Irwin B. Schwabe Co. v. Commissioner

Irwin B. Schwabe Company, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent Irwin B. Schwabe Co. v. Commissioner Docket Nos. 7526, 8585 United States Tax Court 12 T.C. 606; 1949 U.S. Tax Ct. LEXIS 224; April 21, 1949, Promulgated *224 Excess Profits Tax -- Relief Under Section 722 (b) (4). -- The taxpayer corporation is not entitled to relief under section 722 (b) (4) since it has failed to establish that a fair and just amount representing normal earnings to be used as a constructive base period net income would exceed its average base period net income as determined under the growth formula. Benjamin Mahler, Esq., for the petitioner. Thomas R. Wickersham, Esq., for the respondent. Murdock, Judge. MURDOCK *606 The Commissioner denied the petitioner's claims under section 722 (b) (4) for relief from excess profits taxes imposed for the fiscal years ended September 30 in 1941, 1942, and 1943. The only issue for decision is whether he erred in rejecting those claims. FINDINGS OF FACT. The petitioner is a corporation, organized under the laws of New*225 York on September 30, 1939, to take over the business of selling cotton garments previously conducted by Irwin B. Schwabe individually under the name of Irwin B. Schwabe Co. It keeps its books and files its returns on an accrual basis, using a fiscal year ending September 30. The petitioner is entitled to use the excess profits credit based on income, pursuant to section 713 of the Internal Revenue Code. It is an acquiring corporation as defined in section 740. Irwin B. Schwabe Co. is a component corporation as defined in that section. Schwabe was engaged in the business of selling work shirts and play suits from 1930 until the formation of the petitioner in 1939. He did not own any manufacturing facilities at any time material hereto. All work shirts which he sold prior to May 1938 were manufactured for him by Tupelo Garment Co. (hereinafter called Tupelo). Schwabe furnished the material with his orders and specifications, and Tupelo manufactured, packed, and shipped the shirts to his customers. Tupelo billed him for the work on the basis of a fixed price per dozen work shirts, and he in turn billed his customers. Tupelo sold most of its shirts to customers. Schwabe had agreed*226 verbally in 1930 with Tupelo not to solicit business from any of Tupelo's customers or their competitors, including such large mail order and chain store houses as Sears-Roebuck & Co., Montgomery Ward & Co. and J. C. Penney Co. Schwabe never violated that agreement. He made his sales to wholesalers, jobbers, small chain stores, and small mail order houses. *607 Tupelo operated five plants in Mississippi, which produced between 600,000 and 700,000 dozen work shirts annually. Schwabe was continuously ordering shirts to be manufactured by Tupelo and always had an agreement with Tupelo as to the number to be manufactured during the next three or four months. Sometimes Tupelo would not agree to manufacture as many shirts in a given period as Schwabe requested. Schwabe could not have had his shirts manufactured by any other on the same basis as his arrangement with Tupelo, and if he had attempted to obtain a manufacturing plant of his own Tupelo would have canceled immediately its arrangement with him. Tupelo discontinued operations and proceeded to liquidate in May 1938, due primarily to labor and not financial difficulties. Schwabe arranged to purchase its plant at New Albany, *227 Mississippi, through a corporation to be formed by him and Leonard Herrington, who had been the supervisor of all production for Tupelo. The New Albany plant had produced about one-third of Tupelo's output and was considered the best of its five plants. Tupelo had owned all the machinery and equipment in the plants, but had leased the buildings. The Irwin Manufacturing Corporation (hereinafter called Irwin) was organized under the laws of Mississippi on July 25, 1938, to take over the operation of Tupelo's New Albany plant. Tupelo sold the machinery and equipment in the plant and transferred the lease of the building to Irwin. Irwin issued stock in the amount of $ 40,400 for cash upon its organization and issued $ 5,050, the remainder of its authorized stock, for cash on June 30, 1939. The stockholders at that time were Schwabe, who held an interest of 81.1 per cent; Herrington, with an interest of 11.1 per cent; and Alice Wagner, with an interest of 7.8 per cent. Herrington was vice president and supervisor of the operation of the plant. Irwin began operations in August 1938. It operated the plant on the same work week and used substantially the same machinery and factory *228 personnel previously employed by Tupelo, but hired additional clerical workers and supervisors. Irwin manufactured