A B C Brewing Corp. v. Commissioner

A B C Brewing Corp. (Formerly Aztec Brewing Company), a California Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent A B C Brewing Corp. v. Commissioner Docket Nos. 6701, 11570 United States Tax Court 20 T.C. 515; 1953 U.S. Tax Ct. LEXIS 129; May 29, 1953, Promulgated *129 Decisions will be entered under Rule 50. 1. Carry-back of unused excess profits tax credits for 1945 and 1946 denied where petitioner distributed its operating assets and was de facto dissolved in 1944. 2. In the computation of average base period net income under the growth formula of section 713 (f), respondent correctly applied the limitations imposed by subsection (f) (7), in addition to those imposed by subsection (f) (6), limiting the benefits from the application of the growth formula to the increase in base period earnings occurring prior to June 1, 1940. 3. In adjusting excess profits credit under section 713 (g) (4), respondent correctly reduced distributable earnings and profits of 1944 by the excess profits tax liability for that year. 4. Petitioner's income was overstated in 1943 and understated in 1944 by reason of erroneous adjustments in those years of its bad debt reserve account. 5. Unused bad debt reserve transferred to income in 1944 held abnormal income excludible from excess profits tax net income under section 721 (a) (1) of the Internal Revenue Code. 6. Petitioner held not entitled to relief under the provisions of section 722 (b) (4), Internal *130 Revenue Code. Donald C. McGovern, Esq., for the petitioner. R. E. Maiden, Jr., Esq., and R. B. Sullivan, Esq., for the respondent. LeMire, Judge. LeMIRE *515 These proceedings involve excess profits tax deficiencies for the fiscal years ended October 31, 1941, to October 31, 1944, in the respective amounts of $ 956.59, $ 29,513.66, $ 232,437.25, and $ 41,557.63. Also involved is the question of whether and to what extent petitioner is entitled to relief from excess profits tax liability for those years under the provisions of section 722, Internal Revenue Code. Petitioner filed claims for relief under section*131 722 and for refunds of *516 excess profits tax in the aggregate amount of $ 649,915.05. These claims were disallowed in toto. The issues pertaining to the deficiencies are: 1. Whether petitioner is entitled to a carry-back of unused excess profits tax credits for 1945 and 1946. 2. Whether respondent has correctly computed petitioner's average base period net income under the provisions of section 713 (f), Internal Revenue Code. 3. Whether, in adjusting petitioner's excess profits credit for 1944 under section 713 (g) (4), the earnings and profits distributable to shareholders should be reduced by the estimated excess profits tax for that year. 4. Whether petitioner's income for 1943 was overstated and its 1944 income understated by reason of erroneous adjustments of its bad debt reserve account; and, 5. Whether a credit balance in petitioner's bad debt reserve account taken into income in 1944 was abnormal income attributable to prior years within the meaning of section 721 (a) (1) or income attributable to the recovery of bad debts within the meaning of section 711 (a) (1) (E) of the Internal Revenue Code. Petitioner bases its claim for relief under section 722 solely upon *132 section 722 (b) (4). It contends that there were changes in the character of its business during the base period years both in its operations and the products manufactured. The claims for relief, as originally filed, were based on 722 (b) (1), (2), (3), (4), and (5), but in this proceeding petitioner has abandoned all but its 722 (b) (4) claims. Other issues raised in the pleadings have been settled by stipulation and will be given effect under the Rule 50 recomputations. The facts set out below are substantially those found by the commissioner, who took the evidence in the case, with the addition of certain conclusive facts not previously found. Other facts, some of which were stipulated and incorporated in the commissioner's findings by reference, will be stated when necessary in the discussion of the separate issues. FINDINGS OF FACT. 1. The stipulated facts are incorporated herein by this reference. 2. Petitioner is a California corporation with its principal place of business located in San Diego, California. Its returns for the taxable years involved were filed with the collector of internal revenue for the sixth district of California. The returns were prepared on an accrual*133 basis for a fiscal year ending October 31. 3. Petitioner was organized under the laws of the State of California in 1932 under the name of Aztec Brewing Company. Its name *517 was changed to A B C Brewing Corporation on September 21, 1946. Petitioner operated a brewery at San Diego, California, from June 1933 to March 31, 1944. Its stockholders agreed to its dissolution on March 7, 1944, and on April 1, 1944, there was a distribution to the stockholders in partial liquidation of $ 750,000 book value of assets. Petitioner has not actively engaged in the brewery business since March 31, 1944. 4. Petitioner's balance sheets showed the following assets and liabilities at March 31, 1944, and at the close of the taxable years ended October 31, 1944, 1945, and 1946: Assets Mar. 31, 1944 Current assets: Cash on hand $ 11,476.72 Bank of America 554,791.02 $ 566,267.74 Accounts receivable -- Customers 171,136.19 Inventories at cost: Finished stock and containers $ 124,712.63 Beer in storage 55,471.65 Raw materials 115,162.53 Supplies 68,064.24 363,411.05 Total current assets 1,100,814.98 Property plant and equipment: Plant and equipment $ 927,876.15 Less reserve for depreciation 541,415.73 386,460.42 Land 8,501.29 Other assets: Cash deposits $ 5,120.00 Sundry debtors 978.02 Investments (per Contra) 1,696.32 7,794.34 Deferred expenses: Taxes 25,619.94 Insurance 8,016.80 General expense 97.12 33,733.86 Intangible assets: Organization expense 662.95 Trade marks 2,353.83 3,016.78 Total assets 1,540,321.67 Liabilities Current liabilities: Notes payable to vendors $ 18,937.14 Accounts payable 29,730.50 48,667.64 Accrued liabilities: Salaries and wages $ 7,617.43 Social security and unemployment taxes 14,108.41 Other taxes 357,453.77 $ 379,179.61 Total current liabilities 427,847.25 Other liabilities: Credit balances in former customers' accounts $ 240.85 Unrealized profit on excess profit tax bonds (per Contra) 1,696.32 $ 1,937.17 Capital stock 100,000.00 Surplus $ 584,591.42 Current year profits $ 425,945.83 $ 1,010,537.25 Total capital 1,110,537.25 Total liabilities $ 1,540,321.67 *134 *518 Oct. 31 Assets [1946] Cash $ 107,158.61 $ 1,498.11 $ 15,299.58 U. S. Treasury obligations 143,172.23 13,172.23 10,000.00 Total assets 250,330.84 14,670.34 25,299.58 Liabilities Accrued taxes 13,050.36 72.13 Accrued expenses 25.35 21.25 Unrealized profit on excess profits tax bonds 3,172.23 3,172.23 Capital stock 100,000.00 100,000.00 100,000.00 Earned surplus 884,108.25 661,472.76 675,206.20 Subtotal 984,108.25 761,472.76 775,206.20 Less: Liquidation account 750,000.00 750,000.00 750,000.00 Net worth 234,108.25 11,472.76 25,206.20 Total liabilities $ 250,330.84 $ 14,670.34 $ 25,299.58 5. The increase in net worth