*1345 1. The petitioner, a corporation, acquired certain coal leases, agreeing to pay royalties on all coal mined therefrom at the rate of 8 cents per ton, four-tenths thereof to one lessor and six-tenths to the other lessor. After execution of the leases, one lessor agreed the petitioner might retain one-half of its four-tenths of the royalties out of the first coal mined until the same reached $8,000, and the other lessor agreed to waive the first royalties up to $25,000. The Commissioner allowed a paid-in surplus on account thereof in the amount of $33,000 and treated the same as so much depletable capital, allowing a deduction of a proportionate part of such amount in each of the years as the coal to which it applied was mined. Held, that the action of the Commissioner in allowing deductions as indicated was correct and should be approved.
2. Additional deductions from gross income on account of cash royalties paid, expenditures made for mine equipment and for officers' salaries and directors' fees, determined.
*1346 *235 The Commissioner determined deficiencies in income and profits tax for the periods and in the amounts following:
| Period | Docket No. | Deficiency |
| Calendar year 1917 | 28792 | $10,755.33 |
| Six-month period ended June 30, 1918 | 28792 | 2,031.31 |
| Fiscal year ended June 30, 1919 | 26875 | 49,262.89 |
| Fiscal year ended June 30, 1920 | 26875 | 11,557.46 |
| Fiscal year ended June 30, 1921 | 26874 | 16,397.88 |
The cases were consolidated for hearing and decision, and were submitted on the pleadings, testimony of several witnesses, stipulation and exhibits.
The pleadings raise a number of issues, but at the hearing all of them were stipulated, except the following, which remain for the Board's determination:
1. The basis for allowing deductions with respect to a paid-in surplus which the Commissioner allowed on account of the waiver of certain royalties after the acquisition of two coal leases.
2. Is petitioner entitled to additional deductions from gross income for cash royalties paid in the calendar year 1917, the period ended June 30, 1918, and the fiscal year ended June 30, 1919?
3. Is petitioner entitled to deductions from gross income on account of expenditures*1347 made for mine equipment during the year 1917, the six-month period ended June 30, 1918, and the fiscal years ended June 30, 1919, 1920 and 1921?
4. Is petitioner entitled to additional deductions on account of officers' salaries and directors' fees for the fiscal years ended June 30, 1919, 1920 and 1921?
FINDINGS OF FACT.
The petitioner is a Pennsylvania corporation, organized in August, 1912, and is engaged in mining and selling coal, with its principal office at Morrisdale.
*236 F. H. Wigton is the president; his son, R. W. Wigton, manager; and C. B. Maxwell (now deceased) was secretary and treasurer.
1. Shortly after its organization, the petitioner entered into written agreements with the executors of William Dorris and Julia M. Dorris and with Sheldon Potter, trustee, to mine and remove coal from certain land in Morris Township, Clearfield County, Pennsylvania, agreeing to pay royalties on all coal mined at the rate of 8 cents per ton, four-tenths thereof to the Dorris interests and six-tenths to Sheldon Potter, trustee. After the execution of the leases and prior to the time when any coal had been mined, the Dorris interests agreed to waive, out of the*1348 first coal mined, one-half of the four-tenths portion of the royalties to which they were entitled, until the amount waived equaled $8,000, and Potter, trustee, agreed to waive, out of the first coal mined, all of the six-tenths portion of the royalties to which he was entitled, until the amount waived equaled $25,000.
At the time of the organization of the petitioner, F. H. Wigton was the beneficial owner of the six-tenths interest under the Potter trust. He was also the owner of all the original stock issued by the petitioner, except a few shares held by others to qualify them for voting purposes and as directors. The Wigtons, officers of the petitioner, were closely associated in business with the Dorrises, from whom the other lease was obtained, and the two families had been close friends for many years. F. H. Wigton, R. W. Wigton and C. B. Maxwell were, during the years in issue, the owners of all petitioner's stock.
