*1010 1. Members of a partnership engaged in the business of producing motion pictures, all of its pictures having been made under contract for distributors, organized a corporation which took over the assets and continued the business of the partnership. A large part of the earnings, both of the partnership and its successor corporation, was withheld from distribution to firm members and stockholders, and was invested in various properties and enterprises and otherwise accumulated, in accordance with a consistent plan of the individuals (who were members of the partnership and, later, stockholders and officers of the corporation) to build up an organization, sufficiently financed, for the independent production of pictures. Held, the earnings were not accumulated beyond the reasonable needs of the corporation's business; the corporation was neither formed nor, during the years here before us, availed of for the purpose of preventing the imposition of surtaxes upon its stockholders, within the meaning of section 220, Revenue Acts of 1924 and 1926, and section 104, Revenue Act of 1928.
2. Where husband and wife, residents of California, orally agreed that wife's earnings and other*1011 income should remain her own, held, salaries received by her in compensation for her services should not be included in income of her husband. Howard C. Hickman,27 B.T.A. 807">27 B.T.A. 807; affd., 70 Fed.(2d) 985, followed.
*1161 In these proceedings, which, upon motion, were consolidated, petitioners contest respondent's determinations of deficiencies in income taxes against Constance A. deMille, in the amount of $758.50 for the year 1930; and against the other petitioners as follows:
| Cecil B. deMille | ||||
| Year | Cecil B. deMille | Productions, Inc. 1 | ||
| 1924 | $47,211.61 | $157,599.66 | ||
| 1925 | 16,845.75 | 363,605.62 | ||
| 1926 | 19.026.20 | 334,871.25 | ||
| 1927 | 32,656.67 | 138,217.60 | ||
| 1928 | 36,625.42 | 387,599.80 | ||
| 1929 | 13,126.29 | 104,423.60 | ||
| 1930 | 23,995.88 | |||
| Total | 189,487.82 | 1,486,317.53 |
*1012 *1162 Beyond various minor changes made by respondent to incomes reflected by their returns filed for these several years, the deficiencies against petitioner Cecil B. deMille, and the corporation (as to the corporation tax at the lower rates) result mainly from respondent's action in disallowing, as deductions from gross income of the corporation, substantial items, claimed as business expenses, and adding these amounts to deMille's individual income, as dividends received by him from the corporation. Included in such items were amounts paid by the corporation as salary to petitioner Constance A. deMille. The issues raised by the pleadings concerning the most of these numerous adjustments made by respondent have been settled by stipulations of the parties, filed within the time permitted therefor. We refer to them here, in explanation of the absence from our findings of any facts concerning these matters.
Respecting the corporate petitioner, the parties have stipulated the amounts of its net taxable income for each of the years here before us, and these are hereinafter set out. Respecting petitioner Cecil B. deMille, the parties agree as to the amount of his net taxable*1013 income for each of the years before us, except as to one item. The excepted item is the salary paid Constance A. deMille (wife of Cecil B. deMille) by the corporation petitioner. In 1924 it was $24,700; in each 1925 and 1926, $36,400; and in 1927 up to July 29, $25,608.33. She filed separate returns for these years and reported these amounts. Respondent maintains these payments are taxable to petitioner under the community property laws of California Petitioner contends that they are taxable to his wife in accordance with his agreement with her. Which person is taxable is left for uo to decide. It is agreed that if these salary payments are taxable to petitioner, they are to be taxed as ordinary income, and not as dividends.
Respecting petitioner Constance A. deMille, it is stipulated that there is due from her a deficiency in income tax for 1930 of $953.17. An order will be entered accordingly.
Upon recomputation under Rule 50, effect will be given to these several stipulations, which dispose of all issues in these cases but two. Of those issues for our decision the first has been mentioned; it concerns the salaries paid to Mrs. deMille. The second is, whether respondent*1014 was correct in imposing upon Cecil B. deMille Productions, Inc., a tax under the provisions of section 220, Revenue Acts of 1924 and 1926, and section 104, Revenue Act of 1928. The corporate petitioner assails this action as to every year here involved and, in addition, urges that the statutory provisions mentioned, and under which respondent has acted, are unconstitutional.
*1163 FINDINGS OF FACT.
Cecil B. deMille, a resident of Los Angeles, is an outstanding director and producer of motion pictures. Prior to 1913 he had been active in the theatrical business as an actor, playwright, and producer of shows on the legitimate stage. In that year he joined with Jesse L. Lasky, Samuel Goldwyn, and Arthur Friend, in organizing Lasky Feature Play Co. to engage in the production and exhibition of motion pictures. DeMille's duty in the enterprise, upon which he entered immediately, was to produce the pictures. In this he was assisted to a considerable extent by his wife, petitioner Constance A. deMille, who was an actress, and experienced also in the varied managerial details incident to the staging of plays.
From a small beginning (its first film, "Squaw Man", was made*1015 in 1913 at a cost of about $37,000) the Lasky Co. prospered and later merged with other pioneer motion picture concerns to form the Famous Players-Lasky Corporation (hereinafter called Famous Players). Of the enlarged company, deMille was made director general, his duties being, generally, the direction and production of the pictures. Thereafter, due in part to individual ambitions respecting control, difficulties developed within the organization. Goldwyn and Friend were forced out or left the company; so did Bosworth, who was originally interested in one of the merged concerns.
