Opinion
Docket No. 10876.
1947-07-31
AMERICAN PAPER SPECIALTY MANUFACTURING COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Harry Friedman, Esq., and Michael D. Bachrach, C.P.A., for the petitioner. A. W. Dickinson, Esq., for the respondent.
Bonus paid during base period by petitioner to its vice-president, Held to be a consequence of increase in petitioner's gross income in base period, and hence not an abnormal deduction under Internal Revenue Code, section 711(b)(1)(J) and (K). Harry Friedman, Esq., and Michael D. Bachrach, C.P.A., for the petitioner. A. W. Dickinson, Esq., for the respondent.
This proceeding involves deficiencies in excess profits tax for the fiscal years ended February 28, 1942 and 1943, in the respective amounts of $1,244.93 and $2,303.51.
Petitioner assigns as error respondent's refusal to allow as ad addition to petitioner's base period net income for the year ended February 28, 1940, for purposes of determining its excess profits credit, the amount of $4,353.13, claimed to represent an abnormal deduction for compensation to its vice president and plant superintendent, under Internal Revenue Code, section 711(b)(1)(J)(ii).
FINDINGS OF FACT.
Some of the facts have been stipulated, and as stipulated are hereby found.
Petitioner, a Pennsylvania corporation, organized in 1934 for the purpose of the manufacture and sale of paper dishes, filed its returns for the fiscal years involved with the collector for the twenty-third district of Pennsylvania, and computed its excess profits credit based upon income.
Its three officers and stockholders during the fiscal year 1940 were Reuben Balter, president; Joseph Silberstein, secretary-treasurer; and Hugh Griffiths, vice president and plant superintendent. Only Griffiths received a salary or other compensation.
Although Griffiths was at first reluctant to accept employment with petitioner, he did so because of an oral promise by Silberstein that ‘he would be taken care of.‘ In view of this promise, Silberstein endeavored, on several occasions, to secure a bonus for him, but petitioner's president deferred payment.
On February 24, 1940, a special meeting of petitioner's board was held for the purpose of considering ‘the compensation of * * * Griffiths.‘ In the minutes, it was further recorded that:
* * * When Mr. Griffiths was first engaged, it was with the understanding that if the company would earn any substantial profits, suitable adjustment would be made in his salary. Preliminary figures for the present fiscal year indicates (sic) a very satisfactory result, and Mr. Griffiths has suggested that the matter of proper adjustment be given consideration. It was regularly moved and seconded that as a special reward for faithful services covering the years since the company was organized that a bonus of $5,000.00 be voted to Hugh Griffiths, and that said amount be credited to him on the books of the company, to be withdrawn, only as the cash position of the company permits.
It is this bonus payment which forms the background of the present controversy, petitioner claiming the deduction to be abnormal, and respondent refusing to disallow it, reciting as reasons therefor:
The net increase to excess profits net income resulting from the elimination of alleged abnormal deductions for salaries * * * has been disallowed.
It is determined that the increase in compensation by you in the form of wages, salary and bonus in the fiscal year ended February 29, 1940, is a consequence of an increase in your gross income in the base period within the contemplation of Section 711(b)(1)(K)(ii) and, therefore, the amount of such deduction which is in excess of 125 per centum of the average amount of the deductions of such class for the four previous taxable years is not a proper disallowance in computing your excess profits net income under section 711(b) of the Internal Revenue Code.
Accordingly, your application for relief under Section 711(b)(1)(J) and (K) of the Internal Revenue Code is disallowed.
