*3001 Petitioner, an advertising agency, held to be entitled to classification as a personal service corporation. H. K. McCann Co., 14 B.T.A. 234">14 B.T.A. 234, cited and followed.
*251 The Commissioner determined a deficiency of $45,527.78 in income and profits taxes for 1919. The petitioner instituted this proceeding for a redetermination thereof. It alleged that the respondent erred (1) in holding that petitioner was not a personal service corporation as defined in section 200 of the Revenue Act of 1918, (2) in refusing to compute petitioner's tax liability under sections 327 and 328 of the Revenue Act of 1918, (3) in failing to allow as a deduction from gross income a "reserve for Treasury stock," claimed by petitioner as compensation to certain officers and employees in the taxable year.
FINDINGS OF FACT.
For some time prior to 1912 H. K. McCann had been advertising manager of the Standard Oil Co., with his office in New York City. *252 Associated with him there, in*3002 responsible capacities, were Harrison Atwood, R. W. St. Hill, John P. Hallman, and Thomas Nast, Jr. This central advertising department had handled all of the advertising for the Standard Oil Co. and its subsidiaries. In 1911, because of a decree of the United States Supreme Court, the Standard Oil Co. was ordered to give up control of all of its American subsidiaries. Compliance with this decree necessitated the dissolution of the Standard Oil Co.'s central advertising department. At that time McCann recommended to the officials of that company that he and his associates continue the advertising work for the various subsidiary corporations which had composed the Standard Oil Company, probably in a corporate form of organization. This recommendation met with approval and McCann secured appointments as advertising agent from 13 of these subsidiary corporations.
Petitioner was incorporated on November 13, 1911, under the laws of New York, and began business as an advertising agent in an office of its own. Continuously from its incorporation and throughout the year 1919, it conducted business exclusively as an advertising agent with its principal office in New York City. Its*3003 five incorporators were H. K. McCann, R. W. St. Hill, Thomas Nast, Jr., J. P. Hallman, and Harrison Atwood. Each of these five incorporators had a specialized knowledge of some phase of advertising work and all of them with the exception of Thomas Nast, Jr., continued their services as stockholders in petitioner continuously from the time of incorporation throughout the year 1919. Nast was not a stockholder at any time during 1919.
Petitioner's capital stock was $100,000, divided into 1,000 shares of a par value of $100 each. At the time of incorporation all of the authorized stock was subscribed and issued for $10,000 in cash and for assignment to the corporation of agreements, evidenced by letters which McCann had received from the subsidiary Standard Oil companies, authorizing him to act as their advertising agent. No other capital had been paid in for stock prior to December 31, 1919.
In 1913 petitioner opened a branch office in San Francisco, Calif., primarily for convenience in serving the Standard Oil Co. of California, one of petitioner's original clients. In 1915 it opened a branch office in Cleveland, Ohio, and prior to 1919 it organized the H. K. McCann Co., Ltd. *3004 , a Canadian corporation. Petitioner owned all of the stock of such Canadian corporation, except directors' qualifying shares.
The stockholders of petitioner and the number of shares held by each on January 1, 1919, and December 31, 1919, were as follows:
| Jan. 1 | Dec. 31 | |
| Harrison Atwood | 75 | 75 |
| Williams Cochran | 50 | |
| L. W. Ellis | 50 | 50 |
| J. P. Hallman | 25 | 50 |
| K. H. Kelley | 5 | 5 |
| H. K. McCann | 590 | 565 |
| E. W. Mann | 5 | 5 |
| G. F. Murnane | 75 | |
| Sarah Nast, trustee for Thos. Nast St. Hill | 50 | 50 |
| R. W. St. Hill | 75 | 75 |
| Treasury stock | 125 | |
| 1,000 | 1,000 |
*253 Williams Cochran was a stockholder of record until October 27, 1919, when his stock was purchased by McCann for petitioner and became Treasury stock. G. F. Murnane was a stockholder of record until July 23, 1919, when his stock was purchased by McCann for petitioner and became Treasury stock. This purchase was ratified by the board of directors at a meeting on September 17, 1919.
Petitioner rendered service to advertisers, whom it designated as clients. This service varied according to the requirements of the particular case. In a few instances it consisted of such services as the insertion*3005 of advertisements in newspapers or periodicals, minor publicity campaigns, advice on particular questions of advertising or the obtaining of special information for the use of an advertiser. In some instances petitioner's service comprehended an advertising campaign on an extensive scale to create a market for particular products or to extend the market already created. In such a campaign petitioner's service included a survey of the client's advertising situation at that time, a study of the market for its products, its sales policy, competitive market conditions, the classification and selection of media for advertising, the formation of the basic advertising plan and the preparation of estimates of its cost. Its service sometimes included the recommendation and selection of package designs, labels, trademarks, trade names, and trade slogans, and the selection of the particular product to be used as a leader in the advertising. Throughout the campaign petitioner frequently consulted and advised with its clients. Investigations were made of the effect of the advertising upon sales and where it was necessary during the progress of an advertising campaign to make changes in the*3006 plan of advertising such changes were recommended and made by petitioner.
