Consol. Apparel Co.
v.
Comm'r of Internal Revenue

Tax Court of the United States.Mar 21, 1952
17 T.C. 1570 (U.S.T.C. 1952)
17 T.C. 1570T.C.

Docket Nos. 20107 24980.

1952-03-21

CONSOLIDATED APPAREL CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Joseph E. Rapkin, Esq., for the petitioner. Harold H. Hart, Esq., for the respondent.


1. Rentals paid to a family trust which was created for the purpose of acquiring the overriding leasehold estate from petitioner's lessor, disallowed, to the extent that they exceeded the rental which petitioner was obligated to pay in the taxable years under the old lease.

2. Reasonable compensation for services performed by petitioner's president and vice president determined on the evidence.

3. Where amortization deductions on leasehold improvements during the base period years were excessive, due to the fact that the cost of such improvements was spread over the remaining short term of petitioner's lease, held, that such excess should be disallowed under section 711(b)(1)(J), Internal Revenue Code, for the purpose of computing petitioner's average base period net income and its excess profits credits for 1945 and 1946.

4. An amount subscribed and paid during 1946 to a development and advertising association of merchants in petitioner's business district held deductible in full as a business expense of that year.

5. Verification of petitioner's income and excess profits tax returns for 1945 by its president, who was also treasurer, held substantial compliance with the statutory requirement that the returns be signed and sworn to by the president and the treasurer or other principal accounting officer. Joseph E. Rapkin, Esq., for the petitioner. Harold H. Hart, Esq., for the respondent.

These proceedings involve deficiencies and penalties, as determined in the deficiency notices, as follows:

+-----------------------------------------------------------------------------+ ¦ ¦ ¦ ¦Declared ¦ ¦ ¦ ¦ +--------+----------+---------+-------------+-------+--------------+----------¦ ¦Year 1 ¦Income tax¦Penalty ¦value excess-¦Penalty¦Excess profits¦Penalty ¦ +--------+----------+---------+-------------+-------+--------------+----------¦ ¦ ¦ ¦ ¦profits tax ¦ ¦tax ¦ ¦ +--------+----------+---------+-------------+-------+--------------+----------¦ ¦1944 ¦ ¦ ¦$300.05 ¦ ¦$28,478.47 ¦ ¦ +--------+----------+---------+-------------+-------+--------------+----------¦ ¦1945 ¦ ¦$4,072.58¦3,238.10 ¦$809.53¦45,952.43 ¦$21,997.74¦ +--------+----------+---------+-------------+-------+--------------+----------¦ ¦1946 ¦$12,239.72¦ ¦ ¦ ¦22,231.67 ¦ ¦ +-----------------------------------------------------------------------------+ FN1 Fiscal year ending July 31.

By an amendment to the answer filed in Docket No. 24980, respondent asks for increases in the deficiencies and penalties for 1945 and 1946 as follows:

* * * (1) in income tax for the taxable year ended July 31, 1946 in the amount of $2,717.00; (2) in declared value excess-profits tax for the taxable year ended July 31, 1945, in the amount of $701.01 and $177.50 in penalty; (3) in excess profits tax liability for the taxable years ended July 31, 1945 and 1946 in the total amount of $8,127.38 and (4) in the amount of $1,103.02 in penalty for 1945.

The issues presented are (1) the rental deductions to which petitioner is entitled in 1945 and 1946, (2) the reasonableness of salaries paid to petitioner's officers in 1945 and 1946, (3) whether in computing excess profits credits for 1945 and 1946 certain deductions taken for amortization of leasehold improvements should be disallowed under the provisions of section 711(b)(1)(J) and (K), Internal Revenue Code, (4) the deductibility in 1946 of the full amount of subscription and payment which petitioner made in that year to a merchants' promotional and advertising association of which it was a member, and (5) whether petitioner is liable for the statutory 25 per cent penalty for failure to file properly executed income and declared value excess-profits tax and excess profits tax returns for 1945.

Some of the facts have been stipulated.

FINDINGS OF FACT.

1. Rental Deductions.

The stipulated facts are incorporated herein by this reference.

Petitioner is a Wisconsin corporation engaged in the retailing of ladies' and children's ready-to-wear clothing, with its principal store and office located in Milwaukee, Wisconsin. Its returns for the years here involved were filed with the collector for the district of Wisconsin. The returns were made on an accrual basis for a fiscal year ending July 31.

