Opinion
Docket No. 15986.
1949-09-13
GLENSHAW GLASS COMPANY, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Max Swiren, Esq., Joseph D. Block, Esq., and Sidney B. Gambill, Esq., for the petitioner. Hobby H. McCall, Esq., for the respondent.
1. During the base period years petitioner, a glass container manufacturer, paid royalties to Hartford-Empire Co. under a contract which it had with that company. These royalty payments were allowed as deductions by the Commissioner in computing petitioner's net income for the base period years. In a subsequent year these payments were recovered by petitioner as the result of a suit based on the ground that they had been made because of a patent and injunction decree obtained by fraud by Hartford-Empire Co. Held, petitioner's payments of these royalties during the base period years were made under contract and not in settlement of any liability created by a court judgment or decree and do not come within the provisions of section 711(b)(1)(H), I.R.C.; held, further, that $11,020.90 paid by petitioner to Hartford-Empire Co. pursuant to a final decree entered February 10, 1939, by the United States District Court for the Western District of Pennsylvania was a payment which falls within the provisions of section 711(b)(1)(H), and it was abnormal to petitioner and should be disallowed to the extent of $9,316.39 (the amount allowed as a deduction by the Commissioner in 1939) as a deduction in computing petitioner's excess profits credit for the taxable years.
2. Petitioner paid its executives $125,042.65 and $132,930.52 as salaries and bonuses for the taxable years ended September 30, 1943 and 1944, respectively. Held, the salaries are properly deductible as being reasonable compensation for the respective years. Max Swiren, Esq., Joseph D. Block, Esq., and Sidney B. Gambill, Esq., for the petitioner. Hobby H. McCall, Esq., for the respondent.
This proceeding involves deficiencies in excess profits taxes in the amounts of $70,972.35 and $90,410.61 for the taxable years ended September 30, 1943 and 1944, respectively. The deficiencies are primarily due to the disallowance of certain compensation of officers for the years 1943 and 1944, which was explained in a statement attached to the deficiency notice as follows:
1943
The amounts claimed as deductions from gross income for the fiscal year ended September 30, 1943, and alleged to represent compensation of officers, have been adjusted as follows:
+-------------------------------------------------+ ¦Officer ¦Claimed ¦Allowed ¦Disallowed¦ +---------------+-----------+----------+----------¦ ¦Samuel B. Meyer¦$43,347.55 ¦$24,000.00¦$19,347.55¦ +---------------+-----------+----------+----------¦ ¦George W. Meyer¦41,347.55 ¦22,000.00 ¦19,347.55 ¦ +---------------+-----------+----------+----------¦ ¦Albert C. Meyer¦40,347.55 ¦21,000.00 ¦19,347.55 ¦ +---------------+-----------+----------+----------¦ ¦Totals ¦$125,042.65¦$67,000.00¦$58,042.65¦ +-------------------------------------------------+
1944
* * * for the fiscal year ended September 30, 1944 * * * :
+-------------------------------------------------+ ¦Officer ¦Claimed ¦Allowed ¦Disallowed¦ +---------------+-----------+----------+----------¦ ¦Samuel B. Meyer¦$45,976.84 ¦$24,000.00¦$21,976.84¦ +---------------+-----------+----------+----------¦ ¦George W. Meyer¦43,976.84 ¦22,000.00 ¦21,976.84 ¦ +---------------+-----------+----------+----------¦ ¦Albert C. Meyer¦42,976.84 ¦21,000.00 ¦21,976.84 ¦ +---------------+-----------+----------+----------¦ ¦Totals ¦$132,930.52¦$67,000.00¦$65,930.52¦ +-------------------------------------------------+
By appropriate assignments of error petitioner contests these adjustments. Other adjustments contested by petitioner were settled during this proceeding. In addition to contesting the adjustment of officers' compensation, petitioner alleges in the pleadings that certain deductions should be restored to base period income for the purpose of determining petitioner's excess profits tax credit for the taxable years involved herein.
There are, therefore, two issues for us to decide: (1) Whether certain deductions should be disallowed and restored to excess profits net income for the purposes of determining petitioner's excess profits credit; and (2) whether certain sums paid petitioner's officers as compensation are allowable deductions.
FINDINGS OF FACT.
