Petition for Writ of Certiorari — Burford-Toothaker Tractor Co. v. Commissioner
Supreme Court brief1952
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IN THE
Supreme Court Of The United States
NO
BURFORD-TOOTHAKER TRACTOR COMPANY,
Petitioner
vs.
COMMISSIONER OF INTERNAL REVENUE,
”s contention that where an issue of fact
the pleadings and proof is made by competent
and informed witnesses who are not impeached in any way
and no contra evidence is offered, the party who thus car-
ries his burden of proof is entitled to prevail on the issues
of fact thus made and fully proven.
Petitioner also contends that a previous decision of the
Board of Tax Appeals approving the compensation of these
identical officers computed on the same basis is res ad-
judicata here.
3
The uncontroverted facts made by the record.
The case went to the Tax Court on petition for rede-
termination (I. R. C. Section 871 (a) after the Respondent
had fixed an arbitrary amount as the amount of officers’
compensation and the issue there made by the pleadings
(petition, R. 4, answer R. 33) was, as already stated,
the compensation paid was reasonable. The un-
controverted facts on this issue are:
a
Petitioner is a closely held Alabama corporation. All
its stock was owned by the two officers whose compensa-
tion is here involved, and their respective wives. The work
and effort of the two officers was largely responsible for
its growth and success. Since its organization in 1935 these
two officers had been paid a fixed annual salary of
$9,000.00 plus 2% of the gross:sales in excess of $300,000.00,
except in 1985, when the percentage was slightly higher.
The first three full years of the company’s existence
produced the following results:
Year Gross sales Compensation paid
each officer
MN aiikiicisinsanibcigeitl $430,773.00 $11,769.00
19386 _____________. $699,988.00 $16,400.00
BE sikscionctaacel $874,660.00 $20,493.00
Part of the compensation for those three years was dis-
allowed by the respondent but on petition for redetermina-
tion the Board of Tax Appeals approved the full amount
paid for each year. (1940 B. T. A. Docket Number 100911.)
The same basis was continued for the next three years
and was approved by the Commissioner's Technical Staff.
These figures were:
Year Gross sales Compensation paid each
BI isin $ 730,116.00 $17,602.00
1989 ___________.$1,013,260.00 $23,265.00
I Siiscecectoiel $1,211,558.00 $27,231.00
4
The Board of Tax Appeals decision approving the
amount computed on the percentage basis tor 1935-6-7
was rendered October 20, 1941. Petitioner, for that year,
and the two following years, which are those in issue here,
continued to pay‘its two officers on the same basis with the
following result:
Year ’ Gross sales Compensation paid each
SE ceshiieetenbid $1,846,151.00 $39,922.00
RP, _$2,280,348.00 $48,606.50
TN iuhnncecnces $1,562,840.00 $34,246.50
The Commissioner disallowed all compensation in ex-
cess of an arbitrary figure of $25,000.00 for each year.
On petition for redetermination the amount fixed by the
Tax Court is shown in the following tabulation:
Year Amount paid Fixed by Fixed by
Commissioner Tax Court
BOE: wincconnaeka $39,922.00 $25,000.00 $37,500.00
BD we $48,606.50 $25,000.00 $40,000.00
SEE cscenstcinss $34,246.50 $25,000.00 $30,000.00
The amount fixed by the Tax Court had no mathemati-
cal relationship to the gross sales and petitioner contends
that it had no support in the evidence.
The reduction by the Tax Court was:
1941 _. _.$2922.00
SRD $8606.50
1948 . $4246.50
That the compensation was paid without any sacrifice
to the financial well-being of the corporation is shown by
the undisputed fact that during each of the three years the
corporation paid an 8% dividend on its corporate stock
and more emphatically by the fact that during the three
year period, petitioner's surplus increased from approxi-
mately $94,000.00 at the beginning of the period to
$354,000.00 at the close, an increase of $260,000.00, or up-
wards of double its $150,000.00 capital.
5
The results produced are reflected in the sales volume
for the three years in question which was upwards of three
times the total for the preceding three years or
$5,689,300.47 as compared to $1,975,422.64.
The work of these two officers is described by the Tax
ye in its findings of fact, excerpts from which are:
. 40
“The petitioner's business was managed and super-
vised solely by its two officers, Burford and Toothaker.
They worked together as a team. They devoted all of
their time to the business, working six days a week,
an average of two or three nights a week, and often
= Sunday. They participated in various ways in most
es.
“During the years in question petitioner's officers
had additional work because of the Draft Boards (in
attempting to secure deferments for certain vital em-
ployees), and war regulations.”
“The big problem after 1941 was the acquisition
of machinery (new and used) to sell. One method used
to alleviate this problem was to obtain new lines from
other manufacturers to help fill out the scarcity of new
equipment needed.” (R 41)
“During the taxable years it was difficult to obtain
employees with experience to work for petitioner.”
“Petitioner's two officers interviewed all new em-
ployees and supervised their training.”
“The operation of the petitioner required borrow-
ing from banks which was at one time during the tax-
able years as high as $425,000. All of these borrowings
were individually guaranteed by the endorsement of
Burford and Toothaker, who together had a net worth
of approximately $500,000.”
6
Their compensation was fixed by corporate resolutions
each year and had been uniform since 1936.
It is petitioner's contention that under the uncontro-
verted evidence, the compensation was reasonable.
Witnesses in Tax Court Hearing.
On the hearing in the Tax Court there were but four
witnesses. They were petitioner's witnesses and no wit-
nesses were called by the respondent. Briefly stated the
testimony was:
Petitioner's president, Toothaker, (R 76) testified, among
other things, that in his previous employment with an-
other concern (Lombard Company) in similar business
where he owned no stock, had no financial risk and had
fewer duties, his compensation was on a salary and per-
centage of sales basis which would have resulted in sub-
stantially larger compensation, on petitioner's volume of
sales, than actually resulted under the arrangement with
petitioner. His total from petitioner for the three years
was $122,775.00 as compared to what it would have been
on the Lombard basis, namely $177,811.83. He testified
that his own compensation was reasonable for each year
and that of the other officer, Burford, was likewise reason-
able.
The witness, Sybil Young, (R 54) corroborated Tooth-
aker’s testimony as to his arrangement for compensation
with the Lombard Company.
Petitioner’s secretary, Burford, testified, (R 55) among
other things, that his own compensation and the amount
paid Toothaker was reasonable.
The fourth witness, Aldridge, a certified public ac-
countant with many years experience, familiar with pe-
titioner’s business and six other similar concerns, testified
(R 71) that based on his knowledge and experience the
compensation paid these officers was reasonable and in
7
fact less than one other similar concern where larger com-
pensation was paid and the volume was substantially less
than petitioner's.
No effort was made by respondent to impeach or con-
tradict either of these four witnesses and, as stated, no
evidence contrary was offered.
A comparison of the total compensation of the two
officers with the gross sales for all years since and includ-
ing 1936 is:
Year Total sales Total compensation Percentage of
of oiieae compensation
to sales
* 1986 $ 699,988.00 $32,800.00 4.9
* 1937 $ 874,660.00 $40,986.00 4.7
*°19388 $ 780,116.00 $35,204.00 48
*°19389 $1,013,260.00 $46,530.00 4.6
*°1940 $1,211,558.00 $54,462.00 45
1941 $1,846,111.00 $79,844.00 4.3
1942 $2,280,348.00 $97,213.00 4.3
1943 $1,562,840.00 $68,492.00 4.4
A similar comparison of officers compensation to gross
profit is:
Year Gross profit Total Fer pensation Percentage of
sii Pye ype
* 1936 $55,540.00 $32,800.00 59.1
* 19387 $64,980.00 $40,986.00 63.1
*°1938 $53,432.00 $35,204.00 65.9
*°1989 $85,193.00 $46,530.00 54.6
**1940 $95,497.00 $54,462.00 57.0
1941 $162,422.00 $79,844.00 49.2
1942 $396,815.00 $97,213.00 25.5
1943 $267,485.00 $68,492.00 25.6
* Approved by Board of Tax Appeals.
