*202 Petitioner's excessive profits for the fiscal year ended September 30, 1943, held to be the amount determined by the respondent, petitioner not having sustained its burden of proving that respondent erred in its original determination, and respondent not having sustained its burden of proving, as alleged in its amended answer, that petitioner had additional excessive profits for that year.
*1037 The respondent, War Contracts Price Adjustment Board, acting under authority of section 701 (b) of the Revenue Act of 1943, has determined that petitioner's profits realized in the fiscal year ended September 30, 1943, upon contracts subject to renegotiation, as defined by that act, were excessive to the extent of $ 85,000 and after adjustment for state taxes in the amount of $ 7,000 the refund to be made *1038 to the Federal Government was $ 78,000. Formal notification of this determination was mailed to petitioner by registered mail, as required by the cited statute, on June 25, 1945.
FINDINGS OF FACT.
*203 Petitioner was incorporated in 1937, under the laws of New York. Its place of business is located at Long Island City, New York. It was organized to develop and manufacture Aero-thread screwthread, an invention of Harold Caminez. It later developed the Heli-Coil Screw Thread System. Petitioner's products are patented screwthread fastenings or inserts which take the place of the conventional threaded bushing used when alloy steel bolts are fastened into castings of lighter metal.
In the construction of aeroplane engines, aeroplanes, some types of marine engines, tanks, and certain other implements of war, the engines or other parts are constructed of aluminum or aluminum alloy to give the essential lightness in weight. Mountings are attached to these light metal parts by bolts. In view of the fact that these light metals are "soft", as compared with steel or iron, the bolts may not be screwed into threaded holes in the light metal, as the threads in such metal are soon destroyed through heat, vibration, and other causes and the bolt loosens. It was attempted to meet this condition by the insertion in soft metal of a hard metal threaded bushing. This bushing, however, proved*204 in many cases unsatisfactory for when put to great strain heat cracks would develop in the soft metal and the bushing would loosen. Petitioner's Aero-thread screwthread and Heli-Coil Screw Thread System served in large measure to obviate this trouble.
There were other reasons making petitioner's screwthread inserts more satisfactory and efficient than the conventional bushing. With their use the strength of the junction was more than doubled. Where a broken or loosened spark plug bushing had to be removed and renewed the operation required from 12 to 24 hours, whereas this renewal if made with petitioner's insert could be effected in one hour. These inserts were adapted for use with many different types of bolts. Thus petitioner, in the taxable year, manufactured and sold to the Navy kits containing supplies of its thread inserts in 12 different sizes. These replaced some 1,200 different sizes of studs theretofore necessarily purchased and kept in stock for aeroplane engine repairs.
In addition to its manufacture of its screwthread inserts petitioner developed and manufactured a number of different tools for use in efficiently and quickly installing these inserts. These tools*205 ranged in individual cost to petitioner from 47 cents to $ 66 each and were sold by it at prices substantially lower than their cost of manufacture.
*1039 Following its incorporation in 1937, petitioner was engaged in organizing and developing its product and sustained net losses for each of the fiscal years ended September 30, 1938, 1939, and 1940. For the fiscal year 1941 it had net sales of $ 181,092 and a manufacturing profit, before Federal taxes, of $ 37,114, or approximately 20 per cent on net sales. For the fiscal year 1942 petitioner had, before renegotiation, net sales of $ 607,833 and a manufacturing profit of $ 138,526, or 22.79 per cent on net sales. After renegotiation for that year it had adjusted net sales of $ 577,883, which was the amount of the actual net sales reduced by the amount of the refund following renegotiation, upon which its net profit retained, before Federal taxes, amounted to $ 108,526, or 18.78 per cent of adjusted net sales.
For the fiscal year 1943, here in question, petitioner had total net sales of $ 1,056,745 and net income therefrom, before Federal taxes, of $ 208,078. Its production increased 70 per cent over the prior year. This *206 was accomplished with only an 8 per cent increase in production facilities. The prices of its products were neither increased nor decreased over the prior year. During this year petitioner expanded its man hours of work per week by establishing two and three shifts, causing additional labor costs for overtime. It also had an additional labor cost represented by an approximate 15 per cent increase in pay required under a labor union agreement which went into effect early in February of that year.
