73 T.C. 1142">*1155 The reasonable compensation provision, now appearing in section 162(a)(1), was first enacted in 1918. In 1943, Dean Griswold sought to discover the purpose of the provision. He found that there was a dearth of legislative history illuminating its purpose; he concluded that the legislative objective was to enact the limitations which had appeared in the Treasury regulations denying a deduction for payments which were in effect dividends or gifts to shareholders or their relatives. Note, 56 Harv. L. Rev. 997, 1000 (1943). However, later research led Dean Griswold to a different conclusion: He found that the language of the 1918 Act was similar 1980 U.S. Tax Ct. LEXIS 163">*184 to the language of earlier excess profits tax regulations and that such language had been included in such regulations to allow a deduction for reasonable compensation for officers even though no such compensation was actually paid. Thus, he concluded that the provision was not designed as a limitation on the deductibility of compensation. Note, 59 Harv. L. Rev. 286 (1945). Despite Dean Griswold's research, the law has developed otherwise. The reasonable compensation provision has uniformly been considered by the courts to be a restriction on the deductibility of compensation; nevertheless, Dean Griswold's research helps to point the way in deciding the scope of the restriction.

In deciding reasonable compensation cases, the courts have established the propositions that whether the compensation was reasonable is a question to be resolved on the basis of an examination of all the facts and circumstances of the case. Charles Schneider & Co. v. Commissioner, 500 F.2d 148">500 F.2d 148, 500 F.2d 148">151 (8th Cir. 1974), affg. a Memorandum Opinion of this Court, cert. denied 420 U.S. 908">420 U.S. 908 (1975); Pacific Grains, Inc. v. Commissioner, 399 F.2d 603">399 F.2d 603, 399 F.2d 603">605 (9th Cir. 1968), affg. a Memorandum Opinion of this Court. 1980 U.S. Tax Ct. LEXIS 163">*185 The determination of the Commissioner is presumptively correct, and the burden of proving the reasonableness of the compensation is upon the petitioners. Botany Worsted Mills v. United States, 278 U.S. 282">278 U.S. 282 (1929). The factors considered relevant in determining reasonableness of compensation include:

the employee's qualifications; the nature, extent and scope of the employee's work; the size and complexities of the business; a comparison of salaries paid with the gross income and the net income; the prevailing general economic conditions; comparison of salaries with distributions to stockholders; the prevailing rates of compensation for comparable positions in comparable concerns; the salary policy of the taxpayer as to all employees; and in the case of small corporations with a limited number of officers the amount of 73 T.C. 1142">*1156 compensation paid to the particular employee in previous years. * * * [Mayson Mfg. Co. v. Commissioner, 178 F.2d 115">178 F.2d 115, 178 F.2d 115">119 (6th Cir. 1949), revg. a Memorandum Opinion of this Court.]

See also Commercial Iron Works v. Commissioner, 166 F.2d 221">166 F.2d 221, 166 F.2d 221">224 (5th Cir. 1948), affg. a Memorandum Opinion of this Court. No single factor is decisive; rather, we must consider and weigh 1980 U.S. Tax Ct. LEXIS 163">*186 the totality of facts and circumstances in arriving at our decision. 178 F.2d 115">Mayson Mfg. Co. v. Commissioner, supra.Where officers-shareholders, who are in control of a corporation, set their own compensation, careful scrutiny is required to determine whether the alleged compensation is in fact a distribution of profits. Charles Schneider & Co. v. Commissioner, 500 F.2d 148">500 F.2d at 152; Logan Lumber Co. v. Commissioner, 365 F.2d 846">365 F.2d 846, 365 F.2d 846">851 (5th Cir. 1966), affg. on this issue a Memorandum Opinion of this Court.

At trial, the Commissioner and the petitioners presented expert testimony to support their positions. The Commissioner's expert and Hay Associates which employs him are recognized experts in designing plans of executive compensation, and the expert presented a carefully prepared report and testimony on the compensation which he considered reasonable for the officers of Home Interiors. His conclusions were primarily based on a type of analysis which is known as the "Hay method." Under such method, the expert first interviewed Mrs. Crowley, Mr. Carter, and Mr. Horner to learn about the operations of Home Interiors and the roles they performed in such operations. Then, with that information, 1980 U.S. Tax Ct. LEXIS 163">*187 he determined, from a survey of approximately 800 companies, the highest amounts those companies paid to employees in positions requiring similar skill, responsibility, and creativity. To check the results obtained by use of the Hay method, the expert also conducted a "market price analysis" of 6 other direct selling companies and 10 other high growth companies with respect to which information was available. He computed the ratio between the compensation paid to the chief executive officers of such other companies and the sales and profits of such companies, and he applied that ratio to the sales and profits of Home Interiors. As a result, he found that the compensation which would be payable to the officers of Home Interiors under the market price analysis was substantially less than the amounts of compensation which he had found by use of the Hay method. Finally, the Commissioner's expert was 73 T.C. 1142">*1157 of the opinion that the following amounts represented reasonable compensation for the officers of Home Interiors:

In his 1980 U.S. Tax Ct. LEXIS 163">*188 brief, the Commissioner modified the position taken by him in the notices of deficiency and conceded that the amounts of compensation which his expert found to be reasonable for Mrs. Crowley, Mr. Carter, and Mr. Horner are reasonable nondeferred compensation within the meaning of section 162(a)(1). He also conceded that profit-sharing contributions of 15 percent of such amounts are reasonable and deductible under section 404(a).

The petitioners' experts adopted a different approach. They did not undertake to determine what specific amounts of compensation were reasonable for the officers of Home Interiors; instead, they examined the financial reports of Home Interiors, and compared the amount of compensation paid to its officers with its sales and profits. They selected 18 other companies which they considered to be comparable because those companies were of medium size and involved managers with unusual skills. When they compared the amount of earnings which Home Interiors allocated to the payment of executive compensation with the similar information of the other companies, they concluded that Home Interiors was not paying excessive executive compensation. In reaching their 1980 U.S. Tax Ct. LEXIS 163">*189 conclusion, the experts also pointed out that Home Interiors' performance over the years was extraordinary.

We have here a most unusual case: the amounts of compensation paid the officers of Home Interiors were very large, but their efforts produced extraordinary results for Home Interiors and everyone connected with it. However measured, the success of Home Interiors was very impressive. See Hammond Lead Products, Inc. v. Commissioner, 425 F.2d 31">425 F.2d 31 (7th Cir. 1970), affg. a Memorandum Opinion of this Court; Templeton, Kenly & Co. v. Commissioner, 6 B.T.A. 61">6 B.T.A. 61 (1927). Its gross sales in 1968 were $ 4,284,456 and in 1975, $ 97,583,835; thus, during such period, the gross sales increased almost 23 times, or at an average annual 73 T.C. 1142">*1158 rate of 57 percent. The after-tax earnings of Home Interiors in 1968 were $ 60,094 and in 1975, $ 6,858,947; thus, during such period, such earnings increased 114 times, or at an average annual rate of 110 percent. When the performance of Home Interiors is compared with the growth in the GNP and with sales of retail establishments generally, the results are equally impressive: in 1971 through 1975, the GNP increased about 43 percent; retail store sales generally, 1980 U.S. Tax Ct. LEXIS 163">*190 about 44 percent; but Home Interiors' sales, 360 percent. What is more, we are convinced that the extraordinary success of Home Interiors was no accident, nor was it merely due to the generally favorable economic conditions prevailing in the 1960's and 1970's.

Mrs. Crowley spent most of a day on the stand as a witness, and it it clear that she possesses rare talent. See Capitol Market, Ltd. v. United States, 207 F. Supp. 376">207 F. Supp. 376, 207 F. Supp. 376">378-379 (D. Hawaii 1962); Federal Machine & Welder Co. v. Commissioner, 11 T.C. 952">11 T.C. 952, 11 T.C. 952">960 (1948), affd. per curiam 184 F.2d 843">184 F.2d 843 (6th Cir. 1950). The profitability of Home Interiors depended upon its sales, and after hearing her describe her policies and practices in leading Home Interiors, we can understand how she was able to recruit a sales organization of over 17,000 by 1975, why the organization was motivated to produce such exceptional results, and why there was little turnover in personnel. See Gordy Tire Co. v. United States, 155 Ct. Cl. 759">155 Ct. Cl. 759, 296 F.2d 476">296 F.2d 476 (1961). We doubt that she could have been replaced. See Vita-Food Corp. v. Commissioner, 238 F.2d 359">238 F.2d 359, 238 F.2d 359">363 (9th Cir. 1956), revg. on another issue a Memorandum Opinion of this Court.

Mr. Carter also made 1980 U.S. Tax Ct. LEXIS 163">*191 immense contributions to the success of Home Interiors. Its greatest increase in sales and profitability occurred from 1968 through 1977, a period beginning shortly after he assumed a significant role in managing the affairs of the company. His responsibilities were many and varied. He assisted significantly in conducting the rallies and other activities designed to inspire the sales organization, and he wisely managed the inventory and arranged for the design of products which would have a wide appeal. See 155 Ct. Cl. 759">Gordy Tire Co. v. United States, supra.

Mr. Horner's responsibilities were more limited, but his compensation was also considerably less. He was unrelated to Mrs. Crowley and Mr. Carter, and he was employed, in an arm's-length transaction, to assist them in managing the affairs of 73 T.C. 1142">*1159 Home Interiors. He did perform a wide variety of activities which contributed to the success of a very successful company. He had only an insignificant ownership interest in the company, and there is no reason to believe that the company would pay him more than his services were worth to it. See California Vegetable Concentrates, Inc. v. Commissioner, 10 T.C. 1158">10 T.C. 1158, 10 T.C. 1158">1166 (1948).

Though Mrs. Crowley, 1980 U.S. Tax Ct. LEXIS 163">*192 Mr. Carter, and Mr. Horner received large amounts of compensation, the other key employees of Home Interiors also received munificent compensation during the years in issue. In our findings of fact, we included information concerning the compensation of the area and branch managers. That information shows that in 1975, one area manager received $ 295,000 in commissions and that the average commissions received by an area manager in that year were $ 226,000. Similarly, the highest commissions of a branch manager in that year were $ 271,000, and the average for a branch manager for that year was $ 141,000. Although the area and branch managers were required to pay most of their business expenses out of their commissions, we have found that those expenses averaged around one-third of such commissions; thus, even when those expenses are subtracted, those managers were left with very handsome compensation. Morever, the compensation of those managers actually increased at approximately the same rate during the years in issue as did the compensation of Mrs. Crowley, Mr. Carter, and Mr. Horner: the aggregate nondeferred compensation of Mrs. Crowley, Mr. Carter, and Mr. Horner rose from 1980 U.S. Tax Ct. LEXIS 163">*193 $ 954,091.74 in 1971 to $ 2,223,384 in 1975 -- an increase of approximately 133 percent. Whereas, the average commissions of an area manager increased from $ 103,000 in 1971 to $ 226,000 in 1975 -- an increase of 119 percent; and the average commissions of a branch manager increased from $ 59,000 in 1971 to $ 141,000 in 1975 -- an increase of 140 percent.

In judging the reasonableness of the compensation received by Mrs. Crowley, Mr. Carter, and Mr. Horner, it is also significant that all key employees of Home Interiors were compensated on the basis of commissions and that the use of such method of compensation was a longstanding practice of the company. Section 1.162-7(b)(2), Income Tax Regs., provides in part:

Generally speaking, if contingent compensation is paid pursuant to a free bargain * * * before the services are rendered, not influenced by any 73 T.C. 1142">*1160 consideration on the part of the employer other than that of securing on fair and advantageous terms the services of the individual, it should be allowed as a deduction even though in the actual working out of the contract it may prove to be greater than the amount which would ordinarily be paid.

When Home Interiors was first organized, 1980 U.S. Tax Ct. LEXIS 163">*194 it decided to compensate Mrs. Crowley and Mr. Amon, its key officers at that time, primarily on the basis of commissions at 2 1/2 percent of sales. At such time, there was no way of knowing the amount of income that would be produced by such commissions. The company continued to pay Mrs. Crowley commissions at that rate through the years while it was experiencing modest success. The rate of her commissions was never increased; but it was decreased in 1973 and again in 1975 when Home Interiors was experiencing such extraordinary success. The rates of commissions paid to Mr. Carter and Mr. Horner were also established before Home Interiors' great success; those rates too were never increased, but the rate paid to Mr. Carter was also reduced in 1974 and again in 1975.

It is true that each year the board of directors of Home Interiors could have changed the rates of commissions paid to these officers, but in view of the sharply increasing profits of the company and in view of the fact that the other shareholders were receiving increasing benefits, the board of directors had no reason to reduce such commissions. It is also true that Mrs. Crowley and Mr. Carter, together with their families, 1980 U.S. Tax Ct. LEXIS 163">*195 owned slightly more than 50 percent of the stock of Home Interiors; but there were many unrelated shareholders, and together, they held a substantial block of the stock. Thus, this is not a situation in which Mrs. Crowley and her family were free to do as they wished in running the affairs of the company. Compare Harolds Club v. Commissioner, 340 F.2d 861">340 F.2d 861 (9th Cir. 1965), affg. a Memorandum Opinion of this Court. The company was achieving earnings which must have been gratifying to all of its owners, and all of them had reason to favor continuing the arrangements which had resulted in such success.

Moreover, although the commissions actually received by Mrs. Crowley, Mr. Carter, and Mr. Horner increased greatly from 1968 through 1975, those commissions represented a sharply declining percentage of the earnings of Home Interiors. See Capitol Market, Ltd. v. United States, 207 F. Supp. 376">207 F. Supp. at 381. In 1968, Mrs. Crowley's nondeferred compensation represented 97 73 T.C. 1142">*1161 percent of the pre-tax earnings of the company; Mr. Carter's, 67 percent; and Mr. Horner's, 22 percent. However, by 1975, Mrs. Crowley's compensation was equal to only 8 percent of the company's pre-tax earnings; Mr. Carter's, 1980 U.S. Tax Ct. LEXIS 163">*196 8 percent; and Mr. Horner's, 2 percent. Thus, a declining percentage of the company's earnings was allocated to compensation of its executive officers.

Over the years, the shareholders of Home Interiors participated handsomely in its earnings. From 1971 through 1975, the average return on equity was 49 percent. From 1968 through 1975, the dividends distributed to shareholders increased dramatically: in 1968, the aggregate dividends were $ 17,800; in 1971, $ 63,549; and in 1975, $ 544,895. Thus, the dividends in 1975 were approximately 9 times the amount in 1971 and approximately 30 times the amount in 1968. The dividends per share increased in an equally impressive manner: in 1969, the dividends were 10 cents per share; in 1973, $ 1 per share; and in 1975, $ 1.80 per share.

We recognize that the percentage of after-tax earnings distributed as dividends declined over the years in issue. However, the decline was not the result of the payment of higher compensation to the executive officers; it resulted from a decision to retain additional earnings in the business. Such retained earnings increased from $ 864,445 at the close of 1970 to $ 15,333,203 at the close of 1975, and as a result, 1980 U.S. Tax Ct. LEXIS 163">*197 the book value of Home Interiors stock rose from $ 1.27 per share at the end of 1969 to $ 26.62 at the end of 1975. On this record, it is clear that an investment in the stock of Home Interiors was very attractive and that the shareholders were receiving their fair share of the profits of the business. Under such circumstances, there is no ground for concluding that the compensation paid Mrs. Crowley, Mr. Carter, and Mr. Horner represented an arrangement for them to draw off more than their fair share of the profits of the business. See Howard Theatre Co. v. Commissioner, 16 B.T.A. 57">16 B.T.A. 57, 16 B.T.A. 57">60 (1929); cf. Long Island Drug Co. v. Commissioner, 35 B.T.A. 328">35 B.T.A. 328, 35 B.T.A. 328">333-334 (1937), affd. 111 F.2d 593">111 F.2d 593 (2d Cir. 1940), cert. denied 311 U.S. 680">311 U.S. 680 (1940).

The testimony of the Commissioner's expert was persuasive. We were impressed by the thoroughness of his study, and we are convinced that his conclusions as to the reasonable compensation for Mrs. Crowley, Mr. Carter, and Mr. Horner represent the 73 T.C. 1142">*1162 norms for their services. Yet, such conclusion is not dispositive of the issue in this case. Section 162(a)(1) was not designed to regulate businesses by denying them a deduction for the payment of compensation 1980 U.S. Tax Ct. LEXIS 163">*198 in excess of the norm. See Fifth Avenue Coach Lines, Inc. v. Commissioner, 31 T.C. 1080">31 T.C. 1080, 31 T.C. 1080">1095 (1959), affd. and revd. on other issues 281 F.2d 556">281 F.2d 556 (2d Cir. 1960). The payment of abnormally high compensation does warrant a careful scrutiny of the arrangement to be sure that the payments were in fact made for services actually rendered. However, in view of the extraordinary services furnished by Mrs. Crowley, Mr. Carter, and Mr. Horner, we are convinced that they earned large compensation. When their compensation is compared to that received by other employees of the company, it is clear that the compensation of the executive officers was not disproportionate. Also, when the return to shareholders in the form of dividends and appreciation in the value of their stock is examined, it is apparent that the exceptional prosperity of the company was shared with the stockholders.

It is true that the compensation received by Mrs. Crowley and Mr. Carter exceeded the compensation paid to the chief executive officers of many other corporations with much larger sales, more employees, and greater profits; but those other corporations did not experience the superb growth achieved by Home Interiors 1980 U.S. Tax Ct. LEXIS 163">*199 in sales, in earnings, and in return to shareholders. Moreover, in these times of unparalleled inflation, our concept of reasonable compensation must take into consideration such inflation, and as appears in the Forbes information, some other companies were also paying their chief executive officers extraordinary compensation, which might have been considered excessive in other times. Accordingly, after very careful analysis of all the facts and circumstances and careful weighing of those circumstances, we conclude and hold that the compensation paid Mrs. Crowley, Mr. Carter, and Mr. Horner in the years 1971 through 1975 was reasonable within the meaning of section 162(a)(1).

Decisions will be entered under Rule 155 .