** Approved by Technical Staff.
8
It was also undisputed that in addition to their duties
aa a ce aapecrit y agency wedgethann
peals decision p gelcig amount compensa-
tion figured on the same basis as here, the two officers had
many more duties and problems because of the war effort,
including the following:
a. The problem of obtaining new equipment for sale
due to the fact that all but a small percentage of all the
new equipment available was required by the government,
thus making it much more difficult to obtain new equip-
ment for sale.
b. The priorities imposed during those years with
reference to new machinery increased their work. in as-
sisting their customers in obtaining priorities.
c. They lost many of their employees including some
of their key personnel which required extra work in em-
ploying and training new employees in a business in which
it is difficult to find employees already trained.
d. There was added work in connection with the draft
which required their effort in attempting to hold their
employees on the ground that the business in which the
company was engaged was a critical one in the war effort.
e. There were many and complicated war regulations
to be studied to which their business had to be adjusted.
a
tifying on this subject the Tax Court judge stopped him and
indicated that it was not necessary to go farther into that.
(and testified to by all witnesses as being reasonable) and
substituted a figure having no support in the evidence, a
figure which petitioner contends is arbitrary.
ae
The Circuit Court should have reversed the Tax Court
for having disregarded the evidence and the testimony of
qualified witnesses on a question of fact and having fixed
an amount having no support in the evidence.
The decision of Circuit Court of Appeals in affirming
the Tax Court when all the witnesses testified that the com-
pensation was reasonable is in conflict with the following
decision of another circuit court.
Wright-Bernet, Inc. vs. Commissioner,
172 F* 348, CCA 6.
Roth Equipment Company vs. Gallagher,
172 F* 452, CCA 6.
because in the Wright-Bernet case it was held:
“We bear in mind that the findings of fact are not
to be set aside unless clearly erroneous, and that due
regard must be given to the opportunity of the trial
10
court to judge of the credibility of the witnesses, Rule
52 (a), Federal Rules of Civil Procedure, 28 U. S. C.
A.; but the credibility of the witnesses was not at-
tacked here in any way. The Tax Court in its findings
of fact adopted and reiterated the material evidence
introduced by the petitioner, and then decided that
the compensation of each employee for one year was
unreasonable in the amount of $140, and for the
second year in a greater amount. As the petitioner’s
witnesses were qualified and unimpeached, and no
evidence was given to the contrary, their testimony
should have been accepted. Capital-Barg Dry Clean-
ing Co. v. Commissioner, 6 Cir., 181 F 2d 712.” (Em-
phasis supplied)
And in the Roth case it was held:
“We are of the opinion that the findings of the
District Court on the issue of the reasonableness of the
compensation for 1942 were clearly erroneous and
should be set aside. There was little, if any, dispute in
the evidence. The appellee offered no witnesses in
support of his position. No witness testified that the
amounts found by the District Court as reasonable
compensation in 1942 was the reasonable compensa-
tion to which the officers were entitled. The only
direct evidence before the Court on the specific ques-
tion of reasonableness of compensation was the testi-
mony of Harold Hampton and Archie Shearer, both
well-qualified, impartial witnesses, with many years
of experience. They testified that in their opinion the
compensation was reasonable, with Mr. Hampton re-
ferring it as “very reasonable.” The credibility of these
witnesses was not put in issue. The appellee offered
no witness to contradict this testimony or to testify
in any way that the compensation was unreasonable
to any extent. On this crucial and single issue of fact
in this case this unimpeached, uncontradicted testi-
ll
mony from well qualified, impartial witnesses can
not be Revemipted the Court. This court has several
times stated that such testimony should be accepted
by the fact finder in a matter in which the fact finder
has no knowledge or experience upon which he could
exercise an independent judgment.” (Emphasis sup-
plied)
2. The decision of the Circuit Court of Appeals in af-
firming the Tax Court in the instant case is in conflict with
its own decision in J. H. Robinson Truck Lines vs. Commis-
sioner, 183 F’ 739, where the court held that where the is-
sue is whether compensation paid to a corporation presi-
dent, who owned all but three shares of its stock, was
reasonable, the Tax Court may not reject the credible
testimony of competent witnesses who testify without
contradiction or impeachment and, upon a record con-
taining no contrary evidence, determine that salaries
paid are unreasonable and substitute in lieu thereof an
arbitrary amount determined “not upon the evidence,
but apparently upon its own innate conception of
reasonableness.” (Quoted from Hightower Vs. Com-
missioner CCA5 187 F* 535 in commenting on the Robinson
Case) a
3. Whether the Tax Court may, in a case such as this,
do what the Fifth Circuit Court in the Robinson case, and
the Sixth Circuit Court in its two cited cases said it cannot
do and what in the instant case the Fifth Circuit Court
now says it can do, is an important question in federal law
which has not been but should be settle’ by this court.
4. In deciding this case as it has, the Circuit Court has
so far sanctioned a departure by the Tax Court from the
accepted and usual course of judicial proceedings as to
call for an exercise of this court's power of supervision.
5. The question decided in this case is one of general
importance relating to the federal income tax laws and
has not been but should be settled by this court.
es
12
The Questions Presented.
1. Inacase where the issue of fact is whether compen-
sation for services paid by a taxpayer to its employees and
deducted as an expense under the federal income tax law
is reasonable, may the Tax Court reject the credible testi-
mony of competent witnesses who testify without contra-
diction or impeachment and upon a record containing no
contrary evidence determine that salaries paid are unreas-
onable and substitute an arbitrary amount having no sup-
port in the record?
2. Where the Tax Court in a previous decision, (ren-
dered when it was called the Board of Tax Appelas) has
approved as reasonable the amount of compensation paid
by a corporation to its two chief officers arrived at on the
basis of a certain fixed salary plus a percentage of gross
sales for the first three full years of the corporation’s exis-
tence and the amount arrived at on the same basis for the
next three years has been approved by the Technical Staff,
may the Tax Court reject the credible testimony of com-
petent witnesses who testify without contradiction and on
a record containing no contrary evidence determine that
the compensation paid the two identical officers and com-
puted on the identical basis is unreasonable and substitute
an amount having no support in the evidence?
Reasons relied on for the allowance of the writ.
1. It is important for closely held corporate taxpayers
to know by a decision of this Court whether they can pay
their officers on a fixed salary plus a percentage of gross
sales basis.
2. Also, to so know whether they can pay compensa-
tion on that basis especially where the basis has been estab-
lished over a period of years.
8. To so know whether in such a case, the large in-
crease of volume accomplished under the management of
13
officers working on such a basis, is justification for a court
to arbitrarily reduce the amount of compensation resulting
therefrom.
4. To so know whether the officers in such a case
who have taken small compensation in lean beginning
years can be rightly deprived of their proportionately larger
compensation in better years, especially when the dollars
in the “better” years are of greatly less value. ~
5. To so know, as indicated in the Circuit Court's
opinion quoting from the Locke Machine Company case,
whether the fact that “the Government . . . needs tax in-
come” should alter the established basis of a corporation
compensating its officers.
6. It is important also for the respondent Commis-
sion to have this court decide the questions here in-
volved, as an aid in administering the federal income tax
statutes.
7. It is important for all parties concerned’in handling
disputed cases of this kind to know by a decision of this
Court whether, in a case where the evidence on an issue
of fact is to the effect that the amount of compensation
is reasonable and not greater than other employees pay
for similar services, the Tax Court nay disregard the testi-
mony of witnesses who, by their knowledge and experience
are qualified to know and testify, and arbitrarily fix an
amount taken not from the evidence but from the personal
ideas of the judge writing the opinion who may not be
himself informed at all as to what such services are worth.
8. It is important for the Court to hold that where,
in a case involving the isssue of fact as to the reasonable-
ness of officer compensation, the only testimony is to the ef-
fect that the compensation is reasonable and in line with
what other comparable companies pay and there is no
evidence contra, the Tax Court may not go outside of the
a and make a finding drawn from its own independent
i
14
9. It is important for the Court to hold that the evi-
dence, and not one judge’s own notion, should govern the
decision on an issue of fact.
