1942, 1943, and 1944, and for the refund of excess profits taxes paid for the said years as follows: The question for decision is whether the petitioner, for the years in question, was qualified for relief under the provisions of section 722 (b) (4) of the Internal Revenue Code of 1939 and if so, what would be a fair and just amount representing normal earnings to be used as a constructive average base period net income, for excess profits tax purposes. FINDINGS OF FACT. The petitioner, an Ohio corporation, was incorporated July 28, 1937, with its principal office in Middletown, Ohio. It was formed for the declared purpose of engaging "in the business of Engineering, General Machine Work, Blacksmithing and Welding and any other service. similar or allied to the foregoing general lines. To manufacture, buy, sell and general [sic] deal in material, parts, supplies, tools and accessories incident to machine shop business or the other allied activities previously set forth. To acquire, sell, lease, own, hold and maintain all the real and personal property which may be necessary or proper for the objects and purposes aforesaid and the doing of all things necessary and incident thereto." Petitioner was the successor of a preexisting partnership, originally formed in 1922 by August Mokry and William Tesmer. Both Mokry and Tesmer were mechanics. The partnership was originally known as the Auto Repair and Machine Company, but in 1927 the name was changed to The Mokry and Tesmer Machine Company. The partnership had been engaged in doing general machine work and repair work, including the manufacture of parts. For one customer it manufactured "duplicate parts for pretty near all critical machines in the plant." It also built "minor equipment and major equipment." For at least one customer it had manufactured some heavy machinery. At a special meeting of petitioner's board of directors, held subsequent to August 25, 1937, but prior to October 28, 1937, a resolution was adopted authorizing the issuance of 404 shares of petitioner's capital stock, having a par value of $100 per share, for the business and assets of the partnership and the assumption of its liabilities. In an offer received from the partnership, the partnership assets had been listed at $45,788.36 and the partnership liabilities at $2,685.34. The assets included land, buildings, machinery and equipment, accounts receivable, material inventory, work in progress, cash value of life insurance, notes receivable, organization expense, mortgage receiv able, cash in bank, petty cash, and deposit in building and loan association. Also in consideration for the issuance of the stock, the resolution required a full and complete transfer by the partnership of goodwill and an agreement on the part of William Tesmer and August Mokry that they would not engage in a similar business. The shares were to be issued 200 to August Mokry, 200 to William Tesmer, 3 to Robert C. Banker, and 1 to George E. Zecher. George E. Zecher had become an employee of petitioner's predecessor partnership in 1936. Immediately prior thereto and for an undisclosed period, he had a tool and die business of his own. He was a master mechanic as early as 1916. At a special meeting of petitioner's directors, on August 25, 1937, a resolution was adopted providing for the building of a steel frame, brick building, with a built-up roof. The building was to have a frontage of 69 feet, and a depth of 60 feet 4 inches. The cost, according to a preliminary estimate, was stated at $7,158. A further motion was adopted, authorizing an application to the First American Bank & Trust Company for a loan of $5,000 to aid in financing the proposed construction. It was stated in the motion that a prior loan with the said bank had been reduced to $2,200. At the time the above resolution was adopted, the business of petitioner was conducted in a small frame building. The floor space in that building was approximately 3,000 square feet and was not adequate for petitioner's needs. Due to the limited space, petitioner's machinery was overcrowded. By construction of the new building, the floor space was to be doubled or possibly tripled.1 On January 3, 1938, petitioner's board of directors approved the issuance of 30 additional shares of its stock to George E. Zecher in exchange for 2 milling machines, 2 lathes, 2 screw machines, and miscellaneous tools and equipment, which were listed in the resolution at a total of $3,000. These machines had been used by Zecher in his own tool and die business prior to his coming with the predecessor partnership. The machinery acquired from Zecher supplemented the large equipment which petitioner already had. Later on, petitioner added some additional equipment. Among the items added, were a large horizontal boring mill, a heavy crane, a large planer, and a radial drill. The crane runway was installed "around” 1938. The crane was "hooked up" temporarily "along there in '38." At no time during the period pertinent was it permanently "hooked up." 1 At one place in his testimony, Zecher stated that after construction of the new building the floor space of the plant was about doubled. At another place, he testified that the new building had increased the floor space to a little over 9,000 square feet. The building was completed in "and ready to go about June of '39." It was about that time that the equipment was changed around and the added floor space was being utilized. After the improvements, petitioner "got into the building of special machinery, also dies, forming dies, for different organizations around those parts." During the years 1937, 1938, and 1939 petitioner "turned down" some orders.2 The gross receipts, cost of goods sold, gross profits, and net income or loss as shown by petitioner's predecessor partnership on its returns of income for the years 1922 through 1936 and for the 7 months ended July 31, 1937, were as follows: The gross receipts, cost of goods sold, gross profits, and net income of petitioner, as reported by it on its corporation income and excess profits tax returns, for the 5-month period ended December 31, 1937, and for the years 1938 and 1939, were as follows: Petitioner's net income for 1939, as finally determined by the respondent, was $3,221.87, as compared with the loss of $1,661.99 reported by