*174 Decision will be entered for the respondent.
Excess profits tax relief under section 722 (b) (4) of the Internal Revenue Code of 1939 denied where the evidence failed to show an acceptable basis for reconstruction of base period earnings which would result in credits in excess of those used by petitioner under the invested capital method.
*471 This proceeding relates to Federal excess profits taxes paid for the fiscal years ended January 31, 1941, to January 31, 1946, inclusive. The only issue presented*175 is whether petitioner's applications for relief from such excess profits taxes, under section 722 (b) (4) of the Internal Revenue Code of 1939, were properly denied by the Commissioner.
FINDINGS OF FACT.
The stipulated facts have been so found and are incorporated herein by reference.
Petitioner, an Illinois corporation, was incorporated on January 31, 1942. It resulted from the consolidation of two other Illinois corporations: Famous Liquors, Inc., and Gold Seal Liquors, Inc. While the latter had the same name as petitioner, it was an entirely separate entity. Hereinafter, petitioner will be referred to as Acquiring Gold Seal and its identically named component will be referred to as Component Gold Seal.
Component Gold Seal was incorporated under the laws of the State of Illinois on February 6, 1934, as Gold Seal Distillers, Inc. Its authorized capital was $ 20,000, of which $ 12,000 was initially subscribed and issued. On November 9, 1936, the name of Component Gold Seal was changed to Gold Seal Liquors, Inc. Component Gold Seal was engaged in both wholesale and retail sales of liquor until June 28, 1937, when it discontinued its retail operations.
Component Gold Seal amended*176 its original charter to permit the following changes in its capital structure:
| Date | From -- | To -- |
| Oct. 25, 1935 | $ 20,000 | $ 50,000 |
| Apr. 27, 1936 | 50,000 | 100,000 |
| Nov. 9, 1936 | 100,000 | 150,000 |
*472 Component Gold Seal's capital and paid-in surplus changed on the respective dates hereinafter set forth:
| Capital stock | ||||
| Date | Paid-in | Total at | ||
| surplus | date shown | |||
| From -- | To -- | |||
| Feb. 6, 1934 | $ 12,000 | $ 12,000.00 | ||
| Sept. 30, 1934 | $ 12,000 | 17,300 | $ 2,451.14 | 19,751.14 |
| Oct. 30, 1935 | 17,300 | 30,300 | 2,451.14 | 32,751.14 |
| Jan. 31, 1936 | 30,300 | 44,900 | 2,451.14 | 47,351.14 |
| Sept. 30, 1936 | 44,900 | 63,400 | 9,112.99 | 72,512.99 |
| Jan. 5, 1937 | 63,400 | 65,300 | 11,381.02 | 76,681.02 |
| Jan. 31, 1937 | 65,300 | 93,200 | 22,331.77 | 115,531.77 |
| Mar. 30, 1938 | 93,200 | 110,700 | 29,831.77 | 140,531.77 |
| July 31, 1940 | 110,700 | 150,000 | 77,231.77 | 227,231.77 |
In December 1939, $ 15,000 was donated to the capital of Component Gold Seal by stockholders.
Component Gold Seal at the time of its organization was located at 78 West Van Buren Street, Chicago, Illinois, and occupied approximately 2,500 square feet of space. There was a small stockroom and small office in*177 those premises. In November 1935, Component Gold Seal moved all of its wholesale business operations from that location to 420-22-24 South Wells Street, Chicago, Illinois, which premises consisted of approximately 5,400 square feet of space. It retained the original premises at 78 West Van Buren Street, Chicago, Illinois, for its retail operations. During the years 1935 and 1936 additional space was acquired by Component Gold Seal for its wholesale business operations, and the area occupied was increased to approximately 16,000 square feet.
On June 26, 1937, the business of Englewood Wholesale Liquor Distributors, Inc., a competitive wholesale liquor distributor, operating in the city of Chicago, Illinois, was liquidated by Earl Clamage, its president. The sales volume of Englewood for its fiscal year ended October 31, 1936, approximated $ 1,044,000. Clamage arranged with Component Gold Seal to continue to service the customers of Englewood. On June 26, 1937, Clamage together with six salesmen and a portion of the office personnel of Englewood became employees of Component Gold Seal. On September 30, 1937, Clamage acquired 130 shares of the outstanding capital stock of Component*178 Gold Seal and became its sales manager. Clamage left the employ of Component Gold Seal in January 1940.
By the middle of 1937, Component Gold Seal had outgrown its quarters at the Wells Street location. It needed more room for the proper warehousing of merchandise, for its offices, and for salesrooms. It also needed garage facilities.
On August 23, 1937, Component Gold Seal entered into an industrial lease covering the premises at 701-17 West Harrison Street, Chicago, *473 Illinois, consisting of approximately 60,000 square feet of improved building space, for a term beginning September 1, 1937, and ending December 31, 1952. The lease contained an option to purchase for $ 40,000, provided the option was exercised prior to December 31, 1942. Component Gold Seal moved to its new location December 1, 1937, and on December 29, 1937, exercised the option to purchase the premises for $ 40,000.
The facilities occupied by Component Gold Seal from December 1, 1937, consisted of the 5-story office and warehouse building and basement, acquired pursuant to the foregoing option. It occupied during the base period, commencing December 1, 1937, the basement and the first 3 floors of the*179 premises, aggregating approximately 40,000 square feet of space. The fourth and fifth floors, consisting of an additional 20,000 square feet, were leased to other tenants. The 40,000 square feet of space consisted of a general warehouse, a custom bonded warehouse, an area devoted to the accommodation of Lawrence Warehouse System, and general offices and salesrooms. The Lawrence Warehouse System is primarily a means of providing an enclosed area within the premises of a wholesaler where certain merchandise can be segregated from the general inventory into a section controlled entirely by representatives of the Lawrence Warehouse Company. When merchandise is moved into the enclosed area, the wholesaler receives a receipt from the Lawrence Warehouse Company, and this receipt can be pledged with a bank for the purpose of obtaining a loan on the merchandise. When the wholesaler removes any merchandise from the enclosed area, he is required to reduce the amount of his indebtedness to the bank by the amount he received as a loan when that merchandise was placed in the enclosed area.
Component Gold Seal expended $ 52,557.92 during its base period to improve the premises at 701-17 West*180 Harrison Street, Chicago, Illinois, as follows:
| Fiscal year ended January 31 | Amount |
| 1938 | $ 50,776.42 |
| 1939 | 1,537.73 |
| 1940 | 243.77 |
| Total | $ 52,557.92 |
At the Harrison Street location Component Gold Seal had certain facilities which it did not have at the Wells Street location, such as a loading dock, two freight elevators, approximately 5,000 square feet of office space, a garage, and chutes which were installed to convey merchandise from the upper floors to the main floor, and from the main floor to the basement. The warehouse facilities at Harrison Street were adequate to handle at least three times the 172,000 unit cases shipped to the trade during the year 1939.
