Decision will be entered for the respondent.
1. Petitioner, a wholesale liquor dealer, allowed discounts from the list price to its customers in order to meet competition during the base period years 1936-1939. The discounts were known at the time of the sale and were not quantity or cash discounts. Petitioner contends these discounts are abnormal deductions under section 711 (b) (1) (J), I. R. C. 1939, and should be restored to the excess profits net income for the base period years. Held, the discounts are adjustments of the sales price and are made to arrive at gross income; they are not deductions from gross income and not deductions under section 711 (b) (1) (J).
2. Petitioner also contends that its base period earnings were depressed by the amount of the discounts which were given to customers because of a price war which prevailed in the wholesale liquor industry, to which the petitioner belonged, and that it is therefore entitled to relief under section 722 (b) (2), I. R. C. 1939. Held, that the petitioner has not established its right to relief under section 722 (b) (2).
*1026 In a notice of deficiency dated December 5, 1950, the Commissioner determined deficiencies in petitioner's excess profits tax of $ 10,911.86 for the year 1943 and $ 5,004.35 for the year 1944. The deficiency notice, among other things, states:
The deficiency in excess profits tax shown herein results from the disallowance of deferments under Section 710 (a) (5) of the Internal Revenue Code, because of the disallowance of your applications for relief under Section 722 of the Internal Revenue Code.
To this determination of the Commissioner, the petitioner assigned errors, as follows:
A. The Commissioner erroneously determined that discounts and free goods allowed and granted to petitioner's customers in its base period years in excess of 125% of similar deductions for each of the prior four years were not allowable abnormalities within the meaning of Section 711 (b) (1) (J) of the Internal Revenue Code in computing petitioner's excess profits tax base period credit based on income under Section 713 of the Internal Revenue Code.
B. The Commissioner erroneously determined that petitioner did not establish that its excess profits tax computed under sub-chapter E of Chapter 2 of the *236 Internal Revenue Code without the benefit of Section 722 (b) (2) of the Code results in an excessive and discriminatory tax within the provisions of Section 722 (a) and (b) of the Code and that petitioner did not establish what would be a fair and just amount representing normal earnings to be used as a constructive average base period net income for the purposes of an excess profits *1027 tax based upon a comparison of normal earnings and earnings during the excess profits tax calendar years 1943 and 1944.
All references to section numbers herein are of the Internal Revenue Code of 1939, as amended.
FINDINGS OF FACT.
A stipulation of facts has been filed and is incorporated herein by reference.
The petitioner is a corporation organized under the laws of the State of Illinois on December 1, 1933, with its principal office in the city of Rockford, Illinois. During the years material to this proceeding it conducted a wholesale liquor business in said city.
Petitioner has kept its books and filed its income and excess profits tax returns on a calendar year accrual basis since January 1, 1936. It filed timely corporation income, declared value excess-profits, and excess profits tax returns for *237 the taxable years ended December 31, 1943 and 1944, with the then collector of internal revenue for the first district of Illinois.
Petitioner's base period consists of the 4 calendar years 1936, 1937, 1938, and 1939, and since the petitioner was in existence before January 1, 1940, it is entitled to compute its excess profits credit in accordance with the provisions of either section 713 or section 714 and to use whichever amount results in the lesser excess profits tax, as provided by section 712 (a). The method (without the application of section 722) which results in the lesser tax for each of the taxable years 1943 and 1944 is the invested capital method prescribed in section 714.
