
    GORDY TIRE COMPANY v. THE UNITED STATES
    [No. 172-59.
    Decided December 6, 1961]
    
      Randolph W. Thrower for plaintiff. Michael J. Egan, Jr., and Southerland, Asbill & Brennan were on the briefs.
    
      Earl L. Huntington, with whom was Assista/nt Attorney General Louis F. Oberdorfer, for defendant. James P. Garland and Philip R. Miller were on the brief.
   Whitaker, Judge,

delivered the opinion of tbe court:

The question presented in this case is, whether or not the Commissioner of Internal Revenue was justified in disallowing as a deduction the salaries paid plaintiff’s president and secretary-treasurer, and deducted by plaintiff in computing its Federal income taxes for the years 1954 and 1955, and allowing, instead, a salary for plaintiff’s president of considerably less than one-half of the salary paid, and a lesser amount than that paid for plaintiff’s secretary-treasurer.

For five of the last six years plaintiff had paid its president a salary of $18,000 per year, and, at the end of the year, a bonus of $32,000, including the year 1954, one of the tax years involved. In 1955, another year involved, it gave him a bonus of $22,000. The total paid him was $50,000, except for 1955, when it was $40,000.

The secretary-treasurer was paid a salary of $4,800 for each of the years in issue and, in addition, a bonus for 1954 of $1,000, and for 1955, of $2,000.

The Commissioner of Internal Revenue allowed a deduction of only $18,000 for plaintiff’s president, and $4,800 for the secretary-treasurer.

We concur in the action of the Commissioner of Internal Revenue with respect to the salary of plaintiff’s secretary-treasurer, but not with respect to that paid its president.

In view of all the circumstances in this particular case, we do not think the Commissioner of Internal Revenue was justified in disallowing the salary plaintiff paid its president for either of the two years 1954 and 1955.

The law allows a taxpayer to deduct a “reasonable allowance for salaries or other compensation for services actually rendered.” The Commissioner of Internal Revenue was required to allow what plaintiff had deducted unless it was clear that the salaries were unreasonable. In the ordinary business the people connected with it are in the best position of anyone to know what salary was reasonable and what was not; and the Commissioner of Internal Revenue is not justified in setting aside their judgment unless he is convinced it is without foundation.

Too often revenue agents do not credit a taxpayer with a purpose to deal justly with the government. No one likes to pay taxes and no one means to pay more than he justly owes, but we are among those who believe that the great majority of our citizens pay what they think they are due to pay. We think the American people as a whole are honest and decent. We indulge the presumption that they are. So, we indulge the presumption that the salaries paid by plaintiff were reasonable, even though the official to whom the salary was paid and his wife owned all of plaintiff’s stock.

This record reveals Mr. Gordy, plaintiff’s president, as quite a remarkable man, trusted by those who knew him; there is not one thing that reflects on his integrity. He has said that he thinks the salary paid him was fair, and he is in the best position of anyone to know what was fair. Even in the case of a wholly-owned corporation, the Commissioner of Internal Eevenue is not justified in setting aside the salaries paid unless he is convinced they are unreasonable.

The salary the Commissioner of Internal Eevenue allowed in this case is far more unreasonable than the salaries paid and deducted. He allowed $18,000 to the president of a company that over the last five years had done a business of from $3,000,000+ to $4,000,000+, and that had realized net profits before taxes, after deduction of the salaries claimed, of $230,000+, $49,000+, $37,000+, $46,000+, and $77,000 + .

After deduction of the $50,000 salary in 1954 and the $40,000 in 1955, and after taxes, this company had net earnings of $24,907 in 1954, and $40,171 in 1955. This was a return on its invested capital of 5.8% in 1954, and 8.8% in 1955. This compares favorably with the average rate of return of 125 retail tire companies in the United States, which was around 5%.

The $18,000 salary allowed plaintiff’s president was $6,000 less than the commissions earned by plaintiff’s leading salesman. And, yet, the success of the business was almost wholly due to Mr. Gordy’s foresightedness and business acumen. The excellent opinion of the trial commissioner of this court tells in succinct fashion the remarkable story of this man’s success against great odds, of the growth of this business from nothing in 1982 to a $4,000,000 business in 1955, with accumulated net earnings over these years of nearly $400,000. We quote the following from pages 8 to 10 of the trial commissioner’s opinion :

