*244 Decision will be entered under Rule 50.
Held, commissions paid by way of compensation to a sales agent for services rendered were deductible by the petitioner taxpayer, notwithstanding the fact that part of the commissions was paid to petitioner's president under an oral contract for his services as a salesman, the arrangement being a customary one in the trade, there being no concealment and the percentage paid being reasonable.
*394 The Commissioner determined deficiencies in taxes as follows:
| 1939 | 1941 | 1942 | 1943 | |
| Income tax | $ 1,230.25 | $ 7,104.02 | ||
| Declared value excess profits tax | $ 3,933.08 | |||
| Excess profits tax | 20,570.65 | 75,792.58 | $ 100,254.60 |
The only issue to be determined is whether $ 31,557.86, $ 83,658.49, and $ 79,088.48 of the amounts paid by petitioner in 1941, 1942, and 1943, respectively, to its sales agent, and paid by the latter to petitioner's president and treasurer, represent excessive compensation paid by petitioner to its*245 president and treasurer for services rendered. Some of the facts were stipulated.
*395 FINDINGS OF FACT.
The petitioner, an Alabama corporation, with its principal office at Florence, Alabama, is engaged in the manufacture of knitted goods. It was incorporated on March 4, 1927, under the name of "Gardiner-Warring Company," but on December 4, 1947, its name was changed to "J. T. Flagg Knitting Co., Inc." Its returns for the years involved were filed with the collector of internal revenue for the district of Alabama.
Prior to the organization of petitioner, a corporation named Gardiner & Warring Co. operated a knitting mill at Amsterdam, New York. After a survey had been made, those interested in the Amsterdam mill determined that it would be preferable for the mill to be located in the South, nearer the source of its major raw material, cotton. At that time the Chamber of Commerce of Florence, Alabama, was very active in attempting to attract cotton textile industries to Florence, which was a small town with an agricultural background. To induce the mill to locate in Florence, people living there subscribed for substantially all of the preferred stock of petitioner. For *246 the most part, the subscribers were business men and their object in subscribing for the stock was to have an industrial pay roll in town to increase their businesses.
E. I. Goodrich was president of Gardiner & Warring Co. and also of Clift & Goodrich, a sales agency. J. T. Flagg, in traveling through the Mohawk Valley as salesman for a sales agency in Boston, Massachusetts, became acquainted with Goodrich and others interested in the Amsterdam mill. In 1926 he participated in the conferences between representatives of the Amsterdam mill and residents of Florence pertaining to the removal of the mill to Florence and the organization of a new corporation, the petitioner. He has been a member of its board of directors ever since its organization and was its first secretary and treasurer. It was understood that Goodrich would be the president of the new corporation and that he would have charge of purchasing raw materials, financing, and selling. It was also understood, as a protection for the Florence investors, that in the beginning the officers' salaries would be kept low and not exceed $ 10,000. This was satisfactory to Goodrich, as it was understood that the selling would be*247 handled by Clift & Goodrich and his compensation for selling the products of the mill would come out of commissions paid that firm. Goodrich died in the latter part of 1926, before the organization of petitioner. Thereupon his sales agency was liquidated and W. C. Jones, former vice president of Clift & Goodrich, and president of his own newly organized sales agency, called "William C. Jones and Co., Inc.," agreed to accept the same arrangement to which Goodrich had agreed, as and when the organization of petitioner was completed. *396 Jones became the president of petitioner upon its organization. He became ill sometime in 1928, resigned as president, and later died.
Flagg went to Florence and aided in the formation of petitioner. He supervised the construction of the plant, the removal of the machinery from Amsterdam to the Florence plant, and the employment of personnel suitable for the operation of the mill, which commenced operation in the fall of 1927. Until 1929 or 1930, he spent the major part of his time at the mill. Upon the death of Jones, it became his duty to secure the services of another sales agency.
By September 1930 petitioner had an efficient manufacturing*248 organization, with all the various departments well staffed. Its superintendent, named Scott, was a man with 20 years' experience in the knitted goods industry in New York. Flagg was then president of petitioner. After the execution of the contract with an organization known as the Campe Corporation, a selling company, Flagg spent a substantial part of his time in the work of the selling agent as a result of his contemporaneous arrangement of employment by the Campe Corporation for the sale of petitioner's products, at a salary of $ 8,000 a year. Thereafter Flagg devoted the major part of his time to the selling end of the business.
