Connecticut Light & Power Co. v. Commissioner ( 1963 )

The Connecticut Light and Power Company, Petitioner, v. Commissioner of Internal Revenue, Respondent

Connecticut Light & Power Co. v. Commissioner

Docket No. 49321

United States Tax Court

40 T.C. 597; 1963 U.S. Tax Ct. LEXIS 92;

June 26, 1963, Filed

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Decision will be entered under Rule 50.

1. Sec. 722. -- Held, the respondent failed to establish error in his partial allowance of relief because of numerous affirmatively alleged contra-adjustments to the reconstruction. Held, further, that petitioner established (b)(4) base period changes in the character of the business consisting of a difference in capacity for production or operation entitling it to application of the 2-year pushback rule. The amount of the CABPNI determined.

2. Sec. 722. -- Held, that petitioner is entitled to additional adjustment for base period abormality in interest and debt expense.

3. Sec. 722. -- Held, that petitioner is not entitled to additional adjustment to eliminate alleged base period abnormality of excessive depreciation, under E.P.C. 6.

4. Sec. 722. -- Held, that petitioner's sales promotion activities and voluntary inducive rate reductions are not qualifying (b)(4) changes in the character of the business.

5. Sec. 722. -- Held, that under the (b)(4) commitment rule the word "taxpayer" limits the applicability of such rule and, further, that a committed-for change in capacity by another taxpayer corporate entity is not equally committed for by petitioner because of an interchange agreement respecting the use of the energy to be produced by the new facility.

6. Jurisdiction -- Standard Issues. -- Held, that this Court will no longer follow its decision in Mutual Lumber Co., 16 T.C. 370">16 T.C. 370, and, on authority of the decisions of the various circuit Courts of Appeal reversing the Tax Court on this issue, we take jurisdiction of the standard issues properly raised herein.

7. Statute of Limitations. -- Held, that the assessment and collection of additional excess profits taxes are not barred for the years 1941 and 1942, but are barred for the years 1943, 1944, and 1945.

8. Pleadings. -- Petitioner's motion to strike amended answers raising standard issues relative to 1940, for carryover purposes, and taxable years 1941 and 1942 is denied. Further, petitioner's motion to strike all of paragraph 11 of second amended answer raising standard issues relative to taxable years 1943, 1944, and 1945 is granted in part but denied as to that portion raising an alternative issue as to the correct excess profits credit for purpose of determining whether there is an actual overpayment for those years.

9. Unused Credit Carryover. -- Held, that the respondent erred in computing the amount of any unused excess profits credit for 1940 for purposes of carryover to 1941.

10. Excess Profits Credit Based on Income, Sec. 713. -- Adjustment for Net Capital Addition or Reduction as Defined in Subsec. (g). -- Held, that in adjusting excess profits credit under section 713(a)(1)(A), (B), and (C) and for purposes of the capital reduction under section 713(g)(4), the respondent properly reduced the taxable year's earnings and profits available for distribution by the amount of accrued taxes for that year in determining the amount of petitioner's distributions not out of earnings and profits. A B C Brewing Corp., 20 T.C. 515">20 T.C. 515, followed. Held, further, that respondent failed to establish error in not prorating available current earnings to each quarterly dividend distribution for purposes of the capital reduction for each year. Held, further, that respondent erroneously computed the amount of the capital reduction under section 713(g)(4) by failing to include therein the current year's distributions not out of earnings and profits for the year 1940 for carryover purposes and the taxable years 1941 and 1942, and also the cumulative effect of such errors on the computations of the capital reduction for 1943, 1944, and 1945.

11. Adjustment of Excess Profits Credit for 1943, 1944, and 1945 Despite Bar of Statute of Limitation. -- Held, that petitioner's excess profits credit for 1943, 1944, and 1945 must be recomputed to reflect the corrected capital reduction under section 713(g)(4) in redetermining petitioner's excess profits tax liability for those years for purpose of redetermination herein as to whether any overpayments actually exist for those years. Lewis v. Reynolds, 284 U.S. 281">284 U.S. 281, followed.

J. Marvin Haynes, N. Barr Miller, and Arthur H. Adams, for the petitioner.

Arnold I. Weber, for the respondent.

Kern, Judge. Withey, J., dissents on Issues 6 and 7. Scott, J., did not participate in the consideration or disposition of this case. Opper, J., dissenting.

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KERN

This proceeding involves the petitioner's appeal for redetermination of the respondent's partial disallowance of its applications for excess profits tax relief under section 722, I.R.C. 1939, ^*97

The respondent in his statutory notice determined that petitioner qualified for relief under section 722(b)(1) and (b)(4), and further determined a constructive average base period net income (CABPNI) resulting in overassessments for the years involved. The petitioner herein seeks a CABPNI substantially in excess of that determined by respondent, based upon certain alleged errors in respondent's reconstruction and his partial disallowance of certain claims for relief under section 722(b)(4).

This proceeding also involves the respondent's numerous affirmative allegations of error in his statutory notice which are denied by petitioner. Respondent alleges error in his partial allowance of section 722 relief and determination of overassessments on the ground that he failed to make certain so-called contra-adjustments which would cancel out the adjustments previously allowed in his reconstruction of a CABPNI and thereby preclude any section 722 relief and eliminate the overassessments determined in the statutory notice. Respondent further alleges errors in his determination of petitioner's excess profits tax liability for the years 1941 to 1945, inclusive, and affirmatively asserts deficiencies for those years.

The petitioner's excess profits tax liability and the overassessments as determined in the statutory notice for the years 1941 to 1945, inclusive, and also the excess profits tax deficiencies affirmatively asserted herein for those years are as follows:

Excess Profits Tax
Year	Liability	Overassessment	Deficiency
1941	$ 606,909.24	$ 94,394.88	$ 130,670.56
1942	1,266,017.21	3,590.13	94,550.90
1943	470,491.86	47,740.06	18,081.60
1944	19,779.91	52,594.72	26,212.31
1945	988,478.56	54,187.68	33,274.69

The following major and subsidiary questions are presented for our determination as to which the first four major questions and subsidiary questions thereunder arise from petitioner's allegations that respondent erred in failing to reconstruct a fair and just amount representing normal earnings to be used as a CABPNI on the ground that he failed to allow certain additional adjustments in his reconstruction and the remaining major and subsidiary questions arise from the respondent's affirmative allegations of error in his statutory notice:

1. Whether respondent erred in failing to allow for substantial reductions in interest expense and debt discount and expense.

2. Whether respondent, having allowed reconstruction for cost savings resulting from more efficient electric generating facilities completed during the base period, erred in failing to allow for cost savings computed on the same basis for facilities completed after December 31, 1939, and committed for prior to January 1, 1940.

3. Whether respondent erred in failing to eliminate abnormal depreciation deductions in the base period years under respondent's E.P.C. 6.

4. Whether respondent erred in failing to reconstruct for an increased level of sales and earnings under the 2-year pushback rule:

A. For changes in capacity for producing electric energy (1) completed during the base period, and (2) completed after December 31, 1939, and committed for prior to January 1, 1940, and

B. For base period extensions of rural distribution lines to furnish additional electric service and for further extensions which would have been made if all the base period changes in the character of the business had been made 2 years earlier.

5. Whether in the statutory notice respondent erroneously determined the above-stated overassessments resulting, except in part for 1941, from the erroneous partial allowance of relief under section 722 on the ground that he failed to make contra-adjustments which would preclude the allowance of relief and more specifically that he erred:

A. In failing to make contra-adjustments for increased insurance, property taxes, and depreciation which would be constructively incurred on the additional facilities completed in the base period, and also for increased interest and amortization of debt discount and expense on new capital required to finance such additional facilities.

B. In failing to make adjustment for increased welfare and pension expenses incurred after 1937.

C. In failing to make adjustment for constructive loss of earnings in the base period arising from distributions in that period other than out of earnings and profits.

D. In erroneously allowing petitioner an unused excess profits credit carryover, based on constructive earnings under section 722, from the year 1940 to the year 1941.

E. In erroneously characterizing the Stamford Interchange Agreement as making available 15,000 kilowatt capacity.

6. Whether, in computing petitioner's excess profits tax liability for the year 1941, the respondent's statutory notice erroneously determined that there was an unused excess profits credit carryover from the year 1940 in the amount of $ 257,021.36.

7. Whether the petitioner is estopped from claiming an adjustment under section 722 for elimination of alleged abnormal depreciation deductions in the base period years.

8. Whether respondent erroneously scheduled overassessments in excess profits taxes in the above-mentioned amounts for 1941 and 1942, and erroneously rebated (by refund and credit) such amounts to petitioner and, further, whether respondent erroneously failed to make correct capital reductions in computing petitioner's net capital additions, and that there are excess profits tax deficiencies in the above-mentioned amounts for 1941 and 1942.

9. Whether, as alleged by respondent, there is no statutory bar to the assessment and collection of the affirmatively asserted excess profits tax deficiencies for 1941 and 1942 because of alleged executed agreements extending the period of limitations.

10. With respect to the years 1943, 1944, and 1945 as to which respondent has affirmatively asserted the above-mentioned deficiencies and petitioner has plead, inter alia, the statute of limitations, and in the event the Court should determine that petitioner is entitled to the additional adjustments claimed herein under section 722, then in the alternative whether the petitioner's net capital additions as corrected should be used in determining its excess profits tax liability for the years 1943, 1944, and 1945 for the purpose of determining whether any net overpayments actually exist for those years.

11. Whether the Court has jurisdiction over the "standard issues" raised herein.

FINDINGS OF FACT

Some of the facts were stipulated by the parties. We incorporate herein by this reference the stipulation and supplemental stipulations and exhibits attached thereto.

Petitioner is a corporation organized under the laws of the State of Connecticut. Its principal office is located at Berlin, Conn. During all times here material petitioner kept its books and filed its Federal tax returns on an accrual method of accounting for calendar years. Such tax returns were filed with the collector of internal revenue for the district of Connecticut.

Petitioner duly filed its corporation income and excess profits tax returns for the years involved herein on the dates as shown by exhibits attached to the stipulation.

In the returns filed for 1940 and 1941, petitioner computed its excess profits tax credit based on the invested capital method as provided in sections 714-720. Such credit, as adjusted by respondent, was as follows:

1940	$ 5,302,686.01
1941	4,623.640.25

On its returns for the years 1942 to 1945, inclusive, the petitioner determined its excess profits credit under the income method as provided in section 713. Its average base period net income under section 713(f), as adjusted by respondent, for the years 1942 to 1945, inclusive, was $ 3,854,803.45.

The petitioner's average base period net income under section 713(f) for the year 1941 is $ 3,844,849.70.

In its timely filed applications and amendments thereto for relief and refunds under section 722, for the years 1941 to 1945, inclusive, the petitioner claimed relief on substantially the same grounds as set forth in its petition herein. Petitioner's claims include the carryover of unused excess profits credits, based upon a constructive average base period net income, from the year 1940 to 1941 and from 1944 to 1945, as well as the carryback of unused excess profits credits from 1943 to 1941 and 1942 and from 1944 to 1942.

On March 18, 1953, the respondent issued the statutory notice by registered mail, pursuant to section 732, determining a partial allowance and a partial disallowance of petitioner's applications for relief. Petitioner's actual average base period net income was $ 3,781,544. The statutory notice stated, in part, as follows:

It is held that you are entitled to relief under Section 722(b)(1) by reason of a hurricane which resulted in an interruption of normal production and operations, and under Section 722(b)(4) by reason of cost savings based on the additional 25,000 KW unit installed at Montville in 1937, and on the 15,000 KW capacity made available under the Stamford Interchange. The fair and just amount representing earnings to be used as a constructive average base period net income, has been determined to be $ 3,913,000.00 applicable to each of the years 1941 to 1945, inclusive, computed as follows:

	1936	1937
Adjusted excess profits net income before sec.
722 adjustments	$ 3,509,048	$ 3,980,965
Add: Sec. 722 adjustments for hurricane losses
Totals	3,509,048	3,980,965
Deduct: Sec. 722 adjustments for flood losses	3,558	42
Constructive net income per RAR dated Apr.
26, 1950	3,505,490	3,980,923
Add: Sec. 722 adjustments for constructive cost
savings	213,399	189,021
Constructive net income as adjusted	3,718,889	4,169,944
Aggregate
CABPNI -- $ 3,912,730, rounded to

	1938	1939
Adjusted excess profits net income before sec.
722 adjustments	$ 3,660,916	$ 3,975,247
Add: Sec. 722 adjustments for hurricane losses	78,654	7,558
Totals	3,739,570	3,982,805
Deduct: Sec. 722 adjustments for flood losses	10,696	11,471
Constructive net income per RAR dated Apr.
26, 1950	3,728,874	3,971,334
Add: Sec. 722 adjustments for constructive cost
savings	61,879
Constructive net income as adjusted	3,790,753	3,971,334
Aggregate		15,650,920
CABPNI -- $ 3,912,730, rounded to		3,913,000

Accordingly, the claims for refund listed above are disallowed in part.

The petitioner is a public utility. It was originally organized in 1902 as the Rocky River Power Co. and in 1917 changed its name to the Connecticut Light and Power Co. In 1925 petitioner began to acquire various small utility companies throughout the State of Connecticut. Also in 1925 the Connecticut Electric Service Co. was organized as the holding, or parent, company of petitioner and other companies. In 1935 the parent company, with all its subsidiaries and operating assets, was merged into petitioner. For a period of time immediately prior to the base period years, 1936-39, there was no significant change in the franchise territory, in the aggregate, of all the numerous companies ultimately merged into petitioner.

At all times here material petitioner's business has consisted primarily of the production, purchase, transmission, distribution, and sale of electricity and gas. It also furnished steam heat to customers in the city of Bristol and water service for domestic and commercial purposes in five towns. Petitioner's sales of electrical energy during the base period and the excess profits tax years are classified as follows:

1. Domestic (Including residential and rural)

2. Commercial

3. Industrial

4. Other utilities

5. Municipal street lighting

6. Railroad corporations

Approximately 81 percent of petitioner's total gross operating revenue was derived from the sale of electric energy, approximately 18 percent from the sale of gas, and the balance of about 1 percent from the sale of steam, water, and from other miscellaneous sources. As a public utility the petitioner is subject to regulation by the Connecticut Public Utilities Commission.

The State of Connecticut is divided geographically into eight counties which are in turn subdivided into some 169 areas or civil divisions called towns. The various cities and boroughs are located within the geographical boundaries of the towns.

At the beginning of 1936 the petitioner supplied electric service in 105 towns with a population of approximately 580,198. At the end of the base period petitioner supplied electric service in 107 towns with a population of approximately 660,000. The franchise territory served directly by retail sales by petitioner during the base period covered approximately 60 percent of the geographical area of the State of Connecticut, embracing the major portion of the eastern half and a substantial portion of the western half of the State, and including the cities of Bristol, Meriden, New Britain, Norwalk, Putnam, Rockville, Waterbury, Willimantic, Winsted, and Greenwich. Rural and suburban areas constituted the greatest portion of the geographical territory served by petitioner. Of the total population of the territory served by petitioner at the end of the base period, approximately one-half lived in small cities and the other half lived in suburban communities and rural areas. Throughout the base period petitioner also supplied electric energy to four other utilities which purchased a substantial part of their electricity from petitioner for retail as the principal suppliers of electric service in 14 other towns. The remaining towns in the State were supplied by other utility companies which generated their own power.

Electric generating capacity is expressed in terms of kilowatts (kw) and the capacity of a generating unit is expressed in the number of kilowatts of electric energy it is capable of producing in 1 hour of operation. Electric energy is sold in terms of kilowatt-hours and the petitioner's sales herein are expressed in the number of kilowatt-hours (kw-hr) of electric energy distributed to its customers.

A "transmission line" is a powerline of high voltage that transmits electric energy from a generating station to a transmission substation from which the electricity is transmitted to a distribution substation and thence over "distribution lines" to the customers' meters.

A steam generating plant burns coal or oil to convert water to steam, which in turn spins the turbines and produces electric energy. A hydroelectric generating plant uses the power produced by falling water to spin the turbines to produce electricity.

The Glossary of Electric Terms prepared by the statistical committee of the Edison Electric Institute defines "name-plate rating (or manufacturer's guaranteed capacity)" as "The full-load continuous rating of a generator or other piece of electrical equipment under specified conditions as designated by the manufacturer. It is usually indicated on a name-plate attached mechanically to the individual machine or device. Name-plate rating is generally less than, but may be greater than, demonstrated gross capability of the installed machine."

Prior to and throughout the base period petitioner produced electric energy by both steam and hydroelectric generating facilities. Petitioner had two types of hydroplants, namely, the run-of-the-river or stream-flow type and the reservoir or pump-storage type. A stream-flow plant utilizes the power of falling water from the actual flow of a stream or river into a reservoir or pond and then over a dam, usually near the powerplant which is operated when there is sufficient water in the stream. A pump-storage plant utilizes water pumped from a stream or river into a reservoir from which the water is released as needed to generate electricity. In the latter type of hydroplant water can be stored for emergency use or against drought.

Throughout the base period petitioner had steamplants located at Devon and Montville, one pump-storage hydroplant (nameplate capacity 24,000 kw), and a minimum of 11 stream-flow hydroplants (of varying capacity) at various locations. The following schedule shows the nameplate capacity, in killowatts, of the hydroplants and of the steamplants, respectively, owned by petitioner on December 31, 1935-39, inclusive, embracing changes made in such facilities during the base period, and the ratio of each type of such generating capacity to total capacity:

[In kilowatts]
Year	Hydroplants	Percent	Steamplants	Percent	Total	Percent
1935	58,190	35	107,500	65	165,690	100
1936	64,815	38	105,000	62	169,815	100
1937	66,815	34	130,000	66	196,815	100
1938	64,865	33	130,000	67	194,865	100
1939	64,625	33	130,000	67	194,625	100

In addition to the above-mentioned generating capacity of plants owned by petitioner, 15,000-kw capacity became available in March 1938, and 25,000-kw steam generating capacity became available in 1941, to both the petitioner and the Stamford Division of the Connecticut Power Co. by virtue of the interchange agreement, as hereinafter more fully described. From 1940 to 1945, inclusive, the only addition made by petitioner to its generating facilities was a 45,000-kw steam unit installed at Devon in 1942 which resulted in a ratio of steam and hydro facilities of 73 and 27 percent, respectively.

