Hemenway-Johnson Furniture Co. v. Commissioner

Hemenway-Johnson Furniture Co., Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent Hemenway-Johnson Furniture Co. v. Commissioner Docket No. 27201 United States Tax Court 22 T.C. 43; 1954 U.S. Tax Ct. LEXIS 245; April 12, 1954, Filed April 12, 1954, Filed *245 Decision will be entered under Rule 50. Petitioner held entitled to relief under section 722 (b) (4), Internal Revenue Code, by reason of a change in the character of its business during the base period years. A constructive average base period net income is determined from the record. Laurence F. Casey, Esq., for the petitioner. Joseph L. Spilman, Jr., Esq., and George J. LeBlanc, Esq., for the respondent. Withey, Judge. WITHEY *44 This proceeding is based upon the Commissioner's disallowance of petitioner's applications for relief under section 722(a), (b) (2), and (b) ( 4), Internal Revenue Code, for each of the 6 taxable years ended March 31, 1941 through 1946, inclusive. Certain deficiencies were determined solely by reason of petitioner's deferment of excess profits taxes shown on its returns for said*246 years pursuant to the provisions of section 710 (a) (5), Internal Revenue Code. Petitioner's claim is based on the following factors: (1) The business of petitioner was depressed because of temporary economic circumstances unusual in the case of such taxpayer, i. e., a price war; and (2) the acquisition of the assets and store location of its primary competitor, The Johnson Furniture Company, Inc., and in opening 3 branch stores. This Court promulgated an opinion with respect to this petitioner on January 28, 1953, Hemenway-Johnson Furniture Co., 19 T. C. 782. On February 24, 1953, petitioner herein filed a motion for further hearing and petitioner's attorney submitted a written brief in support of this motion. On May 19, 1953, the motion was granted. As a result of this further hearing, at which additional evidence was presented, the Findings of Fact and Opinion promulgated January 28, 1953, have been set aside. FINDINGS OF FACT. The stipulated facts are so found and are incorporated herein. The petitioner was incorporated under the name of Hemenway, Inc., under the laws of Louisiana, on March 31, 1931. It began to operate a retail furniture business*247 in Alexandria, Louisiana, in 1931 and has continued to operate a furniture store there to the present time. In 1932 petitioner opened a retail furniture store at 509 Milam Street, Shreveport, Louisiana. Petitioner filed its excess profits tax returns on the accrual basis for the taxable years involved with the collector of internal revenue for the district of Louisiana. Petitioner's excess profits net income for its base period years is as follows: Fiscal year ended, March 31 [1937] $ 34,410.07 [1938] 2,787.47 [1939] 14,880.27 [1940] 59,552.75 Petitioner's average base period net income computed under the provisions of section 713 (f) without adjustment under section 722 is $ 46,525.38. *45 Facts: Competition With Johnson Furniture Company, Inc. Petitioner's store in Shreveport was opened with a general line of low-priced household furniture and appliances. At that time the largest and best established furniture business in Shreveport was Johnson Furniture Company, hereinafter called Johnson. Johnson's business was almost equal to the combined business of all other furniture dealers in Shreveport. Johnson was incorporated on July 1, 1936, at which time it took *248 over the wholesale and retail furniture business in Shreveport formerly operated by a partnership, composed of F. M. Johnson and J. R. C. Mosley, under the name of "Johnson Furniture Company." The partnership had been organized on January 1, 1925, although prior to such date the business had been operated by F. M. Johnson for a number of years. From 1932 until petitioner acquired it the Johnson business was conducted in a building at 919-923 Texas Avenue, Shreveport. The building, which was originally owned by the partnership and later by Johnson Furniture Company, Inc., was 5 stories in height and contained approximately 130,000 square feet of floor space. Johnson carried a complete line of home furnishings from the cheapest to the most expensive items. The first inventory purchased by petitioner for its