*35 Decision will be entered for the respondent.
On the record held that petitioner is not entitled to relief under section 722 of the Internal Revenue Code since it has failed to establish or show a constructive average base period net income which would result in a greater excess profits credit than that allowed by the respondent on the basis of invested capital.
*385 This proceeding involves petitioner's claims for refund of excess profits tax under section 722 of the Internal Revenue Code of 1939, as amended, for the fiscal years ending January 31, 1943, 1944, 1945, and 1946, in the amounts of $ 2,970.07, $ 20,987.80, $ 40,725.09, and $ 22,771.87, respectively.
The principal*36 issue is whether petitioner is entitled to relief under sections 722 (b) (4) and 722 (b) (5). Other issues raised under sections 711 (b) (1) (H), (I), (J), and (K) and section 722 (b) (1) have been waived by petitioner.
In an amendment to his answer, respondent alleges that the allegation made by petitioner in its petition that the respondent erred in failing to allow the carryover of any unused excess profits credit resulting from an allowance under section 722 is not based on a timely claim for refund.
The testimony was taken before a commissioner of this Court. His findings of fact were duly served on the parties and they filed their objections thereto. After consideration of these objections, we make the following findings of fact.
FINDINGS OF FACT.
The stipulated facts, oral and written, are found as stipulated and are incorporated herein by reference.
The petitioner is a corporation organized under the laws of the State of Maryland with its principal office at 8 East Baltimore Street, Baltimore 2, Maryland. It filed its Federal tax returns for the taxable years involved herein with the collector of internal revenue for the district of Maryland. At all times material hereto, *37 petitioner was engaged in selling at retail men's, women's, and children's shoes, hosiery, ladies' bags, and other accessories in its stores in Baltimore, Maryland.
*386 For the taxable years ended January 31, 1943, 1944, 1945, and 1946, respondent determined petitioner's excess profits tax liabilities to be as follows:
| Year ended | |
| January 31 | Liability |
| 1943 | $ 2,970.07 |
| 1944 | 23,955.28 |
| 1945 | 48,416.33 |
| 1946 | 57,029.04 |
The petitioner duly and timely filed with respondent applications for relief (Form 991) under section 722, I. R. C. 1939, * for such taxable years. Thereafter, petitioner filed voluminous supplemental data in support of such applications. The original applications were filed as follows:
| Year ended | |
| January 31 | Date filed |
| 1943 | Apr. 9, 1946 |
| 1944 | Apr. 11, 1947 |
| 1945 | Jan. 22, 1948 |
| 1946 | Jan. 22, 1948 |
Petitioner's base period years are the fiscal years ended January*38 31, 1937 to 1940, inclusive.
Petitioner's excess profits tax credits, computed under section 713 (income credit method) of the Code, without the application of section 722 of the Code, as finally determined by the respondent, are as follows:
| Year ended | |
| January 31 | Amount |
| 1937 | $ 3,656.47 |
| 1938 | 5,311.76 |
| 1939 | 6,072.17 |
| 1940 | 3,531.68 |
| Arithmetic average | $ 4,643.02 |
| Average base period net income (sec. 713 (f)) | 4,960.83 |
| Excess profits credit (sec. 713) | 4,712.79 |
Petitioner's excess profits credits, computed under section 714 (invested capital method) of the Code, without the application of section 722 of the Code, as finally determined by the respondent, are as follows:
| Year ended | |
| January 31 | Amount |
| 1941 | $ 26,050.39 |
| 1942 | 26,341.91 |
| 1943 | 27,398.70 |
| 1944 | 29,011.96 |
| 1945 | 30,780.73 |
| 1946 | 32,476.43 |
*387 The business of which petitioner is an outgrowth was organized in 1873 to manufacture men's shoes. About 1890, the business commenced the retail sale of men's shoes of a high quality. On January 8, 1903, the business was incorporated under the present name under the laws of the State of Maryland. In 1904, petitioner's original business establishment*39 was destroyed by the Baltimore fire. Shortly thereafter, its business was reestablished at 8 East Baltimore Street, Baltimore, Maryland. In or about 1927, the machine manufacture of shoes was discontinued and since then petitioner has been engaged in the retail sale of men's, boys', ladies', and children's shoes of high quality. In addition to selling shoes, petitioner maintained a shop where custom-made shoes were manufactured to order, and sold hosiery, ladies' bags and other accessories.
Prior to his death in 1940, Isaac S. Hess, president of petitioner during the base period years, had been in the shoe retailing business with petitioner and its predecessor for about 50 years. When Isaac's father and uncle, the founders of the shoe manufacturing business, decided to embark in a retailing enterprise, they sent Isaac to Charlotte, North Carolina, to learn retailing. After several years, Isaac returned to Baltimore and opened the retail enterprise in men's shoes and accessories. From 1904 to 1928, petitioner sold men's shoes and Isaac operated a women's and children's shoe business in the same building by means of a partnership. In or about 1928, petitioner took over from the*40 partnership the women's and children's shoe retailing business.
