26 T.C. 222">*223 In this proceeding, the questions to be determined are entirely different, Docket No. 31942 involving claims for relief under section 722 (b) (4) of the Internal Revenue Code of 1939 for the years 1941 through 1945 and Docket No. 32302, a claim under section 722 (c) of the Internal Revenue Code of 1939 for the year 1943. They will be discussed separately in the opinion.

FINDINGS OF FACT.

Flotill Products, Incorporated, the petitioner in Docket No. 31942, is a California corporation organized February 15, 1939. Its returns for the taxable years involved, the fiscal years ended August 31, 1941 to 1945, inclusive, were filed with the collector of internal revenue for the first district of California.

Flotill Sales Corporation, the petitioner in Docket No. 32302, is a New York corporation. It was organized under the name of Flotill Products, Incorporated, March 31, 1934. In 1941 its name was changed to Flotill Sales Corporation. Its return1956 U.S. Tax Ct. LEXIS 204">*206 for the period involved, the fiscal year ended March 31, 1943, was filed with the collector of internal revenue for the second district of New York.

For identification these corporations will be referred to hereinafter as Flotill Products, California, Flotill Products, New York, and Flotill Sales. Flotill Products, California, operates a vegetable and fruit canning business in the State of California. Its principal place of business is located at Stockton, California. It has other canneries located in that section of the State. Flotill Sales acts as petitioner's selling agent in States east of the Mississippi River.

In March 1939, Flotill Products, California, acquired the capital stock of Flotill Products, New York, and in August 1939 exchanged it for all of that company's assets and liabilities. The capital stock of Flotill Products, New York, was then canceled but its corporate charter was not surrendered and the company was later revived, as hereinafter explained, to act as exclusive selling agent for Flotill Products, California, in the eastern United States. Flotill Products, California, was not licensed to do business in New York.

Flotill Products, New York, was organized1956 U.S. Tax Ct. LEXIS 204">*207 in 1934 for the purpose, primarily, of canning Italian-type tomatoes and tomato paste. Its chief promoter was Tillie Weisberg, now Tillie Lewis. In 1933 she was working as a clerk in the wholesale grocery business in Brooklyn, New York. Among the firm's products was a canned pear-shaped tomato and a paste made therefrom which were imported from Italy. 26 T.C. 222">*224 Tillie conceived the idea of manufacturing these products, or similar products, in this country. She made a trip to Italy in 1933 and while in Naples interviewed Luigi Del Gaizo, whose family owned and operated one of the largest tomato canning businesses in Italy and whose products were among those handled by her firm in New York, and persuaded him to finance the establishment of a plant for canning Italian-type tomatoes in the United States. Del Gaizo agreed to supply $ 10,000 cash and a limited amount of equipment to get the business started. Tillie brought back a small quantity of Italian-type tomato seed when she returned to this country.

It was decided that the venture would be begun experimentally in the San Joaquin Valley in California. Tillie made a trip to that State, her first, and arranged with a small canning1956 U.S. Tax Ct. LEXIS 204">*208 concern located at Merced for the use of its plant and equipment to put up an experimental pack of Italian-type tomatoes. She then visited the farmers in that vicinity and persuaded them to plant a small acreage with the seed which she had brought back from Italy.

The experiment was not entirely successful, due to the fact that special equipment, which the plant did not have, was needed for that type of product. It was found, however, that the Italian-type tomatoes could be grown successfully in California and that they were superior in quality to those grown in Italy. Italian-type tomatoes are used principally for making sauces, such as that used with spaghetti. For this purpose they are preferable to the American or round tomato, commonly grown in this country. They have a higher percentage of solids and a smaller percentage of juices. This quality makes them particularly desirable for tomato paste.

Flotill Products, New York, was organized under the laws of the State of New York to operate the business. The Del Gaizo interests acquired 85 per cent of its capital stock. The other 15 per cent was issued to Tillie and she was named manager of the business. Pacific Can Company1956 U.S. Tax Ct. LEXIS 204">*209 was engaged to build a canning plant at Stockton, California. The plant was occupied in 1935 under a 3-year lease with an option to purchase. The Del Gaizos contributed an additional $ 50,000 working capital and some special equipment for the new plant. They also sent experienced workmen to install the equipment and get the business in operation.

The packing of Italian-type tomatoes in the United States did not gain industry recognition until about 1933. It had been tried in prior years on an experimental basis by a few canners. In 1935 there was one other cannery in the United States packing this type of tomato commercially. It was located at Riverbank, California. Its pack in 1935 was about the same as that of the predecessor company. 26 T.C. 222">*225 There were 8 packers in 1937, 6 in 1938, 12 in 1939, and 17 in 1940. They were all located in California.

