2 T.C. 445">*445 These1943 U.S. Tax Ct. LEXIS 98">*99 consolidated proceedings are for a redetermination of a deficiency in excess profits tax for the calendar year 1940 in the amount of $ 2,194.39 which the respondent has determined against Premier Products Co. as the taxpayer and against the Estate of William D. McCullough, deceased, as transferee of all the assets of Premier Products Co. Transferee liability is admitted, but the amount of the liability, if any, plus interest as provided by law is in controversy.

The sole issue in both proceedings is whether the respondent erred in adding to the "excess profits net income" of Premier Products Co. for the calendar year 1940 an amount of $ 53,471.70. In a statement attached to each deficiency notice, the respondent explained this adjustment as follows:

(a) Under abnormal income attributable to other years, Schedule 1, item 11 of the return, a deduction of $ 53,471.70 was claimed representing proceeds of 2 T.C. 445">*446 life insurance included in normal tax net income, less income and defense taxes allocated to such income. It is held that life insurance proceeds do not constitute abnormal income under Section 721 of the Internal Revenue Code as amended by the Second Revenue Act of 1940. 1943 U.S. Tax Ct. LEXIS 98">*100 Accordingly, the amount of $ 53,471.70 has been added to the excess profits net income.

FINDINGS OF FACT.

Petitioner Premier Products Co. hereinafter sometimes referred to as the "Products Co." was a corporation organized on January 21, 1922 under the laws of the State of Michigan, with its principal office in Detroit. Its returns (Forms 1120 and 1121) for the calendar year 1940 were filed with the collector of internal revenue for the district of Michigan on March 15, 1941.

The Products Co. was dissolved and its assets were transferred to its sole stockholder, estate of William D. McCullough, on December 31, 1940. From the date of its organization in 1922 to the date of dissolution on December 31, 1940, the Products Co. was engaged in the manufacture and sale of cotton padding for automobile seats and upholstering. William D. McCullough was an officer and principal stockholder of the Products Co. from the date of its organization to the date of his death on May 30, 1940.

The petitioner, Estate of William D. McCullough, Deceased, is the estate of William D. McCullough, deceased, acting through John F. Linehan, sole surviving executor of said estate. The estate of William D. McCullough, 1943 U.S. Tax Ct. LEXIS 98">*101 deceased, is the transferee of all of the assets of the Products Co., having received such assets upon dissolution of the Products Co. on December 31, 1940. The assets so received were in excess of the deficiency asserted. Transferee liability is admitted.

Prior to October 1, 1929, McCullough had been an officer and principal stockholder in the Premier Cushion Spring Co. of Detroit, Michigan, a corporation engaged in the manufacture and sale of springs for automobile seats and upholstery. On March 9, 1923, the Premier Cushion Spring Co. took out a life insurance policy (No. 8407819) on the life of McCullough in the amount of $ 50,000 with the New York Life Insurance Co. A similar policy (No. 9168069) was taken out by the Premier Cushion Spring Co. on the life of McCullough in the amount of $ 50,000. with the New York Life Insurance Co. on July 14, 1925. Premiums were paid on these policies by the Premier Cushion Spring Co. from the date of issuance to October 1, 1929, when all of the stock of the Premier Cushion Spring Co. was sold to the Reynolds Spring Co. On December 3, 1929, the Products Co. purchased the life insurance policies above referred to from the Reynolds Spring1943 U.S. Tax Ct. LEXIS 98">*102 Co. for the sum of $ 8,400, and had the policies assigned to the Products Co. Thereafter the Products Co. paid the 2 T.C. 445">*447 premiums on the said policies and during the period from December 3, 1929, to the date of death of McCullough on May 30, 1940, a total amount of $ 20,898.50 was paid by the Products Co. as premiums on said policies. On July 18, 1940, the Products Co. received the entire proceeds of the said policies in the amount of $ 100,376.23. The Products Co. did not receive any income on account of proceeds from life insurance policies at any time during the period of its existence from January 21, 1922, to December 31, 1940, other than the proceeds of $ 100,376.23 received on July 18, 1940, from the two policies on the life of McCullough, above described.

