Nutrena Mills, Inc. v. Commissioner

Nutrena Mills, Inc. (Kansas) (Successor to Nutrena Mills, Inc., of Missouri, Dissolved), Petitioner, v. Commissioner of Internal Revenue, Respondent. Nutrena Mills, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent Nutrena Mills, Inc. v. Commissioner Docket Nos. 29838, 29839 United States Tax Court 26 T.C. 1096; 1956 U.S. Tax Ct. LEXIS 80; September 21, 1956, Filed *80 Decisions will be entered under Rule 50. Excess profits tax relief under section 722 of the Internal Revenue Code of 1939 allowed where petitioner changed the character of its business during and immediately prior to the base period, and its business did not reach the earning level which it would have reached if the changes had been made 2 years earlier. Elmer B. Hodges, Esq., and Florence Middlekamp, Esq., for the petitioner. David Karsted, Esq., for the respondent. Arundell, Judge. ARUNDELL *1096 These consolidated proceedings involve the total disallowance by respondent of petitioner's applications for relief under section 722 of the Internal Revenue Code of 1939, as amended. In these applications petitioner claimed the refund of excess profits taxes for certain years in amounts as follows: Excess profits Docket No. Taxable year ended December 31 tax paid 29838 [1941] $ 80,678.72 29839 [1942] 362,180.69 29839 [1944] 235,485.56 *81 Claims are also made for unused excess profits credit carryovers from preceding years. The testimony was taken before a commissioner of this Court and his findings of fact were duly served on the parties. Objections thereto presented by counsel for the respective parties have been considered. We make the following findings of fact. FINDINGS OF FACT. 1. The petitioner is a Kansas corporation with its principal office and place of business in Kansas City, Kansas. It was incorporated on December 24, 1941. It exchanged its stock for the assets and liabilities of Nutrena Mills, Inc. (a Missouri corporation), in a tax-free reorganization. *1097 The Missouri corporation was then dissolved. The Kansas corporation began operating on January 1, 1942, and thereafter operated continuously. As used herein, the term "petitioner" refers to Nutrena Mills, Inc. (a Kansas corporation), and its predecessors. 2. Petitioner's income tax returns for the calendar years 1940 to 1944, inclusive, were filed with the collector of internal revenue for the sixth district of Missouri. 3. During the periods involved herein petitioner manufactured and sold poultry and livestock feed at wholesale. The*82 manufacture and sale of poultry feeds constituted the principal portion of its business and accounted for most of its profits. Its principal livestock feeds were cattle and sheep, dairy, and pig and hog feeds. 4. Petitioner's feeds consisted of "mixed feeds" and "other miscellaneous feeds" or "other feeds." Mixed feeds were a combination of various ingredients under a formula devised by petitioner to take care of a particular feeding need. Mixed feeds were sold as "Nutrena" products, a brand name in use since 1921. The sale of mixed feeds was pushed by petitioner since such feeds carried higher margins of profit. "Other feeds" included such items as corn chop, bran, shorts, soybean meal, crimped oats, cornmeal, flour, etc. Generally speaking, the miscellaneous or other feed items were carried for the convenience of customers, were purchased rather than manufactured by petitioner, and were sold by petitioner at a low margin of profit. Petitioner's Nutrena products competed with "other feeds" due to the different feeding methods followed by farmers. 5. Prior to 1935 petitioner operated a single feed mill at Kansas City, Kansas. This mill serviced customers in Kansas, Missouri, *83 Iowa, Arkansas, and Oklahoma with some customers in other States. In October 1935, petitioner expanded its operations. It acquired and began operating a feed mill at Coffeyville, Kansas, which is in southeastern Kansas, about 190 miles from Kansas City. With 2 mills in operation petitioner divided its trade territory. The mills were assigned territory upon the basis of which mill could serve the customers therein more cheaply. The dividing line between the two territories ran in a general east-west direction through southern Missouri and Kansas. Coffeyville served customers south of such line; Kansas City served those to the north. During the base period years each mill continued to serve substantially the same trade territory as that originally assigned. 6. Petitioner's acquisition of the Coffeyville mill came about through the circumstances hereinafter related. Prior to 1935, R. E. Whitworth was general manager of Spear Brand Mills, Inc., of Kansas City. Whitworth had had many years of experience in the feed business and was interested in going into business for himself. He had ascertained *1098 that, because of certain transit privileges and advantageous freight *84 rates, a plant in southern Kansas would be able to serve territory in the south, such as Oklahoma, Arkansas, Louisiana, and Texas, much better than a mill located in Kansas City. In February 1935, Whitworth located a feed mill at Coffeyville, Kansas, upon which he secured a lease with option to buy. In an effort to finance his leased property Whitworth approached Van Roy Miller, president of the petitioner. Miller, unwilling to invest in a business that would compete with petitioner, suggested that Whitworth enter the employ of petitioner which would take over and operate the Coffeyville plant. An agreement was reached and pursuant thereto Whitworth assigned his lease to and entered the employ of petitioner on or about August 1, 1935. Thereafter at all times material hereto, Whitworth was in charge of petitioner's operations at Coffeyville. He became a vice president and director of petitioner and later its president. 