Boonton Molding Co. v. Commissioner

Boonton Molding Company, Petitioner, v. Commissioner of Internal Revenue, Respondent Boonton Molding Co. v. Commissioner Docket No. 28076 United States Tax Court 24 T.C. 1065; 1955 U.S. Tax Ct. LEXIS 97; September 26, 1955, Filed *97 Decision will be entered under Rule 50. 1. Changes resulting from merger of petitioner's largest customer and lessening of interest on the part of merged corporation in making sales of petitioner's plastic closures held to cause depression of petitioner's base period earnings, and held, further, such depression was because of temporary economic circumstances unusual in the case of petitioner (sec. 722 (b) (2), I. R. C. 1939) and its average base period net income was an inadequate standard of normal earnings. 2. Petitioner having changed the character of its business during the base period by introduction of injection molding, invention and use of an automatic molding machine, and substitution of commission sales agency for an exclusive jobber, so that by the end of the base period petitioner's earnings had not reached level they would have had it made these changes 2 years earlier, held petitioner's average base period net income was an inadequate standard of normal earnings. 3. Petitioner's constructive average base period net income determined. Harold Wisan, Esq., for the petitioner. Maurice S. Bush, Esq., for the respondent. Opper, Judge. OPPER *1065 By this proceeding petitioner *98 challenges respondent's disallowance of its claims under section 722 (b) (2) and (b) (4) of the Internal Revenue Code of 1939 for relief from excess profits tax liabilities. The years involved are 1941 through 1945 and the amounts of relief claimed are set forth immediately below in our findings of fact, which findings are, except for minor changes, substantially as proposed by the report of the commissioner who heard the evidence in the case. FINDINGS OF FACT. The stipulated facts are hereby found. Petitioner is a corporation organized in 1922 under the laws of the State of New Jersey, with its principal office in Boonton, New Jersey. Petitioner's returns for 1941 through 1945, the periods here involved, were filed with the collector of internal revenue for the fifth collection district of New Jersey. Petitioner filed applications for relief under section 722 of the Internal Revenue Code of 1939 and related relief claims in the following amounts, which applications and claims were denied by the respondent: *1066 [1941] $ 42,665.41 [1942] 135,953.53 [1943] 29,343.79 [1944] 56,548.58 [1945] 139,591.24 Petitioner's excess profits tax liability determined by respondent without application of section 722 is *99 as follows: [1941] $ 43,907.35 [1942] 204,374.66 [1943] 234,293.05 [1944] 212,474.50 [1945] 104,001.09 The deficiencies determined by respondent arose partly from items unrelated to the provisions of section 722 and partly from the deferments by the petitioner of tax payments pursuant to section 710 (a) (5) of the Internal Revenue Code of 1939, and are as follows: [1941] $ 1,241.94 [1942] 5,359.40 [1943] 94,544.48 [1944] 83,927.08 [1945] 50,162.06 Petitioner's excess profits net income for each of the base period years and the average thereof, without taking into consideration the application of the provisions of section 722 of the Internal Revenue Code of 1939, is as follows: [1936] $ 52,996.45 [1937] 46,072.14 [1938] 29,712.25 [1939] 22,845.84 Average 37,906.67 Petitioner's excess profits net income under the income method for the taxable years 1941 to 1945, inclusive, without taking into consideration the application of the provisions of section 722 of the Internal Revenue Code of 1939, is as follows: [1941] $ 145,826.04 [1942] 284,013.29 [1943] 341,153.58 [1944] 336,929.51 [1945] 167,173.58 Petitioner's excess profits credit under the income method for the taxable years 1941 to 1945, inclusive, without taking into consideration the application of the provisions *100 of section 722 of the Internal Revenue Code of 1939, is as follows: *1067 [1941] $ 36,011.34 [1942] 39,841.46 [1943] 40,151.82 [1944] 40,151.82 [1945] 35,534.88 Petitioner's savings in excess profits taxes for the taxable years 1941 to 1945, inclusive, effected under the 80 per cent limitation provisions of section 710 (a) (1) (B) of the Internal Revenue Code of 1939 before application of the 10 per cent postwar refund under the provisions of sections 780 (a) and 784 of the Internal Revenue Code of 1939, are as follows: [1941] None [1942] $ 5,309.99 [1943] 10,908.93 [1944] 4,225.22 [1945] None In a reconstruction of petitioner's average base period net income for the purpose of arriving at petitioner's constructive average base period net income, there should be added to petitioner's average base period net income the following amounts for the respective years due to the change in the ratio of petitioner's borrowed capital to its total capital: [1936] $ 2,323 [1937] 1,073 [196] Petitioner from its organization in 1922 at all times has been engaged in the business of molding plastics. Facts Relating to Injection Molding and Sayre Machine. From its inception, petitioner has continuously manufactured plastic articles by the compression *101 method; during the base period petitioner in addition to compression molding began to manufacture, and has since continuously manufactured, plastic articles by the injection method. The plastic articles manufactured included closures, i. e., bottle caps, and a great variety of other products. Petitioner was primarily a custom molder, making up molded plastic products for specific customers who paid for the molds, as distinguished from a proprietory molder manufacturing and stocking plastic products for sale to customers. Petitioner at all times was one of the pioneers and leaders in the plastic molding industry. Petitioner was the first plastic molder which received the Army and Navy E award during World War II for the excellence of its products. *1068 Petitioner's founder and president, George K. Scribner, is a recognized authority in the field of plastics, being a past president and past chairman of the Board of the Society of the Plastics Industry, a permanent member of the Vocational Advisory Committee of the Board of Education for the City of New York, chairman of the Princeton Plastics Advisory Committee, and the author of books and articles (one of which was republished by the Smithsonian *102 Institute) dealing with plastics. Injection molding is a method of manufacturing plastic articles whereby plastic materials are injected in heated condition into closed molds, and the materials harden while cooling off. By contrast, in compression molding, which is an older process, the plastic materials are poured into open molds which are then closed under pressure and the materials harden through application of heat. The raw materials used for