Phillips
v.
Comm'r of Internal Revenue

Tax Court of the United States.May 25, 1953
20 T.C. 435 (U.S.T.C. 1953)

Docket No. 24505.

1953-05-25

DR. P. PHILLIPS AND SONS, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Newman A. Townsend, Esq., for the respondent.


Petitioner, a Florida, citrus fruit producer, realized income, abnormal in amount, in the taxable year from the sale of its citrus crop. It claimed relief from excess profits tax under section 721(a)(2)(C) of the Internal Revenue Code upon the ground that it had a separate class of income which resulted from the development of tangible property, or, that the income from its citrus operations constituted a class of income under the general provisions of section 721(a)(2). Respondent denied petitioner relief under section 721.

Held, assuming that petitioner had a class of income, which was abnormal in amount, the abnormality resulted from a general improvement in business conditions, so that all of the net abnormal income is attributable to the taxable year and no part thereof is attributable to the previous years. George E. H. Goodner, Esq., and Dewey R. Roark, Jr., Esq., for the petitioner; Newman A. Townsend, Esq., for the respondent.

The discrepancy between the 1937 total acreage in this table and the previous table is unexplained.

No season's average figure given; range of on-tree prices for all grapefruit was $0.73 high and $0.54 low.
Petitioner's citrus fruit sales for the four fiscal years preceding and for the taxable years were as follows:

Decision will be entered for the respondent. Trial counsel for petitioner withdrew after the hearing of this proceeding, and briefs were subsequently submitted on behalf of petitioner by Carolyn F. Agger, Esq., and Walter J. Rockler, Esq.

This proceeding involves petitioner's excess profits tax for the taxable year ending June 30, 1943. Petitioner filed a claim for refund of ‘$119,934.98, or such greater amount as may be refundable,‘ under section 721 of the Internal Revenue Code. Upon notice of respondent's disallowance of its claim, petitioner appealed under section 732 of the Code.

Subsequent to the hearing, the parties stipulated that no issue relating to petitioner's post-war credit or refund, as provided for in sections 780 and 781 of the Code, is involved herein.

The sole issue remaining is whether petitioner had net abnormal income for the taxable year resulting from the development of tangible property (citrus trees) within the meaning of section 721(a), which is attributable to previous taxable years as provided in section 721(b) of the Code.

FINDINGS OF FACT.

Petitioner, a Florida corporation formed in 1922, is engaged primarily in the production of citrus fruit. Its principal place of business is located at Orlando, Florida.

For the taxable year ended June 30, 1943, petitioner filed its income and excess profits tax returns with the collector of internal revenue for the district of Florida. Petitioner maintained its records and reports for tax purposes on the basis of the fiscal year ending June 30. Its books were kept on the accrual method of accounting.

On or before September 15, 1943, petitioner filed its income and excess profits tax returns for the taxable year ended June 30, 1943. On or about June 7, 1945, petitioner filed amended returns for such taxable year. Petitioner's excess profits tax was assessed on the basis of the original return as filed and paid in the amount of $301,922.01. In a letter of May 16, 1949, the respondent asserted a deficiency in petitioner's excess profits tax of $10,793.34 for the taxable year ended June 30, 1943. Thereafter, petitioner paid $1,934.31 of this deficiency and was credited with $1,079.34, the amount of its post-war credit due to this assessment and was credited with other amounts which had been paid on the basis of the amended returns. The total excess profits tax assessed and either paid or credited was $312,715.35.

