*53 Decision will be entered under Rule 50.
Where petitioner seeks to exclude a number of deductions in the computation of its base period net income and the Commissioner denies the propriety of such exclusion, the petitioner, after amending its petition, may establish by evidence its right to such exclusion in the last two years of said base period and accede to the Commissioner's rejection thereof in the first two years, where the exclusions of the last two years of the base period fall in a class differing from that of the exclusions originally claimed for the first two years thereof, even though the petitioner procures a tax advantage thereby under the growth formula set forth in section 713 (f), I. R. C.
*786 *54 The Commissioner determined a deficiency in excess profits tax against the petitioner for the taxable year ended August 31, 1942, in the amount of $ 41,963.82. The petitioner brings this proceeding for a redetermination of its excess profits tax liability.
Three of the errors assigned in the amended petition have been admitted by the respondent in his answer. These involve adjustments increasing excess profits net income of the base period as follows:
(1) Respondent's failure to allow as an adjustment increasing excess profits net income for the base period year ended August 31, 1939, pursuant to the provisions of section 711 (b) (1) (E) of the Internal Revenue Code, flood and fire loss in the amount of $ 1,817.57.
(2) Respondent's deduction, in computing excess profits net income for the base period year ended August 31, 1939, of the sum of $ 3,218.62, which had already been deducted in computing special class net income of that year, and was, therefore, a duplicate deduction of the same item.
(3) Respondent's failure to allow as an adjustment increasing excess profits net income for the base period year ended August 31, 1939, pursuant to the provisions of section 711 (b) (1) (E) *55 of the Internal *787 Revenue Code, loss of $ 3,250 resulting from the dismantling of a plant owned by the petitioner.
This leaves for our decision the question of whether, in computing petitioner's average base period net income, the respondent erred in disallowing the following adjustments claimed by petitioner in its return under section 711 (b) (1) (J) of the Internal Revenue Code, as increasing its excess profits tax net income for base period years:
(a) For the fiscal year ended August 31, 1940, in an amount of $ 28,804.17 for advertising.
(b) For the fiscal years ended August 31, 1938, and August 31, 1939, in the respective amounts of $ 22.52 and $ 775.14 for expenditures for trade-marks.
(c) For the fiscal year ended August 31, 1940, in the amount of $ 1,331.15 due to the difference in foreign exchange between the United States and Canada.
(d) For the fiscal year 1940 in the amount of $ 1,646.13 representing loss of deposited funds due to bank failure.
FINDINGS OF FACT.
The petitioner is a corporation duly organized and existing by virtue of the laws of the State of New York, with its principal place of business at Westfield, New York. At all times material hereto, it*56 was engaged in the manufacture and sale of grape juice and other food products, principally under the trade name of "Welch's," such as "Welch's Grape Juice."
The petitioner at all times material hereto maintained its books of account and filed its income and excess profits tax returns using the accrual method of accounting and a fiscal year ending August 31. Petitioner's income and excess profits tax returns for the fiscal year ended August 31, 1942, were filed with the collector of internal revenue for the twenty-eighth district of New York, at Buffalo, New York, on or about November 15, 1942.
Petitioner's excess profits credit for the fiscal year ended August 31, 1942, is determined under the provisions of section 713 of the Internal Revenue Code. Petitioner was incorporated prior to September 1, 1936; its base period is from September 1, 1936, until August 31, 1940; and its base period years are the taxable years ended August 31, 1937, 1938, 1939, and 1940, respectively.
Petitioner, in its excess profits tax return for the taxable year ended August 31, 1942, claimed the following adjustments increasing excess profits tax net income for base period years as abnormal deductions*57 under section 711 (b) (1) (J) of the Internal Revenue Code:
| Base period year Sept. 1, 1936, to Aug. 31, 1937 | $ 10,265.43 |
| Base period year Sept. 1, 1937, to Aug. 31, 1938 | 4,540.64 |
| Base period year Sept. 1, 1938, to Aug. 31, 1939 | 4,035.51 |
| Base period year Sept. 1, 1939, to Aug. 31, 1940 | 36,405.65 |
*788 The said claimed adjustments consisted of the following items:
| Base-period year | ||
| Adjustment for abnormal deductions under | ||
| sec. 711 (b) (1) (J), claimed by petitioner | Sept. 1, 1936, | Sept. 1, 1937, |
| and disallowed by respondent | to Aug. 31, | to Aug. 31, |
| 1937 | 1938 | |
| Advertising | ||
| Convention expense | $ 1,583.33 | |
| Trade-marks | $ 22.52 | |
| Legal and professional | 46.13 | |
| Directors' fees | ||
| Insurance | 514.98 | |
| Registrar and transfer agent's fees | 67.78 | 2,022.97 |
| Research and experimental | 8,099.34 | 2,387.99 |
| Dues and subscriptions | 32.30 | |
| Foreign exchange | ||
| Group life insurance | 28.73 | |
| Flood and fire loss | ||
| Loss of funds on deposit due to bank failure | ||
| Total | 10,265.43 | 4,540.64 |
| Base-period year | ||
| Adjustment for abnormal deductions under | ||
| sec. 711 (b) (1) (J), claimed by petitioner | Sept. 1, 1938, | Sept. 1, 1939 |
| and disallowed by respondent | to Aug. 31, | to Aug. 31, |
| 1939 | 1940 | |
| Advertising | $ 28,804.17 | |
| Convention expense | 1,651.13 | |
| Trade-marks | $ 775.14 | |
| Legal and professional | ||
| Directors' fees | 1,180.00 | |
| Insurance | ||
| Registrar and transfer agent's fees | 402.54 | 1,793.07 |
| Research and experimental | 1,040.26 | |
| Dues and subscriptions | ||
| Foreign exchange | 1,331.15 | |
| Group life insurance | ||
| Flood and fire loss | 1,817.57 | |
| Loss of funds on deposit due to bank failure | 1,646.13 | |
| Total | 4,035.51 | 36,405.65 |
*58 Respondent disallowed all of the claimed adjustments.
