Gillen & Boney v. Commissioner , 27 T.C. 242 ( 1956 )

Gillen and Boney, a Corporation, and Frank R. Gillen, Russell Stover and Lem T. Jones, Liquidating Trustees of Said Gillen and Boney, a Corporation, Petitioners, v. Commissioner of Internal Revenue, Respondent

Gillen & Boney v. Commissioner

Docket No. 30908

United States Tax Court

27 T.C. 242; 1956 U.S. Tax Ct. LEXIS 56;

October 31, 1956, Filed

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Decision will be entered for the respondent.

Section 722 (I. R. C. 1939) claim for relief denied where excess profits tax credits, based on the most favorable constructive average base period net income allowable under the evidence to remove the effect of the drought, would not exceed the credits allowed petitioner by the respondent based on invested capital.

Whitson Rogers, Esq., and Roger V. Dickeson, Esq., for the petitioners.

David Karsted, Esq., for the respondent.

LeMire, Judge.

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LEMIRE

The Commissioner denied the petitioners' application for relief under section 722 of the Internal Revenue Code of 1939 for the year 1943, and determined a deficiency in excess profits tax for that year in the amount of $ 11,881.54.

Petitioners claim relief under section 722 (b) (1) and (b) (2) based on drought and insect infestation in its trade area during the base period.

FINDINGS OF FACT.

Gillen and Boney was a Nebraska corporation (hereinafter referred to as petitioner), and maintained its manufacturing plant and general offices in the city of Lincoln, Nebraska. It was dissolved on December 15, 1944. Its return for the taxable year 1943 was filed with the collector of internal revenue at Omaha, Nebraska, on an accrual basis and for the calendar year.

Petitioner computed its excess profits credit for 1943 under the invested capital method. Its excess profits net income and its credit so computed were $ 79,241.28 and $ 15,373.90, respectively. Petitioner is entitled to the use of the income method of computing its excess profits credit, and its excess profits net income so computed was $ 77,808.55.

Its excess profits net income (or loss) for each of the base period years was as follows:

		Excess profits
Year		net income (or loss)
1936		($ 11,088.43)
1937		(15,782.97)
1938		(10,573.73)
1939		(10,031.48)
	Total	($ 47,476.61)
	Average (loss)	(11,869.15)

Prior to 1900 petitioner and its predecessor proprietorship were engaged in manufacturing and wholesaling candy products. During the base period and for many years prior thereto petitioner manufactured bulk candies (which included such items as chocolate dipped caramels, peanuts, peanut clusters, creams, etc.), nickel candy bars, penny candies, box candies, and fancy box candies. Petitioner also purchased from other manufacturers and jobbers such items as chewing gum, Lifesavers, Hershey bars, root beer syrup, ice cream cones, and the like, to supplement its own line.

During the base period years the ratio of sales by petitioner of goods purchased to the net sales it its own manufactured products was approximately 27 per cent, whereas the ratio for the years 1922 to 1939 was approximately 31 per cent.

Petitioner's customers were largely grocery stores, drugstores, novelty stores, pool halls, and soft drink parlors throughout its trade area. Petitioner also sold its products to a few wholesale grocery houses which job nationally advertised candy bars, such as Baby Ruth, Milky Way, Mars bars, and Snickers in competition with petitioner's products. In addition, petitioner sold a small amount of its manufactured products to jobbers of candy.

During the 1920's petitioner sold to various chain stores, such as Woolworth, Piggly Wiggly, Hested, and Kresge, and such sales accounted for approximately 3 per cent of petitioner's sales in those years. Sales to chain stores were made on the basis of bids, and competition was primarily on a price basis. During the 1920's and early 1930's petitioner started to lose this type of business because it could not compete on a price basis, and during the base period, sales to chain stores were virtually nonexistent.

Primarily, petitioner's trade area covered the entire State of Nebraska with the exception of the extreme northeast corner. It also included the northern tier of counties in Kansas, as far west as Oberlin, Kansas, the southwestern part of South Dakota, including the southern area of the Black Hills region, and the eastern edge of Wyoming.

During the 1920's petitioner had sales in Omaha, the largest city in Nebraska, as well as in most of the larger cities throughout the Middle West. Such sales accounted for approximately 10 per cent of petitioner's total sales. During the 1930's, and particularly during the base period, the sales in Omaha became practically nil, and its out-of-State sales all but disappeared after the death in 1930 of the broker who handled such sales.

