*55 Decision will be entered for the respondent.
Prior to 1937 petitioner operated a used bag business. In or about May 1937, petitioner expanded the business to include the manufacture and sale of new bags. Since petitioner operated on a fiscal year basis ending September 30, the expansion of its business occurred during its first base period year. Because of difficulties encountered primarily in developing its new bag business, petitioner seeks relief under section 722 (b) (4), Internal Revenue Code of 1939. Held, petitioner changed the character of its business, but failed to establish a fair and just amount representing normal earnings to be used as its constructive average base period net income.
*230 Respondent disallowed petitioner's claims for relief under section 722, Internal Revenue Code of 1939, for the fiscal years ending September 30, 1943, 1944, 1945, and 1946. Petitioner seeks relief under section 722 (b) (4) upon the ground that it changed the character of its business during the base period and its average base period net income does not reflect the normal operation of its business for the entire base period.
Sectional references and the word "Code," as used herein, refer to the Internal Revenue Code of 1939.
FINDINGS OF FACT.
The petitioner is a Missouri corporation organized October 1, 1934, with its principal office and place of business in Kansas City, Missouri. It kept its books and filed its tax returns on the accrual basis for fiscal years ending September 30. Its returns for the fiscal years involved herein were filed with the collector of Internal Revenue for the sixth district of Missouri.
*231 In 1928, Milton Silverman entered the used bag business, doing business as the Central Bag Company, sometimes hereinafter referred to as the Company. At that time he had one employee and conducted his business from a very small building. *57 The business grew and in 1934 Silverman incorporated it as the petitioner herein. Silverman has been the president and majority stockholder of the petitioner since its organization. His wife and brother also owned stock in the petitioner and were secretary and vice president thereof, respectively. By 1937, the used bag business started by Silverman employed about 75 people and occupied a 4-story building containing approximately 60,000 square feet of floor space.
The used bag business conducted by the Company involved buying, cleaning, repairing, and selling all types and sizes of used paper, cotton, and burlap bags. Petitioner bought large and small quantities of used bags from whomever it could, including peddlers. Most purchases were made subject to petitioner's grading and sorting of the bags. Each lot purchased was cleaned, graded, sorted, and piled according to size and quality. Whenever 500 bags accumulated in a pile, the bags were baled, ticketed, and stored for sale. Used bags with holes therein were patched and sewn, after which they were stacked in piles of 500.
The patching of used bags was done on sewing machines designed especially by the manufacturer for patching*58 used bags. These sewing machines stitched in circles, back and forth, crisscross, or any direction the operator wanted to stitch.
The volume of used bags purchased and sold by the Company increased from 1.7 million in 1928 to 16.9 million in 1936. By 1937, Silverman was convinced that the sale of used bags had reached a saturation point due to changes in the industry. One of these changes was the introduction of the dress print bag. These bags, made of colored print cloth, were designed to provide the consumer with a cloth print that could be converted into dresses, curtains, tablecloths, etc. Each conversion of an emptied dress print bag by the consumer permanently reduced the available supply of used bags and increased the need for new bags. Recognizing these facts, petitioner decided to go into the new bag business, producing dress print and white bags. The first sales of new bags by petitioner was in May 1937.
In developing its new bag business petitioner encountered production and selling difficulties attributable in part to the lack of knowledge of its management and in part to the lack of experience of its labor. As management became familiar with the techniques of *59 manufacturing and labor became skilled in operating the equipment, the initial difficulties were overcome. Among the difficulties encountered were the following: Financial; inability to secure true sizing of bags from the cutting machines; lack of uniformity in meeting customers' specifications; *232 making plates to imprint customer's brand on his new bags; finding correct types of ink for printing; locating sources of supply for the various types, weights, and colors of materials specified by the customer; convincing the trade that it was a new bag house as well as a used bag house; and selling its new bags in competition with larger and better established manufacturers, such as Bemis Bag Company, Chase Bag Company, Fulton Bag Company, and Mente Bag Company. The new bag business, like the secondhand bag business, was very competitive.