7. In 1935 Coffeyville was a transit point for rail shipments. This meant that grain, which normally moved from north to south and from west to east, could be milled at Coffeyville while in transit and, as converted, reshipped to its original destination with no*85 increase in freight rates. In addition, Coffeyville enjoyed a favorable freight rate structure over Kansas City in serving trade to the south. With its Coffeyville mill, petitioner was able to compete successfully for business theretofore beyond the reach of its Kansas City mill. The facilities at Coffeyville included equipment to produce cornmeal, corn chop, and other manufactured feeds, which equipment was not available at the Kansas City plant. An adjacent flour mill at Coffeyville furnished the flour, bran, and shorts needed to supply the dealers in its trade territory. Kansas City derived no advantage from the cornmeal, corn chop, and "other foods" manufactured at Coffeyville because such items could be purchased more cheaply in the Kansas City area than they could be acquired from Coffeyville. 8. The management of petitioner expected the Coffeyville plant to develop additional business. Management had built the business at Kansas City primarily upon the basis of carload sales of mixed feeds. It recognized that dealers in the Coffeyville territory were accustomed to buying their flour and cornmeal along with their feeds. In building a business at Coffeyville, management*86 expected to supply the trade with flour, cornmeal, and other low margin feed items but it planned, by educating its customers to the higher feeding values of its Nutrena products, to wean the farmers gradually from the low margin and nonprofitable items to the more lucrative mixed feeds. Management also planned to eliminate flour and cornmeal from its mixed car shipments. Management estimated that it would take about 6 years for Coffeyville to attain a normal sales volume under *1099 this plan. It was expected that when Coffeyville attained such normal sales volume the tonnage would be about two-thirds of Kansas City's tonnage and that costs, net margins, and net profit per ton would be about the same at the 2 plants. 9. The Kansas City and Coffeyville territories had about the same market potential for petitioner's major lines of poultry feeds. The Coffeyville territory included a "broiler area" in northwest Arkansas, which was an important poultry feed market. "Broilers" were 8- to 10- week old chicks weighing 1 3/4 to 2 pounds apiece. Northwest Arkansas was spotted with many small units or installations engaged in producing broilers. As soon as their pens were emptied*87 of one batch of broilers another batch was started. Broilers were produced in this area from 8 to 10 months of each year, which afforded petitioner a long season for marketing various high margin chick feeds. Kansas City had been unable to compete successfully for business in this broiler area. 10. Kansas City and Coffeyville sold substantially the same feeds with the same margin of profit classifications. Owing to differences in local demand each mill sold some feeds that were not sold at the other. The classifications of the various feeds with their margins of profit were as follows: "Other feeds," 4-8 per cent; low margin mixed feeds, 12-16 per cent; medium margin mixed feeds, 20-22 per cent; high margin mixed feeds, 27-28 per cent; and very high margin mixed feeds, 33-50 per cent. The items that accounted for most of the sales in the mixed feed marginal groups were the following: Low margin -- grains, bulky mixed feeds, low protein dairy feeds, horse and mule feeds; medium margin -- egg mash, cattle and sheep feed, high protein dairy feeds, pig and hog feeds; high margin -- chick mash, growing mash, broiler mash, turkey feeds, hog supplement; very high margin -- calf meal, *88 dog food, rabbit pellets. 11. Profits in the feed industry were figured on a per ton basis rather than on a percentage of dollar sales. Petitioner conducted its business in accordance with this practice. It established a margin of profit (in terms of dollars per ton) which it planned to realize on sales of its various feed mixtures. Once fixed, such margins remained fairly constant. Although seldom increased unless manufacturing costs increased, such margins were on occasions reduced to meet competitive conditions in the market or consumer resistance to high prices. Each week petitioner computed the costs of its feed mixtures, based upon the then market, and added thereto the cost of bags or containers, plus its fixed margin of profit, in order to determine the selling prices of its feeds for the coming week. Where its selling prices were out of line, petitioner reduced the dollars of profit per ton it had planned to realize in order to meet its competitors' prices. *1100 12. In petitioner's trade territory, 1934 and 1936 were drought years but 1935 was a year of above-average rainfall. In the drought years the grain crops and grasses normally grown by farmers to feed *89 their livestock and poultry were damaged or destroyed. The demand for mixed and manufactured feeds increased as a result of the droughts but in many instances the farmers wanted a sustenance feed rather than a special feed prepared for a specific purpose. During and following the 1936 drought, all types of livestock feeds were shipped into the drought-stricken States from other parts of the United States. The railroads made rate adjustments to facilitate the movement of such relief shipments. Poultry farmers were affected less by the drought than livestock farmers. The 1936 drought came too late in the year to damage the wheat crop in petitioner's trade territory. 