to proceed with the plans. They were also authorized to negotiate an extension of the lease on the real estate for an additional 5 years so that petitioner could "afford" to carry out the proposed plans. The construction of the warehouse*110 was completed as planned late in 1949 or early 1950.
Also in 1949, petitioner employed two machine tool engineers to make a survey of its equipment, for the purpose of determining the remaining life thereof, the cost of operating the old equipment as compared with operation of the new equipment, and the necessary replacements, with the estimated costs of such replacements. According to the survey, petitioner at that time was in need of machine tool equipment which would cost $ 649,000. Petitioner had previously placed orders for various new machine tools, but it was February 22, 1949, before it had been able to acquire its first new tool.
One purpose in the upgrading of petitioner's machine tools was to enable it to use carbide cutting tools. A machine using carbide tools could cut approximately 4 times as fast as a machine using the old type cutting tools, and by reason of that fact, heavier machines were required for the use of carbide tools. The use of carbide tools in the machine tool industry became widespread during the war years, and after the war the used machines which had been purchased by petitioner had enabled it to begin using carbide tools. Petitioner's old machines*111 were not capable of using carbide tools.
During 1949 petitioner expended $ 60,170.69 for machine tools and equipment, the net outlay being $ 56,475.32. Of the machine tools purchased, 5 were new machines and 8 were used or rebuilt machines. One was a rebuilt tool grinder capable of grinding carbide tools. It was the first such grinder acquired by petitioner.
There was a falling off of business in 1949, and as anticipated petitioner found it necessary to change its credit policy and sales terms to permit the selling of up to 75 per cent of its products on terms of *1038 25 per cent down, with the balance payable over a period of 12 to 24 months. Petitioner at that time began the making of plans to consign its products to dealers, and entered into consignment agreements with dealers in Seattle, Washington, on July 7, 1949; in Los Angeles, California, on August 29, 1949; and in Memphis, Tennessee, on September 13, 1949. During the remainder of the year it shipped machinery to the three consignees in the respective amounts of $ 29,547.50, $ 11,985, and $ 10,451.75.
The slump in petitioner's business in 1949 continued into 1950. By June of 1950, however, there had been an upturn*112 in sales and petitioner's consignees were selling machines as fast as they were received.
In 1950 petitioner again sought to employ Mann to head its engineering department, and in May of that year Mann again visited petitioner's plant. He found the plant much improved. Better tools, both secondhand and new, had been acquired. He was first offered a salary of $ 15,000, then $ 17,500, and finally $ 20,000. The payment of the salary over a 5-year period was to be assured by the deposit of $ 100,000 in escrow. After returning to his home, Mann declined the employment, for personal reasons.
With the outbreak of hostilities in Korea in June of 1950, there was concern as to the resulting effect upon petitioner's operations. Thereafter in 1951, 1952, and the early part of 1953, restrictions were imposed upon strategic materials. To meet the situation, petitioner sought contract work for products which would have priority, and was able to obtain subcontracts for the manufacture of certain machine tools and attachments. Its first product outside the woodworking machinery field was a hacksaw for sawing steel. It was produced in 1950 or 1951 for use in the metal industry.
In the summer*113 of 1951, petitioner obtained a contract with the Morey Machinery Company of New York City for the manufacture of turret lathes, which are machine tools used for work on cast iron and steel. In the fall of 1951, it obtained subcontracts with the Thompson Grinder Company and the American Tool Works, both of Ohio. For the former, it manufactured precision surface grinders, and for the latter, universal and plane tables and trunnion stands, which are attachments for radial drills used in drilling holes in metal products. For use in carrying out these contracts, petitioner, on March 17, 1952, leased a radial drill from the United States Navy Department and at various dates in 1953 acquired 8 other machines under leases with the General Services Administration. In all such leases, it was provided that the machines were to be used only in connection with the national defense work. There was no provision in the Navy agreement that permitted petitioner to purchase the radial drill, but the agreements with the General Services Administration *1039 did give petitioner the right to purchase all or any of the machines at any time after they had been delivered.
