*14 Decisions will be entered under Rule 50.
Petitioner held not to have established that its invested capital was abnormally low. (I. R. C., sec. 722 (c) (3).)
*365 In these consolidated proceedings, respondent determined deficiencies in petitioner's excess profits tax of $ 51.05 and $ 7,506.22 for the taxable years ended February 28, 1942, and February 28, 1943, respectively, and disallowed claims for refund in applications for relief filed by petitioner under section 722 of the Internal Revenue Code for the years ended February 28, 1942, February 28, 1943, February 29, 1944, February 28, 1945, and February 28, 1946. The issues relating to the deficiencies are not pressed, *15 and the only issue remaining is concerned with the disallowance of the claims for relief under section 722.
The proceeding was heard before Edward C. Radue as a commissioner designated for that purpose by the Court. Objections filed by the parties to the report of the commissioner have been carefully considered.
FINDINGS OF FACT.
The findings of fact of Commissioner Radue are hereby adopted as the findings of fact and are incorporated herein by this reference. The facts which we believe pertinent to the disposition of this case are less extensive and will suffice for present purposes.
The petitioner was incorporated under the laws of the State of Delaware on March 4, 1941. It filed its returns for the taxable years with the collector of internal revenue for the fifth district of New Jersey.
Petitioner's excess profits credits based on invested capital for the aforesaid taxable years are computed as follows: *366
| Fiscal years ended | |||
| 2/28/42 | 2/28/43 | 2/29/44 | |
| Average equity invested capital | $ 57,306.00 | $ 105,783.81 | $ 127,917.42 |
| Average borrowed invested capital | |||
| (50% of average borrowed capital) | 170,918.00 | 165,886.00 | 158,239.40 |
| Total invested capital allowed | |||
| as per revenue agent's report | 228,224.00 | 271,669.81 | 286,156.82 |
| Excess profits credit, 8% of invested | |||
| capital | 18,258.00 | 21,733.58 | 22,892.55 |
| Fiscal years ended | ||
| 2/28/45 | 2/28/46 | |
| Average equity invested capital | $ 158,943.41 | $ 198,978.67 |
| Average borrowed invested capital | ||
| (50% of average borrowed capital) | 156,849.14 | 146,805.48 |
| Total invested capital allowed | ||
| as per revenue agent's report | 315,792.55 | 345,784.15 |
| Excess profits credit, 8% of invested | ||
| capital | 25,263.40 | 27,662.73 |
In its applications for relief, the petitioner seeks to substitute, under the provisions of section 722 (c), excess profits credits based on income, using constructive average base period net income determined under subsection (a) of section 722, for its excess profits credits based on invested capital.
In these applications for relief, petitioner's claim for qualification was that its invested capital was "abnormally low" within the provisions of Internal Revenue Code, section 722 (c) (3). No other grounds were set forth in the applications; nor has there been any submission to or consideration of other grounds by the respondent.
Petitioner's business is the manufacture and sale of hose for petroleum products, principally gasoline hose, together with necessary accessories. Except for a period of about 5 weeks at the beginning*17 of its corporate existence, petitioner's principal place of business has always been at Dover, New Jersey.
Petitioner, a Delaware corporation, succeeded to the business of a New York corporation bearing a similar name, hereinafter referred to as the New York Company. J. M. Oden organized the New York Company in 1912. He owned, directly or indirectly, 14,221 shares of its 15,000 shares of outstanding stock. The New York Company also manufactured hose for petroleum products together with accessories therefor. Its principal place of business was in Brooklyn, New York, and major oil and pump companies were its principal customers.
On the death of J. M. Oden, his executors, who decided not to continue the operation of the business, endeavored to dispose of it. They had a cash offer of $ 200,000. They looked with favor upon its acquisition by key employees. Its Brooklyn plant property had been condemned by the city for housing purposes. It agreed to dissolve and sold its trade accounts receivable, inventories, machinery, and other operating assets for $ 300,000, in 6 per cent 10-year debenture bonds, to petitioner, which was organized by three key employees of the New York Company*18 joined by Douglas McReynolds, who had been a distributor in Illinois for the New York Company. The sales agreement limited petitioner's borrowing power, and compelled petitioner on the bondholders' request to pay over substantial portions of its net profits *367 and to provide the bondholders a voice in the management of petitioner.
Pursuant to the sales agreement petitioner was organized with a paid-in capital of $ 50,000. The par value of its stock was $ 20 per share.
Under the sales agreement McReynolds, who was the major stockholder, was designated as manager.