Petitioner was organized in 1932. Its capital stock was held during the taxable years involved as follows:

+-----------------------------------------------------------------+ ¦ ¦Shares of¦Shares of¦ +---------------------------------------------+---------+---------¦ ¦Stockholder ¦common ¦preferred¦ +---------------------------------------------+---------+---------¦ ¦H. LeVine & Bro., Inc ¦197 ¦827 ¦ +---------------------------------------------+---------+---------¦ ¦Ida Rosenberg Leubusher ¦99 ¦376 3/4 ¦ +---------------------------------------------+---------+---------¦ ¦Leonard LeVine ¦1 ¦60 ¦ +---------------------------------------------+---------+---------¦ ¦Aaron Scheinfeld ¦1 ¦1 1/4 ¦ +---------------------------------------------+---------+---------¦ ¦Harry LeVine ¦1 ¦ ¦ +---------------------------------------------+---------+---------¦ ¦B. F. Saltzstein ¦1 ¦ ¦ +---------------------------------------------+---------+---------¦ ¦A. P. Rosenberg or A. P. Rosenberg Estate 1 ¦ ¦78 ¦ +---------------------------------------------+---------+---------¦ ¦Ada LeVine ¦ ¦2 57 ¦ +---------------------------------------------+---------+---------¦ ¦Edward LeVine ¦ ¦50 ¦ +---------------------------------------------+---------+---------¦ ¦Willard LeVine ¦ ¦50 ¦ +---------------------------------------------+---------+---------¦ ¦Totals ¦300 ¦1,500 ¦ +-----------------------------------------------------------------+ FN1 A. P. Rosenberg died in 1945.FN2 Purchased by Ada LeVine in 1944.

H. LeVine & Bro., Inc., is a holding company whose stock was all owned, during the taxable years, by Harry LeVine, his wife, Ada LeVine, and their three sons, Leonard, Willard, and Edward, ages 33, 30, and 26, respectively. Aaron Scheinfeld is the son-in-law of Ida Rosenberg Leubusher, the former wife of A. P. Rosenberg, deceased. A. P. Rosenberg was the brother of Benjamin Rosenberg, who is married to a sister of Harry LeVine. He was the founder of petitioner's predecessor and a former partner of Harry LeVine.

Petitioner's officers were Harry LeVine, president and treasurer, Leonard LeVine, vice president, Aaron Scheinfeld, secretary. The directors were Harry LeVine, B. F. Saltzstein, Aaron Scheinfeld, and Leonard LeVine. The common shares only had voting power.

At the beginning of the tax year 1944 petitioner occupied premises consisting of the basement, ground floor, and a portion of the second floor located on the northwest corner of North Third Street and West North Avenue, Milwaukee, under leases from three different lessors. The major portion of the premises consisted of a portion of the building known as Berlin Arcade Building which was under a lease to Consolidated Mercantile Company, lessee, dated February 1, 1941, for a period ending April 30, 1952, at a yearly rental of $22,000. Consolidated Mercantile Company was a corporation organized at about the time of petitioner's organization whose stock was owned two-thirds by Harry LeVine or his wife and sons and one-third by Mrs. A. P. Rosenberg. It served no purpose but to hold the lease in question for petitioner's benefit and had no other assets. Petitioner paid Consolidated Mercantile Company a rental of $22,500 per year.

The lessor of the Berlin Arcade Building, Third-North Realty Company, held a 99-year lease on the entire building, which in 1944 had 67 years to run.

On May 27, 1944, Harry LeVine, as settlor, created a family trust, or trusts, hereinafter referred to as the Trust, which a few days later, on May 31, 1944, purchased the said 99-year leasehold from Third-North Realty Company, and on October 24, 1944, leased to petitioner the premises which it then occupied for a period of 25 years from August 1, 1944, at an annual rental of 3 per cent of gross sales with a minimum rental of $30,000 per year.

The trust indenture was entitled ‘Harry LeVine Trusts.‘ The trustee was B. F. Saltzstein, an attorney, who had served petitioner as counsel and a director. The corpus consisted of $20,000 cash which Harry LeVine paid to the trustee. The beneficiaries were the wife and three sons of Harry LeVine. There were provisions of the trust indenture, not here material, for the distribution of income and corpus to the beneficiaries, equally. It was specifically provided that the primary purpose of the Trust was the acquisition of the Berlin Arcade Building leasehold. The trustee was authorized to borrow sufficient additional funds for that purpose.

