18 T.C. 1083">*1083 The sole question in this proceeding is whether the Commissioner erred in disallowing petitioner's claims for excess profits tax relief under section 722 (b) (4), Internal Revenue Code, for its taxable 1952 U.S. Tax Ct. LEXIS 97">*98 years 1943, 1944, and 1945, in the respective amounts of $ 2,010.56, $ 2,539.54, and $ 611.05.

The evidence was taken by a Commissioner of the Tax Court and the facts set out below are substantially as found by the Commissioner. Neither party has offered any objection to the Commissioner's findings.

18 T.C. 1083">*1084 FINDINGS OF FACT.

The facts contained in the written stipulation of facts filed by the parties at the hearing are found as set forth therein.

Petitioner is a California corporation organized September 23, 1938. Its returns for the years involved were filed with the collector of internal revenue for the sixth district of California. The returns were prepared on an accrual basis and for a fiscal year ending August 31.

Petitioner's organizers and principal stockholders were J. J. Coonan and Marcus L. Godfrey, Jr., who became, respectively, its president and secretary and treasurer. Coonan had been associated with the A & P for a number of years. Godfrey had had no experience in the grocery business.

Petitioner had outstanding capital stock of $ 18,000 on August 31, 1940. On December 31, 1940, $ 5,000 additional capital was paid in for stock. There were no other changes in1952 U.S. Tax Ct. LEXIS 97">*99 petitioner's capitalization up to the close of the taxable years here involved.

Petitioner began business on November 1, 1938, operating, as a sublessee, the grocery department in the Ideal Market, located at 16th and American Avenue, Long Beach, California. The grocery store had been operated by a chain store group for about five years. On May 20, 1939, petitioner obtained the master lease on the Hi-Lo Market, located in Huntington Park, California, and began operating another grocery store in that location. It subleased the other departments of the market to other tenants. Coonan was in charge of the operations at the Long Beach store while Godfrey spent most of his time at the Huntington Park store. An office was maintained at the Huntington Park store but separate bookkeeping records were kept for each store.

Petitioner was a member of a cooperative purchasing concern known as Spartan Grocers, Ltd., from which it purchased most of its merchandise for both stores. The cooperative, hereinafter referred to as Spartan, had from about 400 to 500 member stores operating in southern California during the years 1938 to 1941, inclusive. It sold to its member stores at uniform prices1952 U.S. Tax Ct. LEXIS 97">*100 which enabled them to compete with the large chain stores. In addition, it furnished advice to its member stores about retail pricing and other matters and furnished them information about market conditions and new merchandise. Both of petitioner's stores were operated under a uniform purchasing and pricing system recommended by Spartan, which was designed to yield a normal gross profit of 14 1/2 to 15 per cent of sales. Petitioner had its inventories and retail prices checked by Spartan from time to time.

During 1940 Godfrey discovered that there were certain irregularities in the operations at one or both of the stores. He learned at about that time that legal action of some sort had been brought against 18 T.C. 1083">*1085 Coonan by a third party. On opening the Huntington Park store himself one morning, he found a cash shortage of $ 1,600. He immediately had a physical inventory taken which disclosed inventory shortages of $ 1,566.55 at the Long Beach store and $ 1,460.54 at the Huntington Park store. Adjustments were subsequently made in petitioner's books to reflect the inventory losses. It was also found that there was a lower profit ratio at the Long Beach store than at the1952 U.S. Tax Ct. LEXIS 97">*101 Huntington Park store. Other evidence of gross mismanagement was found at the Long Beach store, such as the unauthorized removal of merchandise and the withdrawal of cash by the clerks. One of the Huntington Park policemen reported that he had seen Coonan loading cases of merchandise into his private automobile from the back of the Huntington Park store after working hours. In all other respects the business operations of both stores appeared to be in order.

In May 1940 Godfrey, who controlled all of petitioner's stock, forced Coonan out of the business and took over the management of both stores. Soon thereafter Coonan committed suicide. Petitioner was never able to recover any of the losses attributable to him. Petitioner was then in financial difficulties but Godfrey was able to work out a plan with its creditors enabling it to continue in business.

In December 1940 petitioner took over the operation of the meat market in its Huntington Park store and in February 1941 closed out its grocery store at Long Beach.

Petitioner's business began to show a profit immediately after Coonan's removal. It now consists of three complete supermarkets and one grocery department in another.

