1928 BTA LEXIS 3803">*3803 1. The petitioner is not a personal service corporation within the meaning of the Revenue Act of 1918.
2. Reduction of invested capital by an amount of 1919 income and profits taxes approved.
11 B.T.A. 483">*483 This proceeding is for the redetermination of a deficiency in income and profits taxes of $14,358.39 for the fiscal year ended November 30, 1920.
The questions presented for consideration are:
(1) Whether the petitioner is a personal service corporation within the meaning of section 200 of the Revenue Act of 1918, and
(2) Whether the respondent incorrectly reduced invested capital of the petitioner by an amount of 1919 income and profits taxes.
FINDINGS OF FACT.
The petitioner is a corporation, organized and incorporated under the laws of the State of New York, with its principal office in New York City, and is engaged in selling underwear, manufactured by the following mills, directly to retail stores throughout the United States, on a commission basis:
Globe Knitting Works.
Augusta Knitting Corporation.
Charles E. Shedaker & Sons.
1928 BTA LEXIS 3803">*3804 Teischer Knitting Mill.
Bristol Underwear Co.
Popular Underwear Co.
11 B.T.A. 483">*484 The business was conducted as a copartnership prior to 1905, when it was incorporated. Prior to 1912 the petitioner bought and sold merchandise on its own account. Beginning with the year 1912 it gradually discontinued that practice and inaugurated the plan, which is now followed, of selling on a commission basis only.
The commissions earned from sales are payable to the petitioner on the tenth of the month following receipt of payment for shipments made by the mills. Commissions on sales made in the fall of the year were usually received eight or nine months thereafter.
In the years immediately preceding the taxable period under consideration, the practice of the petitioner was to prepare its lines of merchandise so that shortly after the first of each year complete samples were available and the salesmen could proceed to their respective territories. Samples were displayed to retail buyers either in their own showrooms or in the rooms provided by hotels for that purpose, at which time orders were taken and, at the end of the week, forwarded to the office where entries were made in1928 BTA LEXIS 3803">*3805 the sales records and the orders were then placed with the different manufacturers. Due to the growing tendency on the part of retail buyers toward placing their orders directly in New York, instead of with the visiting salesmen, the method of direct selling was changed, and as a result, Bourgeois, who was a salesman in charge of the central western territory, found it necessary to remain in New York for at least five weeks after the first of the year, and also in the early fall, during the period he had ordinarily traveled on the road.
During the fiscal year ended November 30, 1920, there were outstanding 1,000 shares of stock, par value of $100, all of which were held by the following named stockholders in the amounts set opposite their names:
| Shares | |
| Oscar S. Bourgeois, president | 215 |
| O. F. Peckham, vice president | 248 |
| Rodney W. Jones, treasurer | 231 |
| W. F. O'Brien, secretary | 22 |
| J. C. Bray | 3 |
| H. S. Bourgeois | 13 |
| G. A. Sequin | 10 |
| E. W. Robischon | 50 |
| Anna M. Robischon | 208 |
| Total | 1,000 |
Oscar S. Bourgeois, the president of the company, was a salesman in charge of the central western territory. O. F. Peckham, the vice president, was a salesman in the1928 BTA LEXIS 3803">*3806 Pacific Coast territory, which included all of the large cities from Denver west. Rodney W. Jones, treasurer, was a salesman in charge of the southern territory. W. F. O'Brien, the secretary, assisted Jones in keepting contact with the more important retail stores in and about New York and Philadelphia, and he also went into the New England States in the territory formerly covered by Robischon. J. C. Bray covered a portion of 11 B.T.A. 483">*485 Jones' territory in West Virginia and Southern Ohio, keeping in contact with the trade. H. S. Bourgeois, the son of the president, assisted his father as a permanent contact with buyers in his territory. Sequin followed up the trade of H. S. Bourgeois. E. W. and Anna Robischon took no active part in the business whatsoever. Robischon, who was one of the original incorporators, left the petitioner in September, 1918.
In addition to the stockholders and officers, the petitioner employed, during the taxable period under consideration, about fifteen people, who were engaged in purely clerical and administrative work incidental to the conduct of the business. It also employed, in addition to stockholders, officers, and office employees, about1928 BTA LEXIS 3803">*3807 twenty-five outside salesmen, who assisted the principals in keeping contact with the trade. These outside salesmen, who were scattered throughout the United States, called upon buyers, displayed samples and took orders for merchandise. While about 75 per cent of the petitioner's sales were made in New York during the fiscal year 1920, it was still necessary to keep salesmen in the field in order to maintain the accounts of these mills.
All of the salesmen were supplied with samples of the merchandise sold. These samples were made up by the manufacturer according to specifications furnished by the petitioner, which were billed to it at the approximate manufacturing cost. The billing for these samples was on memorandum, that is to say, they were not paid for until the end of the current selling season, at which time the cost was deducted from the amount of commissions due the petitioner. Those samples were ultimately sold for whatever could be realized therefor, which was usually at a heavy loss. At the end of the fiscal year the petitioner owed the mills $46,000 for samples.
