Lincoln Elec. Co.
v.
Comm'r of Internal Revenue

Tax Court of the United States.Jan 11, 1946
6 T.C. 37 (U.S.T.C. 1946)

Docket No. 1296.

1946-01-11

THE LINCOLN ELECTRIC COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Ashley M. Van Duzer, Esq., Thomas V. Koykka, Esq., Sumner Canary, Esq., and Louis C. Weiss, C.P.A., for the petitioner. DeWitt M. Evans, Esq., and T. F. Callahan, Esq., for the respondent.


Voluntary disbursements by petitioner in the purchase of annuities for certain employees in 1940 and additional payments for a similar purchase in 1941, as well as contributions in the latter year to a ‘profit-sharing‘ trust, on the facts, held, (1) not deductible either as ‘compensation for services actually rendered‘ or as ordinary and necessary business expenses, under section 23(a), I.R.C.; (2) not a part of the cost of goods sold to be reflected as such in the computation of gross income, but rather they enter into the computation of net income, in which computation their deductibility from gross income is determined under section 23(a). Ashley M. Van Duzer, Esq., Thomas V. Koykka, Esq., Sumner Canary, Esq., and Louis C. Weiss, C.P.A., for the petitioner. DeWitt M. Evans, Esq., and T. F. Callahan, Esq., for the respondent.

This controversy involves deficiencies in Federal taxes for the taxable years 1940 and 1941 as follows:

+---+ ¦_ ¦ +---¦ ¦¦¦¦¦ +---+

Declared value Year Income tax excess Excess profits tax profits tax _ 1940------------------------ $89,705.04 $18,737.64 $153,898.69 1941------------------------ 189,958.42 103,455.92 923,587.91 _

The contested issues are: (1) Whether petitioner is entitled to deduct in the taxable year 1940, pursuant to to section 23 of the Internal Revenue Code, the amount of $400,008.84 consisting of premiums paid on a group annuity policy, either as additional salary and compensation paid for services actually rendered or as an ordinary and necessary business expense of that year; and (2) whether petitioner is entitled to deduct in the taxable year 1941, under the same statutory provision, the sum of $575,206.43 consisting of premiums paid in that year on the same group annuity policy, and the sum of $1,000,000, paid to the Cleveland Trust Co. as trustee under a trust for the benefit of certain employees, either as additional compensation for services actually rendered or as ordinary and necessary business expenses.

In the event the answer is in the affirmative, a further alternative issue arises, namely, did the respondent properly disallow as a deduction the aggregate amount of $1,055,546.86 as unreasonable compensation paid to certain designated officers and employees of petitioner in 1941.

Other issues raised by the petition have been disposed of by stipulation, effect to which will be given in the computation under Rule 50.

FINDINGS OF FACT.

Petitioner is an Ohio corporation, organized in 1906. The location of its principal manufacturing plant and place of business is and always has been Cleveland, Ohio. It is engaged in the manufacture and sale of electric arc welding machines, electrodes, and supplies. It kept its books and filed its returns on a calendar year accrual basis. Its Federal income tax returns for the taxable years were filed with the collector of internal revenue for the eighteenth district of Ohio, at Cleveland, Ohio.

Petitioner's products were adapted to any industry in which metals were used. The oil industry was one of the large users of its products, but in the years 1940 and 1941 its products were also in demand by the shipbuilding and aeroplane industries.

Its successful growth over the past several years appears from the following schedule based upon corporate records:

+--------+ ¦_ ¦ +--------¦ ¦¦¦¦¦¦¦¦¦¦ +--------+

Earned surplus Net Year Assets Capital Paid-in and Net income Dividends Rate stock surplus undivided sales before paid per profits taxes share 1936 $6,686,218.85 $224,190 $620,647.50 $3,531,927.33 $8,290,876 $2,414,050 $1,347,869 $6.00 1937 8,195,281.40 227,722 859,275.50 4,477,073.87 10,709,085 2,944,683 1,373,776 6.00 1938 8,055,249.26 230,246 1,033,431.50 4,659,150.83 6,791,433 1,604,525 1,152,072 5.00 1939 9,884,225.09 232,104 1,161,633.50 5,309,702.67 9,257,613 2,459,974 1,375,502 6.00 1940 11,045,425.91 234,226 1,308,051.50 6,017,085.50 13,570,320 3,239,755 1,483,680 6.50 1941 12,657,341.73 234,226 1,308,051.50 7,041,122.75 24,024,095 5,720,919 1,835,094 8.00 _

The following schedule sets forth the average number of employees, base pay, cash bonus, annuity premiums, and the contribution to the employees' trust fund for the years 1934 to 1941, inclusive:

+--------+ ¦_ ¦¦¦¦¦¦¦ +--++++++¦ ¦ ¦¦¦¦¦¦¦ +--------+

Average Base pay, Annuity Year number salaries Cash premiums Trust Total of and bonus paid fund employees commissions 1934 404 752,243 $131,785 $884,028 1935 485 957,485 226,480 1,183,965 1936 535 1,180,917 436,375 $486,389.26 2,103,681 1937 666 1,455,986 672,845 359,803.71 2,488,634 1938 650 1,104,687 206,432 99,930.71 1,411,049 1939 637 1,360,686 495,722 132,251.57 1,988,660 1940 740 1,756,234 980,671 400,008.84 3,136,913 1941 979 2,669,269 2,071,315 575,206.43 $1,000,000 6,315,790 _

Eighty-five percent of petitioner's employees operate on a piece-work rate, scientifically ascertained. The rate is fixed and guaranteed for each year and the employee is paid in accord with what he produces and without restriction upon the amount of his production. The base pay of other employees whose duties are not susceptible of piecework treatment is the same or slightly higher than the prevailing wage rate paid by manufacturing industries in the community for similar services. The base pay of the executives, excluding the president, and key men is fixed at a low point. The base pay of only four of these exceeded $6,000 in the taxable year 1941. C. M. Taylor, vice president and sales manager, received $12,453.28; H. F. Kneen, factory superintendent, $8,015.23; A. F. Davis, vice president and secretary, $6,634.08; and G. C. Landis, chief engineer, $6,542.29. Only seven, including the four mentioned, exceeded $5,000.

Since 1934 the petitioner has paid annually a cash bonus. The aggregate amount paid is determined by the board of directors at the close of the year and allocated by the president, who has no share therein. The amount allocated to each employee is based on 3 factors, (1) base pay, (2) length of service, and (3) personal attitude toward the job and cooperative spirit. In 1941 all factory and office workers, irrespective of the length of service, received a cash bonus of approximately 100 percent of the base pay. Included therein were more than 200 factory and office workers whose length of service was from 2 weeks to 11 months. The cash bonus paid in 1941 to certain executives and key men ranged from 100 percent to over 700 percent, in some instances, of their base pay. While a great number of the executives, key men, and the older factory and office employees were stockholders of petitioner, the bonus was in no case determined with reference to stockholdings, and bears no relation thereto.

Since 1934 petitioner's operations have been successful and profitable. This has in large measure been due to its policy of generous treatment of its employees, which has resulted in the building up of a force of loyal and efficient workers. By this treatment it has avoided work stoppages and other labor troubles. Another factor contributing to its success is the fact that it has developed and designed new machine tools and appliances and many improvements in standard power tools permitting their operation at greatly increased speeds, resulting in largely increased production. Petitioner has no monopoly as to its manufactured articles, but sells its products in competition with a number of other manufacturers. Since 1934, although petitioner's earnings have consistently increased, the price at which it sells its products to the public has consistently decreased.