Because of the friction within the organization, and the departure of some of his original associates, deMille felt insecure in his position; feared that he might be ousted. Moreover, he resented, and considered himself hampered by, attempts made, both by fellow executives of the corporation and by representatives of the financial concerns furnishing money for the productions, to restrict his choice and control his judgment respecting types of pictures to be made and to interfere with his conduct of production operations. To assure himself protection, he desired to form an organization of his own, *1016 sufficiently financed, so that it might produce pictures independently, freed from interference of the financiers, whether banking interests or distributing companies, and reap the profits, undivided.
To this end, as early as 1918, he talked with various persons in Famous Players and other studios, whom he wished to take into his organization and, with Constance, discussed the matter with their personal attorney, McCarthy. Beyond discussion however, nothing was done in the matter until 1920. That year, by letter of August 14, deMille notified Famous Players-Lasky Corporation that he was terminating his agreements as its employee; that he was determined to realize his ambition to produce his own pictures with his own *1164 company; that he had organized a partnership through which to so do; and suggested that they make an arrangement whereby the pictures produced by the new organization might be distributed through Famous Players.
Upon McCarthy's advice, the new organization was a partnership, rather than, as contemplated by deMille, a corporation, and the articles were drawn under date of August 16, 1920. A total of $25,000 cash was paid in; $11,250 by Cecil, who had*1017 45 percent interest, $6,250 by Constance, who had 25 percent interest, $5,000 by Ella King Adams, a relative by marriage, who had 20 percent interest, and $2,500 by McCarthy, whose interest was 10 percent. The firm's name was Cecil B. deMille Productions; its purposes were to produce, exhibit, and otherwise deal in motion pictures; to deal in studios, stories, stage properties, and any other things incidental to the production of pictures; to contract for services either for or by the partnership and to buy, sell, and deal generally in real estate and securities.
The agreement also outlined the duties of the several partners. Cecil was to choose the stories, plan and direct the productions; Constance was to be business manager; Ella Adams was to carry on research work, read and write stories and scenarios for the concern, and McCarthy was to handle its legal matters. The partners agreed that should any one of them withdraw, the others should have the right, (first right going to Cecil) to purchase his interest at the amount of his original investment in the firm. A short time later, in order to protect the firm from a sale of a partner's interest to outsiders, and to assure*1018 his control, Cecil obtained written options to similar effect from Adams and McCarthy.
By a separate instrument, deMille contracted to render his services as a director of motion pictures exclusively to the partnership for a term of five years at a salary of $1,500 a week. He was given sole authority in the direction and production of pictures, including the right to select the stories, employ artists, and purchase materials and supplies. He undertook to complete not less than two, nor more than four, pictures each year, so that the partnership might comply with an agreement it made contemporaneously with Famous Players, and was to have at his disposal all the facilities furnished by the latter under that contract. The partnership agreed to insist upon adequate advertising and publicity for the name of deMille in connection with any photoplay which it contracted to produce.
The contract between Famous Players, called the distributor, and the partnership, called the producer, was also dated August 16, 1920. It recited that deMille had previously been employed by Famous Players as a director; that Famous Players wanted more pictures *1165 directed by him; that the partnership*1019 had been formed to produce pictures directed by Cecil, and, continuing, contracted for the delivery to and acceptance by Famous Players of such productions. Famous Players agreed that the producer should make the pictures without interference and that it would furnish all facilities and artists necessary for the productions, and would pay all production costs. The pictures were to belong to Famous Players. For its services, the producer was to receive 30 percent of the net profits realized by the distributor from rentals of the film throughout the world. Against its share of the profits, the partnership was to be paid weekly advances of $3,500 during the first month, $4,500 during the second month, $5,500 during the third month, and $6,500 thereafter. It was guaranteed a return of $200,000 upon each picture within two years after its release, unless these total guarantees should exceed the total profits from all the pictures. Famous Players was to remit weekly the costs of production as they were expended. The contract provided also for publicity for the name of deMille, and, further, for the withholding by Famous Players of $1,000 a week from the advances in payment of Cecil's*1020 personal indebtedness to it of $50,000.
By a separate contract of the same date between Famous Players and deMille individually, he guaranteed the performance of the contract by the partnership, and undertook to carry it out should the firm fail so to do. The repayment of his individual indebtedness to Famous Players was also covered upon terms as above set out. Cecil agreed not to direct any pictures nor permit his name to be used in connection with any pictures, except those to be produced by the partnership and delivered to Famous Players under that contract. He agreed also to continue to serve as director general of Famous Players, without compensation bebond that paid him by the partnership.
So, under these arrangements, the partnership made pictures. It built up a staff of technical experts in all lines incident to the making of pictures, and maintained it continuously, though, of course, with occasional changes in personnel. Although carried on the pay roll of Famous Players, the staff was a part of the firm's organization and subject to its control. By agreement, the partnership earnings were not distributed except through salaries (although the partners reported*1021 and paid tax on their respective shares) but were invested in various enterprises, and in real estate and securities. The concerted aim of the partners was to accumulate a fund - the figure they tentatively fixed was $4,000,000 - with which they might finance their own productions, without the necessity for making them under contract for others, or by borrowing money from distributors, which was *1166 the usual method by which independent producers financed their pictures at the time.
On June 10, 1922, the Cecil B. deMille Productions, Inc. (petitioner here), was organized under the laws of California by the members of the partnership. This company (hereinafter called Productions) was given by charter, broad powers, not only as to the production of motion pictures but also to deal in real estate, securities, and other property. It took over all the assets of the partnership (and assumed its liabilities), issuing in exchange therefor 4,000 shares of its capital stock to the partners in accordance with their partnership interests.
