*895 1. Where the respondent allowed as deductions under section 23(a) of the Revenue Acts of 1928 and 1932 the amounts of fixed salaries paid to petitioner's officers, held, that his disallowance of additional salaries based upon a percentage of net profits was not error, under the facts presneted, upon failure to prove that the distribution of net profits was directly related to services performed so as to be earned.
2. Held that petitioner has failed to present proof as to bases and rates to show error in the respondent's determination of the depreciation allowable upon certain assets of petitioner.
*329 These proceedings, consolidated for hearing and opinion, are for the redetermination of deficiencies in income taxes for the calendar years 1931, 1932, and 1933 in the respective amounts of $3,862.65, $1,548.36, and $1,499.86. It is alleged that the respondent erred in reducing the deduction for officers' salaries for the years 1931, 1932, and 1933 in the respective amounts of $32,000, $10,000, and $10,000. It is also alleged that respondent*896 erred in reducing the deduction for depreciation on certain physical properties for the years 1932 and 1933 in the respective amounts of $1,631.61 and $1,186.24.
FINDINGS OF FACT.
The petitioner is a corporation, organized in 1917 under the laws of the State of New York, and has its place of business in Jamaica, Long Island. It is engaged in the distribution at wholesale of drugs manufactured by others. During the taxable years 1931 to 1933, inclusive, it also sold medicinal liquors.
The authorized capital of the petitioner corporation was $10,000 (100 shares of $100 par value per share) but it issued only 30 shares of stock, which were held equally by the brothers Hyman and Maurice Alkon, and Bernard H. Mindling. In 1921 each of the stockholders sold one-half of his stock to Benedict Maisel, the nominee of the Reliance Distributing Co., a total of 15 shares for approximately $39,000. The stock of this corporation was owned by the parents of Charles J. Steinberg, hereinafter described. In 1926 or 1927 the Reliance Distributing Co. was dissolved and the 15 shares of stock of petitioner were transferred to the Cunard Mercantile Corporation, the stock of which was also owned*897 by the parents of Steinberg. Charles J. Steinberg was not a stockholder of the petitioner, nor did he have any equitable interest in the stock.
Prior to 1930 the petitioner corporation had not paid any dividends. The Steinberg family, who controlled a half interest in the petitioner corporation, having failed to receive any return on their investment, desired that petitioner extend its business operations by putting out a new line of goods and opening a new market in Brooklyn. They also wanted petitioner to employ Charles J. Steinberg. The stockholders were unable to agree upon the future conduct of the business of the petitioner corporation and the Steinbergs, through *330 their nominee, brought suit to dissolve the corporation. The suit was dismissed later, upon the condition that the following arrangement approved by the stockholders would be carried out by the petitioner corporation. The corporation was to extend its market into Brooklyn and promote a new line of goods under its own brand. It was also to employ Charles J. Steinberg to be in charge of the new line. The annual compensation of the officers of the corporation, including Steinberg, was to be at fixed*898 annual rates plus equal shares in 5 0 percent of net profits. The corporation carried out the terms of this understanding. The bylaws of the corporation were amended March 11, 1931, to provide for the annual compensation of officers as follows: President, $13,500; treasurer, secretary, and assistant secretary, $12,500 each. In addition to the annual salary each of these officers was to receive 12 1/2 percent of the net profits of the corporation after substracting from net profits the total due on state and Federal taxes. The bylaws of the petitioner corporation provide that the bylaws may be amended by the affirmative vote of all of the capital stock issued and outstanding or by affirmative vote of the entire board of directors.
During the taxable years the officers of the corporation were: President, Hyman Alkon; treasurer, Maurice Alkon; secretary, Bernard Mindling; assistant secretary, Charles J. Steinberg. They devoted all of their time to the business of the corporation. The duties of these officers are employees respectively were: Hyman Alkon, buyer of all merchandise except medicinal liquor, officer manager; Maurice Alkon, sales manager, credits, collections, and bills*899 payable; Bernard Mindling, purchase and sale of medicinal liquor and keeping records relating thereto, contracts; Charles Steinberg, supervision of distribution of the new Line of products in Brooklyn, credit, finance, insurance, and bad accounts.