In many cases petitioner acted as the advertising agent for large corporations and directed and prepared practically all their advertising. With such clients advertising was a matter of careful planning and budgeting, and petitioner's recommendations for an advertising plan usually included the estimated cost of the advertising and formed a basis upon which budget appropriations were made. Petitioner would submit at least annually a plan of advertising for the year with an estimate of its cost. The preparation of such a plan involved continued consideration of the advertising and merchandising *254 needs of the advertiser. Many clients were retained from year to year and the service to them was in its nature continuous.
After a basic plan for the campaign had been passed and agreed upon, petitioner's service varied with the particular case and media selected. Where advertising was to be placed in newspapers and periodicals it included the selection and recommendation of proper publications, which were submitted to the client for his approval. After approval by the client the petitioner would*3007 issue an order to the publisher reserving the necessary space. Such orders specified the name of the advertiser whose advertising was to be inserted in the space ordered.
Petitioner's service included the preparation of the advertising to be used, including copy and art drawings. A layout of the proposed advertisement would be submitted to the client for his approval. after it had been approved by the client any drawings would be sent to an engraver. The finished engraving with the copy for the advertisement would be sent to a printer to be set into type. Proof would be taken and sent to the client for his approval. When approved, electrotype plates or mats of the advertisement would be made and set out to the publications, together with instructions with respect to its insertion.
Where the media consisted of show cards and booklets, petitioner's service included the outlining of the text; the preparation of a dummy to indicate the character of the booklet; the preparation of rough drawings, layout and copy; the preparation or purchase of art work; and the preparation of the original design of show cards, including art design and text. Where the media consisted of billboard*3008 or out-of-door advertising, petitioner's service included a survey of the territory to determine the location of the billboard, preparation and submission of designs for the advertising, and arranging with the out-door advertising companies for the erection and painting of the billboards. In a publicity campaign petitioner selected the media, drafted and prepared the advertisements, directed the publication of pamphlets and show cards and inserted the advertisements in publications.
In art advertising petitioner first prepared a layout or design to convey to the client an idea of the proposed advertising. When approved by the advertiser this rough was followed in detail in the finished drawing or engraving. Finished drawings were usually made by outside artists, but sometimes by artists employed by petitioner. Most of the art work and all of the mechanical work such as engraving, electrotyping and the preparation of mats was done outside of petitioner's organization.
Petitioner had been granted recognition as an advertising agency by publications and publishers' associations. As a recognized advertising *255 agency, petitioner was allowed by publishers a rebate or*3009 commission on advertising placed with them. These commissions were usually 15 per cent of the schedule rates for advertising. The principal source of petitioner's income for the taxable year was from such commissions and from service fees which were charged on special work, such as booklets, folders, signs and miscellaneous matter, or where the amount expended was small in proportion to the work required of petitioner. On the cost of work which petitioner had executed for its clients such as art work, engraving, electrotypes, composing, and miscellaneous production work a service fee, usually 15 per cent of the cost, was charged.
Bills for advertising were generally rendered to the petitioner, but occasionally were sent by the publishers to the advertiser. Separate bills were required for the advertising of each client. Usually the name of the client or the product advertised was stated in the bill. In most instances invoices were billed to petitioner by specifying the advertiser and designating petitioner as agent. Occasionally they were billed to the advertiser, care of petitioner or billed to the advertiser without mention of petitioner. In all cases such bills and all*3010 bills for drawings, engraving, composition, electrotyping, printing, or other services were checked. Petitioner made certain that the advertising had been inserted and checked the measurement of the space used. The amount of the deductions allowed petitioner was subtracted from the amount of each bill and the client would be billed for the net amount, plus 15 per cent.
In addition to the agency commission it was customary for publishers to allow a discount for payment of their bills within a certain time. It was customary for petitioner to take advantage of this discount, and to pass it on to its clients. Where materials ordered for a client were subject to trade discounts petitioner passed these discounts on to the client. It was petitioner's practice to bill clients for magazine advertising in advance of billing by the publisher in order that petitioner might receive payment from clients before it made payment to the publisher. This was termed billing from schedule. In the case of magazine advertising, which comprised about 60 per cent of the total advertising, the billing was usually made from schedule and promptly paid. In the case of newspaper advertising it was impracticable*3011 to bill from schedule. It was necessary for petitioner to check the advertisements, particularly in regard to the quantity of space used, before billing its clients. It measured each newspaper advertisement in order to correct any variations from schedule in the amount of space used. In 1919 publishers did not send petitioner sufficient extra copies of newspapers to enable it to audit the publishers' bills promptly, and during that year petitioner experienced *256 a large labor turnover which delayed the work of billing clients for newspaper advertising. These conditions affected the synchronizing of petitioner's receipts from clients with its payments to publishers. It was petitioner's practice in such instances to pay the publishers on time and delay the billing to the client until the advertisements could be checked. This delay was from three to seven days and the clients usually paid promptly upon receipt of their bills. This delay accounted in part for the excess of accounts receivable at the end of the year over the amount of such accounts at the beginning of the year. During each month of the year, except February and June, the collections from its clients exceeded*3012 its disbursements for them. During the year 1919 petitioner collected from all clients approximately $565,000 more than its disbursements for their account.
Petitioner ordered space for its clients from publishers. The name of the advertiser was disclosed in all orders for space given by petitioner to publishers. The petitioner purchased no advertising space in bulk and no space for its own account, except a small amount in a trade journal in which it inserted advertisements of its own business. Petitioner expended for its own advertising during 1919, $5,346.90. Petitioner did not order space for a client unless the client knew the cost and approved it. Space ordered for one advertiser could not be used by another or by petitioner.
