The Commissioner denied the petitioner's applications for relief from excess profits taxes under section 722 (b) (2) of the Internal Revenue Code for the fiscal years ending July 31, 1941, 1942, 1943, 1944, 1945, and 1946. The sole issue is whether the business of the petitioner was depressed in the base period because of temporary economic circumstances unusual in the case of the petitioner or because of the fact that an industry of which petitioner was a member was depressed by reason of temporary economic events unusual in the case of such industry.
The proceedings were consolidated for hearing.
FINDINGS OF FACT.
Facts stipulated are so found and incorporated herein by reference.
The petitioner is a Georgia corporation which was organized in 1899. It has its principal place of business at Valdosta, Georgia, and is a manufacturer of cotton sheetings.
The petitioner during the years 1921 through 1941 manufactured standard narrow Class C sheetings (i. e., sheetings 40 inches wide or less, having an average yarn number of from 21 to 28) for use in the manufacture of cotton bags and in the converting trade. These sheetings were made from undyed and unbleached yarns which were also manufactured by the petitioner. (This product is commonly called "grey goods.")
The gray cloth manufactured by the petitioner during all years material to this proceeding was sold through a selling agent in New York. The selling agent sold petitioner's cotton cloth on a commission basis and assumed all credit risks by guaranteeing the accounts receivable.
The cotton textile industry is divisible in two ways. Geographically it is divisible into a Northern division and a Southern division. Secondly, it can be divided into industry groups according to the type product manufactured. Generally speaking there are fourteen such major manufacturing groups. They are listed according to the product manufactured, as follows: Corded yarn, combed yarn, miscellaneous cotton yarn, cordage and twine, cotton duck, sheetings and allied fabrics, print cloths and allied fabrics, napped fabrics, colored yarn fabrics, fine cotton goods, towels and toweling (including wash cloths and terry woven fabrics other than toweling), tobacco and cheese cloths (including gauze, absorbent cotton, and surgical dressing), specialty fabrics, and miscellaneous cotton textile products.
Petitioner is a member of the cotton textile industry, Southern division, sheetings and allied fabrics group.
The mill margin is roughly the difference between the selling price of cotton cloth and the cost of raw cotton.
The petitioner has kept its books and filed its income tax returns on the accrual basis since its organization. Prior to August 1, 1931, petitioner kept its books and filed its tax returns on a calendar year basis and since August 1, 1931, petitioner has kept its books and filed its tax returns on the basis of a fiscal year ending July 31.
The petitioner filed timely corporation income tax, declared value excess-profits tax, and excess profits tax returns for the fiscal years ended July 31, 1941, 1942, 1943, 1944, 1945, and 1946, with the collector of internal revenue for the district of Georgia.
The petitioner filed timely applications for relief (Form 991) under section 722 of the Internal Revenue Code for fiscal years ended July 31, 1941, 1942, 1943, 1944, 1945, and 1946.
Since the petitioner was in existence during its entire base period, that is the fiscal years ended July 31, 1937, 1938, 1939, and 1940, it is entitled to use an excess profits credit based on income under the provisions of section 713 of the Internal Revenue Code. Petitioner's excess profits credit computed under the provisions of section 713 of the Internal Revenue Code and without application of section 722 of the Internal Revenue Code as finally determined by the respondent for each of the fiscal years, ending July 31, 1941 to 1946, inclusive, is as follows:
July 31, 1941 ............................. $55,022.56 July 31, 1942 ............................. 66,056.90 July 31, 1943 ............................. 80,392.30 July 31, 1944 ............................. 80,392.30 July 31, 1945 ............................. 80,392.30 July 31, 1946 ............................. 80,414.84
