1929 BTA LEXIS 2485">*2485 1. Petitioner denied personal service classification because capital was a material income-producing factor. Kossar & Co.,4 B.T.A. 1164">4 B.T.A. 1164.
2. Where taxpayer, on accrual basis, paid in March and December, 1921, for the years 1920 and 1921, respectively, the New York State franchise tax, payable annually in advance and computed upon net income for preceding year, held, said taxes accrued and are deductible for years 1920 and 1921, respectively.
3. Amounts paid as "penalty and interest" on such tax held not deductible as tax, interest, or expense.
4. Amounts withdrawn by managing stockholders of a corporation in excess of their regular salaries and accounted for as temporary loans by those concerned held not deductible as compensation.
5. Since the evidence fails to establish that salaries paid petitioner's officers were abnormally low, and it is furthermore not shown that statutory invested capital is other than normal, special assessment is denied.
1929 BTA LEXIS 2485">*2486 16 B.T.A. 952">*952 This proceeding involves deficiencies in income and profits taxes of $11,547.99 and $8,525.15 for 1920 and 1921. The petitioner alleges the following errors were committed by respondent:
Determining that petitioner was not a personal service corporation.
Disallowing the deduction of New York State franchise taxes, and penalty and interest thereon.
Disallowing the deduction of amounts claimed to be additional salaries to officers.
Refusing to compute petitioner's excess-profits tax under the special assessment provisions of the Revenue Acts of 1918 and 1921.
FINDINGS OF FACT.
The petitioner is a New York corporation with its principal place of business at 42 Loew Avenue, New York. It is, and since 1912 has been, engaged in the business of selling live poultry on commission.
Throughout 1920 and 1921 the petitioner's capital stock was $20,000, consisting of 200 shares having a par value of $100 each. Of this, Max Kossar owned 75 shares, Edward M. Blumenkranz, 75 shares, and until December 19, 1921, Isaac Dinerman and Max Sokoloff, 50 shares. On December 19, 1921, Dinerman and Sokoloff sold 16 B.T.A. 952">*953 their shares to Kossar and Blumenkranz who have1929 BTA LEXIS 2485">*2487 since been the only stockholders.
Kossar and Blumenkranz during the years involved were regularly engaged in the active conduct of the affairs of the petitioner and devoted their entire time to that work. Dinerman and Sokoloff were not so engaged and devoted none of their time to the petitioner's affairs. Kossar and Blumenkranz traveled throughout the country soliciting shipments of live poultry. Substantially all of the business done by petitioner was the result of their efforts.
During 1920 and 1921 live poultry was purchased and assembled in the West and shipped in carload lots to the petitioner in New York City. The consignee named on the bill of lading was either the petitioner or the shipper. If the shipper was the named consignee, petitioner secured delivery of the shipment by notifying the railroad company. This was an established practice. The shipper immediately upon making shipment drew a draft upon the petitioner for a substantial portion of the amount he expected to realize from the sale of the poultry. This draft was accompanied by the bill-of-lading covering the shipment. This draft usually was received by the petitioner two or three days in advance of1929 BTA LEXIS 2485">*2488 the receipt of the car of poultry. Its uniform practice was to make immediate payment of the draft by certified check. If there were insufficient funds in the bank to meet the check it was the practice to negotiate a short loan, from 15 to 30 days, to secure the necessary amount. It was the uniform practice in the trade to honor such drafts when received, regardless of the fact that the shipment had not yet arrived and had not yet been sold. The shippers needed funds in order to carry on their own businesses, and if petitioner had refused to honor the drafts promptly it would have lost the shippers' business.
Upon arrival of the car, speed of disposition was important. As soon as possible, it was unloaded, the poultry sold, and the proceeds, after the deduction of commission, charges and advances, were remitted to the shipper. The commission, in accordance with the practice of he trade, was 4 per cent of the gross sales. Substantially all of petitioner's income was derived from this source. The charges deducted were for freight, express, cartage, coops, labor of unloading, feed, and advances to the men who accompanied the car from the shipping point. These charges were1929 BTA LEXIS 2485">*2489 usually paid by the petitioner during the week in which the shipment was received. If the shipper had drawn for an amount in excess of the net proceeds, the petitioner drew upon the shipper for the difference.
The petitioner sometimes accepted shipments on "joint account" with shippers. In such cases shipments were made upon the advice of the petitioner, no commission was charged, and the profits or losses 16 B.T.A. 952">*954 were divided equally between the shipper and the petitioner. In 1920, 15 such shipments were received by petitioner. On 10 of them the petitioner's share of the profits was $2,349.70, on 5 shipments the petitioner suffered losses of $1,360.36, making a net gain on such shipments for that year of $989.34. In 1921 only 3 such shipments were received. On 2 of them profits of $739.95 were made, on 1 a loss of $112.15 was realized; a net profit for the year on such shipments of $627.80.
The petitioner sold the poultry to slaughter houses and others in New York City. Payment for the poultry was not received by petitioner until 7 to 10 days after the date of the sale.
