*57 Decision will be entered under Rule 50.
Petitioner's business as a canner of fruit juices, mainly orange juice, including some allied products, commenced on April 15, 1933, and was conducted first by an unincorporated group and then by a corporation which was succeeded on July 1, 1937, by petitioner, as the result of a statutory consolidation. Because of a freeze in California which took place in January 1937, and was abnormal in severity and the worst freeze in both temperature and duration in the history of all California citrus districts, petitioner's earnings were depressed in its fiscal years ended May 31, 1938, and May 31, 1939, and to a lesser degree in its fiscal year ended May 31, 1940. To the extent that the base period net earnings were so depressed by the severe freeze which took place, they were an inadequate standard of normal earnings within the meaning of section 722 (b) (1) and/or (2), Internal Revenue Code of 1939. On the evidence, a fair and just amount representing normal earnings to be used as constructive average base period net income for the purpose of section 722 (a) determined.
*250 This proceeding involves applications for relief under section 722 of the Internal Revenue Code of 1939 respecting petitioner's excess profits tax liabilities for the fiscal years ended May 31, 1941, through May 31, 1946. In the statutory notice from which this appeal has been taken the respondent denied petitioner's applications for relief in full and determined deficiencies due from petitioner in excess profits tax for the fiscal years ended May 31, 1944, and May 31, 1945, in the respective amounts of $ 24,754.22 and $ 33,793.68, representing excess profits tax deferred by petitioner under section 710 (a) (5), Internal Revenue Code of 1939.
The petitioner's claims for relief were based on section 722 (b) (1), (2) and/or (4). In petitioner's brief, *59 however, only section 722 (b) (1) and (2) are relied upon and the applicability of section 722 (b) (4) is not pressed.
FINDINGS OF FACT.
Many of the facts have been stipulated and the stipulation of facts is incorporated herein by this reference.
Petitioner is a corporation organized on July 1, 1937, under and by virtue of the laws of the State of California, with its principal office in Santa Ana, California. Its returns were filed with the then collector of internal revenue for the sixth district of California.
Since its incorporation petitioner has been engaged in the business of canning and selling pure single strength orange juice, lemon juice, and allied products, including orange and lemon peel, preserves, marmalade, marmalade base, and orange butter. During the 4 base period years ended May 31, 1937, through May 31, 1940, sales of orange juice and lemon juice constituted approximately 85 per cent of petitioner's total sales, the other products being of minor importance.
Petitioner's business commenced on April 15, 1933, and was conducted first by an unincorporated group and then by a corporation, *251 which was succeeded on July 1, 1937, by petitioner, as the result*60 of a statutory consolidation. The net result of this reorganization was the continuation of the former business of TreeSweet Products Co. intact with a small amount of cash acquired as additional assets. There was no change in management as a result of the nontaxable reorganization. Wendell K. McCracken, petitioner's president and general manager, has been the head of the business from its inception. The unincorporated group made various tests in 1932 to determine the feasibility of a process owned by petitioner and known as the Instovac Process. Petitioner was a pioneer in the industry of canning orange juice, which industry commenced at about the same time in both California and Florida. Petitioner added the canning of lemon juice to its business approximately 2 years later, in 1935.
At the commencement of the business petitioner's management corresponded with 42 brokers throughout the United States, submitting samples of its products to them, and received replies from 38 of them expressing desires to handle petitioner's products. In the summer of 1933 (petitioner's fiscal year ending May 31, 1934), approximately 27,000 gallons of orange juice were canned as petitioner's *61 initial pack, on more or less of an experimental basis. Thereafter production and sales increased at a brisk pace. Approximately 124,000 gallons were canned in the 1935 fiscal year and were sold in 10 of the 38 available markets, and 10 additional markets were added in the following fiscal year, when production amounted to 403,049 gallons. In the 1937 fiscal year 669,056 gallons were canned. Petitioner's sales in dollars showed substantial increases in round figures from $ 27,000 in the first fiscal year ended May 31, 1934, to $ 118,000 in 1935, to $ 422,000 in 1936, and to $ 1,153,000 in 1937. Net profits from operations similarly increased, from a loss of approximately $ 5,000 in the first fiscal year to a profit of $ 1,600 in 1935, $ 26,000 in 1936, and $ 135,000 in 1937.
