Opinion
Docket Nos. 25376 29640.
1954-11-19
HEARN DEPARTMENT STORES, INC., PETITIONER, V. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
Milton D. Solomon, Esq., Max Perl, Esq., and David Alter, Esq., for the petitioner. Arthur W. Wiener, Esq., for the respondent.
Milton D. Solomon, Esq., Max Perl, Esq., and David Alter, Esq., for the petitioner. Arthur W. Wiener, Esq., for the respondent.
On the record it is held that petitioner has failed to establish that it is entitled to constructive average base period net income which is large enough to produce a credit greater than any of the invested capital credits used by the petitioner for the taxable years herein, or that the excess profits taxes paid by it for the years in issue are excessive and discriminatory.
The respondent disallowed in full petitioner's applications for excess profits tax relief, under section 722 of the Internal Revenue Code of 1939, for the fiscal years ended January 31, 1941, through January 31, 1946. The issue is whether petitioner is entitled to excess profits tax relief under the provisions of section 722 (b) (2) or (b) (4).
The proceedings were heard by a commissioner of the Court, the proof consisting of stipulations of fact, oral testimony, and exhibits. The facts as proposed by the commissioner and included in his report filed herein, together with certain additional facts included in our findings set forth below, are adopted and found as our Findings of Fact.
FINDINGS OF FACT.
The petitioner is a New York corporation with its principal office in the city and State of New York. Its income and excess profits tax returns for the periods here involved were filed with the collector of internal revenue for the second district of New York.
Petitioner was organized on July 26, 1932, for the purpose of acquiring the retail department store business of James A. Hearn & Son., Inc. (hereinafter referred to as petitioner's predecessor), which retail department store had been operated under the name of Hearn in one form or another in New York City for more than 100 years. Petitioner acquired such business on July 28, 1932, by purchasing from various members of the Cowl family all of the stock of petitioner's predecessor.
Immediately prior to the acquisition by petitioner the condition of the business of petitioner's predecessor was in a bad state. It was being operated by a creditors' committee. It did little or no advertising. Its inventory was badly depleted and purchases were being made on a daily basis. Employee morale was low because of the constant threat of imminent closing. The business had reached its peak 10 years before, in 1922, when net sales amounted to $17,866,000. From 1922 until July 28, 1932, at which time petitioner acquired the business, net sales had dwindled continuously from the above figure to $3,149,000 for the 6 months period from February 1, 1932, the close of its fiscal year, to July 28, 1932, when it was acquired by the petitioner. Net income had dropped from a net profit of $399,000 in 1924, to a net loss of $1,172,000 for the 11 months ending January 31, 1932, and to a net loss of $911,000 for the 5 months prior to the sale of the business to petitioner.
The store which petitioner's predecessor had occupied and which after July 28, 1932, was occupied by petitioner was and is located on 14th Street between Fifth and Sixth Avenues in New York City. Additional premises were leased for the use of petitioner's 14th Street store as follows:
(a) In October 1932, a building located at 16 West 14th Street;
(b) In February 1934, a building located at 4 West 14th Street;
(c) In September 1934, the third, fourth, and fifth floors of 34-42 West 14 th Street and 33-41 West 13th Street; and
(d) In August 1936, a building located at 14 West 14th Street.
Upon acquisition of the business of its predecessor, petitioner took steps which in its opinion would build up the Hearn business and restore its lost prestige and volume of business. Additional funds were put into the business, a substantial quantity of new merchandise was acquired, and petitioner began a vigorous campaign of advertising. Upon the acquisition of the predecessor's business petitioner took over its employees, together with its executive personnel.
The acquisition of petitioner's predecessor had been by Maurice Levin and J. M. Kaplan, two men of considerable wealth but without experience in the department store field. After the organization of petitioner the top management of the business was in the hands of Maurice Levin, Leonard Ginsberg, and Sidney M. Louis. Louis was without experience in the department store field but Ginsberg had been in charge of merchandising for petitioner's predecessor and was made vice president of petitioner. These three individuals decided questions of policy for petitioner, Levin having the final say in such matters. Levin, Kaplan, and Louis had many interests outside the operation of petitioner's business and served petitioner only part time during its base period years.
From petitioner's organization in 1932 to January 31, 1936, $2,000,000 was paid in for two classes of petitioner's preferred stock and $5,000 for common stock. Subsequently there were exchanges and conversions of stock and a public offering of stock in 1936. By 1938 paid-in capital stock amounted to $2,848,515, consisting of.$1,426,450 for preferred stock and $1,422,065 for common stock. Thereafter there were no significant changes during the base period in the amount of paid-in capital stock. Stock of the petitioner was listed on the New York Curb Exchange in January 1937.
Prior to the organization of petitioner and its acquisition of the business of its predecessor all other department stores located in the 14th Street district had moved to other and better locations further uptown. Prior to that time 14th Street had been a center of department store operations, but after the change in question, that location for the operation of a department store became must less desirable. At the time petitioner acquired the business of its predecessor, 14th Street had been invaded by a large number of small stores. Of these there were more than 100 located on 14th Street. There were also located on 14th Street two substantial specialty stores known as Klein's and Ohrbach's which did a large volume of business in the ready-to- wear line. These two stores were in direct competition with petitioner in the lines of goods carried by them, and their management was aggressive and able. They, as well as the small stores on 14th Street, operated upon a basis which made it possible for them to undersell petitioner or force the latter to substantial reduction in prices. This was due in large measure to the fact that petitioner, as a regular department store, offers services such as credit accounts, deliveries, and exchanges, which were not offered by these other mentioned stores. The cost of such services constituted a substantial portion of the cost of petitioner's sales. Many of the smaller stores operated with a minimum of overhead, due to their small size and the fact that is some cases they were operated by the proprietors without the assistance of employed personnel.
Merchandise sold by petitioner and services rendered by it were similar to those found in department stores generally. Such merchandise included, but was not limited to, the following: Wearing apparel for men, women, and children, furniture and home furnishings, dry goods, toilet goods, stationery, jewelry, silverware, luggage and leather goods, toys and sporting goods, meats and groceries, and wines and liquors. With the exception of furniture and home furnishings, falling within the class of heavy goods, the greater part of the character of goods sold by petitioner could be found in the competing stores on 14th Street. In many cases such stores carried the similar line or brand carried by petitioner. These competing stores in many cases bought the merchandise in sales of distressed goods or goods sold in liquidation of other businesses or excess inventories which other businesses found necessary to dispose of.
