Packer Publishing Co. v. Commissioner , 17 T.C. 882 ( 1951 )

Packer Publishing Company, Petitioner, v. Commissioner of Internal Revenue, Respondent

Packer Publishing Co. v. Commissioner

Docket No. 26369

United States Tax Court

17 T.C. 882; 1951 U.S. Tax Ct. LEXIS 30;

November 28, 1951, Promulgated

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Decision will be entered under Rule 50.

1. Evidence showing long term downward trend in profits of petitioner's newspaper business, rather than variant profit cycle or temporary or unusual economic circumstances, held not to entitle it to relief under sections 722 (b) (3) (A), or 722 (b) (2).

2. Change of contracts during base period which materially altered manner of operation of petitioner's comic supplement business held to entitle it to relief under section 722 (b) (4) as a change in the character of the business.

3. Unused excess profits tax credit carry-over based on special relief and shown in computation of claims for subsequent years held available to petitioner as properly claimed in applications for relief.

4. Standard issue involving deductibility of manager's bonus which varied with profit after taxes held not within Tax Court's jurisdiction in absence of determination of deficiency. Mutual Lumber Co., 16 T.C. 370">16 T. C. 370, followed.

Charles C. Shafer, Jr., Esq., and Lancie L. Watts, Esq., for the petitioner.

William J. Stetter, Esq., for the respondent.

Opper, Judge.

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OPPER

This proceeding is brought for review of respondent's disallowance of petitioner's applications for relief under section 722, Internal Revenue Code, which claimed refunds in the amounts of $ 24,770.36, $ 26,705.20, and $ 19,777.95 for the calendar years 1943, 1944, and 1945, respectively. Petitioner has waived certain issues. The questions for determination are whether petitioner is entitled to relief under subsections 722 (b) (2) or (b) (3) (A) with respect to its newspaper business and under subsection 722 (b) (4) with respect to its comic supplement business and, if so, whether it is entitled to unused excess profits credit carry-overs from the preceding years. If relief is granted, there is a further question -- whether the Court has jurisdiction to recompute petitioner's income and excess profits taxes in order to take into account the consequent increase of a bonus payable under a profit-sharing arrangement based upon net profits after taxes. Some of the facts have been stipulated.

FINDINGS OF FACT.

The stipulated facts are hereby found accordingly.

Petitioner, a Missouri corporation, filed its tax returns with the collector of internal revenue for the sixth district of Missouri.

In 1899 petitioner was organized to produce and publish a weekly trade newspaper to report prices, market conditions, and other trade events. Originally it devoted its reporting principally to the meat packing industry. However, after a few months it transferred its reporting to the wholesale fresh fruit, vegetable, and produce fields. In 1920 petitioner decided that the produce field of wholesale poultry, butter and eggs had need for a separate trade newspaper. Thereafter petitioner prepared, published, and sold two trade newspapers: The Packer for the wholesale fruit and vegetable industry, and The Produce Packer for the wholesale produce industry.

Petitioner's principal office is in Kansas City, Missouri, where it edits, prepares, prints, and publishes its newspapers. In several large cities it maintains branch offices which send to the main office, by telephone, telegraph, and airmail, news items, price quotations, market condition reports, and other pertinent information of interest in the fresh fruit, vegetable, and produce fields. The information is edited and published in the appropriate edition of The Packer or The Produce Packer. There is only one edition of The Produce Packer. The Packer has five editions: The Chicago Packer, The Cincinnati Packer, The Kansas City Packer, The New York Packer, and The Pacific Coast Packer. The various editions of The Packer are substantially the same except that each edition emphasizes certain news items and contains some additional news of particular interest in the vicinity in which that edition is distributed. The Produce Packer and all editions of The Packer are printed in Kansas City on Friday of each week and they are mailed to subscribers throughout the country for receipt on the following Monday morning. The mechanical procedure of printing and mailing is similar to that of other regularly published newspapers.

During the period 1919 to 1939 petitioner made no changes in the method of conducting its newspaper business except for the formation of The Produce Packer in 1920. During that period petitioner employed practically the same staff and followed the same business methods.

Approximately ninety per cent of petitioner's gross income is derived from the sale of advertising and from paid subscriptions. Its salesmen, working out of its branch offices, approach shippers, brokers, commission houses, wholesalers in terminal markets, and distributors throughout the country in order to obtain subscriptions and sell advertising. Its advertising rates ranged, depending upon the size of the contract, from $ 1.80 to $ 3 per inch, prior to 1942, and from $ 2 to $ 3.25 per inch, since 1942. The annual subscription price for The Produce Packer or for any edition of The Packer was $ 2 prior to 1943 and $ 3 in 1943 and thereafter. The subscription price does not return a profit over the cost of paper, postage, and circulation, and it has never been petitioner's policy to earn a profit from subscriptions. However, the existence of a large subscription list aids petitioner in selling advertising.