injection molding differ radically from those used for compression molding. Compression molding uses "thermosetting" plastics, i. e., plastics which are set by heat; injection molding uses "thermoplastic" materials, i. e., plastics which are set by cooling. The materials differ fundamentally, in their physical and chemical characteristics, and they cannot be used interchangeably. The only material available for injection molding prior to and during the early part of the base period was cellulose acetate. Such material had been introduced by Celluloid Corporation (later: Celanese Corporation), and in the beginning sold in small quantities only. In 1936, sales of injection molded products in the industry increased slightly, becoming a commercial *103 factor by 1938. Petitioner manufactured by only the compression method through 1937. In 1938 and 1939, it manufactured by both methods. In 1938 or 1939, a second injection material, styrene, was introduced by the Bakelite Company, and styrene became the most used material in injection molding. Other injection materials also became available. Improvements in cellulose acetate in 1938 were not available to molders until about 1941. Injection molding required a different machine from that used for compression molding. The first type of injection molding machine was patented in the United States on a German invention, and proved unusable commercially. The Cellulose Corporation of America, which manufactured basic raw material for injection molding, thereafter began experimenting itself to develop a commercially usable injection molding machine and finished its first working injection molding machine in 1935, but this was too bulky and expensive to be commercially practicable. In 1935, another American injection molding machine was introduced by Hydraulic Press Manufacturing Company which likewise did not work satisfactorily. *1069 In 1936, the first injection molding machine built in Germany*104 (Isoma) was introduced in the United States. This type of machine was commercially usable, but difficult to operate. The first type injection molding machine which was entirely satisfactory was the Reed-Prentice machine manufactured in the United States. The first 10 of such machines were manufactured in 1937. The beginning of the injection molding industry in the United States can be placed in the years 1935 or 1936, and the first commercial sales of injection molded products in 1938. While articles made of compression molding are resistant to heat well in excess of the temperature of boiling water, articles made of injection materials do not withstand heat over 180 degrees Fahrenheit. Manufacture of the following types of articles, which cannot be made by the compression method, has been made possible by the introduction of injection molding: transparent articles including those having optical qualities; objects in odd or intricate shapes; objects having holes or indentations; and special colors. Except in isolated situations, injection molding and compression molding are not competitive. A specific plastic article which can be manufactured economically by the injection process cannot *105 be manufactured economically by the compression process and vice versa. Molds for injection molding cost less than compression molds. Items made of thermoplastic materials or the waste from the manufacture of such items can be ground up and remolded in injection molding, but this is not possible in compression molding where thermosetting materials are involved. Injection molding opened an entirely new field to the plastic industry involving thousands of new articles, such as household fixtures, bathroom fixtures, tumblers, refrigerator boxes and covers, combs, brush handles, sun glasses, watch crystals, etc. Injection molding is faster than compression molding. Injection molded articles replaced articles made of other materials such as metals, wood, leather, glass, etc., but they did not compete with compression molded articles. The development of injection molding machines and materials was co-related. The introduction of injection molding had an outstandingly important effect on the plastic industry. Petitioner began investigating the possibility of buying injection molding machines in 1934, and was among the first companies in the United States which owned any injection molding machine. On *106 January 1, 1935, petitioner purchased its first injection molding machine. That machine was manufactured by Hydraulic Press Manufacturing Company in Mt. Gilead, Ohio, and cost $ 1,950. At *1070 first it did not function properly. It was completely rebuilt and attachments added, making the total cost $ 4,259. On January 31, 1936, petitioner, for $ 5,800, bought its second injection molding machine, an Isoma machine, made in Germany. It was usable, but not suitable for continuous operation. In April and August 1937, petitioner bought its third and fourth injection machines, respectively, from Reed-Prentice Company of Worcester, Massachusetts. These two machines were from the first 10 satisfactory injection molding machines available in the United States, i. e., the first 10 machines made by Reed-Prentice. They cost $ 5,000 and $ 5,700, respectively. After the end of the base period, petitioner continued to buy additional injection molding machines. Petitioner began injection molding on an experimental basis in 1935, and it continued injection molding experiments until 1938 when it started selling injection molded products. Petitioner's sales of injection molded products during the base period *107 were as follows: [1936] None [1937] None [1938] $ 13,917 [1939] 34,707 Petitioner's reputation during the base period in injection molding was excellent. Petitioner was considered a reliable source of supply, and a firm of good engineers which could produce any job it undertook. In 1938 and 1939, petitioner encountered difficulties in developing the market for injection products, because the material had not been accepted by the general public. The three injection molding machines which petitioner had on December 31, 1939 (not counting the uneconomical Isoma machine), were all built to inject up to 2 ounces of plastic per cycle, and had a combined annual production capacity of between $ 202,500 and $ 216,000, based on 3 shifts a day for only 5 days a week. Petitioner's factory always worked 3 shifts a day from Monday through Friday, and usually 2 shifts on Saturdays. By 1941, petitioner's sales of injection products aggregated $ 257,000, which is more than its production capacity as available at the end of 1939. None of petitioner's 1941 sales of injection products was in war work. Petitioner, during the base period, did not keep a separate record disclosing the profits of injection molding as distinguished *108 from its entire profits. On each unit of sales volume of injection molded