Excess profits net income for each of the base period years computed under section 711 and without the application of section 722 of the Internal Revenue Code is as follows: For fiscal year July 31, 1941 For later years July 31, 1937 ............ $133,136.51 $159,410.56 July 31, 1938 ............ 28,641.29 83,409.99 July 31, 1939 ............ 6,386.75 7,339.24 July 31, 1940 ............ 63,509.38 77,974.54 Petitioner's excess profits tax liability, without the application of section 722 of the Internal Revenue Code, for each of the fiscal years ending July 31, 1941 to 1946, inclusive, is as follows:
July 31, 1941 ............................... $12,081.71 July 31, 1942 ............................... 44,982.68 July 31, 1943 ............................... 130,273.16 July 31, 1944 ............................... 77,237.21 July 31, 1945 ............................... 72,420.17 July 31, 1946 ............................... 30,769.37
For the fiscal years ended July 31, 1935, to July 31, 1940, sales, gross profit, gross profit percentage of sales, compensation of officers, and other items of income and expense for petitioner were as follows: INCOME, PROFIT AND LOSS STATEMENTS District Georgia July 31, July 31, July 31, Year 1935 1936 1937 Sales .............................. $450,874 $652,397 $866,109 Cost of goods sold ................. 456,695 520,372 602,933 Gross profit from sales ............ (5,821) 132,025 263,176 Gross sales from store ............. Cost of goods sold ................. Gross profit from store ............ Gross profit per cent of sales ..... (1.29) 20.23 30.38 15 1/2 Yr. Average 10.58%, 4 Yr. Average 20.50% Interest received on Government obligations ...................... Other interest ..................... (Not seg.) Rents .............................. 7,100 7,391 7,591 Other income ....................... 834 696 1,003 Total income ................. 2,113 140,112 271,770 Loss on sale of cotton contracts ... Compensation of officers ........... 5,556 5,505 20,550 Salaries and wages ................. 3,030 3,095 5,363 Repairs ............................ (Included in "Cost of good sold") Bad debts .......................... 17 35 350 Interest paid ...................... 7,671 11,459 7,319 Taxes .............................. 2,119 4,226 14,916 Contributions ...................... 5,920 Losses by fire, etc. ............... Depreciation ....................... 11,011 16,997 16,040 Loss on commissary ................. Other deductions ................... 14,754 55,035 29,608 Total deductions ............. 44,158 96,352 100,066 Current year net income ............ (42,045) 43,760 171,704 Prior year loss .................... Declared value excess profits tax .. 12,674 Wholly nontaxable interest received July 31, July 31, July 31, Year 1938 1939 1940 Sales ............................. $473,140 $579,584 $585,954 Cost of goods sold ................ 389,986 503,271 452,482 Gross profit from sales ........... 83,154 76,313 122,482 Gross sales from store ............ Cost of goods sold ................ Gross profit from store ........... Gross profit per cent of sales .... 17.57 13.16 20.90 Interest received on Government obligations ..................... Other interest .................... 2,283 Rents ............................. 7,413 6,497 6,795 Other income ...................... 829 1,302 8,253 Total income ................ 91,396 84,112 150,813 Loss on sale of cotton contracts .. Compensation of officers .......... 12,075 10,400 9,000 Salaries and wages ................ 5,720 6,076 6,597 Repairs ........................... Bad debts ......................... 75 321 Interest paid ..................... 7,969 11,445 5,005 Taxes ............................. 9,802 10,378 13,003 Contributions ..................... 230 255 300 Losses by fire, etc. .............. Depreciation ...................... 17,176 17,506 17,006 Loss on commissary ................ Other deductions .................. 4,389 20,392 21,852 Total deductions ............ 57,986 76,773 72,763 Current year net income ........... 33,410 7,339 78,050 Prior year loss ................... Declared value excess profits tax . 76 Wholly nontaxable interest received
