Pepsi-Cola Bottling Co. of Salina, Inc. v. C. I. R.

• Decision Date: 21 January 1976
• Docket Number: No. 74--1388,PEPSI--COLA,74--1388
• Citation: 528 F.2d 176
• Parties: 76-1 USTC P 9107 BOTTLING COMPANY OF SALINA, INC., Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Tenth Circuit

Page 176

528 F.2d 176

76-1 USTC P 9107

PEPSI--COLA BOTTLING COMPANY OF SALINA, INC., Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 74--1388.

United States Court of Appeals,

Tenth Circuit.

Submitted Jan. 23, 1975.

Decided Dec. 8, 1975.

As Amended on Denial of Rehearing

Jan. 21, 1976.

Thomas J. Kennedy, Salina, Kan. (Robert B. Berkley, Salina, Kan., on the brief), for petitioner-appellant.

F. Arnold Heller, Atty., Dept. of Justice, Washington, D.C. (Scott P. Crampton, Asst. Atty. Gen., Gilbert E. Andrews, Elmer J. Kelsey, Daniel F. Ross, Attys., Tax Div., Dept. of Justice, Washington, D.C., on the brief), for respondent-appellee.

Before HOLLOWAY, McWILLIMAS and DOYLE, Circuit Judges.

HOLLOWAY, Circuit Judge.

This appeal challenges a determination made by the Commissioner of Internal Revenue that compensation paid to the executive officer of a closely held corporation was unreasonably high in three tax years, deductions for the full amount of the compensation should be denied, and that deficiencies existed. The Tax Court sustained the findings of unreasonableness of compensation, allowing however more deductions than the Commissioner. 61 T.C. 564.

The taxpayer is the Pepsi-Cola Bottling Co. of Salina, Inc., a Kansas corporation engaged in the manufacture, packaging and distribution of particular name brand soft drinks within an exclusive franchise area. The company began as a sole proprietorship in 1941, operated by R. W. Nesbitt and his wife, Verla Nesbitt. When Mr. Nesbitt died in 1945, Mrs. Nesbitt continued the business as sole proprietor until July 1, 1955, at which time she caused the business to be incorporated. Mrs. Nesbitt, now Mrs. Joscelyn, has served as president and general manager of the corporation since its inception and has at all times held 248 of the outstanding 250 shares of stock (Tr. 50).

On February 14, 1956, the directors of the company adopted a resolution which has remained continuously in effect since that time and which prescribes a contingent compensation arrangement for Mrs. Joscelyn. ¹ Compensation was paid to Mrs. Joscelyn in accordance with the resolution for the years 1956 through 1970. This suit concerns only the compensation which the company deducted on its returns for the calendar years 1968, 1969 and 1970. The compensation to Mrs. Joscelyn in those three years was $67,187, $88,457 and $97,552, respectively, all in accordance with the resolution.

Through the years the company has been highly successful. The national Pepsi Cola Company considers per-capita consumption within a franchise territory to be one of the best measures of a successful franchise holder. By this standard the taxpayer company ranked first in Kansas and in the top 5% of approximately 500 Pepsi Cola bottling plants in the United States. There was undisputed testimony that in the opinion of experienced individuals engaged in the bottling business, the growth and success of the taxpayer company has been due primarily to the managerial attributes and qualities of Mrs. Joscelyn. ²

During the years in issue Mrs. Joscelyn was in good health, was 63, 64 and 65 years of age, and continued to be active in the business. She was the company's only active executive officer for all the years in question. During those years the company employed respectively a total of 56, 60 and 64 persons. Mrs. Joscelyn had no other business activities and the undisputed proof was that she worked 50, 60 or 70 hours a week, working six days a week and on Sundays, if necessary. She performed all types of tasks for the Company (Tr. 24).

The Commissioner determined deficiencies for 1968, 1969 and 1970 in the respective amounts of $35,158.05, $47,859.44 and $50,783.89, concluding that compensation to Mrs. Joscelyn was excessive to the extent that it was in excess of $40,000 for each year in issue (R. 64--65). The taxpayer filed a petition in the Tax Court for a redetermination of the income tax deficiencies.

At trial the Tax Court received testimony and written evidence, including a statistical comparison of executive compensation in the soft drink industry (Exhibit 4--D, 1968 Financial Survey of the Soft Drink Industry, published by the National Soft Drink Association). It was shown also that the company had never paid a dividend to shareholders.