Pursuant to that plan the trustee purchased the leasehold from Third-North Realty Company on May 31, 1944, for a total consideration of $190,000. This amount was made up of the $20,000 of original corpus, plus a loan of $55,000 from Harry LeVine, plus a mortgage and bond issue of $115,000.

The old lease between Third-North Realty Company and Consolidated Mercantile Company was canceled without consideration to either party. In addition to the new lease on the premises then occupied, the trustee gave petitioner an option to rent any of the upper floors of the Berlin Arcade Building at a rental of 3 per cent of the gross sales on that floor with a minimum rental of $6,000 per year.

In 1944 Harry LeVine and his associates were contemplating an expansion of petitioner's business and the outlay of a considerable amount of capital for leasehold improvements. They felt that before making these expenditures petitioner should have the protection of a long term lease on the premises. The existing lease, which they then held, had only 8 more years to run. It was with this in mind that Harry LeVine set up the Trust to purchase the long term lease. The improvements were made about 4 years later at a total cost of approximately $200,000.

Petitioner paid rent to the Trust in 1945 and 1946 in the respective amounts of $49,972.31 and $59,758.33, being 3 per cent of its total net sales for those years of $1,665,743.67 and $1,991,944.33.

The total gross income, expenses, and net income of the Trust for 1944 (June 1 to December 31), 1945, and 1946 were as follows:

+---------------------------------------+ ¦Gross Income and Expenses of Trust ¦ +---------------------------------------¦ ¦Year¦Gross income¦Expenses ¦Income ¦ +----+------------+----------+----------¦ ¦1944¦$35,200.30 ¦$24,991.95¦$10,208.35¦ +----+------------+----------+----------¦ ¦1945¦66,914.27 ¦38,338.81 ¦28,575.46 ¦ +----+------------+----------+----------¦ ¦1946¦77,851.19 ¦38,795.07 ¦39,056.12 ¦ +---------------------------------------+

The major portion of the Trust's gross income consisted of the rentals received from petitioner and rentals of $14,121.51 in 1945 and $12,397.53 in 1946 from other tenants of the Berlin Arcade Building. The Trust's expenses included ground rental amounting to $9,000 per year, taxes, payroll, interest on borrowed money, depreciation, and other miscellaneous expenses.

In its returns for 1945 and 1946 petitioner claimed the deduction of the full amount of rentals paid to the Trust. The respondent in his deficiency notices limited petitioner's rental deductions to 3 per cent of the Berlin Arcade Building sales. These sales amounted to $945,678.74 in 1945 and $1,160,338.61 in 1946. Thus respondent allowed rental deductions of $28,370.36 in 1945 and $34,810.16 in 1946, and disallowed $21,601.95 in 1945 and $24,948.17 in 1946.

In his amended answer in Docket No. 24980 respondent affirmatively pleads that rental deductions are allowable to petitioner only to the extent of $22,500 in each of the years 1945 and 1946, that being the amount which petitioner was obligated to pay under its prior lease.

The rentals which petitioner was required to pay during the taxable years 1945 and 1946 for the said premises were not in excess of $22,500.

2. Officers' Compensation.

In his deficiency notices the respondent disallowed portions of the deductions claimed for compensation to Harry and Leonard LeVine for the years 1944, 1945 and 1946 as follows:

+-----------------------------------------------+ ¦ ¦Harry LeVine ¦Leonard LeVine ¦ +----+---------------------+--------------------¦ ¦Year¦Allowed ¦Disallowed¦Allowed ¦Disallowed¦ +----+----------+----------+---------+----------¦ ¦1944¦$32,000.00¦$15,441.17¦$7,000.00¦$2,000.00 ¦ +----+----------+----------+---------+----------¦ ¦1945¦32,000.00 ¦15,718.65 ¦7,000.00 ¦2,000.00 ¦ +----+----------+----------+---------+----------¦ ¦1946¦32,000.00 ¦17,195.80 ¦7,000.00 ¦4,000.00 ¦ +-----------------------------------------------+

Harry LeVine has been actively engaged in the merchandising of ladies' ready-to-wear clothing in the city of Milwaukee most of his life, and has long been regarded as one of the leading merchants of Milwaukee. He has served as petitioner's president and general manager since its inception in 1932. During the taxable years he also served as treasurer. He is now 60 years of age. He maintains active supervision of all of petitioner's departments.