work shirts exclusively for Schwabe, on substantially the same basis as had Tupelo. The prices charged him by Irwin were comparable to those which had been charged by Tupelo. The Irwin plant was capable of producing at full capacity not later than August 1939. Its production capacity was at least 275,000 dozen work shirts per year. Schwabe was under no restrictions with respect to the customers from whom he could solicit business after May 1938. He began selling to the large mail order houses and chain stores in September 1938. He reduced the sales to his former small customers temporarily *608 to an undisclosed extent, because his supply was not sufficient to fill fully the orders of both types. Schwabe began negotiations during the summer of 1939 for the erection by the city of New Albany of a new plant which he proposed to lease and operate in the manufacture of work shirts. He met with representatives of the city during the course of the negotiations, which lasted four to five months. He promised them that if the city would erect a suitable building he *229 would furnish new machinery for the operation of a shirt factory and would provide an annual pay roll of not less than $ 50,000. They knew of Schwabe's successful operation of the Irwin plant and were confident that he would operate the new enterprise on the same basis and would carry out his agreement. There was no written agreement between Schwabe individually and the city concerning the construction of the new plant or the lease thereof. The I. B. S. Manufacturing Co. (hereinafter called I. B. S.), a corporation, was organized under the laws of Mississippi on December 20, 1939, to enter into a contract with the city of New Albany concerning the erection of the proposed plant. The common stock was issued upon incorporation for cash to Schwabe, Herrington, and Alice Wagner in proportion to their holdings of stock in Irwin. No other stock was ever issued. The reason for forming a new corporation instead of using Irwin was that the city, under the state law governing municipal bond issues, could not deal with an existing plant. A contract between New Albany and I. B. S. was executed on December 21, 1939, by Herrington, as vice president, on behalf of I. B. S. The city agreed to*230 acquire real estate and erect a building suitable for the purposes of I. B. S., to contain not less than 18,000 square feet of floor space and to cost not more than $ 22,500. I. B. S. agreed to lease the building from the city at a rental of $ 1,000 per annum for a period of ten years, with an option to renew the lease for an additional period of ten years and to install in the building garment manufacturing machinery and equipment having a value of not less than $ 20,000. The contract further required I. B. S. to maintain an annual pay roll in specified minimums. The contract had previously been approved by the board of aldermen. The citizens of New Albany had voted at a special election on October 31, 1939, to float a bond issue in order to secure the funds necessary for the erection of the new plant. The population of New Albany was about 3,200 at that time. The representatives of New Albany were relying primarily upon Schwabe to carry out the above contract. The citizens of the city were not told anything about I. B. S. prior to the special election. They had been told by the mayor and the aldermen that Schwabe was *609 back of the contract. Schwabe had conducted *231 all the negotiations for the contract. The new plant was erected pursuant to the contract between I. B. S. and New Albany and was completed in 1940. It was erected solely for the purpose of carrying out that contract. I. B. S. and New Albany entered into a lease contract on September 30, 1940, in accordance with the contract of December 21, 1939. I. B. S. began operations on August 24, 1940, and manufactured shirts exclusively for the petitioner. The annual production capacity of the plant was 120,000 dozen work shirts. Herrington supervised the operation of the plant. Schwabe was president and Jack E. Doron was vice president of the petitioner. It received $ 181,817.04 of assets from Schwabe, subject to liabilities of $ 76,777.04, and on or about September 30, 1939, it succeeded to the business theretofore conducted by him. It issued stock upon its formation which was held 83.2 per cent by Schwabe, 10.4 per cent by Gladys T. Schwabe, and 6.4 per cent by Irwin Wagner. The stock was held 87.7 per cent by Schwabe, 10.9 per cent by Gladys T. Schwabe, 0.9 per cent by Doron, and 0.5 per cent by Wagner on September 30, 1940. Schwabe expected additional production from the then proposed*232 I. B. S. plant when he formed the petitioner. Doron had been successfully engaged in selling cotton garments to wholesalers, jobbers, large chains, and