The following table is a comparison of United States and foreign production and mill consumption of commercial cotton for the years 1922-1939, inclusive: Production (in 1,000 bales) Year beginning August 1 — United States Foreign World 1922 .................................... 10,124 8,327 18,451 1923 .................................... 10,330 8,760 19,090 1924 .................................... 14,006 10,088 24,094 1925 .................................... 16,181 10,562 26,743 1926 .................................... 18,182 9,768 27,930 1927 .................................... 12,957 10,386 23,343 1928 .................................... 14,555 11,247 25,802 1929 .................................... 14,716 11,535 26,251 1930 .................................... 13,873 11,503 25,376 1931 .................................... 16,877 9,602 26,479 1932 .................................... 12,961 10,500 23,461 1933 .................................... 12,712 13,354 26,066 1934 .................................... 9,576 13,466 23,042 1935 .................................... 10,495 15,646 26,141 1936 .................................... 12,375 18,354 30,729 1937 .................................... 18,412 18,333 36,745 1938 .................................... 11,665 15,839 27,504 1939 .................................... 11,516 15,851 27,367 Averages: 1936-1939 ........................... 13,492 17,094 30,586 1922-1939 ........................... 13,414 12,396 25,812 1922-1935 ........................... 13,392 11,053 24,448 Mill consumption (in 1,000 bales) Year beginning August 1 — United States Foreign World 1922 .................................... 6,666 14,671 21,337 1923 .................................... 5,681 14,346 20,027 1924 .................................... 6,193 16,541 22,734 1925 .................................... 6,456 17,712 24,168 1926 .................................... 7,190 18,489 25,679 1927 .................................... 6,834 18,608 25,442 1928 .................................... 7,091 18,687 25,778 1929 .................................... 6,106 18,769 24,875 1930 .................................... 5,263 17,169 22,432 1931 .................................... 4,866 18,023 22,889 1932 .................................... 6,137 18,514 24,651 1933 .................................... 5,700 19,902 25,602 1934 .................................... 5,361 20,119 25,480 1935 .................................... 6,351 21,178 27,529 1936 .................................... 7,950 22,688 30,638 1937 .................................... 5,748 21,825 27,573 1938 .................................... 6,858 21,649 28,507 1939 .................................... 7,784 20,702 28,486 Averages: 1936-1939 ........................... 7,085 21,716 28,801 1922-1939 ........................... 6,346 18,866 25,213 1922-1935 ........................... 6,135 18,052 24,187 Source: U.S. Dept. of Agriculture, "Agricultural Statistics," 1941, pp. 123, 125, 126, and 1945, p. 75. The carry-over at the beginning of the year in foreign countries and in the United States 1921-1940, with the amounts of the United States carry-over held by the U.S. Government and by others 1933-1940 were as follows: United States held by — Grand Foreign Year beginning total countries Total August 1 — U.S. Government Others 1921 .............. 15,169 8,273 6,534 1922 .............. 10,494 7,172 2,832 1923 .............. 7,571 5,246 2,325 1924 .............. 6,614 5,058 1,556 1925 .............. 7,948 6,338 1,610 1926 .............. 10,473 6,931 3,543 1927 .............. 12,654 8,892 3,762 1928 .............. 10,535 7,999 2,536 1929 .............. 10,541 8,228 2,312 1930 .............. 11,892 7,362 4,530 1931 .............. 14,808 8,438 6,370 1932 .............. 18,336 8,658 9,678 1933 .............. 17,116 8,952 8,165 3,626 4,539fn1 1934 .............. 17,540 9,796 7,744 3,037 4,707 1935 .............. 15,072 7,864 7,208 6,027 1,181 1936 .............. 13,649 8,240 5,409 3,237 2,172 1937 .............. 13,695 9,196 4,499 1,665 2,834 1938 .............. 22,702 11,169 11,533 6,964 4,589 1939 .............. 21,638 8,605 13,033 11,045 1,988 1940 .............. 20,272 9,708 10,564 8,733 1,831