Policy No. 8407819 was a life insurance policy, with disability benefits and double indemnity in case of accidental death. The policy became effective on March 9, 1923, upon the payment of a premium of $ 1,655.50 and provided for the payment of an annual premium in like amount on the 9th day of March of each year during the life of the insured.

Policy No. 9168069 was an ordinary life insurance policy. This policy1943 U.S. Tax Ct. LEXIS 98">*103 became effective on July 14, 1925, upon the payment of a premium of $ 1,595.50, and provided for the payment of an annual premium in like amount on the 14th day of July of each year during the life of the insured.

On March 15, 1941, the Products Co. filed its "Corporation Income, Declared Value Excess-Profits, and Defense Tax Return For Calendar Year 1940" on Form 1120 and reported a "Net income for declared value excess-profits tax computation" of $ 83,241.71. Included in this net income was "Other Income" of $ 71,859.46. Upon the net income of $ 83,241.71 tax liabilities were computed and paid as follows:

After deducting the above taxes of $ 5,331.71 and a dividends received credit of $ 850 from the above net income, the return reported a "Normal-tax net income" of $ 77,060, upon which tax liabilities were computed and paid as follows:

The respondent did not make any adjustments in connection with the above mentioned Form 1120.

On March 15, 1941, the Products Co. also 1943 U.S. Tax Ct. LEXIS 98">*104 filed its "Corporation Excess Profits Tax Return For Calendar Year 1940" on Form 1121, 2 T.C. 445">*448 and reported items Nos. 1 to 24, inclusive, as follows ("None" was reported under items here omitted):

1943 U.S. Tax Ct. LEXIS 98">*105 In connection with item 11 above, instruction VIII quoted in full all of section 5 of the Excess Profits Tax Amendments of 1941 which amended section 721 of the Internal Revenue Code inserted therein by Title II, section 201 of the Second Revenue Act of 1940, and then provided as follows:

A taxpayer claiming the benefits of the above provisions of section 721 shall file with its excess profits tax return a statement showing (a) the amount and nature of the item of income claimed to be abnormal; (b) the method used in allocating such abnormal income and the amount allocated to each year; (c) a schedule showing by years the amount, if any, of income of the same class derived during the four taxable years immediately preceding the taxable year, and (d) all other facts upon which the taxpayer relies.

In connection with item 11 above, the Products Co. attached to its return (Form 1121) the following statement:

1943 U.S. Tax Ct. LEXIS 98">*106 2 T.C. 445">*449 The respondent adjusted the above reported excess profits net income as follows:

Upon the excess profits net income of $ 58,411.29 the respondent computed the deficiency of $ 2,194.39 as follows:

1943 U.S. Tax Ct. LEXIS 98">*107 OPINION.

The question involved in these proceedings arises in connection with the excess profits tax imposed by subchapter E of chapter 2 (sections 710 to 752, inclusive) of the Internal Revenue Code, which subchapter may be cited as the "Excess Profits Tax Act of 1940" and was inserted in the Code by Title II, section 201, 2 T.C. 445">*450 of the Second Revenue Act of 1940. It has since been amended by the Excess Profits Tax Amendments of 1941, approved March 7, 1941; by Title II of the Revenue Act of 1941, approved September 20, 1941; and by Title II of the Revenue Act of 1942. These taxes are in addition to the declared value excess profits tax imposed by subchapter B of chapter 2 of the Internal Revenue Code.

Section 710 (a) of the Internal Revenue Code, as amended, imposes the tax on the "adjusted excess profits net income," which term is defined in section 710 (b), as amended, as the "excess profits net income" minus the sum of (1) a specific exemption of $ 5,000; (2) the "excess profits credit" allowed under section 712, as amended; and (3) the unused excess profits credit. Sections 711 to 720, inclusive, as amended, deal with the determination of the "excess profits net income" 1943 U.S. Tax Ct. LEXIS 98">*108 and the "excess profits credit" and may generally be regarded as the sections dealing with the "normal" provisions of the act. Then come the sections dealing with abnormalities and special cases.

