Ecco High Frequency Corp. v. Commissioner of Int. Rev.

• Decision Date: 27 April 1948
• Docket Number: No. 39,Docket 20541.,39
• Citation: 167 F.2d 583
• Parties: ECCO HIGH FREQUENCY CORPORATION v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Second Circuit

167 F.2d 583 (1948)

ECCO HIGH FREQUENCY CORPORATION v. COMMISSIONER OF INTERNAL REVENUE.

No. 39, Docket 20541.

Circuit Court of Appeals, Second Circuit.

April 27, 1948.

C. F. Rothenburg, of Washington, D. C. (Everett Frooks and Margaret Frooks, both of New York City, of counsel), for petitioner.

Theron Lamar Caudle, Asst. Atty. Gen. and Helen R. Carloss and Louise Foster, Sp. Assts. to Atty. Gen., for respondent.

Before L. HAND, SWAN, and AUGUSTUS N. HAND, Circuit Judges.

AUGUSTUS N. HAND, Circuit Judge.

The questions involved in this appeal from the Tax Court are: (1) Whether in computing net income for income tax, declared value excess profits tax, and excess profits tax for the year 1941, there is substantial evidence to support the Tax Court's finding that $40,000 instead of $56,000 claimed by the taxpayer was a properly deductible allowance under section 23 (a) of the Internal Revenue Code, 26 U.S.C.A. Int.Rev.Code, § 23 (a), for the personal services of Emil R. Capita who was its president, treasurer and only salaried officer during the years 1939, 1940 and 1941, and who also acted as its sales engineer; (2) whether the finding of the Tax Court that a portion of the legal fees claimed by the taxpayer as a deduction for tax purposes represented payment for services rendered by the attorney to Capita in his individual capacity and not to the taxpayer.

The business of the taxpayer, Ecco High Frequency Corporation, is the manufacture of electrical high frequency heating equipment. Capita had gained knowledge of the business of manufacturing industrial high frequency equipment through his studies and especially through his employment as factory superintendent of the Lepel High Frequency Corporation, a concern engaged in manufacturing a high frequency converter, by which he was employed between the years 1928 and 1937. In 1937 he decided that it would be advantageous for him to set up a business of his own. To aid his purpose his uncle and aunt agreed to furnish capital to organize Ecco High Frequency Corporation, the taxpayer herein. To that end they each subscribed two thousand dollars and received 50 shares of its stock and entered into an agreement with Capita whereby they held the shares issued in their names for his "exclusive use and benefit." They also agreed that they would assign over their shares to Capita at any time upon his repayment to them of the subscription price, would make no other assignment of their shares except subject to the terms of the foregoing agreement, in the meantime would be entitled to receive all dividends paid on the shares, and in the event of the liquidation of the corporation before repayment of the subscription price would be entitled to receive two thousand dollars each while the balance of the liquidating dividends would be payable to Capita. Neither of the stockholders ever took any active part in the conduct of the business and Capita always regarded the business as his own and devoted all of his efforts to making it a success. He designed all of the equipment which Ecco manufactured, purchased all its materials and sold all its finished products. Most of the sales resulted from his personal contacts. As sales engineer of the corporation he secured contracts for particular types of equipment, supervised the manufacture and saw that the equipment was properly installed and capable of satisfactorily functioning.

The Tax Court found that it was the custom of the trade to pay commissions of 40% on sales of high frequency equipment made within the City of New York and slightly more on sales made outside of that territory. There was also evidence however that almost half of this commission was frequently in turn paid by the sales engineer to agents who secured the prospective purchasers, even though the sales engineer closed the sales himself. See Petitioner's Appendix, pp. 75, 90. The Tax Court did not apply this custom of the trade as a binding standard for fixing the value of Capita's services during the year 1941. The table appended in the margin¹ shows taxpayer's gross sales (less returns and allowances), officers' salaries, net income, federal tax, and dividends paid, for the years 1937-1941, inclusive, as reported in its income tax returns for the respective years.

At a meeting of the taxpayer's stockholders held December 16, 1939, it was agreed that Capita should receive for that year as compensation for his services commissions of 15% of its gross sales. His compensation for 1940 was raised to 30% of gross sales at a stockholders' meeting held December 16, 1940. The same percentage of gross sales, 30%, was voted to him by the directors at a...