The condition of petitioner as of the close of each calendar year from 1921 to 1930, and as of the close of each fiscal year from July 31, 1931, to July 31, 1940, was as follows: BALANCE SHEETS District Georgia Year 1921 1922 1923 1924 Cash ........................ $961 $15,089 $16,490 Notes accounts receivable (net) ...................... 3,992 $24,952 1,511 9,815 Inventories ................. 227,187 233,688 361,657 175,247 Govt. State obligations ... 20,000 20,000 20,000 Land ........................ } { 7,350 7,350 7,350 Net tangible capital assets . } 118,227 { 194,857 189,234 181,246 Reserves .................... 133,830 85,587 93,950 102,374 Other assets ................ 304 -------- --------- -------- -------- Total assets .......... $370,671 $480,847 $594,841 $390,148 ======== ========= ======== ======== Accounts payable ............ $9,969 $4,162 $2,567 $3,393 Bds, Nts, Mtgs, less than 1 yr. ...................... 113,154 103,126 209,626 33,126 Common stock ................ 175,000 175,000 175,000 175,000 Surplus, paid-in or capital surplus, earned ............ 70,328 189,483 205,674 176,772 Other liabilities ........... 2,220 9,076 1,974 1,857 -------- --------- -------- -------- Total liabilities ..... $370,671 $480,847 $594,841 $390,148 Year 1925 1926 1927 Cash ........................ $2,055 $537 Notes accounts receivable (net) ...................... $10,240 5,537 12,440 Inventories ................. 176,275 127,734 84,666 Govt. State obligations ... Land ........................ 7,350 7,550 7,550 Net tangible capital assets . 180,819 178,962 282,583 Reserves .................... 110,799 119,822 121,583 Other assets ................ 719 1,003 -------- -------- -------- Total assets .......... $374,684 $322,557 $388,779 ======== ======== ======== Accounts payable ............ $3,204 $2,985 $7,623 Bds, Nts, Mtgs, less than 1 yr. ...................... 43,125 12,789 57,789 Common stock ................ 175,000 175,000 175,000 Surplus, paid-in or capital surplus, earned ............ 146,441 123,283 139,308 Other liabilities ........... 6,914 8,500 9,059 -------- -------- -------- Total liabilities ..... $374,684 $322,557 $388,779 BALANCE SHEETS District Georgia Year 1928 1929 1930 Cash ........................ $6,698 $2,001 $3,109 Notes accounts receivable (net) ...................... 14,941 15,845 16,632 Inventories ................. 107,360 89,189 92,953 Govt. State obligations ... Land ........................ 7,550 7,550 7,550 Net tangible capital assets . 279,671 268,411 261,234 Reserves .................... 134,668 148,014 160,891 Other assets ................ 3,161 1,626 1,013 -------- -------- -------- Total assets .......... $419,381 $384,622 $382,491 ======== ======== ======== Accounts payable ............ $2,557 $23,280 $13,647 Bds, Nts, Mtgs, less than 1 yr. ...................... 122,289 134,789 167,789 Common stock ................ 175,000 175,000 175,000 Surplus, paid-in or capital surplus, earned ............ 119,535 50,115 24,471 Other liabilities ........... 1,438 1,584 -------- -------- -------- Total liabilities ..... $419,381 $384,622 $382,491 July 31, July 31, July 31, July 31, Year 1931 1932 1933 1934 Cash ........................ $1,998 $156 $1,667 Notes accounts receivable (net) ...................... 22,796 22,495 19,957 $1,140 Inventories ................. 27,992 38,195 40,723 147,216 Govt. State obligations ... Land ........................ 7,550 7,550 7,550 7,550 Net tangible capital assets . 252,671 244,297 226,938 212,700 Reserves .................... 170,392 186,432 204,104 218,452 Other assets ................ 6,799 8,410 7,775 5,794 -------- -------- -------- -------- Total assets .......... $319,806 $321,103 $304,610 $374,400 ======== ======== ======== ======== Accounts payable ............ $5,091 $4,715 $3,964 $2,749 Bds, Nts, Mtgs, less than 1 yr. ...................... 92,789 70,289 53,789 124,471 Common stock ................ 175,000 175,000 175,000 175,000 Surplus, paid-in or capital surplus, earned ............ 42,278 66,411 66,967 64,494 Other liabilities ........... 4,648 4,688 4,890 7,686 -------- -------- -------- -------- Total liabilities ..... $319,806 $321,103 $304,610 $374,400 BALANCE SHEETS District Georgia July 31, July 31, July 31, Year 1935 1936 1937 Cash ................................ $848 $2,574 Notes accounts receivable (net) ... 9,796 20,450 $40,363 Inventories ......................... 135,745 47,972 45,191 Govt. State obligations ........... Land ................................ 7,550 7,550 7,550 Net tangible capital assets ......... 212,720 302,595 291,362 Reserves ............................ 233,295 194,074 212,200 Other assets ........................ 1,430 860 1,236 -------- -------- -------- Total assets .................. $368,089 $382,001 $385,702 ======== ======== ======== Accounts payable .................... $2,593 $3,918 $7,132 Bds, Nts, Mtgs, less than 1 yr. .............................. 