Opinion
Docket No. 39085.
1957-11-20
LANZIT CORRUGATED BOX CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Morris W. Needlman, Esq., for the petitioner. David H. Nelson, Esq., for the respondent.
Morris W. Needlman, Esq., for the petitioner. David H. Nelson, Esq., for the respondent.
Petitioner, a manufacturer of paper boxes, seeks relief under section 722(b) (4), I.R.C. 1939, based upon a change in character resulting from an increase in its capacity for operation and production which occurred partly during the base period and to which it was partly committed during the base period. Held, petitioner has not shown a change in character within section 722(b)(4) because it has failed to show that capacity for operation and production was a bottleneck; and it has failed to show that with increased capacity it would have captured additional business in its competitive area. It has also failed to show that with application of the push-back rule its labor savings resulting from its increased capacity would in turn have resulted in greater average base period net income than that with which it is credited by respondent under section 713(f).
The Commissioner has denied petitioner's timely application for relief and its claim for refund with respect to its excess profits tax for the years ended December 31, 1941 through 1945. The issue for our decision is whether petitioner's average base period net income is an inadequate measure of its normal earnings during that period because of a change in the character of its business within the meaning of section 722(b)(4), I.R.C. 1939. Other issues raised by the pleadings have been abandoned by petitioner.
FINDINGS OF FACT.
Stipulated facts are found.
Petitioner was incorporated in Illinois in 1913 and its corporation income and excess profits tax returns for the years 1940 through 1945 were filed with the collector of internal revenue for the first district of Illinois.
Petitioner is entitled to compute its excess profits tax for the years at issue under section 713 of the 1939 Code.
Petitioner's excess profits net income for each of the taxable years 1941 through 1945, computed under section 711 of the 1939 Code, is as follows:
+---------------------------+ ¦ ¦Income method ¦ +------+--------------------¦ ¦Year ¦(sec.711 (a) (1)) ¦ +------+--------------------¦ ¦1941 ¦$334,088.92 ¦ +------+--------------------¦ ¦1942 ¦301,157.15 ¦ +------+--------------------¦ ¦1943 ¦466,013.89 ¦ +------+--------------------¦ ¦1944 ¦412,086.08 ¦ +------+--------------------¦ ¦1945 ¦311,989.54 ¦ +---------------------------+
Petitioner's excess profits net income for each of the base period years, as finally determined by the Commissioner without the application of section 722 of the 1939 Code, is as follows:
+-------------------------------+ ¦1936 ¦$158,108.91¦ +-------------------+-----------¦ ¦1937 ¦129,939.84 ¦ +-------------------+-----------¦ ¦1938 ¦139,315.94 ¦ +-------------------+-----------¦ ¦1939 ¦152,754.99 ¦ +-------------------+-----------¦ ¦Arithmetic average ¦145,029.92 ¦ +-------------------------------+
Petitioner's average base period net income and excess profits credit (95 per cent of ABPNI), computed pursuant to the provisions of section 713(f) of the 1939 Code for each of the taxable years 1941 through 1945 are $147,041.01 and $139,688.96, respectively.
Petitioner's excess profits tax liability for each of the taxable years 1941 through 1945, as finally determined by the Commissioner without the application of section 722 of the 1939 Code, is as follows:
+----------------+ ¦1941¦$76,176.70 ¦ +----+-----------¦ ¦1942¦140,821.37 ¦ +----+-----------¦ ¦1943¦289,192.44 ¦ +----+-----------¦ ¦1944¦224,349.53 ¦ +----+-----------¦ ¦1945¦138,766.99 ¦ +----------------+
The petitioner contends on brief that for the taxable years 1941 through 1945 it is entitled to a constructive average base period net income of $252,273.25 and a constructive excess profits credit of $239,659.59.
Since 1913 petitioner has been in the business of manufacturing corrugated paper boxes to its customers' specifications. The ‘heart and soul’ of its manufacturing operation, to which all prior and subsequent steps in manufacture are dependent, is a corrugating machine. Two such machines are here involved, a machine capable of processing a sheet of paper 63 inches in width and another capable of processing a sheet 85 inches in width. A 63-inch corrugator was the only such machine in operation in petitioner's plant during the base period.
