*37 Decision will be entered under Rule 50.
Since its incorporation in 1900 petitioner has been continuously engaged in the business of compiling and publishing legal citations. Early in 1938, due to the sense of social responsibility to do something towards providing for the superannuation of its older employees, it pensioned 2 of its employees, who were no longer able to work. Later in 1938 it purchased annuity policies, to commence at age 65, for a number of other employees. In 1939 it continued to pay pensions to the 2 employees pensioned in the previous year, and purchased additional annuity policies for others. The amounts so expended for premiums and pensions were allowed as deductions from gross income in the respective years. Prior to 1938 petitioner had never made any such expenditures. Held, under section 711 (b) (1) (J), I. R. C., that the deductions for both premiums and pensions constituted a single class of deductions separate and distinct from all other classes of deductions; that such deductions for 1938 were abnormal; that such deductions for 1939 were normal because a definite course of conduct had been entered upon in the prior year 1938; and that such*38 abnormality under subparagraph (J) (i) and excess under subparagraph (J) (ii) should be disallowed for the purpose of determining petitioner's excess profits credit; held, further, petitioner has established that the abnormality and excess of the deductions disallowed under subparagraph (J) were not the consequence of any of the factors mentioned in section 711 (b) (1) (K) (ii), I. R. C.
*913 The respondent, for the calendar year 1942, determined a deficiency in declared value excess profits tax of $ 823.25; a deficiency in excess profits tax of $ 22,331.69; and an overassessment in income tax of $ 4,852.30. Petitioner contests the entire deficiency in excess profits*39 tax, but makes no contest as to the remainder of the determination.
Petitioner, in its excess profits tax return, schedule B, line 24 (c), claimed as abnormal deductions under section 711 (b) (1) (J) (ii) and (K) of the Internal Revenue Code for the taxable years in the base period ended December 31, 1938 and 1939, the amounts of $ 52,344.46 and $ 1,011.89, respectively. In a statement attached to the return it explained these amounts as follows:
| Deduction for Premiums on Deferred | ||
| Annuities Purchased for Employees | ||
| 1940 | $ 22,800.73 | |
| 1939 | 17,369.53 | |
| 1938 | 52,344.46 | |
| 1937 | None | |
| 1936 | " | |
| 1935 | " | |
| 1934 | " | |
| 1933 | " | |
| 1932 | " |
| Adjustment of Base Period Net Income Under | ||
| Section 711 (b) (1) (J) of the Internal Revenue Code | ||
| Year 1938 | ||
| Excess of Deduction over 125% of the Average for 1934, | ||
| 1935, 1936, 1937 | $ 52,344.46 | |
| Excess of Deduction over Year 1942 | $ 52,344.46 | |
| Year 1939 | ||
| Excess of Deduction over 125% of the Average for 1935, | ||
| 1936, 1937, 1938 | $ 1,011.89 | |
| Excess of Deduction over Year 1942 | 17,369.53 |
*914 The amounts of the adjustments in the above deductions have no relation to the prices and gross sales of the taxpayer nor are they*40 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 the base period. Furthermore, they have no relation to nor are they a consequence of any change in the type, manner of operation, size or condition of the business engaged in by the taxpayer.
As will appear in our findings, the amounts shown in the above statement attached to the return as deductions for premiums in 1938 and 1939 of $ 52,344.46 and $ 17,369.53, respectively, included deductions for pensions of $ 1,529 and $ 2,132, respectively, so that the correct figures to be considered for these years will appear as follows:
| 1938 | 1939 | |
| (a) Deduction for premiums | $ 50,815.46 | $ 15,237.53 |
| (b) Deduction for pensions | 1,529.00 | 2,132.00 |
| Total | $ 52,344.46 | $ 17,369.53 |
As will also appear in our findings, petitioner, in the taxable year 1942, paid nothing for premiums, but did pay $ 1,493 for pensions.
The respondent, in the statement attached to the deficiency notice, disallowed the above claimed abnormal deductions and explained his adjustments as follows:
Explanation of Adjustments
(a) It is held that the provisions of section*41 711 (b) (1) (J) and (K) of the Internal Revenue Code bar the allowance of your claim for abnormal deductions with respect to the cost of single premium insurance policies purchased for some of your employees during the years 1938 and 1939 in computing the excess profits net income for these two years for the purpose of determining your excess profits credit.
(b) For the same reason given in explanation of adjustment (a), supra, the abnormal deductions adjustments of $ 1,529.00 and $ 1,011.89 in the base period years 1938 and 1939 for pensions paid to former employees are eliminated.
*915 Petitioner, by appropriate assignments of error, contests the above adjustments made by the respondent in such manner as to present for consideration the following issues:
(1) Is petitioner entitled under either subparagraph (J) (i) or (J) (ii) of section 711 (b) (1) of the Internal Revenue Code and section 711 (b) (1) (K) to a disallowance of the deduction for premiums paid in 1938 in the amount of $ 50,815.46?