142,471 135,971 62,000 Common stock ........................ 175,000 175,000 175,000 Surplus, paid-in or capital surplus, earned .................... 25,016 64,530 85,309 Other liabilities ................... 23,009 2,582 56,261 -------- -------- -------- Total liabilities ............. $368,089 $382,001 $385,702 July 31, July 31, July 31, Year 1938 1939 1940 Cash ................................ $4,189 $5,743 $4,046 Notes accounts receivable (net) ... 31,446 43,048 18,679 Inventories ......................... 132,097 53,008 60,007 Govt. State obligations ........... Land ................................ 7,550 7,550 7,550 Net tangible capital assets ......... 257,544 246,119 244,377 Reserves ............................ 302,915 319,332 339,172 Other assets ........................ 3,877 4,213 4,008 -------- -------- -------- Total assets .................. $436,703 $359,681 $338,667 ======== ======== ======== Accounts payable .................... $3,518 $4,203 $194 Bds, Nts, Mtgs, less than 1 yr. .............................. 173,000 93,000 Common stock ........................ 175,000 175,000 175,000 Surplus, paid-in or capital surplus, earned .................... 75,363 81,861 139,395 Other liabilities ................... 9,822 5,617 24,078 -------- -------- -------- Total liabilities ............. $436,703 $359,681 $338,667 The compiled net profit (or loss) less tax-exempt income for manufacturing corporations other than cotton textile, and for cotton textile manufacturing corporations for the years 1922-1939 was as follows: COMPILED NET PROFIT (OR LOSS) LESS TAX-EXEMPT INCOME FOR MANUFACTURING CORPORATIONS OTHER THAN COTTON TEXTILE, AND COTTON TEXTILE MANUFACTURING CORPORATIONS, 1922-1939 (In $1,000) Manufacturing Year corporations Cotton textile other than corporations cotton textile 1922 ................... 2,548,044 92,963 1923 ................... 3,466,977 103,910 1924 ................... 2,803,307 (39,835) 1925 ................... fn1 1926 ................... 3,738,946 (30,843) 1927 ................... 3,011,752 75,842 1928 ................... 3,899,944 10,582 1929 ................... 4,383,755 22,017 1930 ................... 1,209,171 (91,507) 1931 ................... (759,400) (63,570) 1932 ................... (1,752,601) (53,663) 1933 ................... 172,218 31,828 1934 ................... 971,591 8,414 1935 ................... 1,826,708 (10,261) 1936 ................... 3,102,507 35,138 1937 ................... 3,123,298 37,779 1938 ................... 1,262,283 (6,206) 1939 ................... 3,151,164 35,287 Average: 1936-1939 .......... 2,659,813 25,500 1922-1935 .......... 1,963,109 4,298 1922-1939 .......... 2,127,039 9,287 Base period Base period 25.05% 174.57% greater than greater than 1922-1939. 1922-1939.
The income and balance sheet data for nine corporations, Southern sheetings mills, 1922-1939, were as follows: SHEETINGS AND ALLIED FABRICS INDUSTRY, SOUTHERN SHEETINGS MILLS, INCOME AND BALANCE SHEET DATA FOR NINE CORPORATIONS, FILING FISCAL YEAR RETURNS IN 1922-1939 Compiled Ratio of compiled net net profit Total profit (or loss) less Net (or loss) assets tax-exempt income to: Year sales less (end of ($000) tax-exempt year) income ($000) Net sales Total assets ($000) (per cent) (per cent) 1922 ........... 9,509 892 8,811 9.38 10.12 1923 ........... 11,080 653 9,791 5.89 6.67 1924 ........... 11,040 314 10,255 2.84 3.06 1925 ........... 12,730 354 10,025 2.78 3.53 1926 ........... 10,991 409 9,206 3.72 4.44 1927 ........... 10,552 847 9,787 8.03 8.65 1928 ........... 10,859 142 9,492 1.31 1.50 1929 ........... 10,248 309 9,480 3.02 3.26 1930 ........... 8,130 (913) 8,582 (11.23) (10.64) 1931 ........... 6,252 (375) 7,847 (6.00) (4.78) 1932 ........... 5,237 (297) 7,094 (5.67) (4.19) 1933 ........... 7,259 276 7,445 3.80 3.71 1934 ........... 8,808 206 7,869 2.34 2.62 1935 ........... 8,725 (126) 7,733 (1.44) (1.63) 1936 ........... 11,064 739 8,316 6.68 8.89 1937 ........... 10,721 668 8,297 6.23 8.05 1938 ........... 7,051 (132) 7,519 (1.87) (1.76) 1939 ........... 8,372 88 7,924 1.05 1.11 Average: 1936-1939 ... 9,302 341 8,014 3.67 4.26 1922-1939 ... 9,368 225 8,637 2.40 2.61 Per cent: 1936-1939 to 1922-1939 ... 99.30 151.56 92.79 The average spot price of middling cotton in ten markets and the average wholesale prices of three constructions of narrow sheetings for 1922-1940 were as follows: Narrow sheetings: Middling cotton, Average of 7/8 inch: Average wholesale prices Year spot price in ten of three constructions, markets (cents f. o. b. mill per pound) (cents per pound) 1922 ........... 