*59 Decision will be entered for the respondent.
1. Relief under section 721, Internal Revenue Code, denied to manufacturer of piston rings in the absence of proof that petitioner's income for 1942 and 1943 was due in any material part to the development of patents, formulae, and manufacturing processes in prior years, rather than to an increased wartime demand for petitioner's products.
2. Respondent sustained on other issues for lack of proof showing error in his determination.
*636 This proceeding involves deficiencies in declared value excess profits and excess profits taxes for the calendar years 1942 and 1943, as follows:
| Declared value | Excess profits | |
| Year | excess profits | taxes |
| taxes | ||
| 1942 | $ 5,784.08 | $ 54,577.32 |
| 1943 | 7,654.37 | 54,710.49 |
*60 The petitioner alleges that the Commissioner erred (1) in denying relief under section 721, Internal Revenue Code, for the years 1942 and 1943; (2) in failing to allow the correct amount of invested capital to be used in determining excess profits credit for 1942 and 1943; (3) in failing to allow the correct amount of unused excess profits credit carry-over from 1940 and 1941; (4) in determining petitioner's opening and closing inventories for 1942 and 1943; (5) in disallowing a portion of the traveling, entertainment, and general expenses claimed by the petitioner in 1942 and 1943; and (6) in disallowing a portion of the salary paid to George Deeb, Jr., son of the petitioner's president, in 1943. Some of the facts have been stipulated and are found accordingly.
FINDINGS OF FACT.
The petitioner is an Indiana corporation, with its principal office and place of business located at Indianapolis, Indiana. Its returns for 1942 and 1943 were filed with the collector of internal revenue for the district of Indiana. The returns were made for a calendar year and on an accrual basis, in accordance with petitioner's method of keeping its books.
Petitioner was organized October 14, 1929, as*61 successor, under a reorganization, to Garsix Manufacturing Co. That company, hereinafter called Garsix, was organized March 17, 1926, to take over a *637 business, formerly operated as a partnership, of manufacturing pistons and piston rings of various types. Its assets were said to consist of tangible property of a value of $ 20,000 and intangible property of a like amount. Garsix was not successful in its operations and on February 4, 1929, it was placed in receivership. The receivership action was brought by George D. Gardner, a stockholder of the corporation, who alleged in his complaint that the company was indebted to him for moneys advanced for operating expenses in the amount of $ 40,000. The other stockholders were Nancy Lee Gardner, George D. Gardner's wife, and Walter J. Six. Under contract dated June 11, 1929, Six transferred his interest in the business to Gardner.
One of Garsix's employees, George Deeb, was appointed receiver for the corporation in the receivership proceeding. He filed with the court an inventory dated February 28, 1929, showing assets of a total value of $ 4,794.34. He filed with the court a final statement on October 7, 1929, in which *62 he reported that all of the debts of the company had been paid and that the company was then on a dividend-paying basis. The report was approved by the court. The receivership continued until the petitioner was organized to take over the business.
Petitioner's authorized capital stock consisted of 500 shares of no par value, 75 shares of which were issued to George Deeb, 1 share to George D. Gardner, and 124 shares to Nancy Lee Gardner.
George Deeb was first employed by Garsix in 1928. He became president of the petitioner upon its organization and has served in that capacity until the present time.
Under the contract of June 11, 1929, between Six and Gardner, it was agreed that each of them should have the continued use of certain patents pertaining to the manufacture of piston rings which they owned jointly and that either might sell or license his one-half interest therein.
The petitioner began operation on a small scale, with limited equipment. It continued the business of manufacturing piston rings substantially as it had been operated by Garsix. Most of the piston rings then in use, and particularly those used in automobile motors, were made of cast iron. Most of the rings*63 manufactured by the petitioner were made of tempered steel, bronze, or alloys. These rings had been found to be superior to cast iron rings for many uses.
The petitioner operated at a loss every year until 1941. At one time, about 1937, it was deserted by all but one of its employees. The employees numbered from about 16 to 25 during the period 1929 to 1937.
Both the wife and sister of George Deeb, petitioner's president, furnished funds of their own from time to time to meet the pay roll and other operating expenses. The former, Charline Deeb, advanced between $ 18,000 and $ 25,000 of her own funds and the sister a lesser amount.
*638 In the first years of its operations the petitioner had a great many of its rings returned to it as unsatisfactory. It continued its research in materials and manufacturing methods, experimenting with various types of steel and other metals and acquiring whatever assistance it could from metallurgists and research laboratories. It developed certain different kinds of machines for use in its manufacturing processes such as cutting, loading, and forming machines.
