Mine & Smelter Supply Co. v. Commissioner

The Mine and Smelter Supply Company, Petitioner, v. Commissioner of Internal Revenue, Respondent Mine & Smelter Supply Co. v. Commissioner Docket No. 11609 United States Tax Court 10 T.C. 1179; 1948 U.S. Tax Ct. LEXIS 150; June 24, 1948, Promulgated *150 Decision will be entered under Rule 50. Abnormality -- Class -- Section 711 (b) (1) (J) (i) and (K), I. R. C. -- In base period year 1937 petitioner, for the first time, issued to its executives and certain other key personnel a stock bonus, amounting to 28.01 per cent of its outstanding capital stock and having an aggregate par value in excess of 100 per cent of the basic salaries of those participants. The bonus was for the primary purpose of cementing the relationship and continued employment of the participants through giving them a stock ownership interest in the business, and, for a further purpose of partially rewarding them for past services. Held, that the stock bonus was a class of deduction separate from current basic salaries, that such deduction was abnormal in petitioner's business within subparagraph (J) (i), and that the abnormality was not a consequence of any of the factors enumerated in subparagraph (K) (ii); held, further, the limitation of subparagraph (K) (iii) is applicable. Lewis A. Dick, Esq., and Floyd K. Haskell, Esq., for the petitioner. Frank M. Cavanaugh, Esq., for the respondent. Tyson, Judge. Murdock, J., dissenting. Turner J., agrees with this dissent. TYSON *1179 The respondent has determined against petitioner deficiencies and overassessments for the years and in the amounts as follows: Calendar year 1941 Calendar year 1942 Deficiencies Overassessments Deficiencies Overassessments Income tax $ 2,114.85 $ 707.75 Declared value excess profits tax $ 139.84 221.57 Excess profits tax 7,741.68 $ 0.55 Net amount 5,766.67 928.77 The petitioner seeks redetermination of the asserted tax liability and also a determination of overpayments for each of the years 1941 and 1942. The parties have stipulated that petitioner paid its 1941 and 1942 taxes within three years before filing a claim for refund. The petition herein was filed July 22, 1946. By stipulation of the parties at the hearing, the respondent has conceded *152 the second assignment of error, relating to his failure to disallow for 1936 a certain bad debt deduction abnormality under section 711 (b) (1) (J) (i) and (K), Internal Revenue Code, and the petitioner has conceded the third assignment of error, relating to the gain determined by the excess of the market value over cost of certain treasury stock distributed as a stock bonus to employees in 1941 and 1942. Effect to such stipulation will be given in the recomputation under Rule 50. *1180 The only issue remaining in controversy is whether respondent, in determining petitioner's excess profits credit under the income method for the years 1941 and 1942, erred in refusing to disallow as a separate class of deduction abnormal for petitioner, under section 711 (b) (1) (J) (i) and (K) (ii) of the code, the petitioner's distribution of 2,000 shares of its stock of an aggregate value of $ 130,000 as a stock bonus to 27 key employees in 1937, one of its base period years. The proceeding has been submitted upon the pleadings, testimony, and exhibits, and a stipulation of certain facts, including attached exhibits. The stipulation is adopted as part of our findings of fact and included herein*153 by reference. FINDINGS OF FACT. The petitioner, a Colorado corporation originally incorporated in 1895 and reincorporated in 1917, maintains its principal office in Denver, Colorado. It filed its income tax returns for 1941 and 1942 with the collector for the district of Colorado. It has at all times computed its excess profits credit on the income method. For many years petitioner has been engaged in business principally as a wholesaler and retailer of various types of industrial machinery, equipment, tools, materials, etc., and as an agent in selling such types; and its customers include mining companies, contractors, dealers, government agencies, and individuals. In varying degrees petitioner has also engaged in designing and manufacturing special tools and equipment. During the years 1933 to 1942, inclusive, the petitioner's corporate and business organization, type of business conducted, sales territory, plant facilities, and general methods of doing business remained the same, without material change other than normal omissions from and additions to the merchandise inventory carried for sale. Throughout those years there was a steady increase in volume of business in keeping*154 with the general improvement in business conditions. During that time petitioner's general offices were located at Denver, where it maintained the company accounts and the offices of the several top executives who supervised the business