19 T.C. 782">*782 This proceeding is based upon the Commissioner's disallowance of petitioner's applications for relief under section 722 (a), (b) (2) and (b) ( 4), Internal Revenue Code, for each of the six taxable years ended March 31, 1941 through 1946, inclusive. Certain deficiencies were determined solely by reason of petitioner's deferment of excess1953 U.S. Tax Ct. LEXIS 247">*248 profits taxes shown on its returns for said years pursuant to the provisions of section 710 (a) (5), Internal Revenue Code. Petitioner's claim is based on the following factors: (1) The business of petitioner was depressed because of temporary economic circumstances unusual in the case of such taxpayer, i. e., a price war, and (2) the acquisition of the assets and store location of its primary competitor, the Johnson Furniture Company, Inc., and in opening three branch stores.

19 T.C. 782">*783 FINDINGS OF FACT.

The stipulated facts are so found and are incorporated herein.

The petitioner was incorporated under the name of Hemenway, Inc., under the laws of Louisiana, on March 31, 1931. It began to operate a retail furniture business in Alexandria, Louisiana, in 1931 and has continued to operate a furniture store there to the present time. In 1932 petitioner opened a retail furniture store at 509 Milam Street, Shreveport, Louisiana.

Petitioner filed its excess profits tax returns on the accrual basis for the taxable years involved with the collector of internal revenue for the district of Louisiana. Petitioner's excess profits net income for its base period years is as follows:

1953 U.S. Tax Ct. LEXIS 247">*249 Petitioner's average base period net income computed under the provisions of section 713 (f) without adjustment under section 722 is $ 46,525.38.

Facts: Competition With Johnson Furniture Company, Inc.

Petitioner's store in Shreveport was opened with a general line of low priced household furniture and appliances. At that time the largest and best established furniture business in Shreveport was Johnson Furniture Company, hereinafter called Johnson. Johnson's business was almost equal to the combined business of all other furniture dealers in Shreveport. Johnson was incorporated on July 1, 1936, at which time it took over the wholesale and retail furniture business in Shreveport formerly operated by a partnership, composed of F. M. Johnson and J. R. C. Mosley, under the name of Johnson Furniture Company. The partnership had been organized on January 1, 1925, although prior to such date the business had been operated by F. M. Johnson for a number of years. From 1932 until petitioner acquired it the Johnson business was conducted in a building at 919-923 Texas Avenue, Shreveport. The building, which was originally owned by the partnership and later by Johnson Furniture Company, 1953 U.S. Tax Ct. LEXIS 247">*250 Inc., was 5 stories in height and contained approximately 130,000 square feet of floor space. Johnson carried a complete line of home furnishings from the cheapest to the most expensive items. The first inventory purchased by petitioner for its Shreveport store, upon the opening thereof, had been acquired under current market conditions, which in 1932 represented a comparatively low price level. The Johnson inventory, which was considerably larger than that purchased 19 T.C. 782">*784 by petitioner, as aforesaid, had been bought and was held for sale at substantially higher price levels. Consequently, when petitioner sold its merchandise at prices which would yield it a normal mark-up, such prices were far lower than the prices charged at that time by Johnson for comparable merchandise. In order to compete under these conditions Johnson began a campaign to force petitioner out of business in Shreveport. At first this campaign took the form of an intensive promotion of items in its inventory which were comparable with items carried by petitioner's Shreveport store through sales of such items at far lower prices than Johnson's general price level. Subsequently, as the Johnson inventory1953 U.S. Tax Ct. LEXIS 247">*251 came nearer to being on an equal basis with petitioner's from a standpoint of current costs, the promotional efforts of Johnson emphasized gifts of premiums including Packard automobiles and thousands of dollars worth of furniture at extensively advertised raffles.

In July 1935 petitioner moved the location of its Shreveport business to 606 Texas Street, which was in the most important retail district of Shreveport, and had floor space of approximately 35,000 square feet compared to the 24,000 square feet in petitioner's Milam Street store. Concurrently with the move to Texas Street petitioner acquired 10,000 square feet of separate warehouse space so that the entire space of the Texas Street store was available for displays and retailing purposes. Soon after petitioner's move to Texas Street the competition with Johnson became more intense. Johnson's unusual types of promotion and the periods of extreme price cutting became more frequent and were more specifically pointed at petitioner. The competition created by Johnson was a definite and determined effort to put petitioner out of business.

