Opinion
Docket No. 10619.
1951-02-28
THE MATHESON COMPANY, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Leonard W. Ferris, Esq., for the petitioner. Maurice S. Bush, Esq., for the respondent.
Leonard W. Ferris, Esq., for the petitioner. Maurice S. Bush, Esq., for the respondent.
1. Relief is asked under section 722(b)(1) and (5) of the Internal Revenue Code. Held on the facts, that normal production, output or operation was not interrupted or diminished within section 722(b)(1) and that it is not shown that average base period net income was an inadequate standard of earnings, under either subsection (b)(1) or (b)(5). Relief denied.
2. Held further, abnormal deductions under section 711(b)(1)(J)(i) not shown.
The Commissioner denied petitioner's application for excess profits tax relief under section 722 for the years 1941 and 1942 and determined excess profits tax liability of $4,048.16 for 1941 and a deficiency of $7,692.79 in 1942, notice of which was sent in accordance with sections 272 and 732 of the Internal Revenue Code. The issue for our determination is whether petitioner is entitled to relief under the provisions of subsections (b)(1) and (b)(5) of section 722 of the Internal Revenue Code.
FINDINGS OF FACT.
The facts set forth in the stipulation are found as agreed to therein.
Petitioner filed its returns with the collector at Newark, New Jersey.
The Matheson Company, Inc., hereinafter referred to as the ‘old corporation,‘ was organized on July 26, 1928, under the laws of New Jersey. Petitioner, a corporation of the same name, was organized on September 9, 1940, under the laws of the same state. The old corporation was organized by Adam M. Matheson, hereinafter referred to as ‘matheson,‘ who, until April 8, 1937, owned 998 shares of its 1,000 shares of outstanding common stock, and Florence H. Matheson, his wife, who owned not less than 199 of the 210 shares of outstanding preferred stock. The place of business of both corporations was in East Rutherford, New Jersey. The old corporation paid a rental of $100 per month for the plant, including an office building, which it occupied.
At all times important the primary business of the old corporation and petitioner consisted of buying compressed gases in large containers and transferring them to small steel containers, owned by them, for sale to colleges, research laboratories for experimental purposes, and to contractors for use in electric refrigerators. Demurrage was charged on the large containers by the producers after 90 days. In 1936 the old corporation started to acquire its own large cylinders, which, with ones owned by the producers of gases, were returned to the producers to be refilled. Few, if any, sales for refrigerant purposes were made in 1937 or 1938. The company also sold regulators and valves for gas containers. Parts for the devices were purchased from other manufacturers and assembled for sale under the name of the old corporation.
Prior to and during the base period years the old corporation had five full time employees and a part time office girl. Until April 8, 1936, Matheson was chairman of the board, president and treasurer of the old corporation and, as such, hired employees, made purchases and conducted the affairs of the old corporation in accordance with his own ideas. About July 1934 he assumed the duties of shop foreman, which consisted, with assistance, of painting, cleaning and filling the cylinders and preparing them for shipment. Prior to April 1936, Matheson also prepared price lists and advertising material with the assistance of William Dugan, an employee.
William Dugan entered the employ of the old corporation in July 1933, when he was about 35 years of age, at $40 per week, to perform such services as his employer directed, including cooperation in the general development of the business of his employer. He was not a chemist. Dugan was placed in charge of and looked after the cylinders and regulators therefor, including repairs, did some personal work for Matheson, which personal work was not connected with the business of the old corporation, and assisted Matheson in the performance of the latter's duties as shop foreman. Matheson discussed business affairs of the old corporation with Dugan, who was his ‘right hand man.‘ Another duty of Dugan was to increase the number of customers as much as possible.
Matheson suffered a stroke on April 8, 1936, and at no time thereafter was he able to give directions to Dugan on the operation of the affairs of the old corporation. Thereafter Dugan made weekly visits to the Matheson home to discuss business affairs with Matheson or his wife. Matheson continued to sign corporate checks at his home for about 60 days after commencement of his illness. Matheson's wife was not familiar with the operations of the old corporation but Dugan discussed its affairs with her. She permitted Dugan to exercise his best judgment in carrying out his duties and never gave directions to him on how to operate the business. Matheson died on January 25, 1938, at the age of 72 years. After April 1936 Dugan was responsible for the operation of the business and there was no restraint on him as to how the business, including sales, should be managed, except as to financial matters. He and other employees worked hard at their respective jobs. Dugan did everything within his power and the facilities he had with which to work to advance the affairs of the old corporation. Under his management of the business, Dugan, among other things, dealt with creditors and discussed with them the affairs of the old corporation, hired and discharged employees, and, until June 1936, took checks to the home of Matheson for his signature and after July 1937, for the signature of Mrs. Matheson.