By about 1936 or 1937 the petitioner had developed formulae and improved manufacturing*64 methods by which it was able to produce rings that were satisfactory to its customers.
Petitioner used about the same manufacturing methods and equipment in the taxable years 1942 and 1943 that it had used in the years just preceding. Much of its machinery was especially designed for a particular purpose and was not standard. However, petitioner had the use of certain standard equipment furnished by the United States Government for manufacturing rings for war use.
Among petitioner's principal customers were Bendix Corporation, Liquid Carbonic Corporation, Crane Co., Barco Manufacturing Co., Chrysler Corporation, Yuba Manufacturing Co., and Worthington Pump & Machinery Corporation.
Most of petitioner's production during 1942 and 1943 went into manufacture of equipment or materials for war use. The petitioner's rings were used in airplane engines, landing gears, gun turrets and other war equipment. Uniformed officers of the armed forces were stationed in petitioner's plant from time to time to inspect and expedite its war production.
Petitioner's gross sales, gross profit or loss from sales, and net income or loss, as reported in its income tax returns for the years 1929 to 1943, *65 inclusive, were as follows:
| Gross profit or | |||
| Year | Gross sales | (loss) from | Net income |
| sales | or (loss) | ||
| 1929 | $ 1,936.42 | ($ 6,303.85) | |
| 1930 | 23,539.97 | (1,157.37) | |
| 1931 | 19,529.51 | (1,233.00) | |
| 1932 | 10,044.47 | (16.60) | |
| 1933 | 6,156.09 | (8,627.55) | |
| 1934 | 9,738.68 | (400.20) | |
| 1935 | 8,001.05 | (1,363.78) | |
| 1936 | 9,940.12 | (1,714.99) | |
| 1937 | 8,948.20 | (1,914.33) | |
| 1938 | 5,533.94 | (7,171.06) | |
| 1939 | 8,462.59 | (225.61) | |
| 1940 | 11,660.29 | (433.68) | |
| 1941 | 45,274.29 | $ 10,879.35 | 6,214.60 |
| 1942 | 129,592.59 | 60,696.94 | 28,890.10 |
| 1943 | 212,755.24 | 102,576.48 | 37,725.17 |
The petitioner occupies a minor position in the piston ring industry. Large manufacturers produce many times more rings than petitioner. Some of them manufacture steel rings and other types in competition *639 with the petitioner. Petitioner did not employ a sales force or advertise extensively, as did some of the larger manufacturers. Most of its sales and contacts with the public were handled by its president, George Deeb. During 1942 and 1943 petitioner did not use in its business any patents or exclusive trade rights which gave it any material advantage over its competitors.
There was *66 little change in either the cost of materials used in the production of the rings or the selling price of the rings which the petitioner manufactured over the period 1939 to 1943, inclusive.
In determining the deficiencies herein the Commissioner reduced the 1942 opening inventory, as reported in the return for that year, from $ 67,478.41 to $ 5,000 and the 1943 opening inventory from $ 89,672.30 to $ 27,500. He made no adjustment in the closing inventories, as reported in the returns, for either of those years. In making these adjustments the Commissioner took the closing inventory for 1941, as shown in petitioner's return for that year, as the opening inventory for 1942, and took the closing inventory for 1942 as the opening inventory for 1943. The inventories, as reported by the petitioner in its returns and as adjusted by the Commissioner for each of the years 1939 to 1943, inclusive, are as follows:
| Petitioner | Commissioner | |||
| Year | ||||
| January 1 | December 31 | January 1 | December 31 | |
| 1939 | $ 7,756.33 | $ 7,981.82 | $ 7,756.53 | $ 7,981.82 |
| 1940 | 7,981.82 | 8,373.61 | 7,981.82 | 8,373.61 |
| 1941 | 2,800.00 | 5,000.00 | 8,373.61 | 5,000.00 |
| 1942 | 67,478.41 | 27,500.00 | 5,000.00 | 27,500.00 |
| 1943 | 89,672.30 | 29,250.00 | 27,500.00 | 29,250.00 |