At a meeting of the board*114 of directors on November 13, 1951, it was decided that application should be made to the National Production Authority for a certificate of necessity for the construction of a new building for petitioner's plant and for the purchase of needed machine tools. The new building was to be 110 feet wide and 210 feet long. The plans were pursued, and by December 1952, the building contemplated was completed at a cost of $ 245,353.52. The total cost of the building, including the land, was $ 268,832.68. The building contained 23,000 square feet, and after its completion all of petitioner's machine tools were moved into it. The old building was thereafter used for storage. The certificate of necessity under which the building was constructed permitted accelerated depreciation thereof by petitioner. It also provided for accelerated depreciation of machine tools having a cost basis of $ 111,593.38.
Through the use of the leased machinery and the production of machine tools under its subcontracts during the Korean conflict, petitioner realized the advantages of diversifying its business by the manufacture of items other than woodworking machinery. The equipment used for making machine*115 tools could also be used in the manufacture of woodworking machines. Diversification had been practiced by some of petitioner's competitors for many years; one as early as 1929, and another from 1936. By such diversification of products, petitioner could produce items for other markets when the woodworking machinery business was at an ebb, and thus keep the plant in operation. Prior to 1951, petitioner's plant and equipment had not been capable of manufacturing precision tools.
In light of the above, petitioner, in 1954, when the leases on the machines obtained from the General Services Administration were to expire, decided to exercise its privilege of purchasing 7 of the 8 machines. It had no option permitting it to purchase the radial drill from the Navy, and that machine was turned back to the Navy on June 28, 1954.
Petitioner was not able to build any of its woodworking machines for consignment while manufacturing machine tools. It had continued its search, however, for a competent designing engineer, and in 1951 interviewed Robert W. Voges, then an employee of a competitor plant in Beloit, Wisconsin, with a view to employing him to head its engineering department. After*116 the interview, both Voges and petitioner felt that Voges' experience was not sufficient for the undertaking.
In the latter part of 1952 and into 1953, petitioner negotiated with L. E. Blood, of Boston, Massachusetts, to take charge of its engineering program. Blood had designed electric planers and matchers for *1040 the S. A. Woods Machinery Company, one of petitioner's competitors. Although Blood was no longer with that company, petitioner learned that he was available only as a consultant.
Petitioner next sought the services of Wallace D. Johnson. Johnson was a designing engineer, with over 42 years of experience in the woodworking machinery business. For many years, he had been an employee and president of the Yates American Manufacturing Company, but was no longer with that company. On the basis of his recollections of petitioner's plant from observations several years before, Johnson indicated a lack of interest. After a visit to the plant, however, and on the basis of its improved condition, he signed a contract to head and direct petitioner's engineering program for a period of 5 years, at a salary of $ 25,000 a year. As a part of the agreement with Johnson, petitioner*117 was required to place $ 130,000 worth of Government bonds in escrow with one of the local banks. Johnson reported for work in June 1953. In September of the same year, Voges, who had been interviewed in 1951, was brought in as Johnson's assistant. After the employment of Voges, petitioner's engineering staff consisted of Johnson, Voges, three graduate engineers, and two nongraduates, who did detail work for the others.
As early as 1947, petitioner, in its search for machine designing talent, had made it a practice to interview graduates of technical schools, principally at State College, in North Carolina. It was thought that with training and experience, one or more of such newly graduated engineers might become a designer. By 1953 or 1954, six such graduates had been employed, and one had developed to the point where he was of material service to petitioner.
During the years 1949 through 1953, petitioner's active line of woodworking machine products consisted of 10 machines, 4 of which were planer and matcher machines. Three of these planer and matcher machines were belt driven. There is still considerable demand for such machines, because they are cheaper in price, cheaper*118 to operate, and numerous purchasers do not need the extra capacity of an all-electric machine. Johnson, however, proposed to design a complete new line of machines for petitioner, and shortly after assuming his duties, outlined a program whereunder the proposed plan was to be carried out. The machines were to be divided into heavy, medium, and utility machines, and were to include planers and matchers, surfacers, tenoners, ripsaws, resaws, and grinders. At the time of the trial herein, the designing of 17 of the new machines had been completed or was in process, and pilot models had been built on 9 of them. In addition, 20 more machines were on schedule for future work. All 9 of the machines for which the pilot models had been completed were for use in the woodworking industry, but some of them were for markets which had not theretofore been served by petitioner. All of the *1041 pilot models had been tested, and it was anticipated that petitioner would be in production within 60 to 90 days.