For the fiscal year ended June 30, 1939 to 1943, inclusive, petitioner reported the following net income (or loss) as computed for normal tax purposes:

+--------------------------------+ ¦Fiscal year ended ¦Net income ¦ +-------------------+------------¦ ¦June 30 ¦or (loss) ¦ +-------------------+------------¦ ¦ ¦ ¦ +-------------------+------------¦ ¦1939 ¦($25.16) ¦ +-------------------+------------¦ ¦1940 ¦(32,273.21) ¦ +-------------------+------------¦ ¦1941 ¦3,636.16 ¦ +-------------------+------------¦ ¦1942 ¦124,006.43 ¦ +-------------------+------------¦ ¦1943 ¦170,067.89 ¦ +--------------------------------+

Petitioner derived its income from two sources, receipt from the sale of citrus fruit output, and rental and investment income. More than 90 per cent of petitioner's total income for the taxable years 1940 to 1943, inclusive, and almost 90 per cent for the taxable year 1939, resulted from the growing of citrus fruit (oranges, grapefruit, and tangerines), and from the sale thereof. Petitioner's citrus crop was to affiliated companies.

At the time of its organization, petitioner acquired a number of citrus groves, and its citrus acreage has increased from time to time since then. The number of trees for any acre has not varied appreciably from year to year. Very few trees have died and these were promptly replaced.

For the fiscal years ended June 30, 1936 through 1943, petitioner's output of citrus fruit from approximately the same acreage and number of trees was as follows:

+-----------------------------------------------------+ ¦ ¦ ¦ ¦Boxes of citrus¦ +-----------+------------+------------+---------------¦ ¦Fiscal year¦No. of acres¦No. of trees¦fruit produced ¦ +-----------+------------+------------+---------------¦ ¦1936 ¦2379.0 ¦164,979 ¦376,436.0 ¦ +-----------+------------+------------+---------------¦ ¦1937 ¦2445.0 ¦169,616 ¦421,441.0 ¦ +-----------+------------+------------+---------------¦ ¦1938 ¦2558.5 ¦177,268 ¦453,605.0 ¦ +-----------+------------+------------+---------------¦ ¦1939 ¦2558.5 ¦177,268 ¦553,755.5 ¦ +-----------+------------+------------+---------------¦ ¦1940 ¦2558.5 ¦177,268 ¦537,346.0 ¦ +-----------+------------+------------+---------------¦ ¦1941 ¦2558.5 ¦177,268 ¦639,885.0 ¦ +-----------+------------+------------+---------------¦ ¦1942 ¦2558.5 ¦177,268 ¦582,780.5 ¦ +-----------+------------+------------+---------------¦ ¦1943 ¦2558.5 ¦177,268 ¦742,769.5 ¦ +-----------------------------------------------------+

A young citrus tree reaches the bearing stage about its fifth or sixth year. Thereafter its output of fruit increases ratably until the tree reaches maturity sometimes between its fifteenth and twentieth year. After maturity is attained, a tree's production remains relatively constant for 25 or 30 years. The bearing life of the trees in petitioner's groves was about 40 to 50 years.

The age distribution of petitioner's citrus trees, by acres, for the fiscal years ended June 30, 1937 and 1943, was as follows:

+-----------------------------------------------------------------------------+ ¦Fiscal ¦5 years and ¦6-10 ¦11-15 ¦16-20 ¦21 years and ¦Total ¦ ¦year ¦under ¦years ¦years ¦years ¦over ¦acreage ¦ +---------+-------------+--------+---------+---------+-------------+----------¦ ¦1937 ¦523.6 ¦652.2 ¦751.9 ¦190.2 ¦217.4 ¦* 2335.3¦ +---------+-------------+--------+---------+---------+-------------+----------¦ ¦1943 ¦96.3 ¦179.2 ¦949.7 ¦786.7 ¦546.6 ¦2558.5 ¦ +-----------------------------------------------------------------------------+

The increase in total acreage between 1937 and 1943 apparently represented plantings of 156.2 acres and the acquisition of 67 acres of mature citrus trees.

Citrus trees require expert care and supervision. The soil has to be properly fertilized to stimulate the normal growth of young trees and to insure the quality of the fruit and the productivity of mature trees. The trees have to be protected from various insect pests by spraying and dusting, the materials and treatment used varying with the type of insect pest. The trees have to be protected, to the extent possible, from damage resulting from drought, hail and windstorms, and frost and freeze. The trees have to be pruned by topping or hedging; and cover crops, planted in May or June, have to be worked into the soil in September or October. The matured and growing trees in petitioner's groves in the taxable year were the result of years of careful planning, cultivation, and supervision.

