Wm. J. Lemp Brewing Co. v. Commissioner ( 1952 )

Wm. J. Lemp Brewing Company, a Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent

Wm. J. Lemp Brewing Co. v. Commissioner

Docket No. 30136

United States Tax Court

18 T.C. 586; 1952 U.S. Tax Ct. LEXIS 163;

June 20, 1952, Promulgated

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">*163 Decision will be entered under Rule 50.

1. Petitioner during the taxable periods involved was a personal holding company.

2. Petitioner has failed to establish that its failure to file personal holding company returns, Form 1120-H, was due to reasonable cause and the imposition of the 25 per cent penalty for each of the taxable years involved is sustained.

3. The amounts the petitioner is entitled to deduct as reasonable compensation paid to its two officers in the respective taxable years in question determined.

4. The amounts deductible as ordinary and necessary business expenses representing promotional and travel expenditures in the respective taxable years 1944 and 1945 determined.

5. Petitioner's net loss for the year 1946, for purposes of carryback to prior years, determined.

6. Petitioner is not entitled in computing subchapter A net income to a dividends-paid credit under section 27 (h) of the Internal Revenue Code of the amounts disallowed as unreasonable compensation paid to one of its officers holding 50 per cent of its capital stock in the taxable years involved.

7. Petitioner, a personal holding company on the cash basis, is entitled to deduct income and declared">*164 value excess-profits taxes accrued but not paid in the respective taxable years involved.

Samuel H. Liberman, Esq., and Richard D. Duncan, Esq., for the petitioner.

Marvin E. Hagen, Esq., for the">*165 respondent.

LeMire, Judge.

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LeMIRE

">*586 This proceeding involves deficiencies in income tax, declared value excess-profits tax, personal holding company surtax, and penalties as follows:

		Declared	Personal
Year	Income tax	value excess-	holding company	Penalties
		profits tax	surtax
1943			$ 2,851.12	$ 712.78
1944	$ 441.21		5,762.99	1,440.75
1945	1,132.54	$ 239.13	11,037.17	2,759.29

The year 1946 is involved by reason of alleged net loss carry-back to prior years.

The issues involved are:

1. Whether petitioner was a personal holding company and subject to surtax for the calendar years 1943, 1944, and 1945.

2. Whether the respondent properly imposed a delinquency penalty for failure to file personal holding company returns for the taxable years 1943, 1944, and 1945.

">*587 3. Whether the respondent erred in disallowing as excessive a portion of the salaries paid by petitioner to its two officers during each of the taxable years 1943, 1944, and 1945.

4. Whether the respondent erred in disallowing part of the deduction claimed for promotion and entertainment expenses for the taxable year 1944.

5. Whether the respondent erred in disallowing">*166 part of the deduction claimed for traveling expenses for the taxable year 1945.

6. Whether the respondent erred in reducing the net operating loss for 1946 from the sum of $ 10,025.35 to the sum of $ 3,940.35 by disallowing part or all of the following claimed deductions: (a) rent in the sum of $ 2,160; (b) excessive compensation of officers in the sum of $ 3,000; (c) office services in the sum of $ 405; and (d) sales promotion expense in the sum of $ 520.

7. In the alternative, if the petitioner is held to be a personal holding company during the taxable years 1943, 1944, and 1945, did the respondent err in failing to allow a dividends-paid credit for any portion of officers' salaries, promotion expenses and traveling expenses which were disallowed by the respondent.

8. Did the respondent err in computing petitioner's subchapter A net income by failing to allow a deduction for Federal income and declared value excess-profits taxes accrued for the taxable years 1943, 1944, and 1945, but not paid in those years.

FINDINGS OF FACT.

Petitioner was incorporated under the laws of the State of Missouri in 1932, with its principal place of business at St. Louis, Missouri. It kept its books">*167 and filed its returns on the cash receipts and disbursements basis of accounting. Petitioner filed original corporation income and declared value excess-profits tax returns for the calendar years 1943, 1944, 1945, and 1946; an excess profits tax return for 1945; and an amended corporation income and declared value excess-profits tax return and excess profits tax return for 1945, with the collector of internal revenue for the first district of Missouri at St. Louis, Missouri. Petitioner did not file personal holding company returns, Form 1120-H, for any of the years 1943 to 1945, inclusive.

During the taxable years involved petitioner's outstanding capital stock consisted of 20 shares of common of the par value of $ 100 per share. During the same periods the stockholders and the number of shares each held is as follows:

	Wm. J. Lemp, III	Arthur F. Felker	Helen Tischer
Jan. 1, 1943-Mar. 12, 1943	10	10
Mar. 13, 1943-Dec. 31, 1943		10	10
1944		10	10
1945		10	10

">*588 William J. Lemp, III, was a direct lineal descendant of Adam Lemp, who began the manufacture of "Lemp" beer in St. Louis, Missouri, in 1840. In 1932 William J. Lemp, III, organized the petitioner">*168 to preserve the Lemp formulae and the reputation and good will of the Lemp name. From 1932 to his death in 1943 William J. Lemp was president of petitioner and Helen Tischer its secretary. In 1943 Arthur F. Felker became president of petitioner and continued as such officer throughout the taxable periods involved. Helen Tischer continued as secretary and treasurer.

Issue 1. Personal Holding Company.

On August 25, 1939, a written agreement was entered into between Central Breweries, Inc., an Illinois corporation, first party, petitioner, second party, and William J. Lemp, III, third party. The agreement, inter alia, contained the following provisions:

WHEREAS, Second Party and Third Party represent that Third Party is the fourth generation of the Lemp family which engaged for many years in the brewing of beer in the City of St. Louis, Missouri, and was himself identified with the former Wm. J. Lemp Brewing Co., now dissolved, as a stockholder and a director; and

WHEREAS, Second Party and Third Party further represent that said Third Party received from his father, Wm. J. Lemp II, various personal and family records, formulas, analyses of beer, etc., which various documents">*169 and records have been handed down from father to oldest son since Adam Lemp, great-grandfather of Third Party, first began the brewing of beer in St. Louis in 1840, all of which documents and records have been transferred by Third Party to Second Party which now has sole title thereto; and

* * * *

WHEREAS, Second Party and Third Party represent that Second Party has also reserved in the State of Illinois, for use in connection with the designation of a corporate name, the said name of "Lemp" and has registered its corporate name in the patent office of the United States; and

WHEREAS, First Party desires that Third Party become identified with it; and

* * * *

WHEREAS, Second Party and Third Party assert that said name "Lemp" is not available for use by the First Party without the consent of Second Party and Third Party;

NOW, THEREFORE, in consideration of the premises and the mutual covenants and conditions contained herein, it is agreed by and between the parties hereto as follows:

* * * *

SECOND: Second Party and Third Party, jointly and severally agree to give, and by these presents do give, to the First Party, their consent to use by First Party of the name "Lemp" or "Wm. J. Lemp" ">*170 as part of or in connection with the corporate name of First Party.

Second Party and Third Party, jointly and severally, hereby consent to the use by First Party in connection with the manufacture, production, and sale of ">*589 beer to be manufactured by First Party, of the names "Lemp", "Lemp Pale Lager", "Lemp Light Lager", "Lemp St. Louis", and such other and further designations containing the name "Lemp" as shall be mutually agreeable to the parties, and further consent to the use of such names and designations, or any of them, by such persons (including corporations and other entities) and in such manner as may be approved by First Party, provided such use is incident to the production, sale, or distribution of beer by First Party.

THIRD: Second Party and Third Party, jointly and severally, warrant that there is not in existence any corporation organized for the purpose of the manufacture, production, and sale of beer having the name "Lemp" as part of its corporate name or designation, and that neither Second Party nor Third Party, either together or severally, will engage in the manufacture, production, or sale of beer without the written consent of First Party, and will">*171 not, either together or separately, authorize or consent to the use of their names, or either of them, or any of the names or designations mentioned in this contract, by anyone other than First Party in connection with the manufacture, production, or sale of beer.

* * * *

FOURTH: First Party agrees to pay Second Party upon beer manufactured, produced, and sold by it beginning November 1, 1939, royalties as follows:

(a) Fifty cents (50 cents) per barrel on all beer (draught as well as bottled) brewed and sold by First Party under a corporate name including the name "Lemp" and retailed at fifteen cents (15 cents) per bottle or at a comparable price for draught beer, and five cents (5 cents) per barrel on all beer in excess of ninety thousand (90,000) barrels per annum brewed and sold by First Party and retailed at ten cents (10 cents) per bottle or at a comparable price for draught beer.

(b) In the event the only beer produced and sold by First Party under a corporate name including the name "Lemp" is retailed at ten cents (10 cents) per bottle, or at a comparable price for draught beer, First Party agrees to pay to Second Party as the sole and only royalty under this contract, twenty-five">*172 cents (25 cents) per barrel on all beer (draught as well as bottled) brewed and sold by First Party in excess of ninety thousand (90,000) barrels per annum.

(c) In the event arrangements are made by First Party with the consent of Second Party to brew or sell a beer under a name or conditions which entail the payment of royalties to some other person, firm, or corporation, then it is understood and agreed that no royalties whatsoever shall be paid on such beer by First Party to Second Party under this contract, and that the sales of such beer by First Party shall not be included in the number of barrels sold per annum for the purpose of determining royalties due and payable under this contract.

(d) First Party agrees that on or before the twentieth day of each month it will submit to Second Party statement showing amount of fifteen cent (15 cents) per bottle beer and the amount of ten cent (10 cents) per bottle beer sold by it in the preceding month, and will contemporaneously therewith pay to Second Party the royalties, if any, due on account of said sales during the preceding calendar month. The books and records of First Party dealing with such sales shall be open to the inspection">*173 of Second Party at all reasonable times.

FIFTH: Second Party agrees that the documents and records hereinabove referred to, conveyed by Third Party to Second Party by bill of sale dated August 4, 1939, shall at all reasonable times be open to inspection, examination, and use by First Party in such manner as it shall deem appropriate, and Second Party and Third Party agree that all letters, inquiries, and correspondence heretofore and hereafter received by them relative to the possible sale or purchase ">*590 of "Lemp" beer shall be forwarded and delivered within a reasonable time from the receipt thereof to First Party.

SIXTH: It is understood and agreed that it is the mutual desire of all the parties hereto to produce and sell a high quality beer under the "Lemp" name, and to that end the methods of brewing, advertising, and marketing of said beer by First Party are to be agreeable to Second Party; and in the event any dispute or disputes arise as to the methods of brewing, advertising, or marketing of said beer, the parties agree to submit such dispute or disputes to some outside party to be mutually agreed upon, said outside party to be an outstanding experienced brewmaster ">*174 or head of a recognized Laboratory or consulting service.

SEVENTH: It is understood and agreed that Third Party will become identified with the organization of First Party in some official (although possibly non-salaried) capacity, and that First Party will submit to its stockholders for their consideration a proposal to change the corporate name of First Party to Lemp, Inc., or to Wm. J. Lemp Brewing Company, or to some other name including the name "Lemp" to be agreed upon.

EIGHTH: Second Party hereby grants to First Party the exclusive right, option, and privilege for a period of five (5) years from and after the date of this contract, to purchase at any time within said period all of the assets of Second Party, specifically including, without in anywise limiting the generality of the foregoing, this contract and all rights and privileges hereunder and the right to use the corporate name of Second Party and the good will of Second Party, for that number of shares of the common stock of First Party which is equivalent to thirty per cent (30%) of its then outstanding common stock, said thirty per cent (30%) of common stock to be issued out of presently or then authorized but unissued">*175 common stock of First Party.

Second Party agrees that during the period the said option to First Party hereinabove granted shall be in force and effect, it will not sell, assign, transfer, or encumber its assets, or any of them, including this contract, or its corporate subject to the option herein granted to First Party, provided, however, that name, or its good will, or its rights to the use of the name "Lemp", except nothing herein contained shall be construed to deprive Second Party of the right to declare and pay out of its earnings, dividends to its stockholders.

It is understood that all of the existing stockholders of Second Party, as part of the consideration of this contract, agree to give and do hereby give to First Party, an option for the said period of five (5) years, and upon the same terms to acquire all of the outstanding stock of Second Party. Such agreement upon the part of said stockholders is appended to and made a part of this contract.

* * * *

Shortly after the execution of such agreement, Central changed its name to Wm. J. Lemp Brewing Company, but to avoid confusion will be hereinafter referred to as Central. The terms of the agreement were substantially">*176 carried out by all parties. Central, however, did not exercise its option to purchase. On February 28, 1945, Central canceled the contract after giving notice of its intention to do so.

During the entire period from August 25, 1939, to February 28, 1945, both Central and petitioner maintained separate books of account and each had separate officers and employees. No joint bank account was maintained. Petitioner's income was deposited in the bank account of the Laclede Insurance Agency Company of which Arthur ">*591 F. Felker was president. Central did not pay any compensation to any officer or employee of petitioner. No partnership returns were filed by either Central or petitioner in connection with the aforesaid agreement.

During the period 1940 to February 28, 1945, Central manufactured and sold beer under the trade name "Lemp" and paid to petitioner pursuant to the fourth clause of the aforesaid agreement the following amounts:

Year	Amount
1940	$ 3,596.96
1941	1,817.82
1942	1,882.11
1943	8,053.50
1944	12,788.00
1945	19,582.41
1946

Petitioner has never received any income other than the income received pursuant to the agreement of August 25, 1939.

Petitioner">*177 never received a royalty for the production and sale of "Lemp" beer, retailing at 10 cents a bottle, or a comparable price for draught beer, as Central never produced and sold 90,000 barrels of such beer in any of the years involved.

Petitioner and Central did not intend to join together for the purpose of carrying on the business of manufacturing and selling of "Lemp" beer during the taxable years involved as a partnership or as a joint venture.

All the income received by the petitioner under the agreement of August 25, 1939, was personal holding income in the form of royalties.

Issue 2. Penalty.

Petitioner did not file personal holding company returns, Form 1120-H, for any of the years 1943 to 1946, inclusive. In about 1940 Felker exhibited to one Perkins, a former partner of the accounting firm of C. K. Benson, and in the presence of one Nolte, the agreement of August 25, 1939, and inquired about making up the petitioner's returns. He was advised "it's a regular corporation." The question whether or not petitioner was a personal holding company was not discussed. At some undisclosed date Felker was advised that petitioner was not a personal holding company. Petitioner's">*178 returns for the years 1940, 1941, and 1942 do not disclose who prepared such returns. No answer was made to the question on the returns as to whether the corporation was a personal holding company within the meaning of section 501 of the Internal Revenue Code. The petitioner's income and declared value excess-profits tax return for 1943 ">*592 answers a similar question in the negative. Petitioner's 1943 return was prepared by a Miss Becker, a bookkeeper for Laclede Insurance Agency Company. L. A. Ulbrecht, an accountant associated with the C. K. Benson firm, made up the petitioner's 1944 return and Raymond L. Nolte, also associated with the Benson firm, made up the 1945 and 1946 returns of the petitioner. In the 1944, 1945, and 1946 returns the question as to whether the petitioner was a personal holding company was answered in the negative. In the petitioner's tax returns for the years 1940, 1941, and 1942 petitioner's income is reported as "royalties." In all subsequent tax returns petitioner's income was reported as profits, and its business stated as "Beer Sales."

Petitioner has failed to establish that its failure to file personal holding company returns in the taxable">*179 years involved was due to reasonable cause and not to willful neglect.

Issue 3. Reasonableness of Salaries.

During the taxable years 1943 to 1945, inclusive, the petitioner paid to Felker, its president, and to Helen Tischer, its secretary, the following salaries and bonuses:

	Arthur F. Felker		Helen Tischer
Year
	Salary	Bonus	Salary	Bonus
1943	$ 3,300		$ 3,300
1944	3,300	$ 1,000	3,300	$ 1,000
1945	3,300		3,300

During the taxable years 1943 to 1946, inclusive, Felker was president of the petitioner. He had been a long-time friend of William J. Lemp, III, and assisted in the negotiations leading up to the execution of the agreement of August 25, 1939. Thereafter, he became vice president and upon the death of Lemp in March 1943 became president. During the years 1939 to 1946, inclusive, Felker was also president and principal stockholder of Laclede Insurance Agency Company of St. Louis, Missouri, and devoted a considerable part of his time to that enterprise. He also served on the board of directors of several corporations. During the years 1943 to 1945, he received a salary of $ 6,000 annually from his insurance agency company.

During the">*180 years 1943 and 1944 Felker participated in numerous conferences with the officers of Central, which, during the period of the agreement of August 25, 1939, went through two reorganizations. These conferences involved the working out of details in regard to sales methods, distribution, advertising, selection of personnel, etc. ">*593 In 1944 the question arose as to whether Central had rendered a proper accounting to petitioner. Felker demanded an audit and it was determined that petitioner had been underpaid by approximately $ 12,000 during 1944 and prior years, which amount Central paid to petitioner. At the end of 1944, Central served notice of its intention to cancel its contract with petitioner. Felker spent considerable time with petitioner's attorneys discussing the institution of legal action to protect petitioner's interest.

In 1945, after the cancelation of the contract by Central, Felker devoted a portion of his time in an endeavor to develop new avenues for the manufacture of beer under the Lemp name and formulae. He contacted breweries in St. Louis, and other cities, particularly in California and New York. He made a trip to Washington, D.C., to confer with governmental">*181 officials and with representatives of the Department of Agriculture in an attempt to work out a quota of malt under the War Food Administration Order No. 66.

In 1946 Felker had conferences with petitioner's attorneys who filed suit against Central for damages resulting from the cancelation of the contract of August 25, 1939. He further pursued the possibilities of securing a new contract, but not as extensively as in 1945.

After the death of Lemp in March 1943 Helen Tischer became beneficial owner of 50 per cent of petitioner's capital stock. During the years 1943 to 1945, inclusive, she was vice president and secretary-treasurer of petitioner. During those years she participated in numerous conferences with the officials of Central and with Felker in connection with the business of petitioner. After Central canceled its contract with petitioner, Helen Tischer pursued various contacts in an attempt to secure another contract for the manufacture and sale of "Lemp" beer.

During the period from July 1943 to August 16, 1945, Helen Tischer was also employed three days a week in the jewelry store of Perles & Company, Inc., in St. Louis, Missouri. In each of the years 1943, 1944, and">*182 1945, she received a salary from Perles & Company, Inc., of approximately $ 950. In 1945 she also received $ 50 from the Hotel Association of St. Louis, Missouri, for some temporary work, and in 1946 the Hotel Association paid her a salary of $ 1,703.10.

In his notice of deficiency the respondent allowed a deduction of $ 3,000 as reasonable compensation for services rendered to petitioner by Felker for each of the taxable years 1943, 1944, and 1945, and allowed a deduction of $ 600 as reasonable compensation for services rendered to petitioner by Helen Tischer for each of the taxable years 1943, 1944, and 1945.

">*594 The amounts paid by petitioner to Felker as compensation for services actually rendered to it in each of the taxable years 1943, 1944, and 1945 were reasonable.

A reasonable compensation for the services rendered by Helen Tischer to petitioner in the taxable years in question is the sum of $ 2,000 for 1943, $ 3,000 for 1944, and $ 2,000 for 1945.

Issue 4. Promotional Expenses.

In its income and declared value excess-profits tax return for 1944 petitioner claimed a deduction for promotional expenses in the amount of $ 1,887.62. The respondent disallowed $ 750">*183 of such amount.

During 1944 petitioner paid Felker $ 525 and Helen Tischer $ 425 for promotional and entertainment expenses. Of this $ 950 claimed as a deduction the respondent allowed the sum of $ 200. During the year 1944 Felker kept "tabs" of the amounts he expended for promotional and entertainment expenses. He estimated the tabs ran in excess of $ 10 a week and he was reimbursed by petitioner in the amount of $ 525 in that year.

In 1944 Helen Tischer made a trip to Manhattan, Kansas, and to Fort Riley, Kansas, by automobile, a distance of 800 miles, in an effort to promote the sale of "Lemp" beer. While at Fort Riley she gave a party for the soldiers at the U. S. O. and bought beer. She also estimated she traveled 5,000 miles around St. Louis contacting tavern owners and expended $ 93.44 in entertaining and for beer donations. She billed the petitioner at the rate of 5 cents per mile for the use of her automobile, or $ 290, and for a total of $ 135 for meals, entertainment and beer donations, and the petitioner reimbursed her the sum of $ 425 in 1944.

The sums of $ 525 and $ 425 paid by petitioner to Felker and Helen Tischer in the taxable year 1944 were ordinary and necessary">*184 expenses incurred in carrying on petitioner's trade or business.

Issue 5. Traveling Expenses.

In its 1945 corporation income and excess profits tax return, petitioner claimed a deduction of the sum of $ 795.70 representing traveling expenses incurred by its officers. The respondent in determining his deficiency allowed $ 172.51 and disallowed the sum of $ 623.19.

During 1945 the petitioner paid to Felker the sum of $ 670.50 and to Helen Tischer the sum of $ 125.20 for travel expenses.

In 1945 Felker made a trip to New York, New York, Philadelphia, Pennsylvania, and Washington, D. C. He also made a trip to San Francisco, Sacramento and San Jose, California. These trips were taken for the purpose of conferring with various prospects in an ">*595 endeavor to secure another contract for the manufacture and sale of Lemp beer. The eastern trip consumed 15 or 20 days and the western trip several days. The railroad fare for the trip east was $ 172.51 and for the western trip approximately $ 150. The remainder of the sum of $ 670.50 paid to Felker was for hotel bills, meals, taxi fares, and a brief case to replace one destroyed in an accident on the trip.

In 1945 Helen Tischer">*185 made a trip to Cincinnati, Ohio, to discuss the possibility of a new contract for the manufacture of Lemp beer. For railroad fare, hotel bills, meals, etc., she expended $ 75.20. In 1945 she also traveled around St. Louis to ascertain whether any tavern owners displaying "Lemp" beer signs were selling other brands of beer. Helen Tischer estimated she traveled about 1,000 miles and charged petitioner 5 cents a mile or $ 50. Petitioner in 1945 reimbursed her in the sum of $ 125.20.

The amount of $ 795.70, which the petitioner paid to its two officers representing traveling expenses, constitutes ordinary and necessary expenses of the petitioner paid in the taxable year 1945 in carrying on its trade or business.

Issue 6. Net Operating Loss.

In its 1946 corporation income and declared value excess-profits tax return petitioner reported no income and a net loss of $ 10,025.35. In determining his deficiency the respondent disallowed $ 6,085, reducing the net loss of $ 3,940.35. The amount of $ 6,085 of the claimed deductions disallowed by the respondent in determining petitioner's net loss for the year 1946 consists of the following items:

Officers' salaries	$ 3,000
Rent	2,160
Bookkeeping service	405
Promotional expenses	520

">*186 In its 1946 return petitioner claimed a deduction of the amount of $ 6,600, representing a salary of $ 3,300 to Arthur F. Felker and Helen Tischer, respectively. The salaries have never been paid to them. At the close of the year petitioner made an entry on its ledger in the amount of $ 5,578.80 as salaries. This amount represents the sum of $ 6,600 less deductions for withholding taxes and social security. The reason the salaries were not paid in 1946 was that petitioner was conserving its cash on account of litigation to be instituted against Central for canceling the agreement of August 25, 1939.

In 1946 both Arthur F. Felker and Helen Tischer, filing their respective individual tax returns on a cash basis, reported the receipt of $ 3,300 as compensation received from petitioner.

The petitioner's net loss for the year 1946 was not in excess of the amount of $ 3,940.35, as determined by the respondent.

">*596 OPINION.

The first issue presents the question whether, during the taxable years involved, the petitioner was a personal holding company, as determined by the respondent, or a joint venture, as contended by the petitioner. There can be no dispute that the petitioner">*187 meets the two requirements specified in section 501 of the Internal Revenue Code for classification as a personal holding company in the event it is held not to be a joint venture. The burden is upon the petitioner to establish the existence of a joint venture. A joint venture has been defined to be a "special combination of two or more persons where, in some specific venture, a profit is sought without an actual partnership or corporate designation." Tompkins v. Commissioner, 97 F.2d 396; Joring v. Harriss, 292 F. 974">292 F. 974; Aiken Mills v. United States, 144 F.2d 23; Estate of L. O. Koen, 14 T.C. 1406.

All the income received by petitioner during the taxable years in question was received pursuant to the contract of August 25, 1939, between petitioner, William J. Lemp, III, and Central Breweries, Inc., the pertinent provisions of which are set forth in our findings of fact. Petitioner relies upon such agreement as creating a joint venture, while the respondent takes the position that such agreement is one licensing Central to the exclusive use of">*188 the formulae and trade name or trade mark owned by petitioner, in consideration of the payment of fixed "royalties" on certain quantities of beer manufactured and sold under the trade name of "Lemp."

Petitioner points particularly to paragraph "Sixth" of the agreement as indicative of a joint enterprise. It is therein provided:

It is understood and agreed that it is the mutual desire of all the parties hereto to produce and sell a high quality beer under the "Lemp" name, and to that end the methods of brewing, advertising, and marketing of said beer by First Party are to be agreeable to Second Party; * * *

The significance of such provision, when read in the light of the entire agreement, is that petitioner, having licensed the use of its formulae and trade name, desired to retain the right to supervise the methods of brewing, advertising, and marketing of beer sold under the "Lemp" name for the protection and preservation of what petitioner considered a valuable property right. Since the license granted was for an indefinite period, and could be canceled by Central at will, such a protective provision was a most desirable one. The fact that petitioner's officers conferred and ">*189 cooperated with the officials of Central in carrying out the spirit of that provision does not indicate to us that the parties intended to engage in the manufacture and sale of beer as a joint enterprise.

The further contention of the petitioner that since the agreement contains a 5-year option to Central to purchase the property rights of ">*597 petitioner for an ascertainable consideration establishes that the payments to be made under the agreement were not royalties but profits of a joint venture. We think such a contention is without merit. The option was not exercised. The agreement does not contain any provision for the application of any of the so called "royalty" payments towards the purchase price in the event the option was exercised.

Whether or not the parties to a particular agreement have created the relationship of joint venture, as between themselves, depends upon their intention to be gathered from the entire agreement and their conduct in carrying out its provisions.

The agreement in question makes no mention of sharing either profits or losses. That there is no provision for sharing losses is not controlling, but the element of profit sharing is an important">*190 factor in determining whether a joint venture exists. The payments to be made under the agreement are referred to as "royalties." Characterizing them as royalties is not conclusive, if from the entire record it is plain that they were in fact profits. That the payments were not profits seems clear, since they were to be made on the basis of the quantum of beer sold under the "Lemp" trade name, regardless of the realization of profits by Central.

Other evidence bearing on the lack of intention to operate a joint venture establishes that the parties did not maintain a joint bank account, each had separate officers and employees, and each kept separate books and records. Furthermore, neither party filed any partnership returns as required of joint ventures. Secs. 187 and 3797 (a) (2), Internal Revenue Code.

On the basis of the entire record, we conclude that the parties to the agreement of August 25, 1939, did not intend to create the relationship of joint venturers in the manufacture and sale of Lemp beer. The payments made pursuant to such agreement were royalties and constituted personal holding company income as defined in section 502 of the Code. We therefore hold that during">*191 the taxable years involved herein the petitioner was a personal holding company within the purview of section 501 of the Code.

The second issue presents the question whether there was a proper imposition of the penalties for failure to file personal holding company returns for the taxable years in question.

Section 291 of the Internal Revenue Code provides for the imposition of a 25 per cent penalty for failure to file a personal holding company return, "unless it is shown that such failure is due to reasonable cause and not due to willful neglect." The burden of establishing reasonable cause is on the petitioner. Girard Inv. Co. v. Commissioner, 122 F.2d 843. It has been recognized that reliance upon the advice of counsel or of expert accountants sought and received ">*598 in good faith is reasonable cause for failure to file a tax return. See Reliance Factoring Corporation, 15 T.C. 604.

To establish its failure to file personal holding company returns petitioner rests on the testimony of its president, Arthur F. Felker. On direct examination he testified that one Perkins, a certified public accountant, advised">*192 him that the petitioner was not a personal holding company and that he relied upon such advice. The time when such advice was rendered was not fixed, nor was it disclosed what facts were given to Perkins, other than the fact that he was shown a copy of the agreement of August 25, 1939. On cross-examination Felker testified that the consultation with Perkins took place in 1940, that Perkins merely advised that petitioner was a "regular" corporation, and the question as to whether or not petitioner was a personal holding company was not discussed.

In the years 1940, 1941, and 1942, prior to the taxable years involved, the petitioner's tax returns were prepared by petitioner's officers. The question on the tax returns as to whether petitioner was a personal holding company was unanswered. Petitioner's tax return for 1943, one of the taxable years in question, was prepared by one of the bookkeepers employed by the Laclede Insurance Agency Company. The question as to whether petitioner was a personal holding company was answered "No," and a similar answer was made to that question on petitioner's returns for the subsequent taxable years 1944 and 1945. Upon the basis of this record, ">*193 we are unable to conclude that petitioner's officers acted with ordinary business care and prudence.

We, therefore, hold that petitioner has failed to establish that its failure to file personal holding company returns in the taxable years involved was due to reasonable cause and not to willful neglect. The imposition of the 25 per cent penalty in each of the taxable years 1943, 1944, and 1945 is sustained.

The third issue presents the question of the reasonableness of the compensation paid by petitioner to its two officers in the taxable years involved.

Arthur F. Felker was the president and Helen Tischer, secretary and treasurer of petitioner. In the taxable years 1943, 1944, and 1945, each was the owner of 50 per cent of petitioner's capital stock, and each drew identical amounts of compensation. In the taxable years each officer was paid a basic salary of $ 3,300 and in the year 1944 each received a bonus of $ 1,000. In determining his deficiencies the respondent allowed as reasonable compensation to Arthur F. Felker the sum of $ 3,000 and to Helen Tischer the sum of $ 600 in each of the taxable years involved.

After consideration of all the evidence we have found as an ultimate">*194 fact that the amounts which petitioner paid to its president, ">*599 Arthur F. Felker, for services rendered to it in the taxable years were reasonable, and for the services rendered by Helen Tischer the sum of $ 2,000 for 1943 and 1945 and $ 3,000 for the year 1944. While the petitioner awarded equal compensation to its two officers, on the basis of the evidence set forth in our findings of fact, it is our opinion that the experience, efficiency, responsibilities, services and the time each devoted to the business of the petitioner require us to evaluate the reasonableness of the compensation upon an unequal basis. We have also considered the character of the agreement pursuant to which the petitioner received its income, and the nature of the services entailed by its provisions, that both officers devoted only part time to the business of the petitioner, and both earned outside income for their services, and the further fact that the unique nature of the petitioner's business made it inappropriate to produce evidence of amounts paid by other companies for like services.

The fourth and fifth issues relate to the propriety of the respondent's disallowance in part of certain amounts">*195 claimed by the petitioner as deductions representing travel and promotional expenses paid in the taxable years 1944 and 1945. Upon the basis of the evidence, we have found as ultimate facts the amounts incurred and paid for such purposes. We hold that the amounts so found constitute ordinary and necessary business expenses and are properly deductible under section 23 (a) (1) (A) of the Internal Revenue Code.

The sixth issue involves a determination of the petitioner's net loss for the year 1946 for the purposes of a carry-back to prior years.

In determining the petitioner's net loss for 1946, the respondent disallowed $ 3,000 of the total amount of $ 6,600 claimed as a deduction for compensation paid to its two officers. The respondent contends that, since petitioner was on the cash basis and the record establishes no such payments have ever been made to such officers, the petitioner is not entitled to any deduction in 1946 on account of officers' salaries and his allowance in part was erroneous. We agree. A taxpayer on the cash basis is not entitled to deduct expenses incurred but not actually paid in the year the deduction is claimed.

The fact that the officers in their respective">*196 individual tax returns for 1946 reported the receipt of such amounts does not establish payment by the petitioner. Vander Poel, Francis & Co., 8 T.C. 407; Martinus & Sons v. Commissioner, 116 F.2d 732, affirming a Memorandum Opinion of this Court entered February 6, 1940.

The other deductions disallowed by the respondent in determining the petitioner's net loss for 1946 consist of rent of $ 2,160, bookkeeping services of $ 405, and promotional expenses of $ 520, aggregating $ 3,085.

If the amounts erroneously allowed by the respondent for reasonable salaries to petitioner's two officers are excluded, the allowance in ">*600 full of the other expenses above-mentioned would not have the effect of increasing the petitioner's 1946 net loss over the amount allowed by the respondent. Hence, we have deemed it unnecessary to determine the amounts deductible in connection with such other expenditures. The respondent has not requested any increased deficiencies and, as we may not reduce the amount which the respondent has allowed as the petitioner's net loss for 1946, we have found as an ultimate fact that the petitioner's">*197 net loss for 1946 was not in excess of the sum of $ 3,940.35, as determined by the respondent.

As an alternative issue, the petitioner contends that it is entitled to a dividends-paid credit for any portion of officers' salaries, or promotional or travel expenses determined not to constitute proper deductions in the respective taxable years. Of the deductions claimed by the petitioner in the taxable years involved, we have held all of them to be deductible as ordinary and necessary business expenses of petitioner, except certain amounts paid to Helen Tischer as salary which we have found to be excessive.

Section 27 (h) of the Internal Revenue Code specifically limits the dividends-paid credit to such as are distributed pro rata among stockholders of the same class. Each of petitioner's two stockholders owned 50 per cent of the outstanding stock. Since we have allowed the full amounts of salary paid by petitioner to one of its officers, to permit a dividends-paid credit for the salary disallowed the other officer would be in violation of the statute requiring the distributions to be pro rata. W. T. Wilson, 10 T.C. 251, affirmed on other issues, 170 F.2d 423,">*198 certiorari denied 336 U.S. 909">336 U.S. 909; St. Clair Estate Co., 9 T.C. 392, appeal dismissed November 3, 1948. Petitioner's contention is, therefore, without merit.

Also, in the alternative, petitioner contends that in the event it is held to be a personal holding company in computing its subchapter A net income it is entitled to deduct income taxes and declared value excess-profits taxes paid or accrued in the respective years, as provided in section 505 (a) (1).

Petitioner reports its income on the cash basis and this Court has consistently held that such a taxpayer may deduct only the Federal taxes actually paid during the taxable year.

The Courts of Appeals for the District of Columbia and the Second Circuit have disagreed with our interpretation of section 505 (a) (1) of the Code as applied to personal holding companies. Clarion Oil Co., 1 T.C. 751, revd. 148 F.2d 671, certiorari denied 325 U.S. 881">325 U.S. 881; Joan Carol Corporation, 13 T.C. 83, revd. 180 F.2d 751. In Birmingham v. Loetscher Co., 188 F.2d 78,">*199 the Court of Appeals for the Eighth Circuit, in affirming an appeal from the District Court of Iowa, approved the rule as announced by the Court of Appeals for ">*601 the District of Columbia in the Clarion Oil Co. case, supra, and the case of Aramo-Stiftung v. Commissioner, 172 F.2d 896. We have concluded to follow these decisions.

We, therefore, hold that petitioner in computing its subchapter A net income is entitled to deduct the income and declared value excess-profits taxes paid or accrued in the respective taxable years.

Decision will be entered under Rule 50.