An electric utility company produces electricity as it is used. As a consequence the company must at all times maintain, "on the line," generating facilities of sufficient capacity to meet the demands of its customers at any given time, including periods of peak loads. In addition, the company is required at all times to maintain a so-called spinning reserve of generating capacity equivalent to the nameplate capacity of its largest single generating unit. Such spinning reserve must be instantaneously available in the event of emergencies, such as picking up any "outages" that might occur in the breakdown or stoppage of other units. Such reserve or standby capacity is an essential part of a utility company's plant capability to meet the demands of its customers and as such is not idle capacity.

Throughout the base period the petitioner's largest single generating unit had a nameplate capacity of 25,000 kw and petitioner therefore always maintained a spinning reserve of generating capacity equivalent to that amount. Such reserve was kept "hot on the line" thus carrying some of the load and was not standing idle. Petitioner used its various facilities in the manner which provided the most efficient operation under the circumstances obtaining at a given time, but always kept the equivalent of 25,000 kw in reserve.

The so-called "dependable" capacity of an electric generating unit is the maximum amount of energy in kilowatt-hours which the unit can produce under the most adverse conditions, and the dependable capacity of an entire electric generating system is the total amount of energy which the various units in the system can produce under the most adverse conditions and less the spinning reserve. During the base period petitioner used its hydroelectric facilities to the fullest possible extent, but the dependable capacity of those units was at times significantly below their nameplate capacity because of adverse waterflow conditions. The uncertainty of the waterflow in the streams used by petitioner and the great variation in flow during the year, and from year to year, limited the amount of hydro capacity petitioner could depend upon for carrying any substantial part of the steady long-hour load requirements. That load had to be carried primarily by steam-generating capacity which could deliver a definite amount of electric energy 24 hours a day every day in the year. The hydro capacity was available for carrying some part of the steady load and for carrying additional requirements for peak loads of short duration. In view of the uncertain elements involved, petitioner could not rely on hydropower to meet the growing demand of its customers, and in 1939 petitioner determined and announced that future additions to its generating facilities would consist entirely of steam units.

Electric utilities operate around the clock, but the rate of production varies as the load varies at different hours of the day to meet the demand which is normally at the highest peak in the late afternoon and early evening hours.

The maximum system peak load, in kilowatts, on petitioner's main system from 1935 to 1939, inclusive, and the time when such peak load occurred were as follows:

1935 115,555 kw on November 15	5 to 6 p.m.
1936 126,410 kw on December 22	5 to 6 p.m.
1937 129,815 kw on September 13	10 to 11 a.m.
1938 131,301 kw on December 21	5 to 6 p.m.
1939 148,612 kw on November 28	5 to 6 p.m.

On August 27, 1936, petitioner completed and placed into service a new additional 8,000-kw nameplate capacity hydrounit at its Stevenson hydroelectric generating plant at a cost of $ 282,068. Provision for this unit had been made when the Stevenson plant was first constructed. On August 25, 1937, at a cost of $ 172,661, petitioner completed and placed in service its new Scotland hydroelectric plant which had a 2,000-kw nameplate capacity. Such new plant replaced the old Scotland 1,200-kw hydrounit which had been destroyed in the 1936 flood. On August 23, 1937, petitioner completed and placed into service a new additional 25,000-kw nameplate capacity steam unit at its Montville steamplant at a cost of $ 1,892,577.

The total sum spent by petitioner for the construction of the 25,000-kw addition to the Montville plant was from funds acquired as a result of the issue of series "F" bonds as of September 1, 1936, as hereinafter described, and from temporary bank loans. Construction expenditures were made over a 3-year period in the following amounts:

1936	$ 448,843.58
1937	1,382,519.39
1938	61,214.10
	1,892,577.07

During the base period petitioner ceased operation of several of its small hydro generating facilities as follows: The 175-kw plant at Stafford on March 19, 1936; the 760-kw plant at Quidnick on May 28, 1938; the 390-kw plant at Leesville and also the 800-kw plant at Dyer Dam on September 21, 1938. On April 8, 1939, petitioner ceased operation of a 240-kw unit at its Mechanicsville plant but continued operating the remainder of that facility.

In addition to the above-mentioned increases made during the base period to generating facilities owned by it, petitioner also increased the mileage and the voltage of its transmission and distribution lines, and increased the capacity of its transmission and distribution substations. In 1938 petitioner completed and placed into service a new 66,000-volt, double circuit, steel tower transmission line from Norwalk to Stamford and also a similar 66,000-volt transmission line between Willimantic and Rockville, along with related substation equipment. Additional capacity was also provided in the Baldwin Street substation at Waterbury. In 1939 a new distribution center for petitioner's northeastern territory was provided through completion of the Tracy substation. Also in 1939 new high-tension lines were completed, resupplying certain communities which petitioner served. Increases in the voltage of transmission and distribution lines and enlargement of substations enabled petitioner to supply more electric current to customers without constructing new lines and new substations. New construction was taken into petitioner's depreciable assets when the new equipment and facilities were placed into operation.

Joint Exhibit 16-P, included herein by reference, is a schedule setting the amounts of expenditures made by petitioner from 1936 to 1945, inclusive, for additions and replacements to its electric distribution and transmission plants. The schedule also includes the amounts of the retirements from such plants during those years. The total cost of additions and replacements to petitioner's transmission and distribution plant during the base period was as follows:

Year	Distribution	Transmission	Total
	plant	plant
1936	$ 1,320,011.01	$ 11,652.89	$ 1,331,663.90
1937	1,787,305.30	62,232.21	1,849,537.51
1938	1,820,467.31	287,566.26	2,108,033.57
1939	1,540,510.67	113,497.32	1,654,007.99
Total			6,943,242.97

The petitioner's retirements during the base period amounted to a total of approximately $ 1,988,039.

The total cost of the 66,000-volt transmission line between Norwalk and Stamford, included in the total additions and replacements in the next preceding paragraph, was $ 473,810 including $ 40,000 for the cost of land. Of such total cost the amount of $ 409,501 was paid in 1937.

On December 16, 1936, the petitioner and the Connecticut Power Co. entered into an agreement (hereinafter referred to as the interchange agreement) which provided for an interchange of electric power through an interconnection between the main system of the petitioner and the Stamford Division of the Connecticut Power Co. Such agreement first became operative on March 17, 1938, when petitioner completed its above-mentioned 66,000-volt transmission line between its facilities at Norwalk and the Stamford generating facilities of the Connecticut Power Co. The interchange agreement provided as follows:

1. Such interconnection will make possible certain operating savings from the interchange of power and also investment savings through a reduction in the amount of generating capacity that would otherwise be required by the two companies.

2. The facilities necessary for such interconnection will be provided as follows:

a. The Connecticut Light and Power Company will construct, own, operate and maintain at its own expense a double circuit 66 kv line from its Norwalk Substation to the terminus of its existing line on the New Haven Railroad right of way near South Street in Stamford.

b. The Connecticut Power Company will construct, own, operate and maintain at its own expense a double circuit 66 kv connection, including transformers, tap changers, switches and other equipment, each suitable for not less than 15,000 kw of transfer capacity.

3. As soon as the interconnection is completed the operation of the Stamford power plant will be coordinated with the operation of The Connecticut Light and Power Company's main system so as to obtain maximum overall operating economy, the day to day coordination of operations to be by agreement between the operating forces of the two companies.

4. The net savings from such coordinated operation and interchange of power are to be calculated and divided equally between the two companies monthly. The Connecticut Light and Power Company is to act as the accounting agent for this purpose.

5. Investment savings resulting from the reduction in the combined generating capacity will be divided equitably by the following method:

When the maximum load for one hour of either Company exceeds such Company's total firm generating capacity less the capacity of its largest generating unit such Company will be considered as having established a deficiency. In such event it will make payment to the other Company at the rate of $ 1.10 per kw per month for the maximum deficiency established to date until such deficiency is cancelled by the installation of additional generating capacity.

6. The present total firm generating capacity of the Stamford power plant is 38,700 kw and its largest generating unit is 15,000 kw. The present total firm generating capacity of the main system of The Connecticut Light and Power Company is 185,000 kw (including the 25,000 kw unit now under construction at Montville) and its largest generating unit is 25,000 kw.

7. Additions to the generating capacity of the two companies will be made only when required by the combined loads of the interconnected systems, and such additions will be so made in principle as to maintain a reasonably equal relation between loads and installed generating capacities of the respective systems.

8. Emergency power supplied by either company to the other over the interconnection will be billed at the incremental rate of the supplying company as determined for regular interchange power.

9. Each company will designate a representative and these representatives will jointly handle all questions relating to this interchange of power between the two companies. In case of disagreement these representatives will select an arbitrator and if they cannot agree upon an arbitrator either company may call upon the Chairman of the Public Utilities Commission to select the arbitrator.

10. Such interchange of power is to be commenced as soon as the interconnection is completed ready for operation and is to be continued until January 1, 1947 and thereafter until the expiration of not less than twelve months written notice from one Company to the other, which notice may be given at any time after December 31, 1945.

11. The entire arrangement to be subject to the acquisition and retention of the necessary rights of way for the interconnection facilities.

The principal reasons which prompted the execution of the interchange agreement were the investment savings and the operating cost savings which would accrue to both companies as a result of operating the two previously independent systems as an integrated system over a period of years extending at least until January 1, 1947, and thereafter until expiration of the agreement after due notice.

Investment savings resulted from the interchange agreement because additional operating capacity was thereby made available for the integrated system, in that once the two systems were interconnected only one spinning reserve was required. The largest generating unit of the two systems, petitioner's 25,000-kw capacity unit, served as the spinning reserve capacity for the combined systems, and the necessity of maintaining the 15,000-kw reserve capacity of the Connecticut Power Co.'s Stamford Division was eliminated. The release of that reserve capacity provided an additional 15,000-kw capacity available for full use in carrying the daily load requirements of the combined systems without additional investment by either company for new generating facilities.

Operating cost savings resulted from the interchange agreement because it required the power dispatchers of both companies to coordinate their operations so as to obtain the maximum overall operating economy in meeting the total daily consumer demand on the interconnected system. Savings in fuel costs were obtained by first putting on the line the most efficient generating units, which consumed the least amount of fuel, regardless of which company's generating units were being used. As the demand on the integrated system increased the less efficient generating facilities of the combined systems were brought on the line.

Under the interchange agreement both companies were obligated for a period of years, during and after the base period, to operate as an integrated system with an interchange of power from one another as that power was generated in the most economical manner on all of the facilities of both companies, regardless of who owned such facilities. In the event either company used power in excess of its total firm generating capacity less its largest generating unit, it would pay the other company for such power at a fixed rate so long as its generating deficiency continued. Under the agreement additions to the generating capacity of the two companies were to be made only when required by the combined loads of the interconnected systems and so as to maintain a reasonably equal relation between loads and installed generating capacities of the respective systems.

In connection with the interchange agreement and during 1937 the Connecticut Power Co. undertook a major construction program at Stamford costing approximately $ 415,000 for certain new substation and transmission facilities. Included in that program was the building of a 66,000-volt substation immediately adjacent to the Stamford generating plant with a 66,000-volt transmission cable, completed early in 1938 at a cost of $ 282,400, and establishing an interconnection with the transmission system of the petitioner for the agreed interchange of power. In such undertaking it was determined that rather than invest in an additional steam-generating plant at Stamford it would be more economical to purchase from petitioner any increase in primary power needed at Stamford, and further that considerable fuel savings could be effected through the interchange of power with the petitioner.

As of September 15, 1939, the petitioner's general engineer made a report entitled "Estimated System Capacities and Demands with Low Water Conditions and Maximum Hour Demands" setting forth various data to be used only in connection with operating problems. That report set forth, inter alia, the total rated installed generating capacity, the total net capacity, the estimated maximum hour demand for the fall of 1939, and the surplus generating capacity, for the petitioner's main system, for the Connecticut Power Co.'s Stamford Division, and for the two combined systems, respectively, as follows:

	Petitioner's	Stamford	Combined
	main system	division	systems
	Kilowatts	Kilowatts	Kilowatts
Total rated installed
generating capacity	194,125	38,700	232,825
Less largest unit	25,000	15,000	25,000
Total net capacity	169,125	23,700	207,825
Estimated maximum hour demand	138,000	25,000	163,000
Surplus (deficiency) net
capacity	31,125	(1,300)	44,825

That report and the matter of experienced and anticipated loads of the combined systems were considered at a September conference of the two companies' representatives. They further noted that the Stamford Division load exceeded its net generating capacity by 1,300 kw and that it would, therefore, pay petitioner for such deficiency until canceled by the installation of additional generating capacity as provided in the interchange agreement.

During the fall of 1939 studies were made and conferences were held relative to the existing and immediate future loads and the generating capacity of the combined systems. At a conference in October 1939 the representatives of petitioner and the Connecticut Power Co. agreed that a reasonably certain combined peak load of between 165,000 kw and 170,000 kw would be reached during the fall and winter of 1939; that the estimated 1942 combined peak load would be between 190,000 kw and 195,000 kw and additional capacity should be available for such peak load; and that an additional unit of not less than 25,000-kw capacity should be installed at Stamford.

On November 27, 1939, the board of directors of the Connecticut Power Co. authorized the installation of a 40,000-kw steam-powered electric generator at Stamford, but after further consideration and on December 27, 1939, the board rescinded that action and in lieu thereof authorized the installation of a 25,000-kw steam-generating unit at Stamford at an estimated cost of $ 3,500,000. On December 26, 1939, the Connecticut Power Co. placed an order with the General Electric Co. for a turbine generator. Installation of the new 25,000-kw unit at Stamford was completed by October 1941 at a cost of $ 3,325,000 and, under the interchange agreement, that additional capacity became available to both petitioner and Connecticut Power Co., and such unit was used along with the other generating units of the two companies to carry the daily load requirements of the integrated system in the most efficient manner.

In its claims for relief (Form 991) for the years involved herein, the petitioner claimed constructive base period fuel cost savings resulting from (1) the new 25,000-kw capacity steam-generating unit which petitioner installed in 1937 at Montville; (2) the 15,000-kw capacity steam-generating unit at Stamford which was made available to the combined integrated system after March 17, 1938, under the interchange agreement; and (3) the new 25,000-kw capacity steam-generating unit which was ordered by the Connecticut Power Co. prior to December 31, 1939, and was completed and available to the combined integrated system in 1941 under the interchange agreement. Those units used less coal than petitioner's older less efficient facilities, and if such units had been in operation and available during the base period years they would have carried a substantial portion of petitioner's load resulting in substantial fuel cost savings.

The constructive base period fuel cost savings attributable to the Montville 25,000-kw unit and the Stamford 15,000-kw unit, as shown in column A, and also to the 25,000-kw unit made available in 1941, as shown in column B, are as follows:

	Fuel cost savings
Year
	Column A	Column B
1936	$ 213,399	$ 56,124
1937	189,021	52,446
1938	61,879	42,602
1939		66,879

In the reconstruction appearing in the statutory notice the respondent allowed adjustments for the claimed fuel cost savings in the amounts set forth in column A above and disallowed the claimed amounts set forth in column B above.

In the first year of the base period petitioner produced approximately 80.93 percent of its electric energy requirements and in the last year of the base period it was producing approximately 80.23 percent. Most of the balance of petitioner's electric energy requirements was purchased from other Connecticut utility companies, and the remaining purchases were from municipalities and manufacturing companies with generating facilities. Joint Exhibit 14-N, included herein by reference, shows the sources of petitioner's total supply of electric energy from generation, purchase, and interchange receipts, and also shows petitioner's disposition of electric energy for the years 1936 to 1945, inclusive. Such data for the base period years 1936-39 is as follows:

[In thousands of kilowatt-hours]
	Sources and disposition of electric energy
	1936	1937	1938	1939
All sources:
Generation	572,154	609,044	545,684	625,919
Purchases	105,059	139,142	126,068	128,696
29,807		11,039	31,361
Total	707,020	748,186	682,791	785,976
Disposition:
Sales	599,919	646,693	569,956	667,342
Interchange deliveries (gross)	6,916		12,762	5,868
Used by company	5,953	7,583	7,375	7,378
94,232	93,910	92,698	105,388
Total	707,020	748,186	682,791	785,976

Joint Exhibit 21-V attached to the stipulation, included herein by reference, shows the petitioner's annual sales of electric power in kilowatt-hours, the total revenue therefrom, and the total number of petitioner's meters, by classes of customers for each of the years 1935 to 1945, inclusive. Such data for the years 1935 to 1939, inclusive, are set forth in the following three schedules (added to the first schedule is the index of kilowatt-hour sales, 1939=100):

	Total kilowatt-hour sales (in thousands)
Class of customer
	1935	1936	1937	1938	1939
Domestic	95,695	110,695	127,742	140,203	154,267
Commercial	40,005	44,952	50,667	52,966	57,881
Industrial	247,523	292,647	316,283	237,034	304,584
Other utilities	101,340	108,335	118,632	110,976	121,012
Municipal street lighting	10,079	10,218	10,577	10,769	11,087
Railroad and street railway
corporations	35,601	33,073	22,792	18,008	18,511
Total	530,243	599,920	646,693	569,956	667,342
Index 1939 = 100	79.4	89.9	96.9	85.4	100

	Total revenue from kilowatt-hour sales
Class of customer
	1935	1936	1937
Domestic	$ 5,417,876	$ 5,694,824	$ 6,171,760
Commercial	2,380,789	2,498,818	2,528,670
Industrial	3,920,125	4,235,928	4,477,432
Other utilities	1,024,736	1,068,774	1,162,698
Municipal street lighting	593,529	607,361	618,059
Railroad and street railway
corporations	437,419	395,414	253,283
Total	13,774,474	14,501,119	15,211,902

	Total revenue from kilowatt-hour sales
Class of customer
	1938	1939
Domestic	$ 6,284,806	$ 6,314,711
Commercial	2,583,515	2,686,109
Industrial	3,762,189	4,437,726
Other utilities	1,149,562	1,246,011
Municipal street lighting	623,819	640,785
Railroad and street railway
corporations	195,046	194,839
Total	14,598,937	15,520,181

	Total number of petitioner's meters
Class of customer
	1935	1936	1937	1938	1939
Domestic	131,099	135,940	140,944	143,708	148,268
Commercial	17,172	17,425	17,765	17,877	18,152
Industrial	2,261	2,205	2,084	1,942	1,931
14	14	14	14	14
17,896	18,117	18,337	18,543	18,710
Railroad and street railway
3	3	2	1	1
Total	168,445	173,704	179,146	182,085	187,076

The "domestic" classification embraced the residential users of electric energy, that is, persons living in the urban and suburban areas and also in the rural areas, including farms. The "commercial" classification embraced retail stores, offices, and business establishments of various kinds. The "industrial" classification included various kinds of industrial plants using electricity for lighting, manufacturing, or production processes. The "other utilities" classification embraced other public utilities in the nature of wholesale customers supplied with energy for resale to their own customers. The "municipal street lighting" classification embraced the cities and municipalities in petitioner's franchise area. The "railroad and street railway corporations" classification embraced public transportation companies. The petitioner always had different rates for the electric service sold to each class of its customers. Also, petitioner's transmission and distribution costs varied as between classes of customers depending on the type of service and location of the customers.