During the base period it was committed to a course of action which resulted in 1940 in its acquisition and placing in operation of an 85-inch corrugator. During the base period and the years at issue petitioner sold over 75 per cent of its product to customers within an area comprised of the city of Chicago, the northern half of Illinois, and the industrial area bordering the southern shore of Lake Michigan. The area is known in petitioner's industry as zone 9.
Average.FN2 Corrugator center labor costs for a portion of the year 1940 were not normal because of a breaking-in period required for the new 85-inch corrugator.
During the base period petitioner's income was not impaired by a lack of operating or productive capacity. As of December 31, 1939, it had reached its normal level of earnings for the base period.
Petitioner's actual average base period net income is an adequate standard of its normal base period earnings.
Decision will be entered for the respondent. The machine referred to is a ‘double-face’ corrugator. Actually it was operated in conjunction with a ‘single-face’ 63-inch corrugator but the production from the latter was comparatively so insignificant as to be of no moment here.2. Figures are not available for each of the machines separately in 1940. -------- Notes:
Paid in 1936.
Petitioner's business has since its inception been seasonal, corresponding in its variation with that of its customers. Due to the inordinate space required for storage of its finished product, it is inefficient and uneconomical for petitioner to manufacture paper boxes for stock in advance of the orders of customers. Petitioner's monthly production of corrugated paper used in its product, expressed in thousands (M) of square feet and the hours of running time of the 63-inch corrugator necessary to produce the same, was for the base period as follows:
+-------------------------------------------------------------------------------+ ¦ ¦1936 ¦1937 ¦1938 ¦1939 ¦ +-------+-----------------+-----------------+-----------------+-----------------¦ ¦ ¦M ¦ ¦M ¦ ¦M ¦ ¦M ¦ ¦ +-------+---------+-------+---------+-------+---------+-------+---------+-------¦ ¦ ¦square ¦Hours ¦square ¦Hours ¦square ¦Hours ¦square ¦Hours ¦ +-------+---------+-------+---------+-------+---------+-------+---------+-------¦ ¦ ¦feet ¦ ¦feet ¦ ¦feet ¦ ¦feet ¦ ¦ +-------+---------+-------+---------+-------+---------+-------+---------+-------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +-------+---------+-------+---------+-------+---------+-------+---------+-------¦ ¦Jan ¦10,432 ¦429 ¦11,030 ¦438 ¦9,234 ¦363 ¦11,637 ¦394 ¦ +-------+---------+-------+---------+-------+---------+-------+---------+-------¦ ¦Feb ¦9,342 ¦394 ¦13,213 ¦467 ¦10,195 ¦392 ¦12,712 ¦427 ¦ +-------+---------+-------+---------+-------+---------+-------+---------+-------¦ ¦Mar ¦10,193 ¦411 ¦15,336 ¦532 ¦11,974 ¦452 ¦15,973 ¦495 ¦ +-------+---------+-------+---------+-------+---------+-------+---------+-------¦ ¦Apr ¦10,267 ¦403 ¦14,074 ¦487 ¦12,506 ¦439 ¦14,088 ¦438 ¦ +-------+---------+-------+---------+-------+---------+-------+---------+-------¦ ¦May ¦11,397 ¦442 ¦12,925 ¦451 ¦11,141 ¦427 ¦15,746 ¦479 ¦ +-------+---------+-------+---------+-------+---------+-------+---------+-------¦ ¦June ¦10,676 ¦417 ¦12,364 ¦455 ¦11,024 ¦428 ¦13,550 ¦448 ¦ +-------+---------+-------+---------+-------+---------+-------+---------+-------¦ ¦July ¦11,191 ¦441 ¦9,906 ¦372 ¦9,159 ¦360 ¦11,347 ¦375 ¦ +-------+---------+-------+---------+-------+---------+-------+---------+-------¦ ¦Aug ¦11,575 ¦461 ¦12,358 ¦434 ¦12,175 ¦452 ¦15,277 ¦485 ¦ +-------+---------+-------+---------+-------+---------+-------+---------+-------¦ ¦Sept ¦13,626 ¦499 ¦13,000 ¦440 ¦14,587 ¦471 ¦16,236 ¦466 ¦ +-------+---------+-------+---------+-------+---------+-------+---------+-------¦ ¦Oct ¦14,968 ¦541 ¦12,923 ¦451 ¦15,280 ¦516 ¦21,240 ¦568 ¦ +-------+---------+-------+---------+-------+---------+-------+---------+-------¦ ¦Nov ¦13,588 ¦498 ¦9,929 ¦388 ¦12,209 ¦486 ¦18,890 ¦537 ¦ +-------+---------+-------+---------+-------+---------+-------+---------+-------¦ ¦Dec ¦11,818 ¦461 ¦7,373 ¦320 ¦11,283 ¦415 ¦12,377 ¦418 ¦ +-------+---------+-------+---------+-------+---------+-------+---------+-------¦ ¦Total ¦139,073 ¦5,397 ¦144,431 ¦5,235 ¦140,767 ¦5,201 ¦179,073 ¦5,530 ¦ +-------+---------+-------+---------+-------+---------+-------+---------+-------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +-------------------------------------------------------------------------------¦ ¦Note: The forgoing includes production on petitioner's 63-inch double-face ¦ ¦machine only since a 63-inch single-face unit accounted for such an ¦ ¦insignificant part of the total output. ¦ +-------------------------------------------------------------------------------+
Petitioner, because its production was limited by orders, experienced no difficulty in disposing of its base period production to its customers. Its chief competitors were in zone 9 and consisted of 8 corrugated box plants operated by 6 separate companies or corporations. It did not compete to a significant extent with other paper box manufacturers outside zone 9 for the reason that the bulk of its product made shipping costs to any but closely situated customers uneconomical. This is true throughout the industry.
In 1937 petitioner entered upon a course of action which, in July 1938, resulted in an increase in its productive capacity. It purchased, renovated, and put into use additional storage space for its raw materials which permitted the storage and use of rolls of paper of greater diameter, width, and therefore weight than it had theretofore been able to store. The addition of an overhead crane and floor tracking permitted the mechanical transfer of larger rolls of paper fiber from stock to the corrugator, whereas prior thereto such transfer of stock had been done by hand. A new and larger steam boiler and the plumbing incidental thereto was installed, which permitted increased steam pressure to be used in the 63-inch corrugator and was sufficient to furnish adequate pressure also to an 85-inch corrugator when it should be installed. The increased steam pressure resulted, upon its being put into use in July 1938, in an increase in the capacity of the 63-inch corrugator to produce corrugated board.
The additional storage space was provided when petitioner purchased certain land and buildings in 1937 which were adjacent to its manufacturing plant. It was sufficient to provide space for the installation of the 85-inch corrugator and the reinstallation of the 63-inch machine alongside, both of which installations were completed and put into operation in 1940. Prior to any alteration or repair of such land and buildings for manufacturing purposes, however, two of such buildings were renovated and repaired by petitioner during 1937 for rental to others. As soon as the repairs could be made, the buildings were rented during the base period at a total rental of about $30,000 per year. The repairs to the buildings which were rented were completed at a cost to petitioner of $109,745.06.
In the 2 taxable years immediately prior to and during the first 3 years of the base period, the petitioner distributed dividends to its stockholders as follows:
+----------------------------------+ ¦Dec. 27, 1934 ¦$60,000 in cash ¦ +-----------------+----------------¦ ¦Dec. 27, 1934 ¦440,000 in stock¦ +-----------------+----------------¦ ¦Dec. 28, 1935 1 ¦80,000 declared ¦ +-----------------+----------------¦ ¦Dec. 31, 1936 ¦20,000 in cash ¦ +-----------------+----------------¦ ¦1937 ¦80,000 in cash ¦ +-----------------+----------------¦ ¦1938 ¦60,000 in cash ¦ +-----------------+----------------¦ ¦ ¦ ¦ +----------------------------------+
At approximately the same time 1937 and 1938 dividends were paid, amounts in excess thereof were borrowed from petitioner's stockholders and its available cash was not depleted by those dividend payments.
