Doernbecher Mfg. Co. v. Commissioner

DOERNBECHER MANUFACTURING COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. ST. JOHNS INVESTMENT COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Doernbecher Mfg. Co. v. Commissioner Docket Nos. 34853, 43527, 46421, 50607, 50613, 63628, 71534. United States Board of Tax Appeals 30 B.T.A. 973; 1934 BTA LEXIS 1236; June 21, 1934, Promulgated *1236 1. SALARIES. - Amounts distributed in addition to salaries as bonuses to employees in substantial proportion to the stock of petitioner which they had contracted to purchase, held, to be distributions of profits and not deductible as compensation. The dropping of the word "bonus" in later years and the designation as salaries of the sums paid to stockholders does not make the sums paid deductible in the absence of convincing evidence that they were reasonable compensation for services rendered. 2. EXPENSES. - Amount paid by petitioner as its share of expenses of investigating the possibilities of forming a merger are deductible in the year in which the plan to form the merger was abandoned. 3. AFFILIATION. - Stock of petitioner contracted to be purchased by it and held in escrow as collateral security for the purchase price is outstanding stock, and the acquisition by another corporation of the remaining stock, which was less than 95 percent of the outstanding stock, including that in escrow, did not result in affiliation. O. A. Neal, Esq., for the petitioners. Chester A. Gwinn, Esq., for the respondent. ARUNDELL *974 The respondent*1237 determined deficiencies in income tax as follows: Petitioner Docket No. Year Amount Doernbecher Manufacturing Co 34853 [1922] $11,403.55 Do 34853 [1923] 11,697.86 Do 34853 [1924] 11,571.75 Do 34853 [1925] 12,528.45 Do 43527 [1926] 13,793.18 Doernbecher Manufacturing Co 46421 [1927] $12,825.00 Do 50607 [1928] 7,946.41 Do 63628 [1929] 4,503.31 Do 71534 1 1930 7,631.34 St. Johns Investment Co 50613 [1928] 60.05 In the case of the St. Johns Investment Co. the deficiency was determined on the basis of its affiliation with the Doernbecher Manufacturing Co. and will be controlled by the decision in the Doernbecher case for the same year. No separate findings will be made in the St. Johns case. The doernbecher Manufacturing Co. will be spoken of throughout as the petitioner. The deficiencies arise principally out of respondent's disallowance of part of the deductions claimed by petitioner as compensation of officers and employees. The issue as to the propriety of the action of respondent in this respect is presented for decision for each year. In Docket No. 46421, pertaining to the year 1927, counsel*1238 for the respondent filed an amended answer alleging excessive accrual and overstatement of state and county taxes in the amount of $6,112.41 and asked for an increase in the deficiency proposed for that year. No proof was offered on this item, and respondent's prayer for an increased deficiency is denied. In Docket No. 63628 there is in issue petitioner's right to a deduction for its share of the expenses of an investigation in connection with a proposed merger which it claims was abandoned in 1929. In Docket No. 71534 an issue as originally framed was whether petitioner's right to have its income computed on a consolidated basis with that of the Furniture Corporation of America, Ltd., dated from June 23 or October 1, 1930, petitioner claiming the earlier date and respondent having allowed affiliation from the later date. At the hearing counsel for respondent moved for an increased deficiency for 1930 on the ground that affiliation did not exist at any time during the year. *975 Several matters originally in issue have been settled. In Docket No. 34853 counsel for respondent concedes error in his claim of a profit in the year 1923 on the trade-in of a truck. In the*1239 same docket counsel for respondent concedes a $200 loss in 1924 on stock of the Mount Hood Lodge and a $1,000 loss in 1925 on stock of the Gearhart Hotel Co. These losses were claimed by petitioner in 1928 and the respondent's disallowance of them for that year is conceded by petitioner to be correct. In Docket No. 43527 the respondent disallowed the deduction of $3,712.69 as excessive accruals of state and county taxes. He now concedes $1,769.60 to be a proper accrual and deduction. Petitioner offered no proof as to the balance of the sum in dispute and respondent's disallowance thereof is sustained. In Docket No. 71534 counsel for petitioner concedes the correctness of respondent's disallowance of $4,100 claimed for 1930 as a deduction for bonuses to employees and by amended petition in Docket No. 63628 claim is made for the deduction of the $4,100 for the year 1929. Counsel for