*280 Decision will be entered for the respondent.
The petitioner commenced planning and prepublication activity on a trade magazine in 1935 dealing with electronics but, due to the activities of a competitor, it was unable to commence publication until November 1942 when the magazine scored an immediate financial success. Held, relief under section 721, I. R. C. 1939, denied for 1943 because, even assuming arguendo that it in all other respects qualified therefor, the petitioner failed to establish the cost of research or development of the magazine in each of the prior years, making it impossible to compute the amount of any net abnormal income for 1943 attributable to such prior years.
*691 The Commissioner determined a deficiency in the petitioner's excess profits tax for 1943 in the amount of $ 42,158.45. The sole issue herein is whether the petitioner may deduct $ 60,568.71 or some lesser amount from its excess profits net income for 1943 as abnormal net income attributable to prior years for the purpose of the alternative computation of its excess profits tax liability pursuant to section 721 of the Internal Revenue Code of 1939.
FINDINGS OF FACT.
The petitioner, Caldwell-Clements, Inc., is a New York corporation with its principal place of business in New York, New York. Its tax returns for 1943 were duly filed with the collector of internal revenue for the third district of New York.
The petitioner was organized on July 13, 1935, and its sole stockholders were Dr. Orestes H. Caldwell and Maurice Clements, each of whom owned one-half of the stock of the corporation. Caldwell has for many years been a student, scientist, and recognized authority in the field of engineering, has written a number of articles on engineering subjects, and is well known as a writer of such articles. Prior*282 to 1936 he had made a study of what is known as electronics engineering, and possessed considerable knowledge, experience, contacts, and sources of information in that field and had an acquaintance with people active and interested in it. The field of radio is but a small part of the field of electronics. Clements has for many years been engaged in the business of publishing magazines and since the incorporation of the petitioner he has been its president.
For a great many years prior to 1935, Caldwell and Clements had been employed by McGraw-Hill Publishing Company, Inc. (hereinafter *692 referred to as McGraw-Hill). During the period when Caldwell and Clements had been with McGraw-Hill they worked together, Caldwell as the editor of several of the McGraw-Hill publications, and Clements as the manager of these same publications. Clements left the employment of McGraw-Hill during January 1935 and Caldwell left during the middle of the same year, although in January 1935 he knew that he would not continue with McGraw-Hill much longer. After its organization in July 1935 the petitioner's business has been, and still is, the publication of trade and technical magazines.
The*283 first magazine published by petitioner was Radio Today, which was a dealer and service publication designed primarily for an audience composed of radio sales and service people rather than engineers. The first issue of Radio Today appeared in September 1935 and it has been published ever since, although its name was changed from time to time and in 1942 it merged with another magazine acquired from McGraw-Hill.
Planning of a magazine under the name "Engineering Today" was started by the petitioner's officers shortly after the petitioner was organized. In September 1935, Caldwell and Clements commenced work on their plans and budget studies for the publication with the view to bringing it out late in 1937. The persons for whom the petitioner's new magazine, as initially conceived and as it appeared in November 1942, was designed and intended included, among others, the engineers and designers engaged in developing and using electronic apparatus and equipment. These engineers were highly trained technical and mathematical graduates, and any magazine which would be acceptable to them had to contain technical articles written by recognized authors and authorities on the subject of*284 engineering. The new magazine was not intended for the retail storekeepers, businessmen, and merchants who sold or serviced radio and electrical appliances and who were and are the principal readers of Radio Today.
Prior to 1937, the word "electronic" had not gained the wide acceptance with the general public it now has as a generic term, and its use in the title of the petitioner's projected magazine in that field would not have had the significance which later attached to this word. By 1942 the word "electronic" had gained a generic meaning sufficiently widespread for inclusion in a magazine title, and petitioner, therefore, eventually and after the delays later referred to herein, published its new magazine under the name "Electronic Industries" rather than Engineering Today.
The petitioner's books of account disclose that in September 1937 it paid out $ 394.34 for salaries, postage, stationery and supplies, printed matter, and miscellaneous items in connection with the proposed publication of Engineering Today. Apart from these entries for this 1 month, the petitioner's books prior to 1942 do not segregate *693 or show in any identifiable manner the amount of expenses *285 incurred in the development of Engineering Today or Electronic Industries.
