20 T.C. 110">*110 The Commissioner denied in full petitioner's applications for relief under section 722, Internal Revenue Code, and claims for refund of excess profits tax for fiscal years ended January 31, 1942, to January 20 T.C. 110">*111 31, 1946, inclusive. The question for determination is whether the petitioner has established the existence of qualifying factors such as to entitle it to relief under either section 722 (b) (2) or section 722 (b) (5) of the Code.

FINDINGS OF FACT.

The facts which have been stipulated by the parties are found as facts and the stipulation of facts and appended exhibits are incorporated herein by reference.

Petitioner is a corporation organized August 8, 1905, under the laws of the State of Massachusetts, and is authorized to operate as a department store in the city of Haverhill, Massachusetts, with1953 U.S. Tax Ct. LEXIS 192">*194 its principal office at 76-82 Merrimack Street of that city. The business was founded by Frank J. Mitchell in 1872 and was carried on as a partnership until it was taken over by petitioner as of August 1, 1905. Since the date of its incorporation, petitioner has engaged continuously in the business of operating said department store.

Petitioner has, since January 31, 1915, kept its books and filed its Federal income and excess profits tax returns on the accrual basis using a fiscal year ending January 31.

Petitioner filed its excess profits tax returns for the fiscal years 1942, 1943, 1944, 1945, and 1946, with the collector for the district of Massachusetts.

In computing its excess profits tax for the years in question petitioner was entitled, pursuant to section 712 of the Code, to use the excess profits credit based on average base period net income, following the method prescribed in section 713 (f) of the Code, or the invested capital method as set forth in section 714, whichever amount results in a lesser tax for each taxable year.

Petitioner's average base period net income, computed under section 713 (f) of the Internal Revenue Code for each of the fiscal years ended January1953 U.S. Tax Ct. LEXIS 192">*195 31, 1942, January 31, 1943, January 31, 1944, January 31, 1945, and January 31, 1946, is $ 13,052.30, determined as follows:

The excess profits credit of the petitioner under the income credit method is 95 per cent of $ 13,052.30, or $ 12,399.69.

20 T.C. 110">*112 The excess profits credits of the petitioner under the invested capital method as allowed by the Commissioner are, as follows:

Petitioner's corrected normal tax net income without credit for income subject to excess profits tax and the adjusted excess profits net income are:

1953 U.S. Tax Ct. LEXIS 192">*196 For each of its fiscal years, 1942 to 1946, inclusive, petitioner filed in due time, and in appropriate form, applications for relief under section 722 of the Internal Revenue Code.

On November 3, 1949, the Commissioner disallowed petitioner's applications for relief under section 722 for the fiscal years ended January 31, 1942, January 31, 1943, January 31, 1944, and January 31, 1945. On October 10, 1949, the Commissioner disallowed petitioner's application for relief under section 722 for the fiscal year ended January 31, 1946.

Since, and prior to 1920, petitioner's department store in the city of Haverhill has been located in the central part of the shopping district. Said district consists principally of one street about one quarter of a mile in length which parallels the Merrimack River. All of the more important stores are located on the same side of said street, including petitioner's store. Petitioner leased all of the ground floor and basement of a brick building, the rear of which abuts on the bank of the said river. The building is owned jointly by three stockholders, the sons of Nicholas C. Johnson, except for a small adjoining building which petitioner also occupies1953 U.S. Tax Ct. LEXIS 192">*197 and which is owned by outside interests.

During the base period, petitioner's store was the leading one of its kind in the city of Haverhill, its main competition being from other department stores and from so-called specialty stores. Its principal source of business was local although business was also drawn from nearby areas. To the south, 6.9 miles by rail and approximately 9 1/2 miles by road, the city of Lawrence, with a population approximately double that of Haverhill, offered shopping facilities. Petitioner's principal source of income was from sales at retail of its own 20 T.C. 110">*113 departments, and commissions on sales of departments leased to others.

Petitioner's net sales, gross profits, and net income, beginning with the fiscal year ended January 31, 1921, through the fiscal year ended January 31, 1940, are shown by the following schedule:

1953 U.S. Tax Ct. LEXIS 192">*198 During the base period years, petitioner's two principal competitors in Haverhill, engaged in operating department stores selling similar kinds of merchandise, were The Sceva Speare Company located at 20-40 Merrimack Street, approximately 300 feet on one side of the petitioner's store, and the Enterprise Stores, Inc., located at 132-134 Merrimack Street, about 300 feet on the other side of petitioner's store. All three stores were on the same side of the street. The net sales of all departments, leased departments, and owned departments of The Sceva Speare Company and the Enterprise Stores, Inc., for the base period years are as follows:

Yearly Sales of Enterprise Stores, Inc., for Department Store Opened May 19381953 U.S. Tax Ct. LEXIS 192">*199 in Haverhill, Massachusetts

20 T.C. 110">*114 Also, during the base period years the petitioner had competition from two chain stores selling some merchandise similar to that of the petitioner, namely, the W. T. Grant Company located on the same side of the street and between the petitioner's store and The Sceva Speare store, and J. J. Newberry Company located on the same side of the street and between the petitioner's store and Enterprise Stores, Inc.