Prior to the organization of the petitioner the operation of its predecessor for its fiscal years ending February 28, 1922, to February 28, 1931, shows totals as follows:
+-------------------------------------------------------------+ ¦ ¦ ¦Inventory¦ ¦ +------------------------------+---------+---------+----------¦ ¦Fiscal year ending February 28¦Net sales¦at end of¦Net income¦ +------------------------------+---------+---------+----------¦ ¦ ¦ ¦year ¦or (loss) ¦ +------------------------------+---------+---------+----------¦ ¦In thousands of dollars ¦ ¦ ¦ ¦ +------------------------------+---------+---------+----------¦ ¦1922 ¦$17,866 ¦$2,172 ¦$321 ¦ +------------------------------+---------+---------+----------¦ ¦1923 ¦17,124 ¦2,362 ¦292 ¦ +------------------------------+---------+---------+----------¦ ¦1924 ¦17,495 ¦2,557 ¦399 ¦ +------------------------------+---------+---------+----------¦ ¦1925 ¦16,580 ¦2,347 ¦301 ¦ +------------------------------+---------+---------+----------¦ ¦1926 ¦15,627 ¦2,380 ¦150 ¦ +------------------------------+---------+---------+----------¦ ¦1927 ¦15,399 ¦2,373 ¦(30) ¦ +------------------------------+---------+---------+----------¦ ¦1928 ¦15,352 ¦2,385 ¦37 ¦ +------------------------------+---------+---------+----------¦ ¦1929 ¦13,987 ¦2,150 ¦116 ¦ +------------------------------+---------+---------+----------¦ ¦1930 ¦13,465 ¦1,849 ¦13 ¦ +------------------------------+---------+---------+----------¦ ¦1931 ¦13,616 ¦2,089 ¦(432) ¦ +-------------------------------------------------------------+
For the fiscal years ended January 31, 1934, to January 31, 1946, petitioner's net sales, gross income, net income for Federal income tax purposes, and excess profits net income (income method were as follows:
+----------------------------------------------------------------------+ ¦ ¦ ¦ ¦ ¦Excess profits¦ +----------------+----------+------------+--------------+--------------¦ ¦ ¦ ¦ ¦Net income for¦net income ¦ +----------------+----------+------------+--------------+--------------¦ ¦Fiscal year ¦Net sales ¦Gross income¦Federal income¦(income ¦ +----------------+----------+------------+--------------+--------------¦ ¦ended January 31¦ ¦ ¦tax purposes ¦method) ¦ +----------------+----------+------------+--------------+--------------¦ ¦1934 ¦$8,202,419¦$2,987,223 ¦$458,254 ¦$458,254 ¦ +----------------+----------+------------+--------------+--------------¦ ¦1935 ¦14,176,274¦4,037,590 ¦31,313 ¦61,391 ¦ +----------------+----------+------------+--------------+--------------¦ ¦1936 ¦16,435,839¦4,828,875 ¦364,761 ¦274,486 ¦ +----------------+----------+------------+--------------+--------------¦ ¦1937 ¦17,054,072¦5,796,757 ¦569,813 ¦570,364 ¦ +----------------+----------+------------+--------------+--------------¦ ¦1938 ¦20,610,514¦7,021,203 ¦142,140 ¦141,955 ¦ +----------------+----------+------------+--------------+--------------¦ ¦1939 ¦18,341,356¦6,159,274 ¦(239,937) ¦(239,937) ¦ +----------------+----------+------------+--------------+--------------¦ ¦1940 ¦17,471,825¦6,171,341 ¦74,831 ¦74,831 ¦ +----------------+----------+------------+--------------+--------------¦ ¦1941 ¦17,389,409¦6,162,645 ¦349,657 ¦* 355,901 ¦ +----------------+----------+------------+--------------+--------------¦ ¦1942 ¦18,474,120¦6,960,417 ¦594,155 ¦593,980 ¦ +----------------+----------+------------+--------------+--------------¦ ¦1943 ¦18,525,904¦7,152,717 ¦952,081 ¦951,871 ¦ +----------------+----------+------------+--------------+--------------¦ ¦1944 ¦19,653,004¦7,570,198 ¦1,053,005 ¦1,052,830 ¦ +----------------+----------+------------+--------------+--------------¦ ¦1945 ¦21,362,471¦7,986,467 ¦988,844 ¦983,876 ¦ +----------------+----------+------------+--------------+--------------¦ ¦1946 ¦23,790,231¦8,904,886 ¦1,180,904 ¦1,146,987 ¦ +----------------------------------------------------------------------+ (b) TAXPAYERS USING AVERAGE EARNINGS METHOD.— The tax computed under this subchapter (without the benefit of this section) shall be considered to be excessive and discriminatory in the case of a taxpayer entitled to use the excess profits credit based on income pursuant to section 713, if its average base period net income is an inadequate standard of normal earnings because—(2) the business of the taxpayer was depressed in the base period because of temporary economic circumstances unusual in the case of such taxpayer or because of the fact that an industry of which such taxpayer was a member was depressed by reason of temporary economic events unusual in the case of such industry.(4) the taxpayer, either during or immediately prior to the base period, commenced business or changed the character of the business and the average base period net income does not reflect the normal operation for the entire base period of the business. If the business of the taxpayer did not reach, by the end of the base period, the earning level which it would have reached if the taxpayer had commenced business or made the change in the character of the business two years before it did so, it shall be deemed to have commenced the business or made the change at such earlier time. For the purposes of this subparagraph, the term ‘change in the character of the business' includes a change in the operation or management of the business, a difference in the products or services furnished, a difference in the capacity for production or operation, a difference in the ratio of nonborrowed capital to total capital, and the acquisition before January 1, 1940, of all or part of the assets of a competitor, with the result that the competition of such competitor was eliminated or diminished. Any change in the capacity for production or operation of the business consummated during any taxable year ending after December 31, 1939, as a result of a course of action to which the taxpayer was committed prior to January 1, 1940, or any acquisition before May 31, 1941, from a competitor engaged in the dissemination of information through the public press, of substantially all the assets of such competitor employed in such business with the result that competition between the taxpayer and the competitor existing before January 1, 1940, was eliminated, shall be deemed to be a change on December 31, 1939, in the character of the business, or(5) of any other factor affecting the taxpayers business which may reasonably be considered as resulting in an inadequate standard of normal earnings during the base period and the application of this section to the taxpayer would not be inconsistent with the principles underlying the provisions of this subsection, and with the conditions and limitations enumerated therein.
FN* No deduction made for Federal income taxes of $83,876, applicable only in this year.
