35 T.C. 113">*113 Respondent disallowed the petitioner's applications for excess profits tax relief under section 722 of the Internal Revenue Code of 1939¹ for the years 1941 through 1945. Petitioner originally based its claims for relief on section 722(b)(1), (4), and1960 U.S. Tax Ct. LEXIS 44">*45 (5), but section 722(b)(1) and (5) was waived at the trial. The questions presented are:

35 T.C. 113">*114 (1) Whether the petitioner's business, because of purported qualifying changes in the character of its business within the meaning of section 722(b)(4), did not reach, by the end of the base period, the earnings level it would have reached if it had made such changes 2 years earlier; and

(2) Whether the petitioner has established that its excess profits tax, computed without the benefit of section 722, is excessive and discriminatory and has established a fair and just amount representing normal earnings to be used as a constructive average base period net income.

Proposed findings of fact were made by a commissioner of this Court and served upon the parties. Petitioner, with one exception, makes no objections to those findings of fact though it seeks additional findings, and respondent makes several objections to the commissioner's findings1960 U.S. Tax Ct. LEXIS 44">*46 of fact and also requests additional findings. The facts as stipulated are now found, and the commissioner's findings of fact which are not objected to are now adopted for the purposes of this opinion. Where, in the following summary of our findings of fact, we relate facts objected to or requested by the parties, our inclusion of such facts will be deemed rulings on the objections or requests without specifically noting each such objection or request. For the purposes of this opinion, the pertinent facts will be summarized.

FINDINGS OF FACT.

Crown Fastener Corporation, hereinafter referred to as Crown, was incorporated under the laws of Delaware on May 23, 1934, and has its principal office and place of business in Warren, Rhode Island. Coats & Clark, Inc., by merger, is now the successor to Crown.

Crown kept its books and filed its Federal income tax returns under the accrual method of accounting on a calendar year basis for the years here involved. Crown filed its income, declared value, and excess profits tax returns for the years 1940 through 1945 with the then collector of internal revenue for the district of Rhode Island at Providence, Rhode Island.

Crown's excess profits1960 U.S. Tax Ct. LEXIS 44">*47 tax liability for each of the years 1941 through 1944, as finally determined by respondent without the application of section 722, was as follows:

35 T.C. 113">*115 All of the foregoing taxes have been paid by Crown.

Crown was in existence during the entire base period, 1936 through 1939, and was entitled to use an excess profits credit based on income, computed under section 713. Inasmuch as its excess profits credit based on invested capital, computed under section 714 exceeded the credit computed under section 713 for each of the excess profits tax years 1941 through 1944, Crown used the invested capital method in computing its excess profits tax liability. The credits computed under sections 714 and 713 were as follows:

1960 U.S. Tax Ct. LEXIS 44">*48 Crown's actual base period net income under the 1940 and 1941 laws was as follows:

Crown's average base period net income for the excess profits tax years 1940, 1941, and 1942 to 1945, inclusive, computed with the benefits of section 713(f) and section 713(e)(1), was as follows:

Crown was incorporated on May 23, 1934, at the instance of Elisha Walker, the managing partner of the investment banking firm of Kuhn, Loeb & Company, New York, New York, for the purpose of manufacturing slide fasteners or "zippers" by the die-cast method. This method of manufacturing slide fasteners was the outgrowth of the inventions and patents of Louis H. Morin and his father, David Marinsky. Walker and his associates were the original stockholders of Crown with Morin and Marinsky purchasing a small amount of the stock.

35 T.C. 113">*116 After Crown was organized, Whitehall1960 U.S. Tax Ct. LEXIS 44">*49 Patent Corporation, a patent holding company formed by Morin and Marinsky to which they transferred their zipper patents and developments, including the application for the patent on the diecasting machine, licensed it under the aforementioned zipper patents and zipper patent applications, including the patent application on the diecasting machine. Under the licensing agreement Whitehall was to receive a royalty of $ 200,000, plus a fixed amount per zipper. After Coats & Clark, Inc., obtained control of Crown, the royalty was modified to a percentage basis instead of a fixed amount per zipper.

