1929 BTA LEXIS 2502">*2502 1. The petitioner conducted a general undertaking business in the City of Pittsburgh, succeeding to a business conducted as a sole proprietorship. Held, that the petitioner is not entitled to be classed as a personal service corporation for the years 1920 and 1921.
2. The predecessor business had a valuable good will which was in no wise reflected in its invested capital. Held, that the petitioner is entitled to assessment under the provisions of section 328 of the Revenue Acts of 1918 and 1921 for the taxable years involved.
16 B.T.A. 858">*858 The Commissioner asserted deficiencies in income and profits tax of $2,773.37 for 1920, and $1,697.40 for 1921. The petitioner has instituted this proceeding for a redetermination of such deficiencies. It alleges that it is entitled to classification as a personal service corporation, or, in the alternative, that it is entitled to have its tax liability determined under section 328 of the Revenue Acts of 1918 and 1921. It also alleges that the Commissioner erred in disallowing a portion of the allowance taken for1929 BTA LEXIS 2502">*2503 depreciation on physical assets 16 B.T.A. 858">*859 in both 1920 and 1921, and in disallowing an allowance for exhaustion of its leasehold; and in reducing invested capital for the years 1920 and 1921 from the amount shown on its books of account, and in failing to include in invested capital a value for good will acquired by petitioner when it acquired the business and assets of the former owner.
FINDINGS OF FACT.
The petitioner is a Pennsylvania corporation, with its principal office in Pittsburgh. It is engaged in the business of undertaking, embalming, and conducting funerals. Its authorized capital stock is $100,000, consisting of 1,000 shares of a par value of $100 each. It was incorporated in May, 1917, and took over the business and certain assets of Thomas B. Moreland as of June 1, 1917. Thomas B. Moreland succeeded his father in the business upon the death of the latter in 1902. The business was originally established about 1858 as a livery and undertaking business. The livery business was discontinued in 1912. During the taxable years in question petitioner's stock was held as follows:
| T. B. Moreland | 750 shares |
| Lewis Hartwell | 150 shares |
| F. W. Wright | 100 shares |
1929 BTA LEXIS 2502">*2504 T. B. Moreland was president, Lewis Hartwell, vice president, and F. W. Wright, secretary and treasurer. Hartwell had been associated with Moreland since 1901 and Wright since 1906. The business was incorporated in order that Hartwell and Wright might have an interest therein. Moreland turned over the business to the corporation in exchange for $99,500 par value of its capital stock. The balance of the stock was issued to Moreland to reimburse him for the cost of incorporating the business. Upon incorporation Moreland gave to Hartwell and to Wright the shares of stock owned by them during the taxable years.
Wright and Hartwell had an agreement with Moreland not to engage in any other business than that of the petitioner. Either Moreland, Hartwell, or Wright arranged for and directed every funeral conducted by the petitioner. During 1920 Moreland arranged for 10 funerals and attended 92. Hartwell embalmed 248 bodies and arranged 447 funerals and attended 213 funerals. Wright arranged 105 funerals and attended 66. In 1921 Moreland arranged 24 funerals and attended 143; Hartwell embalmed 182 bodies, arranged 266 funerals, and attended 236; Wright arranged 96 funerals and1929 BTA LEXIS 2502">*2505 attended 25. The stockholder attending the funerals looked after the details of the planning, preparation and conducting of the 16 B.T.A. 858">*860 funerals and the interment. When Moreland was not present at the funeral service he was usually present before the service started.
In conducting funerals and attending to the interment, petitioner's services included the embalming, bathing, shaving, and dressing of the deceased; sanitary treatment, such as looking after contagious diseases; procuring and filing of a death certificate; obtaining permits for the moving of bodies from hospitals and for the shipment of them; procuring railroad tickets, and attending to the shipment of bodies; inserting death notices in the press, and in some cases writing the obituary and bringing it to the attention of the papers; advising concerning the casket and trimmings and attending to the engraving of the plate and casket; attending to the selection of suits and dresses and the pressing of clothes; furnishing door cards and cards for the business office; delivering caskets to the residence; taking the rough box to the cemetery; advising concerning the purchase of cemetery lots and the location of graves; 1929 BTA LEXIS 2502">*2506 obtaining vaults in the cemetery and putting in order private vaults and mausoleums; lining the grave and obtaining the device for lowering caskets into it; consulting with friends and relatives of the deceased and arranging the details of the funeral; notifying pall bearers, and sending for pall bearers, ministers, and signers; arranging for the use of petitioner's chapel and providing the music; looking after the details of moving the funeral party to the cemetery; attending to the details of the interment; and sometimes rendering assistance in preparing claims for insurance. All of these services were performed by some one of the petitioner's stockholders.