The production in cases of canned orange juice in California-Arizona and Florida for the years 1933 through 1942, was:
| Year | California- | Florida |
| Arizona 1 | ||
| 1933 | 40,169 | 37,258 |
| 1934 | 285,000 | 57,678 |
| 1935 | 817,232 | 240,967 |
| 1936 | 1,014,734 | 162,452 |
| 1937 | 1,058,725 | 498,206 |
| 1938 | 500,000 | 806,183 |
| 1939 | 814,563 | 926,278 |
| 1940 | 992,963 | 2,851,373 |
| 1941 | 1,208,878 | 3,078,043 |
| 1942 | 1,445,380 | 3,460,302 |
*252 Through the close of its 1937 fiscal year petitioner was the largest single canner of California orange juice, and was also the largest of the few canners of lemon juice. In its 1937 fiscal year petitioner still sold in only 20 markets, having been unable to open more markets due to lack of juice to sell, and as early as November 1936, petitioner had completely sold out of three sizes of orange juice. Petitioner's principal and better markets at all times material hereto were largely middle western markets such as Chicago, Detroit, Cleveland, Columbus, Indianapolis, and Terre Haute. California and the far western States were not good or principal markets for petitioner during any time material hereto. Markets such as Texas, Oklahoma, New York, Los Angeles, and San Francisco were never good markets for petitioner during any time material hereto. The principal markets of the Florida processors, in addition to including petitioner's midwestern markets, also were on the Atlantic seaboard and eastern States and New England.
Petitioner's products were and are sold primarily under the label "TreeSweet." It has always stressed the *63 quality of its juices and has maintained a research department staffed with chemists and laboratory technicians. Its orange juice has consistently sold at a substantial premium over Florida canned orange juice. In the early years petitioner received the seal of acceptance of the American Medical Association and the Good Housekeeping Seal of Approval.
During the base period petitioner used only the summer crop of California oranges, known as Valencias, in its canning of orange juice, the navel oranges being unsatisfactory for canning due to the development of a bitter taste in navels after canning.
The canning season normally runs approximately 4 months from the first of July through October. Petitioner purchased its oranges in southern California from packinghouses, taking what are called "eliminates," which are oranges that are eliminated from fresh fruit shipments due to size, color, or skin blemishes.
Petitioner's practice from the inception of the business to the present time has been to sell, as far as possible, each year's pack during the year of the pack, and, excluding the 2 years 1938 and 1939 referred to below, petitioner sold an average of 97 per cent of its orange juice*64 pack during the year of the pack in the 11-year period, 1936 through 1946, and carried over into the following fiscal year only 3 per cent of the pack.
Petitioner adopted a fiscal year ending May 31 to coincide with the point of lowest inventory of orange juice during the year, before the coming in of a new pack.
Since petitioner packs in a few months what it will sell as far as possible over a period of 12 months, and since it required bank loans to finance the heavy cost occurring during the brief processing season, *253 it always followed the practice, at or about the beginning of the processing season, of preparing an estimated budget of maximum production of its various products and the sales, costs, and gross and net profits for its own information and for presentation to the bank in support of the maximum loans for which the petitioner requested bank commitments. Such a projected operating statement was prepared during June and July 1937, for the fiscal year ended May 31, 1938. It called for the production of 1,120,250 gallons of orange juice from July to October 1937. It called for the packing of 811,775 gallons of lemon juice from November 1937 through April 1938. *65 The budget estimated a net profit before Federal income taxes of $ 184,045.25 for the 1938 fiscal year. During the months of July and August, plus the last few days in June and the first few days in September, petitioner canned 1,020,181 gallons of orange juice, slightly less than the budgeted pack, representing an increase of approximately 52 per cent over its pack of orange juice for the preceding fiscal year 1937, an increase which it determined was justified by prior sales and potential demand.
Sales commenced in accordance with the estimate and by August 31, 1937, petitioner had shipped and invoiced 28 1/2 per cent of the pack and had contracts for the delivery by December 31, 1937, of an additional 30 per cent of the pack, thus accounting for 58 1/2 per cent of the pack. Petitioner's normal pattern was to dispose of approximately 75 per cent of a given year's pack by December 31, and although much of the juice was sold under contracts, the majority of the pack was sold on 30-day "spot" orders.
On August 16, 1937, petitioner advised its brokers that since the trend in the price of juice-grade oranges was upward for the balance of the packing season that it would now book contracts*66 for delivery to December 31, 1937, at specified prices. On January 4, 1938, in a bulletin addressed to its brokers, petitioner stated that it had had a number of requests from its good buyers to extend the expiration date on their orange juice contracts due to the unsettled economic conditions which had been disturbing them during the last 3 months. Petitioner went on to state that since many businessmen felt that business would immediately start to show an increase, it was willing to make the extension to February 28, 1938, except for the 15-ounce which was exhausted.