Nebraska is essentially an agricultural State. While it has some manufacturing and other industries, its economy is based largely on the production and processing of farm products, the most important of which are cattle, hogs, corn, and wheat.

Beginning about 1934 and extending through petitioner's base period, Nebraska and other adjoining areas suffered a severe drought. Average rainfall in Nebraska, over the period 1936 to 1939, inclusive, was less than 70 per cent of normal. Lack of moisture and severe heat at the critical stages of development caused an almost total crop failure of major crops in some of those years.

In addition to the drought there was also a serious infestation of grasshoppers in Nebraska during the base period years, which added to the short production of most farm crops over large areas of the State. This damage in the State of Nebraska alone was estimated by the United States Department of Agriculture at between 11 and 12 million dollars in each of the years 1936, 1937, and 1938.

The adverse effects of the drought in Nebraska and neighboring States were intensified by the fact that the drought followed a prolonged economic depression, due to low prices for farm commodities and other factors, which began in the early 1930's. These results are reflected in the following statistics relating to "cash receipts from farm marketings" in the State of Nebraska:

	Cattle	Hogs	Corn	Wheat	Total
Year	(1,000	(1,000	(1,000	(1,000	livestock and
	dollars)	dollars)	dollars)	dollars)	crops (1,000
					dollars)
1924	$ 114,881	$ 109,981	$ 56,897	$ 50,370	$ 421,087
1925	121,455	141,226	42,958	47,411	444,867
1926	130,683	135,306	28,783	40,987	434,244
1927	107,046	113,212	23,881	74,815	418,364
1928	138,851	121,314	61,177	55,494	484,618
1929	138,316	136,824	40,645	54,941	489,102
1930	119,019	118,172	39,094	32,412	408,392
1931	90,729	79,287	18,463	20,715	279,142
1932	57,506	43,426	7,736	8,368	166,669
1933	57,628	43,253	21,826	16,035	193,353
1934	78,802	53,644	16,767	13,816	227,176
1935	72,216	40,185	1,690	25,204	209,398
1936	92,841	68,838	5,935	34,011	281,020
1937	91,876	39,190	2,893	39,690	250,783
1938	72,603	32,436	9,507	22,312	200,521
1939	78,850	36,701	17,882	24,441	221,494

The totals shown in the last column above include other lesser livestock and livestock products such as dairy products, sheep, and poultry, and other lesser crops such as potatoes, beets, oats, and hay, not shown separately in the table, but do not show Government payments to farmers, shown hereinafter.

The loss of farm production and farm income affected all types of business throughout the drought-stricken area, particularly those which depended largely on farm trade.

As a result of the short production of feed crops during the drought period there was a reduction in the quantity and quality of marketable cattle and hogs. Large quantities of feeds were brought in from other States at additional costs to the farmers, and much of the livestock was sold in poor condition at distress prices. Because of these extra costs of production there was a proportionately greater reduction in farm net income and purchasing power than there was in gross income.

The farmers of Nebraska, in most instances, exhausted their cash reserves as well as their credit, and their spending was reduced to bare necessities. Their houses and farm equipment of all types suffered from lack of repairs and proper maintenance. Government and State agencies instituted various relief programs. The Farm Security Administration made many loans and, in some instances, outright grants to distressed farm families. The Farm Service Administration assisted in working out minimum cost subsistence recipes and budgets. The Agricultural Extension Service of the University of Nebraska organized instruction courses for farm families in repairing and, in some instances, making their own household necessities and personal clothing. Feed sacks were used to make underclothes for the children, and other wearing apparel; old blankets were converted into clothing; and sewing centers were established where overalls, dresses, and other articles, even toys, were made and distributed free to needy families. Altogether, about 4 million garments and as many other articles were made and distributed free to Nebraska families. At the beginning of 1938 over 200,000 persons, approximately 15 per cent of the total population of Nebraska, were on some form of relief.