Petitioner's excess profits net income for each of the taxable years 1943 and 1944, computed under section 711, is as follows:
| Invested capital method | |
| Year | (sec. 711 (a) (2)) |
| 1943 | $ 62,952.18 |
| 1944 | 42,210.25 |
Petitioner's excess profits credit computed pursuant to the provisions of section 714 for each of the taxable years 1943 and 1944, is as follows:
| 1943 | $ 5,958.38 |
| 1944 | 6,637.37 |
The following schedules show petitioner's profit and loss statements per income tax returns 1 filed by petitioner (after revenue agents' *238 adjustments) *1028 for the fiscal years ended November 30, 1934 and 1935; for the period beginning December 1, 1935, and ending December 31, 1935; and for the calendar years 1936 through 1944:
| Fiscal year ended | Period | ||
| November 30 | Dec. 1 to | ||
| Dec. 31, | |||
| 1935 | |||
| 1934 | 1935 | ||
| Gross sales | 1*239 | $ 250,101.74 | $ 34,343.77 |
| Less: Returns and | |||
| allowances | 1 | 1,143.25 | 145.21 |
| Net sales | $ 150,042.81 | $ 248,958.49 | $ 34,198.56 |
| Cost of goods sold | 128,082.04 | 221,771.25 | 30,181.58 |
| Gross profit | $ 21,960.77 | $ 27,187.24 | $ 4,016.98 |
| Purchase discount | 1,608.71 | 704.97 | |
| Bad debt recovery | |||
| Rents | |||
| Total income | $ 23,569.48 | $ 27,892.21 | $ 4,016.98 |
| Total deductions | 23,207.17 | 27,549.96 | 3,840.33 |
| Net income or loss | $ 362.31 | $ 342.25 | $ 176.65 |
| Calendar year | ||||
| 1936 | 1937 | 1938 | 1939 | |
| Gross sales | $ 381,917.29 | $ 471,367.52 | $ 407,354.53 | $ 462,860.61 |
| Less: Returns and | ||||
| allowances | 2,654.90 | 9,348.41 | 17,486.66 | 23,061.46 |
| Net sales | $ 379,262.39 | $ 462,019.11 | $ 389,867.87 | $ 439,799.15 |
| Cost of goods sold | 338,731.67 | 400,803.70 | 341,085.46 | 387,374.12 |
| Gross profit | $ 40,530.72 | $ 61,215.41 | $ 48,782.41 | $ 52,425.03 |
| Purchase discount | 578.86 | |||
| Bad debt recovery | 925.88 | 1,342.96 | 1,379.70 | 1,025.90 |
| Rents | 265.00 | 120.00 | 120.00 | 120.00 |
| Total income | $ 41,721.60 | $ 62,678.37 | $ 50,282.11 | $ 54,149.79 |
| Total deductions | 41,986.23 | 60,795.22 | 51,068.35 | 54,350.69 |
| Net income or loss | ($ 264.63) | $ 1,883.15 | ($ 786.24) | ($ 200.90) |
| 1940 | 1941 | 1942 | |
| Gross sales | $ 556,832.92 | $ 674,574.59 | $ 766,348.76 |
| Less: Returns and allowances | 29,542.84 | 50,365.09 | 45,668.14 |
| Net sales | $ 527,290.08 | $ 624,209.50 | $ 720,680.62 |
| Cost of goods sold | 457,601.36 | 544,121.56 | 626,077.61 |
| Gross profit | $ 69,688.72 | $ 80,087.94 | $ 94,603.01 |
| Interest, Treasury notes | |||
| Trucking credits | |||
| Rents | 80.00 | 100.00 | |
| Gain (or loss) -- capital assets | 360.00 | 481.35 | |
| Purchase discounts | 348.21 | 181.22 | |
| Bad debt recoveries | 948.45 | 2,126.53 | 2,162.81 |
| Refund -- taxes | |||
| Total income | $ 71,425.38 | $ 82,495.69 | $ 97,247.17 |
| Total deductions | 70,965.55 | 77,921.36 | 93,002.65 |
| Net income | $ 459.83 | $ 4,574.33 | $ 4,244.52 |
| 1943 | 1944 | |
| Gross sales | $ 905,844.16 | $ 1,205,412.40 |
| Less: Returns and allowances | 762.64 | 1,566.94 |
| Net sales | $ 905,081.52 | $ 1,203,845.46 |
| Cost of goods sold | 745,226.21 | 1,044,687.42 |
| Gross profit | $ 159,855.31 | $ 159,158.04 |
| Interest, Treasury notes | 62.50 | |
| Trucking credits | 15,930.71 | |
| Rents | 300.00 | 300.00 |
| Gain (or loss) -- capital assets | ||
| Purchase discounts | ||
| Bad debt recoveries | 1,747.57 | |
| Refund -- taxes | 77.00 | 155.07 |
| Total income | $ 177,910.59 | $ 159,675.61 |
| Total deductions | 113,176.96 | 118,713.47 |
| Net income | $ 64,733.63 | $ 40,962.14 |
The petitioner wanted to maintain *240 liquor sales at the distiller's list price, hereinafter called list price. (The record is not clear but it indicates that the distillers or a fair trade law required the petitioner to sell liquor at the list price.) In order to meet competition and sell liquor the petitioner allowed to its customers discounts up to about 10 per cent of the list price. The percentage of discount varied from time to time and between customers but the percentage was known to the customer at the time of the sale. The discounts were not dependent in any way upon the quantity purchased or on the promptness of payment, i. e., they were not quantity or cash discounts.