The business of the plaintiff had its beginning in 1932, when Mr. Gordy, who was then about 24 years old and without capital of his. own, leased a filling station site in Atlanta and began to operate the filling station with the assistance of one employee. A few tires were sold from this site on a retail basis. By 1941, Mr. Gordy had moved to larger quarters, had further expanded his facilities by renting nearby storage spaces, had increased his retail tire business, and had entered the wholesale tire field on an extensive scale.
In the early days of World War II, Mr. Gordy was advised by his suppliers that he should get out of the tire business, because the suppliers believed that an independent dealer would not be able to survive in view of the wartime shortage of tires. Contrary to this advice, Mr. Gordy moved again to still larger quarters, and he added tire recapping operations to his business. While others in the tire industry were cutting down, he maintained and enlarged his sales staff by hiring salesmen who were being discharged by tire manufacturers and by other tire distributors. It was not necessary to have a sales force in order to sell tires during the war, but Mr. Gordy was looking ahead. These decisions by Mr. Gordy proved to be highly advantageous in the years following the war, putting him well ahead of his competition.
The plaintiff was incorporated on June 1, 1946, with Mr. Gordy as president and directing head of the corporation.
In October 1952, the plaintiff moved from downtown Atlanta into a very large building which Mr. Gordy had constructed for the plaintiff at a location that was then within a residential area on the outskirts of Atlanta. The plaintiff’s suppliers endeavored to discourage Mr. Gordy in connection with the projected move of the plaintiff from downtown Atlanta to what was then a noncommercial area that appeared to be out in the country. However, the location was near the site of a proposed expressway that was soon to be built, and Mr. Gordy believed that it was potentially a valuable location for a business enterprise. With the building of the expressway and the subsequent development that occurred in the area of the plaintiff’s new building, that location turned out to be a very valuable one for the plaintiff’s operations, and it gave the plaintiff a decided advantage over its competitors.
Throughout the history of the plaintiff and its predecessor enterprise, with the exception of a year around 1948 or 1949, there has been a steady growth under the leadership ox Mr. Gordy. The plaintiff has gained a nationwide reputation as being a very aggressive and farsighted company and one of the leaders in the tire distribution industry. In size, the plaintiff has become one of the largest, if not the largest, among the independent tire dealers in the country.
Mr. Gordy’s management has been largely responsible for the plaintiff’s growth and for its high standing in the tire distribution field. This is a highly competitive business, in which there are many failures. In his capacity as president and directing head of the plaintiff, Mr. Gordy has been a competent, aggressive operator, and he has established a reputation as a man ox character and integrity. It is this reputation which enabled the plaintiff to obtain the credit that was necessary for its virtually constant program of expansion.

It must be said that the trial commissioner concluded, notwithstanding the foregoing, that a salary of $35,000 was in his opinion a reasonable one.

A salary of $18,000 a year for such a man is absurd. Such a finding of the Commissioner of Internal Revenue is not presumptively correct, and we must consider the matter independently of it.

Can we say that $40,000 and $50,000 are unreasonable? It would not seem to be when there was left a considerably higher return on invested capital than the average company earned, as we set out above. Every year for the last six years the plaintiff had paid Gordy a bonus of $32,000, in addition to his salary of $18,000, except in 1955, when it was $22,000, and, yet during those years the company’s accumulative earnings had increased from $114,000+ to $393,000+.

The president of the Trust Company of Georgia testified that if he were appointed receiver of this tire company, with instructions to operate it, he would be glad to get such a man as Gordy to manage it at a salary of $50,000. The Manager of Credits and Collections of the United States Rubber Company, and the Sales Manager, Gillette Tire Division of the United States Bubber Company, testified the salary paid Mr. Gordy was in line with that paid by comparable companies. These men were friendly witnesses, but we must credit their testimony unless we believe they were speaking falsely. We have no reason to think so. Cross-examination did not discredit them. Even people with an interest in the nature of their testimony are expected to tell the truth, and must 'be presumed to have done so, unless the contrary appears.

Defendant offered no contrary testimony.

We are by no means convinced the president’s salary was unreasonable. If not, the Commissioner of Internal Eeve-nue should have allowed it to stand. Certainly what he did was wholly unreasonable, and, being unreasonable, it is not presumed to be correct. Since there is no presumption in favor of the action of the Commissioner of Internal Beve-nue, or, rather, since this presumption has been clearly rebutted, we should not disturb what the taxpayer himself has done, unless we ourselves think it unreasonable. We do not think it is.

Judgment will be entered in plaintiff’s favor, with the amount to be computed under Buie 38 (c).

It is so ordered.

Daee, Senior District Judge, sitting by designation; Dtjeeee, Judge; and LaeamoRe, Judge, concur.

JoNES, OMef Judge,

dissenting:

I would approve the findings and conclusion of the trial commissioner who heard the evidence.

The law is clear. The single issue is what was a reasonable salary for the president of the company during the period in question. This is largely a factual question.

I admire and pay tribute to any American who can build a successful business in a highly competitive field. He earns and should receive substantial compensation.

But after all the plaintiff has a local business. There are tens of thousands of successful businessmen in hundreds of lines of activity in this broad, big country. That is the glory of this land and the anchor of our safety.

