32 T.C. 292">*292 This proceeding involves respondent's disallowance of petitioner's application for relief under section 722, I.R.C. 1939, and claims for refund of excess profits tax for1959 U.S. Tax Ct. LEXIS 178">*179 the years 1941 to 1945, inclusive, in the following amounts:

The total amount of excess profits tax here in controversy, including claimed carryovers and carrybacks, is $ 229,513.80.

FINDINGS OF FACT.

Some of the facts have been stipulated and are found as set forth in the written stipulation filed by the parties.

Petitioner is an Illinois corporation with its principal office located at Chicago, Illinois. Its income and excess profits tax returns for the taxable years were filed with the collector of internal revenue for the first district of Illinois. The returns were made on an accrual basis for the calendar year.

Petitioner is engaged in the business of operating retail millinery shops on premises which it leases from department and specialty stores. It is the oldest operator of leased millinery shops in the United States. The shops are located in the larger urban centers throughout the United States, but principally along the eastern seaboard.

32 T.C. 292">*293 The lease agreements between petitioner and its lessor stores, at times here material, were usually for a 5-year1959 U.S. Tax Ct. LEXIS 178">*180 term. They provided for annual rentals of from about 15 per cent of gross sales for the earlier years, before 1930, and as high as 20 per cent in later years. The general policies and sales methods of petitioner's shops were under direction of the lessors.

Petitioner did not manufacture millinery but purchased its merchandise in the open market from manufacturers located principally in the larger cities throughout the United States. These purchases were made by various local managers and the merchandise was shipped directly from the manufacturers to petitioner's shops. Petitioner had no warehouse and maintained no inventories, except of a few minor staple commodities which it kept in its New York office. Petitioner's buyers were furnished with a "guide," in pamphlet form, containing data on millinery styles and trends, which was prepared at petitioner's New York office.

There were two principal buying periods in the spring and two in the fall of each year. Due to rapid changes in styles there was a turnover of inventory in the various stores every 3 or 4 weeks. Any stock left over at the end of a season was marked down and disposed of in clearance sales.

There are about 10 1959 U.S. Tax Ct. LEXIS 178">*181 recognized basic styles or shapes in women's hats, such as, cloche, sailor, pillbox, etc. Their popularity varies from time to time according to style changes. Materials and colors are important factors in style changes. Style changes are one of the most important factors in the millinery industry.

From about 1925 and throughout the depression years from 1929 through the early 1930's, the millinery industry, as described in a report prepared by a United States Government economist for the National Industrial Recovery Administration (N.R.A.), was in a state of "progressive demoralization and chaos." The report continued:

The records present a picture of intense and merciless competition, resulting in vast periodic unemployment and an amazingly high mortality rate among manufacturers. During the depression years, fully 20 per cent of the houses in the industry went out of business annually. It is significant that those who have remained in the business three years are now considered old-timers.

The decline in the industry has been continuous. Between 1925 and 1931 dollar volume dropped from 190 millions to 132 millions, despite a very large increase in unit volume. The explanation1959 U.S. Tax Ct. LEXIS 178">*182 is a progressive deterioration of quality, which is in turn due to the intense competition.

In the pre-depression years and particularly before the war, competition had been primarily on the basis of style and quality of workmanship. After 1926, however, because of the general decline in purchasing power the buying public insistently demanded cheap merchandise, and competition was shifted to a basis of price. This demand of the consumer was caused neither by the manufacturer 32 T.C. 292">*294 nor by the retailer, but rather by the public need. It was passed on to the retailer by the consumer, and by the retailer it was passed back to the manufacturer.

