*228 Decisions will be entered for the respondent.
1. Excess Profits Tax -- Relief -- Section 722 (b) (4) -- Commence Business. -- Petitioner, a plywood manufacturing corporation, came into existence in 1939 when its articles of incorporation were filed, but did not commence business so as to qualify for relief under section 722 (b) (4) until after the end of the base period when its officers and directors were elected and its nature and character were fully determined.
2. Excess Profits Tax -- Relief -- Section 722 (c) (3) -- Invested Capital. -- Petitioner has failed to establish that its invested capital was abnormally low, and, therefore, does not qualify for relief under section 722 (c) (3).
*17 Respondent*229 disallowed petitioner's applications for relief under section 722 (b) (4) and (c) ( 3) of the Internal Revenue Code for each of the calendar years 1940, 1941, 1942, 1943, and 1944. The primary issues are whether petitioner commenced business during the base period and, if not, as respondent determined, whether its invested capital was abnormally low.
*18 FINDINGS OF FACT.
The stipulated facts are so found.
Petitioner is a corporation organized under the laws of the State of Oregon with its principal office at Olympia, Washington. It was organized with a total authorized capital stock of $ 750,000 divided into 7,500 shares with a par value of $ 100 each. The organizers of petitioner fixed that amount for capitalization in order to create a high return per share on the stock. Petitioner has regularly maintained its records on the accrual basis and filed its income and excess profits tax returns with the collector of internal revenue for the district of Washington.
Petitioner's articles of incorporation were filed with the Corporation Commissioner for the State of Oregon on or about October 6, 1939, and with the County Clerk of Lane County, Oregon, on or about October 8, 1939.
*230 Issue 1.
In the latter part of 1938 the idea of incorporating Springfield Plywood Corporation occurred to one E. E. Westman. Westman had been connected with the business of manufacturing Douglas fir plywood for a number of years, having been actively engaged in that business since 1921. He was secretary-treasurer of Olympia Veneer Company and later president, 1921 to June 1924, and vice president and manager and later president and general manager of Washington Veneer Company (hereinafter sometimes referred to as the Veneer Company), June 1924 until 1946.
After originating the idea to erect a plywood plant at Springfield, Oregon, Westman consulted with the board of directors of the Veneer Company and with Charles W. Briggs, president and general manager of the Booth-Kelly Lumber Company (hereinafter sometimes referred to as Booth-Kelly).
Booth-Kelly was in the logging and sawmill business. It had a mill and log pond at Springfield and had one of the largest holdings of timber in that part of the state.
Prior to organizing Springfield Plywood Corporation, Westman and his associates had been informed that a promotional scheme was under way to build a plywood plant in the vicinity*231 of Eugene, Oregon. Westman and associates thought that with cheaper logs this plant would be "pretty tough competition" and for that reason were interested in going in there and erecting a plant themselves.
Westman investigated the timber in the vicinity of the proposed site for the plant. The Veneer Company made a test run of about 160,000 to 175,000 feet of this timber and in addition had watched the Booth-Kelly sawmill operations at Eugene and Springfield; both operations made a favorable impression.
*19 Westman urged upon Booth-Kelly that the Veneer Company was experienced in the plywood business and had more markets for plywood than it was producing. Booth-Kelly had a lot of timber. Westman thought it would be of mutual interest if the companies entered into what might be called a joint venture and establish a plywood plant adjacent to the Booth-Kelly mill in Eugene. Booth-Kelly thought well of it, and accordingly Springfield Plywood Corporation was organized. Some of the details of the matter were talked over in 1939, the general idea being at that time that the Veneer Company would furnish the management and the greater part of the money and Booth-Kelly would furnish*232 facilities, such as the ground, pond site, and water, but the capitalization and corporate ownership had not been finally determined.
At this time the Booth-Kelly facilities for log storage were not sufficient to also take care of logs for the proposed plywood plant. To provide such storage facilities Booth-Kelly purchased the necessary property from the city of Springfield and agreed to build a log pond to take care of that storage of logs. Booth-Kelly arranged for building the log pond and started the work shortly after October 9, 1939. By the end of the year the pond was practically completed, that company having expended from $ 20,000 to $ 22,000 on the pond.
Westman received a proposal addressed to the Veneer Company from McManama & Company, dated September 21, 1939, for the construction of the power plant for the plywood plant and furnishing the machinery for the power plant. Westman accepted the proposal before December 31, 1939, and work was started within about a week thereafter. None of the machinery or equipment was delivered to the plant site until after December 31, 1939, and the express written contracts for such were not executed prior to that date.
