Before SWAN, AUGUSTUS N. HAND, and CHASE, Circuit Judges.
Section 102 of the Internal Revenue Code, 26 U.S.C.A. Int. Rev. Code, § 102,*fn1 imposes a surtax upon the net income of a corporation if the corporation is availed of for the purpose of preventing the imposition of surtaxes upon its shareholders through the medium of permitting its earnings or profits to accumulate instead of being distributed, and provides further that the fact that the corporate earnings or profits 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. In the case at bar, after a very detailed and complete review of the financial history of the petitioner's business from its inception, the Tax Court found that during each of the years 1938, 1939 and 1940 the earnings or profits of the petitioner were permitted to accumulate beyond the reasonable needs of its business and the petitioner was availed of in those years for the purpose of preventing the imposition of surtaxes upon its stockholders. These findings resulted in an order redetermining deficiencies in the income taxes of the petitioner, from which it has appealed.
Judge Arundell's memorandum decision made very detailed findings of fact. It is unnecessary to recite them all. There is no substantial dispute as to the primary facts; the dispute relates to the inferences to be drawn from them. William Francis Gibbs and Frederic H. Gibbs are eminent naval architects and marine engineers who have followed their profession for many years. In 1929 they, together with a yacht designer, Daniel H. Cox, organized the petitioner, Gibbs & Cox, Inc., to carry on the business of naval architecture, marine engineering and the designing of all kinds of ships. Each of the three individuals contributed $10,000 to the capital of the corporation and received in return one-third of its stock, but during 1938 the stock of Mr. Cox was purchased by the corporation for $40,000 and retired. Since then the corporation's capital stock has been $20,000, owned equally by the Gibbs brothers. From 1929 to 1933 petitioner was engaged in designing yachts and merchant ships; it had a small staff of employees at 1 Broadway and did little business, its net income not exceeding $2,000 in any of the years through 1933. In the latter year the Navy awarded contracts for destroyers to three shipbuilding companies and, at the Navy's request, petitioner was given supervision over the designing of such vessels. It supervised a large staff of the United Design Department of United Dry Docks, comprising from two hundred to three hundred employees. Petitioner had no responsibility for the payment of wages or other expenses of the United Design Department. This arrangement with the shipbuilding companies expired on November 20, 1935. But there still remained work to be done on the uncompleteu destroyers and the other destroyers on which the shipbuilding companies had received orders, and they desired the petitioner to substitute itself for the United Design Department, which would mean that it would assume responsibility for the payment of more than three hundred employees. Petitioner replied that it was incapable of financing any such operation as the United Design Department. It was then arranged at the instance of Federal Shipbuilding Corporation and Bath Iron Works that if the petitioner would assume responsibility for the payroll and other costs incurred by substituting itself for the United Design Department, Federal would promptly remit to the petitioner amounts equal to its expenditures for the payroll, rent and other operating costs; and Bath was to contribute sums to Federal to assist in this purpose. Accordingly the petitioner employed on its own account a design staff comparable to the United Design Department and rented space at 21 West Street to which the staff was removed. Pursuant to the agreement with Federal that company would remit to the petitioner within a few days after payment by it the amounts of payrolls, rents and other costs with respect to the operations at 21 West Street. Before December 1935 the largest number of employees petitioner had ever had was 45. Following the creation of its design organization in substitution for the United Design Department petitioner had 364 employees in December 1935. Thereafter at the end of the respective years the numbers were as follows: In 1936, 443; in 1937, 487; in 1938, 486; 1939, 582; 1940, 799; 1941, 1318; 1942, 2356. Practically all of these employees were hired on a weekly salary basis. The payroll for salaries and wages jumped from $145,000 in 1935 to $1,222,000 in 1938; $1,872,800 in 1940 and $3,354,600 in 1941. Its staff is by far the largest individual engineering organization in the world.
In addition to the naval work which started in 1933 and continuously increased the petitioner was employed in 1939 to design and procure the materials for a group of British merchant ships, and this was followed late in 1940 by a contract with the Maritime Commission to design the first 312 Liberty ships. The expansion of petitioner's business is reflected in the following table:*fn2
income before Fed. income
1936 $1,296,900 $1,261,500 $5,228
1937 1,538,600 1,504,700 22,881
1938 1,947,400 1,7 15,800 221,832
1939 2,119,000 1,823,500 232,638