
    389 F.2d 802
    GRIFFIN & COMPANY, INC. v. THE UNITED STATES GRIFFIN INDUSTRIES, INC. v. THE UNITED STATES
    No. 130-64
    No. 131-64
    [Decided January 19, 1968]
    
      
      Herbert L. Awe, attorney of record, for plaintiffs.
    
      Edward B. Greemf elder, Jr., with whom was Assistant Attorney General Mitchell Rogovin, for defendant. Philip R. Miller, of counsel.
    
      Before CoweN, Chief Judge, Laramore, Dureee, Davis, SkeltoN, and Nichols, Judges.
    
   Per Curiam:

This case was referred to Trial Commissioner Mastin G. White with directions to make findings of fact and recommendation for conclusions of law under the order of reference and Rule 57(a). The commissioner has done so in an opinion and report filed on December 28,1966. Plaintiffs accept the commissioner’s opinion and findings with respect to “Conduct of Business”, “Automobile Expense”, “Repairs or Improvements”, and “Partial Reserves”, and take exception only with respect to the “compensation issue”. The parties have filed briefs and the case has been argued orally. Since the court is in agreement with the opinion and recommendation of the commissioner, with minor modifications, it hereby adopts the same as modified as the basis for its judgment in this case as hereinafter set forth. Therefore, plaintiffs are entitled to recover portions of the amounts sued for, together with interest as provided by law, and judgment is entered to that effect with the amounts of the recoveries to be determined pursuant to Rule 47(c).

Commissioner White’s opinion, as modified by the court with respect to the “compensation issue”, is as follows:

The plaintiffs, Griffin & Company, Inc., and Griffin Industries, Inc., seek to recover refunds of income taxes which the Internal Revenue Service collected from the respective plaintiffs pursuant to deficiency assessments for the fiscal years 1959, 1960, and 1961 in case No. 130-64, and for the fiscal years 1960 and 1961 in case No. 131-64.

Since the two cases involve common questions of law and fact, they were consolidated for trial purposes under Rule 47(a).

The “Conduct of Business” Issue

Upon audit of the 1960 and 1961 income tax returns of Griffin & Company, Inc., and Griffin Industries, Inc., the Internal Revenue Service (among other things) disallowed net operating loss deductions claimed by Griffin Industries, Inc., in the respective amounts of $11,563.49 for 1960 and $7,938.97 for 1961, disallowed the $25,000 surtax exemption claimed by Griffin Industries, Inc., for each of the years 1960 and 1961, and allocated to Griffin & Company, Inc., income in the respective amounts of $8,672.62 for 1960 and $44,461.07 for 1961 which had been reported by Griffin Industries, Inc., for those years.

The primary basis for the actions of the Internal Kevenue Service referred to in the preceding paragraph was a determination by the administrative agency that Griffin Industries, Inc., was not engaged in the conduct of business as a separate entity during 1960 and 1961, and that it was actually the business activities of Griffin & Company, Inc., which not only earned the income reported on that company’s income tax returns for 1960 and 1961, but also earned the income which Griffin Industries, Inc., reported on its income tax returns for those years. The correctness of this administrative determination will be considered in the present portion of the opinion.

Griffin & Company, Inc., and Griffin Industries, Inc., are two Kentucky corporations, with the same principal place of business, 500 Bergman Avenue, Louisville, Kentucky. (For the sake of convenience, Griffin & Company, Inc., will usually be referred to hereafter in the opinion as “G&C,” and Griffin Industries, Inc., will usually be referred to as “GI.”)

G&C was founded in 1941 by William J. Griffin, who was its chief executive officer and controlling stockholder at all times relevant to this litigation. From the time of its formation, G&C was what is known in the trade as a mechanical contractor. As such, it specialized in producing, and then installing outside its plant at customers’ job sites, sheet metal work and related component parts in connection with heating, ventilating, air-conditioning, dust-collecting, and pneumatic conveying systems. G&C sometimes purchased components manufactured' by other companies, and utilized them in equipment which G&C had contracted to install for its customers.

Prior to April 1960, G&C, in addition to carrying on the work of a mechanical contractor, also manufactured and sold some sheet metal items that were delivered to customers F.O.B. its plant, and were not installed by G&C outside the plant in its role as a mechanical contractor. These items consisted principally of equipment for the processing of tobacco.

G&C maintained a well-equipped plant in Louisville. It had a staff of clerical employees, a staff of professional engineering employees, a labor force of sheet metal workers, a plant superintendent to supervise the sheet metal workers engaged in the fabrication or manufacture of equipment within the plant, and a construction superintendent to supervise the sheet metal workers engaged in the installation of equipment outside the plant at customers’ job sites.

The officers of G&C during the years involved in the present litigation consisted of William J. Griffin, president, Arnold Van Etten, vice president, and William E. Griffin, secretary-treasurer. William E. Griffin was the son of William J. Griffin. Arnold Van Etten was unrelated to the Griffins. William J. Griffin was the controlling stockholder of G&C, but Arnold Van Etten and William E. Griffin were also stockholders in G&C. These three men constituted a majority of the board of directors of G&C.

GI was the successor corporation of Newcomb-Griffin Company, which was formed on October 28, 1955 as a joint venture by Newcomb-Detroit Company and G&C. Newcomb-Detroit Company was located in Detroit, Michigan. It was a manufacturer and supplier of spray booths, ovens, and other miscellaneous products for finishing systems. Prior to 1955, Newcomb-Detroit Company and G&C had worked together on various projects, with Newcomb-Detroit Company supplying some of the equipment installed by G&C in its role as a mechanical contractor. The two companies agreed in 1955 to pool their know-how and abilities through the formation, as a joint venture, of a new corporation which would carry on business operations primarily in the Louisville area.

The result of the agreement mentioned in the preceding paragraph was the incorporation in October 1955 of New-comb-Griffin Company, with 2,500 shares of stock. New-comb-Detroit Company and G&C each contributed $12,500 as capital for the new corporation, and received in exchange all the stock of Newcomb-Griffin Company. Newcomb-Detroit Company received 1,251 shares of the stock, and G&C received 1,249 shares.

Newcomb-Griffin Company was an industrial supplier. It was formed to manufacture industrial ovens, spray booths, flow-coaters, and industrial washing machines.

In August 1957, DeVilbiss Company acquired all the stock of Newcomb-Detroit Company. It was against the policy of DeVilbiss Company to engage in joint ventures with outsiders. Accordingly, Newcomb-Griffin Company, which had been organized as a joint venture by Newcomb-Detroit Company and G&C, discontinued operations after August 1957, except that it finished up some work which was already in progress and it attempted to collect outstanding accounts.

After rather extended negotiations between G&C and DeVilbiss Company, G&C acquired complete control of New-comb-Griffin Company on October 23,1959. This was accomplished by Newcomb-Griffin Company paying to DeVilbiss Company $2,831.01 in redemption of the 1,251 shares of stock in Newcomb-Griffin Company theretofore owned by New-comb-Detroit Company and its successor, DeVilbiss Company. As previously indicated, G&C owned all of the remaining 1,249 shares of stock in Newcomb-Griffin Company then outstanding.

On January 8, 1960, the name of Newcomb-Griffin Company was changed to Griffin Industries, Inc. At the time, this corporation was dormant, and was not engaged in any sort of business activity. It did not have any plant or equipment, and it did not have any employees or labor force. The corporation’s only personnel consisted of its officers, William J. Griffin, president, Arnold Van Etten, vice president, and William K. Griffin, secretary-treasurer (i.e., the same officers as G&C); and its only asset consisted of a relatively modest bank account that was left over from the operations of New-comb-Griffin Company. It had an operating loss carryover, amounting to approximately $20,000, from the previous operations of Newcomb-Griffin Company.

GI remained dormant for a few more months after January 8,1960. In April 1960, however, GI was reactivated by its officers, William J. Griffin, Arnold Van Etten, and William R. Griffin, who were also the officers of G&C.

Beginning in April 1960 and continuing through the remainder of the time that is involved in the present litigation, both G&C and GI were operated by the same management team, consisting of William J. Griffin, Arnold Van Etten, and William E. Griffin, in the manner subsequently outlined.

If an order or contract was obtained for the fabrication of equipment and its installation outside the plant at a customer’s job site, the order or contract was taken in the name of G&C, and the job was performed by G&C.

If an order was obtained for the manufacture of an item or items to be sold F.O.B. the plant, the order was taken in the name of GI. Each order obtained for GI was reflected by a document which was called a “manufacturing order” and which was generally referred to as an “M.O.” The information contained on the face of the M.O. included the item to be manufactured, the name of the customer, the date of delivery, the price, the cost to GI, the dates and amounts of invoices to the customer, and other detailed information. The M.O. also contained, on attached sheets, a detailed listing of all costs, which consisted principally of labor and materials.

Upon receipt of an order for GI, G&C was requested to furnish the labor and materials (except as indicated in the next paragraph) to manufacture the order. The work to be performed by G&C was reflected by a document which was called a “shop order” and which was generally referred to as an “S.O.” The S.O. contained a statement of the services to be furnished by G&C for GI, and on attached sheets there was recorded a detailed listing of all the shop labor used in filling the order, as well as any materials which were furnished by G&C in connection with the job.

If an item to be manufactured under an order taken in the name of GI required a component that could not be produced feasibly in G&C’s plant, an order for such component was placed elsewhere in the name of GI, and payment for the component was effected out of GI’s bank account.

Upon completion of its work for GI on an order, G&C billed GI, by separate invoice, for all direct costs actually incurred by G&C in furnishing the labor to manufacture the particular item for GI, as well as for the cost of any materials furnished by G&C. In addition to these amounts, G&C charged GI an additional amount equal to 100 percent of the cost of labor and materials, this charge being for overhead and profit.

All items produced by G&C for GI were delivered to GI’s customers F.O.B. G&C’s plant. Invoices to the customers were issued in the name of GI.

The critical question in this portion of the opinion is whether the activities of GI during the fiscal years 1960 and 1961 amounted, in substance, to the carrying on of business by GI. Moline Properties v. Commissioner, 319 U.S. 436, 438-439 (1943). The Internal Revenue Service has made a negative determination on this question; and if that determination is correct, the Internal Revenue Service was authorized by the tax laws to “unscramble” the situation existing between G&C and GI, so that income reported by GI might be allocated to G&C as the company that was actually engaged in the conduct of the business that produced the income. Alpha Tank & Sheet Metal Mfg. Co. v. United, States, 126 Ct. Cl. 878, 884, 116 F. Supp. 721, 724 (1953); Grenada Industries, Ine., 17 T.C. 231, 253 (1951), aff'd 202 F. 2d 873 (5th Cir. 1953), cert. den. 346 U.S. 819 (1953).

In my opinion, the evidence, as previously summarized, shows that GI was a mere corporate shell during 1960 and 1961. It did not have any employees or any plant with which to carry on a substantial business as a manufacturer of sheet-metal products. It is true that GI purported to carry on such a business, in that orders were taken and invoices were issued in the name of GI, but tax consequences are based upon the substance of transactions, and not upon the forms in which they are clothed. Ingle Coal Corp. v. United States, 131 Ct. Cl. 121, 129, 127 F. Supp. 573, 579 (1955), cert. den. 350 U.S. 842 (1955); Juniper Investment Co. v. United States, 168 Ct. Cl. 160, 167-168, 338 F. 2d 356, 359-360 (1964); Shaw Construction Co. v. Commissioner, 323 F. 2d 316, 320 (9th Cir. 1963).

The evidence does indicate that G&C and GI maintained separate bank accounts and separate books of account, and that they filed separate Federal and State income tax returns. While these factors, standing alone, might support a finding that the two companies were engaged in the conduct of separate businesses, such factors are not conclusive and they cannot overcome the strong evidence elsewhere in the record showing that the business activities with which we are concerned were conducted, in substance — and that the income in question was actually earned, in substance — by G&C, since only G&C had the personnel and the assets with which to carry on a substantial business as a manufacturer of sheet-metal products.