Petitioner's services also included the furnishing of decorations; caskets and cases; miscellaneous clothing and supplies, such as suits, dresses, undergarments, hose and shirts; carriages and automobiles; chairs for the funeral; and motor wagons and hearses. Petitioner's billing covered charges for embalming, decorations, caskets and cases, dry goods, carriages and automobiles, chairs, motor wagons and hearses, and cash outlay, but no separate charge for petitioner's services and attendance was included in its charges for1929 BTA LEXIS 2502">*2507 the casket and other merchandise sold. Petitioner did not do a merchandising business independent of its business of undertaking and conducting funerals. All merchandise sold by it was sold in connection with the funerals which it conducted.
Petitioner owner certain motor wagons and hearses which it used in connection with funerals. It did not own the carriages and automobiles used, but rented them from outside parties and billed them at their cost to it without profit.
16 B.T.A. 858">*861 When the business of the Thomas B. Moreland Co. was turned over to the corporation as of June 1, 1917, capital stock was credited with $100,000, and this credit was offset by the following debits:
| Accounts receivable | $ 39,924.02 |
| Dry goods | 2,222.57 |
| Embalming account | 165.15 |
| Caskets and cases | 6,958.26 |
| Chair account | 480.00 |
| Paraphernalia | $5,500.00 |
| Rolling stock | 10,750.00 |
| Plant and equipment | 20,000.00 |
| Leasehold | 14,000.00 |
In rendering its income and profits-tax returns for the calendar years 1920 and 1921, the petitioner included in invested capital $100,000 for the value of the assets paid into it for the $100,000 capital stock issued. Of this amount the Commissioner1929 BTA LEXIS 2502">*2508 disallowed $37,303.97 for appreciation of the value of the assets over the amount shown as the depreciated cost on Moreland's individual books of account of the predecessor business. The appreciation in the value of the assets upon incorporation disallowed by the Commissioner was as follows:
| Leasehold | $ 14,000.00 |
| Plant | 18,758.41 |
| Rolling stock | 757.51 |
| Paraphernalia | 3,788.05 |
The minutes of a meeting of the board of directors of the corporation held May 17, 1917, are in part as follows:
On Motion of Mr. Hartwell, duly passed, the officers of the Company were authorized and directed to enter into a lease with Thomas B. Moreland for the first floor of premises of No. 6104 Penn Avenue, Pittsburgh, for a term of six years, the rent to be $5,000 a year for the first year of the term, and $6,000 for the last five years of the term. Said lease to be for the premises now occupied by the business of Thomas B. Moreland - it being the intention of the Company to acquire said business and continue the same therein.
The following communication was received from Thomas B. Moreland:
PITTSBURGH, May 15, 1917.
GENTLEMEN:
I hereby offer to sell to your Company the1929 BTA LEXIS 2502">*2509 Undertaking and Embalming Business heretofore conducted by me at No. 6104 Penn Avenue, Pittsburgh, including book accounts, Dry Goods, Embalming Supplies, Casket and Cases, Chairs, Rolling Stock and Motor Equipment, Paraphenalia, Plant, Furniture, Fixtures, and leasehold premises, as per itemized inventory thereof submitted herewith, and attached hereto, at the price or sum of $99,500: and in consideration therewith, I do agree to accept full paid capital stock of your Company in the par value of $99,500.
(Signed) THOS. B. MORELAND.
Thereupon, the matter was gone over thoroughly, and it appearing to those interested that the actual cash value of the property inventories as submitted was fully worth the sum of $99,500, it was decided to accept the said offer, and 16 B.T.A. 858">*862 to recommend to the stockholders an increase of the capital stock of the Company in a sufficient amount to pay for the same.
Mr. Moreland presiding, the following resolution was unanimously passed:
"RESOLVED, That the capital stock of this Company be increased from $5,000 to $100,000: -
"Resolved, That a meeting of the stockholders be called to convene at the general office of this company on the 17th1929 BTA LEXIS 2502">*2510 day of May, 1917, to take action on approval or dis-approval of the proposed increase of the capital stock of this company the notice by publication, required to be given by the Constitution and laws of this Commonwealth having been waived by the unanimous consent of the stockholders."
On motion, the present stockholders, Messrs. Moreland, Hartwell and Wright, were designated as judges to conduct the election at the special meeting of stockholders to vote upon the proposed increase of capital stock of the company.