The reduction in the number of petitioner's industrial meters during the base period was due primarily to a reclassification of various customers' meters and only a very few industrial concerns actually left the petitioner's franchise area. The Connecticut Public Utilities Commission required the reclassification of 175 meters at the University of Connecticut from industrial to domestic. About 100 customers, each of whom had two meters with one for lighting and another classified industrial, were persuaded by petitioner to use only one meter reclassified as commercial. In addition, various other customers were reclassified from industrial to commercial as required by governmental authority.

During the base period petitioner experienced a substantial increase in its total kilowatt-hour sales, with a varying amount of increase for each class of its customers except railroad and street railway corporations which decreased. The greatest increase occurred in domestic customer kilowatt-hour sales which increased 61.2 percent as compared to such sales for 1935. During the same period and in addition to an increase of 17,169 in the number of domestic customers, the average kilowatt-hour use per domestic customer served by petitioner increased as follows:

	Average kw-hr use
Year	per domestic customer
1935	736
1936	821
1937	913
1938	977
1939	1,047

The substantial increase in the kilowatt-hour sales to petitioner's domestic customers, the increase in the number of domestic customers, and the increase in the average kilowatt-hour use per domestic customer during the base period were due to three principal factors, namely, (1) the extension of distribution lines into previously unserved rural and farm areas, (2) substantially increased electric appliance sales, and (3) inducive rate reductions to encourage greater use of electric energy. The increased sales of electricity to domestic customers during the base period did not result, except to an insignificant degree, from the change by such customers from gas to electricity.

Joint Exhibit 17-Q, included herein by reference, shows various data with respect to petitioner's rural extensions of its distribution lines for the years 1928 to 1945, inclusive. The number of rural customers added to petitioner's distribution system at the time the extension lines were built, the number of miles of rural distribution lines constructed, and the total cost thereof to petitioner for each of the years 1935 to 1939, inclusive, were as follows:

	Number of	Miles of
Year	rural customers	lines constructed	Total cost
	added
1935	531	93.70	$ 189,152
1936	902	177.85	340,702
1937	1,163	235.34	452,799
1938	786	152.30	278,384
1939	873	168.45	310,448

During the base period petitioner constructed a total of 733.94 miles of rural distribution lines and added a total of 3,724 new rural customers, or approximately 5 new customers per mile at the time such lines were built. At the end of 1939 there remained an estimated 1,099 miles of rural extension lines to be constructed to serve an estimated 4,472 new rural customers. Prior to and during the base period the petitioner carried out a rural electrification program of extending its distribution lines into previously unserved territory which was away from concentrations of population.

The petitioner's franchise territory embraced a variety of farmers, such as poultry, dairy, tobacco, and various produce farmers, each of whom could benefit by the use of electrically operated labor-saving equipment. By 1936 petitioner's farm customers had begun to accept electricity as a stable and dependable source of energy because petitioner was able to supply more dependable rural electric service than in the earlier years of farm electrification. Throughout the base period years petitioner employed seven farm representatives who continually made an active survey of the farm population served by petitioner, including customers and potential customers. Those sales representatives interviewed farmers and demonstrated the extent to which labor-saving farm equipment and home appliances could be used, and generally encouraged a greater use of electric energy on the farm.

The petitioner's experience was that its average farm customer used a much greater amount of electric energy than its ordinary residential customer because of the farmer's use of electrically operated farm equipment (such as milkers, brooders, etc.) in addition to household appliances. The following schedule shows the average kilowatt-hour use by such customers during the indicated years:

	Average kw-hr
Year	use per customer
1935	1,404
1936	1,700
1937	1,837
1938	2,041
1939	2,208

In 1936 petitioner made a general survey of its domestic customers in order to determine the extent to which they were using electric appliances and to ascertain the potential market for the sale of new appliances. The survey showed that out of every 100 domestic customers only 40 had an electric refrigerator, only 5 had an electric range, and only 1 had an electric hot water heater. Installations of new appliances constituted load-builders for the petitioner's system. During the base period petitioner conducted appliance sales-promotion campaigns which were directed primarily to the individual customers because they were widely scattered, with about one-half living in numerous small cities and the other half living in suburban communities and rural areas. Petitioner could not effectively employ mass group advertising such as that used in large metropolitan areas.

At the beginning and during the base period petitioner regularly employed approximately 140 persons engaged in sales-promotion work, including supervisory personnel. In 1936 and 1937 petitioner temporarily employed an additional 50 specially trained young women who made surveys in practically every domestic customer's home to determine the extent to which customers were using adequate lighting equipment. During the base period petitioner conducted several aggressive appliance sales compaigns to increase the use of electricity through customers' purchases of electric refrigerators, ranges, and hot water heaters. Petitioner offered its customers special inducements such as very small downpayments with extended installments, and special wiring required for ranges and water heaters free of charge, which saved customers approximately $ 45 per installation. Also petitioner introduced a plan for the rental of water heaters with three-fourths of the rental payments being applied to the purchase price if the customer subsequently bought such appliance.

During the base period years the petitioner was a substantial seller of all types of electrical appliances. Its gross receipts from such sales amounted to $ 1,444,971 for 1936, $ 1,765,457 for 1937, $ 913,182 for 1938, and $ 996,739 for 1939. Petitioner maintained approximately 25 sales outlets and sold about twice as many electrical appliances as the dealers within its franchised territory. During each year of the base period petitioner sold the following number of units of the indicated electrical appliances:

	Number of units sold
Appliance
	1936	1937	1938	1939	Base period
					total
Ranges	1,851	1,876	1,348	1,344	6,419
Refrigerators	4,836	5,744	2,485	2,876	15,941
Water heaters	841	1,059	780	733	3,413
Irons	2,540	2,549	1,888	1,987	8,964
Vacuum cleaners	528	609	663	993	2,793
Clocks	772	965	946	1,047	3,730
Washing machines	1,153	1,146	689	995	3,983
47,989	51,543	47,325	45,900	192,757
Total -- all appliances					238,000

The following schedule shows the average annual kilowatt-hour consumption of electricity per unit by the indicated electric appliance, the total annual kilowatt-hour consumption for the total number of each type of appliance sold by petitioner during the base period years, and also the total normal annual kilowatt-hour consumption of the total number of other miscellaneous electrical appliances sold by the petitioner during the base period years:

	Number of	Annual	Total
Appliance	units sold	kw-hr	annual
	during base	consumption	kw-hr
	period	per unit	consumption
Ranges	6,419	1,200	7,702,800
Refrigerators	15,941	400	6,376,400
Water heaters	3,413	4,000	13,652,000
Irons	8,964	120	1,075,680
Vacuum cleaners	2,793	24	67,032
Clocks	3,730	24	89,520
Washing machines	3,983	48	191,184
Other appliances	192,757		29,154,616
			2,915,460
Total all appliances
sold by petitioner			32,070,076

In addition, the total number of electric appliances sold by dealers in petitioner's franchised territory during the base period (about half as many as petitioner sold) had an estimated total annual consumption of approximately 16 million kilowatt-hours.

In addition to its base period efforts to increase sales of electric energy to domestic customers, the petitioner also engaged in efforts to increase sales of electric power to its commercial and industrial customers. During the base period petitioner's electric sales-promotion personnel included 21 commercial and industrial sales representatives, usually college engineering graduates, who continually made surveys of petitioner's commercial and industrial customers to encourage the greater use of electric energy. The commercial sales representatives gave demonstrations and assisted commercial customers in planning improved interior lighting, window display lighting, air conditioning, etc., and worked with restaurants and hotels in planned use of electricity for cooking and water heating. The industrial sales representatives advised and encouraged more extensive use of electricity for various purposes in industrial establishments of petitioner's customers and they were instrumental in persuading a number of new industrial firms to locate in petitioner's franchised territory. At the beginning of the base period, private industrial firms in petitioner's territory owned steam-generating capacity in excess of 40,000 kilowatts. Petitioner's industrial sales representatives made studies showing the cost of self-generated power as compared with the cost of power purchased from petitioner. By the end of the base period industrial firms with generating capacity of 2,500 kilowatts had switched to using petitioner's power. Such changeovers resulted in an estimated total annual consumption of not less than 5 million kilowatt-hours. Petitioner's commercial and industrial sales-promotion activities resulted in increased-per-customer use of electric energy, except for a decrease in industrial use in 1938.

The following schedule shows the average annual kilowatt-hour use per commercial and industrial customer, respectively, served by petitioner during the years 1935 to 1939, inclusive:

	Average annual kw-hr
	use per --
Year
	Commercial	Industrial
	meter	meter
1935	2,338	109,475
1936	2,577	132,720
1937	2,861	151,767
1938	2,965	122,056
1939	3,202	157,734

As above mentioned, petitioner's electric sales-promotion activities embraced its domestic, commercial, and industrial customers. The petitioner's total promotion expense (including supervision, salaries and commissions, demonstration, advertising, and miscellaneous sales expense); wiring and appliance expenses; income from merchandising, jobbing, and contract work; and the amounts denominated as net promotion expense for new electric service business, for each of the base period years, were as follows:

	1936	1937
Total promotion expense	$ 522,757.11	$ 637,478.04
Wiring and appliance expense	45,962.41	49,672.56
	568,719.52	687,150.60
Less: Income from merchandise, jobbing, and
contract work	411,927.38	538,171.93
Net promotion expense	156,792.14	148,978.67

	1938	1939
Total promotion expense	$ 471,395.10	$ 467,450.54
Wiring and appliance expense	29,529.70	12,155.97
	500,924.80	479,606.51
Less: Income from merchandise, jobbing,
and contract work	211,872.33	245,303.29
Net promotion expense	289,052.47	234,303.22

During the base period petitioner made a number of "inducive" rate reductions for sales promotional purposes. They were entirely voluntary and in no way compelled by the Connecticut Public Utilities Commission. Also, they were in pursuance of petitioner's established policy to make such reductions from time to time as warranted by general business conditions and petitioner's finances. Other Connecticut electric companies made similar reductions. The inducive-rate reduction gave customers an immediate flat reduction in the cost of electricity per kilowatt-hour regardless of the number of kilowatt-hours consumed as distinguished from the so-called objective-rate reduction which resulted in a lower cost per kilowatt-hour only if the customer's consumption increased above a certain minimum amount of usage. Petitioner's inducive-rate reductions were made for the purpose of stimulating greater consumption of electric energy by its existing customers and encouraging the connection of new customers to its lines. At the time inducive-rate reductions were made, petitioner widely advertised the resulting savings to its customers and urged them to increase their consumption of electric energy.

In each of the years 1935 to 1939, inclusive, petitioner voluntarily reduced the rates on domestic, commercial, and industrial electric service. In one or two of those years petitioner made some reduction in the rates for service to other electric corporations and to municipal street lighting. The estimated annual savings to petitioner's customers, generally computed on the volume of consumption at the effective date of the reduction, by principal classes of customers, for the years 1935 to 1939, inclusive, were as follows:

	Estimated annual savings to customers
Year
				Other	Municipal
	Domestic	Commercial	Industrial	electric	street	Total
				corporations	lighting
1935	$ 94,649	$ 101,582	$ 130,217			$ 326,448
1936	249,666	286,467	64,522		$ 19,649	620,304
1937	64,679	24,400	64,986	$ 3,330		157,395
1938	624,554	2,941	34,740	1,944		664,179
1939	78,100	331,441	3,500			413,041

The following schedule shows the average rate in cents per kilowatt-hour and the average revenue per meter for petitioner's domestic and commercial customers, respectively, and also shows petitioner's revenue in cents per kilowatt-hour and average revenue per meter for its industrial customers, for each of the years 1935 to 1939, inclusive:

	Domestic		Commercial		Industrial
Year
	Average	Average	Average	Average	Revenue	Average
	rate per	revenue per	rate per	revenue per	per	revenue per
	kw-hr	meter	kw-hr	meter	kw-hr	meter
	Cents		Cents		Cents
1935	5.66	$ 41.67	5.95	$ 139.13	1.58	$ 1,733.80
1936	5.14	42.26	5.56	143.23	1.45	1,921.05
1937	4.83	44.11	4.99	142.78	1.41	2,148.48
1938	4.48	43.81	4.88	144.61	1.59	1,937.27
1939	4.09	42.86	4.64	148.59	1.46	2,298.15

Petitioner's base period experience was that while inducive-rate reductions gave its customers an immediate savings on their cost per kilowatt-hour of electricity used, the loss of revenue to petitioner from kilowatt-hour sales was only temporary. Such loss was recovered within a limited period of time as the result of the greater consumption of electricity, especially by petitioner's domestic class of customers. Once petitioner's previous total level of revenue was recovered, the continued increase in the use of electric energy resulted in an increased level of operating revenue from kilowatt-hour sales for each base period year except 1938.

During the base period years and for the electric department only petitioner's operating revenue and operating income increased in each base period year except 1938, and its operating income per kilowatt-hour decreased in each year as shown in Joint Exhibit 25-Y, as follows:

	1936	1937
Operating Revenue:
Sale of energy	$ 14,501,119.06	$ 15,211,902.31
Other	4,275.74	3,311.24
Total	14,505,394.80	15,215,213.55
Operating Expenses:
Production	2,950,792.29	3,141,926.94
Transmission	170,488.82	162,206.37
Distribution	1,443,184.95	1,439,370.81
Customers' Acctg. & Col	444,857.15	527,012.51
Sales promotion	156,792.14	148,978.67
Adm. & General	1,008,930.17	1,067,793.91
Total	6,175,045.52	6,487,289.21
Depreciation	2,044,176.62	2,144,151.51
Taxes exclusive Federal Income Taxes	1,071,865.25	1,135,456.30
Rent-leased property	393,883.18	390,863.22
Total	9,684,970.57	10,157,760.24
Utility operating income	4,820,424.23	5,057,453.31
Kw-hr. sold	599,919,650	646,693,398
Operating income per kw-hr. sold	.00804	.00782

	1939
Operating Revenue:
Sale of energy	$ 14,598,936.87	$ 15,520,181.07
Other	4,420.36	4,383.25
Total	14,603,357.23	15,524,564.32
Operating Expenses:
Production	2,724,455.27	3,124,990.57
Transmission	165,948.15	150,430.11
Distribution	1,762,953.17	1,419,455.29
Customers' Acctg. & Col	503,749.70	507,437.55
Sales promotion	289,052.47	234,303.22
Adm. & General	1,140,985.15	1,155,847.61
Total	6,587,143.91	6,592,464.35
Depreciation	1,980,409.47	2,151,632.66
Taxes exclusive Federal Income Taxes	1,218,184.14	1,270,413.57
Rent-leased property	389,558.35	390,868.23
Total	10,175,295.87	10,405,378.81
Utility operating income	4,428,061.36	5,119,185.51
Kw-hr. sold	569,956,236	667,341,535
Operating income per kw-hr. sold	.00777	.00767

During the base period years the petitioner was the largest electric utility in Connecticut in the number of customers and the franchised territory served. Its total number of meters, total annual kilowatt-hour sales in one-thousandths, and average annual kilowatt-hours per meter with respect to its domestic, commercial, and industrial classes of customers for each of the base period years may be compared with similar data for all Connecticut electric utilities other than the petitioner (including about nine principal private companies and also municipalities), as follows:

	Number of meters		Kw-hr. sold (1,000's)
Year
	Petitioner	All others	Petitioner	All others
DOMESTIC CUSTOMERS
1936	135,940	271,861	110,695	202,124
1937	140,944	277,905	127,742	226,679
1938	143,708	280,178	140,203	243,981
1939	148,268	286,183	154,267	265,690
COMMERCIAL CUSTOMERS
1936	17,425	39,975	44,952	152,484
1937	17,765	40,752	50,667	171,736
1938	17,877	40,770	52,966	181,356
1939	18,152	41,357	57,881	198,814
INDUSTRIAL CUSTOMERS
1936	2,205	6,888	292,647	399,710
1937	2,084	6,588	316,283	432,677
1938	1,942	6,487	237,034	345,578
1939	1,931	6,295	304,584	438,157

	Year		Petitioner	All others
DOMESTIC CUSTOMERS
1936	821	744
1937	913	816
1938	977	871
1939	1,047	928
COMMERCIAL CUSTOMERS
1936	2,577	3,815
1937	2,861	4,214
1938	2,965	4,448
1939	3,202	4,807
INDUSTRIAL CUSTOMERS
1936	132,720	58,030
1937	151,767	65,677
1938	122,056	53,272
1939	157,734	69,604

In its Federal income tax returns for the years 1936 to 1939, inclusive, the petitioner deducted the following amounts for depreciation:

Year	Amount
1936	$ 2,372,128.21
1937	2,452,952.09
1938	2,510,420.44
1939	2,549,999.51

The depreciable bases and the composite rates of depreciation used by petitioner in computing the above deductions were a continuation of the depreciable bases and the composite rates of depreciation which the respondent had determined for years prior to 1936. The composite depreciation rates which respondent had previously determined were 3.34 percent for the bulk of petitioner's depreciable assets and 4.255 percent for certain 1926 acquisitions. The annual depreciation charge of $ 114,616.25 for the 1926 acquisitions was only about 5 percent of the total depreciation deduction for each of the base period years.