(2) Is petitioner entitled under subparagraph (J) (i) of section 711 (b) (1) and section 711 (b) (1) (K) to a disallowance of the deduction for premiums paid in 1939 in the amount of *42 $ 15,237.53?
(3) Is petitioner entitled under section 711 (b) (1) (J) and (K) to a disallowance of the deduction for pensions paid in 1938 to the extent of $ 36 ($ 1,529 paid in 1938 but limited under section 711 (b) (1) (K) (iii) to the excess of that amount over the $ 1,493 paid in the taxable year 1942)?
(4) Is petitioner entitled under section 711 (b) (1) (J) and (K) to a disallowance of the deduction for pensions paid in 1939 to the extent of $ 639 ($ 2,132 paid in 1939 but limited under section 711 (b) (1) (K) (iii) to the excess of that amount over the $ 1,493 paid in the taxable year 1942)?
Petitioner also claimed an unused excess profits credit adjustment of $ 28,773.75 in its excess profits tax return. The respondent, in schedule 6 of the statement attached to the deficiency notice, disallowed this claim and explained his disallowance as follows:
It is held that you had no unused excess profits credit carry-over to the year 1942 from the years 1940 and 1941 under the provisions of section 710 (c) of the Internal Revenue Code as amended. Accordingly, the unused excess profits credit adjustment in amount of $ 28,733.75 claimed therefor is eliminated.
Petitioner, by appropriate*43 assignments of error, also contests this disallowance. The solution of this issue, however, depends upon our holding relative to the issues previously stated.
Some of the facts were stipulated and others were developed by oral testimony and by documentary evidence.
FINDINGS OF FACT.
The facts as stipulated are so found.
Petitioner, for all the years pertinent to this proceeding, was a corporation, organized under the laws of the State of New York.
For all the years pertinent to this proceeding petitioner kept its books and filed its tax returns on an accrual basis and for taxable periods of 12 months ended on December 31 of each year. Petitioner's income tax return and its excess profits tax return for the calendar year 1942, and its tax returns for the other years pertinent to this proceeding, were filed with the collector for the second district of New York.
*916 Since its incorporation in 1900 petitioner has been continuously engaged in the business of compiling and publishing legal citations, commonly known as "Shepard's Citations." The income of petitioner is derived from the sale of bound volumes of citations and from new and renewal subscriptions to cumulative supplements.
*44 During the years 1934 to 1943, inclusive, petitioner employed an average of 236 persons.
Prior to 1938 petitioner had never paid a pension to any employee or former employee and had never purchased for any employee any retirement annuity. Except for social security taxes paid for the first time in 1937 under the Federal Social Security Act, petitioner had never before 1938 provided benefits for any of its employees upon or after their retirement. Petitioner considered that its employees had been fully compensated by their current salaries, and until the enactment of social security legislation in 1935 it had never regarded itself as having any responsibility, moral or otherwise, for the superannuation of persons in its employ.
With the enactment of social security legislation in 1935 and the public discussion of employers' duties to employees, the directors and officers of petitioner began thinking of the matter of superannuation of its employees. Such thinking was brought more sharply into focus in 1937, with the first application of the "old age" provisions of the Federal Social Security Act. Yet no serious problem arose until 1938. In the years immediately prior to 1938 no*45 employee had to be retired because of old age. But in the early part of 1938 it happened that two employees became too old and infirm to continue their work. Petitioner then decided to retire those two employees and to pension them. And this prompted petitioner to take action with a view to providing in advance for the superannuation of certain other employees.
Estimates were made of the "old age" benefits which the various employees of petitioner would receive under the Federal Social Security Act. It was found that the older employees of petitioner would not have time before reaching retirement age under the act, i.e., 65 years of age, to build up much in the way of such benefits under the act. It was then decided that petitioner should purchase annuities commencing at the age of 65 for those of its employees who had been with it for 19 years or more. There were 21 such employees, and in the autumn of 1938 petitioner purchased from the Metropolitan Life Insurance Co. 21 single premium annuity policies, respectively, for those 21 persons, expending in such purchase $ 50,815.46.
In 1939 2 more employees came within the 19-year service group, and 2 more single premium annuity*46 policies were purchased. Also in 1939 additional single premium annuity policies were purchased for those within the group who were 50 years of age or over. There were 6 such persons, 5 among those who qualified in 1938 and one among the *917 2 who qualified in 1939. Petitioner expended in 1939 $ 15,237.53 in the purchase of such annuities.
In 1940 petitioner purchased single premium annuity policies for 14 of its employees who had been in its service for 17 years or more, expending $ 22,800.73 in such purchase.
