14 T.C. 45">*45 The Commissioner determined a deficiency of $ 1,760.21 in petitioner's excess profits tax for the fiscal year ended April 30, 1941, in part by restoring to excess profits net income $ 11,021.87 which petitioner deducted on its return as "abnormal income attributable to 14 T.C. 45">*46 other years." Petitioner claimed that one-fourth of this amount represented "taxable income, under section 734 of the Internal Revenue Code, for each of the taxable years ended1950 U.S. Tax Ct. LEXIS 296">*298 April 30, 1937 to 1940, inclusive." The Commissioner determined that no adjustment under section 734 was allowable. Petitioner now defends deduction of the $ 11,021.87 by invoking section 721 and contending that the amount is attributable to other years by virtue of the research and development of an improved grille and air control which was sold by a business in which it had by contract a 60 per cent interest. The case was submitted on a stipulation, which we incorporate by reference as findings of fact, and on exhibits and oral testimony.

FINDINGS OF FACT.

Petitioner, a California corporation with principal office at Los Angeles, filed its excess profits tax return for the fiscal year ended April 30, 1941, with the collector of internal revenue for the sixth district of California. Its returns are prepared on an accrual basis. Petitioner was incorporated on May 1, 1936, by H. S. McClelland, its principal stockholder, and it has since engaged as a contractor or subcontractor in the installation of heating, ventilating, and air conditioning systems in Los Angeles and vicinity. Its business is a continuation of one begun in 1920 by McClelland and conducted by him individually 1950 U.S. Tax Ct. LEXIS 296">*299 until petitioner's incorporation.

In the performance of his contracts McClelland used equipment which he purchased from eastern manufacturers, with the exception of a few plain lattice grilles which he made himself. He also sold a small number of these grilles to others. In the autumn of 1935 Charles Wheeler, a grille salesman familiar with heating and ventilating equipment, proposed to McClelland the establishment of a business for the local manufacture of grilles. McClelland allowed Wheeler to use space for design work in a brick building, 90 x 120 feet, which he owned and occupied for business purposes at 1928 Compton Avenue, Los Angeles. Wheeler's work and designs were found satisfactory, and on May 1, 1936, when petitioner was organized to carry on McClelland's business, petitioner and Wheeler entered into an agreement, termed "Articles of Partnership," for the manufacture and sale of grilles and other equipment. The business was to be known as the Controlair Manufacturing Co. Petitioner agreed to furnish rent-free adequate space for operation at the Compton Avenue premises, to supply electricity, water, gas, and telephone service for six months, and to lend tools and equipment. 1950 U.S. Tax Ct. LEXIS 296">*300 Wheeler agreed to devote his full time and attention to promotion and operation of the business. Both parties were given an equal voice in management and agreed that any devices invented and patents granted should "be owned, maintained 14 T.C. 45">*47 and protected by said copartnership." Checks were to require the signatures of both parties. Petitioner was to receive 60 per cent and Wheeler 40 per cent of the net profits; net losses were to be borne in the same proportion.

After May 1, 1936, petitioner continued operation of the contracting business in the same manner that McClelland had conducted it as an individual proprietorship, and in 5,400 square feet of space assigned to Controlair in McClelland's building Wheeler worked on grilles, using at first a few tools borrowed from petitioner, and later buying equipment for Controlair. At an undisclosed time Wheeler devised an adjustable bar grille which was simple to make, reduced friction in operation, and had additional advantages not offered by existing types. Manufacture and sale of this grille began in 1937, and a patent on it was granted March 28, 1939. Wheeler also devised a control for air volume which was put on the market1950 U.S. Tax Ct. LEXIS 296">*301 in 1937 and on which a patent was granted. By 1938 Controlair Manufacturing Co. was advertising and selling several types of grilles and air controls, registers, ventilators, atomizing nozzles, and other equipment. The adjustable bar grille, however, was its most successful product, accounting for 80 per cent or more of sales, and in 1939 local architects began to specify its use in their plans. Petitioner itself used only from 3 per cent to 6 per cent of the Controlair output.

Petitioner never invested any money at all in the Controlair Manufacturing Co., and the quarters used rent-free in the business were furnished by McClelland, not by petitioner. Wheeler devoted his full time to operating the business; McClelland cosigned checks and held occasional conferences with him. Controlair employed one salesman and a stenographer, who also kept its books. Prior to the fiscal year 1938 its records appeared in segregated accounts on petitioner's books; in that year a separate set of books was opened and maintained for it. For the fiscal years 1937-1941 Controlair reported the following income on partnership returns:

1950 U.S. Tax Ct. LEXIS 296">*302 Controlair's books were kept and its income was reported on the basis of a fiscal year ending April 30.

