*122 1. Renegotiation -- Unilateral Determination -- Statutory Authority. -- The Renegotiation Act authorized the Secretary of War, in the absence of a mutual agreement, to issue a unilateral order determining the amount of excessive profits realized by a contractor or subcontractor in 1942.
2. Renegotiation -- Repairs -- Machinery Used in Performance of War Contracts. -- Amounts received by the petitioner for repairs made on machinery used by his customers in performing war contracts are subject to renegotiation.
3. Renegotiation -- Excessive Profits -- Amount. -- The amount of excessive profits determined.
*70 Unilateral determinations were made that the petitioner realized excessive profits of $ 300,000 for 1942, $ 245,000 for 1943, and $ 45,000 for 1944. The issues for decision are:
(1) Whether the Renegotiation Act gave the Secretary of War authority to issue a unilateral order determining the amount of excessive profits of the petitioner for 1942;
(2) Whether amounts received by the petitioner in each year for repairs made on machinery used by customers in performing war contracts are subject to renegotiation;
(3) Whether the first $ 500,000 of sales in each of the years 1943 and 1944 is exempt from renegotiation;
(4) Whether an aliquot part of the amount which the petitioner paid to his former partner to represent 40 per cent of net earnings for 1942, pursuant to an agreement dissolving the former partnership, is to be substracted in determining profits from renegotiable business and, if not, whether the Fifth Amendment of the Constitution of the United States is violated;
(5) As an alternative to the fourth issue, whether the petitioner and his former partner conducted the business as a joint venture during 1942 so*124 that only a part of the profits belonged to the petitioner;
(6) What amounts represent reasonable compensation for services rendered in each year by the petitioner and his former partner;
(7) In what amount, if any, were the petitioner's profits from renegotiable subcontracts excessive for each year.
FINDINGS OF FACT.
The petitioner and George E. Frawley were experienced machinists in 1935, at which time they formed a partnership known as the L. & F. Machine Company. Their interests from 1937 through 1940 were 60 per cent for the petitioner and 40 per cent for Frawley. *71 The net sales increased from about $ 43,800 in 1936 to over $ 364,000 in 1940, and the profits increased from about $ 8,400 in 1936 to over $ 117,000 in 1940. The equipment increased from about $ 5,200 at the beginning of 1936 to about $ 35,000 at the beginning of 1940.
Frawley decided at the end of 1940 that he did not want to be a partner any longer and he and the petitioner executed a written agreement dissolving the partnership as of December 31, 1940, whereby the petitioner purchased all of Frawley's interest in the business and assumed all of the liabilities of the business. The agreement provided*125 that a statement of the capital investment accounts of each partner was to be prepared and the petitioner was to pay to Frawley an amount equivalent to the latter's net interest in the business. Paragraph 3 of the agreement was as follows:
3. George E. Frawley agrees not to sever his connections with said firm, but agrees to continue to devote his full time and efforts to the interest and the welfare of the business for a period not exceeding two years from and after the date of January 1, 1941, the consideration to be paid by the said Ralph E. Larrabee to the said George E. Frawley as of the 31st day of December, 1941, and the 31st day of December, 1942, or as of the date of termination of such connection, and to be equivalent to 40 per cent of the net profits earned by this company after deducting all operating expenses, Federal and State and other taxes, for the periods of time as hereinabove indicated. No claim for services rendered shall arise in favor of the said George E. Frawley, except as of the dates and to the extent herein specified.
The petitioner has been conducting the business continuously since January 1, 1941, as sole proprietor under the name of L. & F. Machine*126 Company.
The business grew but did not change materially in character from its inception through 1944. It was the operation of a machine shop and included machining, welding, and fabricating equipment and repairing machinery owned by others.
Such items as drop hammers, spot-welding machines, dies, miscellaneous tools, and small parts were fabricated. A customer would furnish a blue print and the petitioner would then make the desired item, using raw materials supplied by the petitioner and parts purchased by it from others.
The petitioner did machine work on materials sent to it by customers.
The petitioner repaired machinery owned and used by its customers, sometimes furnishing material and small replacement parts needed in the repair.