In addition to land and buildings which it purchased in 1928, 1936, and 1937, petitioner also purchased various parcels of improved real estate in Chicago and vicinity in 1934 and 1935 at a cost of $109,687.63. In 1934 it purchased a mortgage on improved real estate in Forest Park, Illinois, for $12,682.74 to which it acquired full title by deed in 1939 by paying an additional $500. None of the aforementioned real estate was in any manner used in petitioner's manufacturing operations but the properties consisted variously of a gasoline station and stores with apartments overhead and another group of apartment buildings. All of these properties were distributed to the shareholders in 1940 and 1941 as taxable dividends. Petitioner received gross rentals from its factory buildings not put to its own use between December 31, 1928, and January 1, 1940, in the amount of $168,634.08.
Petitioner's surplus account increased steadily from $188,298 as of December 31, 1935, to $417,010 at December 31, 1939. From 1934 to and including 1938, petitioner paid cash dividends to shareholders aggregating $300,000.
In 1928 petitioner had purchased for its factory a parcel of real estate in Chicago, Illinois, comprising a portion of a square block, from National Malleable and Steel Castings Co. Although the rest of the square block was available, it was not then purchased by petitioner because the property purchased was considered to be adequate for petitioner's needs. A small adjoining building was purchased in 1936. As part of the consideration for the 1928 purchase, petitioner signed a mortgage on the property amounting to $173,743.37. Of this, the sum of $153,743.37 was due on December 26, 1938. An extension of this mortgage was obtained by petitioner prior to the due date or it was assured of such extension prior to that date.
On August 8, 1939, petitioner placed an order for the purchase of an 85-inch corrugator which was installed and placed in operation in April 1940. The installed cost of the corrugator, together with its auxiliary equipment, was about $89,000. Petitioner's financial position throughout the base period was such that, had it seen fit to do so, it could have acquired the 85-inch corrugator and its incidental equipment at any time.
During the base period and until the trial herein the petitioner operated its plant in two shifts. During seasonal peaks in the base period it operated the 63-inch corrugator in fairly standard shifts of 10 hours each. However, on occasions the shifts were of 11 or 12 hours each. In times of off-peak demand during the base period the petitioner usually operated in 9-hour shifts.
Industry corrugated shipments during the years 1936 to August 1939 reached a high weekly average of 645,138 thousand square feet in the month of March 1937. This average was exceeded by the industry after July 1939, as follows:
+--------------------------+ ¦Month ¦M square feet ¦ +---------+----------------¦ ¦August ¦662,908 ¦ +---------+----------------¦ ¦September¦731,377 ¦ +---------+----------------¦ ¦October ¦828,231 ¦ +---------+----------------¦ ¦November ¦705,369 ¦ +--------------------------+
The industry usually experiences a seasonal decline in the month of december.
Over a long period of time there was a trend in the industry toward the use of larger corrugating machines. This trend was to some extent influenced by changes in the width of the papermaking machines. The 85-inch machine made possible the manufacture of large boxes for packing large or bulky items from one sheet, whereas, when run on smaller corrugators, such boxes sometimes had to be made from two sheets fastened together with a taped joint.
