1954 U.S. Tax Ct. LEXIS 126">*126 1. The sales of standard commercial articles made by petitioner, a sole proprietorship engaged primarily in the wholesale distribution of foundry supplies, should not be excluded from its renegotiable business.
2. Salary allowance and amount of excessive profits made by petitioner from its renegotiable business determined.
22 T.C. 1023">*1023 Respondent has determined that petitioner's profits on contracts subject to renegotiation, during the year ended December 31, 1943, were excessive1954 U.S. Tax Ct. LEXIS 126">*127 to the extent of $ 19,000, or $ 18,811.66 after adjustment for State taxes. In making this determination, the respondent deducted a proportional part of a salary allowance of $ 20,000 for the sole proprietor as an expense.
In the proceedings before this Court petitioner contests the determination of excessive profits by claiming (1) that the respondent has inflated the amount of its renegotiable business incorrectly by including proceeds from contracts not subject to renegotiation in determining petitioner's total renegotiable business; and (2) assuming that respondent has correctly determined the amount of petitioner's contracts subject to renegotiation, the profits realized by petitioner were not excessive. Also, the petitioner claims that the salary allowed as an expense should have been based on a salary of $ 30,000 annually, instead of the $ 20,000 base used by respondent.
22 T.C. 1023">*1024 FINDINGS OF FACT.
During the calendar year ending December 31, 1943, the La Grand Industrial Supply Company, the petitioner, 1 was a sole proprietorship owned and operated by John La Grand, with its place of business in Portland, Oregon.
1954 U.S. Tax Ct. LEXIS 126">*128 John La Grand originally had established a general trucking business prior to 1936. Beginning in that year, he began to wholesale foundry supplies, at first sands and clays, and by the end of 1940, he was handling a full line of foundry supplies.
In 1943, petitioner was engaged primarily in the wholesale distribution of a general line of foundry supplies, including such items as clay, brick, sand, crucibles, chaplets, fillets, moulders' shovels, and protective devices and protective clothing. During the year in issue, petitioner carried approximately 500 different items for foundry use. Approximately 25 per cent of petitioner's business was in general hardware and appliances which he sold also to his customers for foundry supplies and stocked as a convenience to such customers.
Petitioner's customers consisted principally of approximately 40 foundries in the area of Portland, Oregon, and in other nearby Oregon cities. In 1943, petitioner furnished an estimated 85 per cent of the foundry supplies for the entire State of Oregon. In the Portland area, petitioner had practically no competition. Other dealers in the area carried only limited supplies when petitioner entered the field, 1954 U.S. Tax Ct. LEXIS 126">*129 and they virtually ceased to operate as petitioner expanded his business.
The average annual sales, costs, and profits of petitioner for the period 1936-1939 were as follows:
| Average sales | $ 31,548.19 |
| Average costs | 27,688.81 |
| Average profits * | 3,859.38 |
The average net worth of the business at the beginning of the year in the period 1936 through 1939 was $ 17,176.74 and the average net worth at the end of the year during this period was $ 18,521.50.
In 1943, petitioner's sales, costs, and profits, segregated between renegotiable and nonrenegotiable business were:
| Renegotiable | Nonrenegotiable | Total | |
| Net sales | $ 378,207.50 | $ 222,211.57 | $ 600,419.07 |
| Total costs | $ 327,677.12 | $ 191,821.33 | $ 519,498.45 |
| Net profit | $ 50,530.38 | $ 30,390.24 | $ 80,920.62 |
| Per cent profit to sales | 13.36% | 13.68% | 13.48% |
22 T.C. 1023">*1025 Petitioner's net profit on the nonrenegotiable business1954 U.S. Tax Ct. LEXIS 126">*130 in 1943 was approximately 7.8 times greater than its average annual net profit during the period 1936 through 1939.
In 1943, sales of foundry sands and clays in the amount of $ 150,600.44 were made under contracts or subcontracts with departments or agencies which were exempt from renegotiation.
The net worth of the business on January 1, 1943, was $ 105,086.06, and on December 31, 1943, $ 142,076.73. During 1943, drawings totaled $ 43,929.95.