Petitioner, in the course of its fiscal year 1942, had outstanding $ 24,000 in prior preferred stock and $ 77,600 in new preferred stock. Both of these issues of preferred stock were subject to call at a premium. On the first day of the fiscal year 1943 petitioner issued series A 8 per cent debenture bonds in the amount of $ 24,000, due in 1952, in the redemption and cancellation of the prior preferred stock, and issued series B 8 per cent debenture bonds in the amount of $ 88,000, due in 1952, in the redemption and cancellation of the new preferred stock valued at $ 77,600. It charged $ 10,400 to surplus and paid out cash in the amount of $ 2,800. During the fiscal year 1943 the petitioner*207 deducted, in computing its net income, $ 8,800 representing the payments of interest made by it upon the two issues of debenture bonds above referred to, and $ 1,040 representing amortization applicable to that year of the discount on the bonds issued.
Petitioner showed a high degree of efficiency, particularly with regard to attainment of quantity and quality of production, reduction of costs, and economy in the use of facilities and manpower. It had no assistance in the way of Government loans of money or facilities. At the beginning of the fiscal year here in question it had outstanding common stock in a par value of $ 7,750 and earned surplus of $ 54,711. It also then had outstanding bonds in the amount of *1040 $ 112,000. The extent of the risk assumed by petitioner, including the risk incident to reasonable pricing policies, was relatively slight for the calendar year 1943 and less than in the preceding year. Petitioner's patented product was unique in character and constituted a valuable contribution to the war effort, making more effective the implements of war in which it was used and effecting a saving of expense and time in the maintenance of these war implements. *208 Petitioner cooperated fully with the Government and other contractors in supplying technical assistance. The manufacturing operations of petitioner were of considerable complexity, requiring extreme precision. Its product was delivered according to schedule and without delay. As petitioner is a new company, organized in 1937, and was not producing at a profit until 1940, there is no basis for comparison of its war profits with normal prewar earnings as in the case of other companies. Its product for sale in peacetime is based upon the same principle as that of its manufacture for war purposes. It is, however, not a product which can be manufactured for general sale through trade channels, but will normally be sold to manufacturers whose particular thread failures have been studied by petitioner's engineers and remedied through an adaptation of petitioner's screwthread inserts, together with, in some cases, changes in design of the products in which they are to be used.
In addition to the income derived by petitioner in the fiscal year 1943 from its manufacturing operations, it realized income of $ 7,849 in royalties received under agreements for the use of certain of its patents.
*209 Petitioner's profits upon its renegotiated business for the fiscal year 1943 were excessive to the extent of $ 85,000.
OPINION.
The renegotiation of petitioner's war contracts for the fiscal year 1943 here involved resulted in a determination by the Navy Price Adjustment Board that petitioner's profits for that year from these contracts were excessive to the extent of $ 85,000, which, when adjustment was made for $ 7,000 in state taxes, required a refund in the sum of $ 78,000. This determination was adopted by respondent, the War Contracts Price Adjustment Board, as its determination. Respondent, by amended answer, asks that we find petitioner's profits to be excessive to the extent of $ 158,078.
The parties are in agreement as to the total amount of the profits realized by petitioner and subject to renegotiation, with the exception of two items which respondent in his amended answer alleges should be so included. The first of these items is $ 9,840, deducted by petitioner in computing its net profit before taxes. This amount is made up of $ 8,800 in interest paid on debenture bonds issued by it *1041 and $ 1,040 representing the amortization of bond discount applicable *210 to the current year. The second such item is $ 7,849 in royalties received by petitioner.
Respondent contends that the bond interest and discount should be eliminated as a cost and treated as a distribution of profits to stockholders. Our question is limited to that of whether these bonds issued by petitioner evidenced a debt upon which the contested payments were interest. .
