*160 Decision will be entered for the respondent.
Prior to 1938, petitioner had paid some voluntary pensions on a year-to-year basis to a limited number of its retired employees. It did not have any funded group annuity system. In 1938, it entered into group annuity contracts with several insurance companies to provide pensions and annuities for all of its employees in the United States and Canada. Under these contracts payments were made as follows: Payment was made in 1938 of a single premium to purchase annuities for retired employees who were receiving voluntary pensions and for employees who would be eligible to retire by December 31, 1938. Payments were made in 1938 and 1939 for future service retirement annuities which were to provide benefits for continuing employees based on service after 1938. Payments were made in 1938 and 1939 for past service retirement annuities to provide benefits for continuing employees based on service prior to 1938. Held, under section 711 (b) (1) (J), 1939 Code, the deductions for expenditures by petitioner for voluntary pensions, funded pensions, past service retirement annuities, and future service retirement annuities in the base period*161 years 1936-1939, inclusive, constituted a single class of deductions. Held, further, this class was normal for petitioner and does not qualify for relief under section 711 (b) (1) (J) (i).
*626 The issues to be decided relate to petitioner's excess profits tax liability for the fiscal years ended June 30, 1943 and 1944. The petitioner filed refund claims for those years which were disallowed in part. The Commissioner allowed refunds*162 of $ 802,015.97 and $ 555,018.10, respectively, for the fiscal years 1943 and 1944. Petitioner claims that it is entitled to additional refunds for each taxable year under its duly filed claims. Petitioner contends that the Commissioner improperly disallowed its claims for excess profits tax relief to the entent of approximately $ 365,652.26 and $ 73,239.93 for the fiscal years ended June 30, 1943 and 1944.
The question presented involves the proper classification of payments made by petitioner for pensions and retirement annuity premiums in the base period years 1936 to 1939, inclusive, under section 711 (b) (1) (J) of the Internal Revenue Code of 1939.
FINDINGS OF FACT.
The petitioner is a New Jersey corporation having its principal office at Chicago, Illinois. The returns and amended returns for the *627 taxable years were filed with the collector of internal revenue for the first district on Illinois.
Petitioner and its predecessors have continuously operated cereal mills since before the Civil War. It produces such well known food products as Quaker and Mother's Oats; Aunt Jemima Ready-Mixes; Quaker Puffed Wheat and Rice; Quaker Corn Meal and Hominy Grits; Muffets brand*163 Shredded Wheat; Pettijohns Rolled Wheat; Scotch brand Pearled Barley; Quaker Farina, Quaker Macaroni, Egg Noodles and Spaghetti, Quaker, Red Top and Aunt Jemima Flour; Ken-L-Ration, Ken-L-Bisket, and Ken-L-Meal dog foods; and a complete line of animal and poultry feeds principally marketed under the Ful-O-Pep and Quaker brands. All of these products, with the exception of the Ken-L products, have been manufactured and distributed by petitioner for the entire period under consideration, i. e., subsequent to the year 1931. Petitioner began its manufacture and sale of Ken-L products in 1942.
Petitioner operates plants in the United States and in Canada and, therefore, it has employees in both countries.
Prior to September 1, 1938, petitioner did not have any fixed basis for the granting of pension allowances to its employees upon retirement. However, in a limited number of special situations, petitioner, on a voluntary basis, paid pensions to some but not all of the persons retired from its employment, or to widows of persons formerly employed, each case being considered separately. These grants were awarded by petitioner's executive committee, after consideration of requests made*164 by the supervisors of the persons concerned. The pensions were based on financial need, and they continued from year to year at the will of the petitioner. The payments were in no way legally binding obligations of petitioner. There was no publication of the fact that certain individuals who were in need were receiving pensions.
Such voluntary pension payments to selected former employees were continued until September 1, 1938, the date when petitioner purchased annuities for retired persons, former employees, and instituted fixed pension and retirement arrangements which are discussed hereinafter. The only voluntary pensions paid after that date were to other persons, not in its service, who, by reason of early retirement because of disability, or in cases of hardship or personal catastrophe, were found to be in need; and in certain cases, voluntary pensions were paid to the widows of deceased employees.
*628 Payments for voluntary pensions 1 made by petitioner during the years 1932-1944, inclusive, were as follows:
| Year | Amount |
| 1932 | $ 77,022.67 |
| 1933 | 79,702.22 |
| 1934 | 98,720.01 |
| 1935 | 85,030.03 |
| 1936 | 108,688.84 |
| 1937 | 132,233.94 |
| 1938 | 122,412.17 |
| 1939 | 11,296.69 |
| 1940 | 1 |
| 1941 | 11,080.99 |
| Jan. 1 to June 30, 1942 | 8,676.58 |
| July 1 to June 30, 1943 | 17,561.29 |
| July 1 to June 30, 1944 | 21,875.85 |
Such payments of pensions in petitioner's books of account were charged to account No. 818037 -- "Pensions." This was an operating expense account, a subaccount of account No. 818000 -- "General Expenses United States." Prior to January 1, 1937, the accounts were unnumbered. The general expense account was a part of the operating income account used to determine profit or loss from operations. Pensions were similarly reflected in the annual reports of petitioner, being used in the determination of earnings from operations. In petitioner's tax returns for the pertinent years the above-described payments for pensions were deducted as a part of the item "Other Deductions Authorized by Law" and were included as a part of "General and Office Expense" in the subschedule to this item.