Petitioner's trees were fertilized twice a year, once in or about May when the cover crops were planted, and again in or about November after the cover crops were turned into the soil. The amount of fertilizer used depended upon the condition of the trees, but when young growth had been damaged by a frost or freeze a smaller amount was used. A young growing tree required a slightly larger amount each year until it matured, after which, the amount of fertilizer used remained fairly constant. In or about 1939, petitioner began using a better grade of fertilizer which included rare mineral elements, the benefits of which extended over a period of years. The addition of these elements to citrus fertilizers grew out of governmental and other research programs. By using this improved citrus fertilizer, petitioner expected to increase the quality and quantity of its citrus output beginning 3 or 4 years in the future. Petitioner continued using the improved fertilizer in 1943 and thereafter.

During the taxable year ended June 30, 1943, petitioner realized a greater output of citrus fruit than in any preceding year. Its increased production in the taxable year came from the same acreage and the same number of trees that petitioner had operated for the five preceding fiscal years. A large part of this increased production was due to the development and maturation of young citrus trees over a period of years. Favorable weather conditions and the absence of storms, freezes, and drought were important contributing factors to petitioner's record production. Citrus production in Florida and in the United States for the crop season of 1942-1943 broke all records.

Petitioner's gross receipts from sales of citrus fruit for the taxable year 1943 were $1,139,282.34, which included $10,963.51 of miscellaneous citrus income. The cost of sales was $491,648.58, which gave petitioner a gross income from citrus operations for the taxable year of $647,633.76.

For the four preceding taxable years petitioner's gross income from citrus operations was as follows:

+----------------------------------+ ¦Fiscal year ended ¦ ¦ +-------------------+--------------¦ ¦June 30 ¦Gross income ¦ +-------------------+--------------¦ ¦ ¦ ¦ +-------------------+--------------¦ ¦1939 ¦$44,058.22 ¦ +-------------------+--------------¦ ¦1940 ¦22,537.74 ¦ +-------------------+--------------¦ ¦1941 ¦34,115.04 ¦ +-------------------+--------------¦ ¦1942 ¦179,552.50 ¦ +-------------------+--------------¦ ¦Total ¦$280,263.50 ¦ +----------------------------------+

The average gross income for this period was $70,065.88, and 125 per cent of that average was $87,582.35. The excess of petitioner's gross income for the taxable year ($647,633.76) over 125 per cent of its average gross income for the four preceding taxable years ($87,582.35) was $560,051.41.

Petitioner's expenses for the taxable year chargeable or allocated to its citrus operations totaled $601,464.62. Expenses not clearly chargeable to citrus operations were allocated thereto in the ratio which citrus income bore to all income.

For the taxable year 1943 petitioner's administrative and overhead costs, as adjusted, were $109,816.04. Such costs were not included in petitioner's cost of sales ($49,648.58), although they constituted a part of the expenses for citrus grove operations. The proportionate part of such costs which is allocable to gross income from citrus grove operations in excess of 125 per cent of the average gross income of the proceeding 4 years ($560,051.41) was $96,638. The ‘net abnormal income‘ of the petitioner for the taxable year 1943 was $463,413.41 ($560,051.41 minus $96,638).

Petitioner could not, to any substantial degree, control the size of its citrus crop in the taxable year or in any other taxable year. It followed its normal practices in 1943 and made no effort to force a higher yield from its groves. Any attempt to force an increased yield of fruit in one year would probably result in fruit of low quality for that year and would cause a ‘die-back‘ or decline in yield for the following years. The increase in production in 1943 was due to the care the trees had received, the growth the trees had attained, and the favorable weather conditions that prevailed.