C. A. Porter served as vice president and general superintendent of petitioner in charge of manufacturing. He devoted full time to the operation of the mill under the general supervision of Flagg, the active head of the business. Porter's salary varied from about $ 6,000 a year at the beginning to about $ 12,000 or $ 14,000 a year.Throughout the taxable years, petitioner's authorized capital consisted of 1,000 shares of no par common stock and 1,000 shares of 3 1/2 per cent cumulative preferred stock of the par value of $ 100 per share, of which*249 all of the common and 753 1/2 shares of the preferred were issued and outstanding. As of March 1, 1939, J. T. Flagg owned 884 shares of common stock and 233 shares of preferred stock. The remaining 116 shares of common stock were held by 6 persons. The remaining 520 1/2 shares of preferred outstanding were held by 72 persons. One owned 100 shares and another 50 1/2 shares. Fifty-four of the 70 remaining shareholders held 5 or less shares. The stock ownership remained substantially the same throughout the taxable years.
No dividends were paid on either common or preferred stock of petitioner from the date of incorporation through December 31, 1943. Under the provisions of petitioner's articles of incorporation, the preferred stock acquired full voting power with the common stock upon default in payment of two dividends on preferred stock.
*397 The articles of incorporation of petitioner provided for five directors, two of whom were to be residents of Florence, Alabama, so long as any of the preferred stock of the corporation was outstanding and owned by citizens of Florence. During the taxable years the majority of the directors were holders of preferred stock.
The petitioner's*250 net operating profit (or loss), as shown by its income tax returns, for each of the years 1936 to 1943, inclusive, was as follows:
| 1936 | $ 7,688.68 |
| 1937 | (12,433.89) |
| 1938 | (33,326.59) |
| 1939 | (5,116.28) |
| 1940 | 2,041.81 |
| 1941 | 43,338.14 |
| 1942 | 455,276.82 |
| 1943 | 366,338.41 |
The earned surplus (or deficit), as of December 31 for each of the years 1939 to 1943, inclusive, as shown by petitioner's books and as determined by the examining agent after examination of such books, was as follows:
| Earned surplus (or deficit) | ||
| Year | ||
| As determined | ||
| As shown | by revenue | |
| by books | agent | |
| 1939 | ($ 28,304.11) | ($ 50,905.10) |
| 1940 | (25,469.42) | (43,165.63) |
| 1941 | 3,355.26 | (29,766.65) |
| 1942 | 131,354.00 | 36,879.21 |
| 1943 | 226,207.66 | 46,191.42 |
Throughout the period from the beginning of petitioner's operations in 1927, it has sold its products through established selling agents, usually located in New York City. In some instances, an officer of petitioner has been employed by the selling agent or has had a proprietary interest in the business of the selling agent. The following summary shows the date of each contract entered into by petitioner with a selling agent, the*251 name of the agent, the rate of sales commission, the name of the officer of petitioner connected with the agent, and the arrangement existing between such officer and the agent: *398
| Date of contract between | Rate of commission paid | |
| petitioner and sales agent | Name of sales agent | to sales agent |
| Sept. 22, 1927 | William C. Jones & Co | 3% on all petitioner's |
| sales | ||
| Nov. 28, 1928 | Hampshire Underwear | 5%, including factoring |
| & Hosiery Co. | fee, except 4 1/2% on | |
| sales to named customers. | ||
| June 1, 1929 | Robitscher & Daum | 7% on lightweight |
| goods, 6% on special | ||
| goods, 5% on heavyweight | ||
| goods, including | ||
| factoring fee, changed | ||
| Apr. 2, 1933 to 6%. | ||
| Sept. 25, 1930 | Campe Corporation | 5 1/3%, including |
| factoring fee | ||
| Nov. 2, 1931 1 | Frederick Textile Co | 3% on underwear, 5% on |
| outerwear | ||
| Oct. 3, 1931 | John N. Hoag (Pacific | 3% |