The distress conditions described above prevailed not only among the farm families but also in the urban areas, and particularly in the small towns which depended largely upon farm income. The following table shows the total income payments and the per capita income payments to individuals in Nebraska and in the United States as a whole over the period 1929 to 1939, inclusive, as published by the United States Department of Commerce:

	(Millions of dollars) Total		(Dollars) Per capita income
	income payments		payments
Year
	United States	Nebraska	United States	Nebraska
1929	$ 82,617	$ 764	$ 680	$ 557
1930	73,325	749	596	544
1931	61,971	578	500	421
1932	47,432	344	380	251
1933	46,273	374	368	275
1934	53,038	378	420	279
1935	58,558	476	460	353
1936	68,000	534	531	399
1937	72,211	549	561	412
1938	66,045	509	509	384
1939	70,601	523	539	397

Cash farm income from marketings of crops and livestock and Government payments, including all cash agricultural payments such as rentals, price supports, conservation, and parities, for the State of Nebraska, over the period 1924 to 1939, inclusive, was as follows:

	(Thousands of dollars)
Year			Cash farm
	Total crops	Government	income and
	and livestock	payments	Government
			payments
1924	$ 421,087		$ 421,087
1925	444,867		444,867
1926	434,244		434,244
1927	418,364		418,364
1928	484,618		484,618
1929	489,102		489,102
1930	408,392		408,392
1931	279,142		279,142
1932	166,669		166,669
1933	193,353	$ 1,011	194,364
1934	227,176	23,496	250,672
1935	209,398	33,125	242,523
1936	281,020	17,293	298,313
1937	250,783	17,468	268,251
1938	200,521	15,371	215,892
1939	221,494	28,078	249,572

In relation to the 1924-1929 average the percentages of land values over the period 1930 to 1939 and of forced sales and related defaults on purchases of farms in the State of Nebraska and the United States as a whole were as follows:

	Land values		Forced sales and
			related defaults
Year	Percentage		Percentage
	United	Nebraska	United	Nebraska
	States		States
1930	94	93	20.8	17.0
1931	87	88	26.1	24.4
1932	73	74	41.7	39.0
1933	60	57	54.1	63.9
1934	62	60	39.1	51.0
1935	65	60	28.3	45.0
1936	67	60	26.2	44.4
1937	70	60	22.4	42.4
1938	70	57	17.4	38.9
1939	69	54	17.0	39.9

The population of Nebraska dropped from approximately 1,378,000 persons in 1930 to approximately 1,316,000 in 1940. About 35 per cent of the 1930 and 1940 population was urban.

The petitioner's gross sales, gross profit, expenses, other income or deductions, and net profit (or loss) for the period 1918-1941 were as follows:

						Net	Net
Year	Total net	Gross	Per cent	Operating	Per cent	additions or	profit (or
	sales	profit	of sales	expenses	of sales	(deductions)	loss)
						from income
1918	$ 502,920	$ 156,169	31.0	$ 96,373	19.2	($ 2,058)	$ 57,738
1919	619,069	184,942	29.9	126,111	20.4	1,415	60,246
1920	762,763	187,658	24.6	167,026	21.9	18,300	38,932
1921	553,359	161,159	30.3	137,767	25.8	7,117	30,509
1922	517,283	172,877	33.4	144,549	27.9	8,737	37,066
1923	594,351	182,927	30.8	152,400	25.6	(1,354)	29,174
1924	575,004	172,746	30.0	154,160	26.8	8,350	26,936
1925	593,029	180,375	30.3	151,852	25.6	4,532	33,056
1926	620,882	194,258	31.3	162,652	26.2	3,740	35,346
1927	634,012	198,236	31.3	162,001	25.6	1,539	37,774
1928	566,295	170,356	30.1	147,742	26.1	1,461	24,075
1929	490,819	167,608	34.1	144,600	29.5	880	23,888
1930	443,692	144,855	32.6	139,441	31.4	5,597	11,010
1931	322,970	102,367	31.7	125,266	38.8	1,974	(20,924)
1932	201,954	65,571	32.5	92,971	45.9	2,398	(25,002)
1933	181,222	61,571	34.0	77,469	42.7	1,182	(14,716)
1934	194,729	60,509	31.0	76,153	39.1	924	(14,720)
1935	215,321	63,246	29.4	73,434	34.1	270	(9,917)
1936	207,858	63,861	30.7	72,466	34.9	338	(8,266)
1937	199,690	60,317	30.2	72,870	36.5	(676)	(13,229)
1938	182,846	54,508	29.8	64,680	35.4	949	(9,223)
1939	158,226	46,548	29.4	55,589	35.1	777	(9,818)
1940	150,897	41,538	27.5	52,099	34.5	(901)	(11,461)
1941	157,737	42,175	26.7	52,555	33.3	(1,081)	(11,461)

During the 1920's petitioner spent for advertising an average of approximately $ 8,000 per year. The average expenditure for advertising during the base period years was approximately $ 678 per year.

