*2 Decision will be entered for the respondent.
Petitioner, an Indiana corporation, seeks relief from excess profits taxes under section 722 (b) (1), (b) (4), and (b) ( 5) of the Internal Revenue Code of 1939, as amended. Held, petitioner failed to establish facts which would support a constructive average base period net income yielding an excess profits credit greater than that available without the application of section 722.
*623 Petitioner filed applications for relief from excess profits taxes under section 722 of the Internal Revenue Code of 1939, as follows:
| Amount claimed | |
| Year | as refund |
| 1941 | $ 13,082.18 |
| 1942 | 43,545.49 |
| 1943 | 12,450.44 |
*624 Upon disallowance of these applications*3 petitioner filed a petition with this Court, seeking relief under the provisions of section 722 (b) (1), (b) (4), and (b) (5) of the Code. 1
The issue is whether respondent correctly denied petitioner's applications for relief.
FINDINGS OF FACT.
Some of the facts are stipulated and are included herein by this reference.
Petitioner, a gray iron foundry, was incorporated under its present charter in the State of Indiana on January 13, 1922. Prior to 1922 the business had been carried on for many years as a partnership. Its principal office and place of business is Marion, Indiana.
At all times material hereto petitioner kept its books and filed its income and excess profits tax returns on an accrual basis, using the calendar year accounting period. It filed excess profits tax returns for the taxable calendar years 1940, 1941, 1942, and 1943 with the collector of internal revenue for the district*4 of Indiana, at Indianapolis, Indiana.
Petitioner's excess profits net income for each of the years 1940 through 1943 was as follows:
| Under | ||
| Under | invested | |
| income credit | capital | |
| Year | method | method |
| 1940 | $ 12,216.97 | $ 12,216.97 |
| 1941 | 56,158.43 | 59,299.87 |
| 1942 | 67,331.48 | 70,472.91 |
| 1943 | 30,171.57 | 33,313.00 |
For each of the years 1940 through 1943 petitioner's excess profits credit, computed under the invested capital method, and its excess profits tax liability as finally determined by respondent without the application of section 722, was as follows:
| Credit | ||
| computed under | Excess | |
| invested | profits | |
| Year | capital method | liability |
| 1940 | $ 10,744.69 | |
| 1941 | 14,222.22 | $ 15,031.06 |
| 1942 | 14,322.22 | 41,218.09 |
| 1943 | 14,322.22 | 12,591.70 |
In 1925 petitioner purchased the net assets of the Marion Gray Iron Foundry Company, an Indiana corporation, which for many years prior to 1925 had been owned and managed largely by the same stockholders, directors, and officers who owned and managed the petitioner. From 1925 until 1930 both the plant acquired as a result of the merger (hereinafter referred to as plant No. 1) and petitioner's *625 original plant (hereinafter*5 referred to as plant No. 2) were operated separately under petitioner's ownership. Plant No. 1 was closed in 1930 due to reduced demand for petitioner's products resulting from the general business depression. It resumed operation in 1936.
Plant No. 1 had molding equipment and core oven equipment, but the molds were rammed on the floor with no mechanization in the plant. Its annual productive capacity was 8,000 tons. Plant No. 2 was fully mechanized with conveyor equipment and sand-handling facilities. It had productive facilities that could be worked 24 hours a day with an annual productive capacity of 16,000 tons.
Prior to 1936 petitioner never had any real labor trouble. During 1936 and 1937 it experienced labor problems resulting in a strike on July 27, 1937, which shut down both plants for a period of 2 weeks. After the strike petitioner reopened only plant No. 1. Plant No. 2 was never reopened and was disposed of in 1943.
During the years 1935, 1936, and 1937 approximately two-thirds of petitioner's net sales were made to two customers: Olds Motor Company and Schwitzer-Cummins Company. It manufactured manifolds for Olds and stoker parts for Schwitzer-Cummins. By the*6 latter part of 1937, or early 1938, petitioner's sales to these two principal customers declined sharply. Since that time petitioner has received only token orders from the Olds Motor Company.
Prior to 1938 petitioner had supplied approximately 80 per cent of Schwitzer-Cummins Company's total casting requirements. Since 1937 petitioner has continued to supply approximately 25 per cent of Schwitzer-Cummins' casting requirements.
