Gillen & Boney v. Commissioner

Gillen and Boney, a Corporation, and Frank R. Gillen, Russell Stover and Lem T. Jones, Liquidating Trustees of Said Gillen and Boney, a Corporation, Petitioners, v. Commissioner of Internal Revenue, Respondent Gillen & Boney v. Commissioner Docket No. 30908 United States Tax Court 27 T.C. 242; 1956 U.S. Tax Ct. LEXIS 56; October 31, 1956, Filed *56 Decision will be entered for the respondent. Section 722 (I. R. C. 1939) claim for relief denied where excess profits tax credits, based on the most favorable constructive average base period net income allowable under the evidence to remove the effect of the drought, would not exceed the credits allowed petitioner by the respondent based on invested capital. Whitson Rogers, Esq., and Roger V. Dickeson, Esq., for the petitioners. David Karsted, Esq., for the respondent. LeMire, Judge. LEMIRE *243 The Commissioner denied the petitioners' application for relief under section 722 of the Internal Revenue Code of 1939 for the year 1943, and determined a deficiency in excess profits tax for that year in the amount of $ 11,881.54. Petitioners claim relief under section 722 (b) (1) and (b) (2) based on drought and insect*57 infestation in its trade area during the base period. FINDINGS OF FACT. Gillen and Boney was a Nebraska corporation (hereinafter referred to as petitioner), and maintained its manufacturing plant and general offices in the city of Lincoln, Nebraska. It was dissolved on December 15, 1944. Its return for the taxable year 1943 was filed with the collector of internal revenue at Omaha, Nebraska, on an accrual basis and for the calendar year. Petitioner computed its excess profits credit for 1943 under the invested capital method. Its excess profits net income and its credit so computed were $ 79,241.28 and $ 15,373.90, respectively. Petitioner is entitled to the use of the income method of computing its excess profits credit, and its excess profits net income so computed was $ 77,808.55. Its excess profits net income (or loss) for each of the base period years was as follows: Excess profits Year net income (or loss) [1936] ($ 11,088.43) [1937] (15,782.97) [1938] (10,573.73) [1939] (10,031.48) Total ($ 47,476.61) Average (loss) (11,869.15) Prior to 1900 petitioner and its predecessor proprietorship were engaged in manufacturing and wholesaling candy products. During*58 the base period and for many years prior thereto petitioner manufactured bulk candies (which included such items as chocolate dipped caramels, peanuts, peanut clusters, creams, etc.), nickel candy bars, penny candies, box candies, and fancy box candies. Petitioner also purchased from other manufacturers and jobbers such items as chewing gum, Lifesavers, Hershey bars, root beer syrup, ice cream cones, and the like, to supplement its own line. During the base period years the ratio of sales by petitioner of goods purchased to the net sales it its own manufactured products was approximately 27 per cent, whereas the ratio for the years 1922 to 1939 was approximately 31 per cent. *244 Petitioner's customers were largely grocery stores, drugstores, novelty stores, pool halls, and soft drink parlors throughout its trade area. Petitioner also sold its products to a few wholesale grocery houses which job nationally advertised candy bars, such as Baby Ruth, Milky Way, Mars bars, and Snickers in competition with petitioner's products. In addition, petitioner sold a small amount of its manufactured products to jobbers of candy. During the 1920's petitioner sold to various chain stores, *59 such as Woolworth, Piggly Wiggly, Hested, and Kresge, and such sales accounted for approximately 3 per cent of petitioner's sales in those years. Sales to chain stores were made on the basis of bids, and competition was primarily on a price basis. During the 1920's and early 1930's petitioner started to lose this type of business because it could not compete on a price basis, and during the base period, sales to chain stores were virtually nonexistent. Primarily, petitioner's trade area covered the entire State of Nebraska with the exception of the extreme northeast corner. It also included the northern tier of counties in Kansas, as far west as Oberlin, Kansas, the southwestern part of South Dakota, including the southern area of the Black Hills region, and the eastern edge of Wyoming. During the 1920's petitioner had sales in Omaha, the largest city in Nebraska, as well as in most of the larger cities throughout the Middle West. Such sales accounted for