10. Consistent with the principle that ours is a gov-
ernment of laws and not of men, a taxpayer should not be
exposed to the uncertainty of what one judge might think,
based on his own notions, irrespective of uncontroverted
and credible evidence.
11. Consistent with the principle that legal rights
should be known and certain and not otherwise, it is im-
portant that this Court hold that where the Board of Tax
Appeals has approved the amount of officer compensation
computed on a fixed amount plus a definite percent of
sales for certain individuals serving as corporate officers
for certain years, the corporation is justified in con-
tinuing to pay on that basis and should not be penalized
with heavy interest (six years or 36% on part) for having
relied upon apparent official as well as court approval of
its method of compensating those individuals.
12. Under the rule of res adjudicata, equitable estop-
pel or elementary justice, this Court should intervene to
prevent the imposition of additional federal income tax
where a corporation has been assessed with deficiencies
by the Tax Court disallowing part of the compensation paid
its officers on the identical fixed salary and percentage of
sales basis as in previous years when the amount was ap-
proved by the Board of Tax Appeals.
Respectfully submitted,
FRED S. BALL, JR.
Attorney for petitioner
Address 719 First National Bank
Building, Montgomery, Alabama
15
February 1952
I hereby certify that I have served a copy of the fore-
going by mailing a ‘copy to Hon. Ellis N. Slack, Special
Assistant to the Attorney General, Department of Justice,
Washington, D. C., on this ___ day of February, 1952.
Attorney for petitioner
SUBJECT INDEX
Page
Decisions of lower courts.___.--------------------------.------- 1
Grounds for jurisdiction here 2
1. Conflict between circuit courts 2
2. Departure from usual course — 2
8. Construction of 23 a, I. R. C. Mle ere 2
i. Sears Geeene 2
Concise statement of the case 2
I scicashenieiive indbransalassireiaisbelasn tient setinnninbereinsinecispatnia 2
1. Preliminary statement —-____-_-_-________ 2
2. Cases relied upon by Circuit Court 7
8. Conflict with Sixth Circuit on
4. Conflict with its own decision — confusion __... 11
5. More complete statement of undisputed
evidence 14
6. Equitable estoppel .... 35
TABLE OF CASES AND STATUTES
Page
Bennett vs. Commissioner, 118 F? 887 85
Burford-Toothaker Tractor Co., 1941, BTA
I an ec sinlannbes 31
75 Corpus Juris Secundum, 634 8
Dayton P & L Co. vs. Commissioner, 292 U. S. 290 __. 7
Wn. S. Gray, 68 Ct. Cl. 43, 35 F? 968 34
Helvering vs. National Grocery, 304 U. S. 282 7
Hightower vs. Commissioner, 183 F? 739 _...____. 13
Internal Revenue Code, Section 23 (a)
Mayson Mfg. Co. vs. Commissioner, 178 F? 115 _... 28
North Carolina Equipment Co., U. S. T. C.
Docket 4737 27
J. H. Robinson Truck Lines vs. Commissioner,
183 F? 739 _ a Be
Roth Equipment Co. vs. Gallagher, 172 F? 452 _.1, 9, 19
Words and Phrases, Per. Ed
Wright-Bernet Inc. vs. Commissioner,
172 F’ 348 1, 8, 22
SUPREME COURT OF THE UNITED STATES
BURFORD-TOOTHAKER TRACTOR COMPANY,
? Petitioner.
vs.
COLLECTOR OF INTERNAL REVENUE
Respondent.
On petition for certiorari to the Circuit Court
of Appeals for the Fifth Circuit.
BRIEF IN SUPPORT OF PETITION
FRED S. BALL, JR.,
Attorney for petitioner
DECISIONS OF LOWER COURTS
The Tax Court decision is reported in 9 T. C. M. 208.
The Circuit Court decision is reported in 192 6° 633.
GROUNDS FOR JURISDICTION
Conflict between Circuit Courts
1. The decision of the United States Circuit Court
of Appeals for the Fifth Circuit below is in conflict with
the decisions of the Sixth Circuit in:
Wright-Bernet Inc. vs. Commissioner, 172 F* $48, and
Roth Equipment Co. vs. Gallagher, 172 F* 452,
as well as its own decision in:
J. H. Robinson Truck Lines vs. Commissioner, 183 F*
739.
The instant decision follows the dissent in the Robin-
son case instead of the majority decision of the Court.
Departure from usual course.
2. The United States Circuit Court of Appeals has
so far sanctioned the departure by the Tax Court from the
adopted and usual course of judicial proceedings as to call
for an exercise of this Court’s power of supervision, in
failing to accept the testimony of qualified, informed and
unimpeached witnesses where there was no contrary evi-
dence offered and in rendering a judgment unsupported
by any evidence in the record.
Construction of 23 a Internal Revenue Code.
8. It is important for this court to construe Section
23 a of the Internal Revenue Code allowing as a federal
income tax deduction a “reasonable allowance” for com-
pensation for personal services rendered by officers in a
closely held corporation. Nobody knows what is meant by
reasonable, or how to determine, even approximately,
how much can be legally paid.
General importance.
4. The question here is one of general importance
relating to federal income tax laws and has not been but
should be settled by this Court.
Concise Statement of the Case.
This is set out in the petition for certiorari beginning
at page 1, entitled “Summary and Short Statement of the
matters involved.” It would seem needless to repeat it
here.
ARGUMENT
Preliminary Statement
There are a multitude of closely held corporations in
this country in which the chief owners are also the manag-
3
ing heads to whom the corporations are, by the federal
revenue law, allowed to pay compensation for their per-
sonal services and to deduct it as an expense in computing
their federal income tax (I. R. C. 28 a).
The directors of these closely held corporations must
decide each year what amount can lawfully be paid.
This is a dangerous decision to be made. Whatever
compensation is paid must be returned by the individuals
in their own income tax returns and the tax is often in about
as high brackets as the corporation (true in the case at
bar). They know that it may be nearly three years before
they will be audited by the Revenue Bureau and in the
meantime upwards of 36% interest will have accrued on
any deficiency determined, and likely much more, as ev-
eryone knows the Dickens-like delay in final judicial tax
determination. (The taxes here begin with the year 1941
on which ten years or approximately 60% interest would
have accrued).
It is a dangerous decision also because they know,
too, that if part of the officer’s compensation is eventually
disallowed and the corporation is required to pay additional
taxes, there is no refund to the individual officers as is
the case of husband and wife partnerships when wholly
or partially disallowed.
How then may prudent business people know what
amount is to be considered “reasonable” and be legally
paid?
They must find out what is meant by “reasonable.”
If they open the latest published volume of Corpus
Juris Secondum, at page 634 (Vol. 75) they will read:
“The word ‘reasonable’ is a relative generic term
difficult of adequate definition. While it has been said
that it is an ordinary word in common use and fa-
4
miliar to the average person, in fact the dictionaries
give a number of meanings for the word, and it has
various shades of meaning, and the particular shade
is to be determined according to the context and cir-
cumstances of each particular case.
“ ‘Reasonable’ is defined as meaning agreeable
to reason; conformable to reason; governed by reason;
having the faculty of reason; rational; thinking, speak-
ing, or acting rationally, or according to the dictates of
reason; sensible.
“It is also defined as meaning just; proper; fair;
equitable; and, in addition, the term has been con-
strued as meaning honest. ‘Reasonable’ is further de-
fined as meaning ordinary or usual; not immoderate
or excessive; not capricious, arbitrary, or confiscatory.”
If they turn to the standard work on the meaning of
words, “Words and Phrases, Permanent Edition, Volume
36, they will find 169 pages of case digests defining the
word “reasonable.”
The only guide provided by law is that the amount be
“reasonable.” ;
How may business people directing the affairs of
their corporations know what amount is “reasonable?”
