*1215 Petitioner, a corporation organized in 1923 for the purpose of conducting department stores either directly or through stock ownership and acting as purchasing agent for them and others, operated a New York buying office during the taxable years ended January 31, 1935, and January 31, 1936, which furnished buying and other services to four department stores, in two of which petitioner owned no stock, in one, less than 50 percent, and in one, all the stock. These services were furniched at cost, with the idea of utilizing the mass buying power of these stores to increase the profits of the stores in which petitioner owned stock, its dividends therefrom, and its gains on sale of such stock. Held:
(1) the receipts of the petitioner for these services in the taxable years are gross income to it for those years and are not such income as is defined in section 351(b)(1)(A) of the Revenue Act of 1934.
(2) Petitioner is not subject to surtax for these years, under section 351 of the Revenue Act of 1934, nor for penalties for failure to file such surtax returns. Andrew Jergens Co.,40 B.T.A. 868">40 B.T.A. 868, followed.
*1210 Respondent determined deficiencies in personal holding company surtax under section 351 of the Revenue Act of 1934, and penalties for failure to file returns of such tax against the petitioner as follows:
| Fiscal year ended | Personal holding company surtax | Penalty |
| January 31, 1935 | $15,714.61 | $3,928.65 |
| January 31, 1936 | 7,424.25 | 1,856.06 |
*1211 FINDINGS OF FACT.
The petitioner is a corporation, organized in 1923 under the laws of the State of Delaware, with an office at 715 Broad Street, Newark, New Jersey. It filed its income tax returns for the fiscal years ended January 31, 1935, and January 31, 1936, with the collector of internal revenue for the fifth district of New Jersey, at Newark, New Jersey.
Among the purposes of petitioner, as stated in its certificate of incorporation, are those "To establish and conduct one or more general department stores" and "To act as financial, business and/or purchasing agent for domestic and foreign corporations, individuals, partnerships, associations, states, governments or other bodies."
From its organization, a main objective*1217 of the petitioner was to take advantage of centralized buying power.
Petitioner commenced operations by acquiring, as of August 1, 1923, all of the stock of L. S. Plaut & Co., a department store in Newark, New Jersey, and as of March 1, 1924, the petitioner acquired all of the stock of the Palais Royal, Inc., a department store in Washington, D.C. In September 1926, the name of L. S. Plaut & Co. was changed to Kresge Department Store Corporation and the capital of that company was increased from $1,000,000 to $2,000,000, the increased amount of the capital stock being purchased by S. S. Kresge for cash. In 1925 the petitioner acquired a substantial minority of the stock in The Fair, a department store in Chicago, Illinois.
For each of the fiscal years ended January 31, 1935, and January 31, 1936, more than 50 percent in value of the outstanding capital stock of the petitioner was owned by not more than five individuals (of whom S. S. Kresge was one), as that term is used within the provisions of section 351 of the Revenue Act of 1934.
Prtitioner's investment in the stock of the Newark store (Kresge Department Store Corporation) proved to be unprofitable and in 1931 it sold*1218 the stock which it held in that corporation to S. S. Kresge, receiving as part consideration his interest-bearing notes.
During the tax years involved petitioner did not own or operate a department store, but, as prevously stated, did own stock in department store corporations.
During the tax years here involved petitioner maintained in New York City a buying office which functioned for the direct benefit of four department stores. Three of these are mentioned above, in *1212 two of which petitioner held a stock interest during those years. The fourth was the Steinbach-Kresge Store in Asbury Park, New Jersey.
The purpose of the operation of the New York buying office was to make possible through mass buying the more profitable operation of the department stores in which petitioner held a stock interest and by increasing the profits of such stores to increase petitioner's dividend income and also the income which it might derive in case it sold stocks which it owned in those stores.
Most of the bookkeeping of the taxpayer was carried on at its office in Newark, New Jersey, but some of the bookkeeping was carried on at the New York City buying office, including the*1219 making up of the list of the expenses of the New York office, including its pay roll, which was sent to and met by the New Jersey office of the company. The majority of employees in the New York office, numbering from 25 to 30, were either buyers or assistant buyers, but there were some stenographers and switchboard operators.
The petitioner, through its New York office, acted as buying agent for the various department stores which it served. In the great majority of cases, the petitioner received purchase orders from the department stores which it served before it actually bought the goods. In these cases, the manufacturer or seller of goods purchased would invoice the proper department store directly for the goods so purchased.
In some instances lots of merchandise of unusual value, in the judgment of the New York office, were purchased by the petitioner without any previous request from any of the department stores it served. In such cases, invoices were made out to the taxpayer and the taxpayer reinvoiced the appropriate department store for the same at the same price; and passed on to the appropriate department store the discount allowed by the manufacturer or seller.
*1220 In those instances where the manufacturers' or sellers' invoices ran to taxpayer, the shipping designation or direction to one of the department stores served was indicated or else the buying order indicated the designation of a particular department store.
In addition to purchasing service, the New York office was on the alert for persons to fill executive positions in the stores the petitioner was serving. This was done either with or eithout the request of any of such stores. Special attractions or exhibitions to draw persons into these stores were sought and obtained by the New York office and weak departments in the stores being served were surveyed and recommendations offered by the petitioner through its New York office for their improvement. Petitioner, through its New York office, consistently watched for new items, new departments, and special values in merchandise sold in the department stores it served through its *1213 New York office, and that office continually made recommendations about goods available for purchase to those stores. Efforts were made to interest other stores in petitioner's services and in a few instances these efforts were successful.