The Sceva Speare Company in 1934 acquired by purchase the business formerly operated by The Leslie Dry Goods Co., a competitor during petitioner's existence up to the year 1934, when it became bankrupt. The Sceva Speare Company occupied the same store with the same floor area and did not materially change or alter the store fixtures, store layout, or the store front during the base period years. The Enterprise Stores commenced business in May of 1938 in a building previously erected for such occupancy. The Enterprise1953 U.S. Tax Ct. LEXIS 192">*200 Stores, Inc., operate a chain of similar stores in certain cities in New England.

The W. T. Grant Company commenced business in Haverhill in 1916 and moved to its present location in or about the year 1925. The J. J. Newberry Company commenced business in Haverhill in 1925 in its present location, and it succeeded to the business of Nelson's, a chain store of the limited price variety.

Since 1905, and up to 1924, another department store operating under the name of Simonds and Adams Co., a competitor of the petitioner during that period, occupied the premises now occupied by a store of W. T. Grant Company located on the same side of the street and between the petitioner's store and The Sceva Speare store. The Simonds and Adams store ceased and discontinued doing business during the year 1924.

During the flooding of the Merrimack River in March 1936, petitioner's store was flooded to the depth of 28 feet and its business operations were entirely closed down from March 19 to March 30, 1936. The flood had an adverse effect on the petitioner's earnings for the fiscal year ending January 31, 1937. The petitioner was entitled to the benefits of section 711 of the Code, amounting to 1953 U.S. Tax Ct. LEXIS 192">*201 $ 9,400 net direct loss due to the flood, but any reconstructed earnings under section 711, as well as any correction under section 722 (b) (1) for the loss of earnings due to the flood of 1936, would result in reconstructed earnings for the year ended January 31, 1937, insufficient to afford any relief in excess of that resulting from the application of either section 713 (f) or section 714 of the Internal Revenue Code.

The city of Haverhill always has been chiefly an industrial city. During the base period years its population was about 47,000. The 20 T.C. 110">*115 population for the State of Massachusetts, and for the city of Haverhill during the period 1920-1950, is shown by the following table:

Haverhill is located in Essex County, and is about 33 miles north of Boston. Other industrial cities or towns within a radius of 15 miles are Lawrence, Newburyport, and Amesbury. The city of Lowell is approximately 19 miles from Haverhill. Haverhill is on the main line of the 1953 U.S. Tax Ct. LEXIS 192">*202 Boston and Maine Railroad which runs between Boston, and Halifax, Nova Scotia.

During the base period, Haverhill was a manufacturing center in which about 67 per cent of all of its industries were engaged in the manufacture of women's boots and shoes, other than rubber, and the manufacture of boot and shoe cut stock and findings for women's shoes. The class of shoes manufactured was women's specialty and novelty shoes. The manufacture of men's shoes was not significant.

Commencing at approximately the beginning of the present century, and continuing thereafter up to and including the base period, the shoe industry of Massachusetts, generally, and of Haverhill, in particular, declined steadily. Haverhill was particularly affected by virtue of the fact that its shoe industry, during the base period and for decades prior thereto, was highly unionized. In Haverhill, labor costs were maintained at substantially higher levels than those predominating elsewhere. For example, in Maine, New Hampshire, and the southern and western sections of the United States, in comparison, cheap, unorganized labor was available.

The women's specialty shoe manufacturing industry is highly competitive, 1953 U.S. Tax Ct. LEXIS 192">*203 particularly with respect to the lower priced type of shoe which is manufactured in Haverhill. Material costs remain fairly constant throughout the industry so that the margin of profit which can be made by a given manufacturer is directly dependent upon his ability to keep labor costs and other operating expenses such as transportation costs, rent, and taxes, at a minimum. It was, therefore, more profitable for a shoe manufacturer to operate in a locality in which labor costs were lower than they were in Haverhill. Also, other localities offered such inducements as tax-free and rent-free buildings, and other forms of subsidization. Migration in the shoe industry is accomplished with ease. Prior to and during the base period, there was a trend of migration of shoe manufacturers away 20 T.C. 110">*116 from Haverhill. The number of boot and shoe firms in Haverhill decreased from 147 in 1922 to 33 in 1940.