All 9 pilot models of the above machines were displayed at a show of woodworking machinery in Grand Rapids, Michigan, on May 6 and 7, 1954. Most of the manufacturers in the industry*119 were represented at the show and each was exhibiting some new designs or improvements on their old designs. The customer reaction to petitioner's machines was very good.
As of December 31 of the years 1938 to 1953, inclusive, petitioner's financial statements show the following:
| Year | Cash | Accounts and | Govt. bonds | Inventories |
| notes rec. | incl. int. | |||
| 1938 | $ 2,286.70 | $ 11,447.73 | $ 22,227.11 | |
| 1939 | 3,015.10 | 23,266.89 | 15,786.26 | |
| 1940 | 6,075.18 | 16,146.35 | 16,232.02 | |
| 1041 | 17,250.37 | 37,071.91 | 33,738.14 | |
| 1942 | 14,920.78 | 29,498.97 | 58,996.04 | |
| 1943 | 26,743.88 | 24,808.91 | 55,712.29 | |
| 1944 | 7,869.19 | 12,091.95 | $ 50,046.11 | 35,886.98 |
| 1945 | 10,423.32 | 30,381.38 | 23,179.40 | 41,714.54 |
| 1946 | 11,255.35 | 17,797.60 | 73,339.60 | 124,117.04 |
| 1947 | 325,780.23 | 19,057.27 | 74,051.20 | 127,771.41 |
| 1948 | 378,006.03 | 88,778.41 | 452,458.00 | 156,280.24 |
| 1949 | 113,594.64 | 139,432.65 | 709,132.00 | 171,501.43 |
| 1950 | 159,051.03 | 302,429.34 | 655,798.00 | 254,211.71 |
| 1951 | 118,107.18 | 309,763.89 | 663,766.00 | 275,156.36 |
| 1952 | 83,862.19 | 659,352.04 | 395,733.00 | 252,482.51 |
| 1953 | 419,047.60 | 333,270.68 | 403,377.00 | 206,130.60 |
| Year | Total current | Fixed assets | Total assets |
| assets | |||
| 1938 | $ 35,961.54 | $ 8,110.50 | $ 44,072.04 |
| 1939 | 42,068.25 | 8,700.50 | 50,768.75 |
| 1940 | 38,453.55 | 7,737.45 | 46,191.00 |
| 1941 | 88,060.42 | 8,288.15 | 96,871.57 |
| 1942 | 103,415.79 | 11,731.23 | 116,609.74 |
| 1943 | 107,265.08 | 26,260.88 | 135,657.26 |
| 1944 | 105,894.23 | 58,244.49 | 166,824.95 |
| 1945 | 105,698.64 | 74,561.07 | 185,471.71 |
| 1946 | 226,509.59 | 87,241.90 | 317,439.12 |
| 1947 | 546,660.11 | 147,132.33 | 696,716.29 |
| 1948 | 1,075,522.68 | 227,399.50 | 1,309,548.00 |
| 1949 | 1,133,660.72 | 336,355.78 | 1,473,025.05 |
| 1950 | 1,371,490.08 | 456,223.02 | 1,834,368.92 |
| 1951 | 1,366,793.43 | 647,547.41 | 2,023,621.19 |
| 1952 | 1,391,429.74 | 987,549.56 | 2,387,557.20 |
| 1953 | 1,361,825.88 | 1,028,187.72 | 2,401,105.83 |
| Year | Accounts and | Total current | Depreciation |
| notes payable 1 | liabilities 2 | reserve | |
| 1938 | $ 5,638.58 | $ 6,356.05 | $ 1,896.10 |
| 1939 | 17,080.17 | 17,779.32 | 2,672.97 |
| 1940 | 11,036.96 | 11,672.80 | 2,209.02 |
| 1941 | 45,283.79 | 61,575.75 | 2,672.99 |
| 1942 | 55,022.72 | 72,013.79 | 3,764.27 |
| 1943 | 2,185.48 | 34,716.33 | 5,242.99 |
| 1944 | 12,745.67 | 46,691.11 | 9,921.52 |
| 1945 | 41,822.35 | 55,152.00 | 15,822.59 |
| 1946 | 79,643.58 | 124,932.99 | 18,271.99 |
| 1947 | 124,889.71 | 285,694.72 | 29,232.02 |
| 1948 | 74,071.90 | 417,099.66 | 53,761.59 |
| 1949 | 24,013.15 | 250,210.69 | 83,085.63 |
| 1950 | 94,676.95 | 408,921.75 | 119,442.58 |
| 1951 | 38,376.18 | 326,448.45 | 167,679.70 |
