*2953 Held, that respondent did not err in denying personal service classification.
*1321 These proceedings, which were consolidated for hearing, are for the redetermination of deficiencies in income and profits taxes as follows:
| Year | Docket No. | Deficiency |
| 1919 | $19,119.59 | |
| 1920 | 11756 | 25,819.44 |
| 1921 | 13025 | 1,559.88 |
The deficiencies result from the respondent's refusal to classify the petitioner as a personal service corporation. For 1919 and 1920 the respondent determined the petitioner's profits-tax liability under section 328 of the Revenue Act of 1918. The hearing in Docket No. 11756 was limited to the question of the petitioner's right to be classified as a personal service corporation. Further proceedings are to be and under Rule 62 with respect to the amount of relief the petitioner is entitled to under section 328 for the years 1919 and 1920, the respondent having determined that for these years the petitioner is entitled to have its profits-tax liability determined under the provisions*2954 of that section.
FINDINGS OF FACT.
The petitioner is a Missouri corporation with its principal offices at Kansas City, Mo. The company was incorporated, at the instance of Henry K. Turnbull, as "The Turnbull Business Development Company" under a certificate of incorporation dated June 19, 1910, with an authorized capital of $5,000 divided into 500 shares of stock *1322 of a par value of $10 each, 250 shares being preferred stock and 250 common stock. The stock was subscribed for as follows:
| Number of shares | ||
| Preferred | Common | |
| Henry K. Turnbull | 205 | 249 |
| David M. Proctor | 1 | |
| Fred Wolferman | 10 | |
| P. S. Harris | 10 | |
| W. E. Rogers | 10 |
The articles of incorporation do not disclose any preferences given to preferred stock (which was canceled in the latter part of 1919), and the stockholders or directors have never, by by-laws or otherwise, made any distinction between the preferred and the common stock except as to name, and no preferences have ever been given to the preferred stock by any legal action of record taken by the stockholders or directors of the company.
On July 21, 1913, under authority of the Secretary of State of the State of*2955 Missouri, the name of the company was changed to "Potts-Turnbull Advertising Company". The capital stock of the corporation was in no way changed until December 6, 1919, when the Secretary of the State issued a certificate authorizing the increase of the capital stock of the corporation from $5,000 to $100,000. In the increase under this authority, the par value of the shares was increased from $10 to $100 each and the preferred stock was canceled and exchanged for common stock. Under date of January 24, 1920, the capital stock issued and outstanding of $5,000 was canceled and new stock to the amount of $63,500 was issued. This increase was paid up by charging each stockholder's personal account with his share of the new stock, which was offset by the dividends and the cancellation of the old stock and by crediting the balance in the personal account resulting from former dividends which were not drawn by the stockholders. During 1920 additional capital stock to the amount of $2,300 par value was sold and this amount, together with the premium thereon of $3,300, was paid in. During 1921 additional capital stock of the par value of $3,900 was sold and this amount, together with*2956 the premium thereon of $4,324.55, was paid in.
The petitioner was an advertising agency, and it was stipulated that it conducted its business in the same general manner as other advertising agencies. Petitioner made surveys of the market for products of its clients, the salability, the price, the distribution, and other elements, and thereafter made recommendations to the client as to the proper method of advertising, which would include advertising in newspapers, magazines, trade papers, folders, direct literature, printed literature, hangers, outdoor signs, painted signs and *1323 bulletins. If the client approved the plans of petitioner, definite authority as advertising agent would be given petitioner and it would proceed to make layouts, including art and typography, and have the necessary plates and mats made for publications. A schedule subsmitted to the client would include the names of publications to be used, the dates on which the advertisements would be inserted, and the number of lines comprising such advertisements. Orders would then be sent by petitioner to these publishers, or other concerns, for such advertisements, on behalf of the client. The petitioner*2957 did not buy or sell advertising space as a principal.
The publishers or other concerns would render bills to the petitioner for the advertisers. As these bills would perhaps include several advertisers, the petitioner would distribute the appropriate charges to the various advertisers and render bills to them. The Publishers allowed a cash discount where bills were paid within a designated time. In sending bills to advertisers, the petitioner also allowed them the benefit of the discount if remittance was made to the petitioner within the time stated therein. In most cases the advertisers took advantage of the cash discount.