Here we are setting aside the judgment of the trial officer who saw the witnesses face to face, and substituting the judgment of men who, however able they may be, have not had the privilege of listening to any of the witnesses. It is exceedingly difficult for a judicial officer to look at the cold record and accurately determine the credibility of witnesses. It is far easier for one who sees the demeanor of witnesses and who studies the record with great care to correctly gauge and properly measure the facts in issue.

The majority opinion quotes certain parts of the trial commissioner’s opinion, largely those parts that are favorable to the conclusion which the majority has reached. However, when the entire opinion is read a different picture is presented.

We quote further from the trial commissioner’s opinion as follows:

In connection with the weight to be given to the opinion testimony offered by the plaintiff in the present case, it is pertinent to observe that the witnesses who gave such testimony were, in addition to Mr. Gordy, Mrs. Gordy, and the plaintiff’s auditor, officials of organizations which had long maintained, and were still maintaining, business relationships — presumably of a profitable nature — with the plaintiff. [Tr. Comm. Op. p. 4.]
It is also pertinent to inquire in this type of case whether the purported compensation to the owners of a corporation was fixed in advance or retroactively, after the financial situation of the corporation for a particular year had been determined. If the facts show that an amount purportedly representing compensation was fixed at the close of a year, when earnings could be ascertained, the retroactive action tends to characterize such an amount as a dividend rather than as compensation. [Tr. Comm. Op. p. 6.]
A further point considered by the courts is whether the purported compensation had a reasonable relationship to the corporation’s gross profit and net profit on sales. Mayson Mfg. Co. v. Commissioner, supra [178 F. 2d 115], at p. 119; Patton v. Commissioner, supra [168 F. 2d 28], at p. 31. In connection with this standard, the evidence in the record indicates that companies engaged in the tire distribution business paid their executives, on the average, approximately 9.4 percent of gross profits on sales for the years 1954 and 1955, and that such companies still made an average net profit of about 3 percent on sales. The plaintiff’s payments to its executives for the fiscal year 1954 represented 8.14 percent of the plaintiff’s gross profit on sales, and the plaintiff’s payments to its executives for the fiscal year 1955 represented 6.37 percent of the gross profit on sales, so that the plaintiff’s payments to its executives were well within one phase of the standard now under consideration. On the other hand, the plaintiff in 1954 had a net profit on sales of only 0.8 percent, and in 1955 its net profit on sales was only 1 percent. [Tr. Comm. Op. pp. 7-8.]

When the entire opinion is read and the transcript is reviewed, it becomes manifest that the salary paid to Mr. Gordy for the last 4 years, including 1954 and 1955, amounted to more than the average net income remaining during those 4 years after deducting the salaries claimed. It is also undisputed that the bonuses paid were larger than the remaining part of the salary and the only witness on the subject testified that the bonus was not arranged for in advance but was declared at the end of the year; thus it apparently partook more of the quality of a dividend than of a salary. As a dividend it, of course, would not be deductible as a business expense.

It is also apparent that all of the witnesses who testified as to the reasonableness in salary had a financial relationship or dealings with plaintiff, including the banker who had solicited and obtained his business from a competing bank, the manager of a rubber company which sold him $250,000 worth of rubber per year and others who had a business relationship with him. This does not reflect on them, but in measuring the weight of testimony the courts always take such facts into consideration.

No one in so far as we are able to glean from the record has reflected upon the integrity of Mr. Gordy. He was a successful businessman. As indicated in the majority opinion, his business had grown from practically nothing in 1932 to an accumulation of some $400,000. But this is the story of thousands of men and concerns who started near the end of the greatest depression in our history and built their organizations into successful concerns, some of them much more rapidly and extensively than the Gordy Tire Company.

There is no blame whatever attached to any income taxpayer who reduces his taxes in every practical way, but the deductions shoulcT bear some relationship to salaries in similar lines of activity and should bear some relation to the earnings of the company during the period involved. In 1954 the plaintiff company had a net profit of only 0.8 percent and in 1955 a net profit of only 1 percent. This is below the national average of people engaged in the tire business during those 2 years.

Then, too, a decision of this kind adds materially to the problems of those enforcement officers who are clothed with responsibility of setting a pattern. These problems are already difficult. For us as a court sitting in chambers to raise the finding of an experienced trial commissioner 50 percent and to almost triple the finding of the Commissioner of Internal Eevenue as to what is reasonable compensation, in the words of the operator of the old-time traction engine, is to apply enough steam pressure to “bulge the crown sheet.”

Conceding that the Commissioner of Internal Eevenue may have used too much of a general pattern; that he may not have made sufficient allowance for the unusual accomplishments of the plaintiff’s president and thus to some degree may have in a legal sense abused his discretion, we should be careful not to abuse it at the other extreme. If we are to allow $50,000 as a deduction for one officer who was head of a concern which occupies one field of commercial activity in a single city, what should be allowed as deduction for a salary to an official of business concerns that operate on a nationwide scale and especially when they cover multiple fields ?