The following table shows petitioner's combined monthly[2 production of its 63-inch and 85-inch corrugators for 1940, and the monthly production for each of these machines for 1941:
+--------------------------------------+ ¦ ¦ ¦1941 ¦ +-----+--------+-----------------------¦ ¦ ¦1940 ¦M square feet ¦ +-----+--------+-----------------------¦ ¦ ¦M square¦ ¦ +-----+--------+-----------------------¦ ¦ ¦feet ¦ ¦ ¦ ¦ +-----+--------+-------+-------+-------¦ ¦ ¦ ¦Total ¦63? ¦85? ¦ +-----+--------+-------+-------+-------¦ ¦ ¦ ¦ ¦ ¦ ¦ +-----+--------+-------+-------+-------¦ ¦Jan ¦14,909 ¦20,330 ¦5,807 ¦14,523 ¦ +-----+--------+-------+-------+-------¦ ¦Feb ¦16,647 ¦20,058 ¦5,555 ¦14,503 ¦ +-----+--------+-------+-------+-------¦ ¦Mar ¦14,924 ¦22,594 ¦6,533 ¦16,061 ¦ +-----+--------+-------+-------+-------¦ ¦Apr ¦15,576 ¦27,084 ¦10,691 ¦16,393 ¦ +-----+--------+-------+-------+-------¦ ¦May ¦17,219 ¦25,430 ¦10,051 ¦15,379 ¦ +-----+--------+-------+-------+-------¦ ¦June ¦15,792 ¦25,785 ¦10,089 ¦15,696 ¦ +-----+--------+-------+-------+-------¦ ¦July ¦15,183 ¦26,571 ¦10,364 ¦16,207 ¦ +-----+--------+-------+-------+-------¦ ¦Aug ¦18,829 ¦25,980 ¦8,998 ¦16,982 ¦ +-----+--------+-------+-------+-------¦ ¦Sept ¦19,855 ¦28,363 ¦11,451 ¦16,912 ¦ +-----+--------+-------+-------+-------¦ ¦Oct ¦23,738 ¦30,652 ¦13,816 ¦16,836 ¦ +-----+--------+-------+-------+-------¦ ¦Nov ¦21,489 ¦25,716 ¦10,312 ¦15,404 ¦ +-----+--------+-------+-------+-------¦ ¦Dec ¦22,265 ¦28,621 ¦12,816 ¦15,805 ¦ +-----+--------+-------+-------+-------¦ ¦Total¦216,426 ¦307,184¦116,483¦190,701¦ +-----+--------+-------+-------+-------¦ ¦ ¦ ¦ ¦ ¦ ¦ +--------------------------------------+
Petitioner's employees were not sufficiently trained in the use of the 85-inch corrugator to obtain its normal efficient output until the latter part of 1940, at which time its normal capacity reached 60 to 65 thousand square feet per hour.
For the years beginning January 1, 1936, through December 31, 1943, petitioner's gross monthly production of corrugated box material expressed in thousands (M) of square feet, its monthly cost of labor in connection with its ‘corrugation center,‘ and its monthly labor cost per thousand (M) square feet of production was as follows:
+----------+ ¦¦1936¦1937¦ ++----+----¦ ¦¦¦ ¦ ¦¦ ¦ ¦ +++-+-++-+-¦ ¦¦¦ ¦ ¦¦ ¦ ¦ +----------+
Corrugator Corrugator Gross Corrugator center Gross Corrugator center production center labor cost production center labor cost M square labor cost per M M square labor cost per M feet square feet square feet feet Jan 10,445 $1,136.26 $0.1088 11,030 $1,339.19 $0.1214 Feb 9,345 1,056.82 .1131 13,214 1,412.91 .1069 Mar 10,196 1,078.33 .1058 15,336 1,676.09 .1093 Apr 10,267 1,099.52 .1071 14,075 1,570.04 .1115 May 11,401 1,153.14 .1011 13,290 1,447.83 .1089 June 10,683 1,136.16 .1063 12,671 1,572.65 .1241 July 11,193 1,220.36 .1090 9,968 1,228.77 .1233 Aug 11,582 1,280.18 .1105 12,390 1,395.59 .1126 Sept 13,627 1,383.44 .1043 13,001 1,421.26 .1093 Oct 14,983 1,537.59 .1026 12,925 1,442.52 .1116 Nov 13,592 1,496.28 .1101 9,932 1,241.48 .1250 Dec 11,821 1,441.93 .1220 7,378 1,038.35 .1407 Total 139,135 15,020.01 1 .1079 145,210 16,786.68 1 .1156
1938 1939 Jan 9,235 $1,182.01 $0.1280 11,643 $1,195.97 $0.1027 Feb 10,196 1,250.87 .1227 12,714 1,320.23 .1038 Mar 11,976 1,430.05 .1194 15,974 1,444.91 .0904 Apr 12,509 1,388.32 .1110 14,093 1,408.52 .0999 May 11,148 1,359.84 .1220 15,749 1,492.78 .0948 June 11,027 1,356.17 .1230 13,553 1,428.08 .1054 July 9,159 1,123.46 .1227 11,351 1,187.09 .1046 Aug 12,176 1,428.50 .1173 15,278 1,517.49 .0993 Sept 14,589 1,565.99 .1073 16,370 1,477.26 .0902 Oct 15,281 1,662.67 .1088 21,300 1,940.41 .0911 Nov 12,210 1,399.96 .1146 19,004 1,897.75 .0999 Dec 11,287 1,295.61 .1148 12,524 1,411.32 .1127 Total 140,793 16,443.45 1 .1168 179,553 17,721.81 1 .0987