Upon entering the new bag business petitioner ordered as much equipment therefor as its credit would permit and employed some help experienced in manufacturing new bags. Although petitioner expanded its cloth inventory to the limit of its bank credit, it was impossible to carry in stock rolls of cloth in all types, weights, colors, and prints*60 available. Orders from its customers varied according to the nature of the product to be packed, i. e., whether wet or dry, the season of the year, the humidity, colors, sizes, printing, and other specifications. As its business grew petitioner increased its cloth inventory until such inventory exceeded the used bag inventory. During the base period years petitioner manufactured new cotton, Osnaburg (a stout coarse cotton fabric used in overalls, sacking, etc.), burlap, jute, and onion bags. Initially, petitioner manufactured bags only on order and not for stock, but as it became more familiar with the problems of the new bag industry, it was able to stock the more popular sizes in anticipation of orders from customers. Petitioner manufactured cloth bags in approximately 100 different sizes, ranging from very small to very large, but it manufactured no paper bags.
On April 17, 1937, petitioner's used bag business had about 45 pieces of productive equipment in operation. In developing its new bag business petitioner acquired additional productive equipment. By August 15, 1939, petitioner had about 71 pieces of productive equipment, 22 of which were new in petitioner's operations. *61 Such productive equipment included 13 high-speed sewing machines, a bag turning machine, a vacuum bag cleaning system, a power baling machine, 2 cloth cutters, an automatic label paster, an automatic bag cutter and folder, and a 2-color printing press. On or about November 9, 1939, petitioner purchased a 4-color printing press, which was delivered after December 31, 1939.
At April 17, 1937, petitioner's productive equipment included 20 patching machines and 3 high-speed sewing machines. The average skilled operator produced 2,000 used bags daily on the patching machines and 4,000 new bags daily on the high-speed sewing machines. The maximum annual capacity of the 20 patching machines based on 300 working days per year totaled 12,000,000 used bags. On the same working day basis, the maximum annual capacity of the 3 high-speed *233 sewing machines was 3,600,000 new bags. By August 15, 1939, petitioner's maximum annual used bag capacity had increased to 12,600,000 units, by the addition of 1 patching machine, and its maximum annual new bag capacity had increased to 22,800,000 units, by the addition of 16 high-speed sewing machines.
Petitioner continued its used bag business*62 after it started manufacturing new bags. In or about 1936 or 1937, petitioner started buying processed used bags in carlots from other used bag houses. Such used bags were generally resold without appearing in petitioner's plant. When such carlot purchases were received at petitioner's plant, they were redistributed therefrom without further processing.
The petitioner had, at all times after Apil 17, 1937, a larger productive capacity for new and used bags than it actually sold, as shown by the following table:
| Maximum productive capacity | Fiscal year Sept. 30, | ||
| actual production | |||
| Date | Capacity | Year | Units |
