1956 U.S. Tax Ct. LEXIS 236">*236 Decision will be entered under Rule 50.
1. Petitioner, during the base period years 1936 to 1939, inclusive, was the publisher of four national magazines, namely, Collier's, Woman's Home Companion, The American Magazine, and Country Home. In each of the base period years the publication of Country Home showed a substantial loss. At the end of 1939, its publication was discontinued and a substantial saving in expenses of petitioner annually was achieved thereby. Held, the discontinuance by petitioner of publication of Country Home and the savings in expenses annually achieved thereby was a change in the character of petitioner's business within the meaning of
2. Prior to the base period petitioner used the letterpress method of printing its magazines. During the base period petitioner changed to a substantial degree to the gravure method of printing and this change resulted in substantial savings in printing costs of its magazines. Held, this change was a change in the character of petitioner's business within the meaning of
3. Reconstruction due to the two foregoing
4. In addition to relief under
5. Petitioner claims relief under
25 T.C. 1268">*1269 OPINION.
The deficiency notice mailed to petitioner on February 1, 1952, among other things, stated as follows:
You are advised that the determination of your income tax liability for the taxable year ended December 31, 1942, discloses an overassessment of $ 447.86; that the determination of your income tax liability for the taxable years ended December 31, 1943 and 1944, discloses a deficiency of $ 33,759.96; that the determination of your declared value excess profits tax liability for the taxable year ended December 31, 1943, discloses a deficiency of $ 576.82; that the determination of your declared value excess profits tax liability for the taxable year ended December 31, 1944, discloses an overassessment of $ 3,798.99; and that the determination of your excess profits tax liability for the taxable years ended December 31, 1943, 1944 and 1945, discloses a deficiency of $ 1,866,250.35, as shown in the statement attached.
After careful consideration of your applications for relief under
Because of the deferment under
The relief now claimed by petitioner in its petition is for "overassessments and/or refunds" as follows:
| Calendar year ended | Overassessment of |
| December 31 | excess profits tax |
| 1943 | $ 1,699,248.64 |
| 1944 | 609,527.74 |
| 1945 | 432,169.68 |
25 T.C. 1268">*1270 The assignments of error in the petition are numerous and need not be set out here in detail. These assignments of error raise the following issues:
1. Whether or not petitioner is entitled to relief under
2. Whether or not petitioner is entitled to relief under
3. The determination of petitioner's constructive average base period net income resulting from both or either of the qualifying factors set forth in 1 and 2 above.
4. Whether or not petitioner is entitled under
5. Whether or not petitioner is entitled under
Thus it will be seen that the only questions litigated in this proceeding involve petitioner's claim for relief and refunds under
Petitioner, for years the publisher of national magazines including Collier's, Woman's Home Companion, The American Magazine, and Country Home, has two primary contentions in support of its claim for relief under
Extended findings of fact have been made and are filed as a part of the official record of the case. Such part of these findings of fact as is deemed necessary will be stated as we rule upon the several issues which have been presented to us for our decision.
Discontinuance1956 U.S. Tax Ct. LEXIS 236">*243 of Country Home Magazine.
The parties are in no serious dispute that the discontinuance during the base period of Country Home suffices to meet the initial "qualifying factor" requirement of
| Year | Amount |
| 1936 | $ 165,000 |
| 1937 | 364,000 |
| 1938 | 749,000 |
| 1939 | 685,000 |
| $ 1,963,000 | |
| Annual average | $ 490,750 |
Petitioner's publication of various magazines in reality was the operation of one business, and the elimination of one of the magazines would not effect a cost saving of all the charges allocated to it on petitioner's books. Some such charges would not be reduced at all and others would be only partially reduced. Both parties are in agreement as to this but dispute the amount of expenses which should1956 U.S. Tax Ct. LEXIS 236">*244 be eliminated in arriving at the losses to be used for adjustment. Petitioner would fix these continuing costs for 1939, for example, at approximately $ 32,000, while respondent contends that at least $ 334,000 of Country Home costs continued for that year.
