Yeast Products, Inc. v. Commissioner

Yeast Products, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent Yeast Products, Inc. v. Commissioner Docket No. 28926 United States Tax Court 21 T.C. 308; 1953 U.S. Tax Ct. LEXIS 16; November 30, 1953, Promulgated *16 Decision will be entered under Rule 50. 1. Excess Profits Tax -- Sec. 722 (b) (4) Relief -- Constructive Average Base Period Net Income. -- Petitioner filed timely applications and related claims for refund for the taxable years 1943 and 1944, seeking relief under section 722 (b) (4) by reason of having commenced business during the base period. Held, that petitioner's business commenced in 1938 did not reach, by the end of 1939, the earning level it would have reached had it commenced business 2 years earlier. The amount of petitioner's constructive average base period net income determined and relief granted. 2. Excess Profits Tax Credit Carry-Over. -- Held, the so-called "variable credit rule" is applicable in computing an unused excess profits credit adjustment from the year 1941. Nielson Lithographing Co., 19 T. C. 605, followed. Richard P. Jackson, Esq., Alex Schlaffer, Esq., and William B. Van Buren, Esq., for the petitioner. Maurice S. Bush, Esq., for the respondent. Hill, Judge. HILL *308 This proceeding involves the respondent's disallowance of the petitioner's applications for excess profits tax relief under section 722, Internal Revenue Code, and the related claims for *17 refund of excess profits tax in the amounts of $ 23,690.87 and $ 60,823.73 for the taxable years 1943 and 1944, respectively. The applications for relief, Form 991, for the taxable years 1943 and 1944, were duly filed by petitioner on June 15, 1944, and March 15, 1945, respectively. In his notice of disallowance, respondent also determined deficiencies in excess profits tax for the years 1943 and 1944 in the respective amounts of $ 11,668.64 and $ 4,992.24, the payment of which was deferred under Code section 710 (a) (5). The primary questions presented are, whether petitioner is entitled to excess profits tax relief for the taxable years under Code section 722 and more specifically whether petitioner is entitled, under *309 the push-back rule of section 722 (b) (4), to use a constructive average base period net income and, if so, the amount thereof in determining its excess profits tax credit for the taxable years. In the alternative petitioner claims general relief under section 722 (b) (5). There are also involved for the taxable years the questions of petitioner's unused excess profits credit adjustments for carry-overs and carry-backs. The proceeding was heard before Hugh G. Postles *18 as a commissioner designated for that purpose by the Court. Objections filed by the parties to the report of the commissioner have been carefully considered. A previous opinion in this proceeding was promulgated on September 10, 1953. That opinion was reconsidered in response to a motion of the petitioner herein and such opinion was vacated on October 9, 1953. FINDINGS OF FACT. The petitioner is a New Jersey corporation with principal office and place of business in Paterson, New Jersey. It was incorporated on January 14, 1938, and commenced business in May 1938. The petitioner's returns for the taxable years involved were filed with the collector of internal revenue for the fifth district of New Jersey. The petitioner filed timely applications for relief, Form 991, under Code section 722 and related claims for refund, Form 843, of excess profits tax for the years 1943 and 1944. In its applications for relief, petitioner claims qualifying factors for relief primarily under section 722 (b) (4) by virtue of having commenced business during the base period and also for general relief under section 722 (b) (5). Respondent disallowed the claims for relief and refund and determined that *19 petitioner's excess profits tax credit should be computed on the invested capital basis, amounting to $ 4,896 for each of the taxable years 1943 and 1944. The petitioner was organized by Raymond C. Foster and Francis G. Zick who became president and vice president, respectively, and directors of that company. The petitioner issued for cash 1,000 shares of preferred stock for $ 100 per share and 1,000 shares of common stock for $ 1 per share. Its stockholders, in addition to Foster and Zick, included among others a pharmaceutical company and some of its officers and employees, and certain officers of an eastern brewery company. The purpose of organizing petitioner, more particularly hereinafter stated, was the collection of waste yeast or beer "slurry," from breweries for the purpose of processing therefrom several brewers' yeast products. *310 Brewers' yeast is a particular strain of yeast used to induce alcoholic fermentation in making beer. The yeast, an aggregate of minute unicell organisms, grows and multiplies so long as there is substance to feed on and in the course of the fermenting action the yeast originally put into the brewing vat triples in quantity. After the beer is siphoned *20 from the brewing vat the floor of the vat is covered with a residual, thick, muddy solution called "slurry," consisting principally of brewers' yeast but also containing hop particles and resins and other solids which make the yeast very bitter. During the 1930's most of the breweries in this country considered slurry to be a waste byproduct which was washed down the sewer. However, it was generally known that in several European countries, particularly Germany, slurry had been processed as dried brewers' yeast for human consumption because of its nutritional value. In the early 1930's Anheuser-Busch, Inc., a large midwestern brewery which sold certain grain and other byproducts to animal and poultry feed industries, instigated experimentation with dried slurry for feed purposes. The dried slurry, called feed yeast, was found to be such a potent fortifier in feeds, that a great demand was immediately created. Anheuser-Busch, Inc., had the Buffalo Foundry Company build and install drying machinery designed to dry the wet slurry so as not to leave any live yeast cells and yet not kill the vitamin potency of the product. Prior to 1936 Anheuser-Busch, Inc., was producing from 650 to *21 750 tons of dry feed yeast per annum which was only a fraction of the demand. It still had large quantities of waste slurry but found it uneconomical to install additional drying machinery. Up to and including 1939, Anheuser-Busch, Inc., made a sustained effort to interest other concerns in processing dried feed yeast for sale to it as the principal distributor of that product to the feed industry. During the early 1930's and after the beneficial effect of feed yeast in animal and poultry feed had been established, various laboratories conducted research to analyze brewers' yeast from slurry to identify the vitamins therein, and it was found that brewers' yeast was one of the richest natural sources of vitamin B complex in that it contained all of the then known B vitamins plus several unknown elements. Anheuser-Busch, Inc., and also the Pabst Brewing Company began processing slurry for recovery of the yeast