Petitioner's agreements with its clients usually took the form of an exchange of letters stating what petitioner was to do, what compensation it was to receive, and the terms of that compensation. These agreements were not for any fixed length of time. Petitioner's relationship with a client was cancelable by either at will. Upon the termination of the relationship between petitioner and a client petitioner turned over to the client copies*3013 of outstanding contracts which it had made on the client's account and any advertising material, such as drawings, layouts, booklets, and records which petitioner had in its possession. Unused space belonged to the client and could be used by it with or without another agent. Publishers did not require new orders from new agents for unused space that had been ordered for an advertiser by a former agent, but would deal with a new agent in the same way they had dealt with the former agent. Publishers made no objection to the changing of agents by an advertiser.
Publishers used one of two kinds of rates, flat or scale. A flat rate was one charged regardless of the quantity of space used. A scale rate was one which varied with the quantity of space used, decreasing per line as the space used increased. When an advertiser used more space than had been ordered for him and thereby became entitled to a lower rate per line, the advertiser was given the benefit of the lower rate. If the advertiser used less space than had been ordered for him and was thereby subject to a correspondingly higher rate, he was required *257 to pay this rate. Contracts for advertising were usually, *3014 but not always, subject to cancellation by the advertiser.
An advertising agent must be recognized as such by the publisher, or by a publishers' association of which the publisher is a member, before it receives any commissions or discounts on advertising placed by it with such publisher. In granting recognition the major factors considered are professional skill, experience, character and volume of business transacted. Financial responsibility of the agent is a minor factor in granting recognition, but a major and controlling factor in granting credit to any agent. Before any step in an advertising campaign was taken the advertiser agreed to accept petitioner as his agent Petitioner did not serve competing advertisers.
Petitioner's balance sheets as of January 1, 1919, and December 31, 1919, were as follows:
| Jan. 1, 1919 | Dec. 31, 1919 | |||
| ASSETS | ||||
| Cash: | ||||
| N.Y. cash in bank | $5,023.13 | $44,704.15 | ||
| N.Y. petty cash fund | 450.00 | 450.00 | ||
| San Francisco cash in bank | 5,655.57 | 5,936.08 | ||
| Cleveland cash in bank | 800.00 | 273.19 | ||
| $11,928.70 | $51,363.42 | |||
| Accounts receivable | 140,616.60 | 305,258.77 | ||
| Loans and advances: | ||||
| H. K. McCann Co., Ltd. (Canada) | 10,000.00 | 8,000.00 | ||
| Sundry stockholders | 7,500.00 | 6,962.50 | ||
| Sundry employees | 2,177.50 | 2,447.50 | ||
| L. S. Briggs mortgage | 2,375.00 | 2,025.00 | ||
| G. F. Murnane current account | 5,513.72 | |||
| Sundry expense funds | 645.00 | 890.00 | ||
| 28,211.22 | 20,325.00 | |||
| Investments: | ||||
| Liberty bonds | 59,316.50 | 67,370.00 | ||
| H. K. McCann Co., Ltd. (Canada) | 4,633.11 | 4,633.11 | ||
| Seaview and Scarsdale golf clubs | 400.00 | 400.00 | ||
| Advertising Agencies Corp | 200.00 | |||
| Miscellaneous investments | 4,459.58 | |||
| 64,349.61 | 77,062.69 | |||
| Office furniture and fixtures: | ||||
| New York | 5,526.22 | 8,186.96 | ||
| San Francisco | 1,727.44 | 5,307.31 | ||
| Cleveland | 1,002.44 | 1,869.56 | ||
| 8,256.10 | 15,363.83 | |||
| Automobiles | 620.00 | 4,570.00 | ||
| Contract rights (acquired for capital stock) | 90,000.00 | 90,000.00 | ||
| Deferred debit: Liberty bond interest adjustment | 63.25 | |||
| Suspense items rechargeable: | ||||
| Paid to craftsmen | 26,634.99 | 26,707.08 | ||
| Unpaid to craftsmen | 6,885.11 | 12,133.53 | ||
| 33,520.10 | 38,840.61 | |||
| Prepaid rent, San Francisco | 650.00 | |||
| Total | 377,565.58 | 603,434.32 | ||
| LIABILITIES | ||||
| Accounts payable (to publishers) | 22,997.66 | 57,765.00 | ||
| Sundry accounts payable | 317.94 | 2,800.06 | ||
| Notes payable | 20,000.00 | 145,000.00 | ||
| Payable to craftsmen | 6,885.11 | 12,133.53 | ||
| 50,200.71 | 217,698.59 | |||
| CAPITAL | ||||
| Capital stock issued and outstanding | 100,000.00 | 87,500.00 | ||
| Reserve for 1918 taxes | 15,000.00 | |||
| Treasury Stock Reserve | 3,088.30 | |||
| Surplus | 212,364.87 | 295,147.43 | ||
| 327,364.87 | 385,735.73 | |||
| Total | 377,565.58 | 603,434.32 |
*3015 *258 The item "Cash in Bank" represents the balance according to petitioner's cash book, that was available in the banks with which petitioner was making deposits. Petitioner's checks to publishers which had been drawn by it and entered upon its books of account but not charged by the bank against its account amounted to $86,828.03 at January 1, 1919, and $135,513.06 at December 31, 1919.
