*2036 Additional compensation paid to petitioner's president, held to be a reasonable allowance for personal services actually rendered.
*758 This proceeding is for the redetermination of deficiencies in income taxes for the calendar years 1924 and 1925 in the amounts of $761.96 and $4,739.97, respectively. The error alleged is that respondent erred in adding back to income an item of $25,000 representing compensation paid to the president of the petitioner for the year 1925.
At the hearing respondent moved to dismiss the proceeding in so far as it related to the year 1924. This motion was granted without objection from the petitioner.
FINDINGS OF FACT.
The petitioner is a corporation with its principal place of business at Rochester, Pa. It is engaged in the business of manufacturing and selling the ordinary visible gasoline pump used in dispensing gasoline at filling stations.
The president of the petitioner during the year 1925 was W. S. Townsend. Townsend first became associated with the petitioner corporation in 1918 under the following*2037 circumstances: Prior to the signing of the Armistice, Townsend was in Washington engaged in was work, and with the signing of the Armistic he had intended returning to his home in Georgia. However, his employer asked him if he would go to Pittsburgh to inspect a device in which some friend of his was interested, to determine whether it was worth while. Townsend found upon investigation that the man was making a visible pump and after having examined it reported to his employer that it looked like a pretty good idea but that it was too small. Townsend's employer then proposed that, if the right to manufacture the device in the East could be obtained, Townsend should stay and run the business. Townsend agreed that he would stay and operate the business, but it subsequently developed that his employer could not obtain the contract to manufacture the pumps. However, he did acquire the right to sell the pumps in the East, and thereafter Townsend ran the sales company which was engaged in selling the visible pumps manufactured by the petitioner.
*759 The visible pumps were shipped by the petitioner to the sales company in Washington, where the sales company rebuilt them before*2038 shipment to customers. In rebuilding the pumps Townsend found that they were very poor in construction and faulty in design. An engineer was employed in Washington, and a good many ways were found whereby the pumps could be improved. The suggested improvements were relayed back to the petitioner's plant at Rochester, with the result that finally Townsend was asked if he would come to Rochester and take charge of the petitioner. Townsend consented upon certain conditions, namely, that $50,000 of additional capital should be put in the business; that he should have complete charge of the petitioner; and that his employer in Washington should agree to his change of employment. In Washington agreed to and Townsend took charge of the company as its general manager in 1920.
At the time Townsend became general manager, petitioner had nothing but a small shop, very little equipment, and a lot of debts. It was unknown to the trade, and its production was small, amounting to 15 pumps a month. The credit of the company was poor, and most of the goods which it purchased were shipped to it C.O.D.
Townsend early discovered that his principal problem was that of production. After quite*2039 a struggle a production system was installed, the design of the pump was improved, some additions were made to the factory and some secondhand machinery of one sort or another was acquired. After a couple of years the company had a little business running along in very good shape.
In 1920 when Townsend went with petitioner as general manager he was given complete charge of the business. The president of the company at that time was H. C. Fry, Sr., a man of eighty years, who took no active part in the business, with the result that from 1921 until his election as president in 1924, Townsend was performing the duties of the president.
Beginning in 1923 the petitioner began to make progress and by July, 1925, it had become the leader in its industry from the standpoint of volume of sales. It had established a reputation with the oil trade as a concern upon which the trade could depend. It had a little different method of doing business from competing concerns, and as a result some of its larger customers were constantly bringing to petitioner the thought that it should undertake the manufacture and sale of other filling-station equipment in addition to it visible pumps. These*2040 suggestions were made because in purchasing other filling-station equipment the oil companies' dealings had not been so satisfactory as their dealings with the petitioner. One large oil company suggested to Townsend that the petitioner buy the Marvel *760 Equipment Co., from which the oil company was purchasing lubricating oil equipment, grease cans, oil tanks, and equipment of that sort. Several advantages from the consolidation of the two companies were suggested to Townsend by the oil company, and particularly the administration of the Marvel Co.'s business by the petitioner. Such a consolidation was likewise suggested to the Marvel Equipment Co., and a conference was held between a representative of the Marvel Co. and Townsend to discuss the probabilities of a consolidation of the two companies. Townsend arranged a number of meetings and he, together with Fry and Wolf, members of petitioner's board of directors, made several trips to Cleveland to look over the Marvel plant and personnel, and get a general idea of the whole situation. Townsend finally came to the conclusion that there was no basis on which a consolidation could be made, and that if petitioner acquired*2041 the management and control of the Marvel Co., it would have to be by purchase and not by consolidation.
Townsend discussed the various developments with the board of directors of the petitioner and secured their opinion concerning whether or not the petitioner should even think about the purchase. It was agreed that the acquisition of the Marvel Co. would be a good thing for the petitioner, and that Townsend should keep the board informed from time to time as to the progress of his negotiations. Assisting Townsend in his negotiations with the Marvel Co. was George D. Wolf, a director of the petitioner, who was a certified public accountant and the senior member of Wolf & Co., an accounting firm located in Chicago. This firm on behalf of the petitioner made an analysis of the Marvel Co.'s operating statements, and checked the inventories, its accounts, and its financial position to determine definitely whether the profits submitted were correct. In addition Townsend went to New York to interview purchasing agents of various companies, with whom he was closely identified, to make sure that the acquisition of the Marvel Co. and its line of equipment would be favorably received.
