Opposition Brief — Glenshaw Glass Co. v. Commissioner

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CITATIONS

Cases:

Anderson v. Commissioner, decided December 17, 1947____ 11

Bingham, Trust of v. Commissioner, 325 U. 8. 365. _____- 6

Botany Mills v. United States, 278 U. 8S. 282_._...__-_.-- 6

Clinton Co. v. Commissioner, 159 F. 2d 102_____________- 7,9

Commissioner v. Flowers, 326 U. 8. 465____..-..____-_-- 6

Commissioner v. Heininger, 320 U. S. 467.__.__._______- 6

Credit Bureau of Greater N. Y. v. Commissioner, 162 F.

PEA Aken tet ehenhnkvhttiankannotinavbenn esse 12

Crescent Bed Co. v. Commissioner, 133 F. 2d 424_________ 8

Dawson v. Commissioner, 163 F. 2d 664___.._..._______- 12

Dobson v. Commissioner, 320 U. 8. 489___......-.___-_.- 10, 12

Heloering v. Rankin, 205 U. 8. 123. ._-.......-......-..- 10

Long Island Drug Co. v. Commissioner, 111 F. 2d 593,

certiorari denied, 311 U. 8. 680___..........-.....-. 6, 8,11

Mayers, L. & C., Co. v. Commissioner, 131 F. 3d 309, cer-

eran Genied, S16 U.S. 778... 3. nc nee es 9

McDonald v. Commissioner, 323 U.S. 57.._.._.__-_____-- 6

Miller Mfg. Co. v. Commissioner, 149 F. 2d 421__________ 8

og eR ge A SR eee ee 9

Securities Comm’n v. Chenery Corp., 332 U. 8. 194_______- 12

Wilmington Co. v. Helvering, 316 U.S. 164______________ 10

Statutes:

Administrative Procedure Act, c. 324, 60 Stat. 237,Sec.10_.. 9,10

Internal Revenue Code:

Sec. 23 (26 U. S. C. 1940 ed., Sec. 23)__.____.___- 6, 12,14

Sec. 1141 (26 U.S. C. 1940 ed., Sec. 1141)__________ 10

Miscellaneous:

I TC Ne a eo te er ee 10

92 Cong. Record, Part 2, pp. 2157-2159__...._.._._____- 10

(I)

776875—48——1 -

II

Miscellaneous—Continued Page

92 Cong. Record, p. A2087_.-...... .-.----------------- 10

8. Doc. No. 248, 79th Cong., 2d Sess.:

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Treasury Regulations 103:

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Anthe Supreme Court of the United States

Ocroser TERM, 1947

No. 537

GLENSHAW Grass Company, INC., PETITIONER

v.

CoMMISSIONER OF INTERNAL REVENUE

ON PETITION FOR A WRIT OF CERTIORARI TO THE UNITED

STATES CIROUIT COURT OF APPEALS FOR THE THIRD

CIRCUIT

BRIEF FOR THE RESPONDENT IN OPPOSITION

OPINIONS BELOW

The memorandum opinion of the Tax Court

(R. 156a-165a)* is not reported. The per curiam

opinion of the Circuit Court of Appeals (R. 167)

has not yet been reported.

JURISDICTION

The judgment of the Circuit Court of Appeals

was entered October 21, 1947. (R. 168.) The

petitioner for a writ of certiorari was filed Janu-

ary 17, 1948. The jurisdiction of this Court is

* Record references are to the separately bound printed

“Appendix” filed with taxpayer’s petition.

(1)

| :

invoked under Section 240 (a) of the Judicial

Code, as amended by the Act of February 13,

1925.

QUESTION PRESENTED

Whether the court belo-v erred in affirming the

Tax Court’s decision thay $67,000 was a reason-

able salary allowance under Section 23 (a) (1)

(A) of the Internal Revenue Code for the serv-

ices of taxpayer’s three officers and controlling

stockholders during its fiscal year 1942.

STATUTE AND REGULATIONS INVOLVED

These appear in the Appendix, infra, pp. 14-16.