Upon starting operations in 1934, Crown retained Morin and Marinsky as consultants on a yearly retainer basis, which arrangement was in effect throughout the base period. During these years Marinsky and Morin continued their experimental and development work on zippers and zipper parts.

Crown was the only manufacturer of zippers that used the die-cast method. In manufacturing its zippers, Crown heated a zinc alloy until it was molten (825 degrees Fahrenheit) and then forced the molten metal into a die that closed around the tape. The dies were cooled so that the heat of the molten metal1960 U.S. Tax Ct. LEXIS 44">*50 was dissipated without burning, discoloring, or weakening the tape. This method of casting the scoops (the teeth which mesh together to effect the closure) directly on the tape enabled the metal to penetrate into the tape fabric and anchor the scoops securely.

Crown's operations for calendar year 1935 showed the following results: Gross sales, $ 48,535.63; net sales, $ 42,743.96, but after an adjustment of returns and allowances by a revenue agent, net sales of $ 42,121.57; gross profit, $ 6,077.32; and a loss of $ 30,633.22.

In the summer of 1936 the Coats & Clark organization, hereinafter described, became interested in Crown and its method of manufacturing zippers by diecasting. John B. Clark, president, and Frank B. Hutton, treasurer, of J. & P. Coats (R.I.) Inc., one of the constituent companies of the Coats & Clark group, negotiated with Elisha Walker, who, together with his family, controlled Crown.

The purchase of control of Crown was effected on or about August 19, 1936. As a result of meetings of Crown's directors held on August 19 and 20, 1936, the Coats & Clark organization caused its representatives to be elected so as to constitute a majority of the board of directors. 1960 U.S. Tax Ct. LEXIS 44">*51 By virtue of action taken at the directors meeting of August 20, 1936, the Coats & Clark directors caused its representatives to be elected as the chief executive officers of Crown.

Prior to and during the base period, J. & P. Coats (R.I.) Inc. was one of a group of 10 American companies, exclusive of Crown, controlled by J. & P. Coats, Ltd., of Glasgow, Scotland, one of the largest, 35 T.C. 113">*117 if not the largest, thread-manufacturing company in the world. These American companies, together with the parent, will hereinafter sometimes be called the Coats & Clark organization. The chief executive and operating officer of each of the American companies was John B. Clark. The American companies were managed as autonomous companies. For liaison purposes, Clark was a director of the parent company, J. & P. Coats, Ltd. Five of the American companies were manufacturers, two were importers with one a manufacturer as well, two sold the products manufactured and imported, and one owned trademarks but was a non-operating company.

The Coats & Clark companies were closely associated and operated as a unit. Their affairs were managed by a joint committee made up of the American directors of1960 U.S. Tax Ct. LEXIS 44">*52 all companies. In the day-to-day operations of the various companies, including Crown, they were considered as one operating concern divided into four divisions: (1) Finance and Control Division (which in turn was subdivided into (a) Finance, (b) Control, and (c) Central Production and Planning); (2) Manufacturing Division, which was in charge of manufacturing operations; (3) Merchandising Division, which acted as liaison between manufacturing and sales, and which had under its authority the production and designing of new articles, the designing of packaging boxes, etc.; and (4) Sales Division. All four of the divisions came under the jurisdiction of John B. Clark, the chief executive officer of the United States companies.