The Packer is not comparable to other newspapers. It is not a farm journal or a grower's paper. It carries no advertising for consumers. Any increase or decrease in advertising for the newspaper industry as a whole would have little or no effect on petitioner's advertising, although its business reflects general business conditions. It is largely confined to matters of interest to the wholesale fruit and vegetable trade. An average issue contains from 24 to 36 pages, while its sole competitor, the Produce News, which is published in New York City, prints about 6 to 8 pages per issue. The Packer carries approximately four to five times as much advertising as the Produce News.

News of farm crops and prices is printed in the Chicago and New York Journals of Commerce, but those publications do not cover fresh fruit and vegetable news as intensively as The Packer. Fruit and vegetable crop, price and market news is distributed without charge by the Market News Service conducted by the Bureau of Agricultural Economics of the Department of Agriculture. A Report of the Federal Trade Commission on Agricultural Income Inquiry, Part II, submitted to the Congress on June 10, 1937, reported that wholesalers of farm products relied heavily for market news information upon the Market News Service, which maintained branch offices and field men collecting daily market information, made public by the Department of Agriculture through daily bulletins, and news items given to newspapers and to radios for broadcasting.

The fresh fruit and vegetable distribution business upon which The Packer's news and advertising depends, is a Nation-wide industry. Growers sell their products to shippers who are located in the various producing sections. The shippers grade and pack the product, and sell or consign it to receivers in terminal markets. Large terminal markets are located in the major cities throughout the country. The product may be reshipped to smaller local markets and usually it passes through several middlemen in the distribution chain before reaching the retailer. Some wholesalers charge a commission; others operate on a percentage basis, taking a profit based upon cost.

The wholesale fresh fruit and vegetable business is a relatively stable industry. The dominant factor affecting the prosperity of the industry is the wholesale prices of fruits and vegetables. Fruit and vegetable prices are greatly influenced by the amount of production. The periods of prosperity of that industry and of The Packer have generally coincided with periods of high fruit and vegetable prices. A heavy crop with reduced prices is generally unprofitable for wholesalers and reduces petitioner's advertising. An extremely small crop reduces advertising because buyers are readily available. A light crop, somewhat less than average, tends to increase advertising.

The prices of agricultural products suffered a steady decline after the first World War. One of the primary causes was constantly increasing production resulting in a surplus of agricultural commodities. The Agricultural Adjustment Act of 1933 and similar subsequent relief measures halted the downward trend of farm prices.

The business of distribution of fruits and vegetables has been affected by the chain stores, which began purchasing, prior to the 1920's, directly from producers, shippers, and wholesalers. In subsequent years chain store purchasing continued and increased through the year 1939. It removed large quantities of perishable foods from the wholesale markets, was responsible for the elimination of many car-lot receivers who formerly acted as middlemen at one step in the chain of distribution, and reduced the importance of the large terminal markets.

The wholesale fruit and vegetable industry was affected by methods of competition and trade practices followed by the chain stores. One of the largest chain stores, the Great Atlantic and Pacific Tea Co., hereinafter called A & P, followed a practice of featuring sales of particular commodities, called "loss-leaders," which were sold at retail for less than the wholesale price in order to attract trade, and which depressed prices and decreased profits in the wholesale field. A & P utilized a subsidiary, the Atlantic Commission Co., as a purchasing agent. Prior to June 19, 1936, the subsidiary frequently collected brokerage fees from sellers as well as from A & P, although other brokers collected a fee from only the seller or buyer in handling a particular commodity. On June 19, 1936, the Robinson-Patman Act was enacted, amending the Clayton Act. Subsequently, that subsidiary and other purchasing agents of A & P received from their suppliers various allowances, discounts, and other price concessions, alleged by A & P to be for services rendered and quantity buying. On January 25, 1938, the Federal Trade Commission issued a cease and desist order against A & P enjoining illegal discounts resulting not from services or quantity buying, but representing brokerage savings effected by sellers in dealing directly with A & P. On September 22, 1939, that order was affirmed in the case of Great Atlantic & Pacific Tea Co. v. Federal Trade Commission (C. A. 3), 106 F.2d 667">106 F. 2d 667, certiorari being denied on January 2, 1940. The practices of A & P, its commission company, and purchasing agents injured competition. During the base period the Atlantic Commission Co. advertised in The Packer and made purchases from The Packer's customers.

The transportation of fruits and vegetables by motor truck affected the wholesale markets, as they were constituted prior to 1930. During the base period many trucks carried loads from producing areas to small local markets which formerly received perishable foods from larger marketing centers. Unscheduled arrivals of truckloads of perishable foods sometimes caused chaotic prices in terminal markets. Shipments by motor truck diverted great quantities of fruits and vegetables from the large terminal markets and reduced the amount of trade done by wholesalers.

The wholesale fruit and vegetable business has been affected by the practice which developed in 1932 or 1933 on the part of some wholesalers, known as service wholesalers, to take orders by telephone from independent retail stores and to deliver directly to retailers by motor truck on regularly established routes. That practice has expanded greatly. It has reduced the number of purchasers coming to trade in the wholesale markets, and the importance of the large marketing centers, and has resulted in increased competition among wholesalers.

In addition to its trade newspapers, petitioner's only other substantial source of regular income has been profit from the printing of Sunday comic supplements for newspapers which do not have color printing presses. Since its trade papers are printed only on each Friday, it was necessary for petitioner to develop other printing business to keep its equipment and pressmen occupied during the remaining portion of the week.

