Midwest Liquor Dealers, Inc. v. Commissioner

Midwest Liquor Dealers, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent Midwest Liquor Dealers, Inc. v. Commissioner Docket Nos. 26983, 29753 United States Tax Court 20 T.C. 950; 1953 U.S. Tax Ct. LEXIS 73; September 9, 1953, Promulgated *73 Decision will be entered under Rule 50. Petitioner, a wholesale liquor dealer, commenced business on April 10, 1935, approximately 1 year prior to the beginning of its base period. During its base period petitioner embarked upon a program of purchasing whisky in bulk, having it bottled, and selling it as an exclusive distributor within at least part of its area. Petitioner also moved from a rented warehouse in which its operations could not be carried on efficiently to a warehouse which it purchased and in which, with remodeling, it was able to operate its business at lower costs. Held, petitioner has qualified for relief under section 722 (b) (4), Internal Revenue Code. Constructive average base period net income determined. Philip B. Heller, Esq., for the petitioner. Julian L. Berman, Esq., for the respondent. Raum, *74 Judge. RAUM *950 These proceedings were consolidated for trial. Docket No. 26983 relates to the fiscal years ended March 31, 1941 to 1945, inclusive, and Docket No. 29753 relates to the fiscal year ended March 31, 1946. The only issues presented are whether petitioner's applications for relief from excess profits taxes, under section 722 (b) (4) and (b) ( 5) of the Internal Revenue Code, were properly denied by the Commissioner. FINDINGS OF FACT. The stipulated facts have been so found and are incorporated herein by this reference. The petitioner was organized, on April 10, 1935, as a corporation under the laws of the State of Indiana for the purpose of engaging in the wholesaling of wines and liquors. Petitioner filed its excess profits tax returns for the periods involved herein with the collector of internal revenue at Indianapolis, Indiana. It keeps its books of account on the basis of a fiscal year extending from April 1 to March 31 and its base period consists of 4 fiscal years ended March 31, 1937, to March 31, 1940, inclusive. The following schedule indicates petitioner's excess profits net income, its average base period net income, the amount of the excess *75 profits tax paid, and the excess profits tax credit for each of the taxable years: Excess profits Average base period Fiscal year ended Mar. 31 net income net income 1 [1941] $ 37,182.22 $ 24,025.25 [1942] 116,411.62 28,315.80 [1943] 123,883.08 28,315.80 [1944] 112,620.93 28,315.80 [1945] 195,191.05 28,315.80 [1946] 264,403.64 28,315.80 Excess profits Excess profits Fiscal year ended Mar. 31 tax credit used tax paid [1941] 2 $ 22,823.99 $ 2,339.56 [1942] 2 26,900.01 34,530.22 [1943] 2 26,900.01 74,506.28 [1944] 2 26,900.01 65,224.19 [1945] 3 29,719.23 127,441.48 [1946] 3 35,413.06 131,428.99 *951 The petitioner requested relief from excess profits taxes in accordance with the following forms duly filed with the collector of internal revenue at Indianapolis, Indiana: Application for Fiscal year ended Mar. 31 relief under sec. Claim for refund 722 I. R. C. (Form 843) (Form 991) [1941] $ 2,455.73 [1942] 34,628.51 1 $ 37,811.00 [1943] 1 10,363.65 23,727.82 [1944] 2 5,951.83 2 58,155.56 [1945] 65,149.45 [1946] 23,537.00 *76 At the time of petitioner's organization, it had an authorized capital stock of $ 25,000, consisting of 250 shares of preferred stock with a par value of $ 100 each and 500 shares of no par value common stock. Each purchase of 1 share of preferred stock entitled the purchaser to an additional 2 shares of no par common stock. On March 19, 1937, its charter was amended to provide for an additional authorization of 750 shares of common "A" stock with a par value of $ 100 per share. The common "A" stock was issued as follows: Capital stock outstanding Number of Date common Increased "A" shares issued From -- To -- Apr. 30, 1937 [300] $ 25,000 $ 55,000 Mar. 30, 1938 [360] 55,000 91,000 July 6, 1939 [90] 91,000 100,000 During the base period, the petitioner serviced the following counties situated in the northwest section of the State of Indiana: Lake, Porter, La Porte, St. Joseph, Elkhart, Newton, Jasper, Starke, Marshall, Benton, White, Pulaski, and Fulton. Some *77 of the principal cities located within that area are Gary, Hammond, East Chicago, Whiting, Crown Point, Michigan City, La Porte, South Bend, Mishawaka, Elkhart, Goshen, Winamac, and Knox. It is an area which is both industrial (containing a variety of light and heavy industries) and agricultural. Petitioner's first place of business was situated at 3352-54 Michigan Avenue, East Chicago, Indiana, and consisted of the first floor and basement of a former bank building. The premises, which were leased *952 by petitioner, were approximately 9,800 square feet in size. Portions of the premises were still devoted to safety deposit boxes, bank vaults, cages, and a directors' room, which were not susceptible of conversion to warehouse space. The usable space for storage of petitioner's merchandise was approximately 7,500 square feet. The building was used by petitioner primarily for warehouse purposes; some space was allotted for the assembling of orders of less than case lots, a bookkeeping department, a lobby where customers could enter and be received, and a small private office. Since the building was not constructed for use as a warehouse, the weakness of the floors prevented*78 the stacking of merchandise on the first floor to heights in excess of 5 to 6 cases. And because of a low ceiling in the basement the stacks there could not consist of more than 4 or 5 cases. The storage of merchandise in the basement also presented a breakage problem since a seepage of water into the basement weakened the cases on the bottom of the stacks. The stacks were therefore more likely to fall and cause the bottles to break. All of the merchandise which was shipped and received by petitioner had to pass through one door which opened on to an alleyway in the rear of petitioner's premises. The alleyway was shared with the Railway Express Company which occupied the premises opposite the rear of petitioner's warehouse. If