If it is a factual matter, where may they go to find
out what is “reasonable?”
Should they go to other people and ask what is
“usual,” as for instance, a certified public accountant who
audits other comparable concerns and is in position to
know what others pay?
Suppose then, with this decision to make in the first
year of the company’s existence upon advice thus obtained,
they decide upon a merit or incentive system, providing
5
for a fixed salary of modest proportions plus a percentage
of gross annual sales in excess of a substantial minimum
and they set up this plan and continue to use it each year.
After a while, they get “checked” by a Revenue Agent
and he disallows part of what was paid and fixes an amount
selected by him as being reasonable—being certain, it al-
ways seems, to select a figure which will make the com-
pany pay considerably more income tax—and without any
resulting refund to the individuals who, in the meantime
have paid income tax on the amount paid them by the
corporation.
Suppose they then go to the Board of Tax Appeals
with their troubles and on the hearing, in addition to their
own testimony which includes testimony as to a closely
similar method used by another comparable company by
whom one of them had been previously employed, which,
if used by them would have produced larger compensa-
tion, the certified public accountant testified that the
compensation was reasonable and in line with other com-
parable concerns and the Board, in its decision, approves
the amount as “reasonable.”
Would they then be safe in continuing the same plan?
Suppose they did continue it and the next three years are
approved by the Technical Staff people who have large
authority in such matters. Would they then be safe in
continuing further? Suppose they do, and again the agent
comes and again he reduces the amount and again they
go to the same Board of Tax Appeals which by then is
called by another name—The Tax Court. This time as be-
fore, there is the same testimony from the same witnesses
as before and again no one is there who testifies against
the company witnesses and no question is raised as to their
integrity or effort made to impeach their testimony. But
this time a different judge hears the case and although all
the testimony was that the compensation was reasonable
6
and in line with comparable companies this particular
judge has ideas of his own. He disagrees with the Agent's
arbitrary amount but rejects the witnesses’ testimony that
the amount was reasonable and customary, and substitutes
from his own mind a figure selected by him as being the
amount which the company could have properly paid.
Nine years later, in 1950, these business people find
that the amount their corporation paid them in 1941 based
on the same plan of computation as in all the previous
years of the company’s existence (except the first, when
it was a little larger) approved by the Board and later by
the Technical Staff, was unreasonable!
Bewildered, they go to the Circuit Court hoping for
relief there, but the Court turns its head and quotes some-
thing about the Government “needs tax income most vi-
tally.” (R 93)
These suppositions are the facts of this case and these
people are now here at the end of the judicial road asking
that this Court do something about it,—not only for their
own sake, but for the sake of the multitude of other busi-
ness people who are entitled to know what their tax bill
is, or at least to have some idea, without the penalty which
these have suffered as a result of a judge valuing his own
personal opinion above the testimony of informed wit-
nesses.
This Court should take this case and define what is
meant by “reasonable” in relation to closely held corpora-
tion officers’ compensation.
It is petitioner’s contention, among others set out in
the petition, that under the American system of litigating
cases before the courts, it is a basic rule that where an
issue of fact is made by the pleadings, and proof is made
by the credible testimony of competent, informed wit-
nesses and no contrary evidence is offered, the party who
7
thus carries his burden of proof is, as a matter of law, en-
titled to prevail on the issues of fact thus made and proven.
To this general rule, of course, there is the possible
exception where there is a legal presumption to be over-
come. Thus, in this, a federal income tax case, the Com-
missioners determination is presumed to be correct and
the burden is upon the taxpayer to overcome the presump-
tion. The presumption was overcome in this case when the
Tax Court declined to sustain the Commissioner's determi-
nation.
Cases relied upon by Circuit Court.
This case is not similar to Dayton P & L Company vs.
Commissioner, 292 U. S. 290, apparently relied upon by
the Circuit Court, where certain property valuations in a
natural gas rate case were involved and there was a conflict
in the opinion evidence as to the value of certain gas leases.
There was a conflict in the testimony there which called
for judicial determination. In the case at bar there was no
such conflict. The respondent offered no witness to testi-
fy that the compensation was either unreasonable or out
of line with what other comparable companies were pay-
ing at that time for similar services.
The case of Helvering vs. National Grocery Company,
$04 U. S. 282, cited and relied upon by the Circuit Court,
if in point at all, is contrary to the Circuit Court’s decision.
That case involved the question of a corporate taxpayer
accumulating an excess of surplus. The Commissioner de-
termined that the surplus exceeded reasonable needs and
the Board of Tax Appeals sustained the determination. The
Circuit Court reversed and made its own finding, but this
Court sustained the Board on the ground that the Circuit
Court could only determine “whether there was evidence
to support the Board's findings” and should not have made
an independent determination of the matters which had
8
been at issue before the Board” (Emphasis added). In that
case there was also a presumption which apparently the
taxpayer was not able to overcome as is shown by the fact
that the Board sustained the Commissioner. Also, in that
case there was a conflict in the testimony as there were
“twenty-four exhibits introduced by the taxpayer, eleven
by the Commissioner.” With a presumption to be over-
come and a conflict in the testimony, this Court held that
the Board was not obligated to accept as sound the opinion
of the taxpayer's experts. This, in effect, was a holding that
in such a case the Board did not have to accept opinion
evidence as overturning a presumption.
In the case at bar the presumption was overcome
when the Tax Court declined to sustain the Commissioner's
determination. When it made its own “independent de-
termination” it did what this Court held should not have
been done by the Circuit Court in the National Grocery
case.
Conflict with Sixth Circuit.
Contrary to the decision of the Circuit Court below,
the Sixth Circuit under similar circumstances held that the
taxpayer is entitled to prevail. In Wright-Bernet vs. Com-
missioner, 172 F’ 348, a case involving the compensation
of corporation officers, there was a determination by the
Commissioner, a petition to the Tax Court for redetermina-
tion, and on the hearing the issue was whether the com-
pensation was reasonable. The taxpayer’s witnesses, most
of whom were its own employees, testified that the com-
pensation was reasonable and in line with. what other
companies paid. The Tax Court did not sustain the Com-
missioner’s determination but substituted an arbitrary fig-
ure of its own, determining what was a reasonable amount
in each instance. On review the Circuit Court held that
“,.. the simple question before the Tax Court was the
9
reasonableness of the compensation. This, of course, is a
question of fact.” (Emphasis added) After stating that the
rule under 26 U. S. C. A. 1141 (a) is that the Circuit Court
reviews the Tax Court “in the same manner and to the
same extent as a decision of the District Court in civil
actions without a jury,” the court stated the rule to be:
“The findings of fact of the Court below to the
extent that they are unsupported by substantial evi-
dence, or are clearly against the weight of the evi-
dence, or were induced by an erroneous view of the
law are not binding upon this Court.”
‘ The court then wrote:
“We bear in mind that the findings of fact are
not to be set aside unless clearly erroneous, and that
due regard must be given to the opportunity of the
trial court to judge of the credibility of the witnesses,
Rule 52 (a), Federal Rules of Civil Procedure, 28 U. S.
C. A.; but the credibility of the witnes:25 was not at-
tacked here in any way. The Tax Court in its findings
of fact adopted and reiterated the material evidence
introduced by the petitioner, and then decided that the
compensation of each employee for one year was un-
reasonable in the amount of $140, and for the second
year in a greater amount. As the petitioner's witnesses
were qualified and unimpeached, and no evidence
was given to the contrary, their testimony should have
been accepted. Capital-Barg Dry Cleaning Co. v.
Commissioner, 6 Cir., 131 F 2d 712.
“Viewing the case from another angle, no sub-
stantial evidence supports the decision of the Tax
Court. The substantial evidence supports the reason-
ableness of the salaries.”