Shreveport store, upon the opening thereof, had been acquired under current market conditions, which in 1932 represented a comparatively low price level. The Johnson inventory, which was considerably larger than that purchased by petitioner, as aforesaid, had been bought and was held for sale at substantially higher price levels. Consequently, when petitioner sold its merchandise*249 at prices which would yield it a normal markup, such prices were far lower than the prices charged at that time by Johnson for comparable merchandise. In order to compete under these conditions Johnson began a campaign to force petitioner out of business in Shreveport. At first this campaign took the form of an intensive promotion of items in its inventory which were comparable with items carried by petitioner's Shreveport store through sales of such items at far lower prices than Johnson's general price level. Subsequently, as the Johnson inventory came nearer to being on an equal basis with petitioner's from a standpoint of current costs, the promotional efforts of Johnson emphasized gifts of premiums including Packard automobiles and thousands of dollars' worth of furniture at extensively advertised raffles. In July 1935 petitioner moved the location of its Shreveport business to 606 Texas Street, which was in the most important retail district of Shreveport, and had floor space of approximately 35,000 square feet compared to the 24,000 square feet in petitioner's Milam Street store. Concurrently with the move to Texas Street petitioner acquired 10,000 square feet of separate*250 warehouse space so that the entire space of the Texas Street store was available for displays and *46 retailing purposes. Soon after petitioner's move to Texas Street the competition with Johnson became more intense. Johnson's unusual types of promotion and the periods of extreme price cutting became more frequent and were more specifically pointed at petitioner. The competition created by Johnson was a definite and determined effort to put petitioner out of business. The following table shows the net retail sales and percentages of gross profits realized thereon in petitioner's Alexandria and Shreveport stores for the fiscal years ended March 31, 1934 through 1939, inclusive, for petitioner's Alexandria store for the fiscal year ended March 31, 1940, and with respect to petitioner's Shreveport, Texas Street, store for the 5-month period ended August 31, 1939: Hemenway, Inc., Hemenway, Inc., Shreveport store (Milam Alexandria store Street and 606 Texas Street) Fiscal year ended March 31 Percentage Percentage of gross of gross Sales profit on Sales profit on sales sales [1934] $ 173,883.31 44.28 $ 152,518.64 43.12 [1935] 198,340.02 43.33 199,021.70 38.73 [1936] 261,975.42 41.33 276,508.18 38.64 [1937] 334,830.05 42.91 380,253.12 39.89 [1938] 327,819.34 42.63 364,535.01 38.18 [1939] 270,741.40 43.24 340,529.97 40.68 [1940] 329,049.45 43.39 1 176,301.71 39.13 *251 Throughout the years shown in the foregoing table the stocks of merchandise and styles maintained in petitioner's Alexandria and Shreveport stores were almost duplicates of each other. Apart from the reduction in its Shreveport retail gross profits owing to the price cutting to which it was compelled to resort, petitioner in an effort to maintain its gross profits did many things which definitely reduced its net profits, such as giving premiums, providing extra services, and conducting in Shreveport an extremely intensified advertising and sales effort entirely out of proportion to the size of its business there. Nothing was overlooked which might attract people to petitioner's store. Facts: Acquisition of Johnson Furniture Company, Inc., Assets and Business Location. Petitioner's lease for its Shreveport store at 606 Texas Street was to expire June 1940, and by the terms thereof petitioner was required to notify the lessor before June 1939 of any intention to renew such lease. The renewal rent was higher than petitioner considered it could pay, and petitioner's president, Frank Hemenway, Jr., *252 hereinafter called Hemenway, was unsuccessful in obtaining from the lessor *47 an option for renewal near the rent which petitioner could pay. Petitioner's board of directors had definitely decided against renewal under the