and debittering and drying it for sale to pharmaceutical houses for use in products for human consumption. In 1934 Pabst Brewing Company employed Foster to direct sales of several products it was developing, including brewers' yeast. Foster, a graduate of Massachusetts Institute *22 of Technology, had theretofore had years of experience with the Borden Company in charge of *311 sales of specialty products, including malted milk and dry skim milk, throughout the United States. In 1934, in addition to drying slurry as feed yeast, Pabst had devised methods of recovering the yeast, free of hop particles and other impurities, and debittering it to a point where it was reasonably palatable. At the time Foster was employed Pabst was looking for sales outlets for debittered dried brewers' yeast, principally to pharmaceutical companies because of the growing interest in vitamin B complex. During 1935 and 1936 dried brewers' yeast was used for the production of yeast tablets generally sold throughout the country, but the vitamin potency per tablet was low and a large dosage was necessary. During those years several pharmaceutical companies, including Upjohn Company, were experimenting with processes to extract from debittered dried brewers' yeast a vitamin B complex concentrate as an ingredient in certain pharmaceutical preparations. By 1937 Pabst was making debittered brewers' yeast at both of its breweries at Milwaukee and Peoria and its entire production was being sold *23 to Upjohn for extraction of vitamin B complex concentrate. In 1936, due to lack of sufficient production facilities, Pabst refused an offer from certain Japanese interests to purchase annually about $ 85,000 worth of dried brewers' yeast. Foster discussed the problem with the Japanese who were concerned with the possibility of not getting a sufficient supply of dried brewers' yeast from Germany. In his work with Pabst, Foster became acquainted with employees in and the use of yeast by various pharmaceutical companies and, also, he became quite aware of the widespread and growing demand for dried brewers' yeast. In 1933 Upjohn Company employed Zick in its research department. Zick, a biological chemist, had several prior years' experience in laboratory and experimental work along various lines, including dried foods and irradiated substances. He was also experienced in making biological assays, that is, using rats or other animals in testing various substances. His first work for Upjohn was solving a problem of drying a syrupy maltose baby food, to meet competition and improve sales. In 1934 Upjohn had developed and was using in certain preparations a water extract concentrate from *24 yeast, but it had not proved wholly satisfactory in stability or potency. In addition Upjohn had on the market a capsule known as "A B D G Compound," in which the yeast concentrate component was bought from Anheuser-Busch, but the compound leaked through the capsule. At about that time Upjohn and other pharmaceutical companies were making considerable progress in isolating and synthetizing certain vitamins, but Upjohn needed a good concentrate of vitamin B complex from natural sources to meet certain requirements. *312 Sometime in or about 1934 Upjohn placed Zick in charge of experimenting with the extraction of vitamin B complex concentrate. In the course of his study and testing of known data Zick found that a rice polish vitamin B complex on the market did not contain all of the B vitamins and was known to form a gas which exployed sealed containers; that certain clay absorbate vitamins on the market were wholly unsatisfactory because of the clay element; and that the water extract from yeast was not satisfactory because some B vitamins were not soluble in water and thus would not filter, also, it was unstable and when purified lost potency. Using Pabst's debittered dried brewers' *25 yeast, Zick ran a full B complex assay to determine its vitamin content and then tackled the problem of extracting a B complex concentrate from debittered dried brewers' yeast. Zick did considerable pioneer research work to develop the optimum point of solubility and filtration of all the then known vitamins in yeast, together with stability and maximum potency of the extraction. In 1936 Zick perfected a laboratory method of producing the desired B complex concentrate which showed good results, first in biological assays and then in certain hospital tests on humans. Thereupon Upjohn determined to go into the production of a vitamin B complex concentrate extracted from debittered dried brewers' yeast. Zick helped to design the necessary machinery ordered by Upjohn from the Buffalo Foundry Company, supervised the installation, and was in charge of the operation until it was running smoothly. Thereafter he went back to research and experimented with capsulating vitamin products. During the period 1936 to 1937 Upjohn sold vitamin B complex concentrate tablets and the demand was so great that Upjohn, through Foster, purchased all of Pabst's production of debittered dried brewers' yeast. *26 In 1937 Upjohn sent Zick to various parts of this country and Canada to try to obtain additional sources of supply of debittered dried brewers' yeast, but the breweries he visited were not interested in saving slurry and producing debittered yeast. In the latter part of 1937 and in view of the growing demand for dried brewers' yeast and B complex concentrates for human consumption, Foster became interested in starting a business to produce those products from slurry. He was also interested in producing feed yeast. His survey of the field indicated that the vicinity of New York constituted the best location. It was close to a supply of raw material because many breweries in that area were throwing away their slurry. In addition numerous pharmaceutical companies were located east of the Mississippi. Foster made arrangements to buy slurry from Ruppert Brewery and Ballantine Brewery. He then interested Zick in the enterprise as the technical man to manage production. Zick found a suitable plant site in Passaic, New Jersey, in an abandoned *313 paper mill which had sufficient floor space and was located near an ample supply of steam. The latter was vitally necessary in the production methods *27 to be used. The petitioner was organized in January 1938 primarily for the purpose of producing, from slurry, both debittered and non-debittered dried brewers' yeast and, both dry and liquid vitamin B complex concentrates, for sale to pharmaceutical companies. There was a then existing demand and a large potential market for such products. Petitioner's secondary purpose was to produce feed yeast (dried slurry) as a means of using up any excess supply of slurry and of keeping the employees busy when otherwise they might be idle. The demand for feed yeast greatly exceeded the then existing supply but the anticipated margin of profit thereon was small. Zick designed and ordered the necessary equipment from the Buffalo Foundry Company. He laid out and supervised the plant installations primarily for the production of debittered yeast and concentrates, those being the products with which he was