respondent on brief concedes that petitioner is entitled to the deduction for 1929. The matters set forth in this paragraph will be reflected in the recomputation that will need to be made. FINDINGS OF FACT. Petitioner, an Oregon corporation, was incorporated in 1900, and throughout the years*1240 here involved was engaged in the furniture-manufacturing business, with its principal place of business at Portland. Its original capitalization was $300,000, divided into 3,000 shares of the par value of $100 each. On or about February 19, 1921, its capital stock was increased to $2,000,000 par, consisting of 20,000 shares of $100 par value each, and 3,000 shares of the increased capital stock were issued to the then stockholders in lieu of the stock then held by them. On or about November 16, 1922, petitioner declared and issued a stock dividend of 12,000 shares of its capital stock, and on or about May 4, 1923, it declared and issued a stock dividend of 5,000 shares, making the total stock then outstanding 20,000 shares of the total par value of $2,000,000. On December 1, 1920, F. S. Doernbecher, president of petitioner, owned 1,375 shares of stock, H. A. Green owned 688 shares, and B. P. John owned 937 shares. Doernbecher was in poor health and desired to relinquish active control of petitioner's affairs. On that date, December 1, 1920, Doernbecher entered into an agreement to sell his 1,375 shares of stock to H. A. Green, B. P. John, Clarke E. Dye, E. S. Beach, F. A. Tauscher, *1241 Conrad Tauscher, and P. J. Lychywek, all of whom had been in the employ of petitioner for a number of years. The agreed sales price was to be paid in 20 *976 semiannual installments. Until all payments were completed title to the stock was to remain in Doernbecher and the certificates, endorsed in blank, were to be held in escrow by the United States National Bank at Portland. Pending completion of payment of the sales price, all dividends were to be paid to Doernbecher to apply on the sales price, and the purchasers were entitled to declare dividends for that purpose, but for no other purpose except from petitioner's "surplus earnings" and only then with Doernbecher's consent. It was further agreed in the instrument of December 1, 1920, that no additional expense would be incurred by the petitioner corporation "by the increase of salaries or other expenditures" without the written consent of Doernbecher. The 1,375 shares of stock were to be divided among the purchasers as follows: Shares H. A. Green [512] B. P. John [263] Clarke E. Dye [200] E. S. Beach [200] F. A. Tauscher [100] Conrad Tauscher [50] P. J. Lychywek [50] Total 1,375 F. S. Doernbecher*1242 died in 1921, and Edward M. Doernbecher and Ada Doernbecher succeeded to his interests in petitioner. Upon the declaration of stock dividends of November 16, 1922, and May 4, 1923, the stock of petitioner was held of record as follows: Shares held - November 16, 1922 May 4, 1923 Edward M. Doernbecher 3,437 1/2 4,583 1/3 Ada Doernbecher 3,437 1/2 4,583 1/3 B. P. John 4,685 6,246 2/3 H. A. Green 3,440 4,586 2/3 By agreement of December 1, 1922, the conditional sales agreement of December 1, 1920, was amended so as to make changes in the installments to be paid by the purchasers and to provide that in December 1923 the stock should be issued in the names of the several purchasers, who were to endorse the certificates in blank and place them in escrow with the United States National Bank as collateral security for the balance due on the purchase price. In accordance with that agreement certificates were issued on December 19, 1923, as follows: Shares H. A. Green 8,000 B. P. John 8,000 C. E. Dye 1,333 1/3 F. S. Beach 1,333 1/3 F. A. Tauscher 666 2/3 P. J. Lychywek 333 1/3 Conrad Tauscher 333 1/3 Total 20,000 *1243 *977 There were no changes in the stockholdings until 1926, when several transfers were made among the group of record holders, resulting in the holdings being as follows at the close of 1926: Shares H. A. Green 8,135 1/2 B. P. John 8,135 1/2 C. E. Dye 1,356 E. S. Beach 1,356 F. A. Tauscher [678] P. J. Lychywek [339] Total 20,000 On July 18, 1927, B. P. John entered into an agreement with the petitioner corporation to sell his 8,135 1/2 shares of stock to it for an agreed price plus the assumption by petitioner of the balance due from John to Ada and Edward Doernbecher under the conditional sales contract of December 1, 1922. The stock was to remain in escrow with the United States National Bank at Portland, which then held it under the previous contract, until payment of the purchase price, which was to be paid in installments. It was provided in the agreement that until John foreclosed on the stock, which he might do in the event of petitioner's failure to perform under the contract, he should have no right to vote or draw dividends on the stock, "it being expressly understood and agreed that the purchase price herein fixed when paid is in*1244 full payment for said stock as of the date hereof." On June 30, 1928, F. A. Tauscher, and on August 18, 1928, P. J. Lychywek's estate, entered into similar agreements to sell their stock, 678 shares and 339 shares, respectively, to petitioner. Following these transactions, petitioner's outstanding stock, exclusive of that which it contracted to purchase, was held as follows: Shares H. A. Green 8,135 1/2 C. E. Dye 1,356 E. S. Beach 1,356 Total 10,847 1/2 At the time the contract was entered into for the purchase of John's stock, the other stockholders of petitioner agreed in writing to pledge their stock with the then escrow holders thereof, the United States National Bank, as security for the performance of petitioner's contract to purchase John's stock. On June 26, 1930, the above named stockholders, Green, Dye, and Beach, executed separate assignments transferring their stock in petitioner, excepting in each case one share, to the Furniture Corporation of America, Ltd., a Nevada corporation organized June 23, 1930. Each assignment was made expressly subject to the contract of July 18, 1927, under which all the stock of the three vendors was held in*1245 escrow as collateral to secure the payments under the contract *978 with B. P. John. The shares thus assigned to the Furniture Corporation of America, Ltd., were 10,844 1/2 in number. On October 21, 1930, transfers were made on the stock records of petitioner to show stock of record as follows: Shares Furniture Corporation of America, Ltd 10,844 1/2 H. A. Green [1] C. E. Dye [1] E. S. Beach [1] No stock certificate has been delivered to the Furniture Corporation of America, Ltd. All the certificates repressenting petitioner's stock are still held by United States National Bank as security for the performance of petitioner's contract to purchase the stock of B. P. John. Petitioner filed a separate income tax return for the period January 1 to June 23, 1930. Its income and deductions for the remainder of the year 1930 were included in a consolidated return filed by the Furniture Corporation of America, Ltd. The respondent disallowed affiliation for the period prior to October 1, and determined that petitioner should have filed a separate return for the period January 1 to September 30, 1930. During the years 1918 to 1930, inclusive, petitioner's*1246 net sales, net profit according to its books, and percentage of profits to average net worth were as follows: Year Net sales Net profit per books Percentage of profits to net worth [1918] $879,890.39 $157,540.53 16.02 [1919] 1,092,170.33 222,727.78 20.09 [1920] 1,483,860.67 286,926.15 22.53 [1921] 1,530,592.47 401,199.49 26.72 [1922] 1,661,713.56 358,097.14 19.89 [1923] 2,066,419.92 300,446.55 14.47 [1924] 2,058,267.61 249,280.79 10.80 [1925] $2,736,487.53 $407,368.24 16.02 [1926] 2,637,490.53 379,156.12 14.67 [1927] 2,251,121.34 258,061.65 10.57 [1928] 2,856,002.05 167,776.71 6.87 [1929] 2,850,978.22 452,579.07 16.72 [1930] 2,403,496.50 148,659.34 9.37 From 1922 to 1925, inclusive, petitioner paid certain of its employees, who were also stockholders or had contracted to purchase stock, amounts that it designated as salaries and bonuses. The socalled bonuses were based on the volume of petitioner's gross sales and divided among the several recipients according to prearranged percentages. Minutes of the directors' meeting of March 14, 1924, authorizing the bonuses for 1924, which are typical of the action taken in other years, read*1247 as follows: WHEREAS, it has been the policy of this Company to suitably reward its faithful employees for their efforts in upbuilding the success of this Company, and WHEREAS, it is the intention of this Company to pay to said employees for the year 1924, additional compensation for services rendered, NOW THEREFORE. *979 BE IT RESOLVED, that in addition to salaries paid monthly to said employees during the year 1924, there shall be paid a total amount computed as follows: 7% of gross sales not exceeding $1,000,000 6% of gross sales $1exceeding,000,000 and not exceeding $1,100,000 5% of gross sales exceeding 1,100,000 and not exceeding 1,200,000 4% of gross sales exceeding 1,200,000 and not exceeding 1,300,000 3% of gross sales exceeding $1,300,000 and not exceeding $1,400,000 2% of gross sales exceeding 1,400,000 and not exceeding 1,500,000 1/2% of gross sales exceeding $1,500,000 Gross sales as herein used shall mean total sales, less returned goods, being balance as shown in sales account of the general ledger. The total amount as