Generally.— The petitioner is a Pennsylvania corporation, organized in 1900 as the successor to a limited association formed in 1895. Its principal office and place of business is in Glenshaw, Pennsylvania. From the date of its incorporation to the present time petitioner has been continuously engaged in the manufacture of glass bottles and glass containers. For the taxable years here involved petitioner's tax returns were filed with the collector of internal revenue for the twenty-third district of Pennsylvania.
Issue 1.— In the base period years the following amounts were paid by petitioner to Hartford-Empire Co. (hereinafter sometimes referred to as Hartford) as royalties on glass-feeding machines, and were claimed and allowed as deductions in petitioner's returns for the years ended September 30 as indicated:
+-------------------+ ¦1937¦$69,107.22 ¦ +----+--------------¦ ¦1938¦60,630.58 ¦ +----+--------------¦ ¦1939¦* 82,115.88 ¦ +----+--------------¦ ¦1940¦78,356.59 ¦ +----+--------------¦ ¦ ¦ ¦ +-------------------+
FN* It is stipulated that included in the $82,115.88 is $9,316.39 which represents the portion allowed by the respondent of the $11,020.90 paid to Hartford in 1939 pursuant to the provisions of the permanent injunction entered October 19, 1934
All of the payments tabulated above with the exception of the $9,316.39 were made to Hartford as royalties on feeders.
From 1923 until 1932 petitioner used and operated only glass-feeding machines under license agreements with Hartford providing for payment of royalties upon all production from such feeders and limiting the type of containers which petitioner could produce therewith. Each license agreement contained the provision permitting its termination by petitioner upon the payment of a prescribed lump sum minimum royalty. Pursuant to the license agreements, royalties were paid by petitioner to Hartford from 1923 through the fiscal year ended September 30, 1940.
In 1931 and in the forepart of 1932 the petitioner, the McKee Glass Co., George R. Haub and others formed the Shawkee Manufacturing Co. for the purpose of building and selling a new glass feeder. During 1931 and in the forepart of 1932 Haub developed and built in petitioner's plant a new feeder, known as the Shawkee feeder. Petitioner received a nonexclusive license to use the Shawkee feeder free from the payment of any royalties. In March and May, 1932, petitioner installed two Shawkee feeders, replacing two Howard (Hartford licensed) feeders. In April and May, 1933, two additional Shawkee feeders were installed in petitioner's plant. The Shawkee feeder proved to be an efficient, workable feeder, equal to those covered by the Hartford licenses.
On May 31, 1933, Hartford filed suit against petitioner, Shawkee, and others in the United States District Court for the Western District of Pennsylvania, entitled Hartford-Empire Co. v. Shawkee Manufacturing Co., et al., Docket No. 2791. On the basis of an earlier decision in Hartford-Empire Co. v. Hazel-Atlas Glass Co. (CCA-3), 59 Fed.(2d) 399, the complaint charged that the Shawkee feeder infringed the patent owned by Hartford. Relying on the Hazel-Atlas decision, the District Court, on June 27, 1933, entered a preliminary injunction which restrained the defendants from selling Shawkee feeders, but did not apply to the continued use of Shawkee feeders by petitioner. At the time the preliminary injunction was entered, petitioner had removed two Howard feeders and had installed four Shawkee feeders. Thereafter, upon advice of counsel, petitioner decided to proceed more slowly in outfitting its plant with Shawkee feeders and to defer termination of the Hartford licenses agreements pending the outcome of the litigation.
Relying upon its earlier decision in the Hazel-Atlas case, supra, the Court of Appeals for the Third Circuit affirmed the order for the preliminary injunction. Shawkee Mfg. Co. v. Hartford-Empire Co., 68 Fed.(2d) 726. Pursuant to the mandate of the Court of Appeals for the Third Circuit, the District Court entered an order for a permanent injunction on October 19, 1934, restraining the manufacture, sale, and use of Shawkee feeders by petitioner and others and directing an accounting to Hartford. On February 10, 1939, the District Court issued the final decree, the parties having concluded the accounting by a settlement between them. Petitioner paid Hartford the sum of $11,020.90 in settlement of the accounting for royalties on the production of the royalty-free Shawkee feeders. Of this amount, respondent allowed $9,316.39. This settlement was the result of the injunction of October 19, 1934, which remained in effect by the decree of February 10, 1939.