terms of the lease. Hemenway repeatedly but unsuccessfully tried to obtain a different location in Shreveport which would place petitioner in a more competitive position with Johnson. In or about December 1938 it occurred to him that if he could work out with Johnson a merger or a purchase of its assets, petitioner would by so doing remove a competitor and at the same time acquire necessary additional floor space by moving into the Johnson building. He therefore began to negotiate with J. R. C. Mosley, hereinafter called Mosley, representing Johnson. Hemenway then took up with the Guaranty Bank in Alexandria the question of borrowing from the bank upon a temporary basis sufficient money to pay the balance of the purchase price over and above the $ 250,000 which petitioner hoped to raise by marketing debentures to the public. The bank's position was that it would not lend the money representing the balance of the purchase price if petitioner sold debentures, *253 and the only conditions upon which the bank would make a temporary loan of such amount would be if (a) Johnson would take preferred stock for $ 250,000 instead of notes, and (b) petitioner raised another $ 100,000 in the form of preferred stock. Hemenway reported to Mosley that there was no way in which the purchase could be closed unless Johnson would agree to take preferred stock, and that even in such event petitioner would have to sell another $ 100,000 worth of preferred stock. Mosley finally agreed that Johnson would take preferred stock when Hemenway assured him that the deal could not be financed in any other way, and further assured him that the petitioner would give Johnson some notes to replace the preferred stock or refinance the transaction in some other satisfactory way if, as, and when possible. This assurance was not authorized by petitioner's board of directors; it was Hemenway's personal assurance. After Hemenway had reached the aforesaid agreement with Johnson, he offered to sell $ 100,000 worth of petitioner's preferred stock to P. H. Corbett, hereinafter called Corbett, to whom petitioner owed $ 50,000 on a note. Corbett agreed to take such stock if petitioner*254 would give him 1,500 shares of its common stock as a bonus. Petitioner's board of directors declined to do so. Hemenway then endeavored to have Johnson put up the $ 15,000 represented by the common stock demanded by Corbett but succeeded only in securing its agreement to put up the money for 500 shares thereof. Hemenway thereupon put up 1,000 shares of his own stock in petitioner in order to prevent the acquisition of the Johnson business from falling through. There were no discussions with or any assurances given to Corbett that he would be paid off or given notes in respect to the preferred stock purchased by him. On June 3, 1939, petitioner acquired by purchase the business of *48 Johnson and its wholesale subsidiary, the Ark-La-Tex Distributing Company, Inc., including the fixed assets (exclusive of land and buildings), inventories, receivables, and certain prepaid expense items, for a total of $ 584,115.76. The purchase price paid was comprised as follows: Cash, $ 334,115.76, and delivery of 2,500 shares of petitioner's 8 per cent cumulative preferred stock, having a par value of $ 100 per share. The cash was obtained through a loan from the Guaranty Bank, made June*255 5, 1939, bearing an interest rate of 7 per cent, and as a condition to obtaining said loan, petitioner agreed with the bank that not less than $ 200,000 thereof would be repaid before January 1, 1940, through liquidation of inventories and accounts receivable. The bank loan was reduced by petitioner at various times until it was fully repaid on January 5, 1940. Petitioner's charter was amended on March 27, 1940, to authorize the issuance of debentures. On or about March 31, 1940, pursuant to the amendments, the petitioner issued debentures in exchange for its outstanding preferred stock. Petitioner acquired a 10-year lease on Johnson's building, located at 919-923 Texas Avenue, for a basic rental of $ 30,000 per year, and also by amendment of its charter changed its name to "Hemenway-Johnson Furniture Company, Inc." Petitioner continued operation of its store at 606 Texas Street until August 31, 1939, at which time said