1952 U.S. Tax Ct. LEXIS 97">*102 Following is a statement of petitioner's operations for the fiscal years ended August 31, 1939, and August 31, 1940:

18 T.C. 1083">*1086 As between the two stores petitioner's sales, by the 4-week accounting periods used in the fiscal year ended August 31, 1939, and by the monthly accounting periods used in the fiscal year ended August 31, 1940, were as follows:

Of the total cost of sales of $ 252,132 for 1940, shown above, $ 96,066 is attributable to the Long Beach store and $ 156,066 to the Huntington Park store.

Petitioner's balance sheets at August 31, 1939, and August 31, 1940, showed the following assets and liabilities:

Petitioner paid excess profits taxes for the fiscal years ended August 31, 1943, August 31, 1944, and August 31, 1945, in the respective amounts of $ 2,010.56, $ 2,539.54, and $ 611.05. Thereafter, it timely filed claims for refund, under section 722 (b) (4), Internal Revenue Code, of the entire amount of such taxes. In these1952 U.S. Tax Ct. LEXIS 97">*104 claims petitioner asserted that it commenced business during the base period; that it increased its capacity for doing business by opening the Huntington Park store in May 1939; and that predicated upon the growth attributable to the Huntington Park store it is entitled to use a constructive average base period net income of $ 4,468.01. The claims were all disallowed in full by the Commissioner.

In determining petitioner's excess profits tax liability for the taxable years 1943, 1944 and 1945, the Commissioner allowed excess profits credits, based upon invested capital, in the respective amounts of $ 2,174.06, $ 2,018.21 and $ 2,344.85.

18 T.C. 1083">*1087 OPINION.

The petitioner contests the Commissioner's disallowance of its claims for excess profits tax relief under section 722 (a) and (b) (4), quoted in material part below. ¹

1952 U.S. Tax Ct. LEXIS 97">*105 The undisputed facts show, and the Commissioner concedes, that petitioner both commenced business and changed the character of its business during the base period within the meaning of section 722 (b) (4), the section under which petitioner has based its claims for relief. Petitioner began operating its first store, the Long Beach store, on November 1, 1938, and opened its second store, the Huntington Park store, on May 20, 1939. Its statutory base period is the 4-year period September 1, 1937, through August 31, 1940. Those two factors, the commencing of business and the change in the character of the business, that is, a change in the "capacity for production or operation of the business," are the only factors relied upon by the petitioner in its claims for relief and in its petition herein.

The irregularities attributed to the petitioner's former president, Coonan, and his forced separation from the business are referred to in the claims for relief as a "retarding factor of considerable weight in the early history of the company."

The losses attributable to Coonan's mismanagement and thefts cannot be considered here as qualifying factors because they were not 18 T.C. 1083">*1088 relied1952 U.S. Tax Ct. LEXIS 97">*106 upon in petitioner's claims for relief and the facts pertaining thereto were not presented to the Commissioner. See Blum Folding Paper Box Co., 4 T.C. 795; Monarch Cap Screw & Manufacturing Co., 5 T.C. 1220; and Wadley Co., 17 T.C. 269.

The Commissioner's position here is that petitioner has failed to show that it is entitled to an excess profits credit based on reconstructed base period net income in excess of the credits which he has allowed under the invested capital method.

To be entitled to any relief under section 722 (b) (4) petitioner must convert its actual operating losses for the base period years 1939 and 1940, in the amounts of $ 7,813.15 and $ 3,261.28, respectively, into constructive earnings sufficient to produce excess profits credits in excess of the credits allowed by the Commissioner under the invested capital method of $ 2,174.06, $ 2,018.21, and $ 2,344.85, for the respective taxable years 1943, 1944, and 1945. See Green Spring Dairy, Inc., 18 T.C. 217, and cases there cited.

Petitioner has proposed three different reconstructions 1952 U.S. Tax Ct. LEXIS 97">*107 of base period income. In its claims for relief it reconstructed an average base period net income of $ 4,468.01. In its proposed findings of fact petitioner requests the following findings:

19. That the reconstructed net profit for Store #2 for the fiscal year ended August 31, 1940 is the sum of $ 2,891.51 computed as follows:

20. That the normal earning capacity of the petitioner for the only complete and normal earning base period is the earnings of Store #2 for the fiscal year ended August 31, 1940 in the sum of $ 2,891.51.