Petitioner's custom was to collect from its clients in advance of the time the bill to the publisher came due, in order that money would be on hand to pay such bills. As a general rule the petitioner had received from advertisers who paid accounts in advance, or promptly, sufficient funds to pay publishers promptly and to carry the accounts of those advertisers who had not paid their bills to the petitioner before the petitioner was required to pay the publisher. The petitioner always took advantage of the cash discounts allowed by publishers in order*2958 to maintain its recognition as an advertising agency and in all cases allowed the same discounts to advertisers who paid within the discount period.
During the month of May, 1920, which has been selected at random as a typical month as to 1919 and the first portion of 1920, the total amount billed to clients for advertising was $84,344.72. Upon these bills $65,208.19, or 78 per cent of the total amount, was paid during the month that the client was billed or by the 14th of the following month. Between the 14th and 19th of the month following that in which the client was billed, $3,534.74, or 4 per cent, was paid. Substantially all of these bills were paid within 120 days after the date of the bill. Due, however, to the collapse of prices of agricultural products, beginning about the middle of the year 1920, and the consequent inability of advertisers selling to farmers to meet their debts, the month of May is not entirely typical of the whole year 1920 nor of 1921.
Petitioner received most of its income from the commissions generally allowed by publishers to advertising agencies, usually 15 per *1324 cent of the charge for the advertising, and from similar commissions*2959 allowed by others from whom it secured services or materials for its clients, such as the 10 per cent commission on engraving. Petitioner also received fees for services in the preparation of booklets and other advertising material for consultation and advice on advertising problems and for other services not directly connected with the use of advertising space in publications.
The charges made by the petitioner to its clients during the taxable year in question were in character and amount as follows:
| Aggregate of bills sent to clients | |||
| 1919 | 1920 | 1921 | |
| Advertising | $881,740.69 | $1,335,516.57 | $782,302.02 |
| Art work | 16,266.06 | 31,092.96 | 18,639.16 |
| Engraving, etc | 30,382.71 | 53,499.23 | 42,261.33 |
| Service fees | 19,440.70 | 22,263.37 | 3,431.25 |
| Slide service, etc | 599.03 | 4,874.20 | |
| 947,830.16 | 1,442,971.16 | 851,507.96 |
During the taxable years in question, the items of the gross and net income reported by the petitioner were as follows:
| Statement of gross and net income | |||
| 1919 | 1920 | 1921 | |
| INCOME | |||
| Commission on advertising | $118,110.34 | $185,679.14 | $127,134.43 |
| Service fees for preparation of advertising | 19,824.73 | 25,924.75 | 3,371.25 |
| Earnings of art work | 4,184.98 | 28,400.87 | 17,766.15 |
| Discount | 4,107.88 | 9,966.37 | 9,926.74 |
| Commission on engraving | 3,144.27 | 5,535.27 | 3,708.04 |
| Commission on outdoor advertising | 1,228.51 | 3,025.02 | |
| Interest | 2,827.57 | 6,853.53 | |
| Sundry | 965.99 | 156.81 | |
| Adjustments - employees and stockholders | 1,492.99 | ||
| Bad debts collected | 1,060.39 | ||
| Slide service | 360.00 | ||
| Total income | 149,372.18 | 263,081.85 | 172,301.97 |
| EXPENSES | |||
| Salaries - stockholders | 34,535.57 | 49,234.00 | 44,827.00 |
| Salaries - employees (not stockholders) | 34,868.48 | 67,108.69 | 61,862.65 |
| Rent | 2,035.00 | 6,893.33 | 10,380.00 |
| Travel | 4,836.48 | 5,186.33 | 11,532.89 |
| Stationery and office supplies | 1,447.57 | 5,573.67 | 5,887.90 |
| Legal | 217.70 | 140.75 | |
| Light | 173.00 | 434.12 | 663.85 |
| Phones | 662.86 | 1,623.40 | 2,285.94 |
| Telegrams | 161.40 | 609.50 | 509.86 |
| Insurance | 21.50 | 308.51 | 2,498.89 |
| Postage | 757.74 | ||
| Contributions (disallowed) | 97.00 | ||
| Clubs (Chamber of Commerce, etc.) | 114.50 | ||
| Sundry | 1,578.54 | ||
| Interest | 375.56 | 373.49 | |
| Bad debts | 4,860.99 | 14,636.56 | |
| General and miscellaneous business exp | 2,605.79 | 14,208.63 | 7,356.93 |
| Depreciation | 465.12 | 963.85 | 1,542.34 |
| Taxes | 748.96 | 1,884.44 | 2,539.61 |
| Service to Omaha and Chicago offices | 4,311.89 | ||
| Art Department | 16,357.86 | ||
| Repairs | 1,337.60 | ||
| Total expenses | 90,563.76 | 176,550.06 | 166,524.42 |
| Total income | 149,372.18 | 263,081.85 | 172,301.97 |
| Total expenses | 90,563.76 | 176,550.06 | 166,524.42 |
| Net income reported on return | 58,808.42 | 86,531.79 | 5,777.55 |
*2960 *1325 The income items of discount of $4,107.88, $9,966.37, and $9,926.74 for 1919, 1920, and 1921, respectively, represent the discounts earned by the petitioner in paying bills within the time allowed by the publishers but which were not passed on to the advertisers, since they did not make remittance to the petitioner within the time specified in the bills to them.
