Strickland Cotton Mills v. Commissioner

Strickland Cotton Mills, Petitioner, v. Commissioner of Internal Revenue, Respondent

Strickland Cotton Mills v. Commissioner

Docket Nos. 23860, 25163

United States Tax Court

19 T.C. 151; 1952 U.S. Tax Ct. LEXIS 53;

November 7, 1952, Promulgated

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Decisions will be entered for the respondent.

1. Petitioner, a member of the cotton textile industry, Southern division, has not shown that the effect of the large cotton crop of 1937 on the cotton textile industry resulted in an abnormally depressed base period net income entitling it to relief under section 722 (b) (2), Internal Revenue Code.

2. The base period is not to be divided into separate segments; it is a unitary period.

Paul Webb, Jr., Esq., and H. H. Hunt, C. P. A., for the petitioner.

William J. Stetter, Esq., and Stafford R. Grady, Esq., for the respondent.

Withey, Judge.

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WITHEY

The Commissioner denied the petitioner's applications for relief from excess profits taxes under section 722 (b) (2) of the Internal Revenue Code for the fiscal years ending July 31, 1941, 1942, 1943, 1944, 1945, and 1946. The sole issue is whether the business of the petitioner was depressed in the base period because of temporary economic circumstances unusual in the case of the petitioner or because of the fact that an industry of which petitioner was a member was depressed by reason of temporary economic events unusual in the case of such industry.

The proceedings were consolidated for hearing.

FINDINGS OF FACT.

Facts stipulated are so found and incorporated herein by reference.

The petitioner is a Georgia corporation which was organized in 1899. It has its principal place of business at Valdosta, Georgia, and is a manufacturer of cotton sheetings.

The petitioner during the years 1921 through 1941 manufactured standard narrow Class C sheetings (i. e., sheetings 40 inches wide or less, having an average yarn number of from 21 to 28) for use in the manufacture of cotton bags and in the converting trade. These sheetings were made from undyed and unbleached yarns which were also manufactured by the petitioner. (This product is commonly called "grey goods.")

The gray cloth manufactured by the petitioner during all years material to this proceeding was sold through a selling agent in New York. The selling agent sold petitioner's cotton cloth on a commission basis and assumed all credit risks by guaranteeing the accounts receivable.

The cotton textile industry is divisible in two ways. Geographically it is divisible into a Northern division and a Southern division. Secondly, it can be divided into industry groups according to the type product manufactured. Generally speaking there are fourteen such major manufacturing groups. They are listed according to the product manufactured, as follows: Corded yarn, combed yarn, miscellaneous cotton yarn, cordage and twine, cotton duck, sheetings and allied fabrics, print cloths and allied fabrics, napped fabrics, colored yarn fabrics, fine cotton goods, towels and toweling (including wash cloths and terry woven fabrics other than toweling), tobacco and cheese cloths (including gauze, absorbent cotton, and surgical dressing), specialty fabrics, and miscellaneous cotton textile products.

Petitioner is a member of the cotton textile industry, Southern division, sheetings and allied fabrics group.

The mill margin is roughly the difference between the selling price of cotton cloth and the cost of raw cotton.

The petitioner has kept its books and filed its income tax returns on the accrual basis since its organization. Prior to August 1, 1931, petitioner kept its books and filed its tax returns on a calendar year basis and since August 1, 1931, petitioner has kept its books and filed its tax returns on the basis of a fiscal year ending July 31.

The petitioner filed timely corporation income tax, declared value excess-profits tax, and excess profits tax returns for the fiscal years ended July 31, 1941, 1942, 1943, 1944, 1945, and 1946, with the collector of internal revenue for the district of Georgia.

The petitioner filed timely applications for relief (Form 991) under section 722 of the Internal Revenue Code for fiscal years ended July 31, 1941, 1942, 1943, 1944, 1945, and 1946.

