Huttig Sash & Door Co. v. Commissioner

Huttig Sash & Door Company, Petitioner, v. Commissioner of Internal Revenue, Respondent Huttig Sash & Door Co. v. Commissioner Docket No. 11795 United States Tax Court 25 T.C. 550; 1955 U.S. Tax Ct. LEXIS 15; December 19, 1955, Filed *15 Decision will be entered under Rule 50. Petitioner, organized in 1913, is engaged in a general millwork business. It also sells various other building materials for use in the construction and repair of buildings. Its original plant and main office are located in St. Louis, Missouri, and it has branches in Jacksonville, Florida, Roanoke, Virginia, Charlotte, North Carolina, Columbus, Ohio, Louisville, Kentucky, and Knoxville, Tennessee. In 1933, and under a preliminary contract looking to a formal contract with the Insulite Company, petitioner began selling, through all of its branches, a variety of insulation board and hardboard products known as Insulite. The formal and comprehensive contract was executed under date of January 21, 1935, and under it petitioner acquired certain sales territory exclusively and in it the agreements between the parties with respect to petitioner's handling of the products were set forth in detail. In February of 1935, the petitioner began the sale of venetian blinds, and from then on through 1939, it continued to expand and develop that business. In September of 1936, but as of August 22, 1936, petitioner bought the business and assets of *16 a major competitor, with its main plant in Louisville, Kentucky, but with warehouses from which distributions were made in Paducah, Kentucky, and Knoxville, Tennessee. Thereafter in 1937, finding the Knoxville warehouse inadequate, petitioner rebuilt that facility and erected a plant with machinery for manufacturing and processing the products handled by it comparable to that at Louisville and at other branches. In the spring of 1937, and under an arrangement with the Andersen Corporation of Minnesota, petitioner began the handling of complete or unit window assemblies produced by the Andersen Corporation. 1. Held, that with respect to the Insulite and Andersen products, petitioner has failed to prove the necessary facts to show that its average base period net income with respect thereto was an inadequate standard of normal earnings for that period. 2. Held, that the beginning of the manufacturing and sale of venetian blinds in 1935 was a change in the character of petitioner's business within the meaning of section 722 (b) (4), that such venetian blinds business did not, by the end of the base period, reach the earning level it would have reached if such business had been*17 commenced 2 years before it was. 3. Held, that the acquisition of the business and assets of its competitor centered in Louisville, Kentucky, resulted in the elimination of such competitor and in an increased capacity for production for petitioner, and was a change in the character of its business under section 722 (b) (4); that the building of the new plant and facility at Knoxville was likewise a change in the character of petitioner's business, and that, by reason thereof, the business had not, by the end of the base period, reached the earning level which it would have reached if it had had the new facility 2 years before it did. 4. Held, that petitioner's business was not depressed in the base period by reason of conditions covered by section 722 (b) (3) (A). 5. A fair and just amount representing normal earnings to be used as petitioner's constructive average base period net income for the purposes of section 722 determined. Ferdinand Tannenbaum, Esq., for the petitioner. David Karsted, Esq., for the respondent. Turner, Judge. TURNER *18 *551 The respondent has disallowed in full the petitioner's applications for relief under section 722 of the Internal Revenue Code of 1939, and related claims for refund of excess profits tax for the calendar years 1940, 1941, and 1942, in the amounts of $ 13,776.14, $ 106,446.64, and $ 136,692.36. In his notice of disallowance, he also determined deficiencies in excess profits tax of $ 736.79 for 1940 and $ 1,265.84 for 1941. No errors have been assigned with respect to the determination of deficiencies. The questions presented are whether the petitioner is entitled to relief from excess profits tax for the years 1940, 1941, and 1942, under sections 722 (b) (3) (A) and 722 (b) (4) of the Internal Revenue Code of 1939. The petitioner alleges that it made several changes in the character of its business within the meaning of section 722 (b) (4), and further, that its business was*19 depressed within the meaning of section 722 (b) (3) (A). FINDINGS OF FACT. Some of the facts have been stipulated and are found as stipulated. Petitioner, a member of the Ponderosa Pine Stock Woodwork Industries, is a Delaware corporation, and was organized on January 1, 1913. Its principal office is located in St. Louis, Missouri. It keeps its books *552 and files its returns on an accrual basis and for calendar years. It filed its Federal tax returns for the years 1940, 1941, and 1942 with the collector of internal revenue for the first district of Missouri. Applications for relief under section 722 were duly filed for each of the years herein. The petitioner is a taxpayer entitled to use the excess profits credit based on income pursuant to section 713 of the Code. Its excess profits net income, its excess profits credit computed under the invested capital method, and its average base period net income for the years 1940, 1941, and 1942 were as follows: Excess profits credit Average base Excess profits computed under period net Year net income invested income capital method [1940] $ 241,711.36 $ 185,245.84 $ 136,730.43 [1941] 568,340.07 193,214.97 172,839.43 [1942] 556,543.29 202,866.72 172,839.43 *20 Prior to and during the years 1936 through 1939, the petitioner was engaged in the business of manufacturing millwork products and the sale thereof, plus various building materials produced by other companies, for use in the construction and repair of buildings. Its millwork included both custom-made and non-custom wood products. The custom millwork was done exclusively in St. Louis, in what is referred to as the factory. It embraced the manufacture of window sash and frames, doors, trim, cabinets, etc., according to the designs and specifications of architects, for sale largely to contractors in the vicinity of St. Louis for use in the higher priced residences and in hotel and apartment buildings. Non-custom millwork in St. Louis was done in what was known as the warehouse, which was equipped for the manufacture of window sash, frames, and doors from standard stock and for the assembling and glazing of knocked-down window sash, frames, and doors. Similarly, petitioner also produced in its warehouse special or off-size sash, frames, and doors from standard stock. The warehouse department also handled the sale and distribution, primarily to lumber dealers, of petitioner's non-custom*21 millwork and numerous building materials, which in addition to the sash, frames, and doors, included moulding, trim, cabinets, wallboard, insulation material, roofing, screens, weatherstripping, storm sash and doors, and various types of hardware. From time to time, prior to and during the base period years, the petitioner established in various cities, chiefly in the southern and southeastern part of the United States, numerous branch facilities, which carried on business substantially the same as that conducted in and from the St. Louis warehouse department. *553 During the years 1936 through 1939, petitioner had 6 branch facilities, which were located at Jacksonville, Florida, Columbus, Ohio, Charlotte, North Carolina, Roanoke, Virginia, Louisville, Kentucky, and Knoxville, Tennessee. In addition, petitioner owned all of the stock of 3 subsidiary companies, which were equipped for and engaged in business similar to that of the St. Louis warehouse department. These subsidiaries were the Birmingham Sash & Door Company, in Birmingham, Alabama; the Huttig Sash & Door Company of Texas, in Dallas, Texas; and the Memphis Sash & Door Company, in Memphis, Tennessee. Petitioner also*22 owned all of the stock of the Manchester Manufacturing Company, of St. Louis, which was engaged in constructing small buildings, and 60 per cent of the stock of the MissoulaWhite Pine Sash Company, of Missoula, Montana, which supplied about 80 per cent of petitioner's requirements for knocked down sash and frame. The branch at Jacksonville had been opened in 1923, and had operated continuously. The establishment of the branch at Columbus resulted from the purchase, in 1926, of the inventory of the McCleary Timber Company in that city. The branch at Charlotte was opened in 1934. An earlier branch in Charlotte had been established in 1928, and sold in 1930. The Roanoke branch was opened in 1934, as a result of the purchase of the assets of and the leasing of the property occupied by the Roanoke Glass & Door Company. In 1936, as more fully set out hereafter, the petitioner purchased the business and assets of the W. J. Hughes & Sons Company, which had a manufacturing plant at Louisville, Kentucky, and warehouses at Paducah, Kentucky, and at Knoxville, Tennessee. It closed the Paducah warehouse in 1937, and constructed manufacturing facilities at Knoxville similar to those of its*23 other branches. In 1924 petitioner had opened an extension, or branch, of the Jacksonville facility at Miami. The operation there continued until 1928, when it was closed. Similarly, petitioner opened a warehouse in Tampa in 1925, and closed it in 1929. The facilities at St. Louis and Jacksonville were the only facilities in continuous operation from 1923 to 1939, inclusive. The Birmingham Sash & Door Company was organized in 1919, with the petitioner owning 75 per cent of the stock. It acquired the remaining 25 per cent in 1928. The Huttig Sash & Door Company of Texas was organized in 1921, under the name of Dallas Sash & Door Company. The name was changed in 1926. Petitioner at all times owned all of its stock. The Memphis Sash & Door Company was organized in 1924, with petitioner owning 90 per cent of its stock. The remaining 10 per cent was acquired sometime prior to 1936. The petitioner acquired its 60 per cent holding of stock in the Missoula White Pine Sash Company in 1920. *554 The Missoula White Pine Sash Company held timberland and operated sawmills. It also operated a manufacturing plant at Missoula, Montana, where it manufactured knocked-down sash and *24 frame of stock sizes and cut stock lineal materials for making window sash and frame in off-sizes. It supplied approximately 80 per cent of petitioner's requirements for knocked-down sash and frame. All orders for such materials from petitioner's branches were made through the St. Louis office, where any necessary allocations were made. The shipments were made directly from Missoula to the branch locations. The Manchester Manufacturing Company was organized by petitioner in 1916, and petitioner owned all of its stock until it was dissolved on January 1, 1940. Throughout the period of its existence, until it discontinued operations in 1939, that company was engaged in the business of manufacturing, assembling, and erecting small homes, portable school buildings, and garages in the St. Louis area. It sustained operating losses for the base period years of $ 2,604 for 1936, $ 3,899 for 1937, $ 3,704 for 1938, and $ 4,553 for 1939. The petitioner and the Manchester Manufacturing Company maintained separate books and records, but for the years 1916 through 1933 filed consolidated tax returns. Originally petitioner supplied its customers from St. Louis, and