In June 1939*233 Westman gave Coe Manufacturing Company of Painesville, Ohio, an oral order for two lathes, two dryers, two clippers, and saw tables. Coe Manufacturing Company commenced the manufacture of the machinery in June 1939. The dryers were received in November 1939. The contract price for this machinery was $ 156,243.
During the year 1939 Westman received a written proposal from Industrial Engineers & Contractors, Inc., to furnish labor, material, and equipment to construct the veneer plant building for the proposed corporation by letter dated October 12, 1939. That proposal was accepted within a week after it was made by Westman individually, and the main structure was nearing completion by the end of 1939.
Under date of June 7, 1939, Westman addressed a letter that he signed on behalf of the Veneer Company to Briggs, as president of Booth-Kelly, notifying him that the Veneer Company was "going *20 along on the basis of this deal being consummated," though there had been no formal approval by the board of directors.
Under date of June 16, 1939, Westman addressed a further letter that he signed on behalf of the Veneer Company to Briggs, as president of Booth-Kelly, which read in *234 part as follows:
We had our meeting Monday night, when all members of the Board were present, and this was the first time that the two members representing the U. S.Plywood stock have been present at any of these sessions.
As you undoubtedly know, the U. S.Plywood has a substantial interest in our Company, and Mr. Schweppe, of Seattle, represents Ottinger out here on the Coast in any matters as to policy and negotiations of any nature coming up within the industry. He speaks for Mr. Ottinger at any of our plywood meetings, and when I first mentioned to him 2 or 3 weeks ago what we had in mind to do, he asked me if it would be possible for them to put in $ 100,000 into this new setup, to which I answered I would have to discuss this with our Associates here in Olympia, as well as you people in Eugene.
Our Board is entirely for the deal, but it was suggested that we might extend the courtesy to Mr. Ottinger in New York to come out and have a little talk with us, and this forenoon I received the message that he will fly out here, and be in Olympia next Wednesday or Thursday.
I have no way of knowing of course whether or not you would even consider taking U. S.Plywood in as part owner*235 of this setup, and before Mr. Ottinger comes out here, I would like to have a word from you in this respect, wherein it would be understood, of course, that your Company, as well as ourselves, would have absolute control of the situation -- of that I think we both must be sure.
* * * *
It is going to be necessary to have one large lathe and one small machine, and one large hot plate and one small hot plate machine, and I am satisfied that the two hot plate presses will take care of a capacity of 5,000,000' or better per month, whereas previously we thought it would require three machines.
Going over the entire equipment with buildings, I believe it would be advisable to incorporate for $ 600,000 rather than $ 500,000, so that when the plant starts operation we will have everything paid for and a fair amount of working capital.
* * * *
While the writer and other members of the Board do not like to postpone the closing of this deal, it was more or less the consensus of opinion that we should extend the courtesy to Mr. Ottinger to take a trip out here to discuss this matter with us before we legally act, as we naturally like to be on friendly terms with our stockholders and I might also*236 say to you, Mr. Briggs, that I have been working on a deal whereby Mr. Ottinger would sell at least part of his stock, and we in turn would make a deal with Weyerhaeuser Timber Company to invest with us here in Olympia, and from the negotiations so far, it appears that Mr. Ottinger is willing to do so, and that is one more reason for him coming out, and I feel reasonably sure that we will work out a satisfactory deal, but in the meantime, every member of our Board is 100% for this deal, and they have asked me to convey that thought to you as it might appear that we are more or less uncertain as to what we expect to do, which however is not the case.
* * * *
* * * If it is possible to make an arrangement where U. S.Plywood, Weyerhaeuser and Washington Veneer Company would combine their efforts with you towards distribution of the plywood, it would of course give every assurance that that plant would be running 100% at all times, which we are all interested in.
*21 U. S.Plywood, if unable to make a deal with us, on this hot plate manufacturing, will be forced to make their own installation in Seattle, and this they do not care to do, if other arrangements can be made, and as *237 you can well understand, all these things have occupied our minds in connection with our proposed deal with you, and should of necessity be given due consideration no matter what the final decision may be.
Briggs wrote E. B. Tanner, a director of Booth-Kelly, on November 2, 1939, that there would be a further delay in the organization of petitioner because the Ottinger stock deal had not yet been completed.
