Iron Fireman Mfg. Co. v. Comm'r

Iron Fireman Manufacturing Company, Petitioner, v. Commissioner of Internal Revenue, Respondent Iron Fireman Mfg. Co. v. Comm'r Docket No. 1908 United States Tax Court 5 T.C. 452; 1945 U.S. Tax Ct. LEXIS 120; July 19, 1945, Promulgated *120 Decision will be entered under Rule 50. 1. Petitioner, for several years prior to 1940, owned all of the stock of two subsidiary companies, A and B. During some of the earlier years losses sustained by A were deducted in consolidated returns. As the result of its operations, A had become indebted to petitioner in a substantial amount; but its stock was not worthless. In 1940 A transferred all of its assets to B in consideration of the assumption by B of $ 250,000 of the indebtedness owing by it to petitioner and the payment of the $ 15,950.84 in cash. A was then dissolved. Petitioner credited the aggregate $ 265,950.84 against the indebtedness due to it from A. The stock of A had no value after the transaction occurred. Held, petitioner's stock investment in A became worthless in 1940 and was properly deducted from its gross income as a capital loss; held, further, that the computation of the loss was correctly made by petitioner, inasmuch as it excluded the operating losses previously deducted on consolidated returns. Edward Katzinger Co., 44 B. T. A. 533; affd., 129 Fed. (2d) 74. 2. In a timely claim for*121 refund of excess profits tax for 1940 petitioner sought to adjust its base period net income by the disallowance of abnormal deductions in 1937 and 1938 for replacement expenses, occasioned in part by defects in new models of "coal-flow" and anthracite stokers. Under section 711 (b) (1) (J) and (K), I. R. C., such disallowance may be made only if the taxpayer establishes that the abnormality or excess is not a consequence of an increase in its gross income in its base period. Held, that petitioner failed to make the necessary proof. Fletcher Rockwood, Esq., Charles E. McCullough, Esq., and Thomas D. Stoel, Esq., for the petitioner. Earl C. Crouter, Esq., for the respondent. Mellott, Judge. MELLOTT *452 This case involves a deficiency in petitioner's income tax for the calendar year 1940 in the amount of $ 2,618.68 and a claimed*122 overassessment *453 in excess profits tax for the same year in the amount of $ 2,317.20. The questions raised by the pleadings are whether the Commissioner erred (a) in disallowing as a deduction from gross income the sum of $ 11,823.12 claimed by petitioner as a long term capital loss, and (b) in refusing to allow petitioner's claim for refund of excess profits tax based upon its contention that substantial amounts should be restored to its excess profits net income for the base period years as abnormal deductions. The basic facts have been stipulated and by this reference are hereby found. Others set out in our findings are based upon evidence adduced at the trial. FINDINGS OF FACT. Petitioner is an Oregon corporation, with its principal office in Portland, Oregon. Its return for the calendar year 1940 was filed with the collector of internal revenue at Portland, Oregon. On November 22, 1941, petitioner filed a claim for refund of its excess profits tax for the year 1940 in the amount of $ 7,480.49. This claim was allowed by the Commissioner in the sum of $ 5,163.29 and rejected in the sum of $ 2,317.20. Iron Fireman Corporation is an Oregon corporation which petitioner*123 caused to be organized on April 30, 1934. It is, and at all times since its incorporation has been, a wholly owned subsidiary of petitioner and is licensed to act as petitioner's selling agency in all of the states of the United States. Iron Fireman of St. Louis, Inc. (hereinafter referred to as St. Louis Co.), prior to its dissolution in 1940 was a Missouri corporation which petitioner caused to be organized on March 4, 1931, to sell, install, and service its stokers and heating equipment in the vicinity of St. Louis, Missouri. All of its capital stock, consisting of 200 shares of the par value of $ 100 per share, was fully paid for by petitioner and the beneficial ownership of all of the stock was at all times in petitioner, although qualifying shares were issued to individual directors. Petitioner's investment in the stock of St. Louis Co. was recorded on its books by a debit of $ 20,000 to an account entitled "Stock in Iron Fireman of St. Louis," and throughout the corporate life of St. Louis Co. its balance sheet showed a liability for capital stock outstanding of $ 20,000. From 1931 until its dissolution in 1940, St. Louis Co. was an active operating company and carried on*124 a large volume of business as petitioner's selling agency in the St. Louis territory. Its annual sales and net income from March 4, 1931, to December 31, 1939, were as follows: *454 Year Sales Net income (loss) [1931] $ 78,954.65 ($ 29,588.27) [1932] 26,310.45 (20,520.63) [1933] 15,564.09 (1,029.57) [1934] 29,382.53 (2,524.96) [1935] 79,791.71 (6,759.63) [1936] $ 140,601.13 $ 2,639.33 [1937] 224,909.46 (4,274.00) [1938] 220,704.97 (1,981.14) [1939] 220,149.26 (3,279.74) During the years 1931, 1932, and 1933 consolidated income tax returns were