*1956 1. During 1920 and 1921 petitioner was engaged in the business of electrical construction as an independent contractor, and considerable amounts of capital were necessarily used in fulfilling such contracts. It also carried on purely supervisory work, under separate contracts, in which capital was not a material income-producing factor. More than 50 per centum of its gross income was derived from the line of business first mentioned. Held, petitioner was not entitled to classification as a personal service corporation.
2. Petitioner's capital stock was owned by three persons, only one of whom, owning 40 per cent of the stock, was regularly engaged in the active conduct of that branch of the petitioner's business, which was purely supervisory and employed no capital as a material income-producing factor. Held, petitioner was not entitled to the benefits of section 303 of the Revenue Act of 1918 in computing its excess profits taxes for 1920 and 1921.
*1372 This is a proceeding for the redetermination*1957 of deficiencies in income and excess profits taxes, asserted by the respondent, which amounted to $9,424.84 for the year 1920, and to $9,111.95 for the year 1921. The error alleged is that respondent failed to tax petitioner's income as personal service income.
FINDINGS OF FACT.
The petitioner is a corporation, organized in 1902 under the laws of Missouri. It is located and has its principal place of business in St. Louis. During the years involved the petitioner's capital stock was owned and held as follows:
| Per cent | |
| E. P. Allison | 32.73 |
| Mrs. M. D. Allison | 27.27 |
| C. F. Crowley | 40 |
Prior to 1919 the petitioner's sole business was that of general electrical construction, as an independent contractor. During 1920 and 1921 it continued that line of business, and in addition it also rendered services in supervising electrical construction work which was done either by the owner or by a general contractor.
In the electrical contracting branch, in some instances, the business was obtained*1958 through successful bidding in the open market; in others, it was taken on a cost-plus contract. Under either method the petitioner furnished the necessary electrical appliances, supplied the labor, and did, or caused to be done, all things necessary to install the electrical appliances according to the terms of the contracts. The difference between the contract price to be paid to the petitioner and the cost of installing the work determined the profit or loss to petitioner.
In its work of supervision only, the petitioner operated under the terms of eight written agreements, which required the petitioner to commence work at once upon the execution of the agreements, to place orders at once for all necessary materials, and to maintain a sufficient force of men and materials to expedite said work; the agreements also required petitioner to contract in its own name for all materials, labor and other expense items. Under one of the agreements the petitioner was supplied in advance with money to pay for materials, supplies and labor; but in all other instances *1373 petitioner made such payments out of its own funds and was reimbursed, usually on the same day it paid the bills, *1959 or on the following day. The work of securing the supervision agreements was done by E. P. Allison, five of such agreements being thus secured in 1919 and three in 1920. Allison devoted less than 15 per cent of his time, in 1920, to work required by these agreements; in 1921 about 5 per cent of his time was so employed. Crowley devoted 95 per cent of his time in 1920 to the work under the supervision contracts, and his salary for that year was paid by the persons for whom the supervisory work was performed. In 1921 the work of supervision was nearly completed and Crowley devoted to it only about 15 per cent of his time and received his salary from the petitioner. The time of both Allison and Crowley, when not devoted to the supervisory work, was devoted to petitioner's business of electrical construction.
The petitioner maintained an office organization, both in St. Louis and in Chicago, primarily for the purpose of its electrical construction business. Whenever necessary, however, those organizations rendered services in respect of the work under the supervision agreements, but such services required only a small proportion of the time of the office force.
The petitioner's*1960 gross income for the year 1920 amounted to $461,317.01. Of this total, $428,233.13 was derived from electrical construction business, $32,644.95 from commissions for supervisory work, and $438.93 from interest. Its expenses for the year amounted to $427,811.93, the principal items of which were: cost of materials used, $186,972.35; labor, $172,081.67; St. Louis office, $9,512.75; Chicago office, $16,127.16; salaries of officers, $10,300. Net taxable income for the year, less $214.62 derived from interest exempt from income tax, amounted to $36,457.49, of which approximately 89 per cent was derived from the purely supervisory work.