During the taxable years in question the following fixed salaries and percentages of profits were paid:
| For 1931 | For each of years | |||
| 1932 and 1933 | ||||
| Fixed salary | Contingent | Total | Fixed salary | |
| H. Alkon, president | $13,500 | $8,000 | $21,500 | $13,500 |
| M. Alkon, treasurer | 12,500 | 8,000 | 20,500 | 12,500 |
| B. H. Minding, secretary | 12,500 | 8,000 | 20,500 | 12,500 |
| C. J. Steinberg, assistant | ||||
| secretary | 12,500 | 8,000 | 20,500 | 12,500 |
| Total | 51,000 | 32,000 | 83,000 | 51,000 |
| For each of years 1932 and 1933 | |
| continget | Total |
| $2,500 | $16,000 |
| 2,500 | 15,000 |
| 2,500 | 15,000 |
| 2,500 | 15,000 |
| 10,000 | 61,000 |
The fixed salaries were paid during each of the years 1931, 1932, and 1933. The contingent compensation was paid when the amount was determined shortly after the books were close for each year.
In its returns for the years 1931, 1932, and 1933 the petitioner deducted the amounts*900 of $83,000, $61,000, and $61,000, respectively, as *331 compensation of its officers. In determining the deficiencies for the years 1931, 1932, and 1933 the respondent disallowed the amounts of $32,000, $10,000, and $10,000, respectively, of the claimed deductions. The respondent disallowed the deductions for contingent salaries, contending that they represented a distribution of profits and not compensation for the value of services rendered and that the fixed annual salaries allowed represented reasonable compensation for services rendered.
During the prior years gross sales of the petitioner were as follows:
| 1927 | $1,493,004.24 |
| 1928 | 1,763,751.36 |
| 1929 | 1,851,458.04 |
| 1930 | 1,865,923.11 |
It was stipulated that the gross and net sales of petitioner corporation in the taxable years in question were as follows:
| 1931 | 1932 | 1933 | |
| Gross sales | $1,796,098.03 | $1,537,545.88 | $1,524,885.42 |
| Net sales | 1,761,921.92 | 1,500,578.42 | 1,482,254.70 |
In its returns for the years 1931, 1932, and 1933 the petitioner corporation showed the following:
| 1931 | 1932 | 1933 | |
| Gross profits from sales | $255,485.77 | $203,234.97 | $200,814.95 |
| Gross income | 278,236.79 | 218,731.71 | 215,220.99 |
| Net income (after paying salaries) | 37,601.21 | 12,212.60 | 12,475.26 |
*901 Although the petitioner handled more units of sale in 1932 and in 1933 than in 1931, its earnings were less because prices had fallen due to the depression.
Petitioner's policy has been to accumulate its surplus for the purpose of buying additional property and inventory to expand its volume of business. Its surplus at the beginning of 1931 was $390,753.22, at the beginning of 1932 was $432,466.43, and at the beginning of 1933 was $442,488.59. Its inventory between 1924 and the end of 1933 was increased from $87,009.80 to $394,503.08. Petitioner increased its authorized capital in 1933 from $10,000 to $500,000 (5,000 shares of $100 par value per share). Although it has never paid a cash dividend it did, in 1933 pay a stock dividend of 4,170 shares, the stock being distributed in the same proportion as the old stock was held. At that time petitioner had a surplus of approximately $450,000. As a result of this stock dividend, petitioner's surplus at the end of 1933 was reduced to $35,966.15.
*332 In 1933 the outstanding stock totaled 4,200 shares. The stock was held in the following proportions: Hyman and Maurice Alkon and Mindling 16 2/3 percent; Maisel (nominee), *902 50 percent.
