*255 Decision will be entered for the respondent.
The petitioner, through its president (who owned 96 per cent of its stock) and a staff of assistants, conducted a flying school. A substantial amount of capital was used to purchase facilities and equipment, including aircraft, required for the school. Held, on the facts, that petitioner is not a personal service corporation as defined in section 725 (a).
*557 The Commissioner determined deficiencies of $ 97.71 and $ 184.03 in declared value excess profits tax and $ 3,622.15 and $ 15,065.52 in excess profits tax for 1941 and 1942, respectively.
The issues are whether the petitioner was entitled to exemption from excess profits tax as a personal service corporation during both years, and, if so entitled, whether it signified its desire to be exempt for 1941, under section 725 of the Internal Revenue Code, as amended.
FINDINGS OF FACT.
The petitioner is an Iowa corporation, doing business near Sioux City, Iowa. It filed its returns with the collector of internal revenue for the district of Iowa.
*256 The petitioner conducted a flying school, which was the principal source of its income during 1941 and 1942. Its president and general manager was E. L. Graham, who had full power to conduct its affairs in any manner he saw fit. He owned 96 per cent of all the capital stock issued by the petitioner and devoted his entire time to its business. The balance of the stock was owned in equal shares by his wife and his brother, who were secretary and vice president, respectively. They had nothing to do with the business affairs or management of the petitioner. None of the employees of the petitioner had anything to do with its management.
*558 Graham had learned to fly and to maintain flying boats in the Navy during World War I. He started flying again in 1927 and thereafter flew with increasing frequency. He was licensed as a commercial pilot. Meanwhile, he had acquired considerable experience in the operation and maintenance of motors used in tractors and trucks, as well as aircraft. Shortly after the civilian pilots' training program was instituted by CAA (the Civil Aeronautics Administration) he was selected to operate a flying school in conjunction with Morningside College, *257 Sioux City, Iowa. The college participated in the ground school phase of the program. Graham opened the flying school in October 1939 and operated that school for profit under contract with CAA. He taught some of the college classes without compensation. The flying school was operated by the petitioner after its incorporation in September 1940.
The petitioner entered into various contracts with CAA for the purpose of giving flight instruction to student pilots assigned by Morningside College. Under the terms of those contracts the petitioner was required to provide a certain ratio of licensed instructors for students, to provide a certain ratio of approved aircraft for students, to maintain equipment and facilities in accordance with prescribed standards, and to furnish dual, check, and solo instruction in accordance with prescribed flight curricula and within specified schedules of flying time. Between 300 and 400 students received instruction in the courses offered by the petitioner during 1941 and 1942. Most of the instruction consisted of a primary and a secondary course. A heavier type of airplane was used in the secondary course. The ratio of primary trainees to secondary*258 trainees was approximately 2 to 1. The petitioner received $ 290, later increased to $ 370, for each student who completed the primary course of 35 to 40 flight hours. It received approximately $ 800 for each student who completed the secondary course of 40 to 50 flight hours. The petitioner also offered courses for training flight instructors, commercial, and cross-country pilots. Compensation for incompleted courses was paid at hourly rates.
Graham was the petitioner's chief instructor and the only flight examiner on its staff. He was designated as a flight examiner by CAA in May 1940, and he also held a certificate for maintenance of aircraft. During 1941 he taught one complete class of apprentice instructors and also one complete class of secondary students. He knew practically all of the students personally. He gave spot checks, flight checks, and final flight tests to many students during 1941 and 1942. He personally flew with and either examined or instructed 90 per cent of all students. The remaining tests were given by representatives of CCA. Graham worked from daylight to dark, usually 7 days a week. He devoted about 70 per cent of his time to instruction, *559 *259 including checks and tests, about 20 per cent to supervision of other instructors, and about 10 per cent to managerial duties. He was assisted by 5 instructors, 3 mechanics, and 2 office employees, who earned $ 24,537.14 in 1941, and by 11 instructors, 4 mechanics, 3 office employees, and 3 guards, who earned $ 45,064.33 in 1942. Graham's salary was $ 3,600 in 1941 and $ 9,600 in 1942.
The petitioner operated its flying school at the Sioux City Municipal Airport, which it leased, until the Army took over that field early in 1942. It then moved to the old Rickenbacker Field, west of Sioux City, which it could not lease but had to purchase for approximately $ 21,000. The initial payment of $ 3,000 was made in cash from accumulated earnings. The petitioner also spent $ 8,000, about half of which it borrowed, for the construction of an administration building, office facilities, repair shops, and hangars. Other capital was used to purchase airplanes, parachutes, and repair parts for training purposes. Depreciation schedules attached to the petitioner's amended income tax returns for 1941 and 1942 show that at the end of 1941 it owned 13 airplanes, which had cost $ 34,960.42, and*260 that at the end of 1942 it owned a total of 26 airplanes, which had cost a total of $ 77,707.80. Except in the case of 5 planes acquired from Graham in exchange for stock, the petitioner purchased its aircraft by making a down payment of 10 per cent from earnings and borrowing the balance of the purchase price from the Reconstruction Finance Corporation, for which the aircraft and the contracts with CAA were used as security. The petitioner rented 2 airplanes for a period of 3 months in 1941.