The above-mentioned composite depreciation rates, which were determined by respondent in or about 1930 with respect to the years 1926 and 1927, were allowed the petitioner for the years subsequent to 1927 and up through 1939, except for certain 1935 acquisitions as hereinafter set out.

In 1935 petitioner acquired by merger additional depreciable assets from the Rockville-Willimantic Lighting Co., the Monroe Electric Light and Gas Co., and the Northern Connecticut Power Co. Composite rates of depreciation of 3.15 percent, 3.5 percent, and 2.57 percent, respectively, had been previously determined by the respondent and used in the computation of the depreciation deductions for each of these companies. In its Federal income tax return for 1935 petitioner added the depreciable bases of these additional assets to its prior depreciable base, and the depreciation deduction was computed by using petitioner's previously determined composite rate of 3.34 percent.

In a report dated October 15, 1937, covering the year 1935, a revenue agent recommended that the petitioner be required to depreciate the assets acquired by merger by using the composite rates of depreciation which had been previously determined and used by the aforementioned three companies. The revenue agent's proposed adjustments with respect to depreciation related both to depreciable base and to depreciation rates, and he proposed disallowance of charges for excessive depreciation in the amount of $ 163,488.23 for the year 1935.

Under dates of February 12 and March 20, 1940, another revenue agent prepared reports on petitioner's income tax liability for the years 1936, 1937, and 1938. The revenue agent's reports for these 3 years recommended that the same depreciation adjustment as had been proposed for the year 1935, which was still open, be made in respect to the depreciable assets which had been acquired by petitioner by merger in 1935. The agent's reports proposed disallowance of excessive depreciation in the amounts of $ 44,246.70, $ 44,589.83, and $ 25,449.42 for the years 1936, 1937, and 1938, respectively.

Under dates of November 29, 1937, March 4, 1939, February 26, 1940, and May 16, 1940, petitioner filed protests against the depreciation adjustments and other adjustments proposed in the agent's reports covering the years 1935 to 1938, inclusive. In each of these protests petitioner contended in respect to the depreciable assets acquired by merger, that its own composite rate of depreciation, which was 3.34 percent, should be used in the determination of the depreciation deductions instead of the rates of 3.5 percent, 3.15 percent, and 2.57 percent which had been previously determined and used by the three merged companies prior to their merger with petitioner. Several conferences were held with regard to petitioner's protests but respondent did not take any conclusive action as to the years 1936-38 until 1942.

In January 1942, Internal Revenue issued Bulletin "F" (revised January 1942) which superseded the preceding Bulletin "F" issued in 1931 and "Depreciation Studies" published in 1931. The 1942 edition of Bulletin "F" sets forth estimated useful lives and rates of depreciation based on averages, and states they are not prescribed for use in any particular case but are for use solely as a guide in the determination of correct rates in the light of the experience of the particular property under consideration and all other pertinent evidence. During 1942 and thereafter Internal Revenue engaged in making reexaminations of previously determined depreciation rates of all utility companies as rapidly as its manpower would permit.

On June 19, 1942, a conference was held in New Haven, Conn., with respect to the above-mentioned protests filed by petitioner and issues relating to depreciation and other adjustments for the years 1935 to 1939, inclusive. Engineer Revenue Agent Karl Schmitt, of the New York district office and a specialist in the field of electric utility depreciation problems, was requested to attend the conference primarily for advice in respect to an abandonment loss deduction of about $ 130,000 claimed by petitioner for 1938. During the conference Schmitt pointed out that, based on his experience, he thought the petitioner's depreciation deductions for the years 1935 to 1939, inclusive, were higher than those which would be produced by the rates indicated in the 1942 edition of Bulletin "F," but that a redetermination of petitioner's composite rates could not be made without a field examination of petitioner's properties and records. Such an examination could not be made for at least a year because Schmitt was investigating the depreciation rates of numerous other utility companies. The representatives for both the respondent and the petitioner desired to close the years 1935 to 1939, inclusive, and they reached an agreement in settlement of the several questions involved in those years.

Under date of July 7, 1942, Engineer Revenue Agent Schmitt submitted a report covering the petitioner's taxable years 1935 to 1939, inclusive, which was approved by Engineer Reviewer E. R. Ford. With respect to the question of depreciation that report stated, as follows:

It is recommended that the previously established rate of 3.34 percent for this taxpayer be continued and applied in these years to the appropriate depreciable properties, including those acquired in merger October 31, 1935 from Rockville, Willimantic Lighting Company and Monroe Electric Lighting Company. However, for the depreciable property acquired in 1935 from ConnecticutElectric Service Company formerly belonging to Northern Connecticut Power Company, a rate of 2.75 percent is applicable to the gross cost in the hands of Northern Connecticut Power Company.

In the same report it was stated that the matter of depreciation for 1935 to 1939, inclusive, was discussed and agreed to in conference with the taxpayer in New Haven on June 19, 1942, and, further, that:

It is also understood that for the year 1940 a thorough study of the whole question of depreciation is to be made and proper rates and separate reserve established for the gas, electric and water departments.

On September 17, 1942, the respondent sent to petitioner a notice of additional tax liability for the years 1935 to 1938, inclusive. On January 5, 1943, the respondent sent the petitioner a similar notice accompanied by a revenue agent's report covering the year 1939. The foregoing notices for the years 1935 to 1939, inclusive, adopted the depreciation adjustments for each year which had been recommended by Schmitt in his report dated July 7, 1942. The amounts of depreciation deductions allowed in determining such additional tax liabilities and the reductions in the above-mentioned amounts of depreciation claimed on the returns were as follows:

Year	Depreciation	Reduction in
	allowed	amount claimed
1936	$ 2,339,945.77	$ 32,182.44
1937	2,421,402.04	31,550.05
1938	2,498,939.40	11,481.04
1939	2,537,631.86	12,367.65

The respondent's notices of September 17, 1942, and January 5, 1943, referred to the acceptance by petitioner of the total additional liabilities determined therein for the years 1935 to 1939, inclusive, of $ 43,118.56 resulting from various adjustments made for depreciation and other items in question.

Thereafter waivers held by the respondent extending the statutory period for assessing and collecting additional taxes for the years 1935 to 1938, inclusive, were permitted to expire on June 30, 1943, and the statutory period for 1939 expired automatically on March 15, 1943.

In the summer of 1943 Karl Schmitt made a field examination of the petitioner's properties and records and made a valuation report covering depreciation and other items for the years 1940 and 1941, which was submitted on September 16, 1943, and approved by E. R. Ford, engineer reviewer. With respect to depreciation and "as a result of agreement" that report recommended adjustments to petitioner's depreciable base and the allowance of depreciation at a composite rate of 3.15 percent, and further the disallowance of excessive depreciation taken on the returns for each of the years 1940 and 1941. The report stated, in part, as follows:

From a review and study made of such data as was available, which was far from complete, the previously established composite rate of 3.34 percent appeared higher than would ordinarily be found applicable to facilities such as are used in the taxpayer's business. An inspection was also made of the major units of the plant in September 1943. * * *

* * * *

The data for the establishment of proper departmental rates and reserves not being available, it was decided to continue with the use of a composite rate. The total tax reserve as of December 31, 1939 does not appear to be out of line, being about 32 percent of the total depreciable assets.

The question of an allowable rate was gone into at great length and was the subject of discussion in several conferences. It was brought out that deferred maintenance due to war conditions is quite substantial. An estimate from a reliable analysis and study made by the research engineer showing an amount of about $ 850,000 for the years 1942 and 1943 was produced. In view of all the circumstances, giving due regard to incomplete data, undermaintenance and other factors, pertinent to this taxpayer, it was agreed that a reasonable allowance for depreciation at this time would be produced by the use of a rate of 3.15 percent. * * *

The composite character of the petitioner's various depreciable facilities was essentially the same during the base period 1936-39 and the subsequent period 1940-45, except for the above-mentioned increases in the ratio of steam to hydro facilities made during each of those periods, respectively. In the petitioner's industry the composite depreciation rate for steam generating plants is generally higher than for hydroelectric generating plants.

The respondent used the composite depreciation rate of 3.15 percent in the determination of petitioner's excess profits net income for the years 1940 to 1945, inclusive, but in the determination of petitioner's excess profits net income for the base period years, which is used to compute the excess profits credit for the purpose of determining petitioner's excess profits tax liability for the years 1940 to 1945, inclusive, the respondent used the higher composite rates of depreciation set forth in Schmitt's report dated July 7, 1942.

The application of the composite depreciation rate of 3.15 percent to petitioner's depreciable base during the base period years decreases petitioner's depreciation deductions and increases petitioner's excess profits net income in the following amounts:

Year	Amount
1936	$ 144,698.06
1937	149,331.81
1938	153,742.62
1939	155,943.69
Total	603,716.18
Average increase	150,929.05

The capital stock of petitioner outstanding in the hands of the public as of December 31, 1935 through 1939, was as follows:

Capital stock	Dec. 31, 1935	Dec. 31, 1936-1939
Preferred $ 100 par value:
68,044 shares 5 1/2 percent	$ 6,804,400	$ 6,804,400
65,000 shares 6 1/2 percent	6,500,000
Common no par value:
1,147,860 shares, 1935
1,148,126 shares, 1936-39
Stated value	46,206,600	46,217,240
Total	59,511,000	53,021,640

In July 1935 petitioner issued its First and Refunding Mortgage 3 3/4 percent series E bonds, due July 1, 1965, in the amount of $ 10 million. Amortization of debt discount and expense with respect to these series E bonds amounted annually to $ 4,860.24 for tax purposes. The funds derived therefrom were used to call and redeem the series B 5 1/2 percent bonds of petitioner and the 5 percent bonds of the Eastern Connecticut Power Co., and for improvements to property.

During the base period years 1936-39 petitioner refinanced a sizable amount of its long-term debt which resulted in reductions in costs and expenses for interest and amortization of debt discount and expenses. Such reductions were made possible by the retirement of old bonds, issued in some instances at a discount, with the proceeds from the sale of new bonds sold at a premium and bearing a lower interest rate than the old bonds which were retired. In addition to such refinancing, petitioner retired other bonds and debentures through the operation of sinking funds.

The petitioner's long-term indebtedness on January 1, 1936, and on December 31, 1936, 1937, 1938, and 1939, was as follows:

Outstanding long-term	Jan. 1, 1936	Dec. 31, 1936	Dec. 31, 1937
indebtedness
Bonds issued by petitioner:
Series A, 7 percent, due
May 1, 1951	$ 5,080,500	$ 4,928,000	$ 4,771,000
Series C, 4 1/2 percent, due
July 1, 1956	8,618,500
Series D, 5 percent, due
July 1, 1962	7,358,500
Series E, 3 3/4 percent, due
July 1, 1965	10,000,000	10,000,000	9,907,000
Series F, 3 1/2 percent, due
Sept. 1, 1966		7,000,000	7,000,000
20-year debentures, 3 1/2 percent
due Sept. 1, 1956		7,500,000	7,429,000
Series G, 3 1/4 percent, due
Dec. 1, 1966		16,000,000	16,000,000
Series H, 3 1/4 percent, due
Dec. 1, 1968
Bonds assumed by mergers:
Central Connecticut Power
and Light Co., 5 percent,
due Apr. 1, 1937	306,000	298,000
The Bristol and Plainville
Tramway Co., 4 1/2 percent,
due Nov. 1, 1945	540,000
The Northern Connecticut
Power Co., 5 1/2 percent,
due Mar. 1, 1946	2,100,000
The Northern Connecticut
Light and Power Co., 5
percent, due Dec. 1, 1946	196,000	195,000	190,500
The Windsor Locks Water
Co., 5 percent, due June 1,
1951	45,000
The Waterbury Gas Light
Co., 4 1/2 percent, due Nov.
1, 1958	995,000
The Rockville Gas and Electric
Co., 5 percent, due
May 1, 1936	300,000
The Rockville-Willimantic
Lighting Co., series D and
E, 5 percent, due Dec. 1,
1971	375,000
Total	35,914,500	45,921,000	45,297,500

Outstanding long-term	Dec. 31, 1938	Dec. 31, 1939
indebtedness
Bonds issued by petitioner:
Series A, 7 percent, due
May 1, 1951	$ 4,571,000	$ 4,371,000
Series C, 4 1/2 percent, due
July 1, 1956
Series D, 5 percent, due
July 1, 1962
Series E, 3 3/4 percent, due
July 1, 1965
Series F, 3 1/2 percent, due
Sept. 1, 1966	7,000,000	7,000,000
20-year debentures, 3 1/2 percent
due Sept. 1, 1956	7,356,000	7,280,000
Series G, 3 1/4 percent, due
Dec. 1, 1966	16,000,000	16,000,000
Series H, 3 1/4 percent, due
Dec. 1, 1968	15,000,000	15,000,000
Bonds assumed by mergers:
Central Connecticut Power
and Light Co., 5 percent,
due Apr. 1, 1937
The Bristol and Plainville
Tramway Co., 4 1/2 percent,
due Nov. 1, 1945
The Northern Connecticut
Power Co., 5 1/2 percent,
due Mar. 1, 1946
The Northern Connecticut
Light and Power Co., 5
percent, due Dec. 1, 1946	189,000	188,500
The Windsor Locks Water
Co., 5 percent, due June 1,
1951
The Waterbury Gas Light
Co., 4 1/2 percent, due Nov.
1, 1958
The Rockville Gas and Electric
Co., 5 percent, due
May 1, 1936
The Rockville-Willimantic
Lighting Co., series D and
E, 5 percent, due Dec. 1,
1971
Total	50,116,000	49,839,500

The numerous outstanding short-term bank loans owed by petitioner for the years 1936, 1937, and 1938 are set forth in detail in joint Exhibit 54-BBB included herein by reference. Petitioner had no such loans during the years 1935 and 1939. For the year 1936 petitioner's loans at various times from June to September totaled $ 3,500,000, all at 1 1/4 percent interest, and such total amount was paid during October 1936. For the year 1937 petitioner's loans at various times from April to December totaled $ 2,660,000, all at 1 1/2 percent interest, and such total amount was paid as follows: $ 30,000 in October 1937; $ 50,000 in June 1938; and the balance in December 1938. For the year 1938 petitioner's loans at various times from June to September totaled $ 540,000, all at 1 1/2 percent, and such total amount was paid during December 1938.

In October 1936 petitioner issued and sold the following bonds:

$ 7,000,000	First and Refunding Mortgage 3 1/2%, Series F, due September
1, 1966.
$ 7,500,000	Twenty-year 3 1/2% Debentures, due September 1, 1956.

Series F bonds of $ 7 million were sold to the public at 105 percent and, after underwriting commissions, net to the petitioner at 103 percent. Petitioner's expenses in connection with the issue were $ 87,410, leaving a net of $ 7,122,590 for petitioner. The debentures of $ 7,500,000 were sold to the public at 102 percent and, after underwriting commissions, net to the petitioner at 100 percent. Petitioner's expenses in connection with the issue were $ 85,296, leaving a net of $ 7,414,704 for petitioner.

The total net proceeds of $ 14,537,294 received from the sale of the series F 3 1/2 percent bonds and the 3 1/2 percent debentures was used by petitioner as follows:

(a) To repay existing bank loans	$ 3,000,000
This amount had been used in part to redeem the following
bonds on the dates indicated:
May 1, 1936 -- $ 300,000 to pay the First Mortgage 5%
bonds of The Rockville Gas and Electric Co., due
May 1, 1936.
September 1, 1936 -- $ 2,194,500 for the redemption price
of $ 2,100,000 First and Refunding Mortgage
5 1/2% Gold Bonds of The Northern Connecticut Power Co.,
due March 1, 1946.
(b) To pay the redemption price of the following bonds redeemed
on the dates indicated:
November 1, 1936 -- $ 995,000 of The Waterbury Gas Light
Co., First Mortage 4 1/2% Gold Bonds, due November 1,
1958	1,044,750
November 1, 1936 -- $ 540,000 The Bristol and Plainville
Tramway Co. First Mortgage 4 1/2% Gold Bonds, due
November 1, 1945	540,000
December 1, 1936 -- $ 40,000 Windsor Locks Water Co. First
Mortgage 5% Gold Bonds, due June 1, 1941	42,000
December 1, 1936 -- $ 375,000 The Rockville-Willimantic
Lighting Co. First Refunding Mortgage 5% Gold Bonds
Series "D" and "E", due 12-1-1971	$ 393,750
(c) To pay for the redemption price of the outstanding $ 6,500,000
par value of petitioner's 6 1/2% Cumulative Preferred Stock,
redeemed on December 1, 1936	7,475,000
(d) To pay for additions, betterments, and improvements of the
property during 1936	2,041,794
Total	14,537,294

In December 1936 the petitioner issued and sold its series G bonds in the principal amount of $ 16 million bearing interest at the rate of 3 1/4 percent per annum, due December 1, 1966. These bonds were sold to the public at 104 percent of their principal amount and, after underwriting commissions, net to the petitioner at 102 percent. The petitioner received from the sale of said bonds, net of expenses of $ 91,634, the amount of $ 16,228,366. The net proceeds from the sale of series G bonds were used by the petitioner on January 1, 1937, (a) To pay for the redemption of petitioner's seriesC, 4 1/2-percent Sinking Fund Gold Bonds,     principal amount $ 8,530,500 at 105 percent and     accrued interest     $ 8,957,025Less cash in sinking fund         92,675$ 8,864,350(b) To pay for the redemption of petitioner's seriesD, 5 percent Sinking Fund Gold Bonds, principal     amount $ 7,287,000, at 105 percent and accrued     interest     7,651,350Less cash in sinking fund         75,0007,576,350Total               16,440,700

The balance required for the redemption of series C and D bonds above was obtained from the current cash of petitioner.