Until about the middle 1930's the market for Italian-type tomatoes and tomato paste was in the large eastern cities and Chicago. Most of the consumers were of Italian or Jewish extraction. They had become accustomed to the Italian products and were slow to change. However, by 1935 or 1936 the demand was growing for the American1956 U.S. Tax Ct. LEXIS 204">*210 products and a market for them had become well established by 1939 or 1940.

The Del Gaizos retained control of Flotill Products, New York, until 1939 when their stock was purchased by Tillie Weisberg. Under their control the development of the business was handicapped by their refusal to furnish sufficient operating capital, their reluctance to adopt modern methods of canning, and by their insistence on handling all sales of the company's products through their New York distributing company. The supervisory personnel which they furnished for the plant was sometimes inefficient.

Luigi Del Gaizo, the principal stockholder of the predecessor company, died in 1937. Soon thereafter Tillie Weisberg began negotiating with his estate for the purchase of his interest in the business. After considerable delay, caused largely by internal conditions in Italy at that time, the negotiations were finally concluded in March 1939 with the purchase by Tillie of the Del Gaizos' 85 per cent of the stock of Flotill Products, New York, for approximately $ 72,000. The stock of Flotill Products, New York, was then exchanged for stock of Flotill Products, California, as heretofore stated.

Late in 1938, 1956 U.S. Tax Ct. LEXIS 204">*211 when it became evident that she would gain control of the company, Tillie began to make plans for the expansion of the business. Contracts were made with farmers for increased production for the 1939 pack, and new, modern equipment was installed in the plant. The machinery and equipment account was increased from approximately $ 103,000 to $ 151,000 over the period April 1, 1938, to December 31, 1939, and to approximately $ 218,400 on August 31, 1940. The sales activities of the company were increased and new market outlets were established. Bookings had been made for the entire 1939 pack, which was almost double that of the 1938 pack, by the middle of November, the end of the packing season for that year.

The canning season in California usually begins early in August and runs for 70 to 90 days. Contracts for the planting of tomato acreage are entered into by the canners and farmers before the planting season. The following table shows the acreage contracted for by Flotill Products, California, and Flotill Products, New York, for both pear-shaped and round tomatoes for the pack years 1936 to 1940, inclusive: 26 T.C. 222">*226

1956 U.S. Tax Ct. LEXIS 204">*212 In November 1939, Flotill Products, California, prepared a forecast of the 1940 pack, estimating a contractual acreage of 3,904 acres of Italian tomatoes and 797 acres of round tomatoes. The round tomatoes were carried to give a broader market for its products among average American housewives.

For some time after Tillie Weisberg gained control of the business it was hampered by a lack of capital. Most of the new equipment was purchased "on time." Some of the payments to farmers for their produce and the salaries and wages of employees had to be deferred. These conditions improved somewhat in 1940.

The total production, in cases, of Flotill Products, New York, and Flotill Products, California, of both Italian and round tomatoes, tomato paste, and other miscellaneous products for the calendar years 1935 to 1941, inclusive, was as follows:

1956 U.S. Tax Ct. LEXIS 204">*213 The California pack (which was also the United States pack) of Italian-type tomatoes, in cases, for the calendar years 1937 to 1939, inclusive, was as follows:

The United States imports for consumption of canned tomatoes for the calendar years 1936 to 1939, inclusive, in thousands of pounds, practically all of which were from Italy, were as follows: 26 T.C. 222">*227

The export of Italian tomatoes to the United States was curtailed after the outbreak of the war in Europe in the fall of 1939 and virtually ceased about June 1940 when Italy entered the war.

Canned tomatoes and tomato juice were considered important war foods. As with many other food products, the production and prices of canned tomato products greatly increased after the outbreak of the war in 1939.

The following is a summary of the profit and loss statements of Flotill Products, New York, and Flotill Products, California, for the fiscal years ended March 31, 1935 to 1939, inclusive, the short year1956 U.S. Tax Ct. LEXIS 204">*214 ended August 31, 1939, and the fiscal year ended August 31, 1940:

In the computation of profits or losses shown above, deductions were taken for officers' salaries, consisting principally of the salary of Tillie Weisberg, and brokerage and commissions, as follows:

Most of the sales of Flotill Products, California, are to brokers, wholesalers, and chain stores. Contracts for these sales are usually made in the first 3 or 4 months of 1956 U.S. Tax Ct. LEXIS 204">*215 the calendar year, in advance of the canning season. Usually about 60 or 70 per cent of the year's pack is under contract for sale by September. The independent retailers usually buy in small quantities and give repeat orders throughout the year. For lack of storage space or operating funds, buyers 26 T.C. 222">*228 sometimes want their shipments spread out over the year. Canners usually keep sufficient inventory of finished products on hand for this late trade but they do not like to carry over goods from one season to another. Most of the previous year's pack is usually shipped by the end of the year. The goods are carried in inventory until shipped, and are paid for at that time.

