*3653 1. Petitioner having failed to prove by competent evidence that not less than 30 per centum of its total net income was derived from a separate branch of its business, it is not entitled to have its tax determined under the provisions of section 303 of the Revenue Act of 1918.
2. It appearing that the written document herein on Form 870, executed by petitioner, consenting to the assessment of a deficiency, was never approved by the respondent, it is not necessary for us to pass upon the effect thereof if and when it is completed according to its terms.
3. The fact that the respondent's predecessor ruled that the petitioner was entitled to have its taxes determined under section 303 of the Revenue Act of 1918 for prior years, is not binding upon the respondent in this proceeding.
4. Assessment and collection of the deficiency herein is not barred by the period of limitations.
5. Respondent's adjustment of invested capital for the taxable year by an amount of income and profits taxes for 1919 approved.
6. Reduction of current earnings by a tentative tax in determining the amount available for dividends held to be erroneous.
7. The respondent's action in*3654 regarding the share of stock of the New Orleans Cotton Exchange owned by the petitioner as an inadmissible asset is approved.
*1237 This proceeding is for the redetermination of a deficiency in income and profits taxes for the fiscal year ended July 31, 1920, amounting to $8,765.35.
The allegations of error urged by the petitioner in its original, supplemental and amended petition, upon which the respondent joined issue, are:
(1) That the respondent erred in holding that thirty per cent or more of petitioner's income was not derived from a separate trade or business so as to bring it within that class of corporations entitled to assessment as a partly personal service corporation.
(2) That the respondent erred in reopening and redetermining the taxes due for the period in controversy, since the amount of the deficiency had been finally determined and agreed to on Form 870 executed on August 17, 1925.
(3) That the respondent's predecessor in office having previously classified the petitioner and held that its taxes*3655 should be assessed, under the provision of section 303 of the Revenue Act of 1918, for prior years, he erred in reaching a different conclusion with respect to the fiscal year ending July 31, 1920.
(4) That notwithstanding consent in writing was entered into between the parties for a later assessment of taxes due under the return filed for the fiscal year ended July 31, 1920, the period of limitation within which the assessment and collection might be made has already expired.
(5) That the respondent committed error in computing the petitioner's invested capital in each of the following particulars:
(a) Reducing invested capital by an amount of income and profits taxes assessed for the year 1919; (b) The reduction of invested capital on account of dividend paid on October 7, 1919, was incorrectly determined; (c) The respondent treated cotton exchange stock appearing on petitioner's balance sheet for the year in question at a value of $2,500 as an inadmissible asset, thereby reducing invested capital.
FINDINGS OF FACT.
From 1888 to 1909 the business of the petitioner was conducted as a copartnership, composed of John M. Parker, his father and his brother. In 1909 it was*3656 incorporated under the laws of the State of Louisiana, to engage in, and carry on, the cotton factorage and general commission business, and by its charter it was empowered to buy, sell, export or import agricultural products and other merchandise, and also to buy, sell, own, lease, mortgage or hypothecate cotton and other plantations and farms or lands. The authorized capital stock at its inception was $100,000, divided into 1,000 shares of the *1238 par value of $100 each, all of which was issued to the following named stockholders in the amounts set opposite their names:
| Number of shares | |
| Jno. M. Parker | 450 |
| Jos. A. Airey | 300 |
| Jno. F. Finke, Jr | 50 |
| J. M. Bowen | 50 |
| W. B. Mangum (by J. M. Bowen) | 50 |
| Rene Bodet | 50 |
| D. J. Mulligan | 50 |
On February 8, 1917, the authorized capital stock was increased from $100,000 to $200,000, divided into 2,0000 shares of the par value of $100 each, and thereafter on July 29, 1918, by further amendment to the original charter, the authorized capital stock was fixed at $500,000, divided into 5,000 shares of the par value of $100 each, $250,000 of which was common and $250,000 of which was 6 per cent cumulative preferred.