The labor furnished by the petitioner was the largest item involved in the machining and repairing operations of the petitioner.
*72 The total net sales, net profits, and net sales and net profits subject to renegotiation for the years 1942, 1943, and 1944 were as follows:
| Total | Renegotiable | |||
| Net sales | Net profit | Net sales | Net profit | |
| 1942 | $ 1,215,278.24 | $ 492,637.73 | $ 998,594.13 | $ 404,800.42 |
| 1943 | 1,133,732.14 | 391,544.87 | 1,068,202.42 | 368,912.63 |
| 1944 | 821,024.19 | 187,107.37 | 698,034.77 | 159,078.69 |
*127 The building originally occupied by the partnership contained about 2,800 square feet. The plant occupied about 30,000 square feet at the beginning of 1942 and was increased by 5,500 square feet during that year. All of the machinery in use on January 1, 1942, was second hand. Several new machines were installed during the next 3 years. The approximate book values of fixed assets at the beginning of each year were $ 49,000 for 1942, $ 143,000 for 1943, and $ 121,000 for 1944. Inventories increased from about $ 16,000 at the beginning of 1942 to about $ 63,000 at the beginning of 1944. The petitioner owned outright all of the property used in the business. He received no financial assistance from any source during the years involved. He employed from 99 to 145 people during the years involved. Few of them were skilled workers. Wage stabilization caused him to pay relatively low wages which were generally from 10 to 15 cents an hour lower than his competitors.
Production line methods could not be used on much of the work done by the petitioner but some volume machining of a few items resulted in a lowering of costs. The quality and quantity of the work done was good. The*128 petitioner was economic in the use of manpower. There was little or no spoilage resulting from poor work in the plant. His costs were reasonable. His charges to customers were relatively low. He gave efficient service and cooperation to his customers. He was sometimes able to correct mistakes or make suggestions to the advantage of his customers.
The petitioner paid Frawley $ 52,235.84, the net amount of his capital interest in the partnership, early in 1941, in accordance with the agreement dissolving the partnership, and Frawley at that time conveyed his interest in the partnership to the petitioner. Frawley devoted his time and efforts to the business during 1942 and received, pursuant to paragraph 3 of the Dissolution Agreement, as 40 per cent of the net profits for 1942, $ 175,181.57 in 1942 and $ 8,353.90, with interest, in 1946.
The petitioner employed Frawley during 1943 and 1944 under an oral agreement at an annual salary of $ 36,000, plus Social Security and *73 unemployment taxes thereon. The duties performed by Frawley as an employee of the petitioner were of an executive nature and included the preparation of bids, supervision of production in the shop to *129 insure prompt delivery, signing pay roll checks, purchasing materials, hiring and supervision of personnel, dealing with customers, deciding with the petitioner upon the purchases and sale of machinery and equipment, and general supervision of the work in the absence of the petitioner.
The services performed by the petitioner were similar in nature to those performed by a general manager. He gave instructions to and supervised the work of his foremen, bid on jobs, consulted with customers, handled priorities, and did most of the buying. He worked long hours.
The Under Secretary of War made a unilateral determination on November 3, 1944, that $ 300,000 of the profits realized by the petitioner during 1942 under contracts and subcontracts subject to renegotiation were excessive. The record does not show what allowance was made in that determination for compensation for the services rendered by the petitioner and Frawley.
The War Contracts Price Adjustment Board made unilateral determinations that $ 245,000 for 1943 and $ 45,000 for 1944 represented excessive profits on contracts and subcontracts subject to renegotiation. The Board, in making those determinations, held that reasonable*130 allowances as compensation for the services rendered by the petitioner and Frawley in each year were $ 30,000 for the petitioner and $ 20,000 for Frawley.
The petitioner had excessive profits from its renegotiable business of $ 270,000 for 1942, $ 215,000 for 1943, and $ 15,000 for 1944.
The stipulations of the parties and the joint exhibits introduced in evidence are incorporated herein by this reference.
OPINION.