The trial commissioner has nearly doubled the salary allowance made by the Commissioner by raising it to $35,000 per year. In the light of this record that seems adequate— even generous. But in deference to the judgment of the trial officer, who perhaps more than anyone else has studied the background of this case, I would approve his finding. But to raise that another 50 percent is, it seems to me, indefensible. The record is silent as to whether any other businessman in Atlanta received a salary of $50,000 per annum.

I would adopt the trial commissioner’s findings of fact and opinion.

FINDINGS OP PACT

Tbe court, having considered the evidence, the report of Trial Commissioner Mastin G. White, and the briefs and argument of counsel, makes findings of fact as follows:

1. (a) The plaintiff, the Gordy Tire Company, is a Georgia corporation and has its principal place of business in Atlanta, Georgia.

(b) As its name indicates, the plaintiff is a dealer in tires. It is an independent dealer, and operates on both a retail and a wholesale basis.

(c) At all times material to this litigation, the plaintiff filed its Federal income tax returns on the basis of a fiscal year that ended on October 31, and computed its taxable income on the accrual basis.

2. The business of the plaintiff had its beginning in 1932, when Herbert I. Gordy, who was then about 24 years old and without capital of his own, leased a filling station site in Atlanta, and began to operate the filling station with the assistance of one employee. A few tires were sold from this site on a retail basis. By 1941, Mr. Gordy had moved to larger quarters, had further expanded his facilities by renting nearby storage spaces, had increased his retail tire business, and had entered the wholesale tire field on an extensive scale.

3. In the early days of World War II, Mr. Gordy was advised by his suppliers that he should get out of the tire business, because the suppliers believed that an independent dealer would not be able to survive in view of the wartime shortage of tires. Contrary to this advice, Mr. Gordy moved again to still larger leased quarters, and he added tire recapping operations to his business. While others in the tire industry were cutting down, he maintained and enlarged his sales staff by hiring salesmen who were being discharged by tire manufacturers and by other tire distributors. It was not necessary to have a sales force in order to sell tires during the war, but Mr. Gordy was looking ahead. Even though greater profits could be made at retail during the war, Mr. Gordy elected to remain primarily a wholesale distributor so that he would have his organization of retail dealers intact at the end of the war. These decisions by Mr. Gordy proved to be highly advantageous in the years following the war, putting him well ahead of his competition.

4. The business referred to in findings 2 and 3 was operated by Mr. Gordy for some time prior to June 1, 1946, in the form of a partnership, the partners being Mr. Gordy and his wife, Mrs. Lilla W. Gordy.

5. The plaintiff was incorporated on June 1, 1946, as successor to the partnership mentioned in finding 4. In exchange for the partnership property, valued at $60,000, the plaintiff issued 1,200 shares of its stock to Mr. and Mrs. Gordy. The following year, $40,000 was paid into capital, and 800 additional shares of stock were issued to Mr. and Mrs. Gordy. The stock thus issued has constituted at all times the plaintiff’s entire outstanding capital stock, and it has been held by Mr. Gordy to the extent of 60 percent and by Mrs. Gordy to the extent of 40 percent.

6. The plaintiff’s original board of directors consisted of Herbert I. Gordy, Mrs. Lilla W. Gordy, and George B. Boyd; and these persons continued to serve as members of the board at all times material to this litigation.

7. At the initial meeting of the plaintiff’s board of directors held on May 31, 1946, Herbert I. Gordy was elected president of the company and Mrs. Lilla W. Gordy was elected secretary-treasurer of the company. At the same meeting, the board adopted the following resolution concerning the compensation that should be paid to Mr. Gordy and Mrs. Gordy:

Upon motion duly made and unanimously carried, it was resolved that the salary of Herbert I. Gordy, as President of the corporation, be fixed and established at Fifteen Hundred ($1,500.00) Dollars per month until further action of the directors, and that the salary of Mrs. Lilla W. Gordy, as Secretary-Treasurer of the corporation be fixed and established at Four Hundred ($400.00) Dollars per month, until further action of the directors.

8. At all times material to this litigation, Mr. Gordy has continued to serve as president and directing head of the plaintiff and Mrs. Gordy has continued to serve as secretary-treasurer of the plaintiff.

9. (a) A resolution identical with that quoted in finding 7 was adopted by the plaintiff’s board of directors at a meeting held on January 13,1947.

(b) At the meeting on January 13, 1947, the plaintiff’s board of directors also took the following action:

After discussion, upon motion duly made and carried, it was resolved that m addition to his salary, the President of the corporation should receive a bonus of 15% of the net profit before income taxes, earned by the company during its fiscal year ending October 31,1947.

(c) Pursuant to the action referred to in paragraph (b) of this finding, a bonus amounting to $4,945.63 was paid to Mr. Gordy by the plaintiff for the fiscal year 1947.