*474 During the base period Component Gold Seal sold Hiram Walker, Schenley, Seagram's, Calvert, Brown-Forman, Carstairs, and various other brands of whiskey produced by the major distilleries. One of these brands was Old Sunny Brook, which it purchased from Famous Liquors, Inc. It also sold Scotch whiskey, wines, brandies, and cordials. It dealt with case goods, and did not purchase bulk whiskey Most of its sales were made in Cook County, Illinois, which includes the city of Chicago. It also did *181 some business in Kane County. During the base period years it served approximately 3,000 accounts.
At the close of the calendar year 1939 Component Gold Seal had 77 persons in its employ, including a sales director, a sales manager, and 25 salesmen. The trade was serviced by having its salesmen call on its customers periodically. Some orders were received from customers by phone. The orders received were prepared for shipment and sent out on Component Gold Seal's own trucks, of which there were seven during the year 1939.
The following table shows the results of the operations of Component Gold Seal for the fiscal years ended January 31, 1935, to January 31, 1942, inclusive:
| Fiscal year ended January 31 | |||
| 1935 | 1936 | 1937 | |
| Net sales: | |||
| Wholesale | $ 721,613.48 | $ 1,247,386.89 | $ 2,051,262.27 |
| Retail | 118,775.91 | 100,268.50 | 77,441.79 |
| Total | 840,389.39 | 1,347,655.39 | 2,128,704.06 |
| Cost of goods sold | 767,604.96 | 1,240,548.01 | 1,941,978.92 |
| Gross profit | 72,784.43 | 107,107.38 | 186,725.14 |
| Less: Sales, salaries, and | |||
| commissions | 4,062.99 | 14,970.77 | 36,841.18 |
| Gross profit after sales, | |||
| salaries, and commissions | 68,721.44 | 92,136.61 | 149,883.96 |
| Less: | |||
| Officers' salaries | 13,185.00 | 18,155.00 | 24,219.00 |
| Other executive salaries | 10,340.00 | 10,475.00 | 14,230.00 |
| Other salaries and wages | 7,853.87 | 14,670.69 | 30,339.87 |
| Rent | 5,952.00 | 7,500.00 | 10,810.00 |
| Depreciation | 1,314.52 | 1,924.59 | 2,397.53 |
| Advertising | 2,576.72 | 2,465.21 | 1,687.97 |
| Insurance | 1,060.62 | 2,692.34 | 4,044.01 |
| Sales promotion | 995.80 | 2,816.25 | 7,282.74 |
| Other expenses | 16,390.29 | 21,833.06 | 32,784.91 |
| Total | 59,668.82 | 82,432.14 | 127,796.03 |
| Operating profit | 9,052.62 | 9,704.47 | 22,087.93 |
| Add: | |||
| Interest | 6.34 | ||
| Other income | 255.86 | 699.05 | |
| Profit from -- | |||
| Sale of C/A | 21.44 | ||
| Rent | |||
| Settlement of claim | |||
| Net profit | 9,058.96 | 9,960.33 | 22,808.42 |
| Fiscal year ended January 31 | |||
| 1938 | 1939 | 1940 | |
| Net sales: | |||
| Wholesale | $ 2,872,450.06 | $ 2,666,567.05 | $ 3,086,529.36 |
| Retail | 45,686.51 | ||
| Total | 2,918,136.57 | 2,666,567.05 | 3,086,529.36 |
| Cost of goods sold | 2,671,345.56 | 2,453,024.79 | 2,810,798.53 |
| Gross profit | 246,791.01 | 213,542.26 | 275,730.83 |
| Less: Sales, salaries, and | |||
| commissions | 57,564.35 | 58,684.08 | 64,539.21 |
| Gross profit after sales, | |||
| salaries, and commissions | 189,226.66 | 154,858.18 | 211,191.62 |
| Less: | |||
| Officers' salaries | 19,965.82 | 8,818.35 | 14,357.50 |
| Other executive salaries | 19,256.83 | 6,271.50 | 22,850.01 |
| Other salaries and wages | 46,787.98 | 44,361.13 | 49,336.93 |
| Rent | 8,340.00 | ||
| Depreciation | 3,797.32 | 5,611.79 | 5,589.72 |
| Advertising | 1,112.35 | 466.96 | 738.65 |
| Insurance | 5,289.17 | 6,906.67 | 7,827.65 |
| Sales promotion | 15,003.10 | 13,756.47 | 19,830.53 |
| Other expenses | 49,512.63 | 54,275.85 | 67,469.02 |
| Total | 169,065.20 | 140,468.72 | 188,000.01 |
| Operating profit | 20,161.46 | 14,389.46 | 23,191.61 |
| Add: | |||
| Interest | |||
| Other income | 466.86 | ||
| Profit from -- | |||
| Sale of C/A | |||
| Rent | 2,950.00 | 4,425.00 | |
| Settlement of claim | |||
| Net profit | 20,161.46 | 17,806.32 | 27,616.61 |
*475 During and prior to the base*183 period, Milton M. Friedman was middle western representative of a New York importing firm which had the United States distributorship for Martini and Rossi vermouth (sold as a nonalcoholic beverage during Prohibition), John Jamieson ryes, and several brands of port and sherry. As such representative he covered as many as 14 States, calling on the wholesale and retail trade. When National Prohibition was repealed, Friedman also became agent for certain Scotch whiskeys, Bardinay brandy, and Jamaica rums.
In March 1937, Friedman and two others began negotiating with National Distillers Products Corporation (herinafter referred to as National) in New York to secure bulk whiskey (in barrels) with the right to bottle and distribute such whiskey under one or more of National's labels. On his return to Chicago, Friedman caused Famous Liquors, Inc. (hereinafter sometimes referred to as Famous), to be organized under Illinois law on April 13, 1937, for the purpose of engaging in the wholesale liquor business. Friedman became its president.
In April 1937, 900 shares of no-par-value common stock (out of a total authorized capital of 21,000 shares) of Famous were issued for a stated value *184 of $ 18,000. Later the following changes were made in its capital structure:
| Outstanding capital | ||
| stock | ||
| Date | From -- | To -- |
| Apr. 30, 1938 | $ 18,000 | $ 39,000 |
| Apr. 25, 1939 | 39,000 | 48,000 |
| Apr. 30, 1940 | 48,000 | 60,000 |
National and Famous entered into several agreements dated June 17, 1937, September 30, 1937, and July 14, 1938, covering the purchase of Kentucky bourbon whiskeys in barrels to be bottled under the brand name of Old Sunny Brook at not less than 93 proof. The exclusive right was granted Famous to distribute whiskey bottled under this brand name in the State of Illinois. The number of barrels of Old Sunny Brook acquired by Famous, and the number bottled during the years 1937, 1938, 1939, and the period December 31, 1939, to January 30, 1940, under the above-mentioned agreements, were as follows:
| Barrels | Barrels | |
| acquired | bottled | |
| 1937 | 4,053 | 923 |
| 1938 | 4,256 | 2,470 |
| 1939 | 4,933 | 2,447 |
| Dec. 31, 1939 to Jan. 31, 1940 | 223 |
The inventory of Kentucky bourbon whiskeys owned by Famous and available for bottling under the Old Sunny Brook label on the dates listed below and its original cost were as follows: *476
| Date | No. of | Original |
| barrels | cost | |
| June 30, 1937 | 2,106 | $ 291,190.49 |
| Dec. 31, 1937 | 3,130 | 327,844.71 |
| Dec. 31, 1938 | 4,916 | 309,951.96 |
| Dec. 31, 1939 | 7,402 | 411,430.89 |
| Jan. 31, 1940 | 7,179 | 396,674.77 |
*185 In addition to the Old Sunny Brook contracts, National and Famous entered into agreements granting Famous the exclusive right to distribute whiskey bottled under the brand names of Shenandoah and Chicken Cock in the States of Illinois, Missouri, Kentucky, Iowa, and Colorado. The Shenandoah and Chicken Cock labels were relatively unknown and their contribution to the development of Famous was insignificant.