large mail order houses for a number of years. He was employed by the petitioner as a salesman and continued as its vice president until October 1947. The petitioner paid him a salary of $ 10,000, plus a bonus of $ 3,500, as compensation for his services during the fiscal year ended September 30, 1940. The petitioner began to sell sport shirts in 1940. The sport shirts were different from the work shirts and took about 50 per cent longer to manufacture, but they were higher priced and were sufficiently more profitable than work shirts to justify their production. The petitioner sold the sport shirts principally to Montgomery Ward & Co. and Sears-Roebuck & Co. The introduction of sports shirts caused a temporary loss of production to Irwin because the factory workers had to be trained in the use of different machinery. The plants were not capable of peak production of sport shirts until the spring of 1940. The cotton garment business was highly competitive. The sales of Schwabe fluctuated generally the same as those of his competitors*233 during the base period. His principal competitors were larger than the petitioner and represented about one-half of the country's total annual work shirt production of 6,000,000 to 7,000,000 dozen. Any additional business which Schwabe or the petitioner might have obtained *610 during the base period would necessarily have been taken from competitors. Some of the other four plants previously operated by Tupelo were reopened for the first time late in 1939 or 1940. Schwabe stated at the annual directors' meeting of the petitioner on September 30, 1940, that "competition on work shirts became so keen that it was necessary for the corporation to manufacture additional items." The volume of work shirts sold during years of business depression did not vary much from the volume sold in normal times. However, the price at which they were sold during the depressed years was much lower than in normal times. 1937 was a depressed year in the cotton textiles industry. The petitioner had no difficulty in getting sufficient material with which to maintain production prior to September 30, 1940. J. C. Penney Co. was experiencing difficulty at that time in securing the material which it*234 supplied for the work shirts it ordered from the petitioner. That did not affect the petitioner's production, however, since it had other large customers and some of its available production was converted to the manufacture of sport shirts. The petitioner did not have any Government contracts until the latter part of 1941. The total sales and earnings of Schwabe and the petitioner from all sources were as follows: Period covered Total sales Gross profit Net income 3/1/30 to 12/31/30 $ 136,885.66 $ 8,073.59 ($ 1,788.78) year 1931 367,102.85 26,998.97 12,750.86 [1932] 238,080.92 19,253.88 8,116.65 [1933] 344,120.70 40,853.33 26,498.38 [1934] 418,894.41 28,101.87 14,624.44 [1935] 414,622.55 32,489.29 14,904.09 [1936] 562,827.47 57,129.94 35,595.37 [1937] 428,309.47 36,421.52 15,994.34 [1938] 629,352.10 58,443.08 29,586.77 9 mos. ended 9/30/39 766,779.05 55,973.04 28,313.94 Year ended 9/30/40 1,117,383.77 120,508.70 48,919.55 The net income for the periods through September 30, 1939, did not exclude salaries of Schwabe, whereas that for the fiscal year ended September 30, 1940, was after all salaries. The*235 sales of work shirts and the gross profits therefrom were as follows for the periods shown below: Period covered Dozens sold Sale price Gross profit Calendar year 1936 111,251 $ 477,935.60 $ 48,916.85 [1937] 86,464 369,492.70 31,528.87 [1938] 129,230 506,392.33 43,721.92 9 mos. ended 9/30/39 153,853 661,577.02 43,923.43 Year ended 9/30/40 * 189,986 932,758.86 98,128.60 *611 The production of work shirts and sport shirts by Irwin was as follows: Dozen Dozen 4-week period ended -- work sport shirts shirts Aug. 27, 1938 8,614 Sept. 24, 1938 14,203 Oct. 22, 1938 15,504 Nov. 19, 1938 14,350 Dec. 17, 1938 15,912 Jan. 14, 1939 13,511 Feb. 11, 1939 15,659 Mar. 11, 1939 16,236 Apr. 8, 1939 13,056 May 6, 1939 15,424 June 3, 1939 16,282 June 30, 1939 15,911 July 29, 1939 13,441 Aug. 26, 1939 17,586 Sept. 23, 1939 18,514 Oct. 21, 1939 18,839 Nov. 18, 1939 17,201 Dec. 16, 1939 23,203 Jan. 13, 1940 10,222 [7] Feb. 10, 1940 13,027 [199] Mar. 9, 1940 11,279 1,793 Apr. 6, 1940 9,185 3,710 May 4, 1940 10,338 3,539 June 1, 1940 10,540 3,418 June 30, 1940 10,688 3,671 July 27, 1940 12,802 1,187 Aug. 24, 1940 10,218 4,673 Sept. 21, 1940 9,625 4,541 Oct. 19, 1940 7,937 4,345 *236 I. B. S. manufactured an additional 3,080 dozen work shirts during the fiscal year ended September 30, 1940. The inventories of finished and unfinished work shirts held by Schwabe and the petitioner at the end of the indicated fiscal periods, and firm orders of Penney for