The net tangible assets thus acquired (all of which represented accumulated earnings of the partnership) totaled $252,389.82, as follows: *1022
| Cash in banks | $30,000.00 | |
| Securities and Investments | 54,519.86 | |
| Automobiles | 5,190.00 | |
| Furniture and Fixtures | 230.00 | |
| Props | 24,371.50 | |
| Scenarios and Picture rights | 10,000.01 | |
| Loans receivable (of which deMille owed | ||
| $110,013.33) | 145,578.45 | |
| $269,889.82 | ||
| Accounts payable | 17,500.00 |
The several contracts mentioned above, to which the partnership and deMille individually were parties, were taken over and continued in force by the new company (though whether by written assignment does not appear) and valued together with the good will of the old firm, at $150,000. The technical staff was likewise taken over by the new company and continued in existence, subject to the company's control, throughout the years here before us, although its personnel, most of the time was carried on the pay rolls of concerns with which this company made contracts.
The possibility of tax avoidance by means of the corporation, or of avoidance of surtaxes upon the shareholders by permitting the company's profits to accumulate, was neither mentioned nor discussed by any of the stockholders at the time this company was organized, nor at any time thereafter, until respondent began*1023 his investigation which culminated in issuance of the notices of deficiencies herein.
Productions continued to make pictures for Famous Players under the contract of August 16, 1920. There was considerable friction, chiefly over production costs, accounting methods, and division of the profits, which finally brought about the termination of the contract. It was succeeded by a new agreement between Famous Players and Productions dated November 16, 1923.
*1167 Respecting the production of the pictures, the direction thereof by deMille, the exclusive right to his services, publicity for his name, the furnishing of studio facilities, artists and money by Famous Players, the provisions of the old contract were, in the main, repeated in the new. The principal changes concerned the division of the earnings. On pictures made under the old contract, Productions' share was reduced to 20 percent of gross earnings up to a million dollars, and 25 percent above that amount. On pictures to be made under the new contract, Productions was to receive 15 percent of such earnings up to one million, and 25 percent above that amount. Against Productions' share, Famous Players was to advance*1024 $6,731 weekly. It was agreed also that, in event of termination of the contract, Productions should receive all contracts and rights to the services of its staff, and of a specified number of artists.
Difficulties soon arose between the parties under this contract - again over production costs and attempted interference with deMille in his selection of stories and filming of the pictures. Within a year it was apparent that the friction would force cancellation of the contract, for both parties were dissatisfied.
Late in 1924, Productions' directors prepared to meet cancellation, expecting soon to be forced to finance their own pictures and, to that end, made efforts to restrict expenditures and conserve the company's funds. In addition, they investigated several studio properties with a view to purchase, and finally, after some delay over price, in January 1925, contracted to buy a studio owned by the Thomas H. Ince Corporation for $500,000, of which $50,000 was paid in cash or equivalent by April 23, 1925. In the meantime, deMille had undertaken negotiations with Famous Players, looking to a revision of the existing, or the making of a new contract. His efforts failed; *1025 the contract was terminated early in 1925, and he then was authorized by the directors to participate in the formation of a new distributing organization.
Meanwhile, McCarthy and his associates disagreed. Exercising his rights under the option originally given to cover the partnership's interest, deMille in April 1924, bought McCarthy's stock for $2,500 and made a settlement of all his other claims for a total of $20,000.
DeMille's negotiations, conducted chiefly with the Producers Distributing Co. of New York City about the time the Famous Players' contract was canceled, resulted in the organization of the Cinema Corporation of America, in which several concerns participated. The Cecil B. deMille Pictures Corporation was organized to take over the contract of purchase of the Ince studio; its stock was issued to Cinema; one half of Cinema's common stock was issued to Productions. The remaining Cinema stock was issued to W. W. *1168 Hodkinson Corporation (which owned Producers Distributing Corporation) in exchange for its stock. Productions and the Producers Distributing Corporation each paid $50,000 into Cinema; and the Hodkinson Corporation undertook to furnish it*1026 additional funds (for which it was to receive Cinema's preferred stock) to meet production costs of pictures.
Under date of February 13, 1925, Productions and deMille individually entered into a contract with Cinema and the deMille Pictures Corporation. Cinema agreed to pay Cecil a salary of $2,000 a week, to pay Productions $4,500 a week for the release of his services; and to furnish funds for picture production. Cecil agreed to serve Cinema; he was made executive head of the business in California, and given complete authority in all matters pertaining to production, including the selection of scenarios and artists. Upon termination of the contract his services were to revert to Productions, whose only benefit under the agreement was the right to receive payment for relinquishing deMille's services. The Pictures Corporation was to supply the studio, completely equipped.
Trouble started almost immediately under this contract. The concerns in New York failed to promptly advance the initial funds agreed upon to Cinema; Cinema failed to promptly advance picture expenses for Productions. On several occasions Productions had to guarantee the payment of the weekly studio pay*1027 rolls. Friction was more or less continuous. Cinema failed to acquire theatres to serve as outlets for pictures, as had been agreed upon (verbally) although Productions, on its part, had invested substantial sums in a western theatre chain and in another chain which it organized. Cinema's selling organization was not successful and, consequently, the income from picture rentals was insufficient to carry out the purpose for which the corporation was formed. As early as November 1925 a representative of Cinema stated that the company would not perform its contract; in 1926 it was apparent that the company was not capable of supplying money in the amounts needed for picture production. The contract was terminated early in 1927, but the picture "King of Kings" was thereafter delivered to Cinema under a separate contract of March 26, 1927.
In February 1925 (for reasons not disclosed by the record) deMille exercised his option and purchased the Productions stock owned by Ella King Adams for $5,000, leaving one share standing in her name as nominee.