The petitioner claims that the Sixth Supplemental National Defense Appropriations Act of April 28, 1942, as amended by the Revenue Act of 1942, hereafter called the Renegotiation Act, conferred no authority on the Secretary of War to make a unilateral determination that the petitioner realized excessive profits for 1942. His argument is that excessive profits for 1942 could be recaptured only by the mutual agreement of the contractor or subcontractor and the War Department. He points out that the opinions of the legislators and others at the time the bill was being considered, and later, differed on this point. However, section 403 (a) of the Renegotiation Act defined renegotiate and renegotiation to "include the refixing *74 by the Secretary of the Department of*131 the contract price" and the Secretary made numerous unilateral determinations of excessive profits with respect to years ending before July 1, 1943. A unilateral determination of excessive profits for 1942 made by the Secretary of War was involved in Lichter v. United States, 334 U.S. 742">334 U.S. 742. The present point was not raised by the litigants but, nevertheless, the Court said that the Government, in the absence of a mutual agreement with a contractor or subcontractor, might announce its unilateral determination of the amount of excessive profits claimed. The Revenue Act of 1943 was enacted on February 25, 1944. Section 701 (b) amended section 403 of the Renegotiation Act to include 403 (e) (2), providing that any contractor or subcontractor "aggrieved by a determination of the Secretary made prior to the date of the enactment of the Revenue Act of 1943 with respect to a fiscal year ending before July 1, 1943, as to the existence of excessive profits, which is not embodied in an agreement with the contractor or subcontractor, may * * * file a petition with the Tax Court of the United States for a redetermination thereof." The jurisdiction of this Court*132 and the petitioner's right to be here were made to depend upon the issuance of a unilateral order by the Secretary. Those provisions clearly indicate a Congressional intention that the Secretary had the right to make a unilateral determination. The Secretary had the authority to make the unilateral determination for 1942 dated November 3, 1944.
The petitioner contends that the amounts which he received for repairs made by him on machines owned and used by his customers in performing prime contracts are not subject to renegotiation. Section 403 (a) (5) of the Renegotiation Act defines subcontract as "any purchase order or agreement to perform all or any part of the work, or to make or furnish any article, required for the performance of any other contract or subcontract." The repairs made by the petitioner sometimes included materials or parts supplied by the petitioner. Sales of machinery to be used in the performance of war contracts are renegotiable. National Electric Welding Machines Co. v. Stimson, 10 T. C. 49; Providence Wool Combing Co. v. Secretary of War, 14 T.C. 979">14 T. C. 979. The customers of the petitioner*133 in the performance of their contracts had to use machines. Those machines required repairs. The repairs were a part of the work required for the performance of the contracts. Appropriated Government funds used to pay the contractors were, in turn, used by the contractors to pay the petitioner for the repairs. This fact alone is sufficient to distinguish Davis v. Patterson, 12 T. C. 335, the only case cited by the petitioner on this point. The repair work performed by the petitioner on machinery used by its customers in the performance of their war contracts is a subcontract within the quoted definition.
*75 Another contention of the petitioner is that only the excess over $ 500,000 of its sales for 1943 and 1944 is subject to renegotiation. This point has been decided adversely to the petitioner. Beeley v. W. C. P. A. B., 12 T.C. 61">12 T. C. 61.
The petitioner paid Frawley $ 183,535.47 in accordance with paragraph 3 of their agreement dissolving their former partnership. That payment represented 40 per cent of the net profits of the business for 1942. The petitioner argues that the $ 183,535.47 must be subtracted*134 or eliminated in some way in determining his net profits for 1942 subject to renegotiation. If Frawley had continued as a partner, his share of the profits for 1942 would not escape renegotiation, but wages of an employee are not subject to renegotiation. The record does not show what amount, if any, representing compensation for Frawley was deducted in arriving at the unilateral determination that $ 300,000 of the 1942 profits were excessive. Nevertheless, the petitioner claims that the portion of his profits allocable to renegotiable sales which he paid to Frawley is larger than the total "retained" profits from that part of the business after renegotiation and, as a result, not only is he left with no profits for the year but some of his property has been taken in violation of the Fifth Amendment of the Constitution. The facts would not support that argument if it appeared either that a substantial portion of the payment to Frawley represented a part of the purchase price of Frawley's interest, a capital expenditure, rather than an expense incurred in hiring Frawley during 1942, or that the 40 per cent due Frawley was to be computed after renegotiation.