Under date of November 16, 1939, Briggs advised Westman that the board of directors of Booth-Kelly had authorized him to subscribe for stock in petitioner when the log purchase contract was executed "so that when the time comes for the completion of your organization we may be in position to sign whatever agreement is decided upon."
Under date of December 21, 1939, Briggs addressed a further letter to Tanner notifying him that the Ottinger stock deal was finally going through and that Westman's group "are hopeful of being able to complete the organization of the Springfield Plywood Corporation before the 10th of January, when somebody will have to put up the cash for the December expenditures."
Under date of January 10, 1940, Westman addressed a letter that he signed on behalf of*238 the Veneer Company to C-W Plywood Company, which maintained offices in Chicago and had been one of the Veneer Company's selling agencies for many years. The letter read in part as follows:
Dear Raleigh and Jac:
We expect to conclude the deal with the Weyerhaeuser Timber Company on Thursday, January 18th, whereby the U. S. Plywood Company's interest is being purchased by the Weyerhaeuser Timber Company, and in addition thereto, they are making an additional investment, on an even basis with our own stockholders for the purpose of expanding our activities into Springfield, Oregon, which plant is now under construction.
The minutes of the incorporators' meeting on March 7, 1940, reveal that on that date the first meeting of subscribers to the stock of the company was held, the first board of directors elected, and later the same day the first meeting of the directors was held and the officers elected. The stock subscriptions for 6,250 out of the 7,500 authorized shares were unanimously accepted.
The minutes of the regular annual meeting of the directors of the Veneer Company on February 13, 1940, read in part as follows:
The affairs of the proposed subsidiary, Springfield Plywood*239 Corporation were discussed at length. It was reported that in connection with the company's plants it probably would be necessary for Washington Veneer Company to join in a three party contract in connection with the log purchases by Springfield Plywood Corporation.
On motion duly made and seconded, the President, Mr. E. E. Westman, was authorized to execute for and on behalf of the corporation any such contracts *22 and agreements as may be necessary or proper in connection with the securing of logs and other materials for use in the plants of Springfield Plywood Corporation.
The petitioner filed an income tax return for the calendar year 1939 which reported that it had had no income or expenses during such calendar year and owned no assets as of December 31, 1939. This return was transmitted to the collector of internal revenue at Tacoma, Washington, by a letter dated June 29, 1940, that also directed attention to an associated affidavit, duly executed under the same date by petitioner's corporate secretary, one Norton Clapp. Such affidavit read in part as follows:
Corporation was chartered on October 6, 1939, and the first organization meeting of stockholders was held on*240 March 7, 1940, at which time the first officers were elected. No business was transacted by the corporation during 1939, the corporation had no income and the Treasurer elected on March 7, 1940, was of the opinion no return was required.
Petitioner did not begin actual manufacture of plywood before July 1940.
Neither the type and grade of plywood which petitioner would produce nor the productive facilities to be employed by it were fully determined until after December 31, 1939. The manner in which its product would be merchandised and sold was not determined until after December 31, 1939. Petitioner's capitalization was not determined until after December 31, 1939. Neither the nature of the petitioner nor the character of its business had been determined as of the end of the base period.
Petitioner did not commence business during the base period.
Issue 2.
Petitioner was created and organized to help satisfy an ever increasing demand for plywood stimulated by the prewar boom starting in 1939. Both the Veneer Company and United States Plywood Corporation, hereinafter referred to as the Plywood Corporation, owner and operator of a plywood plant in Seattle, Washington, could*241 not adequately supply their markets.
Since its original organization in June 1924, the principal activity of the Veneer Company has been the manufacture and sale of Douglas fir plywood although it also operated a sawmill and engaged in logging operations during the major part of the base period and certain prior years. In 1928 or 1929 it substantially doubled its productive facilities by erecting a separate "No. 2" plant about one-half mile from its original plant in Olympia. It was then contemplated that a substantial part of this additional productive capacity could be utilized by selling plywood for export. Sometime during 1931 or 1932 *23 when the export market and general business conditions were both very poor, a new corporation, known as Capital Plywood Company, which was organized under the joint sponsorship of Veneer Company and Harbor Plywood Company, took over the operation of this second plant under a temporary lease arrangement which continued in effect until some time in 1937 or 1938 when the Veneer Company reacquired it. The Veneer Company's officers continued the active management of the Capital plant without receiving any direct compensation from Capital *242 Plywood Company throughout the period of this lease and the Veneer Company made no direct charge to Capital for their services in this connection. The Capital Plywood Company had been completely dissolved for some time before the petitioner was organized but the No. 2 plant continued to be operated in its name for certain purposes and there never had been any very complete change in its relationship to the original plant even during the period when Harbor Plywood Company had a joint interest in its operation. For example, it was not uncommon during this period for a particular raft of logs to be bought in common and divided between the two plants for processing.
