*235 Decision will be entered for the respondent.
Petitioner acted as a broker and commission seller of cotton yarn during the years 1922 to 1942. It claims that it is entitled to relief under section 722 (b) (2) and (b) (4), I. R. C., from excess profits taxes for the years 1941 and 1942.
1. Held: Petitioner has not shown that its business was depressed within the meaning of section 722 (b) (2) during the base period by reason of a "record" cotton crop in 1937 or the effect of that crop on cotton yarn prices.
2. Held, further: Petitioner has not shown (1) that it changed the character of its business within the meaning of section 722 (b) (4) by emphasizing the sale of colored yarn instead of natural yarn; or (2) that if there was a change in the character of its business, that such change took place "immediately prior to the base period, * * *."
*681 The issue is the correctness of the respondent's disallowance of petitioner's application for relief from excess profits tax for the years 1941 and 1942 under section 722 (b) (2) and (b) ( 4) of the Internal Revenue Code.
*682 In a prior proceeding, reported under the same title in 12 T. C. 589, it was held that this Court had jurisdiction of the case and the respondent's motion to dismiss was denied.
FINDINGS OF FACT.
Some of the facts were stipulated, are so found and incorporated herein by this reference.
Petitioner is a New York corporation in dissolution, with its principal office at 88 Leonard Street, New York, New York. It was organized under the laws of the State of New York in February 1922 and maintained its principal place of business in the City of New York. Petitioner was dissolved on or about December 31, 1942. Its excess profits tax returns for the periods here involved were filed with the collector of*237 internal revenue for the third district of New York.
During its entire existence petitioner was engaged in the business of dealing in cotton yarn. Most of this business consisted of selling yarn on a commission basis, that is, orders were solicited from consumers of cotton yarn and then petitioner placed the order with one of the mills it represented. In addition to its commission business petitioner made certain sales on a brokerage basis. On the commission sales petitioner realized 5 per cent, on its brokerage sales 2 per cent. In its method of accounting petitioner entered all commission sales on its books in a "sales account." In the case of brokerage sales only the brokerage fee earned was entered on the books. Petitioner also received a 5 per cent commission on all goods purchased for its own account.
On the sale of yarn on a commission basis, petitioner assumed the credit risk of the customer. Petitioner would pay the mill and then bill the customer. On brokerage sales the mill would bill the customer directly and the customer paid the mill with no credit risk on petitioner's part. Petitioner's selling territory extended to a radius of 60 to 70 miles from New York City.
*238 The types of cotton yarn dealt in by petitioner can be generally classified as either colored yarn or grey yarn, the latter being yarn in the natural color. The business of selling grey yarn largely involves considerations of price and standards of yarn thickness, denominated as of a certain "count." The business of selling colored yarn involves the additional considerations of consistency of supply source and color likeness. At some time prior to the base period years it was determined that petitioner would concentrate more of its activities in the colored yarn market. Colored yarns sold at a higher price than grey yarn, and since petitioner's commissions were based on sales price a larger income in relation to the poundage handled was anticipated. The petitioner did not increase its organization due to any emphasis on the *683 colored yarn sales. Petitioner sold some colored yarn in 1927 or 1928 and in every year thereafter.
The following advertisement appeared in Davison's Textile Blue Book, beginning on or about August 1, 1932, and was repeated in the annual edition thereafter:
INDUSTRIAL YARN CORPORATION
CARDED COTTON YARNS COMBED
Natural, Stock Dyed, Bleached and Mercerized*239 -- Knitting, Weaving and Braiding -- Cones, Skeins, Tubes, Warps and Beams
88 LEONARD STREET
NEW YORK
The record does not show how much of petitioner's business prior to 1936 consisted of colored yarn sales. The sales' records for the years prior to 1936 were destroyed in 1947.
There were three principal mills manufacturing colored yards which were represented by the petitioner during the years 1936 through 1942, inclusive, as follows: Cross Cotton Mills, Locke Cotton Mills, Perkins Hosiery Mills, and its successor, Jordan Mills, Inc. Petitioner also sold small quantities of colored yarn from the Grantville Mills, Georgia Manufacturing Company, Davidson Cotton Mills, and Russell Manufacturing Company, as "fill-in" yarn. Hill Spinning Company was represented for its grey yarn on perforated tubes, which yarn was made especially for dyeing.