Newspapers throughout the country buy color comics for their Sunday supplements from various syndicates which subcontract with enterprises able to do color printing. In order to engage in printing for that trade, in 1923 petitioner purchased a four-color printing press. The color plates are assembled on the press at various points and successively superimposed upon the same sketch. Proof copies are run and adjustments are made in order to eliminate blurred images and overlapping of colors. This process of assembling the plates, checking proofs, and making adjustments until adequate copies of a particular comic can be printed is known in the trade as a "make-ready," and it requires approximately two to three hours. After the "make-ready" of a comic is completed, several thousand copies can be printed in about twenty minutes. The printing of such copies is referred to as a "run."

In many instances, various newspapers in different areas of the country use exactly the same comics. When one printer prepares supplements for newspapers using the same comics, only one "make-ready" is required, and they are all printed in one "run." It is then only necessary, at the top of the comic page, to adjust the press for the name of the particular newspaper. That process is referred to in the trade as a change of the "fudgehead," which is a small plate containing the name of a newspaper. A change of "fudgehead" requires about five minutes.

From October 1923 to June 1930 petitioner printed comic supplements for King Features Syndicate under a contract providing for payment of cost plus 65 cents per 1,000 copies, cost being defined as being all expenses except depreciation and administrative expenses.

From June 1930 to August 20, 1938, petitioner printed comic supplements for the same syndicate on a competitive bidding basis. During this period an increasing number of short "runs" were ordered. The contract prices did not vary with the size of the "run," and petitioner complained to the syndicate, without success, concerning the excessive number of short "runs." During the period January 1, 1936, to August 20, 1938, petitioner's costs per "run" increased considerably; its comic supplement profits substantially decreased; it was unable to compete with other publishers contracting with the syndicate; and it concluded that it could not do business profitably with the syndicate.

From August 20, 1938, through December 1938 petitioner printed no comic supplements. Beginning in January 1939 and thereafter, through competitive bidding petitioner obtained contracts with Newspapers Enterprise Association, which was in the business of preparing comic supplements for about 15 to 20 newspapers, all using the same comic strips. The contracts with that association called for approximately 200,000 to 300,000 copies, which could be printed on a single "run," requiring only one "make-ready," the only necessary adjustments being change of "fudgeheads." During 1939 petitioner's comic sales for the months January to December, inclusive, were $ 1,773, $ 2,786, $ 2,990, $ 2,824, $ 2,894, $ 4,433, $ 3,071, $ 3,058, $ 3,234, $ 3,181, $ 4,486, and $ 3,144, respectively.

Petitioner has never maintained cost accounting records to show the separate profits of its respective trade papers, but its records show the gross advertising and subscription income of each paper. It has maintained records for its comic supplement business, showing sales, wages, miscellaneous expenses, and "profit" of that business, but not taking into account depreciation and administrative expenses. It has maintained records of income from various miscellaneous sources. The failure of petitioner's accounting system to segregate expenses of The Packer and The Produce Packer makes it impossible to determine exactly the net profit or loss resulting from either one of these activities.

Petitioner's general manager, Roy V. Fellhauer, has been employed since 1941 under a profit-sharing agreement, which provides, in addition to an annual salary of $ 6,500, for a bonus of 10 per cent of net earnings in excess of $ 7,000 up to $ 17,000, 15 per cent of net earnings in excess of $ 17,000 up to $ 27,000, and 20 per cent of net earnings in excess of $ 27,000. Under the agreement, all taxes on income, profits or capital are to be treated as expenses in determining net earnings. Fellhauer's bonuses under the agreement for the years 1941 to 1945, inclusive, have been zero, $ 3,301.52, $ 5,656, $ 6,620.07, and $ 6,059.86, respectively.

During the years 1920 to 1939, inclusive, petitioner's gross advertising and subscription income from all five editions of The Packer were as follows:

	Advertising	Subscription
Year	income	income
1920	$ 332,056.34	$ 25,978.70
1921	301,068.33	20,069.09
1922	321,313.26	27,604.14
1923	327,003.35	28,603.62
1924	293,260.40	27,212.78
1925	287,624.15	29,302.18
1926	294,493.03	28,120.34
1927	278,609.50	28,244.42
1928	292,874.47	27,264.27
1929	287,739.80	27,472.05
1930	258,668.77	25,510.71
1931	209,863.28	24,025.29
1932	147,669.82	18,241.43
1933	127,013.09	17,186.30
1934	153,549.22	19,459.82
1935	163,257.63	19,800.24
1936	167,780.94	21,598.12
1937	183,468.81	21,357.58
1938	169,165.33	20,037.62
1939	170,049.37	20,414.56

During the years 1923 to 1939, inclusive, petitioner's profits from its comic supplement printing business while it operated on a cost plus basis, and the sales, expenses, and profits of that business during the remaining period, without taking into account depreciation and administrative expenses, were as follows:

	Comic		Other	Total
Year	sales	Wages	expenses	expenses	Profit
1923					$ 3,518
1924					15,427
1925					16,883
1926					19,431
1927					21,128
1928					20,481
1929					18,770
1930					16,457
1931	$ 61,603	$ 27,148	$ 15,283	$ 42,431	19,172
1932	46,943	21,140	12,078	33,218	13,725
1933	36,655	15,805	10,107	25,912	10,743
1934	44,777	19,469	13,432	32,901	11,896
1935	43,457	21,886	13,244	35,130	8,327
1936	62,569	33,925	21,463	55,388	7,181
1937	66,853	35,608	30,906	66,514	339
1938	41,956	20,323	15,370	35,693	6,262
1939	37,874	10,137	21,567	31,704	6,170

During the years 1920 to 1939, inclusive, petitioner's additional sources of income included earnings from job printing, bad debt recoveries, sale of waste paper, interest, and miscellaneous income, including profit from a credit reporting service. Petitioner's profit and loss statement for 1923 included comic supplement profit of $ 3,517.57 in the total for miscellaneous income, and its statements for the years 1924 to 1931, inclusive, included bad debt recoveries in the respective totals for miscellaneous income. The income from these respective sources, as reported in petitioner's statements of income and expense, was as follows:

	Miscellaneous		Sale of
	printing	Bad debts	waste	Miscellaneous
Year		collected	paper		Interest
1920		$ 3,843.12	$ 691.59	$ 294.92	$ 251.25
1921		3,317.53	358.95	467.36	4.32
1922		5,080.31	259.42	648.14	1.68
1923		3,844.08	469.42	4,525.76	6.85
1924			324.44	4,164.01	26.33
1925			288.37	4,426.94
1926			247.69	6,035.92
1927			207.43	6,194.64
1928			168.69	5,672.47
1929			244.92	5,830.59
1930			147.39	5,459.44
1931			144.80	7,016.93
1932		1,290.05	36.51	12,875.29
1933		845.51	170.58	23,808.50
1934		812.36	118.86	3,221.22
1935		622.89	116.80	8,462.13
1936		1,165.34	194.12	8,806.39
1937		1,203.24	252.31	10,749.86
1938		339.85	150.61	14,070.33	3.70
1939	$ 5,311.57	397.51	218.81	705.72

During the years 1919 to 1939, petitioner's total net income, its profit from comic supplement printing without deduction of an allocable share of depreciation and administrative expense, and its total net income from sources other than its comic supplement printing income as thus determined, were as follows:

		Comic	Net income
Year	Net income	supplement	less comic
		profit	supp. profit
1919	$ 73,403		$ 73,403
1920	73,921		73,921
1921	57,243		57,243
1922	95,402		95,402
1923	98,161	$ 3,518	94,643
1924	67,010	15,427	51,583
1925	68,863	16,883	49,980
1926	71,181	19,431	51,750
1927	54,462	21,128	33,334
1928	69,527	20,481	49,046
1929	67,993	18,770	49,223
1930	27,669	16,457	11,212
1931	26,820	19,172	7,648
1932	12,925	13,725	(800)
1933	14,497	10,743	3,754
1934	39,428	11,896	27,532
1935	28,109	8,327	19,782
1936	22,101	7,181	14,920
1937	33,920	339	33,571
1938	23,180	6,262	16,918
1939	22,332	6,170	16,162

The earnings of all corporations in the United States in millions of dollars, on the basis indicated, and the indices determined as shown, for the years 1920 to 1939, are as follows:

			Total less tax
	Total less tax	Index	exempt income,	Index
Year	exempt income	(1920-35=100)	plus int. paid	(1922-39=100)
1920	5,873	176.9	8,708	122.0
1921	458	14.0	3,599	50.4
1922	4,770	143.9	7,839	109.8
1923	6,308	190.0	9,586	134.3
1924	5,363	161.0	8,808	123.4
1925	7,621	229.0	11,238	157.4
1926	7,505	225.1	11,493	161.0
1927	6,510	195.1	10,885	152.5
1928	8,227	247.0	12,808	179.4
1929	8,740	263.0	13,665	191.4
1930	1,551	47.0	6,413	89.8
1931	(3,288)	(99.0)	1,204	16.9
1932	(5,644)	(170.0)	(1,600)	(22.4)
1933	(2,547)	(76.9)	964	13.5
1934	94	3.0	3,516	49.3
1935	1,696	51.0	4,957	69.4
1936	4,369	131.0	7,451	104.4
1937	4,407	132.1	7,410	103.8
1938	1,608	48.0	4,479	62.8
1939	4,509	135.1	7,306	102.4

The wholesale price indices of the United States Bureau of Labor Statistics for all commodities and all foods for the years 1920 to 1939, and for fruits and vegetables for the years 1926 to 1939, with 1926 prices taken at 100, are as follows:

	All commodities	All	Fruits and
Year		foods	vegetables
1920	154.4	137.4
1921	97.6	90.6
1922	96.7	87.6
1923	100.6	92.7
1924	98.1	91.0
1925	103.5	100.2
1926	100.0	100.0	100.0
1927	95.4	96.7	96.7
1928	96.7	101.0	96.5
1929	95.3	99.9	97.8
1930	86.4	90.5	96.6
1931	73.0	74.6	72.4
1932	64.8	61.0	58.0
1933	65.9	60.5	61.7
1934	74.9	70.5	67.5
1935	80.0	83.7	63.6
1936	80.8	82.1	71.9
1937	86.3	85.5	74.2
1938	78.6	73.6	58.2
1939	77.1	70.4	62.0