On the date of the permanent injunction, October 19, 1934, petitioner had seven royalty-free Shawkee feeders in operation and was manufacturing 65 per cent of its total production on these machines. It had by then dismantled five Howard (Hartford licensed) feeders. Upon the issuance of the permanent injunction the royalty-free Shawkee feeders were dismantled. In order to do business and and comply with the injunction it was necessary for petitioner to reinstall, and it did reinstall, the Howard feeders and pay royalties as provided in the license agreements, which it did until December 1, 1940. Were it not for the injunction of 1934, petitioner would have continued to install royalty-free Shawkee feeders to replace the Howard feeders.
After December 1940, petitioner made the decision to discontinue all further payments of feeder royalties to Hartford. This decision was the result of information disclosed in antitrust proceedings prosecuted against Hartford. Based upon documents uncovered in that case, proceedings were instituted in 1941 charging that the judgment entered in 1932 in Hartford-Empire Co. v. Hazel-Atlas Glass Co., supra, had been secured through fraud and that the Hazel-Atlas judgment was fraudulently employed to secure the permanent injunction against petitioner in 1934 in Shawkee Mfg. Co. v. Hartford-Empire Co., supra. Simultaneously, Hazel-Altas Glass Co. filed its petition making the same charges of fraud in the procurement of the judgment against it. The proceedings were consolidated for hearing and the applications to vacate the judgments were denied by a divided court. On appeal, the Supreme Court of the United States in 1944 ordered both the judgment against Hazel-Atlas and the judgment against petitioner set aside upon the grounds of fraud. Hazel-Atlas Glass co. v. Hartford-Empire Co., 322 U.S. 238; Shawkee Manufacturing Co. v. Hartford-Empire Co., 322 U.S. 271. The Supreme Court ordered that the fraudulently obtained judgment entered against petitioner in 1934 be annulled and set aside, that Hartford's bill of complaint be dismissed, and that petitioner be permitted to bring appropriate proceedings for restitution and damages. Such proceedings for restitution and damages were brought and culminated in a decision by the United States Court of Appeals for the Third Circuit in Hartford-Empire Co. v. Shawkee Mfg. Co., 163 Fed. (2d) 474, holding (a) that petitioner would not have paid the feeder royalties to Hartford but for the fraudulently induced 1934 injunction, and (b) that petitioner was entitled to restitution of such royalties. The Circuit Court of Appeals remanded the case for further proceedings in conformity with its opinion. Thereafter, in settlement of the entire matter, Hartford paid petitioner the sum of approximately $813,000.
The payment of $11,020.90 by petitioner to Hartford-Empire Co. pursuant to the final decree entered February 10, 1939, by the United States District Court for the Western District of Pennsylvania was attributable to that court decree and the deduction of the payment was ‘abnormal‘ for petitioner as that term is used in section 711(b)(1)(H) of the Internal Revenue Code. The abnormality was not a consequence of an increase in the gross income of petitioner in its base period or a decrease in the amount of some other deduction in its base period, and was not a consequence of a change at any time in the type, manner of operation, size, or condition of the business engaged in by the taxpayer. Petitioner ceased paying feeder royalties to Hartford in 1941, simultaneously with its discovery of Hartford's fraud and the commencement of its successful attack upon the decree. Petitioner has not paid feeder royalties to Hartford or taken deductions therefor since that time.
Issue 2.— Petitioner's executives were the three Meyer brothers, Samuel B., George W., and Albert C., who had been associated with petitioner for 42, 37, and 48 years, respectively. During the taxable years involved herein Samuel B. was president, treasurer, general manager, and sales manager; George W. was secretary, assistant treasurer, and assistant general manager in complete charge of production; and Albert C. was in charge of engineering, designing, and product improvement. These three brothers were especially well qualified to conduct the business of petitioner. From the time of their undertaking the management in 1921 the financial condition and growth of the company were outstanding in their consistency and extent. From 1928 to 1944 petitioner's growth exceeded the average of the industry. Petitioner made a net profit in every year for the 22 years ended September 30, 1944, and a dividend was paid in each year with the exception of 1934. There has been a consistent and material increase in plant and equipment, all of which has been financed from earnings. The dividends for the taxable years 1943 and 1944 amounted to 22 to 24 per cent, respectively.