The respondent argues*135 that reasonable compensation for Frawley's services during 1942 was $ 14,000 and the remainder of the $ 183,535.47 was a capital expenditure representing a part of the purchase price which the petitioner paid for Frawley's 40 per cent interest in the business. The petitioner has not met that argument in his briefs. Frawley as a partner prior to 1941 had been receiving 40 per cent of the profits. He decided that he did not want to be a partner any longer although he wanted to continue his services in the business for two years. The respondent's argument, that $ 183,535.47 was mostly for the 40 per cent partnership interest and not merely compensation for services after Frawley ceased to be a partner and was relieved of the risks, obligations, and responsibilities of a partner, is not without merit despite the wording of paragraph 3 of the agreement.
The petitioner points out that the dissolution agreement was entered into at arm's length when the parties had no reason to anticipate renegotiation, and argues that Frawley was entitled to receive and actually received 40 per cent of the net profits before renegotiation. A small part of the total payment was made to Frawley long after*136 *76 the unilateral determination for 1942 had been made. However, the theory of renegotiation is that the contractor or subcontractor has received money which by right does not belong to him, which came from appropriated funds, which he must return to the Government, and which does not form a part of his net income for Federal income tax purposes. "Contracts must be understood as made in reference to possible exercise of rightful authority of government, and no obligation of a contract can extend to defeat the legitimate government authority." Louisville & Nashville R. R. v. Mottley, 219 U.S. 467">219 U.S. 467; Steuart & Bro. v. Bowles, 322 U.S. 398">322 U.S. 398; Ring Construction Corporation v. Secretary of War, 8 T. C. 1070, affd. 178 F. 2d 714, certiorari denied 339 U.S. 943">339 U.S. 943. The Court concludes that the dissolution agreement did not require the payment to Frawley of any more than 40 per cent of the legal net profits of the petitioner for 1942, i. e., of the amount which the petitioner was allowed to retain as his net profits from the business*137 after he had been required to refund the amount determined to be excessive. Cf. Floyd v. Ring Construction Co., 66 F. Supp. 436">66 F. Supp. 436. That conclusion is the same whether the amount paid was merely compensation for Frawley's services or was, in part, purchase price for Frawley's interest in the business since, whatever it was, it was computed as a part of net profits, and the net profits of the petitioner as finally determined will not include the amount taken from him under renegotiation.
An alternative contention of the petitioner that he and Frawley were engaged in a joint venture during 1942 offers no solution since the evidence, especially the stipulation, clearly shows that they were not engaged in a joint venture. Balestrieri & Co. v. Commissioner, 177 F.2d 867">177 F. 2d 867.
A reasonable allowance for the services of Frawley for 1942 must be deducted in computing the profits of the business and a part of that deduction must be allocated to the renegotiable business. The amount which he was actually paid for his services during 1943 is a reasonable allowance for each year. The difference between that amount and 40 per cent*138 of the net profits after renegotiation, or whatever part thereof was intended to compensate Frawley for his services, will be too slight to affect the final determination of excessive profits for the year.
The ultimate issue in the case is what amount, if any, of the profits from renegotiable business for each year was excessive. The petitioner devotes less than a page of his brief to this point as a separate issue. The Court finds no reason in the petitioner's argument or in the facts to make any change in the unilateral determinations except on the basis of reasonable allowance for compensation of the petitioner and Frawley. The record shows that the War Contracts Price *77 Adjustment Board allowed $ 30,000 as reasonable compensation for the petitioner and $ 20,000 as reasonable compensation for Frawley for the years 1943 and 1944. The evidence shows that those amounts were inadequate and the Court has determined the amount of excessive profits for each year after taking into consideration reasonable allowances for the compensation of those two men.
An order will issue in accordance herewith.