*1243 1. In 1936 the petitioner paid its secretary, who owned two-ninths of its preferred stock and one-third of its common stock, a salary of $125 per week from May 27, 1936, to the end of the calendar year, or a total of $4,000. Of this amount the respondent disallowed the deduction of $2,461.75 as being in excess of reasonable compensation for the services performed. Held, that reasonable compensation for the services performed was not in excess of $1,538.25, the amount allowed by the respondent.
2. In the computation of the surtax on undistributed profits the respondent has allowed a specific credit under section 14(c) of the Revenue Act of 1936 of the difference between $5,000 and the excess of 10 percent of the adjusted net income for surtax purposes ($15,831.62) or $3,416.84. Petitioner contends that since the adjusted net income is less than $50,000 it is entitled to a specific credit of $5,000. Held, that the specific credit allowable is $3,416.84.
3. In 1936 the petitioner received reimbursement from its vendors of $2,737.29 representing processing taxes allocable to sales of petitioner's products made on or before January 6, 1936, which products were sold*1244 at prices including the burden of the processing taxes. The petitioner did not pass on to its vendees any part of the $2,737.29 received. Held, that the petitioner is liable to unjust enrichment tax upon the reimbursements in question.
*1026 This proceeding is for the redetermination of deficiencies in income tax and unjust enrichment tax for 1936 in the amounts of $786.81 and $1,314.37, respectively. The petitioner alleges that the respondent erred in the determination of the deficiencies (1) by disallowing the deduction of $2,461.75 of the $4,000 salary paid to its secretary in 1936; (2) by allowing a specific credit under section 14(c) of the Revenue Act of 1936 of $3,416.84 instead of $5,000; and (3) by holding it liable to unjust enrichment tax upon reimbursements of $2,737.29 received from its vendors in respect to processing taxes.
FINDINGS OF FACT.
1. The petitioner is a corporation, with its principal office at Philadelphia, Pennsylvania. Its income tax return for 1936 was filed with the collector*1245 for the first district of Pennsylvania, at Philadelphia.
2. Petitioner is engaged in the manufacture and sale of men's and boys' seamless hosiery. Each spring and fall it brings out a new *1027 line of hosiery which it sells during the following six months. Its line is highly styled and its success depends upon novelty yarns, patterns, colors, and ideas. All of petitioner's styles and patterns are original, and are designed after accumulating ideas obtained by shopping the better-class stores and consulting the trade.
3. Petitioner's total outstanding stock in 1936 consisted of 900 shares of preferred stock of a par value of $100 per share and 900 shares of common stock of a par value of $1 per share, each share of stock of each class being entitled to one vote.
4. In May 1936 Fannie Goldberg purchased 200 shares of petitioner's preferred stock, and 300 shares of common stock, investing therein between $15,000 and $20,000 of her own funds. Thereafter, all of the stock of the corporation was owned by Benjamin L. Grabosky, Richard D. Goldberg, and his mother, Fannie Goldberg. The stock which Fannie Goldberg purchased had been the property of petitioner's former*1246 secretary. On May 27, 1936, Fannie Goldberg was elected a director and secretary of petitioner and she has continued to hold such position ever since. At a meeting of the board of directors held May 27, 1936, the salaries of the president, the vice president, and the secretary (Fannie Goldberg) were fixed at $125 per week each.
5. During the balance of the year 1936, or after she became a director and secretary, Fannie Goldberg received $4,000 as salary. The two other officers each received compensation of $12,675. Petitioner's total gross sales of hosiery in 1936 amounted to $786,134.18; its net income, as reported in its income tax return, was $15,368.10.
6. By resolution of the board of directors of May 27, 1936:
* * * the President, Vice-President or Secretary of this Company is authorized to sign checks upon the said account; and to sign, endorse, accept, make, execute and deliver checks, notes, drafts, acceptances and/or bills of exchange for deposit, discount, rediscount or any other purpose, and to do all lawful acts requisite for affecting these premises, all checks on the Bank Account of Corporation to be countersigned by either Benjamin L. Grabosky or S. Grabosky.