| 1952 | 49,070.94 | 384,085.42 | 238,066.49 |
| 1953 | 3 66,823.80 | 3 230,877.61 | 351,235.91 |
*1042
| Net worth | ||||
| Year | Total liabilities | |||
| and capital | ||||
| Capital stock | Paid-in surplus | Earned surplus | ||
| 1938 | $ 25,338.60 | $ 20,554.80 | ($ 10,073.51) | $ 44,072.04 |
| 1939 | 25,338.60 | 20,554.80 | (15,576.94) | 50,768.75 |
| 1940 | 25,338.60 | 20,554.80 | (13,584.22) | 46,191.00 |
| 1941 | 25,338.60 | 20,554.80 | (13,270.57) | 96,871.57 |
| 1942 | 25,338.60 | 20,554.80 | (5,061.72) | 116,609.74 |
| 1943 | 25,338.60 | 66,554.80 | 3,804.54 | 135,657.26 |
| 1944 | 25,263.60 | 66,554.80 | 18,393.92 | 166,824.95 |
| 1945 | 25,263.60 | 66,554.80 | 22,678.72 | 185,471.71 |
| 1946 | 25,263.60 | 66,554.80 | 82,415.74 | 317,439.12 |
| 1947 | 25,263.60 | 66,554.80 | 289,971.15 | 696,716.29 |
| 1948 | 653,163.60 | 66,554.80 | 119,058.35 | 1,309,548.00 |
| 1949 | 653,163.60 | 66,554.80 | 420,010.33 | 1,473,025.05 |
| 1950 | 832,563.60 | 66,554.80 | 406,886.19 | 1,834,368.92 |
| 1951 | 832,563.60 | 66,554.80 | 630,374.64 | 2,023,621.19 |
| 1952 | 832,563.60 | 66,554.80 | 866,286.89 | 2,387,557.20 |
| 1953 | 832,563.60 | 66,554.80 | 919,873.91 | 2,401,105.83 |
*121 The following is a breakdown into the categories indicated of petitioner's inventories on December 31, of the years 1943 through 1952:
| Year | Raw | Goods in | Finished | Secondhand | Total |
| materials | process | stock | machines | ||
| 1943 | $ 13,130.83 | $ 35,244.16 | $ 6,036.38 | $ 1,300.92 | $ 55,712.29 |
| 1944 | 12,390.09 | 22,226.89 | 1,020.00 | 250.00 | 35,886.98 |
| 1945 | 15,597.24 | 25,950.30 | 120.00 | 47.00 | 41,714.54 |
| 1946 | 45,100.14 | 75,613.56 | 3,403.34 | 124,117.04 | |
| 1947 | 53,420.87 | 72,148.51 | 2,202.03 | 127,771.41 | |
| 1948 | 95,644.75 | 42,327.96 | 18,307.53 | 156,280.24 | |
| 1949 | 77,879.60 | 61,490.61 | 16,581.22 | 15,550.00 | 171,501.43 |
| 1950 | 153,854.63 | 77,720.36 | 9,211.72 | 13,425.00 | 254,211.71 |
| 1951 | 185,214.15 | 71,167.21 | 14,275.00 | 4,500.00 | 275,156.36 |
| 1952 | 153,690.48 | 90,512.71 | 6,454.32 | 1,825.00 | 252,482.51 |
For the years 1935 through 1953, the result of petitioner's operations are shown by profit and loss statements as follows:
| Profit from | Profit (loss) | Net profit | |||
| Year | Sales | Gross profit | operations | before | (loss) after |
| (loss) 1 | income taxes 2 | taxes 3 | |||
| 1935 | $ 56,920.05 | $ 13,670.35 | ($ 1,487.19) | ($ 884.27) | ($ 884.27) |
| 1936 | 121,226.05 | 25,934.23 | (5,137.69) | (52.32) | (61.66) |
| 1937 | 166,610.15 | 36,954.20 | (5,584.32) | (61.50) | (61.50) |
| 1938 | 136,457.16 | 28,318.11 | (12,479.78) | (8,348.64) | (8,348.64) |
| 1939 | 215,689.12 | 41,553.42 | (5,768.77) | (1,727.33) | (1,727.33) |
| 1940 | 273,632.12 | 61,436.58 | 118.44 | 4,147.60 | 4,147.60 |
| 1941 | 462,390.96 | 115,366.63 | 2,429.89 | 7,847.76 | 5,192.59 |
| 1942 | 533,783.82 | 123,930.38 | 14,432.49 | 14,076.78 | 7,137.87 |
| 1943 | 512,768.09 | 121,817.77 | 9,206.35 | 14,232.35 | 8,600.70 |
| 1944 | 452,607.36 | 144,950.49 | 34,336.30 | 35,513.05 | 15,625.05 |
