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8. Whether an Independent Investor Would Have Approved
Petitioner's Pay to Choate
If the employee and employer did not deal at arm's length,
for example, if the employee is the employer's sole or
controlling shareholder, the amount of compensation paid may be
unreasonable. Owensby & Kritikos, Inc. v. Commissioner, supra at
1324. Choate has been petitioner's majority shareholder at all
times since Choate founded petitioner. Thus, we must decide
whether an independent investor would have approved petitioner's
pay to Choate. Id. at 1326-1327. We believe that an independent
investor would have approved Choate's compensation because his
efforts led to its rapid growth and financial success.
The prime indicator of the return a corporation is earning
for its investors is its return on equity. Id. In Elliotts,
Inc. v. Commissioner, 716 F.2d 1241, 1247 (9th Cir. 1983), revg.
and remanding T.C. Memo. 1980-282, the U.S. Court of Appeals for
the Ninth Circuit concluded that a rate of return on equity of 20
percent would satisfy an independent investor and would show that
the employee was not exploiting his position with the taxpayer.
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