20.49 1923 ........... 28.63 1924 ........... 27.79 1925 ........... 23.10 1926 ........... 16.62 33.59 1927 ........... 16.85 32.77 1928 ........... 19.15 33.14 1929 ........... 18.20 32.27 1930 ........... 12.73 25.19 1931 ........... 7.90 18.15 1932 ........... 6.11 14.86 1933 ........... 10.05 22.39 1934 ........... 16.17fn1 29.48 1935 ........... 15.77fn1 28.36 1936 ........... 11.93 26.47 1937 ........... 11.22 27.87 1938 ........... 8.58 19.35 1939 ........... 9.04 20.75 1940 ........... 9.98 21.94 {1936-1939 10.19 1936-1939 23.59 Averages ....... {1922-1939 15.57 1926-1939 26.06
The price index published by the Bureau of Labor Statistics for all commodities, cotton goods, brown sheetings and middling cotton for 1922-1940 was as follows: INDEXES OF WHOLESALE PRICES OF ALL COMMODITIES, COTTON GOODS, BROWN SHEETINGS, AND MIDDLING COTTON, 1922-1940 [1926=100] Brown sheetings Middling Year All Cotton cotton commodities goods Series 1: Series 3: at New 4/4, 4/4, York 48 x 48, 56 x 60, 2.85 4.00 1922 ............ 96.7 104.3 105.1 111.3 121.0 1923 ............ 100.6 116.9 133.3 132.1 167.0 1924 ............ 98.1 114.7 131.7 121.3 163.9 1925 ............ 103.5 110.0 120.0 112.2 133.8 1926 ............ 100.0 100.0 100.0 100.0 100.0 1927 ............ 95.4 97.1 97.8 99.6 100.2 1928 ............ 96.7 100.4 110.2 98.7 114.1 1929 ............ 95.3 98.8 102.0 93.3 109.0 1930 ............ 86.4 84.7 85.3 78.5 77.1 1931 ............ 73.0 66.1 58.8 58.4 48.7 1932 ............ 64.8 54.0 50.4 44.6 36.6 1933 ............ 65.9 71.2 71.4 66.2 49.5 1934 ............ 74.9 86.5 88.9 84.8 70.4 1935 ............ 80.0 83.4 89.8 81.3 67.8 1936 ............ 80.8 80.3 79.1 78.9 69.1 1937 ............ 86.3 84.3 87.0 83.4 65.3 1938 ............ 78.6 65.4 62.0 57.8 49.3 1939 ............ 77.1 67.2 64.3 60.0 53.9 1940 ............ 78.6 71.4 69.7 65.3 59.3 Averages: 1936-1939 ... 80.7 74.3 73.1 70.0 59.4 1922-1939 ... 86.3 88.1 90.9 86.8 88.7 1926-1939 ... 82.5 81.4 81.9 77.5 72.2 The petitioner's average base period net income is not an inadequate standard of normal earnings because the industry of which it was a member was not depressed by reason of temporary economic events unusual in the case of that industry within the meaning of section 722 (b) (2) of the Internal Revenue Code.
OPINION.
WITHEY, Judge:
Petitioner bases its claim for relief on section 722 (b) (2), Internal Revenue Code. This section is set forth in the margin. To prevail under this section petitioner must show that its average base period net income is an inadequate standard of normal earnings because its business was depressed or because the taxpayer's industry was depressed by reason of temporary economic events unusual in the industry. It must, also, by competent evidence, establish a fair and just constructive average base period net income. Petitioner's contentions are that the temporary economic depression of the industry is evidenced by (1) the disparity between the price of cotton goods as compared with the price of all commodities during the base period years; (2) the oversupply of raw cotton during the base period years and its depressing effect upon the price of cotton goods during the base years; and (3) "the character of the circumstances under which the oversupply of raw cotton was created as it relates to section 722 (b) (2)." The Court is unable to distinguish between the last two contentions as the evidence relating to both contentions is the same. We have therefore considered them together.
SEC. 722. GENERAL RELIEF — CONSTRUCTIVE AVERAGE BASE PERIOD NET INCOME.
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(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 —
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(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,
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Based on the Bureau of Labor Statistics, Wholesale Prices, the index of all commodities during the base period was 93.51 per cent of the 1922-1939 average while the price of cotton goods was 84.34 per cent of the 1922-1939 average, or a difference of 9.17 per cent. This small disparity is merely the ordinary fluctuation that can be found by examining the yearly index of prices of cotton as compared to other commodities.
