*84 Decision will be entered under Rule 50.
1. Held, petitioner, in 1940, acquired substantially all of the properties of a partnership bearing the same name in an exchange to which section 112 (b) (5), Internal Revenue Code, applies and petitioner is, therefore, an "acquiring corporation" within the meaning of section 740 (a) (1) (D), Internal Revenue Code, and is entitled to an excess profits credit based upon the average base period net income of the partnership adjusted as required by section 742 (g), Internal Revenue Code
2. Adjustments to the partnership's base period net income for the purposes of computing petitioner's excess profits credit for the years here involved, determined.
*857 This litigation involves deficiencies in income and excess profits taxes of petitioner for years and in amounts as follows:
| Year | Tax | Deficiency |
| 1942 | Excess profits | $ 36,394.78 |
| 1943 | Excess profits | 22,654.61 |
| 1944 | Excess profits | 20,627.07 |
| 1945 | Excess profits | 1,970.91 |
| 1945 | Income | 6,854.13 |
Many of the issues raised in the pleadings have been settled by stipulation of the parties. The primary question awaiting our consideration and disposition is whether petitioner's acquisition of its initial assets from a partnership of the same name qualified petitioner as an "acquiring corporation" within the intendment of section 740 (a)*86 ( 1) (D) of the Internal Revenue Code. Dependent upon our holding with respect thereto, other questions arise which involve the propriety of certain deductions under sections 742 and 711 of the Code, some of which questions have been settled by stipulation.
The parties have further stipulated that any unused excess profits credit to which we find petitioner to be entitled shall be computed under Rule 50 of this Court's Rules of Practice.
Also involved, and contingent upon our rulings herein, are certain claims for refund sought by petitioner, the bases for which were disallowed by respondent in his statutory notice.
FINDINGS OF FACT.
The stipulations of facts filed by the parties are adopted and by this reference made a part hereof.
*858 The petitioner, The R. & J. Furniture Company, is an Ohio corporation with its principal office at Canton, Ohio. The tax returns for the years here involved were filed with the collector of internal revenue for the eighteenth district of Ohio at Cleveland.
The R. & J. Furniture Company, a partnership (hereinafter referred to as the partnership), was organized April 11, 1932, under the firm name and style of Simons Furniture Company, which name*87 was later changed to R. & J. Furniture Company. The partnership consisted of Reuben F. Jacobson and Bennie Rudner, each of whom owned an equal interest therein at all times material hereto. The partnership commenced business in a rented building which it occupied continuously until its ultimate dissolution. During its existence, the partnership acquired additional properties adjoining the original building and expanded its facilities. Until June 1, 1940, on or about which date it transferred its assets to petitioner, it conducted in such premises the retail furniture business which was, at that time, and by such transfer, taken over by the petitioner.
The petitioner was incorporated on May 29, 1940. At the time the transfer took place, on or about June 1, 1940, the total book value of all the assets carried on the books of the partnership was $ 394,149.48, which assets included all of its real estate, including an elevator, at a total book value of $ 59,457.27. The total book value of the assets as shown on the closing balance sheet of the partnership which assets were transferred to the petitioner, excluding such real estate, was $ 334,692.21; its total liabilities were $ 118,692.21. *88 The only asset not transferred to petitioner was the fee in the above-mentioned real estate of the partnership. The instrument evidencing the transfer to petitioner reads, in part, as follows:
KNOW ALL MEN BY THESE PRESENTS
That we, Reuben F. Jacobson and Bennie Rudner, Partners, Doing Business Under the Firm Name and Style of R & J Furniture Company, a Partnership, Canton, Ohio,
in consideration of - - - Two Hundred and Sixteen (216) shares of the common capital stock of The R & J Furniture Company, a Corporation, the declared value of One Thousand Dollars ($ 1000.00) per share, issued and delivered to us, the receipt whereof is hereby acknowledged, do hereby Grant, Bargain, XXX and Convey to the said The R & J Furniture Company, a Corporation, Canton, Ohio, its successors and assigns, the following described personal property, to-wit:
The entire stock in trade, furniture, fixtures, equipment, motor vehicles, good will, insurance, leasehold estates, and any and all other assets, tangible and intangible, of every kind and nature used by them in the conduct of and pertaining to the furniture and house furnishing business located at 314 Cherry Ave. S. E., Canton, Ohio.