Petitioner has always paid its top executives compensation based on a fixed salary plus a percentage of sales or net profits. In 1940 Harry LeVine's compensation was fixed at $27,000 per year plus 10 per cent of net profits, provided dividends of not less than $20,000 per year were paid to the stockholders. In 1941 the base salary was increased to $27,900 and in 1942 it was further increased to $33,000 and all contingencies based on the payments of dividends were removed. It remained so fixed throughout the taxable years involved.

Leonard LeVine began his employment with petitioner in 1940. He had graduated from the Wharton School of Finance at the University of Pennsylvania in 1939 with a B.S. degree. After graduation he worked at Marshall Field in Chicago for about one year, and thereafter he spent about three months with petitioner's resident buyer in New York for the purpose of learning that phase of the business. He returned to Milwaukee and his employment with petitioner about November 1940. His salary from petitioner was $6,985 in 1941 and $9,000 in 1942. On December 18, 1941, he enlisted in the armed forces and remained in the service until February 1946 when he was discharged with the rank of major. On his separation from the service he reentered his employment with petitioner. Petitioner continued to pay Leonard his salary of $9,000 per year while he was serving with the armed forces.

Prior to his enlistment Leonard served petitioner as buyer of coats and suits and also assisted his father in the general management of the store. In 1946 he received a salary of $11,000.

In addition to their regular compensation Harry and Leonard LeVine received certain benefits during 1944, 1945 and 1946 under a pension trust plan which petitioner set up for its employees in 1943. The plan was approved by the Treasury Department as a qualified plan under section 165, Internal Revenue Code. Out of the total of about 150 employees there were 49 who participated in the pension plan in 1944, 53 in 1945, and 62 in 1946. Petitioner's total contributions to the pension trust fund in 1944, 1945, and 1946 were $25,690, $31,047.97, and $32,422.15, respectively. The amounts credited under the plan to Harry and Leonard LeVine in 1944, 1945 and 1946 were as follows:

+--------------------------+ ¦ ¦ ¦Leonard¦ +----+-------------+-------¦ ¦Year¦Harry LeVine ¦LeVine ¦ +----+-------------+-------¦ ¦1944¦$9,341.36 ¦$541.20¦ +----+-------------+-------¦ ¦1945¦3,416.20 ¦585.00 ¦ +----+-------------+-------¦ ¦1946¦8,398.20 ¦585.00 ¦ +--------------------------+

Petitioner's only other officer, Aaron Scheinfeld, received a salary of $5,400 per year in each of the taxable years. The compensation paid to all other employees amounted to $169,647.36 in 1944, $186,803.10 in 1945, and $217,159.58 in 1946.

Petitioner has paid substantial dividends to both preferred and common stockholders since 1933. Its total annual dividends since 1936 have averaged about $29,000. They dropped off to $17,672.50 in 1944, and $18,000 in each of the years 1945 and 1946. The dividends on common stock decreased from $21,000 in 1943 to $7,500 in each of the years 1944, 1945, and 1946. Petitioner's surplus increased from $77,721.48 in 1943 to $156,089.83 in 1946.

The respondent has determined that reasonable compensation for Harry LeVine was $32,000 per year and for Leonard LeVine $7,000 per year for all of the taxable years and has disallowed the deduction of all compensation including salaries and pension trust fund benefits in excess of those amounts.

Reasonable compensation for the services actually performed by Harry LeVine in each of the years 1944, 1945, and 1946 is $37,500. Reasonable compensation for the services performed by Leonard LeVine for each of such years is $9,000. These amounts are exclusive of pension trust benefits.

3. Abnormal Base Period Deductions.

During the latter part of 1936 petitioner began the installation of a cooling system in its store which it completed in 1938 at a total cost of $8,043.23. It began a complete alteration of the store in 1938 on which it expended $30,476.25 in 1938 and $563.55 in 1939. A new children's department was opened on the second floor with 2,500 additional square feet of floor space which petitioner leased from a wholly owned subsidiary for $100 a month. The cost of this improvement was approximately $9,000. Petitioner's principal lease was for a term ending August 31, 1942, and the improvements pertaining thereto were amortized over that period. Early in 1942 petitioner obtained a renewal of this lease for a period of approximately ten years beginning with September 1, 1942. Thereafter, the unamortized balance of leasehold improvements was written off over the life of the new lease, resulting in a comparatively small annual deduction from that date. Petitioner's gross sales and the amortization deductions taken in its returns for leasehold improvements in the years 1932 to 1946, inclusive, were as follows:

+---------------------------------------------+ ¦ ¦ ¦Amortization¦ +-----------------+--------------+------------¦ ¦ ¦ ¦of leasehold¦ +-----------------+--------------+------------¦ ¦Year ended- ¦Total sales ¦improvements¦ +-----------------+--------------+------------¦ ¦Aug. 31, 1933 ¦$364,590.07 ¦$67.29 ¦ +-----------------+--------------+------------¦ ¦Aug. 31, 1934 ¦600,662.55 ¦1,035.08 ¦ +-----------------+--------------+------------¦ ¦Aug. 31, 1935 ¦699,248.58 ¦967.78 ¦ +-----------------+--------------+------------¦ ¦Aug. 31, 1936 ¦768,744.92 ¦ ¦ +-----------------+--------------+------------¦ ¦Aug. 31, 1937 2 ¦875,313.04 ¦567.34 ¦ +-----------------+--------------+------------¦ ¦Aug. 31, 1938 2 ¦780,982.06 ¦4,565.42 ¦ +-----------------+--------------+------------¦ ¦Aug. 31, 1939 2 ¦725,260.69 ¦8,683.51 ¦ +-----------------+--------------+------------¦ ¦July 31, 1940 2 ¦1 645,656.95¦1 8,250.04¦ +-----------------+--------------+------------¦ ¦July 31, 1941 ¦763,793.60 ¦8,812.13 ¦ +-----------------+--------------+------------¦ ¦July 31, 1942 ¦977,161.41 ¦1,261.20 ¦ +-----------------+--------------+------------¦ ¦July 31, 1943 ¦1,216,631.19 ¦1,261.42 ¦ +-----------------+--------------+------------¦ ¦July 31, 1944 ¦1,260,007.26 ¦1,261.41 ¦ +-----------------+--------------+------------¦ ¦July 31, 1945 ¦1,409,239.47 ¦1,100.73 ¦ +-----------------+--------------+------------¦ ¦July 31, 1946 ¦1,627,255.45 ¦1,100.73 ¦ +---------------------------------------------+ FN1 Eleven month period.FN2 Base period years.

In computing its excess profits credit, based on income, for the taxable years, petitioner claimed an adjustment under section 711(b)(1)(J), Internal Revenue Code, on account of alleged abnormal amortization and depreciation deductions taken in the base period years. The abnormal deductions claimed in the 1944 return were $748.49 in 1937, $3,636.96 in 1938, $7,458.27 in 1939, and $8,367.44 in 1940. In its 1945 and 1946 returns petitioner claimed adjustments for the base period years 1938, 1939, and 1940 only in the respective amounts of $4,063.63, $8,181.72, and $8,573.46. The average base period income as recomputed in the 1944 return was $38,549.27 and in the 1945 and 1946 returns was $38,701.18. The respondent disallowed the claims based on such adjustments.

4. Contribution to Upper Third Street Advancement Association.

In 1946 petitioner subscribed $7,500 to an association of merchants known as Upper Third Street Advancement Association for advertising and promotional purposes. The association had projected a tentative program calling for the expenditure of $113,000 over a 5-year period as follows:

+----------------------------+ ¦Street decorations ¦$35,000¦ +--------------------+-------¦ ¦Newspapers ¦41,000 ¦ +--------------------+-------¦ ¦Sound trucks ¦1,000 ¦ +--------------------+-------¦ ¦Special inducements ¦7,000 ¦ +--------------------+-------¦ ¦Movie shorts ¦4,000 ¦ +--------------------+-------¦ ¦Radio ¦25,000 ¦ +----------------------------+

There is no evidence as to how much of the fund was intended to be spent or was actually spent each year.

Petitioner agreed to pay and did pay half of its subscription, $3,750, to the association in 1946 and deducted that amount in its income tax return for that year as an advertising expense. The respondent allowed only $437.50 of the amount claimed and disallowed the balance of $3,312.50. The amount allowed was the portion allocable to the taxable year 1946 under a pro rata allocation of the proposed expenditures by the association over the 5-year period.

