Draper & Co.
Comm'r of Internal Revenue

Tax Court of the United States.Sep 28, 1945
5 T.C. 822 (U.S.T.C. 1945)

Docket No. 6376.



Hugh D. McLellan, Esq., George R. Blodgett, Esq., and Karl W. Baker, C.P.A., for the petitioner. Carl A. Stutsman, Jr., Esq., for the respondent.

1. Petitioner is one of the largest buyers and sellers of raw wools in the United States and has had a very prosperous business for many years. Prior to 1939 its policy had been to pay its key men moderate basic salaries, but to pay bonuses in years of good profits. In 1939 petitioner adopted a standard mathematical formula for paying bonuses in addition to the basic salaries. This formula was in effect during the fiscal year ended November 30, 1941, under which bonuses were paid to six key men. The respondent allowed as deductions from gross income all the basic salaries and a portion of the bonuses equal to the basic salaries and disallowed the balance as excessive compensation. Upon the evidence, held, petitioner is entitled to deduct as reasonable compensation all of the basic salaries plus the bonuses.

2. During August 1941 petitioner also adopted a retirement plan whereby annuity contracts would be taken out with insurance companies for all officers or employees who had been with petitioner for at least 19 years. Each such annuity contract required an annual premium of not in excess of one-third of the salary of such officer or employee. For the taxable year petitioner's board of directors voted to pay the annual premiums for the first year and for 2 years in advance on each such contract. Contracts were taken out and premiums for 3 years were paid for 5 key men and 4 employees. As to the key men the respondent disallowed all of the premiums as excessive compensation. Upon the evidence, held, the respondent's disallowance is sustained as to the key men, since they had already been adequately compensated by basic salaries and large bonuses. As to the 4 employees, the respondent allowed the premiums for the first year as a deduction for additional compensation, but disallowed the advance premiums for 1942 and 1943, on the ground that they did not represent an accrued expense. He makes no claim that to allow the amounts in question would be unreasonable compensation as to these 4 employees. Held, the respondent is sustained as to the advance premiums paid for years 1942 and 1943 because they were not properly accruable in 1941. Hugh D. McLellan, Esq., George R. Blodgett, Esq., and Karl W. Baker, C.P.A., for the petitioner. Carl A. Stutsman, Jr., Esq., for the respondent.

This proceeding involves deficiencies in income tax, declared value excess profits tax, and excess profits tax determined by the respondent against petitioner for the fiscal year ended November 30, 1941, in the amounts of $66,445.83, $28,808.57, and $53,552.39, respectively.

The deficiencies result from four adjustments to net income set out in a statement attached to the deficiency notice as follows:

+-----------------------------------------------------------------------------+ ¦Net income as disclosed by item 30 of page 1 of your ¦ ¦$225,080.58¦ ¦return (Form 1120) ¦ ¦ ¦ +-----------------------------------------------------+-----------+-----------¦ ¦Unallowable deductions and additional income: ¦ ¦ ¦ +-----------------------------------------------------+-----------+-----------¦ ¦(a) Excessive compensation ¦$303,044.17¦ ¦ +-----------------------------------------------------+-----------+-----------¦ ¦(b) Advance premiums ¦5,974.94 ¦ ¦ +-----------------------------------------------------+-----------+-----------¦ ¦(c) Accrued Massachusetts excise tax ¦252.05 ¦309,271.16 ¦ +-----------------------------------------------------+-----------+-----------¦ ¦Total ¦ ¦534,351.74 ¦ +-----------------------------------------------------+-----------+-----------¦ ¦Additional deductions: ¦ ¦ ¦ +-----------------------------------------------------+-----------+-----------¦ ¦(d) Accrued capital stock tax ¦3,605.00 ¦3,605.00 ¦ +-----------------------------------------------------+-----------+-----------¦ ¦Net income adjusted ¦ ¦530,746.74 ¦ +-----------------------------------------------------------------------------+

Petitioner by appropriate assignments of error contests adjustments (a) and (b), and instead of the above mentioned deficiencies it claims that it is entitled to a refund of $804.71 of income tax as a result of adjustments (c) and (d), which latter adjustments are not in controversy.


Petitioner is a corporation, organized in January 1922 under the laws of the Commonwealth of Massachusetts, and it has its principal office in Boston, Massachusetts. On February 13, 1942, it filed with the collector for the district of Massachusetts corporation tax returns on the accrual basis for the fiscal year ended November 30, 1941, on Forms 1120 and 1121. On Form 1120 it computed as its liability total income and income defense taxes due of $54,019.34, but no declared value excess profits tax liability. The notice of deficiency was mailed to petitioner on August 2, 1944, and the petition for redetermination was filed on October 30, 1944. No claim for refund has been filed.

Adjustment (a) referred to in our opening statement as ‘Excessive compensation $303,044.17‘ consisted of ‘Officers' Compensation Disallowed— $271,218.41‘1”’ and ‘Stockholder-Employees' Compensation Disallowed— $31,825.76,‘,” and it was further explained in paragraphs 4 and 5 of the statement attached to the deficiency notice as follows:

4. Officers' Compensation Disallowed— $271,218.41.

Officers' Compensation of $156,000 representing basic salaries paid plus bonus equal to 100 percent thereof has been allowed as reasonable compensation for services rendered. The amount of $427,216.41 claimed in the return in excess thereof, or $271,218.41, is therefore determined to be excessive compensation for services actually rendered and not deductible as ordinary and necessary expenses.

+-----------------------------------------------------------------------------+ ¦Claimed ¦ +-----------------------------------------------------------------------------¦ ¦ ¦ ¦ ¦Premiums ¦ ¦ +-------------------------------+----------+-----------+----------+-----------¦ ¦ ¦ ¦ ¦Paid on ¦ ¦ +-------------------------------+----------+-----------+----------+-----------¦ ¦Name ¦Basic ¦Bonus ¦Annuity ¦Total ¦ +-------------------------------+----------+-----------+----------+-----------¦ ¦ ¦Salary ¦ ¦Contracts ¦ ¦ +-------------------------------+----------+-----------+----------+-----------¦ ¦Paul A. Draper, president and ¦$30,000.00¦$102,000.00¦$29,350.81¦$161,350.81¦ ¦treasurer ¦ ¦ ¦ ¦ ¦ +-------------------------------+----------+-----------+----------+-----------¦ ¦Robert W. Dana, vice president ¦18,000.00 ¦72,000.00 ¦17,579.00 ¦107,579.00 ¦ +-------------------------------+----------+-----------+----------+-----------¦ ¦Malcolm Green, vice president ¦18,000.00 ¦72,000.00 ¦17,579.00 ¦107,579.00 ¦ +-------------------------------+----------+-----------+----------+-----------¦ ¦George W. Brown, assistant ¦12,000.00 ¦27,000.00 ¦11,709.60 ¦50,709.60 ¦ ¦treasurer ¦ ¦ ¦ ¦ ¦ +-------------------------------+----------+-----------+----------+-----------¦ ¦Amounts claimed ¦78,000.00 ¦273,000.00 ¦76,218.41 ¦427,218.41 ¦ +-----------------------------------------------------------------------------+

