Rochester Button Co. v. Commissioner

Rochester Button Company, Petitioner, v. Commissioner of Internal Revenue, Respondent Rochester Button Co. v. Commissioner Docket No. 4472 United States Tax Court 7 T.C. 529; 1946 U.S. Tax Ct. LEXIS 105; August 13, 1946, Promulgated *105 Decision will be entered under Rule 50. Petitioner's receipt of gross income from the manufacture and sale of plastic buttons, developed by its own research, held, to entitle petitioner to relief under Internal Revenue Code, section 721 (a) (2) (C), to the extent of the excess over 125 per cent of the average amount of the gross income from all of the same class for four prior years, after deducting direct costs and expenses of deriving such abnormal income, including selling expense. H. A. Mihills, C. P. A., for the petitioner. Harold D. Thomas, Esq.,*106 for the respondent. Opper, Judge. OPPER *529 Petitioner contests respondent's determination of a deficiency in excess profits tax in the amount of $ 124,783.69 for the fiscal year ended October 31, 1941. Petitioner having abandoned an issue raised in its pleading, one issue remains: Whether petitioner is entitled to relief from excess profits tax under section 721 (a) (2) (C) of the Internal Revenue Code for the year involved, and, if so, the amount. Petitioner resists respondent's disallowance of a deduction of $ 300,470.77 from excess profits net income claimed by petitioner to be abnormal income attributable to other years under section 721. Some of the facts have been stipulated. FINDINGS OF FACT. The stipulated facts are hereby found accordingly. Petitioner is a New York corporation, with its principal office at Rochester, New York. The tax returns for the period involved were filed with the collector of internal revenue for the twenty-eighth district of New York. *530 Upon its incorporation on April 26, 1926, petitioner acquired certain assets, including the name and business of the predecessor Rochester Button Co. organized in 1904 (hereinafter referred to as*107 Rochester); certain assets of the Superior Ivory Button Co. of Newark, New Jersey, organized in 1920 (hereinafter referred to as Superior); and the assets of the Shantz Button Corporation of Rochester, New York, organized in 1924 (hereinafter referred to as Shantz). At the time of its organization petitioner acquired five factories, two in Rochester, New York, one in Newark, New Jersey, one in Long Branch, New Jersey, and one in Akron, New York. To concentrate operations and to improve operating efficiency, one of the Rochester plants and the plants in Newark and Long Branch were disposed of, these plants not having been operated since 1929. The Akron plant was not operated from 1929 to 1934, in which year it was reequipped for the manufacture of casein blanks, and it is now an important unit in petitioner's business. Petitioner's principal plant, located in Rochester, New York, consists of a seven-story and basement building connected with a four-story and basement building, owned in fee by petitioner. Both buildings are of brick and mill construction. Its Akron plant consists of several buildings of concrete and hollow tile construction, all connected. This plant receives casein*108 from petitioner's Wisconsin facilities and other sources, which is made into blanks to be finished in Rochester. Petitioner also occupies rented quarters in New York City, Baltimore, Cincinnati, and Philadelphia, used primarily to service stock and as sales offices for the respective territories. Petitioner's three predecessors, whose assets and businesses it acquired in 1926, had been engaged in the manufacture and sale principally of vegetable ivory buttons for the garment trade, catering largely to the men's clothing trade. Each company had made different grades of buttons, the highest grade being manufactured by Rochester, which had the reputation of making the finest quality of ivory buttons in the country, and for that reason its name was selected by petitioner as its name. These companies were producing approximately 45 to 50 per cent of the total production of vegetable ivory buttons then being made. Their sales volume approximated $ 3,000,000. Through mismanagement and the adoption of poor merchandising policies, they had lost a considerable volume of sales. In 1928 petitioner acquired the business of the London Button Co. (hereinafter referred to as London), which as*109 a jobbing business had handled a substantial amount of the output of Superior and of Shantz, as well as products of other American and foreign producers. In a further effort to strengthen its business, petitioner shortly thereafter *531 entered into arrangements with a Chicago button company which was to represent it in the Middle West. This added impetus was needed by petitioner, since its sales volume had fallen off to approximately one and one-half million dollars at that time. Petitioner's principal business has been the manufacture and sale of buttons used largely in the clothing trade; in excess of 80 per cent of its production has been used in men's outer clothing, such as overcoats, coats, vests and trousers; the balance has been used primarily for men's and women's sweaters, jackets, and outer garments. Petitioner has made buttons from three basic materials: Vegetable ivory, casein, and a carbamide plastic. Buttons made of casein are marketed by petitioner under the trade names of "Niesac," "Robulith," and "Duo Horn"; buttons made from the carbamide plastic are sold under the registered trade name "Technoid." Vegetable ivory buttons are made of Tagua nuts, grown in*110 the northern part of South America, the better quality being grown in Ecuador and Colombia. Prior to 1934 almost all of petitioner's production was from this raw material. These nuts are individually handled and sawed into slices with hand saws. Only about 6 per cent of the total shipment of nuts remains in the final button product. Separate individual hand-turning operations are required, and an experienced button turner working 8 to 9 hours turns out 60 to 70 gross of buttons. After being turned, the buttons have to be separately drilled on automatic equipment; this is followed by a scouring and polishing process, which lasts 5 days and night. The buttons are then spray-dyed for mottled colors or dyed in vats for solid colors. Thereafter the buttons are dried and tumbled, and the better grades are brushed and finished. Since the nuts are not uniform in texture, 18 to 20 different casts are discovered, although the buttons have been dyed in the same vat. Individual sorting is therefore necessary to provide a uniform product. The direct labor in an ivory button is approximately 70 per cent of the total direct cost, as compared to only 20 per cent in the case of plastic buttons. *111 Twenty-eight to 30 different operations are necessary to produce buttons of this type. There was a shortage in the supply of Tagua nuts in 1940 and 1941, occasioned by a shortage of the stock in South America and of shipping facilities. Recognizing the trend in the employment of synthetics as a base for buttons, together with the 1929 depression conditions which led clothing manufacturers to seek less expensive buttons, petitioner devoted time and effort to the perfection of plastic buttons, which it realized would replace vegetable ivory buttons. Plastic buttons, made of celluloid and fuller's earth, appeared as early as 1910, but they were susceptible to heat and were not well *532 received. By 1930 casein buttons were used in substantial volume in the women's wear trade. These were made from an imported casein sheet. The manufacturing process from sheets caused excessive waste of material and consequently limited the sale of this type of button to manufacturers of higher priced garments. Petitioner commenced its general research in this field in 1930, with a view to