27 T.C. 810">*810 Respondent determined overassessments in income tax and deficiencies in declared value excess-profits tax and excess profits tax for the years 1944 and 1945 as follows: 27 T.C. 810">*811

1957 U.S. Tax Ct. LEXIS 261">*262 Respondent also gave notice of the disallowance of a claim for refund asserted in petitioner's application for relief under section 722 of the Internal Revenue Code of 1939 (Form 991) for the year 1944, and of claims for refund on Form 843 for the years 1944 and 1945.

Respondent also advised petitioner that inasmuch as no excess profits tax was assessed, paid, or found due for 1942 and 1943, its applications for relief for those years did not constitute claims for refund. The applications for 1942 and 1943 were filed to secure the benefit of carryovers of unused excess profits credit.

Respondent, by amended answer, made claim for increased deficiencies in excess profits tax for 1944 and 1945 but in his brief has abandoned such claim.

Petitioner has waived all the issues raised in its petition except its claim for relief under section 722 (a) and (b) (1) for the year 1944 and its claim for carryovers of unused excess profits credit from 1942 and 1943. No claim for relief under section 722 was filed for the year 1945.

The testimony was taken before a commissioner of this Court and his findings of fact were duly served on the parties. Objections thereto presented by counsel for the1957 U.S. Tax Ct. LEXIS 261">*263 respective parties have been considered. We make the following findings of fact.

FINDINGS OF FACT.

The petitioner, a Colorado corporation with principal business office in Denver, Colorado, was organized in 1919 and has been continuously engaged in the business of mining and selling coal in Colorado since 1920. Petitioner's tax returns for the years involved herein were filed with the then collector of internal revenue for the district of Colorado.

Petitioner is entitled to use the excess profits credit based on income. Petitioner's arithmetic average base period net income was $ 56,876.15. Petitioner's average base period net income, computed under section 713 (e) of the 1939 Code, was $ 66,052.82 and 95 per cent thereof resulted in an excess profits credit of $ 62,750.18.

Petitioner's coal mines are located in Weld County, Colorado, which is in the Northern Colorado Coal Field, hereinafter referred to as the Northern Field. The subbituminous coal mined in the 27 T.C. 810">*812 Northern Field supplied approximately 85 per cent of the demand for industrial and domestic coal in the Denver and northeastern Colorado market. Due to favorable freight rates in the Northern Field, there is1957 U.S. Tax Ct. LEXIS 261">*264 little competition in that market area from coal from other mining districts and the sale of coal from outside the Northern Field is not a substantial determining factor as to the supply or price of coal in this Northern Field.

Mining started in the Northern Field in about 1880 and from time to time various coal mines have been exhausted and closed and new mines opened. In the Northern Field it was not uncommon to encounter faults which occurred by reason of a geological upheaval after the coal beds were formed by compressed vegetation, but the presence of a fault did not necessarily have a direct bearing upon the quality of the coal adjacent to the fault. In the Northern Field it was not uncommon to encounter areas of coal impregnated with dirt and foreign matter causing a high ash content, but usually the impregnated coal was found in streaks or layers and rarely throughout a coal seam. It is very unusual in this field to find a seam of coal impregnated throughout, from floor to roof, with rock or slate. The rock strata of the entire Northern Field is relatively soft and readily decomposes upon contact with air and water. In order to prevent air from reaching the rock strata1957 U.S. Tax Ct. LEXIS 261">*265 and to avoid a cave-in during mining operations, a layer of coal was usually left on the floor, sides, and roof of entryways, rooms, etc. Also, because of the soft rock strata, the room and barrier pillars of coal could not be completely mined out during the final stage of mining operations prior to exhaustion and abandonment of any particular section of a mine. In the Northern Field, 100 per cent coal extraction was impossible; and, due to varying factors, the percentage of extraction recovery varied with different mines and with different sections of a single mine. Those conditions resulted in an average extraction recovery of approximately 50 per cent of a coal seam in the Northern Field during the base period years.

During the years involved, the petitioner operated 3 mines, namely, the Clayton Mine which was opened in 1920 and exhausted and closed in 1942; the Morrison Mine which was opened in 1930 and is still operating; and the Washington Mine which was acquired and developed during 1937, 1938, and 1939 and was put into operation in 1940 and is still operating.