| 1945 | 494,644.80 | 111,343.29 | 183.44 | 3,579.16 | 2,394.52 |
| 1946 | 840,470.02 | 225,318.29 | 87,793.30 | 92,921.64 | 54,043.98 |
| 1947 | 1,501.191.90 | 525,389.34 | 341,785.23 | 354,180.89 | 207,322.78 |
| 1948 | 2,282,167.65 | 1,078,497.80 | 765,007.12 | 772,591.65 | 450,418.91 |
| 1949 | 1,978,186.98 | 841,361.57 | 511,039.17 | 516,114.89 | 301,170.37 |
| 1950 | 2,180,219.40 | 868,618.44 | 530,681.38 | 550,859.87 | 301,326.51 |
| 1951 | 2,592,061.94 | 938,143.34 | 477,762.57 | 492,876.78 | 232,458.45 |
| 1952 | 2,494,182.80 | 952,195.40 | 535,356.38 | 552,853.81 | 253,852.25 |
| 1953 | 2,135,148.04 | 720,760.92 | 216,557.79 | 193,476.98 | 71,660.82 |
*1043 The following is a statement by the indicated groupings or categories of petitioner's sales of woodworking machinery and other products, for the years 1951, 1952, and 1953, as shown by its books of account:
| 1951 | 1952 | 1953 | |
| Woodworking machinery: | |||
| Woodworking machines | $ 2,185,186.84 | $ 485,454.71 | $ 889,288.44 |
| Repair parts -- Supplies | 294,652.35 | 232,266.57 | 181,813.71 |
| U. S. agencies | 446,076.85 | 147,432.64 | |
| Knives -- Heads | 58,068.91 | ||
| Total | $ 2,479,839.19 | $ 1,163,798.13 | $ 1,276,603.70 |
| Other: | |||
| Newman hand saws | $ 221,100.00 | ||
| Outside sales | $ 27,202.88 | 4,296.10 | $ 15,656.12 |
| Blower equipment | 33,907.76 | 11,709.72 | 24,643.47 |
| Morey Machinery Co | 51,112.11 | 777,161.06 | 429,974.83 |
| American Tool Works | 81,503.58 | 37,607.89 | |
| Rockwell Manufacturing Co | 12,651.50 | ||
| Thompson Grinder Co | 234.614.21 | ||
| Job work | 102,545.18 | ||
| Atlanta Paper Co | 235,465.35 | ||
| Total | $ 112,222.75 | $ 1,330,384.67 | $ 858,544.34 |
| Total sales | $ 2,592,061.94 | $ 2,494,182.80 | $ 2,135,148.04 |
*123 In 1950, an agent of the respondent, after examining petitioner's returns for 1947 and 1948, suggested to petitioner's officers that it should have a definite dividend policy.
On August 10, 1950, petitioner declared a stock dividend of 1,794 shares, or 1 share of stock for each 4 shares outstanding. Earned surplus was charged and the capital account was credited with $ 179,400, or $ 100 for each additional share issued. At the same time, a cash dividend of $ 10 per share, or $ 89,700, was declared, payable to stockholders of record on August 15, 1950. This was the first cash dividend paid by petitioner after its incorporation in 1934. On December 31, 1950, an additional dividend of $ 5 per share, or $ 44,850, was declared, payable on June 10, 1950. Additional dividends of $ 1 and $ 2 per share were declared in 1951 and 1952, and paid in 1952 and 1953 in the respective amounts of $ 8,970 and $ 17,940. A dividend of $ 2 per share, or $ 17,940, was declared in 1953, and paid in 1954.
Petitioner's officers were aware of the additional surtax liability they personally would have if additional dividends were paid, and were also aware of section 102 liability that the company might*124 have if dividends were not paid.
