*1956 Personal service classification denied.
*1169 The Commissioner determined deficiencies in income tax in the amount of $19,611.97 for the year 1920 and $36,577.22 for the year 1921. The petitioner brings this proceeding for a redetermination of its tax liability. It alleged that the Commissioner erred in (a) denying petitioner classification as a personal service corporation under section 200 of the Revenue Acts of 1918 and 1921; (b) including in the net income of petitioner amounts earned by William S. Smith in his individual capacity, amounting to $17,784.33 for the year 1920 and $12,844.60 for 1921; (c) determining petitioner's tax liability without the benefit of sections 327 and 328 of the Revenue Acts of 1918 and 1921.
The Commissioner in his answer admits that the petitioner is entitled to the benefit of sections 327 and 328 of the Revenue Acts of 1918 and 1921 in the computation of its tax. Upon motion filed and granted the hearing was limited to the issues which did not involve special assessment.
FINDINGS OF FACT.
The petitioner*1957 is a Louisiana corporation with its principal office at 232 Bater Building, New Orleans, La. It is engaged in the business of stevedoring.
*1170 The petitioner was incorporated in 1918 to continue the stevedoring business of Terrence Smith and W. S. Smith, his son, who had been in partnership under the name of T. Smith & Son for about eight years prior to the incorporation. Three hundred and thirty-two shares of capital stock of the par value of $100 each were issued for cash and for the various tangible and intangible assets of the partnership. The original stockholders ware W. S. Smith, who subscribed to 230 shares; Terrence Smith, who subscribed to 100 shares, and Leon Verges, who subscribed to two shares as qualifying shares. Early in 1919 W. S. Smith acquired the interest of his father, Terrence Smith, upon the oral agreement that the father would have the privilege thereafter of withdrawing from the corporation whatever cash he needed as long as he lived, in the same manner as if he had retained his interest in the corporation.
After the transfer the father continued nominally to hold the office of president of the corporation and continued to perform the same*1958 duties he had theretofore performed. In the taxable years in question the son was the active head of the business and maintained contacts with the clients. Father and son consulted every day about the details of the business and laid out plans of action. The son engineered all plans of action and made the final decisions thereon. The clients were accustomed to look to the son as the active head of the business. The employees consulted him alone on all matters pertaining to the finances of the company, but they also consulted the father on matters pertaining to handling the actual operations at the ships. Both the father and son had started in the business as laborers known as longshoremen and had worked their way up through the successive stages of screwmen, foremen, superintendent, and finally engaged in business as stevedores. Terrence Smith, the father, had been engaged in the stevedoring business about 25 years prior to the incorporation of petitioner. William S. Smith, the son, had worked for his father until about 8 years prior to the incorporation of petitioner, when the partnership of T. Smith & Son was formed. The father began the stevedoring business without capital*1959 and no capital was contributed by the son on the formation of the partnership. Both father and son were experienced in all details of the business and capable of affording the service petitioner offered. They both enjoyed a wide acquaintance in business circles and excellent reputations. It was the experience and ability of these men in the loading and discharging of vessels which the clients sought when engaging the services of petitioner. In the taxable years the business enjoyed a continuation of the patronage of its former clients, and a very few, if any, new clients were obtained.
The services of petitioner to its clients consisted of acting as stevedore in the loading and unloading of vessels. It required expert *1171 knowledge of various kinds of cargo; of methods of handling and storing miscellaneous cargo, which included inflammable and/or perishable articles; of the location within the vessel of general and/or mixed cargo in such a manner as to preserve the stability and seaworthiness of the vessel, and in such order as to facilitate the unloading of the cargo at the various ports of call. It included the formation of plans for cargo stowage where the vessel*1960 was to be loaded; conferences in relation thereto with the New Orleans Board of Underwriters, the masters of the vessel and with the ship agent; in some cases the drafting of a stowage plan, and the superintendence of structural changes in the vessel where necessary to fit the hold for special cargo or where a bare boat was to be loaded; furnishing the necessary labor, tools, and equipment and the physical execution and the supervision of all operations necessary in the loading and unloading of a vessel.