The following table shows the net retail sales and percentages of gross profits realized1953 U.S. Tax Ct. LEXIS 247">*252 thereon in petitioner's Alexandria and Shreveport stores for the fiscal years ended March 31, 1934 through 1939, inclusive, for petitioner's Alexandria store for the fiscal year ended March 31, 1940, and with respect to petitioner's Shreveport, Texas Street, store for the five-month period ending August 31, 1939:

19 T.C. 782">*785 Throughout the years shown in the foregoing table the stocks of merchandise and styles maintained in petitioner's Alexandria and Shreveport stores were almost duplicates of each other.

Apart from the reduction1953 U.S. Tax Ct. LEXIS 247">*253 in its Shreveport retail gross profits owing to the price cutting to which it was compelled to resort, petitioner in an effort to maintain its gross profits did many things which definitely reduced its net profits, such as giving premiums, providing extra services, and conducting in Shreveport an extremely intensified advertising and sales effort entirely out of proportion to the size of its business there. Nothing was overlooked which might attract people to petitioner's store.

Facts: Acquisition of Johnson Furniture Company, Inc., Assets and Business Location.

Petitioner's lease for its Shreveport store at 606 Texas Street was to expire June 1940, and by the terms thereof petitioner was required to notify the lessor before June 1939 of any intention to renew such lease. The renewal rent was higher than petitioner considered it could pay, and petitioner's president, Frank Hemenway, Jr., hereinafter called Hemenway, was unsuccessful in obtaining from the lessor an option for renewal near the rent which petitioner could pay. Petitioner's board of directors had definitely decided against renewal under the terms of the lease. Hemenway repeatedly but unsuccessfully tried to 1953 U.S. Tax Ct. LEXIS 247">*254 obtain a different location in Shreveport which would place petitioner in a more competitive position with Johnson. In or about December of 1938 it occurred to him that if he could work out with Johnson a merger or a purchase of its assets, petitioner would by so doing remove a competitor and at the same time acquire necessary additional floor space by moving into the Johnson building. He therefore began to negotiate with J. R. C. Mosley, hereinafter called Mosley, representing Johnson. Hemenway then took up with the Guaranty Bank in Alexandria the question of borrowing from the bank upon a temporary basis sufficient money to pay the balance of the purchase price over and above the $ 250,000 which petitioner hoped to raise by marketing debentures to the public. The bank's position was that it would not lend the money representing the balance of the purchase price if petitioner sold debentures, and the only conditions upon which the bank would make a temporary loan of such amount would be if (a) Johnson would take preferred stock for $ 250,000 instead of notes, and (b) petitioner raised another $ 100,000 in the form of preferred stock. Hemenway reported to Mosley that there was1953 U.S. Tax Ct. LEXIS 247">*255 no way in which the purchase could be closed unless Johnson would agree to take preferred stock and that even in such event petitioner would have to sell another $ 100,000 worth of preferred stock. Mosley finally 19 T.C. 782">*786 agreed that Johnson would accept the balance of the purchase price in preferred stock since in no other way could the deal be closed. After Mosley agreed to accept preferred stock Hemenway gave him his personal assurance to do all that he (Hemenway) could to pay off Johnson for the preferred stock when, as, and if petitioner was ever in a position to do so. This assurance was not authorized by petitioner's board of directors; it was Hemenway's personal assurance. After Hemenway had reached the aforesaid agreement with Johnson, he offered to sell $ 100,000 of petitioner's preferred stock to P. H. Corbett, hereinafter called Corbett, to whom petitioner owed $ 50,000 on a note. Corbett agreed to take such stock if petitioner would give him 1,500 shares of its common stock as a bonus. Petitioner's board of directors declined to do so. Hemenway then endeavored to have Johnson put up the $ 15,000 represented by the common stock demanded by Corbett but succeeded1953 U.S. Tax Ct. LEXIS 247">*256 only in securing its agreement to put up the money for 500 shares thereof. Hemenway thereupon put up 1,000 shares of his own stock in petitioner in order to prevent the acquisition of the Johnson business from falling through. There were no discussions with or any assurances given to Corbett that he would be paid off or given notes in respect of the preferred stock purchased by him.