13. During the drought years petitioner developed a substitute feed for corn known as Korn Replacement Cubes, hereinafter referred to as KRC. Petitioner classified KRC as a cattle feed. KRC was manufactured at Kansas City and all sales except a few hundred tons bought by Coffeyville for resale were from that plant. Petitioner's markup or profit margin on KRC was about $ 7 or $ 8 per ton. Being an emergency ration, KRC was sold at a competitive price with no attempt to realize a large profit therefrom. KRC was manufactured*90 in the form of cubes which made its production more expensive than the manufacture of other mixed feeds. The period of highest demand for KRC was the last 6 months of 1936 when the farmers suffered most from the 1936 drought. During this 6-month period the average expense per ton for milling, selling, advertising, and administering petitioner's feed products at Kansas City was $ 7.86. During the months of November and December 1936, petitioner's advertising expenditures in trade papers, farm papers, and radio exceeded $ 17,000. Similar expenditures for the same months in 1937, 1938, and 1939 totaled $ 361, $ 1,179, and $ 1,652, respectively. A majority of the excessive expenditures in 1936 was due to advertising KRC. 14. The tonnage of KRC sold by petitioner during the years 1934 to 1939, inclusive, by quarters and annually, included in the total tonnage of cattle and sheep feed sold annually for such years, in rounded tons, was as follows: Quarters Total tonnage sold Year 1st 2d 3d 4th KRC Cattle and sheep feed [1934] 1,484 1,484 4,335 [1935] 1,888 [96] 2,932 4,923 [20] 3,738 5,566 9,436 11,171 [1937] 2,218 1,340 [110] 4,093 4,683 [201] 1,677 *91 *1101 15. During the period 1930 to 1939, inclusive, petitioner's volume of business followed certain consistent patterns. Its mixed feed business constituted the major portion of its business and its poultry feeds were the principal feeds sold in the mixed feeds group. Quarterly sales followed a consistent pattern in that second quarter sales were generally the highest, followed in order by sales for the first quarter, then the fourth quarter, and finally the third quarter. Sales for the first 6 months of each year exceeded sales for the last 6 months at Kansas City and at Coffeyville. These patterns are established by the tables in the paragraphs which follow. 16. Petitioner's total sales, its total sales of mixed feeds, poultry feeds, and "other feeds," in rounded tons, for the years 1930 through 1939, were as follows (note, "Total mixed" includes poultry and all other mixed feeds): (Tons) Year Total Total Total Total sales mixed poultry other [1930] 55,848 47,771 36,109 8,076 [1931] 21,466 16,936 12,942 4,530 [1932] 19,709 12,943 9,934 6,766 [1933] 26,213 17,138 12,469 9,075 [1934] 31,752 26,071 17,227 5,681 [1935] 54,332 47,389 36,055 6,944 [1936] 92,712 77,383 55,148 15,329 [1937] 75,536 67,022 52,716 8,514 [1938] 49,127 43,120 35,392 6,007 [1939] 58,206 46,968 37,731 11,238 *92 17. Petitioner's total sales at Kansas City and at Coffeyville, with total sales of mixed feeds, poultry feeds, and "other feeds," in rounded tons, for the base period years, were as follows (note, "Total mixed" includes poultry and all other mixed feeds): Kansas City (Tons) Year Total Total Total Total sales mixed poultry other [1936] 68,250 63,965 45,840 4,285 [1937] 55,896 52,449 41,988 3,447 [1938] 31,484 29,335 25,322 2,149 [1939] 37,552 31,875 24,993 5,677 Coffeyville [1936] 24,462 13,418 9,308 11,045 [1937] 19,640 14,573 10,728 5,067 [1938] 17,643 13,785 10,070 3,858 [1939] 20,654 15,093 12,738 5,561 The ratio of Coffeyville mixed feed sales to Kansas City mixed feed sales had not reached the expected two-thirds by the end of the base period. Such ratios were: 21 per cent for 1936; 28 per cent for 1937; *1102 47 per cent for 1938; and 47 per cent for 1939. Mixed feed sales of Coffeyville, as above, included flour and cornmeal sales as follows: 1936, 1,983.94 tons; 1937, 1,778.25 tons; 1938, 2,088.52 tons; 1939, no sales. The ratio of Coffeyville mixed feed sales to Kansas City mixed feed sales, after eliminating*93 cornmeal and flour from Coffeyville tonnage sales, would be: 18 per cent for 1936; 24 per cent for 1937; 40 per cent for 1938; and 47 per cent for 1939. 18. Quarterly, semiannual, and annual sales of all feeds and poultry feeds at Kansas City and at Coffeyville, for the base period years, in rounded tons, showed a consistent pattern as follows: Kansas City (all feeds) (Tons) Year First Q Second Q 6 Months Third Q Fourth Q 6 Months Annual [1936] 11,117 23,106 34,223 15,042 18,985 34,027 68,250 [1937] 18,756 22,574 41,330 8,198 6,368 14,566 55,896 [1938] 7,160 13,516 20,676 5,153 5,655 10,808 31,484 [1939] 8,315 14,913 23,228 7,090 7,234 14,324 37,552 Coffeyville (all feeds) [1936] 6,339 8,029 14,368 4,376 5,718 10,094 24,462 [1937] 6,982 6,230 13,212 3,149 3,279 6,428 19,640 [1938] 4,080 5,409 9,489 3,764 4,390 8,154 17,643 [1939] 5,680 6,595 12,275 3,740 4,639 8,379 20,654 Kansas City (poultry feeds) [1936] 8,878 20,056 28,934 6,699 10,207 16,906 45,840 [1937] 14,154 17,933 32,087 5,101 4,800 9,901 41,988 [1938] 6,164 11,740 17,905 3,454 3,963 7,417 25,322 [1939] 6,348 11,713 18,061 3,564 3,368 6,932 24,993 Coffeyville (poultry feeds) [1936] 2,040 3,004 5,044 1,287 2,977 4,264 9,308 [1937] 3,988 3,573 7,561 1,354 1,813 3,167 10,728 [1938] 2,572 3,009 5,581 1,617 2,873 4,490 10,070 [1939] 4,140 4,111 8,251 1,762 2,725 4,487 12,738 *94 19. Petitioner's quarterly sales of cattle and sheep feeds, dairy feeds, and pig and hog feeds, followed a different pattern from that shown by all feed sales and poultry feed sales but the volume of sales in these 3 mixed-feed categories was too small to alter the pattern of all feeds. During the base period years the largest volume of sales in each of the 3 categories of mixed feeds aforementioned occurred in the last 6 months of 1936 and the first 6 months of 1937, which 12-month period is the equivalent of the 1936 crop year for corn. During these 12 months petitioner's Kansas City plant sold 14,554 tons of cattle and sheep feed, which constituted about 73 per cent of the entire tonnage of such feed sold at both plants during the base period. Comparable percentages for dairy feeds and pig and hog feeds show that 43.4 per cent and 44.6 per cent, respectively, of the tonnage sold during the base period was sold during the 12-month