products of $ 12 (which was the price which by custom during 1938 through 1940 was *1071 used for the output of one injection machine per hour of production), petitioner's material cost was $ 4.80 (based on a rule of thumb that material costs are 40 per cent of sales prices), its actual manufacturing cost was $ 1.70 comprising labor and overhead, and its gross profit was $ 5.50 on each $ 12 sale, or in excess of 40 per cent on sales. In 1939, petitioner's gross profit on all operations, injection molding and compression molding combined, placed on a comparable basis, was 25 per cent on sales. Petitioner's total selling and administrative expenses during the base period, excluding officers' salaries, which did not vary, but including all other fixed charges, bore the following relation to its sales: Year Per cent [1936] 12.3 [1937] 13.1 [1938] 15.6 [1939] 17.3 The introduction of injection molding caused more manufacturers to go into the business of molding and selling plastic articles. During the base period and during the years immediately following the base period the demand for injection molded articles increased at a greater rate *109 than did manufacturing facilities for injection molded articles. A substantial portion of petitioner's business during the base period consisted of plastic closures, i. e., caps, made of plastic, for bottles and other containers. During the base period plastic closures were made exclusively by the compression process by petitioner and by all other manufacturers. During the base period petitioner had adequate plant capacity to manufacture for all its bottle cap orders. Prior to the invention of the fully automatic Sayre machine, petitioner produced plastic closures on hand-operated semiautomatic machines. Competitors had the Lauterbach automatic machine in 1936, which permitted them to reduce the price on the 28-millimeter caps. Petitioner in June 1938 engaged Gordon Sayre, an engineer and professional inventor, to develop a fully automatic molding machine. Sayre had worked before with Dr. Kettering of General Motors, and for the International Business Machine Company and the National Cash Register Company. Sayre completed the first experimental fully automatic machine for petitioner in February 1939. Most of the parts for this machine were handmade. Between February 1939 and the end of *110 that year, petitioner arranged for having casting patterns made to manufacture the parts of the fully automatic Sayre machines, and petitioner ordered parts for 10 such machines from Sipp-Eastwood Corporation. *1072 The first fully automatic Sayre machine assembled was installed in petitioner's plant in September 1939, for which it had to rebuild molds to demonstrate its operation because the spacing was different. By the end of 1939 petitioner had in operation two such Sayre automatic machines, but it had to obtain new 28-millimeter molds, which it did not do until sometime in 1940. During 1940 further work and improvements took place on the Sayre machine. By July 1, 1940, petitioner's capacity was about 500,000 28-millimeter caps a week, and by August 23, 1940, its capacity was about 1,700,000 caps a week. By February 1941, six fully automatic Sayre machines were installed in petitioner's plant. Experimental operation of the fully automatic Sayre machine was conducted by petitioner from February to November 1939. On December 1, 1939, the first automatic Sayre machine was producing caps which were taken out of the engineering department and turned over to the production department. The *111 Sayre machines could be used to mold plastic articles other than caps. The Sayre machine combines into one fully automatic process the following individual steps required under the method of manufacturing bottle caps used by petitioner prior to the introduction of the Sayre machine: weighing the raw material, preforming the pills, feeding the pills into the molding machine, ejecting the caps, blowing them into a tumbler and tumbling the caps to remove the "flash" and the "fins." The Sayre machine incorporated petitioner's patented process of automatically stripping the bottle caps from the pins (inner core) of the molds without destroying the thread inside the caps by which the caps are later screwed on the container. This stripping is done while the plastic material is still in an elastic state before being completely hardened. By contrast, all manufacturers of plastic bottle caps, other than petitioner, employed a procedure requiring unscrewing the bottle caps from the pins, which could be done by a separate automatic process. On the Sayre machine and prior to the use of the Sayre machine, petitioner's patented stripping process gave it a substantial cost saving, in manufacturing, *112 over its competitors. The fully automatic Sayre molding machine also saved raw material by reducing the waste incurred upon transporting the goods in process between the successive stages of manufacture in hand operation. The fully automatic Sayre molding machine was patented by petitioner and was not licensed to any of petitioner's competitors. Licenses on three Sayre machines were made to noncompeting plastic molders *1073 in 1939, but the machines were not delivered because the licensees' business did not materialize. In 1939, Hartford-Empire Company, a large company controlling patents for the bottle glass industry, negotiated with petitioner with a view to the utilization of the Sayre patents abroad. The only other fully automatic plastic molding machines which were in use during the base period and thereafter were the Lauterbach machines. The Lauterbach molding machine produced in a given period only a fraction of the plastic closures produced by the Sayre machine. The Lauterbach made 20 caps in 45 seconds, while the Sayre made 96 caps in 45 seconds. The Lauterbach molding machine during the base period did not strip the caps off the machine as did the Sayre machine, but required separate *113 unscrewing. During the base period and for many years thereafter users of the Lauterbach machine tumbled the caps as a separate operation. The Lauterbach did not cure the plastic material as thoroughly as the Sayre machine, nor could the Lauterbach machine be used to produce caps in as large sizes as could the Sayre machine. The Lauterbach machine could not produce caps with the "liner recess" as did the Sayre machine, nor could any competitor. Anchor Cap & Closure Corporation, on the termination of a contract with petitioner hereinafter mentioned, could obtain a license. The "liner recess" was an invention patented by petitioner. It consisted of an annular recess or groove at the inside bottom of the cap. Such a recess could be produced only on molding machines using petitioner's patented method of stripping the caps off the machine instead of having to unscrew the caps. Into this annular recess is inserted