* * * *

The foregoing printed forms, on which petitioner's claims for excess profits tax relief were filed, required certain questions to be answered. To the question "Was change in capacity for production or operation of business consummated during a taxable year ending after December 31, 1939, as a result of a course of action to which taxpayer was committed prior to January 1, 1940?", petitioner answered "Yes." The question, "Did the business reach, by the end of the base period, the earning level it would have reached if the business had been commenced, or if the change in the character of the business had occurred, 2 years prior to the time the commencement or change occurred?", was left unanswered by petitioner, and in its claims for excess profits tax relief it provided no particulars as to that question.

Petitioner's excess profits net income for each of the calendar years 1936 through 1939 (herein also referred to as the "base period" or "base period years") was as follows: 18 T.C. 548">*550

1952 U.S. Tax Ct. LEXIS 161">*165 After applying the growth formula in section 713 (f) of the Internal Revenue Code, petitioner's average base period net income, without benefit of section 722 of the Internal Revenue Code, was $ 4,422.17 with respect to each of the years in issue, and the resulting excess profits credit was $ 4,201.06 for each of these years.

Petitioner's principal business, since its incorporation and at all times material hereto, consisted of the operation of a single moving picture theatre, known as Studio Theatre (hereinafter also referred to as the "theatre"), located in downtown Phoenix, Arizona.

In 1932, Harold Stetson and his brother Albert Stetson (hereinafter also referred to as the "Stetsons") felt there was an opportunity in Phoenix, Arizona, for a small motion picture theatre. They began negotiations with Ackel Investment Company (hereinafter also referred to as "Ackel") for a lease on the property at 18-20 East Washington Street in Phoenix (hereinafter also referred to as the "Ackel property"). But being unable to conclude a transaction with Ackel at that time, in October 1932 the Stetsons leased for a term of 5 years, from Mrs. Anna B. Thalheimer, the adjoining property at 14-16 East1952 U.S. Tax Ct. LEXIS 161">*166 Washington Street (hereinafter also referred to as the "Thalheimer property"). A one-story, store-front building on the Thalheimer property was to be converted into the contemplated theatre; this conversion, involving considerable alteration in the existing structure, thereafter was completed, and the theatre was opened for business on December 22, 1932.

During the period that negotiations were being carried on for a location for the theatre, Harold Stetson went to Los Angeles, California, to arrange for films to be shown at the theatre. While there he met Milton Arthur who, with his brother Harry Arthur (hereinafter also referred to as the "Arthurs"), agreed to finance the theatre for a half interest therein.

Petitioner was then organized, and the lease of the Thalheimer property (hereinafter referred to as the "Thalheimer lease") was assigned to it. Each of the Stetsons and the Arthurs received 25 per cent of petitioner's capital stock. Shortly after petitioner was organized, the Arthurs transferred their 50 per cent interest to Cabart 18 T.C. 548">*551 Theatres Corporation (hereinafter referred to as "Cabart"), a theatre-operating corporation which they controlled. In October 19371952 U.S. Tax Ct. LEXIS 161">*167 Cabart transferred this 50 per cent interest to Publix-Rickards-Nace, Inc., a subsidiary of Paramount Pictures, Incorporated (hereinafter referred to as "Paramount"), and this 50 per cent interest continued to be so held at least through the years in issue.

The theatre, when it was opened, had a total seating capacity of 337 seats. Shortly after petitioner began operating the theatre, its officers were of the opinion that its seating capacity was inadequate for its operation at a sufficiently profitable level.

With the motive of expanding the seating capacity of the theatre, petitioner negotiated in 1934 for a lease of the adjoining Ackel property. On December 31, 1935, petitioner entered into such a lease (hereinafter referred to as the "Ackel lease") for a term of 15 years to commence February 1, 1936. This lease provided for a total rental of $ 135,000, to be paid as follows: $ 1,450 upon the signing of the lease; $ 650 per month starting March 1, 1936; $ 750 per month starting February 1, 1939; and $ 800 per month starting February 1, 1945. Petitioner in addition agreed to pay the lessor, in specified installments, a bonus of $ 7,500. The lease further provided:

4. Said 1952 U.S. Tax Ct. LEXIS 161">*168 Lessee further covenants and agrees not to make or cause to be made any material alterations or changes of any kind in or to said leased premises subsequent to the first contemplated alterations or changes intended to be made by the said Lessee without the written consent of the Lessor first obtained therefor; however, Lessee has the right to make any changes or alterations without Lessor's consent at any time during the term of this lease provided such changes or alterations do not weaken or cause the value of the said building or premises to be lessened or diminished.

* * * *

11. And the said Lessee further agrees not to let or underlet the whole of the said leased premises, or to assign this lease or any interest herein, without the written consent of the Lessor first had and obtained therefor, and any attempt by the said Lessee to assign this lease, or any interest therein, in whole or in part, or to let or to underlet said premises, in whole, shall, at the option of the Lessor, immediately terminate this lease, and the Lessor shall be entitled to the immediate possession of said leased premises thereupon, and all rents paid by said Lessee in advance on account of said premises1952 U.S. Tax Ct. LEXIS 161">*169 shall be forfeited to said Lessor for damages due to it for such attempt to violate the conditions of this lease; however, the said Lessee is hereby given the right to mortgage its leasehold without the consent of the Lessor, and it is further provided that the Lessee shall have the right, without obtaining the consent of the Lessor, to sublet the second floor of the said building and space on the first floor not to exceed (50%) per cent of the total floor space thereof.

It is further agreed between said Lessor and said Lessee that no consent by said Lessor to any assignment of this lease or any interest therein, or the subletting the whole of said premises hereby leased, shall be held to waive the covenant not to assign this lease or any interest therein or to sublet the said premises without the written consent of the Lessor as to any further assignment or subletting.