most familiar. Based on his experience at Upjohn, Zick designed the plant equipment for an estimated production capacity per annum of approximately 1,400,000 pounds of debittered yeast with equipment located in one room and 110,000 pounds of dry concentrate with separate equipment in another room. *28 The debittered yeast required additional processing as compared with non-debittered yeast. The dry concentrate required a drying process applied to liquid concentrate. Zick's experience at Upjohn was that in extracting B complex vitamins from yeast, the yield in pounds of dry concentrate amounted to approximately 15 per cent of the quantity in pounds of dried brewers' yeast used as the basic ingredient. The estimated production capacity was on a basis of three 8-hour shifts a day for a 6-day week throughout the year. The production methods were such as to require 24-hours-a-day operations and each shutdown necessitated a thorough cleaning of the equipment. In planning the petitioner's plant capacity Zick and Foster took into consideration their knowledge that Upjohn was then paying Pabst 23 cents a pound for debittered yeast used as the raw material for making concentrates, and was charging itself $ 2.03 a pound for its concentrates over and above costs and various interdepartmental expenses, including assays. Throughout the periods involved Zick was in charge of production, assay, and experimentation work and Foster was the general manager and in charge of sales. The petitioner's *29 plant was sufficiently equipped to commence operation in May 1938 and with the purchase of centrifuges, mixers, and additional tanks in June 1938 the plant was fully equipped for all purposes for which it was designed. At all times material here the petitioner's machinery and equipment remained essentially the same except *314 that in August 1939 it purchased an additional filter press used in making concentrates. The petitioner had tank trucks for hauling slurry from the breweries and slurry-holding tanks for storage prior to processing. The plant had a drying and centrifuge room wherein debittered and non-debittered yeast (including feed yeast) were produced. The equipment in that room included, inter alia, one atmospheric dryer, a pulverizer, a vibrating screen, centrifuges, mixers, wooden and copper tanks, and various pumps. The atmospheric dryer was used for all products made in the drying and centrifuge room and thus was a controlling factor in the total production capacity of that room. The plant had a separate concentrating room for the production of liquid and dry concentrates and the equipment in that room included, inter alia, one 1,000-gallon copper cooker and condenser, *30 filter presses, one 200-gallon-an-hour vacuum pan and condenser with vacuum and centrifuge pumps and condensate tank, one alcohol recovery column with pumps and tanks, one agitator, a reciprocating vacuum pump, several closed copper tanks, and one single drum vacuum dryer and condenser. All the equipment in the concentrating room was used in producing both liquid and dry concentrate. The use of the single drum vacuum dryer was the most prolonged operation, the waiting period for complete dehydration in making dry concentrates, and thus that piece of equipment was a controlling factor in the total production capacity of the concentrate room. The petitioner's methods of production of its various yeast products were, briefly, as follows: Feed yeast was simply dried slurry. From the holding tank slurry was pumped directly to the preheater and then to the atmospheric dryer which evaporated the liquid. The end product was a flaky substance consisting of brewers' yeast and hop particles, bitter resins and beer solids. The dried slurry, called feed yeast, was packed in bags for shipment. It was the only product made for use in animal and poultry feeds. All of petitioner's other yeast products *31 were for human consumption. Non-debittered yeast was processed from slurry. The slurry from the holding tank was screened to remove hop particles, beer solids, etc. and then pumped to the preheater and atmospheric dryer. The end product was a very bitter dried brewers' yeast, either in flaky or pulverized form, which was packed for shipment. Washed or ironized yeast was processed from slurry. The slurry, from the holding tank, was screened to remove hop particles, beer solids, etc. and then washed so as to recover as nearly as possible a 100 per cent pure yeast solution which was then pumped to the preheater and the atmospheric dryer. The process removed only a little of the bitter taste. The end product was a non-debittered dried *315 brewers' yeast, either in flaky or pulverized form, which was packed for shipment. That product was also used by petitioner for processing a non-debittered concentrate. Debittered yeast was processed from slurry. The slurry, from the holding tank, was screened to remove hop particles, beer solids, etc. The yeast liquid was then pumped to a mixing tank where a certain alkaline was added and then pumped to a centrifuge which separated liquids from yeast solids. *32 That mixing and centrifuging process was repeated until the bitter taste was thoroughly removed. The debittered yeast liquid was pumped to storage tanks and then to the preheater and the atmospheric dryer. The end product was debittered dried brewers' yeast, either in flaky or pulverized form, which was packed for shipment. That product was also used by petitioner for processing debittered concentrates. Yeast concentrate was processed from dried brewers' yeast (either debittered or non-debittered) derived from slurry in petitioner's own plant, or, from dried primary brewers' yeast purchased from suppliers of that product. The primary yeast, which was cultured or grown, was free of any bitterness. The production unit was called a "C" batch, denoting the concentrate produced from a certain quantity of yeast used as the basic ingredient. Measured quantities of yeast and water were placed in a cooker and after cooking at a specified temperature the yeast was cooled in a storage tank. An alcohol solvent was then added and after standing for a period of time the yeast and alcohol solution was put through a filter press. The resulting filtrate, containing the extracted vitamins, went *33 into a holding tank. The filtrate was pumped into a heated vacuum pan causing evaporation of a portion of the alcohol solvent and producing a liquid concentrate. The evaporated solvent passed off to a distillate receiver for recovery of the alcohol. Depending upon a customer's specifications, the liquid concentrate was put through the vacuum dryer for additional evaporation and concentration in liquid form and/or was mixed as a syrup before packaging for shipment. To produce a dry concentrate the liquid concentrate from the vacuum pan was completely dehydrated in the vacuum dryer and the resulting flaky or powdered concentrate was packaged for shipment. Under actual operating conditions during the last quarter of 1939, the maximum production capacity of petitioner's plant was dependent upon factors involving the quantities of various products produced. The approximate maximum