the liner, i. e., the thin round gasket of elastic material which is necessary in any cap to completely seal the container. The primary purpose of all bottle caps is to hold the liner in place on the glass finish. There is no functional difference in this respect between a plastic *114 and metal cap. Metal caps were used earlier than plastic caps and cost much less. During the base period a great many more metal than plastic caps were used for whiskey closures. The "liner recess" has three advantages over the glued-in liner which was being used by all of petitioner's competitors; (a) the liner cannot fall out of the cap, resulting in leakage; (b) it uses no glue, which sometimes develops an odor, and (c) the "liner recess" permits tighter sealing of the bottle because it is the only design which permits the liner to rotate when the cap is screwed on. Petitioner made bottle caps in various sizes. The most important size, which was also the median size of petitioner's production, was 28-millimeter. Twenty-eight-millimeter caps were used primarily by *1074 whiskey manufacturers, but some of them were also sold to other industries. Sizes other than 28-millimeter were used for cosmetics, dentifrices, shoe shines, ink, bleaches, etc. Petitioner's capacity to manufacture bottle caps on the two fully automatic machines which petitioner had installed by the end of the base period, after the molds were made and acquired and improvements made on the machines, would have been 2,000,000 *115 caps per week based on an average cap size of 28 millimeter, on 5 days' operation and on 3 shifts per day. Petitioner sold the following quantities of plastic closures during and in the years immediately preceding the base period: (In thousands of caps) Year 28-mm Other than 28-mm Totals [1] 64,000 [1] 115,000 [1935] 53,869 53,068 106,937 [1936] 51,837 52,155 103,992 [1937] 35,882 42,392 78,274 [1938] 21,409 49,678 71,087 [1939] 12,567 66,930 79,497 Sales are substantially equivalent to production. The cost of manufacturing a thousand 28-millimeter bottle caps by the method used by petitioner prior to the introduction of the Sayre machine (exclusive of material cost) was 73.11 cents, consisting of 34.78 cents direct labor plus 38.33 cents indirect labor and overhead. The 1939 cost of manufacturing a thousand 28-millimeter plastic caps on the fully automatic Sayre machine (exclusive of material cost) amounted to 9.45 cents, consisting of 3.26 cents direct labor plus 6.19 cents indirect labor and overhead, assuming 1 employee operated 2 Sayre machines. Actually 1 employee could operate 6 or more. The saving in the cost of manufacturing one thousand 28-millimeter bottle caps by use of the fully automatic *116 Sayre machine over the method used by petitioner prior to the introduction of that machine would be 63.66 cents, consisting of a saving of 31.52 cents of direct labor (the difference between 34.78 cents and 3.26 cents) and 32.14 cents of indirect labor and overhead (the difference between 38.33 cents and 6.19 cents). This saving is exclusive of any saving in material cost, which would be present but not computed. In the manufacture of plastic bottle caps during the base period, hand-operating machines were not put out of business by fully automatic machines. Petitioner at all times, including the base period, could and did sell its bottle caps at prices established by competitors, whether or not *1075 they used automatic machines, and during the base period had to and did make price reductions because of such price reductions as competitors put into effect. Petitioner found that prior to 1930 it was hampered in making a more profitable showing on its custom plastic products business because of price cutting in the industry. Petitioner found a more stable item in its business was compression molded bottle caps or closures. Petitioner began selling plastic closures prior to 1930. It was among *117 the first manufacturers in the United States to manufacture plastic closures. Facts Relating to Anchor Contract. In 1930, Anchor Cap & Closure Corporation approached petitioner and proposed to take over the exclusive sale of its bottle caps, making its large sales and distribution organization thus available to petitioner. Anchor was engaged in the distribution of various types of closures and glass containers. It manufactured metal but not plastic closures. In 1930, petitioner entered into a contract with Anchor whereby Anchor agreed to purchase from petitioner its entire requirements of plastic closures and petitioner undertook not to sell plastic closures to any other party. The price for the caps was to be the price published by Armstrong Cork Company, or "other representative competition," less 25 per cent irrespective of quantity. The time requirement for the giving of notice by Anchor or petitioner pursuant to which their 1930 contract would be terminated, was changed by the Supplemental and License Agreement dated December 11, 1934, and was further changed on June 30, 1937. Pursuant to the 1937 modification, Anchor could cancel on 1 year's notice, and petitioner could cancel *118 on 2 years' notice. Prior to and during the base period, and to a limited extent thereafter, Anchor gave petitioner orders for closures for whiskey manufacturers, the pharmaceutical trade, drug companies, the cosmetics industry, and others. Petitioner's sales of plastic closures as compared to those of the whole industry of 18- to 38-millimeter caps, during the years 1933 through 1939, were as follows: (In thousands of caps) Petitioner's sales in Year per cent Industry Petitioner's of shipments sales industry [1933] 320,454 64,000 19.97 [1934] 403,642 115,000 28.47 [1935] 354,587 106,937 30.16 [1936] 391,827 103,992 26.54 [1937] 451,291 78,274 17.34 [1938] 408,281 71,087 17.41 [1939] 521,841 79,497 15.23 *1076 Sales and production are substantially equivalent. Until 1937 Anchor had approximately 35 sales offices, 3 or 4 of which sold plastic closures in large quantities. Until 1937 Sterling Smith, one of Anchor's vice presidents, devoted his entire time to developing the plastic bottle closure business. Petitioner then was one of the four largest manufacturers of plastic closures. Petitioner's closures were among the best produced in the entire industry. In the early part of 1937, Hocking Glass Company acquired a financial interest in Anchor. In *119 December 1937, Hocking merged with Anchor, and the name of the combined company was changed to Anchor-Hocking Glass Corporation. Anchor and Hocking were larger business enterprises than petitioner. Hocking's president, Collins, and its general manager, Fisher, assumed personal control of the Anchor plastic cap business early in 1937, before the formal corporate merger. Stewart, who had been Anchor's founder, and its president since 1912, continued with that company for a short time and left soon