Royal Crown Bottling Co. of Knoxville
v.
Comm'r of Internal Revenue

This case is not covered by Casetext's citator
Tax Court of the United States.Jun 30, 1954
22 T.C. 688 (U.S.T.C. 1954)

Docket No. 21881.*

1954-06-30

ROYAL CROWN BOTTLING COMPANY OF KNOXVILLE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

George E. H. Goodner, Esq. , and Dewey R. Roark, Jr., Esq. , for the petitioner. William T. Holloran, Esq. , for the respondent.


Petitioner, during the base period, had a change in management and operation and has qualified for relief under section 722(b), Internal Revenue Code. Constructive average base period net income, determined. George E. H. Goodner, Esq., and Dewey R. Roark, Jr., Esq., for the petitioner. William T. Holloran, Esq., for the respondent.

This proceeding seeks a review of respondent's disallowance of petitioner's claims for refund and relief under section 722 of the Internal Revenue Code for the taxable years ended October 31, 1942, 1943, and 1944 in the respective amounts of $12,101.56, $33,140.14, and $21,272.94.

As the case is argued on brief, the issues are whether petitioner is entitled to relief under section 722(b)(4) of the Internal Revenue Code and the amount thereof.

FINDINGS OF FACT.

The petitioner filed its income and excess profits tax returns for the years in issue with the collector of internal revenue for the district of Tennessee.

The petitioner's excess profits tax liability for the fiscal years ending October 31, 1942 through 1944, was as follows:

+----------------------------------------+ ¦Fiscal year ending October 31¦Itability ¦ +-----------------------------+----------¦ ¦1942 ¦$12,101.56¦ +-----------------------------+----------¦ ¦1943 ¦33,140.14 ¦ +-----------------------------+----------¦ ¦1944 ¦23,042.01 ¦ +----------------------------------------+

Petitioner's excess profits credit under the invested capital method, for the fiscal years ending October 31, 1942 through 1944, was as follows:

+---------------------------------------------------+ ¦Fiscal year ending October 31¦Excess profits credit¦ +-----------------------------+---------------------¦ ¦1942 ¦$8,142.63 ¦ +-----------------------------+---------------------¦ ¦1943 ¦9,717.01 ¦ +-----------------------------+---------------------¦ ¦1944 ¦10,696.00 ¦ +---------------------------------------------------+

In its Application for Relief Under Section 722 of the Internal Revenue Code, appears the following:

Excess profits net income or deficit in excess profits net income for each taxable year in the base period, computed without regard to section 722.

+-----------------------------------------------------------------------------+ ¦Calendar year ¦Amount ¦ +------------------------------------------------------------------+----------¦ ¦Year 1936 ¦$6,838.83 ¦ +------------------------------------------------------------------+----------¦ ¦Jan. 1, 1937, to Dec. 31, 1937 ¦8,465.88 ¦ +------------------------------------------------------------------+----------¦ ¦Jan. 1, 1938, to May 31, 1938 ¦2,209.91 ¦ +------------------------------------------------------------------+----------¦ ¦June 1, 1938, to Oct. 31, 1938 ¦7,026.82 ¦ +------------------------------------------------------------------+----------¦ ¦Nov. 1, 1938, to Oct. 1, 1939 ¦6,105.67 ¦ +------------------------------------------------------------------+----------¦ ¦Nov. 1, 1939, to Oct. 31, 1940 ¦5,930.39 ¦ +------------------------------------------------------------------+----------¦ ¦ ¦$36,577.50¦ +------------------------------------------------------------------+----------¦ ¦Total—Less 10/12 of year 1936 ¦5,701.92 ¦ +------------------------------------------------------------------+----------¦ ¦ ¦$30,875.58¦ +------------------------------------------------------------------+----------¦ ¦Average base period net income determined without regard to ¦$7,718.89 ¦ ¦section 722 ¦ ¦ +-----------------------------------------------------------------------------+

Adjustments made by respondent support an average base period net income determined without regard to section 722 of $7,667.63.

The Chero Cola Bottling Company, hereinafter sometimes referred to as Chero Cola, was incorporated in 1923. Prior to incorporation. the business was conducted by a partnership. Until June 1, 1938, it was engaged in bottling, selling, and distributing soft drinks and beer in Knoxville, Tennessee, and certain surrounding territory. Its soft drink operations were under franchises or licenses from the manufacturers of the syrups. It sold to retailers who sold to consumers. Under a franchise from Nehi, Inc., it bottled and sold Nehi products. It also bottled and sold the nationally advertised Hires Root Beer, Welch Ade, and other soft drinks. The Nehi Franchises, in accordance with its practice, were issued to Fred H. Austin, as an individual. Fred H. Austin had been president and general manager of the Chero Cola Bottling Company for many years. Nehi franchises could be canceled at any time by Nehi. Nehi required a bottler to serve the entire area covered by his franchise.

Fred Austin was a large minority stockholder in the Chero Cola Bottling Company. The minutes of the annual meeting of stockholders of the company, held on February 16, 1937, record the unanimous adoption of a motion that

a vote of thanks be extended to the Officers for the excellent [ sic] manner in which the business had been conducted the past year and the improved showing in the financial condition of the Company, and especially to the President Mr. Fred H. Austin for his untiring efforts in the interest of the Company. On the same date the company's directors restored the salary of Fred H. Austin ‘to $350 per month as previously paid, but voluntarily reduced by Mr. Austin to $270 during the past several depression years.’ In 1937, Fred Austin changed over the operation of the company owned and operated delivery trucks to a truck rental system, thus eliminating a repair shop and the investment in truck insurance, tags, and painting.

Fred Austin had had a chronic illness for several years. He became incapacitated the last two or three months of 1937 and was confined to a hospital around Christmas of 1937. He died on February 3, 1938, as a result of this illness.

Immediately upon the death of Fred Austin, Nehi canceled the franchises issued to him, and sent an agent into the plant to enable it to operate during an interim period.