In the development of the two inventions only nominal expense was incurred. Legal fees of about $ 350 were paid in procuring the patents, but the patents and inventions were not capitalized on the books. On its return for the fiscal year 1941 Controlair reported depreciable assets having a cost of $ 8,699.11, consisting of machinery 14 T.C. 45">*48 and a little office equipment. The prices at which its grilles and other products were offered varied very little from 1937 to 1941. There were slight increases on some because of the use of rubber nubs and other improvements; there were small decreases on others. Labor costs remained about the same during the period and the price of sheet steel used in manufacture kept within the narrow range of $ 3.80 to $ 4 a hundredweight, but the use of extra jigs and dies effected a little saving in manufacturing costs in the latter part of the period.

During the six years 1936-1941, the annual estimated valuation of construction for which building permits were issued by the city of Los Angeles steadily increased from $ 62,653,541 in 1936 to $ 87,238,8181950 U.S. Tax Ct. LEXIS 296">*303 in 1941. The latter figure is 115.47 per cent of the annual average for the preceding four years. During 1940 petitioner was awarded several large "war contracts."

On its excess profits tax return for the fiscal year 1941 petitioner reduced its normal tax net income by "abnormal income attributable to other years" in the amount of $ 11,021.87. In explanation it referred to "a contract" of May 1, 1936, whereby it:

* * * was to furnish space, equipment and credit to Charles Wheeler with which the latter was to develop and exploit processes and designs for grilles used in air-conditioning and other devices. For furnishing such facilities, taxpayer was to receive 60% of the net revenue * * *.

Petitioner's income from the "Wheeler Contract" for the fiscal year 1941 was $ 22,050.90; its average income for the base period fiscal years 1937-1940 was $ 8,823.23, of which 125 per cent is $ 11,029.03. Subtracting this figure from the "Wheeler Contract" income of $ 22,050.90, petitioner arrived at the $ 11,021.87 claimed as representing "abnormal income attributable to development work in four prior years." By attributing one-fourth of this abnormal income, or $ 2,755.47, to each of the 1950 U.S. Tax Ct. LEXIS 296">*304 base-period years, it recomputed the tax for each year as if that amount had been included in each year's income and arrived at a total of $ 2,587.08 as the aggregate additional taxes, with interest, which would be due by virtue of such inclusions. It added this total to the excess profits tax as the amount due to application of section 734. The Commissioner disallowed the adjustment of income by subtraction of the $ 11,021.87 claimed as abnormal, because "no adjustment under section 734 of the Internal Revenue Code is allowable with respect to this item."

OPINION.

Admitting error in its reliance on section 734, Internal Revenue Code, on the tax return for the fiscal year 1941, petitioner now invokes section 721 as support for elimination from its excess profits income of the $ 11,021.87, contending that this amount was abnormal and attributable to other years. Section 721, a relief 14 T.C. 45">*49 provision, limits the tax on abnormal income to the amount of additional tax which would have been due if the parts of such income attributable to other years had been added to the incomes of those respective years.

By subsection (a) (1) of section 721:

* * * The term "abnormal income" means1950 U.S. Tax Ct. LEXIS 296">*305 income of any class * * * if it is abnormal for the taxpayer to derive income of such class, or, if the taxpayer normally derives income of such class but the amount of such income of such class includible in the gross income of the taxable year is in excess of 125 per centum of the average amount of the gross income of the same class for the four previous taxable years * * *.

In subsection (a) (2) several classes of income are described, among them:

(C) Income resulting from * * * research, or development of * * * patents, formulae, or processes * * *, extending over a period of more than 12 months; * * *

While the classes described are not exclusive of others which may be recognized as reasonable under the Commissioner's regulations, sec. 35.721-2, Regulations 112; Eitel-McCullough, Inc., 9 T.C. 1132; Premier Products Co., 2 T.C. 445, the taxpayer's election of a class is irrevocable, section 721 (a) (2), and the Commissioner requires that a taxpayer claiming the relief benefits shall file with its excess profits tax return a detailed statement in duplicate regarding the amounts and classes of income which it deems1950 U.S. Tax Ct. LEXIS 296">*306 abnormal, sec. 35.721-3, Regulations 112.

As petitioner failed to file such a statement or even to refer to section 721 on its return for the fiscal year 1941, respondent argues that the omission is fatal to its right to any relief otherwise available, especially since no class of income has been specified in the pleadings and briefs now before the Court. In Soabar Co., 7 T.C. 89, we recognized a taxpayer's right to make its relief claim under section 721 for the first time in its petition to this Court, and while no "class" of abnormal income is expressly specified here, it is patent from the argument and evidence that petitioner deems its income from the Wheeler contract to be in part abnormal because resulting from the development of patents for grille and air control devices. Being a relief provision, section 721 is to be sympathetically applied, Ramsey Accessories Manufacturing Corporation, 10 T.C. 482, and we shall consider the claim here in issue on its merits.

