Decision will be entered for the respondent.
Petitioner, engaged in the operation of a bakery and the distribution of bakery goods by means of house-to-house delivery, seeks relief under section 722 (b) (2) and (b) (4) of the Internal Revenue Code, 1939, from excess profits taxes for 1943, 1944, and 1945 on the grounds that its base period earnings were depressed because of a price war, and that it increased its capacity for production and operation. Held, petitioner is not entitled to relief under section 722 (b) (4) as it has not shown a change in the character of its business within the meaning of that section. Held, further, assuming, but not deciding, that petitioner is qualified for consideration for relief under section 722 (b) (2), petitioner has nevertheless failed to establish that it is entitled to a constructive average base period net income which is large enough to produce a credit greater than the credit used by the petitioner under section 713 (f) of the 1939 Code, or that the excess profits taxes for the years in issue are excessive and discriminatory.
*968 FINDINGS OF FACT.
The petitioner is a California corporation, incorporated in 1931 to engage in the operation of a bakery and the distribution of bakery goods by means of house-to-house delivery. Its principal office is at Los Angeles, California.
Petitioner's books and returns were on the accrual and calendar year basis for all years material hereto. Its returns were filed with the collector of internal revenue for the sixth district of California.
Petitioner filed income, declared value excess-profits, and excess profits tax returns for the calendar years 1940 to 1945, inclusive. The excess profits tax liability and excess profits net income as determined by respondent for the taxable years, without benefit of section 722, were as follows:
| Excess profits | Excess profits | |
| Year | tax | net income |
| 1940 | 1 $ 86,012.37 | |
| 1941 | 129,403.87 | |
| 1942 | 339,952.42 | |
| 1943 | $ 330,327.34 | 708,314.52 |
| 1944 | 440,995.40 | 716,284.65 |
| 1945 | 503,223.43 | 809,166.19 |
In the computation of petitioner's excess profits tax liability for the taxable years 1942 and 1943, unused excess profits credits of $ 128,923.13 and $ 85,013.49 were allowed *233 by respondent as carry-overs from the years 1940 and 1941, respectively.
Petitioner was in existence during the entire base period, and is entitled to use the excess profits credit based on income under the *969 provisions of section 713 of the Internal Revenue Code of 1939. The excess profits credits under section 713 were as follows:
| Statutory | 95 per cent of | 6 per cent of | ||
| Year | ABPNI | ABPNI | capital | Credit allowed |
| reduction | ||||
| 1940 1 | $ 226,247.89 | $ 214,935.50 | $ 214,935.50 | |
| 1941 | 226,247.89 | 214,935.50 | $ 518.14 | 214,417.36 |
| 1942 | 226,247.89 | 214,935.50 | 2,924.63 | 212,010.87 |
| 1943 | 226,247.89 | 214,935.50 | 4,446.00 | 210,489.50 |
| 1944 | 205,206.91 | 194,946.56 | 4,446.00 | 190,500.56 |
| 1945 | 226,247.89 | 214,935.50 | 4,446.00 | 210,489.50 |
Petitioner's average base period net income used by respondent in determining petitioner's excess profits credits for the taxable years and the detail of adjustments under sections 711 and 713 were as follows:
| 1936 | 1937 | 1938 | 1939 | |
| Net income per R. A. R | $ 86,994.56 | $ 61,320.70 | $ 202,219.22 | $ 177,813.51 |
| Additions: | ||||
| Capital losses | 2,000.00 | 2,000.00 | ||
| Dividends received credit | 450.50 | |||
| Demolition losses | 46,581.00 | 987.69 | 4,067.72 | |
| Abnormal deductions: | ||||
| Advertising | 42,366.66 | |||
| $ 86,994.56 | $ 108,352.20 | $ 205,206.91 | $ 226,247.89 | |
| Deductions: | ||||
| Dividends received | 530.00 | |||
| Excess profits net income | ||||
| as adjusted | $ 86,994.56 | $ 107,822.20 | $ 205,206.91 | $ 226,247.89 |
The *234 adjustment under section 711 (b) (1) (J) in 1939 for an abnormal deduction relating to advertising does not apply to the taxable year 1944 because of the limitation contained in section 711 (b) (1) (K) (iii).
The petitioner filed timely applications for relief for the taxable years 1943, 1944, and 1945. In its application for relief for the taxable year 1943 petitioner included in its computation of such relief a carry-over of unused excess profits credit from 1941 determined on the basis of a constructive average base period net income for each of the years 1940, 1941, and 1942. The refunds claimed by the petitioner under section 722 prior to the filing of the petition herein and the excess profits tax deficiencies determined by the respondent were as follows:
| Refunds | Deficiencies | |
| Year | claimed | determined |
| 1943 | $ 274,505.46 | $ 38,653.00 |
| 1944 | 107,683.56 | 31,982.01 |
| 1945 | 101,840.84 | 26,310.74 |
*970 The deficiencies, totaling $ 96,945.75, consisted of amounts deferred under section 710 (a) (5) of the 1939 Code. In its applications for relief petitioner claimed relief under section 722 (b) (2) based on a "price war" which began in August 1939, and under section 722 (b) (4) based on an increase in capacity for *235 production and operation. Respondent denied relief and determined the deficiencies aforementioned by letter dated November 17, 1950. The petition herein was filed January 24, 1951.
On December 27, 1951, after the mailing of the notice of deficiency and the filing of the petition herein, the petitioner paid to the collector of internal revenue the total amount of the deficiencies involved herein: $ 96,945.75 plus interest in the amount of $ 40,164, or a total of $ 137,109.75. On January 30, 1952, additional interest was paid in the amount of $ 14.86, making total payments of $ 137,124.61 in respect of the deficiencies asserted.
The above amount was paid pursuant to a letter from the Treasury Department dated December 4, 1951, containing the following statement: "The signing and filing of this waiver will not preclude the petitioner from prosecuting the pending appeal with respect to excess-profits tax relief under the provisions of Section 722 of the Internal Revenue Code and its status before the Tax Court is in no wise affected thereby."
Petitioner's sales for the years 1931 to 1945, inclusive, its net taxable income (or loss) for the years 1931 to 1935, inclusive, its excess profits *236 net income for the base period years, 1936 to 1939, inclusive, with and without the adjustment for abnormal advertising under section 711, and its excess profits net income for the years 1940 to 1945, inclusive, were as follows:
| Base period | ||||
| Net taxable | years, excess | Excess profits | ||
| Year | Sales | income (loss) | profits net | net income |
| income | ||||
| 1931 | $ 348,004.00 | ($ 37,053.70) | ||
| 1932 | 869,280.82 | 36,218.14 | ||
| 1933 | 1,085,171.50 | 40,817.27 | ||
| 1934 | 1,556,790.04 | 31,886.77 | ||
| 1935 | 2,088,621.07 | 91,835.30 | ||
| 1936 | 2,754,660.89 | $ 86,994.56 | ||
| 1937 | 3,360,077.99 | 107,822.20 | ||
| 1938 | 3,616,341.19 | 205,206.91 | ||
| 1939 | 3,834,624.21 | 1 226,247.89 | ||
| 1940 | 4,010,210.72 | $ 86,012.37 | ||
| 1941 | 4,459,978.28 | 129,403.87 | ||
| 1942 | 5,392,356.31 | 339,952.42 | ||
| 1943 | 6,900,120.51 | 708,314.52 | ||
| 1944 | 8,258,083.73 | 716,284.65 | ||
| 1945 | 8,250,725.43 | 809,166.19 |
*971 Petitioner's competition included other bakeries delivering from house to house, corner bake shops, general bakeries, including Van de Kamps which had about 170 stores in petitioner's marketing area, wholesalers who sold to retail stores, and general grocery markets which were expanding to some degree during the base period, but the principal *237 competition was from the general bakery, Van de Kamps, and from the corner bake shops.