Terrence Smith, the father, devoted all his time to petitioner's business during the taxable years. He worked every day from 6.30 or 7 in the morning to 5 or 6 in the afternoon and performed the same duties he had performed prior to the transfer of his stock to his son. His principal activities consisted in supervising the loading and discharging of vessels which petitioner served for its clients. He planned and advised with his son concerning petitioner's stevedoring operations from day to day and was consulted by employees on the question of handling ships. He died in June, 1924, at the age of 71 years.
William S. Smith, the son, was engaged for a part of his time during*1961 the taxable years in the personal management and superintendence of the stevedoring operations of the firm known as Lykes Brothers through the medium of a corporation that controlled the Southern Stevedoring Co. He had personally arranged this business connection and the operations were conducted on an agreed basis of a one-half share in the profits derived therefrom. He personally supervised the loading and discharging of all the vessels served by the Southern Stevedoring Co. The gross income and disbursements of these operations were accounted for on the books of the petitioner as regular corporate transactions. The gross income from the Southern Stevedoring Co.'s business was $267,252.94 in 1920 and $146,781.45 in 1921. In its income-tax return for these years petitioner included these amounts in its gross income.
During the taxable years all the ships loaded for the Southern Stevedoring Co., and about 25 or 30 per cent of those loaded by petitioner, were loaded with mixed cargo which required a definite and particular survey of the vessel to allocate the various portions of the cargo. The other ships serviced by petitioner were loaded with cargoes of cotton and combinations*1962 of cotton and oil and other general *1172 cargo and did not require so much skill. When a vessel was being loaded or discharged by both petitioner and the Southern Stevedoring Co., the father supervised the work done by petitioner, and the son that of the Southern Stevedoring Co. If more vessels were being handled by petitioner than by the Southern Stevedoring Co., the son divided his time as he thought necessary between them. He handled all of its financial matters and was the deciding factor of its business policy. He devoted all of his time to the stevedoring business, working from early in the morning until late in the evening.
There were short intervals of time when neither the father nor the son were present at the loading or discharging of a vessel. At such times the foreman supervised the operations under instructions given him by either the father or the son, as the case might be.
The son was in close touch with the nitrate interests of the du Pont de Nemours Co. and other nitrate concerns which were served by petitioner, and frequently advanced cash for short periods of time, purely as a matter of accommodation in meeting expenses, for which he was always*1963 reimbursed, sometimes immediately. He borrowed money on his individual responsibility when necessary to make these loans.
Labor was an important item in the operations of petitioner. It was at all times under the direction and supervision of the father and son, who gave detailed directions to the foremen relative to the work. An average of 10 or 12 foremen were employed by petitioner at salaries as high as $75 per week. Some of these foremen had been with petitioner for a number of years. The foremen usually attended to the employment and discharge of longshoremen, who were employed as needed. The wages of longshoreman were fixed by an arbitration board and not by the petitioner. The compensation for labor and the salaries paid by petitioner in 1920 and 1921 were as follows:
| 1920 | 1921 | |
| Labor and clerk hire, ships | $928,335.50 | $585,690.48 |
| Office salaries | 6,329.53 | 14,161.86 |
| Other salaries: | ||
| W. S. Smith | 4,800.00 | 25,700.00 |
| Terrence Smith | 4,800.00 | 25,800.00 |
The office force consisted of one stenographer, one bookkeeper, and one paymaster and his assistant. A warehouse man was employed to look after the tools and equipment. All other employees*1964 were directly connected with the loading and unloading of vessels. The office force was paid twice a month. The labor was paid every Saturday afternoon.
