19 T.C. 174">*174 Petitioner filed applications for relief under section 722, Internal Revenue Code, and claims for refunds of excess profits tax, as follow:

The first issue presented is whether petitioner is entitled to relief of excess profits tax under section 722 (b)(1), Internal Revenue Code. Similar issues1952 U.S. Tax Ct. LEXIS 55">*56 are presented under section 722 (b)(2) and section 722 (b)(4), I. R. C. There is also presented a question whether the petitioner is entitled to a constructive unused excess profits credit carry-over from the year 1940.

FINDINGS OF FACT.

The facts stipulated are found accordingly.

The petitioner, A. B. Frank Company, was incorporated under the laws of the State of Texas, in 1891. During the years 1936 to 1939, inclusive, and the taxable years, it was engaged in wholesaling dry goods, automotive tools and parts, radios, electric refrigerators, and air conditioners. Its principal place of business is San Antonio, Texas. The petitioner kept its books and filed its income and excess 19 T.C. 174">*175 profits tax returns on the accrual basis of accounting for the calendar year. The tax returns and claims for refunds for the period in question were filed with the collector of internal revenue for the first district of Texas.

From 1921 to 1933 the petitioner was primarily engaged in the wholesale dry goods business. During the years from 1936 through 1939, the petitioner sold about 15,000 different articles of merchandise, including such items as:

1952 U.S. Tax Ct. LEXIS 55">*57 Such things as books and magazines, formal wear, fur coats, furniture, chinaware, jewelry, luggage, men's clothing, millinery, silverware, and sporting goods were not included in its merchandise. The petitioner sold dry goods and apparel through 13 departments but the sale of work clothes accounted for more than 10 per cent of the petitioner's sales during the years from 1936 through 1939. Throughout this period petitioner's factory payroll exceeded $ 50,000 a year and its manufacturing costs exceeded $ 60,000 annually.

Petitioner's products were sold to retailers operating rural variety or general stores. The principal ultimate consumer of petitioner's merchandise was the agricultural worker, usually engaged in cotton picking, and his family. The petitioner's sales were largely dependent upon the trade carried on by the rural stores with the cotton pickers. During the 1920s and 1930s the channels and methods of distribution of dry goods were altered and improved by the increased use of automobiles, better highways, and the advent of chain stores. Several large chain organizations, including Sears Roebuck & Co., Montgomery Ward & Co., and J. C. Penney Co. began opening retail1952 U.S. Tax Ct. LEXIS 55">*58 outlets in Texas in the 1920s. The number of retail chain stores and their sales increased substantially on a national scale during the 1920s and the following decade. The petitioner sold some of its merchandise to these concerns and increased such sales in the years 1936-39. During the period from 1929 through 1939 there was an increase nationally in the number of women's ready-to-wear stores and an appreciable decline nationally in the rural general merchandise stores. Similarly, national sales of general and dry goods stores in 1939 were less than those of 1929. Department store sales had similarly 19 T.C. 174">*176 declined, whereas variety stores sales had increased during this period. In Texas the number of general and dry goods stores and their sales decreased between 1929 and 1939. Texas department stores also suffered a decline in number over the same years but were able to increase their sales.

Due, in part, to the mechanization of farms, there has been a trend, to some extent, of persons moving away from the farms in Texas. In southcentral Texas the trend was a shift from agricultural to non-agricultural employment during the years 1930-40. Cotton is still largely cultivated1952 U.S. Tax Ct. LEXIS 55">*59 and picked by hand today.

The petitioner's trading area was centered in southcentral Texas. This area was principally an agricultural and ranching district although some manufacturing activities were carried on in the cities and elsewhere. The petitioner did not sell any substantial amount of dry goods in the Houston area nor in the east Texas area centered at Dallas and Fort Worth. In the early 1930s petitioner's sale of dry goods decreased substantially. The petitioner corporation found that as its wholesale dry goods decreased, its accounts receivable were reduced and its investment in inventory declined, and that in proportion to its business the petitioner possessed an excess of capital. To employ this capital that accumulated, it was decided to take on another line of business. In 1933 it acquired the Taylor Distributing Company and the Southern Equipment Company, spending approximately $ 100,000 for the assets of the latter firm. The assets and operation of these companies were incorporated in the petitioner's wholesale business as separate departments.

