*203 Decision will be entered under Rule 50.
1. Petitioner, a public carrier engaged in the transportation of passengers by motor bus, held, not entitled to relief (1) under sec. 722 (b) (4), I. R. C., because of the establishment in November, 1939, of a new bus route to supplement one of its several existing routes, or (2) under sec. 722 (b) (5), I. R. C., because of an alleged loss of $ 667.12 resulting from the operation of the new route for the period November 13 to December 31, 1939, or (3) under sec. 722 (b) (4) because of the gradual replacement during the base period years 1936 and 1937, and prior years, of a number of its old buses with new type buses which were more convenient and more economical to operate.
2. Held, that petitioner's acquisition July 1, 1938, of a contract for carrying the United States mail to and from Seattle and several suburban points on its bus routes was a limited change in the character of its business, for which petitioner is entitled to an adjustment under sec. 722 (b) (4).
*824 The petitioner contests respondent's disallowance of claims for refund filed under section 722, Internal Revenue Code, for the years 1941 and 1942 in the respective amounts of $ 2,279.38 and $ 20,619.55. The 1941 claims covered the entire amount of the excess profits tax paid by the petitioner for that year, while the 1942 claims, for $ 20,619.55, were for only a portion of the $ 74,140.80 of excess profits tax paid for that year.
The claims, as filed with the respondent, set forth six separate grounds for petitioner's contentions that its excess profits taxes, computed without reference to section 722, were excessive and discriminatory and that the average base period income was an inadequate standard of normal earnings. Petitioner has since abandoned two of the grounds urged in its claims, and in this *205 proceeding it rests upon the following four grounds:
(1) That on November 13, 1939, it established a new bus route and extended the services on some of its other routes, and that the returns on these services did not reach the level by December 31, 1939, which they would have reached had the additions been made two years previously; for which an adjustment should be made under section 722 (b) (4);
(2) That it sustained an operating loss on its newly established route over the period November 13 to December 31, 1939; for which an adjustment should be made under section 722 (b) (5);
(3) That during the base period years 1936 and 1937 it sustained operating losses due to the use of a number of old type buses which were in the process of being replaced by new, more efficient, and more economical buses, and that adjustment for such losses should be made under section 722 (b) (4); and
(4) That prior to its base period it held a contract for carrying United States mail from Seattle to Des Moines, Washington, and other intermediate points which it lost to another applicant on June 30, 1934; that it regained the contract for the four-year period beginning July 1, 1938; and that an adjustment*206 should be made therefor under section 722 (b) (4).
In its claim for refund petitioner sought an adjustment under section 722 (b) (1) on account of the loss of the mail contract revenue during the base period 1936, 1937, and the first half of 1938.
*825 FINDINGS OF FACT.
Petitioner is a Washington corporation, with its principal place of business at Seattle. It filed its returns for 1941 and 1942 with the collector of internal revenue for the district of Washington.
Petitioner is a common carrier, operating buses for transporting passengers over several suburban routes out of Seattle. It has two principal routes extending to the south and three to the north of Seattle for about 15 miles in each direction.
Upon its organization in 1928 petitioner took over and consolidated three separately operated bus systems out of Seattle. It was issued a certificate of public convenience and necessity by the Department of Public Service of the State of Washington, which has been renewed from time to time. Petitioner carries passengers to and from within the city limits of Seattle and outlying points, but is not permitted to operate within the city limits in competition with municipal transportation*207 lines.
On May 26, 1939, petitioner made application to the Department of Public Service for a new route to supplement one of its principal routes to the north of Seattle, known as Haller Lake-Lago Vista, and for an extension of the services on that route. This application was rejected as to the new route and the application of a rival company, which had been filed May 4, 1939, for a route covering a portion of the same territory was granted. On petitioner's appeal to the Superior Court of Thurston County the action of the Department of Public Service was reversed and it was directed to grant petitioner's application in full. The court ruled:
That the department was without jurisdiction to grant the application of Roy E. Furse to render service in the territory already served by the Suburban Transportation System without first giving that company an opportunity to render any additional service which the territory might require.
Service on the new route was inaugurated by petitioner November 13, 1939, although an amended certificate authorizing such change was not issued to petitioner by the Department of Public Service until January 17, 1940. This additional service resulted *208 in an increased mileage for the Haller Lake-Lago Vista route of 232.4 miles for each weekday and 165.2 miles for Sundays and holidays, or a total increased mileage for the period November 13 to December 31, 1939, of approximately 10,000 miles. Petitioner's total mileage for 1939 on all of its routes was approximately 793,000 miles.