In 1936 petitioner purchased from the Sun Life Assurance Co. of Canada a group retirement annuity policy. It provides for the payment to the employees covered therein of a retirement annuity based on age and sex, computed under tables in the policy. Initially the policy included only those earning under $3,500 annually, and excluded salesmen and branch office employees. In 1938 the salary limitation was removed. The branch office employees were added as beneficiaries in 1939, and in 1940, the salesmen. All employees are now covered who have been in petitioner's employ one year and are over 15 and under 60 years of age. All the annuities purchased were fully paid and no further annual payments were required. Under the contract, in a subsequent year petitioner could buy new additional annuities for employees for whom annuities had already been purchased or annuities for other eligible employees. Petitioner, however, was not required to do this. But, if for 2 consecutive premium dates the cash premiums it paid for such purposes were not in excess of $5,000, the insurance company had the privilege of refusing further premiums except credits for cancellations. The amount of premiums which petitioner was permitted to pay in after the year of the contract could not exceed $600,000 in any one year. In the event the employee dies or his employment is terminated for any cause other than disability, all his rights are forfeited except where the annuity already accrued for that employee is equal to his then annual salary or $3,500, whichever is less. In the latter case, the accrued annuity becomes the property of the withdrawing employee and he has the right to exercise all the options and privileges inherent therein, except the right to assign any interest or benefit to which he may be entitled. The policy further provides that, in the event of the severance from employment before retirment age, ‘there shall become available on account of the contributions of the Employer allocated to such employee * * * an amount equal to 90% of the total of such contributions together with interest at the rate of three and one-half per cent (3 1/2%) per annum compounded annually, or the total of such contributions, whichever shall be the greater. Such amount shall in no event be refunded to the Employer but shall be retained by the Company until the next premium due date and shall form part of the premium then allocated at the direction of the Employer in accordance with the terms of Provision XVII * * * ,‘ that is, among other employees covered by the policy.

The average age of the employees covered by the annuity contract for 1940 was 33.2 years, and for the year 1941, 32.5 years. The amount of the annuity purchased is a percentage of the year's base pay of the employee who becomes a beneficiary.

The number of employees who lost all rights by severance from their employment or death and the number who became entitled to annuities under the policy by reason of reaching retirement age, and the amounts expended or credited for premiums therefor, are shown in the following schedule:

+----------------------------------------------------------+ ¦ ¦Severance from ¦Deverance ¦Vested in ¦ +-----+-----------------+----------------+-----------------¦ ¦Year ¦employment ¦by death ¦employees ¦ +-----+-----------------+----------------+-----------------¦ ¦ ¦Number¦Amount ¦Number¦Amount ¦Number¦Amount ¦ +-----+------+----------+------+---------+------+----------¦ ¦1937 ¦15 ¦$7,011.85 ¦1 ¦$540.83 ¦4 ¦$16,638.07¦ +-----+------+----------+------+---------+------+----------¦ ¦1938 ¦13 ¦6,635.58 ¦2 ¦4,730.71 ¦1 ¦52,566.82 ¦ +-----+------+----------+------+---------+------+----------¦ ¦1939 ¦33 ¦30,153.21 ¦----- ¦------ ¦1 ¦7,872.51 ¦ +-----+------+----------+------+---------+------+----------¦ ¦1940 ¦27 ¦31,834.73 ¦2 ¦8,368.28 ¦3 ¦19,499.59 ¦ +-----+------+----------+------+---------+------+----------¦ ¦1941 ¦31 ¦24,793.57 ¦----- ¦------ ¦1 ¦1,769.06 ¦ +-----+------+----------+------+---------+------+----------¦ ¦Total¦119 ¦100,428.94¦5 ¦13,639.82¦10 ¦98,346.05 ¦ +----------------------------------------------------------+

Petitioner did not inform its employees of the amounts allocated to them under the annuity contract, nor were they delivered individual contracts.

The purchase of the annuity contract was authorized by the board of directors. In each of the following years 1940 and 1941 the resolution was identical and reads as follows:

RESOLVED, That the officers of this Company be and they hereby are authorized to purchase annuities for its employees as added compensation for past services in such amounts and upon such terms as the officers in their discretion shall determine.

In December 1941 petitioner established a trust for the benefit of certain of its employees and paid $1,000,000 to the Cleveland Trust Co. as trustee. The creation of the profit-sharing plan and the payment of the $1,000,000 in 1941 were pursuant to a resolution of petitioner's board of directors duly adopted December 18, 1941. That resolution provides in part as follows:

After due consideration of a report by the President to the Board of Directors on the subject of bonus and profit sharing plans it was decided:

1. That it was through the efficiency, loyal conscientious effort and unusual cooperation and ability of the employees and executives included in the Plan described hereinafter that the remarkable increase in production was accomplished, with only a small increase in plant capacity and number of employees, the selling prices of the Company's products were actually materially descrased (sic) in the face of generally rising costs, and the sales of the Company were greatly increased with resulting increased profits; and

2. That the Company should share a portion of its profits with certain of the officers and employees whom the Board believes were entitled to additional compensation on account of the value of services rendered; and

3. That to promote the conservation of this additional compensation by the employees the funds should be set aside in a trust for future distribution; and

4. That such a plan will safeguard the future of the employees and become a more permanent benefit to them than if it were distributed at the present time as it will assist in providing financial security in time or times of adversity which may come upon them in the future; and

5. That such plan will assist in the effort of the government of the United States to curb the inflationary effect of an increased consumer purchasing power in the face of restricted supplies of consumer goods, and

6. That the investment of funds of the Plan in governmental bonds or obligations will assist in financing the rearmament and National Defense program of the United States.

All who were in petitioner's regular employ on December 31, 1941, excluding salesmen, the president, J. F. Lincoln, and J. C. Lincoln, chairman of the board of directors and treasurer, were included in the plan. It also included those who had been in its employ within the year but who were then absent on leave in the military service. The share of each beneficiary is in the proportion set opposite his name in the trust instrument. It is that proportion of the total trust fund represented by the ratio of his total cash compensation in the period January 6 to December 5, 1941, to the total compensation of all the beneficiaries. The pertinent provisions of the trust instrument are that ‘In no case shall any part of the Trust Estate revert to the Company or be paid directly or indirectly to or for the benefit of the Company,‘ and, further, ‘This agreement is made without the right to modify or amend the same in any respect whatsoever.‘ The trustee, with the approval of the ‘Committee,‘ may invest and reinvest the funds in any securities or real estate other than in shares of stock or obligations of petitioner or any subsidiary of the petitioner. This ‘Committee‘ was composed of three persons, named and so designated, of which the president of petitioner was a member ex officio. The other two members, officers of petitioner, were specifically named and designated. In the event of their inability to serve, successors were to be selected by petitioner's directors.

The trust is to continue for a period of ten years, unless distribution of all the share interests pursuant to its terms has been fully completed prior thereto. Other material provisions are as follows:

10. It is hereby provided that, except as specifically limited or restricted by Paragraphs 11 and 12 hereof, the time or times of segregation of assets hereunder and the disposition of such assets shall be in the sole discretion of the Committee.

