Decision will be entered for the respondent.
Petitioner was incorporated on September 20, 1940, for the purpose of furnishing guards to California industrial plants whose products were important to the national defense program. It had $ 600 of invested capital. It experienced a net operating loss during its first 15 months of operation but realized taxable income in 1942, 1943, and 1944. It claimed excess profits tax relief under section 722 (c) for such years. Held, even assuming that petitioner established the existence of the qualifying conditions for relief under such section, it failed to establish a basis for reconstruction of normal base period earnings which would allow greater excess profits credits than those allowed by the respondent on the invested capital basis.
*524 This is a proceeding to recover excess profits taxes paid by the petitioner for the calendar years 1942 to 1944, inclusive, in the following amounts:
| Year | Excess profits tax paid | |
| 1942 | $ 8,219.26 | (less post-war refund credit of $ 821.93) |
| 1943 | 3,391.45 | (less post-war refund credit of $ 339.15) |
| 1944 | 14,119.36 |
Petitioner's *18 claim for relief was filed under section 722 (c) of the 1939 Code. 1*19
Some of the facts were stipulated.
FINDINGS OF FACT.
The stipulated facts are so found and are incorporated herein by this reference.
*525 Petitioner, a California corporation, was incorporated on September 20, 1940. Its income and excess profits tax returns for the calendar years 1942, 1943, and 1944 were filed with the collector of internal revenue for the sixth district of California at Los Angeles. It used the accrual method of accounting. At all times material hereto its principal business activity was the furnishing of guard service for the protection of industrial plants and facilities.
In or about 1939, Ralph E. Davis (hereinafter referred to as Davis), who was in the investment banking business, became Commandant of the Marine Corps League in the Los Angeles area. Thereafter, former marines were constantly contacting him seeking jobs. In an effort to meet this situation Davis set up a Marine Corps League committee, the purpose of which was to aid honorably discharged *20 marines in securing jobs. H. M. Holland (hereinafter referred to as Holland), an employment officer with the Veterans Administration, was appointed chairman of this committee. Holland formed an organization, designated Ex-Marine Guards Battalion, which attempted to place such ex-marines in private industry as guards or watchmen. From time to time Davis advanced money to Holland in connection with these activities. Holland also used Davis' name to charge uniforms and other items to an account for the Ex-Marine Guards Battalion, which account Davis had to pay. Upon the advice of his attorney, Davis decided to limit his liabilities by organizing a corporation.
The organization of a business corporation was not the initial goal of petitioner's sponsors; their primary interest was securing employment for ex-marines, no matter how menial the job. The idea of making a profit out of securing jobs for ex-marines originated with Holland. Davis, however, was also convinced that a commercial business could be developed from furnishing guards for the protection of industrial plants. Davis convinced George Holmes (hereinafter referred to as Holmes), one of his customers, of the possibilities *21 of profits and the two of them agreed to, and did, finance the petitioner. In addition, Holmes, although not an ex-marine, agreed to loan petitioner money.
The first enumerated purpose for petitioner's formation, as stated in its articles of incorporation, was as follows:
(a) To furnish guards and/or watchmen to individuals, firms and corporations engaged in the manufacture or production of such things as may be necessary and/or essential to the welfare of the public, particularly to those individuals, firms and corporations engaged in the manufacture of items integral or important to the program of national defense.
Petitioner's original authorized capital stock was 600 shares of common stock without par value. At a directors' meeting on September 25, 1940, the value of petitioner's common stock was set at $ 1 per *526 share and the issuance of 100 shares each to Holmes, Holland, and Davis for the sum of $ 300 was authorized. On October 25, 1940, an application for a permit to issue such 300 shares was executed by petitioner and filed with the California Commissioner of Corporations. On October 29, 1940, a permit to issue such stock was granted. The stock issued to Holland was paid *22 for by Holmes and Davis.
At the first meeting of petitioner's board of directors on September 25, 1940, the following officers were elected: Holmes, president; Holland, vice president; Davis, secretary and treasurer. Shortly thereafter, Holmes resigned as president. At a special meeting of the board of directors on October 23, 1940, Holland was elected president and treasurer; and Davis, vice president and secretary. Holland died during February 1941, and Davis was elected president of petitioner on March 12, 1941, and continued in that capacity until May 28, 1944.