A further explanation of the continual migration of shoe manufacturers from Haverhill is found in the fact that the retail markets for shoe products were constantly moving westward so that the increased transportation costs involved in serving these markets rendered Haverhill less desirable. 1953 U.S. Tax Ct. LEXIS 192">*204 Moreover, there has been a tendency since 1900 for shoe manufacturers to operate in larger plants of a size not to be found in Haverhill. ¹

Between 1928 and 1939, the United States imported low priced women's specialty shoes from Czechoslovakia in quantities which were sufficient to create a substantial element of competition with American producers of low priced women's specialty shoes, including those of Haverhill. Advantageous tariff rates and cheap foreign production costs explain the volume of these imports, which ceased entirely after the spring of 1939 when Germany1953 U.S. Tax Ct. LEXIS 192">*205 occupied Czechoslovakia.

Labor became organized in Haverhill's shoe manufacturing industries prior to 1900. Labor strongly opposed arbitration until 1920, when a local board of arbitration was set up. A permanent local board was created in 1923 which arbitrated wage disputes until the whole system broke down at the end of 1928. A new arbitration agreement covering two-thirds of the shops in Haverhill was made, effective January 1, 1936, and thereafter, a substantial number of wage disputes were arbitrated under that agreement.

Haverhill has had a long history of industrial strikes antedating 1900. Most, if not all, of the major strikes occurring in Haverhill have been a result of wage disputes. The following schedule shows the extent of strikes in Haverhill between 1927 and 1940:

1953 U.S. Tax Ct. LEXIS 192">*206 20 T.C. 110">*117 Although numerous shoe firms in Haverhill have failed or migrated as a direct consequence of strikes, the chief causes of failures or migrations have been mismanagement and inability to operate profitably in Haverhill, irrespective of strikes. Numerous economic advantages such as cheap labor and cheap operating costs offered by other localities have provided inducements to shoe manufacturers to move away from Haverhill.

Petitioner's average base period net income was depressed, due principally to low net sales as a result of the decreased purchasing potential of its relatively fixed class of customers.

The underlying cause of the decreased purchasing potential of petitioner's customers was the steady and permanent decline of the women's specialty shoe manufacturing industry and the related industries of Haverhill. That decline has been due chiefly to business failures and migration to other localities. The economic factors which have been productive of the decline, the failures, and the migrations are permanent in character, and they relate chiefly to the impacts of competition.

OPINION.

1953 U.S. Tax Ct. LEXIS 192">*207 The question is whether petitioner is entitled to any relief under sections 722 (b)(2), or 722 (b) (5), Internal Revenue Code. The pertinent provisions of section 722 are set forth below. ²

1953 U.S. Tax Ct. LEXIS 192">*208 20 T.C. 110">*118 The petitioner bases its claim for relief upon a theory which consists of several contentions which, summarized, are as follows: (a) petitioner contends that its potential customers are limited principally to the inhabitants of Haverhill; (b) that the inhabitants of Haverhill are, for the most part, dependent for their purchasing power upon the wages paid to them by the women's specialty shoe industry and related industries which are located in Haverhill, which comprise approximately 67 per cent of all Haverhill's industry; (c) that Haverhill's shoe and related industries have had a history of satisfactory machinery for the arbitration of labor disputes from 1918 until the present time except for the period 1929 to 1935, inclusive; (d) that as of the first day of January 1929, Haverhill's arbitration machinery completely broke down and was not effectively restored until the early part of 1936, and unsettled wage disputes caused severe strikes between 1929 and 1936, so that the shoe industry in Haverhill was unable to meet its contractual obligations and thereby earned a poor reputation among the normal and potential buyers of its products; (e) that this situation caused 1953 U.S. Tax Ct. LEXIS 192">*209 many manufacturers to move out of Haverhill, while others failed and went out of business, all of which caused wide-spread unemployment in Haverhill, and severe and abnormal reductions of the purchasing potential of petitioner's fixed class of customers; (f) that with the return of responsible labor leadership to Haverhill in 1936, arbitration machinery was restored and further strikes were substantially eliminated, but, nevertheless, the reputation of Haverhill's shoe industry for stability in meeting contractual demands was not fully restored until approximately 1939, the close of the base period; (g) that the abnormally depressed level of petitioner's base period earnings is attributable to the industrial unrest found in Haverhill in the period 1929 to 1935, inclusive, which condition of unrest constituted a temporary economic event unusual in petitioner's experience.