Since the petitioner was in existence during its entire base period, that is the fiscal years ended July 31, 1937, 1938, 1939, and 1940, it is entitled to use an excess profits credit based on income under the provisions of section 713 of the Internal Revenue Code. Petitioner's excess profits credit computed under the provisions of section 713 of the Internal Revenue Code and without application of section 722 of the Internal Revenue Code as finally determined by the respondent for each of the fiscal years, ending July 31, 1941 to 1946, inclusive, is as follows:

July 31, 1941	$ 55,022.56
July 31, 1942	66,056.90
July 31, 1943	80,392.30
July 31, 1944	80,392.30
July 31, 1945	80,392.30
July 31, 1946	80,414.84

Excess profits net income for each of the base period years computed under section 711 and without the application of section 722 of the Internal Revenue Code is as follows:

	For fiscal year
	July 31, 1941	For later years
July 31, 1937	$ 133,136.51	$ 159,410.56
July 31, 1938	28,641.29	33,409.99
July 31, 1939	6,386.75	7,339.24
July 31, 1940	63,509.38	77,974.54

Petitioner's excess profits tax liability, without the application of section 722 of the Internal Revenue Code, for each of the fiscal years ending July 31, 1941 to 1946, inclusive, is as follows:

July 31, 1941	$ 12,081.71
July 31, 1942	44,982.68
July 31, 1943	130,273.16
July 31, 1944	77,237.21
July 31, 1945	72,420.17
July 31, 1946	30,769.37

For the fiscal years ended July 31, 1935, to July 31, 1940, sales, gross profit, gross profit percentage of sales, compensation of officers, and other items of income and expense for petitioner were as follows:

INCOME, PROFIT AND LOSS STATEMENTS
District    Georgia
Year	July 31,	July 31,	July 31,
	1935	1936	1937
Sales	$ 450,874	$ 652,397	$ 866,109
Cost of goods sold	456,695	520,372	602,933
Gross profit from sales	(5,821)	132,025	263,176
Gross sales from store
Cost of goods sold
Gross profit from store
Gross profit per cent of sales	(1.29)	20.23	30.38
	15 1/2 Yr. Average 10.58%,
	4 Yr. Average 20.50%
Interest received on Government obligations
Other interest	(Not. seg.)
Rents	7,100	7,391	7,591
Other income	834	696	1,003
Total income	2,113	140,112	271,770
Loss on sale of cotton contracts
Compensation of officers	5,556	5,505	20,550
Salaries and wages	3,030	3,095	5,363
Repairs	(Included in "Cost
	of goods sold")
Bad debts	17	35	350
Interest paid	7,671	11,459	7,319
Taxes	2,119	4,226	14,916
Contributions			5,920
Losses by fire, etc
Depreciation	11,011	16,997	16,040
Loss on commissary
Other deductions	14,754	55,035	29,608
Total deductions	44,158	96,352	100,066
Current year net income	(42,045)	43,760	171,704
Prior year loss
Declared value excess profits tax			12,674
Wholly nontaxable interest received

INCOME PROFIT AND LOSS STATEMENTS
District     Georgia
Year	July 31,	July 31,	July 31,
	1938	1939	1940
Sales	$ 473,140	$ 579,584	$ 585,964
Cost of goods sold	389,986	503,271	452,482
Gross profit from sales	83,154	76,313	122,482
Gross sales from store
Cost of goods sold
Gross profit from store
Gross profit per cent of sales	17.57	13.16	20.90
	15 1/2 Yr. Average 10.58%,
	4 Yr. Average 20.50%
Interest received on Government obligations
Other interest			2,283
Rents	7,413	6,497	6,795
Other income	829	1,302	8,253
Total income	91,396	84,112	150,813
Loss on sale of cotton contracts
Compensation of officers	12,075	10,400	9,000
Salaries and wages	5,720	6,076	6,597
Repairs	(Included in "Cost
	of goods sold")
Bad debts	75	321
Interest paid	7,969	11,445	5,005
Taxes	9,802	10,378	13,003
Contributions	230	255	300
Losses by fire, etc
Depreciation	17,176	17,506	17,006
Loss on commissary
Other deductions	4,389	20,392	21,852
Total deductions	57,986	76,773	72,763
Current year net income	33,410	7,339	78,050
Prior year loss
Declared value excess profits tax			76
Wholly nontaxable interest received

The following table is a comparison of United States and foreign production and mill consumption of commercial cotton for the years 1922-1939, inclusive:

	Production (in 1,000 bales)			Mill consumption
				(in 1,000 bales)
Year beginning August
1 --
	United	Foreign	World	United	Foreign	World
	States			States
1922	10,124	8,327	18,451	6,666	14,671	21,337
1923	10,330	8,760	19,090	5,681	14,346	20,027
1924	14,006	10,088	24,094	6,193	16,541	22,734
1925	16,181	10,562	26,743	6,456	17,712	24,168
1926	18,182	9,768	27,930	7,190	18,489	25,679
1927	12,957	10,386	23,343	6,834	18,608	25,442
1928	14,555	11,247	25,802	7,091	18,687	25,778
1929	14,716	11,535	26,251	6,106	18,769	24,875
1930	13,873	11,503	25,376	5,263	17,169	22,432
1931	16,877	9,602	26,479	4,866	18,023	22,889
1932	12,961	10,500	23,461	6,137	18,514	24,651
1933	12,712	13,354	26,066	5,700	19,902	25,602
1934	9,576	13,466	23,042	6,361	20,119	25,480
1935	10,495	15,646	26,141	6,351	21,178	27,529
1936	12,375	18,354	30,729	7,950	22,688	30,638
1937	18,412	18,333	36,745	5,748	21,825	27,573
1938	11,665	15,839	27,504	6,858	21,649	28,507
1939	11,516	15,851	27,367	7,784	20,702	28,486
Averages:
1936-1939	13,492	17,094	30,586	7,085	21,716	28,801
1922-1939	13,414	12,396	25,812	6,346	18,866	25,213
1922-1935	13,392	11,053	24,448	6,135	18,052	24,187

Source: U. S. Dept. of Agriculture, "Agricultural Statistics," 1941, pp. 123, 125, 126, and 1945, p. 75.

The carry-over at the beginning of the year in foreign countries and in the United States 1921-1940, with the amounts of the United States carry-over held by the U. S. Government and by others 1933-1940 were as follows:

				United States
				held by --
Year beginning August	Grand	Foreign	Total
1 --	total	countries
				U. S. Government	Others
1921	15,169	8,273	6,534
1922	10,494	7,172	2,832
1923	7,571	5,246	2,325
1924	6,614	5,058	1,556
1925	7,948	6,338	1,610
1926	10,473	6,931	3,543
1927	12,654	8,892	3,762
1928	10,535	7,999	2,536
1929	10,541	8,228	2,312
1930	11,892	7,362	4,530
1931	14,808	8,438	6,370
1932	18,336	8,658	9,678
1933	17,116	8,952	8,165	1 3,626	1 4,539
1934	17,540	9,796	7,744	3,037	4,707
1935	15,072	7,864	7,208	6,027	1,181
1936	13,649	8,240	5,409	3,237	2,172
1937	13,695	9,196	4,499	1,665	2,834
1938	22,702	11,169	11,533	6,964	4,589
1939	21,638	8,605	13,033	11,045	1,988
1940	20,272	9,708	10,564	8,733	1,831

The condition of petitioner as of the close of each calendar year from 1921 to 1930, and as of the close of each fiscal year from July 31, 1931, to July 31, 1940, was as follows:

BALANCE SHEETS
District    Georgia
Year	1921	1922	1923
Cash	$ 961		$ 15,089
Notes & accounts receivable
(net)	3,992	$ 24,952	1,511
Inventories	227,187	233,688	361,657
Govt. & State obligations	20,000	20,000	20,000
Land	118,227	7,350	7,350
Net tangible capital assets		194,857	189,234
Reserves	133,830	85,587	93,950
Other assets	304
Total assets	$ 370,671	$ 480,847	$ 594,841
Accounts payable	$ 9,969	$ 4,162	$ 2,567
Bds, Nts, & Mtgs, less than 1 yr	113,154	103,126	209,626
Common stock	175,000	175,000	175,000
Surplus, paid-in or capital surplus,
earned	70,328	189,483	205,674
Other liabilities	2,220	9,076	1,974
Total liabilities	$ 370,671	$ 480,847	$ 594,841

BALANCE SHEETS
District    Georgia
Year	1924	1925	1926	1927
Cash	$ 16,490		$ 2,055	$ 537
Notes & accounts receivable
(net)	9,815	$ 10,240	5,537	12,440
Inventories	175,247	176,275	127,734	84,666
Govt. & State obligations
Land	7,350	7,350	7,550	7,550
Net tangible capital assets	181,246	180,819	178,962	282,583
Reserves	102,374	110,799	119,822	121,583
Other assets			719	1,003
Total assets	$ 390,148	$ 374,684	$ 322,557	$ 388,779
Accounts payable	$ 3,393	$ 3,204	$ 2,985	$ 7,623
Bds, Nts, & Mtgs, less than 1 yr	33,126	43,125	12,789	57,789
Common stock	175,000	175,000	175,000	175,000
Surplus, paid-in or capital surplus,
earned	176,772	146,441	123,283	139,308
Other liabilities	1,857	6,914	8,500	9,059
Total liabilities	$ 390,148	$ 374,684	$ 322,557	$ 388,779