Petitioner's accounts receivable represented the amounts charged to clients on its books whether or not payment was due to the publishers and whether or not payment had been made by petitioner. Accounts receivable at the beginning and at the end of the year represented the debit balances in the accounts of advertisers for advertising space or preparatory material and included the commissions due petitioner on such accounts in the amount of $19,686.32 at the beginning of the year and $45,888.15 at the end of the year. During the first 20 days of January, 1919, petitioner collected from all clients $104,534.04, and during the first 20 days of January, 1920, it collected from all clients $237,216.96. These collections included certain items charged to clients during those 20 days, and*3016 all of the accounts receivable on January 1, 1919, and on December 31, 1919, were not collected during such 20 days. Petitioner's accounts receivable from all clients at March 1, 1919, were $232,181.51. The total amount of collections from all clients during the first 20 days of April, 1919, was $237,806.76. These collections included certain items charged to clients during those 20 days. Petitioner's accounts receivable at September 1, 1919, were $160,000.50. The total amount of collections from all clients during the first 20 days of September, 1919, was $140,900.14. These collections included certain items charged to clients during those 20 days. All accounts receivable at March 1, 1919, and September 1, 1919, were not collected within such 20-day period.
The loans and advances to H. K. McCann, Ltd., of $10,000 at the beginning of the year and $8,000 at the end of the year represented petitioner's funds left on deposit in the Canadian bank of its subsidiary corporation. Checks on the Canadian bank account were signed by petitioner's treasurer in New York, and these funds could have been withdrawn at any time. They were allowed to remain in the Canadian bank due to unfavorable*3017 rates of exchange. The items of $7,500 at the beginning of the year and $6,962.50 at the end of the year represented loans and advances to petitioner's stockholders. The item of $2,177.50 at the beginning of the year and $2,447.50 at the end of the year represented loans and advances to petitioner's employees. The L. S. Briggs mortgage represented a second mortgage held by petitioner on the home of one of its employees. It drew interest during the taxable year at the rate of 6 per cent. The G. F. Murnane current account represented advances made for the personal *259 account of Murnane, a stockholder of petitioner, while he was absent in Europe on Red Cross work. This amount was ultimately collected from Murnane and petitioner charged no interest on the advances. Sundry expense funds represented money in the hands of petitioner's stockholders for emergency expenses.
The investment in Liberty bonds represented subscriptions by petitioner or its employees in United States Liberty bonds, the company having subscribed to Liberty bond issues and having allowed its employees to place their subscriptions through it and to make payment by deductions from their compensation. *3018 The item of $4,633.11 represents petitioner's investment in the capital stock of the H. K. McCann Co., Ltd. Prior to the organization of the McCann Co., Ltd. petitioner had maintained an office in Canada, and upon the organization of that company turned over to it certain furniture and fixtures of that office and the debit balance of the Imperial Oil Co. account, the total value of which was $4,633.11, in exchange for all of its capital stock, except five qualifying shares. The item of $400 represents one share of stock each in the Seaview and Scarsdale Golf Clubs. This stock was issued in the name of two of petitioner's stockholders, St. Hill and Hallman. The item of $200 represents stock taken by petitioner in a corporation organized by the leading advertising agencies to assist the Army and Navy in recruiting campaigns after the war and in disposing of surplus material. Petitioner received no dividends from this stock. Miscellaneous investments of $4,459.58 were composed of an investment of $1,000 in the Bestol Co., $1,000 in the National Outdoor Advertising Bureau and $2,459.58 in Sanford Briggs, Inc. This last item represented cash advanced by McCann to Sanford Briggs*3019 in 1919 at the time he started in business for himself as a commercial artist, Briggs having until that time been in the employ of petitioner. This loan was turned over to petitioner and assumed by it prior to December 31, 1919. Petitioner received no interest, dividends, or other types or forms of income from any of its investments, except Liberty bonds.
The item of furniture and fixtures represents the ordinary office fixtures and did not include any printing presses, electrotyping or similar equipment. The item automobiles represents automobiles used by petitioner in its business. The item of contract rights $90,000, represents the agreements appointing petitioner as an advertising agent for certain subsidiaries of the Standard Oil Co., for which 900 shares of petitioner's stock was issued to McCann at organization. The suspense item rechargeable, paid to craftsmen, represents items for art or mechanical work which had been paid by petitioner but not yet billed to the client. Suspense items payable to craftsmen represent similar items unpaid by petitioner.
*260 The item of accounts payable to publishers represents accounts payable for space which had been billed*3020 to the client but for which checks had not been sent to the publisher. In order to distribute more regularly the work of preparing checks, it was customary to prepare such checks in advance of the date of payment and to hold them for mailing until a day when they would be received by the publisher, in the ordinary course of the mail, at or just prior to the discount date. Checks were entered in the books as of the date when drawn, not when mailed. The amount due publishers, including the amount for which checks had not been mailed or had not been paid, was in excess of the amount shown on the annual statement.