work shirts which were unshipped at the end of those latter periods, were as follows: Penney Fiscal period ended -- Finished work shirts Unfinished orders work shirts unshipped at end 12/31/35 $ 20,781.60 12/31/36 48,616.42 $ 52,947.59 12/31/37 52,251.51 10,867.07 12/31/38 10,528 doz. 38,217.20 36,907.45 21,555 doz. 9/30/39 8,660 doz. 30,977.90 55,107.54 26,769 doz. 9/30/40 10,919 doz. 56,201.24 65,877.25 23,336 doz. The sales made by Schwabe and petitioner to the large chain stores and mail order houses (in dozens) were as follows: Sept. - Dec., Period ended Period ended [1938] Sept. 30, 1939 Sept. 30, 1940 * J. C. Penney Co 24,549 79,198 59,736 Sears Roebuck & Co 2,971 17,667 S. H. Kress & Co 2,492 9,564 Montgomery Ward & Co 7,550 *237 The petitioner's excess profits net income during the base period, average excess profits net income for those years, average base period net income computed upon a general average, and average base period net income computed upon the growth formula for the purposes of *612 the excess profits credit based on income for the fiscal year 1941 and the fiscal years 1942 and 1943, are as follows: For purposes For purposes Excess profits net income year ended Sept. 30 -- of credit for of credit for [1941] 1942 and 1943 [1937] $ 6,871.21 $ 7,694.59 [1938] 12,945.52 14,945.72 [1939] 22,131.44 25,646.08 [1940] 38,768.59 47,669.55 Average excess profits net income during base period 20,179.19 23,988.98 Average base period net income general average 23,076.73 27,581.67 Average base period net income growth formula 33,858.40 41,067.27 The petitioner paid excess profits taxes for its fiscal years 1941, 1942, and 1943 in the amounts of $ 5,618.34, $ 91,639.84, and $ 144,777.58, respectively. Applications for relief under section 722 (b) (4) of the code and claims for refunds based thereon in the amounts of $ 5,618.12, $ 49,786.83, and $ 56,018.82 in respect of its *238 fiscal years 1941, 1942, and 1943 were duly filed by the petitioner and denied by the respondent. The stipulation of facts is incorporated herein by this reference. OPINION. The petitioner claims relief under section 722 (b) (4). It has been stipulated that this petitioner is entitled to use the excess profits credit based on income. The average of the normal earnings of such a taxpayer for a base period are compared with its earnings for the taxable year in determining its excess profits tax. This is accomplished through an excess profits credit. The issue in this case relates solely to the question of what amount should be regarded as normal average base period net income for the purpose of computing the excess profits credit based upon income. The actual earnings of the base period are used for that purpose, unless one of the relief provisions applies. Here one of the relief provisions has already been applied by the Commissioner. That is, the Commissioner has computed an excess profits credit under the growth formula to arrive at a credit substantially higher than that computed by the use of actual earnings during the base period. See section 713 (f) applicable to 1941 *239 and section 742 (h) applicable to 1942 and 1943. The petitioner claims, however, that it is entitled to an even greater credit, computed under section 722 by the use of a constructive average base period net income to represent what it says should be regarded as its normal earnings for the base period. The petitioner is a corporation which was organized on September 30, 1939. It took over on that date a business of selling play suits and work shirts which had previously been conducted by Irwin B. Schwabe, an individual, under the name of Irwin B. Schwabe Co. The *613 business did not include the manufacture of the play suits and work shirts being sold. The claims for relief filed by the petitioner relate only to that part of its business involving the sale of work shirts and, consequently, relief can not be based upon any other phases of its business. Blum Folding Paper Box Co., 4 T. C. 795. The base period for the purpose of section 722 began on October 1, 1936, and ended on September 30, 1940. The petitioner was in existence only during the last twelve months of that period. The parties have stipulated that the petitioner is an acquiring*240 corporation and the business previously conducted by Schwabe as a sole proprietorship is a component corporation. See section 740 (a) (1) (D), (b) (5), and (h). Where, as here, the income of the sole proprietorship is included with the income of the taxpayer in computing the average base period net income, the taxpayer is to be treated as if the business of the sole proprietorship during that period had been a part of the business of the taxpayer. See sec. 722 (e) (2). Section 722 allows relief where a taxpayer establishes that its