During 1937 petitioner reduced its bonded indebtedness in the amount of $ 623,500. This amount is accounted for by the payment at maturity, on April 1, 1937, of the Central Connecticut Power and Light Co. underlying bonds amounting to $ 298,000, and the retirement of other bonds and debentures through the operations of sinking funds.

In December 1938 the petitioner sold at private sale $ 15 million of First and Refunding 3 1/4-percent Series "H" Bonds for 104.9137 percent of their principal amount. The petitioner received from the issuance of said bonds, net of expenses of $ 87,038, the amount of $ 15,650,017. Part of the proceeds from the sale of the series H bonds was used to pay for redemption of $ 9,720,000 First and Refunding Mortgage Series "E" Bonds bearing an interest rate of 3 3/4 percent per annum. The old bonds were redeemed at 105 percent of the principal amount of $ 10,206,000.

After redemption of the series E bonds, there remained $ 5,444,017 of the proceeds from the series H bonds. Of such sum $ 3,120,000 was used in 1938 to repay bank loans. The remaining $ 2,324,017 was carried in the petitioner's cash balance on hand at December 31, 1938 and 1939, available for capital requirements or operational purposes, and resulted in those cash balances being in excess of the approximately $ 1 million cash balance normally maintained by petitioner.

During 1939 petitioner reduced its bonded indebtedness by $ 276,500 through the operations of the sinking funds.

In the determination of petitioner's base period net income the respondent allowed deductions for interest and amortization of bond discount and expenses on the bonds and bank loans outstanding during the years 1936 to 1939, inclusive, as follows:

Deductions allowed	1936	1937
Interest on bonds	$ 1,773,504.34	$ 1,754,058.60
Amortization of bond discount and expenses	72,756.81	18,553.28
Stamp taxes paid	30,500.00
Interest on bank loans	8,969.00	16,860.00
Total deductions	1,885,730.15	1,789,471.88

Deductions allowed	1938	1939
Interest on bonds	$ 1,737,416.36	$ 1,836,034.79
Amortization of bond discount and expenses	(13,037.01)
Stamp taxes paid	15,000.00
Interest on bank loans	42,766.00
Total deductions	1,808,302.22	1,822,997.78

In addition to the deductions in the next preceding paragraph, the amounts of bond premium and unamortized bond discount and expenses incurred by petitioner in connection with the bond redemptions made in the years 1936 through 1939 were also allowed in the determination of petitioner's income tax liability for the years 1936 to 1939, inclusive, as follows:

	Amounts allowed in determining
Year	income tax liability
1936	$ 272,978.93
1937	1,811,090.74
1938	32,807.19
1939	644,822.62

However, in the determination of petitioner's base period net income for the above years, these amounts were added to such net income under section 711 for the purpose of determining petitioner's excess profits tax credit under the income method.

Joint Exhibit 46-TT, included herein by reference, is a schedule entitled "Summary of Average Borrowed Capital and Interest Paid in Base Period," which sets forth in detail with respect to each bond issue outstanding during the years 1936 to 1939, inclusive, the average outstanding, the interest rate, the interest paid, and also the total amounts thereof. Such totals for the indicated years are as follows:

Year	Average	Interest	Interest
	outstanding	rate	paid
1936	$ 37,786,936	4.6934	$ 1,773,504
1937	45,535,448	3.8521	1,754,058
1938	45,280,772	3.8370	1,737,416
1939	50,055,495	3.6680	1,836,035

The petitioner's above-mentioned refinancing of a sizable amount of its long-term debt, by retirements of certain higher interest rate bond issues with the proceeds of lower interest rate series F, G, and H bond issues, resulted in reductions in interest and debt expense as to the portions of its long-term debt so refinanced. The higher interest and debt expense on the old bonds were reflected in petitioner's level of earnings up to the dates of their respective retirements. The reductions and/or savings in interest and debt expense were only partially reflected in petitioner's level of earnings during the years 1936, 1937, and 1938, but were fully reflected therein for the last base period year 1939 and subsequent years.

As of March 1, 1938, petitioner entered into group annuity contract No. GA-0177 with the Aetna Life Insurance Co. to provide annuities for petitioner's employees subscribing to the plan, payable when such employees reached age 65. The total premium for the retirement annuity of each employee was to be determined from a table in the contract on the basis of age and salary. Under the plan the employees contributed a percentage of their earnings and the petitioner contributed approximately 170 percent of the amount contributed by the employees. During the 10 months of 1938 in which the plan was effective, the employees contributed $ 75,528.42 and the petitioner contributed $ 124,898.40. During the year 1939 the petitioner contributed $ 135,955.20. Prior and subsequent to the above contract, petitioner had certain welfare and pension expenses other than the annuity plan. The total amounts of welfare and pension expenses incurred by petitioner, including amounts charged to expense and amounts capitalized on the books but deducted for tax purposes, for the years 1936-39, were as follows:

	Total welfare and pension expenses
	1936	1937	1938	1939
Total charged to expense
on books	$ 52,899.57	$ 59,848.32	$ 211,323.57	$ 209,004.96
Add: Additional pension
expense capitalized on
books but deducted for
tax purposes			10,917.76	12,788.31
Total	52,899.57	59,848.32	222,241.33	221,793.27

Included herein by reference are Exhibit 75, showing an allocation of total welfare and pension expenses between petitioner's electric and other departments, and Exhibit TTT, showing petitioner's operating payroll exclusive of payroll charged to construction and non-operating accounts, both for the years 1936 to 1939, inclusive. Construction of certain facilities was handled by petitioner's own employees. As between the beginning and end of the base period petitioner's deductions for welfare and pension expenses had reached a relatively permanent higher amount, and the latter was fully reflected in petitioner's level of earnings for the last base period year 1939.

In each of the years from 1922 through 1939 the petitioner made dividend distributions, for tax purposes, not out of earnings, as shown by Exhibit NNN, included herein by reference. After the payment of dividends petitioner had a surplus at December 31 of each of the years 1935 to 1939, inclusive, as shown by the condensed balance sheets in joint Exhibits 28-BB to 32-FF, included herein by reference. The petitioner's dividend distributions made in excess of earnings for tax purposes in each of the years 1935 to 1939, inclusive, and also its surplus at the end of those years were as follows:

	Distributions
Year	in excess of	Surplus at
	earnings for	December 31
	tax purposes
1935	$ 2,050,155.19	$ 3,767,796
1936	1,553,961.14	2,991,326
1937	1,918,265.58	3,280,487
1938	1,635,845.70	3,119,910
1939	190,291.19	3,353,748

The petitioner's excess profits taxes for the years involved herein, computed without the benefit of section 722, are excessive and discriminatory in that its average base period net income is an inadequate standard of normal earnings because as provided in section 722(b)(1) normal production and operation of the business was interrupted by reason of a hurricane during the base period, and further, as provided in section 722(b)(4), the petitioner during the base period changed the character of the business by a difference in the capacity for production or operation and the average base period net income does not reflect the normal operation for the entire base period of the business. The business of the petitioner did not reach, by the end of the base period, the earning level which it would have reached if petitioner had made the change in the character of the business 2 years before it did so. A fair and just amount representing normal earnings to be used as a constructive average base period net income is the amount of $ 4,300,000 for the purpose of computing an excess profits credit based on the income method for the years involved herein.

Standard Issues

Among the numerous exhibits attached to the stipulation and supplemental stipulations, included herein by reference, are the petitioner's income and excess profits tax returns for the years involved, and also Exhibit BBBB -- certificates of assessments and payments covering the years 1941 through 1945; Exhibit CCCC -- certificates of overassessment covering the years 1941 and 1942; Exhibit DDDD -- worksheets with reference to Exhibit CCCC showing the underlying computations; Exhibit EEEE -- waivers of restrictions on assessment and collection of deficiency in tax and acceptance of overassessment (Form 870) for the years 1941 and 1942 and petitioner's letters of transmittal; Exhibit FFFF -- notices of allowance of tentative amortization adjustment for the years 1942, 1943, and 1944; and Exhibits VVV through AAAA -- revenue agents reports and supplemental reports variously covering the years 1940 to 1942 and 1943 to 1945, respectively. It is stipulated that such revenue agents' reports shall be accepted as proof of data therein taken from petitioner's books and records, and as proof of adjustments made to petitioner's tax returns in arriving at tax liability as set forth in the statutory notice.

The petitioner and respondent executed a series of agreements (Form 872) whereby the period of limitations for assessment and collection of additional taxes was extended to June 30, 1953, for each of the years 1941 and 1942, and extended to June 30, 1950, for each of the years 1943, 1944, and 1945. There were no further agreements executed by the parties extending the statutory period of limitation.

The respondent's statutory notice of partial disallowance, mailed on March 18, 1953, refers to petitioner's applications for section 722 relief and claims for refund; to the constructive average base period net income of $ 3,913,000 determined by the Excess Profits Tax Council on or about January 21, 1952, as applicable to the year 1940 for carryover purposes and to the taxable years 1941 to 1945, inclusive; to the supplemental revenue agent's report dated June 5, 1952, covering the years 1940, 1941, and 1942 (Exhibit XXX herein); and to the supplemental revenue agent's report dated July 18, 1952, covering the years 1943, 1944, and 1945 (Exhibit AAAA herein). Those reports refer to data and schedules contained in earlier revenue agents' reports.

The petitioner had a deficit in its earnings and profits for tax purposes for each of the years 1939 to 1945, inclusive.

The amounts of the petitioner's quarterly dividends on common stock paid on the 1st of January, April, July, and October and the amounts of its quarterly dividends on prefered stock paid on the 1st of March, June, September, and December of each of the years 1940 to 1945, inclusive, are set forth in the revenue agents' reports, included herein by reference and particularly in Exhibits VVV and YYY herein. The latter exhibit embraces schedules of respondent's computations showing the petitioner's net income and the various adjustments thereto, including deductions for income tax for 1940 and income and excess profits taxes for 1941 to 1945, inclusive, in arriving at petitioner's earnings and profits for tax purposes available for distribution. As therein computed, the petitioner made dividend distributions not out of earnings and profits for tax purposes during each of the years 1940 to 1945, inclusive.

With respect to the year 1940 the supplemental revenue agent's report dated June 5, 1952 (Exhibit XXX herein), referred to in the statutory notice, embraces the computation which shows that petitioner had no excess profits tax liability for 1940, under the invested capital method, and no excess profits tax previously assessed for that year. The report further shows the computation of the excess profits credit for 1940 for carryover purposes only. In the computation under the invested capital method, the excess profits net income was adjusted by adding thereto the income tax of $ 995,100.92 for 1940, resulting in no unused excess profits credit for 1940. In the computation under the income method, a similar adjustment for 1940 income tax was not made to petitioner's excess profits net income as set forth in the amount of $ 3,460,328.64, and respondent's allowance of an excess profits credit of $ 3,717,350 (or 95 percent of the CABPNI of $ 3,913,000 allowed by respondent under section 722) resulted in an unused excess profits credit of $ 257,021.36 for 1940, which was allowed as a carryover to 1941.

In computing the excess profits credit for 1940 under the income method for carryover purposes only, mentioned in the next preceding paragraph, the respondent made no adjustment thereto for net capital reduction because of 1940 dividend distributions not out of earnings and profits for tax purposes, determined to be in the amount of $ 654,930.77. Briefly stated, the amount of such distributions was computed in revenue agent's report, Exhibit VVV, in the following manner: Petitioner's net income for 1940 as finally determined for tax purposes was $ 4,154,262.04, and after certain adjustments thereto including the deduction of $ 995,100.92 Federal income tax for 1940, the net 1940 income available for distribution for tax purposes was determined to be $ 3,153,529.23, and petitioner's 1940 preferred and common dividend distributions amounted to a total of $ 3,808,460, exclusive of Treasury stock dividends.

Attached to the statutory notice and included herein by reference is the statement setting forth the respondent's computation of petitioner's excess profits tax liability and the amount of the overassessment at issue herein for each of the taxable years 1941 to 1945, inclusive. In connection therewith the computation, based on the income method for each taxable year, shows an excess profits credit (at 95 percent of the $ 3,913,000 CABPNI allowed by respondent under section 722) in the amount of $ 3,717,350 as further adjusted by either a plus or minus adjustment for net capital addition or reduction in arriving at petitioner's adjusted excess profits net income and its excess profits tax liability. The computation of the adjustment for net capital addition or reduction as made by respondent will be set forth for each taxable year.

With respect to the excess profits credit for 1941, the respondent's minus adjustment for net capital reduction in the amount of $ 39,295.85 consisted of 6 percent of $ 654,930.77, representing petitioner's 1940 dividend distributions not out of earnings and profits for tax purposes, arrived at as hereinabove set out. No similar adjustment was made for any such distributions made by petitioner during the taxable year 1941. Further, the respondent allowed an unused excess profits credit carryover from 1940 to 1941 in the amount of $ 257,021.38 arrived at as hereinabove set out.

With respect to the excess profits credit for 1942, the respondent's plus adjustment for net capital addition in the amount of $ 668,436.40 consisted of 8 percent of $ 8,355,454.95 representing the difference between a capital addition of $ 10,750,660.90 (at 93.9726 percent of $ 11,440,208) from the sale of preferred stock on January 22, 1942, and capital reductions in the total amount of $ 2,395,205.95. The latter amount consisted of the amount of $ 936,077.10 (at 83.5616 percent of $ 1,120,224) resulting from retirement of preferred stock on March 1, 1942, and dividend distributions not out of earnings and profits for tax purposes determined to be in the amounts of $ 654,930.77 for 1940 and $ 804,198.08 for 1941. Respondent's adjustment for 1942 net capital addition did not take into account any dividend distributions not out of earnings and profits for tax purposes, made by petitioner during the taxable year 1942.

The respondent's plus adjustment to petitioner's excess profits credit for net capital addition amounted to $ 639,924.47 for 1943, $ 601,595.58 for 1944, and $ 537,737.43 for 1945. Those amounts represented 8 percent of the net capital addition for each year, respectively, computed as the difference between a capital addition of $ 11,440,208 resulting from the sale of preferred stock in 1942, and the total capital reductions determined for each year, respectively. The latter amount consisted of the preferred stock retired in 1942 and dividend distributions not out of earnings and profits for tax purposes determined to be in the amounts for the indicated years, as follows:

	1943
Preferred stock sold, 1942	$ 11,440,208.00
Preferred stock returned, 1942	1,120,224.00
Dividend not out of earnings:
1940	654,930.77
1941	804,198.08
1942	754,843.62
1943	106,955.67
1944
1945
Total capital reductions	3,441,152.14
Net capital addition	7,999,055.86

	1944	1945
Preferred stock sold, 1942	$ 11,440,208.00	$ 11,440,208.00
Preferred stock returned, 1942	1,120,224.00	1,120,224.00
Dividend not out of earnings:
1940	654,930.77	654,930.77
1941	804,198.08	804,198.08
1942	754,843.62	754,843.62
1943	428,998.16	428,998.16
1944	157,068.67	631,726.44
1945		323,569.02
Total capital reductions	3,920,263.30	4,718,490.09
Net capital addition	7,519,944.70	6,721,717.91

Exhibit CCCC, consisting of certificates of overassessments included herein by reference, shows that respondent allowed petitioner overassessments in excess profits tax in the amounts of $ 94,394.88 for 1941 and $ 3,590.13 for 1942 which have been rebated by refund or credited as payment for other unpaid assessments.

OPINION

The respondent, in his statutory notice, partially disallowed petitioner's applications for relief under section 722 of the Internal Revenue Code of 1939 and related claims for refund, and further partially allowed such application for relief. This partial allowance was based on respondent's determination of petitioner's qualification under sections 722(b)(1) and (b)(4) and a constructive average base period net income (CABPNI) of $ 3,913,000 applicable to each of the years 1941 to 1945, inclusive, resulting in relief to petitioner over that available under section 713(f) and in an overassessment of excess profits taxes for each of those years. In arriving at such CABPNI the respondent determined, for each base period year, the petitioner's adjusted excess profits net income without benefit of section 722, and reconstructed such net income for each year to the extent affected by his partial allowance under both (b)(1) and (b)(4) and then took the average thereof for those years, as set out in our Findings of Fact.

There is no issue herein raised by either party with respect to the correctness of respondent's determination that petitioner qualified under section 722(b)(1) by reason of a hurricane which resulted in an interruption of normal production and operation, or with respect to respondent's adjustment therefor in his reconstruction. However, in conjunction with his affirmative pleading that petitioner is not entitled to any relief under subsection (b)(4), respondent herein contends that any reconstruction based on the subsection (b)(1) qualifying factor standing alone results in a CABPNI which affords no relief.