In a letter dated May 24, 1938, to its bank, McCracken stated that he had just returned from a 3-month trip in the east and that he desired to bring the bank up to date on the general market conditions existing in the canned food industry, and TreeSweet in particular. He went on to state that the buyers were making purchases from hand-to-mouth, with no future commitments, that is, their purchases were only in quantities needed for immediate requirements, with the *254 idea in mind that the price tendency was down, rather than up. McCracken went on to state:
Our pack of orange juice this season was approximately*67 50% over the pack of the previous season. During the previous season we had withdrawn further sales as early as February 1st, and could have sold considerably more orange juice than we packed that year. Based on that fact, and not foreseeing the depression during our orange juice packing season of the summer of 1937, we increased the size of our orange juice pack during that summer. Our sales went along satisfactorily until January of this year [1938], and due to the depression and reluctance of buyers to purchase their summer requirements at this time, we will not be able to sell out our entire pack of orange juice by the end of our fiscal year, May 31st, as was done during the previous year. * * *
In late August 1937, petitioner received its first letter of complaint from one of its brokers regarding the quality of the 1937 pack and the complaints soon became general throughout the country. After canning, the juice took on a bitter taste and this bitterness increased as time went on, if, in the meantime, the orange juice had not been consumed. Due to the inferior quality petitioner's sales and contracts suffered to a substantial degree. Contracts had been entered into with*68 approximately 115 buyers, contracting for 141,955 cases. Of these, 53,549 cases were shipped after the contracts. There was a default with respect to 83,568 cases. The buyers under the contracts later accepted 33,369 cases, with the result that buyers defaulted and refused to take a net of 57,793 cases, which default was due in a substantial degree to the inferior quality of the juice. To some extent it was also due to depressed business conditions which existed during the calendar year 1938.
The cause of the deterioration in petitioner's 1937 pack was mainly a freeze which occurred in January 1937, in the citrus-growing areas of California at a time when the Valencia oranges were on the trees. Some of the trouble which petitioner experienced with its 1937 pack was due to bad cans, but this damage was not substantial. In June 1938, the American Can Company, the supplier of the cans, paid petitioner $ 20,000 in settlement of juice spoilage due to defective cans. The freeze was abnormal in severity and was the worst freeze in both temperature and duration in the history of all California citrus districts. The entire orange crop, whether the oranges showed serious effects of *69 the freeze or not, had been affected from a maturity standpoint, with the result that the juice did not hold up with the passage of time. This was not realized at first.
The freezing temperature confronted petitioner with problems it had not theretofore encountered, including that of determining the probable effect of the freeze on the fruit available for canning and how to select, handle, and grade the fruit, both in purchasing and processing. From the time of the freeze until canning operations *255 commenced, petitioner's chief chemist consulted those in the United States, whom he thought would have possible knowledge of the subject, in his intensive investigation to determine the probable and possible effect of the freeze. He conferred with the Director Emeritus of the University of California's Citrus Experimental Station at Riverside, California, who had experience with a freeze in Florida in 1894-1895 and had conducted research at Riverside after a major freeze in California in 1913, and who stated that no harmful substance would occur as a result of frost damage. Draper, petitioner's chemist, visited the citrus canning areas of both Texas and Florida and talked to *70 a majority of the experienced men in the industry in those States. During April Draper visited the Washington, D. C., offices of the United States Department of Agriculture and consulted with the Chief of the Food Research Division of the Bureau of Agricultural Chemistry and Soils. As a result of these surveys and other conversations by Draper and McCracken, petitioner's president and manager, with the leading authorities in the United States working in the appropriate Government departments and with technicians in the canning industry, the conclusion was reached that if a careful job was done of grading out the frozen fruit during the packing season, a satisfactory commercial quality of canned orange juice could be produced and that taxpayer could produce commercial juice of such quality and in such quantity as would result in substantial profits.
