1960 U.S. Tax Ct. LEXIS 222">*222 Decisions will be entered for the respondent.
Any change by petitioner in its products or services during the base period, held, on the facts, not substantial within the meaning of section 443, I.R.C. 1939, so as to qualify for excess profits tax relief.
33 T.C. 728">*729 In these consolidated proceedings respondent determined deficiencies in petitioner's income (excess profits) tax of $ 12,369.21 and $ 42,678.50 for 1950 and 1953, respectively. The principal issue is whether petitioner is entitled to excess profits1960 U.S. Tax Ct. LEXIS 222">*223 tax relief pursuant to section 443, I.R.C. 1939; more specifically, whether there was a substantial change in the products or services furnished by petitioner during its base period and if so, whether more than 33 per cent of its net income for 1950 and 1951 is attributable to one or more of such new products or services. Respondent concedes that petitioner met the requirements of section 443(a)(3), I.R.C. 1939.
Another matter referred to in the pleadings is whether petitioner is entitled to additional excess profits credit carryovers and carrybacks for the years in issue. This is the only question involving 1953. The parties apparently agree that an adjustment will be effected in a Rule 50 computation depending upon whether petitioner succeeds on the principal issue.
FINDINGS OF FACT.
The stipulated facts are found.
Petitioner, Rogers Corporation, is a corporation organized under the laws of the Commonwealth of Massachusetts on July 29, 1927, with its principal place of business in Killingly, Connecticut. It has been engaged in the manufacture and sale of paper and allied products since 1927. In the beginning it primarily produced heavy paper products, such as electrical insulation1960 U.S. Tax Ct. LEXIS 222">*224 for motors and transformers, stock for notebook covers, and pressing boards used by the textile industry.
Petitioner filed its income and excess profits tax returns for the years 1950, 1951, and 1953 with the collector (director) of internal revenue for the district of Connecticut. It kept its books and filed its returns on an accrual method of accounting and on a calendar year basis.
During the period here involved petitioner operated plants in Killingly and Manchester, Connecticut.
On August 1, 1941, petitioner entered into a contract with Bakelite Corporation, hereafter called Bakelite. At no time was Bakelite affiliated with petitioner. The contract provided that petitioner would convert and process for Bakelite its own raw materials, together with resins furnished by Bakelite, into resinous-pulp board products. These were defined as follows:
DEFINITION OF PRODUCTS. The expression "products" as used in this agreement shall be understood to mean products resulting from the combination 33 T.C. 728">*730 of phenolic resins with fibres in a beater, converted into board on a wet machine and thereafter dried and cut into sheets, strips and/or blanks, all as more particularly described1960 U.S. Tax Ct. LEXIS 222">*225 in Schedule A hereto annexed and made a part hereof.
The parties agreed that petitioner would supply, at its own expense, the labor and facilities, as well as the raw materials other than resins, necessary to produce the resinous-pulp board products required to be delivered to Bakelite under the contract, in the quantities and during the periods therein described. The title to the resins was to be retained by Bakelite.
From August 1, 1941, through July 31, 1949, petitioner's Manchester plant was used primarily for this contract and the operations therein were part of a step that resulted in end products commonly called bakelite. The final stage was the molding of materials into castings. This was preceded by the manufacture of materials which were to be used in the molding. At all material times petitioner's manufacturing operations in this field consisted of manufacturing materials to be used by others in molding.
Various processes were used to manufacture materials to be used in molding. At least three were in common use during the period here involved. They were: (1) Waste rags were macerated and chemicals were produced. These were sold separately to molders. The molders1960 U.S. Tax Ct. LEXIS 222">*226 themselves then mixed the two before loading them into their molds. (2) Paper was impregnated with chemicals. As distinguished from the first process, this process provided a product which, in sheets or fabricated form, could be sold to the molder as ready-mixed material. (3) Papermaking fibers were mixed with chemicals in a beater and made into a board. This process had the same advantage as the second process in that the product could be sold to the molder ready-mixed for molding. In addition, it had an advantage over both of the other processes in that it resulted in a more complete association of chemicals and fibers, thereby improving the characteristics of the finished moldings.
Under the contract with Bakelite, petitioner used only the above third process in its Manchester plant operations. Bakelite supplied petitioner with the necessary resins. Bakelite stored and processed its chemicals at petitioner's Manchester plant and to this end maintained an employee there, rented floor space and purchased steam, electrical power and, occasionally, labor from petitioner.
Bakelite, with limited success, attempted to keep secret from petitioner the chemicals used in its resins.