Ned Hess, vice president and treasurer of petitioner during the base period years and a son of Isaac, has been in the shoe retailing business as an employee and officer of petitioner since 1920. He first served an apprenticeship which included trips to England and France to study how women's shoes were styled, manufactured, and sold. Ned Hess specialized in high grade women's shoes.
George B. Hess, secretary of petitioner during the base period years and a son of Isaac, entered the shoe business with petitioner in 1925 upon graduation from Johns Hopkins University. His apprenticeship and education in the shoe business included trips to England where he studied manufacturing and distribution procedures. He has been an officer of petitioner since 1928 and has specialized in men's shoes. For 15 years, he has headed the National Men's Shoe Style Committee, and has held other important posts in national shoe organizations.
At the beginning of the base period, the name and reputation of the petitioner as an outstanding shoe retailer had been established. Isaac and other members of the Hess family had made personalized*41 services and high quality merchandise a traditional and fundamental *388 part of petitioner's shoe business. Many innovations in the shoe business were introduced by the Hess family. Since the start of the business, custom shoes have been made to order for the customer's needs. In 1892, Isaac Hess, in collaboration with scientists at Johns Hopkins University Medical School, developed an orthopedic last which was in use for 45 years. This special interest in people with foot ailments and deformities earned great respect for petitioner and its predecessor. In petitioner's store, a salesman waited on only one customer at a time in contrast to the chain store practice of serving several. Petitioner maintained a complete shoe repair service at its Baltimore Street store and gave free shoe shines. It was the first shoe business in the country to install a fluoroscope machine for fitting shoes. Many prominent people in the East bought their shoes from petitioner. Its customers included the so-called "carriage trade," the people from the best residential sections of Baltimore, and the office and "white collar" workers, many of whom had been customers for 50 years or more.
In*42 1904, petitioner's store at 8 East Baltimore Street was located in a good shopping area, rather general in character. Shortly after World War I, a trend developed toward Charles Street and Howard Street as women's shopping centers. Charles Street at that time was known as the "Fifth Avenue" of Baltimore. Four department stores, located at or near the intersections of Howard Street with Lexington and Saratoga Streets, were about six blocks north and west of the Baltimore Street store, while the better shops on Charles Street were three or four blocks north. In the late 1920's or early 1930's, Baltimore Street developed a trend toward a men's shopping center in the vicinity of petitioner's store. As this trend continued, petitioner's Baltimore Street store became less and less desirable as a location for selling high quality ladies' shoes. Nevertheless, despite this trend the sales of ladies' shoes at the Baltimore Street store showed increases in the fiscal years ending January 1935, 1936, and 1937, and in the latter year such sales were larger than the store had had in any one of the preceding 6 years.
In the late 1920's petitioner considered opening a store in the downtown *43 area of Baltimore that would feature women's and children's shoes. The location of such a store depended on whether Charles Street or Howard Street would develop into the better business area. This problem was partially resolved in 1930 when petitioner opened a new store at 21st and Charles Streets to specialize in the sale of children's shoes and accessories. This store was operated by petitioner throughout the years here involved.
In or about 1931, petitioner considered and rejected a location for a women's shoe store on Charles Street. Thereafter, and prior to December *389 1934, petitioner considered locating a store on Lexington Street between Charles and Liberty Streets. During 1934, petitioner negotiated for a lease on property at 304 North Howard Street for a new ladies' and children's shoe store. The minutes of the directors meeting of December 14, 1934, show that negotiations were in progress at the same time for 314 North Howard Street, but that the latter property was not to be considered unless negotiations for 304 North Howard Street failed. Ned G. Hess reported that additional capital of approximately $ 100,000 would be required to open and operate the new*44 store. Such estimate included $ 10,000 for losses for the "first few years during development stage." Petitioner failed to secure the premises at 304 North Howard.
Petitioner continued its efforts to secure another location, and on or about May 25, 1936, executed a 10-year lease for the premises at 312-314 North Howard Street. The two small stores on these premises were demolished and a new building erected thereon by the lessor. Petitioner's officers consulted with the lessor at length about the building, its construction, and the details thereof. The new building was "tailored" to petitioner's specifications, and the first floor wall between it and the adjoining property at 316 North Howard Street was constructed of very thin material so that it could be broken through at any time. The new building, sometimes referred to as the "A" building, was completed and opened as petitioner's Howard Street store on February 22, 1937.
One of the factors which influenced petitioner to locate its new store on North Howard Street was the plan of the City of Baltimore to develop North Howard Street into an arterial highway connecting the downtown shopping area with the northern residential*45 areas. On April 13, 1935, the City of Baltimore passed an ordinance providing for the condemnation of certain lands necessary for carrying out this plan. Construction of the first section of the North Howard Street arterial highway began on June 29, 1937, and the last section thereof was completed on August 14, 1941. Construction of the section of this highway between Saratoga and Centre Streets did not commence until April 1, 1940, and was completed on May 19, 1940. The Howard Street store was located in this section. Petitioner expected that the highway would be very beneficial to this store.