*2042 As a result of these investigations the directors of the petitioner agreed that, if the Marvel Co. could be purchased for $1,000,000, it would be a good buy and that the price paid would be reasonable.
Shortly thereafter actual negotiations were entered into looking to the purchase of all the stock of the Marvel Co. since the petitioner did not care to purchase less than 100 per cent of that company's stock. The Marvel Co. was interested in becoming a part of the petitioner's organization, so Townsend was able to secure for the petitioner thirty-day options to purchase all the stock at a total price of $832,000.
*761 In order to purchase this stock it was necessary to secure a large amount of cash. Townsend, together with Wolf, procured this money by means of loans from the Union Trust Co. of Chicago in the amount of $250,000, the Mellon National Bank of Pittsburgh in the amount of $250,000, the Baltimore Trust Co. of Baltimore in the amount of $250,000, and the First National Bank of Pittsburgh in the amount of $50,000. In securing the first loan of $250,000, which was procured from the Union Trust Company of Chicago, it was necessary for Townsend and Wolf to personally*2043 endorse the petitioner's note.
The result of the negotiations and the plan to finance the purchase were formally reported to the petitioner's board of directors at a meeting held on May 13, 1925, as shown by the following minutes:
Mr. Townsend gave a brief history of the negotiations with the Marvel Equipment Company concerning the procuring of the options and investigation of the Company's relations with the trade, also the report of Wolf and Company's auditors on the accounts of the Marvel Equipment Co. Marvel's profits this year after taxes were $126,000.00 and it was estimated they would do $65,000.00 in April. Mr. Townsend explained how the purchase could be financed as he had procured the following loans, Union Trust Co., Chicago, $250,000.00; Baltimore Trust Company, Baltimore, $250,000.00; Mellon National Bank, Pittsburgh, $250,000.00 and First National Bank, Pittsburgh, $50,000.00. These loans with a portion of our certificates of deposit will amply take care of the proposed purchase. Mr. Townsend was highly complimented by the directors for procuring the options on the purchase of the stock of the Marvel Equipment Company at such a reasonable figure. The directors*2044 unanimously approved the acceptance of the options. On motion of Mr. Harry C. Fry, Jr., duly seconded by Mr. Fischer and carried the president was authorized to make the purchase of the outstanding stock of the Marvel Equipment Company.
At the same meeting the board of directors adopted the following resolution:
On motion of Mr. Wolf duly seconded by Mr. Harry C. Fry, Jr., and carried, Mr. Townsend was granted a special compensation of $25,000.00 for services in connection with the purchase of the Marvel Equipment Company, to be paid at the convenience of the Treasurer but the entire amount is to be paid within three months from date.
In conducting negotiations leading up to the acquisition of the Marvel Co., Townsend had acted as the president and managing head of the petitioner. He had no agreement or arrangement with the petitioner respecting any additional compensation for his services, and the first time he knew that he was to receive extra compensation for such services was when the above resolution was passed. Nobody else connected with the petitioner received any additional compensation in connection with this matter. A reasonable amount of compensation for Townsend's*2045 services was agreed upon by George D. Wolf and H. C. Fry, Jr., two of the directors of the petitioner, a *762 few hours prior to the directors' meeting of May 13, 1925, and their recommendation was accepted by the board of directors.
Townsend's regular salary for his services to the petitioner for the calendar year 1925 was fixed by a resolution of the executive committee adopted May 13, 1925, as follows:
The following members of the executive committee were present at a meeting held this date: Mr. W. S. Townsend, Mr. H. C. Fry, Jr., and Mr. G. D. Wolf.
On motion of Mr. Wolf duly seconded and carried the compensation of Mr. W. S. Townsend for 1925 was fixed at a salary of $25,000.00 per year and a bonus of 5% of net profits before taxes determined by the current Profit and Loss Statement.
The total compensation received by Townsend from the petitioner under the foregoing resolutions during 1925 amounted to $89,174.66. Townsend returned this amount as salary received by him upon his individual income-tax return for 1925. Townsend received salaries from the petitioner for the calendar years 1921 to 1926 as follows:
| 1921 | $9,666.72 |
| 1922 | 10,833.34 |
| 1923 | 22,955.54 |
| 1924 | 48,379.18 |
| 1925 | 89,174.66 |
| 1926 | 69,051.66 |
*2046 At no time prior to or during 1925 did Townsend hold more than 25 per cent of the petitioner's capital stock.
