petitioner's business under section 722 (b) (4) of the 1939 Code, and is a qualifying event leading to a reconstruction of petitioner's base period earnings.

The installation, during the base period, of the Sutherland pulp refiners is a change in the method of operation of petitioner's business under section 722 (b) (4) of the 1939 Code, and is a qualifying event leading to a reconstruction of petitioner's base period earnings.

The installation, during the base period, of the McDonald dehydrators is a change in the method of operation of petitioner's business under section 722 (b) (4) of the 1939 Code, and is a qualifying event leading to a reconstruction of petitioner's base period earnings.

Petitioner's actual base period net income, as determined by respondent, is an inadequate standard of normal earnings by reason of the change in its ratio of nonborrowed to total capital and the change in the operation of its business. To arrive at the constructive average base period net income, the following amount is to be added for each of the base period years to the actual base period income as appropriately adjusted:

Change in capital ratio___

Change in method of operation__.

Total__.

$80, 957

250, 860

$331, 817

In consideration for the 14 Sutherland pulp refiners received from Sutherland, petitioner, in accordance with the provisions of the aforesaid contracts, paid to Sutherland the aggregate sum of $238,573.81 as licensing fees for their use.

Petitioner claimed, and respondent allowed, the following amounts which were deducted in petitioner's income tax returns for the years 1936, 1937, and 1938 under the caption of "Lease and Licensing Fees, Pulp Refiners":

The amounts paid by petitioner for leases and licensing fees for the use of the Sutherland refiners in 1935, 1936, and 1937 were amortized on petitioner's books over a period of 12 months from the date of installation. No depreciation deduction was claimed on petitioner's returns for these refiners or allowed for the years 1940 through 1945. Petitioner did not acquire title to, or ownership in, the Sutherland refiners until 1942.

The amounts paid in 1936, 1937, and 1938 as lease and licensing fees for the use of the Sutherland refiners were properly expensed and did not represent cost of a depreciable asset.

Petitioner paid to the collector of internal revenue at New Orleans, Louisiana, on February 10, 1941, the amounts of $180,000 and $220,000 in settlement of deficiencies in income tax and surtax on undistributed profits for the years 1936 and 1937, respectively, with interest thereon. These taxes were paid pursuant to a decision of the United States Board of Tax Appeals, Docket No. 102390, entered on February 14, 1941, pursuant to written stipulation signed by counsel for petitioner and the Commissioner of Internal Revenue.

Petitioner paid on July 31, 1940, to the collector of internal revenue at New Orleans, Louisiana, as capital stock tax for the year ended June 30, 1940, the amount of $30,250 on $27,500,000 elective declared value of capital stock at the effective rate of $1.10 per each full $1,000 of declared value.

Petitioner deducted on its income tax returns, and was allowed as a deduction for the year 1939, the amount of $20,462 in respect of the capital stock tax for the year ended June 30, 1940.

Petitioner showed in its capital stock tax return for the year ended June 30, 1940, an adjusted declared value for its capital stock of $20,136,546.16, but elected to declare in its return for that year an elective declared value of $27,500,000, and paid its capital stock tax on the latter amount.

Respondent erred in failing to allow as a deduction for the year 1940 the amount of $2,750, representing the defense tax applicable to capital stock tax for the year ended June 30, 1940, which petitioner paid to the collector of internal revenue at New Orleans, Louisiana, on or before July 31, 1940.

Respondent further disallowed the amount of $7,038.51, representing capital stock tax accruable and paid for the year 1939.

Relief Under Section 722.

Petitioner claims that a number of qualifying events under section 722 (b) (2) and (4) 1 justify a reconstruction of its base period earn

1 Internal Revenue Code of 1939.

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 if [the taxpayer's] average base period net income is an inadequate standard of normal earnings because

(2) the business of the taxpayer was depressed in the base period because of temporary economic circumstances unusual in the case of such taxpayer or because of the fact that an industry of which such taxpayer was a member was depressed by reason of temporary economic events unusual in the case of such industry,

(4) the taxpayer, either during or immediately prior to the base period, commenced business or changed the character of the business and the average base period net income does not reflect the normal operation for the entire base period of the business. If the

ings. Apart from establishing these qualifying events, petitioner must also provide a basis from which we may determine a fair and just amount representing such reconstructed earnings. Unless an amount may be thus established in excess of the credit as otherwise computed by respondent, no relief should be granted under section. 722. Monarch Cap Screw & Manufacturing Co., 5 T. C. 1220.