The Tax Court concluded that the company had shown the Commissioner's determinations as to reasonable amounts of compensation to be erroneous, but it did not agree that Mrs. Joscelyn's compensation during the years in issue was a reasonable allowance for personal services actually rendered within the meaning of § 162 of the Internal Revenue Code (R. 74). The Court found that $50,000 for 1968, $54,500 for 1969 and $57,500 for 1970 constituted reasonable compensation to Mrs. Joscelyn for the services rendered (R. 78). Since only the company appealed, we address solely the issue whether the Tax Court erred in finding that the compensation paid by Mrs. Joscelyn was unreasonable to the extent that it exceeded the amounts stated above.

Section 162(a)(1) of the Internal Revenue Code of 1954 permits a taxpayer to deduct as ordinary and necessary business expenses 'a reasonable allowance for salaries or other compensation for personal services actually rendered.' 26 U.S.C.A. § 162(a)(1). The controlling principles for review of Tax Court decisions under this section of the Code are clear. No fixed rule applies to determine a reasonable salary. Reasonableness depends on the circumstances of each case and the question is one of fact which must be determined in light of all the evidence. Perlmutter v. C.I.R., 373 F.2d 45, 47 (10th Cir.). The taxpayer has the burden of showing that the amounts deducted were in fact reasonable compensation. Botany Worsted Mills v. United States, 278 U.S. 282, 49 S.Ct. 129, 73 L.Ed. 379 (1929); see also Perlmutter, supra at 47.

The factors to be considered in determining reasonableness of compensation have been stated innumerable times. The Tax Court accepted the formulation found in Mayson Mfg. Co. v. C.I.R., 178 F.2d 115, 119 (6th Cir.), without apparent disagreement from either party. We present these factors in a numerical listing to facilitate further references. They include:

1. The employee's qualifications.

2. The nature, extent and scope of the employee's work.

3. The size and complexities of the business.

4. A comparison of salaries paid with the gross income and the net income.

5. The prevailing general economic conditions.

6. A comparison of salaries with distributions to stockholders.

7. The prevailing rates of compensation for comparable positions in comparable concerns.

8. The salary policy of the taxpayer as to all employees.

9. In the case of small corporations with a limited number of officers the amount of compensation paid to the particular employee in previous years.

The situation must be considered as a whole, with no single factor being decisive. Moreover, the action of a corporate board of directors in voting salaries for a given period is entitled to the presumption that such salaries are reasonable and proper. Mayson, supra at 119.

Since the determination of reasonableness is a factual one, this court need only decide whether or not the findings of the Tax Court are clearly erroneous. Commissioner of Internal Revenue v. Duberstein, 363 U.S. 278, 291, 80 S.Ct. 1190, 4 L.Ed.2d 1218; Perlmutter, supra at 47. And we note at the outset that in determining reasonableness of compensation special scrutiny should be given to compensation paid by a corporation whose stock is closely held. Ibid.

The Tax Court carefully weighed the evidence presented in light of the factors discussed in Mayson. It pointed out that Mrs. Joscelyn gave very sparse testimony herself. The Court found that the taxpayer has failed to carry its burden of proving that the compensation paid was reasonable. Although the bulk of the evidence was offered by the taxpayer, we find that there was substantial proof to support the finding and conclusion of the trier of fact. Socash v. Addison Crane Co., 120 U.S.App.D.C. 308, 346 F.2d 420, 421; West v. H. K. Ferguson, 382 F.2d 630, 632 (10th Cir.). We cannot say the Tax Court was clearly in error in finding that the compensation paid to Mrs. Joscelyn in 1968, 1969 and 1970 was unreasonable insofar as it exceeded the amounts of $50,000, $54,500 and $57,500, respectively.

On appeal the taxpayer makes two main points: (1) that the Tax Court erred in disallowing use of the agreed compensation formula which was adopted in good faith and was reasonable when adopted, which is the proper time at which to judge the agreement, and which has been consistently followed; and (2) that the Court erred in using statistical data from a 1968 soft drink industry survey on executive compensation without proof of comparability to the services rendered by Mrs. Joscelyn, which the taxpayer claimed to be unique and primarily responsible for the company's growth and success. (Brief of Appellant at 10--11, 26).

The taxpayer did not present evidence on each of the Mayson factors with the object of proving the compensation reasonable. Rather, the company attempted to explain the absence of proof of several of these factors by urging that those factors were not readily applicable to the specific situation herein. First, the company offered little or no evidence of the nature, extent and scope of Mrs. Joscelyn's work, factor 2. Indeed, the Tax Court was moved to comment that 'many dark areas' were left in this part of the case (R. 74). The company also offered no evidence on the prevailing economic conditions, factor 5, or on the salary policy of the company as to other employees, factor 8. There was a survey exhibit, discussed below, comparing salaries with those paid by other companies, factor 7.

As stated, the Tax Court considered a comparison with other soft drink executives shown by the national survey (See...