Allowed Paul A. Draper $30,000.00 $30,000.00 None $60,000.00 Robert W. Dana 18,000.00 18,000.00 None 36,000.00 Malcolm Green 18,000.00 18,000.00 None 36,000.00 George W. Brown 12,000.00 12,000.00 None 24,000.00 Amounts allowed 78,000.00 78,000.00 None 156,000.00 Amounts disallowed None 195,000.00 $76,218.41 271,218.41

5. Stockholder-Employees' Compensation Disallowed— $31,825.76.

Stockholder-employees' compensation of $29,400.00 representing basic salaries paid plus bonus equal to 100 percent thereof has been allowed as a deduction. The amount of $61,225.76 claimed in the return in excess thereof, or $31,825.76, is therefore determined to be excessive compensation for services actually rendered and not deductible as ordinary and necessary expenses.

+------------------------------------------------------------------------------+ ¦Claimed ¦ +------------------------------------------------------------------------------¦ ¦ ¦ ¦ ¦Premiums ¦ ¦ +------------------------------------+---------+----------+---------+----------¦ ¦ ¦ ¦ ¦Paid on ¦ ¦ +------------------------------------+---------+----------+---------+----------¦ ¦Name ¦Salary ¦Bonus ¦Annuity ¦Total ¦ +------------------------------------+---------+----------+---------+----------¦ ¦ ¦Claimed ¦ ¦Contracts¦ ¦ +------------------------------------+---------+----------+---------+----------¦ ¦Kenneth F. Clarke, buyer and ¦$7,200.00¦$27,000.00¦$7,025.76¦$41,225.76¦ ¦salesman ¦ ¦ ¦ ¦ ¦ +------------------------------------+---------+----------+---------+----------¦ ¦Charles D. Draper, buyer and ¦7,500.00 ¦12,500.00 ¦None ¦20,000.00 ¦ ¦salesman ¦ ¦ ¦ ¦ ¦ +------------------------------------+---------+----------+---------+----------¦ ¦Amounts claimed ¦14,700.00¦39,500.00 ¦7,025.76 ¦61,225.76 ¦ +------------------------------------------------------------------------------+

Allowed Kenneth F. Clarke $7,200.00 $7,200.00 None $14,400.00 Charles D. Draper 7,500.00 7,500.00 None 15,000.00 Amounts allowed 14,700.00 14,700.00 None 29,400.00 Amounts disallowed None 24,800.00 $7,025.76 31,825.76

Adjustment (b) referred to in our opening statement as ‘Advance premiums $5,974.94‘ was explained in the statement attached to the deficiency notice as follows:

+----------------------------------------+ ¦(b) Advance premiums¦ ¦$5,974.94¦ +--------------------+---------+---------¦ ¦As claimed in return¦$9,074.94¦ ¦ +--------------------+---------+---------¦ ¦As allowed herein ¦3,100.00 ¦ ¦ +--------------------+---------+---------¦ ¦Amount disallowed ¦5,974.94 ¦ ¦ +----------------------------------------+

For details in respect of this disallowance refer to introductory paragraph 6 of this statement.

Attention is called to the fact that this disallowance was not made by the revenue agent in his reports of examination but is in addition to disallowances made by him therein.

A detailed computation of the disallowance is shown in the following table:

+---------------------------------------------------+ ¦ ¦3 Years' ¦ ¦ ¦ +--------------------+---------+---------+----------¦ ¦ ¦Premium ¦1 Year's ¦ ¦ +--------------------+---------+---------+----------¦ ¦ ¦Allowed ¦Premium ¦Disallowed¦ +--------------------+---------+---------+----------¦ ¦ ¦by Agent ¦Allowance¦ ¦ +--------------------+---------+---------+----------¦ ¦Adrian Keller ¦$3,220.14¦$1,100.00¦$2,120.14 ¦ +--------------------+---------+---------+----------¦ ¦Alice Scott ¦2,049.18 ¦700.00 ¦1,349.18 ¦ +--------------------+---------+---------+----------¦ ¦Genevieve McCausland¦1,756.44 ¦600.00 ¦1,156.44 ¦ +--------------------+---------+---------+----------¦ ¦Harry Hamilton ¦2,049.18 ¦700.00 ¦1,349.18 ¦ +--------------------+---------+---------+----------¦ ¦Totals ¦9,074.94 ¦3,100.00 ¦5,974.94 ¦ +---------------------------------------------------+

Paragraph 6 of the statement attached to the deficiency notice is as follows:

6. Advance Premiums Disallowed— $5,974.94.

Premiums of $5,974.94 paid on annuity contracts for benefit of non-stockholder-employees, which were not due and payable until subsequent to the taxable year have been disallowed as not representing an accrued expense for the taxable year.

Petitioner is engaged in the business of buying and selling wool and is one of the largest wool dealers in the United States. It does not carry on any manufacturing operations. Its purchases of wool during the fiscal year ended November 30, 1941, amounted to $17,400,000 and its net sales in the same fiscal year amounted to $18,728,414. It buys wool not only in the western part of the United States, but in all other parts of the world where wool is grown, including South America, South Africa, Australia, New Zealand, France, and other countries. It buys wool in the grease, that is, in the form in which it is clipped from the sheep, and either resells the wool in that form or has it scoured by independent contractors and then sells clean wool. The wool dealer business is to be distinguished from that of ‘top makers,‘ which involves a further processing of the wool after it has been cleaned. Its business is almost wholly buying and selling wool on its own account, with consequent inventory risks, as distinguished from merely acting as agent or consignee for others.

The types of wool differ greatly as to suitability for use in particular machinery or fabrics. Wool of a given specification in one country is not the same as the corresponding specification in another country, and the two can not be used interchangeably in machinery. Petitioner's customers sometimes utilize the experience and knowledge of petitioner's executives to find special wools which the customers desire for special fabrics.

