
    WARE KNITTERS, INC. v. THE UNITED STATES
    No. 67-54.
    Decided December 3, 1958
    
      
      Mr. Paul P. Lip ton for plaintiff.
    
      Mr. Harold S. Larsen, with whom was Mr. Assistant Attorney General O hartes K. Rice, for defendant. Mr. James P. Garland was on the brief.
   Whitaker, Judge,

delivered the opinion of the court:

Plaintiff sues to recover the amount of income and excess profits taxes alleged to have been illegally exacted by reason of the disallowance of a deduction of salary it paid to its vice-president, Robert L. Nields, while, on leave of absence from plaintiff during World War II, he was employed by the Sikorsky Division of the United Aircraft Corporation, first, as a production pilot, and, later, as an experimental or test pilot.

Its deduction depends upon the proper construction of section 23 (a) (1) (A) of the Internal Revenue Code of 3939, as amended, as applied to the facts of this case. This section reads:

In computing net income there shall be allowed as deductions:
(a) Expenses.—
(1) Trade or business expenses.—
(A) In General. — All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered; * * *

This section allows the deduction of “ordinary and necessary expenses * * * in carrying on any trade or business”; that is to say, speaking broadly, such expenditures as the taxpayer deems proper for its profitable operation. Salaries to officers and employees, of course, are such expenses, but the Act places a limitation on such a deduction. It says they must be reasonable and for services “actually rendered.” Do the salary payments made while Nields was employed by Sikorsky come within the statute ?

The facts are: All the stock in plaintiff was owned by James F. Nields, Jr., with the exception of 25 shares owned by his wife. Robert L. Nields, to whom the payments in question were made, was the brother of James F. Nields, Jr. In February 1939 Robert was employed as a salesman by the plaintiff company at $18.00 a week. Three years later, on February 21,1942, he was elected to the Board of Directors, and two days later was elected vice-president of the company, and continued as director and vice-president throughout the period in question.

In July 1942 Robert left regular employment with plaintiff and entered the Civilian Pilot Training Program. This program required practically his entire time. In August 1942 he joined the Army Air Corps Enlisted Reserve as a private, but continued his services with the Civilian Pilot Training program. After completion of his course, he was given, on September 29,1942, the rating of an instructor, and thereafter he was engaged by a civilian school, which had a contract with the Army, in instructing Air Force cadets how to fly. For this service he received from the school $150 a month, at first, which was gradually increased to $400 a month.

On April 3, 1944, Robert was discharged from the Army Air Corps Enlisted Reserve, and severed his connection with the Civilian Pilot Training program. Immediately thereupon he accepted employment with the Sikorsky Division of the United Aircraft Corporation at Bridgeport, Connecticut, first, as a production pilot, and, later, as an experimental or test pilot. This division of the United Aircraft Corporation was exclusively engaged in manufacturing airplanes for use by military and naval personnel. While employed by this company Robert received a salary of something over $400 a month. He continued with this company until September 1945, shortly after the cessation of hostilities, and then returned to regular employment with the plaintiff.

Prior to Robert’s entry upon the Civilian Pilot Training program, he had received from plaintiff salary as follows: For the fiscal years ending June 30,1940, $1,366.00; June 30, 1941, $2,761.00; and June 30, 1942, $9,848.55. For the three years during which he was absent from his regular employment with plaintiff he received as salary from plaintiff $5,000 each year in plaintiff’s preferred stock, and, in addition, received cash as follows:

Fiscal year ending: Amount

June 30, 1943_$2, 706. 00

June 30, 1944_ 3,140.00

June 30, 1946_ 2,486. 00

Plaintiff was permitted to deduct the salary paid Robert while he was engaged in the Civilian Pilot Training program, but was denied the deduction when he entered the employment of the Sikorsky Division of the United Aircraft Corporation as a test pilot of airplanes for use by the military. While employed in the Civilian Pilot Training program and as a test pilot for the Sikorsky Division of the United Aircraft Corporation, Robert rendered no substantial service to plaintiff, except, plaintiff’s brother James F. Nields, Jr., the president of the company, having entered service with the Red Cross and having been sent overseas, was in no position to supervise the company’s business, top supervision of it devolved upon Robert, as vice-president. However, this supervision consisted of but little more than reviewing reports sent him and conversations with employees of the company relative to company business, and attendance on meetings of the Board of Directors.