As *89 a part of the consideration herein and by acceptance hereof, the grantee assumes and agrees to pay all of the liabilities of said partnership as shown by *859 statement and balance sheet made by Schlanger & Mestel, Certified Public Accountants, in the sum of $ 118,692.21, to which statement and balance sheet reference is hereby specifically made.
In addition to the assets thus transferred, and as part of the consideration for the petitioner's issuance of its stock and assumption of the partnership's liabilities, the partnership also at the same time transferred to petitioner $ 83,016.90 face amount of accounts receivable previously charged off by the partnership. Neither the good will, or any value therefor, nor the charged-off accounts receivable, or any value therefor, was included on the closing balance sheet of the partnership or on the opening balance sheet of the petitioner.
The first meeting of the board of directors of petitioner was held on May 31, 1940. The corporate minutes of such meeting read, in part, as follows:
It was further brought to the attention of the Board of Directors that as a part of the consideration for said exchange, the said Reuben F. Jacobson*90 and Bennie Rudner, partners, doing business as R & J Furniture Company, being the owners in fee of parts of Lots Nos. 148, 149 and 164, and the said Bennie Rudner, as an individual, being the owner of part of Lot No. 149 in the City of Canton, Ohio, upon which the aforesaid business is conducted, will execute to this said corporation leases for all of said premises for such term and upon such conditions as the parties hereto shall hereafter mutually agree upon .
On or about June 1, 1940, the petitioner acquired possession and occupancy, as lessee, of all the real estate owned by the partnership. The consideration recited in the lease was, among other things, the payment of a monthly rental of $ 1,000, the payment of all water, gas, and electric bills, the payment of all expenses incurred in repairing and maintaining the buildings, and levies on the property including those levied upon the fee simple title, and the obligation to keep all the buildings and improvements fully insured and to pay the premiums for such purposes. The lease thus acquired was for an initial term of 5 years and gave the petitioner the right to 10 successive renewals for terms of 5 years each. The remaining*91 useful physical life of the buildings, and the remaining useful economic life of the land and buildings, was, on June 1, 1940, less than the 55 years for which the petitioner acquired the right to the possession and use thereof.
The petitioner took immediate possession of all of the real estate and has since had the entire possession and occupancy thereof, except for one building which petitioner subleased to another firm on or about January 1, 1942. The partnership never had possession of or occupied any part of the real estate at any time after May 31, 1940. It was dissolved immediately following the exchange, pursuant to an agreement of dissolution, and never engaged in any business of any kind at any time after May 31, 1940. Upon dissolution of the partnership on or about June 1, 1940, the fee title to all the real estate owned was *860 transferred to the two partners, as individuals, subject to the lease theretofore given by it to petitioner.
The business of petitioner is a continuation of the business conducted by the partnership. At the time of the exchange, petitioner issued 216 shares of stock. These shares were the only shares issued at that time by petitioner *92 and were issued in an equal number to each of the two partners of the partnership, except for two shares which were issued as qualifying shares. For a number of years prior to the exchange, and particularly during the years 1935 through 1939 and up to the time of the exchange, the partnership did a large amount of advertising through the media of newspapers, radio, billboards, and direct mail. It also carried on extensive business promotional activities. It developed and advertised certain business slogans, such as "R. & J. Leads the Way," "Out of the High Rent District," "Stark County's Largest and Friendliest Home Furnishing Institution," through which its business became widely known. From January 1, 1935, through May 31, 1940, the partnership built up a large list of customers, of which it kept record from 1934 to the time of the exchange. The number of customers increased from year to year and on May 31, 1940, the partnership's record thereof contained 14,979 names. The advertising and promotional activities carried on by the partnership resulted in a profitable business and established a big amount of good will with the public. The partnership's sales increased from $ *93 157,174.96 in 1933 to $ 437,214.26 in 1939. During the first 5 months of 1940, its sales totaled $ 196,832.81. Its advertising was a major factor in the growth and promotion of its business. The business slogans and the record of customers' names were turned over to petitioner by the partnership at the time of the exchange, and petitioner has continued and continues to use such slogans and record in its advertising and business promotional activities. Two of the slogans were registered by the petitioner in 1946 with the Secretary of State of Ohio. Many of the customers whose names were on the record thus turned over to petitioner by the partnership are active customers of petitioner at the present time. At the time of the exchange, the partnership transferred 4,153 active accounts to petitioner. From 1935 to 1940, inclusive, the partnership almost doubled its floor space and the number of its employees increased from a base period low of 26 at the end of 1937 to 51 at the end of 1940.