In connection with the conclusion stated above, it should be mentioned that the plaintiffs offered oral testimony to the effect that GI was continued in existence for the purpose of facilitating an agreement with the Sheet Metal Workers International Association whereby sheet metal “production” laborers could be employed and used on certain types of work. Sheet metal workers fall within two union classifications — journeymen sheet metal “construction” workers and sheet metal “production” workers. The journeymen construction workers are more highly skilled and receive higher wages than the production workers. Only the highly skilled journeymen construction workers are permitted by the union rules to fabricate and install items that are to be made of sheet metal and installed by the employer outside his plant at customers’ job sites. On the other hand, the less skilled production workers are permitted by the union rules to manufacture items that are to be made of sheet metal and sold F.O.B. the employer’s plant.

At all times pertinent to this litigation, journeymen sheet metal “construction” workers in Louisville were members of Local Union No. 110 of the Sheet Metal Workers International Association. In 1960, they received a minimum hourly wage of $4.60. The sheet metal “production” workers in Louisville were members of Local Union No. 425 of the Sheet Metal Workers International Association. Their hourly wage in 1960 ranged from $1.70 to $2.85.

Lonnie Gaither was business agent for Local Union No. 110 (“construction” workers) in 1960, and he also acted as business agent for Local Union No. 425 (“production” workers).

G&C has always had a union shop. Being engaged in the mechanical contracting business, it relied before August 1960 on Local Union No. 110 (“construction” workers) to provide not only the laborers needed for the fabrication and installation of equipment that was to be installed by G&C outside its plant at customers’ job sites, but also the laborers needed for the manufacture of equipment sold by G&C F.O.B. its plant. The employment of union “construction” workers by G&C during the period prior to August 1960 for all of its jobs, irrespective of whether a particular job involved work of a “construction” nature or work of a “production” nature, was covered by an agreement between Local Union No. 110 and the Louisville Sheet Metal Contractors Association, of which G&C was a member.

G&C was aware that it would be economically beneficial — * and G&C wished — to substitute the less expensive “production” workers for the more expensive “construction” workers on jobs where the nature of the work permitted it under the union rules. Prior to October 1959, G&C attempted to obtain a union contract that would permit the company to use sheet metal production workers for the manufacture of items that were to be sold P.O.B. the plant, but was unable to do so.

On August 11, 1960, however, G&C was able to make an agreement with the union which permitted G&C for the first time to employ the less skilled and less expensive members of Local Union No. 425 (“production” workers) in the manufacture of items that were to be sold F.O.B. the plant. This agreement was mutually beneficial to G&C and to the Sheet Metal Workers International Association: it was beneficial to G&C because it reduced labor costs on certain kinds of work; and it was beneficial to the union because it increased the number of gainfully employed members of the union in Louisville. Also, at the time when the labor agreement was made in August 1960, Lonnie Gaither, the negotiating business agent for the union, was concerned over the possibility that G&C’s shop might be organized by the competing boilermakers’ union.

Since the labor contract under which G&C employed sheet metal “construction” workers was between Local Union No. 110 and tlie Louisville Sheet Metal Contractors Association, Lonnie Gaither insisted upon a separate agreement between the union and G&C covering the employment of sheet metal “production” workers by G&C.

After the labor agreement of August 11, 1960 was made, G&C employed and utilized sheet metal “production” workers for the manufacture of items which were sold F.O.B. the plant. G&C continued to employ and utilize sheet metal “construction” workers for the fabrication and installation of equipment that was to be installed outside the plant at customers’ job sites. As indicated earlier in this opinion, orders for the fabrication of equipment and its installation outside the plant were being taken at the time in the name of G&C, while orders for the manufacture of items to be sold F.O.B. the plant were being taken in the name of GI, with GI, in turn, engaging G&C to provide the labor and materials necessary for the production of such items.

The inference is warranted from the objective evidence in the record that the existence of GI, and its relationship to G&C, lacked real significance with respect to the willingness of the union to enter into the labor agreement of August 11, 1960, authorizing the employment by G&C of “production” laborers on certain types of work. There is nothing in the evidence to indicate that, during the negotiation of the August 11,1960 labor agreement between G&C and the union, there was even any mention of GI; the labor agreement was made by the union with G&C, and not with GI; it was G&C, and not GI, that employed and utilized “production” laborers pursuant to the agreement; the “production” laborers employed pursuant to the agreement were employees of G&C, and not of GI; they received their work assignments and their supervision from G&C, and not from GI; they worked in a plant and used equipment provided by G&C, and not by GI; and they received their wages from G&C, and not from GI. This objective evidence outweighs the subjective understanding of witnesses for the plaintiffs that the existence of GI somehow facilitated the obtaining of the labor agreement which permitted the employment of sheet metal “production” laborers by G&C. Cf. Urban Redevelopment Corp. v. Commissioner, 294 F. 2d 328, 332 (4th Cir. 1961).

For the reasons previously given in this portion of the opinion, I believe that the Internal Revenue Service was justified in determining that GI was not, in substance, engaged in the conduct of business as a separate entity in 1960 and 1961 and, accordingly, that GI should not be recognized for tax purposes in 1960 and 1961, and income reported by GI for those years was actually taxable to G&C.

The conclusion stated in the preceding paragraph makes it unnecessary to consider whether, if GI had earned taxable income in 1960 and 1961, it would have been entitled to claim a net operating loss deduction and the $25,000 surtax exemption for each of those years.

The “Compensation” Issue

It has been previously mentioned that the three officers of G&C during the years involved in the present litigation were William J. Griffin, president, Arnold Yan Etten, vice president, and William R. Griffin, secretary-treasurer. William J. Griffin was the controlling stockholder of G&C, and the other two officers were also stockholders. These three men constituted a majority of G&C’s board of directors. There were two other members of the board in 1960, Mrs. William J. Griffin and Ray Heil. In 1961, Mrs. William J. Griffin was the only other member of the board in addition to William J. Griffin, Arnold Yan Etten, and William R. Griffin.

William J. Griffin received a salary of $15,000 per year in 1960 and 1961. Arnold Van Etten received an annual salary of $9,600 and 1960 and 1961. William R. Griffin received a salary of $8,400 in 1960 and a salary of $8,850 in 1961.

Pursuant to actions by G&C’s board of directors, William J. Griffin, Arnold Yan Etten, and William R. Griffin each received $25,000 during the fiscal year 1960 and $27,500 during the fiscal year 1961, in addition to the salaries paid to these individuals during the respective years. Such additional amounts were stated in the minutes of the meetings of the board of directors to be bonuses.

Upon audit of G&C’s income tax return for the fiscal year 1960, the Internal Revenue Service determined that $27,500 of the amount paid to Arnold Yan Etten and $20,000 of the amount paid to William R. Griffin as compensation during that year constituted reasonable compensation and had been properly deducted as business expenses by G&C, but that $7,100 of the amount paid to Arnold Van Etten and $13,400 of the amount paid to William E. Griffin did not constitute reasonable compensation and could not properly be deducted by G&C.

Upon audit of G&C’s income tax return for 1961, the Internal Eevenue Service again allowed $27,500 of the amount paid to Arnold Yan Etten and $20,000 of the amount paid to William E. Griffin as reasonable compensation and thus deductible by G&C, but held that $9,600 of the amount paid to Arnold Yan Etten and $16,350 of the amount paid to William E. Griffin in 1961 did not constitute reasonable compensation and could not properly be deducted by G&C.

The Internal Eevenue Service accepted as reasonable the entire amounts of $40,000 and $42,500 which G&C paid to William J. Griffin as compensation for the years 1960 and 1961, respectively.

G&C questions the correctness of the determinations by the Internal Eevenue Service that portions of the amounts paid to Arnold Yan Etten and1 William E. Griffin as compensation for 1960 and 1961 did not constitute reasonable compensation and were not deductible by G&C.

There is no definite formula by which the question of the reasonableness, for income tax purposes, of compensation in any particular instance can be determined. Irby Construction Co. v. United States, 154 Ct. Cl. 342, 346, 290 F. 2d 824, 826 (1961). This is a question of fact that must be determined upon the basis of all the facts in each separate case. Bringwald, Inc. v. United States, 167 Ct. Cl. 341, 347, 334 F. 2d 639, 643 (1964) ; Boyd Construction Co. v. United States, 168 Ct. Cl. 579, 586, 339 F. 2d 620, 624 (1964).

The determinations by the Internal Eevenue Service on the reasonableness of the compensation paid by taxpayers to their employees are presumed to be correct, and a taxpayer who attacks an administrative decision on this point has the burden of showing by a preponderance of the evidence that the total amounts paid as compensation were reasonable. Duffin v. Lucas, 55 F. 2d 786, 796 (6th Cir. 1932), cert. den. 287U.S. 611 (1932); Northlich, Stolley, Inc.v. United States, 177 Ct. Cl. 435, 442, 368 F. 2d 272, 277 (1966).

Since Arnold Yan Etten and William E. Griffin, the persons whose compensation is under consideration in the present litigation, were stockholders, officers, and directors of G&C, the taxpayer has a special burden of showing by clear and convincing evidence that the amounts paid to Messrs. Van Etten and Griffin were actually reasonable compensation for services performed, and not in reality dividends disguised as compensation. Northlieh, Stolley, Inc. v. United States, supra, 177 Ct. Cl. at page 443, 368 F. 2d at page 278. Even a payment that is reasonable is not deductible if it was actually a distribution of earnings, as contrasted to compensation for services rendered. Irby Construction Co. v. United States, supra, 154 Ct. Cl. at page 347, 290 F. 2d at page 827. In the present case the small amount of dividends paid by the company over the years, as contrasted to its accumulated earnings, is significant.

Perhaps the most significant factor to consider in determining the reasonableness of compensation is the amount paid to similar employees by similar concerns engaged in similar industries. Patton v. Commissioner, 168 F. 2d 28, 31 (6th Cir. 1948); cf. R. J. Reynolds Tobacco Co. v. United States, 138 Ct. Cl. 1, 14, 149 F. Supp. 889, 897 (1957), cert. den. 355 U.S. 893 (1957). In this connection, the plaintiff G&C did not offer any evidence that would permit the court to apply the test of comparability in the present litigation. The defendant, on the other hand, offered summaries of financial statements of Liberty Engineering & Manufacturing Company and of its 70 percent stockholder, Kirk & Blum, and the testimony of Liberty Engineering’s president, George Jackson, and chief engineer, Jesse Groves, and of Kirk & Blum’s president and chief executive officer, Eichard Blum, for the purpose of showing that Liberty Engineering was comparable to G&C and that Jesse Groves’ duties and responsibilities for Liberty Engineering made him a comparable employee to Arnold Yan Etten.

Liberty Engineering & Manufacturing Company was a Louisville-based mechanical contracting company that employed sheet metal trade union labor in the design, production, and installation of tobacco processing, dust collecting, wood collecting, scrap paper collecting, fume removal, and air conditioning systems, and it also manufactured tobacco processing equipment. G&C and Liberty Engineering performed the same sort of jobs for the same or similar customers. They were both mechanical contractors. They both estimated and bid jobs for tobacco processing companies and for fume, dust, and waste removal systems and for industrial air conditioning systems. Liberty Engineering’s total sales for 1960 and 1961 amounted to $1,810,085 and $1,501,043, respectively, while G&C’s total sales for the same years amounted to $1,595,263 and $1,432,410, respectively.

Arnold Yan Etten began working for G&C as a draftsman in 1944 at a salary of $1.00 per hour. He was then 19 years old and had graduated from high school two years earlier. He did not attend college. In 1948, Mr. Yan Etten was made a field engineer at a salary of $55 per week. He continued in that job through 1952, at which time he was being paid $125 per week. In 1953, he was made vice president of G&C; and he was vice president of the company during the years involved in the present case.

As vice president of G&C, Mr. Yan Etten was in charge of the engineering department. He was not, however, a registered engineer licensed to practice in Kentucky.