Holmes at no time took as active an interest in the management and operation of the petitioner as Holland or Davis. Until Holland's death in February 1941, petitioner operated under his active management; thereafter, it operated under Davis. Holland's management was inefficient as he was a poor businessman and organizer. In addition, he misrepresented petitioner to prospective customers, claiming that the Federal Bureau of Investigation (hereinafter referred to as the F. B. I.) recommended its services and also investigated all of its men. An F. B. I. agent brought these misrepresentations to Davis' attention and demanded *23 that they cease. As a consequence, Davis demanded Holland's resignation as president on the day before Holland died. Had these events occurred in 1938, Davis would have succeeded Holland as president just as he did in 1941.
The F. B. I. became familiar with Holland's misrepresentations as a result of industrial plant surveys conducted by it during 1940 and 1941. These surveys were conducted at the request of another government agency commencing in the closing months of 1939. The purpose of such surveys was to determine the adequacy of the protection being given to the industrial plants in which another government agency was interested. The F. B. I. has never had under its supervision a security program for private industrial plants.
During January 1941, Davis and an F. B. I. agent discussed the quality of the protective services that industrial plants were using. Further discussions followed during February and March of 1941. The agent advised Davis that no satisfactory plant protective service was available and that there was a real need therefor. At that time there were a number of well established detective agencies, as well as other concerns, operating in the Los Angeles *24 area, that were offering plant protection services of one type or another. Davis believed that in order to compete successfully with these concerns, petitioner *527 would have to offer a superior type plant protection service. In developing and organizing such a service for petitioner, Davis sought information from, and the advice and assistance of, various men experienced in secret service, fire prevention, and plant protection work.
In October 1940, petitioner inquired of the Detective License Bureau of California about a detective and investigator's license. In December 1940, the application and other required documents were forwarded to the Detective License Bureau. On or about March 13, 1941, license number 1009 was issued to petitioner covering the period to July 1, 1941. The license authorized petitioner to engage in the business of private detective investigation, watchman, and/or private patrol in California, and was renewed annually thereafter. Petitioner's specialized activity was listed in the Directory of the Detective License Bureau as "private guard service."
During June 1941, petitioner amended its articles of incorporation and bylaws in two particulars: (1) By increasing *25 its board of directors from 3 to not less than 5 nor more than 7 directors; and (2) by restricting the transfer of its stock to persons whose integrity or Americanism was unquestionable. The resolution increasing petitioner's board of directors specifically stated, in part, as follows:
and, provided further, that no one shall be elected to the Board of Directors except those who are citizens of the United States, of unquestioned Americanism, and whose names shall be submitted to the Federal Bureau of Investigation, the Army Intelligence Division and the Navy Intelligence Division, at least sixty (60) days prior to the time such person or persons assume the duties of a Director of this corporation.
The principal reason for limiting the transfer of its stock to persons whose integrity or Americanism was unquestionable was the recited fact that "* * * this corporation is engaged in the business of furnishing guards, particularly to those plants which are engaged in governmental defense work, * * *."
Two new directors were elected to petitioner's board of directors on June 16, 1941, after the amendment of its articles of incorporation and bylaws. They were Colonel A. T. Marix, president *26 of the Retired Officers Association of the United States, who was experienced in protective and organizational work, and Burnett Wolfson, an attorney.
During June 1941, petitioner filed an application with the California Commissioner of Corporations for a permit to issue the remaining 300 shares of its capital stock to Davis, Holmes, M. A. Holmes, A. T. Marix, and Burnett Wolfson at a price of $ 1 per share. The California Commissioner of Corporations issued such permit on July 2, 1941. After the issuance of this stock, the capital of the petitioner remained at $ 600 throughout the period of its corporate existence.
*528 Petitioner authorized modest salaries for certain of its officers during the taxable years. A salary of $ 150 a month was authorized for Davis from February 15, 1941, to December 15, 1941, and $ 300 a month thereafter. This authorization was by action of the board of directors on February 20, 1942. At the same meeting the board of directors authorized a salary of $ 150 a month for its secretary, Sharp, commencing February 1, 1942, plus a $ 20 a month maintenance and expense fund, and prohibited the president from paying any employee in excess of $ 200 a month without *27 first securing their consent. In August 1942, the directors authorized a monthly expense account of $ 75 for Davis, and in April 1943, increased his salary to $ 500 per month, subject to approval first being had and obtained from governmental authorities so to do. No salaries were authorized or paid to the vice president or treasurer.