* * * *

18 T.C. 548">*552 22. Lessee agrees to use the said premises for the purpose of conducting therein the following business; Motion picture theatre, general theatre, and other similar amusement purposes.

* * * *

28. It is understood and agreed by the parties hereto that for the first time, the Lessee has the right, 1952 U.S. Tax Ct. LEXIS 161">*170 without obtaining the consent of the Lessor as hereinbefore provided, to change, alter or remodel the building on the premises herein leased, and make the same fit for its use and purposes; however, nothing herein contained shall be construed as giving Lessee the right to change, alter or remodel the same building subsequent to the first change, alteration or remodeling save and except as in Paragraph 4 herein contained.

On or about February 1, 1936, an agreement was entered into by petitioner which extended the Thalheimer lease to February 1, 1951.

At the time the Ackel lease was made, the Ackel property had on it a two-story building with a basement (hereinafter referred to as the "Ackel building"). A tenant on the second floor of this building was in possession from month to month and without a lease. The ground floor and basement were occupied by another tenant, Ratner's Apparel Shop (hereinafter referred to as "Ratner's"), which had a lease that expired on January 31, 1938. The Ackel lease was subject to the rights of Ratner's, and provided:

23. It is understood by the parties hereto that the premises herein described are at the present time occupied by a tenant under lease. 1952 U.S. Tax Ct. LEXIS 161">*171 Lessor hereby covenants and agrees to assign to the Lessee simultaneously with the execution of this lease agreement all its rights, title and interest in and to the lease herein mentioned.

In leasing the Ackel property, petitioner intended to use part of the ground floor of the Ackel building for enlargement of the theatre. The existing frontage of the theatre was considered sufficient by petitioner for its purposes, and the frontage of the Ackel building was considered too valuable to be used as a theatre entrance. Petitioner therefore contemplated subleasing the front portion of the ground floor of the Ackel building, to an extent not in excess of 50 per cent of the available footage on that floor, and utilizing the remainder of that floor for enlargement of the theatre.

Petitioner's intended use of the Ackel property contemplated that Ratner's would vacate its space in the Ackel building. Before executing the Ackel lease, petitioner had received an oral promise from Ratner's that it would vacate the premises in return for payment by petitioner of $ 100 per month for the remainder of the term of Ratner's lease, which then had 24 months to run. However, upon approaching Ratner's1952 U.S. Tax Ct. LEXIS 161">*172 for performance of this agreement immediately after execution of the Ackel lease, petitioner was told that Ratner's had just transferred its remaining 2-year interest, in the space at the Ackel property, to Darling Shops, Inc. (hereinafter also referred to as 18 T.C. 548">*553 "Darling"). Thereafter, Darling entered into possession and paid rent to petitioner for that space.

Enlargement of the theatre was dependent upon procurement of the means with which to finance it. Neither petitioner itself nor the Stetsons were able during the base period to finance such an enlargement, and petitioner's financial condition during the base period years was such that bank credit was unavailable for this purpose.

At the time of the negotiations for the Ackel lease and prior to petitioner's entering into that lease, assurance had been given petitioner by Cabart that the latter would finance the cost of enlargement. But Darling's presence at the Ackel building prevented immediate action on the intent to enlarge the theatre, and before Darling's sublease expired, Cabart was either unable or unwilling to provide the necessary finances. On or about November 1, 1936, Milton Arthur, acting for Cabart, wrote1952 U.S. Tax Ct. LEXIS 161">*173 the following letter:

STUDIO THEATRE

PHOENIX, ARIZONA

Dear Harold: I have had Stanbery and Leo Hungerford working on the plans for the enlargement of the Studio Theatre and expect to come over to Phoenix shortly. In the meantime, I should like to have Al and you give some thought to the possibility of interesting West Coast in a half interest in the Studio Theatre, Inc., your retaining 25% and we 25%.

There are many advantages in a deal of this kind from a protective point of view as well as a financial point of view. I am finding it extremely difficult to finance a building which I think would meet our needs for the next 14 or 15 years, and I have wondered many, many times, if a 25% interest in a large proposition would not be much better than a 50% interest in a small one.

* * * *

In September 1937, Publix-Rickards-Nace, Inc., the Paramount subsidiary referred to above, while it was negotiating to acquire Cabart's 50 per cent interest in petitioner, offered to finance the enlargement, if the Stetsons would surrender enough of their stock in petitioner so that they would no longer have a 50 per cent interest. The Stetsons were unwilling to do so, and petitioner declined this1952 U.S. Tax Ct. LEXIS 161">*174 offer in October 1937.

Upon Cabart's elimination as a source for financing the enlargement, petitioner was left without the financial means for carrying out the desired expansion, and it was lacking the necessary financial resources when the sublease to Darling expired at the end of January 1938. It therefore was unable at that time to proceed with its intention to use the Ackel property for enlargement purposes, and, still having that property on its hands, it was interested in easing its position through continued subletting of space in the Ackel building.

Darling, on the other hand, was interested in remaining in possession at the Ackel building. Petitioner was agreeable to this, provided 18 T.C. 548">*554 Darling obtained the consent of Ackel to it. Darling negotiated with Ackel, and obtained such consent from Ackel, paying Ackel a bonus of about $ 4,500. As part of Darling's negotiations with Ackel, the latter also agreed to extend the Ackel lease 3 years; petitioner wanted such an extension in order to restore, to the period for which it would have the use of the Ackel property, time lost through an extension of occupancy by Darling.