over the period October 31, 1945, to October 31, 1946, of $ 13,733.44, as shown above, was derived as follows: Recoveries on bad debts $ 150.00 Refund of California franchise tax 204.12 Postwar refunds of excess profits tax 13,472.70 Total additions 13,826.82 California franchise tax $ 21.25 Federal income tax 72.13 Total reductions 93.38 Net increase $ 13,733.44 *519 6. Petitioner's returns for the years 1945 and 1946 showed the following*135 items of gross income and deductions: Fiscal year ended Oct. 31 Gross income [1946] Interest on U. S. obligations $ 582.00 Recoveries on bad debts 256.00 $ 150.00 Refund of California franchise tax 204.12 Total income 838.00 354.12 Deductions Capital stock tax 62.50 California franchise tax 12,621.34 21.25 Collection fee on debt recoveries 30.00 Total deductions 12,713.84 21.25 Net income or (loss) ($ 11,875.84) $ 332.87 7. Petitioner maintained a bank account throughout 1944, 1945, and 1946, and during those years its president and auditor performed various services on its behalf, such as the preparation and filing of Federal and state returns, petitions to the Tax Court, applications for relief under section 722, and taking care of other matters relating to the winding up of petitioner's affairs. Some collections were made in 1945 and 1946 on accounts previously charged off by the petitioner and certain minor expenses were incurred. 8. Petitioner's auditor received a letter from its attorney dated January 4, 1946, reading in part as follows: It is also believed advisable to file a corporation excess profits tax return for*136 the year ended October 31, 1945, even though no tax is due for that year in order to show a basis for claiming the benefits of an unused excess profits credit carryback. That return has been prepared and is enclosed herewith in triplicate. 9. No certificate of dissolution has yet been filed on petitioner's behalf with the secretary of state pursuant to section 5200, California Corporation Code. 10. Petitioner maintained a bad debt reserve and claimed the amounts credited thereto as deductions in its returns. The following table shows the bad debt charges and credits to the reserve, the outstanding notes and accounts receivable, and petitioner's total "charge sales" in each of the years 1936 to 1942, inclusive: *520 Bad accounts Credit to Notes and Fiscal year ended Oct. 31 charged to reserve and accounts Charge sales reserve charge to receivable expense [1936] $ 39,342.00 $ 66,862.30 $ 252,007.47 $ 2,289,984.91 [1937] 59,550.84 43,868.51 253,052.55 1,754,740.00 [1938] 29,092.31 28,276.59 232,941.14 1,413,829.00 [1939] 18,093.73 14,801.40 173,825.63 1,474,430.00 [1940] 20,061.93 16,826.13 163,367.68 1,734,787.00 [1941] 18,381.48 19,390.80 189,939.48 2,199,820.00 [1942] 8,972.25 30,470.42 223,733.74 3,047,044.00 *137 11. Following is an analysis of petitioner's bad debt account for the years 1939 to 1943, inclusive, compiled from petitioner's books and records: Dr. Nov. 1, 1938, balance Additions to reserve -- F. Y. 10/31/39 Bad accounts charged to reserve -- F. Y. 10/31/39 $ 13,263.09 Recoveries of accounts charged to reserve -- F. Y. 10/31/39 4,830.64 Oct. 31, 1939, balance Additions to reserve -- F. Y. 10/31/40 Bad accounts charged to reserve -- F. Y. 10/31/40 18,515.99 Recoveries of accounts charged to reserve -- F. Y. 10/31/40 1,771.69 Adjustment on account of revenue agent's disallowance of bad debt deductions for prior years 14,687.18 Oct. 31, 1940, balance Additions to reserve -- F. Y. 10/31/41 Bad accounts charged to reserve -- F. Y. 10/31/41 15,670.75 Recoveries of accounts charged to reserve -- F. Y. 10/31/41 2,710.73 Oct. 31, 1941, balance Additions to reserve -- F. Y. 10/31/42 Bad accounts charged to reserve -- F. Y. 10/31/42 8,599.42 Recoveries of accounts charged to reserve -- F. Y. 10/31/42 1,872.83 Oct. 31, 1942, balance Additions to reserve -- F. Y. 10/31/43 Bad accounts charged to reserve -- F. Y. 10/31/43 adjustment Recoveries of accounts charged to reserve -- F. Y. 10/31/43 6,833.92 Adjustment of reserve to reflect a balance equal to 14 per cent of accounts receivable outstanding at 10/31/43 -- This amount reported as "Other Income" 60,120.00 Oct. 31, 1943, balance Additions to reserve -- F. Y. 10/31/44 Adjustment of reserve on account of bad debt deduction for F. Y. 10/31/42 disallowed in deficiency notice $ 18,639.77 Balance reported as "Other Income" on return for F. Y. 10/31/44 22,301.51 Oct. 31, 1944, bad debt recoveries F. Y. 10/31/44 reported as other income on return 2,771.56 *138 Cr. Bal. Nov. 1, 1938, balance $ 22,797.28 Additions to reserve -- F. Y. 10/31/39 $ 34,319.22 Bad accounts charged to reserve -- F. Y. 10/31/39 Recoveries of accounts charged to reserve -- F. Y. 10/31/39 Oct. 31, 1939, balance 39,022.77 Additions to reserve -- F. Y. 10/31/40 18,823.57 Bad accounts charged to reserve -- F. Y. 10/31/40 Recoveries of accounts charged to reserve -- F. Y. 10/31/40 Adjustment on account of revenue agent's disallowance of bad debt deductions for prior years Oct. 31, 1940, balance 22,871.48 Additions to reserve -- F. Y. 10/31/41 22,101.53 Bad accounts charged to reserve -- F. Y. 10/31/41 Recoveries of accounts charged to reserve -- F. Y. 10/31/41 Oct. 31, 1941, balance 26,591.53 Additions to reserve -- F. Y. 10/31/42 33,843.25 Bad accounts charged to reserve -- F. Y. 10/31/42 Recoveries of accounts charged to reserve -- F. Y. 10/31/42 Oct. 31, 1942, balance 49,962.53 Additions to reserve -- F. Y. 10/31/43 42,456.76 Bad accounts charged to reserve -- F. Y. 10/31/43 adjustment 3,153.63 Recoveries of accounts charged to reserve -- F. Y. 10/31/43 Adjustment of reserve to reflect a balance equal to 14 per cent of accounts receivable outstanding at 10/31/43 -- This amount reported as "Other Income" Oct. 31, 1943, balance $ 28,619.00 Additions to reserve -- F. Y. 10/31/44 $ 12,322.28 Adjustment of reserve on account of bad debt deduction for F. Y. 10/31/42 disallowed in deficiency notice Balance reported as "Other Income" on return for F. Y. 10/31/44 Oct. 31, 1944, bad debt recoveries F. Y. 10/31/44 reported as other income on return *139 *521 12. In his notice of deficiency for 1942 respondent increased petitioner's income by the amount of $ 18,639.77 stating: The addition to the reserve for bad debts, claimed as a deduction in the amount of $ 30,470.72, has been determined to be $ 18,639.77 in excess of a reasonable amount of addition to the reserve. Section 23 (k), Internal Revenue Code. This adjustment by the respondent was reflected in petitioner's bad debt reserve account for 1943 as shown in the above analysis of the account. 13. Petitioner claimed a bad debt deduction of $ 35,622.84 in its 1943 return, being the difference between the additions to the reserve in that year, or $ 42,456.76, and $ 6,833.92 of bad debt recoveries. 14. In its income tax return for 1944 (Form 1120) petitioner reported as other income the balance in its bad debt reserve at October 31, 1944, of $ 22,301.51 plus $ 2,771.56 of bad accounts previously charged to the reserve. 15. It is stipulated that there should be excluded from petitioner's excess profits net income bad debt recoveries of $ 2,710.73 in 1941, $ 534.17 in 1942, $ 180.66 in 1943, and $ 651.36 in 1944. 