filed by petitioner and St. Louis Co. and the net losses of the latter in those years, in the total amount of $ 50,445.80, were offset against petitioner's income. Thereafter, separate returns were required, and the losses of St. Louis Co. were unavailable as a deduction or offset against the income of petitioner or its affiliated companies. During the period from March 4, 1931, to December 31, 1939, petitioner followed the practice of selling merchandise to St. Louis Co. on open account. The transactions between the two companies were recorded on petitioner's books in a running account entitled "St. Louis Branch Control." *125 When merchandise was shipped to St. Louis Co. and when expenses were paid for its account by petitioner, charges to this account were made, and as payments were made the running account was credited. In the table which follows is a statement of the total charges and credits to the account by years: Year Charges Payments Balance at end of year [1931] $ 57,822.50 $ 9,541.02 $ 48,281.48 [1932] 21,621.44 930.96 68,971.96 [1933] 13,837.01 31,326.00 51,482.97 [1934] 24,508.59 21,000.00 54,991.56 [1935] 68,541.17 19,500.00 104,032.73 [1936] 82,445.39 41,500.00 144,978.12 [1937] 154,802.51 63,500.00 236,280.63 [1938] 146,291.53 89,500.00 293,072.16 [1939] 130,077.39 114,929.79 308,219.76 Total 699,947.53 391,727.77 At December 31, 1939, St. Louis Co. was indebted to petitioner on this open account in the amount of $ 308,219.76. Its total assets on that date were $ 306,342.02 and its liabilities, exclusive of capital stock, aggregated $ 348,610.94. In the financial statements of St. Louis Co. for the year 1939 the indebtedness to petitioner was shown as a current liability under the caption "Due Iron Fireman Mfg. Co.," and for every year from 1931 to*126 1938, inclusive, the balance current from time to time had likewise been shown on the balance sheets of St. Louis Co. under the same caption. In December 1939 preparations were made by the officers of the parent and subsidiary companies to sell the assets of St. Louis Co. to Iron Fireman Corporation, and to dissolve St. Louis Co. The parties *455 intended the transfer to be effective as of the end of the year 1939, at a price equal to the value of the net assets of St. Louis Co. on that date; but, because of the pressure of year-end business and the necessity of waiting for the annual audit of St. Louis Co. for a determination of values, the actual formalities were not completed until March 1940. The financial statement of St. Louis Co. for the year 1939, adjusted to conform to the consolidated balance sheet for petitioner and its affiliated companies completed and released by Price, Waterhouse & Co. on February 6, 1940, showed net assets on December 31, 1939, of the value of $ 265,950.84 (exclusive of the account payable to petitioner) and a cumulative operating deficit in the amount of $ 62,268.92. The transfer of the net assets to Iron Fireman Corporation was accomplished*127 by a bill of sale dated March 9, 1940, and St. Louis Co. was dissolved by resolutions of its stockholders and directors adopted March 11, 1940. By a further resolution, adopted by the directors of St. Louis Co. on March 25, 1940, the directors confirmed the sale of all of its assets to Iron Fireman Corporation as of the end of the year 1939, for a total purchase price equal to the net asset value on that date, to wit, $ 265,950.84. Of this amount, $ 15,950.84 was paid by Iron Fireman Corporation to St. Louis Co. in cash and the balance of $ 250,000 was paid by Iron Fireman Corporation by the assumption of that amount of indebtedness due from St. Louis Co. to petitioner. All of the assets of St. Louis Co. (consisting of $ 15,950.84 in cash and the assumption by Iron Fireman Corporation of $ 250,000 of the indebtedness owing by St. Louis Co. to petitioner) were then distributed to petitioner pursuant to a resolution of the board of directors of St. Louis Co. adopted March 25, 1940. From and after January 1, 1940, the St. Louis business was conducted as a retail branch of Iron Fireman Corporation, but in the same manner and with the same personnel as when carried on by St. Louis Co.*128 The annual sales of the St. Louis branch, as shown by the books of Iron Fireman Corporation for the year 1940, were $ 387,118.58 and the net income therefrom was $ 26,656.54. In its income tax return for the calendar year 1940, petitioner treated the assets of St. Louis Co. (that is, cash in the amount of $ 15,950.84, and the promise of Iron Fireman Corporation to assume and pay the obligation of the St. Louis Co. to petitioner to the extent of $ 250,000) which were distributed to it upon the dissolution of that company, as a credit to be applied against the indebtedness owing to petitioner. Petitioner claimed that, since the net assets so distributed were insufficient to cover its advances to the subsidiary, there remained no assets for distribution to it as the sole stockholder. Accordingly, it treated its stock investment in St. Louis Co. as becoming entirely worthless in *456 the year 1940, and deducted from its gross income for 1940 a net long term capital loss in the