In 1941 petitioner purchased single premium annuity policies for 20 of its employees who had been in its service for 15 years or more, expending $ 30,235.74 in such purchase.
In 1942 petitioner did not purchase any annuity policies for any of its employees.
In 1943 petitioner adopted a pension retirement plan designated to benefit all employees in petitioner's service, other than aliens and persons already over 65 years of age, who regularly received annual earnings over $ 2,400 and who had completed 5 years of service with petitioner. This plan provided that individual annual premium retirement policies should be applied for to provide benefits for each participating*47 employee, petitioner paying the annual premiums as they become due. In 1943 petitioner paid $ 5,500 as contribution under the plan to cover such annual premiums. The plan was submitted on March 9, 1944, to the Bureau of Internal Revenue for approval under sections 165 and 23 (p) of the Internal Revenue Code and was approved by the Commissioner on October 21, 1944.
During these years petitioner continued to pay pensions to one or both of the two former employees whom it had retired in 1938. The amounts so paid in pensions from 1938 through 1943 were as follows:
| 1938 | $ 1,529 |
| 1939 | 2,132 |
| 1940 | 2,132 |
| 1941 | $ 2,214 |
| 1942 | 1,493 |
| 1943 | 962 |
In its income tax returns for the calendar years 1938 through 1943 petitioner claimed and was allowed as deductions the aforesaid amounts which it expended in the payment of pensions and in the purchase of annuities or in contributions to the pension retirement plan.
The policies which petitioner purchased in 1938 provided for annuity benefits commencing when the annuitant reaches the age of 65. The amount of the annuity in each case was calculated to be equal to one-half of 1 per cent of the employee's current annual salary not in excess of*48 $ 7,500, multiplied by his total years of service. The 21 employees for whom these policies were purchased ranged in age from 35 years to 59 years, with the exception of one, who was 71 years old. A separate policy was purchased for each employee, and the cost of each policy varied not only according to the amount of annuity to be provided, but also according to the age at the time of purchase of the employee to be benefited. The cost of these policies was regarded *918 by petitioner as a distinct class of expenditure, and, together with the amounts expended in the payment of pensions, was so treated on petitioner's books and in its tax returns.
The policies which petitioner purchased in 1939 were essentially similar to those purchased in 1938, except that those purchased in 1939 provided for annuity benefits commencing at age 65 in an amount calculated to be equal to one-fourth of 1 per cent (instead of one-half of 1 per cent) of the employee's current annual salary not in excess of $ 7,500, multiplied by his total years of service, and except that 1939 was the second year, instead of the first, in petitioner's history in which such provision was made for the retirement of*49 employees.
The cost of the policies in 1938 and 1939, respectively, was regarded by petitioner as a distinct class of expenditure, separate from compensation and from any category of expense involved in the cost of production or regular operation of petitioner's business. On petitioner's books and in petitioner's income tax returns the expenditures made in the purchase of the annuity policies were classified, together with the amounts paid in pensions, in a group by themselves separate from all other classes of deductions.
The policies were not considered as bonuses given to the employees. It is the practice of petitioner to pay bonuses by way of Christmas gifts or by way of sharing of profits. Bonuses are paid in cash, and bonuses represent only a small proportion of salaries. Also bonuses are generally distributed widely among employees, though occasionally special bonuses are paid to key personnel, such as heads of departments and executive officers. In contrast to bonuses, the annuity policies were purchased for a special group of employees selected according to the length of time they had been in petitioner's service and constituting less than one-tenth of the total number*50 of employees. And the cost of each policy was on the average equal to about 60 per cent of the annual salary of the employee benefited.
When petitioner decided in 1938 to purchase annuity policies for the 21 employees who had been in its service for 19 years or more, it arranged for each employee to fill out an application for an annuity policy. These applications were then forwarded to the Metropolitan Life Insurance Co. and when the policies were issued they were given to the respective employees. When petitioner delivered the policies to the respective employees, it told them that it had purchased the policies because it felt that some action should be taken to supplement "old age" benefits under the Social Security Act in the case of the older employees, who would not have sufficient opportunity to build up much in the way of benefits under the act. It also explained to those employees that giving them the annuity policies would have no effect on their future salaries.
*919 Petitioner received a ruling from the Treasury Department to the effect that the annuity policies thus given to the employees did not constitute taxable income to them.
New York State unemployment *51 insurance taxes paid by petitioner in 1938 were based on the amount of compensation paid by petitioner to its employees. For such purpose compensation included not only salaries and wages, but also bonuses. But it did not include the amounts expended in the purchase of the annuity policies. Similarly, Federal social security taxes paid by petitioner and premiums paid by petitioner on workmen's compensation insurance were based on the amount of compensation paid to its employees. For none of these purposes were the amounts expended by petitioner in the purchase of annuity policies regarded as compensation.