Petitioner's operations during the base period years are reflected in the following statement showing petitioner's net income per books before Federal income taxes and surplus adjustments for those years, together with related items of receipts and disbursements:
+-----------------------------------------------------------------------------+ ¦Fiscal year ended January 31 ¦ ¦ ¦ ¦ ¦ +-----------------------------+-----------+-----------+-----------+-----------¦ ¦ ¦1937 ¦1938 ¦1939 ¦1940 ¦ +-----------------------------+-----------+-----------+-----------+-----------¦ ¦ ¦1 store ¦3 stores ¦3 stores ¦3 stores ¦ +-----------------------------+-----------+-----------+-----------+-----------¦ ¦Net sales ¦$17,054,072¦$20,610,514¦$18,341,356¦$17,471,825¦ +-----------------------------+-----------+-----------+-----------+-----------¦ ¦Gross profit ¦5,148,878 ¦6,160,536 ¦5,205,357 ¦5,306,375 ¦ +-----------------------------+-----------+-----------+-----------+-----------¦ ¦Purchase discounts ¦497,675 ¦611,474 ¦562,532 ¦571,291 ¦ +-----------------------------+-----------+-----------+-----------+-----------¦ ¦Total gross profit ¦$5,646,553 ¦$6,772,010 ¦$5,767,889 ¦$5,877,666 ¦ +-----------------------------+-----------+-----------+-----------+-----------¦ ¦Leased departments net income¦120,330 ¦182,985 ¦271,092 ¦223,084 ¦ +-----------------------------+-----------+-----------+-----------+-----------¦ ¦Fur storage and misc. income ¦29,874 ¦66,208 ¦120,293 ¦70,591 ¦ +-----------------------------+-----------+-----------+-----------+-----------¦ ¦Gross income ¦$5,796,757 ¦$7,021,203 ¦$6,159,274 ¦$6,171,341 ¦ +-----------------------------+-----------+-----------+-----------+-----------¦ ¦Officers' salaries ¦$44,224 ¦$71,004 ¦$62,880 ¦$60,220 ¦ +-----------------------------+-----------+-----------+-----------+-----------¦ ¦Other salaries ¦2,272,388 ¦3,197,253 ¦2,816,548 ¦2,744,397 ¦ +-----------------------------+-----------+-----------+-----------+-----------¦ ¦Occupancy expense ¦372,208 ¦568,116 ¦665,333 ¦616,283 ¦ +-----------------------------+-----------+-----------+-----------+-----------¦ ¦Repairs and maintenance ¦139,275 ¦80,308 ¦61,509 ¦41,051 ¦ +-----------------------------+-----------+-----------+-----------+-----------¦ ¦Interest paid ¦1,322 ¦21,500 ¦27,517 ¦11,870 ¦ +-----------------------------+-----------+-----------+-----------+-----------¦ ¦Miscellaneous taxes ¦64,061 ¦159,986 ¦177,154 ¦156,722 ¦ +-----------------------------+-----------+-----------+-----------+-----------¦ ¦Depreciation ¦75,055 ¦156,318 ¦151,451 ¦158,992 ¦ +-----------------------------+-----------+-----------+-----------+-----------¦ ¦Advertising ¦1,117,154 ¦1,173,252 ¦1,167,577 ¦1,087,183 ¦ +-----------------------------+-----------+-----------+-----------+-----------¦ ¦Supplies ¦238,057 ¦341,565 ¦280,847 ¦282,356 ¦ +-----------------------------+-----------+-----------+-----------+-----------¦ ¦Services purchased ¦541,710 ¦652,319 ¦633,493 ¦604,030 ¦ +-----------------------------+-----------+-----------+-----------+-----------¦ ¦Unclassified ¦135,670 ¦190,000 ¦154,568 ¦148,139 ¦ +-----------------------------+-----------+-----------+-----------+-----------¦ ¦Traveling ¦8,214 ¦8,208 ¦11,265 ¦6,890 ¦ +-----------------------------+-----------+-----------+-----------+-----------¦ ¦Communication ¦45,177 ¦76,444 ¦75,256 ¦70,398 ¦ +-----------------------------+-----------+-----------+-----------+-----------¦ ¦Insurance ¦66,066 ¦103,248 ¦94,313 ¦87,956 ¦ +-----------------------------+-----------+-----------+-----------+-----------¦ ¦Professional services ¦6,858 ¦55,955 ¦39,558 ¦28,221 ¦ +-----------------------------+-----------+-----------+-----------+-----------¦ ¦Total expense ¦$5,127,439 ¦$6,855,476 ¦$6,419,269 ¦$6,104,708 ¦ +-----------------------------------------------------------------------------¦ ¦Net income (or loss) as per books before Federal ¦ +-----------------------------------------------------------------------------¦ ¦income tax and surplus ¦$669,318 ¦$165,727 ¦($259,995) ¦$66,633 ¦ ¦adjustments ¦ ¦ ¦ ¦ ¦ +-----------------------------------------------------------------------------+
For the fiscal years ended January 31, 1934, to January 31, 1946, inclusive, the petitioner's gross profits (with and without discounts), rent, officers' salaries, and total operating expenses as percentages of sales were as follows:
+---------------------------------------------------------------------+ ¦ ¦Gross profit ¦ ¦ ¦ ¦ +----------------------------+-----------------+----+---------+-------¦ ¦ ¦ ¦ ¦Rent¦Officers'¦Total ¦ +----------------------------+--------+--------+----+---------+-------¦ ¦Fiscal year ended January 31¦Without ¦With ¦ ¦salaries ¦expense¦ +----------------------------+--------+--------+----+---------+-------¦ ¦ ¦discount¦discount¦ ¦ ¦ ¦ +----------------------------+----------------------------------------¦ ¦ ¦Per cent ¦ +----------------------------+----------------------------------------¦ ¦1934 ¦31.31 ¦34.84 ¦2.95¦0 ¦30.83 ¦ +----------------------------+--------+--------+----+---------+-------¦ ¦1935 ¦24.63 ¦27.61 ¦1.80¦0 ¦27.43 ¦ +----------------------------+--------+--------+----+---------+-------¦ ¦1936 ¦25.58 ¦28.60 ¦1.72¦0.22 ¦27.56 ¦ +----------------------------+--------+--------+----+---------+-------¦ ¦1937 ¦30.19 ¦33.11 ¦2.18¦0.26 ¦30.07 ¦ +----------------------------+--------+--------+----+---------+-------¦ ¦1938 ¦29.89 ¦32.86 ¦2.76¦0.34 ¦33.26 ¦ +----------------------------+--------+--------+----+---------+-------¦ ¦1939 ¦28.38 ¦31.45 ¦3.63¦0.34 ¦35.00 ¦ +----------------------------+--------+--------+----+---------+-------¦ ¦1940 ¦30.37 ¦33.64 ¦3.53¦0.34 ¦34.94 ¦ +----------------------------+--------+--------+----+---------+-------¦ ¦1941 ¦30.92 ¦33.92 ¦3.46¦0.52 ¦33.38 ¦ +----------------------------+--------+--------+----+---------+-------¦ ¦1942 ¦33.51 ¦36.43 ¦3.08¦0.44 ¦34.12 ¦ +----------------------------+--------+--------+----+---------+-------¦ ¦1943 ¦34.58 ¦37.37 ¦3.15¦0.87 ¦33.79 ¦ +----------------------------+--------+--------+----+---------+-------¦ ¦1944 ¦34.43 ¦37.24 ¦2.98¦0.86 ¦33.46 ¦ +----------------------------+--------+--------+----+---------+-------¦ ¦1945 ¦33.50 ¦36.26 ¦2.70¦0.84 ¦32.94 ¦ +----------------------------+--------+--------+----+---------+-------¦ ¦1946 ¦33.49 ¦36.14 ¦2.51¦1.07 ¦32.67 ¦ +---------------------------------------------------------------------+
Petitioner's business after the first year of its operation not having shown the gross volume of business anticipated and desired, it put into operation in September 1934 a new policy of operation which it designated a ‘no-profit plan.’ This plan it advertised extensively. Under it the policy was to mark up its cost prices on merchandise in an amount sufficient only to pay expenses. It was thought that this plan would largely increase gross sales and that the increased business thus obtained could be subsequently retained by the business after the no-profit plan was discontinued. This plan was discontinued in August 1935 and another policy adopted, termed ‘share-the-profit plan.’ Under this latter plan a sales quota was set and it was agreed that at the end of the year if this quota was reached certain refunds would be made to purchasers and distributions of cash to the employees. Under this plan the markups from cost were higher than under the no-profit plan and were designed to show a profit in excess of the distributions anticipated to be made. The quota of sales was not reached from September 1935 through December 1935, during which time this plan was in operation. Although no distributions of cash were necessary to employees or to customers by the terms of this plan, the petitioner did make some distributions of cash to customers.
