1928 BTA LEXIS 4071">*4071 Petitioner held entitled to personal service classification.
10 B.T.A. 565">*565 Respondent has determined deficiencies in income and profits taxes for the calendar years 1919 and 1921 in the amounts of $2,081.91 and $3,037.45, respectively. Petitioner claims personal service classification.
FINDINGS OF FACT.
Petitioner is an Oregon corporation, conducting the business of an advertising agency, and has its principal office at Portland. It was incorporated in 1918 with a capital stock of $25,000. At the same time its incorporators organized a Washington corporation with a 10 B.T.A. 565">*566 like capitalization and having an office at Seattle. The two corporations were merged in 1919 and the capital stock of the Oregon corporation was increased to $50,000. The deficiency for 1919 was computed on the consolidated net income and invested capital of the two companies.
In 1919 Messrs. Botsford, Constantine, and Tyler each owned one-third of the capital stock of the companies, with the exception of qualifying shares.
In 19211928 BTA LEXIS 4071">*4072 Tyler retired from the business, and thereafter Botsford and Constantine owned all the stock in equal shares and on July 9 of that year the name of the corporation was changed to Botsford-Constantine Co. Each had had previous experience in advertising work, Constantine having been engaged in that field since 1906 and Botsford since 1908. Constantine was in charge of the Seattle company and Botsford managed the one in Portland. Tyler was president of the companies and divided his time between the two until 1920, when a San Francisco branch was opened and he was placed in charge of that office. These principal stockholders were regularly engaged in the active conduct of the affairs of the petitioner.
All of petitioner's advertising accounts came to it through the efforts of the principal stockholders. Petitioner employed no solicitors of accounts. On learning of a prospective advertiser, one of the stockholders would get in touch with the prospect with a view to securing the account. When a contract was made the stockholder representative of the petitioner would make a study of the advertiser's product to determine how it could best be advertised. After deciding upon a plan1928 BTA LEXIS 4071">*4073 of advertising, the size of the advertisements, and the media to be used, all of which duties were performed by one of the principal stockholders, the plan would be submitted to the advertiser with an estimate of the cost. If the plan was approved by the advertiser, space in the medium selected was ordered by an order clerk employed by the petitioner. Thereafter petitioner kept in touch with the advertiser through one of the stockholders or through its so-called account executives, who called on the advertisers, but the latter always consulted one of the three principal stockholders in regard to any work to be done for an advertiser. The details of advertisements were worked out between a stockholder and the account executive, and when illustrations were needed they were ordered from an artist capable of executing well the particular kind of drawing wanted. When the details were completed the case was turned over the petitioner's production man, who procured engravings and had the type set.
Space for running advertisements was ordered from publishers in the name of the advertisers and not petitioner's name. In giving 10 B.T.A. 565">*567 orders for space petitioner used an order form1928 BTA LEXIS 4071">*4074 which set forth, among other things, the name of the advertiser, the date or dates on which the advertisement was to run, the position to be given the advertisement, and the gross rate for the space ordered.
Petitioner's income consisted of fees and commissions. In some cases where the amount of advertising was small petitioner received a fee for handling the work. Where it was necessary to employ an artist or have some special work produced by some one outside of petitioner's staff, the cost of such work, plus a commission of 15 per cent, was charged to the advertiser. The greatest part of the income was from commissions of 13 per cent to 15 per cent, allowed to petitioner by publishers, figured on the cost of the advertising to the advertiser. Some publishers also allowed a discount of 2 per cent to 3 per cent for prompt payment, which, in most cases, was passed along by petitioner to the advertiser.
It was the practice of publishers to bill petitioner for the gross cost of the advertising run for its clients, and in practically all cases the name of the advertiser was mentioned in the bill. The petitioner usually billed the advertiser and received payment, except for1928 BTA LEXIS 4071">*4075 a small part of the business, in advance of the date payment was due the publisher, and where payment was made promptly by the advertiser, petitioner was able to use such funds to meet publishers' bills. In case of small amounts unpaid by advertisers at the due date, petitioner paid the publisher from its own funds. In other cases petitioner secured from advertisers trade acceptances or notes, some of which were discounted at its bank. The amount of the notes and acceptances taken in 1919 is not shown. In 1921 petitioner took trade acceptances in the aggregate amount of $113,869.57. Those discounted at periods ranging from 10 days to 70 days in advance of the due date aggregated $26,710.92. The balance were deposited for collection, with the exception of two, aggregating $1,846.80 which were marked "Held" and were taken up by notes, and one in the amount of $600 for which a note was given.