STATEMENT

The facts found the Tax Court (R. 157a-161la)

may be summarized as follows:

Since its incorporation in 1900 taxpayer has

engaged in the manufacture of glass bottles and

containers. It reports its income on the basis of

fiscal years ending September 30. The three

Meyer brothers—Samuel, George, and Albert—

were associated with taxpayer for many years as

its executive officers. During the taxable years,’

Samuel was president, treasurer, general manager

and sales manager; George was secretary, assist-

ant treasurer, and assistant manager in charge of

‘Only the fiscal year 1942 is involved in this appeal. The

Tax Court overruled the Commissioner’s determination in

toto as to the fiscal year 1941, and in part as to the fiscal year

1942. (R. 163a-164a.) The Commissioner did not cross-

appeal.

-_—

production ; and Albert was in charge of engineer-

ing and designing. (R. 157a.) Taxpayer had 6,000

shares of stock outstanding, of which the Meyer

family owned 3,432 shares, the Beck and Berner

families respectively owned 1,437 and 958 shares,

and the remaining 173 shares were owned by

others. A voting trust formed in 1939 of which

the three Meyer brothers were the voting trustees

held 3,017 shares (about 51% of the total), of

which 2,958 were owned by the Meyer family, 48

by one Murphy, and 11 by one Heinl. Murphy

and Heinl were employees of taxpayer. The

board of directors during 1941 consisted of the

three Meyer brothers, Ruth Meyer (a sister), a

member of the Beck family (who was related to

Samuel Meyer’s wife), a member of the Berner

family, and Heinl. The board was the same dur-

ing 1942, except that Murphy was elected in place

of Ruth Meyer. (R. 158a, 162a.)

The Meyer brothers were eminently qualified to

conduct the business, and under their progressive

management taxpayer made a met profit in each of

the twenty years ending with 1942. It had paid

a dividend in each of those years except in 1934,

and in the taxable years the dividends totaled

16% of the capital stock. The book value of the

stock increased from less than $60 per share in

1921 to $212 in 1941 and $234 in 1942. Tax-

payer’s plant and equipment were modern, up-to-

date improvements being financed from earnings.

During the taxable years and for many years

a

4

prior thereto taxpayer operated on a 24-hour and

7-day week basis, and had an average of from

350 to 375 employees. The three Meyer brothers

had no executive assistants and worked long hours,

taking no vacations in the taxable years nor, with

one exception, in the previous 10 to 15 years.

(R. 157a-158a.) The net sales, the net income

before executives’ compensation and federal taxes,

the total salaries paid the three Meyer brothers,

the earned surplus, and the cash dividends, during

the 10-year period from 1933 through 1942 were as

follows (R. 159a) :

Net income

execu- Total Earned Cash

Year Net sales tive salaries | executive Jus dividend

and Federal | salaries — paid

taxes

ere $673, 751. 63 $93, 259. 45 $27,900.00 | $386, 805. 45 4.50

ee ee 692, 414. 69 36, 011. 25 20, 925. 00 304, 544.74 0.00

Ee 1, 099, 892. 20 31, 614. 78 27, 900. 00 395, 087. 72 1.00

DUONG Bicnddcntnnadenel 1, 374, 909. 55 133, 392. 57 27, 900. 00 468, 939. 85 4.00

RE ETL 1, 908, 865. 07 319, 009. 42 31, 000. 00 588, 103. 42 12.47

ERE aS 1, 622, 277. 34 104, 627. 55 37, 750. 00 616, 281. 11 1.00

eae 1, 912, 698. 81 209, 953. 39 37, 000. 00 764, 850. 18 2.25

SSS 2, 008, 039. 56 179, 977. 75 37, 000. 00 858, 252. 81 4.00

EE eclinicea nite 2, 416, 310. 93 249, 643. 24 67, 000. 00 950, 361. 84 8.00

Re eee 2, 700, 910. 21 447, 533. 127, 479. 85 983, 012. 09 8.00

The increase in sales for 1942 was due to higher

prices and the increased war demand for taxpay-

er’s products. (R. 163a.)