overcoming losses which it had sustained from the time of its organization, but its work for about two years*112 was exploratory; it was of educational value to petitioner in later years. Prior to 1932 petitioner hired a chemist, who worked with its president, Neil O. Broderson, who also had had previous experience in experimentation with a plastic button base, to explore the field of plastics in search of a suitable button plastic. By 1933 or 1934 petitioner discovered a plastic material, urea formaldehyde, that had the required physical properties to permit of the production of a quality plastic button. This button was marketed under the trade name of "Technoid." At first it was available only in solid colors; it was necessary for petitioner to devise a means of creating a mottled button from this base. It developed a method of spray dyeing with stencil, a mottling while the button was still in powdered form. By this means a button more durable than the ivory button was developed. The Technoid button was favorably received and produced such substantially increased profits in the years 1937 through 1940 that petitioner has made no application for relief under section 721 with reference to this type of button. In 1938, after securing one of petitioner's employees, a competitor produced*113 a button similar to the Technoid button. The Technoid button is one of the types of buttons that has generally replaced the vegetable ivory button. Petitioner's early experiments, looking to the development of an improved casein plastic button, were not highly successful because of the belief of the chemist in charge that no new methods of production could be devised. Monthly cost of sales was 98 to 102 per cent of the selling value of the casein merchandise then being produced at the Akron plant. Upon the chemist's transfer to other work, Broderson and his brother, sometime prior to 1939, undertook experiments to produce a mottled casein rod with a controlled mottling effect that would enable them to take a cross section of the end of the rod and produce a suitable button for the clothing industry. At first one color and then another color was added as the casein came from the extrusion machine, but the effect was to produce rings of the particular colors, which had no "eye appeal," and the buttons so produced were not acceptable to the trade. Further experimentation led up to the use of a division of extruding tubes which split the *533 circular mottling in half and left*114 a mottling inside of rings which went completely around the rod, such mottlings being semihorseshoe in shape, and particularly desirable since such mottlings were similar to those on buttons produced from the horns of Indian water buffalo. The product thus produced was very salable. It enabled petitioner to eliminate its original method of spray dyeing white blanks. The new method was much more satisfactory than spray dyeing since casein was not sufficiently absorbent to have the dye penetrate through the button. Moreover, spray-dyed buttons tended to fade or to change the mottling effect. The use of the new method also eliminated some shading and sorting operations. The first pattern made by this operation was named "Challenge." A patent application covering this successful mottled-in-rod development was filed on December 15, 1939, and is still pending, although some claims thereunder have been allowed. Petitioner is still endeavoring to prove other of its claims and there has been some recent action thereon. Petitioner has also continued its production of solid color buttons. Petitioner's research in the development of Niesac "mottled in the rod" buttons was the forerunner*115 of the development of "Robulith" material. "Robulith" is petitioner's trade name of irridescent buttons. Irridescent materials can be produced in Europe in sheet form by a method too costly to capture volume business at a substantial profit. It had been the desire of button manufacturers for some time to find a way of producing, synthetically, mother-of-pearl as made by the oyster. Study showed that the cause of a pearly appearance in a material was not a matter of color, but rather of refraction of light. After discovering a pigment which would create a pearly appearance in solution, petitioner was still confronted with the problem of orienting the pigments in the rod so as to obtain irridescence in the cross section of the rod. Although petitioner was not wholly successful in this regard, it was able to produce a material in a rod so that when the rod formed the crystals would turn at right angles to the rod. Robulith buttons have the orientation at right angles in the center and thus a pearly appearance, but the orientation is parallel at the edges. There is less waste of material in cutting button blanks from the rod than from the sheet. At the time petitioner developed*116 this method, other button manufacturers had not learned how to produce the irridescent appearance in the end of the rod. Robulith buttons were offered to the trade in 1940 and met with immediate acceptance, particularly among makers of slack suits and sport shirts. Pearl buttons and specially carved ivory buttons had theretofore been generally used for these purposes. *534 Only smaller sizes of ivory buttons, Nos. 18, 22, and some No. 24's, were adaptable to the sportswear trade. The Robulith button permitted the introduction of different sizes and colors and has generally replaced the ivory button in this area. The patent application covering the pigment basic to the making of Robulith buttons was filed December 26, 1941, and the patent was issued February 16, 1943. Petitioner's application was not filed earlier as it had not decided up to that time whether to apply for a patent or keep the formula secret. Knowledge gained from the development of the mottled rod for Niesac buttons permitted petitioner to develop a domestic Duo Horn button that would duplicate the appearance of imported Duo Horn buttons which petitioner was making from casein button blanks or sheets imported*117 from Estonia. Although attractive in appearance, the imported Duo Horn button was not colorfast. Initial difficulty was experienced as a more refined type of casein was necessary. A better method of producing a more refined run of casein was developed by Dr. Fink, who worked at the University of Wisconsin, on a fellowship sponsored by petitioner. This permitted petitioner to produce an attractive casein blank to replace the Estonian product. The Duo Horn button was introduced about 1940, after a research program of approximately five years. The domestic buttons were produced in a line of colors duplicating the colors and effect of the imported buttons and were produced from rods at a much lower cost than production from imported blanks or sheets. From the time it first started using urea formaldehyde as a button base, petitioner had under consideration the manufacture and sale of wash buttons. Wash buttons are a class of staple buttons, made in the past from fresh water pearl shells and used on underwear and wash garments of all types and are illustrated by the buttons used on men's shirts. A survey of the cost of production convinced petitioner that under the then existing *118 methods of production the margin of profit was exceedingly small. Petitioner, through Broderson, its assignor, filed an application for a patent on April 21, 1934, covering a new process of molding wash buttons and Patent No. 2,084,427 was issued on June 27, 1937. Research was held in abeyance for a short time because of difficulty in properly plating the molds. Thereafter research in this field was resumed and was completed prior to 1941. This improved process involved the development of a new type of die construction that molded holes directly in the buttons, leaving the waste material at the back of the buttons in