amount of $ 11,823.12, computed as follows: Due from St. Louis Co. (Exclusive of stock investment) $ 308,219.76 Proceeds of sale of net assets turned over to petitioner $ 250,000.00 15,950.84 265,950.84 Loss upon account receivable due from St. Louis Co 42,268.92 Net operating losses deducted on consolidated returns, 1931, 1932, 1933 50,445.80 Less loss upon account receivable 42,268.92 8,176.88 Investment in Capital Stock of St. Louis Co 20,000.00 Less excess of amount deducted on consolidated returns over loss on account receivable 8,176.88 Net long term capital loss 11,823.12 *129 In his determination of the deficiency the Commissioner disallowed as a deduction from petitioner's gross income for 1940 the above described sum of $ 11,823.12 on the ground that: (a) The stock of St. Louis Co. had no value at the beginning of the calendar year 1940; and (b) the loss sustained, if any, was not allowable by reason of the provisions of section 112 (b) (6) of the Internal Revenue Code. The capital stock of the St. Louis Co. was not worthless at the beginning of the year 1940. The petitioner began business as a partnership in 1923 and was incorporated in 1926. Throughout the period from 1923 to 1940 it was engaged in the manufacture and sale of automatic coal stokers for domestic and industrial use. It has three manufacturing plants, located at Portland, Oregon, Cleveland, Ohio, and Toronto, Canada. The plants at Portland and Cleveland are owned and operated by petitioner and the plant at Toronto, Canada, is owned and operated by Iron Fireman Manufacturing Co. of Canada, Ltd., a wholly owned subsidiary of petitioner. The portland plant has been in operation since 1926 and the Cleveland plant since 1930. Until 1941 all research and development work was carried on*130 at the Portland plant. Petitioner's products are sold through dealers and seven retail branches, five of which are in the United States and two in Canada. There are approximately 1,400 dealers in the United States. This method of distribution has been followed since petitioner's organization. Petitioner guarantees its products against defective material and workmanship for a period of one year under a written guarantee. If defects covered by the guarantee occur the customer makes a claim *457 to the dealer, who makes the necessary correction and bills petitioner for the cost. Sometimes the necessary replacements are shipped to the dealer without charge and charged to the "Replacements and Allowances" account, to which all expenditures incident to replacing or repairing defective parts of stokers and allowances in lieu of replacements are charged. Charges to this account do not affect any other operating expense account. Replacement and allowance expenses are incurred after the sales have been made and after the incidents which produce gross income have occurred. The automatic coal stoker produced by petitioner consists of the "hopper" model, manufactured since 1923, which*131 carries the coal automatically from a hopper filled by hand, and the "bin feed" model, manufactured since 1933, which conveys the coal directly from the coal bin to the furnace. The latter model was called the "coal flow" after 1936. Both of these models were designed in various types and sizes for domestic and industrial use. Prior to 1927 petitioner's stokers were designed and used only for bituminous coal. The first stokers to burn anthracite coal were put out in 1927. They were of the hopper model. Development work continued on this model until 1935 or 1936 when it was put on the market in quantity. The "coal flow" model to burn anthracite was first put out in 1933. This model also was continued in an experimental state until 1936 when it was put on the market in quantity. There were defects in the design of both models of anthracite stokers which necessitated large expenditures in replacements and allowances. The principal difference between an anthracite and a bituminous machine is the burning head, or portion of the machine that is in the firebox of the furnace. The design of the burning head for bituminous coal was changed to adapt it to anthracite. For this purpose*132 considerable experimental work and improvement on the anthracite burning heads was necessary. In 1936 some of these were put out to replace earlier models in use and about March 1937 the new burning heads were put on the entire line of anthracite equipment. In actual operation it was found that the new burning heads would not handle all the various types of anthracite coal encountered throughout the field. Petitioner has continuously developed and improved its stokers through experiment and research, utilizing the experience gained by the actual operation of its stokers in the field. In accordance with this policy and its guarantee, petitioner in 1937, 1938, and part of 1939 replaced most of the burning heads with designs improved to eliminate the objectionable features. The ash conveyer in the anthracite models, which had been found too noisy for domestic use, was also redesigned and replacements were made during this period. During this same period petitioner experienced trouble with the design *458 of the bin feed or "coal flow" stokers. Defects developed in the transfer housing drive and it became necessary to change the design for better lubrication and to replace *133 parts to correct the installations already made. Prior to 1935 the sale of anthracite stokers amounted to less than 1 percent of the total sales of petitioner. From 1936 to 1940 the anthracite stokers comprised between 15 and 20 percent of the total sales. All of the anthracite stokers were manufactured at the Cleveland plant for distribution to the eastern section of the United States, where anthracite coal is used. Since its organization petitioner has continuously sought to improve its stokers and has maintained experimental laboratories for that purpose. It has made changes from time to time in the construction and design of its stokers, but has never followed a policy of getting out yearly models. The changes in its machines have been evolutionary and along its basic idea of mechanical stokers. The net sales and replacements and allowances expense for the years 1928 to 1932, inclusive, were as follows: Replacements Year Sales and allowances expense [1928] $ 1,947,386.16 $ 38,733.72 [1929] 3,011,936.66 34,683.01 [1930] 3,081,703.97 43,006.06 [1931] 1,949,829.51 24,413.00 [1932] 1,671,989.93 8,226.54 The sales referred to above were substantially all of*134 bituminous stokers. The following table shows petitioner's total sales and replacements and allowances during the years 1933 to 1940 inclusive: Replacements Percentage of Year Sales and allowances expense to expense sales Percent [1933] * $ 1,990,057 $ 7,659 0.385 [1934] 2,647,776 7,704 0.291 [1935] 3,645,186 16,089 0.441 [1936] 4,943,430 14,309 0.289 [1937] 5,279,354 48,013 0.910 [1938] 4,584,332 44,413 0.969 [1939] 4,861,218 35,744 0.735 [1940] 5,647,556 22,663 0.401 The following table shows petitioner's total sales and replacements and allowances expense for coal flow and anthracite type of stokers for the years 1935 to 1940, inclusive: *459 Replacements Percentage of Year Sales and allowances expense to sales expense Percent [1935] $ 212,922 $ 1,135 0.52 [1936] 765,960 2,351 0.31 [1937] 1,000,554 27,947 2.79 [1938] 783,303 25,028 3.18 [1939] 784,907 21,889 2.78 [1940] 913,057 9,368 1.03 Petitioner's gross income for the years 1933 to 1940 was as follows: Year Sales Cost of sales Other income Gross income [1933] * $ 1,991,262.99 $ 842,663.94 $ 46,410.64 $ 1,195,009.69 [1934] 2,647,776.03 1,244,972.39 62,946.50 1,465,750.14 [1935] 3,645,186.37 1,839,140.39 88,693.50 1,894,739.48 [1936] 4,943,430.38 2,464,767.05 133,849.75 2,612,513.08 [1937] 5,279,354.21 2,674,578.33 143,036.96 2,747,812.84 [1938] 4,584,332.48 2,406,053.96 84,494.57 2,262,773.09 [1939] 4,861,218.18 2,495,269.53 91,835.52 2,457,784.17 [1940] 5,647,556.24 3,016,219.99 98,603.14 2,729,939.39 *135 Petitioner had a normal amount of expenditures for replacements and allowances every year as an incident to the type of business in which it is engaged. These expenses varied from year to year in a reasonably constant proportion to the sales made in the prior year and, to some extent, in the current year. In years like 1937 and 1938, when new models were being tried out, the replacements and allowances expenditures may be abnormal, by reason of defective machinery or models, in proportion to sales. A substantial part of the increase in replacements and allowances during the years 1937, 1938, and 1939 was due to greatly increased sales of stokers in those years and the extraordinary increase in replacements and allowances on coal flow and anthracite machines in 1937, 1938, and 1939 was occasioned by defective models of those machines being put on the market in quantity, beginning in 1935 and 1936. By an amended excess profits tax return and claim for refund filed November 21, 1941, petitioner, in computing its excess profits tax credit for the taxable year 1940, sought to restore to its average base period*136 net income its deductions for replacements and allowances expense to the extent of $ 25,350.06 in the year 1937 and $ 17,502.33 in the year 1938, on the ground that its deductions of this class during each of said years were abnormal in amount within the meaning of section 711 (b) (1) (J) of the Internal Revenue Code. Its computation of the amount to be restored in each of said years was substantially as follows: *460 Prior year deductions Calendar year Calendar year [1933] $ 7,658.68 [1934] 7,704.33 $ 7,704.33 [1935] 16,088.58 16,088.58 [1936] 14,309.29 14,309.29 [1937] 48,012.58 Total of 4 prior years 45,760.88 86,114.78 Average of 4 prior years 11,440.22 21,528.70 125% of average of 4 prior years (A) 14,300.28 (A) 26,910.88 Deductions for 1940 (B) 22,662.52 (B) 22,662.52 Deductions for current year (C) 48,012.58 (C) 44,413.21 Abnormal expenses to be restored (C minus B, which is greater than A) 25,350.06 17,502.33 The Commissioner denied petitioner's request for relief under section 711 (b) (1) (J), and rejected the claim for refund to the extent that it was based upon restoration of the deductions shown above. OPINION. The first*137 question is whether respondent properly disallowed a deduction