On May 21, 1937, the board of directors of petitioner adopted a policy to provide for the retirement from active service of its employees. *166 In general, it was agreed that a plan would be applicable, at the ages of 65 for males and 60 for females, to all officers and employees of the company and its subsidiaries, excepting only those from time to time exempted or whose services might be specifically continued beyond the stated ages by action of the board of directors or of the executive committee. The board of directors requested and authorized the executive committee of petitioner to proceed with the preparation of a pension plan.
Petitioner's executive committee consulted with the Prudential Insurance Company of America and the Metropolitan Life Insurance Company, and in due course a group annuity contract was applied for and a contract was executed by petitioner and those insurance companies. Although the contract was not executed until December *629 27, 1938, it was made effective as of September 1, 1938, and prior to December 27, 1938, petitioner's directors and stockholders approved a plan and authorized the making of certain payments by petitioner.
In Quaker Oats Company's "Application for Group Annuity Contract" it is stated that Prudential and Metropolitan each shall be liable under such group annuity *167 contract only for that part of the retirement annuity benefits or other payments puchased by or arising out of the share of the total considerations that have been or shall have been paid thereunder by the employer to it as its share and received by it as its share; and that the respective liabilities under the group annuity contract of Prudential and of Metropolitan shall be several and not joint. The application stated, further, that such application was made for a group annuity contract, with considerations payable in advance, providing for retirement annuities for a group of employees of the employer; and that the form of the group annuity contract applied for was that which had been prepared and designated by Prudential and Metropolitan as No. GA-904-157-J. It was stated in the application, also, that the employer agreed that the group annuity contract would not become effective unless at least 75 per cent of the employees eligible for coverage for future service annuities made application for such coverage; that the employer agreed to submit to the insurance companies all proposed forms of announcements to the employees relative to the "Plan of Retirement Annuities" as defined*168 in the group annuity contract; that the employer would announce promptly to the employees any change in the plan or suspension in payment of considerations under the group annuity contract; and that the employer would allow all employees, who were eligible, to participate therein without regard to their affiliation or nonaffiliation with any organization or association whatsoever.
The application was accepted by both insurance companies.
The contract recites that each insurance company, for itself but not for the other insurance company, is obligated severally to make its share of the payments to annuitants of retirement annuity benefits, as provided under the contract. The contract states, in part, as follows:
THE AGGREGATE CONSIDERATION for Future Service Annuity hereunder on any Due Date is the sum of (1) the Contributing Employees' monthly Contributions as hereinafter provided and (2) the Employer's monthly Future Service Contributions as hereinafter provided; and such aggregate Consideration shall be due and payable on each Due Date by the Employer to the Insurance Companies, the first payment being due on the Effective Date hereof. Any Considerations paid hereunder for Past*169 Service Annuity for any person eligible therefor shall be paid to the Insurance Companies by the Employer *630 on or before the Effective Annuity Date of such person. Payment to the Insurance Companies of each Consideration shall be made by payment of The Prudential's share of such Consideration to The Prudential at its Home Office in exchange for its official receipt in respect of its share, and by payment of the Metropolitan's share of such Consideration to the Metropolitan at its Home Office, in exchange for its official receipt in respect of its share.
THE RETIREMENT ANNUITY BENEFITS to be provided, in accordance with the Plan, for the several Active Employees covered hereunder consist of Past Service Annuities and Future Service Annuities as specified in the Plan. The Prudential and the Metropolitan shall each be liable only for that part of the Retirement Annuity Benefits or other payments hereunder purchased by or arising out if its share, as herein defined, of the total Considerations that have been or shall have been paid hereunder and received by it in accordance with the preceding paragraph, and the liabilities hereunder of The Prudential and of the Metropolitan *170 shall be several, not joint. Neither The Prudential nor the Metropolitan shall be liable for any part of the Retirement Annuity Benefits hereunder for which the appropriate Consideration shall not have been paid hereunder by the Employer and received by The Prudential and the Metropolitan respectively.
The insurance contract provided, further, among other things, as follows: The contract contains various definitions. Contract year is the calendar year, January 1 through December 31, except that the first contract year is from September 1, 1938, through December 31, 1938. Among definitions are the following:
E. FUTURE SERVICE ANNUITY, PAST SERVICE ANNUITY AND RETIREMENT ANNUITY: "Future Service Annuity," as used herein, shall mean the annuity provided hereunder in respect of employment of a Contributing Employee on and subsequent to the Effective Date hereof. "Past Service Annuity," as used herein, shall mean the annuity provided hereunder in respect of employment, of the persons eligible therefor, prior to the Effective Date hereof.
"Retirement Annuity," as used herein, shall mean the aggregate of Past Service Annuity and Future Service Annuity, or each separately if a person covered*171 hereunder is entitled to either Past Service Annuity alone or Future Service Annuity alone.
Other definitions are: An "Active Employee" is a person in the employ of the employer (the petitioner) while covered by the policy prior to his retirement date. A "Contributing Employee" is an active employee with respect to whom future service annuity shall have been purchased and in force under the contract. A "Former Employee" is a contributing employee whose employment with the employer shall be terminated before his "effective annuity date," meaning his "retirement date." An "Annuitant" is the term applied to a person after the occurrence of his effective annuity date, such person having been either an active employee, or a former employee, or a person who is covered by the contract whose normal retirement date is the effective date of the contract.