Facts Relating Primarily to the Section 722 (b) (2) Issue.
A large variety of bakery products was produced by petitioner. The number of varieties produced during the base period ranged between 58 and 88. Each variety had a required baking time and temperature, and there was considerable variation in the two factors. About 80 per cent of petitioner's total production, in pounds, was produced in its bread department, and included coffee cake, doughnuts, bread rolls, and loaves of bread. The figure for bread sales shown on petitioner's books is not broken down according to these separate products, but covers the bread department as a whole. About 85 per cent of the bread department's production was loaves of bread.
Petitioner's bread production, in loaves and pounds, and its bread sales for the years 1935 to 1939, inclusive, were as follows:
| Sales from | |||
| Year | Loaves | Pounds | its bread |
| department | |||
| 1935 | 8,992,968 | 10,631,678 | $ 1,463,357.23 |
| 1936 | 11,478,628 | 13,843,080 | 1,898,243.84 |
| 1937 | 13,397,659 | 16,527,226 | 2,324,503.43 |
| 1938 | 14,563,273 | 17,931,573 | 2,521,247.78 |
| 1939 | 15,448,895 | 18,950,370 | 2,594,345.82 |
Petitioner's estimated annual cake *238 and cookie production during the base period years, based upon pounds produced in weekly test periods, was as follows:
| Total pounds annually 1 | ||
| Year | ||
| Cookies | Cakes | |
| Pounds | Pounds | |
| 1936 | 548,639 | 1,538,186 |
| 1937 | 735,163 | 1,868,854 |
| 1938 | 843,947 | 1,903,382 |
| 1939 | 936,052 | 1,996,449 |
*972 Petitioner's production of bread during 1939, by periods, was as follows:
| Regular | Competitive | |||
| Periods | ||||
| 1 lb. | 1 1/2 lb. | 1 lb. | 1 1/2 lb. | |
| Jan. 3 to Feb. 18 (7 weeks) | 557,043 | 775,741 | 88,964 | |
| Feb. 19 to Mar. 25 (5 weeks) | 405,745 | 552,893 | 58,214 | |
| Mar. 26 to Apr. 29 (5 weeks) | 404,989 | 567,538 | 55,849 | |
| Apr. 30 to June 3 (5 weeks) | 406,506 | 560,752 | 53,160 | |
| June 4 to July 8 (5 weeks) | 405,518 | 587,835 | 51,786 | |
| July 9 to Aug. 12 (5 weeks) | 411,867 | 556,900 | 45,729 | |
| Total loaves (32 weeks) | 2,591,668 | 3,601,659 | 353,702 | |
| Total lbs. (32 weeks) | 2,591,668 | 5,402,489 | 530,553 | |
| Total lbs.: 11,359,113 | ||||
| Aug. 13 to Sept. 16 (5 weeks) | 411,461 | 388,923 | 247,392 | |
| Sept. 17 to Oct. 21 (5 weeks) | 428,546 | 384,570 | 293,610 | |
| Oct. 22 to Nov. 25 (5 weeks) | 416,097 | 371,781 | 288,969 | |
| Nov. 26 to Dec. 30 (5 weeks) | 366,108 | 367,138 | 18,208 | 306,406 |
| Total loaves (20 weeks) | 1,622,212 | 1,512,412 | 18,208 | 1,136,377 |
| Total lbs. (20 weeks) | 1,622,212 | 2,268,618 | 18,208 | 1,704,566 |
| Total lbs.: 7,591,257 | ||||
| Total production for 1939: Loaves -- 15,448,895; pounds -- 18,950,370. |
| Miscellaneous | ||
| Periods | ||
| 1 lb. | 1 1/2 lb. | |
| Jan. 3 to Feb. 18 (7 weeks) | 488,033 | 50,191 |
| Feb. 19 to Mar. 25 (5 weeks) | 364,881 | 36,212 |
| Mar. 26 to Apr. 29 (5 weeks) | 371,442 | 42,365 |
| Apr. 30 to June 3 (5 weeks) | 391,589 | 33,143 |
| June 4 to July 8 (5 weeks) | 420,963 | 35,834 |
| July 9 to Aug. 12 (5 weeks) | 448,040 | 35,225 |
| Total loaves (32 weeks) | 2,484,948 | 232,970 |
| Total lbs. (32 weeks) | 2,484,948 | 349,455 |
| Total lbs.: 11,359,113 | ||
| Aug. 13 to Sept. 16 (5 weeks) | 446,529 | 39,046 |
| Sept. 17 to Oct. 21 (5 weeks) | 453,209 | 42,896 |
| Oct. 22 to Nov. 25 (5 weeks) | 420,608 | 42,705 |
| Nov. 26 to Dec. 30 (5 weeks) | 408,566 | 41,180 |
| Total loaves (20 weeks) | 1,728,912 | 165,827 |
| Total lbs. (20 weeks) | 1,728,912 | 248,741 |
| Total lbs.: 7,591,257 | ||
| Total Production for 1939: Loaves -- 15,448,895; pounds -- 18,950,370. |
From March 7, 1937, to August 15, 1939, only regular loaves were sold by petitioner and the prices were 10 cents for the 1-pound loaf and 13 cents for the 1 1/2-pound loaf. In August 1939 there was a reduction at retail of 2 cents and 3 cents on the 1-pound and 1 1/2-pound loaves, respectively. The reduction was initiated by Ralphs Grocery Co., a large local chain-retailer, which had its own bakery. On August 4, 1939, Ralphs Grocery Co. advertised regular prices on its 1-pound loaf at 5 *240 cents and on its 1 1/2-pound loaf at 7 cents as compared with prior prices of 7 cents and 9 cents. On the same day Safeway Stores advertised similar prices, and on August 14, 1939, Continental Baking Co. (makers of "Wonder" bread) followed suit announcing reductions from 10 cents and 13 cents to 8 and 10 cents. Petitioner, which produced bread of a higher quality than that of Ralphs or Safeway, had been selling its 1-pound loaf for 10 cents and its 1 1/2-pound loaf for 13 cents, the same as for "Wonder" bread. Reduction in price by others forced petitioner to reduce its 1-pound loaf to 8 cents and its 1 1/2-pound loaf to 12 cents, and this reduction it put into effect on August 16, 1939. On August 26, 1939, petitioner began distribution of a "competitive" 1 1/2-pound loaf at 10 cents. On December 15, 1939, it added a competitive 1-pound loaf to its bread line which it sold for 8 cents and returned the selling price of its "regular" (Olympic) loaves to 10 and 13 cents. In July 1940 it discontinued the 1-pound competitive loaf but continued the 1 1/2-pound competitive loaf at 10 cents until September 1941 when it was discontinued. In April 1941 petitioner reduced the prices on *241 its regular *973 (Olympic) loaves to 8 and 10 cents, which prices were raised to 9 and 12 cents in September 1941, where they were "frozen" in 1942 by O. P. A.