Florence H. Matheson was a drug addict. She was nervous, weak and unstable and at times very incoherent in her speech. At other times she acted almost normal.
About May 1936 Leo McLaughlin, a lawyer with no experience in the business of the old corporation, advised Dugan at the plant that he was representing Florence H. Matheson. Thereafter until April 1937 he visited the plant about once each week. He did no more than look around and made no attempt to interfere with the operation of the plant. In June 1936 he started to sign checks of the old corporation. He signed them in blank and left them with the bookkeeper.
On April 8, 1937, Matheson resigned as treasurer of the old corporation and McLaughlin, who at that time was secretary and held one share of the corporation's preferred stock, was elected by the board of directors to fill the vacancy. At the same meeting the directors appointed McLaughlin a committee of one to continue the affairs of the corporation on behalf of the board of directors. On the same day Matheson and his wife and McLaughlin delivered their stock to the corporation for transfer and each class of stock was reissued to them in one certificate as joint tenants with right of survivorship.
In May 1937 McLaughlin discharged Dugan and immediately appointed another man to perform Dugan's duties. Dugan and another employee promptly informed Matheson's wife of McLaughlin's action and threatened to resign. As a result of the disclosure and threat, Matheson's wife caused McLaughlin to remove the employee appointed by him. Dugan and other employees returned to work the next day. The old corporation paid to McLaughlin not in excess of $817 in 1936 and $2,105 in 1937.
In June 1937 Dugan displayed to Mrs. Matheson at her home corporate books, which, according to Dugan, disclosed that McLaughlin had taken money of the old corporation. The next day, at Dugan's suggestion, they consulted the prosecuting attorney of Bergen County, New Jersey, about the matter and he referred them to his law partner, Roger W. Breslin. Breslin, who was retained to protect the interest of Matheson and his wife, got in touch with McLaughlin about the matter and as a result he left the plant and never returned. Thereafter until her death on January 18, 1940, at the age of 56 years, Breslin represented Mrs. Matheson in connection with her personal matters and interest in the old corporation. He consulted her on an average of three or four times each week. The death certificate for Mrs. Matheson showed as the cause of her death suffocation by smoke in her bedroom, which was destroyed by fire. Breslin was appointed executor of her estate on January 29, 1940.
On July 27, 1937, on motion of Mrs. Matheson, the stockholders of the old corporation elected Dugan director of the corporation to take the place of McLaughlin. At a meeting held the same day the directors elected Dugan and Elsie K. Heil, an employee, vice president and secretary, respectively, and Mrs. Matheson treasurer of the corporation, and ordered that all of the outstanding stock of the corporation be surrendered for reissuance as follows:
+-----------------------------------------+ ¦ ¦Common ¦Preferred ¦ +--------------------+--------+-----------¦ ¦Florence H. Matheson¦997 ¦150 ¦ +--------------------+--------+-----------¦ ¦William J. Dugan ¦1 ¦5 ¦ +--------------------+--------+-----------¦ ¦August C. Mere ¦1 ¦5 ¦ +--------------------+--------+-----------¦ ¦A. M. Matheson ¦1 ¦50 ¦ +-----------------------------------------+
Mrs. Matheson was present at the meetings. Breslin held a proxy for Matheson at the meetings.
After the meetings on July 27, 1937, Breslin determined the checks to be issued by the old corporation, after consulting Dugan and the bookkeeper, and Mrs. Matheson signed them as treasurer after he approved them. Breslin made the decisions for Mrs. Matheson with respect to affairs of the old corporation, including the amount of money to be paid to her. Breslin exercised general supervision over the financial and other affairs of the corporation and checked work being done by the billing clerk, bookkeeper and the filling of orders by Dugan, for which purposes he spent two or three afternoons each week at the corporation's plant.