Considering all of the evidence submitted on the issue, none of which satisfies us as justifying any mathematically certain result, we have arrived at an appropriate adjustment for the continuing costs which is reflected in the CABPNI set forth in our ultimate findings of fact. Undoubtedly such continuing costs as remained would not be eliminated by discontinuing the publication of Country Home in 1939. We have endeavored to give full effect to this fact in our reconstruction.
25 T.C. 1268">*1272 Gravure Printing.
There is a fundamental difference between petitioner's letterpress and its high-speed multicolor gravure printing, which relates to both the process and the equipment. This fact, we think, was clearly established by evidence at the hearing. Gravure printing is a form of intaglio printing and entails the transfer of ink from recesses or depressions in the printing plate or cylinder to the paper as distinguished from the1956 U.S. Tax Ct. LEXIS 236">*245 use of a letterpress plate where the ink is carried on a raised design. Gravure preparation is more elaborate and detailed than that for letterpress and calls for workers who are more highly skilled and who require longer training. Gravure preparatory workers are difficult to find and petitioner had to institute an elaborate training program to supply them. Such training takes a number of years to complete. We have found as a fact that a printing plant which changes from exclusive letterpress to substantial amounts of gravure printing undergoes a basic fundamental and substantial change. Petitioner first purchased high-speed gravure presses in 1934, and put them into operation with the February 1936 issue of Woman's Home Companion. Petitioner, in November 1937, projected a change and replacement schedule in its printing presses which would have made it, when completed, primarily a high-speed gravure plant. By the end of the base period it actually had obtained 6 presses capable of high-speed gravure work. The schedule called for the eventual acquisition of 17 high-speed gravure presses. In addition to the 6 such presses installed in the base period petitioner also installed1956 U.S. Tax Ct. LEXIS 236">*246 2 other presses before the end of 1941. In round figures, during the base period, petitioner's letterpress and high-speed multicolor gravure presses printed the following number of Collier-size pages of combined 1- and 2- and 3- and 4-color:
| Year | Letterpress | Gravure |
| 1936 | 17,500,000,000 | 800,000,000 |
| 1937 | 17,800,000,000 | 2,000,000,000 |
| 1938 | 15,700,000,000 | 2,000,000,000 |
| 1939 | 14,700,000,000 | 4,000,000,000 |
It can be seen by this that by the end of the base period petitioner had not become primarily a gravure plant for its 1- and 2- and 3- and 4-color printing; but it had greatly increased its use of multicolor gravure. Although monotone gravure printing had been used by petitioner from an early date in the 1920's, it was not until the base period that a substantial shift from letterpress to high-speed multicolor gravure took place. We believe that this was not a routine change, "a mere improvement of older equipment or ordinary technological improvements developed to perform the same functions in the same manner," but was a "substantially different process of manufacturing" 25 T.C. 1268">*1273 and the introduction of substantially different equipment within the intent of
As we have many times said, a taxpayer seeking relief under 722 (b) (4), in addition to showing the substantial change, must also show that there was a higher level of earnings directly attributable to the change.
1956 U.S. Tax Ct. LEXIS 236">*248 As a direct result of the change petitioner's normal earnings were increased over what they would have been had the change not been made. It is immaterial that due to other causes petitioner's over-all earnings decreased after the change was made. The pertinent factor is that petitioner's base period earnings would have been considerably smaller than they were had the * * * [change not been made].
As will subsequently appear, such is the case here.
Respondent contends that petitioner's decision to use multicolor high-speed gravure printing seriously affected its competitive position in the national advertising field, and that this and various other relatively permanent factors, of both internal and external origin, established petitioner as having a relatively permanent decline in its normal earnings during the base period years within the meaning of E. P. C. 42 (
Upon a careful consideration of the record, we are convinced that by the end of the base period petitioner's business was not in a state of relatively permanent decline. Although there can be no doubt from the evidence adduced that to some extent some advertisers did not like to use magazines printed in gravure and that some purchasers of magazines felt that those printed in gravure were of inferior quality, and that radio and other types of magazines were taking advertising dollars, we do not believe that these factors showed that there was a permanent decline in petitioner's business by the end of the base period.
