Plaintiff sues for the refund of additional taxes assessed against it as the result of the disallowance of part of the compensation paid its manager in the year 1941.
Plaintiff is a brokerage company engaged in the sale of machine tool's. During the time in question it represented exclusively a number of manufacturers of machine tools within the territory embracing all of the States of Missouri, Oklahoma and Kansas, the southern half of Illinois, eastern Nebraska, and, for certain tools, the State of Colorado. Robert R. Stephens was the president and sole stockholder of plaintiff. He and one other sales engineer were the only two employees, other than clerical help.
In 1924 he was appointed a captain in the Reserve Corps of the Ordinance Department of the United States Army. On February 1, 1941, he was called into active duty and assigned to the Cleveland Ordinance District. This occupied his entire time and made it impossible for him to devote any substantial time to plaintiff’s business. It was, therefore, necessary for him to secure a man to manage the business during his absence. He asked his brother T. C. Stephens to do so.
T. C. Stephens had been employed by plaintiff for a little over two years as a sales engineer. From this employment T. C. Stephens in the previous year (1940) had realized a total compensation of $14,400, ' but when he was selected to take charge of the business, he asked for a fixed' compensation of from $40,000 to $50,000 a year. Robert R. Stephen's was unwilling to pay him so large a fixed salary, but preferred, instead, to pay a small fixed salary plus a percentage of the profits of the business. He proposed to his brother that he accept a salary of about $8,000, plus a bonus of one-half of the net profits of the business before deduction of taxes. Robert R. Stephens believed, and so. represented to his brother, that the volume of business during the year 1941 would probably be double that of 1940. If so, he said to his brother that he would realize a total compensation of between $40,000 to$50,000 a year.
This proposal was agreed to. ,
The profits for 1941, however, far exceeded anything either one of the brothers had expected. Instead of the volume of sales doubling in the year 1941, they were • four or five times what they were in 1940. It resulted that T. C.’ Stephens under his contract received a bonus of $169,031.42, which, together with his fixed salary,- made the total compensation received by him $176,984.99.
Plaintiff in its tax return claimed a deduction of the 'full compensation paid T. C. Stephens. The Revenue Agent who examined the return disallowed $141,984.99 of the amount, on the ground that the salary paid T. C. Stephens was unreasonable to that extent. ' The Commissioner of Inter*1016nal Revenue disallowed $61,984.99 of the amount. This also was on the ground that to this extent the compensation paid was unreasonable. Resulting taxes were assessed and paid. Plaintiff then filed claim for refund, which was disallowed, and it then brought this suit.
We are of opinion that the Commissioner of Internal Revenue was in error in disallowing -any part of the compensation paid T. C. Stephens.
In the year 1940 Robert R. Stephens had received a compensation of $30,000 for managing plaintiff’s business. When T. C. Stephens was asked to take over the management he asked for a salary of from $40,000 to $50,000, somewhat of an increase, but justified, he said, since it was anticipated the volume of business would double in the ensuing year, entailing additional work and responsibility. This was not an unreasonable demand. This demand was not assented to, but the compensation agreed upon, it was estimated, would amount to about this amount, if the volume of business doubled, as was expected. It was not unreasonable to expect that the business would double, but no one had any reason to expect a much larger increase. The business of machine tool manufacturers generally increased in 1941 about 75 percent over 1940. Plaintiff had no reason to expect that its own business in 1941 would be four or five times its 1940 business.
The test of the reasonableness of a salary agreed upon is the situation existing at the time the agreement is entered into; it is not to be determined by subsequent events not foreseen by the contracting parties. This is explicitly recognized by the Treasury Regulations. Section 19.23 (a)-6 of Regulations 103 says in part: “The circumstances to be taken into consideration are those existing at the date when the contract for services was made, not those existing at the date when the contract is questioned.”
At the time this salary arrangement was agreed upon it appeared to be a reasonable one. As it turned out, the amount paid was much larger than had been anticipated. Things happened in the year 1941 that neither of the brothers expected. The Western Cartridge Company Small Arms Plant was established in plaintiff’s territory, and also the Remington Arms Plant, and large war contracts were entered into by the Emerson Electric Company and the McQuay-Norris Company, neither of which had previously engaged in this line of business. While Robert R. Stephens and T. C. Stephens did expect a large increase in the volume of business, they had no good reason to believe that there would be such a tremendous increase.
• The Regulations cited above further say: “ * * * Generally speaking, if contingent compensation is paid pursuant to a free bargain between the employer and the individual made before the services are rendered, not influenced by any consideration on the part of the employer other than that of securing on fair and advantageous terms the services of the individual, it should be allowed as a deduction even though in the actual working out of the contract it may prove to be greater than the amount which would ordinarily be paid.”
There can be no doubt that this contract was entered into between plaintiff and T. C. Stephens “pursuant to a free bargain between” them. Robert R. Stephens owned all the stock in the plaintiff; T. C. Stephens owned none, except one share to qualify him as a director. This was not a distribution of the profits of the business in the guise of salary. Nor was Robert R. Stephens making a gift to his brother of the profits of his business. This is evidenced by the fact that when it developed that T. C. Stephens was realizing an unexpectedly large amount under the contract, his brother insisted upon a reduction of the amount to be paid in subsequent years. The amount agreed upon was the amount which T. C. Stephens originally requested.
Plaintiff had to pay, and did pay T. C. Stephens the amount of the salary agreed upon for 1941, and it is unjust for it to be required to pay taxes as if this compensation had not been paid. T. C. Stephens paid taxes, in the amount of $105,693.74, *1017on the salary received by him. The Government should not demand from him taxes on what he received, and then charge the corporation with taxes as if it had not paid him what he actually received. The taxes paid by T. C. Stephens amounted to $105,-693.74. The Government demanded and got $42,273.88 as if T. C. Stephens had received only a part of his salary, although he paid taxes on all of it.
The conclusion we have reached is in line with our former opinion in William S. Gray & Co. v. United States, 35 F.2d 968, 68 Ct.Cl., 480; and with the opinion of the Fifth Circuit Court of Appeals in Austin v. United States, 28 F.2d 677, and with a number of decisions of the Tax Court. We do hot think it runs counter to the Supreme Court’s opinion in Botany Worsted Mills v. United States, 278 U.S. 282, 49 S.Ct. 129, 73 L.Ed. 379, and the other cases cited by defendant. An essential difference between this case and those cited by defendant is that in them the recipient of the salary owned a substantial amount of stock in the company, whereas here he owned none.
Judgment will be entered in plaintiff’s favor against the defendant for $42,273.-88, plus interest as allowed by law.
HOWELL, MADDEN, and LITTLE-TON, Judges, concur.