In addition to his duties as treasurer of the petitioner, Rodney W. Jones was also president of1928 BTA LEXIS 3803">*3808 the Augusta Knitting Corporation during the taxable year.
The petitioner had an arrangement with the Augusta Knitting Corporation whereby, in consideration of one per cent, it guaranteed the collection and payment of that company's accounts. This arrangement, considering the expense incurred in guaranteeing accounts and collecting them, was unprofitable.
The compensation of officers for the year ended November 30, 1920, was $51,000, and the salaries paid to employees, other than officers and stockholders, were $92,862.90.
The following tabulation appended to its tax return for 1920 shows the expenses incurred in the operation of the business during the year under consideration, other than officers' salaries:
| Administrative and general expenses | $6,565.53 |
| Advertising | 2,209.85 |
| Automobile expenses | 1,000.00 |
| Buyers' selling expenses | 316.20 |
| Collection charges | 316.57 |
| Commissions paid to salesmen | 46,018.50 |
| Director's fees | 500.00 |
| Entertainment | 1,130.09 |
| Charged back from mills for expenses incurred on erroneous orders | |
| given by us | 820.91 |
| Exchange | 33.99 |
| Road expenses of Chicago office | 1,885.00 |
| Expressage | 635.72 |
| Freight and cartage | 404.97 |
| Insurance, fire | 655.06 |
| Printing and stationery | 2,443.62 |
| Rent and light, New York office | 4,947.68 |
| Rent, Chicago office | 660.00 |
| Road account (traveling expenses) | 41,280.59 |
| Salaries | 92,862.90 |
| Selling expenses | 1,070.63 |
| Stamps | 1,086.27 |
| Storage | 19.79 |
| Telephone and telegraph | 2,119.98 |
| Discount | 75.44 |
| 209,059.29 |
1928 BTA LEXIS 3803">*3809 11 B.T.A. 483">*486 The assets and liabilities of the petitioner as set forth in its balance sheets for the periods November 30, 1919, and November 30, 1920, are as follows:
| Nov. 30, 1919. | Nov. 30, 1920. | |
| ASSETS. | ||
| Cash | $21,600.16 | $15,220.15 |
| Security a/c | 38,969.58 | |
| Accounts receivable | 11,012.32 | 17,520.36 |
| Accounts receivable: | ||
| Commission | 75,042.75 | 151,571.23 |
| Advance to salesmen | 2,934.34 | 1,598.64 |
| Bills receivable | 62,650.00 | 81,650.00 |
| Merchandise | 10,743.69 | 7,333.45 |
| Investment in stock of mills | 28,500.00 | |
| Furniture and fixtures | 10,023.48 | 10,436.76 |
| Insurance, prepaid | 486.60 | |
| Insurance, life | 6,693.48 | 7,727.00 |
| Rent, prepaid | 395.83 | |
| Liberty bonds | 20,350.00 | |
| War-savings stamps | 839.58 | |
| 250,785.63 | 332,513.77 | |
| LIABILITIES. | ||
| Capital stock | 100,000.00 | 100,000.00 |
| Bills payable | 41,637.33 | 62,000.00 |
| Accounts payable | 19,939.57 | 52,156.56 |
| Commission due salesmen | 14,830.28 | 23,933.27 |
| Expenses earned, unpaid | 375.00 | |
| Commission earned, unpaid | 525.00 | |
| Accounts payable, unpaid | 414.00 | |
| Road expenses | 144.57 | |
| Reserve for depreciation of furniture and fixtures | 9,995.98 | 10,436.76 |
| Surplus | 36,631.95 | 82,963.47 |
| Reserve for taxes | 26,291.95 | 1,023.71 |
| 250,785.63 | 332,513.77 |
1928 BTA LEXIS 3803">*3810 11 B.T.A. 483">*487 The item of $38,969.58, shown among the assets in the foregoing balance sheet of November 30, 1920, represents an investment in capital stock of the Globe Knitting Works which was purchased as a protective measure against the loss of that company's business when it urged that Robischon be reinstated with the petitioner; the item of $17,520.36 represents miscellaneous accounts receivable; the item of $151,571.23 represents commissions payable to the company by various mills; the item of $1,598.64 represents sums advanced to salesmen for traveling expenses which are applied against their commissions earned; the sum of $81,650 represents notes of the various mills covering commissions earned by the petitioner which were not collectible in cash. The amount of $62,000 shown among the liabilities in the balance sheet represents notes which had been discounted at the banks; of the sum of $52,156.56 shown among the liabilities as accounts payable, $46,000 represented amounts due the mills for samples purchased, and the remainder of that sum represented obligations incurred for current expenses; the sum of $23,933.27 represents commissions due and payable to salesmen for services1928 BTA LEXIS 3803">*3811 rendered.