BALANCE SHEETS
District    Georgia
Year	1928	1929	1930
Cash	$ 6,698	$ 2,001	$ 3,109
Notes & accounts receivable
(net)	14,941	15,845	16,632
Inventories	107,360	89,189	92,953
Govt. & State obligations
Land	7,550	7,550	7,550
Net tangible capital assets	279,671	268,411	261,234
Reserves	134,668	148,014	160,891
Other assets	3,161	1,626	1,013
Total assets	$ 419,381	$ 384,622	$ 382,491
Accounts payable	$ 2,557	$ 23,280	$ 13,647
Bds, Nts, & Mtgs, less than 1 yr	122,289	134,789	167,789
Common stock	175,000	175,000	175,000
Surplus, paid-in or capital surplus,
earned	119,535	50,115	24,471
Other liabilities		1,438	1,584
Total liabilities	$ 419,381	$ 384,622	$ 382,491

BALANCE SHEETS
District    Georgia
Year	July 31,	July 31,	July 31,	July 31,
	1931	1932	1933	1934
Cash	$ 1,998	$ 156	$ 1,667
Notes & accounts receivable
(net)	22,796	22,495	19,957	$ 1,140
Inventories	27,992	38,195	40,723	147,216
Govt. & State obligations
Land	7,550	7,550	7,550	7,550
Net tangible capital assets	252,671	244,297	226,938	212,700
Reserves	170,392	186,432	204,104	218,452
Other assets	6,799	8,410	7,775	5,794
Total assets	$ 319,806	$ 321,103	$ 304,610	$ 374,400
Accounts payable	$ 5,091	$ 4,715	$ 3,964	$ 2,749
Bds, Nts, & Mtgs, less than 1 yr	92,789	70,289	53,789	124,471
Common stock	175,000	175,000	175,000	175,000
Surplus, paid-in or capital surplus,
earned	42,278	66,411	66,967	64,494
Other liabilities	4,648	4,688	4,890	7,686
Total liabilities	$ 319,806	$ 321,103	$ 304,610	$ 374,400

BALANCE SHEETS
District    Georgia
Year	July 31,	July 31,	July 31,
	1935	1936	1937
Cash	$ 848	$ 2,574
Notes & accounts receivable (net)	9,796	20,450	$ 40,363
Inventories	135,745	47,972	45,191
Govt. & State obligations
Land	7,550	7,550	7,550
Net tangible capital assets	212,720	302,595	291,362
Reserves	233,295	194,074	212,200
Other assets	1,430	860	1,236
Total assets	$ 368,089	$ 382,001	$ 385,702
Accounts payable	$ 2,593	$ 3,918	$ 7,132
Bds, Nts, & Mtgs, less than 1 year	142,471	135,971	62,000
Common stock	175,000	175,000	175,000
Surplus, paid-in or capital surplus, earned	25,016	64,530	85,309
Other liabilities	23,009	2,582	56,261
Total liabilities	$ 368,089	$ 382,001	$ 385,702

BALANCE SHEETS
District    Georgia
Year	July 31,	July 31,	July 31,
	1938	1939	1940
Cash	$ 4,189	$ 5,743	$ 4,046
Notes & accounts receivable (net)	31,446	43,048	18,679
Inventories	132,097	53,008	60,007
Govt. & State obligations
Land	7,550	7,550	7,550
Net tangible capital assets	257,544	246,119	244,377
Reserves	302,915	319,332	339,172
Other assets	3,877	4,213	4,008
Total assets	$ 436,703	$ 359,681	$ 338,667
Accounts payable	$ 3,518	$ 4,203	$ 194
Bds, Nts, & Mtgs, less than 1 yr	173,000	93,000
Common stock	175,000	175,000	175,000
Surplus, paid-in or capital surplus, earned	75,363	81,861	139,395
Other liabilities	9,822	5,617	24,078
Total liabilities	$ 436,703	$ 359,681	$ 338,667

The compiled net profit (or loss) less tax-exempt income for manufacturing corporations other than cotton textile, and for cotton textile manufacturing corporations for the years 1922-1939 was as follows:

Compiled Net Profit (or Loss) Less Tax-Exempt Income for Manufacturing Corporations Other Than Cotton Textile, and Cotton Textile Manufacturing Corporations, 1922-1939