Charles M. Brown, a brother-in-law of Fred Austin, resided in Baltimore, Maryland, during the years 1922 to early in 1938, inclusive. While there he was employed in wholesaling and distributing oil by the Island Export Company and the Continental Oil Company as a salesman in the Baltimore-District of Columbia area, and later as Baltimore manager having supervision of five or six salesmen.

Brown had visited his sister and brother-in-law in Knoxville on several occasions during which Fred Austin had described the advances made by the Chero Cola Bottling Company in the sale of a comparatively new drink, Royal Crown Cola, sometimes called R–C Cola. In October 1937, Brown took a pleasure trip through the Southern States and noticed the progress which was being made in the promotion and sale of Royal Crown Cola. He made no visits to Royal Crown bottling plants and no survey of any retail stores.

Brown came to Knoxville for Fred Austin's funeral and after studying the matter went to Nehi's main office at Columbus, Georgia, to seek the Knoxville franchise for its products. Nehi conditioned the granting of the franchise to Brown on the physical separation of the beer from the soft drink business, and the discontinuance of other soft drinks. Brown agreed to make Royal Crown his leader in his territory. At this time Coca-Cola and Pepsi Cola franchises for this territory had been issued. They were preferable bottling franchises.

Brown was elected president and a member of the board of directors of Chero Cola Bottling Company on February 16, 1938. The written franchises to bottle and sell Royal Crown Cola, Par-T-Park, and Nehi in the Knoxville territory were issued to Brown on April 22, 1938. During this period the Chero Cola Bottling Company continued to bottle and sell soft drinks and distribute beer.

Brown's salary for a 3-year period was fixed by the board of directors on February 17, 1938, at $5,000 per year plus a bonus of 5 per cent of the net earnings of the company up to the amount of the average net earnings for 1935 through 1937, plus an additional bonus of 15 per cent of the net earnings above the 3-year average of 1935–37. On November 1, 1940, Brown's base salary was increased $3,600 per year and at the end of the fiscal year ending October 31, 1941, a special bonus of $2,400 was to be paid to him in addition to the bonus previously provided. When Brown commenced his employment with the Chero Cola Bottling Company, he wished to be able to obtain a substantial stock interest in the company.

On March 17, 1938, at a meeting of the board of directors of Chero Cola Bottling Company, a resolution was duly passed ‘that the certificate of incorporation of this company be amended’ as follows:

* * * * * * *

1. To reincorporate the company under Chapter 90 of the Public Acts of General Assembly of State of Tennessee for the year 1929.

2. To change the capital structure of the company so as to convert the present issue of stock outstanding into shares of no par or in such other form as stockholders might determine.

3. To change the name of the corporation to ‘Royal Crown Bottling Company’ or to such other name as the stockholders might determine.

4. To transact such other business as might come before the meeting.

* * * * * * *

Chapter 90 of the Public Acts of General Assembly of the State of Tennessee for the year 1929 provides:

Reincorporation.—Any corporation organized and existing under the laws of this state and which might be or have been organized under this article, may reincorporate under this article either under the same name or a different name by recording in the office of the register of the county in which its principal office is located and filing with the secretary of state a certificate authorized by a meeting of the stockholders called for that purpose, and executed and acknowledged, as herein provided for, a certificate of incorporation, setting forth the statements required in an original certificate by section 3714, and in addition surrendering the existing charter of the corporation and accepting the provisions of this article. Upon filing thereof said corporation shall be deemed to be incorporated hereunder and shall be entitled to and be possessed of all the privileges, franchises and powers as if originally incorporated under this article; and all the properties, rights and privileges theretofore belonging to said corporation, which were acquired by gift, grant, conveyance, assignment or otherwise shall be and the same are ratified, approved and confirmed and assured to said corporation with like effect and to all intents and purposes as if the same had been originally acquired through incorporation under this article; provided, however that any corporation thus reincorporating hereunder shall be subject to all the contracts, duties and obligations, theretofore resting upon the corporation whose charter is thus surrendered or to which said corporation shall then be in any way liable, but such corporation shall not be subject to the payment of an additional charter tax for such reincorporation, unless its capital stock shall be in such certificate increased.

The charter of ‘Reincorporation’ was issued May 24, 1938, by the Secretary of State of the State of Tennessee in the name of ‘Royal Crown Bottling Company of Knoxville.’ It authorized the company to have outstanding a maximum to 1,250 shares, no-par-value, common capital stock. Each holder of the 1,123 shares of $100 par value Chero Cola Bottling Company stock received, share for share, no-par-value stock of the Royal Crown Bottling Company of Knoxville. Some new stockholders were added, including Brown and Clyde Austin, brother of Fred Austin.

The minutes of the annual meeting of the stockholders of petitioner held February 14, 1939, recite that when Brown undertook his new employment it was ‘with the distinct understanding that we would obtain for him a substantial interest in the Company, since he was unwilling to devote his time and energy to build up the Company merely for salary compensation’; that it had been impossible for Brown to find sufficient stock and that therefore an increase to 2,500 shares was being made in the capital stock of the company to permit Brown to acquire a substantial number for not less than its book value. No further increase was made through 1945.

During the base period years, the geographic area served by Chero Cola and petitioner remained unchanged, and comprised a territory within approximately a 50-mile radius of Knoxville. In this area the peak soft drink selling season starts in May and runs through August—a period of 3 to 4 months—and the soft drink distributor must be ready for it. This area is close to the center of the greatest market for cola drinks.

On taking charge of the Chero Cola Bottling Company in February 1938, Brown found that the plant was inefficient in arrangement and operation; that some of the equipment was old and worn; that certain employees were inefficient; and that the territory covered by the franchise was not being adequately or properly worked. He immediately took steps to correct these matters. He rearranged the plant; acquired some new plant equipment; introduced 2 new panel body advertising trucks with Royal Crown advertising crews and paint shop; replaced 4 delivery trucks with ones of larger capacity; added 2 new truck routes; introduced and equipped 2 substation warehouses about 50 miles out in the territory; separated soft drinks and beer personnel and operations; substantially increased the number of retail dealers served by petitioner between April 1, 1938, and the end of October 1938; put new salesmen and truckdrivers through a training of 4 to 8 weeks; and eliminated preferential discounts to certain customers.