Petitioner's yarn sales on a commission basis were as follows:
| SALES | |||||
| Colored Yarn sales (excluding | Grey Yarn sales (including | ||||
| brokerage and Hill Spinning Co.) | Hill Spinning | ||||
| Co.) | |||||
| Year | |||||
| Percent of | Total | ||||
| Dollars | Pounds | total | sales | ||
| 1936 | 123,870 | 288,100 | 24.06 | $ 390,976 | $ 514,864 |
| 1937 | 240,580 | 641,650 | 45.21 | 291,579 | 532,159 |
| 1938 | 136,002 | 456,950 | 33.95 | 264,574 | 400,576 |
| 1939 | 176,768 | 519,375 | 35.10 | 326,774 | 503,542 |
*240 Petitioner's sales of colored yarn on a brokerage basis were as follows:
| Sales of colored yarn on brokerage basis | ||
| [All from Cross Cotton Mills] | ||
| Year | Pounds | Dollar sales |
| 1936 | 270,000 | $ 135,783 |
| 1937 | 140,300 | 63,303 |
| 1938 | 406,000 | 137,228 |
| 1939 | 290,650 | 106,058 |
*684 Petitioner represented between 30 and 40 grey yarn mills prior to 1935 and through 1939. In its territory it had at least 20 grey yarn competitors which were sales agents similar to petitioner. In all, petitioner had 35 to 40 grey yarn competitors, including sales agents, jobbers, brokers, and mills selling directly.
The colored yarn mills represented by petitioner were not in competition with each other. Petitioner had only seven or eight competitors selling colored yarn in its territory. Petitioner had only six colored yarn competitors listed in the 1938 edition of Davison's Blue Book.
Petitioner's colored yarn customers used only dyed yarns. Petitioner had no part in the planning of production controls or inventory of either the grey yarn or the colored yarn manufacturers it represented. The colored yarn business requires that close attention be given the exactness of the various*241 batches of colored yarn. In order to assure its customers of consistency of supply of the various colors of yarn it was necessary for petitioner's officers to visit the manufacturers for the purpose of coordinating the customer's requirements with the capacity of the mill concerned.
Contracts for the sale of grey yarn did not specify the mill from which delivery was to be made. Petitioner was the exclusive representative in its territory for its principal colored yarn mills. These mills did not compete in petitioner's territory because of the difference in product.
A mill manufacturing stock-dyed colored yarn does not, as a rule, manufacture grey yarn because of the pieces of colored yarn which might contaminate the grey yarn. Colored yarn is either stock-dyed or package-dyed. Stock-dyed yarn is dyed in the raw cotton state before it is spun into yarn. Package-dyed yarn is natural yarn wound on a perforated tube and then dyed.
Colored yarn sells for a higher price than the same quality and count of grey yarn. The price differential between fine count grey yarn and similar count colored yarn is appoximately 15 cents per pound. The price differential between the two types of*242 coarse count yarn is 12 to 13 cents per pound. Package-dyed colored yarn is slightly higher in price than the same count of stock-dyed colored yarn.
It is customary in the grey yarn business for a sales agent to trade on its own account. The mills desired this since it helped to sustain the market and partially to relieve the mills of inventory. Petitioner had agreements with the colored yarn mills it represented that it was not to purchase colored yarn for its own account.
*685 Philadelphia is the leading grey yarn center. New York is the center for sales of colored yarn. The market for colored yarn is more concentrated than the market for grey yarn.
There was no increase in the number of colored yarn mills selling in the petitioner's territory during the years 1936 to 1939. All of the colored yarn mills represented by petitioner were southern mills.
During the years 1936 through 1939 the petitioner's costs incurred in selling colored yarn were not perceptibly different than those involved in selling grey yarn.
The Cross Cotton Mills, one of the principal mills represented by petitioner, manufactured package-dyed fine count yarn. Its yarn was used generally for such things*243 as polo shirts and underwear. Prior to and during 1935 and 1936 Cross Cotton Mills sold mostly grey yarn. As early as 1932 petitioner's president solicited Cross Mills for its colored yarn business. The petitioner began to get some colored yarn business from Cross in 1934 or 1935. It became the exclusive representative in its territory for Cross colored yarn in 1936.
In 1934 the Cross dyeing machinery had a capacity of from 5,000 to 6,000 pounds per week. Petitioner recommended increasing this capacity, and by 1936 Cross installed additional machinery. The capacity of Cross Cotton Mills increased from 14,000 pounds per week in 1936 to 20,000 pounds per week in 1938 and to 40,000 pounds per week in 1939. This additional dyeing equipment was bought by Cross largely because of the increased volume of business in colored yarn brought by petitioner.