store was closed and all business moved to the Johnson location. The Ark-La-Tex Distributing Company, Inc., was operated as Ark-La-Tex Wholesale Company and continued as petitioner's wholesale department. For the first few months after petitioner's acquisition*256 of the Johnson business Hemenway spent most of his time studying the organization thereof and familiarizing himself with the methods of operation followed by Johnson in order to determine whether petitioner's methods or those of Johnson should be applied in future operations in the Texas Avenue store. By the end of August 1939 petitioner had consolidated the office employees and accounting and bookkeeping operations of the Texas Street store with the Texas Avenue office. By the first of December 1939 the combined number of petitioner's employees in Shreveport, which totaled 139 at the time of petitioner's acquisition of Johnson, had been reduced to 104. In the consolidation of the businesses petitioner eliminated competing lines of merchandise and selected those which it preferred to handle. Facts: Branch Store Openings. On October 18, 1938, petitioner opened a branch retail furniture store in Bunkie, Louisiana, a town having a population of about 3,500 located about 30 miles southeast of Alexandria. On March 23, 1939, petitioner opened another branch retail furniture store in Bossier City, Louisiana, which had a population of about 5,500 and was located in the immediate vicinity*257 of Shreveport, just across the Red River. On *49 May 1, 1939, a third branch retail store was opened in Vivian, Louisiana, a town having a population of about 2,500 and located about 30 miles northwest of Shreveport. All 3 branches have been in continuous operation up to the present time. Facts: Constructive Average Base Period Net Income. Petitioner operated only the Texas Avenue store in Shreveport during the 4 months of September-December prior to January 1, 1940. The actual retail sales made by petitioner, Johnson Furniture Co., Inc., and Johnson Corporation, a subsidiary of Johnson Furniture Co., Inc., in Shreveport, for the fiscal years ended March 31, 1937, 1938, 1939, and for the period ended December 31, 1939, were as follows: Fiscal year ended Mar. 31, 1937 Month Johnson Hemenway, Furniture Johnson Inc. Co., Inc. Corporation April $ 27,872.73 $ 37,074.21 May 38,446.63 38,562.46 June 42,418.20 77,650.02 July 32,928.32 46,626.77 August 26,726.81 40,434.74 September 31,003.80 77,132.03 October 30,373.58 39,860.12 November 37,339.54 51,248.58 December 47,077.09 74,788.72 January 18,807.29 36,971.37 February 17,932.83 47,846.85 $ 6,171.74 March 29,326.30 60,269.26 9,946.36 Total $ 380,253.12 $ 628,465.13 $ 16,118.10 Total actual Shreveport retail sales $ 1,024,766.35 *258 Fiscal year ended Mar. 31, 1938 Month Johnson Hemenway, Furniture Johnson Inc. Co., Inc. Corporation April $ 28,604.32 $ 62,970.71 $ 18,998.99 May 29,331.39 63,564.69 46,043.06 June 41,224.18 73,176.63 10,347.66 July 29,241.22 45,165.22 8,163.92 August 26,709.10 36,494.73 8,855.18 September 22,261.73 49,615.14 4,837.44 October 34,501.77 53,022.44 (428.50) November 36,254.76 59,319.30 3,852.41 December 47,453.51 72,777.62 2,511.33 January 21,166.20 40,078.63 (4.08) February 19,207.22 31,209.40 March 28,579.61 48,663.78 945.00 Total $ 364,535.01 $ 636,058.29 1 $ 104,122.41 Total actual Shreveport retail sales $ 1,104,715.71 Fiscal year ended Mar. 31, 1939 Month Johnson Hemenway, Furniture Inc. Co., Inc. April $ 25,591.61 $ 49,538.07 May 23,895.05 65,027.23 June 23,925.58 74,861.29 July 28,212.00 37,280.91 August 27,680.48 49,311.46 September 27,917.24 47,948.74 October 25,944.17 40,938.61 November 25,470.49 42,380.79 December 56,629.90 66,008.90 January 23,267.70 33,726.24 February 22,606.37 36,355.30 March 29,389.38 44,276.31 Total $ 340,529.97 $ 587,653.85 Total actual Shreveport retail sales $ 928,183.82 *259 Fiscal year 1940 919-923 Hemenway- Texas Ave. Johnson Month Hemenway, Johnson store of Furniture Inc. (606 Furniture Hemenway- Co., Inc. Texas St.) Co., Inc. Johnson 919-923 Furniture Texas Ave. Co. store April $ 33,401.17 $ 42,947.26 May 33,166.61 56,953.80 June 34,274.58 $ 50,020.03 July 32,186.72 42,651.80 August 43,272.63 30,817.05 September $ 57,398.53 October 70,435.41 November 70,931.00 December 91,516.79 January