excess profits tax without the relief, is excessive and discriminatory, and further establishes what would be a fair and just amount to represent normal earnings to be used as a constructive average base period net income. The tax is to be considered excessive and discriminatory where a taxpayer, like this one, entitled to use the excess profits credit based on income, shows that its average base period net income is an inadequate standard of normal earnings because the taxpayer changed the character of the business during the base period and the average base period net income does not reflect the normal operation of the business for the entire base*241 period. The term "change in the character of the business" is defined to include, inter alia, a change in the operation or management of the business, a difference in the capacity for production or operation, and the acquisition before January 1, 1940, of a part of the assets of a competitor, resulting in the elimination or diminution of its competition. Section 722 (b) (4) provides that the change shall be deemed to have been made two years before it occurred if the business of the taxpayer had not reached the earning level by the end of the base period which it would have reached if the change had actually occurred two years earlier. The same subparagraph also refers to a change in the capacity for production or operation of the business consummated after December 31, 1939, as a result of a course of action to which the taxpayer was committed prior to January 1, 1940. These are the provisions of section 722 (b) (4) under which this petitioner claims relief. It was incumbent upon the petitioner to prove in this proceeding (1) that it changed the character of its business during the base period, (2) that its average base period net income is an inadequate standard of normal*242 earnings because of that change, and (3) what *614 would be a fair and just amount to represent normal earnings for use in determining constructive average base period net income. Furthermore, the petitioner will not be entitled to relief under section 722 unless the constructive average base period net income which it establishes is greater than its average base period net income determined under the growth formula. That is, the relief which it has been granted already under the growth formula will stand until the petitioner shows that it is entitled to greater relief under section 722. Homer Laughlin China Co., 7 T. C. 1325. The petitioner contends that it changed the character of its business in several ways within the meaning of section 722 (b) (4). Its arguments are unsound in so far as they are based upon the assumption that either Irwin or I. B. S., separate corporations, engaged in the manufacture of shirts, were components of the petitioner or in any other way so identified with the petitioner, engaged only in sales, as to make their acts acts of the petitioner for present purposes. Irwin, rather than the petitioner, acquired Tupelo's*243 plant at New Albany. The record does not show that Irwin became a part of the business of Irwin B. Schwabe Co. which the petitioner later took over, and even if Tupelo is to be regarded as a competitor, nevertheless, the petitioner has not shown that either it or its component acquired any of the assets of Tupelo. Likewise, any commitments of Schwabe or I. B. S. based upon manufacturing, all of which were made after the petitioner was organized and had taken over the sales business, can not be regarded as commitments of this petitioner. The petitioner bases some of its arguments upon the employment of Doron and his election to the office of vice president. There was no commitment to Doron which would aid the petitioner under section 722, and the evidence as a whole does not show that the petitioner is entitled to any relief or that it even qualifies for relief on the basis of its contentions based solely upon the employment of Doron. The petitioner's argument that there was a difference in its capacity for operation before and after May 1938 is the strongest one advanced and the only one of its contentions to support a change in the character of its business which will be discussed*244 in detail. The petitioner argues that Schwabe was restricted in two ways under his arrangement with Tupelo. One was that Tupelo was unwilling to use more than an undisclosed portion of its manufacturing capacity to manufacture shirts for Schwabe. The other was that Tupelo was dealing directly with some of the large mail order and chain store companies, and its understanding with Schwabe was that he would in no way compete in that field with Tupelo. There is opinion testimony to the effect that Schwabe could have sold more work shirts during the first part of the base period had Tupelo