Roth Office Equipment Company vs. Gallagher, 172
F* 452, is also a Sixth Circuit case involving reasonableness
10
of corporation officers’ compensation where, after a de-
termination by the Commissioner, the taxpayer paid the
deficiency and sued in the District Court. That court dis-
regarded the uncontradicted testimony and made an inde-
pendent determination of its own as to what amounts
would be reasonable in one of the years. On appeal the
Circuit Court wrote: -
“We are of the opinion that the findings of the
District Court on the issue of the reasonableness of
the compensation for 1942 were clearly erroneous
and should be set aside. There was little, if any, dis-
pute in the evidence. The appellee offered no wit-
nesses in support of his position. No witness testified
that the amounts found by the District Court as reas-
onable compensation in 1942 was the reasonable com-
pensation to which the officers were entitled. The
only direct evidence which the Court on the specific
question of reasonableness of compensation was the
testimony of Harold Hampton and Archie Shearer,
both well-qualified, impartial witnesses, with many
years of experience. They testified that in their opin-
ion the compensation was reasonable, with Mr. Hamp-
ton referring to it as “very reasonable.” The credibility
of these witnesses was not put in issue. The appellee
offered no witness to contradict this testimony or to
testify in any way that the compensation was un-
reasonable to any extent. On this crucial and single
issue of fact in this case this unimpeached, uncon-
tradicted testimony from well-qualified, impartial
witnesses can not be P ara, the Court. This
Court has several times stated that such testimony
should be accepted by the fact-finder in a matter in
which the fact-finder has no knowledge or experience
upon which he could exercise an independent judg-
ment. Capitol-Barg Dry Cleaning Co. v. Commission-
er, 6 Cir., 131 F. 2d 712, 715; Toledo Grain & Milling
ll
Co. v. Commissioner, 6 Cir., 62 F. 2d 171, 178. See
Lawton v. Commissioner, 6 Cir., 164 F. 2d 380, 384;
Weizer v. Commissioner, 6 Cir., 165 F. 2d 772, 775.
As was pointed out in T. P. Taylor & Co. v. Glenn,
D. C. W. D. Ky., 62 F. Supp. 495, 499, if the compen-
sation paid is unreasonable the appellee certainly
could have produced some experienced witness from
the industry who would have said so, and the failure
to offer such a witness on the crucial issue in the case
operates very strongly against his contention. The
burden of proof in cases of this kind is upon the tax-
payer, but we are of the opinion that that burden has
been met when the taxpayer introduces uncontra-
dicted, unimpeached testimony from well-qualified,
impartial witnesses sustaining its contention, unless
the established facts themselves are such as to show
that such testimony ought not to be accepted.”!
Conflict with its own decision—confusion.
Curiously enough, and to add to the confusion, the
majority opinion of the court in its own case of J. H. Robin-
son Truck Lines vs. Commissioner, 183 F? 739, C. C. A. 5,
was in accord with the two Sixth Circuit cases first cited.
Another case where the Commissioner made a determina-
tion disallowing part of the officers’ compensation and the
Tax Court, while not accepting his determination, disre-
garded the uncontroverted testimony and arbitrarily re-
duced the amount paid. The Court wrote:
“Here, pointing to the fact that it offered evi-
dence fully and completely supporting the reasonable-
ness of the deductions claimed and the Commissioner
1 The final statment in the opinion as to whether the establish-
ed facts themselves are such as to show that such testimony ought
not be —— may necessitate an examination of the facts of the
case at bar for that and these will presently be more fully
set out than are outlin ed
in the petition.
12
offered no evidence whatever, petitioner insists that
the finding and judgment of the Tax Court is not only
clearly erroneous but is without any support in the
evidence and may not stand. We agree.
“To support its claim that the salary it paid Rob-
inson, as president, and the rents it paid him as land-
lord were reasonable, petitioner introduced the
testimony of Robinson and of two other witnesses.
Robinson testified positively, and without contradic-
tion or impeachment, that the salaries paid him were
in line with, that is were comparable to, salaries paid
presidents of other similar lines.
“As to the rents paid him, he testified that they
were reasonable, indeed were less than rents the cor-
poration paid others.
“The other two witnesses testified positively and
without equivocation, contradiction, or impeachment,
that the ies paid Robinson were in line with, that
is the same as, salaries paid to presidents of similar
companies, and that the rents paid to Robinson were
reasonable and compared favorably with rents charg-
ed by others, indeed were considerably less than were
paid by and to others in similar circumstances.
“The Commissioner offered no evidence.
“The Tax Court rejected all of the evidence of all
of the witnesses, and upon a record containing no
evidence whatever supporting them, sustained the
Commissioner's determinations that the rents and sal-
aries were excessive.
“Upon settled principles, it cannot do this, and
in doing so, it erred.”
There was a dissent by one judge, which the decision
here follows.
13
In Hightower vs. Commissioner, 187 F* 535, CCA 5,
mentioned by the Circuit Court in the case at bar, the
taxpayer failed to overcome the prescription in favor of
the Commissioner's determination and the Fifth Circuit
affirmed but in so doing it mentioned its Robinson case
and wrote:
“Petitioner's reliance on Robinson Truck Lines v.
Commissioner, 5 Cir., 183 F. 2d 739, will not at all
do. There the taxpayer supported his position by dis-
interested and uncontradicted testimony, credible in
itself and not impeached in any way. The Commis-
sioner offered no testimony, and the Tax Court, not
upon the evidence but apparently upon its own in-
nate conception of reasonableness, sustained the Com-
missioner’s determination.
“We quite properly held there that this amounted
to little more than fiating.” (Emphasis added)
The rule should be, it is submitted, that where the
credible testimony of qualified and unimpeached witnesses
on an issue of fact is met by none in opposition, and there is
no presumption to be considered, the testimony of these
witnesses should not be arbitrarily disregarded as was done
by the Tax Court here.
As a practical matter, it does seem in this case as
was pointed out in T. P. Taylor vs. Glenn, supra that if
there was any room for a difference of opinion as to wheth-
er the compensation paid here was reasonable, the Com-
missioner, with all the resources at his command, could
have found and produced competent witnesses to testify
that it was excessive. The fact that the Commissioner did
not produce such a witness would indicate that no wit-
ness with the necessary qualifications could be found who
could conscientiously testify that the compensation paid
here was unreasonable.
14
If no such witnesses could be found, the Tax Court,
as a court and not an investigating committee, should act
only on the evidence before it. It should not go outside of
the evidence, beyond the record, for its decision in this
case where a clear cut issue has been made between the
parties by the pleadings and competent testimony produced
to sustain the burden undertaken.
If, however, the duty rests upon the court in such a
case to examine the facts to ascertain whether the facts
themselves justify the acceptance of the witnesses, the
undisputed facts of this case could not possibly justify, to
any reasonable mind, any conclusion other than that the
testimony was entirely credible.
More complete statement of undisputed facts.
There was no dispute as to the material facts. Some of
them are set out in the petition. A more complete sum-
mary is here furnished:
1. The petitioner is a corporation organized under
the laws of Alabama in the year 1934 with a capital of $50,-
000.00. Since its organization it has been engaged in sell-
ing and servicing road and other machinery. It has only
four stockholders, Mr. and Mrs. H. H. Toothaker and Mr.
and Mrs. J. Lamar Burford. Mr. Toothaker and Mr. Bur-
ford are petitioner's only officers, serving in the capacities
of president and secretary, respectively Burford and
Toothaker devoted their undivided time and efforts to the
service of the petitioner company. During the three years
in question they worked six days a week and frequently
on Sundays and at night. They performed not only the
duties customarily performed by the chief executive offi-
cers of a business concern but also attended to many other
duties in connection with its buying, selling, and servicing.
2. Burford and Tothaker worked together as a team,
each taking the other’s place in the office, plant, or field
15
as the exigencies of the business required. The duties
and functions performed by them were numerous and
varied. These duties are generally set out in a Company
Procedure Manual (Exhibit 5) jointly prepared by them
and based on their many years of experience in this kind
of business. The company’s business and affairs were
managed and supervised solely by these two officers.