transacted through its four divisions, each of the divisions being headed by a branch manager. The manufacturing division, known as the Marcy Mill Division, located in Denver, designed and manufactured, or farmed out for manufacture, special industrial tools and equipment in the nature of rock bit grinders, density controllers, pulverizers, concentrating tables, etc. The three sales divisions or branch offices, located in Denver, Salt Lake City, Utah, and El Paso, Texas, respectively, were each divided into six departments, each under the direction of a department head. Those departments were two functional departments consisting of division *1181 accounting and warehousing and four sales departments. The four sales departments consisted of the machinery department handling pneumatic and hydraulic metal and wood cutting machinery, equipment, etc.; the mill supply department handling various supplies, etc., used by industries and utilities; *155 the electrical department handling electrical apparatus, motors, copper wire, supplies, etc.; and the chemical department handling equipment, supplies, etc., for chemical laboratories. The petitioner's activities in designing and manufacturing special equipment varied from time to time from 10 per cent to 20 per cent of its total business activities. In connection with its principal business of selling, petitioner's three branches each stocked approximately 14,000 items of merchandise during each of the years 1933 to 1939, and thereafter the number of items gradually increased, along with continued improved business conditions. Throughout the years the type and variety of products sold, and also those produced in petitioner's business, required the services of specially trained executives and other key men having both technical training and years of practical experience in that particular specialized business. During the years from 1901 to 1929 the controlling stock interest in petitioner was owned by Joseph Seep. His son, A. H. Seep, was the local manager in Denver, and his son-in-law, one Fennessy, was president, invested with over-all administrative control centered in the *156 general offices located in New York City. Because the western executives were dissatisfied with that arrangement, Joseph Seep transferred the petitioner's general offices to Denver in 1929, and A. H. Seep became its president. Subsequently, upon Joseph Seep's death in 1929, his stock in petitioner descended equally to his eight living children, all of whom lived in the eastern part of the United States, except A. H. Seep, who lived in Denver, and thereafter until 1937 the eastern stockholders retained the controlling interest and determined petitioner's general policies, including the compensation paid to executives and other key employees. Commencing in 1930, petitioner's business suffered a sharp decline because of the general business recession and more particularly on account of the death of Joseph Seep, on whose personal credit the petitioner had previously borrowed capital, and A. H. Seep was forced to pledge his own securities as collateral for the company loans. Petitioner's volume of business was at its lowest ebb during 1932, and thereafter its business slowly improved, but in 1934 its financial affairs were in a critical condition, and also A. H. Seep, president of petitioner, *157 had to withdraw from active participation in its business because of illness. A meeting was held at Denver in 1934 for consideration of petitioner's financial affairs by the western executives and representatives of the eastern stockholders. The latter refused to give *1182 petitioner any financial or other assistance and one stockholder suggested a sale, merger, or liquidation of petitioner. Several of the western executives, who had been with petitioner for over 25 years, expressed their willingness to assume the responsibility of overcoming petitioner's financial difficulties and pledged their services toward that end. In March 1936 A. H. Seep died and was succeeded as president of petitioner by his son, Albert E. Seep, who had been in the company's employ since graduation from college in 1930 and had been vice president of petitioner since 1934. Albert E. Seep also became the financial adviser of his mother, who was the executrix of his father's estate, 25 per cent of the assets of which were pledged as security for loans to the petitioner. At the time Albert E. Seep became president the morale of petitioner's executives and key employees was not good, due to moderately*158 low salaries paid in the past, particularly during the depression, and also to doubts as to the future prosperity of the business. Albert E. Seep was a young man with only a few years business experience and knew that if petitioner was to prosper it was necessary to retain the executives and key employees whose services, knowledge, and ability had, over a long