Per Ctjriam :
These cases come before the court on plaintiff's exceptions to a recommended decision filed February 7, 1973, by Trial Judge Boald A. Hogenson, pursuant to Buie 134(h). The court has considered the cases on the briefs and oral argument of counsel. Since the court agrees with the recommended decision, as hereinafter set forth, it hereby adopts the same as the basis for its judgment in the cases. Therefore, it is concluded that in computing its taxable income for each of the years 1964-1967, plaintiff is entitled to deductions, as reasonable allowances for salaries and other compensation paid for personal services actually rendered, in the sum of $75,000 per year for its president, B. O. Giles, $37,500 per year for its viee president, Bay Neely, and $25,000 for 1964 and $37,500 for each of the years 1965-1967 for its treasurer, James Giles. Entry of judgment is deferred until the amounts of recovery on plaintiff's petitions and defendant's counterclaims have been determined in further proceedings pursuant to Eule 131, to permit offsetting of the amounts of recovery to arrive at a net judgment in favor of the party entitled to recover the larger sum.
OPINION OF TRIAL JUDGE
Hogenson, Trial Judge:
In these three consolidated cases, plaintiff, a Tennessee corporation organized in 1959, seeks judgment for refund of alleged overpayments of Federal income tax for calendar years 1964 through 1967. Plaintiff timely filed its return for each year, and paid the amount of tax computed thereon.
For 1964 and 1965, plaintiff paid deficiency assessments, which reflected partial disallowances by the Internal Eevenue Service of deductions for officers' compensation paid by plaintiff. In timely claims for refund, plaintiff challenged such disallowances, and also alleged other grounds for relief. More than 6 months elapsed without allowance or disallowance of such claims. Plaintiff timely filed its petition herein for such years, Docket No. 140-68, alleging the same grounds for recovery as asserted in its claims.
Plaintiff timely filed claims for refund of amounts of tax paid as reported on its returns for 1966 and 1967. Such claims were not acted upon within 6 months, and plaintiff timely filed its petitions herein, Docket No. 76-69 for 1966 and Docket No. 337-69 for 1967, covering its claims for those years.
In the latter two cases, defendant filed counterclaims for unpaid deficiencies, assessed after commencement of such cases, for the years 1966 and 1967. Such deficiencies were based in part on partial disallowances of deductions for officers' compensation paid by plaintiff for such years.
On the representation of the parties that it appeared reasonably certain that all other issues would be settled, the trial of these cases was limited to the issues of law and fact relating to the right of either party to recover on the question of extent of deductibility of officers' compensation.
On October 22, 1971, after the trial had been held, the parties filed a stipulation that all issues but one had been settled by agreement of the parties; that the only remaining issue concerned officers' compensation paid by plaintiff to certain of its officers, E. O. Giles, Eay Neely and James Giles; and that the amount of refund to which plaintiff might be entitled, or the amount of additional deficiency which it may owe, should be determined under Eule 131(c) (2) on the basis of the disposition of the compensation issue by the court and the agreement on the other issues.
During the years 1964-1967, plaintiff was engaged in manufacturing and sale to independent dealers of mobile homes, and commencing in 1967, also travel trailers.
Out of 1,100 outstanding shares of plaintiff's stock, E. O. Giles owned 960 shares in 1964 and 840 shares in the years 1965-1967. Eay Neely and his wife, Dorothy (daughter of E. O. Giles), owned respectively 40 and 30 shares in 1964, and 70 and 60 shares in 1965-1967. James Giles (son of E. O. Giles) and his wife, Maxine, had the same respective share holdings as did the Neelys.
Plaintiff deducted, for Federal income tax purposes, the following amounts of compensation paid to its president, E. O. Giles, to its vice president, Eay Neely, and to its treasurer, James Giles, as well as the following amounts of compensation paid to its secretary, Earl Helton, and to its non-officer chief of sales, Bernard Eockstadt:
No issue has been raised as to the compensation paid to Helton and Eockstadt. Eockstadt resigned his employment with plaintiff in the middle of 1965.
