GENERAL SMELTING COMPANY, A CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 2795. Promulgated November 15, 1944.

1. Petitioner's president and directing head, who had served in that capacity for a good many years, in 1937 retired as president and was elected chairman of petitioner's board of directors. He was 72 years of age and in good health. He continued to serve petitioner, but in a somewhat reduced capacity. He continued to determine the buying and selling policies of petitioner, which were its most important requirements. Held, the sums which were paid this former president in the taxable years 1938, 1939, and 1940, under agreement between him and petitioner's board of directors, as pension for past services and as compensation for services actually rendered petitioner in the taxable years were reasonable and the amounts so paid are allowable as deductions under section 23 (a), Revenue Act 1938 and Internal Revenue Code.

2. Petitioner was an operating company, its business primarily consisting of the manufacture and sale of secondary zinc and aluminum. In the conduct of its business it was required to carry inventories of raw materials of considerable value and bills receivable of considerable size. Petitioner's business was highly competitive, and in 1938 it decided upon a plan of modernization of its plant which was to and did extend over a period of several years. In 1939 World War No. 2 broke out in Europe and the volume of petitioner's business was substantially increased thereby. Petitioner did not distribute any of its earnings and profits in 1939 and 1940, but retained them in its business for the purpose of financing its modernization program and its increased business. Held, that in 1939 and 1940 petitioner was not availed of for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its earnings or profits to accumulate instead of being distributed to its stockholders and it is not liable for the surtax imposed by section 102 of the Internal Revenue Code. Whitney Chain & Mfg. Co., 3 T. C. 1109, distinguished.

Yale L. Schekter, Esq., for the petitioner.

W.J. McFarland, Esq., for the respondent.

The Commissioner has determined deficiencies against petitioner as

follows:

The petition assigns numerous errors attacking the correctness of the determination which the Commissioner has made. The assignments of error which are now pressed raise the following issues: (1) Did the Commissioner err in disallowing as deductions from the gross income of the petitioner for the taxable years 1938, 1939, and 1940 the sum of $14,400 paid in each year by petitioner to T. Lewis Thomas, the chairman of its board of directors and its former president, as compensation for services actually rendered to petitioner in the taxable year and in part as pension payments for his past services? (2) Was the petitioner availed of in the taxable years 1939 and 1940 for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its earnings or profits to accumulate beyond the reasonable needs of petitioner's business instead of being divided or distributed to its stockholders?

FINDINGS OF FACT.

Many of the facts have been stipulated. The stipulation is incorporated herein by reference.

The petitioner is a corporation organized under the laws of the State of New Jersey, with its principal office in Philadelphia. Its returns for the periods here involved were filed with the collector for the first district of Pennsylvania at Philadelphia. Petitioner's business is that of buying, selling, and smelting ores and minerals and metallic substances. It has engaged in that business continuously since 1904, its business consisting primarily of the manufacture and sale of secondary zinc and aluminum. During the taxable years petitioner had only one class of stock authorized, namely, 3,000 shares of common stock of a par value of $100 per share. Of these shares, 2,950 were outstanding and 50 shares were held in the company's treasury. In April 1926 T. Lewis Thomas transferred by gift all but 50 shares of the stock held by him in petitioner to his son, Lowell S. Thomas, and his daughter, Marjorie T. Pomeroy. Following this transfer the holders of the issued and outstanding capital stock of petitioner were:

In March 1936 T. Lewis Thomas sold and transferred his 50 shares to General Smelting Co., and in April 1938 Marjorie T. Pomeroy and

Lowell S. Thomas acquired by purchase, equally, the 24 shares previously issued to S. J. Lloyd, so that since April 1938 to the present date all the issued stock of General Smelting Co. has been held as follows:

Issue 1.-T. Lewis Thomas was one of the incorporators of General Smelting Co. in 1904. He served as a director of the company continuously from 1904 to 1936, as president of the company continuously from 1908 to 1937, and as chairman of the board of directors of the company continuously from 1937 to the present date. Prior to March 1937 he was the president and active head of the petitioner and had active control of all the buying and selling and administrative policies. The entire operation was under him and he spent four to five days a week at the office.

In March 1937 Thomas retired as president of petitioner and was succeeded by his son, Lowell S. Thomas, who became president and the active head of petitioner. T. Lewis Thomas was then elected chairman of petitioner's board of directors, and he continued to serve petitioner, but in a somewhat reduced capacity. He remained largely in control of the buying and selling policy; he maintained his contact with many of the larger customers; he was at the office an average of three days a week; he continued to be active, even to the extent of going over the mail; he has had years of experience in the business, the most important element of which was the decision of when to buy and when to sell, and he continued to make most of those decisions for the company.