10. No further formal action with respect to the compensation of Mr. Gordy or Mrs. Gordy was taken by the plaintiff’s board of directors during the period between January 13, 1947, and the end of the fiscal year 1955.

11. In 1951, the plaintiff was notified by its lessor that the latter desired to take over the occupancy of the premises then occupied by the plaintiff. A search was thereupon undertaken for some other place to which the plaintiff might move; but by that time the plaintiff had grown to such an extent and its space needs were so great that no building could be found in downtown Atlanta which was suitable for the plaintiff’s operations. Mr. Gordy, as president of the plaintiff, decided that a building would be constructed for the plaintiff on some lots that he individually owned at a location which was then within a residential area on the outskirts of Atlanta. The plaintiff’s suppliers endeavored to discourage Mr. Gordy in connection with the projected move of the plaintiff from downtown Atlanta to what was then a noncommercial area that appeared to be out in the country. However, Mr. Gordy’s land was near the site of a proposed expressway that was soon to be built, and Mr. Gordy believed that it was potentially a valuable location for a business enterprise. Mr. Gordy went ahead with the plan and constructed a building for the plaintiff. The construction was undertaken by Mr. Gordy in his individual capacity. Later, he organized a corporation, known as the Gordy Realty Corporation, to complete the construction and hold title to the property; and he transferred the property to that corporation. Upon the completion of the building, the plaintiff moved into it in October 1952 as the lessee of the Gordy Eealty Corporation. With the building of the expressway and the subsequent development that occurred in the area of the plaintiff’s new building, that location turned out to be a very valuable one for the plaintiff’s operations, and it gave the plaintiff a decided advantage over its competitors. Soon, the new building was insufficient for the plaintiff’s space needs, and an extension was added to the building by the Gordy Eealty Corporation. Also, additional contiguous land was acquired by the Gordy Eealty Corporation for an expansion of the plaintiff’s parking lot.

12. Mr. Gordy held and owned the entire outstanding stoek of the Gordy Eealty Corporation from the date of its incorporation through the period that is involved in this litigation.

13. Throughout its history, with the exception of a year around 1948 or 1949, the plaintiff has had a steady growth under the leadership of Mr. Gordy. It has gained a nationwide reputation as being a very aggressive and farsighted company and one of the leaders in the tire distribution industry. The plaintiff was one of the first tire dealers in the United States to install electrical equipment for the retreading of tires. The plaintiff began the recapping of tires during World War II, contrary to the advice of its suppliers, and then greatly expanded its recapping operations in about 1954 or 1955, when it began the recapping of aircraft tires and of tires that are used on giant earth-moving equipment. The plaintiff is one of the few tire dealers in the United States equipped for the recapping of giant-size tires. It has the most complete recapping shop in the United States. Also, the plaintiff has long sought to maintain the most complete inventory of tires in its section of the country.

14. During the fiscal years that are involved in the present litigation, 1954 and 1955, the prospects for the plaintiff’s continued success were good; and the corporation has continued to grow and prosper since those years.

15. In recent years, tbe plaintiff has become one of the largest, if not the largest, among the independent tire dealers in the United States. Other tire dealers from different parts of the country visit the plaintiff’s place of business in order to get ideas for the improvement of their own businesses.

16. Mr. Gordy’s management has been largely responsible for the plaintiff’s growth and for its high standing in the tire distribution field. This is a highly competitive business, in which there are many failures. In his capacity as president and directing head of the plaintiff, Mr. Gordy has been a competent, aggressive operator, and he has established a reputation as a man of character and integrity. It is this reputation which enabled the plaintiff to obtain the credit that was necessary for its virtually constant program of expansion. The long-range thinking and planning, in an effort to anticipate marketing opportunities for the plaintiff, have been done by Mr. Gordy, who has constantly been on the lookout for ways and means of increasing the volume of the plaintiff’s business. Mr. Gordy has directed the purchasing policies of the plaintiff and, in this connection, he has developed and maintained contacts with suppliers throughout the United States, and these contacts have been extremely valuable to the plaintiff with respect to the making of advantageous purchases. Mr. Gordy has also directed the sales activities of the plaintiff, maintaining cordial relations with large numbers of customers and potential customers throughout the State of Georgia and in part of South Carolina, and furnishing leads to the plaintiff’s salesmen. Also, Mr. Gordy has directed the financial activities of the plaintiff.

17. For many years prior to the fall of 1952, Mrs. Gordy assisted her husband by doing typing and mailing work at home, sending out advertising material, making bank deposits, and helping with the entertainment of visiting customers and suppliers. Also, her husband consulted Mrs. Gordy on many problems that arose in the conduct and expansion of the tire business during those years. After the plaintiff moved into its new building in October 1952, Mrs. Gordy became quite active in the plaintiff’s credit department. She began to occupy a desk in the office and to keep rather regular office hours. Her customary working day began at about 9:30 a.m. and continued until about 4 p.m. Mrs. Gordy worked with, and assisted the credit manager. Her special field of activity was in connection with the collection of delinquent accounts. Mrs. Gordy’s duties in the credit department continued through the fiscal years 1954 and 1955. Also, she continued to assist her husband in the entertainment of visiting customers and suppliers, and her husband continued to consult her with respect to office problems.