The Internal Eevenue Sea*vice, upon audit of plaintiff's tax returns, determined that no more was deductible as reasonable annual compensation for E. O. Giles, Eay Neely, and James Giles than $25,000 each for the years 1964, 1966 and 1967, and $25,220.76 each for 1965. The assessed deficiencies inflected disallowances of deductions of compensation paid to them in excess of such amounts.
Plaintiff began constructing mobile 'homes in early 1960 on a very small basis in Tazewell, Tennessee. Its first mobile homes were relatively high-priced, .and did not Bell well. K.. O. Giles then established the policy, Which plaintiff has practiced since 1961, to build mainly low cost units, more readily saleable in plaintiff's market area. In 1962, plaintiff moved its operations to a larger plant 'located in ¡Middlesb'oro, Kentucky. 'By 1965, this new plant was expanded so that its floor space increased from 60,000 to 180,000 square feet, almost five times the floor space of the original shop in Tennessee.
During the years in issue, plaintiff manufactured five to six different models of mobile homes, each model having a variety of floor plans. In late 1967, it ¡began producing travel trailers in five different models. All these units were built on an assembly line where component parts were added as each unit moved from station to station. The completed units were delivered by plaintiff's 40 trucks to 100 to 125 independent dealers located in 20 to 22 surrounding states.
Plaintiff was able to sell its mobile homes at a price substantially less than the price of comparable models of other manufacturers because of (1) its efficient operations, (2) its elimination of some accessories which other manufacturers included in their units, and (3) its cheaper labor costs in •the area of its plant operations.
Plaintiff's dollar sales volume increased from $276,828 in 1960 to $6,776,757 in 1964, and decreased somewhat each year thereafter to $5,629,603 in 1967. During this period of declining dollar sales volume, however, plaintiff's pre-tax income increased from $321,104 in 1964 to $937,808 in 1967. Only in 1966, when the entire industry was adversely affected by a tight money market, did plaintiff's pre-tax income decline from the previous year. Also, plaintiff's cost of materials used in the manufacturing process declined each year from $5,303,826 in 1964 to $3,124,273 in 1967, and plaintiff succeeded at producing mobile homes of a larger size at a declining cost per square foot of floor space.
During the years 1964-1967, plaintiff's four officers constituted the entire management staff, and its only other executive employee was Bernard Rockstadt until he resigned in mid-1965. Plaintiff's administrative personnel were otherwise a secretary-receptionist, an inventory clerk, two to three office clerks, and two sales and dispatching clerks. The inventory clerk and the two sales and dispatching clerks assisted the three officers whose compensation is in issue, and the office clerks and secretary-receptionist assisted the corporate secretary.
The rest of plaintiff's employees were workmen in the plant operations and truekdrivers, varying from year-end forces of 119 in 1964, 212 in 1965, 221 in 1966, to 212 in 1967. The truekdrivers constituted about 20 to 30 of these employees. Plaintiff hired its first plant foreman in 1965. A plant inspector was added in 1966. Four additional plant foremen were hired in 1967.
Plaintiff's founder and president, R. O. Giles, is a native Teimessean, born in 1906, whose formal education ended at the sixth grade. Prior to entering the mobile home manufacturing business, he owned and operated a variety of enterprises, including a country store, a tomato canning operation, a farm, a sawmill, home construction, a planing mill, a lumber yard, an automobile distributorship and garage, and a cedar manufacturing shop which produced bedroom suites, wardrobes and chests. It was while he was engaged in the cedar manufacturing business that he expanded the floor capacity of his shop, purchased and installed machinery for production of mobile homes, and organized plaintiff corporation.
During the years in question, R. O. Giles functioned not just as titular chief executive but as the real head of the company. He was the person responsible for the organization, commencement and development of the business to the status of operations attained at the commencement of the years in issue, and remained its active leader throughout the period directly concerned in this case. He determined basic policy, although some decisions were made in consultation with the vice president and the treasurer. He .participated in every facet of the business. Most of his time was spent supervising the production employees, all of whom he hired personally. Since they were unskilled workmen, he taught them how to construct the units. He handled the purchasing and supervised the installation of all machinery. Experienced in the lumber and milling industries, he purchased and supervised the cutting of rough lumber used in plaintiff's operations. He also assisted in designing new mobile home models and in making changes in the floor plans of existing models. His direct participation in sales activities, however, was limited to taking incoming telephone orders when other personnel were not available, and to meeting occasional visitors to the plant, sometimes taking them to plaintiff's local dealer for accomplishment of sales.