Petitioner purchased a building in 1926 for office and warehouse. This is a small one-story brick structure, originally designed for a garage and converted by petitioner into a building suitable for its needs. In its returns for each of the years 1932 and 1933 petitioner claimed depreciation upon the building in the amount of $2,462.40, using a rate of 3 percent on a basis of $82,080.02. The respondent disallowed this depreciation, but allowed depreciation in the amount of $2,075.75, using a rate of 2 1/2 percent on a basis of $83,030.02.
On May 30, 1933, the petitioner completed a new sprinkler system in its building. In its return for the year 1933 the petitioner claimed a deduction for depreciation of the sprinkler system in the amount of $311.97, for seven months of the taxable year, using a rate of 10 percent on a basis of $5,348. The respondent allowed only $207.98, using a rate of 6 2/3 percent upon a basis of $5,348.
In its return for the year 1932 the petitioner claimed a deduction for depreciation on eight automobiles in the amount of $3,952.37, using a rate of 33 1/3 percent on a basis of $13,129.43. The respondent disallowed such depreciation, *903 but allowed depreciation upon eight automobiles in the amount of $2,564.34, using a rate of 25 percent on a basis of $11,222.40.
In its return for the year 1933 the petitioner claimed a deduction for depreciation upon 11 automobiles in the amount of $3,387.43, using a rate of 33 1/3 percent upon a basis of $15,006.27. The respondent disallowed such depreciation but allowed depreciation upon spondent disallowed such depreciation but allowed depreciation upon 11 automobiles in the amount of $2,548.76, using a rate of 25 percent on a basis of $14,632.26.
OPINION.
HARRON: Issue 1. - The petitioner contends that the total salaries paid to the four officers were reasonable and deductible as ordinary and necessary expenses. The respondent contends that only the fixed annual salaries are deductible and that the contingent compensation was not payment for services rendered, but represents a distribution of profits and is not ordinary and necessary expense within the meaning of the applicable provisions of the statutes.
To determine whether salaries or other compensation are reasonable so as to be deductible from gross income as a business claimed is requires that the petitioner*904 prove that the total amount claimed is reasonable payment for services rendered. The fact that the directors or stockholders have approved the entire amount claimed or that an agreement to pay these amounts is set forth in a contract or in the bylaws of the petitioner does not make the amounts paid *333 ordinary and necessary expenses of business under the income tax laws. See Samuel Heath Co. v. United States,2 Fed.Supp. 637; L. Schepp Co.,25 B.T.A. 419.
Section 23(a) of the Revenue Acts of 1928 and 1932 includes in deductible business expense "a reasonable allowance for salaries or other compensation for personal services actually rendered." A business concern may make payment for services in diverse ways - by a fixed annual salary; by a flat salary plus commissions; by a salary plus a bonus; by a salary plus a share in net earnings. Compensation paid by any of these methods is a deductible expense if reasonable and for services rendered. It is a corollary of this rule that when net earnings are paid to employees as compensation it must be shown that the amount paid out of net earnings is directly related to services performed*905 so as to be earned.
There is no question here regarding the reasonableness and deductibility of the fixed annual salaries. The question is narrowed to whether payment of 12 1/2 percent of net earnings to each of four executive officers, a total of 50 percent of net earnings, was also reasonable compensation for services rendered, and the burden of proof is on the petitioner to show that it was. A review of the evidence fails to show that the services of each officer were worth 12 1/2 percent of net earnings, or more or less. Excepting that all four devoted all of their time to petitioner's business, there is no evidence to show that they separately performed such services as to have earned the share in net earnings allocated, even though each of the officers had distinct duties and some were in charge of distinct divisions of the business. A comparison of the facts in this proceeding with those in the case of Gray & Co. v. United States, 35 Fed.(2d) 968, is not favorable to petitioner's contention, although petitioner relies largely on the decision therein. There the officers received shares in net profits ranging from 60 percent to 5 percent after*906 a dividend of 7 percent per annum was paid to all stockholders, which indicates that the shares in net earnings bore some relation to the value of services rendered by each officer. There also the fund of "net earnings" available for additional compensation to officers did not exist until a return on outstanding stock had been paid, which is not the case in the instant proceedings. The petitioner agreed to pay its officers 50 percent of net earnings each year without giving consideration to the effect of this on the ability of the corporation to pay earnings on capital invested in the business. Petitioner has never paid a cash dividend. In the taxable years in question net earnings left after paying salaries would have enabled payment on capital invested in the business of 9 percent in 1931 but less than 3 percent in both 1932 and 1933. While the relation of compensation to net income is not the only test of reasonableness, it is important where a corporation *334 has failed to pay dividends and appears to fail to consider the effect of paying fixed percentages of net income to its officers who are stockholders upon its ability to make a return on investment.
