Opinion
Docket No. 51537.
1958-02-27
GENERAL TIRE & RUBBER COMPANY, PETITIONER, V. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Richard W. Wilson, Esq., and Gustave Simons, Esq., for the petitioner. Robert E. Johnson, Esq., for the respondent.
Richard W. Wilson, Esq., and Gustave Simons, Esq., for the petitioner. Robert E. Johnson, Esq., for the respondent.
Petitioner, a manufacturer of coated fabrics, engaged in a program of research resulting in the development of a resin coating known as Tolex. Held, a portion of the income resulting from the sale of Tolex constitutes net abnormal income resulting from research and development within the meaning of section 721(a)(2)(C), I.R.C. 1939, and is allocable to the years during which the research and development program was in operation, pursuant to section 721(b), I.R.C. 1939.
The respondent denied taxpayer's claims for refund of excess profits taxes under section 721 of the Internal Revenue Code of 1939 for the years 1942 through 1945.
The sole issue presented for our decision is the question whether taxpayer derived net abnormal income of a class specified by section 721(a)(2)(C) of the 1939 Code during 1942, 1943, 1944, and 1945, attributable to prior years so as to entitle taxpayer to the relief accorded by that section.
The petition herein was filed by the Textileather Corporation. Subsequent to the filing of the petition and answer, Textileather Corporation was merged with the General Tire & Rubber Company. Consequently, upon motion for substitution made at the trial, the caption of the proceeding was changed to indicate the substitution of General Tire & Rubber Company as petitioner.
FINDINGS OF FACT.
Some of the facts have been stipulated and are found accordingly.
Textileather (sometimes hereinafter referred to as taxpayer) is a corporation organized under the laws of the State of Delaware in 1927 with its principal place of business located at Toledo, Ohio. It filed its corporation income and declared value excess-profits tax returns and excess profits tax returns for 1942, 1943, 1944, and 1945 with the collector of internal revenue for the tenth district of Ohio.
Taxpayer filed claims for refund under section 721 of the 1939 Code for the years and in the amounts as follows:
+-------------------------+ ¦Year ¦Amount of claim ¦ +------+------------------¦ ¦1942 ¦$39,119.01 ¦ +------+------------------¦ ¦1943 ¦365,408.09 ¦ +------+------------------¦ ¦1944 ¦380,523.66 ¦ +------+------------------¦ ¦1945 ¦156,629.87 ¦ +-------------------------+
Amended claims for refund under section 721 were filed by Textileather for the years and in the amounts as follows:
+-------------------------+ ¦Year ¦Amount of claim ¦ +------+------------------¦ ¦1942 ¦$14,274.96 ¦ +------+------------------¦ ¦1943 ¦56,983.99 ¦ +------+------------------¦ ¦1944 ¦102,128.99 ¦ +-------------------------+
The foregoing claims and amended claims were disallowed in full by the respondent.
The taxpayer here contends that its net abnormal income due to research and development and attributable to prior years is $25,498.55 for 1943, $585,145.16 for 1943, $568,913.81 for 1944, and $261,989.13 for 1945.
Beginning in 1927, Textileather was engaged in the manufacture and sale of rubber-coated fabrics and pyroxylin-coated fabrics, and in the dyeing and finishing of cotton cloth. It did not manufacture finished products, i.e., luggage upholstery, etc., but only coated fabrics, the end uses of which were in competition with leather. Textileather abandoned its rubber department in 1936 or 1937, but added duck impregnation and vinyl-coated fabrics during the period 1942 to 1945.
During the 1920's a strong demand arose, originating principally in the automotive, furniture, and luggage industries, for a new and different product superior to the then known pyroxylin-coated materials. Pyroxylin is a nitrocellulose compound which when pigmented and plasticized into a semifluid form can be spread by a coater.
The uses of pyroxylin are restricted because of its resistance to flexing, stretching, and folding, its tendency to crack at low temperatures, its unsatisfactory resistance to abrasion, and its high degree of inflammability.