The "A" building at petitioner's Howard Street store was approximately 25 feet wide and 121 feet in depth. It was a three-story building with a basement and an elevator. On the first floor, petitioner located the selling area for higher priced women's shoes, ladies' hosiery, ladies' handbags, a cashier and wrapping counter, and stock rooms. The selling areas for children's shoes, hosiery, and wearing apparel, less expensive women's shoes, and a stock room were located *390 on the second floor. Originally, a window dressing department and a lunchroom for employees were located *46 on the third floor, but after 1938, part of the third floor was used for bargain sales of women's shoes. The receiving and delivery departments, and the utilities, were located in the basement, but after September 1, 1938, part of the basement was used for selling men's and boys' shoes.
In 1938, about a year and a half after the A building at Howard Street was opened, petitioner began to negotiate for a lease of the adjoining property at 316 North Howard Street. On December 23, 1939, a lease for this property was executed. The lease provided that petitioner would make certain improvements and alterations to the premises in accordance with approved plans and specifications attached to the lease. At ground level, the leased building, hereinafter sometimes referred to as "B" building, had a frontage of 20 feet and a depth of 121 feet, a small basement, and two upstairs floors, shallow in depth.
Immediately after signing the lease for B building, alterations on the premises were started. A barricade was erected on the first floor of A building, so that the wall between A and B buildings could be removed, and the dirt and refuse therefrom left in B building. The alterations created*47 dirt, temporary loss of storage space, and confusion, which had an adverse effect on petitioner's business. The alterations to B building were completed in February 1940, and the enlarged store opened for business. After the alterations to B building were completed, only the first floor and basement thereof were available for petitioner's use. The petitioner was committed to the expansion of its Howard Street store into B building prior to December 31, 1939.
After February 1940, all ladies' shoes, expensive and less expensive, were sold on the first floor of A and B buildings, and the second floor of A building was used for children's shoes, hosiery and accessories. This arrangement narrowed the use of the elevator to shifting merchandise and transporting customers to the children's department.
Petitioner's capacity for housing or storing shoes and its capacity for seating customers increased as a result of the expansion of its Howard Street store. The increase in its shoe storage capacity was as follows:
| A Building | A and B | |
| Buildings | ||
| (pairs) | (pairs) | |
| First floor | 5,282 | 22,872 |
| First floor balcony | 6,000 | |
| Second floor, ladies | 3,800 | |
| Second floor, children | 3,800 | 7,600 |
| Total | 18,882 | 30,472 |
*48 *391 Approximately 1,000 to 1,500 pairs of men's and boys' shoes were stored in the basement of A building in connection with the sale of such shoes, but no change in this storage capacity resulted from the opening of B building. The increase in its seating capacity was as follows:
| A Building | A and B | |
| Buildings | ||
| (chairs) | (chairs) | |
| First floor | 46 | 102 |
| Second floor, ladies | 24 | |
| Second floor, children | 22 | 45 |
| Total | 92 | 147 |
The number of chairs used in the basement for the sale of men's and boys' shoes is undisclosed. The chairs used in bargain sales of ladies' shoes on the third floor of A building were taken from the first and second floors.
At January 31, 1936 and 1937, petitioner used 14,444 square feet of its Baltimore and Charles Streets stores for selling purposes 1 and 3,525 square feet thereof for nonselling purposes. After opening the Howard Street store and after some rearranging of space in the other two stores, petitioner was using 20,132 square feet for selling purposes and 9,774 square feet for nonselling purposes on January 31, 1938. During the fiscal year ended January 31, 1939, petitioner converted 3,111 square feet of nonselling*49 space at the Howard Street store to selling area so that on January 31, 1939, the selling and nonselling areas at the three stores were 23,243 square feet and 6,663 square feet, respectively. During the fiscal year ended January 31, 1940, petitioner added 2,188 square feet of selling space to its men's and boys' shoe department at its Baltimore Street store and reduced in like amount the selling space at such store in its ladies' and children's departments. In February 1940, after B building was opened, petitioner's selling and nonselling areas totaled 25,950 square feet and 6,663 square feet, respectively. During its base period and including amounts for which it was committed on December 31, 1939, petitioner increased its capacity for operation in square footage by 79.66 per cent in selling space, and by 89.02 per cent in nonselling space. Selling and nonselling floor space at the stores at the beginning and end of the base period, including the commitment for the B building at December 31, 1939, was as follows: *392
| February 1, 1936 | January 31, 1940 | |||
| Store | Selling | Nonselling | Selling | Nonselling |
| Square feet | ||||
| Baltimore Street | 12,424 | 2,844 | 10,252 | 5,016 |
| Charles Street | 2,020 | 681 | 2,488 | 213 |
| Howard Street 1 | 2 13,210 | 1,434 |
Petitioner's gross sales less returns, its gross profits from sales, and its taxable net income for its base period years, with percentages to sales, were as follows:
| Year ended January 31 | Gross sales | Gross profits |
| less returns | from sales | |
| 1937 | $ 615,860.10 | $ 231,783.31 |
| 1938 | 801,818.18 | 303,699.74 |
| 1939 | 790,357.65 | 309,071.56 |
| 1940 | 804,569.56 | 311,780.95 |
| Year ended January 31 | Percentage | Taxable net | Percentage |
| to sales | income | to sales | |
| 1937 | 37.6 | $ 9,911.82 | 1.61 |
| 1938 | 37.9 | 5,459.74 | .68 |
| 1939 | 39.1 | 6,242.31 | .79 |
| 1940 | 38.8 | 3,544.90 | .44 |
Petitioner's average annual net earnings*51 during the period January 1, 1924, to January 31, 1940, were $ 7,660.05, and the average ratio of such earnings to net sales for that period was 1.5073 per cent.