On January 13, 1940, the Veneer Company and the Plywood Corporation entered into a contract by the terms of which the Plywood Corporation was given an exclusive preferential right to purchase from the Veneer Company, effective July 1, 1940, Douglas fir plywood equal to 2,000,000 square feet per month on a 3/8-inch basis, contingent upon full operation of the plants of petitioner and the seller, at a price 7 per cent under the market price to jobbers and subject to a discount of 2 per cent for payment within 10 days, and the*243 Veneer Company was given the right to all orders of Douglas fir plywood that were received by the Plywood Corporation in excess of the monthly production of the Seattle plant of the Plywood Corporation in an amount equal to 2,000,000 square feet on a 3/8-inch basis. All of the orders of the Plywood Corporation were to be placed with the Veneer Company and could be filled by it from production of its plant or petitioner's plant. The contract was to remain in force for a period of 3 years and continue thereafter unless terminated by written notice given in accordance with terms of the contract. The contract was entered into to comply with a condition the Plywood Corporation made to the sale by it to the Weyerhaeuser Lumber Company of 2,005 shares of stock it held of the Veneer Company.
Booth-Kelly, the Veneer Company, and petitioner entered into a written agreement on May 11, 1940, by the terms of which Booth-Kelly leased to petitioner for a term of 15 years with an option of renewal for terms of 5 years but not in excess of 35 years, at an annual rental of $ 4,000, a plant site and storage pond which had an opening to the lessor's storage pond, and Booth-Kelly agreed to pay cash*244 for *24 its subscription of 250 shares of petitioner's stock and to purchase an additional 750 shares of stock for $ 75,000, payable $ 5 per thousand feet of logs purchased from it by petitioner, any balance at the end of 3 years to be paid in cash by the purchaser, and Booth-Kelly was given an unassignable option for 3 years to purchase an additional 500 shares for $ 50,000 cash. The agreement gave petitioner first call on all logs produced by Booth-Kelly and not required for its manufacturing purposes and petitioner agreed to purchase, to the extent of the ability of Booth-Kelly to supply, all of its requirements of logs from Booth-Kelly. Booth-Kelly agreed to purchase from petitioner its requirements of plywood for sale to its customers, but not in excess of a quantity measured by its holdings of stock of petitioner, the quantity not to be less than 10 per cent nor more than 25 per cent of petitioner's production, any unfilled orders at the end of one month to be filled the next month. It was agreed that neither Booth-Kelly nor the Veneer Company would knowingly accept orders from wholesalers for resale to jobbers. Sales by petitioner to Booth-Kelly were to be at prices*245 not greater and upon terms not less favorable than sales by petitioner to the Veneer Company. All products of petitioner not sold to Booth-Kelly pursuant to the agreement were to be sold to the Veneer Company at, unless otherwise agreed, the jobber's price less 7 per cent and less 2 per cent for cash in 10 days. The agreement contained another provision reading as follows:
It is agreed that the Plywood Company has at present no operating or administrative organization and that the Veneer Company has a large organization with long and successful experience in plywood manufacturing and marketing. It is agreed that the operating and administrative organization should be kept as small and as economical as possible and that this may be accomplished as follows: The Veneer Company agrees that its organization shall furnish general supervision over the construction and equipment of the Plywood Company's plant until it is fully completed and in full operation; and thereafter shall furnish general supervision of the maintenance of said plant, of log buying, and of production and shipping operations. For said services the Plywood Company shall pay the sum of $ 10,000.00 for all services *246 rendered by the Veneer Company up until the time said Plywood Company starts operating, and thereafter the Plywood Company shall pay to the Veneer Company $ 1,000.00 per month for such services. Such provisions for compensation shall be adjusted from time to time as conditions warrant so that said compensation shall at all times be reasonable.
The petitioner constructed a plant on the leased premises in 1940 at a cost of about $ 872,000.
The Veneer Company gave to petitioner such financial assistance as it needed to start and continue in production. Booth-Kelly carried most of petitioner's log inventories. The plan was for the Veneer Company and Booth-Kelly to take 75 per cent and 25 per cent, respectively, of petitioner's production, on selling terms providing for a discount of 2 per cent for payment within 10 days. The Veneer Company *25 made immediate payment upon receipt of invoices for shipments to it.