Wool in the grease is bought at prices fixed by reference to poundage, which includes the weight of the dirt and the grease as well as the wool, and the scouring which is necessary for use of the wool by mills involves a shrinkage of 35 to 80 percent in weight. Experience and judgment are required of petitioner's executives to estimate this shrinkage factor on each lot of wool the petitioner handles. The wool business is highly competitive. Many wool houses specialize in certain kinds of wool, or wools of certain origins, but the petitioner's business has involved the handling of all kinds of wools grown all over the world. The margin of profit in the business of wool dealers is usually small, and profits are made by selling large volumes at narrow margins. Great care must be used to avoid large losses. Conduct of the business is entirely dependent upon consistent and constant efforts by the executive personnel to create business, without which no business would take place. Of primary importance are the executives' contracts with growers in the domestic field, and with foreign markets, in order that the executives in the business may know continually where in the world is available, at the best values, wool of a particular type needed for a customer's special requirements as dictated by the customer's machinery or proposed fabric.

During the fiscal year ended November 30, 1941, and prior thereto, petitioner's business was dependent largely upon the efforts of five executives who either carried on themselves, or directed, all of its activities, including all of its buying and selling. This group included the four directors of the petitioner, Paul A. Draper (hereinafter sometimes referred to as Draper as distinguished from his nephew Charles Dana Draper), Robert W. Dana, Malcolm Green, and George W. Brown, and, in addition thereto, Kenneth F. Clarke. The remaining employees of petitioner consisted of Charles Dana Draper, who was a buyer-salesman, residing in South America, four other salaried buyers, three salaried salesmen, and twenty-seven office and clerical employees, including bookkeepers, clerks, stenographers, sample boys, etc. All of the executives participate in the decision upon every important transaction in which the corporation engages. The decision is arrived at by the joint judgment of these executives in conference, and no material commitment is made without a conference of at least three of them. The other salaried buyers and commission agents and brokers do nothing but submit to Boston information about parcels of wool which are available in their fields, and they have no authority to buy until instructed by the executives.

Personal buying experience in the various fields of the world enables an executive to study much more wool, and to learn many more types, than he could see in Boston from importations, which enables him to buy more efficiently and to buy fibre best suited for the purpose intended. Personal experience of the executives in buying wool in the producing countries afforded them opportunities to observe the personnel of the local buying agencies, so that the most advantageous type of buying arrangements could be made, and enabled contracts to be made in those countries which put them in touch with unusual sources of supply on which profits might be made. Some of these contacts enabled petitioner to receive wool on consignment from various countries, which is in addition to its usual business and on which petitioner made money without assuming any great risk. Over the last twenty-three years petitioner's executives have become familiar with most of the wool clips grown west of the Mississippi, and when the local agent describes a grower's clip in relation to its quality the year before petitioner's executives have the knowledge, through samples of former clips of the same grower or through description, on which to base their judgment. Executives have spent substantial periods of time in all of the important wool growing countries of the world and have built up a personal knowledge of clips grown in all these countries and personal contacts with growers therein. They keep samples of each lot of wool handled by it, the number of such samples running into thousands. Because of such personal knowledge and contacts, and the elaborate sample file which they have accumulated over along period of years, they are able to judge the quality, value, and market for wool offered for sale by growers throughout the world.

All the executives gave their full time to the business in 1941 and in prior years and never took any long vacations. None of them had any outside business activity. They have been employed by petitioner since 1922. Each of the executives is constantly planning the type of merchandise which will prove most profitable in view of where the best values are to be found at the moment all over the world, determining whether it is the proper time to buy wool or whether purchases should be delayed, and having in mind the variety of needs at the time of their customers and whether the wool can be resold quickly.

Draper is and always has been the executive head of the business. He started to work in the wool business in 1907 at the age of 20, immediately after his graduation from Harvard College. After about a year's work in various elementary capacities with a wool firm in Norwood, Massachusetts, he went to work for Crimmins & Peirce Co., the largest wool dealer in the country at that time. Shortly after he went with that company in 1908 it opened a wool buying office in San Francisco and he was sent out to work in that office. The work involved contracting the wool growers in California, Nevada, Oregon, and other western states. After about two and one-half years of traveling among the wool growers in that section, which gave him an intimate knowledge of the wool of each grower, he became manager of the San Francisco office, remaining as such until 1916. He was then called back to the Boston office and helped to run the western business from the home office and went out and sold wool to mills throughout the New England states. In the middle of 1917 he was sent to South America, where he lived for two years, buying wool for the company. He was called back to Boston in 1919 and was made an officer and a director in Crimmins & Peirce Co. upon his return. His activities were in part managerial and to a great extent selling wool and making contacts with manufacturers. He was one of the heads of the concern, although he had only a small investment in it. His basic annual compensation at the time was about $10,000, but in the two years while he was acting as buyer in South America, he received additional compensation of $50,000 in each year. He was active in Crimmins & Peirce Co. until the owners of that company decided to liquidate the business and retire in 1921. The owners of Crimmins & Peirce Co. indicated their faith in the ability of Draper by investing substantial amounts of money in petitioner, which was organized by him, and by letting him represent them on petitioner's board of directors instead of themselves becoming directors, as he urged them to do. He is the chief creative genius in the business, thinking up new ways to produce volume and profits, new customers, and new fields in which to find more profitable wool to handle. His services to petitioner were of an overall nature, including having the final decision in all matters pertaining to buying or selling and to the operation of the business. He was the guiding head of the company and carried the greatest responsibility. Draper has always worked a long day, and large amounts of his time outside regular working hours are taken up by telephone calls, telegrams, and cables from all parts of the world from which petitioner buys its wool. He has valuable contacts among many large manufacturers, whose confidence he has won. He sells to many large woolen mills, including the American Woolen Co., which is the largest. He arranges the lines of credit which enable petitioner to carry on its large volume of business, and the lending banks rely to a large extent on the personal confidence they have in him.

Dana is in charge of petitioner's scoured and pulled wool departments and all of its business in Australia, New Zealand, and South Africa. He was one of the original incorporators of petitioner and has worked for it since organization. He started to work for Crimmins & Peirce Co. as an office boy and sample boy in 1914. Prior to that time he had worked as a mill operative for a short period before going to Dartmouth College. In the latter part of 1914 he was sent by Crimmins & Peirce Co. to California as an assistant to Draper. His work consisted of inspecting wool and later buying wool from the domestic wool growers in the West. He became manager of the California office in 1916 and remained there until the latter part of 1918, when he was sent to China to investigate the possibility of establishing an office there. In the following year he was sent to South Africa for the same purpose. This trip required about one year and he acquired many personal contacts which are still used in connection with petitioner's purchases from that territory. After the incorporation of petitioner in 1922 he made trips to the London wool market in 1922, two in 1923, and in 1924, for the purpose of buying wool and also selling through a sales outlet he established in England. During the 1924 trip he visited a section of France which is a center for the pulling of sheep skins and bought wool there. In 1933 he went to Australia and New Zealand, made many contacts there, and established advantageous buying arrangements, including establishing their own buying personnel in New Zealand, which are still used by petitioner. His great experience in South Africa, New Zealand, and Australia gives him a knowledge, second to no one in the business, of the way wool is raised and sold in those countries. He has his own built-up group of wool customers.