In 1930, Textileather moved its operations from Newark, New Jersey, to Toledo, Ohio, where a new plant was built which was equipped with a research laboratory. Beginning in 1931, taxpayer began an intensive program of research and development for the purpose of creating and perfecting a new and different product that would meet the needs and demands of industry for a leatherlike material without the inherent weaknesses of pyroxylin which could be used in the numerous field to which pyroxylin-coated fabrics were unsuited. The foregoing program of research, exploration, and development was conducted without interruption until the end of 1940. Additional impetus was given the research and development work in 1932 and 1933 by the adoption of fixed specifications by certain members of the automotive industry, including Chrysler Corporation, Ford Motor Company, and Fisher Bodies, requiring a degree of endurance not then found in any existing product.
The research and experimental work conducted by Textileather included the testing of certain types of resins, such as alkyd resins and resyl resins, but none was found adequate for the purpose. In 1938 or 1939, Bakelite Corporation, a division of Union Carbide and Carbon Corporation, developed and began the commercial production of a high molecular weight vinyl resin. This was a new product, previously unobtainable, and proved to be a satisfactory base for the material petitioner was seeking to produce. With the vinyl resin as a base, it was then necessary to develop the remaining constituents of the desired compound, i.e., the plasticizers, lubricants, stabilizers, and pigments, that could be combined with the resin base to develop a coating which was resistant to all kinds of weather and to many different chemicals and that possessed many of the characteristics of leather. By the end of 1940, a satisfactory produce was developed which was thereafter named and registered ‘Tolex.’ The final testing of Tolex, in the form of trial runs, was done on equipment belonging to the National Carbon Company of Cleveland, Ohio, during the closing months of 1940 and January 1941. Tolex was an entirely new and unique product in the field of leatherlike, plastic-coated fabrics, possessing qualities far superior to the pyroxylin-coated materials then used, such as flexing, folding, and resistance to heat, fire, cold, and to various chemicals. In addition to its adaptability to end uses in products adaptable to items for which leather, rubber, and pyroxylins could not be used.
A low molecular weight vinyl resin was also produced by Union Carbide and Carbon Corporation, beginning in 1938. Low molecular weight vinyl resins are closely related to high molecular weight vinyl resins, and are produced for similar end uses. During World War II, low molecular weight vinyl resins were sometimes used as substitutes for high molecular weight vinyl resins.
During the latter part of 1940, Textileather placed an order with Farrell-Birmingham Company for machinery and equipment necessary to manufacture Tolex. Delivery thereon was delayed for more than a year. The actual commercial production of Tolex did not begin until May 1942.
The research, experimental, and developmental expenses paid or incurred by the taxpayer in the development of Tolex for the years 1931 to 1940, inclusive, were as follows:
+------------------+ ¦Year ¦Amount ¦ +------+-----------¦ ¦1931 ¦$11,993.85 ¦ +------+-----------¦ ¦1932 ¦7,691.97 ¦ +------+-----------¦ ¦1933 ¦5,321.78 ¦ +------+-----------¦ ¦1934 ¦7,575.84 ¦ +------+-----------¦ ¦1935 ¦7,203.11 ¦ +------+-----------¦ ¦1936 ¦10,567.86 ¦ +------+-----------¦ ¦1937 ¦13,615.31 ¦ +------+-----------¦ ¦1938 ¦10,884.51 ¦ +------+-----------¦ ¦1939 ¦19,915.29 ¦ +------+-----------¦ ¦1940 ¦29,062.42 ¦ +------+-----------¦ ¦Total ¦123,831.94 ¦ +------------------+
Although the development of Tolex was a peacetime project for the purpose of supplying various industries, including the automotive and luggage industries, with a normal commercial product, the United States had entered World War II shortly prior to the first production of Tolex and, consequently, during the years 1942 through 1945, the entire output of this product was utilized for military and defense purposes. During World War II, certain restrictions were imposed upon the production of Tolex. Because of the allocation of raw materials and the system of priority ratings then in effect, the supply of resins, textiles, and other materials necessary for the production of Tolex was inadequate to meet the existing demand. Tolex was sold under price restrictions. During the years 1942, 1943, 1944, and 1945, taxpayer was the sole producer of Tolex, and, during 1942 and 1943, it was without active competition in the production of marketable high molecular weight vinyl fabrics.