During the taxable years petitioner's borrowings on notes were as follows:
| Date | Paid | Amount | |
| of note | |||
| 1919 | |||
| January 8 | February 6 | $1,000 | |
| February 6 | February 19 | 2,000 | |
| March 8 | March 26 | 2,000 | |
| August 2 | October 2 | 2,000 | |
| 1921 | |||
| January 31 | February 17 | $100 | 500 |
| March 19 | 100 | ||
| April 19 | 100 | ||
| May | 100 | ||
| June 19 | 100 | ||
| 1921 | |||
| February 9 | February 24 | $3,000 | |
| March 3 | March 21 | 5,000 | |
| April 1 | April 26 | 4,000 | |
| May 31 | June 22 | 5,000 | |
| June 30 | July 20 | 2,500 | |
| September 28 | October 27 | 5,000 | |
| September 30 | October 3 | 3,000 | |
| October 29 | November 28 | 5,000 | |
| December 5 | December 27 | 5,000 |
1928 BTA LEXIS 4071">*4076 10 B.T.A. 565">*568 When the corporations were organized, Botsford, Constantine, and Tyler each paid in $1,000 in cash to each company. The balance of the capital stock was issued for the good will built up by the three men through their years of experience and contracts with advertisers. They had a few so-called contracts with advertisers which were subject to cancellation by the advertisers at any time upon short notice. The combined balance sheet of the two corporations as of the close of 1918 and 1919 is as follows:
| Dec. 31, 1918 | Dec. 31, 1919 | Average | |
| ASSETS | |||
| Contracts (good will capitalized) | $45,346.50 | $45,346.50 | $45,346.50 |
| Furniture and fixtures | 1,731.56 | 3,442.16 | 2,586.86 |
| Liberty bonds | 750.00 | 1,505.35 | 1,126.68 |
| Petty cash | 1.68 | 1.51 | 1.59 |
| Accounts receivable | 28,954.50 | 37,676.50 | 33,315.42 |
| Notes receivable | 522.00 | 261.00 | |
| Trade acceptances | 749.91 | 26,543.70 | 13,646.80 |
| Suspense | 54.32 | 1,271.50 | 662.91 |
| 78,110.47 | 115,785.06 | 96,947.76 | |
| LIABILITIES | |||
| Capital stock | 50,000.00 | 50,000.00 | 50,000.00 |
| Cash | 4,309.58 | 2,079.44 | 3,194.51 |
| Notes payable | 5,000.00 | 6,370.23 | 5,685.11 |
| Accounts payable | 4,914.57 | 2,457.29 | |
| Space accounts | 11,170.71 | 45,397.93 | 28,284.32 |
| Unearned commission | 1,744.00 | 872.00 | |
| Due to clients | 126.13 | 63.06 | |
| Surplus | 2,715.61 | 10,067.33 | 6,391.47 |
| 78,110.47 | 115,785.06 | 96,947.76 |
1928 BTA LEXIS 4071">*4077 Petitioner's balance sheet at the close of the years 1920 and 1921 is as follows:
| Dec. 31, 1920 | Dec. 31, 1921 | Average | |
| ASSETS | |||
| Cash | $807.79 | $3,010.81 | $1,909.30 |
| Accounts receivable, clients | 48,011.46 | 47,957.32 | 47,984.39 |
| Accounts receivable, interest | 4.33 | 2.16 | |
| Trade acceptances (clients) | 4,000.00 | 11,931.36 | 47,965.68 |
| Stock | 40.00 | 540.00 | 290.00 |
| Suspense | 389.68 | 312.50 | 351.09 |
| Furniture and fixtures | 4,891.37 | 4,256.51 | 4,573.94 |
| Contracts (good will capitalized) | 45,346.50 | 45,346.50 | 45,346.50 |
| Customer liabilities | 5,913.87 | 2,596.94 | |
| 109,405.00 | 113,355.00 | 111,380.00 | |
| LIABILITIES | |||
| Capital stock | $50,000.00 | $50,000.00 | $50,000.00 |
| Surplus | 7,660.19 | 17,600.29 | 12,630.24 |
| Bills payable (to bank) | 4,000.00 | 2,000.00 | |
| Sundries | 14,905.55 | 12,259.17 | 13,582.36 |
| Space (accounts payable) | 26,925.39 | 31,824.63 | 29,375.01 |
| Trade acceptances discounted | 5,913.87 | 2,956.93 | |
| Reserve for contingent liability | 1,670.91 | 835.46 | |
| 109,405.00 | 113,355.00 | 111,380.00 |
For the taxable years petitioner charged off as bad debts the amounts, and with the explanations, as follows:
| 1919 | |
| Client refused payment | $140.00 |
| 1921 | |
| Phez Company | $2,868.76 |
| Washington Tire & Rubber Co | 310.50 |
| Western Industrial Chemical Co | 66.03 |
| Norman Waterhouse | 42.16 |
| Woodtite Laboratories | 6.65 |
| Total for 1921 | 3,294.10 |
1928 BTA LEXIS 4071">*4078 10 B.T.A. 565">*569 The Phez Company item was for advertising placed with the Saturday Evening Post, published by the Curtis Publishing Co. That company refused to accept advertisements unless it was assured of payment at the time it went to press, which was two months before the date of issue. When it appeared that the Phez Company was likely to be delinquent in the payment of this item, a conference was held in petitioner's office between representatives of the Curtis Publishing Co., the petitioner, and the Phez Company. The Curtis representative demanded that the Phez Company pay the account; he made no demand upon petitioner. The account was, however, paid by petitioner, and the Phez Company gave petitioner warehouse receipts as collateral security and subsequently paid the account in full. Of the Washington Tire & Rubber Co. account only a small part represented a charge for advertising space, the balance being charged for a survey of that company's business made by petitioner.
Petitioner was granted recognition by various publishers' associations, including the American Newspaper Publishers' Association, the Periodical Publishers' Association, and the Agricultural Publishers' 1928 BTA LEXIS 4071">*4079 Association. Recognition as an advertising agency was also granted it by the Curtis Publishing Co. by an instrument dated August 26, 1921, containing the terms upon which the Curtis Company would accept advertising from petitioner. The gross advertising placed by petitioner in 1921 amounted to $528,267.69, of which $103,230 represented advertising placed with the Curtis publications.
For the taxable years the income of the companies as reported in their returns and the deductions claimed for salaries were as follows:
| Washington corporation | Oregon corporation | Petitioner | |
| 1919 | |||
| Income from commissions and service | $21,859.85 | $43,017.88 | |
| Officers salaries | 9,600.00 | 11,555.00 | |
| Other salaries | (Not shown) | 8,794.31 | |
| 1921 | |||
| Gross income | $75,999.71 | ||
| Stockholders salaries: | |||
| C. P. Constantine | 7,800.00 | ||
| D. M. Botsford | 7,800.00 | ||
| Officers' salaries (other than stockholders) | 6,509.00 | ||
| Employees' salaries | 19,171.00 |
10 B.T.A. 565">*570 Among the nonstockholder employees of the corporations were the following:
| Name | Designation | Monthly salary |
| Booth | Account executive or contact man | $500 |
| Brunn | Copywriter | 300 |
| Sieck | Account executive | 350 |
| Milne | Production Manager | 300 |
| Stowell | Copywriter | 200 |
| Balckington | Bookkeeper | Not stated |
| Pearson | Account executive or contact man | 500 |
| Shiffer | Art director | 400 |
| Kraft | Copywriter | Not stated |
| Manly | Advertising writer and contact man | Not stated |
| Botsford | Copywriter | Not stated |
| Mr. and Mrs. Clark | Artists | Piece-work basis |
1928 BTA LEXIS 4071">*4080 Each office had also at least one stenographer and from one to four clerks. These employees were not all employed at any one time. The list includes some who served only a short time.
The duties of the account executives or contact men were to keep in touch with petitioner's clients and go over the details of their advertising with them. The copywriter prepared the copy that was to go into advertisements from the plans advanced by others, and at times originated and developed advertising ideas. The production manager performed various duties, including handling office details, preparation of accounting statement, and some service work on advertising.
OPINION.
ARUNDELL: Although for the year 1919 there are two corporations here involved, the one having its offices at Seattle, Wash., was virtually only a branch of the one at Portland, Oreg., and the Commissioner, in determining the deficiency for 1919, has consolidated them. In 1921 there was only the Oregon Company, whose capital had been increased, and which had absorbed the other. For convenience in discussion we shall consider the corporations as one and speak of them collectively as the petitioner.
1928 BTA LEXIS 4071">*4081 The tests that a corporation claiming personal service classification must meet are set out in the well considered case of , as follows: (1) It must be engaged in rendering personal service as distinguished from trading, merchandising or manufacturing; (2) its income must be primarily due to the activities of the principal stockholders; (3) the principal stockholders or owners must themselves be regularly engaged in the active conduct of the affairs of the corporation; and (4) capital whether invested or borrowed may not be a material income-producing factor.
We have found as a fact in this case that the three men who held all the stock in 1919 and the two who owned it all in 1921, except 10 B.T.A. 565">*571 qualifying shares, were regularly engaged in the active conduct of petitioner's affairs; likewise, it is clear that petitioner's income was not derived from "trading, merchandising or manufacturing." These elements may therefore be eliminated in petitioner's favor from further consideration.