capacity of the drying and centrifuge room was controlled by the capacity of the atmospheric dryer which was either 1,440,000 pounds of non-debittered yeast (including feed yeast) or 1,350,000 pounds of debittered yeast. Accordingly, the use of the dryer had to be allocated between the production of non-bittered *34 and debittered yeast products. The approximate maximum capacity *316 of the concentrate room was either 110,500 pounds of dry concentrate or 37,500 gallons of liquid concentrate and the use of the equipment in that room had to be allocated between the production of liquid and dry products. At all times herein material the petitioner purchased slurry from breweries under agreements requiring it to take all the slurry contracted for, whether or not used in petitioner's production. The price paid by petitioner for slurry was on the basis of a unit price of 2.8 cents per pound of yeast solids contained therein. During 1938 Zick found that the Ruppert Brewery slurry could not be successfully debittered and an additional supply of slurry was obtained from other brewers. At all times material here petitioner had an ample supply of slurry to meet its needs and overall production capacity. Slurry obtained from Ballantine Brewery and Schaffer Brewery debittered satisfactorily, except that the different batches would not always debitter to a uniform degree. That factor was immaterial in the production of some concentrates, but presented a problem where thoroughly debittered dry concentrates were *35 ordered by customers. Some time during 1939 petitioner started making concentrates with primary brewers' yeast as the basic ingredient because it contained no bitters and resulted in a uniform product, which contained the same vitamin B complex as concentrates produced from brewers' yeast recovered from slurry. Furthermore, there was a loss of 25 per cent of the yeast content of slurry in the centrifuging process of thoroughly debittering yeast for use in concentrates, while there was no such loss in the use of primary yeast. From May to the end of 1938 and during most of 1939, petitioner was actually going through a stage of development of both its products and markets. Foster called on various pharmaceutical concerns which were very much interested in petitioner's yeast products, as a needed additional source of supply, or as a new product, or as a better substitute for a vitamin product then in use, such as rice polish. However, each concern made its own assay for potency, stability, etc. of petitioner's samples. Then each concern made its own specifications, particularly as to concentrates, depending on its ultimate use of the product in pharmaceutical preparations. That resulted *36 in time-consuming operations by petitioner in experimentation and assay work to produce acceptable tailormade sample products, because a complete assay, using rats, required a period of 6 to 8 weeks. In numerous instances there was a lapse of several months between the time Foster first approached a pharmaceutical company and the receipt of an order for a specialized yeast product. In the meantime rejected products represented a considerable waste in materials and costs. During 1938 Zick found that at the start of a "C" batch of concentrate he could not put more than 300 pounds of yeast in the cooker because of excessive *317 foaming and thus the end product of about 15 per cent of the basic ingredient was limited to about 45 pounds of dry concentrate. Prior to the end of 1939, through the use of de-foamers and other controls, Zick could start a "C" batch with 400 pounds of yeast in the cooker and produce therefrom about 60 pounds of dry concentrate. That speeded up production. Also, prior to the end of 1939 Zick developed a new chemical assay method for determining the vitamin content and potency of his concentrates within 5 or 6 hours, which saved waste and greatly speeded production *37 of samples according to specifications of customers and prospective customers. Furthermore, under the Federal Food and Drug Act, petitioner was required to accurately label the contents of its products for human consumption. The petitioner had a net operating loss of $ 21,356.23 for 1938 and of $ 44,539.81 for 1939. The petitioner's balance sheets at the end of those years were as follows: ASSETS [1939] Cash $ 9,748.04 $ 1,511.43 Accounts receivable 879.10 1,523.15 Inventories 22,314.47 16,839.36 Depreciable assets 51,806.38 57,978.16 Less reserve for depreciation (2,313.84) (9,145.06) Other assets: Organization expenses 523.26 523.26 Prepaid expenses 1,602.97 671.84 Security deposit 50.00 50.00 Total assets $ 84,610.38 $ 69,952.14 LIABILITIES Accounts payable $ 888.40 $ 13,342.24 Notes payable 3,248.68 300.00 Accrued expenses 350.53 526.94 Capital stock: Preferred stock 100,000.00 120,000.00 Common stock 1,000.00 1,200.00 Surplus (deficit) (20,877.23) (65,417.04) Total liabilities $ 84,610.38 $ 69,952.14 The petitioner's total net sales during each month of 1938 and 1939 were as follows: [1939] January $ 1,099.80 February 1,319.12 March 7,895.60 April 4,066.75 May 7,001.00 June $ 246.00 8,620.41 July 561.00 5,868.00 August $ 5,492.35 September $ 88.80 6,447.25 October 182.68 3,541.25 November 418.80 8,135.37 December 186.00 6,799.00 Totals $ 1,683.28 $ 66,225.90 *318 *38 During 1938 and 1939 petitioner's principal customers and its sales, in quantity and dollar amount as to each product, were as follows: [1939] Customer Quantity Dollar amount Quantity Dollar amount Feed Yeast Anheuser-Busch, Inc., St. 260,000 lbs. $ 19,200.00 Louis, Mo. Non-Debittered Yeast Ironized Yeast 1,350 lbs. $ 186.00 180,000 lbs. $ 18,955.00 Laboratories, Atlanta, Ga. Sundry customers 150 lbs. 30.88 4,655 lbs. 523.35 1,500 lbs. $ 216.88 184,655 lbs. $ 19,478.35 Washed or Ironized Yeast (non-debittered) Chocolate Products, Chicago, Ill. 10,475 lbs. $ 1,245.00 Ironized Yeast 500 lbs. 70.00 Laboratories, Atlanta, Ga. Sundry customers 300 lbs. 36.00 11,275 lbs. $ 1,351.00 Debittered Yeast Bakon Yeast, Inc., New 1,005 lbs. $ 200.00 York, N. Y. Purity Drug Co., Passaic, 1,125 lbs. $ 315.00 4,050 lbs. 1,149.75 N. J. Upjohn Co., Kalamazoo, 2,900 lbs. 713.40 50,850 lbs. 11,700.30 Mich. Sundry customers 375 lbs. 123.00 4,018 lbs. 1,098.88 4,400 lbs. $ 1,151.40 59,923 lbs. $ 14,148.93 Non-Debittered Yeast Concentrate Gelatin Products Co., Detroit, Mich. 150 lbs. $ 377.00 1,500 lbs. $ 2,000.00 Debittered Yeast Concentrate (#380) Burroughs Wellcome Co., Tuckahoe, N. Y. 2,526 lbs. $ 10,104.00 Sundry customers 25 lbs. 103.00 2,551 lbs. $ 10,207.00 Liquid Concentrate (S-100 Syrup) Sharp & Dohme, Inc., Philadelphia, Pa 3 1/2 gals. $ 70.00 Sundry customers 1/4 gal. 6.25 3 3/4 gals. $ 76.25 Liquid Concentrate (S-50 Syrup) Purity Drug Co., Passaic, N. J. 98 1/2 gals. $ 723.75 Miscellaneous Products Sundry customers $ 61.00 Gross sales of all products $ 1,745.28 $ 67,246.28 Less returns and allowances 62.00 1,020.38 Net sales $ 1,683.28 $ 66,225.90 *39 *319 The petitioner's sales prices were fixed on a basis of the existing market prices and a consideration of the amount of processing involved in each product. The liquid concentrates involved specified formulas