In the instant proceedings the applicable section of the Internal Revenue Code is section 721, entitled "Abnormalities In Income In Taxable Period." This section, as amended, is applicable to all taxable years beginning after December 31, 1939. The material provisions of section 721, as amended, are in the margin. ³

1943 U.S. Tax Ct. LEXIS 98">*109 2 T.C. 445">*451 At the outset it may be noted that under section 732 (c) of the Internal Revenue Code the determination of the question here involved "shall not be reviewed or redetermined by any court or agency except the Board." The instant question, however, does not arise under section 721 (a) (2) (C) or section 722, and in any event is for a taxable year beginning before December 31, 1941, which makes section 222 (c) of the Revenue Act of 1942 inapplicable. This latter section provides that:

Section 732 (relating to review of abnormalities by the Board) is amended by inserting at the end thereof the following new subsection:

"(d) Review by Special Division of Board. -- The determinations and redeterminations by any division of the Board involving any question arising under section 721 (a) (2) (C) or section 722 shall be reviewed by a special division of the Board which shall be constituted by the Chairman and consist of not less than three members of the Board. The decisions of such special division shall not be reviewable by the Board, and shall be deemed decisions of the Board."

The parties agree that the proceeds of $ 100,376.23, less the sum of the cost of the policies and subsequent1943 U.S. Tax Ct. LEXIS 98">*110 premiums paid thereon of $ 29,298.50, or $ 71,077.73 were properly included in the gross income of the Products Co. under Code section 22.

Petitioners contend (1) that the net proceeds of $ 71,077.73, less the income and defense taxes allocated thereto in the amount of $ 17,606.03, or $ 53,471.70, constitute "abnormal income" under section 721 (a) (1); (2) that no amount should be deducted from the abnormal income of $ 53,471.70 in arriving at the "net abnormal income" under section 721 (a) (3); (3) that all but 3.941 percent of such net abnormal income of $ 53,471.70 is attributable to previous years under section 721 (b); and (4) that the tax should be recomputed accordingly 2 T.C. 445">*452 under section 721 (c). We shall consider these four contentions in the order given.

1. In filing its return on Form 1121, which is the United States corporation excess profits tax return prescribed by the Treasury Department, the Products Co. in arriving at its excess profits net income deducted from normal tax net income the amount of $ 18,494.40 as income and defense taxes under item 4 and the amount of $ 53,471.70 as "Abnormal income attributable to other years" under item 11. The latter amount1943 U.S. Tax Ct. LEXIS 98">*111 represented the net insurance proceeds of $ 71,077.73 (included as a part of the normal-tax net income) less $ 17,606.03 which was that part of the $ 18,494.40 attributable to the net proceeds of $ 71,077.73. The respondent adjusted the excess profits net income as so reported by petitioner by adding thereto the amount of $ 53,471.70 deducted under item 11, with the explanation that "It is held that life insurance proceeds do not constitute abnormal income under Section 721 of the Internal Revenue Code as amended by the Second Revenue Act of 1940."

Section 721 was added to the Internal Revenue Code by section 201 of the Second Revenue Act of 1940 and in its original form relief was limited to income falling within one of the six classes specifically referred to therein. Section 721 was later amended by section 5 of the Excess Profits Tax Amendments of 1941 and by section 221 of the Revenue Act of 1942 to read as set forth in our footnote 3, and to be applicable with respect to taxable years beginning after December 31, 1939. The separate classes of income described in subsection (a) (2) are the same as the original six classes referred to above. Subsections (a) and (b) were a 1943 U.S. Tax Ct. LEXIS 98">*112 part of the 1941 amendments and subsections (c), (d), (e), and (f) were a part of the 1942 amendments, the latter two subsections being new in the 1942 Act. Subsection (f) has not been printed in the margin because it is entirely foreign to any question we have here. In reporting H. R. 3531 relative to the 1941 amendments back to the House, the Committee on Ways and Means submitted a report (H. R. Rept. No. 146, p. 9, 77th Cong., 1st sess.), a part of which is as follows:

Section 721 of the present law provides relief with respect to certain abnormalities in income in the taxable period. These abnormalities, six in number, are specifically described. * * * It is believed advisable to extend the principle of this section to any abnormal item of income. As the types of abnormal income that may occur cannot be predicted in advance, adequate relief can only be granted by thus extending the scope of this section.