For at least 2 years prior to September 1942, Radio Today published incidental articles and gave departmental attention to the broader phases of the electronics industry from the point of view of interesting its radio readers in the increasing applications of vacuum tubes and amplifier equipment in fields outside space radio and for the purpose of pointing out the new field of opportunity to local servicemen in maintaining electronic equipment. Radio Today did not treat fully of electronics in all its aspects -- manufacture, applications, communications-design, production, and use -- while Electronic Industries when finally published effectively served this field.
The preparatory work or prepublication activities in connection with Electronic Industries included: The conception of the commercial possibilities of a technical magazine designed for a select group of top level engineers and designers who were in charge of experimental and production programs for their companies; the outlining of a field to be covered and of an editorial program; the development through questionnaires, investigations, and other *286 research activities of a list of potential readers selected and classified according to industry, title, or function; and the cuttting of stencils with the names of the potential readers so determined.
Caldwell was responsible for the editorial work for Electronic Industries and Clements attended to the publishing, sales, and circulation efforts.
The petitioner intended to start publication of its new magazine, then named "Engineering Today," with the November 1937 issue. By mid-1937, it had completed the artwork and copy for an advertisement which it intended would be published prior to November 1937 in Printer's Ink, a magazine enjoying great prestige and standing among advertisers and advertising representatives. Formal announcement of the forthcoming publication of Engineering Today was made to potential subscribers, advertisers, and contributors by distribution of 1,000 engraved cards about September 1937. These cards referred to the magazine as "a new conception in technical radio journalism." The advertisement designed for Printer's Ink also described the magazine in the following terms:
THE publishers of RADIO TODAY, now acknowledged leaders in radio publishing, announce*287 another distinctive magazine -- ENGINEERING TODAY -- for all engineers and technicians who are engaged in the design and production of radio products or the operation of broadcasting and communication services.
The new magazine will have its eye on all developments of future significance, but it will put its chief emphasis on those things that affect the products and services of TODAY or the very near future. It will have new editorial features, giving the reader a service that is not now rendered by any other publication.
If your business can be improved by a new and intimate contact with the *694 active projects in every branch of the radio science, be sure to provide a place for ENGINEERING TODAY in your 1938 advertising budget.
November PREVIEW ISSUE, 10,000 copies. Circulation is built on a highly selective basis, absolutely guaranteeing coverage of the buying power of the field. * * *
Publication of the petitioner's new magazine in November 1937 was postponed because of the competitive activities of McGraw-Hill. On June 20, 1939, McGraw-Hill, the petitioner, Caldwell, and Clements, individually, and Electrical Week, Inc., a corporation wholly owned by the two individuals, *288 entered into an agreement for the stated purposes of (1) combining in one adequately financed operating company the magazines Radio and Television Retailing and Wholesaler's Salesman published by McGraw-Hill, Radio and Television Today published by the petitioner, and Electrical Week published by Electrical Week, Inc., and (2) employing Caldwell and Clements, individually, to manage these publications.
Caldwell and Clements felt that this agreement was the best available temporary solution of the problem posed by the competition of McGraw-Hill. However, McGraw-Hill did not deliver the magazine Radio Retailing until January 1942 and did not deliver the second magazine at all. The magazine Electrical Week was abandoned.
After the execution of the contract, Clements and Caldwell were still unable to achieve a working relationship with McGraw-Hill, which then owned pursuant to the agreement of June 20, 1939, 60 per cent of their corporations, under which they felt they could publish their electronics magazine although they continued their work on preparing lists of potential engineer readers and an editorial program. Clements and Caldwell reacquired majority stock control of their *289 corporations in March 1942 when McGraw-Hill's interest was reduced to 49 per cent.
In 1949 and 1950, the petitioner commenced actions in the Federal and New York State courts against McGraw-Hill with respect to losses and damages it had allegedly suffered to publishing properties owned by it. These actions were settled by an agreement dated December 31, 1953, pursuant to which McGraw-Hill paid the petitioner $ 100,000, although it continued to deny the validity of the claims asserted against it.