Petitioner acquired its Dover plant property for $ 45,000. The cash payment therefor of $ 15,000 was advanced to it by the New York Company and $ 30,000 obtained by a mortgage.
At the time the sales transaction took place between the New York Company and the petitioner, which was during a war period, it took considerably less money to get started in business, particularly a business producing material needed for war, than in ordinary times. A great many fortunes were made in the early war years on "shoestrings." During petitioner's first year in business, which is the taxable year ended February 28, 1942, it became*19 engaged in the production of facilities for national defense. The exact extent of petitioner's involvement in defense production during this taxable year is not shown in the record. Petitioner was heavily involved in defense production during the taxable years ended February 28, 1943, February 29, 1944, February 28, 1945, and February 28, 1946.
When the petitioner took over the business of the New York Company on March 1, 1941, it continued the same general type of business, including its line of various types of hose. Petitioner retained practically all of the New York Company's old customers and practically all of its personnel, when it moved to Dover. The companies which competed in the market for hose for petroleum products were Electric Hose & Rubber Company, The United States Rubber Company, and Hewit-Robbins. They were very much larger companies, had expensive lead presses, which neither petitioner nor the New York Company possessed, and made many products other than petroleum hose.
The machinery and equipment of the New York Company, during the base period, were at all times adequate to take care of its orders. The same basic machinery and equipment also adequately served*20 the needs of the petitioner during the period here involved despite the fact that its sales during this period were substantially higher than those of the New York Company during the base period years. The original cost of the New York Company's building, machinery, and equipment averaged $ 632,272.88 during the base period years and the cost of the land on which the building was located in Brooklyn was $ 73,517.25. The original cost of the petitioner's building, *368 machinery, and equipment averaged $ 256,561.44 during the 5 taxable years here involved and the land on which the building was located cost $ 2,300. The greater cost of the New York Company's building, land, machinery, and equipment over that of the petitioner did not give the New York Company any greater capacity for production than petitioner enjoyed. The difference in cost of the same machinery and equipment to the New York Company and the petitioner is due to the fact that the petitioner purchased same at secondhand values. The difference in costs of land and buildings is due to the fact that petitioner's land and building are located in the suburbs of New Jersey where real estate values were much cheaper*21 than in Brooklyn, New York. Judged solely by the criteria of the amount of capital required to produce the same amount of petroleum hose and accessories, the invested capital, both owned and borrowed, of the New York Company is not comparable to that of the petitioner in the taxable years here involved.
At the end of each base period year, the New York Company had the following totals of capital stock and surplus and the following amounts of borrowed capital:
| Capital stock | ||
| Year | and surplus | Mortgage payable |
| 1936 | $ 474,462.91 | $ 105,000 |
| 1937 | 483,808.63 | 101,000 |
| 1938 | 537,788.92 | 94,600 |
| 1939 | 502,947.26 | 88,200 |
The annual gross sales of the New York Company for the years indicated were as follows:
| 1936 | $ 863,338.31 |
| 1937 | 888,827.07 |
| 1938 | 680,305.03 |
| 1939 | 736,500.66 |
The annual net sales of petitioner for the periods indicated were as follows:
| Fiscal year | Amount |
| 1942 | $ 897,667.42 |
| 1943 | 1,261,898.51 |
| 1944 | 1,316,652.39 |
| 1945 | 1,547,008.21 |
| 1946 | 1,760,274.71 |
The fair market value of the assets purchased by the petitioner from the New York Company on March 1, 1941, for a consideration other than cash, did not exceed $ 200,000 which was the best cash*22 offer the New York Company had received for the assets. An appraisal made for insurance purposes in 1941 discloses reproductive and sound values aggregating substantially in excess of this amount.
*369 Petitioner has not established the existence of a qualifying factor for relief under the provisions of section 722 (c) of the Internal Revenue Code.
OPINION.
Because petitioner was not organized until after December 31, 1939, under Internal Revenue Code, sections 712 and 714, it was required to compute its excess profits tax credits based on invested capital. It is now seeking a higher excess profits credit based on a constructive average base period net income under the provisions of the Code, sections 722 (c) (1), 722 (c) (3) and 722 (a).
Petitioner's claims for relief make no reference to a claim under section 722 (c) (1), nor is there a showing of any waiver by the respondent which might eliminate the necessity for an explicit claim under this section. No issue with respect to section 722 (c) (1) is therefore properly before the Court. Angelus Milling Co. v. Commissioner, 325 U.S. 293">325 U.S. 293; Blum Folding Paper Box Co., 4 T. C. 795;*23 Hummel & Downing Co., 19 T.C. 61">19 T. C. 61.