Petitioner thereupon purchased a water separator, a machine widely used in the fresh fruit packing houses, and the principle of which is that frozen fruit, having a lighter specific gravity, floats higher in the water and can be removed from the fruit that is to be processed. Petitioner was the only canning company to install and use *71 such a separator. The equipment was operated by a person experienced in its use. During the year 1937, petitioner employed six men as extra fruit buyers, who had had much experience in the inspection of citrus fruit, in order to procure the best available fruit for canning. As the fruit was received at petitioner's plant, tests were made from each load to determine to what extent it contained frosted fruit. If the ratio was too high, the entire load would be discarded. Fruit considered satisfactory for canning was then run through the separator, and tests were again made after passing through the separator in order to determine that the separator was working correctly. During the canning season three graduate chemists and two technicians were employed in the laboratory, the purpose of the laboratory inspection being to maintain a uniform quality of juice, particularly in regard to sugar and acid content and taste.
*256 Petitioner was 1 of approximately 20 packers of California orange juice who proceeded to pack during the summer of 1937. Two of the other large packers were Libby, McNeill & Libby (whose brand was "Libby"), and California Packing Corporation (whose brand *72 was "Del Monte"). All experienced the same deterioration of their 1937 pack, with the result that they did not sell as expected. As a result, neither of the other two large packers canned any orange juice during 1938 and 1939, and most of the smaller canners became bankrupt and went out of business.
As a consequence of the freeze and the resultant deteriorating pack petitioner was unable to sell during the same fiscal year approximately 97 per cent of its orange pack, as in a normal year, but, on the contrary, was forced to carry over into its next fiscal year 34 per cent of its 1937 pack of orange juice. Its dollar net sales of all products, instead of the estimated substantial increase over fiscal year 1937 sales, declined to $ 763,195 in the fiscal year 1938, from $ 1,153,481 in the preceding year. And, instead of its estimated net income of $ 184,045.25, petitioner sustained a net loss from operations during the 1938 fiscal year of $ 106,596.
At a directors' meeting held March 17, 1938, it was decided that a determined effort should be immediately made to dispose of the remaining orange juice and orange butter inventory, even at the sacrifice of profit. On March 21, 1938, *73 McCracken wrote the bank that the company had not changed its price since the last packing season, but that since business conditions were not as good as the previous year, the company's directors at its March 17, 1938, meeting had decided to put a special effort behind sales even if the policy included the sacrificing of some of the profits. Following, in April 1938, a special sales promotional allowance was put into effect and on April 30, 1938, petitioner wrote its brokers, as follows:
Our sales promotional allowance, which was made available during the month of April, has met with so much success that we have decided to continue it during the month of May on the same basis. If you can obtain the full cooperation of your buyers, our sales during the month of May should be even greater than during the month of April, since they will not have the competition of cheap fresh citrus fruits from Florida and California during May.
On May 24, 1938, McCracken wrote the bank that due "to business conditions, there will be a larger than normal carry-over of canned products, particularly peaches, tomatoes and corn," and that these above normal carryovers of canned products "had a tendency*74 to depress price structures." McCracken went on to state, as follows:
If business conditions do not improve between now and our orange juice packing season, we expect to cut our orange juice pack to about 50% of last year. In other words, we hope that we will not again find ourselves with inventory on hand which must be sold without profit due to lack of buying power in the country.
*257 The fiscal year 1939 was also a loss year for petitioner due in a substantial degree to the 1937 freeze. In that year petitioner's loss from operations was $ 82,728. This was brought about in a substantial degree as follows: Being burdened with a carryover of 34 per cent of its 1937 pack of inferior juice, or 343,939 gallons, and its finances being in strained condition, with limited bank credit, petitioner decided in the summer of 1938 to pack only 527,616 gallons of orange juice. The 1938 pack was of good quality, and as soon as it was available petitioner commenced to market the carryover of 1937 inferior pack under a different, secondary label, and in limited markets. In the remaining markets petitioner had to institute methods to build up its name and sales with the new 1938 pack. *75 One of the principal means of doing this was by way of store demonstrations in which people were encouraged to sample the new pack. Selling expenses were unusually high in bringing about this rehabilitation and also in disposing of the 1937 inferior pack in competition with distressed stocks of others, including Del Monte's and Libby's, the latter marketing its distressed stock under the secondary label "Amita."