During the latter part of 1941, the petitioner prepared a "dummy" of an advertising brochure intended as an initial mailing piece in connection with the proposed publication of two magazines, Radio and Television Retailing purchased from McGraw-Hill and merged with the petitioner's Radio Today, and Radio Engineering Today which was to have included another purchased magazine Communications, but the transaction for the purchase of the latter magazine was never completed. Radio Engineering Today was designed as a professional *695 publication for the engineer, technician, and manufacturer in radio, broadcasting, communications, and allied industries, and was similar in concept to Electronic*290 Industries.
The magazine Electronic Industries, as published in November 1942, was essentially the same magazine which the petitioner's officers had been planning since 1935. It differed in editorial content, advertising, and intended audience from Radio Today which the petitioner had published since 1935.
Electronic Industries was an immediate financial success and has been published monthly since November 1942. Three issues of the magazine were published during the last quarter of 1942 and the net profit derived therefrom by the petitioner was $ 2,082.59. The net profit derived for the year 1943 was $ 72,046.56. The magazine was very favorably received by the advertisers and readers it was designed to serve.
The advertising revenue derived by the petitioner each month during the years 1942 and 1943 from its publication of Radio Today and Electronic Industries, respectively, was as follows:
| Electronic | Total | ||
| Year | Industries | Radio Today | advertising |
| revenue | |||
| 1942 | |||
| January | 1 | $ 14,979.58 | $ 14,979.58 |
| February | 1 | 9,337.18 | 9,337.18 |
| March | 1 | 20,496.74 | 20,496.74 |
| April | 1 | 8,449.85 | 8,449.85 |
| May | 1 | 7,752.01 | 7,752.01 |
| June | 1 | 10,928.46 | 10,928.46 |
| July | 1 | 8,508.43 | 8,508.43 |
| August | 1 | 9,786.00 | 9,786.00 |
| September | 1 | 9,608.68 | 9,608.68 |
| October | $ 16,027.12 | 10,683.13 | 26,710.25 |
| November | 11,820.01 | 11,913.19 | 23,733.20 |
| December | 14,014.67 | 10,727.36 | 24,742.03 |
| Total | 2 $ 41,861.80 | 2 $ 133,170.61 | 2 $ 175,032.41 |
| 1943 | |||
| January | $ 16,425.51 | $ 10,022.98 | $ 26,448.49 |
| February | 35,211.19 | 9,047.30 | 44,258.49 |
| March | 21,457.55 | 18,661.95 | 40,119.50 |
| April | 24,676.98 | 10,190.97 | 34,867.95 |
| May | 34,723.26 | 14,345.32 | 49,068.58 |
| June | 29,856.84 | 13,608.06 | 43,464.90 |
| July | 34,627.50 | 14,237.36 | 48,864.86 |
| August | 38,712.76 | 14,226.93 | 52,939.69 |
| September | 39,595.87 | 16,671.51 | 56,267.38 |
| October | 43,191.91 | 16,872.22 | 60,064.13 |
| November | 39,249.47 | 18,973.43 | 58,222.90 |
| December | 47,079.53 | 17,422.99 | 64,502.52 |
| Total | 2 $ 404,808.37 | 2 $ 174,281.02 | 2 $ 579,089.39 |
The number of advertisers in Radio Today increased during the period from November 1942 through December 1943 from 58 to 81 or by approximately 30 per cent whereas the number of advertisers in Electronic Industries rose during the same period from 86 to 246 for an increase of approximately 186 per cent. The companies which *696 advertised in both magazines ranged from approximately 15 per cent to 30 per cent of the number of companies that advertised in Electronic Industries during this period and during most of these 14 months the percentage was 20 per cent or less.
In 1942 the petitioner spent $ 7,051.44 for advertising and sales expenses for the purpose of selling space in Electronic Industries to advertisers and in the same year it spent $ 2,967.95 on circulation expenses for the purpose of promoting subscriptions to the magazine. In 1943 the petitioner spent $ 71,454 on advertising and sales of space and $ 57,860.69 on circulation, of which latter amount $ 44,729.84 was for printed matter consisting largely of circulation promotional literature.