1940 1941 Jan 14,975 $2,172.32 $0.1451 20,480 $1,921.24 $0.0938 Feb 16,699 2,301.33 .1378 20,227 1,804.99 .0892 Mar 14,992 2,342.85 .1563 22,751 1,974.22 .0868 Apr 15,619 2,428.73 .1555 27.301 2,570.64 .0942 May 17,223 2,237.41 .1300 25,527 2,443.82 .0957 June 15,799 2,055.08 .1301 25,813 2,554.59 .0990 July 15,211 1,793.85 .1179 26,606 2,413.89 .0907 Aug 18,864 1,873.84 .0993 26,045 2,620.45 .1006 Sept 19,903 1,905.58 .0957 28,411 2,821.56 .0993 Oct 23,945 2,184.66 .0912 30,676 2,918.93 .0952 Nov 21,489 1,911.86 .0890 25,786 2,431.25 .0943 Dec 22,317 2,000.72 .0896 28,715 2,771.41 .0965 Total 217,036 2 25,208.23 1 2 .1161 308,338 29,246.99 1 .0949
1942 1943 Jan 28,324 $2,765.55 $0.0976 19,672 $2,184.80 $0.1111 Feb 23,628 2,451.99 .1038 20,470 2,261.71 .1105 Mar 25,876 3,087.39 .1193 22,621 2,658.23 .1175 Apr 24,525 2,733.42 .1115 22,387 2,648.10 .1183 May 19,120 2,315.04 .1211 20,312 2,366.29 .1165 June 16,154 1,865.50 .1155 22,504 2,399.14 .1066 July 15,907 2,061.24 .1296 21,884 2,866.60 .1310 Aug 16,174 2,058.92 .1273 21,114 2,638.21 .1250 Sept 17,817 2,116.14 .1188 23,083 2,693.05 .1167 Oct 20,605 2,314.49 .1123 22,739 2,540.95 .1117 Nov 19,406 2,242.32 .1155 21,813 2,547.48 .1168 Dec 20,855 2,278.08 .1092 23,163 2,663.45 .1150 Total 248,391 28,290.08 1 .1139 261,762 30,468.01 1 .1164
OPINION.
WITHEY, Judge:
Petitioner claims qualification to reconstruct its base period net income for the purpose of determining its excess profits tax for the years at issue under section 722(b)(4), I.R.C. 1939, because of a change in the character of its business during the base period. The claimed change in character, it contends, occurred because of an increase in its capacity for operation and production, part of which increase took place within the base period and to part of which it was committed during the base period resulting in an increase in capacity which, had it taken place 2 years prior, would in turn have resulted in increased average base period net income, thus affording it tax relief with respect to its excess profits taxes here in issue. Respondent now concedes an increase in petitioner's capacity for production which took place and was put into operation in July 1938 and, further, that during the base period it was committed to a course of action which resulted in a further increase in capacity through the installation in 1940 of an 85-inch corrugating machine in its manufacturing plant. However, respondent insists that such increases in capacity even had they taken place 2 years prior to the date of the two installations would not have resulted in increased base period net income but instead would have resulted in decreased base period net income because of increased cost of such installations and depreciation and cost of operation thereof. In this connection he relies upon National Grinding Wheel Co., 8 T.C. 1278; Green Spring Dairy, Inc., 18 T.C. 217, affd. (C.A. 4, 1953) 208 F.2d 471; Farmers Creamery Co. of Fredericksburg, Va., 18 T.C. 241; and Schneider's Modern Bakery, Inc., 19 T.C. 763. In those cases this Court followed the principle that an increase in capacity for operation or production which did not or would not lead to increased base period net income is not a change in the character of a taxpayer's business within the meaning of section 722(b)(4) which would qualify it to reconstruct its base period net income. We think the cases have application here.