been willing to manufacture more shirts for him. However, *615 there is little, if any, evidence in the record to support those opinions. The evidence does not show the exact arrangement in this respect between Tupelo and Schwabe. For example, it does not show how many shirts or what portion of the total capacity of Tupelo was available to Schwabe at any particular time during the base period, whether this maximum changed from time to time or remained the same, or the relation at any time during the base period between the number of shirts actually sold by Schwabe and the maximum that Tupelo*245 would have manufactured for him. There is no evidence of any particular instance in which Schwabe could have sold additional shirts but was prevented from doing so because Tupelo would not manufacture them for him. His sales in 1937 were far below his sales in 1936. There is no evidence to show that the falling-off was due to a reduction in the allotment fixed by Tupelo. It may have been due instead to the fact that Schwabe was unable to sell in that year as many shirts as Tupelo would have manufactured for him. The increase in inventories is not adequately explained. Thus, it is not so clear that Schwabe's capacity to make sales during the first part of the base period was limited by his inability to have more shirts manufactured by Tupelo. Schwabe, as long as he was dependent upon Tupelo for the manufacture of his shirts, could not have gone into competition with Tupelo by endeavoring to make sales of his shirts to any of the large chain store or mail order houses, but just how much of a restriction upon him that was is not so clear. However, he began to make sales to Penney during the last four months of 1938; his sales to Penney during the remainder of the base period were*246 large; he began to make sales to Sears and to Kress during the third year of the base period; those sales increased during the fourth year of the base period and in that year sales were made to Montgomery Ward; and Doron, who like Schwabe was an experienced salesman, was employed by the petitioner, beginning in September 1939. The statute provides that "a difference in the capacity for * * * operation" shall be regarded as a change in the character of the business for the purpose of section 722 (b) (4). After May 1938 the entire production of Irwin was available to Schwabe and the petitioner, and they actually sold to the large chain store and mail order houses. Prior to that time some undisclosed portion of the capacity of Tupelo was available to Schwabe and he was not in position to solicit as customers any of the large chain store or mail order houses. Do these circumstances indicate a difference in the capacity for operation of this petitioner after May 1938 as compared to before May 1938 within the meaning of section 722 (b) (4)? It will be assumed for present purposes that they do. The next question is whether the petitioner has shown that its average base period net income*247 is an inadequate standard of normal *616 earnings because of a change such as the one described in the preceding paragraph. Closely related to that is the further question of what would be a fair and just amount to represent normal earnings for use in determining constructive average base period net income. The petitioner argues that the demand for work shirts exceeded its available supply at all times during the base period; this continued until the I. B. S. plant reached full production; the earning level of the business at the end of the base period was not as great as it would have been had the change in the character of the business occurred two years earlier; twice the volume of shirts actually sold during the calendar year 1939 could have been sold had they been available; and, therefore, its average base period net income is an inadequate standard of normal earnings. It argues that the constructive average base period net income should be for the 1941 credit $ 72,986.42, and for the credits for the later years $ 87,349.45, compared with actual averages of $ 20,179.19 and $ 23,988.98, and averages under the growth formula of $ 33,858.40 and $ 41,067.27. 