The contract set forth a "Plan of Retirement Annuities." The "Plan" made provision for (a) "Persons Eligible For Coverage For *631 Future Service Annuity," and (b) for "Persons Eligible For Coverage For Past Service Annuity," as follows, prior to amendments made after 1938:
PERSONS ELIGIBLE FOR COVERAGE FOR FUTURE SERVICE ANNUITY:
*172 Each person in the employ of the Employer shall be eligible for coverage hereunder as a Contributing Employee on any day upon which all of the following requirements are satisfied:
(1) Such day is the first day of a calendar month and is subsequent to August 31, 1938;
(2) Such person has completed at least six months of service with the Employer and has been approved by the Employer as a regular Employee;
(3) Such person if a man has attained his 30th but not his 65th birthday, and if a woman has attained her 25th but not her 60th birthday; and
(4) Such person is employed in The United States of America;
except that requirement (4) may in individual cases be waived by mutual consent of the Employer and the Insurance Companies.PERSONS ELIGIBLE FOR COVERAGE FOR PAST SERVICE ANNUITY:
(1) Each person who has been retired from active employment by the Employer and who was receiving a pension from the Employer on August 31, 1938; and
(2) Each person in the employ of the Employer on September 1, 1938, who on said date (a) has completed at least six months of service with the Employer and has been approved by the Employer as a regular Employee, and (b) if a man has attained his 30th*173 birthday and if a woman has attained her 25th birthday;
shall be eligible as of September 1, 1938, for coverage for Past Service Annuity, provided such person on September 1, 1938, or on the last date of employment prior thereto, was employed in The United States of America, except that such condition as to location of employment may in individual cases be waived by mutual consent of the Employer and the Insurance Companies. Each person in the employ of the Employer on September 1, 1938, who on said date is eligible for coverage for Past Service Annuity as specified above, shall continue so eligible until his Effective Annuity Date provided he remains in the employ of the Employer until such date.In order to be covered by the contract as a "contributing employee" any person in the employ of the employer (petitioner) during the active term of the contract (provided such person is eligible for coverage for future service annuity) shall complete and deliver to the employer a form of individual application for coverage, such form to be provided by the insurance companies. Any other person in the employ of the employer on September 1, 1938, and any person who had been retired from*174 active employment by the employer and who was receiving a pension from the employer on August 31, 1938, would be covered under the contract as "an Active Employee or as an Annuitant," provided such person was eligible under the contract for "Past Service Annuity," and provided the employer had made at least one contribution toward past service annuity on his behalf. It was provided that the coverage of each such person for past service annuity *632 as an active employee or as an annuitant would become effective as of the first day upon which any past service annuity was purchased for him.
The contract specified the contributions to be made by contributing employees; the annual rate of the future service annuity purchased for a contributing employee for each contract year; the annual rate of the past service annuity purchased for a person; and the annual rate of a retirement annuity purchased for a person. With respect to the annual rate of a past service annuity, separate provisions fixed different rates in the case of a person who was not receiving a pension from the employer on August 31, 1938, and in the case of a person who was receiving a pension from the employer on August*175 3, 1938.
The contract specified the basis of the employer's contributions in respect to a future service annuity purchased from each insurance company, and the basis of the employer's contributions in respect to a past service annuity purchased under the "Plan." The contract specified the minimum and the maximum total amount which the employer should and could make during 1939, during the years 1940-1943, inclusive, and during 1944, and thereafter. Also, the contract set forth the amount of the consideration to be paid by the employer for the purchase of a past service annuity for any person. Furthermore, the contract gave the employer the right to elect at any time to discontinue payment of past service contributions.
The entire contract, together with various amendments, is incorporated herein by this reference.
In harmony with the group annuity contracts entered into for its United States employees, petitioner, in 1938, made substantially the same arrangements with the Canadian Government and the Canada Life Assurance Company for the benefit of its Canadian employees.
The retirement benefit arrangements evolved by petitioner were explained to its United States employees in a *176 booklet entitled "Retirement Annuity Plan." Petitioner's objectives were stated as follows:
The object of the Plan outlined in this announcement is to provide regular income after retirement for employees in the United States of The Quaker Oats Company and its wholly owned domestic subsidiaries (collectively referred to as the "Company"), who are or may hereafter become eligible under the Plan.
* * * *
Under the new Plan retirement incomes are built up in proportion to years of service. Those who come into the Plan comparatively young in the service will have many years in which to build up income credits before reaching retirement age. They will pay in a percentage of their earnings and the Plan provides a fixed income for them after retirement in proportion to what they have paid. This income will be at least double what their contributions alone would buy. The Company makes up the difference. This comes under what is referred to in the Plan as "Future Service." Older employees who are nearing or may *633 have reached Normal Retirement Age have little or no chance now to build up retirement credits through "Future Service." The Company recognizes the faithful and loyal *177 service they have rendered in the past years and as it is able expects to make up the necessary credits for this so-called "Past Service."
The above booklet was also sent to the common stockholders by petitioner's president with the following explanation:
More than a year ago we engaged consultants of high standing to study our situation, recommend a definite retirement plan, and make estimates of costs involved in the proper financing of such a plan. Together we have evolved a plan which has been unanimously adopted by your Board of Directors. A copy of the booklet outlining the Plan for the United States is enclosed. The Plan for Canada is different only as necessary due to the absence of any provision corresponding to the United States Social Security Act and to provide for the purchase of annuities in Canada.
Under the Plan, Retirement Annuities will be purchased from The Prudential Insurance Company of America and the Metropolitan Life Insurance Company for employees in the United States, and in Canada partly from the Dominion Government and partly from the Canada Life Assurance Company. We believe that this method of providing for retirements gives the employees the greatest*178 possible security and the Company the lowest possible cost.
Both the Company and the employees will contribute to the purchase of annuities based on service after September 1, 1938 (called "Future Service"). The employees will pay fixed percentages of their earnings and the Company will pay the balance of the cost. The Company's share of the cost of providing for Future Service annuities is estimated to be not more than $ 250,000.00 per year, the exact amount depending on certain credits arising in the operation of the Plan.