In its amended petition filed January 17, 1947, the petitioner abandoned all of the claimed adjustments except those involving advertising, trade-marks, foreign exchange, flood and fire loss, and loss of funds on deposit due to bank failure.
In computing its net income, normal tax net income, special class net income and/or excess profits net income for the taxable years set forth in the following tabulation, the amounts claimed by and allowed to petitioner as deductions of the descriptions there set forth were as follows:
| Loss of funds | |||||
| Taxable year | Foreign | Flood and | on deposit | ||
| ended Aug. 31 -- | Advertising | Trademarks | exchange | fire loss | due to bank |
| failure | |||||
| 1935 | * | $ 154.55 | * | None | * |
| 1936 | $ 521,053.47 | 467.31 | None | None | None |
| 1937 | 610,957.29 | 140.71 | None | None | None |
| 1938 | 725,985.40 | 530.03 | $ 116.11 | None | None |
| 1939 | 717,197.99 | 1,179.08 | 148.64 | $ 1,817.57 | None |
| 1940 | 856,564.58 | * | 2,049.23 | None | $ 1,646.13 |
| 1941 | 807,861.32 | 676.57 | 699.26 | None | None |
| 1942 | 827,760.41 | 94.40 | 718.08 | None | None |
*59 The above loss of $ 1,817.57 from fire and flood during the base period year ended August 31, 1939, is excludible from deductions in computing petitioner's excess profits net income for that year under the provisions of section 711 (b) (1) (E) of the Internal Revenue Code.
At all times material here the petitioner's method of operation with respect to production and sale of Welch's Grape Juice was substantially uniform. The business of petitioner was originated in 1869, when the principal of pasteurization, which had been announced shortly before that by Louis Pasteur in France, was adopted. The *789 commercial product was originally labeled "Dr. Welch's Unfermented Communion Wine," but about 1892 the label was changed to "Welch's Grape Juice."
In the process of production of Welch's Grape Juice the grapes are purchased from the grape growers on contracts made during the summer based on the anticipated yield in July. The contract of purchase provides that the grapes will be delivered at market price, which is not known at the time the contract is made. The grapes are delivered over a period of four weeks, usually in the month of October. They are taken into the factory from*60 the grower, where they are washed, steamed, crushed, and pressed and then stored in the cellars for an aging period which is necessary before the juice can be bottled for commercial use in order to precipitate the excess tartaric acid. During the year the juice is brought out of the cellar storage and bottled, mostly in quarts and pints, 12 quarts or 24 pints to the case. The processing of the grapes and the bottling of the grape juice has been a mechanized process without any substantial change since prior to 1915. In addition to grape juice, petitioner, during the period from 1935 through 1942, also sold tomato juice, grape jelly, grape jam, and four other kinds of jelly, but the greater part of the business consisted of the manufacture and sale of grape juice. Petitioner's pack may go up one year and down the next approximately 10 per cent, depending upon the size of the crop. Petitioner carries over enough grape juice from one year to last through the first few months of the succeeding year until the new juice is ready for use. It was the practice of petitioner periodically to make selling plans based upon the estimated sales for the current fiscal year.
In November of the*61 fiscal year, when the quantity and cost of the grapes were known, petitioner would ascertain how many cases it had in prospect as compared with what it had previously sold and would make a selling budget based on what it had to sell. This budget consisted of the estimated selling and advertising expenses for the fiscal year. The budget was prepared by the sales manager, the advertising manager, and the president and was submitted to the board of directors for approval. It was usually approved as submitted. This budget of selling and advertising expenses was based entirely on estimated sales in cases of Welch's Grape Juice, without regard to other products, because practically all the advertising expense was directed to the sale of grape juice. The advertising expense of the other products, such as tomato juice, jam, and jellies, was only about 1 per cent of the total advertising expenditure.
Petitioner's sales organization was divided into 25 district sales territories, each with a district manager. In 8 or 10 of the large cities the district managers had sales offices and from 40 to 60 salesmen working under them, who were always on a salary basis. The salesmen *790 would*62 go out and take the retail orders and turn them in to the jobbers. The jobbers would in turn place the orders and the grape juice was shipped to them. The number of salesmen would vary from year to year. There was no change in the general selling methods employed by petitioner during the years from 1935 to 1942.