First, except for Woman's Home Companion, petitioner's magazines at the end of 1939 were showing a decided upward trend in revenue over that received in 1938. And the evidence convinces us that such decreases as did occur in 1938 were not due to petitioner's use of high-speed gravure printing. We know, for example, that Woman's Home Companion had a stable share of the market even though substantial gravure printing appeared 1956 U.S. Tax Ct. LEXIS 236">*251 in it in 1937, and no gravure printing appeared in it in 1938. We also know that The Saturday Evening Post, which was printed in letterpress, lost a greater share of the market than petitioner's comparable Collier's which was using gravure. The demise of Country Life in 1939 cannot be attributed to its use of gravure. Other causes than the use of gravure brought about the demise of Country Life. There would have to be a more marked showing that use of gravure caused petitioner to lose business than is the case here for us to conclude that its use caused petitioner to be in a state of relatively permanent decline.
As further evidence of the absence of any relatively permanent decline insofar as petitioner is concerned, Collier's main competitor, The Saturday Evening Post, lost 2 cents per page advertising revenue from 1936 to 1939, while Collier's stayed stable. The Ladies' Home Journal lost 7 cents per page over that period while petitioner's comparable Woman's Home Companion lost 5 cents per page; Cosmopolitan, 25 T.C. 1268">*1275 the chief competitor of petitioner's The American Magazine, lost 2 cents per page during the same period while The American Magazine stayed stable.
Respondent1956 U.S. Tax Ct. LEXIS 236">*252 contends that petitioner was obliged to expend large sums to build up its circulation in the last 2 years of the base period. We do not view this as any evidence of petitioner's decline, particularly when it appears that similar increases in expenditures were made just prior to and early in the base period and petitioner had its 2 best income years thereafter.
Perhaps more basically, a substantial difficulty with respondent's position is that we are dealing with the reconstruction of this petitioner's normal earnings for the base period, and the record establishes to our satisfaction that there was no permanent decline in petitioner's business during the base period. Under the present circumstances, we are not able to accept or to follow respondent's theory that because more dollars were being spent for advertising, for example for radio advertising, petitioner was in a state of relatively permanent decline because it did not obtain these dollars. See
And there is more to show that respondent is in error in contending that by the end of the base period petitioner was in a state of permanent decline, if it need be said.
The following table shows that petitioner's advertising revenue, circulation revenue, and combined average net paid circulation per issue increased as follows:
| Combined | |||
| average net | |||
| Year | Advertising | Circulation | paid |
| revenue | revenue | circulation per | |
| issue | |||
| 1936 | $ 19,057,000 | $ 10,346,000 | 7,310,226 |
| 1937 | 21,202,000 | 10,627,000 | 7,657,683 |
| 1938 | 18,465,000 | 10,655,000 | 7,809,970 |
| 1939 | 19,180,000 | 10,802,000 | 7,953,380 |
Its excess profits net income, before any statutory adjustments, was as follows:
| Year | Amount |
| 1936 | $ 3,481,602.49 |
| 1937 | 3,414,004.90 |
| 1938 | 1,853,404.05 |
| 1939 | 2,100,344.14 |
25 T.C. 1268">*1276 Moreover, viewed from the long-range history of petitioner's earnings, the fluctuations are not such as to convince us that petitioner was in relatively permanent decline. The year 1938 was1956 U.S. Tax Ct. LEXIS 236">*254 generally a bad year for all business and particularly so for the magazine industry. Petitioner's income for 1939 greatly exceeded the annual average of its income from 1922-1939 and was considerably larger than many of its years prior to the base period. Broadly viewed, these facts establish that petitioner was not in a state of relatively permanent decline.