This constantly increasing pressure for cheaper merchandise had a revolutionizing effect upon the industry. Before the depression, so-called popular hats were sold for an average wholesale price of $ 24.00 per dozen, while the cheapest was sold for $ 16.50 per dozen. * * *

In the early 1930's, in addition to the other difficulties of the millinery industry, there developed a fashion trend for women to go without hats. Theretofore women seldom appeared in public without some type of hat. Among the more important causes to which this so-called1959 U.S. Tax Ct. LEXIS 178">*183 "hatlessness" was ascribed were changed economic conditions resulting from the general business depression in the late 1920's and early 1930's; the movement to the suburbs in many of the larger urban communities; the progressive freedom which women began to practice in customs and mode of dress; the increase of automobiles and women drivers; the change to more elaborate hair styles, to which hats were not suited; and the publicity given to motion picture actresses and other prominent women who began to appear in public without hats. By the middle 1930's hatlessness had become a well-recognized problem of the millinery industry.

The following table shows, for such years as statistics are available for the United States, the wholesale dollar volume of millinery manufactured, estimated retail dollar volume, physical unit volume, female population, unit prices wholesale, unit prices retail, per capita expenditures for hats, and hats purchased per capita:

The figures appearing in the above table are contained in a report prepared by the Millinery Stabilization Commission, Inc. They are in some respects admittedly inaccurate but they are said to represent the best estimate that can be made from the data available.

32 T.C. 292">*295 The Millinery Stabilization Commission, Inc., was created by joint agreement between management and labor groups in the New York-New Jersey sector of the industry early in 1936 following termination of the N.R.A. Code of Fair Competition for the Millinery Manufacturing Industry. The purpose, as the title indicates, was to stabilize the millinery industry, particularly as to labor and management relations and trade practices. At the outset, it1959 U.S. Tax Ct. LEXIS 178">*185 adopted for its members the same fair trade practices as were contained in the N.R.A. code. Later, in 1937, it promulgated a set of its own regulations which were voluntarily adopted by most of the millinery manufacturers and retailers in the New York-New Jersey sector. The commission later appointed a trade promotion committee whose function was to promote sales of millinery. Hatlessness was one of the sale problems which the committee recognized and sought to correct. Among other measures, it scheduled millinery style shows throughout the country and engaged models wearing hats to appear on opening days of racetracks, in Easter parades, and on the boardwalks at Atlantic City. Efforts were made to induce actresses and other prominent women to make public appearances in hats. Representatives of the millinery retailers began attending the seasonal style shows in increasing numbers, resulting in better understanding and cooperation between them and the manufacturers. Through these and other activities of the manufacturers and other segments of the millinery industry, efforts were made to induce women to become more conscious of hats as a mode of dress. Emphasis was placed on1959 U.S. Tax Ct. LEXIS 178">*186 the fashion concept of the proper hat for a particular occasion or costume.

The adverse effect of hatlessness on the industry extended beyond the 1930's and, in fact, still exists. It is recognized today as an important factor to be dealt with in the millinery industry.

There were three separate divisions of the retail millinery industry: The chains or syndicates which leased shops from department stores, the group in which petitioner belonged; the retail departments which the department stores themselves operated; and the independent retail shops. The syndicates were the largest of these groups. There were about seven of the principal syndicates, among which petitioner ranked second in point of volume of business. Petitioner and its larger competitor had similar profit patterns for the entire 1923 to 1943 period, and similar ratios of net income to sales. This net income pattern conformed to that of all United States corporations throughout the 1923 to 1943 period, except that it did not reach the low point of other corporations in 1932, and declined somewhat below the general index in 1936, 1937, and 1938. Thereafter the improvement in both patterns was about the same, except1959 U.S. Tax Ct. LEXIS 178">*187 that when war broke 32 T.C. 292">*296 out millinery got a little lift. The millinery industry was the only industry that did not have a wartime price regulation.