*67 In making its returns for 1942 and 1943 the petitioner had the assistance of an employee of the Fidelity Trust Co. He arrived at the inventory figures shown in the returns after making a survey of the materials shown to him by the petitioner's president, who verified the returns. After receiving the notice of deficiencies for 1942 and 1943, the petitioner employed an accounting firm to make an inventory of the merchandise on hand as of December 31, 1944, and to reconstruct inventories for 1943 and 1942. In arriving at the cost of the merchandise the accountants deducted the cost of materials on hand as of December 31, 1944, as shown by petitioner's books, and then calculated the labor costs on finished goods and goods in process of manufacture by making a time study of the manufacturing processes used by the petitioner with respect to each product. Then, taking petitioner's records of sales during 1944 and costing the merchandise sold in the same manner in which it had costed the merchandise on hand, they determined the opening inventory of 1944. By the same method they determined the opening and closing inventories for 1942 *640 and 1943. The results reached by the accountants*68 are shown in the following table:
| Material | ||||
| Closing | Cost value | and labor | Opening | |
| Year | inventory | in sales | purchased | inventory |
| 1944 | $ 50,284.73 | $ 42,691.85 | $ 52,854.67 | $ 40,121.91 |
| 1943 | 40,121.91 | 31,839.31 | 39,014.64 | 32,946.58 |
| 1942 | 32,946.58 | 26,629.59 | 20,522.10 | 39,054.07 |
| 1941 | 39,054.07 | 9,134.26 | 9,932.56 | 38,255.77 |
| 1940 | 38,255.77 | 2,355.87 | 1,976.00 | 38,635.64 |
| 1939 | 38,635.64 | 1,709.80 | 1,614.00 | 38,730.84 |
George Deeb, petitioner's president, spent a considerable portion of his time during 1942 and 1943 traveling on business of the petitioner. He sometimes traveled by train and sometimes by automobile. He kept no record of such travel, either as to the number of trips, the mileage, the time required, or the amounts of money expended. For each trip he would get cash or a check from his secretary in the amount which he thought might be needed. He would spend some of those funds for actual travel expenses, some for entertainment of customers, and some for special tools and equipment which were scarce or not obtainable through regular channels. He kept no record and made no account to his secretary, who was in charge of the books, of how this*69 money was spent. In petitioner's returns for 1942 and 1943 the travel expenses were claimed in the respective amounts of $ 4,205 and $ 5,130.36. The Commissioner disallowed $ 2,000 of the amount claimed in 1942 and $ 2,500 of that claimed in 1943.
The Commissioner also disallowed $ 381.50 claimed in the 1942 return under general expense, representing payments made to Hoosier Motor Club and Tarkington Aviation Corporation and "unsubstantiated disbursements of cash." The Commissioner also disallowed in the 1943 return $ 525 claimed as payments to Hoosier Motor Club and American Jersey Cattle Club and other "unsubstantiated disbursements of cash."
Petitioner claimed deduction in its 1943 return of $ 5,000 for salary paid to George Deeb, Jr., son of petitioner's president. The Commissioner disallowed $ 4,000 of that amount. George Deeb, Jr., was not regularly employed by the petitioner during 1943. He worked for an accounting firm in Indianapolis, Indiana, during the latter portion of 1942 and until March or April of 1943, when he entered the armed services as an aviation cadet. He received his basic training at Marana, Arizona, and after advanced training at Marfa, Texas, was commissioned*70 as a second lieutenant in March 1944. He served as a test pilot in 1945.
Prior to entering the military service George Deeb, Jr., had been interested in aviation and had taken a ground school course for about a year while attending Butler University and also had some flight instructions. *641 He took a special interest in the performance of piston rings, which were used in both the motors and landing gears of some of the planes, because of his father's connection with the piston ring business. From time to time while in the service he communicated to his father the information that he gained as to the faults developed in the piston rings in use and suggested manufacturing improvements. He also used his contacts with motor and airplane manufacturers to try to promote petitioner's sales of rings.
The value of the services of George Deeb, Jr., to the petitioner in 1943 was not in excess of the compensation of $ 1,000 allowed by the Commissioner.
OPINION.
(1) Relief under section 721. -- It is petitioner's contention that all of its 1942 and 1943 income resulted from research and development of tangible property, patents, formulae, and processes extending over the period*71 beginning not later than 1929 and ending about 1936 or 1937, and was therefore abnormal income within the meaning of section 721 (a) (1) and of the class described in subsection (a) (2) (C).