A no-profit plan such as petitioner put in operation is not a wise merchandising plan and does not benefit a business in the long run. Its benefit is to merely gross sales temporarily at the expense of profits. Such a plan is not one an expert on department store operation would in fact engage in.
It is difficult for a department store to change from a policy of low markup to a policy of normal markup. Particularly at petitioner's competitive location, increasing its markup was a serious merchandising problem for petitioner. Before and during the base period the petitioner engaged in aggressive and promotional selling. It found that promotional sales did not usually result in profits. Petitioner sometimes sold standard brands of merchandise below list prices, and some suppliers of standard brands did not want to sell their goods to petitioner.
In 1937 petitioner, in an endeavor to increase its business, bought two department stores, one in the Bronx and the other in Newark, New Jersey, to be operated by it under the names of ‘Hearns-Bronx’ and ‘Hearns-Newark.’ It also contracted conditionally to acquire a third branch store operated by its owners under the name of Gertz, in Jamaica, Long Island. The agreement to acquire this store was conditioned upon petitioner realizing at least $2,600,000 from a contemplated issue of its preferred stock.
The acquisition of the Bronx and Newark stores entailed a large outlay of funds by petitioner, not only in increased inventory but in permanent improvement to these stores by the addition of facilities including escalators and the building of an additional story on one store. The premises occupied by these stores were rented, the leases being taken over by petitioner. The amounts actually spent for these items on the Bronx and Newark stores exceeded by several hundred thousand dollars the amounts that had been anticipated by petitioner's management. The total expenditures by petitioner on these stores for furniture and fixtures and leasehold improvements were in the sum of $1,170,577.
It was usual for branch stores like the petitioner's branch stores to take business away from the centrally located main store, and it was estimated by petitioner that the Bronx store alone would reduce the sales of the main store by 5 to 7 per cent.
The annual net sales of petitioner's main store, together with its two branch stores, during petitioner's base period and for 3 years thereafter were as follows:
+--------------------------------------------------------------------------+ ¦Fiscal year ended January 31¦14th Street store¦Bronx store ¦Newark store ¦ +----------------------------+-----------------+-------------+-------------¦ ¦1937 ¦$17,054,000 ¦ ¦ ¦ +----------------------------+-----------------+-------------+-------------¦ ¦1938 ¦14,943,500 ¦* $3,772,400¦* $1,894,600¦ +----------------------------+-----------------+-------------+-------------¦ ¦1939 ¦12,100,700 ¦3,454,000 ¦2,786,600 ¦ +----------------------------+-----------------+-------------+-------------¦ ¦1940 ¦11,767,600 ¦3,424,500 ¦2,279,700 ¦ +----------------------------+-----------------+-------------+-------------¦ ¦1941 ¦11,957,500 ¦3,453,700 ¦1,978,200 ¦ +----------------------------+-----------------+-------------+-------------¦ ¦1942 ¦12,544,800 ¦3,697,900 ¦2,231,400 ¦ +----------------------------+-----------------+-------------+-------------¦ ¦1943 ¦12,449,200 ¦3,725,400 ¦2,351,300 ¦ +--------------------------------------------------------------------------+ FN* Store open for only part of the year.
By June of 1938 the petitioner recognized that sales in the Bronx and Newark stores were not up to its expectations. Sales consistently declined for each full year of the base period in each one of the petitioner's three stores. Its experience with the Newark store was especially disappointing. In this store, except for June of 1939, sales for every month of the base period were lower than sales for the corresponding months of the preceding years. As a result petitioner, in September 1939, discontinued credit sales at the Newark store. Sales in that store were put on a ‘cash and carry’ basis, and as a result sales of heavy merchandise had to be discontinued.
Annual gross profits for each of the petitioner's three stores during petitioner's base period were as follows:
+------------------------------------------------------------------+ ¦Fiscal year ended January 31¦14th Street¦Bronx ¦Newark ¦ +----------------------------+-----------+-------------+-----------¦ ¦ ¦store ¦store ¦store ¦ +----------------------------+-----------+-------------+-----------¦ ¦1937 ¦$5,646,553 ¦ ¦ ¦ +----------------------------+-----------+-------------+-----------¦ ¦1938 ¦4,840,811 ¦* $1,287,354¦* $643,845¦ +----------------------------+-----------+-------------+-----------¦ ¦1939 ¦3,760,262 ¦1,122,526 ¦885,101 ¦ +----------------------------+-----------+-------------+-----------¦ ¦1940 ¦3,975,936 ¦1,193,993 ¦707,737 ¦ +------------------------------------------------------------------+ FN* Store open for only part of the year.
Before general overhead, general advertising, and officers' salaries, which were all charged as expenses to petitioner's main store, expenses amounted to over $800,000 for each full year in each of the petitioner's two branch stores during the base period.
The opening of the two branch stores in 1937 directly led to increased cost to the petitioner thereafter. Several hundred additional employees were required in each of the petitioner's two branch stores. There was increased overhead, and the addition of depreciable assets in each of these stores increased operating expenses of the branch stores.
