*3297 1. Fixed salaries and additional compensation based on profits authorized and paid to officers during the years 1918 and 1919 allowed as an expense deduction where such compensation was for personal services actually rendered and was reasonable in amount.
2. A notice of a deficiency sent to one of two affiliated corporations which does not show a determination of any additional tax liability on behalf of the other affiliated company does not, in the absence of any agreement between the companies, authorize the filing of an appeal with the Board by the corporation to which no notice of a deficiency has been sent. American Creosoting Co., et al.,12 B.T.A. 247">12 B.T.A. 247.
*154 This proceeding is for the redetermination of deficiencies for 1918 and 1919 in the amounts of $79,458.55 and $53,620.13, respectively. For 1918 the petitioners filed a claim for abatement in the amount of $85,367.78 of which amount the Commissioner has allowed $5,909.23. The*3298 deficiency for 1919 is a proposed additional assessment.
The errors alleged in the petition are, (1) the disallowance for the year 1918 of a deduction of $113,070 of the compensation paid to the officers of said affiliated companies; (2) the disallowance for 1919 of a deduction of $119,035.12 of the compensation paid to the officers of said affiliated companies, and the disallowance of a deduction of $1,500 compensation paid to the sales manager of said companies; and (3) determining the average inadmissible assets for 1919 to be $422,879.08 instead of $162,732.71.
*155 The Commissioner has conceded the correctness of the petitioners' contention in regard to the amount of average inadmissibles for the year 1919.
At the hearing before the Board counsel for the petitioners moved for a dismissal of the appeal of the Chicago Talking Machine Co. on the grounds that the Commissioner has not notified said company of a deficiency in tax for either of the years 1918 or 1919 as required by the statute, and that the Board therefore has no jurisdiction to hear and determine its appeal.
FINDINGS OF FACT.
The petitioners were affiliated corporations during the taxable years*3299 1918 and 1919 and filed consolidated returns for each of such years. They were engaged in the business of buying and selling at wholesale the products of the Victor Talking Machine Co.
Each of the companies was capitablized at $100,000. Prior to 1917 their capital stock, except for qualifying shares, was owned by the Victor Talking Machine Co. and was held in trust for that company by one of its officers.
Prior to 1906, the Chicago Talking Machine Co. had not been a financial success. The Victor Talking Machine Co. was endeavoring to find a competent person to place in charge of the Chicago office. A. D. Geissler had been a salesman for Victor Talking Machine products in San Francisco and had made a great success there. The records of the company show that he had sold five times as many goods on one invoice as any other salesman of the Victor Company had ever sold up to that time. At the suggestion of A. D. Geissler's father, who was the sales manager for the Victor Talking Machine Co., the son, A. D. Geissler, was placed in charge of the Chicago office. The sales of the Chicago Talking Machine Co. soon began to expand rapidly. As a result of his success with the Chicago*3300 Talking Machine Co., he was in 1913 made general manager and vice president of the New York Talking Machine Co.
In 1915 and 1916 Geissler drew a salary of $5,000 from each of the two companies which he was then representing as general manager and in 1916 he received a bonus of $17,500. During the latter part of that year he received an offer of employment which he was tempted to accept by reason of the fact that his compensation would in all probability be in the vicinity of $100,000 a year. The officers of the Victor Talking Machine Co. were anxious to retain him in its employ. There was discussion among them as to whether his salary should be increased to $50,000 or $100,000 per year. In lieu of this offer he was given an opportunity with his associates in the two companies *156 which he represented as general manager to acquire the stocks of those companies. Accordingly, in January, 1917, the entire stock of the Chicago Talking Machine Co. and of the New York Talking Machine Co. was purchased by five individuals - A. D. Geissler, Daniel H. Creed, R. J. Keith, Griffith P. Ellis and William C. Griffith. The consideration for the purchase of the stock was $1,800,000, *3301 to be paid semiannually over a period of 20 years. It was provided in the purchase agreement that in order to protect the interests of the Victor Company in the deferred payment of the purchase price, the net quick assets of the two companies should at no time fall below $1,250,000, the approximate net quick assets at the date of transfer.
