*67 Decision will be entered under Rule 50.
Petitioner having commenced business during the last base period year held entitled under section 722 (b) (4) to use a constructive average base period net income determined from the evidence.
*990 In applications for relief from excess profits taxes, petitioner claimed refunds in the amounts of $ 4,214.91, $ 5,087.78, and $ 9,548.94 for the calendar years 1941, 1942, and 1943, respectively. Respondent disallowed these applications for relief and determined a deficiency in excess profits tax for the year 1943 in the amount of $ 4,369.14.
The deficiency arises from petitioner's deferment of a portion of its excess profits tax under the provisions*68 of section 710 (a) (5) of the Internal Revenue Code. The sole issue for our determination is whether petitioner is entitled to relief from excess profits taxes for the years 1941, 1942, and 1943 under the provisions of section 722 of the Internal Revenue Code.
FINDINGS OF FACT.
Some of the facts are stipulated and are hereby found accordingly.
Petitioner, a corporation, was organized on October 5, 1939, under the laws of the State of New York, for the purpose of tanning and finishing sheep skivers and East India semitanned goatskins for the fancy leather goods industry. It was formally dissolved on January 3, 1949. The returns for the years in question were filed with the collector of internal revenue for the first district of New York.
Petitioner's work was mainly on a contract basis. It received semitanned skins, processed them at a fixed price which included labor and finishing materials, and then returned them to the supplier for manufacture and ultimate sale. A hand-boarding operation or an embossing process was used to produce morocco and other individualized grains of leather on the goatskins. The skivers, which are the upper grained split of sheep skins, were retanned*69 to make them soft and pliable. Both the goatskins and skivers were treated with a variety of lacquers and glazes to produce a waterproof and color-fast product.
The goatskin leathers were used primarily by manufacturers of women's handbags, wallets, and other finished goods. The sheep skivers were used in belt linings and very low-priced handbags. Petitioner received an average price of 11 cents per square foot for *991 retanning and finishing East India goatskins and 4 cents per square foot for retanning and finishing sheep skivers.
Petitioner's chief stockholders and managers from its inception and throughout the years in issue were William Emmerich, Joseph Gutenstein, and Hans Fleisch. All three had had considerable experience in Europe in the leather tanning, processing, and finishing field before they came to the United States in 1936, 1937, and 1938. Before going into business, they obtained information from manufacturers, jobbers, dealers, trade associations, and trade magazines about the production, selling prices, and existing and potential market for fancy leather goatskins and skivers.
Shortly before and for several months following petitioner's organization, *70 the three principals, in conjunction with a Dr. Emil Plaveczky, experimented in the development of cellulose nitrate lacquers and glazes to be applied to goatskins and skivers. During 1939 their efforts were on a trial and error basis, and it was not until early in 1940 that a finishing material was produced which satisfied petitioner's managers.
Prior to this time, cellulose nitrate lacquers had been used to some extent on cowhide and cattleskins, but they were not in general use in the United States on goatskins and skivers. Petitioner was the first in the United States to apply cellulose nitrate lacquers successfully to goatskins and skivers and to produce color-fast and waterproof finishes in a wide variety of colors. By means of certain secret processes in the application of such lacquers and glazes, petitioner was also able to produce a first grade, high quality product out of third and fourth grade goatskins and skivers.
Before petitioner commenced business, United States production of genuine hand-grained morocco leather was insignificant and American manufacturers wishing to utilize morocco leather relied upon the importation of finished goatskins from Great Britain. Petitioner's*71 product was superior to the slight amount of finished goatskins that had been produced in the United States prior to its organization.
During the period 1936 through 1939, approximately 80 per cent of the morocco used in the handbag industry was in the standard shades of black, brown, and navy blue, while only 20 per cent was in the high shade colors. English exporters were not equipped to make quick deliveries on orders of leathers in high shade colors and their matching of such colors was at times imperfect. During the period 1936 through 1939 there was a prejudice in favor of the imported English product. During that period there was also keen competition in that segment of the leather tanning industry which specialized in finishing East India goatskins.
*992 During the years in issue petitioner produced finished East India goatskin leathers principally for Loewengart & Company. Loewengart & Company imported and sold finished goat leather until 1939 when it began importing East India semitanned goatskins and having them finished in the United States. Commencing in the early part of 1940, Loewengart & Company engaged in extensive advertising and promotional efforts to *72 publicize to the trade and to consumers the morocco and other goatskin leathers processed for it by petitioner and sold under the trade name of "Gahna."