Green is in charge of petitioner's grease wool department. He went to work for Crimmins & Peirce Co. in 1919 directly from high school, working first as an errand boy and then as a sample boy. Crimmins & Peirce recognized that he had unusual ability and planned to give him unusual opportunities to acquire experience in different places, but he became so valuable that the plans for his foreign experience were curtailed. In 1922 petitioner sent him to South America alone at the age of 19 to buy wool under instructions from the home office. He returned to Boston early in 1923 and was sent to Texas to purchase wool from the growers in Texas in the shearing season. He went back to South America in the fall of 1923 for the purpose of buying wool there and returned and went to Texas in the spring of 1924. These annual trips to South America and Texas continued for a period of approximately five years. Petitioner bought domestic wool direct from the growers, rather than through dealers. Green became acquainted with many of them on his trips to Texas. He has maintained most of those acquaintances. He also made many contacts in South America which he has kept. In 1923 he began to take an active part in the selling of wool and built up many sales contacts all over New England and New Jersey. In the fiscal year ended November 30, 1941, he had immediate charge of all of petitioner's domestic wool business, which in that year amounted to something in excess of 30,000,000 pounds in the grease. His function was to see that the wool was properly bought, and he had a great deal to do with the selling of much of it. He was also instrumental to a large degree in the business that was done in South America because of the contacts that he had built up on his many trips to that country.

Brown also had worked for Crimmins & Peirce Co. prior to the liquidation of that company. He was one of the original incorporators of petitioner. His duties for petitioner covered a wide range which in many businesses of petitioner's size would require several men to whom salaries would be paid. He is head of the office and the personnel. Under Draper he handles the work of arranging for loans. He is head of the foreign exchange department and has a good knowledge of this subject. He is head of the warehousing department and also handles all insurance matters of petitioner, which are very important in its business. He has charge of the overall movement of wool for petitioner.

Clarke is in charge of petitioner's scoured wool department. He graduated from the Boston University School of Business Administration. He started to work for petitioner in 1922 as an office boy. He later became a sample boy and then worked on records in the selling department. In connection with this work he met prospective buyers and did some selling. He was sent to Texas in 1933 and 1934 to buy wool and to the London wool market in 1935. He made in all five or six trips to Texas for the purpose of buying wool. He started to make selling trips to the Middle West in 1933 and 1934 and has continued to make such trips at least twice a year since that time. He is the man primarily responsible for petitioner's sales to mid- western mills. He has built up valuable personal contacts among these mills and secured the confidence of such customers. He is responsible for the arrangements that must be made with independent contractors to have the grease wool scoured. He has good ability to know wool values and helps many of the mill men in the planning of their fabrics. He has an expert knowledge of scoured wools and can select for the manufacturers the ones that will best fit their individual needs. Clarke was the only employee who was not an officer or director who was chosen to participate in the compensation arrangement for senior executives, and this was done because of his continually increasing value to petitioner.

Charles Dana Draper was petitioner's South American buyer, living in South America for a period of two and one-half to three years, including the entire fiscal year ended November 30, 1941. He had acquired substantial experience in petitioner's business prior to being sent to South America. He was in charge of the entire wool buying operations in South America and expended large sums of money for wool purchased under the direction of the executives in Boston. His total compensation was less than what the petitioner had paid his predecessor or had to pay to the man who took his place when he was requisitioned for the Army, the new man being neither an officer nor a director of the petitioner. Since receiving an honorable discharge from the Army he has been spending five days a week in Washington, where he is chief of one of the wool divisions of the War Production Board. He is a nephew of Draper.

The practice originated by Draper of guaranteeing to the mill the cost, on a clean or scoured basis, of wool sold in the grease has been a large factor of petitioner's business. It involves a risk to petitioner if the grease wool does not result in as much scoured wool as the petitioner has guaranteed, and it requires great skill by the executives.

The incorporators of petitioner included Draper, Dana, Brown, and others, all of whom had been employed prior to 1922 by Crimmins & Peirce Co. This wool house had been the largest wool dealer in the country and had been very successful for a long period of years. In the latter part of 1921 the principals of this wool house decided to retire and arranged for a voluntary liquidation. Various wool houses were formed in 1921 and 1922 by men who had worked for Crimmins & Peirce Co. Petitioner was the largest of these houses and was recognized as the major successor to Crimmins & Peirce Co. and handled the major portion of its liquidation. Both the Crimmins family and the Peirce family invested substantial amounts in petitioner at the time of its organization.

Petitioner was organized with an authorized capital stock of $1,000,000, consisting of 10,000 shares of $100 par value each. The original issue of stock in 1922 consisted of 5,218 shares, for which $521,800 was paid in to the petitioner. At the end of 1922 a stock dividend of 50 percent was declared, in payment of which 2,609 shares with a par value of $260,900 were issued to the stockholders. In the latter part of 1923 a further stock dividend of 30 percent was declared on the stock then outstanding and 2,163.7 shares of the original stock with a par value of $216,370 were issued. At the time of these stock dividends 9.3 shares were issued for cash at their par value of $930 in order to avoid the issuance of fractional shares in connection with the stock dividends. This accounted for the issue of the total authorized stock. The amount of cash actually paid in to the petitioner for the 10,000 shares was $522,730, or an average of $52.27 per share.

Of the original investment of $521,800 in the petitioner, $225,000 was put in by the Crimmins and Peirce families, $125,000 by Draper, $50,000 each by his two brothers, $10,000 by Dana, $5,000 by Brown, and $2,000 by Draper as trustee for Green. The balance of the original capital was paid in by thirteen other employees of petitioner. Prior to the end of 1922 $60,000 of the stock taken by the Crimmins and Peirce families sold to employees of petitioner, at which time the holdings of Dana were increased to $20,000 and those of Brown to $13,000, the balance being taken by other employees. The outstanding stock of petitioner during the fiscal year ended November 30, 1941, consisted of 3,163 shares, which were held as follows:

+-----------------------------------------------+ ¦Stockholder ¦Relationship¦Shares held¦ +----------------------+------------+-----------¦ ¦1. George W. Brown ¦Husband of 2¦6 ¦ +----------------------+------------+-----------¦ ¦2. Madeline M. Brown ¦Wife of 1 ¦310 ¦ +----------------------+------------+-----------¦ ¦3. Kenneth F. Clarke ¦ ¦49 ¦ +----------------------+------------+-----------¦ ¦4. Gladys N. Dana ¦Wife of 5 ¦300 ¦ +----------------------+------------+-----------¦ ¦5. Robert W. Dana ¦Husband of 4¦110 ¦ +----------------------+------------+-----------¦ ¦6. Charles Dana Draper¦Nephew of 8 ¦10 ¦ +----------------------+------------+-----------¦ ¦7. Marjorie E. Draper ¦Wife of 8 ¦2,000 ¦ +----------------------+------------+-----------¦ ¦8. Paul A. Draper ¦Husband of 7¦100 ¦ +----------------------+------------+-----------¦ ¦9. Malcolm Green, Jr ¦ ¦278 ¦ +----------------------+------------+-----------¦ ¦Total ¦ ¦3,163 ¦ +-----------------------------------------------+

The remainder of the 10,000 shares originally issued was held in the treasury of petitioner, having been reacquired prior to 1941, mostly from former employees at the time that they severed their connections with petitioner. The only stock which was ever acquired by petitioner from any of the persons who were stockholders in 1941 was 50 shares bought in 1929 from Gladys N. Dana, who in 1934 purchased from petitioner 60 shares at a higher price. Draper and his wife owned 2,100 shares of stock at January 1, 1927, and neither he nor his wife acquired any additional stock nor disposed of any of such stock prior to November 30, 1941. These 2,100 shares did not represent a majority of the outstanding stock until after March 31, 1936, but have represented a majority of the outstanding stock since shortly after that date.

Petitioner has been very successful. During the period from January 1, 1922, to November 30, 1941, its net earnings, after deducting all compensation paid and all taxes, amounted to $2,885,782.54. During the same period it paid out to stockholders $1,139,030.35 in cash dividends and $1,208.701.04 for stock reacquired, a total of $2,347,731.39. Its net worth at November 30, 1941, amounted to $1,060,781.15 after the distribution of the $2,347,731.39. The book value per share of the 3,163 shares outstanding at November 30, 1941, was $335.37, or more than six times the amount of $52.27 paid in per share.

Cash dividends paid by petitioner from 1922 to 1941, inclusive, amounted to $182.15 per share outstanding. A 50 percent stock dividend was paid in 1922 and a 30 percent stock dividend was paid in 1923. The cash dividends paid during the fiscal year ended November 30, 1941, amounted to $18 per share on each share of stock outstanding, which was equivalent to 35.10 percent on each original $100 investment.

Each stockholder who invested $10,000 in the business at the time of its organization in 1922 and held his stock until November 30, 1941, received in cash dividends during the period $34,184.25 and owned at November 30, 1941, 195 shares, which shares had a book value of $65,397.15, or $55,397.15 more than his investment.

Following the procedure that had been in effect in Crimmins & Peirce Co. and which is customary in the wool business, petitioner has always maintained a policy of paying basic salaries plus additional compensation in years when the services of the employees produce profits which justify additional compensation. In the earlier years there was no fixed mathematical formula covering the amount of additional compensation to be paid, the amount in each year being determined according to the results for that year. In April 1939 it was decided to establish a definite mathematical formula for paying additional compensation for the services which, it was believed largely produced the profits of the company. For the two preceding years petitioner had sustained losses. On April 3, 1939, the following vote was adopted by the board of directors:

VOTED that the treasurer or assistant treasurer be and they hereby are authorized to pay reasonable additional compensation to employees of the Company, for personal services rendered to the Company during the current fiscal year, equal to sixty-five (65) percent of the net profit of the Company, after deducting fixed annual compensation for officers and directors (referred to below) but before deducting accrued Federal income and excess profits taxes, which is to be divided in accordance with a memorandum of agreement dated April 3, 1939, identified by the signatures of all the directors. Said additional compensation is in addition to and exclusive of the fixed annual compensation previously voted to said officers and directors, for personal services rendered, aggregating seventy-eight thousand (78,000) Dollars, as follows: (Then follows an itemization of the $78,000 shown in the above mentioned statement attached to the deficiency notice as ‘basic salary‘ claimed and allowed.)

The memorandum of agreement dated April 3, 1939, referred to in the above vote, except for the signatures of Draper, Dana, Green, and Brown, is as follows:

Memorandum of agreement made this third day of April, 1939, relative to distribution of profits for the ensuing year.

From the net profits of the company, after payment of dividends, there shall be paid, as additional compensation, ten percent (10 percent) to employees of the company other than those listed below; the amounts to be paid to various individuals to be later determined by the Board of Directors.

From the net profits, as defined above, there shall be paid to the following individuals, as additional compensation, a sum equal to fifty-five percent (55 percent) of the net profits, to be distributed according to the following percentages:

+-----------------------+ ¦Paul A. Draper ¦34% ¦ +------------------+----¦ ¦Robert W. Dana ¦24% ¦ +------------------+----¦ ¦Malcolm Green ¦24% ¦ +------------------+----¦ ¦George W. Brown ¦9% ¦ +------------------+----¦ ¦Kenneth F. Clarke ¦9% ¦ +------------------+----¦ ¦Total ¦100%¦ +-----------------------+

The foregoing arrangement shall be in effect for the fiscal year beginning April 1st, 1939.

Contingent compensation allocated according to the same memorandum of agreement was voted for the fiscal year ended November 30, 1940, and for the fiscal year ended November 30, 1941, except that the votes read ‘not in excess of‘ 65 percent instead of ‘equal to‘ 65 percent.

The formula for contingent compensation adopted in April 1939 was arrived at by the directors after full discussion of the relative extent to which the services of the individuals involved contributed to the earnings of petitioner. The percentages of profit to be paid to the executives were not determined by their stockholdings and bore no relation thereto.

Under the formula adopted in 1939 for computing the amount of contingent compensation, and continued in 1940 and 1941, an allowance was made for the deduction of 6 percent of the net worth of petitioner, as a return on capital, before arriving at the amount of the earnings which would be divided among the employees pursuant to the formula.

The total net earnings of petitioner and its wholly owned subsidiaries, after deduction of the contingent compensation and all annuity premiums as well as all other compensation, expenses, and taxes, amounted during the fiscal year ended November 30, 1941, to $199,298.80, which was equivalent to $63.01 per share on the 3,163 shares of capital stock outstanding.

The net sales of petitioner had exceeded $17,000,000 in six earlier years, including one in which they exceeded the sales for the taxable year. Net sales amounted to less than $2,000,000 in each of the fiscal years ended March 31, 1931, to 1933, inclusive.