Annuities based on service prior to September 1, 1938, including present pensioners, (called "Past Service") will be paid for by the Company. * * *
* * * *
Although the cost to purchase annuities for Past Service for our people is a large amount, it will cost the Company very much less to purchase annuities than to continue our present policy of paying all pensions out of current earnings or surplus as we go along. It is estimated that pensions based on service before September 1, 1938, in 15 to 17 years will reach a total of nearly $ 400,000.00 per year, not including the additional amount of pensions based on service after September 1, 1938. The large saving*179 in cost is the result of interest earnings at favorable rates on the funds turned over to the insurance companies.
To provide for the cost of Past Service annuities in the near future and to take advantage of favorable rates for purchases of annuities available during the next five years, it is desirable that the Company pay in during the next five years the sums required to cover items (a) and (b) and the major part of item (c). The fund so set up will earn interest of at least 3 1/4%. The spreading of payments over a period of years instead of immediate purchase will somewhat increase the cost because the interest earned on the fund will be less than if fully paid in at once. No obligation for the purchase of Past Service annuities has been created beyond the payments actually made from time to time. The amounts to be paid in from year to year will be determined by the Board of Directors or the Executive Committee as in their judgment circumstances warrant. Should unforeseen conditions or changes at any time make it advisable, payments to the insurance companies on account of Past Service may be suspended or discontinued.
*634 The retirement benefits under this Plan supplement*180 those payable under the Social Security Act to United States employees, and the combination based on the present Act will produce annuities amounting to 50 to 60% of average earnings, except that the formula as to earnings over $ 3,000.00 is lower, but believed adequate. Pensions provided for Canadian employees compare favorably with other Canadian retirement plans.
The Plan is available to all employees, including officers, but in no case can anyone, even the highest paid executive, receive a retirement annuity exceeding $ 12,000.00 per year.
In case of an employee leaving the service of the Company his contributions will be returned to him with interest; after twenty years of service the Future Service annuities purchased at the Company's cost become vested in the employee subject to certain conditions; and in case of death either before or after retirement there is a guaranteed return to the legal representatives of the employee of the total of his contributions with interest, to the extent not already paid in the form of annuities.
Pursuant to the applicable provisions of the annuity contracts between petitioner and the insurance companies, petitioner paid premiums for annuities*181 in respect of past services as described in the contracts. The premiums paid by petitioner during the years 1938-1944, inclusive, were as follows:
| Year | Amount |
| Prior to 1938 | -- 0 -- |
| 1938 | 2 $ 2,591,617.90 |
| 1939 | 916,223.76 |
| 1940 | 1,026,714.45 |
| 1941 | 1,337,997.76 |
| Jan. 1 to June 30, 1942 | 464,071.92 |
| July 1 to June 30, 1943 | 1,237,373.05 |
| July 1 to June 30, 1944 | 674,483.83 |
| Total | 8,248,482.67 |
The premiums paid in 1939, 1940, 1941, in the 6 months ended June 30, 1943, and in 1944, were paid by petitioner for single premium annuities in*182 respect of past service for 2,360 employees. Only 288 of these employees had retired and become annuitants by December 31, 1944.
All of the premiums paid by petitioner for annuities in respect of past service were debited to an account on petitioner's general ledger numbered 280250 (changed to No. 284510 on January 1, 1940) entitled "Past Service Annuity Expense." At the end of the fiscal period, after adjustment for Federal income tax, this account was closed *635 directly to earned surplus and such premiums were so reflected in petitioner's annual reports. In petitioner's income tax returns for the pertinent taxable periods, the premiums were deducted as a part of the item, "Other Deductions Authorized by Law," and were included as, "Employees Past Service Annuity Expense," in a subschedule to that item.
At all times since September 1, 1938, petitioner's eligible employees continuously have been offered the opportunity to obtain an annuity in respect of future service as provided in petitioner's group annuity contracts. Payments of premiums for the purchase of annuities in respect of future service have been made at all times to the insurers in monthly amounts estimated *183 to cover the annuity cost at rates then prevailing. Annual adjustments were made to reflect the exact cost. This cost has increased since 1938 because of higher wage and salary levels, increased annuity rates, changes in employees' ages, and for other reasons. The premiums paid by petitioner for annuities in respect of future service, and deducted by it for income tax purposes, in the years 1938-1944, were as follows:
| Year | Amount |
| Prior to 1938 | -- 0 -- |
| 1938 | $ 103,472.60 |
| 1939 | 178,651.10 |
| 1940 | 1 |
| 1941 | 229,606.81 |
| Jan. 1 to June 30, 1942 | 8,676.58 |
| July 1 to June 30, 1943 | 17,561.29 |
| July 1 to June 30, 1944 | 21,875.85 |
These premiums were charged to account No. 818035 entitled "Retirement Annuity Expense -- United States," a subaccount of account No. 818000 entitled "General Expenses -- United States," and to account No. 818135 entitled "Retirement Annuity Expense -- Canada," a subaccount of account No. 818100 entitled "General Expenses -- Canada." These general expense items were a part of the operating income account used to determine profit or loss from operations, and were so reflected in petitioner's annual reports. In petitioner's tax returns for*184 the taxable years 1938-1944, petitioner's payments of premiums for the purchase of such annuities were deducted as a part of the item "Other Deductions Authorized by Law" and were included as a part of "General and Office Expense" in a subschedule to that item.
During petitioner's base period years, there was no substantial change in the type, manner of operation, size, or condition of petitioner's business, and the amounts expended as set forth above were not a consequence of an increase in petitioner's gross income.
