*1998 Special assessment denied.
*912 This proceeding is for the redetermination of deficiencies in income and profits taxes amounting to $8,567.09 for the year 1919 and $32,466.07 for the year 1920. For the year 1920 the respondent has granted special assessment under sections 327 and 328 of the Revenue Act of 1918, but the petitioner alleges that in making such special assessment respondent did not use proper comparatives.
The petitioner also alleges that the respondent erred by denying special assessment for the year 1919. The hearing herein related solely to that year and was restricted to the matters set forth in subdivisions (a) and (b) of Rule 62 of the Board's rules of practice.
FINDINGS OF FACT.
The petitioner is a corporation incorporated under the laws of the State of California and during the years 1919 and 1920 was engaged in the production of motion picture photoplays, commonly designated as "comedies."
*913 In 1914 the Rolin*1999 Film Co. was incorporated with a capital stock of $7,500, which was owned by Hal E. Roach and another person. In 1917 Hal E. Roach, with the financial assistance of Pathe Exchange, Inc., purchased his associate's stock in the Rolin Film Co. and in 1919 was the sole owner of the stock. In August, 1920, the name of the Rolin Film Co. was duly changed to "Hal E. Roach Studios."
During the year 1919 the Rolin Film Co., pursuant to contracts duly entered into, controlled exclusively the professional services of Harold C. Lloyd as an actor in motion pictures.
Hal E. Roach was one of the outstanding directors and managers of the production of motion picture comedies. He was notable for his ability to discover and develop motion picture actors.
During the year in question Pathe Exchange, Inc., was the distributor of all the comedies produced by the Rolin Film Co., including those in which Harold C. Lloyd acted.
In April, 1918, the Rolin Film Co. had entered into an agreement with the Pathe Co. granting to the Pathe Co., among other things, the exclusive right, subject to the terms of the agreement, to distribute motion pictures in which Harold C. Lloyd posed. This agreement*2000 contained, among other things, the following recitals:
WHEREAS, ROLIN represents that it has heretofore entered into an agreement with HAROLD C. LLOYD, whereby the latter has agreed to pose and act during the period covered by this contract and its contemplated extension exclusively in comedies produced by ROLIN; and
WHEREAS, ROLIN represents that it heretofore entered into an agreement with H. E. ROACH, whereby the latter has agreed to devote all his time and energy in behalf of ROLIN during the period of this contract and its contemplated extension.
The agreement provided that, within five days from the definite acceptance of each picture, Pathe would pay to the Rolin Film Co. on account thereof a lump sum of $2,450 and would further pay 50 per cent of the net profits "derived from the release and exploitation" of each picture accepted by Pathe, the profits to be computed as set forth in the agreement.
In April, 1919, the Rolin Film Co. and Pathe Exchange, Inc., entered into a further agreement by which Pathe was granted, subject to the terms of the agreement, the exclusive right to distribute motion pictures in which Harold C. Lloyd posed.
This agreement contained the*2001 following recital, among others:
WHEREAS, said ROLIN entered into a certain agreement with one Harold C. Lloyd, an actor of peculiar and unique ability, whereby said Harold C. Lloyd agreed to enter the employ of and said Rolin agreed to engage the services of said Harold C. Lloyd for a period of one year from April First, Nineteen Hundred and Nineteen, and * * *.
The *914 agreement contained also a covenant in words as follows:
Said ROLIN further covenants and agrees that it will not during the life of this agreement use or permit the use of the names of ROLIN FILM COMPANY, HAL ROACH, or HAROLD C. LLOYD or any combination of words in which said names are used directly or indirectly in connection with the production, presentation, exhibition, or otherwise by any firm, corporation, or individual other than PATHE, of any motion picture photoplay.
It was further agreed by the parties to the contract made in April, 1919, as follows:
FIFTH: For each motion picture comedy produced by said ROLIN and accepted by PATHE as aforesaid, PATHE agrees to advance to said ROLIN the sum of Sixteen Thousand ($16,000.00) Dollars in the following manner: TO WIT:
(a) Upon commencement*2002 of the production of each of said motion picture comedies PATHE shall advance to said ROLIN the sum of Three Thousand Five Hundred ($3,500.00) Dollars.
(b) Each week thereafter for three successive weeks PATHE shall advance to said ROLIN the further sum of Three Thousand Five Hundred ($3,500.00) Dollars.
(c) Upon the delivery to PATHE by said ROLIN of the negative of such motion picture comedy, together with one sample positive print thereof, PATHE shall advance to said ROLIN a further sum of Two Thousand ($2,000.00) Dollars.
It was also agreed that the Rolin Film Co. should be paid the net receipts from the comedies after deduction therefrom of the amount of said advances and the cost of distribution as computed under the terms of the contract.
The contract of April, 1918, related to the distribution of one-reel comedies and the contract entered into in April, 1919, related to the distribution of two-reel comedies. During the year 1919 the physical assets of the Rolin Film Co. consisted of automobiles, trucks, cameras, "flats," and a small amount of furniture and equipment necessary for making short comedies. Its maximum borrowing capacity at the banks was $10,000. The*2003 Film Co. at frequent intervals sent telegrams to the Pathe Exchange, Inc., requesting funds in stated amounts for the purchase of films and other materials necessary to produce pictures for delivery to Pathe and also to meet its accruing pay rolls. The funds requested were advanced by Pathe.