All of the mineral rights in the property embraced in the Clayton and Morrison Mines were owned by the Union Pacific1957 U.S. Tax Ct. LEXIS 261">*266 Railroad Company, hereinafter referred to as the Union Pacific, and were leased by the petitioner on the basis of a fixed rental and a royalty of 15 cents a ton on all coal mined. Under the leases, Union Pacific was furnished with maps and reports of petitioner's mining operations. 27 T.C. 810">*813 Every 4 months a Union Pacific mining engineer inspected petitioner's mines and conferred with petitioner's mining engineer and superintendent as to the operations. Petitioner's officers, mining engineer, and mining superintendent decided upon the location of development work and the driving of entryways. Once a particular section of the leased premises was developed for mining operations, Union Pacific insisted that petitioner extract therefrom all of the minable coal prior to abandonment of that section. Such requirement was in line with good mining practices because of the cost of development and maintenance of the entryways, and also from the standpoint of the safety of the miners.

Petitioner employed the retreat and break-line pattern method of mining in which main haulage and ventilation entryways and the panel entries are driven to the farthest point of the section from which coal 1957 U.S. Tax Ct. LEXIS 261">*267 is to be mined. Rooms are opened from the panel entries and coal is mined starting at the farthest point of a section and retreating along a predetermined line. The last extractions are the room pillars and barriers, to the extent that safety of the miners will permit, and after all of the recoverable coal has been mined from a section or block of coal, a caving is induced to break the overburden rock strata to relieve the roof pressure and to prevent a "squeeze" on the line of retreat. Barrier pillars of coal along main haulage and ventilation entryways are maintained as long as those entryways with tracks, loading spaces, etc., are continued in use in mining adjoining or more distant sections or blocks of coal. During the base period years, the petitioner's percentage of extraction recovery of coal varied in different sections of its mines but averaged approximately 65 per cent of the coal seam, which was better than the general average for the Northern Field.

The Clayton Mine, opened in 1920, was in a seam of coal at a depth of approximately 340 feet below the surface. During the years 1936 to 1939, inclusive, the Clayton seam was approaching exhaustion and the operations in1957 U.S. Tax Ct. LEXIS 261">*268 that mine were restricted to retreat mining in restricted working spaces. During the base period years and until the Clayton Mine was closed in 1942, production was declining with the result that petitioner could not look to that mine for any increased tonnage as an offset for any possible loss of planned or anticipated production from the Morrison Mine during 1938 and 1939.

The Morrison Mine, opened in 1930, was in a seam of coal at a depth of approximately 160 feet below the surface. Approximately 22 per cent of the Morrison seam overlapped the lower Clayton seam. A major fault cut diagonally across the northwestern and northern portion of the Morrison Mine. Petitioner's experience in the Morrison Mine was that as development work and mining operations approached the major fault, the coal was of a poorer quality than that 27 T.C. 810">*814 found in other areas of the Morrison seam, since the coal in the faulted area was characterized by a reduction in hardness and luster as well as an increased impregnation of rock and dirt which lessened its marketable quality. The degree of impregnation varied in various blocks of coal in the faulted area.

In 1936, petitioner developed a northwest1957 U.S. Tax Ct. LEXIS 261">*269 section of the Morrison Mine (hereinafter referred to as section S) in the vicinity of the major fault. In driving entryways and panels into that section, petitioner unexpectedly encountered a subnormal grade of dirty, bony, curly coal which was of poorer quality than theretofore encountered in the Morrison Mine. As work progressed in opening rooms in 1937, it was discovered that the whole seam in section S, from floor to roof, was impregnated with dirt and other foreign matter. That condition resulted in a higher than usual ash content (going from about 5 per cent to probably 15 per cent) which prohibited the sale of any portion of the production for domestic (lump, egg, pea) usage, but the coal was marketable when crushed for industrial usage. Prior to 1937, the petitioner had never encountered a whole seam of dirty, impregnated coal in either the Clayton or Morrison Mines and, in fact, when mining the area along the same fault at the lower Clayton level, good coal was obtained. The Union Pacific, in accordance with its rights as lessor, insisted that section S be mined out rather than abandoned. Also, since the section had been developed, good mining practice dictated that1957 U.S. Tax Ct. LEXIS 261">*270 extraction be completed along the established retreat and break-line pattern to prevent a squeeze or heavy roof trouble. Petitioner's officers and mining superintendent decided to continue operations of mining the subnormal coal. During 1937, 1938, and 1939, petitioner carried on mining operations in section S and by the end of 1939 all coal that could be safely extracted had been completely mined out. All coal extracted from that section had to be crushed for industrial usage. The dirty, impregnated coal in section S presented a weaker seam for mining operations which required a greater amount of timber bracing, caused trouble with roof settling, slowed down the mining operation, and also resulted in an extraction recovery, during the 3-year period 1937, 1938, and 1939, of an estimated 10,000 tons less than petitioner's average 65 per cent recovery.