The selling expenses were more or less fixed, and the real purpose of the budget was to set up the advertising expenses. The budgeted amount for advertising for each fiscal year was set up at a figure of approximately $ 0.85 per case of grape juice that it was estimated would be sold during the fiscal year. The custom and practice was to set up the budget for each fiscal year at a figure covering both selling and advertising expenses, which was obtained by multiplying the estimated sales in cases by approximately $ 1.50, of which approximately $ 0.85 per case represented advertising. The amount budgeted for advertising per case varied very little from year to year. After the board of directors had approved an estimated amount of sales of Welch's Grape Juice in cases for the coming year the accounting department was instructed to break down this estimated amount among*63 the several months of the year. The management watched the sales as they progressed and tried to keep within the budget figures. If the sales went down they tried to cut down the advertising and selling expenses accordingly. Reports for actual sales for each month were compared to the budgeted amounts based on estimated sales. It was the practice of the company to adhere as nearly as possible to the budget of $ 1.50 per case for advertising and selling expenses. If there was a change in estimated sales occurring toward the end of the year the $ 0.85 per case basis might be exceeded, but, if the change occurred as early as February in the year, adjustments could be made so that the approximate basis would ordinarily be maintained. Prior to 1940, the principal factors resulting in actual sales being below the estimated sales were general business conditions and the kind of weather during the summer months, when the greater portion of the sales were made. It was the policy of the company when the actual sales fell below the estimated sales to make a revised budget, based on a revised estimate of sales.
Except for the fiscal year ended August 31, 1938, actual sales of grape juice*64 came very close to the estimated sales in each of the fiscal years ended August 31, 1935 to August 31, 1939, inclusive. In the fiscal year ended August 31, 1938, actual sales fell substantially below estimated sales and the advertising budget, based on selling 900,000 cases of grape juice for that fiscal year, was revised in February 1938 to approximately 740,000 cases. This revision was made because of the drop in sales.
Throughout the years 1935 through 1942 the price at which petitioner sold its grape juice was higher than the price at which other *791 brands were sold by other companies. During this period petitioner's grape juice was sold at approximately $ 4.25 a case for pints and $ 4 a case for quarts, the largest volume of sales being in pints. This price was approximately from $ 0.75 to $ 1 a case higher than the price at which other brands were sold by petitioner's competitors. On this basis petitioner sold approximately 50 per cent of the country's total sale of grape juice prior to 1940.
In October 1939 there was a large crop of grapes and petitioner's pack was approximately 10 per cent larger than for the previous year. Petitioner's competitors also had more*65 tonnage and a competitive price situation resulted, so that the differential between petitioner's price and that of its competitors increased to approximately $ 2 per case. In some instances competitors sold grape juice at as low as $ 1.70 per case, which was virtually what it cost petitioner to produce Welch's Grape Juice. This price cutting occurred all over the country, particularly in the large cities.
As a result of this price cutting petitioner's monthly sales of grape juice fell off substantially below the originally estimated monthly sales. By the end of March 1940 the drop was approximately 60,000 cases. This condition was discussed by the officers of petitioner and was considered very serious. It was, however, regarded as temporary, because petitioner's competitors were selling grape juice at near cost of manufacture. In February 1940 petitioner's officers made a revised estimate of sales of Welch's Grape Juice for the year. It was thought that sales of Welch's Grape Juice might equal the sales of the previous year, which totaled 838,575 cases as against the original estimate of 950,000 cases for the fiscal year ended August 31, 1940. The revised estimate was therefore*66 approximately 850,000 cases. It was also decided not to make at that time any change in the advertising budget and to hold the line on prices instead of meeting price cutting by price cutting, and to that end they went all out on advertising and not only did not reduce the advertising budget in accordance with past established practice, but spent more than the amount originally budgeted. This policy was justified by the results. Before the end of the year the sales started to come back.