Ray Neely, plaintiff's vice president, finished high school, worked on a farm, was employed by Southern Railway, and engaged in the service station and trucking business before he entered plaintiff's employment in 1961. He earned as much as $120 per week in these endeavors. He had had no previous experience in the mobile home business. Giles hired him to assist in purchasing materials, inventory control and supervising production. In time, he assumed primary responsibility for the purchasing and inventory functions, and continued handling them until James Giles was employed in February 1964. After being trained by Neely for several months, James Giles was assigned such matters.
Beginning in 1963, Ray Neely worked extensively in sales, in cooperation with Bernard Rockstadt, and when the latter resigned in mid-1965, Neely became primarily responsible for sales. Sales were conducted generally over the telephone, and dealers called plaintiff to place orders, sometimes for as many as 10 units. Two clerks, employed in 1965, assisted by taking-telephone orders, lessening the effect of Rockstadt's departure. Sales activities also consisted of visiting dealers and supplying them with advertising brochures, and attending out-of-state mobile home shows four or five times each year. Sales incentives such as rebates were provided to dealers who attained prescribed sales levels.
Eay Neely, to a lesser extent than E. O. Giles, supervised production workers. With the aid of the latter, Neely designed the new model of mobile home introduced in 1965, planned rearrangements of floor spaces on the various models, and also designed the five models of travel trailers in 1967. Neely priced the units sold, using a hill of materials furnished by James Giles, and adding labor, overhead, profit and hidden costs to arrive at profitable wholesale prices. Neely's other responsibilities included preparing advertising brochures, collecting payments from dealers, conducting transactions with banks, and hiring truckdrivers. He was also in charge of dispatching deliveries of units to dealers, selecting highway routes, securing road-use permits, distributing fuel stickers, and directing departure of trucks early in the morning.
James Giles, plaintiff's treasurer, completed high school and thereafter owned and operated a refrigerator sales and service business for 3 or 4 years. He earned about $6,000 to $7,000 a year before his employment by plaintiff in February 1964. He had had no experience in the mobile home business. Giles hired him to work primarily in purchasing and inventory control, and to learn the overall business.
During 1964, Eay Neely assisted James in purchasing for several months until James learned the function sufficiently to take over complete responsibility. Purchasing was conducted primarily over the telephone, although suppliers also visited plaintiff's office. James bought all of the materials, supplies, equipment 'and appliances for the mobile homes, except rough lumber. There were over 500 different items involved, including steel frames, axles, wheels, plumbing and electrical components, aluminum sheeting, plywood, furnaces, refrigerators, air conditioners, mattresses, box springs, sinks, lavatories, commodes, gas and electric ranges, carpeting, linoleum, and many others. James also assumed responsibility for inventory control. He closely observed production operations and the functioning of the overall business to aid him in his handling of purchasing and inventory control. He acknowledged lack of acquaintance with technical concepts of inventory management, but thoroughly understood the practicalities of his assignment, i.e., that sufficient mate rials and supplies bad to ¡be on hand when needed for manufacturing operations, and that excessive inventories would adversely affect the business. Rapid turnover of inventory is characteristic of successful operations in the mobile home industry.
Plaintiff's Federal income fax returns for the years 1964-1967 reflect the following:
Year Inventory Beginning purchased for inventory manufacture
1964_ $192, 168 $5, 303, 826
1965.. 216,172 4, 774, 319
1966__ (297, 383 4,169,398
1967_ 303, 430 3,124, 273
The inventory at the end of 1967 (same as beginning inventory for 1968) was $341,506. The record in this case discloses no explanation for the steady increases in the dollar volume of inventories. However, based upon all of the factors involved in the successful operation of plaintiff's business, it is concluded that the purchasing of materials and supplies and the control of inventories were reasonably well accomplished.