5. Penalty.

Petitioner's income and excess profits tax returns for 1945 were timely filed. They were signed by ‘Harry LeVine, Pres.‘ but were not sworn to or signed by any other officer. Harry LeVine was president and treasurer of petitioner corporation and had been since its organization in 1932. The returns were prepared by Raymond Scribner, a certified public accountant, who had served as petitioner's accountant since its inception.

OPINION.

1. Rental Deductions.

LEMIRE, Judge:

Respondent's present position is that petitioner's deduction for rental of the Berlin Arcade Building space occupied under its lease from the Berlin Arcade Building space occupied under its lease from the Trust during 1945 and 1946 is limited under section 23(a)(1)(A) to $22,500, the amount which it was obligated to pay in those years under its lease agreement with Consolidated Mercantile Company. That company served no purpose but to hold the lease from Third-North Realty Company on the premises occupied in the Berlin Arcade Building for petitioner's benefit. It had no other assets. In view of these facts both parties have, in effect, disregarded the lease agreement, if there was any, between petitioner and Consolidated Mercantile Company, and have treated petitioner as the lessee of Third-North Realty Company.

Section 23(a)(1)(A), Internal Revenue Code, authorizes the deduction of ‘rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity.‘ Thus, in addition to the ‘ordinary and necessary‘ test for all business expenses, rentals must be required to be made as a condition to the continued use or possession of the premises.

Evidence was offered by the petitioner to the effect that the rentals agreed upon by petitioner and the Trust were reasonable in amount; but the crux of our question here is whether they were the amounts petitioner was required to pay for the continued use of the premises. That question depends upon all of the facts and circumstances under which the lease arrangement was made.

First, it must be kept in mind that the transactions under consideration were, for the most part, within an intimate family group and must therefore be given close scrutiny. Higgins v. Smith, 308 U.S. 473; Helvering v. Clifford, 309 U.S. 331; Commissioner v. Tower, 327 U.S. 280. The petitioner corporation, its principal stockholder, H. LeVine & Bro., Inc., Consolidated Mercantile Company, and the Trust were all under the direct control of Harry LeVine and members of his family. Except for the tax advantage to be gained by this group, there is no explanation as to why petitioner was willing in 1944 to give up the lease that still had approximately eight years more to run at a rental of $22,500 a year and accept a new 25-year lease under which its rental was more than doubled. We do not believe that petitioner would have agreed to such an arrangement in an arm's length transaction with an independent lessor.

Petitioner argues that because of its plan to expand its business it required a long term lease before making costly leasehold improvements. It is not explained why petitioner itself might not have purchased the overriding lease from Third-North Realty Company, or what necessity there was for the intervening Trust. While we do not question petitioner's right to choose this method of conducting its affairs, we must nevertheless inquire whether the consequent results justify the deduction sought. It may well be, as petitioner contends, that Third-North Realty Company would have been unwilling to grant a new lease or to extend the old lease, after the leasehold improvements had been made, but there was no longer any uncertainty about petitioner's continued occupancy after the Trust had acquired the overriding lease. The Trust and petitioner were under the same control and the beneficiaries of the Trust were all stockholders of the petitioner.

Apparently the Trust acquired the overriding lease from the Third-North Realty Company subject to the existing sublease to Consolidated Mercantile Company, and petitioner, so that the negotiations for petitioner's new lease were entirely between petitioner and the Trust.

The facts here are essentially like those in Stanwick's, Inc., 15 T.C. 556, affirmed per curiam (C.A. 4, 1951), 190 F.2d 84. There the taxpayer corporation's sole stockholder held a lease with an unexpired term of about five years on premises which he permitted his corporation to occupy without a new lease agreement. He obtained a longer term lease from the lessors at a slightly increased rental, then with their consent subleased the premises to his wife at the same rental, and the wife leased the premises back to the corporation at a greatly increased rate, based on a percentage of gross sales. We held that the excess of the rentals paid to the wife over the rentals which the husband paid to the owners was not deductible under section 23(a)(1)(A). See also Limericks, Inc., 7 T.C. 1129, affd. (C.A. 5, 1948) 165 F.2d 483; and Roland P. Place, 17 T.C. 199 (on appeal, C.A. 6).

Whether or not the increased rentals which petitioner obligated itself to pay to the Trust under the new lease were more than reasonable rentals for the premises at that time we do not need to decide. In any event they were not ‘required * * * as a condition to the continued use * * * of property,‘ at least for the period of the old lease, and are not deductible under section 23(a)(1)(A). We have found above, in accordance with respondent's amended pleadings in Docket No. 24980, that the rental which petitioner was required to pay in 1945 and 1946, and is therefore entitled to deduct in those years, was not in excess of $22,500.