For the fiscal year ending September 30, 1941,

the annual salaries of the Meyer brothers had been

fixed at $14,000 for Samuel, $12,000 for George,

and $11,000 for Albert. At a meeting of tax-

payer’s board of directors held August 20, 1941,

it was resolved that additional compensation of

a

5

$10,000 be paid to each of the Meyer brothers;

this resolution was unanimously adopted and was

ratified at a stockholders’ meeting held November

19, 1941. At a subsequent meeting of the board

of directors, held February 4, 1942, it was re-

solved that for the fiscal year ending September

30, 1942, the annual compensation of the Meyer

brothers should be $24,000 for Samuel, $22,000

for George, and $21,000 for Albert; and that, in

addition to these fixed sums, each was to be paid,

on or before November 15, 1942, 714% of the net

profits of the company for that fiscal year com-

puted after deducting the sum of $45,000 but

before deducting income taxes and the percentage

of net profits to be paid to them. Each of the

Meyer brothers refrained from voting upon his

own compensation, and the resolutions were rati-

fied at a stockholders’ meeting on November 18,

1942. Later in the year 714% of the company’s

net profits based on a certain formula was set

aside for payment of bonuses to key employees.

(R. 159a-161a.)

In its 1941 and 1942 tax returns taxpayer de-

ducted $67,000 and $127,479.85, respectively, as

compensation paid to the three Meyer brothers.

The Commissioner determined that not more than

$37,000 constituted reasonable compensation in

each year, and disallowed deduction of the excess.

(R. 6a-7a, 163a-164a.) The Tax Court found

that $67,000 constituted reasonable compensation

in each year (R. 161a); accordingly it overruled

am ——y

6

the Commissioner’s determination in toto as to

the year 1941 and sustainéd it in part as to the

year 1942 (R. 161a-165a.). Taxpayer appealed

from that portion of the Tax Court’s decision

which partially sustained the Commissioner’s de-

termination for 1942. (R. 166a.) The Oircuit

Court of Appeals affirmed per curiam without an

opinion. (R. 167.)

ARGUMENT

1. Whether a salary payment is ‘‘reasonable,”’

and hence deductible as an “ordinary and neces-

sary’? business expense under Code Section

23 (a) (1) (A) and the long-standing applicable

Treasury Regulations (Appendix, infra), presents

a pure question of ultimate fact. Taxpayer had

the burden of proving that the claimed deduction

was reasonable in amount (Botany Mills v. United

States, 278 U. 8. 282, 289), and the Tax Court’s

finding of the amount constituting reasonable com-

pensation is entitled to finality on appeal if sup-

ported by substantial evidence (Commisstoner v.

Flowers, 326 U. S. 465, 470; McDonald v. Commis-

stoner, 323 U. 8. 57, 64-65; Commissioner v. Hein-

inger, 320 U. S. 467-475; Trust of Bingham v.

Commissioner, 325 U. 8. 365, 370; Long Island

Drug Co. v. Commissioner, 111 F. 2d 593 (C. C. A.

2d), certiorari denied, 311 U.S. 680).

The record unquestionably warrants the Tax

Courts finding (R. 161, 163) that $67,000 repre-

sented reasonable compensation for the services

| cry aera rere nces nm

7

of taxpayer’s three executive officers—the Meyer

prothers—during its 1942 fiscal year. As is

plain from its opinion, the Tax Court weighed all

the relevant factors, those favorable to taxpayer

as well as those unfavorable. The compensation

of the three Meyer brothers had just been in-

creased from $37,000 in 1940 to $67,000 in 1941,

an increase of over 80%. (R. 159a.) The Tax

Court, overruling the Commissioner’s determina-

tion that only $37,000 was reasonable, concluded

that this increase was justified by the nature of

their services and allowed the full $67,000 claimed

for 1941. (R.163a.) For 1942, the taxable year

here involved, taxpayer claimed a deduction of

$127,479.85 as compensation to the Meyer broth-

ers, of which $67,000 represented fixed salaries

and $60,479.85 represented 2214% of its 1942 net

profits (714% to each brother). (R. 160a-161a,

163a-164a.) It is this further increase in com-

pensation—an increase of about 90% over the

1941 compensation of $67,000—-which the Tax

Court concluded was excessive. (R. 163a-165a.)

The court pointed out (R. 163a), and taxpayer

does not deny, that the only fact adduced to

justify deduction of such a substantial percent-

age of taxpayer’s net profits as compensation to

the Meyer brothers—in addition to their already

increased fixed salaries—was an increase in its

net sales for that year. This factor, while rele-

vant, is by no means conclusive of the reasonable-

ness of the compensation paid (Clinton Co. v.

