*3850 The petitioner held to be a personal service corporation for the taxable period ended December 31, 1919.
*162 In this proceeding the petitioner seeks a redetermination of its income and profits tax liability for the fiscal period February 1 to December 31, 1919, for which the respondent has determined a deficiency of $3,317.32. The sole question involved is whether the petitioner is entitled to be classed as a personal service corporation under the provisions of section 200 of the Revenue Act of 1918 for the taxable period in question.
FINDINGS OF FACT.
The petitioner is a Minnesota corporation with its office in Minneapolis. It was organized February 1, 1919, at which time it took over the business of one Mac Martin, which business Mac Martin had conducted in an individual capacity prior thereto.
Mac Martin had taken a course at the University of Minnesota prior to 1904. He had taken art work and other subjects tending specially to qualify him as an advertising man. When he left the University in 1903, he sold advertising for a few*3851 months and then *163 went to St. Louis, where he worked for an advertising agency. In 1904 he returned to Minneapolis and, not finding employment there, he started into business for himself, soliciting opportunity to write and illustrate advertisements. His business gradually developed into an advertising agency. Prior to 1919 he had procured many clients. He had also associated with him in 1918 C. R. Ferrall, who had formerly been the western manager of an eastern advertising agency. The petitioner corporation was formed in order that Ferrall and some other employees of Martin might have an interest in the business and that when any partner should leave the business a new partnership need not be formed.
The going business of Martin when paid in to the corporation by Mac Martin and his wife, Mary W. Martin, consisted of the following assets and liabilities:
| Assets: | ||
| Cash | $3,589.87 | |
| Accounts receivable | 26,267.87 | |
| Advance to publishers | 6,264.00 | |
| Stocks, bonds and mortgage | 16,275.00 | |
| Library | 2,171.65 | |
| Furniture and fixtures | 3,486.60 | |
| Supplies | 377.30 | |
| Good will | 20,000.000 | |
| Total | $78,432.29 | |
| Liabilities: | ||
| Accounts payable | 28,292.81 | |
| Net assets | 50,139.48 |
*3852 For the above net assets of $50,139.48, 482 shares of stock, par value $100, were issued, of which 350 shares were issued to Mac Martin and 132 shares to Mary W. Martin, his wife.
The total capital stock of the petitioner, which is all common stock, was held during the period February 1, 1919, to December 31, 1919, as follows:
| Shares | |
| Mac Martin | 350 |
| Mary W. Martin | 132 |
| C. R. Ferrall | 1 100 |
| A. Rooney | 30 |
| E. Cleveland | 20 |
| Theo. Kirby | 20 |
| Total stock issued | 652 |
All of the above stockholders, excepting Mary W. Martin, the second largest stockholder and owning over 21 per cent of the average outstanding stock for the period, were actively engaged in the business.
*164 The profit and loss statement as reflected by the books for the period February 1, to December 31, 1919, is as follows:
| Agency income: | |||
| Agency commission from space - | |||
| Space billed to advertisers | $343,248.99 | ||
| Less - | |||
| Amount credited to publisher | $285,295.15 | ||
| Accrual for unbilled space | 9,264.23 | ||
| 294,559.38 | |||
| $48,689.61 | |||
| Agency commission from material - | |||
| Material billed to advertisers | 39,522.77 | ||
| Less: Amount credited to vendors | 35,290.12 | ||
| Agency commission from art work - | |||
| Art work billed to advertisers | 9,191.62 | ||
| Less: Amount credited to producers | 6,095.68 | ||
| 3,095.94 | |||
| Income from consultation service | 2,410.76 | ||
| Discounts - | |||
| Earned | 7,566.08 | ||
| Allowed | 7,404.06 | ||
| Net income from discounts | 162.02 | ||
| Total agency income | 58,590.98 | ||
| Other income: | |||
| Liberty bond interest | $232.38 | ||
| Minnesota & Ontario bond interest | 120.00 | ||
| Real estate mortgage interest | 300.00 | ||
| Accrued interest on stockholders' notes | 794.09 | ||
| Dividend, Perfection Manufacturing Co. stock | 30.00 | ||
| Dividend Federal Schools (Inc.) | 142.50 | ||
| 1,618.97 | |||
| Total | 60,209.95 | ||
| Deduct: | |||
| Officers' salaries, commissions & bonuses | $23,365.29 | ||
| Office salaries | 11,336.61 | ||
| Expenses | 9,492.94 | ||
| Bad debts | 1,111.56 | ||
| Interest paid | 313.40 | ||
| 45,619.80 | |||
| Net income (11 months) | 14,590.15 |
*3853 The compensation paid to the respective officers and stockholders of the corporation for the taxable period is as set out below:
| Mac Martin, president and manager of production | $9,583.33 |
| Chas. R. Ferrall, vice president and sales manager | 6,884.51 |
| Agnes Rooney, secretary-treasurer and media selection | 2,302.25 |
| Elaine Cleveland, copywriter | 1,725.00 |
| Theo. Kirby, service and copywriter | 2,870.20 |
| Total | 23,365.29 |
The petitioner's method of doing business was not unlike that of most advertising agencies. The first transaction in meeting a prospective *165 client was a proposal to him of an analysis and study of his business to ascertain whether certain advertising could benefit; thereupon, when the advertiser authorized such analysis, the petitioner laid down a campaign. Martin, the principal stockholder, might be helped in laying down the campaign by his associates, the other stockholders.