1 *248 The respondent has not argued the question of whether or not the petitioner changed the character of its business. His argument is that, even assuming a change, nevertheless, the petitioner has not shown that its average base period net income was an inadequate standard of normal earnings because of any change in the character of the business, or that a fair and just amount to represent its average normal earnings would exceed the average base period net income under the growth formula. While it might seem reasonable to conclude that the sales of this business would have been greater in the first part of the base period if Schwabe had had all the shirts he could sell and had been free to sell them to anyone to whom he could make a sale, nevertheless, this record does not justify the conclusion that they would have been great enough to produce earnings in excess of the average allowed under the growth formula. Indications in the record that the sales made by Schwabe were limited by factors other than the number of shirts which Tupelo would have manufactured for him have already been mentioned. There is also some evidence tending to show that the sales during the latter part of the*249 base period would not have been greater under any circumstances. There were then no restrictions upon the prospective customers to whom sales might be made, but the petitioner argues that its sales were still limited by lack of shirts, since the Irwin and I. B. S. plants were not able to manufacture as many shirts during *617 the whole of that period as they could have manufactured had they gotten started 2 years earlier. That is true, of course, with regard to I. B. S., but it is not at all clear in the case of Irwin. The production record of Irwin indicates that it could have manufactured more work shirts during the latter part of the base period, but that it merely kept pace with the work shirt selling demands of the business of the petitioner. For example, it produced 23,203 dozen work shirts in the four weeks ended December 16, 1939, and it maintained an average production of over 19,000 dozen for the 5 periods of 4 weeks each preceding that date. Thereafter its production of work shirts declined, declined even more rapidly than its inventories increased. The increases in its inventories also indicate to some extent that lack of work shirts to sell was not responsible*250 for the failure to earn greater profits during the base period. The petitioner argues that the inventories in the latter part of that period were merely sufficient to cover the undelivered Penney orders as of the end of each fiscal year. However, the inventory of finished and unfinished work shirts increased by about $ 36,000 during the last year of the base period, while the undelivered orders of Penney decreased by more than 3,000 dozen shirts. Furthermore, Penney supplied its own material for the shirts which it ordered and the cost of such material would hardly be reflected in the inventories of the petitioner. There are some other indications that the ability of the petitioner to sell work shirts during the latter part of the base period was not taxing the capacity of Irwin to make such shirts. For example, the work shirt capacity of Irwin was deliberately limited early in 1940 by a partial change-over to the manufacture of sport shirts. There may have been competition from the other Tupelo plants which were reopened about that time. Schwabe stated at the annual meeting of the directors of the petitioner on September 30, 1940, that "competition on work shirts became so*251 keen that it was necessary for the corporation to manufacture [sic] additional items." There is thus some reason to believe that the petitioner had fully realized by the end of 1939 the full benefit which it was going to derive from the termination of Tupelo and the new relationship with Irwin. The record does not show what portion of the petitioner's profit for any year was attributable to the work shirt business as distinguished from the play suit and later the sport shirt business. Even if it were apparent that the average actual earnings of the petitioner for the base period were an inadequate standard of normal earnings because of the difference in its business after May 1938 as compared to prior to May 1938, nevertheless, the petitioner would still lose because it has failed to show that a fair and just amount to represent normal earnings for use in determining constructive average base period net income *618 would exceed its average base period net income as determined under the growth formula. The petitioner is not entitled to the relief claimed under section 722, but must be content with the substantial benefits given it under the growth formula. Footnotes *. Includes sales of 27,529 dozen sport shirts at a price of $ 188,853.38. The record does not show what portion of the gross profit for that year was attributable to the sales of work shirts.↩ *. The record does not show what portion of the sales for this period were sales of sport shirts.↩ 1. The excess profits net income for the base period years for the purpose of the 1941 credit is somewhat less than the same figures for the purpose of the credits for the later years because of a change in the law. See section 711 (b) (1) (A), repealed with respect to taxable years beginning after December 31, 1940, by sections 202 (c) (2) and 205 of the Revenue Act of 1941.↩