The petitioner's place of business was in West Washington Market. Its booth and office was1929 BTA LEXIS 2485">*2490 rented from the City of New York. A small portion of the poultry sold by it was brought to the stalls in West Washington Market, but the major portion was sold direct from the railroad yards. Petitioner was licensed under state laws, bonded as to responsibility, sold only live poultry, and was not permitted to slaughter poultry.
During 1920 and 1921, in addition to Kossar and Blumenkranz, the petitioner employed a man to unload, two weigh-masters, a stenographer, a bookkeeper, and, for a portion of the time, a salesman. These were the only employees of the petitioner during those years. All poultry was unloaded under the direction of either Kossar or Blumenkranz, and all sales, with the exception of a few carloads sold by the salesman mentioned above, were made by Kossar or Blumenkranz.
The following are the assets and liabilities of the petitioner on January 1, 1920, December 31, 1920, and December 31, 1921, as shown by the books:
| Jan. 1, 1920 | Dec. 31, 1920 | Dec. 31, 1921 | |
| Assets: | |||
| Drafts | $35,610.00 | $51,500.00 | $31,700.00 |
| Accounts receivable | 114,135.24 | 165,135.69 | 223,089.42 |
| Fixtures | 2,050.00 | 2,050.00 | 2,055.00 |
| Liberty bonds | 24,699.28 | ||
| Gas deposit | 5.00 | 5.00 | 5.00 |
| 176,499.52 | 218,690.69 | 256,849.42 | |
| Liabilities: | |||
| Bills payable - bank | 45,200.00 | 22,500.00 | 28,000.00 |
| Accounts payable | 9,598.41 | 12,935.04 | 8,823.89 |
| Loans payable | 20,000.00 | 20,000.00 | 41,000.00 |
| Cash overdraft | 25,110.57 | 54,548.18 | 47,090.14 |
| Interest | 200.00 | 323.89 | |
| Capital stock | 20,000.00 | 20,000.00 | 20,000.00 |
| Surplus | 56,390.54 | 88,707.47 | 111,611.50 |
| 176,499.52 | 218,690.69 | 256,849.42 |
1929 BTA LEXIS 2485">*2491 16 B.T.A. 952">*955 The following is a statement of the items of income and expense as shown by the books for 1920 and 1921:
| 1920 | ||
| Sales | $ 3,823,366.11 | |
| Less purchases | 3,825,046.24 | |
| Loss on sales | -1,680.13 | |
| Commissions | 149,769.67 | |
| Gross income | 148,089.54 | |
| Less expenses: | ||
| Rent | $1,872.00 | |
| Salaries of officers | 15,600.00 | |
| Salaries - other | 31,200.00 | |
| Phone and telegraph, etc. | 4,400.08 | |
| Loss on Liberty bonds | 270.43 | |
| Travel expense | 6,168.52 | |
| Carmen | 5,800.00 | |
| Bad accounts written off | 16,410.51 | |
| Rebates and allowances | 20,220.85 | |
| Sundries, interest, freight, etc | 9,980.93 | |
| 111,923.32 | ||
| Net profit | 36,166.22 | |
| 1921 | ||
| Sales | 3,876,884.54 | |
| Purchases | 3,883,776.69 | |
| Loss on sales | 6,892.15 | |
| Commissions earned | 160,302.66 | |
| Gross income | 153,410.51 | |
| Less expenses: | ||
| Rebates, allowances and mark-offs | $28,392.94 | |
| Wages | 31,668.00 | |
| Carmen | 7,890.00 | |
| Bonus | 4,043.60 | |
| Inspection | 2,394.00 | |
| Salary, officers | 20,800.00 | |
| Entertainment | 8,350.73 | |
| Telephone, telegraph, etc | 6,866.32 | |
| Rent | 1,872.00 | |
| Interest | 2,563.87 | |
| Travel expense | 6,440.62 | |
| Light and fuel | 109.18 | |
| Miscellaneous items | 2,671.90 | |
| 124,063.16 | ||
| Net income | 29,347.35 |
Capital was a1929 BTA LEXIS 2485">*2492 material income-producing factor of petitioner's business.
16 B.T.A. 952">*956 In March, 1921, the petitioner paid $767.74 New York State franchise tax for 1920, pursuant to a return filed in 1920. It at the same time paid $45.77 as penalty and interest thereon. These amounts were charged by petitioner to its surplus account and were not deducted by either petitioner or respondent in computing petitioner's taxable income. In December, 1921, petitioner paid $1,403.15 New York State franchise tax. This amount was not deducted by petitioner or respondent in computing petitioner's taxable income.
The books and records of the petitioner were kept and returns were rendered on an accrual basis.