Petitioner first sold colored yarn for Locke Cotton Mills in 1934. It became its exclusive representative in 1935 or 1936. Locke Cotton Mills sold only colored yarn. Locke Cotton Mills went into receivership in October 1938, and the 5,000 pounds of cotton yarn sold during 1939 by the petitioner represented inventory on hand when Locke*244 went into receivership. The Locke Cotton Mills never went back into the yarn business. When the Locke Company went into receivership the petitioner lost a certain amount of business until it could supply the customers formerly supplied with Locke yarn with yarn from another manufacturer.
The petitioner first sold yarn for Perkins Hosiery Mills in 1936. Perkins manufactured coarse count stock-dyed colored yarn. Petitioner did not get the exclusive representation of the Perkins mill. In 1938 Perkins Hosiery Mills discontinued business and a new firm was started under the name of Jordan Mills, Inc. Jordan made only a coarse count stock-dyed colored yarn. Petitioner first sold yarn for *686 Jordan in 1939 and in that year became its exclusive representative. Petitioner's president made frequent trips to the Jordan Mills and succeeded in persuading Jordan to raise its quality standards so that its product would be acceptable to former Locke customers.
The Davidson, Russell, Georgia, and Grantville Mills also made colored yarn. Petitioner was never the exclusive representative for these mills and most of its sales for them were small amounts to be used as "fill-ins" where *245 the specific order or type of yarn could not be produced by the petitioner's regular mills.
There are no regularly published prices on colored yarn as there are on grey yarn. The price of colored yarn is determined by the price of grey yarn plus an allowance for processing and dyeing. As a result the prices of colored yarn fluctuate in the same pattern as those of grey yarn. The price at which petitioner sold colored yarn was lower than the cost of grey yarn plus outside dyeing costs.
An index of the prices of cotton and cotton yarn during the period 1922 to 1939, inclusive, is as follows:
| Cotton prices per | ||||||
| pound, cotton middling | Wholesale prices f. o. b. mill for | |||||
| 15/16, average 10 | carded cotton grey yarn | |||||
| markets | ||||||
| Year | ||||||
| Cents per pound | Index 1922-1939 = 100 | |||||
| Cents per | Index 1922- | |||||
| pound | 1939 = 100 | 10/1 cones | 40/1 cones | 10/1 cones | 40/1 cones | |
| (Northern | (Southern | (Northern | (Southern | |||
| Mills) | Mills) | Mills) | Mills) | |||
| 1922 | $ 0.205 | 134.3 | $ 0.361 | $ 0.516 | 125.78 | 122.8 |
| 1923 | .286 | 187.4 | .448 | .585 | 156.10 | 139.2 |
| 1924 | .278 | 182.2 | .444 | .536 | 154.70 | 127.6 |
| 1925 | .231 | 151.4 | .386 | .504 | 134.50 | 119.9 |
| 1926 | .166 | 108.8 | .324 | .459 | 112.89 | 109.2 |
| 1927 | .169 | 110.7 | .306 | .444 | 106.62 | 105.7 |
| 1928 | .195 | 127.8 | .326 | .451 | 113.59 | 107.3 |
| 1929 | .186 | 121.9 | .322 | .457 | 112.20 | 108.8 |
| 1930 | .132 | 86.5 | .242 | .406 | 84.32 | 96.6 |
| 1931 | .082 | 53.7 | .176 | .314 | 61.32 | 74.7 |
| 1932 | .063 | 41.3 | .139 | .248 | 51.92 | 59.0 |
| 1933 | .085 | 55.7 | .220 | .347 | 76.66 | 82.6 |
| 1934 | .124 | 81.3 | .283 | .443 | 98.61 | 105.4 |
| 1935 | .121 | 79.3 | .274 | .413 | 95.47 | 98.3 |
| 1936 | .123 | 80.6 | .248 | .399 | 86.41 | 95.0 |
| 1937 | .118 | 77.3 | .265 | .398 | 92.33 | 94.7 |
| 1938 | .090 | 59.0 | .192 | .317 | 66.90 | 75.4 |
| 1939 | .093 | 60.9 | .210 | .327 | 73.17 | 77.8 |
*246 In its colored yarn business petitioner's deliveries under contract extended over a period of time although all deliveries were made at the price set at the time of the contract. As a result there was a lag in time between price fluctuations and their effect upon petitioner.