During World War II, Tolex was utilized in the production of aircraft, tanks, life rafts, gun mount covers, surgical hospital sheeting, life jackets, bedding, navy bags, and numerous other military items.
At the conclusion of World War II, no plant reconversion was necessary to enable Textileather to commence civilian production. However, certain new equipment was purchased in order to meet the normal industrial demand for different styling. Textileather operated at full capacity in the production of Tolex during the war years and has continued to operate at full capacity thereafter.
The industrial demand for a product possessing the qualities of Tolex was felt at the close of World War II. Tolex was sold for use in the automotive, furniture, luggage, leather goods, shoe, upholstery, pharmaceutical, bicycle, and saddle industries, as well as for use in the production of bookbinding, baby carriages, toys, garments, motion picture screens, and in theater and auditorium installations.
Tolex did not supplant pyroxylins during World War II; however, in certain industries a substantial portion of pyroxylin purchases ultimately was replaced by purchases of Tolex. The sales of Tolex increased sharply and consistently after the removal of wartime restrictions, but it was not until 1948 that the inroads made upon pyroxylins by Tolex became clearly apparent. Taxpayer's net sales of pyroxylin and Tolex for the period 1947 to 1950, inclusive, were as follows:
+------------------------------+ ¦Year¦Pyroxylin net ¦Tolex net ¦ +----+--------------+----------¦ ¦ ¦sales ¦sales ¦ +----+--------------+----------¦ ¦1947¦$3,738.503 ¦$4,888,976¦ +----+--------------+----------¦ ¦1948¦2,344,761 ¦6,648,299 ¦ +----+--------------+----------¦ ¦1949¦2,126,360 ¦8,003,749 ¦ +----+--------------+----------¦ ¦1950¦2,754,542 ¦10,252,169¦ +------------------------------+
In 1942 the taxpayer constructed a small building adjacent to its plant at a cost of $27,055.93 and purchased new machinery and equipment costing $93,256.95 in order to enable it to produce Tolex in sufficient quantities to meet the wartime demand. In addition to the foregoing assets, the undepreciated cost as of December 31, 1942, of taxpayer's buildings ($774,924.48), machinery and equipment ($1,509,893.48), machinery in the process of installation ($8,541.03), and furniture and fixtures ($43,265.74) totaled the amount of.$2,336,624.46.
Textileather's net sales, gross profits, and net profits on Tolex for the years 1942 to 1945, inclusive, were as follows:
+-----------------------------------------------------+ ¦Year ¦Net sales ¦Gross profit¦Net profit¦ +----------------+------------+------------+----------¦ ¦(5/1-12/31) 1942¦$685,005.81 ¦$57,080.02 ¦$16,550.22¦ +----------------+------------+------------+----------¦ ¦1943 ¦3,152,645.95¦709,741.12 ¦543,246.31¦ +----------------+------------+------------+----------¦ ¦1944 ¦4,038,466.47¦919,176.56 ¦704,267.21¦ +----------------+------------+------------+----------¦ ¦1945 ¦3,519,665.18¦843,347.44 ¦599,301.17¦ +-----------------------------------------------------+
The profit and loss statement of Textileather for each of the years 1942, 1943, 1944, and 1945 is as follows:
+---------------------------+ ¦PROFIT AND LOSS STATEMENT ¦ +---------------------------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +---------------------------+
