*715 This proceeding involves a deficiency in income tax and surtax liability of petitioner for the year 1934, determined by respondent in the respective amounts of $63.81 and $24,691.36. It also involves a penalty of 25 percent of the latter amount, or $6,172.84 imposed by respondent because of petitioner's failure to file a return on Form 1120H as a personal holding company. The question here presented is whether petitioner, during the taxable year, was a personal holding company within the meaning of section 351(b)(1) of the Revenue Act of 1934, set out in the margin. 2 Petitioner contends that it was not and is, therefore, not liable for the payment of such surtax and penalty.
*959 FINDINGS OF FACT.
Petitioner is a corporation organized under the laws of the State of Virginia in July 1924. Its principal office is located in Washington, D. C. During the taxable year here involved more than 50 per centum in value of its outstanding stock was owned by or for not more than five individuals.
*716 In 1934 the petitioner maintained five offices in the State of Virginia and two offices in the State of Tennessee. At the beginning of 1934 it had 8,902 loans outstanding, and at the end of 1934 it had 10,035 loans outstanding. The petitioner did not make loans of over $300.
Each of the seven offices of the corporation was licensed by the state wherein it operated; paid an annual fee of $250 for the privilege of doing business, and was under the supervision of state banking officials. During the year 1934 the company had an average of 9,468 active customer borrowers with total outstanding loan balances of $952.926. The average loan per borrower was about $134. In connection with each of the loans made in 1934 written applications had to be taken, the applicants' credit standing had to be checked, security in the form of chattel mortgages was taken, *960 the mortgages were notarized and recorded, and detailed bookkeeping records were kept both in the office making the loan and in the home office. Wherever a chattel mortgage on property was taken as security, an appraisal had to be made of such property; closing papers had to be prepared and executed, and extensive collection efforts kept up in order to prevent delinquencies. The Seaboard offices were in competition with Morris Plan Banks, and other banking organizations in the states where they operated and they had constant need for capital, which was difficult to secure.
Petitioner was licensed by and operated offices in the States of Tennessee and Virginia under the provisions of so-called Uniform Small Loan Statutes in effect in those states.
In each of petitioner's offices there was a manager, a cashier, one or more additional clerks, and two appraisers, sometimes known as "outside men." Business was secured through advertising in the newspapers, direct mail advertising and personal contacts. As previously indicated, the actual handling of a loan account, of which petitioner had more than nine thousand in 1934, involved an interview with the applicant, the taking of a*961 written application, checking the borrower's credit standing, through merchants' credit associations, and by personal investigation; securing the loan, in 90 percent of the cases, by taking a chattel mortgage on personal property, which chattel mortgages had to be notarized and recorded. Where chattels were taken, the appraisers would go out and inspect and appraise the property in question, as well as to make a check to see that it was free and clear from other encumbrances. These outside men were furnished an automobile by the company, which paid all expenses and upkeep thereof. The closing papers for the loan were executed in the office, whereupon bookkeeping records were *717 established in order that the customermight make his payments by monthly installments. Master bookkeeping records were kept in the home office. Defaults were frequent on these accounts and when payments were overdue a collection letter would be written. If no response was had to that the outside man would be sent to make a personal contact; and where other things failed, the mortgaged property would be replevined or suit instituted. Collection pressure had to be constant, and was expensive.
*962 For the year 1934 the petitioner filed a Federal income tax return on Form 1120, in which it reported income and expenses as follows:
| Interest on loans, notes, mortgages, bonds and bank deposits, etc | $256,528.56 | |
| Rents | 1,687.70 | |
| Dividends | 2,972.00 | |
| Other income | 14.45 | |
| Total income | 261,202.71 | |
| Deductions: | ||
| Compensation of officers | $26,436.64 | |
| Rent on business property | 8,681.91 | |
| Interest | 1,204.99 | |
| Taxes | 8,761.33 | |
| Bad debts (charged off $31,201.13 - collected prior year $29,488.05) | 1,716.08 | |
| Dividends | 2,972.00 | |
| Depreciation | 1,760.40 | |
| Salaries and wages | 53,596.13 | |
| Other reductions | 30,320.77 | |
| 135,450.25 | ||
| Net income reported | 125,752.46 |
The only adjustment made to the net income in the deficiency letter was to disallow excessive depreciation of $464.03, resulting in adjusted net income of $126,216.49.