The expenditures made by petitioner in the purchase of the annuity policies were also treated separately from compensation in petitioner's accounting practice. On its books petitioner had opened in 1938 a new account, entitled "Pension Roll," when it paid its first pensions to the two old employees retired in April 1938. When petitioner purchased the annuity policies later in 1938, the cost of these policies was charged on its books to this new account. The amounts so charged represented amounts paid to the insurance company as the insurance company billed petitioner for policies*52 applied for. Each billing generally covered several policies, and the amounts recorded on petitioner's books did not indicate the amounts of premiums paid for particular policies, but only the sum of premiums for whatever policies happened to be issued at one time. The names of the individuals for whom the policies were purchased were not indicated in petitioner's formal books of account. The only records which petitioner kept of the names of the individuals for whom the policies were purchased and of the individual cost of the respective policies were copies of the applications filed with the insurance company and an informal loose leaf book showing, among other things, the formula used in determining the amount of the annuity to be purchased in each case and an approximation of the amount of social security benefits which the individual would receive at the age of 65. When the "Pension Roll" account was closed, the balance was transferred directly to "Profit and Loss."
On the other hand, salaries, wages, and bonuses paid to all employees other than salesmen were initially charged to an account entitled "Payroll Account" and salaries, wages, bonuses, and commissions paid to salesmen*53 were initially charged to accounts entitled "Salesmen's Salaries" and "Salesmen's Commissions." These accounts were periodically closed by transferring the amounts there recorded among various departmental expense accounts such as "Cost of Goods Sold," "Publication Expenses," "Indirect Editorial Salaries," "General Office *920 Salaries," "Officers' Salaries," "Packing and Shipping Supplies," "General Maintenance," etc. This was done in order to determine the various groups of expenses involved in production.
In petitioner's Federal income tax return the amounts expended in the purchase of the annuity policies were claimed, together with the amounts paid in pensions, as a distinct class of deductions. The sum of such amounts was so listed in a schedule filed as part of the return explaining the composition of an aggregate amount entered on the printed form under "Other deductions authorized by law." Other classes of deductions listed in this schedule included, for example, "Advertising," "Postage," "Group Insurance," and "Telephone & Telegraph." On the other hand, deductions for compensation paid to the employees were classed separately in the return. Such deductions for compensation*54 were claimed under "Cost of Goods Sold" for the most part and to some extent under "Officers' Salaries" and other headings.
No deductions in respect of annuity policies or in respect of pensions had been claimed in any of petitioner's income tax returns for the four taxable years prior to 1938, or in any return for any previous taxable year in petitioner's history, because prior to 1938 petitioner had never purchased annuities for any employees or paid any pensions.
The pensions were paid to two persons of advanced age who in the early part of the year 1938 became incapable of continuing their work and were retired. These pensions were paid to those persons after they had ceased to render any services to petitioner. Petitioner considered that those persons had been fully compensated for their past services, and petitioner did not regard the pensions as a reward for past services, but rather as fulfillment of a social responsibility.
The deductions aggregating $ 50,815.46 for petitioner's expenditures in the calendar year 1938 in the purchase of annuity policies and the deductions aggregating $ 1,529 for petitioner's expenditures in 1938 in the payment of pensions, claimed and allowed*55 in computing petitioner's net taxable income for that year, constituted deductions of a separate and distinct class and deductions of such class were abnormal for petitioner; also those deductions were in their entirety in excess of 125 per cent of the average amount of deductions of such class for the four previous taxable years, there having been no deductions of such class prior to 1938.
The deductions aggregating $ 15,237.53 for petitioner's expenditures in the calendar year 1939 in the purchase of annuity policies and the deductions aggregating $ 2,132 for petitioner's expenditures in 1939 in the payment of pensions, claimed and allowed in computing petitioner's net taxable income for that year, constituted deductions of a separate and distinct class, but for 1939 were not abnormal expenditures for petitioner.
*921 Petitioner's sales for 1938 were $ 798,759.98, as compared with $ 652,834.89 for the preceding year and $ 607,691.53, the average for the four preceding years.
The annual gross income of petitioner for the years 1934 through 1943 was as follows:
| 1934 | $ 329,176.48 |
| 1935 | 330,278.26 |
| 1936 | 324,880.17 |
| 1937 | 325,313.79 |
| 1938 | 412,897.58 |
| 1939 | $ 373,987.33 |
| 1940 | 389,571.39 |
| 1941 | 410,924.32 |
| 1942 | 399,849.34 |
| 1943 | 469,744.15 |
*56 The only significant increase in gross income in the base period occurred in 1938. This was caused by the publication in that year of revised bound volumes of petitioner's "Federal Reporter Citations." Petitioner had been preparing this work for publication for several years.
By October 1938, when the annuity policies were purchased, petitioner's officers knew that there would probably be an increase in petitioner's gross income for 1938 over the year 1937.
