*106 Decision will be entered for the respondent.
Installation of mechanical equipment in petitioner's plant during a base period year held, on the facts, not shown to have interrupted or diminished "normal production, output, or operation" so as to entitle petitioner to relief under section 442 (a) (1), I. R. C. 1939.
*953 Respondent determined deficiencies in petitioner's income tax for the fiscal year ended September 30, 1950, of $ 4,005.78, and for the year ended September 30, 1951, of $ 8,836.70. *107 Petitioner, having conceded all other adjustments, raises as the sole issue whether it is entitled to determine its excess profits net income by using the credit computation providing relief to the taxpayer whose base period includes a year meriting special consideration for abnormalities. Specifically, petitioner contends that the mechanization of parts of its plant operations during the fiscal year ended September 30, 1947, was an unusual event diminishing its output as contemplated by section 442 (a) (1), Internal Revenue Code of 1939.
FINDINGS OF FACT.
Certain facts were contained in a stipulation and accompany exhibits, and are hereby found.
Petitioner, an Ohio corporation, is engaged in a foundry business which has been operating for 50 or 60 years. It keeps its books and files its tax returns on an accrual basis for the fiscal years ending September 30. It filed its income and excess profits tax returns for the fiscal years ended September 30, 1950, and September 30, 1951, with the collector of internal revenue for the eighteenth district of Ohio.
Petitioner was incorporated in 1934 and was in the same general type of business before October 1, 1945, and continuously through*108 September 30, 1951. It operated a gray iron foundry, manufacturing many types of iron castings used in a variety of industries. Almost all production during the years involved consisted of castings specially made to fill specific orders. Petitioner's foundry contained five departments: (1) A pattern receiving and storage department where patterns for molds were received from customers and stored for future use; (2) a molding department where patterns were placed in metal flasks and the mold made from sand from the sand storage area; (3) a *954 core-making department where the internal cavities in molds were formed; (4) a charging department where cupola furnaces were charged with metallic raw materials and the molten iron prepared for pouring into the mold; and (5) a cleaning and chipping department where the molded castings were shaken out of the molds and cleaned of sand, roughness, and foreign objects.
Prior to 1946 the foundry operations were primarily manual, dependent on large amounts of common labor. Operations had been conducted in that same manner for many years.
Starting in September 1946, petitioner commenced a modernization program designed to mechanize its operations. *109 It began to install new equipment, including overhead and sand storage bins, sand-mixing tanks, overhead conveyors, new track, "sand-slingers," and machinery for shaking castings from the molds. The mechanization required excavation of a large tunnel across the heart of the foundry, another tunnel perpendicular to the first, and other smaller excavations. Petitioner never before undertook so great an operational change.
Quicksand and water conditions delayed completion of the underground work. Petitioner's regular cranes aided in the construction work. The concrete could have been poured in 16 days if it had been done continuously. The actual construction period covered 9 months. Certain larger equipment could not be installed without shutting down the plant, and petitioner used the annual vacation shutdown for that purpose.
The construction was accomplished in a piecemeal fashion to avoid shutting down the foundry except for the vacation period. The construction of the tunnel and other construction work handicapped some foundry operations. Petitioner lost no orders due to the change in methods and some new customers were obtained during that year.
Petitioner's production*110 and sales, in net tons, were as follows:
| Fiscal year ended | ||
| September 30 | Production | Sales |
| 1945 | 6,913 | 6,967 |
| 1946 | 7,496 | 7,477 |
| 1947 | 6,918 | 6,906 |
| 1948 | 6,794 | 6,863 |
| 1949 | 4,432 | 4,487 |
| 1950 | 4,205 | 4,089 |
| 1951 | 6,240 | 6,273 |
During the fiscal years 1945 through 1947 petitioner usually operated 6 days each week. During the fiscal years 1946 and 1947 it had constant backlogs of at least 2,000 tons. The foundry had an annual capacity of 8,000 tons.
Petitioner grossed $ 5.96 less per ton in the fiscal year 1947 than the average gross profit per ton for the fiscal years 1945 and 1946. Its selling price increased $ 51.92 in the fiscal year 1947, but its average cost increased $ 57.88 per ton.
*955 Petitioner's direct labor costs increased $ 9.31 per ton sold during the fiscal year 1947, while its indirect labor costs increased $ 10.46 as compared to the average ton sold during the fiscal years 1945 and 1946. Its direct labor hours per ton produced increased in 1947 by 2.11 hours, while its indirect labor hours increased by 4.54 hours. In the fiscal year 1948 the direct and indirect labor hours decreased from those in 1947 by 3.22 hours and 4.21 hours, respectively.
Direct*111 labor hours decreased in the fiscal year 1947 by 13,316, but indirect labor increased by 19,428 hours. Prior experience for petitioner's foundry set the ratio of direct to indirect labor hours at 5 to 3. Indirect labor hours during the fiscal year 1947 exceeded the number of hours predictable from the experience ratio by 27,418 hours, based on the actual number of direct hours. Direct labor hours during the fiscal year 1947 were 45,696 hours less than the hours predictable from the experience ratio, based on the actual number of indirect hours.
Petitioner expended the following amounts for equipment and machinery:
| Fiscal year ended | |
| September 30 | Amount |
| 1945 | $ 35,659.26 |
| 1946 | 67,342.76 |
| 1947 | 200,972.63 |
| 1948 | 63,991.65 |
| 1949 | $ 24,942.41 |
| 1950 | 66,755.79 |
| 1951 | 98,634.76 |
Other physical changes were made as late as the fiscal year 1953.