During the taxable years and for many years prior thereto petitioner operated its plant 24 hours, 7 days a week, employing approximately 450 persons. In the taxable years the 3 executives had no assistants and as a consequence worked long hours, with but one vacation in the last 10 or 15 years. These executives were instrumental in the development of the Shawkee feeder and contributed to the advancement of the art of glass container manufacturing.
During the taxable years the responsibilities and duties of the petitioner's officers had materially increased, due both to large increases in production and sales and to the difficulties of wartime operations. The average net sales of the petitioner for the four years 1936-1939 amounted to $1,704,662.69. The net sales for the taxable year 1943 were $3,033,221.12, or an increase of 77 per cent, and for 1944 were $3,055,517.05, or an increase of 79 per cent. The average sales for the taxable years 1941 and 1942 were $2,558,610.57, with the taxable year 1943 and the taxable year 1944 each registering increases of approximately 18 per cent over this average. During the war years, although procurement of orders presented relatively no problem, numerous other problems arose to engage the attention of the management. Difficulties in the allocation of orders among customers, in complying with numerous regulations, in the maintenance and replacement of equipment, in obtaining, training, and holding labor, and in obtaining allocations of scarce raw materials, all imposed additional duties and responsibilities.
Being engaged in the manufacture of beverage ware, as distinguished from food containers, petitioner did not receive the advantage of Government allocations of raw materials. Moreover, in order to get the greatest amount of packaging with the least amount of raw materials, the War Production Board required the production of light weight containers. The manufacture of light weight containers required the maintenance of all operating equipment at maximum operating efficiency, highly skilled designing of mold equipment, a retraining of supervisors and labor force comparable to that required when embarking upon the manufacture of a new line of production, and, in general, materially increased the duties of the executives. Resourcefulness and ingenuity were required to maintain the petitioner's operation upon the 24-hour basis necessary to efficiency. That this was done with superior ability is evidenced by the fact that the petitioner was operating at 120 per cent of its rated capacity, or at close to its absolute maximum. Moreover, the petitioner's increase in volume, unlike that of many other companies, was not entirely war induced. In 1940 petitioner was operating at 104 per cent of its rated capacity, while the industry was operating at but 68.5 per cent. During the taxable years petitioner attained a rate of production of 113 per cent and 120 per cent, respectively, of its rated capacity.
On June 30, 1939, a voting trust was executed in which 3,017 shares (51 per cent of the outstanding stock) were deposited. Samuel B., George W., and Albert C. Meyer were the trustees and had the exclusive power to vote the stock deposited therein. The voting trust was to terminate before 10 years only if 80 per cent of the holders of the voting trust certificates approved such action. The Meyer brothers owned or voted in the taxable years 1943 and 1944 over 80 per cent of the shares on deposit in the voting trust.
At a meeting of petitioner's board of directors held on November 18, 1942, a salary of $24,000 for the taxable year 1943 was voted to Samuel B. Meyer, $22,000 to George W. Meyer, and $21,000 to Albert C. Meyer, plus, in each case, an additional sum equal to 7 1/2 per cent of the net profits of the company for the fiscal year ended September 30, 1943, after the deduction of the sum of $45,000 (equal to a return of 15 per cent upon the capital stock.) By subsequent action an additional sum of $110,000 (equal to the estimated reserve necessary to provide for royalties in the event of the loss of the Hartford-Empire litigation) was deductible from net profits prior to the computation of the 7 1/2 per cent bonus. At a meeting of the board of directors on December 1, 1943, the same compensation was voted for the taxable year 1944. In that year the deduction of the reserve for the Hartford-Empire litigation amounted to $100,000, rather than $110,000. These large reserves were never needed or used, and after the successful outcome of the Hartford-Empire litigation they were returned to earned surplus. In each of the taxable years here involved an additional sum equal to 7 1/2 per cent of the net profits of the petitioner, calculated on the same basis, was divided among other employees.