On December 29, 1938, McLaughlin filed suit in a Chancery Court of New Jersey against the old corporation, Elsie K. Heil, Dugan and Mrs. Matheson, in which he alleged, among other things, that (1) in May 1936, he entered into an agreement with representatives of some of the creditors of the old corporation, whereby they would refrain from applying for a liquidation of the assets of the corporation, provided the complainant was placed in sole charge of the management of the corporation's affairs and that the then manager be withdrawn; (2) that in August 1936, the complainant entered into an agreement with Florence H. Matheson, in which it was agreed that she would receive $75 per week until the death of her husband and thereafter $50 per week for the remainder of her life; that in the event she predeceased her husband, Matheson was to receive $75 per week for the remainder of his life; that the complainant, as manager of the business, would receive $50 per week for the remainder of his life when, in the opinion of the complainant, the amount could be paid to him without harming the old corporation and that after the payments provided for had been made, the profits of the old corporation should be divided equally between Florence H. Matheson and the complainant, he to become the sole owner of the stock of the old corporation upon the death of Florence H. Matheson; (3) that prior to and in January 1937 the complainant made withdrawals from the old corporation in partial payment of back salary as manager; (4) that to make the agreement effective, about April 8, 1937, the stock of the old corporation was reissued to the Mathesons and himself as tenants in common with right of survivorship; (5) that in June 1937, the complainant was unlawfully prevented from managing the business; (6) that thereafter the stock was unlawfully reissued in August 1937; and prayed, among other things, that (a) a receiver pendente lite be appointed to manage and conduct the affairs of the corporation; (b) Florence H. Matheson, Dugan, and Elsie K. Heil be restrained from managing or interrupting with the management of the business; (c) an injunction be issued to restrain them from disposing of the assets of the corporation; (d) the defendants be restrained from paying dividends or salary to any of the officers of the corporation and transferring stock; (e) the reissuance of stock in August 1937 be declared null and void; and that (f) the directors and officers prior to the eviction of the complainant be reinstated. Various claims made in the complaint were denied in an affidavit filed by Florence H. Matheson.
The complaint was settled about February 1, 1940, by payment of $5,000 to the complainant by the old corporation.
The estate of Florence H. Matheson succeeded to the stock issued to her and her husband on July 27, 1937.
During the base period years the old corporation paid the following amounts to the Mathesons, which amounts were claimed as deductions for salaries and allowed by the respondent:
+--------------------------------------+ ¦ ¦A. M. Matheson ¦F. H. Matheson ¦ +----+----------------+----------------¦ ¦1936¦$3,672.80 ¦ ¦ +----+----------------+----------------¦ ¦1937¦7,200.00 ¦ ¦ +----+----------------+----------------¦ ¦1938¦340.00 ¦$5,200 ¦ +----+----------------+----------------¦ ¦1939¦ ¦5,200 ¦ +--------------------------------------+
The sales effort of the old corporation was confined almost entirely to the mailing of circulars and price lists to old and prospective customers. It was not practical to solicit business by salesmen. The corporation utilized every means known to it to obtain new names for its mailing list. During 1936, on December 1, 1937, in January 1939 and on November 30, 1939, 3,085, 3,171, 2,229, and 2,384 price lists, respectively, for gases for laboratories and industrial uses were mailed to prospective customers. No price lists were mailed in 1938. In 1936, 1937, 1938, and 1939 it mailed out 2,416, 841, 1,134, and 742 circulars, respectively, for refrigerating gas. In 1937 it mailed out 2,906 copies of an illustrated booklet, with prices, on regulators. The bulletin had been prepared by Dugan. The circulars printed and advertisements inserted before the illness of Matheson were prepared by him and Dugan. The old corporation also advertised its products in chemical trade publications and operated a display booth in chemical expositions held biennially in New York City. The advertisements run after Matheson became ill were prepared by Dugan.
During the years 1936 to 1939, inclusive, the old corporation spent for gases the amounts of $20,910.89, $21,034.09, $20,911.91, and $25,368.48, respectively. Producers of the gases not only did not sell the products in small containers but purchased the products in small cylinders from the old corporation.
About 60 to 70 per cent of the chemical producing industry is located within 90 miles of petitioner's plant.