*636 Petitioner's sales volume and number of employees during the period 1934 to 1939, inclusive, were as follows:
| Year | No. of | Sales |
| employees | ||
| 1934 | 3,974 | $ 63,292,000 |
| 1935 | 3,959 | 65,826,000 |
| 1936 | 4,129 | 70,360,000 |
| 1937 | 4,068 | 66,370,000 |
| 1938 | 4,026 | 63,825,000 |
| 1939 | 4,003 | 60,411,000 |
The prices of petitioner's products are governed by competitive conditions and fluctuate largely because of the fluctuations in the cost of the agricultural commodities from which they are made.
Petitioner's "Retirement Annuity Plan" was submitted on July 7, 1944, to the Bureau of Internal Revenue for approval as an annuity plan under sections 165 and 23 (p), Internal*185 Revenue Code of 1939, as amended, and was approved by the Commissioner of Internal Revenue on August 14, 1944.
No claim was made by petitioner in its original returns for the taxable years for relief under the provisions of section 711 (b) (1) (J), Internal Revenue Code of 1939.
On April 11, 1945, petitioner filed an amended excess profits tax return for the taxable year ended June 30, 1944, and a claim for refund of excess profits tax for that year, claiming deductions of a class abnormal for petitioner under section 711 (b) (1) (J), Internal Revenue Code of 1939, based on the premiums of $ 2,591,617.90 in 1938, and $ 916,223.76 in 1939, paid by petitioner for past service retirement annuities. No claim for relief based on the pensions or premiums for future service retirement annuities paid by petitioner in its base period years was made. The statement attached to the amended return to support the claim for disallowance of abnormal deductions said, in part, that the amounts taken as deductions for past service retirement annuities during the pertinent taxable periods totaled $ 8,248,482.67; that payments after September 1, 1938, for pensions and future service retirement annuities*186 had been treated by petitioner as "operating expenses usual to the type of business" in which petitioner was engaged and had been so reflected in its published financial statements; that the "purchase of Past Service Retirement Annuities was charged to surplus on the books of the Company as being an entirely separate and distinct class from the usual costs of doing business and was so reflected in its published financial statements"; that the "procedure has had the approval of its public accountants and is in conformity *637 with generally accepted accounting principles and practices"; and that petitioner claimed that "the deductions for purchase of Past Service Retirement Annuities in the years of 1938 and 1939 were abnormal deductions of a class that was abnormal for the taxpayer and should be disallowed as a deduction in accordance with section 711 (b) (1) (J)."
On April 3, 1946, and October 6, 1947, with respect to the taxable years ended June 30, 1943, and on April 3, 1946, October 6, 1947, and June 7, 1951, with respect to the taxable year ended June 30, 1944, petitioner filed claims for refund with the collector of internal revenue for the first district of Illinois within*187 the time allowed as extended by waivers. In these claims, it was contended that petitioner had had in its base period four separate classes of deductions, which it called "Pensions," "Future Service Retirement Annuities," "Funded Pensions," and "Past Service Retirement Annuities." In the refund claims certain terms were used which had a particular meaning, as follows:
"Pensions" included the deductions for pensions for the years 1936 to 1939, inclusive; "Future Service Retirement Annuities" included the deductions for premiums for future service retirement annuities for the years 1938 and 1939; "Funded Pensions" included $ 1,926,680.77 of the deduction of $ 2,591,617.90 for premiums for past service retirement annuities for the year 1938; "Past Service Retirement Annuities" included the remaining balance of $ 664,937.13 of the deduction of $ 2,591,617.90 for past service retirement annuities for the year 1938, and the deduction for past service retirement annuities for the year 1939; "Funded Pensions" included all premiums paid in 1938 for past service retirement annuities for all former employees who had been receiving pensions on September 1, 1938, and all other employees who, *188 under the retirement annuity plan, had been eligible to retire on that date or had become eligible by December 31, 1938, and had been retired by the latter date; "Past Service Retirement Annuities" for the year 1938 included all premiums paid in that year for past service retirement annuities for 22 employees who had been eligible under the plan to retire on September 1, 1938, or who had become eligible by December 31, 1938, but who had not been retired on the latter date.
The Commissioner disallowed petitioner's claims in part, with the following explanation:
the determination of your excess profits tax liability for the taxable year ended June 30, 1943 discloses an overassessment of $ 802,015.97, that the determination of your excess profits tax liability for the taxable year ended June 30, 1944 discloses an overassessment of $ 555,018.10, * * *. It is noted that on July 19, 1951, you executed a waiver of the restrictions provided by section 272 (a) of the Internal *638 Revenue Code, consenting to the assessment and collection of the deficiency of excess profits tax, and an acceptance of the overassessments of excess profits tax shown in this notice.
The overassessments will*189 be made the subject of certificates of overassessment which will reach you in due course through the office of the Director of Internal Revenue for your district, and will be applied by that official in accordance with the provisions of section 322 (a) of the Internal Revenue Code.
In making these determinations, your claims for refund (Forms 843) filed April 3, 1946 and October 6, 1947 for 1943, April 11, 1945, April 3, 1946, October 6, 1947 and June 7, 1951 for 1944, and October 6, 1947 for 1945, under section 711 (b) (1) (J) of the Code relating to abnormalities within the base period, have been given careful consideration, and it has been determined that the basis of the claims for 1943 and 1944 should be allowed in part, and that the basis of the claim for 1945 should be allowed in full. Other adjustments affecting your excess profits tax liability for 1945 result in a deficiency for that year.
It is held that there is no class of deductions in the base period which were abnormal, within the meaning of section 711 (b) (1) (J) (i) of the Internal Revenue Code.
It is further held that deductions in the base period years for pensions, funded pensions, past service retirement annuities*190 and future service retirement annuities, constituted one class of deductions normal for the taxpayer. To the extent this class of deductions was in excess of the limitations prescribed under section 711 (b) (1) (J) (ii) and (K) (iii), they have been disallowed in an amount equal to such excess, in computing the excess profits credit based on income under section 713 of the Internal Revenue Code.
In accordance with the requirement of section 732 of the Internal Revenue Code, notice is given of the disallowance in part of your claims for refund under section 711 (b) (1) (J) of the Code for 1943 and 1944 and of the disallowance of your claim for refund under section 711 (b) (1) (J) of the Code for 1945.
Petitioner's excess profits taxes for the taxable years ended June 30, 1943, and June 30, 1944, have been correctly determined and paid, subject only to adjustment, if any, conforming to the opinion of the Court on the issues here in controversy.
Petitioner's deductions for employee retirement benefits during the base period years 1936-1939, inclusive, for voluntary and unfunded pensions, funded pensions, annuities based on past service, and annuities based on future service, constituted*191 a single class of deductions.
Petitioner's single class of deductions during the base period years 1936-1939, inclusive, was a class normal for petitioner which does not qualify for relief under section 711 (b) (1) (J) (i).
The stipulated facts are found as stipulated; the stipulations of facts are incorporated herein by this reference.
OPINION.
The questions to be decided involve application of the provisions of section 711 (b) (1) (J), 1939 Code. 3 Petitioner *639 made payments in its base period years for various retirement benefits. The problem is the classification of these payments under the provisions of section 711 (b) (1) (J), so that adjustments of petitioner's excess profits net income for each of the base period years may be properly computed.
*192 Section 711 (b) (1) (J) was intended to be, and is, a remedial statute. The legislation of which this section is a part "attempts to provide, both by specific terms and in carefully guarded general terms, a set of flexible rules which should alleviate at least the bulk of the severe hardship cases which may arise." Report of the Committee on Ways and Means, H. Rept. No. 146, 77th Cong., 1st Sess. (1941). It must, therefore, be given a reasonable and rational construction in order that it may provide the intended relief. Bonwit Teller & Co. v. United States, 283 U.S. 258">283 U.S. 258; Green Bay Lumber Co., 3 T.C. 824">3 T. C. 824.
The prime object of the various sections of the statute is to ascertain and tax excess profits. The ascertainment of excess profits involves a comparison based either upon petitioner's income experience during a prior test period, or upon its invested capital, according to whichever method of computation results in the lesser tax. Sec. 712 et seq., 1939 Code. In petitioner's case, the computation based on income results in the lesser tax. Thus, the comparison is with the average income for a 4-year period. *193 The excess profit is computed after giving "excess profits credit" for 95 per cent of the average base period net income as finally ascertained. Sec. 713 (a) (1) (A). *640 In short, the statute provides for the determination of the average base period net income, a 95 per cent credit based upon that average, and the tax on the excess profit.
The taxable years here are fiscal years ended on June 30, 1943 and 1944; the base period years are 1936 to 1939, inclusive.
In order to arrive at an equitable computation of excess profits, a fair average for the base period income must be ascertained. This is done by first computing "the excess profits net income" for each of the base period years; then certain adjustments may be made if they are permissible. We are concerned here with problems about two adjustments, those described in section 711 (b) (1) (J) (i) and (J) (ii). These adjustments provide relief by eliminating certain abnormalities.
Subsection (J) (i) provides for adjustment of the "excess profits net income" for each base period year by disallowance of deductions which are abnormal in class. Subsection (J) (ii) provides for adjustment of the excess profits net income*194 for each base period year by disallowing abnormalities in amount. That is to say, once a class is established as normal for a taxpayer under subsection (J) (i), it may still be disallowed in an amount which exceeds 125 per cent of the deductions taken for such class for the 4 previous taxable years. Subsections (J) (i) and (J) (ii) are modified by section 711 (b) (1) (K) (iii), which limits any disallowance so that it cannot exceed the amount by which the deductions for a class for the base period years exceed the deductions for the same class in the taxable year in which the excess profits tax is being computed.
In this case, petitioner made certain expenditures for employee retirement benefits in all of its base period years, i. e., 1936-1939, inclusive. Prior to 1938, petitioner had no fixed arrangements for providing its employees with retirement benefits. That is to say, prior to 1938, petitioner merely paid voluntary pensions to a limited number of employees on a year-to-year basis. Effective as of September 1, 1938, petitioner entered into three group annuity contracts which were to fix and to fund pensions and retirement arrangements for all of its employees in both the*195 United States and Canada. Any voluntary payments made thereafter by petitioner were only for particular individuals in cases of extreme hardship.
Petitioner asks this Court to find, as an ultimate fact, that the expenditures made by it for employee retirement benefits, as deducted by it in the base period years, consist of four separate classes of deductions for purposes of the subsection (J) adjustments. The following constitute petitioner's contentions and what petitioner asks the Court to find and conclude:
*641 (1) Deductions which were taken in all of the base period years (1936-1939) for discretionary payments made by petitioner to certain retired employees, which petitioner calls voluntary and unfunded pensions, constituted a class of deduction normal for petitioner. Such deductions during the base period years 1936 and 1937 were abnormal in amount under subsection (J) (ii). Such deductions exceeded the limitations imposed by subsection (K) (iii), and should be disallowed in the amounts of $ 2,290.43 for 1936, and $ 15,939.84 for 1937.
(2) Deductions for funded pensions, i. e., for a single premium paid to purchase life annuities in 1938 for retired employees who were*196 receiving voluntary pensions, and for employees who would be eligible to retire by December 31, 1938, constituted a class of deduction abnormal for petitioner under subsection (J) (i). Such deduction exceeded the limitation imposed by subsection (K) (iii), and should be disallowed for the base period year 1938 in the amount of $ 1,926,680.77.
(3) Deductions for future service retirement annuities in the years 1938 and 1939, which provide benefits for continuing employees based on service after 1938, are a class of deduction abnormal for petitioner for 1938 under subsection (J) (i); they are normal for petitioner in 1939; but they are abnormal in amount under subsection (J) (ii). However, because of the limitation of (K) (iii), petitioner asks for no disallowance of deductions for either of the base period years 1938 and 1939.
(4) Deductions for past service retirement annuities in the years 1938 and 1939, which provide benefits for continuing employees based on service prior to 1938, constituted a class of deduction abnormal for petitioner under subsection (J) (i) for both 1938 and 1939. Petitioner requests no disallowance of such deduction for base period year 1938 due to the *197 limitation of subsection (K) (iii), but asks for the disallowance of $ 241,739.93 for base period year 1939.
Respondent, on the other hand, contends that petitioner's deductions for all employee retirement benefits, whether voluntary or under the group annuity contracts, constituted only one class of deduction, and that such class was normal for petitioner. However, respondent has made the following determination: "To the extent this class of deductions was in excess of the limitations prescribed under section 711 (b) (1) (J) (ii) and (K) (iii), they have been disallowed in an amount equal to such excess in computing the excess profits credit based on income under section 713 of the Internal Revenue Code." Respondent granted petitioner certain refunds based on the above determination.
Subsection (J) provides that the classification of deductions shall be determined under regulations prescribed by the Commissioner. Regulations 112, section 35.711 (b)-2, deal with the general subject *642 of abnormal deductions in the base period, and provide that deductions which are treated under subsection (J) "may be grouped by the taxpayer, subject to approval by the Commissioner on the examination*198 of the taxpayer's return, in such other classes as are reasonable in a business of the type which taxpayer conducts, and are appropriate in the light of the taxpayer's business experience and accounting practice." The question of classification, therefore, becomes largely one of fact. Cf. Green Bay Lumber Co., supra;Great American Indemnity Co., 19 T. C. 229, affirmed per curiam 211 F.2d 407">211 F. 2d 407.
Petitioner discusses various and allegedly unusual features which each one of its four categories of retirement benefits had so as to make one category different from each of the others, in order to refute respondent's contention that all four categories constituted one class for purposes of subsections (J) (i) and (J) (ii). Petitioner argues, for example, that the large payment of $ 1,926,680.77, which it made in 1938 to purchase life annuities for 263 persons who had retired from petitioner's employ during the years 1918 through 1938, is a separate class because the payment was a single and nonrecurring payment, because it was exceptionally large, because it constituted a fixed commitment on the part of*199 petitioner as compared with its purely voluntary payments in prior years, and because it constituted an unusual benefit in contrast with ordinary pension plans.
None of these reasons are persuasive. It is difficult to see how petitioner's kind of funded pensions differ as to class from, for example, the voluntary pensions for which it had been making payments previously. The size of the payment, alone, is no justification for making a separate classification. Great American Indemnity Co., supra.Petitioner entered into a fixed commitment by the purchase of the life annuities, but it did so just as voluntarily as it voluntarily had paid pensions on a year-to-year basis prior to 1938. Petitioner merely prepaid for future years, retirement benefits for which it had been paying previously on an annual basis. Such annuity purchases were merely a voluntary continuation of a voluntary retirement benefit policy which petitioner had commenced many years before 1938.
In this respect, petitioner's situation does not differ from that in Frank Shepard Co., 913">9 T. C. 913. There the corporate taxpayer had never paid a pension to any*200 employee prior to 1938. Early in 1938, the taxpayer retired 2 employees who had become too old to continue their work, and voluntarily paid them pensions aggregating $ 1,529. In 1939, and in subsequent years, the voluntary pensions were continued to these 2 persons. However, in 1938, the taxpayer purchased single premium annuity policies for 21 employees, who had been with it for 19 years or more, at a total cost of $ 50,815.46. In 1939, 2 more employees came within the 19-year-service group and 2 more single premium *643 annuity policies were purchased. In addition, single premium annuity policies were purchased for 6 persons who were 50 years of age or over, at a cost of $ 15,237.53. The policies provided for annuity benefits commencing when the annuitant reached the age of 65. This Court held in considering the application of subsections (J) (i) and (J) (ii) as follows (p. 924):
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*201 one class for the purpose at hand.
In this case, petitioner's voluntary pension payments and its single premium payment for funded annuities are not different from one another. One was a continuation of the other. In petitioner's own explanation to its stockholders it stated:
Although the cost to purchase annuities for Past Service for our people is a large amount, it will cost the Company very much less to purchase annuities than to continue our present policy of paying all pensions out of current earnings or surplus as we go along. It is estimated that pensions based on service before September 1, 1938, in 15 to 17 years will reach a total of nearly $ 400,000.00 per year, not including the additional amount of pensions based on service after September 1, 1938. The large saving in cost is the result of interest earnings at favorable rates on the funds turned over to the insurance companies.
Furthermore, it does not appear that any of the characteristics of petitioner's expenditures in 1938 and 1939 for the past service annuities and for the future service annuities led to a separate classification for those amounts. Petitioner, in these two categories, merely established methods*202 of computing retirement benefits, and of minimizing its cost by providing for employee contributions in the cases of those rendering services after the effective date of the plan.