In the latter part of 1926 Productions began negotiations for a new connection, and under date of April 11, 1927, made a contract*1028 with Pathe Exchange, Inc., deMille, individually, and Pictures Corporation also joining as parties. In the main, it repeated the arrangements of prior contracts in which Productions had entered. *1169 For a consideration of $5,000 weekly, Productions relinquished deMille's services, retaining the right to reclaim them upon termination of the contract. Cecil agreed to serve Pathe at a salary of $2,500 a week. Pathe and the Pictures Corporation were to furnish a completely equipped studio, and supply funds for the making of pictures. A specified number of pictures were to be directed personally be deMille and a certain number of others were to be produced under his supervision. Cecil was given complete authority in matters pertaining to the production of pictures, but was limited in his employment of artists and selection of stories. He promised to withhold his name from any pictures except those produced under this contract, and publicity for his name in connection with such pictures was arranged. In connection with this contract, Productions exchanged its Cinema stock for Pathe stock.
The contract with Pathe was terminated by an agreement of April 18, 1928. Productions*1029 was paid $50,000 cash; the respective rights of the parties as to claims, royalties, rights to services of artists, technical experts and other employees, use of deMille's name, insurance on his life, and other matters were adjusted. Shortly thereafter, Productions sold its Pathe stock at a profit of $786,032.97.
In 1928, "sound" pictures were sufficiently perfected as to become marketable, and the motion picture industry was revolutionized. Studios and equipment became useless, and had to be rebuilt and replaced; the demand for artists, greatly changed, and new methods of production developed. Productions sustained a capital loss of $20,000 on its properties; its royalties on silent pictures previously released were greatly curtailed, but it received the amounts guaranteed to it under its prior contracts.
Before the Pathe contract was terminated, Productions started negotiations with Metro-Goldway-Mayer Pictures Corporation (hereinafter called Metro) and entered into a contract with Metro on July 31, 1928. This contract was subject to cancellation upon 30 days' notice at Metro's election, and deMille individually guaranteed compliance by Productions with its terms. It recites*1030 that the parties "desire to contract for the production of three feature photoplays to be personally directed by Cecil B. deMille." As in other contracts, Cecil's services were relinquished by Productions, and he undertook to give them to Metro; the use of his name was granted to Metro, publicity for it arranged, and its use in connection with other pictures restricted during the term of the agreement. Cecil was given complete authority respecting the pictures, including the right to select the stories and casts. Productions was to receive a percentage of the income from each picture and, in addition, $175,000 on each production costing a million dollars or more, and $150,000 for each production costing $750,000 or more, to be advanced in weekly payments *1170 of $5,000. Metro was to furnish the money, and the facilities; was to take over or secure insurance on Cecil's life, and do the accounting. Metro also agreed to purchase Productions' obsolete "silent" equipment (from this arose the capital loss before mentioned). This contract remained in force during the remainder of the period here before us, but disputes, beginning within that period, mainly concerning Metro's*1031 attempts to restrict deMille in his choice of stories and types of productions, caused its termination in April 1931.
From the organization of Productions, throughout the time here material, deMille and his associates, as directors of the company, continued the aim and purpose they had pursued as partners, namely, to save the company's earnings, to accumulate a fund sufficient so that the company might be able to produce its own pictures. While the greater part of Productions' income was its share of picture profits received under its contracts, it dealt actively in securities, both listed and unlisted, and in real estate. It acquired a number of business properties which it lit; it bought a theater or two; it purchased several ranch properties, some used for purposes of picturemaking, others operated to some small extent for farming or fruitgrowing. It sought to invest and lay aside all the money it could, and took interests in varied enterprises - Arizona cotton lands, 0il development, a construction company, and others - some successful, some not. It made no pictures except under contracts, and into the production of such pictures it put no money of its own, the funds being*1032 supplied by the other parties to the contracts. Most of its picture profits were from productions personally directed by deMille, although some income came from about 30 pictures produced under his supervision.
Productions' gross income during this period (subject to some corrections in order to accord with the net income agreed upon); its net income as stipulated; its receipts under its contracts as picture profits (including weekly advances); the dividends paid to its stockholders; and its surplus at the end of each year, were as follows:
| Picture | Dividends | ||||
| Year | Gross income | Net income | profits | paid | Surplus |
| 1924 | $396,582.81 | $174,021.18 | $351,629.00 | $4,000.00 | $309,366.66 |
| 1925 | 617,406.24 | 462,360.84 | 564,813.03 | 4,000.00 | 708,730.14 |
| 1926 | 705,788.91 | 538,773.67 | 621,086.06 | 40,000.00 | 1,136,129.30 |
| 1927 | 360,595.90 | 162,350.95 | 287,930.68 | 40,000.00 | 1,239,403.97 |
| 1928 | 1,057,081.21 | 908,122.19 | 418,224.72 | 2 56,000.00 | 1,568,477.56 |
| 1929 | 1 418,842.70 | 66,520.42 | 431,258.09 | 48,000.00 | 1,606,515.33 |
Upon organization, Productions issued*1033 4,000 shares of common stock ratably to the members of the predecessor partnership, a few shares being held by nominees. Changes followed deMille's purchase *1171 of McCarthy's stock in 1924, and Adam's stock in 1925. In 1927 the stock was held as follows: Cecil (president and director) 2,897 shares; Constance (vice president and director) 1,000 shares; Mrs. F. E. Calvin (deMille's daughter and a director) 100 shares; Gladys Rosson (secretary of company and director) 1 share; A. J. King (business manager and director) 1 share; Ella King Adams (director, researcher, writer) 1 share. By the stock dividend in 1928, these amounts were doubled, and thereafter, through 1929, the holdings remained without change.
The salary paid deMille by Productions fluctuated, bing adjusted by the directors to meet the situation when he was paid directly by distributors, and when the cancellation of a contract seemed imminent, expenditures were reduced to consever funds. Salaries were paid as follows:
| Cecil B. | Constance | John A. | Gladys | ||
| Year | deMille | A. deMille | Fisher | A. J. King | Rosson |
| 1924 | $78,000.00 | $24,700.00 | $5,200.00 | ||
| 1925 | 15,000.00 | 36,400.00 | 5,000.00 | ||
| 1926 | 6,166.66 | 36,400.00 | |||
| 1927 | 26,000.00 | 43,900.00 | $12,050.00 | ||
| 1928 | 110,583.35 | 44,200.00 | 15,600.00 | $6,529.17 | |
| 1929 | 130,500.00 | 44,200.00 | 15,600.00 | 8,550.00 |
*1034 In 1924, Mrs. Adams was paid a salary of $15,600; in 1925 the company dispensed with her services. Fisher, who had been with the partnership and continued with the corporation as general manager, was succeeded by King.
Likewise, deMille's indebtedness to Productions fluctuated. His indebtedness to the partnership (before mentioned), taken over by the corporation, was discharged by the transfer to the company of a tract of about ten acres, in or near Los Angeles, known as Laughlin Park. The deMille residence, and, adjacent to it, the Productions' office building, which included a projection room, film vault, large library and museum, were on this tract. Since the transfer of the property deMille has paid rent of $600 a month to Productions for the residence. Productions subdivided the property; sold ten lots at a substantial profit; has four unsold.
Cecil owed Productions as follows at the end of each year:
| Year | Open account | Notes |
| 1924 1 | $614.36 | $5,000.00 |
| 1925 | 1,710.07 | 10,000.00 |
| 1926 | 1,878.19 | 113,400.00 |
| 1927 | credit (469.37) | 65,400.00 |
| 1928 | 4,371.56 | 25,900.00 |
| 1929n1 | 10,900.00 |
*1035 *1172 Beyond his stock of Productions, deMille owned properties, both real and personal, of very substantial values; his personal assets were not taken over in toto by either the partnership or the corporation. So, also, with Constance deMille. Below are set out his net income each year and the income taxes heretofore paid by deMille and Productions.
| Net income, | Taxes paid, | Taxes paid, | |
| Year | Cecil 1 | Cecil | Productions |
| 1920 | $56,518.26 | ||
| 1921 | 24,540.54 | ||
| 1922 | 12,291.60 | $9,952.19 | |
| 1923 | 6,881.22 | 21,183.18 | |
| 1924 | $81,636.00 | 1,420.76 | 12,807.18 |
| 1925 | 123,075.83 | 16,172.05 | 52,081.03 |
| 1926 | 147,322.40 | 23,404.73 | 66,488.73 |
| 1927 | 137,781.60 | 25,287.03 | 19,042.13 |
| 1928 | 144,463.52 | 33,243.64 | 85,979.30 |
| 1929 | 168,204.17 | 31,119.73 | 5,420.37 |
The production cost of pictures made by petitioner under its several*1036 contracts greatly varied. The cost of the smaller pictures ran from $200,000 to $400,000. The so-called feature pictures cost from $2,000,000 up to about $5,000,000.
Cecil B. deMille Productions, Inc., was not formed, nor, during the years 1924 to 1929, inclusive, was it availed of for the purpose of preventing the imposition of surtaxes upon its shareholders through the medium of permitting its gains and profits to accumulate, instead of being divided or distributed. Nor, during this time, was the corporation a mere holding or investment comapny.
Cecil and Constance deMille were married in 1902. At that time she was on the stage; had earnings of her own. She and her husband agreed (orally, but never in writing) that her salary, other income and property should remain her own. That agreement was reiterated in 1923; "that our salaries were entirely separate and that our financial affairs were individual." Constance, during the years here under riview, always had substantial properties in her own name, and received a substantial income, both from her salaries paid by Productions, and other sources. Her properties and income she has managed herself, without control or dominance*1037 of her husband.
During the existence of the partnership, and since the organization of Productions, she has been active in the management of the business. She has taken charge of the company's real estate, assisted in the negotiation of contracts, viewed plays and read stories in search for material for films, assisted in the planning and criticism *1173 of productions, and supervised the financial affairs of the company. No issue is raised concerning the reasonableness of the compensation paid by Productions to her, to Cecil or to any other officer or employee.
OPINION.
GOODRICH: In view of the interpretative discussions as to the legislative history, and prohibitive purposes of section 220 of the Acts of 1924 and 1926, and section 104 of the Revenue Act of 1928 3 (the material provisions of which are almost identical) contained in prior decisions of cases arising under these provisions, 4 it is unnecessary to here attempt any further observations concerning the statute. Certainly, this case demands none for, as submitted, it requires us only to answer these very definite questions of fact: Was this company organized, or was it used for the purpose of preventing*1038 the imposition of surtaxes on its stockholders; did it accumulate, rather than distribute its earnings, so that surtaxes might be avoided? There is, of course, considerable argument as to what may be the "reasonable needs" of the corporate petitioner's business, and whether its accumulations exceeded that measure but, after all, that line of inquiry leads but to a rebuttable presumption granted by the statute as an aid to enforcement. The extensive record in this case would not justify the resting of it upon a presumption; the deeper question must be answered.