The old corporation was receiving a good price for the products it sold and did not have a plant larger than it required to conduct its affairs, or an excessive number of employees. During the base period it handled about 75 per cent of the commercial gases available at that time. Lack of funds prevented it from adding other types of gas prior to the time Matheson became ill.
The net sales and net income or net losses of the old corporation for the years shown were as follows:
+------------------------------------+ ¦Year¦Net sales ¦Net income¦Net loss ¦ +----+----------+----------+---------¦ ¦1929¦$51,452.50¦$1,736.74 ¦ ¦ +----+----------+----------+---------¦ ¦1930¦67,927.89 ¦2,757.88 ¦ ¦ +----+----------+----------+---------¦ ¦1931¦55,014.50 ¦ ¦$4,937.64¦ +----+----------+----------+---------¦ ¦1932¦37,141.74 ¦ ¦5,023.87 ¦ +----+----------+----------+---------¦ ¦1933¦47,556.39 ¦ ¦4,948.83 ¦ +----+----------+----------+---------¦ ¦1934¦(1) ¦(1) ¦(1) ¦ +----+----------+----------+---------¦ ¦1935¦51,896.11 ¦ ¦346.87 ¦ +----+----------+----------+---------¦ ¦1936¦50,295.03 ¦ ¦52.84 ¦ +----+----------+----------+---------¦ ¦1937¦54,224.89 ¦ ¦368.92 ¦ +----+----------+----------+---------¦ ¦1938¦55,168.18 ¦4,466.68 ¦ ¦ +----+----------+----------+---------¦ ¦1939¦64,375.29 ¦8,458.09 ¦ ¦ +------------------------------------+
Sales were made throughout the United States.
Sales of gas by the chemical industry increased during the last war and are not a fair guide of normal sales volume in years prior to the war.
The Interim Holding Co., Inc., was organized on August 29, 1940, under the laws of New Jersey and by September 9, 1940, it had acquired by purchase for cash and notes all of the outstanding stock of the old corporation. On September 9, 1940, when the Interim Holding Co., Inc., filed its certificate of incorporation with the Secretary of State of New Jersey, the old corporation and Interim Holding Co., Inc., were merged or consolidated under the name of The Matheson Company, Inc., the petitioner herein. The Interim Holding Co., Inc., performed no business other than to acquire the stock of the old corporation. Petitioner made no changes in the books and records of the old corporation in the merger or consolidation.
The only competitor of the old corporation in the sale of gases in small cylinders was the Ohio Chemical Co., which was located in Cleveland, Ohio. It was engaged primarily in the sale of gases for medical purposes, a type of product the old corporation did not handle. The old corporation sold several times as many different kinds of gases as its competitor. The sales records of the competitor for the base period years were destroyed.
George Ferris became president of the old corporation on August 30, 1940. He held the same office in the Interim Holding Co., Inc., and has been president of petitioner since its organization. He is not a chemist and had no experience in the chemical gas business prior to August 30, 1940.
In its returns for 1941 and 1942 petitioner claimed excess profits credits computed under the provisions of section 713(f). In 1943 it filed applications for relief under section 722(b)(1), (4) and (5). The claim under subsection (1) was based upon ‘loss of management.‘ The same exhibits, attached to the applications for relief under subsections (b)(1) and (b)(4), were cited as grounds for relief under (b)(5). Included in one of the exhibits was a statement by petitioner that salaries were paid to the Mathesons without rendition of management services. The respondent denied the applications upon the ground that petitioner had not established a right to the relief claimed. In his determination of the excess profits tax liability of petitioner for the taxable years, respondent made no adjustment of the amounts claimed in the returns as excess profits credits.
OPINION
DISNEY, Judge:
In its applications to the Commissioner for relief, petitioner invoked subsections (b)(1), (4) and (5) of section 722. Here it relies only upon subsections (b)(1) and (5).
Reviewed by the Special Division. SEC. 722. GENERAL RELIEF— CONSTRUCTIVE AVERAGE BASE PERIOD NET INCOME.(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—(1) in one or more taxable years in the base normal production, output, or operation was interrupted or diminished because of the occurrence, either immediately prior to, or during the base period, of events unusual and peculiar in the experience of such taxpayer,(5) of any other factor affecting the taxpayer's 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. 2. The term was used without any apparent intent to abandon the theory that, in addition thereto, there was an interruption of business. -------- Notes:
Not available.