period July 1, 1936, to June 30, 1937, inclusive. *1103 20. The total tonnage sales of mixed feeds, in rounded tons, sold by petitioner in the principal States in its trade territories, namely, Missouri, Kansas, Iowa, Oklahoma, and Arkansas, for*95 the years 1930 through 1939, with separate table for Coffeyville sales, 1935-1939, inclusive, were as follows: (Tons) Year Missouri Kansas Iowa Oklahoma Arkansas 5-State total [1930] 12,192 11,234 8,248 4,233 [885] 36,792 [1931] 4,340 3,669 3,156 1,961 [233] 13,359 [1932] 3,929 4,004 1,913 1,258 [81] 11,185 [1933] 5,962 6,364 2,133 [607] 15,930 [1934] 8,974 12,962 2,658 [968] 1,079 26,641 [1935] 12,506 23,164 4,981 1,532 1,428 43,611 [1936] 25,831 27,915 9,749 3,482 4,057 71,034 [1937] 20,088 20,657 11,333 4,135 4,288 60,501 [1938] 12,766 11,143 5,848 3,207 5,653 38,617 [1939] 14,905 13,286 5,782 3,402 6,172 43,547 Coffeyville 1 [812] 1,941 [1936] 3,423 2,483 3,458 4,054 13,418 [1937] 3,555 2,573 4,135 4,284 14,547 [1938] 2,270 2,135 3,206 5,653 13,264 [1939] 3,031 2,716 3,401 6,166 15,314 21. Petitioner's sales, analyzed according to margins*96 of profit, in rounded tons, for the base period years, at Kansas City and Coffeyville, and the ratio of Coffeyville sales to Kansas City sales were as follows: Feeds by Margins of Profit Mixed feeds Other Total Year feeds 1 4-8 Low Medium High Very high per cent 12-16 20-22 27-28 33-50 per cent per cent per cent per cent (Tons) [1936] Kansas City 4,285 4,764 35,627 23,408 [167] 68,250 Coffeyville 13,029 1,493 6,523 3,388 [31] 24,462 Ratio 304% 31% 18% 14% 19% 36% [1937] Kansas City 3,447 3,266 32,051 16,953 [179] 55,896 Coffeyville 6,845 [705] 9,063 2,995 [31] 19,640 Ratio 199% 22% 28% 18% 17% 35% [1938] Kansas City 2,149 1,963 12,400 14,708 [264] 31,484 Coffeyville 5,946 [540] 6,659 4,375 [123] 17,643 Ratio 277% 28% 54% 30% 46% 56% [1939] Kansas City 5,677 2,590 13,342 15,554 [388] 37,552 Coffeyville 5,561 [743] 7,951 6,137 [263] 20,654 Ratio 98% 29% 60% 39% 68% 55% *1104 22. Petitioner's tonnage sales, analyzed according to the percentage that each profit margin classification was to total annual sales, *97 for the base period years, at Kansas City and Coffeyville, were as follows: [1937] Profit margins by classes of feed Kansas Coffeyville Kansas Coffeyville City City Per cent Other feeds, 4-8 per cent 1 6.3 53.3 6.2 34.8 Low, 12-16 per cent 7.0 6.1 5.9 3.6 Medium, 20-22 per cent 52.2 26.7 57.3 46.2 High, 27-28 per cent 34.3 13.8 30.3 15.3 Very high, 33-50 per cent .2 .1 .3 .1 Total 100.0 100.0 100.0 100.0 [1939] Profit margins by classes of feed Kansas Coffeyville Kansas Coffeyville City City Per cent Other feeds, 4-8 per cent 1 6.8 33.7 15.1 26.9 Low, 12-16 per cent 6.2 3.1 6.9 3.6 Medium, 20-22 per cent 39.4 37.7 35.5 38.5 High, 27-28 per cent 46.7 24.8 41.4 29.7 Very high, 33-50 per cent .9 .7 1.1 1.3 Total 100.0 100.0 100.0 100.0 23. Separate books and records were kept by petitioner at its Kansas City plant and its Coffeyville plant. A separate set of books was opened for its experimental farm at Pleasant Hill, Missouri, when it began operating in or about 1937. Petitioner prepared monthly summaries*98 from these separate books which it used in conducting its operations. Petitioner kept no consolidated books of account. The Coffeyville account was carried on the Kansas City books as an advance account. Any money used by Coffeyville was charged to this advance account; any money made by Coffeyville was credited to this advance account. The only operations conducted by petitioner that did not have a separate set of books at location were its warehouse operations, the facts with respect to which are hereinafter found. The operations of its warehouses were reflected on the books of Kansas City or Coffeyville depending upon which plant supervised or serviced the warehouse. Petitioner's books contained a complete record of its tonnage sales of mixed feeds but recorded only the total tonnage of miscellaneous or other feeds since petitioner handled them principally as a broker and not because of the profit realized from their sale. 24. The profit and loss reflected by petitioner's monthly summaries of its operations for the base period years were as follows: *1105 Year Net sales Cost of Gross profit Expenses 1 goods sold 1936: Kansas City $ 2,901,129.14 $ 2,144,128.22 $ 757,000.92 $ 474,713.15 Coffeyville 857,750.52 735,291.25 122,459.27 94,242.44 Total $ 3,758,879.66 $ 2,879,419.47 $ 879,460.19 $ 568,955.59 1937: Kansas City $ 2,711,119.99 $ 2,142,030.72 $ 569,089.27 $ 435,298.43 Coffeyville 872,086.41 755,849.28 116,237.13 112,092.61 Total $ 3,583,206.40 $ 2,897,880.00 $ 685,326.40 $ 547,391.04 1938: Kansas City $ 1,140,866.54 $ 776,232.72 $ 364,633.82 $ 314,505.85 Coffeyville 541,591.02 417,084.85 124,506.17 123,526.70 Total $ 1,682,457.56 $ 1,193,317.57 $ 489,139.99 $ 438,032.55 1939: Kansas City $ 1,355,003.01 $ 941,361.88 $ 413,641.13 $ 363,599.36 Coffeyville 683,923.70 511,371.32 172,552.38 155,466.05 Total $ 2,038,929.71 $ 1,452,733.20 $ 586,193.51 $ 519,065.41 *99 Net operating Other Year profit income and Net profit 2 deductions 1936: Kansas City $ 282,287.77 ($ 32,600.91) $ 249,686.86 Coffeyville 28,216.83 7,821.09 36,037.92 Total $ 310,504.60 ($ 24,779.82) $ 285,724.78 1937: Kansas City $ 133,790.84 $ 14,865.85 $ 148,656.69 Coffeyville 4,144.52 14,514.00 18,658.52 Total $ 137,935.36 $ 29,379.85 $ 167,315.21 1938: Kansas City $ 50,127.97 $ 15,953.90 $ 66,081.87 Coffeyville 979.47 10,359.53 11,339.00 Total $ 51,107.44 $ 26,313.43 $ 77,420.87 1939: Kansas City $ 50,041.77 $ 13,299.52 $ 63,341.29 Coffeyville 17,086.33 9,926.10 27,012.43 Total $ 67,128.10 $ 23,225.62 $ 90,353.72 The item "Cost of goods sold" includes the ingredients, containers, and bags, but no labor or overhead. A breakdown of Kansas City's net profit for 1936 and 1937, by 6-month periods, shows a $ 217,429.01 profit on sales*100 of 34,223.51 tons for the first 6 months of 1936 compared with a profit of $ 32,257.85 on sales of 34,029.49 tons for the last 6 months. For 1937 Kansas City showed a profit of $ 188,973.09 on sales of 41,330.47 tons during the first 6 months, and a loss on the sale of 14,566 tons during the last 6 months. 