Flotill Products, California, filed claims for relief under section 722 for the taxable years 1941 to 1945, inclusive. The respondent determined that it was entitled to relief under section 722 (b) (4), Internal Revenue Code of 1939 --

by virtue of your incorporation during the base period (1939), coupled with a change in the character of the business continued by the new corporation, as evidenced by the change in management policies subsequent to acquisition of undivided control by the new ownership in1956 U.S. Tax Ct. LEXIS 204">*216 1939.

Flotill Products, California's excess profits tax liability, as finally determined by the respondent, the amounts previously assessed, and the overassessments or deficiencies found for each of the taxable years, are as follows:

In his determination, the respondent allowed Flotill Products, California, a constructive average base period net income of $ 79,228.64 for 1941, and $ 106,576.06 for each of the years 1942, 1943, and 1944. In disallowing the claim for 1945 respondent stated that the company's tax liability for that year, computed under the 80 per cent limitation provided by section 710 (a) (1) (B) of the Internal Revenue Code, was less than its tax liability computed under section 722.

In 1940 Tillie Weisberg and her associates decided to reactivate Flotill Products, New York, to act as a sales agent for Flotill Products, California, in the eastern United States. By amendment to its corporate1956 U.S. Tax Ct. LEXIS 204">*217 charter its name was changed to Flotill Sales Corporation. Its capital stock consisting, under its amended charter, of 100 shares of no-par-value was all purchased by Tillie Weisberg for $ 10,000. New quarters were leased and brokers and salesmen were engaged to handle the canned tomatoes, tomato paste, and other products of Flotill Products, California.

On September 1, 1940, an agreement was entered into between Flotill Sales and Flotill Products, California, whereby the former was granted an exclusive sales agency in the States east of the Mississippi 26 T.C. 222">*229 River for the products of the latter. The contract was to run for 5 years commencing September 1, 1940, but could be terminated by either party on 30 days' written notice. Under its terms Flotill Sales agreed to use its best efforts for the promotion and sale of the products, and was required to maintain sales offices and to employ salesmen and brokers for that purpose. It was entitled to receive a commission of 5 per cent on such sales. It was also permitted to handle other noncompetitive products in addition to those of Flotill Products, California.

Flotill Sales operated under the above-described agreement, as modified, 1956 U.S. Tax Ct. LEXIS 204">*218 until its dissolution on May 1, 1943. Its income was all derived from sales of products of Flotill Products, California, some of which it handled as agent and some of which it purchased and sold on its own account. Following is a summary of Flotill Sales' profit and loss statements for the years ended March 31, 1941, 1942, and 1943, and for the period April 1 to May 1, 1943, as adjusted by revenue agent's reports:

Flotill Sales' excess profits net income, as adjusted, 1956 U.S. Tax Ct. LEXIS 204">*219 was $ 16,013.71 for 1941, $ 7,904.74 for 1942, and $ 68,707.43 for 1943.

The balance sheets of Flotill Sales showed assets and liabilities on March 31, 1941, 1942, and 1943, as follows:

Flotill Sales was dissolved May 1, 1943, and its assets, including the sales contract with Flotill Products, California, were distributed to Tillie Weisberg, its sole stockholder. She sold the contract in 26 T.C. 222">*230 that year to another corporation, Flotill Sales of Delaware, for $ 250,000, of which $ 50,000 was paid in cash. She had no financial interest in the purchasing company, although its stockholders were her former associates in Flotill Products, California, or Flotill Sales, or were in some way connected with the business of those1956 U.S. Tax Ct. LEXIS 204">*220 companies. One of the stockholders was Meyer Lewis whom she married in 1948.

In computing Flotill Sales' excess profits tax liability, the respondent allowed excess profits credits of $ 11,422.01 for the year 1941 and $ 12,964.19 for the year 1942, computed under the income method, and $ 4,934.95 for 1943 based on invested capital. The 1941 and 1942 credits were based on the 1936-1939 income of Flotill Products, New York. These were the methods of computing excess profits credits used by Flotill Sales in its returns.