11. If at any time the Committee shall have filed with the Trustee a written instrument setting forth the name of any Beneficiary and

(a) (if such Beneficiary be living at such time) instructing the Trustee to set aside all of such Beneficiary's share and dispose of such share, upon certain terms and conditions set forth in such instrument, to or for the benefit of such Beneficiary, with provisions whereby in case of his or her decease before such disposition shall have been completed the balance shall be disposed of, upon certain terms and conditions set forth in such instrument, to or for the benefit of some one or more or all of the following persons named in such instrument, to wit, the spouse of such Beneficiary, the children of such Beneficiary, and the executor or administrator of such Beneficiary, or

(b) (if such Beneficiary be not living at such time) instructing the Trustee to set aside all of such Beneficiary's share and dispose of such share, upon certain terms and conditions set forth in such instrument, to or for the benefit of some one or more or all of the following persons named in such instrument, to wit, the spouse of such Beneficiary, the children of such Beneficiary, and the executor or administrator of such Beneficiary,

then, in either such case, the Trustee shall thereupon set aside such share and shall thereupon or thereafter dispose of the same in accordance with such instructions. * * * The Committee shall have full power and authority to instruct the Trustee respecting the disposition of such share or to for the benefit of the person or persons so named in such instrument, including, but without limiting the generality hereof, power and authority to instruct the Trustee to invest and reinvest in any manner referred to in such instrument such share or any part thereof to be retained by the Trustee, and power and authority to restrict or prohibit or to require the Trustee to restrict or prohibit any person or persons from alienating, commuting, anticipating or encumbering or suffering the alienation, commutation, anticipation or encumbrance of any right, title or interest in or to (a) any income or principal of any part of such share or part thereof to be retained and disposed of by the Trustee, and/or (b) any income or principal of any proceeds or avails of any annuity contract which it may purchase pursuant to such instructions.

12. In case the disposition of the Trust Estate shall not have been completely provided for under the provisions of the next preceding paragraph before the thirty-first day of December, 1951, then on said date the Committee shall file with the Trustee written instruments setting forth the names of the Beneficiaries whose shares shall not have been segregated as provided for under the provisions of such paragraph and instructing the Trustee to segregate and dispose of such shares, such instructions to be limited in the same manner in all respects as provided in such paragraph as to the instructions provided to be filed under such paragraph.

14. The Trustee shall have power and authority with the written approval of the Committee, to make any division or distribution of the Trust Estate required under the provisions of this instrument, in cash or in kind, or partly in cash and partly in kind, according to the discretion of the Trustee and the Committee, any division or distribution in kind to be at such valuations as the Trustee may establish therefor with the written approval of the Committee. Any determination made as herein provided shall be final and conclusive upon all persons whomsoever.

16. The Committee shall be obligated to carry out the Plan as set forth in said resolutions of the 18th day of December— , 1941, but in no case shall the Trustee have any duty to inquire whether or not the Committee shall have complied with the Plan.

The beneficiaries were not informed by petitioner of the respective share or interest in the fund.

The purpose in the creation of the trust was to establish a fund from which petitioner, through the committee, could provide separation allowances to employees whom it anticipated it would be forced to drop from its employ after the termination of the emergency and the reduction in the volume of its production which would necessarily follow, and allowances to or for the benefit of families or estates of employees who died in service. As to the shares of the trust fund standing in the names of individuals who were retained in its employ and were living upon the termination of the trust, it was intended that payment, by direction of the committee, would be made to the Sun Life Assurance Co. to increase the amounts of the annuities of the several individuals under the existing annuity contract.

The cash bonus paid in the taxable year 1941 was authorized by the board of directors in a resolution adopted November 29, 1941, reading as follows:

RESOLVED, That this Company in addition to the regular rate of pay and all overtime earned by its employees to week ending November 30, 1941, pay as year end bonus, or added compensation, the sum of not to exceed $2,250,000.00, to be distributed by the President of the Company as he may determine.

A resolution identical except as to amount was adopted on December 9, 1940. The amount authorized to be distributed in 1940 was $1,100,000.

The amounts paid as cash bonuses in 1940 and 1941 were allowed as deductions by the respondent.

No employee reported as income the respective amounts allocated to him or her out of the funds used to purchase annuity contracts in the taxable years 1940 and 1941. No employee reported as income in the year 1941 the amount of the share or interest allocated to him or her in the $1,000,000 fund paid into a trust established by petitioner in that year.

The amount of $400,008.84 appropriated by petitioner in the taxable year 1940 and the amount of $575,206.43 appropriated in 1941 and used for the purchase of funded annuity contracts for certain employees at retirement age were neither compensation paid for services actually rendered, ordinary and necessary expenses of petitioner within the purview of section 23(a) of the Internal Revenue Code, nor a cost of goods sold to be reflected in the computation of gross income.

The amount of $1,000,000 appropriated by petitioner in 1941 and used to establish a profit-sharing trust was neither compensation paid for services actually rendered, an ordinary and necessary expense of petitioner within the purview of section 23(a) of the code, nor a cost of goods sold to be reflected in the computation of gross income.

OPINION.

LEECH, Judge:

The sole contested issue for the taxable year 1940 arises from respondent's disallowance, as a deduction from gross income, of the sum of $400,008.84 paid by petitioner in that year to the Sun Life Assurance Co. of Canada to purchase funded annuity contracts for certain of its officers and employees. The issues for 1941 arise from respondent's disallowance as a deduction (1) of the sum of $575,206.43 paid to purchase similar annuity contracts and (2) of the amount of $1,000,000 paid by petitioner to a so-called ‘employees' profit-sharing trust.‘

In the deficiency notices for the respective taxable years the respondent explained the disallowance of each of the above deductions as ‘not an allowable deduction within the provisions of Section 23 of the Internal Revenue Code. ‘ In the notice for the year 1941, the respondent set forth as additional grounds for the disallowance of the amounts of $575,206.43 and $1,000,000 that, to the extent set out in a schedule attached to the deficiency notice, the amounts were ‘considered unreasonable compensation and not allowable under the provisions of section 23(a) of the Internal Revenue Code.‘ He attacks there the reasonableness of the compensation paid to 438 out of a total of over 900 employees. In both taxable years the respondent has allowed as reasonable the total amount actually paid petitioner's employees, consisting of the base pay plus the cash bonus.

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: * * *

Respondent contends that the expenditures in the purchase of annuity contracts and the payment to the trust under the so-called profit-sharing plan did not constitute salaries or compensation paid for services actually rendered. As to the expenditures for annuity contracts, the grounds urged in support of such determination, briefly summarized, are: (1) The employees were not parties to the contract; (2) they had no vested rights to receive anything thereunder unless they survived the contingencies of forfeiture by death or severance from petitioner's employ and reached the retirement age of 60 years; (3) there was no contractual or legal obligation upon petitioner to make the payments in the respective years or to make further payments; (4) the employees had already been adequately and fully compensated for the services rendered through the base pay and cash bonuses; (5) the employees were not informed of the respective interests allocated to them; and (6) no employee returned as income the amounts allocated in the respective taxable years. Substantially similar grounds are urged for disallowing the deduction of the expenditure of $1,000,000 to the ‘profit-sharing trust‘ in 1941.

Petitioner argues that such amounts are properly deductible either (a) as compensation paid for personal services actually rendered, or (b) if not such compensation, they are allowable as an ‘expense‘ of doing business, or (c) if they do not constitute a deduction from gross income, then they are merely a cost of goods sold, to be reflected in the computation of gross income, and that as to this respondent has no jurisdiction. We limit our discussion and decision to those contentions.

