Brampton Woolen Co. v. Commissioner

BRAMPTON WOOLEN CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Brampton Woolen Co. v. Commissioner Docket No. 24842. United States Board of Tax Appeals 18 B.T.A. 1075; 1930 BTA LEXIS 2529; February 11, 1930, Promulgated *2529 1. The amount of additional compensation, voted and paid to the officers of the petitioner corporation in 1919 for services performed in 1918, is not allowable as a deduction from income for 1918. 2. An increased deduction claimed by the petitioner on account of alleged accelerated depreciation of machinery in 1918 denied for lack of evidence to show that it is entitled to a greater rate than that allowed by the respondent. Harry A. Fellows, Esq., and Henry M. Ward, Esq., for the petitioner. John D. Kiley, Esq., for the respondent. TRAMMELL *1075 This is a proceeding for the redetermination of a deficiency in income and profits taxes for the calendar year 1918 in the amount of $2,224.95. The petitioner assigns as errors (1) the action of the respondent in refusing to allow as a deduction from income for 1918 additional officer's salaries voted and paid in 1919 in the amount of $30,000, and (2) refusal of the respondent to allow as a deduction from income for 1918 depreciation on its machinery at the rate of 15 per cent per annum. FINDINGS OF FACT. The petitioner is a New Hampshire corporation with its principal office at Newport. *2530 It was organized in 1906, and in 1918 was engaged under a Government contract in the manufacture of woolen-and-cotton goods used mainly for shirtings. During the year 1918, the stock of the corporation was owned as follows: Shares of stock owned Name Common Preferred Sam D. Lewis $5,000 $10,000 Franklin P. Rowell 5,000 10,000 Vincent J. Brennan, sr 5,000 10,000 John McCrillis 5,000 10,000 Lizzie M. Richards 5,000 10,000 25,000 50,000 *1076 The officers of the corporation during 1918 were as follows: Sam D. Lewis, president. Franklin P. Rowell, vice president. John McCrillis, secretary-treasurer. Vincent J. Brennan, Sr., agent or general manager. Vincent J. Brennan, Sr., who was agent or general manager, was the only officer who devoted his entire time to the affairs of the corporation. The other officers devoted only such part of their time to its affairs as was necessary or might be required. Pursuant to a resolution adopted by the board of directors on October 25, 1916, officers' salaries for the year 1918 were authorized as follows: Vincent J. Brennan, Sr $10,000 Sam D. Lewis [800] John McCrillis [800] *2531 These were the only officers' salaries actually paid during the year 1918. At a meeting of the board of directors of the corporation, held on June 11, 1919, additional officers' salaries were authorized for the year 1918 as follows: Vincent J. Brennan, Sr $10,000 Sam D. Lewis 8,500 John McCrillis 8,500 Franklin P. Rowell 3,000 Total 30,000 At the meeting of June 11, 1919, the board of directors adopted the following minutes: At a meeting of the directors of the Brampton Woolen Company held in the directors' room of the First National Bank, in Newport, New Hampshire, on Wednesday, June 11, 1919, at which the following directors were present: Vincent J. Brennan, Sr., Franklin P. Rowell, John McCrillis and Sam D. Lewis, it was voted to pay, as of December 31, 1918, an additional salary or bonus to the following officers, to-wit, Vincent J. Brennan, Sr., $10,000, Sam D. Lewis, President and Auditor, $8,500, John McCrillis, Treasurer, $8,500, and Franklin P. Rowell, Vice-President, $3,000 for services performed during the year 1918. It was also voted to instruct the Treasurer to set up in the balance sheet of December 31, 1918, the following items as liabilities: *2532 Reserve for amortization $90,225.76 Reserve for salaries, for bonus 30,000.00 It was also voted to approve and affirm all loans heretofore made by the Treasurer and the proposed loan of $30,000 from the Manchester National Bank. The additional salaries authorized were paid on the 11th or 12th of June, 1919. *1077 The directors of the corporation held numerous informal meetings during the year 1918, at which the matter of increasing the salaries of the officers was discussed. It was generally agreed that the amount of the compensation then authorized and being paid to the officers was insufficient and that there should be substantial increases commensurate with the duties performed. However, at no time during 1918 did the board of directors of the petitioner, by formal or informal action, vote, fix or agree upon the amount of additional salaries or compensation to be paid to its officers, or take any affirmative action with respect thereto. After considerable informal discussion, it was agreed that any increase in the compensation paid to the officers should bear some reasonable relation to the gross and net earnings of the company for 1918, and*2533 it was also agreed to consult auditors for the purpose of determining what would constitute reasonable salaries in comparison with