above computed shall be paid as follows: B. P. John 2/5 H. A. Green 2/5 C. E. Dye 1/15 E. S. Beach 1/15 F. A. Tauscher 1/30 P. J. Lychwek 1/60 Conrad Tauscher 1/60 *1248 and the corporation is hereby authorized to pay each of the above employees on December 31, 1924, the additional amount of 1924 salary as above provided. The amounts paid and claimed as deductions in income tax returns as salaries and bonuses and the deductions allowed by the respondent as reasonable salaries were as follows: [1925] H. A. Green: Salary $36,000.00 $36,000.00 $36,000.00 $36,000.00 Bonus 36,346.56 37,139.65 37,124.95 39,278.46 Total 72,346.56 73,139.65 73,124.95 75,278.46 Allowed 36,000.00 36,000.00 36,000.00 36,000.00 B. P. John: Salary 36,000.00 36,000.00 36,000.00 36,000.00 Bonus 36,346.56 37,139.65 37,124.95 39,278.46 Total 72,346.56 73,139.65 73,124.95 75,278.46 Allowed 36,000.00 36,000.00 36,000.00 36,000.00 E. S. Beach: Salary 8,500.00 8,500.00 8,500.00 9,374.97 Bonus 6,057.76 6,189.94 6,187.50 6,416.54 Total 14,557.76 14,689.94 14,687.50 15,791.51 Allowed 8,500.00 8,500.00 8,500.00 9,374.97 C. E. Dye: Salary 12,000.00 12,000.00 12,000.00 12,000.00 Bonus 6,057.76 6,189.94 6,187.50 6,416.54 Total 18,057.76 18,189.94 18,187.50 18,416.54 Allowed 12,000.00 12,000.00 12,000.00 12,000.00 F. A. Tauscher: Salary 5,000.00 5,000.00 5,000.00 5,000.00 Bonus 3,028.89 3,094.97 3,093.75 3,203.46 Total 8,028.89 8,094.97 8,093.75 8,203.46 Allowed 5,000.00 5,000.00 5,000.00 5,000.00 P. J. Lychywek: Salary 4,000.00 4,000.00 4,000.00 4,250.00 Bonus 1,514.44 1,547.49 1,546.90 1,606.54 Total 5,514.44 5,547.49 5,546.90 5,856.54 Allowed 4,000.00 4,000.00 4,000.00 4,250.00 Conrad Tauscher: Salary 3,600.00 3,600.00 1 2,700.00 Bonus 1,514.44 1,547.49 1,491.83 Total 5,114.44 5,147.49 4,191.83 Allowed 3,600.00 3,600.00 2,700.00 *1249 *980 Bonuses were discontinued after 1925, and salaries voted were thereupon increased. The amounts paid and claimed as deductions in income tax returns as salaries and the deductions allowed by the respondent as reasonable salaries were as follows: [1929] H. A. Green Salary $75,000.00 $75,000.00 $75,000.00 $75,000.00 Allowed 36,000.00 36,000.00 36,000.00 36,000.00 B. P. John Salary 75,000.00 75,000.00 Allowed 36,000.00 36,000.00 E. S. Beach Salary 18,500.00 18,500.00 18,500.00 18,500.00 Allowed 12,000.00 12,000.00 12,000.00 12,000.00 C. E. Dye Salary 18,600.00 18,600.00 18,600.00 18,600.00 Allowed 12,000.00 12,100.00 12,000.00 12,000.00 F. A. Tauscher Salary 8,400.00 8,400.00 7,200.00 Allowed 6,000.00 6,000.00 5,500.00 P. J. Lychywek Salary 6,600.00 6,900.00 1 2,400.00 Allowed 5,000.00 5,300.00 1,666.67 For the period January 1 to September 30, 1930, petitioner paid the following sums to the persons named: H. A. Green $43,750.00 E. S. Beach 9,300.00 C. E. Dye 11,499.95 Total 64,549.95 *1250 The total was claimed as a deduction for compensation, and the respondent allowed $38,000 and disallowed $26,049.95. The allocation made by respondent to the several individuals is not shown. H. A. Green has been in the furniture business for 24 years, and has been with the petitioner for 20 years. In 1913 he became manager of the Seattle branch of the petitioner, and secretary of the petitioner in 1916. He assumed active management of the petitioner corporation in the latter part of 1918, and became president in 1923. In 1914 he became sales manager of petitioner and assistant to president Doernbecher. After going to Portland in 1914 he *981 assumed entire general management of all operations of petitioner's business, including merchandising and promotion work, and supervised all of the warehouses, with the aid of assistants. When Green became connected with the petitioner in 1913 it employed approximately 225 employees and at the time of the death of Doernbecher in 1921 had between 250 and 300 employees. Under the management of Green the number of employees has increased until in 1930 it had about 900 employees, and at the time of the hearing of these proceedings*1251 the employees numbered approximately 2,500. Green devoted his entire time to petitioner's business, and during all of the years involved in these proceedings he put in a great deal of overtime, working nights, Sundays, and holidays. Under his administration new and efficient machinery was devised and installed. When he first became connected with petitioner it required from two to two and one half weeks to work lumber into completed furniture. At the present time lumber received at the factory in the morning is worked into completed furniture and placed into cars for shipment the same day. B. P. John entered the employ of petitioner's predecessor in 1890. He was secretary of petitioner from 1912 to 1927, when he contracted to sell his stock. In the latter years of his connection with petitioner he was production manager, and had charge of logging, timber and towing operations, logging camps and sawmills, and sawmill and manufacturing operations. He also had charge of plant and buildings, purchases of machinery, outside purchases of lumber and veneer, and determined wage scales and employed factory help. John devoted his entire time to the petitioner's business, putting in*1252 long hours and much overtime. After contracting to dispose of his stock in 1927 he purchased the plant of another furniture-manufacturing company at Portland, Oregon, and has increased to a substantial extent the production of the company. The number of employees of that company has increased from about 50 to in excess of 500 since John acquired the plant. E. S. Beach became connected with petitioner in 1914 and was office manager and had charge of accounting and financial matters. He devoted his entire time to the business of the petitioner, working long hours and much overtime. C. E. Dye became connected with petitioner in 1919 as sales manager and in 1928 became vice president. He occupied the position of general sales manager and was assistant to Green. He had charge of all warehouse operations. At various times the petitioner had warehouses at Los Angeles, San Francisco, Seattle, Salt Lake City, and Denver. He devoted his entire time to the business of petitioner, putting in long hours and much overtime. *982 F. A. Tauscher was employed by petitioner's predecessor in 1890 and has continued with the petitioner ever since, except for a short period in the*1253 year 1928. From 1922 until he sold his stock in petitioner in June 1928 he was assistant to John, was the petitioner's shipping and warehouse superintendent, was also petitioner's designer, and supervised part of the finishing operations. After he sold his stock in 1928 he took a vacation and upon his return went to work as assistant designer, working six hours a day and ten months a year because of his health. After he sold his stock the duties he had performed were divided among three other employees. He has had over forty years' experience in the furniture business and is considered an excellent designer for the class of furniture produced by petitioner. After selling his stock and giving up some of his duties with petitioner Tauscher received a salary of $500 per month. P. J. Lychywek was employed by petitioner's predecessor in 1890, and continued in the service of petitioner until his death in 1928. He was plant engineer, maintained all plant machinery and equipment, assisted in the purchase of machinery, supervised its installation, and also assisted in the construction of new buildings and additions to the plant. After his death the duties which he had performed were*1254 divided between two men. Conrad Tauscher was employed by petitioner's predecessor in 1890, and after incorporation of the petitioner continued in its employ until his death in 1924. He had charge of petitioner's sawmill, veneer, and logging operations, which operations supplied the factory with the most of its hardwood, lumber, and veneer. He was considered an excellent hardwood, lumber, and veneer man, and when he died his son, who had been brought up in the business, took his place but did not perform all of the duties that had been performed by his father. In 1929 a number of furniture companies on the west coast proposed merging and appointed a committee to investigate the possibilities of the proposal. Under an agreement entered into by the interested companies the committee caused an appraisal of assets to be made and investigated various matters concerning the several companies, including financial affairs, and conducted negotiations with investment bankers. It was agreed that if the merger was not completed the bills of the appraisers and auditors would be paid by the individual companies. All other expenses would be prorated among them. In November 1929 the committee*1255 advised petitioner that the proposed merger had been abandoned and that petitioner's share of the expenses of the committee amounted to $9,902.58. That sum was paid by petitioner and claimed as a deduction in its income tax return for the year 1929. The deduction so claimed was disallowed by the respondent. *983 In June 1930 theFurniture Corporation of America, Ltd., was organized, and brought together a number of furniture-manufacturing companies through the purchase of their assets. The petitioner, while interested in the merger thus effected, did not directly enter into it. Petitioner's stockholders, as heretofore related, assigned their stock in petitioner to the Furniture Corporation of America, Ltd., under