*1173 The operations of loading or discharging a vessel were usually completed in short periods, rarely exceeding a week. Upon the completion of any single operation a bill was rendered to the client and was thereupon due and payable. With reference to operations which were not completed at the end of any week, the understanding with the clients was that they would supply sufficient cash, upon request, to meet the shortage of the pay roll attributable to the operations to be charged to them. These payments were made by them when requested by the petitioner. Under the procedure followed by the petitioner the paymaster computed every Friday the approximate amount of the pay roll due on the following day, whereupon the clients were notified by telephone of the amounts of cash desired for pay roll purposes that week. This amount did not exceed the amount which would be due petitioner upon the completion of the operation. Collections were made Saturday morning. The petitioner, however, did not always ask for these advances*1965 and frequently paid for labor out of its own funds prior to settlement by the clients. From August 2, 1919, to May 16, 1921, petitioner received total advances from its clients in the sum of $692,000. This sum included the advances from Lykes Brothers for the account of the Southern Stevedoring Co.
Not all of the charges to clients were settled promptly. With reference to large and active accounts with particular clients the books reflect single items which remained unsettled for periods as long as several months. When it was necessary to use lumber in fitting out a vessel this lumber was purchased by the petitioner for the shipper and was billed to the petitioner on a monthly basis. It was delivered directly to the ship and petitioner did not keep any stock of lumber on hand. In rendering bills to its clients petitioner charged them for the cost of the lumber, plus 15 per cent. These bills were usually paid by the client before they were required to be paid by petitioner. A considerable quantity of bags and tax tags were purchased by petitioner and carried on hand as a matter of accommodiation to the nitrate interests. No profit was realized by petitioner on the sale of*1966 such bags and tax tags. A variety of port fees, minor expenses, and miscellaneous supplies were frequently paid for in cash by petitioner as a matter of accommodation to the clients and were billed to the clients without additional profit.
In order to conduct the business of stevedoring it was necessary for petitioner to own certain tools and equipment, such as wheel-barrows, tubs, picks, and shovels, trucks, etc., necessary in the loading and discharging of vessels. These had accumulated over the years of operation, replacements being made as articles wore out, and *1174 many articles dated back to the days of the partnership. Included among the equipment was an electric hoist purchased at approximately $1,000. This was purchased during the war for use on ships which were not equipped with a hoist or winch. It was used little, if at all, during the taxable years. None of the clients possessed such tools and equipment, and it was customary in the business for the stevedores to supply them. These was no specific compensation paid for the use of this equipment, but the clients looked to petitioner's ability to furnish it and its use was considered in arriving at the*1967 unit price per article or per ton which petitioner charged for its services.
Petitioner owned a small plat of real estate on which was located a house used by the watchman who had charge of the main warehouse adjoining it where the tools and equipment were stored. No part of it was rented and no income was derived from it. The warehouse was owned by Terrence Smith and rented to petitioner. The books of petitioner reflect loans in amounts and for purposes as follows:
| Date borrowed | Date repaid | Purpose | Amount |
| December, 1919 | February, 1920 | To provide ready cash, to meet payments of extra wages due labor under a retroactive award in arbitration. | $7,000 |
| July, 1920 | November, 1920 | For general business purposes | 6,000 |
| Do | do | do | 10,000 |
| August, 1920 | do | Borrowed by W. S. Smith for his personal use (proceeds immediately paid out for his account) | 3,500 |
Beginning in the fall of 1920 and extending through the entire year of 1921 the petitioner carried on hand large amounts of cash, ranging from $27,000 to $64,000. Bad debts in the amounts of $9,187.97 and $6,939.51 were deducted from gross income on the returns filed for 1920 and 1921, respectively, *1968 and allowed by the Commissioner in the determination of the deficiencies in question.
Petitioner's income was derived from charges for its services in loading or discharging vessels. For the simpler operations of loading vessels or discharging them compensation was billed at agreed prices per article, or per ton or cargo. Where on account of some unusual circumstances the charges could not be determined on the unit basis, and in cases where structural alterations of the vessel were necessary, the prices were based on the cost of labor and lumber, plus a percentage thereof for the services of petitioner.