On June 3, 1939, petitioner acquired by purchase the business of Johnson and its wholesale subsidiary, the Ark-La-Tex Distributing Company, Inc., including the fixed assets (exclusive of land and buildings), inventories, receivables, and certain prepaid expense items, for a total of $ 584,115.76. The purchase price paid was comprised as follows: cash, $ 334,115.76, and delivery of 2,500 shares of petitioner's 8 per cent cumulative preferred stock, having a par value of $ 100 per share. The cash was obtained through a loan from the Guaranty Bank, made June 5, 1939, bearing an interest rate of 7 per cent, and as a condition to obtaining said loan, petitioner agreed with the bank that not less than $ 200,000 thereof would be repaid before January 1, 1940, through liquidation of inventories and accounts1953 U.S. Tax Ct. LEXIS 247">*257 receivable. The bank loan was reduced by petitioner at various times until it was fully repaid on January 5, 1940. Petitioner acquired a 10-year lease on Johnson's building, located at 919-923 Texas Avenue, for a basic rental of $ 30,000 per year, and also by amendment of its charter, changed its name to "Hemenway-Johnson Furniture Company, Inc." Petitioner continued operation of its store at 606 Texas Street until August 31, 1939, at which time said store was closed and all business moved to the Johnson location. The Ark-La-Tex Distributing Company, Inc., was operated as Ark-La-Tex Wholesale Company and continued as petitioner's wholesale department.

For the first few months after petitioner's acquisition of the Johnson business Hemenway spent most of his time studying the organization 19 T.C. 782">*787 thereof and familiarizing himself with the methods of operation followed by Johnson in order to determine whether petitioner's methods or those of Johnson should be applied in future operations in the Texas Avenue store. By the end of August 1939 petitioner had consolidated the office employees, accounting, and bookkeeping operators, of the Texas Street store with the Texas Avenue office. 1953 U.S. Tax Ct. LEXIS 247">*258 By the first of December 1939 the combined number of petitioner's employees in Shreveport, which totaled 139 at the time of petitioner's acquisition of Johnson, had been reduced to 104. In the Consolidation of the businesses petitioner eliminated competing lines of merchandise and selected those which it preferred to handle.

Facts: Branch Store Openings.

On October 18, 1938, petitioner opened a branch retail furniture store in Bunkie, Louisiana, a town having a population of about 3,500, located about 30 miles southeast of Alexandria. On March 23, 1939, petitioner opened another branch retail furniture store in Bossier City, Louisiana, which had a population of about 5,500 and was located in the immediate vicinity of Shreveport, just across the Red River. On May 1, 1939, a third branch retail store was opened in Vivian, Louisiana, a town having a population of about 2,500 and located about 30 miles northwest of Shreveport. All 3 branches have been in continuous operation up to the present time.

Facts: Constructive Average Base Period Net Income.

Petitioner operated the Texas Avenue store solely during the 4 months of September-December prior to January 1, 1940.

Petitioner's1953 U.S. Tax Ct. LEXIS 247">*259 actual retail sales, all companies, in Shreveport, for the fiscal years ending March 31, 1937, 1938, 1939, and for the period ending December 31, 1939, were as follows:

In petitioner's reconstruction it first 1953 U.S. Tax Ct. LEXIS 247">*261 constructed sales for the fiscal year ended March 31, 1940, as follows: (1) By determining what percentage the total sales for the months of September to December 1936, 1937, and 1938 of all stores was to the yearly sales of all stores for the fiscal years ended March 31, 1937, 1938, and 1939, and (2) by assuming that this percentage was equal to the actual sales made by petitioner for the 4 months of the consolidated operation at Texas Avenue, (3) the reconstructed Texas Avenue sales for the fiscal year ended March 31, 1940, were then computed by dividing the actual sales by the above percentage in (1). Sales for fiscal years ending March 31, 1937, 1938, and 1939 were computed by finding the per cent that the petitioner's retail sales in its Shreveport store during the 4 months ending December 31, 1939, was to the average of the aggregate retail sales in Shreveport by both companies during the comparable periods of the three preceding base period years. This percentage was then applied to the total yearly retail sales by both companies and the product is the constructive retail Shreveport sales for the fiscal years ending March 31, 1937, 1938, and 1939.

Petitioner then determined1953 U.S. Tax Ct. LEXIS 247">*262 the cost of goods sold with respect to these sales. Petitioner's actual expenses for 5 months' retail operations in its Texas Street store ending August 31, 1939, and for 10 months' retail operations at the Texas Avenue store, ending March 31, 1940, were as follows: 19 T.C. 782">*789

1953 U.S. Tax Ct. LEXIS 247">*263 Next, petitioner added actual expenses of the two Shreveport stores and deducted bad debts, administrative salaries, interest, and advertising. This result was multiplied by the percentage of 1939 constructive sales to the combined retail sales made by petitioner during the fiscal year ended March 31, 1940, in its Texas Avenue store, Texas 19 T.C. 782">*790 Street store for 5 months and Johnson for the months of April and May 1939, prior to its acquisition by petitioner.