There was made a complete investigation of the client's business; from that there was laid out the plan which the petitioner recommended to the advertiser; that plan covered ways and means of advertising; went into the sales and other departments of the business*3854 affecting the sales; it included merchandising plans; recommendations were made of publications suitable to the business; copy was prepared by the partner and sent on by it to the publications. In 1919 this work of servicing the clients in the way just described was handled by Martin and Ferrall; employees did detail work under their direction; no employees serviced clients independently; no client was turned over to any employee for handling by that employee by himself; there were no employees capable of planning a campaign; the conferences were not turned over to employees; the planning was done by either Martin or Ferrall, or both; the media were passed on either by Martin or Ferrall. One or the other wrote some or all of the copy and approved practically all that went through the office.
In the case of the artists, Martin and Ferrall, or one of them, developed the theme; sometimes they would send the artist's work back and instruct him to make corrections according to their ideas. Martin generally looked after that work himself.
For these services the petitioner was paid by way of commissions from publishers and sometimes by a special charge made to the advertiser. The*3855 petitioner worked for the advertiser's interest and uniformly charged the advertiser a commission of 15 per cent of the cost of the advertising even though the publisher allowed a commission to the agency of only 10 per cent. The agency also charged the advertiser a commission of 15 per cent upon the cost of drawings, plates, etc., made or procured by the petitioner.
Bills for advertising were sent by the publisher directly to the agency and the agency forwarded such bills immediately to the advertiser. The bills uniformly allowed a discount for payment on or before a certain date. The petitioner had an understanding with the advertiser in each case that the bills should be paid by the advertiser prior to the discount date in order that the petitioner might have the money in hand to forward to the publisher in order that the petitioner could secure the benefit of the discount. In any case where an advertiser did not forward a remittance promptly, Martin called him up on the telephone, reminding him of the agreement *166 existing between them and requesting immediate remittance. In practically all cases the petitioner received a remittance from the advertiser before it*3856 was necessary for the petitioner to make remittance to the publisher. In 1919 the petitioner sent 1,430 bills to advertisers; in the case of 1,239 of these the advertiser paid the money over to the petitioner before it was paid to the publisher. The other 191 were slow. The bill to the advertiser stated:
This bill must be paid by (blank date) in order to receive the discount, which is . (Stating the exact amount of the publisher's discount.)
During the taxable period, February 1 to December 31, 1919, remittances were made to publishers before receipt of remittances from clients in the aggregate amount of $76,083.67. On three different occasions during the taxable period the petitioner borrowed $10,000 to enable it to meet its current bills. The gross amount borrowed was at no time in excess of $10,000.
The balance sheet as reflected by the petitioner's books at December 31, 1919, was as follows:
| ASSETS: | ||
| Cash in bank | $7,591.88 | |
| Accounts receivable - | ||
| Clients' accounts | $19,127.01 | |
| Sundry accounts | 177.25 | |
| Advances to officers and employees | 810.40 | |
| 20,114.66 | ||
| Material purchased for advertisers | 2,669.40 | |
| Advance to publishers (Curtis Publishing Co.) | 9,441.67 | |
| Stockholders' notes receivable | 17,426.61 | |
| Accrued interest on above | 794.09 | |
| 18,220.70 | ||
| Stocks and bonds - | ||
| Liberty bonds | 12,182.50 | |
| War savings certificates | 421.80 | |
| Industrial bonds | 2,000.00 | |
| Federal Schools (Inc.) stock | 3,225.00 | |
| Perfection Manufacturing Co | 800.00 | |
| National Outdoor Advertising Bureau | 100.00 | |
| 18,729.30 | ||
| Material and supplies inventory | 539.63 | |
| Furniture and fixtures | 4,643.22 | |
| Library | 2,693.63 | |
| Good will | 20,000.00 | |
| 104,644.09 | ||
| LIABILITIES: | ||
| Accounts payable | 12,095.29 | |
| Accrual for unbilled space | 9,264.23 | |
| Accrual for unbilled material | 328.33 | |
| Capital stock issued | 65,200.00 | |
| Surplus | 16,529.63 | |
| Special surplus - premium on capital stock sold | 1,226.61 | |
| 104,644.09 |
*3857 *167 The petitioner always procured from advertisers in advance of ordering any advertising a signed authorization to act as the advertiser's agent to buy space for him.