At the request of the Department of Public Service, petitioner, on January 25, 1940, furnished it a summary of the results of its operation on the new Haller Lake-Lago Vista route over the period November 13, 1939, to January 12, 1940, which showed, among other things, that for the first 12 days of January, 1940, a loss was sustained on the new route of 4.52 cents per mile for weekdays and 10.44 cents *826 per mile for Sundays and holidays. This loss was based on petitioner's average cost per mile of operations over all of its routes for the entire year 1939, amounting to 17.84 cents per mile.
Petitioner knew at the time the new route was inaugurated that it would, in all probability, not show a profit on an average cost per mile basis in 1939, or immediately thereafter. Petitioner's experience had been that a period of two or three years was required*209 to develop a new route to the point of profitable operation. On the other hand, the services on this new route did not add appreciably to the allover cost of petitioner's operations.
In addition to inaugurating the new Haller Lake-Lago Vista route, petitioner in 1939 increased the number of trips and added to the mileage on some of its other routes. The total increased mileage in 1939 was 24,363.6 miles on weekdays and 1,834.5 miles on Sundays and holidays. On the basis of a full year this would have amounted to an increase of about 82,000 miles in 1939, which was less than 10 per cent of petitioner's total mileage on all of its routes at the beginning of 1939.
In its claim for refund petitioner claimed an adjustment under section 722 (b) (5) for the "Additional net income that would have been realized [in the base period year 1939] if taxpayer had not expanded its facilities during the year 1939," computed as follows:
| Daily schedule, 24,363.6 miles at 4.52 cents | $ 1,101.23 |
| Sunday and holiday, 1,834.5 miles at 10.44 cents | 191.52 |
| Total | 1,292.75 |
Petitioner claims an actual loss on the operation of the new Haller Lake-Lago Vista route in 1939 of $ 667.12, computed*210 as follows:
| Period | Average | Days | Total passengers | Average |
| daily | fare 1 | |||
| Weekdays, 11/13-11/30 | 175.9 | 15 | 2,638.5 | 13.7 cents |
| Sundays and holiday, 11/13-11/30 | 72.5 | 3 | 217.5 | 13.7 cents |
| Weekdays, 12/1-12/31 | 236.0 | 25 | 5,900.0 | 13.7 cents |
| Sundays and holiday, 12/1-12/31 | 69.3 | 6 | 415.8 | 13.7 cents |
| Total | 49 | 9,171.8 |
| Period | Total | Cost 2 | Actual |
| revenue | loss | ||
| Weekdays, 11/13-11/30 | $ 361.47 | $ 621.90 | $ 260.43 |
| Sundays and holiday, 11/13-11/30 | 29.80 | 88.42 | 58.62 |
| Weekdays, 12/1-12/31 | 808.30 | 1,036.50 | 228.20 |
| Sundays and holiday, 12/1-12/31 | 56.96 | 176.83 | 119.87 |
| Total | 1,256.53 | 1,923.65 | 667.12 |
*211 *827 According to petitioner's records, the average per mile gross revenue from its entire Haller Lake-Lago Vista route during each of the base period years was less than the average per mile cost of operations on all of its combined routes.
In 1932 petitioner designed and put into operation, experimentally, a new type of bus, known as "Tri-Coach." It differed from the conventional type bus in that the power unit consisted of a Ford truck chassis, with the wheel base shortened, to which a trailer coach was connected by a single "fifth wheel" suspension mounted about 18 inches forward of the power axle. The driver's seat was inside of the passenger coach. In 1934 the second Tri-Coach, embodying some improvements over the original model, was put into operation. The new type buses proved so successful that by the end of 1934 petitioner had decided to replace all of its conventional buses with them. It acquired three more of the Tri-Coaches in 1935, three in 1936, and four in 1937.
The number of new and old type buses in operation during the years 1936 to 1939, inclusive, and the number of miles traveled by each type were as follows:
| Tri-Coaches | Others | |||
| Year | Number | Miles | Number | Miles |
| operated | traveled | operated | traveled | |
| 1936 | 8 | 449,547.2 | 5 | 270,080.2 |
| 1937 | 12 | 623,823 | 4 | 120,504 |
| 1938 | 12 | 699,908 | 3 | 57,047 |
| 1939 | 12 | 733,812 | 5 | 58,942 |
*212 Soon after the close of 1936 petitioner made a study from its records of the comparative costs of operating the Tri-Coaches and the conventional type buses in 1936, which disclosed the following results:
| Tri-Coaches | Others | |
| (per mile) | (per mile) | |
| Gasoline | 2.13 cents | 3.06 cents |
| Oil | .13 cents | .31 cents |
| Labor and repairs | .87 cents | 1.48 cents |
| Materials (repairs) | .48 cents | .87 cents |
| Tire rental | .35 cents | .63 cents |
| Total | 3.96 cents | 6.35 cents |
In 1937 the Washington State Legislature enacted into law a new traffic code which made it illegal in that state to carry passengers for hire in a trailer. Petitioner maintained that its Tri-Coaches did not come within the prohibition of the act, but it agreed, nevertheless, not to put any more of them into operation. Petitioner was permitted to continue and did continue using the 12 Tri-Coaches which it then had in operation through 1937.