Pursuant to this consent of Ackel, petitioner, 1952 U.S. Tax Ct. LEXIS 161">*175 on or about January 20, 1938, subleased the entire Ackel property to Darling for a period of 5 years, from February 1, 1938, to and including January 31, 1943. However, petitioner reserved the right to terminate this sublease, upon 60 days' written notice, at any time after 3 years from February 1, 1938; provided that, if the termination occurred between January 31, 1941, and February 1, 1942 (the fourth year of this sublease), then petitioner was required to pay $ 1,000 to Darling. The total rental agreed to be paid by Darling for the entire term of this sublease was identical with the total rental payable by petitioner to Ackel (entirely exclusive of the bonus payable by petitioner to Ackel) during the same 5-year period. Prior to this sublease, Darling was sublessee only of the space on the ground floor which Ratner's had occupied; now it became sublessee of the entire Ackel building, and it, rather than petitioner, collected rent from the occupant of the second floor.

On or about the same day, January 20, 1938, Ackel and petitioner entered into a written agreement which (1) extended the Ackel lease for 3 years, to February 1, 1954, for a total rent of $ 28,800 for this additional1952 U.S. Tax Ct. LEXIS 161">*176 term, payable $ 800 per month; and (2) provided for consent by Ackel to sublease of the entire premises by petitioner to Darling. Thereafter, on or about July 29, 1940, petitioner likewise obtained a 3-year extension of the Thalheimer lease, to February 1, 1954.

Still confronted with the problem of financing the desired enlargement of the theatre, the Stetsons thereafter considered renting out in advance the ground-floor space at the Ackel building that would be available for a tenant after the contemplated enlargement had been made, and requiring such a tenant to pay a substantial advance rental, which could then be used to finance the necessary enlargement alterations.

On or about June 1, 1940, petitioner entered into a written agreement with Herb Bland Clothing Company, Inc. (hereinafter also referred to as "Bland"), which occupied premises neighboring the theatre, to sublease "that portion of the Ackel property which is contemplated to be remodeled into a storeroom as per plans and specifications prepared by architects Alexander & Burton, dated April 18 T.C. 548">*555 27, 1940 * * *." It was further provided that the "lease shall begin on such date as the parties hereto may mutually 1952 U.S. Tax Ct. LEXIS 161">*177 agree upon, which said date shall be not earlier than September 1, 1940, and not later than May 15, 1941; and said lease shall terminate on January 31, 1951; provided, however, that the first party [petitioner] obtains an extension of its existing lease on the Thalheimer property to January 31, 1954, then said lease shall terminate January 31, 1954." Provision was made for a monthly rental, and it was provided that "$ 7,500.00, in cash, shall be paid to the first party [petitioner] by second party [Bland] upon the execution of a formal lease embodying this agreement." The agreement further provided that if petitioner "shall be unable, by reason of * * * lack of finances for construction purposes, to proceed with the work provided to be done in accordance with the plans and specifications hereinabove mentioned, or substantially in accordance therewith, then this agreement shall be void and both parties will stand released and discharged therefrom."

Bland thereafter wrote petitioner, on or about February 27, 1941, that it was willing to substitute, in its place under this agreement, a specified sublessee on specified conditions and to cancel Bland's "rights in that certain agreement 1952 U.S. Tax Ct. LEXIS 161">*178 entered into with you calling for the financing up to $ 7,500 for the alterations of the Studio Theatre and the Darling Shop properties." This substitution of parties was not made.

This arrangement with Bland to obtain financing for the enlargement of the theatre "fell through" and the aforesaid amount of $ 7,500 was never paid to petitioner by Bland. On or about April 29, 1941, Bland wrote to petitioner to advise that it was ready to proceed under the foregoing agreement and to start negotiations leading to execution of the sublease involved. Petitioner replied, on or about May 2, 1941, that it too was willing to negotiate and proceed pursuant to that agreement, but that "the undersigned [petitioner], making due allowance for the $ 7500 cash installment to be paid by you under said agreement, is still unable by reason of lack of finances for construction purposes to proceed with the work provided to be done in substantial accordance with the plans and specifications mentioned in said written agreement, and there is no present prospect that Studio Theatre, Inc. will be able to provide such finances. Unless such finances are available, it would serve no purpose to negotiate relative1952 U.S. Tax Ct. LEXIS 161">*179 to the formulation and execution of the formal written lease."

Bland's initial desire to lease space in the Ackel property resulted from its uncertainty as to whether it would be able to get a renewal of its lease at the premises it occupied. Thereafter it obtained such 18 T.C. 548">*556 renewal, and its interest in the Ackel property waned. Subsequently it consented to surrender its rights to space in the Ackel property provided that such space was not leased to a tenant which might compete with Bland.

On or about April 11, 1941, petitioner executed a written agreement to sublease part of the Ackel property to Karl's Shoe Stores, Ltd. (hereinafter referred to as "Karl's"). The agreement recited that the Ackel property had been leased by petitioner; that petitioner had sublet to Darling; that petitioner had entered into an agreement with Bland; that Karl's was desirous of renting, at the ground floor of the Ackel building, an area extending over the entire usable frontage and a depth of about 89 feet; that some time would be required to obtain approval, of Paramount and certain related corporations, to the agreement to sublease then being made; and that, in the event of such approval, 1952 U.S. Tax Ct. LEXIS 161">*180 time would also be required to obtain possession of the premises from Darling. The parties agreed that the term of the sublease would begin at petitioner's option either on September 1, 1941, October 1, 1941, or February 1, 1942, after 90 days' prior notice by petitioner, and that possession would be given to Karl's 45 days in advance of the beginning of the term so as to enable it to make certain improvements at the premises; and that the term would end on January 31, 1949, with an option in Karl's to extend the term to January 31, 1954. A rental was fixed, and Karl's agreed --

immediately upon the execution and delivery of the final form of sublease and of all written instruments required hereunder, signed by both parties, to pay and deposit the sum of Twenty Thousand Dollars ($ 20,000) in escrow with the First National Bank of Arizona, Phoenix, as payment of the initial installment of rental, with written instructions to said Bank to pay and deliver said sum, and all thereof, until Studio upon the delivery unto said Bank of a certificate of completion of said Alexander and Burton, architects, certifying to the completion of all alterations of the premises * * *.

