Dr. Pepper Bottling Co., Inc. v. C.I.R., 012268 FEDTAX, 4453-65

Docket Nº:4453-65.
Opinion Judge:HOYT, Judge:
Party Name:DR. PEPPER BOTTLING COMPANY, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Attorney:P. McKinley Harris, for the petitioner. Dennis M. Feeley, for the respondent.
Case Date:January 22, 1968
Court:United States Tax Court
 
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27 T.C.M. (CCH) 73 (1968)

T.C. Memo. 1968-13

DR. PEPPER BOTTLING COMPANY, INC., Petitioner

v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

No. 4453-65.

United States Tax Court.

January 22, 1968

Respondent disallowed a large portion of the salary paid by petitioner to its president and deducted in its return for the fiscal year ended February 29, 1964. The president had not received any salary for many years because of petitioner's financial situation but performed valuable executive services for petitioner throughout the years and in the year at issue in particular.

Held: The services rendered petitioner by its president were unique, vital to petitioner's financial success and valuable. Respondent's disallowance of three quarters of his salary is unreasonable. The salary deduction of $12,521.91 claimed is found to be a reasonable allowance for actual services rendered to petitioner by its president in its fiscal year ended February 29, 1964.

P. McKinley Harris, for the petitioner.

Dennis M. Feeley, for the respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

HOYT, Judge:

Respondent determined deficiencies in petitioner's income taxes for the fiscal years ended February 28, 1962, February 28, 1963, and February 29, 1964, as follows:

Year Ended Deficiency

Feb. 28, 1962 $ 6,397.17

Feb. 28, 1963 5,059.08

Feb. 29, 1964 11,822.87

The only issue remaining for decision is whether the salary of $12,521.91 paid to petitioner's president during its taxable year ended February 29, 1964, is a deductible business expense beyond the amount of $3,000 allowed by respondent. Certain other unrelated issues have been conceded entirely or settled by the parties, and these can be taken care of in the Rule 50 computation. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly and adopted as our findings. The petitioner is a corporation having its principal place of business at the time the petition to this Court was filed at 2320 Frankfort Avenue, Louisville, Kentucky. The petitioner filed its Federal income tax returns for the fiscal years ended February 28, 1962, February 28, 1963, and February 29, 1964, with the district director of internal revenue at Louisville. During the fiscal year ended February 29, 1964, hereinafter referred to as fiscal 1963, the officers of petitioner were as follows: Robert T. Roark, president; Willette J. Roark, secretary-treasurer; and J. T. Sympson, vice president and manager. The board of directors also consisted of these same three persons. In fiscal 1963, the petitioner had 1,000 shares of $100 par value common stock outstanding. These shares were held by the following persons in the amounts indicated:

Shareholder Number of

Shares

Robert T. Roark

(president) 100

Willette J. Roark

(secretary-treasurer) 100

Mary Cash 100

Elizabeth Swindle 100

Dan Worth Cash 250

John Swindle, Jr. 250

J.T. Sympson (vice

president) 100

Total 1,000

Some of the above-named individuals are related by blood or by marriage. Willette J. Roark is the wife of Robert T. Roark, petitioner's president. Mary Cash and Elizabeth Swindle are the sisters of Robert Roark, and Dan Worth Cash and John Swindle, Jr., are their respective husbands. J. T. Sympson, the vice president and manager, is apparently unrelated by blood or marriage to any other officer or shareholder. The petitioner corporation is engaged in the manufacture, bottling, sale and distribution of carbonated beverages and soft drinks in the Louisville area. Robert T. Roark, hereinafter referred to as Robert, established petitioner in 1935, together with another Dr. Pepper Bottling Company at Lexington, Kentucky. Subsequently, he established Dr. Pepper bottling companies at Indianapolis and Muncie, Indiana. Robert, as mentioned, is still president of the petitioner corporation. However, as indicated above, 50 percent of petitioner's stock was held by his two brothers-in-law in fiscal 1963 and Robert and his wife together held only 200 of the 1,000 shares outstanding. During fiscal 1963, Robert owned stock in Pepsi General Bottlers, in the Doctor Pepper Company (Texas), and in the Dr. Pepper Bottling Company of South Carolina, but he exerted no efforts on behalf of and held no official titles or positions with any of these other mentioned soft drink companies. He did, however, actively pursue business interests in cattle, oil and beverage supplies. The beverage supply business was located in Waco, Texas, and was organized as a partnership, selling extracts and other supplies to bottlers. This beverage supply partnership sold only extract to bottlers; it did not sell sugar or syrup. Local bottlers buying from the partnership had to combine their own sugar with the purchased extract in order to produce flavoring syrup. The beverage supply partnership had customers in addition to petitioner corporation and operated at a profit. Robert lived in Louisville from 1935, the year petitioner was established, until 1950. In 1950 he moved to Texas because of his father's advancing age and because certain business interests were located there which would require his attention. At the time Robert left Louisville, the petitioner's profits were low. In order to improve petitioner's position as much as possible, Robert agreed not to take any salary from the corporation although he continued to perform services for it. In 1961 or 1962 Robert determined to devote more time to the affairs of petitioner, because its profits had remained at a low level. In the decade, 1950 to 1960, Robert had pressed other business activities with greater zeal. The marketing of soft drinks in the Louisville area is a competitive undertaking, but Robert had a thorough background in soft drink marketing which he could bring to bear on petitioner's situation. Although he decided in 1961 or 1962 to devote greater attention to petitioner's problems, and in fact did thereafter do so, Robert did not return to Louisville. During the years 1961-1962 and through February of 1964, Robert presided over petitioner's fortunes from Texas, leaving routine daily operations in the hands of the resident vice president in Louisville, whose duties were to manage the bottling plant, assume charge of the employed personnel, and supervise other purely local operations and routine matters. This resident vice president owned 100 shares of petitioner's common stock, as indicated above. Robert's responsibilities, in contract to the resident manager's, were broader in scope. While he gave final approval and considerable attention to many purely local matters, such as the repair of a roof or the erection of a new garage, he concerned himself primarily with the marketing of the product, the handling of all petitioner's franchise, labor and other contractual relationships, all authorization and buying of raw materials such as sugar, and all dealings with grantors of petitioner's franchises. Additionally, Robert was primarily and ultimately responsible for petitioner's financial situation and structure, and he made all financial and major policy decisions. The record does not specifically reveal the level of petitioner's profits prior to the time in 1961 when Robert decided to devote more attention to petitioner's affairs. However, petitioner's corporate income tax returns for the fiscal years ending in February of 1962 (fiscal 1961), 1963 (fiscal 1962), and 1964 (fiscal 1963), reveal a consistent and impressive increase in gross sales, although the corresponding change in profits before taxes does not reflect an increase for the final year due to increases in several important costs and expenses, including Robert's salary, the issue sub judice. Other substantial increases in the costs or expenses of doing business which occurred from fiscal 1962 to fiscal 1963 included a sharp rise in the cost of sugar, far and away the single most significant aspect of petitioner's ‘ cost of goods sold,‘ as well as a dramatic increase in the cost of repairing petitioner's fleet of trucks. During fiscal 1963 the construction of a new garage to modernize petitioner's repair facilities and alleviate maintenance costs was undertaken. Robert made all decisions with respect to this matter, including supervision of the plans and specifications. Extracts from petitioner's tax returns reveal the following financial picture:

Fiscal 1961 Fiscal 1962 Fiscal 1963

Gross Sales $767,098.41 $855,783.10 $948,700.47

Cost of Goods Sold 359,734.14 398,210.41 461,463.06

Gross Profit 407,364.27 457,572.69 487,237.41

Other income unrelated to the

sale of soft drinks 6,635.55 7,473.97 8,591.37

Total income before deductions 413,999.82 465,046.66 485,828.78

Total deductions 344,256.91 379,987.52 445,543.39

Net profit (income) before taxes 69,742.91 85,059.14 50,285.39

Going into fiscal 1961, petitioner showed earned surplus and undivided profits of only $82,808.08. There is no...

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