and varying degrees of concentration. The petitioner's prices on its products varied to some extent during 1938 and 1939, but its basic prices on certain products to principal customers in 1939 were approximately as follows: Feed yeast 7 1/2 cents per pound Non-debittered yeast 10 1/2 cents per pound Debittered yeast 23 cents per pound Debittered dry concentrate $ 4 per pound Liquid concentrates $ 6 and $ 20 per gallon During 1939, the first full year of operations, the petitioner's costs of materials used were approximately 2.8 cents per pound for non-debittered yeast including feed yeast; 4 cents per pound for debittered yeast; $ 2.05 per pound for dry concentrates; and $ 4.50 per gallon for liquid concentrates. During that year the petitioner's gross sales, material costs, factory costs, deductions, and net loss, in round figures, were as follows: *320 Gross sales $ 66,226 Material costs 1*40 $ 43,215 Factory costs: Trucking $ 5,251 Labor 11,537 Power 2,054 Water 1,046 Steam 6,293 Insurance [325] Assay cost 2,064 Miscellaneous 1,470 Supplies 2,445 Total factory costs 2 32,485 Total cost of sales 75,700 Gross profit or (loss) ($ 9,474) Deductions: Compensation of officers $ 18,333 Office salaries [720] Rent 2,490 Repairs 2,015 Bad debts Taxes 1,535 Depreciation 6,831 Other deductions 3 2,940 Total deductions 34,864 Net income or (loss) ($ 44,338) In December 1939 Anheuser-Busch, Inc., offered to contract with petitioner to purchase 80 tons of feed yeast per month at the prevailing price of 7 1/2 cents per pound. In the same month petitioner agreed to supply as much feed yeast as it was able to produce but not in excess of 60 tons (120,000 pounds) per month which, on an annual basis, would equal the maximum drying capacity of its atmospheric dryer. At the end of 1939 petitioner had a market for all of the feed yeast it desired to produce and it had arrangements with seven brewers for an ample supply of slurry. However, petitioner's production of feed yeast was necessarily limited by the quantity of other non-debittered yeast and also debittered yeast produced. Prior to 1938 the Ironized Yeast Laboratories of Atlanta, Georgia, imported from England *41 non-debittered dried brewers' yeast used in processing an ironized yeast tablet which was coated so that the *321 bitterness of the yeast was immaterial. Those tablets had been on the market for several years. Petitioner contacted that company in 1938 and made deliveries of sample products. The Ironized Yeast Laboratories entered into a contract for a period of 12 months beginning May 1, 1939, for the purchase from petitioner of 200,000 to 400,000 pounds of non-debittered yeast at a price of 10 1/2 cents per pound. If the petitioner had started business 2 years before it actually did so, then the reasonable estimate of the amount of Ironized Yeast Laboratories' purchases of non-debittered yeast from petitioner would be 300,000 pounds during the year 1939. Prior to 1938 Upjohn Company of Kalamazoo, Michigan, had a large demand for a vitamin B complex concentrate tablet which it had on the market. The dry concentrate used in those tablets was extracted by Upjohn from debittered dried brewers' yeast, derived from slurry. Upjohn purchased Pabst Brewing Company's entire output of debittered yeast. During 1938 and 1939 Upjohn did not have a sufficient supply of debittered yeast to meet its *42 growing requirements for extracted concentrates and, after a testing period, began making purchases of debittered yeast from petitioner at a price of 23 cents per pound. If the petitioner had started business 2 years before it actually did so, then the reasonable estimate of the amount of Upjohn's purchases of debittered dried brewers' yeast from petitioner would be 130,000 pounds during the year 1939. In addition to producing non-debittered and debittered dried brewers' yeast for sale to customers, the petitioner also produced those products during 1938 and part of 1939 for use as the basic ingredient for its extraction of liquid and dry vitamin B complex concentrates. Prior to the end of 1939 petitioner was using primary yeast as the basic ingredient for most of its concentrates because that eliminated the process of thoroughly debittering yeast derived from slurry and resulted in more uniform batches of concentrates. During the period from 1932 to 1938 the Burroughs Wellcome Company of Tuckahoe, New York, was developing and producing certain yeast extracts for use in products for retail trade. During those years it purchased yeast spore (that is primary yeast) from Anheuser-Busch, *43 Inc. In 1938 Burroughs Wellcome was producing a dry yeast concentrate and marketing a compressed yeast tablet under the name of "Tabloid Yeast Concentrate" which was nationally advertised as a vitamin B complex product and for which there was a large demand. In 1938 the petitioner supplied Burroughs Wellcome with samples, as per specifications, of petitioner's dry vitamin B complex concentrate (#380) and Burroughs Wellcome, after testing, concluded it was the best product of its kind then available. Sometime in 1939 Burroughs Wellcome discontinued its own production *322 of dry yeast concentrate and began purchasing the petitioner's dry concentrate (#380) at $ 4 per pound for use in compressed tablets. If the petitioner had started business 2 years before it actually did so, then the reasonable estimate of the amount of Burroughs Wellcome's purchases of dry vitamin B complex concentrate (#380) from petitioner would be 15,000 pounds during the year 1939. During 1938 Sharp & Dohme, Inc., of Philadelphia, Pennsylvania, placed on the retail market a liquid B complex phosphate which contained a B complex extract made from rice polish. Under certain conditions the rice polish extract tended *44 to form a gas which exploded the containers. During 1939 Sharp & Dohme purchased, at $ 20 per gallon, small quantities of petitioner's liquid concentrate (S-100) and experimented therewith along with samples of concentrates of two other companies, for the purpose of finding a substitute for the rice polish extract. Toward the end of 1939 Sharp & Dohme definitely decided that petitioner's liquid concentrate (S-100) would be used as an ingredient for the vitamin content of its phosphate product, but a contract with petitioner had not been entered into at the end of the year 1939. Sharp & Dohme's 1939 volume of sales of its B complex phosphate would have required the purchase of 1,137 1/2 gallons of petitioner's product if it had been used as an ingredient during that year. If the petitioner had started business 2 years before it actually did so, then the reasonable estimate of the amount of Sharp & Dohme's purchases of liquid concentrate (S-100) from petitioner, at a price of $ 20 per gallon, would be at least 1,500 gallons during the year 1939. In 1939 the United Drug Company of Boston, Massachusetts, had several thousand agencies throughout the country for the retail sale of its *45 many pharmaceutical products, under the name of Rexall Drugs. During 1939 United experimented with samples of petitioner's liquid concentrate (S-50) for use as a vitamin ingredient for mixture in liquid