*3657 The entire capital stock, both preferred and common, for the fiscal year ended July 31, 1920, was owned by John M. Parker, president, Joseph A. Airey, vice president, John F. Fink, Jr., secretary, and R. Bodet, a salesman, except for 1,500 shares which were issued to and in the names of three minor children of the said Joseph A. Airey, on May 23, 1919. That stock was originally owned by Airey and was transferred from his name to those of his children. Those stockholders, except, of course, Airey's minor children, were all actively engaged in the conduct of the petitioner's business and gave their entire time thereto.
While the powers granted to the petitioner by its charter were extremely broad, its activities were confined to representing interior cotton planters and merchants as selling agents. All of the cotton bought or sold during the year in question (except as hereafter indicated) was handled as agents for others. The methods of doing business may be classified as (a) where funds were advanced to planters to grow crops, and (b) the planter financed himself and shipped the cotton to the petitioner to be sold, securing advances against his cotton after shipment, and*3658 (c) the planter financed himself to grow the crop and he consigned his cotton, requiring no financing whatever, and (d) what is known as dealing in f.o.b. or so-called "to arrive" cotton.
For the fiscal year ended July 31, 1920, the petitioner handled 132,909 bales of cotton, the gross proceeds from which amounted to $22,849,772.37. The commissions earned from those sales are classified as follows:
| Number of bales cotton | Commission | |
| Cotton on which crop advances made | 3,097 | $6,676.82 |
| Cotton sold delivered in interior | 5,500 | 2,750.00 |
| Cotton on which advances made against Bs/L or after receipt | 42,677 | 92,007.73 |
| Cotton sold against which no advances were made | 24,640 | 53,121.38 |
| F.O.B. or To Arrive Cotton | 56,995 | 52,628.50 |
| Total | 132,909 | 207,184.43 |
*1239 On the last two of the above-named classes, that is, cotton sold against which no advances were made and f.o.b. cotton, no capital whatsoever was required, it being sold before arrival and a draft made with bill or lading attached which were presented to the buyer who took up the draft. Therefore, of the total commissions of $207,184.43 appearing in the above tabulation, $101,434.55 represents*3659 commissions derived from business upon which capital was necessary, and $105,749.88 from business upon which no capital was required.
The petitioner has always advanced funds to farmers on crops where the credit risk would justify. Because of the considerable decline in the market price of cotton during the fiscal year ended July 31, 1920, however, the demand for such advances was limited.
The petitioner maintained no separate office for its loan business and had no separate employees or books of account therefor. There was, however, a separate office maintained for the conduct of the so-called "to arrive" business which was in charge of July F. Finke, Jr., a stockholder. That class of business was separately provided for under the rules of the New Orleans Cotton Exchange. Rule 6 of the rules of that Exchange provides, "Sellers of cotton to-arrive shall be responsible in every respect for the proper fulfillment of all contracts, whether the name of the interior shipper be stated in the contract or not". That means that when the petitioner sells a quantity of cotton for interior shipment it guarantees that the cotton will be shipped by the interior shipper according to samples, *3660 and if the buyer does not pay, the petitioner will make good to the interior man. In those cases the petitioner acts in the nature of a factor.
In addition to the commissions and brokerage income the petitioner also derived certain income from the sales of what is known as "cotton loose", which in the year under consideration amounted to something over $26,000. This cotton is accumulated through the receipt of samples which, under the rules of the Exchange, are the property of the buyers who frequently do not claim them.
The petitioner did not deal in cotton futures except hedges for its customers, nor did it buy and sll or own any cotton on its own account during the taxable period.
*1240 While the petitioner's books of account show notes payable of $400,000 at July 31, 1920, those funds were borrowed from banks for and on account of customers whose cotton was pledged as security therefor.
The petitioner employed thirty-four employees during the fiscal year ended July 31, 1921, including the stockholders, of which number only nineteen were engaged for a full period of twelve months. The employees, other than stockholders, were engaged in purely clerical work, *3661 such as stenographic, bookkeeping, opening cotton, and making account sales.
The amount of capital invested or owned by firms engaged in the cotton brokerage business is not considered to be of paramount importance by customers who have cotton to sell. Customers dealing with the petitioner, that is, those who had cotton to sell, were primarily concerned with the petitioner's reputation for honesty and reliability in conducting the business entrusted to it.