(In $ 1,000)
	Manufacturing
Year	corporations	Cotton textile
	other than cotton	corporations
	textile
1922	2,548,044	92,963
1923	3,466,977	103,910
1924	2,803,307	(39,835)
1925	(1)	(1)
1926	3,738,946	(30,843)
1927	3,011,752	75,842
1928	3,899,944	10,582
1929	4,383,755	22,017
1930	1,209,171	(91,507)
1931	(759,400)	(63,570)
1932	(1,752,601)	(53,663)
1933	172,218	31,828
1934	971,591	8,414
1935	1,826,708	(10,261)
1936	3,102,507	35,138
1937	3,123,298	37,779
1938	1,262,283	(6,206)
1939	3,151,164	35,287
Average:
1936-1939	2,659,813	25,500
1922-1935	1,963,109	4,298
1922-1939	2,127,039	9,287
	Base period	Base period
	25.05%	174.57%
	greater than	greater than
	1922-1939.	1922-1939.

The income and balance sheet data for nine corporations, Southern sheetings mills, 1922-1939, were as follows:

Sheetings and Allied Fabrics Industry, Southern Sheetings Mills, Income and Balance Sheet Data for Nine Corporations, Filing Fiscal Year Returns in 1922-1939

		Compiled
		net profit	Total
	Net	(or loss)	assets
Year	sales	less tax-exempt	(end of
	($ 000)	income	year)
		($ 000)	($ 000)
1922	9,509	892	8,811
1923	11,080	653	9,791
1924	11,040	314	10,255
1925	12,730	354	10,025
1926	10,991	409	9,206
1927	10,552	847	9,787
1928	10,859	142	9,492
1929	10,248	309	9,480
1930	8,130	(913)	8,582
1931	6,252	(375)	7,847
1932	5,237	(297)	7,094
1933	7,259	276	7,445
1934	8,808	206	7,869
1935	8,725	(126)	7,733
1936	11,064	739	8,316
1937	10,721	668	8,297
1938	7,051	(132)	7,519
1939	8,372	88	7,924
Average:
1936-1939	9,302	341	8,014
1922-1939	9,368	225	8,637
Per cent: 1936-1939 to 1922-1939	99.30	151.56	92.79

	Ratio of compiled net
	profit (or loss) less
	tax-exempt income to:
Year
	Net sales	Total assets
	(per cent)	(per cent)
1922	9.38	10.12
1923	5.89	6.67
1924	2.84	3.06
1925	2.78	3.53
1926	3.72	4.44
1927	8.03	8.65
1928	1.31	1.50
1929	3.02	3.26
1930	(11.23)	(10.64)
1931	(6.00)	(4.78)
1932	(5.67)	(4.19)
1933	3.80	3.71
1934	2.34	2.62
1935	(1.44)	(1.63)
1936	6.68	8.89
1937	6.23	8.05
1938	(1.87)	(1.76)
1939	1.05	1.11
Average:
1936-1939	3.67	4.26
1922-1939	2.40	2.61
Per cent: 1936-1939 to 1922-1939

The average spot price of middling cotton in ten markets and the average wholesale prices of three constructions of narrow sheetings for 1922-1940 were as follows:

		Narrow sheetings:
	Middling cotton	Average of
	7/8 inch: Average	wholesale prices
Year	spot price in ten	of three constructions,
	markets (cents	f. o. b. mill
	per pound)	(cents per pound)
1922	20.49
1923	28.63
1924	27.79
1925	23.10
1926	16.62	33.59
1927	16.85	32.77
1928	19.15	33.14
1929	18.20	32.27
1930	12.73	25.19
1931	7.90	18.15
1932	6.11	14.86
1933	1 10.05	22.39
1934	1 16.17	29.48
1935	1 15.77	28.36
1936	11.93	26.47
1937	11.22	27.87
1938	8.58	19.35
1939	9.04	20.75
1940	9.98	21.94
	1936-1939 10.19	1936-1939 23.59
Averages	1922-1939 15.57	1926-1939 26.06

The price index published by the Bureau of Labor Statistics for all commodities, cotton goods, brown sheetings and middling cotton for 1922-1940 was as follows:

Indexes of Wholesale Prices of All Commodities, Cotton, Brown Sheetings, and Middling Cotton, 1922-1940 ¹