of $ 11,823.12 representing the net long term capital loss claimed by petitioner for the year 1940 on its investment in the capital stock of the St. Louis Co., a wholly owned subsidiary. Petitioner concedes that on the basis of the stipulated facts, the substance of which is shown in our findings, the stock of St. Louis Co. had no actual liquidating value at the beginning of the year 1940. At that time the total assets were approximately $ 306,000 and the liabilities $ 348,000 -- a difference of $ 42,000, shown as a deficit in surplus. It argues, however, that the stock had a potential value, pointing out that the next year the same business, operated in a similar manner and with the same personnel, produced a net income in excess of $ 26,000, or more than two-thirds of the amount of the existing deficit, and that the owner of the stock had a reasonable hope and expectation that continued operation of the business would result in reestablishing a substantial equity in the stock. We agree with petitioner and have found as a fact that the stock was not worthless at the beginning of the year 1940. No attempt to rationalize*138 completely the conclusion which has been reached need be made. The view we have taken accords with that frequently expressed by this and other courts. For example, in Sterling Morton, 38 B. T. A. 1270; affd., 112 Fed. (2d) 320, where the taxpayer was claiming a loss in one year and the Commissioner was contending that it had occurred in an earlier year, it was said: The ultimate value of stock, and conversely its worthlessness, will depend not only on current liquidating value, but also on what value it may acquire in the future through the foreseeable operations of the corporation. Both factors of value must be wiped out before we can definitely fix the loss. If the assets *461 of the corporation exceed its liabilities, the stock has a liquidating value. If its assets are less than its liabilities but there is a reasonable hope and expectation that the assets will exceed the liabilities of the corporation in the future, its stock, while having no liquidating value, has a potential value, and can not be said to be worthless. * * * Numerous cases have been decided applying, by implication, the view thus expressed, *139 among others H. Liebes & Co., 23 B. T. A. 787; Walter H. Goodrich & Co., 40 B. T. A. 960; Olds & Whipple, Inc. v. Commissioner, 75 Fed. (2d) 272; B. F. Sturtevant Co., 47 B. T. A. 464; Rassieur v. Commissioner, 129 Fed. (2d) 820; Miami Beach Bay Shore Co. v. Commissioner, 136 Fed. (2d) 408; and Smith v. Helvering, 141 Fed. (2d) 529. On the authority of the cited cases it is held that the stock of St. Louis Co. was not worthless at the beginning of 1940. But respondent does not peg his disallowance of the claimed deduction solely to his argument that the stock became worthless prior to the taxable year. He contends that, regardless of whether the stock had any value at the beginning of the year, the claimed deduction must be denied under section 112 (b) (6) of the Internal Revenue Code1 because cash in the sum of $ 8,176.88 must be regarded as "property" distributed on liquidation and no gain or loss can be recognized. His argument is ingenious, but *140 in our judgment erroneous under the facts before us. Here there was no liquidating dividend. The St. Louis Co. owed petitioner $ 308,219.76. The proceeds from the sale of its assets amounted to only $ 265,950.84, an amount insufficient to pay its indebtedness. There were, therefore, no assets left for distribution to its stockholders on liquidation. *141 The sum of $ 8,176.88 which respondent contends was property distributed on liquidation was not an asset of the St. Louis Co. It was a part of the sum of $ 50,445.80 representing net operating losses of the St. Louis Co. deducted by petitioner in consolidated returns for prior years, $ 42,268.92 of which was offset against petitioner's loss from advancements to St. Louis Co. in like amount, leaving a balance of $ 8,176.88 which petitioner offset against its capital stock investment of *462 $ 20,000 in computing the claimed long term capital loss in the amount of $ 11,823.12. This method of computation was proper. Edward Katzinger Co., 44 B. T. A. 533; affd., 129 Fed. (2d) 74. All of the assets of the St. Louis Co. were distributed to petitioner in part payment of its indebtedness to petitioner and, since nothing remained for distribution to the stockholders, there was no distribution in complete liquidation within the purview of section 112 (b) (6). H. G. Hill Stores, Inc., 44 B. T. A. 1182; Glenmore Distilleries, Inc., 47 B. T. A. 213. We hold, therefore, *142 that petitioner is entitled to the claimed deduction for loss from the stock of the St. Louis Co.B. F. Sturtevant Co., supra. The last question is whether petitioner is entitled to restore to its base period income for the years 1937 and 1938, for excess profits tax purposes, replacement expenses in those years alleged to be "abnormal" within the meaning of section 711 of the Internal Revenue Code as amended, retroactively, by sections 3 and 17 of the Excess Profits Tax amendments of 1941. 