Among the Coats & Clark companies was Spool Cotton Company organized in 1898, hereinafter referred to as Spool Cotton. It acted as factor and sales agent for products manufactured by the other Coats & Clark companies in the United States. It sold thread and other notions to (1) manufacturers who used such articles in producing their own products, referred to herein as "industrial sales," and (2) chain stores and other retail outlets, referred to herein as 1960 U.S. Tax Ct. LEXIS 44">*53 "domestic sales." Spool Cotton had specialized knowledge and experience in both the industrial and domestic sales markets. It had had long experience in the distribution and sale of small articles to retail outlets selling notions. It sold articles bearing the Coats & Clark trademark and had built a reputation over the years for high quality merchandise. At all times material hereto, Spool Cotton's activities covered the United States from Maine to California. It divided the country into various sales districts and employed several hundred people in carrying on its activities, having 618 employees in January 1937 and 808 in December 1939. Spool Cotton maintained 11 depots or warehouses throughout the country where it kept stocks of the Coats & Clark products that it sold. The depots were a very significant 35 T.C. 113">*118 key element in the distribution facilities of Spool Cotton during the base period.

Over the years Spool Cotton had built up a great deal of goodwill with its customers because of its prompt delivery service. Customers relied on this practice because it permitted them to operate with a smaller investment in inventory since they knew they could always get fast service1960 U.S. Tax Ct. LEXIS 44">*54 from the Coats & Clark depots.

On or about August 21, 1936, after management and control of Crown had passed to directors representing Coats & Clark, Crown appointed Spool Cotton as the sole selling agent of its products. For its services, Spool Cotton received commissions as follows:

From the date of purchase until the end of 1936, 8 1/2 per cent of net sales plus a charge for office space.

During 1937, 8 1/2 per cent of net sales plus a charge of $ 2,040 for office space.

For the period 1938 through 1943, 10 per cent of net sales plus an additional 3 1/2 per cent of such net sales made through depots.

In 1936, when it began selling Crown's products, Spool Cotton used its regular salesmen to handle such sales (it acquired not more than two salesmen from Crown). It was common practice whenever a new article was introduced, that certain salesmen of Spool Cotton would be instructed specially on the best methods to follow in promoting the sale of the new article, in this instance, zippers.

Crown started operations in a small plant in the Bronx having approximately 4,000 square feet. In July 1936 Crown recognized that it would have to have more floor space, and on or about October 1960 U.S. Tax Ct. LEXIS 44">*55 13, 1936, moved its plant from the Bronx to Warren, Rhode Island. The plant at Warren was much larger covering a total area of 92,740 square feet, exclusive of storage sheds.

In July 1936 Crown had 10 chain-casting machines in its plant in the Bronx and had other machines on order. During each of the base period years Crown added new chain-casting machines as follows: 21 in 1936, 10 in 1937, 22 in 1938, and 15 in 1939. The new machines were metal-casting machines, except the 10 added in 1937, which were acetate-casting machines used for manufacturing plastic zippers. Twenty of the machines added in 1938 were ordered in September 1937. During 1940 and 1941, Crown added 10 more metal-casting machines, 4 in 1940 and 6 in 1941. By the end of 1939, practically all of Crown's machines had been converted to or were new compressed air machines.

Prior to April 12, 1937, Clark became dissatisfied with the operating efficiency of the chain-casting machines at Warren. He went to Warren and together with Lohse made a study of the operational difficulties at the plant. At that time the plant was operating on a 1-shift-per-day basis, and was losing a considerable amount of time 35 T.C. 113">*119 1960 U.S. Tax Ct. LEXIS 44">*56 each morning in melting the zinc so that the day's operations could start. On or about April 12, 1937, management, at Lohse's suggestion, placed the chain-casting machines on a 3-shift, 24-hour-per-day, 5-day-a-week schedule. On or about October 29, 1937, management increased Crown's operations to a full 7-day-a-week basis and thereafter maintained such schedule for all times material hereto.

After Coats & Clark acquired control and management of Crown, Morin and Marinsky continued to be retained at all times material hereto to conduct experimental and development work. They operated in association with the Gries Machine Company of New York City which continued to build the machines ordered and used by Crown in its plant at Warren. Patents granted to Morin or Marinsky were assigned to Whitehall Patent Corporation, which licensed Crown thereunder.