February March Total $ 176,301.71 $ 99,901.06 $ 123,488.88 $ 290,281.73 Total: Petitioner's retail Shreveport sales 10 months ended December 31, 1939 $ 590,072.32 *50 The following schedule shows the actual wholesale sales made by petitioner and by Johnson Furniture Co., Inc., through its subsidiaries, by months, for the 3 fiscal years ended March 31, 1939, and for the 9 succeeding months ended December 31, 1939: Statement of Actual Wholesale Sales Fiscal year ended Mar. 31, 1937 Month Johnson Furniture Johnson Ark-La-Tex Co., Inc., Corporation Dist. wholesale Co. department April $ 30,117.82 May 16,666.05 June 36,884.56 July 25,782.72 August 25,928.25 September 34,756.98 October 36,070.59 November 29,866.73 December 44,829.74 January 20,184.36 February 29,067.31 $ 1,838.87 March 5,500.00 $ 30,542.90 Total (net) $ 330,155.11 $ 7,338.87 $ 30,542.90 Consolidated total $ 368,036.88 *260 Statement of Actual Wholesale Sales Fiscal year ended Mar. 31, 1938 Month Johnson Ark-La-Tex Corporation Dist. Co. April $ 13,488.99 $ 29,698.63 May 27,030.43 27,441.45 June 15,393.20 20,090.24 July 14,567.84 21,931.63 August 4,677.92 29,800.61 September 2,302.17 31,024.32 October 5,996.14 25,933.83 November (315.03) 21,960.57 December (226.24) 25,052.40 January (288.70) 11,277.79 February 14,446.99 March 31,547.70 Total (net) $ 82,626.72 $ 290,206.16 Consolidated total $ 372,832.88 Fiscal year ended Fiscal year 1940 1 Mar. 31, 1939 Month Ark-La-Tex Wholesale Ark-La-Tex Wholesale Ark-La-Tex Wholesale Dist. Co. Dist. Co. Dist. Co. Dist. Co. Co. (petitioner) April $ 21,985.53 $ 10,431.28 $ 29,985.04 May 19,958.79 8,455.97 24,391.86 June 23,431.11 12,387.40 $ 9,218.31 July 21,099.02 22,901.15 August $ 5,176.76 33,636.75 18,387.64 September 4,046.68 29,224.60 30,272.06 October 5,357.46 27,688.42 20,110.48 November 4,287.72 25,165.27 22,781.10 December 5,820.78 33,968.85 27,842.32 January 2,781.58 26,260.34 February 3,324.69 25,746.34 March 6,160.13 26,134.23 Total (net) $ 36,955.80 $ 314,299.25 $ 31,274.65 $ 54,376.90 Consolidated total $ 351,255.05 *261 The following is a statement showing the net income of the petitioner's branch stores for the fiscal year ended March 31, 1940: *51 Fiscal Year 1940 Bunkie, La. Bossier, La. Vivian, La.1 Sales $ 42,317.73 $ 37,610.42 $ 29,606.45 Cost of sales 19,857.70 21,133.30 16,510.82 Gross profit 22,460.03 16,477.12 13,095.63 Expense 15,921.30 12,112.01 11,229.92 Operating profit 6,538.73 4,365.11 1,865.71 Other income 528.12 2,006.16 1,322.20 Total income 7,066.85 6,371.27 3,187.91 Other expense 15.00 362.40 16.00 Net income $ 7,051.85 $ 6,008.87 $ 3,171.91 The following is a statement showing the net income of the petitioner's Alexandria, Louisiana, store for the fiscal years ended March 31, 1937, 1938, 1939, and 1940: [1940] Sales $ 334,830.05 $ 327,819.34 $ 270,741.40 $ 329,049.45 Cost of sales 191,152.16 188,072.86 153,672.17 186,277.39 Gross profit 143,677.89 139,746.48 117,069.23 142,772.06 Expenses 138,849.44 155,429.60 124,549.61 130,723.70 Operating profit 4,828.45 (15,683.12) (7,480.38) 12,048.36 Other income 21,867.23 Total income 33,915.59 Other expense 9,773.12 Net income $ 4,828.45 ($ 15,683.12) ($ 7,480.38) $ 24,142.47 *262 The following statement shows the net income for the Ark-La-Tex Distributing Company, Inc., wholesale, for the fiscal years ended February 28, 1938 and 1939, respectively: [1939] Sales $ 263,581.90 $ 319,712.72 Cost of sales 230,690.29 267,840.53 Gross profit 32,891.61 51,872.19 Expenses 34,057.71 36,275.45 Operating profit (1,166.10) 15,596.74 Other income 25,628.52 Net income $ 24,462.42 $ 15,596.74 The following statement shows the actual expenses of Hemenway, Inc., for the fiscal years ended March 31, 1937, 1938, and 1939: *52 Fiscal Year Ended Mar. 31, 1937 Expenses Alexandria Shreveport General Salaries -- Administrative $ 32,200.00 $ 9,110.04 Salaries -- Office 6,759.50 5,799.02 Salaries -- Collectors 8,135.66 3,890.75 Office stationery 1,347.05 1,761.63 Postage 1,505.91 1,289.57 Telephone and telegraph 1,171.02 1,615.45 Traveling 1,352.04 2,341.26 Dues and subscriptions 968.60 694.71 Legal and professional 1,743.91 2,042.23 Licenses and taxes 4,933.93 3,809.96 Insurance 480.00 480.00 Interest and discount 53.95 168.81 $ 5,750.98 Miscellaneous administrative 1,996.81 1,173.14 