Mr. Yan Etten was primarily responsible for many of the jobs that G&C performed for its principal customer, Brown & Williamson Tobacco Corporation. During the period of time involved in the present litigation, G&C installed various pieces of equipment for Brown & Williamson at its Lexington, Kentucky, stemmery, and also converted its mechanical conveying system there to a pneumatic system, which at the time was an unusual technological advancement. Mr. Yan Etten also handled 50 or 60 smaller jobs for Brown & Williamson during the fiscal years 1960 and 1961, from which G&C received about $50,000 in each year.

Mr. Van Etten personally, in August or September of 1960, obtained a large order from American Machine & Foundry Company for various pieces of equipment to be used in the P. Lorillard stemmery at Danville, Virginia. This order amounted to more than $200,000 for the fiscal years 1960 and 1961.

Mr. Yan Etten designed and patented substantial improvements on a centrifugal classifier. Since 1960, approximately 800 centrifugal classifiers, containing Mr. Yan Etten’s patented innovations, have been sold. Such sales accounted for approximately $360,000. Other than his compensation in the form of salaries and bonuses, Mr. Yan Etten did not receive anything for his patent.

Jesse Groves held an engineering degree and was a registered engineer licensed to practice in Kentucky. During 1960 and 1961, he was the chief engineer for Liberty Engineering & Manufacturing Company, and supervised the design, manufacture, and fabrication of air conditioning, dust collecting, fume removal, and general ventilating systems. He was second in charge to George L. Jackson, Liberty Engineering’s president, and he was a member of Liberty Engineering’s board of directors. He was the officer of Liberty Engineering who was primarily responsible for work performed for the tobacco industry.

Arnold Van Etten and Jesse Groves both supervised the staff engineers of their respective companies and, in turn, both were responsible to the chief executive officers of their respective companies. Both Mr. Yan Etten and Mr. Groves were officers and members of the boards of directors of their respective companies. They were both in charge of the production of tobacco processing systems and dust and waste control systems, from customers’ drawings and specifications.

It seems to me that the evidence presented by the defendant shows that Arnold Van Etten and Jesse Groves were comparable employees of comparable companies engaged in similar work.

Liberty Engineering & Manufacturing Company’s payments to Jesse Groves as compensation for 1960 and 1961 amounted to $17,469 in each of these years, while G&C’s payments to Arnold Van Etten as compensation amounted to $34,600 in 1960 and $37,100 in 1961. It will be noted that Mr. Van Etten’s purported compensation from G&C in each of the two years was approximately twice as great as the amount which Jesse Groves received from Liberty Engineering. This is a strong indication that the Internal Revenue Service did not commit error when it determined that only $27,500 of the amount paid to Arnold Van Etten 'by G&C in each of the years 1960 and 1961 could properly be regarded as reasonable compensation and as deductible by G&C.

A further circumstance supporting the determination of the Internal Revenue Service is that the amounts paid by G&C to Arnold Van Etten as compensation during the 4-year period immediately preceding 1960 never exceeded $14,400 in any year, and then in 1960 and 1961 his purported compensation was jumped to $34,600 and $37,100, respectively. There is nothing in the evidence to indicate that there was any great increase in Mr. Van Etten’s duties and responsibilities for G&C in 1960 cur 1961 to justify such a jump in Mr. Van Etten’s compensation for services rendered to the company. This warrants an inference that the comparatively large payments which G&C made to Mr. Van Etten in 1960 and 1961 were partially based on factors other than mere compensation for services rendered.

The evidence in the record indicates that William R. Griffin was less experienced than Arnold Van Etten, and that his duties and responsibilities for G&C were less important than those of Mr. Van Etten, during 1960 and 1961. Detailed information concerning William R. Griffin and his work for G&C is set out in finding 75. If, as I believe, the record supports the determination of the Internal Revenue Service that only $27,500 of the total amount paid by G&C to Arnold Van Etten as compensation for each of the years 1960 and 1961 constituted reasonable compensation, it must also be held on the basis of this record that the administrative agency did not commit error in determining that only $20,000 of the amount paid by G&C to William R. Griffin as compensation for each of the years 1960 and 1961 constituted reasonable compensation, and, therefore, that the additional amounts of $13,400 and $16,350 paid to William R. Griffin in 1960 and 1961, respectively, did not constitute reasonable compensation and were not properly deductible by G&C.

As indicated heretofore in this part of the opinion, the plaintiff G&C has failed to sustain its burden of proving by a preponderance of the evidence that the full amounts of $34,600 and $37,100 which G&C paid to Arnold Van Etten in 1960 and 1961, respectively, and the full amounts of $33,400 and $36,350 which G&C paid to William R. Griffin in 1960 and 1961, respectively, constituted reasonable compensation for services rendered by the two officials during those years.

The 11 Automobile Expense” Issue

On its income tax returns for the fiscal years 1959,1960, and 1961, G&C deducted the amounts of $3,198, $4,090, and $7,072, respectively, as automobile expenses.

Upon auditing G&C’s income tax returns for the three years mentioned in the preceding paragraph, the Internal Revenue Service disallowed for each year $1,200 of the total amount claimed by G&C as automobile expenses. G&C attacks the correctness of these disallowances in the present litigation.

The figures set out in the first paragraph of tins portion of the opinion included the expenses incurred by G&C in connection with three automobiles which the company owned or leased and which were assigned to the three officers of the company, William J. Griffin, Arnold Van Etten, and William R. Griffin, who were also directors and stockholders.

Each of the three officers used his assigned company automobile to commute between his home and the office, driving the automobile home each day after working hours, keeping it at his home overnight, and then driving it to work in the morning. Each officer also used his assigned company automobile whenever it was necessary for him to travel during the business day between the office and outside projects where work was being done by G&C at customers’ job sites.

The record does not contain mileage data or other evidence showing the relative extent to which the three officers of G&C used their assigned company automobiles to travel between their homes and the office, on the one hand, and to travel between the office and outside work projects, on the other hand.

The proper rule for application in the present litigation with respect to the automobile expense issue was stated by •bliis court in Boyd Construction Co. v. United States, 168 Ct. Cl. 579, 584, 339 F. 2d 620, 623 (1964). In that case, the court said:

* * * [Automobile] expense is deductible where the automobile is used in furtherance of the taxpayer’s business, but automobile expense arising from personal use is not deductible. Where the automobile is used for both business and personal purposes, an allocation must be made. * * * The determination made by the Commissioner is presumed correct. * * * The evidence shows that the automobiles in question were used for both personal and company business, but no record was kept as to the amount of mileage for each purpose. In view thereof, it is considered that the determination by the Commissioner must stand. * * *

In the present litigation, the allocation by the Internal Eevenue Service of G&C’s automobile expenses as between expenses incurred in furtherance of the company’s business and expenses incurred for the personal convenience of the three officers of the company in commuting between their homes and the office is presumptively correct. The administrative determination must be upheld in the absence of clear evidence showing such allocation to have been incorrect.

The “Repairs or Improvements” Issue

During the fiscal year 1961, G&C expended $363.54 for the cleaning and sandblasting, and $1,174.07 for the painting, of three steel trusses. G&C also expended $2,135 in 1961 for the relocation of lighting fixtures in the company office. All these amounts were deducted as business expenses by G&C on its income tax return for the fiscal year 1961.

Upon auditing G&C’s income tax return for 1961, the Internal Eevenue Service disallowed all the deductions mentioned in the preceding paragraph, on the ground that such expenditures were for capital improvements. The correctness of this administrative determination is questioned by G&C in the present litigation.

The three steel trusses had been acquired by G&C in about 1952 for use in the construction of an anticipated addition to G&C’s plant. The construction of the plant addition was delayed, however, and the steel trusses were stored outside in the weather for several years. Because of the exposure to the weather, the steel trusses became severely etched and rusted. Finally, when G&C was ready to proceed with the construction of the long-delayed plant addition, it cleaned, sandblasted, and painted the steel trusses in order to make them suitable for use in the structure. After being rehabilitated, the steel trusses were utilized by G&C in the construction of the addition to the plant.

The 1961 expenditures in connection with the relocation of lighting fixtures in the company office were occasioned when G&C carried out a program of relocating certain partitions in the office portion of the company plant. As part of this program, the lighting fixtures in the area were taken down, moved, and relocated, at a cost of $2,135 for labor and materials.

The deductibility of the expenditures involved in this part of the opinion depends upon the purpose for which such expenditures were made. If their purpose was merely to repair property and thus keep it in good condition during its probable useful life, the expenditures were deductible as business expenses. Illinois Merchants Trust Co., 4 B.T.A. 103, 106 (1926). On the other hand, if the purpose of the expenditures in question was to improve property and thus increase its value, the expenditures were capital in nature and were not deductible as business expenses. Duffy v. Central R.R., 268 U.S. 55, 62-63 (1925). The question of purpose is, of course, a factual issue. Russell Box Co. v. Oommissioner, 208 F. 2d 452, 454 (1st Cir. 1953).

With respect to the sums that were expended to clean, sandblast, and paint the steel trusses, the plaintiff G&C contends — and seemingly with justification — that these operations merely restored the steel trusses to an ordinarily useful condition. However, the rehabilitation of the steel trusses was incidental to, and an essential part of, the construction of an addition to G&C’s plant. The purpose of constructing the plant addition was obviously to improve G&C’s property and increase its value. Hence, it is my opinion that the expenditures made by G&C in connection with the construetion of the plant addition, including the cost of getting the steel trusses in suitable condition for use as part of the plant addition, were capital expenditures.

The relocation of partitions in the company office was also a program designed to improve G&C’s property. Therefore, since the expenditures made by G&C to take down, move, and relocate the lighting fixtures were necessarily part of this property improvement program, it is my opinion that these were also capital expenditures, and not expenses for repairs that G&C could properly deduct on its 1961 income tax return.

Partial Recoveries

The defendant concedes that, under its theory — which I believe to be correct — that GI was not, in substance, engaged in the conduct of business as a separate entity during 1960 and 1961, and that income reported by GI on its income tax returns was properly taxable to G&C, GI is entitled to recover some of the income taxes which the Internal Revenue Service collected from GI for the fiscal years 1960 and 1961.

Also, the parties have filed a stipulation which shows that G&C was entitled to depreciate certain capital improvements within shorter periods of time than were determined by the Internal Revenue Service in auditing G&C’s income tax returns for the fiscal years 1959, 1960, and 1961, and in making deficiency assessments against G&C for those years.

Therefore, it appears that both GI and G&C are entitled to partial recoveries in the present litigation.

Findings of Fact

The Plamtijfs

1. Griffin & Company, Inc., and Griffin Industries, Inc., are Kentucky corporations, with the same principal place of business, 500 Bergman Avenue, Louisville, Kentucky. (For the sake of convenience, Griffin & Company, Inc., will usually be referred to hereafter in the findings as “G&C,” and Griffin Industries, Inc., will usually be referred to as “GI.”)

2. G&C was founded in 1941 by William J. Griffin, its chief executive officer and controlling stockholder during all rele-vault times, who had previously had considerable as an engineer and as a mechanical contractor for Liberty Engineering & Manufacturing Company and for E. I. du Pont de Nemours & Company.

3. (a) From the time of its formation, G&C was what is known in the trade as a mechanical contractor. As such, it specialized in producing, and then installing outside its plant at customers’ job sites, sheet metal work and related component parts in connection with heating, ventilating, air-conditioning, dust-collecting, and pneumatic conveying systems. G&C sometimes purchased components manufactured by other companies, and utilized them in equipment which G&C had contracted to install for its customers.

(b) Some of G&C’s jobs as a mechanical contractor were bid in competition with other mechanical contractors, where the practice was to award the job to the low bidder. Other jobs were not bid in competition, but G&C was awarded the job on a cost-plus-percentage basis. The practice of G&C on non-bid jobs was to charge the customer the actual cost of labor and materials, plus 50 percent overhead for work performed in its shop (or 15 percent overhead for work performed at the customers’ job site), plus 10 percent profit.

(c) G&C’s non-bid jobs were performed principally for the tobacco industry, which was very secretive about its manufacturing processes used to produce cigarettes. Because the tobacco companies guarded their secret blend processes zealously, the practice in the tobacco industry was for each company to rely on just one equipment producer that the tobacco company trusted and assumed would not disclose its secret processes. Brown & Williamson Tobacco Corporation had been a permanent customer of G&C since shortly after 1941, when G&C was formed. During the periods relevant to this litigation, Brown & Williamson was G&C’s largest customer.