In our opinion the evidence fails to support this contention. From its inception the petitioner, largely through its president, conducted a certain amount of research and experimentation in piston ring manufacturing for commercial use. In so doing it merely continued the business which had been operated for a number of years by its predecessors. At the time petitioner came into existence the business was well established. This is shown by the fact that the petitioner in 1930, the first full year of its operations, had the largest volume of business of any year prior to 1941. Its sales in that year amounted to over $ 23,000, while for some of the several years next succeeding they fell off to approximately one-third that amount. Sales rose spectacularly from $ 11,000, using round figures, in 1940 to $ 45,000 in 1941, $ 129,000 in 1942, and $ 212,000 in 1943. Undoubtedly, the petitioner had done much in the meantime to improve its production and its manufacturing processes, but it was in *72 no sense pioneering in a new field and its large volume of business in the taxable years was not due to the use of any patents, exclusive rights, or special manufacturing technique which it had developed. Rather, we think, it was due to the increased demand for piston rings of all types as a result of the war.
The petitioner would have us believe that it struggled along with its efforts to develop a satisfactory method of manufacturing piston rings of steel, bronze, and alloys, as distinguished from cast iron, from its organization in 1929 until about 1936 or 1937, when its problems all became solved and it arrived at a point where it could enjoy *642 the fruits of its years of research and experimentation. This, however, was not the situation. The petitioner did not gain the use of any manufacturing patent or discovery in 1938, or any other year, to which it could attribute its large volume of business in 1942 and 1943. Its progress in improving its products and developing satisfactory manufacturing methods was slow and gradual. There is nothing in the evidence to support the claim that in the absence of the war-stimulated increase in the demand for piston rings the petitioner*73 would have met with any materially greater success in 1941, 1942, and 1943 than it had enjoyed in prior years.
The Commissioner's regulations provide that abnormal income resulting from increased sales due to increased demand for the taxpayer's products may not be attributable to prior years. Sec. 35.721-3, Regulations 112. We said in Soabar Co., 7 T. C. 89, that this provision of the regulation carries out the intent of Congress and is in harmony with the spirit and purpose as well as the word of the law.
We have purposely omitted from our findings of fact many of the facts requested by the petitioner because we regard them as merely cumulative or wholly immaterial. Even if it be granted that some portion of petitioner's income for the taxable years 1942 and 1943 resulted from improvement of its production and the development of formulae and manufacturing processes over the prior years by the petitioner as well as its predecessors, it is obvious, however, that not all of its income for 1942 and 1943 may be attributable to those sources. Undoubtedly, some of it was attributable to good management and sound manufacturing practices. The burden rests*74 upon the petitioner to show abnormality of income attributable to prior years. Cf. Pantasote Leather Co., 12 T. C. 635. Petitioner has not borne this burden.
In the view that we take of the question, it is not necessary here to discuss the failure of the proof in other respects, such as the absence of competent figures upon which to compute the statutory "net abnormal income" for either of the taxable years or the base period years. Cf. Soabar Co., supra, and Eitel-McCullough, Inc., 9 T. C. 1132. The absence of proof as to what portion of petitioner's income for the taxable years was abnormal income within the meaning of the statute is fatal to its claim for relief under section 721. The facts here, unlike those in Ramsey Accessories Mfg. Corporation, 10 T. C. 482, afford no basis upon which we could make any independent allocation of net abnormal income to prior years or any determination of net abnormal income for any of the years involved.
(2) Invested capital. -- In his notice of deficiency the Commissioner reduced petitioner's invested capital, as*75 reported in its returns, from $ 72,692.58 to $ 48,506.10 for 1942 and from $ 85,962.88 to $ 48,276.95 for 1943. The petitioner alleges that the Commissioner erred in so *643 doing. In its brief, however, it makes no argument on this issue. It states that petitioner's books do not properly reflect its invested capital and refers to certain numbered paragraphs of its requested findings, 4, 11, and 25, which are said to offer a basis for the computation of the correct invested capital.
Number 4 of the requested findings sets forth that, as stipulated, petitioner's predecessor, Garsix, was capitalized at $ 50,000.
Number 11 relates to the stipulated fact that George D. Gardner in his receivership action against Garsix stated in his petition that Garsix was indebted to him for moneys advanced to it in the amount of $ 40,000.
Number 25 relates to the advances which, according to testimony adduced at the trial, were made to the petitioner by both the wife and the sister of George Deeb, the petitioner's president.