During the 1920s the petitioner solicited business in Mexico but its volume of sales there declined. This decrease1952 U.S. Tax Ct. LEXIS 55">*60 was blamed upon the declining value of the peso, the general uncertainties of business conditions and import duties in Mexico and the development of a domestic industry in that country. The petitioner did not actively solicit business in Mexico between 1933 and 1939, and its sales during this period were insubstantial. In 1939 it was decided to again solicit sales in Mexico, and a few sales were made to a former salesman of petitioner's goods in 1939 and one or two salesmen were hired in 1940. The development of petitioner's Mexican business was on a much more modest scale than its previous efforts. During World War II, the petitioner had less merchandise to export to Mexico and it did not sell appliances in that country. In the years from 1921 through 1948, the petitioner made sales and realized net profits, by years, as follow: 19 T.C. 174">*177

The average annual sales of domestic dry goods for the period 1921-39 were $ 2,920,167. The average annual sales of these goods for the period 1936-39 were $ 2,264,291. The average total annual sales of the petitioner were $ 3,549,700 during 1921-39 and $ 3,159,775 during 1936-39. The average net profit for the term 1921-39 was $ 102,306. For the period 1936-39 the average net profit was $ 129,686.

1952 U.S. Tax Ct. LEXIS 55">*62 During the period 1921 through 1939 the petitioner's total gross profits and gross profits from the sale of dry goods and appliances were as follows:

19 T.C. 174">*178 The total gross profit of the petitioner's business averaged $ 627,447 during the years 1921-39. During 1936-39 the total gross profit average was $ 610,534. The average gross profit on the sale of dry 1952 U.S. Tax Ct. LEXIS 55">*63 goods was $ 572,882 for the years 1921-39. Gross profit on dry goods averaged $ 442,981 during the period 1936-39.

The demand for the merchandise wholesaled by the petitioner in this country was related to the prosperity of the cotton farmers and laborers. The demands for the petitioner's products were dependent, to a great extent, upon the number of persons employed in producing the cotton crop in petitioner's trading area.

In 1936 a drought existed in parts of Texas. The drought was severe in the northwestern areas and drought conditions extended into southwestern Texas and into the outer limits of petitioner's trading area in moderate and slight degree.

During the taxable years involved, the petitioner was entitled to use the excess profits credit based on income. The petitioner's actual average base period net income was $ 129,662.04 for 1941 and $ 131,114.06 for each of the succeeding four years.

OPINION.

The petitioner seeks relief from excess profits tax under section 722, Internal Revenue Code. ¹ The petitioner is entitled to use the excess profits credit based on income. It is petitioner's contention that the tax computed without the benefit of section 72219 T.C. 174">*179 1952 U.S. Tax Ct. LEXIS 55">*64 results in an excessive and discriminatory tax because its average base period net income is an inadequate standard of normal earnings due to the factors stated in section 722 (b)(1), (2), and (4).

1952 U.S. Tax Ct. LEXIS 55">*65 The petitioner bases its claim for relief under section 722 (b) (1), I. R. C., upon the existence of a drought in parts of Texas which were included within petitioner's trading area. The greater portion of petitioner's area was free from the drought condition and those sections affected suffered in moderate degree. Whatever the extent of the drought in the area in which the petitioner traded, the evidence does not disclose what effect the drought had upon petitioner's business. No evidence was introduced relating the drought to a diminution or interruption of petitioner's business. Under section 722 (b) (1), I. R. C., the interruption or diminution of normal production, output, or operation must result because of the occurrence of events which are unusual and peculiar in the experience of the taxpayer. The causal relationship in this instance is left entirely to surmise. Without evidence that the drought caused petitioner's business to be interrupted or diminished, we must deny relief based upon section 722 (b) (1), I. R. C.