*828 In its claim for refund petitioner claimed an adjustment under section 722 (b) (4) for the excess cost of operating the old, or conventional, type buses in 1936 and 1937 over what it would have cost to operate the Tri-Coaches had it replaced all of the old type with them*213 prior to January 1, 1936, computed as follows:
| Year | Mileage, old | Excess cost | Loss |
| type | per mile | ||
| 1936 | 270,080.2 | 2.39 cents | $ 6,454.92 |
| 1937 | 120,504 | 2.39 cents | 2,880.05 |
Petitioner and its predecessors for a number of years held contracts with the Post Office Department for carrying the United States mails between Seattle and several suburban communities on their bus routes. For the period July 1, 1930, to June 30, 1934, petitioner held a contract for carrying the mails on its Des Moines and Burien routes, for which it was paid at the rate of $ 1,680 per year. Petitioner lost this contract to a competitive bidder for the period July 1, 1934, to June 30, 1938, but regained it for the period July 1, 1938, to June 30, 1942, on a bid somewhat lower than its previous contracts. Its compensation under the new contract amounted to $ 545.70 for the last half of 1938 and $ 1,128.99 for the entire year 1939. The contract has been renewed continuously since that time.
Carrying the mails did not require petitioner to make any extra trips and required only one additional stop, the one made at the Seattle Post Office.
In its claim for relief for the year 1941 petitioner*214 claimed an adjustment under section 722 (b) (1) on account of the loss of mail contract revenue at the rate of $ 1,680 per year for 1936, 1937, and the first half of 1938.
Petitioner's excess profits net income, computed without regard to section 722, was $ 19,602.65 in 1936, $ 14,700.38 in 1937, $ 11,444.31 in 1938, and $ 19,507.91 in 1939. Its average base period income, computed without regard to section 722, was $ 16,313.81, as applicable for 1941, and as applicable for 1942, determined in accordance with section 713 (e) (1), was $ 16,815.92. The average base period net income claimed by petitioner in its application for relief under section 722 was $ 28,559.47.
OPINION.
The petitioner qualifies as a corporation entitled to have its excess profits credit computed under section 713, Internal Revenue Code, on the basis of its average base period net income, having been in existence during all of the base period years 1936 to *829 1939, inclusive. It contends, however, that the computation of its excess profits tax by use of its excess profits credit based on income without the benefit of section 722 results in an excessive and discriminatory tax. It undertakes to establish*215 what would be a fair and just amount representing normal earnings to be used as a constructive average base period net income.
Petitioner contends, first, that the establishment of the new Haller Lake-Lago Vista route on November 13, 1939, was a change in the character of its business within the meaning of section 722 (b) (4) and that this was one of the causes which contributed to the inadequacy of its base period earnings as a standard of normal earnings. In its brief petitioner states that it is now limiting its claim under this issue to the establishment of the new route and is abandoning any claim on account of the extension of its services on its other routes.
Section 722 (b) (4) authorizes an adjustment of the base period net income where average base period net income is an inadequate standard of normal earnings because of a change in the character of the business. The term "change in the character of the business" is defined as including "a change in the operation or management of the business, a difference in the products or services furnished, a difference in the capacity for production or operation." The purpose of the second sentence in section 722 (b) (4), as indicated*216 by the Commissioner's regulations and by the bulletin on section 722 (see Regulations 112, sec. 35.722-3, p. 139, and Bulletin on Section 722 of the Internal Revenue Code, Nov. 1944, pp. 86-87) is to establish the maximum earnings at the end of the base period to which the taxpayer can lay claim for the purpose of reconstructing its average base period net income for the entire base period. Thus, in cases where at the end of the base period the level of earnings ultimately resulting from the change had not been reached, this "push-back" method is used to determine what the maximum constructive earnings at the end of the period would be. They are then used in reconstructing earnings for all four of the base years. However, if the level of earnings resulting from the change had been reached before the end of the base period, no resort to the second sentence in section 722 (b) (4) is necessary. Instead, in that case, it is only necessary to take the earnings as they had leveled off after the change on or before the end of the base period and reconstruct the average base period income for all four years on that basis.