As a result of this act by the board of directors petitioner expended $ 856,564.58 in advertising for the fiscal year ended August 31, 1940. This expenditure amounted to approximately $ 1.04 per case of Welch's Grape Juice actually sold in the fiscal year 1940, namely, 822,959 cases. This was the largest advertising expenditure for any year in petitioner's history either before or after the year ended August 31, 1940. The increased expenditure for advertising for the year ended August 31, 1940, was due to the severe price cutting competition which occurred in that year. The following statement for the years 1936 to 1942, inclusive, *792 shows the various types of advertising used by petitioner*67 and the amounts spent thereon during the base period years:
| 1936 | 1937 | 1938 | 1939 | |
| Sundries | $ 1,780.72 | $ 2,196.15 | $ 2,178.02 | $ 978.00 |
| Export | 5,280.94 | 5,025.80 | 9,433.66 | 7,799.50 |
| Preparation charges | 7,900.66 | 7,749.22 | 11,040.78 | 8,007.90 |
| Newspaper | 132,146.04 | 177,200.77 | 153,528.71 | 145,515.30 |
| General magazines | 13,481.25 | 15,334.00 | 12,655.03 | 6,660.75 |
| Cooperative advertising | 18,715.61 | 23,366.36 | 41,668.47 | 53,921.62 |
| Booklets | 9,128.79 | 6,477.64 | 4,578.21 | 376.32 |
| Trade papers | 5,994.50 | 10,790.87 | 16,523.02 | 12,649.73 |
| Store display | 19,023.37 | 22,250.83 | 18,024.36 | 20,816.55 |
| Outdoor | 135.13 | 107.61 | 101.90 | |
| Radio | 217,792.34 | 250,545.44 | 317,587.10 | 348,168.66 |
| Direct mail | 5,405.79 | 3,655.63 | 6,172.17 | 4,358.36 |
| Jell aid expense | 2,644.14 | |||
| Prizes | 16,045.31 | 31,582.67 | 43,606.48 | 19,919.20 |
| Back bar displays | 38,077.38 | 36,291.59 | 18,408.04 | 13,384.29 |
| Mass displays | 45,528.02 | 53,532.56 | ||
| Food shows and | ||||
| demonstrations | 10,434.83 | 7,851.90 | 13,623.53 | 9,671.58 |
| Samples | 17,201.80 | 10,503.29 | 11,322.19 | 10,469.07 |
| Jobbers salesmen commission | 866.70 | |||
| Welchade promotion | ||||
| Total | 521,053.47 | 610,957.29 | 725,985.40 | 717,197.99 |
| 1940 | 1941 | 1942 | |
| Sundries | $ 123.30 | $ 207.72 | $ 1,224.38 |
| Export | 10,362.66 | 13,481.58 | 11,705.56 |
| Preparation charges | 11,344.07 | 10,670.14 | 9,795.74 |
| Newspaper | 188,154.52 | 171,413.21 | 143,162.06 |
| General magazines | 7,998.56 | 1,822.67 | 2,340.92 |
| Cooperative advertising | 59,238.34 | 53,835.71 | 59,511.04 |
| Booklets | |||
| Trade papers | 12,295.77 | 10,854.86 | 15,794.62 |
| Store display | 23,444.31 | 13,126.37 | 12,220.22 |
| Outdoor | |||
| Radio | 393,957.06 | 399,395.79 | 463,364.42 |
| Direct mail | 3,133.75 | 3,009.77 | 4,364.68 |
| Jell aid expense | |||
| Prizes | 21,076.04 | 29,630.91 | 18,074.25 |
| Back bar displays | 14,875.79 | 88,187.97 | 78,300.35 |
| Mass displays | 92,020.80 | ||
| Food shows and | |||
| demonstrations | 7,273.25 | 3,805.42 | 1,075.51 |
| Samples | 11,266.36 | 8,419.20 | 4,059.67 |
| Jobbers salesmen commission | |||
| Welchade promotion | 2,766.99 | ||
| Total | 856,564.58 | 807,861.32 | 827,760.41 |
*68 The gross sales, cost of sales, gross profit on sales, other income, total gross income, total deductions, net deductions, deductions for advertising, number of cases of Welch's Grape Juice sold, and the advertising cost per case for each of the fiscal years ended August 31, 1936, through 1942, were as follows: *793
| Fiscal year ended August 31 -- | ||||
| 1936 | 1937 | 1938 | 1939 | |
| Gross sales | $ 3,589,172.85 | $ 4,325,257.20 | $ 4,146,823.19 | $ 4,463,116.54 |
| Cost of sales | 2,080,376.17 | 2,438,664.99 | 2,338,514.24 | 2,413,072.47 |
| Gross profit on | ||||
| sales | 1,508,796.68 | 1,886,592.21 | 1,808,308.95 | 2,050,044.07 |
| Other income | 26,094.86 | 24,633.87 | 26,997.76 | 26,183.51 |
| Gross income | 1,534,891.54 | 1,911,226.08 | 1,835,306.71 | 2,076,227.58 |
| Deductions | 1,291,504.73 | 1,434,288.65 | 1,593,197.07 | 1,613,313.45 |
| Net income | 243,386.81 | 476,937.43 | 242,109.64 | 462,914.13 |
| Advertising | $ 521,053.47 | $ 610,957.29 | $ 725,985.40 | $ 717,197.99 |
| Cases of Welch | ||||
| Grape Juice sold | 629,107 | 745,999 | 768,759 | 838,575 |
| Advertising cost | ||||
| per case Welch | ||||
| Grape Juice sold | $ 0.828 | $ 0.819 | $ 0.944 | $ 0.855 |
| Fiscal year ended August 31 -- | |||
| 1940 | 1941 | 1942 | |
| Gross sales | $ 4,398,401.09 | $ 5,049,749.95 | $ 7,366,330.37 |
| Cost of sales | 2,351,448.72 | 2,771,682.26 | 4,475,916.22 |
| Gross profit on | |||
| sales | 2,046,952.37 | 2,278,067.69 | 2,890,414.15 |
| Other income | 28,386.54 | 43,348.16 | 54,552.17 |
| Gross income | 2,075,338.91 | 2,321,415.85 | 2,944,966.32 |
| Deductions | 1,787,134.44 | 1,823,903.96 | 2,010,302.25 |
| Net income | 288,204.47 | 497,511.89 | 934,664.07 |
| Advertising | $ 856,564.58 | $ 807,861.32 | $ 827,760.41 |
| Cases of Welch | |||
| Grape Juice sold | 822,959 | 1,006,431 | 974,452 |
| Advertising cost | |||
| per case Welch | |||
| Grape Juice sold | $ 1.041 | $ 0.803 | $ 0.849 |
*69 *794 The excess in the petitioner's expenditures for advertising for the fiscal year ended August 31, 1940, was due to an endeavor by petitioner to meet the price cutting competition of its competitors in that year. It was not a consequence of an increase in the gross income of the petitioner in its base period or a decrease in the amount of some other deduction in its base period and was not a consequence of a change at any time in the type, manner of operation, size, or condition of the business engaged in by the petitioner during the taxable year.