For the year 1921 the gross income amounted to $332,268.95, of which $301,336.96 was derived from electrical construction business, $30,055.67 from commissions for supervisory work, and $876.32 from interest. Expenses for the year amounted to $295,470.76, the principal items being: cost of materials used, $107,577.57; labor, $96,616.41; salaries of officers, $18,666.66. Net taxable income for the year, less $215.22 derived from interest exempt from income tax, amounted to $37,641.76, of which approximatelu 79 per cent was derived from the purely supervisory*1961 work. In each year the items "cost of materials used" and "labor," represent expenses incurred in connection with petitioner's electrical construction business, and have no relation to the petitioner's supervisory work. The other items represent general expenses, not directly resulting from nor allocable to either branch of petitioner's work.
*1374 The petitioner claimed classification for the years 1920 and 1921 as a personal service corporation. Upon audit, the respondent refused to allow such classification.
OPINION.
MARQUETTE: A personal service corporation is defined by section 200 of the Revenue Act of 1918 as one:
* * * 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; but does not include * * * any corporation 50 per centum or more of whose gross income consists * * * of gains, profits or income derived from trading as a principal * * *.
In order to become entitled to classification as a personal service corporation, *1962 therefore, it is requisite that the petitioner meet each and all of the requirements set out in the statute above quoted. Robischon & Peckham Co.,11 B.T.A. 483">11 B.T.A. 483.
The evidence shows that in the year 1920 the petitioner's gross income amounted to $461,317.01, of which $428,233.13 was derived from the business of independent contracting for electrical construction work. It also shows that in 1921 the petitioner's gross income amounted to $332,268.95, of which $301,336.96 was likewise derived from the independent contracting business. Some of the construction contracts were obtained by successful competitive bidding in the open market, while others were taken on the cost-plus basis. But regardless of the character of the contracts as to the basis on which payment was to be made, in fulfilling them it was necessary for the petitioner to use considerable amounts of capital. Thus, in 1920, the cost of material furnished by the petitioner in its construction contracts amounted to $186,972.35 and its labor costs were $172,081.67. In 1921 the cost of materials furnished amounted to $107,577.57 and labor costs were $98,616.41. That the use of capital in connection with*1963 the fulfillment of those contracts was a material income-producing factor is, in our opinion, beyond doubt, and the petitioner is not entitled to personal service classification. See Thompson & Binger, Inc.,1 B.T.A. 1093">1 B.T.A. 1093.
One other question is involved in this proceeding, namely, whether the petitionfr is entitled to have its excess profits taxes computed under section 303 of the Revenue Act of 1918. That section reads as follows:
SEC. 303. That if part of the net income of a corporation is derived (1) from a trade or business (or a branch of a trade or business) in which the employment of capital is necessary, and (2) a part (constituting not less than 30 per centum of its total net income) is derived from a separate trade or *1375 business (or a distinctly separate branch of the trade or business) which if constituting the sole trade or business would bring it within the class of "personal service corporations," then (under regulations prescribed by the Commissioner with the approval of the Secretary) the tax upon the first part of such net income shall be separately computed (allowing in such computation only the same proportionate part of the credits*1964 authorized in sections 311 and 312), and the tax upon the second part shall be the same percentage thereof as the tax so computed upon the first part is of such first part: Provided, That the tax upon such second part shall in no case be less than 20 per centum thereof, unless the tax upon the entire net income, if computed without benefit of this section, would constitute less than 20 per centum of such entire net income, in which event the tax shall be determined upon the entire net income, without reference to this section, as other taxes are determined under this title. The total tax computed under this section shall be subject to the limitations provided in section 302.
From the evidence it appears that during each of the years here involved the petitioner carried on two classes of work: (1) that of an independent contractor; and (2) that of supervising electrical construction and installation, not requiring the use of capital by the petitioner, and for which the petitioner received for its service either a fixed monthly fee, or a commission. It also appears that in 1920 the petitioner received for its purely supervisory work, $32,644.95 and that its total taxable net*1965 income for the year amounted to $36,457.49. In 1921 it received for supervisory work $30,055.67, while its total taxable net income amounted to $37,641.76. The supervisory work, then, contributed about 89 per cent of the net income for 1920, and about 79 per cent for the year 1921. If such supervisory work constituted a separate branch of petitioner's trade, which if constituting the sole trade or business would bring the petitioner within the class of personal service corporations, then under the statute the petitioner's excess profits taxes are to be computed in accordance with the provisions of section 303.