| Coast representative). | ||
| July 1, 1933 2 | McLoughlin Co | 3% on first million of |
| sales, 4% thereafter. | ||
| Mar. 14, 1936 | A. J. Armstrong & Co | 3% on underwear, 4% on |
| outerwear | ||
| May 19, 1938 | Goldflagg Mills, Inc | 3% on underwear, 4% on |
| outerwear | ||
| Mar. 1, 1939 | C. F. Roman | 3% on underwear, 4% on |
| outerwear |
| Date of contract between | Officer of petitioner | |
| petitioner and sales agent | Name of sales agent | employed by sales agent |
| Sept. 22, 1927 | William C. Jones & Co | William C. Jones, president |
| Nov. 28, 1928 | Hampshire Underwear | |
| & Hosiery Co. | None | |
| June 1, 1929 | Robitscher & Daum | None |
| Sept. 25, 1930 | Campe Corporation | J. T. Flagg, president |
| Nov. 2, 1931 1 | Frederick Textile Co | J. T. Flagg |
| Oct. 3, 1931 | John N. Hoag (Pacific | |
| Coast representative). | None | |
| July 1, 1933 2 | McLoughlin Co | J. T. Flagg |
| Mar. 14, 1936 | A. J. Armstrong & Co | J. T. Flagg |
| May 19, 1938 | Goldflagg Mills, Inc | J. T. Flagg |
| Mar. 1, 1939 | C. F. Roman | J. T. Flagg |
| Date of contract between | Compensation received by | |
| petitioner and sales agent | Name of sales agent | officer from sales agent |
| Sept. 22, 1927 | William C. Jones & Co | Participation in profits |
| of sales agent. | ||
| Nov. 28, 1928 | Hampshire Underwear | |
| & Hosiery Co. | ||
| June 1, 1929 | Robitscher & Daum | |
| Sept. 25, 1930 | Campe Corporation | $ 8,000 per year salary. |
| Nov. 2, 1931 1 | Frederick Textile Co | J. T. Flagg owned |
| 20% of the stock of | ||
| sales agent, received a | ||
| share in the profits | ||
| (as determined by board | ||
| of directors), with a | ||
| guarantee of $ 50 per | ||
| week. | ||
| Oct. 3, 1931 | John N. Hoag (Pacific | |
| Coast representative). | ||
| July 1, 1933 2 | McLoughlin Co | $ 1,000 per month. |
| Mar. 14, 1936 | A. J. Armstrong & Co | 2% on sales up to |
| $ 600,000 ($ 12,000 a | ||
| year maximum). | ||
| May 19, 1938 | Goldflagg Mills, Inc | 2% on all sales |
| of petitioner's products | ||
| made by sales agent. | ||
| Mar. 1, 1939 | C. F. Roman | 2% on all sales of |
| petitioner's products | ||
| made by sales agent. | ||
| (Rate was reduced to | ||
| 1 1/2% for 1940, then | ||
| restored to 2%.) |
*253 *399 A written contract of employment, dated January 28, 1931, was entered into by Flagg and Frederick Textile Co., which contract was signed by Flagg individually and as president of the sales agency. In addition to the $ 50 a week, Flagg was to be paid his traveling expenses and to receive such percentage of the net profits of Frederick Textile Co. "as the Board of Directors shall consider fair and proper."
The employment of Flagg by the McLoughlin Co. was evidenced by a written contract, dated July 1, 1932, which provided for its continuance for the duration of the contract between the sales agency and petitioner.
The contract of employment between Armstrong & Co. and Flagg was in writing, dated March 14, 1936, and provided, in part, as follows:
This agreement is subject and subordinate to the agreement by and between A. J. Armstrong Co. Inc., of New York City, and Gardiner-Warring Co. Inc., of Florence, Ala., dated March 14, 1936.
The sales contract dated May 13, 1938, between petitioner and Goldflagg Mills, Inc., was signed by Flagg as president and treasurer of petitioner. On the same date, Flagg entered into a written contract with Goldflagg Mills, Inc., which provided*254 in part that Flagg was to receive a 2 per cent commission on all sales of petitioner's products by such agency, with a minimum of $ 800 a month, and that Flagg was to pay his own sales expenses unless such expenses were assumed or directed by the company. Flagg warranted that he would produce annually $ 750,000 of bona fide orders of first class accounts. Flagg and Goldfarb each owned 50 per cent of the stock of Goldflagg Mills, Inc. Flagg sold his stock to Goldfarb and the above contract was terminated.