*1039 Respondent makes a strong case supporting his action in laying a tax under these sections, and maintaining his position under petitioner's attack. But it is a case based upon circumstantial evidence. He points out that in the beginning, Cecil deMille, his wife and their associates, had little with which to do business beyond the intelligence, professional skill, and reputation of deMille as a director of motion pictures. He argues that the initial earnings *1174 of the partnership which preceded this company, and since then, the greater part of the income both of the partnership and the corporation were garnered because of Cecil's personal earning power, based upon his recognized talents as a director.
Respondent points out further that the creation of the partnership distributed (so far as taxability was concerned) amongst several people the salary theretofore earned by, and taxable alone to deMille, and that Cecil's taxes thus were reduced. (Of course, the partners were taxed on their distributable shares of the firm's earnings.) The formation of the partnership, he argues, marked the first step in carrying out a conceived avoidance scheme.
Continuing, he*1040 calls attention to the fact that the corporation, this petitioner, was organized, took over the assets and the business of the partnership, not long after the Revenue Act of 1921 had freed corporate incomes from the war-time levies laid upon them, so that the share of profits on pictures accruing to this group under the contracts could be received by a corporation subject to a lower tax than that levied upon individual recipients. That result, he argues, proves that the company was formed for purposes of avoidance. And as proof that it was availed of for that purpose thereafter, respondent deems sufficient the fact that a large part of the company's earnings were from year to year accumulated as investments in securities, in real estate, and in numerous varied enterprises, many of which had little or no relation to the motion to the motion picture business.
There is weight to respondent's argument. The facts are that substantial earnings which, at least in the beginning, arose mainly from the personal talents and efforts of one man, were turned in to a firm; that later, a corporation was formed, and those earnings, together with assets previously bought with prior accumulations*1041 of them, were transferred from the firm to the company; that this corporation, although it distributed substantial amounts as salaries, along with some dividends, withheld from distribution to its shareholders, a large part of its income. And, of course, the shareholders have not paid the surtaxes for which they would have been liable had they received as dividends the amounts so withheld.
But the taxes under these statutory provisions are not imposed because of effects; avoidance per se is not prohibited. It is the purpose, the intention motivating a course of conduct, which is made controlling by the very words of the statute. Unless the purpose was to prevent the imposition of surtaxes, the tax may not be imposed. Admittedly, circumstances may evidence a purpose, and circumstances such as we find here, without a further showing, justify the finding of the prohibited purpose at which these provisions are aimed.
*1175 However, there is a further showing in this case - one which cannot be disregarded, and which overweighs the evidence of purpose presented by the circumstances. DeMille, McCarthy, and Fisher, all connected with the first organization, the*1042 partnership, all having to do with the formation of the corporation, all serving thereafter as directors of the company (McCarthy until 1924; Fisher until 1926) testified. Under oath, each flatly denied that the company was formed for the purpose of preventing the imposition of surtax upon its shareholders; or that it was availed of, or accumulated its profits for that purpose. They denied that the matter of surtax avoidance by the shareholders was ever discussed, or that the possibility of such avoidance was ever a consideration in determining the disposition of the company's earnings. These denials remain unshaken by cross-examination. Of course, such denials are not entirely controlling. Perhaps they are to be expected, for without them there would be no controversy.
But the proof here goes well beyond mere denial of prohibited intent. It shows affirmatively a plan necessitating the accumulation of earnings and the end to which they might ultimately be used. The witnesses testified fully as to the purpose for which the company was formed - to create an organization for the independent production of pictures - and as to their purpose in accumulating, rather than distributing*1043 its earnings, and building a surplus - to enable that organization to finance its own productions.
There is extensive evidence concerning the needs of the business, the necessity for a large surplus to meet the cost of its own productions in event of cancellation of the company's contracts, and concerning the friction and disputes which pointed to imminent cancellation, against which the only protection was that independence assured by an ample reserve. The testimony concerning the purpose for which the corporation was formed and the purpose for which its surplus was accumulated is corroborated by the minutes of the meetings of the directors of the company - the contemporaneous record reflecting the company's activities and the reasons therefor.
We are not ready to disregard this testimony or to say that the recorded thoughts of the company's guiding heads, the writing of which was begun more than a decade ago, was artfully drawn for self-service against the future day of trial. Those denials of wrongful intent, those declarations of a purpose other than the avoidance of taxes in the building of a surplus, we believe, as against the evidence of circumstance from which might*1044 be drawn inferences to opposite effect.
Nor are we ready to say that the plans for the company and the purpose for which its surplus was accumulated were too far-fetched *1176 to be within the limits of reasonable business ambition. From the record it is apparent that the company, when producing under contracts for others, was beset with controversies and difficulties and frequently, if not constantly, endangered by the possibility of cancellation of its contracts. The desire and determination of the stockholders to advance the activities of their company from those of a producer under contracts, to those of an independent producer, financed sufficiently to insure the making and marketing of its own pictures, seem not unreasonable.
Whether the money necessary to the realization of that determination is raised upon loans, by sale of stock, or by conservation of earnings seems immaterial, so long as the last plan does not result in an accumulation of profits unreasonable to the needs of the business. In view of the evidence as to the costs of picture production, and as to the marketing hazards of the business which involve the risk that the talent and taste of the producer*1045 may not satisfy the public fancy, we cannot say that the surplus accumulated by this corporate petitioner was beyond that necessary to its ends. Consequently, for these reasons, we have made our finding, and hold that respondent erred in imposing upon petitioner the taxes provided by these sections of the statutes.
