E.J. Harrison and Sons, Inc. - Page 44

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          because (as discussed in this section) the evidence strongly                
          suggests an intent to distribute profits to Mrs. Harrison in the            
          guise of compensation, we find that an independent investor in              
          petitioner would object to the size of Mrs. Harrison’s                      
          compensation, even assuming arguendo that petitioner’s retained             
          earnings for the audit years represented a reasonable return on             
          shareholder equity when viewed in relation to the ROE at                    
          comparable companies.  Thus, application of this factor furnishes           
          additional evidence that Mrs. Harrison was greatly                          
          overcompensated during the audit years.6                                    

               6  Even assuming petitioner’s ROE were relevant to our                 
          decision in this case, petitioner’s computation of ROE during the           
          audit years is open to question.                                            
               Petitioner argues that ROE represents net profit (after                
          taxes) divided by equity (defined as invested capital plus                  
          retained earnings less treasury stock), and that petitioner’s ROE           
          for the audit years was either 22 percent (using beginning year             
          equity) or 12.3 percent (using the average of beginning year and            
          yearend equity).  Petitioner stresses that either result compares           
          favorably with the 14.9 percent ROE for comparably sized                    
          companies during the same period as compiled by Mr. Carey.                  
          Petitioner ignores ROE derived from using yearend equity,                   
          presumably because, under that approach, average ROE for the                
          audit years is 7.4 percent, substantially below the 14.9 percent            
          average ROE for comparably sized companies.  In fact, it is                 
          unclear which of the three approaches is proper in this case                
          because it is not known which approach was used in the                      
          computation of ROE for the comparably sized companies reflected             
          in Mr. Carey’s report.                                                      
               Another reason to question the use of petitioner’s annual              
          ROE in evaluating shareholder return is the inability to follow,            
          on the basis of the returns as filed, all of the year-to-year               
          changes in equity.  For several years, those changes cannot be              
          explained by the income (or loss) for the year, and the                     
          description of the reconciling item is either unclear or not                
                                                             (continued...)           




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