The base period was a period of constant change and development in Crown's manufacturing techniques. Having adopted a different method of manufacturing zippers from its competitors, Crown had to learn by trial and error how to surmount the various problems it encountered. Technological changes were occurring during this same time in 1960 U.S. Tax Ct. LEXIS 44">*57 the slide fastener industry generally, so that Crown's experience though more intensive was not unusual. Changes in its operations during the base period increased Crown's manufacturing capacity and enabled it to sell zippers in markets which it could not otherwise serve. In many instances, United States patents were granted for inventions that were developed in improving Crown's manufacturing techniques.

During and immediately prior to the base period, Crown made the following changes and improvements: (1) Improved the method of melting metal; (2) use of new special metal alloys in its diecasting machines; (3) increase in the efficiency of the diecasting machines by an improvement in design of the "gooseneck," one of the parts; (4) purchase of a German machine which permitted unskilled labor to cut efficient dies; (5) development of a method of plating and enameling zippers; (6) solved difficulties involving the tapes; (7) simplified the method of diecasting the slider in the zipper; (8) developed an automatic locking device; (9) designed a machine to cast and trim zipper parts in a single operation and (10) increased the rate of machine operation by using compressed air as a means1960 U.S. Tax Ct. LEXIS 44">*58 of operation.

After Crown moved its plant to Warren it materially increased the number of its employees. On February 1, 1937, it had 160 employees. During February 1937, and each month thereafter through December 1941, Crown was hiring and losing employees. Crown's employees at the end of each calendar quarter from March 31, 1937, through December 31, 1941, were as follows: 35 T.C. 113">*120

The largest increase in Crown's labor force occurred in June 1938 and August 1938. In June, 110 new employees were hired and 7 left for a net increase of 103. In August 128 new employees were hired and 24 left for a net increase of 104.

During the base period, Crown increased its equity capital from $ 150,870 in July 1936 to $ 1,990,000 at December 31, 1939. Each increase1960 U.S. Tax Ct. LEXIS 44">*59 in equity capital was accomplished by the issuance of rights to the common stockholders, in accordance with their preemptive rights, permitting them to acquire, as the case might be: (a) Additional shares of common stock, or (b) shares of $ 9 par voting preferred stock, or (c) in 1939, shares of a new $ 10 par convertible second preferred stock.

Late in 1939, Crown employed Rath & Strong, a firm of management consultants previously used by the Coats & Clark organization, to make a study of its operations and wage incentive rates at Warren. The study was to cover the application and the effectiveness of incentive rates, problems of production, and problems of quality of merchandise.

The Rath & Strong survey was completed and a written report thereon was prepared late in November 1939. Prior to submitting the written report, and on or about November 27, 1939, Strong and Harlow presented their findings orally to Clark and Hutton. Subsequently, and under date of December 21, 1939, their written report was submitted. This report, 44 pages in length, criticized various operations at the Warren plant, pointed out undesirable practices and procedures, and recommended 32 changes to assist1960 U.S. Tax Ct. LEXIS 44">*60 the management of Crown in solving its problems. The survey and the recommendations dealt principally with the rate setting, inspection, and casting departments, process and product changes, supervision, and management.

After Strong and Harlow made their verbal report, Rath & Strong was retained to assist Crown's management in making effective their recommendations. On December 19, 1939, Clarence Gray, an employee of Rath & Strong, went to the Warren plant to start this work. Gray was to go through the plant from one end to the other and establish proper incentive rates on every job in the plant, to assist in setting proper incentive rates, to help management train the supervisory staff in the fundamentals of good incentives, to help the whole organization 35 T.C. 113">*121 to set up proper controls, and to develop better processes for inspection for quality control of zippers similar to the highest standards of quality maintained by Coats & Clark. Gray was assisted in this work by Frederick Hornbruch, another Rath & Strong employee. Gray worked at the Warren plant on full time until about the middle of 1940, and for a year thereafter on a part-time basis. Strong visited the plant about1960 U.S. Tax Ct. LEXIS 44">*61 once a week during the first 6 months and about twice a month during the succeeding year.