Flagg and C. F. Roman became acquainted about 1930. In February 1939, Flagg met Roman in New York and told him that he was thinking of making a change in the selling agency of petitioner. He explained to Roman, among other things, what the arrangement would be and asked if Roman would be interested. Roman had been engaged in the underwear business for about ten years. During the first three years he traveled as salesman for a wholesale house in Detroit and thereafter became buyer for a competitive jobbing establishment in Detroit. In 1932 he went to New York and was there employed as salesman. About August 1938 he went into business as sales agent for himself. Roman had *255 had considerable experience in the sale of outerwear, a phase of the knitting business which petitioner was just beginning. Flagg was also interested in Roman because of his buying experience with the jobbing establishments. The products of petitioner *400 were going primarily to chain stores and mail order houses and Flagg wanted to extend its outlet to jobbers.
During the discussions between Flagg and Roman, the employment of Flagg as salesman by Roman was frankly discussed. Flagg would not have entered into an exclusive sales contract with Roman without an arrangement for his employment by Roman. Likewise, Roman would not have entered into an exclusive contract with petitioner without the services of Flagg, because he felt that he would not be able to sell petitioner's entire output without Flagg's services as salesman and his sales connections, including large accounts with Montgomery Ward, Sears Roebuck, and others, with whom Roman had had no contacts.
The discussion between Flagg and Roman resulted in the signing of a contract by Roman as agent, and by Flagg as president and treasurer of petitioner, as principal. The contract dated March 1, 1939, contained the following*256 provisions:
1. This agreement shall be valid and binding upon each of the parties hereto and their respective successors and assigns for a term of three years from the date of the execution hereof, unless sooner terminated by the mutual agreement of the parties. In the event of cancellation it is agreed A: that contract is not cancellable for a period of two years from date of execution; B: thereafter in the event of cancellation same shall be effective at the end of three months from the date that same is mutually agreed upon.
2. The agent is made and constituted sales agent and distributor of the principal with the exclusive right to sell and distribute its products any place in the United States, Canada, Mexico and throughout the world.
3. The parties agree that person or persons mutually agreeable shall be selected as employees of the agent in the sale and promotion of the principals products.
4. The agent agrees that all orders so procured shall be subject to acceptance by the principal at the principals [sic] office in Alabama and the credit of the customer to whom sold shall be subject to credit checking and acceptance by the factoring division of the Trust Company of *257 Georgia or any other factor or credit agency that the principal may in the future designate.
5. The principal agrees that merchandise ordered through the agent shall be billed directly to the customer and collected by the principal or its factor. The agent is not responsible for any credits with respect to sales so made by it; it being understood that the principal or its factor shall pass upon the acceptance of all orders and credits.
6. In the event remittances are made to the agent by any customer, the agent agrees to transmit the original check immediately to the principal.
7. In full compensation for the agents [sic] services under this agreement the principal agrees to pay and the agent agrees to accept on the total gross shipments of the principal during each month that this contract is in effect 3% on underwear and 4% on outerwear; such commissions to be paid to the agent on or before the 10th of the following month. The principal agrees to report daily to the agent all shipments of merchandise made by it together with the destination and amount thereof.
*401 8. Accurate records and accounts shall be kept by the principal and by the agent of all transactions under*258 this agreement and each parties records and accounts shall be opened to inspection by the other party at all reasonable times.
9. It Is Agreed that should any dispute as to the correctness of any statement arise that same shall be settled by an audit made by Arthur F. Morton Co., public accountants with office at Atlanta, Ga.
Contemporaneously, Roman and Flagg entered into an oral agreement, pursuant to which Flagg was to be employed for an indefinite period as salesman by Roman, his compensation for his services to be a commission of 2 per cent on the total sales of petitioner's products made by the sales agency. The division of the commission was based on the estimated sales of Flagg and the sales of Roman. Flagg was to pay his own traveling and other expenses incurred in selling and Roman was to bear his own expenses, including the expense of his office and facilities in New York and his own traveling expenses. They also had an understanding that under certain conditions the respective share in the commission could be changed. At the time the contract was entered into Roman was representing two mills, for which he sold part of their output. At the end of 1939 Roman gave up*259 selling for the two mills and therefore could and did give his entire time to the sale of petitioner's products. Thereupon Flagg's participation in the commission was reduced from 2 per cent to 1 1/2 per cent. In 1941 sales to the Government increased, which entailed more work on the part of Flagg, as a result of which the original arrangement was restored. Both Flagg and Roman considered the division of the commission fair.