The income items of interest, $2,827.57 and $6,853.53 for 1920 and 1921, respectively, represent interest on the notes of some of the petitioner's clients who were unable to pay their bills promptly.
The expense items of bad debts of $4,860.99 and $14,636.56 for 1919 and 1921, respectively, represent either space ordered and not paid for by client or service fees that were not paid.
The taxpayer did not derive any gains, profits, or income from trading as a principal or from a Government contract made between April 6, 1917, and November 11, 1918.
The assets and liabilities of the petitioner as of the beginning and end of each of the taxable years involved were as follows:
| Dec. 31, 1918 | Dec. 31, 1919 | Dec. 31, 1920 | Dec. 31, 1921 | |
| ASSETS | ||||
| Furniture | $2,107.86 | $4,700.25 | $8,674.71 | $13,881.10 |
| Accounts receivable (clients) | 47,807.64 | 67,280.06 | 180,680.78 | 86,249.35 |
| Accounts receivable (others) | 7,909.93 | 2,134.47 | 127.67 | 4,026.98 |
| Bills receivable (clients) | 15,000.00 | 1,449.64 | 43,950.00 | 53,607.31 |
| Stationery and office supplies | 386.79 | 622.71 | ||
| Cash | 95,095.86 | 109,218.46 | 37,755.48 | |
| Prepaid insurance | 1,647.17 | 1,951.30 | ||
| 73,212.22 | 171,282.99 | 344,298.79 | 197,471.52 | |
| LIABILITIES | ||||
| Capital stock | 5,000.00 | 5,000.00 | 65,800.00 | 69,700.00 |
| Undivided surplus | 10,000.00 | 10,000.00 | 52,361.00 | |
| Paid in surplus | 3,300.00 | 7,624.55 | ||
| Undivided profit | 37,465.26 | 6,101.14 | ||
| Overdraft | 11,650.95 | |||
| Reserve for taxes | 2,162.02 | 2,873.52 | 730.41 | |
| Reserve for bad debts | 3,600.00 | |||
| Accounts payable (publishers, etc.) | 29,567.45 | 97,770.27 | 187,628.95 | 76,132.36 |
| Accounts payable (other) | 12,831.80 | 18,173.94 | 2,022.07 | 12,183.06 |
| Bills payable (bank) | 2,000.00 | 25,000.00 | ||
| Bills payable (publishers, etc.) | 29,323.76 | |||
| Accrued interest | 263.01 | |||
| 73,212.22 | 171,282.99 | 344,298.79 | 197,471.52 |
*2961 The calendar year 1919 and early part of the year 1920 taken as one period was the banner period for the Potts-Turnbull Co. During the years prior to this period the corporation had established itself with the advertisers of the country, and more particularly with those advertisers employing as an advertising medium the farm journals and publications having a wide circulation among farmers and agriculturalists. As a result some of the largest accounts enjoyed by the company during the years 1919 and 1920 were the accounts of advertisers dealing in products intended for the farmers. The agricultural industry, and more particularly throughout the great middle *1326 western section of the country, which is primarily an agricultural country, collapsed utterly about the middle of 1920. With the collapse of the agricultural and stock-raising industry those persons dealing primarily in the products used by that industry immediately found their credits positively frozen. Three of the larger accounts handled by the company during the year 1920 were the Ottawa Manufacturing Co. of Ottawa, Kans., the Rahe Auto & Tractor School of Kansas City, Mo., and the A. J. Kirstin Co. of Escanaba, *2962 Mich.