Petitioner's primary contention is that the questioned disbursements are allowable as deductions from gross income under the statute as compensation paid for services actually rendered. Such deductions, of course, are permissible only by legislative grace and, to sustain its position, petitioner must establish that the payments fall clearly within one of the statutory provisions authorizing their allowance. New Colonia Ice Co. v. Helvering, 292 U.S. 435. There are only two sections of the revenue laws granting deductions for payments of compensation made to an officer or employee in the years here involved. These are sections 23(a)(1)(A) of the code, heretofore set out, and section 23(p) of the code, limited by section 165, as these sections read prior to amendment by the Revenue Act of 1942. It is conceded that sections 23(p) and 165 do not apply. Petitioner rests its case on this point on section 23(a). It is contended that the items in dispute constitute ‘compensation (paid)‘ within that section.

SEC. 23. DEDUCTIONS FROM GROSS INCOME.In computing net income there shall be allowed as deductions:(p) PENSION TRUSTS.—(1) GENERAL RULE.— An employer establishing or maintaining a pension trust to provide for the payment of reasonable pensions to his employees shall be allowed as a deduction (in addition to the contributions to such trust during the taxable year to cover the pension liability accruing during the year, allowed as a deduction under subsection (a) of this section) a reasonable amount transferred or paid into such trust during the taxable year in excess of such contributions, but only if such amount (1) has not theretofore been allowable as a deduction, and (2) is apportioned in equal parts over a period of ten consecutive years beginning with the year in which the transfer or payment is made.(3) EXEMPTION OF TRUSTS UNDER SECTION 165.— The provisions of paragraphs (1) and (2) of this subsection shall be subject to the qualification that the deduction under either paragraph shall be allowable only with respect to a taxable year (whether the year of the transfer or payment or a subsequent year) of the employer ending within or with a taxable year of the trust with respect to which the trust is exempt from tax under section 165.

SEC. 165. EMPLOYEES' TRUSTS.(a) EXEMPTION FROM TAX.— A trust forming part of a stock bonus, pension, or profit-sharing plan of an employer for the exclusive benefit of some or all of his employees—(1) if contributions are made to the trust by such employer, or employees, or both, for the purpose of distributing to such employees the earnings and principal of the fund accumulated by the trust in accordance with such plan, and(2) if under the trust instrument it is impossible, at any time prior to the satisfaction of all liabilities with respect to employees under the trust, for any part of the corpus or income to be (within the taxable year or thereafter) used for, or diverted to, purposes other than for the exclusive benefit of his employees,shall not be taxable under section 161, but the amount actually distributed or made available to any distributee shall be taxable to him in the year in which so distributed or made available to the extent that it exceeds the amounts paid by him. Such distributees shall for the purpose of the normal tax be allowed as credits against net income such part of the amount so distributed or made available as represents the items of interest specified in section 25(a).(b) TAXABLE YEAR BEGINNING PRIOR TO JANUARY 1, 1940.— The provisions of clause (2) of subsection (a) shall not apply to a taxable year beginning prior to January 1, 1940.

To be allowable as deductions of compensation, amounts paid to officers and employees for services must be compensation for services actually rendered to the employer. Section 23(a), supra. If not of that character, no necessity of inquiring as to their reasonableness exists. Undoubtedly, as petitioner apparently concedes, the word ‘paid‘ used in the first clause of section 23(a), supra, in connection with ‘expenses‘ in which ‘salaries or other compensation‘ are later included, must be treated as applying also to ‘salaries or other compensation.‘ Considering the section as thus construed, were these disbursements in dispute ‘compensation (paid)‘?

Of course, as petitioner argues, a payment for services, to be deductible, need not be limited to services rendered in the taxable year. Lucas v. Ox Fibre Brush Co., 281 U.S. 115. Nor is it required that the employer be legally obligated to make the payment at the time of performance of the services, but it must be made as a consideration for services actually rendered to the employer. Old Colony Trust C. v. Commissioner, 279 U.S. 716.

What is meant in the statute by the expression ‘compensation (paid)‘? Is that term of such little meaning there that it is satisfied by a showing of mere disbursement by the employer? We think not. ‘Compensation‘ is defined in Webster's New International Dictionary, as, inter alia, the ‘Act or principle of compensating.‘ Thus, there is an inference from the use of that word that there must be receipt of the payment by the employee before that payment can be said to constitute ‘compensation.‘ See sec. 22(a). This inference is emphasized by the use of the additional word ‘paid.‘ ‘Paid‘ to whom? We think that the use of the combined terms ‘compensation‘ and ‘paid‘ could mean only ‘paid to the employee.‘ But, since section 165 is not applicable, if these disbursements for annuities and to the trust when made were ‘compensation (paid)‘ to employees, why would they not be taxable, as such, at that time to the employees under section 22(a)? See Cecil W. Taylor, 2 T.C. 267; affd., Miller v. Commissioner, 144 Fed.(2d) 287; and Renton K. Brodie, 1 T.C. 275. Yet none of the ‘recipients‘ treated them so. No ‘annuitant‘ reported any of the amounts paid for ‘his annuity.‘ It is difficult to believe that the officers included in the trust were not aware of its purport. But none of them, nor the employees, reported any part of the payments to the trust. True, the correctness of that action is not before us. But, it undoubtedly lurks in the background against which the pending question must be considered. Where payments of compensation consisted of securities, the measure of the ‘compensation (paid),‘ and so deductible if reasonable, under section 23(a), has been consistently held to be the same as the measure of the ‘income derived from * * * compensation‘ taxable to the employee under section 22(a). That measure is the fair market value of those securities when received by the employee. International Freighting Corporation, 45 B.T.A. 716; affd., 135 Fed.(2d) 310; Edison Bros. Stores, Inc., 45 B.T.A. 472; reversed on another point, 133 Fed.(2d) 575; Alger-Sullivan Lumber Co. v. Commissioner, 57 Fed.(2d) 3; Hudson Motor Car Co. v. United States, 3 Fed.Supp. 834; Package Machinery Co., 28 B.T.A. 980; Indianapolis Glove Co. v. United States, 96 Fed.(2d) 816.

In the case of Richard R. Deupree, 1 T.C. 113, a single premium retirement annuity contract was purchased at its fair market price to the annuitant from an insurance company, at the direction of the employer upon the request of the petitioner-employee, from a fund established for the purpose. This policy was then delivered unconditionally to the employee-petitioner as additional compensation for past services. The employer had deducted its cost of the policy under section 23(a) of the code. The controversy before this Court involved only the simultaneous taxability to the employee-petitioner of such amount as ‘compensation (paid)‘ under section 22(a), as proposed by respondent. We affirmed on the ground that petitioner had constructively received as compensation the amount expended by the employer for the annuity. Then, in Renton K. Brodie, supra, involving identical facts except that the annuity contracts there involved were purchased by the employer for the employees without their knowledge or consent, we reached the same conclusion, there the annuity policies could have been bought by the employee annuitants at the same fair market price for which the employer purchased them. The policies were actually and unconditionally delivered to the annuitants. They could not be deprived of them. The annuitant employees could designate their beneficiaries. The findings of fact in that case contained, inter alia, the following paragraph:

Each annuity contract was labeled ‘Special Single Premium Retirement Annuity with Income Settlements at Optional Ages Non-Participating.‘ The insurance company agreed to pay in monthly installments a definite ‘life income,‘ commencing on the annuitant's seventieth birthday. If he should die after that day but before he received 120 monthly payments, the remaining payments were to be made serially to his beneficiary. Prior to the annuity date the annuitant might elect to receive a life income with or without a ‘Ten-years CERTAIN‘ feature. If the annuitant should die during the continuance of the contract the company agreed to pay to his designated beneficiary (or survivor) a certain sum as a ‘death benefit.‘ During the first three years that sum is the amount of the premium or consideration paid for the contract and thereafter it is the amount of such consideration plus an interest surcharge. The right to change the beneficiary was reserved to the annuitant.