In January 1951, another of respondent's agents examined petitioner's books and records with reference to the year 1949. At his request, petitioner submitted a statement setting forth its reasons for the retention of earnings in the business. In the statement, the opinion was expressed that at that time an approximate additional amount of $ 829,000 above what the company then had would be required, through future earnings or borrowed money, to carry out petitioner's future business plans.
*1044 The two principal stockholders, in joint returns with their wives, reported net income for the years 1949, 1950, and 1951, as follows:
| George F. Newman, Jr. | Wm. M. York | |
| 1949 | $ 80,952.19 | $ 55,096.30 |
| 1950 | 146,878.48 | 75,886.71 |
| 1951 | 146,465.93 | 72,329.97 |
The shares of stock outstanding and the record owners thereof on the dates indicated, are set forth in the following schedule:
| Shares owned December 31 | ||||||
| Shareholder | ||||||
| 1935 | 1945 | 1948 | 1949 | 1950 | 1951 5 | |
| George F. Newman 1 | 562 | 31 | ||||
| George F. Newman, Jr. 2 | 534 | 4,632 | 4,632 | 4,835 | 4,835 | |
| George F. Newman, Jr., Trustee | 975 | 975 | ||||
| Wm. M. York 3 | 315 | 315 | 2,420 | 2,220 | 1,575 | 1,535 |
| Wm. M. York, Jr. 4 | 50 | 150 | 787 1/2 | 807 1/2 | ||
| Frank A. York 4 | 50 | 150 | 787 1/2 | 807 1/2 | ||
| Mary H. Lewis | 2 | 2 | 16 | 16 | ||
| Victor W. Stout | 1 | 8 | 8 | 10 | 10 | |
| Others | 17 | 14 | ||||
| Total | 896 | 897 | 7,176 | 7,176 | 8,970 | 8,970 |
Petitioner's books reflect paid-in surplus as of January 1, 1945, of $ 66,554.80, contributed as follows:
| Year | Wm. M. York | George F. Newman | Total |
| 1937 | $ 10,000 | $ 10,000.00 | |
| 1938 | 8,180 | $ 2,374.80 | 10,554.80 |
| 1942 | 16,100 | 29,900.00 | 46,000.00 |
| Total | $ 34,280 | $ 32,274.80 | $ 66,554.80 |
Of the 1942 contributions, $ 20,000 represented accrued but undrawn salaries of officers, $ 13,000 for George F. Newman, and $ 7,000 for William M. York. The salaries were contributed in 1942 because of the needs of the petitioner, and have since remained in the business.
The following is the compensation paid to petitioner's officer-stockholders during the years 1945 through 1952:
| Year | Geo. F. | Geo. F. | Wm. M. | H. L. | V. W. | Total |
| Newman | Newman, Jr. | York | Newman 1 | Stout 2 | ||
| 1945 | $ 13,065 | $ 27,250.40 | $ 11,059.00 | $ 8,578.00 | $ 59.952.40 | |
| 1946 | 13,500 | 44,732.03 | 11,448.00 | 8,856.00 | 78,536.02 | |
| 1947 | 16,125 | 72,769.65 | 12,572.00 | 9,052.80 | 110,519.45 | |
| 1948 | 8,500 | 117,515.82 | 34,902.40 | $ 10,326.90 | 171,245.12 | |
| 1949 | 96,013.97 | 41,440.00 | 11,630.00 | 149,083.97 | ||
| 1950 | 98,162.98 | 49,570.00 | 12,265.00 | 159,997.98 | ||
| 1951 | 121,820.46 | 50,680.00 | 13,280.00 | 185,780.46 | ||
| 1952 | 91,222.30 | 50,640.00 | 13,832.00 | 3 162,120.30 |
*1045 George F. Newman, Jr.'s compensation has consisted of salary and commissions on sales. During World War II his compensation was frozen at a percentage on sales, plus a salary of $ 132.50 a week. During 1949 through 1951, he received the same weekly salary and 2 per cent on the first $ 50,000 of sales, and 5 per cent on all sales above that amount.
In his determination of the deficiencies herein, respondent determined petitioner's "undistributed Section 102 net income" and "Section 102 surtax" as follows:
| Section 102 | Section 102 | |
| net income | surtax | |
| 1949 | $ 300,952.03 | $ 104,866.53 |
| 1950 | 219,446.96 | 73,487.08 |
| 1951 | 191,008.63 | 62,538.32 |
The accumulations of*127 petitioner's earnings or profits during the taxable years 1949, 1950, and 1951 were not beyond the reasonable needs of its business, and petitioner was neither formed nor availed of for the purpose of preventing the imposition of the surtax upon its shareholders, through the medium of permitting earnings or profits to accumulate instead of being divided or distributed.