Petitioner's sales and net profits for the years 1922 through 1942 were as follows: *687
| Net income (or | ||
| Year | Sales | deficit) (before |
| taxes) | ||
| 1922 (11 mos.) | $ 518,725.95 | $ 2,817.29 |
| 1923 | 544,514.21 | 4,407.41 |
| 1924 | 460,155.12 | (545.44) |
| 1925 | 466,214.13 | (529.77) |
| 1926 | 426,310.48 | (4,777.32) |
| 1927 | 546,030.54 | 5,796.62 |
| 1928 | 1,012,562.99 | 3,461.75 |
| 1929 | 940,933.66 | 3,790.48 |
| 1930 | 606,833.70 | (4,265.43) |
| 1931 | 366,448.64 | (8,679.66) |
| 1932 | 236,796.05 | (4,876.18) |
| 1933 | 463,252.77 | 7,694.56 |
| 1934 | 437,017.08 | 1,757.68 |
| 1935 | 483,221.79 | 1,100.09 |
| 1936 | 514,846.61 | 4,069.20 |
| 1937 | 532,159.51 | 596.08 |
| 1938 | 400,576.24 | 1,027.77 |
| 1939 | 503,542.18 | 3,746.30 |
| 1940 | 562,446.87 | 3,175.93 |
| 1941 | 1,050,081.16 | 26,280.43 |
| 1942 | 1,647,247.11 | 38,616.68 |
Petitioner paid its officers, salaries as follows:
| Sidney Cohn, | ||
| Year | president and | Nathan Jacobs, |
| treasurer | secretary | |
| 1936 | $ 12,000 | $ 4,150 |
| 1937 | 7,500 | 4,570 |
| 1938 | 7,000 | 4,570 |
| 1939 | 10,000 | 5,200 |
| 1940 | 9,000 | 5,200 |
| 1941 | 18,000 | 7,500 |
| 1942 | 24,000 | 10,000 |
*247 Respondent has allowed petitioner excess profits tax credits based on the invested capital method as follows:
| 1940 | $ 6,936.65 |
| 1941 | 7,663.18 |
| 1942 | 9,235.93 |
Petitioner's excess profits credits based on income are as follows: 1940 and 1941 -- $ 2,293.53; 1942 -- $ 2,625.34.
Petitioner paid excess profits taxes for the taxable years 1941 and 1942 in the amounts of $ 3,430.67 and $ 22,150.18, respectively. There was no excess profits tax liability for the year 1940.
Petitioner filed claims for relief under section 722 for the taxable years 1941 and 1942 on November 15, 1943, which claims were disallowed by the respondent in his letter dated May 13, 1946.
Petitioner reconstructed its average base period net income so as to arrive at the amount of $ 28,753.
OPINION.
In computing its excess profits taxes for the taxable years 1941 and 1942, petitioner used an excess profits tax credit based on invested capital which credit was higher than its excess profits *688 credit based on income. Petitioner now seeks to show that it is entitled to reconstruct, under the provisions of section 722 (b) (2) and (b) (4), 1 an average base period net income so as to entitle it to a greater*248 excess profits tax credit than that already available to it.
*249 Petitioner's first contention is that it made a change in its character of business immediately prior to the base period years within the meaning of section 722 (b) (4). The substance of the petitioner's claim is that prior to the alleged change of the character of its business it was acting as a sales agent for grey or natural cotton yarn, and that after the change it specialized in the sale of colored cotton yarn. Petitioner contends that as a result of the change it had new customers, new suppliers, a new sales policy, new competitors, and a higher earning potential. It was incumbent upon the petitioner to show that it made a change in the character of its business and that that change occurred during or immediately prior to the base period years.
The record as a whole is entirely unconvincing, and in the aggregate, does not prove that petitioner made a substantial change in the character of its business.
Even were we to conclude that there had been a substantial change in the character of the business, petitioner has not proved the time when such a change took place. It has not demonstrated that it took place "immediately prior to the base period," as required by the*250 statute.
The sales records which might have tended to establish such a fact were destroyed by petitioner in 1947, subsequent to the filing of its application for relief and the petition in this case. In the present state of the record, declarations on the part of petitioner's officers that *689 its sales of colored yarn prior to the base period were "limited and slight" find little corroboration in the proven facts.