an exposed position where it could be removed by tumbling in barrels, in a treatment which *535 the buttons would otherwise receive. Other processes left the flash in the center of the button, requiring a drilling operation to remove. This enabled petitioner to produce wash buttons at a great saving in machinery. This particular method of production enabled petitioner to enter this branch of business on a profitable basis. Petitioner's research and development in perfecting the types of buttons which form the basis of its claim for relief under section 721 were*119 completed prior to the commencement of the taxable year involved. During the taxable year petitioner's sales of vegetable ivory buttons increased due to the war effort, as the Quartermaster General's office insisted on the use of ivory buttons until some time in 1942, when it finally allowed the use of plastic buttons. Petitioner conducted and financed all of the research leading to the new products -- "Niesac" mottled in the rod buttons, "Robulith" buttons, "Duo Horn" buttons, and the development and use of the pin die mold construction for leaving flash on the back of wash buttons. The following table shows the amounts charged by petitioner to an account called "Experimental and Research," which amounts were charged to cost of manufacturing and deducted on petitioner's income tax returns in computing its taxable income: Calendar year Amount Fiscal year ended Oct. 31 Amount 1928 approx $ 1,700.00 [1936] $ 2,129.09 1929 " 1,300.00 [1937] 10,754.96 1930 " 2,400.00 [1938] 12,101.48 1931 " 4,000.00 [1939] 6,033.14 [1932] 3,485.65 [1940] 8,003.43 [1933] 10,918.98 [1941] 15,043.43 [1934] 16,794.10 [1942] 13,840.55 1935 (10 months) 649.54 [1943] 15,645.16 The greatest part*120 of such amounts consisted of labor and supplies. No part of Broderson's salary is included. Owing to limited laboratory facilities, petitioner found it necessary to carry out experimentation on its production machinery, using personnel engaged in production, no part of the expenses of which is included in the expenditures charged to the "Experimental and Research" account. The beginning of the replacement of ivory buttons with synthetics opened a new avenue for experimental and developmental work in the button industry. Prior thereto, although expenditures for such work were made by petitioner, it was not customary to expend any material amount of money therefor. The art of making buttons from natural products left little room for improvement in that field. Petitioner is constantly striving to overcome competition and is continuing in its endeavor to improve certain of its products. One *536 of its post-war objectives is to construct a plant to produce an entirely new plastic substance, which has passed through the development stage and is now operating on a pilot plant scale. This will enable petitioner to make further improvements in its product. Petitioner has applied*121 for patents other than those mentioned and has additional patents now pending. Other manufacturers have patents, secret processes, and formulae, the majority being mechanical patents on types of machinery and equipment with which to produce buttons. In 1940 petitioner was capable of producing as many buttons as were produced by it in 1941. It was not operating at full capacity in 1940, but was operating at full capacity in 1941. A summary of petitioner's net taxable income (losses) as shown by its tax returns appears as follows: Dec. 31, 1926 ($ 20,621.98) Dec. 31, 1934 $ 117,877.21 Dec. 31, 1927 (248,290.47) (10 mos.) Oct. 31, 1935 121,333.34 Dec. 31, 1928 (203,538.99) Oct. 31, 1936 108,827.23 Dec. 31, 1929 ( 57,912.90) Oct. 31, 1937 192,752.03 Dec. 31, 1930 (131,042.57) Oct. 31, 1938 (28,605.05) Dec. 31, 1931 ( 55,519.18) Oct. 31, 1939 178,707.63 Dec. 31, 1932 (127,985.81) Oct. 31, 1940 326,150.73 Dec. 31, 1933 69,772.31 Oct. 31, 1941 761,339.48 Petitioner's profit and loss statements for the years ended October 31, 1937, 1938, 1939, 1940, and 1941, are as follows: *537 Year ended Oct. 31 -- [1939] Sales less returns and allowances $ 1,513,694.55 $ 990,771.01 $ 1,539,322.41 Cost of goods sold 982,751.66 822,661.90 1,042,239.80 Gross profit 530,942.89 168,109.11 497,082.61 Selling, administrative and general expenses 307,091.33 271,240.62 320,817.74 Operating profit -- (loss) 223,851.56 (103,131.51) 176,264.87 Other deductions -- net 22,077.27 (2,942.54) 5,393.47 Profit (loss) before Federal taxes on income 201,774.29 (100,188.97) 170,871.40 Reconcilement to taxable net income (loss) as shown by Federal income tax returns filed: Add: -- (deduct): Depreciation adjustment 31,269.58 31,976.04 32,129.39 Plant assets expense 3,692.25 Duty refund (466.88) Expense of registration of securities (14,500.34) Compensation adjustment (2,002.90) (2,013.72) (762.58) Amortization of bond discount (16,003.06) Additions -- (charges) against reserves 1,515.31 31,253.31 (26,654.50) Legal expense (1,525.55) Tax adjustments, etc (222.69) 1,917.27 (101.45) Federal tax on bond interest 556.41 Profit on equipment traded Contributions 345.00 Moving expense (8,106.02) 8,106.02 Taxable income -- (loss) per returns 192,752.03 (28,605.05) 178,707.63 *122 Year ended Oct. 31 -- [1941] Sales less returns and allowances $ 1,555,599.76 $ 2,871,166.62 Cost of goods sold 943,446.08 1,683,651.27 Gross profit 612,153.68 1,187,515.35 Selling, administrative and general expenses 322,976.18 476,644.24 Operating profit -- (loss) 289,177.50 710,871.11 Other deductions -- net (5,309.61) (1,487.89) Profit (loss) before Federal taxes on income 294,487.11 712,359.00 Reconcilement to taxable net income (loss) as shown by Federal income tax returns filed: Add: -- (deduct): Depreciation adjustment 33,748.66 39,862.05 Plant assets expense Duty refund Expense of registration of securities Compensation adjustment Amortization of bond discount Additions -- (charges) against reserves (2,479.22) 10,140.79 Legal expense Tax adjustments, etc 9.86 (810.19) Federal tax on bond interest Profit on equipment traded 384.32 (212.17) Contributions Moving expense Taxable income -- (loss) per returns 326,150.73 761,339.48 (Parentheses indicate credits and loss.) *538 Details of cost of goods sold for the same years are as follows: Year ended Oct. 31 -- [1939] Materials used $ 331,432.88 $ 165,415.15 $ 201,985.15 Labor 507,577.38 381,041.40 512,971.74 Purchases for resale 159,751.19 48,111.89 49,748.24 Manufacturing expenses: Provision for vacation pay, bonuses, etc 13,090.10 8,929.19 Supplies 32,228.13 62,483.80 109,247.81 Depreciation 47,899.46 49,183.24 50,521.79 Heat, light, power, and water 40,756.43 34,119.19 38,850.36 Local taxes 10,171.95 10,007.81 9,838.68 Federal and state pay roll taxes 13,562.62 14,653.25 20,827.38 Insurance 13,357.82 11,336.13 13,554.65 Repairs and maintenance 3,606.49 3,879.22 1,264.05 Experimental and research 10,754.96 12,101.48 6,033.14 Moving and rearranging departments 10,424.51 Other expenses 8,146.70 9,485.23 8,723.59 180,484.56 230,763.96 267,790.64 1,179,246.01 825,332.40 1,032,495.77 Deduct: Discount earned 4,030.06 1,726.85 2,396.89 Sales of scrap and waste 6,769.25 1,536.61 3,020.43 Sales of raw materials 39,078.81 12,588.79 Labor and expense redistributed 20,418.74 30,715.96 17,403.04 31,218.05 73,058.23 35,409.15 1,148,027.96 752,274.17 997,086.62 Net change in in-process and finished inventories (deduct *) * 165,276.30 70,387.73 45,153.18 Cost of goods sold 982,751.66 822,661.90 1,042,239.80 *123 Year ended Oct. 31 -- [1941] Materials used $ 215,624.31 $ 401,666.58 Labor 519,706.57 800,400.08 Purchases for resale 46,655.21 25,037.96 Manufacturing expenses: Provision for vacation pay, bonuses, etc 9,643.90 27,000.00 Supplies 115,397.98 200,940.61 Depreciation 52,614.52 55,584.59 Heat, light, power, and water 38,871.58 50,053.99 Local taxes 9,693.09 9,493.21 Federal and state pay roll taxes 20,917.67 