date of June 26, 1930. OPINION. ARUNDELL: The issue that runs through all the years before us in these proceedings is that of whether amounts paid to petitioner's stockholders, who were also employees, are deductible in full as reasonable allowances for salaries. From 1922 on through 1925 petitioner paid its stockholder-employees certain salaries plus bonuses designated in the minutes of directors' meetings as "additional compensation." Beginning with 1926*1256 the bonus system was discontinued and thereafter the stockholders were paid flat amounts approximately equal to the total of salaries and bonuses previously paid. The bonuses paid in the earlier period were not distributed according to individual efforts or results, but were based on petitioner's gross sales and allocated according to predetermined percentages. The respondent allowed as deductions the basic salaries paid, and disallowed the bonuses on the theory that they were distributions of earnings and not ordinary and necessary business expenses. In the later period, 1926 to 1930, the respondent allowed as salary deductions amounts equal to, and in some cases substantially more than, the amounts he determined represented deductible salaries in the earlier years. The respondent having made a determination that the amounts claimed by petitioner are excessive, the burden is on petitioner to show that the amounts involved are but reasonable compensation for the services rendered and are no more than ordinary and necessary expenses of conducting its business. *1257 . In , we said: When the Commissioner has made a determination, the taxpayer who attacks it must prove by evidence of the services rendered and their value that a correct determination would exceed that of the Commissioner. Where the payments are to kinsfolk or to shareholders, the proof must also show that they were not influenced by family considerations and were not disguised distributions of profits. In , in discussing the question of reasonableness of salaries, the court said: There can be no doubt that the corporation was entitled to deduct from the income it received all the ordinary and necessary expenses incurred in carrying on its business, including a reasonable compensation to its officers and *984 employees. But the salaries which are paid in order to constitute an allowable deduction must be a reasonable and fair compensation for the services rendered. The expenses which can be deducted are the "ordinary and necessary expenses." If a corporation sees fit to pay its employees*1258 extraordinary, unusual, and extravagant salaries, distributing the profits of the business in the guise of salaries to its officers, who hold the stock and control its affairs, such salaries manifestly do not constitute the "ordinary and necessary expenses" of the business, which can be deducted under the statute. The government is not bound or concluded either by any resolution which the corporation adopts, or by its method of keeping books, upon the question as to whether any particular payment is a salary payment or a division of surplus. Examining the documentary evidence, a close relationship between stock ownership and the distribution of the so-called bonuses at once appears. The several stockholder-employees, the percentages of Doernbecher's stock for which they were to pay under the contract of December 1, 1920, and the percentages of bonus distributions were as follows: Name Shares held Percentage of cost Percentage of bonus H. A. Green [40] B. P. John 1 263 [40] C. E. Dye [8] 6 2/3 E. S, Beach [8] 6 2/3 F. A. Tauscher [4] 3 1/3 Corad Tauscher [2] 1 2/3 P. J. Lychywek [2] 1 2/3 Total 1,375 [100] *1259 While the distributions based on petitioner's gross sales were not exactly in the same ratio as stock ownership, the two are sufficiently close to raise a most strong presumption that there was a direct conection between them. Although there was the variation between percentage of stock ownership and that of distribution as set out above, the amounts distributed, with but insignificant variations, were in direct proportion to stockholdings. Thus in 1922 and 1923 F. A. Tauscher, owning twice as much stock as P. J. Lychywek and Conrad Tauscher, received twice the amount distributed that they did. C. E. Dye and E. S. Beach each owned twice the amount of stock owned by F. A. Tauscher and each received double the amount paid to Tauscher. H. A. Green and B. P. John in all the years 1922 to 1925 received the same amounts as "bonuses", there being a difference of one share in amount of stock issued to them at December 1, 1920, and their stockholders being equal after December 19, 1923. In*1260 1924 and 1925 the same situation obtained, with differences of but