one of the Express Company's trucks desired to use the alleyway, any truck which was loading or unloading merchandise for petitioner had to stop its operations in order to give it a means of access to the alleyway. Petitioner's rear door, which was only 40 inches wide, was too narrow to permit the use of standard size warehouse trucks. The single door operation was such that it was not possible for petitioner to ship and receive merchandise at the same*79 time. When merchandise was being delivered to the petitioner, it was necessary to remove it from the delivery truck and place it on a small hand truck, to push the hand truck into the building, and to unload and stack the cases. When the cases were to be stored in the basement, they were placed on a metal slide and pushed down into the basement where they were received by a laborer and stacked. When the cases stored in the basement were needed, it was necessary, at first, to carry them up to the first floor by hand. Later, a conveyor with a rubber belt was installed to carry those cases mechanically to the first floor. On November 15, 1936, the petitioner leased an old store building, adjoining the bank premises which it was then using, and gained approximately 4,400 square feet of additional warehouse space. A *953 doorway was cut through the wall which separated the two buildings and a ramp was built to facilitate movement between the buildings, since the floor levels therein were different. Another adjacent store building was leased and cut into on November 18, 1939, and approximately 2,000 square feet of space was thereby added. The problems created by the availability*80 of only a single narrow doorway through which to carry on shipping and receiving operations were in no way alleviated by the acquisition of the two adjoining stores. Petitioner's shipping department consisted of warehouse men, helpers, and truck drivers. The petitioner's salesmen solicited orders from customers and turned them over to the shipping department. This department frequently became congested while filling orders and it was necessary for others outside of the department to assist in the preparation of such orders. Salesmen, who were anxious to serve their customers' needs, frequently prepared the orders personally and made deliveries in their own cars. The salesmen frequently devoted as much as two hours a day to that kind of work. This condition prevailed throughout the base period. All but one of the salesmen were hired on a commission rather than a salary basis, and no extra costs were incurred by reason of their work in the shipping department. Petitioner also made use of the facilities of 3 public warehouses, 2 of which were located in Chicago and 1 in Hammond, Indiana, about 5 or 6 miles from petitioner's warehouse. Charges for using those warehouses consisted*81 of a handling charge of 5 cents per case when the merchandise was received; 5 cents per case a month for storage; and 5 cents per case, handling charge, when the merchandise left the warehouse. It was necessary for petitioner to send one of its trucks to pick up the merchandise from the public warehouses. The truck would transport the merchandise to petitioner's warehouse where it would be unloaded, carried in, and stacked. The use of a public warehouse caused extra handlings of the merchandise by petitioner's employees. Petitioner used the public warehouses not only to store domestic merchandise but also to store imported merchandise in the United States Customs bonded warehouses (referred to hereinafter as bonded warehouses) located within such public warehouses. Petitioner had an importer's basic permit which allowed it to import merchandise without paying duty thereon at the time of importation provided that it was stored in bonded warehouses. The bonded warehouse is a locked enclosure constructed in accordance with customs regulations; the key to the lock is in the custody of the customs service. The duty on merchandise so stored is paid at the time the merchandise is withdrawn*82 from the warehouse. By making use of such facilities, petitioner was *954 able to buy imported whiskeys in larger quantities with the same cash outlay. Thus, it was enabled not only to obtain the merchandise at quantity discounts, but also to effect savings on transportation charges since the goods could be brought in directly to the port of Chicago. The additional costs incurred by using the bonded warehouse were inconsequential in relation to the savings that could be made on the cost of the merchandise stored therein. Petitioner did not have a bonded warehouse on its own premises, which were such that the requirements for housing a bonded warehouse probably could not be met. Petitioner expended the following amounts for public warehouse charges: Calendar year Amount [1936] $ 727.53 [1937] 1,485.38 [1938] 1,604.36 [1939] 1,208.06 The maximum number of cases of merchandise which petitioner had stored in public warehouses at any particular time was approximately 3,000. Generally, however, petitioner did not have that amount of whiskey stored in public warehouses. On February 19, 1940, after devoting a substantial period of time toward finding suitable premises*83 for its warehouse and office, the petitioner acquired, by purchase, the corner land and building at 2316-18-20 Broadway Avenue, in East Chicago, Indiana. The building was originally constructed for use as a garage and contained two floors and a basement. It contained somewhere between 22,500 and 23,000 square feet of usable space. The building was of brick, concrete, suspended steel truss, and concrete floor construction. Its doors were not large enough to permit large trucking equipment to back in and they were enlarged to accommodate such units. The floors were reinforced with steel for the same purpose. A ramp which connected the basement to the roof was removed to give more space. A conveyor system capable of moving merchandise between the basement and the two floors was installed. Air conditioning, private offices, a bookkeeping department, and other improvements were installed prior to moving from the old premises. The cost of the land and building was $ 22,500; and the cost of the improvements