During 1939, Loewengart & Company imported English morocco at an average cost per square foot of 26, 23.4 and 22.1 cents for first, second, and third grade leathers, respectively, and sold them for 29, 27, and 25 cents. After 1939, Loewengart & Company imported semintanned goatskins from India at an average price of 11 cents per square foot, had them processed and finished by petitioner at an average cost of 11 cents per square foot, and sold them to the trade at an average price of not more than 25 cents. The prices of finished morocco imported from England and of semitanned goatskin imported from India remained stable during the years 1937, 1938, and 1939, except for slight seasonal fluctuations.
During the years 1939 through 1941, petitioner's plant capacity was such that it could tan, process, and finish at least 4,000,000 square feet of leather per year. During the year 1939, 20,576,000 units of women's and children's handbags of leather were manufactured in the United States. The average handbag requires 3 square feet of *73 leather resulting in over 60,000,000 square feet of leather being used in the handbag industry in 1939.
Prior to 1940, there was very little use of fancy goatskin leathers in the handbag industry. Total imports of all fancy goat and kid leathers, both grained and embossed, other than gold and silver embossed, were as follows during the base period years:
| Year | Square feet |
| 1936 | 430,524 |
| 1937 | 355,698 |
| 1938 | 478,321 |
| 1939 | 636,598 |
During 1940 and 1941, the use of goatskin leathers in the handbag industry increased substantially. This was partially the result of the advertising and promotional efforts of Loewengart & Company, the superior quality of petitioner's leathers, the wide variety of colors made available by petitioner to match other articles of apparel, the short delivery dates petitioner could offer, and the low price of petitioner's *993 product as compared with imported goatskin leathers and other types of leathers.
Several months after Pearl Harbor, the end use of cattle, calf, and kip hides was restricted and they could no longer be used for luxury items. During the period when there was a shortage of other leathers, the handbag industry bought any available*74 leather that could be used for the manufacture of handbags.
The preference of the public in the matter of colors and grains of leather for women's apparel is a matter of fashion. The manufacturer of the leather or the finished product merely fills the want, he does not create the desire for the product.
All other fancy leathers, except for sheep skivers, have always been higher in price than finished goatskins. Calfskin leather cost the manufacturer at least twice as much as goatskin, while cowhide, lizard, alligator, and ostrich cost from two to four times as much as finished goatskin. Goatskins are smaller in size and have imperfections in the skins that have to be removed. Calfskins and cowhides are larger and do not have these imperfections.
Prior to 1939, the billfold and leather novelty industry used East India goatskins to a substantial extent in their products, but they were principally imports of finished goatskin leather. Approximately 11,500,000 leather wallets and billfolds were manufactured in the United States in 1937. Since the average wallet or billfold requires 1 1/2 square feet of leather, approximately 17,000,000 square feet of leather were used in the wallet*75 and billfold industry during that year.
Sometime after 1939, there was a substantial increase in sales to the wallet and billfold industry of domestically finished goatskins in fancy shade colors. Approximately 1,000,000 square feet of goatskins were sold to that industry by Loewengart & Company in 1941. Prince Gardner and Buxton, the two largest billfold and wallet manufacturers in the United States, substituted petitioner's products for the imported products.
If petitioner had commenced business in 1937, had received the benefit of Loewengart & Company's promotional activities, and had produced the type of goatskin product it later produced, at a price cheaper than the imported English product and available on a short-time delivery basis, petitioner could have captured a portion of the market in the wallet and billfold industry.
Before petitioner commenced business, sheep skivers had been used mainly as lining material. Petitioner developed a chrome retannage different from that previously used in the industry. This process *994 resulted in sheep skivers being used for the first time in the manufacture of a low-priced handbag. Petitioner marketed its skivers in a broad*76 variety of colors. During the first 2 years of its operation, petitioner processed 1,500,000 square feet of skivers on a contract basis for handbag manufacturers. The firm of Hesslein & Samstag was its principal account.