31,575.41 Insurance 13,102.23 18,657.45 Repairs and maintenance 2,464.43 15,441.95 Experimental and research 8,003.43 15,043.43 Moving and rearranging departments Other expenses 11,098.76 16,539.25 281,807.59 440,329.89 1,063,793.68 1,667,434.51 Deduct: Discount earned 2,416.26 3,325.33 Sales of scrap and waste 5,029.02 12,852.79 Sales of raw materials 32,407.20 31,492.00 Labor and expense redistributed 9,214.79 12,607.19 49,067.27 60,277.31 1,014,726.41 1,607,157.20 Net change in in-process and finished inventories (deduct *) * 71,280.33 76,494.07 Cost of goods sold 943,446.08 1,683,651.27 *539 Details of selling, administrative, and general expenses of petitioner*124 for the same years are as follows: Year ended Oct. 31 -- [1939] Selling expenses: Executive and salesmen's salaries and commissions $ 136,722.43 $ 114,150.68 $ 137,864.50 Supervision and clerical 22,026.25 23,959.89 23,489.36 Shipping salaries 14,721.92 14,421.56 17,844.98 Shipping supplies 7,258.89 7,276.84 9,006.04 Freight and cartage 5,090.75 783.76 1,904.96 Traveling and entertainment 14,772.82 13,351.83 14,464.23 Local taxes 1,449.54 1,430.84 1,339.57 Federal and state pay roll taxes 3,343.15 4,772.17 5,374.58 Branch office expenses 31,759.30 31,306.07 33,564.32 Advertising and other expenses 8,815.05 13,505.98 13,229.49 Total 245,960.10 224,959.62 258,082.03 Administrative and general expenses: Executive salaries 20,800.00 20,800.00 22,434.55 Clerical salaries 5,387.40 5,662.80 5,763.12 Legal and professional 5,861.69 1,349.40 9,777.85 Traveling and entertaining 2,934.53 2,943.40 2,757.63 Stationery and office supplies 720.05 400.33 576.28 Local taxes 104.99 98.53 98.95 Corporate taxes 6,672.79 8,350.72 13,121.49 Provision for doubtful accounts 7,576.57 2,479.22 3,924.03 Federal and state pay roll taxes 684.83 995.27 828.96 Other expenses 10,388.38 3,201.33 3,452.85 Total 61,131.23 46,281.00 62,735.71 Total 307,091.33 271,240.62 320,817.74 *125 Year ended Oct. 31 -- [1941] Selling expenses: Executive and salesmen's salaries and commissions $ 135,086.53 $ 219,102.25 Supervision and clerical 30,759.28 35,676.98 Shipping salaries 20,045.45 28,513.91 Shipping supplies 8,609.73 14,385.49 Freight and cartage 3,089.70 5,321.70 Traveling and entertainment 16,319.51 17,468.19 Local taxes 1,190.26 1,318.20 Federal and state pay roll taxes 4,544.98 4,434.03 Branch office expenses 36,811.18 39,249.44 Advertising and other expenses 13,166.43 18,112.94 Total 269,623.05 383,583.13 Administrative and general expenses: Executive salaries 25,949.80 43,300.00 Clerical salaries 5,670.82 6,014.97 Legal and professional 3,532.58 3,830.65 Traveling and entertaining 2,319.89 2,070.69 Stationery and office supplies 481.15 318.25 Local taxes 96.93 96.66 Corporate taxes 5,804.21 22,114.83 Provision for doubtful accounts 4,016.33 7,300.25 Federal and state pay roll taxes 699.65 661.79 Other expenses 4,781.77 7,353.02 Total 53,353.13 93,061.11 Total 322,976.18 476,644.24 *540 On its excess profits tax return (Form 1121) for the taxable*126 year petitioner claimed as a deduction from its normal tax net income, "abnormal income attributable to other years" in the amount of $ 300,470.77, computed in the following manner in the schedule attached to the return: Gross Income Received or accrued in previous years Buttons Fiscal years ended Oct. 31 -- [1940] "Robulith" [0] $ 20,505.38 "Duo Horn" [0] "Technoid" (mottled) $ 38,223.83 $ 51,269.26 $ 143,672.69 133,877.45 "Technoid" (wash) [0] 10,114.79 20,938.76 39,358.16 "Niesac" (mottled) [0] 14,381.76 38,223.83 61,384.05 164,611.45 208,122.75 Gross Income Received Average 125% of or accrued for 4 years average in Exclusion taxable year 1941 "Robulith" $ 5,126.34 $ 6,407.93 $ 100,210.00 * $ 93,802.07 "Duo Horn" [0] 100,117.02 100,117.02 "Technoid" (mottled) 91,760.81 114,701.02 94,953.32 [0] "Technoid" (wash) 17,602.93 22,003.66 68,320.18 46,316.52 "Niesac" (mottled) 3,595.44 4,494.30 64,729.46 * 60,235.16 118,085.52 147,606.91 428,329.98 300,470.77 General Note: All of the expenses incident*127 to the research and development which resulted in the foregoing abnormal income were made in prior years and therefore no deduction has been made on account of such expenditures in the determination of abnormal income attributable to other years. Note *: Exclusion limited to gross profit obtained. Schedule -- Item "A" -- "Robulith" Buttons Fiscal years ended October 31 -- [1941] Sales [0] $ 32,675.19 $ 171,569.00 Cost of goods sold [0] 11,906.90 71,359.00 Gross profit realized on sales [0] 20,768.29 100,210.00 Comparable profit on products supplanted [0] 262.91 (loss) 5,134.36 Income attributable to development [0] 20,505.38 105,344.36 * * * * Schedule -- Item "B" -- "Duo Horn" Buttons Fiscal years ended October 31 -- [1941] Sales [0] $ 208,215.60 Cost of goods sold [0] 52,656.23 Gross profit realized on sales [0] 155,559.37 Comparable profit on products supplanted [0] 55,442.35 Income attributable to development [0] 100,117.02 Schedule -- Item "C" -- "Technoid" Mottled Buttons Fiscal years ended October 31 -- [1939] Sales $ 331,695.94 $ 227,493.95 $ 463,821.29 Cost of goods sold 123,522.07 99,340.54 193,131.83 Gross profit realized on sales 208,173.87 128,153.41 270,689.46 Comparable profit on products supplanted 169,950.04 76,884.15 127,016.77 Income attributable to development 38,223.83 51,269.26 143,672.69 *128 Schedule -- Item "C" -- "Technoid" Mottled Buttons Fiscal years ended October 31 -- [1941] Sales $ 476,792.43 $ 700,542.08 Cost of goods sold 190,632.93 361,442.03 Gross profit realized on sales 286,159.50 339,100.05 Comparable profit on products supplanted 152,282.05 244,146.73 Income attributable to development 133,877.45 94,953.32 *541 Schedule -- Item "D" -- "Technoid" Wash Buttons Income attributable to development in connection with this product determined upon the basis of reduction of cost of production resulting from the development of processes and formulae which resulted in an increased margin of profit. Fiscal years ended October 31 -- [1941] Gross -- sold [0] 329,472 951,762 1,446,991 2,858,585 Cost of drilling operation eliminated [0] $ 10,114.79 $ 20,938.76 $ 39,358.16 $ 68,320.18 Schedule -- Item "E" -- "Niesac" Mottled Buttons Income attributable to development in connection with this product determined upon the basis of reduction of cost of production resulting from the development of processes and formulae which resulted in an increased margin of profit. FFiscal years ended October 31 -- [1941] Sales [0] $ 53,467.05 $ 194,888.73 Cost of goods sold [0] 39,085.29 130,159.27 Gross profit realized on sales [0] 14,381.76 64,729.46 Cost of mottling operation eliminated [0] 20,524.55 81,358.09 *129 Respondent disallowed the whole of the amount so claimed, holding "that the amount claimed as abnormal income attributable to other years does not come within the purview of section 721 of the Internal Revenue Code, and the amount is, therefore, added back to excess profits net income." In the computation of gross profit realized on sales, as shown in the schedule attached to the excess profits tax return, the amounts representing the cost of goods sold are based upon individual standard costs of the items sold. Such standard costs are in accordance with the cost system maintained by petitioner and represent so-called predetermined normal cost of labor, material, and manufacturing overhead entering into the making of each kind and size of buttons. The system is completely departmentalized. The standard costs are determined in the beginning of each fiscal year and are adjusted during the year for any substantial changes in wage rates. There were no substantial changes in cost elements in 1941 which required a change of predetermined costs. The variation of the aggregate predetermined costs from the aggregate actual costs was only approximately 1 per cent of the total standard *130 cost of sales for the fiscal year 1941. Petitioner's cost system was installed in 1938 and has been consistently in use since that time. It has proved satisfactory and is used also for factory management. A predetermined standard cost or unit standard cost is based on an assumed rate or volume of production, and if production falls above or below such measure the difference is reflected in the variance *542 account. The estimate of a unit standard cost is based upon operations for a prior period, and if the volume of production for the prior period were less than for the current year, the unit standard cost for the current year might be overstated by reason of the differences occasioned by a greater volume of production. The net sales and cost of goods sold of the products manufactured by petitioner for the year ended October 31, 1941, were as follows: Cost of goods Classification Net sales sold Ivory (vegetable) $ 575,756.40 $ 470,766.19 Casein: Niesac 206,818.56 184,877.67 Niesac (mottled -- new product) 194,888.73 130,159.27 Robulith 171,569.00 71,359.00 Duo Horn 208,215.60 52,656.23 Urea Formaldehyde: Technoid (solid) 231,032.11 84,834.95 Technoid (mottled) 700,542.08 361,442.03 Technoid (wash and trouser) 469,147.72 331,877.86 Miscellaneous 113,196.42 51,062.87 Total net sales 2,871,166.62 Total cost of goods sold (at standard costs -- per cost records) 1,739,036.07 Deduct variance account (difference between actual and standard costs -- per cost records) 18,220.59 1,720,815.48 Deduct: Inventory adjustment -- end of year $ 31,756.21 Discounts earned 3,325.33 Sales of scrap and waste, less cost 12,852.79 Sales of raw materials, less cost 4,381.44 $ 52,315.77 Add: Experimental and research expense $ 15,043.43 Depreciation and adjustment 108.13 15,151.56 37,164.21 Cost of goods sold per profit and loss statement 1,683,651.27 *131 The gross merchandising profit of petitioner for the fiscal year 1941 was $ 1,150,351.14. A classified statement of the net sales of petitioner from 1933 to 1941, inclusive, showing separately sales of the different kinds of buttons it made, as prepared from petitioner's books, is as follows: *543 Year ended Year ended Ten months Dec. 31, 1933. Dec. 31, 1934. ended Oct. Amount Amount 31, 1935. Amount Ivory (vegetable) $ 876,013.90 $ 602,741.29 $ 603,752.67 Casein development: Niesac (solid) 1,243.05 98,163.15 Niesac (mottled) Robulith Duo Horn Urea formaldehyde development: Technoid (solid) Technoid (mottled) 8,724.66 71,447.05 Technoid (wash and trouser) Miscellaneous (domestic and imported, purchased, etc.) 176,585.21 162,626.25 186,163.55 Total 1,052,599.11 775,335.25 959,526.42 Year ended Oct. 31, 1937 Year ended Oct. 31, 1936. Units Average Amount shipped unit (gross) price Amount Ivory (vegetable) $ 576,477.22 800,228 $ 0.65 $ 524,099.40 Casein development: Niesac (solid) 301,145.74 2,001,748 .19 387,507.73 Niesac (mottled) Robulith Duo Horn Urea formaldehyde development: Technoid (solid) Technoid (mottled) 235,592.95 271,678 1.22 331,695.94 Technoid (wash and trouser) Miscellaneous (domestic and imported, purchased, etc.) 231,408.34 257,040 1.05 270,391.48 Total 1,344,624.25 3,330,694 .45 1,513,694.55 *132 Year ended Oct. 31, 1938 Units shipped Average (gross) unit price Amount Ivory (vegetable) 503,434 $ 0.65 $ 329,945.21 Casein development: Niesac (solid) 1,065,759 .20 211,543.98 Niesac (mottled) Robulith Duo Horn Urea formaldehyde development: Technoid (solid) Technoid (mottled) 227,408 1.00 227,493.95 Technoid (wash and trouser) 329,472 .17 55,474.21 Miscellaneous (domestic and imported, purchased, etc.) 162,089 1.03 166,313.66 Total 2,288,162 .43 990,771.01 Year ended Oct. 31, 1939 Units shipped Average (gross) unit price Amount Ivory (vegetable) 588,050 $ 0.65 $ 384,024.56 Casein development: Niesac (solid) 1,539,427 .21 327,930.44 Niesac (mottled) Robulith Duo Horn Urea formaldehyde development: Technoid (solid) Technoid (mottled) 484,589 .96 463,821.29 Technoid (wash and trouser) 951,762 .14 136,376.12 Miscellaneous (domestic and imported, purchased, etc.) 224,391 1.01 227,170.00 Total 3,788,219 .41 1,539,322.41 Year ended Oct. 31, 1940 Units shipped Average (gross) unit price Amount Ivory (vegetable) 584,310 $ 0.57 $ 331,474.39 Casein development: Niesac (solid) 1,000,796 .22 225,705.90 Niesac (mottled) 132,380 .40 53,467.05 Robulith 63,001 .52 32,675.19 Duo Horn (See note *) Urea formaldehyde development: Technoid (solid) 62,439 .86 53,431.92 Technoid (mottled) 516,917 .92 476,792.43 Technoid (wash and trouser) 1,446,991 .13 192,417.81 Miscellaneous (domestic and imported, purchased, etc.) 309,326 .62 * 189,635.07 Total 4,116,160 .38 1,555,599.76 *133 Year ended Oct. 31, 1941 Units shipped Average (gross) unit price Amount Ivory (vegetable) 1,253,647 $ 0.46 $ 575,756.40 Casein development: Niesac (solid) 963,354 .21 206,818.56 Niesac (mottled) 446,698 .44 194,888.73 Robulith 341,725 .50 171,569.00 Duo Horn 171,028 1.22 208,215.60 Urea formaldehyde development: Technoid (solid) 309,994 .75 231,032.11 Technoid (mottled) 703,133 1.00 700,542.08 Technoid (wash and trouser) 2,858,585 .16 469,147.72 Miscellaneous (domestic and imported, purchased, etc.) 191,048 .59 113,196.42 Total 7,239,212 .40 2,871,166.62 *544 The figures showing the average unit selling prices were derived by dividing the amount of sales by the number of units shipped. A schedule showing the unit selling prices for the kinds of buttons sold during 1941, the unit standard cost applicable to such buttons, the unit selling prices, and the unit standard cost of buttons claimed by petitioner*134 to have been replaced by the new types of buttons it developed is as follows: *545 Sizes (One gross represents Fiscal a unit) year [24] Niesac Mottled Challenge (produced from new mottling in the rod method -- first sold in the year 1940) Unit sales price [1940] $ 0.50 Unit sales price [1941] .50 Standard cost [1940] .1804 Standard cost [1941] .1900 Buttons produced by old spray mottling method Unit sales price [1939] .40 Standard cost [1939] .2442 Robulith (First sold in the year 1940) Brook and Duke Unit sales price [1940] .85 Unit sales price [1941] .85 Standard cost [1940] .2033 Standard cost [1941] .2255 Earl Unit sales price [1940] .75 Unit sales price [1941] .75 Standard cost [1940] .1788 Standard cost [1941] .1893 Blend and Spun Unit sales price [1940] $ 0.55 .60 Unit sales price [1941] .55 .60 Standard cost [1940] .1742 .2034 Standard cost [1941] .1969 .2255 Gem Unit sales price [1940] .45 .50 Unit sales price [1941] .45 .50 Standard cost [1940] .1496 .1788 Standard cost [1941] .1607 .1893 Jewel Unit sales price [1940] $ 0.50 $ 0.55 $ 0.65 Unit sales price [1941] .50 .55 .65 Standard cost [1940] .1208 .1336 .1616 Standard cost [1941] .1443 .1582 .1727 Vegetable ivory buttons Unit sales price [1939] .60 .75 Standard cost [1939] .4609 .4799 Duo Horn (Domestic -- first sold in the year 1940) Unit sales price [1940] $ 1.50 Unit sales price [1941] 1.50 Standard cost [1940] .4168 Standard cost [1941] .3740 Buttons (imported) Unit sales price [1940] 1.50 Standard cost [1940] .6389 Technoid wash and trousers, per great gross Troy Unit sales price [1938] $ 1.55 $ 1.65 Unit sales price [1939] 1.55 1.65 Unit sales price [1940] 1.55 1.65 Unit sales price [1941] 1.55 1.65 Standard cost [1940] .87 1.00 Standard cost [1941] .98 1.13 Ace Unit sales price [1938] 1.65 2.40 Unit sales price [1939] 1.65 2.40 Unit sales price [1940] 1.65 2.40 Unit sales price [1941] 1.65 2.40 Standard cost [1940] .89 1.16 Standard cost [1941] 1.02 1.20 Crown Unit sales price [1938] 1.65 Unit sales price [1939] 1.65 Unit sales price [1940] 1.65 Unit sales price [1941] 1.65 Standard cost [1940] 1.01 Standard cost [1941] 1.18 *135 Sizes (One gross represents Fiscal a unit) year [50] Niesac Mottled Challenge (produced from new mottling in the rod method -- first sold in the year 1940) Unit sales price [1940] $ 0.60 $ 0.85 $ 1.35 $ 1.75 $ 2.25 Unit sales price [1941] .60 .85 1.35 1.75 2.25 Standard cost [1940] .2634 .3582 .5668 .6994 .9940 Standard cost [1941] .2659 .3494 .5527 .6697 .9293 Buttons produced by old spray mottling method Unit sales price [1939] .45 .65 .85 1.25 1.75 Standard cost [1939] .3295 .4322 .5718 .8043 1.0359 Robulith (First sold in the year 1940) Brook and Duke Unit sales price [1940] .95 1.35 Unit sales price [1941] .95 1.35 Standard cost [1940] .3177 .4064 Standard cost [1941] .3464 .4380 Earl Unit sales price [1940] .85 1.15 Unit sales price [1941] .85 1.15 Standard cost [1940] .2931 .3818 Standard cost [1941] .3102 .4018 Blend and Spun Unit sales price [1940] Unit sales price [1941] Standard cost [1940] Standard cost [1941] Gem Unit sales price [1940] Unit sales price [1941] Standard cost [1940] Standard cost [1941] Jewel Unit sales price [1940] Unit sales price [1941] Standard cost [1940] Standard cost [1941] Vegetable ivory buttons Unit sales price [1939] Standard cost [1939] Duo Horn (Domestic -- first sold in the year 1940) Unit sales price [1940] $ 1.75 $ 2.50 $ 4.00 $ 5.00 Unit sales price [1941] 1.75 2.50 4.00 5.00 Standard cost [1940] .4850 .6187 .9171 1.0159 Standard cost [1941] .4343 .5299 .7880 .8732 Buttons (imported) Unit sales price [1940] 1.75 2.50 4.00 5.00 Standard cost [1940] .8653 1.0572 1.8636 2.1997 Technoid wash and trousers, per great gross Troy Unit sales price [1938] Unit sales price [1939] Unit sales price [1940] Unit sales price [1941] Standard cost [1940] Standard cost [1941] Ace Unit sales price [1938] 3.00 Unit sales price [1939] 3.00 Unit sales price [1940] 3.00 Unit sales price [1941] 3.00 Standard cost [1940] 1.83 Standard cost [1941] 2.00 Crown Unit sales price [1938] Unit sales price [1939] Unit sales price [1940] Unit sales price [1941] Standard cost [1940] Standard cost [1941] *136 Sizes (One gross represents Fiscal a unit) year [55] Niesac Mottled Challenge (produced from new mottling in the rod method -- first sold in the year 1940) Unit sales price [1940] Unit sales price [1941] Standard cost [1940] Standard cost [1941] Buttons produced by old spray mottling method Unit sales price [1939] Standard cost [1939] Robulith (First sold in the year 1940) Brook and Duke Unit sales price [1940] Unit sales price [1941] Standard cost [1940] Standard cost [1941] Earl Unit sales price [1940] Unit sales price [1941] Standard cost [1940] Standard cost [1941] Blend and Spun Unit sales price [1940] Unit sales price [1941] Standard cost [1940] Standard cost [1941] Gem Unit sales price [1940] Unit sales price [1941] Standard cost [1940] Standard cost [1941] Jewel Unit sales price [1940] Unit sales price [1941] Standard cost [1940] Standard cost [1941] Vegetable ivory buttons Unit sales price [1939] Standard cost [1939] Duo Horn (Domestic -- first sold in the year 1940) Unit sales price [1940] $ 6.00 Unit sales price [1941] 6.00 Standard cost [1940] 1.3609 Standard cost [1941] 1.1571 Buttons (imported) Unit sales price [1940] 6.00 Standard cost [1940] 2.8067 Technoid wash and trousers, per great gross Troy Unit sales price [1938] Unit sales price [1939] Unit sales price [1940] Unit sales price [1941] Standard cost [1940] Standard cost [1941] Ace Unit sales price [1938] Unit sales price [1939] Unit sales price [1940] Unit sales price [1941] Standard cost [1940] Standard cost [1941] Crown Unit sales price [1938] Unit sales price [1939] Unit sales price [1940] Unit sales price [1941] Standard cost [1940] Standard cost [1941] *137 *547 The variations in the aforementioned two statements as to unit sales price is accounted for by virtue of the facts that buttons were sold to jobbers at discounts ranging from 15 to 20 per cent, buttons were sold to better customers at less than regular selling prices, odd lots and mismatched buttons were sold at less than cost, and the greatest quantity of buttons sold was represented by the lower priced items. The unit sale prices in the schedule were the established regular net selling prices, while the unit selling prices for 1940 and 1941 averaged the prices shown in the classified statement for the aforementioned reasons. The following schedule shows the loss which would have been sustained had the vegetable ivory buttons, which were supplanted by Robulith buttons, been produced during the fiscal year 1941: Sales of Robulith buttons Standard cost of comparable Total cost of ivory buttons comparable Size Gross (per gross) ivory buttons [16] 110,749 $ 0.5313 $ 58,840.94 [18] 38,339 .5536 21,224.47 [20] 4,413 .4846 2,138.54 [22] 4,828 .4923 2,376.82 [24] 150,638 .4923 74,159.09 [30] 30,120 .5267 15,864.20 [34] 2,638 .7959 2,099.58 176,703.64 Net sales of Robulith buttons 171,569.00 Loss 5,134.64 *138 The loss figure is derived by multiplying the standard cost of comparable vegetable ivory buttons by the actual sales of Robulith buttons. In computing the cost of mottling operations eliminated in the amounts of $ 20,524.55 for the fiscal year 1940 and of $ 81,358.09 for the fiscal year 1941, as appearing on the schedule attached to excess profits tax return, petitioner multiplied the standard cost of spraying operations eliminated by the new development and the actual sales of Niesac mottled buttons for the periods involved to arrive at the figures. A schedule showing the computation of the 1941 figure is as follows: Sales of Niesac mottled Standard cost buttons of spraying Total cost of operation spraying eliminated by operation new development eliminated Size Gross (per gross) [24] 242,898 $ 0.1333 $ 32,378.30 [30] 90,190 .1746 15,747.17 [34] 61,675 .2443 15,067.20 [40] 10,547 .3499 3,690.40 [45] 35,349 .3499 12,368.62 [50] 6,020 .3499 2,106.40 Total 81,358.09 *548 In computing the comparable profiit it would have derived in the fiscal year 1941 on the sale of the product supplanted by the domestic Duo Horn buttons, *139 which product was the button made from imported sheets or blanks, petitioner multiplied the standard cost of comparable imported Duo Horn buttons and the actual sales of domestic Duo Horn buttons, and this sum was subtracted from the net sales of domestic Duo Horn buttons, as appears from the following schedule: Sales of domestic Duo Standard cost Horn buttons of comparable Total cost of imported Duo comparable Horn buttons imported Duo Size Gross (per gross) Horn buttons [24] 114,840 $ 0.7206 $ 82,753.70 [30] 22,352 .9482 21,194.17 [34] 23,047 1.1417 26,312.76 [45] 7,885 1.9708 15,539.76 [50] 2,477 2.3133 5,730.04 [423] 2.9381 1,242.82 152,773.25 Net sales of domestic Duo Horn buttons 208,215.60 Profit 55,442.35 In computing the cost of drilling operations eliminated in the manufacture of Technoid wash buttons, petitioner multiplied the standard cost of the operation eliminated and the gross buttons sold, as appears from the following schedule: Gross buttons sold 2,858,585 Standard cost of drilling operation eliminated by new development in processes: Labor $ .0116 Burden .0123 $ .0239 Gross sold, 2,858,585 times $ .0239 $ 68,320.18 *140 Petitioner's gross sales of buttons for the fiscal year ended October 31, 1942, amounted to $ 3,079,766.19, composed of the following items: Units shipped Average Amount (gross) unit price Ivory (vegetable) 1,549,173 $ 0.43 $ 661,258.49 Casein development: Niesac (solid) 453,569 .39 176,369.91 Niesac (mottled) 411,530 .61 251,883.75 Robulith 424,846 .51 214,999.39 Duo Horn 113,877 1.28 145,477.12 Urea Formaldehyde development: Technoid (solid) 225,553 .83 187,054.74 Technoid (mottled) 532,574 1.07 571,663.41 Technoid (wash and trouser) 4,245,410 .18 780,717.46 Miscellaneous (purchased, etc.) 105,827 .85 90,343.92 Total 8,062,359 3,079,766.19 Statements prepared by the Bureau of Census, United States Department of Commerce, show that during the calendar year 1941 "the total number of men's and youths' suits cut from all materials amounted to 