Crown accepted most of the Rath & Strong recommendations but at least four of them were not adopted. Some of the recommendations accepted were routine and would have applied to most manufacturing establishments; some were applicable specially to Crown. When these recommendations became effective, the Warren plant became a more efficient operating plant and production increased. The establishment of proper wage incentive rates brought out defects on the part of management that caused delays and improved employee relationships since the employee was no longer charged with "down time" for factors over which he had no control.

In its 1937 industrial sales report, Crown referred to its recently inaugurated stock service plan which permitted it to concentrate on items used by certain industries, namely, work shirts, handbags and other lightweight leather goods, dress trade, housecoats, polo shirts, ladies' suits, radiator covers, garment bags, rubber overshoes, suede, woolen, and leather jackets (separators). During 1938, Crown experienced "quite some difficulty" in getting the mail-order houses1960 U.S. Tax Ct. LEXIS 44">*62 to anticipate their needs so it could build up the necessary stocks. Lack of experience by the mill, merchandise, and sales departments to properly plan production was also charged with affecting sales and with the carryover in stock.

Crown continued to have difficulty in 1939 in putting its service stock plan into operation. During the first quarter, it prepared large quantities of separating zippers in anticipation of mail-order requirements and to some extent service stock items. Because of mail-order and domestic line requirements, Crown reported that "it was not possible to build up our regular Service Stock items to the point that would permit us to do a proper servicing job."

It was 1940 before Crown was able to operate fully its service stock plan. Under this plan minimum stocks of zippers for specific end uses were maintained for each style, length, color, and finish, so that the sales department was in a position to ship immediately upon receipt of an order. Prior thereto, Crown obtained an order from a customer, manufactured the zippers specifically for that customer, and then shipped the zippers to him. This procedure resulted in delays in servicing customers, particularly1960 U.S. Tax Ct. LEXIS 44">*63 when orders piled up, and in overruns and underruns of the customer's order by the mill. The 35 T.C. 113">*122 manufacturer's ability to make quick deliveries was important to industries subject to seasonal demand and rapid style changes.

Prior to 1938 Crown was selling its zippers in the industrial markets and making plans to enter the retail or domestic markets. On December 14, 1937, Crown's executive committee set May 1, 1938, or sooner if possible, as the date for release of the retail line. On April 25, 1938, Crown's executive committee set July 1, 1938, as the offering date of its retail lines. A price policy for the various classes of trade, including mail-order houses was tentatively approved, subject to later review by the executive committee.

Crown's service stock on hand at July 1, 1938, amounted to approximately 3 million zippers consisting of 1 million industrial service stock, 250,000 domestic service stock, 1,500,000 supplementary stock, and 250,000 broken-lot stock. On August 25, 1938, all of the 701 items required to be placed in stock for service of the domestic trade were actually in stock with the exception of 21. During the remainder of the base period and through1960 U.S. Tax Ct. LEXIS 44">*64 June 1940, Crown's domestic service stock increased steadily as shown by the following table, which also shows the percentage that domestic stock was of total stock:

Although the initial release of Crown zippers to the domestic trade was planned for July 1, 1938, this release date was postponed again until on or about August 29, 1938, when most of the 701 items required to service the domestic trade were in stock. The initial offering of the Crown zipper line to the domestic trade occurred in the New York sales district and was gradually extended 1960 U.S. Tax Ct. LEXIS 44">*65 to other districts. At the date of release and during the base period, 60 per cent of the zipper sales by domestic or United States manufacturers was in metropolitan New York.