By virtue of the foregoing, the three named officers of the petitioner received the following compensation in the taxable years:
+----------------------------------------------------+ ¦ ¦Samuel B. Meyer¦George W. Meyer¦Albert C. Meyer¦ +----+---------------+---------------+---------------¦ ¦1943¦$43,347.55 ¦$41,347.55 ¦$40,347.55 ¦ +----+---------------+---------------+---------------¦ ¦1944¦45,976.84 ¦43,976.84 ¦42,976.84 ¦ +----------------------------------------------------+
As disclosed by the notice of deficiency, the Commissioner disallowed all deductions over and above the base salaries of $24,000, $22,000, and $21,000, respectively. This resulted in the disallowance of the deductions to the extent of $58,042.65 for the taxable year 1943 and $65,930.52 for the taxable year 1944.
The board of directors for the taxable years herein consisted of Samuel B. Meyer, Albert C. Meyer, George W. Meyer, John A. Berner, J. Howard Beck, John W. Heinl, Jr., and Thomas A. Murphy. Heinl and Murphy were the only persons not related to the Meyer brothers or their wives who deposited their stock certificates in the voting trust, and Heinl and Murphy received the largest bonus from petitioner, with the exception of the Meyer brothers. The board of directors acted as an independent body in making its decisions.
The compensation paid to the three principal executive officers in each of the taxable years bore no relation to their stockholdings and was not a distribution of dividends in any respect. For many years prior to the taxable years herein the Meyer brothers' salaries were low.
The compensation paid to the three Meyer brothers, totaling $125,042.65 and $132,930.52 for the fiscal years ended September 30, 1943 and 1944, respectively, was reasonable for services actually rendered to petitioner, and petitioner's allocation of the salaries among the three executives was a proper allocation.
OPINION.
BLACK, Judge:
Issue 1.— The question presented under this issue is whether the royalty payments during the base period years were attributable to the fraudulently induced decree and were abnormal deductions for petitioner and should, therefore, be restored to petitioner's base period income for the purpose of determining its excess profits tax credit for the taxable years herein. Petitioner contends that these royalty payments were (1) attributable to the decree and (2) were abnormal deductions for petitioner and therefore are within the meaning of section 711(b)(1)(H) of the Internal Revenue Code. The pertinent provisions of the Internal Revenue Code are printed in the margin.
Decision will be entered under Rule 50. SEC. 711. EXCESS PROFITS NET INCOME.(b) TAXABLE YEARS IN BASE PERIOD.—(1) GENERAL RULE AND ADJUSTMENTS.— The excess profits net income for any taxable year subject to the Revenue Act of 1936 shall be the normal-tax net income, as defined in section 13(a) of such Act; and for any other taxable year beginning after December 31, 1937, and before January 1, 1940, shall be the special-class net income, as defined in section 14(a) of the applicable revenue law. In either case the following adjustments shall be made (for additional adjustments in case of certain reorganizations, see section 742 (e)):(H) Payment of Judgments, and So Forth.— Deductions attributable to any claim, award, judgment, or decree against the taxpayer, or interest on any of the foregoing, if abnormal for the taxpayer, shall not be allowed, and if normal for the taxpayer, but in excess of 125 per centum of the average amount of such deductions in the four previous taxable years, shall be disallowed in an amount equal to such excess;(K) Rules for Application of Subparagraphs (H), (I), and (J).— For the purposes of subparagraphs (H), (I) and (J)—(ii) Deductions shall not be disallowed under such subparagraphs unless the taxpayer establishes that the abnormality or excess is not a consequence of an increase in the gross income of the taxpayer in its base period or a decrease in the amount of some other deduction in its base period, and is not a consequence of a change at any time in the type, manner of operation, size, or condition of the business engaged in by the taxpayer.
Respondent contends that the evidence shows that the subject amounts paid to Hartford-Empire Co., with the exception of the $11,020.90 paid on or before the date of the court decree entered February 10, 1939, during the base period years were paid as royalties pursuant to contracts in existence prior to the decree. Respondent further contends that the stipulated royalties paid to Hartford in 1937, 1938, 1939, and 1940, with the exception of the $11,020.90 mentioned, were not paid pursuant to any court decree and, therefore, do not fall within the provisions of section 711(b)(1)(H) upon which petitioner relies. We think these contentions of respondent must be sustained. Petitioner contends that the payments in question were royalties paid in accordance with the terms fixed in its contract with Hartford, but contends that if it had not been for the court injunction it would have terminated its contract with Hartford and used Shawkee feeders, for which it would have had to pay no royalties. Petitioner's contention in this respect is stated by its president in his testimony as follows:
We paid royalties to Hartford during these years because we had to pay them. We were under injunction by the Court that we could not use the Shawkee feeder and there weren't any other feeders that we could get that would produce bottles. So that we could continue in business we were forced to pay royalties to Hartford. That is why we paid it.