a few cents. Thus in 1924 F. A. Tauscher, with twice the stock of Lychywek, received in distribution $3,093.75 and Lychywek $1,546.90. *985 Based on stock, Tauscher should have received 5 cents more. In the same year Beach and Dye, with twice the stock of Tauscher, were paid twice as much as Tauscher as bonuses. In 1925 Beach and Dye each received the same amount, $6,416.54, which was slightly more than twice Tauscher's $3,203.46, and this latter sum was not quite double Lychwek's $1,606.52. Moreover, comparing the basic salaries and the bonuses, a further relationship between stockholdings and bonuses is apparent. It may be presumed that the basic salary is some indication of the directors' judgment of the worth of the employee to the business. Here we find employees with substantially different basic salaries, but having contracted to purchase the same amounts of stock, receiving the same amounts as bonuses. Beach with a basic salary of $8,500 from 1922 to 1924 and $9,374.97 in 1925, and Dye with a basic salary of $12,000 in all these years, each contracted to buy the same amount of stock, and each*1261 received the same distribution every year. Conrad Tauscher's basic salary was $3,600 in 1922 and 1923 and that of Lychywek was $4,000. Each contracted to purchase the same amount of stock and received equal amounts in distribution. With these figures before us the conclusion is inescapable that the annual distributions designated as bonuses were in fact distributions of profits to stockholders and were not salaries paid for services rendered. For the purpose of this phase of the case we think that the several employees who contracted to purchase Doernbecher's stock on December 1, 1920, should be considered to be stockholders throughout the entire period, although stock was not issued in their names until in December 1923. All of them were parties to the contract of purchase and all eventually received their stock. Beginning with 1926 the distribution of bonuses was discontinued and the amounts paid to stockholder-employees were thereafter designated as salaries. The principal stockholders, Green and John, thereafter were paid $75,000 each, which was but $278.46 less than the total received by each in 1925. The other stockholders all received more after 1925, the increases*1262 from 1925 to 1926 being as follows: Beach, $2,708.49; Dye, $183.46; F. A. Tauscher, $196.54; Lychywek, $1,043.46. No reason is given for the change from salary plus bonus system to the straight salary method of compensation. It is apparent, however, that none of the stockholders suffered any decrease, except Green and John in comparatively small amounts, in the annual sums received, and which in the prior years we have held represented in part distributions of profits to stockholders. In each of the years involved the respondent has allowed deductions of substantial amounts as compensation to these employee for services rendered, and the evidence does not convince us that the amounts so allowed were not reasonable sums. *986 The petitioner offered the testimony of witnesses to establish what amounts would constitute reasonable salaries for Green and John. These witnesses were experienced in the wholesale and retail furniture business and knew something of some of the manufacturing concerns. However, they did not know what salaries were paid by manufacturers to the men who occupied the positions similar to those of Green and John, and we are not convinced that they had*1263 sufficient familiarity with the manufacture of furniture to be able to give an opinion of what constituted reasonable salaries sufficiently reliable to form the basis for a finding of fact. The evidence abundantly establishes that the several stockholders performed valuable services for petitioner, that each was skilled in his field of duty, and that they all served petitioner loyally and whole-heartedly. But it does not establish to our satisfaction that they were entitled to any greater sums than allowed by the respondent as reasonable compensation. We accordingly sustain the respondent on the salary issue for all years. The item of $9,902.58 paid by petitioner in 1929 as its share of the expenses of investigating the possibilities of a proposed merger of furniture concerns in our opinion should be allowed as an expense deduction in that year. It appears that the respondent's only reason for disallowance is that some of the information gathered in that investigation was availed of by companies entering into another merger in 1930. The evidence is that petitioner was not a party to the 1930 merger. Its nearest approach to participating was that in 1930 a newly organized corporation*1264 which took over the assets of a number