The Veneer Company furnished all of the supervisory services for petitioner. The only management the Veneer Company had at petitioner's plant was a factory superintendent. Duties of a general manager and officers of higher levels were conducted from the Olympia office*247 of the Veneer Company. The Veneer Company effected the sale of substantially all plywood produced by petitioner, kept most of the books of account of petitioner in its Olympia office, made all disbursements other than payroll, purchased its requirements of logs and accepted all credit responsibility for its accounts.
No officers of petitioner received compensation for their services as such with the exception of the assistant treasurer who received $ 3,200 in 1940, $ 3,825 in 1941, and $ 5,080.70 in 1944.
Petitioner paid the following amounts to the Veneer Company for management and supervision fees: 1940, none; 1941, $ 16,500; 1942, $ 18,000; 1943, $ 19,050; and 1944, $ 9,000.
More than one-half of the 7,000 shares of stock outstanding of the Veneer Company was owned by the Weyerhaeuser Lumber Company, which had extensive timber holdings.
At the close of 1940 the 7,500 shares of stock of petitioner were held as follows:
| Individuals (35) | 2,000 |
| Booth-Kelly | 1,000 |
| Veneer Company | 4,500 |
Eight new plywood plants commenced production in 1941, a year in which demand for plywood under the stimulus of wartime requirements increased one-third over the previous year.
Sales of petitioner*248 during the years 1940 to 1944, inclusive, as disclosed by its books, were as follows, cents omitted:
| 1940 1 | 1941 | 1942 | 1943 | 1944 | |
| Plywood: | |||||
| Booth-Kelly | $ 64,998 | $ 492,143 | $ 725,073 | $ 802,665 | $ 974,349 |
| Weyerhaeuser | 123,717 | 568,856 | 669,591 | 974,459 | 1,268,866 |
| Veneer Co | 477,153 | 1,644,207 | 1,799,291 | 1,931,734 | 1,310,424 |
| Others | 184 | 1,292 | 2,103 | 2,454 | 1,941 |
| By-products | 1,623 | 7,040 | 11,718 | 16,138 | 18,360 |
| Lumber | 114,759 | 769,969 | |||
| Logs | 3,367 | 8,478 |
Petitioner paid no dividends during the taxable years.
Sales of plywood by the Veneer Company during the years 1941 to 1944, inclusive, as disclosed by its books, were as follows:
| 1941 | $ 4,473,073.35 |
| 1942 | 4,178,437.50 |
| 1943 | 3,987,701.00 |
| 1944 | 3,581,954.00 |
*26 The monthly average sales, receivables and ratios of sales to receivables of petitioner and the Veneer Company during the years 1941 to 1944, inclusive, as disclosed by their books, were as follows:
| Ratios | |||
| Year | Sales | Receivables | (per cent) |
| Petitioner: | |||
| 1941 | $ 226,128 | $ 36,494 | 16.14 |
| 1942 | 267,701 | 54,038 | 20.19 |
| 1943 | 319,963 | 63,428 | 19.82 |
| 1944 | 363,041 | 98,967 | 27.26 |
| Washington Veneer Co.: | |||
| 1941 | $ 459,837 | $ 518,922 | 112.85 |
| 1942 | 441,347 | 461,566 | 104.58 |
| 1943 | 409,604 | 472,107 | 115.26 |
| 1944 | 591,990 | 568,975 | 96.11 |
*249 The invested capital of petitioner and the Veneer Company for the years 1940 to 1944, inclusive, as disclosed by their books, were as follows, cents omitted:
| PETITIONER | ||
| 1940 | 1941 | |
| Equity invested capital beginning of | ||
| year: | ||
| Stock | $ 750,000 | |
| Accumulated earnings | 58,218 | |
| Paid in for stock | $ 565,825 | |
| Borrowed capital (50 per cent) | 28,318 | 5,865 |
| Total | $ 594,143 | $ 814,083 |
| Taxable net income | 79,864 | 478,402 |
| Return on invested capital | 13.44% | 58.77% |
| VENEER COMPANY | ||
| Invested capital | $ 1,419.223 | $ 1,618,554 |
| Taxable net income | 718,198 | 557,676 |
| Return on invested capital | 50.61% | 34.46% |
| PETITIONER | |||
| 1942 | 1943 | 1944 | |
| Equity invested capital beginning of | |||
| year: | |||
| Stock | $ 750,000 | $ 750,000 | $ 750,000 |
| Accumulated earnings | 248,050 | 348,483 | 471,874 |
| Paid in for stock | |||
| Borrowed capital (50 per cent) | 36,109 | 60,928 | |
| Total | $ 998,050 | $ 1,134,592 | $ 1,282,802 |
| Taxable net income | 345,155 | 430,322 | 373,990 |
| Return on invested capital | 34.58% | 37.93% | 29.15% |
| VENEER COMPANY | |||
| Invested capital | $ 1,822,503 | $ 1,854,754 | $ 2,230,150 |
| Taxable net income | 253,841 | 486,747 | 703,937 |
| Return on invested capital | 13.93% | 26.24% | 31.56% |
*250 The aggregate earnings of petitioner to the close of 1943, after income and excess profits taxes, were $ 471,537.81.
The monthly inventory of logs of petitioner during the years 1941 and 1942 ranged from $ 1,444 to $ 42,742, the average being $ 17,884 in 1941, when the average monthly inventory turnover was 3.86 per cent, and $ 29,455 in 1942, when the turnover was 3.02 per cent. The average monthly log inventory turnover of the Veneer Company was .94 per cent in 1941 and 1.11 per cent in 1942.
Petitioner's total production of Douglas fir plywood was physically equivalent to 76,623,000 square feet of 3/8-inch plywood in 1941 and 84,031,000 square feet of the same thickness in 1942.
The excess profits net income and excess profits credit, each based on the invested capital method reported by petitioner in its returns, the constructive average base period net income claimed by petitioner in its applications for relief under section 722 and the excess profits credits of petitioner determined on the invested capital method without *27 the benefit of section 722, and the excess profits tax liability of petitioner, as determined by respondent, omitting cents, were as follows for the*251 taxable years:
| 1940 | 1941 | |
| Excess profits net income | $ 61,645 | $ 465,981 |
| Excess profits credit claimed | 47,750 | 65,178 |
| Constructive average base period | ||
| net income | 344,815 | 407,897 |
| Excess profits credit determined | 47,531 | 65,126 |
| Excess profits tax liability | 2,212 | 203,646 |
| 1942 | 1943 | 1944 | |
| Excess profits net income | $ 255,287 | $ 503,377 | $ 386,386 |
| Excess profits credit claimed | 79,741 | 91,087 | 100,433 |
| Constructive average base period | |||
| net income | 429,778 | 429,778 | 429,778 |
| Excess profits credit determined | 79,844 | 89,035 | 100,433 |
| Excess profits tax liability | 249,599 | 303,918 | 222,709 |
Petitioner's invested capital was not abnormally low.
OPINION.
Issue 1.
To qualify under section 722 1 petitioner must prove that the tax computed without the benefit of section 722 results in an excessive and discriminatory tax and what would be a fair and just amount representing normal earnings to be used as a constructive average base period net income.
*252 It must also prove that it commenced business after the beginning of and during the base period since that is the factor upon which it bases its claim for relief under section 722 (b) (4), which states:
(b) Taxpayers Using Average Earnings Method. -- The tax computed under this subchapter (without the benefit of this section) shall be considered to be excessive and discriminatory in the case of a taxpayer entitled to use the excess profits credit based on income pursuant to section 713, if its average base period net income is an inadequate standard of normal earnings because --
* * * *
(4) the taxpayer, either during or immediately prior to the base period, commenced business or changed the character of the business and the average base period net income does not reflect the normal operation for the entire base period of the business. * * * [Emphasis added.]
*28 It seems clear from the voluminous record in this case that although petitioner was technically in existence in 1939 when its articles of incorporation were filed, it had not in fact commenced business before December 31, 1939, as required by the statute.
Our recent decision in Victory Glass, Inc., 17 T. C. 381,*253 is not in point, that being a case where actual business operations were undertaken almost simultaneously from the time of incorporation. Here, the correspondence carried on between the incorporators clearly indicates the many changes in the capital structure prior to the organizational meeting in March 1940.
On that date the first meeting of subscribers to the stock of the company was held and the first board of directors elected and, later the same day, the first meeting of the directors was held, and the officers were elected.
The corporation then for the first time was in a position to transact any business. Petitioner did not actually commence the production of plywood until some time in July 1940.
We find that petitioner did not commence business during the base period and, accordingly, it does not qualify for relief under section 722 (b) (4).