The petitioner's fixed assets, after allowance for depreciation, at the end of each of the years 1936 through 1943 were as follows:
| 1936 | $ 4,099.75 |
| 1937 | 6,419.14 |
| 1938 | 9,208.66 |
| 1939 | 16,038.52 |
| 1940 | $ 18,966.20 |
| 1941 | 24,162.46 |
| 1942 | 21,430.15 |
| 1943 | 19,251.09 |
The petitioner's total current liabilities at the end of each of the years 1936 through 1943 were as follows:
| 1936 | $ 991.58 |
| 1937 | 780.80 |
| 1938 | 3,063.83 |
| 1939 | 7,675.96 |
| 1940 | $ 9,396.41 |
| 1941 | 36,573.41 |
| 1942 | 29,296.24 |
| 1943 | 19,972.14 |
During 1943, John La Grand devoted his full time to running the business. He was assisted by his brother who acted as a general assistant and sales representative until September, when he left the organization. In addition, four truck drivers1954 U.S. Tax Ct. LEXIS 126">*131 and four helpers, and an office staff of two stenographers and a part-time bookkeeper were employed by the business.
Petitioner's operation in 1943 involved the warehousing and wholesale distribution of a line of merchandise for which there was great demand as a result of wartime production. Approximately 50 per cent of petitioner's entire business was in sales of carload lots of merchandise which was delivered directly to the customer. Petitioner's business did not vary from its peacetime business except for an increased range of merchandise and a greatly increased volume of sales. The volume of sales during 1943 held the risk in the business to a minimum. Petitioner's closing inventory was $ 38,346.33. The opening inventory of $ 40,752.52 was turned over more than 11 times during the year.
Petitioner received no Government financing or other aids such as rapid amortization privileges, but his business required only a small amount of working capital and fixed assets. At the end of 1942, the current assets totaled $ 112,550.41, of which $ 40,752.52 was in inventory, $ 52,848.85 in accounts receivable, $ 750 in Government bonds, and $ 18,199.04 in cash. The fixed assets, consisting1954 U.S. Tax Ct. LEXIS 126">*132 of buildings, furniture 22 T.C. 1023">*1026 and equipment, and automotive equipment had a book value, after depreciation, of $ 14,251.09 at the end of 1943. The only other fixed asset in the business was land with a book value of $ 5,000 at the end of 1943.
Petitioner did not add any value to the merchandise he sold, nor did he make any engineering, inventive, or developmental work on his merchandise. His business was efficiently conducted and some economies developed which petitioner passed on to his customers in reduced prices. Such economies were small and resulted primarily from the volume of business transacted and not from John La Grand's ingenuity or inventiveness.
A reasonable salary allowance for John La Grand's services to his company in 1943 is $ 25,000.
Petitioner received excessive profits of $ 15,000 from its renegotiable business in 1943.
OPINION.
The respondent has determined by a unilateral order that the petitioner, the La Grand Industrial Supply Company, received excessive profits for the year 1943 in the amount of not less than $ 19,000 2 after allowing a proportional part of a salary allowance of $ 20,000 for the services of the owner and sole proprietor, John La Grand. 1954 U.S. Tax Ct. LEXIS 126">*133
Both the salary allowance and the determination of excessive profits are challenged by the petitioner in the proceeding before us. Petitioner also contends that the respondent has erroneously included in the renegotiable portion of the business a very substantial amount attributable to sales of standard commercial articles which should be exempt from renegotiation.
Section 403 (a) (7), the Renegotiation Act of 1943, 3 provides generally that a "standard commercial article" is one (a) which is identical with articles manufactured and sold for prewar civilian use; (b) for which there exists a competing product; and (c) for which 22 T.C. 1023">*1027 a maximum price had been fixed under the Emergency Price Control Act. The Renegotiation Act further provides in section 403 (i) (4) (D) that the War Contracts Price Adjustment Board may, in its discretion, exempt sales of standard commercial articles from renegotiation, "if, in the opinion of the Board, competitive conditions1954 U.S. Tax Ct. LEXIS 126">*134 affecting the sale of such [articles] are such as will reasonably protect the Government against excessive prices."
1954 U.S. Tax Ct. LEXIS 126">*135 Thus, under the Renegotiation Act, contracts for the sale of commercial articles were not automatically or mandatorily exempt from renegotiation. They were exempt if the War Contracts Price Adjustment Board exempted them and, concededly, the Board did not exempt contracts for the sale of the products here involved from renegotiation.
But the petitioner contends that this Court has the authority to exempt the proceeds of the sales of these articles from renegotiation. He argues that, under section 403 (e) (1) of the Renegotiation Act,
A proceeding before the Tax Court to finally determine the amount, if any, of excessive profits shall not be treated as a proceeding to review the determination of the Board, but shall be treated as a proceeding de novo.
The petitioner contends that under the above authority this Court may exercise the discretion initially reposed in the War Contracts Price Adjustment Board and exempt from renegotiation the sales of the standard commercial articles which the Board did not exempt.