The first and last named companies were manufacturers of products utilized by farmers; the Rahe Auto & Tractor School was an occupational school located in Kansas City, Mo., which attracted its students from the farming territory and which utilized for its advertising publications delivered directly to the farmers. The gross business of the Ottawa company for the year 1920 was $435,606.49.
During the early part of the year the business placed each month for the company was paid for promptly, and in some instances advance payments were made, as was true with practically all of the advertising clients. In the latter part of the year and while its business was still good, the Ottawa Manufacturing Co. undertook an enlarged program of advertising which ran as high as $94,000 in the month of November, and while substantial payments were made on account, almost before the petitioner's officers could realize the general situation, the advertiser fell behind in its payments to the extent that at the end of 1920 it owed on open account for advertising placed, including an order for more than $80,000 of advertising in December, 1920, the sum of $60,065.04. In addition to this item*2963 owing on open account, the advertiser owed the petitioner $20,000 in notes at the end of 1920. The following table shows the amount of business placed by the Ottawa Manufacturing Co. from month to month during 1920, together with the dates and manner of payments:
| Gross business, year 1920 | |||
| Payments | |||
| Month | Amount of business | Manner | Amount |
| January | $29,705.94 | Jan. 15 - Check | $2,675.00 |
| 16 - Check | 2,000.00 | ||
| 27 - Check | 29,020.82 | ||
| February | 14,594.95 | Feb. 26 - Check | 13,026.64 |
| March | 2,838.17 | Mar. 25 - Check | 96.00 |
| 25 - Check | 2,368.34 | ||
| April | 7,935.97 | Apr. 21 - Check | 842.90 |
| 23 - Check | 8,629.32 | ||
| May | 9,445.88 | May 25 - Check | 10,055.32 |
| June | 6,113.86 | June 25 - Check | 5,275.15 |
| July | 13,940.00 | ||
| August | 32,881.85 | Aug. 2 - Check | 1,003.00 |
| September | 62,627.46 | Sep. 1 - Check | 10,000.00 |
| October | 80,086.55 | Oct. 2 - Check | 20,000.00 |
| 11 - Notes | 60,000.00 | ||
| 12 - Check | 125.00 | ||
| November | $94,476.61 | Nov. 4 - Check | $450.00 |
| 10 - Check | 23,550.28 | ||
| 12 - Note | 10,000.00 | ||
| 12 - Note | 10,000.00 | ||
| 12 - Note | 10,000.00 | ||
| December | 80,959.25 | Dec. 6 - Check | 7,500.00 |
| 10 - Check | 7,500.00 | ||
| 15 - Note | 10,000.00 | ||
| 15 - Note | 10,000.00 | ||
| 15 - Note | 10,000.00 | ||
| 15 - Note | 10,000.00 | ||
| 15 - Note | 10,000.00 | ||
| 15 - Note | 10,000.00 | ||
| 15 - Note | 10,000.00 | ||
| 15 - Note | 10,000.00 | ||
| 15 - Note | 10,000.00 | ||
| 15 - Note | 10,000.00 | ||
| 28 - Check | 10,000.00 | ||
| 28 - Note | 20,000.00 | ||
| 28 - Check | 15,000.00 | ||
| 31 - Check | 50,000.00 | ||
| 435,606.49 | (Checks and notes) | 429,127.77 |
*2964 *1327 The same situation existed as to the other accounts mentioned, and the following tables show the gross business from them, together with the dates and manner of payment:
| A. J. KIRSTIN COMPANY | |||
| Gross business, year 1920 | |||
| Payments | |||
| Month | Amount of business | Manner | Amount |
| August | $500.00 | ||
| September | 3,422.03 | Sept. 30 - Check | $3,417.08 |
| October | 12,363.41 | Oct. 27 - Check | 2,500.00 |
| November | 13,199.56 | Nov. 12 - Check | 9,169.12 |
| December | 12,372.40 | Dec. 6 - Check | 15.70 |
| 8 - Check | 1,073.00 | ||
| 31 - Check | 441.00 | ||
| 41,857.40 | 16,615.90 |
| RAHE AUTO & TRACTOR SCHOOL | |||
| Gross business, year 1920 | |||
| Payments | |||
| Month | Amount of business | Manner | Amount |
| January | $16,576.31 | Jan. 10 - Check | $19,857.65 |
| February | 9,186.43 | Feb. 11 - Check | 15,851.77 |
| March | 3,859.68 | ||
| April | 5,761.24 | Apr. 16 - Check | 5,000.00 |
| May | 6,927.06 | May 1 - Check | 5,000.00 |
| 25 - Check | 5,000.00 | ||
| June | 4,138.12 | June 24 - Note | 4,925.00 |
| 24 - Note | 4,900.00 | ||
| 29 - Check | 1,786.58 | ||
| July | $4,091.08 | ||
| August | 4,975.55 | ||
| September | 5,924.20 | Sept. 11 - Note | $5,000.00 |
| 23 - Note | 4,158.17 | ||