The item of $ 1,646.13 claimed by petitioner as abnormal in the fiscal year 1940 for "loss of funds on deposit due to bank failure" represented a loss due to the closing of a bank in Lawton, Michigan, where one of the petitioner's plants was located. The account was used to meet pay rolls and was usually maintained at a balance of approximately $ 3,000. It had been so maintained for approximately 10 years. The bank failed and closed in April 1937. A small liquidating dividend was received in 1940 and the balance of the account, $ 1,646.13, was then written off and claimed and allowed as a deduction in petitioner's income tax*70 return for the year ended August 31, 1940. It is stipulated that such loss of funds in the amount of $ 1,646.13 for the base period year 1940 is a deduction of a class which was abnormal for petitioner within the meaning of section 711 (b) (1) (J) (i).
The loss of funds on deposit in the Lawton, Michigan, bank was solely a consequence of the failure of the bank and was not a consequence of an increase of the gross income of petitioner in its base period or a decrease in the amount of some other deduction in its base period, and was not a consequence of a change at any time in the type, manner of operation, size, or condition of the business engaged in by the petitioner.
The amounts shown as having been allowed as deductions for trade-marks in the base period years represented legal expenses and fees for renewing the registration of petitioner's trade-marks in states and foreign countries. Special counsel were employed for this purpose. An unusually large number of original trade-mark registrations expired in 1939, which occasioned the need for renewing such registrations. Three items which could not be identified as representing renewal registrations amounted to $ 35.40, $ 32.50, *71 and $ 106.63, respectively, during the year 1939.
Between the years 1939 and 1940 the United States dollar exchange value of the Canadian dollar dropped from approximately 100 to 90. Petitioner had a branch business in Canada and in the fiscal year 1940 the profits of the Canadian branch amounted to approximately $ 19,000. Of the amount of $ 2,049.23 claimed as a deduction by petitioner for 1940 as foreign exchange, $ 1,916.62 represented the amount of adjustment necessary to properly state in terms of United States*795 dollars the amount of profit at the Canadian branch. Although claimed in its income tax return for the year ended August 31, 1940, the item of $ 1,916.62 was not entered in petitioner's books until 2 years later. The remainder of the $ 2,049.23, amounting to $ 132.61, as well as the amounts of $ 116.11 and $ 148.64 deducted by petitioner for the years 1938 and 1939, represented bank charges on checks issued and collected by the Canadian branch. The item of $ 718.08 deducted for 1942 is of the same nature as the item of $ 1,916.62 deducted for 1940. The excess of the deductions for foreign exchange for the year ended August 31, 1940, was caused by the drop*72 in value of the Canadian dollar following the outbreak of the war. Petitioner computed the excess or abnormality of each of the claimed class of deductions for the base period years involved as follows:
| Class of deduction | Advertising | Trade-marks | |
| Base period year involved -- | |||
| Year ended | Aug. 31, 1940 | Aug. 31, 1939 | Aug. 31, 1938 |
| Deductions of same class for 4 | |||
| preceding taxable years: | |||
| Year ended Aug. 31, 1939 | $ 717,197.99 | ||
| Year ended Aug. 31, 1938 | 725,985.40 | $ 530.03 | |
| Year ended Aug. 31, 1937 | 610,957.29 | 140.71 | $ 140.71 |
| Year ended Aug. 31, 1936 | 521,053.47 | 467.31 | 467.31 |
| Year ended Aug. 31, 1935 | 154.55 | 154.55 | |
| Year ended Aug. 31, 1934 | 861.47 | ||
| Total of 4 preceding taxable years | 2,575,194.15 | 1,292.60 | 1,624.04 |
| Average of deductions of same | |||
| class for 4 preceding taxable | |||
| years | 643,798.54 | 323.15 | 406.01 |
| 125% of average of 4 preceding | |||
| years | 804,748.18 | 403.94 | 507.51 |
| Deduction of same class for base | |||
| period year involved | 856,564.58 | 1,179.08 | 530.03 |
| Excess or abnormality under | |||
| section 711 (b) (1) (J) | 51,816.40 | 775.14 | 22.52 |
| Deductions of same class for year | |||
| ended Aug. 31, 1942 | 827,760.41 | 94.40 | 94.40 |
| Excess of deductions for year | |||
| ended Aug. 31, 1942, over | |||
| deductions of same class for base | |||
| period year involved | 28,804.17 | 1,084.68 | 435.63 |
| Excess or abnormality under | |||
| section 711 (b) (1) (J), | |||
| as limited by section | |||
| 711 (b) (1) (K) (iii) | 28,804.17 | 775.14 | 22.52 |
| Loss of funds | ||
| Foreign | on deposit | |
| Class of deduction | exchange | due to bank |