Through his connection with former selling agents of petitioner, Flagg had built up a sizeable business with the larger mail order houses and chain stores. In the early thirties he had done considerable Government business and was familiar with the method of handling Government contracts. The responsibility of getting and handling war contracts devolved upon him. As the war effort continued, he spent practically all of his time on Government contracts. This required a great deal of work with the various bureaus, not only as to their requirements, but as to the availability of certain types of goods. In many instances knitting mills did not have the equipment to produce the goods specified. It was necessary to go to the various bureaus and explain the *260 situation and have alternate specifications drawn in order that the products desired could be manufactured. It was necessary to assist in obtaining approval of raw materials, of fabrics, and of design, and, at times, to aid in designing certain garments to be used for specfic purposes. During the taxable years Flagg devoted all of his time to the business of petitioner, the greater part of which *402 was spent in selling its products under the employment with Roman. He made more sales than Roman. He was at the mill in Florence about 50 per cent of his time. However, most of his time at the mill was devoted to the selling phase of the business and the remainder of his time to his executive and administrative duties as president and treasurer of petitioner. During 1941, 1942, and 1943, and prior thereto, petitioner had a factoring arrangement with the Trust Co. of Georgia. Flagg represented petitioner in all conferences relative thereto.
Roman handled practically all of the civilian sales. During the war one of the most difficult and important jobs of a salesman was to refuse business of civilian customers in such a manner as not to offend them and to retain their good will*261 and accounts. This condition arose because of the limited supply of civilian goods. In addition, Roman aided considerably in servicing Government contracts procured by Flagg, in locating and obtaining needed raw materials, in submitting samples made according to specification to inspection officers of the Government for approval, and in other respects. He spent about 25 per cent of his time at the mill in Florence, sometimes being there as long as four weeks at a time. Flagg and Roman each had a very good reputation in the textile field.
A sales agent, in order to work efficiently, must have extensive knowledge of the mill he represents, including its equipment, capacity, and products it manufactures and can manufacture, the state of the market, styles, and price ranges. He must maintain his contacts with old, new, and prospective customers. He must know what each customer desires in particular garments, styles, and prices, and the problems of his customers and of the mill, must see that distribution is balanced between small and large users, and sell the type of product which the mill is best able to manufacture. Sometimes he helps in styling new garments. Occasionally garments*262 are picked up and taken to the mill to have them made up. He must be on the lookout for sources of supply for raw material for the mill. After orders are booked, he must service the contract, i. e., see that the goods are made right, packed properly, and shipped when wanted, and that the customer is satisfied. The Government inspectors were especially strict in this requirement.
The contract of March 1, 1939, between petitioner and Roman was not recorded in the minutes of the petitioner or approved by formal action of its directors. However, the directors discussed and approved of the Roman contract and also knew that Flagg was employed by Roman and that he was being compensated by Roman for his sales work.
*403 After the expiration of the Roman contract in March 1942, it was not extended by written agreement. However, the same arrangement was continued during the remainder of the taxable period.
The selling of products of a knitting mill through a sales agent on a percentage basis is not unusual. It is generally considered a sound business arrangement, particularly where the sales volume does not run over 10 or 15 million dollars, for the reason that selling costs per *263 unit are fixed and easily ascertainable. Petitioner's predecessor, the mill located at Amsterdam, had sold its products through a sales agency.
It is not uncommon in the textile industry for an official of a mill to be employed by the mill's sales agency and to receive compensation from the latter.
The commissions of 3 per cent on underwear and 4 per cent on outerwear provided for in the Roman contract of March 1, 1939, were reasonable and in line with rates of sales commissions generally paid by other mills.
During the war period rates of commission generally remained the same and were not reduced, even though the mill was engaged chiefly in producing for the Government.