Meanwhile, competitors selling the cheaper grade of bread maintained their 5 and 7 cent prices until September 1940 when they were raised to 6 and 8 cents. These prices continued until September 1941 when they were raised to 7 and 9 cents and frozen there by the O. P. A. in 1942. Continental Baking Co. continued its 8 and 10 cent prices until September 1941.
During the base period years there were 6 bankruptcies in the baking industry in Southern California, 5 of which occurred during the last 5 months of 1939 following the price reduction of bread initiated in August 1939. During the base period years there were 937 failures in the baking industry in the United States, 140 of which occurred during the last half of 1939. One of the 5 last mentioned was a manufacturer of crackers and cracker products. Another of the 5 last mentioned commenced business about 11 months before the petition in bankruptcy was filed.
Petitioner's principal competitor in its house-to-house delivery was Davis Standard Bread Company, also known as Davis *242 Perfection Baking Company, hereinafter referred to as the Davis Company. The Davis Company had been in business for 35 years, and in 1939 operated about 200 house-to-house delivery routes. The only other baker doing a house-to-house delivery business was a small concern with about 25 routes. Within a few months after the price reduction in August 1939 the Davis Company began having financial difficulties, was placed first in receivership, later in bankruptcy, and finally closed its doors in August 1941, 1 month before the period of the price reduction ended. Factors, in addition to the price cut, that contributed to the failure of the Davis Company included the poorer quality of its cakes and sweet goods, its default in payments on 215 new cars purchased in 1937 or 1938, and some damage suits for food poisoning.
During the base period years Ralphs Grocery Company, hereinafter referred to as Ralphs, operated a chain of 25 to 30 supermarkets and its own bakery with a full line of bakery products. The supermarkets were operated on a cash and carry basis with no credit and no deliveries. The supermarkets were the only outlet for Ralphs' line of bakery products. In volume of sales, *243 Ralphs was one of the leaders in the Los Angeles area among bakers who sold their products at retail.
In the early months of 1939 Ralphs remodeled the interior of its bakery, installed new equipment, and improved its facilities. The remodeled bakery lowered production costs and enabled Ralphs to make a better loaf of bread than previously. In an attempt to increase *974 its sales volume and acquaint the public with its improved bread, Ralphs advertised a 3-day special bread sale on August 4, 1939, at 5 and 7 cents for the small and large loaves, respectively. In fixing these selling prices, Ralphs carefully computed its bread costs to avoid any violation of a State law prohibiting sales below costs. When the other bakers and retailers of bread reduced their bread prices, the 3-day special price became Ralphs' new regular price.
Petitioner's average weekly sales for all routes, its average weekly sales per route, and its average number of routes per week during the base period were as follows:
| Average | Average | Average | |
| Base period year | weekly sales, | weekly sales, | number routes, |
| all routes | per route | per week | |
| 1936 | $ 52,974.25 | $ 183.94 | 288 |
| 1937 | 64,616.88 | 200.67 | 322 |
| 1938 | 69,545.02 | 206.36 | 337 |
| 1939 | 73,742.77 | 204.27 | 361 |
*244 Petitioner's operations during the 13 weeks in August, September, and October 1939 were as follows:
| Sales by weeks | |||
| 1939 | Routes | ||
| Week ending | |||
| Total sales | Average sales | ||
| Aug. 5 | $ 67,080.00 | $ 184.29 | 364 |
| Aug. 12 | 68,026.25 | 186.89 | 364 |
| Aug. 19 | 65,420.45 | 179.23 | 365 |
| Aug. 26 | 64,986.81 | 178.05 | 365 |
| Sept. 2 | 68,172.97 | 183.27 | 372 |
| Sept. 9 (5 days) | 58,208.40 | 156.47 | 372 |
| Sept. 16 | 65,226.77 | 176.29 | 370 |
| Sept. 23 | 70,877.59 | 192.08 | 369 |
| Sept. 30 | 69,598.10 | 188.10 | 370 |
| Oct. 7 | 67,959.96 | 183.68 | 370 |
| Oct. 14 | 68,762.37 | 185.34 | 371 |
| Oct. 21 | 69,439.79 | 187.17 | 371 |
| Oct. 28 | 70,285.19 | 188.93 | 372 |
The following table shows the pounds of bread loaves produced in each period by petitioner for the years 1936-1939 (the year is divided into 10 periods of 5 weeks each, except for the first period which is 7 weeks):
| Period | 1936 | 1937 | 1938 | 1939 |
| 1 | 1,721,098 | 2,222,194 | 2,525,615 | 2,417,420 |
| 2 | 1,184,784 | 1,636,883 | 1,758,375 | 1,741,600 |
| 3 | 1,216,916 | 1,605,858 | 1,744,371 | 1,775,059 |
| 4 | 1,221,015 | 1,525,450 | 1,725,968 | 1,768,677 |
| 5 | 1,234,547 | 1,490,617 | 1,671,514 | 1,839,644 |
| 6 | 1,313,615 | 1,570,826 | 1,663,480 | 1,816,688 |
| 7 | 1,409,505 | 1,564,010 | 1,645,410 | 1,871,031 |
| 8 | 1,535,060 | 1,651,955 | 1,761,157 | 1,963,369 |
| 9 | 1,513,947 | 1,606,811 | 1,712,528 | 1,891,888 |
| 10 | 1,489,543 | 1,615,633 | 1,699,925 | 1,865,467 |
| Total pounds | 13,840,030 | 16,490,237 | 17,908,343 | 18,950,863 |
*975 The indexes of pounds of bread loaves produced *245 during the months July to October 1936-1939, inclusive, were as follows (5-week period ended in August=100.00):
| 1936-38 | ||
| 5-week period ended in | average | 1939 |
| July | 96.68 | 101.27 |
| August | 100.00 | 100.00 |
| September | 101.57 | 103.00 |
| October | 108.81 | 108.08 |
Some of petitioner's costs decreased during the base period while other costs increased. The average cost of petitioner's flour per barrel declined during the base period as follows:
| Year | Cost per bbl. |
| 1936 | $ 6.35 |
| 1937 | 5.16 |
| 1938 | 5.16 |
| 1939 | 4.30 |
A barrel of flour will make 300 pounds of bread, which made the flour in petitioner's bread cost an average of 2.12 cents per pound loaf in 1936, 1.72 cents per pound loaf in 1937 and 1938, and 1.43 cents per pound loaf in 1939. The cost of raw materials, including flour, used in manufacturing petitioner's bread and cakes during the base period, as a percentage of bread and cake sales, decreased 5.47 per cent. During the same period petitioner's labor costs, manufacturing expenses, and operating expenses increased, as percentages of bread and cake sales, in the aggregate, 2.37 per cent. During the base period the total costs of petitioner's bread and cake sales and its total cost of all sales decreased, percentagewise, with a corresponding *246 increase in its gross profits. The following table shows percentage figures for each base period year for total cost to sales, gross profit, all sales, before adjustment for loss on unsold merchandise, which was carried as a part of selling expense during each of the base period years, and gross profit after adjustment for loss on unsold merchandise:
| Per cent | ||||
| 1936 | 1937 | 1938 | 1939 | |
| Total cost, bread and cake sales | 49.69 | 51.01 | 48.02 | 46.70 |
| Total cost, pie sales | 49.85 | 49.85 | 49.41 | 49.93 |
| Gross profit, all sales | 50.29 | 49.08 | 51.87 | 53.04 |
| Loss on unsold merchandise | 5.62 | 4.91 | 4.87 | 5.38 |
| Adjusted gross profit | 44.67 | 44.17 | 47.00 | 47.66 |
If petitioner had not used competitive bread in 1936, 1937, and 1939 it would have realized additional income in those years of $ 5,877.86, $ 535.74, and $ 47,795.52, respectively.