*1247 RESOLVED FURTHER, that the President, Vice-President or Secretary of this Company, (only, however, with the countersignature of either Benjamin L. Grabosky or S. Grabosky) is authorized from time to time to borrow money for this Company from the said CENTRAL-PENN NATIONAL BANK of Philadelphia, and as security for the repayment thereof to pledge, either originally or in substitution, securities, debts, obligations and/or interests therein and/or evidences thereof now or hereafter in the possession of the Company, and for such loans to execute and deliver the written obligations of this Company, and for such terms, and with such provisions as to the security therefor, as may be required by said Banks, as they shall deem proper.
7. In 1936 Fannie Goldberg was 27 years of age. She visited the petitioner's office "occasionally." She also "shopped" the stores in *1028 Philadelphia and New York for the purpose of obtaining new ideas as to styles of hosiery and also make purchases of hosiery to show to the other officers of the company. She attended directors' meetings, and was available to sign checks, etc., in the absence of other officers.
Petitioner's president and vice*1248 president spent much of their time during nine or ten months of each year in traveling and obtaining orders for hosiery to be manufactured. While they were away a superintendent was in charge of the operation of petitioner's plant.
8. In his audit of the return the respondent reached the conclusion that the salary paid to Fannie Goldberg was in excess of a reasonable amount for the services performed by her. He, accordingly, disallowed the deduction of $2,461.75 of the $4,000 paid to her and allowed the deduction of only $1,538.25. Reasonable compensation for her services for the period May 27 to December 31, 1936, was the amount allowed as a deduction by the respondent.
9. In the determination of the deficiency the respondent, following his regulations, allowed a specific credit for the computation of the undistributed profits tax under section 14(c) of the Revenue Act of 1936 of $3,416.84, which was the difference between 10 percent of the undistributed net income for surtax purposes and $5,000.
10. During 1936 the petitioner was reimbursed by its vendors in the sum of $15,030.34 representing processing taxes included in the cost of cotton yarn purchased by the petitioner. *1249 It did not refund any part of this amount to its vendees. Its products were sold at prices which included the burden of the processing taxes borne by it in the purchase of yarn.
11. Of the reimbursements totaling $15,030.34 received by petitioner from its vendors in 1936, $2,737.29 was properly allocable to sales of petitioner's products made prior to January 7, 1936. The petitioner filed an unjust enrichment tax return for 1936 on form 945 showing therein "Amount of reimbursement and refunds or credits $14,894.47", but did not report any tax liability thereon. The respondent determined an unjust enrichment tax due from the petitioner for 1936 as follows:
| Computation of Tax | |
| Taxable net income | $2,737.29 |
| Tax on unjust enrichment at 80 percent | 2,189.83 |
| Less: Income tax credit | 875.46 |
| Correct unjust enrichment tax liability | 1,314.37 |
| Unjust enrichment tax assessed (Account Number NUE 777) | None |
| Deficiency in tax on unjust enrichment | 1,314.37 |
*1029 OPINION.
SMITH: The first question for consideration is whether the petitioner is entitled to deduct from its gross income of 1936 more than $1,538.25 paid during that year to its secretary. The*1250 petitioner actually paid $4,000 for such services. The respondent disallowed the deduction of $2,461.75 as being in excess of reasonable compensation.