During its base period, petitioner's officers received salaries aggregating $ 60,000 in the first base period year, and $ 67,500 in each of the other base period years. Such salary payments constituted the following percentages of petitioner's annual gross sales less returns:
| Year ended | |
| January 31 | Per cent |
| 1937 | 9.7 |
| 1938 | 8.4 |
| 1939 | 8.5 |
| 1940 | 8.4 |
Petitioner's gross sales less returns, by stores, during the base period, were as follows:
| Gross sales less returns | |||
| Year ended Janury 31 | |||
| Baltimore Street | Charles Street | Howard Street | |
| store | store | store | |
| 1937 | $ 550,379.81 | $ 65,480.29 | |
| 1938 | 396,550.94 | 67,299.36 | $ 337,967.88 |
| 1939 | 306,483.97 | 64,708.02 | 419,165.66 |
| 1940 | 288,131.09 | 64,256.08 | 452,182.39 |
The decline in sales at the Baltimore Street store, which followed the opening of the Howard Street store, was due largely to decreasing *393 sales in ladies' and children's shoes and accessories. Such decline is illustrated by dollar sales of ladies' and children's shoes at the two stores*52 during the base period years (cents omitted):
| Baltimore Street store | Howard Street stores | |||
| Year ended January 31 | ||||
| Ladies' | Children's | Ladies' | Children's | |
| shoes | shoes | shoes | shoes | |
| 1937 | $ 232,632 | $ 39,924 | ||
| 1938 | 109,440 | 21,640 | $ 240,804 | $ 44,223 |
| 1939 | 53,477 | 11,131 | 299,963 | 45,563 |
| 1940 | 41,034 | 9,219 | 325,870 | 46,798 |
In June of 1940, petitioner discontinued the sale of ladies' shoes at the Baltimore Street store, except for custom-made shoes.
During the 4 fiscal years preceding the opening of its Howard Street store, petitioner's books showed net operating profits in both men's and ladies' shoes at the Baltimore Street store, but, thereafter, it showed net operating profits during the base period only in its men's shoes, as follows:
| Men's shoes | ladies' shoes | |
| Fiscal year | (per cent) | (per cent) |
| 1934 | 8.5 | 3.1 |
| 1935 | 5.5 | 0.6 |
| 1936 | 7.0 | 1.9 |
| 1937 | 6.5 | 0.2 |
| 1938 | 7.7 | (2.4) |
| 1939 | 5.9 | (3.3) |
| 1940 | (1) | (1) |
A like comparison of net operating profit percentages at petitioner's Howard Street store is shown in the table which follows (the total sales of men's and boys' shoes at the Howard*53 Street store were about 6 or 7 per cent of the total sales of ladies' high quality and less expensive (Coquette) shoes):
| Men's shoes | Ladies' shoes | Coquette shoes | |
| Year ended January 31 | (per cent) | (per cent) | (per cent) |
| 1938 | 3.5 | (3.2) | (0.7) |
| 1939 | 8.9 | 1.1 | (1.8) |
| 1940 | (1) | (1) | (1) |
The Charles Street store operated at a loss for the first 3 years after its opening. Its first profitable year of operation was the fiscal year 1934. Its books showed percentages of operating profit to net sales through the fiscal year 1940 approximately as follows (net sales are gross sales less returns, discounts, and adjustments on sales): *394
| Percentage | |
| of | |
| profit to | |
| Fiscal year | net sales |
| 1934 | 5.7 |
| 1935 | 4.3 |
| 1936 | 5.4 |
| 1937 | 2.9 |
| 1938 | 3.4 |
| 1939 | 3.4 |
| 1940 | (1) |
During the base period, December sales were the highest monthly sales at the Baltimore Street store, followed by June and September. At the Charles Street store, September sales were highest, followed by May *54 and October. The monthly gross sales less returns at the Howard street store during the base period were as follows:
| Year ending January 31 -- | |||
| 1938 | 1939 | 1940 | |
| February | $ 3,452.45 | $ 18,785.39 | $ 22,606.81 |
| March | 37,200.92 | 38,779.80 | 48,158.23 |
| April | 24,204.95 | 46,332.61 | 39,033.56 |
| May | 30,890.24 | 30,719.78 | 44,000.02 |
| June | 32,906.29 | 43,261.60 | 40,283.59 |
| July | 26,614.90 | 29,910.24 | 35,547.72 |
| August | 15,379.29 | 21,529.63 | 23,789.84 |
| September | 35,831.08 | 39,358.26 | 46,591.23 |
| October | 30,446.77 | 42,299.76 | 39,484.13 |
| November | 32,895.32 | 31,096.86 | 35,151.10 |
| December | 38,092.43 | 42,636.47 | 39,675.39 |
| January | 26,690.31 | 29,645.93 | 32,500.72 |
| Totals | 1 $ 334,604.95 | 1 $ 414,356.33 | 1 $ 446,822.34 |
Easter Sunday occurred on the following dates during the calendar years 1936-1939, inclusive:
| 1936 | April 12 |
| 1937 | March 28 |
| 1938 | April 17 |
| 1939 | April 9 |
During the calendar years 1937, 1938, and 1939, *55 petitioner advertised and held numerous special sales of ladies' shoes at the Howard Street store. Many of such sales advertised a wide selection of sizes in ladies' shoes.