approximately 10 per cent of petitioner's total sales. During the 1930's, and particularly during the base period, the sales in Omaha became practically nil, and its out-of-State sales all but disappeared after the death in *60 1930 of the broker who handled such sales. Nebraska is essentially an agricultural State. While it has some manufacturing and other industries, its economy is based largely on the production and processing of farm products, the most important of which are cattle, hogs, corn, and wheat. Beginning about 1934 and extending through petitioner's base period, Nebraska and other adjoining areas suffered a severe drought. Average rainfall in Nebraska, over the period 1936 to 1939, inclusive, was less than 70 per cent of normal. Lack of moisture and severe heat at the critical stages of development caused an almost total crop failure of major crops in some of those years. In addition to the drought there was also a serious infestation of grasshoppers in Nebraska during the base period years, which added to the short production of most farm crops over large areas of the State. This damage in the State of Nebraska alone was estimated by the United States Department of Agriculture at between 11 and 12 million dollars in each of the years 1936, 1937, and 1938. *245 The adverse effects of the drought in Nebraska and neighboring States were intensified by the fact that the drought followed*61 a prolonged economic depression, due to low prices for farm commodities and other factors, which began in the early 1930's. These results are reflected in the following statistics relating to "cash receipts from farm marketings" in the State of Nebraska: Cattle Hogs Corn Wheat Total Year (1,000 (1,000 (1,000 (1,000 livestock and dollars) dollars) dollars) dollars) crops (1,000 dollars) [1924] $ 114,881 $ 109,981 $ 56,897 $ 50,370 $ 421,087 [1925] 121,455 141,226 42,958 47,411 444,867 [1926] 130,683 135,306 28,783 40,987 434,244 [1927] 107,046 113,212 23,881 74,815 418,364 [1928] 138,851 121,314 61,177 55,494 484,618 [1929] 138,316 136,824 40,645 54,941 489,102 [1930] 119,019 118,172 39,094 32,412 408,392 [1931] 90,729 79,287 18,463 20,715 279,142 [1932] 57,506 43,426 7,736 8,368 166,669 [1933] 57,628 43,253 21,826 16,035 193,353 [1934] 78,802 53,644 16,767 13,816 227,176 [1935] 72,216 40,185 1,690 25,204 209,398 [1936] 92,841 68,838 5,935 34,011 281,020 [1937] 91,876 39,190 2,893 39,690 250,783 [1938] 72,603 32,436 9,507 22,312 200,521 [1939] 78,850 36,701 17,882 24,441 221,494 The totals*62 shown in the last column above include other lesser livestock and livestock products such as dairy products, sheep, and poultry, and other lesser crops such as potatoes, beets, oats, and hay, not shown separately in the table, but do not show Government payments to farmers, shown hereinafter. The loss of farm production and farm income affected all types of business throughout the drought-stricken area, particularly those which depended largely on farm trade. As a result of the short production of feed crops during the drought period there was a reduction in the quantity and quality of marketable cattle and hogs. Large quantities of feeds were brought in from other States at additional costs to the farmers, and much of the livestock was sold in poor condition at distress prices. Because of these extra costs of production there was a proportionately greater reduction in farm net income and purchasing power than there was in gross income. The farmers of Nebraska, in most instances, exhausted their cash reserves as well as their credit, and their spending was reduced to bare necessities. Their houses and farm equipment of all types suffered from lack of repairs and proper maintenance. *63 Government and State agencies instituted various relief programs. The Farm Security Administration made many loans and, in some instances, outright grants to distressed farm families. The Farm Service Administration assisted in working out minimum cost subsistence recipes and budgets. The Agricultural Extension Service of the University of Nebraska organized instruction courses for farm families in repairing and, in some instances, making their own household *246 necessities and personal clothing. Feed sacks were used to make underclothes for the children, and other wearing apparel; old blankets were converted into clothing; and sewing centers were established where overalls, dresses, and other articles, even toys, were made and distributed free to needy families. Altogether, about 4 million garments and as many other