tonics, etc. which United had produced and sold for several years. After assays and numerous tests in certain mixtures United determined, in December 1939, to use the petitioner's liquid concentrate in a new product to be offered to the public. In a letter to petitioner, dated December 15, 1939, United stated that an ultraconservative estimate of its initial requirement would be 500 gallons of petitioner's liquid concentrate and that it could not go far wrong on an estimate of using 1,000 gallons a year. The letter further stated that after the product was established on the retail market there was a possibility of using 5,000 gallons a year. If the petitioner had started business 2 years before it actually did so, then the reasonable estimate of the amount of United Drug's purchases of liquid *323 concentrate (S-50) from petitioner, at a price of $ 6 per gallon, would be at least 1,000 gallons during the year 1939. During 1939 the International Vitamin Corporation of New York City, *46 New York, negotiated with petitioner to experiment with and produce a particular liquid vitamin B complex concentrate to be sold under the trade name "Blexin" to meet a greatly expanding demand for such a product by certain pharmaceutical companies. Before the end of 1939 the petitioner had developed the desired liquid concentrate and International had printed labels and was making arrangements for the sale of Blexin. The petitioner's liquid concentrate, Blexin, was superior in vitamin content and stability to a slightly similar rice polish B complex extract then produced by a California company which sold its product to one pharmaceutical company at the rate of about 3,000 gallons per month during 1938. If the petitioner had started business 2 years before it actually did so, then the reasonable estimate of the amount of International's purchases of liquid concentrate (Blexin) from petitioner, at a price of $ 6 per gallon, would be 12,000 gallons during the year 1939. During the year 1939 the petitioner's atmospheric dryer in its drying and centrifuge room had an annual production capacity of either 1,440,000 pounds of non-debittered yeast or 1,350,000 pounds of debittered yeast *47 made from slurry. After allocating the use of the dryer to the production of the above estimated purchases of 300,000 pounds of non-debittered and 130,000 pounds of debittered yeast for human consumption, the petitioner had a production capacity of approximately 1 million pounds of feed yeast for animals and poultry. During the year 1939 the petitioner's concentrate room had an annual production capacity of either 110,500 pounds of dry concentrate or 37,500 gallons of liquid concentrate made from primary yeast as the basic ingredient. That capacity, allocated between the production of liquid and dry concentrates, was in excess of the above mentioned total estimated purchases of 14,500 gallons of liquid and 15,000 pounds of dry concentrates. During the year 1939, the petitioner had the plant capacity to produce the estimated purchases of products at certain prices by principal customers, as follows: Product Unit price Quantity Sales price Drying and centrifuge room: Feed yeast $ 0.075 1,000,000 lbs $ 75,000 Non-debittered yeast 0.105 300,000 lbs 31,500 Debittered yeast 0.23 130,000 lbs 29,900 Concentrate room: Dry concentrate (#380) 4.00 15,000 lbs 60,000 Liquid concentrate (S-100) 20.00 1,500 gals 30,000 Liquid concentrate (S-50) 6.00 1,000 gals 6,000 Liquid concentrate (Blexin) 6.00 12,000 gals 72,000 Total gross sales $ 304,400 *48 *324 Based on the 1939 costs of materials used in the petitioner's products during 1939, the costs of materials (on a quantum basis) for the estimated amount of products mentioned in the next preceding paragraph, would have totaled approximately $ 137,600. The petitioner's actual factory costs and deductions for 1939, projected to cover the increased production for gross sales amounting to approximately $ 300,000, would have amounted to approximately a total of $ 68,410 for factory costs and a total of $ 48,212 for deductions. Based on the foregoing estimated gross sales, costs, and deductions, if petitioner had started business 2 years before it actually did so, the petitioner would have realized for the year 1939, the following: Gross sales $ 304,400 Materials costs $ 137,600 Factory costs 68,410 206,010 Gross profit $ 98,390 Deductions 48,212 Net profit $ 50,178 Per cent net profit 16.4 In the petitioner's line of business there was no material change in the costs of materials, labor, steam, etc. or in sales prices of comparable products during the base period years. If petitioner had started business 2 years before it actually did so, it would have attained during the base period years its proportionate *49 share of the then existing market for vitamin products. During the years 1936 to 1939 there was a rapid growth in the demand for and the production and sale of vitamin products, including, inter alia, certain isolated and synthetized B vitamins and the B complex vitamins from natural sources. The synthetic vitamins then produced did not cover the whole range of the then known B vitamins contained in brewers' yeast and while the separate synthetic vitamins could be combined and used by pharmaceutical companies in certain preparations, they were not in direct competition with natural B complex vitamins used in other preparations. The B complex from yeast contained all the then known vitamins plus unknown vitamins and being derived from a natural source, it constituted the preferable vitamin element in certain preparations. With respect to its various products the petitioner encountered little direct competition. Instead, during 1938 and 1939, petitioner had the problem of establishing with the prospective customers the purity, potency, stability, etc. of its products for human consumption, after which certain markets were more or less assured. The market for feed yeast was greatly *50 in excess of the total supply of all producers of that product. The petitioner's market with the Ironized Yeast Laboratories for non-debittered yeast had no domestic competition. The *325 petitioner's market with the Upjohn Company for debittered yeast filled that company's demand for the product in addition to the supply by two other producers. The petitioner's markets for concentrates were based principally on tailormade products to fill special needs of the customers or prospective customers and in certain respects were new products in the vitamin field. The liquid B complex extract from rice polish which had been on the market since prior to 1936 and was used in substantial quantities during 1938 and 1939, was not in direct competition with petitioner's specialized liquid concentrates because the rice polish extract did not contain all of the B vitamins found in yeast and was not as potent or stable as petitioner's products. Competition was not actually a material limitation upon the growth of petitioner's business and would not have been a limiting factor if petitioner had started business 2 years before it actually did so. According to the Biennial Census of Manufacturers published *51 by the Department