period of years, helped create petitioner's complex and specialized business, and he concluded that a stock bonus to such personnel would reward them for faithful services, would give them an ownership position in keeping with that of the other stockholders not employed in the business, and also would serve as further incentive for such personnel to remain in the employment of petitioner. At that time the members of the eastern Seep family owned 59.31 per cent and the Denver Seep family owned 14.12 per cent of petitioner's outstanding capital stock. Albert E. Seep took immediate steps for the purchase of a sufficient amount of eastern held stock to gain control of petitioner for the purposes of protecting the assets of the A. H. Seep estate pledged as security for loans to the company and reestablishing the company's sound*159 financial condition and also for the purpose of solidifying and revitalizing the company's management. As a result of Albert E. Seep's efforts, the ownership of petitioner's stock by the Denver Seep family increased to 49.02 per cent by March 4, 1937, and to 57.76 per cent by December 31, 1937. In the spring of 1937 Albert E. Seep formulated fairly definite plans which contemplated that the petitioner would execute employment contracts with 27 executives and other key employees for a stated period of years; that the petitioner would issue 2,000 shares of its capital stock, having an aggregate value of $ 130,000, to those persons in 1937 as a stock bonus; and that petitioner would pay cash bonuses to those same persons in subsequent years, commencing in 1938, as a profit-sharing incentive. Proposed employment contracts were *1183 drafted by petitioner's counsel with the aid of certain executives and, as a matter of convenience, the stock bonus plan and the cash bonus plan, which they considered as two separate plans, were incorporated in one contract, the terms of which Albert E. Seep discussed with various executives, who gave their approval thereof. On June 3, 1937, the petitioner's*160 board of directors held a special meeting in Denver for the purpose of considering the advisability of entering into the proposed contracts of employment with certain executives and key personnel, and in connection therewith the president stated, inter alia, that the contracts "would provide for the immediate payment of a bonus, or additional compensation and also a certain percentage of the net profits of the company after proper provision had been made for the stockholders." The directors agreed that the company should enter into contracts with certain named persons for terms of employment of five years for executives and three years for other key personnel in order, inter alia, "to insure the continuity and future success of the business" and "to partially recognize the valued services rendered" by the named individuals. Thereupon, the board of directors adopted a resolution which authorized a setting aside, out of each year's net earnings, of 12 per cent on the par value of outstanding capital stock and dividing the remainder of such earnings 60 per cent to "Surplus Account Special," to be retained for use by the company, and 40 per cent to a "Surplus Account Employees," *161 and, further, it adopted a series of resolutions authorizing the term of employment, the amount of the 1937 stock bonus, and the bonuses for subsequent years represented by a stated percentage of the "Surplus Account Employees," to be embodied in the contract with each named executive and key employee. The action of the board of directors on June 3, 1937, was confirmed and ratified without a dissenting vote at a special meeting of petitioner's stockholders at Denver, held after proper notice to all stockholders, on August 26, 1937, at which a total of 6,110 shares were voted out of the total of 7,140 outstanding shares owned by both eastern and western stockholders. The contract of employment entered into between petitioner and each executive and other key men, respectively, provided, inter alia, that: Whereas, the Company has in its employ several men holding various positions of large responsibility, who have been with the Company for many years; * * * for several years last past, and particularly through the period of the depression, the Company paid its key men less than they could have commanded elsewhere; * * * it is for the best interests of the Company and its stockholders*162 that a cooperative plan, providing for the payment of certain bonuses or additional compensation to the men who have been and now are responsible for the success of the business of the Company, be adopted. * * * *1184 * * * Employee has expressed his willingness to enter into this agreement, * * * * * * in consideration of the sum of Ten Dollars ($ 10.00) in hand paid by Employee to the Company, * * * and * * * of the covenants and agreements hereinafter set forth * * * It