As grounds for relief in the claims filed with the Commissioner under subsection (b)(1) petitioner relied upon events which it classified by the term ‘Loss of management.‘ The same events were relied upon as factors for relief under (b)(5). The statement made by petitioner for each claim, sets forth, among other things, the illness and subsequent death of Matheson; that Mrs. Matheson was a drug addict; that after Matheson became ill, it was impossible for him or his wife to manage the business or employ anyone capable of doing so; that the litigation with McLaughlin was not only expensive but distracted employees and made the old corporation's existence uncertain, and as a result, throughout the entire base period the business was ‘without executive management of any kind.‘ One of the affidavits, signed by Roger Breslin, asserts that the old corporation was without management after Matheson suffered a stroke in 1936.
In its petition, petitioner alleged that the old corporation was without management during the entire base period. The opening brief of petitioner refers, as clearly events under subsection (b)(1), to the operation of the business ‘without responsible management‘ after Matheson became ill and as factors under subsection (b)(5) to the claim that Mrs. Matheson was not only incapable of managing the business but that her and her husband's condition made it impossible to hire a manager; and that under the prevailing circumstances, Dugan was unable to furnish ‘anything approaching management.‘ In its reply brief, petitioner admits that there was some kind of management, and then concedes that this Court has no duty to distinguish between good and bad management. Under the circumstances, we regard petitioner as having abandoned its contention that the character of the management of the old corporation in the base period after Matheson became ill is an event or factor for us to consider under the issue.
Despite abandonment of management as a basis for relief, as set forth in its claim and petition, the petitioner asserts that certain events occurred, with certain results, and that factors existed, during the base period, to diminish /2/ the normal operation and output of the old corporation. Reference is then made to the illness of Matheson, the actions of McLaughlin, the physical condition of Mrs. Matheson and her participation in the business in spite of her condition, the lack of qualifications of Dugan to conduct the business, the uncertainty that existed whether McLaughlin would succeed in his efforts to acquire the business or whether the Mathesons would ‘continue as owner,‘ and the inability of the Mathesons to give Dugan orders, authority, or advice. These events appear to us to be essentially matters of management. The petitioner, however, prefers to treat them as ‘events unusual and peculiar‘ in its experience, under subsection (b)(1).
The regulations, however, provide that: ‘unusual and peculiar events contemplated in section 722(b)(1) consist primarily of physical rather than economic events or circumstances.‘ Regulations 112, section 35.722-3(a). The regulation is consistent with the report of the Committee on Finance, Senate Rept. No. 1631, page 198, 1942-2 C.B. 649. The events being relied upon here can not be regarded as physical events. The same paragraph of the regulation goes on to explain that such events would include floods, fires, explosion, strikes, etc., also to state that they ‘would not include economic maladjustments such as higher prices of materials * * * or any other agent of production * * * .‘ We consider that the events relied on by petitioner do not fall into the category of physical circumstances.
Regardless, however, of the nature of the events required for relief under subsection (b)(1), the net income during the base period must, if relief is to be obtained, be an inadequate standard of normal earnings because ‘ * * * normal production, output, or operation was interrupted or diminished * * * .‘
487
There is nothing in the facts here which establishes that the circumstances relied upon ‘interrupted or diminished‘ the normal production, output, or operation of the business. The illness and subsequent death of Matheson gave rise at most to no more than loss of his personal physical services for the remainder of the base period. This was not interruption, but was permanent. Operation, largely without his physical assistance, was the normal state of affairs for the old corporation at all times after he suffered a stroke in April 1936. So far as diminution is concerned, McLaughlin, as early as May 1936, held out to Dugan that he was representing Mrs. Matheson, and it does not appear that his authority in that regard was questioned prior to June 1937. In the meantime, he became a joint stockholder with the Mathesons and was authorized to act on behalf of the directors. His participation in the affairs of the business, legally or illegally, a matter we need not attempt to resolve, may have caused, as petitioner alleges, some anxiety on the part of employees as to their jobs and future policy of the business, not nothing in the facts is contrary to the idea that operations continued without interruption or diminution under the guidance or direction of Dugan, without interference by McLaughlin, until May 1937, when he discharged Dugan and appointed another employee to take over his duties. Dugan testified that he was familiar with the methods Matheson had of obtaining new business, that he had greater responsibilities after Matheson became ill; that he was permitted to take full charge of sales; and that there was no restraint on his conduct of the business, except as to financial matters.