The total compensation, excluding payment of premiums on annuity policies of all of petitioner's salaried employees, including all executives, buyers, salesmen, clerks, etc., and including all contingent compensation, amounted to $492,383 in the fiscal year ended November 30, 1941, which was equivalent to 2.6 percent of its net sales. For the entire period from April 1, 1939, to November 30, 1941, in which the plan of contingent compensation was in effect, the total cash compensation paid to salaried employees of all kinds amounted to 2.7 percent of net sales. For the twenty-year period to November 30, 1941, total compensation of all salaried employees, including amounts paid for annuities, amounted to 2.4 percent of net sales.

Petitioner's balance sheets as of the beginning and end of the fiscal year ended November 30, 1941, were as follows:

+------------------------------------------------------+ ¦ ¦Beginning of¦End of year ¦ +----------------------------+------------+------------¦ ¦ ¦year ¦ ¦ +----------------------------+------------+------------¦ ¦Assets: ¦ ¦ ¦ +----------------------------+------------+------------¦ ¦Cash ¦$203,117.98 ¦$216,975.72 ¦ +----------------------------+------------+------------¦ ¦Accounts receivable ¦1,086,495.75¦506,555.61 ¦ +----------------------------+------------+------------¦ ¦Merchandise ¦1,156.202.02¦1,213,409.60¦ +----------------------------+------------+------------¦ ¦Advances on wool purchases ¦72,398.02 ¦211,149.75 ¦ +----------------------------+------------+------------¦ ¦Cash value on life insurance¦62,155.03 ¦71,823.66 ¦ +----------------------------+------------+------------¦ ¦Investments ¦151,000.00 ¦151,000.00 ¦ +----------------------------+------------+------------¦ ¦Deferred charges ¦10,494.72 ¦13,504.69 ¦ +----------------------------+------------+------------¦ ¦Capital assets ¦10,760.04 ¦25,503.87 ¦ +----------------------------+------------+------------¦ ¦Total ¦2,752,623.56¦2,409,922.90¦ +----------------------------+------------+------------¦ ¦Liabilities and capital: ¦ ¦ ¦ +----------------------------+------------+------------¦ ¦Accounts payable ¦87,754.32 ¦192,641.75 ¦ +----------------------------+------------+------------¦ ¦Acceptances payable ¦408,070.55 ¦ ¦ +----------------------------+------------+------------¦ ¦Notes payable ¦1,150,000.00¦1,000,000.00¦ +----------------------------+------------+------------¦ ¦Debentures payable ¦156,500.00 ¦156,500.00 ¦ +----------------------------+------------+------------¦ ¦Capital stock outstanding ¦316,300.00 ¦316,300.00 ¦ +----------------------------+------------+------------¦ ¦Surplus ¦633,998.69 ¦744,481.15 ¦ +----------------------------+------------+------------¦ ¦Total ¦2,752,623.56¦2,409.922.90¦ +------------------------------------------------------+

Petitioner's total borrowings during the fiscal year ended November 30, 1941, were over $5,000,000 and at other times approximately $6,000,000. These borrowings were upon unsecured, unendorsed notes signed by petitioner. A total line of credit was established by Draper at the beginning of each fiscal year at six banks, the largest being the First National Bank of Boston, from which its borrowings rose as high as $1,500,000 during 1941. It was agreed that petitioner would keep the amount of wool at risk within its capital of approximately $1,000,000 and that the loans would cover the financing of wool which had been sold or for which petitioner had orders. The lending banks did not require petitioner to submit evidence of the orders, but had confidence in Draper and loaned money upon his statement that they had orders to cover the same.

The recognized minimum brokerage commission on the sale of wool is 1 percent. The recognized minimum brokerage commission on the purchase of wool is 1 percent in the case of foreign wool and 1 cent a pound in the case of domestic wool bought in the grease. If the petitioner had not had these executives, it would have had to buy and sell through brokers, whose commissions at these minimum rates, applied to the volume of wool bought and sold by the petitioner in 1941, would have amounted to approximately the total of all the contingent compensation paid to the executives and of all other buying and selling expenses. Included among such other expenses for this computation are all amounts paid to buyers and salesmen, agents and brokers, by way of both salaries and commissions, and all telephone and telegraph charges incurred by petitioner in connection with its buying and selling.

In August 1941 petitioner adopted a plan providing for additional compensation through the purchase of retirement annuities commencing at age 65 for such of its officers and employees who had been in petitioner's service for at least 19 years, or who might thereafter complete such number of years of service. Each such annuity contract required an annual premium not in excess of one-third of the salary of such officer or employee. Petitioner authorized its treasurer to pay in the fiscal year 1941 the annual premiums for the first year and for two years in advance on each such contract. Petitioner did not obligate itself to pay premiums in future years, but left that question for future determination. Each contract was delivered to the respective officer or employee for whose benefit it was made. At a meeting of petitioner's board of directors on October 6, 1941, it was:

VOTED The annuitant shall have no rights under the contract on his sole signature except the right to change and successively change the beneficiaries named to receive payment in the event of his decease, or method of settlement to them. Any and all other rights, options or benefits contained in the contract or permitted by the insurance company, including, but without limitation of the foregoing, the right to receive dividends, assign the contract as collateral security, or surrender the same to the company for its cash value, shall be reserved to the Annuitant, but only with the written consent of Draper & Company, Incorporated, its successors and assigns: PROVIDED, HOWEVER, that if said Draper & Company, Incorporated, its successors and assigns shall give its consent to the exercise of any right, any amount which may be payable under the contract during the lifetime of the annuitant by reason of the exercise of such right shall be payable to and for the sole benefit of the annuitant.

At the close of the fiscal year 1941 the only persons who had been in petitioner's service for at least nineteen years and who were therefore eligible for the retirement plan were Draper, Dana, Green Brown, Clarke, Adrian C. Keller (traffic manager), Alice M. Scott (secretary), Genevieve McCausland (telephone operator and file clerk), and Harry H. Hamilton (messenger).

Pursuant to the retirement plan petitioner made applications in 1941 to certain insurance companies for annuity contracts for the above named officers and employees. The policies issued pursuant to those applications required annual premiums until age 65 equal in the case of each officer or employee to one-third of his basic salary and provided retirement annuities commencing at age 65. The policies were delivered by the insurance companies to petitioner, which delivered them in 1941 to the respective annuitants named therein. The policies delivered to the annuitants contained a special provision restricting the annuitant's rights to immediate benefits under the policies in accordance with the above vote of the board of directors on October 6, 1941.

In 1941 petitioner paid to the insurance companies one annual premium on each of the policies and deposited with the insurance companies amounts which would be sufficient, when interest was added, to cover the annual premiums on the policies when they became due in 1942 and 1943. The advance deposits would have been repaid by the insurance companies to petitioner if, before the premium became due, petitioner had requested such repayment, but petitioner did not intend in 1941 to ask for a refund of any of the advance premium deposits. There was no requirement on the part of the insurance companies that three years' premiums be paid in 1941.