During the 1938 fiscal year petitioner spent $ 86,784 for sales advertising, promotion, sample, travel, and entertainment, compared with $ 43,718 during 1937. Petitioner did not immediately reduce prices when it realized it was in trouble with the 1937 pack. It first tried these sales promotion ideas, then gave allowances of various kinds, and finally resorted to outright price cuts to dispose of the inferior pack. The losses on the old pack continued to mount. The value of the inferior pack had been written down at the close of the 1938 fiscal year, but it soon became necessary to reduce prices on that pack even further. The result was that the inferior pack, which had cost 54 cents per gallon to produce and which had sold at 67 cents per gallon during the year of the*76 pack, sold during the 1939 fiscal year at 43 cents per gallon (less than the direct cost of production), and 29,897 gallons which were carried over into the 1940 fiscal year were sold at 28 cents per gallon. In addition, approximately 27,000 gallons of the inferior pack were dropped from inventory due to unsalability. Meanwhile, petitioner's new packs of good quality in the fiscal years 1939 and 1940 were selling at from 54 to 57 cents per gallon, representing petitioner's normal 25 per cent of gross profit based upon the cost of said packs. Sales of the new pack in the fiscal year 1939 picked up as the year progressed, and although 150,340 of the 1938 pack of 527,616 gallons remained unsold at May 31, 1939, this carryover of good inventory was sold during June and July, the first 2 months of the 1940 fiscal year, before the 1939 summer pack became available.
*258 On August 3, 1939, petitioner addressed a letter to its bankers in which, among other things, it stated:
May I say just a word in regard to the operations of our company during the past two years? All of the citrus juice canners made the same mistake in 1937, during which year we packed a large amount of juice of*77 very inferior quality. Disposing of it at distressed prices broke the smaller canners and, due to large inventories on hand, neither Libby nor California Packing Corp. packed any orange juice during the 1938 packing season. During the 1938 season TreeSweet packed 192,707 cases of orange juice of good quality, all of which has been sold and the tag end will be shipped out during the next two weeks. Into our 1938 year we carried over 137,017 cases of 1937 pack orange juice. At the end of the previous fiscal year this carry-over was written down to prevailing market, but in order to move it, it was necessary to break our price considerably lower. We wish to point out the important fact that practically all of the inferior 1937 pack was sold under a second label (Forecast) in markets such as Texas, Oklahoma, Buffalo, New York, Los Angeles and San Francisco, which have never been good markets for us. * * * All of this old 1937 pack has now been sold, with the exception of some of the larger sizes, which have been completely charged off our books. They do, however, have some salvage value.
You questioned the possibility of overcoming buyers' prejudice toward canned orange juice due*78 to the inferior 1937 pack. * * * We have today received orders from our Dallas broker for a straight car of 2,365 cases of 1938 pack orange juice. The car was sold to 11 different buyers, including A & P and Safeway. Only the 1938 pack has been sold in our good markets, such as Chicago, Detroit, Cleveland, Minneapolis, Columbus, Boston, Philadelphia, Toronto, etc. Some money has been spent for store demonstrations in these markets, which has overcome buyers' prejudice to the inferior 1937 pack. As evidence of this, we list on a separate sheet sales to some of our large buyers during the first six months of this year as compared with last year.
As a result of the 1937 freeze, the consequent sales of the inferior pack below cost, the heavy selling expenses required to dispose of that pack and to rehabilitate petitioner's good name with a new pack, petitioner had been reduced by the end of the 1939 fiscal year to the low point of its finances, with working capital reduced to $ 21,000. It had an accumulated deficit in earned surplus of $ 229,817. It had been able to maintain good relations with its bank, upon which it was dependent in determining the size of its budgeted pack in*79 the summer of 1939, for its 1940 fiscal year. Petitioner requested a line of credit of $ 175,000 in July 1939. The bank declined to grant such request and petitioner, after consultation with the bank officials, revised its estimated pack for the 1940 fiscal year to accommodate a line of credit of $ 128,000, which the bank authorized. Based upon this line of credit, petitioner could budget for net sales in the 1940 fiscal year of only $ 716,512, and its actual net sales in that year amounted to $ 730,946. Sales improved to such a degree that petitioner was sold out of orange juice in January 1940.
There are variations each year in selling prices of orange juice due to variations in the cost of fresh fruit. The orange juice competes with the fresh orange and must always sell at a lower price.
*259 Petitioner commenced the base period with a stated capital of $ 22,412, and a paid-in surplus of $ 75,516. In connection with the increase in operating capacity referred to hereinafter, petitioner, in July 1937, sold through an investment banker in Los Angeles its first public offering of stock, consisting of 20,000 shares of common stock which netted petitioner $ 132,000, thereby*80 doubling its then investment. At or about the same time petitioner's stockholders, who had previously loaned sums aggregating $ 61,648 to petitioner, canceled the notes as a contribution to paid-in surplus. Hence, by May 31, 1938, petitioner's stated capital was $ 91,269 and its paid-in surplus was $ 253,288, at which figures they remained throughout the balance of the base period and the excess profits tax years.