The new equipment above mentioned included a filter, a Hydradarco purifier, and a water cooler of double previous capacity to provide the additional cool water necessary for the larger Royal Crown bottles. The items of machinery were shipped in April 1938 and were to replace obsolete items which had been in use for over 20 years. As of December 31, 1936, the machinery and equipment of Chero Cola had a book value of $53,071.73, and the reserve for depreciation had a balance of $41,975.08.

After the 1938 selling season was over, petitioner contracted for the following other new machines which were shipped in February 1939:

1 Cem Mixer

1 Cem 28? machine

1 Cem Saturator

1 Conveyor layout

1 72-bottle per minute Miller Hydro-Bottle Washer and Sterilizer Installation of this machinery required the removal of the front windows of the building. They were replaced with a different type window. The bottling room was rearranged and partitions removed to accommodate the new and larger machinery. An electric elevator replaced a hand operated one.

This new machinery was financed by a $20,000 mortgage on all of petitioner's assets.

The bottling equipment used by Chero Cola had a rated capacity of 50 bottles per minute if operated without interruption. Changing from the bottling of one flavor to the bottling of another required that the production line be stopped and the syrup machines cleaned before bottling a different flavor. Longer working hours, or a second shift, would permit increased production. The actual capacities of the bottling equipment and the bottle washer limit each other. Installation of new machinery is frequently made to reflect the benefits of recent technological improvements. The new machinery and rearrangement of the plant, including installation and use of continuous conveyor belts, increased petitioner's efficiency.

During the base period years, and up to the present date, the Nehi corporation employed sales representatives who acted as over-all sales managers of the bottling plants under their jurisdiction. The sales representatives aided the bottlers under their jurisdiction, including Chero Cola and the Royal Crown Company, by helping train the driver-salesmen employed by the bottler; by checking to see that the advertising displays were erected in the proper locations and that the dealers' stores were adequately stocked; by conducting sales training courses; by planning a general sales program; by checking to see that the bottler maintained a standard sanitary product and increased his sales per capita; by examining the bottlers' sales and production reports; and by having the bottlers eliminate nonproductive activities and follow through with the sales program established by Nehi. If the bottler was not following through with the sales program established by Nehi, it was the duty of the sales representative to find the reason. The bottlers were supervised carefully by the Nehi corporation.

Nehi, Inc., first tested Royal Crown Cola, a cola drink in a 12-ounce bottle, in 1934, and the testing continued through 1935. The year 1936 was the first year in which Royal Crown Cola was in commercial production. In that year Nehi started its extensive advertising of Royal Crown Cola. The Chero Cola Bottling Company sold Royal Crown Cola throughout the year 1936. Prior to 1939, such advertising was on a local or plant-by-plant basis, in conjunction with the advertising of Nehi representatives and an advertising agency in Atlanta. Georgia. Nehi supplied its bottlers with advertising material. In 1938 Nehi engaged Batton, Barton, Dursten and Osborne of New. York to undertake national advertising of Royal Crown Cola, and this program was under way in 1939.

During the base period, in accordance with Nehi's policy, it paid or reimbursed Chero Cola or petitioner for a portion of the local advertising expenses. Nehi would not pay for advertising in a franchise area unless the local bottler paid a proportionate part, sometimes half, of the expenses. Nehi supplied its bottlers, including petitioner, with metal and other signs at a lower price than the bottler could obtain them. Beer companies supplied signs, including neon signs, at no cost to their distributors.

In a statement attached to the claim of Nehi for relief under section 722 of the Internal Revenue Code, the percentages of R–C Cola advertising to sales of Royal Crown concentrate by Nehi for 1936 to 1939, inclusive, were listed as follows:

+-------------------------------------------------------+ ¦Year¦Percentage of R–C advertising expense to R–C sales¦ +----+--------------------------------------------------¦ ¦1936¦16.6 ¦ +----+--------------------------------------------------¦ ¦1937¦24.8 ¦ +----+--------------------------------------------------¦ ¦1938¦44.9 ¦ +----+--------------------------------------------------¦ ¦1939¦46.8 ¦ +-------------------------------------------------------+

The Nehi corporation had to spend a greater amount for advertising of R–C Cola in proportion to its sales during the base period than the Coca-Cola Company, and continues to do so. The Coca-Cola Company is the largest seller of cola beverages.

As of January 1, 1939, the Nehi corporation thought that petitioner's territory was not selling up to the amount expected for its population. Its vice president, who was its general manager, and its district sales manager went to Knoxville and with Brown planned petitioner's merchandising program for 1939.

In 1939 petitioner advertised Royal Crown Cola by door-to-door canvassing with young ladies offering a bargain price on the new 6-bottle ‘carry-home’ package, and in 1939 petitioner also commenced using an ‘Audiochrom,’ which was a recording device attached to the telephone system that recited the time of day and mentioned Royal Crown Cola. The use of the Audiochrom cost $400 per month for a period of 18 months. In addition to the Audiochrom, the Royal Crown Company, in the fall of 1939, contracted for several large spectacular billboards for the purpose of advertising Royal Crown Cola.

Petitioner's books and tax returns do not show the direct amounts paid for advertising of its various products. Brown has no personal knowledge of the specific expenditures of Chero Cola for advertising during the years 1934 through 1937, which was prior to his association with the business.