The petitioner seeks a CABPNI substantially in excess of that determined in respondent's statutory notice, based upon alleged errors in respondent's partial disallowance of its subsection (b)(4) claims for relief, and also in respondent's reconstruction of the CABPNI determined for purposes of his partial allowance of relief.

The respondent denies error in his partial disallowance. Further, respondent affirmatively pleads that he erred in his statutory notice in determining a partial allowance of relief, alleging that he erroneously failed to make certain so-called contra-adjustments which would cancel out the subsection (b)(4) adjustments previously allowed and result in a CABPNI which would preclude any section 722 relief and eliminate the overassessments. Furthermore, respondent affirmatively pleads error in his determination of petitioner's excess profits taxes in matters involving so-called standard issues, whereby respondent seeks redetermination of a substantial increase in the excess profits tax liability from which the petitioner sought relief in initiating this proceeding.

The section 722 issues involved herein arise only under subsection (b)(4). The applicable statutory provisions of the Internal Revenue Code of 1939 are set forth in the margin. *637 burden of proving alleged qualifications in addition to those determined in respondent's statutory notice and of establishing a fair and just amount to be used as a CABPNI in excess of that determined by respondent. The respondent has the burden of proof as to each of his various affirmative allegations of error in his partial allowance of relief. We will discuss the section 722(b)(4) issues involved in such order of arrangement and either separately or collectively as we deem appropriate for the purposes of this opinion.

In his statutory notice respondent determined that petitioner qualified under section 722(b)(4) by reason of cost savings based on the additional 25,000-kw steam generating capacity installed at petitioner's Montville plant in 1937 and on the 15,000-kw steam generating capacity made available to petitioner in March 1938 under the interchange agreement. In his pleadings the respondent alleged error in such determination only with respect to his characterizing the interchange agreement as making available an additional 15,000-kw capacity. There is no issue properly before the Court with respect to the correctness of respondent's determination as to the additional 25,000-kw capacity installed at Montville, and respondent's contention on brief that it was merely a normal routine change, not within the scope of subsection (b)(4), serves only to cloud an already complex case. In any event, the facts herein establish that the additional 25,000-kw steam generating facility installed at a cost of $ 1,892,577 constituted "a difference in the capacity for production or operation" (emphasis supplied) and thus a qualifying factor as a base period change in the character of the business within the meaning of section 722(b)(4). With respect to the 15,000 kw made available to petitioner in 1938, we are of the opinion that respondent has failed to prove error in his statutory notice determination that it also constituted a similar (b)(4) qualifying factor. The facts establish that the terms of the Stamford interchange agreement and the petitioner's construction of a 66,000-volt transmission line between Norwalk and Stamford at a cost of $ 473,810, including $ 40,000 for the cost of land, made available to petitioner's system an additional 15,000 kw steam generating capacity in 1938. The record does not support the respondent's contention herein that there was merely a normal routine arrangement for petitioner's purchase of a supply of electric energy on a favorable basis instead of additional capacity for petitioner's production or operation.

The above base period changes materially increased the petitioner's capacity by a total of 40,000 kw for the production of steam-generated electricity which was more dependable to meet daily load requirements than hydroelectric generating facilities, and lowered cost of production of electric energy which directly resulted in a higher level of normal earnings. We conclude that the amounts of such cost savings were properly allowed by respondent as adjustments in the reconstruction of base period income and determination of partial relief under section 722(b)(4). Cf. Bergstrom Paper Co., 26 T.C. 1167">26 T.C. 1167, petition for review dismissed (C.A. 7, Jan. 30, 1958), and authorities cited therein.

Related to the next preceding issue is the petitioner's assignment of error that respondent, having allowed a reconstruction adjustment for cost savings resulting from base period changes in the character of the business, erred in failing to allow cost savings computed on the same basis for steam generating facilities completed after December 31, 1939, and alleged to have been committed for by petitioner prior to January 1, 1940. This pertains to the new 25,000-kw generating unit which was authorized and ordered prior to December 31, 1939, and the installation thereof completed at Stamford in October 1941 by the Connecticut Power Co. (not the petitioner herein) to provide additional generating capacity for the integrated system as contemplated by the interchange agreement. The petitioner contends that this was a section 722(b)(4) commitment with respect to the Connecticut Power Co.; that under the interchange agreement such company was obligated to construct the new generating facility and make the additional capacity available to petitioner for production or operation; and that petitioner was obligated to use such additional capacity in its interchange operations with resulting cost savings and, accordingly, the change in capacity was equally committed for by petitioner within the meaning of subsection (b)(4). The respondent contends, inter alia, that to qualify for a subsection (b)(4) commitment the change in capacity consummated after December 31, 1939, must be "as a result of a course of action to which the taxpayer was committed prior to January 1, 1940" (emphasis supplied), and that petitioner, the taxpayer herein, never took any course of action on its own account to authorize, order, and install the new generating unit. The respondent further contends that even though upon completion the new unit was used along with the other generating units of the two companies to carry the daily load requirements of the integrated system under the interchange agreement, nevertheless, a course of action to which another taxpayer was committed may not be imputed to petitioner for the purposes of section 722(b)(4) relief. We agree with the respondent's contention.

The general rules of the relief section 722 contain broad phraseology which has been given liberal construction in determining the applicability of that section to various factual situations presented in claims for relief from alleged excessive and discriminatory excess profits taxes. However, in our opinion, where specific language of that statute denotes requisite requirements, the latter must be squarely met by the taxpayer seeking relief. With respect to the subsection (b)(4) commitment rule, we have heretofore held that "capacity" is a word with specific limitations upon the applicability of that rule. Newburgh Transfer, Inc., 17 T.C. 841">17 T.C. 841. We are also of the opinion that the word "taxpayer" specifically limits the applicability of such rule to the taxpayer as the requisite entity which must be committed to making a change in capacity as such. See Barth Smelting Corporation, 30 T.C. 1073">30 T.C. 1073. It should be noted that in the instant case the alleged commitment was not for the installation of machinery by or for the sole use of the taxpayer, did not result in the taxpayer obtaining any interest, leasehold, or otherwise in the property to be constructed, and did not create as to the taxpayer the right or obligation to receive a determinable amount of energy. Cf. Southern California Edison Co., 19 T.C. 935">19 T.C. 935. In any event, a (b)(4) qualification under the commitment rule applies only to a change in capacity, Newburgh Transfer, Inc., supra, and any other (b)(4) change in the character of the business must have occurred immediately prior to or during the base period. Corn Products Co., 36 T.C. 969">36 T.C. 969. Here there is no base period event to support the claimed adjustment for additional cost savings relating to the new Stamford 25,000-kw unit completed after December 31, 1939. We sustain the respondent's disallowance of any reconstruction adjustment on this issue.

In addition to the above-mentioned increases made by petitioner in the capacity of its own generating facility during the base period, the petitioner also substantially increased the mileage and the voltage of its transmission and distribution lines, and increased the capacity of its transmission and distribution substations during the base period as detailed in our Findings of Fact. Such base period additions to petitioner's transmission and distribution facilities at a total cost of $ 6,943,242.97, including some replacements, materially increased petitioner's capacity for operation and actual operation in delivery of electric energy not only to old customers but to new customers, particularly of the domestic category, which directly resulted in increased sales and a higher level of normal earnings. The petitioner alleges that the respondent, in his reconstruction, erred in failing to allow any adjustment to base period income for increased sales and level of earnings attributable to such changes. The respondent counters with the contention that they were merely normal routing changes not within the purview of section 722(b)(4). In our opinion, these base period changes, separately or certainly when considered altogether, constituted a qualifying (b)(4) base period change in the character of the business as "a difference in the capacity for production or operation." Cf. Lansburgh & Bro., 30 T.C. 1114">30 T.C. 1114, 1118. We hold that respondent erred in failing to make any reconstruction adjustment on account thereof.

The petitioner's various sales-promotion activities and voluntary rate reductions during the base period, as detailed in our Findings of Fact, clearly did not constitute subsection (b)(4) changes in the character of the business, either as "a change in the operation or management of the business" or otherwise, but rather constituted intensified normal activities in petitioner's growing business.

The petitioner alleges that the respondent, in his reconstruction, erred in failing to allow an additional adjustment to base period net income to reflect elimination of alleged abnormal deductions for depreciation in the base period years as compared to deductions for depreciation in the subsequent taxable years. It would serve no useful purpose to set forth the lengthy arguments of the parties. Briefly stated, petitioner contends that having qualified for relief the reconstruction of its normal earnings should eliminate an alleged base period abnormality of excessive depreciation pursuant to respondent's E.P.C. 6, 2 C.B. 123">1946-2 C.B. 123, and respondent contends that the latter is not applicable to the facts in the instant case. We agree with respondent.

In Southern California Edison Co., supra, the respondent in 1943 determined lower depreciation rates than were claimed by the taxpayer on its returns for each of the years 1936-39. The reduced rates were applied for tax purposes both prospectively to later years and retroactively to earlier years, but, because of the statute of limitations, they were given no effect prior to 1939. The reduced rates applied to 1939 were no less appropriate for the earlier base period years and if applied thereto the taxpayer's depreciation would have been reduced and net income increased by substantial amounts for each of the years 1936-38. For purposes of section 722 the reduced depreciation rates were applied by respondent in determining normal earnings for 1939 but not for the earlier years 1936-38. This Court held that, so far as concerned a reconstruction under section 722, the rates used for 1939 should be used in determining normal earnings for the three earlier base period years as required by E.P.C. 6 for the correction of abnormal depreciation deductions in such earlier years. The date of the respondent's determination of the reduced depreciation rates was immaterial to the Court's holding because the actual application thereof to 1939 constituted the occurrence of a base period event. The Court further held that E.P.C. 6 required correction for abnormal interest deductions to the extent that base period net income did not reflect interest savings on long-term debt retirement and refunding which occurred at various times during the base period. However, with respect to the taxpayer's claim for adjustment for alleged abnormal base period interest deductions as compared to subsequent years where bonds outstanding at the close of 1939 were refunded in 1941 at a lower rate of interest, this Court held that no effect could be given to such transaction in reconstructing the taxpayer's base period net income because reference to post-1939 events is prohibited by section 722(a). This last holding is, in our opinion, controlling in the instant case on petitioner's claimed adjustment for alleged abnormal or excessive depreciation allowed for the entire base period as compared with the subsequent taxable years involved. The crux of the factual situation herein is that the petitioner and respondent agreed upon a composite depreciation rate of 3.34 percent as the appropriate rate applicable in determining a reasonable allowance for depreciation for tax purposes for all 4 base period years, and thus there was no abnormality as between any one or more of those years as was true in the Southern California Edison case. Thereafter as a result of inspection of the properties and conferences, the petitioner and respondent agreed to a lower composite depreciation rate of 3.15 percent as the appropriate rate applicable in determining a reasonable allowance for depreciation for different taxable years 1940-45. This was a post-1939 event, which incidentally involved a question of fact relating only to the years 1940-45, and pursuant to the prohibition of section 722(a) no regard shall be had to such event in reconstructing petitioner's base period net income. The respondent is sustained on his disallowance of the claimed additional adjustment for alleged abnormal depreciation deductions in the base period years. Further, our conclusion on this issue obviates any necessity of passing on the question of whether petitioner is estopped from claiming an adjustment for abnormal depreciation as affirmatively pleaded by respondent.

The petitioner alleges that the respondent, in his reconstruction of base period net income, erred in failing to allow an additional adjustment to reflect substantial reductions in interest expense and debt discount and expense. This is a claim for correction of a base period abnormality. Our Findings of Fact set forth in detail the petitioner's base period refunding of a sizable portion of its long-term bond indebtedness at lower interest and debt expense. The higher interest and debt expense on the old refunded bonds were reflected in petitioner's level of earnings up to the dates of the respective retirements of the old bonds. The reductions and/or savings in interest and debt expense were only partially reflected in petitioner's level of earnings during the years 1936, 1937, and 1938, but were fully reflected therein for the last base period year 1939. In Southern California Edison Co., supra, where the taxpayer retired long-term indebtedness in each of the base period years thereby reducing the amount of interest payable, this Court said at page 998:

Keeping in mind E.P.C. 6, we think petitioner's average base period net income is abnormally low for failure completely to reflect these reduced interest charges, and that this is an abnormality which requires correction. * * * Correction is needed only to the extent that the actual earnings do not reflect the interest savings.

And, further, where the taxpayer refunded a bond issue in the base period at reduced interest rates, this Court said at page 999:

To the extent that petitioner's average base period net income fails to reflect this reduction in interest, we think it likewise contains an abnormality which requires correction under E.P.C. 6 for essentially the same reasons as obtain respecting the retired indebtedness. * * *

In the instant case and on authority of the Southern California Edison case we hold that the claimed abnormality correction may be made but only to the extent that actual base period earnings do not reflect the petitioner's interest and debt expense savings.

The petitioner alleges that the respondent, in his reconstruction of base period net income, erred in failing to reconstruct for an increased level of sales and earnings under the 2-year pushback rule, and further claims application of that rule to certain enumerated events. Based upon a study of the record herein, we are convinced that "the business of the taxpayer did not reach, by the end of the base period, the earning level which it would have reached if the taxpayer had * * * made the change in the character of the business two years before it did so," and, accordingly, "it shall be deemed to have * * * made the change at such earlier time," but only in regard to petitioner's qualifying subsection (b)(4) changes. The petitioner is entitled to a reconstruction of an increased level of sales and earnings under the 2-year pushback rule as applied to the hereinbefore-determined qualifying changes in plant facilities completed by petitioner during the base period for increased capacity for production of electric energy, and also for increased capacity for operation of the business in transmission and distribution of electric energy. However, the petitioner is not entitled to the contended-for application of the 2-year pushback rule to the claimed Stamford additional generating capacity as to which we have held petitioner was not committed, or the claimed additional extensions of rural distribution lines which would have been made if all the base period changes in the character of the business had been made 2 years earlier. Since neither of those alleged changes constituted a qualifying factor, there can be no push back thereof. Further, with respect to the additional extensions of rural distribution lines which petitioner claims it would have made with 2 more years' experience based on other qualifying factors, we are of the opinion that the record fails to establish what, if any, such lines might reasonably have been built. We think the record shows that petitioner's base period construction of transmission and distribution lines constituted the total that actual base period conditions warranted.

As hereinbefore mentioned, the respondent's partial allowance was based upon a CABPNI arrived at through year-by-year reconstruction of base period net income. We find the year-by-year method of reconstruction not only complex, but unnecessary in regard to certain aspects of this case. We find that certain circumstances or matters for which adjustments are claimed by both parties herein were for all practical purposes fully reflected in petitioner's actual earning level for its last base period year. Accordingly, and based upon a consideration of the whole record, we conclude that the appropriate reconstruction of a CABPNI in the instant case should be made on the basis of ascertaining the earning level which petitioner would have reached by the end of 1939, after application of petitioner's section 722 qualifying factors (including the pushback rule where applicable) to its business operations under existing base period conditions, and backcast with an appropriate index to arrive at a base period average. See 7- Up Fort Worth Co., 8 T.C. 52">8 T.C. 52; Lansburgh & Bro., supra; and Copco Steel & Engineering Co., 31 T.C. 629">31 T.C. 629.

Having reached the conclusion set forth in the next preceding paragraph and in connection with the reconstruction for the year 1939, we hold that no adjustments need be made for interest and debt expense savings occasioned by base period refunding of outstanding long-term bonds at lower interest rates or cost savings resulting from more efficient steam-generating facilities which became available during the base period as claimed by petitioner, or for increased interest and debt expense on new additional borrowed capital required to finance base period additions to petitioner's plant facilities, or for increased insurance, property taxes, and depreciation incurred on such additional facilities, or for increased welfare and pension expenses incurred after 1937 as contra-adjustments claimed by respondent.

Furthermore, in connection with respondent's claimed contra-adjustments, we conclude and hold that respondent has not established his affirmative plea of error in his determination in failing to make an adjustment for an alleged abnormality which would reduce reconstructed base period net income for alleged constructive loss of earnings arising from dividend distributions other than out of earnings and profits for tax purposes. On the record we conclude that respondent has failed to establish a sound factual basis in support of his theory of constructive loss of earnings and, in any event, that respondent's proposed computation of amounts (in terms of interest on constructive additional borrowed capital in sums equivalent to such dividends), as representing alleged constructive loss of earnings in each base period year, fails to establish any justifiable amounts thereof. The record establishes that after payment of dividends, other than out of earnings for tax purposes, the petitioner had a substantial surplus in each base period year and there is no basis herein for a finding as to what amounts, if any, of constructive borrowings could be said to be attributable to petitioner's dividend policies. Furthermore, this claimed abnormality adjustment for constructive loss of earnings would result in a double diminution of base period net income because, as above concluded, petitioner's level of earnings for 1939 reflects deductions for increased interest incurred on additional borrowed capital required to finance base period additions to petitioner's plant facilities. We hold against respondent on this issue, which has served only to add complexity to the instant case.

The respondent affirmatively alleges error in his determination in allowing the petitioner an unused excess profits credit carryover, based on constructive earnings under section 722, from the year 1940 to the year 1941, that is computed on the basis of the CABPNI of $ 3,913,000 determined by respondent under section 722. The burden of this affirmative allegation is simply that if respondent erred in allowing section 722 relief then he further erred in using the CABPNI as a basis for computing the excess profits credit for 1940 and the resulting carryover. This issue is dependent upon whether any relief is granted in this proceeding. Respondent's separate assignment of error, raising the question of the correct amount of any carryover from 1940, will be discussed hereinafter. The remaining so-called contra-adjustment, affirmatively claimed by respondent that he erroneously characterized the Stamford Interchange Agreement as making available an additional 15,000-kw capacity during the base period, has been hereinabove decided adversely to respondent.