other plants. For these reasons, decision of the matter was deferred until after the close of the calendar year 1918, and no additional compensation was agreed upon or voted in 1918. The by-laws of the corporation required that a record of all meetings of the board of directors be kept in writing. As shown by the minute book, meetings of the board of directors were held during the year 1918 on February 6, April 8, May 4, October 4, and November 21, respectively. At the directors' meeting of February 6, 1918, the salary of Vincent J. Brennan, Jr., was fixed at $4,500 per annum for the year 1918. No additional salaries were authorized for the year 1918 at any of said directors' meetings. The petitioner's tax return for 1918 was executed by its president and treasurer on June 11, 1919, the date of the meeting of the board of directors at which the additional salaries for 1918 were authorized. Sam D. Lewis, president, and John McCrillis, treasurer, each filed an individual tax return for the year 1918 in which he reported as salary received from*2534 the petitioner the amount of $800, the amount of compensation authorized and paid in said years. Subsequent to June 11, 1919, each filed an amended return for 1918 in which was reported the additional salary authorized on June 11, 1919. In its return for 1918 the petitioner deducted depreciation on its machinery at the rate of 15 per cent per annum. Thereafter, the respondent determined that the depreciation claimed was excessive and that the actual depreciation sustained was not more than 5 per cent. Subsequently, as a result of conferences, the respondent amended his original determination to allow a rate of 7 1/2 per cent. The petitioner's principal machinery in 1918 consisted of 6 spinning machines, 64 looms, a fulling machine, mixing machine, washing machine, drying machine and napping machine. Approximately *1078 65 to 70 per cent of the total value of the petitioner's machinery was represented by the spinning machines and looms. During the year 1918 the petitioner's plant was operated approximately 15 per cent to 20 per cent overtime. The 6 spinning machines in operation during the year 1918 were acquired by the petitioner between 1906 and 1910, and are*2535 in use at the present time. Of the 64 looms in use in 1918, 36 were acquired in 1906 and the remainder were acquired between 1906 and approximately 1910. Of the 36 looms acquired in 1906, 12 are in use at the present time, the others having been discarded about 1926. Of the 28 looms acquired between 1906 and 1910, 16 are in use at the present time, 12 having been discarded about 1927. The remaining machinery, consisting of the fulling machine, washing machine, drying machine, mixing machine and napping machine, acquired between 1906 and 1910, is still in use. During the year 1918 the petitioner purchased its power from the local electric light company, and experienced considerable trouble due to the electric current at times being either insufficient or in excess of the voltage required to operate its machinery properly. These changes in the current voltage resulted in excessive breakage of the moving parts of the various machines. The broken parts were promptly repaired or replaced and the machines kept in constant use. The petitioner kept its books of account and made its tax returns by the accrual method. OPINION. TRAMMELL: The petitioner contends that it is entitled*2536 to deduct from gross income, in computing net income for 1918, $30,000 voted by the directors and paid to the officers on or about June 11, 1919, as a bonus or additional compensation for services performed during the year 1918. It is unnecessary to consider or decide here whether said amount is an allowable deduction for 1919, since the latter year is not before us and the petitioner is not asserting any claim in the alternative or otherwise that said amount is allowable for 1919. The only question raised is whether or not the additional compensation is allowable as a deduction from income for 1918. Also, in the view we take of the matter, as indicated below, it is unnecessary to consider whether the additional salaries paid in 1919, together with the regular salaries paid in 1918, constitute reasonable compensation for the services rendered in 1918. It is provided in section 234(a)(1) of the Revenue Act of 1918, that in computing the net income of a corporation, there shall be allowed as deductions "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or *1079 business, including a reasonable allowance for salaries*2537 or other compensation for personal services actually rendered." Thus, while the amount of the salary or other compensation may have been reasonable for the services actually rendered, it is not deductible in the taxable year unless it was either paid or liability therefor incurred in such year. ; ; ; . The petitioner kept its books by the accrual method, and therefore only such amounts may be deducted as were definitely accrued or incurred in the