*976 After giving effect to all excess profits net income adjustments except the adjustment for abnormal advertising under section 711, petitioner's profit and loss data for 1939, by periods, show the following sales and net profit:
| Period 1*247 | Sales | Net profit | |
| Jan. 1-Feb. 18 | $ 487,352.09 | $ 41,494.18 | |
| Feb. 19-Mar. 25 | 375,681.84 | 31,603.78 | |
| Mar. 26-Apr. 29 | 372,490.99 | 31,022.90 | |
| Apr. 30-June 3 | 365,428.84 | 30,714.43 | |
| June 4-July 8 | 371,786.12 | 12,632.70 | |
| July 9-Aug. 12 | 370,444.40 | 21,840.97 | |
| Total, 32 weeks | 2,343,184.28 | 169,308.96 | |
| Average per week | 5,292.15 | ||
| Aug. 13-Sept. 16 | 352,520.40 | 5,019.51 | |
| Sept. 17-Oct. 21 | 377,326.08 | 4,884.48 | |
| Oct. 22-Nov. 25 | 378,009.59 | 5,282.64 | |
| Nov. 26-Dec. 31 | 383,583.86 | (614.36) | |
| Total, 20 weeks | 1,491,439.93 | 14,572.27 | |
| Average per week | 728.61 | ||
| Total, year | $ 3,834,624.21 | $ 183,881.23 |
In his report to the directors dated February 2, 1940, petitioner's president listed 1939 expenditures on buildings and equipment in the aggregate amount "of $ 324,000.00 -- most of which was spent between July and December 31st, 1939." His report also stated, in part, as follows:
The sky was blue and all was well until a Bread War hit August 14th, 1939, and is still in effect. We dropped from a monthly profit of $ 15,000 a month to a loss. This cost us a needed $ 75,000.00 in cash.
The World War with advancing prices hit August 25th. This material cost increase was probably $ 25,000.00.
The A. F. of L. declared September 18th we were on the "Unfair List," and have continuously hit our Sales Department. This cost us about 5% in Sales and customers or probably $ 2,000.00 to $ 3,000.00 a week in Sales.
During the last 4 1/2 months of 1939 petitioner was involved in what is commonly known as a bread war or price war. This was a temporary economic circumstance unusual to the petitioner during its base period.
Facts Relating Primarily to the Section 722 (b) (4) Issue.
At all times material hereto Paul H. Helms was president and general *248 manager of the petitioner. He was an experienced executive in the bakery industry prior to his organization of petitioner in 1931. He and his wife controlled the petitioner through ownership of all the outstanding shares of stock by the Helms family. Paul H. Helms devoted his full time to the management of petitioner's business. No *977 unusual management difficulties were encountered by Paul H. Helms, although the financing of petitioner's steady growth presented him with some hard problems.
From inception petitioner's method of distribution of its products has been by means of selling at retail to individual customers, house to house. Two separate groups of salesmen carried out this policy, each group being headed by a sales manager. In the "Coach Department" group, petitioner furnished the delivery equipment. This department covered the city of Los Angeles and some immediately contiguous towns, the salesmen loading their merchandise each morning at the plant. In the "Franchise Department" group, each salesman bought his own delivery equipment, his commission percentage being a little higher to compensate therefor. The salesmen in this group covered cities in Los Angeles County *249 (outside the city of Los Angeles) and other contiguous counties.
Petitioner maintained "outpost" buildings in the "Franchise" territories and delivered daily thereto by means of large relay trucks and trailers. Individual salesmen picked up their loads from the outposts. Both groups of salesmen placed their orders 2 days in advance of distribution, it being the function of the production department to fill the gross amount ordered. Returns of merchandise by the coach and franchise salesmen were sold insofar as possible at a "day-old" store. Such returns were charged to the "day-old" store at regular selling prices, and the excess thereof over the receipts of the "day-old" store was entitled on the petitioner's records "Loss on Unsold Merchandise." All salesmen worked on a commission basis with a minimum guarantee per week.
It was the practice of petitioner, at all times material hereto, to increase the number of coach routes in the city of Los Angeles by splitting and rearranging old routes as well as by entering newly populated areas of the city; also to increase the number of franchise routes in outlying communities by splitting and rearranging old routes as well as by entering *250 communities and areas not theretofore served. When a route was split it was because the number of families in the area had increased. An average route had 1,200 to 1,300 families.
The petitioner's method of accounting used the same number of units (pounds) for production and sales. The production was based on the orders placed by the route salesman 2 days prior to the date of actual production. The total production was charged to salesmen and credited to sales. Unsold merchandise was charged to "Loss on Unsold Merchandise," and credited to the salesmen. Amounts realized from the sales of such merchandise at the "day-old" store were credited to that account and the balance was the "Loss on Unsold Merchandise."
*978 During the period 1931 through 1939 petitioner made nine additions to its plant. These additions were reflected in the annual increase in its plant, properties, and equipment account and in the increase in its floor space during such period as follows:
| Plant, | Floor space | ||
| Year | properties, and | added during | Total, Dec. 31, |
| equipment | year, 1*251 square | square feet | |
| feet | |||
| 1931 | $ 599,367.55 | 64,527 | |
| 1932 | 652,649.58 | 12,180 | 76,707 |
| 1933 | 750,999.81 | 33,046 | 109,753 |
| 1934 | 1,030,543.15 | 109,753 | |
| 1935 | 1,201,889.53 | 39,423 | 149,176 |
| 1936 | 1,611,442.22 | 149,176 | |
| 1937 | 1,967,138.10 | 44,785 | 193,961 |
| 1938 | 2,056,033.50 | 193,961 | |
| 1939 | 2,417,888.23 | 36,777 | 230,738 |
In addition to the square feet of floor space shown in the above table, petitioner occupied a temporary office building in 1931 which originally had 1,500 square feet of floor space. This building was enlarged in 1931 by adding 1,380 square feet and in 1933 by adding 1,150 square feet, making a total of 4,030 square feet. In 1937 this building was converted into a hostess house for visitors to the plant.