Relief is also sought under the provisions of section 722 (b) (4) upon the premise that the petitioner changed the character of its business and the average1952 U.S. Tax Ct. LEXIS 55">*66 base period net income does not reflect the normal operation for the entire base period. A change in the character of the business includes a change in the operation of the business and a difference in the capacity for production or operation. It is petitioner's contention that the qualifying factor under this provision 19 T.C. 174">*180 is the petitioner's entrance into the Mexican market in 1939. In the 1920s petitioner had actively engaged in trade in Mexico, but due to a decline in sales, no effort was made to continue this trade between 1933 and 1939. In 1939 it was decided to reenter this market and sales were made in the years following. A few sales were made in Mexico in 1939. The reentry into the Mexican market on a small scale, after a period of inactivity in that area, does not constitute a change in operation or capacity to operate sufficient to justify the relief sought. In Southland Industries, Inc., 17 T.C. 1551, and East Texas Motor Freight Lines, 7 T.C. 579, cited by petitioner, the enlargement of the trading area was extensive and the change in operation and capacity was substantial in character. In 1952 U.S. Tax Ct. LEXIS 55">*67 the present instance, the sale of merchandise to a former salesman in 1939 and the employment of one or two salesmen in 1940 constitute the only change which occurred. Orders had been accepted between 1933 and 1939 but were not actively solicited. The change envisaged by section 722 (b) (4), I. R. C., requires a departure from the general character of petitioner's business. Stonhard Co., 13 T.C. 790. The return to active solicitation of sales in Mexico upon a smaller scale than before did not constitute a change such as is required.

Nor can petitioner successfully contend that it was committed to a course of action prior to 1940 resulting in a change of capacity for production or operation consummated after 1939. The petitioner's decision again to enter the Mexican market and the employment of one or two salesmen did not constitute a commitment to any course of action. The evidence does not sustain the petitioner's contention that it was committed to trade in the Mexican market prior to January 1, 1940. The testimony of petitioner's officers indicates that the Mexican market was considered unstable due to the fluctuation in the value of currency1952 U.S. Tax Ct. LEXIS 55">*68 and the sudden change in import duties. In 1939 it was thought that the value of the peso had become reasonably steady and reentry into the market was made on a modest scale. This decision in 1939 and the action taken in that year did not commit the petitioner to any course of action in the Mexican market. Whether due to fear of the instability of the Mexican market or to other reasons, it is evident that nothing was undertaken prior to 1940 that could constitute a commitment with regard to selling in Mexico. We are unable to find a valid basis for relief under the provisions of section 722 (b) (4), I. R. C.

The third basis for the relief sought is a depression in the business of the taxpayer because of the temporary and unusual circumstance of a great decline in the cotton industry, as a qualifying factor under section 722 (b) (2), I. R. C. The initial requirement to be met is a 19 T.C. 174">*181 depression in the taxpayer's business. Petitioner contends that the depression is manifested by the fact that the average of domestic sales of dry goods during the years 1921 through 1939 was $ 2,920,167, whereas the average of these sales for the base period years 1936 through 1939 was $ 1952 U.S. Tax Ct. LEXIS 55">*69 2,264,291. Gross profits derived from the sale of domestic dry goods during the period 1921 through 1939, petitioner contends, averaged $ 512,214 and the average base period gross profit for the same items, $ 442,981. It must also be noted that total sales by the petitioner averaged $ 3,549,700 during the 19 years from 1921 through 1939. During the base period years total sales averaged $ 3,159,775. Total gross profit for the entire business averaged $ 627,447 over the long term and $ 610,534 during the base period. These figures indicate a decrease in total sales principally caused by the decline in the sale of dry goods. The decrease in dry goods gross profit was the principal factor in the smaller decline in total gross profit.