Petitioner's inventories for the fiscal years ended January 31, 1936, to January 31, 1940, inclusive, were as follows:
| Year ended | |
| January 31 | Amount |
| 1936 | $ 158,350.29 |
| 1937 | 144,491.45 |
| 1938 | 186,406.48 |
| 1939 | 168,937.07 |
| 1940 | 210,210.09 |
*395 Such inventories were distributed among the three stores as follows:
| Year ended January 31 | Baltimore | Charles | Howard |
| Street store | Street store | Street store | |
| 1936 | $ 145,973.35 | $ 12,376.94 | |
| 1937 | 129,975.24 | 14,516.21 | |
| 1938 | 93,926.94 | 15,276.61 | $ 77,202.93 |
| 1939 | 78,825.85 | 10,211.11 | 79,900.11 |
| 1940 | (1) | (1) | (1) |
The Howard Street store (A building) attracted customers and potential customers in large numbers. Within 6 or 8 months after opening, the first floor rug was so worn by traffic that it had to be replaced. During peak periods there was congestion and insufficient seating space on that floor, delays were encountered in making sales, and as a result of that condition as well as the confusion*56 brought about by reason of alterations being made to add B building to the store in late December 1939 and January 1940 some sales were lost. Apart from these lost sales, a normal level of sales for this store was attained during or prior to the fiscal year ended January 31, 1940.
The total number of employees of petitioner corporation, excluding officers, on January 31 of each of the years listed, was as follows:
| 1935 | 78 |
| 1936 | 86 |
| 1937 | 105 |
| 1938 | 117 |
| 1939 | 121 |
| 1940 | 121 |
In June 1939, petitioner determined that "within a year" it would discontinue the sale of women's and children's shoes on the second floor of the Baltimore Street store. In July and August 1939, alterations were made on the first floor of this store where the men's department was located. These alterations included cabinet work and new fixtures costing $ 2,470, electrical work, photographic murals depicting Baltimore in 1873 and in 1939, and a new bootblack stand. Petitioner's alterations and repair accounts for its Baltimore Street store totaled $ 4,552.84 for the fiscal year ended January 31, 1940. For the preceding 4 fiscal years, such accounts totaled $ 2,538.74 for 1936, $ 305.20 for 1937, $ 1,632.81*57 for 1938, and $ 851.65 for 1939, or an average for the 4 preceding years of $ 1,332.10. The aforementioned expenditures for the fiscal year ended January 31, 1940, exceeded the average for the 4 preceding years by $ 3,220.74. On its tax return for that fiscal year, petitioner claimed a total deduction for alterations and repairs at its three stores of $ 4,937.51. In the depreciation schedules attached to such return, petitioner claimed no depreciation on any asset acquired in July or August 1939.
*396 Petitioner's selling expense (payroll) in its ladies' and children's departments at the Baltimore Street store declined less rapidly than the sales volume after the Howard Street store opened. Special efforts were made to keep the customers of these departments. Frequently merchandise was brought over from the Howard Street store by bundle boys, and transportation by taxicab was provided if the customer would go to the Howard Street store. In 1940, the ratio of petitioner's selling expense (payroll) to net sales for its ladies' and children's departments at the Baltimore Street store was 17.64 per cent as compared with a 1936 low of 10.16 per cent. The net sales, selling *58 expense (payroll) and ratio of such expense to net sales for the fiscal years 1936 to 1940, inclusive, for such departments at the Baltimore Street store, were as follows:
| Year | Net sales 1 | Selling expense | Ratio |
| (payroll) | (per cent) | ||
| 1936 | $ 262,173 | $ 26,638.97 | 10.16 |
| 1937 | 292,379 | 31,574.10 | 10.80 |
| 1938 | 140,340 | 20,983.65 | 14.95 |
| 1939 | 70,094 | 11,736.57 | 16.74 |
| 1940 | 55,780 | 9,842.44 | 17.64 |
For the 4 years preceding the fiscal year 1940, petitioner's selling expense (payroll) averaged 13.16 per cent of net sales. In this connection, petitioner's fiscal year 1940 exceeded the average by 4.48 per cent, or $ 2,498.94 (4.48 per cent of 1940 net sales of $ 55,780).
If petitioner had opened its Howard Street store (A building) 2 years before it did, and if it had added B building 2 years prior to the end of the base period, its gross sales less returns for the Howard Street store for the taxable year ended January 31, 1940, would have been in excess of the stipulated sales figure of $ 452,182.39, but they would not have been in excess of $ 553,000.