articles were made and distributed free to Nebraska families. At the beginning of 1938 over 200,000 persons, approximately 15 per cent of the total population of Nebraska, were on some form of relief. The distress conditions described above prevailed not only among the farm families but also in the urban areas, and particularly in the small towns which depended*64 largely upon farm income. The following table shows the total income payments and the per capita income payments to individuals in Nebraska and in the United States as a whole over the period 1929 to 1939, inclusive, as published by the United States Department of Commerce: (Millions of dollars) Total (Dollars) Per capita income income payments payments Year United States Nebraska United States Nebraska [1929] $ 82,617 $ 764 $ 680 $ 557 [1930] 73,325 [1931] 61,971 [1932] 47,432 [1933] 46,273 [1934] 53,038 [1935] 58,558 [1936] 68,000 [1937] 72,211 [1938] 66,045 [1939] 70,601 [397] Cash farm income from marketings of crops and livestock and Government payments, including all cash agricultural payments such as rentals, price supports, conservation, and parities, for the State of Nebraska, over the period 1924 to 1939, inclusive, was as follows: (Thousands of dollars) Year Cash farm Total crops Government income and and livestock payments Government payments [1924] $ 421,087 $ 421,087 [1925] 444,867 444,867 [1926] 434,244 434,244 [1927] 418,364 418,364 [1928] 484,618 484,618 [1929] 489,102 489,102 [1930] 408,392 408,392 [1931] 279,142 279,142 [1932] 166,669 166,669 [1933] 193,353 $ 1,011 194,364 [1934] 227,176 23,496 250,672 [1935] 209,398 33,125 242,523 [1936] 281,020 17,293 298,313 [1937] 250,783 17,468 268,251 [1938] 200,521 15,371 215,892 [1939] 221,494 28,078 249,572 *65 *247 In relation to the 1924-1929 average the percentages of land values over the period 1930 to 1939 and of forced sales and related defaults on purchases of farms in the State of Nebraska and the United States as a whole were as follows: Land values Forced sales and related defaults Year Percentage Percentage United Nebraska United Nebraska States States [93] 20.8 17.0 [88] 26.1 24.4 [74] 41.7 39.0 [57] 54.1 63.9 [60] 39.1 51.0 [60] 28.3 45.0 [60] 26.2 44.4 [60] 22.4 42.4 [57] 17.4 38.9 [54] 17.0 39.9 The population of Nebraska dropped from approximately 1,378,000 persons in 1930 to approximately 1,316,000 in 1940. About 35 per cent of the 1930 and 1940 population was urban. The petitioner's gross sales, gross profit, expenses, other income or deductions, and net profit (or loss) for the period 1918-1941 were as follows: Net Net Year Total net Gross Per cent Operating Per cent additions or profit (or sales profit of sales expenses of sales (deductions) loss) from income [1918] $ 502,920 $ 156,169 31.0 $ 96,373 19.2 ($ 2,058) $ 57,738 [1919] 619,069 184,942 29.9 126,111 20.4 1,415 60,246 [1920] 762,763 187,658 24.6 167,026 21.9 18,300 38,932 [1921] 553,359 161,159 30.3 137,767 25.8 7,117 30,509 [1922] 517,283 172,877 33.4 144,549 27.9 8,737 37,066 [1923] 594,351 182,927 30.8 152,400 25.6 (1,354) 29,174 [1924] 575,004 172,746 30.0 154,160 26.8 8,350 26,936 [1925] 593,029 180,375 30.3 151,852 25.6 4,532 33,056 [1926] 620,882 194,258 31.3 162,652 26.2 3,740 35,346 [1927] 634,012 198,236 31.3 162,001 25.6 1,539 37,774 [1928] 566,295 170,356 30.1 147,742 26.1 1,461 24,075 [1929] 490,819 167,608 34.1 144,600 29.5 [880] 23,888 [1930] 443,692 144,855 32.6 139,441 31.4 5,597 11,010 [1931] 322,970 102,367 31.7 125,266 38.8 1,974 (20,924) [1932] 201,954 65,571 32.5 92,971 45.9 2,398 (25,002) [1933] 181,222 61,571 34.0 77,469 42.7 1,182 (14,716) [1934] 194,729 60,509 31.0 76,153 39.1 [924] (14,720) [1935] 215,321 63,246 29.4 73,434 34.1 [270] (9,917) [1936] 207,858 63,861 30.7 72,466 34.9 [338] (8,266) [1937] 199,690 60,317 30.2 72,870 36.5 (676) (13,229) [1938] 182,846 54,508 29.8 64,680 35.4 [949] (9,223) [1939] 158,226 46,548 29.4 55,589 35.1 [777] (9,818) [1940] 150,897 41,538 27.5 52,099 34.5 (901) (11,461) [1941] 157,737 42,175 26.7 52,555 33.3 (1,081) (11,461) *66 During the 1920's petitioner spent for advertising an average of approximately $ 8,000 per year. The average expenditure for advertising during the base period years was approximately $ 678 per year. During the 1920's petitioner employed approximately 11 salesmen. During the 1930's the number of salesmen was reduced to 8. *248 Because of the drought and, to a lesser extent, insect infestation and their effect on farm income and business generally in the State of Nebraska, petitioner's earnings