It was customary in the business to allow commissions to shipping agents of approximately 2 1/2 per cent of the bill rendered. It was also customary to make payment of sums arbitrarily arrived at to ship's officers on account of personal service and facilities rendered available by them at the ships.
*1175 The gross income, expenses, net income, and net profits were as follows:
| 1920 | 1921 | |
| Gross income | $1,223,031.43 | $913,697.77 |
| Expenses: | ||
| Labor | 928,335.50 | 585,690.48 |
| Wages of office and warehouse staff | 6,339.50 | 15,361.86 |
| Salary of T. Smith | 8,300.00 | 25,700.00 |
| Salary of W. S. Smith | 4,800.00 | 25,800.00 |
| Ship expense | 152,327.55 | 118,824.90 |
| Various ordinary expenses | 54,827.87 | 44,740.18 |
| Depreciation | 1,843.55 | 2,125.13 |
| Bad debts and/or allowances to clients | 9,187.97 | 6,939.51 |
| Total expenses | 1,170,961.94 | 825,182.06 |
| Net income | 52,069.49 | 88,515.71 |
| Federal income and profits tax paid | 7,677.66 | |
| Net profits according to the books | 52,069.49 | 80,838.05 |
*1969 The gross income from the Southern Stevedoring Co. business is included in the amount stated above as gross income.
Petitioner's accounts were kept on the accrual basis and were subject annually to an audit by a public accountant. The net profits were transferred on the books to the stockholders in proportion to their respective holdings. Personal transactions of W. S. Smith were handled on petitioner's books as a matter of convenience. He kept no books of his own.
The returns for 1920 and 1921 were filed by petitioner on Form 1065 provided by the Commissioner for the use of personal service corporations. All of the net profits were shown as distributed to the stockholders. The balance sheets reflected the following:
| Dec. 31, 1919 | Dec. 31, 1920 | Dec. 31, 1921 | |
| Assets | |||
| Cash | $1,680.80 | $45,774.06 | $64,671.23 |
| Accounts receivable | 17,435.30 | 1 14,623.79 | 38,424.47 |
| Investments | 1,200.00 | 1,200.00 | |
| Accommodation loans to employees and friends | 1,281.30 | 2,000.00 | 450.00 |
| Tools and equipment | 14,868.74 | 17,240.76 | 18,817.58 |
| Furniture and fixtures | 200.00 | 351.00 | 369.90 |
| Horses, wagons, harness, and automobile | 800.00 | 3,986.28 | 4,001.33 |
| Real estate | 2,500.00 | 2,500.00 | 2,500.00 |
| Investments belonging to and held for W. S. Smith | 6,315.43 | 6,315.43 | |
| Total | 56,281.57 | 93,991.32 | 129,234.51 |
| Liabilities | |||
| Accounts payable | 1,150.00 | 28,386.02 | 34,289.31 |
| Accrued bonus to one employee | 1,000.00 | ||
| Borrowed from bank | 7,000.00 | ||
| Account of T. Smith | 325.39 | 5,955.78 | |
| Capital and stockholders' accounts | |||
| Capital stock | 33,200.00 | 33,200.00 | 33,200.00 |
| Leon Verges (undrawn profits) | 86.30 | 313.67 | |
| W. S. Smith (undrawn profits) | 4,519.88 | 32,091.63 | 54,788.42 |
| Total | 46,281.57 | 93,991.32 | 129,234.51 |
*1176 OPINION.
PHILLIPS: The petitioner claims personal service classification for the calendar years 1920 and 1921 within section 200 of the Revenue Acts of 1918 and 1921. The respondent denied this classification and asserted the deficiency here in question. The petitioner further alleges that the services performed for the Southern Stevedoring Co. were performed by W. S. Smith in his individual capacity and prays in the alternative that its net income, as found by the Commissioner, be corrected by deducting therefrom compensation received for those services in the sum of $17,784.33 in the year 1920, and $12,844.60 in the year 1921.