Burford, with credit and accounting experience, super-
vised the financial affairs of the company, its credits and
collections. Toothaker, with engineering and sale ex-
perience, organized and supervised the shop. Both par-
ticipated in the sales. Each of them actively participated
in the general management and supervision of all depart-
ments of the business. They personally participated in
all sales involving trade-ins and credit. Each of them per-
sonally made sales and participated in closing sales made
by their salesmen. They made frequent visits to the fac-
tories of the Caterpillar Tractor Company, whose sales
franchise they operated in territory consisting of counties
in south Alabama and North Florida. That they were
recognized as unusually experienced and capable execu-
tives is shown by the fact that their plant was selected by
the Caterpillar Company as a place for training some of
its district representatives and further by the fact that on
one occasion Toothaker was asked to and made a speech
to the Caterpillar people about how to run a dealership.
The employees under their supervision during the years
involved were 56, 65 and 71, respectively.
8. During the years involved, Toothaker was 44, 45
and 46, respectively, and Burford was ten years younger.
Toothaker’s education and experience consisting of a high
school education, attendance until his junior year at the
University of Illinois studying civil engineering. After a
period of war service in World War I, he attended the
University of Grinoble in France, which was followed by
two or three years’ experience as a civil engineer with the
16
Illinois State Highway Department. He was then in the
road contracting business about five years, following
which he went into the construction machinery business,
in which he handled accounts similar to those of the pres-
ent company, where he remained three or four years.
After that he was employed as Sales and Service Manager
for the Lombard Company of its construction machinery
department for about a year which was work somewhat
comparable with the work of the present company. He
and Burford then organized the Georgline Company in
Augusta, Georgia, which handled the Caterpillar Trac-
tor account with other road machinery accounts and they
remained in it from 1931 until 1934, when the present
company was organized. Burford completed high school.
He worked in the machine shop of Lombard Iron Works &
Supply Company, also in their supply and accounting de-
partment, and was cashier and in charge of the office at
the time he left after ten years in its employ. He had sev-
eral years experience in the tractor business before he
and Toothaker organized the present company.
During Toothaker’s employment with the Lombard
Company, in which he held no stock and in which his
duties and responsibilities were greatly less than in the
present company, his compensation was a salary of
$350.00 per month plus a percentage of one percent of
sales from $150,000 to $200,000, and on the next $50,000
1%%, and on the next $50,000, 2%, and on everything
over $300,000, 3%.
4. The work of the two officers was substantially in-
creased during the years in question by new and added
work in dealing with problems which arose in their busi-
ness in connection with the war effort.’
* This was found to be true by the Tax Court and excerps from
its decision are quoted in the petition. There would. have been
even more testimony than was offered but the Tax Court judge
suggested that he was satisfied.
17
5. The operation of the company required relatively
large borrowings from banks which was as high as
$425,000. All of these borrowings were individually guar-
anteed by the endorsement of Burford and Toothaker,
who together had a net worth of approximately $500,000.
6. Under the management of Burford and Toothaker
of the company with an initial capital of $50,000 and
which was $150,000 during the three year period, the fol-
lowing results were accomplished in comparison with the
preceding three year period: (Petitioner's Exhibit 4. Cents
omitted).
1987-8-9 1941-2-3
Total sales $2,954,935 $5,689,300
Sales of used equipment 299,332 1,357,416
Profit before federal
income taxes 97,827 581,124
Federal income taxes paid 18,009 425,584
Profit after income taxes 79,817 175,529
7. During each year of the three year periods the
company paid a dividend of $12,000, which was 8% of its
$150,000.00 capital.
8. After payment of all operating expenses, includ-
ing bonuses to salesmen, the annual 8% dividend and the
salaries in question, the company increased its surplus
approximately from $94,000 to $354,000, an increase of
approximately $260,000 on its capital of $150,000.
9. During the years in question the annual salaries of
Burford and Toothaker were $9,000.00 plus 2% on all
sales in excess of $300,000.00. This has been their basis
of compensation each year since the company was organ-
ized in 1934, except in 1935 when the basis was slightly
higher. The amount of the compensation paid to the two
officers (total for the two), the total sales of the company,
the profits (before federal income tax), the dividends paid
i
18
and the percentage of the officers’ compensation to the
sales for each year of the company’s existence was as fol-
lows:
Year Compensation Total sales Profits | Dividends Percentage
paid Burford of officers’
& Toothaker compensation
(Total) sales
1935 23,5388 480,773 5.4
1986 32,800 699,988 23,740 10,000 49
1937 40,986 874,660 23,994 10,200 4.7
1938 35,204 730,116 18,228 6,780 48
19389 46,530 1,013,260 38,653 10,560 4.6
1940 54,462 1,211,558 41,085 12,000 4.5 |
1941 79,844 1,846,111 82578 12000 43
1942 97,213 2,280,348 299,602 12,000 43
1943 68,492 1,562,840 198,943 12000 44
A comparison of the compensation which Toothaker re-
ceived from the petitioner company with what he would
have been entitled to on the basis of his previous employ-
ment by the Lombard Company is as follows: (Petitioner’s
Exhibit 7)
Year Compensation re- Amount on basis
ceived from present of Lombard Company
company employment
1941 39,922.50 57,616.15
1942 48,606.50 70,360.47
1943 34,246.00 49,835.21
Total — 8 year 122,775.00 177,811.88
19
11. The company was examined by the respondent’s
agents for the three preceding years (1938-9-40) and the
Technical Staff approved the salaries as reasonable. R. 12.
The Board of Tax Appeals in the case of Burford-Tooth-
aker vs. Commissioner, Docket No. 100911 decided that
the salaries paid these officers for the years 1935-6-7
computed on the same basis (except slightly higher for
one year, 1985), was reasonable.
With these as the undisputed facts, it is submitted
that they justify no other conclusion than that the testi-
mony of the witnesses was the only testimony that could
have honestly been given.
Comparison with other cases factually comparable.
A comparison of the facts of this case with those of
other comparable cases shows that not only was the com-
pensation paid here “reasonable” but it was substantially
less, measured by any yardstick, than what was approved
by the Courts and the Tax Court itself for officers occupy-
ing similar positions in other comparable companies for
the same approximate period. Thus:
A comparison of the record facts in Roth Equipment
Company vs. Gallagher case, supra (172 F* 452) with those
in the case at bar shows:
(a) In both cases the years were almost the same, 1941-
2 in Roth, 1941-2-3 in present case.
(b) In both cases the stock was closely held—80% in
Roth case.
(c) In the Roth case there was no bonus or additional
compensation agreement made in advance but only after
the amount of the profits were known. Here the compen-
sation was fixed in advance and was standard in each of
the years and had been the same (except for one year,
1985, for a larger percentage) in each of the years pre-
ceding.
20
(d) Whether the increase in the sales was due primarily
to officers’ effort or otherwise was a matter of dispute in
the Roth case and in the instant case the Tax Court was not
willing to attribute the increase in sales “altogether to the
efforts of the two officers (R.46) even though the Court
stopped Burford from testifying further in that respect on
the hearing (R. 65, footnote 1, this brief).
(e) A comparison of net profit of the two companies,
the compensation allowed as reasonable by the Circuit
Court of Apeals, and the ratio of officers’ compensation to
net profit shows the following:
Roth
yong Net Profit —— yet agra
net profit
1941 $38,958.00 $46,452.00 119%
1942 $57,015.00 $86,482.00 151%
Average 135 %
Burford-Toothaker
1941 $82,528.00 $79,844.00 96%
1942 $299,602.00 $97,213.00 82%
Average 64%
The result is that the two year average percentage of
officers’ compensation to net profit allowed in the Roth
case, 185%, is more than double the percentage, 64%, paid
in the instant case.
(f) The record does not disclose any dividends paid in
the Roth case while in the case at bar, the company regu-
larly paid 8% each year on its stock, a total of $36,000.00
in dividends.