One of the magazines which Caldwell and Clements worked on*292 during the period of their employment by McGraw-Hill was named Electronics. The idea of this magazine had been conceived by Clements who wrote the complete developmental presentation and was its first manager when it was brought out in 1930. It contained technical articles requiring engineering and mathematical knowledge and was somewhat similar to the petitioner's Electronic Industries except that the McGraw-Hill publication was intended for a much broader audience in the engineering field and could be purchased by the general public, whereas the petitioner's magazine was designed for a selective and highly specialized audience consisting of administrative and executive engineers in order to avoid waste circulation from an advertiser's point of view. The petitioner's officers felt that they had a different concept of the editorial approach, one that was commercial as well as technical, and that they appreciated more than did McGraw-Hill the impact of the vacuum tube on industrial development and in 1943 the importance of electronics in war industries.
The experience which Caldwell and Clements had acquired in the publishing of Electronics for McGraw-Hill was of great value to *293 the petitioner in expediting the preparatory work on and the publication of Electronic Industries.
The stipulation of facts and the exhibits annexed thereto are incorporated herein by this reference.
OPINION.
The petitioner was organized July 13, 1935, by two former editorial employees of McGraw-Hill Publishing Company, Inc., who had worked together for many years in that company as publisher and as editor of technical magazines dealing with the fields of radio and electronics. The petitioner was able to commence publication in September 1935 of a magazine, Radio Today, designed for radio sales and service dealers, and also to commence planning and other preparatory work toward the publication of a technical magazine intended for a highly selective audience of top level engineers *697 and designers. Due to the competitive activities of McGraw-Hill, petitioner's officers felt that it was not possible for the petitioner to bring out this new magazine Electronic Industries until November 1942 when it scored an immediate financial success -- an unusual event in the publishing business which may be explained by the rapid progress and flourishing conditions in the electronics industry*294 caused by the war.
In the instant proceeding, the petitioner seeks a reduction in its excess profits tax for 1943 under the relief provisions of section 721 of the Internal Revenue Code of 1939 on the ground that a portion of its income for that year was abnormal and was attributable to prior years during which the magazine Electronic Industries was under development.
As we stated in E. W. Williams Publications, Inc., 282">25 T. C. 282, 290:
In order to obtain relief, the taxpayer must establish within the framework of the statute and applicable regulations, (1) the class and amount of abnormal income in the taxable year; (2) the amount of net abnormal income derived therefrom; and (3) the portion of net abnormal income which is attributable to other taxable years. [Citations omitted.]
The petitioner and the respondent have joined issue at every step of the way through the statutory pattern of section 721 and the regulations issued thereunder. Before proceeding further, we shall note briefly the specific points in dispute.
1. The petitioner elected to classify its purported abnormal income from its magazine Electronic Industries or, in the alternative, *295 from all of its magazines, under section 721 (a) (2) (C). 1 It contends that the preparatory editorial and prepublication work of its officers and employees on Electronic Industries prior to 1943 resulted in the receipt in that year of the class of abnormal income which is defined in section 721 (a) (2) (C) as a "separate class * * * resulting from * * * research, or development of tangible property, * * * or processes, * * * extending over a period of more than 12 months." In the alternative, it argues that if it should be determined that the income received in 1943 was not of the class described in section 721 (a) (2) (C), then it was not of a class described in any of the subparagraphs A through F of section 721 (a) (2) and was, therefore, classifiable in accordance with the last sentence of section 721 (a) (2). 2*296 No regulations have been issued under this sentence of the statute.
The respondent, after first contending that petitioner had no income in 1943 of any class defined as abnormal in section 721 (a) (2), contends *698 that the petitioner is bound by its irrevocable election to classify its income from Electronic Industries under section 721 (a) (2) (C) and cannot seek relief in the alternative under the last sentence of section 721 (a) (2). He further argues that class (C) income does not include "the type of activity performed by the petitioner in connection with the publication and promotion of a magazine such as 'Electronic Industries,'" a conclusion suggested by dictum in our Opinion in E. W. Williams Publications, Inc., supra, at page 291, and urges that to treat the petitioner's gross income from advertising and sales of a magazine as a separate nonspecific class under section 721 (a) (2) would be too broad a classification under*297 the statute.