Salaries -- Porter and maid 1,080.80 830.08 Porters' supplies 1,493.62 2,842.97 Rent 8,368.51 17,211.13 Heat, light and water 2,177.90 2,292.53 Insurance 1,160.00 960.00 Depreciation 707.24 553.04 Additional rent 870.00 Advertising 7,952.83 23,252.91 Salesmen's salaries 13,920.56 7,816.25 Commissions on electric refrigerators 15,849.50 Commissions 9,006.60 2,776.04 Discounts 304.60 999.57 Miscellaneous selling $ 1,692.37 $ 2,912.75 Salaries -- Receiving and shipping 3,834.00 2,305.00 Salaries -- Repairs 7,105.48 1,691.25 Salaries -- Drivers and helpers 3,872.12 5,901.32 Supplies -- Delivery 3,623.03 4,804.30 Auto repairs 1,839.77 1,317.30 Gas and oil 4,331.29 3,065.81 Garage rent 191.50 243.74 Insurance 360.00 360.00 Depreciation 1,956.42 1,331.48 Extra hauling 352.42 1,349.12 Bad debts $ 8,947.17 Refrigerator service 1,944.56 Cash short 16.89 Worthless stock Total $ 138,849.44 $ 134,842.66 $ 16,659.60 Fiscal Year Ended Mar. 31, 1938 Salaries -- Administrative $ 31,375.00 $ 8,100.04 Salaries -- Office 7,317.91 6,122.54 Salaries -- Collectors 7,788.16 4,732.00 Office stationery 1,260.85 1,634.69 Postage 1,371.17 1,693.89 Telephone and telegraph 969.58 1,694.56 Traveling 1,155.86 1,652.02 Dues and subscriptions 1,090.30 1,039.87 Legal and professional 1,802.77 2,026.12 Licenses and taxes 7,014.31 5,224.14 Insurance 480.00 470.00 Interest and discount 69.70 187.23 $ 10,100.02 Miscellaneous administrative 4,764.16 2,403.87 Salaries -- Porter and maid 1,060.80 1,143.57 Porters' supplies 4,990.98 1,147.60 Rent 9,590.00 18,959.85 Heat, light and water 2,686.90 2,661.93 Insurance 1,440.00 1,410.00 Depreciation 884.80 689.77 Additional rent 2,039.00 Advertising 9,236.66 19,873.90 Salesmen's salaries 17,822.75 10,758.37 Commissions on electric refrigerators 10,628.99 Commissions 7,700.94 2,970.99 Discounts 258.53 306.22 Miscellaneous selling 2,599.29 3,111.60 Salaries -- Receiving and shipping 4,099.92 3,300.00 Salaries -- Repairs 7,473.32 3,440.00 Salaries -- Drivers and helpers 3,863.50 6,721.83 Supplies-Delivery 3,181.14 6,372.33 Auto repairs 2,114.29 2,445.61 Gas and oil 5,066.65 3,842.12 Garage rent 250.00 108.75 Insurance 480.00 470.00 Depreciation 1,837.50 1,486.50 Extra hauling 292.86 1,418.68 Bad debts 6,123.06 Refrigerator service Cash short Worthless stock Total $ 155,429.60 $ 140,269.58 $ 16,223.08 Fiscal Year Ended Mar. 31, 1939 Salaries -- Administrative $ 20,500.00 $ 8,900.04 Salaries -- Office 6,901.83 5,471.66 Salaries -- Collectors 7,530.26 6,182.15 Office stationery 945.74 1,227.76 Postage 1,356.35 1,744.07 Telephone and telegraph 927.56 1,706.32 Traveling 1,629.31 1,331.52 Dues and subscriptions 934.66 1,115.73 Legal and professional 1,818.94 1,832.05 Licenses and taxes 6,770.88 5,554.45 Insurance 480.00 360.00 Interest and discount 15.64 88.85 $ 8,428.04 Miscellaneous administrative $ 1,814.25 $ 1,687.58 Salaries -- Porter and maid 1,060.80 1,159.78 Porters' supplies 652.99 1,060.76 Rent 11,220.00 17,811.17 Heat, light and water 2,279.80 2,835.25 Insurance 1,440.00 1,080.00 Depreciation 824.84 666.22 Additional rent Advertising 8,420.73 18,907.82 Salesmen's salaries 13,736.42 10,458.11 Commissions on electric refrigerators 11,654.69 Commissions 4,394.33 3,567.88 Discounts 225.24 227.23 Miscellaneous selling 2,738.03 3,122.24 Salaries -- Receiving and shipping 4,502.42 3,638.75 Salaries -- Repairs 7,619.98 4,992.91 Salaries -- Drivers and helpers 3,806.00 7,021.10 Supplies -- Delivery 2,347.45 5,300.57 Auto repairs 1,507.56 3,134.54 Gas and oil 4,154.16 3,654.33 Garage rent 60.00 120.10 Insurance 480.00 360.00 Depreciation 1,278.15 1,063.56 Extra hauling 175.29 1,044.99 Bad debts $ 9,230.35 Refrigerator service Cash short 8.08 Worthless stock 1,500.00 Total $ 124,549.61 $ 140,084.18 $ 19,166.47 *263 *53 The following statement shows the actual expenses of Johnson Furniture Co., Inc., and subsidiaries for the fiscal years ended June 30, 1937, 1938, and 1939: *54 Fiscal Year Ended June 30, 1937 Johnson Johnson Expenses Furniture Corporation Co., Inc. Officers' salaries $ 20,000.00 $ 5,000.00 Other salaries 108,917.39 29,833.00 Rent Repairs 778.77 Bad debts 14,508.32 Interest 30,216.89 Taxes 7,016.70 44.50 Contributions 812.28 Amortization bond discount 1,043.29 Depreciation 10,033.10 340.00 Dues -- Association 1,094.72 