Unionization of the bulk of petitioner's employees occurred early in petitioner's base period. This unionization substantially and adversely affected the costs and profit-making ability of petitioner's stores. This was due not only to the additional dollar cost of labor and fringe benefits but also the hours worked. The annual increase in cost to petitioner by reason of unionization was estimated by petitioner to be from $150,000 to $200,000 per year.
During its later base period years petitioner's salaries (other than officers' salaries) and petitioner's occupancy or rental expense became considerably larger in amount and in per cent of net sales than they had been in petitioner's first base period year as reflected in the following statement:
+-----------------------------------------------------------------------+ ¦ ¦ ¦Salaries other than ¦Occupancy or rental¦ +-----------------+-----------+---------------------+-------------------¦ ¦ ¦ ¦officers' salaries ¦expenses ¦ +-----------------+-----------+-----------------------------------------¦ ¦Fiscal year ended¦Net sales ¦ ¦ +-----------------+-----------+-----------------------------------------¦ ¦January 31 ¦ ¦Amount ¦Ratio to ¦Amount ¦Ratio to ¦ +-----------------+-----------+----------+----------+--------+----------¦ ¦ ¦ ¦ ¦sales ¦ ¦sales ¦ +-----------------+-----------+----------+----------+--------+----------¦ ¦ ¦ ¦ ¦Per cent ¦ ¦Per cent ¦ +-----------------+-----------+----------+----------+--------+----------¦ ¦1937 ¦$17,054,072¦$2,272,388¦13.32 ¦$372,208¦2.18 ¦ +-----------------+-----------+----------+----------+--------+----------¦ ¦1938 ¦20,610,514 ¦3,197,253 ¦15.51 ¦568,116 ¦2.76 ¦ +-----------------+-----------+----------+----------+--------+----------¦ ¦1939 ¦18,341,356 ¦2,816,548 ¦15.36 ¦665,333 ¦3.63 ¦ +-----------------+-----------+----------+----------+--------+----------¦ ¦1940 ¦17,471,825 ¦2,744,397 ¦15.71 ¦616,283 ¦3.53 ¦ +-----------------------------------------------------------------------+
The petitioner's ratio of total expenses to sales increased from approximately 27.5 per cent for the fiscal years ended January 31, 1935 and 1936; to 30 per cent for the fiscal year 1937; to 33 per cent for the fiscal year 1938; and to 35 per cent for the fiscal years 1939 and 1940.
The conditional agreement entered into on May 29, 1937, to acquire the Gertz department store in Jamaica, Long Island, was not carried out. Such agreement was subject to the condition that petitioner receive $2,600,000 from a contemplated issue of petitioner's preferred stock. Such preferred stock was not issued. Petitioner had, on June 24, 1937, reached a tentative understanding with the First New Amsterdam Corporation for the latter to undertake a new issue of $3,000,000 in its preferred stock. An estimated $350,000 of the amount realized would be the cost of underwriting. Of the expected $2,650,000 net receipts from this financing, in excess of $1,600,000 would be required under the plan of financing for the redemption of petitioner's old issue of preferred stock and something in excess of $1,000,000 for the purchase of the Gertz store. Although payment of approximately $400,000 of the purchase price of the Gertz store was to be deferred until February 10, 1939, the petitioner would naturally require funds for inventory, improvements, and operations in that store when acquired.
Petitioner's tentative understanding with the First New Amsterdam Corporation anticipated the execution of a firm underwriting agreement. Such firm underwriting agreement was never executed. Even if such firm underwriting agreement had been executed it was contemplated to carry a customary condition known as a ‘market clause’ under which the underwriter was permitted to cancel the agreement if, in the exercise of its judgment, there was any substantial change in the financial position of the petitioner or in the existing economic or market condition taking place before the issuance of the contemplated preferred stock. Subsequent to the execution of the tentative agreement the stock market became depressed and the First New Amsterdam Corporation withdrew because of the difficulty of marketing new issue stock under such conditions. Thus, petitioner's plan for its financing by a new issue of $3,000,000 preferred stock was by these conditions ended prior to the execution of even a firm understanding with the underwriter.
During the months of March 1937 to December 1938, inclusive, petitioner owed varying and substantial sums to its creditor banks. During these months petitioner borrowed from three banks, namely, the Bank of Manhattan Company, the Commercial National Bank and Trust Company, and the National City Bank. During the other months of the base period the petitioner had no bank borrowings except for relatively small loans for short period during the fall of 1936 and 1939. In 1938 the petitioner had good bank credit available. All during 1939 the petitioner had bank credit available which the petitioner did not utilize. The bank credit available to petitioner in 1939 totaled at least a million dollars. The petitioner's banks were eager to lend funds to the petitioner in 1939. During most of the period from September 1937 to December 1939, inclusive, the petitioner borrowed varying sums up to $600,000 from J. M. Kaplan and/or his interests. The money for these loans came from Regano Corporation, a corporation controlled by J. M. Kaplan. Subordination agreements gave priority to potential creditors' claims of petitioner's banks and other creditors over the claims of Regano Corporation. On May 14, 1937, Maurice Levin made an offer in writing to furnish the money necessary for the acquisition and improvement of the Newark store and to lease such premises to the petitioner for a rental to be determined by arbitration. He made a similar offer with regard to the cost of six escalators and the building of a fourth floor at the Bronx store. Petitioner did not accept these offers as it considered the expenses in question could be met out of its own working capital. Kaplan and Levin were men of very substantial wealth and they or their corporations were ready, willing, and able to lend petitioner such funds as petitioner might need for its operations during its base period. During that period petitioner's monthly cash balances were adequate for its needs and it experienced no difficulties in paying its trade creditors. Its bills were paid before they became due.