All of the foregoing causes us to conclude that this is not the occasion for resort to the principles involved in the concept of "relatively permanent decline" and thus put a ceiling on petitioner's reconstruction as outlined in E. P. C. 42, supra. Respondent, in his brief, lays great stress on E. P. C. 42. We do not think it is applicable to the facts in the instant case. See
There is a preliminary question as to whether petitioner's reconstruction is to be made on the basis of the 6 gravure presses which were actually installed during the base period plus the 2 which were ordered and installed in 1941, petitioner having in 1937 set up a replacement schedule for presses which contemplated the replacement of 17 letterpresses with the same number of high-speed gravure presses. We believe that petitioner's reconstruction should include the 2 presses ordered and installed in 1941. See
The record as a whole shows in our opinion that petitioner made "changes in position unequivocally establishing the intent to make the changes [in capacity for production or operation]," and that is enough to establish the "commitment" required by the statute. S. Rept. No. 1631, 77th Cong., 2d Sess., p. 202; see also
In that case it was held on the basis of the legislative history 1 that 1956 U.S. Tax Ct. LEXIS 236">*256 the absence of a contract was not necessarily conclusive on the question of commitment. The Opinion quoted from the legislative history as follows:
"Progress to the point where the taxpayer could not withdraw without substantial detriment may be given substantial weight in determining whether or not taxpayer has committed itself * * *. On the other hand, commitment claims are not to be rejected solely on the ground that taxpayers which have otherwise complied with all of the essentials in commitment cases may, nevertheless, be in a position where they might have withdrawn without substantial detriment prior to January 1, 1940."
25 T.C. 1268">*1277 At this point we think that attention should be called to the fact that in the year 1939, petitioner had an extensive training program in force. The testimony shows that more than 30 employees were being trained during that year, not for immediate production but in anticipation of future needs, including those presses which1956 U.S. Tax Ct. LEXIS 236">*257 were ordered in 1940. This training program was necessary because it took a period of 2 or more years to train a gravure preparatory employee, whereas it was possible to order and install the presses in a shorter period. The expenses of this training program were a financial commitment of substantial proportions within the meaning of
Any change in the capacity for production or operation of the business consummated during any taxable year ending after December 31, 1939, as a result of a course of action to which the taxpayer was committed prior to January 1, 1940, * * * shall be deemed to be a change on December 31, 1939, in the character of the business, * * *
Push-Back.
In connection with a reconstruction, respondent has a further position which is that petitioner must be denied the use of the push-back rule because petitioner has not shown that had it made the change 2 years before it did so it would have reached a higher level of earnings. He argues that had petitioner instituted the change 2 years earlier there would have been no available gravure preparatory workers1956 U.S. Tax Ct. LEXIS 236">*258 and other aids to the production of satisfactory high-speed multicolor gravure. But on the basis of the established facts, we conclude, as our findings disclose, that had petitioner started 2 years earlier, by the end of 1939 it would have obtained and trained the necessary gravure preparatory workers, been able to sell and print its advertising in multicolor gravure, and thus would have been able to effect additional cost savings which we have long regarded as the equivalent of increased income.
We think petitioner has established by facts proved at the hearing that it is entitled to the use of the 2-year push-back rule in this matter of a substantial changeover to gravure printing and we have used it in our reconstruction.
In considering the amount of petitioner's reconstructed base period earnings attributable to the two 722 (b) (4) changes which we have been discussing, we are constrained to note that the computation on the part of petitioner must stem from an inherent optimism, a failure to deal with all the conditions which prevailed and attended the change to the use of high-speed multicolor gravure, and other infirmities. But we are satisfied that there is a satisfactory1956 U.S. Tax Ct. LEXIS 236">*259 showing justifying some relief for petitioner and we have so determined in our ultimate findings of fact, which read as follows:
25 T.C. 1268">*1278 Ultimate Facts.
Petitioner's base period discontinuance of Country Home and its base period adoption of multicolor high-speed gravure printing constituted changes in the character of its business within the meaning of
Petitioner's base period net income is an inadequate standard of normal earnings because of these changes.