It should be observed that the petitioner here did not specifically request the War Contracts Price Adjustment Board to exempt the sales of his products from renegotiation1954 U.S. Tax Ct. LEXIS 126">*136 but, in the view we take of the case, this makes no difference. The Board, in considering its power to exempt standard commercial articles, had ruled that it would not exempt individual contracts for furnishing these articles, and such exemptions as would be granted would be by types or classes of articles. (Renegotiation Regulations dated March 24, 1944, as revised, secs. 354.2 and 845.)
The respondent contends that the authority to exempt contracts for the sale of standard commercial articles from renegotiation rests exclusively in the discretion of the War Contracts Price Adjustment Board and this Court has no authority to review the Board's action, or lack of action, in granting or denying permissive exemptions from renegotiation.
Assuming, without deciding, that this Court has the authority to review the discretionary authority of the Board to exempt standard commercial articles from renegotiation, and that the petitioner's products were such articles, we think that the petitioner has not shown that competitive conditions were such in his business as would reasonably protect against excessive prices and excessive profits. The 22 T.C. 1023">*1028 only conclusions which the record reasonably1954 U.S. Tax Ct. LEXIS 126">*137 supports are that the petitioner did not gouge his customers, that at times he charged them less than the controlled prices fixed for his merchandise by O. P. A., and that he did pass on at times to his customers certain savings resulting from the volume of his business. However, more than this is necessary to justify a conclusion that competitive conditions surrounding this business were such that the Government was reasonably protected against excessive prices. Cf. Moening v. War Contracts Adjustment Board, 14 T.C. 589.
Turning next to the remaining questions, we think that the record clearly shows that the principal reason for petitioner's large profits in 1943 was the very great demand for his merchandise which was inspired by the war production orders of his customers. During this period he had no difficulty in selling his supplies. The problem was to keep his bins and shelves full of merchandise. Consequently, there was little risk in his operation. Much of the merchandise he sold never even passed through his warehouse but was delivered directly to the customer in carload lots with the petitioner merely arranging the details of the 1954 U.S. Tax Ct. LEXIS 126">*138 delivery and handling the invoices.
We are not convinced that petitioner's business was a complex or intricate operation. It did not involve manufacturing or fabricating; it was a simple wholesaling operation made easier by an unusual demand. No doubt petitioner did work hard during this year but many other patriotic citizens did likewise. We have no doubt that the petitioner was required by the demands of his business to work long hours and often on weekends and recognition of his efforts should be reflected in the salary allowance that should be made in determining whether the petitioner realized excessive profits.
Testimony of several witnesses was offered to establish what would be an appropriate salary for petitioner's services during 1943. After carefully weighing this testimony and all the facts, we think that $ 25,000 would be a reasonable salary allowance to be taken into consideration in determining whether excessive profits were realized in 1943. 4
1954 U.S. Tax Ct. LEXIS 126">*139 All the factors which bear on the reasonableness of the profits which petitioner realized from the renegotiable portion of his business have been weighed by the Court in determining whether petitioner received excessive profits. We have considered particularly that the extraordinary wartime demand for petitioner's merchandise resulted in a rapid turnover of his inventory, that such a condition diminished substantially the normal risks in a mercantile operation 22 T.C. 1023">*1029 and enabled the petitioner to do a large volume of business with comparatively little capital. In the light of these circumstances, we have found that petitioner's profits were excessive in the amount of $ 15,000.
An order in accordance with the Opinion will be entered.
Footnotes
1. Hereinafter the firm and the owner are referred to interchangeably as petitioner.↩
*. Profit as a percentage of sales 12.24 per cent.↩
2. The amount, after allowance for State taxes, is $ 18,811.66.↩
3. Sec. 403 (a). For the purposes of this section --
* * * *
(7) The term "standard commercial article" means an article --
(A) which is identical in every material respect with an article which was manufactured and sold, and in general civilian, industrial, or commercial use prior to January 1, 1940,
(B) which is identical in every material respect with an article which is manufactured and sold, as a competitive product, by more than one manufacturer, or which is an article of the same kind and having the same use or uses as an article manufactured and sold, as a competitive product, by more than one manufacturer, and
(C) for which a maximum price has been established and is in effect under the Emergency Price Control Act of 1942, as amended, or under the Act of October 2, 1942, entitled "An Act to amend the Emergency Price Control Act of 1942, to aid in preventing inflation, and for other purposes," or which is sold at a price not in excess of the January 1, 1941, selling price.↩
4. Of course, only that part of the gross salary of $ 25,000 which is equal to the ratio between renegotiable sales and total sales for the year 1943 is taken into consideration in determining whether excessive profits were realized from renegotiable sales.↩