The acreage and farm value of commercial truck crops planted for marketing during the years 1918 to 1939, inclusive, as reported in the publication of the United States Department of Agriculture, entitled "Agricultural Statistics, 1941," were as follows:

		Farm value
Year	Acreage	(1,000
	(acres)	dollars)
1918	471,120	104,186
1919	521,850	117,667
1920	619,400	123,534
1921	621,270	135,130
1922	791,750	152,810
1923	732,710	172,904
1924	910,280	180,866
1925	969,650	195,120
1926	1,064,940	185,698
1927	1,122,200	192,768
1928	1,220,840	217,126
1929	1,304,560	224,419
1930	1,449,790	204,369
1931	1,505,520	177,504
1932	1,550,740	145,827
1933	1,451,440	142,403
1934	1,660,860	163,863
1935	1,652,030	177,354
1936	1,727,870	194,488
1937	1,691,460	205,208
1938	1,728,720	182,989
1939	1,753,330	205,365

The quantity of surplus fruits and vegetables purchased for free distribution by the United States Government under relief programs from October 3, 1933, through June 30, 1939, as reported by the Department of Agriculture publication, entitled "Agricultural Statistics, 1941," was as follows:

Commodity	Quantity	Unit
Fruits:
Apples, dried	16,192,000	Pounds.
Apples, fresh	9,050,828	Bushels.
Apricots, dried	3,590,000	Pounds.
Blackberries,
canned	76,960	Cases.
Cherries	30,000	No. 10 cans.
Figs, dried	809,800	Pounds.
Grapes	19,019,202	Pounds.
Grapefruit, fresh	4,513,228	Boxes.
Grapefruit, juice	3,685,964	Cases.
Oranges	4,061,489	Boxes.
Peaches, dried	15,954,954	Pounds.
Peaches, fresh	13,894	Bushels.
Pears, fresh	881,178	Boxes.
Plums	32,355	Boxes.
Prunes, dried	205,273,925	Pounds.
Prunes, fresh	13,743	Bushels.
Vegetables:
Beans, dried	156,508,877	Pounds.
Beans, fresh	2,341,633	Pounds.
Beets, fresh	18,971,798	Pounds.
Cabbage, fresh	207,039,584	Pounds.
Carrots, fresh	11,046,050	Pounds.
Cauliflower	100,118	Crates.
Celery	295,550	Crates.
Corn, fresh	17,730	Bushels.
Onions	62,389,615	Pounds.
Peas, canned	864,192	Cases.
Peas, dried	30,592,645	Pounds.
Peas, fresh green	2,631,554	Pounds.
Potatoes, flour	1,761,720	Pounds.
Potatoes, starch	800,000	Pounds.
Potatoes, sweet	972,362	Bushels.
Potatoes, white	11,478,034	Bushels.
Tomatoes, canned	116,701	Cases.
Tomatoes, fresh	20,992,659	Pounds.
Turnips, fresh	1,570,665	Pounds.

Petitioner's excess profits net income for the years 1940 through 1945, inclusive, computed under section 711 (b), without the application of section 722; is: $ 14,934.12, $ 18,700.24, $ 44,216.81, $ 75,570.54, $ 127,154.91, and $ 130,972.05, respectively.

Petitioner's excess profits net income for the base period years 1936 to 1939, inclusive, without the application of section 722, is: $ 22,100.93, $ 33,920.21, $ 23,180.40, and $ 22,331.73, respectively.

Petitioner is entitled to compute its excess profits credit under either section 713 or 714 of the Internal Revenue Code, having been in existence during the entire base period. Computation under section 713 for 1943, 1944, and 1945 results in the lesser tax. Petitioner's excess profits credit computed under section 713, after adjustments under section 711, without the application of section 722, for the years 1940 through 1945, inclusive, is: $ 28,453.49, $ 29,015.74, $ 30,513.85, $ 30,081.86, $ 30,831.22, and $ 30,740.26, respectively.

Petitioner's application for relief under section 722 for the years 1943, 1944, and 1945 claimed refunds of excess profits tax for those years of $ 24,770.36, $ 26,705.20, and $ 19,777.95, respectively. Petitioner's application for relief for 1943 claimed, among other matters, unused excess profits credit carry-overs from 1940, 1941, and 1942, arising from application of section 722 to those years. Its application for relief for 1944 contained, among other matters, a computation of tax which took account of an unused excess profits credit carry-over from 1942 in an amount equal to the unused excess profits credit carry-over from 1942 shown in its application for relief for 1943. The application for relief for 1944 stated that it incorporated by reference all matters contained in relief applications for other years, and stated that it relied for support of the claim upon the statement of facts attached to the application for relief for 1943. The petition alleged that respondent had erred, among other errors, in failing to determine that petitioner was entitled for 1943 and 1944 to unused excess profits credit carry-overs in the amounts equal to those shown in its application for relief for those years.