(g) Both cases involved war years. As to this the Sixth
Circuit wrote in the Roth case:
21
“Although war conditions caused the industry
in general to boom, yet there was keen competition
for such increased business among the competing
firms. The experience of the three officers, the
contacts and good will established by years of work,
hard work and long hours, plus the operation of
the bonus plan enabled them to take advantage of
the favorable situation and for a few years receive
liberal compensation. But it was still compensation
for personal services, and of a kind that is entitled
to liberal compensation when the results were suf-
ficiently successful to pay it.”
“The fact that much of the increased business
of the Company during 1941 and 1942 was due to
war conditions does not seem to be very material.
In a business involving the personal services of its
officers, as in the present case, increased business
meant increased work and increased responsibilities.
War orders added the complicated factor of priorities.
While unusual economic conditions brought on by
the war is a factor to be considered in these cases, the
Tax Court has held several times that this alone does
not establish unreasonableness where war business
has resulted in increased work and responsibility.”
It is submitted that approval of the reasonableness of
the officers’ Compensation in the case at bar is justified
even more than in the Roth case.
Comparison of the facts in Wright-Bernet, Inc. vs.
Commissioner, supra (CCA 6) 172 F? 348, involving the
reasonableness of officers’ salaries for similar years—1942-3,
two of the years involved herein shows:
1. In both cases the officers whose compensation was
at issue (1) participated in sales, (2) performed administra-
tive as well as executive duties, (3) worked exceedingly long
hours, (4) were experienced and capable, (5) themselves
owned a large majority of the corporate stock.
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25
In the Wright-Bernet case the Tax Court had, as here
reduced the amount of officer's compensation to a figure
selected by the court in disregard of the testimony. In its
opinion the Circuit Court wrote that the “success of the
business is shown by the record to be due mainly to the
work of the four employees whose salaries are in question.”
That is true here.
There, the Circuit Court in referring to the rule as to
the presumptive correctness of the Commissioner's deter-
mination wrote:
“The Tax Court considered that this case did
not require the application of the doctrine of the
presumptive correctness of the Commissioner's de-
termination, and decided that it called for a de-
cision upon its facts. While the findings of fact give
full credit to the experience, qualifications, ability,
and unusual industry of the four employees, and
the Tax Court reduced the deficiencies found by the
Commissioner, it made substantial reductions in the
salaries fixed by the corporation.”
There, as here, the employees whose salaries were in
question, testified that they were reasonable and a third
party corroborated them just as the witness Aldridge, an
independent certified public accountant, testified that the
compensation was reasonable and even less than in a com-
parable instance (R. 74).
What was held and written in that case is applicable
here, namely:
“As the petitioner’s witnesses were qualified and
unimpeached, and no evidence was given to the con-
trary, their testimony should have been accepted.
Capital-Barg Dry Cleaning Co. v. Commissioner, 6
Cir., 181 F 2d 712.”
26
A case decided by the Tax Court, North Carolina
Equipment Company (Docket 4737, decided June 4, 1945)
involving the reasonableness of officers’ salaries for one
of the same years as here, is comparable.
(a) The North Carolina Equipment Company was op-
erating in the same kind of business as Burford-Toothaker
and handling some of the identical liries of equipment and
the background and experience of the president of the
North Carolina Equipment Company case is strikingly
parallel to that of Toothaker, the president here, and his
duties were closely similar.
(b) There, as here, the officers involved owned a large
majority of the stock.
(c) Compensation of officers in that case as here was
based on a fixed salary with additional compensation or
“bonus.” In that case instead of the additional compensa-
tion being based on a small percentage of the sales above
a certain fixed amount as here it was based on a large per-
centage of the profits.
(d) For the year 1941 the North Carolina Equipment
Company paid to its officers 55.6% of its total compensa-
tion to all employees, of which 33.8% was paid to its presi-
dent while here the amount paid to all officers was but
43.2% of total compensation paid all employees and the
president here was paid only about 21.6% of the total as
against 33.8% paid there to the president.
(e) A comparison of the dividend record of the two
companies, using the five years of figures shown in that
case with the record of the company in the case at bar
shows the percentage of dividends of the North Carolina
Company to be an average of 8.06% of its original invested
capital compared to 21.39% in the instant case or move than
double. As the courts seem to place value on dividend
payments in determining reasonableness of compensation
27
paid to officers, these figures indicate that on this basis
of comparison as well as others, the compensation in the
instant case was proportionately smaller than that ap-
proved in the North.Carolina case.
(f) On a sales volume basis, for the year 1941, the
president who owned more than 50% of the stock was paid
compensation which amounts to 2.8% of the sales as com-
pared to 2.165% to the president in the case at bar. In
that case all officers drew 4.72% of sales compared to
4.33% for the corresponding year in the instant case and
an average for the three years of $4.30%.
Thus on every fair basis of comparison the officers’
compensation in the case at bar is substantially less than
that approved as reasonable in the North Carolina Equip-
ment Company case for officers doing closely similar work.
Mayson Manufacturing Company vs. Commissioner,
(CCA 6), 178 F? 115, is another case where. the officers
whose compensation was in question and their immediate
families owned all the corporate stock. While the year
1948 was the only one involved so as to offer a comparison
with the case at bar. A comparison of officers’ compensa-
_ with sales of the two companies for the three years
ows:
WOE'F %LT'0G safes 0} uoNvsueduIOD jo o8e}us010g JO o8¥1aAe Ieay-¢
BCE'V %8'6I 00°Z6F'89 OO'SPL'LET O0'OFS'ZOS'T —-00'86F‘969 evel
%IEV %0'TS 00°813°L6 OO'SZI'SOT O0'GFEO8TS ~—00' 6 L‘66F Gv6T
a MEE'V %L'6I OO'FFS'GL$ 00'8S'8L $ OO'TITOPS'T$ OO'sso‘o6e$ FET
segue
0} u0On sores
-esuoduioo 0} uones
jo 938 uadui0o uonesusdw0o
-yusoi0d jo oBe SAd0TJJO uonesuedui0co sores
JoyeyQO], -yusozond JayeyQOo |, $,1991}JO JayeyQOoO], te
“propng uosheW “ppg Uoshey ~proping GOSAERY #004
-n wn oa oon iitaninnes VCD TIC AL IN ROOK
29
The significant point of this comparison is that the of-
ficers in the Mayson case approved by the Sixth Circuit for
1943 was considerably more than four times as much in
relation to sales as in the case at bar and that was true also
in the other years under consideration.
Attention is called also to the fact that for the year
1943, the sales of Burford-Toothaker were 2% times those
of the Mayson Company, yet the compensation of officers
of the Mayson Company was more than double that of Bur-
ford-Toothaker for that year. The ratios for the other years
are even more favorable to Burford-Toothaker as to reas-
onableness of compensation.
The results obtained should be given weight. Com-
parison of the Mayson Company case and Burford-Tooth-
aker case shows: :
Year Amount of Amount of Ratio of Ratio of
Profits of profits officers’ officers’
Mayson be- Burford- compen- compensa-
fore taxes Tothaker sation tion to
and officers’ before taxes to its profits be-
compensation and officers’ before de- fore deduct-
compensation ducting ing com-
1941 $129,591.00 $162,422.00 60.4% 49.1%
1942 200,359.00 396,816.00 52.5% 24.5%
1943 314,721.00 267,435.00 43.1% 25.6%
3-Year Average Percentage 52.0% 33.1%
These figures show that for these three years the of-
ficers of the Mayson Company received as compensation
an average of 52% of the profits for the three years, while
the officers of Burford-Toothaker received an average of
only 33.1% for the same three years. It should be noticed
also that in the Mayson case the additional compensation
30
paid officers was based on a high percentage of the net
profits as compared to a small percentage of the sales in
excess of a maximum basis in the present case. In deciding
whether officers’ compensation is dividends in disguise,
there is certainly more logic for assuming that percentages
of compensation as based on profits are dividends under
the guise of compensation than in assuming that a small
percentage of sales above a certain figure may represent
dividends. The former method of determining additional
compensation was followed in the Mayson case and the
latter method in the case at bar.
A fair comparison of the facts of the comparable cases
—Roth, North Carolina Equipment, Mayson Manufactur-
ing, and the Wright-Bernet—in all of which the officers’
compensation was held to be reasonable, should leave no
doubt as to a similar conclusion here.