Petitioner changed its operational methods pursuant to a managerial decision that such change was necessary to retain its favorable competitive position. Mechanization resulted in lower unit costs.
Petitioner's normal operations were not interrupted or diminished because of the occurrence in the fiscal year ended September 30, 1947, of an*112 event unusual and peculiar in its experience.
OPINION.
Petitioner makes no claim that its base period income failed to reflect the normal operation of its business because of a change in the character of the business. It could not do this in any case because in order to avoid "subjective judgments" subsection (b) (4) of the predecessor section 722 was purposely and specifically removed from the relief afforded by the 1950 amendments:
The provision of relief in cases involving changes in management or operation has been eliminated for several reasons. Such changes do not of themselves prove that the character of the business has altered. A determination of that nature proved extremely difficult under the prior law and involved the very type of subjective judgments which your committee is convinced should be avoided in *956 the new law. * * * [H. Rept. No. 3142, 81st Cong., 2d Sess. (1950); 1951-1 C. B. 200.]
It is petitioner's contention that its situation falls within the provisions 1 of section 442 (a) (1), Internal Revenue Code of 1939, in that, during 1947, one of its base period years, "normal production, output, or operation was interrupted*113 or diminished because of the occurrence * * * during such taxable year, of events unusual and peculiar in the experience of such taxpayer." Petitioner's installation of laborsaving machinery and the consequent disruption of its physical plant is the specific event relied upon.
The parties appear to be in agreement that section 722 (b) (1), and hence the present section which is its counterpart, 2 was intended to refer to physical as opposed to economic events which are governed by subsection (b) (2). See, *114 e. g., Southern California Edison Co., 19 T. C. 935; Matheson Co., 16 T.C. 478">16 T. C. 478. We may likewise assume for purposes of this discussion, although respondent is in vigorous disagreement, that a physical act such as the installation of new machinery, which is the consequence of a decision of management rather than of an external force, is nevertheless included in the events covered by subsection (1).
The difficulty is that both in its earlier form and under the present language "normal production" must be "interrupted or diminished" for the statute to authorize relief. These words refer not to profits but *115 to physical operations. That is, when the statute speaks of "production, output, or operation," it is using terms which are meant to apply to the physical output of the enterprise rather than its managerial or economic operations. As the committee report shows, the concept of changes in "management or operation" as distinguished from physical output was done away with by the elimination of subsection (b) (4). Use of the term "operation" in conjunction with "production" and "output" was presumably intended to include such enterprises as retail business where there is no actual production or output in the usual sense. This construction is fortified by the juxtaposition of the words "interrupted or diminished" which would not seem to be appropriate to describe, for example, merely an increase in *957 costs or a decrease in net profits. "It is to be noted that section 722 (b) (1) is concerned with an unusual event interrupting or diminishing production, output, or operation. The language of the statute does not refer to an event which only affects the profit-making ability of the corporation without affecting production." D. L. Auld Co., 17 T. C. 1199, 1205.*116
For all that the record shows, what petitioner produced in the critical year 1947 was normal for it. If we take the fiscal years 1945, 1946, 1948, and 1949, constituting 2 years on each side of the one in question, 3 we find that the average production in tons (the only unit of production available to us) was about 6,410, whereas the production during 1947 was over 6,900. There is no indication here that petitioner's 1947 production was less than normal. The same result follows if we compare the 1947 production with any other years shown by the record, except the fiscal year 1946. But on these figures there is much more reason to believe that that year was above normal than that all the other years were below. 4 And petitioner makes no claim that the production for any other year than 1947 was diminished by the physical events of the changeover.
*117 It is true petitioner submits detailed figures indicating that its profits were lower in 1947 than in other years. This appears to be the result of greater costs of production due to increased material prices and higher labor charges. Under 722 (b) (1) it was incumbent upon a claimant in addition to proof of qualification to show that its base period net income was an inadequate standard of normal earnings. Attempts have sometimes been made to show this by assertions of reduced income. See, e. g., Triangle Raincoat Co., 19 T. C. 548. Such evidence did not under section 722 (b) (1) and certainly does not under section 442 (a) (1) take the place of proof of the basic requisites.
It is not the decrease in profits which determines petitioner's primary eligibility under subsection (1); it is the diminution or interruption of its normal production, output, or operation. D. L. Auld Co., supra. This, as we have seen, has not been shown to have been interrupted or reduced below normal.
Without considering other possible defects in petitioner's qualification for relief, and limiting our discussion to section 442 (a) (1), which*118 is the only one under which the claim is made, we conclude that the deficiency was properly determined.
Decision will be entered for the respondent.
Footnotes
1. SEC. 442. AVERAGE BASE PERIOD NET INCOME -- ABNORMALITIES DURING BASE PERIOD.
(a) In General. -- If a taxpayer which commenced business on or before the first day of its base period establishes that, for any taxable year within, or beginning or ending within, its base period:
(1) normal production, output, or operation was interrupted or diminished because of the occurrence, either immediately prior to, or during such taxable year, of events unusual and peculiar in the experience of such taxpayer * * *↩
2. "Corresponding in scope generally to section 722 (b) (1) and (2) of the prior excess profits tax law, section 442 is a relief measure which provides a means for adjusting certain abnormalities in the taxpayer's net income for a base period year or years." (H. Rept. No. 3142, 81st Cong., 2d Sess. (1950); 1951-1 C. B. 198↩,224.)
3. Petitioner's business has been in existence some 50 years, but there are no figures earlier than 1945.↩
4. Even in comparison with that year, production during the changeover portion of 1947 was curtailed by only about 2 1/2 per cent.↩