taxable year. The respondent contends that no legal liability was incurred in 1918 on the part of the corporation to pay the additional salaries involved and that the amount voted and paid in 1919 is not deductible from 1918 income. The petitioner's contention is that a liability was created in 1918 by the informal action of the directors, and that the amount is deductible as having been incurred in 1918. We have repeatedly held that a corporation may be bound by the informal action of its board of directors, but in*2538 order for the corporation to be so bound, it must affirmatively appear the definite action was in fact taken. ; . The evidence in the instant case discloses that it was the practice of the petitioner's directors during 1918 to meet informally, and that during that year many such meetings were held at which no resolutions were formally adopted or minutes recorded. At those meetings the matter of increasing the salaries of the officers was frequently discussed. Sam D. Lewis, president of the petitioner, testified as follows: Q. Give us as nearly as you can what the substance of the discussion was in regard to the increasing of the salaries? A. Finally we felt that we had perhaps better wait until the close of the year, as we had decided to have auditors to find out what would be a reasonable salary to charge in comparison with other plants, and that is the reason why it was not voted until after the end of the calendar year. McCrillis, secretary and treasurer of the petitioner, testified that the matter was discussed at many informal meetings of the directors and it was*2539 decided that there should be a substantial increase in the salaries, but no rate of increase was fixed during the year 1918. Brennan, another of the directors, testified: Q. Was there any decision reached with regard to fixing the amount of salaries at any time in 1918? A. No, I don't think so. The evidence, in our opinion, is not sufficient to establish that any legal liability was incurred by the petitioner corporation during 1918 *1080 to pay the additional compensation in controversy, and since the amount was not accrued in 1918, it is not an allowable deduction from income for that year. The second and remaining issue is whether or not respondent erred in refusing to allow depreciation on the petitioner's machinery at the rate of 15 per cent per annum. The amount or value of the machinery which forms the basis for computing the depreciation allowance is not in controversy, the only question being what rate is properly applicable for the tax year. In its return for 1918 the petitioner claimed a deduction for depreciation at the rate of 15 per cent, and the respondent allowed 5 per cent. Thereafter, as a result*2540 of conferences held, respondent modified his determination by increasing the rate allowed to 7 1/2 per cent. The petitioner contends in effect that the exhaustion, wear and tear of its machinery was accelerated during 1918, due in part to the necessity of employing inexperienced labor, but mainly due to the wide variation in voltage of the electrical power supply which was purchased from the local electric light company. The evidence relating to the labor situation does not in our opinion establish any accelerated depreciation. The situation with respect to the power supply resulted in irregular and improper operation of the machinery, and caused considerable breakage. However, the broken parts were promptly repaired or replaced and the machines continued in use. The evidence respecting the power supply and the conditions resulting therefrom does not establish, we think, that depreciation of the petitioner's machinery was accelerated. The evidence tends rather to show that the expense for repairs and inaintenance was increased. This conclusion is further supported by the fact that a very substantial portion of the machinery purchased during the years from 1906 to 1910, and*2541 which was in use in 1918 under the conditions referred to, was still rendering satisfactory service at the date of the hearing in October, 1929. Other machines were discarded in 1926 and 1927, after 20 years or more of continuous service. It is shown that during 1918 the petitioner's plant was operated approximately 15 per cent to 20 per cent overtime. If we assume from this fact that the depreciation was accelerated 20 per cent over normal, or in proportion to the overtime operation, we find, on the other hand, that the respondent increased the allowance for depreciation from 5 per cent to 7 1/2 per cent, or an increase of 50 per cent of the normal rate. Depreciation is a question of fact, and the burden is on the petitioner to show by a preponderance of the evidence that it is entitled to a larger deduction than that allowed by the respondent. We are *1081 unable to conclude from the record before us that the petitioner is entitled to an increased allowance. Accordingly, the determination of the respondent is approved. Judgment will be entered for the respondent.