Comparison with previous board decision.
By way of further comparison attention is called to
what the Board of Tax Appeals wrote concerning the reas-
onableness of the compensation of these identical officers,
in its 1940 decision dealing with the years 1935, 6 and 7.
(Docket 100911 Oct. 20, 1940; Exhibit 2):
“In the instant case we are convinced that Bur-
ford and Tothaker, the two officers, personally built
up petitioner's business through their diligence and
ingenuity. They devoted their entire time to manage-
ment of the petitioner and even financed the corpora-
tion personally on several occasions. Petitioner’s prof-
its can largely be attributed to the personal activity of
its two officers. Regardless of the fact that the officers
and their wives owned all petitioner's stock equally,
nevertheless self-awarded bonuses wou!d not be un-
reasonable or necessarily disguised dividend distribu-
tions if: (a) like concerns in like circumstances paid
31
like officers a comparable salary, and (b) the officers
actually performed the duties of these officers or (e)
it can be otherwise proven that the circumstances
involved merited the additional compensation for
services actually rendered.”
The Court then made a comparison between the basis
of Toothaker’s compensation when employed by the Lom-
bard Company, a road machinery concern, in a position
with somewhat similar sales duties under a contract for a
monthly salary and a percentage of sales with the basis of
his compensation as an employee of the present company
with the result that in each year his compensation figured
on the Lombard basis would have produced a larger
amount than he drew as an officer of the present company.
The same comparison continues to be true in the in-
stant case where in each of the three years his Lombard
compensation would have substantially exceeded his salary
with the present company. During the three year period
the columns shown in Petitioner's Exhibt 7 show that the
compensation paid Toothaker in the three years in ques-
tion was $55,026.83 less than that he would have » vet
entitled to on the same volume of sales under the Lombard
agreement.
The favorableness of this comparison in this case is in-
creased by consideration of the fact that in his present po-
sition Toothaker has many executive and other duties as
President of the company which he did not have as Sales
- and Service Manager of but one of Lombard’s depart-
ments.’ Moreover, he did not have to pledge his individual
resources in obtaining financial assistance for the company
as he did for the present company.
The Court concluded that on the basis of that criterion
the compensation paid to the officers in that case was
* Construction machinery department.
aan Seles eens Vasa
Sata eR ae Be SRR ee 29 7 Rat POR i eRe
32
reasonable. On the basis of the same criterion applied here,
the result would be the same.
But the Court in that case did not confine itself to that
one test but went further and held that:
“Thus far we have only considered the reason-
ableness of the compensation by comparison with a
like concern. We do not, however, rest our conclusion
merely upon this comparison but by scrutinizing the
petitioner's books in the light of the facts adduced, we
arrive at the same conclusion on other grounds. Pe-
titioner declared large proportionate dividends in
1936 and 1987 and by the close of its third full year
of business had built up an undistributed surplus
equal to more than half of its outstanding common
stock, and its sales’ volume had been more than dou-
bled in this same space of time. All this was due most-
ly to the efforts of Burford and Toothaker. When
faced with a successful corporation such as this which
actually declares dividends qua dividends and builds
up a surplus after all compensation and expenses are
paid, we hestitate to find officers’ compensation un-
reasonable unless it is unconscionably large in ratio
to the duties performed. Neither officer’s salary here
could be said to be unconscionably large in view of
his efforts and the satisfactory results obtained there-
by. The fact that the corporation is a “close” one mere-
ly arouses suspicion, which, when the circumstances
are examined, proves to be false. The entire compen-
sation paid to each officer for each of the years in
question was reasonable.”
Attention has already been called to the fact that in
addition to their regular work, these two officers in the
abnormal years here under consideration had greatly in-
creased work. As was stated by the Tax Court Judge dur-
ing the hearing: “It doesn’t take very much to convince
33
me that the war effort did increase the duties of business
men. (R. 64)
Not only were their duties and strain increased (Tooth-
aker has since died) but the money they were paid was
worth considerably less than in prior years due to the drop
in purchasing value from 101.9% in 1985 to 80.9% in 1943,
according to Commerce Department figures.
The Internal Revenue Bureau’s “Committee on Ap-
peal and Review Recommendation” has had this to say
about an established practice of salary payment:
“Established Practice.—Where salaries have been
fixed long before any Excess Profits Tax Law was con-
templated, the Income Tax Unit is not authorized by
the law or regulations to arbitrarily change the
amounts deductible. Neither is the Unit authorized
to look back of any corporation resolution fixing sal-
aries after the passage of the Excess Profits Tax Law,
provided there is no evidence of intent to reduce the
the tax of the corporation, and provided that after
deducting the amount fixed and paid the corporation
has a normal return on its invested capital left, or
where such deduction does not reduce the net earn-
ings subject to tax below that of competing concerns
which secure the services of officers and employees
by open bargaining.” A. R. R. 53, 2 Cumulative Bulle-
tin, 110.
To the same general effect is William S. Gray, 68 Ct.
of Cl. 43, 35 i** 968:
“The policy of agreeing to pay a percentage of
the earnings before they are earned, or even a sum
in the nature of a bonus after they are earned, is
based primarily upon sound business principles.”
If, therefore, it is necessary for the Court to examine
the testimony for credibility or to compare decisions in
4
other cases it would seem that the comparisons here fur-
nished would leave no room for doubt as to the credibility
of the witnesses here and the error of the Courts below.
Equitable Estoppel.
The final point is whether the technical r napa
of the rule of equitable estoppel were met in
that the decision in the former decision was candies
here because of fact that (a) the parties are identical, (b)
the issue as to whether officers compensation paid is
identical, (c) the same general kind of services are involved,
and (d) the basis for computing the officers’ compensation
is identical in two of the former years and slightly less
than in the other? The Tax Court in its opinion held that
although these matters are the same in each case, the fact
that the present case pertains to a different period (differ-
ence in years only) and different conditions (harder, if
anything), actually prevents the application of the rule of
res judicata or “equtable estoppel.”
On this point it is submitted that what was written in
Bennett vs. Commission, CCA 5, 113 F? 837, is applicable:
“Res judicata rests on a rule of public policy
designed to put an end to mere contentious litiga-
tions. Under that rule an issue once finally settled
by the judgment of a court of competent jurisdic-
tion remains settled. . . .
. . that the cinies of res judicata applies to
cases in courts under the tax laws, and that where the
parties are the same and the questions identical, the
fact that different tax years are involved will not pre-
vent its application.” (Emphasis supplied)
In this case the corporate taxpayer had, from the be-
ginning, established a system of officer compensation on
the basis of salary plus percentage of sales. The amount
35
it paid on this basis was questioned by the Commissioner
for the first three, 1985, 6, 7, and upheld and approved
by the Board of Tax Appeals. It paid on the same basis for
the next three years, 1938-9-40. The Commissioner again
questioned the amount and his officers charged with the
responsibility of settling such matters considered it and
approved it. Thus for the second time the government, by
its proper officials, considered and approved the amount
arrived at on the salary and percentage of sales method.
The company with its first six years approved, con-
tinued to pay on the same basis for the next three years,
1941-2-3, but then the same court which had previously
approved the amount computed on the salary and per-
centage of sales method reverses itself and holds the other
way.
This is a case where every equitable consideration
requires that the rule of res judicata or equitable estoppel
be invoked both on the legal considerations present and
also on the basis of simple justice.
CONCLUSION
It is submitted that for the reasons stated, this Court
should accept this case, rectify the unjust result of the
Court below and settle the question of what is a “reason-
able” allowance for compensation and hold that when
qualified and informed witnesses and with no testimony
to the contrary, testify (without impeachment) that the
amount paid is reasonable, the court should accept the
testimony and not go outside the record and make an in-
dependent determination unsupported by anything in the
record.
Respectfully submitted,
Fred S. Ball, Jr.
Montgomery, Alabama
Attorney for Petitioner
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