The first sales of Crown zippers to the domestic trade occurred in July 1938 when sales were a little over $ 5,000. For the last half of 35 T.C. 113">*123 1938, domestic sales of Crown zippers totaled $ 72,833.95. Total net sales of Crown zippers, industrial and domestic, for 1938 were $ 917,452.73.

Sales of Crown zippers to the industrial and domestic trade by units, regardless of style, length, color, and finish, and the total thereof for the years 1935 through 1941 were as follows:

Crown's service stock on hand at July 1, 1938, included approximately 1 million industrial service stock zippers, which, together with supplementary and broken-lot stocks, amounted to 2,750,000 zippers. By1960 U.S. Tax Ct. LEXIS 44">*66 the end of July 1938 this total had increased to 3,196,000 and to 3,700,700 by the end of August. These increases in industrial service stocks occurred despite reduced production and operation of chain machines at 20 to 40 per cent below capacity. Crown's industrial service stocks, which include supplementary, broken-lot and mail-order stocks, increased from June 30, 1938, as set forth in the table below. Metal chain-casting machines available and chain-casting machines used for No. 4 and No. 5 chain only, using last week of each month, were as follows:

35 T.C. 113">*124 For the 3 weeks preceding the last week ending in September 1938, the metal chain-casting machines in use were 44.75, 45, and 44.88. For 2 weeks before and 2 weeks after the last week in October 1939 the chain status reports indicate that more machines were in use than were available for use. There is no explanation of this discrepancy.

From time to time during the base period Talon, Inc., hereinafter referred to as Talon, reduced its prices and Crown likewise reduced prices to meet this competition. Late in 1937, for example, there was a general reduction in zipper prices by both companies. In November 1938 there was another general reduction in prices by Talon varying from 6 to 10 per cent, which Crown met. At the end of 1939 and early in 1940 there was a further reduction approximating1960 U.S. Tax Ct. LEXIS 44">*68 5 per cent in Crown's industrial prices.

During the base period the prices of Crown's domestic zippers were reduced, the reduction to retailers and jobbers occurring on or about November 1, 1938, and the reduction to chain stores occurring on or about March 15, 1939.

In addition to reducing its prices during these years, Crown supplied other benefits to its customers in order to hold them. Such benefits, in addition to different discounts, included cabinets and trays, displays, prepaid freight, kickbacks in the case of Montgomery Ward & Co. and Sears Roebuck & Co, sacrifice sale of obsolete items, and outright grants in the case of one foreign account.

During the period 1928 to 1941, inclusive, the zipper industry sold the following numbers of zippers without regard to the length thereof:

During the period 1936 to 1941 the industry's industrial sales ranged between 93 and 95 per cent of its total sales. In 1934 and 1935 Talon supplied about 90 per cent of these industrial1960 U.S. Tax Ct. LEXIS 44">*69 sales, even though various competitors had appeared including the G. E. Prentice Manufacturing Co. in 1926, the United States Rubber Co. in 1928, Waldes-Kohinoor, Inc., in 1933, Crown in 1934, Conmar Products Corporation in 1935, and others at various times. Most of these firms competed in the industrial markets, so that in 1937, when Crown was planning to enter the domestic markets, its management estimated that Talon accounted for about 95 per cent of the retail or domestic sales. By 35 T.C. 113">*125 the end of the base period a number of new firms had entered the zipper field.

By 1931 and 1932 the zipper industry was experiencing important competition from foreign made zippers. During 1932, Talon complained to the United States Tariff Commission of unfair methods of competition from these imports and secured a temporary exclusion order which was made permanent in 1934 based upon certain patents of Talon. Shortly after the exclusion order became permanent, two of Talon's most important patents expired, so that the patent rights, upon which the exclusion order was based, no longer afforded Talon protection. Thereafter, and in 1935, the importation of foreign made zippers increased 1960 U.S. Tax Ct. LEXIS 44">*70 noticeably and amounted to 12,992,573 units valued at $ 462,829. The industry appealed to the Tariff Commission and secured an increase from 45 to 66 per cent ad valorem in the tariff rate on zippers and parts thereof, effective July 31, 1936. The increase in duty had a small effect on imports from Czechoslovakia but had practically no effect on imports from Japan, the principal competing country, which supplied 55 per cent of the units imported in 1935. The Japanese and Czechoslovakian zippers competed with American zippers primarily in the industrial markets, although some Japanese fasteners appeared in retail stores.