| in units | |||
| Used Bags | |||
| Apr. 17, 1937 | 12,000,000 | 1937 | 10,828,000 |
| 1938 | 6,308,000 | ||
| Aug. 15, 1939 | 12,600,000 | 1939 | 7,131,000 |
| 1940 | 6,475,000 | ||
| New Bags | |||
| Apr. 17, 1937 | 3,600,000 | 1937 | 139,000 |
| 1938 | 456,000 | ||
| Aug. 15, 1939 | 22,800,000 | 1939 | 1,062,000 |
| 1940 | 2,138,000 |
Salaries and wages increased after petitioner entered the new bag business as shown by the following table comparing net sales, salaries and wages, and percentage of the latter to the former from calendar year 1928 through the fiscal year 1940:
| Year | Net sales | Salaries and | Per cent | |
| wages | to sales | |||
| Calendar: | ||||
| 1928 | $ 113,273.10 | $ 11,698.06 | 10.32 | |
| 1929 | 167,122.08 | 19,937.38 | 11.93 | |
| 1930 | 201,273.02 | 25,083.57 | 12.46 | |
| 1931 | 175,789.73 | 12,149.53 | 6.91 | |
| 1932 | 168,486.73 | 7,213.17 | 4.28 | |
| 1933 | 232,960.61 | 8,922.43 | 3.83 | |
| 9 months 1934 | 229,369.13 | 10,892.00 | 4.75 | |
| Fiscal, Sept. 30: | ||||
| 1935 | 335,599.28 | 14,761.88 | 4.40 | |
| 1936 | 466,101.65 | 16,246.73 | 3.49 | |
| 1937 | 539,833.28 | 47,576.46 | 8.81 | |
| 1938 | 386,500.18 | 38,666.07 | 10.00 | |
| 1939 | 466,538.07 | 42,995.82 | 9.22 | |
| 1940 | 618,433.30 | 60,482.17 | 9.78 |
*63 *234 In its used bag business, petitioner received orders from customers for the printing of trade-marks and other descriptive matter on the used bags. Petitioner had no bag printing press, and such printing was contracted for with a third party. After it entered the new bag business, petitioner received orders for labels, that is, paper bands pasted or sewn on the bags, as well as for printing directly on such new bags. Until it acquired its own bag printing press, in or about 1939, petitioner continued to contract for its bag printing.
During the base period years petitioner borrowed money from time to time to finance its operations. The end-of-the-month average of its outstanding bank loans for each of the base period years was as follows:
| Calendar | Average bank loans |
| year | end of the month |
| 1936 | $ 9,167 |
| 1937 | 21,438 |
| 1938 | 15,896 |
| 1939 | 12,583 |
The raw materials used in manufacturing burlap bags are imported into this country. The outbreak of war in Europe, in September 1939, increased the demand for bags of all kinds. This increased demand was reflected in the increases in prices for burlap cloth and used bags during the last 4 months of 1939. Burlap prices*64 per yard at New York in August 1939, were 4.3 cents for "8 oz., 40 in." and 5.5 cents for "10 1/2 oz., 40 in." The prices per yard jumped to 6.1 cents and 7.5 cents, respectively, in September 1939, and to a 1939 high of 7.8 cents and 11.1 cents, respectively, in November. Similarly, secondhand bags for coffee, Cuban sugar, fertilizer, potatoes, cottonseed meal, and feeds showed increases in prices of 50 to 100 per cent during September to December 1939, inclusive.
Petitioner's sales, in dollars, and in units, and the unit average price for the calendar years 1928 to 1939, inclusive, in used and new bags, were as follows:
| Used bags | New bags | |||||
| Calendar | Sales dollars | Sales units | Unit | Sales dollars | Sales units | Unit |
| year | average | average | ||||
| 1928 | $ 113,359.06 | 1,770,070 | $ .0640 | |||
| 1929 | 167,200.08 | 2,568,663 | .0650 | |||