On that record it was held that these annuity policies, when so delivered to the employees, conferred upon them directly or through their designees such irrevocable and certain benefits which they could freely choose under the policy options, as to constitute ‘compensation (paid)‘ to the employees in the amounts of the respective costs of their policies to the employer. The case of George Matthew Adams, 18 B.T.A. 381, was cited as the principal support for our conclusion. There this Court affirmed the action of the respondent in taxing to an employee as compensation the amount of a premium on a life insurance policy on the life of the employee paid by his employer. In so doing we rested our decision largely on the facts that the policy was delivered irrevocably to the employee and he ‘could designate the beneficiaries.‘

To the same effect are the recent decisions in Oberwinder v. Commissioner, 147 Fed.(2d) 255, and Robert P. Hackett, 5 T.C. 1325.

With these considerations in mind, what is the effect of the evidence here? Petitioner points to the resolution which designates the questioned disbursements as compensation for services rendered. But that formal action is not decisive. The question is whether the designation, as such, is genuine or fictitious. Bogardus v. Commissioner, 302 U.S. 34. The record discloses that 85 percent of petitioner's employees operate on a guaranteed piecework rate. Each is paid in accord with what he produces, without restriction upon the amount of his production. The base pay of other employees, whose duties are not susceptible of piecework treatment, is fixed favorably to the prevailing wage rate paid by manufacturing industries in the community for similar services. In addition to the base pay as thus fixed, petitioner in each of the taxable years paid cash bonuses. In 1940, the cash bonus was in excess of 50 percent of the base pay. In 1941, the cash bonus was approximately 100 percent of base pay to regular employees and ranged from 100 percent to over 700 percent in the case of certain executives and key men. The respondent makes no attack on these cash payments. Such generous cash payments might well be considered full compensation for services actually rendered. Cf. Botany Worsted Mills v. United States, 278 U.S. 282. Our inquiry, however, is limited to the additional amounts paid to purchase annuity contracts and the amount contributed to the so-called profit-sharing trust and designated by petitioner as ‘additional compensation.‘

These payments were not made under any agreement or prior understanding with the employees. Petitioner makes no such claim. The amounts to be appropriated were not determined until the close of the year after the services had been performed and the yearly profits ascertained. The employees were not officially informed that such ‘additional compensation‘ had been provided. Nothing evidencing their interests in either the annuity contract or the trust was delivered to them. Throughout the hearing, the president of the petitioner referred to the payments as ‘incentive pay.‘ It is true, as petitioner argues, there are many decisions where so-called ‘incentive pay‘ has been recognized as compensation and taxed to the recipient. But such cases are those where the services were performed under a prior existing contract; where the payments were cash bonuses paid for services actually rendered; or where some absolute benefit has been conferred upon the employee in the form of a true annuity or life insurance contract. Cf. Commissioner v. Bonwit, 87 Fed.(2d) 764; George Matthew Adams, supra; Richard R. Deupree, supra; Renton K. Brodie, supra; Charles L. Jones, 2 T.C. 924; Oberwinder v. Commissioner, supra; Hubbell v. Commissioner, 150 Fed.(2d) 516. The rationale of such cases is that the employee then actually or constructively received something of value.

Let us first consider the payments for annuities. This may be made more clear by stating an illustrative case. Assume that John Doe is 30 years of age, has been an employee of petitioner for 10 years, and his name appears on the list attached to and made a part of the annuity contract. By this list it appears that, of the total premium paid by petitioner, the sum of $1,200 is allocated to the purchase of an annuity of $150 per year payable to John Doe in 30 years when he reaches the age of 60. By the terms of the annuity contract he has no present vested interest in the annuity, nor is the employer obligated under a definite pension plan, constituting a provision of its contract of employment, to make any further payments in future years increasing the amount of the annuity. If John Doe dies or for any other reason ceases to render service to petitioner before the expiration of 30 years the annuity, as to him, is canceled and 90 percent of the $1,200, together with interest thereon at 3 1/2 percent per annum compounded annually, or the entire $1,200, whichever amount is larger, although not refundable to petitioner, is made available to it either to buy additional annuities for employees for whom annuities have already been purchased or to purchase an annuity for a new employee who takes the place of John Doe. If the latter survives the 30-year term and renders service to petitioner during that period he obtains a vested interest in the annuity, with the right to exercise options thereunder. He may also secure a similarly vested interest prior to the expiration of 30 years if petitioner in future years, although not obligated to do so, buys him additional annuities sufficient to bring the annuities standing in his name to an amount equal to his yearly salary, or $3,500, whichever is less.

Petitioner contends that under these facts it has, in the present year, paid John Doe $1,200 as compensation for services which he has actually rendered to it. It is argued that, since the payment of that sum is made in the taxable year and may not be recaptured under any circumstances for use for general corporate purposes and since its payment was authorized as compensation for services rendered, it is an allowable deduction for that year, although receipt of any payment by John Doe may be delayed for many years and, in fact, may never be received by him or his estate. We think the position is not tenable.

The fair market price of such a policy to the employee annuitant is not established. In fact it may be doubted that he could have bought such a policy— certainly nothing before us so indicates. As to the employee, any benefit upon the payment by the petitioner-employer was too uncertain and nebulous. Neither he nor his estate will be entitled to receive anything of value in the future unless he remains in the employ of petitioner and renders service in that employment over a long term of years. We conclude that the contested payments by petitioner for annuities did not constitute ‘compensation (paid).‘

The same general conditions pointed out with respect to the payments for annuities are also present, in great measure, in the employees' trust created by petitioner in 1941 and to which it transferred $1,000,000 in that year. This expenditure was made from petitioner's very large wartime profits and occurred after those profits were determined. The payment was purely voluntary. The fact that any such payment would be made was not communicated to the employees during 1941. It was made after the payment of the largest cash bonus in the history of the company and also after the declaration of the largest cash dividend ever paid by petitioner.