In addition to the foregoing responsibilities, James Giles assisted to a lesser degree than Ray Neely in supervising production employees. He also hired truckdrivers, and purchased trucks. He supervised the dispatching of trucks to deliver parts to dealers and to bring purchased supplies to plaintiff's plant. He assisted in designing units and in preparing advertising brochures. James participated to a minor extent in sales, directly accounting for about 5 percent of total sales. He also attended the mobile home shows, where he met suppliers and observed their displays.
The three officers involved shared responsibility for some functions. They supervised the frequent repairs required on vehicles, decided replacement of worn-out trucks, occasionally inspected for quality on the assembly line, and even after all five plant foremen were employed, they continued to supervise the production employees. The United Mine Workers organized the employees in 1965, following a 5-week strike, and thereafter all three officers spent considerable time negotiating union contracts, with the aid of an attorney, and handling employee grievances.
Earl Helton, the corporate secretary and only non-relative officer, attended Bowling Green University for almost 2 years, studying bookkeeping and accounting. After 1940, he worked as a bookkeeper earning as much as $125 per week. He joined plaintiff in 1963 and assumed the responsibilities of office manager. His duties included making the payrolls, keeping the ledgers, accounts receivable and accounts payable, and hiring office personnel. He engaged in sales activities for a short period beginning with the resignation of Bernard Bockstadt in 1965, but in early 1966, on his own choice, he returned exclusively to his original responsibilities as office manager.
K. O. Giles determined the amount of compensation the officers and Bernard Bockstadt received. He apparently relied upon his own subjective considerations as to the value of their services. He seemed affected by the fact that in his 1959 search for a superintendent of plant operations, two applicants each proposed compensation at $150 per week and 3 percent of sales. However, he did not hire either applicant because he deemed such compensation excessive.
The three officers involved and Bernard Bockstadt, and for a short period, Earl Helton, received a commission on sales. Such compensation was in addition to basic salary and bonus. The commission, according to plaintiff, was based upon a simple and logical plan. When Bockstadt was hired in 1962 as chief of sales, Giles agreed to pay him one-half of 1 percent of total company sales over the $23,000 per month level then being attained. Bockstadt was not to benefit from Giles' sales efforts up to that time. Bay Neely was originally employed by Giles for $100 per week, but when he began working in sales in 1963, Giles decided to pay him the same commission as Bockstadt was receiving. James received this same commission from the day he started work in February 1964. Beginning in 1964, Giles also decided, after a discussion with the other officers, that he should receive a commission of 1 percent of total company sales over $23,000 per month. Significantly, Earl Helton received a commission (the same as that of Bay Neely and James Giles) only while he was engaged in direct sales activities after the departure of Eockstadt.
These payments, although termed a "commission,"' obviously had no relationship to the actual sales attributable to each individual since (1) the percentage was based upon total company sales, and (2) some officers, such as E. O. Giles and James, accounted for only minimal sales. In addition, Eockstadt was the only person precluded from benefiting from sales attributable to someone else's earlier efforts. James Giles, for example, received a commission on all sales over $23,000 a month, even though the total sales in the year before he joined plaintiff, 1963, amounted to $3,827,153.55. Faced with these circumstances, plaintiff commenced to call the commissions "incentive compensation" at the trial of these cases.
For the years 1964-1967, the amounts of salary, bonus and commission paid to each officer whose total compensation is in issue, as well as those of Earl Helton and Bernard Eock-stadt, were as follows:
Plaintiff's expert witness, Robert F. Klumpp, a former partner of Arthur Anderson & Company, knowledgeable on accounting practices in the mobile home industry, testified that a commission based upon sales is an acceptable, if somewhat unsophisticated, manner of compensating officers in that industry. In a closely held corporation, however, where the stockholders are related, a commission on total company sales for general services rendered, paid to the related officers, appears to be an arrangement by which the officer-stockholders are drawing off some of the corporate profits in the guise of compensation, but not in actuality for personal services rendered. Hampton Corp., 23 CCH Tax Ct. Mem. 899, 902 (1964), aff'd U.S. Tax Cas. (65-2, at 96, 616) ¶9611 (9th Cir. June 11, 1965); Am-Plus Storage Battery Co. v. Commissioner, 35 F. 2d 167, 169 (7th Cir. 1929).