Petitioner did not reach by the end of 1939 the earning level it would have reached had it made its multicolor high-speed gravure change 2 years before it did so.
A fair and just amount to represent petitioner's constructive average base period net income is $ 518,000 in excess of its average base period net income, after adjustments already allowed in the deficiency notice under
Our reconstruction under which we have reached the CABPNI shown in our ultimate findings has been made upon a consideration of the entire record.
Petitioner also claims relief by reason of base period expenditures for research and development as provided in
1956 U.S. Tax Ct. LEXIS 236">*262 We must, therefore, conclude that the record furnishes no basis for an ascertainment of the existence of research labor costs in the development of multicolor gravure printing process or of the years in which such expenditures might have been made. The absence of such material is fatal to petitioner's 721 (a) (2) (C) claims, for without it the petitioner is not able to satisfy the statute by making, for the years 1940 through 1945, a computation of the allocation of percentages to be applied to net abnormal income for the pertinent years and the further computation of net abnormal income and the allocation of net abnormal income to the years in which the research took place. See
Moreover, although our findings disclose that petitioner during the pertinent years had some activity which might qualify as research and development activity, it was insignificant, we think, compared to the obvious fact that most of what petitioner is claiming to be research and development expenses has not been shown to be such, but rather appears to be the training of personnel in the gravure process (which petitioner admittedly1956 U.S. Tax Ct. LEXIS 236">*263 needed), the development through experience (including visits to other plants) of gravure skills and techniques, and the adaptation and use of important machines and processes developed by others. Cf.
The record is such that there are not sufficient foundations for us to make findings either as to amounts of research labor costs and in what years they were expended, or the extent of petitioner's true 25 T.C. 1268">*1280 research and development activity. This issue is decided for respondent.
Petitioner also claims that it is entitled to additional relief by reason of the provisions of
1956 U.S. Tax Ct. LEXIS 236">*265 We shall first take up the amount which petitioner paid out in employees' bonuses in 1936 and the amount which it paid for moving certain power lines in 1938 in its plant at Springfield. Insofar as 25 T.C. 1268">*1281 the amounts paid in these respects, there is no dispute. That has been stipulated. We do not think that either of these expenditures is entitled to a separate classification for they are not shown to differ substantially from many other items in other groupings of expenditures. See
The case at bar is obviously distinguishable from
And the expenses for moving the power lines in petitioner's plant at Springfield, Ohio, were part of an expansion of its facilities and they are not shown to be different from comparable general expenditures for maintenance and repairs, or entitled to a separate classification. See
A different situation exists as to the executives' bonuses which were paid in 1936 and 1937, due to the good earnings which existed in those years. They were not paid in 1938 and 1939, due to the falling off in business in those years. They were not paid again until the years 1943, 1944, and 1945, when they were paid in the amounts shown in our Findings of Fact because of the notable increases of petitioner's income in those years. We agree with petitioner that these executives' bonuses which it paid in 1936 and 19371956 U.S. Tax Ct. LEXIS 236">*267 were abnormal in amount within the meaning of
The provisions of
Under the circumstances, we conclude that petitioner is not entitled, under
1956 U.S. Tax Ct. LEXIS 236">*269
We have just ruled against petitioner as to the three
| After all adjustments allowed or allowable | |||
| under section 711 -- | |||
| Year | |||
| for 1943 | for 1944 | for 1945 | |
| 1936 | $ 3,481,602.49 | $ 3,482,271.63 | $ 3,482,271.63 |
| 1937 | 3,553,112.65 | 3,547,283.59 | 3,561,743.47 |
| 1938 | 2,002,676.64 | 1,980,604.86 | 1,988,699.81 |
| 1939 | 2,209,959.25 | 2,206,522.30 | 2,206,522.30 |
| Average | $ 2,811,837.76 | $ 2,804,170.60 | $ 2,809,809.30 |
25 T.C. 1268">*1283 It is therefore our conclusion that petitioner is entitled to use1956 U.S. Tax Ct. LEXIS 236">*270 as a CABPNI in the computation of its excess profits tax for the years 1943, 1944, and 1945, the above average amounts plus $ 518,000, which is the sum we have determined should be added because of the two 722 (b) (4) factors which we have held to exist. See
With respect to the question of unused excess profits credit carryover for 1941, which is a matter for recomputation under Rule 50, the parties are in agreement that the "variable credit rule" provided for in the Bulletin on
Reviewed as to
Decision will be entered under Rule 50.