It is further1952 U.S. Tax Ct. LEXIS 161">*181 understood and agreed that if said Twenty Thousand Dollars ($ 20,000) so placed in escrow shall not be so paid unto Studio by March 1, 1942 the amount of said escrow shall be returned by said Bank unto Karl's.

In this agreement, written approval by Paramount was made a condition to execution of a sublease to Karl's, and it was required that the provisions of such a sublease should contain a "guarantee by Paramount of full and faithful performance by Studio of all of its covenants, promises and agreements thereunder, including delivery and continued peaceable possession of the demised premises. Such guarantee shall be in written form satisfactory to Karl's."

On or about August 20, 1941, petitioner gave Darling formal notice of termination, effective November 1, 1941, of the latter's sublease of the Ackel property and advised Darling that petitioner would pay it $ 1,000 upon delivery of possession.

18 T.C. 548">*557 An architect's blueprint, of structural changes to be made in enlarging the theatre, was drafted by Alexander and Burton, and is referred to above in the agreement between petitioner and Bland made on or about June 1, 1940, and also in the later agreement between petitioner and1952 U.S. Tax Ct. LEXIS 161">*182 Karl's. This blueprint was dated April 27, 1940, and its first use was in connection with the aforesaid agreement between petitioner and Bland. Rough sketches preceded this blueprint, and ideas contained in the blueprint existed prior to its drafting; the blueprint was not prepared prior to 1940.

Thereafter, in December 1941, renovation of the Ackel property was commenced in order to enlarge the theatre. Enlargement was achieved by widening the theatre, adding seats to each row, and adding a section of about 60 seats along the side of the theatre. Construction work required the theatre to close for most of January 1942. The alterations were completed at the end of January 1942, after which the seating capacity of the theatre was 518 seats. ¹ There had been no change in the seating capacity of the theatre between 1932 and 1942. This enlargement of 1942 was completed substantially in accordance with the blueprint of Alexander and Burton, referred to above.

1952 U.S. Tax Ct. LEXIS 161">*183 Throughout the base period and up to the time the enlargement of the theatre was thus made, petitioner had an unequivocal intent to expand the seating capacity of the theatre. That intent was never abandoned or suspended during that entire time, and the enlargement of the theatre in 1942 was made in accordance with that intent. Throughout all those years petitioner sought finances to put that intent into effect, and as soon as it found such finances it proceeded with the enlargement of the theatre.

The increase in the seating capacity of the theatre in 1942 was a change in petitioner's capacity for production or operation, and a change in the character of its business, within section 722 (b) (4), Internal Revenue Code. That change was consummated as a result of a course of action to which petitioner was committed prior to January 1, 1940.

Petitioner's profit or loss for the years 1933 through 1939, as submitted by it in support of its applications for excess profits tax relief and as adjusted by respondent, was as follows (the adjustments for 1936, 1937, and 1939 were made to reduce deductions for depreciation; the adjustment for 1938 was made to add a deduction for capital stock1952 U.S. Tax Ct. LEXIS 161">*184 tax): 18 T.C. 548">*558

1952 U.S. Tax Ct. LEXIS 161">*186 During the base period, seven theatres besides Studio Theatre were in operation in Phoenix. Of the seven theatres, Paramount, by itself or through subsidiaries, operated four; Fox West Coast Theatres operated a fifth; a sixth was operated by the owner of a group of theatres in southern Arizona; and the seventh was an independent theatre which showed only Mexican pictures. All of these theatres had larger seating capacities than the original capacity of Studio Theatre.

Petitioner rented or "purchased" the films shown at the Studio Theatre. Harold Stetson purchased films on behalf of petitioner during the first year of its existence. Cabart handled the purchase of films for petitioner thereafter and until it sold its stock in petitioner in October 1937 to the Paramount subsidiary referred to above. Paramount handled the purchase of films for petitioner for the remainder of the base period as well as thereafter.

"First-run" referred to the first showing of a motion picture film in a trade area. "Second-run" referred to the second showing of a film 18 T.C. 548">*559 in a trade area, and in Phoenix during the period since 1932, this usually occurred about sixty days after the first run. 1952 U.S. Tax Ct. LEXIS 161">*187 "Third-run" referred to the third showing of a film in a trade area, and in the case of Studio Theatre this usually occurred thirty days after the second run. "Revival" referred to any film which had finished the ordinary showings and was no longer for sale on a competitive basis. The age of a revival might vary from a year to fifteen or twenty years after its original showing. The "drawing power" of a film diminished with each showing; thus a second-run drew fewer persons than a first-run, and a third-run drew fewer persons than a second-run.

Prior to the acquisition of the stock interest in petitioner by the Paramount subsidiary referred to above, Studio Theatre operated almost exclusively with second-run and third-run feature pictures. Starting with the acquisition of that interest in petitioner and until February 1940, petitioner operated almost exclusively with third-run feature pictures. From February 1940 until the end of April 1941, petitioner operated almost exclusively with revival and third-run feature pictures. From the end of April 1941 until January 1943, petitioner operated primarily with revival feature pictures, although on occasion it used some second-run pictures. 1952 U.S. Tax Ct. LEXIS 161">*188 Petitioner initially changed to revivals in order to reduce its expense of renting films.