In other words, petitioner converted its voluntary retirement arrangement into certain fixed arrangements. The record as a whole shows that the objective of petitioner's plan, and the expenditures for both premiums and pensions for the four categories of benefits, was substantially the same. Varying degrees of social security were provided for retired employees, for continuing employees when they did retire, and for the families of deceased employees which covered periods of time under those circumstances when regular salary payments would no longer be forthcoming; e. g., during retirement, or disability, and upon death.
This singleness of purpose is apparent from careful analysis of the entire record. According to the testimony of an insurance company pension consultant, "A group contract is like a tent: It covers everything, and everything is built under it." In the words of the insurance contract itself: "The retirement annuity benefits to be provided, in *644 accordance with the Plan for the *203 several Active Employees covered hereunder, consist of Past Service Annuities and Future Service Annuities as specified in the Plan." The special provisions of the contract provided that the "Past Service Annuity" was to include the categories which petitioner has called "funded pensions" and "Past Service Retirement Annuities." In petitioner's explanatory booklet entitled "Retirement Annuity Plan," petitioner's objective was stated to be the provision of "regular income after retirement for employees * * * who are or may hereafter become eligible under the Plan." In this booklet, petitioner discussed the advantages of the "Future Service Retirement Annuities," and it stated that "older employees who are nearing or may have reached Normal Retirement Age have little or no chance now to build up retirement credits through 'Future Service.' The Company recognizes the faithful and loyal service they have rendered in the past years and as it is able expects to make up the necessary credits for this so-called 'Past Service.'"
The record as a whole shows that the objective of petitioner's retirement arrangements for all four categories of benefits was substantially the same. The difference*204 between the number of employees covered under petitioner's old voluntary plan, and under its new group annuity policies is only one of degree and it does not change the character of petitioner's deductions. Cf. Tovrea Land & Cattle Co., 10 T.C. 90">10 T. C. 90.
Petitioner's reliance on its accounting entries is also misplaced. Although these are of some importance, separate classification and treatment by petitioner's accounting staff for bookkeeping purposes does not control the question of separate classification for the purposes of section 711 (b) (1) (J). Cf. Frank H. Fleer Corporation, 10 T. C. 191. In any event, after a careful examination of petitioner's books, tax returns, and refund claims, we are aided little in the matter of classification because of the vagueness of petitioner's entries in its books, as well as because of its many inconsistent positions.
It is concluded and held that petitioner's expenditures under its earlier policy of paying voluntary pensions and under the group annuity contracts for all four types of benefits, i. e., voluntary pensions, funded pensions, past service retirement annuities, and future*205 service retirement annuities, constitute one single "class" of deductions as the word "class" is used in the statute. The objective and purpose for all four types of expenditures was substantially the same, and we know of no reason why they should be grouped into more than one "class" for the purpose of the statute. Frank Shepard Co., supra;Arrow-Hart & Hegeman Electric Co., 7 T.C. 1350">7 T. C. 1350.
The uncontroverted facts show that petitioner's policy of providing retirement benefits for its employees was initiated prior to the base period. In Frank Shepard Co., supra, we held that the continuation *645 of a class of deductions in subsequent years established a definite course of conduct rendering such deductions normal in the later years. Accordingly, it is held that all of the deductions for petitioner's employee retirement benefit expenditures in the base period years before us were all of a class normal for petitioner. See, also, Colonial Amusement Co. of Philadelphia, 11 T.C. 67">11 T. C. 67.
In essence, the dispute between the parties relates to the payments in 1938 *206 for funded pensions, and the payments in 1939 for past service retirement annuities. Our conclusion that petitioner had one class of deductions, only, means that petitioner's theory about both items is rejected.
It appears that respondent has allowed petitioner the maximum permissible relief under section 711 (b) (1) (J) (ii) and (K) (iii) in regard to any abnormalities in amount. Both parties have stipulated that the excess amount of the deductions during the base period years for pensions and group annuity premiums was not a consequence of an increase in petitioner's base period gross income, or a change at any time in the type, manner of operation, size, or condition of the business engaged in by petitioner; and the record is amply clear that the excess of such deductions was not a consequence of a decrease in the amount of some other deduction in petitioner's base period. Therefore, no adjustments need be made because of the limitations of section 711 (b) (1) (K) (ii). By virtue of respondent's determinations, petitioner's refund claims were allowed in part. Respondent's determinations are consistent with the conclusions we have reached. It is our understanding, therefore, *207 that Rule 50 recomputations are not necessary.
Decision will be entered for the respondent.
Footnotes
1. Petitioner describes this arrangement as "pensions, voluntary and unfunded."↩
1. Not stated.↩
2. Of this amount, $ 1,926,680.77 was paid by petitioner for premiums for single premium annuities in respect of past service for persons retired from petitioner's service during the years 1918-1938, inclusive; and $ 664,937.13 was paid by petitioner for premiums for single premium annuities in respect of past service for 22 persons who attained normal retirement age on or before December 31, 1938, but whose employment with petitioner was continued after January 1, 1939.↩
1. Not stated.↩
3. SEC. 711. EXCESS PROFITS NET INCOME.
(b) Taxable Years in Base Period. --
(1) General rule and adjustments. -- The excess profits net income for any taxable year subject to the Revenue Act of 1936 shall be the normal-tax net income, as defined in section 13 (a) of such Act; and for any other taxable year beginning after December 31, 1937, and before January 1, 1940, shall be the special-class net income, as defined in section 14 (a) of the applicable revenue law. In either case the following adjustments shall be made * * *:
* * * *
(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.↩