16. In its 1944 excess profits tax return (Form 1121) petitioner*140 claimed an exclusion from excess profits net income, as abnormal income under section 721, restored bad debt recoveries in the amount of $ 9,979.23, representing the difference between the balance in the bad debt reserve account at the beginning of the year 1944, $ 28,619, and the amount which the respondent disallowed as an addition to the bad debt reserve in 1942, $ 18,639.77. Respondent determined that this was not abnormal income within the meaning of section 721, Internal Revenue Code. 17. In determining petitioner's excess profits credit for 1944 the respondent made a net capital reduction of $ 3,508.20, computed as follows: COMPUTATION OF NET CAPITAL REDUCTION On or about March 31, 1944 you made a distribution to your stockholders in the amount of $ 750,000.00. Of this distribution it has been determined that the amount of $ 100,000.00 was not out of earnings and profits. In accordance with the provisions of section 713 (g) (2) of the Internal Revenue Code there is determined a net capital reduction of $ 58,469.95 as shown in the following: $ 100,000.00 x 214/366 $ 58,469.95 *522 COMPUTATION OF EXCESS PROFITS CREDIT Average base period net income $ 50,530.19 95 per cent of $ 50,530.19 48,003.68 Less: 6 per cent of $ 58,469.95 net capital reduction 3,508.20 Excess profits credit determined $ 44,495.48 *141 It is stipulated that: In computing a $ 3,508.20 net capital reduction for the fiscal year 1944 Respondent reduced petitioner's earnings and profits for said fiscal year by $ 278,492.82, which was the excess profits tax on said fiscal year profits as estimated by Respondent. 18. From the time it began business in 1932 petitioner manufactured and sold full strength beer containing approximately 3.7 per cent alcohol by weight, 3.2 per cent beer and a small amount of ale and bock beer. Some of its beer was sold in bottles and cans and some in kegs. The bottle beer was sold under a number of different names. Petitioner's best grade of beer, after 1938, was sold under the name "A B C Supreme." This was a quality beer made under a different formula from petitioner's other beers. Most of petitioner's beer was marketed in California although about 10 per cent of its sales was for "export," or out of state, trade. 19. Over the period 1934, the first full year of petitioner's operations, to 1942, inclusive, petitioner's gross sales of beer, gross profits, total expenses, and net excess profit income or losses from operations, as shown in its books, were as follows: Excess profits Year Gross sales Gross profits Total expenses net income or (losses) [1934] $ 3,168,865.32 $ 1,207,973.12 $ 841,268.52 $ 366,704.60 [1935] 2,288,840.82 732,503.29 721,744.06 10,759.23 [1936] 2,289,984.91 729,265.54 658,631.09 70,634.45 [1937] 1,982,399.06 556,113.81 569,357.40 (13,243.59) [1938] 1,650,941.07 426,307.71 552,599.06 (126,291.35) [1939] 1,669,933.23 499,887.01 490,429.52 9,457.49 [1940] 1,918,057.29 597,496.97 517,444.26 80,052.71 [1941] 2,424,350.77 774,672.02 626,890.69 147,781.33 [1942] 3,476,683.89 1,281,607.35 737,972.01 543,635.34 *142 It is stipulated that petitioner's excess profits net income for the base period years 1937 to 1940, inclusive, was as shown in the last column. The decrease in petitioner's sales, by volume, was from 202,667.72 barrels in 1934 to 122,260.36 in 1937. During the same period the volume of sales of beer by California breweries as a whole increased from 1,815,760 barrels in 1934 to 2,345,643 barrels in 1937. The following table shows petitioner's relative position among the California breweries in each of the years 1934 to 1942, inclusive: *523 Petitioner's relative Barrel position Petitioner's volume in Barrel among percentage California volume in California of total Year of all California breweries beer sales California of petitioner based on breweries sales volume [1934] 1,815,760 177,995 [3] 9.80 [1935] 1,846,142 131,597 [5] 7.12 [1936] 2,276,795 130,798 [7] 5.74 [1937] 2,345,643 105,739 [8] 4.52 [1938] 2,162,418 89,216 [9] 4.11 [1939] 2,252,120 87,512 [10] 3.88 [1940] 2,216,391 91,899 [9] 4.15 [1941] 2,386,371 114,311 [8] 4.79 [1942] 2,934,593 156,633 [7] 5.34 20. Petitioner's balance sheet as of October *143 31, 1937, showed total assets of $ 1,151,676.04 and a net surplus of $ 446,270.55. The assets exclusive of plant and equipment were $ 413,710.56 and the current and deferred liabilities $ 605,405.49. 21. In August 1938, petitioner applied to the Reconstruction Finance Corporation for a loan of $ 200,000, but a loan in this amount was refused. The Reconstruction Finance Corporation later offered to lend $ 140,000 to petitioner, but this was refused. Petitioner and its larger creditors, including the Bank of America, with claims totaling $ 185,000, entered into an agreement of September 22, 1939, whereby petitioner mortgaged its real and personal property to them, and the creditors agreed to accept payment under a plan which designated the Bank of America in San Diego to receive monthly payments from petititoner of 60 cents per barrel of beer sold, with a minimum payment of $ 2,500 per month, and distribute this money to the creditors in proportiton to creditors' claims. Petitioner's obligations to the Bank of America and its other creditors under the above-mentioned agreement were fully paid off within a period of approximately 2 years. 22. In the latter part of 1937 petitioner's*144 officers decided upon certain changes to be made in petitioner's operations. The most important of these were improving the quality of the beer, revising the methods of distribution, tightening the credit policy, and eliminating waste. 23. In April 1938, petitioner employed a new brewmaster and engaged chemists and physicists to assist him. They were instructed to work out a formula for making the finest beer that could be manufactured regardless of cost. They developed a new beer, manufactured under a new formula, calling for higher percentages of eastern malt and imported hops than had been theretofore used in petitioner's best quality beer. This new beer was put on the market in August 1938 *524 under the trade name of "A B C Supreme." The letters "A B C" had been used in combination with other words, descriptive of the type or quality of the beer, by the petitioner in its trade names for its better quality beers since 1933. The A B C Supreme beer sold at a price of $ 1.90 a case as compared with $ 1.70, $ 1.50, $ 1.20, and $ 1.10 for some of petitioner's other beers. The additional cost of manufacturing the new beer, including ingredients and labels, was only a few *145 cents a case. 24. In April 1939 petitioner began using a new gold-colored aluminum foil label on A B C Supreme beer. Metallic labels were also used on petitioner's "Aztec" beer. Paper labels were used on all of the other brands. Metallic labels had previously been introduced to the trade and were then in use by a San Francisco brewery. 