During 1920 the salaries of Kossar and Blumenkranz were $7,800 each. During 1921 the salary of each was $10,400. During 1920 Kossar withdrew amounts totaling $3,192.08, which were charged to his personal account. During the same year Blumenkranz withdrew amounts totaling $5,653.63, which were charged to his account. During 1921 both Kossar and Blumenkranz withdrew additional amounts which were charged to their personal accounts. It was intended that these amounts should be repaid if Kossar1929 BTA LEXIS 2485">*2493 and Blumenkranz were ever able to do so. At no time were they able to make repayment of these amounts.
During 1920 the petitioner paid, and charged to surplus, $959.81 on account of Kossar and $669.49 on account of Blumenkranz, a total of $1,629.30, constituting the personal income tax, Federal and New York State, of Kossar and Blumenkranz. These amounts were not deducted by the petitioner or by the respondent in determining petitioner's taxable income.
During 1921 the petitioner paid on account of personal Federal and State income taxes for Kossar and Blumenkranz the amounts of $1,871.73 and $2,084.93, respectively. These amounts were also charged to surplus and were not deducted by the petitioner or the respondent in determining the petitioner's taxable income.
OPINION.
STERNHAGEN: Petitioner seeks for 1920 and 1921 to bring itself within the class of "personal service corporations" defined in section 200, Revenue Acts of 1918 and 1921, which are not subject to tax. Sec. 218(e). A similar attempt for 1918 and 1919 failed because, in the opinion of the Board, capital was a material income-producing factor. 1929 BTA LEXIS 2485">*2494 . The evidence in this proceeding leads to the same conclusion and we hold that for 1920 and 1921 petitioner is not entitled to be classified as a personal service corporation. ; ; , affirming ; ; 16 B.T.A. 952">*957 ; . We need not consider the fact that until December 19, 1921, 50 shares or one-fourth of the outstanding stock was held by two people who were not "regularly engaged in the active conduct of the affairs of the corporation. See .
The New York State franchise tax was that imposed by N.Y.L. 1909, ch. 62, art. 9 A. By section 209 a tax was in this instance imposed "for the privilege of exercising its franchise in this state" payable annually in advance for the year beginning November 1, computed upon the net income of1929 BTA LEXIS 2485">*2495 the preceding calendar year. The rate was 4 1/2 per cent. To a taxpayer upon a simple and consistent accrual basis, as the parties agree as to this petitioner, this tax of $767.74 for 1920 and $1,403.15 for 1921 accrued in 1920 and in 1921, respectively. Deduction should be made and the deficiency is modified accordingly. ; .
But the amount of $45.77 paid in March, 1921, as "penalty and interest" is not a tax, , and is not deductible as such. Nor is any part of it to be treated as interest, ;. Petitioner does not claim the deduction as ordinary and necessary expense, nor has any evidence been offered so to establish it. However doubtful may be the deductibility of a penalty when all the circumstances are in evidence, see , it can not be said that the mere payment is per se an ordinary and necessary expense of carrying on a trade or business. 1929 BTA LEXIS 2485">*2496
The petitioner claims deductions of amounts withdrawn by Kossar and Blumenkranz in excess of their regular salaries. The evidence as to the amounts is not entirely clear, but in any event they are not, in our opinion, salaries or compensation and are not deductible as such. They were treated by those concerned as advances and accounted for as temporary loans. Blumenkranz testified that they expected to pay them back. Their services were apparently fully compensated by the salaries which they agreed upon of $150 per week or $7,800 each in 1920 and $200 per week or $10,400 each in 1921, and we find no justification in the evidence for increasing these amounts by reason of advances to these stockholders of their personal taxes or other withdrawals.
The petitioner claims special assessment under section 327, and relies upon the idea that the salaries actually paid were lower than they might have been and that therefore net income was abnormally high. In support thereof petitioner introduced the opinion of Herbert Frankel, the president of a competing corporation, that the services of Kossar and Blumenkranz were each worth $20,000 a year. 16 B.T.A. 952">*958 Blumenkranz had reciprocally1929 BTA LEXIS 2485">*2497 testified to the same effect for Frankel in an earlier proceeding before the Board, . Even if we were to adopt this as a reasonable opinion (which we are unwilling to do), it does not follow that the corporation's payment of a lower amount is under the circumstances an abnormal condition affecting capital or income calling for the use of special assessment. The standard of salaries is not definitely fixed and there is a wide field within which they may vary without constituting an abnormal condition. We think the opinion of this witness that the salaries might reasonably have been higher is insufficient to prove an abnormal condition. If Kossar and Blumenkranz had taken $20,000 each, the total salaries would have been increased by $34,400 in 1920 and $19,200 in 1921, and these amounts would not have been justified by the earnings.
Furthermore, since it is not contended that the statutory invested capital is other than normal, special assessment is precluded by section 327, which provides:
* * * This subdivision shall not apply to any case (1) in which the tax (computed without benefit of this section) is high merely because the1929 BTA LEXIS 2485">*2498 corporation earned within the taxable year a high rate of profit upon a normal invested capital * * *.
The respondent's determination should be modified by deductions of the New York State franchise taxes as above decided, and in other respects it is sustained.
Reviewed by the Board.
Judgment will be entered under Rule 50.