| 1930 | 201,273.02 | 3,104,602 | .0648 | |||
| 1931 | 175,789.73 | 2,806,316 | .0626 | |||
| 1932 | 168,486.73 | 2,945,765 | .0571 | |||
| 1933 | 232,960.61 | 5,709,953 | .0408 | |||
| 1934 | 316,008.68 | 7,383,862 | .0428 | |||
| 1935 | 354,655.17 | 10,025,382 | .0354 | |||
| 1936 | 484,487.81 | 16,941,239 | .0286 | |||
| 1937 | 494,548.88 | 10,828,283 | .0457 | $ 22,636.49 | 139,099 | $ .1627 |
| 1938 | 366,843.33 | 6,308,588 | .0581 | 28,979.08 | 456,510 | .0635 |
| 1939 | 436,486.02 | 7,131,753 | .0612 | 75,685.57 | 1,062,460 | .0712 |
*65 *235 Petitioner's net sales, cost of goods sold, expenses, operating net income, other income and deductions, and net income for specified taxable years, according to its books and records, prior to adjustments by respondent, were as follows:
| Operating | Other | |||||
| Taxable | Net sales | Cost of sales | Expenses | net income | income or | Net income |
| year 1 | deductions | |||||
| 1928 | $ 113,273.10 | $ 82,536.53 | $ 22,817.27 | $ 7,919.30 | ($ 234.46) | $ 7,684.84 |
| 1929 | 167,122.08 | 120,948.31 | 39,876.74 | 6,297.03 | 6,297.03 | |
| 1930 | 201,273.02 | 145,874.31 | 52,045.76 | 3,352.95 | 5.53 | 3,358.48 |
| 1931 | 175,789.73 | 129,041.51 | 43,156.42 | 3,591.80 | 3,591.80 | |
| 1932 | 168,486.73 | 127,453.87 | 36,735.15 | 4,297.71 | 314.84 | 4,612.55 |
| 1933 | 232,960.61 | 189,581.60 | 38,748.88 | 4,630.13 | 287.17 | 4,917.30 |
| 1934 | 229,369.13 | 187,931.23 | 35,238.05 | 6,199.85 | 6,199.85 | |
| 1935 | 335,599.28 | 285,125.72 | 47,251.99 | 3,221.57 | 237.50 | 3,459.07 |
| 1936 | 466,101.65 | 409,409.86 | 52,440.19 | 4,251.60 | 220.00 | 4,471.60 |
| 1937 | 539,833.28 | 435,026.09 | 101,315.13 | 3,492.06 | 390.00 | 3,882.06 |
| 1938 | 386,500.18 | 290,853.02 | 90,568.95 | 5,078.21 | 515.29 | 5,593.50 |
| 1939 | 466,538.07 | 345,310.07 | 111,038.19 | 10,189.81 | 315.86 | 10,505.67 |
| 1940 | 618,433.30 | 458,496.96 | 136,395.93 | 23,540.41 | 295.00 | 23,835.41 |
After adjustments were made by respondent, primarily to the fiscal years 1937 to 1940, inclusive, petitioner's net sales, cost of sales, expenses, operating net income, and net income for such years were as follows:
| Fiscal year | Net sales | Cost of sales | Expenses | Operating | Net income |
| net income | |||||
| 1937 | $ 539,833.28 | $ 415,149.49 | $ 98,425.17 | $ 25,868.62 | $ 26,258.62 |
| 1938 | 386,500.18 | 270,330.39 | 89,235.90 | 26,418.60 | 26,933.89 |
| 1939 | 466,538.07 | 324,804.07 | 108,225.96 | 33,192.18 | 33,508.04 |
| 1940 | 618,433.30 | 390,719.55 | 179,999.69 | 47,419.06 | 47,714.06 |
Petitioner's accounting system was installed in 1928 by a certified public accountant, and since that time such system has been maintained continuously. A perpetual inventory record was a part of the accounting system so installed and such record was based upon a physical inventory of the Company's used bags. Thereafter, Milton Silverman, personally, kept the perpetual inventory record. Prior to and during the base period Silverman checked his*67 perpetual inventory records two or three times a day on various items, and as a rule, over the course of a month, all used bag items carried in the perpetual inventory were checked. No physical inventory of petitioner's used bags was taken between 1928 and the latter part of 1943, when, at respondent's request, a physical inventory was taken by a third party as of November 6, 1943.