Is Agreed: * * * * That the Company hires Employee as and said Employee agrees to work for and remain in the service of the Company, for a term of years, commencing on the first day of January, A. D. 1937, unless sooner terminated in accordance with * * * this agreement * * *. * * * * A. In consideration of the faithful services rendered on behalf of the Company by Employee, the Company will, in addition to the payment of his regular salary for the year 1937, as fixed by the Board of Directors, as a bonus or additional compensation issue and deliver forthwith to said Employee a certificate for shares of its common capital stock of the par value of $ 65.00 per share. B. That in addition*163 to the regular salary to be paid Employee by the Company, commencing with the year 1938, which salary shall be fixed annually by the Board of Directors of the Company, Employee shall receive as compensation for his services as a bonus or extra compensation to be fixed and determined annually * * * * * * * * * * immediately following the close of the fiscal year. * * * The amount of the additional compensation to be paid commencing with the year 1938 was to be a sum equal to a percentage of a "Surplus Account Employees." The company reserved the right at its election to pay such bonus or extra compensation in cash, notes, or shares of its stock of an equal book value, and to terminate the contract in a certain manner. With respect to the company's stock acquired under the contract, the employee for himself, his heirs, executors, etc., agreed not to sell, pledge, hypothecate, or in any manner transfer the shares without first offering them to the company at their then book value, or if the employee left the employ of the company by death, discharge, or otherwise during the life of the contract the company should have a 90-day option to purchase the stock at its book value and*164 12 months to pay for it, but the company was not obligated to repurchase such stock. The stock bonuses, totaling 2,000 shares, issued in 1937 pursuant to the employment contracts entered into amounted to 28.01 per cent of petitioner's then outstanding capital stock. All those persons who participated in the stock bonus plan did so solely on the basis of being actively engaged in petitioner's business as executives or other key employees and irrespective of the fact that some of them were already stockholders. The amount of the stock bonus for 1937 and also the amount of the subsequent annual profit-sharing bonus for each participant was fixed in accordance with the relative importance of his position. The amount of the stock bonus was not determined by any percentage *1185 of and had no relation to petitioner's gross income, which had steadily increased from 1933 as a result of a gradual increase in the volume of sales following the general upward business trend. No prior stock bonus had ever been issued by petitioner, and in 1937 it was not contemplated that any further stock bonuses would be issued similar to the one issued in that year, because, while it was designated*165 and paid as additional compensation for services rendered, it was primarily for the purpose of cementing the participants' relations with the company by giving them a stock ownership interest in the business. For accounting purposes, the stock bonus was considered as a special nonrecurring expense apart from usual salaries and, accordingly, the aggregate amount of $ 130,000 was entered in a special account in the general office in Denver instead of being charged to the regular salary accounts which were maintained separately for each division, or branch office, and the general office, respectively. In those latter accounts entries were also made reflecting the profit-sharing cash bonuses paid pursuant to the employment contracts for 1938 and subsequent years. With respect to the executives and other key employees who executed employment contracts in 1937 and for the years indicated, their total basic salaries, their stock bonuses in par value, and their profit-sharing cash bonuses were as follows: Profit-sharing Year Total basic Total stock cash salaries bonuses bonuses 1933 * $ 65,198.51 1934 * 68,368.39 1935 * 74,602.78 1936 * 94,308.97 [1937] 104,492.20 $ 130,000.00 [1938] 102,364.48 $ 8,700.00 [1939] 106,674.41 11,140.00 [1940] 108,180.03 26,150.00 1941 * 166,362.15 14,809.50 57,250.00 *166 The 1941 stock bonus of 150 shares having a par value of $ 14,809.50 was not contemplated in the 1937 plan and was not issued pursuant to the 1937 employment contracts, but resulted from petitioner's reacquisition of those shares which had been issued as a 1937 stock bonus and its reissuance thereof as additional bonuses to 13 of the original 27 participants in the 1937 stock bonus plan for the purpose of equalizing their stock holdings. Just prior to 1942 petitioner entered into new employment contracts, effective