The total sales of petitioner on which commissions were paid to Roman, and the approximate portion of sales thereof to the Government and to civilians, respectively, during 1941, 1942, and 1943, were as follows:
| Year | Total sales | Government | Civilian |
| 1941 | $ 4,012,509.60 | $ 3,173,509.60 | $ 839,000 |
| 1942 | 5,568,799.37 | 5,064,799.37 | 504,000 |
| 1943 | 5,832,715.60 | 5,432,715.60 | 400,000 |
During the years 1939 to 1943, inclusive, J. T. Flagg received a salary from petitioner as follows:
| 1939 | $ 5,400 |
| 1940 | 5,200 |
| 1941 | 5,200 |
| 1942 | 5,300 |
| 1943 | 5,200 |
*264 The following summary shows, for the years 1939 to 1943, inclusive, the amounts of petitioner's sales, the amounts of sales (cloth, scrap, factory sales) on which no commissions were paid, sales during 1939 on which commissions were paid to others, sales on which commission was paid to Roman, total commissions paid by petitioner, commission *404 paid to Roman, commission paid to Flagg by agents, amount disallowed, and amount allowed by the Commissioner:
| 1939 | 1940 | 1941 | |
| Sales | $ 897,522.67 | $ 1,243,523.00 | $ 4,081,159.58 |
| Sales (no commissions paid) | 13,162.70 | 15,476.85 | 68,649.98 |
| Sales (commission paid to others) | 66,132.18 | ||
| Sales (commission paid to Roman) | 818,227.79 | 1,228,046.15 | 4,012,509.60 |
| Total commissions paid | 27,830.42 | 38,221.44 | 121,425.56 |
| Commission paid to Roman | 25,672.93 | 38,218.46 | 121,446.44 |
| Paid Flagg by agents | 14,396.24 | 20,000.00 | 63,180.37 |
| Amount disallowed by | |||
| Commissioner | 31,557.86 |
| 1942 | 1943 | |
| Sales | $ 5,579,644.12 | $ 5,870,667.86 |
| Sales (no commissions paid) | 10,844.75 | 37,952.26 |
| Sales (commission paid to others) | ||
| Sales (commission paid to Roman) | 5,568,799.37 | 5,832,715.60 |
| Total commissions paid | 167,707.43 | 175,463.05 |
| Commission paid to Roman | 167,707.43 | 175,463.05 |
| Paid Flagg by agents | 120,534.10 | 116,230.05 |
| Amount disallowed by | ||
| Commissioner | 83,658.49 | 79,088.48 |
*265 Traveling expenses paid by Flagg in 1941, 1942, and 1943 were as follows: 1941, $ 6,822.51; 1942, $ 6,075.61; and 1943, $ 6,341.57. These amounts were claimed as deductions by Flagg and allowed by the Commissioner.
The petitioner also claimed as deductions certain amounts as traveling expenses of Flagg in the years 1941, 1942, and 1943 which were allowed by the Commissioner.
The Commissioner determined reasonable compensation for services of Flagg to be as follows:
| 1941 | 1942 | 1943 | |
| Compensation | $ 30,000.00 | $ 36,100.00 | $ 36,000.00 |
| Traveling expense | 6,822.51 | 6,075.61 | 6,341.57 |
| Total | 36,822.51 | 42,175.61 | 42,341.57 |
In explanation of the adjustments made, the Commissioner in his notice of deficiency stated as to each adjustment as follows:
It is held that $ 63,180.37 [$ 120,534.10 and $ 116,230.05] of the sales commissions paid by you to your sales agent, C. F. Roman, which, during the year 1941, [1942 and 1943] were paid by C. F. Roman to J. T. Flagg, who is your president and treasurer, actually represents excessive compensation paid by you to J. T. Flagg for*266 services rendered to the extent of $ 31,557.86 [$ 83,658.49 and $ 79,088.48]. Section 23 (a) (1) (A) of the Internal Revenue Code.
The fixed salary paid by petitioner, plus the amount of commissions paid by Roman in the years 1941, 1942, and 1943 to Flagg, represents a reasonable allowance for salaries or other compensation for personal services actually rendered by him during the taxable years in carrying on the business of petitioner.
It was stipulated that petitioner is entitled to a deduction of $ 2,875.67 for the year 1939, representing a debt ascertained to be worthless and charged off within the taxable year.
*405 The respondent admits that, by electing to take the shortened amortization period for the Cherry Hill property, petitioner became and is entitled to deduct, as amortization, in addition to the amounts allowed by the deficiency notice, the further amounts of $ 1,899.08 for 1942 and $ 3,816.50 for 1943.
OPINION.
The respondent on brief concedes that Flagg's selling activities were considerable and that he devoted a large portion of his time to selling the products of petitioner. He also concedes that the evidence shows that the selling of a product of a knitting mill through a sales agency on a percentage basis is not unusual, particularly where the sales*267 volume does not exceed that attained by the petitioner during 1941, 1942, and 1943, and that such is considered a sound business arrangement. He states that he has not and does not now contend otherwise. He further states as follows:
There is no reason why the Commissioner should object to any such arrangement unless the officer in question receives a total compensation, including the amounts received indirectly through the sales agent as a conduit, which is in excess of that which is reasonable. In the instant case, however, that was precisely what the Commissioner determined.