2. Officers' Compensation.

There is no single factor that determines the reasonableness of compensation paid to corporate officers. It is a question to be determined from all of the facts, including the volume of business done by the taxpayer, the experience, skill, and general qualifications of the officers, the importance of the services which the officers perform, the amount of time they devote to the business, the extent to which their services contribute to the success of the business, the standard of compensation for similar services in the industry generally, and other factors.

Where, as in the instant case, the officers and their families are in control of the corporation, their compensation is not the result of free bargaining on the sole basis of advantage to the corporation. The fact that the compensation is paid under a percentage of profits agreement of long standing does not determine the question of its reasonableness. Oswald Co. v. Commissioner, 185 F.2d 6, certiorari denied 340 U.S. 953.

As to Harry LeVine, the percentage of profits contingency occasioned by little risk, because of the relatively large base salary of $33,000 which he was to receive in any event. The respondent has reduced his compensation even below that figure, to $32,000. However, after careful consideration of all the evidence we have found, as stated above, that $37,500 is reasonable compensation for his services in each of the years under consideration. While there is evidence that the salaries paid to the top executives in similar businesses in that locality were considerably less than $37,500, there is also evidence that Harry LeVine's services to petitioner were of larger scope and of greater value than the services performed by these other executives. There can be no doubt as to his position as an outstanding figure in his field of merchandising.

We have also found on the evidence that $9,000 is reasonable compensation for the services performed by Leonard LeVine in each of the taxable years. That was the amount of salary paid to him in 1944 and 1945. The evidence fails to justify the increase of his salary to $11,000 in 1946.

The amounts found as reasonable compensation for these officers are exclusive of the pension trust benefits.

3. Abnormal Base period Deductions.

Section 711(b)(1)(J), Internal Revenue Code, as amended in 1941, provides that in computing average base period net income there shall be disallowed, under certain conditions, deductions taken in the base period years which were abnormal either as a class or as to amount. The deductions recognized as abnormal in amount are those in excess of 125 per cent of the average deductions of that class taken in the four preceding taxable years.

Petitioner claims that its amortization deductions on leasehold improvements in the base period years were abnormal in amount. The excess of such deductions in the base period years over the average annual deductions of that class for the preceding four years is ascertainable from the stipulated figures as set out in our findings of fact.

Respondent takes the position in his brief that petitioner has not met the requirements of section 711(b)(1)(K)(ii). This subsection provides:

(ii) Deductions shall not be disallowed under such subparagraphs (711(b)(1)(J)) unless the taxpayer establishes that the abnormality or excess is not a consequence of an increase in the gross income of the taxpayer in its base period or a decrease in the amount of some other deduction in its base period, and is not a consequence of a change at any time in the type, manner of operation, size, or condition of the business engaged in by the taxpayer.

Since the ‘excess‘ here was not a consequence of an increase in petitioner's gross income (there was no increase) or decrease in other deductions (none is claimed by respondent or shown in the evidence), our question is whether it was the consequence of a change in the type, manner of operation, size, or condition of petitioner's business.

The leasehold improvements themselves resulted from, and in the language of the statute were a consequence of, petitioner's efforts to improve its store and thereby increase its business. The abnormal or excessive amortization deductions taken on the improvements in the base period were a direct result of the short term of the lease under which petitioner occupied the premises and the consequent necessity for the accelerated depreciation deductions on the improvements. Petitioner had no choice but to spread the cost of the improvements, other than those in the children's department, over the remaining term of the lease under which it occupied the premises. The installation of air conditioning facilities and the alterations, repairs, and improvements made on the floor space already occupied by petitioner neither resulted from nor caused any change in the type, manner of operation, size, or condition of petitioner's business. Petitioner continued to operate just as it had before the improvements were made. The changes, such as were made, were not those with which subsection (K)(ii) is concerned.

The respondent devotes considerable discussion in his brief to the question whether the costs of the improvements made in adding the children's department were, as petitioner claims, or were not, as he contends, included in the figures shown in the stipulation of facts as amortization of leasehold improvements. Petitioner claims that it did not amortize the improvements in the children's department with the other leasehold improvements for the reason that it controlled the lease on the premises occupied by that department, and, therefore, was not required or permitted to amortize the cost of those improvements over the term of the leasehold, as it did the other improvements. Respondent argues that in any event the depreciation deductions on the improvements in the children's department were of the same class and should be grouped with the deductions on other leasehold improvements, and that the abnormality, if any, was in part at least a consequence of a change in the size of the business.