Prior to February 6, 1937, Talon instituted suit, and on or about that date obtained an injunction, later made permanent, against Japanese importers of zippers because of infringements of Talon's patents, one of the infringements being on the separating fastener for which Talon had also licensed Crown. Sales of separable zippers were important since they were for the industrial markets and were increasing during the years 1939, 1940, and 1941. As a result of these efforts, Talon was able to license and limit Japanese imports to a quota of 36 million separable zippers1960 U.S. Tax Ct. LEXIS 44">*71 of an average length of 6.8 inches until December 31, 1939, and thereafter the quota for each year was to be 18 per cent of the total number of zippers, including all imports, sold within the United States during the preceding calendar year. This action by Talon benefited Talon and the entire industry.

During the period 1936 to 1941, inclusive, the number of zipper units imported into the United States by country of origin was as follows:

35 T.C. 113">*126 The percentage of total imports to total sales in the United States and the percentage of Japanese imports to such total sales for the years 1936 to 1941, inclusive, based on unit sales, were as follows:

1960 U.S. Tax Ct. LEXIS 44">*72 The unit value of all zippers imported into this country and of Japanese and Czechoslovakian zippers for the years 1936 to 1941, inclusive, was as follows:

The combined net sales, as reported by eight zipper manufacturers on their income tax returns for the base period years, in rounded figures, and the total value of all imports into this country during the years 1936 to 1941, inclusive, were as follows:

The eight companies that filed income tax returns for all 4 base period years (without implying that all were in full operation during each of the 4 years) were: Talon, Conmar Products Corporation, the G. E. Prentice Manufacturing Co., Waldes-Kohinoor, Inc., Stronghold Fastener1960 U.S. Tax Ct. LEXIS 44">*73 Co., Inc., Swan Fastener Corporation, Ideal Fastener Corporation, and Crown.

In addition to the competition from imported zippers during the base period, the industry was subject to a great deal of competition from other closing devices such as buttons, hooks and eyes, snap fasteners, buckles, and laces. Zippers were more costly than these 35 T.C. 113">*127 other types of closing devices, which sold at prices that the zipper industry could not afford to meet.

During the base period Crown regularly maintained certain records to reflect production at its Warren plant. These records were kept under five different classifications, two by the production planning department and three by the cost accounting department. The two records kept by the production planning department showed the production of chain by the chain-casting machines in 1,000 double inches of good castings and the production of finished zippers in units of 1,000 good finished zippers. The three records kept by the cost accounting department showed good castings in 1,000 double inches, good finished zippers in units of 1,000, and the standard cost of production at the factory excluding fixed charges. These records constituted1960 U.S. Tax Ct. LEXIS 44">*74 Crown's production records during the years 1937 to 1941, inclusive. These records in units of 1,000 double inches of good chain castings ignored the various lengths of zippers (4 1/2" to 50") the sliders and other parts requisite for a completed zipper, the plating and enameling costs, separable and nonseparable zippers, and metal and plastic zippers. Similarly, these records in terms of 1,000 units of good finished zippers ignored the various lengths, lumped together separable and nonseparable zippers and plastic and metal zippers.

Crown's books were regularly kept on a modern standard cost system. Production costs were broken down into two classes: (1) Variable costs and (2) fixed costs. Similarly, sales costs were broken down into (1) variable costs of sales and (2) fixed costs of sales. Standard variable costs of production consisted of wages, direct and indirect, material of all kinds, power, chemicals and enamel that might be consumed, and various other cost elements that varied directly with the volume of production that passed through the plant.