In addition to National's labels acquired under the above-mentioned contracts, Famous handled the distribution of Lanson champagne. Friedman retained his personal agency for the lines handled by the New York importing house previously referred to.
Famous maintained an office at 308 West Washington Street, Chicago, Illinois. The bulk whiskey was bottled for it by National and shipped in cases to the Wakem & McLaughlin warehouse in Chicago for the account of Famous. Wakem & McLaughlin charged 10 cents a case for the first month of storage and 5 cents a month thereafter. Independent cartage companies were used for the delivery of merchandise to the customers of Famous.
The delivery costs of Famous during its base period years were as follows:
| Fiscal year ended April 30 | Amount |
| 1938 | $ 5,542.26 |
| 1939 | 8,723.02 |
| 1940 | 19,659.13 |
*186 In the fiscal year ended April 30, 1940, no delivery charges were incurred for the period from January 31, 1940, to April 30, 1940, for the reason that these facilities were furnished by Component Gold Seal.
Because of the limited facilities of Famous, its sales were limited to the sale of full cases. The warehouse did not have any facilities for splitting cases into less than full case lots, and Famous did not engage in that type of business.
By January 31, 1940, Famous had eight salesmen who were thoroughly trained in the type of business which it conducted, calling on both the wholesale and retail trade. The average salesman was able to handle approximately 150 accounts. Famous attempted to develop the Chicago market primarily and its salesmen concentrated on the sale of Old Sunny Brook within the Chicago metropolitan *477 area. A very small percentage of Famous's total sales was made outside of this area in Du Page County and Kane County, Illinois.
The background of bulk whiskey contracts such as Famous had with National was as follows:
At the end of Prohibition, National and its components owned approximately 350 brand names of which not more than 20 brands were put*187 in commerce. The 20 brands consisted of those which had been sold during Prohibition as medicinal whiskeys as well as some that were not sold during Prohibition. Old Sunny Brook, Old Hermitage, Hill and Hill, Bond and Lillard, Old McBrayer, and Hannah Mills were brand names for 7-year-old, bottled-in-bond whiskey which National put in commerce immediately after repeal of Prohibition in case units, viz: in cases of 12, 24, or 48 bottles (depending on the bottle size).
During the years 1934 and 1935 there was a trend among distributors for widespread handling of numerous brands, representing all distillers, without promotion of any particular brand, and the relationship between distillers and wholesalers was rather chaotic from the standpoint of distribution of brands.
In the Chicago area alone, there were approximately 9,000 retail liquor dealers and 150 wholesale liquor dealers during the base period. The wholesale liquor business was keenly competitive during that time, and large discounts were being given to secure business. All of the wholesalers could call on any of the retailers in the Chicago area. There were no legal restrictions on the number of retailers which could *188 be licensed in any given area during the base period. Retail liquor licenses were freely issued to such establishments as groceries, drugstores, etc.
It is characteristic of the liquor business that per capita consumption of whiskey in an area does not vary significantly from year to year merely because of the introduction of new brands. The effect of this on the liquor industry is that if one brand has gains, it must be at the sacrifice of another or others because the total amount that can be sold will not change appreciably.
It was to overcome the effect on National of the wholesalers' practice of not promoting any specific brand that National conceived its bulk-sale/exclusive-label, or "contract brand" arrangements. It was thought that this new system of selling whiskey, because it offered a wholesaler the exclusive rights to distribute specific brands in a given territory, would encourage promotion of the National brand in question in preference to other brands. It further helped National because it created an opportunity to sell its whiskey in advance of what its planned sales might otherwise be. To the extent that such *478 sales in bulk could be made, National*189 had the added advantage of shifting its inventory burden to the wholesaler.
If a wholesaler purchased bulk whiskey from National and had this whiskey bottled by National, and if he fully followed the markup suggested by National, he could expect an advantage of about $ 1.50 per case over what he might have realized if he had bought the same whiskey in case lots.
National, however, did not exercise any control over the prices which the wholesaler could charge and the latter would not necessarily take the markup which National suggested. The wholesaler put his own price on the merchandise.
During the base period it was customary for National and its franchised wholesalers to sponsor "deals" for the retailers. The wholesaler would offer to the retailing trade a special discount on the contract brand for a limited period (generally 5 to 30 days). National would absorb half of the discount by issuing a credit memorandum to the wholesaler. The result of such a deal was to diminish or wipe out (depending on the amount of discount) the extra profit per case which the wholesaler might expect to get under a bulk whiskey contract. While the deal could be availed of only for a limited period*190 by the retailers, there was no restriction on how much they could purchase during the deal period, and they were encouraged to purchase as much as possible, even a 2-year supply. When Famous had a deal, it would be offered to all retailers. Deals were made for the purpose of getting customers to buy the product in larger quantities. Famous had some deals on its "contract brands" during the base period. One form of deal was to make up a combination case, consisting of 9 bottles of 93 proof and 3 bottles of 100 proof (bottled-in-bond) whiskey, and sell it for the price of a case of 93 proof.
In practice, the bulk contracts worked as follows: National sold warehouse certificates, for barrels of whiskey, to its selected wholesalers for which the wholesaler gave a promissory note. National retained the certificates as collateral and the wholesaler executed a power of attorney, in favor of National, to deal with the retained certificates. Under the contract of sale, the wholesaler was required to pay for costs of bottling, labels, insurance, taxes, storage, handling, and advertising. While the promissory notes bore due dates, the wholesaler did not actually pay the note at that time. *191 Rather, he paid for the whiskey as he ordered it withdrawn and bottled, the payment being applied to reduce the note account.