The stock was transferred to the above-named individuals as of January 1, 1917, and was pledged with the Victor Talking Machine Co. as security for the purchase price. Geissler acquired 75 per cent of the stock of each company, Creed and Keith 6.25 per cent each, and Ellis and Griffith 2.5 per cent each. The portion of the stock which each was permitted to acquire was determined upon the basis of the estimated value of each to the business. The remaining 7 1/2 per cent of the stock of each company, less one share in each held by W. J. Staats, an officer of the Victor Talking Machine Co., was held by Geissler as trustee. In May, 1919, Creed acquired one-half of the stock of each company held by the trustee, increasing his holdings to 10 per cent in each company. Geissler, Creed, Keith, Ellis and Staats became directors of both the New York*3302 and the Chicago companies.
During the taxable years the petitioners' stock was held as follows:
| New York Talking Machine Co. | |
| From January 2, 1917, to May 23, 1919 | |
| Arthur D. Geissler | 750 |
| Daniel A. Creed | 62 1/2 |
| Royden J. Keith | 62 1/2 |
| Griffith P. Ellis | 25 |
| William C. Griffith | 25 |
| Arthur D. Geissler, Trustee | 74 |
| Walter J. Staats | 1 |
| From May 23, 1919, to January 1, 1920 | |
| Arthur D. Geissler | 750 |
| Daniel A. Creed | 100 |
| Royden J. Keith | 62 1/2 |
| Griffith P. Ellis | 25 |
| William C. Griffith | 25 |
| Arthur D. Geissler, Trustee | 36 1/2 |
| Walter J. Staats | 1 |
| Chicago Talking Machine Co. | |
| 1917 and 1918 | |
| Arthur D. Geissler | 7,500 |
| Daniel A. Creed | 625 |
| Royden J. Keith | 625 |
| Griffith P. Ellis | 250 |
| William C. Griffith | 250 |
| Arthur D. Geissler, Trustee | 749 |
| Walter J. Staats | 1 |
| 1919 | |
| Arthur D. Geissler | 7,500 |
| Daniel A. Creed until May, 1919, thereafter 1,000 | 625 |
| Royden J. Keith | 625 |
| Griffith P. Ellis | 250 |
| William C. Griffith | 250 |
| Arthur D. Geissler, Trustee, until May, 1919, thereafter, 374 | 749 |
| Walter J. Staats | 1 |
*157 Stock held in the name of Arthur D. Geissler, Trustee, was voted by him and dividends were*3303 paid thereon to him as "Trustee."
Upon the purchase of the petitioner's stock in 1917, A. D. Geissler became president, general manager, and treasurer of both the Chicago Talking Machine Co. and the New York Talking Machine Co. Thereafter he divided his time equally between the two companies.
D. A. Creed first became connected with the Chicago company in 1902. In 1912 he was office manager and credit manager of the Chicago company. In 1913 he was made comanager with R. J. Keith of the Chicago company. During the years 1917 and 1918 he was general manager of the Chicago company, and in 1919 was also general manager of the New York company.
R. J. Keith became connected with the Chicago company in 1907 as a salesman. He later became sales manager. After 1913 he served as comanager with D. A. Creed.
Each of the officers devoted all of his time to the petitioners' business. Creed received a salary of $6,000 in 1916.
About the time of the purchase of the petitioners' stock in 1917 it was agreed informally that each of the above-named officers would receive a fixed salary from each of the companies, and if the earnings should be sufficient each would receive additional*3304 compensation in the nature of a bonus sufficient to make the total compensation for the year 1917 as follows:
| Geissler | $120,000 |
| Creed | 15,000 |
| Keith | 15,000 |
| Ellis | 6,000 |
| Griffith | 4,000 |
*158 On December 14, 1917, the following resolution was adopted by the directors of the New York company:
After consideration, on motion, duly made and seconded, the following resolutions were adopted, by the vote of all the directors present except that no director voted in respect of his own compensation:
RESOLVED that the agreement which has been made between this Company and Arthur D. Geissler, whereby this company agreed to pay him as compensation for services rendered and to be rendered by him to this Company during the year 1917 a fixed sum of $12,500 and twenty-five per cent, of the net profits of this Company before deducting Federal taxes and any sums paid as compensation to employees of the Company which is based upon a percentage of the profits but after deducting all amounts paid to employees as compensation for services which are not based upon a percentage of profits be, and it hereby is, formally in all things approved.
RESOLVED that the agreement*3305 which has been made between this company and Daniel A. Creed, whereby this Company agreed to pay him as compensation for services rendered and to be rendered by him to this Company during the year 1917 a fixed sum of $3,000 and two and four-tenths per cent of the net profits of this Company before deducting Federal taxes and any sums paid as compensation to employees of the Company which are based upon a percentage of the profits but after deducting all amounts paid to employees as compensation for services which are not based upon a percentage of profits be, and if hereby is, formally in all things approved.