The cost of fuel and oil used in the type of airplanes owned by the petitioner was $ 1 to $ 1.20 per hour on the smaller planes; gasoline alone for the larger types of planes was $ 10.50 to $ 11 per hour. When those planes were rented on occasion to pilots the petitioner received $ 8 per hour for the smaller planes and $ 15 to $ 18 per hour for the larger planes, which included the cost of fuel and oil. The petitioner reported in its amended income tax returns that the cost of plane operation and maintenance was $ 16,806.63 in 1941 and $ 23,192.12 in 1942.
The capital stock of the petitioner had a book value of $ 8,453. That amount represents the stipulated value of personal property furnished*261 by Graham at the time of incorporation in exchange for all of the stock. The petitioner had accumulated earnings as follows: $ 917.96 at January 1, 1941, $ 13,602.41 at January 1, 1942, and $ 20,728.77 at December 31, 1942. The average borrowed capital of the petitioner was $ 8,742.67 in 1941 and $ 34,399.34 in 1942. The entire capital for the taxable years under consideration was used to purchase facilities and equipment to conduct the flying school.
The petitioner's amended income tax returns for 1941 and 1942 contained balance sheets as of the end of those years as follows: *560
| Dec. 31, 1941 | Dec. 31, 1942 | |
| ASSETS | ||
| Cash | $ 7,363.38 | $ 1,191.46 |
| Notes and accounts receivable | 11,958.78 | 48,898.05 |
| Inventories | 384.34 | 844.83 |
| Deposit on airplane | 125.00 | 390.00 |
| Furniture, equipment (including airplanes and | ||
| parachutes) less depreciation | 34,689.50 | 97,910.82 |
| Prepaid expenses | 2,590.77 | 6,459.35 |
| Total | 57,111.77 | 155,694.51 |
| LIABILITIES | ||
| Accounts payable | 2,366.77 | 14,028.06 |
| Bonds, notes, and mortgages payable | 17,478.70 | 77,798.73 |
| Accrued taxes | 6,249.06 | 18,184.50 |
| Other liabilities | 1,362.37 | |
| Surplus reserves | 2,427.35 | 2,427.35 |
| Capital stock | 8,453.00 | 8,453.00 |
| Earned surplus and undivided profits | 18,774.52 | 34,802.87 |
| Total | 57,111.77 | 155,694.51 |
*262 The petitioner received $ 75,729.17 in 1941 and $ 137,504.96 in 1942 as compensation from all sources for flight instruction. It derived additional income of $ 4,176.63 in 1941 and $ 2,711.73 in 1942 from charter flights, the storage and repair of private planes, and miscellaneous sales and services. The petitioner has not contested determinations of the Commissioner which held that its net income for 1941 was $ 22,530.19 and that its net income for 1942 was $ 24,880.08.
The petitioner failed to signify its desire to be exempt from excess profits tax as a personal service corporation on its original 1941 income tax return and it filed an excess profits tax return. An amended 1941 income tax return was filed on or about March 15, 1944, to which was attached a personal service corporation return of income (undistributed Supplement S net income). An amended excess profits tax return was filed on or after May 29, 1944, in which it was stated that petitioner was not subject to excess profits tax.
The stipulation of facts is incorporated in its entirety by reference.
OPINION.
The main question for decision is whether the petitioner is a personal service corporation within section 725*263 (a) of the Internal Revenue Code. 1
*561 The respondent concedes that*264 the petitioner has met all of the statutory conditions for qualification, except the following:
1. That the petitioner's "income is to be ascribed primarily to the activities of shareholders who are regularly engaged in the active conduct of the affairs of the corporation," and