776875—48——2

8

Commissioner, 159 F. 2d 102 (C. C. A. 7th) ; Long

Island Drug Co. v. Commissioner, supra) ; espe-

cially where, as here (R. 163a), the increase in

sales was not attributable to increased services

but to the war demand and higher prices for tax-

payer’s goods (cf. Miller Mfg. Co. v. Commis-

stoner, 149 F’. 2d 421, 423 (C. C. A. 4th)). More-

over, as the Tax Court further noted (R. 164a),

the additional compensation for 1942 was meas-

ured by a percentage of taxpayer’s net profits;

provided for the same percentage (744%) to

each of the Meyer brothers, although their fixed

salaries differed; and was not awarded before

their services were rendered, but after opera-

tional results for the first quarter were known.

See Section 19.23 (a)-6 (2) of Treasury Regula-

tions 103 (Appendix, infra). What is more, the

compensation was not fixed by an arms length bar-

gain; the Meyer brothers were the controlling

stockholders and directors of taxpayer (R. 158a,

162a),*° an important factor to be considered.

Crescent Bed Co. v. Commissioner, 133 F. 2d 424

(C. C. A. 5th). Nor was any competent proof

>The Tax Court found (R. 158a, 162a), and it is not dis-

puted, that the Meyer family owned 3.432 of the 6,000 out-

standing shares of taxpayer; that a voting trust of which

the Meyer brothers were voting trustees held 51% of the

shares; and that three of the seven directors were the Meyer

brothers themselves, while two of the other directors (Mur-

phy and Heinl) were employees who had deposited their

stock in the voting trust and shared in a bonus awarded at

the same time that the additional compensation to the Meyer

brothers was awarded.

a

9

offered by taxpayer to afford a comparison of the

compensation it paid the Meyer brothers with

that paid ‘‘for like services by like enterprises

under like cireumstances’”’. Section 19.23 (a)-6

(3) of Treasury Regulations 103 (Appendix,

infra) ; Clinton Co. v. Commissioner, supra. As

the Tax Court observed (R. 162a), taxpayer’s so-

called expert witnesses were not qualified to ex-

press an expert opinion; and even assuming they

qualified, the Tax Court would not have been

bound by their opinion. In re Rae’s Estate,

147 F. 2d 204 (C. C. A. 3d); L. & C. Mayers Co.

v. Commissioner, 131 F. 2d 309 (C. C. A. 2d),

certiorari denied, 318 U. S. 773.

Under the circumstances the Tax Court was

fully justified in concluding that taxpayer failed

to meet its burden of proving that the amount of

$127,479.85 it deducted for 1942 represented rea-

sonable compensation. Indeed, the Tax Court was

more than liberal in overruling the Commis-

sioner’s determination that $37,000 was reason-

able, and in allowing $67,000 instead. Under

familiar rules governing the scope of judicial re-

view of the Tax Court’s factual determinations,

affirmance of its decision by the court below was

clearly correct.

2. Taxpayer’s elaborate discussion (Pet. 4-25)

of the scope of appellate review of Tax Court

decisions is academic. For even assuming, ar-

guendo, that the Administrative Procedure Act,

c. 324, 60 Stat. 237, applies to the Tax Court

—_ aa

10

and also that it ‘‘enlarges’’ the scope of review

of its decisions,‘ affirmance of the Tax Ccurt’s

decision by the court below was correct. Tax-

payer’s argument reduces itself, in terms of this

ease, simply to the contention (Pet. 3, 20-24)

that the court below was precluded from affirm-

ing the Tax Court’s decision because ‘‘no find-

ing’? was made as to the reasonableness of the

claimed salary deduction for 1942. To so con-

tend, however, is to disregard the plain tenor of

the Tax Court’s findings and opinion.’ The

* The standards prescribed in Section 10 of the Administra-

tive Procedure Act for review of administrative agency ac-

tions are essentially the same as those prescribed in Section

1141 (c) of the Internal Revenue Code for review of Tax

Court decisions. The so-called “substantial evidence” rule

embodied in Section 10 (e) (B) (5) of that Act has long been

applied upon review of Tax Court decisions. See, e. g., /Ze/-

vering V. Rankin, 295 U.S. 123, 131; Wilmington Co. v. Hel-

vering, 316 U.S. 164, 168; Dobson v. Commissioner, 320 U.S.