It is admitted by the respondent that petitioner is entitled to the benefit of sections 327 and 328 of the Revenue Acts of 1918 and 1921 in the computation of its tax.
Section 200 of the Revenue Acts of 1918 and 1921 defines a personal service corporation as follows:
The term "personal service corporation" means a corporation whose income is to be ascribed primarily to the activities of the principal owners or stockholders who are themselves*1971 regularly engaged in the active conduct of the affairs of the corporation and in which capital (whether invested or borrowed) is not a material income-producing factor; but does not include any foreign corporation, nor any corporation 50 per centum or more of whose gross income consists either (1) of gains, profits, or income derived from trading as a principal, or (2) of gains, profits, commissions, or other income, derived from a Government contract or contracts made between April 6, 1917, and November 11, 1918, both dates inclusive.
Petitioner is not a foreign corporation, nor was 50 per centum or more of its income derived from trading as a principal or from gains, profits, commissions or other income derived from Government contracts. William S. Smith, the principal stockholder, was regularly engaged in the active conduct of the affairs of the corporation. It remains, then, to determine whether petitioner's income is to be ascribed primarily to the activity of its principal stockholder, and whether capital, invested or borrowed, was a material income-producing factor.
Petitioner was engaged during the taxable years in the business of stevedoring. The business had been*1972 founded about 25 years prior to 1918 by Terrence Smith, who was an experienced and successful stevedore and had built up a good reputation. About 9 years prior to 1918 Terrence Smith took his son, William S. Smith, into partnership with him. W. S. Smith was also an experienced stevedore. In 1918, for reasons growing out of a second marriage of Terrence Smith, petitioner was organized to carry on the business of the partnership. The capital stock, with the possible exception of 2 qualifying shares, was turned over for the assets of the partnership. Two hundred and thirty shares were issued to W. S. Smith *1177 and 100 shares were issued to Terrence Smith. In 1919 W. S. Smith acquired the 100 shares of stock from his father, and in 1921 he acquired the two qualifying shares, so that in 1920 he owned all the stock except two shares, and in 1921 he was the sole stockholder.
During the taxable years petitioner's income was derived from the loading and discharging of cargo from ships. The petitioner was paid a certain price per unit of cargo loaded or unloaded, except that in complicated cases it might be paid on a cost-plus basis. It furnished and paid for the labor and*1973 supervision on the job. Its profit or loss was the difference between the amount paid it for loading or discharging the cargo and the cost to it of performing the work. In many respects it may be compared with any other contractor who engages to perform certain work at an agreed price, furnishing the necessary labor and materials. It is urged, however, in substance, that the proper handling and stowing of the cargo was of such great importance that the element which labor played in the performance of the task undertaken must be disregarded; that it was the personal skill, technical knowledge, judgment and experience of the principal stockholder which shipowners and their agents desired; and that it was these qualifications in the petitioner's organization which enabled it to secure the work in preference to others. It seems pertinent to point out that petitioner did not limit its activities to furnishing shipowners with the personal skill, technical knowledge, judgment and experience of its principal stockholder, with such incidental help as might be necessary to enable him to apply these qualifications. It is not in the position of one who supervises the work of others. It undertook*1974 to perform the entire task of loading and unloading ships, as a contractor would undertake to construct a building or a road. Expert supervision of the labor was necessary, but the same is true of any substantial undertaking. It seems doubtful whether it can be said that petitioner's income is to be ascribed primarily to the services performed by those who planned and supervised its activities, but in the instant case we find it unnecessary to base a decision upon a determination of that question. For the purposes of this case we may assume that it was personal skill, technical knowledge, judgment and experience in supervising the loading and unloading of cargo that produced the income. The record leaves no doubt that a substantial part of such income-producing activities was performed by the elder Smith, who was not a stockholder. His experience was greater than that of his son. It was he who had built up the business and the clients were those who had been served by petitioner and its predecessor for years. Either Terrence Smith or W. S. Smith had the necessary qualifications to carry on the work, and both were very active in the business during the years before us. William*1975 S. Smith, the principal stockholder, *1178 exercised a general supervision over the business, particularly in regard to policy and finance, but the actual supervision of loading and discharging vessels was divided between himself and his father. He personally supervised the loading and discharging of vessels serviced for the Southern Stevedoring Co. and assisted as much as his time permitted in supervising other vessels being serviced by the petitioner.
