Miller & Sons Drywall, Inc. - Page 26

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               As we have mentioned, the independent investor test measures           
          whether a corporation’s shareholders received a fair return on              
          their investment.  Return on equity measures the appreciation of            
          the stockholders’ investments through the corporation’s                     
          retainment of earnings.  See Owensby & Kritikos, Inc. v.                    
          Commissioner, 819 F.2d at 1326-1327; Home Interiors & Gifts, Inc.           
          v. Commissioner, 73 T.C. 1142, 1161 (1980); see also Rev. Rul.              
          79-8, 1979-1 C.B. 92 (stating compensation may be reasonable even           
          when the corporation never paid a substantial portion of its                
          earnings and profits as a dividend).                                        
               Each party’s expert analyzed whether an independent investor           
          would consider the amount of compensation paid by petitioner                
          reasonable in light of the return on equity (ROE) petitioner’s              
          shareholders received.  To do this, the experts first determined            
          the appropriate assumed rate of return on equity that an                    
          independent investor would find acceptable for each year in                 
          issue.  The parties do not agree on the assumed equity rate of              
          return.  The second step is to determine the appropriate period             
          in which to compare the ROE received by petitioner’s shareholders           
          with the assumed rates.  The parties do not agree on the                    
          appropriate period.                                                         











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