The following shows the profit realized or loss sustained by Famous for each of its fiscal years ended April 30, 1938, 1939, and 1940: *479
| Fiscal year ended April 30 | ||||
| 1938 | 1939 | |||
| Gross sales | $ 553,796.35 | $ 686,421.43 | ||
| Less: Returns and | ||||
| allowances | 10,420.42 | 5,641.07 | ||
| Net sales | $ 543,375.93 | $ 680,780.36 | ||
| Cost of goods sold: | ||||
| Inventory, beginning | $ 21,020.37 | |||
| Material purchases | $ 470,706.26 | 601,582.26 | ||
| $ 470,706.26 | $ 622,602.63 | |||
| Inventory, ending | 21,020.37 | 449,685.89 | 50,190.52 | 572,412.11 |
| Gross profit | $ 93,690.04 | $ 108,368.25 | ||
| Deductions: | ||||
| Officers' salaries | $ 17,500.00 | $ 20,250.00 | ||
| Salaries and wages | 23,100.45 | 20,379.04 | ||
| Rent | 825.90 | 1,164.09 | ||
| Bad debts | 233.55 | 608.45 | ||
| Interest | 11,587.71 | 14,225.51 | ||
| Taxes | 2,867.41 | 3,285.75 | ||
| Contributions | 284.95 | |||
| Depreciation | 70.93 | 87.19 | ||
| Advertising | 2,469.91 | 2,685.54 | ||
| Delivery | 5,542.26 | 8,723.02 | ||
| Insurance | 2,693.38 | 6,457.03 | ||
| Licenses and permits | 487.50 | 285.00 | ||
| Office and | ||||
| miscellaneous | 550.96 | 1,545.06 | ||
| Sales expense | 5,796.61 | 13,910.78 | ||
| Telephone and | ||||
| telegraph | 1,049.26 | 981.55 | ||
| Traveling | 1,421.16 | 1,915.33 | ||
| Legal and accounting | 1,240.00 | 336.67 | ||
| Embezzlement | 868.73 | |||
| Entertainment | 764.55 | |||
| Bonuses | 1,820.00 | |||
| 77,436.99 | 100,578.24 | |||
| Operating income (or | ||||
| loss) | $ 16,253.05 | $ 7,790.01 | ||
| Other income: | ||||
| Interest | 50.57 | |||
| Insurance | ||||
| Adjustment of prior | ||||
| operations | ||||
| Net profit | $ 16,253.05 | $ 7,840.58 |
| Fiscal year ended April 30 | ||
| 1940 | ||
| Gross sales | ||
| Less: Returns and | ||
| allowances | ||
| Net sales | 1 $ 812,017.30 | |
| Cost of goods sold: | ||
| Inventory, beginning | $ 50,190.52 | |
| Material purchases | 764,663.45 | |
| $ 814,853.97 | ||
| Inventory, ending | 83,877.34 | 730,976.63 |
| Gross profit | $ 81,040.67 | |
| Deductions: | ||
| Officers' salaries | $ 15,300.00 | |
| Salaries and wages | 19,204.44 | |
| Rent | 1,333.14 | |
| Bad debts | 1,500.26 | |
| Interest | 630.63 | |
| Taxes | 2,393.52 | |
| Contributions | ||
| Depreciation | 385.86 | |
| Advertising | 6,109.35 | |
| Delivery | 19,659.13 | |
| Insurance | ||
| Licenses and permits | 275.00 | |
| Office and | ||
| miscellaneous | 905.65 | |
| Sales expense | 11,881.33 | |
| Telephone and | ||
| telegraph | 758.87 | |
| Traveling | 1,446.85 | |
| Legal and accounting | ||
| Embezzlement | ||
| Entertainment | 1,264.83 | |
| Bonuses | ||
| 83,048.86 | ||
| Operating income (or | ||
| loss) | ($ 2,008.19) | |
| Other income: | ||
| Interest | ||
| Insurance | 295.86 | |
| Adjustment of prior | ||
| operations | 7,007.20 | |
| Net profit | $ 5,294.87 |
In addition to the Old Sunny Brook label which Famous was authorized to use, there were three other National bulk-contract brands being sold in the Chicago area (by *193 other wholesalers): Hill and Hill, Bond and Lillard, and Old McBrayer. Old Sunny Brook was an immediately recognized and strongly accepted brand in the area, and was easy to sell.
National was not satisfied with the volume of sales of Old Sunny Brook in the Chicago trade area in 1939, and urged that some change should be made as to the increase of capital and the increase of sales organization.
Toward the latter part of 1939, Friedman began discussions with Component Gold Seal about combining the two operations. At the end of January 1940, Friedman and his eight salesmen moved to the Component Gold Seal premises. The last January paycheck of these people was issued by Gold Seal.
*480 On invoices dated January 31, 1940, Famous sold whiskey to Component Gold Seal, allowing a wholesaler's discount. Similarly Famous sold whiskey to Component Gold Seal on February 1, 1940. The February 1 invoices were billed at cost. On February 28, 1940, the prices on the January 31 invoices were adjusted downward to cost. These sales represented inventory of Famous at January 31, 1940, which was taken over by Component Gold Seal. This inventory consisted of the following:
| 1,550 5/12 | cases Old Sunny Brook, representing bottled in bond and 4-year |
| old 93-proof merchandise | |
| 136 | cases Chicken Cock |
| 166 | cases Bourbon DeLuxe |
| 1,852 5/12 | total number of cases |
*194 This represented a normal inventory as of the close of business January 31, 1940. Except for this inventory of approximately 103 barrels (1,550 5/12 cases -- 15 cases per barrel), all of the bottlings of Old Sunny Brook were sold in the base period of Famous. There was a definite relationship between the number of cases bottled each month and the number of sales of cases each month.
After January 31, 1940 (the end of Component Gold Seal's base period), all sales by Famous to Component Gold Seal were at cost plus an "override" of 35 cents per case.
A special meeting of the board of directors of Famous was held on April 10, 1940. Among the stated purposes of this meeting was "the declaration of additional compensation of the officers of the corporation commensurate with the value of their services and to formally consider the application of merger which had heretofore been pending with GOLD SEAL LIQUORS, INC., an Illinois corporation." The following resolutions were adopted:
Be It Resolved that GERSHEN FEIN is hereby elected to the office of secretary of this corporation to fill the vacancy created by the resignation of JEANNETTE SCHWARTZ.
Whereas, MILTON M. FRIEDMAN, president, *195 and SAMUEL H. POKRASS, vice-president, have heretofore rendered valuable services for and on behalf of this company, and whereas the compensation heretofore received by said persons is wholly inadequate for the valuable services so rendered,
It Is Hereby Resolved that the compensation of the officers for the year ending the 30th day of April, 1940, shall be as follows:
MILTON M. FRIEDMAN $ 9,500.00
SAMUEL H. POKRASS $ 4,000.00
Whereas, the present stockholders of this company have indicated their desire to acquire additional capital stock and to provide additional working capital for the company and further to facilitate the conclusion of the arrangements now pending with GOLD SEAL LIQUORS, INC.,
*481 It Is Hereby Resolved that the present stockholders shall be permitted to acquire SIX HUNDRED (600) shares of the unissued common stock of this company at the declared value of TWENTY DOLLARS ($ 20.00) per share.