Thomas B. Moreland owned the premises at No. 6104 Penn Avenue, Pittsburgh. Other tenants in the block were paying approximately the same rentals as were provided for in the lease given by Moreland to the petitioner. But their leases were about to expire. Tenants across the street for similar premises were paying $8,000 to $8,500 per annum. The premises at 6104 Penn Avenue were in demand and the petitioner had numerous opportunities to rent them.
The leasehold acquired by the petitioner from Moreland for the six-year period beginning June 1, 1917, was placed upon the petitioner's books of account at a value of $14,000. In its income-tax returns for 1920 and 1921, 1929 BTA LEXIS 2502">*2511 the petitioner deducted for amortization of the leasehold one-sixth of $14,000, or $2,333.33 for each of the taxable years, which deduction was disallowed by the Commissioner in computing the deficiencies.
The net income of the predecessor business for the five calendar years 1912 to 1916, inclusive, was as follows:
| 1912 | $46,016.31 |
| 1913 | 42,750.15 |
| 1914 | 44,393.12 |
| 1915 | 41,994.83 |
| 1916 | 48,953.55 |
| Total | 224,107.96 |
| Average annual net income | 44,821.59 |
The net income of the petitioner for the calendar years 1920 and 1921, as determined by the Commissioner, was $82,168.27 and $71,602.70, respectively.
Petitioner's balance sheets at December 31, 1919, December 31, 1920, and December 31, 1921, were as follows:
| Dec. 31, 1919 | Dec. 31, 1920 | Dec. 31, 1921 | |
| Assets: | |||
| Cash | $38,640.21 | $41,440.15 | $33,553.57 |
| Government securities | 19,230.50 | 26,246.00 | 1,246.00 |
| Other securities | 24,962.50 | 49,333.33 | |
| Inventories | 26,424.31 | 31,831.20 | 20,101.27 |
| Accounts receivable | 33,193.43 | 36,360.19 | 41,583.43 |
| Leaseholds | 9,333.34 | 7,000.00 | 4,666.66 |
| Equipment | 15,727.52 | 14,154.77 | 29,101.76 |
| Motor equipment | 14,160.98 | 13,632.87 | |
| Paraphernalia | 3,567.84 | 3,568.58 | |
| Cemetery lot | 15.00 | 280.00 | |
| 160,278.13 | 199,211.26 | 179,866.02 | |
| Liabilities: | |||
| Accounts payable | 8,636.40 | 14,509.02 | 4,719.52 |
| Capital stock | 100,000.00 | 100,000.00 | 100,000.00 |
| Surplus | 51,641.73 | 84,702.24 | 75,146.50 |
| 160,278.13 | 199,211.26 | 179,866.02 |
1929 BTA LEXIS 2502">*2512 16 B.T.A. 858">*863 Petitioner's gross income for the years in question was as follows:
| 1920 | 1921 | |
| Undertaking business | $215,106.36 | $192,995.10 |
| Daily bank balance | 2,105.55 | |
| Customers' accounts recovered | 3,555.25 | 4,456.50 |
| Discounts earned on purchases | 789.77 | 696.73 |
| Taxable interest on Liberty bonds | 900.00 | |
| Taxable interest from other sources | 3,002.52 | |
| 221,556.93 | 202,050.85 |
Petitioner's ordinary and necessary expenses for the years in question were as follows:
| 1920 | 1921 | |
| Salaries and wages | $13,184.07 | $12,994.88 |
| Rent | 9,636.00 | 10,549.00 |
| General expenses | 6,238.87 | 2,936.67 |
| Auto repairs and supplies | 4,284.85 | 5,155.60 |
| Insurance premiums charged off | 1,808.22 | 2,116.39 |
| Advertising | 622.08 | 2,007.50 |
| Miscellaneous undertaking expenses | 917.66 | |
| Miscellaneous expenses | 1,185.46 | |
| Auto hire | $944.65 | $370.65 |
| Repairs | 541.43 | |
| Attorneys' fees | 500.00 | |
| Accountants' fees | 262.50 | |
| Traveling expenses | 250.00 | |
| Telephone | 1,019.02 | |
| Heat and light | 508.15 | |
| Total | 37,904.20 | 40,129.45 |
Its compensation to officers for the years in question was as follows:
| 1920 | 1921 | |
| T. B. Moreland, president | $17,000 | $14,000 |
| F. W. Wright, secretary and treasurer | 7,300 | 6,800 |
| Lewis Hartwell, vice president | 7,500 | 7,000 |
| Total | 31,800 | 27,800 |
1929 BTA LEXIS 2502">*2513 16 B.T.A. 858">*864 The cost of goods sold, including caskets, clothing, etc., for the calendar years 1920 and 1921 was $55,012.17 and $52,640.53, respectively. At sundry times the petitioner had opportunities to sell its business. It refused, however, to put any price upon it. The value of the good will of petitioner was large. The business was well established and many families engaged the services of petitioner many different times over a period of more than 50 years. None of the good will was reflected in the statutory invested capital of the petitioner.