Because of divergence of facts - and each case involving this issue must bottom on its own facts - the prior decisions cited give little support to respondent's determination. In some of the cases, the principal shareholders transferred to the corporations substantial amounts of income-producing properties, permitting the corporations thereafter to receive and accumulate those revenues, and thus immediately reducing their individual incomes and the taxes thereon. Not so here. Neither Cecil nor Constance deMille stripped themselves of assets. On the contrary, each owned substantial properties beyond their stock of petitioner, and each individually received the income therefrom.
In other cases, the controlling stockholders enjoyed the profits of the corporations by means of large loans to themselves, which they did not repay. Again, not so here. Constance deMille*1046 borrowed nothing from petitioner; Cecil ran a small open account which in 1927 was overpaid, and in addition borrowed on note. His initial indebtedness to the company was discharged by the transfer of real estate. In 1924, the company owed deMille a net amount of $40,000. In 1925, Cecil owed it $10,000. The largest loan made him was in 1926 - $90,000 at one time, and in the same year about $13,000 more. By the end of the next year he had repaid $48,000; in 1928 he repaid about $40,000 more, and in the next year petitioner owed him about $72,000.
*1177 We cannot but comment upon the attempt made by petitioner on brief to take much of our time with criticisms of the design and effect of the statutory provisions here involved. Such efforts are wasted. The laws are enacted by the Congress, not by us, and "arguments as to expediency, or of economic mistake or wrong in taxation" are here immaterial and have no place. . Our sole duty is to see to it that the mandates of the statutes are followed in the cases brought to us for decision. As to petitioner's contentions respecting the unconstitutionality of*1047 the statute, these heretofore have been decided adversely.
Since Cecil and Constance deMille agreed, prior to 1924, that compensation for her personal services should be her separate income, respondent erred in including in Cecil's income for the years 1924 to 1927, inclusive, the salaries paid Constance by Productions. ; affd., .
Reviewed by the Board.
Judgment will be entered under Rule 50.
MCMAHON, dissenting: It appears from the findings of fact that, from the organization of Cecil B. deMille Productions, Inc., through the years before us, deMille and his associates adhered to the "purpose, which they had pursued as partners, namely, to save the company's earnings, to accumulate a fund sufficient so that the company might be able to produce its own pictures"; that "the usual method by which independent producers financed their pictures at that time" was by "borrowing money from distributors"; that "its personnel most of the time was carried on the payrolls of concerns with which this company made contracts"; that "it made no pictures except under contracts, and into the*1048 productions of such pictures it put no money of its own, the funds being supplied by the other parties to the contracts. Most of its picture profits were from productions personally directed by deMille, although some income came from about 30 pictures produced under his supervision"; and that "while the greater part of Productions' income was its share of picture profits received under its contracts, it dealt actively in securities, both listed and unlisted, and in real estate. It acquired a number of business properties which it let; it bought a theatre or two; it purchased several ranch properties, some used for purposes of picture-making, others operated to some small extent for farming or fruit-growing. It sought to invest and lay aside all the money it could, and took interests in varied enterprises - Arizona cotton lands, oil development, a construction company, and others - some successful, and some not."
*1178 There is no showing that the accumulation of "the gains or profits" in question here was within "the reasonable needs of the business" activities of the corporation, numerous and diverse, as actually engaged in during the years before us; most of those business*1049 activities, all but one or two at best, were not germane to the production by it of pictures for others under contracts; and none of the other activities were essential to such production. In construing and applying the statute we are concerned with "the business", not a business, which was actually carried on; and in the last analysis the vital question here presented, in this respect, is as to whether its accumulation of "gains or profits" in order that it "might be able to produce its own pictures" in the future, which it had never done, instead of producing pictures for others under contract as it had always done, is within or "beyond the reasonable needs of the business" of the corporation as thus carried on. If it is beyond such "reasonable needs", then the respondent made out a prima facie case under the same subsection of the statute which is applicable and there arises another question as to whether petitioner has overcome the prima facie case made out by respondent.
In my opinion, as to the petitioner, Cecil B. deMille Productions, Inc., the facts establish "that the gains or profits" were permitted "to accumulate beyond the reasonable needs of the business", within*1050 the meaning of section 220 of the Revenue Acts of 1924 and 1926, and section 104 of the Revenue Act of 1928, applicable here. The words "the business" as there used mean the business as actually carried on at the time in question. These words do not mean business which the corporation is authorized to do but has not done. They do not mean business which the corporation merely wishes to do or even contemplates doing at some future time. They do not mean wholly new business or a wholly new phase of an old business which has never been actually engaged in. They do not mean a type of business activity which has never been engaged in by the corporation but which may or may not be engaged in at some future time so that an effort may be made to realize the personal ambition of a stockholder, however laudable, even though he be the moving spirit and genius of the corporation. They do not permit saving up money or accumulating surplus to be used at some future time in an effort to satisfy such ambition. The statute deals with the realities of "the business", as actually carried on, not with the hopes or aspirations of its stockholders. Any other construction of the statute would be*1051 unreasonable and beyond the ordinary meaning of its language. In the instant proceeding it affirmatively appears that the surplus in question was not necessary and was not accumulated to enable the corporation to carry on its business as carried on in the years before us, *1179 but it was "permitted to accumulate" to enable the corporation to do something different from that which was done in the years in question. During those years it did not produce pictures; it rendered services, personal in character, to others who did produce pictures; and it desired, thereafter, to produce its own pictures, something quite different from merely rendering services to other who did produce pictures. This contemplated a departure from carrying on its business as it had been carried on in the years in question. Such accumulation is "beyond the reasonable needs of the business" within the meaning of the statute. Hence, we have here, under the same subsection of these statutes, "prima facie evidence of a purpose to escape the surtax."