Films were rated by the producer according to quality, those considered best being rated as "A," and those considered progressively poorer in quality being rated "B," "C," and "D." During the period 1932 through 1939, petitioner was able to obtain films only by purchasing an entire block or group of pictures at one time from a given producer. These blocks would include A, B, C, and D pictures. Many of the D pictures were so poor in quality and drawing power that, although paid for, they would not be shown; these pictures were referred to as PNU's (pay and not use).

The cost to a theatre of a film diminished rapidly in relation to the order of showing, first-run being most expensive, second-run less expensive, and revivals ordinarily costing substantially less than third-run films. The cost further varied with the rating of the film, an A picture being the most expensive. The A pictures sometimes rented for a flat amount and sometimes on the basis of a percentage of the theatre's gross receipts on the showing; the rental charged for B, C, and D films would ordinarily be a flat amount, and1952 U.S. Tax Ct. LEXIS 161">*189 varied with the rating. The cost also tended to vary to some extent with the theatre's capacity, so that the cost of a film might be higher to a theatre of greater seating capacity.

During the base period, Studio Theatre's box office usually opened at 10 a. m. and closed at 10 p. m., although on Saturday it might be open until 11 p. m. The change from matinee to evening shows during the base period took place either at 5 p. m. or at 6 p. m.

18 T.C. 548">*560 Studio Theatre showed single-feature bills from the time it opened in 1932 until about the end of 1935; then, to meet competition, it began to show double-feature bills as well during a transition period which lasted until about April 1936; and thereafter it adopted the policy of showing only double-features.

Usually at least six complete shows were run per day with a single feature, and four complete shows per day with a double feature. The number of shows varied both for single and double features, however, and often there were more than four showings per day of double features. On Saturdays the number of showings usually increased.

During the base period, the theatre's periods of greatest business, or "peak demand," were during1952 U.S. Tax Ct. LEXIS 161">*190 evening showings throughout the week and during matinees on Saturday and Sunday. The "peak period" during weekday evening performances was about one hour from about 6:30 p. m. to about 7:30 p.m.

Weekday matinees which did not come on holidays were usually times of poor business for the theatre, and, if at those times during the base period the seating capacity of the theatre had been greater than 337 seats, there would have resulted very little increase in petitioner's gross receipts from admissions. Increased earnings from increased capacity could come only during the times of "peak demand" described above.

Petitioner was not permitted to have standees within the theatre during the base period. Waiting customers were lined up outside the theatre. It was petitioner's experience that, when there were such lines of waiting customers, persons coming to the theatre often tended to go elsewhere rather than wait in line. There were times in the course of the base period, during the foregoing periods of peak demand, when petitioner lost customers and its paid admissions were reduced because the theatre was then filled to capacity and petitioner was unable to provide these customers 1952 U.S. Tax Ct. LEXIS 161">*191 with seats promptly. There were times during "peak periods" when petitioner lost customers because it could not accommodate them promptly or only after a brief wait. At such times, if petitioner had more seats in the theatre, it could have sold more tickets, and it would have increased its average base period net income.

Because of the expansion of the seating capacity of Studio Theatre from 337 seats to 518 seats, petitioner's average base period net income, as determined under the growth formula of section 713 (f) of the Internal Revenue Code, does not reflect the normal operation of the business for the base period, and petitioner's average base period net income as thus determined is an inadequate standard of normal earnings for Studio Theatre as expanded to 518 seats.

Operation of Studio Theatre as enlarged to a seating capacity of 518 seats entailed greater expenses than operation of Studio Theatre 18 T.C. 548">*561 with its original seating capacity of 337 seats. Because of the foregoing expansion in seating capacity, and taking into account this increase in expenses as well as all the other facts and circumstances found herein to have been established, a fair and just amount representing1952 U.S. Tax Ct. LEXIS 161">*192 normal earnings to be used by petitioner as a constructive average base period net income is $ 1,500 more than petitioner's average base period net income of $ 4,422.17 determined under the foregoing growth formula.

Petitioner commenced the sale of candy and similar items in the lobby of its theatre in 1937 or 1938, at which time confectionary vending machines were installed in the theatre lobby. These machines were not owned or operated by petitioner; it received a commission of 35 per cent of the net proceeds of the machines.

In July 1941, after the end of the base period but before the theatre was enlarged, a confectionary "counter" was installed in the lobby of the theatre for the sale of items such as candy and popcorn. This "counter" replaced the candy vending machines, which were used in the lobby up to that time. Installation of this "counter" was completely unrelated to the enlargement thereafter made in the theatre in 1942. Installation of this "counter" was not made as a result of a course of action to which petitioner was committed prior to January 1, 1940.

Because of the location of the front lobby doors of the theatre prior to the time the alterations were made in1952 U.S. Tax Ct. LEXIS 161">*193 1942 enlarging the theatre, this confectionary "counter" was not too readily accessible to persons already admitted into the theatre. Among the alterations made to the theatre in 1942, the front lobby doors were moved forward about fifty or sixty inches toward the box-office so that they were located immediately behind the box-office, and the area within the lobby was thus increased. After this expansion in lobby space, the "counter" in the lobby became more readily accessible to persons already admitted into the theatre. No change was made in the "counter" itself at that time. At the same time that the theatre was enlarged in 1942, there was installed a second "counter" at the entrance to the theatre outside the front lobby doors, for sale of confectionary items such as candy and popcorn to persons outside the theatre. Nothing concerning either of these "counters" appeared in the architectural blueprint of Alexander and Burton, referred to above.

Addition of the "counter" outside the lobby in 1942 and the increased accessibility of the "counter" inside the lobby at about the same time did not result in a material difference in petitioner's capacity for production or operation, 1952 U.S. Tax Ct. LEXIS 161">*194 and did not constitute a change in the character of petitioner's business.