The item notes payable at the beginning of the year represents a note for $20,000 given by petitioner to finance the purchase of Liberty bonds, and was secured by all of petitioner's Liberty bonds as collateral. The notes payable at the end of the year includes notes given by petitioner in its Liberty bond transactions. It also represents money borrowed by petitioner for use in its business. The item is made up of four notes payable to the Liberty National Bank, being the last four notes in the following schedule of petitioner's notes payable transactions, all of which*3021 were payable to the Liberty National Bank:
| Date | Amount | Term | Date paid | Form of payment |
| Dec. 2, 1918 | $20,000.00 | Feb. 4, 1919 | Extended; new note. | |
| Feb. 4, 1919 | 30,000.00 | 90 days | May 5, 1919 | Do. |
| Feb. 28, 1919 | 40,000.00 | Demand | Mar. 12, 1919 | Cash. |
| May 5, 1919 | 30,000.00 | 60 days | July 7, 1919 | Extended; new note. |
| July 2, 1919 | 50,000.00 | Demand | July 9, 1919 | Cash. |
| July 7, 1919 | 30,000.00 | Oct. 6, 1919 | Extended; new note. | |
| Aug. 18, 1919 | 40,000.00 | Demand | Aug. 22, 1919 | Cash. |
| Oct. 3, 1919 | 20,000.00 | Oct. 7, 1919 | Do. | |
| Oct. 6, 1919 | 30,000.00 | 3 months | Jan. 6, 1920 | Extended; new note. |
| Oct. 14, 1919 | 15,000.00 | Jan. 12, 1920 | Jan. 12, 1920 | Cash. |
| Dec. 2, 1919 | 50,000.00 | Jan. 10, 1920 | Do. | |
| Dec. 18, 1919 | 50,000.00 | Demand | Sept. 2, 1920 | Do. |
The items payable to craftsmen represent bills payable to craftsmen for art and mechanical work. The item treasury stock reserve represents the estimated book value in the taxable year of one-fifth of certain capital stock which petitioner had agreed to issue to Mann, already a stockholder, and Palmer, an employee (25 shares), provided they remained with petitioner's organization for five*3022 years.
No client asked petitioner to prepay bills for its advertising or to extend credit to it, and petitioner never offered to do either of these things. No publisher asked petitioner to guarantee any bill for advertising and petitioner never did so. Publishers did not inquire concerning petitioner's financial condition and petitioner never furnished a statement of its financial condition to any publisher. Publishers inquired into the financial condition of advertisers. Petitioner's clients had excellent financial ratings.
*261 Petitioner's income and expenses for 1919 were as follows:
| Income: | ||||
| Advertising commissions | $505,010.41 | |||
| Art and mechanical and fees - | ||||
| New York | $59,724.33 | |||
| Cleveland | 20,050.95 | |||
| San Francisco (per books) | $29,980.05 | |||
| Less artists | 14,894.79 | |||
| 15,085.26 | ||||
| 94,860.54 | ||||
| Interest from Liberty bonds | 2,200.41 | |||
| Interest on bank balance | 606.43 | |||
| Interest, miscellaneous | 545.77 | |||
| Sale of old papers | 108.96 | |||
| Miscellaneous | 314.60 | |||
| $603,647.12 | ||||
| Expenses: | ||||
| Advertising | 5,346.90 | |||
| Corporation taxes | 1,612.27 | |||
| Express and postage | 4,669.72 | |||
| Interest paid | 2,068.05 | |||
| Legal expense | 689.91 | |||
| Rent | 33,882.68 | |||
| Supplies and stationery | 13,422.96 | |||
| Telephone and telegraph | 6,061.15 | |||
| Traveling expenses | 18,260.96 | |||
| Membership dues | 5,211.56 | |||
| Insurance | 814.97 | |||
| Salaries of employees (not stockholders) | 278,560.87 | |||
| Salaries of stockholders | 66,754.15 | |||
| Entertainment | 8,100.51 | |||
| Directors' fees | 910.00 | |||
| General and miscellaneous expenses | 26,720.85 | |||
| Research and investigation | 3,914.60 | |||
| Depreciation | 2,911.00 | |||
| Losses from bad debts | 2,574.66 | |||
| 482,477.77 | ||||
| Net income (per books) | 121,169.35 | |||
| Add: | ||||
| Depreciation not allowed | 603.52 | |||
| Salary paid in stock | 3,088.30 | |||
| 3,691.82 | ||||
| Income per Commissioner's contention | 124,861.17 |
*3023 The item advertising commissions, $505,010.41, represents petitioner's income from commissions and service fees charged by petitioner to its clients for handling certain types of advertising. The item art and mechanical fees, $94,860.54, represents petitioner's income from commissions and fees on art and mechanical work which it executed for its clients. The deduction of $14,894.79 from the San Francisco art and mechanical fees represented petitioner's payments to free-lance artists to whom it had supplied desk room and *262 finished drawings for which petitioner had billed its clients. The item miscellaneous interest, $545.77, represents $450 interest on Victory Loan bonds and $95.77 interest on the mortgage of L. S. Briggs, an employee. The item of miscellaneous income, $314.60, represents receipts by the company of accounts that had been charged off in previous years. None of petitioner's income during 1919 was received on Government contracts made at any time.