The amounts paid by petitioner in 1941 with respect to the persons eligible under the retirement plan were as follows:

+------------------------------------------------------+ ¦ ¦1941 annual¦Advance ¦ ¦ +--------------------+-----------+----------+----------¦ ¦ ¦premium ¦premium ¦Total ¦ +--------------------+-----------+----------+----------¦ ¦ ¦ ¦deposits ¦ ¦ +--------------------+-----------+----------+----------¦ ¦Paul A. Draper ¦$10,000 ¦$19,350.81¦$29.350.81¦ +--------------------+-----------+----------+----------¦ ¦Kenneth F. Clarke ¦2,400 ¦4,625.76 ¦7,025.76 ¦ +--------------------+-----------+----------+----------¦ ¦Genevieve McCausland¦600 ¦1,156.44 ¦1,756.44 ¦ +--------------------+-----------+----------+----------¦ ¦Adrian C. Keller ¦1,100 ¦2,120.14 ¦3,220.14 ¦ +--------------------+-----------+----------+----------¦ ¦George W. Brown ¦4,000 ¦7,709.60 ¦11,709.60 ¦ +--------------------+-----------+----------+----------¦ ¦Malcolm Green ¦6,000 ¦11,579.00 ¦17,579.00 ¦ +--------------------+-----------+----------+----------¦ ¦Harry H. Hamilton ¦700 ¦1,349.18 ¦2,049.18 ¦ +--------------------+-----------+----------+----------¦ ¦Alice M. Scott ¦700 ¦1,349.18 ¦2,049.18 ¦ +--------------------+-----------+----------+----------¦ ¦Robert W. Dana ¦6,000 ¦11,579.00 ¦17,579.00 ¦ +--------------------+-----------+----------+----------¦ ¦Total ¦31,500 ¦60,819.11 ¦92,319.11 ¦ +------------------------------------------------------+

The total amount so paid, including advance premium deposits in 1941, was claimed by petitioner as a deduction on its tax return for the fiscal year ended November 30, 1941, as an ordinary and necessary business expense.

In accordance with a vote of the directors of petitioner, the total amounts paid under the retirement plan in the fiscal year ended November 30, 1941, were deducted in arriving at the net profit to which the percentages under the contingent compensation formula were applied. In 1942, because of enactment by the Revenue Act of 1942 of new provisions relating to the purchase of retirement annuities for employees, the foregoing plan, which did not meet such new provisions, was terminated and a new pension plan was adopted, meeting such new requirements. To the date of termination of the old plan, no additional employees became eligible under that plan. The new plan was subsequently approved by the Commissioner of Internal Revenue, and it was put into effect in 1942 and has since been continued in effect.

A reasonable allowance for salaries or other compensation for personal services actually rendered in the case of the officers and employees of petitioner here in question for the fiscal year ended November 30, 1941, is as follows:

+-----------------------------+ ¦Paul A. Draper ¦$132,000¦ +--------------------+--------¦ ¦Robert W. Dana ¦90,000 ¦ +--------------------+--------¦ ¦Malcolm Green ¦90,000 ¦ +--------------------+--------¦ ¦George W. Brown ¦39,000 ¦ +--------------------+--------¦ ¦Kenneth F. Clarke ¦34,200 ¦ +--------------------+--------¦ ¦Charles Dana Draper ¦20,000 ¦ +-----------------------------+

The amount of $5,974.94 representing advance premiums deposited covering the years 1942 and 1943 for annuity contracts obtained by petitioner for Keller, Scott, McCausland, and Hamilton were not accruable liabilities of petitioner for the fiscal year ended November 30, 1941.


BLACK, Judge:

The two issues here involved are: (1) Did the respondent err in disallowing as a deduction from gross income $303,044.17 as excessive compensation? (2) Did the respondent err in disallowing as a deduction from gross income $5,974.94 as advance premium deposits? The applicable statute as to each issue is section 23(a)(1)(A) of the Internal Revenue Code, which is set forth in the margin. We shall consider the issues in the order stated.

SEC. 23. DEDUCTIONS FROM GROSS INCOME.In computing net income there shall be allowed as deductions:(a) EXPENSES.—(1)TRADE OR BUSINESS EXPENSES.—(A) In General.— All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered * * *

(1) During the taxable year petitioner paid to the six key men named in our findings total basic salaries of $92,700 and total bonuses of $312,500, and paid to insurance companies for the benefit of five of the six men total premiums of $83,244.17 on annuity contracts, making a grand total of $488,444.17, which petitioner contends it is entitled to deduct under the statute as representing ‘a reasonable allowance for salaries or other compensation for personal services actually rendered.‘ The respondent allowed all of the basic salaries and a portion of the bonuses equal to the basic salaries, and disallowed the balance of the bonuses of $219,800 and all of the premiums or a total disallowance of the above mentioned amount of $303,044.17. A complete itemization of the totals here mentioned is in our findings.

We have included Charles Dana Draper as a key man.

In the recent case of Miller Manufacturing Co. v. Commissioner, 149 Fed. (2d) 421, the Fourth Circuit, among other things, said:

It is well settled that the question of what constitutes, for the tax deduction here in issue, reasonable compensation to a specific officer of a corporation, is essentially a question of fact, to be determined by the peculiar facts and circumstances in each particular case. (Citations.) These facts and circumstances vary so widely that each corporate tub must more or less stand upon its own botton. (Citations.) A determination by the Commissioner of a reasonable allowance for compensation, in a specific case, carries a clear presumption of correctness and places upon the taxpayer the burden of proving that it is entitled to a deduction larger than that determined by the Commissioner. (Citations.)

Has petitioner proven that it is entitled to a deduction larger than that determined by the respondent? We think it has. Petitioner has put in evidence a mass of evidentiary facts, much of which we have set out in our findings. From all of this evidence we have concluded and found as an ultimate fact that ‘a reasonable allowance for salaries or other compensation for personal services actually rendered‘ by the six key men consisted of their basic salaries, plus the total bonuses paid them under the mathematical formula adopted in 1939, but not any of the premiums paid or deposited on the annuity contracts under the retirement plan adopted in 1941. We think the respondent erred in disallowing a portion of the bonuses paid under the mathematical formula. This formula was adopted prior to the taxable year in an arm's length transaction and was intended as the establishment of a sound, practical, and reasonable basis of compensation for personal services actually rendered. The respondent's Regulations 103, section 19.23(a)-6, provides in part as follows:

* * * The test of deductibility in the case of compensation payments is whether they are reasonable and are in fact payments purely for services. This test and its practical application may be further stated and illustrated as follows:

(2) The form or method of fixing compensation is not decisive as to deductibility. While any form of contingent compensation invites scrutiny as a possible distribution of earnings of the enterprise, it does not follow that payments on a contingent basis are to be treated fundamentally on any basis different from that applying to compensation at a flat rate. Generally speaking, if contingent compensation is paid pursuant to a free bargain between the employer and the individual made before the services are rendered, not influenced by any consideration on the part of the employer other than that of securing on fair and advantageous terms the services of the individual, it should be allowed as a deduction even though in the actual working out of the contract it may prove to be greater than the amount which would ordinarily be paid.