19,689,032, as compared with 15,924,840 during [the *549 calendar year] 1940, an increase of approximately 24 per cent." Only 15,722,174 were cut in the calendar year 1942. In addition, in both 1941 and 1942, a large amount of clothing was cut for the armed forces. From 1937*141 or 1939 the button industry expanded from approximately 12 plastic button manufacturers to many more than that in 1941. There has been a greater expansion of button manufacture than there has been an expansion of the civilian button business. However, there was an increased demand for buttons in 1941 over 1939 and 1940. OPINION. As in W. B. Davis & Son, Inc., 1 W. B. Knight Machinery Co., 2 and Southwestern Oil & Gas Co., 3 this proceeding involves the application of section 721 (a) (2) (C), dealing with income in excess profits tax years resulting "from exploration, discovery, prospecting, research, or development of tangible property, patents, formulae, or processes, or any combination of the foregoing, extending over a period of more than 12 months." Petitioner asserts that under section 721 (b) part of its income was "net abnormal income" "attributable to" "previous" *142 "taxable years" by reason of the program of investigation and development of new types of buttons and button material which it carried on during earlier periods. It does not claim this as an abnormal type of income, but as exceeding by more than 25 per cent the income of base years. 4*143 From these premises it concludes that under section 721 (c) its tax should be so reduced as not to exceed the tax computed without the inclusion of such net abnormal income except to the extent of the increase in tax which would have resulted if the income had been received in the prior years to which it is attributed. 5 *550 It is apparent at the outset that little persuasive force derives from respondent's contention that this was not abnormal income as applied to petitioner. The term "abnormal" when used in section 721 is not to be restricted to its ordinary or usual meaning. The statute*144 carries, in addition, at least as to income abnormal in size, its own definition of that word, and whether a taxpayer measures up to its terms is a conclusion to be gathered solely from the standards set forth in the act itself. "* * * the statute means just what it says -- that any income of the type or class specified in subsection (a) (2) of section 721 is to be recognized in applying the relief measures which the statute grants." W. B. Knight Machinery Co., supra, 532. It seems to us to make no difference whether, as respondent contends, petitioner was habitually and continuously engaged in experimentation and research. If in the tax year the income it enjoyed as the result of prior activities in this field was more than 25 per cent greater than that for the base years, the necessary condition has been met. This preliminary proposition, however, leads to a further problem. Because petitioner's experimentation resulted in the development of several distinct products and because only as to some is the 125 per cent formula applicable, a different mathematical result is said to follow depending upon whether we accept respondent's contention that all items must be considered*145 together since they fall into the same statutory class (Regulations 109, sec. 30.721-1), or whether each item which exceeded the 125 per cent is made the basis of relief without consideration for those which fall below. See Mertens, Law of Federal Income Taxation, vol. 7A, p. 187. The detailed facts of petitioner's claim in this respect are set out in our findings and need not be repeated. In general, they show that "Robulith," "Duo-Horn," "Technoid" (wash) and "Niesac" have the required excess for exclusion from excess profits income, whereas in the case of "Technoid" (mottled) the amount received in the excess profits tax year fell below 125 per cent of the base years by approximately $ 19,000. From this petitioner argues that the exclusion, roughly $ 300,000, should be the total shown for the four items first listed, whereas respondent insists that the $ 19,000 should be deducted and the remaining net excess from the whole class, approximately $ 281,000, measures the outer limit of permissible relief. The statutory formula for making the determination presently involved seems to emerge with sufficient clarity from a consideration of the various provisions. First, the term *146 "abnormal income" is defined in subdivision (a) (1) as "income of any class includible in the *551 gross income of the taxpayer for any taxable year," and as applied to the present controversy it is limited to "income of such class includible in the gross income of the taxable year [which] is in excess of 125 per centum of the average amount of the gross income of the same class for the four previous taxable years." (Emphasis added.) Under subdivision (a) (2) "Each of the following subparagraphs shall be held to describe a separate class of income," and the "class" with which we are here concerned is, as we noted at the outset, "Income resulting from exploration, discovery, prospecting, research, or development of * * * patents, formulae, or processes, or any combination of the foregoing." The only amount with respect to which relief is granted is the "net abnormal income" which "means the amount of the abnormal income less * * * (A) 125 per centum of the average amount of the gross income of the same class determined under paragraph (1) * * *." We see no escape from the conclusion that in arriving at the amount for which petitioner is entitled to relief both the abnormal*147 income and the net abnormal income must be computed by reference to each "separate class of income." Nowhere does the legislation refer to individual items within a class. The abnormal income is defined only by reference to the total derived from any class. When all the provisions are read together, the difficulty becomes apparent of attempting to determine the amount of the disputed income for the taxable year, the corresponding income for the base years, the abnormal income, or the net abnormal income, without in each case including one indivisible figure for the total amount falling into the description of a specific class. Perhaps the difficulty would appear less formidable if we were here dealing with a claim that type, rather than size, of the income was abnormal; for it seems evident from the terms of the act that in a situation of that sort, if it were normal for the taxpayer to have any income whatever which falls within the description of a particular class, the applicability of the section would automatically disappear. See Premier Products Co., 2 T. C. 445, 453; W. B. Davis & Son, Inc., supra. It may be for that very reason that petitioner*148 inferentially concedes that this is not an abnormal type case, since it was not abnormal for it to have some income falling within the described class. But it seems to us that equally in the instance of abnormality based on size, as in the present case, the test must be a comparable one; and the 25 per cent leeway must be applied to the class as a whole, precisely as the type-of-income test would be similarly applied were the claim based upon that phase of abnormality. *552 On this aspect of the controversy we view respondent's position as correct. This conclusion leads in turn to a further question. Since the abnormal income consists of the excess over 125 per cent of similar income enjoyed in the four base period years, respondent insists that it was petitioner's burden to show its total income from all sources within the specified class for the base period and that it has failed to carry that burden. While we agree that the showing is necessary, we think it has been adequately made. The record leaves something to be desired, but it is easy to understand that a taxpayer's books are not kept with prophetic vision as to the future requirements of income tax legislation. *149 The source of petitioner's income from the sales of its products has been stipulated. The products and a general description of their origin likewise appear. It is sufficiently evident from the record as a whole what part of petitioner's income can be said to have arisen out of processes for which it was primarily responsible. At least the facts have achieved that completeness where the burden of going forward with any possible contradictory material reasonably fell upon respondent. Three additional questions remain for disposition. The first is the amount of "any direct costs or expenses, deductible in determining the normal-tax net income of the taxable year, through the expenditure of which such abnormal income was in whole or in part derived." 