Section 23 of the Revenue Act of 1936 permits a taxpayer to deduct from gross income in the determination of net income:
(a) * * * All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered: * * *
What constitutes a "reasonable allowance for salaries" is a question of fact, to be determined from all of the evidence in the case. See . The petitioner's president, Fannie Goldberg's son, testified that his mother's services were of great value to the corporation; that she shopped the stores of Philadelphia and New York for the purpose of purchasing hosiery and for obtaining ideas that might be helpful in the business. He also testified that it was she who was responsible for an innovation of manufacturing boys' and men's hosiery with elastic in the top of the sock which obviated the*1251 necessity of wearing garters, and that the petitioner was the first manufacturer of such hosiery. It does not appear, however, whether this innovation was prior to the time that Fannie Goldberg became an officer of the corporation or not. The witness could not tell how often Fannie Goldberg visited the office of the petitioner corporation during 1936. She attended directors' meetings and signed the minutes of such meetings, which, however, were prepared by counsel. She "occasionally" visited the office of the petitioner.
From a consideration of all of the evidence in this case we are of the opinion that reasonable compensation for Fannie Goldberg's services to the petitioner in 1936 was in the amount of $1,538.25. The disallowance of $2,461.75 of the claimed salary deduction is approved.
The second question for consideration is whether the petitioner is entitled to a specific credit under section 14(c)(1) of the Revenue Act of 1936 of $5,000, or to a specific credit of $3,416.84, as determined by the respondent. The petitioner contends that it is entitled to a specific credit of the larger amount.
*1030 The respondent determined a surtax on undistributed profits*1252 in his deficiency notice as follows:
| Taxable net income | $17,783.47 |
| Less: Normal tax | 1,951.85 |
| Adjusted net income | 15,831.62 |
| Less: Specific credit | 3,416.84 |
| Remainder subject to surtax | 12,414.78 |
| 7 percent on $1,583.16 | 110.82 |
| 12 percent on $1,583.16 | 189.98 |
| 17 percent on $3,166.32 | 538.27 |
| 22 percent on $3,166.32 | 696.59 |
| 27 percent of $2,915.82 | 787.27 |
| 7 percent of $3,416.84 (specific credit) | 239.18 |
| Total surtax | 2,562.11 |
The petitioner does not contest the correctness of the respondent's computation except as to the amount of the specific credit. It would compute the surtax on undistributed profits as follows:
| Adjusted net income | $15,831.62 |
| Less: Dividends paid credit | |
| Undistributed net income | 15,831.62 |
| Specific credit claimed | 5,000.00 |
| Net income subject to surtax | 10,831.62 |
| 7 percent of $1,583.16 | 110.82 |
| 12 percent of $1,583.16 | 189.98 |
| 17 percent of $3,166.32 | 538.27 |
| 22 percent on $3,166.32 | 696.59 |
| 27 percent of $1,332.66 | 359.82 |
| 7 percent of specific credit (7% of $5,000) | 350.00 |
| Total surtax | 2,245.48 |
Section 14(c) of the Revenue Act of 1936 provides in part as follows:
(c) ADJUSTED NET INCOME LESS THAN $50,000. -
*1253 (1) SPECIFIC CREDIT. - If the adjusted net income is less than $50,000, there shall be allowed a specific credit equal to the portion of the undistributed net income which is in excess of 10 per centum of the adjusted net income and not in excess of $5,000, such credit to be applied as provided in paragraph (2). [Italics supplied.]
This provision of the law was drafted by the Conference Committee. There was no provision in the Revenue Bill of 1936, as it passed the House or the Senate, comparable to section 14(c). The conference report throws no light upon the correct construction of the provision.
*1031 Article 14-3 of Regulations 94, promulgated under the provisions of the Revenue Act of 1936, provides in part as follows:
ART. 14-3. Specific credit if adjusted net income is less than $50,000. - Section 14(c) provides for a specific credit in the case of a corporation which has an adjusted net income of less than $50,000. This specific credit is an amount equal to the excess of $5,000 or the total undistributed net income, whichever is less, over 10 percent of the adjusted net income and is to be deducted from the undistributed net income before*1254 computing the surtax. * * *
It then gives three examples for the computation of the total surtax on undistributed profits, namely, upon taxpayers having a net income of $1,000, of $25,000, and of $49,900. Under the respondent's regulations the taxpayer with a small undistributed net income is entitled to a proportionately larger (in reference to its total undistributed net income) specific credit than a corporation with a larger undistributed net income. Thus a taxpayer with a net income of $1,000 is entitled to a specific credit of $900; that with a net income of $25,000 to a specific credit of $2,500; and that with a net income of $49,900 to a specific credit of $10.