OPINION.
SMITH: The first point made by the petitioner is that it is a personal service corporation within the meaning of section 200 of the Revenue Acts of 1918 and 1921. This section defines a personal service corporation as follows:
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; but does not include any foreign corporation, 1929 BTA LEXIS 2502">*2514 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.
The evidence shows that the entire capital stock of the petitioner was owned by three individuals all of whom devoted their entire time to its business. The petitioner meets all the tests of a personal service corporation, unless it be that capital was a material income-producing factor in the earning of the income. The petitioner contends that capital was not an income-producing factor by reason of the fact that no merchandise was sold by the petitioner except in connection with its undertaking business. The petitioner was not a dealer in merchandise in the sense that it sold caskets or other merchandise to other undertaking concerns or to any person desiring to purchase such merchandise. This does not mean, however, that the petitioner did not make a profit upon the merchandise sold in connection with a funeral. Persons desiring the services of the petitioner1929 BTA LEXIS 2502">*2515 selected a casket according to their requirements. We are of the opinion that capital was a material income-producing factor in the production of net income. The fact that the petitioner did not make a business of dealing in caskets is not determinative of the issue. The balance sheets of the petitioner as of the close of the years 1919, 1920, and 1921 showed that it had inventories of $26,424.31, $31,831.20, and $20,101.27, respectively. The petitioner also had equipment, including motor equipment, of $29,888.50, $27,787.64, 16 B.T.A. 858">*865 and $29,101.76 at the close of each of the years 1919 to 1921, inclusive. The petitioner's cost of goods sold for 1920 and 1921 was $55,012.17 and $52,640.53, respectively. Capital was necessarily used in the acquisition of hearses and other equipment of the petitioner. In reality a charge was made for the use of the hearses, even though it was not billed separately to the client. The petitioner owned securities from which an income was received. The amount of the securities held at the close of 1920 and 1921 was in excess of $50,000. We are therefore of the opinion that the petitioner has not sustained the burden of proving that capital1929 BTA LEXIS 2502">*2516 was not a material income-producing factor in the production of its income and that it is therefore not entitled to personal service classification. Cf. ; .
Petitioner also alleges that in the computation of its net income the respondent has erred in disallowing a portion of the amounts claimed as a deduction for depreciation on physical assets and also in disallowing an amount representing an exhaustion of its leasehold. Petitioner has, however, offered no evidence to prove error on the part of the respondent in disallowing a part of the depreciation on physical assets taken. There is no evidence as to the rates allowed by the respondent in determining depreciation and we have no evidence that the value of the physical assets at the date taken over by the petitioner was in excess of the cost to Thomas B. Moreland when he acquired them in the conduct of his individual business. The petitioner strongly contends, however, that the leasehold acquired by the petitioner at June 1, 1917, had a fair market value on that date of $14,000; that the lease ran for a period of only six years; 1929 BTA LEXIS 2502">*2517 and that therefore it is entitled to exhaust the value of the leasehold at the date of acquisition over the life of the lease. We are of the opinion, however, that there is no merit in this contention. The lease was entered into by Moreland with the corporation after the organization of the corporation. It was not a lease in existence before the organization of the corporation which was paid into the corporation in exchange for a given amount of capital stock. The petitioner had no capital invested in the lease. It therefore had no capital which exhausted with the expiration of the lease. The provision of the statute permitting the deduction of depreciation and exhaustion is for the purpose of returning to the petitioner its capital investment in an asset. ; . Upon the evidence of record the disallowance of deductions for depreciation and exhaustion of the leasehold made by the respondent are sustained.