In its returns for fiscal years 1941, 1942, and *59 1943, petitioner claimed carryforward of unused excess profits credit. Similar claim was made in its applications under section 722. In computing the excess profits credit of petitioner under invested capital method, respondent allowed in the fiscal year ended January 31, 1943, the unused excess profits credit of the fiscal years ended January 31, 1941, and January 31, 1942.
OPINION.
Petitioner seeks relief under section 722 of the Internal Revenue Code of 1939, as amended, 2 because of a change in its *397 capacity for production or operation consummated during and after the base period.
*60 During the taxable fiscal years 1941 through 1946 petitioner computed its excess profits credits under section 714 (invested capital method) and was allowed credits ranging from $ 26,050.39 to $ 32,476.43. Its arithmetical average base period income was $ 4,643.02. In order to be entitled to any relief, petitioner had the burden of establishing a constructive level of earnings for its last base period year which would result in a constructive average base period net income large enough to produce credits in excess of those based on invested capital.
At the beginning of the base period, petitioner operated two stores in Baltimore, one at 31st and Charles Streets which sold children's shoes and the other at 8 East Baltimore Street which sold ladies' and men's shoes. On February 22, 1937, petitioner opened a new store *398 at 312-314 Howard Street which specialized in the sale of ladies' shoes. During the fiscal year ended January 31, 1938, when the Howard Street store had been in operation for approximately 11 months, petitioner's sales at its three stores amounted to $ 801,818.18. Two years later, when the Howard Street store had been in operation for approximately 2 years, *61 petitioner's sales at its three stores during the fiscal year ended January 31, 1940, amounted to $ 804,569.56, or approximately $ 3,000 more than its sales in the first base period year in which the three stores were in operation. The failure of petitioner's stores to show any substantial increase in sales after the Howard Street store was opened was partially due to the fact that increases in sales of ladies' shoes at that store were largely offset by a correlative decline in the sales of such shoes at the Baltimore Street store. Petitioner's taxable net income of $ 17,991.16 for the fiscal year ended January 31, 1936, and $ 9,911.82 for the fiscal year ended January 31, 1937, declined to $ 5,459.74 for the fiscal year ended January 31, 1938. It increased to $ 6,242.31 for the fiscal year ended January 31, 1939, and declined to $ 3,544.20 for the fiscal year ended January 31, 1940.
In the face of this unimpressive record of net income during the base period, petitioner contends that it is entitled to a constructive net income of $ 50,818.16 for its last base period year, and a constructive average base period net income of $ 48,455.11. In arriving at constructive net income, *62 petitioner used constructive sales of $ 1,012,731.33 for its last base period year and employed an operating profit ratio to sales of 13 per cent before officers' salaries and employee bonuses.
The petitioner made changes in the character of its business within the intendment of section 722 (b) (4) by reason of the opening of the new Howard Street store A building in February 1937 and its commitment to add B building thereto. These changes entitled it to a reconstruction of its average base period net income under the 2-year push-back rule. Petitioner's contention is that if these changes had been made 2 years earlier the sales of the Howard Street store for the last base period year would have been 50 per cent greater than its actual sales for that year. Its officers, Ned Hess and George B. Hess, testified to this effect and indicated that the opinion thus expressed was based upon loss of sales at the A store during the base period because of lack of capacity for storing shoes and for seating customers and because of the disruption of business during the period when alterations, incident to adding B building to A building, were being made.
Neither in its original nor its amended*63 applications for relief under section 722 did the petitioner present facts to the Commissioner or indicate that it was claiming that sales were lost at its Howard Street store during the base period because of any lack of capacity for housing or *399 storing merchandise. On the contrary, in these applications the principal officers of petitioner stated under oath that during the calendar year 1939 the petitioner had adequate stores of merchandise. 3 In the circumstances, the claim that lack of storage capacity restricted petitioner's sales will not be considered for the first time in this proceeding. Blum Folding Paper Box Co., 4 T. C. 795, 799; Wadley Co., 17 T. C. 269, 281; cf. Green Spring Dairy, Inc., 18 T. C. 217, 241.
Petitioner's*64 application for relief did contain allegations that sales were lost at the Howard Street store because it did not have sufficient seating space to accommodate customers, and we are convinced that there is merit to these allegations. This case, however, is unusual in several respects, and we are satisfied on the entire record that the evidence presented does not warrant the granting of any relief.