The purposes and the amount of floor space used in petitioner's operations at pertinent dates are shown by the following table:
| Dec. 31, 1931, | Dec. 31, 1935, | Dec. 31, 1939, | |
| Purposes | square feet | square feet | square feet |
| Raw material storage | 6,550 | 16,046 | 14,469 |
| Production: | |||
| Bread | 15,227 | 21,713 | 36,501 |
| Cake | 6,720 | 8,640 | 12,056 |
| Shipping | 9,120 | 26,436 | 57,986 |
| Loading | 24,594 | 60,626 | 86,554 |
| Operating and shops | 2,316 | 15,715 | 23,172 |
| Total | 64,527 | 149,176 | 230,738 |
| Hostess House | 2,880 | 4,030 | 4,030 |
Productive machinery added during the years 1931 through 1939 was as follows:
| Bread | Bread | Bread | Cake | Cake | Cake tools | |
| Year | machinery | ovens | tools and | machinery | ovens | and |
| fixtures | fixtures | |||||
| 1931 | $ 44,187 | $ 56,727 | $ 16,030 | $ 8,677 | $ 9,560 | $ 11,276 |
| 1932 | 7,922 | 166 | 7,989 | 2,861 | 5,104 | |
| 1933 | 3,161 | 4,087 | 872 | 4,409 | ||
| 1934 | 23,573 | 44,669 | 10,891 | 10,644 | 6,309 | |
| 1935 | 32,457 | 10,209 | 1,402 | 4,682 | ||
| 1936 | 65,814 | 48,433 | 11,648 | 973 | 7,227 | |
| 1937 | 65,083 | 13,176 | 9,558 | 12,223 | ||
| 1938 | 10,957 | 21,412 | 3,983 | 6,145 | ||
| 1939 | 26,466 | 56,743 | 15,588 | 161 | 15,217 |
*252 *979 Prior to December 15, 1931, petitioner baked its products in rotary cake ovens and Simplex peel ovens. On December 15, 1931, petitioner completed the installation of its first automatic traveling or tunnel oven. This oven was 9 feet wide and 70 feet long, and it added 630 square feet of baking area to petitioner's baking capacity. A rotary oven had about 15 per cent of the capacity of a 9' x 70' traveling oven. The latter oven had about four heating chambers for heat variations, a traveling hearth, and a variable speed motor to control the heat and time factors in the baking process. On April 19, 1934, petitioner completed the installation of its second 9' x 70' traveling oven. Installation of the third 9' x 70' traveling oven was completed on June 3, 1937. At that time, space was provided for the eventual installation of a fourth traveling oven, and the electrical wiring, fixtures, plumbing, and other connections therefor were put in. Petitioner was financially unable to install a fourth automatic oven in 1937 even though its management considered that there was an available market for such additional production. On December 5, 1939, petitioner completed the installation of *253 its fourth traveling oven. This oven was the largest installed, being 11.4' x 70'. During the base period the baking area of petitioner's traveling ovens increased from 1,260 square feet to 2,688 square feet. During the same period petitioner acquired additional bread and cake machinery, bread and cake tools, and bread and cake fixtures for use with its increased baking capacity.
Petitioner's costs, with respect to the expansion of its facilities during the period August 1, 1936, to September 30, 1937, included $ 212,733.04 for plant buildings and $ 279,187.74 for bread and cake oven, machinery, tools, and fixtures, approximately $ 10,000 of which covered the cost of electrical wiring, fixtures, plumbing, and other connections installed in preparation for the acquisition of a fourth traveling oven. During the period July 1, 1939, to March 31, 1940, petitioner expended approximately $ 195,000, as hereinabove mentioned, on additions to its buildings and equipment, $ 50,000 for suburban loading rooms and $ 79,000 for trucks, trailers, coaches, and franchise cars. Petitioner was committed to its 1939-1940 expansion program prior to December 31, 1939.
The additions to its plant and equipment *254 in 1936-1937 and in 1939-1940 were financed by petitioner out of earnings, borrowings, and sales of capital stock. Prior to 1937 Paul H. Helms had secured a line of credit up to $ 300,000 for petitioner with the California Bank, the amount owed to be represented by a demand note. On or about April 1, 1937, the California Bank demanded payment from petitioner of the amount of its outstanding loan. Paul H. Helms then arranged for a line of credit with the Security First National Bank *980 of Los Angeles in the amount of $ 400,000 which was increased in or about August 1937 to $ 500,000. During the 1936-1937 expansion period petitioner issued preferred stock to Paul H. Helms and his wife in the amount of $ 125,000, $ 50,000 of which was for cash and $ 75,000 in consideration for the assumption by Paul H. Helms of a liability of the petitioner with Baker Perkins Company of Saginaw, Michigan, for the purchase of an oven and machinery. Paul H. Helms borrowed the money to purchase the stock and pay petitioner's debt. This transaction was treated as a loan between the parties, although evidenced by the issuance of capital stock. Later, petitioner repurchased this stock, principally during *255 1938 and 1939, and Paul H. Helms used the proceeds thereof to repay his individual borrowings. Petitioner's notes payable and capital stock accounts show the following changes during the base period:
| Year ending December 31 | Notes payable | Capital stock |
| 1935 | $ 171,500 | $ 611,353 |
| 1936 | 220,000 | 755,581 |
| 1937 | 390,000 | 868,701 |
| 1938 | 285,000 | 820,701 |
| 1939 | 530,383 | 755,701 |
The number of petitioner's house-to-house delivery routes increased each year from 1932 to 1941, inclusive. The number of routes at the end of each year and the average number of routes per year were as follows:
| Average number | ||
| Number of | of routes | |
| Year | routes at end | (weighted on a |
| of year | weekly basis) 1 | |
| 1932 | 138 | 125 |
| 1933 | 165 | 151 |
| 1934 | 220 | 192 |
| 1935 | 265 | 242 |
| 1936 | 311 | 288 |
| 1937 | 333 | 322 |
| 1938 | 344 | 337 |
| 1939 | 375 | 361 |
| 1940 | 379 | 376 |
| 1941 | 386 | 381 |
The 31 routes added in 1939 consisted of 26 franchise routes and 5 coach routes. The franchise routes were as follows: 10 routes in Ventura County; 12 routes in Santa Barbara County; 1 route in San Bernardino County; and 3 routes in San Diego County. Two franchise and two coach routes were added in 1940 and seven franchise routes in 1941.
A route required a year to a year and one-half to develop *256 to full capacity. The sales by the 26 franchise routes established in 1939 were: $ 34,710.78 for the first 32 weeks in 1939, and $ 71,678.85 for the last 20 weeks, or a total for the year of $ 106,389.63. The sales of the *981 5 coach routes for the same respective periods in 1939 were $ 9,912.77 and $ 14,298.14, or a total for the year of $ 24,210.91. For the franchise routes established prior to 1939 the average sales per route per week for the 32- and 20-week periods in 1939 were $ 223.08 and $ 218.94, respectively, or an average (weighted) for the year of $ 221.49 per route per week. For the coach routes established prior to 1939, the corresponding figures were $ 195.35 and $ 188.75, respectively, or an average (weighted) for the year of $ 192.81 per route per week.