1942
Total Finishing Corduroy Pyroxylin Rubber Tolex Dept. Dept. Dept. Dept. Dept. Sales to $11,313,457.81 $1,033,934.54 $499,902.12 $8,893,338.65 $197,219.54 $689,062.96 customers Returned goods (62,182.77) (46.41) (59,183.95) (485.49) (2,466.92) Prepaid (28,841.91) (1,229.89) (25,512.68) (389.46) (1,709.88) freight 11,222,433.13 1,032,658.24 499,902.12 8,808,642.02 196,344.59 684,886.16 Revenue from salvaged 196,679.85 5,944.10 50,351.58 140,177.89 86.63 119.65 material Revenue from 19,418.00 19,418.00 sales of scrap Net sales 11,438,530.98 1,058,020.34 550,253.70 8,948,819.91 196,431.22 685,005.81 Cost of sales 9,045,598.05 815,180.18 434,256.36 7,037,320,13 165,413.54 593,427.84 Cost variances 91,764.03 50,440.26 36,195.57 (7,359.02) (5,722.01 18,209.23 Reject and 309,693.62 13,233.72 47,030.98 204,872.30 44,556.62 rework expense Allowance for reject (401,241.43) (57,868.92) (20,314.69) (294,786.50) (3.42) (28,267.90) reworked Solvent (33,203.04) (33,203.04) reclaimed Net cost of 9,012,611.23 820,985.24 497,168.22 6,906,843.87 159,688.11 627,925.79 sales Gross profit 2,425,919.75 237,035.10 53,085.48 2,041,976.04 36,743.11 57,080.02 from sales Commercial expenses: Shipping 223,208.35 64,298.99 19,869.64 128,144.04 156.28 10,739.40 expense Selling 231,066.73 19,173.33 193,997.89 2,380.07 15,515.44 expense Administrative 213,243.04 30,400.36 19,191.88 142,978.55 6,397.29 14,274.96 expense 667,518.12 113,872.68 39,061.52 465,120.48 8,933.64 40,529.80 Net profit 1,758,401.63 123,162.42 14,023.96 1,576,855.56 27,809.47 16,550.22 Other income 58,741.48 Other expenses (63,425.16) Net revenue 1,753,717.95
+---------------------------+ ¦PROFIT AND LOSS STATEMENT ¦ +---------------------------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +---------------------------+
1943
Total Finishing Corduroy Pyroxylin Rubber Tolex Dept. Dept. Dept. Dept. Dept. Sales to $10,843,262.89 $1,037,640.53 $560,845.73 $6,085,026.59 $50,805.68 $3,108,944.36 customers Returned goods (64,198.43) (45,731.96) (18,466.47) Prepaid (44,511.58) (1.13) (33,719.29) (121.38) (10,669.78) freight 10,734,552.88 1,037,639.40 560,845.73 6,005,575.34 50,684.30 3,079,808.11 Revenue from salvaged 256,352.19 19,440.24 46,757.47 117,317.64 72,837.84 material Revenue from 10,790.16 10,790.16 sales of scrap Net sales 11,001,695.23 1,067,869.80 607,602.20 6,122,892.98 50,684.30 3,152,645.95 Cost of sales 8,838,219.10 857,491.34 491,738.71 4,837,448.37 42,754.55 2,608,786.13 Cost variances 232,143.95 203,999.64 83,255.91 169,347.95 1,117.33 (225,576.88) Reject and 478,413.21 19,155.02 51,068.76 221,367.92 186,821.51 rework expense Allowance for reject (370,814.43) (55,739.31) (22,865.54) (165,083.65) (127,125.93) reworked Solvent (71,682.19) (71,682.19) reclaimed Net cost of 9,106,279.64 1,024,906.69 603,179.84 4,991,398.40 43,871.88 2,442,904.83 sales Gross profit 1,895,415.59 42,963.11 4,404.36 1,131,494.58 6,812.42 709,741.12 from sales Commercial expenses: Shipping 236,171.78 71,628.11 22,701.72 95,343.55 46,498.40 expense Selling 293,520.48 13,141.36 216,468.86 897.84 63,012.42 expense Administrative 250,529.84 24,108.21 12,739.95 154,404.68 2,293.01 56,983.99 expense 780,222.10 108,877.68 35,441.67 466,217.09 3,190.85 166,494.81 Net profit (or 1,115,193.49 (65,914.57) (31,037.31) 665,277.49 3,621.57 543,246.31 loss) Other income 26,944.24 Other expense (64,835.29) Net revenue 1,077,302.44