| failure | ||
| Base period year involved -- | ||
| Year ended | Aug. 31, 1940 | Aug. 31, 1940 |
| Deductions of same class for 4 | ||
| preceding taxable years: | ||
| Year ended Aug. 31, 1939 | $ 148.64 | |
| Year ended Aug. 31, 1938 | 116.11 | |
| Year ended Aug. 31, 1937 | None | |
| Year ended Aug. 31, 1936 | None | |
| Year ended Aug. 31, 1935 | ||
| Year ended Aug. 31, 1934 | ||
| Total of 4 preceding taxable years | 264.75 | |
| Average of deductions of same | ||
| class for 4 preceding taxable | ||
| years | 66.19 | |
| 125% of average of 4 preceding | ||
| years | 82.74 | |
| Deduction of same class for base | ||
| period year involved | 2,049.23 | $ 1,646.13 |
| Excess or abnormality under | ||
| section 711 (b) (1) (J) | 1,966.49 | 1,646.13 |
| Deductions of same class for year | ||
| ended Aug. 31, 1942 | 718.08 | None |
| Excess of deductions for year | ||
| ended Aug. 31, 1942, over | ||
| deductions of same class for base | ||
| period year involved | 1,331.15 | 1,646.13 |
| Excess or abnormality under | ||
| section 711 (b) (1) (J), | ||
| as limited by section | ||
| 711 (b) (1) (K) (iii) | 1,331.15 | 1,646.13 |
On its income and excess profits tax return for the fiscal year ended August 31, 1937, petitioner claimed other deductions as follows: *74
| Item | Amount |
| Advertising | $ 610,957.29 |
| Commissions and brokerage | 86,143.24 |
| Office salaries and supplies | 8,034.72 |
| Traveling | 52,829.85 |
| Hotel expense | 30,182.30 |
| Insurance | 5,977.74 |
| Warehouse expense | 22,375.85 |
| Cartage | 3,464.64 |
| Welchade dispenser expense | 1,056.67 |
| Postage | 6,507.25 |
| Telephone and telegraph | 5,190.14 |
| Convention expense | 7,699.13 |
| Collection | 549.73 |
| Trade marks | 140.71 |
| Printing department | 576.47 |
| Export | 3,762.52 |
| Portfolios | 810.68 |
| Office supplies | 5,244.83 |
| Distribution | $ 2,103.91 |
| Factory warehouse expense | 10,396.12 |
| Legal and professional | 2,814.55 |
| Directors' fees | 620.00 |
| Unemployment insurance | 15,838.65 |
| Dues and subscriptions | 1,652.51 |
| Bank service charges | 190.43 |
| Experimental | 11,734.14 |
| Group insurance | 2,156.90 |
| Registrar and transfer agent | 3,303.10 |
| Jel Aid loss | 7,485.01 |
| Factory and warehouse | 2,169.69 |
| Employees' pensions | 960.00 |
| Heat, light, and power | 1,524.34 |
| Miscellaneous | 16,089.98 |
| Total | 930,543.11 |
*796 The items included as "other deductions" on the 1937 return are typical of the items included under that heading on each of the other returns for the fiscal years 1933 to 1940.
In computing petitioner's excess profits net income for the*75 base period year ended August 31, 1939, respondent deducted from petitioner's special class net income for that year the sum of $ 3,218.62 representing losses on certain plant and equipment. Said losses had already been deducted in determining petitioner's special class net income, from which respondent again deducted the said sum of $ 3,218.62.
During the base period year ended August 31, 1939, petitioner sustained a loss of $ 3,250 not compensated for by insurance or otherwise, arising from the dismantling of one of its plants and the abandonment and/or loss of useful value thereof, which was allowed as a deduction in computing its special class net income for said year. Said deduction is excludible from deductions in computing petitioner's excess profits net income for said year under the provisions of section 711 (b) (1) (E) of the Internal Revenue Code.
OPINION.
In its excess profits tax return for the year ended August 31, 1942, petitioner claimed certain adjustments for abnormal deductions under sec. 711 (b) (1) (J) of the Internal Revenue Code applicable to its base period years ended August 31, 1937, 1938, 1939, and 1940. These claimed adjustments were all disallowed by*76 the respondent.
In its amended petition the petitioner alleges that, in computing its base period net income, the respondent erred in failing to allow the following adjustments as increasing excess profits net income for the base period years indicated:
| Base period year | |||
| Adjustment for abnormal | |||
| deductions under section | |||
| 711 (b) (1) (J), claimed by | Sept. 1, 1937 to | Sept. 1, 1938 to | Sept. 1, 1939 to |
| petitioner and disallowed | Aug. 31, 1938 | Aug. 31, 1939 | Aug. 31, 1940 |
| by respondent | |||
| Advertising | $ 28,804.17 | ||
| Trade-marks | $ 22.52 | $ 775.14 | |
| Foreign exchange | 1,331.15 | ||
| Flood and fire loss | 1,817.57 | ||
| Loss of funds on deposit | |||
| due to bank failure | 1,646.13 | ||
| Total | 22.52 | 2,592.71 | 31,781.45 |
Other adjustments claimed in its return are not contested in the amended petition.