even after various of the*25 branch facilities had been established that practice was continued to a substantial degree. By 1929, however, a plan was under way to expand the operations of the branches by having each branch gradually take over all the territory it could serve to a better advantage than from St. Louis, freight rates and other factors being considered. It was expected that this new plan of operation would reduce the volume of sales from St. Louis by approximately $ 800,000 a year. To offset this loss in sales from St. Louis, petitioner planned to manufacture at the St. Louis warehouse substantially all of its requirements for telephone cabinets, ironing board cabinets, kitchen cabinets, and other specialties. The greater part of the loss in St. Louis sales was to be made up, however, by increased efforts to secure a larger volume of business in the St. Louis area. During the base period years, most of the State of Missouri, southern Illinois, and 12 counties in northeastern Arkansas were served from St. Louis. The Jacksonville branch served the State of Florida and most of Georgia. The Columbus territory was in Ohio and had a radius of approximately 100 miles, with Columbus as the center. *26 The Roanoke branch served Virginia and West Virginia. The Charlotte branch served the States of North Carolina and South Carolina. The Louisville branch served most of the State of Kentucky, middle Tennessee, and southern Indiana. The Knoxville branch served eastern Tennessee, together with a small area of southeastern Kentucky*555 and similarly a small portion of northern Georgia. Alabama and a part of Georgia were served from Birmingham, by the Birmingham Sash & Door Company. Western Tennessee, Mississippi, and most of Arkansas were in the territory of the Memphis Sash & Door Company. The Huttig Sash & Door Company of Texas served north central and northeastern Texas. Insulite Products. On April 20, 1933, the petitioner entered into an agreement termed a "Memorandum of Understanding" with the Insulite Company, of Minneapolis, Minnesota, covering an arrangement for the distribution by petitioner of a wide variety of insulation board and hardboard products. They included insulation board and hardboard used for sheathing, laths, tile for acoustical purposes, planking for interior decoration, plaster bases, interior dry-wall construction where plaster is not used, termite*27 board, roof insulation, and cold storage insulation board, all of which were sold under the trade name of Insulite. Insulite was first manufactured in the early 1920's and was the first rigid insulation board made. It is made from wood pulp ground cold under a patented process, with extra long fibers which give it greater tensile strength. Asphalt is used as an ingredient to prevent fungus rot and other deterioration. Under the contract, it was agreed that the sales representatives of the two companies would immediately endeavor to secure sufficient orders for Insulite from the lumber dealer trade to form a nucleus for carload shipments. Any balances of such cars were to be filled with assorted stock of Insulite products "for the account of the Huttig Sash & Door Company to be shipped to their warehouses" at Dallas and Birmingham. The unsold portions of the carloads were to be stored in the said warehouses, and it was understood that the States of Texas, Louisiana, Alabama, Mississippi, and Georgia were to be served from those warehouses. As to Dallas, both the portion of the carload shipments which had been sold and the portion which was to be stored in the warehouse, pending*28 sale, were to be billed to Huttig, according to the regular payment terms of Insulite, which were "2% fifteen days, sixty days net." In the case of the shipments to the Birmingham area, only the portion sold in advance was to be so billed, whereas the portion not so sold was to be stored in the warehouse for Insulite's account "under regular consignment agreement with Birmingham Sash & Door Company." The Insulite Company agreed that it would handle through the Huttig Company all of the carload business that could be transacted in that manner, without loss of patronage, and that it would endeavor to handle all of its business in those territories through the Huttig Company as rapidly as it could be accomplished. The Huttig Company obligated itself to purchase its entire requirements *556 of insulating board for the territories mentioned from the Insulite Company. It also agreed to observe at all times the regularly established dealer price scale of Insulite. It was to handle all invoicing and collections in the territories, and was to receive active sales assistance, supplemented by necessary literature, reasonable advertising, and full cooperation from Insulite. The agreement*29 was referred to as a preliminary undertaking "looking forward to the consummation of a formal contract to cover similar operations" in Tennessee, Virginia, South Carolina, North Carolina, West Virginia, Florida, eastern half of Missouri, Kentucky, and the southern part of Illinois. It was further agreed that pending completion of such later arrangement, the sales representatives of both companies would immediately collaborate with each other in an attempt to institute "pool-car business," to be handled by the Huttig Company, in Kentucky, Tennessee, West Virginia, and Florida. Pursuant to the agreement of April 20, 1933, the petitioner began making sales of Insulite in its St. Louis and all of its branch territories, except that Insulite products were already being sold from Columbus and had been so sold when and at all times since that branch was acquired in 1926. Under date of January 21, 1935, the formal contract envisioned in the agreement of April 20, 1933, was executed by the Insulite Company, on the one hand, and the Huttig Sash & Door Company, Memphis Sash & Door Company, Birmingham Sash & Door Company, and Huttig Sash & Door Company of Texas, on the other. Under that contract, *30 the Insulite Company granted exclusive rights for the sale of its products, except as to certain specified classes of trade for the States of Louisiana, 1Florida, Georgia, South Carolina, North Carolina, Tennessee, Alabama, and Mississippi; specified parts of the States of Virginia, West Virginia, Illinois, Missouri, Kentucky, and Texas; and the State of Arkansas, from and after February 1, 1935. Insulite agreed to supply to Huttig and Huttig agreed to take from Insulite all of its requirements of insulation board and hardboard products. Huttig also agreed that it would sell at Insulite's published prices and at the rates of commission shown in a schedule attached to the contract. Huttig agreed to sell the Insulite products under the name of "Insulite," and under no other name, and that it would observe the selling policies, method, and conditions of sale laid down by Insulite. Insulite was to pay the freight on all direct shipments to Huttig's customers or to Huttig warehouses. Huttig was to pay the freight on all shipments resold from the warehouse stocks. All shipments made to the warehouses in St. Louis, Jacksonville, Birmingham, Memphis, *557 Roanoke, Charlotte, *31 and Dallas were to be on a consignment basis, and storage was to be at Huttig's expense. The title to the consigned stocks remained in Insulite. The petitioner was to be responsible and liable to Insulite for the value of all consigned stocks, such liability "to be in addition to the liability of the respective subsidiary companies." Huttig was to assume full responsibility for invoicing and collecting all accounts "covering its resale of Insulite products, whether made from consigned stocks, stocks shipped on open account, or by direct shipments from the Insulite Company to Huttig's customers." Insulite was to supply Huttig, free of charge, with literature, samples, and selling "helps," and Huttig agreed not to "make any representation or give any warranty in respect of Insulite products other than those contained in the literature" so provided. Huttig assumed the entire responsibility for shipping instructions and methods of pooling shipments, and Insulite was not to be responsible with respect thereto. The agreement was to run for a period of 5 years from January 21, 1935, subject to certain specified rights of termination. *32 The prices at which the Insulite products were to be sold and the commissions the petitioner was to receive, as specified in the contract, varied as between dealers, jobbers, and dealer distributors. There were also some variations in the prices and commissions with respect to sales to roofing contractors, cold-storage contractors, reserve supply companies, the Federal Government, and industrial cold-storage users, and with respect to sales made for use on Federal Government jobs only. In the case of one-half inch building board, for instance, and as between dealers, jobbers, and dealer distributors, the prices per thousand feet, surface measurement, for carload lots in all zones, were $ 33, $ 30, and $ 31, respectively, whereas the commissions to petitioner were $ 7.79, $ 4.79, and $ 5.79, leaving a net price to be transmitted by petitioner to Insulite of $ 25.21 per thousand feet in the case of sales in all 3 categories. For the purposes of the contract, the prices and commissions on all of the products varied substantially as between half carload, quarter carload, and less than carload lots, and as between zones. The zones specified were Eastern, Western, and Southern. Under*33 date of February 2, 1935, the Insulite Company contracted with the Masonite Corporation, of Laurel, Mississippi, for the manufacture of all of its needs for hardboard, after which Insulite discontinued the manufacture of that product. Under date of May 1, 1935, the Insulite Company entered into a contract with the petitioner and its subsidiaries to provide for the sale by them of hardboard manufactured for Insulite by the Masonite Corporation. Insulite's contract with the Masonite Corporation had provided that the hardboard so procured could be sold under the name of Insulite. Generally, the provisions of the May 1 contract relating to the hardboard *558 manufactured by Masonite were comparable to those in the contract of January 21, 1935. The contract did carry its own list covering the prices to dealers, Huttig's commission, and Huttig's net cost. It was also specified that these prices were f. o. b. Laurel. The Texas territory was extended to all of Texas, except El Paso County, and some counties in Illinois were dropped. Also on May 1, 1935, minor revisions were made to the contract of January 21, with reference to the products Insulite continued to manufacture. As*34 was done in the hardboard contract, the Texas territory was extended to all of Texas, but one county, and some Illinois counties were dropped. On February 1, 1936, a revised contract between the Insulite Company and the petitioner and its subsidiaries covering the Insulite products manufactured by the Insulite Company was executed. This contract contained new schedules of prices, a restatement of the provisions as to the parties to whom Insulite reserved the right to sell its products, and changed the provision with respect to the payment of freight charges. Under this contract, the Insulite products were charged to Huttig, f. o. b. the Insulite Company plant at International Falls, Minnesota, the adjustment, if any, for this change being made effective in the new schedule of prices. In other respects, the contract did not substantially vary the prior arrangement between Insulite and petitioner and its subsidiaries. A supplement to the hardboard contract was also executed on February 1, 1936, whereby 6 counties in Kansas and 