In my view this prima facie case made by the respondent has not been overcome. I appreciate that there is a finding of fact that "Cecil B. deMille Productions, *1052 Inc., was not formed, nor, during the years 1924 to 1929, inclusive, was it availed of for the purpose of preventing the imposition of surtaxes upon its shareholders through the medium of permitting its gains and profits to accumulate, instead of being divided or distributed"; and that it is in effect stated in the opinion that the witnesses testified that the purpose in accumulating the earnings of the corporation and building a surplus was "to enable that organization to finance its own productions"; but the majority opinion, in effect, holds, and in my opinion erroneously, that its "gains or profits" were "not permitted to accumulate beyond the reasonable needs of the business." I am unable to conclude that such finding would have been made if the majority had proceeded upon the theory that the corporation's "gains or profits" were "permitted to accumulate beyond the reasonable needs of the business." On the contrary, the inescapable inference to be drawn is that the error of the Board in this respect induced the conslusion of fact which is reflected by the finding as made. Accepting the premise that the facts establish a prima facie case for the respondent, and taking into consideration*1053 the entire record, there is, in my opinion, no adequate basis for the majority's finding or conclusion to the effect that the corporation, during the years 1924 to 1929, inclusive, was not availed of for the purpose of preventing the imposition of the surtax upon "its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed." Subsection (a) and (b) of section 220, supra.
Respondent has not only made out a prima facie case under the statute, but there is other evidence, some of which is circumstantial, which tends strongly to support his determination in this respect. Circumstantial evidence is often more convincing than categorical denials of purpose made long after the events occur, and so it is *1180 here. The majority opinion states that "of course, such denials are not entirely controlling. Perhaps they are to be expected, for without them there would be no controversy." The majority opinion does point our at full value in considerable detail many of the strong elements of the proof which tends to support respondent's contention. It is not necessary to impute perjury to any witness in reaching the*1054 conclusion which I have reached and I do not do so. To the extent that their denials are, in effect, conclusions of fact, which we must form from all of the proof bearing upon the subject of purpose, they are not binding upon us. There is other proof upon the subject which is inconsistent with such conclusions of the witnesses. The only material result of consequence accomplished during the years before us by the accumulations in question is that each stockholder of the corporation has been enabled to "escape the surtax" in question; this result followed inevitably from what was done. It is elementary that intent, which is synonymous with purpose, is to be inferred from acts or conduct; and that it is presumed that the natural and necessary or probable consequences of acts, intentionally performed, are intended. It is apparent that the accumulations of surplus in question were accomplished with a high degree of intelligence on the part of those responsible for them. Cf course, accumulations of surplus for a purpose which carried them "beyond the reasonable needs of the business", such as we have here as pointed out herein, which is the very thing, in view of the statute, which*1055 establishes the prima facie case made out by the respondent, can not serve to overcome such prima facie case; they are "prima facie evidence of a purpose to escape the surtax."
As heretofore pointed out herein, there are findings that "the usual method by which independent producers financed their pictures at that time", was by "borrowing money from distributors"; and that "its personnel, most of the time was carried on the pay rolls of concerns with which this company made contracts." There is no showing that either of these methods connot be adopted when, as and if the corporation actually engages in producing its own pictures independently, instead of producing pictures for others. The corporation, with deMille dominating it as he did, was apparently quite resourceful in financing all of its activities without disturbing any of the surplus in question here.
In my opinion the prima facie case made out by the respondent, coupled with the proof which supports his contentions, has not been overcome by the proof which tends to support the contentions of the petitioners upon the subjects of the "reasonable" financial needs of "the business" of the corporation, or its purposes or*1056 those of its stockholders "to escape the surtax"; and, for the reasons herein set forth, I cannot agree with the majority in so far as they *1181 hold that any of the "additional" taxes in question herein, as specified in subsection (a) of section 220, supra, applicable here, are not to be imposed.
SMITH and ADAMS agree with this dissent.
Footnotes
1. Proceedings of the following petitioners are consolidated herewith: Cecil B. deMille Productions, Inc., and Constance A. deMille. ↩
1. The amounts of deficiencies as here set out, include for each of these years taxes under sec. 220, Revenue Acts of 1924 and 1926, and sec. 104, Revenue Act of 1928. ↩
2. Also 100 percent stock dividend $400,000. ↩
1. Loss on security sales $24,639.07. ↩
1. In 1924, Productions owed deMille, upon note or mortgage, $45,000; and in 1929, $83,000. Productions' largest loan to deMille was made in October 1926, when, at his request the directors loaned him $90,000. Repayment of this loan was completed subsequent to 1929. ↩
1. Amounts stated for 1924 to 1927, inclusive, are reduced by elimination of salary payments to Constance A. diMille. Amounts stated for 1928 and 1929, include dividends and capital net gains as stipulated. This statement does not supplant the stipulation filed by the parties, and is subject to correction to accord therewith. ↩
3. SEC. 220. (a) If any corporation, however created or organized, is formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed, there shall be levied, collected, and paid for each taxable year upon the net income of such corporation a tax equal to 50 per centum of the amount thereof, which shall be in addition to the tax imposed by section 230 of this title and shall (except as provided in subdivision (d) of this section) be computed, collected, and paid upon the same basis and in the same manner and subject to the same provisions of law, including penalties, as that tax.
(b) The fact that any corporation is a mere holding or investment company, or that the gains or profits are permitted to accumulate beyond the reasonable needs of the business, shall be prima facie evidence of a purpose to escape the surtax.
[Subdivisions (c) and (d) here omitted.] ↩
4. ; ; affd., ; certiorari denied, ; ; ; ; (on review, C.C.A., 9th Cir.). ↩