Giving full faith and credit to this testimony and other similar testimony in the record, we still think it is clear that the payments here involved, with the exception of the $11,020.90, were paid as royalties under a contract and were not payments ‘attributable to any * * * decree against the taxpayer ‘ within the meaning of section 711(b)(1)(H). The title of subparagraph (H) is ‘Payment of Judgments, and So Forth.‘ These payments here involved were not made in payment of any liability under a judgment or decree. We think that in order for petitioner to prevail in its contentions it would have to make a showing that the payments in question were made in discharge of a liability imposed by a judgment or decree. Such seems to have been the intent of Congress in enacting subparagraph (H). The report of the congressional committee of conference on the Second Revenue Act of 1940 had this to say about the subject section of the Internal Revenue Code:
(8) An additional adjustment was provided, applicable only to taxable years in the base period, to the effect that deductions attributable to any claim, award, judgment, or decree against the taxpayer, or interest thereon, would not be required to be taken into account if, in the light of the taxpayer's business, it is abnormal for the taxpayer to incur a liability of such character or, if the taxpayer normally incurs liabilities of such character, the amount of the particular liabilities of such character in the taxable year is grossly disproportionate to the average amount of liabilities of such character in each of the four previous taxable years. (1940-2 C.B. 651.)
From this, it seems to us, that Congress clearly intended for the ‘judgment or decree‘ to be in the nature of a liability.
Petitioner, in urging that the payments in question should be held to be ‘attributable to any * * * decree against the taxpayer‘ within the meaning of subparagraph (H), strongly relies on Hartford-Empire Co. v. Shawkee Mfg. Co., supra (163 Fed.(2d) 474). We do not think that case is in point here. It did not in any sense involve an interpretation of 711(b)(1)(H). One of the main things decided in that case was that, where patent and injunction decrees were procured by fraud, royalty payments made by defendants because an injunction forced them to retain royalty contracts with plaintiff could be recovered by defendants with interest, even though an injunction bond had not been given. We have no such question here. The effect of that suit was to permit petitioner to have restitution of all the royalties that it had paid Hartford during the base period years, plus expenses which it had incurred and also damages. Petitioner had paid out those royalties during 1937, 1938, 1939, and 1940 under its contract with Hartford; it had received deductions for them in the respective years, not as payments of any judgment or decree, but as payments of royalties, which they were. The Commissioner properly allowed the deductions as royalties. The beginning of our findings of fact on issue 1 states: ‘In the base period years the following amounts were paid by petitioner to Hartford-Empire Co. * * * as royalties on glass-feeding machines, and were claimed and allowed as deductions * * * .‘ This finding is based on a stipulation of the parties. The fact that in a subsequent year it was discovered that these payments were obtained by fraud and petitioner was able to obtain restitution of the payments on that ground, it seems to us, does not alter the nature of the deductions in the years when they were claimed and allowed. It had been perfectly normal for many years for petitioner to pay royalties to Hartford. We do not think it was abnormal within the meaning of the statutes for it to pay them during the base period years here involved. It would doubtless have been abnormal, as we have already said, if they had paid these royalties in settlement of a court judgment or decree, but, as we have endeavored to point out, this was not done.
What we have said above does not apply to $11,020.90 which it is stipulated was paid by the petitioner to Hartford pursuant to the final decree entered February 10, 1939, by the United States District Court for the Western District of Pennsylvania in proceedings in equity No. 2791, entitled Hartford-Empire Company v. Shawkee Manufacturing Company, et al., and of which amount the petitioner was allowed by respondent a deduction of $9,316.39 for the taxable year ended September 30, 1939. It seems to us that this $11,020.90 payment clearly comes within the provisions of section 711(b)(1)(H) and that the $9,316.39 of this amount which was allowed as a deduction by the Commissioner in 1939 should be disallowed (restored to income) in computing petitioner's excess profits credit under Rule 50. We so hold.