The expense item for advertising, $5,346.90, represents the cost of advertising which petitioner did for itself during 1919. The item of corporation taxes, $1,612.27, represents state taxes in New York, *3024 California, and Ohio. The item of interest paid, $2,068.05, represents interest on petitioner's notes paid to the Liberty National Bank during the year. The item of traveling expenses, $18,260.96, represents traveling expenses of petitioner's officers in all of its three offices in connection with its service to its clients. The item of membership dues, $5,211.56, represents dues paid to business organizations of which petitioner was a member. The item of insurance represents premiums for insurance which petitioner carried on furniture and fixtures. The item general expenses, $26,720.85, represents general expenses that could not be allocated to other detailed accounts. The item of $3,914.60, represents expenses incurred by petitioner in research and investigation that were not billed to its clients. The item losses from bad debts, $2,574.66, represents the debts ascertained to be worthless and charged off in the taxable year. Of this amount, at least, $1,158.58 represents commissions and service fees which were charged, but not collected. The balance represents losses of cash expenditures for clients which petitioner had made. The item salary paid in stock, $3,088.30, represents*3025 the estimated value of one-fifth of certain treasury stock which petitioner had agreed to give to two of its employees.
During 1919 petitioner paid salaries of $278,560.87 to its employees. The total number of employees in petitioner's service during the year, regardless of length of time employed, was 252. Of these 89 remained in its employ continuously throughout the year and 163 were employed for an average term of approximately four months. The average number employed throughout the year was 145. These employees were variously classified as service assistants, visualizers, or layout artists, artists, copywriters, investigators, bookkeepers, clerks, stenographers, mechanical men and miscellaneous office employees. It also used number of free-lance artists, who were not regular employees, in the execution of art work.
In petitioner's organization all accounts of clients were in charge of stockholders who planned, advised and contacted with clients concerning their advertising needs. In all advertising campaigns a stockholder outlined the plans for the campaign which were submitted *263 to advertisers for their approval and when approved by the advertiser he supervised*3026 the execution of the plan by the petitioner. Stockholders frequently consulted with the advertisers relative to their advertising needs and studied their manufacturing, advertising and marketing situation with a view to recommending effective plans for their advertising. Any trade or summary investigation to be made in connection with the advertising of the client would be planned by a stockholder and any recommendations based on such investigation would be made by a stockholder. Stockholders consulted with clients on matters concerning the style and form of advertising; selection of general kinds of media; appropriations for advertising; the results of advertising and the advertiser's marketing situation, and recommended changes which were deemed necessary in the advertising plans during the campaign.
During 1919 all new clients were secured by stockholders and all major contacts of the petitioner and its clients were made through its stockholders. A stockholder consulted with the advertiser concerning the method and policy of the advertising and made studies of the sales, advertising and general business situation of clients. On some occasions conferences with clients were*3027 attended by investigators or copywriters of petitioner in order that they might get more definitely certain facts and angles of the business that could be employed in the preparation of copy, and become more familiar with the detailed outline of plans for investigation and research. Stockholders directed the preparation of the advertising and art work for the clients whom they served, which was executed in detail by visualizers, artists, and employees. A stockholder had general supervision of the accounts which he serviced and passed upon all advertising, including copy and art work for those accounts before they were submitted to clients or adopted for use in publications. The form and style of advertisements was often the result of conferences between the stockholder and employees, such as visualizers and artists.
Atwood, a stockholder, was in charge of petitioner's office in San Francisco during the taxable year and planned and supervised the advertising of clients of that office. He was one of the original incorporators of petitioner and was an experienced advertising man. He was the only stockholder of petitioner located in the San Francisco office, and was assisted in*3028 his work there by 88 employees, 17 of whom worked throughout the year, and the balance a portion of the year, being subject to the labor turnover of the office. The total salary paid these employees was $63,483.33. Among these employees were seven service assistants, three of whom worked throughout the year and one of whom received a salary of $7,083.32. The annual rate of compensation paid the others varied from $2,100 per year to *264 $6,750 per year. There was also one office manager in the San Francisco office who received a salary of $3,313. Among the other employees, four were copywriters, one was a visualizer, who was paid a salary of $5,076.49, three were investigators, one of whom worked throughout the year and received a salary of $3,175, and numerous clerks and stenographers. Atwood received a salary of $9,300.
L. W. Ellis, a stockholder, was in charge of petitioner's branch office in Cleveland during 1919 and planned and supervised the advertising for clients of that office. He was also a vice president and director of petitioner. He came into petitioner's organization in 1915, having been selected because of experience which gave him knowledge of the*3029 farm markets required in the service of petitioner's clients in Cleveland. He was assisted in his work by 30 employees, of whom 9 worked throughout the year and the others a portion of the year. These employees were paid a total salary of $27,901.49. Among these employees were five service assistants, one visualizer, two layout artists, three copywriters, one investigator, clerks, stenographers, and office employees. Ellis received a salary of $8,100 in 1919.
Katherine H. Kelley, a stockholder, was confidential secretary to McCann in New York in 1919. She did not render any direct service to petitioner's clients during the taxable year. Her salary was $2,360.
G. F. Murnane, a stockholder during a portion of the taxable year, was not regularly engaged in petitioner's business. During the early part of 1919 he was engaged in Red Cross work. His stock was purchased by McCann for petitioner and became treasury stock. This purchase was ratified by the board of directors at a meeting on September 17, 1919. Murnane was paid a salary of $500 during the taxable year.
Sarah Nast, a stockholder, was not actively engaged in petitioner's business in 1919. She held 50 shares*3030 of petitioner's stock under an oral trust for Thomas Nast St. Hill, who was a stepson of R. W. St. Hill, and was being supported by him. She was represented by R. W. St. Hill as proxy at stockholders' meetings. Thomas Nast St. Hill was employed by petitioner from July 21, 1919, to December 31, 1919, as an investigator. His total salary was $586.63.