Petitioner's case must, therefore, be considered only under section 722 (c) (3), which by its terms incorporates section 722 (a). That section (722 (c) (3)) provides that the tax on a taxpayer in petitioner's position shall be considered excessive and discriminatory "if the excess profits credit based on invested capital is an inadequate standard for determining excess profits because * * * (3) the invested capital of the taxpayer is abnormally low." If these requirements are met, the petitioner's burden then is to proceed to establish the fair and just amount representing normal earnings for use as a constructive average base period net income.
Petitioner has made no attempt to compare its invested capital with the invested capital of other corporations because it feels that its competitors in the manufacture of gasoline hose were so large and devoted to the manufacture of so many products other than gasoline hose that comparison would be fruitless.
Petitioner seeks to establish that its invested capital was abnormally low by a ratio showing of the average of its annual average equity invested capital to 100 per cent*24 of its annual average borrowed capital; and by a ratio showing of the capital stock and surplus and the mortgages payable of its predecessor corporation at the end of each of the base period years 1936 through 1939; and by a percentage comparison of the turnover of its capital in sales during its fiscal years 1942 through 1946 with that of its predecessor during the base period years. The authorities upon which petitioner relies for this procedure are: (1) That part of EPC 35 (1949-1 C. B. 134, 135, revising part VII (D) of the Bulletin on Section 722), which states:
*370 (D) Abnormally Low Invested Capital.
Section 722 (c) (3) deals with corporations having abnormally low invested capital. In such cases there must be present some identifiable abnormality in the taxpayer's business situation which affects the amount of its invested capital.
It is sufficient if the abnormality is established by analysis of the circumstances affecting the taxpayer's own invested capital, although comparisons with other corporations may be used. For example, the fact that invested capital is abnormally low might be established by showing an abnormally high ratio of *25 borrowed capital to total invested capital * * *
and (2) Regulations 112, section 35.722-4 (c), providing as follows:
(c) The invested capital of the taxpayer is abnormally low. If the type of business done by the taxpayer is not one in which invested capital is small but the invested capital of the taxpayer is unusually low because of peculiar conditions existing in its case, the excess profits credit based on invested capital will be considered an inadequate standard for determining excess profits. Thus, suppose that a corporation commenced business in 1941 with a leased plant valued at $ 1,000,000, but with equity invested capital and borrowed capital of only $ 40,000. If the invested capital of such company is unusually low relative to the size of its operations, its excess profits credit based on invested capital might be an inadequate standard for determining excess profits, and the taxpayer would be subject to an unreasonable tax burden if required to compute its excess profits tax under the invested capital method.
Under EPC 35, the problems of the norms of the ratio of borrowed capital to total invested capital, or possibly the norms of the turnover of capital*26 in sales, are merely substituted for the problem of ascertaining when invested capital is abnormally low. As to what these norms might be, the record is silent, except for the suggestion that the history of the New York predecessor supplies them. But that alone can hardly be indicative of what is normal.
There have been no adjudications which bear directly upon the present case. Cases dealing with "thin capitalization" as a factor in determining whether payments by corporation to stockholders were dividends or interest have been examined without finding any benefit to the taxpayer.
With the case in such a posture as this, i. e., the complete absence of any proof as to what normals might be, it is impossible for us to say that petitioner has met its burden and established that its invested capital was abnormally low in order to come within the provisions of section 722 (c) (3). Such a conclusion makes it unnecessary for us to resolve the difficult problem raised by respondent of whether in making the comparison of borrowed capital to total invested capital we are required to compare the full 100 per cent of average borrowed capital or the statutory 50 per cent thereof. Cf. Springfield Plywood Corporation, 18 T. C. 17,*27 which approves the conclusion of the Bulletin on Section 722, page 131, that the term "invested capital," as used in section 722 (c) (3), means the statutory invested capital, *371 which includes both equity invested capital and only 50 per cent of borrowed invested capital. Acceptance of respondent's position would, of course, greatly increase the percentages of petitioner's equity invested capital.
Petitioner's $ 300,000 debenture obligation, which was a factor in computing its invested capital, was $ 100,000 in excess of the fair market value of all the assets. Consequently, petitioner's contention that it had income-producing assets which it could not include in its invested capital, if such could be a consideration in view of our basic conclusion, lacks conviction.
Nor are we called upon to adjudicate the other issues presented, which are dependent on the initial premise.
Reviewed by the Special Division.
Decisions will be entered under Rule 50.