The depletable capital of the petitioner with respect to the foregoing leases was, both at the time of acquisition and on March 1, 1913, $189,720.67, exclusive of any effect which may be given to the fact that the payment of royalties was waived to the extent*1349 of $33,000 as indicated above. The total tonnage involved was 4,300,000 tons, thus giving a depletion unit of $.044121 per ton, without giving effect to the free-royalty provision. The following statement shows the manner in which coal was mined under the two leases as well as the manner in which free and cash royalties applied:
| Potter Lease | ||||||
| Period | Coal mined from 1,366 acres | Coal mined from 300 acres | Total Coal | Royalty at .6 of 8?? | Free Royalty | Cash royalty |
| To Dec. 31, 1916 | 246,601 | 162,751 | 409,352 | $19,649.48 | $19,649.48 | 0 |
| Calendar year 1917 | 142,267 | 40,375 | 182,642 | 8,766.78 | 5,350.52 | $3,416.26 |
| 6 months ending 6/30/18 | 73,460 | 73,460 | 3,526.07 | 0 | 3,526.07 | |
| Fiscal year 6/30/19 | 122,553 | 122,553 | 5,882.54 | 0 | 5,882.54 | |
| Total | 584,881 | 203,126 | 788,007 | 37,824.87 | 25,000.00 | 12,824.87 |
| Doris Lease | ||||||
| Period | Coal mined from 1,366 acres | Coal mined from 300 acres | Total coal | Royalty at .4 of 8?? | Free royalty | Cash royalty |
| To Dec. 31, 1916 | 246,601 | 246,601 | $7,891.24 | $3,945.64 | $3,945.63 | |
| Calendar year 1917 | 142,267 | 142,267 | 4,552.55 | 2,276.28 | 2,276.29 | |
| 6 months ending 6/30/18 | 73,460 | 73,460 | 2,350.72 | 1,175.36 | 1,175.38 | |
| Fiscal year 6/30/19 | 122,553 | 122,553 | 3,921.69 | 602.72 | 3,318.90 | |
| Total | 584,881 | 584,881 | 18,716.20 | 8,000.00 | 10,716.20 |
*1350 *237 In the determination of the deficiencies with which we are concerned, the Commissioner allowed a paid-in surplus of $33,000 on account of the royalties which were waived by the respective lessors shortly after the lease agreements were entered into, and also allowed deduction of a pro rata part of such amount in each of the years as the coal was mined to which the free royalties applied.
2. For the fiscal years ending June 30, 1919, June 30, 1920, and June 30, 1921, salaries were regularly authorized by petitioner for its three officers in the total amount of $60,000 for each of the three years, the amount for each officer being as follows: R. W. Wigton, $24,000; F. H. Wigton, $16,000; and C. B. Maxwell, $20,000. The petitioner kept its books on the accrual basis and accordingly accrued the foregoing total amount for the various years in question. The amounts were paid either in the respective years to which they applied or in subsequent years. The salaries paid were not in direct proportion to the stock owned by the three officers. In addition to the aforementioned salaries, the petitioner also paid directors' fees to its three officers for the fiscal years ended*1351 June 30, 1919, and June 30, 1920, in the amount of $1,800, that is $600 for each officer for each year. The Commissioner disallowed the directors' fees for 1919 and 1920 and salaries to the extent of $28,000 in each of the years in question.
F. H. Wigton, president, and R. W. Wigton, secretary and sales manager, maintained offices in Philadelphia, Pennsylvania, from which they exercised general supervision over the petitioner and marketed all of its coal without expense to it, except their salaries, which cost petitioner less than it would have cost had the petitioner paid the customary commission for the sale of its coal or had paid even the minimum rate of commission for effecting a sale of the quantity of coal sold for petitioner by the Wigtons. The Wigtons assumed responsibility with respect to both sales and collections.
During the years here in question F. H. Wigton was also president of the Morrisdale Coal Company, as well as of the Miller Coal Company. Likewise, R. W. Wigton was an officer in both of the aforementioned companies. The sales of coal for the petitioner were made by the aforementioned officers through the Morrisdale Coal *238 Company. No charge*1352 was made by the Morrisdale Coal Company for the sale of petitioner's coal. Petitioner paid no commissions or compensation for the sale of its coal other than was represented by the salaries to these officers, and such salaries were less than the average commissions which were ordinarily paid for the marketing of the same amount of coal.
