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warrants scrutiny. The mere existence of such a
relationship, however, when coupled with an absence of
dividend payments, does not necessarily lead to the
conclusion that the amount of compensation is
unreasonably high. Further exploration of the
situation is necessary.
In such a situation, as discussed earlier, it is
appropriate to evaluate the compensation payments from
the perspective of a hypothetical independent
shareholder. If the bulk of the corporation’s earnings
are being paid out in the form of compensation, so that
the corporate profits, after payment of the
compensation, do not represent a reasonable return on
the shareholder’s equity in the corporation, then an
independent shareholder would probably not approve of
the compensation arrangement. If, however, that is not
the case and the company’s earnings on equity remain at
a level that would satisfy an independent investor,
there is a strong indication that management is
providing compensable services and that profits are not
being siphoned out of the company disguised as salary.
[Fn. ref. omitted.]
Even under the variants of the independent investor test
applied by the Courts of Appeals for the Second, Seventh, and
Ninth Circuits, a firm’s high or low return on equity may not be
dispositive of the reasonableness of a shareholder-officer’s
compensation. Exacto Spring Corp. v. Commissioner, supra at 839
(noting possible situations where presumption of compensation’s
reasonableness may be rebutted by showing that company’s high
return was not due to shareholder-officer’s efforts); Elliotts,
Inc. v. Commissioner, 716 F.2d at 1247 n.5 (noting a shareholder-
employee’s compensation may be reasonable even though company
suffers a loss or inadequate return on equity).
Petitioner and its expert Mr. Gelfond contend that an
independent investor would be satisfied with the 43.82 percent
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