The purchase of the annuity policies and pensions had no connection whatever with the increase in petitioner's gross income. The purchase of the policies and pensions was a result of a voluntary act on the part of petitioner's board of directors. There was no agreement or understanding with the employees that petitioner would purchase such annuity policies or pensions in the event that petitioner's income should increase or in any other event.
The decision of the board of directors to purchase the policies was not caused by the increase in gross income. That decision was taken on October 14, 1938. It was the result of petitioner's desire to provide for superannuation of older employees in consequence of its increasing sense*57 of responsibility towards such employees. The decision would have been taken in the absence of any increase in gross income. Petitioner had enough cash on hand prior to the increase in gross income to purchase the policies.
The annual deductions from petitioner's gross income other than those claimed for the payment of pensions and the purchase of annuities for the years 1934 through 1943 were as follows:
| 1934 | $ 227.909.44 |
| 1935 | 242,304.46 |
| 1936 | 259,389.07 |
| 1937 | 255,448.09 |
| 1938 | 278,687.19 |
| 1939 | $ 281,174.35 |
| 1940 | 279,925.55 |
| 1941 | 321,855.95 |
| 1942 | 299,388.28 |
| 1943 | 329,726.14 |
There was no significant decrease in the base period in the amount of any deductions related in any way to the deductions claimed and allowed for the amounts expended in the purchase of annuity policies and pensions in 1938 and 1939, respectively.
*922 There has been no change in the type of petitioner's business since its incorporation in 1900. Since its incorporation its business has consisted of compiling and publishing legal citations. There has been no change in its manner of operation. There has been no change in the size or condition of the business, except for normal growth; and there*58 was no relation between the deductions in respect of the purchase of the annuity policies and pensions in 1938 and 1939 and such growth.
The publication in 1938 of a bound revision of petitioner's "Federal Reporter Citations" did not constitute a change in the size or condition of petitioner's business. It has been the practice of petitioner for many years to prepare and periodically to publish revisions of its publications.
The market for petitioner's publications is necessarily limited. There has been no significant change in that market. The prices at which petitioner's publications are sold are determined by the costs of production and the custom of the trade. This has been true since petitioner first entered business.
Petitioner has established that the abnormality and excess of the deductions which it claimed and was allowed for income tax purposes in 1938 and 1939 in respect of its expenditures in the purchase of the annuity policies and pensions for those years, respectively, were not a consequence of an increase in the gross income of petitioner in its base period or a decrease in the amount of some other deduction in its base period, and were not a consequence of a change*59 at any time in the type, manner of operation, size, or condition of the business engaged in by petitioner.
OPINION.
We shall consider together the four issues set out in our preliminary statement. They are so closely connected that they can be treated together. The applicable statute 1*60 and regulations 2 are set forth in the margin.
*61 *923 Our first problem is to determine to what extent the deductions in 1938 and 1939 for premiums and pensions come within the term "class" as that term is used in the applicable statute. The determination of that issue is considerably clarified by our recent holding on issue No. 5 in Arrow-Hart & Hegeman Electric Co., 7 T. C. 1350, 1372. There we held that deductions for pensions, payments to widows, sickness pay, and severance allowance, all together constituted one single "class" separate and distinct from routine salaries or any other *924 class of deductions. In the instant proceeding petitioner on its books and in its returns treated the expenditures for both premiums and pensions as one single class under the heading of "Pension Roll" account. In the deficiency notice the respondent separated the two, but has made no particular point about it. Petitioner is not so much concerned with whether the expenditures for premiums and pensions be considered as one single class or as two separate classes, although it does favor considering them as two separate classes. Its main contention on this point is that neither expenditure be grouped*62 with some other class of deduction, and on this main contention it is our opinion and holding that petitioner is correct. Arrow-Hart & Hegeman Electric Co., supra.It is also our opinion and holding that the expenditures for both premiums and pensions constitute one single "class" of deductions as that term is used in the statute. The objective of both expenditures was substantially the same, and we know of no reason why they should not be grouped into one class for the purpose at hand. Cf. Truax v. Corrigan, 257 U.S. 312">257 U.S. 312, cited in Green Bay Lumber Co., 3 T.C. 824">3 T. C. 824, 829.
Our next problem is to determine whether under section 711 (b) (1) (J) (i), the "deductions of such class" namely, the deductions for both premiums and pensions considered together as one class, were "abnormal" for petitioner, in both 1938 and 1939, two of petitioner's base period years.
Year 1938.
We first take up and decide the issue as to the year 1938.