The accounts receivable, in the face amount of $ 83,016.90, previously charged off by the partnership and transferred to the petitioner in the exchange, but which were not included, nor any value*94 shown therefor, on the closing balance sheet of the partnership or on the opening balance sheet of petitioner, were accounts for merchandise sold on credit by the partnership. Such accounts were all secured by chattel *861 mortgages, and had a value of approximately $ 50,613.10 as of the date of the transfer. Collections made by petitioner thereon, after the transfer thereof to petitioner, totaled $ 62,046.78. In addition thereto, merchandise, the retail selling price for which had been approximately $ 6,000 or $ 7,000, was recovered by petitioner on such accounts.
The net earnings of the partnership for each of the years 1935 to 1939, inclusive, and for the 5 months from January 1, 1940, through May 31, 1940, were as follows:
| Year | Net earnings |
| 1935 | $ 55,001.94 |
| 1936 | 79,277.20 |
| 1937 | 62,280.06 |
| 1938 | 19,858.54 |
| 1939 | 79,757.48 |
| 1940 (Jan. 1 to May 31) | 26,752.72 |
The capital invested in the partnership during each of the years 1935 to 1939, inclusive, and during the first 5 months of 1940 was as follows:
| At Dec. 31, 1934 | $ 121,121.73 |
| At Dec. 31, 1935 | 166,560.22 |
| At Dec. 31, 1936 | 171,351.36 |
| At Dec. 31, 1937 | 209,367.36 |
| At Dec. 31, 1938 | 205,545.75 |
| At Dec. 31, 1939 | 262,161.81 |
| At May 31, 1940 | 275,457.27 |
| Total for seven different consecutive closing | |
| dates during above period | $ 1, 411,565.50 |
| Average invested capital for entire period | $ 201,652.22 |
*95 The net income of the partnership during each of the base period years, exclusive of any adjustments permitted under section 711 (b) (1) (J) and (K), Internal Revenue Code, was as follows:
| Year | Net income |
| 1936 | $ 79,277.20 |
| 1937 | 62,080.06 |
| 1938 | 19,858.54 |
| 1939 | 79,757.48 |
From the time it was organized up until October 27, 1937, the partnership had regularly followed the charge-off method of deducting bad debts for income tax purposes. On October 27, 1937, it obtained the consent of the respondent to change its method of deducting bad debts to the reserve method. Thereafter, until its dissolution on or about May 31, 1940, the partnership used such reserve method of deducting bad debts. The change was made on December 31, 1937, by which date debts determined to be bad and charged off in 1937 totaled $ 40,610.68. In making the change a reserve for bad debts was set up on the partnership's books in the amount of $ 96,234.96. The *862 debts previously determined to be bad and charged off during the year were debited thereto leaving a balance in the reserve of $ 55,624.28, such balance representing 20 per cent of the accounts receivable outstanding on the books at December*96 31, 1937. Entitlement to the deduction of the reserve so set up was sustained in Bennie Rudner, 47 B. T. A. 35.