6 No evidence dealing specifically with this requirement of the statute was produced, and on that premise respondent contends that petitioner's claim must be disallowed in full for failure of proof. Here again, the record leaves much to be desired, but there is evidence from which we think the necessary computation can be made. Cf. Cohan v. Commissioner (C. C. A., 2d Cir.), 39 Fed. (2d) 540. Cost*150 of goods sold has already been eliminated by the method of arriving at the gross abnormal income. In addition, under the head of "Selling" expense petitioner has shown its total costs (approximately $ 383,500) of making sales for the year in question. See Seghers "What Price Section 721 Relief," Taxes, Oct. 1944, pp. 434, 436; Barlow & Elpern "Abnormal Income from Research & Development," Taxes, May 1946, pp. *553 448, 458. We may assume that these are the over-all direct costs applicable generally to the disposition of all of petitioner's products, and it appears reasonable that through some portion of their expenditure the abnormal income was in whole or in part derived. In the absence of a more accurate standard, we are driven to the assumption that this amount is directly attributable to the collection of the abnormal income in the same proportion that the abnormal income bore to petitioner's total gross merchandising profit for the year, a figure for which appears in our findings of fact. No other "direct" costs seem to be involved. Cf. W. B. Davis & Son, Inc., supra. The necessary detail of calculation can be incorporated in the recomputation under Rule 50. *151 The second remaining question deals with the proposition that "we know that no part of such [abnormal] income can be so attributed [to other years] which was due solely to improvement in business conditions." W. B. Knight Machinery Co., supra; see also Southwestern Oil & Gas Co., supra. Although in the Knight case the factor representing the profit due to improvement in business was stipulated, here the parties do not agree upon it, and it must, if supplied at all, be found from the facts in evidence. There can be little doubt that, knowing all the factors, a consideration of so general a nature would still necessarily reduce in the last analysis to a matter of opinion. The present record shows, in addition to the products which were the outgrowth of petitioner's research, the sales history of standard vegetable ivory buttons dealt in regularly and consistently for a number of years. The average dollar amount of the annual sales of this button for the four base period years compared to the sales of the same button for the year in issue will give a factor of increase which seems to us the nearest to accuracy which can be elicited under the present circumstances. Only*152 the remaining proportion of the figure arrived at for net abnormal income may be attributed to other years and hence form the basis for permissible relief. W. B. Knight Machinery Co., supra. Any other increase in income or reduction in costs apparently need not concern us here. Southwestern Oil & Gas Co., supra. As on the previous point, the necessary computation may be carried out under Rule 50. Finally, there is the problem of allocating the resulting abnormal income among the respective prior years. In W. B. Knight Machinery Co., supra, the record showed a continuation of the research on petitioner's existing machine models into the tax year under consideration and for that reason some of the abnormal income was attributed to that year. Here in every case the research was completed prior to the present tax year. The evidence indicates that petitioner's research which resulted in the products with respect to which relief is being *554 granted commenced in about 1931. In each of the ten years beginning in 1931, and prior to the year in issue, petitioner undertook expenditures for "experimental and research" purposes, the several amounts of which are set forth*153 in our findings of fact. Although it is not apparent that the result would be materially different if some other method were employed, we take the view that under the present circumstances the income attributable to prior years should be divided among the ten years mentioned -- 1931 through fiscal 1940 -- in the same proportion that the respective annual expenditures in question bear to the total of the same expenditures for all of those years. See W. B. Knight Machinery Co., supra. Reviewed by the Special Division. Decision will be entered under Rule 50. Footnotes *. Includes sales of domestic Duo Horn buttons in the amount of $ 9,167.23, representing buttons purchased by garment manufacturers for trial use, before their general acceptance by the trade.↩ 1. 5 T. C. 1195↩. 2. 6 T. C. 519↩. 3. 6 T. C. 1124↩. 4. SEC. 721. ABNORMALITIES IN INCOME IN TAXABLE PERIOD. (a) Definitions. -- For the purposes of this section. (1) Abnormal Income. -- The term "abnormal income" means income of any class includible in the gross income of the taxpayer for any taxable year under this subchapter if it is abnormal for the taxpayer to derive income of such class, or, if the taxpayer normally derives income of such class but the amount of such income of such class includible in the gross income of the taxable year is in excess of 125 per centum of the average amount of the gross income of the same class for the four previous taxable years * * *.↩ 5. SEC. 721. * * * * * * * (c) Computation of Tax for Current Taxable Year. -- The tax under this subchapter for the taxable year, in which the whole of such abnormal income would without regard to this section be includible, shall not exceed the sum of: (1) The tax under this subchapter for such taxable year computed without the inclusion in gross income of the portion of the net abnormal income which is attributable to any other taxable year, and (2) The aggregate of the increase in the tax under this subchapter for the taxable year (computed under paragraph (1)) and for each previous taxable year which would have resulted if, for each previous taxable year to which any portion of such net abnormal income is attributable, an amount equal to such portion had been included in the gross income for such previous taxable year.↩ 6. SEC. 721. ABNORMALITIES IN INCOME IN TAXABLE PERIOD. (a) Definitions. -- For the purposes of this section -- * * * * (3) Net abnormal income. -- The term "net abnormal income" means the amount of the abnormal income less, under regulations prescribed by the Commissioner with the approval of the Secretary, (A) 125 per centum of the average amount of the gross income of the same class determined under paragraph (1), and (B) an amount which bears the same ratio to the amount of any direct costs or expenses, deductible in determining the normal-tax net income of the taxable year, through the expenditure of which such abnormal income was in whole or in part derived as the excess of the amount of such abnormal income over 125 per centum of such average amount bears to the amount of such abnormal income.↩