An intent to take action with respect to either of those "counters" was not part of the course of action to which petitioner was committed 18 T.C. 548">*562 prior to January 1, 1940, and which resulted in enlargement of the theatre in 1942.

The population of Phoenix, Arizona, was 48,118 in 1930 and 65,414 in 1940, according to the census for those years. The population of Maricopa County, Arizona, in which Phoenix was located, was 186,193 according to the census taken as of April 1, 1940, and the civilian population of Maricopa County as of November 1, 1943, was estimated by the U. S. Bureau of Census at 206,095. The 1940 census of Maricopa County showed a population increase of 23.3 per cent over the 1930 census for that county.

OPINION.

In 1932 petitioner was organized and commenced its business of operating a motion picture theatre, named Studio Theatre, at Phoenix, Arizona. Converted shortly theretofore from a one-story, store-type building on premises leased several months earlier by persons responsible for petitioner's formation, Studio Theatre had been opened with a capacity of 337 seats. Petitioner's business1952 U.S. Tax Ct. LEXIS 161">*195 experience convinced its management within the next two years that this seating capacity was too small for operation at a satisfactory level of profit, and it was decided to increase the seating capacity of the theatre. It actually took a lease on adjacent property on December 31, 1935, in order to provide such additional seating capacity. The unexpected failure to obtain immediate possession from a sublessee at that property together with subsequent difficulties in securing the necessary financing prevented petitioner from carrying out its plan for some time. Finally, the theatre's capacity was expanded in January 1942 to 518 seats. Petitioner claims that the enlargement of its theatre entitles it to excess profits tax relief under section 722 of the Internal Revenue Code, ² by reason of a change in "the character of the business" within subparagraph (b) (4).

1952 U.S. Tax Ct. LEXIS 161">*196 18 T.C. 548">*563 There appears to be no dispute that the substantial increase in seating capacity resulted in the requisite "difference in the capacity for production or operation" of the theatre, and therefore constituted a change in the character of petitioner's business within the terms of (b) (4). It is quite clear that petitioner's expansion in seating capacity qualified as such a change, and we have so found.

Relief is generally available under (b) (4), however, only if the change occurred "either during or immediately prior to the base period." But exception to this time limitation is made by the statute with respect to "Any change in the capacity for production or operation of the business consummated during any taxable year ending after December 31, 1939, as a result of a course of action to which the taxpayer was committed prior to January 1, 1940 * * *." The change here involved having been consummated in 1942, respondent urges that it is a change which fails to come within (b) (4) because it did not result from a course of action to which petitioner was committed prior to the specified date. We are unable to agree with this contention, and think that the expansion in seating1952 U.S. Tax Ct. LEXIS 161">*197 capacity which took place in 1942 was the result of a "commitment" within the meaning of the statute.

At the end of 1935, petitioner leased premises adjacent to the theatre with the purpose of acting on the desire of its management for an increase in seating capacity. Enlargement was to be achieved through expansion into a portion of a building located at these adjacent premises. This lease was for a term of 15 years, and obligated petitioner to pay a total rental of $ 135,000, and in addition petitioner agreed to pay the lessor-owner, Ackel Investment Company, a bonus of $ 7,500. The record shows, first, that, prior to the execution of this lease from Ackel, petitioner had assurance of a source for financing the expansion; and, secondly, that prior to execution of that lease, 18 T.C. 548">*564 it had the promise of a tenant at the adjacent premises that the latter promptly thereafter would transfer its lease, which still had 2 years to run and which covered a portion of the premises needed for the contemplated enlargement, to petitioner for an agreed consideration.

Petitioner therefore thought, and with reason, that it would be ready to proceed with the expansion in due course after the1952 U.S. Tax Ct. LEXIS 161">*198 Ackel lease was executed. It was prevented from doing so, however, by a chain of developments which started with the unanticipated failure of the tenant to abide by its promise to transfer its lease to petitioner; instead, that tenant transferred its rights to another party, which then moved into the premises for the remaining 2 years of the transferor's lease. The effect of this continued occupancy was that petitioner was unable to proceed with the enlargement and to take advantage of the offer it then had of financial assistance; and before the 2-year period of that occupancy had expired, that offer was withdrawn, and petitioner found itself at the end of that 2-year period without some other substitute which was immediately available on acceptable terms. Therefore, when petitioner found at the expiration of this 2-year period that the new occupant was interested in remaining for a further term, petitioner sublet the entire Ackel property for an additional 5 years beginning on February 1, 1938, but sooner terminable at petitioner's option after 3 years from that date. Thereafter petitioner continued to try to find means with which to finance the expansion; and when it succeeded1952 U.S. Tax Ct. LEXIS 161">*199 in doing so in 1941, it terminated this sublease, and proceeded to have the structural alterations made which were involved in achieving the contemplated expansion.

Although the record is not without some suggestion that before the end of the base period petitioner, possibly because of the discouraging turn of events, at least suspended if not substantially abandoned its interest and intent in carrying through the expansion and put off the expansion for further examination at some indefinite time in the future, we think the facts and circumstances on the whole show rather a continuing, active interest in expansion and a continuing, persistent search for a way of financing it. True, there are facts which make suspect a claim that petitioner continued to be seriously "committed" to enlargement of the theatre, such as the long period of some six years between petitioner's lease of the adjoining Ackel premises and the consummation of the enlargement, and petitioner's sublease of the Ackel property for a minimum period of three years, beginning in the base period and extending beyond the end of the base period, during which petitioner disabled itself from making the enlargement. We find, 1952 U.S. Tax Ct. LEXIS 161">*200 however, that these facts are largely explained by the remainder of the record in a manner which does not negate the continued existence of a substantially unabated intent and effort to enlarge the 18 T.C. 548">*565 theatre. The circumstances mentioned, rather than indicating an abandonment or suspension of prior intent, seem to us in the context of this record to reflect a subsisting attempt on petitioner's part to cope with and resolve its difficulties in a way which would minimize potential losses and yet permit it to realize its objective of expansion.