Petitioner claims a constructive average base period net income for The Packer of $ 39,493, alleged to be equivalent to The Packer's actual average net income for the years 1919 to 1935, inclusive, and computed in the following manner: From its total net income for each of the years 1919 through 1939, inclusive, petitioner deducted the respective profits from comic supplement printing, the latter being computed without deducting depreciation and administrative expenses. No deductions were made for other sources of income. The remaining net income was taken as equivalent to the joint net income of The Packer and The Produce Packer. The Packer's net income was calculated as being that portion of the remaining net income computed by applying to such net income a percentage determined by the ratio of advertising gross income from The Packer to total advertising gross income. Petitioner's annual net income from The Packer, thus computed, averaged $ 39,493 during the years 1919 to 1935, inclusive, and averaged $ 18,980 during the base period years 1936 through 1939. Petitioner's annual net income from The Produce Packer, computed in a similar manner, averaged $ 4,563 for the years 1919 to 1935, inclusive, and $ 1,412 during the base period years 1936 through 1939.

Petitioner's applications for relief proposed a constructive total base period net income for its comic printing business of $ 57,126, computed by taking 27.3 per cent of the actual average annual comic supplement sales for the base period of $ 52,313, 27.3 per cent being the average percentage of "net profit" from comic printing for the years 1931 to 1935, inclusive, as disclosed by petitioner's records. At the hearing petitioner claimed a constructive average base period net income for its comic supplement printing business of $ 12,000, computed in the following manner: Petitioner adopted as its constructive average base period gross income, from comic supplement printing, the sum of $ 40,348, which is twice the amount of its actual comic supplement sales for the last half of 1939. As a deduction for wages, petitioner subtracted $ 10,893, which is 27 per cent of $ 40,348, 27 per cent being the actual ratio during 1939 of petitioner's wage expense to its comic supplement sales. As a deduction for other expenses, petitioner subtracted $ 17,229, which is 42.7 per cent of $ 40,348, 42.7 per cent being the actual ratio during the years 1936 to 1939, inclusive, of petitioner's recorded non-wage expenses arising out of comic supplement printing to such sales for that period. No deduction was taken for depreciation and administrative expenses. The constructive average base period net income, thus computed, is $ 12,226. Petitioner's brief asserts $ 12,000 to be the constructive average base period net income, computed by the method above described, except that the percentage of non-wage or "other expenses" to comic supplement sales for each of the base years was calculated by taking the actual percentage for each base period year and dividing by 174.1, the latter figure being a total obtained by adding together those actual percentages for the base period years. As thus computed, the constructive total base period net income was $ 48,904.

Respondent disallowed the claims for refund asserted in the applications for relief and determined that petitioner's excess profits tax liability for 1943, 1944, and 1945, without the application of section 722, was $ 27,321.10, $ 73,806.76, and $ 77,148.19, respectively.

The Packer's business was not depressed in the base period because of temporary economic circumstances unusual in its experience.

The Packer's business was not depressed in the base period by reason of conditions generally prevailing in its industry subjecting it to a profit cycle differing materially in length and amplitude from the general business cycle.

Petitioner changed the character of its comic supplement printing business during the base period, and the average net income during that period does not reflect its normal operation for the entire base period.

Petitioner's excess profits taxes for the years 1943, 1944, and 1945, as computed without the benefit of section 722, are excessive and discriminatory, and petitioner is entitled to relief under that section.

The sum of $ 12,000 is a fair and just amount representing normal earnings from the comic supplement printing business for use as a constructive average base period net income for purposes of the excess profits tax.

OPINION.

I.

Petitioner's claim for relief under section 722, Internal Revenue Code, was founded upon four propositions: (1) That the earnings of its trade journals, The Packer and The Produce Packer, were "depressed in the base period because of temporary economic circumstances unusual" ¹ in its case or in the case of its industry, within the scope of subsection (b) (2); (2) that its business was "depressed" during the base period by reason of being subjected to "a profits cycle differing materially in length and amplitude from the general business cycle," ² under subsection (b) (3) (A); (3) that its comic supplement printing activity underwent a "change in the character of" ³ its business during the base period entitling it to relief as provided in subsection (b) (4); and (4) that (b) (5) was operative.

Petitioner has now expressly waived its claim under the last mentioned subsection, and has, in addition, withdrawn all requests for relief as applied to The Produce Packer. Of the, remaining questions under section 722, we shall for convenience first consider the applicability of (b) (3) (A).

II.

There are numerous flaws in the statement and implementation of this aspect of petitioner's contention, but we disregard the subsidiary and concentrate on the central fallacy. The purpose of the "cycle" provision, as its language and background make clear, is to protect from discriminatory treatment the business which, by reason of its peculiar cycle, was in a depression phase of its development during the base period, thus using an unreasonably low comparative, as related to the general economy, to measure its subsequently earned excess profits. Roy Campbell, Wise & Wright, Inc., 15 T.C. 894">15 T. C. 894.