RESOLVED that the agreement which has been made between this Company and Royden J. Keith, whereby this Company agreed to pay him as compensation for services rendered and to be rendered by him to this Company during the year 1917 a fixed sum of $3,000, and two and four-tenths per cent of the net profits of this Company before deducting Federal taxes and any sums paid as compensation to employees of the Company which are based upon a percentage of the profits but after deducting all amounts paid to employees as compensation for services which are not based upon a percentage*3306 of profits be, and it hereby is, formally in all things approved.
RESOLVED that the agreement which has been made between this company and Griffith P. Ellis, whereby this Company has agreed to pay him as compensation for services rendered and to be rendered by him to this Company during the year 1917, six-tenths of one per cent of the net profits of this Company before deducting Federal taxes and any sums paid as compensation to employees of the Company which are based upon a percentage of the profits but after deducting all amounts paid to employees as compensation for services which are not based upon a percentage of profits be, and it hereby is, formally in all things approved.
RESOLVED that the agreement which has been made between this Company and William C. Griffith, whereby this Company agreed to pay him as compensation for services rendered and to be rendered by him to this Company during the year 1917, six-tenths of one per cent of the net profits of this Company before deducting Federal taxes and any sums paid as compensation to employees of the Company which are based upon a percentage of the profits but after deducting all amounts paid to employees as compensation*3307 for services which are not based upon a percentage of profits be, and it hereby is, formally in all things approved.
On the same day a resolution was passed by the board of directors of the Chicago company similar in all respects except that in addition *159 to the stated percentage of the profits fixed salaries of $4,200 and $2,400 for Ellis and Griffith were approved.
For 1918 it was agreed informally by the directors of the companies that the compensation to be paid to each of the officers would be the same as had been agreed upon for 1917 and that the compensation in addition to fixed salaries would be apportioned between the two companies on the basis of the earnings of each. The compensation actually paid to the officers for 1918 was not exactly in accordance with the percentage of profits agreed upon for 1917 in the above resolution. Of the total compensation of $143,286.72 for the year 1918 the Commissioner allowed a deduction of $30,216.72, the same amount which he had allowed for 1917. All of such disallowance was in respect of the salaries and bonuses of Geissler, Creed, and Keith.
For the year 1919 it was agreed by the directors informally that substantially*3308 the same compensation would be paid as was paid for the year 1918.
The compensation paid to the above-named officers for the years 1917, 1918, and 1919 was as follows:
| 1917 | ||||
| Company | Fixed compensation | Additional | ||
| Compensation | Total | |||
| New York Co | $12,500.01 | $38,980.00 | $51,480.01 | |
| A. D. Geissler | Chicago Co | 12,499.95 | 55,226.80 | 67,726.75 |
| New York Co | 3,742.08 | 3,742.08 | ||
| D. A. Creed | Chicago Co | 6,000.00 | 5,301.77 | 11,301.77 |
| New York Co | 6,000.00 | 3,742.08 | 9,742.08 | |
| R. J. Keith | Chicago Co | 5,301.77 | 5,301.77 | |
| New York Co | 935.52 | 935.52 | ||
| Griffith P. Ellis | Chicago Co | 3,750.00 | 1,325.44 | 5,075.44 |
| New York Co | 935.52 | 935.52 | ||
| William C. Griffith | Chicago Co | 2,250.00 | 1,325.44 | 3,575.44 |
| 1918 | ||||
| New York Co | $12,500.03 | $37,250.14 | $49,750.17 | |
| A. D. Geissler | Chicago Co | 12,499.92 | 49,959.51 | 62,459.43 |
| New York Co | 3,000.00 | 4,074.23 | 7,074.23 | |
| D. A. Creed | Chicago Co | 3,000.00 | 5,464.32 | 8,464.32 |
| New York Co | 3,000.00 | 4,074.23 | 7,074.23 | |
| R. J. Keith | Chicago co | 3,000.00 | 5,464.32 | 8,464.32 |
| New York Co | 814.85 | 814.85 | ||
| Griffith P. Ellis | Chicago Co | 4,466.68 | 1,092.88 | 5,559.56 |
| New York Co | 814.85 | 814.85 | ||
| William C. Griffith | Griffith Co | 1,200.00 | 1,092.88 | 2,292.88 |
| 1919 | ||||
| New York Co | $12,500.04 | $21,226.15 | $33,726.19 | |
| A. D. Geissler | Chicago Co | 12,499.89 | 61,224.99 | 73,724.88 |
| New York Co | 3,749.97 | 4,088.00 | 7,837.97 | |
| D. A. Creed | Chicago Co | 3,750.00 | 11,791.53 | 15,541.53 |
| New York Co | 3,000.00 | 3,183.92 | 6,183.92 | |
| R. J. Keith | Chicago Co | 3,000.00 | 9,183.79 | 12,183.79 |
| New York Co | 1,297.15 | 1,297.15 | ||
| Griffith P. Ellis | Chicago Co | 5,500.02 | 3,741.54 | 9,241.56 |
| New York Co | 849.05 | 849.05 | ||
| William C. Griffith | Chicago Co | 3,150.00 | 2,449.00 | 5,599.00 |
Under the direction of the above-named officers the business of both the petitioners grew rapidly. The gross sales of the Chicago company increased from $551,347.56 in 1912 to $1,623,648.78 in 1916 and those of the New York company from $641,804.07 in 1912 to $1,693,868.72 in 1916. During this period the business of both companies was under the general supervision and direction of executives of the Victor Talking Machine Co., who gave their services without cost to the petitioners.