Crown's production for the years 1937 to 1940, inclusive, and for the first 6 months of 1941 under each of the five classifications1960 U.S. Tax Ct. LEXIS 44">*75 aforementioned was as follows:

35 T.C. 113">*128 The dollar amounts above do not take into account differences or variances between Crown's standard variable costs and its actual costs of production. Exhibit 77, a monthly schedule of Crown's standard variable costs of production, 1937 through June 30, 1941, is incorporated herein and made a part hereof by this reference.

Measured in terms of standard variable costs, Crown's production of zippers increased steadily during the period July 1, 1937, to December 31, 1940. Its average weekly costs in1960 U.S. Tax Ct. LEXIS 44">*76 July 1937 were $ 5,330; in December 1940 its average weekly costs were $ 28,719, with the high for the period, $ 32,000, occurring in October 1940. After adjusting the first 6 months of 1941 to the same standard variable cost basis as the previous period, Crown's weekly average increased to a high of $ 34,067 in May 1941.

For the period 1936 to 1941, inclusive, Crown's unit sales plus the net increase in its inventory at the end of the year indicated total unit production as follows:

At January 1, 1936, Crown's fixed assets totaled $ 36,852.86, and its reserve for depreciation1960 U.S. Tax Ct. LEXIS 44">*77 was $ 3,750.02, giving a net balance of $ 33,102.84. During each of the base period years Crown made substantial additions to its fixed assets, particularly machinery and equipment, and during these years it depreciated, disposed of, and charged off various fixed assets, with the result that, on December 31, 1939, its fixed assets aggregated $ 575,387.69, its reserve for depreciation amounted to $ 117,229.79, and the net balance of its fixed assets was $ 458,157.90. The details with respect to the increase in Crown's fixed assets during the base period years are contained in Exhibit 46 which is incorporated herein by reference.

Late in 1938 Crown's management anticipated the need of additional capital. A proposal was submitted to the directors to amend the corporate charter and create a new class of $ 10 par second preferred stock convertible into common on a share for share basis. On or about December 21, 1938, Crown's charter was so amended and 126,000 shares of second preferred stock was authorized to be issued. On December 29, 1938, Crown authorized the issuance of 35,000 shares of second preferred to meet its need for $ 350,000 of additional capital. Common 35 T.C. 113">*129 stockholders1960 U.S. Tax Ct. LEXIS 44">*78 were authorized to subscribe for seven-tenths of a share of second preferred for each share of common, the subscription price to be paid by January 30, 1939.

At a meeting of Crown's executive committee on June 21, 1939, Hutton presented a statement prepared by the Finance and Control Division which estimated profits based on sales of $ 3 million and also showing the effect of a 10 per cent reduction in selling prices. The executive committee approved at this meeting the purchase of 15 air-operated metal chain-casting machines, heretofore mentioned. The executive committee was advised at this meeting that additional capital would be required in the near future and the issuance of additional second preferred stock was discussed, but action was deferred until a later meeting.

The minutes of Crown's executive committee meeting on August 2, 1939, contained the following minutes with respect to Crown's need of additional capital:

2. Capitalization. The Treasurer [Hutton] reported that in view of the present expansion program, it would be necessary for the company to secure additional working capital to finance its operations.

After discussion it was decided to recommend to the Board1960 U.S. Tax Ct. LEXIS 44">*79 of Directors that, whereas the Corporation is now authorized to issue 126,000 shares of 2nd Preferred Stock of the par value of $ 10.00 per share, of which only 35,000 have been issued, it now issue 60,000 additional shares of the authorized 2nd Preferred Stock in the amount of $ 600,000, and that the same be offered for sale to the Common stockholders at par, the funds secured from the sale to be used as follows: --

1. Liquidate the present bank loan

2. Furnish capital to finance the expansion program now under way, and

3. Provide funds to finance normal operations.