While petitioner's failure to contract during the base period for the necessary alterations incident to expansion may be taken into account, it is not necessarily conclusive of the question of commitment. That is made clear by the history of the statute, ³ as is shown in the statement of the Senate Committee on Finance that "the commitments made need not take the form of legally binding contracts only." S. Rept. No. 1631, 77th Cong., 2d Sess., pp. 201-202. See also E. P. C. 15, 1947-1 C. B. 89, amending Bulletin on section 722, p. 58: "Progress to the point where the taxpayer could not withdraw without substantial1952 U.S. Tax Ct. LEXIS 161">*201 detriment may be given substantial weight in determining whether or not taxpayer has committed itself * * *. On the other hand, commitment claims are not to be rejected solely on the ground that taxpayers which have otherwise complied with all of the essentials in commitment cases may, nevertheless, be in a position where they might have withdrawn without substantial detriment prior to January 1, 1940." We think it incorrect to say on this record that petitioner could have withdrawn from enlargement of the theatre without incurring "substantial detriment"; the evidence does not show, for example, that it was able to recoup the bonus of $ 7,500 it paid on originally leasing the Ackel property, and it was a matter of speculation whether it would be able to recover the amount of rent for which it became liable for the remainder of the term of that lease. Even if we were to assume, however, that petitioner did not proceed during the base period to a point from which it could not withdraw without substantial detriment, we would still be satisfied, on all the facts and circumstances, that it had adopted a course of action within the statute which resulted in the enlargement of the theatre. 1952 U.S. Tax Ct. LEXIS 161">*202 If petitioner failed to proceed beyond such a point, it was due to the difficulties 18 T.C. 548">*566 which it encountered without fault or design on its part, and failure to progress further under those circumstances was not evidence of a change in its plans. The record as a whole shows in our opinion that petitioner made "changes in position unequivocally establishing the intent to make the changes [in capacity for production or operation]," and that is enough to establish the "commitment" required by the statute. S. Rept. No. 1631, 77th Cong., 2d Sess., p. 202; see also Treasury Regulations 112, sec. 35.722-3 (d).

1952 U.S. Tax Ct. LEXIS 161">*203 The mere existence of a change in the character of the business within (b) (4) is not enough, however, to entitle petitioner to relief under section 722. Petitioner must also prove that, because of such change, its actual average base period net income does not reflect the normal operation during the base period of the business as changed, and it must also establish a fair and just amount representing normal base period earnings for the changed business.

Respondent contends that petitioner has failed to prove compliance with these additional requirements, and that in any event it therefore must be denied relief. Respondent points out that the average base period net income of $ 4,422.17 used by petitioner (computed by use of the section 713 (f) growth formula) was about twice as great as the average of its excess profits net income for the base period years, which amounted only to $ 2,179.17; and respondent contends that in such circumstances petitioner must prove, if it is to get any relief, that it is entitled to a constructive average base period net income large enough to produce a credit in excess of the credit computed under the growth formula. Irwin B. Schwabe Co., 12 T.C. 606, 613-614.1952 U.S. Tax Ct. LEXIS 161">*204 While petitioner's proof is not as complete as might be desired, we are convinced on the record that its average base period net income even under the growth formula does not reflect the normal base period earnings of Studio Theatre enlarged to a capacity of 518 seats, and we are satisfied on all the evidence that, because of the expansion in seating capacity, petitioner is entitled to a constructive average base period net income which is $ 1500 more than its average base period net income of $ 4,422.17 under the growth formula.

Expansion in the theatre's seating capacity could have no effect in increasing petitioner's base period income unless it would have had customers for those additional seats. If seating capacity was not a factor which limited petitioner's base period earnings, then obviously it cannot be said that it would have enjoyed greater earnings with greater capacity. Indeed, to the extent that additional capacity would have imposed higher expenses without bringing a comparable increase in customers and revenues, petitioner's net base period earnings would have declined rather than increased. It was therefore incumbent on petitioner to show that it lost customers1952 U.S. Tax Ct. LEXIS 161">*205 because of 18 T.C. 548">*567 insufficient seating capacity during base period years, and to prove the extent to which its net income would have increased, after allowance for increased expenses which would have been incurred, if its theatre during the base period had 518 rather than 337 seats. Cf. Green Spring Dairy, Inc., 18 T.C. 217, 237-240.

The record shows that during the base years Studio Theatre had periods of "peak attendance," which recurred on certain days of the week and at certain times of the day, and that during such periods there was a convergence of customers seeking admission to the theatre. It further appears in the record that at such times queues of waiting customers outside the theatre were not uncommon, due to the limited seating capacity of the theatre, and that not infrequently it happened, in such circumstances, that some persons would not wait long enough to be seated and others, seeing a line for admission to the theatre, would not wait at all. Such persons were lost as customers because the seating capacity was not larger during base period years. It may well have been, as respondent emphasizes, that on many such days the theatre1952 U.S. Tax Ct. LEXIS 161">*206 had not reached its "saturation point," in the sense that the aggregate number of persons admitted for all the performances during the day was less than the maximum number of persons who could have been accommodated throughout the entire day even by a theatre with 337 seats. Petitioner nevertheless could lose customers on such days because of the irregular and inconstant flow of customers; on the same day there might be times of surplus seating capacity and times of insufficient seating capacity. We are satisfied that there were concentrations of customers during these times of "peak demand" which the 337-seat capacity could not absorb, resulting in a loss of revenue which could have been avoided had a larger seating capacity been available.