As already noted, the construction of A building and the commitment to add B building at the Howard Street location are qualifying factors under section 722 (b) (4), and the taxpayer is entitled to have the 2-year push-back rule applied to its operations. However, the present situation is not typical of the one in which the push-back rule is generally applied. In the usual case, the taxpayer is given 2 more years in which to build up demand, goodwill and the like, and a determination is made with respect to profits from increased sales resulting from the hypothetical increased demand that would have been generated by the 2 additional years of experience. In contrast, the goodwill of the Hess shoe enterprise in Baltimore had been firmly established prior to the opening of the Howard Street*65 store. When that store was opened in 1937, the public response was instantaneous, vigorous, and enthusiastic. Ned G. Hess, one of petitioner's officers and stockholders, testified that "practically from the day we opened our doors we were so overwhelmed by customers -- and again I would like to say because of the foundation that our forefathers had laid down -- that we were literally swamped." Normal demand was attained virtually at once upon the opening of the A building at Howard Street, and the use of the 2-year push-back rule would have had no appreciable effect upon sales if limited to a consideration of sales at the A building alone. But the essence of petitioner's claim is that its sales were limited by inadequate selling area and seating facilities at the A building; that if the 2-year push-back rule is applied to the B building (thus providing it with adequate space during the last 2 years of the base period), it would have attained a higher level of sales with an accompanying increase in profits; and that correction must also be made for losses or decreases in income arising during the transition of the retail ladies' shoe operation from the Baltimore Street store *400 *66 to the Howard Street store, as well as for loss of profits sustained during the period in late 1939 and early 1940 when the B building was being made ready for unification with the A building.
We agree with petitioner's position as thus outlined, and if petitioner's excess profits tax credits had been computed on the income basis, it would certainly be entitled to relief. But its credits were not measured by income; they were determined upon the invested capital method. And in order to obtain relief, it was necessary for petitioner to establish a level of earnings, after making the necessary corrections and adjustments, that would result in larger credits than the ones actually employed. We think that even after the permissible correction of abnormalities, petitioner has failed to establish a sufficiently high level of earnings to justify relief. Some increases in sales would have resulted if the added capacity of the B building had been acquired 2 years prior to the end of the base period. But we do not agree with petitioner's officers that that increase would have been proportionate to the additional selling area and seating capacity provided by the B building or that it would*67 have amounted to 50 per cent of the actual sales of the Howard Street store in the last base period year.
The Howard Street store was not selling at peak capacity throughout every day or every month during the base period. And obviously when it was not operating at full capacity it did not lose sales because of insufficient seating facilities. Moreover, even at the height of a peak day it is unreasonable to assume that every potential customer walked out of the store merely because she had to wait for her turn to be served. Undoubtedly, some customers did not wait, and for that reason we have found that sales at the Howard Street store would have been in excess of the stipulated sales figure of $ 452,182.39 if the B building had been added 2 years prior to the end of the base period. But it is our best judgment on the record that such sales (including correction for loss of sales during the period that B building was being added to A) would not have exceeded $ 553,000.
To be sure, two of petitioner's officers testified that in their opinion the actual sales would have increased by 50 per cent. But we think they were unduly optimistic in their estimates, and that our finding is*68 more consonant with the facts before us.
The parties are in disagreement as to the method of determining profit upon the reconstructed sales. Petitioner insists upon an operating profit of 13 per cent of sales before officers' salaries and employee bonuses, proceeding upon the assumption that officers' salaries would remain constant and that only a comparatively slight upward revision would be necessary in connection with bonuses. But we find such reconstruction unacceptable for several reasons. In the first place, the use of a 13 per cent figure was based on earnings of the Baltimore Street and Charles Street stores for the fiscal years ended *401 January 31, 1936, to January 31, 1939, inclusive. The earnings of these two stores for the year ended January 31, 1940, and the low operating profit ratio of the Howard Street store in the base period, were disregarded on the theory that they did not reflect normal operating conditions. Petitioner's base period and pre-base period experience at its Baltimore Street store indicates that a substantially lower net profit margin on ladies' shoes, which were the principal product sold at Howard Street, was normal for petitioner's*69 business. In the circumstances, the complete disregard of the operating profit ratio of the Howard Street store, and the use of earnings of selected stores during selected years in arriving at the 13 per cent operating profit ratio (before officers' salaries and employee bonuses) to sales, convinces us that that ratio does not properly reflect petitioner's base period experience.
Moreover, the assumption that officers' salaries would remain constant in the face of the increased earnings postulated by petitioner is highly unrealistic on this record. Petitioner was a closely held family corporation, and the evidence shows that over a long period of years officers' salaries were closely correlated either to net sales or earnings, with the result that a comparatively small amount of taxable net income would be left after payment of such salaries. We are not prepared to make the naive assumption that the hypothetical increase in sales and profits urged upon us by petitioner would not have been accompanied by a substantial increase in officers' salaries.
Finally, the record shows that 1.61 per cent was the highest ratio of net income to sales attained by petitioner during the base period, *70 and this was achieved during the first year of that period prior to the opening of the Howard Street store. While sales volume increased after that store was opened, net income declined and the net income ratio to sales declined.
In petitioner's last base period year the actual sales of the Charles Street store were $ 64,256.08 and of the Baltimore Street store $ 288,131.09. If to these amounts are added maximum reconstructed sales of $ 553,000 for the Howard Street store, the total sales of petitioner for the last base period year would be $ 905,387.17. Even if it be assumed that the ratio of net income to sales was 1.61 per cent, the maximum realized by petitioner during the base period, 4 and that it had abnormal expenses in its last base period year of approximately $ 6,000, 5 its total net income for that year would not reach $ 21,000 which would make its constructive average base period net income under $ 20,000 in accordance with indices employed by petitioner (and agreed to by respondent) for the base period years, and its *402 excess profits credit less than $ 19,000. This falls short of the invested capital credits ranging from $ 27,398.70 to $ 32,476.43 allowed*71 petitioner for the taxable years in issue.