were depressed so that its average base period net income was an inadequate standard of normal earnings. The excess profits tax paid by petitioner for the taxable year 1943 was not excessive or discriminatory. Petitioner was not entitled to a constructive average base period net income large enough to produce a credit greater than the invested capital credit used by petitioner and allowed by the respondent. OPINION. Petitioner claims a refund of excess profits tax paid for the year 1943 in the amount of $ 24,123.12. Petitioner's average base period net income was a loss of $ 11,869.15, and for the taxable year 1943 it used the excess profits tax credit based on invested capital which*67 amounted to $ 15,373.90. Petitioner is claiming relief under section 722 (b) (1) and (b) (2) of the Internal Revenue Code of 1939 on the ground that its business was depressed during the base period years by the drought which prevailed over its trade area. It has been stipulated that the evidence presented in the cases of S. N. Wolbach Sons, Inc., 22 T. C. 152, Sartor Jewelry Co., 22 T. C. 773, and Schwarz Paper Co., 23 T. C. 605, could be considered as evidence in the present proceeding. On the basis of the findings of fact in those cases, which are incorporated herein, the respondent concedes that during the base period years a serious drought occurred in the State of Nebraska. We have found that because of the drought and its effect on farm income and business generally in the State of Nebraska, petitioner's earnings were depressed during the base period years so that its average base period net income was an inadequate standard of normal earnings. The drought is a qualifying factor under section 722 (b) (2); S. N. Wolbach Sons, Inc., supra; Sartor Jewelry Co., supra.*68 For the year 1943 petitioner is entitled to an excess profits tax credit based on income if that should result in a lesser tax. To be entitled to relief petitioner must show to what extent its earnings were depressed by reason of the drought and provide some reasonably accurate means of reconstructing its base period earnings. Petitioner must further show that it is entitled to a constructive average base period net income which will result in a larger excess profits tax credit, based on income, than that allowed by the respondent under the invested capital method. Farmers Creamery Co. of Fredericksburg, Va., 18 T. C. 241; Godfrey Food Co., 18 T. C. 1083. For 1943 petitioner's excess profits tax credit based on invested *249 capital is in the amount of $ 15,373.90. On brief, petitioner contends for a reconstructed average base period net income of at least $ 27,200. The respondent argues that if petitioner's base period net income is reconstructed to remove the effects of the drought, the resulting credit will not exceed the credit based on invested capital. After considering the evidence and the methods of reconstruction*69 proposed by petitioner, and weighing the evidence as to factors having a bearing on the earnings of petitioner, other than those resulting from the effects of the drought, we are convinced that no reasonable reconstruction compatible with petitioner's experience will yield an excess profits credit based on income greater than its excess profits tax credit based on invested capital. It will be noted that petitioner suffered a considerable net loss in each year during the period 1931 to 1941, inclusive, ranging from a high of $ 25,000 to a low of approximately $ 8,300. Its total sales declined progressively from 1928 to 1934. Petitioner's operating expenses during the base period years were, percentagewise, considerably in excess of the operating expenses in the years in which it had net income. The period of the drought commenced in 1934 and continued through the base period years. We are persuaded that petitioner has overestimated the effect of the drought on its base period sales. An adjustment of petitioner's gross sales to the highest point justified by the evidence and an application of a reasonable ratio of net profits to sales based on actual experience would not result in*70 a reconstructed average base period net income yielding an excess profits credit more than the $ 15,373.90 credit allowed petitioner under the invested capital method. We conclude, therefore, that there was no error in respondent's disallowance of petitioner's claim for relief under section 722. Cf. Sartor Jewelry Co., supra, and Schwarz Paper Co., supra. Reviewed by the Special Division. Decision will be entered for the respondent.