While being fully aware of the disparity of price between all commodities opposed to the price of raw cotton, it is nevertheless incumbent upon us to consider particularly the specific industry of which petitioner is a member, that is, the sheetings industry, Southern division. Regs. 112, sec. 35.722-2 (b) (8). We compare the price of middling cotton to the price of narrow sheetings. The average price per pound of middling cotton went from 15.57 cents for the 1922-1939 period to 10.19 cents for the base period, a decrease of 5.38 cents or 34.55 per cent; at the same time the price per pound of narrow sheetings went from 26.06 cents for 1926-1939 to 23.59 cents in the base period, a decrease of 2.47 cents or 9.47 per cent. In other words, the price of middling cotton decreased 263 per cent more than the price of narrow sheetings. Thus, it can be seen that the price of finished sheetings is not proportionately based on the price of raw cotton and the crux of petitioner's major premise is not sustained. Further, the cost of raw cotton was 60 per cent of the price of narrow sheetings in the long period (1922-1939) whereas the cost of raw cotton represented only 43 per cent of the price of narrow sheetings in the base period. This would indicate the textile manufacturer can obtain a higher profit when raw cotton is selling at a lower price.
SEC. 35.722-2. CONSTRUCTIVE AVERAGE BASE PERIOD NET INCOME. —
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( b) Rules for determination.
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(8) For the purposes of section 722 and of section 35.722-3 ( b) and ( c), no exclusive definition of the concept "industry" can be constructed. In general an industry may be said to include a group of enterprises engaged in producing or marketing the same or similar products or services under analogous conditions which are essentially different from those encountered by other enterprises. The mere similarity of product and marketing methods, however, is not enough of itself to comprehend taxpayers satisfying such conditions within the same industry. Factors such as geographical location, character and location of markets, availability and character of raw material supply, and other conditions under which operations are carried on must be considered. Regard may be had to trade custom and practice in determining whether a group of enterprises constitutes an industry.
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Petitioner further contends, as before stated, that the oversupply of raw cotton was unusual causing a decrease in the price of cotton goods and emphasizes the character of the circumstances under which the oversupply was created. Examination of Exhibit 8-H discloses a constant fluctuation in the production of commercial cotton during the 1922-1939 period. In 1922 production was 10,000,000 bales; by 1926, five years later, production was 18,000,000 bales; a decrease to 13,000,000 bales occurred in 1927; a rise to 16,800,000 bales in 1931; 1932 witnessed a drop to 13,000,000 bales; and 1934 a continuation of the downward trend to 9,500,000 bales. Production again rose to 18,400,000 bales in 1937 and dropped sharply to 11,600,000 bales in 1938. In Industrial Yarn Corporation, 16 T.C. 681, 689, we said:
* * * It is not unusual for a cotton crop to vary in size from year to year. The fortuitous circumstances that 1937 may have produced a cotton crop of extraordinary size does not, of itself, create an abnormality in petitioner's business of the character sufficient to bring petitioner within the scope of the cited section. * * *
It must be remembered that petitioner is not a cotton grower. It is a manufacturer. The effect of the large cotton crop was to reduce the cost of cotton to petitioner but it did not reduce the necessary profit it had to maintain to keep in business. Its success depended on keeping its costs of production down. The price of the raw cotton was reduced by the large crop and the price of cotton cloth was in turn reduced but its mill margin during the base period was substantially maintained. The statements of petitioner's condition evidence the fact that it did not overstock during the base period. Petitioner's average base period inventory was $72,576 as against the 10-year average from July 31, 1931, to July 31, 1940, inclusive, of $72,814. In petitioner's fiscal year ended July 31, 1938, when petitioner claims an abnormal crop, its inventory did not exceed its inventory for the two highest years, 1934 and 1935.
For the base period years, ending July 31, 1937 to 1940, the average cost of goods sold was 79.50 per cent of sales as compared to the 1921-1936 average of 89.42 per cent of sales. The 1937-1940 average of 79.50 per cent is almost as low as the lowest year in the prior period, namely, 1934 when the cost of goods sold was 79.14 per cent of sales. This shows petitioner had a higher gross profit and a lower cost of goods sold in the base period years which is contrary to petitioner's contention that its industry was depressed. The carry-over chart shows that of the abnormal crop more than half was being held by the United States Government and others. The petitioner was still buying in proportion to production capacity and was not bound by reason of the large crop of 1937 to buy more than it wanted.