For the most part the invoices would show the list price, the discount, and the net price. The transaction in the above instance would be recorded by debiting accounts receivable and crediting sales for the list price at the time the sale was made. When the customer paid the *1029 salesman, cash would be debited and accounts receivable credited for the list price and discount would be debited and cash credited for the discount. The salesman would only collect the net price from the customer.
Sometimes the invoice would only show the net price (list *241 price less discount) and sales would only be credited for that amount at the time of the transaction. In 1938 and 1939, the petitioner made monthly journal entries to remedy this. For sales which were recorded at the net price, sales would be credited and discounts debited for the amount of the discount.
The discounts on sales were accounted for in the income tax returns as a reduction of gross sales in arriving at net sales (see schedules, supra) under the heading "Returns and allowances." Also accounted for in the tax returns for some of the base period years under the heading "Returns and allowances" are amounts representing purchase discounts, cash over and under, delivery expense, and returned goods. The major portion of the amounts under "Returns and allowances" consists of sales discounts.
At least a few other wholesale liquor dealers in the Rockford, Illinois, area were giving discounts similar to those allowed by the petitioner.
OPINION.
The questions in this proceeding relate to certain discounts which the petitioner allowed to its customers. The petitioner seeks a reduction of excess profits tax for the years 1943 and 1944 on the ground that these discounts represented abnormal *242 deductions under section 711 (b) (1) (J) or, on the alternative ground, that it is entitled to relief under section 722 (b) (2), because a price war depressed its base period earnings by the amount of these abnormal discounts. Petitioner in its brief chiefly argues its assignment of error that it is entitled to section 711 (b) (1) (J) relief.
Section 711 (b) (1) (J) Issue.
The petitioner granted these discounts to its customers in order to meet competition. They were not quantity or cash discounts. The rate of discount varied from time to time and between customers but the rate was known at the time a sale was made. The petitioner wanted to maintain its sales at list prices insofar as possible. Therefore, it recorded its sales at the list price rather than the net price. The invoice would usually show the list price, the discount, and the net price. For a period, some of the invoices only showed the net prices. The discount, i. e., the difference between the list price and the net price, was restored to sales by journal entries at the end of each month. *1030 The record shows that the customers would only pay the petitioner the net price, rather than pay the list price and receive the *243 discount from the petitioner as a cash rebate.
Section 711 (b) (1) (J) provides for a disallowance of abnormal deductions in computing the excess profits net income for the base period years. Deductions under this section mean statutory deductions or deductions allowable under section 23. Colorado Milling & Elevator Co., 17 T.C. 1280">17 T. C. 1280, 1285 (1952), appeal dismissed (C. A. 10, 1953) 205 F. 2d 551; Crow-Burlingame Co., 15 T. C. 738, 752 (1950), appeal dismissed on stipulation of parties (C. A. 8, 1951) 192 F.2d 574">192 F. 2d 574; Universal Optical Co., 11 T.C. 608">11 T. C. 608, 621 (1948). The petitioner argues that these discounts are deductions from gross income under section 23 (a), relying on Polley v. Westover, (S. D. Calif. 1948) 77 F. Supp. 973">77 F. Supp. 973. The respondent, on the other hand, contends that these discounts are not deductions from gross income but are adjustments of the sales price that are made in order to arrive at gross income.