When T. Lewis Thomas retired as president and was elected chairman of petitioner's board of directors he was 72 years of age and in good health. The compensation per annum paid him as president by the petitioner during the years 1930-1936 was as follows:

The amount paid him as chairman of the board by the petitioner in

The above payments were entered on the books of petitioner as administrative expenses and were reported by petitioner on its yearly Federal tax returns under "Salaries and wages (not deducted elsewhere)."

On his individual Federal income tax return for each of the years 1937-1940 inclusive, T. Lewis Thomas reported under "Salary and other compensation for personal services" the items of income set forth above.

The compensation of $14,400 per annum above mentioned was fixed by the board of directors of the petitioner in agreement with T. Lewis Thomas and was based on two things: (1) Pension for services which he had rendered petitioner in the past thirty-two years; (2) as compensation for services which he was still to render to petitioner and which he did in fact render during each of the taxable years.

The volume of business of the petitioner was $1,312,125 in 1938, $1,761,393 in 1939, and $2,308,073 in 1940.

Petitioner has not adopted a fixed pension plan, but in various cases between 1923 and 1942 it has by corporate action approved and made payments to employees and their dependents on occasions of illness or death. The individual cases where this has been done are enumerated in the stipulation, but it is unnecessary to set them forth in detail here. The payments of $14,400 to T. Lewis Thomas in each of the taxable years 1938, 1939, and 1940 were reasonable, considering the volume of business transacted by petitioner and the services which Thomas had rendered to petitioner in the past and the services which he continued to render it in the taxable years.

Issue 2.-The business in which petitioner is engaged is highly competitive. Conditions in the industry made it necessary for petitioner to plan and carry out a program involving new buildings and installation of modern machinery. The plan was studied and formulated in 1938, in which year land was bought by petitioner at a cost of $6,688, and in 1940 additional land was bought by petitioner at a cost of $8,311.83. On this land petitioner has built three new buildings a smelting department building, a new zinc distilling building. and a new aluminum building. In addition, new machinery and equipment were installed by petitioner. Much of this was done under the advice and guidance of Singmaster & Breyer, metallurgical engineers, pursuant to written contract dated June 19, 1940.

These expenditures for the years 1937 to 1942, including land, buildings, machinery, and equipment, cost $112,562.71, and the work still to be done on this modernization program will cost an additional $152,500. These additional facilities were a reasonable need of the petitioner's business.

The outbreak of the Second World War on September 1, 1939, gave petitioner reasonable ground for the belief that its business would

materially increase, and it did in fact increase, as shown by the volume of its business for the following years:

Purchases of scrap in the smelting industry are usually made for cash, and an increased business volume required additional working capital.

At December 31, 1933, T. Lewis Thomas owed to petitioner the sum of $146,103.98 for moneys loaned to him by petitioner for his personal use, and at December 31, 1936, that indebtedness was $146,288.39 and it was reflected on the books of the petitioner as an account receivable. During 1936 T. Lewis Thomas met with financial difficulties, whereupon his indebtedness to the petitioner was settled upon payment by him of $500 and the balance of $145,788.39 was charged off on its books by the petitioner. In its Federal income and excess profits tax return for the year 1936 the petitioner claimed as a deduction from its gross income the above item of $145,788.39 as a bad debt, and it was allowed by respondent.

The petitioner in 1938, 1939, and 1940 paid the premiums on certain policies of insurance on the life of T. Lewis Thomas and also loans and interest due on these policies during said years. The total yearly amounts so paid out by petitioner were:

The above payments are reflected on the yearly balance sheets of petitioner as an asset account under the heading "Payments on Life Insurance policies." These policies had been pledged by T. Lewis Thomas with the Corn Exchange National Bank as security for a personal debt, and subject thereto T. Lewis Thomas had on March 20, 1936, assigned these policies to petitioner on account of his debt to petitioner above described. As the above stated payments on these policies were made by petitioner the cash value of the policies increased and petitioner's equity therein increased. These payments were made by petitioner in good faith for the business purpose of attempting to recoup from the policies part of the debt which was owing to it by T. Lewis Thomas and was charged off as a bad debt in 1936.

Petitioner's gain (or loss) after accrual of Federal income taxes for the years 1935 to 1942, inclusive, was: