*132 Decision will be entered for the respondent.
1. Claim for relief under section 722 (b) (4) and (b) (5) denied, where petitioner failed to establish that its base period net income was an inadequate standard of normal earnings because of allegedly unfavorable terms of a contract under which it operated until near the end of the base period.
2. Petitioner's claim for relief under section 722 (b) (5), based upon disparity between depreciation deductions in base period years and taxable year, denied.
*755 The respondent disallowed the petitioner's claim for relief under section 722, for the year 1941, in the amount of $ 35,859.43. The claim was made under section 722 (b) (4) and (b) (5), on the ground that the petitioner*133 was obligated to operate under an allegedly unfavorable contract during the base period years. Further claim was made under section 722 (b) (5) on the ground that there was a disparity between deductions taken for depreciation on petitioner's plant during the base period years and those of the taxable year.
*756 FINDINGS OF FACT.
Petitioner is a corporation with its principal place of business at St. Stephen, South Carolina. Its return for the year involved was filed at Columbia, South Carolina.
Petitioner was organized under the laws of Delaware on July 17, 1928, to operate a lumber mill. Upon organization it acquired, by assignment from its parent corporation, Turner-Farber-Love Company of Memphis, Tennessee (now Turner Lumber Company), a contract which that company, as buyer, had entered into with Santee Timber Corporation, as seller, for the purchase of a tract of timber located in the Santee River swamp near St. Stephen.
Under that contract, dated May 18, 1928, the buyer acquired from the seller the right to cut and sell the timber from a large tract of 24,423 acres of timberland located in Berkeley County, South Carolina. The contract provided, in substance:
(a) That*134 the buyer would, as expeditiously as possible, acquire a millsite in the vicinity and construct an adequate plant for the manufacture of lumber.
(b) That the buyer would cut all merchantable timber on said tract, except culls, of certain specified sizes.
(c) That the buyer would pay to the seller --
as the basic price of the said timber the sum of Seven Dollars ($ 7.00) per thousand feet, board measure, for all lumber produced therefrom grading #2 Common and Better, lumber scale, shipping count; and the said basic price, dating from the 1st day of October, 1928, shall, in lieu of interest, be increased and/or added to at the rate and in the sum of three and one-half cents (3 1/2) per thousand feet (measured and counted as aforesaid) per month during the life of this contract; provided: (a) That for such of the timber as shall, due to defects in the timber and/or logs, but not to bad manufacture or improper handling, produce lumber grading #3 Common and Below, the Buyer shall only pay to the Seller one-half of the selling price of such low grade lumber in excess of Twelve and 50/100 Dollars (12.50) per thousand feet, measured and counted as aforesaid, F. O. B. Mill, if there *135 be such excess; provided, that in no case shall the Buyer be required to pay on account of such one-half more than Seven Dollars ($ 7.00) per thousand feet.
(d) That "The said basic price plus said monthly increases and/or additions shall be paid to the Seller monthly, viz: on the 15th day of each month for all lumber shipped during the preceding calendar month; * * *."
(e) That the buyer would ship not less than 5 million feet of lumber prior to January 1, 1930, and thereafter during the life of the contract not less than 6 million feet during each 6 months' period, and that all timber on the tract would be cut, manufactured into lumber, and shipped not later than January 1, 1942.
(f) That the buyer would deposit with the seller $ 50,000 in cash as a continuing guarantee for performance of the contract; and
*757 (g) That the seller would retain a lien upon the timber, logs, lumber, and other products to secure the payment of the purchase money, and the faithful performance of the contract by the buyer.
Petitioner completed its lumber plant, consisting of the mill, spur railroad, houses, and other necessary equipment, and began operations under the contract in 1929. For several*136 years it operated both a lumber mill and a stave mill. The stave mill, which used timber unsuitable for making lumber, burned down in 1936 and was never rebuilt.
Petitioner finished cutting the timber on the Santee tract in October 1939. The following table shows the amount of saw-timber cut from the tract and manufactured into lumber, the average stumpage rate paid by petitioner, and the total stumpage cost to petitioner during the years 1929 to 1939, inclusive:
| Year | M' cut | Stumpage | Stumpage |
| rate per M' | charged | ||
| 1929 | 10,699 | $ 7.541 | $ 80,678.76 |
| 1930 | 17,903 | 7.907 | 141,551.97 |
| 1931 | 16,066 | 8.323 | 133,715.76 |
| 1932 | 9,272 | 8.754 | 81,164.14 |
| 1933 | 12,361 | 9.162 | 113,247.24 |
| 1934 | 7,569 | 9.650 | 73,040.40 |
| 1935 | 13,186 | 10.072 | 132,812.03 |
| 1936 | 10,971 | 10.511 | 115,321.40 |
| 1937 | 10,180 | 11.163 | 113,643.79 |
| 1938 | 13,916 | 11.536 | 160,540.32 |
| 1939 | 5,802 | 11.886 | 68,964.85 |
| Total | 127,925 | $ 1,214,680.66 |
A comparative statement of petitioner's logging costs for the years 1937 through 1941, which covers operations on the Santee tract through 1939 and on the White and Friant tract (discussed infra) in 1940 and 1941, is as follows:
| Cutting and hauling, | |
| loading, transportation, | |
| and logging overhead | |
| Year | (per M') |
| 1937 | $ 8.980 |
| 1938 | 8.560 |
| 1939 | 7.866 |
| 1940 | 12.350 |
| 1941 | 15.269 |
*137 Petitioner manufactured 10 grades of lumber from the timber it cut; and the 1939 market price of these grades ranged from $ 51.84 per thousand feet for the best grade, down to $ 10.80 per thousand feet for the least desirable. Petitioner was able to manufacture a much higher percentage of the better grades of lumber from the timber cut from the Santee tract than from the timber cut from the White and Friant tract.
In addition to the saw-timber cut from the Santee tract during the period 1929 to 1936, inclusive, petitioner also cut 15,227 feet of stave mill logs for which the stumpage cost was $ 36,914.07.
*758 Under the terms of the contract with the Santee Timber Corporation petitioner was not required to pay for the timber cut until the lumber manufactured therefrom was shipped. This was usually 6 months or more after the timber was cut. The following table shows the stumpage cost of the inventories of logs, lumber, and staves on petitioner's yards at the close of each of the years 1929 through 1939, inclusive:
| 1929 | $ 56,203.69 |
| 1930 | 121,741.07 |
| 1931 | 139,856.30 |
| 1932 | 112,779.23 |
| 1933 | 127,619.03 |
| 1934 | 130,108.82 |
| 1935 | $ 111,374.27 |
| 1936 | 78,325.02 |
| 1937 | 82,114.38 |
| 1938 | 130,430.74 |
| 1939 | 63,023.19 |
*138 At December 31, 1939, petitioner's books showed a balance due Santee Timber Corporation for stumpage of $ 63,023.19. The parties agreed on January 24, 1940, that there was a balance due under the contract of $ 61,824.01, which was satisfied by a credit against the remaining balance in the guaranty deposit account of $ 30,252.56 and by payment of $ 31,571.45 in cash by petitioner.
During the period 1933 to 1939, inclusive, petitioner purchased small quantities of logs from outside sources, as follows:
| Year | Logs | Rate per M' | Cost |
| purchased -- M' | |||
| 1933 | 26 | $ 8.552 | $ 222.34 |
| 1934 | |||
| 1935 | 82 | 12.215 | 1,001.62 |
| 1936 | 15 | 10.469 | 157.03 |
| 1937 | 305 | 16.374 | 4,994.12 |
| 1938 | 563 | 15.261 | 8,591.89 |
| 1939 | 1,108 | 15.46 | 17,131.07 |
The following table shows the lumber shipped, the average sales price, and the total amounts received by petitioner for each of the years 1929 to 1941, inclusive:
| Year | M feet | Sales price | Amount |
| per M' | |||
| 1929 | 3,104 | $ 49.702 | $ 154,274.45 |
| 1930 | 9,016 | 43.657 | 393,611.30 |
| 1931 | 13,680 | 31.029 | 424,472.32 |
| 1932 | 13,092 | 23.882 | 312,660.34 |
| 1933 | 12,031 | 28.989 | 348,764.45 |
| 1934 | 8,726 | 33.458 | 291,956.84 |
| 1935 | 17,176 | 26.793 | 460,196.87 |
| 1936 | 16,970 | $ 30.774 | $ 522,238.28 |
| 1937 | 11,315 | 41.309 | 467,415.51 |
| 1938 | 12,275 | 32.139 | 394,510.99 |
| 1939 | 13,108 | 34.786 | 455,977.29 |
| 1940 | 8,989 | 36.049 | 324,023.50 |
| 1941 | 13,146 | 42.671 | 560,949.78 |
*139 While cutting the timber from the Santee tract, petitioner was constantly looking for other tracts of timber that might be purchased advantageously. About March 1938, petitioner began negotiations for the purchase of a tract comprising about 2,942 acres in the Santee Swamp area, a few miles below its St. Stephen mill, known as the *759 White and Friant tract. In November 1939, one of the owners visited petitioner's plant and made an offer in writing, dated November 16, 1939, to sell petitioner the tract for $ 65,000. This was the price that had been first discussed in the negotiations. Under the terms of this offer there was to be paid $ 11,000 cash and $ 18,000 each year thereafter with interest at 4 per cent from date of purchase. The offer further provided that the purchaser would establish a sinking fund for the deferred payments by paying into such fund $ 6 per thousand feet of timber cut. The sinking fund payments were later changed to $ 7 per thousand feet.
Petitioner notified the owners by a telegram dated December 22, 1939, that it would be willing to close the deal on the terms stated in the offer and upon showing of a clear title to the property. It had developed*140 that there was a claim against the property which might affect the transfer of title. A court order clearing the title was obtained April 5, 1940, and the transaction was closed on that date. In the meantime, petitioner had purchased a 12-acre site for a logging camp near the tract and had obtained permission to haul the timber across a section of the Francis Marion National Forest between the upper end of the tract and the highway.
Petitioner began cutting timber on the White and Friant tract in May 1940, and finished in 1941. It cut 6,229,000 feet in 1940 and 7,980,000 feet in 1941, which, based upon the purchase price for the tract of $ 65,000, resulted in an average stumpage cost of $ 4.575 per thousand feet. This stumpage cost of $ 4.575 per thousand feet (unlike that for the Santee tract which included an additional amount in lieu of interest) did not include any addition for interest on the purchase price, since such interest was paid separately at the rate of 4 per cent per annum. Petitioner also purchased logs from other sources of 1,520,000 feet in 1940 and 1,431,000 feet in 1941.
In December 1941, petitioner purchased another tract of timber known as the Pee Dee tract*141 paying $ 245,000 cash based on a stumpage price of $ 8 per thousand feet. The timber on this tract was of a better quality than that on the Santee tract.
Petitioner has continued to operate its lumber mill up to the present time. Except in the case of the Santee contract, petitioner has never purchased timber under a contract calling for an accelerated stumpage cost.
At all times here material, petitioner's authorized capital stock consisted of 2,000 shares of a par value of $ 100 each. Originally, 1,990 of these shares, all except the qualifying shares, were issued to Turner-Farber-Love Company. That company continued to own a majority of petitioner's stock at all times here material.