By the use of the book figures, and allocations between beer, soft drinks, and Royal Crown Cola of component items of expense, on a percentage of cases produced (except an attribution of 95 per cent of soft drink advertising expenses to Royal Crown Cola in 1938 and 1939), the profits and losses sustained for the period indicated were as follows:

+-----------------------------------------------------------------------------+ ¦Year ¦All other soft drinks and ¦Royal Crown ¦Total: ¦ ¦ ¦beer ¦Cola ¦ ¦ +----------------------+-----------------------------+--------------+---------¦ ¦1936 ¦$2,653.02 ¦ ¦$2,653.02¦ +----------------------+-----------------------------+--------------+---------¦ ¦1937 ¦8,558.43 ¦ ¦8,558.43 ¦ +----------------------+-----------------------------+--------------+---------¦ ¦Jan. 1, 1938–May 31, ¦2,957.27 ¦($2,770.62) ¦186.65 ¦ ¦1938 ¦ ¦ ¦ ¦ +----------------------+-----------------------------+--------------+---------¦ ¦June 1, 1938–Oct. 31, ¦10,815.45 ¦(2,634.72) ¦8,180.73 ¦ ¦1938 ¦ ¦ ¦ ¦ +----------------------+-----------------------------+--------------+---------¦ ¦Nov. 1, 1938–Oct. 31, ¦20,931.65 ¦(14,687.95) ¦6,243.70 ¦ ¦1939 ¦ ¦ ¦ ¦ +----------------------+-----------------------------+--------------+---------¦ ¦Nov. 1, 1939–Oct. 31, ¦18,246.58 ¦(10,444.17) ¦7,802.41 ¦ ¦1940 ¦ ¦ ¦ ¦ +-----------------------------------------------------------------------------+

1936 ($436.71); 1937 ($3,877.82).
1 Compare this profit and loss statement with net income statement, infra.
Nehi., in trying to promote sales of Royal Crown Cola over other brands of cola, pent as high as 44 per cent of the money received for the product. Its total expenditures were 20 per cent to 30 per cent of its gross revenue, and 90 per cent of those expenditures went to promote Royal Crown Cola, including amounts paid to reimburse bottlers for advertising.
Expenditures for advertising may be reduced after the market demand has been established. Petitioner's franchise for Nehi products provided that a reasonable amount, and not less than 2 cents a case should be expended by petitioner for advertising Nehi products. Petitioner's Royal Crown franchise required it to ‘loyally cooperate with the company in its plans for expanding the volume of sales.’
During the years 1936 through 1939, there was no significant change in the cost of materials and labor involved in the soft drink business.
During the years 1923 through 1939, the establishments engaged in the manufacture of nonalcoholic beverages, carbonated or noncarbonated, excluding those bottling fruit and vegetable juices, numbered as follows:

Sales for 1938 are not available.

One unit equals 69 1/2 cases.

The record does not satisfactorily disclose acceptable figures for this year from comparable sources, but reference to other record material would indicate that in 1937 Royal Crown Cola sales constituted more than 70 per cent of all of Chero Cola's sales of soft drinks.

Data for years 1936 and 1937 and period Jan. 1, 1938, to May 31, 1938, taken from returns filed by Chero Cola Bottling Co., Knoxville, Tennessee.

1935–1939 = 100.

Formerly the Chero Cola Bottling Company—name changed in May 1938. Change in filing period from calendar to fiscal year basis ending May 1938.

The standard selling price of Royal Crown Cola received by the bottler during the petitioner's base period was 80 cents per case plus 50 cents deposit on the wooden case. The price of Royal Crown Cola was usually fixed by the price of Coca-Cola.

Nehi's sales of Royal Crown Cola concentrate to Chero Cola or petitioner, measured in units and computed for cases for the years 1936 to 1939, inclusive, were as follows:

+--------------------+ ¦Year¦Units¦Cases* ¦ +----+-----+---------¦ ¦1936¦367 ¦25,445 ¦ +----+-----+---------¦ ¦1937¦1,262¦87,499 ¦ +----+-----+---------¦ ¦1938¦1,168¦80,981 ¦ +----+-----+---------¦ ¦1939¦1,472¦102,059 ¦ +--------------------+

Petitioner's and Chero Cola's respective beer sales by cases for the periods indicated were as follows:

+----------------+ ¦Year¦Cases sold ¦ +----+-----------¦ ¦1936¦73,533 ¦ +----+-----------¦ ¦1937¦126,029 ¦ +----+-----------¦ ¦1938¦99,676 ¦ +----+-----------¦ ¦1939¦132,403 ¦ +----------------+

The cost of materials per case of soft drinks produced by Chero Cola and petitioner, respectively, in the year 1937, and the period June to October 31, 1938, was as follows:

+-------------------------------------------------------+ ¦1937. ¦ +-------------------------------------------------------¦ ¦ ¦R-C Cola ¦Nehi ¦Par-T-Pak¦ +------------------------+----------+---------+---------¦ ¦Total cost of materials ¦$28,354.42¦$8,666.65¦$1,619.45¦ +------------------------+----------+---------+---------¦ ¦Number of cases produced¦95,714 ¦28,909 ¦5,443 ¦ +------------------------+----------+---------+---------¦ ¦Cost per case ¦$0.2962 ¦$0.2998 ¦$0.2981 ¦ +-------------------------------------------------------+

+-------------------------------------------------------+ ¦Period June 1 to October 31, 1938. ¦ +-------------------------------------------------------¦ ¦ ¦R-C Cola ¦Nehi ¦Par-T-Pak¦ +------------------------+----------+---------+---------¦ ¦Total cost of materials ¦$12,207.61¦$1,486.11¦$7,611.40¦ +------------------------+----------+---------+---------¦ ¦Number of cases produced¦43,342 ¦5,479 ¦24,871 ¦ +------------------------+----------+---------+---------¦ ¦Cost per case ¦$0.2886 ¦$0.2712 ¦$0.3060 ¦ +-------------------------------------------------------+

In a letter from Brown, dated March 30, 1948, to Geroge E. H. Goodner, petitioner's tax counsel, it is stated:

While it is possible for us to give a list of the number of cases of Royal Crown Cola sold for each of the years beginning with 1938 on through 1942, yet it will not be possible for us to show the profit on this particular portion of our total business, any more than a department store could say exactly what percentage of their total profit for any year came from the sale of hats, shoes, dresses, etc. * * *

In a pamphlet published by the American Bottlers of Carbonated Beverages, entitled ‘An Economic Study of the Bottled Soft Drink Industry (1941)’ (p. 21), it is stated that sales and delivery expense together ‘account for upwards of one-third of the bottlers' total costs.’ The study continues: ‘In view of the degree to which the industry is limited to the five-cent price ceiling, the maintenance and extension of volume are peculiarly conditioned, therefore, upon sales promotion and upon adequate delivery service.’