The Polley case, supra, did not involve a section 711 (b) (1) (J) issue but involved the deductibility of quantity discounts that were given by the taxpayer, a wholesale liquor dealer, to all customers on the same basis. The list price was collected from the customer and *244 the discount was refunded periodically in cash. The State of California, the taxpayer's residence, made it a misdemeanor to "give secret rebates or make any secret concessions" to a retail dealer. It appears that in the Polley case, the entire list price which was collected was reported as gross income and the discounts which were refunded to customers in cash were taken as deductions from gross income under section 23 (a). The Commissioner disallowed a deduction under section 23 (a) for the discounts. The court held that the giving of the discounts did not violate the law of California or frustrate any sharply defined national or State policy and that they were ordinary and necessary business expenses under section 23 (a).
Aside from the fact that the quantity discounts in the Polley case, supra, are essentially different from those involved herein, we think the petitioner's reliance is misplaced. The Polley case did not discuss or decide the issue involved herein, i. e., whether the discounts were deductions to arrive at gross income or were deductions from gross income; the results would have been the same if the discounts were allowed in either instance. Here, unlike the Polley*245 case, the parties agree that the discounts must be deducted to arrive at net income, but the respondent insists that the discounts are adjustments to arrive at gross income rather than deductions from gross income, relying upon Pittsburgh Milk Co., 26 T. C. 707 (1956), on appeal C. A. 3.
In the Pittsburgh Milk Co. case, supra, the Pennsylvania law required the petitioner to sell milk at a list price. The taxpayer entered *1031 into agreements with its customers to give them certain discounts. The rate of discount was known at the time of sale and the discounts were not quantity or cash discounts. It collected the full price and paid back to the customers the amount of the discounts. The question involved was "what effect, if any, should be given for income tax purposes to the allowances (sometimes called discounts or rebates) which the petitioner corporation made to certain purchasers of its milk in willful violation of the Milk Control Law of Pennsylvania." We held that the discounts were adjustments of the gross sales price made to arrive at the net sales price, i. e., that the amounts of the agreed allowances should be applied to reduce the corporation's gross sales.
The taxpayer, in *246 the instant case, seeks a disallowance of the discounts which it contends are abnormal deductions in amounts under section 711 (b) (1) (J), in recomputing its excess profits net income for the base period years. The discounts involved herein, however, are essentially of the same nature as those involved in Pittsburgh Milk Co., supra. Accordingly, we hold that the discounts involved herein are deductions to arrive at gross income. They are not deductions from gross income or deductions within the meaning of section 711 (b) (1) (J). The respondent's determination regarding the 711 (b) (1) (J) issue is, therefore, upheld.
Section 722 (b) (2) Issue.
The alternative issue is whether the petitioner is entitled to relief under section 722 (b) (2). It contends that it is entitled to relief on the ground that a price war prevailed during the base period in the wholesale liquor industry of which it was a member. The petitioner did not argue this question in its brief, stating that it would submit the issue on the record in view of the decisions of the Tax Court in other instances of claimed relief based on price war.
The record contains the facts previously discussed regarding the discounts *247 and the testimony of the petitioner's accountant that he knew of a few other wholesale liquor dealers who also gave similar discounts. Petitioner also submitted a computation of its proposed constructive average base period net income. This constructive average base period net income was arrived at by restoring to book net income or loss the excess of the discounts and free goods allowed in the base period years over the ratio of those allowed in the period prior thereto computed from the statement of income attached to the stipulation of facts.
On the basis of the record, we do not think the petitioner has established its right to relief under section 722 (b) (2). It has not shown that its business "was depressed in the base period because of temporary economic circumstances unusual in" its case or "that an industry *1032 of which" it "was a member was depressed by reason of temporary economic events unusual in the case of such industry."
The fact that petitioner and a few other liquor dealers gave discounts does not establish a ruinous price war. It indicates nothing more than competition. Cf. Harlan Bourbon & Wine Co., 14 T. C. 97 (1950); Empire Liquor Corporation, 25 T. C. 1183 (1956); *248 Seggerman Nixon Corporation, 26 T. C. 442 (1956). We, therefore, uphold the respondent in regard to this issue.
Reviewed by the Special Division as to the section 722 issue.
Decision will be entered for the respondent.
Footnotes
1. The details of cost of goods sold and deductions, although shown on the returns, are included in our schedules condensed.↩
1. Not shown.