| 23 - Note | 5,000.00 | ||
| Interest | 175.00 | ||
| October | 9,451.93 | Oct. 27 - Check | 46.71 |
| 26 - Note | 6,000.00 | ||
| November | 17,304.32 | Nov. 12 - Note | 5,000.00 |
| 19 - Note | 4,687.51 | ||
| Dec. 2 | 24,095.23 | Dec. 17 - Note | 5,064.69 |
| 17 - Note | 6,000.00 | ||
| 17 - Note | 6,000.00 | ||
| 112,291.15 | (Checks and notes) | 109,453.08 |
*2965 *1328 About the same time that the petitioner took notes from the above indicated clients it also took notes from another client, Coleman-Lambert Co., from which the petitioner obtained about one-third of its gross business during 1919 and 1920 and up to the summer of 1921.
Some of the notes taken from the Ottawa Manufacturing Co. for the business placed during 1920 remained unpaid except as to having been renewed from time to time at the beginning of 1924, at which time the Ottawa Manufacturing Co. owed the petitioner on notes in excess of $61,000. On February 29, 1924, the Capper Publishing Co. of Topeka, Kans., owning and publishing a number of farm journals of large circulation throughout the Middle West and with which company large amounts of advertising were placed for the Ottawa Manufacturing Co. during 1920, extended a credit of $29,205.39 to the petitioner as a result of negotiations. The credit was extended largely because of the difficulties encountered by the petitioner with reference to the Ottawa Manufacturing Co. account and because of the failure of that company to meet its advertising bills promptly. This credit was immediately applied on notes given*2966 to the petitioner by the Ottawa Manufacturing Co. for advertising originating in the year 1920.
The item of accounts payable (publishers, etc.) represented the total amount of bills which had been received from the publishers and on which a discount period had not expired at the end of the year. The item of bills payable (bank) of $25,000 at December 31, 1921, represented money the petitioner had borrowed to pay publishers and to continue operations during the preceding period when money was not coming in from the advertisers. While the petitioner did not ordinarily borrow money, during the period beginning in the *1329 latter part of 1920 such action became necessary in order for it to continue in business.
The capital stock of the petitioner was owned during the taxable years as indicated in the following table. Except in 1919, as indicated, all stock was common stock. The increase of capital stock was legally effected in December, 1919, and the changed distribution, as shown for the year 1920 in the table below, was by agreement effective as of December 31, 1919, although it was recorded as of January 24, 1920.
| Ownership of stock | |||
| Number of shares owned | |||
| Stockholder | 1919 | 1920 | 1921 |
| H. K. Turnbull: | |||
| Preferred | 239 | ||
| Common | 65 | 257 | 257 |
| (Additional, after Oct 1, 1919, 50 shares, common.) | |||
| Fannie S. Turnbull | 90 | 199 | 199 |
| B. F. McGuirl | 25 | 72 | 73 |
| (Additional share acquired Feb. 2, 1921.) | |||
| W. J. Krebs | 20 | 72 | 72 |
| P. S. Harris: | |||
| Preferred | 10 | ||
| Common (until Feb. 2, 1921) | 1 | ||
| S. T. Balcom, preferred | 1 | ||
| Otto Barth (up to Oct. 1, 1919) | 50 | ||
| H. R. Palmer | 24 | 50 | |
| (Additional, after July 1, 1920, 4 shares.) | |||
| (Additional, after Jan. 1, 1921, 22 shares.) | |||
| A. G. Degen | 10 | 14 | |
| (Additional after July 1, 1920, 4 shares.) | |||
| J. G. Stephenson (from Feb. 1, 1920, to July 1, 1920) | 8 | ||
| S. T. Claflin (after July 1, 1920) | 10 | 10 | |
| L. W. Webster (after Apr. 1, 1920) | 5 | 5 | |
| F. E. Whalen (after Jan. 13, 1921) | 12 | ||
| F. B. Gradolf (after Jan. 1, 1921) | 5 | ||
| Total shares | 500 | 658 | 697 |
*2967 All of the above stockholders were regularly engaged in the active conduct of the affairs of the corporation with the exception of (1) P. S. Harris, who was a stockholder during 1919 and 1920 only; (2) S. T. Balcom, who was a stockholder during 1919 only, holding one share which was given to her by her brother, H. K. Turnbull, to qualify her for a directorship; and (3) Fannie S. Turnbull, who was the wife of H. K. Turnbull.
