*310 Decision will be entered for the respondent.
Section 722(b) (2) -- Depressed Business -- Temporary Economic Condition. -- The petitioner has failed to show either that its business or the business of the industry of which it was a member was depressed during the base period years by Japanese competition, or that the Japanese competition was a temporary economic event unusual either in the case of the petitioner or in the case of the industry.
*96 The Commissioner has disallowed the petitioner's applications for relief under section 722. The petitioner filed applications relating to its taxable years 1941 and 1942, each ended on September 30. No excess profits tax was*311 due from the petitioner for the year 1941. That year is involved herein only to the extent that an unused excess profits credit for that year might be carried over to 1942. The Commissioner determined a deficiency of $ 15,795.89 in excess profits tax for the fiscal year 1942, but the deficiency is not contested in this proceeding. The only issue for decision is whether the respondent erred in disallowing the petitioner's applications for relief under section 722 (b) (2) and (5), as amended.
*97 FINDINGS OF FACT.
The petitioner was organized as a New Jersey corporation in 1920. Its returns and its applications for relief were filed with the collector of internal revenue for the fifth district of New Jersey.
The business of the petitioner at all times material hereto was the purchase of linen and cotton twine from others and the tying of it into netting. Most of its nets were sold for use by commercial fishermen, but it also manufactured and sold some for camouflage purposes and for tennis nets. It sold on a nation-wide basis. The petitioner and three other firms manufactured from 90 to 95 per cent of the total domestic production of fish nets and netting, and of this the*312 petitioner's share was about 18 per cent.
The approximate domestic production in pounds of cotton fish nets and netting was 2,249,000 in 1931, 1,769,000 in 1932, 1,866,000 in 1933, 1,765,000 in 1934, and 2,496,000 in 1935, or an average annual production of about 2,000,000 pounds. The average domestic production of the same articles for the years 1936 to 1939 was approximately 2,500,000 pounds.
The principal imports of cotton fish nets and netting for the years shown were as follows (in pounds):
| Year | Japan | Netherlands | United |
| Kingdom | |||
| 1932 | 120,000 | 38,000 | 5,000 |
| 1933 | 129,000 | 27,000 | 13,000 |
| 1934 | 212,000 | 90,000 | 30,000 |
| 1935 | 280,000 | 40,000 | 15,000 |
| 1936 | 408,000 | 12,000 | 26,000 |
| 1937 | 802,000 | 31,000 | 10,000 |
| 1938 | 474,000 | 14,000 | 8,000 |
| 1939 | 719,000 | 36,000 | 10,000 |
The imports from Japan were not substantial prior to 1932.
The duty imposed upon the importation of cotton fish nets and netting was 40 per cent ad valorem from 1930 without change through the base period. Efforts were made by the domestic industry as early as October 1932 and later to have the tariff rate on fish nets and netting increased and to limit in other ways the imports of Japanese netting. *313 The Tariff Commission completed investigations. There was no indication at any time material hereto that any change would be made in the tariff rate. The efforts of the industry to curtail Japanese imports resulted in an agreement negotiated by representatives of the domestic industry with representatives of the Japanese Government in July 1938. This was the best and only arrangement which the domestic industry could obtain in its efforts to limit Japanese competition. The domestic production of cotton fish nets and netting increased slightly following the agreement, although there were at that *98 time large stocks of Japanese netting in the United States. The agreement was in part as follows:
The Japanese Cotton Fish Nets Export Association has agreed upon the following arrangement, for the purpose of voluntary limitation on the part of the said Association, of the exports of cotton fish nets and nettings from Japan to the United States:
1. The exportation of cotton fish nets and nettings from Japan to the United States is to be voluntarily limited by the Japanese Cotton Fish Nets Export Association for three years as follows:
| 1938 | 600,000 pounds |
| 1939 | 600,000 pounds |
| 1940 | 500,000 pounds |
*314 And subject to the following adjustments:
(a) The amount for any given year may be increased up to 20 percent, but the basic total for the three years' period is not to exceed 1,700,000 pounds.
(b) In case the annual American production of cotton fish nets and nettings for 1938 or 1939 should increase over 2,230,000 pounds (1937 production), the following year's quota shall be increased proportionately, provided that this percentage increase is calculated in pounds upon 600,000 pounds.
2. Transshipments are to be controlled effectively by the said Association and the quantities of transshipments shall be counted in the total of the above figures.