It will be observed that the Act quoted heretofore allows a salary deduction only for “personal services actually rendered.” This section, however, has been construed to permit a deduction of salary paid for services rendered in the past or as an inducement for the employee to continue his connection with the company and to return to it at the expiration of his leave of absence. Such payments are considered “ordinary and necessary expenses”, within the meaning of 23 (a) (1) (A) of the Revenue Code. They may also be considered to be payments on account of services to be actually rendered on return from leave of absence. Kilpatrick v. United States, 52-1 USTC par. 9303 (S. D. N. Y. 1952); Burwell, Inc., v. United States, 113 F. Supp. 26 (W. D. S. C. 1953); Berkshire Oil Co., 9 T. C. 903 (1941); N. B. Drew, 12 T. C. 5 (1949); Meyer Products Co., Inc., 6 T. C. M. 1196 (1947); Hemmenway-Johnson Furniture Co., Inc., 7 T. C. M. 330 (1948); C. Morris Watkins, 9 T. C. M. 995 (1950); Silvio Amoroso, 10 T. C. M. 186 (1951); John L. Ashe, Inc., 11 T. C. M. 194 (1952); Article 108, Treasury Regulations 45 (1920 Ed.).

Amounts paid as pensions are allowable under the regulations, under certain circumstances, and amounts paid to persons in the military service, who are expected to return to their former employment, are allowable under certain circumstances.

In many instances, when a person enters upon his employment he does so in the expectation that an amount shall be paid to him currently for his services, and, also, an amount to be paid later as a pension. Since the pension is for services actually rendered, it has been held that such sums are deductible.

Likewise, if an employee has a long period of illness, during which the company continues to pay his salary, such payments are deductible, because they are paid partly in consideration of past services, as an inducement for him to return, and for services to be rendered when the employee does return to work. His salary is paid, in part, at least, because the company thinks that it is to its profit to pay it in order to secure the employee’s services in the future, and on account of those services.

For the same reason, payments of salary made to a person who enters the military or naval service during the war, with the expectation of returning to his prior employment after his discharge therefrom, are held to be deductible. The allowance of such a deduction is permissible under the Act only on the theory that when the Act permits the deduction of compensation for services actually rendered, it refers to services rendered either currently, or in the past, or on account of services to be rendered in the future. In the latter case they are in the nature of a retainer, paid to insure the availability of one’s services when needed, and on account of his future service.

Viewing the case from this standpoint alone, we see no logical distinction between the amounts paid to Robert during his period of service as a civilian in teaching Air Force cadets how to fly and during his period of service with the Sikorsky Division of the United Aircraft Corporation in testing the airplanes which the cadets would fly after he had approved them. If the company is entitled to deduct the salary paid him while he was employed in the first capacity, it would seem it is entitled to the deduction while he was employed in the second. In both capacities he was employed, not by the Government of the United States, but by private corporations. While he was instructing cadets how to fly he was employed by a school which had a contract with the Air Force to furnish instruction, and while he was testing airplanes for the cadets to fly he was also employed by a private company. The amounts paid him by plaintiff during both periods can be lawfully deducted only on the theory that they were payments made to induce his return to his former employment and for services to be rendered when he should return to work.