Petitioner began selling bread and bakery products in Los Angeles County in 1931; in 1933 it expanded to San Bernardino County; in 1934 to Orange County; in 1935 to Riverside County; and in 1939 to Ventura, Santa Barbara, and San Diego counties. The population in 1940 of the principal cities in counties wherein petitioner operated franchise routes, the number of franchise routes in such counties at December 31, 1939, *257 and the number of chain grocery stores operating in such counties were as follows:
| 1940 | Routes Dec. | Number of | |
| County | population 1 | 31, 1939 | chain grocery |
| stores | |||
| Ventura | 30,769 | 10 | 15 |
| Santa Barbara | 34,958 | 12 | 16 |
| Riverside | 34,696 | 13 | 16 |
| San Bernardino | 88,169 | 17 | 24 |
| Orange | 73,931 | 18 | 24 |
| San Diego | 289,348 | 3 | 59 |
| Los Angeles | 2,785,643 | 120 |
The theoretical or technical capacity of petitioner's 9' x 70' traveling oven was about 2,500 one-pound loaves of regular bread per hour of continuous operation, or about 4 loaves of bread per hour per square foot of hearth area. If 1 1/2-pound loaves of regular bread were being baked, the oven capacity was about 2,625 to 2,750 pounds of bread per hour. The oven's capacity for baking hearth breads (such as Vienna and rye), which amounted to about 20 per cent of petitioner's total bread production, was approximately 1,250 pounds per hour. For coffee cake and bread rolls the oven's capacity was about 1,250 pounds per hour, and for cakes *258 its capacity was 2,900 pounds per hour. For cookies the oven's capacity was 1,300 pounds per hour. Changeovers in the oven from one product to another with different baking time or temperature required adjustments which caused an average loss in baking time during the base period of 11 per cent. The 11.4' x 70' traveling oven installed in 1939 had 126.7 per cent of the capacity of the 9' x 70' traveling oven, or 798 square feet of baking area (630 x 126.7).
*982 The ratio of petitioner's bakery products to each other and to total production remained practically the same from year to year and during the base period. This was also true of pies, which were purchased and not baked by petitioner. The total production of its ovens in thousands of pounds and percentages of total for 1936-1939, inclusive, were as follows:
| Total Oven Production (thousands of pounds) | ||||||
| Bread | Coffee cake, | |||||
| Year | loaves | bread, rolls | Cakes | Cookies | Miscellaneous | Total |
| 1936 | 13,843 | 1,982 | 1,538 | 549 | 181 | 18,093 |
| 1937 | 16,527 | 1,689 | 1,869 | 735 | 210 | 21,030 |
| 1938 | 17,932 | 1,915 | 1,903 | 844 | 228 | 22,822 |
| 1939 | 18,950 | 1,888 | 1,996 | 936 | 240 | 24,010 |
| Percentages of Total Oven Production | ||||||
| Year | Per cent | |||||
| 1936 | 76.5 | 11.0 | 8.5 | 3.0 | 1.0 | 100.00 |
| 1937 | 78.6 | 8.0 | 8.9 | 3.5 | 1.0 | 100.00 |
| 1938 | 78.6 | 8.4 | 8.3 | 3.7 | 1.0 | 100.00 |
| 1939 | 78.9 | 7.9 | 8.3 | 3.9 | 1.0 | 100.00 |
During *259 each of the base period years petitioner operated its ovens 307 days except 1936, in which it operated 308 days because 1936 was a leap year.
At all times material hereto, Southern California, and particularly Los Angeles and the surrounding communities, increased steadily in population. The census figures for the United States, California, Los Angeles County, and the city of Los Angeles show the growth in population from 1910 through 1940 as follows:
| Los Angeles | Los Angeles | |||
| Year | United States | California | county | city |
| 1910 | 91,972,266 | 2,377,569 | 504,131 | 319,198 |
| 1920 | 105,710,620 | 3,426,861 | 936,455 | 576,673 |
| 1930 | 122,775,046 | 5,677,251 | 2,208,492 | 1,238,048 |
| 1940 | 131,669,275 | 6,907,387 | 2,785,643 | 1,504,277 |
Facts Relating to Claimed Adjustments.
The annual salary paid to Paul H. Helms, which was claimed and allowed as a deduction, from the inception of the business through the taxable year 1945, was as follows:
| Year | Salary |
| 1931 | |
| 1932 | $ 10,000 |
| 1933 | 10,400 |
| 1934 | 10,400 |
| 1935 | 15,400 |
| 1936 | $ 15,900 |
| 1937 | 52,000 |
| 1938 | 52,000 |
| 1939 | 52,000 |
| 1940 | 52,000 |
| 1941 | $ 18,550 |
| 1942 | 48,000 |
| 1943 | 48,000 |
| 1944 | 48,025 |
| 1945 | 48,000 |
*983 The increased salary paid in 1937 was provided for on September 29, 1937, in a resolution which fixed the salary at "$ 1,000.00 per week, retro-effective from *260 January 1st, 1937." The grounds stated in the resolution for the corporate action were "that * * * Paul H. Helms, having promoted the success of this Corporation through his ability, leadership and untiring efforts, and having received only a nominal salary from this Corporation in previous years, and taking into consideration his twenty-five (25) years of experience in the baking business, * * * be hereafter compensated for his services with a salary reasonably commensurate with his duties and ability * * *."
Petitioner's annual advertising expenses and the percentage of such annual expenses to sales for each of the years 1931 to 1945, inclusive, were as follows:
| Advertising | Per cent | |
| Year | expenses | to sales |
| 1931 | $ 2,432.17 | .70 |
| 1932 | 15,854.02 | 1.82 |
| 1933 | 15,881.65 | 1.46 |
| 1934 | 48,633.76 | 3.12 |
| 1935 | 47,161.65 | 2.26 |
| 1936 | 121,646.88 | 4.42 |
| 1937 | 90,845.22 | 2.70 |
| 1938 | 91,714.24 | 2.54 |
| 1939 | $ 152,169.16 | 3.97 |
| 1940 | 107,109.98 | 2.67 |
| 1941 | 95,794.05 | 2.15 |
| 1942 | 45,208.11 | .84 |
| 1943 | 49,484.98 | .72 |
| 1944 | 164,191.13 | 1.99 |
| 1945 | 84,182.98 | 1.02 |
Advertising expenses during petitioner's base period years were for the following purposes:
| Advertising | Local sales | Hostess | Athletic | Dental | ||
| Year | agency | promotion | house | foundation | foundation | Total |
| 1936 | $ 76,929.60 | $ 43,898.84 | $ 818.44 | $ 121,646.88 | ||
| 1937 | 32,001.07 | 35,211.32 | $ 11,782.75 | 8,236.15 | $ 3,613.93 | 90,845.22 |
| 1938 | 29,043.23 | 38,053.24 | 14,950.42 | 9,766.45 | (99.10) | 91,714.24 |
| 1939 | 81,131.71 | 42,773.21 | 18,325.96 | 9,938.28 | 152,169.16 |
Advertising *261 expenses designated "Advertising Agency" covered radio and newspaper advertising placed through an agent on a commission basis. "Local Sales Promotion" covered petitioner's own art department and print shop which developed local display advertising. "Hostess House" was used by women's organizations for meetings and fund-raising purposes. The "Athletic Foundation" was created to attract boys and girls. The Hostess House and the Athletic Foundation were media used to bring people to petitioner's plant in order to acquaint them with petitioner's products and to take them on a tour of petitioner's bakery.