In harvesting its citrus crops, petitioner picked substantially all the fruit on its trees except tangerines. In certain years due to climatic or other conditions beyond its control, the quality of part of its tangerine crop would be such that it would not be worth picking. In the taxable year petitioner picked and disposed of 206,750 1/2 boxes of tangerines, which was 98,930 boxes more than the previous fiscal year, and represented about 61.8 per cent of petitioner's increased yield for the taxable year over the fiscal year 1942.

Petitioner purchased no citrus fruit for resale in the taxable year 1943. The number of boxes of citrus fruit picked and sold during the taxable year 1943 exceeded the previous year by 159,989 boxes, i.e., 742,769 1/2 minus 582,780 1/2.

The average prices per box that petitioner received for its citrus crops during the fiscal year ended June 30, 1937, through 1943, were as follows:

+-----------------------------------------------------------+ ¦ ¦Oranges ¦ ¦ ¦ +-----------------+-------------------+----------+----------¦ ¦Fiscal year ¦Early & ¦ ¦Grapefruit¦Tangerines¦ +-----------------+---------+---------+----------+----------¦ ¦ ¦midseason¦Valencias¦ ¦ ¦ +-----------------+---------+---------+----------+----------¦ ¦1937 ¦$1.00 ¦$1.00 ¦$0.65 ¦$0.50 ¦ +-----------------+---------+---------+----------+----------¦ ¦1938 ¦.60 ¦.60 ¦.52 ¦.70 ¦ +-----------------+---------+---------+----------+----------¦ ¦1939 ¦.64 ¦.83 ¦.37 ¦.53 ¦ +-----------------+---------+---------+----------+----------¦ ¦1940 ¦.61 ¦.89 ¦.54 ¦.90 ¦ +-----------------+---------+---------+----------+----------¦ ¦1941 ¦.64 ¦1.14 ¦.46 ¦.51 ¦ +-----------------+---------+---------+----------+----------¦ ¦1942 ¦.78 ¦1.17 ¦.64 ¦1.22 ¦ +-----------------+---------+---------+----------+----------¦ ¦1943 ¦1.64 ¦2.15 ¦1.07 ¦1.25 ¦ +-----------------+---------+---------+----------+----------¦ ¦1939-1942 Average¦$0.67 ¦$1.01 ¦$0.50 ¦$0.79 ¦ +-----------------------------------------------------------+

The season's average on-tree prices for Florida oranges, grapefruit, and tangerines for the fiscal years ending June 30, 1937, through 1943, were as follows:

+-------------------------------------------------------------+ ¦ ¦Oranges ¦ ¦ ¦ +-----------+---------------------------+----------+----------¦ ¦Fiscal year¦ ¦ ¦Grapefruit¦Tangerines¦ +-----------+-----------------+---------+----------+----------¦ ¦ ¦Early & midseason¦Valencias¦ ¦ ¦ +-----------+-----------------+---------+----------+----------¦ ¦1937 ¦$1.13 ¦$1.92 ¦$0.51 ¦ ¦ +-----------+-----------------+---------+----------+----------¦ ¦1938 ¦.75 ¦.58 ¦.59 ¦ ¦ +-----------+-----------------+---------+----------+----------¦ ¦1939 ¦.44 ¦.82 ¦.22 ¦ ¦ +-----------+-----------------+---------+----------+----------¦ ¦1940 ¦.46 ¦.62 ¦.42 ¦ ¦ +-----------+-----------------+---------+----------+----------¦ ¦1941 ¦.64 ¦.98 ¦.33 ¦.$0.64 ¦ +-----------+-----------------+---------+----------+----------¦ ¦1942 ¦.90 ¦1.35 ¦* .54 ¦1.34 ¦ +-----------+-----------------+---------+----------+----------¦ ¦1943 ¦1.47 ¦2.02 ¦.92 ¦1.18 ¦ +-------------------------------------------------------------+