The determination*907 of whether compensation paid is a reasonable and ordinary business expense for purposes of computing net income under the income tax laws is dependent upon the facts in each proceeding. Out of many determinations of such issues tests emerge which may be applied, yet their application to given sets of facts is difficult. Petitioner has stressed the argument that high percentages of net income have been allowed as reasonable compensation as a part of the ordinary and reasonable expenses of operating corporations. The relation of compensation to net income is only one of the tests of reasonableness. Many other factors are determinative of reasonableness and each case is dependent upon its particular set of facts. There are cases where salaries, or other compensation, which have been held reasonable have represented a high percentage of net earnings, but all of the facts supporting reasonableness must be considered and such results as petitioner refers to have been, rather, the fortuitous results of all factors involved. "The question of reasonableness of salaries must be determined with reference to volume of business, the profits made, the character of the services for which compensation*908 was paid, and all other pertinent facts shown." New York Talking Machine Co.,13 B.T.A. 154, 161.
Looking at the total compensation paid each officer, comprising both salary and a fixed percentage of net earings, we fail to find satisfactory proof that the amounts paid were reasonable and not more than reasonable. Opinions of witnesses as to the reasonableness of amounts paid by petitioner were not supported by facts showing what other concerns in the same business with corresponding gross income pay for services similar to those rendered by petitioner's executive officers. Petitioner having failed to sustain the burden of proof to show that respondent's determination was erroneous with respect to reasonable compensation, it is held that the amounts paid out of net earnings are not deductible as ordinary and necessary business expense.
It is not necessary to determine that the amounts paid out of net earnings were a distribution to the three stockholders in the nature of dividends, but it is pointed out that whether such distributions are in proportion to stockholdings is not necessarily determinative of such result. "By unanimous agreement among the stockholders*909 of a corporation, the profits may be divided and distributed other than ratably according to stockholdings", see Joseph Goodnow & Co.,5 B.T.A. 1154, 1158, and 6 Fletcher on Corporations, 6114, sec. 3674.
Issue 2. - With respect to the question whether respondent erred in partially disallowing the total amounts claimed by petitioner for *335 depreciation of various types of property - a building, a sprinkler system, and various kinds of automobiles - the issues arise out of the fact that petitioner and respondent used different bases and different rates of depreciation. The burden of proof was on the petitioner to show that the bases and rates used by respondent were wrong. Articles 204, 205, and 591 of Regulations 77 make it clear that in general the cost of the property is the basis, and the useful life of the property must be estimated to provide the rate of depreciation. And yet petitioner did not introduce evidence other than the opinion of an officer of the corporation to provide the elements for affirmatively showing what the bases and rates should be, or that the bases and rates used by respondent were wrong. In the absence of necessary proof*910 to the contrary the bases and rates used by respondent are presumed to be correct, and his determination is sustained. Uncasville Manufacturing Co.,19 B.T.A. 920; affirmed in Uncasville Manufacturing Co. v. Commissioner, 55 Fed.(2d) 893; Elmore Milling Co.,27 B.T.A. 84; affirmed in Elmore Milling Co. v. Commissioner, 70 Fed.(2d) 736.
Decision will be entered for the respondent.