The sales, gross income, and net income of petitioner for the fiscal years ended February 28, 1935, through February 28, 1943, were as follows:
+-----------------------------------------------------------------+ ¦Fiscal year ended February 28—¦Sales ¦Gross income¦Net income¦ +------------------------------+----------+------------+----------¦ ¦ ¦ ¦ ¦ ¦ +------------------------------+----------+------------+----------¦ ¦1935 ¦$93,149.86¦$26,210.42 ¦$4,260.28 ¦ +------------------------------+----------+------------+----------¦ ¦1936 ¦101,868.24¦27,929.83 ¦3,949.22 ¦ +------------------------------+----------+------------+----------¦ ¦1937 ¦88,317.05 ¦23,281.95 ¦1,778.70 ¦ +------------------------------+----------+------------+----------¦ ¦1938 ¦63,692.22 ¦15,255.66 ¦614.27 ¦ +------------------------------+----------+------------+----------¦ ¦1939 ¦95,577.02 ¦22,792.93 ¦3,093.07 ¦ +------------------------------+----------+------------+----------¦ ¦1940 ¦120,853.73¦35,526.78 ¦6,292.26 ¦ +------------------------------+----------+------------+----------¦ ¦1941 ¦114,429.23¦34,712.61 ¦9,666.31 ¦ +------------------------------+----------+------------+----------¦ ¦1942 ¦154,073.19¦60,736.38 ¦34,364.54 ¦ +------------------------------+----------+------------+----------¦ ¦1943 ¦129,027.22¦40,028.50 ¦14,932.76 ¦ +------------------------------+----------+------------+----------¦ ¦ ¦ ¦ ¦ ¦ +-----------------------------------------------------------------+
The amounts paid Griffiths as compensation for the fiscal years 1935 through 1943 and claimed by petitioner and allowed as deductions in the tax returns for the respective years were as follows:
+------------------------------------------------+ ¦Fiscal year ended Feb 28—¦Salary¦Bonus ¦Total ¦ +-------------------------+------+--------+------¦ ¦ ¦ ¦ ¦ ¦ +-------------------------+------+--------+------¦ ¦1935 ¦$2,550¦ ¦$2,550¦ +-------------------------+------+--------+------¦ ¦1936 ¦2,600 ¦ ¦2,600 ¦ +-------------------------+------+--------+------¦ ¦1937 ¦2,600 ¦ ¦2,600 ¦ +-------------------------+------+--------+------¦ ¦1938 ¦2,600 ¦ ¦2,600 ¦ +-------------------------+------+--------+------¦ ¦1939 ¦2,600 ¦$150.00 ¦2,750 ¦ +-------------------------+------+--------+------¦ ¦1940 ¦2,650 ¦5,000.00¦7,650 ¦ +-------------------------+------+--------+------¦ ¦1941 ¦2,600 ¦200.00 ¦2,800 ¦ +-------------------------+------+--------+------¦ ¦1942 ¦2,600 ¦200.00 ¦2,800 ¦ +-------------------------+------+--------+------¦ ¦1943 ¦2,600 ¦300.00 ¦2,900 ¦ +-------------------------+------+--------+------¦ ¦ ¦ ¦ ¦ ¦ +------------------------------------------------+
Griffith's duties consisted of plant supervision, production scheduling, hiring of employees, and policy formulation.
The wages paid by petitioner to employees, other than officers, were as follows:
+----------------------+ ¦Fiscal year ¦ ¦ +------------+---------¦ ¦ended ¦ ¦ +------------+---------¦ ¦Feb. 28— ¦Wages ¦ +------------+---------¦ ¦ ¦ ¦ +------------+---------¦ ¦1936 ¦$8,548.17¦ +------------+---------¦ ¦1937 ¦8,183.04 ¦ +------------+---------¦ ¦1938 ¦3,942.68 ¦ +------------+---------¦ ¦1939 ¦3,382.11 ¦ +------------+---------¦ ¦1940 ¦5,894.39 ¦ +----------------------+
The deduction in controversy was a consequence of an increase in petitioner's gross income in its base period.
OPINION.
OPPER, Judge:
The bonus paid in the last year of the base period to one of petitioner's officers can not be disallowed as an abnormal deduction under section 711(b)(1)(J) unless petitioner ‘establishes‘ that the ‘abnormality‘ did not result from an ‘increase in the gross income of the taxpayer in its base period.‘ Section 711(b)(1)(K)(ii). There was an increase in petitioner's income ‘in‘ the base period, in that in the year in question, which was in the base period, gross income was some $35,000, compared with a maximum of $28,000 for any previous year, $23,000 for the prior year, and an average of about the same figure for all five of the earlier years shown by the record. See William Leveen Corporation, 3 T.C. 593. Net income, presumably at least partly on this account, was even greater proportionally than for any other year.
We think the record shows that it was this increase in income which caused the directors to vote the unprecedented bonus to the officer in question. The minutes recite that the ‘purpose of the meeting‘ was to consider the compensation of ‘the superintendent.‘ They then point out that, under the original arrangement made with him, ‘if the company would earn any substantial profits,‘ an adjustment would be made. ‘preliminary figures for the present fiscal year,‘ presumably then available to the directors, are characterized in the minutes as ‘very satisfactory.‘ Nevertheless, the bonus awarded at that time was ‘to be withdrawn, however, only as the cash position of the company permits.‘
It is difficult to believe that the statements noted would have appeared in the minutes at all had they been considered entirely irrelevant. That an inference may be drawn of some connection in the minds of the directors between unsatisfactory earnings in the past, the contrasting results of the current year, and payment of the increased compensation seems to us thus hardly debatable. If the payment was not to some extent the consequence of these circumstances, it has at least not been explained why the statements were made at all, and hence petitioner has not ‘established‘ that there was no such causal connection. We think the deficiency was properly determined, without finding it necessary to examine respondent's additional contention.
Decision will be entered under Rule 50.