In July, 1925, the revenue agent examined the books and records of the petitioner for the fiscal years ended July 31, 1920, and July 31, 1921, and he found, after computing the taxes under the provisions of section 303 of the Revenue Act of 1918, a net additional tax of $584.65. He segregated the income of the petitioner under section 303 of the Revenue Act of 1918 as follows:
| Capitalistic | Personal service | Total | |
| Income | |||
| Commissions | $207,184.48 | $207,184.48 | |
| Brokerage | 4,257.50 | 4,257.50 | |
| Cotton samples | $26,264.73 | 26,264.73 | |
| Interest | 101,357.86 | 101,357.86 | |
| Miscellaneous earnings | 4,728.99 | 4,728.99 | |
| Bad debts recovered | 2,452.13 | 2,452.13 | |
| Total income | 134,803.71 | 211,441.98 | 346,245.69 |
| Expenses | |||
| Interest | 41,407.99 | 41,407.99 | |
| Bad debts | 4,677.52 | 4,677.52 | |
| Cotton account | 800.00 | 800.00 | |
| Salaries | 8,818.43 | 35,273.74 | 44,092.17 |
| Officers' salaries | 10,800.00 | 43,200.00 | 54,000.00 |
| Taxes licenses | 2,844.41 | 11,377.66 | 14,222.07 |
| Rent | 668.00 | 2,672.00 | 3,340.00 |
| Miscellaneous expense | 3,902.56 | 15,610.26 | 19,512.82 |
| Depreciation | 15.68 | 62.72 | 78.40 |
| Loss on sale of Liberty bonds | 2,177.01 | 2,177.01 | |
| Total expenses | 76,111.60 | 108,196.38 | 184,307.98 |
| Taxable net income | 58,692.11 | 103,245.60 | 161,937.71 |
*3662 The respondent did not adopt the findings of the revenue agent insofar as he computed petitioner's tax under the provisions of section 303, supra. However, the net income of $161,937.71 shown in the revenue agent's computation above is the same as finally determined in respondent's deficiency notice.
*1241 As a result of the aforementioned revenue agent's examination the petitioner executed an agreement, entitled, "agreement consenting to assessment of a deficiency", under date of August 17, 1925, on Form 870 supplied by the Treasury Department, waiving the right of appeal under section 274(a) of the Revenue Act of 1924, with respect to the net additional tax of $584.65 found to be due by said revenue agent. That form of agreement contains the following note: "This agreement is subject to the approval of the Commissioner and is not an agreement as provided under section 1006, Revenue Act of 1924." No approval of this agreement by the respondent was ever communicated to the petitioner.
The petitioner applied to the respondent's predecessor in office for classification as a personal service corporation and he received a communication from Commissioner Roper dated*3663 September 22, 1919, stating that its taxes should be assessed in accordance with the provisions of section 303 of the Revenue Act of 1918, as a partly personal service corporation, and that the income from commissions and brokerage should be considered as arising from personal service, and the remainder of said income as derived from the use of capital. There were no changes in the petitioner's method of doing business during the period subsequent to Commissioner Roper's ruling hereinabove referred to and the end of the fiscal year under consideration.
Under date of July 22, 1925, the petitioner and the respondent entered into a consent in writing whereby the period for assessment of income and profits or war-profits taxes due under any return made by or on behalf of the petitioner for the fiscal years ended July 31, 1920, and July 31, 1921, should be extended until December 31, 1926, at which time said consent should expire, "except that if a notice of a deficiency in tax is sent to said taxpayer by registered mail before said date and (1) no appeal is filed therefrom with the United States Board of Tax Appeals then said date shall be extended sixty days, or (2) if an appeal is*3664 filed with said Board then said date shall be extended by the number of days between the date of mailing of said notice of deficiency and the date of final decision by said Board". The notice of deficiency was mailed the petitioner on December 18, 1925.
The petitioner had representation on the New Orleans Cotton Exchange which, being a corporation, is accomplished by one or more of its officers being full members of said Exchange and amenable to its rules. To enjoy the full privileges of the Exchange the member must pay initiation fees and annual dues and must own one share of stock in the Exchange. The petitioner owned one share of said stock which it carried on its books at $2,500. Parker and Airey also owned one share of stock.