However, the payments of salary made while Robert was employed by Sikorsky do not come within the letter of article 108 of Regulations 45 (1920 ed.), promulgated under the Revenue Act of 1918, which contained a provision identical with that contained in the Internal Revenue Code of 1939. This same provision has been carried down in subsequent revenue acts. This article provided for deductions of amounts paid for pensions, for amounts paid as compensation for personal injuries received, and for amounts paid to an employee’s widow or heirs, in recognition of services rendered in the past. It also contained this provision:

Salaries paid by employers during the continuance of the war to employees who are absent in the military or naval service or are serving the Government in other ways at a nominal compensation, but who intend to return at tbe conclusion of the war, are allowable deductions.

It is, of course, well established that repeated re-enactment of an Act that had been construed by the Department charged with its enforcement evidences Congressional sanction of the construction the Department has placed upon it.

While Robert was employed by the Sikorsky Division of the United Aircraft Corporation, he was not in the military or naval service, nor was he serving the Government in any other way, and, hence, it is said that the salary payments are not allowable. But the question is not, do they come within the regulation, but do they come within the Act.

The regulation is not an extension of the provisions of the Act, nor can it be a limitation upon it. It is valid only as a proper construction of the Act.

Now, the Act permits a deduction for salaries paid for services “actually rendered.” The regulation recognizes that the payment does not have to be paid for services currently rendered; they may have been rendered in the past, as in the ease of pensions, or in the future, as in the case of persons in the military service who expect to return to their former employment. The Act is silent on whether the services must have been rendered currently, or could have been rendered in the past, or are expected to be rendered in the future. But the regulation construes the Act to allow the deduction for past and for future service. This construction apparently has been approved by Congress by repeated re-enactment of the statutory provision.

The re-enactment of the provision cannot be construed to limit Congressional approval to the deductions mentioned in the regulation, i. e., pensions, workmen’s compensation, salaries paid while in the military service, etc., and for these things only, because this would mean Congressional approval of a departmental extension or limitation on the Act, and this is beyond the power of the Department; the Department can only construe, not enlarge or limit. Hence, Congressional re-enactment means approval of the construction, not approval of an attempted enlargement or restriction.

The construction approved is that the services for which the payment is made may have been rendered in the past or as an inducement for future service and on account of service in the future. The Act so construed permits the deduction for salary paid Bobert while employed by Sikorsky, as well as when be was employed to instruct Air Force cadets.

Thus the regulation cannot be relied upon to deny the deduction ; it, rather, supports the construction of the Act that permits it.

Since the salary payments were made by the company, not as a gratuity, but to induce continued service and for services to be rendered on return, we think they are deductible, as a proper expense of carrying on the business, and as salary for services actually rendered. We see no logical distinction between the payments made to him while he was employed by a school to give instruction in flying to Air Force cadets, and the payments made while he was employed to test airplanes for the cadets to fly.

Plaintiff is entitled to recover, together with interest, and judgment will be entered to that effect. The amount of recovery will be determined in further proceedings under Kule 38 (c).

It is so ordered.

McLaughlin, District Judge, sitting by designation; Madden, Judge; and Jones, Chief Judge, concur.

FINDINGS OF FACT

The court, having considered the evidence, the report of Commissioner William E. Day, and the briefs and argument of counsel, makes findings of fact as follows:

1. The plaintiff is a corporation duly organized under the laws of the Commonwealth of Massachusetts on May 16,1938, and has its principal place of business at Ware, Massachusetts. It is, and was during all times material herein, engaged in the manufacture of cotton knit goods.

2. On January 1, 1942, and at all material times thereafter, the plaintiff’s outstanding common stock consisted of 352 shares, of which 327 shares were owned by James F. Nields, Jr., and 25 shares were owned by his wife, Martha B. Nields.

S« Prior to April 1, 1944, James F. Nields, Jr., who had been the driving force in the organization and management of the company, served as the plaintiff’s president and treasurer. On March 29, 1944, because of his departure for overseas for service with the Ned Cross, he resigned as president but continued to hold the office as treasurer.

4. In February 1939, Kobert L. Nields, then 25 years old, was employed by the plaintiff at a salary of $18 per week. The business was developing rather rapidly, and Kobert L. Nields was employed to assist his brother, James F. Nields, Jr. in the sales end of the business. Kobert L. Nields started work in the office at Ware and then in the knitting room, creating new fabrics and learning about the operation of the machinery and the general operations of the company.