The social security tax returns filed by the petitioner with the respondent, which show wages paid to employees, show the following amounts paid to Davis: 1941, none; 1942, $ 3,000; 1943, $ 5,068; 1944 to May 31, $ 2,500.
Originally petitioner's employees were required to be honorably discharged marines with at least 4 years' service. Later, honorably discharged Army and Navy veterans, who had completed basic training, were also employed, as well as nonveterans. Petitioner organized its guard force along military lines with captains, lieutenants, sergeants, corporals, senior guards, and guards. Guards furnished by petitioner to its customers received a 6-weeks training course which included public relations, fire prevention, fire protection, classified information, guard tactics, and safety courses.
Petitioner's guard service was rendered on its customers' *28 property pursuant to oral contracts. Patrol work, such as checking merchants' doors or burglar alarm systems, was not a part of its guard service. The military training and experience of its guards enabled petitioner to furnish a better guard service than other agencies engaged in detective, investigative, and/or patrol work. Petitioner's guard service was better than the guard service rendered by a company's own employees in that it was more flexible in an emergency, more economical for the company, and more impartial, as petitioner's guards were uninterested in internal company politics and were not seeking to better their position with the company. The guard service which petitioner provided for its customers required about 3.32 guards, on a 40-hour basis, to man one guard station 24 hours a day. During and prior to the taxable years, petitioner secured contracts from companies that had formerly used other agencies or their own employees. Some of these companies continued to use the guard services of the partnership, General Plant Protection Company, which succeeded the petitioner.
*529 The total number of petitioner's customers, the hours of guard service rendered them, and the *29 total amount billed such customers for stated weeks during the years 1941 to 1944, inclusive, were as follows:
| Period | Number of | Total | Total |
| customers | hours | billing | |
| Week ended Aug. 24, 1941 | 14 | 2,655 | $ 2,071.75 |
| 2 weeks ended Aug. 30, 1942 | 29 | 29,219 1/2 | 26,546.21 |
| 2 weeks ended Aug. 30, 1943 | 41 | 50,431 | 57,380.53 |
| 2 weeks ended May 21, 1944 | 36 | 32,806 | 38,637.71 |
By August 16, 1942, petitioner lost 6 of the 14 customers it had on August 24, 1941. The reason given petitioner for the loss of this business was that the military authorities insisted on supervising the guard service at plants having war contracts. During and prior to the taxable years, petitioner lost or failed to secure other customers for like stated reasons.
Petitioner's monthly income for the period December 1940 to December 1941, inclusive, was as follows:
| 1940 | ||
| Dec | Cash | $ 1,928.00 |
| 1941 | ||
| Jan | Cash | $ 1,725.70 |
| Feb | Cash | 2,027.75 |
| Mar | Cash | 2,145.42 |
| Apr | Cash | 3,283.90 |
| May | Cash | 5,400.29 |
| June | Cash | 6,558.55 |
| a/c Rec. -- Accrued Income | 3,000.14 | |
| July | a/c Rec. -- Accrued Income | 9,255.12 |
| Aug | a/c Rec. -- Accrued Income | 7,976.21 |
| Sept | a/c Rec. -- Accrued Income | 10,985.07 |
| Oct | a/c Rec. -- Accrued Income | 8,844.21 |
| Nov | a/c Rec. -- Accrued Income | 10,294.16 |
| Dec | a/c Rec. -- Accrued Income | 19,604.43 |
| Total | $ 91,100.95 |
A comparative *30 statement of petitioner's income and expenses, before net operating loss deduction, as finally determined by respondent, shows petitioner's net income or loss during its corporate existence, as follows:
| Sept.-Dec. | 1941 | 1942 | |
| 1940 | |||
| Receipts-service | $ 2,232.57 | $ 92,272.82 | $ 608,069.67 |
| Salaries and wages | 2,191.78 | 77,836.24 | 519,538.23 |
| Gross income | $ 40.79 | $ 14,436.58 | $ 88,531.44 |
| Expenses | 591.67 | 11,651.09 | 48,054.48 |
| Expenses -- other | 136.32 | 3,575.35 | 24,109.90 |
| Net income (loss) | 1 (687.20) | (789.86) | 16,367.06 |
| 1943 | Jan. 1-May 28 | |
| 1944 | ||
| Receipts-service | $ 1,203,037.43 | $ 471,194.75 |
| Salaries and wages | 1,024,477.26 | 393,468.03 |
| Gross income | $ 178,560.17 | $ 77,726.72 |
| Expenses | 87,763.18 | 2 39,325.41 |
| Expenses -- other | 81,366.71 | 11,415.42 |
| Net income (loss) | 9,430.28 | 26,985.89 |
*530 The principal items included in "Expenses -- other" are compensation insurance, group insurance, and social security and state unemployment tax.