During 1938, petitioner was conducting mining operations in a section of the Morrison Mine (hereinafter designated section A) which was immediately south of and adjoined section S, mentioned in the next preceding paragraph. Section A overlapped a portion of the underlying Clayton seam which had been mined out and abandoned in 19281957 U.S. Tax Ct. LEXIS 261">*271 or 1929. After mining out rooms in section A, petitioner started the operation of mining out room pillars and barriers when 27 T.C. 810">*815 an unexpected general subsidence occurred in that section. The mine floors gave way, trouble was encountered in maintaining the roof, and timber bracing could not be kept in place to insure safety of the miners. No similar subsidence had occurred in the Morrison or Clayton Mines prior to 1938. The subsidence was due in part to a weak rock strata between the Morrison and Clayton seams but there was nothing in connection with the mining of the lower Clayton seam underlying section A that should have precipitated the subsidence. The subsidence was a permanent condition which required abandonment of section A and petitioner's plans for production of coal from that section during 1938 and 1939. At the time of the subsidence, petitioner had extracted approximately 50 per cent of the estimated recoverable coal in section A. The abandonment of the partially mined section A resulted in an extraction recovery of an estimated 32,500 tons less than otherwise might have been produced from that section during 1938 and 1939 if the subsidence had not occurred.

1957 U.S. Tax Ct. LEXIS 261">*272 In 1933, a fire occurred in connection with mining operations in a section of the Morrison Mine (hereinafter designated section B) which was immediately east of the above-mentioned section S and in close proximity to section A. The fire was sealed off in 1933 in accordance with good mining practice, which should have extinguished the fire. In 1938, petitioner planned to resume mining operations in section B. Upon breaking the seal to that section, petitioner unexpectedly discovered that the fire was still burning. There had been no indication that the fire was active even though the section was bordered by double entryways in constant use. Fires are not infrequent in coal mines, but usually an effective seal, so as to cut off all air, will extinguish them in a few months' time. This occurrence was abnormal and had never occurred before in either the Clayton or Morrison Mines. Petitioner again had to seal off section B for the protection of the rest of the mine and had to abandon its plan of operation for mining that section during 1938 and 1939. Section B has not been mined since it was again sealed off in 1938, with a resultant loss of an anticipated production of an estimated1957 U.S. Tax Ct. LEXIS 261">*273 24,000 tons of coal which otherwise might have been recovered from that section if the fire had not continued burning prior to and during 1938.

In 1938, petitioner's prior operations in the northern area of the Morrison Mine had resulted in coal extractions around 3 sides of a section (hereinafter designated section C) which was adjacent to the major fault, and some distance to the northeast from the above-mentioned badly impregnated section S. In 1938, petitioner planned to mine coal from section C, but as entryways were started into that 27 T.C. 810">*816 section it was discovered that the coal was so thoroughly impregnated with foreign matter that it was wholly unmarketable. This occurrence had never before been experienced in this mine. In 1938, after obtaining Union Pacific's consent, petitioner bypassed and abandoned section C, with a resultant loss of anticipated production during 1938 and 1939 of an estimated 25,000 tons of coal which otherwise might have been recovered from that section if it had contained marketable coal.

In the petitioner's experience, it had not encountered prior to 1938 a concurrence of the events and conditions outlined above with reference to sections S, 1957 U.S. Tax Ct. LEXIS 261">*274 A, B, and C of the Morrison Mine. Such events diminished the petitioner's planned production of coal during the years 1938 and 1939.

The tons of subbituminous coal produced in the Northern Field, in Colorado, and by the petitioner, as shown by reports to the State of Colorado, for the years 1922 to 1939, inclusive, are as follows:

1957 U.S. Tax Ct. LEXIS 261">*275 Petitioner's major production season was from September 1 to April 1, depending upon the weather. During the spring and summer months, equipment was repaired and development work was carried on for operations planned for the next season, and mining was done only as required to meet the needs of some industrial users. During the base period years, petitioner had several sections of the Morrison Mine developed for mining operations, but it was expensive and time consuming to move equipment from one section to another in the event a planned operation could not be carried out. The subbituminous coal produced from the Northern Field and the petitioner's mines is a high-moisture coal, and if stored above ground the moisture evaporates, 27 T.C. 810">*817 causing the coal to disintegrate. Because of that condition, petitioner did not stockpile or carry an inventory of mined coal.