3 counties in Oklahoma were added. In November of 1936, the 6 counties in Kansas and, effective May 1, 1937, the 3 counties in Oklahoma were stricken from*35 the petitioner's sales territory and released to Insulite. Effective May 1, 1937, 15 counties in north central Illinois and 7 counties in northeastern West Virginia were released by petitioner to Insulite. Effective the same date, 18 counties in Indiana were added to petitioner's territory. The addition of the 18 counties in Indiana and the release of the 15 counties in north central Illinois covered both hardboard and insulation board products. The contracts between the Insulite Company and petitioner and its subsidiaries both with respect to Insulite products and hardboard products were rewritten and executed under date of February 1, 1939. For the purposes of this case, the contracts, insofar as appears, were in substance a restatement of prior contracts. New schedules of prices were attached and the provisions governing the reservation of rights of direct sale by Insulite in the territory granted to petitioner were restated. Effective as of June 1, 1939, the right to sell Insulite and hardboard products in the State of Texas was released to the Insulite Company, except for certain named counties in the northeastern *559 and north central parts of the State. These counties, *36 as had been true theretofore, were to be serviced by the Huttig Sash & Door Company of Texas. Effective September 1, 1939, the petitioner released to the Insulite Company its right to sell both Insulite products and hardboard products in 4 counties in the State of Missouri and 6 counties in the State of Arkansas. Following the execution of the contract of January 21, 1935, petitioner, in connection with its program for the promotion of sales of Insulite prducts, set up an engineering department and conducted an educational program for architects, contractors, engineers, jobbers, and dealers. It took into its organization in the assigned territories about one-third of the former employees of the Insulite Company therein, and Insulite lent its aid in the procurement of some additional personnel. The shipments of Insulite products by the Insulite Company for the years 1931 to 1939, inclusive, and the petitioner's sales of Insulite products for the years 1934 to 1939, inclusive, in terms of thousands of square feet, were as follows: Shipments by the Sales by petitioner in M sq. ft. Insulite Company Year All M sq. ft. branches Columbus Total except Columbus [1931] 67,687 [1932] 48,794 [1933] 49,443 [1934] 48,289 1 1,184 [1935] 56,064 2,589 [1936] 108,640 3,627 1 570 4,197 [1937] 130,208 4,201 1 57 4,358 [1938] 98,382 6,675 1 302 6,977 [1939] 121,467 7,760 1 682 8,442 *37 The petitioner's sales in dollars, given in round figures, of Insulite products according to the territories of petitioner's various branches, for each of the years 1934 to 1939, inclusive, were as follows: [1939] St. Louis $ 26,173 $ 50,934 $ 53,969 $ 62,942 $ 52,160 $ 70,161 Columbus [1] 21,080 2,462 10,262 23,193 Jacksonville 5,678 13,826 16,822 15,500 31,511 16,190 Roanoke 7,264 37,630 38,695 44,160 49,737 57,137 Charlotte 4,939 22,468 24,309 34,982 38,125 45,580 Louisville 16,502 24,308 36,343 Knoxville 12,634 28,501 38,696 Total 44,054 124,858 154,875 189,182 234,604 287,300 *560 Under the contracts with the Insulite Company, the petitioner would bill and collect the full selling price of Insulite products from the dealers to whom sales were made and would report the sales to Insulite. Insulite would then bill petitioner at net prices, after the making of the allowances due petitioner for its commissions on the sales and any other items for which Insulite was obligated under the contract. The transactions*38 with respect to Insulite products being handled in that manner, the petitioner would not become the owner of any Insulite inventory. 2 Andersen Products. In the spring of 1937, the petitioner entered into an oral agreement with the Andersen Corporation, of Bayport, Minnesota, to distribute casement and double-hung sash and frames comprising complete window assemblies produced by the Andersen Corporation. Andersen Corporation agreed to put engineers in petitioner's territory to assist petitioner in its contacts with architects and contractors. Andersen also supplied architects with materials for tracing its window units on their plans and for instructing building contractors in the installation of those units. The petitioner was not the exclusive*39 dealer for Andersen products in its market area. The Andersen double-hung window unit consisted of a complete assembly of frame, sash, weights, storm sash, and screen, and the casement unit was likewise a complete window unit. In one type of casement window the sash would slide sideways in a channel cut in the sill. The window units had numerous special features of design and construction which had been developed by Andersen and which were covered by various patents. The jamb was designed to lock into the sill so as to prevent the absorption of moisture. The window had a device which permitted double glazing. The storm sash was fitted on the outside of the jamb and a metal insert screen was fitted on the inside of the window. The hardware used was of Andersen's own design. The Andersen window units were manufactured from sugar pine and Idaho pine, and were comparable to custom millwork in quality. This pine was of a better quality than Ponderosa pine. The Andersen units were used in better class residences, apartments, and apartment hotels. They were delivered to purchasers as completely assembled units, ready to set in place in the course of the erection of a building. *40 Assembly costs to a building contractor were accordingly absorbed in the price paid for the window. *561 The custom-made sash and frame produced by petitioner in its St. Louis factory according to architects' specifications were not assembled by petitioner as complete units, but were delivered as separate parts. The costs of assembly to the building contractor were not covered by the price paid for the various parts of the completed window. The ultimate cost of petitioner's custom-made window, when installed, was comparable to that of the Andersen window. Petitioner's custom-made windows were sold from the St. Louis factory and much, at least, of the potential market therefor in the branch territories was not exploited. The Andersen products were sold from all of petitioner's branch establishments, and as was true of petitioner's custom-made windows, the Andersen windows were sold to purchasers not reached by petitioner's stock products. In addition, when petitioner sold Andersen window units for a structure, it was in a more favorable position to sell other items of millwork and materials for the same job. Petitioner's purchases of Andersen products for distribution from *41 the St. Louis warehouse and its six branch facilities, for the years 1937, 1938, and 1939, were as follows: [1939] St. Louis $ 5,242.75 $ 30,460.92 $ 12,386.47 Jacksonville 5,331.39 5,189.40 5,112.87 Columbus 7,329.92 6,688.00 12,211.62 Roanoke 31.97 13,968.81 23,965.23 Charlotte 457.26 19,128.51 63,491.34 Lousiville 8,355.75 11,732.40 10,249.07 Knoxville 2,023.95 4,860.55 6,789.77 Total 28,772.99 92,028.59 134,206.37 Beyond the recording of its purchases and possibly its opening and closing inventories of Andersen products, petitioner maintained no separate or segregated account of its dealings therein or the profit or loss result thereof for any of the base period years. Venetian Blinds. In February 1935, the petitioner began to manufacture, assemble, and distribute venetian blinds. For that purpose, it organized a completely separate operation at St. Louis. It installed new specialized machinery and began distribution of the blinds through lumber dealers. In 1936, it expanded its avenues of distribution to include manufacturers' agents, awning manufacturers and distributors, interior decorators, and department stores. These*42 were new channels of distribution, with which petitioner had had no previous contact. In 1937, it installed machinery for manufacturing metal venetian blinds, and began the manufacture and distribution thereof. *562 The petitioner's sales of and operating net income (or loss) from venetian blinds for the years 1935 to 1939, inclusive, were as follows: Operating net Year Sales profit (or loss) [1935] $ 6,862 ($ 6,072) [1936] 46,116 (15,721) [1937] 66,442 (5,687) [1938] 94,120 4,602 [1939] 181,904 12,777 From its venetian blinds operation, the petitioner sustained an average net operating loss of $ 1,007 for the base period. According to the Census of Manufacturers, the value of production of venetian blinds in the United States for the census years 1931, 1933, 1935, 1937, and 1939, was as follows: Value Year ($ 1,000) [1931] $ 1,396 [1933] 1,446 [1935] 1,507 [1937] 2,780 [1939] 5,258 By the end of 1938, the petitioner had overcome most of its production and marketing difficulties which it had encountered in starting its venetian blind business, and while by the end of 1939 it had approached a normal level of earnings for that branch of its business, it *43 had not reached the earning level which it would have reached if it had commenced such business 2 years before it did so. And by reason thereof, petitioner's average base period net income computed without reference to section 722 is an inadequate standard of normal earnings. Hughes Company. The W. J. Hughes & Sons Company, of Louisville, Kentucky, hereafter referred to as the Hughes Company, had been one of if not petitioner's most potent competitor for over 30 years. It manufactured, assembled, and glazed knocked-down sash and frame, and distributed the same line of products as that distributed by petitioner. In Louisville it had machinery and equipment for manufacturing the various millwork items in a manner comparable to that of petitioner at its St. Louis warehouse and at its various branch establishments. It had warehouses at Paducah, Kentucky, and Knoxville, Tennessee. After the manufacturing and processing had been done at Louisville, shipments of production were in tractor trailers to the Knoxville and Paducah warehouses for distribution to the dealer trade. Distribution to dealers was also made from the Louisville plant. On September 9, 1936, the petitioner entered*44 into a contract to purchase the business and certain assets of the Hughes Company at *563 a price of $ 213,452.90. The assets acquired by petitioner were connected with the wholesale business and consisted of all stock in trade at Louisville, Knoxville, and Paducah, contracts made or in force on or after August 22, 1936, outstanding accounts and bills receivable, and claims; office furniture, fixtures, supplies, equipment, etc.; goodwill, brands, copyrights, trademarks, trade names, and patents; and the right to use the name of the Hughes Company. The Hughes Company agreed not to engage, directly or indirectly, in the wholesale buying or selling of sash, doors, or allied materials for 10 years. It retained its buildings, but leased office and warehouse space and the plant and the machinery and equipment therein at Louisville to petitioner, for a period of 5 years, beginning October 1, 1936. It also leased to petitioner its warehouse facilities at Paducah and Knoxville. Petitioner closed the warehouse at Paducah in 1937. The Hughes Company had capable personnel and a complete selling organization, which petitioner was able to "fuse" into its own organization. The selling*45 organization extended into Florida, North Carolina, South Carolina, West Virginia, Virginia, Alabama, and Georgia, as well as Kentucky and east Tennessee, and