In order to qualify for such computation of excess profits taxes the petitioner must show that, considering its purely supervisory work to be its only business, (1) the income from such work is ascribable primarily to the activities of the principal owners or stockholders; (2) that such principal stockholders were themselves regularly engaged in the active conduct of petitioner's affairs, and (3) that capital was not a material income-producing factor.
With respect to the one question of petitioner's right to tax computation under section 303, the second requirement*1966 set forth above must be taken to mean that the principal stockholders were regularly engaged in the active work of carrying out the contracts for supervision only.
The evidence shows that Mrs. Allison owned 27.27 per cent of petitioner's stock and that she contributed no services of any character to the company's affairs, either in 1920 or 1921, and shows *1376 that E. P. Allison owned 32.73 per cent of the stock. He testified with respect to the contracts for supervisory work as follows:
Q. Now, Mr. Allison, you testified you rendered approximately fifteen per cent. of your time to services in connection with these contracts in 1920, didn't you?
A. Yes, sir.Q. You do not think any part of your time should have been charged to these eight contracts?
A. No, sir; I do not. Q. What should it have been charged to? A. None of it.Q. All charged to the straight contracting business, is that correct?
A. Yes, sir. Q. What was the basis for that statement?A. Because my time was not specific time spent, but it was simply for the purpose of advising or in negotiating or closing the contract. In other words, my time was not applied on those*1967 personal service contracts as Mr. Crowley's time was applied. His was in active construction on engineering and supervising construction work. My time was spent as I came in contact with them in investigating or in checking the business as a whole.
Q. And you still believe that you spent approximately 15 per cent. of your time in 1920 in connection with the work on these eight contracts?
A. I would not take oath on that, but I would say to the best of my knowledge and belief. If I were to get down to an oath I would say five to seven per cent. and not over 15 per cent.
Q. But not over 15? A. Not over 15 per cent.Q. From five to seven to fifteen per cent. of your time was devoted to these eight contracts in the yfar 1920, is that correct?
A. Yes, sir. I have a hard time to establish that fact, because my time was spent in a general way, not a specific part of my time.
Q. But you are willing to testify it was not in excess of 15 per cent. is that correct?
A. Yes, sir.Q. You feel that none of your salary should be charged to the expenses of these eight contracts now in question?
A. Yes, sir, that is correct, because that is a fact. You might*1968 qualify that in this way, because of the fact that it was not the intent of the contracts that my time should be charged against them. It was not the intent of the contracts that I was to devote my personal time to those contracts.
Q. Whose time was to be devoted to them? A. Mr. Crowley's.Q. And therefore you intended Mr. Crowley to devote his time to the performance thereof and not your time?
A. That is correct.Q. And for that reason you think none of your time should be charged to these eight contracts?
A. Yes, sir.It also appears from the evidence that Crowley, who owned the remaining 40 per cent of the stock, devoted 95 per cent of his time in 1920 and 15 per cent of his time in 1921 to the work under the supervisory contracts.
*1377 It is apparent, we think, that such time and attention as was devoted to the supervisory work by E. P. Allison during both years, did not serve to stamp him as one who was regularly engaged in that work. He was occasionally called upon for advice concerning the work, and he negotiated three supervisory contracts in 1920. His services in connection with that branch of the work were rendered from time to time*1969 as required, and not as a regular part of his work. His testimony clearly shows that he and Crowley planned and intended that the supervisory work should be cared for by Crowley, while Allison devoted himself to other work. The facts here are similar to those in Albrecht & Weaver, Inc.,9 B.T.A. 560">9 B.T.A. 560, wherein it was held that such intermittent and irregular services were not equivalent to being regularly engaged in the active conduct of the company's affairs. See also Matteson v. Willcuts, 12 Fed.(2d) 447.
Both Allison and his wife were principal stockholders. Robischon v. Peckham Co., supra. Together they owned 60 per cent of petitioner's capital stock. As neither of them was regularly engaged in the supervisory work carried on by the petitioner, the requirements of section 303 of the Revenue Act of 1918 have not been met.
Judgment will be entered for the respondent.