January 1, 1942, for a term of five years, providing, inter alia, for certain profit-sharing cash bonuses as additional compensation for a total of 34 executives and other key employees, which included *1186 only 25 of the original 27 embraced in the 1937 plan, and also providing for the petitioner's right to acquire its shares of stock held by the employee, whether acquired under the June 1937 contracts or otherwise, upon termination of his employment. The contracts effective January 1, 1942, contained no provision for any stock bonus similar to the 1937 contracts. *167 During 1942 petitioner issued 90 shares of treasury stock, having a par value of $ 9,675, as a stock bonus to 3 employees who had not theretofore participated in the 1937 stock bonus plan. For the year 1942 the basic salaries paid to 34 executives and key employees totaled $ 141,003.10 and the cash bonuses paid them totaled $ 171,832.50. The petitioner's net sales, gross income, and total administrative salaries of executives and key men and also of other administrative employees who did not receive any bonuses, and including stock and cash bonuses for years after 1936 but excluding factory wages, as disclosed by petitioner's tax returns for the years 1933 to 1942, were as follows: Year Net sales Gross income Total administrative salaries [1933] $ 1,678,811.32 $ 333,468.69 $ 209,617.62 [1934] 2,388,567.10 472,098.01 245,036.28 [1935] 2,946,407.94 537,607.41 242,662.73 [1936] 3,793,744.03 658,250.31 282,284.74 [1937] 5,120,797.09 929,958.33 501,327.17 [1938] 3,752,556.49 679,820.71 336,247.50 [1939] 3,851,104.64 702,140.76 349,585.48 [1940] 4,641,664.71 822,704.86 400,097.18 [1941] 6,739,281.90 1,186,065.88 567,139.28 [1942] 7,542,694.68 1,265,841.40 668,179.64 *168 The stock bonus, in the aggregate amount of $ 130,000, paid by petitioner in 1937 was claimed and allowed as a deduction in petitioner's income tax return for 1937 as a part of the total compensation paid employees for that year. The 1937 stock bonus was a class of deduction separate from current basic administrative salaries and was abnormal in the petitioner's business. That bonus was not the consequence of an increase in the gross income or a decrease in the amount of salary deductions or of any other deductions of petitioner in its base period, and it was not a consequence of a change, at any time, in the type or character of the business, in the size of plant facilities or territory served, in the manner of operation in manufacturing or selling, in the organization or administration, or in the condition of the business of the petitioner. OPINION. The question presented is whether, in determining petitioner's average base period net income for the purpose of computing *1187 its excess profits credit under the income method for the taxable years 1941 and 1942, the petitioner is entitled to an adjustment of its 1937 income through the elimination from and consequent restoration*169 to base period income of an abnormal deduction under the provisions of section 711 (b) (1) (J) (i) and (K), Internal Revenue Code. 1 More specifically, petitioner contends that the character of the 1937 stock bonus was such that it constituted a deduction of a separate class from current salaries and that the deduction was abnormal for petitioner within subparagraph (J) (i) and, further, that the abnormality was not a consequence of any of the factors specified in subparagraph (K) (ii) as limitations upon the application of subparagraph (J). *170 Petitioner makes no claim for any adjustment under the provision of subparagraph (J) (ii), which pertains to abnormalities in amount rather than class. The respondent contends that the 1937 stock bonus was claimed on the 1937 return and allowed as a deduction for additional compensation, which was normal for petitioner and not properly subject to a separate classification. He further contends, in the alternative, that, if the deduction was a class abnormal for petitioner within subparagraph (J) (i), supra, then it was a consequence of an increase in gross income, of a decrease in the amount of salary deduction, of a change in size, of a change in the manner of operation as a result of the Denver Seep family's acquisition of a controlling stock interest. *1188 In Green Bay Lumber Co., 3 T. C. 824, 830, we held that subparagraph (J), supra, is a remedial provision which should be construed reasonably in order to give the relief it was intended to provide and, further, that it was not intended to limit the classification of deductions to the statutory deduction categories of section 23 of the code. In that case and in numerous other cases*171 involving subparagraph (J), supra, we decided the question of classification to be one largely of fact in determining whether or not a certain item of business expense was of such a character as to reasonably warrant a separate classification