25. A comparative table of the monthly average sales price per ton, gross profit per ton, and percentage of gross profit per ton, by 6-month periods, and annually, of mixed feeds at Kansas City, for the base period years, together with mixed feed tonnage sales for such years, follows: *1106 [1939] Sales price (per ton): 1st 6-month period $ 41.39 $ 54.02 $ 40.09 $ 41.54 2d 6-month period 47.10 42.28 36.14 43.54 Annual 44.24 48.15 38.11 42.54 Gross profit (per ton): 1st 6-month period $ 13.14 $ 11.32 $ 13.04 $ 13.02 2d 6-month period 9.59 8.88 10.12 12.18 Annual 11.36 10.10 11.58 12.60 Percentage of gross profit (per ton): 1st 6-month period 31.59% 20.94% 32.52% 31.32% 2d 6-month period 20.50% 21.37% 27.95% 27.94% Annual 26.04% 21.16% 30.24% 29.63% Tonnage sales, mixed feeds, Kansas City 63,965T 52,449T 29,335T 31,875T *101 26. No determination can be made from petitioner's monthly summary records of the amount of net profit realized from the sale of a ton of a particular type of feed but the average net profit per ton from all feeds sold can be determined from such monthly summaries. For the base period years the average net profit per ton from all feeds sold was as follows: Average net profit per ton Year Kansas City Coffeyville Total [1936] $ 3.66 $ 1.47 $ 3.08 [1937] 2.66 .95 2.22 [1938] 2.10 .64 1.58 [1939] 1.69 1.31 1.55 27. A comparison of petitioner's percentages of gross profits to net sales for the base period years, at Kansas City and Coffeyville, computed from the preceding summary of profit and loss for such years (paragraph 24), shows a steadily rising trend for Coffeyville: (Per cent) [1939] Kansas City 26.1 20.99 32.0 30.5 Coffeyville 14.3 13.3 23.0 25.2 Ratio Coffeyville to Kansas City 54.8 63.3 71.9 82.6 28. The sale of poultry feeds during and prior to the base period was influenced by various economic factors, including commercial broiler production in petitioner's trade territory, production of chickens, the*102 cash position of farmers, the increasing competition, and the poultry feed price ratio. 29. Commercial broiler production in Arkansas, Oklahoma, Missouri, and Kansas increased steadily during the years 1934 through *1107 1939. The largest increase occurred in Arkansas as shown by the following table: Production in thousands Year Arkansas Oklahoma Missouri Kansas [1934] 1,500 1,000 1,200 [1935] 1,800 1,100 1,260 [1936] 3,000 1,200 1,350 [1937] 4,000 1,350 1,450 [1938] 6,000 1,450 1,600 [1939] 8,000 1,600 1,800 [750] 30. The number of chickens on farms at January 1 of each year and the number of chickens produced in petitioner's trade territory declined during the period 1930 to 1939, inclusive. In the States of Missouri, Kansas, Iowa, Arkansas, and Oklahoma the average annual production of chickens for this period aggregated 136,315,000. For the first 5 years thereof the average annual production was 150,076,000; for the last 5 years thereof it was 122,554,000. Following the drought years, chicken production in the 5 States declined as follows: 130,318,000 in 1934 to 122,352,000 in 1935; and 132,188,000 in 1936 to 105,476,000*103 in 1937. Arkansas was the only one of the 5 States that maintained a relatively constant production. During the same period petitioner's sales of poultry feed in such States increased from an annual average of 17,736 tons for the first 5 years to an annual average of 43,408 tons in the last 5 years. 31. The feed business is designed primarily to supplement homegrown grains. The cash position of farmers was an important factor in their purchases of mixed and other feeds for their poultry and livestock. During the base period years the cash position of farmers and other individuals in petitioner's trade territory was better than at any other time during the period 1930 to 1939, inclusive. The total cash farm income and the total income payments to individuals during the base period years in Arkansas, Iowa, Kansas, Missouri, and Oklahoma exceeded any other 4 years during such decade. Total cash receipts from farm marketings of eggs, chickens, and turkeys during the base period in such States were exceeded only by such receipts for the 4 years, 1935-1938, inclusive, during the 9-year period 1931-1939, inclusive. 32. During the period 1927 through 1939, the number of mixed-feed manufacturing*104 establishments in the United States almost trebled The increase in such establishments in the United States, in the 5 principal States in petitioner's trade territory, and in the totals for such 5 States, for the bi-census years 1927 through 1939, was as follows: *1108 Census year United Arkansas Kansas Iowa Missouri Oklahoma 5-State States total [1937] 1,126 [1939] 1,383 [195] 33. For many years petitioner and other feed manufacturers carried on an advertising program to educate farmers in the use of and the benefits to be derived from mixed or formula feeds. One of the first of these formula feeds brought to the attention of farmers was chick mash. The feed manufacturers attempted to convince the farmers that their chick mash would get more livability, more gain in weight, and a stronger, healthier chick in a shorter length of time than the farmer's feeding program. With the acceptance of this mixed feed, other formula feeds were offered*105 such as egg mash, with the result that farmers became familiar with the feeding ratios for their end products, namely, milk, eggs, and meat. The poultry feed price ratio is the number of pounds of poultry feed which was equivalent in value, on local farm markets, to one pound of chicken (live weight). When the poultry feed price ratio was high, farmers were encouraged to raise more poultry because of the relatively low price of feed. The poultry feed price ratios for the United States, by months, during the base period years were as follows: (Lbs.) Year Jan. Feb. Mar. Apr. May June [1936] 10.1 10.3 10.2 10.4 10.1 10.0 [1937] 5.7 5.7 6.1 6.1 6.0 6.1 [1938] 10.0 9.6 9.8 10.0 10.1 10.0 [1939] 9.7 9.9 9.7 9.5 9.0 8.7 (Lbs.) Year July Aug. Sept. Oct. Nov. Dec. Aver. [1936] 8.5 7.0 6.7 6.4 6.1 5.5 8.4 [1937] 6.5 7.9 8.7 9.8 10.1 10.0 7.4 [1938] 9.7 9.7 9.9 9.6 9.7 9.5 9.8 [1939] 9.2 8.9 8.0 7.8 7.6 7.0 8.8 The average poultry feed price ratio for the years 1924 to 1939, inclusive, was 8.6875; for the base period years it was 8.6. 