The proof leaves us somewhat in doubt as to the numbers of customers and the amounts of revenue thus lost. We think petitioner has failed to establish that it could have filled substantially all 518 seats with any appreciable regularity if they had existed during the base period years. The proof is also somewhat unsatisfactory as to the extent to which petitioner's expenses would have risen as a result of these additional seats. While we 1952 U.S. Tax Ct. LEXIS 161">*207 believe from the record that they would have been somewhat less than the resulting increase in revenues, we are not satisfied that they would have been as insignificant as petitioner contends. Such expenses as salaries and compensation and the cost of utilities would have remained substantially the same or would have risen only a little. On the other hand, there can be little doubt that there would have been a substantial increase in depreciation deductions, resulting from the alterations and equipment necessary to make the enlargement. Taking into account 18 T.C. 548">*568 all of the facts and circumstances relating to the effect of the expanded seating capacity on petitioner's revenues from admissions and on its expenses of operation, and considering the record as a whole, we find the evidence to establish that petitioner's average base period net income of $ 4,422.17, as determined under the growth formula, does not reflect the normal earnings of Studio Theatre with a capacity of 518 seats; and that, because of the increase in seating capacity, petitioner is entitled to a constructive average base period net income which is $ 1,500 more than the foregoing actual average base period net1952 U.S. Tax Ct. LEXIS 161">*208 income of $ 4,422.17.

Petitioner claims that the "changes" made in the theatre in 1942 entitled it to relief because of the impact on its earnings, not only of a rise in income from admissions to the theatre, but also of an alleged increase in its sales of certain confectionary items such as candy and popcorn. Petitioner began to sell such items during the base period, through vending machines placed in the theatre lobby by an operator which paid petitioner a commission. In 1941, this arrangement was discontinued, and petitioner installed its own candy "counter" in the lobby in place of those vending machines. In 1942, when the seating capacity of the theatre was increased, the space in the lobby was enlarged by moving forward the doors behind the box-office at the entrance to the theatre, and a second candy "counter" was also installed outside those doors astride the theatre entrance. While the testimony in this connection is somewhat confusing, that is our understanding from the record of the sequence and nature of events relating to petitioner's sale of candy and popcorn.

The claim petitioner urges in these circumstances is rather uncertain. While petitioner stated in the 1952 U.S. Tax Ct. LEXIS 161">*209 claim it filed with respondent that it started to sell such items during 1938, petitioner does not seem to rely for relief on the fact of commencement of such sales during the base period. If it means to press a claim based on that fact, it must be unsuccessful if only for failure of proof that its normal earnings from those items, under the arrangement which existed during the base period for their sale, were not adequately reflected in the higher average base period net income which resulted from use of the growth formula of section 713 (f). Cf. Irwin B. Schwabe Co., 12 T.C. 606. If petitioner's claim for relief depends on the installation of its own candy counter in 1941, we are unable to find the necessary "commitment" by petitioner to that development prior to January 1, 1940. The only "commitment" we have been able to find on petitioner's part relates to expansion in the seating capacity of the theatre; that took place in 1942 and, on the evidence, has not been shown to have had any connection with the installation of the candy "counter" more than a year earlier.

18 T.C. 548">*569 The claim petitioner makes with respect to its sales of candy and popcorn1952 U.S. Tax Ct. LEXIS 161">*210 seems to be based rather on the alterations petitioner made in enlarging the theatre in 1942, and, while not articulated too well, seems to rest on the dual assertion that the new "outside-counter" would contribute substantially to such sales by reaching persons outside the theatre, and that the old "inside-counter" would add to sales for the reason that enlargement of the lobby made the latter "counter" more readily accessible to patrons already admitted to the theatre. We are unable to find on the record, however, that these "changes" in 1942 relating to sales of candy and popcorn were the result of a course of action to which petitioner was committed prior to January 1, 1940.

Moreover, we are unable to find that the "changes" made in 1942 with respect to sales of candy and popcorn worked a change in the character of petitioner's business within (b) (4). Those "changes" were not of sufficient scope or importance, so far as petitioner's operations were concerned, to qualify as a change in the character of its business. While commencement of the sale of candy and popcorn in a chain of more than fifteen theatres owned by a taxpayer may be of sufficient business importance to it 1952 U.S. Tax Ct. LEXIS 161">*211 to qualify as a change in the character of its business (cf. Jefferson Amusement Co., 18 T.C. 44), it does not follow that petitioner's addition of a second "counter" in a single theatre, in which such items were already being sold, is of comparable consequence to warrant similar treatment. Even less significant for petitioner, on the evidence before us, was the action taken in 1942 with respect to the "indoor-counter." The record in this case leaves us with no doubt whatever that under the statute there was no substantial difference made in petitioner's capacity for production or operation and no change in the character of its business in 1942 in connection with its sales of candy and popcorn. Cf. Treasury Regulations 112, sec. 35.722-3 (d); Farmers Creamery Co. of Fredericksburg, Va., 18 T.C. 241, 250-254; Clermont Groves, Inc., 17 T.C. 1616, 1621-1622; Wisconsin Farmer Co., 14 T.C. 1021, 1028.

Respondent asserts that petitioner derived abnormal income during the base period as a result of its connection with Paramount Pictures, Incorporated, which controlled1952 U.S. Tax Ct. LEXIS 161">*212 a 50 per cent stock interest in petitioner, and that a reconstruction under section 722 must be adjusted to exclude such income. The record is insufficient to establish, however, that "abnormal income" was in fact realized by petitioner because of that relationship or, if it was, the amount thereof, and there is consequently no occasion to pass on the matter.

Reviewed by the Special Division.

Decision will be entered under Rule 50.