At all times material hereto petitioner operated in leased premises, and it increased its capacity from the inception of its business in 1933, as indicated by the amounts of its investment in leasehold improvements, viz:
| Year ended | Leasehold improvements |
| May 31 | and equipment |
| 1935 | $ 25,267 |
| 1936 | 33,476 |
| 1937 | 91,987 |
| 1938 | 127,950 |
| 1939 | 128,046 |
| 1940 | 138,869 |
Three major factors in citrus juice production which limit or determine the capacity of a plant are as follows: (1) Juice extraction capacity, (2) canning capacity, i. e., filling and sealing capacity, and (3) pasteurization capacity.
The orange juice productive summary for the 3 years 1935 to 1937, is presented as follows:
| Production | Capacity | |||
| Period | Plant | Gallons | gallons | gallons |
| hours | packed | per | per hour | |
| hour | ||||
| June 1-Nov. 5, 1935 | 1,513 3/4 | 407,745 | 269 | 270 |
| June 30-Nov. 4, 1936 | 1,166 | 565,266 | 485 | 650 |
| June 15-Sept. 18, 1937 | 1,180 3/4 | 1,010,974 | 856 | 1,300 |
*81 Petitioner's excess profits net income and losses during the base period were as follows:
| Fiscal year | Excess profits |
| ended May 31 | net income (or loss) |
| 1937 | $ 93,906.66 |
| 1938 | (130,909.98) |
| 1939 | (101,246.06) |
| 1940 | 68,088.16 |
Petitioner's excess profits credit based upon invested capital was higher than the credit based upon average income, and petitioner has *260 been allowed excess profits credits based upon invested capital in the following amounts:
| Year ended | Invested |
| May 31 | capital credit |
| 1941 | $ 30,482.10 |
| 1942 | 27,799.62 |
| 1943 | 31,118.49 |
| 1944 | 31,983.78 |
| 1945 | 35,191.86 |
| 1946 | 36,607.63 |
During the 6 taxable years petitioner realized excess profits net income and incurred excess profits tax liability (computed without the benefit of relief under section 722) as follows:
| Excess profits | Excess profits | |
| Year ended May 31 | net income | tax liability |
| (before relief) | ||
| 1941 | $ 122,597 | $ 17,149.63 |
| 1942 | 194,643 | 72,451.30 |
| 1943 | 181,442 | 132,190.97 |
| 1944 | 118,844 | 75,012.78 |
| 1945 | 229,310 | 150,892.09 |
| 1946 | 349,779 | 138,549.52 |
Petitioner paid these excess profits taxes within the time prescribed by law, except that $ 24,754.22 and $ 33,793.68 for*82 the years ended May 31, 1944, and May 31, 1945, respectively, were deferred under section 710 (a) (5), Internal Revenue Code of 1939, and have not been paid.
Petitioner filed a timely application for relief under section 722, Internal Revenue Code of 1939, for each of the taxable years 1941 through 1946, claiming a constructive average base period net income in the sum of $ 171,211 and it also filed timely claims for refund on Form 843 of the portions of the excess profits taxes which had not been paid at the time of the filing of the applications for relief. These applications for relief were disallowed by respondent in the notice of deficiency.
Petitioner's average base period net income is an inadequate standard of normal earnings because its normal production, output, or operation was interrupted or diminished because of the occurrence during the base period of an event unusual and peculiar in petitioner's experience, to wit, the abnormal freeze in California in January 1937. The business of petitioner was depressed during its fiscal years 1938 and 1939 because of the occurrence of this abnormal freeze.
Petitioner's excess profits tax for the years in question, computed without*83 relief, was excessive and discriminatory because of the foregoing factors. A fair and just amount representing normal earnings to be used as a constructive average base period net income for the purposes of an excess profits tax based upon a comparison of normal earnings and earnings during an excess profits tax period is $ 84,000.
*261 OPINION.