H. K. Turnbull, the principal stockholder, was president and directing head of the business of the petitioner and devoted all of his time thereto. He either initiated and carried on or participated in the negotiations for obtaining advertising of all the large advertisers that the petitioner had as clients during the years here involved. He initiated the general plans in formulating advertising plans for clients, gave directions as to how they should be worked out, and *1330 supervised the carrying out of these directions. He supervised and conferred daily with the "contact men" hereinafter referred to. Turnbull was paid salaries as follows:
| 1919 | $26,260.57 |
| 1920 | 30,000.00 |
| 1921 | 18,000.00 |
The following table shows the classes, *2968 the average number, and the total compensation of the petitioner's employees who were not stockholders during the years involved:
| 1919 | 1920 | 1921 | ||||
| Employees not stockholders | Average number | Total compensation | Average number | Total compensation | Average number | Total compensation |
| Contact men or account executives | 5 | $17,213.48 | 4 | 4 | $12,920.00 | |
| Bookkeepers, stenographers, clerks, errand boys, etc | 11 | 11,774.09 | 25 | $56,577.19 | 24 | 37,397.75 |
| Artists | 3 | 5,280.91 | 2 | 2,572.55 | 4 | 7,600.15 |
| Copy writers | 1 | 600.00 | 4 | 7,958.95 | 2 | 3,944.75 |
| 20 | 34,868.48 | 35 | 67,108.69 | 34 | 61,862.65 |
An account executive as known in an advertising agency is the particular individual who looks after the general details and the development of the accounts in his charge. It is his duty to assist the copy department in the preparation of advertisements, circulars and follow-up literature required by the client. The account executive calls on the client and furnishes the means of contact between the agency and the client; plans the client's advertising program, and is responsible for the production of business. While some of the account executives or*2969 contact men obtained a small amount of new business or new accounts the stockholders, chiefly Turnbull, were primarily responsible for initiating and obtaining such business.
During the year 1919 the petitioner employed at different times for varying periods of employment eight account executives who were not stockholders of the company, serving at salaries ranging from $125 per month to $325 per month.
The petitioner employed during 1920 an average of four account executives who were not stockholders at salaries ranging from $200 to $450 per month. During 1920 the petitioner employed bookkeepers, stenographers, clerks, typists, etc., at salaries ranging from $26 per month to $150 per month.
The artists prepared "layouts" or sketches which were used in connection with the advertising obtained from clients. The copywriters wrote the text matter appearing in the advertisements after they had been given the plan and had been informed as to the size of the advertisements. Sometimes such matter was very extensive *1331 and had to be clearly studied out before it was written. Sometimes the copywriter came in contact with the advertisers but very little of their work was*2970 done without supervision and check by the stockholders.
OPINION.
TRAMMELL: The only issue for consideration at this time is whether the petitioner is entitled to personal service classification for the years 1919, 1920, and 1921. The petitioner contends that during these years its income was to be ascribed primarily to the activities of the principal owners or stockholders who were regularly engaged in the active conduct of its affairs and that capital, whether invested or borrowed, was not a material income-producing factor.
For the years here involved the petitioner employed nonstockholders as contact men or account executives, artists, copywriters, bookkeepers, stenographers, clerks, errand boys, et cetera, as set out in our findings of fact, and at the salaries here indicated.