Bank charge 193.54 5.25 Employees' insurance 48.85 General expense 2,155.01 1,003.84 Insurance 2,856.81 64.67 Lights, gas, and water 4,700.29 Legal and auditing 7,125.50 426.26 Office expense 4,100.30 269.01 Postage 1,935.04 9.06 Telephone and telegraph 2,315.82 257.32 Direct expense 5,895.63 2,600.99 Auto and delivery 13,015.49 823.56 Advertising 36,007.26 1,395.57 Travel expense 2,324.48 1,248.76 Collection expense 2,361.00 Air conditioning 88.28 Sales expense 101.41 Trustees' fees Cash shortage Loss or refund 20,153.92 Interest and discount 2,936.19 Total $ 302,546.59 $ 43,511.48 *264 Fiscal Year Ended June 30, 1938 Johnson Ark-La-Tex Johnson Expenses Furniture Dist. Co. Corporation Co., Inc. Officers' salaries $ 12,500.00 $ 12,500.00 Other salaries 96,184.29 13,219.00 $ 5,472.68 Rent 1,000.00 Repairs 1,316.91 Bad debts 29,448.03 Interest 11,231.54 Taxes 16,494.59 205.00 156.88 Contributions 234.50 Amortization bond discount 1,002.84 Depreciation 12,848.39 170.00 Dues -- Association 255.50 Bank charge 204.21 Employees' insurance 493.59 General expense 3,497.74 270.74 Insurance 2,790.48 Lights, gas and water 5,144.82 Legal and auditing 2,472.25 Office expense 2,475.88 267.35 84.85 Postage 1,657.88 117.77 23.00 Telephone and telegraph 2,763.82 26.25 84.03 Direct expense 6,359.89 33.90 2,677.09 Auto and delivery 11,447.52 427.50 526.48 Advertising 37,831.85 5,293.27 1,378.91 Travel expense 1,492.97 915.84 1,143.82 Collection expense 12,726.64 605.95 Air conditioning 1,486.96 Sales expense 1,687.54 51.83 Trustees' fees Cash shortage 72.99 Loss or refund Interest and discount Total $ 274,636.66 $ 34,057.71 $ 14,081.39 *55 Fiscal Year Ended June 30, 1939 Johnson Ark-La-Tex Expenses Furniture Dist. Co. Co., Inc. Officers' salaries $ 20,208.37 $ 10,216.64 Other salaries 69,098.61 16,236.28 Rent 6,000.00 Repairs 2,899.35 Bad debts 18,627.21 Interest 11,487.95 Taxes 17,811.72 834.98 Contributions 292.10 Amortization bond discount 923.13 Depreciation 11,422.59 Dues -- Association 594.50 Bank charge Employees' insurance 224.02 General expense 3,512.60 115.50 Insurance 8,054.75 Lights, gas and water 4,679.92 Legal and auditing 2,116.62 Office expense 1,597.75 152.00 Postage 1,573.14 385.28 Telephone and telegraph 2,370.92 64.39 Direct expense 3,714.24 1,500.12 Auto and delivery 12,101.26 Advertising 19,411.13 (1,226.81) Travel expense 2,045.87 1,997.07 Collection expense 9,854.83 Air conditioning Sales expense Trustees' fees 164.00 Cash shortage 83.08 Loss or refund Interest and discount Total $ 224,869.66 $ 36,275.45 *265 For the Johnson Furniture Company's fiscal year ended June 30, 1937, the respondent disallowed a deduction claimed by such company for administrative salaries to the extent of $ 15,000. The following statement shows the Shreveport wholesale expenses and other wholesale income from June through December 1939: Shreveport Wholesale Expenses and Other Income re Books From June Through December 1939 June July August September Expenses: Freight $ 119.26 $ 1,386.56 $ 1,089.11 $ 1,009.56 Salaries 850.00 1,372.84 1,310.34 1,336.74 General expense 756.65 2,272.00 618.08 949.40 Advertising 426.41 646.59 Travel expense 452.26 367.92 Inventory adjustment 354.43 146.75 283.63 472.72 Bad accounts 92.18 229.01 183.87 302.72 Total $ 2,172.52 $ 5,407.16 $ 4,363.70 $ 5,085.65 Other Income -- Wholesale: Handling charges $ 980.07 $ 984.05 $ 1,034.75 Shreveport Wholesale Expenses and Other Income re Books From June Through December 1939 October November December Total Expenses: Freight $ 695.68 $ 1,484.25 $ 2,232.50 $ 8,016.92 Salaries 1,395.07 1,168.34 1,005.84 8,439.17 General expense 928.54 504.62 630.59 6,659.88 Advertising 942.11 1,098.75 620.08 3,733.94 Travel expense 289.38 226.57 270.31 1,605.54 Inventory adjustment 316.73 357.01 446.56 2,377.83 Bad accounts 201.10 227.81 278.42 1,515.11 Total $ 4,768.61 $ 5,067.35 $ 5,484.30 $ 32,348.39 Other Income -- Wholesale: Handling charges $ 589.41 $ 903.28 $ 1,385.22 $ 5,876.78 *266 *56 The following statement shows the other income received by petitioner at 919-923 Texas Avenue for the period ended September 1, 1939, to December 31, 1939: Other income September October November December Total [1939] Bad debts recovered $ 704.38 $ 415.92 $ 585.72 $ 711.97 $ 2,417.99 Over and short 19.63 (19.17) 