after the merger. Sterling Smith, Anchor's vice president, who had devoted his entire time to the plastic closure business, was assigned to duties outside the plastic closure department early in 1937 and left Anchor-Hocking altogether in 1938. After the merger with Hocking, Anchor's method of remunerating its plastic closure salesmen was changed to salary and commission, whereas previous to the merger they were paid only on a commission basis. Costello, the sales manager of Anchor's Chicago district, left the employ of Anchor-Hocking in April 1938 because he had been dissatisfied with Anchor-Hocking policies and formed his own company, Container & Closure Sales, Inc. Costello had been Anchor's *120 top salesman of plastic closures. Stauft, also one of Anchor's outstanding plastic closure salesmen, serving the Cincinnati district, left Anchor in 1938. Among his customers were Seagram and Jergens. Kelly, another of Anchor's outstanding plastic closure salesmen, serving the San Francisco territory, left Anchor in 1938. Among his customers were National Distillers and Schenley Distillers. After Anchor's experienced closure sales force had left, Hocking's old sales force remained to replace Anchor's personnel, but Hocking's salesmen had no experience in selling plastic closures. By 1939, Anchor-Hocking had ceased to sell plastic closures to Hiram Walker, its entire demand for 28-millimeter plastic closures *1077 having been supplied by petitioner prior to the merger of Anchor and Hocking. Walker at that time was the largest user of plastic closures for whiskey bottles in the United States, and was a pioneer in the use of plastic caps. Walker used 120 to 150 million caps annually. The next largest user, Seagram, used 50 to 60 million. Competitors of Anchor and Anchor-Hocking sold 28-millimeter plastic caps to Seagram during the base period. The third largest user used 20 to 25 million. On *121 December 30, 1938, Anchor, pursuant to its contract right, canceled its contract with petitioner as of December 30, 1939, and elected to avail itself of the option to use the stripping and liner inventions. Anchor owned all the molds for making the caps and took them. The drop in Anchor-Hocking's sales of petitioner's plastic caps during the later portion of the base period was to some extent attributable to the fact that Anchor's salesmen, Costello, Kelly, and Stauft, left Anchor-Hocking. Petitioner's loss in sales due to the Anchor merger was primarily in 28-millimeter caps. The average annual prices at which petitioner sold unlined plastic molded bottle caps, per thousand, during the taxable years 1932 to 1939, inclusive, are as follows: Average Average price for price for all 28-mm Year caps caps [1932] $ 3.45 [1933] 3.32 [1934] 3.33 [1935] 3.35 $ 3.45 [1936] 3.36 3.39 [1937] 3.19 3.39 [1938] 2.85 3.12 [1939] 2.72 3.06 Petitioner made bottle caps exclusively of phenolic plastics. The cost to petitioner of this material, including transportation and warehousing, was 14 cents per pound during the entire base period. Petitioner's material cost, including transportation and warehousing, for one thousand *122 28-millimeter caps during the base period was $ 1.36. Petitioner's wages in the production of plastic bottle caps were based on piecework, and the respective rates remained constant during the entire base period. During the base period petitioner's cost of manufacturing one thousand 28-millimeter bottle caps, including material, direct labor, indirect labor, and overhead, was $ 2.09, $ 1.36 of which was for material and $ 0.73 was for direct and indirect labor and overhead. *1078 During the base period petitioner's production of molded plastic products made by the compression method (as distinguished from molding by the injection method) consisted of (a) plastic molded caps, and (b) custom molded products other than caps, hereinafter referred to as "other custom molded products." Except for the taxable year 1936, petitioner's net sales of other custom molded products (by compression molding) declined during the base period. For its bottle caps the petitioner had only one customer, the Anchor Cap & Closure Corporation and its successor. Petitioner had between 150 and 300 customers for its other custom molded products during the base period. The following schedule shows petitioner's total dollar *123 sales on all products and a breakdown of such sales into (a) sales of bottle caps, (b) sales of other custom molded products (by compression method), and (c) sales of injection molded products for the taxable years 1933 to 1939, inclusive: Net Sales. Other custom Bottle caps molded Injection Totals all Year by products by molded molded compression compression products products [1933] $ 203,998 $ 103,064 $ 307,062 [1934] 364,889 155,388 520,277 [1935] 340,168 251,862 592,030 [1936] 339,717 298,028 637,745 [1937] 241,528 436,278 677,806 [1938] 194,945 281,373 $ 13,917 490,235 [1939] 208,863 258,614 34,707 502,184 The petitioner's net sales of compression molded bottle caps showed a continuing decline during the 5-year period beginning with 1934 and ending with 1938. Net sales of bottle caps declined approximately $ 99,000 from 1935 to 1937, and declined approximately $ 33,000 from 1937 to 1939. The petitioner's net sales of other custom molded products by compression molding increased approximately $ 184,000 from 1935 to 1937, and declined approximately $ 178,000 from 1937 to 1939. There was a general business recession in 1938. After the termination of the Boonton-Anchor contract, Anchor-Hocking began manufacturing its own plastic bottle caps *124 on the automatic Lauterbach machine under licenses from Owens-Illinois which owned the Lauterbach patents. These patents were licensed to several companies which also might compete with petitioner. From 1930 through 1939, petitioner sold its entire closure output to a single jobber, Anchor. At the end of 1939 petitioner changed its method of distribution from selling exclusively to Anchor to selling directly to manufacturers through selling agents. *1079 Petitioner decided in 1939 to concentrate its closure sales efforts primarily on the two or three largest whiskey manufacturers and also to emphasize 28-millimeter caps which is the standard size for whiskey bottles. In September 1939, George Costello negotiated with petitioner to permit him to take over the sale of petitioner's plastic closures in the Middle West. Costello had been one of Anchor's top salesmen of plastic closures. He had sold large quantities of Boonton bottle caps to Hiram Walker and other whiskey manufacturers while he had worked for Anchor. On December 1, 1939, petitioner entered into a sales agency agreement with Container & Closure Sales, Inc., an Illinois corporation which had been organized by Costello after he left *125 Anchor early in 1938, whereby petitioner appointed that corporation its exclusive sales agent for a number of designated States in the Middle West, including Kentucky. The New York area had been Anchor's best sales territory. Petitioner was advised by Costello that he thought his company could sell to Walker and Seagram 100 million of petitioner's whiskey bottle caps during the first year as well as 20 to 25 million closures to Pepsodent, plus additional quantities to other users. In August 1940, the orders from both Walker and Seagram were at a rate of about 2 million caps per week, and by that time petitioner was able to produce at a rate of about 1,700,000 caps per week. After petitioner's contract with Anchor had terminated by cancellation, petitioner continued selling plastic closures other than 28-millimeter to Anchor. In 1940, such sales amounted to 48 million caps. However, petitioner refused to, and did not, sell Anchor any 28-millimeter caps (except for some negligible orders) because that size was used by the large whiskey companies to which petitioner then sold through its own selling agents, Container & Closure Sales, Inc. Container & Closure Sales, Inc., began supplying *126 petitioner with substantial orders for whiskey bottle caps from Hiram Walker and Seagram within 2 or 3 months after the agency contract had gone into effect. Petitioner's bottle caps, at all times including the base period, had a high standing with the trade. While petitioner tooled up to meet the specifications of Walker and Seagram for their whiskey cap orders, Jergens, Pepsodent, and other large users of plastic bottle closures requested price quotations on petitioner's caps. It was necessary for petitioner to make up new bottle cap molds before it could recommence its bottle cap business after cancellation of the Boonton-Anchor contract. Petitioner's patented "liner recess" was considered an advantage over the glued-in liner by Anchor, whiskey manufacturers, and other users of plastic closures. *1080 Petitioner was approached by competitors to permit them to use the liner recess patent, but petitioner refused. Petitioner's sales agency agreement with Container & Closure Sales, Inc., provided for a selling commission of 5 per cent on the invoice value of the merchandise. As above stated, petitioner's sales of closures to Anchor pursuant to contract were billed at 25 per cent below the prevailing *127 market selling price. The selling price to distillers and other customers of petitioner's closures was the same regardless of whether the sale was made by Anchor or by Container & Closure. Petitioner's additional cost of selling through Container & Closure, instead of to Anchor (such as additional travel expenses, telephone calls, and all other additional expenses of any kind), was less than 6 cents per 1,000 caps. Petitioner did not make the change to direct selling earlier because of the Anchor contract requirement that petitioner had to give 2 years' notice to Anchor (as contrasted with Anchor's right to termination on 1-year notice to petitioner), and because petitioner had an advantageous position with Anchor and would have to make the expensive capital investment in the molds, which Anchor owned. The following schedule shows for the years 1936 to 1939, inclusive, the composite gross sales in millions of dollars for all United States corporations filing Federal income tax returns as compiled by the Bureau of Internal Revenue and published in "Statistics of Income for 1940," part 2, page 285: Gross sales Year (millions of dollars) [1936] $ 100,586 [1937] 108,383 [1938] 91,195 [1939] 101,576 The following *128 schedule shows, for the years 1936 to 1939, inclusive, the total combined net profit (or loss) less tax-exempt income plus interest paid, in millions of dollars, of all United States corporations filing Federal income tax returns as compiled by the Bureau of Internal Revenue and reported in its annual publication entitled "Statistics of Income for 1940": Amount Year (millions of dollars) [1936] $ 7,451 [1937] 7,410 [1938] 4,479 [1939] 7,306 The index figures of industrial production in the United States (total manufacturing), as compiled from figures published by the Federal Reserve Board for the following years, are as follows: *1081 Index (1936 to Year (1939 average=100) [1936] 100.7 [1937] 109.4 [1938] 84.3 [1939] 105.6 The combined sales and earnings to the nearest thousand dollars for the years 1936 to 1939, inclusive, of eight representative companies engaged in the same industry (plastic molding) as that of petitioner, are shown below, together with the percentage of earnings to sales in each of said years: Sales of eight Percentage of Years representative Net income earnings companies to sales [1936] $ 4,131,000 $ 179,000 4.33 [1937] 4,840,000 154,000 3.18 [1938] 4,380,000 159,000 3.63 [1939] 5,138,000 181,000 3.52 Average 3.67 The sales and earnings *129 of the petitioner for the taxable years 1936 to 1945, inclusive, are shown below, together with the percentages of earnings to sales: Percentage of Years Petitioner's Excess profits excess profits sales net income net income to sales [1936] $ 637,745 $ 52,996 8.31 [1937] 677,806 46,072 6.80 [1938] 490,235 29,712 6.06 [1939] 502,184 22,846 4.55 Average 6.43 [1940] 716,064 30,186 4.22 [1941] 1,082,559 145,826 13.47 [1942] 1,877,430 284,013 15.13 [1943] 2,350,765 341,154 14.51 [1944] 2,401,911 336,930 14.03 [1945] 2,745,471 167,174 6.09 The sales and gross profits of the petitioner for the taxable years 1936 to 1941, inclusive, but omitting deductions for repairs and depreciation, are shown below, together with the percentage of gross profits to sales: Percentage of Year Petitioner's Gross profits gross profits sales to sales [1936] $ 637,745 $ 195,802 30.7 [1937] 677,806 206,604 30.5 [1938] 490,235 159,927 32.6 [1939] 502,184 162,698 32.4 Average 31.6 [1940] 716,064 163,466 22.8 [1941] 1,082,559 278,076 25.7 Average 24.3 *1082 ULTIMATE FINDINGS. Because of the changes brought about by and attendant upon the merger of Anchor and Hocking, including the substantial lessening of interest on the part of the merged corporation in making sales of petitioner's plastic closures, petitioner's earnings were depressed *130 during the base period because of temporary economic circumstances unusual in the case of petitioner so that its average base period net income was an inadequate standard of normal earnings. Petitioner's average base period net income is an inadequate standard of normal earnings because during the base period it changed the character of its business by reason of the introduction of injection molding and its operation of the fully automatic Sayre molding machine, and its substitution of a commission sales agency in place of sales effected solely to a single jobber. Petitioner did not reach, by the end of the base period, the earnings level which it would have reached if it had made the above changes 2 years before