As shown by the above table of compensation paid to them, the combined amount of salary and bonus paid to each of the three officers increased markedly for 1965 over 1964. The combined increase for R. O. Giles was $19,250, and for Ray Neely and James Giles, $10,900 each (taking into consideration that James' salary amount in 1964 was not for a full year). Earl Helton, on the other hand, received only a combined increase of $1,750. When R. O. Giles, under cross-examination, was asked to explain the reason for the increased compensation, he was only able to respond that the officers were "worth it." It cannot reasonably be found that the responsibilities of the officers changed substantially during the period involved. The number of units sold by plaintiff increased only slightly from 2,100 in 1964 to 2,239 in 1965, declining thereafter to 2,152 in 1966 and to 1,982 in 1967, and presumably production paralleled these figures during the same years. A plant foreman was hired along with the additional production employees in 1965, and other plant supervisors were added in the remaining years. Two sales clerks were employed in 1965 to take telephone orders. Plaintiff's net sales reached the highest level in 1964 for the 4 years in issue. The sharp increase in the combined salary and bonus for each of the three officers in 1965, thereafter substantially maintained in 1966 and 1967, warrants an in ference that the comparatively large payments in 1965-1967 were partially based on factors other than mere compensation for services rendered. Griffin & Company v. United States, 182 Ct. Cl. 436, 453, 389 F. 2d 802, 812 (1968).
With respect to the substantial bonus paid to each of the three officers in each of the 4 years involved, and bearing in mind their relative stock holdings, consideration is given to the principle that a bonus paid to a nonstockholder employee, which is reasonable, might be unreasonable if paid to a large stockholder, because bonus incentive would presumably not be needed to call forth the stockholder's best efforts. Irby Construction Co. v. United States, 154 Ct. Cl. 342, 347, 290 F. 2d 824, 827 (1961).
Of course, what constitutes reasonable allowances (for which deductions from plaintiff's taxable income are to be allowed under section 162(a) (1) of the Internal Revenue Code of 1954) for salaries and other compensation paid to the three officers for personal service's actually rendered, depends upon all of the facts and circumstances in this case, without any one factor controlling. Jones Bros. Bakery, Inc. v. United States, 188 Ct. Cl. 226, 231, 411 F. 2d 1282, 1285 (1969).
Paragraph (a) of Treas. Reg. § 1.162-7, 37 CUM. BULL. (Part 1) 63, 70 (1958), states that the test of deductibility in the case of compensation payments is whether they are reasonable and are in fact purely for services, ¡and in paragraph (b) (3) thereof, it is stated that in any event "the allowance for the compensation paid may not exceed what is reasonable under all the circumstances", and that it is "in general, just to assume that reasonable ¡and true compensation is only sutíh amount as would ordinarily be paid for like services by like enterprises under like circumstances."
This court has recognized and applied the test of compensation paid to similar employees of similar concerns in similar industries, Griffin & Company v. United States, supra, but has held that reasonable comparability in its various aspects must be established to prove reasonableness of compensation paid. Northlich, Stolley Inc. v. United States, 177 Ct. Cl. 435, 444, 368 F. 2d 272, 278 (1966); R. J. Reynolds Tobacco Co. v. United States, 138 Ct. Cl. 1, 14, 149 F. Supp. 889, 897, cert. denied, 355 U.S. 893 (1957).
Considerable evidence was presented concerning compensation paid to officers of other mobile home manufacturing companies, but such evidence cannot be accepted as determinative of the reasonableness of officers' compensation in this case, because with respect to some of such companies, incom-parabilitj is clearly shown, both with respect to the nature of their operations and the services performed by their officers, and because with respect to the others, there is either insufficient or no proof as to similarity of operations and services performed.
Skyline 'Homes, Inc., was a giant company in the mobile home manufacturing industry, having 13 plants in 1964, increasing to 24 by 1968, located in various states nationwide. Its president, executive vice president, and treasurer were paid combined salary and bonus in the respective amounts of $65,000, $51,721 and $30,200 for the year ended May 31,1965; $75,000, $52,040 and $40,012 for fiscal year 1966; $75,000, $84,684 and $50,119 for fiscal year 1967; and $100,000, $130,000 and $75,000 for fiscal year 1968.