The following table shows petitioner's total sales, net income, percentage of net income to sales, and the number of stores operated by petitioner for the years 1922 to 1955, inclusive:

Petitioner operated its shops on a budget plan. It prepared a budget for each separate shop on a 6-month basis. Each budget showed the shop's actual sales for the corresponding period for the prior year, and the projected sales for the current 6-month period. Advertising expenses were budgeted, generally, at a fixed percentage of estimated sales. It was 4 per cent of estimated sales originally but in 1932 was raised to 5 per cent and in 1936 to 6 per cent. There was a decrease of 5 per cent in 1941 and a return to 4 per cent in 1938. Each shop was allocated a portion of the total advertising budget computed on that basis. The amount depended upon the shop's contractual requirements and other considerations affecting its advertising needs. Newer shops required more advertising than the older ones. Most of petitioner's advertising in the 1930's was in the medium of newspapers.

Petitioner's actual advertising expenses, as shown in its profit and 32 T.C. 292">*297 loss statements, and other expenses, expressed as a percentage of sales, for the years 1922 to 1948, inclusive, were as follows:

1959 U.S. Tax Ct. LEXIS 178">*189 Respondent computed petitioner's excess profits net income for the taxable years 1941 to 1945, inclusive, under the income method, allowing an excess profits credit, computed under section 713(f), I.R.C. 1939, of $ 41,970.73 (petitioner's actual average base period net income was $ 37,679.78); an unused excess profits credit carryover from 1940 to 1941 of $ 23,276.63; and specific exemptions of $ 5,000 in 1941, 1942, and 1943, and $ 10,000 in 1944 and 1945. Petitioner timely filed applications for relief for each of the taxable years under section 722, I.R.C. 1939, based on a constructive average base period net income of $ 122,000.

Petitioner's adjusted excess profits net income, as determined by respondent, the excess profits taxes paid by petitioner, and the amount of the refund claims filed by petitioner were as follows:

1959 U.S. Tax Ct. LEXIS 178">*190 Petitioner's business was not depressed during the base period because of temporary economic circumstances, and its average base period net income is not an inadequate standard of normal earnings.

OPINION.

Petitioner's contentions are that its base period net income was depressed because of an unusual and temporary economic 32 T.C. 292">*298 circumstance identified as "hatlessness," which entitles it to excess profits tax relief under section 722(b)(2), I.R.C. 1939. ¹ Petitioner proposes to correct this abnormality by restoring to base period income that portion of its advertising expenses for each of the base period years which it attributes to the cost of combating hatlessness. The resulting constructive average base period net income under the proposed adjustment is $ 111,527.11.

1959 U.S. Tax Ct. LEXIS 178">*191 In our opinion the evidence fails in several respects to support petitioner's contentions.

Petitioner's average base period net income is abnormally low only when compared with the high income years from 1922 to 1927, inclusive, and those after 1942. The average earnings for the pre-base period years 1927-1935 was $ 33,844.15 as against actual average base period income of $ 37,679.78. The allover 1927-1942 average was only $ 40,157.72, which is below the excess profits credit figure of $ 41,970.73 computed under section 713(f), I.R.C. 1939.

But even assuming that petitioner's base period earnings were depressed, the evidence is far from convincing that the major cause was hatlessness as petitioner contends. There is evidence that in the base period years there were other factors adversely affecting the whole millinery industry, including the depression, labor troubles, cutthroat competition, low per unit prices, and increasing costs of operation. Petitioner, in its brief, speaks of a "multiple causation for 'hatlessness.'" ² This suggests that hatlessness was not a prime cause for 32 T.C. 292">*299 women not spending as much for hats but was itself the result of other causative circumstances. 1959 U.S. Tax Ct. LEXIS 178">*192 It may be oversimplification to say that women did not buy hats because they did not wear hats. To satisfy the statute we should look further to find the reason why they did not buy as many or as expensive hats and the real cause of the lack of dollar-volume sales.

The evidence does not show the unit volume of hat sales before 1937 but for the 3 last base period1959 U.S. Tax Ct. LEXIS 178">*193 years the number of hats sold increased substantially from year to year. The per capita sales are not given before 1938, but even they show a slight increase between 1938 and 1939. In any event, there is no possible means of determining on the evidence of record what dollar amount of petitioner's theoretical unrealized base period income may reasonably be attributed to any hatlessness.