18. (a) In connection with the annual audit of the plaintiff’s books around the end of each fiscal year during the period 1948-1955, the plaintiff’s board of directors informally decided that, in addition to the salary payments aggregating $18,000 that had been made to Mr. Gordy during the particular fiscal year pursuant to the resolution of January 13, 1947 (see findings 7 and 9(a)), an additional payment denominated as a bonus would be made to Mr. Gordy for the fiscal year. The amounts of the bonuses for the several fiscal years during the period previously mentioned are indicated in the following table:

Year Amount of bonus
1948_$13,292.19
1949_ 8, 628.94
1950_ 32, 000. 00
1951_ 32, 000. 00
Year — Continued. Amount of 'bonus
1952_$32,000.00
1953_ 32,000. 00
1954_ 32, 000. 00
1955_ 22, 000. 00

Each of these bonuses was entered on the plaintiff’s books as of the end of the particular fiscal year (October 31), and the amount was subsequently paid or credited to Mr. Gordy in the latter part of December, or within 2% months after the end of the fiscal year.

(b) The reduction in the amount of the annual bonus to $22,000 for the fiscal year 1955, as compared with the annual bonuses of $32,000 each which Mr. Gordy had received for the 5 preceding fiscal years, was due (1) to the desire of the plaintiff’s board of directors to improve the financial picture of the corporation for the fiscal year 1955, and (2) to the fact that Mr. Gordy had realized a substantial gain in 1955 from the sale of privately owned timber (see finding 26).

19. In connection with the annual audit of the plaintiff’s boobs around the end of each of the fiscal years 1954 and 1955, the plaintiff’s board of directors informally decided that, in addition to the salary payments aggregating $4,800 that had been made to Mrs. Gordy during the particular fiscal year pursuant to the resolution of January 13,1947 (see findings 7 and 9(a)), an additional payment denominated as a bonus would be made to Mrs. Gordy for the fiscal year. The amounts of the bonuses were fixed as $1,000 and $2,000 for the respective fiscal years 1954 and 1955'. Each of these bonuses was entered on the plaintiff’s books as of the end of the particular fiscal year (October 31), and the amount was subsequently paid or credited to Mrs. Gordy in the latter part of December, or within 2y2 months after the end of the fiscal year.

20. (a) For the fiscal year 1954 (one of the two years involved in the present litigation), the plaintiff paid to Mr. Gordy a total of $50,000. Of this total amount, $18,000 was paid to him in monthly payments of $1,500 each pursuant to the resolution of January 13,1947. These monthly payments were treated as salary on the plaintiff’s books and records, and Federal income taxes were withheld by the plaintiff on such amounts. The remainder of $32,000 was treated on the plaintiff’s books and records as a bonus (see finding 18(a)).

(b) For the fiscal year 1954, the plaintiff paid to Mrs. Lilla W. Gordy a total of $5,800. Of this total amount, $4,800 was paid to her in monthly payments of $400 each pursuant to the resolution of January 13, 1947. These monthly payments were treated as salary on the plaintiff’s books and records, and Federal income taxes were withheld by the plaintiff on such amounts. The remainder of $1,000 was treated on the plaintiff’s books and records as a bonus (see finding 19).

21. (a) For the fiscal year 1955 (the other year involved in the present litigation), the plaintiff paid to Herbert I. Gordy a total of $40,000. Of this total amount, $18,000 was paid to him in monthly payments of $1,500 each pursuant to the resolution of January 13, 1947. These monthly payments were treated as salary on the plaintiff’s books and records, and Federal income taxes were withheld by the plaintiff on such amounts. The remainder of $22,000 was treated on the plaintiff’s books and records as a bonus.

(b) For the fiscal year 1955, the plaintiff paid to Mrs Lilla W. Gordy a total of $6,800. Of this total amount, $4,800 was paid to her in monthly payments of $400 each pursuant to the resolution of January 13, 1947. These monthly payments were treated as salary on the plaintiff’s books and records, and Federal income taxes were withheld by the plaintiff on such amounts. The remainder of $2,000 was treated on the plaintiff’s books and records as a bonus.

22. (a) The plaintiff filed timely Federal income tax returns for the fiscal years 1954 and 1955.

(b) On the return for 1954, the plaintiff reported a net income of $46,967.99 and a tax liability of $18,803.64. The plaintiff claimed as deductions for 1954 the amounts of $50,000 paid to Mr. Gordy purportedly as compensation and $5,800 paid to Mrs. Gordy purportedly as compensation.