Petitioner's witness testified, in support of its claim under this provision, that petitioner's was "a seventeen-year profit cycle extending from 1919 to 1935." ⁴ This would, of course, call for the beginning of a new and comparable cycle in 1936, with the 4 years 1936 through 1939 being roughly comparable to those from 1919 through 1922. ⁵ To achieve the objective of section 722(b) (3) (A) it would hence be necessary to show that petitioner's history had been one of depression in the earlier 4-year period, thus indicating a similarly depressed condition in the base period.

The facts, however, are exactly contrary. General business profits for the 1919-1922 period averaged annually 134.6 per cent of the 1919-1935 average, while petitioner's profits for the same period were averaging 177 per cent of its 1919-1935 profits. ⁶ Petitioner's own yearly income averaged $ 72,198 for 1919-1923, as against $ 39,493 for 1919-1935; and its average annual advertising volume -- the principal source of its income -- was $ 320,360 for the 1920-1923 period compared with $ 254,754 for 1920-1935 and $ 178,616 for 1936-1939. ⁷ In other words, either petitioner's witness was mistaken as to its profits cycle, or petitioner's business was, as respondent contends, in a general downward trend, so that the next cycle would, except for the war, have shown constantly decreasing figures as compared to the period 17 years earlier. See El Campo Rice Milling Co., 13 T.C. 775">13 T. C. 775. In neither event could petitioner fall within (b) (3) (A) or show that the base period was an unfair or discriminatory criterion for measuring its excess profits. Roy Campbell, Wise & Wright, Inc., supra;El Campo Rice Milling Co., supra;Pabst Air Conditioning Corporation, 14 T.C. 427">14 T. C. 427.

In arriving at this conclusion we express no opinion as to whether petitioner was, as it contends, a member of the fruit and vegetable industry, or in the alternative an industry by itself, or neither. If the last, it has failed in an essential element of its proof, Pabst Air Conditioning Corporation, supra; if the second, its cycle, as we have seen, indicates that the base period was a high point for it on the cyclical approach and hence could not have been a "depressed" period as the statute requires; El Campo Rice Milling Co., supra; and if the first, it was either typical of its industry, which then would not have been depressed either, or it departed from the industry cycle for peculiarities of its own, which again eliminates relief under (b) (3) (A). Roy Campbell, Wise & Wright, Inc., supra.We conclude that subsection (b) (3) (A) has thus been shown to be inapplicable.

III.

Assuming that a comparison of The Packer's earnings during the base period with those for the entire 20 years ending with it show a comparatively depressed condition, we must look further under (b) (2) since "A declining business or industry which was depressed because of economic conditions of a permanent rather than a temporary nature does not come within" the classification of (b) (2). S. Rept. No. 1631, 77th Cong., 2d Sess., 1942-2 C. B. 504, 650. The depression must come about due to "temporary economic circumstances" unusual for petitioner or its industry. Section 722 (b) (2), supra.

In order to carry its burden of showing the existence of that requirement, petitioner resorts to a single assertion -- that unfair competition by the Great Atlantic & Pacific Tea Co. during the base period injured the business of its chief advertising customers, the fruit and vegetable wholesalers, and hence reduced their advertising commitments to it.

As corroboration for this position we are referred to the opinion of the Third Circuit Court of Appeals in Great Atlantic & Pacific Tea Co. v. Federal Trade Commission, 106 F. 2d 667. There a cease and desist order against the A & P was sustained forbidding it to exact discounts and other favors from fruit and vegetable producers selling to it, on the ground that "petitioner's [A & P's] receipts of net prices, allowance and discounts in lieu of brokerage injured competition."

Assuming that this opinion can be treated as proof of the facts there found, but see Harlan Bourbon & Wine Co., 14 T. C. 97, the effect is to destroy rather than support petitioner's case. True, the decree was entered at about the end of the base period; true also, the forbidden practices appear to have arisen about June 19, 1936, the date of the passage of the Robinson-Patman Act, thus coinciding roughly with the beginning of the base period.

But, as the above quotation and other parts of the opinion demonstrate, the prohibited exactions were merely a substitute for brokerage payments which had previously been required by the A & P but were forbidden by the Robinson-Patman Act. "Congress had ascertained that trade practices such as those employed by the petitioner [A & P] prior to June 19, 1936, resulted in unfair competition. Prior to the passage of the Robinson-Patman Amendment the petitioner received brokerage * * * from sellers. Following the amendment, the petitioner inaugurated the three methods heretofore referred to to avoid that which the Act forbade. As we have stated the attempted avoidance is unsuccessful. * * *" (Emphasis added.)

The unfair competition with its customers by the A & P of which petitioner complains is thus a practice of long standing, how long the record does not show exactly, but apparently for at least 20 years. See Fish Net & Twine Co., 8 T. C. 96. Only the form was somewhat different during the base period; the effects were obviously -- and assertedly -- the same. The "economic event" was consequently not "temporary" nor "unusual." See Acme Breweries, 14 T. C. 1034; Harlan Bourbon & Wine Co., supra.And passage of the Robinson-Patman Act was not an "economic event" at all. Acme Breweries, supra.More important, it could not have accounted for any "depression" of petitioner's business during the base period since, as we noted under II, supra, petitioner's profits and advertising contracts were not adversely affected during prior periods when similar practices obtained, but instead show a continual downward trend through its entire demonstrated history. See S. Rept. 1631 supra. Monarch Cap Screw & Manufacturing Co., 5 T.C. 1220">5 T. C. 1220. It follows that there is no showing of an excessive or discriminatory excess profits computation under (b) (2). See Industrial Yarn Corporation, 16 T.C. 681">16 T. C. 681.