In East Texas Motor Freight Lines, 7 T. C. 579,*217 we held that there was a change in the character of the taxpayer's business, within the meaning of section 722 (b) (4), where the taxpayer, a public carrier of freight by motor truck on established intrastate routes, added a new intrastate route and also new interstate routes, which increased *830 its mileage approximately one-third and opened up an entirely new type of operation. We said in our opinion:
We think the evidence before us clearly proves that "during * * * the base period" petitioner "changed the character" of its business. Prior to the acquisition of the three new routes from Dallas to Fort Worth, from Texarkana to Memphis, and from Memphis to St. Louis, petitioner was predominantly an intrastate carrier. Thereafter its business was that of an interstate carrier, as well as an intrastate carrier. These acquisitions not only added approximately 600 miles of additional territory to be served by petitioner, but opened up an entirely new type of operation, namely, the straight load or key point operation as distinguished from the old interchange or joint haul operation. Under this new type of operation petitioner was able to haul more freight at a considerable *218 lesser cost per ton of freight hauled. This resulted in larger profits for petitioner. We think that these changes can reasonably be regarded as "a change in the operation * * * of the business, a difference in the * * * services furnished, [and] a difference in the capacity for * * * operation" as those terms are used in section 722 (b) (4) * * *.
The change in petitioner's business resulting from the establishment of the new Haller Lake-Lago Vista route was of considerable less scope than that of the taxpayers in the East Texas Motor Freight Lines case. The changes made by the petitioner did not call for any new type of equipment or operations and did not then, or later, result in any larger volume of business at less cost per mile or per fare. The figures given to us indicate that the increase in mileage was less than 10 per cent of petitioner's total mileage. The new route served the same general territory that petitioner was already serving. It supplemented the old Haller Lake-Lago Vista route, which had been in operation since 1928 and paralleled that route, only two blocks away, for a considerable distance. As affecting petitioner's total operations, it amounted to*219 little more than the extension of the services on petitioner's old routes.
In its proposed reconstruction of base period net income petitioner seems to assume that the new Haller Lake-Lago Vista route, if it had been established two years earlier, would have yielded approximately the same return of income in 1938 and 1939 as its old established routes. That assumption is not justified on any evidence before us. Petitioner's secretary and general manager testified that this new territory had not been sufficiently developed to justify the inauguration of the new route before 1939 and that to have commenced it earlier would have meant only a longer period of operating losses. While it was the testimony of this witness that the development of a paying route ordinarily required two or three years, this can not be taken to mean that any new route might be expected to reach a paying basis within that time, regardless of the progress and development of the territory which it served. Petitioner's records show that the combined revenue from the new and the old Haller Lake-Lago Vista *831 routes in each of the years 1936 to 1939, inclusive, was less than the average per mile cost of*220 operations on all of its combined routes. There is nothing in the evidence to show, and we can not assume, that the new Haller Lake-Lago Vista route would have been any more profitable at the end of the base period years had it been established two years earlier than it was.
We do not think that the evidence shows any error on the part of the respondent in refusing to make an adjustment under section 722 on account of petitioner's expansion of its services in 1939.
Petitioner next contends that it sustained a net loss on the operation of its new Haller Lake-Lago Vista route over the period November 13 to December 31, 1939, of $ 667.12, for which an adjustment should be made under section 722 (b) (5). In computing the amount of the alleged loss petitioner has taken the cost factor of 17.84 cents per mile which was the average cost per mile of its entire operations on all of its routes for the year 1939. No other evidence was offered as to the added cost of operating the new route or as to whether the revenue derived from it was more or less than the additional expenses.
Even accepting the fact that a loss such as claimed may have been realized on the operation of the new route for*221 the period November 13 to December 31, 1939, it was not sufficient to cause any substantial distortion of petitioner's average base period net income. Section 722 (b) (5), under which petitioner's claim for this item is made, relates to "any other factor affecting the taxpayer's business which may reasonably be considered as resulting in an inadequate standard of normal earnings during the base period." (Italics supplied.) We do not think that the small loss which may have resulted in 1939 from the operation of the new route may reasonably be considered as resulting in an inadequate standard of normal base period earnings.