[1926 = 100]
			Brown sheetings
					Middling
Year	All commodities	Cotton	Series 1:	Series 3:	cotton
		goods	4/4,	4/4,	at New
			48 x 48,	56 x 60,	York
			2.85	4.00
1922	96.7	104.3	105.1	111.3	121.0
1923	100.6	116.9	133.3	132.1	167.0
1924	98.1	114.7	131.7	121.3	163.9
1925	103.5	110.0	120.0	112.2	133.8
1926	100.0	100.0	100.0	100.0	100.0
1927	95.4	97.1	97.8	99.6	100.2
1928	96.7	100.4	110.2	98.7	114.1
1929	95.3	98.8	102.0	93.3	109.0
1930	86.4	84.7	85.3	78.5	77.1
1931	73.0	66.1	58.8	58.4	48.7
1932	64.8	54.0	50.4	44.6	36.6
1933	65.9	71.2	71.4	66.2	49.5
1934	74.9	86.5	88.9	84.8	70.4
1935	80.0	83.4	89.8	81.3	67.8
1936	80.8	80.3	79.1	78.9	69.1
1937	86.3	84.3	87.0	83.4	65.3
1938	78.6	65.4	62.0	57.8	49.3
1939	77.1	67.2	64.3	60.0	53.9
1940	78.6	71.4	69.7	65.3	59.3
Averages:
1936-1939	80.7	74.3	73.1	70.0	59.4
1922-1939	86.3	88.1	90.9	86.8	88.7
1926-1939	82.5	81.4	81.9	77.5	72.2

The petitioner's average base period net income is not an inadequate standard of normal earnings because the industry of which it was a member was not depressed by reason of temporary economic events unusual in the case of that industry within the meaning of section 722 (b) (2) of the Internal Revenue Code.

OPINION.

Petitioner bases its claim for relief on section 722 (b) (2), Internal Revenue Code. This section is set forth in the margin. ¹ To prevail under this section petitioner must show that its average base period net income is an inadequate standard of normal earnings because its business was depressed or because the taxpayer's industry was depressed by reason of temporary economic events unusual in the industry. It must, also, by competent evidence, establish a fair and just constructive average base period net income. Petitioner's contentions are that the temporary economic depression of the industry is evidenced by (1) the disparity between the price of cotton goods as compared with the price of all commodities during the base period years; (2) the oversupply of raw cotton during the base period years and its depressing effect upon the price of cotton goods during the base years; and (3) "the character of the circumstances under which the oversupply of raw cotton was created as it relates to section 722 (b) (2)." The Court is unable to distinguish between the last two contentions as the evidence relating to both contentions is the same. We have therefore considered them together.

Based on the Bureau of Labor Statistics, Wholesale Prices, the index of all commodities during the base period was 93.51 per cent of the 1922-1939 average while the price of cotton goods was 84.34 per cent of the 1922-1939 average, or a difference of 9.17 per cent. This small disparity is merely the ordinary fluctuation that can be found by examining the yearly index of prices of cotton as compared to other commodities.

While being fully aware of the disparity of price between all commodities opposed to the price of raw cotton, it is nevertheless incumbent upon us to consider particularly the specific industry of which petitioner is a member, that is, the sheetings industry, Southern division. Regs. 112, sec. 35.722-2 (b) (8). ² We compare the price of middling cotton to the price of narrow sheetings. The average price per pound of middling cotton went from 15.57 cents for the 1922-1939 period to 10.19 cents for the base period, a decrease of 5.38 cents or 34.55 per cent; at the same time the price per pound of narrow sheetings went from 26.06 cents for 1926-1939 to 23.59 cents in the base period, a decrease of 2.47 cents or 9.47 per cent. In other words, the price of middling cotton decreased 263 per cent more than the price of narrow sheetings. Thus, it can be seen that the price of finished sheetings is not proportionately based on the price of raw cotton and the crux of petitioner's major premise is not sustained. Further, the cost of raw cotton was 60 per cent of the price of narrow sheetings in the long period (1922-1939) whereas the cost of raw cotton represented only 43 per cent of the price of narrow sheetings in the base period. This would indicate the textile manufacturer can obtain a higher profit when raw cotton is selling at a lower price.