of Commerce, in editions for the years as indicated, the sales of all types of vitamin products at the selling price at the factory (generally referred to as wholesale prices) and including vitamin products and special formulas sold to or prescribed by physicians and vitamin products packaged for sale to the general public, were as follows: [1925] $ 342,554 [1927] 1,443,211 [1929] 4,483,769 [1931] 6,039,507 [1935] $ 16,111,802 [1937] 27,098,510 [1939] 41,862,480 Statistical data published by the Department of Commerce discloses for the years indicated, the amounts in billions of dollars of "Disposable Personal Income" (which is income remaining to persons after deduction of personal tax and non-tax payments to general government) before any breakdown as to data on personal savings, personal consumption expenditures, etc.; and also similarly published but separate data discloses "Retail Drug Store Sales," as follows: (The separate data is combined in one schedule only for convenience.) Disposable personal Retail drugstore income in sales in Year billions billions [1929] $ 82.5 $ 1.690 [1930] 73.7 1.554 [1931] 63.0 1.438 [1932] 48.8 1.182 [1933] 45.2 1.066 [1934] 51.6 1.156 [1935] 58.0 1.233 [1936] 66.1 1.344 [1937] 71.1 1.527 [1938] 65.5 1.474 [1939] 70.2 1.563 *52 *326 As compiled by the Bureau of Internal Revenue and reported in its publication "Statistics of Income for 1940," the composite amount of gross sales and also of net profit less tax-exempt income plus interest paid, for the years indicated, in millions of dollars for all United States corporations filing Federal income tax returns, was as follows: Gross sales Net profit Year in millions in millions [1936] $ 100,586 $ 7,451 [1937] 108,383 7,410 [1938] 91,195 4,479 [1939] 101,576 7,306 The petitioner's average base period net income is an inadequate standard of normal earnings because the petitioner commenced business during the base period and its business did not reach, by the end of the base period, the earning level which it would have reached if it had commenced business 2 years before it did so. The excess profits tax of petitioner computed under chapter 2, subchapter E, of the Code, without the benefit of section 722, is excessive and discriminatory. The sum of $ 36,760 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 comparison of normal earnings and earnings during the excess *53 profits tax years 1943 and 1944 involved in this proceeding. The petitioner, pursuant to the provisions of section 710 (a) (5) of the Code, deferred payment of excess profits taxes for the years 1943 and 1944 in the respective amounts of $ 11,668.64 and $ 4,992.24. The petitioner's applications for relief under section 722 of the Code included claims for unused excess profits credit carry-overs, based on a constructive average base period net income, from the taxable years 1941 and 1942 to the taxable year 1943; and from the taxable years 1942 and 1943 to the taxable year 1944. These applications also included claims for unused excess profits credit carry-backs, based upon a constructive average base period net income, from the taxable years 1944 and 1945 to the taxable year 1943; and from the taxable years 1945 and 1946 to the taxable year 1944. At the end of 1939 the business of the petitioner, after application of the 2-year push-back rule, was still in a state of continued development and growth and had not reached a normal level of production, sales, and earnings during 1940 and 1941. In determining the unused excess profits credit carry-over from the year 1941, the sum of $ 29,000 *54 fairly represents the constructive average base period net income for the year 1941. *327 OPINION. In this proceeding petitioner seeks relief from excess profits taxes for the years 1943 and 1944, under the provisions of the Internal Revenue Code, section 722 (a) and section 722 (b) (4)1*55 and in the alternative under section 722 (b) (5). There is no question herein but that under section 712 the petitioner is entitled to have its excess profits credit *56 computed either under section 713 based on income or under section 714 based on invested capital, whichever amount results in the lesser tax under chapter 2, subchapter E, of the Code. Here the petitioner had no net income during its base period years 1938 and 1939 and respondent computed and allowed, for the taxable years involved, an excess profits credit based on petitioner's invested capital. There is no issue as to the amount so determined. The claimed relief may be granted only if petitioner meets the qualifying factors prescribed under the general rule provided in section 722 (a), namely, if it establishes (1) that the tax (computed without the benefit of section 722) is excessive and discriminatory, and (2) what would be a fair and just amount representing normal earnings to be used as a constructive average base period net income; provided such amount gives rise to an excess profits credit which is greater than the credit otherwise available to petitioner. Under section 722 (b) (4) the petitioner's tax (computed without the benefit of section 722) "shall be considered to be excessive and discriminatory" if petitioner establishes the further qualifying factors that its average *57 base period net income is an inadequate standard of *328 normal earnings because it commenced business during the base period and its average base period net income does not reflect the normal operation for the entire base period of the business. The petitioner did commence business in May 1938 which was during the base period. The facts of record and the testimony of witnesses establish to our satisfaction that petitioner's operating losses, or zero average base period net income, do not reflect the normal operation for the entire base period of the business. This conclusion is supported by factual circumstances peculiar to petitioner's getting into production. At the time petitioner commenced business there was a demand for the basic yeast products it proposed to process for sale to pharmaceutical companies. However, it immediately became necessary to make certain modifications of its products, particularly the concentrates, according to each prospective customer's specifications, with the result that the entire 8 months of 1938 and most of 1939 were devoted to experimentation and development with attendant losses in materials and labor costs and in production for sale. Before the *58 end of 1939 petitioner's efforts began to bear fruit, that is, actual orders and substantial prospective orders. On the record, it is clear that petitioner's business did not reach, by the end of 1939, the earning level which it would have reached if petitioner had commenced business 2 years before it did so. We conclude and have found as an ultimate fact that petitioner's average base period net income is an inadequate standard of normal earnings. The petitioner has satisfied the requirements of section 722 (b) (4). Victory Glass, Inc., 17 T. C. 381. We have further concluded and found as an ultimate fact that the petitioner's excess profits tax for the years involved, computed without the benefit of section 722, is excessive