The chairman then informed the directors that a great deal of work had been done for the purpose of working out an arrangement whereby stockholders of FAMOUS LIQUORS, INC., would exchange their holdings for a number of shares of GOLD SEAL LIQUORS, INC., stock, *196 pursuant to a Plan of Reorganization which had not as yet been formally set forth. The Chairman also informed the directors that the entire selling organization of the FAMOUS LIQUORS, INC., had heretofore been absorbed by GOLD SEAL LIQUORS, INC., and that it was appropriate at this time to ratify that act and also to entitle the officers of that company to formally conclude the reorganization program. Whereupon, on motion duly made and seconded the following resolutions were unanimously adopted:
Resolved that the action taken heretofore by the officers of this corporation in connection with the development of a Plan of Reorganization with GOLD SEAL LIQUORS, INC., is hereby ratified.
Be It Further Resolved that the president and secretary of this corporation are hereby authorized to negotiate and to approve an arrangement whereby all of the outstanding stock of FAMOUS LIQUORS, INC., an Illinois corporation, may be exchanged for stock of GOLD SEAL LIQUORS, Inc., upon such terms and conditions which the said officers may determine, it being understood that the stockholders of this corporation shall assign all of their stock to FAMOUS LIQUORS, INC., and FAMOUS LIQUORS, INC., will*197 deliver an equivalent number of shares of said stock to GOLD SEAL LIQUORS, INC., and that GOLD SEAL LIQUORS, INC., will in exchange therefor, turn over to said FAMOUS LIQUORS, INC., a sufficient number of shares, based upon the respective book values at the close of business on the 31st day of January, 1940. FAMOUS LIQUORS, INC., will then distribute the shares of GOLD SEAL LIQUORS, INC., stock to its respective shareholders in the exact proportion required by their holdings at the time of said exchange.
The chairman then advised the board that a formal Plan of Reorganization was in the process of completion and that said plan would become a part of the records of this corporation and would be available for ratification at a future date.
On June 3, 1940, Friedman was elected president and director of Component Gold Seal.
On July 31, 1940, a written "Plan of Reorganization of Gold Seal Liquors, Inc. and Famous Liquors, Inc., Illinois Corporations" was signed by Friedman as president of Famous and by Friedman as president of Component Gold Seal whereby Component Gold Seal issued its stock to Famous's stockholders in exchange for their stock in Famous, pro rata, based upon a January*198 31, 1940, valuation.
Monthly sales of Famous for the period shown were as follows, divided as between Component Gold Seal and all others (cents omitted): *482
| Sales to -- | ||||
| Total | ||||
| Component | Others | |||
| Gold Seal | ||||
| Fiscal year ended Apr. 30, 1938: | ||||
| May 1937 | $ 3,460 | $ 47,056 | $ 50,516 | |
| June 1937 | 2,441 | 27,470 | 29,911 | |
| July 1937 | 4,560 | 27,850 | 32,410 | |
| August 1937 | 2,141 | 26,743 | 28,884 | |
| September 1937 | 5,307 | 24,337 | 29,644 | |
| October 1937 | 4,260 | 37,822 | 42,082 | |
| November 1937 | 3,250 | 42,356 | 45,606 | |
| December 1937 | 7,403 | 49,982 | 57,385 | |
| January 1938 | 3,091 | 48,856 | 51,947 | |
| February 1938 | 3,145 | 17,299 | 20,444 | |
| March 1938 | 8,780 | 109,612 | 118,392 | |
| April 1938 | 3,955 | 32,201 | 36,156 | |
| Total | $ 51,793 | $ 491,584 | $ 543,377 | |
| Fiscal year ended Apr. 30, 1939: | ||||
| May 1938 | $ 3,382 | $ 34,157 | $ 37,539 | |
| June 1938 | 5,016 | 107,853 | 112,869 | |
| July 1938 | 2,803 | 21,013 | 23,816 | |
| August 1938 | 859 | 27,107 | 27,966 | |
| September 1938 | 3,279 | 45,577 | 48,856 | |
| October 1938 | 4,459 | 61,770 | 66,229 | |
| November 1938 | 3,035 | 53,887 | 56,922 | |
| December 1938 | 4,798 | 65,550 | 70,348 | |
| January 1939 | 3,952 | 64,412 | 68,364 | |
| February 1939 | 628 | 81,576 | 82,204 | |
| March 1939 | 1,476 | 38,735 | 40,211 | |
| April 1939 | 890 | 44,565 | 45,455 | |
| Total | $ 34,577 | $ 646,202 | $ 680,779 | |
| Fiscal year ended Apr. 30, 1940: | ||||
| May 1939 | $ 2,174 | $ 51,449 | $ 53,623 | |
| June 1939 | 1,497 | 35,689 | 37,186 | |
| July 1939 | (990) | 57,194 | 56,204 | |
| August 1939 | 435 | 49,230 | 49,665 | |
| September 1939 | 4,244 | 55,107 | 59,351 | |
| October 1939 | 812 | 57,093 | 57,905 | |
| November 1939 | 891 | 89,828 | 90,719 | |
| December 1939 | 2,719 | 95,197 | 97,916 | |
| January 1940 | 18,295 | 76,621 | 94,916 | |
| February 1940 | 70,950 | 8,996 | 79,946 | |
| March 1940 | 83,842 | 83,842 | ||
| April 1940 | 50,744 | 50,744 | ||
| Total | $ 235,613 | $ 576,404 | $ 812,017 | |
| Period May 1, 1940, to Jan. 31, 1941: | ||||
| May 1940 | $ 57,091 | $ 57,091 | ||
| June 1940 | 97,138 | $ 1,762 | 98,900 | |
| July 1940 | 38,909 | 6,000 | 44,909 | |
| August 1940 | 4,724 | 4,724 | ||
| September 1940 | 114,958 | 6,057 | 121,015 | |
| October 1940 | 47,509 | 524 | 48,033 | |
| November 1940 | 89,541 | 89,541 | ||
| December 1940 | 124,706 | 10,080 | 134,786 | |
| January 1941 | 30,605 | 7,622 | 38,227 | |
| Total | $ 605,181 | $ 32,045 | $ 637,226 |
*199 Apparent per capita consumption of distilled spirits in Illinois in wine gallons was as follows:
| Year | Per capita consumption |
| 1934 | 0.84 |
| 1935 | 1.08 |
| 1936 | 1.50 |
| 1937 | 1.64 |
| 1938 | 1.41 |
| 1939 | 1.56 |
*483 Acquiring Gold Seal qualifies as an acquiring corporation under section 740 (a) (4) of the Internal Revenue Code of 1939. Component Gold Seal and its subsidiary corporation, Famous, qualify as component corporations under section 740 (b) (4) of the Internal Revenue Code of 1939. For the excess profits tax taxable years beginning after January 31, 1942, Acquiring Gold Seal is entitled to use the average base period net income computed under section 742 of the Internal Revenue Code of 1939.