it actually did. A fair and just amount representing normal earnings, to be used by petitioner as a constructive average base period net income, is an amount equal to $ 76,000 more than petitioner's average base period net income otherwise determined without the benefits of section 722. OPINION. Petitioner seeks relief from excess profits taxes under section 722 (b) (2) and (4) of the Internal Revenue Code of 1939. I. Its position under section 722 (b) (2)1*132 is that its actual *131 base period net income is an inadequate standard of normal earnings because its business was depressed during that period by reason of the merger of Anchor, its contractual sole outlet for caps, with Hocking Glass Company, and the changes in policies incident to the merger. Most drastic of these, according to petitioner, were the changes in crucial sales and other personnel and the decline of interest in petitioner's plastic closures. *1083 The facts disclose that, compared with the rest of the industry, petitioner lost substantial ground during the last 3 years of its base period on the sales of its bottle closures. Our findings show petitioner's declining percentages of total caps sold by the entire industry. From the end of 1934 through 1938 petitioner was in a continuing decline with respect to its net sales of caps and in a substantially similar decline from the end of 1936 through 1939 as to its percentage of caps sold as compared to the caps sold by the entire industry. We know that 1938 was a year of general business recession, and that petitioner's plastic caps for the whiskey trade were to some extent luxury items in that a cheaper metal cap might be satisfactorily used in their stead. We also know that there was considerable competition in this field. Nonetheless we think the figures demonstrate and the evidence discloses that something additional to the general recession and competition happened to petitioner's plastic closure business in 1937, 1938, and 1939. The Anchor-Hocking merger, the effect of which was apparent at that time, was not accomplished until December 1937. But we *133 are satisfied that earlier in that year petitioner's business suffered by reason of the influence of the Hocking interests preparatory to the merger. This developed in 1937 into unfavorable changes of personnel, including the vice president who had devoted his full time to supervising the plastic closures portion of the business. Despite respondent's contentions to the contrary, this depression from the loss of customers was just as much a "temporary economic circumstances, unusual in the case of this taxpayer" as were the situations in Ainsworth Manufacturing Corporation, 23 T. C. 372, and Southern California Edison Co., 19 T. C. 935. In the former we said: The bulletin prepared by the Bureau of Internal Revenue on section 722 at page 16, part III, states: "The term 'economic' includes any event or circumstance * * * externally caused with respect to a particular taxpayer, which has repercussions on the * * * volume of sales of * * * an individual taxpayer * * *" In the latter we said: Indeed, section 35.722-3 (b) of Regulations 112, after discussing the meaning of the word "temporary," provides an example which goes far to sustain petitioner's position: "An example * * * might be a *134 taxpayer which for a long period of years conducted business with one customer which it lost during the base period because such customer decided to manufacture for itself the product it had formerly bought from the taxpayer. The taxpayer would be compelled to develop a new market. The average earnings of the taxpayer for the period of time during which the taxpayer was engaged in obtaining new customers would not represent an adequate standard of its normal earnings and would be sufficient cause for the establishment of a constructive average base period net income under section 722," *1084 Nor are we any more constrained here than in Ainsworth to deny petitioner relief merely because its long range average net income from 1922 through 1939 is shown by the stipulation to be less than its actual average base period net income. Petitioner was in a new and growing business. To adjust for the depression which we conclude existed in petitioner's base period, reference to petitioner's industry position in 1936 -- its first base period year -- is not without significance. In that year petitioner was not affected by the Anchor-Hocking contemplated merger. It seems to us that it then had about *135 as much of the industry's total business as it was going to obtain in this competitive field. But to allow for additional pressures of increasingly strong competition which appear to have been present and growing, 2 we conclude that without the depressing factors resulting from the Anchor-Hocking merger petitioner may be regarded as producing 20 per cent of the entire industry's plastic closure caps in the remaining 3 years of its base period. Such an adjustment would increase petitioner's actual average base period net income. Petitioner is also claiming relief by reason of section 722 (b) (4) changes in the character of its business, when during the base period petitioner introduced injection molding, invented and commenced using the Sayre automatic molding machine, and effected changes from sales of its products through a single jobber to sales by a commission sales agency. Our findings of fact make it abundantly clear that these changes satisfy the so-called qualifying factor of the statutory provision. *136 See Lamar Creamery Co., 8 T. C. 928; Fishbeck Awning Co., 19 T. C. 773. Indeed, respondent does not strongly contend otherwise. II. Petitioner's long-established process of manufacturing its plastic products was by compression molding, and it was not until 1938 that its work with injection molding justified its commercial introduction. At that time suitable materials and machines were available to make injection molding commercially feasible although improvements in material continued after the base period. The two processes are substantially different in method and in the type of product which can be made. The articles that can be made by one process are not efficiently made with the other. Except incidentally, injection molding does not compete with compression molding. *1085 Petitioner's president, who was a pioneer in the entire field of manufacturing and introducing plastics, testified that had petitioner introduced its injection products 2 years before it did so, by December 31, 1939, it would have been selling more than $ 250,000 of such product. Articles manufactured by injection plastic were not new inventions but amounted to a use of the plastic medium for established products. *137 Such a presentation had novelty of color, texture, and design. Our conclusion must be that substantial demand did exist during the entire base