(c) On the return for 1955, the plaintiff reported a net income of $77,788.44 and a tax liability of $34,231.36. The plaintiff claimed as deductions for 1955 the amomits of $40,000 paid to Mr. Gordy purportedly as compensation and $6,800 paid to Mrs. Gordy purportedly as compensation.

23. Upon an examination of the plaintiff’s income tax returns for the fiscal years 1954 and 1955, the Commissioner of Internal Revenue disallowed as deductions all amounts paid to Mr. Gordy in excess of $18,000 per year and all amounts paid to Mrs. Gordy in excess of $4,800 per year. This action by the Commissioner was based upon two grounds: (1) that the disallowed amounts did not constitute “a reasonable allowance for salaries or other compensation for personal services actually rendered,” within the meaning of that phrase as used in Section 23(a)(1)(A) of the Internal Revenue Code of 1939, as amended by Section 121(a) of the Revenue Act of 1942 (56 Stat. 798, 819), and as used in Section 162(a) (1) of the Internal Revenue Code of 1954 (68A Stat. 45); and (2) that such disallowed amounts were not “paid or incurred during the taxable year” involved in the respective disallowances, within the meaning of that phrase as used in the statutory provisions previously cited.

24. Because of the disallowances referred to in finding 23, the Commissioner of Internal Revenue assessed income tax deficiencies and interest against the plaintiff for the fiscal years 1954 and 1955, as indicated in the following table:

25. The plaintiff paid the deficiencies and interest mentioned in finding 24, filed with the Internal Revenue Service a timely claim for refund, which was rejected, and filed this suit within the time prescribed by law.

26. During 1954 and 1955, Mr. Gordy, in addition to serving as president of the plaintiff, was also president of the Gordy Realty Corporation; he owned and operated a sizable farm (which produced a gross income of more than $22,000 in 1954 and more than $26,000 in 1955); and he supervised sales of timber from timberland which he owned (realizing from such timber sales a gross income of $5,518.22 in 1954 and ‘$42,383 in 1955). These activities, however, required a relatively small portion of Mr. Gordy’s time, in comparison with the amount of time that he devoted to the plaintiff’s operations.

27. The plaintiff employed George R. Boyd (see finding 6) during the fiscal years 1954 and 1955. With the title of general manager, Mr. Boyd acted as Mr. Gordy’s assistant when Mr. Gordy was present and was in charge of the plaintiff’s operations whenever Mr. Gordy was absent. For the fiscal year 1954, the plaintiff paid Mr. Boyd $5,200 as salary and a bonus in the amount of $5,500, or total compensation amounting to $10,700. For the fiscal year 1955, the plaintiff paid Mr. Boyd $6,000 as salary and a bonus in the amount of $6,000, or total compensation amounting to $12,000.

28. During the fiscal years 1954 and 1955, the plaintiff retained the Wolff Management Engineering Company to provide management assistance to Mr. Gordy. This company made up cash projections and sales projections a year in advance, and revised such data from time to time. It also worked up for each department of the plaintiff comparative data relative to the expenses for the current year, as compared with expenses for the preceding year. Personnel from the Wolff Management Engineering Company spent, on the average, about 2 days per month with the plaintiff. The cost of these services to the plaintiff amounted to $16,087.24 for the fiscal year 1954 and $15,146.14 for the fiscal year 1955.

29. The plaintiff employed a full-time credit manager during the fiscal years 1954 and 1955 at a salary of approximately $6,500 per annum.

30. The plaintiff pays its salesmen on a commission basis. The earnings of the plaintiff’s salesmen during the period that is involved in the present litigation ranged from about $600 per month to about $2,000 per month.

31. The following table shows the plaintiff’s volume of sales, gross profit, net profit before taxes, and Federal taxes during the period 1946-1955:

32.The following table is a comparative analysis of the plaintiff’s capital stock, net earnings, dividends, retained earnings, and total invested capital at the end of each fiscal year during the period 1946-1955:

33. (a) The plaintiff had profits which, after taxes, provided a return on invested capital of 5.8 percent in 1954 and 8.8 percent in 1955. This highly respectable return on invested capital was made in spite of the fact that these years came shortly after the unsettling move to new quarters away from downtown Atlanta against the advice of suppliers and in spite of the fact that, during these two years, the company was incurring unusual expenses in entering into new ventures.

(b) None of the plaintiff’s return on invested capital was paid out in the form of dividends during 1954 or 1955, or at any other time.

34. The following table shows a comparative analysis of the bonuses paid to Mr. Gordy prior to 1954 and paid to Mr. and Mrs. Gordy during 1954 and 1955, the tax liability as a result of having paid those amounts as bonuses rather than as dividends, the tax liability that would result if those amounts were treated as dividends, and the difference between the two tax treatments:

35.(a) Each year, the United States Rubber Company makes a special study of the operations of its 125 major tire dealers and, based thereon, it obtains certain averages representing the group experience, which it uses for its guidance and the guidance of its dealers in their operations and financial planning.