Acquiring Gold Seal and Component Gold Seal have kept their books and filed their income and excess profits tax returns on a fiscal year ended January 31 on an accrual basis. Famous kept its books and filed its income and excess profits tax returns on a fiscal year ended April 30 on an accrual basis until January 31, 1941, when it changed to a fiscal year ending January 31.
Component Gold Seal filed timely corporation income, declared value excess-profits, and excess profits tax returns*200 for the taxable years ended January 31, 1941 and 1942, and Acquiring Gold Seal filed timely corporation income, declared value excess-profits, and excess profits tax returns for the taxable years ended January 31, 1943, 1944, 1945, and 1946, with the collector of internal revenue for the first district of Illinois. Famous filed timely income, declared value excess-profits, and excess profits tax returns for the period May 1, 1940, to January 31, 1941, and the fiscal year ended January 31, 1942, with the collector of internal revenue for the first district of Illinois.
Component Gold Seal's base period consisted of the fiscal years ended January 31, 1937 through 1940; the base period of Famous consisted of the fiscal years ended April 30, 1937 through 1940.
Acquiring Gold Seal filed timely applications for relief on Form 991 under section 722 of the Internal Revenue Code of 1939 for Component Gold Seal for the taxable years ended January 31, 1941 and 1942, and for itself for the taxable years ended January 31, 1943, 1944, 1945, and 1946, and timely related claims for refund on Form 843 for the taxable years ended January 31, 1943 and 1944.
Component Gold Seal and Famous were in existence*201 before January 1, 1940, and are entitled to compute their excess profits credit in accordance with the provisions of either section 713 or section 714 of the Internal Revenue Code of 1939 and to use whichever amount results in the lesser excess profits tax as provided by section 712 (a) of the Internal Revenue Code of 1939. With respect to Component Gold Seal the computation under section 714, Internal Revenue Code of 1939, resulted in the lesser excess profits tax for the fiscal years ended January 31, 1941 and 1942. With respect to Famous the computation *484 under section 713, Internal Revenue Code of 1939, resulted in the lesser excess profits tax for the period May 1, 1940, to January 31, 1941, and the fiscal year ended January 31, 1942.
The excess profits net income of Component Gold Seal, Acquiring Gold Seal, and Famous as determined by the Commissioner of Internal Revenue for the periods shown hereunder, were as follows:
| Invested capital method | |
| Period | (Sec. 711 (a) (2)) |
| Component Gold Seal: | |
| Year ended Jan. 31, 1941 | $ 54,271.14 |
| Year ended Jan. 31, 1942 | 111,292.87 |
| Acquiring Gold Seal: | |
| Year ended Jan. 31, 1943 | 257,201.48 |
| Year ended Jan. 31, 1944 | 672,567.41 |
| Year ended Jan. 31, 1945 | 664,560.75 |
| Year ended Jan. 31, 1946 | 508,474.05 |
| Income method | |
| (Sec. 711 (a) (1)) | |
| Component Famous Liquors: | |
| May 1, 1940, to Jan. 31, 1941 | $ 15,464.23 |
| Year ended Jan. 31, 1942 | 21,218.67 |
*202 The excess profits net income of Component Gold Seal and Famous for each of the base period years was as follows:
| Component | ||
| Gold Seal | Famous | |
| Year | (Fiscal Jan. 31) | (Fiscal Apr. 30) |
| 1937 | $ 22,786.98 | 1 $ 19,479.95 |
| 1938 | 20,161.46 | 16,024.07 |
| 1939 | 17,806.32 | 7,840.58 |
| 1940 | 27,616.61 | 5,294.87 |
The average base period net income and the excess profits credits of Component Gold Seal, Famous, and Acquiring Gold Seal computed under the indicated sections were as follows for the periods stated below:
| Average base | Excess profits | |
| period net income | credit computed | |
| Period | (Sec. 713) | under sec. 714 |
| Component Gold Seal: | ||
| Year ended Jan. 31, 1941 | $ 19,586.34 | $ 36,990.59 |
| Year ended Jan. 31, 1942 | 23,330.09 | 56,681.64 |
| Sec. 713 | ||
| Component Famous Liquors: | ||
| Period May 1, 1940, to Jan. 31, 1941 | 11,255.65 | $ 10,692.87 |
| Year ended Jan. 31, 1942 | 12,159.87 | 11,551.88 |
| Supplement A | ||
| sec. 713 (e) | Sec. 714 | |
| Acquiring Gold Seal: | ||
| Year ended Jan. 31, 1943 | $ 34,801.23 | $ 89,204.31 |
| Year ended Jan. 31, 1944 | 34,801.23 | 62,522.09 |
| Year ended Jan. 31, 1945 | 34,801.23 | 82,690.03 |
| Year ended Jan. 31, 1946 | 34,801.23 | 99,911.77 |
*203 Acquiring Gold Seal's and its components' excess profits tax liabilities for the taxable years ended January 31, 1941, 1942, 1943, 1944, *485 1945, and 1946, without the benefit of section 722 of the Internal Revenue Code of 1939, are as follows:
| Components | |||
| Year ended January 31 | Acquiring | ||
| Gold Seal | |||
| Gold Seal | Famous | ||
| 1941 | $ 3,070.14 | 1 | |
| 1942 | 18,844.49 | $ 1,633.38 | |
| 1943 | $ 132,027.14 | ||
| 1944 | 457,418.33 | ||
| 1945 | 445,240.14 | ||
| 1946 | 298,497.55 |
OPINION.
Petitioner contends that it is entitled to excess profits tax relief under section 722 (b) (4) of the Internal Revenue Code of 1939. 1*204 In two of the years for which relief is claimed -- the years ending January 31, 1941, and January 31, 1942 -- Component Gold Seal was in existence, and petitioner's claim for those years relates to that corporation. 2 For the ensuing years ending January 31, 1943 through 1946, its claim for relief relates to itself as an "acquiring *486 corporation." 3 No claim for relief was filed relating to Component Famous Liquors, which had a fiscal year ending April 30.
*205 The petitioner's first contention is that the excess profits tax of Component Gold Seal for the years ending January 31, 1941, and January 31, 1942, computed without the benefit of section 722, resulted in an excessive and discriminatory tax. It urges that there are four factors which qualify Component Gold Seal for relief under section 722 (b) (4), and that it has established that, for those 2 years, a fair and just amount representing normal earnings to be used as a constructive average base period net income is at least $ 141,635.
The respondent contends that even if it be assumed that one or more of the factors enumerated in section 722 (b) (4) occurred during the base period of Component Gold Seal, the petitioner is not entitled to relief because, even under assumed conditions, Component Gold Seal could not reasonably have been expected to make sufficiently higher earnings to overcome the "gap" between the credits under the average earnings method, and the credits actually used under the invested capital method.