from what would otherwise be its general category for purposes of tax deductions. Thus, we held in Green Bay Lumber Co., supra, that certain bad debts were of a separate class from other deductible bad debts; in Arrow-Hart & Hegeman Electric Co., 7 T. C. 1350 (third and fourth issues), that a special assessment of school tax was not of a separate class from other deductible taxes (fifth issue), that certain payments for pensions, sick pay, etc., were of a separate class from current routine salaries (sixth issue), that interest on funds borrowed to retire preferred stock was not of a separate class from other deductible interest on loans for current operations; in Harris Hardwood Co., 8 T. C. 874, 885, that unemployment compensation payments were of a separate class from other deductible taxes; in Oaklawn Jockey Club, 8 T. C. 1128,*172 following the holding on the sixth issue in Arrow-Hart case, that interest on loans during a so-called dormant period was not of a separate class from other deductible interest on loans for current operations; in Frank H. Fleer Corporation, 10 T. C. 191, that a bad debt resulting from a transaction not directly connected with the business was of a separate class from other deductible bad debts, and that certain excise taxes were not of a separate class from other deductible taxes; and in Wentworth Manufacturing Co., 6 T. C. 1201, that some eleven items of business expenses each should be given separate classifications for determining the abnormality thereof either in class or in amount under subparagraph (J), supra. From these authorities it is clear that in the instant case the petitioner's 1937 stock bonus, which was deducted in that year under the general category of compensation, may be classed separately from the routine or normal administrative salaries paid in that year if the facts herein establish that the stock bonus payments were of a character sufficiently different to reasonably warrant separate classification. *173 The terms of the employment contract executed by petitioner in June 1937 with each of the selected 27 executives and key employees and the circumstances leading up to that cooperative plan show that the stock bonus was founded upon two considerations: (1) Primarily, to give the participants stock ownership interests in the business which would serve as a further incentive for such personnel to remain in *1189 the employment of petitioner, and (2) to partially reward the participants for past services rendered in positions of responsibility. No such stock bonus had ever been declared by petitioner prior thereto, and the testimony is clear that at that time it was not contemplated that similar bonuses would be subsequently issued. The stock bonus was not related to petitioner's earnings and was of a character different from the profit-sharing cash bonuses provided for in the contracts starting with the year 1938, since the latter were dependent upon earnings and were intended solely as additional compensation for the services rendered in each subsequent year for which paid. The 1937 stock bonus amounted to over one-fourth of petitioner's then outstanding capital stock and the*174 aggregate par value thereof, in the amount of $ 130,000, was in excess of 100 per cent of the total basic salaries paid the participants for 1937. Further, the stock bonus was, at the time (several years prior to the enactment of the Excess Profits Tax Act containing relief provisions), considered by petitioner as a special or abnormal nonrecurring expense apart from regular compensation and was entered in a special account kept in the Denver general office instead of being charged to the regular salary accounts maintained separately by each division and the general office, respectively. We are of the opinion that the facts summarized in the immediately preceding paragraph establish that the 1937 stock bonus of 2,000 shares issued to petitioner's employees was of such a character as to constitute a separate class of deduction. The fact that, in addition to the primary purpose of giving employees an ownership position, there was a further purpose in issuing the bonus, of partially recognizing the past services of the employees, does not alter the classification. Arrow-Hart & Hegeman Electric Co., supra (5th issue); Green Bay Lumber Co., supra;*175 and Frank H. Fleer Corporation, supra.We are of the further opinion that the same facts establish that the stock bonus was so unusual and extraordinary in the petitioner's business as to be "abnormal" within the meaning of section 711 (b) (1) (J) (i), supra. On this feature, the more outstanding facts are that no such stock bonus had ever been issued before by petitioner, that it was not contemplated that bonuses of a similar character would be thereafter issued, and that the size of the bonus was over one-fourth of petitioner's outstanding stock and in excess of 