In 1932 the Olympic games were held in Los Angeles. Prior thereto petitioner obtained an exclusive contract to serve the athletes in Olympic Village. As a result thereof petitioner named its bread "Olympic Bread," copyrighted the name, and built its original bread *984 business around the name. The 1936 Olympic games were held in Berlin, Germany, and the U. S. Olympic Committee asked for the Helms' formulas, recipes, and supervision for the baking of their bread for the Olympic games. Petitioner complied with this request and sent over a baker who supervised the baking of all breads *262 for the Olympic teams in Berlin. The story of America's athletes using Olympic Bread was publicized by the petitioner over the radio, in the newspapers, and on billboards. The cost of this publicity in 1936 was $ 44,928.53 as compared with $ 76,718.35 of advertising expenses for all other purposes in 1936. The only previous event of this character occurred in 1932 during which year petitioner expended $ 15,854.02 for all its advertising. The purpose of this advertising campaign was to build up the brand name "Olympic" and create goodwill. No selling cost in 1936 was replaced by this institutional advertising expense of $ 44,928.53. Petitioner's other advertising expenses in 1936, amounting to $ 76,718.35, exceeded petitioner's total advertising expenses for any previous year. Petitioner's advertising expense for 1936 was abnormal to the extent of $ 44,928.53. This institutional advertising campaign did not produce substantial immediate results in petitioner's house-to-house marketing, but it kept the name of petitioner's bread alive over a 4- to 6-year period.
For 1939 petitioner's advertising expenses included an item of $ 81,131.71 which represented the cost of advertising *263 handled through its advertising agency. The corresponding item for 1938 was $ 29,043.23. The difference, $ 52,088.48, represented a special newspaper and a special radio campaign of institutional character. The special newspaper campaign was directed against the anti-bread diet programs which were then rampant. The special radio program was intended to strengthen petitioner against the reduction in price of bread which impended for several months as rumors and broke out in August 1939 in full force. Petitioner's advertising expenses for 1939 of $ 152,169.16 were abnormal to the extent of $ 52,088.48, but under sections 711 (b) (1) (J) and (K) (iii) only $ 42,366.66 thereof was disallowable in determining petitioner's average base period net income and this amount was used by respondent for all taxable years, except 1944, as hereinabove mentioned. The excess of petitioner's advertising cost for 1944 over the preceding war years largely represented participation in the bond-selling campaign pursuant to suggestion of the Treasury Department.
In 1937 petitioner's operating expenses totaled $ 186,209.30. Included therein was an item of $ 28,595.99 designated as "moving and remodeling *264 expense." This expense item was incurred in connection with the expansion program begun in 1936 and completed in 1937. The amount was charged on petitioner's books to its repairs and renewals account, an operating expense account. No breakdown of *985 the item, as between moving expense and remodeling expense, was shown on the petitioner's books. The only previous item of moving and remodeling expense shown on petitioner's books was $ 768.89 in 1933. For 1938 and 1939 petitioner's books show moving and remodeling expenses of $ 3,747.20 and $ 3,830.18, respectively. In computing petitioner's excess profits net income for 1937, the $ 28,595.99 was deducted as a part of the operating expenses of that year.
In 1941 respondent determined that petitioner had deducted excessive depreciation on its buildings and equipment for 1938 and 1939, and reduced the depreciation rates thereon. Petitioner accepted the depreciation rates as revised by respondent. At the time respondent lowered the depreciation rates, all years prior to 1938 were barred by the statute of limitations. Based upon the revised depreciation rates used for 1938 and 1939, petitioner claimed and was allowed excessive depreciation *265 on its buildings and equipment for 1936 and 1937 in the respective amounts of $ 21,873.53 and $ 24,077.19.
All expenses vary with the volume of business done except interest paid, salary of Paul H. Helms, president of petitioner, and certain other supervisory salaries, which nonvariable expenses were in the following amounts during the base period:
| Supervisory | ||||
| Interest | Salary of | salaries (other | ||
| Year | paid | Paul H. | than salary of | Total |
| Helms | Paul H. Helms) | |||
| 1936 | $ 12,388.36 | $ 15,900 | $ 24,337.50 | $ 52,625.86 |
| 1937 | 20,708.22 | 52,000 | 24,440.00 | 97,148.22 |
| 1938 | 22,252.49 | 52,000 | 24,440.00 | 98,692.49 |
| 1939 | 20,509.40 | 52,000 | 24,440.00 | 96,949.40 |
Significant items of 1939 costs and expenses by periods are as follows:
| Manufacturing | Selling expense | ||
| labor, | |||
| manufacturing | |||
| Period 1 | expense, and | ||
| operating | Advertising | Other 3 | |
| expense 2 | |||
| Jan. 1-Feb. 18 | $ 88,983.40 | $ 13,427.06 | $ 182,554.29 |
| Feb. 19-Mar. 25 | 67,075.95 | 11,853.32 | 139,843.02 |
| Mar. 26-Apr. 29 | 67,248.21 | 9,966.77 | 140,234.05 |
| Apr. 30-June 3 | 67,744.40 | 17,080.55 | 133,975.90 |
| June 4-July 8 | 67,482.49 | 26,018.73 | 143,874.81 |
| July 9-Aug. 12 | 66,737.26 | 12,117.87 | 145,373.46 |
| Total, 32 weeks | $ 425,271.71 | $ 90,464.30 | $ 885,855.53 |
| Aug. 13-Sept. 16 | 68,209.41 | 18,011.27 | 139,858.95 |
| Sept. 17-Oct. 21 | 71,324.84 | 17,436.10 | 146,836.21 |
| Oct. 22-Nov. 25 | 72,567.30 | 14,151.38 | 148,576.19 |
| Nov. 26-Dec. 31 | 83,475.92 | 12,106.11 | 148,110.08 |
| Total, 20 weeks | $ 295,577.47 | $ 61,704.86 | $ 583,381.43 |
| Total, 52 weeks | $ 720,849.18 | $ 152,169.16 | $ 1,469,236.96 |
| Period 1 | Office | Administrative |
| expense | expense | |
| Jan. 1-Feb. 18 | $ 7,108.35 | $ 25,187.19 |
| Feb. 19-Mar. 25 | 4,521.00 | 19,476.75 |
| Mar. 26-Apr. 29 | 4,638.01 | 19,909.77 |
| Apr. 30-June 3 | 4,621.66 | 19,123.83 |
| June 4-July 8 | 4,949.14 | 18,704.58 |
| July 9-Aug. 12 | 4,599.15 | 18,803.42 |
| Total, 32 weeks | $ 30,437.31 | $ 121,205.54 |
| Aug. 13-Sept. 16 | 4,801.88 | 18,219.01 |
| Sept. 17-Oct. 21 | 5,103.63 | 20,031.30 |
| Oct. 22-Nov. 25 | 4,905.65 | 18,480.29 |
| Nov. 26-Dec. 31 | 4,825.99 | 28,093.73 |
| Total, 20 weeks | $ 19,637.15 | $ 84,824.33 |
| Total, 52 weeks | $ 50,074.46 | $ 206,029.87 |
*986 Petitioner always installed ovens in anticipation of further development of its market. To avoid offering stale goods to customers, it was petitioner's policy to get the oven capacity ready and then develop the market, i. e., the routes.