Charles B. Maxwell, vice president and general manager, was in charge of petitioner's mining operations at Morrisdale, Pennsylvania, and had been associated with petitioner's president for many years. He was an experienced and valuable man in the business and was considered one of the best mining engineers and coal operators in central Pennsylvania.
The salaries of the aforesaid three officers and the directors' fees paid them were reasonable.
3. In his computation of net income respondent disallowed as deductions and capitalized the following expenditures made by petitioner during the respective periods:
| Calendar year 1917: | |
| Purchase of 2 Jeffrey coal cutters | $4,941.20 |
| Six months ended June 30, 1918: | |
| Purchase of 6-ton electric locomotive | 4,218.80 |
| Fiscal year ended June 30, 1919: | |
| Repairing motor-generator set | 1,686.92 |
| New truck for mining machine | 820.00 |
| Repair for 10-ton motor | 550.00 |
| 2 friction drum hoists | 900.00 |
| 1 scraper loader set | 3,000.00 |
*1353 The production of coal from petitioner's mine had reached the fully developed stage on January 1, 1917. The above mentioned expenditures did not increase the coal output nor result in more than a negligible reduction in the cost of production. They did not add to the value of petitioner's property, but were necessary in order to maintain normal production.
With respect to various issues which were raised in the pleadings, but upon which the parties reached an agreement at the time of the hearing, the following facts were stipulated:
| Period | Invested capital |
| 1917 | $288,843.11 |
| Six-month period ended June 30, 1918 | * 323,337.29 |
| Fiscal year ended June 30, 1919 | 323,721.23 |
| 1920 | 350,969.91 |
| 1921 | 339,094.61 |
Each of the foregoing amounts is subject to appropriate adjustment on account of such decision as may be made with respect to the opposing claims of the parties as to exhaustion or depletion of the *239 paid-in surplus of $33,000 allowed by the Commissioner because of royalties which were waived. The last four amounts are also to be*1354 adjusted on account of the correct tax as finally determined for the preceding year or years, that is, on account of any change which may be made from that determined by the Commissioner. A further adjustment will also be necessary in case the Board should reverse the Commissioner as to certain items which he has held should be capitalized, but which the petitioner contends should be allowed as deductions from gross income for the respective years in which the expenditures were made.
There is also no dispute between the parties as to the cost of plant and equipment, and the depreciation deductions as allowed thereon by the Commissioner, except as indicated above, and they have submitted a statement, which is incorporated herein by reference, showing the cost of plant and equipment, the depreciation rates used by the Commissioner in arriving at the depreciation deductions allowed by him, and the depreciation reserves which have been considered in arriving at the stipulated invested capital shown above.
OPINION.
SEAWELL: Various issues were raised in the pleadings, but all were disposed of at the hearing through certain stipulations except three, which we will consider in the*1355 order set out in our findings.
1. The facts and contentions of the parties as to the first issue are as follows: In 1912 petitioner acquired two coal leases which the parties have stipulated covered an available tonnage of $4,300,000 tons. One lease applied to a six-tenths interest in certain coal property and the other to a four-tenths interest in the same property (except as to 300 acres which were released from the former lease to a related company under certain conditions which do not appear to be in dispute), and the petitioner was obligated under the leases to pay a royalty of 8 cents for each ton of coal mined, six-tenths of such amount going to one lessor and four-tenths to the other. After the execution of the leases and prior to the time when any coal had been mined, one lessor waived royalties to the extent of $25,000 and the other to the extent of $8,000 out of the first coal mined, as shown in our findings. On account of the foregoing waiver of royalties, the Commissioner allowed a paid-in surplus to the petitioner of $33,000. The parties have stipulated that the depletable capital of the petitioner in 1912 and on March 1, 1913, exclusive of the effect to be given*1356 to the paid-in surplus on account of free royalties, was $189,720.67. On the basis of the foregoing depletable capital and the stipulated tonnage of $4,300,000 tons, the Commissioner determined a depletion unit of 4.4121 cents per ton and has allowed depletion deductions in each of the years consistent with such determination.