Webster's New International Dictionary, 2d Ed. Unabridged, defines abnormal as "Deviating from the normal condition; not corresponding to the type; markedly or*63 strangely irregular." That definition was accepted and applied as a proper test of abnormality in R. C. Harvey Co., 5 T. C. 431, and in City Auto Stamping Co., 7 T. C. 354. Since petitioner had been in business for more than 35 years prior to 1938 and was conducting essentially the same business without ever having made any expenditure of the class which it made in 1938 for pensions and the purchase of annuity policies, it seems self-evident that such expenditures which were allowed as deductions in 1938 were abnormal for petitioner in 1938. They represented a deviation from the type of expenditure ordinary or usual for petitioner. Cf. Green Bay Lumber Co., supra.But even if we were wrong in holding that these deductions were abnormal for petitioner in 1938, the result would be the same. As far as the deductions for 1938 are concerned, it would make no difference whether they were abnormal or normal. If abnormal, the 1938 deductions would not be allowed under section 711 (b) (1) (J) (i), and, if normal, they would be disallowed under section 711 (b) (1) (J) (ii) for the reason that petitioner*64 had no *925 deductions of such class for the four taxable years previous to 1938 and the total deductions for 1938 would therefore also be the "amount equal to such excess" provided for in the statute.
Year 1939.
But we can not sustain petitioner's contention that its expenditures in 1939 for annuity premiums and pensions were abnormal to it within the meaning of section 711 (b) (1) (J) (i). Petitioner's contention with respect to 1939 in substance is: That the year 1939 was only the second year in the petitioner's history of more than 35 years in which it purchased retirement annuities for any of its employees; that in 1939 the petitioner still had no formulated plan or policy with respect to the superannuation of employees; and that the same circumstances which rendered abnormal the expenditures made in 1938 in the purchase of annuity policies and the payment of pensions rendered also abnormal similar expenditures made in 1939.
It seems clear to us, however, upon the whole record that in 1938 petitioner definitely decided to enter upon a course of conduct of providing annuities and pensions for its superannuated employees and, therefore, in years subsequent thereto when*65 this class of expenditures was continued such expenditures became normal. The following facts in the record, among others, convince us that this course of conduct was entered upon in 1938 by petitioner. In 1939 petitioner expended $ 15,237.53 in the purchase of such annuities and $ 2,132 in the payment of pensions. In 1940 petitioner purchased single premium annuities for employees at a cost of $ 22,800.73 and paid pensions of $ 2,132. In 1941 petitioner expended $ 30,235.74 in the purchase of annuity policies and $ 2,214 in pensions. In 1942 petitioner did not purchase any annuity policies but expended $ 1,493 in pensions. It seems clear from the record that the reason petitioner did not purchase any annuity policies in 1942 was on account of the 1942 Revenue Act, which provided for new pension plans, and petitioner began at once to formulate such a plan for its employees, which was perfected in 1943 and was approved by the Commissioner of Internal Revenue October 21, 1944. Therefore, we hold that, petitioner having set out on a course of conduct in 1938 of providing annuities and pensions to its superannuated employees and having expended in that year $ 52,344.46 for that*66 purpose, such expenditures, although abnormal for 1938, when continued for 1939 and subsequent years can not be classed as abnormal for those years under the provisions of section 711 (b) (1) (J) (i). We hold that such expenditures for 1939 should be disallowed only to the extent that they fall within the provisions of section 711 (b) (1) (J) (ii). Cf. Arrow-Hart & Hegeman Electric Co., supra.
*926 In arguing that these expenditures for 1939 should be disallowed as abnormal on the same basis as those for 1938, petitioner strongly relies on City Auto Stamping Co., supra. We think the instant case is clearly distinguishable from that case on its facts. In the City Auto Stamping Co. case, the taxpayer, a manufacturing corporation, in 1933 paid approximately $ 300,000 on judgments in suits brought by the superintendent of banks alleging unlawful preference in withdrawal of deposits. In 1937 it paid approximately $ 70,000 in settlement of a suit brought against it involving a dispute over a contract as to patent rights, also in settlement of a suit brought by stockholders, alleging mismanagement in connection with*67 the patent rights and the litigation growing therefrom. Under these facts we held that the $ 70,000 expended in 1937 in the settlement of the judgment claims in that year was abnormal within the meaning of section 711 (b) (1) (J) (i), and that this abnormality was not destroyed by the fact that the taxpayer back in 1933 had paid a judgment of $ 300,000 which was wholly unrelated to the judgments paid in 1937. In thus holding we said: "Logic forbids a conclusion that the fact that there are two abnormalities causes both to become normal." Manifestly, we have no such facts here and the case of City Auto Stamping Co. is not controlling. We overrule petitioner on this point.
Under the limitation provided for in subparagraph (K) (iii) of section 711 (b) (1), the deductions of the class for 1938 of $ 52,344.46 must be reduced by the deduction of the class for 1942 of $ 1,493.
Subparagraph (K) (ii) of section 711 (b) (1) provides that for the purposes of subparagraphs (H), (I), and (J) of section 711 (b) (1):
(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*68 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.