After a careful consideration of all of the evidence, our conclusion is that excess profits tax relief under section 722 (b) (4) must be denied because petitioner has failed to establish an amount to be used as its constructive average base period net income which would produce excess profits credits for the taxable years greater than the credits based on invested capital allowed by the respondent.
Although petitioner has not waived its alternate claim that it is entitled to relief under section 722 (b) (5), its brief contains no argument relating to, or specific reference to, these provisions. *72 Moreover, there is no evidence of any factors affecting its base period earnings other than those advanced in support of its claim under section 722 (b) (4). In the circumstances, we hold that petitioner does not qualify for relief under section 722 (b) (5).
Reviewed by the Special Division.
Decision will be entered for the respondent.
Footnotes
*. Unless otherwise stated herein, all sectional and Code references are to the Internal Revenue Code of 1939.↩
1. Opened February 22, 1937, with 7,392 square feet of selling space and 4,545 square feet of nonselling space.↩
2. This amount includes 2,707 square feet of selling space at Howard Street which was acquired when the B building was added in February 1940.↩
1. Storage of merchandise was included within the meaning of the term "selling purposes" in the testimony, and that same meaning is employed herein.↩
1. Profit or loss by departments not available.↩
1. Profit or loss by departments not available.↩
1. Actual profit for each store could not be determined as petitioner ceased recording interstore transfers in or about April 1939.↩
1. These totals are less than those previously shown as the gross sales less returns of this store because they do not include shoe repair sales of $ 3,362.93 for the fiscal year 1938, $ 4,809.33 for the fiscal year 1939, and $ 5,360.05 for the fiscal year 1940↩
1. Not available.↩
1. Gross sales less returns, discounts, and adjustments on sales.↩
2. SEC. 722. GENERAL RELIEF -- CONSTRUCTIVE AVERAGE BASE PERIOD NET INCOME.
(a) General Rule. -- In any case in which the taxpayer establishes that the tax computed under this subchapter (without the benefit of this section) results in an excessive and discriminatory tax and establishes what would be a fair and just amount representing normal earnings to be used as a constructive average base period net income for the purposes of an excess profits tax based upon a comparison of normal earnings and earnings during an excess profits tax period, the tax shall be determined by using such constructive average base period net income in lieu of the average base period net income otherwise determined under this subchapter. In determining such constructive average base period net income, no regard shall be had to events or conditions affecting the taxpayer, the industry of which it is a member, or taxpayers generally occurring or existing after December 31, 1939, except that, in the cases described in the last sentence of section 722 (b) (4) and in section 722 (c), regard shall be had to the change in the character of the business under section 722 (b) (4) or the nature of the taxpayer and the character of its business under section 722 (c) to the extent necessary to establish the normal earnings to be used as the constructive average base period net income.
(b) Taxpayers Using Average Earnings Method. -- 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 entitled to use the excess profits credit based on income pursuant to section 713, if its average base period net income is an inadequate standard of normal earnings because --
* * * *
(4) the taxpayer, either during or immediately prior to the base period, commenced business or changed the character of the business and the average base period net income does not reflect the normal operation for the entire base period of the business. If the business of the taxpayer did not reach, by the end of the base period, the earning level which it would have reached if the taxpayer had commenced business or made the change in the character of the business two years before it did so, it shall be deemed to have commenced the business or made the change at such earlier time. For the purposes of this subparagraph, the term "change in the character of the business" includes a change in the operation or management of the business, a difference in the products or services furnished, a difference in the capacity for production or operation, a difference in the ratio of nonborrowed capital to total capital * * *. Any change in the capacity for production or operation of the business consummated during any taxable year ending after December 31, 1939, as a result of a course of action to which the taxpayer was committed prior to January 1, 1940, or any acquisition before May 31, 1941, from a competitor engaged in the dissemination of information through the public press, of substantially all the assets of such competitor employed in such business with the result that competition between the taxpayer and the competitor existing before January 1, 1940, was eliminated, shall be deemed to be a change on December 31, 1939, in the character of the business, or
(5) of any other factor affecting the taxpayer's business which may reasonably be considered as resulting in an inadequate standard of normal earnings during the base period and the application of this section to the taxpayer would not be inconsistent with the principles underlying the provisions of this subsection, and with the conditions and limitations enumerated therein.↩
3. Thus, it was alleged that "[in] the year 1939 although the taxpayer had adequate stores of merchandise available," sales were lost because of lack of seating space for customers.↩
4. This figure is also in excess of the ratio of 1.5073 per cent for the entire period beginning January 1, 1924, through the end of the base period.↩
5. A review of the evidence relating to abnormal expenses occasioned by the shift of the ladies' retail shoe operation to the Howard Street store convinces us that such expenses could not have exceeded $ 6,000 in the last base period year.↩