We understand petitioner's position to be, substantially, that the sequence of events summarized above began with the breakdown of arbitration machinery in Haverhill, and that this was a temporary economic circumstance unusual in the case of petitioner within the scope of section 722 (b) (2).

The parties agree that1953 U.S. Tax Ct. LEXIS 192">*210 although petitioner is not a member of the shoe industry, the successful operation of its store depends, in large measure, upon the prosperity of the shoe industry in the city of Haverhill. The fluctuations in petitioner's gross sales over the years follow the same general pattern as the fluctuations in the total payroll of Haverhill's shoe and related industries. The fact that petitioner's base period earnings were indirectly rather than directly affected by the fortunes of the local shoe industry would not of itself disqualify petitioner from relief under section 722 (b) (2). However, there 20 T.C. 110">*119 rests upon petitioner the burden of proving that its sales were abnormally reduced by a temporary economic event unusual in its experience. Industrial Yarn Corporation, 16 T.C. 681; Del Mar Turf Club, 16 T.C. 749; Wadley Co., 17 T.C. 269; Granite Construction Co., 19 T.C. 163. See, also, E. P. C. 12, 1947-1 C. B. 80.

The respondent concedes that no well-defined system of arbitrating labor disputes was operative in Haverhill from1953 U.S. Tax Ct. LEXIS 192">*211 1929 to 1935, inclusive. The chief point of respondent's argument is, however, that the presence or absence of arbitration machinery during that or any other period was merely an isolated, incidental circumstance which could neither have avoided nor furthered the steady, permanent decline in Haverhill's shoe industry which had commenced in approximately 1923, and had continued through the base period.

The issue under section 722 (b) (2) involves determination, first, of what economic factors have caused petitioner's low base period earnings, and, second, whether these economic factors were temporary and unusual in the experience of the petitioner within the intendment of section 722.

After thorough examination of the voluminous record in this proceeding, we are unable to ascribe to petitioner's history of low base period earnings, the causative factor which it asserts.

We have found as a fact that the processes for abitration of labor disputes were inoperative in Haverhill's shoe manufacturing industry for a substantial period of time prior to the base period. We have also found, however, that the steady, continuous, and permanent decline of the Haverhill shoe manufacturing industry1953 U.S. Tax Ct. LEXIS 192">*212 itself, which commenced at approximately the beginning of the present century and reached its lowest level during the base period years, was attributable, on the whole, to permanent economic factors.

The decline of shoe production in Haverhill was due principally to (1) the expansion of western markets; (2) the lower cost of production outside of Haverhill in consequence of Haverhill's relatively high, unionized wage scale; (3) the many and varied forms of inducement which competing localities outside of Haverhill offered to Haverhill shoe manufacturers in order to persuade them to move their site of operations; (4) the increasing tendency, because of the increased profits inherent in such a system, to manufacture shoes in large plants geared for high volume output, of the sort for which the small plants in Haverhill were ill suited, and (5) competition between 1928 and 1938 from low cost shoes imported from Czechoslovakia.

We are unable to trace any clearly defined or ascertainable effect upon Haverhill or its shoe manufacturing industry to industrial strife during the period of a breakdown in arbitration from 1929 through 1935. For example, there is no correlation between population1953 U.S. Tax Ct. LEXIS 192">*213 trends 20 T.C. 110">*120 and the ups and downs of arbitration. The population of Haverhill reached a high of 53,884 in 1920, and it declined by 4,652 in 1925. However, during the entire 5-year period, a system of labor-management arbitration existed in Haverhill. Conversely, Haverhill's population decreased by 3,000 between 1935 and 1940 in spite of the resumption of arbitration on January 1, 1936. Furthermore, a total of 40 manufacturers moved out of Haverhill from 1936 to 1940, inclusive, a period of continuously available arbitration procedures for Haverhill's shoe industry.

Noteworthy, also, is the fact that, except for the year 1936, in which no strikes were reported in Haverhill, there were some strikes in every year from 1927 to 1940, inclusive. It is significant that, with the exception of major strikes in 1929, 1933, and 1934, man hours lost by reason of strikes were as great in the years preceding and subsequent to the breakdown of arbitration procedures in Haverhill, i. e., when arbitration systems were available to labor and management, as they were in the years when there were no arbitration procedures.