34. During the depression years petitioner used "bonded warehouses" *106 in the distribution of its Nutrena feeds. Under this method of distribution, petitioner shipped Nutrena feeds in carload lots to *1109 bonded warehouses on a consignment basis. The local bonded warehouses parceled out the carload shipments, remitting to petitioner as the feed was sold. Other dealers in the area could procure their supplies from the local bonded warehouse at cost, plus a small warehousing charge. The number of local bonded warehouses to which petitioner consigned feeds fluctuated but at one time during the depression petitioner had as many as 45. Petitioner paid the bonded warehouse a commission on each ton of feed sold and in addition paid certain warehouse expenses. 35. During the base period years and thereafter, petitioner continued to use bonded warehouses in distributing its products. The arrangement was not always mutually satisfactory and bonded warehouse openings and closings were occurring all the time. Prior to June 30, 1938, petitioner used a bonded warehouse at St. Joseph, Missouri, for the distribution of its feeds in that area. St. Joseph was a relatively large livestock center with trucks delivering livestock directly from the farms to *107 the stockyards. Nearby dealers used these trucks to bring back supplies of feeds at a cost below rail freight rates. Petitioner became dissatisfied with its arrangement at St. Joseph for a number of reasons, including the expense of the operation, the unsatisfactory service rendered to other dealers, insufficient distribution in the territory, and unwillingness to let the bonded warehouse extend credit for the petitioner. Due to this dissatisfaction and the conviction that it could distribute its products at a lower price from its own warehouse, petitioner, on or about June 30, 1938, purchased a warehouse in St. Joseph, Missouri, canceled its arrangements with its distributor there, and started its first company-owned warehouse operation. 36. Petitioner's total tonnage sales at St. Joseph as compared with its total tonnage sales at Kansas City, by 6-month periods, during the base period years were as follows: St. Joseph Period [1939] (Tons) 1st 6 months 2,131.23 2,865.54 1,239.32 2,087.90 2d 6 months 2,176.25 738.66 990.65 1,373.99 Total 4,307.48 3,604.20 2,229.97 3,461.89 Kansas City 1st 6 months 34,223.51 41,330.47 20,676.41 23,227.71 2d 6 months 34,026.49 14,565.66 10,807.43 14,324.23 Total 68,250.00 55,896.13 31,483.84 37,551.94 *108 *1110 37. During the base period years St. Joseph's total tonnage sales increased each year, percentagewise, over total Kansas City tonnage sales. The largest percentage of increase occurred after the establishment of the company-owned warehouse at St. Joseph. The percentages for the base period years were as follows: 1936, 6.31 per cent; 1937, 6.44 per cent; 1938, 7.08 per cent; 1939, 9.22 per cent. The percentages for 6-month periods in 1938 were 5.99 per cent for the first 6 months and 9.17 per cent for the second 6 months. The ratio of St. Joseph's tonnage sales to Kansas City's tonnage sales (excluding the St. Joseph tonnage) for the base period years showed a corresponding increase. The ratios were as follows: 1936, 6.74 per cent; 1937, 6.88 per cent; 1938, 7.62 per cent; 1939, 10.15 per cent. For the first 6 months of 1938 the ratio was 6.38 per cent, for the last 6 months the ratio was 10.09 per cent. During the 30-month period of bonded warehouse operation in the base period years, St. Joseph's tonnage sales were 6.31 per cent of Kansas City's (including St. Joseph). The ratio for the same 30-month period (excluding St. Joseph) was 6.74 per cent. For the 18-month*109 period of company-owned operation in the base period years St. Joseph's tonnage sales were 9.21 per cent of Kansas City's (including St. Joseph), and its ratio to Kansas City (excluding St. Joseph) for the same 18-month period was 10.14 per cent. 38. Prior to October 1, 1939, petitioner had no distributor of its products at Oklahoma City, Oklahoma. Dealers in that area were called upon by petitioner's salesmen. When petitioner's management began discussing the establishment of other company-owned warehouses, patterned after and based upon its St. Joseph operation, Coffeyville urged Oklahoma City as a site therefor. After investigating the situation, management decided to establish a company-owned warehouse there. On or about October 1, 1939, petitioner opened a company-owned warehouse at Oklahoma City. 39. Petitioner's management recognized that its company-owned warehouse at Oklahoma City would encounter difficulties absent from its St. Joseph experience. There had been no concentrated coverage of the Oklahoma territory by salesmen pushing petitioner's products, as at St. Joseph. There would be very strong local competition from other distributors of feeds. In addition to *110 selling its products, petitioner had to sell its stricter credit policies, as dealers in the territory had been accustomed for many years to buying feed supplies on more lenient credit terms than petitioner was willing to provide. Even so, at the time management opened its company-owned warehouse at Oklahoma City, it expected to develop the volume of business from this area to the point where normal sales volume would account for 10 per cent of the total Coffeyville volume. By December 31, 1939, the *1111 Oklahoma City operation was just beginning to function and only a very small