The sales of and the bad debt deductions allowed to the partnership for the years 1933 to 1939, were as follows:
| Year | Sales | Bad debts |
| 1933 | $ 157,174.96 | $ 10,295.02 |
| 1934 | 195,947.27 | 8,720.83 |
| 1935 | 226,959.92 | 10,302.38 |
| 1936 | 333,452.19 | 31,921.94 |
| 1937 | 404,336.41 | 96,234.96 |
| 1938 | 265,920.93 | 39,830.20 |
| 1939 | 437,214.26 | 32,104.92 |
The deductions allowed petitioner for bad debts during the years here involved were as follows:
| 1942 | $ 44,075.21 |
| 1943 | 31,804.26 |
| 1944 | 28,092.74 |
| 1945 | 39,050.26 |
Prior to 1936 there were no Federal or Ohio State unemployment insurance taxes provided by law. For the base period years 1936 to 1939, inclusive, the partnership paid and took deductions for the following Federal and State unemployment taxes which it paid at the following rates on its payroll to the Federal and State governments:
| Unemployment | ||
| insurance tax | ||
| Rate | ||
| Year | per cent | Amount |
| 1936 | 1 | $ 393.55 |
| 1937 | 2 | 1,020.36 |
| 1938 | 3 | 1,250.45 |
| 1939 | 3 | 1,779.85 |
For the years 1941 to 1945, inclusive, the petitioner paid out*97 and took deductions for such taxes, as follows:
| Unemployment | ||
| insurance tax | ||
| Rate | ||
| Year | per cent | Amount |
| 1941 | 3.0 | $ 2,451.57 |
| 1942 | 1.2 | 884.13 |
| 1943 | 1.4 | 942.38 |
| 1944 | 1.2 | 867.85 |
| 1945 | 1.2 | 838.56 |
To determine the net income of the partnership as though it had been a corporation during the base period years, charges are required against its net income as shown above for State of Ohio franchise tax *863 and for Federal capital stock tax for each of the base period years in amounts as follows:
| State of Ohio | Federal capital | |
| Year | franchise tax | stock tax |
| 1936 | $ 166 | $ 390 |
| 1937 | 171 | 360 |
| 1938 | 209 | 360 |
| 1939 | 205 | 396 |
The amounts paid to the partners during the base period prior to any division of profits and which were designated as "salaries" on the partnership books, were as follows:
| Year | Bennie Rudner | R. F. Jacobson |
| 1936 | $ 1,900.00 | $ 3,720.00 |
| 1937 | 1,308.32 | 5,233.33 |
| 1938 | 1,300.00 | 5,200.00 |
| 1939 | 1,300.00 | 5,200.00 |
The actual salaries paid the two ex-partners as officers of the corporate petitioner during the years 1941 through 1945 totaled $ 35,833 annually. On its excess profits tax returns for the years 1942 *98 and 1943, the petitioner, having assumed the status of an acquiring corporation, made an adjustment to the base period net income of the predecessor partnership for "officers' salaries" in the amount of $ 35,833.
The petitioner divested itself of the used furniture department of its business as of January 1, 1942. Prior to this date and during the base period date, such a department was operated by it and its predecessor, the partnership.
Substantially all of the partnership's properties were acquired by petitioner in 1940 solely in exchange for its stock.
OPINION.
It is petitioner's position that, for excess profits tax purposes, it is entitled to compute its excess profits credit for the years involved under the income method provided in section 713, Internal Revenue Code, 1 using as its average base period net income the earnings of the partnership during the years 1936 to 1939, inclusive. For petitioner to prevail, the transaction by which it acquired its initial assets must be shown to have been such as to qualify petitioner as an "acquiring corporation" within the meaning of section *864 740 (a) (1) (D) of the Internal Revenue Code. 2*100 So to qualify, two statutory prerequisites*99 must be met. First, petitioner must have acquired "substantially all" of the properties of the partnership. Second, the transfer wherein such acquisition was achieved must have constituted an exchange to which the provisions of section 112 (b) (5)3 of the Code, "* * * or so much of section 112 (c) or (e) as refers to section 112 (b) (5), or to which a corresponding provision of a prior revenue law, is or was applicable."