Skyline's total number of corporate officers varied from nine in 1964 to six by 1968. Each officer had substantial amounts set aside by the company in a retirement plan, with benefits fully vested after 10 years of employment, and except for the corporate secretary, the company paid premiums on $45,000 term life insurance, payable to the beneficiary named by the officer. Skyline's national sales coordinator was paid between $25,000 and $28,000 annually. Each of Skyline's plants had a plant manager, paid $20,000 to $35,000 per year, a sales manager, paid $18,000 to $20,000 per year, and one to three salesmen. While each plant manager was responsible for the performance of his plant, many responsibilities were centralized in the corporate headquarters, such as purchasing, designing, pricing, accounting, and selection of dealers. The plant and the corporate headquarters worked together in preparing invoices and in conducting transactions with local financial institutions. The duties of the corporate officers of Skyline were executive in nature.
Guerdon Industries, Inc., another nationwide mobile home manufacturing company, had eight plants in 1964, which increased to 19 by 1968. By the latter year, Guerdon employed about 2,900 persons, of whom 2,600 were engaged in manufacturing operations, 75 in sales (including 38 field representatives engaged in the solicitation of orders from dealers) and 225 in administrative duties. Its mobile homes were marketed through approximately 1,200 dealers throughout the United States.
Mr. Robert Meneely, an experienced corporate management official, was president of Guerdon from November 23, 1965, to October 6, 1967. He received direct compensation of $46,654 for the fiscal year ended April 30, 1967. Mr. F. L. Cappaert, chairman of the board of directors of Guerdon, received direct remuneration of $75,000 and $5,250 set aside for his benefit in the company's profit-sharing retirement plan. For the following year, serving as Guerdon's president, Cappaert received the same compensation. Cappaert was a principal stockholder. Meneely owned no stock in Guerdon.
Redman Industries, Inc., had five mobile unit manufacturing plants in 1964, which increased to nine by 1968. Plant managers received a salary of $20,000 to $30,000 per year and a bonus based upon the plant's profits. The highest amount paid to a plant manager during the years in question was just over $50,000. Plant managers were responsible for the profit performance of their plants, and they had to operate within a predetermined budget for labor and other expenses. However, they were not responsible for designing, engineering, advertising, purchasing, bookkeeping, accounting, and payroll functions.
During the years in question, Mr. James Redman, holding the title of president and later chairman of the board of directors, was the supervisor of overall operations of Redman. Other officers included a vice president of finance, responsible for maintaining internal accounting controls, preparing budgets, operating plans and the payroll; a vice president of materials, responsible for negotiating supply contracts, establishing inventory and cost controls, and training the purchasing agents employed by the plants; a vice president of industrial relations, responsible for handling union matters; a vice president of sales; and a vice president of operations.
Redman's officers received as compensation a base salary and a bonus which, was based upon a percentage of pre-tax profits. During its fiscal years 1965-1968, the amounts of combined salary and bonus paid to J ames Redman and the next highest paid officers were as follows:
Parkwood Homes, Inc., began mobile home manufacturing in one plant at Bristol, Indiana, in 1962, added a second plant at Moultrie, Georgia, in 1965 or 1966, and in 1968, opened a third and a fourth plant in Texas and at Middle-bury, Indiana. Its overall volume of units sold did not greatly exceed that of plaintiff during the years in question, but similarity of operations ends there. Apparently each plant had a manager, and also a sales manager and one or two salesmen.
Parkwood's president, Raymond F. Bassett, was responsible for all phases of production, the design of the units and the establishment of new plants. Pie also reviewed all pricing prepared by cost accountants. As vice president, Robert Gaume was primarily responsible for sales, and he also did whatever else was necessary to manage the company, as there were no formal rules delineating responsibilities. As treasurer, Clayton Merrill was responsible for keeping the financial records, paying the bills, handling the payroll and working with the credit manager.
B & J "Woodcraft, Inc. manufactured furniture, counter tops, cabinets, doors and other furnishings and trim for mobile homes. During the years in question, its officers were the same as those of Parkwood, and Parkwood was its pri mary customer. Parkwood's president and vice president each, owned 50 percent of B & J's stock.