OPINION.
SMITH: A personal service corporation is defined by section 200 of the Revenue Act of 1918. To come within that definition a corporation must meet all of the requirements of the statute enumerated as follows:
1. The income of the corporation must be ascribed primarily to the activities of the principal owners or stockholders.
2. The principal owners or stockholders must themselves be actually engaged in the active conduct of the affairs of the corporation.
3. Capital (whether invested or borrowed) must not be a material income-producing factor.
4. Gains, profits or income derived from trading as a principal must not amount to or exceed 50 per centum of the gross income.
No question is raised by the respondent but that the petitioner met the other requirements of a personal service corporation.
The first element of the definition of a personal service corporation is directed toward the elimination of inequality of taxation of partnerships, on the one hand, and corporations*3858 in which the income is due primarily to the personal activities of the principal stockholders (whether professional, clerical, executive, or manual), on the other hand. * * * (.)
The question before the Board is primarily one of classification If the petitioner fairly meets the requirements of a personal service corporation it is to be taxed as such. This is not a question of the exemption of the petitioner from taxation; for a personal service corporation is not exempt from taxation.
The application of section 200 of the Revenue Act of 1918 to an advertising agency received careful consideration in the case of . The decisions of the Board and of the courts in personal service corporation tax cases were exhaustively reviewed in that case. The facts in this case are much the same as those which obtained in the case considered by Judge Westenhaver.
The first objection made by the respondent to the classification of the petitioner as a personal service corporation is that the income of the corporation can not be ascribed primarily to the activities*3859 of the principal owners or stockholders. We think, however, that the evidence is to the contrary. Most of the clients of the petitioner were obtained by Mac Martin and C. R. Ferrall. They were in close personal touch with the advertisers and were responsible for the *168 success of the agency. We can not doubt that the advertisers placed their business in the hands of the petitioner by reason of the personal services rendered by these stockholders. It is inconceivable that this business could have been retained by the petitioner had these men not been connected with it.
The respondent also objects that the second largest stockholder, Mary W. Martin, was not actually engaged in the active conduct of the affairs of the corporation and therefore that it can not be said that the principal owners or stockholders were actually engaged in the active conduct of the business of the petitioner.
Mary W. Martin owned slightly more than 20 per cent of the stock of the corporation. All of the other stockholders were actively engaged in the business of the corporation. We think that the ownership by Mary W. Martin of approximately 21 per cent of the stock of the corporation is*3860 insufficient to defeat the provision of the statute that the principal owners or stockholders must themselves be actually engaged in the active conduct of the affairs of the corporation. Cf. .
We now come to the question as to whether capital, whether invested or borrowed, was a material income-producing factor. Witnesses for the petitioner testified that capital was not essential in the conduct of an advertising agency; that the petitioner in no case attempted to finance its clients and that it had an agreement with them to the effect that in all cases advertising bills should be paid to the petitioner within such time as would enable it to remit to the publishers before the due date. This was in order that the petitioner might take advantage of the large discounts offered by the publishers for the prompt payment of bills. In 1919 the petitioner sent 1,430 bills to advertisers and in only 191 cases did the advertiser fail to remit to the petitioner before it was necessary for the petitioner to forward the remittances to the publisher in order to obtain a discount. It further is in*3861 evidence that where the petitioner remitted to the publisher before the advertiser paid the bill, the advertiser was not more than a few days late in making payment. Only a negligible amount of earnings was realized by the petitioner from its capital. In the light of these facts we think that capital was not a material income-producing factor in producing the income of the petitioner.
The respondent also objects to the classification of the petitioner as a personal service corporation upon the ground that it can not be said that gains, profits or income derived from trading as a principal did not exceed 50 per centum of the gross income. This argument is based upon the contention that the petitioner purchased *169 space from publishers which it sold to the advertiser. In our opinion the evidence does not support this contention. The same contention was considered by the court in , and also by the Board in . The petitioner clearly was not contracting for space in pubications which it sold to advertisers. Although it derived some profit upon drawings and plates which*3862 it made or had made for it and furnished to the advertiser the amount of income from this source was far less than 50 per cent of the total income. Upon the record as made the claim of the petitioner that it was a personal service corporation for the period February 1 to December 31, 1919, must be and is sustained.
Reviewed by the Board.
Judgment will be entered for the petitioner.
Footnotes
1. Of which 99 shares were issued May 10, 1919. ↩