IV.

When we come to the claim under (b) (4), however, more favorable treatment is required. The "change in the character" of petitioner's comic supplement business upon which it relies is a new contract with a new customer under which it was possible to achieve the same production with less labor. The details need not be reiterated. They appear in our findings.

It is adequate to note that the reconstructed base period income as submitted by petitioner and incorporated in our findings makes use of actual 1939 figures as these are involved in the concept of change of business, and actual prior year percentages to the extent that no change in practice is contended for.

Thus, the sales for the 4-year period are reconstructed by using actual sales for the last half of 1939; expenses of labor are based upon actual percentage of 1939 labor to such 1939 sales; but other expense is arrived at by taking the percentage of actual cost to actual sales for the prior years, since petitioner's claim is not based upon any change in such expense, and there is no indication that the percentage of expense to sales would have varied in prior years even had the new contract then been in effect.

We conclude that petitioner is entitled to use a reconstructed base period income under (b) (4) for its comic supplement income and that its method of arriving at such income is reasonable and should be approved. Wisconsin Farmer Co., 14 T.C. 1021">14 T. C. 1021.

V.

Respondent now concedes that if petitioner is entitled to any relief under section 722, it may relate the computation back to the years 1941 and 1942 by means of carry-overs to 1943, one of the years before us. He makes no similar concession for 1944. But his sole objection to the carry-over to that year appears to be that petitioner's claim for relief failed to contain any reference to it. As to this, a closer examination reveals that petitioner's computation of its claim under section 722 for 1944 includes an unused excess profits tax credit from 1942. We view this as a sufficient notice to respondent of petitioner's position. See Higginson v. United States (Ct. Cl.), 81 F. Supp. 254">81 F. Supp. 254; United States v. Humble Oil & Refining Co. (C. A. 5), 69 F. 2d 214. Its reconstructed base period income for the comic supplement business under section 722 accordingly entitles it to carry-overs to both 1943 and 1944 if that turns out to be warranted under the recomputation.

VI.

There having been no determination of any deficiencies as to income tax or excess profits tax, jurisdiction is lacking to deal with the question whether such relief as is being granted would entitle petitioner to a larger deduction for its manager's bonus which consists of a percentage of profit after taxes. The proceeding in these respects must be dismissed. Mutual Lumber Co., 16 T.C. 370">16 T. C. 370.

Reviewed as to section 722 by the Special Division.

Decision will be entered under Rule 50.

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Footnotes

• 1. (b) Taxpayers Using Average Earnings Method. -- The tax computed under this subchapter (without the benefit of this section) shall be considered to be excessive and discriminatory in the case of a taxpayer entitled to use the excess profits credit based on income pursuant to section 713, if its average base period net income is an inadequate standard of normal earnings because --

  * * * *

  (2) the business of the taxpayer was depressed in the base period because of temporary economic circumstances unusual in the case of such taxpayer or because of the fact that an industry of which such taxpayer was a member was depressed by reason of temporary economic events unusual in the case of such industry↩

• 2. (3) the business of the taxpayer was depressed in the base period by reason of conditions generally prevailing in an industry of which the taxpayer was a member, subjecting such taxpayer to

  (A) a profits cycle differing materially in length and amplitude from the general business cycle, or ↩

• 3. (4) the taxpayer, either during or immediately prior to the base period, commenced business or changed the character of the business and the average base period net income does not reflect the normal operation for the entire base period of the business. If the business of the taxpayer did not reach, by the end of the base period, the earning level which it would have reached if the taxpayer had commenced business or made the change in the character of the business two years before it did so, it shall be deemed to have commenced the business or made the change at such earlier time. For the purpose of this subparagraph, the term "change in the character of the business" includes a change in the operation or management of the business, a difference in the products or services furnished, a difference in the capacity for production or operation * * *.↩

• 4. Petitioner's brief, p. 83.↩

• 5. "As students became aware that the problem involved more than the analysis of turning points, they gave increasing recognition to a four-phase cycle, marked by the stages of expansion, recession, depression, and revival. * * *

  "In tracing the course of the cycle, one must plunge in medias res, that is, choose one of its phases as the starting point. Assuming that we begin with the period of revival the first task is to determine how revival produces the next phase -- prosperity. It must then be shown how prosperity produces conditions leading to recession, recession gathers momentum in creating depression, and finally depression ultimately develops into a new revival. * * *

  "* * * With the expansion of production, we are back to where we started." Achinstein, "Introduction to Business Cycles," 1950, Thomas Y. Crowell Co., pp. 4, 143, 147.↩

• 6. Computed from table at p. 60 of petitioner's brief.↩

• 7. Taken from tables at p. 36 of petitioner's brief.↩