During 1919 the petitioner employed an average of five nonstockholders as contact men at salaries ranging from $125 to $325 per month and whose total compensation for the year amounted to $17,213.48. During 1920 and 1921, the average number of this class of employees was four. In 1920 their salaries ranged from $200 to $450 per month, and for 1921 their total compensation amounted to $12,920. *2971 In 1919 the number of nonstockholding contact men or account executives alone exceeded the number of active stockholders. They assisted in preparing copy for advertisements, circulars, and follow-up letters required by the clients. They called on clients, furnished the means of contact between the petitioner and its clients, and were responsible for the production of business. These were not mere ministerial employees, such as stenographers and bookkeepers. The duties performed by this class of employees were unquestionably a material part of the service rendered by the petitioner.
While the evidence indicates that the work performed by the artists was only incidental to the chief service rendered by the petitioner, it also indicates that the work performed by the copy writers was of considerable importance.
In 1919 the average number of employees, including copy writers and contact men, was 20, for 1920 and 1921 the average was 35 and 34, respectively. These employees were as necessary to the operation of the business as the services of the stockholders. Aside from the amount of discount received in 1918 on account of the prompt payment of bills, the facts for that year*2972 which would warrant the personal service classification were no stronger than for the years involved *1332 in this proceeding. For 1918 we held that the petitioner was not entitled to personal service classification. .
From a consideration of the facts in these proceedings, we can not find that the services of nonstockholding employees, taken as a whole, were not a material income-producing factor, during at least the year 1919, and that the petitioner's income for that year is to be ascribed primarily to the principal stockholders. See Cuyahoga Abstract & Title Co. v. Commissioner, 29 Fed.(2) 448.
The petitioner contends that for 1920 and 1921, the owners of 70 per cent and 71 per cent, respectively, of its stock and who were regularly engaged in the active conduct of the affairs of the corporation were the principal stockholders and as such fulfilled the statutory requirements. For 1920 the number of inactive stockholders was reduced from 3 to 2 by S. T. Balcom selling her one share of stock to H. K. Turnbull. While Harris held 10 shares in 1919, he had only 1 share in 1920, when Fannie S. Turnbull's holdings increased*2973 from 90 to 199 shares. In 1920, of the 10 stockholders, Fannie S. Turnbull held the second largest amount of stock, having 30.24 per cent, and Harris held the smallest amount, or about 16 per cent. In 1921 Fannie S. Turnbull was the only inactive stockholder to hold stock throughout the year. Harris held one share until February 2, 1921, when he ceased to be a stockholder.
We have heretofore considered whether the principal stockholders of a corporation were regularly engaged in the conduct of a corporation's business when large percentages of stock were held by inactive stockholders. In , where 31.1 per cent of the stock was held by those who gave no attention to the business, we held that the principal stockholders were not regularly engaged in the conduct of the petitioner's business. In , we refused to allow personal service classification where approximately 33 per cent of the stock was held by inactive stockholders. On this question, the United States District Court in the case of *2974 , said:
The law was directed at absentee stock ownership. If the service rendered is in the nature of personal service and is rendered by the owners of the business, the law intended a separate classification for income and excess profits taxes. It was intended to give corporations performing services of this nature and in this manner the same tax position as a partnership. The dominating purpose was to distinguish between corporations engaged in trade, merchandising, and manufacturing, in which much capital is required, and without which profits may not be earned, and corporations performing personal services, in which large capital is not usually required or necessary to its efficient conduct. The discrimination is between income earned by capital and *1333 income earned by personal effort. The specifie limitations in section 200 were inserted in aid of this dominant purpose and to prevent evasion. They should not be stressed to the point of destroying the major purpose of the law. Sections 200 and 218, Revenue Act of 1918 (Comp. St. §§ 6336 1/8a, 6336 1/8i), tax personal service at the same rate and in*2975 the same manner as partnerships. The number of partners and the amount of their respective interests is not made a test. So, under this section, the amount of the interest of the several stockholders is not to be taken as a controlling test. The controlling test must be looked for in another direction. It is whether the activities of the corporation are carried on by its owners regularly engaged, not whether some of its owners have a greater or less amount of stock. The law intended to forbid absentee stockholding interests of a material size.
We think in this case that the inactive stockholders for 1920 and 1921 held sufficient stock, to wit, 30.3 per cent in 1920 and 28.5 per cent in 1921, to be classified as principal stockholders. The requirement of the statute that the principal stockholders must be regularly and actively engaged in the business was, in view of this fact, not met.