It is true that under certain circumstances it has been held that, in computing net income for purposes of income tax, amounts paid as interest upon securities issued by a close corporation to its preferred stockholders in exchange for their stock is to be treated as nothing more than a dividend payment. The question of whether such payments constitute interest upon indebtedness or dividends upon an interest in the nature of that of a stockholder is one of fact. ; ; affd., ; affd., . "The *211 determining factors are usually listed as the name given to the certificates, the presence or absence of maturity date, the source of the payments, the right to enforce the payment of principal and interest, participation in management, status equal to or inferior to that of regular corporate creditors, and intent of the parties." ; reversed, ; U. S. Supreme Court reversed Circuit Court, .
In the present case the securities issued are denominated bonds and have a fixed maturity date, a fixed rate of interest, and both principal and interest are payable upon maturity out of the assets of the corporation, whether or not there is a surplus. There is no indication of an intention on the part of the petitioner in the issuance of these securities that its obligation was to be anything less than that of a debtor. The distinction between a shareholder and a creditor set out by the court in , has often been quoted with approval. The court said:
* * * The*212 final criterion between creditor and shareholder we believe to be the contingency of payment. The shareholder is entitled to nothing, prior to liquidation, except out of earnings. Even on liquidation, at least in New York, arrears of cumulative dividends are confined to earnings. . These debenture bondholders were not so limited. The interest could be deferred, but it was not lost, though the company had no earnings; it could be collected, together with the principal, in 1954, from the corpus of the debtor's property, regardless of whether there should be a surplus. See . This distinction marks the vital difference between the shareholder and the creditor. The shareholder is an adventurer in the corporate business; he takes the risk, and profits from success. The creditor, in compensation for not sharing the profits, is to be paid independently of the risk of success, *1042 and gets a right to dip into the capital when the payment*213 date arrives. The courts have very frequently been called upon to determine whether the rights of a claimant are those of shareholder or creditor. Each case has turned on its special facts, and to cite them all would not be useful, if it were possible. We think all the decisions which we have examined may be harmonized by adopting the criterion above suggested. The decision of this court in , is entirely consistent with this view. There interest on the so-called bonds was to be paid only out of earnings, and upon liquidation or dissolution the whole residue of the corporate assets after payment of the debts was to go to the bondholders. * * *
Upon the renegotiation of excessive profits here in controversy, basing the original determination, this deduction of bond interest was approved and allowed. Respondent now urges its disallowance in affirmatively contending that the amount of excessive profits is in excess of the amount originally determined. The burden of proof is, accordingly, upon respondent to establish that this payment was, in fact, not interest, but a distribution of profits. .*214 In support of its contention respondent merely points out that most of the holders of preferred stock accepted, upon liquidation of that stock, these bonds in payment of the amounts due them and that the stock of the corporation was rather closely held. We think that this proof, at least, falls far short of that necessary. See ;;. Respondent has failed to carry its burden.
As to the $ 7,849 in royalties received by petitioner, which respondent asks us to consider as renegotiable income, it may be pointed out that the contract or contracts under which these payments were received were not included in those renegotiated by respondent. By section 701 (e) (1) of the Revenue Act of 1943, our jurisdiction is limited to a "redetermination" of the amount found by the respondent as excessive profits realized by the contractor upon contracts which it has renegotiated. Moreover, the issue of the includibility of this item of royalties in renegotiable income was likewise first *215 raised by respondent at the hearing before this Court. Thus, in any event, if the item of "patent royalties received" had any connection with one or more of the contracts renegotiated, the burden was upon respondent to establish that fact. No evidence, however, was presented even tending to show such connection, or even to establish that this business was renegotiable in character. We have accordingly found that the net profits of petitioner, before income taxes and subject to renegotiation, are in the sum of $ 208,078.
Respondent, as a basis for its assertion that petitioner's profits were excessive in the amount of $ 158,078, or $ 73,078 more than the sum originally determined, asks us to find that upon the evidence *1043 here the petitioner's efficiency was only average, that its contribution to the war effort was minor, and that its cooperation with its customers was average. We do not think the evidence justifies such finding. The record, we think, supports fully our finding that petitioner was highly efficient, that its contribution to the war effort was substantial, and that it showed a high degree of cooperation *216 with the Government and other contractors in rendering service. We have reached these conclusions upon the degree of existence of these statutory factors solely upon the basis of the evidence presented at the hearing before this Court.