In each of the cases where adjusted net income is in excess of $5,000 the specific credit is computed as the difference between 10 per centum of the adjusted net income and $5,000. The respondent has interpreted the provision as meaning that the specific credit shall be only a "portion" of the undistributed net income regardless of the amount. The respondent has found that the petitioner's adjusted net income or undistributed net income for 1936 was $15,831.62. The "portion" of that adjusted net income "which*1255 is in excess of 10 per centum of the adjusted net income and not in excess of $5,000" is $3,416.84. This is in accordance with article 14-3 of Regulations 94.
The petitioner contends that the respondent's regulations and return Form 945 are not in accordance with the statute. It submits:
The portion of $15,831.62 [the undistributed net income determined by the respondent] which is in excess of $1,583.16 is $14,248.46. Thus, the credit would be $14,248.46, were it not for the last part of the provision "not in excess of $5,000" which limits it to $5,000.00. The allowable credit is then $5,000.00.
It will be seen from the foregoing that the petitioner would interpret the phrase "equal to the portion of the undistributed net income which is in excess of 10 per centum of the adjusted net income and not in excess of $5,000" as meaning that in every case where the excess of the adjusted net income over 10 per centum thereof is $5,000 or more the taxpayer is entitled to a specific credit of $5,000. Thus, a corporation with an adjusted net income of $49,900 would be entitled to the same specific credit as one with a net income of, for instance, $6,000, and a corporation with*1256 an adjusted net income of *1032 $5,600 would be entitled to a specific credit of $5,000 whereas one with an adjusted net income of $5,000 would be entitled to a specific credit of only $4,500.
We think that the respondent's interpretation of the statute is correct. It was undoubuedly the intention of Congress to give a corporation with a small adjusted net income a larger specific credit under this provision of the law than a corporation with a large adjusted net income. The respondent's regulations give that interpretation to the statute. The petitioner's interpretation does not. The most that can be said for the petitioner's method of computation is that it is a possible interpretation of the statute. We think that the respondent's interpretation is the more reasonable one. It considers the word "portion" as referring to such part of the undistributed net income as falls between 10 per centum of the undistributed net income and $5,000. In other words, it uses the amount of $5,000 as a measuring stick, and includes within the measuring stick the 10 per centum of the undistributed net income. This interpretation gives every corporation with a large undistributed net*1257 income (but less than $50,000) a smaller specific credit than any corporation with a lesser undistributed net income, which is what we believe Congress intended. We approve the respondent's determination that the petitioner is entitled to a specific credit of $3,416.84 and reject the petitioner's contention upon this point.
The third question in issue is whether the petitioner is subject to unjust enrichment tax for 1936 and, if so, the amount thereof. The petitioner alleges that it is not liable for such tax on any of the following grounds:
(a) The rebates or credits which respondent seeks to tax were gifts or gratuities to petitioner by its vendors and are therefore not taxable.
(b) If it be held that the rebates or credits were not gratuities, then they were reductions in the purchase price of petitioner's goods and therefore do not constitute taxable income.
(c) If it be held that the rebates or credits were not gifts and did not constitute reductions in the purchase price of goods, but did constitute refunds of processing taxes paid by petitioner, then petitioner was not unjustly enriched.
(d) The tax on so-called unjust enrichment is unconstitutional, null, and*1258 void.
Relative to its first contention, the petitioner submits that $954.74 refunded to it by the Palmetto Yarn Corporation and $1,417.23 refunded to it by the Johnston Mills, two of its vendors, totaling $2,371.97, were refunded by vendors who were under no legal obligations to make the refunds. It therefore submits that these constituted gifts; that the petitioner received them as gifts; and that they are exempt from the unjust enrichment tax. Admittedly, these *1033 amounts are included in the $2,737.29 upon which the respondent has based his computation of unjust enrichment tax.
