Midvale Co. v. Comm'r of Internal Revenue

• Decision Date: 31 March 1953
• Docket Number: Docket No. 31121.
• Citation: 19 T.C. 1216
• Parties: THE MIDVALE COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

19 T.C. 1216

THE MIDVALE COMPANY, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 31121.

Tax Court of the United States.

Promulgated March 31, 1953.

J. Marvin Haynes, Esq., for the petitioner.

George J. Le Blanc, Esq., for the respondent.

Petitioner's claim for relief under section 722 on the ground of a ‘change‘ in the character of its business due to increased capacity actually installed or committed for prior to 1940, held properly disallowed in view of petitioner's failure to show that its reconstruction of a fair and just amount representing normal earnings was more than the excess profits credit to which it is entitled in any event under section 713.

Respondent denied petitioner's applications for relief from excess profits tax amounting to $1,376,253.22, $1,844,337.93, $2,139,843.69, $2,629,904.52, and $2,627,898.61 for the calendar years 1940, 1941, 1942, 1943, and 1944, respectively, petitioner having also filed claims for refund which included such amounts. The only contested issue is whether petitioner is entitled to any relief under the provisions of Internal Revenue Code, section 722, subsections (a) and (b)(4). Most of the facts are stipulated.

FINDINGS OF FACT.

The stipulated facts are hereby found accordingly.

Petitioner is a corporation which was organized under the laws of the State of Delaware on March 28, 1923, as a successor to The Midvale Steel & Ordnance Company. Its plants and principal office are located at Nicetown, Philadelphia, Pennsylvania. Its facilities, which date back to 1870, were constructed primarily for naval ordnance work. Petitioner filed its excess profits tax returns for the periods here involved with the collector of internal revenue for the first district of Pennsylvania.

As a consequence of the 1922 Washington Limitation of Armament Treaty, petitioner's plants and facilities were put to very little use for ordnance work during the years 1924 to 1933, inclusive, and its annual average of ordnance sales for these years was about $800,000. During this period petitioner endeavored to develop a market for certain industrial machinery and parts, such as shafts, reaction chambers, heavy oil equipment containers, and hardened rolls. Little effort was made to develop a market for lighter commercial products because petitioner, with its heavy facilities, could not compete with concerns properly equipped to produce lighter machinery and parts. As petitioner was able to use only a small portion of its plant and facilities, it permitted a large part of its ordnance plant and facilities to become idle and to deteriorate. It scrapped many of its furnaces and machines. While it had ten open hearth furnaces in 1923, four were subsequently destroyed and four deteriorated to the extent that only the foundations and frames remained on January 1, 1936.

At July 1, 1934, the naval strength of the United States had diminished far below the treaty limits and there were overage vessels which could be replaced under the treaty provisions. In 1934 the Naval Replacement Act of 1934, sometimes referred to as the Vinson-Trammell Act, authorized the President to construct a sufficient number of vessels to bring the Navy up to full treaty strength and to maintain it there by replacing overage vessels with vessels of modern design and construction. In 1935 the replacement program met with difficulties. In 1937 the completion of new shipbuilding continued to be handicapped and delayed.

About 1935 or 1936, officials of petitioner were called to Washington for a conference and were advised that petitioner would have to carry a large part of the load in the Navy's new construction program. Petitioner then began to rebuild its plants and facilities so that it could meet the Navy's requirements. The principal products produced by petitioner for the Navy were armor, guns, projectiles, propulsion parts, shells, gun mounts, and shafts. The time it ordinarily takes petitioner to produce ordnance materials ranges from 5 to 9 months, but the big guns require as much as 20 months.

Petitioner has five departments: Melting, forging, heat treating, machining, and testing. In the Melting Department scrap pig iron and other ingredients, such as chrome, nickel, and molybdenum, are placed in the melting furnaces and are melted. When the mixture reaches the proper chemical composition it is tapped into iron molds and cooled. The product at this state is known as an ingot. In the Forging Department the ingot is heated to forging temperature, and pressed into the rough shape of the final product desired. In the Heat Treating Department the product undergoes certain heating and cooling operations to prepare it for handling in the Machining Department. There the product is machined into an almost finished product, except that test metal is left on the ends. The product then goes back to the Treating Department where it is quenched and cooled. In the Testing Department coupons are taken out of the product and tested to determine whether the product will meet Government requirements. If the product passes these requirements it is taken back to the Machining Department where it is finally machined to the desired size and the test metal is cut off. The product is then ready for delivery.