tonnage had moved through the company-owned warehouse. During the base period years the general economic conditions and business fluctuations were about the same at Oklahoma City and Kansas City. 40. On or about December 1, 1939, petitioner established a company-owned warehouse at Omaha, Nebraska. Omaha, like Oklahoma City, was a terminal market and, like the latter, its territory had not been closely serviced. Petitioner had an excellent distributor in Iowa so that the distribution from Omaha would be primarily in Nebraska. Here, as at Oklahoma City, a good deal of local competition was expected*111 but petitioner's investigations convinced it that the potential market justified the establishment of a company-owned warehouse. At the time it established the Omaha operation, management expected the development of a normal sales volume of 15 per cent of the Kansas City tonnage. General economic conditions and the fluctuations of business would have been about the same at Omaha, Kansas City, and elsewhere in petitioner's trade territory during the base period years. At December 31, 1939, the Omaha operation had barely started. 41. The petitioner is entitled to use the excess profits credit based on income. 42. Petitioner's excess profits net income for the calendar years 1940 and 1941, computed under the law governing the imposition of excess profits taxes for the year 1941, and its excess profits net income for the calendar years 1942 and 1944, was as follows: Year Amount [1940] $ 104,173.32 [1941] 356,651.65 [1942] 551,758.26 [1944] 713,339.63 43. The excess profits net income of petitioner, computed without regard to section 722 of the Internal Revenue Code for 1939, for each taxable year during the base period under the law applicable to the year 1941, and its excess *112 profits net income, computed without regard to such section, for each taxable year during the base period, computed under the law applicable to the year 1942 and subsequent years, was as follows: Amount Year 1941 law 1942 law [1936] $ 277,036.28 $ 278,247.17 [1937] 154,719.28 154,884.09 [1938] 67,442.18 67,442.18 [1939] 84,944.48 84,944.48 Aggregate $ 584,142.22 $ 585,517.92 Arithmetic average 146,035.55 146,379.48 *1112 Petitioner's supplement A average base period net income for 1940 and 1941 was $ 146,035.55; its excess profits credit for each of such years was $ 138,733.77. Under section 742 (b), Internal Revenue Code of 1939, petitioner's supplement A average base period net income for 1942 and 1944 was $ 161,898.72; its excess profits credit for each of such years was $ 153,803.78. 44. Petitioner filed timely applications for relief and claims for refund under section 722 (a) and (b) (4). The claims were based upon changes in the character of business immediately prior to or during the base period, including the establishment and operation of a new plant at Coffeyville, Kansas, and the establishment and operation of company-owned warehouses at St. *113 Joseph, Missouri, Oklahoma City, Oklahoma, and Omaha, Nebraska. The constructive average base period net income claimed in petitioner's applications for relief and the petitions herein were: $ 451,582.07 for 1941 and $ 451,925.99 for 1942 and 1944. Claim was also made, in connection with 1941, for any unused excess profits credit for 1940. 45. The stipulated facts, oral and written, are so found, and are incorporated herein by reference. Exhibits S and T, being detailed profit and loss summaries of petitioner's operations by quarters and annually for specified years at Kansas City and Coffeyville, respectively, are found as facts and incorporated herein by reference. Ultimate Findings. 46. Immediately prior to the base period, petitioner changed the character of its business by the establishment of the new plant at Coffeyville, Kansas. It also changed the character of its business by the establishment of three company-owned and -operated warehouses, one at St. Joseph, Missouri, on June 30, 1938, one at Oklahoma City, Oklahoma, on October 1, 1939, and one at Omaha, Nebraska, on December 1, 1939. As a result of these changes petitioner's average base period net income does*114 not reflect the normal operation for the entire base period of its business. 47. Petitioner's business did not reach, by the end of the base period, the earning level it would have reached if the above changes in character had occurred 2 years earlier. 48. Petitioner's average base period net income is an inadequate standard of normal earnings. 49. Petitioner's excess profits tax for the calendar years 1941, 1942, and 1944, computed without the benefit of section 722, results in an excessive and discriminatory tax. 50. A fair and just amount representing petitioner's constructive average base period net income is $ 156,035.55 for the year 1940 for *1113 carryover purposes; $ 166,035.55 for 1941; and $ 166,379.48 for 1942 and 1944. OPINION. Petitioner's claims for relief are based primarily upon the ground that it had several changes in the character of its business both during and immediately prior to the base period years 1936 to 1939, inclusive, and that because of these changes its average base period net income did not reflect the normal operation for the entire base period of the business. It contends that its business did not reach, by the end of the base period, the earning*115 level which it would have reached if it had made these changes 2 years before it did so, and that under subsection (b) (4) of section 722 1 of the Internal Revenue Code of 1939, it shall be deemed to have made the changes at such earlier time. In its applications for relief and in the petitions before this Court, petitioner claimed a constructive average base period net income of over $ 451,000. In its brief, however, petitioner reduced this amount to about $ 265,000. In our findings we have found $ 166,035.55 for 1941; $ 166,379.48 for 1942 and 1944; and $ 156,035.55 for 1940, for carryover purposes. The reason for the