The Commissioner, in his deficiency notice, has determined deficiencies in petitioner's excess profits tax for its taxable years ended May 31, 1944, and May 31, 1945, of $ 24,754.22 and $ 33,793.68, respectively. These deficiencies are due entirely to the disallowance of deferments in payment of excess profits tax heretofore allowed by the Commissioner in accordance with the provisions of section 710 (a) (5). The Commissioner also states in his deficiency notice, as follows:
In making this determination of your excess profits tax liability careful consideration has been given to your previously mentioned applications for relief under Section 722 of the Internal Revenue Code (Form 991), and related claims (Form 843), and it has been determined that no amount of constructive average base period net income is allowable for any of the *84 taxable years mentioned.
Petitioner makes no assignment of error as to the correctness of the deficiencies determined by respondent but it does contest the correctness of respondent's disallowance of its applications for relief under section 722. Petitioner contends that it is entitled to relief under section 722 (b) (1), (2), and (4) and that --
Respondent erred in disallowing petitioner's claims for relief and in refusing to determine that petitioner's constructive average base period net income should be at least the sum of $ 171,211.00, and in refusing to determine that petitioner is entitled to an excess profits credit based upon that amount for each of the taxable years ended May 31, 1941, 1942, 1943, 1944, 1945 and 1946.
Because of its contention that it is entitled to relief under section 722, petitioner alleges that it is entitled to refunds, as follows:
| Taxable year | |
| ended May 31 | Amount of refund |
| 1941 | $ 17,149.63 |
| 1942 | 72,451.30 |
| 1943 | 132,190.98 |
| 1944 | 75,012.78 |
| 1945 | 113,783.46 |
| 1946 | 48,961.91 |
As has already been stated, respondent, in his deficiency notice, has determined that petitioner is not entitled to any relief for any of the taxable years and has denied*85 its applications for relief. Respondent still maintains that position.
Our Findings of Fact show that in its fiscal year ended May 31, 1937, petitioner had excess profits tax net income of $ 93,906.66. In its fiscal years 1938 and 1939, petitioner had losses of $ 130,909.98 and $ 101,246.06, respectively. Petitioner contends that if it had not been for the California freeze of January 1937, it not only would have had no losses in its 2 fiscal years 1938 and 1939, but that it would have had *262 very substantial profits in each of those 2 fiscal years. It has been stipulated, as follows:
The 1937 freeze in California, in January of that year, was abnormal in severity, and was the worst freeze in both temperature and duration in the history of all California citrus districts.
Because of the effects of this freeze on its earnings in its fiscal years 1938 and 1939, petitioner contends for relief under section 722 (b) (1) and/or (2), 1939 Code, printed in the margin. 1 Petitioner, in its petition, also claims relief under section 722 (b) (4). However, petitioner does not argue the applicability of that subsection in its brief and under the facts we do not see where it is applicable. *86 Therefore, we shall confine our discussion to petitioner's claims for relief under section 722 (b) (1) and/or (2).
*87 Petitioner, in its brief, contends for a constructive average base period net income of $ 172,669, and that this amount should be used in computing its excess profits tax credit instead of the invested capital credit which the Commissioner has used in his denial of petitioner's applications for relief under section 722 and his determination of the deficiencies for petitioner's fiscal years 1944 and 1945.
Respondent, on his part, contends that petitioner's heavy losses in its fiscal years 1938 and 1939 were not due to the freeze which occurred in California in January 1937, but would have been sustained on account of depressed business conditions in 1938, regardless of the freeze. We think respondent's position cannot be sustained on the face of the evidence, both oral and documentary, which is in the record. We have endeavored in our Findings of Fact to give a correct reflection of what this evidence shows and no point would be served in repeating those facts in this Opinion. We think it is sufficient to point out that in the first year of the base period, the fiscal year 1937, petitioner had excess profits net income of $ 93,906.66. There is no reason to believe, we think, but*88 that in the following 2 fiscal years, 1938 and 1939, petitioner would have had very substantial net income in each of the years, except for the severe freeze in 1937. Instead of substantial amounts of net income which we think petitioner would have had in each of those years, it had severe losses, the *263 amounts of which we have already stated. The facts as to how the effects of this January 1937 freeze on petitioner's business extended down as far as petitioner's 1939 fiscal year and, even to some extent in the fiscal year 1940, are detailed in our Findings of Fact and need not be repeated here. That such a freeze as the abnormal California freeze in January 1937 was such an unusual and peculiar event affecting petitioner's business as qualifies petitioner for relief under section 722 (b) (1) and/or (2), seems to us clear. Cf. S. N. Wolbach Sons, Inc., 22 T. C. 152; Morrow-Thomas Hardware Co., 22 T. C. 781; and Schwarz Paper Co., 23 T.C. 605">23 T. C. 605. But, as we said in the Schwarz Paper Co. case:
However, it is not sufficient for petitioner merely to prove grounds for relief. It *89 must go further and show facts which will be sufficient to establish a constructive average base period net income which, when used in a computation of its excess profits tax credit, will result in a lesser tax than by computing the credit by the use of the invested capital method. * * *
It is respondent's contention that even assuming that petitioner has established its right to relief under section 722 (b) (1) and/or (2), nevertheless any constructive average base period net income arrived at under a reasonable reconstruction would be less than petitioner's excess profits credit computed on the invested capital method and, therefore, would afford no relief.