petitioner on its return. At December 31, 1939, petitioner had made a journal entry crediting to earned surplus previously accrued but unpaid officers' salaries in the amount of $4,570.81, of The evidence as to the orders which were "turned down" is quite indefinite. There is Indication that some of them may have been little more than inquiries which may or may not have ripened into orders. There was testimony that certain work was "turned down" in 1937 because petitioner did not have the necessary equipment, but we are not advised whether or not such work could be done after completion of the improvements. The record is also much the same as to other orders which were "turned down." which $4,355.77 was for salaries accrued prior to January 1, 1939. Respondent's determination of a net income of $3,221.87, as against the reported loss of $1,661.99, includes an adjustment for the said $4,570.81 so credited to earned surplus. Petitioner's excess profits credits computed by the invested capital method which were used in computing its excess profits tax for each of the years 1941, 1942, 1943, and 1944 were $4,604.47, $5,289.08, $6,416.12, and $8,502.60, respectively. Its excess profits credit under the invested capital method for the year 1940, as reported on its excess profits tax return for that year, was $3,907.21. Petitioner's excess profits tax liability for each of the years 1940 through 1944, as finally determined by the respondent, without application of section 722 of the 1939 Code, and the excess profits tax paid by petitioner for such years, are as follows: 1 On its returns for the years 1943 and 1944, petitioner claimed the benefit of the deferment provisions of section 710 (a) (5) of the Internal Revenue Code of 1939, and deferred payment of excess profits taxes in the respective amounts of $9,196.21 and $8,454.33 for the years 1943 and 1944. The petitioner timely filed applications for relief under section 22 of the Internal Revenue Code of 1939 for each of the years 1941, 1942, 1943, and 1944, and for the refund of excess profits taxes paid for such years in the respective amounts of $4,927.52, $49,574.10, $19,620.29, and $16,309.86. The constructive average base period net income under section 722 as claimed by petitioner in its applications for section 722 relief was $30,930. It was the determination of the respondent, for each of the said years, that petitioner had not established its right to relief under section 722 of the 1939 Code. OPINION. TURNER, Judge: By section 722 (a) of the Internal Revenue Code of 1939,3 it is provided that in any case in which the taxpayer estab SEC. 722. GENERAL RELIEF-CONSTRUCTIVE AVERAGE BASE PERIOD NET INCOME. (a) GENERAL RELIEF.-In any case in which the taxpayer establishes that the tax computed under this subchapter (without the benefit of this section) results in an excessive and discriminatory tax and establishes what would be a fair and just amount representing normal earnings to be used as a constructive average base period net income for the purposes of an excess profits tax based upon comparison of normal earnings and earnings during an excess profits tax period, the tax shall be determined by using such lishes that its excess profits tax computed without the benefit of section 722 results in an excessive and discriminatory tax, and further establishes what would be a fair and just amount "to be used as a constructive average base period net income," the tax is to be determined by the use of such constructive average base period net income, in lieu of the average base period net income otherwise determined. under the statute. In section 722 (b) (4) of the 1939 Code, it is provided that the tax "shall be considered to be excessive and discriminatory" if the taxpayer's "average base period net income is an inadequate standard of normal earnings," by reason of the fact that during or immediately prior to the base period, it commenced business or changed the character of its business, and its average base period net income does not reflect the normal operation for the entire base period. Section 722 (b) (4) further provides that if, by the end of the base period, the business did not reach the earning level which it would have reached if the commencement or change in the character of the business had occurred 2 years earlier, the commencement or change is to be deemed to have occurred at such earlier time. And for the purposes of section 722 (b) (4), the term "change in the character of the business" includes a change in the operation or management, a difference in the products, and a difference in the taxpayer's capacity for production or operation. It is the claim of the petitioner that it meets the requirements of section 722 (b) (4) for relief under section 722, for the reasons that during the base period (1) it commenced business, namely, in 1937, (2) it experienced a change in its products, (3) it enlarged its plant and thereby its capacity for production, and (4) it experienced a change in management. Aside from the merits or demerits of claims (1), (2), and (4), the record does show that the petitioner did, in the base period, enlarge its plant by the construction of a new and larger building and the installation of some additional machinery, and while there is no constructive average base period net income in lieu of the average base period net income otherwise determined under this subchapter. ・・・ (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 (4) the taxpayer, either during or immediately prior to the base period, commenced business or changed the character of the business and the average base period net income does not reflect the normal operation for the entire base period of the business. If the business of the taxpayer did not reach, by the end of the base period, the earning level which it would have reached if the taxpayer had commenced business or made the change in the character of the business two years before it did so, it shall be deemed to have commenced the business or made the change at such earlier time. For the purposes of this subparagraph, the term "change in the character of the business" includes a change in the operation or management of the business, a difference in the products or services furnished, a difference, in the capacity for production or operation |