made therein, or for which commitments had been made prior to the end of the base period, was $ 13,881.07. The new premises provided for simultaneous shipping and receiving operations, *84 which could be performed inside the warehouse. The merchandise being received was taken from the trucks and put directly *955 on the conveyor system on which it was sent to the proper location in the warehouse, where it was removed and stacked. This process involved less handling of the merchandise and there was therefore less labor involved and a smaller likelihood of breakage. The petitioner also arranged for a part of its new warehouse to become a bonded warehouse. The cost of this enclosure was $ 309. Merchandise could be stacked in the new warehouse to heights of 12 to 15 cases and the use of public warehouses was eliminated. The operational difficulties which petitioner had encountered at its old warehouse were eliminated and petitioner was able to send its delivery trucks to the out-lying country areas in its territory two or more times a week; when using its old warehouse petitioner was able to service those areas only once a week. Petitioner, at the end of the base period, owned five delivery trucks. It acquired its first truck in 1935 and the others during the course of the base period. Petitioner employed men as truck drivers and helpers at a salary approximating*85 $ 27 weekly. Petitioner also had four other employees regularly working in connection with shipping and warehouse operations. Their salaries ranged from approximately $ 20 per week to $ 40 per week. Petitioner's warehouse salaries or shipping room wages during the base period were as follows: Fiscal year ended Mar. 31 Amount [1937] $ 4,102.04 [1938] 3,806.13 [1939] 3,637.33 [1940] 4,830.46 In the first few years after the repeal of prohibition, conditions in the liquor industry were chaotic. The relationship between wholesalers and distillers was not a close one. It was not uncommon for a wholesaler to stock the lines of several distillers. Petitioner, during this period and shortly after its organization, handled the following principal lines: Schenley, Seagram, Hiram Walker, Frankfort, and Glenmore. Sales of products in the Schenley line accounted for a substantial part of petitioner's sales and also represented a major factor in the total liquor business done in petitioner's area. Petitioner was one of several distributors in its area that handled Schenley products and therefore the business was very competitive. The relationship between the wholesalers and the*86 retailers during that period was also unstable. Wholesalers did not have planned sales programs or trained sales forces. In May of 1936, the petitioner, for the first time, started to handle and distribute the products of the Penn-Maryland Company, which was operating as a division of the National Distillers Products Corporation *956 (hereinafter referred to as National). In August 1938, the petitioner stopped purchasing Schenley lines, replacing them with National's products. Prior to that time, although it had a distributor for its whiskies in petitioner's area, National was not a major factor in that market, since only 300 to 400 cases 1 of its products were being sold each month. Petitioner's purchases of Schenley and National products during the base period were as follows: Schenley products National products 1 Fiscal year ended Mar. 31 in unit in unit cases cases [1937] 21,582 3,794 [1938] 17,791 14,105 [1939] 2*87 6,815 28,676 [1940] 27,830 Late in 1937, National decided to begin the sale of bulk whiskeys to its distributors, and to give the distributors the right to use certain National labels on such whiskeys when they were converted to bottled goods. Such arrangements were formalized in contracts between National and its distributors, and the bulk whiskeys purchased under the plan as herein explained will be referred to as the "contract brands." National believed that such practice would establish closer relations between the distributors and itself, and it was contemplated that the distributors would take a greater interest in the promotion and distribution of such whiskeys and National products, in general. Other considerations*88 in National's decision to enter the bulk whiskey field were that National could anticipate its profit on the whiskey at the time the contract for its sale was made and that by creating a demand for whiskey of a certain quality and age it could "force" the distributors to purchase in advance of their actual needs in order to assure themselves of a continuous supply of like whiskeys in the future. Pursuant to the typical bulk whiskey contract, the distributor buys whiskey in original proof gallons by the barrel. The particular barrels purchased are identified by serial numbers. The distributor pays all insurance, storage, and local taxes on the whiskey. The distributor pays the purchase price for the whiskey by giving the distiller an *957 interest-bearing note. When it desires to have the whiskey delivered it is bottled for the distributor by the distiller in sizes that the distributor chooses, and a charge is made by the distiller for bottling. The distiller retains possession of the warehouse receipts for the whiskey and the distributor signs a power of attorney giving the distiller authority to deal with the warehouse receipts. On December 1, 1938, the petitioner entered*89 into its first contract with National for the purchase of bulk whiskey. The following table summarizes the contracts made by petitioner and National for purchases of bulk whiskey during petitioner's base period: Number Date of Label to be Contract date of distillation used barrels Dec. 1, 1938 [50] Nov. 15, 1935 Coon Hollow [100] Jan. 8, 1936 [200] Mar. 18, 1936 [50] Apr. 3, 1936 [100] June 6, 1936 Dec. 31, 1938 [15] Mar. 5, 1935 Bond & Lillard [15] May 18, 1935 [40] July 18, 1935 [10] Aug. 30, 1935 [20] Nov. 26, 1935 [65] Jan. 9, 1936 and Jan. 18, 1936 [65] Feb. 26, 1936 and Feb. 28, 1936 [125] Mar. 3, 1936 and Mar. 20, 1936 [25] Apr. 22, 1936 [25] June 18, 1936 [170] July 21, 1936 and July 22, 1936 [25] Sept. 1, 1936 [25] Oct. 7, 1936 [25] Nov. 6, 1936 [50] Dec. 9, 1936 Jan. 3, 1939 [75] Mar. 15, 1937 Bond & [75] Apr. 15, 1937 Lillard [75] May 14, 1937 [75] June 15, 1937 Nov. 1, 1939 [50] Nov. 30, 1935 Old Crow [100] Dec. 10, 1935 and Dec. 11, 1935 [50] Jan. 14, 1936 [50] Feb. 13, 1936 Nov. 1, 1939 [100] Apr. 1936 Old Crow [100] May 1936 [50] June 1936 Proof to Contract date Type of be not Age to be whiskey less than not less than Dec. 1, 1938 Ohio Bourbon 90 o 36 months. Dec. 31, 1938 Kentucky 93 o 36 months. Bourbon Jan. 3, 1939 Kentucky 93 o 36 months. Bourbon Nov. 1, 1939 Kentucky 93 o 48 months. Bourbon Nov. 1, 1939 Kentucky 93 o 48 months. Bourbon *90 The petitioner, sometime prior to November 4, 1939, also agreed to purchase 600 barrels of 1938 distillations and 300 barrels of 1939 distillations of "Bond & Lillard" from National. The purchase of the 1938 distillations was to be made sometime after January 1, 1940, at *958 a date to be selected by National and carrying charges were to begin on January 1, 1940, the 1939 distillations were to be purchased on or after January 1, 1941, when specified by National, and carrying charges were to begin on January 1, 1941. These agreements were incorporated into formal contracts of purchase and sale on April 30, 1941, and March 31, 1942, respectively. 2 In the fall of 1938, petitioner was appointed by National as the sole and exclusive distributor, in lake, La Porte, and Porter counties in*91 Indiana, for all of National's nationally distributed standard brands 3 of domestic whiskeys, except with respect to the so-called secondary brands, which included the contract brands derived from bulk whiskeys. Exclusive distribution rights over the contract brands were given to petitioner in the individual contracts. In some of its bulk whiskey contracts, petitioner was given exclusive distribution rights in the entire State of Indiana and in others the rights extended only to Lake, La Porte, and Porter counties. Petitioner was granted the right to use the "Bond & Lillard" brand label in conjunction with its purchase of bulk whiskeys. There was also an understanding between petitioner and National that it could adopt on a similar basis the use of "Sunny Brook" and "Hill & Hill" labels. In December 1939, petitioner for the first time made use of the "Hill & Hill" and "Sunny Brook" labels*92 in the conversion of its bulk whiskeys to bottled goods. When converting the bulk whiskey into bottled goods petitioner could use these labels interchangeably with respect to any of the bulk whiskey it had purchased. The petitioner was one of two contract holders serving the State of Indiana with National's contract brands of whiskey. It was the practice of petitioner, as a contract holder, in developing the sale of its contract brands to exchange barrels of whiskey which it owned, for barrels of similar whiskey, owned by National or other contract holders, with a distillation date different from its own whiskey. This was done in order to maintain continuity of the product that petitioner was offering for sale when petitioner was short of whiskeys of a certain distillation date or age. The power of attorney which petitioner gave to National was used by National in making these exchanges. When the petitioner ordered the bottling of its bulk whiskey an additional charge for bottling was made by National. The petitioner's *959 bulk whiskey contracts made during its base period with National set the bottling charge as follows: 4 $ 1.50 per case of quarts 2.00 per case of*93 pints 2.50 per case of half-pints A certain amount of bulk whiskey that is aging in barrels is lost due to seepage, evaporation, and similar causes. The general experience of owners of bulk whiskeys establishes that where the whiskeys are bottled in bond (i. e. at least 4 years old and 100 proof) the yield per barrel will average approximately 13 cases of 3 gallons each. Where the whiskey is bottled at less than 100 proof there would be an average yield of 15 cases per barrel. In the event that the whiskey is bottled in cases of "fifths" (i. e. 12 bottles each containing one-fifth of a gallon) the yield per barrel would be approximately 18 1/2 cases. Taking all factors into account, an overall average yield of 15 cases can be expected from the average barrel of whiskey at the time of bottling. National did not promise what the yield of a barrel of whiskey would be; but a certain amount of whiskey is lost through waste and spilling in the process of bottling, and National did assure its purchasers of bulk whiskey that such loss would not be greater than 1 per cent. *94 It was expected by National and its purchasers of bulk whiskey that the final costs to the purchaser of a case of bulk whiskey which had been converted to bottled goods would be less than the cost of a case of like whiskey if it were purchased as case goods. Such cost differential is sometimes referred to as "bottler's profit." At no time during the base period, however, was it possible to acquire from National a case of whiskey bearing the same label as one of the contract brands; the contract brands could only be obtained through conversion of bulk whiskey to bottled goods by a contract holder. It was estimated by petitioner and National that the bottler's profit on the contract brands would, on the average, amount to $ 1.50 per case. The normal or usual mark-up on whiskey during the base period was 17 1/2 per cent. By using such mark-up, a wholesaler such as petitioner would earn a gross profit of approximately 15 per cent on sales. Generally, a period of approximately 4 to 5 years is needed to establish a new brand of whiskey on the market. The problems involved in so doing were building up the retailers' confidence in the product, so *960 that the whiskey can be put*95 on their shelves, and gaining consumers' acceptance, so that repeat sales will be made. A persistent advertising and promotional campaign is needed to bring about such results. Although some of the labels used on the contract brands were used prior to the adoption of the prohibition amendment and there were some sales of those brands as medicinal whiskey during prohibition, the problems created in attempting to introduce those brands to a new generation of potential customers and to recapture old customers were similar to the problems met in attempting to establish a completely new brand. Petitioner experienced difficulty in attempting to establish the "Coon Hollow" brand on the market. It finally decided to give up its rights to distribute whiskey under the "Coon Hollow" label and exchanged such rights for the use of another label. The introduction of the contract brands in petitioner's area was supported by advertising campaigns, the funds for which were contributed equally by petitioner and National, at the rate of 25 cents per case. The fund so created, together with supplemental amounts provided by National, gave those brands advertising in local newspapers, displays at *96 the point of purchase, outdoor advertising, and other promotional assists. The campaign started at the time when petitioner first offered the contract brands to the public. In merchandising the contract brands it was common to offer the whiskey at reduced prices. Such special offers (referred to in the trade as deals) were participated in by both National and petitioner, and petitioner would receive a credit from National for one-half of the difference between petitioner's regular selling price of the whiskey and the amount for which it was sold in the deal. Although a particular deal might last from 5 to 30 days, it was usual for retailers to buy during deals and stock up until the time when the next deal was offered. There was no established deal and the discount offered could be in any amount. Deals are offered usually until the brand becomes established on the market. Deals on the contract brands continued at least until the end of petitioner's base period. It would not be unusual for deals to be offered on a particular brand for any period up to 8 years. That portion of the price reduction, which was borne by petitioner during the period that a deal was in operation, eliminated*97 a part, if not all, of the bottler's profit that might have been earned by the petitioner on bulk whiskey sales. The following schedule is a statement of petitioner's profit and loss for the periods indicated: *961 Fiscal year ended Mar. 31 -- April 10, 1935 to March 31, [1938] Sales $ 683,526 $ 1,350,323 $ 1,676,734 Less -- Special discounts Net sales $ 683,526 $ 1,350,323 $ 1,676,734 Less -- Cost of goods sold 598,424 1,171,535 1,454,355 Gross profit on sales $ 85,102 $ 178,788 $ 222,379 Add -- miscellaneous income [33] Total gross income $ 85,168 $ 178,813 $ 222,412 Less -- Expenses: Salaries: Officers $ 6,209 $ 10,825 $ 13,190 Manager 3,550 4,325 5,368 Sales commissions 19,866 37,118 45,396 Others 11,200 21,399 27,620 Bonuses: Officers 15,000 20,000 Manager 10,000 15,000 Auto and truck maintenance 3,133 5,201 6,167 Bad debts 2,890 2,326 2,960 Professional fees 3,975 6,893 7,352 Rent 1,250 1,950 2,400 Selling expense 2,107 7,715 12,146 Taxes and licenses 4,254 8,097 11,559 Stationery, printing, and office supplies 1,438 1,969 1,454 Telephone and telegraph 1,642 2,402 2,711 General expense 1,346 1,823 1,616 Depreciation 1,134 2,065 2,961 Insurance [774] 2,081 2,982 Repairs and maintenance building [613] 1,092 [951] Traveling expense [874] Shipping supplies [181] Dues and subscription [315] 1,120 1,066 Financing charges [38] Light [638] Interest [620] Cash shortages -- net [172] A. D. T. and watch service [120] Armored car service [475] Advertising [591] 1,650 Breakage [302] Loss on sale of assets [55] Bank service [298] Contributions [150] Collection expense Loss on advances to salesmen Total expenses $ 68,168 $ 147,867 $ 188,262 Net income $ 17,000 $ 30,946 $ 34,150 *98 Fiscal year ended Mar. 31. -- [1940] Sales $ 1,516,509 $ 1,634,038 Less -- Special discounts 17,873 15,261 Net sales $ 1,498,636 $ 1,618,777 Less -- Cost of goods sold 1,302,005 1,412,175 Gross profit on sales $ 196,631 $ 206,602 Add -- miscellaneous income [393] Total gross income $ 197,055 $ 206,995 Less -- Expenses: Salaries: Officers $ 11,456 $ 13,413 Manager 5,663 6,646 Sales commissions 40,656 44,235 Others 24,904 26,475 Bonuses: Officers 15,000 20,000 Manager 15,000 15,000 Auto and truck maintenance 6,589 5,712 Bad debts 2,670 Professional fees 4,675 4,108 Rent 3,200 3,473 Selling expense 13,156 9,322 Taxes and licenses 10,719 10,926 Stationery, printing, and office supplies 1,908 2,327 Telephone and telegraph 3,043 3,196 General expense 1,882 2,405 Depreciation 2,788 3,185 Insurance 3,203 3,549 Repairs and maintenance building [765] Traveling expense 1,740 1,585 Shipping supplies [285] Dues and subscription 1,439 1,427 Financing charges Light [731] Interest [222] Cash shortages -- net [16] A. D. T. and watch service [273] Armored car service [540] Advertising [633] Breakage [346] Loss on sale of assets [15] Bank service [255] Contributions Collection expense [718] Loss on advances to salesmen [234] Total expenses $ 174,101 $ 181,783 Net Income $ 22,954 $ 25,212 *99 Petitioner's net sales for its base period were as follows: Fiscal years Month 1936-37 1937-38 April $ 80,455.70 $ 145,648.04 May 74,730.93 145,583.14 June 94,853.21 130,472.17 July 78,718.40 123,654.62 August 80,067.99 130,359.28 September 106,337.45 154,990.19 October 126,443.56 172,069.45 November 129,978.97 155,931.93 December 201,768.59 200,255.93 January (following year) 117,359.50 106,356.21 February 116,270.07 95,146.80 March 143,338.41 116,266.08 Total $ 1,350,322.78 $ 1,676,733.84 Fiscal years Month 1938-39 1939-40 April $ 112,879.87 $ 121,037.70 May 105,714.65 118,593.58 June 167,818.80 109,686.51 July 67,977.73 91,395.17 August 91,866.40 112,287.31 September 116,266.34 137,475.96 October 127,026.13 148,871.09 November 146,500.96 153,129.08 December 195,290.87 217,853.57 January (following year) 113,124.76 133.722.73 February 126,712.03 134,129.91 March 127,457.24 140,594.45 Total $ 1,498,635.78 $ 1,618,777.06 *962 Petitioner's sales in case units during its base period were as follows: 5 Unit cases included in sales Second quarter, 1936 (April-June) 15,327 Third quarter, 1936 (July-September) 16,891 Fourth quarter, 1936 (October-December) 29,368 First quarter, 1937 (January-March) 24,418 Total, fiscal year ended Mar. 31, 1937 86,004 Second quarter, 1937 (April-June) 26,073 Third quarter, 1937 (July-September) 24,702 Fourth quarter, 1937 (October-December) 31,967 First quarter, 1938 (January-March) 19,571 Total, fiscal year ended Mar. 31, 1938 102,313 Second quarter, 1938 (April-June) 23,747 Third quarter, 1938 (July-September) 16,724 Fourth quarter, 1938 (October-December) 28,778 First quarter, 1939 (January-March) 23,054 Total, fiscal year ended Mar. 31, 1939 92,303 Second quarter, 1939 (April-June) 22,090 Third quarter, 1939 (July-September) 19,204 Fourth quarter, 1939 (October-December) 31,634 First quarter, 1940 (January-March) 25,882 Total, fiscal year ended Mar. 31, 1940 98,810 *100 Apparent per capita consumption of distilled spirits in Indiana in wine gallons was 0.80 in 1936; 0.97 in 1937; 0.83 in 1938; and 0.91 in 1939. Petitioner commenced business immediately prior to the base period and as a result thereof its average base period net income did not reflect normal earnings for petitioner's business. Petitioner also changed the character of its business by its acquisition of new warehouse facilities. As a result of such change petitioner was able to operate its business more efficiently and at lower costs. Petitioner further changed the character of its business by entering into the bulk whiskey field. Had it made such change 2 years earlier, its annual sales of bulk conversions would have increased by 4,000 cases. Petitioner's excess profits tax for the fiscal years ended March 31, 1941, to March 31, 1946, inclusive, computed without the benefit of section 722 is*101 excessive and discriminatory. A fair and just amount to be used as petitioner's constructive average base period net income is an amount equal to $ 10,000 more than petitioner's average base period net income determined without the benefit of section 722. *963 OPINION. Petitioner contends that it is entitled to excess profits tax relief under section 722 (a) and 722 (b) (4) of the Internal Revenue Code, 6 by reason of (1) commencing business immediately prior to the base period; (2) changing its capacity for operation of its business by acquisition of larger warehouse facilities from which business could be operated more profitably; and (3) changing the operation of its business by engaging in the purchase of bulk whiskeys. *102 1. Petitioner maintains that it qualifies for relief under section 722 (b) (4) because it commenced business immediately prior to the base period and its average base period net income does not reflect normal operations for the entire base period. Petitioner began operations on April 10, 1935, and thus had slightly less than a full year of experience prior to the beginning of its base period. It is therefore entitled *964 to relief on account of this commencement factor if the factor prevented the average base period net income from reflecting normal operations of the business for the entire period. The Government has taken the position that petitioner attained a normal competitive position almost immediately after starting business, and that its base period earnings were not adversely affected by reason of this factor. Accordingly, it opposes relief on this ground. It is quite true, as the Government points out, that petitioner's sales position was better in the second base period year than in its last 2 base period years. And we think that petitioner would not have reached a higher level of sales during the last 3 years of the base period, or by the end of the base period, *103 merely by commencing business 2 years earlier. The evidence is persuasive that the business was such that it did not require a long period for petitioner to attain normal operations. However, some initial development was required, and the formative stage had not yet been fully completed by the beginning of the base period. Petitioner's sales during the first half (April through September 1936) of its first base period year appear to be out of line, and we are satisfied that such condition was due to the fact that petitioner had not yet reached its stride. Respondent opposes relief with respect to this factor on the further ground that even if petitioner had enjoyed a higher level of sales during the first 6 months, additional compensation to its officers would have wiped out any increased earnings. We do not agree. We think that petitioner would have had additional sales, had it commenced business earlier, and that such additional sales would have resulted in additional profits even after taking into account increased costs of operation. In determining petitioner's constructive average base period net income a correction will therefore be made in petitioner's earnings for the*104 first half year of the base period by reason of the commencement factor. 2. Petitioner relies upon its acquisition of new warehouse facilities as a second ground for relief. We agree that the move into the new warehouse brought about a substantial change in petitioner's operations with resulting economies that are not reflected in its average base period net income. The new facilities made it unnecessary for petitioner to use outside public warehouses, thereby achieving a net savings through the elimination of the charges made by the public warehouses. Moreover, the use of public warehouses had entailed additional handling of the merchandise, since petitioner's trucks were required to transport the goods to the public warehouse in the first instance and then at a later time to transport them to petitioner's place of business when withdrawn from the public warehouse. Thus, the new facilities acquired by petitioner resulted in the reduction of use of petitioner's trucks as well as some savings in personnel. Also, *965 petitioner's new premises contained a United States Customs bonded warehouse which enabled petitioner to achieve savings on its purchases of imported merchandise. *105 We conclude that petitioner's move into its new warehouse was a change in the character of its business within the meaning of (b) (4), and our reconstruction will take into account the savings which were available to petitioner as a result of that move. 3. Petitioner contends that it changed the character of its business during the base period by entering into the practice of purchasing bulk whiskey from National Distillers, taking on National's entire line of bottled goods, and at the same time abandoning the Schenley line. The relief sought by petitioner is based upon a two-fold assumption: That if it had made this change 2 years earlier, then, first, it would have been able to sell 15,000 additional cases a year of the so-called contract brands, derived from its bulk purchases, and, secondly, that it would have been able to sell 15,000 additional cases a year of National's bottled goods. 7 *106 We must reject the second assumption on the evidence before us. As far as we know, National's bottled goods which are here involved represented established brands, and they merely replaced brands in the Schenley line which petitioner abandoned at the time it took on the National line. We are not satisfied that if petitioner had abandoned the Schenley line in favor of National 2 years earlier, it would have enjoyed any higher level of sales of National's bottled goods by the end of the base period. Thus, petitioner's sales of "Old Grand Dad" and "Old Taylor," two of National's most prominent established brands, were higher in its third base period year than its fourth, being 5,265 cases for the fiscal year ended March 31, 1939, and 4,580 cases for the fiscal year ended March 31, 1940. 8 No satisfactory explanation was given for the decline. Certainly, we are not convinced that if petitioner had embarked upon its program of dealing in National's merchandise 2 years earlier, there would have been any difference in its sales of National's bottled goods. Accordingly, even assuming that petitioner's acquisition of National's entire bottled line in place of the Schenley line could*107 appropriately be considered for purposes of relief under (b) (4), we conclude that petitioner has failed to establish that its earnings attributable to sales of National's bottled goods would have attained a higher level by the end of the base period. In the circumstances, we must reject petitioner's position to *966 the extent that it seeks a reconstruction containing additional earnings allocable to sales of National's bottled goods. Petitioner's operations in relation to its bulk purchases present a different picture. The brands involved in these purchases required promotional activities extending over some 4 or 5 years before they could be regarded as established brands in petitioner's territory. We think that the type of operation revolving around the bulk purchases was so markedly different from petitioner's prior mode of doing business*108 as to constitute a change within the meaning of (b) (4). However, our principal difficulty with this aspect of the case lies in the amount of relief sought by petitioner. We think that the estimates of additional sales by use of the 2-year push-back rule and the profits allegedly attainable from such sales are highly inflated. Petitioner urges that by applying the 2-year push-back rule it would have increased its sales of contract brands from 5,000 cases a year at the end of the base period to 20,000 cases a year. Upon consideration of the entire record, we do not accept the latter figure as a reliable estimate. Moreover, the evidence before us persuasively establishes that the application of the 2-year push-back rule to petitioner's entering the bulk whiskey field would not have increased consumption of whiskey in the area which it served. Accordingly, any increase in the sale of contract brands would be at the expense of other brands, whether carried by petitioner or its competitors. Therefore, in order to determine the net effect upon petitioners earnings of any increase in sales of contract brands, such increase would have to be reduced by the adverse effect that it might*109 have on other brands sold by petitioner. The state of the record is thoroughly unsatisfactory in this respect, but, doing the best we can with the materials at hand, it is our best judgment that if petitioner had undertaken its bulk whiskey program 2 years earlier, it would have had a net increase in sales of about 4,000 cases a year. A further difficulty with the amount of relief sought by petitioner is its assumption that there should be included in reconstructed earnings, due to increased sales of contract brands, a so-called bottler's profit, averaging approximately $ 1.50 on each case of bulk whiskey in addition to the usual profit earned by a distributor on the sale of bottled whiskey. True, there was evidence relating to the anticipated bottler's profit, and we have made a finding of fact that recognized that situation. But the weakness in petitioner's position is that the bottler's profit was in large measure illusory. The evidence reveals that much, if not all, of the bottler's profit was eliminated by deals which National and petitioner would enter into with liquor retailers in the course of their promotional efforts with the contract brands. Although a particular deal, *110 providing for a specified price reduction per case to the retailer might be in effect only for a period *967 of from 5 to 30 days, the record makes it clear to us that such deals were recurrent and became a part of the permanent buying plan of the retailers. A retailer, anticipating his needs, would stock up on a particular brand during the period of a deal. He could then make substantial purchases of that same brand again when another deal was offered with respect to it at a future time. We are satisfied from the record that deals played a crucial part in the merchandising of the contract brands. Petitioner did not show how frequently deals occurred, or how much of the bottler's profit would be offset by such deals. In the circumstances, we do not have any confidence in petitioner's contention that it is entitled to reconstruction that contemplates a bottler's profit of about $ 1.50 a case. However, we do think that there was some residual bottler's profit, and in our reconstruction we shall give some, but not substantial, weight to this factor. Taking into account all of the circumstances outlined above, and giving effect to all of the evidence, we conclude that petitioner*111 is entitled to a constructive average base period net income in an amount equal to $ 10,000 more than its average base period net income computed without the benefit of section 722 of the Internal Revenue Code. 9 Reviewed by the Special Division. Decision will be entered under Rule 50. Footnotes 1. Determined without regard to sec. 722, I. R. C.