Petitioner's excess profits net income during its corporate existence is the amount of net income or loss shown above.
For 1942 and 1943 petitioner's "Expenses -- other" as set forth above included compensation insurance in the respective *31 amounts of $ 11,572.89 and $ 34,186.91. A rebate of compensation insurance in the amount of $ 16,992.57 was received by petitioner in 1944. The books of the petitioner show $ 6,517.83 was received January 7, applying to the period January 28, 1942, to January 1, 1943, and the balance of $ 10,474.74 was received July 8, applying to 1943.
Petitioner's balance sheets as of December 31, 1941 to 1944, inclusive, show the following assets and liabilities:
| December 31 | ||||
| 1941 | 1942 | 1943 | 1944 | |
| Assets: | ||||
| Cash (overdraft) | ($ 3,371.34) | $ 3,803.16 | $ 12,047.41 | $ 2,000.00 |
| Due from employees | 4,228.07 | 5,222.67 | 8,989.70 | 6,711.86 |
| Uniforms | 345.64 | 275.00 | 5,224.08 | |
| Accounts receivable | 7,373.33 | 16,920.41 | 27,420.52 | 5,981.85 |
| Furniture and fixtures | 729.21 | 3,039.54 | 4,957.63 | |
| Guns and ammunition | 1,306.92 | 6,672.60 | 9,490.85 | |
| Deposits | 13.28 | 13.00 | 71.02 | 4,141.49 |
| Autos | 853.68 | 3,850.21 | 10,806.48 | |
| Leasehold improvements | 538.91 | 538.91 | ||
| Organization expenditures | 229.25 | 229.25 | ||
| Bunkhouse equipment | 5,323.24 | |||
| Field equipment | 763.40 | |||
| Total | $ 11,478.79 | $ 40,564.75 | $ 85,862.49 | $ 18,835.20 |
| Liabilities and Capital: | ||||
| Accrued payroll | $ 13,752.65 | |||
| Accounts payable | $ 3,182.53 | $ 2,970.92 | 5,422.47 | $ 1,292.14 |
| Notes payable | 6,527.53 | 7,395.64 | ||
| Accrued social security and | ||||
| unemployment tax | 1,362.98 | 8,320.75 | 15,887.94 | 1,704.36 |
| Accrued capital stock tax | 187.50 | 250.00 | 312.50 | 12.50 |
| Employee contributions | ||||
| O. A. B. and State | ||||
| unemployment | 668.48 | 3,663.93 | 17,444.33 | |
| Accrued Federal taxes | 9,669.22 | 10,927.37 | 17,433.40 | |
| Accrued insurance payable | 10,730.47 | 4,125.14 | ||
| Reserve for depreciation | 443.72 | 2,490.40 | 8,551.61 | |
| Reserve for bad debts | 5,981.85 | |||
| Capital stock | 600.00 | 600.00 | 600.00 | 600.00 |
| Surplus | (1,493.95) | 5,203.89 | 2,233.15 | (12,314.19) |
| Total | $ 11,478.79 | $ 40,564.75 | $ 85,862.49 | $ 18,835.20 |
*32 During the taxable years petitioner, like many other concerns, suffered from wartime restrictions, shortages, and governmental interference. The demands of war and industry for manpower in 1942 and 1943 made it difficult for petitioner to obtain men of the quality it desired. Equipment shortages and a housing problem in Northern California, where petitioner furnished quarters for its guard units, were also experienced by petitioner. Governmental control of security measures, particularly after Pearl Harbor, interfered with petitioner's operations.