was in competition with petitioner's Charlotte, Roanoke, and Jacksonville branches, as well as the operations centered in St. Louis. After acquisition, the Hughes Company operations were designated as Hughes Division -- Huttig Sash & Door Company. The stationery used during the first 2 years was headed "W. J. Hughes & Sons Company," with the words "Division of Huttig Sash & Door Company" appearing in small print. Within that time petitioner was successful in its efforts to win over and retain the loyalty of the dealers of the Hughes Company, and thereafter the designation of "W. J. Hughes & Sons Company" was dropped and the operation was conducted under the name "Huttig Sash & Door Company -- Hughes Division." Petitioner found the Knoxville warehouse inadequate to serve its territory as fully and completely as it normally did in its operations elsewhere, and in 1937 a new building was erected and equipped with machinery for carrying on manufacturing operations necessary to service the territory served and to be served from*46 Knoxville, to the end that the manufacturing for the area to be served and theretofore done at Louisville could be done at Knoxville. After employing and training the necessary personnel, petitioner was in a position to "properly service" the east Tennessee territory. While the contract with the Hughes Company was not executed until September 9, 1936, petitioner took over the business and operated it from August 22, 1936. The net sales and operating net profit of the "Hughes Division" for the periods indicated were as follows: *564 Period Aug. 22 to Dec. 31, 1936 Operating Sales net profit Louisville $ 202,280 $ 15,586 Knoxville 90,932 7,779 Paducah 19,589 1,230 Period 1937, 1938, and 1939 Louisville Knoxville Operating Operating Year Sales net profit Sales net profit [1937] $ 584,667 $ 46,058 $ 272,218 $ 22,445 [1938] 417,779 9,402 269,226 13,153 [1939] 518,557 27,986 360,529 27,520 The percentage of net profits to sales for the Hughes Division and for all of the operations of the petitioner, for the indicated periods, were as follows: All operations of Hughes Division petitioner Year Percentage Year Percentage Aug. 22 to Dec. 31, 1936 7.93 [1936] 5.16 [1937] 8.04 [1937] 7.92 [1938] 3.21 [1938] 2.05 [1939] 6.31 [1939] 4.46 *47 The acquisition of the assets of the Hughes Company eliminated competition and increased petitioner's capacity to manufacture, assemble, and glaze knocked-down sash and frame parts. After such acquisition, the Hughes Division serviced areas which petitioner had serviced theretofore from St. Louis. In abandoning the Knoxville warehouse as theretofore operated, and erecting a new manufacturing and assembling facility at Knoxville in 1937, the petitioner further increased the capacity for production of its Hughes Division. The east Tennessee marketing area, including Knoxville, Chattanooga, and Johnson City, was a prosperous one, in which there was a generally increasing demand for housing and other building construction attributable to the activities of the Tennessee Valley Authority. By the end of 1939, the business of the Hughes Division was at a normal level of earnings for the operation which had been acquired by petitioner in 1936, from the W. J. Hughes & Sons Company, but it had not, by the end of 1939, reached the earning level it would have reached if it had had the new plant at Knoxville 2 years before it did. Because of the change in petitioner's business thorugh the elimination*48 of its competitor, the Hughes Company, and the erection of the new plant at Knoxville, petitioner's average base period net income computed without reference to section 722 is an inadequate standard of normal earnings. *565 Facts Relating to Applicability of Section 722 (b) (3) (A). For the years 1922 to 1939, inclusive, petitioner's total gross sales to customers and its operating profit (or loss), as shown by its records, and related indexes on a 1922-1939=100 basis, were as follows: Year Sales to Index Net profit Index customers 1922-1939=100 (or loss) 1922-1939=100 [1922] $ 2,937,922 107.35 $ 355,253 290.36 [1923] 3,633,591 132.77 485,588 396.89 [1924] 3,492,417 127.61 281,528 230.11 [1925] 4,046,603 147.86 487,073 398.11 [1926] 4,043,709 147.76 312,735 255.61 [1927] 2,996,392 109.49 (27,915) (22.82) [1928] 2,889,414 105.58 44,202 36.13 [1929] 2,509,651 91.70 (56,952) (46.55) [1930] 2,114,776 77.27 (115,114) (94.08) [1931] 1,440,095 52.62 (143,811) (117.54) [1932] 1,034,937 37.82 (140,798) (115.08) [1933] 1,041,025 38.05 (440) (.36) [1934] 1,252,421 45.76 (24,507) (20.04) [1935] 2,087,044 76.27 63,322 51.76 [1936] 3,032,379 110.80 156,398 127.83 [1937] 3,669,510 134.09 289,349 236.50 [1938] 3,216,303 117.53 65,686 53.69 [1939] 3,822,454 139.67 170,648 139.48 Av. 1922-1939 $ 2,736,702 100.00 $ 122,347 100.00 Av. 1936-1939 $ 3,435,162 125.52 $ 170,520 139.37 *49 As the result of restrictions on building construction during World War I, there was both an increase in the demand for and in the actual construction of housing during the early 1920's. The Florida land boom of the 1920's resulted in abnormal building activity in that State during 1924, 1925, and 1926. During the 1920's and 1930's there was a substantial movement of various types of industries into southern States embraced in the petitioner's market area which affected the demand for housing. At various times during the period from October 1933 to May 1939, the Tennessee Valley Authority commenced the construction of eight dams variously located in Tennessee, northern Alabama and western North Carolina, of which two were completed in 1936, one in 1938, one in 1939, and the remainder at different times from 1940 to 1945. In the general area of the dam sites, and from and after the beginning of construction of the dams, there was an increased demand for housing and other building construction. During the years 1922 through 1939 the petitioner's St. Louis factory sales and its St. Louis warehouse department sales did not necessarily fluctuate in the same direction; that is, one *50 might rise, while the other fell, during any given period of time. During the early 1930's the petitioner took on allied lines of materials used in repair and replacement work, which, although offering a short margin of profit, helped petitioner's volume of profits in the St. Louis warehouse *566 department and branch facilities. Over the years, as petitioner expanded the policy of establishing additional branch facilities, its custom millwork factory in St. Louis became less important to petitioner's business as a whole, and the St. Louis warehouse department experienced substantial losses of sales by reason of the taking over by the branches of territory formerly served from St. Louis. The petitioner could profitably sell and ship less than carload lots from its branches, and for that reason began to sell to many dealers who were not in a position to buy in carload lots. A branch could service the needs of a dealer in its territory more effectively than could be done from St. Louis. The branches were also in a better position to make adjustments of discounts on list prices and of freight and packing charges to meet competition within their respective territories. Because*51 of varying conditions and elements entering into the making of sales and affecting profits thereon within any particular territory, and with respect to the facility serving a territory, the amount of sales and the amount of profits did not necessarily fluctuate in the same direction; that is, sales might rise and profits might fall, or vice versa, within a given period of time. A survey of the Ponderosa Pine Stock Woodwork Industry, of which petitioner was a member, shows with respect to 17 out of 28 members, the relation of the average 1936-1939 net sales to average 1922-1939 net sales; the relation of average 1936-1939 net income to average 1922-1939 net income; and the average 1936-1939 relation of net income to net sales, as follows: Average sales Average net Average Corporation 1936-1939, income relation net 1922-1939=100 1936-1939, income to 1922-1939=100 net sales 1936-1939 Individual corporations: A 100.74 326.41 4.66 B 100.38 21.59 0.96 C 121.12 190.12 9.31 D 133.47 411.53 6.48 E 94.76 18.28 2.08 F 85.42 (11.59) (1.22) G 99.17 31.35 3.06 H 106.91 403.21 4.18 I 93.41 16.64 1.11 J 186.88 246.56 2.42 K 87.49 66.79 5.39 L 115.05 125.73 5.58 M 121.12 111.67 7.20 N 98.36 13.20 0.97 O 90.85 26.14 4.09 P 99.13 (454.70) (1.69) Q 124.13 152.99 10.56 *52 The compiled earnings of all corporations in the United States filing corporate income tax returns for the years 1922 to 1939, inclusive, *567 discloses net profit (or loss) before Federal income taxes, for each of those years, resulting in the following averages: Total less tax-exempt Total as reported Total less tax-exempt income and plus income interest paid Index Index Index Amount 1922- Amount 1922- Amount 1922- ($ 1,000,000) 1939=100 ($ 1,000,000) 1939=100 ($ 1,000,000) 1939=100 Average 1922-39 5,825 100.0 3,434 100.0 7,135 100.0 Average 1936-39 6,728 115.5 3,724 108.4 6,662 93.4 The compiled value of contracts awarded, in thousands of dollars, for total building, excluding manufacturing and not including public works and utility construction, in States wholly or partially in the petitioner's market area, for each of the years 1922 to 1939, inclusive, discloses a general over-all picture of substantial amounts of contracts awarded in 1922 to 1928, some decline in 1929, greater declines in 1930 and 1931, a marked drop in 1932 and 1933, increases in 1934 and 1935, and fairly substantial amounts*53 in 1936 to 1939, resulting in the following averages: Contracts awarded -- valuation (thousands of dollars) States wholly in petitioner's States not wholly in petitioner's market area market area Average Average States States 1922-1939 1936-1939 1922-1939 1936-1939 Florida 57,401 59,209 Missouri 77,418 56,052 Georgia 30,934 30,112 Tennessee 29,203 28,011 Kentucky 25,819 28,665 Illinois 251,322 108,517 North Carolina 36,482 36,094 Indiana 49,852 43,956 South Carolina 11,433 16,897 Ohio 161,223 123,756 Virginia 32,667 43,739 West Virginia 15,070 15,839 The petitioner's business was not depressed in the base period years 1936 to 1939, inclusive. A fair and just amount representing normal earnings to be used as petitioner's constructive average base period net income, for the purpose of section 722, is the amount which exceeds petitioner's average base period net income computed without reference to section 722 by $ 33,000. OPINION. It is the claim of the petitioner that its excess profits tax for the years 1940, 1941, and 1942 computed without the *568 benefit of section 722 of the Internal Revenue Code*54 of 19393 results in an excessive and discriminatory tax, and that it qualifies for section 722 relief because of five changes in the character of its business within the meaning of section 722 (b) (4) and because its business was depressed in the base period within the meaning of section 722 (b) (3) (A). *55 To qualify under section 722 (b) (4) for the relief provided by section 722 (a), a taxpayer's average base period net income must have been an inadequate standard of earnings because "the taxpayer, either during or immediately prior to the base period, commenced business or changed the character" of its business and its actual "average base period net income" did "not reflect the normal operation" of the business "for the entire base period." And for the purposes of section 722 (b) (4), there was a change in the business if during or immediately prior to the base period there was "a difference *569 in the products or services furnished" or a difference in the taxpayer's "capacity for