Petitioner next contends that it suffered a loss in 1936, 1937, and the first six months of 1938 on account of the loss of its mail contract, for which an adjustment should be made under section 722 (b) (4). This item was claimed originally under section 722 (b) (1). In this proceeding petitioner argues that the procurement of the mail contract on July 1, 1938, was a change in the operation of the business, within the meaning of subsection (b) (4), and that an adjustment should be made therefor under that subsection. According to petitioner's computation, *222 this would result in an addition to base period income of $ 545.70 in 1936, $ 1,128.99 in 1937, and $ 583.29 in 1938.
We think that the procurement of the mail contract and the services performed thereunder constituted a change in the character of petitioner's business within the meaning of section 722 (b) (4). Carrying the United States mail under a term contract was an entirely different operation from carrying passengers for single trip fares. The mail *832 contract constituted only a small percentage of petitioner's business, it is true, but to that limited extent it was a change which had a direct effect upon petitioner's average base period net income.
Relief under section 722 (b) (4) is proper where the actual average base period income does not involve normal operations after the change has taken place. The adjustment requires the construction of a normal base period income for the entire base period, patterned on conditions as they existed after the change took place. Thus, the proper adjustment here would be to add to petitioner's net income for 1936, 1937, and 1938 the amount of net income which it would have derived from the mail contract, acquired on July 1, *223 1938, if it had held the contract during all of the base period. Since the evidence is that the additional expenses incident to handling the mail were negligible, the entire amount of the compensation received under the contract is the measure for the additions to be made to the base period net income. Petitioner actually received $ 545.70 for the last half of 1938 and $ 1,128.99 for the full year 1939. We think that the "fair and just amount representing normal earnings" would be arrived at by adding $ 1,128.99, a full year's compensation under the contract, to the net income for each of the years 1936 and 1937, and by adding to 1938 income so much as is required to bring the total compensation for that year to $ 1,128.99.
Petitioner's remaining contention is that it is entitled to an adjustment under section 722 (b) (4) on account of the loss resulting in 1936 and 1937 from the operation of the old type buses which had been replaced with the Tri-Coaches, computed as shown above in our findings of fact, by comparing the costs of operating the new and the old type buses. The adjustment sought results in additions of $ 6,454.92 and $ 2,880.05 to income for the respective base period*224 years 1936 and 1937.
In its brief petitioner states:
Petitioner realizes that it might be questionable whether the replacing of its old type buses with Tri-Coach equipment would be a change in the character of the business contemplated by section 722 (b) if that were the only claim being made by petitioner for adjustment under said section. However, since other of its claims under said section will require a computation of a constructive average base period net income for petitioner, it is believed that such excess cost of operating the old type equipment in those two years should be taken into consideration.
Each separate claim must of course rest on its own merits. Because an adjustment may or may not be required on one ground does not affect the taxpayer's right to an adjustment on some other ground.
Petitioner computes its alleged loss on the basis of what it would have saved had it replaced all of its old type buses with Tri-Coaches at the beginning of 1936. In other words, petitioner claims to have lost what it might have saved by a complete change. We agree with petitioner's suggestion that, standing alone, the addition of the Tri-Coaches *833 did not result in a*225 change in the petitioner's business within the meaning of section 722 (b) (4). There was no change in the "operation or management" of the business, nor was there any difference "in the products or services furnished" or "in the capacity for production or operation." The most that petitioner claims for the Tri-Coaches is that they were more convenient to operate and more economical than the old type buses. They performed the same services as the old buses in substantially the same manner and on the same routes. There is no proof that the use of the Tri-Coaches resulted in any increase in the number of passengers carried or in petitioner's gross revenue.
The mere addition of new and improved equipment to replace that in use or to meet expanding business is not a change such as contemplated by section 722 (b) (4). That is a common occurrence within the normal operation of many types of business.
Decision will be entered under Rule 50.
Footnotes
1. The average fare of 13.7 cents per passenger is the actual average revenue per passenger on the Haller Lake route for the entire year 1939.↩
2. The cost of operation is computed as follows:
Period Miles per Days Miles day Weekdays, 11/13-11/30 232.4 15 3,486.0 Sundays and holiday, 11/13-11/30 165.2 3 495.6 Weekdays, 12/1-12/31 232.4 25 5,810.0 Sundays and holiday, 12/1-12/31 165.2 6 991.2 Total 10,782.8 Period Cost per Total cost mile Weekdays, 11/13-11/30 17.84 cents $ 621.90 Sundays and holiday, 11/13-11/30 17.84 cents 88.42 Weekdays, 12/1-12/31 17.84 cents 1,036.50 Sundays and holiday, 12/1-12/31 17.84 cents 176.83 Total 1,923.65 The cost per mile of 17.84 cents was the actual cost per mile for 1939 of petitioner's entire operations on all its routes.↩