The question posed as to whether petitioner acquired "substantially all" of the partnership's properties is essentially one of fact to be resolved as an ultimate conclusion based upon the peculiar facts and circumstances attending the transfer with which we are concerned. Cf. Peabody Hotel Co., 7 T. C. 600. The important factors to be considered in arriving at such conclusion include the nature of the properties retained by the partnership, *101 the purpose for which they were so retained, and the amount thereof. Milton Smith, 34 B. T. A. 702. As we said in Daily Telegram Co., 34 B. T. A. 101, at page 105:
The term "substantially all" is a relative term, dependent on the facts of any given situation. It is obvious that what might in one case, with a certain total of property involved, constitute substantially all of such property, might be but a small part of the total property involved in another case. In the present case a reading of the instrument in question leaves one with the impression that petitioner undertook to transfer substantially all of its properties. The evidence is that the agreement was substantially carried out and that thereafter petitioner had only "a few thousand dollars in real estate properties * * *." This was the testimony of one of the two owners of petitioner, who was also a party to the agreement. Giving this expression its normal meaning and considering the total amount of property involved, we have concluded and found as a fact that the new corporation acquired substantially all of the properties of petitioner. * * *
Although*102 the foregoing involved the meaning of the term "substantially all" as used in a different statute, the same reasoning and principle *865 there applied is applicable here. With such rationale in mind, we examine the record here made.
The petitioner was incorporated in 1940 to take over and continue the retail furniture business theretofore actively carried on by the partnership since the formation thereof in 1932. At the time of the exchange here in question, the gross assets of the partnership, exclusive of any value to be attributed to good will or certain accounts receivable theretofore written off, had a total book value of $ 394,149.98. Of this amount of assets, $ 334,692.21, or approximately 85 per cent thereof, was transferred to petitioner. The partnership's good will, as well as its previously charged-off accounts receivable in the face amount of $ 83,016.90, the respective values of which were not included in the amount of the foregoing assets, were also transferred to petitioner. Uncontradicted evidence establishes the value of such receivables at the time to have been approximately $ 50,613.10. As in Daily Telegram Co., supra, so*103 here, a reading of the instrument of transfer leaves us with the impression that the partnership undertook to transfer substantially all of its properties. In fact, there appears to be no question that the only asset of the partnership not so transferred to petitioner, was the fee in the real estate which was owned and occupied by the partnership and which, together with an elevator, had a book value of $ 59,457.27. The real estate, the fee to which was thus retained by the partnership, was leased to petitioner and used by it in its business. Under this lease, petitioner had the right to possess, occupy, and use such real estate for a period of 55 years, or for a longer period than the useful physical and economic life thereof. Leaseholds for such an extended period of time have been administratively classified in Regulations 111, section 29.112 (b) (1)-1, and the predecessors thereof, as property of a like kind with and the equivalent of a fee in real estate within the purview of the taxing statute. See Century Electric Co., 15 T. C. 581; cf. also Standard Envelope Mfg. Co., 15 T. C. 41. The validity of the cited *104 regulation is no longer open to question. Century Electric Co., supra; see also Commissioner v. Crichton, 181">122 F. 2d 181, affirming 42 B. T. A. 490. Thus, it appears that petitioner acquired a leasehold interest in the property, the bare fee of which was retained, and, which, if not the equivalent of a fee, constituted substantially all of the partnership's interest therein.
It is the position of the respondent, however, that the leasehold estate was acquired by petitioner, not for stock, but for a separate continuing obligation to pay a substantial rent as long as petitioner occupied and used the premises. True, the lease as executed recites as consideration therefor the payment of rent and all other expenses with respect to the property. But, from the evidence it seems clear that the leasehold estate, which, as we have pointed out, was substantially *866 equal to the fee, was obtained by petitioner in exchange for its stock. The consideration recited in the actual lease instrument was the right to retain the leasehold estate thus obtained. A similar principle applies when leasehold*105 estates are sold, as they often are. In such cases, the consideration involved is other than the rent, etc., stipulated in the instrument of lease. With respect to the question involving the transfer of the partnership's good will, respondent, while conceding on brief that petitioner acquired all of such good will in some manner, not only disputes the propriety of the value assigned thereto by petitioner, but also argues that the transfer of the entire amount thereof was not made solely in exchange for stock.