Petitioner asks us, upon brief, to find as a fact that, in case of the death of any beneficiary, payment of his or her proportionate part of the trust fund would be made to his or her family or estate and that at the termination of the trust any portion of the several shares of the beneficiaries not theretofore distributed would be received by them. However, an examination of the terms of the trust instrument establishes, we think, that such a finding is not supported by the record. It is true that 890 of petitioner's employees are, by the trust instrument, designated as beneficiaries, with interests in specific percentages of the total fund. The trustee, however, appears to be little more than a mere custodian. It is to invest and reinvest the fund only by and with the approval of the ‘Committee,‘ except no securities of petitioner or its subsidiaries are to be purchased. It can distribute the fund only in accordance with orders which it receives from the ‘Committee.‘ The trustee is relieved from liability if the ‘Committee‘ exceeds its authority. This committee of 3 is chosen from petitioner's officers. It is provided that the president of petitioner shall be a member ex officio. The other 2 members are designated by name, as are their successors in case of their deaths or failure to serve. If all of the named members become unable to serve, successors are to be appointed by petitioner's directors. Thus petitioner at all times retained control of the committee. The trust is to continue for a term of 10 years. No distribution may be made to or for the benefit of any ‘beneficiary‘ during that period except by the voluntary action of the committee. The latter may, wholly within its discretion, direct the trustee to pay over all or part of any share to or for the benefit of any beneficiary. It is within its discretion to determine for what the ‘benefit‘ expenditures shall be made. The beneficiary has no right to select or direct the particular benefit for which his or her share is to be expended. In the event of the death of a beneficiary, his or her particular share does not represent an asset of the decedent's estate unless the committee sees fit, within its discretion, to pay it over to the estate. It is discretionary with the committee as to whether it shall pay the share to the widow and/or to one or more of the children, or expend part or all of it for the ‘benefit‘ of one or more of those persons. The beneficiary has no right to designate the party who is to receive payment nor what the ‘benefit‘ shall be. Cf. Renton K. Brodie, supra, and Gisholt Machine Co., 4 T.C. 699. Upon the termination of the trust, if a beneficiary be living the committee may, in its discretion, either distribute his share to him or use it, in some way, for his benefit, the committee to be the judge as to what that ‘benefit‘ shall be.

The meaning of ‘benefit‘ has been broadly constructed. Helvering v. Evans, 126 Fed.(2d) 270; certiorari denied, 317 U.S. 638. Under the present circumstances it could well include uses of the funds which would result in no practical benefit either to the employees or their families or, at most, but a very remote one.

The purpose of petitioner in the creation of the trust and the planned use of the fund, under the direction of the committee, are explained in the testimony of petitioner's president. He states that it was anticipated that petitioner could not retain in its employ its full force after the close of the emergency and the consequent reduction in its volume of manufacture. He testified that petitioner desired to establish a fund from which it could make payments to employees whom it was forced to drop from the rolls in the future and that it was intended that, as to those employees who were not dropped and who survived the 10-year term of the trust, the committee would direct that their remaining shares of the fund be used by the trustee to purchase additional annuities for them under the existing annuity contract. As we have heretofore pointed out, a payment to an employee under these annuities, or the creation of vested interests in such annuities, was conditioned, in each case, upon the employee remaining in the service of petitioner until he or she reached the age of 60 years. Death or separation from the service terminated all rights.

As is true of the annuities, the record is silent as to the fair market price to the employees of their interests in this trust. In fact, whether such interests could have been purchased by the employees may be doubted.

We have no doubt that in the creation of this trust, as in the purchase of the annuities, one of the purposes petitioner had in mind was the benefit of its employees. That purpose is admirable. But we think that the benefits to the employees upon the payment to the trust in 1941 were so uncertain, indefinite, and intangible as not to constitute ‘compensation (paid)‘ to the employees. Admittedly, petitioner can not recapture this fund, but the practical effect of its action appears to us to be little more than the creation of a reserve for use in future years in making payments to or for deserving employees or to such among the families of deceased employees as it may voluntarily decide to benefit.

Petitioner relies heavily upon our decision in Gisholt Machine Co., supra. It is argued that the situation there was identical with that here. We do not agree. There the issue was the deductibility of the payment by an employer to a trust for the employees, as compensation, under section 23(a) of the code. In that case the production employees of the taxpayer had received a large increase in pay in the taxable year. There had been no corresponding increase in the pay of executives and certain key employees. In these circumstances the taxpayer authorized the distribution of an amount by a committee, which amount we found, as a fact, constituted reasonable compensation for the services actually rendered by these latter employees. It was not revealed whether they reported any of this amount as compensation. Under the plan adopted, a portion of this additional compensation was distributed in cash to the designated employees and the balance was placed in trust for future distribution. There are many differences in the facts there and those here. One very significant difference is that, unlike the situation here, in case of the death of any one of the beneficiaries of the trust before distribution to him of his share of the trust fund, payment would be made of his share to any beneficiary he might designate. See Renton K. Brodie, supra. Thus, it may be said to have been implicitly decided that the employee there received a benefit having a then value equal to its cost to the taxpayer— which value, as stated, we found as a fact constituted reasonable compensation for past services, and so allowed the contested deduction.

Congress has gone far in sections 23(p) and 165, to indicate its approval of provision by employers for the old age financial security of their employees. Deduction of payments for that purpose is there authorized under certain conditions. Why the disbursements in controversy, even assuming their reasonableness, were not made so as to comply with the law, we do not know. It may be assumed that petitioner preferred to keep the benefits from and control of the transferred funds which this record shows it retained rather than to relinquish them. Likewise we assume that petitioner deliberately chose to determine for itself if, as, and when such disbursements and their amounts should be made in the future rather than to lose those rights and commit itself to the definite program for the future required by section 165. See Regulations 103, arts. 19.23(p)-1 and 19.165-1. In any event we think that, to be deductible as ‘compensation (paid),‘ under the applicable section, the payments must be more than merely irrevocable by the employer. The employer can not retain the substance and grant only the shadow. The benefit to the employee, when such disbursements are made, must be less illusory and more certainly tangible and definite than those here in dispute. Congress has not said that such disbursements are deductible merely because they are praiseworthy.

In view of our conclusion that the disbursements in dispute did not constitute compensation paid for services rendered, any question of their reasonableness becomes moot.

This brings us to a consideration of petitioner's further contention that the disbursements are deductible as ordinary and necessary business expenses in that they constitute a cost of maintaining an incentive plan or program.

We have already decided that these payments were not ‘compensation (paid).‘ Section 23(a) deals specifically with ‘compensation (paid).‘ It describes particularly the payments of compensation for services which are allowable as deductions. Such payments are not allowable unless they fall within those specifications. Under the doctrine of ‘inclusio unius est exclusio alterius‘ we think the section denies the deduction of such payments for services, regardless of their designation, since they fall outside the field of allowable compensation deductions. Aside from this conclusion, and in any event, has petitioner established that the questioned disbursements were deductible as ordinary and necessary expenses?

It is argued that the disbursements were ordinary. True, petitioner had bought similar annuities in prior years, but the contribution to the trust in 1941 was the first such payment. To be deductible, however, expenses must be both ‘ordinary and necessary.‘ And ‘necessary‘ means more than commendable on the part of the employer and generally beneficial to him, as these undoubtedly were. Welch v. Helvering, 290 U.S. 111. In both of the taxable years, petitioner had paid cash bonuses in such large amounts as to make employment in its service a thing to be highly valued. None of the questioned disbursements were made because of any legal obligation. They were decided upon and authorized at the conclusion of the year's business when the profits of operation and the effect thereon of income and excess profits taxes were apparent. The amount of the contested deficiencies is about 75 percent of the payments in controversy. In authorizing these payments, petitioner evidently anticipated their allowance as deductions from its large gross income. It was obvious that these large expenditures, if deductible, could be made without much reduction in the surplus of petitioner. The situation was that, if these earnings were not disbursed through some deductible expenditure, practically the entire amount would have had to be paid as income and excess profits taxes. But the high rates of these taxes were deliberately fixed by Congress for the purpose of increasing the public revenue to meet rapidly growing Government expenditures for military purposes by taking a great part of such abnormally high profits resulting directly or indirectly from those Government expenditures.