25. Beginning in 1939 A B C Supreme was put up in flint glass bottles instead of the brown glass theretofore used. These bottles, with the metallic labels, made an attractive container and gave added customer appeal to A B C Supreme beer. 26. During the base period petitioner distributed its beer through branch offices or agencies and distributors. In San Diego its bottle beer was handled by a local distributor and its keg beer was delivered directly to the retailers. Until about 1938 or 1939 most of petitioner's beer sales were of keg beer. In 1938 petitioner began delivering bottle beer directly to the San Diego retailers, eliminating the distributor. This resulted in an increase in net profits on San Diego bottle beer sales of about 30 cents per case. Petitioner employed about 15 salesmen to operate its trucks in the San Diego district. 27. *146 Outside of San Diego petitioner sold beer through it own branch offices and through distributors. The following list shows the location of these branch offices and the dates when they were opened and closed: Opened Closed Bakersfield 8/1/34 10/31/34 Fresno 11/1/34 2/1/36 Glendale 7/1/34 4/1/40(Business transferred to San Fernando 4/1/40) Indio 4/1/42 After 10/31/42 Los Angeles 2/1/35 4/30/39 Monterey 1/1/41 After 10/31/42 Oakland 10/1/34 4/1/35 Santa Ana 12/15/38 9/1/39 San Bernardino 8/1/40 10/31/42 San Fernando 9/1/34 4/1/35 San Fernando (Reopened 4/1/40) 4/1/40 9/1/42 San Francisco 9/1/34 4/1/35 San Miguel 4/1/41 8/31/41 San Jose 8/1/34 4/1/35 *525 Where it did not have branch offices petitioner sold through distributors for both local (in California) and export (outside of California) trade. 28. The competitive policies of California brewers prior to and during the base period years had resulted in certain unethical and sometimes illegal practices, such as allowing container deposits of less than the cost of the containers, granting rebates, and extending unwarranted credits. In 1940, petitioner made an inventory of its containers, *147 bottles, kegs, and cases, and discovered that it had an inventory loss of approximately $ 83,000. It immediately took measures to reduce those losses and to strengthen its credit policies. 29. Petitioner never operated at full capacity during the base period. During 1939 and 1940 it was able to produce all the beer that it could sell. 30. Petitioner's sales of packaged beer in metropolitan San Diego increased from 125,156 gallons in 1937 to 161,678 in 1938, 395,213 in 1939, 760,487 in 1940, and over 1,000,000 in 1941 and 1942. The number of barrels and dollar value of A B C Supreme beer sales through all outlets in 1938 and 1939 were: Year Barrels Dollar value 1938 (Aug., Sept., Oct.) 1,144.74 $ 20,937.95 1939 (F. Y. ended Oct. 31) 27,306.41 562,319.43 31. The following table shows the number of gallons of beer sold in California by three of petitioner's most important competitors during the years 1933 to 1940, inclusive: Acme-LA. Rainier Los Angeles Year Brewing Co. Brewing Co. Brewing Co. [1933] 4,926,799 4,190,190 [1934] 6,552,864 4,888,611 [1935] 2,280,701 6,798,949 4,674,999 [1936] 4,518,277 7,745,032 5,883,303 [1937] 5,382,832 8,886,619 7,207,812 [1938] 5,377,208 8,314,059 7,841,349 [1939] 6,626,632 9,386,320 8,687,624 [1940] 7,514,182 9,599,327 9,294,948 *148 32. Petitioner filed with respondent claims for relief under section 722 (b) (1), (2), (3), (4), and (5) and claims for refund of excess profits taxes as follows: Dates Dates Dates Dates filed for filed for filed for filed for F. Y. F. Y. F. Y. F. Y. [1944] Original 991 3/18/43 3/18/43 1/15/44 2/8/45 Amendment 9/9/43 9/9/43 3/24/44 7/13/46 Form 843 7/24/44 10/12/44 Amendment 7/13/46 7/13/46 7/13/46 *526 All of these claims were disallowed by the respondent. The claims under subsection (b) (1), (2), (3), and (5) have since been abandoned. OPINION. The issues will be discussed in the order in which they are set out above. Issue 1: Carry-back of Unused Excess Profits Credits for 1945 and 1946. The question presented in this issue is whether the unused excess profits credits for the years 1945 and 1946, after petitioner had ceased operations and had distributed all of its assets except cash and U. S. Treasury obligations, may be carried back under the provisions of section 710 (c) (3) (B), Internal Revenue Code, to the prior years 1943 and 1944. Respondent contends that petitioner was de facto dissolved in 1944, citing*149 Wier Long Leaf Lumber Co. v. Commissioner, 173 F. 2d 549, and is, therefore, not entitled to a carry-back of excess profits credits from 1945 and 1946. The Wier Long Leaf Lumber Company case, among other related cases listed in the margin, 1 is also cited by petitioner. Petitioner ceased its regular business operations about April 1, 1944, and began distributing its assets to its stockholders. By the close of that fiscal year, October 31, 1944, its remaining assets consisted of cash and*150 U. S. Treasury obligations in the amount of $ 250,330.84, and it had outstanding liabilities of approximately $ 16,000, including accrued taxes of approximately $ 13,000. That is essentially the same position the corporation in the Wier Long Leaf Lumber Company case was in at the beginning of the year 1944. It had previously distributed the major portion of its assets in the process of liquidation but still had on hand at the beginning of 1944 approximately $ 110,700 of cash, $ 31,230.83 of "post war refund of excess profits tax," and an insignificant amount of accounts receivable. Its balance sheet showed liabilities of $ 8,118.86, including $ 1,250 of accounts payable; Federal income tax payable, $ 1,974.80; accrued payroll taxes, $ 195.97; and reserves for contingent liabilities, etc., $ 4,621.29. On this state of its affairs, the court held that the corporation, though not dissolved, de jure must be regarded for the purpose of its claims for unused excess profits credit carry-back for 1944 as de facto dissolved, and, therefore, not entitled to an unused excess profits credit carry-back. However, a carry-back was allowed for 1943, the court saying: *527 When on January*151 1, 1943, petitioner began the year, it had assets worth nearly $ 1,000,000, including more than $ 100,000 of accounts receivable, subject to liabilities of $ 542,539.42. Its liquidation had just begun. It was still in form and in fact a corporation, still carrying on, in winding up, the business for which it was incorporated, still making some, though small, profits, still engaged in necessary and orderly liquidation. Having entered the year as a going corporation, it continued to be a going corporation, at least for the whole of that year. Other cases in which the carry-back of unused excess profits credits or operating losses were disallowed under the rule of the Wier Long Leaf Lumber Company case, are: Winter & Co. ( Indiana), 13 T. C. 108; Gorman Lumber Sales Co., 12 T. C. 1184; and Rite-Way Products, Inc., 12 T. C. 475. See, also, Whitney Manufacturing Co., 14 T. C. 1217, which was distinguished from those cases on its facts. On the facts in the instant case, we think that the petitioner must be held to have been de facto dissolved at the beginning*152 of the fiscal year 1945 and, consequently, not entitled to a carry-back of excess profits credit from that year or from 1946. Issue 2: Computation of Average Base Period Net Income Under Section 713 (f). This issue involves the application of subsections (6) and (7) of section 713 (f), Internal Revenue Code. Section 713 pertains, generally, to the determination of excess profits credit based on income. Subsection (f) relates to the determination of average base period net income when there are increased earnings in the last half of the base period, and provides certain formulas for that purpose. Subsection (f) (6) limits the average base period net income determined under subsection (f) to "the highest excess profits net income for any taxable year in the base period." Subsection (7) provides a further limitation on the excess profits net income for any base period year ended after May 31, 1940, aimed at limiting the benefits to be derived from application of the growth formula under subsection (f) to the increase in earnings occurring prior to June 1, 1940. See report of Committee on Ways and Means, 1941-1 C. B., pp. 554-555. These subsections, *153 insofar as here material, are set out in the margin. 