Bottlers of soft drinks, like the petitioner, are somewhat dependent upon local economic conditions. Improvement in local economic conditions in petitioner's franchise area during its base period tended to result in an improvement in its sales and earnings.

Department store sales, bank debits, and increases in population in a franchise area are measures of the economic condition of the area.

The estimated population for the city of Knoxville and its suburbs for the years 1933 through 1939, was as follows:

+-------------+ ¦1933¦149,788 ¦ +----+--------¦ ¦1934¦150,813 ¦ +----+--------¦ ¦1935¦152,042 ¦ +----+--------¦ ¦1936¦153,799 ¦ +----+--------¦ ¦1937¦158,218 ¦ +----+--------¦ ¦1938¦163,797 ¦ +----+--------¦ ¦1939¦170,153 ¦ +-------------+

Population of the counties included in petitioner's franchise area for the years 1930 and 1940 was as follows:

+---------------------------------------------+ ¦Population of counties served¦1950 ¦1940 ¦ +-----------------------------+-------+-------¦ ¦Knox County ¦155,902¦178,468¦ +-----------------------------+-------+-------¦ ¦Union County ¦11,371 ¦9,030 ¦ +-----------------------------+-------+-------¦ ¦Grainer County ¦12,737 ¦14,356 ¦ +-----------------------------+-------+-------¦ ¦Cocke County ¦21,755 ¦24,083 ¦ +-----------------------------+-------+-------¦ ¦Hamblen County ¦16,616 ¦18,611 ¦ +-----------------------------+-------+-------¦ ¦Jefferson County ¦17.14 ¦18,621 ¦ +-----------------------------+-------+-------¦ ¦Servier County ¦20,480 ¦23,291 ¦ +-----------------------------+-------+-------¦ ¦Blount County ¦33,989 ¦41,116 ¦ +-----------------------------+-------+-------¦ ¦Anderson County ¦19,722 ¦26,504 ¦ +-----------------------------+-------+-------¦ ¦Subtotal ¦310,486¦354,080¦ +---------------------------------------------+

Population of parts of counties served Loudon County (Civil District No. 2) 8,369 9,481 Roane County (Civil Districts Nos. 1, 2, 3, and 5) 21,758 24,711 Campbell County 21,807 25,351 Scott County (Civil Districts Nos. 1, 2, 3, and part of 5) 7,053 8,216 Morgan County (all Civil Districts except 12 and one-half of 5 12,347 13,580 and 6) 381,820 435,419

The index of department store sales for the years 1936 to 1939, inclusive, for the indicated cities in the Atlanta Federal Reserve District, is as follows:

+-----------------------------------------+ ¦ ¦Average Daily Sales * ¦ +-----------------+-----------------------¦ ¦ ¦1936 ¦1937 ¦1938 ¦1939 ¦ +-----------------+-----+-----+-----+-----¦ ¦Knoxville, Tenn ¦96 ¦105 ¦101 ¦110 ¦ +-----------------+-----+-----+-----+-----¦ ¦Montgomery, Ala ¦103 ¦101 ¦96 ¦105 ¦ +-----------------+-----+-----+-----+-----¦ ¦Nashville, Tenn ¦93 ¦108 ¦105 ¦118 ¦ +-----------------+-----+-----+-----+-----¦ ¦Jackson, Miss ¦100 ¦104 ¦104 ¦109 ¦ +-----------------+-----+-----+-----+-----¦ ¦Chattanooga, Tenn¦96 ¦104 ¦102 ¦110 ¦ +-----------------+-----+-----+-----+-----¦ ¦Birmingham, Ala ¦99 ¦109 ¦101 ¦111 ¦ +-----------------+-----+-----+-----+-----¦ ¦New Orleans, La ¦99 ¦102 ¦104 ¦111 ¦ +-----------------------------------------+

The amount of bank debits (measured in millions of dollars) in the following cities for the years indicated, as compiled by the Federal Reserve bank for the Atlanta District, is as follows:

+--------------------------------------------+ ¦ ¦1936 ¦1937 ¦1938 ¦1939 ¦ +-----------------+--------+-----+-----+-----¦ ¦Knoxville, Tenn ¦297 ¦346 ¦341 ¦368 ¦ +-----------------+--------+-----+-----+-----¦ ¦Nashville, Tenn ¦911 ¦1,005¦936 ¦1,023¦ +-----------------+--------+-----+-----+-----¦ ¦Jackson, Miss ¦343 ¦316 ¦336 ¦332 ¦ +-----------------+--------+-----+-----+-----¦ ¦New Orleans, La ¦2,463 * ¦2,719¦2,589¦2,655¦ +-----------------+--------+-----+-----+-----¦ ¦Augusta, Ga ¦213 ¦216 ¦185 ¦220 ¦ +-----------------+--------+-----+-----+-----¦ ¦Montgomery, Ala ¦260 ¦279 ¦249 ¦274 ¦ +-----------------+--------+-----+-----+-----¦ ¦Chattanooga, Tenn¦458 ¦511 ¦480 ¦536 ¦ +-----------------+--------+-----+-----+-----¦ ¦Birmingham, Ala ¦888 ¦1,069¦945 ¦1,060¦ +--------------------------------------------+

The following is a comparative statement of net income of petitioner for its base period:

+-----------------------------------------------------------------------------+ ¦Royal Crown Bottling Company of Knoxville. ¦ +-----------------------------------------------------------------------------¦ ¦Comparative profit and loss statements. ¦ +-----------------------------------------------------------------------------¦ ¦(Cents omitted) ¦ +-----------------------------------------------------------------------------¦ ¦ ¦ ¦ ¦Jan. 1, 1938¦June 1, 1938, ¦Oct. 31,¦Oct. 31,¦ ¦ ¦1936 ¦1937 ¦to May 31, ¦to Oct. 31, ¦1939 ¦1940 ¦ ¦ ¦ ¦ ¦1938 * ¦1938 ¦ ¦ ¦ +-------------+--------+--------+------------+--------------+--------+--------¦ ¦Sales ¦$237,572¦$359,589¦$106,610 ¦$164,434 ¦$366,455¦$388,242¦ +-------------+--------+--------+------------+--------------+--------+--------¦ ¦Cost of goods¦173,582 ¦270,390 ¦78,195 ¦114,033 ¦254,171 ¦266,462 ¦ ¦sold ¦ ¦ ¦ ¦ ¦ ¦ ¦ +-------------+--------+--------+------------+--------------+--------+--------¦ ¦Gross profit ¦$63,990 ¦$89,199 ¦$28,415 ¦$50,401 ¦$112,284¦$121,780¦ ¦from sales ¦ ¦ ¦ ¦ ¦ ¦ ¦ +-------------+--------+--------+------------+--------------+--------+--------¦ ¦Other ¦ ¦ ¦ ¦313 ¦98 ¦313 ¦ ¦interest ¦ ¦ ¦ ¦ ¦ ¦ ¦ +-------------+--------+--------+------------+--------------+--------+--------¦ ¦Net capital ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦gain (or ¦ ¦1,830 ¦(624) ¦ ¦435 ¦87 ¦ ¦loss) ¦ ¦ ¦ ¦ ¦ ¦ ¦ +-------------+--------+--------+------------+--------------+--------+--------¦ ¦Other income ¦2,082 ¦1,594 ¦3,167 ¦1,510 ¦1,943 ¦3,256 ¦ +-------------+--------+--------+------------+--------------+--------+--------¦ ¦Total Income ¦$66.072 ¦$92,643 ¦$30,958 ¦$52,224 ¦$114,760¦$125,436¦ +-------------+--------+--------+------------+--------------+--------+--------¦ ¦Compensation ¦$3,360 ¦$4,395 ¦$2,100 ¦$2,333 ¦$5,905 ¦$7,846 ¦ ¦of officers ¦ ¦ ¦ ¦ ¦ ¦ ¦ +-------------+--------+--------+------------+--------------+--------+--------¦ ¦Salaries and ¦6,503 ¦5,866 ¦3,435 ¦5,223 ¦14,491 ¦14,631 ¦ ¦wages ¦ ¦ ¦ ¦ ¦ ¦ ¦ +-------------+--------+--------+------------+--------------+--------+--------¦ ¦Repairs ¦1,047 ¦1,264 ¦791 ¦507 ¦1,065 ¦2,849 ¦ +-------------+--------+--------+------------+--------------+--------+--------¦ ¦Bad debts ¦452 ¦390 ¦243 ¦141 ¦277 ¦76 ¦ +-------------+--------+--------+------------+--------------+--------+--------¦ ¦Interest paid¦281 ¦1,479 ¦282 ¦306 ¦1,266 ¦1,033 ¦ +-------------+--------+--------+------------+--------------+--------+--------¦ ¦Taxes ¦3,649 ¦7,209 ¦2,788 ¦2,977 ¦6,703 ¦7,329 ¦ +-------------+--------+--------+------------+--------------+--------+--------¦ ¦Contributions¦ ¦ ¦15 ¦ ¦28 ¦84 ¦ +-------------+--------+--------+------------+--------------+--------+--------¦ ¦Depreciation ¦7,519 ¦5,212 ¦1,216 ¦1,342 ¦3,778 ¦4,628 ¦ +-------------+--------+--------+------------+--------------+--------+--------¦ ¦Other ¦37,700 ¦58,366 ¦17,922 ¦31,240 ¦75,097 ¦79,655 ¦ ¦deductions ¦ ¦ ¦ ¦ ¦ ¦ ¦ +-------------+--------+--------+------------+--------------+--------+--------¦ ¦Total ¦$60,511 ¦$84,181 ¦$28,792 ¦$44,069 ¦$108,610¦$118,131¦ ¦Deductions ¦ ¦ ¦ ¦ ¦ ¦ ¦ +-------------+--------+--------+------------+--------------+--------+--------¦ ¦Current Year ¦$5,561 ¦$8,462 ¦$2,166 ¦$8,155 ¦$6,150 ¦$7,305 ¦ ¦Net Income ¦ ¦ ¦ ¦ ¦ ¦ ¦ +-----------------------------------------------------------------------------¦ ¦Bource: Returns filed, adjusted for changes made by Bureau of Internal ¦ ¦Revenue. ¦ +-----------------------------------------------------------------------------+

Change in filing period from a fiscal May 31 to fiscal year ending October 31.


The case sales are based upon a bottler's obtaining 69 1/2 cases from each unit of concentrate purchased from Nehi.

Sales not segregated on the 1936 returns.

For 1939 the average per capita consumption of Royal Crown Cola for the 23 franchise territories which surround it, all of which were bottling Royal Crown Cola in 1936, was 10.78 bottles. The per capita consumption of Royal Crown in petitioner's territory was 5.5 bottles. Had the Knoxville franchise area sold at the same rate per capita as did first mentioned franchise territories, it would have sold 4,758,194 bottles or 198,258 cases in 1939.