2 *143 There is no contention that the deductions were of a class abnormal for the taxpayer or that there is any error in the computation shown in our findings. The disallowance of the claimed adjustments is predicated upon respondent's determination that petitioner has failed to make the proof required under subsection (K) (ii), supra. Since *463 he does not contend that the excess is not a consequence of a decrease in the amount of some other deduction in its base period, the question which evolves is whether petitioner has established -- in the language of the statute -- "that the excess is not a consequence of an increase in the gross income of the taxpayer in its base period * * * and is not a consequence of a change at any time in the type, manner of operation, size, or condition of the business engaged in by the taxpayer." The establishing or proving by competent evidence of these "negative facts" is a difficult task; but, since it is required by the statute "in clear and express terms, its rigors may not be abated by softening construction." William Leveen Corporation, 3 T. C. 593. The statute, however, is remedial and should be given a reasonable*144 and rational construction. Bonwit Teller & Co. v. United States, 283 U.S. 258; United States v. Dickerson, 310 U.S. 554; Green Bay Lumber Co., 3 T. C. 824. The four prior years which are applicable to the base period year 1937 are 1933 to 1936, inclusive, while those applicable to the base period year 1938 are 1934 to 1937. During these five years -- including for comparison 1938 also -- the gross income and replacement expenses were as follows: Year Gross income Replacement expense [1933] $ 1,195,009.69 $ 7,659 [1934] 1,465,750.14 7,704 [1935] 1,894,789.48 16,089 [1936] $ 2,612,513.08 $ 14,309 [1937] 2,747,812.84 48,013 [1938] 2,262,773.09 44,413 The excess, computed as provided in the statute, which may be disallowed if the conditions prescribed are met, is $ 25,350.06 for 1937 and $ 17,502.33 for 1938. (Hereinafter approximate figures will be used in the discussion.) The first query therefore is: Has the excess of $ 25,000 for 1937 or the excess of $ 17,000 for 1938 been shown to have been "not a consequence of an increase in the gross income of the taxpayer *145 in its base period?" If this question is answered entirely in the negative -- if the required proof has not been made as to either year -- then it is manifest petitioner can not prevail even though it be assumed proof has been made that the abnormality or excess was not a consequence of a change in the type, manner of operation, size, or condition of its business. There was an increase in gross income in the first base period year (1937) over the gross income of the preceding year of approximately $ 135,000, the increase being $ 950,000 over the average of the four prior years. Pointing out that the income of the second base period year (1938) was approximately $ 485,000 less than the preceding year, *464 whereas there was only a slight reduction in replacement expense during the latter year (from $ 48,000 to $ 44,000) petitioner insists it has shown that there was a "lack of causal relationship between gross income and replacements and allowance expense," especially when other evidence introduced by it is also considered. The other evidence, as inferentially appears from our findings, consisted of a showing that a substantial portion of the increase in replacement expense had*146 resulted from defects in the anthracite burners and the "coal-flows," which had been put out chiefly after 1935, and from the securing of additional capital in the amount of $ 900,000 through the issuance of new stock, some of which had been used in carrying its own paper, which latter fact accounts for some of the increase in "other income." Respondent undertook to establish through the introduction of tables, using the same basic figures as those shown upon petitioner's exhibits but arranged differently, and by cross-examination of the witnesses, what he characterized as a "lag" in the replacement expenses -- i. e., that a substantial part of the sales made in one year resulted in much of the increase in replacement expense in a later year. We have not incorporated the tables prepared by him in our findings; but it is obvious that there was some "lag." Both parties also undertook to show, by dividing the sales between anthracite burners and "coal-flows" on the one hand and bituminous stokers and other products on the other, that there was, or was not, a causal connection between the increase in gross income from the sale of the latter products and the increase in replacement expense. *147 That there was some increase in the sales of the latter and a corresponding increase in gross income from that source is clear from the following schedule: Sales of Sales of Year Total sales anthracite stokers bituminous stokers and coal-flows and other products [1933] $ 1,991,262.99 None $ 1,991,262.99 [1934] 2,647,776.03 None 2,647,776.03 [1935] 3,645,186.37 $ 212,922.00 3,432,264.37 [1936] 4,943,430.38 765,960.00 4,177,470.38 [1937] 5,279,354.21 1,000,554.00 4,278,800.21 [1938] 4,584,332.48 783,303.00 3,801,029.48 It is also clear