↩ 2. Based upon income method, sec. 713, I. R. C.↩ 3. Based upon invested capital method, sec. 714, I. R. C.↩ 1. The total relief claimed for the fiscal year ended March 31, 1943, was $ 71,902.47.↩ 2. The total relief claimed for the fiscal year ended March 31, 1944, was $ 64,107.39.↩ 1. These figures do not take into account purchases from National of "bulk whiskeys" which were not converted to bottled goods. The practice of purchasing bulk whiskeys and converting them to bottled goods will be hereinafter explained.↩ 1. The terms "cases" or "unit cases" as used herein represent the equivalent of: ↩ Size Number in case Wine gallons Fifths (1/5 of one gallon) 12 bottles 2.4 Quarts 12 bottles 3.0 Pints 24 bottles 3.0 One-half pints 48 bottles 3.0 2. The final purchase of Schenley products consisted of 400 cases in August 1938. 2. The April 30, 1941, contract was for 300 barrels of whiskey (one-half of that provided for in the original agreement) and the March 31, 1942, contract was for 600 barrels (twice as much as provided in the original agreement).↩ 3. Some of these nationally distributed standard brands were "Old Grand Dad," "Old Taylor," "Mount Vernon," and "Old Overholt."↩ 4. The contract executed March 31, 1942, which formalized the purchase and sale agreement made on or about November 4, 1939, had bottling charges of $ 1.75, $ 2.25, and $ 2.75 for quarts, pints, and half pints, respectively.↩ 5. Petitioner, on occasion, sold merchandise at cost to other distributors. Such sales are not included in this schedule.↩ 6. SEC. 722. GENERAL RELIEF -- CONSTRUCTIVE AVERAGE BASE PERIOD NET INCOME. (a) General Rule. -- In any case in which the taxpayer establishes that the tax computed under this subchapter (without the benefit of this section) results in an excessive and discriminatory tax and establishes what would be a fair and just amount representing normal earnings to be used as a constructive average base period net income for the purposes of an excess profits tax based upon a comparison of normal earnings and earnings during an excess profits tax period, the tax shall be determined by using such constructive average base period net income in lieu of the average base period net income otherwise determined under this subchapter. In determining such constructive average base period net income, no regard shall be had to events or conditions affecting the taxpayer, the industry of which it is a member, or taxpayers generally occurring or existing after December 31, 1939, except that in the case described in the last sentence of section 722 (b) (4) and in section 722 (c), regard shall be had to the change in the character of the business under section 722 (b) (4) or the nature of the taxpayer and the character of its business under section 722 (c) to the extent necessary to establish the normal earnings to be used as the constructive average base period net income. (b) Taxpayers Using Average Earnings Method. -- The tax computed under this subchapter (without the benefit of this section) shall be considered to be excessive and discriminatory in the case of a taxpayer entitled to use the excess profits credit based on income pursuant to section 713, if its average base period net income is an inadequate standard of normal earnings because -- * * * * (4) the taxpayer, either during or immediately prior to the base period, commenced business or changed the character of the business and the average base period net income does not reflect the normal operation for the entire base period of the business. If the business of the taxpayer did not reach, by the end of the base period, the earning level which it would have reached if the taxpayer had commenced business or made the change in the character of the business two years before it did so, it shall be deemed to have commenced the business or made the change at such earlier time. For the purposes of this subparagraph, the term "change in the character of the business" includes a change in the operation or management of the business, a difference in the products or services furnished, a difference in the capacity for production or operation, a difference in the ratio of nonborrowed capital to total capital, and the acquisition before January 1, 1940, of all or part of the assets of a competitor, with the result that the competition of such competitor was eliminated or diminished. Any change in the capacity for production or operation of the business consummated during any taxable year ending after December 31, 1939, as a result of a course of action to which the taxpayer was committed prior to January 1, 1940, or any acquisition before May 31, 1941, from a competitor engaged in the dissemination of information through the public press, of substantially all the assets of such competitor employed in such business with the result that competition between the taxpayer and the competitor existing before January 1, 1940, was eliminated, shall be deemed to be a change on December 31, 1939, in the character of the business, or↩ 7. In petitioner's reply brief it is asserted that it is not relying upon the abandonment of the Schenley line in favor of National's bottled goods as a separate claim for relief. Yet, its proposed reconstruction assumes additional sales of 15,000 cases of National's bottled goods, and the evidence suggests that this factor in some undefined way is related to petitioner's entering into the bulk whiskey field. In the circumstances, we deal with the point here.↩ 8. Other National items, apart from bulk conversions, showed an increase in sales from 19,897 cases to 20,834 cases in the last base period year over the preceding year.↩ 9. Petitioner has founded its claim to relief under (b) (5) as well as (b) (4). However, it has not relied upon any facts or circumstances for its (b) (5) claim that were not also relied upon for its (b) (4) claim. In such circumstances, no additional relief is available under (b) (5). Cf. Roy Campbell, Wise & Wright, Inc., 15 T. C. 894, 901-902; Mitchell & Co., 20 T. C. 110↩.