Flotill Sales filed an application for excess profits tax relief under section 722 for the taxable year ended March 31, 1943, which respondent disallowed. The excess profits tax liability, as finally determined by the respondent, was $ 60,289.25, of which $ 41,297.74 had been previously assessed.

In its petition Flotill Sales alleged error in the respondent's failure to find that petitioner was entitled to relief under the provisions of section 722 (c) of the Internal Revenue Code of 1939.

Written stipulations of facts were filed in both proceedings and are incorporated herein by reference.

The changes which were made during the base period in the ownership, management, 1956 U.S. Tax Ct. LEXIS 204">*221 and business operations of Flotill Products, California, were substantial and were potentially productive of increased earnings.

At the close of its base period, Flotill Products, California, had not reached the level of earnings that it would have reached if the changes in management and operations of its business had been made 2 years earlier than they were.

A fair and just amount representing petitioner's constructive average base period net income is $ 140,000.

OPINION.

The first part of this Opinion will pertain to Flotill Products, Incorporated, Docket No. 31942. The term "petitioner" as herein used will refer to that company. Respondent determined that Flotill Products, Inc., qualifies for excess profits tax relief under section 722 (b) (4) --

by virtue of your incorporation during the base period (1939), coupled with a change in the character of the business continued by the new corporation, as evidenced by the change in management policies subsequent to acquisition of undivided control by the new ownership in 1939.

26 T.C. 222">*231 Respondent has made a partial allowance of petitioner's claims for relief based on a constructive average base period net income of $ 106,576.06. 1956 U.S. Tax Ct. LEXIS 204">*222 Petitioner contends that it is entitled to a constructive average base period net income of $ 247,000.

Petitioner complains that in computing its average base period net income in this manner respondent has failed to apply "or properly to apply" the 2-year push-back rule of section 722 (b) (4). Respondent insists to the contrary, that he has applied, and properly applied, the push-back rule. He refers to the ruling of the Excess Profits Tax Council that --

In view of all of the foregoing factors, the Council panel has decided that the claimant's earnings from its actual pack in 1939 comprises a fair and just approximation of the amount which might have been earned at the end of the base period if the qualifying changes had occurred two years earlier.

Respondent, in his brief, refers to it as "a mere coincidence of fact" that the actual earnings for the last year of the base period were considered to be the same as the level of earnings based on the actual length of the development period after the changes.

As pointed out, respondent recognizes that in 1939 there were qualifying changes in the character of the business under section 722 (b) (4). These changes were inaugurated by1956 U.S. Tax Ct. LEXIS 204">*223 Tillie Weisberg when she acquired the controlling interest in the petitioner corporation in March 1939; in fact, some of the changes were begun late in 1938, when it became evident that she would acquire the Del Gaizos' stock interests. She increased the contracted tomato acreage with the farmers and began installing new, improved equipment and generally modernizing the plant. She increased the sales activities and established new outlets for petitioner's products. The contract acreage was increased from 1,650 acres in 1938 to approximately 2,712 acres in 1939, and the 1940 acreage was further increased to 5,165 acres. The entire 1939 pack, which was almost twice the 1938 pack, had been sold by the middle of November, about the end of the 1939 packing season. At December 31, 1939, and at the close of petitioner's base period, August 31, 1940, there was a well-established market for the pear-shaped tomatoes and tomato paste which the petitioner was producing, and the prospects were for further market expansion.

In view of the evidence in this case, we think respondent's determination of the amount representing a fair and just amount as petitioner's average base period net income1956 U.S. Tax Ct. LEXIS 204">*224 as recited in our Findings of Fact was too low. At the same time, petitioner's proposed reconstruction results in too high a figure in this respect. From our study of the evidence, we are convinced that because of the short period for development under the changed conditions petitioner's earnings had not reached their normal level by the end of the base period. After 26 T.C. 222">*232 carefully considering the whole record and petitioner's proposed reconstruction of base period earnings, we have concluded that a fair and just amount representing petitioner's average base period net income is $ 140,000.

Petitioner concedes that its constructive average base period net income should be adjusted for taxes in its excess profits credit for 1941.

We turn now to Flotill Sales Corporation, Docket No. 32302, and hereinafter the term "petitioner" will be used to refer to that company.

Petitioner claims excess profits tax relief for the taxable year ending August 31, 1943, under section 722 (c). ¹ It contends that in computing its excess profits tax credit for that year it was deprived of the use of its base period income experience under section 713, Internal Revenue Code of 1939, by section 740, 1956 U.S. Tax Ct. LEXIS 204">*225 and that the credit based on invested capital is an inadequate standard of normal earnings because the sales contract with Flotill Products, California, which was the principal source of its earnings, was an intangible asset not includible in invested capital. Respondent has computed petitioner's excess profits credit under section 713 (the income method) for 1941 and 1942 in the respective amounts of $ 11,422.01 and $ 12,964.19, and under section 714 (the invested capital method) for 1943 in the amount of $ 4,934.95, in accordance with petitioner's returns for those years.