that there was a substantial increase in the sales of anthracite stokers and coal-flows between 1933 and 1937. It is true, as petitioner points out, that some of the increase in gross income resulted from using capital to carry paper on conditional or installment sales contracts and that a substantial part of the increase in replacement expense resulted from defects in the anthracite burners *465 and "coal-flows." We can not assume, however, even though there was some testimony to that effect, that the replacement expense on the other products remained precisely the same as it had been in the last of the years*148 prior to the base period year or that it was the average either of the preceding four years or of the preceding ten years. We think it is fair to say, however, that the ratio appears to have been substantially the same. Petitioner argues that respondent ignores completely the wording of the statute when he, in the preparation of some of his exhibits and in his argument bottomed thereon, refers to the sales of the various products and makes comparisons, percentagewise, of sales and replacement expense. It is true, as petitioner points out, that the provision of the applicable statute refers solely to gross income. We, however, have kept that in mind and, throughout our consideration of the issue, have assumed that gross income was used in the statute in its normal sense, i. e., as meaning net sales -- gross sales less cost of sales -- plus other income, William Leveen Corporation, supra, notwithstanding the fact that for some purposes petitioner seems to desire that gross sales be used. (Its Exhibits 2 and 3 were the basis on which the first two tables shown in our findings have been prepared.) Proof of the essential conditions is extremely difficult*149 and no criticism of petitioner or its counsel is intended or implied. It, in good faith, appears to have endeavored to bring forth the type of evidence suggested in William Leveen Corporation, supra -- "proving affirmatively that the abnormal deduction is a consequence of something other than the increase in gross income and that such proven cause is the converse or opposite of an increase in gross income and could not be identified with an increase in gross income." The proof has been sufficient to show, as conceded by respondent, that some part of the increased expenditure for replacements on anthracite stokers and "coal-flows" was unrelated to an increase in gross income and sales; but, in spite of the analysis of the facts set out in petitioner's reply brief, we are of the opinion it has failed to show that none of the increase in replacement expense was attributable to an increase in the sales of bituminous stokers and other products and to show that all of the "excess" resulted from the sale of coal-flows and anthracite burners. In this connection it has been assumed, arguendo, that the class of deductions may thus be subdivided -- a conclusion*150 which we deliberately refrain from expressing. Moreover petitioner's argument in support of separating the two -- anthracite stokers and coal-flow as one and bituminous stokers and other products as the other -- for present purposes, materially weakens its contention that the last portion of the statute is not likewise an insuperable obstacle to the granting of the relief sought, as is persuasively argued by respondent. In our *466 judgment, however, it is unnecessary to determine whether sufficient proof has been made under that part of the statute. We merely hold that petitioner has failed to establish that some part of the excess was not a consequence of an increase in its gross income in its base period. What has been said is dispositive of the issue. It would serve no useful purpose to review the analysis made by the parties of the figures as to which there is no dispute or to monument those relied upon by the respondent to show the alleged "lag." Comparisons with later base period years or averaging the gross income and replacement expenses over such years, as well as comparisons with years preceding those referred to in the statute as the four years prior to the base*151 period, seem to be wholly unnecessary and not required. Such comparisons indicate, on the one hand, as respondent suggests, that increases in replacement expense were not unusual in petitioner's experience; 3 but they also indicate that there was abnormality in amount in the two base period years. The statute is designed to prevent unfair application of the tax in abnormal cases. But there is a commensurate need for restricting its application to the cases for which it was designed. (See legislative history set out in Green Bay Lumber Co., supra.) The comparison suggested by petitioner indicates an ultimate leveling off of the replacement expense to less than one-half of one percent in 1940. That is approximately twice as much as in some of the earlier years, stated in percentage; but it is still less than it was during some of the earlier years. This, and other evidence, supports the finding we have made that the expenditures vary from year to year in a reasonably constant proportion to sales, with high points