and discriminatory. This is based upon the petitioner's having met the requirements of section 722 (b) (4) and our finding that the sum of $ 36,760 would be a fair and just amount, representing normal earnings to be used as a constructive average base period net income, which amount would give rise to an excess profits credit greater than the credit computed and allowed on the basis of petitioner's invested capital. At the trial of this proceeding and with *59 respect to the amount of the constructive earnings, the petitioner took the position that if it had commenced business 2 years before it did so, its 1939 level of business would have resulted in gross sales and a net profit in excess of the amounts found in our findings of fact; that its constructive earnings would have been approximately the same amount for each of the years 1939, 1938, 1937, and 1936; and that petitioner is entitled to a constructive average base period net income in excess of the amount found in our findings of fact. The respondent contends that petitioner *329 has failed to prove the claimed amount of constructive earnings or any other amount. The petitioner's proposed reconstruction can not be accepted in toto for the reason that it is not fully supported by the facts and the credible testimony of witnesses. The petitioner's proposed gross sales for 1939 are excessive because some of the assumed sales included therein by certain witnesses are not based on reasonable estimates bearing a demonstrable relation to the existing and/or probable market for petitioner's products in that year. To the extent that the opinions of certain witnesses were not based upon the facts *60 of record or were given without revealing basic evidential material, they lack a proper foundation, Avey Drilling Machine Co., 16 T. C. 1281, 1299, and have been disregarded. However, we are satisfied that the record herein does establish a proper basis for reconstruction and upon our own appraisal of the facts and testimony herein we have proceeded to find the sum which, in our judgment, would be a fair and just amount representing normal earnings to be used as a constructive average base period net income. In this connection we have proceeded on the premise that in the application of section 722 (b) (4) the "purpose of the 2-year push-back rule is to establish a figure which is assumed to be the maximum amount which would have been earned by the taxpayer in its last base period year, if it had commenced business 2 years before it did" and that the "assumed figure is then used as a point of departure in reconstructing the taxpayer's average base period net income (using appropriate indices * * *) in order to determine his excess profits credit." Del Mar Turf Club, 16 T. C. 749, 766. Also see Suburban Transportation System, 14 T. C. 823, 829. Further, it is recognized that section 722*61 of the Code does not prescribe an exact criteria for a reconstruction, see Danco Co., 14 T. C. 276, 288, but instead "it calls for a prediction and an estimate of what earnings would have been under assumed circumstances, an approximation where an absolute is not available and not expected," Victory Glass, Inc., supra, at page 388. The Findings of Fact fully set forth the various factors establishing the assumed maximum amount of net profit of $ 50,178 which would have been earned by petitioner in its last base period year 1939, if it had commenced business 2 years before it did so. It would serve no useful purpose to review these factors here. We have used the reconstructed net profit for 1939 as the point of departure in backcasting those earnings over the prior base period years 1938, 1937, and 1936, taking into consideration the business statistics placed in the record. The statistics on business in general and on disposable personal income disclose the year 1938 as one of general business recession. On the other hand, the statistics on all types of vitamin sales disclose *330 a steadily expanding market for vitamin products throughout the base period years. Based upon a consideration *62 of the whole record, we conclude that the sum of $ 36,760 would be a fair and just amount, representing normal earnings to be used as a constructive average base period net income for purposes of an excess profits tax based upon comparison of normal earnings and earnings during the excess profits tax years 1943 and 1944 involved in this proceeding. In view of the above conclusion it is not necessary to discuss petitioner's alternative claim for relief under section 722 (b) (5). With respect to the question of unused excess profits credit carry-overs and carry-backs, which are matters for recomputation under Rule 50, the petition raised an issue only with regard to the correctness of respondent's method of computing an unused excess profits credit adjustment from the year 1941, wherein respondent applied the "variable credit rule" provided for in the Bureau of Internal Revenue Bulletin on Section 722 and Regulations 112, section 35.722-3 (d). That "rule" was approved in Nielson Lithographing Co., 19 T. C. 605, wherein we said: In other words, the variable credit "rule," as stated above, may be considered when the last year of the base period reflects substantially less than a full level *63 of normal operation, and after the application of the 2-year push-back rule the question arises whether earnings had reached a normal level during the first and second excess profits tax taxable years. The rule provides that earnings during these 2 years of growth should not be reduced by an excess profits credit based upon a normal earning capacity. Failure to apply the variable credit "rule" in a situation such as we have here would result in a double benefit to the petitioner, and such was not intended by section 722. Also, see Radio Shack Corporation, 19 T. C. 756, 762. In the instant case the record establishes and we have found that at the end of 1939 the business of petitioner, after application of the 2-year push-back rule, was still in a state of continued development and growth and had not reached a normal level of production, sales, and earnings during 1940 and 1941. On the facts of record we are satisfied that this is an appropriate case for the application of the variable credit rule and for the purpose of computing the unused excess profit credit adjustment, if any, under Rule 50, we have found petitioner's constructive average base period net income to be $ 29,000 for *64 1941. Reviewed by the Special Division. Decision will be entered under Rule 50. Footnotes 1. Includes cost of brewers' slurry, primary yeast, alcohol, and other materials for products sold, and also for experimental, waste, and rejected products. 2. Exclusive of payroll taxes and personal property taxes, which are included in "Taxes" listed under deductions.↩ 3. Includes cost of advertising, traveling expenses, communications, stationery, insurance other than plant, professional fees, etc.↩ 1. No comparable data published.↩ 1. 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 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, * * * (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. * * *↩