The merchandise inventories of petitioner at the end of each of the fiscal years ended January 31, 1934, to January 31, 1946, were as follows:
+--------------------------------+ ¦Fiscal year ¦Merchandise ¦ +------------------+-------------¦ ¦ended January 31 ¦inventories ¦ +------------------+-------------¦ ¦1934 ¦$1,615,294 ¦ +------------------+-------------¦ ¦1935 ¦2,322,404 ¦ +------------------+-------------¦ ¦1936 ¦2,456,808 ¦ +------------------+-------------¦ ¦1937 ¦3,095,147 ¦ +------------------+-------------¦ ¦1938 ¦2,881,369 ¦ +------------------+-------------¦ ¦1939 ¦1,976,453 ¦ +------------------+-------------¦ ¦1940 ¦1,891,122 ¦ +------------------+-------------¦ ¦1941 ¦1,963,339 ¦ +------------------+-------------¦ ¦1942 ¦2,490,675 ¦ +------------------+-------------¦ ¦1943 ¦2,738,498 ¦ +------------------+-------------¦ ¦1944 ¦2,590,778 ¦ +------------------+-------------¦ ¦1945 ¦2,521,843 ¦ +------------------+-------------¦ ¦1946 ¦3,208,666 ¦ +--------------------------------+
The petitioner's annual inventory turnover figures for each of the fiscal years ended January 31, 1934, to January 31, 1942, inclusive, were as follows:
+-------------------------------------+ ¦Fiscal year ¦Annual inventory ¦ +------------------+------------------¦ ¦ended January 31 ¦turnover ¦ +------------------+------------------¦ ¦1934 ¦3.43 ¦ +------------------+------------------¦ ¦1935 ¦4.75 ¦ +------------------+------------------¦ ¦1936 ¦4.19 ¦ +------------------+------------------¦ ¦1937 ¦3.82 ¦ +------------------+------------------¦ ¦1938 ¦3.68 ¦ +------------------+------------------¦ ¦1939 ¦4.31 ¦ +------------------+------------------¦ ¦1940 ¦3.85 ¦ +------------------+------------------¦ ¦1941 ¦4.84 ¦ +------------------+------------------¦ ¦1942 ¦3.70 ¦ +-------------------------------------+
The merchandise inventory of the petitioner at the end of each month during the petitioner's base period years was as follows:
+-----------------------------------------------------------+ ¦ ¦Fiscal year ended January 31 ¦ +-----------------------+-----------------------------------¦ ¦Month ¦1937 ¦1938 ¦1939 ¦1940 ¦ +-----------------------+--------+--------+--------+--------¦ ¦In thousands of dollars¦ ¦ ¦ ¦ ¦ +-----------------------+--------+--------+--------+--------¦ ¦February ¦$2,604 ¦$3,448 ¦$3,104 ¦$2,294 ¦ +-----------------------+--------+--------+--------+--------¦ ¦March ¦2,773 ¦3,967 ¦3,564 ¦2,668 ¦ +-----------------------+--------+--------+--------+--------¦ ¦April ¦2,705 ¦3,923 ¦3,404 ¦2,475 ¦ +-----------------------+--------+--------+--------+--------¦ ¦May ¦2,682 ¦3,653 ¦3,246 ¦2,295 ¦ +-----------------------+--------+--------+--------+--------¦ ¦June ¦2,596 ¦3,359 ¦2,871 ¦2,082 ¦ +-----------------------+--------+--------+--------+--------¦ ¦July ¦2,520 ¦3,191 ¦2,635 ¦1,886 ¦ +-----------------------+--------+--------+--------+--------¦ ¦August ¦3,116 ¦4,463 ¦2,992 ¦2,359 ¦ +-----------------------+--------+--------+--------+--------¦ ¦September ¦3,527 ¦4,486 ¦3,049 ¦2,781 ¦ +-----------------------+--------+--------+--------+--------¦ ¦October ¦3,609 ¦4,385 ¦3,031 ¦2,990 ¦ +-----------------------+--------+--------+--------+--------¦ ¦November ¦3,492 ¦4,193 ¦2,918 ¦2,907 ¦ +-----------------------+--------+--------+--------+--------¦ ¦December ¦3,107 ¦3,231 ¦2,206 ¦2,063 ¦ +-----------------------+--------+--------+--------+--------¦ ¦January ¦* 3,095¦* 2,881¦* 1,976¦* 1,891¦ +-----------------------------------------------------------+ FN* Reserve for discounts deducted only in year-end inventory.
In the New York Federal Reserve District, merchandise stocks were at their lowest annual levels in July and August of the years 1935 to 1939, inclusive. The peak of the inventory stocks usually occurred about October 31. Petitioner's merchandise inventory remained high or increased during 1937 until the peak inventory was reached during the summer of that year. Thereafter merchandise inventories declined and remained at lower levels during the remainder of the base period.
By January 1938 the petitioner was heavily overstocked with merchandise inventory. It was then carrying about $1,000,000 more than was necessary. The excessive inventory was due in part to the falling off of business. By January 1938 the petitioner decided upon an operating policy of considerably lowered merchandise inventories. Such policy was to be followed out regardless of whether or not the petitioner was in need of cash. Such policy was expected to reduce merchandise inventories by $600,000 to $1,000,000. This policy of operating with small inventories was maintained during the remainder of petitioner's base period and was in effect in 1939 when ample credit was available to petitioner. In the fall of that year the petitioner took no steps to increase its merchandise inventories although it anticipated price rises. Not to buy merchandise inventory, if needed, especially when credit was available, is not good merchandising.
For the fiscal years ended January 31, 1936 to 1946, inclusive, the salaries paid to officers of petitioner, as shown by its Federal income tax returns, were as follows:
+--------------------------------------------------------------+ ¦ ¦Leonard ¦Maurice¦Sidney ¦All ¦ +----------------------------+--------+-------+--------+-------¦ ¦Fiscal year ended January 31¦Ginsberg¦Levin ¦M. Louis¦others ¦ +----------------------------+--------+-------+--------+-------¦ ¦1936 ¦$25,000 ¦ ¦ ¦$11,100¦ +----------------------------+--------+-------+--------+-------¦ ¦1937 ¦25,481 ¦$2,564 ¦$5,128 ¦11,051 ¦ +----------------------------+--------+-------+--------+-------¦ ¦1938 ¦29,711 ¦5,016 ¦10,032 ¦26,244 ¦ +----------------------------+--------+-------+--------+-------¦ ¦1939 ¦29,269 ¦ ¦9,295 ¦24,315 ¦ +----------------------------+--------+-------+--------+-------¦ ¦1940 ¦27,000 ¦ ¦9,001 ¦24,219 ¦ +----------------------------+--------+-------+--------+-------¦ ¦1941 ¦38,615 ¦ ¦17,096 ¦34,687 ¦ +----------------------------+--------+-------+--------+-------¦ ¦1942 ¦32,336 ¦ ¦16,846 ¦31,442 ¦ +----------------------------+--------+-------+--------+-------¦ ¦1943 ¦48,106 ¦30,048 ¦32,054 ¦50,101 ¦ +----------------------------+--------+-------+--------+-------¦ ¦1944 ¦54,558 ¦30,048 ¦37,103 ¦46,592 ¦ +----------------------------+--------+-------+--------+-------¦ ¦1945 ¦61,664 ¦30,096 ¦39,480 ¦48,427 ¦ +----------------------------+--------+-------+--------+-------¦ ¦1946 ¦64,707 ¦30,048 ¦41,487 ¦115,771¦ +--------------------------------------------------------------+
During the petitioner's base period the salaries of Levin and Louis were set at low figures by contracts between these officers and petitioner. During the base period and 2 years thereafter Levin and Louis did not devote their full time to the business of petitioner. During the base period and for at least 2 years thereafter Levin was president and later chairman of the board of petitioner, and Louis was secretary, executive vice president, and/or treasurer of the petitioner.