*531 Business activity and manufacturing employment in Southern California experienced a rapid growth from September 1940 to May 1944, inclusive. Some companies in this area that had been producing peacetime goods shifted to the production of war goods. Manufacturing employment in the State of California increased more than 117 per cent from 1939 to 1942, inclusive, which was the largest percentage increase of any State. By contrast, manufacturing employment in the United States increased only 44.5 per cent during the same period. A monthly index of business activity in Southern California, 1936-1951, inclusive, with 1939-1940 = 100, shows *33 indexes as follows: September 1940 -- 106.6; May 1944 -- 211.4; averages of the monthly indexes for the years 1936 to 1944, inclusive: 1936 -- 86.9; 1937 -- 95.4; 1938 -- 89.4; 1939 -- 95.5; 1940 -- 104.5; 1941 -- 130.2; 1942 -- 153.9; 1943 -- 194.5; 1944 -- 211.4.
If petitioner had begun business January 1, 1938, business and economic conditions would have been less favorable than at September 20, 1940. Business activity, employment, and payrolls were lower in 1938 than in 1940. In the "Service -- Business Service" classification, Statistics of Income, which would have included petitioner, 65 per cent of the corporations reported no net income on their 1938 tax returns as compared with 57 per cent for 1940. Industry was less concerned in 1938 about protective and security measures. Many companies that required such measures used their own employees as watchmen and guards rather than outside agencies. During and prior to the base period years, it was a general policy of the oil companies to use their own employees to guard their industrial plants. Many of petitioner's best customers during the taxable years followed this policy until they contracted for petitioner's guard services. *34 These customers included, among others, the following companies with the approximate date when they contracted for petitioner's services: Byron-Jackson Company, 1940; Tidewater Associated Oil Company, 1941; General Petroleum Corporation, February 1942; Shell Oil Company, July 1942; Wilshire Oil Company, September 1942. These five companies accounted for half of the total hours billed in each of the 2-week periods hereinabove set forth for 1942, 1943, and 1944. Factors favorable to petitioner, if it had started business on January 1, 1938, would have been the absence of wartime restrictions, military supervision of security measures, and shortages.
The petitioner was partially liquidated May 28, 1944, pursuant to the consent of the shareholders. The business operations and the assets and liabilities with respect to continuing the business were transferred to a partnership as the nominee of the then shareholders; namely, Holmes, Davis, Aleene R. Holland, widow of Holland, A. G. Wolfson, Arthur T. Marix, and Marvin A. Holmes. The partnership *532 operated the business at first under the name of Ex-Marine Guards Company; but, in 1947 or 1948, it changed its name to General Plant Protection *35 Company, under which name it has since operated. The plan of liquidation and dissolution adopted by petitioner's stockholders provided for complete liquidation and dissolution on or before December 31, 1947.
Petitioner filed timely applications for relief (Form 991) under section 722 of the Internal Revenue Code of 1939 and claims for refund (Form 843), alleging therein, as grounds for relief, the presence of factors set forth in subsections (c) (1) to (c) (3), inclusive, of section 722. It claimed therein that it was entitled to a refund of all excess profits taxes paid in the following amounts for the years indicated:
| Year | Excess profit tax paid | |
| 1942 | $ 8,219.26 | (less post-war refund credit of $ 821.93) |
| 1943 | 3,391.45 | (less post-war refund credit of $ 339.15) |
| 1944 | 14,119.36 |
A notice of disallowance of applications for relief and claims for refund with respect to section 722 of the Internal Revenue Code of 1939 was mailed by the respondent to the petitioner under date of July 18, 1951. The petition herein was filed October 8, 1951.
Under the provisions of section 712 (a) of the Internal Revenue Code of 1939, the petitioner's statutory excess profits credit allowance is to be computed under the *36 provisions of section 714 of such Code based on invested capital.
Petitioner's excess profits credits based on invested capital pursuant to section 714, as computed by respondent in determining petitioner's excess profits tax liability for the years 1942, 1943, and 1944, are $ 167.23, $ 586.62, and $ 276.93, respectively.