The evidence of record bearing upon the value of the good will of the partnership shows that the partnership was at all times a going and prosperous concern from and after its formation in 1932. It never sustained an operating loss and always made substantial profits. Moreover, the business carried on by the partnership appears to have been generally stable in that the wares sold by it were not subject to violent price fluctuations. In short, all the facts here give the partnership a financial history of a going, prosperous concern with the number of customers and its business generally increasing. These facts, based upon the undisputed evidence before us, all have a direct*106 bearing upon the value of the partnership's good will. There are many methods of determining such value. One method is by applying the venerable formula set out in A. R. M. 34, 2 C. B. 31. The value of $ 310,488.13 assigned to the intangible asset of the partnership as of the time of its transfer, and here advocated by petitioner, was so determined. Respondent urges that expert testimony as to what a willing buyer would pay for the business as a going concern is the best evidence of the value of the good will thereof, and that no such testimony has been here presented. The absence of such testimony is not fatal, however. Absent an actual arm's-length sale as a comparative, the testimony of an expert witness is little, if anything, more than an opinion formed after consideration of the same financial history which we have before us. Moreover, the book value of many of the partnership's assets used in petitioner's determination may have, in some situations, probative weight comparable with opinion evidence in respect to value. We do not believe we are required to fix a precise value of the partnership's good will on the date it was transferred to petitioner. *107 Suffice it to say, it was very considerable and added to the value of the transferred assets in a substantial amount.
On the record here made we have come to the ultimate conclusion and found as a fact that petitioner acquired substantially all of the partnership's properties in 1940 solely in exchange for stock. Moreover, immediately after the exchange the partners were in control of *867 petitioner and the stock received by each was substantially in proportion to his interest in the partnership properties prior to the exchange. This being true, the transaction was an exchange to which section 112 (b) (5) is applicable. It follows, and we therefore hold, that petitioner is an "acquiring corporation" within the meaning of section 740 (a) (1) (D); the partnership is a component corporation within the provisions of section 740 (b) (5) and petitioner is entitled to an excess profits credit for the years involved based upon the average base period net income of such component corporation adjusted as required by section 742 (g) of the Code. 4 See also Faigle Tool & Die Corporation, 7 T. C. 236.
*108 The computations of the various adjustments thus required are made just as if the partnership had been a corporation during the base period years. Section 742 (g), supra. The parties are in agreement as to the adjustment to be made with regard to the Ohio State franchise tax and the Federal capital stock tax, and the respective amounts thereof.
Among adjustments as to which the parties are in disagreement are the officers' salaries; the adjustment, if any, to be made with regard to a certain bad debt expense deduction allowed petitioner's predecessor partnership for the year 1937; and the adjustment, if any, to be made in connection with deductions allowed the partnership during the base period years 1936 to 1939, inclusive, for Federal and State of Ohio unemployment insurance taxes.
The computation of the base period net income of the partnership, which, for our purposes, is a component corporation of petitioner, must reflect a reasonable deduction for salary or compensation to each partner. See Regulations 112, section 35.742-1 (b) (2), 5 the *868 pertinent portion of which appears in the margin. The question of what would have constituted reasonable salaries for officers*109 during the base period had the partnership been a corporation is one of fact and the burden of establishing such reasonableness is upon the taxpayer.
To this end, petitioner*110 has produced evidence that the partners were paid in each base period year, before any division of profits, amounts which were designated as salaries on the partnership books and which, in the aggregate, ranged from approximately $ 5,600 to approximately $ 6,500 per year. It is petitioner's contention that this evidence of what was actually paid the partners in the base period years constitutes the best evidence of the "reasonable deduction" for salaries, and that such payments should be used in computing the base period net income of the partnership under section 742, supra. The situation here is just the converse of that usually made in determining salaries. Here it is to petitioner's advantage to establish the reasonableness of small salaries, while respondent argues for high salaries. But the tests of reasonableness are still the same as in income deduction cases.
The record is devoid of any evidence bearing upon a number of important factors usually considered essential in determining the reasonableness of salaries. Moreover, petitioner's contention as to the weight to be given to the salaries actually paid by the partnership is deprived of much of its probative force*111 by the fact that, when, again as its own assessor, it prepared and filed its initial excess profits tax return for 1942 and again for 1943, it considered $ 35,833, the figure here advocated by respondent, as a reasonable allowance for officers' salaries in adjusting the base period net income of the partnership for the purposes of computing its excess profits credit based thereon. D. & N. Auto Parts Co., 8 T.C. 1192">8 T. C. 1192.