The total number of square feet of East India goatskin processed by petitioner for Loewengart & Company during the years 1943 to 1948, inclusive, was as follows:
| Year | Square feet |
| 1943 | 1,555,768 |
| 1944 | 2,904,443 |
| 1945 | 2,583,727 |
| 1946 | 4,174,072 |
| 1947 | 1,357,066 |
| 1948 | 488,605 |
Petitioner's net profit for the years 1939 through 1948 was as follows:
| Net profit or (loss) | |
| per audit reports | |
| Year | or books |
| 10/5/39 to 12/31/39 | $ 434.54 |
| 1940 | 1,072.99 |
| 1941 | 18,220.56 |
| 1942 | 14,895.68 |
| 1943 | 30,703.73 |
| 1944 | 32,454.81 |
| 1945 | 14,216.38 |
| 1946 | 1 55,514.88 |
| 1947 | (20,299.97) |
| 1948 | (17,576.22) |
The reasons for petitioner's dissolution on January 3, 1949, were as follows: (a) The fact that William Emmerich, the senior member of petitioner, had died; (b) the fact that its principal customer, Loewengart & Company, had chosen to build a plant in Mercersburg, Pennsylvania, and go into the manufacturing of the very products petitioner had perfected, with*77 a consequent diminution in orders to petitioner; (c) the fact that Joseph Gutenstein, the second of petitioner's three shareholders, had left petitioner to work with Loewengart & Company; (d) the fact that both Emmerich's estate and Gutenstein desired to be paid out of the business; and (e) the fact that Hans Fleisch, the remaining stockholder, could not take upon himself the burden of running petitioner's business in his individual capacity.
The nitro-cellulose lacquers and the techniques of the application developed and introduced to the United States by petitioner are in widespread use today. During the years 1946 through 1950, Loewengart & Company, which went into the finishing business for itself, processed an average of 4,000,000 square feet of goatskins per year. This amount represented about 40 per cent of total goatskin leather finished in the United States.
United States imports of semitanned goatskins from India for the years 1935 through 1939 and 1946 through 1950 were as follows: *995
| Number of bales | |
| (3,000 square | |
| Year | feet per bale) |
| 1935 | 310 |
| 1936 | 129 |
| 1937 | 252 |
| 1938 | 301 |
| 1939 | 294 |
| 1946 | 5,477 |
| 1947 | 2,643 |
| 1948 | 1,209 |
| 1949 | 771 |
| 1950 | 2,146 |
The excess*78 profits tax credits allowed petitioner under the invested capital method were as follows:
| 1941 | $ 3,648.53 |
| 1942 | 5,375.59 |
| 1943 | 6,145.78 |
Petitioner's profit and loss statement for the period October 5, 1939, through December 31, 1939, is as follows:
| PETITIONER'S 1939 PROFIT AND LOSS STATEMENT | |
| Audit report | |
| Oct. 5 to Dec. 31, | |
| 1939 | |
| Sales: Regular | $ 9,638.64 |
| Sales: Contracts | 5,497.23 |
| Total sales | 15,135.87 |
| Less cost of goods sold: | |
| Purchases raw materials | 20,640.73 |
| Tanning and finishing | 2,567.10 |
| Freight-In | 73.26 |
| Factory labor | 5,802.10 |
| Rent | 1,000.00 |
| Light, heat, and power | 549.30 |
| Water | 85.20 |
| Repairs | 57.24 |
| Expenses | 223.85 |
| Total charges | 30,998.78 |
| Less inventories at close | 19,426.68 |
| Cost of goods sold | 11,572.10 |
| Gross profit | $ 3,563.77 |
| Delivery expenses | $ 157.80 |
| Selling expenses | 128.96 |
| Office and general expense | 903.80 |
| Officers' salaries | 1,448.00 |
| Interest and discount, etc | 143.11 |
| Unemployment insurance | 322.56 |
| State taxes | 25.00 |
| Total operating expense | 3,129.23 |
| Net profit before other income | 434.54 |
| Net profit or (loss) per audit report | 434.54 |
| Net profit or (loss) per tax returns | (156.52) |
*996 In its*79 applications for relief petitioner computed its constructive average base period net income as follows:
| PETITIONER'S RECONSTRUCTION | |||
| Gross Sales | |||
| For goatskins: 1,500,000 sq. ft. at 11 cents | $ 165,000 | ||
| For skivers: 1,500,000 sq. ft. at 4 cents | 60,000 | ||
| Total constructive sales | $ 225,000 | $ 225,000 | |
| Direct Costs | |||
| Goatskins: | |||
| Direct labor 1,500,000 sq. ft. at $ 5.00 | $ 75,000 | ||