2 *154 *528 It is stipulated that petitioner's gross sales and excess profits net income (or loss) for the base period years were: Excess profits net Year Gross sales income (or loss) F. Y. 1937 $ 1,982,399.06 ($ 13,243.59) F. Y. 1938 1,650,941.07 (126,291.35) F. Y. 1939 1 1,669,933.23 9,457.49 F. Y. 1940 2 1,918,057.29 80,052.71 Petitioner contends that its average base period net income, after the limitations imposed by subsection (f) (6), is $ 79,867.81. Respondent has determined that petitioner's average base period net income must be further limited by subsection (f) (7) to $ 50,530. Petitioner offers no reason for rejecting respondent's computation other than the bare statement that it is contrary to the "clear and unambiguous language of the statute." It seems to us, however, that the plain wording of the statute requires the computations of the average base period net income in the manner followed by the respondent. There is nothing in the statute to indicate that the limitation provided in subsection*155 (f) (7) was not intended to apply, along with that in subsection (f) (6), in the determination of the average base period net income under section 713 (f). The subsections deal with different phases of the computation of average base period net income; (f) (6) limits the average base period net income for all base period years to the highest excess profits net income for any one of those years, while (f) (7) limits the net income of any base period year extending beyond May 31, 1940, to the amount computed under the formula provided therein. The respondent's determination, in this respect, has not been shown to be erroneous. Issue 3: Adjustment of Excess Profits Tax Credit Under Section 713 (g) (4) -- Earnings and Profits Available for Distribution to Shareholders in 1944, Reduced by the Estimated Excess Profits Tax for That Year. The adjustment in question is shown in respondent's notice of deficiency in Docket No. 11570, as follows: *529 COMPUTATION OF NET CAPITAL REDUCTION On or about March 31, 1944 you made a distribution to your stockholders in the amount of $ 750,000.00. Of this distribution it has been determined that the amount of $ 100,000.00 was *156 not out of earnings and profits. In accordance with the provisions of section 713 (g) (2) of the Internal Revenue Code there is determined a net capital reduction of $ 58,469.95 as shown in the following: $ 100,000.00 x 214/366 $ 58,469.95 COMPUTATION OF EXCESS PROFITS CREDIT Average base period net income $ 50,530.19 95 per cent of $ 50,530.19 48,003.68 Less: 6 per cent of $ 58,469.95 net capital reduction 3,508.20 Excess profits credit determined $ 44,495.48 It is stipulated that in computing a $ 3,508.20 net capital reduction for the fiscal year 1944, respondent reduced petitioner's earnings and profits for the fiscal year by $ 278,492.82, which was the excess profits tax on said fiscal year profits, as estimated by respondent. There is no other evidence bearing on this issue. The excess profits credit based on income, under section 713 of the Internal Revenue Code, is 95 per cent of the average base period net income (713 (a) (1) (A)), plus 8 per cent of the net capital additions (713 (a) (1) (B)), minus 6 per cent of the net capital reductions (713 (a) (1) (C)), as defined in subsection (g). Subsection (g) (4) provides that: The daily capital reduction*157 for any day of the taxable year shall be the aggregate of the amounts of distributions to shareholders, not out of earnings and profits, after the beginning of the taxpayer's first taxable year under this subchapter and prior to such day. Respondent has ruled that in determining whether, for the purpose of section 713 (g) (4), a distribution to stockholders was made from earnings or profits of the taxable year such earnings and profits must be reduced by the amount of the accrued excess profits tax for that year. See I. T. 3719, 1945 C. B., p. 265. Where the excess profits credit is computed on the basis of invested capital, under section 718, the excess profits tax liability of each taxable year must be accrued at the end of that year and serves to reduce the accumulated earnings and profits at the beginning of the next succeeding taxable year rather than those of the current year. Stern Brothers & Co., 16 T. C. 295; Gorman Lumber Sales Co., supra. Section 713, relating to the computation of excess profits credit based on income, contains no provision similar to that found in *530 section*158 718 (c) (3), 3 dealing with the computation of excess profits credit based on invested capital, which expressly prohibits the deduction of the current year's excess profits tax in determining the earnings and profits available for distribution. There is no actual inconsistency in the different treatment*159 accorded the accrued excess profits taxes under sections 713 and 718. In each instance the taxes for the current year are accrued at the end of the year with a resulting decrease in earnings and profits of that year and a reduction of the invested capital of the succeeding taxable year. Respondent properly reduced petitioner's earnings and profits for the taxable year 1944 by the amount of the accrued excess profits tax for that year. Since the correct amount of the tax is an issue in these proceedings, an adjustment of the accrual must be made under a Rule 50 recomputation. Issue 4: Bad Debt Reserve Adjustments -- Alleged Overstatement of Income for 1943 and Understatement for 1944. Petitioner maintained a bad debt reserve account based on 14 per cent of its accounts and notes receivable. For the fiscal year ended October 31, 1942, it claimed an addition to its bad debt reserve of $ 30,470.72 which was $ 18,639.77 in excess of 14 per cent of its accounts and notes receivable. Respondent disallowed the said amount of $ 18,639.77 as a deduction in that year. In its books, however, petitioner did not reduce its bad debt reserve as of the close of the year 1942 to reflect *160 the adjustment made by respondent. It claimed a deduction in its 1943 return of $ 35,622.84, representing the difference between the addition to its reserve in that year, $ 42,456.76, and the amount recovered on accounts previously charged to the reserve, $ 6,833.92. Also, at the close of 1943 it debited (reduced) the reserve by the amount of $ 