I. Change in Capital Ratio Under 722 (b) (4).

Respondent concedes that petitioner qualifies for relief in the years 1941 through 1945 under section 722 (b) (4) because of a change in its ratio of nonborrowed capital to total capital which occurred during the base period, but challenges the amount of petitioner's reconstruction for those years and the availability of any relief for the year 1940. Petitioner's claim for refund for that year did not specifically claim relief because of the change in its capital ratio.

Respondent takes the position that the conference memorandum filed in 1945 contained the earliest claim of this ground for relief as to 1940, and that even if that memorandum were construed as an amendment to the original claim, it was then barred by the statute of limitations. Petitioner does not deny that the statute of limitations barred the assertion of new grounds for relief for 1940 prior to the filing of its conference memorandum. But it contends that the only ground for relief which it was required to claim under respondent's regulations at the time its original application was filed in

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 purpose of this subparagraph, the term "change in the character of the business" includes a change in the operation or management of the business, a difference in the products or services furnished, a difference in the capacity for production or operation, a difference in the ratio of nonborrowed capital to total capital,

* Certain adjustments in actual base period earnings have been allowed by respondent under section 713 (e) (1), in computing the credit for the years 1942 through 1945. Any reconstructed credit must exceed actual earnings as adjusted under section 713 before relief may be granted under section 722 for these years, as petitioner may not avail himself of both sections. Stimson Mill Co., 7 T. C. 1065, affd. (C. A. 9) 163 F. 2d 269, certiorari denied 332 U. S. 824; Dowd-Feder, Inc., 10 T. C. 345, affd. (C. A. 6) 173 F. 2d 673.

* Regulations 109, section 30.722–5 (a), prior to its amendment in November 1945 but after May 1943, read in part as follows:

the application for relief shall set forth in detail and under oath each ground under section 722 upon which the claim for relief is based, and facts sufficient to apprise the Commissioner of the exact basis thereof. The mere statement of the provision or provisions of law under section 722 upon which the claim for relief is based shall not constitute an application for relief within the meaning of section 722. ••• If it is not possible for the taxpayer prior to September 16, 1943, to obtain, prepare, and present all the detailed information required to establish its eligibility for relief and the amount of its constructive average base period net income,such information may be submitted within a reasonable time after filing the application as a supplement to the application. No new grounds presented by the taxpayer after September 15, 1943, will be considered in determining eligibility for relief or the amount of the constructive average base period net income to be used in computing such relief for taxable years beginning in 1940 or 1941. [1943 C. B. 761, 786. Emphasis added.]

September 1943 was a "change in the character of the business"; that the specific facts relating to a change in its capital ratio are merely detailed evidentiary matter in support of its timely statutory ground, rather than a ground in themselves; and that such detailed information, contained in its June 1945 conference memorandum together with information to support allegations of increased capacity and change in method of operation, was presented within the "reasonable time” after the filing of the original application which is allowed by the regulations for the furnishing of such material.

Congress has seen fit to specify a change in the ratio of nonborrowed to total capital as a specific qualifying change in the character of a business for purposes of section 722 (b) (4). It is difficult to conceive that such a claim should be classified as mere "evidentiary matter," rather than a qualifying ground which the regulation, as amended in May 1943, required to be claimed on the appropriate claim form within the time specified by the statute of limitations. The evidence indicates that petitioner so treated the application in 1945. In 1943, it had filed a claim on Form 991 simultaneously for each of the years 1940 and 1941. These claims contained substantially identical allegations of grounds for relief; neither mentioned a change in capital ratio as such a ground. But in March 1945, just before the statute of limitations expired on the 1941 claim, but after it had expired for amending the 1940 form, the 1941 application was amended as required by the regulations, and petitioner used the following language:

Without waiving any of the several grounds set forth in its application for relief under section 722 *** your applicant asserts as an additional ground for relief under sub-section (B)-(4) of said section 722, the difference in the ratio of its non-borrowed capital to its total capital during and immediately prior to the base period. [Emphasis added.]