Thus his contention is that in the present case the portion of the commissions which the petitioner paid to Roman and which in turn Roman paid over to Flagg, petitioner's chief stockholder and chief officer, for services rendered, were in fact part of the compensation paid by petitioner to Flagg and that such payments by Roman to Flagg actually represent excessive compensation paid by petitioner to Flagg for services to the extent of $ 31,557.86, $ 83,658.49, and $ 79,088.48 in the years 1941, 1942, and 1943, respectively. He disallowed the deduction of such amounts in computing the tax liability of petitioner. *268 His determination and entire argument are based upon the proposition that substance rather than form governs in the law of Federal taxation.
Accepting respondent's argument, and regarding the commissions paid to Flagg by Roman as compensation paid by petitioner to Flagg for his selling activities, the fact that the amount of commissions paid to him in the taxable years increased as the result of greater sales is not decisive, nor is it an adequate reason for disallowing the commissions as business expense deductions unless the rates of commission fixed by the contract were unreasonable and unless Flagg was not responsible for the increased volume of sales or a goodly share thereof.
The respondent does not question that taxpayer and Roman were separate and distinct entities. Neither does he question the selling *406 expense as such. He concedes that the rates or amounts of commissions paid to Roman were no more than usually paid to a sales agent. Apparently it is only the fact that Flagg was employed by Roman as a salesman that moved respondent to his determination.
It is true, as argued by respondent, that in Alexander Sprunt & Son, Inc., 24 B. T. A. 599,*269 respondent's action in disallowing $ 286,071.30 of a claimed deduction of $ 336,554.48 was approved. However, in that case the latter amount was paid by taxpayer, under the guise of commissions, to a new Bremen, Germany, partnership composed of fourteen holders of all the outstanding common stock of taxpayer, only one of whom was actively engaged in the affairs of the taxpayer in Europe and spent about one-half of his time in Bremen attending to the affairs of the old and new Bremen firms, the old firm being in the process of liquidation. Two of taxpayer's executive officers and members of both Bremen firms made several trips to Europe for the purpose of assisting in the liquidation of the affairs of the old Bremen firm and of further developing and retaining the business of the firm for taxpayer's benefit. In the opinion, it is stated:
The record does not show that the new Bremen firm was directly responsible for a single dollar's worth of petitioner's sales in 1923, that is, that the members of the firm consummated a single dollar's worth of sales for the petitioner's benefit. * * * The fact that the payments made to the Bremen firm were not in excess of the commissions usually*270 paid to selling agents does not of itself prove the reasonableness of these payments. The question is, was the total amount paid reasonable for the services rendered by the Bremen firm to the petitioner; and the answer must be in the negative, since the evidence is far from convincing that the firm rendered any services of substantial benefit to the petitioner. * * * [Emphasis supplied.]
The decision of the Board on this issue was affirmed by the Circuit Court of Appeals for the Fourth Circuit, 64 Fed. (2d) 424.
It is to be noted that in the same case the Commissioner had also disallowed the deduction of net commissions of $ 39,689.75 on sales made within the year credited to the account of a French corporation acting as petitioner's selling agent in France. As to this issue the Board stated:
* * * We think that the respondent's determination in this matter is erroneous. The evidence leaves no room to doubt the separateness of the two corporations, and there is no indication of fraud, attempt at tax evasion, or other circumstance which might justify or require a disregard of the separate corporate entities. The allowance of commissions to the *271 French corporation could hardly be termed distributions of profits, since the corporation owned none of the petitioner's capital stock. The only question which might arise in connection with these commission allowances would be the matter of the bona fides of the allowances, and as to that, the evidence shows clearly that the allowances were made for services actually rendered in the consummation of sales for petitioner's *407 benefit, and were computed at rates customarily allowed to petitioner's other selling agents. They represent a proper charge against the petitioner's gross sales as a part of their cost, and are a proper deduction in computing net income. [Emphasis supplied.]
No appeal was taken by the Commissioner from the decision on this issue.