The petitioner's actual average base period net income is $ 3,781,544 while its average base period net income under the "growth formula" of section 713(f) as adjusted by respondent is $ 3,844,849 for 1941 and $ 3,854,803 for the years 1942 to 1945, inclusive. In his notice of partial disallowance, the respondent determined that petitioner qualified for relief under section 722(b)(1) and (b)(4), and further determined a constructive average base period net income of $ 3,913,000 applicable to the taxable years 1941 to 1945 and also to 1940 for purpose of carryover of unused excess profits credit. Respondent has failed to establish his affirmative allegations that he erroneously allowed any relief. Petitioner claims a CABPNI of $ 5,032,811 based on a reconstruction embracing all the adjustments claimed herein, some of which have been hereinabove decided adversely to petitioner, and, accordingly, such claimed CABPNI is not substantiated. However, the petitioner has carried its burden of establishing a basis for determining a fair and just amount representing normal earnings to be used as a CABPNI in an amount in excess of its average base period net income computed without regard to section 722.

We have found as a fact, and so hold, that petitioner's average base period net income is an inadequate standard of normal earnings and that petitioner's excess profits tax for the years involved herein, computed without the benefit of section 722, results in an excessive and discriminatory tax.

We have given full consideration to all the facts in the voluminous record herein. We have applied the 2-year pushback rule to petitioner's (b)(4) base period changes in the character of the business embracing "a difference in the capacity for production or operation" and including increased capacity of generating facilities, high voltage transmission lines and substations, and also increased mileage of transmission and distribution lines, all of which directly resulted in increased sales of electric energy and a higher level of normal earnings. In applying the 2-year pushback rule we have given consideration to petitioner's own experience in expansion and growth of its business. We have used our best judgment in reconstructing a reasonable amount of increased sales and level of earnings which would have been reached as of December 31, 1939, in the light of petitioner's qualifying factors under base period circumstances. We have applied an appropriate index figure for the purpose of backcasting to obtain a base period average. In the exercise of our best judgment, we have determined that a fair and just amount representing normal earnings to be used as a constructive average base period net income for the purpose of computing petitioner's excess profits credit based on the income method is $ 4,300,000 for the taxable years 1941 to 1945, inclusive. Such CABPNI is also applicable to the year 1940 for purposes of any carryover of unused excess profits credit based on the income method. A further adjustment for income taxes will be made for the year 1940 in the recomputation under Rule 50. Cf. Copco Steel & Engineering Co., supra, and Lansburgh & Bro., supra at 1121.

Standard Issues

The respondent's affirmative pleading that there are no overassessments and that there are deficiencies in petitioner's excess profits taxes for the years 1941 to 1945, inclusive, is premised upon allegations of error in his statutory notice.

Respondent's alleged error in his allowance of any section 722 relief has been decided adversely to respondent in our determination of a CABPNI to be used in lieu of petitioner's average base period net income (otherwise computed without benefit of section 722) for purposes, inter alia, of computing petitioner's excess profits credit in the recomputation to be made under Rule 50.

Respondent's further allegations of error in the statutory notice, broadly stated for present purposes, pertain primarily to the computation of the allowable excess profits credit and relate to alleged requisite adjustments involving issues other than those arising under section 722, that is, so-called standard issues.

This proceeding was initiated under section 732 of the 1939 Code solely by reason of the petitioner's appeal from respondent's statutory notice of partial disallowance of its claims for relief under section 722 and for refund of excess profits taxes for the years involved. No deficiencies in such taxes were asserted in the statutory notice and the standard issues have been raised by respondent's amended answers to the petition herein.

Both parties assert that the Court is squarely faced with the question of whether, under the circumstances herein, it has jurisdiction of the several so-called standard issues. Petitioner urges that this Court should continue to follow its position taken in Mutual Lumber Co., 16 T.C. 370">16 T.C. 370, that the Court lacks jurisdiction. Respondent urges that this Court has been consistently reversed on this jurisdictional issue and that we should now follow the decisions of the various Courts of Appeals. CIBA Pharmaceutical Products, Inc. v. Commissioner, 297 F. 2d 77, reversing and remanding 35 T.C. 337">35 T.C. 337; Commissioner v. Seminole Mfg. Co., 233 F. 2d 395; Commissioner v. Blue Diamond Coal Co., 230 F. 2d 312; Commissioner v. S. Frieder & Sons Co., 228 F.2d 478">228 F. 2d 478; Commissioner v. Poe Manufacturing Co., 224 F. 2d 254, reversing and remanding T.C. Memo. 1954-158; Martin Weiner Corp. v. Commissioner, 223 F. 2d 444, reversing and remanding on this issue 21 T.C. 470">21 T.C. 470; Commissioner v. Pittsburgh & Weirton B. Co., 219 F.2d 259">219 F. 2d 259, reversing and remanding 21 T.C. 888">21 T.C. 888; Willys-Overland Motors v. Commissioner, 251">219 F. 2d 251; Packer Pub. Co. v. Commissioner, 211 F. 2d 612, remanding 17 T.C. 882">17 T.C. 882; Claremont Waste Mfg. Co. v. Commissioner, unreported; City Machine & Tool Co. v. Commissioner, 194 F. 2d 535; H. Fendrich, Inc. v. Commissioner, 192 F. 2d 916.

In Dixie Portland Flour Co., 31 T.C. 641">31 T.C. 641, and Air Preheater Corporation, 36 T. C. 982, both involving section 722 claims for relief and standard issues raised by the taxpayers, this Court said it preferred to bypass the controversial jurisdictional question of standard issues by disposing of the latter on the ground that they were without merit. In CIBA Pharmaceutical Products, Inc., 35 T.C. 337">35 T.C. 337, 355, 356, involving section 722 claims for relief and a claimed standard issue deduction, this Court followed Mutual Lumber Co., supra, in holding that it lacked jurisdiction of the standard issue, but further expressed the view that if we had jurisdiction to decide such issue we would decide it for the taxpayer. On appeal on the jurisdictional question the Tax Court was reversed, as above noted.

The circuit Court of Appeals, to which this case may go on appeal, has taken the position that the Tax Court has jurisdiction of standard issues raised in a section 722 relief case. Martin Weiner Corp., supra. In Dixie Portland Flour Co., supra, and Air Preheater Corporation, supra, this Court without taking jurisdiction nevertheless considered the merits of the standard issues raised and determined them to be without merit. In the instant case the jurisdictional question may not be so bypassed. On the record herein we are persuaded that the standard issues not only have merit, but that the issues involving the correct computation of the allowable excess profits credit require consideration and decision on the merits in order that this Court may make the requisite redetermination of this proceeding.

A further consideration herein, with respect to the jurisdictional issue, is that on the record we have concluded and found that petitioner is entitled to a CABPNI in an amount greater than that allowed by respondent which, if the only issue herein, would necessarily result in larger excess profits credits and overassessments than those computed in respondent's statutory notice of partial allowance of relief. However, we are persuaded that the record discloses further error in the statutory notice in that it incorporates incorrect amounts on account of adjustments required by statute in arriving at the excess profits credit based on the income method. The CABPNI herein determined constitutes only a part of the basis for computation of petitioner's allowable excess profits credit. The petitioner is certainly not entitled to a decision, under Rule 50 recomputation, that there are excess profits tax overpayments in any amounts greater than actually overpaid.

Upon reconsideration of the long controversial question of this Court's jurisdiction over standard issues raised in section 722 relief cases, we will no longer follow the rule announced in Mutual Lumber Co., supra. On authority of the decisions of the various circuit Courts of Appeals hereinabove cited, we take jurisdiction of the standard issues properly raised in this proceeding.

The petition herein having been filed pursuant to section 732(a) of the 1939 Code, ^{*648 assessment and collection of taxes or the refund or credit of overpayments" and, further, pursuant to section 732(b), 4 if this Court "finds that there is no overpayment of tax" and "further finds that there is a deficiency" this Court "shall have jurisdiction to determine the amount of such deficiency."}

Statute of Limitations

It is stipulated herein that the petitioner and respondent executed waivers whereby the period of limitations for the assessment and collection of additional taxes for 1941 and 1942 was extended to June 30, 1953, and for the years 1943, 1944, and 1945 was extended to June 30, 1950. On the date of respondent's notice of disallowance, March 18, 1953, there was no bar to the assessment and collection of additional taxes for the years 1941 and 1942, and the respondent's affirmative assertion of deficiencies for those years, in his amended answers filed herein, is timely. See sec. 272(a). With respect to the asserted deficiencies for the years 1943, 1944, and 1945, as to which petitioner has pleaded the bar of the statute of limitations, it has been held that a deficiency asserted for the first time in respondent's answer to a petition filed with this Court, based upon a disallowance of a section 722 claim, is untimely if it was barred when the notice of disallowance was mailed. F. W. Poe Manufacturing Co., 25 T.C. 691">25 T.C. 691, affirmed on other grounds 245 F.2d 8">245 F. 2d 8; Commissioner v. S. Frieder & Sons Co., 247 F. 2d 834.See section 275(a) period of limitation; section 276 (b) waivers; section 729(a) laws applicable to excess profits tax. In May Broadcasting Co. v. Commissioner, 299 F. 2d 84, the Court of Appeals for the Eighth Circuit distinguished that case from Commissioner v. S. Frieder & Sons, Co., supra, as follows: "Frieder deals with limitations as to the Government asserting a deficiency. Such issue brings into play statutes not directly involved in the taxpayer's claim for redetermination in the present case." If the recent case of Overland Corporation (formerly Willys-Overland Motors) v. Commissioner, 316 F. 2d 777, (C.A. 6, 1963) he considered as holding to the contrary, then, with due deference to the Court of Appeals for the Sixth Circuit, we adhere to the views expressed by us in Overland Corporation, 34 T.C. 1001">34 T.C. 1001, and in F. W. Poe Manufacturing Co., supra, and choose to follow the opinion of the Court of Appeals for the Third Circuit in Commissioner v. S. Frieder & Sons, Co., supra. Accordingly we decide that no deficiencies in tax may be assessed or collected for those years. However, as we shall explain more fully later in this opinion, the correct amount of petitioner's excess profits credits for those years must be determined herein for the purpose of determining the amount, if any, of excess profits tax refunds to which petitioner is entitled, even though this determination requires a consideration of tax liabilities otherwise not collectable by reason of the statute of limitations.

Pleadings

At the hearing on this proceeding the Court denied petitioner's motion to strike those paragraphs of respondent's amended and second amended answers which relate to his affirmative allegations of errors raising standard issues for the taxable years 1941 and 1942 and for 1940 for unused credit carryover purposes, and also affirmative assertions for deficiences for 1941 and 1942. Petitioner's motion for reconsideration of such ruling was taken under advisement and, upon due reconsideration thereof, the denial of petitioner's motion to strike, as above set out, is reaffirmed.

Further, at the hearing on this proceeding the Court granted the petitioner's motion to strike paragraph 11 of respondent's second amended answer. Subparagraphs 11 (1) to (4), inclusive, set forth affirmative allegations of errors in failing to correctly compute petitioner's net capital additions with resulting errors in determining the amount of the excess profits credit for each of the years 1943, 1944, and 1945, and also affirmative assertions for deficiencies for those years. The Court took under advisement respondent's motion for reconsideration of such ruling with respect to the second amended answer subparagraph 11(5). The latter is an alternative plea, in the event it is determined herein that petitioner is entitled to section 722 relief, that the Court further determine that petitioner's corrected net capital additions be used in determining its excess profits tax liability for the purpose of determining whether there is an actual overpayment in excess profits tax for each of the years 1943, 1944, and 1945. Upon due reconsideration of the premises, we are of the opinion that the pleading in said subparagraph 11(5) should be considered and decided on its merits and, accordingly, petitioner's motion to strike is denied with respect thereto.

Unused Credit Carryover

In section 722 cases, where this Court grants relief and determines a CABPNI and the year 1940 is involved, the adjustment for 1940 income tax has been ordinarily considered a matter for recomputation under Rule 50 rather than consideration on the merits in the opinion. Cf. Copco Steel & Engineering Co., supra, and Lansburgh & Bro., supra.

In the instant case respondent affirmatively alleges, and petitioner denies, error in the statutory notice allowance of an unused excess profits credit carryover from 1940 to 1941 in the amount of $ 257,021.36 based on the income method. In his computation for carryover purposes respondent used petitioner's excess profits net income as determined in the amount of $ 3,460,328.64 for 1940, and allowed an excess profits credit of $ 3,717,350 (or 95 percent of the CABPNI of $ 3,913,000 allowed by respondent under section 722) resulting in the amount of $ 257,021.36 as an unused excess profits credit for 1940.

Respondent contends that such computation is erroneous in that it is made under the 1939 Code provisions applicable to 1940 instead of those applicable to 1941 which are controlling for carryover purposes and, accordingly, that he erred in failing to adjust petitioner's excess profits net income as determined for 1940 by adding thereto the income tax of $ 995,100.92 for 1940, which would result in no unused excess profits credit carryover to the taxable year 1941.

Section 711(a) of the 1939 Code, as amended by the Revenue Act of 1940, provided that the excess profits net income would be the normal-tax net income, as defined in section 13(a)(2), with certain adjustments and if the excess profits credit were computed under section 713 (income method) such adjustments included a deduction for income tax as provided in section 711(a)(1)(A). However, the Revenue Act of 1941 amended section 711(a)(1)(A) to eliminate any deduction for income tax. See S. Rept. No. 673, to accompany H.R. 5417 (Pub. L. 250), 77th Cong., 1st Sess., p. 14 (1941). The Revenue Act of 1941 also amended 1939 Code section 710(c)(2) which sets forth the definition of unused excess profits credit and provides, in part, that "For such purpose the excess profits credit and the excess profits net income for any taxable year beginning in 1940 shall be computed under the law applicable to taxable years beginning in 1941." See also Regs. 112, sec. 35.710-3.

In the instant case we have determined that petitioner is entitled to a CABPNI of $ 4,300,000 which is applicable to the year 1940 for carryover purposes only. The computation of any unused excess profits credit for 1940 for purposes of carryover to 1941 will be made pursuant to the law applicable to 1941 in the recomputation under Rule 50. The issue with respect to an alleged further adjustment in computing the excess profits credit for 1940 for carryover purposes, and involving an alleged correction for net capital reduction, will be discussed in connection with respondent's claimed adjustment for net capital reduction or addition for the taxable years 1941 to 1945, inclusive.

Excess Profits Credit Adjustment for Net Capital Addition or Reduction

Under the section 722 issue herein we have determined a CABPNI of $ 4,300,000 and pursuant to section 722(a) the petitioner's excess profits "tax shall be determined by using such constructive average base period net income in lieu of the average base period net income otherwise determined under this subchapter." (Emphasis supplied.)

Insofar as applicable herein, section 713 of the 1939 Code ^{section 713(a)(1) (A), (B), and (C), the petitioner's excess profits credit based on income is computed as 95 percent of the average base period net income (the CABPNI herein), plus 8 percent of the net capital addition or minus 6 percent of the net capital reduction as defined in subsection (g). Briefly stated for our purposes, subsection (g)(1) defines net capital addition as the excess, divided by the number of days in the year, of the aggregate of daily capital addition over the aggregate of daily capital reduction for each day of the taxable year, and subsection (g)(2) defines net capital reduction as the converse thereof. Subsection (g)(4) provides that the daily capital reduction for any day of the taxable year shall be the aggregate of the amounts of distributions to shareholders, not out of earnings and profits, after the beginning of the taxpayer's first taxable year under the excess profits tax law and prior to such day.}

The respondent affirmatively alleges error, which petitioner denies, in the statutory notice computation of the petitioner's allowable excess profits credit for each of the years 1940 to 1945, in that he failed to make the required plus or minus adjustment to the credit on account of petitioner's correct net capital addition or reduction. Respondent further alleges that such error results from his failure to determine the correct amount of "the daily capital reduction," as required by section 713(g)(4), on account of petitioner's distributions not out of earnings and profits in the form of "dividends."

There is no dispute as to the facts herein that petitioner had no accumulated earnings on January 1, 1940, and had a deficit in its earnings and profits for tax purposes for each of the years 1940 to 1945, inclusive; and, further, that petitioner made quarterly distributions to its stockholders in the form of "dividends" on its preferred and common stock in the amounts and on the dates during those years as set forth in revenue agents' reports included herein by reference.

The revenue agent's report, Exhibit YYY herein, embraces schedules showing respondent's computations of petitioner's net income and the various adjustments thereto, including deductions for income tax for 1940 and income and excess profits tax for 1941 to 1945, inclusive, in arriving at petitioner's earnings and profits for tax purposes available for distribution. As therein computed, the petitioner made substantial distributions not out of earnings and profits for tax purposes during each of the years 1940 to 1945, inclusive.

In respondent's statutory notice the petitioner's distributions, not out of earnings and profits for each of the years 1940-42, were treated as not giving rise to a capital reduction until the following year while on the other hand such distributions for each of the years 1943-45 were treated as giving rise to a capital reduction in the year of distribution. Respondent asserts that his determinations for the years 1940-42 were clearly erroneous. Respondent further asserts that while his treatment of distributions not out of earnings for the years 1943-45 was correct, he erroneously understated the amount of capital reduction for each year because of the error as to the prior years 1940-42 and the cumulative effect of capital reductions for distributions not out of earnings since the first excess profits tax taxable year. See Regs. 112, sec. 35.713-2(a).

Petitioner asserts that for all years involved herein its earnings before taxes were in excess of dividends paid. Petitioner contends that in determining its excess profits credit with adjustments for capital changes as provided in section 713, based on the income method, the computation of the amount of dividend distributions not out of earnings for purposes of the capital reduction under subsection (g)(4) should be consistent with the provisions of section 718, relating to the computation of excess profits credit based on invested capital, which expressly prohibits the deduction of the current year's taxes in determining the current year's earnings and profits available for distribution.