Petitioner maintains that Component Gold Seal qualifies for relief under section 722 (b) (4) because it commenced business immediately prior to the base period and its*206 average base period net income does not reflect normal operations for the entire base period. It *487 urges that if Component Gold Seal had started its operations 2 years earlier that it did the volume of sales attained at the close of its base period would have materially increased with resultant higher earning levels. Component Gold Seal commenced business on February 6, 1934, following the repeal of the Eighteenth Amendment. Its base period began on February 1, 1936. Thus by the beginning of its base period it had engaged in business for a period of approximately 2 years. In order to receive the benefit of the 2-year "pushback" under section 722 (b) (4) it was incumbent upon the petitioner to show that the business of Component Gold Seal did not reach by the end of the base period the earning level which it would have reached if commencement of its business had been made 2 years before it actually was made. The business of Component Gold Seal was not one which required a long development period. Cf. Midwest Liquor Dealers, Inc., 20 T. C. 950, 964. Its wholesale sales, which amounted to only $ 721,613 for the year ended January 31, 1935, *207 and to $ 1,247,387 for the year ended January 31, 1936, rose to $ 2,051,262 for the year ended January 31, 1937, its first base period year. Its earnings for the latter year were higher than in any succeeding year except the last base period year which ended on January 31, 1940, even though the trend of its sales was to some extent upward. Our conclusion is that the petitioner has not shown that the commencement of the business of Component Gold Seal in 1934 resulted in its base period earnings being unrepresentative of normal earnings, and that it is not, therefore, entitled to relief by reason of the commencement factor.
As a second ground for relief, petitioner relies upon the change in the capacity for operation of the business of Component Gold Seal resulting from the acquisition of new facilities. In December 1937 Component Gold Seal acquired 60,000 square feet of space in a building located at 701-17 West Harrison Street, Chicago, Illinois, and during the same month exercised an option to purchase these new quarters for $ 40,000. The new quarters provided it with adequate space for its offices and salesrooms, and garage facilities, which it did not have before the move, *208 and labor-saving devices were installed for the handling of its merchandise.
Petitioner contends that the change immediately created dollar savings on the existing volume of Component Gold Seal as a result of the elimination of garage rents and warehouse costs and the more effective handling of merchandise. While some savings may have accrued from these factors, the evidence does not convince us that they were substantial in amount as they are not reflected in the total amount of the deductions of Component Gold Seal before and after the change. If there had not been a decline in the salaries of officers *488 and other executives during the fiscal year 1939, the percentage relation of deductions to wholesale sales would have been approximately the same during the base period years. This would indicate that any rental or warehousing costs which were eliminated by the acquisition of the Harrison Street building were largely offset by other costs incurred by Component Gold Seal as owner of these premises. About the only financial benefit we can find with confidence that it derived from the move is the income which it realized from renting the unused space in the new quarters*209 to others. This rental amounted to $ 2,950 for the fiscal year 1939 and $ 4,250 for the fiscal year 1940.
Petitioner also contends that some savings accrued from the change to the new quarters when in January 1940 Component Gold Seal combined its operations with those of Famous. Prior to January 1940 Famous used Wakem & McLaughlin for the storage of its merchandise. While the evidence does not disclose the amount paid annually to the latter concern for storage, it does show that 10 cents per case was paid for the first month of storage and 5 cents per case per month thereafter, with a charge for withdrawals. It also shows that 2,447 barrels of Old Sunny Brook were bottled for Famous during the year 1939, and this indicates that approximately 36,705 cases (conversion rate of 15 cases per barrel) went in and out of the public warehouse. On this basis the petitioner has computed the storage costs to be not less than $ 3,670 for the first month and urges that to the extent the case goods were held in storage for longer than one month, the storage costs would exceed that amount. It also urges that Famous paid some undisclosed amounts for storing Lanson champagnes and other items, *210 and the amounts shown in our findings to cartage companies for delivering its merchandise. While storage and cartage costs were eliminated in January 1940, insofar as Famous was concerned, any savings which accrued to the combined businesses cannot be ascertained by looking only at the amounts which Famous had been paying for storage and cartage prior to that time. Although Component Gold Seal thereafter stored the case goods on its premises and delivered them in its trucks, these services were not rendered without cost to it, and that cost cannot be overlooked in estimating any savings in storage and cartage costs which resulted from the move. These savings will be taken into consideration in connection with the relief which, as hereinafter noted, petitioner urges Component Gold Seal is entitled to receive by reason of the fact that its business was combined with that of Famous immediately prior to the end of its last base period year.
The remaining factors upon which petitioner relies for relief relate to the change in the management of the business of Component Gold *489 Seal in January 1940, and the absorption by it on that date of the sales personnel, inventory, and business*211 of Famous. The respondent concedes that these changes occurred within the base period of Component Gold Seal and that they are factors which qualify it for consideration for relief under section 722 (b) (4). The petitioner contends that if these changes had been made 2 years prior to January 1940, Component Gold Seal would have reached a substantially higher level of earnings by the end of its base period.
In January 1940, Friedman, the president and principal stockholder of Famous, succeeded Clamage who had served as sales manager of Component Gold Seal for a period of approximately 2 1/2 years. At that time Friedman had had considerable experience in the liquor business, and had served as president of Famous during the 3 base period years in which it was in business. During those years the earnings of the latter corporation steadily declined even though its sales volume increased. There is some evidence which indicates that some factors not of a managerial nature might have been partially responsible for this decline in earnings. Even assuming this to be true, however, an examination of the results of the operations of Famous during the base period years while managed by Friedman, *212 and of the operations of Component Gold Seal during approximately the same period while managed by Clamage, does not convince us that the change in management alone, if effected 2 years prior to January 1940, would have resulted in any higher level of earnings for Component Gold Seal at the end of its base period. Our conclusion is that Component Gold Seal is not entitled to relief because of the change made in the management of its business in January 1940.
There remains the question as to the earning level Component Gold Seal would have reached at the end of its base period if the personnel, inventory, and business of Famous had been absorbed by it 2 years prior to January 1940. The record of Famous during the base period, when substantially all of its sales were of Old Sunny Brook, shows an increase in sales volume accompanied by a decline in earnings in each base period year in which it operated. The record of Component Gold Seal shows a trend of increased sales during the base period without a corresponding increase in earnings. The failure of the earnings of both corporations to keep pace with increased sales indicates that competition was severe and that profits were being*213 sacrificed to get business. This condition would undoubtedly have been reflected in earnings of the last 2 base period years if the businesses of the two components had been combined in January 1938.