Herein it is shown that Flagg was, during the taxable years, the president and administrative head of petitioner. The petitioner was established in Florence, Alabama, primarily through the efforts of Flagg. Until September 1930 he devoted himself to the building and establishment of a well functioning manufacturing plant. However, to be successful financially the plant needed a greater outlet for its products. *272 Flagg then made his first arrangement for selling such products with the Campe Corporation on a salary basis. An arrangement whereby an official of a mill is employed by the sales agent of the mill, either on a salary basis or on a commission basis or both, was not uncommon in the textile or knitting goods industry. It had been the practice of the president of petitioner's predecessor, the company located at Amsterdam, New York. Furthermore, from the very outset, and all during the time the organization of petitioner was discussed, it was understood that the salary paid to the president was not to include compensation for selling activities. Such compensation was to be obtained through a collateral arrangement with the sales agency. Thus the selling activities of the president were not services to petitioner ordinarily required and expected of him as president of taxpayer.
For his services as president and administrative head of petitioner, Flagg was paid $ 5,200 in 1941 and 1943 and $ 5,300 in 1942, which amounts were not questioned by respondent nor classed within the excessive compensation disallowed as such. On March 1, 1939, well before petitioner's prosperous years, petitioner*273 entered into the agreement with Roman.
The rates of commission paid by petitioner to Roman were not in excess of rates of commission usually paid to sales agents in the same field. No question was raised by respondent either as to the total paid to Roman or as to the amount paid to Flagg by Roman in 1939 and 1940. There can be no question on the record that Flagg was a valuable and a vital element in petitioner's success. He devoted his entire time to the affairs of petitioner, the greater part of his time being spent in sales activities. During the taxable years the bulk of petitioner's products was produced for and sold to the Government. The sales on which commissions were paid by petitioner to Roman in 1941, 1942, and 1943 amounted to $ 4,012,509.60, $ 5,568,799.37, and $ 5,832,715.60, respectively. *408 Of such sales, more than $ 3,170,000 in 1941, $ 5,064,000 in 1942, and $ 5,432,000 in 1943 were Government sales. Contracts covering such sales were obtained and handled by Flagg. The responsibility for getting and handling Government contracts fell to Flagg because of his prior experience in that field. Roman agreed that Flagg's commission be increased from 1 1/2*274 per cent to 2 per cent. Roman handled practically all of the civilian sales and assisted in servicing Government contracts. The division between Flagg and Roman of the commissions agreed to be paid by petitioner to Roman was originally based upon the estimated sales each could produce. This arrangement was continued. When Roman gave up the two mills for which he had been selling, in order to devote more time to the sales of petitioner, his share of the commissions was increased, but when the sales to the Government increased, they went back to the original arrangement, because it "entailed more work on Mr. Flagg's part," as testified by Roman.
The commission was not based upon the net profits of petitioner, but on the volume of business or sales brought to the mill by the sales agent. Such sales were produced and consummated through the efforts of Roman and Flagg, the latter producing considerably more sales than the former. Although the demand for petitioner's product was increased as a result of the war effort and consequent Government purchases, the evidence shows that it was necessary to go out and compete for the Government business. The evidence also shows that it entailed*275 more effort and time than commercial business. Such business was gotten primarily by Flagg. That the sales were of benefit to petitioner is shown by its increase in net profits. Petitioner operated at a net loss in 1937, 1938, and 1939. Its net profits in 1940 to 1943, inclusive, were as follows: $ 2,041.81, $ 43,338.14, $ 455,276.82, and $ 366,338.41.
Whether compensation is reasonable or unreasonable in amount is a question of fact. Each case is to be determined upon its own peculiar facts. Where such question is involved, as stated in Wood Roadmixer Co., 8 T. C. 247, cited by respondent, prior decisions dealing with the same question "are not of great value as precedents." In that case the salaries paid to two shareholders owning all but two shares of the stock of taxpayer were based primarily on net earnings of taxpayer for the year and were out of line with compensation previously paid, and the services rendered by them were but a little more, if any, in the taxable year than those rendered in prior years.
Upon consideration of all the evidence, noting that the payments were pursuant to the 1939 agreement, that the increase in business was*276 primarily due to Government contracts for which Flagg was chiefly responsible, that the percentage paid and the selling arrangement were customary in the trade, and that there was no concealment from or *409 fraud upon the stockholders, it is our conclusion that respondent erred in disallowing part of the commissions paid to Roman and that he was not justified in holding that the part of the Roman commissions paid by Roman to Flagg represented unreasonable compensation paid by petitioner to Flagg. The action of respondent in disallowing $ 31,557.86, $ 83,658.49, and $ 79,088.48 of the claimed deductions for sales commissions was erroneous.
Decision will be entered under Rule 50.