The habit Mrs. Matheson had of taking drugs, and her physical condition in other respects, can not, under the circumstances here, be treated as an event effective to interrupt or diminish normal business, under the statute. Nothing appears in the facts contrary to the idea that the condition did not exist for a long time prior to the base period and, if so, her ailments would not be an ‘unusual or peculiar event in the experience‘ of the old corporation, occurring immediately prior to or during the tax period. Whatever infirmities she had, to affect her in taking up where Matheson left off, were cured by her designation to act for her of, first, McLaughlin and then Breslin. It is not shown that her disabilities were such that the business of the corporation was interrupted or diminished.
After the occurrence of the alleged events. Dugan carried on the activities of the old corporation to the best of his ability, a fact conceded by petitioner, without, as he testified, any restraint, except as to financial matters, on how he should conduct the business. After April 1936 operation of the business under the handicaps alleged by petitioner was normal for the old corporation and no proof was made that the alleged events interrupted operations for any period of time, or diminished operations.
However, even if we were to assume that events, recognizable under subsection (b)(1), occurred and continued, as alleged by petitioner, nevertheless they must, in order to be given effect under the statute, in the language of section 722(b), have resulted in ‘an inadequate standard of normal earnings. In Monarch Cap Screw & Mfg. Co., 5 T.C. 1220, 1228, we said that the phrase ‘refers to a standard or measure of earnings which falls below that established over a reasonable length of time and under normal conditions by the taxpayer or by other taxpayers engaged in the same or a similar business under comparable conditions. It is such a standard as would result in an 'abnormally low excess profits credit’.‘ We went on to compare the average base period net income with that of the previous period, from 1930, and concluded that the operations in the base period were ‘reasonably within the realm of normalcy, as established by the experience of the petitioner.‘ Regulations 112, section 35.722-3(a), also, on this point, states:
The taxpayer's normal production, output, or operation for those years in which interruption or diminution has been established may be determined by reference to its average production, output, or operation with respect to products or services of the same class. This determination may be made in the light of the experience of the taxpayer prior to its first excess profits tax taxable year (but not after May 31, 1940) or in the light of the experience of a comparable competitor or of an industry of which the taxpayer is a member, engaged in manufacturing or selling the same products or rendering the same services. No particular years or specific number of years in such experience need be selected in establishing normal production, output, or operation. * * *
Earnings of another taxpayer engaged in a business similar to the old corporation under comparable conditions are not in evidence for comparison. the old corporation had earnings totaling about $4,000 in 1929 and 1930 and net losses aggregating about $15,000 during the years 1931, 1932, and 1933. The financial result of operations in 1934 was not available for proof. The net losses were reduced to $346.87 in 1935, $52.84 in 1936, and $368.92 in 1937. Net income of $4,466.68 was realized in 1938 and $8,458.09 in 1939. Net sales were only about $400 less in 1936 than the prior year and in 1939 they were about $14,000 in excess of those for 1936. The profit in 1938 was earned in spite of an increase of only about $950 in net sales over 1937. A comparison of the earnings with the profits realized after 1939 is prohibited. Section 722(a); Clinton Carpet Co., 14 T.C. 581. The above figures disclose net losses as a standard or norm for the period prior to the base period, and net earnings as standard during the base period. They not only fail to bear out the idea that during the base period the actual profits were not representative of normal earnings, but, on the contrary, disclose affirmatively a condition in excess of normal for petitioner. Therefore, notwithstanding the alleged events relied upon by the petitioner, and even assuming their existence, the petitioner has wholly failed to demonstrate that average base period net income is an inadequate standard of normal earnings for the old corporation. We find no grounds for relief under subsection (b)(1).
Little need be said concerning the application of subsection (b)(5). To be entitled to relief under its provisions, it must at least be shown that some factor reasonably resulted in an ‘inadequate standard of normal earnings.‘ If the earnings during the base period were normal, no relief may be granted, Clinton Carpet Co., supra. Here, as above seen, they were even better than normal, in view of which no relief may be given under subsection (b)(5).
