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distributions to Mrs. Harrison by stressing that, despite the
large payments to her, petitioner’s ROE during the audit years
would have been more than satisfactory in the eyes of an
independent investor in petitioner. Indeed, the Court of Appeals
for the Ninth Circuit in Elliotts, Inc. v. Commissioner, 716 F.2d
at 1247, states that, in any potential conflict of interest
situation, “it is appropriate to evaluate the compensation
payments from the perspective of a hypothetical independent
shareholder.” The test suggested in Elliotts, Inc. is whether
retained earnings “represent a reasonable return on the
shareholder’s equity in the corporation”. Id. Petitioner argues
that its ROE during the audit years was more than adequate to
satisfy a hypothetical independent investor; and it further
argues that that fact alone should make Mrs. Harrison’s
compensation during those years “presumptively reasonable”,
consistent with the holding of the Court of Appeals for the
Seventh Circuit in Exacto Spring Corp. v. Commissioner, 196 F.3d
833, 839 (7th Cir. 1999), revg. Heitz v. Commissioner, T.C. Memo.
1998-220. Petitioner would restrict the application of the
Elliotts, Inc. factors to years in which the corporate employer
suffers a loss so that ROE is negative.
Petitioner’s approach is not the law in the Ninth Circuit;
and the Court of Appeals for the Seventh Circuit, in Exacto
Spring (a case involving the reasonableness of compensation paid
to an employee-shareholder “indispensable to Exacto’s business”
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