While considering cotton production, we should not fail to observe the increase in mill consumption which shows petitioner's industry was not depressed. At a time when the base period United States production increased 100,000 bales over the 1922-1935 average, the base period United States mill consumption increased 950,000 bales over the 1922-1935 average. Since petitioner is in the mill end of the industry, the above comparison shows a more favorable position for its phase of activity therein. Comparing the base period years to the long period of 1922-1939 we find mill consumption in 1936 was 125 per cent of the long period, 1937 was 91 per cent, 1938 was 108 per cent, 1939 was 122 per cent and the average base period consumption was 112 per cent of the long period. This further shows petitioner's advantageous position in the base period.
Lastly, petitioner must show that because of the temporary depression its actual average base period net income is an inadequate standard of normal earnings. Petitioner has not done this. It has, in lieu thereof, treated the base period as being comprised of separate yearly units, proof of a depression in any one of which entitles it to relief under section 722 (b) (2). We must, as stated in Wadley Co., 17 T.C. 269, treat all of the base period years as a unit, for in that case we said "the base period is not to be divided into separate segments; it is a unitary period * * *." Examination of the income statements for petitioner shows average sales for the base period of $626,199 as against sales from January 1, 1921, to July 31, 1940, of $454,636, an increase of $171,563 or 37 per cent over the long period. At the same time average net income during the base period was $72,626 as against an average of $18,998 for the 18 7/12-year period from January 1, 1922 to July 31, 1940, an increase of $53,628 or 282 per cent over the long period average net income even after substantial increases in officers' salaries were allowed in a so called depressed period, the 1939 salaries paid to petitioner's officers being twice the 1926-1936 average.
The increase in base period net income above noted is also true as to nine other Southern sheetings mills, whose net sales for the base period were 99.3 per cent of the 1922-1939 average and whose base period net profit was 151.56 per cent of the 1922-1939 average. The same profit picture can be viewed by comparing the manufacturing corporations other than cotton textile with the cotton textile corporations. By so doing we see that the base period average net profit of cotton textile corporations of $25,500,000 was 174 per cent greater than the average net profit for the period from 1922-1939 of $9,287,000 of the cotton textile corporations. At the same time the base period net profit for other manufacturing corporations was only 25.05 per cent greater than the net profit for the long period of 1922-1939.
We have made a detailed examination of the many exhibits presented by petitioner but fail to see that the effect of the large cotton crop in the year 1937 upon petitioner's industry resulted in the temporary economic depression of petitioner's business during the base period. U.S. Treasury Department Bulletin on Section 722 of the Internal Revenue Code (Nov. 1944), Part III, par. (B), p. 17.
(B) SCOPE OF SECTION 722 (b) (2).
Since the economic circumstances giving rise to relief must be temporary and unusual, it is important that the taxpayer furnish evidence concerning the exact nature of the circumstances alleged. It is not sufficient that the taxpayer merely show a depression during the base period by comparing its earnings during this period with earnings in a prior period, accompanied by general allegations concerning hard times or unfortunate conditions. It is expected that for all industries and all taxpayers there will be fluctuations from year to year in their earnings experience. Such fluctuations are perfectly normal, and in fact occurred in the experience of corporations generally during the base period. The year 1938 was in general a year of poor profits, and it would be improper under section 722 (b) (2) to grant relief due to that fact. In some particular industries one or more of the other years of the base period were depressed because of usual and recurring circumstances. Thus, it is necessary that the circumstances alleged under section 722 (b) (2) be identified specifically as to character, causes, extent and severity, and that positive evidence be presented to show that they were both peculiar and temporary.
It is, therefore, our conclusion that petitioner has not established its right to relief under section 722 (b) (2), for it would be completely disregarding the facts to find petitioner's industry, the Southern sheetings mills, was depressed in the base period as compared to the average long term period 1922-1939. Foskett Bishop Co., 16 T.C. 456; Winter Paper Stock Co., 14 T.C. 1312; Monarch Cap Screw Manufacturing Co., 5 T.C. 1220; Fish Net Twine Co., 8 T.C. 96.
In view of the fact that petitioner has not proved its industry was depressed it is unnecessary to comment on petitioner's constructive average base period net income reconstruction.
Reviewed by the Special Division.
Decisions will be entered for the respondent.