We are convinced that petitioner had built up a loyal and efficient force of employees which was an important factor in the success of its business. Undoubtedly the preservation of that condition would be a benefit to petitioner in the future. Such future benefit would be more direct and tangible than would have been that resulting from the payment of approximately similar amounts to the Government as taxes. But this loyalty and efficiency already existed at the end of 1939. To preserve this condition the petitioner, in the taxable years, had paid very large cash bonuses which greatly exceeded those of earlier years. In the face of those facts and the prospective impact of the high tax rates on its current large profits, has petitioner carried its burden of establishing that the large additional disbursements in dispute were made because these expenses were ‘necessary‘ to preserve this loyalty and efficiency in its employees? We pass that question because, even if petitioner had established that fact, we think it would still not be entitled to the contested deduction as a necessary business expense.

Petitioner cites many cases in support of its position. They fall into two general classes, neither of which fits the present picture. One class includes those cases where expenditures were found to constitute reasonable compensation paid to the employees for services rendered and allowed as such. In the other class are cases where expenditures were made in furnishing employees facilities for medical or surgical aid, healthful recreation, or religious worship, the furnishing of which was held, under particular circumstances, to have been reasonably necessary to the furtherance of the general interests of the employer. None of these cases seem to us to be controlling or even helpful.

However, we think Welch v. Helvering, supra, directly supports our conclusion. As was pointed out by Mr. Justice Cardozo in that case, the fact that voluntary payments are necessary for the development of petitioner's business in the sense that they are appropriate and helpful does not establish them as necessary within the purview of section 23(a), supra. Many such expenses are more in the nature of capital expenditures than deductible operating expenses. In that case the taxpayer, carrying on a business as a grain buyer for the Kellogg Co., paid certain of his customers in each of the taxable years a large portion of his gross income from commissions. These customers were former creditors of a company with which the taxpayer had been connected and which had gone through bankruptcy. The payments of the taxpayer to the creditors were upon debts due them but the collection of which was barred by the discharge in bankruptcy. These payments were made by the taxpayer to these creditors to make possible the establishment of business relations and improve his credit with them and create a good will which would enable him to do business with them, from which he would realize profit. It was held there that, although the disbursements were made for such purpose and had the effect anticipated, they were not necessary business expenses subject to deduction, but more nearly resembled capital outlays to build up a good will among those on whom the success of the business of the taxpayer depended. There, the expenditures were made to create friendly relations and retain customers. Here, the disbursements were made to maintain such relations and secure the continued and uninterrupted service of employees.

Petitioner's second alternative argument is that the payments in question do not represent deductions from gross income, allowability of which is to be determined under section 23 of the code, but really constitute an item of cost of goods sold and thus are to be reflected in computing gross income. As such, petitioner argues that respondent is without jurisdiction to eliminate them or redetermine their amount. It is contended that they are of the same character as costs paid by petitioner for raw materials or for base pay of its productive employees under their contracts of employment.

We think that this theory needs little discussion. In its returns for the taxable years petitioner did not so treat these questioned items. They were not included in such costs there, but were deducted from gross income. Its position now is that voluntary bonuses and allowances paid at the end of the year from profits computed upon costs expended or accrued prior to that time constitute a cost of goods sold. We disagree. Petitioner cites no authority and we know of none supporting this position. Cost of goods sold, here means, we think, the amount which the manufacturer pays for raw material and for the labor and expense entering into the conversion and fabrication of that material into the finished product. The items in controversy represent payments voluntarily made and not determined upon until after the payment of all such costs and the manufacture of the goods were completed. These articles were then left in the employer's hands free to sell at a price based upon that cost. The items in dispute were voluntary payments from the profit accruing to petitioner from such sale. This profit petitioner was free to use for any purpose. To hold that such disbursements constitute a cost of goods sold would require the conclusion that the provisions of section 23(a) regarding the deduction of payments for services rendered has no application to manufacturing corporations. But there is an unbroken line of cases in other courts as well as the Tax Court in which the deductibility of compensation payments to the employees of a manufacturing corporation was determined under section 23(a). We think those cases were properly so decided and that the position of petitioner here is without merit.

See cases of character represented by: Wagegro Corporation, 38 B.T.A. 1225; Van Hooser & Co. v. Glenn, 50 Fed.Supp. 279; Toledo Grain & Milling Co. v. Commissioner, 62 Fed.(2d) 171; Seinsheimer Paper Co. v. United States, 63 Ct.Cls. 429; Botany Worsted Mills v. United States, 63 Ct.Cls. 405; affd., 278 U.S. 282; Gisholt Machine Co., 4 T.C. 699; Werner Machine Co. v. Manning, 129 Fed.(2d) 105.

Since certain issues were disposed of by stipulation,

Decision will be entered under Rule 50.

Reviewed by the Court.

VAN FOSSAN, J., dissents.

SMITH, J., dissenting: The petitioner contends that the premiums paid by it in the amounts of $400,008.84 in 1940 and $575,206.43 in 1941 upon a group annuity policy to the Sun Life Assurance Co. of Canada are deductible from gross income as ‘ordinary and necessary‘ expenses of operation. The premiums paid on this policy in the years 1936 to 1939, inclusive, in the respective amounts of $486,389.26, $359,803.71, $99,930.71, and $132,251.57 were apparently allowed by the respondent as legal deductions from gross income. In my opinion there is no more reason for the respondent to question the deduction of the amounts paid in the taxa4le years before us than in prior years. The respondent does not contend that the amount of the premium paid in 1940, together with other amounts paid as compensation to the employees, was in excess of reasonable compensation for services rendered. And for the year 1941 the respondent has determined only that the amounts of the premium paid on the policy plus the $1,000,000 paid to the Cleveland Trust Co. as trustee constitute unreasonable compensation for services rendered during those two years. I do not think there is any more ground for questioning the reasonable ness of compensation for 1941, so far as the premium is concerned, than for the year 1940.

The premiums paid on this policy were for the benefit of the petitioner's employees. The employees knew that they were the beneficiaries under the policy. The premiums paid constituted incentive compensation to them. That such incentive compensation was effective in obtaining unusual efforts on the part of the employees is abundantly shown by the record. The profits from operation were enormous.

In my opinion it should be the policy of the Government not to question the amounts of incentive compensation paid to nonstockholder employees. Such incentive compensation inures to the benefit of the employees, avoids labor disputes, and in the instant case greatly increased the output of and the profits of the corporation.

I do not think the fact that the employees are not taxable during the taxable years upon any part of the premiums paid to the insurance company is relevant in this case. Cf. Commissioner v. Bonwit (C.C.A., 2d Cir.), 764; Gisholt Machine Co., 4 T.C. 699; Phillips H. Lord, Inc., 1 T.C. 286.

Nor do I think it is material than an employee may lose some of his benefits under the insurance contract if he ceases to be an employee. The petitioner can never recover any part of the premiums which it has paid upon the policies. The benefits lost by the employee upon severance of his relations with the company accrue to other employees. I therefore am of the opinion that the amounts constitute legal deductions from gross income as ordinary and necessary expenses of operation.

The payment of $1,000,000 to the Cleveland Trust Co. as trustee in December 1941 seems to me to fall in a different category. It is quite clear that this payment was made by the petitioner in consideration of the fact that it would greatly reduce its excess profits tax for 1941. The respondent has determined that the payment (added to other compensation paid) was in excess of reasonable compensation for services rendered and I am of the opinion that the evidence does not disprove his determination. I therefore concur in the opinion so far as it disallows the deduction from gross income of 1941 of the $1,000,000 in question.