When examination is made of corporate earnings the pattern is not the same. Net profits of the corporation over the period 1921 through 1939 show an average of $ 102,306 per year. During the base period, however, this average was exceeded by more than $ 25,000 with an average of $ 129,686. The total earnings during the base period aggregated $ 518,743 which is a greater amount than was earned by the corporation during any other 4-year period between1952 U.S. Tax Ct. LEXIS 55">*70 1921 and 1940 with one exception. Average net earnings during the base period substantially in excess of the long-term average demonstrates that the base period is not an inadequate standard of normal earnings. Foskett & Bishop Co., 16 T.C. 456; Industrial Yarn Corporation, 16 T.C. 681. The average corporate net profits shown here would indicate that the base period was not one in which the business carried on by the petitioner corporation was depressed.

Prior to 1933, the petitioner engaged primarily in the wholesale dry goods business. In that year it began to sell automotive parts, radios and other appliances with the purchase of the assets of the Taylor Distributing Company and the Southern Equipment Company. Its sales in these fields were substantial as were the gross profits received upon such sales. The acquisition of these new lines of merchandise was largely accomplished by the investment of capital formerly tied up in the dry goods business. By 1936 the petitioner corporation had established itself in these new fields and maintained its sales and gross profits upon these items at a substantial level throughout1952 U.S. Tax Ct. LEXIS 55">*71 the base period. It is apparent that the diversion of capital from the dry goods business to the sale of appliances was the principal means of maintaining the petitioner's average total gross 19 T.C. 174">*182 profit for the base period years at $ 610,534 in comparison with the long term average of $ 627,447. The increase in net profits during the base period to an average of $ 129,686 over the long term average of $ 102,306 may similarly be attributed, in great measure, to the return on the capital investment in the new lines of merchandise. Whatever loss was sustained by the absence of dry goods sales in Mexico was, to a great extent, overcome by the earnings on the diverted capital. The increase in average net profits during the base period over the long-term average manifests that the petitioner's business was not depressed.

The entry into the sale of appliance merchandise was not a change of character of business either during or immediately prior to the base period. See Acme Breweries, 14 T.C. 1034. By 1936 the petitioner was established in this line of endeavor. Petitioner contends, however, that the appliance sales made by it during the base period1952 U.S. Tax Ct. LEXIS 55">*72 cannot be used in a comparison of net earnings between that period and the years 1921-1939. It is said by petitioner that like must be compared with like, and that a comparison of net earnings is improper because the average income from appliance sales in the base period more than offset its loss of business in its basic dry goods business.

Section 722 (b) (2), I. R. C., requires the business of the taxpayer to be depressed in the base period. During and prior to the base period the petitioner's business consisted of wholesaling dry goods and appliances. In the determination of whether this business was depressed, we must look at the entire business and not merely one segment of it. The petitioner's business consisted of the sale of many different types of merchandise, and appliances cannot be set apart from the rest. The sales of appliances were made through separate departments of the petitioner's enterprise. We cannot disregard the return on a portion of the capital devoted by the petitioner to its operations before and during the base period. This capital was diverted from the dry goods portion of the business in 1933 after the petitioner discontinued active solicitation1952 U.S. Tax Ct. LEXIS 55">*73 of sales in Mexico. The capital was still invested by the petitioner corporation in its wholesale business which had merely been expanded to include new merchandise. We see no reason to exclude from consideration the earnings received on the sale of appliances from a comparison with earnings upon the same capital when it was devoted to the sale of dry goods. It is our conclusion that although the dry goods sales may have been depressed, the capital released from this line of merchandise was devoted to the sale of appliances which prospered sufficiently to prevent any depression in the taxpayer's business. We are of the opinion that petitioner's business as an entity was not depressed during the base period and for this fundamental reason relief cannot be granted under the terms of section 722 (b) (2), I. R. C.

19 T.C. 174">*183 No evidence to sustain a basis for relief under any other provisions of section 722, I. R. C., is found. Petitioner's claim for an unused excess profits credit carry-over from 1940 must be denied in the absence of a constructive average base period net income determined under section 722, I. R. C.

Decision will be entered for the respondent.