+---------------------------+ ¦PROFIT AND LOSS STATEMENT ¦ +---------------------------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +---------------------------+
1944
Total Finishing Corduroy Pyroxylin Rubber Tolex Dept. Dept. Dept. Dept. Dept. Sales to $10,393,445.93 $820,841.35 $570,840.84 $4,852,063.41 $132,215.18 $4,017,485.15 customers Returned goods (49,509.49) (37,711.36) (11,798.13) Prepaid (33,877.61) (5.71) (28,061.25) (840.88) (4,989.77) freight 10,310,058.83 820,841.35 570,835.13 4,786,290.80 131,394.30 4,000,697.25 Revenue from salvaged 203,717.73 46,092.92 50,268.47 69,587.12 37,769.22 material Revenue from 12,346.73 12,346.73 sales of scrap Net sales 10,526,123.29 879,281.00 621,103.60 4,855,877.92 131,394.30 4,038,466.47 Cost of sales 8,459,123.86 676,574.44 493,586.33 3,890,457.78 112,744.88 3,285,760.43 Cost variances 338,533.82 142,605.32 59,141.90 286,973.73 (5,027.89) (145,159.24) Reject and 375,365.43 14,458.48 50,276.62 175,465.11 135,165.22 rework expense Allowance for reject (362,378.37) (51,974.56) (23,089.37) (130,787.84) (50.10) (156,476.50) reworked Solvent (73,532.32) (73,532.32) reclaimed Net cost of 8,737,112.42 781,663.68 579,915.48 4,148,576.46 107,666.89 3,119,289.91 sales Gross profit 1,789,010.87 97,617.32 41,188.12 707,301.46 23,727.41 919,176.56 from sales Commercial expenses: Shipping 236,303.19 52,134.56 25,638.29 120,365.75 38,164.59 expense Selling 228,702.88 13,069.76 139,804.06 1,213.29 74,615.77 expense Administrative 271,029.57 23,308.08 16,224.58 126,375.05 2,992.87 102,128.99 expense 736,035.64 88,512.40 41,862.87 386,544.86 4,206.16 214,909.35 Net profit (or 1,053,075.23 9,104.92 (674.75) 320,756.60 19,521.25 704,267.21 loss) Other income 26,840.82 Other expense (69,401.40) Net revenue 1,010,514.65
+---------------------------+ ¦PROFIT AND LOSS STATEMENT ¦ +---------------------------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +---------------------------+
1945
Total Finishing Corduroy Pyroxylin Rubber Tolex Dept. Dept. Dept. Dept. Dept. Sales to $9,729,466.99 $822,824.97 $452,727.99 $4,946,981.16 $28,984.32 $3,477,948.55 customers Returned goods (22,311.04) (11,946.55) (10,364.49) Prepaid (26,808.55) (39.34) (16,617.24) (262.74) (9,889.23) freight 9,680,347.40 822,785.63 452,727.99 4,918,417.37 28,721.58 3,457,694.83 Revenue from salvaged 243,741.15 59,161.35 38,705.37 83,904.08 61,970.35 material Revenue from 10,055.63 10,055.63 sales of scrap Net sales 9,934,144.18 892,002.61 491,433.36 5,002,321.45 28,721.58 3,519,665.18 Cost of sales 7,924,997.03 681,946.00 390,648.96 4,067.243.95 24,042.98 2,761,115.14 Cost variances 111,162.11 53,706.34 83,087.00 66,191.85 (916.19) (90,906.89) Reject and 308,032.03 18,058.96 38,301.67 117,725.49 133,945.91 rework expense Allowance for reject (315,810.50) (55,445.11) (18,270.59) (114,258.38) (127,836.42) reworked Solvent (30,376.45) (30,376.45) reclaimed Net cost of 7,998,004.22 698,266.19 493,767.04 4,106,526.46 23,126.79 2,676,317.74 sales Gross profit 1,936,139.96 193,736.42 (2,333.68) 895,794.99 5,594.79 843,347.44 from sales Commercial expenses: Shipping 227,962.69 48,567.48 21,470.74 134,506.33 23,418.14 expense Selling 269,065.38 12,905.70 133,903.43 484.35 121,771.90 expense Administrative 276,921.08 24,194.17 13,447.28 139,249.89 1,173.51 98,856.23 expense 773,949.15 85,667.35 34,918.02 407,659.65 1,657.86 244,046.27 Net profit (or 1,162,190.81 108,069.07 (37,251.70) 488,135.34 3,936.93 599,301.17 loss) Other income 25,094.02 Other expense (58,247.44) Net revenue 1,129,037.39