The petitioner's above contention has been heretofore considered and decided adversely to it. In ABC Brewing Corporation, 20 T.C. 515">20 T.C. 515, 528-530, affd. 224 F. 2d 483, we held that section 713 contains no provision similar to that found in section 718 and, further, in the computation of the excess profits credit under the income method that respondent properly reduced the taxpayer's earnings for the taxable year by the amount of accrued taxes for that year in arriving at earnings and profits available for distribution for purposes of determining the taxable year's capital reduction under section 713(g)(4).

The respondent asserts an additional error in his method of computation of the capital reduction for each year involved on account of petitioner's distributions not out of earnings and profits, pursuant to section 713(g)(4). In the computations on which the statutory notice was based respondent determined that current earnings were first exhausted by the earliest distributions during the year before determining the time at which distributions not out of earnings were paid. Respondent now contends that current earnings remaining after the making of distributions in the form of "dividends" on preferred stock should be prorated to each quarter, with a resulting adjustment for daily capital reduction occurring at the time of each quarterly distribution in the form of "dividends" on common stock in the amount that each quarterly common stock distribution exceeded the proportion of total earnings or profits attributable to that quarter. Respondent alleges that the method of proration he now contends for would serve to further increase the amount of the daily capital reduction for each of the years 1940 to 1945, inclusive. Section 115(a) of the 1939 Code defines the term "dividend," in part, as any distribution made by a corporation to its shareholders "out of the earnings or profits of the taxable year (computed as of the close of the taxable year without diminution by reason of any distributions made during the taxable year), without regard to the amount of the earnings and profits at the time the distribution was made," and section 115(b) provides, in part, that "every distribution is made out of earnings or profits to the extent thereof." Under the facts of record and the cited statutory provisions the respondent has failed to establish any basis for prorating current earnings to each quarterly distribution for determining the capital reduction for each year. On this issue we hold against respondent.

We conclude and hold in the instant case that in determining petitioner's allowable excess profits credit based on income under the provisions of section 713(a)(1) (A), (B), and (C), the computation of the amount of capital reduction provided for in section 713(g)(4) embraces petitioner's distributions not out of earnings and profits made in each taxable year as hereinbefore decided, and also such distributions for the excess profits tax years prior thereto. Accordingly, we further conclude and hold that in arriving at the excess profits credits allowed in the statutory notice for the years involved, the respondent erroneously computed the amount of the capital reduction by failing to include therein the current year's distributions not out of earnings and profits for the year 1940 (for purposes of unused credit carryover) and the taxable years 1941 and 1942, and also the cumulative effect if any of such errors on the computations of the capital reduction for each of the subsequent years 1943, 1944, and 1945. Since the correct amount of petitioner's excess profits tax for each of the years involved is at issue herein, the appropriate adjustments to the excess profits credit for each year will be made in the Rule 50 recomputation. Further, such recomputation will necessarily embrace the matter of whether respondent erroneously scheduled over-assessments in excess profits taxes for the years 1941 and 1942 as affirmatively pleaded by respondent in connection with this issue.

We come to the last standard issue herein with respect to the excess profits credit as adjusted for net capital addition or net capital reduction and involving the question of the computation of the corrected capital reduction under section 713(g)(4), as hereinabove decided, to the extent applicable to the years 1943, 1944, and 1945. This is an alternative issue affirmatively asserted by respondent in the event this Court allows petitioner section 722 relief and despite the bar of the statute of limitations to the assessment and collection of any deficiency in excess profits tax for those years.

Respondent contends that the bar of the statute of limitations is an entirely separate issue having no bearing on the Court's jurisdiction to redetermine the petitioner's correct tax liability for the years before it even though assessment and collection of any deficiency would be barred. Respondent's position is that since the years 1943, 1944, and 1945 are before the Court for redetermination of petitioner's claims for relief and refund of excess profits taxes, the Court's jurisdiction over those matters necessarily embraces jurisdiction to redetermine the correct amount of petitioner's allowable excess profits credit for each of those years to the extent necessary to determine the amount, if any, of the refund of excess profits taxes to which petitioner is entitled. We agree with that contention.

Here the respondent contends that petitioner's excess profits credit must be recomputed to reflect the corrected capital reduction under section 713(g)(4) in redetermining petitioner's excess profits tax liability for the years 1943, 1944, and 1945 for the purpose of the Court's decision in this proceeding as to whether any net overpayments of excess profits taxes actually exist for those years.

Respondent relies on the doctrine announced in Lewis v. Reynolds, 284 U.S. 281">284 U.S. 281. In that case the taxpayer filed a claim for refund of income tax grounded upon respondent's disallowance of claimed deductions. The respondent rejected the claim for refund on the basis that he had previously allowed an improper deduction and that a correct recomputation of the tax liability resulted in additional tax which was barred from assessment by the statute of limitations. The taxpayer contended that respondent lacked authority to redetermine and reassess the tax after the statute had run. The trial court upheld the respondent and its judgment was affirmed by the circuit Court of Appeals which was affirmed by the Supreme Court. In its opinion the Supreme Court quoted with approval the following language of the Court of Appeals:

The above quoted provisions clearly limit refunds to overpayments. It follows that the ultimate question presented for decision, upon a claim for refund, is whether the taxpayer has overpaid his tax. This involves a redetermination of the entire tax liability. While no new assessment can be made, after the bar of the statute has fallen, the taxpayer, nevertheless, is not entitled to a refund unless he has overpaid his tax. The action to recover on a claim for refund is in the nature of an action for money had and received, and it is incumbent upon the claimant to show that the United States has money which belongs to him.

The Supreme Court further stated that:

While the statutes authorizing refunds do not specifically empower the Commissioner to reaudit a return whenever repayment is claimed, authority therefor is necessarily implied. An overpayment must appear before refund is authorized. Although the statute of limitations may have barred the assessment and collection of any additional sum, it does not obliterate the right of the United States to retain payments already received when they do not exceed the amount which might have been properly assessed and demanded.

Bonwit Teller & Co. v. United States, 283 U.S. 258">283 U.S. 258, says nothing in conflict with the view which we now approve.

In our opinion the decision in the Lewis v. Reynolds case is controlling here, where petitioner seeks excess profits tax refunds, the amounts of which are dependent upon a recomputation of its excess profits tax liability and the allowable excess profits credit. If the recomputation herein is based in part on erroneous adjustments it would result in an erroneous credit not in accord with the statutory requirements of section 713(a)(1) (A), (B), and (C). Accordingly, we conclude that the Rule 50 recomputation herein must reflect the corrected capital reduction in order to arrive at petitioner's allowable excess profits credit and the amounts of any actual overpayments for the years 1943, 1944, and 1945.

Reviewed by the Special Division as to the 722 issues.

Reviewed by the Court as to non-722 issues.

Decision will be entered under Rule 50

OPPER

Opper, J., dissenting: This is apparently only one more grudging step on an endless road. Having at last accepted the jurisdictional command of the first Fendrich^{Fendrich case that --}

it is clear from the statutory provisions and legislative history that Congress established a procedure for the proper determination of the entire tax, and that such determination of the whole tax involves a single procedure which began with the timely filing of the application under § 722 and included the rejection thereof by the Commissioner and the petition to the Tax Court.

* * * *

We think all pertinent issues bearing upon the tax liability under Chapter 2 Subchapter E could be raised by the taxpayer. However, this is a two-way street. Had a deficiency been found, such deficiency could have been assessed and collected. The original application suspended the Statute of Limitations and thereafter, the entire excess profits tax liability was open for determination. (Emphasis added.)

H. Fendrich, Inc. v. Commissioner, 242 F. 2d 803, 807 (C.A. 7, 1957), reversing 25 T.C. 262">25 T.C. 262 (1955).

In arriving at its conclusion, the court relied upon and cited with approval American Stand. Watch Co. v. Commissioner, 229 F. 2d 672 (C.A. 2, 1956).

Adopting the reasoning of Fendrich, supra, May Broadcasting Co. v. Commissioner, 299 F. 2d 84 (C.A. 8, 1962), reversing 33 T.C. 1007">33 T.C. 1007 (1960), after a dissent in which seven members of the present Tax Court concurred, declares that (p. 89) --

[a] valid basis exists for a Congressional desire to suspend the statute of limitations upon the filing of a § 722 application. The excess profits law presents many complex problems. The record here shows that the taxpayer's application * * * was not acted upon until more than 9 years after its filing * * *

Of course, as in any statute of limitations situation, the Commissioner could have protected himself. But of what avail to the parties or to this Court would a premature denial of section 722 relief be?

Nor is Commissioner v. F. W. Poe Mfg. Co., 245 F. 2d 8 (C.A. 4, 1957), affirming on other grounds 25 T.C. 691">25 T.C. 691 (1956), any authority for the present result. Quite the contrary. Judge Parker makes it clear (pp. 9, 11) --

that the reasoning of the Tax Court was erroneous and that the correct rule is that stated by the 7th Circuit [in Fendrich]. * * * Only the invoking of relief under section 722 could free the matters embraced in the standard issues from the bar of the statute of limitations. * * *.

* * * *

[This] case is just as though no relief under that section had been asked.

Only the comparatively early case of Commissioner v. S. Frieder & Sons Co., 247 F. 2d 834 (C.A. 3, 1957), affirming a Memorandum Opinion of this Court, superficially appears to hold to the contrary. But on examination it is apparent that the holding is in accord with F. W. Poe Mfg. Co., supra, for in Frieder (p. 838) "the taxpayer * * * has agreed to withdraw its [sec. 722] claim if the Tax Court is sustained on the statute of limitations issue." And Frieder must be compared with the most recent and interesting of all the authorities in this field. In Overland Corporation v. Commissioner, 316 F. 2d 777 (C.A. 6, 1963), reversing 34 T.C. 1001">34 T.C. 1001 (1960), both the Commissioner and the taxpayer were contending for standard-issue consideration despite the bar of the statute of limitations. The court held, after quoting at length from Fendrich and May Broadcasting Co.:

From consideration of the applicable statutes and the foregoing authorities we conclude: * * * (4) that the decision of the Tax Court should be reversed and these cases remanded to that court for determination on the merits of all claims of Overland for relief and refund of taxes and the Commissioner's claims for deficiency assessments.

Of course, invocation of the doctrine of Lewis v. Reynolds, 284 U.S. 281 (1932), would mitigate somewhat the detriment to respondent of the effect of the statute of limitations if we were not also granting relief under section 722. But it is not clear to me whether this theory applies also to section 722 refunds; ^{section 722 itself, I respectfully dissent on the commitment issue. It seems to me that under the interchange agreement petitioner was committed prior to the end of 1939 to take and pay for an indefinite but ascertainable amount of energy to be generated by the 25,000-kilowatt steam unit to the construction of which the Connecticut Power Company had in turn become committed on December 27, 1939. This was a change in capacity deemed to be a change in the character of petitioner's business on December 31, 1939. Studio Theatre Inc., 18 T.C. 548">18 T.C. 548 (1952). It may be that we should have to determine from the applicable evidence what the amount to be added would be, but this is a familiar task under section 722. See Blaisdell Pencil Co., 1469">16 T.C. 1469 (1951).}

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Footnotes

• 1. Except as otherwise noted the Code sections referred to herein are the Internal Revenue Code of 1939, as amended.↩

• 1. Interchange receipts were from the Connecticut Valley Power Exchange in 1936, and from the Connecticut Power Co. in 1938 and 1939.↩

• 2. Line losses of energy in the course of transmission and distribution.↩

• 1. Represents the number of meters for power sales to other utility companies.↩

• 2. Represents the number of street lamps in service on December 31 of each year located in the following number of cities: 73 for 1935; 74 for 1936; 75 for 1937; 76 for 1938; and 77 for 1939.↩

• 3. Represents the number of railroads or street railways to which power was supplied. Petitioner sold electric power to the New York, New Haven & Hartford RR. throughout the base period and thereafter. Petitioner stopped selling electric power to the Connecticut Co. in 1927 and to the Connecticut Railway & Lighting Co. in 1938, when those companies ceased their streetcar operations.↩

• 1. Includes ironers, heating appliances, lamp kits, radios, etc.↩

• 1. Operating expenses for year 1938 include deduction for hurricane loss.↩

• 1. Kilowatt-hours sold divided by number of meters.↩

• 2. This date is as per stipulation par. 46, while stipulation par. 48 as to petitioner's long-term indebtedness at Dec. 31, 1936, does not include series C and D on that date.↩

• 1. Amortization of bond discount and expenses on bonds outstanding for 1939, reduced by the amortization premium applicable to series H bonds.↩

• 3. SEC. 722. GENERAL RELIEF -- CONSTRUCTIVE AVERAGE BASE PERIOD NET INCOME.

  (a) General Rule. -- In any case in which the taxpayer establishes that the tax computed under this subchapter (without the benefit of this section) results in an excessive and discriminatory tax and establishes what would be a fair and just amount representing normal earnings to be used as a constructive average base period net income for the purposes of an excess profits tax based upon comparison of normal earnings and earnings during an excess profits tax period, the tax shall be determined by using such constructive average base period net income in lieu of the average base period net income otherwise determined under this subchapter. In determining such constructive average base period net income, no regard shall be had to events or conditions affecting the taxpayer, the industry of which it is a member, or taxpayers generally occurring or existing after December 31, 1939, except that, in cases described in the last sentence of section 722(b)(4) and in section 722(c), regard shall be had to the change in the character of the business under section 722(b)(4) or the nature of the taxpayer and the character of its business under section 722(c) to the extent necessary to establish the normal earnings to be used as the constructive average base period net income.

  (b) Taxpayers Using Average Earnings Method. -- The tax computed under this sub-chapter (without the benefit of this section) shall be considered to be excessive and discriminatory in the case of a taxpayer entitled to use the excess profits credit based on income pursuant to section 713, if its average base period net income is an inadequate standard of normal earnings because --

  * * * *

  (4) the taxpayer, either during or immediately prior to the base period, commenced business or changed the character of the business and the average base period net income does not reflect the normal operation for the entire base period of the business. If the business of the taxpayer did not reach, by the end of the base period, the earning level which it would have reached if the taxpayer had commenced business or made the change in the character of the business two years before it did so, it shall be deemed to have commenced the business or made the change at such earlier time. For the purpose of this subparagraph, the term "change in the character of the business" includes a change in the operation or management of the business, a difference in the products or services furnished, a difference in the capacity for production or operation * * *. Any change in the capacity for production or operation of the business consummated during any taxable year ending after December 31, 1939, as a result of a course of action to which the taxpayer was committed prior to January 1, 1940, * * * shall be deemed to be a change on December 31, 1939, in the character of the business, * * *↩

• 4. SEC. 732. REVIEW OF ABNORMALITIES BY BOARD OF TAX APPEALS [NOW THE TAX COURT OF THE UNITED STATES].

  (a) Petition to the Board. -- If a claim for refund of tax under this subchapter for any taxable year is disallowed in whole or in part by the Commissioner, and the disallowance relates to the application of section 711(b)(1) (H), (I), (J), or (K), section 721, or section 722, relating to abnormalities, the Commissioner shall send notice of such disallowance to the taxpayer by registered mail. Within ninety days after such notice is mailed (not counting Sunday or a legal holiday in the District of Columbia as the ninetieth day) the taxpayer may file a petition with the Board of Tax Appeals for a redetermination of the tax under this subchapter. If such petition is so filed, such notice of disallowance shall be deemed to be a notice of deficiency for all purposes relating to the assessment and collection of taxes or the refund or credit of overpayments.

  (b) Deficiency Found by Board in Case of Claim. -- If the Board finds that there is no overpayment of tax in respect of any taxable year in respect of which the Commissioner had disallowed, in whole or in part, a claim for refund described in subsection (a) and the Board further finds that there is a deficiency for such year, the Board shall have jurisdiction to determine the amount of such deficiency and such amount shall, when the decision of the Board becomes final, be assessed and shall be paid upon notice and demand from the collector.↩

• 5. SEC. 713. EXCESS PROFITS CREDIT -- BASED ON INCOME.

  (a) Amount of Excess Profits Credit. -- The excess profits credit for any taxable year, computed under this section, shall be --

  (1) Domestic corporations. -- In the case of a domestic corporation --

  (A) 95 per centum of the average base period net income, as defined in subsection (d),

  (B) Plus 8 per centum of the net capital addition as defined in subsection (g), or

  (C) Minus 6 per centum of the net capital reduction as defined in subsection (g).

  * * * *

  (g) Adjustments in Excess Profits Credit on Account of Capital Changes. -- For the purposes of this section --

  (1) The net capital addition for the taxable year shall be the excess, divided by the number of days in the taxable year, of the aggregate of the daily capital addition for each day of the taxable year over the aggregate of the daily capital reduction for each day of the taxable year.

  (2) The net capital reduction for the taxable year shall be the excess, divided by the number of days in the taxable year, of the aggregate of the daily capital reduction for each day of the taxable year over the aggregate of the daily capital addition for each day of the taxable year.

  * * * *

  (4) The daily capital reduction for any day of the taxable year shall be the aggregate of the amounts of distributions to shareholders, not out of earnings and profits, after the beginning of the taxpayer's first taxable year under this subchapter and prior to such day.↩

• 1. H. Fendrich, Inc. v. Commissioner, 192 F. 2d 916↩ (C.A. 7, 1951).

• 2. "We do not reach the question whether the taxpayer could find refuge in the statute of limitations if the government were claiming equitable diminution of a refund otherwise payable to the taxpayer. Cf. Stone v. White, 1937, 301 U.S. 532">301 U.S. 532 * * *; Lewis v. Reynolds, 1932, 284 U.S. 281">284 U.S. 281 * * *." Commissioner v. S. Frieder & Sons Co., 247 F.2d 834">247 F. 2d 834, 838↩.