(3) In any event the allowance for the compensation paid may not exceed what is reasonable under all the circumstances. It is in general just to assume that reasonable and true compensation is only such amount as would ordinarily be paid for like services by like enterprises under like circumstances. * * *

Applying this test of deductibility to the evidence in this proceeding, we are of the opinion that the basic salaries plus the total bonuses paid under the 1939 formula are not in excess of the ‘reasonable allowance‘ specified in the statute. They were paid purely for personal services actually rendered and were never intended as a guise for something else. Although all of the six key men were also stockholders, the payments in question bore no relation to their stock ownership or, in the case of Draper, Dana, and Brown, to the stock ownership of themselves and their wives. The payments were, we think, reasonable when viewed in the light of the nature of petitioner's business and the personal services rendered, the history of petitioner and its large earnings over a period of years, the treatment received by petitioner's stockholders, the fact that such payments were based upon definite agreements entered into before the services were rendered, and the commissions customarily paid for buying and selling wool. We hold, therefore, that the basic salaries plus the total bonuses paid under the 1939 formula are deductible. Cf. Austin v. United States, 28 Fed.(2d) 677; Gray & Co. v. United States, 35 Fed.(2d) 968; Thomas N. Perkins, 33 B.T.A. 606, 622.

We think the following quotation from the court's opinion in Gray & Co. v. United States, supra, applies with equal force to the facts of the instant case as it did to the facts of that case:

* * * The action of the board of directors under ordinary circumstances in fixing the salaries raises a fair presumption of reasonableness in such case, and this presumption is the stronger in this case because the practice of compensating on what may be called a contingency was a settled policy of the corporation extending over a period of years prior to the years in question here and after these years, and in each year it was based upon the profits for that year. If the profits were small, the sum realized from the percentage was small, and if the profits were large, the sum so realized was larger, depending in each year upon the loyalty, vigilance, and intelligent effort, and the stimulated ambition of each of the parties. The success of the business was largely due to the individual efforts of these men, and the diligence they displayed and attention they gave to the particular branch of the business allotted to them. Its earnings did not depend upon the activities and efforts of a large number of subordinates.

So it was, we think, in the instant case.

Regarding the $83,244.17 premiums and advanced premium deposits on annuity contracts paid to certain insurance companies for the benefit of Draper, Dana, Green, Brown, and Clarke, we are of the opinion that the respondent's disallowance of this amount as representing excessive compensation should be sustained. The retirement plan was not adopted until more than eight months of the taxable year had passed. We think that when this amount is added to the $405,200 of basic salaries and bonuses which we have already held to be allowable, the result is excessive compensation. Excessive compensation can not be allowed as a deduction under the provisions of 23(a)(1)(A). We, therefore, sustain the respondent's determination as to the $83,244.17. It is proper to point out that no contention is made by petitioner that the $83,244.17 in question is deductible under section 23(a) and (p), relating to pension trusts, or any other provision of the statute save and except 23(a)(1)(A). If we are wrong in denying petitioner a deduction for the $83,244.17 in question on the ground stated above, nevertheless, we think that part of the $83,244.17 which represented advance premium deposits to pay premiums for 1942 and 1943 would still be nondeductible for the reasons stated under issue 2, immediately following.

(2) The reason given by the respondent in the statement attached to the deficiency notice for disallowing the advance premiums of $5,974.94 was that this did not represent ‘an accrued expense for the taxable year.‘ He makes the same contention in his brief, plus the additional contention that the payment of this amount by petitioner in the taxable year was not a ‘necessary‘ expense in 1941. The payment was intended as additional compensation for Keller, Scott, McCausland, and Hamilton. The respondent does not contend that this amount when added to the compensation for these four individuals would result in excessive compensation. In his brief he says that these four employees do not appear to have been overcompensated. In his brief respondent submits the following in support of his contention:

* * * It appears that these advance premiums were not required to have been paid by the petitioner and would have been refunded to it by the respective insurance companies if a demand had been made by petitioner prior to the time such premiums became due under the policies. It is submitted that a taxpayer on an accrual basis may not claim as a deduction an advance payment of an amount for which it was not obligated. Such advance premiums should be deductible only in the year in which they are due. They were not a ‘necessary‘ expense in 1941.

We think respondent must be sustained in this contention. With reference to the payment of these advanced premiums, it has been stipulated as follows:

In addition to paying the first annual premiums due in 1941, the petitioner paid to the insurance companies in 1941 amounts sufficient, when interest was added, to cover the annual premiums on the policies when they became due in 1942 and in 1943. * * * These amounts would have been repaid by the insurance companies to the petitioner if, before such premiums became due, the petitioner had requested such repayment and would have been so repaid, if the annuitant had died before the premiums became due, to the petitioner except that in the case of the Columbian National Life Insurance Company the payment, if the annuitant had died, would have been made to the beneficiaries named in the policies. The petitioner did not intend in 1941 to ask for a refund of any of the aforesaid advance premium payments.

The fact that petitioner did not intend in 1941 to ask for a refund of any of these advance premiums it seems to us is immaterial. The fact remains that it was not obligated to make payment of these advance premiums to the insurance companies until such premiums became due, and, having made them, it could have had them repaid by the insurance companies at any time prior to the time such premiums became due. This seems to be true as to all the insurance companies, including the Columbian National Life Insurance Co., although in the latter case there would have been some difference in repayment if the annuitant had died before such advance premiums became due. We do not think this latter feature makes any difference as to petitioner's right to accrue the advance premiums in 1941. At any rate, the petitioner does not make any point that the advance premiums deposited on the policies in the Columbian National Life Insurance Co. should be treated differently from the advance premiums deposited on the other policies. There is no segregation of the premiums which would enable us to do this, even if we should decide that it should be done.

The respondent in his determination of the deficiencies has allowed petitioner a deduction for the 1941 premiums paid on these particular policies involved in issue 2. He has disallowed the $5,974.94 advance premiums deposited on these policies for the years 1942 and 1943 as not properly accruable as an obligation in 1941, and in this we sustain him.

Decision will be entered under Rule 50.