2. Assuming that the petitioner qualified for relief under section 721 (a) (2), the respondent argues next that the petitioner has failed in its burden of proving what portion of its income in 1943 was not attributable to such factors as management, salesmanship, and goodwill, since income arising from such sources is not of a type for which relief is granted under section 721 (a) (2) (C). E. W. Williams Publications, Inc., supra. The petitioner contends that it has proved as far as it is possible in any case to do so the extent to which its income in 1943 is not attributable to these factors, and requests this Court to make its own determination, based upon the entire record, which will make an allowance for the income-producing effect of these elements.
3. Assuming, arguendo, that the petitioner is able to establish the amount of its net abnormal income for 1943, as defined under section 721 (a) (3), the respondent argues that the petitioner has failed in its burden of proving what, if any, portion of such net abnormal income was not due solely to an improvement in business conditions. Regs. 112, sec. 35.721-3. The parties are in*298 dispute as to the computation of a factor of business improvement which will give effect to such elements as high prices, low operating costs, and increased physical volume due to increased demand or decreased competition.
4. Finally, again assuming arguendo that all previous contested points have been settled in the petitioner's favor, the respondent contends that the record affords no satisfactory basis upon which any net abnormal income that may be found for 1943 can be apportioned to prior years.
After careful consideration of the entire record and for the reasons set forth below, we are in agreement with respondent's final contention and must deny the petitioner the relief requested under section 721. It is, therefore, unnecessary for us to consider or decide the various other points in issue.
The excess profits tax was first enacted by the Second Revenue Act of 1940 and was made effective for taxable years beginning after December 31, 1939. Under the provisions of section 721 (c), which the petitioner desires to use in computing its excess profits tax for *699 1943, it is necessary to determine the amounts by which its excess profits taxes in each of the years 1940*299 through 1942 would be increased by the inclusion in the gross income of the respective years of the portion of the net abnormal income for 1943 attributable thereto. The rates at which the excess profits tax was imposed varied in each of the years 1940 through 1943. Sec. 710, as amended. It is, therefore, essential to the success of the petitioner's case that it establish the amounts of net abnormal income derived in 1943 attributable to each of the years prior thereto in which the excess profits tax was in effect so that the excess profits taxes for those years can be recomputed giving effect to the inclusion of the proper portion of the net abnormal income received in 1943. Cf. Ramsey Accessories Manufacturing Corporation, 10 T. C. 482, 488-489. Furthermore, it appears from the exhibits annexed to the stipulation of facts that the petitioner had losses in 1940 and 1941 and net income in 1942 so that the attribution of the net abnormal income from 1943 to the correct prior years is of added importance to the computation of the petitioner's excess profits tax for 1943 under section 721 (c).
Regulations 112, section 35.721-7, pertaining to abnormal*300 income from research or development, provide, in part, as follows:
In general, an item of net abnormal income of the class described in this section is to be attributed to the taxable years during which expenditures were made for the particular exploration, discovery, prospecting, research, or development which resulted in such item being realized and in the proportion which the amount of such expenditures made during each such year bears to the total of such expenditures.
This method of allocating net abnormal income of the taxable year to prior years has been followed by this Court. W. B. Knight Machinery Co., 6 T. C. 519; Rochester Button Co., 7 T.C. 529">7 T. C. 529.
In the instant case, there is no satisfactory evidence in the record which establishes either the total amount expended on any research or development activities in connection with Electronic Industries or the amounts expended in any of the years prior to 1942. The petitioner has suggested no other method by which we may attribute any net abnormal income derived in 1943 to the respective prior years, and we know of none.
The parties have stipulated that with the *301 exception of a ledger sheet of September 1937 showing expenditures of $ 394.34, the petitioner's books "prior to 1942 do not segregate or show in any identifiable manner the amount of expenses incurred in the development of 'Electronic Industries' or 'Engineering Today.'" The only evidence in the record with respect to the amount expended on "research or development" in connection with the new magazine is the testimony of Clements, the petitioner's president since its inception. In response to a question from the petitioner's counsel as to whether he could state *700 approximately how much it cost to develop Electronic Industries, Clements testified that it would be very difficult for him "to state precisely" unless he could include an estimate of the time put in by himself and Caldwell, and that if such time were considered "you would probably have six figures." When asked for specific items for which money would have been spent in addition to the time of the petitioner's two chief officers, Clements testified that "perhaps the largest single item [aside from the officers' time] was the development of a mailing list," the culling of the names of 12,000 to 14,000 top level executive*302 engineers and designers from a list of 100,000, "the questionnairing, personal visits, postage, then putting all of that data on addressograph plates, that could have cost anywhere from $ 30,000 to $ 40,000."