For the year 1918 the gross sales of the New York company were $1,507,035.53 and of the Chicago company $1,760,908.58. For 1919 the gross sales of the New York company were $1,971,682.46 and of the Chicago company $2,330,838.38. The net profits for the years 1918 and 1919 were $41,087.15 and $61,366.61 for the New York company, and $117,949.52 and $167,997.08 for the Chicago company. Both of the companies paid a dividend of 10 per cent in each of the years 1918*3310 and 1919 and added large amounts to their surplus.
Under date of January 4, 1926, the respondent mailed to the New York Talking Machine Co. a deficiency notice stating in part:
An examination of income tax returns and of books of account and records discloses an additional tax for the year 1919 amounting to $53,620.13, and an overassessment for the year 1918 amounting to $5,909.23, as shown in the attached statement and accompanying schedules.
In the attached statement reference was made to the affiliated company, the Chicago Talking Machine Co., in connection with consolidated invested capital, consolidated net income and other matters pertinent to the computation of the tax liability of an affiliated corporation, but the deficiency notice does not state or show that any tax liability on behalf of the Chicago Talking Machine Co. was ever determined for the taxable years. No copy of this deficiency letter or other notice of a deficiency in tax for the years 1918 and 1919 was ever mailed to the Chicago Talking Machine Co. From the deficiency letter of January 4, 1926, the New York Talking Machine Co. and the Chicago Talking Machine Co. have filed a joint petition with the*3311 Board.
OPINION.
SMITH: With the invested capital question contained in the second assignment of error settled by stipulation, the only remaining issue on the merits is that of the salary deductions for the years 1918 and 1919. The respondent contends that the salary deductions taken in *161 the petitioners' returns for those years and now claimed as an expense deduction are unreasonably large and represent a distribution of dividends in the guise of compensation for services rendered. It same was duly authorized by the petitioners' directors.
We do not believe that the facts which we have set out above at considerable length bear out the respondent's contention. It is true that the amounts of additional compensation paid to the officers in both the years 1918 and 1919 bear a somewhat close relationship to their stock holdings, but this fact alone does not establish that such amounts were paid as a distribution of profits rather than as compensation for services. ; *3312 . Wherever it appears that compensation has been paid by a corporation to its stockholders in the proportion of their stock holdings it is incumbent on the taxpayer satisfactorily to show that the compensation was in payment for is not questioned that the compensation in dispute was actually paid to the officers during the taxable years and that the payment of the personal services actually rendered and was reasonable in amount. . The fact that the compensation is large in amount is no bar to the deduction of the amount as an ordinary and necessary expense provided that it is paid in pursuance of an agreement to pay the compensation, is for personal services actually rendered, and constituted only reasonable compensation for such services. . In that case the Board allowed the deduction from gross income of compensation paid to Greene in 1919 of $235,138.75.
The evidence before us leaves no doubt that the amounts paid to the officers for both the years 1918 and 1919 in the form of fixed salaries and bonuses were*3313 in payment for personal services actually rendered. Each of the officers devoted all of his time to the business and apparently rendered highly efficient and valuable services. Other than the relationship of the compensation to stock holdings there is nothing in the record to indicate that any of the payments made to the officer-stockholders as compensation were in fact a return on their capital investments.
The question of the reasonableness of the salaries must be determined with reference to the volume of business, the profits made, the character of the services for which the compensation was paid and all other pertinent facts shown.