1956 U.S. Tax Ct. LEXIS 204">*226 Section 722 (c) provides relief only for corporations "not entitled to use the excess profits credit based on income pursuant to section 713." Section 712 provides "a domestic corporation which was in existence before January 1, 1940" must compute its excess profits credit under section 713 (income method) or section 714 (invested capital method), whichever results in the lesser tax.

Respondent takes the position that petitioner was "in existence" during the entire base period and is therefore not qualified for relief under section 722 (c). Petitioner does not deny that it was in existence prior to January 1, 1940, but contends that it was deprived of 26 T.C. 222">*233 the right to compute its excess profits credit under section 713 by reason of section 740, ² Internal Revenue Code of 1939.

1956 U.S. Tax Ct. LEXIS 204">*227 Section 740 deals with methods for computing excess profits credit based on income where, under certain circumstances, there has been a change in ownership of the business. So far as here material, it requires the apportionment of the base-period income experience of the "acquiring" corporation and the "component" corporation. It does not deny the component corporation (in this case, Flotill Sales) the use of its base period experience but does set a limitation on such use. We may assume, as petitioner here contends, that under section 740 (c) and by reason of the transfer of this business and assets to Flotill Products, California, in August 1939, and the fact that it had no income thereafter during the base period, it was deprived, in computing its excess profits tax for 1943, of the credit based on its income experience which it had used and which respondent allowed for the prior excess profits tax years 1941 and 1942.

As we construe the statute, the right to relief under section 722 (c) is not dependent upon the application of any of the provisions of section 740. Section 722 (c) provides that --

The tax computed under this subchapter (without the benefit of this section) 1956 U.S. Tax Ct. LEXIS 204">*228 shall be considered to be excessive and discriminatory in the case of a taxpayer, not entitled to use the excess profits credit based on income pursuant to section 713, if the excess profits credit based on invested capital is an inadequate standard for determining excess profits * * *

Section 712 (a) provides that --

In the case of a domestic corporation which was in existence before January 1, 1940, the excess profits credit for any taxable year shall be an amount computed under section 713 or section 714, whichever amount results in the lesser tax under this subchapter for the taxable year for which the tax under this subchapter is being computed. * * *

Section 713 provides for the computation of such credit under the income method and section 714 under the invested capital method.

Thus, only a taxpayer not entitled to use the income method under section 713 is eligible for relief under section 722 (c), and the sole test for determining that right is whether the taxpayer was "in existence before January 1, 1940."

Since petitioner admittedly was in existence at least up to August 18, 1939, it meets the requirements of section 713 and it, therefore, fails to qualify for relief1956 U.S. Tax Ct. LEXIS 204">*229 under section 722 (c). We have heretofore said 26 T.C. 222">*234 that a corporation is "in existence" for the purpose of section 712 (a) from the day it is created until its corporate rights are legally terminated. Eveready Loan Co., 2 T.C. 1035. We said in that case:

Congress, in the exercise of its sovereign power to tax, might have set forth, in most unequivocal language, the test to be applied in ascertaining when a domestic corporation was "in existence" for the purposes of section 712 (a). It would have been a simple matter to have specifically made, beyond any question whatever, the actual conducting of business the test. Such requirement would have been binding and conclusive, declarations in state corporation laws regarding the date from which "existence" runs to the contrary notwithstanding. Rudolph Wurlitzer Co. v. Commissioner, 81 Fed. (2d) 971. * * *

Corporations are creatures of law. They have no being save at government will and have no powers apart from those authorized by grant or implied therefrom. They come into existence, in a legal sense, at the moment the conditions precedent thereto, as determined1956 U.S. Tax Ct. LEXIS 204">*230 by the statute under which they are formed, are complied with. They are thereafter "in existence" until their life is terminated. * * *

For the reasons stated, respondent is sustained in his determination that petitioner was in existence during the base period, and is, therefore, not entitled to relief under section 722 (c).

Reviewed by the Special Division.

Decision will be entered under Rule 50 in Docket No. 31942.

Decision will be entered for the respondent in Docket No. 32302.

Murdock, J., dissenting: I agree with the majority on the Flotill Products, Inc., case, but I do not agree that Flotill Sales Corporation should be denied relief for the reasons given in the opinion.