The stipulated facts are so found and are incorporated herein by reference.
During the base period there was a change in the productive capacity of the petitioner's business.
Lack of productive capacity was not a factor which to any appreciable extent limited petitioner's sales.
The excess profits tax paid by petitioner for the years in issue was not excessive and discriminatory. Petitioner was not entitled to a constructive average base period net income which was large enough to produce a credit greater than the credit received under section 713 of the 1939 Code.
OPINION.
Respondent determined deficiencies in petitioner's excess profits taxes and disallowed claims for relief under section 722 of the 1939 Code as follows:
| Excess profits | Claim for | |
| Year | tax | relief, |
| deficiencies | sec. 722 | |
| 1943 | $ 38,653.00 | $ 274,505.46 |
| 1944 | 31,982.01 | 107,683.56 |
| 1945 | 26,310.74 | 101,840.84 |
*267 The issues for decision are (1) whether the average base period net income is an inadequate standard of normal earnings because the business of petitioner was depressed in the base period because of temporary economic events unusual in its base period experience within the purview of section 722 (b) (2), and (2) whether the average base period net income is an inadequate standard of normal earnings because of a change in the character of petitioner's business during the base period because of a difference in its capacity for production or operation within the purview of section 722 (b) (4).
Assuming, but not deciding, that the economic circumstances which petitioner contends acted as a depressant to its average base period net income qualify petitioner for relief under section 722 (b) (2), we are nevertheless unable to grant such relief. The Commissioner has applied the growth formula under section 713 (f) to petitioner's base period net income and a substantial adjustment thereof has resulted to petitioner's benefit. Under the facts as found, computation of the available relief which might be accorded petitioner on the basis of the mentioned assumption discloses that under no circumstances *268 *987 would such relief exceed that afforded by the application of the growth formula. Petitioner, therefore, has not demonstrated that section 722 (b) (2) may be here applied.
Petitioner asks relief also under section 722 (b) (4) upon the basis of a change in its capacity for operation and production occurring within the base period, or with respect to a portion of such change in capacity to which it had been committed during the base period and which was brought to fruition subsequent thereto. The facts found clearly demonstrate that during its existence petitioner has enjoyed an aggressive and foresighted management which took advantage of not only the normal avenues of expansion and growth but also made available extraordinary avenues, such as its use of the term "Olympic" in its advertising and the identification of its product generally with the Olympic games. It is also plain from the record that its management was sufficiently aggressive to anticipate growth and expansion by providing increases in its productive capacities prior to increased demand. Indeed, it is apparent that such was the policy of petitioner. In order to be entitled to relief under section 722 (b) (4) petitioner *269 must show not only a change in its productive capacity but in addition thereto that such change not only effects a change in the character of its business but also one which, if available, would increase its base period income. Green Spring Dairy, Inc., 18 T. C. 217. The following excerpt from Green Spring, which is strikingly similar to the case at bar, is applicable here, page 238:
The foregoing data furnish dramatic evidence that petitioner's business was growing steadily without the new plant prior to 1937. However, the old plant was reaching its saturation point at about that time and if the growth was to continue, enlarged facilities would have to be supplied. This does not mean that the new facilities caused the growth thereafter. Rather, the enlarged facilities afforded by the new plant enabled the growth to continue. The prior advent of the new plant 2 years earlier does not persuade us that petitioner's growth during that 2-year period would have been substantially greater than it in fact was. And we are similarly not persuaded that petitioner would have attained a level of sales by the end of 1939 that would have been substantially higher than was in fact attained at *270 that time.
The evidence establishes, in our opinion, that productive capacity did not operate materially to restrict petitioner's sales during the first two base period years, 1936 and 1937. No evidence has been introduced to show that in either of those years any customers or sales were lost because petitioner's production facilities were inadequate; on the contrary, there is evidence that both in 1936 and 1937 petitioner could have served at least some additional customers if it had been able to get them. In both years major strides were made in increasing the number of new customers and new routes, and petitioner's growth appears to have been about as much as market and competitive conditions then permitted. * * *
There can be no doubt that during petitioner's base period it did consistently and repeatedly expand its productive capacity, but it *988 has failed to show that such expansion resulted in additional income. It is true that the facts show a steady and consistent rise in income not only during petitioner's base period years but from its inception, but that increase in income is apparently more nearly attributable to its aggressive management and the resultant increase in demand *271 for its product than to its increase in productive capacity. As in Green Spring, supra, the increased capacity permitted rather than caused its expansion and growth. Indeed, the facts indicate that its increase in sales was at a more or less consistent rate from the date of its inception throughout its experience with the exception that the rate of its increase in sales was slightly depressed at the time of and after its 1937 increase in capacity for production. We think it is clear that whatever changes took place with respect to petitioner's capacity for production and operation those changes did not bear the proper relationship to its increased earnings to warrant the granting of the relief otherwise authorized by section 722 (b) (4).
Assuming further, but not deciding, that petitioner's average base period net income should be increased by the disallowance under section 711 (b)(1)(J) of abnormal deductions for depreciation in 1936 and 1937, and abnormal advertising expenses in 1936, nevertheless, petitioner would not be entitled to any relief in excess of that granted by respondent in applying section 713 (f) of the 1939 Code.
Reviewed by the Special Division.
Decision will be entered *272 for the respondent.
Footnotes
1. Withdrew as counsel November 8, 1954.↩
1. Computed under 1941 Act for carry-over purposes; income taxes not deducted.↩
1. For purposes of unused excess profits credit carry-over. Income taxes not deducted pursuant to 1941 Act.↩
1. In computing excess profits tax for 1944 this amount must be reduced by $ 42,366.66 for abnormal advertising, or a total of $ 183,881.23.↩
1. Above figures do not include doughnuts, eclairs, cream puffs, seasonal fruit-cake production, popcorn, potato chips, and special cake orders, such as birthday, wedding cakes, etc.↩
1. Periods are of 5 weeks, excepting the first, which is of 7 weeks.
1. Some of the additions were started in one year and completed in the next year.
1. Total number of routes each week divided by weeks in the year.↩
1. Principal cities in the county only, except for Los Angeles County. The principal cities in Los Angeles County, exclusive of the city of Los Angeles, had a total population in 1940 of 608,765. The city of Lo Angeles had a total population in 1940 of 1,504,277.↩
1. Periods are of 5 weeks excepting the first, which is of 7 weeks.↩
3. Includes loss on unsold merchandise.↩
2. Included in cost of goods sold.↩