Moreover, there is no evidence that under trade practice or custom, commission selling of colored yarn is greatly different from selling grey yarn. Petitioner sold some colored yarn as early as 1927 and each year thereafter. It advertised in trade publications in 1932 that it was in the colored yarn business. Petitioner's president testified that it was decided in 1934 or 1935 to emphasize colored yarn.
We conclude that petitioner has not established that there was a qualifying change "immediately prior" to the base period years within the meaning of section 722 (b) (4). Accordingly, petitioner is not entitled to any relief under that subsection of the Code.
There remains petitioner's contention that it has qualified for relief under section 722 (b) (2). The*251 substance of the petitioner's claim under this provision of section 722 is that its earnings were adversely affected by a temporary and unusal depression of prices in the cotton yarn industry in 1938 and 1939. It should be pointed out initially that petitioner's average earnings were, in fact, greater in the base period than in the years 1922 to 1939. See Foskett & Bishop Company, 16 T. C. 456, where we said:
* * * An examination of petitioner's earnings from 1922 through 1939, shows that for these years petitioner suffered an average net loss of $ 4,713.76, while for the base period years 1936 through 1939, petitioner showed an average profit of $ 704.45. It, therefore, seems that petitioner has not established its right to relief under section 722 (b) (2), for it would be ignoring the facts to find that petitioner's business was depressed in the base period as compared to its earnings for the average long-term period 1922 to 1939. Winter Paper Stock Co., 1312">14 T. C. 1312. Cf. Monarch Cap Screw & Manufacturing Co., 5 T.C. 1220">5 T. C. 1220.
The basic facts in the present case bear a striking similarity*252 to the situation which obtained in the above quoted excerpt. This fact alone apparently would require us to find that the petitioner's business was not depressed in the base period years.
Furthermore, petitioner's basic premise on this issue does not commend itself to us as being sound. It contends there was a depression in cotton prices in 1938 and 1939 caused by a "record" cotton crop in 1937, and a decrease in cotton consumption in 1938. In our judgment, this fact, if proven, would not be ipso facto a temporary economic event unusual in the case of petitioner's business within the meaning of that phrase as used in section 722 (b) (2). It is not unusual for a cotton crop to vary in size from year to year. The fortuitous circumstances that 1937 may have produced a cotton crop of extraordinary size does not, of itself, create an abnormality in petitioner's business of the character sufficient to bring petitioner within the scope of the cited section. We are not convinced by the evidence of record that petitioner's income was adversely affected in any appreciable *690 degree by the size of the 1937 cotton crop. It would appear that petitioner's income was more dependent*253 upon the success of its officers as yarn salesmen rather than the current market quotations for raw cotton or cotton yarn. This factor would apply with equal force in all years.
We therefore hold that the petitioner has not shown that its business was depressed during the base period years within the meaning of section 722 (b) (2).
Inasmuch as petitioner has failed to establish that it qualified for relief under section 722 (b) (2) or (b) (4), it is unnecessary for us to discuss its reconstruction of base period income under such subsections.
Decision will be entered for the respondent.
Footnotes
1. SEC. 722. GENERAL RELIEF -- CONSTRUCTIVE AVERAGE BASE PERIOD NET INCOME.
* * * *
(b) Taxpayers Using Average Earnings Method. -- The tax computed under this subchapter (without the benefit of this section) shall be considered to be excessive and discriminatory in the case of a taxpayer entitled to use the excess profits credit based on income pursuant to section 713, if its average base period net income is an inadequate standard of normal earnings because --
* * * *
(2) the business of the taxpayer was depressed in the base period because of temporary economic circumstances unusual in the case of such taxpayer or because of the fact that an industry of which such taxpayer was a member was depressed by reason of temporary economic events unusual in the case of such industry,
* * * *
(4) the taxpayer, either during or immediately prior to the base period, commenced business or changed the character of the business and the average base period net income does not reflect the normal operation for the entire base period of the business. If the business of the taxpayer did not reach, by the end of the base period, the earning level which it would have reached if the taxpayer had commenced business or made the change in the character of the business two years before it did so, it shall be deemed to have commenced the business or made the change at such earlier time. For the purposes of this subparagraph, the term "change in the character of the business" includes a change in the operation or management of the business, a difference in the products or services furnished, a difference in the capacity for production or operation, a difference in the ratio of non-borrowed capital to total capital, * * *
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