Clements also testified as follows in response to a question by the petitioner's counsel as to what percentage of the total amount of development work was performed during the years 1940 through 1942, inclusive:
A. Mr. Reinhart, I could only give you a wild guess based on developmental work on many magazines, sort of a crescendo. I'm pretty certain we knew in 1940 that we were going to start this publication and we knew also in the year we were just started we would have our greatest expense. Now, if you mean in time from '35 or '37 up to '42, it would be very difficult to break down, but I should say the three years subsequent to the first issue, we probably did 50 per cent of our work --
Q. The three years subsequent to the first issue?A. Prior to the first issue. I beg your pardon, and 1942, the key year, we probably did somewhere around 20 or 22 per cent and a shorter or a smaller percentage in the years prior. Possibly 14 or 16 and down to 10, but that again I say is*303 a guess.
Q. Was any developmental work done after November of 1942?A. What do you mean by "developmental work", Mr. Reinhart?Q. The development of the magazine as distinguished from the promotion of the magazine.
A. Well, it's like birth. I call the developmental period the incubation. When the baby was born in November 1942, the full momentum was there and it was then a matter of our monthly editorial service, building paid subscriptions. I don't think we had any developmental expenses after November 1942.
Q. Have you any way of knowing how much of the total cost of developing the magazine contributed to those years, 1940, '41 and '42?
A. Well, Mr. Reinhart, you have many intangibles. The developmental work of our publications is quite different with the experience in the consumer field. In the consumer field you can get an idea for a pulp magazine and you can publish it in a few weeks, but I believe our major expense was the many, many years' experience we had of knowing what to do and how to spend our dollars more efficiently. I would say possibly 50, 60 per cent.
Q. During those three years?A. Yes, sir.Clements further testified that he was "afraid to hazard a guess" *304 as to what degree the reputations and experience of himself and Caldwell *701 were encompassed in the development work on Electronic Industries and that he "could only hazard a guess" as to how much the income derived from Electronic Industries in 1943 was the result of prior development work.
It is apparent from Clements's testimony that he had no clear understanding of what constituted research and development expenditures in connection with the preparatory work on the magazine as distinguished from those which should be classed as promotional or management, salesmanship, or goodwill. His testimony consisted entirely of a number of uncorroborated generalized statements admittedly based largely, if not completely, on guesswork. It amounted to nothing more than an expression of opinion lacking any basis in the evidence, and we cannot accept it as satisfactory evidence of the proportions in which any development expenses are attributable to years prior to 1943. See Pabst Air Conditioning Corporation, 14 T.C. 427">14 T. C. 427. We have no knowledge of the specific items or amounts considered by Clements in "guessing" at the percentages of development work attributed*305 by him to these years and we cannot, on this record, make the findings of fact as to such percentages required for an allocation to each of the prior years of any net abnormal income which the petitioner might have derived in 1943. Crowell-Collier Publishing Co., 25 T. C. 1268. Thus, even if the petitioner successfully cleared all other hurdles, it cannot succeed absent a basis upon which we can allocate any net abnormal income for 1943 to the prior years, Atlumor Manufacturing Co., 12 T. C. 949, and relief under section 721 must be denied.
Reviewed by the Special Division.
Decision will be entered for the respondent.
Footnotes
1. Not in publication.↩
2. Gross before agency commissions.↩
1. SEC. 721 (a) (2) (C).
Income resulting from exploration, discovery, prospecting, research, or development of tangible property, patents, formulae, or processes, or any combination of the foregoing, extending over a period of more than 12 months; * * *↩
2. The classification of income of any class not described in subparagraphs (A) to (F), inclusive, shall be subject to regulations prescribed by the Commissioner with the approval of the Secretary.