3. The Japanese exportation is to spread over a variety of types and sizes, approximately in such a manner, as last year's export record, and is not to concentrate, particularly, on any small group of types or sizes of cotton fish nets and nettings.
Japanese netting was sold in the United States at about the cost of the raw materials used for similar articles by domestic manufacturers. The quality of the netting imported from Japan was originally poor in workmanship and materials as compared to the domestic article, but the quality improved*315 until about 1938, after which it was about equal to that of the domestic product. All domestic manufacturers sold netting at the prices established by the largest producer in the industry. The petitioner listed prices on October 24, 1938, on its products which were lower than the corresponding prices in January 1934. The reduction on the principal products subject to Japanese competition was 10 cents per pound. Some customers of the petitioner, in numbers and at times not disclosed by the record, began to buy all of their goods from Japanese imports, and other customers bought some Japanese imports. These customers were located on the Pacific Coast and near the Great Lakes. The petitioner after 1938 made sales to an undisclosed number of its old customers who previously had been buying Japanese goods.
The following table shows to the nearest dollar the amount of the petitioner's net sales, gross profits, total income, total deductions, net income or losses, and officers' salaries, as reported by the petitioner on its returns or as adjusted by the Commissioner for a period of about 21 years: *99
| Year | Net sales | Gross profit | Total |
| income | |||
| 1920 | $ 394,324 | $ 76,854 | $ 77,017 |
| 1921 | 324,246 | 63,079 | 63,079 |
| 1922 | 386,178 | 90,583 | 90,598 |
| 1923 | 498,333 | 90,659 | 92,728 |
| 1924 | 555,983 | 93,579 | 95,297 |
| 1925 | 588,647 | 127,459 | 128,854 |
| 1926 | 623,587 | 118,787 | 121,017 |
| 1927 | 547,572 | 154,435 | 157,481 |
| 1928 | 554,530 | 135,710 | 137,510 |
| 1929 | 565,296 | 135,006 | 136,266 |
| 1930 | 500,824 | 115,747 | 116,726 |
| 1931 | 357,915 | 99,654 | 101,389 |
| 1932 | 275,226 | 71,181 | 73,185 |
| 1933 | 255,759 | 86,007 | 87,189 |
| 1934 | 409,100 | 93,701 | 95,279 |
| 1935 | 421,614 | 98,959 | 100,324 |
| 1936 | 493,294 | 130,543 | 131,587 |
| 1937 | 524,198 | 138,857 | 140,306 |
| 1938 | 441,990 | 110,859 | 111,979 |
| 1939 2 | 341,808 | 113,058 | 114,686 |
| 1940 | 501,240 | 153,869 | 154,953 |
| Year | Total | Net income | Officers' |
| deductions | (loss) | salaries 1 | |
| 1920 | $ 85,855 | $ (8,838) | $ 29,100 |
| 1921 | 71,374 | 17,234 | 14,550 |
| 1922 | 87,244 | (15,912) | 20,550 |
| 1923 | 82,331 | (16,709) | 16,275 |
| 1924 | 93,122 | (9,536) | 18,700 |
| 1925 | 109,020 | 25,103 | 18,700 |
| 1926 | 115,272 | 8,017 | 19,900 |
| 1927 | 105,818 | 51,543 | 19,900 |
| 1928 | 115,945 | 21,137 | 21,100 |
| 1929 | 119,361 | 16,773 | 23,700 |
| 1930 | 122,201 | (5,475) | 22,300 |
| 1931 | 116,371 | (14,982) | 19,550 |
| 1932 | 97,902 | (24,717) | 14,490 |
| 1933 | 96,344 | (9,155) | 14,280 |
| 1934 | 93,550 | 1,729 | 14,280 |
| 1935 | 96,096 | 812 | 12,480 |
| 1936 | 132,346 | 2,656 | 36,700 |
| 1937 | 143,886 | (3,580) | 36,760 |
| 1938 | 115,803 | (3,824) | 12,606 |
| 1939 2 | 112,643 | 2,044 | 24,454 |
| 1940 | 155,745 | (791) | 26,601 |
The net losses shown for 1922, 1923, and 1924 involve some duplications due to loss carry-overs.
The following table shows the salaries paid during the base period years to officers. These officers owned all of the capital stock of the petitioner.
| Name | Title | 1936 | 1937 | 1938 | 1939 1 | 1940 2 |
| J. Lichtenstein | president | $ 7,500 | $ 7,500 | $ 5,000 | $ 5,000 | |
| I. Lichtenstein | treasurer | 10,000 | 10,000 | 7,500 | 7,050 | |
| V. Lichtenstein | vice president | 9,600 | 9,630 | $ 6,303 | 5,977 | 7,500 |
| L. Lichtenstein | secretary | 9,600 | 9,630 | 6,303 | 5,977 | 7,050 |
| Total | 36,700 | 36,760 | 12,606 | 24,454 | 26,601 |
The petitioner reported no tax due on its excess profits tax return for the fiscal year ended September 30, 1941.
The petitioner reported a tax liability of $ 32,153.44 on its excess profits tax return for the fiscal year ended September 30, 1942. That amount was computed on an excess profits credit of $ 29,924.87 which was based on invested capital pursuant to section 714. The amount of the tax liability reported was paid in full in four installments of $ 8,038.36 each.
The petitioner filed its applications for relief under section 722 for each of the taxable years 1941 and 1942 on September 15, 1943. It was entitled to use the excess profits credit based on income, pursuant to section 713, but the amount thereof was zero. The petitioner claimed that its excess profits tax for the fiscal year ended September 30, 1942, was excessive and discriminatory for the reasons specified *100 in section 722 (b) (1), (2), (3), and (5), as more fully described in a statement attached to its applications. It claimed in each application that its actual income during a base period ended September 30, 1939, *318 had been depressed by unfair Japanese competition and that it was entitled to use a constructive average base period net income of $ 59,923.56. That amount was reconstructed on the basis of an estimated increase in the sales shown on its tax returns for the base period years 1936, 1937, and 1938 and the nine months ended September 30, 1939. The estimated increase in sales was computed on the basis of an estimated 10 per cent loss in sales prices plus an estimated 10 per cent loss in the volume of sales. All expenses were estimated to have increased an average of 10 per cent. The petitioner claimed net relief of a refund or credit of $ 41,759.70.
The respondent, in a notice of deficiency dated November 21, 1944, determined that the petitioner's correct excess profits tax liability for the taxable year ended September 30, 1942, was $ 37,356.95, which was computed on the basis of the excess profits credit used by the petitioner in its return. The respondent made an allowance against the amount of tax liability reported by the petitioner, due to the renegotiation of war contracts pursuant to section 3806 (b). That allowance left a net tax previously assessed of $ 21,561.06 and resulted*319 in a deficiency of $ 15,795.89.
The stipulation of facts is incorporated herein by this reference.
OPINION.
The petitioner in its application for relief under section 722 mentioned subparagraphs (1), (2), (3), and (5) of section 722 (b). It abandoned at the hearing any claim for relief under subparagraphs (1) and (3). The facts and arguments which it presents require a consideration only of subparagraph (2), since no "other factor" for relief under (5) has been urged.
Section 722 is entitled "General Relief -- Constructive Average Base Period Net Income." It states a general rule in paragraph (a). If a taxpayer establishes that the excess profits tax would otherwise result in an excessive and discriminatory tax and establishes also what would be a fair and just amount representing normal earnings to be used as a constructive average base period net income for the purpose of an excess profits tax based upon a comparison of normal earnings and earnings during an excess profits tax period, then the tax must be determined by the latter method. Section 722 (b) (2) is as follows:
(b) Taxpayers Using Average Earnings Method. -- The tax computed under this subchapter (without the benefit*320 of this section) shall be considered to be excessive and discriminatory in the case of a taxpayer entitled to use the excess *101 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.
The petitioner does not clearly differentiate between a claim that its own business was depressed in the base period and a claim that the industry of which it was a member was depressed. The conditions to which it points affected the whole industry, and not the petitioner alone, so that its contention perhaps should be that the excess profits tax, without the benefit of section 722, is excessive and discriminatory, since its average base period net income is an inadequate standard of normal earnings because the domestic fish net industry, of which it was a member, was depressed in the*321 base period by reason of temporary economic events unusual in the case of that industry, to wit, "a ruinous price war" with importers of Japanese fish nets during the base period years. However, at other times the petitioner seems to contend that its base period net income is an inadequate standard of normal earnings because its business was depressed in the base period as the result of temporary economic circumstances unusual in its case, to wit, "ruinous Japanese competition" in which fish nets were imported from Japan and sold at less than cost of similar domestic products. Both contentions will be discussed.
The record does not justify a finding that the domestic fish net industry was depressed in the base period. There is evidence to show the production in pounds of cotton fish nets by the industry during the years 1931 through 1935, for which the annual production was about 2,000,000 pounds. The president of the petitioner testified that the average annual domestic production of the same articles during the base years was approximately 2,500,000 pounds. No figures for other periods appear. This evidence tends to show that the industry was not depressed during the base *322 period, measured by pounds of production. The record does not contain figures from which the dollar values of the production for the base period or the earnings could be compared with those of any other period.
The evidence shows that the petitioner and other domestic manufacturers had to meet competition from cheap Japanese goods and the petitioner and others failed to make some sales which might have been made if there had been no such competition. There is evidence of the amount in pounds of the Japanese importations and there is evidence of the percentage of the total domestic business done by the petitioner. It argues that its business was depressed because it lost *102 its proportionate part of the domestic demand filled by Japanese netting during the base period. The petitioner made a reduction in its prices in the latter part of 1938. The evidence would indicate that these reductions were in line with those made by other domestic producers at or about that time. The petitioner also makes some contention based upon an abortive claim that the customs authorities did not carry out the provisions of the Tariff Act imposing a 90 per cent ad valorem duty on imported fish*323 netting but, instead, collected a duty of only 40 per cent.
It is not clear just how such an argument would aid the petitioner in any event. The petitioner has not shown that its low earnings or operating losses of the base period were due to Japanese competition. The volume of the petitioner's net sales and gross profits during the base period years was larger than for any prior period since 1930. Its net income or loss as adjusted for income tax purposes for the six years 1930 through 1935 shows a very large loss. The average amount paid during those years as officers' salaries was $ 16,230. Similar losses for the base period years were very much smaller despite the fact that the total salaries paid to the officers, who were likewise sole stockholders, were very much larger during the base period years than during the earlier period. Thus, these figures show that the petitioner was doing better in volume and financially in the base period years than in the prior years, despite increased salaries to its officer-stockholders. The only period during which the petitioner made substantial profits was that from 1925 through 1929. A comparison of the operations of the petitioner*324 for that period with the base period would tend to show that the business was depressed during the base period, but the evidence does not show that the difference in results between the two periods was due to Japanese competition.
A reduction in prices does not necessarily lead to the conclusion that business was depressed. The evidence does not show the existence of a ruinous price war between the producers of domestic netting and importers of Japanese netting during the base period. There is no evidence that the petitioner or any other domestic producer engaged in such a war or sold any goods below cost during the base period. Failure to obtain additional sales is not synonymous with "depressed." The most that can be said for the petitioner on this record is that, if there had been no Japanese competition from 1932 through the base years, the petitioner and the domestic fish net industry generally would probably have been able to make some sales in addition to those which they actually made during all of those years in certain areas. Such evidence does not justify a conclusion that the business of the petitioner or the business of the industry of which it was a member was depressed*325 because of Japanese competition, within the meaning *103 of the word "depressed" as used in section 722 (b) (2), when it is considered in the light of the other evidence, which indicates that the business of the petitioner, as well as that of the industry as a whole, was larger in the base period years than it had been for a number of years preceding. This is fatal to the petitioner's case, because it was incumbent upon the petitioner to show either that its business was depressed in the base period or that the industry was depressed.
If there had been no such failure of proof, the next burden of the petitioner would be to show that the alleged price war or competition resulting from cheap fish nets imported from Japan was a temporary economic event unusual in the case of this taxpayer or in the case of the industry as a whole. The evidence does not show that the competition through fish nets imported from Japan was temporary or unusual either in the case of the petitioner or in the case of the domestic fish industry. The competition had been going on for some time and the indications were at the end of the base period that it might be expected to continue indefinitely. The*326 evidence does not show that there was any material change taking place or expected in the prices at which the Japanese goods were being sold or in the rate of duty to which they were subjected. The evidence was that the quality of the Japanese imports had been steadily improving until towards the close of the base period, at which time it was difficult to distinguish the domestic article from the imported one. Thus, as stated above, the indications were that the competition, which had been going on for a number of years and which had become well established, might be expected to continue indefinitely. The petitioner has failed in this aspect of the case also.
The Commissioner argues convincingly that there are other defects in the petitioner's proof, such as, for example, failure to show what would be a fair and just amount representing normal earnings to be used as a constructive average base period net income. It is not necessary to consider other phases of his argument. The petitioner has not shown that it is entitled to any relief under section 722 (b) (2) or (5) because of any circumstances connected with competition resulting from the importation of Japanese netting during*327 the base period years.
Reviewed by the Special Division.
Decision will be entered for the respondent.