substantially lesser amount for 1940 is due to the application of the so-called variable credit rule, which rule has been approved and applied by this Court in a number of cases. See Nielsen Lithographing Co., 19 T. C. 605, 614; Radio Shack Corporation, 19 T. C. 756, 762; Yeast Products, Inc., 21 T. C. 308, 330; Lily Mills Co., 21 T. C. 900, 911; and Springfield Tablet Manufacturing Co., 22 T. C. 35, 43. *116 We hold that the opening of the new plant and the three company-owned and -operated warehouses during or immediately prior to the *1114 base period constituted a "change in the character" of petitioner's business. Respondent does not seriously contend that petitioner does not qualify for consideration for relief. His main contention against allowing petitioner any relief under section 722 is that petitioner has not established that its average base period net income is an inadequate standard of normal earnings because of these changes. The parties have stipulated and we have so found that petitioner's average base period net income for 1940 and 1941 is $ 146,035.55, which is also its arithmetic average for the base period for years beginning prior to January 1, 1942; and that for 1942 and 1944 it is $ 161,898.72, which, due to the benefit of section 742 (b) (2), is $ 15,519.24 in excess of its arithmetic average for the base period of $ 146,379.48 for years beginning after December 31, 1941. We think petitioner has established that if the changes in character had been made 2 years earlier it would have had at the end of the base period an earning level considerably in excess*117 of its actual level. At Coffeyville it was constantly selling more feeds with a high margin of profit and less feeds with a low margin of profit. This means that if petitioner had opened the Coffeyville plant 2 years sooner and had had 2 years additional experience, its constructive net income for the base period would have been higher than its actual net income for that period. At St. Joseph the ratio of tonnage sales to Kansas City's tonnage sales increased considerably after the establishment of the company-owned and -operated warehouse in that city. In any reconstruction of net income for the base period, we think this improvement should be reflected throughout the base period. By December 31, 1939, the operations at Oklahoma City and Omaha were just beginning to function. These company-owned and -operated warehouses were in effect regarded by petitioner as additional plants except that petitioner did all of its manufacturing at the Kansas City and Coffeyville plants. We think that it may reasonably be assumed that if these two warehouses that were opened in 1939 had been opened 2 years earlier, they would have been as successful as the one at St. Joseph and that some additional*118 income should be reconstructed accordingly. We have found as an ultimate fact that for the years 1941, 1942, and 1944, petitioner has established a constructive average base period net income of $ 20,000 in excess of its arithmetic average base period net income for those years instead of $ 118,892.75 contended for by petitioner. In arriving at this figure, we have given consideration to all of the facts set out in our findings and to the respondent's contention that some adjustment should be made in reconstructing normal earnings for any abnormal benefit petitioner may have derived from the drought situation referred to in our Findings of Fact. Also, in arriving at this figure we have rejected petitioner's contention that certain expenses which appeared on the books at Kansas City should *1115 be allocated to Coffeyville. We do not think the evidence supports petitioner in this regard. The above-mentioned $ 20,000, when added to petitioner's arithmetic average base period net income for the years 1941, 1942, and 1944, produces a constructive average base period net income in excess of petitioner's average base period net income for those years in the amounts set out in our*119 findings. Reviewed by the Special Division. Decisions will be entered under Rule 50. Footnotes 1. The following sales of cornmeal, etc., not properly classified as mixed feed, are included herein for lack of a breakdown of such tonnage sales by States: 1935, 349; 1936, 1,984; 1937, 1,778; 1938, 2,089; 1939, 1,376.↩ 1. Includes cornmeal and flour.↩ 1. Includes cornmeal and flour.↩ 1. Includes labor, milling, selling, advertising, and administrative expenses.↩ 2. Does not include losses on operation of experimental farm in the amounts of $ 12,942.16, $ 7,474.66, and $ 3,881.84 for the years 1937, 1938, and 1939, respectively.↩ 1. Sec. 722 (a). General Rule. -- In any case in which the taxpayer establishes that the tax computed under this subchapter (without the benefit of this section) results in an excessive and discriminatory tax and establishes what would be a fair and just amount representing normal earnings to be used as a constructive average base period net income for the purposes of an excess profits tax based upon a comparison of normal earnings and earnings during an excess profits tax period, the tax shall be determined by using such constructive average base period net income in lieu of the average base period net income otherwise determined under this subchapter. * * * (b) Taxpayers Using Average Earnings Method. -- The tax computed under this subchapter (without the benefit of this section) shall be considered to be excessive and discriminatory in the case of a taxpayer entitled to use the excess profits credit based on income pursuant to section 713, if its average base period net income is an inadequate standard of normal earnings because -- * * * * (4) the taxpayer, either during or immediately prior to the base period * * * 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 * * * made the change in the character of the business two years before it did so, it shall be deemed to have * * * 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 * * *↩