During the 1920's petitioner employed approximately 11 salesmen. During the 1930's the number of salesmen was reduced to 8.

Because of the drought and, to a lesser extent, insect infestation and their effect on farm income and business generally in the State of Nebraska, petitioner's earnings were depressed so that its average base period net income was an inadequate standard of normal earnings.

The excess profits tax paid by petitioner for the taxable year 1943 was not excessive or discriminatory. Petitioner was not entitled to a constructive average base period net income large enough to produce a credit greater than the invested capital credit used by petitioner and allowed by the respondent.

OPINION.

Petitioner claims a refund of excess profits tax paid for the year 1943 in the amount of $ 24,123.12.

Petitioner's average base period net income was a loss of $ 11,869.15, and for the taxable year 1943 it used the excess profits tax credit based on invested capital which amounted to $ 15,373.90. Petitioner is claiming relief under section 722 (b) (1) and (b) (2) of the Internal Revenue Code of 1939 on the ground that its business was depressed during the base period years by the drought which prevailed over its trade area.

It has been stipulated that the evidence presented in the cases of S. N. Wolbach Sons, Inc., 22 T.C. 152">22 T. C. 152, Sartor Jewelry Co., 22 T. C. 773, and Schwarz Paper Co., 23 T. C. 605, could be considered as evidence in the present proceeding. On the basis of the findings of fact in those cases, which are incorporated herein, the respondent concedes that during the base period years a serious drought occurred in the State of Nebraska. We have found that because of the drought and its effect on farm income and business generally in the State of Nebraska, petitioner's earnings were depressed during the base period years so that its average base period net income was an inadequate standard of normal earnings.

The drought is a qualifying factor under section 722 (b) (2); S. N. Wolbach Sons, Inc., supra; Sartor Jewelry Co., supra. For the year 1943 petitioner is entitled to an excess profits tax credit based on income if that should result in a lesser tax.

To be entitled to relief petitioner must show to what extent its earnings were depressed by reason of the drought and provide some reasonably accurate means of reconstructing its base period earnings. Petitioner must further show that it is entitled to a constructive average base period net income which will result in a larger excess profits tax credit, based on income, than that allowed by the respondent under the invested capital method. Farmers Creamery Co. of Fredericksburg, Va., 18 T. C. 241; Godfrey Food Co., 18 T.C. 1083">18 T. C. 1083.

For 1943 petitioner's excess profits tax credit based on invested capital is in the amount of $ 15,373.90. On brief, petitioner contends for a reconstructed average base period net income of at least $ 27,200.

The respondent argues that if petitioner's base period net income is reconstructed to remove the effects of the drought, the resulting credit will not exceed the credit based on invested capital.

After considering the evidence and the methods of reconstruction proposed by petitioner, and weighing the evidence as to factors having a bearing on the earnings of petitioner, other than those resulting from the effects of the drought, we are convinced that no reasonable reconstruction compatible with petitioner's experience will yield an excess profits credit based on income greater than its excess profits tax credit based on invested capital.

It will be noted that petitioner suffered a considerable net loss in each year during the period 1931 to 1941, inclusive, ranging from a high of $ 25,000 to a low of approximately $ 8,300. Its total sales declined progressively from 1928 to 1934. Petitioner's operating expenses during the base period years were, percentagewise, considerably in excess of the operating expenses in the years in which it had net income.

The period of the drought commenced in 1934 and continued through the base period years.

We are persuaded that petitioner has overestimated the effect of the drought on its base period sales. An adjustment of petitioner's gross sales to the highest point justified by the evidence and an application of a reasonable ratio of net profits to sales based on actual experience would not result in a reconstructed average base period net income yielding an excess profits credit more than the $ 15,373.90 credit allowed petitioner under the invested capital method.

We conclude, therefore, that there was no error in respondent's disallowance of petitioner's claim for relief under section 722. Cf. Sartor Jewelry Co., supra, and Schwarz Paper Co., supra.

Reviewed by the Special Division.

Decision will be entered for the respondent.