60,120, representing the excess in the reserve over 14 per cent of accounts receivable. This left a credit balance in the reserve of $ 28,619. The notice of deficiency disallowing the deduction of the $ 18,639.77 in 1942 was received by the petitioner in September 1944. To adjust this disallowance, petitioner deducted that amount from the reserve of that year (1944) and credited it to its surplus account, but did not *531 report it as income in its return. Also, during 1944, petitioner added to the reserve $ 12,322.28, making a total of $ 40,941.28 which, after deduction of the $ 18,639.77, left a balance of $ 22,301.51. Petitioner reported that amount in its 1944 return as other income. We have gone to some length in explaining the operation of the bad debt reserve account because of the difficulty we had in understanding just what*161 petitioner's contentions are in this issue. The allegation of error contained in the petition is that: The Commissioner erred in failing to increase petitioner's reserve for bad debts as of October 31, 1943, by $ 18,639.77 and thus erroneously determined petitioner's excess profits net income to be $ 18,639.77 more than the correct amount thereof. According to petitioner's brief, the result sought, or one of the results, is to restore the $ 18,639.77 item to 1944 bad debt reserve account, with a resulting increase in the excess profits tax income of that year. As above shown, the balance in the reserve was carried into income in 1944, after the petitioner had begun liquidation and there was no longer any need for the bad debt reserve. As a corollary to this contention, petitioner contends, under Issue 5, that all of this income from the conversion of the bad debt reserve account to income in 1944 should be excluded from excess profits tax net income either as bad debt recoveries, under section 711 (a) (1) (E), or as abnormal income, under section 721 (b) (1). We agree with petitioner that, as alleged in its petition, the erroneous treatment of the $ 18,639.77 in its accounts *162 resulted in an overstatement of 1943 income by that amount. Inasmuch as the amount was disallowed by respondent as an addition to reserve in 1942, and correctly so, as petitioner now concedes, it should have been taken out of the reserve in that year. Petitioner would then have gone into 1943 with a reserve of $ 31,322.76, instead of $ 49,962.53, and the excess in the reserve at the close of 1943, 14 per cent of accounts receivable, which was taken into 1943 income, would have been $ 41,480.23, instead of $ 60,120. Likewise, as petitioner contends, it was error to reduce the reserve by the amount of $ 18,639.77 in 1944, thereby reducing by that amount the balance in the reserve which petitioner converted to income in that year. These are bookkeeping errors which can be readily corrected under the Rule 50 recomputation. Issue 5: Unused Bad Debt Reserve -- Exclusion From Excess Profits Net Income as Bad Debt Recoveries Under Section 711 (a) (1) (E) or as Abnormal Income Under Section 721 (a) (1). Petitioner contends that the balance in the bad debt reserve account which it added to income in 1944, after collection or distribution of *532 all outstanding*163 notes and accounts receivable, increased by $ 18,639.77, the item discussed in the next preceding issue, should be excluded from excess profits income either as abnormal income under the provisions of section 721 (a) (1) or as income attributable to the recovery of bad debts under section 711 (a) (1) (E). We have held that section 711 (a) (1) (E) is inapplicable where there has not been an actual recovery of bad debts. Zellerbach Paper Co., 8 T. C. 511. Moreover, the evidence fails to show that the amount in question, or any portion of it, was not allowed as a bad debt deduction for a taxable year beginning prior to January 1, 1940, as required in section 711 (a) (1) (E). See J. F. Johnson Lumber Co., 3 T. C. 1160; Ralphs-Pugh Co., 7 T. C. 325. Section 711 (a) (1) (E) being inapplicable, petitioner's relief, if any is due, must be found in section 721 (a) (1). Under that section the question is whether the conversion of the bad debt reserve to income resulted in the receipt in that year of "abnormal income" within the meaning of the statute. Petitioner's bad debt reserve was a general reserve*164 as distinguished from a reserve for specific bad debts. In each year certain uncollectible accounts were deducted, along with the recoveries on accounts previously debited, and certain additions were credited to the reserve, so that at the end of the year the balance was not in excess of 14 per cent of accounts and notes outstanding. At the beginning of 1944 the reserve stood at $ 28,619, which is the amount petitioner should have transferred to income in that year after the accounts were all collected or distributed in liquidation. We think that this was income of a separate class and that it was abnormal in petitioner's experience to receive income of such class within the meaning of section 721 (a) (1). It was a class of income similar to that referred to in subsection 721 (a) (2) (D) as "Income includible in gross income for the taxable year rather than for a different taxable year by reason of a change in the taxpayer's accounting period or method of accounting." The Commissioner's regulations provide (Regs. 112, sec. 35.721-8) that: This class may include such items of income as are includible in gross income for the taxable year by reason of a change from the installment*165 method to the straight accrual method of accounting, a change in inventory method, or a change from the reserve method to the specific charge-off method for the treatment of bad debts. * * * However, under the regulations (sec. 35.721-3), petitioner is entitled to the exclusion in 1944 of only the amount of abnormal income shown to be attributable "in whole or in part to other taxable years," and, as the regulations further provide, "Items of net abnormal income are to be attributed to other years in the light of the events in which such items had their origin and only in such amounts as are *533 reasonable in the light of such events." Petitioner recognizes these requirements and states in its brief: The crux of this issue is the "amount attributable to other years" Section 721 (b), Internal Revenue Code. It is petitioner's contention that to the extent its credit balance in the Reserve for Bad Debts was excessive or greater than needed when it went into its first excess profits tax year (11/1/40-10/31/41) up to the amount of its unused credit balance in said Reserve at October 31, 1944 (when it was no longer needed), it is attributable to these other years prior to November*166 1, 1940. Petitioner submits that its reserve at October 31, 1940, of $ 22,871.48, which was 14 per cent of its outstanding notes and accounts receivable, was excessive to the extent of $ 16,240.25, since all but $ 6,631.23 of such notes and accounts receivable were subsequently collected; that this excess remained in the reserve until the account was closed in 1944; and that of the $ 28,619 properly to be taken into normal income in that year, $ 16,240.25 should be excluded from excess profits net income. What gave rise to the