5.80 (9.96) (3.70) Carrying charges (337.47) 2,050.22 2,490.31 3,752.98 7,956.04 Purchase discount 712.54 983.96 624.31 1,117.44 3,438.25 Miscellaneous 71.42 71.42 Total $ 1,170.50 $ 3,430.93 $ 3,706.14 $ 5,572.43 $ 13,880.00 Petitioner's average base period net income computed without the benefit of section 722 is an inadequate standard of normal earnings because petitioner changed the character of its business during the base period and its earnings did not reach the level at the end of the base period which they would have reached had the change taken place 2 years before it did. A fair and just amount representing normal earnings to be used as a constructive average base period net income is $ 71,000. OPINION. It is conceded that the petitioner's acquisition of certain*267 of the assets, plus the store location of Johnson, and the opening of three branch stores during the base period years, represents changes in capacity for operation within the import of section 722 (b) (4) of the Internal Revenue Code. 1 It is therefore unnecessary for us to consider the section 722 (b) (2) factor alleged by petitioner as a ground for relief as it is an alternative qualifying factor under the *57 statute; and, since petitioner has qualified on the ground that it changed its capacity for operation, it is not necessary for it also to meet the alternative qualifying factor. Rand Beverage Co., 18 T. C. 275, 287; Fishbeck Awning Co., 19 T. C. 773, 781. *268 The determination of what is a fair and just amount to be used as a constructive average base period net income calls for a prediction and an estimate of what earnings would have been under assumed conditions, an approximation where an absolute is not available and not expected. Victory Glass, Inc., 17 T. C. 381, 388. The problem requires the use of some imagination and practical judgment. Radio Shack Corporation, 19 T. C. 756, 762. "The statute does not contemplate the determination of a figure that can be supported with mathematical exactness." Danco Co., 17 T. C. 1493, 1498. The petitioner has submitted numerous computations and exhibits purporting to set forth what it believes to be its constructive average base period net income. Respondent also has submitted several computations which result in a constructive average base period net income substantially less than that allowed petitioner under the provisions of section 713 (f). No useful purpose would be served to discuss here the various arithmetical indices or formulas used in the different reconstructions. We can not agree with*269 all of the assumptions of the petitioner. Nor are we able to find merit in all of respondent's contentions. However, a consideration of the contentions of the parties in connection with the evidence of record convinces us that the petitioner is entitled to a greater average base period net income than the amount of $ 46,525.38 allowed by the respondent. From a consideration of the various factors set out in our findings, we have concluded and found as a fact that $ 71,000 is a fair and just amount to be used as a constructive average base *58 period net income. In accordance with section 711 (b) (1) (A) for the year ending March 31, 1941, the constructive average base period net income for that year is to be reduced by the amount of petitioner's income tax for said year. Reviewed by the Special Division. Decision will be entered under Rule 50. Footnotes 1. Operations for 5 months ended August 31, 1939, when this store was closed.↩ 1. Net.↩ 1. Through December 31, 1939.↩ 1. Eleven months ended Mar. 31, 1940.↩ 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 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 cases 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) Taxpayer 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 -- * * * * (2) the business of the taxpayer was depressed in the base period because of temporary economic circumstances unusual in the case of such taxpayer or because of the fact that an industry of which such taxpayer was a member was depressed by reason of temporary economic events unusual in the case of such industry. * * * * (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, * * * shall be deemed to be a change on December 31, 1939, in the character of the business, or↩