1960 U.S. Tax Ct. LEXIS 222">*227 Petitioner delivered the products produced under the contract with Bakelite to Bakelite or to customers of Bakelite. With respect to these products, petitioner did not seek other customers and had no sales force.
33 T.C. 728">*731 From August 1, 1941, through July 31, 1949, petitioner, in its Killingly plant, engaged in the production and manufacture of special paperboards primarily for electrical insulation, shoe products, and other industrial applications, and in converting operations such as punching, drawing, and shipping its own and purchased materials. This plant was not used in operations under the contract with Bakelite.
On July 29, 1948, Bakelite sent petitioner a notice to terminate the contract as of July 31, 1949. Upon termination on July 31, 1949, petitioner ceased operations under the contract, purchased Bakelite's chemicals stored in the Manchester plant, and received from Bakelite a list of customers who purchased the products produced at the Manchester plant.
From August 1, 1949 through 1951, petitioner sold resin impregnated products produced at the Manchester plant to Bakelite, some of Bakelite's former customers, and new customers. It developed a sales force to effect1960 U.S. Tax Ct. LEXIS 222">*228 such sales. These products were similar to those produced under the contract with Bakelite, and petitioner continued to use the process whereby papermaking fibers were mixed with chemicals in a beater and made into a board.
In August 1949, petitioner commenced a research and development program in the field of resin impregnated products. In the early part of 1949, it had already started some informal research in extruded resin impregnated products. As a result of this program, it developed a resin impregnated material designated RX and produced it in 1949, 1950, and 1951 by means of extrusion of mixed products from a machine comparable to a meat grinder. The RX material could be used instead of the diced resin impregnated board. It eliminated waste, reduced labor costs, and required less electrical power and equipment.
In 1950, petitioner developed the "Duroid 600" resin impregnated board. It produced this by precipitating resin on the papermaking fibers from a solution rather than adding the resin mechanically
After the contract with Bakelite was terminated petitioner began to manufacture as well as purchase resins. From August 1, 1949 through 1951, petitioner purchased resins1960 U.S. Tax Ct. LEXIS 222">*229 in dollar amounts as follows:
| Aug. 1, | |||
| Name of vendor | through | 1950 | 1951 |
| Dec. 31, 1949 | |||
| Bakelite | $ 183,089 | $ 366,125 | $ 349,456 |
| Barrett | 120,200 | ||
| Snyder | 49,089 | ||
| Irvington | 2,000 |
33 T.C. 728">*732 From August 1, 1949 through 1951, petitioner manufactured resins for its own use in dollar amounts of $ 15,874, $ 89,160, and $ 128,514, respectively. The resins purchased and produced were similar to those previously used by petitioner under its contract with Bakelite.
On October 16, 1950, petitioner entered into an agreement with the Bakelite Division of Union Carbide and Carbon Corporation, formerly referred to as Bakelite. This agreement provided, in part:
1. [Bakelite] hereby agrees to sell and ship to [petitioner], and [petitioner] hereby agrees to purchase from [Bakelite] and pay for, upon the terms and conditions and in the quantity and at the price hereinafter stated, "Bakelite" brand products, said materials bearing [Bakelite's] grade designations:
Phenolic resins, varnishes and solutions and such other similar laminating products as [Bakelite] may manufacture and [petitioner] may desire to purchase and BM-17069 and BM-9667.
This Agreement shall 1960 U.S. Tax Ct. LEXIS 222">*230 continue from October 1, 1950 to September 30, 1951, and thereafter unless and until terminated by either party upon not less than six (6) months' prior written notice to the other party.2. The materials shall be in accordance with [Bakelite's] standard specifications for "Bakelite" brand products * * *
QUANTITY3. A minimum of 75% of [petitioner's] requirements of phenolic laminating varnishes, resins and resin solutions, BM-17069 and BM-9667. Seventy-five per cent of [petitioner's] total production requirements is currently estimated at 135,000 to 150,000 pounds per month.
[Bakelite], except at its option, shall be under no obligation to supply hereunder more than 150,000 pounds of phenolic laminating varnishes, resins and resin solutions, BM-17069 and BM-9667 during each monthly period.
* * * *
If for any reason [Bakelite] is unable to supply [petitioner] with the quantity of materials which [petitioner] agrees to purchase hereunder, then, upon giving written notice to [Bakelite] of its intention so to do, [petitioner] may purchase elsewhere such quantity of materials as [Bakelite] is unable to supply.