being reached in years when new models are being tried out. But the fact that these high points are abnormal does not entitle petitioner*152 to the relief sought unless it can establish that none of the excess or abnormality was a consequence of an increase in gross income. In its reply brief petitioner argues respondent has not shown that there had been an increase in gross income, as distinguished from gross sales, with respect to the bituminous stokers and "coal-flows." Respondent had no burden of making such proof. The burden rested upon petitioner throughout -- not only because of the presumption of correctness attaching to the Commissioner's action in disallowing the claim for refund, but also because, under the statute, it must "establish" the necessary facts. As indicated above, total sales minus cost of sales is the formula usually applied for determining gross income. Throughout the five-year period 1933 to 1937, inclusive, sales, cost of sales, and income all increased in substantially the same proportions. *467 Sales *153 of products other than anthracite stokers and "coal-flows" increased and sales of the latter increased from less than 1 percent of the total to 19 percent. The assumption made by the respondent that a substantial portion of the increase in gross income resulted from an increase in the sales of bituminous stokers and products other than anthracite burners and "coal-flows" is not unjustified in the absence of proof to the contrary. Moreover the increase in the sales of the anthracite burners also tends to support his ultimate conclusion. The conflicting views and inferences of the parties are irreconcilable. In the main those of the respondent seem to be the sounder. The burden was upon petitioner to prove that the abnormality was not a consequence of the increase in its gross income. It, in our judgment, has failed to do so. We therefore sustain the Commissioner's action in disallowing the claim for refund to the extent that it was disallowed. Decision will be entered under Rule 50. Footnotes *. See second table following.↩ *. The slight discrepancy in the figures in the two tables is not explained.↩ 1. SEC. 112. RECOGNITION OF GAIN OR LOSS. * * * * (b) Exchanges Solely in Kind. -- * * * * (6) Property received by corporation on complete liquidation of another. -- No gain or loss shall be recognized upon the receipt by a corporation of property distributed in complete liquidation of another corporation. For the purposes of this paragraph a distribution shall be considered to be in complete liquidation only if -- (A) the corporation receiving such property was, on the date of the adoption of the plan of liquidation, and has continued to be at all times until the receipt of the property, the owner of stock (in such other corporation) possessing at least 80 per centum of the total combined voting power of all classes of stock entitled to vote and the owner of at least 80 per centum of the total number of shares of all other classes of stock * * *.↩ 2. SEC. 711. EXCESS PROFITS NET INCOME * * * * (b) Taxable Years in Base Period. -- * * * (1) General rule and adjustments. -- The excess profits net income for any taxable year subject to the Revenue Act of 1936 shall be the normal-tax net income, as defined in section 13 (a) of such Act; and for any other taxable year beginning after December 31, 1937, and before January 1, 1940, shall be the special-class net income, as defined in section 14 (a) of the applicable revenue law. In either case the following adjustments shall be made * * *. * * * * (J) Abnormal Deductions. -- Under regulations prescribed by the Commissioner, with the approval of the Secretary, for the determination, for the purposes of this subparagraph, of the classification of deductions -- (i) Deductions of any class shall not be allowed if deductions of such class were abnormal for the taxpayer, and (ii) If the class of deductions was normal for the taxpayer, but the deductions of such class were in excess of 125 per centum of the average amount of deductions of such class for the four previous taxable years, they shall be disallowed in an amount equal to such excess. (K)Rules for Application of Subparagraphs (H), (I), and (J). -- For the purposes of subparagraphs (H), (I), and (J) -- (i) * * * (ii) Deductions shall not be disallowed under such subparagraphs unless the taxpayer establishes that the abnormality or excess is not a consequence of an increase in the gross income of the taxpayer in its base period or a decrease in the amount of some other deduction in its base period, and is not a consequence of a change at any time in the type, manner of operation, size, or condition of the business engaged in by the taxpayer. (iii) The amount of deductions of any class to be disallowed under such subparagraphs with respect to any taxable year shall not exceed the amount by which the deductions of such class for such taxable year exceed the deductions of such class for the taxable year for which the tax under this subchapter is being computed.↩ 3. Note that in 1928 replacement expense had been at the rate of approximately $ 20,000 on each $ 1,000,000 of sales.↩