Petitioner's business was seasonal and there is no indication in the record but that its existing capacity during the base period before any increase thereof was sufficient, with slight exception, to meet the peak demands of its sales activities. In July 1938, it put into operation a new steam boiler and the necessary plumbing in connection therewith to attach it to its existing 63-inch corrugator. This installation permitted an increase in its speed of production of corrugated board. However, even after the installation of the boiler, the increased capacity was used in less than half the remaining months of the base period. During such months as the production exceeded the peak production prior to such installation, such excess production was not sufficient in amount to render petitioner's actual base period experience an inadequate measure of normal production, particularly in view of the fact that its base period net income has been determined under section 713(f). That section is designed to give due consideration to the natural growth of the taxpayer and affords adequate relief from excess profits tax where mere technological growth has taken place as distinguished from a change in character. Petitioner's claimed change in character is in reality a technological growth.
In our view petitioner has failed in its proof with respect to its base period market. Even assuming that it did not arrive at its normal level of income which might be expected from the sale of its product in view of its increased capacity, it has failed to convince us that it would have been able at any time during the base period to capture from its competitors sufficient additional sales to have resulted in increased income attributable to such increased capacity. The proof petitioner has offered with respect to market conditions in its industry during the base period relates to the sales and production experience of some 21 paper box manufacturers, other than itself, located within an area in the United States roughly east of the Mississippi River. Six of the 21 companies referred to are within zone 9, which is the area within which petitioner made more than 75 per cent of its sales during the base period. The area consists of the city of Chicago, the northern half of the State of Illinois, and the industrial area bordering the southern tip of Lake Michigan. Within that area the 6 companies or corporations, other than petitioner, operate 8 paper box factories. These 8 factories constitute petitioner's main competition. To all but an inconsequential extent, petitioner does not compete with the remaining 15 paper box manufacturers above referred to for the reason that the bulk of its product when shipped to customers any appreciable distance from its plant makes such shipments uneconomical because of the excessive freight rates involved. In fact this is true of its entire industry. Nowhere does it appear that with its existing capacity prior to July 1938 petitioner ever lost a customer because of inability to fulfill his order for paper boxes. It is significant too that had petitioner needed additional productive capacity in order to obtain any new customers during the base period it was financially able to acquire it. After July 1938, when the new and more powerful steam boiler had been attached to the 63-inch corrugator, there is no indication that such increased capacity led to the acquisition of any new customers. Indeed, during most of the remainder of the base period its plant was operated below its capacity existing prior to that time. The increase in petitioner's capacity permitted an increase in its base period income but did not cause such increase. Green Spring Diary, Inc., supra.
Petitioner makes claim for increased average base period net income on the basis of a reduction in its labor cost. Due to the fact that with application of the push-back rule petitioner from April 1938 would have produced its actual square footage of paper box material with 15 employees in one-third the time actually required, it follows that its labor cost would have been reduced to an extent. However, we are unable to find from this record that such reduction in labor cost would have resulted in increased net income to an extent which would exceed the allowances already granted by respondent under section 713(f). We are impressed too that if depreciation upon the new equipment is considered, its savings through reduction in labor cost would be considerably less although we are given no explicit evidence with respect to the depreciation actually taken by petitioner upon its new equipment.
It follows that petitioner has failed to demonstrate that its increased capacity for operation and production during the base period even with the application of the push-back rule with respect to installation of the 85-inch corrugator would have resulted in increased base period net income. We therefore conclude that petitioner has failed to show that its actual average base period net income is an inadequate standard upon which to determine its excess profits taxes for the years 1941 through 1945.
Reviewed by the Special Division.