The operation of a department store is a complicated matter calling for the best ability and competency of executives trained in that field. Prior to 1932, Levin, Kaplan, and Louis had had no experience in the department store field. Ginsberg, who had been taken over from petitioner's predecessor and placed in charge of the merchandising operations of petitioner, had not theretofore been in a top executive position, except as vice president in charge of merchandising with petitioner's predecessor during the distressing last years of its operation. At the time of the hearing of this proceeding Ginsberg and Louis were no longer in the department store field.
For the fiscal years ended January 31, 1938, to January 31, 1942, inclusive, the net incomes or losses by stores as compiled from petitioner's yearly operating and financial statements were as follows:
+-----------------------------------------------------------------------------+ ¦ ¦14th Street ¦ ¦ ¦ +----------------------------------+-------------+-------------+--------------¦ ¦ ¦store ¦Bronx store ¦Newark store ¦ +----------------------------------+------------------------------------------¦ ¦Fiscal year ended January 31 ¦In thousands of dollars ¦ +----------------------------------+------------------------------------------¦ ¦1938 ¦($289) ¦$461 ¦($7) ¦ +----------------------------------+-------------+-------------+--------------¦ ¦1939 ¦(626) ¦386 ¦(20) ¦ +----------------------------------+-------------+-------------+--------------¦ ¦1940 ¦(282) ¦445 ¦(97) ¦ +----------------------------------+-------------+-------------+--------------¦ ¦1941 ¦(119) ¦484 ¦(8) ¦ +----------------------------------+-------------+-------------+--------------¦ ¦1942 ¦(22) ¦564 ¦115 ¦ +-----------------------------------------------------------------------------¦ ¦NOTE: Loss figures are in parentheses. All general overhead and advertising ¦ ¦were charged to the 14th Street store. ¦ +-----------------------------------------------------------------------------+
Sales in the petitioner's Newark store were declining during petitioner's base period years. Instead of enjoying earnings during the base period years, petitioner's Newark store suffered progressively increasing losses from operations, even though all general overhead and advertising were charged to the 14th Street store. The petitioner's Newark store was not successful during the base period years and for at least 2 years thereafter.
Sales in the petitioner's Bronx store were declining during the petitioner's base period years. Earnings and gross profits of the Bronx store were lower in the base period years ended January 31, 1939, and January 31, 1940, than the earnings and gross profits had been for that store during the period ended January 31, 1938. The period ended January 31, 1938, was not a full year and was the initial period of the operation of the Bronx store by the petitioner.
Sales in the petitioner's 14th Street store were declining during the petitioner's base period years. For the last 3 years of the base period the 14th Street store had losses after being charged with all of the petitioner's general overhead and advertising. The gross profits of the 14th Street store for the fiscal year ended January 31, 1938, were more than $800,000 under the gross profits for the fiscal year ended January 31, 1937. The gross profits of the 14th Street store for the fiscal year ended January 31, 1939, were more than $1,000,000 under the gross profits for the fiscal year ended January 31, 1938. The gross profits of the 14th Street store for the fiscal year ended January 31, 1940, were more than $1,600,000 under the gross profits for the fiscal year ended January 31, 1937.
After the fiscal year ended January 31, 1938, the annual net sales of the petitioner for all stores consistently declined for each base period year and for 1 year thereafter. In the fiscal years ended January 31, 1939, 1940, and 1941, the total gross income of the petitioner from all stores was more than $800,000 under the gross income for the fiscal year ended January 31, 1938. The excess profits net income (income method) of the petitioner during its base period years was considerably less when it operated three stores than such income had been previously when it had operated only one store.
During the year 1936 the department store industry in general experienced rising sales and rising prices. Starting in May of 1937, the department store sales trend was downward until May of 1938. Thereafter, through December of 1939, the department store sales trend was upward. It is characteristic and usual for department store sales to vary with business conditions in general. The decreased level of department store sales in 1938 was not an unusual economic circumstance.
Included in petitioner's competition were large New York City department stores such as R. H. Macy & Co., Gimbel Bros., Bloomingdale Bros., and Abraham & Straus. R. H. Macy & Co. had a much greater volume, a higher markup, and a better location than petitioner. The petitioner's prices, volumes, markups, and dollar amount of average sale were lower than such items were for Bloomingdale Bros. and Abraham & Straus, and petitioner's location was different from theirs. The other New York City department stores mentioned carried the same kinds of merchandise that petitioner did. To the extent that petitioner sold the same kind of merchandise at lower prices than the competitors did, the petitioner's expenses would tend to be a greater percentage of sales for the petitioner than for its competitors. Because of difference in management ability, the stature of members of the board of directors, sales volume, retail techniques, research, and size of average sale, Bloomingdale Bros., and Abraham & Straus were not comparable competitors of petitioner to the extent of having comparable operational figures.
For the years 1935 to 1939 the petitioner's sales, when compared with department store sales in general, reflect the declining condition of the petitioner. The petitioner's sales decreased, relative to department store sales in general, after the petitioner's two branch stores had been acquired in 1937. Despite an upward trend in sales of the department store industry in 1938, the petitioner had a generally downward trend in sales during the entire base period after 1937.
The petitioner spent large sums on advertising during the base period years and prior thereto. Its ratio of advertising expenses to net sales averaged more than 6 per cent during petitioner's base period years, the fiscal years ended January 31, 1937, to January 31, 1940, inclusive. For department stores in general, the ratio of advertising expenses to net sales averaged less than 4 per cent for the calendar years 1936 to 1939, inclusive.