BLACK, J., dissenting: I wish to note my dissent to the conclusions reached in the majority opinion. In the light of certain prior decisions of this Court published in our B.T.A. and T.C. reports, it is difficult for me to see how the majority could reach the conclusion which it has reached in the instant case. I shall not write any lengthy dissenting opinion. I shall simply cite and briefly comment upon some of the cases with which, as I view it, the majority opinion is in direct conflict.

First, as to the $400,008.84 appropriated by petitioner in the taxable year 1940, and the amount of $575,206.43 appropriated in 1941 and used for the purchase of funded annuity contracts for certain employees named in the group retirement annuity policy. Petitioner points out in its brief that, in the few cases where the employer's right to the deduction has been questioned, the Tax Court has allowed the premium payments to the employer as a deduction. Petitioner cites in support of this contention certain memorandum opinions of this Court, and Phillips H. Lord, Inc., 1 T.C. 286. I shall not comment upon the memorandum opinions cited by petitioner because they are not to be found in our published T.C. reports. However, I shall briefly comment upon Phillips H. Lord, Inc., supra.

I think that case fully supports petitioner's contention. It is true that in the Lord case money was paid, in the first instance, to a trustee who then paid it as a premium to the insurance company issuing the employees' annuity policy. There is, however, in my opinion no reason to attribute different legal consequences to a situation where, as here, the money was paid direct to the Sun Life Assurance Co. in the purchase of the group retirment annuity policy, rather than through the medium of a trustee to the Equitable Life Assurance Society for a group retirement annuity policy, as was done in the case of Phillips H. Lord, Inc. To say that a distinction exists on that kind of a ground would, it seems to me, be pure hairsplitting and without any legal justification. Therefore, I think the case of Phillips H. Lord, Inc., supra, fully supports the group retirement annuity policy premium deductions which petitioner seeks to have allowed in the instant case.

Now, as to the deduction of the $1,000,000 which petitioner paid over in 1941 to the Cleveland Trust Co., as trustee, for future distribution to its employees in accordance with the plan and for the purposes named in a resolution adopted by petitioner's board of directors on December 18, 1941, I think this deduction is on all fours with that which was in controversy in the case of Gisholt Machine Co., 4 T.C. 699. In that case the Commissioner disallowed a deduction in 1941 of $173,500 paid by the taxpayer corporation to the trustee of its newly established ‘Executive Employees' Retirement Trust.‘ He determined that the amount was not deductible under either section 23(a) or section 23(p); that it was not a reasonable allowance for compensation for personal services of employees or otherwise an ordinary and necessary business expense; and that the trust was not an employees' trust under section 165, as amended by section 218 of the Revenue Act of 1939. The taxpayer claimed that the deduction was allowable under section 23(a)(1)(A), providing for the allowance for salaries or other compensation for personal services actually rendered. Petitioner conceded that section 23(p) was not applicable and claimed no deduction under that subparagraph of the statute. We sustained petitioner's contention that the deduction was allowable under section 23(a)(1)(A), and among other things said:

In our opinion, the amount of $173,500 which was actually paid by the corporation to the trustees of the employees' retirement trust in 1941 was deductible by the corporation under section 23(a) because it was within the compensation paid by it to its employees for services actually rendered by them. See I.T. 3346, C.B. 1940-1, pp. 62, 64. Therefore, it is unnecessary, and would be improper, to consider the question whether, if the amount did not fall within section 23(a), it is nevertheless deductible because it falls within the description of subsection (p). * * *

The majority opinion herein undertakes to distinguish the Gisholt Machine Co. case on its facts, but, to my way of thinking, the distinction which the majority opinion undertakes to draw is altogether unconvincing. To be sure, there are, as one would naturally expect, certain differences of phraseology in the trust indenture involved in the Gisholt Machine Co. case from the phraseology of the trust indenture in the instant case. However, such differences as there are, are, in my opinion, without any controlling significance. The real outstanding purpose of both trust was to provide future financial benefits for the taxpayer's employees who were named therein and the payments were beyond recall by the taxpayer. That was the real substance of the trust indentures in both cases, and if we were right in allowing the taxpayer the deduction in the Gisholt Machine Co. case, as I think we were, then we should allow it here. The Commissioner did not appeal the Gisholt Machine Co. case and it, therefore, stands unreversed. For other cases which I think support petitioner's contention for the $1,000,000 deduction of the irrevocable contribution which it made in 1941 to the trust estate for the exclusive benefit of its employees, see Hibbard, Spencer, Bartlett & Co., 5 B.T.A. 464; Elgin National Watch Co., 17 B.T.A. 339; Oxford Institute, 33 B.T.A. 1136; and Texas Pipe Line Co., 32 B.T.A. 125; affd., 87 Fed.(2d) 662.

Much is made of the fact, in the majority opinion, that no employee of petitioner had any such vested right in the corpus of the trust which was set up as would require him to return the amount allocated to him as income in 1941 and that none of such employees did return any of the amounts as income in that year. This, in my opinion, is without any controlling significance and it has been many times so decided by this Court.

The important inquiry in a case such as we have here is: Did the taxpayer irrevocably part with the money which it paid to the ‘employees' trust and, if so, does the payment fall within the ambit of ‘ordinary and necessary business expenses‘ as contemplated by section 23(a)(1)(A)? If these questions are answered in the affirmative, the deduction is allowable to the employer regardless of whether the amounts so paid are taxable to the employee in that particular year. The court, in affirming our decision in the Texas Pipe Line Co. case, supra, gave attention to this question and ruled against the Commissioner's contention in the following language: ‘This expense was incurred and paid even though no specific employee had a vested right to the stock until some subsequent time.‘

Now, in arriving at the views I have expressed above, I have made no attempt to discuss whether the benefits allocated to each employee under the $1,000,000 paid to this employees' trust in 1941, plus other compensation paid, results in excessive compensation for 1941 to some of the employees. The Commissioner in his determination of the deficiencies for 1941 attacks the reasonableness of the compensation paid to 438 out of a total of over 900 employees. It may well be that, as to some of these 438 officers and employees of petitioner in 1941, the premiums paid for the group annuity policy and the $1,000,000 paid to the employees' trust, plus other compensation which they had already received, would result in excessive compensation for 1941. Cf. Draper & Co., 5 T.C. 822. The majority, however, makes no findings of fact upon this subject and, therefore, I make no attempt to discuss it or express any opinion as to its merit. Plainly, the majority opinion does not rest any of its disallowance of the deductions claimed in 1941 upon the ground of the unreasonableness of the payments, for the opinion, after ruling that the items in question were not deductible as compensation paid, says: ‘In view of our conclusion that the disbursements in dispute did not constitute compensation paid for services rendered, any question of their reasonableness becomes moot. ‘ Therefore, it is plain that if any part of the deductions in dispute is to be disallowed on the ground of unreasonableness, the majority opinion would have to be based upon further and additional findings of fact and this case would have to be reconsidered. This fact is made all the more plain when it is considered that the Commissioner has only determined that the total compensation of 438 of petitioner's employees was excessive out of a total of more than 900 which are involved.

For reasons above stated, I respectfully dissent from the majority opinion.