Petitioner had a change in management during its base period within the meaning of section 722(b)(4) of the Internal Revenue Code. Its business did not reach, by the end of its base period, the earning level which it would have reached had this change occurred two years earlier. Had the change occurred two years earlier, the petitioner's earning level would have been $3,500 greater than that actually reached by the end of its base period. Because of this fact, petitioner's average base period net income is an inadequate standard of normal earnings. The sum of $11,000 would be a fair and just amount representing normal earnings to be used as a constructive average base period net income.

OPINION.

VAN FOSSAN, Judge:

In order to qualify under section 722(b)(4) petitioner contends that it commenced business in the base period on the issuance of the corporate charter at the time of its change in name and reincorporation in 1938; that during the base period it had a change of operation and management; and that there was also a difference in products which it furnished. It is our conclusion that petitioner is correct in contending that it had a change in its operation and management during the base period. Prior to Brown's becoming president, Austin had been through several years of chronic illness terminating in his hospitalization and death. Brown brought to the organization new vigor and a new approach which manifested itself in the remodeling of the plant, in the institution of more efficient methods of operation, in intensive training of salesmen, in substantially increasing the number of retail outlets, and in an advertising campaign. After Brown became president, the operation of petitioner's business was markedly different from that obtaining theretofore. We believe that Brown's operations adequately disclose a change of operation and management; and we are further convinced that because of this factor petitioner's average base period net income is an inadequate standard of normal earnings.

Having concluded that petitioner thus qualifies, it is not necessary for us to consider whether a qualification has been established by reason of the other above enumerated factors upon which petitioner relies, although the effect of these may nonetheless be reflected in the reconstruction of petitioner's constructive average base period net income. See Rand Beverage Co., 18 T. C. 275.

Upon consideration of the entire record, we have concluded and found as a fact that petitioner, by the end of its base period, would have reached an earning level for the year ending October 31, 1940, $3,500 in excess of its actual earnings for that period. Using the population figures of Knoxville as an appropriate basis for backcasting, it is our conclusion that $11,000 is a fair and just amount representing normal earnings to be used as a constructive average base period net income.

Reviewed by the Special Division.

Decision will be entered under Rule 50.

* Hearing in this case was conducted by Commissioner Edward C. Radue.

+------------------------------+ ¦Year¦Number of establishments ¦ +----+-------------------------¦ ¦1923¦4,514 ¦ +----+-------------------------¦ ¦1925¦4,210 ¦ +----+-------------------------¦ ¦1927¦4,769 ¦ +----+-------------------------¦ ¦1929¦5,154 ¦ +----+-------------------------¦ ¦1931¦4,250 ¦ +----+-------------------------¦ ¦1933¦2,903 ¦ +----+-------------------------¦ ¦1935¦3,175 ¦ +----+-------------------------¦ ¦1937¦3,920 ¦ +----+-------------------------¦ ¦1939¦4,504 ¦ +------------------------------+

The sales of Royal Crown concentrate by Nehi for the years 1936, 1937, 1939, and 1940, measured in units and cases, were as follows:

+-------------------------------------------+ ¦Year * ¦Unit sales¦Estimated case sales ** ¦ +-------+----------+------------------------¦ ¦1936 ¦51,645 ¦3,580,720 ¦ +-------+----------+------------------------¦ ¦1937 ¦156,546 ¦10,853,856 ¦ +-------+----------+------------------------¦ ¦1939 ¦257,156 ¦17,829,483 ¦ +-------+----------+------------------------¦ ¦1940 ¦294,598 ¦20,425,461 ¦ +-------------------------------------------+

It is usually impossible for a bottler of soft drinks to keep an inventory of a greater amount of bottled drinks than is necessary to supply its customers for more than two or three days, because of the amount of storage space required.

The percentage of Royal Crown Cola case sales to the totals of all soft drinks for the periods indicated are as follows:

+---------------------------------------------------------+ ¦Year ¦Percentage of Royal Crown case sales to all sales¦ +-------+-------------------------------------------------¦ ¦1937 * ¦ ¦ +-------+-------------------------------------------------¦ ¦1938 ¦61.89 ¦ +-------+-------------------------------------------------¦ ¦1939 ¦65.91 ¦ +-------+-------------------------------------------------¦ ¦1940 ¦72.34 ¦ +---------------------------------------------------------+

The sales of carbonated beverages in the United States and the State of Tennessee for the years 1935, 1937, and 1939 were as follows:

+------------------------------------------------------------------------------------+ ¦ ¦1935 ¦1937 ¦1939 ¦ +---------+------------------------+------------------------+------------------------¦ ¦ ¦Total cases¦Value ¦Total cases¦Value ¦Total cases¦Value ¦ +---------+-----------+------------+-----------+------------+-----------+------------¦ ¦United ¦192,935,607¦$158,525,348¦354,478,839¦$271,722,992¦472,763,117¦$354,186,912¦ ¦States ¦ ¦ ¦ ¦ ¦ ¦ ¦ +---------+-----------+------------+-----------+------------+-----------+------------¦ ¦Index ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦1939 = ¦40.8 ¦44.8 ¦75.0 ¦76.7 ¦100.0 ¦100.0 ¦ ¦100 ¦ ¦ ¦ ¦ ¦ ¦ ¦ +---------+-----------+------------+-----------+------------+-----------+------------¦ ¦Index ¦54.4 ¦58.3 ¦100.0 ¦100.0 ¦133.4 ¦130.3 ¦ ¦1937 =100¦ ¦ ¦ ¦ ¦ ¦ ¦ +---------+-----------+------------+-----------+------------+-----------+------------¦ ¦Tennessee¦6,769,610 ¦$5,374,687 ¦11,107,095 ¦$8,700,846 ¦13,617,932 ¦$10,570,775 ¦ +---------+-----------+------------+-----------+------------+-----------+------------¦ ¦Index ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦1939 = ¦49.7 ¦50.8 ¦81.6 ¦82.3 ¦100.0 ¦100.0 ¦ ¦100 ¦ ¦ ¦ ¦ ¦ ¦ ¦ +---------+-----------+------------+-----------+------------+-----------+------------¦ ¦Index ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦1937 = ¦60.9 ¦61.8 ¦100.0 ¦100.0 ¦122.6 ¦121.5 ¦ ¦100 ¦ ¦ ¦ ¦ ¦ ¦ ¦ +------------------------------------------------------------------------------------+