Issue 2.
Inasmuch as petitioner did not commence business until 1940 it must rely upon section 722 (c) 2 for any relief to which it may be entitled. Subsections (c) (1) and (2) relate to inadequacy of the excess profit credit because of the class of business in which the taxpayer was engaged. Petitioner concedes that its business*254 was not within either of those classes. Subsection (3) relates to conditions existing with respect to a particular corporation. Petitioner contends, in the alternative, that its invested capital was abnormally low and therefore qualifies for relief under subsection (3). The specific contention of petitioner, as summarized by it on brief, is:
*29 * * * that in a case where a corporation does not have sufficient invested capital to pay for its plant; where it has no working capital whatsoever and no capital to meet contingencies; where it is only able to start manufacturing and continue so to do because of intangible benefits in the shape of assured outlets through its stockholders, assured supply of logs through one of its stockholders, and a helping hand through another of its stockholders, it has an invested capital which is so low that it is not a fair basis for determining the excess profits credit and it has therefore an invested capital which is abnormally low within the meaning of section 722 (c) (3).
*255 We agree with the conclusion in Bulletin on Section 722, p. 131, that the term "invested capital" in subsection (c) (3) means invested capital determined under the Code for excess profits tax purposes.
The Code contains no definition of the term "abnormally low" in the same subsection. The word "abnormal" is defined in Webster's New International Dictionary as meaning "Not conformed to rule or system; deviating from the type; anomalous; irregular." Section 35.722-4 of Regulations 112 provides that:
* * * If the type of business done by the taxpayer is not one in which invested capital is small but the invested capital of the taxpayer is unusually low because of peculiar conditions existing in its case, the excess profits credit based on invested capital will be considered an inadequate standard for determining excess profits. Thus, suppose that a corporation commenced business in 1941 with a leased plant valued at $ 1,000,000, but with equity invested capital and borrowed capital of only $ 40,000. If the invested capital of such company is unusually low relative to the size of its operations, its excess profits credit based on invested capital might be an inadequate standard*256 for determining excess profits, and the taxpayer would be subject to an unreasonable tax burden if required to compute its excess profits tax under the invested capital method. [Emphasis added.]
Use of the indefinite term "unusually low" to describe the statutory term "abnormally low" adds nothing substantial to the problem.
The nearest approach to a definition in the Bulletin is a statement that: "The words 'abnormally low' indicate that there must be present some identifiable abnormality in the taxpayer's invested capital structure." Situations are then mentioned, because of which invested capital of the taxpayer "may be abnormally low." None of them are intended to be more than indications of an abnormally low invested capital. We agree with a statement of the Council that: "There must be a substantial departure from the normal or usual invested capital structure for the industry, and the taxpayer must demonstrate that such is true in its case for reasons peculiar to itself." Whether or not a taxpayer's invested capital is abnormally low is a factual question and no criteria can be prescribed as a yardstick. All of the evidence in each case must be considered in determining*257 the ultimate fact.
In its applications for relief and petitions, petitioner claimed constructive average base period net income of $ 344,815.95 to be used as *30 a basis for excess profits credit in 1940, $ 407,897.64 in 1941 and $ 429,778.91 in each of the subsequent taxable years. On brief it asks us to find constructive average base period net income of $ 385,575.38, based upon constructive net income for it during the base period, and if we find the computation "at all out of line," and use the Veneer Company as a comparative, that we determine constructive average base period net income in the amount of $ 238,496.20. The maximum amount claimed as constructive average base period net income is about 87 per cent of the aggregate excess profits net income during the taxable years.
While in its application for relief petitioner compared its productive capacity, paid-in capital and earned surplus with the Veneer Company and asserted in a protest filed with the Internal Revenue Agent in Charge that the Veneer Company was "not necessarily a comparative," on brief it refers to the excess of its return on invested capital over the earnings of the Veneer Company as an indication*258 that it was under-capitalized and says that the evidence offered by it "shows an abnormally low invested capital considering the petitioner and Washington Veneer Company" and that if it was normal in the industry as a whole to commence business without sufficient capital to pay the cost of a plant and working capital, the respondent should have established the fact.
The Veneer Company not only produced plywood, the business in which petitioner was engaged, but conducted lumbering and sawmilling operations, hence some of the capital of the Veneer Company was employed in activities other than those in which petitioner was engaged. A business of that sort would ordinarily require a higher paid-in capital than petitioner had, particularly in view of the fact it had its own sales organization and had to bear the full cost of administering its affairs. Any use of its capital as a comparative would require that proper weight be given for the difference in character of business in which it was engaged. Using it as a comparative for the limited purpose suggested by petitioner does not establish that petitioner's invested capital was abnormally low.