5. In January 1942, James F. Nields, Jr. went to Washington, D. C. for service with the War Production Board, which service continued until April 1944. During this time he was able to and did spend weekends at his home and at the plaintiff’s factory.

6. At a special meeting of plaintiff’s stockholders held February 21, 1942, Kobert L. Nields was elected to plaintiff’s board of directors, and he was elected vice president at a meeting of the board of directors held February 23, 1942. He was re-elected to the board of directors at meetings held July 15,1942, July 23,1943, July 19,1944, and July 18,1945. He continued to hold his office as vice president throughout the war and is still a vice president and director.

7. Kobert L. Nields was married in the month of October 1941, and his first child was born in July 1942.

8. In July 1942, Kobert L. Nields, who was then subject to call by the local Selective Service Board, entered the Civilian Pilot Training program. This was a full-time program and Kobert L. Nields withdrew from regular employment with the plaintiff in order to carry it out. He was given a leave of absence from the firm but continued to occupy the office of vice president and member of the board of directors.-

9. In August 1942, while engaged in the Civilian Pilot Training program, Kobert L. Nields joined the Army Air Corps Enlisted Keserve as a private. Upon being sworn in, he was placed on inactive duty status for completion of the civilian training.

10. On about September 29, 1942, Eobert L. Nields, who had had earlier flying experience obtained a flying rating as an instructor, an advanced rating. Under the Civilian Pilot Training program, he was assigned in October 1942, to Maxwell Field, Alabama, and on about December 23, 1942, to a training detachment at Clarksdale, Mississippi. As a civilian, receiving pay as a civilian, he was there engaged in teaching the art of flying airplanes to Army Air Force cadets. His pay for this work began at $150 per month and increased from time to time to about $400 per month. As such instructor, he was employed by the civilian school which had contracted with the Army to instruct Air Corps cadets. Eobert L. Nields was so engaged until February 11,1944.

11. On April 3,1944, Eobert L. Nields was given an honorable discharge from the Army Air Corps Enlisted Eeserve. He was thereafter subject to call by his local Selective Service Board. That board classified him in some manner as engaged in work that was essential to the war effort.

12. Upon leaving Clarksdale, Mississippi, Eobert L. Nields became immediately employed at a monthly salary slightly in excess of $400 by the Sikorsky Division of United Aircraft Corporation at Bridgeport, Connecticut, as a production pilot, and later as an experimental or test pilot. Eobert L. Nields continued civilian employment at Sikorsky until August or September 1945. At that time he returned to work at the plaintiff company.

13. From the time Eobert L. Nields left his employment at the plaintiff company in June 1942 until he returned in August or September 1945, he received pay from the plaintiff. He reported such pay as income on his income tax returns and paid the tax shown to be due on the amount thereof.

14. The Commissioner of Internal Eevenue allowed deductions claimed by the plaintiff on its Federal income tax returns in respect of the salaries paid to Eobert L. Nields for the fiscal years ended June 30, 1942, 1943 and 1946. As to the year 1944 he disallowed $3,113.66 of the amount claimed as deductions, and as to 1945 he disallowed the entire amount claimed.

15.Salaries were paid by tbe plaintiff to Eobert L. Nields for tbe fiscal years indicated as follows:

Fiscal year ended: Amow/it

6/30/40 _$1,366.00

6/30/41 _•_ 2,761.00

6/30/42 _ 9,848.55

6/30/43 _ 7,705.00

6/30/44 _ 8,140.00

6/30/45 _ 7,485.00

6/30/46 _10,712.74

For each of the fiscal years ended June 30, 1943, 1944 and 1945, $5,000 of such amounts were paid in $100 par value preferred stock of the plaintiff corporation. All other amounts shown were paid in cash.