(d) Prior to April 1960, G&C manufactured and sold some items made of sheet metal that were delivered F.O.B. its plant, and were not installed by G&C outside its plant in its role as a mechanical contractor. These items consisted principally of equipment for the processing of tobacco.

(e) G&C maintained a well-equipped plant in Louisville. It had a staff of clerical employees, a staff of professional engineering employees, a labor force of sheet metal workers, a plant superintendent to supervise the sheet metal workers while they were engaged in the fabrication or manufacture of equipment within the plant, and a construction superintendent to supervise the sheet metal workers while engaged in the installation of equipment outside the plant at customers’ job sites.

4. The officers of G&C during the years involved in the present litigation were:

President-William J. Griffin

Vice President_Arnold Van Etten

Secretary-Treasurer-William B. Griffin

5. The stockholders of G&C, and their respective shares, were as follows on the dates indicated:

June 30, 1959

William J. Griffin_6, 000

J. Gladys Griffin_ 800

A. Van Etten_ 400

Andrew W. Duncan_ 157

William E. Griffin_1,157

Bay Heil_ 55

Treasury_1,438

June 30, 1960

William J. Griffin_ 6, 264

J. Gladys Griffin_ 825

A. Van Etten_ 739

Andrew W. Duncan_ 157

William E. Griffin_1,474

Bay Heil_ 55

Treasury_ 486

June 30, 1961

William J. Griffin_6, 000

J. Gladys Griffin_ 825

A. Van Etten_ 975

Andrew W. Duncan_ 157

William E. Griffin_1, 724

Bay Heil_ 55

Jo Ann Griffin_ 132

Pamela Griffin- 132

6. For the fiscal years 1947 through 1961, was owned by the following persons in the following percentages:

[In percent]

7. The members of the board of directors of G&C were as follows on the dates indicated:

June 30, 1961 — W. J. Griffin

A. Van Etten

W. R. Griffin

J. Gladys Griffin

June 30, 1960 — W. J. Griffin

A. Van Etten

W. R. Griffin

Bay Heil

J. Gladys Griffin

June 30, 1959 — W. J. Griffin

W. B. Griffin

A. Van Etten

J. Gladys Griffin

Bay Heil

8. The officers of GI were as follows on the dates indicated:

December 30, 1960

President-William J. Griffin

Vice-President_A. Van Etten

Secretary-Treasurer_William E. Griffin

December 30, 1961

President_A. Van Etten

Vice-President_William E. Griffin

Secretary-Treasurer_Mrs. D. J. Martin

Chairman of the Board_William J. Griffin

9. The members of the board of directors of GI were as follows on the dates indicated:

Dec. 30, 1959 — William J. Griffin

Arnold Van Etten

William E. Griffin

Dec. 30, 1960 — William J. Griffin

Arnold Van Etten

William E. Griffin

M. W. Nicholson

Philip J. Miller

Adolph Spear

Dec. 30, 1961 — William J. Griffin

Arnold Van Etten

William E. Griffin

Adolph Spear

M. W. Nicholson

Mrs. D. J. Martin

Fred M. Goldberg

10. Both G&C and GI keep their records and file their Federal income tax returns on the completed contract basis.

Administrative Proceedings

11. G&C filed timely Federal income tax returns for the fiscal years ended June 30,1959, June 30, 1960, and June 30, 1961, with the District Director of Internal Revenue at Louisville, Kentucky, and paid the tax liability shown thereon, in the following amounts:

Year Amount

F/Y June 30, 1959_$8, 908.86

F/Y June 30, 1960_30,118.02

F/Y June 30, 1961_ 21,804.86

12o GI filed timely Federal income tax returns for the fiscal years ended September 80,1960 and September 30,1961, with the District Director of Internal Revenue at Louisville, Kentucky, and paid the tax liability shown thereon, in the following amounts:

Year Amount

F/Y September 30, 1960- None

F/Y September 30, 1961_$19,193. 73

13. (a) In auditing the income tax returns of G&C and GI for the fiscal years 1960 and 1961, the Commissioner of Internal Revenue:

(1) allocated to G&C for 1960 income in the amount of $8,672.62 which was reported by GI for that year;

(2) allocated to G&C for 1961 income in the amount of $44,461.07 which was reported by GI for that year;

(3) disallowed a net operating loss deduction in the amount of $11,563.49 claimed by GI for 1960;

(4) disallowed the $25,000 surtax exemption claimed by GIfor 1960;

(5) disallowed a net operating loss deduction in the amount of $7,938.97 claimed by GI for 1961; and

(6) disallowed the $25,000 surtax exemption claimed by GI for 1961.

(b) In auditing the income tax returns of G&C for the fiscal years 1960 and 1961, the Commissioner of Internal Revenue:

(1) disallowed $7,100 of the amount deducted by G&C for 1960 as compensation to Arnold Van Etten;

(2) disallowed $13,400 of the amount deducted by G&C for 1960 as compensation to William R. Griffin;

(3) disallowed $9,600 of the amount deducted by G&C for 1961 as compensation to Arnold Van Etten; and

(4)disallowed $16,350 of the amount deducted by G&C for 1961 as compensation to William R. Griffin.

(c) In auditing the income tax returns of G&C for the fiscal years 1959, 1960, and 1961, the Commissioner of Internal Revenue disallowed a deduction in the amount of $1,200 claimed by G&C as an automobile expense for each of the three years.

(d) In auditing the income tax returns of G&C for the fiscal years 1959, 1960, and 1961, and in computing allowable depreciation, the Commissioner of Internal Revenue:

(1) held for each of the three years that an asphalt driveway constructed on April 1,1959 should be depreciated over a 5-year life, rather than a 3-year life as claimed by G&C;

(2) held for each of the three years that a prefabricated light-weight steel warehouse constructed in 1958 should be depreciated over a 40-year life, rather than a 20-year life as claimed by G&C;

(3) held for each of the three years that a steelax building constructed in 1958 should be depreciated over a 40-year life, rather than a 20-year life as claimed by G&C;

(4) held for each of the three years that office improvements made in 1958 should be depreciated over a 40-year life, rather than a 10-year life as claimed by G&C;

(5) held for 1960 and 1961 that office improvements made in 1960 should be depreciated over a 40-year life, rather than a 10-year life as claimed by G&C; and

(6) held for 1961 that improvements to the prefabricated light-weight steel warehouse should be depreciated over the remaining life of the warehouse.

(e) In auditing the income tax return of G&C for the fiscal year 1961, the Commissioner of Internal Revenue disallowed as deductible expenses for repairs the sum of $2,135 expended on light fixtures, the sum of $363.54 expended on the cleaning of steel, and the sum of $1,174.07 expended on the painting of steel.

14. (a) Upon audit of G&C’s Federal income tax returns for the years 1959-1961, the Commissioner of Internal Revenue made timely assessments of tax deficiencies and interest against G&C, as follows:

Tax Interest Year

$2,697.30 $640.61 F/Y June 30,1959.,

17,162.91 3,203.35 F/YJuno30, I960..

42,928.66 5,436.65 F/Y June 30,1961..

(b) G&C paid said amounts on October 31,1963.

15.(a) Upon audit of GI’s Federal income tax returns for 1960 and 1961, the Commissioner of Internal Revenue made timely assessments of tax deficiencies and interest against GI, as follows:

Tax Interest Year

$6,013.01 $1,032.00 F/Y September 30, 1960.

9,828.27 1,074.93 F/Y September 30,1961-

(b) GI paid said amounts on October 31,1963.

16.(a) G&C filed timely claims for the refund of taxes paid for the fiscal years ended June 30,1959, June 30, 1960, and June 30, 1961. These claims were disallowed, and the present suit (No. 130-64) followed.

(b) GI filed timely claims for refund of taxes paid for the fiscal years ended September 30,1960 and September 30, 1961. These claims were disallowed, and the present suit (No. 131-64) followed.

Newcomb-Griffin, Company

17. GI is the successor corporation of Newcomb-Griffin Company, which was formed on October 28, 1955. (New-comb-Griffin Company will usually be referred to in subsequent findings as “Newcomb-Griffin.”)

18. The formation of Newcomb-Griffin was brought about by Newcomb-Detroit Company (hereinafter referred to as “Newcomb-Detroit”) and G&C, which companies, having worked together on various projects, decided to pool their respective know-how and abilities and engage in business, primarily in the Louisville area.

19. Newcomb-Detroit was a manufacturer and supplier of spray booths, ovens, and other miscellaneous products for finishing systems, whereas G&C was a mechanical contractor. Prior to 1955, G&C had several contracts with General Electric Company for fabrication and erection in the field, and Newcomb-Detroit was the builder and supplier of some of the products erected by G&C.

20. During the year 1955, the presidents of G&C and New-comb-Detroit discussed the possibility of a joint venture between the two companies, with Louisville as the new company’s base of operations. Newcomb-Detroit had patents on certain component products which it sold in the Louisville area; but since its principal plant was located in Detroit, Michigan, Newcomb-Detroit thought that a manufacturing outlet near the place of installation would have financial as well as practical advantages. It was thought that G&C, as a mechanical contractor, but lacking the manufacturing experience of Newcomb-Detroit, would be in a position to work closely with the new company in providing its know-how and erection services.

21. On the incorporation of Newcomb-Griffin, 2,500 shares of its stock were authorized. Newcomb-Detroit and G&C each contributed $12,500 as capital for the new corporation, and received in exchange all the stock of Newcomb-Griffin. Newcomb-Detroit received 1,251 shares of stock in Newcomb-Griffin, and G&C received 1,249 shares.

22. (a) In connection with the formation of Newcomb-Griffin, three separate agreements were executed.

(b) A contract between G&C and Newcomb-Griffin provided that G&C was to furnish all labor, materials, equipment, and facilities to Newcomb-Griffin. Detailed provisions were inserted for the payment by Newcomb-Griffin to G&C for such services.

(c) A contract between Newcomb-Detroit and G&C provided, among other things, that should either Newcomb-Detroit’s or G&C’s “contractual and stoekownership relation with Newcomb-Griffin cease, then for five years thereafter * * * Griffin [G&C] will not participate in any manner in the design, manufacture, sale or installation of industrial ovens, spray booths and air supply, metal treatment and parts washers in the United States.” The reason for this provision was that Newcomb-Detroit had developed these items and as a consequence had special know-how with respect to their design, manufacture, and erection, as well as owning certain patents relating thereto. In the same contract, it was also agreed as follows:

2. Both Griffin [G&C] and Newcomb-Detroit agree that if either demands in writing that the other buy-or-dissolve, the one upon whom demand is made is entitled to and must within 30 days either (a) buy the stock of Newcomb-Griffin Company owned by the demanding party, for book value without any figure for good will, or (b) vote its stock of Newcomb-Griffin Company for dissolution of same. Both Griffin [G&C] and New-comb-Detroit agree that if either shall buy the other’s stock in Newcomb-Griffin Company, such purchaser will take prompt steps to require Newcomb-Griffin Company to terminate the use of any portion of the name of the other (the selling) company.

(d) The third contract was between Newcomb-Detroit and Newcomb-Griffin, and it obligated Newcomb-Detroit to supply to Newcomb-Griffin the former’s technical know-how and data with respect to the products mentioned in paragraph (c) of this finding. This contract further provided that “in the event Newcomb-Detroit shall cease to be associated with Newcomb-Griffin, then for five years after such cessation, or for a period equal to the time during which such association continued, whichever be the shorter period, New-comb-Griffin will not attempt to sell or fabricate industrial oven, spray booths and air supply, metal treatment and parts washers, and wet dust collectors and alterations to these products * * * [within a hundred-mile radius of Louisville, Kentucky (excluding that part which includes Ohio)].”

23. (a) Newcomb-Griffin was an industrial supplier. It was formed to manufacture industrial ovens, spray booths, flow-coaters, and industrial washing machines. These products were used in the appliance industry to prepare and enamel metal goods. Substantial percentages of these products were sold to General Electric Company at Appliance Park in Louisville.