The average return on the invested capital*259 of the Veneer Company for the years 1940 to 1944, inclusive, was 31.36 per cent, against 34.77 per cent for petitioner by treating the earnings for 5 months in 1940 as profits for a full year. Petitioner asserts that its average rate of return for that period was 39.41 per cent, or 8.05 per cent in excess of the Veneer Company. It does not explain the method it employed in arriving at the 39.41 figure, but it appears to have resulted from placing the earnings in 1940 on an annual basis. Of the invested capital of the Veneer Company, $ 450,000 was invested in stock of petitioner, which petitioner does not appear to have taken into account. Elimination of the amount results in average earnings of about 40 *31 per cent on the capital actually used in its business, a ratio in excess of petitioner's earnings. The comparison indicates that petitioner's invested capital was abnormally high, rather than abnormally low, as contended by it. If other comparatives would tend to prove that petitioner's invested capital was abnormally low, the obligation to produce them was on petitioner, not the respondent.
Petitioner contends that the abnormalities relied upon by it enabled it to commence*260 business on paid-in capital of $ 750,000, without which it would have had to have $ 1,250,000.
The amount of capital stock of petitioner was fixed at $ 750,000 rather than a greater amount, for the effect it would have on the rate of return per share to the stockholders. The lack of need for more capitalization is apparent. Petitioner had no sales, administrative or inventory problems. The Veneer Company and Booth-Kelly agreed to take all of its production. The Veneer Company administered the affairs of petitioner for a small fee, assumed credit risks 3 and advanced funds needed for operation, and Booth-Kelly carried most of its inventory of logs. Its borrowings, for purposes not established, were never large and the amounts were small in comparison with other items of invested capital, which consisted of paid-in capital and earnings.
Petitioner was a member of a closely knit organization. Its affairs were conducted more like a department of its majority stockholder, the Veneer*261 Company, than a separate entity. Such situations may frequently exist where common control is present and cannot be said to be abnormal for an industry as a whole. Petitioner had earnings, after taxes, of about $ 472,000 at the close of 1944. In any event, earnings alone do not establish an abnormally low invested capital. Under the facts present here, we do not think petitioner has proved that its invested capital was abnormally low, and we so find.
Reviewed by the Special Division.
Decisions will be entered for the respondent.
Footnotes
1. Last 5 months.↩
1. SEC. 722. GENERAL RELIEF -- CONSTRUCTIVE AVERAGE BASE PERIOD NET INCOME.
(a) General Rule. -- In any case in which the taxpayer establishes that the tax computed under this subchapter (without the benefit of this section) results in an excessive and discriminatory tax and establishes 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 tax based upon a comparison of normal earnings and earnings during an excess profits tax period, the tax shall be determined by using such constructive average base period net income in lieu of the average base net income otherwise determined under this subchapter. In determining such constructive average base period net income, no regard shall be had to events or conditions affecting the taxpayer, the industry of which it is a member, or taxpayers generally occurring or existing after December 31, 1939, except that in the cases described in the last sentence of section 722 (b) (4) and in section 722 (c), regard shall be had to the change in the character of the business under section 722 (b) (4) or the nature of the taxpayer and the character of its business under section 722 (c) to the extent necessary to establish the normal earnings to be used as the constructive average base period net income.↩
2. (a) General Rule. -- In any case in which the taxpayer establishes that the tax computed under this subchapter (without the benefit of this section) results in an excessive and discriminatory tax and establishes 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 tax based upon a comparison of normal earnings and earnings during an excess profits tax period, the tax shall be determined by using such constructive average base period net income in lieu of the average base period net income otherwise determined under this subchapter. * * *
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(c) Invested Capital Corporations, Etc. -- The tax computed under this subchapter (without the benefit of this section) shall be considered to be excessive and discriminatory in the case of a taxpayer, not entitled to use the excess profits credit based on income pursuant to section 713, if the excess profits credit based on invested capital is an inadequate standard for determining excess profits, because --
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(3) the invested capital of the taxpayer is abnormally low.↩
In such case for the purposes of this subchapter, such taxpayer shall be considered to be entitled to use the excess profits credit based on income, using the constructive average base period net income determined under subsection (a). * * *3. Practically none was involved.↩