Petitioner, on the other hand, contends that by the elimination of the effects of the abnormal freeze of January 1937 on petitioner's business during the base period, a constructive average base period net income of $ 172,669 is arrived at and that we should make a finding that,
A fair and just amount representing normal earnings to be used as a constructive average base period net income for the purposes of an excess profits tax based upon a comparison of normal earnings and earnings during an excess profits tax period is $ *90 172,669.
The manner by which petitioner arrives at this constructive average base period net income of $ 172,669 is detailed in Exhibit 51, introduced in evidence by petitioner and which was compiled by its president and general manager, W. K. McCracken, and concerning which he testified at length at the hearing. This proposed reconstruction which has been submitted by petitioner has been carefully studied and considered but we find ourselves unable to agree to it. It seems to us that the reconstruction submitted by petitioner attributes all of its troubles during its fiscal years 1938 and 1939 to the abnormal freeze of January 1937. While, as we have already said, we think the record well establishes that the January 1937 freeze greatly affected petitioner's business in its fiscal years 1938 and 1939 in an adverse manner, we do not think the freeze was the only factor which adversely affected petitioner's business in those 2 taxable years. We think there is merit in respondent's contention that the recession *264 in general business which both sides agree occurred in the calendar year 1938 and which, therefore, existed in part of petitioner's fiscal years 1938 and 1939, *91 also adversely affected petitioner's business in those 2 taxable years.
We think also that, as respondent argues in his brief, the growing competition with Florida orange juice which began to be an important factor during these 2 fiscal years was also an adverse factor which affected petitioner's business. Cf. Lamar Creamery Co., 8 T. C. 928. In the Lamar Creamery Co. case, we said:
But can such competition be considered as a temporary economic circumstance unusual in the case of petitioner or of the industry of which petitioner was a member? We do not think it can be so considered. Competition is present in almost any business. Instead of it being something unusual, it is quite common. It is of the very essence of our capitalistic system. * * *
While it is true that in the instant case petitioner does not contend that the growing competition of petitioner's product with Florida orange juice should be considered as a qualifying factor under section 722 (b) (2), nevertheless in its reconstruction it gives no effect whatever to this growing competition with Florida orange juice. In fact, it contends strongly that this Florida orange juice*92 competition had no effect on its business in the fiscal years 1938 and 1939, and attributes, as we have already said, all of the adversities which petitioner encountered in the 2 above-named fiscal years to the result of the abnormal freeze which took place in January 1937. We find ourselves unable to agree to this position. We think, in making any reasonable reconstruction, that not only the factor of the abnormal freeze should be given effect, but also the factors of the business recession in the calendar year 1938 and the increasing Florida orange juice competition in both fiscal years. When this is done, we are unable to approve the reconstruction submitted by petitioner by which a constructive average base period net income of $ 172,669 is arrived at. We have carefully studied the record and the briefs of both parties and have come to the conclusion that a constructive average base period net income of $ 84,000 is reasonable and should be used in arriving at petitioner's relief under section 722.
We realize, of course, that in making surmises which are necessary in arriving at a reasonable reconstruction giving effect to the factors which a taxpayer has proved as a basis *93 for relief under section 722, it is generally impossible to be exact. The best that can be done is to make a reasonable approximation. This we have done in arriving at a constructive average base period net income of $ 84,000. This should be used in a recomputation under Rule 50, instead of the credit based on invested capital which the Commissioner has used in his deficiency notice.
Reviewed by the Special Division.
Decision will be entered under Rule 50.
Footnotes
1. Arizona is an insignificant factor.↩
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 --
(1) in one or more taxable years in the base period normal production, output, or operation was interrupted or diminished because of the occurrence, either immediately prior to, or during the base period, of events unusual and peculiar in the experience of such taxpayer,
(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,↩