We find much more troublesome the second test enumerated above, viz: Is the income of petitioner to "be ascribed primarily to the1928 BTA LEXIS 4071">*4082 activities of the principal owners or stockholders"? It is clearly in evidence that the business of petitioner which resulted in income had its inception in contacts made by some one of the principal stockholders; that the stockholders secured all contracts for the placing of advertising and that after the business had been secured, the activities of the stockholders did not cease, but were continued through contact with the advertisers. The employees of petitioner never solicited or obtained any accounts. The list of employees set out in the findings of fact is misleading in that the employees there listed were not all in petitioner's employ at one time. The list includes those who were employed at any time, some of them being engaged during only part of the taxable years. This is the testimony of one of the principal stockholders and it is corroborated by the salary figures. Nor can a proper conception of the duties of the employees be had from the titles set out. They had no creative duties; they came into petitioner's scheme of operation only after an income-producing account had been obtained and the income-producing idea conceived by one of the principal stockholders; their1928 BTA LEXIS 4071">*4083 duties were purely routine and they were employed by petitioner only because the principal stockholders did not have the time to devote to office details and routine matters. The large amount of advertising which petitioner placed during the taxable years resulted from the recognized ability of the stockholders to handle advertising satisfactorily and not because of the number of employees it had. While the employees perhaps were the means of petitioner placing more advertising than would be possible were the stockholders required to handle all office details, this does not destroy the fact that the business was secured by the stockholders and the income was primarily due to their activities. It was to them that advertisers looked for service and it was for their services that the advertisers paid. The petitioner could not function without the stockholders, whereas the employees were not an indispensable factor. We do not attempt to say that petitioner's income was due solely to the activities of the stockholders. It is not necessary to go to that extent as all that the law requires is that it be primarily attributable to their activities. 1928 BTA LEXIS 4071">*4084 . In the case of , personal service classification was denied partly on the ground that there was no evidence as to the character 10 B.T.A. 565">*572 of the services performed by a large group of nonstockholder employees. Such is not the case here, for the evidence fully described their duties and is convincing that no material part of petitioner's income may be ascribed to their activities. The opinion in , is singularly apt on this phase of the case. We quote from it as a proper conclusion in this case:
On the whole, it must be found that the employees to whom these salaries were paid were clerks and assistants, such as are found in every law office and whose work bore no material relation to the needs of the business either as a business getter or as a directing head.
Finally, there is a question of whether capital was a material income-producing factor. We have found as a fact that, except for a small part of the advertising placed, petitioner was paid by the advertiser for space used before payment1928 BTA LEXIS 4071">*4085 was due the publisher. In all of those cases petitioner had no need for, and did not use its capital. We gather from the record, although not clearly shown, that petitioner was not primarily liable to publishers for the value of the space. Regardless of its legal liability, the fact is that in the majority of its accounts petitioner was not called on to use its capital. The actual method of operation and not the theoretical or legal liability is what controls. ; . The only cash capital paid in was $3,000. For the balance of the capital stock issued, the three principal stockholders paid in furniture and fixtures and the good will of advertisers that they had built up through their personal handling of advertising. The stockholders had very few actual contracts with advertisers and such as they did have were subject to cancellation on short notice. For the most part the so-called good will shown in the balance sheet consisted merely of an understanding between the advertiser and the stockholder that the latter would handle the advertising matter of his client.
1928 BTA LEXIS 4071">*4086 The borrowings of petitioner from its bank are set forth in detail to show the small amount as compared to the volume of business transacted. The maximum borrowed at any time was $8,000 and the average amount of the borrowings was only $2,326.21. It is evident that no material part of income could have been derived from these short-time loans.
For the year 1919 the excess of petitioner's accounts receivable and trade acceptances over the accounts payable for space averaged $18,939.90. Deducting from this the 15 per cent commission leaves an excess of $11,856.27. The advertising space for that year amounted to about $442,000 and the gross income was $66,141.19. For 1921 the average of receivable and trade acceptances exceeded the average of space accounts payable by $26,575.06. Commissions deducted from 10 B.T.A. 565">*573 the receivables leave an average excess of $18,182.56. For that year petitioner placed advertising in the amount of $528,267.69 and had a gross income of $75,999.71. From these figures it is clear that even if all the excess of receivables over payables be considered as capital it was not sufficient to play any material part in the production of the gross income, 1928 BTA LEXIS 4071">*4087 which we have held in , is the income referred to in the statute. In the case of , where personal service was allowed, the evidence indicated the use of from $10,000 to $20,000 in a business which placed $200,000 in advertising. The average capital in this case compared to gross income and advertising placed is less than that in the Conover case, and capital was not, in our opinion, a material income-producing factor.
Reviewed by the Board.
Judgment will be entered for the petitioner.