The perpetual inventory record was used by petitioner in valuing its inventory for tax purposes. Petitioner's tax returns stated that inventory was valued at cost or market whichever was lower, but *236 actually such inventory was valued by considering each used bag to be a unit and each unit as weighing one-half pound, regardless of size. The total units shown by the perpetual inventory record was then reduced to pounds and valued according to the market price of scrap burlap. For the fiscal years 1937-1942, inclusive, petitioner reported that its inventory under this method had the following value:
| Taxable year | Burlap bags | Yard goods | Total |
| 1937 | $ 21,667.48 | $ 1,249.64 | $ 22,917.12 |
| 1938 | 22,865.73 | 2,408.18 | 25,273.91 |
| 1939 | 32,683.63 | 4,138.46 | 36,822.09 |
| 1940 | 37,659.95 | 3,869.19 | 41,529.14 |
| 1941 | 50,719.66 | 21,025.60 | 71,745.26 |
| 1942 | 31,669.22 | 44,632.96 | 76,302.18 |
*68 Petitioner insured its merchandise and its machinery and equipment (but not automobiles and trucks) under a 90 per cent co-insurance contract, which meant that the insurance carried represented only 90 per cent of the insurable values. Included in the merchandise so insured was merchandise on consignment to petitioner for repairs, the quantity of which varied from time to time. The amount of fire insurance carried by petitioner on the contents of its buildings at the end of the fiscal years 1934 to 1940, inclusive, was as follows:
| Fiscal year | |
| ending September 30 | Amount |
| 1934 | $ 50,000 |
| 1935 | 62,000 |
| 1936 | 98,500 |
| 1937 | 125,000 |
| 1938 | 125,000 |
| 1939 | 165.000 |
| 1940 | 179,000 |
Petitioner's balance sheet for the fiscal year ended September 30, 1940, showed net depreciable assets (automobiles, trucks, and equipment) in the amount of $ 16,643.17.
The installation of a system of cost accounting, as a part of its books and records, was considered by petitioner. A complete survey of petitioner's operations and of the factors involved in determining costs was made by a certified public accountant. After completing the survey, the accountant advised against such a system because *69 so many factors in its used bag business changed from day to day. Among the factors militating against a cost system were: Delayed adjustments of purchase prices; inaccurate count on "holey" bags and scraps; substitutions to fill orders; deterioration of bags packed with chemicals; *237 departures from normal in cases of misfit or individually sized bags; increased personnel for keeping cost accounting records; cost records would be bulky as used bag business seldom had a repeat order for a certain type of bag unless from the same customer. In lieu thereof petitioner maintained a month-to-month running analysis of sales in dollars and units.
On or about July 21, 1943, a special agent of respondent's intelligence unit began investigating petitioner's books and records for the fiscal years 1940, 1941, and 1942. At that time these years were the only taxable years of the petitioner then open to investigation under the statute of limitations. The investigation lasted several months, during which time petitioner's accountant and attorney complied with all requests from the special agent for information and assistance. At the conclusion of his investigation the special agent proposed*70 and the petitioner agreed to various adjustments, some favorable to petitioner and some against petitioner. The principal adjustment proposed by the special agent involved substantial increases in the value of petitioner's closing inventories for each of the 3 open years, due primarily to a repricing of the units in petitioner's inventory. The aggregate amount of the understatement of inventory at September 30, 1942, was approximately $ 178,000, and the amount thereof which the special agent proposed to allocate to the closing inventory for the fiscal year 1940 was $ 78,747.39. The special agent accepted petitioner's opening inventory valuation for the fiscal year 1940.
At this stage of the investigation, an experienced revenue agent was assigned to the case, as the special agent had had no experience in excess profits tax cases. The revenue agent objected to placing $ 78,747.39 in petitioner's income for the last base period year because of the tax consequences that would flow therefrom under section 713 (f) of the Internal Revenue Code of 1939. After conferences between the parties, it was agreed that the $ 78,747.39 increase in fiscal 1940 inventory should be spread equally*71 over the fiscal years ending September 30, 1937, 1938, 1939, and 1940. As a part of that agreement, petitioner paid additional taxes, resulting from the various adjustments, amounting to about $ 108,000, and withdrew its then pending applications for relief for the fiscal years ending September 30, 1941 and 1942.