Petitioner marketed 98 per cent of its coal production in Denver and northeastern Colorado. Approximately 75 per cent of petitioner's production was for industrial usage and approximately 65 per cent of total production was sold under contract directly to industrial users. During the base period years, petitioner fulfilled1957 U.S. Tax Ct. LEXIS 261">*276 all of its contracts for industrial coal, but to do so, during 1938 and 1939, it was necessary to crush coal normally used for domestic purposes. The crushing of domestic coal for industrial use was not a common practice, but it was not unusual in the experience of petitioner. Petitioner's industrial coal was shipped by rail.

Normally about 25 per cent of petitioner's production was for domestic (lump, egg, pea) coal which contains less impurities and thus a lower ash content than industrial coal. Of the coal sold by petitioner for domestic use, approximately 3 or 4 per cent was shipped by rail and the balance was hauled in the dealers' own trucks. The Morrison Mine is situated about a mile from a paved highway, and since the early 1930's there has been some decline in the trucking of coal from that mine.

Notwithstanding the fact that natural gas and oil have been a growing competitor of the coal mining industry of the Northern Field for years prior to the base period, nevertheless the demand for coal due to the growth of population and industry in the Denver area has tended to soften that competition. From about 1930 and throughout the base period years, there has been a more1957 U.S. Tax Ct. LEXIS 261">*277 or less general decline in the total tons of coal produced in the Northern Field.

The petitioner's experience during the base period years was that it had the same customers, that during 1938 and 1939 it fulfilled its industrial coal contracts as above mentioned, but had other orders it could not fill, and that during 1938 and 1939 it had approximately the same market as existed in 1936 and 1937 if it had maintained a 1938-1939 production approximately equal to its 1936-1937 production.

The petitioner's books of account were kept and its tax returns were filed on the calendar year, accrual basis of accounting. In connection with petitioner's profit and loss statements, balance sheets, and tax returns, petitioner has used actual tons of coal sold as representing tons produced and does not include the additional, annual tonnage which was produced and used on the premises as boiler coal for generating power, etc., in the operation of the mine. Petitioner's profit and loss statements and comparative balance sheets for the years 1932 to 1944, inclusive, as per the books and its tax returns as adjusted, are set forth on pages F, G, H, I, and J of Exhibit 4, included herein 27 T.C. 810">*818 by1957 U.S. Tax Ct. LEXIS 261">*278 reference. A summary of the profit and loss statements for the base period years is as follows:

A summary of the tons produced (sold), the net income from property, and the net income from property per ton of each mine for the base period years 1936 to 1939, inclusive, is as follows:

1957 U.S. Tax Ct. LEXIS 261">*279 A summary of the net coal sales per ton, the cost of mining per ton, and the selling and administrative expenses per ton of petitioner's two mines for the base period is as follows:

27 T.C. 810">*819 OPINION.

Petitioner claims relief under section 722 (a) and (b) (1) of the Internal Revenue Code of 1939, ¹ for the calendar year 1944, and also the benefit of any carryovers of unused excess profits credit from the years 1942 and 1943 based on a constructive average base period net income for those years. It contends that the happenings in sections S, A, B, and C of its Morrison Mine were "events unusual and peculiar" in its experience and that as a result of such so-called unusual and peculiar events its "normal production, output, or operation was interrupted or diminished" during the years 1938 and 1939.

1957 U.S. Tax Ct. LEXIS 261">*280 The respondent contends that none of the so-called events were unusual or peculiar within the meaning of section 722 (b) (1) and that petitioner has not shown that they caused an interruption or diminishment in petitioner's normal production, output, or operation. The respondent further contends that "even if the events were 'unusual and peculiar' and even if they, either individually or together, did affect petitioner's production, no reconstruction which comports with logic and the evidence would exceed the petitioner's excess profits credit computed under section 713 (e)."

For reasons hereinafter stated, we agree with the respondent's latter contention. Therefore, we need not decide whether petitioner has established a qualifying factor under section 722 (b) (1) by reason of the happenings in sections S, A, B, and C of its Morrison Mine. We may for the purposes of this opinion assume that it has, and immediately direct our attention to whether, on the basis of such assumption, a constructive average base period net income could logically be established under section 722 (a) which would be in excess 27 T.C. 810">*820 of petitioner's average base period net income allowed under section1957 U.S. Tax Ct. LEXIS 261">*281 713 (e) ² of the 1939 Code in the amount of $ 66,052.82.