Petitioner has failed to establish what would be a fair and just amount representing normal earnings to be used as a constructive average base period net income.

OPINION.

It is conceded that the petitioner's acquisition of certain of the assets, plus the store location of Johnson, and the opening of three branch stores during the base period years, represents changes in capacity for operation within the import of section 722(b) (4) of the Internal Revenue Code. ¹ It is unnecessary for us 19 T.C. 782">*791 to consider the section 722(b) (2) factor alleged by petitioner as a ground for relief because of our ultimate grounds for decision herein. Under the provisions of section 722 (a) the taxpayer must go further than merely establishing1953 U.S. Tax Ct. LEXIS 247">*264 the existence of a factor which meets one of the requirements under the subsections of section 722 (b); it must also show a fair and just amount representing normal earnings to be used as a constructive average base period net income, section 722 (a) (see footnote 1). Danco Co., 14 T.C. 276, 282, 287; Tin Processing Corporation, 16 T.C. 713, 722; Singer Bros., Inc., 15 T.C. 683, 692.

1953 U.S. Tax Ct. LEXIS 247">*265 We find that petitioner's reconstruction is based on factors that are not to be considered under the meaning of section 722 (a). The Code specifically provides:

In determining such constructive average base period net income, no regard shall be had to events or conditions affecting the taxpayer, the industry of which it is a member, or taxpayers generally occurring or existing after December 31, 1939, * * *

Petitioner has used as a basis for the computation of its reconstructed expenses, events which took place after December 31, 1939. In so doing, it erred. Singer Bros., Inc., supra, 695; Wisconsin Farmer Co., 14 T.C. 1021, 1033.

What petitioner is endeavoring to construct here is the normal earnings after giving effect to the section 722 (b) (4) factor. Normal earnings are those earnings which would be realized from the operation of its Shreveport business, formerly two separately owned furniture businesses which had been in competition with each other. The new business was in operation in the base period only during 4 months ending December 31, 1939, which is the date to which we are limited with respect to reconstruction1953 U.S. Tax Ct. LEXIS 247">*266 facts and fiscal data.

Petitioner in its reconstruction has been meticulous in its computation of sales for the base period. Petitioner has kept sales records on a monthly basis up to December 31, 1939, so that it is possible to see how the new operation progressed. But the determination of normal receipts is not enough. Petitioner must establish "what would be a fair and just amount representing normal earnings * * *," section 722 (a) (see footnote 1). (Emphasis supplied.) In its construction of expenses for the fiscal year ended March 31, 1940, petitioner has used the total of combined expenses for its Texas Street store for 5 months until it was closed in August 1939 and its Texas Avenue store for 10 months ending March 31, 1940. This construction is contrary to the language of section 722 (a) (see footnote 1) because it includes events and conditions occurring after December 31, 1939, which are strictly prohibited by the statute in the determination of constructive average base period net income. The reconstruction of 19 T.C. 782">*792 base period income must be related to the taxpayer's actual business experience in the base period. Godfrey Food Co., 18 T.C. 1083.1953 U.S. Tax Ct. LEXIS 247">*267 Petitioner has used the total expenses of three different businesses, i. e., its Texas Street expenses, the expenses when Texas Street and Texas Avenue were both being operated by petitioner, and the expenses of Texas Avenue after the Texas Street store was closed, but petitioner has not shown the specific expenses of the new business from September to December 31, 1939. The expenses for the 10 months used by the petitioner in its reconstruction are not a lawful basis for reconstruction not only because they cover a period after December 31, 1939, but because they contain items of expense that were incurred while both Shreveport stores were in operation which are not representative of the new business.

We have endeavored to reconstruct a fair and just amount representing normal earnings but are prevented from doing so because nowhere in the evidence is it shown what the expenses of petitioner in the new operation were for the period prior to January 1, 1940. As a result of our foregoing conclusion, it is not necessary to discuss other factors in the reconstruction.

We, therefore, conclude that the petitioner has not shown it is entitled to relief under section 722.

Reviewed by the1953 U.S. Tax Ct. LEXIS 247">*268 Special Division.

Decision will be entered for the respondent.