The petitioner argues also that regardless of its right to relief under section 722 it is entitled under section 711(b)(1)(J) of the Internal Revenue Code to the restoration of the compensation paid the Mathesons during the base period years to its income for such years and the disallowance of this compensation as a deduction in determining average base period net income. It is pointed out that under subsection (J)(i) of section 711(b)(1) under the heading of ‘Abnormal Deductions‘ that ‘Deductions of any class shall not be allowed if deductions of such class were abnormal for the taxpayer.‘ Since no reliance is placed upon subsection (J)(ii), it is clear that reliance is placed only upon abnormality in class and not in amount. It is equally clear to us that the deduction for compensation to the Mathesons were not, so far as the record before us shows, abnormal in class. The services of the Mathesons appear to be placed by the petitioner in the class of management, and management to a corporation of the nature of petitioner is obviously the normal thing. The petitioner has contended that there was no management but, in effect, agrees that there was some. We think the petitioner has made no showing in this respect of abnormality as to the deductions for the Mathesons. Moreover, subsection (K)(ii) requires a showing by the petitioner that the alleged abnormality was not a consequence of a change in the manner of operation of the business. In fact, the petitioner's contention appears to be that the abnormality in deduction was a result, in part at least, of a change in manner of operation, in that A. M. Matheson is alleged to have no longer operated as usual the affairs of the company, and that it had to be otherwise carried on. For these reasons alone it must be held that no showing has been made under section 711. In addition, we think the petitioner which, of course, has the burden has not met it on the facts. The amounts paid to A. M. Matheson were $3,672.80 for 1936, $7,200 for 1937, and $340 for 1938. He suffered a stroke on April 8, 1936, and died on January 25, 1938. It is apparent that as chairman of the board and president up to 1938 and as treasurer up to April 8, 1937, he may have earned considerable salary; and the amount involved in 1938 is small, though the period he lived in that year is short. He had, after the stroke, discussed business affairs with Dugan, and signed checks for about 60 days. He did not resign as treasurer until April 8, 1937. Leo McLaughlin from about May 1936 exercised at least some supervision until about June 1937, when Breslin was retained to protect the interest of Matheson and his wife, and consulted Mrs. Matheson an average of three or four times a week, until 1940. Nothing appears as to what Matheson and wife paid Breslin, or McLaughlin— though McLaughlin was paid by the corporation, $817 in 1936 and $2,105 in 1937. The Mathesons secured some one to look after corporate matters, and may, for such substitution for themselves, have paid over to Breslin and McLaughlin the amounts paid them by the corporation. Florence H. Matheson was paid nothing in 1936 and 1937, and $5,200 for each of the years 1938 and 1939. Though a drug addict she at times acted normal. She acted promptly to protect the corporate interests by causing McLaughlin to remove his appointee to fill Dugan's place, and likewise promptly by going to the prosecuting attorney about Leo McLaughlin's actions. She frequently consulted with Breslin. Payments, particularly those to Matheson in 1936, may have been additional compensation for past services. Lucas v. Ox Fibre Brush Co., 281 U.S. 115. The record here is entirely too indefinite to say that Florence H. Matheson did not earn the payments made to her. On this evidence, we can find nothing to require the conclusion that the amounts paid the Mathesons, and claimed and allowed as deductions in the base period years, should be thrown back into income, and we so hold. This renders it unnecessary to consider other questions raised by the parties as to the claim for such disallowance in computation of excess profits tax credit.
The petition in this case states that deficiencies for years ending December 31, of 1943 and 1944 have not been determined but that the decision in this case will determine whether or not such deficiencies should be determined and the amount thereof, if any, and further states certain amounts as estimated as being in dispute for 1943 and 1944. No further mention of the years 1943 and 1944 in this respect is made throughout the case or upon briefs. No deficiencies were determined for those years. We hold that they are not herein involved.
There remains the matter of correct computation of excess profits tax credit, to reflect net capital reductions in the credit, based on income. The parties stipulate the matter in part and appear willing to stipulate it altogether.
Because of stipulation by the parties
Decision will be entered under Rule 50.