Following the strike petitioner hired salesmen and sought additional business. During the years 1938 and 1939 it effected a substantial increase in its volume of sales to customers other than Olds and Schwitzer-Cummins, as illustrated by the following schedule:
| Customer 1 | 1936 | 1937 | 1938 | 1939 |
| G. W. Davis | $ 6,964.01 | |||
| Case Crane | 10,288.96 | $ 16,376.75 | $ 5,703.83 | |
| General Implement | 17,285.64 | 21,282.90 | ||
| Ertel Mach | 12,972.35 | 14,136.60 | $ 17,291.71 | 18,770.47 |
| Warner Mach | 17,061.02 | 27,580.46 | 42,005.02 | 53,925.97 |
| American Lawnmower | 18,692.41 | |||
| Great States | 5,010.62 | |||
| Kingston Prds | 14,935.76 | |||
| Link Belt | 6,183.06 | |||
| Wayne Pump | 5,809.88 | 11,656.79 | ||
| Electric Auto | 6,239.09 | |||
| Thompson | 10,129.14 | 14,083.42 | 22,357.33 | |
| Altorfer Bros | 27,575.68 | 70,267.78 | 107,845.63 | |
| Delco Remy | 38,830.70 | 5,419.02 | ||
| U. S. Machine | 18,981.58 | 43,884.92 | ||
| Chefford | 12,713.84 | |||
| McQuay Norris | 6,209.98 | |||
| Schwitzer-Cummins | 150,126.54 | 166,800.25 | 49,693.55 | 61,511.16 |
| Olds Motor | 102,897.02 | 79,314.47 | 17,165.49 | 25,730.37 |
| Total | 362,417.39 | 414,075.92 | 246,564.36 | 358,653.50 |
*626 For many years prior to 1932 the chief stockholders in petitioner were members of the Gartland family and the Schaumleffel family. In 1932 the Schaumleffel family sold their stock interest in petitioner to the Gartlands. Through neglect some of this stock was not transferred until 1937.
During the 1920's Francis X. Gartland, Sr., was petitioner's general manager. He continued in that capacity through 1939.
The net sales of the Schwitzer-Cummins Company for each of the fiscal years 1936 through 1939 were as follows:
| Year | Net sales |
| 1936 | $ 2,349,671 |
| 1937 | 3,616,229 |
| 1938 | 4,100,083 |
| 1939 | 3,088,600 |
The schedule below shows the factory sales of passenger cars by General Motors Corporation during the base period years:
| Passenger | |
| Year | cars |
| 1936 | 1,548,000 |
| 1937 | 1,582,000 |
| 1938 | 887,000 |
| 1939 | 1,243,000 |
The following schedule shows petitioner's sales and net profits for each of the years 1913 to 1939, inclusive, and the sales and net profits of the Marion Gray Iron Foundry Company for each of the years 1913 to 1925, inclusive:
| Net profit | |||
| Year | |||
| Atlas | Marion | Total | |
| 1913 | $ 8,859.50 | $ 50,794.07 | $ 59,653.57 |
| 1914 | 10,532.47 | 51,195.97 | 61,728.44 |
| 1915 | 25,871.90 | 78,868.66 | 104,740.56 |
| 1916 | 48,266.30 | 85,415.59 | 133,681.89 |
| 1917 | 32,544.11 | 41,166.97 | 73,711.08 |
| 1918 | 17,331.81 | 67,758.46 | 85,090.27 |
| 1919 | 38,245.19 | 44,776.35 | 83,021.54 |
| 1920 | 93,883.99 | 49,108.75 | 142,992.74 |
| 1921 | (28,407.10) | (40,969.55) | (69,376.65) |
| 1922 | 13,590.88 | 14,159.71 | 27,750.59 |
| 1923 | 2,736.08 | (6,082.64) | (3,346.56) |
| 1924 | (3,524.32) | (13,189.81) | (16,714.13) |
| 1925 | (14,640.17) | (8,296.33) | (22,936.50) |
| 1926 | (18,929.92) | (18,929.92) | |
| 1927 | 9,824.99 | 9,824.99 | |
| 1928 | 43,383.11 | 43,383.11 | |
| 1929 | 10,865.77 | 10,865.77 | |
| 1930 | (4,158.17) | (4,158.17) | |
| 1931 | (22,206.96) | (22,206.96) | |
| 1932 | (37,308.95) | (37,308.95) | |
| 1933 | (27,344.92) | (27,344.92) | |
| 1934 | (15,569.17) | (15,569.17) | |
| 1935 | (1,938.79) | (1,938.79) | |
| 1936 | (1,447.95) | (1,447.95) | |
| 1937 | (1,072.64) | (1,072.64) | |
| 1938 | (11,657.34) | (11,657.34) | |