+-----------------------------------------------------------+ ¦ ¦ ¦Per box¦ ¦ +--------------------------+-----------+-------+------------¦ ¦Fiscal years ended June 30¦No. boxes ¦average¦Sales amount¦ +--------------------------+-----------+-------+------------¦ ¦1939 ¦ ¦ ¦ ¦ +--------------------------+-----------+-------+------------¦ ¦Oranges, early & midseason¦225,127 1/2¦.64 ¦$143,123.64 ¦ +--------------------------+-----------+-------+------------¦ ¦Oranges, Valencias ¦72,006 ¦.83 ¦59,802.10 ¦ +--------------------------+-----------+-------+------------¦ ¦Grapefruit ¦104,733 ¦.37 ¦39,111.22 ¦ +--------------------------+-----------+-------+------------¦ ¦Tangerines ¦151,889 ¦.53 ¦80,938.85 ¦ +--------------------------+-----------+-------+------------¦ ¦Totals ¦553,755 1/2¦ ¦322,975.81 ¦ +-----------------------------------------------------------+

1940 Oranges, early & midseason 264,628 .61 $161,348.70 Oranges, Valencias 80,861 .89 72,077.98 Grapefruit 64,181 .54 34,594.26 Tangerines 127,676 .90 114,908.40 Totals 537,346 $382,929.34

1941 Oranges, early & midseason 255,936 .64 $162,762.42 Oranges, Valencias 96,671 1.14 110,468.66 Grapefruit 140,539 .46 64,814.08 Tangerines 146,739 .51 74,642.50 Totals 639,885 $412,687.66

1942 Oranges, early & midseason 290,554 1/2 .78 $226,862.56 Oranges, Valencias 80,083 1/2 1.17 94,045.77 Grapefruit 104,322 .64 66,980.40 Tangerines 107,820 1/2 1.22 131,541.01 Totals 582,780 1/2 $519,429.74

1943 Oranges, early & midseason 307,419 1.64 $505,480.90 Oranges, Valencias 111,432 2.15 239,478.80 Grapefruit 117,168 1.07 124,821.63 Tangerines 206,750 1/2 1.25 258,437.50 Totals 742,769 1/2 $1,128,318.83

Petitioner's production, operating costs, cost per box, and selling price per box for the fiscal years 1939 to 1943, inclusive, were as follows:

+-----------------------------------------------------------------------------+ ¦Fiscal years ended ¦No. of boxes ¦Operating ¦Per box ¦Per box selling ¦ ¦June 30 ¦produced ¦costs ¦cost ¦price ¦ +--------------------+----------------+------------+---------+----------------¦ ¦1939 ¦553,755 1/2 ¦$362,026.68 ¦$0.654 ¦$0.583 ¦ +--------------------+----------------+------------+---------+----------------¦ ¦1940 ¦537,346 ¦439,344.09 ¦.818 ¦.712 ¦ +--------------------+----------------+------------+---------+----------------¦ ¦1941 ¦639,885 ¦458,771.51 ¦.717 ¦.645 ¦ +--------------------+----------------+------------+---------+----------------¦ ¦1942 ¦582,780 1/2 ¦428,736.96 ¦.736 ¦.891 ¦ +--------------------+----------------+------------+---------+----------------¦ ¦1943 ¦742,769 1/2 ¦601,464.62 ¦.810 ¦1.519 ¦ +-----------------------------------------------------------------------------+

Petitioner picked its citrus fruits and delivered them to the packing house platform with the result that its selling prices, quoted in the above tables, are different from the season's average ‘on tree‘ prices for Florida oranges, grapefruit, and tangerines.

A number of factors affected the prices that petitioner received for its citrus fruit. Included therein were: the efforts made by one of petitioner's affiliates in prior years to build up the Dr. Phillips brand; the general condition of prosperity existing throughout the United States; the size of the citrus crops in Florida, Texas, and California; the amount of competing fruits such as apples, pears, and some vegetables; the government purchases for the armed services, lend-lease, and other related activities; the quality of its crop; and wartime economic conditions.