1957 U.S. Tax Ct. LEXIS 261">*282 Under section 713(e), petitioner was permitted to substitute 75 per cent of the average excess profits net income of its 3 best years (1936, 1937, and 1938) for its poorest year (1939). This resulted in a substitution of $ 52,842.25 of excess profits net income in place of its actual excess profits net income for 1939 of $ 16,135.58, or a benefit to petitioner of $ 36,706.67. Before petitioner can obtain any further relief under section 722, it must establish that if these assumed, unusual, and peculiar events had not occurred, it would have had an excess profits net income for the base period in excess of its actual amount, plus the benefit it received under section 713(e). Under the facts of this case, such a reconstruction, in our opinion, has not been established.

In its application for relief and in its brief, petitioner claims it has established a constructive average base period net income of $ 100,852. In arriving at this amount, petitioner has made no reconstruction of its 1936 and 1937 excess profits net income but has reconstructed the tonnage produced and the net income from both the Clayton and Morrison Mines for the years 1938 and 1939. It then applied the growth1957 U.S. Tax Ct. LEXIS 261">*283 formula under section 713 (f) of the 1939 Code, which is not permitted under our decision in Homer Laughlin China Co., 7 T.C. 1325. A summary of petitioner's reconstruction, together with the arithmetical average and the average under section 713 (e), are in the margin. ³

27 T.C. 810">*821 It is obvious that petitioner's reconstruction is wholly out of line with the facts set out in our findings. Of the additional excess profits net1957 U.S. Tax Ct. LEXIS 261">*284 income reconstructed for 1938 of $ 70,616.98 ($ 103,413.83 minus actual of $ 32,796.85), $ 42,043.04 represented additional income reconstructed at the Clayton Mine and $ 28,573.94 at Morrison. Of the additional excess profits net income reconstructed for 1939 of $ 74,443.97 ($ 90,579.55 minus actual of $ 16,135.58), $ 38,452.89 represented additional income reconstructed at the Clayton Mine and $ 35,991.08 at Morrison. No basis exists for any reconstruction of the net income from the Clayton Mine. All of the alleged unusual and peculiar events were at the Morrison Mine and not at the Clayton Mine.

Petitioner, in reconstructing the additional excess profits net income from the Morrison Mine for the years 1938 and 1939 of $ 28,573.94 and $ 35,991.08, respectively, has disregarded the constant decline in the net income per ton realized during the base period at that mine. As set out in our findings, the net income per ton at the Morrison Mine declined from 37.8 cents per ton in 1936 to 9.4 cents in 1938 and 6.9 cents in 1939. This decline was due largely to the lower sales price of coal at the Morrison Mine from $ 2.479 per ton in 1938 to $ 2.225 per ton in 1939, in the increased1957 U.S. Tax Ct. LEXIS 261">*285 cost of mining in 1938, and in the increased cost of selling and administrative expenses in 1938 and 1939.

As previously stated, all the alleged unusual and peculiar events occurred at the Morrison Mine. If we were to asume that these so-called events were unusual and peculiar in the experience of petitioner, and that because thereof, petitioner's normal production, output, or operation was interrupted or diminished, and that absent such assumed events petitioner's production and sales at the Morrison Mine during the last half of the base period would have been 91,500 ⁴ tons greater than was actually produced and sold during that period, we fail to see how petitioner's additional net income from such additional tonnage could amount to as much as the benefit of $ 36,706.67 which petitioner received under section 713 (e). A net income of that magnitude on 91,500 tons would average over 40 cents per ton and petitioner's actual net income per ton at the Morrison Mine during 1938 and 1939 was only 9.4 cents and 6.9 cents, respectively, and in fact its net income during the entire base period from the Morrison Mine never reached as much as 40 cents per ton.

1957 U.S. Tax Ct. LEXIS 261">*286 On the basis of all the evidence, we hold that petitioner has failed to show that it is entitled to any relief under section 722 for the 27 T.C. 810">*822 year 1944, or to the benefit of any carryovers of unused excess profits credit from the years 1942 and 1943 based on a constructive average base period net income for those years.

Reviewed by the Special Division.

Decision will be entered for the respondent.