(b) Newcomb-Griffin also manufactured roller conveyors, belt conveyors, and related components.

(c) Newcomb-Griffin did not manufacture any pneumatic conveying systems.

24. Although a majority of Newcomb-Griffin’s stock was held by Newcomb-Detroit, the contract between Newcomb-Detroit and G&C provided, in effect, that neither stockholder was to have control of the board of directors of Newcomb-Griffin. It was provided that a two-thirds majority stockholder vote, rather than a simple majority, was necessary for any decision requiring action by the stockholders, and that the two stockholders were to be equally represented on the board of directors of Newcomb-Griffin.

25. Newcomb-Griffin’s operations resulted in the following gross sales and profit (or loss) for the periods indicated:

Period Gross Sales Profit (Loss)

Pirst 9 months_ $216,369.00 ($6,778.00)

P/Y ended 9-30-57.. 176,901.00 (11,787.76)

P/Y ended 9-30-58-4,679.34 698.54

26. Newcomb-Griffin was billed by Newcomb-Detroit or G&C for any services performed for Newcomb-Griffin by either company.

27. (a) In August 1957, the DeVilbiss Company (hereinafter referred to as “DeVilbiss”) acquired all of the stock of Newcomb-Detroit. It was against DeVilbiss’ policy for it to engage in joint ventures with outsiders. On August 22, 1957, A. L. Newcomb, James Cornelius, and I. B. MacLellen (all representatives of Newcomb-Detroit) tendered their resignations as officers and members of the board of directors of Newcomb-Griffin. Willian J. Griffin received notice in 1957 of these resignations, but they were not formally accepted until December 1959, and no replacements were elected until 1960.

(b) After December 31, 1957, Newcomb-Griffin did not render any further invoices to customers. Newcomb-Griffin filed an occupational license fee return for the calendar year 1958 which reported “No Activity.”

(c) Annual meetings of the stockholders and of the board of directors of Newcomb-Griffin were held in 1955 and 1956, but no such meetings were conducted after November 10, 1956, until December 30,1959.

28. After the acquisition of Newcomb-Detroit by DeVil-biss, Newcomb-Griffin finished up some work which was in progress at the time of acquisition, and also attempted to collect outstanding accounts.

29. (a) One such account involved an amount due New-comb-Griffin by Cumberland Corporation. On January 3, 1958, Mr. Newcomb of Newcomb-Detroit inquired about the difficulties in the collection of this account. He was advised in a letter dated January 20, 1958 by George Griffin, a vice president of G&C, that Cumberland was in the process of refinancing.

(b) On March 8, 1958, Mr. Jackson, attorney for New-comb-Griffin, advised Mr. Tyler, attorney for DeVilbiss, that on February 10, 1958 Cumberland had filed a petition for voluntary bankruptcy and that Newcomb-Griffin had filed a mechanic’s lien in the amount of $7,685.34. He stated that it would be some time before a distribution was made, but “In the meantime we would appreciate hearing from you and your client as to what action you would like to take with reference to winding up the affairs of Newcomb-Griffin Company.”

(c) On March 11, 1958, Mr. Tyler replied as follows:

Before an opinion can be formulated relative to winding up the affairs of Newcomb-Griffin Company, we should like to know whether or not the Mechanics Lien will provide the company with a secured claim and if not, are there assets from which general creditors can expect an appreciable dividend ?

(d) Early in 1959, the Cumberland matter was resolved.

30. (a) At the request of DeVilbiss, Patrick H. Mitchell, a certified public accountant, examined the books of New-comb-Griffin as of May 1, 1959, and prepared the following balance sheet as of that date:

ASSETS

Casia in Bank_ 6, 555. 60

Accounts Receivable: Newcomb-Detroit_ 646.81

Organization Expense_ 359.61

LIABILITIES 6, 562.02

Accounts Payable_ 750. 00

Pat Mitchell, CPA_ 150.00

NET WORTH - 900.00

Capital Stock_ 25,000. 00

Deficit_ 19,337.98

- 5,662.02

6,562.02

(b) On July 14,1959, Mr. Mitchell wrote to DeVilbiss that there “has been little change in the financial position of New-comb-Griffin since September 30,1957.”

(c) Newcomb-Griffin’s 1958 and 1959 Federal income tax returns did not reflect any business activity during those years.

(d) Newcomb-Griffin was not engaged in any active business during the calendar years 1958 and-1959.

31.During its 1956-1959 taxable years, Newcomb-Griffin reported taxable net income and net operating losses as follows:

1956 - ($6, 778. 851

1957 - (11,786.76)

1958 - 186.63

1959 - ( 1,123.48)

32. From the date when the Newcomb-Detroit stock was acquired by DeVilbiss, W. J. Griffin had from time to time inquired of DeVilbiss about the status of Ne wcomb - Griffin. In July or August 1959, DeVilbiss advised G&C that G&C could either sell its stock in Newcomb-Griffin to DeVilbiss or buy from DeVilbiss the latter’s stock in Newcomb-Griffin at book value.

33. G&C offered to purchase the Newcomb-Griffin stock held by DeVilbiss on August 27,1959. On October 6,1959, Mr. Mitchell was appointed to act as escrow consummating the sale. On October 23,1959, the sale was consummated by a payment of $2,831.01 to DeVilbiss by Newcomb-Griffin in redemption of the stock owned by DeVilbiss.

34. As of May 1, 1959, the book value of Newcomb-Grif-fin’s 2,500 outstanding shares was $5,653. On October 23, 1959, Newcomb-Griffin paid $2,831.01 to DeVilbiss (successor to Newcomb-Detroit), representing the then book value of the 1,251 shares of Newcomb-Griffin stock, and DeVilbiss surrendered the 1,251 shares of Newcomb-Griffin. This left G&C and its stockholders the 100-percent owner of the remaining 1,249 shares outstanding.

Griffm Ind/ustries

35. (a) Shortly after the stock redemption referred to in findings 33 and 34, Fred M. Goldberg, a Louisville attorney, was retained by Newcomb-Griffin for the purpose of amending its articles of incorporation, so as to change the name of the company to Griffin Industries (GI), among other things. The change was necessary because of the original agreement between Newcomb-Detroit and G&C. Mr. Goldberg was requested to expedite this matter.

(b) On December 30,1959, the board of directors of New-comb-Griffin voted to change its name to Griffin Industries, Inc., and on January 8,1960, an amendment of its articles of incorporation was filed in Frankfort, Kentucky, thereby effecting the change in name. This amendment effected also a change in corporate purpose “to engage generally in the design, manufacture, and sale of industrial machinery and equipment for cooling, heating, drying, humidifying, conditioning, conveying, separation, blending, filtering, dust collecting, and kindred products throughout the United States and elsewhere.”

36. (a) On March 19,1960, a meeting of William J. Griffin, M. W. Nicholson, Adolph Spear, Phil Miller, and Bob Howard was convened at the Pendennis Club in Louisville. The minute of this meeting, initialed by William J. Griffin, stated as follows:

Wm. J. Griffin advised group: Griffin Industries, Inc. formerly Newcomb-Griffin, had authorized capital of $25,000.00,10.00 par value — 2500 shares. Now has a loss carry forward of $20,000.00.

Griffin & Company owns_ 1249 shares

A. Van Etten owns_ 417 ”

Wm. R .Griffin owns_ 417 ”

Wm. J. Griffin owns_ 417 ”

2500 shares total

(b) As of the date of the typed minute, March 21, 1960, Arnold Yan Etten, William J. Griffin, and William E. Griffin each owned 417 shares of GI stock, though it was not until mid-May 1960 that these actual shares were issued to Yan Etten and the Griffins at a total price in the amount of $2,831, the book value of these shares as of the end of 1959.

37. (a) On April 1, 1960, GI’s stockholders voted to increase its number of authorized shares of stock from 2,500 to 10,000 shares, and on April 14,1960, an amendment of its articles of incorporation was filed, thereby effecting the increase in authorized shares.

(b) On May 10, 1960, G&C received 500 shares of GI stock from GI, on paying $5,000, or a price of $10 per share.

38. Shares of stock of GI were acquired by the following stockholders on the dates indicated:

39. On or about March 24, 1960, the balance of the old Newcomb-Griffin bank account was transferred into a new account styled Griffin Industries, Inc.

40. Under the date of March 28, 1960, William J. Griffin sent to old customers of G&C, and to those regarded as prospective customers of G&C or GI, a letter stating as follows:

Effective April 1, 1960, Griffin Industries, Inc., affiliated with Griffin & Company, will handle the manufacturing of machinery and equipment for domestic and export shipments F.O.B. Louisville, Kentucky.
Griffin & Company will handle engineering and mechanical contract work requiring field erection and other work related to the construction industry.
The separation of manufacturing from our contract work will increase our efficiency in the handling of various orders for our customers and it is to this end that we have made this separation.
We solicit your orders for Griffin Industries as well as for Griffin & Company and will make every effort to have you satisfied with the performances of these two companies.

41. On April 13,1960, W. J. Griffin sent to Fred M. Goldberg a letter which stated as follows:

Reference is made to your letter of April 6th regarding purposes for which Griffin Industries, in effect, had been revived. Briefly, our thinking is this:
(1) Due to Griffin & Company’s expansion in the manufacturing field, the officers considered the matter of separating our construction operations from purely manufacturing operations. The point being that with an increased flow of manufactured goods coming into our plant, we would in the not-too-distant future be pricing ourselves out of this very desirable market by the employment of labor at the construction scale of wages. Griffin Industries by so taking orders for manufactured items would be able to, in the future, set up a separate manufacturing unit, employing the proper labor at the proper rate to enable us to compete with other manufacturers doing similar work at a manufacturing scale. In the interim, Griffin Industries would sub-contract the manufacture of machinery items to Griffin & Company, or others, to accomplish this end.
(2) Griffin & Company will continue the manufacture of items which includes the field erection of these items, using construction labor to do the total job.
(3) Before Griffin Industries can completely separate themselves from Griffin & Company, we feel that it is in order to proceed on the basis outlined above.

42. GI was reactivated in April 1960. The first purchase order contract for GI was made on April 6, 1960. The first substantial purchase order contract for GI was made on May 6, 1960. This was an order for 5 linear separators at a contract price of $18,055.

43. As of May 10,1960, a point of time subsequent to GI’s reactivation and during GI’s 1960 taxable year, G&C and its stockholders owned 100 percent of the stock of GI.

44. GI did not have any employees of its own, did not own any tools or equipment except for 10 welding machines (see finding 63), did not own or lease any real property, and did not borrow any money to finance business operations.

45. GI was controlled by G&C and its stockholders within the meaning of Section 482 of the 1954 Internal Revenue Code.

46. (a) On or about October 23, 1959, Newcomb-Griffin (predecessor of GI) purchased 51 percent of its stock from DeVilbiss, thereby increasing the percentage ownership by G&C of the number of shares of Newcomb-Griffin’s outstanding shares of stock from 49 percent to 100 percent.

(b) As of September 30,1960, the end of GI’s 1960 taxable year, G&C owned “at least 50 percentage points more” of GI stock than it owned on October 1,1959, the beginning of GI’s 1960 taxable year, within the meaning of Section 382(a) (1) (A) of the 1954 Code.

(c) This increase in G&C’s percentage ownership of GI was attributable to the decrease in the amount of Newcomb-Griffin (predecessor of GI) stock outstanding, within the meaning of Section 382(a) (1) (B) (ii) of the 1954 Code.

47. During the fiscal years that ended September 30, 1960 and September 30, 1961, GI reported on its Federal income tax returns the following data:

R/Y 1960 F/Y 1961

$49,492.26 $796,836.87 Sales_

37,836.41 762,909.51 Cost of Sales.

11,656.84 43,927.36 Gross Profit-

12,172.10 44,048.36 Net Income..

48. Other than its officers, GI had no employees during the fiscal years involved in the present litigation. All direct labor was purchased by GI from G&C.