We have heretofore held that for the purposes of section 711(b)(1)(J) adjustments of base period net income the classification of deductions is not limited to the statutory deduction categories of section 23, Internal Revenue Code, and that a division of the base period deductions of a general class, as between normal and abnormal deductions, is permissible. See Green Bay Lumber Co., 3 T.C. 824; Mine & Smelter Co., 10 T.C. 1179; and cases therein cited. Here, the abnormality in the base period amortization deductions pertains only to the improvements made on the premises subject to the short term lease; and those improvements were not a consequence of any change in the type, manner of operation, size, or condition of the business, within the meaning of subsection (K)(ii). There was no necessity for accelerating the amortization deductions on the improvements pertaining to the children's department where the term of the leasehold was controlled by petitioner, and those deductions should not be taken into account in computing the abnormality. The improvements as a whole may have contributed to an increase in petitioner's business, certainly they were intended to do so, and the amortization deductions were, of course, the result of the improvements having been made, but that is not to say they were the consequence of any change in the type, size, etc., of the business. It is the cause of the abnormality with which the statute is concerned. R. C. Harvey Co., 5 T.C. 431; Wentworth Manufacturing Co., 6 T.C. 1201; Pacific Gas & Electric Co., 7 T.C. 1142. For instance, if in adding its children's department or otherwise enlarging its operations petitioner had made leasehold improvements on premises which it leased for only a short term, the accelerated amortization deductions on such improvements would have been a consequence of the change.

We think that the abnormal base period amortization deductions should be disallowed, subject to the limitations prescribed by the statute.

4. Contribution to Upper Third Street Advancement Association.

The respondent has disallowed the major portion of the deduction claimed by the petitioner for 1946 of $3,750, which it pledged and paid to the Upper Third Street Advancement Association in that year. Respondent determined that since the funds were intended to be spent for advertising and promotional work over a 5-year period the deduction should be allocated on that basis. The amount which he allocated to and allowed for 1946 was $437.50

There is no statutory requirement or authorization for such an allocation. Reasonable costs of advertising are generally allowable as business expenses. They are deductible under section 23(a) in the year when paid, or if the taxpayer reports on an accrual basis, in the year when the liability is incurred. Petitioner made its returns on an accrual basis. It accrued in its books and deducted in its 1946 return not the full amount of its subscription to the association but only the amount paid in that year. That amount at least was properly accrued and deducted as an expense of that year.

Section 43, Internal Revenue Code, to which respondent refers in his brief, does not authorize the spreading of depreciation deductions in respect of the cost of advertising or the acquisition of any non-taxable capital asset. See A. Finkenberg's Sons, Inc., 17 T.C. 973; X-Pando Corporation, 7 T.C. 48; Carey Machine & Supply Co. v. Hofferbert, decided January 25, 1950 (D.C. Md.).

The respondent has cited no case in support of his position and we find none. He was in error, we think, in disallowing any portion of the $3,750 payment claimed by the petitioner in its return.

5. Penalty.

The respondent has determined against the petitioner a 25 per cent penalty for 1945 because of its failure to file a proper return for that year. The return which petitioner did file was found to be deficient in that it was signed by petitioner's president alone and not with another officer, as required by the statute.

Section 52, Internal Revenue Code, provides that any corporation subject to tax shall make a return ‘sworn to by the president, vice president, or other principal officer and by the treasurer, assistant treasurer, or chief accounting officer.‘ Although Harry LeVine signed the return as president of the company, he was in fact both president and treasurer. Literally then, the return was signed by the petitioner's president and treasurer. Perhaps Harry LeVine should have signed twice, once as president and again as treasurer, but that, we think, is not a serious defect. In our opinion the return as filed substantially complied with the requirements of the statute as to verification. See Edwin J. Schoettle Co., 13 B.T.A. 950; Indiana Rolling Mills Co., 13 B.T.A. 1141; J. F. Anderson Lumber Co., 15 B.T.A. 475; Ethel D. Co., 27 B.T.A. 25, affd. 70 F.2d 761.

Decisions will be entered under Rule 50.