| 1939 | 2,714.61 | 2,714.61 | |
| Average 1922-1939 | (5,005.16) | ||
| Base period average | (2,865.83) |
| Sales | |||
| Year | Atlas | Marion | Total |
| 1913 | $ 95,167.90 | $ 207,875.93 | $ 303,043.83 |
| 1914 | 91,226.22 | 208,359.82 | 299,586.04 |
| 1915 | 162,578.43 | 283,675.37 | 446,253.80 |
| 1916 | 177,013.61 | 261,460.30 | 438,473.91 |
| 1917 | 178,658.74 | 221,798.46 | 400,457.20 |
| 1918 | 224,767.07 | 286,222.24 | 510,989.31 |
| 1919 | 240,234.65 | 282,526.96 | 522,761.61 |
| 1920 | 322,359.30 | 342,659.71 | 665,019.01 |
| 1921 | 49,293.24 | 58,191.22 | 107,484.46 |
| 1922 | 76,110.68 | 87,736.52 | 163,847.20 |
| 1923 | 149,944.73 | 130,406.63 | 280,351.36 |
| 1924 | 77,593.57 | 52,187.88 | 129,781.45 |
| 1925 | 114,097.35 | 21.30 | 114,118.65 |
| 1926 | 185,758.86 | 185,758.86 | |
| 1927 | 284,322.55 | 284,322.55 | |
| 1928 | 595,368.99 | 595,368.99 | |
| 1929 | 618,221.78 | 618,221.78 | |
| 1930 | 357,582.51 | 357,582.51 | |
| 1931 | 259,062.80 | 259,062.80 | |
| 1932 | 117,778.77 | 117,778.77 | |
| 1933 | 146,713.72 | 146,713.72 | |
| 1934 | 264,825.77 | 264,825.77 | |
| 1935 | 382,880.49 | 382,880.49 | |
| 1936 | 414,776.80 | 414,776.80 | |
| 1937 | 437,201.52 | 437,201.52 | |
| 1938 | 248,105.68 | 248,105.68 | |
| 1939 | 375,824.46 | 375,824.46 | |
| Average 1922-1939 | |||
| Base period average |
*627 The following index reflects the sales experience of 1,135 gray iron foundries during the years 1936 through 1939:
| Index | |
| Year | (1939 = 100) |
| 1936 | 91.7 |
| 1937 | 117.4 |
| 1938 | 73.4 |
| 1939 | 100.0 |
*9 The strike of July 1937 was an unusual and peculiar event in petitioner's experience.
The removal of a substantial portion of the Olds and Schwitzer-Cummins business from petitioner's plants was a consequence of the strike.
Petitioner has not shown 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.
OPINION.
Petitioner brings claims for relief under section 722 (b) (1), (b) (4), and (b) ( 5) of the Internal Revenue Code of 1939, as amended. 2
*10 We find it unnecessary in this case to decide whether or not there are present qualifying factors under section 722 (b) (1), (4), or (5), and the petitioner does not claim relief under section 722 (b) (2). *628 No decision on these points need be made because petitioner has not established a constructive average base period net income which would entitle it to relief greater than that already available to it. Thus, although petitioner had shown that it qualifies under section 722, we would nonetheless be unable to grant relief. The establishment of eligibility for relief is only one factor which must be considered. Powell-Hackney Grocery Co., 17 T. C. 1484 (1952). Section 722 (a) requires the petitioner also to establish a fair and just amount representing normal earnings to be used as a constructive 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. Moreover, since the comparison is made through the use or application of the excess profits credit computed on the basis of the constructive average base period net income, the petitioner must*11 prove or establish a constructive average base period net income sufficient to produce an excess profits credit greater than that already computed without the benefit of section 722. R. W. Eldridge Co., 19 T. C. 792 (1953). This, petitioner has failed to do.
Following the 1937 strike, petitioner intensified its selling activities and substantially increased its sales to customers other than Olds and Schwitzer-Cummins.