In 1950 and 1951, petitioner's net income was $ 308,176.88 and $ 333,980.41, 1960 U.S. Tax Ct. LEXIS 222">*231 respectively, and its net income attributable to the Manchester plant was $ 107,816.84 and $ 148,123.36, respectively. During the same period, the products produced at the Manchester plant were resin impregnated products or materials made out of resins mixed with fibers.
During the years 1950 and 1951, Industry Classification Number 26 "Paper and allied products" was the industry classification under section 447, I.R.C. 1939, to which was attributable the largest amount of petitioner's gross receipts.
During petitioner's base period there was no substantial change in the products or services furnished by it at the Manchester plant. Neither 40 per cent of petitioner's gross income nor 33 per cent of its net income for either of the years 1950 or 1951 was attributable to new products or services furnished by it after July 31, 1949.
33 T.C. 728">*733 OPINION.
When the Congress substituted the provisions 11960 U.S. Tax Ct. LEXIS 222">*233 of section 443 (Korean war), Excess Profits Tax Act of 1950, for those previously included in section 722(b)(4), 2 it seems clear it was not bent upon enlarging the relief available. 31960 U.S. Tax Ct. LEXIS 222">*234 Since the subject matter covered in both sections was in general some change in the base period operation1960 U.S. Tax Ct. LEXIS 222">*232 of the business, we can safely assume at the outset that only changes, that is, the advent of something new, were intended 4 to be covered by section 443.
Granting for present purposes that petitioner's operation under its contract with Bakelite prior to July 31, 1949, was different from that subsequently engaged in, that alone is far from sufficient. Not only must the change have been "substantial," but it must have been so in the sense that, following the introduction of the "new" products 33 T.C. 728">*734 or services, the gross or net income from such products must aggregate more than 40 or 33 per cent, respectively. 5
1960 U.S. Tax Ct. LEXIS 222">*235 Here, if any, only a limited number of aspects can be thought of as "new" or "changed" from petitioner's previous operations. It manufactured a part of the resins used instead of having them all furnished by Bakelite, it sold direct to some customers instead of through Bakelite, and it developed "RX" and "Duroid 600." But for all that appears, the bulk of the services or products contributed by its Manchester plant was identical or similar to what had gone on before. There has been no showing that any changes in products were "substantial" as that word is used in the statute. There are not, in fact, any figures whatever from which such a comparison could be drawn.
We are accordingly unable to find that petitioner meets the statutory qualification for relief under section 443.
Decisions will be entered for the respondent.
Footnotes
1. SEC. 443. AVERAGE BASE PERIOD NET INCOME -- CHANGE IN PRODUCTS OR SERVICES.
(a) In General. -- If a taxpayer which commenced business on or before the first day of its base period establishes with respect to any taxable year that --
(1) During so much of its three immediately preceding taxable years as falls within the 36-month period ending on the last day of its base period, there was a substantial change in the products or services furnished by the taxpayer,
(2) More than 40 per centum of its gross income or 33 per centum of its net income for such taxable year is attributable to one or more of the new products or services, and
(3) Its average monthly excess profits net income (determined under subsection (e)) for such taxable year exceeds 125 per centum of its average monthly excess profits net income (determined under subsection (e)) for the taxable years ending within its base period and prior to the taxable year in which the first change to which gross income is attributed for the purpose of this subsection occurred,↩
then, in computing its excess profits credit for taxable years under this subchapter which end on or after the last day of the earliest taxable year with respect to which the requirements of paragraphs (1), (2), and (3) are satisfied, its average base period net income determined under this section shall be the amount computed under subsection (b).2. 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. * * * 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, * * *↩
3. "Your committee is aware of the fact that the relief provided by section 722(b)(4) of the prior law was available in several areas beyond that involving solely a change in products or service to which the present bill is limited. * * *" (H. Rept. No. 3142, 81st Cong., 2d Sess. (1950), p. 19.)↩
4. "Corporations which commenced business before the base period and made substantial changes in their products or services during the last 36 months of the base period may elect a substitute base period net income. This provision is intended to replace the 'new products' adjustment authorized under section 722(b)(4) of the World War II law. * * *" (S. Rept. No. 2679, 81st Cong., 2d Sess. (1950), p. 21.)↩
5. "To qualify for relief under the 'new product' provision the change in products or services must have been 'substantial' in the sense that by the end of the third year (or earlier) following the year in which the products or services were introduced, the gross income from such products must aggregate to more than 40 percent of the taxpayer's gross income or 33 percent of the taxpayer's net income in that year. * * *" (Excess Profits Tax Act of 1950, As Agreed to by the Conferees (Dec. 1950) p. 14.)↩