489. Besides, the legislative history of the Act indicates that

it was not intended to alter existing rules governing the review

of factual determinations by administrative agencies. The

original draft of Section 10, prepared by the American Bar

Association Committee on Administrative Law, carried the

comment that its provisions were not intended to expand the

scope of judicial review. 30 A. B. A.J. 46. See also, to the

same effect, the statements by Senator McCarran, Chairman

of the Senate Judiciary Committee, explaining the bill on

the floor of the Senate. 92 Cong. Record, Part 2, pp. 2157-

2159 (S. Doc. No. 248, 79th Cong., 2d Sess., pp. 321-322).

And see Representative Hobbs’ extension of remarks, 92

Cong. Record, p. A2987 (S. Doc. No. 248, supra, p. 415).

° At the outset of its opinion (R. 157a) the Tax Court

stated that “The only issue submitted is the reasonableness

of the compensation paid” for the two taxable years in-

ll

basic and only issue before the Tax Court was

whether the $127,479.85 claimed by taxpayer, or

the $37,000 allowed by the Commissioner, or some

in-between figure, represented a ‘‘reasonable”

allowance; it properly addressed itself to that

issue and found that $67,000 was reasonable.

And the only question before the court below was

whether that finding of ultimate fact was sup-

ported by substantial evidence. The evidentiary

facts dispositive of this case are undisputed and,

we submit, they support the Tax Court’s decision

“under any theory of judicial review”. Ander-

volved. After reviewing the evidence, it found (R. 16la,

163a—164a) that $67,000 was “reasonable” for each year. Tax-

payer’s insistence (Pet. 21, 23) that the Tax Court made no

finding that $67,000 was reasonable for 1942 because it did

not preface that figure with the word “only” is sheer quib-

bling. Indeed, taxpayer acquiesced in the Commissioner’s

proposed computation of the 1942 deficiency based on the

Tax Court’s allowance of $67,000. (R. 165a.)

Equally untenable is taxpayer's assertion (Pet. 3, 19, 20)

that the Tax Court predicated its decision solely on the

ground that the payment in excess of $67,000 represented a

dividend distribution rather than compensation. True, in

answer to taxpayer’s contention below that it was not a divi-

dend, the Tax Court in the concluding portion of its opin-

ion (R. 164a) stated that taxpayer had not sustained the

burden of proving that contention; but this was patently a

cumulative ground for its decision. Nor is there any basis

for taxpayer's corollary supposition (Pet. 19) that a distri-

bution of corporate earnings which represents “compensa-

tion” rather than a dividend must be deemed a deductible

business expense; to qualify for deduction under Section

23 (a) (1) (A) and the pertinent Regulations the “compen-

sation” must be “reasonable.” See Long Island Drug Co. v.

Commissioner, supra, pp. 594-595.

a

12

son v. Commissioner (C. CO. A. Tth), decided De-

cember 17, 1947 (1948 C. C. H., par. 9109);

Credit Bureau of Greater N. Y. v. Commissioner,

162. F. 2d 7, 9 (C. C. A. 2d); Dawson v. Com-

missioner, 163 F. 2d 664, 667 (C. C. A. 6th).

3. Taxpayer does not and cannot allege conflict

with any other decision. Its assertion (Pet. 20)

of ‘‘probable conflict’’ with Securities Comm’n

v. Chenery Corp., 332 U. 8. 194, and like decisions,

rests entirely upon its gratuitous assumption that

the Tax Court made ‘‘no findings’’ respecting the

reasonableness of the claimed salary deduction.

Far from precluding affirmance of the Tax

Court’s decision, the Chenery case demands it.

This Court there held (p. 207) that upon review

of an administrative agency action the appellate

court’s ‘‘duty is at an end’’ if the administrative

action is ‘‘based upon substantial evidence’’ and

does not lack a ‘‘rational and statutory founda-

tion’. Certainly its duty upon review of Tax

Court decisions is no greater, for ‘‘every reason

ever advanced in support of administrative fi-

nality applies to the Tax Court’’. Dobson v.