Petitioner is not entitled to any relief from its excess profits tax liabilities for the taxable years 1942 to 1944, inclusive, under any of the provisions of section 722 (c) of the 1939 Code.
OPINION.
In order to qualify for relief under the provisions of section 722 (c), a taxpayer must establish the existence of one or more of the qualifying conditions enumerated in that section and, in addition, must show that its excess profits tax is excessive and discriminatory because of the existence of one or more such conditions. As we observed in Danco Co., 14 T. C. 276, 282 (1950):
The existence of one of the qualifying conditions specified in the statute is not sufficient to establish a taxpayer's right to relief under section 722 (c), for the reason that the condition may not result in the invested capital method being an inadequate standard for the determination of the *37 excess profits credit or because it may be more than outweighed by other unusual war conditions *533 operating to the taxpayer's advantage during the taxable years. Therefore, the taxpayer must demonstrate the inadequacy of its excess profits credit based on invested capital by showing that the inadequacy results from one of the above factors and by establishing within the framework of section 722 (a) * * * a fair and just amount representing normal earnings to be used as a constructive average base period net income. * * *
For our purposes here in deciding whether the respondent was justified in denying petitioner's claims for relief, we assume that petitioner has established the existence of at least one of the qualifying conditions. The necessary causal relationship between such condition and excessive and discriminatory excess profits taxes, however, has not been shown. To the contrary, this record discloses that petitioner's very existence and success was brought about primarily because of the wartime need for the guard service which it rendered. Petitioner has failed to show that it would have made a profit or even remained in business during the base period years. Hence, it *38 failed to establish a fair and just amount representing normal earnings for use as a constructive average base period net income. Jackson-Raymond Co., 23 T. C. 826 (1955); Harry Lang Manufacturing Co., 19 T. C. 567 (1952); and Fezandie & Sperrle, Inc., 5 T. C. 1185 (1945).
We think it highly implausible, on the facts of the record here, to assume that petitioner could have successfully begun business during the base period and developed a sufficient demand for its services to realize earnings of $ 17,000 per year, which amount it seeks to establish as its reconstructed base period earnings. Once it was decided to incorporate petitioner, its first enumerated purpose for being was to furnish guards for plants engaged in production essential to the public welfare, particularly those plants engaged in production of items integral or important to the national defense program. Prior to the war years, many of petitioner's best customers had utilized their own employees for guard purposes; and, for all that this record shows, would have continued to do so, absent the defense program with its attendant manpower shortages and need for expanded guard service. Moreover, during the first 15 months *39 of its existence, petitioner showed a net operating loss rather than any net income. Not until after the United States actually entered the war did it realize net income from its operations. Petitioner has failed to show any facts which could be used to establish a fair and normal profit during the base period years to form a framework for reconstruction of a base period net income under section 722 (a). See Crowncraft, Inc., 16 T. C. 690 (1951).
Reviewed by the Special Division.
Decision will be entered for the respondent.
Footnotes
1. SEC. 722. GENERAL RELIEF -- CONSTRUCTIVE AVERAGE BASE PERIOD NET INCOME.
* * * *
(c) Invested Capital Corporations, Etc. -- The tax computed under this subchapter (without the benefit of this section) shall be considered to be excessive and discriminatory in the case of a taxpayer, not entitled to use the excess profits credit based on income pursuant to section 713, if the excess profits credit based on invested capital is an inadequate standard for determining excess profits, because --
(1) the business of the taxpayer is of a class in which intangible assets not includible in invested capital under section 718 make important contributions to income,
(2) the business of the taxpayer is of a class in which capital is not an important income-producing factor, or
(3) the invested capital of the taxpayer is abnormally low. In such case for the purposes of this subchapter, such taxpayer shall be considered to be entitled to use the excess profits credit based on income, using the constructive average base period net income determined under subsection (a). For the purposes of section 713 (g) and section 743, the beginning of the taxpayer's first taxable year under this subchapter shall be considered to be that date after which capital additions and capital reductions were not taken into account for the purposes of this subsection.
1. Respondent allowed loss of $ 704.09; difference unexplained.↩
2. Includes $ 229.75 organizational expense.↩