In this reconstruction of base period net income petitioner takes the actual sales of the Huntington Park store for 1940 amounting to $ 180,345, but reduces the cost of goods sold by the amount of the inventory loss of $ 1,460.54 attributable to the Huntington Park store. Taking the reconstructed 1940 net profit of the second store of $ 2,891.51 and applying the indices of Business Activity prepared by the Security First National Bank of Los Angeles, as contained1952 U.S. Tax Ct. LEXIS 97">*108 in the stipulation of facts, petitioner arrives at a constructive average base period net income of $ 2,697 and a constructive average base period credit for each of the taxable years of $ 2,962.15.

18 T.C. 1083">*1089 In its brief petitioner proposes a reconstructive average base period net income of $ 3,016 and an excess profits credit of $ 2,962.15. As a starting point, petitioner takes 14 1/2 per cent of the gross sales of the Huntington Park store for the fiscal year ended August 31, 1940, amounting to $ 3,226, as representing the normal expected earnings of that store, and applying the indices of Business Activity compiled by the Security First National Bank of Los Angeles, under the so called push-back rule, determines reconstructive earnings for the base period years 1937, 1938, 1939, and 1940, of $ 2,980, $ 2,887, $ 2,970, and $ 3,226, respectively.

On the evidence before us we cannot make any finding as to what extent, if any, petitioner's earning level at the close of its base period would have been increased had it commenced operations or opened its Huntington Park store two years earlier than it did. No contention is made and no proof has been offered to show that this second1952 U.S. Tax Ct. LEXIS 97">*109 store, and petitioner's business as a whole, had not attained its normal growth, in terms of sales volume, by the end of the base period.

Petitioner's reconstruction as set out in its proposed findings relates only to the operations of the Huntington Park store. Any proper reconstruction of normal operations for the base period must necessarily embrace all of petitioner's business. The Long Beach store was not closed out until 1941 after the close of the base period, and there is no evidence that its closing was a result of or, in point of time, was in any way related to the opening of the Huntington Park store.

The unsoundness of petitioner's reconstruction of base period income as set out in its brief lies in the use of the arbitrary percentage of sales formula as a starting point in computing normal base period earnings. While it is found as a fact that the uniform purchasing and pricing system under which petitioner operated was "designed" to yield a profit of 14 1/2 per cent or 15 per cent of gross sales, it has not been found, nor does the evidence support such a finding, that that was normal in the experience of other retail grocers similarly situated or would have been 1952 U.S. Tax Ct. LEXIS 97">*110 normal for the petitioner, after adjustment for all proven base period abnormalities.

The reconstruction of base period income must be related to the taxpayer's individual business experience. The intention of Congress to avoid setting up any theoretical standard of normal base period earnings for any industry or class of taxpayers is clearly manifest throughout the excess profits tax relief provisions of the statute. We rejected the taxpayer's computation of average base period net income on the basis of such a formula in Danco Co., 14 T.C. 276, where we said:

The petitioner states that its constructive average base period net income should be computed on the basis of the general formula which was commonly 18 T.C. 1083">*1090 used by Artisan and other companies from 1936 to 1939 to fix the sales price of custom work. Thus, the petitioner contends that 20 per cent of its net sales in 1942 and 1943 fairly represents a constructive average base period net income to be used in computing its excess profits credit for each year. It makes no effort to establish what its own sales, gross profits, administrative costs, or net income could reasonably have been expected1952 U.S. Tax Ct. LEXIS 97">*111 to be during the base period years. In our opinion, a fair and just amount representing petitioner's normal earnings can not be established under the method proposed.

The inherent fallacies in the petitioner's contentions are obvious. It is abundantly clear that by "constructive average base period net income" section 722 (a) contemplates that a taxpayer's normal earnings over the base period years will be expressed as a fixed amount and not as a percentage to be applied to sales from year to year as proposed by the petitioner. * * *

Although section 35.722-4 (c) of Regulations 112 recognizes the fact that no exact criteria can be prescribed for the computation of the constructive average base period net income of a taxpayer under section 722 (c), we feel that the taxpayer seeking relief must be prepared to submit the facts from which this Court may reasonably determine with some degree of accuracy the probable amount of its normal earnings for use as a constructive average base period net income.

Even after adjustment of petitioner's actual base period income for the losses attributable to Coonan's mismanagement and thefts and making such other adjustments as the evidence warrants1952 U.S. Tax Ct. LEXIS 97">*112 petitioner would not be entitled to as large excess profits credits as have been allowed by the Commissioner. On the evidence, we must therefore sustain the Commissioner's disallowance of petitioner's claims for relief.

Reviewed by the Special Division.

Decision will be entered for the respondent.