The dollar sales of R–C Cola and all soft drinks by Chero Cola and petitioner, respectively, for the calendar year 1937 and the fiscal year ended October 31, 1939, were as follows:

+--------------------------------------+ ¦R–C Cola ¦$68,339.93¦$77,016.67¦ +----------------+----------+----------¦ ¦Index 1937 = 100¦100.0 ¦112.7 ¦ +----------------+----------+----------¦ ¦All soft drinks ¦97,029.75 ¦118,628.43¦ +----------------+----------+----------¦ ¦Index 1937 = 100¦100.0 ¦122.3 ¦ +--------------------------------------+

Petitioner's and Chero Cola's respective dollar sales of beer and soft drinks during its base period, together with the percentage of R–C Cola sales to all soft drink sales, were as follows:

+----------------------------------------------------------------------------------+ ¦Royal Crown Bottling Company. ¦ +----------------------------------------------------------------------------------¦ ¦ANALYSIS OF SALES REPORTED ON FEDERAL INCOME TAX RETURNS. * ¦ +----------------------------------------------------------------------------------¦ ¦ ¦ ¦ ¦Period Jan.¦Period June¦Fiscal year¦Fiscal year¦ ¦ ¦1936 ** ¦1937 ¦1, 1938 to ¦1, 1938 to ¦ending Oct.¦ending Oct.¦ ¦ ¦ ¦ ¦May 31, ¦Oct. 31, ¦31, 1939 ¦31, 1940 ¦ ¦ ¦ ¦ ¦1938 ¦1938 ¦ ¦ ¦ +----------+-----------+-----------+-----------+-----------+-----------+-----------¦ ¦Soft ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦drinks ¦ ¦ ¦ ¦ ¦ ¦ ¦ +----------+-----------+-----------+-----------+-----------+-----------+-----------¦ ¦R–C Cola ¦ ¦$68,339.93 ¦$20,846.44 ¦$34,487.03 ¦$77,016.67 ¦$101,079.22¦ +----------+-----------+-----------+-----------+-----------+-----------+-----------¦ ¦Nehi ¦ ¦24,373.60 ¦7,860.30 ¦5,208.32 ¦2,878.00 ¦32,333.81 ¦ +----------+-----------+-----------+-----------+-----------+-----------+-----------¦ ¦Par-T-Pak ¦ ¦4,316.22 ¦1,903.85 ¦18,728.43 ¦36,685.81 ¦5,958.64 ¦ +----------+-----------+-----------+-----------+-----------+-----------+-----------¦ ¦Upper Ten ¦ ¦ ¦ ¦ ¦2,048.00 ¦971.07 ¦ +----------+-----------+-----------+-----------+-----------+-----------+-----------¦ ¦Total ¦ ¦97,029.75 ¦30,610.59 ¦58,423.78 ¦118,628.43 ¦140,342.74 ¦ +----------+-----------+-----------+-----------+-----------+-----------+-----------¦ ¦Beer ¦ ¦ ¦ ¦ ¦ ¦ ¦ +----------+-----------+-----------+-----------+-----------+-----------+-----------¦ ¦Budweiser ¦ ¦$67,551.90 ¦$24,993.48 ¦$36,838.95 ¦$83,279.60 ¦$98,447.61 ¦ +----------+-----------+-----------+-----------+-----------+-----------+-----------¦ ¦Champagne ¦ ¦70,122.68 ¦11,076.38 ¦67.52 ¦ ¦ ¦ +----------+-----------+-----------+-----------+-----------+-----------+-----------¦ ¦Dreury Ale¦ ¦132.00 ¦ ¦ ¦ ¦ ¦ +----------+-----------+-----------+-----------+-----------+-----------+-----------¦ ¦Falls City¦ ¦71,296.13 ¦27,766.75 ¦52,938.55 ¦136,001.93 ¦136,647.91 ¦ +----------+-----------+-----------+-----------+-----------+-----------+-----------¦ ¦Fehrs ¦ ¦164.00 ¦ ¦ ¦ ¦ ¦ +----------+-----------+-----------+-----------+-----------+-----------+-----------¦ ¦Kreuger ¦ ¦38,244.63 ¦12,256.66 ¦16,165.60 ¦28,545.17 ¦12,804.06 ¦ +----------+-----------+-----------+-----------+-----------+-----------+-----------¦ ¦Ole Towne ¦ ¦12,773.86 ¦ ¦ ¦ ¦ ¦ +----------+-----------+-----------+-----------+-----------+-----------+-----------¦ ¦Patrick ¦ ¦2,273.56 ¦36.85 ¦ ¦ ¦ ¦ ¦Henry ¦ ¦ ¦ ¦ ¦ ¦ ¦ +----------+-----------+-----------+-----------+-----------+-----------+-----------¦ ¦Total ¦ ¦262,558.76 ¦76,130.12 ¦106,010.62 ¦247,826.70 ¦247,899.58 ¦ +----------+-----------+-----------+-----------+-----------+-----------+-----------¦ ¦Grand ¦$237,572.35¦$359,588.51¦$106,740.71¦$164,434.40¦$366,455.18¦$388,242.32¦ ¦total ¦ ¦ ¦ ¦ ¦ ¦ ¦ +----------+-----------+-----------+-----------+-----------+-----------+-----------¦ ¦Percentage¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦of R–C ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦Cola to ¦ ¦70.4 ¦68.1 ¦59.0 ¦64.9 ¦72.0 ¦ ¦all soft ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦drinks ¦ ¦ ¦ ¦ ¦ ¦ ¦ +----------------------------------------------------------------------------------+