*1221 The expenses of the New York purchasing office were totaled monthly by the Newark office and thereupon, and once a month, the Newark office billed the various department stores which the petitioner was serving, as follows: After deducting the $100 per month payment to be made by the Steinbach-Kresge Co. store at Asbury Park, New jerseyto whom that amount was billed monthly, the balance of the expenses was prorated among the other stores served by the petitioner, according to the percentage which the annual sales of each store served bore to the total sales of all such stores for the prior year.
The receipts and expenses of the New York City buying office of the petitioner were equal.
In its income tax return for 1935, the petitioner reported total income of $156,429.18, including interest income in the amount of $93,889.98, and $61,720.73 as gross income received for services rendered by the New York office to the stores it thus served. In its return for 1936, it similarly reported total income of $96,277.05, including interest income in the amount of $63,406.45 and gross income in the sum of $32,759.48.
OPINION.
LEECH: The ultimate legal question in this case is whether*1222 or not the petitioner is subject to the surtax imposed upon personal holding companies by section 351 of the Revenue Act of 1934. The answer to that question depends upon whether or not the petitioner was, during the taxable years, a personal holding company as defined in section 351(b) of that act, and that turns here upon whether or not at least 80 percent of petitioner's gross income for either or both of the taxable years, under the cited section, was derived from "royalties, dividends, interest, annuities, and * * * gains from the sale of stock or securities." So much is conceded by both parties.
The position of the respondent is that more than 80 percent of petitioner's gross income was derived from "interest." This position is premised upon the validity of his contention that items received by the petitioner for services rendered through its operation of the New York City buying office do not constitute "gross income" either in shole or in a sufficient part to reduce the percentage of gross income from interest below the 80 percent requirement. Petitioner says all such receipts were gross income to it.
Respondent supports his position by the argument that these receipts*1223 "represent merely reimbursement for the maintenance of a *1214 buying office which was conducted for the direct benefit of various department stores and not for the direct benefit of the petitioner." He argues that "The only effect the New York office could have upon the petitioner's taxable income was to indirectly make possible an increase in the amount of dividends that petitioner might receive upon the stock in some of the department stores which it held by increasing the profits of those stores and that would be to simply indirectly increase its purely personal holding company income in the form of dividends and such was the very income section 351 was designed to reach." It is then argued in the alternative, as we understand it, that the business of the New York buying office should be segregated and some or all of the expenses of the office deducted from the receipts through that office in the determination of the amount of "gross income" therefrom. The case of All ; affd., *1224 , is cited in support of this position. However, the facts, so far as the record there discloses them, are easily distinguishable from those here. The buying was there done by a wholly owned subsidiary in its name, and for its parent. It was organized for and existed, in substance, only as "a purchasing and exporting agent for its principal, 'a Russian organization' in Russia."
Here the petitioner was organized to conduct department stores by direct ownership or through subsidiary companies and to act as purchasing agent for those and others desiring the service. It proposed to bring the benefit of the resulting mass buying power to those it served, including those stores in which it was directly interested, and thus increase their profits and dividends to it as well as its gains on any sale of its stocks in those stores.
In conformance with this purpose and plan, the petitioner, during the taxable years, through its New York buying office, acted as purchasing agent for several department stores, only one of which it controlled through stock ownership, in one of which it owned less than 50 percent of the stock, and in at least two others owned no*1225 stock. It attempted to secure such business from other corporations and, on occasion, the facilities of its New York buying office were so used. Nor were its services limited to those of buying, but included the procurement of desirable executives and desirable merchandise for the several department stores using its New York facilities. Where, as was true in most cases, petitioner purchased goods for a particular store, they were invoiced directly to that store and so paid.
The argument of the respondent that the dividends it thus sough to increase were the very income which section 351, supra, sought to reach is beside the question, since the surtax there laid was not imposed on dividends or any other form of income as such, but was *1215 levied only "upon the undistributed net income of every personal holding company." That term is defined by the statute and does not include such a company as we think petitioner was during the taxable years.
In our judgment, the facts in , present a stronger case for respondent than those here. That case involved section 351(b)(1)(A) of the Revenue Act of 1934, which is the provision*1226 with which we are presently concerned. There the Jergens Co. contracted with Woodbury, a wholly owned manufacturing subsidiary, and Sales, a wholly owned selling subsidiary company, to furnish certain of its facilities and services to them at cost. These costs were merely annually allocated by the parent on the books of the subsidiaries, which it kept, one of which companies had neither funds nor bank account. The amounts thus charged to these subsidiary companies were then used to reduce the deductible expenses of the parent company. The question was whether these allocated expenses were gross income under section 22(a) of the same revenue act. It was conceded that, if they were, the petitioner was not subject to the contested tax proposed under section 351, supra. The Board held that these expenses were gross income to petitioner, despite the fact that Woodbury and Sales were wholly owned and dominated subsidiaries which the parent was alone serving. In so holding every argument made here for respondent was answered.
Upon the authority of that case, we conclude petitioner was not subject to the contested surtaxes or penalties.
Decision will be entered for the petitioner.*1227