(b) The studies made by the United States Rubber Company for the years 1954 and 1955 indicated that the 125 companies, on the average, paid their executives approximately 9.4 percent of gross profits on sales. For the fiscal year 1954, tbe compensation paid to the plaintiff’s executives was 8.14 percent of the gross profit on sales, and for 1955 it was 6.87 percent of the gross profit on sales.

(c) The studies made by the United States Kubber Company for 1954 and 1955 indicated that the 125 companies had an average net profit of about 3 percent on sales after taxes. The plaintiff had a net profit of .8 percent and 1 percent on sales after taxes for the respective fiscal years 1954 and 1955.

(d) The average rate of return on investment among the 125 companies in 1954 and 1955 was around 5 percent. The plaintiff’s return on invested capital in 1954 was 5.8 percent, and in 1955 it was 8.8 percent. However, none of the plaintiff’s return on invested capital was paid out in the form of dividends in 1954 or in 1955 or at any other time.

36. For the fiscal years 1954 and 1955, Mr. Gordy received compensation from the Gordy Kealty Corporation in the amount of $600 per year, and Mrs. Gordy received compensation from that corporation in the amount of $300 per year.

37. Several persons of standing in the business world, who were familiar with the plaintiff’s history and with Mr. Gordy’s contribution to the plaintiff’s progress through the years, testified for the plaintiff that, in their opinion, the payments in the total amounts of $50,000 and $40,000 which the plaintiff made to Mr. Gordy for the fiscal years 1954 and 1955, respectively, constituted reasonable compensation for Mr. Gordy’s services to the plaintiff during those years. With one exception, these witnesses were officials of organizations that had long maintained, and were still maintaining, business relationships — presumably of a profitable nature— with the plaintiff. The exception was a certified public accountant who had been employed for many years to make periodic audits of the plaintiff’s books and records.

38. Mrs. Gordy, Mr. Gordy, and the certified public accountant mentioned in finding 37 testified for the plaintiff that, in their opinion, the amounts aggregating $5,800 and $6,800 which the plaintiff paid to Mrs. Gordy for the fiscal years 1954 and 1955, respectively, constituted reasonable compensation for Mrs. Gordy’s services to the plaintiff during those years.

39. The defendant did not introduce any oral testimony on the reasonableness of the compensation for Mr. Gordy or Mrs. Gordy during the fiscal years 1954 and 1955.

4Qr The payments whieh- the plaintiff made te -Herbert L Gordy her the fiscal years 49h4 and 405h up te a total ef $35;QQ9 poe annum; and tibe payments which the -plaintiff made te Mrs? Lilla- W* Gordy fer the fiseal years 49M and: -1-955 up te a total ef $4^00 per annum; constituted reasonable a-l-lowaneos fer salaries er ether eompensatien fer personal services ae-tually- rendered and were paid er ineurrod d-ur-i-n-g the respective taxable -years.- However; the -plaintiff has faded te sustain Its burden ef establishing by elear and eentineing preef that the payments -which it made fer the fiseal years 4054 and 4955 te Herbert L Gerdy in e-seess ef $85;099 -per annum and te Mrsr tidla Wr Gerdy in esecss ef $4^800 per annum eenstituted reasonable aHewanees fer salaries er ether eompensatien fer persenal services aetually •nO-n d 3TülXvCV3TT5tC*

40. The payments which the plaintiff made to Herbert I. Gordy of $50,000 for the fiscal year 1954 and of $40,000 for the fiscal year 1955, and the payments which the plaintiff made to Mrs. Lilla W. Gordy for the fiscal years 1954 and 1955 up to a total of $4,800 per annum, constituted reasonable allowances for salaries or other compensation for personal services actually rendered and were paid or incurred during the respective taxable years.

CONCLUSION OP LAW

Upon the foregoing findings of fact, which are made a part of the judgment herein, the court concludes as a matter of law that the plaintiff is entitled to recover, together with interest as provided by law, and judgment will be entered to that effect. The amount of recovery will be determined pursuant to Kule 38(c) of this court.

In accordance with the opinion of the court and on a memorandum report of the commissioner as to the amount due thereunder, it was ordered on February 16,1962, that judgment for plaintiff be entered for $32,888.04, together with interest as provided by law, such interest to be computed from May 2, 1958. 
      
       The term, “the plaintiff,” is used here in a broad sense to include both the corporation and the enterprise that preceded the corporation.
     
      
       The internal Revenue Code of 1954 was enacted on August 16, 1954, to replace the Internal Revenue Code of 1939, as amended. This change occurred during the 1954-1955 period that is’ involved in the present litigation.
     
      
      The court, on Its own motion pursuant to Kule 54(a) of the rules of the court to correct the findings of fact entered herein, entered an order on December 12, 1961, correcting finding number 40. The text as it appears here reflects the amendment.
     