The test of whether an item is abnormal is clarified to provide expressly that if the item includible in the gross income of the taxable year is in excess of 125 percent of the average amount of the gross income of the same class for the four previous years it shall be considered1943 U.S. Tax Ct. LEXIS 98">*113 abnormal. If the taxpayer was not in existence for the four previous taxable years, the test period is the period during which it was in existence. An item will also be considered abnormal if it is of a class which the taxpayer normally does not receive.

2 T.C. 445">*453 The Commissioner issued Regulations 109 (Cumulative Bulletin 1941-1, p. 117) relating to the excess profits tax under the Internal Revenue Code as amended by the Second Revenue Act of 1940, which were approved by the Secretary on February 8, 1941. This was prior to the enactment on March 7, 1941, of the Excess Profits Tax Amendments of 1941. On May 3, 1941, T. D. 5045 (C. B. 1941-1, p. 69), amending Regulations 109, was issued by the Commissioner and approved by the Secretary. Section 30.721-1 of Regulations 109, inserted therein by paragraph 18 of T. D. 5045, provides in part as follows:

Sec. 30.721-1. Abnormalities in income in taxable year. -- Section 721 provides relief where abnormal income (as defined in section 721(a)) for any excess profits tax taxable year is attributable to other taxable years. The term "abnormal income" means income of any class1943 U.S. Tax Ct. LEXIS 98">*114 includible in the gross income of the taxpayer for any excess profits tax taxable year (A) if it is abnormal for the taxpayer to derive gross income of such class, or (B) if the taxpayer normally derives gross income of such class but the amount of such income of such class is in excess of 125 per cent of the average amount of the gross income of the same class determined for the four previous taxable years or, if the taxpayer was not in existence for four previous taxable years, the taxable years during which the taxpayer was in existence. It is abnormal for a taxpayer to derive income of any class only if the taxpayer had no gross income of that class for the four previous taxable years. * * *

Giving due consideration to the report of the Committee on Ways and Means and the Commissioner's regulations, it is our opinion that the amount of $ 53,471.70 of net insurance proceeds here involved was "abnormal income" as that term is defined in section 721(a)(1). We think it was abnormal for the Products Co. to derive income of such class. During the entire period of its existence it did not derive any income of this class until the taxable year here involved. It meets the test laid1943 U.S. Tax Ct. LEXIS 98">*115 down by the Ways and Means Committee Report as being "of a class which the taxpayer normally does not receive" and the provision of the regulations that "It is abnormal for a taxpayer to derive income of any class only if the taxpayer had no gross income of that class for the four previous taxable years." We hold that the proceeds were abnormal income.

The parties to these proceedings agree that the proceeds in question do not fall within any of the six specific classifications of abnormal income described in section 721(a)(2). This section provides in part that "The classification of income of any class not described in subparagraphs (A) to (F), inclusive, shall be subject to regulations prescribed by the Commissioner with the approval of the Secretary." In this connection section 30.721-2 of Regulations 109, inserted therein by paragraph 18 of T. D. 5045, provides in part as follows:

Sec. 30.721-2. Classification of income. -- Section 721(a)(2) (A), (B), (C), (D), (E), and (F) sets forth six separate classes of income. Income which 2 T.C. 445">*454 does not fall within those provisions may be grouped by the taxpayer, subject to approval by the Commissioner1943 U.S. Tax Ct. LEXIS 98">*116 on the examination of the taxpayer's return, in such other classes as are reasonable in a business of the type which the taxpayer conducts, and as are appropriate in the light of the taxpayer's business experience and accounting practice.