| Tanning and finishing materials at $ 1.50 | 22,500 | ||
| $ 97,500 | |||
| Skivers: | |||
| Direct labor 1,500,000 sq. ft. at $ 1.75 | $ 26,250 | ||
| Tanning and finishing materials at $ 0.90 | 13,500 | ||
| 39,750 | |||
| Total direct costs | $ 137,250 | ||
| Factory Overhead | |||
| Indirect labor (6% of direct labor) | $ 6,000 | ||
| Factory supervision (2 officers at $ 10,000) | 20,000 | ||
| Heat and power | 4,500 | ||
| Factory expense and repairs | 6,500 | ||
| Depreciation: Building and equipment | 2,500 | ||
| Water | 1,000 | ||
| Payroll taxes (direct, indirect and supervision) | 5,000 | ||
| Insurance (including compensation) | 4,000 | ||
| Real estate taxes | 1,000 | ||
| Total | $ 50,500 | ||
| Selling Expense | |||
| Packing and shipping wages | $ 1,500 | ||
| Freight, cartage, deliver, and depreciation -- auto | 500 | ||
| Packing and shipping material | 1,000 | ||
| Total | $ 3,000 | ||
| General Expense | |||
| Office salaries | $ 1,500 | ||
| Postage | 150 | ||
| Stationery and supplies | 200 | ||
| Telephone and telegraph | 600 | ||
| Executive salaries 1 at | 10,000 | ||
| Executive salaries 1 at | 2,000 | ||
| Taxes General | 1,000 | ||
| Taxes Payroll | 300 | ||
| Light | 1,000 | ||
| Legal and services | 1,000 | ||
| Miscellaneous, charity, etc | 1,500 | ||
| Total | $ 19,250 | ||
| Total cost | $ 210,000 | ||
| Reconstructed net income ($ 225,000-$ 210,000) | $ 15,000 |
*80 *997 Respondent's computation of petitioner's constructive average base period net income most favorable to petitioner is as follows:
| RESPONDENT'S RECONSTRUCTION | ||
| 1936 | 1937 | |
| 1. Imports of grained, embossed, | ||
| etc., fancy goat | ||
| & kid leather (sq. ft.) | 430,524 | 355,698 |
| 2. 40% of import volume | ||
| (line 1) (sq. ft.) | 172,209 | 142,279 |
| 3. Petitioner's claimed billing | ||
| price morocco (per | ||
| sq. ft.) | $ 0.11 | $ 0.11 |
| 4. Reconstructed sales morocco | ||
| fancy goat | ||
| leather, line 2 & line 3 | $ 18,942.99 | $ 15,650.69 |
| 5. Highest % of net profit | ||
| attained by petitioner | ||
| 1946 | 8.98 | 8.98 |
| 6. Reconstructed net profit | ||
| on morocco fancy goat | ||
| (lines 4 & 5) | $ 1,701.08 | $ 1,405.43 |
| 7. Reconstructed net profit | ||
| on skivers as claimed | ||
| by petitioner * | $ 1,197.00 | $ 1,197.00 |
| 8 Total constructive net | ||
| income (line 6 + 7) | $ 2,898.08 | $ 2,602.43 |
| 9. Total for base period. | ||
| Sum of 4 base period | ||
| years | $ 12,299.76 | |
| 10. Constructive average | ||
| base period net in-income | ||
| (line 9/4) | $ 3,074.94 |
| RESPONDENT'S RECONSTRUCTION | ||
| 1938 | 1939 | |
| 1. Imports of grained, embossed, | ||
| etc., fancy goat | ||
| & kid leather (sq. ft.) | 478,321 | 636,598 |
| 2. 40% of import volume | ||
| (line 1) (sq. ft.) | 191,328 | 254,639 |
| 3. Petitioner's claimed billing | ||
| price morocco (per | ||
| sq. ft.) | $ 0.11 | $ 0.11 |
| 4. Reconstructed sales morocco | ||
| fancy goat | ||
| leather, line 2 & line 3 | $ 21,046.08 | $ 28,010.29 |
| 5. Highest % of net profit | ||
| attained by petitioner | ||
| 1946 | 8.98 | 8.98 |
| 6. Reconstructed net profit | ||
| on morocco fancy goat | ||
| (lines 4 & 5) | $ 1,889.93 | $ 2,515.32 |
| 7. Reconstructed net profit | ||
| on skivers as claimed | ||
| by petitioner * | $ 1,197.00 | $ 1,197.00 |
| 8 Total constructive net | ||
| income (line 6 + 7) | $ 3,086.93 | $ 3,712.32 |
| 9. Total for base period. | ||
| Sum of 4 base period | ||
| years | ||
| 10. Constructive average | ||
| base period net in-income | ||
| (line 9/4) |
Petitioner's actual average base period net income is an inadequate standard of normal earnings because petitioner commenced business only 2 months and 26 days before the end of the base period. Petitioner did not reach, by the end of the base period, the earning level which it would have reached if petitioner had commenced business 2 years before it actually did. Petitioner is entitled to the benefits of the "push-back" rule.