*490 Despite the unimpressive record of Famous and Old Sunny Brook during 3 base period years, petitioner urges that if Component Gold Seal had acquired the business and personnel of Famous 2 years earlier than it did, it would have enjoyed substantially higher sales and earnings by the end of its base period. Some idea of its chances of achieving these favorable results may be gleaned from the experience of Component Gold Seal with the Englewood Wholesale Liquor Distributors, Inc. On June 26, 1937, Clamage, president of the latter corporation, liquidated that company and joined forces with Component Gold Seal. He brought six salesmen and some office personnel with him and became sales manager of Component Gold Seal. For the last fiscal year of its business (ended October 31, 1936), Englewood's sales were approximately $ 1,044,000. During the 12 months (July 1936 to June 1937) prior to acquiring the Englewood business, the wholesale sales of Component Gold Seal amounted to *214 $ 2,372,811. During the 12 months following the combining of the two businesses (July 1937 to June 1938), its wholesale sales amounted to $ 3,006,283, an increase of $ 633,472. This increase was substantially less than the $ 1,044,000 of sales which Englewood had had in its last full year of operations. In the last full year of Component Gold Seal before combining with Englewood, when it had a net operating profit of $ 22,087, its wholesale transactions amounted to $ 2,051,000. For the year of acquisition ending January 31, 1938, its net operating profit declined to $ 20,161, even though its wholesale sales increased to $ 2,872,450. In the last base period year its sales increased to $ 3,086,529 and its net operating profit to $ 23,191. This profit was only slightly in excess of the net operating profit of $ 22,087 realized in the year ended January 31, 1937, prior to the acquisition of Englewood and its sales personnel.
In the light of the experience of Component Gold Seal after it acquired Englewood, we cannot share the optimism of witnesses for petitioner who expressed the opinion that its sales would have reached a volume of approximately $ 6,000,000 if it had acquired the*215 business and sales personnel of Famous 2 years prior to January 1940. Neither can we share their optimism that its earnings would have reached a level of $ 141,635, $ 161,000, $ 222,500, or $ 227,960 by the end of its base period, after allowing to Famous an "override" of 35 cents per case on sales of Old Sunny Brook. The combined sales of the two components in the last base period year amounted to approximately $ 3,900,000, and their combined earnings (including a $ 7,000 income addition to Famous as an accounting adjustment) to approximately $ 33,000. We have carefully considered the evidence submitted by petitioner to establish that with 2 additional years of experience Component Gold Seal, with a sales force of 33 men selling *491 Old Sunny Brook and other items in the Component Gold Seal line of merchandise, and with some savings in overhead resulting from the combination, would have reached an earning level by the end of its base period of from $ 141,635 to $ 227,960. It does not convince us that one component, by absorbing the business and personnel of another component which had a base period record of increased sales and declining earnings, with Old Sunny Brook as*216 its principal product, could reasonably anticipate by the end of its base period any substantial increase in the total earnings realized by the two components in their last base period years, even if the combination had occurred in January 1938. If it had, our best judgment is that although some increased sales might have been achieved by the end of the base period, any increase then reached in the earning level of the combined businesses would not be enough to give Component Gold Seal a constructive average base period net income sufficiently high to entitle it to a credit based upon such income in excess of the credits actually employed by it based upon invested capital for the years ended January 31, 1941, and January 31, 1942. We hold, therefore, that the respondent did not err in disallowing petitioner's claim for relief for those years. Cf. Green Spring Dairy, Inc., 18 T.C. 217">18 T. C. 217.
The parties have stipulated that Acquiring Gold Seal qualifies as an acquiring corporation under section 740 (a) (4) of the Internal Revenue Code of 1939; that Component Gold Seal and its subsidiary corporation, Famous, qualify as component corporations under section*217 740 (b) (4); and that for the years ended January 31, 1943 to 1946, inclusive, Acquiring Gold Seal is entitled to use the average base period net income computed under section 742 of the Code.
Petitioner's remaining contention is that the excess profits credit of Acquiring Gold Seal based upon the actual average base period net income of its component corporations is an inadequate standard of normal earnings, and that a fair and just amount representing normal earnings to be used as a constructive average base period net income for its fiscal years ending January 31, 1943 to 1946, inclusive, is $ 174,790.
For the purposes of section 722, Acquiring Gold Seal is deemed to be entitled to all of the qualifying factors for relief of its components. Its claim for relief for the years ending January 31, 1943 to 1946, inclusive, is based upon the same arguments advanced in support of its claim for relief relating to Component Gold Seal, with certain modifications necessary because of the consolidation effected on January 31, 1942. What we have heretofore said about the base period experience of its components need not be repeated. Suffice to say that that experience did not qualify Component*218 Gold Seal for relief, and Acquiring Gold Seal had to overcome a much larger "gap" between *492 credits based on average base period net income and credits based on invested capital in order to be entitled to relief. Giving effect to all of the evidence, the most favorable constructive average base period net income allowable would not be in excess of the credits actually used by petitioner based on invested capital. This circumstance distinguishes Midwest Liquor Dealers, Inc., 20 T.C. 950">20 T. C. 950, where some relief was allowed based on changes under section 722 (b) (4), somewhat comparable to the ones involved herein. We conclude, therefore, that the respondent did not err in disallowing petitioner's claim for relief under section 722 for the years ending January 31, 1943 to 1946, inclusive.
Reviewed by the Special Division.
Decision will be entered for the respondent.
Footnotes
1. Includes $ 205,536 sales at cost to Component Gold Seal for 3 months ended Apr. 30, 1940.↩
1. Computed in accordance with sec. 713 (d), I. R. C. 1939↩.
1. None. Period May 1, 1940, to Jan. 31, 1941.↩
1. SEC. 722. GENERAL RELIEF -- 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, and the acquisition before January 1, 1940, of all or part of the assets of a competitor, with the result that the competition of such competitor was eliminated or diminished. 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, * * *↩
2. Under Illinois law, all components to a statutory consolidation cease to exist upon effectuation of the consolidation. The resulting corporation succeeds to all rights, duties, privileges, and immunities of its components. Business Corporation Act of July 13, 1933, Ill. Rev. Stat. ch. 32, sec. 157.69 (a) through (e) (1945).↩
3. I. R. C. 1939:
SEC. 740. DEFINITIONS.
For the purposes of this Supplement --
(a) Acquiring Corporation. -- The term "acquiring corporation" means --
(1) A corporation which has acquired --
(A) substantially all the properties of another corporation and the whole or a part of the consideration for the transfer of such properties is the transfer to such other corporation of all the stock of all classes (except qualifying shares) of the corporation which has acquired such properties, or
(B) substantially all the properties of another corporation and the sole consideration for the transfer of such properties is the transfer to such other corporation of voting stock of the corporation which has acquired such properties, or
* * * *
(4) A corporation the result of a statutory consolidation of two or more corporations,
(b) Component Corporation. -- The term "component corporation" means --
(1) In the case of a transaction described in subsection (a) (1), the corporation which transferred the assets;
* * * *
(4) In the case of a statutory consolidation, all corporations consolidated, except the corporation resulting from the consolidation;
* * * *
(d) In the case of a taxpayer which is an acquiring corporation the base period shall be the four calendar years 1936 to 1939, both inclusive, except that, if the taxpayer became an acquiring corporation prior to September 1, 1940, the base period shall be the same as that applicable to its first taxable year ending in 1941.
(e) Base Period Years. -- In the case of a taxpayer which is an acquiring corporation its base period years shall be the four successive twelve-month periods beginning on the same date as the beginning of its base period.
(f) Existence of Acquiring Corporation. -- For the purposes of section 712 (a)↩, if any component corporation of the taxpayer was in existence before January 1, 1940, the taxpayer shall be considered to have been in existence before such date.