*760 Petitioner's investment in plant and equipment, unadjusted for depreciation, as shown by its books at December 31 for each of the years 1929 to 1939, inclusive, was as follows:
| 1929 | $ 250,287.78 |
| 1930 | 271,975.72 |
| 1931 | 415,557.26 |
| 1932 | 422,985.15 |
| 1933 | 422,985.15 |
| 1934 | 431,040.02 |
| 1935 | $ 431,040.02 |
| 1936 | 406,735.94 |
| 1937 | 406,669.20 |
| 1938 | 406,669.20 |
| 1939 | 406,669.20 |
At December 31, 1939, petitioner's books showed depreciable assets of $ 399,166.45 and a depreciation reserve of $ *142 399,157.45, leaving a book value of only $ 9. Petitioner claimed no depreciation deductions for 1941, since its assets were fully depreciated in that year.
The deductions claimed for depreciation in petitioner's returns, and the amounts allowed by respondent for the years 1936 to 1939, inclusive, were as follows:
| Year | Claimed | Allowed |
| 1936 | $ 63,826.49 | $ 42,852.27 |
| 1937 | 43,477.52 | 25,895.64 |
| 1938 | 27,684.69 | 35,743.87 |
| 1939 | 17,828.37 | 17,825.82 |
Petitioner's net income or loss for each of the years 1929 to 1941, inclusive (as shown by its books for the period 1929-1933 and as determined by respondent for the period 1934-1941), and the net income or loss of petitioner and its affiliated companies for the period 1929-1933, inclusive (as reported in consolidated returns filed for those years), were as follows:
| Net income (or | ||
| Net income | loss), petitioner | |
| Year | (or loss) | and its affiliates |
| 1929 | ($ 88,893.00) | ($ 5,702.87) |
| 1930 | 24,536.78 | (75,965.74) |
| 1931 | (21,967.34) | (379,416.00) |
| 1932 | (85,457.92) | (413,637.73) |
| 1933 | 13,309.13 | (158,678.55) |
| Net income | |
| Year | (or loss) |
| 1934 | $ 1,517.51 |
| 1935 | (41,523.47) |
| 1936 | 43,408.51 |
| 1937 | 38,287.65 |
| 1938 | (6,980.62) |
| 1939 | 19,360.65 |
| 1940 | 39,913.93 |
| 1941 | 123,212.57 |
*143 Petitioner's average base period net income for the year 1941, as finally determined by respondent under the provisions of section 713 of the Internal Revenue Code of 1939, was $ 27,813.70, computed as follows: *761
| Excess profits | ||
| Year | net income | |
| 1936 | 1 $ 53,606.51 | |
| 1937 | 38,287.65 | |
| 1938 | 2 0.00 | |
| 1939 | 19,360.65 | |
| Aggregate | $ 111,254.81 | |
| Average | $ 27,813.70 |
Petitioner's excess profits tax liability for 1941, as finally determined by respondent without regard to section 722, was $ 37,805.20.
Certain facts were stipulated, and they are incorporated herein by reference.
OPINION.
Petitioner's principal contention is that it qualifies for relief under subsection (b) (4) of section 722, or in the alternative, under subsection (b) (5). In support of this contention, it presents a threefold argument: First, that during most of the base period it was compelled, by the terms of the Santee contract, to pay abnormally high prices for stumpage, and that this had a depressive effect on its base period earnings; second, *144 that toward the end of the base period, it changed the character of its operations by terminating the Santee contract and purchasing the White and Friant tract, from which it was able to acquire timber at a much lower stumpage rate; and third, that if it had been able to make this change 2 years earlier, its average base period earnings would have been substantially higher. The Santee contract, referred to, is the one which petitioner acquired at the time of its incorporation from its parent company; and under the terms of this contract, the stumpage price of the timber increased on a month-to-month basis as the timber was cut, with the result that the prices paid during all of the base period were from $ 3 to $ 4 per thousand feet higher than they were in 1929 when operations under the contract began. The contract provided that this acceleration in price was to be "in lieu of interest" on the basic $ 7 price.