Williams Cochran was a stockholder of record until October 27, 1919, but was not regularly and actively employed in petitioner's business. His stock was purchased by McCann for petitioner October 27, 1919, and became treasury stock. Cochran received dividends on his stock up to the time it was purchased by McCann.
J. P. Hallman, a stockholder, was a director and the treasurer of petitioner during the taxabale year and was regularly and actively engaged in petitioner's business. He had charge of the accounting, *265 billing, collecting, and finances of petitioner's business and supervised the media statistics in the New York office. He secured and helped to service one account in 1919. He received a salary of $9,300.
E. W. Mann, a stockholder, was located in the New York office of petitioner and planned and supervised*3031 the advertising of certain clients of that office. A great deal of his time was spent in developing and securing new business. Mann had been associated with petitioner since its organization and was an experienced advertising man. He received a salary of $9,894.15, in the taxable year.
R. W. St. Hill, a stockholder, was vice president and secretary of petitioner. He was located in the New York office during the taxable year and was regularly and actively engaged in petitioner's business. He planned and supervised the advertising of certain clients of that office. He had been associated with petitioner from its incorporation and was an experienced advertising man. His salary was $9,300 in the taxable year.
H. K. McCann was a stockholder and president of petitioner and during the taxable year was regularly and actively engaged in its business. He exercised general supervision over the business and served in a consulting capacity the stockholders who had charge of the accounts and the managers of the branch offices. He frequently consulted with clients on matters of major importance. He personally serviced the accounts of some of the clients of the New York office and*3032 assisted in the servicing of other accounts. His salary was $18,000.
Employees of petitioner who were classified as service assistants acted as assistants to the stockholders in charge of the advertising of clients. They were capable, efficient men, whose functions were to handle the routine matters in the service of clients and to relieve the stockholder in charge of the account of such duties as he could delegate to them in order that he might devote his time to other phases of the advertising service. These service assistants were assigned to stockholders and each stockholder had one or more of them who assisted him in connection with petitioner's advertising service. Stockholders were sometimes accompanied by service assistants in consultations with clients. The advertising upon which they worked was discussed with the stockholder in charge. Suggestions were sometimes made by service assistants and accepted by stockholders. Stockholders delegated to service assistants such work as they performed and the service assistants were capable of executing in detail the portions of work assigned to them. Among their duties were the supervision of the progress through the office*3033 of the advertising on which they functioned, supervising the gathering of information and the necessary data to be used in connection with the advertising of the client, contacting with clients on routine matters *266 and interviewing representatives of publishers. They sometimes assisted in writing copy. The assisted the stockholder and performed duties similar to his, but subject to his direction. They sometimes participated to some extent in discussions at conferences between the stockholder and clients and at such times advanced their own ideas. At other times they attended such conferences but took no part. Petitioner had in its employ in 1919 twenty-one service assistants, to whom it paid salaries of $54,176.95. Of these employees 10 worked throughout the year and the average number employed during the year was 14. When the stockholder in charge of an account was absent from his office, the work on the account was carried forward during his absence by a service assistant.
The function of the visualizers or layout artists was to reduce to a rough drawing, layout, or dummy, the idea which it was sought to embody in the advertising. When this layout had been satisfactorily*3034 executed and approved by the client, it would form the basis upon which the finished drawings, or paintings, for the pictorial portion of an advertisement were prepared by an artist. The quality which an artist put into the work was individual. He was given the idea, which was sought to be embodied in the advertising plan, by a stockholder or his assistant and would visualize this idea. In conferences concerning the form and style of the layout, booklet, or rough drawing, the stockholder would suggest the general ideas of the advertising and the visualizer or layout artist would visualize those ideas and in many instances supplement them by their own ideas. Sometimes these ideas were accepted by the stockholder and sometimes they were not. The building up of a satisfactory representation of the advertising idea was sometimes a mutual process between the stockholder in charge of the account and the artist or visualizer who sought to give expression to the idea. In all cases the layout was satisfactory to the stockholder before it was submitted to the client for his approval. After the approval of the finished layout, it would be given over to the art or production division which*3035 supervised the actual production of the advertising in its finished form. Much of the art work was done outside of petitioner's organization. In the New York office petitioner had what it called the art division of its production department which was in charge of a foreman who directed the production of the art work in that office. He received a salary of $8,350 in the taxable year.
Petitioner had in its employ about 20 copywriters, who worked with the stockholder in the preparation of advertising copy, and who also wrote copy for pamphlets and booklets which were used in advertising. They were given assignments by the stockholder or assistant and they used their own intelligence in producing copy along the *267 general plan being pursued. Their copy was subject to review and approval by the stockholder in charge of the account and ultimately by the client whose approval was necessary. They were men of some experience and were able to do efficient work in their line. They were capable of interchanging ideas and carrying out the preparation of copy along the lines of the advertising scheme. In some instances the copywriter was given certain facts and ideas and worked*3036 out in collaboration with some member of the art department the development of the copy and rough. Sometimes copy was written by stockholders and sometimes typical headlines and typical finished copy would be prepared by the stockholder which the copywriter would follow in preparing further advertisements along the same general line. The salaries of copywriters ranged from $100 a month to $4,425 a year, and the average salary was about $2,000 a year.
Investigators were employed to ascertain facts and gather data to be used in connection with the formation and checking of the advertising campaign or in the advertisements. This information had to do with facts relating to the things to be advertised, such as the market for the material, or the nature and extent of competition. Sometimes it took the form of a canvass of the territory to be covered and interviews with dealers and consumers. Sometimes information was sought as to the reaction of the dealer or consumer to the advertisements. Sometimes a questionnaire prepared by a stockholder was used to obtain information. In other cases investigators obtained information by interviews and transmitted that information to the stockholder*3037 in charge of the account, who used it as a basis for his recommendations to the client concerning the general plan of advertising campaign to be adopted. This classified information was essential to the quality of the service given by petitioner. Petitioner employed 10 investigators during the taxable year, to whom it paid salaries ranging from $1,625 to $3,175 a year. Four of these were employed continuously throughout the year and received total salaries of $9,029.
Bookkeepers, clerks, stenographers, checkers, type and mechanical men were employed by petitioner and performed the routine duties indicated by their classification. Included under the head of mechanical employees were those who looked after the preparation of engravings, the making and forwarding of electrotypes or mats and the composition of type. They would issue orders to the manufacturers for plates, engravings, composition or other work which was done outside of petitioner's organization. One Palmer, an employee, was a director of petitioner during 1919 although not a stockholder. He had the title of general manager and was in charge of the personnel and office routine of the New York office. He also did*3038 work *268 as a service assistant. The total compensation paid to him during the taxable year was $10,594.11. Another employee, L. S. Briggs, was a director of the company although not a stockholder. He had charge of the production department in the New York office during the taxable year, and exercised general supervision over the preparation of the advertising, both from the standpoint of art and copy and the mechanical phases of its preparation. In the exercise of his duties he contacted with stockholders and gave suggestions and ideas for portraying in a graphic way ideas that they had in mind for advertising. In the preparation of such work he would assign somebody in his department to assist the stockholder in carrying out the idea that had been discussed and agreed upon. His salary during the year was $8,350. No solicitors or salesmen were employed by the petitioner.
Petitioner's gross advertising business increased from $2,757,236.54 in 1918 to $4,382,362.55 in 1919 and its gross income increased from $386,502.35 in 1918 to $603,647.12 in 1919. There was no definite proportion between the amount of income that the petitioner was to realize from an account and*3039 the amount of time and effort expended by the stockholder who was servicing it. When new accounts were added it was necessary to increase the number of employees in order to take care of the advertising. Where the amount expended in advertising was small and it was not necessary to prepare an extensive campaign or where the service was routine, such as the insertion of notices in publications, the clients were serviced by petitioner's organization without requiring any particular activities on the part of the stockholders.
During 1919 the expenditures of petitioner's clients for advertising exceeded $4,382,000. Of this amount $3,310,000 was expended by ten clients whose advertising expenditures ranged from $114,000 to $840,000 each. Ten other of such clients expended $475,000 in amounts ranging from $31,000 to $77,000 each. Approximately 44 per cent of the total amount expended was for advertising of the Standard Oil companies which had been the original clients of petitioner.
The Commissioner found a deficiency of income and profits taxes in the amount of $45,527.78. Petitioner filed its income-tax reuturn for the calendar year 1919 and claimed classification as a personal*3040 service corporation which the respondent denied.
OPINION.
PHILLIPS: In , we reached the conclusion that this petitioner was a personal service corporation in 1918. Most of what we said in that opinion has *269 equal application to the situation of the petitioner in 1919, the year before us. During this year the petitioner did a larger volume of business than in 1918 and the number of its employees increased. Some of these employees were called upon to perform more important functions than in the former year. The stockholders, however, continued as the active, creative force in the handling of all business and their experience, judgment and planning remained as the foundation of the service rendered. The business of the petitioner continued to be the rendition of advertising counsel and advice to a relatively small number of large advertisers, all of whom had been procured by the stockholders by reason of their advertising experience and all of whom were served personally by the stockholders in matters of importance.
A greater amount of capital was used in the business than in the prior year, petitioner having*3041 recourse to substantial loans at the banks, but the circumstances are such as to indicate that such capital played no material part in producing income. It had been the custom of petitioner to bill its clients in time to receive their payments before it made payment for their accounts. Because of the large volume of business and the substantial turnover of clerks in its employ, it fell behind in rendering bills to its clients although it continued to pay all bills of publishers and craftsmen within the discount period. To accomplish this sums were borrowed at the bank from time to time, but except for the amounts used to carry the Liberty and Victory bonds which had been purchased as a patriotic duty, the loans were used for very short periods. The amount outstanding at the end of the year is not representative of the average amount used throughout the year, in fact, it was much greater at the close of the year than at any other time. No advantage accrued to the petitioner from these loans for the discount received from the publishers for prompt payment was passed on to the client although payment was not received from it until after payment had been made to the publisher. The*3042 clients it served were corporations of excellent financial standing and did not avail themselves of petitioner's services because of any credit which petitioner could have or may have extended.
We are of the opinion that petitioner was a personal service corporation in 1919 and that its income is to be taxed to its stockholders rather than to it. Since the petitioner is subject to no tax, it becomes unnecessary to discuss the other issues set out in the assignments of error. There is no deficiency.
Reviewed by the Board.
Decision will be entered accordingly.