Section 501 of the Revenue Act of 1936 provides in part as follows:
(a) The following taxes shall be levied, collected, and paid for each taxable year (in addition to any other tax on net income), upon the net income of every person which arises from the sources specified below:
* * *
(2) A tax equal to 80 per centum of the net income from reimbursement received by such person from his vendors of amounts representing Federal excise-tax burdens included in prices paid by such persons to such vendors, to the extent that such net income does not exceed the amount of such Federal excise-tax*1259 burden which such person in turn shifted to his vendees.
The question arises as to what difference it makes whether the petitioner's vendors were under any legal obligation to make the refunds or rebates which were made. The unjust enrichment tax is imposed upon such reimbursements and in our opinion it is entirely immaterial whether the vendors were under any legal obligation to make the refunds or not. There is no evidence that they were made with a donative intent. It is common knowledge that many thousands of dollars were refunded under the same conditions that refunds were made by the Palmetto Yarn Corporation and the Johnston Mills. It would indeed be an anomalous situation that the liability to the unjust enrichment tax depends upon whether the vendors are legally liable to make the refunds. In our opinion there is no merit whatever in the petitioner's contention.
The second contention is that the refunds made by petitioner's vendors constitute "reductions in the purchase price of goods." Petitioner then submits that a reduction in the purchase price of an article does not constitute the realization of "income."
It is true that the refunds were made for the purpose*1260 of reimbursing the petitioner for a part of the price which was paid by the petitioner for the yarn. But the petitioner manufactured the yarn into hosiery and sold that hosiery to its customers, including in the sales price the burden of the processing taxes which it had paid to its vendors. The very purpose of the enactment of the unjust enrichment tax was to subject to tax gains of this character. In our opinion there is no merit in this contention.
The third contention is that it was not "unjustly" enriched by the receipt of the refunds. Whatever the petitioner may think with regard to the justness or unjustness of the tax, it is indubitably true that the petitioner obtained these refunds or rebates as a result of the holding of the Supreme Court in , that the law imposing the processing taxes was unconstitutional. *1034 Congress has declared that taxpayers who receive refunds of processing taxes without having borne the burden thereof have been unjustly enriched. We can see no merit in this contention of the petitioner.
The final contention of the petitioner is that the unjust enrichment tax is unconstitutional, *1261 null, and void. But the constitutionality of the tax has been upheld by numerous decisions of the courts. See ; ; . See also ; .
Reviewed by the Board.
Decision will be entered for the respondent.
DISNEY dissents.
MELLOTT, dissenting: It seems to me that petitioner's method of computing the specific credit under section 14(c) accords with the statute. Its "undistributed net income" was $15,831.62. Its "adjusted net income" was $15,831.62. The "portion of the undistributed net income which is in excess of 10 per centum of the adjusted net income" ($15,831.62-$1,583.16) is $14,248.46. Since the credit may not exceed $5,000 petitioner is limited to that amount.
The majority approve the respondent's computation, which takes "the*1262 difference between 10 per centum of the net income and $5,000." If Congress had intended the specific credit to be "an amount equal to the excess of $5,000 or the total undistributed net income, whichever is less, over 10 percent of the adjusted net income" it could very easily have said so; but it did not. We should not distort the language used simply to allow a taxpayer with a small undistributed net income a proportionately larger credit than one with a larger income. This was taken care of by Congress when it denied the specific credit to a corporation having an adjusted net income in excess of $50,000. There is nothing in the act before us or in its legislative history to indicate that Congress intended to do aught than to allow a small corporation a specific credit of $5,000 provided the portion of its undistributed net income, which is not in excess of 10 per centum of its adjusted net income, equals that amount.
MURDOCH, LEECH, and TURNER agree with this dissent.