Petitioner further contends, as before stated, that the oversupply of raw cotton was unusual causing a decrease in the price of cotton goods and emphasizes the character of the circumstances under which the oversupply was created. Examination of Exhibit 8-H discloses a constant fluctuation in the production of commercial cotton during the 1922-1939 period. In 1922 production was 10,000,000 bales; by 1926, five years later, production was 18,000,000 bales; a decrease to 13,000,000 bales occurred in 1927; a rise to 16,800,000 bales in 1931; 1932 witnessed a drop to 13,000,000 bales; and 1934 a continuation of the downward trend to 9,500,000 bales. Production again rose to 18,400,000 bales in 1937 and dropped sharply to 11,600,000 bales in 1938. In Industrial Yarn Corporation, 16 T. C. 681, 689, we said:

* * * It is not unusual for a cotton crop to vary in size from year to year. The fortuitous circumstances that 1937 may have produced a cotton crop of extraordinary size does not, of itself, create an abnormality in petitioner's business of the character sufficient to bring petitioner within the scope of the cited section. * * *

It must be remembered that petitioner is not a cotton grower. It is a manufacturer. The effect of the large cotton crop was to reduce the cost of cotton to petitioner but it did not reduce the necessary profit it had to maintain to keep in business. Its success depended on keeping its costs of production down. The price of the raw cotton was reduced by the large crop and the price of cotton cloth was in turn reduced but its mill margin during the base period was substantially maintained. The statements of petitioner's condition evidence the fact that it did not overstock during the base period. Petitioner's average base period inventory was $ 72,576 as against the 10-year average from July 31, 1931, to July 31, 1940, inclusive, of $ 72,814. In petitioner's fiscal year ended July 31, 1938, when petitioner claims an abnormal crop, its inventory did not exceed its inventory for the two highest years, 1934 and 1935.

For the base period years, ending July 31, 1937 to 1940, the average cost of goods sold was 79.50 per cent of sales as compared to the 1921-1936 average of 89.42 per cent of sales. The 1937-1940 average of 79.50 per cent is almost as low as the lowest year in the prior period, namely, 1934 when the cost of goods sold was 79.14 per cent of sales. This shows petitioner had a higher gross profit and a lower cost of goods sold in the base period years which is contrary to petitioner's contention that its industry was depressed. The carry-over chart shows that of the abnormal crop more than half was being held by the United States Government and others. The petitioner was still buying in proportion to production capacity and was not bound by reason of the large crop of 1937 to buy more than it wanted.

While considering cotton production, we should not fail to observe the increase in mill consumption which shows petitioner's industry was not depressed. At a time when the base period United States production increased 100,000 bales over the 1922-1935 average, the base period United States mill consumption increased 950,000 bales over the 1922-1935 average. Since petitioner is in the mill end of the industry, the above comparison shows a more favorable position for its phase of activity therein. Comparing the base period years to the long period of 1922-1939 we find mill consumption in 1936 was 125 per cent of the long period, 1937 was 91 per cent, 1938 was 108 per cent, 1939 was 122 per cent and the average base period consumption was 112 per cent of the long period. This further shows petitioner's advantageous position in the base period.

Lastly, petitioner must show that because of the temporary depression its actual average base period net income is an inadequate standard of normal earnings. Petitioner has not done this. It has, in lieu thereof, treated the base period as being comprised of separate yearly units, proof of a depression in any one of which entitles it to relief under section 722 (b) (2). We must, as stated in Wadley Co., 17 T. C. 269, treat all of the base period years as a unit, for in that case we said "the base period is not to be divided into separate segments; it is a unitary period * * *." Examination of the income statements for petitioner shows average sales for the base period of $ 626,199 as against sales from January 1, 1921, to July 31, 1940, of $ 454,636, an increase of $ 171,563 or 37 per cent over the long period. At the same time average net income during the base period was $ 72,626 as against an average of $ 18,998 for the 18 7/12-year period from January 1, 1922 to July 31, 1940, an increase of $ 53,628 or 282 per cent over the long period average net income even after substantial increases in officers' salaries were allowed in a so called depressed period, the 1939 salaries paid to petitioner's officers being twice the 1926-1936 average.

The increase in base period net income above noted is also true as to nine other Southern sheetings mills, whose net sales for the base period were 99.3 per cent of the 1922-1939 average and whose base period net profit was 151.56 per cent of the 1922-1939 average. The same profit picture can be viewed by comparing the manufacturing corporations other than cotton textile with the cotton textile corporations. By so doing we see that the base period average net profit of cotton textile corporations of $ 25,500,000 was 174 per cent greater than the average net profit for the period from 1922-1939 of $ 9,287,000 of the cotton textile corporations. At the same time the base period net profit for other manufacturing corporations was only 25.05 per cent greater than the net profit for the long period of 1922-1939.