taxable income in 1944 was not that the balance in the reserve represented excessive additions made to the reserve in prior years but rather that it represented additions which had been allowed as deductions in prior years. Thus, the amounts of the 1944 reserve attributable to prior years would depend upon the deductions taken in the prior years; and the extent of petitioner's relief for 1944 under subsection 721 (c) would depend upon the effect of the reallocations on the excess profits taxes for those prior years. A reasonable allocation might be made, we think, by allocating the 1944 reserve to the excess profits tax years 1941, petitioner's first excess*167 profits tax year, 1942, and 1943, in proportion to the correct additions to the reserve (that is, the amounts allowed) in those years as shown in the analysis of the account appearing in finding 11 above. Since, however, there was a balance in the reserve at the beginning of 1941 (November 1, 1940) of $ 22,871.48, a like proportion of the 1944 balance of the reserve should first be allocated to years prior to 1941 and eliminated from further consideration in the excess profits tax computation. 722 Issue: Change in the Character of the Business. In support of its claim for relief under section 722, petitioner contends that during the base period it changed the character of its business within the meaning of section 722 (b) (4) and that as a result of such change its average base period net income is an inadequate standard of normal earnings. Petitioner's base period years are the fiscal years ended October 31, 1937, 1938, 1939, and 1940. Its actual profits or losses for the base period years, and its excess profits tax net income for the years 1941 to 1944, inclusive, as determined by respondent, were as follows: *534 Base period years Excess profits tax years 1937 loss $ 13,243.59 [1941] $ 85,911.72 1938 loss 126,291.35 [1942] 538,385.86 1939 profit 9,457.49 [1943] 844,062.28 1940 profit 80,052.71 [1944] 321,127.34 *168 For its base period years petitioner had an average loss of $ 12,506.18. Its average base period net income, as determined by respondent under the provisions of section 713 (f), was $ 50,530. The relief sought by petitioner is based upon a proposed constructive average base period net income of $ 251,128.85. In arriving at this figure, petitioner starts with the actual 1939 earnings of $ 9,457.49, to which it adds constructive increased earnings attributable to the alleged qualifying changes as follows: (a) Excess profits net income fiscal year 1939 $ 9,457.49 (b) Increased profits as a result of change in method of distributing beer in San Diego and change in brewmasters, and change in price policy by putting ABC Supreme on the San Diego market at a higher price to the retailer resulting in a higher net profit to petitioner 114,304.33 (c) Increased profits as a result of change in price policy by putting ABC Supreme beer on the California market and the export market (outside California) at a higher price to the distributors resulting in a higher net profit to petitioner: (1) California distributors 23,960.85 (2) Export distributors 13,164.06 (d) Increased profits as a result of change of method of distributing beer in Los Angeles, Santa Ana, and Glendale 61,501.07 (e) Increased profits as a result of a change from a liberal credit policy to a strict credit policy 13,302.71 (f) Change in method of handling bottles in hands of customers to assure their return and eliminate prior losses 17,712.63 Fiscal year 1939 excess profits net income as reconstructed 253,403.14 F/Y 1940 excess profits net income assumed at F/Y 1939 level 253,403.14 F/Y 1938 reconstructed on industry index of net profits (84.62 per cent of $ 253,403.14) 214,429.74 F/Y 1937 reconstructed on industry index of net profits (111.79 per cent of $ 253,403.14) 283,279.37 Aggregate excess profits net income base period $ 1,004,515.39 Constructive average base period net income $ 251,128.85 *169 A glance at the record of petitioner's operations shows that its earnings greatly depreciated during the base period, particularly for the first 3 years. The evidence indicates, too, that this depreciation was due to conditions affecting petitioner's individual business and not affecting the brewery industry as a whole. For example, while petitioner's sales of beer were falling off at a fairly steady rate from approximately *535 178,000 barrels in 1934 to below 100,000 barrels in 1938, 1939, and 1940, the combined sales of all California breweries increased at an equally constant rate from 1,815,750 barrels in 1934 to over 2,216,000 barrels in 1940. In volume of sales, petitioner declined from third place among California breweries in 1934 to ninth place in 1940. Petitioner's heaviest operating loss, $ 126,291.35, occurred in 1938. At the end of that year, its credit standing was seriously impaired and it was on the verge of bankruptcy. In 1939 there was a turn for the better and a small profit was realized. Earnings then arose to approximately $ 80,000 in 1940, $ 147,000 in 1941, and $ 543,000 in 1942. The fact that petitioner began its recovery during the latter part*170 of the base period and soon thereafter regained its position near the top of the industry and increased its profits approximately to their prebase period level, indicates that the cause or causes of the reverses were corrected during the base period. This in itself, however, is not enough to entitle petitioner to relief under section 722 (b) (4). Petitioner must show, in further compliance with the provisions of subsection (b) (4), that in bringing about this improvement in its position it "changed the character of its business," so that "the average base period net income does not reflect normal operations for the entire base period of the business," and, further, that "if such change or changes had taken place 2 years earlier than they did it would have reached a higher earning level by the end of the base period." Only such changes are recognized as qualifying factors under section 722 (b) (4), and, ordinarily, only qualifying factors are to be taken into account in the application of the push-back rule under subsection (b) (4). See Southern California Edison Co., 19 T. C. 935. The only changes, we think, which, by the most liberal application of*171 the statute, require serious consideration as possible "changes in the character of the business" are the changes in the method of distributing beer in San Diego, Los Angeles, and other areas -- a "change in the operation * * * of the business" -- and the production of a higher quality beer -- a "difference in the products * * * furnished." There was no change in petitioner's management. The duties of the new brewmaster were to work out the formulas for beer and supervise the actual brewing operations. He introduced no innovations in petitioner's plant, either in the way of formula or in the process employed. The business as a whole was at all times under the management and control of Edward P. Baker, who was also president and a director. It was he who, as petitioner states in its brief, was directly responsible for petitioner's success. Neither do we think that the tightening of the