We have found as an ultimate fact that petitioner has established that the abnormality and excess here are not a consequence of any of the factors mentioned in subparagraph (K) (ii). Although petitioner experienced an increase in gross income in its base period, notably in the year 1938, it has established to our satisfaction that the expenditures which it made in 1938 and 1939 for the premiums and pensions here in question, and the abnormality and excess of such expenditures, were not a consequence of such increase in its gross income. It has shown that these expenditures and the increase in the gross income were totally unrelated. Petitioner has convinced us that it would have purchased the annuity policies and *927 paid the pensions regardless of whether its gross income increased or not. Petitioner had ample funds to make these expenditures without the increase which it had in its gross income. The making of these*69 expenditures was purely a voluntary action on the part of petitioner's board of directors. There was no agreement or understanding with any of the employees or with anyone else requiring petitioner to purchase the annuity policies or pay the pensions in the event of an increase in its gross income or in any other event. Petitioner has also shown that the abnormality and excess in question were not the consequence of a decrease in the amount of some other deduction in its base period. When the policies were delivered to the respective beneficiaries they were told that the receipt of such policies would have no effect on their future salaries one way or the other and that the purchase of such policies was purely a voluntary action on the part of petitioner. During the four years prior to 1938 petitioner's deductions actually increased rather than decreased. They also increased during the years 1938 and 1939 without taking into consideration the amounts deducted for the premiums and pensions here involved. There has been no change in the type, manner of operation, size, or condition of the business engaged in by petitioner for a number of years. Petitioner has compiled and published*70 citations since its incorporation in 1900, and there has not been any change other than the normal growth which might take place in the period of a decade. We are satisfied from the evidence that petitioner has established that the abnormality and excess here in question were not a consequence of a change at any time in the type, manner of operation, size, or condition of the business engaged in by petitioner. We think that petitioner has successfully shown that the abnormality and excess here in question were the direct consequence of petitioner's board of directors' voluntary decision made under a sense of social responsibility to do something towards providing for the superannuation of its older employees, and that such abnormality and excess were not the consequence of any of the factors mentioned in subparagraph (K) (ii). We hold, therefore, that petitioner's excess profits net income for 1938 and 1939 as determined by the respondent should be adjusted in accordance with this opinion. Petitioner's excess profits credit will be determined accordingly.
The above holding will automatically require an adjustment in petitioner's unused excess profits credit carry-over to the year*71 1942 from the years 1940 and 1941, which adjustment will be made under Rule 50.
Decision will be entered under Rule 50.
*928 Disney, J., dissenting: The majority opinion concludes, rightly I think, that the deductions for pensions and annuities, not having occurred through petitioner's 35 years of previous existence, were abnormal in class for 1938; nevertheless, concludes that for 1939 they were normal. In substance, the reason given for the holding of normality in 1939 is that they were instituted as a course of conduct in 1938, and continued throughout 1939 to 1942, inclusive. In my view, such reason contravenes the essential basis for the excess profits tax and its ascertainment. The prime object of the various sections of the statute is to ascertain and tax excess profits. Ascertainment as to how much is excess involves, of course, a comparison. That comparison is with the average income from a 4-year period called the base period. In order to arrive fairly at the amount of excess, a fair average for the base period income must be arrived at. This is done by first computing "the excess profits net income" for each of the base period years, and then *72 applying certain other sections to get at the average. To prevent unfairness, abnormalities are avoided by the use, so far as here pertinent, of the provisions of section 711 (b) (1) (J) (i), which provides for adjustment of the "excess profits net income" for each base period year by disallowance of deductions which are abnormal in class. The excess profit is computed after giving "excess profits credit" for 95 per cent of the average base period net income as finally ascertained, including the use of section 711 (b) (1) (J) (i) above. The end and object of the statute is the determination of the average base period net income, the credit, and the tax on the excess profit. The taxable year here is 1942; the base period years are 1936 to 1939, inclusive.