16. The plaintiff, in addition to making payments during the war to Eobert L. Nields, made regular payments of salary to three key employees during their service in the armed forces who had contributed to its early development, and whose services the plaintiff wished to retain when the war was over.

17. There is some evidence in the record that Eobert L. Nields did perform some services for the plaintiff while he was employed by Sikorsky at Bridgeport. Such services were of little substance, except his attendance at six stockholders’ meetings, two of which were held on separate Saturday mornings.

18. In computing plaintiff’s tax liability for the year ended June 30,1944, the Commissioner of Internal Eevenue allowed a deduction for salary paid to Eobert L. Nields in the amount of $5,026.34, but disallowed the balance of the deduction claimed. The amount allowed as a deduction for the year ended June 30,1944, was based upon the allowance of a salary for the period from July 1,1943, to and including February 11, 1944. The sum of $5,026.34 was computed on the basis of 226/366 of $8,140.

19. In computing plaintiff’s tax liability for the year ended June 30, 1945, the Commissioner of Internal Eevenue has disallowed the deduction claimed by plaintiff for salary paid to Eobert L. Nields in the amount of $7,485.

20. Plaintiff filed Corporation Income and Declared Value Excess Profits Tax Eeturns (Forms 1120) and Corporation Excess Profits Tax Returns (Forms 1121) for its fiscal years ended June 30, 1944, and June 30, 1945, with the Collector of Internal Revenue, Boston, Massachusetts, on or before October 15,1944, and September 15, 1945, respectively. The taxes shown as due on these returns were paid.

21.Following an examination of plaintiff’s tax returns for the said years, the Commissioner of Internal Revenue assessed deficiencies in declared value excess profits tax and excess profits tax, plus interest, as follows:

Yewr ended Year ended

6/30/44 6/30/45

D. V. E. P. T._$1, 826.91 " $590.22

Interest _ 321.51 68.45

E. P. T_ 21, 920. 88 7,115.21

Interest _ 3, 644. 06 825.26

22. The amounts assessed for the year ended June 30,1944, plus “delay” interest on declared value excess profits tax and excess profits tax in the respective amounts of $51.44, less a post-war refund credit against excess profits tax in the amount of $2,192.09, was paid, or credited, by plaintiff as follows:

On or about 11/16/48_$2,199. 86

On or about 1/15/49_ 23, 902.63

23. The amounts assessed for the year ended June 30, 1945, plus “delay” interest on declared value excess profits tax and excess profits tax in the respective amount of $15.77 was paid or credited as follows:

On or about 11/16/48_ $674.44

On or about 1/15/49- 7, 940.47

24.The deficiencies set forth in finding 21 were based in part on the Commissioner’s disallowance of deductions claimed by plaintiff for salary paid to Robert L. Nields while employed by Sikorsky, as follows:

Tear ended 6/30/44_$3,113.66

Tear ended 6/30/45_ 7, 485

25.Plaintiff filed claims for refund, on Forms 843, of declared value excess profits tax and excess profits tax, based on the disallowance of deductions claimed for salary paid to Robert L. Nields as follows:

26.Plaintiff’s claims for refund for the year ended June 30,1944, have been allowed in part as follows:

D. Y. E. P. T._ $331. 74

E. P. T- 3,933.61

27. Plaintiff was notified by registered letter dated August 7, 1952, of the disallowance, to the extent not previously allowed, of its claim for refund of excess profits tax for the year ended June 30, 1944, but has not been notified of the disallowance of its claim for refund of declared value excess profits tax for the year ended June 30, 1944.

28. Plaintiff was notified by registered letter dated February 19, 1952, that its claim for refund of declared value excess profits tax and excess profits tax for the year ended June 30, 1945, were disallowed in full.

CONCLUSION OP LAW

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

In accordance with the opinion of the court and on a memorandum report of the commissioner as to the amount due thereunder, it was ordered on March 20,1959, that judgment for the plaintiff be entered for $9,037.72, plus interest as provided by law.  