*1242 Invested capital of the petitioner for the fiscal year ended July 31, 1920, was finally determined by the respondent as follows:
| Capital stock and surplus reported | $602,608.27 | |
| Add: | ||
| 1. 1917 income and profits tax refund | $3,377.84 | |
| 2. 1918 income and profits tax refund | 7,104.37 | |
| 10,482.21 | ||
| Total | 613,090.48 | |
| Deduct: | ||
| 3. 1919 income tax, $36,942.07, prorated | $15,569.24 | |
| 4. Portion of dividend, October 7, paid from surplus, $41,032.60 X 299/366 days | 33,521.17 | |
| 5. Inadmissible deduction | 701.62 | |
| 49,792.03 | ||
| Invested capital adjusted | 563,298.45 |
*3665 The deductions from invested capital hereinabove of $15,569.24, $33,521.17 and $701.62 are explained by the respondent in his deficiency notice as follows:
3. Federal income and profits taxes are deemed to have been paid out of the net income of a taxable year for which they are levied and accordingly may be included in the computation of invested capital only until such taxes become due and payable. The correct tax liability for the preceding year has, therefore, been prorated from the due date in accordance with Article 845. Regulations 45.
4. Dividends paid after the first days of the taxable year are considered to have been paid out of current earnings prorated for the year, and the dividends in excess of such earnings are deemed to have been paid out of surplus existing at the beginning of the taxable year allocated from the date of payment. The dividend of $62,500.00 paid October 7, 1920 [1919] has, therefore, been prorated on the above basis, resulting in the elimination of $33,521.17 from your invested capital. See Articles 857 and 858, Regulations 45.
The computation of the dividend adjustment follows:
| Taxable net income for year | $161,937.71 | |
| Add: | ||
| Nontaxable income | 913.01 | |
| Total | 162,850.72 | |
| Deduct: | ||
| Donations | $1,907.30 | |
| Tentative tax | 43,673.74 | |
| 45,581.04 | ||
| Amount of earnings available for dividends | 117,269.68 | |
| Dividend paid October 7, 1920 [1919] | 62,500.00 | |
| Paid from surplus [current earnings] | 21,467.40 | |
| Paid from surplus | 41,032.60 |
*3666 5. Cotton exchange stock, $2,500.00, appearing upon your balance sheets as at the beginning and end of the taxable year is considered an inadmissible asset, *1243 and in accordance with Article 852, Regulations 45, may be included in invested capital only to the extent as set forth in the following schedule:
| Inadmissible assets beginning of year | $2,500.00 |
| Inadmissible assets end of year | 2,500.00 |
| Average for year | 2,500.00 |
| Admissibles and inadmissibles beginning of year | 2,351,107.59 |
| Admissibles and inadmissibles end of year | 1,666,781.66 |
| Average | 2,008.944.62 |
| Percentage which inadmissibles is of total assets | .1244% |
OPINION.
MORRIS: While there are a number of questions urged for consideration, the major one is set forth in the first allegation of error herein to the effect that the respondent erroneously held that the petitioner was not entitled to have its taxes computed and assessed under the provisions of section 303 of the Revenue Act of 1918.
Section 303 of the Revenue Act of 1918 provides:
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*3667 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 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 propertionate part of the credits 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. * * *
Thus it will be seen that in order for the petitioner to overcome the prima facie correctness of the respondent's determination, it must prove that the amount of net income from sources not involving the use of capital is not less than 30 per centum of the total net income, and, furthermore, that the branch of the business from which said income is derived is distinctly separate from that branch of the business in which the employment*3668 of capital is necessary; failure to establish either of these requirements must necessarily preclude the relief which it seeks.
At the hearing the petitioner's counsel devoted considerable time and attention to the organization of the petitioner, the various amendments to its charter, the increases in its capitalization, the stock ownership during the taxable year, and a classification of the various sources of income, but we fail to find anywhere in the record proof of a segregation of income (other than commissions) or of the expenses to the separate branches of business, so that the percentage of net income from these two sources may be determined. While the *1244 petitioner has satisfactorily established a proper segregation of its commissions, that is not sufficient to comply with the statute, which provides that it shall derive not less than 30 per centum of its total net income from a separate trade or business or a distinctly separate branch of a trade or business.