I can not bring myself to believe that normality of deductions for 1939 can, under the objectives and mechanics of the excess profits law, be found by examining years later than 1939 -- the last base period year. Later years do not comprise the period with which essentially the profits for 1942 are compared; and of course 1942 can not be compared with itself, which is, in effect, done by the majority opinion, so far as 1939 normality*73 is made to depend upon the deduction situation in 1942. In my opinion, whether deductions in 1939 were normal depends upon the history of previous years and can not be predicated upon examination of later nonbase period years. The matter, I think, is to be viewed, not from later years, but from the base period (and perhaps earlier years). Otherwise, I see no comparison between 1942 and the base period, which is the basic idea in the whole statute, in order that any "excess" may be determined. Not only does it appear logically impossible to arrive at an "excess" of the taxable year over "the test period" (Regulations 112, sec. 35.711 (b)-2 (b)), but certain statutory provisions indicate to me that it was never Congressional *929 intent to determine abnormality of a deduction in a base period year by considering whether it was normal in later years. First, in section 711 (b) (1) (J) (ii), as to abnormalities in amount, the comparison is with the four previous years; and in section 711 (b) (1) (K) (i), which is one of the "rules for application of subparagraphs (H), (I), and (J)," it is provided that if the taxpayer was not in existence for four previous years, the *74 average to determine abnormality in amount may be ascertained by considering the previous years of existence and later years up to the "second taxable year under this subchapter" -- which is 1941, since 1940 was the first year of the excess profits tax law. See Regulations 112, sec. 35.711 (b)-2. Thus, we see that in determining the average in amount, only previous years, in the usual situation, and only up to 1941 in the unusual situation of no previous four years, are to be regarded. Only in the absence of previous existence or experience, to the extent of four years, is any later time to be considered. The number of years is, in any event, to be no more than four. I think the same logic applies to determining normality in class, and that we may not determine normality in 1939 by normality in later years which do not enter into the test. Yet here, we see the majority covering five years, 1938-1942, inclusive, to determine normality, going into future years to use hindsight, and in particular using a period after 1941, the taxpayer's "second taxable year under this subchapter." In this connection, I note that Regulations 112, section 37.711 (b)-2 (b), providing for*75 the statement required of taxpayers claiming disallowance of abnormal deductions under (H), (I), or (J), requires a showing for only four preceding years (or such years as the taxpayer is required to use in determining the average). Nothing requires or indicates that it may use later years, and, as above seen, it may not go beyond 1941, or beyond four years.
Consideration of section 722 (a) also indicates, in my opinion, that future years may not help determine abnormality; for thereunder a "fair and just amount representing normal earnings" may 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" (italics supplied), and "in lieu of the average base period net income otherwise determined under this subchapter"; but it is provided that, in determining such constructive average base period net income, "no regard shall be had to events or conditions affecting the taxpayer, the industry of which it is a member, or taxpayers generally occurring or existing after December 31, 1939," (with certain exceptions not pertinent here). I suggest that*76 this language makes it completely clear that the excess profits tax is based on comparison, and that, with good reason, events or conditions (normality or abnormality) after the *930 "test period" are necessarily in logic not regarded. I can see no reason to distinguish in this respect between the actual and the constructive base period net income, and have no doubt that Congress intended none. Yet here, the majority determines normality of deductions in 1939 in part because of conditions in 1940-1942, inclusive. I think no sound base for an excess profits tax can be so determined.
Footnotes
1. SEC. 711 [I. R. C.]. 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 * * *
* * * *
(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.↩
2. Sec. 35.711 (b)-2 [Regulations 112]. Abnormal Deductions in Base Period. -- Adjustments in the excess profits net income for a taxable year in the base period are required in order to disallow deductions of a class which is abnormal for the taxpayer, and to disallow the amount by which deductions of a class normal for the taxpayer exceed 125 percent of the average amount of deductions of such class for the four previous taxable years. * * *
A class of deductions is abnormal only if the taxpayer had no deductions of that class in the taxable years prescribed for determining average deductions.
The taxpayer must establish that the abnormality or excessiveness of the deduction 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. * * *
In order for the deduction of any class to be disallowed, the deductions of such class for the taxable year in the base period must exceed the deductions of the same class for the taxable year for which the excess profits tax is being computed, and any amount which may be disallowed shall be no greater than the amount by which the deductions of such class for the base period taxable year exceed the deductions of the same class for the taxable year for which the excess profits tax is being computed. * * *
(a) Classification of deductions. -- Section 711 (b) (1) (H) and (I) sets forth specific classes of deductions, the amount of which in any base period taxable year may be totally disallowed if abnormal for the taxpayer or disallowed to the extent of the excess over 125 percent of the average of such class if normal for the taxpayer. Section 711 (b) (1) (J) permits the classification of other deductions in accordance with these regulations. In any case, the amount of deductions of any class which may be disallowed shall be determined in the manner previously set forth in this section.
* * * *
Deductions which do not fall within either of the classes specified in section 711 (b) (1) (H) and (I) may be grouped by the taxpayer, subject to approval by the Commissioner on the examination of the taxpayer's return, in such other classes as are reasonable in a business of the type which the taxpayer conducts, and are appropriate in the light of the taxpayer's business experience and accounting practice. * * *
(b) Statement required. -- If in computing its excess profits net income for a taxable year in the base period, the taxpayer claims the disallowance under section 711 (b) (1) (H), (I), or (J)↩ of any amount previously allowed as a deduction, there shall be submitted a full statement showing the computation of the amount to be disallowed, the prices and gross sales of the taxpayer's product, and the condition of the taxpayer's business which demonstrate that the disallowed amount 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 * * *