production or operation." It is also provided that if, by the end of the base period, the business did not reach "the earning level it would have reached if the taxpayer had * * * made the change * * * two years before it did so, it shall be deemed to have * * * made the change at such earlier time." It is the claim of the petitioner that there were five such changes in the character of its business either during or immediately prior to the base period. The claimed changes were (1) the execution*56 of the contract with Insulite on January 21, 1935, and the subsequent selling of Insulite products thereunder; (2) the distribution of Andersen windows, beginning in the spring of 1937; (3) the manufacture and sale of venetian blinds, commencing in 1935; (4) the elimination of a substantial competitor through the purchase of the wholesale business of W. J. Hughes & Sons Company in 1936; and (5) the construction, in 1937, of a new plant and facilities replacing the Knoxville warehouse of the recently acquired Hughes Company business. As to Insulite products, Andersen windows, venetian blinds, and the Knoxville facility, it is the claim of the petitioner that its business had not, by the end of the base period, reached the earning level it would have reached if each of the changes had been made 2 years before it was. As to the Louisville branch, the petitioner concedes that its business did reach its normal level of earnings in 1939. It is the position of the respondent that neither the execution of the contract with Insulite on January 21, 1935, and the subsequent selling of Insulite products thereunder, the distribution of Andersen windows, beginning in the spring of 1937, nor the*57 construction of a new plant and facilities at Knoxville, in 1937, was a change in business within the meaning of section 722 (b) (4). He concedes that the commencement of the manufacture and sale of venetian blinds in February of 1935 was such a change, but takes the position that by the end of the base period the venetian blinds business had reached a normal earning level. He likewise concedes that the acquisition of the Hughes Company business and assets in September of 1936, was a change in the character of the petitioner's business within the meaning of the said section, but contends that the earnings realized by the petitioner from the Hughes Company business after its acquisition and during the base period were normal. Insulite Products. Whatever the significance which may be attached to the January 21, 1935, contract with the Insulite Company, certain it is that it did not mark the beginning of the sale of Insulite products by petitioner to its customers since the facts show that fairly substantial sales had *570 been made under the 1933 contract by all of petitioner's branches at least as early as 1934 and by the Columbus branch since it had been acquired in 1926. *58 It is to be noted also that petitioner makes no claim that the selling of Insulite products under the 1933 contract was a commencement of such sales "immediately prior to the base period," and as respondent points out, it has been held that events occurring in 1933 and 1934 were not, for the purposes of section 722 (b) (4), "immediately prior to the base period." Monarch Cap Screw & Manufacturing Co., 5 T. C. 1220; Acme Breweries, 14 T. C. 1034; A. B. Frank Co., 19 T. C. 174; and West Flagler Amusement Co., 21 T. C. 486. Equally, if not more, significant, however, is the absence of proof that the petitioner had not been selling a line of products similar or comparable to Insulite products, even though it had not dealt in the products of the Insulite Company itself. See Stonhard Co., 13 T. C. 790; Triangle Raincoat Co., 19 T. C. 548; and Permold Co., 21 T. C. 759. Cf. Lamar Creamery Co., 8 T. C. 928, and 7-Up Fort Worth Co., 8 T. C. 52.*59 To support its claim that a difference in its products, and therefore a change in the character of its business within the meaning of section 722 (b) (4), was effected by the execution of the January 21, 1935, contract and the subsequent selling of Insulite products thereunder, petitioner puts its emphasis on the comprehensive character of the contract, stressing the point that for the first time an arrangement, complete as to details, for its handling of those products was established; that beginning with that contract, petitioner, with few exceptions, was to have certain sales territory exclusively; that thereafter it set up an engineering staff which would be available for consultation and advice to prospective purchasers of Insulite products; and, finally, that the force of its claim is clearly indicated by the fact that the volume of its Insulite products business generally increased each year thereafter through 1939. No ultimate purpose would be served, however, even if we should determine that the consummation of the 1935 contract did effect a difference within the meaning of the statute in petitioner's products and services, as the petitioner contends, rather than a normally*60 expected development of its Insulite business, conducted by the Columbus branch as early as 1926 and by all other branches beginning with the 1933 contract, and not therefore a qualifying factor under section 722 (b) (4), as the respondent contends, since, for reasons appearing hereafter, we are still unable to conclude on the proof herein that petitioner has made its case. For the purpose of securing relief under section 722, the occurrence of a change in the character of a taxpayer's business is important only if the change directly resulted in an increase in normal earnings, and because the change occurred in the base period, or immediately *571 prior thereto, the operation was not at a normal level for the base period and the consequence was that the actual average base period net income computed under section 713 did not adequately reflect a normal operation for the entire base period. Wisconsin Farmer Co., 14 T. C. 1021, 1029; Farmers Creamery Co. of Fredericksburg, Va., 18 T. C. 241, 254; Permold Co., supra;Pratt & Letchworth Co., 21 T. C. 999; M. W. Zack Metal Co., 22 T. C. 349, 352;*61 and Union Parts Mfg. Co., 24 T. C. 775. Our first difficulty in applying the above test to the instant case is that we do not know what petitioner's base period net earnings from the sale of Insulite products were, and such being the case, it would hardly be possible to justify the conclusion that, insofar at least as the net profits from Insulite sales were concerned, the petitioner's actual average base period net income did not reflect a normal operation for the entire base period. Admittedly, petitioner's net profits on Insulite sales are not segregated or separately shown on any records maintained during the base period or prior thereto, and in an effort to establish such net profits, for the purposes of its section 722 claims, it prepared elaborate retrospective schedules and offered them in evidence. The schedules in question purported to show, by branches, petitioner's total dollar sales of all products for each of the years 1934 through 1939, the cost of the goods sold, and according to the various categories, such as salaries, commissions, general office expense, insurance, etc., the total of its selling and administrative expenses, and finally, *62 the total of its resulting net profits. With respect to Insulite products and for the same years, the schedules purported to show the same facts in comparable detail. In the case of the Insulite products, however, it was apparent on the face of the schedules that, excepting possibly the amounts paid to the Insulite Company in respect of Insulite sales and one or two items of expense, none of the items under cost of goods sold or selling and administrative expenses represented petitioner's actual outlay in the various categories. To the contrary, they were admitted and obvious allocations made on the basis of widely varied percentage factors from the total of the expenditures by the petitioner under the various headings in its over-all operations. The admission of the schedules in evidence was objected to by the respondent, but after a conference between counsel, at the instigation of the Court, it was stipulated that the figures relating to petitioner's total sales, the costs thereof, and the selling and administrative expenses relating thereto, as listed in the schedules, were as shown by petitioner's books of account, and further, that the amounts shown as the total dollar sales*63 of Insulite products for the years in question *572 were likewise true and correct. As showing the facts agreed upon, the schedules were admitted in evidence. As to the remaining parts of the schedules, the petitioner was left to its proof. The petitioner's dollar sales of Insulite products by branches and for the years 1934 through 1939, as shown by the above schedules and stipulated as above stated, appear in our Findings of Fact. The amounts claimed by petitioner as its purchases of Insulite products and as its realized net profits on Insulite sales for the said years, and as shown by the schedules, are as follows: Claimed Insulite Purchases Branch or warehouse [1939] St. Louis $ 22,692 $ 40,390 $ 42,797 $ 49,913 $ 40,194 $ 56,792 Columbus [1] 17,520 1,582 9,435 24,818 Jacksonville 5,124 11,282 13,727 12,648 26,093 12,832 Roanoke 6,549 26,981 27,744 31,663 36,497 40,164 Charlotte 4,409 16,694 18,061 25,992 28,323 33,838 Louisville 13,575 19,120 30,775 Knoxville 9,766 22,241 29,709 Total 38,774 95,347 119,849 145,139 181,903 228,928 Claimed Net Profits Branch or warehouse [1936] St. Louis $ 189.64 $ 3,334.91 $ 2,439.50 Columbus 357.64 Jacksonville 177.61 1,064.95 (1,602.42) Roanoke 129.91 5,968.28 4,216.37 Charlotte 78.82 2,917.60 2,670.39 Louisville Knoxville Total 575.98 13,285.74 8,081.48 *64 Claimed Net Profits Branch or warehouse [1939] St. Louis ($ 1,252.52) ($ 3,335.50) ($ 4,858.61) Columbus 49.75 (387.90) 170.91 Jacksonville (1,767.79) (363.08) (1,996.20) Roanoke 5,647.02 7,445.85 8,366.20 Charlotte 3,543.24 3,750.30 4,413.56 Louisville 34.31 (398.60) 316.13 Knoxville 651.90 1,268.21 3,779.03 Total 6,905.91 7,979.28 10,191.08 In making its allocations of costs and expenses to arrive at its claimed net profits on the Insulite sales made by a particular branch for a given year, the petitioner first determined the percentage of Insulite sales to the total sales of the branch and then applied that percentage factor, or one-half thereof, to the total of the expenditures of the branch for the year in the category being allocated. From the testimony of the official who made the allocations appearing in the said schedules, the application of the whole of the percentage factor, or one-half thereof, appears to have been bottomed in some way not at all clear on the proposition that, except as to Insulite, the expenditures and costs from which the allocations were being made were to be regarded as having*65 been related to millwork products, and since in the case of millwork there were greater nonproductive or handling costs than in the case of Insulite, the allocation of nonproductive costs to Insulite sales should be made by use of only one-half of the above *573 percentage factor. Just why nonproductive costs and expenses relating to Insulite sales should ratably be one-half the nonproductive costs and expenses relating to millwork and other items sold by petitioner has not been demonstrated and is not clear, support therefor insofar as we have been able to determine being limited to the stated conclusion of the officer who made the allocations and the asserted approval thereof by petitioner's auditors. In short, except for the unsupported opinion of the witness, we do not know whether the amounts allocated from nonproductive costs and expenses as the costs of Insulite sales bear any resemblance to actual costs, nor whether an analysis of the total of such costs and a study of the Insulite operations in comparison with total operations could or could not produce a satisfactory showing of actual costs and expenses. In the case of salesmen's commissions, an entirely different*66 factor was applied. More often than not, the percentage was 3 1/2 per cent of 80 per cent of sales, but in numerous instances, and without explanation, the factor applied was 3 1/2 per cent of 85 per cent of sales. At first blush, it might be reasonable to conclude that the percentages applied were supposed to represent the established rates of commissions paid by the petitioner in respect of the sales of all of its products for the given year, either throughout its territory or in the territory of a particular branch. Such, however, could not be the case, since in the same schedules and with respect to Andersen windows the allocation of commissions in every instance is at the rate of 3 1/2 per cent of 85 per cent of sales. Furthermore, with respect to Insulite, the allocations are shown at 3 1/2 per cent of 80 per cent of sales for one or more branches, while for another branch or branches and for the same year, at 3 1/2 per cent of 85 per cent of sales, and in the case of the Roanoke branch, for the years 1934 through 1937, the schedules show allocations at 3 1/2 per cent of 80 per cent of 85 per cent of sales. In allocating the costs of merchants' licenses, still another percentage*67 factor was applied in all instances. The explanation is not clear, but it was said that the factor used was arrived at in each instance through an analysis of such licenses, and that inventory normally entered into the determination of merchants' licenses, but in the case of Insulite, petitioner had no inventory of its own, since the Insulite products were handled on a consignment basis and actually belonged to the Insulite Company. Strangely enough, the factor used in allocating the costs of merchants' licenses was in each instance likewise applied in allocating social security taxes. Just what the connection was between merchants' licenses and social security taxes, or what, if anything, the presence or absence of inventories had to do with such taxes, we are not advised. *574 Two of the consistently larger items under selling and administrative expenses were shown as "Salesmen's-Salaries, Spec. Men" and "Salesmen's Expenses." The amounts so shown are not the result of application of any of the percentage factors appearing, and there is some indication in the testimony of petitioner's officer witness that they are supposed to represent the amounts actually expended for the*68 purposes stated. Similarly, the amounts shown in each instance as purchases of Insulite products were purportedly the amounts transmitted to the Insulite Company in respect of the Insulite products sold and were as shown by the invoices submitted to petitioner by that company. If the amounts so shown as salesmen's salaries, salesmen's expenses, and the purchases of Insulite products sold were the amounts actually so expended, it is not clear just why the petitioner failed to submit the invoices or the books showing the said salaries and expenses, make a proper showing of a summary therefrom, or produce them for examination by respondent's counsel and possible stipulation with respect thereto. It thus appears that when the last word has been said, the amounts applied as costs and expenses in arriving at the claimed base period net profits from Insulite sales, except possibly the cost and expense items covered in the preceding paragraph, are, insofar as shown by the proof, merely the amounts which in the opinion of the officer making the allocations approximate such costs and expenses. There are, of course, occasions when there is no available direct evidence of an ultimate fact *69 and resort to opinion testimony appears to be the only recourse. But if an opinion is to be regarded as much, if anything, more than a guess, there should be some proof or agreed factual basis therefor. Pabst Air Conditioning Corporation, 14 T. C. 427, 436, 437; Beringer Bros., Inc., 18 T. C. 615, 642-644; and 7- Up Fort Worth Co., supra.We have no doubt that the allocations appearing on the above schedules were, in the opinion of the witness who made them, fair and reasonable, but as to the factual basis therefor, we are, for the most part, not advised. Accordingly, we have made no finding of the amount of petitioner's base period net profits on Insulite sales. Aside, however, from the above difficulties as to proof of the net profits which were actually realized by petitioner during the base period on Insulite sales, we are unable to see just how the net profits therefrom as claimed, even if accepted as actual, would or could justify the conclusion that due to the taking on of the Insulite products line, petitioner's actual base period net earnings did not reflect a normal operation for*70 the entire period, whether the taking on of the line be said to have occurred under the 1933 contract or the contract of January 21, 1935. *575 It is true, of course, that beginning with 1935, the first year of operations under the January 21, 1935, contract, and through 1939, the volume of Insulite sales did show consistent and substantial increases both in quantity of Insulite products sold and the dollar volume of the sales made, and if the relief sought turned on the proposition that the Insulite business did not reflect a normal operation for the entire base period because, due to the taking on of the Insulite products line during or immediately before the base period, the quantity of products sold and the dollar volume of the sales made in the base period were not at a normal level for the entire base period, there might be some justification for petitioner's conclusion. The prerequisite for relief, however, is that by reason of the change either during or immediately prior to the base period, the actual net profits for the base period did not adequately reflect a normal operation for the entire base period. And if the base period net profits from the sale of Insulite*71 products in the amounts claimed by petitioner as its actual net profits be accepted as correct, we have no such consistent or substantial increase in such profits for the years 1935 through 1939. In fact, the net profits as claimed for 1935 were substantially greater than the claimed net profits for any one of the base period years. It is to be noted also that even though the quantity of Insulite products sold and the dollar volume of the sales made in the years 1935 through 1939 were consistently and substantially increasing from year to year, the net profits therefrom as claimed by petitioner were consistently and substantially decreasing from 1935 through 1937, and it was only with respect to 1938 over 1937 and 1939 over 1938 that the trend was reversed and they began to increase. And even then, the net profits for 1939 as claimed were still approximately 23 per cent less than the claimed net profits on 1935 sales, even though the quantity of Insulite products sold was approximately three times and the dollar volume of the sales more than twice those for 1935. Why this should be so, the record does not show. 4 Whether it is due to substantial error in the amounts of costs*72 and expenses allocated by petitioner's officer in arriving at its claimed net profits from Insulite sales, or whether it was due to other factors not primarily or substantially attendant upon the taking on of the Insulite line of products, whether under the 1933 *576 contract or the 1935 contract, we are unable to tell. If the latter happens to be the explanation, then, of course, it is not covered in the claim made. Lamport Co., 17 T. C. 1079, 1084, and Trunz, Inc., 15 T. C. 99, 104, 105. *73 In that same connection, the claimed results of petitioner's Insulite business according to the operations of the individual branches are, if possible, even less persuasive of merit in the claim herein. On first impression, the claim would appear to be supported by the claimed results of operations of the Charlotte and Roanoke branches, since as to those branches the claimed net profits, after a falling off in 1936 in comparison to 1935 in the case of the Charlotte branch and a similar falling off in 1936 and 1937 in the case of the Roanoke branch, indicated consistent and steady gains each year thereafter through 1939, and for 1939 indicated an increase of approximately 51 per cent over 1935 for the Charlotte branch and approximately 40 per cent for Roanoke. With respect to the St. Louis and Jacksonville branches, however, the indicated experience was directly to the contrary. On the basis of the dollar volume of sales, the Insulite business of the St. Louis branch was substantially greater than that of any other branch, and yet, even according to petitioner's own representations as per the retrospective schedules, there was a steady drop from claimed net profits of $ 3,334.91*74 for 1935, to a net loss of $ 1,252.52 for 1937, and increasing net losses for 1938 and 1939, in which latter year the indicated net loss was $ 4,858.61. With respect to the Jacksonville branch, after claimed net profits of $ 1,064.95 for 1935, net losses are indicated for each of the base period years, the net loss for 1939 being shown on the schedules at $ 1,996.20. In short, the indicated net results of the Insulite business of the St. Louis branch had worsened from 1935 through 1939 by approximately 245 per cent, and during the same period, that of the Jacksonville branch by approximately 287 per cent. To a substantial extent, the difference between the claimed profitable operations at the Charlotte and Roanoke branches and the indicated unprofitable operations at the St. Louis and Jacksonville branches are accounted for by the ratable differences allocated in the costs and expenses discussed heretofore. To illustrate, the ratio of represented costs and expenses, exclusive of payments made to the Insulite Company on account of goods sold, to the total sales for the St. Louis branch ranged from a low of approximately 14 per cent for 1935, to a high of approximately 29.3 per cent*75 for 1938, and in the case of the Jacksonville branch, from a low of approximately 11 per cent for 1935, to a high of approximately 33 per cent for 1939. With respect to the Charlotte and Roanoke branches, the corresponding percentages were substantially less. At the Charlotte branch, the percentage for *577 1935 was approximately 12.7 per cent, and from that point increased to a high of only approximately 16 per cent for 1939. At the Roanoke branch, the approximate percentages for 1935 and 1939 were 12.4 per cent and 14.7 per cent, with intervening percentages of approximately 17.4 per cent for 1936, 16 per cent for 1937, and 11.6 per cent for 1938. Another point of contrast on the basis of the figures appearing in the retrospective schedules is in the percentage of claimed gross profits to sales, the approximate percentages for the years 1935 through 1939, for the four branches, being: [1939] St. Louis 20.7 20.7 20.7 22.9 19.1 Jacksonville 18.4 18.4 18.4 17.2 20.7 Charlotte 25.7 25.7 25.7 25.7 25.8 Roanoke [29] 28.3 28.3 26.6 29.7 As to how such extremely varied and contrary operating results as between branches may*76 be reconciled with the petitioner's claim that its Insulite business was not at a normal level for the base period because of the taking on of the Insulite products line immediately prior to the base period, namely, under the arrangement provided for in