The government's purchases of canned citrus products and the total United States pack of such citrus products (in thousands of cases of 24 No. 2 cans) for specified seasons were as follows:

+--------------------------------+ ¦Season ¦Total U.S.¦Total Gov't. ¦ +-------+----------+-------------¦ ¦ ¦pack ¦purchases ¦ +-------+----------+-------------¦ ¦1940-41¦26,655 ¦2,704 ¦ +-------+----------+-------------¦ ¦1941-42¦24,603 ¦4,059 ¦ +-------+----------+-------------¦ ¦1942-43¦31,102 ¦12,320 ¦ +--------------------------------+

Petitioner's increased production in the taxable year was due to a combination of circumstances including favorable weather conditions, the maturation of the trees in its groves, and the care, cultivation, and fertilization of the groves. The increased income realized by petitioner in the taxable year resulted primarily from increased prices attributable to wartime conditions and the large increase in production. No part of the net abnormal income realized by petitioner in the taxable year was attributable to prior years.

OPINION.

RICE, Judge:

Petitioner contends that it qualifies for relief from excess profits tax for the taxable year 1943 under the provisions of section 721 of the Internal Revenue Code. That section deals with abnormalities in income in an excess profits tax period. It defines the terms used, the separate classes of income, and provides for computing ‘the amount of net abnormal income‘ and that shall be attributed to other years, thereby reducing the excess profits tax for the taxable year. We have held that it was enacted by Congress to prevent the unfair application of the excess profits tax in abnormal cases, and that it imposes both affirmative and negative burdens of proof upon a taxpayer attempting to qualify thereunder. The pertinent provisions of the section are set forth in the margin.

Soabar Co., 7 T.C. 89, 96 (1946)

Eitel-McCullough, Inc., 9 T.C. 1132, 1146 (1947)

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, * * *(2) SEPARATE CLASSES OF INCOME.— Each of the following subparagraphs shall be held to describe a separate class of income:(C) Income resulting from exploration, discovery, prospecting, research, or development of tangible property, patents, formulae, or processes, or any combination of the foregoing, extending over a period of more than 12 months;All the income which is classifiable in more than one of such subparagraphs shall be classified under the one which the taxpayer irrevocably elects. The classification of income of any class not described in subparagraphs (A) to (F), inclusive, shall be subject to regulations prescribed by the Commissioner with the approval of the Secretary.(3) NET ABNORMAL INCOME.— The term ‘net abnormal income‘ means the amount of the abnormal income less, under regulations prescribed by the Commissioner with the approval of the Secretary, (A) 125 per centum of the average amount of the gross income of the same class determined under paragraph (1), and (B) an amount which bears the same ratio to the amount of any direct costs or expenses, deductible in determining the normal-tax net income of the taxable year, through the expenditure of which such abnormal income was in whole or in part derived as the excess of the amount of such abnormal income over 125 per centum of such average amount bears to the amount of such abnormal income.(b) AMOUNT ATTRIBUTABLE TO OTHER YEARS.— The amount of the net abnormal income that is attributable to any previous or future taxable year or years shall be determined under regulations prescribed by the Commissioner with the approval of the Secretary. * * *

Petitioner claims that in 1943 its gross income included a class of income that was abnormal in amount, was a separate class of income as described in subparagraph 721(a)(2)(C), and that it had ‘net abnormal income‘ in the amount of $463,413.41, a portion of which is attributable to previous years under section 721(b) and respondent's regulations with respect thereto. If it had no 721(a)(2)(C) class income, petitioner claims, in the alternative, that such income should be classified under the general provisions of 721(a)(2).