For the purpose of constructing an average base period net income, petitioner computed the percentage of increase in sales to customers other than Olds and Schwitzer-Cummins for each of the years 1936, 1937, 1938, and 1939. Sales to Olds and Schwitzer-Cummins were then reconstructed for each of the base period years by increasing sales to these two customers proportionately to the increase in sales to other customers. Actual sales to other customers and constructed sales to Olds and Schwitzer-Cummins were added together to arrive at total constructed sales. Constructed profits for each of the years were computed by multiplying constructed sales by a profit ratio of 11.62 per cent. The growth formula provided in section 713 (f) was *12 applied and a total constructed average base period net income of $ 100,619.22 determined.
There are several fundamental errors in this reconstruction, and it is entirely out of line with the facts set forth in our findings. Petitioner may not, on one hand, rely on the loss of business from Olds and Schwitzer-Cummins as a basis for relief under section 722 and, on the other, reconstruct earnings to include (1) profits from sales to Olds and Schwitzer-Cummins, as if sales to these two customers had never declined, and (2) increased sales to other customers resulting at least in part from an effort to replace the lost Olds and Schwitzer-Cummins business. Cf. Southern California Edison Co., 19 T. C. 935 (1953). Furthermore, there is no evidence that, all factors being normal, petitioner's sales to Olds and *629 Schwitzer-Cummins would have increased at the same rate as sales to other customers.
The profit ratio of 11.62 per cent used by petitioner in its reconstruction was computed from sales and profits for the years 1913 through 1929. This period includes the abnormally high profits of World War I and excludes the loss years 1930 through 1938. *13 In the period 1922 through 1939 petitioner realized profits in only 5 years -- 1922, 1927, 1928, 1929, and 1939. All others were loss years. Its average loss during this time was in excess of $ 5,000; its average loss during the base period was $ 2,865; and its average loss in the 6 years preceding the base period was more than $ 18,000. In view of such a persistent loss history, it is impossible to justify a profit ratio of 11.62 per cent, or a constructive average base period net income of $ 100,619.22. Although any computation under section 722 must be based on assumptions, such assumptions must comport with reason when associated with known facts. D. L. Auld Co., 17 T. C. 1199 (1952).
After reconstructing earnings under section 722, petitioner applied the growth formula provided in section 713 (f). It is well established that a taxpayer cannot secure relief under both section 713 and section 722. Central Bag Co., 27 T. C. 230 (1956), citing Homer Laughlin China Co., 7 T. C. 1325 (1946), and Stimson Mill Co., 7 T. C. 1065 (1946), affd. 163 F. 2d 269*14 (C. A. 9, 1947), certiorari denied 332 U.S. 824">332 U.S. 824 (1947), rehearing denied 332 U.S. 839">332 U.S. 839 (1947).
Petitioner received credits against excess profits taxes computed under the invested capital method of $ 14,222.22 for 1941 and $ 14,322.22 for 1942 and 1943. Considering the record as a whole, and particularly petitioner's persistent history of losses, it is impossible for us to arrive at a constructive average base period net income which would yield a credit greater than that already available to petitioner without the application of section 722. This would be true, even were we to conclude that petitioner qualified under section 722 (b) (4) and that the push-back rule applies. We must, therefore, sustain respondent's disallowance of petitioner's claims.
Reviewed by the Special Division.
Decision will be entered for the respondent.
Footnotes
1. Unless otherwise indicated, all references to Code section numbers are to the Internal Revenue Code of 1939, as amended.↩
1. Includes all customers to whom petitioner sold more than $ 5,000 in merchandise during any base period year.↩
2. 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,
* * * *
(4) the taxpayer, either during or immediately prior to the base period, commenced business or changed the character of the business and the average base period net income does not reflect the normal operation for the entire base period of the business. If the business of the taxpayer did not reach, by the end of the base period, the earning level which it would have reached if the taxpayer had commenced business or made the change in the character of the business two years before it did so, it shall be deemed to have commenced the business or made the change at such earlier time. For the purposes of this subparagraph, the term "change in the character of the business" includes a change in the operation or management of the business, a difference in the products or services furnished, a difference in the capacity for production or operation, a difference in the ratio of nonborrowed capital to total capital, and the acquisition before January 1, 1940, of all or part of the assets of a competitor, with the result that the competition of such competitor was eliminated or diminished. * * *
(5) of any other factor affecting the taxpayer's business which may reasonably be considered as resulting in an inadequate standard of normal earnings during the base period and the application of this section to the taxpayer would not be inconsistent with the principles underlying the provisions of this subsection, and with the conditions and limitations enumerated therein.↩