The taxpayer in its original petition declared that the disallowance of these adjustments constituted errors by the Commissioner. However, *797 in its amended petition the taxpayer claimed that only those rejected adjustments which applied to the last two years of the base period, together with one unimportant adjustment in the third base period year, were erroneous. The taxpayer*77 waived all claims of error for the rejection of the other adjustments in the first two years of the base period. Inasmuch as the taxpayer claimed relief under the "growth formula" set forth in section 713 (f) of the Internal Revenue Code, the acceptance of respondent's refusal to make adjustments to the first two years of the taxpayer's base period materially benefited the taxpayer under the "growth formula."
The respondent now argues on brief that where, as here, the petitioner has computed its excess profits tax credit under the so-called "growth formula," sec. 713 (f) of the Internal Revenue Code, it may not invoke the provisions of section 711 (b) (1) (J) unless it shows that the claimed adjustments are all of the adjustments permitted under that section for the entire term of the base period years.
Section 711 (b) (1) (J) is a remedial statute and the taxpayer has the burden of showing that the relief which he claims comes within the purview of that section as limited by subsection (K), but we find nothing in either the statute or the regulations promulgated thereunder which places on him the burden of proving that there are no other deductions in any of the base period years*78 which might be disallowed as abnormal within the meaning of the statute. We find nothing in section 711 (b) (1) (J) to indicate that it is to be applied differently when 713 (f) is applicable. Cf. Colson Corporation, 5 T. C. 1035; Fain Drilling Co., 8 T. C. 1174.
It is true that in its return the petitioner claimed certain adjustments for base period years under section 711 (b) (1) (J), but all the claimed adjustments were disallowed by the respondent in determining the deficiency here in question. In its amended petition the petitioner alleges error as to some of the adjustments formerly claimed and disallowed by the respondent, but not as to all. The respondent would now have the petitioner prove that the claimed adjustments which he disallowed and the petitioner thereafter abandoned were (or were not) abnormal within the meaning of section 711 (b) (1) (J). We know of no rule of pleading that would require such proof. Only the adjustments claimed in the amended petition are in issue here. Cf. Wentworth Manufacturing Co., 6 T. C. 1201.
The respondent admits and the parties have stipulated*79 that the petitioner is entitled to claimed adjustments for the base period year ended August 31, 1939, as follows: Flood and fire loss in the amount of $ 1,817.57; loss from dismantling a plant owned by the petitioner, $ 3,250, and $ 3,218.62 which had previously been deducted in computing special class net income for that year.
*798 The remaining issues presented for our decision are whether the respondent erred in disallowing the claimed adjustments under section 711 (b) (1) (J) of the Internal Revenue Code for advertising, expenditures for trade-marks, foreign exchange, and loss of funds due to bank failure. These items constitute classes of deductions for the taxpayer and were so treated by it on its books of account and tax returns.
Advertising Expense.
The petitioner contends that in computing its excess profits tax net income for the base period year ended August 31, 1940, it is entitled to an adjustment under section 711 (b) (1) (J) (ii) of the Internal Revenue Code for advertising expense in the amount of $ 28,804.17, as in excess of 125 per cent of the average amount of deductions for such class for the four previous taxable years. It argues that the excess amount*80 spent for advertising in that year was expended to maintain its sales of Welch's Grape Juice during an extraordinary and unusual price war, inaugurated by its competitors, without cutting its prices, and was not the consequence of any of the limitations set out in section 711 (b) (1) (K) (ii) of the code. 1
The respondent contends that the increase in advertising expense was a consequence of (1) an increase in gross income, or (2) a decrease in other selling expenses, and (3) a change in the condition of the business engaged in by the petitioner, *81 and therefore, the requirement of subsection (K) had not been met.
Subsection 711 (b) (1) (J) (ii) of the code provides:
(ii) If the class of deductions was normal for the taxpayer, but the deductions of such class were in excess of 125 per centum of the average amount of deductions of such class for the four previous taxable years, they shall be disallowed in an amount equal to such excess.
There is no question that the class of deductions here was normal for the taxpayer or that the deductions for such class for the base period year 1940 were in excess of 125 per cent of the average amount of deductions of such class for the four previous taxable years. They therefore come squarely within subsection (J) (ii) and must be disallowed, as contended by the petitioner, unless, as contended by the respondent, the petitioner has failed to meet its burden of proof under subsection (K) (ii). In our opinion it has met this burden of proof.
The record very definitely shows that the excess amount expended *799 for advertising in the base period year ended August 31, 1940, was a consequence of the price cutting inaugurated by petitioner's competitors in that year. Petitioner had two courses*82 open to it. It could meet price cutting by price cutting, or stand pat on its prices and meet the extraordinary competition by increasing its advertising. It chose the latter course, and subsequent developments proved that policy justified by the results. It had lost sales in the beginning of the year, but before the end of the year the volume of sales started to come back, and, while it did not sell as many cases of grape juice in 1940 as it had originally estimated, it did sell 822,959 cases in that year as against 838,575 cases in 1939. However, due to the unusual competitive situation under which it operated in 1940, the advertising expense per case reached an all time high of $ 1.041 per case sold. This increase was not a consequence of an increase in the gross income of the taxpayer. The excess expenditure was to maintain sales while holding the line on prices that had been standardized throughout the years. In fact, during the fiscal year 1940 petitioner's gross income was substantially less than it was during the fiscal year 1939, when the advertising expenses were $ 0.855 per case of Welch's Grape Juice sold. Increased expenditures for advertising may cause an increase*83 in gross income, but such income need not be a consequence of them. Cf. R. C. Harvey, Co., 5 T. C. 431; Wentworth Manufacturing Co., supra.