credit policy or the elimination of losses in handling bottles constituted changes in the *536 character of the business. These were nothing more than the usual precautions incident to the successful operation of a large and complicated business, such as petitioner's. We have no doubt that*172 these changes, along with others described in the evidence, such as the radio advertising program organized in 1938, contributed to petitioner's recovery, but considered in their relationship to petitioner's entire operations, were not changes in the character of the business, within the meaning of the statute. The "A B C Supreme" beer, referred to above sometimes as petitioner's "new beer," was of the same general type and quality of other premium beers sold by petitioner's competitors, and previously by the petitioner itself, and it was manufactured by substantially the same process. It contained more eastern malt and imported hops than the premium beer previously manufactured by petitioner, and for that reason was considered by some to be of better quality. While it may have been a better product, it was in no sense a new product. Such changes as there were in the formula or in the brewing process were no more than what any manufacturer might normally do to improve the quality and consumer acceptance of its products. It was not like the change in 7- Up Fort Worth, 8 T. C. 52, where the taxpayer was bottling "7-Up" exclusively and during the base*173 period added a new non-competitive orange drink to its products, or like the addition of the ice-cream mix business in Lamar Creamery Co., 8 T. C. 928. As to the changes in the distribution of beer, the evidence is that for several years prior to 1938 petitioner's bottled beer was handled in San Diego by a local distributor. Early in 1938 petitioner eliminated the distributor and began delivering bottled beer direct to the retailers. There was no change in the keg beer which at all times had been delivered directly to the retailers. Up until about 1938 or 1939 most of petitioner's San Diego sales were of keg beer. By the end of 1939, however, this situation was reversed and the bottled sales greatly exceeded the keg beer sales. In making this change in San Diego, petitioner increased its local salesmen in that district from two to four and organized a sales campaign, with the result that the number of San Diego retail outlets was increased from 189 in January 1938 to 458 in October 1939. In 1939 petitioner eliminated its branch offices in Los Angeles, Santa Ana, and Glendale, and established distributors at those points. The Glendale branch office*174 had been opened in 1934 and the Los Angeles in 1935. The Santa Ana office was opened December 15, 1938, and closed January 1, 1939. Similar shifts in the method of distributing beer were made from time to time in other localities, both before and after the base period years. (See finding 27 above.) Apparently, what petitioner did was *537 to change from one method of distribution to another whenever the conditions in a locality seemed to warrant it. It established distributors in some areas and eliminated them in others. There was no change in over-all policy or in general operations. Taken together, all of the changes made by petitioner in his business during the base period years, both those urged as 722 (b) (4) qualifying factors and others, may have been responsible for the reversal of the downward trend in petitioner's earnings and the restoration of its former earning level, but we cannot find that any one of those changes, or all of them taken together, constituted a change in the character of the business, within the meaning of the statute. Such a change, we said in Avey Drilling Machine Co., 16 T. C. 1281, 1298, "must be a substantial*175 departure from the preexisting nature of the business." Here there was no change like the change of a common carrier of freight from an intrastate to interstate carrier as in East Texas Motor Freight Lines, 7 T. C. 579. Petitioner's claims for relief under section 722 (b) (4) were, we think, correctly disallowed. It might be pointed out that petitioner has derived a substantial measure of benefit from the application of the growth formula under section 713 (f). Its base period net income so computed by the respondent was $ 50,530, as compared with his actual average base period net loss, $ 12,506.18. Reviewed by the Special Division as to the 722 issue. Decision will be entered under Rule 50. Footnotes 1. Bowman v. Glenn, 84 F. Supp. 200, affd., 184 F. 2d 670; Whitney Manufacturing Co., 14 T. C. 1217; Winter & Co. ( Indiana), 13 T. C. 108; Gorman Lumber Sales Co., 12 T. C. 1184; Mesaba-Cliffs Min. Co. v. Commissioner, 174 F. 2d 857; Rite-Way Products, Inc., 12 T. C. 475↩. 2. SEC. 713. EXCESS PROFITS CREDIT -- BASED ON INCOME. (f) Average Base Period Net Income -- Increased Earnings in Last Half of Base Period. -- The average base period net income determined under this subsection shall be determined as follows: * * * * (6) The amount ascertained under paragraph (5) shall be the average base period net income determined under this subsection, except that the average base period net income determined under this subsection shall in no case be greater than the highest excess profits net income for any taxable year in the base period. For the purpose of such limitation if any taxable year is of less than twelve months, the excess profits net income for such taxable year shall be placed on an annual basis by multiplying by twelve and dividing by the number of months included in such taxable year. (7) For the purposes of this subsection, the excess profits net income for any taxable year ending after May 31, 1940, shall not be greater than an amount computed as follows: (A) By reducing the excess profits net income by an amount which bears the same ratio thereto as the number of months after May 31, 1940, bears to the total number of months in such taxable year; and (B) By adding to the amount ascertained under subparagraph (A) an amount which bears the same ratio to the excess profits net income for the last preceding taxable year as such number of months after May 31, 1940, bears to the number of months in such preceding year. The amount added under this subparagraph shall not exceed the amount of the excess profits net income for such last preceding taxable year.↩ 1. Includes $ 9,292.11 sales of beers not manufactured by petitioner.↩ 2. Includes $ 5,953.21 sales of beers not manufactured by petitioner.↩ 3. SEC. 718. EQUITY INVESTED CAPITAL. (c) Rules for Application of Subsections (a) and (b). -- For the purposes of subsections (a) and (b) -- * * * * (3) Computation of earnings and profits of taxable year↩. -- For the purposes of subsection (a) (3) (B) and (b) (2) in determining whether a distribution is out of earnings and profits of any taxable year, such earnings and profits shall be computed as of the close of such taxable year without diminution by reason of any distribution made during such taxable year or by reason of the tax under this subchapter or chapter 1 for such year and the determination shall be made without regard to the amount of earnings and profits at the time the distribution was made.