The inventory and other adjustments agreed to by the parties increased petitioner's excess profits net income for the fiscal years 1937-1940, inclusive, its average base period net income, and its average base period net income computed under section 713 (f) (7). The excess profits net income as reported and adjusted was as follows: *238
| Excess profits net income | ||
| Fiscal year | ||
| Reported | Adjusted | |
| 1937 | $ 4,013.31 | $ 23,613.54 |
| 1938 | 6,376.92 | 24,324.96 |
| 1939 | 11,071.62 | 30,502.92 |
| 1940 | 23,784.61 | 43,135.26 |
| Average | 11,311.62 | 30,394.17 |
| Growth formula (sec. 713 (f) (7)) | 1 22,367.39 | 38,924.48 |
*72 For the taxable years ending September 30, 1943 to 1946, inclusive, petitioner filed timely tax returns. For such taxable years respondent determined petitioner's excess profits tax liability to be, and the petitioner paid, the following amounts:
| Fiscal year | Tax liability |
| 1943 | $ 129,482.85 |
| 1944 | 119,440.88 |
| 1945 | 237,335.51 |
| 1946 | 65,175.52 |
For each of the taxable years 1943 to 1946, inclusive, petitioner filed an application for relief (Form 991) under section 722 of the Internal Revenue Code of 1939. Such applications for relief were filed with respondent on November 20, 1947. Petitioner based its right to relief upon a change in the character of its business within the meaning of section 722 (b) (4) of the 1939 Code. In its applications for relief petitioner computed its average base period net income under section 713 (f) (7), without the benefit of section 722, as $ 38,924.48, and its constructive average base period net income under section 722 (b) (4), as $ 158,989.72. The refunds claimed by petitioner for the several taxable years in its applications for relief were as follows:
| Fiscal year | Refund claimed |
| 1943 | $ 12,834.46 |
| 1944 | 106,925.31 |
| 1945 | 71,933.33 |
| 1946 | 17,492.50 |
*73 In 1937 petitioner changed the character of its business in that it entered into the manufacture and sale of new bags.
Petitioner failed to show that its average base period net income was an inadequate standard of normal earnings because of the change in the character of its business during the base period.
Petitioner failed to establish what would be a fair and just amount representing normal earnings to be used as a constructive average base period net income.
Petitioner is not entitled to relief from excess profits tax under section 722 of the Code.
*239 The stipulated facts are found accordingly. Exhibit A, a comparative Profit and Loss Statement for the taxable periods between January 1, 1928, and September 30, 1940, Exhibit 2, a Monthly Analysis of Sales from January 1928 through September 1940, and Exhibit 5, a Certificate of Assessments and Payments of Income and Excess Profits Taxes for the Fiscal Years 1943 through 1946, are included herein by reference due to their detailed nature.
OPINION.
In this case petitioner's excess profits tax liability for the taxable years was determined by using an average base period net income of $ 38,924.48. This amount was computed*74 under section 713(f) (6) and (7), which is the so-called growth formula. This statutory formula increased the excess profits credit petitioner would have otherwise had since its average base period net income, as adjusted by respondent, was $ 30,394.17.
In its applications for relief and in its petition, the petitioner claimed that it was entitled to $ 158,989.72 as a fair and just amount representing normal earnings during the base period. The grounds asserted were that petitioner had changed the character of its business during the base period by entering into the manufacture and sale of new bags. At the hearing, petitioner admitted that it could not justify the $ 158,989.72 claim, and on brief, reduced its claim to $ 94,629.94.
The statutory provisions which apply are found in section 722 (b) (4). The particular language therein upon which petitioner relies is that "the taxpayer * * * during the base period, * * * 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." The term "change in the character of the business" is defined as including, inter alia, "a difference*75 in the products or services furnished," and "a difference in the capacity for production or operation."