OPINION.
Under section 102 of the Internal Revenue Code of 1939, 1 a surtax is imposed upon the net income of a corporation, if such corporation "is formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders * * * through the medium of permitting earnings or profits to accumulate instead of being divided or distributed." And by subsection (c) thereof, it is provided that the "fact that the earnings or profits of a corporation are permitted to accumulate beyond the reasonable *1046 needs of the business shall be determinative of the purpose to avoid surtax upon shareholders."
*128 The respondent has determined such surtax deficiencies against petitioner for the years herein, on the ground that it was availed of for the purpose of preventing the imposition of the surtax upon its shareholders, through the medium of permitting its earnings and profits to accumulate beyond the reasonable needs of its business, and the case has been submitted and argued by the parties on that premise.
The evidentiary facts as shown of record have been found in considerable detail, and, in our opinion, no discussion or elaboration thereof is needed to justify the ultimate finding that petitioner did not accumulate its earnings or profits beyond the reasonable needs of its business, or to sustain the conclusion that petitioner was not availed of for the purpose of preventing the imposition of the surtax upon its shareholders, within the meaning of section 102. It is, of course, patent that petitioner was not formed for that purpose, and there has been no claim or determination that it was.
The respondent's determination of section 102 liability is accordingly rejected. See and compare Helvering v. National Grocery Co., 304 U.S. 282">304 U.S. 282; Helvering v. Chicago Stock Yards Co., 318 U.S. 693">318 U.S. 693;*129 Crawford County Printing & Publishing Co., 17 T. C. 1404; J. L. Goodman Furniture Co., 11 T. C. 530; L. R. Teeple Co., 47 B. T. A. 270; Cecil B. De Mille, 31 B. T. A. 1161, affd. 90 F. 2d 12, certiorari denied 302 U.S. 713">302 U.S. 713; and William C. De Mille Productions, Inc., 30 B. T. A. 826.
Decision will be entered under Rule 50.
Footnotes
1. Includes customers' deposits on orders.↩
2. Includes accrued liabilities and accrued taxes.↩
3. Includes $ 37,611 for "Employees' Past Service Annuity Contract," of which only $ 4,179 is a current liability.↩
1. Less selling and general and administrative expense.↩
2. Includes "other income," less "other expense."↩
3. Less State and Federal income taxes.↩
5. No changes as of December 31, 1953.↩
1. Died May 2, 1948.↩
2. President -- Son of George F. Newman.↩
3. Vice president and treasurer.↩
4. Sons of Wm. M. York.↩
1. H. L. Newman was vice president and superintendent from January 1, 1945, to January 23, 1946, and vice president until sometime prior to January 1, 1948.↩
2. V. W. Stout was secretary after May 7, 1948.↩
3. D. O. Warner, who had become assistant secretary, but who was not a stockholder, received compensation in the amount of $ 6,426, which, with the compensation received by the stockholder-officers, accounts for the total compensation of $ 162,120.30 paid to petitioner's officers during 1952.↩
1. SEC. 102. SURTAX ON CORPORATIONS IMPROPERLY ACCUMULATING SURPLUS.
(a) Imposition of Tax. -- There shall be levied, collected, and paid for each taxable year (in addition to other taxes imposed by this chapter) upon the net income of every corporation (other than a personal holding company as defined in section 501 or a foreign personal holding company as defined in Supplement P) if such corporation, however created or organized, is formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders or the shareholders of any other corporation, through the medium of permitting earnings or profits to accumulate instead of being divided or distributed, a surtax equal to the sum of the following:
27 1/2 per centum of the amount of the undistributed section 102 net income not in excess of $ 100,000, plus
38 1/2 per centum of the undistributed section 102 net income in excess of $ 100,000.
* * * *
(c) Evidence Determinative of Purpose. -- The fact that the earnings or profits of a corporation are permitted to accumulate beyond the reasonable needs of the business shall be determinative of the purpose to avoid surtax upon shareholders unless the corporation by the clear preponderance of the evidence shall prove to the contrary.↩