The interest reported of $256,528.56 is carried on petitioner's books in the following interest accounts:
| Interest account, Norfolk, Va | $25,034.82 |
| Interest account, Richmond, Va | 32,496.75 |
| Interest account, Lynchburg, Va | 37,694.54 |
| Interest account, Roanoke, Va | 30,451.66 |
| Interest account, Portsmouth Va | 48,396.59 |
| Interest account, Knoxville, Tenn | 45,567.41 |
| Interest account, Chattanooga, Tenn | 30,222.50 |
| Interest account, Discontinued office | 221.29 |
| Interest on bonds and time loan | 6,443.00 |
| Total | 256,528.56 |
*963 *718 Petitioner introduced in evidence for the purpose of showing in detail its income and expenditures for 1934, an exhibit containing the following figures:
| Income | ||
| Gross earnings of offices: | ||
| Norfolk, Va | $25,034.82 | |
| Richmond, Va | 32,496.75 | |
| Lynchburg, Va | 37,694.54 | |
| Roanoke, Va | 30,451.66 | |
| Portsmouth, Va | 48,396.59 | |
| $174,074.36 | ||
| Knoxville, Tenn | 45,567.41 | |
| Chattanooga, Tenn | 30,222.50 | |
| 75,789.91 | ||
| Discontinued office | 221.29 | |
| Interest on municipal bonds | 653.22 | |
| Interest on corporation bonds and notes | 5,576.45 | |
| Interest on time loan | 213.33 | |
| Gross rents | 12,225.00 | |
| Dividends | 2,972.00 | |
| Cash overages | 14.45 | |
| Bad debts collected | 29,485.05 | |
| Total income | 301,225.06 | |
| Expenditures | ||
| Officers' salaries | $26,436.64 | |
| Rents | 8,681.91 | |
| Interest paid | 1,204.99 | |
| Taxes | 8,761.33 | |
| Salaries and wages | 53,596.13 | |
| Expenses of rental properties | 10,537.30 | |
| Bad debts written off | 31,201.13 | |
| Telephone and telegraph | 1,348.49 | |
| Auto expense | 4,385.83 | |
| Legal and audit | 3,990.32 | |
| Postage | 6,512.71 | |
| Stationery and printing | 3,292.83 | |
| Advertising | 7,355.91 | |
| Association dues | 616.50 | |
| Bond premiums, etc | 753.81 | |
| Heat and light | 268.12 | |
| General expense | 1,074.97 | |
| Travel expense | 721.28 | |
| Depreciation on furniture - fixtures and autos | 1,760.40 | |
| Total expenditures | 172,500.60 | |
| Net income | 128,724.46 |
*964 This "net income" figure exceeds the net income reported by petitioner in its return by the sum of $2,972, for the reason that in *719 its return petitioner deducted this amount under item 22, as dividends.
In the small loan business costs of investigation and of servicing the loan "come very high in relation to the principal of the loan." Applicants must be looked up by call at their home and inquiry made in the neighborhood to ascertain their community standing and by clearance through a credit exchange. "Servicing" includes the collection of periodic installments "which become extensive when the installments are small"; follow-ups of delinquent accounts; review and revision of contracts when the debtor is unable to pay; and constant collection pressure, preferably by means other than legal procedure. These investigation and servicing costs are inherent in the nature of the business.
Petitioner made no allocations of such costs to the individual loans made by it.
An item of $4,384.83 was expended by petitioner during the taxable year for automobiles maintained for the appraisers or "outside men" employed by it. The item for "salaries and wages" of $53,596.13*965 deducted by it in its return included no executive salaries, but represented wages of the employees, previously described, who "serviced" these loans. Its expense for telegraph and telephone service during the taxable year amounted to $1,348.49.
The pertinent statute of Tennessee reads as follows:
Rate of interest ant fee. - Every person, licensed hereunder, may lend any sum of money not exceeding in amount the sum of three hundred dollars, and may contract for, charge and receive thereon interest not to exceed six percent per annum; provided, however, that the licensee may charge and receive for investigating the moral and financial standing of the applicant, investigating the security, titles, etc., and for other expenses and losses of every nature whatsoever, and for closing the loan, a fee not above three percent per month of the principal sum lent over the term of the loan, both interest and fee to be computed on the unpaid balance of the principal due at the end of each month over the life of the loan.
More than 80 per centum of petitioner's gross income for the year 1934 was derived from dividends and interest.
The petitioner did not file a return on Form 1120H*966 for the year 1934. It did file a regular income tax return for that year on Form 1120. In 1938 petitioner had its auditor prepare and submit a return on Form 1120H, which was not signed or verified.
OPINION.
KERN: The questions raised in this proceeding were recently considered by the Circuit Court of Appeals for the First Circuit in *720 the case of (December 22, 1939), affirming , and decided contrary to the contentions of the petitioner.
On the authority of that case and because of the reasons therein given,
Decision will be entered for respondent.
Footnotes
1. Originally entered as a memorandum opinion of same date. ↩
2. SEC. 351. SURTAX ON PERSONAL HOLDING COMPANIES.
* * *
(b) DEFINITIONS. - As used in this title -
(1) The term "personal holding company" means any corporation (other than a corporation exempt from taxation under section 101, and other than a bank or trust company incorporated under the laws of the United States or of any State or Territory, a substantial part of whose business is the receipt of deposits, and other than a life-insurance company or surety company) if - (A) at least 80 per centum of its gross income for the taxable year is derived from royalties, dividends, interest, annuities, and (except in the case of regular dealers in stock or securities) gains from the sale of stock or securities, and (B) at any time during the last half of the taxable year more than 50 per centum in value of its outstanding stock is owned, directly or indirectly, by or for not more than five individuals * * *. ↩