The report of the revenue agent's examination was offered in evidence by the petitioner and was qualifiedly received. We can not accept the contents of that report except insofar as it may*3669 aid in determining the proven facts or to the extent that the contents have been admitted or adopted by the respondent. Let us see, however, what the petitioner's net income from the two sources is with the aid of the segregation of income and expenses, other than commissions, reported by the revenue agent.
The revenue agent, as we have shown in the findings of fact herein, found the total income to be $346,245.69, from which total expenses of $184,307.98 have been deducted, leaving a total net income subject to tax of $161,937.71. For the purpose of computing the petitioner's tax for the period in question under the provisions of section 303, supra, he has segregated the total income into "capitalistic" and "personal service," allocating $134,803.71 to the former and $211,441.98 to the latter class. He has deducted from the so-called capitalistic income, total expenses of $76,111.60, and from the so-called personal service income, $108,196.38, leaving a net income of $58,692.11 attributable to the capitalistic branch of the business, and $103,245.60 as attributable to the personal service branch of the business. So computing, he finds the percentage of income from capitalistic*3670 sources to be 36.24.
The respondent, as we have indicated, did not sustain the revenue agent insofar as the computation of the tax under section 303, supra, is concerned, however, the total net income as ultimately determined by the respondent of $161,937.71, exactly agrees with the amount found by the revenue agent.
The total amount of commissions earned by the petitioner for the year ended July 31, 1920, of $207,184.43 (which differs from the amount found by the revenue agent by five cents) was included in the class of personal service income by the revenue agent in his computation. At the hearing of this proceeding the testimony adduced by the petitioner's witnesses disclosed that $101,434.55 of that amount represented commissions derived from business upon which capital was necessary and that $105,749.88 was from business upon which no capital was required. The petitioner went no farther than to prove the gross commissions and what it regarded as a proper segregation thereof.
*1245 Reverting to the testimony of the petitioner's witness that of the $207,184.43, commissions earned during the year, $101,434.55 represents commissions from business upon which capital*3671 was necessary and that the balance of $105,749.88 was from business upon which no capital was necessary, and using the balance of the computations found in the revenue agent's report, we arrive at the following:
| Capitalistic | Personal service | |
| Commissions (segregated according to testimony) | $101,434.55 | $105,749.88 |
| Other income (as segregated by revenue agent) | 134,803.71 | 4,257.50 |
| Total income | 236,238.26 | 110,007.38 |
| Total expenses (as segregated by revenue agent) | 76,111.60 | 108,196.38 |
| Total net income | 160,126.66 | 1,811.00 |
Therefore, even accepting the testimony as to the segregation of commissions and adopting the segregation of other income and expenses to be found in the revenue agent's report, we find, that of the total net income of $161,937.66, nearly all, or $160,126.66, represents income derived from purely capitalistic sources and only $1,811 from the personal service branch of the business.
We realize that in the segregation of expenses made by the revenue agent the $108,196.38 allocated to personal service applied also to the commissions earned of $101,434.55, which he classified as personal service, but in the earning of which we find from*3672 the testimony that the employment of capital was necessary. Obviously, therefore, the net income from personal service was greater than the $1,811 shown in the above table, but as no further allocation of the expenses was offered we are unable to say how much greater it should be. The petitioner, therefore, has failed to meet the first test of the statute.
The further limitation of section 303 is that the business from which the personal service income is derived must be a separate trade or business or a distinctly separate branch of the trade or business. Considering all the evidence on this phase of the case we are of the opinion that the petitioner does not meet this requirement of the statute. See ; . The respondent's determination with respect to the first point is accordingly approved.
With respect to the second allegation of error urged by the petitioner it seems only necessary to point out that while the petitioner executed an agreement consenting to the assessment of a deficiency on Form 870 on August 17, 1925, which appears to have been received in the*3673 office of the revenue agent on the day following, agreeing to the assessment of the deficiency as found by the revenue agent in his report dated July 23, 1925, it does not appear that the respondent *1246 ever approved that agreement, which approval was made an express condition precedent to its validity. It is, therefore, not necessary for us to pass upon the force and effect of such an agreement when completed according to its terms.