It is questionable whether petitioner's termination of the Santee contract and purchase of the White and Friant tract constitutes a "change in the character of the business," or more specifically a "change in the operation," within the intendment of section 722 (b) (4). Normally, *145 a change to an assertedly more advantageous arrangement for the purchase of material to be manufactured is regarded to be routine, and not to be such a change as will provide the basis for granting relief under subsection (b) (4). Cf. Austin Co., 22 T. C. 703, 716; *762 Wisconsin Farmer Co., 14 T.C. 1021">14 T. C. 1021, 1029; Regs. 112, sec. 35.722-3 (d). In the case at bar, petitioner was engaged at all times, both before and after the change of its source of supply, in the manufacture and sale of lumber of the same general type and by means of the same method of operation. And, it does not appear that either petitioner or the industry to which it belonged has ever established any standard plan of operation, based upon any particular type of contract under which timber rights are acquired.
However, assuming arguendo that a change in the operation did occur, such change is important only if it resulted in an increase of normal earnings which is not adequately reflected by petitioner's average base period net income. Wisconsin Farmer Co., supra. The evidence here does not establish, in our*146 opinion, that petitioner's change in its source of supply meets this test. It is true that the gross stumpage price paid under the Santee contract was greater than that on the White and Friant operation. But the difference is not nearly so great as appears at first glance. The basic price of the stumpage under the Santee contract was $ 7 per thousand feet, and the difference between that and the $ 11.886 actually paid represented a charge "in lieu of interest" on the basic $ 7 price; whereas the stumpage cost for the White and Friant timber carried no such charge for interest, because interest was paid separately from the stumpage. Also, the stumpage price paid in respect of the White and Friant tract was more than $ 3.573, as suggested by petitioner; for, since the purchase price of the tract was $ 65,000 and 14,209,000 feet were cut therefrom, the correct stumpage rate, exclusive of interest, was approximately $ 4.58 per thousand feet. Thus, when the stumpage prices for both tracts are adjusted to the correct basic amounts, there is a spread between the two of only about $ 2.42 per thousand feet; and this spread may be accounted for by two other factors. In the first place, *147 the quality of the timber on the Santee tract was superior to that on the White and Friant tract; as is shown by our findings of fact, the petitioner was able to manufacture therefrom a much higher percentage of the better grades of lumber and it was able to sell the same at higher prices. In the second place, the cost of operations on the Santee tract was much lower than on the White and Friant tract; as shown in our Findings of Fact, petitioner's logging expenses in 1939 were $ 7.92 per thousand feet as compared to $ 15.27 in 1941, when it was operating on the White and Friant tract.
Finally, it must be noted that petitioner's average base period net income of approximately $ 27,000 per year is considerably higher than its income for any pre-base period year. In the light of this and all the foregoing facts, we are not convinced that petitioner's base period earnings were depressed, or that those earnings would have been any *763 greater if it had begun operations on the White and Friant tract 2 years earlier.
We hold, therefore, that petitioner has not shown that it qualifies for relief under section 722 (b) (4).
As to petitioner's claim under subsection (b) (5), so far *148 as it relates to the alleged change in the character of the business, its counsel conceded on brief that it "relies primarily upon (b) (4) for qualification, but that as an anchor to the windward it also claims relief under (b) (5)." It need only be pointed out that, where facts properly applicable to a claim under one of the other subsections of section 722 (b) have been found insufficient to support such claim, these same facts cannot be relied upon to support a claim under subsection (b) (5). Constitution Publishing Co., 23 T. C. 19; Granite Construction Co., 19 T. C. 163, 173; Clermont Groves, Inc., 17 T. C. 1616; George Kemp Real Estate Co., 12 T.C. 943">12 T. C. 943.
Petitioner also claims relief under section 722 (b) (5), on the ground that no depreciation deductions were taken or allowable in the taxable year 1941 on the assets that had been fully depreciated and on which substantial depreciation deductions were taken in the base period years. This claim is identical to that which was presented, and decided adversely to the taxpayer, in Park & 46th Street Corporation, 14 T. C. 588.*149 See also Clinton Carpet Co., 14 T. C. 581, wherein we pointed out the lack of any provision in the statute for comparing base period and post-base period earnings.
Reviewed by the Special Division.
Decision will be entered for the respondent.