The petitioners' combined gross sales for 1918 were $3,267,944.11 and for 1919, $4,302,521.04. Their net profits were $159,036.67 for 1918 and $229,363.69 for 1919. The total administrative salaries, bonuses, commissions and salesmen's salaries and expenses amounted to $190,438.11 in 1918 and $219,473.24 in 1919, or approximately 5 *162 per cent of gross sales for each year. Considering the comparatively small amount of capital employed in the business and the fact that its earnings depended almost entirely upon the personal efforts*3314 of its officers and employees, we find no disproportion between salaries and gross business or net profits.
The evidence in the case is convincing that the officers were all men of ability and possessed qualifications for their respective duties and that they rendered services to the petitioners commensurate in value with their compensation. The evidence is specially convincing in regard to A. D. Geissler, who received considerably larger compensation than any of the other officers. A former officer of the Victor Talking Machine Co., who was treasurer of that company during the years 1918, 1919, and 1920, testified that A. D. Geissler was really the outstanding man in the jobbing business, in introducing salesmanship methods or in building up the companies' business and that he gave other jobbers objectives to obtain. "He was what we then called the wheel horse of the jobbing field. When New York did not show the results that we thought it ought to show we thought we ought to have him there and Geissler's activities were divided between New York and Chicago." It was testified that if A. D. Geissler and his associates had not been permitted to acquire the shares of stock of the*3315 Chicago and New York companies the Victor Company would have increased his compensation to somewhere between $50,000 and $100,000 per year. The testimony of officers of the Victor Talking Machine Co. is convincing that the amounts received by Geissler during the years 1918 and 1919 as compensation for personal services rendered to the two petitioners was only reasonable compensation for services rendered the companies by him. It was also testified that large salaries were paid by the Victor Talking Machine Co. to their own salesman and that total compensation to important officers and salesman was regularly in the form of salaries plus a bonus or commissions. The general manager of the Victor Talking Machine Co. for the year 1916 received as compensation for his services for that year $45,000 plus commissions of $83,858.39, making a total compensation for the year of $128,858.39. By reason of the ability of Geissler and his associates the business of the two petitioners had been built up to a point where they were taking about 20 per cent of the product of the Victor Company.
Creed and Keith were both experienced men in the business. Creed had been with the Chicago company*3316 since 1902 and Keith since 1907. They had served as comanagers of the Chicago company since 1913. In 1919 Creed was offered the position of general sales manager *163 for the Victor Company at a fixed salary of $25,000 a year and a bonus that would probably have amounted to an equal amount.
It should be noted too that during the period here under consideration there was a general increase in salaries in practically all lines of business, due in part to the stimulation of war-time trade and the decreased purchasing power of the dollar. It was not an uncommon custom for corporations during those years to pay compensation to their officers and employees upon the basis of a percentage of net earnings. According to the testimony of reliable and competent witnesses the compensation paid by the petitioners to their officers and employees compared favorably with that paid by other corporations similarly engaged and was reasonable in amount.
We are of the opinion that the amounts in controversy are within the deductions authorized by section 234(a)(1) of the Revenue Act of 1918.
In regard to the jurisdictional question raised by counsel for the petitioners at the hearing*3317 of this proceeding, it appears that the respondent on January 4, 1926, mailed a deficiency notice to the New York Talking Machine Co. in respect of its tax liability for both the years 1918 and 1919. The compensation shown therein was made upon the consolidated returns for those years filed by the New York Talking Machine Co. and the Chicago Talking Machine Co. This deficiency letter does not propose any additional assessment or state that any additional tax liability exists against the Chicago Talking Machine Co. for the taxable years. No copy of such notice or other notice of any deficiency for either of the years 1918 or 1919 was ever mailed to the Chicago Talking Machine Co. Under such circumstances the Chicago Talking Machine Co. was without right of appeal to the Board. ; . An order will issue dismissing the proceeding in so far as it relates to the Chicago Talking Machine Co.
Since there is no showing that the New York company and the Chicago company ever entered into any agreement authorizing the assessment and collection of the taxes found to be due upon*3318 their consolidated returns or consented in any way to the assessment and collection of such taxes upon any basis other than that prescribed in section 240(a) of the Revenue Act of 1918, the New York Talking Machine Co. is liable only for so much of the above-stated deficiencies for 1918 and 1919 computed in accordance with the decision herein as may be determined upon the basis of the net income properly assignable to it.
Reviewed by the Board.
Judgment will be entered under Rule 50.