The petitioner further contends that the respondent erred in his determination of invested capital by excluding from it $37,303.97 16 B.T.A. 858">*866 claimed by the respondent1929 BTA LEXIS 2502">*2518 to represent an appreciation of the value of assets at the time of the transfer of the assets of the individual business of Thomas B. Moreland to the petitioner corporation. The petitioner has introduced no evidence that the fair market value of the tangibles paid in to the petitioner corporation was in excess of the amount determined by the respondent, which was the cost to Thomas B. Moreland. The petitioner contends, however, that it was the intention of the petitioner to pay in to the corporation good will of the predecessor business and that that good will was much in excess of $37,303.97; that in any event the petitioner should be entitled to include in invested capital $100,000 for the value of the assets paid in and not $62,696.03, the amount allowed by the respondent. Section 331 of the Revenue Acts of 1918 and 1921 is a complete bar to the inclusion of any portion of the $37,303.97 contended for. Even though the good will of the individual business was worth $37,303.97 or an amount much greater than that - which we believe to be the fact, nevertheless, the evidence does not prove that this good will was obtained by Moreland at an outlay of a single penny. Under section1929 BTA LEXIS 2502">*2519 331 the asset consisting of good will can not be included in the invested capital at an amount in excess of the cost to Moreland. This observation applies equally to the alleged value of the leasehold and to the alleged value of the good will. The exclusion by the respondent of $37,303.97 from the petitioner's invested capital is sustained.
The final point made by the petitioner is that there are abnormalities with respect to its income and invested capital for the taxable years which warrant the determination of its tax liability under the provisions of section 328 of the Revenue Acts of 1918 and 1921. We can not upon the record find any abnormality in the net income. It is true that the rental charged the petitioner under its lease with Thomas B. Moreland was somewhat less than would have been charged by Moreland to another tenant. But the petitioner paid only the rental that was charged and the amount paid was allowed as a deduction from gross income. We are of the opinion, however, that there was an abnormality in the invested capital of the petitioner. The good will of the individual business of Moreland was undoubtedly very valuable. 1929 BTA LEXIS 2502">*2520 The petitioner computes the value by using a 10 per cent return upon the tangibles and allocating the balance of the earnings to the good will at an amount of several hundred thousand dollars. Although we are not persuaded that the amount is as great as the amount claimed, we are of the opinion that the value was as great as the amount of the entire capital stock of the petitioner. Although the mere fact that the invested capital of a corporation is subject to the limitation prescribed by section 331 of the Revenue Acts of 1918 and 1921, does not of itself entitle the corporation 16 B.T.A. 858">*867 to assessment under section 328 - ; ; ; , nevertheless, the abnormality occasioned thereby may be of such magnitude as to warrant assessment under section 328. In , we said:
It is true that we have held that the mere fact of statutory exclusion of values from invested capital does not indicate an abnormality, yet, where, as in 1929 BTA LEXIS 2502">*2521 , and , there is thereby created an abnormality affecting invested capital and income, the petitioner is entitled to special assessment. * * *
We do not think that this is a case of a tax being high "merely because the corporation earned within the taxable year a high rate of profit upon a normal invested capital." Section 327(d) of the Revenue Acts of 1918 and 1921. The statutory invested capital of the petitioner was abnormally low. We are of the opinion that the petitioner is entitled to have its tax liability for the years in question determined under the provisions of section 328. Further proceedings will be had under Rule 62(c) and (d).
Reviewed by the Board.
MARQUETTE and MURDOCK dissent.
PHILLIPS, dissenting: I am of the opinion that the preponderance of the evidence establishes that the petitioner was engaged primarily in rendering personal service and should be classified as a personal service corporation under section 200. While capital was necessary and was used, its use impresses me as incidental or subordinate to the personal1929 BTA LEXIS 2502">*2522 service rendered.
Both the courts and this Board have pointed out that a corporation may be within section 200 though capital is necessary to the transaction of its business. Capital must be a "material income-producing factor" if the corporation is to be held to fall outside the personal service classification. The extent to which capital may be used without becoming "a material income-producing factor" is not susceptible of precise measurement. Each case must be considered on its own facts. Here the income was $183,000 and $162,000 for the years 1920 and 1921, respectively. The capital actually employed was approximately $100,000 and one-third of this represented credit extended. There can be no question that the services performed were personal in character. Granting a most liberal return on the capital employed, the great bulk of the income must be attributed to some cause other than the use of capital. The majority opinion apparently assigns this to good will. But in such a business as that in 16 B.T.A. 858">*868 which the petitioner is engaged, good will can be built up and maintained only by satisfactory personal service. The recognition of such a substantial good will1929 BTA LEXIS 2502">*2523 value as to create an abnormality when excluded from invested capital seems to me a recognition of the overwhelming part which personal service played in the production of income.
Upon the record as a whole I am of the opinion that petitioner was engaged in the rendition of a personal service; that the use of capital, while necessary, was incidental to the service rendered and was not a material income-producing factor and that petitioner should be classified as a personal service corporation.