Aside from life insurance and retirement benefits provided, Parkwood and B & J paid compensation directly to their three officers as follows:
Sales managers for Parkwood received a salary between $15,000 and $22,000 per year, and a purchasing agent had a beginning salary of between $200 and $225 per week, with more to be paid if he remained with Parkwood.
Skyline, Guerdon, Bedman and Parkwood, with their multi-plant operations, their division of responsibilities, and delegation of duties to non-officers, were clearly not comparable in their operations to plaintiff company, and the services performed by their officers were not similar.
Defendant requested findings of fact as to the compensation paid to officers of other mobile home manufacturers, namely, Lonergan Corporation, Fleetwood, Divco-Wayne, Champion, Town and Country, Princess-Zimmer, Commodore, Monarch and Conner. There is no evidence in the record concerning either the duties and responsibilities of the individual officers, or the operations of the companies. It is •concluded that the various amounts of such compensation, standing alone, are irrelevant as a measure of the reasonableness of compensation paid to plaintiff's officers.
Although consistently holding that there is no definite formula for determining reasonableness of compensation in any particular instance, and that it is a question of fact to be resolved anew in each case, without any one fact to be considered controlling to the exclusion of all others, Jones Bros. Bakery, Inc. v. United States, supra, Irby Constr. Co. v. United States, supra, this court nevertheless has recognized and applied performance ratios, based on financial statistics, as guides in deciding reasonableness of compensation of corporate officers. Boyd Constr. Co. v. United States, 168 Ct. Cl. 579, 339 F. 2d 620 (1964); Gordy Tire Co. v. United States, 155 Ct. Cl. 759, 296 F. 2d 476 (1961).
In support of its position that the full amounts of compensation paid to its president, vice president and treasurer were reasonable and deductible in computing its taxable income, plaintiff relies heavily on performance ratios of plaintiff and 15 other companies, computed by Eobert F. Klumpp. The other companies were those which were engaged, as was plaintiff, primarily in the manufacturing of mobile homes, as opposed to travel trailers, and which filed documents with the Securities and Exchange Commission, setting forth financial data as to their operations in the years 1964-1967. Mr. Klumpp considered these 15 companies (referred to herein as the larger group of other companies) representative of the industry, because their combined sales amounted to 39 percent in 1966 and 48 percent in 1967 of the total sales in the United States. Of these 15 manufacturers, Mr. Klumpp considered nine of them (herein referred to as the smaller group of other companies) comparable to plaintiff, because each of the nine had sales in 1964 less than $20,000,000, thus excluding the giants of the industry.
Plaintiff asserts that four sets of performance ratios, computed by Mr. Klumpp from the financial data relating to the years 1964-1967, are the most important to prove the reasonableness of compensation paid to its officers. Each percentage stated herein is the weighted average per year for the 4 years.
First, after allowing all of the compensation paid by plaintiff to its officers in computing pre-tax income, plaintiff's average annual pre-tax income was 8.05 percent of its net sales, compared to 4.4 percent attained by the larger group, and 5.3 percent by the smaller group of other companies.
Second, the average annual return on invested capital (after-tax net income as a percentage of beginning stockholders' investment) was 72 percent for plaintiff, 20.6 percent for the larger group, and 39:3 percent for the smaller group of other companies.
Third, during three of the years involved, plaintiff extended a total of $101,215.12 to R. O. Giles as loans. The Internal Revenue Service treated these disbursements as dividends. This determination was contested by R. O. Giles by the filing of two petitions in this court, and his individual cases were consolidated with subject cases. At the outset of the trial, plaintiff and R. O. Giles conceded the correctness of the dividend determination, and the individual suits brought by R. O. Giles were subsequently dismissed by stipulation of the parties. No other amounts of money were distributed by plaintiff as dividends since its formation. These disbursements amounted to an average annual 6.85 percent of plaintiff's beginning stockholders' investment over the 4-year period involved, compared to an average annual cash dividend of 5.23 percent for the larger group of other companies, and 4.25 for the smaller group.