It is apparent from the facts, and respondent admits, that petitioner changed the character of its used bag business during the base period years. Respondent insists, however, that this is not enough. He contends that petitioner must also establish a fair and just amount to be used as a constructive average base period net income, and that such amount exceeds the average base period net income computed under the provisions of section 713(f). Pittsburgh & Weirton Bus Co., 21 T. C. 888 (1954), reversed on another point 219 F. 2d 259 (C. A. 4, 1955); Green Spring Dairy, Inc., 18 T. C. 217 (1952), affirmed on another point 208 F. 2d 471 (C. A. 4, 1953); Powell-Hackney Grocery Co., 1489">17 T. C. 1489 (1952); Sartor Jewelry Co., 22 T. C. 773 (1954); Schwarz Paper Co., 23 T. C. 605 (1955); Wentworth Military, Scientific, *240 ., 22 T. C. 721 (1954);*76 Acme Breweries, 14 T. C. 1034 (1950); Lamar Creamery Co., 8 T. C. 928 (1947).
Since a qualifying factor has been established, we will examine next petitioner's contention that $ 94,629.94 is a fair and just amount to be used as a constructive average base period net income. In arriving at such amount, petitioner applied its version of the push-back rule upon the theory that, had it started the new bag business 2 years before it did, its net operating income would have increased during each of the base period years. After reconstructing its excess profits net income for each base period year, petitioner then applied section 713(f) (6) and (7), in order to secure the benefits of the growth formula in addition to the special relief claimed under section 722.
It is now well established that a taxpayer cannot secure relief under both section 713 and section 722. Homer Laughlin China Co., 7 T. C. 1325 (1946); Stinson Mill Co., 7 T. C. 1065 (1946), affd. 163 F. 2d. 269 (C. A. 9, 1947) certiorari denied 332 U.S. 824">332 U.S. 824 (1947),*77 rehearing denied 332 U.S. 839">332 U.S. 839 (1947); Dayton Rubber Co., 26 T. C. 389 (1956). The claimed constructive average base period net income of $ 94,629.94 is erroneous, therefore, to the extent of any portion thereof added under section 713 (f).
Petitioner's reconstructed excess profits net income for the fiscal years ending September 30, without the benefit of the growth formula, was as follows: 1937 -- $ 40,354.98; 1938 -- $ 57,598.03; 1939 -- $ 64,103.20; 1940 -- $ 110,030. An average of the reconstructed net income for petitioner's base period years is $ 68,021.55, so that the difference between this average and the amount claimed of $ 94,629.94 is attributable to petitioner's application of the growth formula and must be excluded under the Stinson and Laughlin cases, supra.
In view of the fact that petitioner's reconstructed average base period net income of $ 68,021.55 exceeds the $ 38,924.48 average computed under the growth formula, we will analyze petitioner's reconstruction further in order to determine whether $ 68,021.55 is a fair and just amount within the meaning of the statute.
The various steps in petitioner's*78 reconstruction for the base period years may be briefly stated as follows: Unit prices of new and used bags were determined by dividing dollar sales by unit sales; the percentages of cost of sales, salaries and wages, other expenses, and operating net income to net sales for each year were computed from petitioner's base period experience; unit sales of new and used bags were then reconstructed; next, unit prices were applied to reconstructed unit sales to arrive at total dollar sales for each base period year; dollar sales were then reduced by the use of the aforementioned percentages to determine cost of sales, salaries and wages, and other expenses, and to arrive at operating net income, which was then averaged.