Nor was the increase in advertising expenditures a consequence of a decrease in the selling expense, as contended by the respondent. There is no evidence in the record that there was any decrease in selling expense over the normal amount spent. The salesmen were largely salaried employees and there is no evidence that the sales force was decreased or that salaries were cut as the result of the additional advertising. Nor do we find any change in the condition of the business engaged in by the petitioner within the meaning of the statute. It is true that there was a change in the general marketing conditions due to causes which we have discussed, but this did not bring about a change in the type, manner of operation, size, or condition of petitioner's business within the meaning of the statute.
We hold that petitioner is entitled to the relief claimed in the amount of $ 28,804.17 for the base period year ended August 31, 1940, in computing its average base period net income.
Trade-marks*84 .
In the base period years ended August 31, 1938 and 1939, it had had expenditures for trade-mark registration in excess of 125 per cent of the four preceding base period years in the respective amounts of $ 22.52 and $ 775.14. This excess was due, particularly in the fiscal year 1939, to an unusual number of registrations on account of original *800 registrations expiring in that year. The respondent refused to disallow this excess under section 711 (b) (1) (J) (ii) and contends that the "trade-marks" expense is not a class of deductions under the statute and, moreover, that petitioner has failed in its burden of proof under (K) (ii).
The respondent argues that trade-mark expense is largely legal and, while the lawyers employed were not necessarily the same as were employed for other legal work, the amount claimed should be considered a selling expense and grouped accordingly, regardless of how the items may be classified on the petitioner's books.
The treatment of expenditures for "trade-mark" registration and re-registration as a class of expenditures appears reasonable. The petitioner so treated it in its books and in its income tax returns and, while this fact is not conclusive, *85 it is persuasive when considered in the light of the evidence that the expense involved was largely due to re-registration costs. While trade-mark expense was normal to petitioner, this expense may and does become unusually large in years when a large number of trade-marks must be renewed. Since the expense was due largely to renewals, it was not due to any of the limitations set out under subparagraph (K) (ii). We hold, therefore, that the claimed excess for the fiscal years 1938 and 1939 should be disallowed in computing the base period net income for the respective years. Cf. Wentworth Manufacturing Co., supra.
In its excess profits tax return the petitioner claimed an adjustment for the fiscal year ended August 31, 1940, in the amount of $ 1,916.62, due to the drop in value of the Canadian dollar. It appears that this deduction was due originally to petitioner's recording the profits from its Canadian branch on its books in American dollar value and so reporting it in its income tax returns. In our opinion this deduction was taken and allowed to correct an error in the statement of petitioner's gross income from its Canadian branch. It is *86 not a class of deduction -- it is not even a deduction falling under section 23 of the Internal Revenue Code. It does not represent any expenditure of money or the incurring of any liability. We hold that the claimed adjustment was properly disallowed by the respondent.
The parties stipulate that the loss of funds on deposit due to the failure of a bank at Lawton, Michigan, in the amount of $ 1,646.13, for the base period year ended August 31, 1940, is a deduction which was abnormal for the taxpayer within the meaning of section 711 (b) (1) (J) (i) of the Internal Revenue Code.
The respondent contends, however, that the petitioner has failed to prove that this loss of funds on deposit was not a consequence of the limiting factors enumerated in subparagraph (K) (ii).
The evidence is that petitioner had for many years maintained an account at the bank in an amount of approximately $ 3,000 to meet *801 pay rolls and local bills at its plant at Lawton. Each week the manager of the local branch would submit to the main office a report of his expenditures from this account and the account in the bank would be correspondingly reimbursed in like amount. Upon failure of the bank, the*87 petitioner sustained a loss in the amount of $ 1,646.13, which was claimed and allowed on its income tax return for 1940.
We hold that, under the facts, the claimed loss was a consequence of the bank failure and was not a consequence of any of the factors enumerated in subparagraph (K) (ii). Since the parties agree that the deduction was abnormal to petitioner within subsection (J) (i), it should be disallowed in computing petitioner's base period net income for the year ended August 31, 1940.
Decision will be entered under Rule 50.
Footnotes
*. Amount, if any, for this taxable year not stated in this tabulation.↩
1. SEC. 711. EXCESS PROFITS NET INCOME.
* * * *
(ii) Deductions shall not be disallowed under such subparagraphs unless the taxpayer establishes that the abnormality or excess is not a consequence of an increase in the gross income of the taxpayer in its base period or a decrease in the amount of some other deduction in its base period, and is not a consequence of a change at any time in the type, manner of operation, size, or condition of the business engaged in by the taxpayer.↩