Respondent arrives at its figure of $ 158,078 which it contends represents excessive profits by using a different method of computing a reasonable profit from that adopted in the renegotiation of petitioner for the fiscal year 1943, here involved, as well as for the prior year. In the renegotiation for both of those years the volume of net sales was taken into consideration and a determination was made as to what would represent a fair return on such volume of sales. Here respondent uses as the basis for computation the net worth of petitioner and seeks to determine what would be a reasonable return upon such amount. The excess, it is contended, represents excessive profits.
It may be that there are situations in which an allowance of a normal return upon the net investment by the contractor would represent a fair and just determination of a reasonable profit upon its war business. We do not think, however, that such basis can be used in the present*217 case. At the beginning of the year in question petitioner had a net worth of $ 7,750 in common stock and earned surplus of $ 54,711. It also had $ 112,000 borrowed capital, for which it had issued bonds in the same amount. Respondent eliminates this borrowed capital and asks that a return be allowed petitioner only upon the investment represented by its common stock and its earned surplus. It is argued that to allow it to retain $ 60,000 of its net profits before taxes will leave sufficient profits remaining after payment of taxes to represent a fair return on its investment.
This method of computation does not take into consideration the possession by petitioner of assets which, although they are of exceptional value, as indicated by this record, are not reflected in that value on the balance sheet. These are the patents which it owns and controls. Moreover, such method of computation also disregards the specific statutory mandate requiring other facts to be taken into consideration in addition to net worth.
For the year prior to the one here involved petitioner had net sales of $ 607,833 upon which it realized a net profit, before taxes, of $ 138,526 or 22.79 per cent. Upon*218 renegotiation it was permitted to retain of *1044 these net profits $ 108,526, representing 18.78 per cent of its adjusted net sales after renegotiation. Here respondent's method of computation would permit petitioner to retain net operating profits in the current year of only slightly more than 50 per cent of the amount of profits permitted to be retained in the prior year upon renegotiation, although it is established here that petitioner increased its production in the current year 70 per cent by running two and three shifts and operating seven days a week.
Petitioner asks that a reasonable profit be computed upon the volume of its business, i. e., its net sales. It is argued that since 18.78 per cent of adjusted net sales was considered as reasonable in its operation for the prior year, this same percentage should be allowed upon its increased net sales for the year here involved.
We do not agree. It is clear to us that a different situation governing its pricing policy existed in the present year from that confronting the petitioner at the beginning of the prior year. In the present year its manufacturing and engineering problems and difficulties had been in large measure*219 overcome. As a result, we are convinced that there was little risk assumed by petitioner in its pricing for this year. Its product had been accepted and it could be reasonably foreseen that its production would be increased and its return of profit would be larger by reason of such production increase. Cf. . Even if it could have been reasonably anticipated that labor or other costs would increase, we think it could also have been anticipated that such increased costs would be offset by the gain from reduced unit costs of manufacturing incident to the increased production, so that its percentage of profit on net sales would be maintained and, at least since its prices were not reduced, that it would realize a substantially larger amount in net profits from its operations than in the prior year.
Under these conditions we think that petitioner without risk could have reduced the prices charged for its products and that in maintaining these prices at the same level it has realized profits in excess of what would be reasonable.
The burden is upon respondent to establish that petitioner realized excessive profits*220 in an amount in excess of $ 85,000, as determined by the Navy Price Adjustment Board, and upon petitioner to establish that it realized no excessive profits or that such profits were in an amount less than that determined by that Board.
We conclude upon the record that petitioner and respondent have failed to carry their respective burdens of proof. See Accordingly we have found that petitioner's profits for the fiscal year 1943 were excessive in the amount of $ 85,000.
An order will be issued in accordance herewith.