With respect to the Melting Department petitioner had in operation on January 1, 1936, two open hearth furnaces, each capable of producing about 28,000 net tons of ingots per year. On the same date it also had in operation four electric melting furnaces, capable of producing a total of about 17,500 net tons of ingots per year. By reason of ordnance orders received and other ordnance contracts in preparation by the Navy, petitioner started reconstructing four of the open hearth furnaces which it had permitted to deteriorate. By redesigning these furnaces, by strengthening the bottoms, and by installing water-cooled doors, the load capacity of the furnaces was increased by one-third. Reconstruction work was completed on an abandoned furnace during each of the following periods: early 1937, January, June, and December 1939. In the last month, petitioner's operating open hearth capacity was more than two and one-half times greater than it was in January 1936.

Petitioner's total operating capacity for producing ingots, including both open hearth and electric furnaces, at the end of each of the base period years, stated in both net tons and pounds of ingots, is as follows:

+--------------------------+
                ¦Year¦Net tons¦Pounds      ¦
                +----+--------+------------¦
                ¦1936¦73,500  ¦147,000,000 ¦
                +----+--------+------------¦
                ¦1937¦101,500 ¦203,000,000 ¦
                +----+--------+------------¦
                ¦1938¦101,500 ¦203,000,000 ¦
                +----+--------+------------¦
                ¦1939¦185,500 ¦371,000,000 ¦
                +--------------------------+
                

Petitioner's facilities for processing ingots through its forging, treating, machining, and testing departments had also been allowed to deteriorate after 1923, and many of them had been scrapped. The ordnance materiel developed under the Vinson-Trammell Act differed from that produced prior to 1023. The ships required larger guns, bigger and thicker pieces of armor, and heavier shells. The changes required were not finally completed until 1941. Petitioner was unable in 1939 to make immediate use of all of its increased ingot-producing capacity, but by the end of 1939 petitioner had a processing capacity for producing armor of 1,000 tons per month.

During the base period major changes were completed in facilities for forging, heating, and machining armor plate which cost petitioner $194,597.38. Of this figure, $188,289.85 was deducted as part of the cost of specific ordnance contracts while the balance of $6,307.53 was charged to expenses in the year the expenditures were made. During the base period petitioner frequently deducted the cost of changes in its processing facilities as part of the cost of its ordnance contracts.

Between December 22, 1938, and January 1, 1940, petitioner expended $678,132.02 to increase its armor-producing facilities from 1,000 to 1,700 per month. Of this amount, $276,092.74 was expended in connection with preparations for the installation of a 6,500-ton press which was leased to petitioner by the Navy Department. Arrangements for petitioner to inspect this press were made on May 28, 1938, the Chief of the Bureau of Ordnance, United States Navy, wrote petitioner a letter dated September 1, 1939, and the lease agreement itself was signed on March 12, 1940. The letter stated in part:

An exigency of the service exists to expedite the Navy shipbuilding program in the cause of National Defense. One of the controlling factors is the delivery of armor for battleships on the dates required by the building yards. In order to meet these dates it has become necessary to expand facilities for armor production in this country.

The lease agreement stated in part:

WHEREAS, the Department entered into a contract under date of November 24, 1939, with the Lessee for the manufacture of armor for Battleships Nos. 61 and 62; the Lessee having in addition other contracts with the Department for furnishing armor for other Battleships now under construction in private and Government yards; and

WHEREAS, there exists an exigency of the service to expedite the Naval Shipbuilding Program in the cause of National Defense; and

WHEREAS, the delivery of the Armor for the above-mentioned vessels in the minimum time is urgently necessary to expedite completion of the aforesaid vessels; and

The total cost of the project to expand armor production to 1,700 tons per month was $1,048,207.74. This change was not completed until July 1940. The dates these expenditures were authorized, the dates the different projects were completed, and the amounts involved were as follows:

+------------------------------------------------------------------------------+
                ¦Authorized          ¦           ¦                            ¦                ¦

...