100 per cent of the total basic salaries paid the participants for 1937. The fact that on petitioner's 1937 income tax return the stock bonuses were shown on the same schedule with administrative salaries for that year for purposes of the expense deduction claimed and allowed is immaterial in the determination of the questions here involved. The two subsequent and comparatively small stock bonuses *1190 of 150 shares issued in 1941 and 90 shares issued in 1942 were not the result of any fixed policy, but rather were the result of uncontemplated circumstances arising, and do not, *176 in our opinion, change the aspect of abnormality of the 2,000-share stock bonuses in 1937. The new employment contracts, effective January 1, 1942, further evidence the fact that the 1937 stock bonus was not adopted as a regular policy payment of additional compensation, for such contracts provided only a continuation of the plan for annual profit-sharing bonuses. Our next consideration is whether the abnormality of the stock bonus was a "consequence of," that is, whether it followed and was dependent upon any one of the negative factors enumerated in subparagraph (K) (ii), supra. The evidence herein is directed not only to establishing that those negatives did not exist, but also goes further, in line with the suggestion made by this Court in William Leveen Corporation, 3 T. C. 593, to establish affirmatively that the abnormal deduction was a consequence of something other than those negative factors. See also City Auto Stamping Co., 7 T. C. 354, 362. The documentary evidence and the uncontradicted testimony show, conclusively in our opinion, that the 1937 stock bonus was a consequence of and solely dependent upon*177 the then existing need of solidifying and revitalizing the management of the business through recognition of the services and abilities of the executives and other key employees and cementing their relations with petitioner by giving them stock ownership in the business they had helped to create. The coincidental occurrence of a gradual but steady increase in petitioner's gross income from 1933 to 1937 did not lead to the stock bonus, for the latter had no particular relation thereto, percentagewise or otherwise, and the uncontradicted testimony is that the abnormal stock bonus would have occurred regardless of whether or not there was any increase in gross income, cf. Pacific Gas & Electric Co., 7 T. C. 1142, and Harris Hardwood Co., supra, for the stock bonus was designed primarily to give the key personnel ownership interests in the business. It is stipulated that, except as to deductions for salaries, the stock bonus was not a consequence of a decrease in the amount of some other deduction, and the facts show that there was no decrease in deductions for salaries. The record is clear that there was no change, at any *178 time material here, in the type or size of petitioner's business, and the evidence does not support respondent's contention that the stock bonus was a consequence of a change in the manner of operation or the condition of the business within subparagraph (K) (ii), supra. The manner of petitioner's operation through a home office and four divisions continued without any change in the line of products handled, the territory *1191 served, or the manner of conducting business, and the executives and other key men to whom the bonus was paid were not new employees in newly created jobs, cf. Wentworth Manufacturing Co., supra, but were old employees carrying on their regular work. The financial condition of the business was no doubt improved in 1937 over 1934, as contended by respondent, but it was a gradual improvement resulting from a normal increase in net sales and gross income coincident with generally improved business conditions, and, as above stated, the stock bonus was not related to petitioner's gross income. If the stock bonus itself brought about subsequent improved business conditions for petitioner, that is not a factor to be given *179 consideration here, for we are concerned only with antecedent changes upon which the bonus was dependent. Laredo Bridge Co., 7 T. C. 17. The respondent's contention that the stock bonus was a consequence of "a change in the manner of the operation of the business as a result of the Denver Seep family's acquisition of a controlling stock interest" is based upon the premise that in order to issue the bonus it was necessary for the western stockholders to acquire control from the eastern stockholders. The facts refute such a premise and for this reason, if for none other, the contention is without merit. There is nothing in the record to indicate that the eastern stockholders or any of them at any time were opposed, or would have been opposed, to the 1937 stock bonus. We hold that the limitations of subparagraph (K) (ii), supra, do not prohibit the application of the relief provision