In the latter part of 1920 the petitioner found it necessary to depart from the usual method of collecting from advertisers before making payment of publishers' bills. Certain of its clients from whom it received a large part of its business were unable on account of the then existing agricultural*2976 depression to pay for the advertising which had been ordered. From these the petitioner accepted notes in payment of bills. In 1920 the petitioner accepted notes amounting to $210,000 from the Ottawa Manufacturing Co., whose gross business for the year amounted to $435,606.49. Some of this client's notes taken during 1920 remained unpaid at the beginning of 1924. From another client, Rahe Auto & Tractor School, whose gross business in 1920 amounted to $112,291.15, the petitioner took notes amounting to $56,735.37. The petitioner also carried the A. J. Kirstin Co. on an open account to the extent of $25,241.50 on a gross business of $41,857.40. About the same time that the petitioner was taking notes from the above-mentioned clients, it also took notes in an undisclosed amount from another client from which it obtained about one-third of its business during 1919, 1920, and until the middle of 1921.
During 1920 the petitioner's income from discounts amounted to $9,966.37, or 3.7 per cent of the total income. Income from interest amounted to $2,827.57, or 1.7 per cent of total income. The income for 1920 from these two sources therefore constituted 5.4 per cent of the total*2977 income. In 1921 petitioner's income from discount was $9,926.74, and from interest was $6,853.53, which amounts constituted 5.7 per cent and 3.9 per cent respectively, or a total of 9.6 per cent of the total income.
*1334 With respect to the borrowings by the petitioner after the beginning of the agricultural depression in the latter part of 1920, H. K. Turnbull testified as follows:
Q. Did you borrow any substantial sums any time during this period?
A. We had to during that period to remain alive. Q. Can you give any details about that, when and how much?A. I do not recall the date or the amount but I know it was necessary for us to continue to discount our bills with the publishers or lose our agency recognition or standing as it is.
* * *
Q. Do you know the amount of money that you borrowed during 1920?
A. No. sir. Q. Can you give any general idea of the amount? A. I do not recall.Q. The statement of liabilities and assets shows $25,000 bills payable at the end of 1921. Would you say that amount was large or small as compared with the condition throughout that year?
A. I do not remember.He further testified:
Q. Now, will*2978 you state the nature of the item of bills payable, bank, $25,000 for December 31, 1921?
A. We had to borrow some money to pay these publishers, and keep ourselves going during that period when the money was not coming in from these advertisers.
Q. Suppose you had not borrowed that money, what would have happened?
A. We would have been out of business. Q. You would have lost your agency recognition? A. Yes, sir.* * *
A. I might add a little more in answer to that last question. It is possible that we could have gone along in some way for we had a good name, and ridden over that difficulty in some different way which might have been in accord with the income tax regulations as they seem now to want to apply them, but, we did what seemed to us a business like thing, and followed the a business like procedure at the time, and did the best that we knew how without in any way changing the character or type of our business.
From the above, it is clear that the petitioner was financing substantial portions of the advertising of certain of its largest clients. In paying publishers or otherwise arranging with them for payment of the advertisers' bills or accepting*2979 notes from the advertisers, the petitioner was extending credit to the advertisers.
While income from discount and interest does not constitute a very great part of the total income, yet the returns from the use of capital are not to be looked for in these items of income alone. During 1920 and 1921 the petitioner was borrowing money for use in the business. Some of it was being used to pay publishers for the advertising done for the petitioner's clients. The petitioner contends that the payments were made to the publishers in order to maintain its recognition or standing as an advertising agency. It is not so important why *1335 the petitioner used borrowed money in its business, but it is important, in view of the provisions of the statute, that it did use substantial amounts of borrowed money in carrying on its business. The record does not show that the petitioner's income for 1920 and 1921 would not have been just as large if it had not extended credit to its clients. But on the other hand, there is much to indicate the contrary. In fact, the testimony of the petitioner's president shows that the company's existence actually depended upon the use of capital, either*2980 paid in or borrowed.
In view of all the facts, we are of the opinion that capital was a material income-rpoducing factor in 1920 and 1921. For neither of the years involved has the petitioner met the requirements of the statute in order to come within the personal service classification.
Reviewed by the Board.
Further proceedings will be had under Rule 62(d) in Docket No. 11756. Judgment will be entered for the respondent in Docket No. 13025.
SIEFKIN did not participate.
MORRIS and VAN FOSSAN concur in the result.