The respondent has reduced the petitioner's invested capital for the year ended November 30, 1920, by the sum of $1,712.25, representing a pro rata portion of 1919 income and profits taxes.
The petitioner filed a personal service return of income on Form 1065 for the period ended November 30, 1920, but the respondent denied it the right to classification as a personal service corporation under the provisions of section 200 of the Revenue Act of 1918, because he regarded it as a business in which capital was essential, and for the reason that the profits could not be ascribed primarily to the activities of the principal stockholders.
OPINION.
MORRIS: The first allegation of error urged by the petitioner is that the respondent erred in denying the petitioner classification as a personal service corporation as defined in section 200 of the Revenue Act of 1918. That section of the Act provides:
That when used in this title -
* * *
The term "personal service corporation" means a corporation whose income is to be ascribed primarily to the activities of the principal owners or stockholders who are themselves regularly engaged in the active conduct of the affairs1928 BTA LEXIS 3803">*3812 of the corporation and in which capital (whether invested or borrowed) is not a material income-producing factor; but does not include any foreign corporation, nor any corporation 50 per centum or more of whose gross income consists either (1) of gains, profits or income derived from trading as a principal, or (2) of gains, profits, commissions, or other income, derived from a Government contract or contracts made between April 6, 1917, and November 11, 1918, both dates inclusive.
11 B.T.A. 483">*488 Therefore, in order for the petitioner to prevail in this proceeding, the Act must be satisfied in three particulars, viz, the income must be primarily attributable to the activities of the principal stockholders; the principal stockholders must be regularly engaged in the active conduct of its business; and capital must not be a material income-producing factor. The existence of each of those elements is essential to the classification sought by the petitioner. , and 1928 BTA LEXIS 3803">*3813 .
Examining the facts of record with respect to the first test, that is, the ascribability of the income to the activities of the principal stockholders, we find, that, in addition to the stockholders themselves, who were officers, and actively engaged in the business as salesmen in addition to their other duties, the petitioner employed about forty other people, about fifteen of whom were engaged in purely clerical and administrative work, and about twenty-five of whom were salesmen scattered throughout the United States. We find upon examination of the expense schedule appended to the petitioner's tax return for the period ended November 30, 1920, that commissions paid to salesmen for that period amounted to $46,018.50, and that salaries, other than those paid to officers, were $92,862.90, which reveals that the salaries paid to salesmen and employees, other than stockholders, were $87,881.40 greater than the amount paid to said stockholders who claim that the petitioner's income is ascribable primarily to their activities.
With respect to the second test, that is, whether the principal stockholders1928 BTA LEXIS 3803">*3814 are in fact regularly engaged in the active conduct of the business, we find that E. W. Robischon, who held 50 shares of stock, and his wife, Anna M. Robischon, who held 208 shares, during the taxable period under consideration, took no active part in the conduct of the business whatsoever. Therefore, one stockholder, owning 20.8 per cent of the stock, which, in our opinion, made her one of the principal stockholders, took no part in the conduct of the business, and if the Robischon interests are consolidated, the percentage of ownership of nonactive stockholders is increased to 25.8 per cent, leaving stockholders owning only 74.2 per cent engaged in the active conduct of the business.
With respect to the third test, that is, that capital must not be a material income-producing factor, it would seem only necessary to refer to the figures contained in the balance sheet and the expense tabulation set forth hereinbefore in the findings of fact. It is important, however, to observe in this connection, that the commissions earned on sales made by the petitioner in the fall of the year are not collected until eight or nine months thereafter. Considering this fact, together with the1928 BTA LEXIS 3803">*3815 extraordinary large pay roll obligations that 11 B.T.A. 483">*489 must be met in the payment of salesmen and other employees and for the advancement of traveling expenses, it is extremely difficult, if not impossible, to see how it can be successfully maintained that capital is not a material income-producing factor. That these salesmen are responsible for a great portion of the petitioner's income is clear, and that they must be financed and compensated during the interim between the sale of goods and the collection of commissions therefor is equally as clear.
In addition to the other expenditures heretofore referred to, there are such other items as advertising, traveling expenses, selling expenses, and fire insurance, and in the balance sheet there are obligations in the form of bills payable of $62,000, accounts payable of $52,156.56, and commissions due salesmen of $23,933.27, all of which mitigate most strongly against the petitioner's position.
Considering all of the facts of the case, particularly those brought out in our discussion, together with a further important disclosure that the petitioner, in consideration of an amount in addition to its commissions, guaranteed the1928 BTA LEXIS 3803">*3816 collection and payment of accounts due the Augusta Knitting Corporation, we are constrained to hold that the petitioner is not a personal service corporation within the meaning of the Act.
The second allegation of error herein was not urged by the petitioner's counsel either at the hearing or in his brief. Since it does not appear that the adjustment of invested capital complained of violates the provisions of the regulation in force during the period in question, we are of the opinion that section 1207 of the Revenue Act of 1926 is controlling and that the respondent's action should be approved.
Judgment will be entered for the respondent.