We have found on the uncontroverted evidence that these advances amounted to from $ 18,000 to $ 25,000 by the wife and some lesser, undetermined amount by the sister. However, *76 we have not found, and the evidence does not show, whether these amounts were advanced as loans or gifts to the petitioner or to George Deeb, personally; whether they were represented by notes; whether they were ever repaid by the petitioner or George Deeb; or whether they were intended as contributions of capital. Deeb's wife was the principal stockholder of petitioner, while his sister owned none of its shares.
To be includible in equity invested capital under section 718, Internal Revenue Code, the advances, even if we could determine the exact amount, must have been paid in for stock or as paid-in surplus, or as contributions to capital. To be includible as borrowed capital under section 719 they must have been "evidenced by a bond, note, bill of exchange, debenture, certificate of indebtedness, mortgage, or deed of trust."
On the evidence before us we can make no determination that any of the amounts claimed came within the requirements of the statute. We therefore find no error in the respondent's determination of petitioner's invested capital.
(3) Excess profits credit carry-over. -- The petitioner claims an increase in its unused excess profits credit carry-over based*77 upon whatever increase is allowed in its invested capital. Since we have found that on the evidence of record the petitioner is not entitled to any increase in its invested capital, it follows that no adjustment is to be made in its unused excess profits credit carry-over.
(4) Inventories. -- The petitioner admits that the inventories as reported in its returns were incorrect. It contends, however, that the adjustments made in the notice of deficiency were also erroneous. What the Commissioner did was to adjust the opening inventory of each taxable year to the amount reported in petitioner's returns as the *644 closing inventory of the previous year. This adjustment was, of course, proper, provided the closing inventories were correctly reported. In any event, consistency requires that the opening inventory of each year correspond to the closing inventory of the preceding year.
The petitioner now contends that the inventories as reconstructed by the accountants which it engaged for that purpose should be substituted for those used by the Commissioner.
We may assume that the accountants made an honest effort to establish impartial inventories and that their calculations*78 were based on the best records available to them in petitioner's books. The fact remains, however, that their computation is at best an estimate. It represents an effort on the part of the accountants to supply by theoretical calculations the vital factors which are lacking in petitioner's records. If, as petitioner admits, records are lacking on which correct inventories could now be established, the fault lies with the petitioner, and the hardship is of its own making. To meet the burden of overcoming the prima facie correctness of the Commissioner's determination the petitioner is required to do more than come forward with the best evidence available. It must submit evidence that shows the Commissioner's determination to be in error. In this, we think, the petitioner has failed.
(5) Traveling, entertainment, and general expenses. -- In this issue the evidence, again, is wholly lacking to show that the Commissioner erred in disallowing a portion of the deductions claimed by the petitioner for travel, entertainment, and general expenses. The petitioner admittedly kept no records of the amounts actually spent for traveling and entertainment. Apparently, the amounts claimed*79 in each year represented the total of the amounts which George Deeb estimated would be needed and which he withdrew for the various trips that he made. We do not know how many trips were made or to what places. He testified that he spent some of the funds for tools and equipment. These may all have been capital expenditures. At any rate, they were not deductible as travel expenses.
It seems to us that in the light of the evidence the Commissioner's allowance of more than one-half of the $ 4,205 claimed as a deduction in 1942 and the $ 5,130.36 claimed in 1943 was generous.
There is no evidence on which we can make any ruling as to the deductibility of the items claimed as payments made to the Hoosier Motor Club and the Tarkington Aviation Corporation or as to the "unsubstantiated disbursements of cash." The respondent's disallowance of these items is therefore sustained.
(6) Salary of George Deeb, Jr. -- The petitioner claimed a deduction of $ 5,000 in 1943 for salary paid to George Deeb, Jr. The Commissioner allowed $ 1,000 and disallowed $ 4,000 of that amount.
*645 George Deeb, Jr., was neither an officer nor a regular employee of the petitioner in 1943. He was *80 employed by an accounting firm in Indianapolis, Indiana, for the first three or four months of that year and served in the armed forces as an aviation cadet for the remainder of the year. The contention is made that while he was serving as an aviation cadet he rendered valuable services to the petitioner by studying the use of piston rings in airplane motors and landing gears, advising the petitioner of needed improvements, and aiding petitioner in making contacts with potential customers.
The record completely fails to support this contention. It is our opinion that any services that George Deeb, Jr., rendered the petitioner in 1943 were only remotely related to the petitioner's business and were of no more than nominal value. Again, we think, the Commissioner was liberal in his allowance of $ 1,000 of the $ 5,000 claimed.
Decision will be entered for the respondent.