period, that more demand could have been developed, as respondent virtually concedes, had products been available, and that had petitioner commenced this process 2 years before it did so, by December 31, 1939, its gross sales from it would have been $ 60,000, which was scarcely one-fourth of its then capacity. The facts also show that petitioner's gross profit on its injection molded products was 40 per cent on sales compared to an over-all comparable profit of 25 per cent. Had petitioner made this change 2 years before it did so, it would have increased its actual average base period net income. III. And the Sayre machine must, as we have said, be regarded as the type of change envisaged by section 722 (b) (4). It was an extensive change to a machine which was of a new type and fully automatic. Its prime accomplishment was that it effected considerable cost saving in the manufacturing process. See Brown Paper Mill Co., 23 T. C. 47; Morgan Construction Co., 23 T. C. 242; Nielsen Lithographing Co., 19 T. C. 605. Although somewhat similar cost *138 saving had been accomplished by use of the Lauterbach machine by petitioner's competitors, nonetheless petitioner had sold in that market at a profit and the cost saving was quite real to it and capable of ready translation into additional income. Petitioner limits its claim on the Sayre machine to the production of caps. Had petitioner had the Sayre machine available 2 years earlier than it did in December 1939, we are convinced that by December 31, 1939, petitioner would have been producing substantially its entire cap production of 104,368,000 (as reconstructed under section 722 (b) (2)) 3 by the use of the Sayre machines. To make a proper adjustment for this throughout the base period years, we regard it as reasonable to use petitioner's 1936 actual and its section 722 (b) (2) reconstructed production figures for the other years. The two Sayre machines installed and in operation on December 31, 1939, would have been capable of this production. We have found that there was a cost saving of 63.66 cents per thousand on 28-millimeter caps by use of the Sayre machine. A large part of *1086 the cap production was not 28-millimeter caps, and as to these the saving would not be so large. *139 However, we are convinced that it would be something. On the other hand, estimates of the amount of saving seem to us unduly optimistic and we conclude that savings would have been effected but in a smaller amount than has been claimed, which should be an addition to petitioner's actual base period net income. IV. Finally, there is the matter of petitioner's initiation of a new sales method. As we have stated petitioner's change from its contractual sole jobber outlet through Anchor to direct selling by the use of salesmen on a commission basis satisfies the initial qualifying requirements of section 722 (b) (4). See Midwest Liquor Dealers, Inc., 20 T. C. 950; Wisconsin Farmer Co., 14 T. C. 1021. Such a program was embarked upon during the base period. The findings of fact demonstrate that this was a substantial change and that substantial savings resulted from it. Our problem is to ascertain under the 2-year push-back rule what earning level petitioner would have reached by December 1939 had it made this change 2 years before it did so. There is ample indication *140 that the new commission sales outlet was an extremely able one and that it possibly could have produced orders for 28-millimeter caps alone to exceed the number of caps petitioner had produced in any one year. The plan was that petitioner's initial activities in this field would be directed to whiskey manufacturers' consumption of 28-millimeter caps, which in 1939 amounted to 200 million caps. But it was not contemplated that petitioner would do a 28-millimeter business to the exclusion of all other activity. It was endeavoring to obtain the very large consumers as its customers. Another facet in the development of the new sales program is that petitioner continued to make all size caps, except 28 millimeter, for Anchor after the cancellation of the contract. These sales to Anchor continued for 2 years, presumably while Anchor was equipping itself for production. A substantial argument could be made on the foregoing to justify reconstructed increased production and sales during the base period, but petitioner has claimed no more than a reconstruction based upon actual base period sales. At least the prospect for the 28-millimeter cap business had a strong foundation. Respondent's *141 view that had petitioner been selling through salesmen in the push-back period, because of the competitive conditions, it would not have sold at the same dollar figure at which Anchor sold is one of those conjectures so prevalent in this type of case. In the present circumstances, it must be resolved substantially in petitioner's favor. Petitioner had long been selling at established market price, *1087 and the quality and novel features of its caps would tend to establish that it would not be forced into crippling price concessions. Upon a consideration of all the factors, we are of the opinion that had petitioner commenced this method of selling 2 years before it did so, it would have effected saving and hence increased the constructive average income for the base period years. V. The stipulated adjustment under section 722 (b) (4) for the change in the ratio of borrowed capital to total capital works a further increase in petitioner's constructive average base period net income of $ 1,000. Such an adjustment is indicated factually, and respondent's argument that alone it would not be "substantial" as required by the statute fades by reason of the other items allowed. See Rand Beverage Co., 18 T. C. 275. As *142 indicated in our ultimate findings the foregoing calls for an increase of $ 76,000 in petitioner's constructive average base period net income. Reviewed by the Special Division. Decision will be entered under Rule 50. Footnotes 1. Not presently available.↩ 1. Not presently available.↩ 1. SEC. 722. GENERAL RELIEF -- CONSTRUCTIVE AVERAGE BASE PERIOD NET INCOME. (b) Taxpayers Using Average Earnings Method. -- The tax computed under this subchapter (without the benefit of this section) shall be considered to be excessive and discriminatory in the case of a taxpayer entitled to use the excess profits credit based on income pursuant to section 713, if its average base period net income is an inadequate standard of normal earnings because -- * * * * (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, * * * 2. For example in 1939, when there was an increase in sales of about 8 million over 1938, petitioner showed a decline from 17.41 per cent to 15.23 per cent in percentage of industry sales.↩ 3. We are in agreement with the Bulletin on Section 722 which provides on page 143 for such multiple basis for section 722↩ relief.