The original investment in the Guarantee Liquid Measure Co. was approximately $143,000, the increase in the size of its business being due to profits earned by the company rather than to any additional capital invested therein. The total sales and net income as shown by petitioner's books for the calendar years 1921 to 1926, inclusive, were as follows:
| Year | Sales | Net income |
| 1921 | $498,247.54 | 1 $15,962.23 |
| 1922 | 691,495.48 | 3,811.91 |
| 1923 | 1,797,276.16 | 274,773.53 |
| 1924 | $4,034,212.67 | $665,377.14 |
| 1925 | 4,476,864.41 | 940,840.65 |
| 1926 | 4,590,198.54 | 866,071.00 |
The entire management of the petitioner's business during these years was handled by Townsend and the decisions incident thereto were made by him. The sales of the petitioner's products were closely supervised by him, and he was personally responsible for more than 50 per cent of its sales contracts.
Upon its return for 1925 the petitioner deducted $87,074.66 as compensation of officers, which included $64,174.66 paid to Townsend. Respondent allowed this deduction in*2047 its entirety. In schedule 2 *763 attached to its return petitioner claimed under administrative expenses an item entitled "Bonus - Office - $64,587.50," which sum included the $25,000 paid to Townsend as special compensation for services in connection with the purchase of the Marvel Equipment Co. It is respondent's refusal to allow this $25,000 deduction which results in the deficiency for 1925.
OPINION.
MORRIS: The sole issue presented is whether under the facts herein the petitioner is entitled to deduct the extra $25,000 payment made to Townsend in 1925 as "a reasonable allowance for salaries or other compensation for personal services actually rendered," within the meaning of section 234(a)(1) of the Revenue Act of 1924. The entire question, as we view it, is one of reasonableness, that is, whether the personal services rendered by Townsend to the petitioner were actually worth $89,174.66. The respondent concedes that petitioner is entitled to deduct $64,174.66 of Townsend's compensation, but disputes the reasonableness of the remaining $25,000.
The petitioner has carefully developed the facts from the date of Townsend's first connection with it down through*2048 the taxable year, and calls our attention to the growth of its business from obscurity to an outstanding position in its industry under Townsend's skillful leadership and management. Beginning with a loss of almost $16,000 in 1921 Townsend so capably managed the petitioner's business that by 1925 the net income was over $940,000. During the intervening years the petitioner's net income rose steadily, jumping from $3,800 in 1922 to over $274,000 in 1923. It is interesting to note that as the petitioner's business grew Townsend's salary was increased, and if the $25,000 item be excluded from his 1925 salary, it appears that each year Townsend's salary was increased with the increase in petitioner's sales.
The particular facts which influenced the board of directors in voting this additional compensation to Townsend were the circumstances surrounding petitioner's acquisition of the Marvel Equipment Co. This company manufactured and sold a line of gasoline filling-station equipment, which, together with petitioner's visible pumps, would enable the petitioner to completely equip filling stations. The detailed investigations conducted by Townsend revealed that petitioner could well*2049 afford to pay a million dollars for the Marvel Equipment Co., and the board of directors signified its willingness to purchase at that price. Townsend's negotiations resulted in the purchase of the Marvel Co. for $832,000, which represented a saving to the petitioner of $168,000. Having acquired the stock, *764 Townsend then proceeded to raise the necessary cash to make the purchase. This he accomplished, at least partially, by personally endorsing petitioner's note for $250,000.
The minutes of the directors' meeting of May 13, 1925, clearly reveal the feelings of the board of directors with respect to Townsend's achievement in buying the Marvel stock for $832,000. They not only "highly complimented" him, but expressed their appreciation of his efforts in a more concrete form. Prior to the meeting Wolf and Fry agreed that Townsend's services should be rewarded and they further agreed that $25,000 would be a reasonable compensation to Townsend for his efforts. Their recommendation was accepted by the Board, and the resolution adopted states that the $25,000 was "a special compensation * * * for services in connection with the purchase of the Marvel Equipment Co. * * *2050 *."
At the hearing George D. Wolf, one of the directors of the petitioner, testified in considerable detail with respect to the services rendered by Townsend in acquiring the Marvel Co.'s stock, and likewise he gave in some detail the nature of the investigations which were conducted by Townsend and himself prior to the actual purchase. Wolf testified that Townsend was responsible for arranging and handling the negotiations, and then related how he and Fry had agreed upon the $25,000 payment to Townsend authorized by the resolution of the board of directors on May 13, 1925. Wolf further stated that he considered the $25,000 voted to Townsend was a reasonable compensation for services rendered, and that he realized at the time the amount was voted that such a disbursement would reduce the amount of profits available for dividends.
Respondent calls attention to our decisions in the ; ; and , which cases he considers are authorities for his position that this claimed deduction should be disallowed. We have examined the*2051 above cited cases, but we can not agree that they are controlling under the facts herein. We are convinced by the record that the amount paid Townsend for the year 1925 constituted a reasonable compensation for personal services actually rendered, and that the petitioner is entitled to deduct this $25,000 payment under section 234(a)(1) of the Revenue Act of 1924.
This proceeding, in so far as it relates to the year 1924, is dismissed and decision will be entered for the respondent.
Decision will be entered under Rule 50.
Footnotes
1. Loss. ↩