The value of the shipments of pyroxylin, manufactured by American producers during the period 1936 to 1945, inclusive, as published by the Department of Commerce was as follows:
+---+ ¦¦¦¦¦ +---+
Total value of Total value of Year pyroxylin industry Number of pyroxylin industry shipments firms shipments per establishment 1936 $20,889,112 20 $1,044,456 1937 22,263,094 20 1,133,155 1938 17,478,049 20 873,902 1939 21,033,279 21 1,001,585 1940 21,049,683 21 1,002,366 1941 32,870,665 21 1,565,270 1942 27,935,912 21 1,330,282 1943 24,763,095 21 1,179,195 1944 27,930,186 21 1,330,009 1945 1 26,576,432 21 1,265,544
The production and value of output of vinyl resins during the period 1938 to 1949, inclusive, were as follows:
+---------------+ ¦ALL VINYL ¦ ¦RESINS ¦ +---------------¦ ¦ ¦ ¦ ¦ ¦ +---+---+---+---¦ ¦ ¦ ¦ ¦ ¦ +---------------+
Production Value of output Year (thousands Price per pound (millions of of lbs.) dollars) 1938 2,486 $7.79 1939 4,329 2.67 1940 7,952 4.75 1941 22,980 $0.77 17.69 1942 52,156 .70 36.51 1943 95,564 .54 51.60 1944 126,892 .49 62.18 1945 122,708 .42 51.54 1946 155,609 .39 60.69 1947 177,442 .39 69.20 1948 218,237 .41 89.48 1949 267,686 .42 112.43
The demand (estimated in part) for vinyl-coated fabrics (low molecular weight vinyl) during the years 1938 to 1949, inclusive, was as follows:
+----------------------------------+ ¦ ¦Demand ¦ +----------+-----------------------¦ ¦Year 1 ¦(millions of dollars) ¦ +----------+-----------------------¦ ¦1938 ¦$0.2 ¦ +----------+-----------------------¦ ¦1939 ¦.3 ¦ +----------+-----------------------¦ ¦1940 ¦.6 ¦ +----------+-----------------------¦ ¦1941 ¦2.1 ¦ +----------+-----------------------¦ ¦1942 ¦4.3 ¦ +----------+-----------------------¦ ¦1943 ¦5.8 ¦ +----------+-----------------------¦ ¦1944 ¦6.6 ¦ +----------+-----------------------¦ ¦1945 ¦5.3 ¦ +----------+-----------------------¦ ¦1946 ¦9.7 ¦ +----------+-----------------------¦ ¦1947 ¦11.2 ¦ +----------+-----------------------¦ ¦1948 ¦12.8 ¦ +----------+-----------------------¦ ¦1949 ¦12.5 ¦ +----------+-----------------------¦ ¦ ¦ ¦ +----------------------------------+ SEC. 721. ABNORMALITIES IN INCOME IN TAXABLE PERIOD.(a) DEFINITIONS.— For the purposes of this section—(1) ABNORMAL INCOME.— The term ‘abnormal income’ means income of any class includible in the gross income of the taxpayer for any taxable year under this subchapter if it is abnormal for the taxpayer to derive income of such class, or, if the taxpayer normally derives income of such class but the amount of such income of such class includible in the gross income of the taxable year is in excess of 125 per centum of the average amount of the gross income of the same class for the four previous taxable years, or, if the taxpayer was not in existence for four previous taxable years, the taxable years during which the taxpayer was in existence.