Issue 2.— The question presented under this issue is whether respondent erred in disallowing certain compensation paid by petitioner to three of its officers. Respondent contends that the amount paid the three executive officers of petitioner is not reasonable compensation for services. The applicable section of the Internal Revenue Code is printed in the margin.
SEC. 23. DEDUCTIONS FROM GROSS INCOME.In computing net income there shall be allowed as deductions:(a) EXPENSES.—(1) TRADE OR BUSINESS EXPENSES.—(A) In General.— All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered; traveling expenses (including the entire amount expended for meals and lodging) while away from home in the pursuit of a trade or business; and rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity.
In a former proceeding, Glenshaw Glass Co. (unpublished memorandum opinion, Oct. 14, 1946); affirmed per curiam (CCA-3), Oct. 21, 1947; certiorari denied, 333 U.S. 842, we held that for the year 1942 petitioner had not carried its burden of establishing that certain bonuses paid petitioner's executives were not, in fact, distributed as profits in the guise of compensation. We have before us now the tax years 1943 and 1944 in which bonuses were paid the same executives under a plan similar to the plan of 1942. However, in each of the three years separate action was taken by the board of directors establishing the bonus plan. Not only are the three bonus plans for the respective years separable, but a finding as to the reasonableness of salaries for the years 1943 and 1944 is necessarily based upon different factors, e.g., an increase in sales and profits and a heavier burden upon the executive officers. The finding made in Glenshaw Glass Co., supra, on the question of salaries for 1942 does not make res judicata the question of the reasonableness of salaries for 1943 and 1944. Commissioner v. Sunnen, 333 U.S. 591. Cf. National Bank of Commerce of Seattle, 12 T.C. 717; Maud H. Bush, 10 T.C. 1110. The matter raised in this proceeding is not, in the language of the Sunnen case, supra, ‘identical in all respects with that decided in the first proceeding. ‘ We do not have here ‘the very same facts and no others.‘ Therefore, the reasonableness of salaries for 1943 and 1944 is not res judicata and we are free to examine all the evidence in order that we may make a finding as to the reasonableness of salaries for these years.
Petitioner concedes that, if the amounts disallowed by respondent were a disguised distribution of profits, they are not deductible as a business expense. Botany Worsted Mills v. United States, 278 U.S. 282; Glenshaw Glass Co., supra. Petitioner has proved, however, to our satisfaction that the salaries paid were for services rendered and they were not a distribution of profits.
The board of directors acted as an independent body and, though the Meyer brothers controlled 51 per cent of the stock through the voting trust, it can not be said that they dominated the board of directors, nor is it possible to conclude that the salaries were a distribution of profits and hence a breach of the fiduciary duty to the detriment of the remaining stockholders. A voting trustee can not legally use his power for the aggrandizement, preference, or advantage of the fiduciary to the exclusion or detriment of the cestui. Cf. Pepper v. Litton, 308 U.S. 295. There is no evidence of a breach of this fiduciary obligation of the Meyer brothers and there is no reason to assume it.
A leading management engineer in the glass industry testified that petitioner ranked with the top glass manufacturers in the country and that he regarded the salaries, plus bonuses, paid in each taxable year as reasonable. Not only were the salaries paid during these years reasonable, but there is evidence showing that in prior years the executives of petitioner were receiving an unreasonably low salary.
The financial record of petitioner discloses that it has prospered since the Meyer brothers have managed it. The net worth of petitioner has increased steadily and profits have been earned in increasing amounts, with a like increase of dividends to petitioner's stockholders. Perhaps some of the increase in petitioner's business is attributable to the war; however, increased business meant increased work and new problems confronted petitioner's executives, for which they are entitled to compensation. Roth Office Equipment Co. v. Gallagher, 172 Fed.(2d) 452. There is evidence showing that petitioner's salaries were comparable to those of other manufacturers in the glass industry.
On the basis of all the evidence, including the work of the three executives and the record of petitioner in the glass industry, we hold that the salaries paid petitioner's three executives for the taxable years 1943 and 1944 were reasonable. Cf. Wright-Bernet, Inc. v. Commissioner, 172 Fed.(2d) 343. On this issue the Commissioner is reversed.