In view of the language of the regulations as it existed when petitioner first filed its claim for 1940, and its own conduct with respect to its application for the year 1941, we are satisfied that its claim as filed for 1940 is insufficient to support a claim for qualification for relief in that year because of a change in capital ratio during the base period. Respondent properly refused to entertain such a claim. See Angelus Milling Co. v. Commissioner, 325 U. S. 293, affirming (C. A. 2) 144 F.2d 469, which affirmed 1 T. C. 1031; Hummel & Downing Co., 21 T. C. 231.

T. D. 5393, approved July 21, 1944, amended the last sentence of the section of Regulations 109 quoted in footnote 3, supra, to read as follows:

No new grounds presented by the taxpayer after the period of time for filing a claim for credit or refund prescribed by section 322 will be considered in determining whether the taxpayer is entitled to relief or the amount of constructive average base period net income to be used in computing such relief for a taxable year. [1944 C. B. 415, 421.] This permitted the amendment of the 1941 application which would otherwise have been barred by the superseded language of the regulation; but it apparently came too late for the terms of the new provision to permit an amendment of the 1940 claim.

And as to the years for which petitioner is concededly entitled to benefit from its qualification for a change in capital ratio, respondent in some respects properly modified the proposed reconstruction. The governing regulations require that reconstruction be allowed only to the extent that retired borrowed capital is offset by a corresponding increase in equity invested capital during the base period. This limitation petitioner has not observed. But it does not question the propriety of such an adjustment which must accordingly be made in petitioner's reconstruction. Jefferson Amusement Co., 18 T. C. 44, 53, 63.

Although it is not entirely clear that the parties are in disagreement, the rate of interest to be used in computing the interest adjustment should likewise be the actual rate in effect in each year. Petitioner seeks to have disallowed interest deductions for each base period year by the extent to which those actual deductions exceed the interest computed at the rate it was paying on December 31, 1939, notwithstanding it was paying only the lower rate after October 1938. We think that a reconstruction for each year on the actual permissible reduction in borrowed capital and on the basis of actual effective rates in each year is both necessary and appropriate to accomplish the remedial purpose of the statute. See Foskett & Bishop Co., 16 T. C. 456, 463.

Petitioner seeks to adjust certain amortization expense deductions as the functional equivalent of interest as a part of its reconstruction under section 722 (b) (4), on the ground that these amortization expenses are the reciprocal effect of variations in interest rates. Respondent contends that the governing regulations' refer solely

5 "For the purposes of section 722 (b) (4) a difference in the ratio of nonborrowed capital to total capital does not obtain merely because borrowed capital has been reduced or because equity invested capital has been increased. Such difference arises only when there is a decrease in borrowed capital offset by a corresponding increase in equity capital. In such event the amount of interest, on borrowed capital so retired during the base period, which has been deducted in computing average base period net income shall be disallowed as a deduction in computing constructive average base period net income. For the purposes of the preceding sentence, the amount of borrowed capital retired during the base period shall be limited to the increase in equity invested capital (whether by amounts paid in for stock, as paid-in surplus, or as contributions to capital, or by the amount of accumulated earnings and profits) for such period." (Regs. 112, sec. 35.722-3 (d) (4).)

Since respondent does not question the propriety of the higher interest deductions, this is not a proper case for the adjustment of the base period year returns under section 734. "E. g., "* If a taxpayer operated during the base period in whole or in part on borrowed capital, the interest paid or accrued on such capital would be a deduction in computing average base period net income. If during the base period borrowed capital was reduced so that at the end of its base period the interest deduction was reduced, deductions for interest during the base period would be greater than such deductions during the excess profits tax taxable years. If the total capital at the end of the base period was as large as or larger than the total capital prior to the reduction of the borrowed capital, the average base period net income, to the extent that it was reduced by the interest deduction, would furnish an inadequate standard for determining excess profits. (Regs. 112, sec. 85.722-3 (d) (4).)