2. That the petitioner's "capital is not a material income-producing factor." (Italics supplied.)
Similar conditions were provided in the sections of former revenue acts relating to personal service corporations. 2 Then, as now, Congress employed words of degree which required further definition by the courts according to the facts of each case. It is hard to reconcile many of the former decisions. See William A. Brady Theatre Co. v. Commissioner, 42 Fed. (2d) 181. For present purposes the apparent conflict in those precedents may be illustrated by reference to four decisions of the Circuit Courts of Appeal, each involving a corporation which conducted a school. In Shipley School v. McCaughn, 34 Fed. (2d) 281, and Strayer's Business College v. Commissioner, 35 Fed. (2d) 426, cited by the petitioner, *265 the taxpayers succeeded; in Metropolitan Business College v. Blair, 24 Fed. (2d) 176, and Atlanta-Southern Dental College v. Commissioner, 50 Fed. (2d) 34, cited by the respondent, the taxpayers failed to qualify as personal service corporations. In each of these cases the stockholders were assisted by other teachers and capital was invested in school equipment. The differences between these cases were differences in degree. For example, in the first two cases the amount of capital was $ 25,000 or less; in the latter two cases the capital was about $ 100,000. It is to be noted, however, that the decisions in the first two cases did not consider the school quarters, which were leased, as being part of the capital involved. We have recently held that a valuable leasehold constitutes capital within the meaning of section 725(a). Fairfax Mutual Wood Products Co., 5 T. C. 1279. See William A. Brady Theatre Co. v. Commissioner, supra.
*266 In another line of cases the decisions turned upon the percentage ratio of gross income derived from capital to the total gross income of the taxpayers. In Edward P. Allison Co. v. Commissioner, 63 Fed. (2d) 553, 558, which is typical, it was said of those cases:
It is apparent that no definite percentage ratio of gross income derived from capital sources to total gross income can be fixed as the exact point at which capital becomes a material income-producing factor. The contribution of capital to income is a matter largely of approximation. The way in which capital *562 makes its contribution is important. If utilized in the form of salaries, wages, office rent, etc., it does not make it a material income-producing factor, even though such expenditures are usually essential to the production of income. * * *
When the use of capital goes further and gives character to a sizable portion of the operations of the corporation, the percentage of gross income directly attributable to capital sources required to render capital a material income-producing factor need not be very great.
The petitioner in the present case has not afforded us with*267 any break-down of the income derived from its capital. We do not know that it could have done so. Yet there is ample evidence that capital was an income-producing factor in its business. We think that the petitioner has failed to show that it was not a material factor.
The petitioner's stock, its mean accumulated earnings, and its average borrowed capital were not less than $ 24,000 in 1941 and $ 60,000 in 1942, all of which was invested in facilities and equipment for its flying school. During 1941 it occupied leased quarters. The petitioner's balance sheets show even greater invested and borrowed capital at the end of those years. They also show that it had assets consisting of "furniture, equipment (including airplanes and parachutes) less depreciation" of $ 34,689.50 at the end of 1941 and $ 97,910.82 at the end of 1942. The petitioner owned 13 airplanes at the end of 1941 and it purchased 13 additional planes during 1942. The undepreciated cost of the 26 planes was $ 77,707.80. The petitioner could not have operated its flying school without such equipment.
In the case of Atlanta-Southern Dental College, supra, emphasis was given to*268 the large amount of the capital investment, there $ 100,000. It was said in part (p. 37) that:
* * * As to the tuition fees, it is perfectly plain that they were earned and produced by the use of a plant and equipment without which, no matter how eloquent the teaching of the stockholding professors might have been, no matter how magnetic the influence and drawing capacity of the stockholders, no single student could have been drawn to the school, or if drawn, kept, and instructed there.
In the present case the tuition fees were even more directly related to the use of the petitioner's equipment. The petitioner was compensated for the use, as well as for instruction in the use, of airplanes on the basis of flight time. For example, the evidence includes a typical contract with CAA under which the petitioner had to provide 2 approved airplanes for the first 10 students and 1 additional plane for each additional 10 students. Under that contract the flight instruction consisted of not less than 35 hours of flying time, of which a minimum of 13 1/2 hours was solo. The petitioner was compensated in installments upon the completion of scheduled stages of flight time. If any student*269 failed to complete the course, the petitioner *563 received payment at hourly rates, not exceeding the aggregate installment for each stage. Thus, the income was earned in large part by the use of the airplanes in which it had invested substantial capital.
On these facts we hold that the petitioner's capital was a material income-producing factor during 1941 and 1942. In so holding it is unnecessary to determine whether the other provisions of the statute have been met. The Commissioner correctly determined that the petitioner was not a personal service corporation within section 725(a).
Decision will be entered for the respondent.
Footnotes
1. SEC. 725. PERSONAL SERVICE CORPORATIONS. [As added by section 201 of the Second Revenue Act of 1940.]
(a) Definition. -- As used in this subchapter, the term "personal service corporation" means a corporation whose income is to be ascribed primarily to the activities of shareholders who are regularly engaged in the active conduct of the affairs of the corporation and are the owners at all times during the taxable year of at least 70 per centum in value of each class of stock of the corporation, and in which capital 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 of gains, profits, or income derived from trading as a principal. For the purposes of this subsection, an individual shall be considered as owning, at any time, the stock owned at such time by his spouse or minor child or by any guardian or trustee representing them.↩
2. Section 200 of both the Revenue Acts of 1918 and 1921 provided in part that: "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 affairs of the corporation and in which capital (whether invested or borrowed) is not a material income-producing factor * * *."↩