Petitioner's proposed reconstruction plan of restoring a portion of the advertising costs ³ to base period income is wholly unacceptable. ⁴ It of course presupposes that some ascertainable amount of such advertising expenses was incurred in combating hatlessness. There is no foundation in the record for such a calculation. Aside from the irrelevance of such a "managerial decision," see Granite Construction Co., 19 T.C. 163">19 T.C. 163, Hearn Department Stores, Inc., 23 T.C. 266">23 T.C. 266, there is no showing that advertising was intended to or did check hatlessness. The evidence is that most of petitioner's advertising was in the newspapers. Presumably those advertisements were presented in the usual style and price formats. There is no evidence that1959 U.S. Tax Ct. LEXIS 178">*194 any substantial amount of petitioner's advertising was directed against hatlessness. It could have been, and presumably was, intended to increase sales like any other advertising, although for all that appears it could equally have been directed toward obtaining higher prices or moving lower cost merchandise. Any direct attack against hatlessness apparently was left to the special committee of the Millinery Stabilization Commission, Inc.

So far we have discussed only the factual questions presented. As a matter of law, petitioner has the further burden of establishing that its business was depressed in the base period "because of temporary economic circumstances unusual in the1959 U.S. Tax Ct. LEXIS 178">*195 case of such taxpayer." Fish Net & Twine Co., 8 T.C. 96">8 T.C. 96; Lamar Creamery Co., 8 T.C. 928">8 T.C. 928; Wadley Co., 17 T.C. 269">17 T.C. 269; Mitchell & Co., 20 T.C. 110">20 T.C. 110.

Assuming again that hatlessness may be accepted as an economic circumstance or event, the evidence is conclusive that it was not unusual 32 T.C. 292">*300 nor temporary. See Acme Breweries, 14 T.C. 1034">14 T.C. 1034; Packer Publishing Co., 17 T.C. 882">17 T.C. 882, revd. (C.A. 8) 211 F.2d 612; Brown Paper Mill Co., 23 T.C. 47">23 T.C. 47, appeal dismissed (C.A. 5) 255 F.2d 77, certiorari denied 358 U.S. 906">358 U.S. 906. Hatlessness is clearly a function of style, or fashion, an element that is always present in the clothing industries, and is no more entitled to be viewed as unexpected or unusual than normal competition. See 8 T.C. 928">Lamar Creamery Co., supra;Constitution Publishing Co., 23 T.C. 19">23 T.C. 19.

The hatless trend had begun to exert a significant effect1959 U.S. Tax Ct. LEXIS 178">*196 on the industry at least as early as 1931, 5 years before the base period and, as we have seen, has continued up to the present time and certainly throughout the tax years. And if we are permitted to look beyond the base period, we note that the substantial and continuous increase in dollar sales and profits after 1940 was due entirely to increased prices through 1944 and not at all to any increase in unit sales per capita in the entire country, which remained static or actually declined; although of course petitioner's considerable expansion in the number of its retail outlets during these years presumably raised its own unit sales and its share of the retail market. ⁵

The per capita sales of hats in 1947 and 1948, the latest years for which figures are available, was less than for the base period years, although the per capita expenditures for1959 U.S. Tax Ct. LEXIS 178">*197 millinery and the dollar value of sales almost doubled. ⁶ What is indicated is that there has been no general decline in hatlessness but that prosperity has caused an increase in average hat prices and the industry, including both the manufacturers and the retailers, has learned how to prosper in spite of a decline in per capita unit volume. While, as petitioner contends, hatlessness may have ceased to cause distress after the 1930's, it has not ceased to exist nor has it even diminished.

For the reasons discussed, we think that respondent correctly disallowed petitioner's claims for excess profits tax relief under section 722.

Reviewed by the Special Division.

Decision will be entered for the respondent.