For the taxable years here involved, excess profits net incomes and excess profits credits of the petitioner were based on the invested capital credit method and were as follows:
+---------------------------------------------------+ ¦ ¦Excess profits¦Excess profits¦ +---------------------+--------------+--------------¦ ¦Year ended January 31¦net income ¦credit ¦ +---------------------+--------------+--------------¦ ¦1941 ¦$274,656.04 ¦$247,093.19 ¦ +---------------------+--------------+--------------¦ ¦1942 ¦599,471.18 ¦273,842.46 ¦ +---------------------+--------------+--------------¦ ¦1943 ¦956,802.99 ¦284,192.50 ¦ +---------------------+--------------+--------------¦ ¦1944 ¦1,053,497.58 ¦278,523.70 ¦ +---------------------+--------------+--------------¦ ¦1945 ¦984,176.23 ¦291,952.80 ¦ +---------------------+--------------+--------------¦ ¦1946 ¦1,157,582.06 ¦297,496.38 ¦ +---------------------------------------------------+
Excess profits net income or net loss (income credit method), with total and arithmetic average thereof, for the petitioner for its base period years would be as follows:
+------------------------------------------------------+ ¦ ¦ ¦For use in the ¦ +---------------------+--------------+-----------------¦ ¦ ¦For use in the¦taxable years ¦ +---------------------+--------------+-----------------¦ ¦Year ended January 31¦taxable year ¦ended Jan. 31, ¦ +---------------------+--------------+-----------------¦ ¦ ¦ended Jan. 31,¦1942, 1943, 1944,¦ +---------------------+--------------+-----------------¦ ¦ ¦1940 ¦1945, and 1946 ¦ +---------------------+--------------+-----------------¦ ¦1937 ¦$486,098 ¦$570,364 ¦ +---------------------+--------------+-----------------¦ ¦1938 ¦117,777 ¦141,955 ¦ +---------------------+--------------+-----------------¦ ¦1939 ¦(239,937) ¦(239,937) ¦ +---------------------+--------------+-----------------¦ ¦1940 ¦62,515 ¦74,831 ¦ +---------------------+--------------+-----------------¦ ¦Total ¦$426,453 ¦$547,213 ¦ +---------------------+--------------+-----------------¦ ¦Average ¦$106,613 ¦$136,803 ¦ +------------------------------------------------------+
The required increases in petitioner's actual average base period income (arithmetic average) to equal the average base period net income equivalent of petitioner's actual excess profits credit (based on invested capital) would be as follows:
+--------------------------------------+ ¦ ¦Required increase ¦ +------------------+-------------------¦ ¦Fiscal year ¦in average base ¦ +------------------+-------------------¦ ¦ended January 31 ¦period net income ¦ +------------------+-------------------¦ ¦1941 ¦$153,485.09 ¦ +------------------+-------------------¦ ¦1942 ¦151,452.22 ¦ +------------------+-------------------¦ ¦1943 ¦162,347.00 ¦ +------------------+-------------------¦ ¦1944 ¦156,379.84 ¦ +------------------+-------------------¦ ¦1945 ¦170,515.74 ¦ +------------------+-------------------¦ ¦1946 ¦215,983.09 ¦ +--------------------------------------+
The petitioner's actual excess profits credits (based on invested capital) converted to an equivalent average base period net income would be as follows:
+-------------------------------------+ ¦Year ended ¦Equivalent average ¦ +------------+------------------------¦ ¦January 31 ¦base period net income ¦ +------------+------------------------¦ ¦1941 ¦$260,098.09 ¦ +------------+------------------------¦ ¦1942 ¦288,255.22 ¦ +------------+------------------------¦ ¦1943 ¦299,150.00 ¦ +------------+------------------------¦ ¦1944 ¦293,182.84 ¦ +------------+------------------------¦ ¦1945 ¦307,318.74 ¦ +------------+------------------------¦ ¦1946 ¦352,786.09 ¦ +-------------------------------------+
The petitioner first made a claim for relief under section 722 (b) (5) on its supplement to application for relief under section 722 of the Internal Revenue Code of 1939. This supplement was filed with the Commissioner of Internal Revenue on October 22, 1947, which date is more than 3 years after the due date for the filing of petitioner's tax returns for the fiscal years which ended January 31, 1941, 1942, 1943, and 1944. Only in its applications for relief filed on Form 991 for the fiscal year ended January 31, 1946, did petitioner indicate a claim under section 722 (b) (5) for that year.
After increasing its capacity for operations by the addition of two branch stores in 1937, the petitioner failed to realize increased earnings because its sales declined and its costs increased. The decline in sales was due to lack of demand for petitioner's goods, in other words, to lack of customers. The lack of demand for petitioner's goods was caused by the petitioner's competition and the petitioner's merchandising policies. The increased costs of the petitioner were due to the expansion, financial, and merchandising policies of the petitioner. The decline in sales and the increase in costs for the petitioner resulted from competition and/or the expansion, financial, and merchandising policies of the petitioner. Such policies and competition are the reasons for the failure of petitioner to realize increased earnings after its increase in capacity for operations.
The petitioner was not depressed during its base period. The petitioner's average base period dales were about $18,400,000 per year. Omitting the relatively short period from March 1, 1931, to January 31, 1933, for which figures are not available, the average sales of the petitioner and its predecessor for the period from March 1, 1921, to January 31, 1940, were about $15,800,000 per year. Hence, the average base period sales were more than the average long-term sales. The petitioner's average excess profits net income was about $137,000 per year for the base period years. This figure was not much below the long-term average net income of about $150,000 per year of the petitioner and its predecessor for the periods from March 1, 1921, to February 28, 1931, and from February 1, 1933, to January 31, 1940. The petitioner's average base period sales of about $18,400,000 were considerably larger than the average sales of about $16,000,000 of the longer period of the petitioner from February 1, 1933, to January 31, 1940, inclusive.
After March of 1937, the monthly sales of the petitioner's 14th Street store for every month in 1937 were lower than sales of that store during the corresponding months of 1936. This decline in petitioner's sales at its 14th Street store had begun at least several months before the occurrence of any of the alleged difficulties of the petitioner.
A department store should complete its developmental period and operate profitably in 3 years. Despite the hindrance of a depression, but with experienced and competent management, a large department store in New York City found itself within the 3 years following its 1930 reorganization. The longest developmental period estimate, indicated by the petitioner's expert witness, was 5 years and this was for a new store. Having taken over an established store in 1932, the petitioner should certainly have completed its developmental period with its main store before 1939.
With 2 years additional experience, the petitioner's level of sales and earnings would not have been higher than the actual level of the petitioner for its last base period year, the fiscal year ended January 31, 1940. The petitioner's operations during its base period and thereafter evidenced no true growth in the petitioner's sales, in the petitioner's gross profits, or in the petitioner's earnings.
The petitioner has failed to establish that its business was depressed in the base period because of temporary economic circumstances unusual in the case of petitioner.
The petitioner did not change the character of its business by a change in the operation or management of its business during the base period.
There was a change in the character of the petitioner's business during the base period because of an increase in capacity for operations, in that two branch stores were opened by petitioner in 1937, but increased earnings for the petitioner did not result from the petitioner's increase in capacity for operations.
The petitioner has failed to establish that its business did not reach the earning level which it would have reached if the petitioner had made its change in capacity for operations 2 years before it did so.
Petitioner has failed to establish that is business was in an organizational and developmental stage at the end of its base period.
Petitioner has failed to establish that its business was affected by any other factor which would not be inconsistent with the principles underlying the provisions of section 722 (b) or with the conditions and limitations enumerated therein.
Petitioner has failed to establish that it is entitled to constructive average base period net income which is large enough to produce a credit greater than any of the invested capital credits used by the petitioner for the taxable years herein, or that the excess profits taxes paid by it for the years in issue are excessive and discriminatory.
OPINION.
BRUCE, Judge:
At the hearing the petitioner asserted a claim for relief under section 722(b) (2), (b)(4), and (b)(5).