the contract of January 21, 1935, does not appear. It follows, we think, and we hold, that petitioner has failed to substantiate its claim as to Insulite products, and the claim is accordingly rejected. Andersen Products. With respect to Andersen products, the petitioner's claim must likewise be rejected. It is, of course, true that petitioner did not begin handling those products until the spring of 1937, and if they were of such character as to represent a new or different product within the meaning of the statute, the change did occur within the time specified for qualifying for relief. Actually, however, we know even less about the profits results from the handling of the Andersen products than in the case of Insulite. The evidence does show petitioner's purchases for the base period years, and it is our understanding that the inventory figures at the beginning and end of the respective years are actual. In short, we are*77 to that extent in a position to determine the cost of the Andersen products sold, but we do not know the amounts for which they were sold, and hence the net results, or whether those results were profits or losses. Furthermore, the state of the record with respect to other costs and expenses relating to the sales of Andersen products is comparable in all pertinent aspects to that outlined above as to Insulite. The petitioner has shown of record a rather detailed description of Andersen windows for the purpose of demonstrating that they were in *578 fact a different product from its regular line of windows, frames, and sash, whether custom built or stock, and, therefore, qualified as a difference in its products under the statute. In view, however, of the failure to show the results of its handling of the Andersen line for the base period years, we have no way of knowing whether with respect thereto it would otherwise be qualified for relief. See Wisconsin Farmer Co., supra;Farmers Creamery Co. of Fredericksburg, Va., supra;Permold Co., supra;M. W. Zack Metal Co., supra;*78 and Union Parts Mfg. Co., supra.It may well be that the absence of any segregation on petitioner's books of its sales of Andersen products, or the expenses relating thereto, is an indication that during the base period and prior to the excess profits tax years at least, the petitioner itself did not look upon the Andersen products as a line of goods substantially different from the line of goods theretofore sold. See and compare Stonhard Co., supra. Venetian Blinds. The respondent concedes that the commencement of the manufacture and sale of venetian blinds in February of 1935 did constitute a change in the character of petitioner's business within the meaning of section 722 (b) (4), but he does not agree that $ 22,307, as contended for by petitioner, is a fair and just amount to be used as petitioner's average base period net income from its venetian blinds operations, it being his claim that $ 6,169 is the just and fair amount to be so used. It is our view that in their construction of the amounts contended for, both parties have taken steps and have proceeded on the basis of factual conclusions not supported by*79 the evidence, and under the statute, neither amount is a fair and just amount to be used for the purposes stated. Although the respondent in his construction has proceeded on a contrary basis, we are satisfied from the evidence, and have found as a fact that petitioner's venetian blinds business, by the end of the base period, had not reached the earning level it would have reached if the business had been commenced 2 years before it was. On the other hand, it is not at all clear from the evidence that with an additional 2 years of operations the volume of petitioner's sales would have increased by the end of 1939 to the level indicated by a straight line projection of its actual sales for a further period of 2 years, as petitioner contends. Having reconstructed venetian blinds sales in the manner indicated, petitioner next computed its 1939 constructive net profits therefrom by applying its actual 1939 venetian blinds profits factor of .0702 to 1939 sales as reconstructed. It then concluded or assumed that a proper amount to be regarded as its constructive average base period venetian blinds net profits would stand in relation to its reconstructed 1939 venetian blinds net profits*80 as its base period millwork net profits for its *579 St. Louis, Jacksonville, Columbus, Roanoke, and Charlotte branches were to its 1939 millwork net profits for those branches. Claiming that its 1939 millwork net profits for the five branches were, in round numbers, 75 per cent of its average base period millwork net profits for the said branches, 5 and then treating its 1939 constructive venetian blinds net profits as being 75 per cent of its constructive average base period venetian blinds net profits, it arrived at the $ 22,307 contended for. Stated differently, it concluded that its constructive average base period venetian blinds net profits would be the amount representing 133 1/3 per cent of its reconstructed 1939 venetian blinds net profits. *81 It is with this last step of petitioner's construction that we have our major difficulty. We have found nothing in the evidence to support the proposition that petitioner's base period trend of millwork net profits, or the relation of such net profits for the year 1939 to the average of the net profits therefrom for the base period, would in any way be indicative of the base period net profits which normally might have been expected from venetian blinds. As a matter of fact, one factor strongly urged by petitioner as indicating that its venetian blinds business had not reached a normal level of earnings by the end of 1939, was that it was only when drastic departures were made from the usual methods used by petitioner in marketing its millwork that it began to make real headway in the marketing of venetian blinds, and that the full force of that change in marketing procedures had not run its course by the end of the base period. Furthermore, the petitioner, in its reply brief, concedes that "obviously" venetian blinds sales would not follow the sale of millwork. The reason advanced in justification of the application of the above millwork net profits ratio to arrive at constructive*82 average base period net profits for venetian blinds was that to determine a normal operation for a taxpayer, use should be made of representative base period activities of such taxpayer, and millwork being the principal business of petitioner and the millwork of the 5 branches being a large portion of the petitioner's entire business, it was accordingly representative of petitioner's base period activities. In support of this claim, E. P. C. 8, 1947-1 C. B. 73, is cited. Rather obviously, no rule of thumb, whether suggested in a published bulletin or even by regulation itself, is to be blindly applied, to say nothing of a situation, as in this case, where on the evidence its application would tend to bring about a distorted result and would not reflect the normal situation contemplated by the statute. We find no support in the facts of record for the conclusion that if petitioner had started its venetian blinds business 2 years before it did *580 its average base period net profits in a normal operation thereof would have been ratably any higher than they actually were for 1939. And in arriving at our conclusion as to "a fair and just amount representing*83 normal earnings" to be used as petitioner's "constructive average base period net income," we have made due allowance for the increased sales of venetian blinds and the correspondingly added amount of profits for 1939 which, as we read the evidence, petitioner would have experienced if its venetian blinds operation had commenced 2 years before it did. Hughes Company. The petitioner's acquisition of the business and assets of W. J. Hughes & Sons Company in September of 1936, but as of August 22, 1936, is conceded by respondent to have been a change in the character of the petitioner's business within the meaning of section 722 (b) (4), inasmuch as it eliminated a competitor, and resulted in increased capacity for petitioner. His concession, however, is with respect to such acquisition as a unit, embracing both the Louisville and Knoxville facilities, designated at first by petitioner as Hughes Division -- Huttig Sash & Door Company, and after 2 years, as Huttig Sash & Door Company -- Hughes Division. Respondent's contention is that the Hughes Division experienced normal earnings during the period August 22, 1936, to December 31, 1939, and the decline in the percentage of net *84 profits to sales being in harmony with petitioner's operations as a whole, the proper and reasonable method of construction was to "annualize" the Hughes Division profits for the period August 22 to December 31, 1936, to arrive at what would have been normal for 1936, and that the results, averaged with actual net profits for 1937, 1938, and 1939, would give the amount to be used as the constructive average base period net profits, or an increase over the average of net income from August 22, 1936, to December 31, 1939, of $ 11,030.78. In his construction, the respondent made no allowance for the erection of the new and added facilities at Knoxville. The petitioner, in its construction, has proceeded on the theory or assumption that the Louisville and Knoxville operations should be dealt with separately. It concedes that the Louisville operation was normal for 1939, but contends for a construction for the base period by applying to its purported 1939 millwork net profits, the factor above described and as contended for in the case of the venetian blinds operation, to arrive at claimed constructive average base period net income for the Louisville operation of $ 34,325. As to the*85 Knoxville operation, it is claimed that, due to the construction of the new facility in 1937, the business had not reached the earning level which it would have reached by the end of 1939 if the change had occurred 2 years *581 before it did. It accordingly reconstructed 1939 millwork sales by assuming that with an additional 2 years of operation millwork sales would have been increased over its actually experienced 1939 sales by the same percentage that such sales were greater than 1937 sales. To such reconstructed 1939 millwork sales, it then applied its purported 1939 millwork net profits factor and arrived at claimed reconstructed 1939 net profits, and then to such reconstructed 1939 net profits applied the factor contended for with respect to venetian blinds, to arrive at claimed constructive average base period net income for Knoxville of $ 36,624. On the record before us, we are unable to accept the construction of either party. The facts show that in the purchase of the business and assets of the Hughes Company one competitor, not two, was eliminated, and that the business of the competitor was centered in Louisville, where the manufacturing and processing were done, *86 with distributing warehouses in Knoxville and Paducah. Such being the case, we think the respondent properly treated the Hughes Division as a unit in making his construction of the amount to be used as the constructive average base period profits due to the elimination of the Hughes Company as a competitor. Furthermore, beyond the petitioner's assertion to that effect, we have found nothing of substance to indicate that from the effective date of acquisition through 1939, the net profits of the Hughes Division, both Knoxville and Louisville and for the period indicated, were, to say the least, any lower than would result from a normal operation of the Hughes Company business