Testimony with respect to individual strikes merely serves to further1953 U.S. Tax Ct. LEXIS 192">*214 illustrate the invalidity of petitioner's theory that arbitration spelled the difference between prosperity and poverty in Haverhill's shoe manufacturing industry. Mrs. Moran, a witness called by the petitioner as an expert on labor relations in Haverhill, testified as follows:

A. Well, abuses can be as bad one way as they can the other, and the shoe workers felt they were being abused. And at this point there was a little bit of shoe business, and they thought they'd get back all they lost. So one Monday morning they organized a parade, and everybody was on the street and they stayed out.

A. '33.

A. '29; that was to get the ten percent cut.

Q. Who provoked that?

By the Court:

A. Well, the manufacturers, in order to stay in business, claimed they needed a ten percent reduction in labor prices.

David H. Hilliard, one of respondent's witnesses, testified as follows with respect to a strike occurring in 1942 which lasted between 8 and 10 days:

A. 1953 U.S. Tax Ct. LEXIS 192">*215 Yes. United Shoe Workers Union had requested a general wage increase. The manufacturers could not see their way clear to grant the increase to them and it went to arbitration. They called Copelof, the Federal Arbitrator, who 20 T.C. 110">*121 was the arbitrator in the case. He handed down a decision that was unacceptable to the workers. They all just walked off the jobs, quit work.

The mere existence of one or more of the factors set forth in section 722 (b) (2) does not of itself entitle a taxpayer to relief. The petitioner must show that as a result of the existence of such factor its base period net income was depressed. Clinton Carpet Co., 14 T.C. 581.

Therefore, even though arbitration in Haverhill did break down temporarily prior to the base period, petitioner's claim for relief under section 722 (b) (2) must fail in the absence of proof of causal relationship between that temporary economic factor and petitioner's low base period earnings. Petitioner has failed to establish such relationship.

We have found as a fact that petitioner's base period net income was low, but we have found, also, that its low earnings were due principally to low net1953 U.S. Tax Ct. LEXIS 192">*216 sales. However, low base period earnings do not ipso facto entitle petitioner to relief. Such earnings must be shown to be subnormal earnings as a result of an event listed in one of the subsections of 722 (b). Monarch Cap Screw & Manufacturing Co., 5 T.C. 1220, 1229; Wadley Co., supra, 269, 277; Trunz, Inc., 15 T.C. 99, 103. Petitioner has failed to meet its burden in this respect.

We have given consideration to those economic factors which, based on the record, explain the decline which took place in Haverhill's shoe manufacturing industry. The issue as presented by the parties has made such consideration necessary. It should be pointed out, however, that the petitioner is a member of the retail department store business. While it is true that petitioner's economic success hinges substantially, if but indirectly, upon the fortunes of the local shoe manufacturing industry, it is equally true that during the base period petitioner encountered direct competition from two new competitors. The Sceva Speare Company operated its store at a distance of 300 feet on one side of petitioner's1953 U.S. Tax Ct. LEXIS 192">*217 store, while Enterprise Stores was located only 300 feet on the other side. Both were operated by persons who were both experienced and successful in the retail merchandising business. Each made substantial sales during the base period. To what extent this new competition affected petitioner's sales has not been established. However, since petitioner has the burden of proving that this permanent economic factor -- direct competition -- did not adversely affect its base period sales, and since petitioner has failed to prove that the factor of direct competition did not cause its low base period earnings, the doubts in the matter must be resolved against the petitioner.

It is held that petitioner does not qualify for relief under section 722 (b) (2).

20 T.C. 110">*122 We come now to a consideration of petitioner's alternative claim for relief under section 722 (b) (5). Neither in its petition, nor at the trial of this proceeding, nor on brief has petitioner made clear whether it seeks relief under subsection (b) (5) on the basis of the same factors which have already been considered in connection with petitioner's claim for relief under section 722 (b) (2), or on the basis of some "other1953 U.S. Tax Ct. LEXIS 192">*218 factor." Relief must be denied in either event. Relief cannot be afforded under section 722 (b) (5) where petitioner has not even identified the so-called "other factors." Wadley Co., supra, 269, 285. If, on the other hand, petitioner's claim for relief under subsection (b) (5) is predicated on factors which we have separately considered and rejected, above, petitioner must fail. Granite Construction Co., supra; General Metalware Co., 17 T.C. 286; Foskett & Bishop Co., 16 T.C. 456; Roy Campbell, Wise & Wright, Inc., 15 T.C. 894; George Kemp Real Estate Co., 12 T.C. 943. It is held that petitioner does not qualify for relief under section 722 (b) (5).

Reviewed by the Special Division.

Decision will be entered for the respondent.