We are of the opinion that, on this point, petitioner has failed to prove its case. That being true, we have no alternative to sustaining the respondent.
We turn now to the question of whether any part of the bad debts deductions, allowed the partnership for 1937, may be disallowed for the purposes of computing excess profits credit based on income. The pertinent provisions of the Code are section 711 (b) (1) (J) and (K). 6
*112 *869 In 1937, the partnership changed from the charge-off method of deducting bad debts, which method it had regularly followed from the time of its organization, to the reserve method of deducting bad debts. This change was effected as of December 31, 1937, pursuant to permission earlier obtained from respondent. In making the change, a reserve for bad debts was set up on the partnership's books in the amount of $ 96,234.96. The debts previously determined to be bad and charged off during that year, in the aggregate amount of $ 40,610.68, were debited thereto. The balance of $ 55,624.28 thus remaining in the reserve represented 20 per cent of the accounts receivable outstanding at December 31, 1937. The partnership's right to deduct the entire amount of the reserve in its returns for 1937 was sustained in Bennie Rudner, 47 B. T. A. 35, wherein it was said that:
There can be no question that $ 96,234.96, the amount of the deduction claimed, covers the bad debt requirements of the partnership for a two-year period and that deduction of the full amount in 1937 results in the distortion of net income for that year. It is the logical result, *113 however, of the change from the specific charge-off method to the reserve method of accounting for bad debts and is in keeping with the decisions * * *.
Petitioner argues that the findings of fact, opinion, and the decisions cited in the foregoing case make both the question of abnormality of the deduction, as well as the cause of such abnormality, res judicata here. We do not feel that a definite ruling by us on that question is necessary to a proper disposition of the question before us. While we *870 do not agree with petitioner's contention that the evidence shows the deduction to have been abnormal as to class, the evidence adduced does clearly show that the deduction in controversy was abnormal in amount, in that it was in excess of 125 per centum of the average of the bad debts deductions for the preceding 4 taxable years by the amount of $ 77,097.41. Moreover, petitioner has also affirmatively proven that such abnormality was a consequence of something other than those factors proscribed by section 711 (b) (1) (K) (ii). William Leveen Corporation, 3 T.C. 593">3 T. C. 593.
Respondent draws no support from Crow-Burlingame Co., 15 T. C. 738,*114 which he cites, inasmuch as we are unable to subscribe to his contention that the partnership's change in the accounting procedure by which it deducted bad debts comes within the proscription of the pertinent statute as constituting a change in the manner of operation of its business.
Accordingly, we hold that the abnormal deduction for bad debts allowed the partnership in 1937 should be disallowed in computing petitioner's excess profits credit based on income to the extent of the amount by which such deduction was in excess of 125 per centum of the average amount of bad debts deductions for the four previous taxable years as further limited by section 711 (b) (1) (K) (iii).
There remains the question of whether any part of the deductions for Federal and State of Ohio unemployment taxes allowed the partnership during the years 1936 through 1939 should be disallowed in the computation of petitioner's excess profits credit based on income pursuant to section 711 (b) (1) (J) and (K), the pertinent portions of which are set forth supra in footnote 6.
During the base period years, petitioner's predecessor and component corporation, the partnership, paid Federal and State of Ohio unemployment*115 insurance taxes at various rates and in varying amounts. Such rates and the amounts so paid are set forth above in our Findings of Fact.
Petitioner contends that the deductions for such taxes paid were abnormal in amount. It has, on brief, computed, in accordance with the limitations contained in section 711 (b) (1) (J) (ii) and K (iii), supra, the amounts of the abnormalities which it maintains should be disallowed in determining its excess profits credit for each of the years here under review. We have checked the petitioner's mathematical computations and are satisfied as to their accuracy and as to the propriety of the method employed therein. See Harris Hardwood Co., 874">8 T. C. 874. But, as pointed out in the Harris case, such amounts are to be eliminated from the partnership's deductions for the base period years in computing petitioner's excess profits credit for the excess profits tax years involved only if petitioner has established that the *871 abnormalities or excesses are not the consequences of any of the proscriptions contained in section 711 (b) (1) (K) (ii). This, in our opinion, petitioner has failed to do.