The Film Co. kept an open account with Pathe in which were entered various charges when pictures were shipped to Pathe and in which the amounts received from Pathe were credited.
On January 1, 1919, Pathe owed the petitioner $5,800; on January 31, 1919, $2,100; on February 28, 1919, $5,400; and on March 31, 1919, $1,100. On May 31 the said account between Pathe and the petitioner balanced. The petitioner was indebted to Pathe on its general account for funds advanced as follows:
| April 30, 1919 | $650 |
| June 30, 1919 | 19,025 |
| July 31, 1919 | 8,500 |
| Aug. 31, 1919 | 21,000 |
| Sept. 30, 1919 | $14,000 |
| Oct. 31, 1919 | 21,410 |
| Nov. 30, 1919 | 14,000 |
| Dec. 31, 1919 | 21,410 |
*915 The total amount advanced to the Rolin Film Co. by the Pathe Exchange, Inc., during 1919, for the purposes before mentioned was $85,435.
Hal E. Roach was the sole owner of the $7,500 of capital stock*2004 of the Film Co. During 1919 he received a salary as director and sole executive amounting to $30,150. The invested capital of the studios during 1919 as found by the respondent was $31,841.31 and its net income as computed by the respondent amounted to $28,205.54.
During 1919 the Rolin Film Co. received from Pathe the sum of $29,238 as royalties on pictures produced in prior years. It received no royalties for pictures produced in 1919.
The respondent denied an application by petitioner for a special assessment for 1919 under the provisions of section 328 of the Revenue Act of 1918.
OPINION.
VAN FOSSAN: The issue with respect to the comparatives used by the respondent in the special assessment for the year 1920 is not now before us for determination. The sole question for our consideration is whether or not there were present in the petitioner's business in 1919 abnormal conditions so affecting petitioner's capital or income that, under the provisions of section 327 of the Revenue Act of 1918, it is entitled to have its tax computed pursuant to the terms of section 328 of the Act.
The petitioner bases its claim that its income for 1919 was affected by abnormal conditions*2005 principally on the contentions that:
(1) The right to the exclusive services of Hal E. Roach and Harold C. Lloyd were intangible assets of great value which can not be included in invested capital, and
(2) That the advances made by the Pathe Exchange, Inc., were borrowed capital necessary to petitioner's operations and could not be included in the invested capital.
In our opinion the mere fact that Harold C. Lloyd was an actor "of peculiar and unique ability," whose professional services the petitioner, by contract, controlled exclusively, and the fact that Hal E. Roach was a manager and director of great distinction, do not constitute abnormality within the provisions of the statute. In the successful production of motion pictures the personality and histrionic ability of the actors must, necessarily, play an important part, and management, of course, is usually a large factor in the success of any business. But to hold that the presence in any motion *916 picture organization of distinguished actors and unusually capable management and direction gives rise to an abnormality affecting the producing corporation's income would be to put a premium on mediocrity and would*2006 be to say that factors which are inherent, to a greater or less degree, in the very nature of the business, are abnormal. In our opinion there is nothing in the proof which leads to such a conclusion.
Nor are we impressed by the petitioner's contention that Hal E. Roach's salary was abnormally low, that he was worth more to the corporation than the amount of that salary and that, therefore, there was an abnormality. There was testimony to te effect that the Christie Film Co. would have been willing to pay Hal E. Roach $2,000 a week for his services, which amount is approximately $75,000 a year more than he received as salary from the petitioner. This evidence is not convincing. It was testified that the leading producers of photoplay comedies were Mack Sennett, the Christie Film Co. and the petitioner. It is obvious, therefore, that the Christie Film Co. would have found it to its advantage to employ at a very high salary the sole stockholder, manager and director of a principal competitor, thereby lessening competition in its branch of the photoplay industry. It does not necessarily follow that Hal E. Roach was worth the same amount to petitioner. It should be observed that, *2007 as the sole stockholder of the petitioner, Hal E. Roach was entitled to receive not only his salary as the petitioner's chief executive, but also whatever dividends were earned and declared. His salary of $30,150 a year was substantial in amount and there is no evidence from which it can be inferred that this sum was not commensurate with the value of the services he rendered. Moreover, since petitioner's net income for the year 1919 was only $28,205.54, it is apparent that payment to Hal E. Roach of a salary amounting to $75,000 more than he actually received would have created a deficit of approximately $45,000. The payment of such a salary, therefore, would have been unreasonable. ; .
While it is apparent that the advances made to the petitioner by Pathe Exchange, Inc., contributed to the petitioner's production and income, we have held heretofore that the use of borrowed capital does not in itself create an abnormality. ; *2008 ; . There is no evidence that it was unusual in the industry for distributors of photoplays to make such advances to producers as were made by Pathe Exchange, Inc., to the petitioner. In other words, there is no evidence in the record from which it can be inferred that the *917 advances referred to created any condition whatever which was abnormal in the business of producing photoplay comedies.
We are of the opinion that the respondent did not err in denying petitioner's application for assessment for the year 1919 under the provisions of sections 327 and 328 of the Act of 1918.
Decision will be entered in due course for the Respondent as to the year 1919; further proceeding shall be had under Rule 62(c) respecting the calendar year 1920.