49. The plaintiffs presented oral testimony to the effect that GI was continued in existence and was utilized, as indicated in subsequent findings, for the purpose of facilitating an agreement with the Sheet Metal Workers International Association whereby sheet metal “production” laborers could be employed and used on certain types of work.

The Union Agreement of August 11, 1960

50. (a) Sheet metal workers fall within two union classifications — journeymen sheet metal “construction” workers and sheet metal “production” workers. The j oumeymen construction workers are more highly skilled than the production workers. Only the highly skilled journeymen construction workers are permitted by the union rules to fabricate and install items that are to be made of sheet metal and installed by the employer outside his plant at customers’ job sites as parts of buildings, factories, etc. On the other hand, the less skilled production workers are permitted by the union rules to manufacture items that are to be made of sheet metal and sold F.O.B. the employer’s plant.

(b) At all pertinent times, journeymen sheet metal construction workers in Louisville were members of Local Union No. 110 of the Sheet Metal Workers International Association. In 1960, Lonnie Gaither was business agent for Local No. 110. Members of Local No. 110 were journeymen sheet metal construction workers, qualified to fabricate and install custom sheet metal items used in buildings, factories, etc. In 1960, they received a minimum hourly wage of $4.60.

(c) At all pertinent times, sheet metal production workers in Louisville were members of Local Union No. 425 of the Sheet Metal Workers International Association. In 1960, the hourly wage rate of the sheet metal production workers ranged from $1.70 to $2.85. Lonnie Gaither, mentioned in paragraph (b) of this finding as business agent for Local No. 110 (“construction” workers), also acted in 1960 as business agent for Local No. 425 (“production” workers).

(d) Both of the union locals mentioned in this finding were within the same international union, the Sheet Metal Workers International Association.

(e) G&C has always had a union shop. Being engaged in the mechanical contracting business, it relied before August 1960 on Local No. 110 to provide not only the laborers needed for the fabrication and installation of equipment that was to be installed by G&C outside its plant at customers’ job sites, but also the laborers needed for the manufacture of equipment sold by G&C F.O.B. the plant. The employment of such union construction workers by G&C during the period prior to August 1960 for all of its jobs, irrespective of whether a particular job involved work of a “construction” nature or work of a “production” nature, was covered by an agreement between Local No. 110 and the Louisville Sheet Metal Contractors Association, of which G&C was a member.

(f) G&C was aware that it would be economically beneficial — and G&C wished — to substitute the less expensive production workers for the more expensive construction workers on jobs where the nature of the work permitted it under the union rules.

(g) Prior to October 1959, G&C attempted to obtain a union contract that would permit the company to use sheet metal production workers for the manufacture of items that were to be sold F.O.B. the plant, but was unable to do so..

51. (a) On August 11, 1960, G&C was able to make an agreement with Local No. 110 (“construction” workers) permitting G&C for the first time to employ the less skilled and less expensive members of Local No. 425 (“production” workers) on certain kinds of work. This agreement was mutually beneficial to G&C and to the Sheet Metal Workers International Association: it was beneficial to G&C because it reduced labor costs on certain kinds of work; and it was beneficial to the union because it increased the union’s number of gainfully employed members in Louisville.

(b) At the time when the labor agreement of August 11, 1960 was made, Lonnie Gaither, the negotiating business agent for the union, was concerned over the possibility that C&G’s shop might become organized by the competing boilermakers’ union.

(c) Since the existing labor contract tinder which G&C employed and used sheet metal “construction” workers was between Local No. 110 and the Louisville Sheet Metal Contractors Association, Lonnie Gaither insisted upon a separate agreement between the union and G&C covering the employment of sheet metal “production” workers by G&C.

(d) The jurisdiction of the “production” workers was described in the labor agreement of August 11,1960 as:

(1) Machinery, equipment, and auxiliaries which the company sells F.O.B. the plant.
(2) Single or multiple units of machinery, equipment, or auxiliaries of customer or company design.
(3) Miscellaneous structural steel fabrication, plate work, and components used on construction work, erected by construction trades.

(e) The labor agreement of August 11,1960 also provided that G&C could assign highly skilled “construction” workers to perform any of the work described in the contract as being within the jurisdiction of the less expensive “production” workers.

52. The inference is warranted from the objective evidence in the record that the existence of GI, and its relationship to G&C, lacked real significance with respect to the willingness of the union to enter into the labor agreement of August 11, 1960, authorizing the employment and utilization by G&C of “production” laborers on certain types of work. Ths evidence does not establish that, during the negotiation of the labor agreement, there was even any mention of GI; the labor agreement of August 11, 1960 was made by the union with G&C, and not with GI; it was G&C, and not GI, that employed and utilized “production” laborers pursuant to the agreement; the “production” laborers employed pursuant to the agreement were employees of G&C, and not of GI; they received their work assignments and their supervision from G&C, and not from GI; they worked in a plant and with equipment provided by G&C, and not by GI; and they received their wages from G&C, and not from GI.

Relationship Between G&C cmd GI

53. (a) During the time involved in the present litigation, the same management team, consisting of William J. Griffin, Arnold Van Etten, and William It. Griffin, ran both G&C and GI.

(b) G&C had a plant, clerical employees, a staff of professional engineering employees, and a work force of laborers.

(c) GI did not have a plant or any kind of employees or laborers. Its only personnel consisted of the officers of the company. Its only asset consisted of the bank account left over from the operations of Newcomb-Griffin.

(d) If an order or contract was obtained for the fabrication of equipment and its installation outside the plant at a customer’s job site, the order or contract was taken in the name of G&C, and the job was performed by G&C. G&C utilized its sheet metal “construction” workers for the job.

(e) If an order was obtained for the manufacture of an item or items to be sold F.O.B. the plant, the order was taken in the name of GI. The work was done as indicated in subsequent findings.

54. Each order obtained for GI during the years involved in the present litigation was reflected by a document called a “manufacturing order” (hereinafter referred to as an “M.O.”). The information contained on the face of the M.O. included the item to be manufactured, the name of the customer, the date of delivery, the price, the cost to GI, the dates and amounts of invoices to the customer, and other detailed information. The M.O. also contained on attached sheets a detailed listing of all costs, which consisted primarily of labor and materials.

55. Upon receipt of an order for GI, G&C was requested to furnish the labor and materials (except as indicated in finding 59) to manufacture the order. The work to be performed by G&C was reflected by a “shop order” (hereinafter referred to as an “S.O.”). The S.O. contained a statement of the services to be furnished by G&C for GI, and on attached sheets there was recorded a detailed listing of the cost of all shop labor (by individual employees and hours) used in filling the order, as well as any materials which were fumishd by G&C in connection with the job.

56. (a) Upon completion of its work, G&C billed GI, by separate invoice, for all direct costs actually incurred by it in furnishing the labor to manufacture the particular item for GI, as well as for the cost of any materials which might have been furnished by G&C. In addition to these amounts, G&C charged GI an additional amount of 100 percent for overhead and profit.

(b) G&C normally charges its non-bid customers cost plus 60 percent, consisting of a 50 percent overhead markup (shop burden) plus a 10 percent profit. The additional charge made to GI was to compensate G&C for the added expenses incurred by G&C because of the GI operation, and also included a charge for rent.

(c) For the period April 1, 1960 to September 30, 1961, the direct labor and material cost actually incurred by G&C for work performed for GI was $290,943.16. With respect to such work during this period of time, G&C billed and was paid by GI $456,041.39. G&C’s gross profit was $165,098.23.

57. The invoice to the outside customer on an item manufactured by G&C for GI was issued in the name of GI.

58. The funds of G&C and GI were not intermingled. Each had its separate books of account, and each had its separate bank account. Each filed separate Federal and State income tax returns.

59. If an item to be manufactured under an order taken in the name of GI required a component that could not be produced feasibly in G&C’s plant, an order for such component was placed elsewhere in the name of GI, and payment for the component was effected out of GI’s bank account.

60. In producing items for the filling of orders taken in the name of GI, G&C utilized its sheet metal “production” workers employed under the labor agreement of August 11, 1960.

61. Each company issued its own purchase orders to suppliers, and each issued its own invoices to its customers.

62. On June 23, 1960, the following letter was sent to all vendors at the request of Mrs. Dorothy Martin, bookkeeper and office manager of G&C:

Gentlemen :
Ee: Griffin & Company, Griffin Industries, Inc.
April 1, 1960, Griffin Industries, Inc. was formed and is entirely separate from Griffin & Company.
It has been called to my attention by our Bookkeeping Department that we are being invoiced incorrectly. Many orders placed by Griffin Industries are being invoiced to Griffin & Company. This creates quite a problem in our bookkeeping division.
We would like to point out that the purchase orders are entirely different in their physical makeup. We do not wish to return incorrect invoices. However, if we are invoiced incorrectly and to the wrong company and the purchase order number is not shown, these invoices will not be put in line for payment and will be returned to the respective vendor.
Your cooperation in this matter will be greatly appreciated.
Very truly yours,
GRiufiN & Company
E. W. Bethel
Purchasing Agent

63. (a) On April 12, 1960, GI purchased two welding machines at a cost of $1,250. On April 28, 1960, GI purchased six welding machines at a cost of $3,930. On June 23, 1961, GI purchased two welding machines at a cost of $1,310.

(b) GI charged G&C as rent for the use of each of these welding machines $25 per month, which amount was paid by G&C and reported by GI as “Other Income” on its Federal income tax returns.

,64. On March 22, 1963, the Internal Bevenue Service approved a profit sharing plan for G&C. On the same date, it approved a profit sharing plan for GI.

65. In- substance, the business conducted in the names of G&C and GI by the management team of William J. Griffin, William It. Griffin, and Arnold Van Etten was essentially one business, and not two businesses conducted by separate companies.

Oomfensation of Officers

,66. (a) During the years involved in this litigation, the business of G&C was conducted under the leadership of William J. Griffin, president, Arnold Van Etten, vice president, and William B. Griffin, secretary-treasurer. William B. Griffin was the son of William J. Griffin. Arnold .Van Etten was unrelated to the Griffins.

(b) The three officers worked as a “team” in running the company. Together, they performed all the necessary executive responsibilities inherent in operating a company with a sales volume of approximately 1% million dollars each year. Specifically, each officer was generally assigned to particular projects, jobs, or accounts. Each, of course, was responsible for and handled the particular administrative duties relating to his office and activities.

(c) Although the three officers generally worked together on all jobs performed by G&C, usually one of the officers assumed particular responsibility for a specific project.

,87. William J. Griffin was the chief sales engineer for Liberty Engineering & Manufacturing Company when he left that company to begin his own business. Brown & Williamson Tobacco Corporation was one of Liberty Engineering’s customers, and William J. Griffin coordinated Liberty Engineering’s work for Brown & Williamson. Shortly after the formation of G&C in 1941, Brown & Williamson became one of its customers, and was its largest customer in 1960-1961, accounting for sales of approximately $1,200,000 in those years.

88. .(a) William J. Griffin received an annual $15,000 salary in 1960 and in 1961.

(b) During 1960 and 1961, William J. Griffin determined the amount of compensation to be paid to his son, William B. Griffin, and to Arnold Van Etten. William It. Griffin received an $8,400 salary in 1960 and an $8,850 salary in 1961. Arnold Van Etten received an annual salary of $9,600 in 1960 and in 1961.

89. On March 3, 1960 and on June 16, 1961, the board of directors of G&C voted to pay cash bonuses to salaried employees of the company, who were not officer-stockholders, for 1960 and 1961, respectively. In 1960 these bonuses were equivalent to one month’s salary for the several employees, and in 1961 they were specified amounts ranging from $150 to $1,093. William J. Griffin testified that these bonuses represented reasonable compensation for services actually rendered. G&C has never had any regular practice with reference to awarding bonuses.

/70. Upon vote of G&C’s board of directors, William J. Griffin, William E. Griffin, and Arnold Van Etten each received $25,000 during the fiscal year 1960 and $27,500 during the fiscal year 1961, in addition to the salaries paid to these individuals during the respective years. Such additional amounts were stated in the minutes of the meetings of the board of directors to be bonuses.