During the*116 base period years and up until about January 1, 1942, the business carried on first by the partnership and later by petitioner included a used furniture department. As of January 1, 1942, petitioner divested itself of this department, and, for aught the record shows, some part of the amount by which the deductions for unemployment tax in the base period years was in excess of such deductions for the excess profits tax years involved may have been due to this change in the size of petitioner's business. At least petitioner has failed to prove otherwise. Therefore, no part of the deductions in question may be disallowed. See Iron Fireman Manufacturing Co., 5 T.C. 452">5 T. C. 452.
All stipulations and concessions of the parties will be reflected in the Rule 50 recomputation consequent hereon. Proper effect will be accorded any unused excess profits credit to which recomputation shows petitioner to be entitled.
Decision will be entered under Rule 50.
Footnotes
1. SEC. 713. EXCESS PROFITS CREDIT -- BASED ON INCOME.
(a) Amount of Excess Profits Credit. -- The excess profits credit for any taxable year, computed under this section, shall be --
(1) Domestic Corporations. -- In the case of a domestic corporation --
(A) 95 per centum of the average base period net income,
(B) Plus 8 per centum of the net capital additions as defined in subsection (g), or
(C) Minus 6 per centum of the net capital reduction as defined in subsection (g).
* * * *↩
2. SEC. 740. DEFINITIONS.
For the purposes of this Supplement --
(a) Acquiring Corporation. -- The term "acquiring corporation" means --
(1) A corporation which has acquired --
* * * *
(D) substantially all the properties of a partnership in an exchange to which section 112 (b) (5), or so much of section 112 (c) or (e) as refers to section 112 (b) (5)↩, or to which a corresponding provision of a prior revenue law, is or was applicable.
3. SEC. 112. RECOGNITION OF GAIN OR LOSS.
(b) Exchanges Solely in Kind. --
* * * *
(5) Transfer to corporation controlled by transferor. -- No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange. * * *↩
4. SEC. 742. SUPPLEMENT A AVERAGE BASE PERIOD NET INCOME.
In the case of a taxpayer which is an acquiring corporation, its average base period net income (for the purpose of the credit computed under section 713) shall be the amount computed under section 713 or the amount of its Supplement A average base period net income, whichever is the greater. The Supplement A average base period net income shall be the amount computed without regard to subsection (h) of this section or computed under subsection (h) of this section, whichever is the greater. The Supplement A average base period net income shall be computed as follows:
* * * *
(g) In the case of a partnership which is a component corporation by virtue of section 740 (b) (5), the computations required by this Supplement shall be made, under rules and regulations prescribed by the Commissioner with the approval of the Secretary, as if such partnership had been a corporation. For the purpose of such computations, in making the adjustment for income taxes required by section 711 (b) (1) (A)↩, the partnership so regarded as a corporation shall be considered as having distributed all its net income as a dividend.
5. SEC. 35.742-1. General Rules for Determining Supplement A Average Base Period Net Income. -- * * *
(b) General average method. -- * * *
(2) Determination of excess profits net income or deficit in excess profits net income of acquiring corporation and each component corporation. -- * * *
In the case of a component corporation which is a partnership * * * its excess profits net income or deficit in excess profits net income for each taxable year in the base period shall be determined as though such partnership * * * had been a corporation for each such year. Among the adjustments which are necessary in computing the excess profits net income or deficit in excess profits net income are the following:
(I) A reasonable deduction for salary or compensation to each partner * * * for personal services actually rendered shall be allowed;↩
6. 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):
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(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 the amount equal to such excess.
(K) Rules for Application of Subparagraphs (H), (I), and (J). -- For the purposes of subparagraphs (H), (I), and (J) --
(i) If the taxpayer was not in existence for four previous taxable years, then such average amount specified in such subparagraphs shall be determined for the previous taxable years it was in existence and the succeeding taxable years which begin before the beginning of the taxpayer's second taxable year under this subchapter. If the number of such succeeding years is greater than the number necessary to obtain an aggregate of four taxable years there shall be omitted so many of such succeeding years, beginning with the last, as are necessary to reduce the aggregate to four.
(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.↩