Footnotes
*. Findings of Fact have been made and are filed as part of the official record of this case but are not printed in full as a part of the Opinion.↩
1. S. Rept. No. 1631, 77th Cong., 2d Sess., pp. 201-202.↩
2.
SEC. 721 . ABNORMALITIES IN INCOME IN TAXABLE PERIOD.(a) Definitions. -- For the purposes of this section --
(1) Abnormal income. -- The term "abnormal income" means income of any class includible in the gross income of the taxpayer for any taxable year under this subchapter if it is abnormal for the taxpayer to derive income of such class, or, if the taxpayer normally derives income of such class but the amount of such income of such class includible in the gross income of the taxable year is in excess of 125 per centum of the average amount of the gross income of the same class for the four previous taxable years, or, if the taxpayer was not in existence for four previous taxable years, the taxable years during which the taxpayer was in existence.
(2) Separate classes of income. -- Each of the following subparagraphs shall be held to describe a separate class of income:
* * * *
(C) Income resulting from exploration, discovery, prospecting, research, or development of tangible property, patents, formulae, or processes, or any combination of the foregoing, extending over a period of more than 12 months; * * *
* * * *
(3) Net abnormal income. -- The term "net abnormal income" means the amount of the abnormal income less, under regulations prescribed by the Commissioner with the approval of the Secretary, (A) 125 per centum of the average amount of the gross income of the same class determined under paragraph (1), and (B) an amount which bears the same ratio to the amount of any direct costs or expenses, deductible in determining the normal-tax net income of the taxable year, through the expenditure of which such abnormal income was in whole or in part derived as the excess of the amount of such abnormal income over 125 per centum of such average amount bears to the amount of such abnormal income.↩
3.
SEC. 711 . EXCESS PROFITS NET INCOME.(b) Taxable Years in Base Period. --
(1) General rule and adjustments. -- The excess profits net income for any taxable year subject to the Revenue Act of 1936 shall be the normal-tax net income, as defined in section 13 (a) of such Act; and for any other taxable year beginning after December 31, 1937, and before January 1, 1940, shall be the special-class net income, as defined in section 14 (a) of the applicable revenue law. In either case the following adjustments shall be made (for additional adjustments in case of certain reorganizations, see section 742 (e)):
* * * *
(J) Abnormal Deductions. -- Under regulations prescribed by the Commissioner, with the approval of the Secretary, for the determination, for the purposes of this subparagraph, of the classification of deductions --
(i) Deductions of any class shall not be allowed if deductions of such class were abnormal for the taxpayer, and
(ii) If the class of deductions was normal for the taxpayer, but the deductions of such class were in excess of 125 per centum of the average amount of deductions of such class for the four previous taxable years, they shall be disallowed in an amount equal to such excess.
(K) Rules for Application of Subparagraphs (H), (I), and (J). -- For the purposes of subparagraphs (H), (I), and (J) --
* * * *
(ii) Deductions shall not be disallowed under such subparagraphs unless the taxpayer establishes that the abnormality or excess is not a consequence of an increase in the gross income of the taxpayer in its base period or a decrease in the amount of some other deduction in its base period, and is not a consequence of a change at any time in the type, manner of operation, size, or condition of the business engaged in by the taxpayer.
(iii) The amount of deductions of any class to be disallowed under such subparagraphs with respect to any taxable year shall not exceed the amount by which the deductions of such class for such taxable year exceed the deductions of such class for the taxable year for which the tax under this subchapter is being computed.↩