Commissioner, 320 U. S. 489, 498.

13

CONCLUSION

There is no occasion for further review. This

case presents a pure question of fact. Neither

an important question nor a conflict is involved.

The petition should therefore be denied.

Respectfully submitted.

/ Purr B. PERLMAN,

Solicitor General.

/ THERON LAMAR CAUDLE,

Assistant Attorney General.

/ SEWALL Key,

~——————_ GgorcE A. STINSON,

/ Harry Baum,

Special Assistants to the Attorney General.

FEBRUARY 1948.

APPENDIX

Internal Revenue Code:

Sec. 23. DEDUCTIONS FROM GROSS INCOME.

In computing net income there shall be

allowed as deductions:

(a) [As amended by Section 121 of the

Revenue Act of 1942, c. 619, 56 Stat. 798]

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 allow-

ance for salaries or other compensation for

personal services actually rendered; * * *

(26 U.S. C. 1940 ed., Sec. 23.)

Treasury Reguiations 103, promulgated under

the Internal Revenue Code:

Sec. 19.23 (a)-6. Compensation for per-

sonal services——Among the ordinary and

necessary expenses paid or incurred in car-

rying on any trade or business may be in-

cluded a reasonable allowance for salaries

or other compensation for personal services

actually rendered. The test of deducti-

bility in the case of compensation payments

is whether they are reasonable and are in

fact payments purely for services. This

test and its practical application may be

further stated and illustrated as follows:

(1) Any amount paid in the form of

compensation, but not in fact as the pur-

chase price of services, is not deductible.

(a) An ostensible salary paid by a corpora-

tion may be a distribution of a dividend

(14)

—

15

on stock. This is li to occur in the

ease of a corporation having few share-

holders, ly all of whom draw sal-

aries, If in such a case the salaries are

in excess of those ordinarily paid for simi-

lar services, and the excessive payments

correspond or bear a close relationship to

the stock holdings of the officers or em-

ployees, it would seem likely that the sala-

ries are not paid wholly for services ren-

dered, but that the excessive payments are

a distribution of earnings upon the stock.

(b) An ostensible sa may be in part

payment for property. This may occur, for

example, where a partnership sells out to

a corporation, the former partners agreeing

to continue in the service of the corpora-

tion, In such a case it may be found that

the salaries of the former partners are not

merely for services, but in part constitute

payment for the transfer of their business.

(2) The form or method of fixing com-

tion is not decisive as to deductibility.

ile any form of contingent compensation

invites scrutiny as a possible distribution

of earnings of the enterprise, it does not

follow that payments on a contingent basis

are to be treated fundamentally on any

basis different from that app! ing to com-

pensation at a flat rate. as, speak-

ing, if contingent compensation is paid pur-

suant to a free bargain between the em-

ployer and the individual made before the

services are rendered, not influenced by any

consideration on the part of the employer

other than that of securing on fair and

advantageous terms the services of the indi-

vidual, it should be allowed as a deduction

even though in the actual working out of

the contract it may prove to be greater than

1§

the amount which would ordinarily be paid.

(3) In any event the allowance for the

compensation ar ye may not exceed what is

er

reasonable under all the circumstances. It

is in general just to assume that reasonable

and true compensation is only such amount

as would ordinarily be paid for like services

by like enterprises under like circum-

stances. The circumstances to be taken into

consideration are those existing at the date

when the contract for services was made,

not those existing at the date when the

contract is questioned.

am * * * *

Sec. 19.23 (a)-8. Bonuses to employees.—

Bonuses to employees will constitute allow-

able deductions from gross income when

such payments are made in good faith and

as additional compensation for the services

actually rendered by the employees, pro-

vided such payments, when added to the

stipulated salavies, do not exceed a reason-

able compensation for the services rendered.

It is immaterial whether such bonuses are

paid in cash or in kind or partly in cash

and partly in kind. Donations made to

employees and others, which do not have in

them the element of compensation or are in

excess of reasonable compensation for serv-

ices, are not deductible from gross income.

U S. GOVERNMENT PRINTING OFFICE: 1948