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F. Independent Investor
In addition to and in conjunction with the above-considered
traditional tests, the Court of Appeals for the Ninth Circuit has
also used an independent investor test. In Elliotts, Inc. v.
Commissioner, supra at 1245, that test was described as follows:
A relevant inquiry is whether an inactive, independent
investor would be willing to compensate the employee as
he was compensated. The nature and quality of the
services should be considered, as well as the effect of
those services on the return the investor is seeing on
his investment. The corporation’s rate of return on
equity would be relevant to the independent investor in
assessing the reasonableness of compensation in a small
corporation where excessive compensation would
noticeably decrease the rate of return.
The Court of Appeals for the Ninth Circuit has employed the
independent investor test in conjunction with the other above-
discussed tests as another means of measuring the reasonableness
of officer compensation.
Petitioner contends that we should disregard the traditional
tests and focus solely upon the independent investor test, in the
same manner as the Court of Appeals for the Seventh Circuit did
in Exacto Spring Corp. v. Commissioner, 196 F.3d 833 (7th Cir.
1999). Petitioner contends that the traditional tests do not fit
petitioner’s situation, and use of the traditional tests “invites
arbitrary decisions”. Before we decide whether it would be
appropriate to focus solely on the independent investor test, we
will first consider it in light of facts of this case.
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