Respondent contends that the growing of citrus crops is not a ‘development of tangible property‘ which entitles petitioner to classify its income from citrus operations as 721(a)(2)(C) income. He maintains that the separate class of income provided for this subparagraph was intended for the mining industry, corporations that develop new processes, and similar entrepreneur activities. But, he says, even if the cultivation of citrus trees is within the ambit of the section, petitioner fails to qualify for the reason that all of its claimed abnormal income was due to increased prices, increased demand, government buying for lend-lease and for the armed forces, and other factors.

In claiming that it has a separate class of income under 721(a)(2)(C), petitioner specifically limits its claim to income resulting from the ‘development of tangible property.‘ No claim is made that it had income resulting from exploration, discovery, prospecting, research, patents, formulae, or processes. It argues that citrus trees are ‘tangible property‘ and that the promotion of their growth by proper cultivation is ‘development‘ for the reason that the term ‘to develop‘ means literally ‘to promote the growth of.‘ Income resulting from increased productivity of maturing citrus trees, says petitioner, is ‘income resulting from the development of tangible property,‘ and the application of materials and labor to the cultivation of young citrus trees, the fertilization and irrigation of the soil, the planting of cover crops, and the spraying, dusting, and pruning of its citrus trees are as much developmental activities as activities designed to facilitate the removal of oil from wells or coal from mines.

Webster's New-International Dictionary, Second Edition.

Southwestern, Oil & Gas Co., 6 T.C. 1124 (1946).

Morrisdale Coal Mining Co., 13 T.C. 448 (1949).

Petitioner's alternative contention is based upon the amendments to section 721 of the Code by section 5 of the Excess Profits Tax Amendments of 1941, which provided that ‘classification of income of any class not described in subparagraphs (A) to (F), inclusive, shall be subject to regulations prescribed by the Commissioner with the approval of the Secretary.‘ It claims that this amendment broadened the scope of section 721 to include any classification of income under appropriate Treasury Regulations, and cites in support thereof a decision of this Court, which held that royalty income was different in character and had no qualities or attributes in common with any other type of income derived from petitioner's operations as a manufacturer of hosiery, and, therefore, was a ‘class of income‘ within the meaning of 721(a)(2). It submits that, if denied 721(a)(2)(C) classification, it had a class of income under the general unlettered provisions of 721(a)(2) because it derived abnormal income from its citrus operations in the taxable year which is attributable to prior years. Except for this one reference to its alternative contention, which appears in a footnote, petitioner's original and reply brief seek to establish its right to relief under 721(a)(2)(C).

Section 721(a)(2), footnote 3, supra.

W. B. Davis & Son, Inc., 5 T.C. 1195, 1207 (1945).

We find it unnecessary to decide the questions raised by petitioner's arguments because even if we assume, as we did in Primas Groves, Inc., and Graves Brothers Co., that petitioner's citrus income constituted a separate or any class of income for the base period and the taxable year, which under the statutory formula is abnormal in amount and which, when reduced pro rata by direct costs or expenses, results in net abnormal income, we are, nevertheless, convinced that petitioner has failed to prove that any part of such net abnormal income is attributable to prior years so as to entitle it to relief.

Primas Groves, Inc., 15 T.C. 1195, 1207 (1945).

Graves Brothers Co., 17 T.C. 1499 (1952).

Our findings show that petitioner's net abnormal income, computed under the statutory formula was $463,413.41, and we do not understand that respondent objects to the correctness of this computation. In adjusting this amount to give effect to wartime conditions, petitioner concedes that increased prices in the taxable year gave rise to a substantial part of its net abnormal income for 1943, namely, $228,773.71; but it contends that such amount reflected all other wartime factors, so that any further adjustments for factors such as low operating costs, increased demand including government purchases, and decreased competition, as specified in respondent's regulations, are inapplicable, unnecessary, and unreasonable in the circumstances of this case.