An estimate made by the Department of Commerce for 21 reporting firms.
because of a realization during 1942, 1943, 1944, and 1945 of abnormal income due to exploration, discovery, research, or development attributable to prior years.
The taxpayer seeks to qualify for relief under section 721(a)(2)(C) on the basis of a class of income resulting from conducting research and development of tangible property during the period 1931 to 1940.
The respondent contends that the product in question, Tolex, did not result from Textileather's research and development; that, even if it did so result, such research did not extend over a period of more than 12 months; and, further, assuming that Textileather's research extended over a period of more than 12 months, the respondent contends that the abnormal earnings resulting from the sale of Tolex during the period 1942 to 1945, inclusive, were attributable to factors other than research and development during prior years. On brief, respondent asserts in the alternative that if we should find in favor of the taxpayer on the foregoing contentions, the maximum portion of the abnormal income due to research and development and attributable to prior years is $1,540.03 for 1942, $38,188.35 for 1943, $57,194.51 for 1944, and $36,048.58 for 1945.
The income in question was derived from the sale of Tolex during the years 1942, 1943, 1944, and 1945. The gross income from the sale of the new product, Tolex, during the foregoing years exceeded 125 per cent of the average gross income of the same class for the previous 4 years. Pursuant to the statutory definition of abnormal income contained in section 721(a)(1) of the 1939 Code,
1Estimated for years 1938-1945; actual for years 1946-1949.
The average annual sales of the pyroxylin industry for the 4 years immediately preceding each of the taxable years here involved, the pyroxylin sales during each taxable year, and the increased demand factor for pyroxylin for each year may be summarized as follows:
+---+ ¦¦¦¦¦ +---+
Average of annual Business improvement Year sales in the 4 Industry sales in factor (column preceding years the taxable year (3) divided by column (2))
(1) (2) (3) (4) Per cent 1942 $23,107,919 $27,935,912 120.89 1943 25,722,385 24,763,095 96.28 1944 26,654,839 27,930,186 104.79 1945 28,374,964 26,576,432 93.66
The average annual sales of vinyl-coated fabrics (low molecular weight vinyl), based on estimated demand figures, for the 4 years immediately preceding each of the taxable years in issue, the demand for vinyl-coated fabrics during each taxable year, and increased demand factor for vinyl-coated fabrics for each year may be summarized as follows:
+----+ ¦¦¦¦¦¦ +----+
Demand (millions of dollars)
1942 1943 1944 1945 Average annual sales of 4 prior years $0.8 $1.82 $3.2 $4.7 Demand for taxable year $4.3 $5.8 $6.6 $5.3 Increased demand 538% 319% 206% 113%
During 1942 to 1945, inclusive, Textileather's abnormal income from Tolex (gross profit from sales), direct costs and expenses of marketing Tolex, net abnormal income from Tolex, and net abnormal income due to research and development attributable to other years were as follows:
+----+ ¦¦¦¦¦¦ +----+
1942 1943 1944 1945 Abnormal income $57,080.02 $709,741.12 $919,176.56 $843,347.44 Excess over 125% of prior 4 $57,080.02 $691,903.61 $679,544.95 $316,473.15 years average Direct costs and expenses $40,529.80 $162,299.14 $158,818.00 $91,517.35 Net abnormal income from Tolex $16,550.22 $529,604.47 $520,726.05 $224,955.80 Business improvement factor 538% 319% 206% 113% Net development income due to research and development attributable to other years $2,786.62 $149,418.19 $227,502.06 $179,168.34
We accordingly find that the amounts of $2,768.62 for 1942, $149,418.19 for 1943, $227,502.06 for 1944, and $179,168.34 for 1945 represent the taxpayer's net abnormal income attributable to research and development expenditures which should be allocated to each of the years of development in the proportion that each year's development expenses bear to the total thereof.
OPINION.
WITHEY, Judge:
The question here presented is whether the taxpayer is entitled to the relief accorded by section 721(a)(2)(C) of the 1939 Code