*241 It was in connection with its reconstruction of new and used bag sales for the base period years that petitioner invoked its version of the push-back rule. This consisted of pushing back fiscal 1939 and 1940 sales to fiscal 1937 and 1938, respectively, and then reconstructing fiscal 1939 and 1940 sales. Ignoring the several assumptions made by petitioner, which respondent contends are erroneous, the reconstructed sales claimed by petitioner are as follows:
| Fiscal year | New bags | Used bags |
| 1937 | 1,062,000 | 7,131,000 |
| 1938 | 2,138,000 | 6,475,000 |
| 1939 | 3,678,856 | 6,308,000 |
| 1940 | 6,330,207 | 6,308,000 |
*79 Petitioner's reconstruction assumes that there was a demand for, and that it could have sold in the competitive market in which it operated, the annual increase in new bags shown by its reconstructed sales. But there is no satisfactory proof in the record to support the assumption. The evidence shows that petitioner's productive capacity in each year of the base period was greater than the volume of bags it was able to sell; its sales were never circumscribed by its actual ability to produce. This was admitted by petitioner's principal witness. The new bag business was highly competitive. The record as a whole does not justify the conclusion that lack of capacity to produce restricted petitioner's sales. The evidence establishes that, rather, petitioner's earnings up until the latter part of 1938 were limited by its ability to sell its products and not by its ability to manufacture.
Petitioner had 2 1/2 years experience in manufacturing and selling new bags before the beginning of its last base period year. Its record of monthly sales reached a more or less stable level in the latter part of 1938 which continued throughout 1939. The beginning of petitioner's last base period*80 year was the time of the beginning of the war abroad and the evidence shows that thereafter the demand for all types of bags, and the prices, increased. Petitioner's principal witness has stated that from 1939 on sales could be made of all of the bags which could be supplied.
The record does not justify reconstruction of petitioner's sales on the basis of its productive capacity since its capacity to produce was not a limiting factor of sales. Green Spring Dairy, Inc., supra;Farmers Creamery Co. of Fredericksburg, Va., 18 T. C. 241; Robinson Terminal Warehouse Corporation, 19 T. C. 1185; National Grinding Wheel Co., 8 T.C. 1278">8 T. C. 1278.
Petitioner's reconstruction cannot be approved because it contains many erroneous assumptions and unexplained discrepancies which destroy its probity. For example, one of petitioner's unexplained discrepancies is its statement that 1937 sales of 139,000 new bags represented "the production for 3 months" during the fiscal year 1937. We *242 are unable to find any proof in the record to support this statement, or justify its use *81 by petitioner in annualizing its 1937 "fiscal year production" as 556,000 new bags. Actually, petitioner sold 139,099 new bags during the 8-month period May to December 31, 1937, and there is no basis in this record for assuming that such sales represented 3 months' production, 5 months' production (i. e., to the end of the fiscal year), or a full 8 months' production. Furthermore, petitioner's reconstruction makes use of post-December 31, 1939, events, which is strictly prohibited by statute, and which was recognized by petitioner in its offers of exhibits containing data relating to 1940 and later.
The entire record has been carefully considered but we must conclude that petitioner's reconstruction is unacceptable, and that no fair and just amount has been established which can be used as a constructive average base period net income. Nor can we, after a careful analysis of the facts, arrive at a fair and just amount which would exceed the $ 38,924.48 determined by respondent.
We see no merit in petitioner's contention that respondent has attempted to inject a standard issue by contending that petitioner's actual base period net income cannot be determined. This defense was raised*82 because of the arbitrary manner in which the parties settled the adjustments which were made to petitioner's base period income. The burden of showing that it was entitled to a larger excess profits credit than respondent allowed was on the petitioner. This it has failed to do, and respondent's determination of petitioner's excess profits tax liability for the taxable years is approved.
Reviewed by the Special Division.
Decision will be entered for the respondent.
Footnotes
1. Taxable years 1928 to 1934 are calendar years; 1934 is a 9-month period ending September 30, 1934; 1935 to 1940, inclusive, are fiscal years ending September 30.↩
1. Petitioner's Exhibit 13, a revenue agent's report, received without objection, shows this amount. The correct amount under section 713 (f) (7) as limited by section 713 (f) (6), appears to be $ 19,546.95. If, as respondent contends on brief, $ 22,367.39 is the excess profits credit, then the growth formula average was computed without regard to the limitations in section 713 (f) (6) and (7)↩.