71.G&C’s dividend record was as follows:

Per Share Total Amount Year

1948 $0 60 $4,000

less 1.00 9,960

1962 1.00 10,000

1963 1.00 10,000

1964 1.00 10,000

72.For the fiscal years 1953-1961, officers of G&C received from G&C the following amounts as compensation:

73.(a) As indicated in the following table, the Internal Eevenue Service determined, with respect to the sums paid by G&C to Arnold Van Etten and W. E. Griffin as compensation for the fiscal years 1960 and 1961, that portions were reasonable and thus deductible by G&C, and that other portions did not constitute reasonable compensation and were not deductible by G&C:

A. Van Etten W. R. Griffin

Fiscal Year

Allowed (Disallowed) Allowed (Disallowed)

1960.. $27,600 ($7,100) $20,000 ($13,400)

1961.. 27,600 (9,600) 20,000 (16,360)

(b)The Commissioner accepted as reasonable the compensation of $40,000 and $42,500 paid to W. J. Griffin for the years 1960 and 1961, respectively.

74. (a) Arnold Van Etten (who is unrelated to the Griffins) began working for G&C as a draftsman in 1944, at a salary of $1.00 per hour. Mr. Van Etten was then 19 years old, and he had graduated from high school two years earlier. He did not attend college.

(b) In 1946, Mr. Van Etten was made a field engineer at a salary of $55 per week. He continued in that job through 1952, at which time he was being paid $125 per week. In 1958 he was made vice president of G&C. He was vice president of G&C during the years involved in the present case.

(c) As vice president of G&C, Mr. Van Etten’s duties consisted of being in charge of the engineering department, supervising and working on specific jobs, participating in labor negotiations, purchasing inventory and component parts, and supervising various jobs in the plant and in the field.

(d) Each Monday morning prior to working hours, Mr. Van Etten met with the shop superintendent, the chief engineer, and any other engineers handling particular jobs, to discuss and endeavor to resolve whatever problems they might have.

(e) During the fiscal years that ended June 30, 1960 and June 30, 1961, Mr. Van Etten was responsible for a number of G&C’s jobs. He was primarily responsible for many of the Brown & Williamson Tobacco Corporation jobs. During this period of time, G&C installed various pieces of equipment for Brown & Williamson at its Lexington, Kentucky, stemmery, and also converted its mechanical conveying system there to a pneumatic system, which at the time was an unusual technological advancement. Mr. Van Etten also handled 50 or 60 smaller jobs for Brown & Williamson during these years, from which G&C received about $50,000 in each year.

(f) In 1960, Mr. Van Etten and W. B>. Griffin together handled a $170,000 job for International Harvester. This job involved the fabrication and installation of a dust collecting system for a foundry cupola. Despite the size of the job, the field erection had to be — and it was — completed in three weeks, which was the period of time of Harvester’s shut-down. The job was completed by working two shifts, weekends, and overtime during the week.

(g) Mr. Van Etten personally, in August or September of 1960, obtained for GI a large order from American Machine and Foundry Company for various pieces of equipment for use in the P. Lorillard stemmery at Danville, Virginia. In dollars, this order amounted to over $200,000 for the years that ended September 30, 1960 and September 30, 1961.

(h) A centrifugal classifier is a machine which separates the product from an air stream. The basic machine is manufactured by several other companies. Mr. Van Etten, however, designed a different type of center tube within the unit and a longer throat on the unit in connection with the bid on the American Machine and Foundry job for Lorillard. He obtained a patent on these innovations on December 31, 1963, which patent was assigned to GI.

(i) Since 1960, GI has sold approximately 800 centrifugal classifiers with Mr. Van Etten’s patented innovations. Those sales accounted for approximately $360,000. Other than his compensation, Mr. Van Etten did not receive anything from GI or G&C for his patent.

(j)An ordering cylinder is a stainless steel cylinder used to rotate a mass of tobacco and present it to a mixture of steam, water, and air to soften it and prepare it for further manufacture. The ordering cylinders sold to American Machine and Foundry by GI were specially designed by Mr. Van Etten to meet difficult specifications of performance, and Mr. Van Etten’s designs were successful in meeting these specifications.

(k) During the years involved in this case, Mr. Van Etten at times worked 60-70 hours per week, and many weekends.

(l) Peter Ten Eyck Nevius, a civil engineer who was assistant plant manager of the tobacco machinery division of American Machine and Foundry in 1960 and 1961, found Mr. Van Etten to be competent in handling the job. Mr. Nevius felt that Mr. Van Etten was GI, in that he sold the job, designed it, and supervised the manufacture of the equipment.

(m) George Hilgartner, chief engineer of Brown & Williamson since 1954, worked with Mr. Van Etten in 1960 and 1961 and found him to'be “very competent.”

(n) Mr. Van Etten was not a registered engineer licensed to practice in Kentucky.

(o) The evidence discloses that Mr. Van Etten personally contributed as an officer of G&C substantial and responsible services, which were actually rendered and which were directly related to the production of corporate income.

751. (a) William R. Griffin has been president of G&C since July 1,1962. During the years in issue, he was secretary-treasurer of G&C.

(b) W. R. Griffin began working part-time for G&C in 1944, at the age of 15, as a junior draftsman. He became a full-time employee in 1951 as a field engineer at a salary of $50 per week. He was a field engineer until he entered the military service in 1954.

(c) W. R. Griffin returned to G&C in 1956 as a field engineer. His maximum salary in that position was $150 per week. He was made secretary-treasurer of the company in September 1956. His salary as secretary-treasurer was $650 per month.

(d) As secretary-treasurer, W. R. Griffin’s administrative duties included receiving and reading all incoming correspondence and directing such correspondence to the proper individuals. He was responsible for the payroll, the signing of the payroll checks, the signing of checks for all payables, all tax checks, and signing Federal, State and local forms, the insurance program, and the general correspondence. In addition, W. R. Griffin met with the other two officers of the company almost daily to discuss the daily operation of the business and the problems that might come up, such as labor conditions, job conditions, plant expansion, inventory control, and equipment purchases.

(e) The administrative activities did not take up a major portion of W. R. Griffin’s time. He also devoted time to estimating work, to design work, and to the general supervision of the j obs that he was handling.

(f) Two of the larger jobs for which W. E. Griffin was responsible during the years in issue were the Standard Gra-vure Printing Company job for F. W. Owens & Associates and the Shawnee High School job for the City of Louisville.

(g) G&C was a subcontractor on the Standard Gravure project, which was a bid job. W. K. Griffin did the estimating work and submitted a bid for G&C against other qualified mechanical contractors. G&C was the successful bidder, and in the fall of 1958 was awarded a subcontract, which was for approximately $605,000. The job entailed the fabrication and installation of a complete heating and cooling system, which had to operate within certain specified temperature and humidity variations. W. E. Griffin supervised and was responsible for the handling of all facets of this job. Luring the time when the job was in progress, he was at the job site by 7:00 A.M. or 7:30 A.M. There was a maximum of 30 sheet metal workers under his control and direction on the Standard Gravure contract. It was completed in the fall of 1959, 30 days ahead of schedule, for which G&C received a $13,000 bonus.

(h) The Shawnee High School project was another bid job, which was estimated and handled by W. E. Griffin. The $250,000 contract was obtained in 1960 and the job was completed in the latter part of 1961. The Shawnee High School contract was basically a heating and ventilating job. A new classroom facility, cafeteria, and gymnasium were added to the building, and this required the reworking of the existing boiler plant, the installation of a new boiler, and the installation of a miscellaneous exhaust system.

(i) As previously mentioned, W. E. Griffin was jointly responsible with Mr. Van Etten for the 3-week International Harvester job in 1960, which was a $170,000 sale. In 1961, W. E. Griffin was solely responsible for and handled a similar job for International Harvester during its shutdown period.

(j) During the years involved in the present case, W. E. Griffin handled other jobs of a minor nature for G&C, such as a $10,000 Philip Morris job which was performed during a Christmas shut-down.

(k) William Heckman, general superintendent lor F. W. Owens & Associates, the general contractor on the Standard Gravure job, was in contact with W. E. Griffin virtually every day of the 10 months it took to complete that project. He also worked with W. E. Griffin on the Shawnee High School job. He has worked with mechanical contractors since 1945, and he stated that W. E. Griffin compared favorably with any mechanical contractor with whom he had worked.

(l) During the years involved in this case, W. E. Griffin worked many weekends and on numerous occasions longer than an 8-hour day.

(m) W. E. Griffin is not a college graduate.

(n) W. E. Griffin is not a registered engineer licensed to practice in Kentucky.

(o) The evidence discloses that William E. Griffin personally contributed as an officer of G&C substantial and responsible services, which were actually rendered and which were directly related to the production of corporate income.

76» The following table accurately reflects G&C’s total sales, profit before taxes, Federal income taxes, State taxes, and net profit after taxes, as originally reported for the years indicated:

Year Ended 6/30 Total Sales Profit Before Taxes Federal Tax State Tax Profit After Taxes

1961. $1,432,410 $54,840 $21,804 $1,812 $31,224

1960-1,595,263 71,544 30,118 2,399 39,027

1959-3,091,614 38,866 8,908 1,597 28,361

1958-900,194 (62,666)

1957-1,301,660 (3,285)

1956-1,149,945 27,404 7,715 984 18,705

1955-1,372,291 29,569 9,376 19,285

1964-1,346,949 70,381 32,498 1,702 36,181

1953-, 1,104,641 66,652 32,611 1,496 32,545

,77. (a) W. J. Griffin, president of G&C, determined the amounts of the salaries which were paid to Messrs. Van Etten and W. E. Griffin during the fiscal years 1960 and 1961. W. J. Griffin testified that these officers were paid “for what

I considered services rendered and a fair market value on their services in cash.” He stated that there was a direct relationship between the financial position of the company and the salaries paid.

(b) In the judgment of W. J. Griffin, the compensation paid to Messrs. Van Etten and W. E. Griffin for each of the years involved in the litigation represented compensation for their efforts in contributing to the financial success of G&C in these years.

(c) The decision of W. J. Griffin with respect to the salaries, without regard to the bonuses, paid Messrs. Van Etten and W. E. Griffin for the years involved in the litigation was an independent arm’s-length determination to compensate these officers for actual services performed.

78.The following additional capital contributions in exchange for G&C’s stock were made by Messrs. William J. Griffin, A. Van Etten, and William E. Griffin during the years 1960 and 1961:

Year W. J. Griffin A. Van Etten W. R. Griffin

1961.. $9,440 $10,000

1960.. $10,660 13,660 12,960

79.(a) On September 25, 1961, G&C charged GI $19,500 for the following:

Salaries in Engineering respecting design on production items, April 1960 through September 30,1961 :

W. R. Griffin_ $7,500

A. Van Etten_ 7,500

Engineering & Drafting_ 4, 500

$19, 500

(b) This invoice was paid on October 6,1961.

80.In reports prepared by the U.S. Treasury Department, Internal Eevenue Service, entitled “Statistics of Income— Corporation Income Tax Eeturns” and prepared in accordance with the provisions of Section 6108 of the Internal Eev-enue Code of 1954, tbe following data appear for tbe years 1960 and 1961:

No. of Returns in Survey Total Compiled Receipts Net Income Before Taxes

I960 (000) (000)

Construction General---. 66,260 $32,140,410 $579,108

Special trade contractors-34,816 11.654.346 197,339

1981

Construction General_ 72,332 32.893.347 379,212

Special trade contractors-38,392 12,249,277 128,934

81. (a) Tbe plaintiff G&C offered no evidence of com.' parable companies or comparable employees witb wbicb tbe amounts paid to G&C’s officers could be compared to determine whether they were reasonable in amount. Tbe defendant offered summaries of financial statements of Liberty Engineering & Manufacturing Company and of its 70 percent stockholder, Kirk & Blum, and testimony by Liberty Engineering’s president, George J ackson, and chief engineer, Jesse Groves, and Kirk & Blum’s president and chief execuj tive officer, Kichard Blum, for tbe purpose of showing that Liberty Engineering was comparable to G&C and that Jesse Groves’ duties and responsibilities for Liberty Engineering made him a comparable employee to Arnold Van Etten.