The third allegation of error urged by the petitioner is that the respondent erred in reaching a different conclusion with respect to the fiscal year July 31, 1920, than was reached by his predecessor in office for preceding years. The mere fact that the respondent's predecessor in office heard and determined questions of fact presented to him as to former years and ruled that the petitioner was entitled to have its taxes computed and assessed under the provisions of section 303, supra, is not controlling upon the respondent where he considers that a different conclusion should be reached based upon the facts presented to him for the period under consideration. We are, therefore, of the opinion that the respondent was entirely justified*3674 in his action with respect to the fiscal year ended July 31, 1920. See ; ; also .
The fourth allegation of error herein is that the deficiency set forth in deficiency notice of December 18, 1925, out of which this proceeding arose, is barred by the statute of limitations, for the reason that the assessment of August 3, 1925, and the alleged contract of August 17, 1925, terminated all the rights and privileges conferred by the consent in writing entered into on July 22, 1925, which consent was not intended to grant, and did not grant, the right to reaudit returns and reassess additional taxes as often as the collector might see fit to do so.
This issue was not urged by the petitioner's counsel in his brief nor at the hearing. An examination of the consent entered into between the parties discloses no limitations whatsoever upon the collector or the respondent to assess taxes rightfully due at any time within the period of limitation as extended by said consent.
We know of no justification in law for holding that, notwithstanding*3675 the period of limitation has been extended by consent in writing between the parties, the period has expired because of an alleged former assessment (of which we have no proof other than the fact that the revenue agent made an examination and rendered his report), and an agreement as evidenced here, which, as we have shown in our discussion of the second allegation of error herein, was never finally consummated between the parties. We, therefore, hold that the period of limitation, within which assessment and collection of the tax may be made, has not expired.
Allegation of error 5(a) herein is that the respondent committed error in reducing petitioner's invested capital by an amount of income and profits taxes for 1919.
*1247 Section 1207 of the Revenue Act of 1926 provides:
The computation of invested capital for any taxable year under the Revenue Act of 1917, the Revenue Act of 1918, and the Revenue Act of 1921, shall be considered as having been correctly made, so far as relating to the inclusion in invested capital for such year of income, war-profits, or excess-profits taxes for the preceding year, if made in accordance with the regulations in force in respect*3676 of such taxable year applicable to the relationship between invested capital of one year and taxes for the preceding year.
Since no proof was offered at the hearing of this proceeding that the adjustment complained of was not made in accordance with the regulations in force during the taxable period in question, we approve the findings of the respondent with respect thereto.
The allegation of error 5(b) herein is set forth by the petitioner in the following language:
Commissioner erred in computation of the reduction of taxpayer's invested capital on account of dividend paid on October 7, 1919, said error on the part of the Commissioner was caused by an erroneous determination of the current year's earnings available for said dividend, said earnings being reduced by tentative tax in the sum of $43,673.74 resulting in a deduction of $33,521.17 from taxpayer's invested capital, whereas said reduction should be $26,989.80.
The respondent erred in reducing invested capital by subtracting from current earnings a tentative tax in determining the amount of such income available for dividends. See *3677 , and numerous later decisions.
The petitioner alleges that the respondent erred in treating stock of the New Orleans Cotton Exchange, owned by it, and carried on its books at a value of $2,500, as an inadmissible asset in determining its invested capital. Section 325 of the Revenue Act of 1918 provides:
The term "inadmissible assets" means stocks, bonds, and other obligations (other than obligations of the United States), the dividends or interest from which is not included in computing net income, * * *
In , the Board said:
We are of the opinion that the words "the dividends or interest from which is not included in computing net income" identify a type or class of investment and they have no reference to received income.
It was testified that the stock of the New Orleans Cotton Exchange does not have any earning power. Although the charter, constitution, by-laws and rules of that exchange were introduced in evidence, not in reference to this particular point, however, we are unable to determine therefrom, in the absence of other evidence as to the operation*3678 of the exchange, whether its stock does or does not belong in that type or class of investment included in section 325 above quoted. The respondent's action in treating it as an inadmissible asset is, therefore, sustained. See also .
Judgment will be entered under Rule 50.