Case Name: COLLINS-McCARTHY CANDY CO., Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Court: United States Board of Tax Appeals
Jurisdiction: United States
Decision Date: 1926-09-30
Citations: 4 B.T.A. 1280
Docket Number: Docket No. 4302
Parties: COLLINS-McCARTHY CANDY CO., Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
Judges: 
Reporter: Reports of the United States Board of Tax Appeals
Volume: 4
Pages: 1280–1284

Head Matter:
COLLINS-McCARTHY CANDY CO., Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
Docket No. 4302.
Decided September 30, 1926.
W. W. Spalding, Esq., for the petitioner.
Robert A. Littleton, Esq., for the respondent.

Opinion:
OPXNION.
Millikek
: The petitioner seeks a redetermination of the tax in this case on the ground that the artificial reduction of the net income for pre-war years, occasioned by unreasonable amounts that were paid as salaries, results in an abnormality under section 327 (d) of the Revenue Act of 1918, and that we should either adjust the salaries for the pre-war years, thereby eliminating the abnormality, or, failing to do that, accord to the petitioner the benefits of section 328 of the Revenue Act of 1918.
We took occasion in the Appeal of Gray & Davis, Inc., 1 B. T. A. 222, to discuss the plan and purpose of the war-profits credits and the effect of pre-war net income in determining such credits. The plan and scope of the statute need not be again discussed. Section 320 of the Revenue Act of 1918 provides that the net income of a corporation shall be ascertained for the years 1911 and 1912 upon the basis and in the manner provided by section 38 of the Corporation Excise Tax Law of August 5, 1909, and for 1913 by section II of the Income Tax Act of October 3, 1913. By reference to the two sections of the law above set forth, it is provided that, in ascertaining net income, there shall be deducted from gross income of the corporation all ordinary and necessary expenses actually paid within the year. When salaries paid within a year are challenged on the ground that the amounts paid are unreasonable and therefore do not represent ordinary and necessary expenses, the Board will not hesitate to consider this question when pertinent to the case at issue. Nor have the courts failed to exercise this prerogative. See Becker Bros. v. United States, 7 Fed. (2d) 3. If salaries for the pre-war years were unreasonable in amount or in excess of sums duly authorized by the board of directors of the corporation, and the payment of such salaries has affected the pre-war net income, we are of the opinion that the salaries should be adjusted to represent what is a reasonable amount of compensation for services rendered. We have noted that the corporation is entitled to deduct ordinary and necessary expenses incurred in carrying on its business, including a reasonable compensation to its officers; but if it paid or sought to deduct salaries that were not authorized or were unreasonable in amount, it did not follow the mandate of the law in that respect. We have ruled in Appeal of Georgia Veneer & Package Co., 2 B. T. A. 584, that where a taxpayer set up a reserve not authorized by law the pre-war net income should not be affected by such unlawful reserve. The net income for pre-war years is to be the true net income, and, when unlawful deductions either diminish or increase such net income, they should be corrected by either eliminating the deductions from the computation or by substituting therefor lawful deductions.
The corporation, by resolution of its board of directors at the beginning of each pre-war year, passed a resolution fixing the salaries to be paid to officers. Upon the facts in this case, we are of the opinion that the salaries authorized represented a reasonable compensation for services performed. It will be noted that sums in excess of salaries authorized were paid. As concerns such excess, we are of the opinion that the same was unreasonable in amount and amounted to nothing more than a means of distributing surplus.
Some testimony was introduced in an attempt to show that the salaries authorized by the resolution of the board of directors of the corporation were excessive and unreasonable in amount and that other amounts should be substituted therefor. We are content to rest our decision on this point upon the proposition that the action of the board of directors of a corporation in authorizing salaries for a given year is entitled to the presumption of correctness unless the contrary be proven, and, such not having been done in this case, the action of the board of directors must stand.
Pre-war net income should be determined by the allowance of a deduction for salaries of $30,000 for the year 1911; $19,500 for the year 1912, and $4,500 for the year 1913. The average that will thus result for the pre-war years represents reasonable compensation for services performed.
Since no abnormality results by reason of the decision here rendered, no basis exists for the application of the provisions of section 328 of the Revenue Act of 1918.
Order of redetermination will he entered on 10 days' notice, under Rule 50.