of companies purchased petitioner's stock from its stockholders. As far as petitioner was concerned the proposed merger in connection with which it incurred expenses was abandoned in 1929 and it is entitled to the deduction claimed. The remaining question is that of affiliation in the year 1930 with the Furniture Corporation of America, Ltd., hereinafter called the Furniture Corporation. The facts, in brief, are that on June 26, 1930, Green, Beach, and Dye assigned all their stock except qualifying directors' shares to the Furniture Corporation, expressly subject to the contract of July 18, 1927, between Green, Beach, Dye, Tauscher, and Lychywek, on the one side, and John on the other. Under that contract all of the stock which Green, Beach, and Dye assigned to the Furniture Corporation was placed in escrow with the United States National Bank at Portland as collateral security to guarantee the performance of the contract under which the petitioner had contracted to purchase John's stock. The contract with John gave him the right to foreclose on the stock in case of default, but it was provided that until he did foreclose, "this agreement*1265 shall not in any way or manner affect the rights of the first parties to vote their *987 respective stock hereby pledged as collateral." The assignors attempted to deliver the stock to the assignee on October 1, 1930, but John refused to release it from escrow. The petitioner filed a consolidated return with the Furniture Corporation for the period June 26 to December 31, 1930. The respondent allowed affiliation and determined income on a consolidated basis from October 1 to December 31, 1930, and refused to allow affiliation prior to October 1. The respondent's position now is that there was no statutory affiliation at any time in the year 1930. The assignment of June 26, 1930, in our opinion was effective as of that date to transfer ownership to the Furniture Corporation of 10,844 1/2 shares of stock. The prior pledge agreement of the assignors with John did not deprive them of title and ownership. Where there exists the requisite statutory ownership, affiliation is not denied because the stock has been pledged, *1266 , or leased, including the right to the lessee to vote the stock, . But there is still the question of whether the 10,847 1/2 shares of Green, Beach, and Dye constituted all the outstanding stock at June 26, 1930, or whether the 8,135 1/2 shares standing in the name of John and held in escrow throughout 1930 should also be considered to be outstanding stock. Petitioner's view if that the contract with John was a contract of purchase and sale and that John's stock thereupon became treasury stock, leaving only the 10,847 1/2 shares of Green, Beach, and Dye as outstanding stock in 1930. We think it unnecessary to decide whether the agreement with John was a contract of sale vesting title presently in the petitioner, or a contract to sell under which John retained title until payment was completed. In either event the 8,135 1/2 shares which were the subject of the contract continued to be outstanding stock throughout 1930. If title passed to the corporation upon execution of the contract, the stock again became outstanding when it was deposited*1267 with the bank as collateral security for performance of the terms of the contract. If title remained in John the stock clearly was outstanding. By the same token that stock pledged or leased was taken into consideration in determining the matter of affiliation in the cases above cited, John's block of stock must be treated as outstanding stock here. It cannot be ignored or treated as nonexistent, "Stock once issued is and remains outstanding until retired and canceled by the method provided by statute for the retirement and cancellation of capital stock." , quoting . No action is shown to have been taken by petitioner to retire and cancel the John block of stock. The statute requires direct ownership of *988 at least 95 percent "of the stock" in order to constitute an affiliation. It follows from what we have said that the John block of 8,135 1/2 shares must be considered as part "of the stock" of petitioner. As that block was not owned by the Furniture Corporation at any time during 1930, there was no affiliation in*1268 that year, and the respondent erred, as he now claims, in allowing affiliation for a part of the year. Decision will be entered under Rule 50. Footnotes 1. Period Jan. 1 to Sept. 30. ↩ 1. This employee died in October 1924. ↩ 1. This employee died April 30, 1928. ↩ 1. John was the record holder of 249 shares more than Green at the time the contract was executed. The 263 shares under the contract of December 1, 1920, made his holdings and Green's equal. ↩