*240 There is no dispute between the parties as to the correctness of the allowance by the Commissioner on account of the original depletable capital of $189,720.67. The difference arises with respect to the adjustment to be made on account of the paid-in surplus item of $33,000. The Commissioner considered that since the paid-in surplus which he allowed was applicable only to the first coal mined until the royalties waived equaled $33,000, the deduction allowable in each year should be based on the so-called depletion or exhaustion of that amount as the coal to which it applied was mined. On the other hand, the petitioner contends that the paid-in surplus should be considered as applicable to the entire tonnage in the mine and therefore the depletion unit should be adjusted on the basis of a total depletable capital of $189,720.67 plus $33,000, *1357 and such unit applied to all coal mined. We are of the opinion that the action of the Commissioner should be sustained. Since the allowance of the paid-in surplus is not in dispute, we have little information as to the circumstances surrounding its allowance other than subsequent to the execution of the lease voluntary concessions were made by the lessors to the extent of $33,000. It was not therefore depletable capital existing at the acquisition of the lease, nor is it shown to have existed at March 1, 1913, but rather it appears to be capital recognized by the parties on account of benefits which inured to the petitioner for only a limited period, namely, the period during which coal was mined from the property involved without the payment of royalties. A deduction on account of such capital would therefore properly be confined to such period and the adjustment to invested capital would follow on the same basis.
Another question which is related to the foregoing issue is the deduction allowable on account of cash royalties paid. On its returns the petitioner claimed deductions for royalties as follows:
| For calendar year 1917 | $11,381.36 |
| Six months ended June 30, 1918 | 5,876.80 |
| Fiscal year ended June 30, 1919 | 11,695.27 |
*1358 The Commissioner allowed deductions in the following amounts:
| Calendar year 1917 | $2,276.24 |
| Six months ending June 30, 1918 | 1,175.36 |
| Fiscal year ending June 30, 1919 | 6,393.20 |
The record shows that royalties were paid or accrued in the amounts of $5,692.55, $4,701.45 and $9,201.44 for 1917, the six-month period ended June 30, 1918, and the fiscal year ended June 30, 1919, respectively, and accordingly the petitioner is entitled to an additional deduction in each of the foregoing years of the difference between the amounts allowed by the Commissioner and the foregoing amounts now shown to have been paid in the respective years.
*241 2. As to the salary deductions claimed by the petitioner, we are convinced that the evidence more than satisfies the requirement of the statute as to reasonableness. Little question could be raised as to the salary of C. B. Maxwell, who was described as one of the best mining engineers in central Pennsylvania and who, on account of more lucrative offers elsewhere, was retained by the petitioner in part because of his stock interest therein. With respect to R. W. Wigton and F. H. Wigton, the evidence shows that they not*1359 only exercised general supervision over the petitioner in their capacity as officers and assumed full responsibility for collections, but also were responsible for the entire sales of petitioner's coal. No commission or compensation was paid for the sales of coal other than was represented by their salaries. As measured by commissions alone, when compared with the commissions paid by other concerns for similar services, the salaries are reasonable. The fact that they held similar offices with two other concerns is not decisive as to the salary allowances which may be deducted on account of services to the petitioner; the test is whether the compensation which is sought to be deducted by the petitioner is reasonable when measured by the services rendered to the petitioner, and as to this we are satisfied. On the whole, we are of the opinion that the salaries as well as the directors' fees claimed by the petitioner as deductions on account of compensation to the three officers named are reasonable and should be allowed.
3. We are of the opinion that the expenditures for mining equipment set forth in our findings of fact come within the rule laid down in various prior court and*1360 Board cases wherein similar items have been allowed as deductions, and accordingly the action of the Commissioner as to this issue is reversed. ; ; ; ; and Tennessee.
Judgment will be entered under Rule 50.
Footnotes
*. (This amount is subject to appropriate adjustment on account of the period involved of less than a year.) ↩