There is no dispute that the $ 22,050.90, which petitioner received as its share of Controlair profits in fiscal 1941 exceeded 125 per cent of the average1950 U.S. Tax Ct. LEXIS 296">*307 amount of its shares for the four base period years by $ 11,021.87. Hence its income from Controlair was abnormal in this amount under the definition of section 721 (a) (1), and, since Controlair was operated as a separate business, we consider petitioner's 14 T.C. 45">*50 income from this source as a "class" within the meaning of subsection (a) (2). Cf. Arrow-Hart & Hegeman Electric Co., 7 T.C. 1350. But it is not enough that the class of income was abnormal. Petitioner must also establish that all or part of it was attributable to other years and must offer a factual basis for the proper allocation of such part among years of the base period to which it was attributable. Otherwise, section 721 affords no relief. Sec. 35.721-3, Regulations 112; Steel or Bronze Piston Ring Corporation, 13 T.C. 636; Harris Hardwood Co., 8 T.C. 874; Geyer, Cornell & Newell, Inc., 6 T.C. 96.

In its brief petitioner reasons that the evidence "plainly shows" that it, "in conjunction with Mr. Wheeler, developed grilles of new type and principle during the base period years" and that1950 U.S. Tax Ct. LEXIS 296">*308 "the fruition of these efforts" first became substantial in the fiscal year 1941. It argues that, as costs of labor and material were relatively constant and there was small fluctuation in the estimated value of construction work for which building permits were issued in the Los Angeles area, its abnormal income from Controlair for the fiscal year 1941 should be attributed to development work during the base period, and that "it is not necessary to allocate the abnormal income to any particular year." It relies on W. B. Knight Machinery Co., 6 T.C. 519, as supporting its contention. We therein held the taxpayer entitled to relief under the view that part of the abnormal profits from the sale of a new machine which it had developed by large experimental expenditures during 1936-1940 and which was not commercially successful until 1940, should be attributed to the years of experiment. The amount of profit attributed to each prior year was proportionate to the experimental expenditure of that year.

In the record of this proceeding petitioner, in our opinion, has failed to provide any adequate factual basis for an application of the principles followed1950 U.S. Tax Ct. LEXIS 296">*309 in W. B. Knight Machinery Co., supra. McClelland allowed Wheeler the free use of space for experimental work in the fall of 1935. In his own words, he wanted Wheeler "to work out some designs of grilles and to see whether he could really form a business or not." Petitioner was not organized until May 1, 1936. It was then that the contract with Wheeler was made, and, so far as the record shows, the experimental work on the successful grille may have been already completed. Controlair's gross receipts for the fiscal year 1937 were $ 15,299.20; the adjustable bar grille accounted for 80 per cent or more of Controlair's sales, and McClelland testified that manufacture of the grille began in 1937. He did not testify as to when development work on it began or was completed, and nothing in the record is inconsistent with the possibility that all development work had been done when petitioner acquired by contract an interest in it. Abnormal income may not be attributed to a previous year by 14 T.C. 45">*51 reason of the taxpayer's investment in an asset, sec. 35.721-3, Regulations 112; Premier Products Co., supra, or, a fortiori1950 U.S. Tax Ct. LEXIS 296">*310 , by reason of an acquisition without investment. The record, moreover, affirmatively excludes the possibility that development work extended over a period of more than twelve months, a condition essential to the application of section 721 (a) (2) (C), for manufacture of the grille began in the first year of petitioner's existence.

Petitioner has, therefore, failed to establish that any part of its abnormal income of fiscal 1941 resulted from research or development work extending over a period of more than twelve months or that a part of such income should be attributed to prior years for any other reason. While this conclusion makes it unnecessary to pass upon the adequacy of the record to support other facts essential to petitioner's claim for relief, we would point out, nonetheless, that no basis has been laid for attributing some specific part of income to the two patented products. Petitioner made no cash disbursements at all. Wheeler apparently did all the work, and Controlair's development cost is stipulated to have been nominal. The only item expressly mentioned is an estimated $ 350 in fees incurred by Controlair in 1938 in procuring the patents. Whatever recognition1950 U.S. Tax Ct. LEXIS 296">*311 should be accorded petitioner's relation with Wheeler as that of a partner, the practical effect of the contract was simply to vest petitioner with a right to 60 per cent of Controlair's net profits in consideration of the use of space rent-free. And petitioner did not even contribute the space, although it agreed to do so. The testimony on this point is very clear:

Q. Mr. McClelland, did you furnish the space for that [Controlair business] or did H. S. McClelland, Inc., furnish the space?

A. No. No money whatsoever.

There is no evidence that McClelland transferred the building to petitioner, and it would thus appear that petitioner paid no consideration in cash, space, or services for its right to 60 per cent of the profits from Controlair. The most that the record shows is the initial loan of a few tools and occasional conferences between Wheeler and McClelland, petitioner's chief stockholders.

We have held a taxpayer entitled to relief under section 721 where it appeared that substantial money and effort had been devoted by it over a long period to the development of an article which produced substantial profits in 1950 U.S. Tax Ct. LEXIS 296">*312 a subsequent year and that there was some foundation for segregating and attributing a part of that profit to a prior year or years because of research and development. Ramsey Accessories Manufacturing Corporation, supra; Producers Crop Improvement association, 7 T.C. 562; Rochester Button Co., 7 T.C. 529.

Reviewed by the Special Division.

Decision will be entered for the respondent.