of subparagraph (J) (i), supra, in the instant case. The respondent erred on this issue. In our opinion, the stock bonuses paid in 1941 and 1942 should be regarded as of the same class of deductions as the 1937 stock bonus for the purpose of applying subparagraph*180 (J) as limited by subparagraph (K) (iii); that is to say, the amount of the deduction for the stock bonus to be disallowed (eliminated as an abnormal deduction) under subparagraph (J) for the year 1937 shall not be in excess of the amount by which the 1937 stock bonus of $ 130,000 exceeds the stock bonus of $ 14,809.50 for the taxable year 1941 and of $ 9,675 for the taxable year 1942, for which latter years the tax is being computed. Decision will be entered under Rule 50. MURDOCK Murdock, J., dissenting: The result reached by the majority in holding that the entire stock bonus was a class of deduction separate from current cash salaries, was abnormal in class, and, therefore, should be disallowed as a deduction, defeats the very purpose of the *1192 statute. That purpose is to construct what would be normal income for the base years by eliminating deductions for items which were not normal for those years. The findings show that the directors entered into the bonus contracts for terms of employment of five years for the executives and three years for other key personnel in order to keep them in the business and in part to recognize the valued services rendered by *181 the named individuals, for which services they had not been adequately compensated. There was no change in the cash compensation of these employees during the base period years. The conclusion is inescapable that, to some extent at least, the stock bonus represented a part of proper compensation for services rendered by these officers during the four base years, along with and in addition to cash that was paid to them. Normal income for the base period years can not be determined without allowing adequate compensation for officers and key employees. The effect of the majority opinion is to subtract a part of the reasonable allowance for compensation for officers and key employees in order to arrive at normal net income. The result is just the opposite. One arrives by that method at more than normal income and gives the taxpayer an advantage which the statute never intended. The Commissioner recognized all this in allowing the deduction for 1937. While these bonus payments in 1937 might have been abnormal to the extent, if any, that they compensated these men for services rendered outside the base period years, they are not abnormal in so far as they compensated them for services*182 rendered during the base period years. Footnotes *. In each of these years there were only 26 of the 27 employees who participated in the 1937 plan.↩ 1. SEC. 711. EXCESS PROFITS NET INCOME. * * * * (b) Taxable Years in Base Period. -- (1) General rule and adjustments. -- The excess profits net income for any taxable year subject to the Revenue Act of 1936 shall be the normal-tax net income, as defined in section 13 (a) of such Act; and for any other taxable year beginning after December 31, 1937, and before January 1, 1940, shall be the special-class net income, as defined in section 14 (a) of the applicable revenue law. In either case the following adjustments shall be made (for additional adjustments in case of certain reorganizations, see section 742 (e): * * * * (J) Abnormal Deductions. -- Under regulations prescribed by the Commissioner, with the approval of the Secretary, for the determination, for the purposes of this subparagraph, of the classification of deductions -- (1) Deductions of any class shall not be allowed if deductions of such class were abnormal for the taxpayer, and (ii) If the class of deductions was normal for the taxpayer, but the deductions of such class were in excess of 125 per centum of the average amount of deductions of such class for the four previous taxable years, they shall be disallowed in an amount equal to such excess. (K) Rules for Application of Subparagraphs (H), (I), and (J). -- For the purposes of subparagraphs (H), (I), and (J) -- * * * * (ii) Deductions shall not be disallowed under such subparagraphs unless the taxpayer establishes that the abnormality or excess is not a consequence of an increase in the gross income of the taxpayer in its base period or a decrease in the amount of some other deduction in its base period, and is not a consequence of a change at any time in the type, manner of operation, size, or condition of the business engaged in by the taxpayer. (iii) The amount of deductions of any class to be disallowed under such subparagraphs with respect to any taxable year shall not exceed the amount by which the deductions of such class for such taxable year exceed the deductions of such class for the taxable year for which the tax under this subchapter is being computed.↩