Regs. 112, Sec. 35.721-3 AMOUNT ATTRIBUTABLE TO OTHER YEARS.Items of net abnormal income are to be attributed to other years in the light of the events in which such items had their origin, and only in such amounts as are reasonable in the light of such events. To the extent that any items of net abnormal income in the taxable year are the result of high prices, low operating costs, or increased physical volume of sales due to increased demand for or decreased competition in the type of product sold by the taxpayer, such items shall not be attributed to other taxable years. Thus, no portion of an item is to be attributed to other years if such item is of a class of income which is in excess of 125 percent of the average income of the same class for the four previous taxable years solely because of an improvement in business conditions. In attributing items of net abnormal income to other years, particular attention must be paid to changes in those years in the facts which determined the amount of such income, such as changes in prices, amount of production, and demand for the product. No portion of an item of net abnormal income is to be attributed to any previous year solely by reason of an investment by the taxpayer in assets, tangible or intangible, employed in or contributing to the production of such income.

We cannot agree that petitioner's adjustment for price increases on the sale of its citrus fruit adequately measures the entire improvement in business conditions in the taxable year, nor can we agree that its adjustment for price increases adequately measures the actual increase in prices that petitioner received for its citrus fruit in the taxable year. In determining its price increase adjustment, petitioner made up an index using Florida on-the-tree orange and grapefruit prices for the years 1935-36 through 1939-40 as a base of 100. In arriving at the base price, it assigned the average price of oranges during the period a weight of four, and grapefruit a weight of one. On this index, prices for the taxable year had increased 97.5 per cent over the average prices of the base period. Petitioner then computed the amount of net abnormal income attributable to price increases in the excess profits tax year of 1943 to be $228,773.71.

Petitioner's contention is stated as follows: ‘Mathematically sated, abnormal income for the year ended in 1943 attributable to the price is determined as follows: 197.5/100 equals $463,413.41/x. 'x’ is the amount of income which is not attributable to the price rise. 'x' is $234,639.70. $463,413.41 less $234,639.70 equals $228,773.71, the amount of income attributable to the price rise.‘

The petitioner's position is reflected by its contention that ‘an adjustment for price rises cannot, under the regulation, exceed net abnormal income, since the 'items of net abnormal income’ cannot exceed total net abnormal income. ‘ Petitioner would read respondent's Regulations, section 35.721-3, supra, to mean that in no instance could higher prices in the taxable year create all of the net abnormal income so that no part thereof could be attributed to prior years. But this case illustrates how improvement in business conditions generally, including higher prices, can result in net abnormal income in an excess profits tax year, all of which is attributable to the taxable year and none of which can be attributed to previous taxable years. Our findings show that for the first three of the four previous taxable years petitioner's average annual cost per box of citrus fruit exceeded its average annual selling price per box, and that only in the taxable year 1942 did its average selling price per box exceed its average cost per box. It is not surprising, therefore, to find that the average cost per box for the four previous years exceeded the average selling price per box for such years by 2.3 cents per box. It also appears that petitioner's average selling price per box for the taxable year exceeded its average cost per box by 70.9 cents, and exceeded the average cost per box for the four preceding taxable years by 78.8 cents per box. If these price differentials are applied to the boxes of fruit sold by petitioner in the taxable year, it is at once apparent that no part of the net abnormal income is attributable to any previous taxable year and that all of it is attributable to the excess profits tax year 1943. This is true even though adjustment is made for the increased cost per box of citrus fruit in the taxable year.

Thus, even assuming petitioner had a separate class of income under 721(a)(2)(C), or a class of income under 721(a)(2) generally, we are of the opinion that it its not entitled to relief under section 721. In so holding we have weighed the various factors set forth in our findings which affected citrus fruit pieces, including the heavy demand for fresh and processed citrus fruit during the taxable year, and the effect that high prices had on the amount of fruit picked by the petitioner. Actually petitioner realized large profits in the taxable year because good weather conditions produced a record crop which petitioner sold at high prices due to a war inflated economy. The excess profits which resulted from such external changes in business conditions were the profits which Congress intended to tax. Soabar Co., supra.

Footnote 1, supra.

Reviewed by the Special Division.