Fourth, the corporate Federal income tax returns of four mobile home manufacturers show that each of such companies paid as compensation to its officer and non-officer sales and administrative personnel a higher average annual percentage of pre-tax pre-compensation income than plaintiff did. Redman, Lonergan, Parkwood, and Skyline paid respectively 52.03, 49.59, 45 and 36.49 percent, while plaintiff paid 33114 percent.
Relying on R. J. Reynolds Tobacco Co. v. United States, supra, defendant argues that plaintiff's performance ratios are useful only as an investment analysis and that they fail to establish the worth of the services of the individual officers. In Reynolds, this court held that reasonableness of officers' compensation was not shown by comparison of the total amount paid by the taxpayer with the aggregate amount paid by each of its three competitors, without proof of the duties and responsibilities of individuals doing like jobs. In subject case, plaintiff's officers performed duties clearly not comparable to those of the officers of Redman, Parkwood and Skyline, and no evidence was introduced to show the duties of Lonergan's officers. However, it is established that as a group, the officer, sales and administrative personnel perform similar functions in both large and small mobile manufacturing companies. While the fourth set of ratios does not prove the reasonableness of compensation paid to any one officer, it does tend to show the reasonableness of compensation paid for all officer, sales and administrative services, and thus to place in proper perspective the compensation paid to officers of a small company, who performed extensively duties usually assigned to non-officer personnel in large companies.
In the alternative to its basic position that plaintiff failed to prove that the amounts paid to its officers represented reasonable compensation for their services, defendant argues that under the formula utilized in Charles McCandless Tile Service v. United States, 191 Ct. Cl. 108, 422 F. 2d 1836 (1970), 15 percent of plaintiff's net profits (before Federal income tax and compensation paid to the officers involved) should be considered a return on equity capital and a distribution of corporate earnings, and to that extent not deductible as officers' compensation. MeOandless, however, is clearly distinguishable from subject case. There, the court expressly stated that no precise formula was available to strike a balance between compensation and investment-return in the closely held corporation, and it was only after an examination of the entire record that the court concluded that a return of equity capital of 15 percent was reasonable. Each of the two stockholder-officers owned 50 percent of the corporate voting stock, and each received identical compensation, which amounted to 50 percent of the net profits (before Federal income tax and the two officers' compensation) during each of the 3 years involved. Moreover, in McCandless, the company never paid dividends, in any form, to its stockholders.
In subject case, three of plaintiff's four officers were stockholders. Two of the five stockholders were not officers. The compensation paid to the three stockholder-officers was not proportional to their respective stockholdings. The president held 12 times the number of shares of either the vice president or the treasurer. The president's compensation was about twice that of either the vice president or the treasurer, with the latter two owning the same number of shares and receiving about the same compensation. The compensation paid to the three officers amounted to about 27.6 percent of plaintiff's net profits (before their compensation and Federal income tax) over the period involved. Moreover, plaintiff paid dividends as previously described. In short, clear factual differences preclude the application of the McCandless formula herein.
After consideration of the cited cases in the light of all of the evidence adduced in the trial of this case, it is concluded that in computing plaintiff's taxable income in each of the years 1964-1967, plaintiff is entitled pursuant to section 162(a)(1) of the Internal Kevenue Code of 1954 to deductions, as reasonable allowances for salaries and other compensation paid for personal services actually rendered, in the amount of $75,000 per year for its president, K. O. Giles, $37,500 per year for its vice president, Kay Neely, and $25,000 for 1964 and $37,500 for each of the years 1965-1967 for its treasurer, James Giles. By 1964, K. O. Giles and Kay Neely were thoroughly experienced in the handling of plaintiff's business. James Giles was inexperienced when he commenced his employment with plaintiff in 1964, and spent several months in training before assuming primary responsibility for purchasing and inventory control of supplies and materials.
Entry of judgment should be deferred until the amounts of recovery on plaintiff's petitions and defendant's counterclaims have been determined in further proceedings pursuant to Kule 131, to permit offsetting of the amounts of recovery to arrive at a net judgment in favor of the party entitled to recover the larger sum.
The concurring opinion of DAVIS, Judge, follows the opinion of the trial judge which has been adopted by the court.