We have made a detailed examination of the many exhibits presented by petitioner but fail to see that the effect of the large cotton crop in the year 1937 upon petitioner's industry resulted in the temporary economic depression of petitioner's business during the base period. U. S. Treasury Department Bulletin on Section 722 of the Internal Revenue Code (Nov. 1944), Part III, par. (B), p. 17. ³

It is, therefore, our conclusion that petitioner has not established its right to relief under section 722 (b) (2), for it would be completely disregarding the facts to find petitioner's industry, the Southern sheetings mills, was depressed in the base period as compared to the average long term period 1922-1939. Foskett & Bishop Co., 16 T. C. 456; Winter Paper Stock Co., 14 T.C. 1312">14 T. C. 1312; Monarch Cap Screw & Manufacturing Co., 5 T. C. 1220; Fish Net & Twine Co., 8 T.C. 96">8 T. C. 96.

In view of the fact that petitioner has not proved its industry was depressed it is unnecessary to comment on petitioner's constructive average base period net income reconstruction.

Reviewed by the Special Division.

Decisions will be entered for the respondent.

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Footnotes

• 1. As of Nov. 30, 1933.

  Source: U. S. Dept. of Commerce, Bureau of Census, "Cotton Production and Distribution," Bulletin No. 182, 1944-1945, p. 52, and New York Cotton Exchange, "Cotton Yearbook," 1945-1946, pp. 48-49.↩

• 1. Data not available.

  Source: Bureau of Internal Revenue, "Statistics of Income" and "Source Book of Statistics of Income."↩

• 1. Includes processing tax of 4.0 cents per pound from Aug. 1933 to Dec. 1935.

  Source: U. S. Dept. of Agriculture, "Agricultural Statistics," 1935, p. 433, and "Prices of Cotton Cloth and Raw Cotton, and Mill Margins for Certain Constructions of Unfinished Cloth," September 1937, p. 23, and January 1947, Table 19.↩

• 1. Processing tax of 4.0 cents per pound on cotton is not reflected in above indexes of cotton prices from August 1933 to December 1935. With the processing tax included, the cotton price indexes are as follows:

  Year average	1926 = 100
  1933	59.4
  1934	93.1
  1935	90.9
  1922-1939	91.8
  1926-1939	76.2

  Source: Bureau of Labor Statistics, "Wholesale Prices," annual bulletins.↩

• 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 --

  * * * *

  (2) the business of the taxpayer was depressed in the base period because of temporary economic circumstances unusual in the case of such taxpayer or because of the fact that an industry of which such taxpayer was a member was depressed by reason of temporary economic events unusual in the case of such industry,

  * * * *↩

• 2. SEC. 35.722-2. CONSTRUCTIVE AVERAGE BASE PERIOD NET INCOME. --

  * * * *

  (b) Rules for determination.

  * * * *

  (8) For the purposes of section 722 and of section 35.722-3 (b) and (c), no exclusive definition of the concept "industry" can be constructed. In general an industry may be said to include a group of enterprises engaged in producing or marketing the same or similar products or services under analogous conditions which are essentially different from those encountered by other enterprises. The mere similarity of product and marketing methods, however, is not enough of itself to comprehend taxpayers satisfying such conditions within the same industry. Factors such as geographical location, character and location of markets, availability and character of raw material supply, and other conditions under which operations are carried on must be considered. Regard may be had to trade custom and practice in determining whether a group of enterprises constitutes an industry.

  * * * *↩

• 3. (B) Scope of Section 722 (b) (2).

  Since the economic circumstances giving rise to relief must be temporary and unusual, it is important that the taxpayer furnish evidence concerning the exact nature of the circumstances alleged. It is not sufficient that the taxpayer merely show a depression during the base period by comparing its earnings during this period with earnings in a prior period, accompanied by general allegations concerning hard times or unfortunate conditions. It is expected that for all industries and all taxpayers there will be fluctuations from year to year in their earnings experience. Such fluctuations are perfectly normal, and in fact occurred in the experience of corporations generally during the base period. The year 1938 was in general a year of poor profits, and it would be improper under section 722 (b) (2) to grant relief due to that fact. In some particular industries one or more of the other years of the base period were depressed because of usual and recurring circumstances. Thus, it is necessary that the circumstances alleged under section 722 (b) (2)↩ be identified specifically as to character, causes, extent and severity, and that positive evidence be presented to show that they were both peculiar and temporary.