Since the Products Co. only had one class of abnormal income, namely, life insurance proceeds, there is no necessity in these proceedings for the grouping in such other classes provided for in the regulations above quoted.

2. Petitioners' second contention is that no amount should be deducted from the abnormal income of $ 53,471.70 in arriving at the "net abnormal income" under section 721 (a) (3). Since the respondent makes no contention that any amount should be so deducted, we hold that the net abnormal income is likewise $ 53,471.70.

3. The respondent in order to sustain his determinations of the deficiency and transferee liability, respectively, relies primarily on attempting to rebut successfully petitioners' third contention, which is that all but 3.941 percent of the net abnormal income is attributable to previous years under sections 721 (b). Congress has provided that the amount of the net abnormal income attributable to years other than1943 U.S. Tax Ct. LEXIS 98">*117 the taxable year "shall be determined under regulations prescribed by the Commissioner with the approval of the Secretary," and in the above mentioned committee report it is noted that:

* * * The mere fact that an item includible in the gross income of the taxpayer is abnormal, or is in excess of 125 percent of the average amount of the gross income of the same class for the test period, does not result in the exclusion of such item from excess-profits net income. It is necessary that the item be found attributable to other taxable years. Consequently, if an increase in business renders an item of income in excess of 125 percent of the income for the test period, the increase in business will not result in such increased income being excluded from excess-profits net income.

Was any part of the net abnormal income of $ 53,471.70 attributable to other taxable years? Section 30.721-3 of Regulations 109, inserted therein by paragraph 18 of T. D. 5045, provides in part, as follows:

Sec. 30.721-3. Amount attributable to other years. -- The mere fact that an item includible in gross income is of a class abnormal either in kind or in amount does not result1943 U.S. Tax Ct. LEXIS 98">*118 in the exclusion of any part of such item from excess profits net income. It is necessary that the item be found attributable under these regulations in whole or in part to other taxable years. Only that portion of the item which is found to be attributale to other years may be excluded from the gross income of the taxpayer for the year for which the excess profits tax is being computed.

Items of net abnormal income are to be attributed to other years in the light of the events in which such items had their origin, and only in such amounts as are reasonable in the light of such events. To the extent that any items of net abnormal income in the taxable year are the result of high prices, low operating costs, or increased physical volume of sales due to increased demand 2 T.C. 445">*455 for or decreased competition in the type of product sold by the taxpayer, such items shall not be attributed to other taxable years. Thus, no portion of an item is to be attributed to other years if such item is of a class of income which is in excess of 125 per cent of the average income of the same class for the four previous taxable years solely because of an improvement in business conditions. In attributing1943 U.S. Tax Ct. LEXIS 98">*119 items of net abnormal income to other years, particular attention must be paid to changes in those years in the factors which determined the amount of such income, such as changes in prices, amount of production, and demand for the product. No portion of an item of net abnormal income is to be attributed to any previous year solely by reason of an investment by the taxpayer in assets, tangible or intangible, employed in or contributing to the production of such income.

* * * *

Specific methods of treating items of net abnormal income of the six classes specified in section 721 (a) are set forth in sections 30.721-6 to 30.721-11. These methods are to be applied subject to the provisions of this section.

A taxpayer claiming benefits of section 721 shall file with its excess profits tax return a detailed statement in duplicate containing the following information:

(1) the amount and a description of each class of income claimed to be abnormal, and the amount and a description of each item in each such class;

(2) for each class of income claimed to be abnormal, the amount and a description of each item of income of the same class derived during the four taxable years immediately1943 U.S. Tax Ct. LEXIS 98">*120 preceding the taxable year, and the aggregate amount of such items for each taxable year;

(3) for each class of income claimed to be abnormal, the amount of net abnormal income, the amount of each item of net abnormal income, and the computations by which these amounts were determined;

(4) the transactions in which each such item had its origin, the method used in allocating such item, the amount allocated to each year, and the reasons therefor; and

(5) all other facts upon which the taxpayer relies.