- 43 -
that the amount of compensation is unreasonably high." Id. In
situations in which a potentially exploitable relationship
exists, such as the present case, the Court of Appeals indicated
that the Court should make an inquiry from the perspective of an
independent investor to determine whether the investor would be
satisfied with the company's return on equity after the compensa-
tion at issue was paid. Id. at 1247.
Return on equity is calculated by dividing the net profit
(after payment of compensation and taxes) by the shareholder's
equity. Id. Respondent argues that we should use the beginning
shareholder's equity to calculate return on equity. Petitioner
argues that we should use the average of the beginning and
yearend shareholder's equity to calculate that return. The Court
of Appeals in the Elliotts, Inc. case calculated the return on
equity using the yearend shareholder's equity. Following that
approach, see Golsen v. Commissioner, 54 T.C. 742 (1970), affd.
on another issue 445 F.2d 985 (10th Cir. 1971), if we were to
divide petitioner's net profit after taxes (but before utiliza-
tion of net operating loss carryforwards/carrybacks) by its
yearend shareholder's equity, as reflected in its financial
statements for each of the years indicated, petitioner would have
the following percentage return on equity:
Percentage
Year Ended Return on Equity
Feb. 28, 1987 31
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