(b) Kirk & Blum was engaged in work similar to G&C, except it did not produce any tobacco processing systems. It was roughly three times the size of G&C and Liberty Engineering, and used manufacturers’ sales representatives in principal cities.

82. Liberty Engineering & Manufacturing Company was a Louisville-based mechanical contracting company employing sheet metal trade union labor in the design, production, and installation of tobacco processing, dust collecting, wood collecting, scrap paper collecting, fume removal, and air conditioning systems, and it also manufactured tobacco processing equipment. Because of the special qualifications of its president, George L. J ackson, Liberty Engineering also designed, produced, and installed its own humidity and temperature control systems as part of its ventilation work. During the relevant periods, Liberty Engineering’s stock was owned 70 percent by Bark & Blum of Cincinnati (a larger company which also designed, produced, and installed dust and fume control, waste removal, and industrial ventilating systems) and 30 percent by its president, George L. Jackson.

,83. G&C and Liberty Engineering perf ormed the same sort of jobs for the same or similar customers. They were both mechanical contractors. They both estimated and bid jobs and performed custom jobs for tobacco processing companies and for fume, dust, and waste removal systems, and for industrial air conditioning systems.

84. (a) During the years in issue, G&C did not employ any salesmen. The sales functions for G&C (as well as for GI) were performed by the three officers of the company, William J. Griffin, Arnold Van Etten, and William B. Griffin.

(b) Kirk & Blum, a company with sales more than twice the amount of the sales of G&C and GI during the years involved in the present litigation, employed approximately 15 salesman per year. The salaries paid by Kirk & Blum to its salesmen amounted to $134,729 in 1960 and $138,837 in 1961. In addition, Kirk & Blum paid approximately $50,000 per year to manufacturers’ sales representatives.

(c) Liberty Engineering & Manufacturing Company, which had a sales volume similar to that of G&C and GI, employed an average of 7 salesmen during the years 1960 and 1961. The salaries paid by Liberty Engineering to these salesmen amounted to $65,543 in 1960 and $69,397 in 1961.

85. The financial statements of G&C for the period 1948-1961, and the financial statements of Liberty Engineering for the period 1951-1962, were admitted in evidence. G&C’s 5-year period, 1957-1961, and Liberty Engineering’s comparable period, 1957-1962, are summarized as follows:

G&C

Year Total Sales Net Assets tTnion & Clerical Payroll Engineers and Draftsmen Paid to Engineers and Draftsmen Paid to Officers

1961. $1,432,410 $434,351 $696,289.91 $57,171 $115,950

3960. 1,695,263 383,895 677,292.91 36,975 108,000

1959. 3,091,514 310,623 705,627.11 29,524 49,500

1958-900,194 277,251 334,727.27 34,253 58,093

1957. 1,301,660 367,135 388,116.03 54,397 65,868

LIBERTY ENGINEERING & MANUFACTURING COMPANY

Year Total Sales Net Assets Union & Clerical Payroll Engineers and Draftsmen Paid to Engineers and Draftsmen Paid to Officers

1962-$1,494,974 $616,101 $583,391 $69,701 $54,058

1961-1,601,043 590,984 587,029 86,080 63,058

1960-1,810,085 643,876 763,242 81,299 62,410

1969. 1,963,238 793,498 789,765 83,614 60,374

1958-2,654,228 824,768 988,480 84,966 59,694

1957. 3,174,518 702,740 1,284,091 79,530 69,782

86. From 1951 to 1962, Liberty Engineering paid cash dividends in two years. In 1957, it paid dividends in the total amount of $33,000. In 1958, it paid dividends in the total amount of $16,500.

87. George L. Jackson held a bachelor’s and a master’s degree in engineering and was a registered engineer licensed to practice in Kentucky. In 1928, he purchased Liberty Engineering’s predecessor. He was president of Liberty Engineering in 1960-1961 and a member of its board of directors. He estimated, bid, and sold jobs, made design drawings, and personally supervised the construction and installation of equipment and was responsible for the company’s administrative affairs. In addition, he designed humidity control systems to be used in the overall ventilating systems.

88. Jesse Groves held an engineering degree and was a registered engineer licensed to practice in Kentucky. During 1960-1961, he was Liberty Engineering’s chief engineer and supervised the design, manufacture, and fabrication, from customers’ drawings, of air conditioning, dust collecting, fume removal, and general ventilating systems. He was second in charge to George L. Jackson, Liberty Engineering’s president, and he was a member of Liberty Engineering’s board of directors. Jesse Groves was Liberty Engineering’s officer primarily responsible for work performed for tbe tobacco industry. He personally supervised the making and installation of tobacco separators and classifiers, and personally installed dryers and shaker conveyors.

89. Arnold Van Etten and Jesse Groves both supervised their companies’ staff engineers and were both, in turn, responsible to tlieir chief executive officers, William J. Griffin and George Jackson, respectively. Both Van Etten and Groves were officers and members of their companies’ board of directors. They were both responsible for producing tobacco processing systems and dust and waste control systems, from customers’ drawings and specifications.

90. William R. Griffin’s duties and responsibilities were not as important or as extensive as those of Arnold Van Etten or Jesse Groves. He was younger and less experienced than any of the other officers who testified.

91. For the 10-year period 1952-1961, the various employees mentioned in previous findings received the following amounts as compensation from their respective companies:

Year Richard Blum George Jackson William J. Griffin Jesse Groves Arnold Yan Etten William R. Griffin

1961 $30,771 $33,024 $42,500 $17,469 $37,100 $36,350

1960-28,326 32,376 40,000 17,469 34,600 33,400

1959-29.827 31,984 22.500 17,365 14,400 12,600

1955-28,300 31,984 21,999 16,695 10,999 9,816

1957-21,167 33,024 19.500 15,733 9,480 7,926

1956-21,660 24,024 25,042 13,728 10,549

1955-21,660 24,024 35,009 13,156 15,404

1954_. 19,853 23,023 54,235 12,586 23,863

1953-19.828 21, 097 55,830 11,465 15,586

1952-18,000 20,020 43,247 11,380

>92. Paul Whitman, Jr., president of Market Research Associates, a Louisville company, testified as an expert witness on the question of reasonable compensation. From 1960 to 1966, he was engaged extensively in executive recruiting. Also, he has served as a consultant in helping to develop employee compensation programs, primarily in the area of heard all the relevant testimony and observed the witnesses, and he had been given G&C’s financial statements prior to trial and had studied them prior to his testimony. He testified that, in his opinion, G&C would have been required to pay between $15,000-$25,000 yearly to fill Arnold Van Etten’s position in 1960-1961, and it would have been required to pay between $10,000-$20,000 yearly to fill William sales incentives. Mr. Whitman was present at the trial and E. Griffin’s position in 1960-1961. Mr. Whitman was never told the amount of salary deemed reasonable by the Commissioner of Internal Eevenue.

Automobiles

93. (a) During 1959-1961, G&C deducted the following automobile expenses:

1959 1960 1961

Automobile expense_ $2,426 $2,745 $2,249

Depreciation — automobile. 772 1,345 4,823

Total.. $3,198 $4,090 $7,072

(b) The figures set out in paragraph (a) of this finding included the expenses incurred by G&C in connection with three automobiles which the company owned or leased and which were used by the three officers of the company, William J. Griffin, Arnold Van Etten, and William E. Griffin, who were also directors and stockholders. Each of the three officers used his assigned company automobile to commute between his home and the office, driving the automobile home each day after working hours, keeping it at bis home overnight, and then driving it to work in the morning. Each officer also used his assigned company automobile whenever it was necessary for him to travel during the business day between the office and outside projects where work was being done by G&C at customers’ job sites.

(c) The record does not contain mileage data or other evidence showing the relative extent to which the three officers of G&C used their assigned company automobiles to travel between their homes and the office, on the one hand, and to travel between the office and outside work projects, on the other hand.

(d) During 1959-1961, there was a parking lot on the property used for the Griffin offices and plant. This parking lot was enclosed by a woven steel fence, with barbed wire on top, which was 6 feet in height. The fence had three gates, which were locked during the night.

(e) The examining revenue agent disallowed a deduction in the amount of $1,200 for automobile expenses during each of G&C’s taxable years 1959,1960, and 1961.

(f) G&C offered no evidence regarding the amount of the automobile expenses which related to its business purposes.

(g) G&C offered no evidence that the automobile expenses deducted were not, in fact, the total expenses (business and personal) incurred regarding the three automobiles during the taxable years.

Repairs or Improvements

94. (a) In about 1952, G&C acquired three steel trusses for use in connection with the anticipated construction of an addition to G&C’s plant. The construction of the plant addition was delayed, however, and the steel trusses were stored outside in the weather for several years. As a result of exposure to the weather, the steel trusses became severely etched and rusted.

(b) During the fiscal year 1961, G&C expended $363.54 for the cleaning and sandblasting of the steel trusses mentioned in paragraph (a) of this finding. In addition, G&C during 1961 expended $1,114.07 for the painting of these steel trusses.

(c) The steel trusses previously mentioned in this finding, after being cleaned, sandblasted, and painted, were utilized by G&C in the long-delayed construction of the addition to its plant.

95. During the fiscal year 1961, G&C relocated certain partitions in the office portion of its plant. In connection with the relocation of the partitions, the lighting fixtures in the area were taken down, moved, and relocated. The changing of the lighting fixtures involved a total expenditure of $2,135 for labor and materials.

96. The expenditures mentioned in findings 94 and 95 were deducted by G&C on its 1961 Federal income tax return. However, such deductions were disallowed by the Internal Revenue Service, upon auditing G&C’s income tax return for 1961. The basis for the disallowances was an administrative determination that such expenditures were for capital improvements.

Depreciation

07. The following are capital improvements which, have a useful life of 10 years:

(a) An amount of $2,081.39 expended for electrical improvements in the fiscal year that ended June 30,1958, which is evidenced by G&C’s shop order No. 110.

(b) An amount of $2,480 expended for plumbing improvements, which is evidenced by G&C’s shop order No. 115.

(c) An amount of $5,253.53 expended for heating and air-conditioning, which is evidenced by G&C’s shop order No. 105.

(d) An amount of $3,340.10 expended for partitions, which is evidenced by G&C’s shop order No. 120.

,98. With respect to the expenditure of $31,652.18, as evidenced by shop order No. 100, the useful life of the improvements represented by the expenditure of $7,483.07 is in dispute. One-half thereof, or $3,741.54, was expended for improvements having a useful life of 10 years and the remainder, or $3,741.53, was expended for improvements having a useful life of 25 years.

99. The following are capital improvements which have a useful life of 25 years:

(a) An amount of $1,928.95 expended for electrical repairs, which is evidenced by G&C’s shop order No. 210.

(b) An amount of $1,625.25 expended for heating and air-conditioning repairs, which is evidenced by G&C’s shop order No. 205.

(c) An amount of $1,427 expended for plumbing repairs, which is evidenced by G&C’s shop order No. 215.

<100. During the fiscal year that ended June 30,1960, G&C expended $7,458.21 for the construction of a concrete slab for use in loading and unloading steel. This improvement has a useful life of 20 years.

101. During the fiscal year that ended June 30,1960, G&C expended $1,690 for the construction of a concrete slab, which was used in conjunction with the loading platform mentioned in finding 100. This improvement has a useful life of 40 years.

102. G&C is entitled to use the double declining method of accounting for the purpose of computing its depreciation allowances with respect to the improvements listed in findings 97 to 101, inclusive.

103. G&C constructed an asphalt driveway on April 1, 1959. The useful life of this driveway is 4 years.

104. G&C constructed a prefabricated light-weight steel warehouse in 1958. The useful life of this warehouse is 25 years.

105. G&C constructed a steelax building in 1958. The useful life of this building is 25 years.

Conclusion of Law

Upon the foregoing findings of fact and opinion, which are adopted by the court and made a part of the judgment herein, the court concludes as a matter of law that the plaintiffs are entitled to recover portions of the amounts sued for, together with interest as provided by law, and judgment is entered to that effect. The amounts of the recoveries will be determined in accordance with Rule 47 (c).  