*998 Petitioner's excess profits tax liability, computed under subchapter E without the benefit of section 722, is excessive and discriminatory. Petitioner qualifies for relief under section 722 (b) (4) of the Internal Revenue Code.
A fair and just amount representing petitioner's constructive average based period net income is $ 6,500.
OPINION.
*82 There appears to be no quarrel as to petitioner's qualification for relief under section 722 (b) (4). Indeed, literal conformity to the requirements of that section could scarcely be more evident. Petitioner officially commenced business within the "base period," on October 5, 1939, to be precise, and so near to its close that despite respondent's efforts, it seems difficult to deny that with an income of but $ 434.54 it had not reached its normal earning capacity by the end of its last base period year. 1
It is rather the size of the reconstructed income, *83 and its relationship to an invested capital credit, to which petitioner was permitted to resort under section 714 in filing its returns, that constitutes the real issue. Only if its income credit under the reconstruction will be of greater benefit than the credit it thus automatically acquires can there be relief under section 722. Green Spring Dairy, Inc., 18 T. C. 217; Block One Thirty-Nine, Inc., 17 T. C. 1364.
In weighing the various factors involved, we have, as our ultimate finding of fact, arrived at a constructive average base period net income which grants petitioner some relief but not in anything like the size claimed by it. We regard respondent's estimates as too low. The goatskin market during the base period might have been increased had petitioner's cheaper, more flexible, and more speedily procurable product been available. But without looking to actual events subsequent to 1939, see Southern California Edison Co., 19 T. C. 935; Del Mar Turf Club, 16 T. C. 749, only approximations are possible as to the time and extent of petitioner's success*84 with its experimentation on its new tannery processes, as to the scope and enthusiasm of any promotion campaign conducted on behalf of its products, and possibly as to the costs, both direct and indirect, of its operations.
*999 Under the 2-year anticipation of the "push-back" rule, 2 all these and other material factors must be considered against an economic background very different from the wartime activity existing during the actual events. The figure we have found is the best we have been able to arrive at, taking into account all relevant elements. See Fishbeck Awning Co., 19 T. C. 773; Radio Shack Corporation, 19 T. C. 756; National Grinding Wheel Co., 8 T. C. 1278.
*85 Reviewed by the Special Division.
Decision will be entered under Rule 50.
Footnotes
1. Per books.↩
*. Petitioner's claimed reconstruction of skiver operations follows:
↩
Sales (1,500,000 sq. ft. at 4 cents) $ 60,000 Labor (1,500,000 sq. ft. at 75 cents) $ 26,250 Materials (1,500,000 sq. ft. at 90 cents) 13,500 Overhead (50% of labor) 13,125 52,875 Gross profit $ 7,125 Selling (1.33% of sales) $ 798 General and administrative (8.55% of sales) 5,130 5,928 Net profit $ 1,197 1. Section 722 (b). * * * The tax computed under this subchapter * * * shall be considered to be excessive and discriminatory * * * if its average base period net income is an inadequate standard of normal earnings because --
* * * *
(4) The taxpayer either during or immediately prior to the base period commenced business * * * and the average base period net income does not reflect the normal operation for the entire base period of the business. * * *↩
2. Section 722 (b) (4)↩. * * * 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 * * * two years before it did so, it shall be deemed to have commenced the business * * * at such earlier time. * * *