which had been acquired. We are of the view, however, that the respondent was in error in refusing to give any effect to the erection in 1937 of the new plant in Knoxville. We are satisfied from the evidence that it resulted in a sufficiently substantial increase in petitioner's capacity for operation to justify its being taken into account in the construction herein, and further, that the business of the Knoxville facility resulting from the erection of the new plant did not reach the earning level it would*87 have reached if it had had the new plant 2 years before it did. On the other hand, it does not follow, as petitioner has apparently assumed, that the increase in sales from the Knoxville facility and the net profits thereon from 1937 to the end of 1939 was wholly, or even in major part, attributable to the erection of the new plant. Prior thereto, the millwork for the Knoxville distribution was done at Louisville. The new facility was erected in 1937, but we do not know whether it was completed early or late in the year, and, as a consequence, we do not know what portion of the millwork for Knoxville was done at Louisville and what part at Knoxville. Neither is there any indication as to the basis on which the charge for millwork was made as between Louisville and Knoxville. We do know, however, *582 that the 1937 margin of profits on sales as between Louisville and Knoxville was slightly more than three-tenths of 1 per cent in favor of Knoxville, whereas by the end of 1939, that margin had increased to approximately 2 2/10 per cent. It is also quite conceivable that some of the areas served by Knoxville after the erection of its millwork facility were so located that they*88 had theretofore been served directly from the millwork plant at Louisville, rather than by shipping the goods first to Knoxville and then redistributing them to the purchasers. The evidence also shows that prior to the purchase, the petitioner had been a rather heavy competitor of the Hughes Company. Petitioner's sales in the Louisville and Knoxville areas, prior to the purchase, had been made from the plant in St. Louis, and there is no indication that petitioner in its construction has made any allowance either with respect to Louisville or Knoxville for the profits which merely represented a shift of profits from the St. Louis plant. It is, of course, likely that the switch from petitioner's St. Louis operations to Louisville and Knoxville was, to some extent, offset by the prior Hughes Company business going to others of petitioner's branches. But we are left wholly in the dark as to the net results and the consequential effect on a proper reconstruction of the base period net profits of the Hughes Division. In arriving at our conclusion as to "a fair and just amount representing normal earnings" to be used as petitioner's "constructive average base period net income," we have*89 accordingly made such allowance for the elimination of its competitor, the Hughes Company, and the increase in its capacity for production resulting from the construction of the new plant in Knoxville as in our opinion is justified and required on the evidence and under the statute. Applicability of Section 722 (b) (3) (A). With respect to the applicability of section 722 (b) (3) (A), the petitioner bases its claim on the proposition that its St. Louis and Jacksonville branches were the only facilities in continuous operation from 1923 through 1939, that the territories served by the branches opened subsequent to 1923 were previously served from St. Louis and Jacksonville, and that the elimination of all the changes occurring subsequent to 1923 establishes a proper basis to determine its cyclical experience in the years 1922 through 1939 and whether its business was depressed in the base period years. As supporting that claim, it contends that its millwork sales and net operating profits therefrom for its St. Louis and Jacksonville territories for the years 1922 through 1939 constitute the proper yardstick, compared with other data, to establish that its base period*90 millwork net profits were depressed by reason of conditions generally prevailing in its industry, *583 thereby subjecting it to a profits cycle materially different in length and amplitude from the general business cycle. It accordingly claims that section 722 (b) (3) (A) is applicable, and by reason thereof, it is entitled to reconstruct its base period net earnings in all of its categories, except venetian blinds and possibly custom millwork, and for all of its branches, and that its average base period net income so reconstructed and including the constructions above claimed under section 722 (b) (4) is $ 358,307, and is the fair and just amount to be used as its constructive average base period net income. It is the position of the respondent that the business of the petitioner was not depressed during the base period years. In an effort to show depressed earnings during the base period, the petitioner used the heretofore discussed retrospective allocations of overhead selling and administration expenses, etc., to segregate millwork operations from Insulite and Andersen products handled by it. Its next step was to make retrospective allocations of sales by States for the*91 years 1922 through 1939. It then selected the St. Louis and Jacksonville operations and compared their estimated average base period earnings with their average long-term earnings as representative of its profits cycle and depressed condition. The elimination of the other branch facilities was for the purpose of eliminating alleged growth and non-cyclical factors. It would serve no useful purpose, however, to enter into a detailed discussion of the reconstruction so made as the basis for its claimed relief under section 722 (b) (3) (A), because it is our opinion and we hold that petitioner has failed to establish that it is entitled to any relief under that section. Except for the venetian blinds department, operated as a separate unit, and possibly the custom millwork department in St. Louis, the record clearly establishes that petitioner operated an integrated business of non-custom millwork and various types of building supplies through its St. Louis warehouse department and each of its several branches. The purpose of establishing branches was to render better service to customers in areas formerly supplied by long hauls from St. Louis, and the establishment of each new branch*92 inevitably resulted in a loss of sales by the St. Louis warehouse to such branch. It is in our opinion thus apparent that the millwork sales and profits experienced by the St. Louis and Jacksonville branches for each of the years 1922 through 1939, even if it be assumed that such sales and net profits could be shown, would not and could not be representative of the condition and fluctuations of the petitioner's business over the period 1922 through 1939. Moreover, the fallacy of the proposed segregation of millwork sales and profits for the St. Louis and Jacksonville facilities is demonstrated by petitioner's inability to show any satisfactory and accurate segregation of millwork earnings apart from the business of each facility taken as a whole. *584 In A. B. Frank Co., supra, at page 182, we said, "In the determination of whether this business was depressed, we must look at the entire business and not merely one segment of it." That principle is applicable in the instant case. On the record before us, and looking to the petitioner's business as a whole, we are of the opinion, and have found as an ultimate fact that petitioner's business was*93 not depressed in the base period years 1936 to 1939, inclusive. We have held above, however, that petitioner has qualified for section 722 relief because its venetian blinds business, commenced in 1935, had not, by the end of the base period, reached the earning level it would have reached if it had been started 2 years before it was and because of the increase in petitioner's capacity for production, due to its elimination of its competitor, the Hughes Company, and the erection of the new plant at Knoxville. Based on that holding, and on the evidence, it is our opinion, and we have so found, that "a fair and just amount representing normal earnings" to be used as petitioner's "constructive average base period net income," for the purposes of section 722, is the amount which exceeds petitioner's average base period net income computed without reference to section 722 by $ 33,000. Reviewed by the Special Division. Decision will be entered under Rule 50. Footnotes 1. No regular solicitation was ever made in Louisiana, and the business there, which was handled by the Memphis Sash & Door Company, was limited to an occasional mail order.↩ 1. Estimated.↩ 2. Not available.↩ 1. Not available.↩ 2. There is some indication that petitioner did have a small inventory of Insulite products at its Columbus branch at various times, but, if so, the arrangement with the Insulite Company and the terms for the purchase of goods in advance of their sale are not shown.↩ 3. SEC. 722. GENERAL RELIEF -- CONSTRUCTIVE AVERAGE BASE PERIOD NET INCOME. (a) General Rule. -- In any case in which the taxpayer establishes that the tax computed under this subchapter (without the benefit of this section) results in an excessive and discriminatory tax and establishes what would be a fair and just amount representing normal earnings to be used as a constructive average base period net income for the purposes of an excess profits tax based upon comparison of normal earnings and earnings during an excess profits tax period, the tax shall be determined by using such constructive average base period net income in lieu of the average base period net income otherwise determined under this subchapter. In determining such constructive average base period net income, no regard shall be had to events or conditions affecting the taxpayer, the industry of which it is a member, or taxpayers generally occurring or existing after December 31, 1939, except that, in 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) 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 -- * * * * (3) the business of the taxpayer was depressed in the base period by reason of conditions generally prevailing in an industry of which the taxpayer was a member, subjecting such taxpayer to (A) a profits cycle differing materially in length and amplitude from the general business cycle * * * * * * * (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. * * *↩ 1. Not available↩ 4. On brief, it is asserted that the profits in 1936 and 1937 were low, due to engineering and development expenses. As to what was covered by the reference to development expenses and under what category it may have been charged in the retrospective schedules, we are not even able to make a good guess. Conceivably, the reference to engineering expenses could have been to the amounts shown on the schedules as salaries and expenses, "Spec. Men." If those items were intended to cover engineering costs, they are, as heretofore noted, amounts asserted or claimed but not proved. Furthermore, such charges in the said schedules were not new to 1936 and 1937, for which the net profits as claimed were low, but they likewise appear on the said schedules for 1935, when, as noted above, such claimed net profits were substantially higher than for any year through 1939.↩ 5. On the evidence, we should be hard pressed if it should become necessary to make a finding of fact as to petitioner's millwork net profits for the 5 branches mentioned, either for the year 1939 or for the base period years. The evidence in many respects is quite indefinite and far from satisfactory.↩