Terrence Smith was regularly and actively engaged in supervising the loading and discharging of ships serviced by petitioner, and utilized his own knowledge, experience and judgment in this work. In fact, the evidence indicates he was consulted by administrative employees in regard to these matters. Certainly he was not a mere routine employee engaged in carrying out the plans and instructions of his son. When it was necessary to formulate and draft a stowage plan where vessels were loaded with miscellaneous cargo, such plans were drafted by W. S. Smith, but not all the vessels loaded required such plans. The evidence indicates that the vessels of the Southern Stevedoring Co. and approximately only 30 of the other vessels*1976 serviced by petitioner required such plans. It was not necessary to draft plans for these other vessels serviced by petitioner which were loaded with cargo requiring less skill in loading, and there is no evidence that the discharging of vessels required extraordinary skill. Certainly Terrence Smith was capable of directing such operations. Terrence Smith was not considered an ordinary employee in the business. He was considered one of the executive heads of the business and functioned as such.
The incorporation of petitioner and the subsequent transfer of the stock held by Terrence Smith to his son were occasioned by personal reasons. Terrence Smith did not retire from the business, but remained active and performed substantially the same duties he had heretofore performed. We do not think that it would be seriously argued that in prior years he was not a primary factor in the production of income. He was the founder of the business, the senior member of the partnership, and became the president of petitioner corporation upon its organization. His name had always been connected with the business and clients expected to receive and, we believe, did receive his skill and*1977 experience as a stevedore when engaging petitioner.
Stevedoring was a very active and strenuous business which required long hours of service. In the taxable years W. S. Smith had relieved his father of some of the strain and had assumed the active business management, but Terrence Smith was by no means eliminated. He was an active figure on the docks and at the office, working from early in the morning to late in the afternoon directing the loading and discharging of vessels for petitioner. His *1179 salary was $4,800 and 1920 and $25,800 in 1921. We think he was substantially as much of a factor in the production of income in the taxable year as was his son, and that under the facts before us petitioner's income can not be ascribed primarily to the activities of the younger Smith, and this is true whether we consider the profits from the operations of the Southern Stevedoring Co. as income to the petitioner or to W. S. Smith personally. If we consider it as belonging to petitioner, we can not overlook the fact that W. S. Smith devoted a large part of his time to those operations and the petitioner received only one-half the profits from them. If we consider that he*1978 devoted only a part of his time to petitioner's business, the conclusion must be that he left to Terrence Smith the supervision of a large proportion of petitioner's work. In either case it directly affects the quantum of petitioner's income produced by W. S. Smith. These conditions are evidenced by the fact that in the year 1920, when the gross income from the Southern Stevedoring Co. was $267,250.94, petitioner's gross income of $1,223,031.43 yielded a profit of $52,069.49, and in 1921, when the gross income from the Southern Stevedoring Co.'s business was $146,781.45, a gross income of $913,697.77 yielded a profit of $80,838.05. The mere fact that the principal or sole stockholder of the corporation exercises general supervision over its affairs, and is the final authority in the determination of its policy, does not of itself mean that he alone is the primary factor in the production of its income, where, as here, the activities of a nonstockholder are shown also to be a primary factor in the production of the income. It is our conclusion that the claim for personal service classification must be denied.
Petitioner urges that the service rendered to the Southern Stevedoring*1979 Co. was a personal service rendered by W. S. Smith under a contract which he had entered into with Lykes Brothers, who controlled the Southern Stevedoring Co., and that the profits from that service were income to W. S. Smith and not to petitioner. W. S. Smith testified to that effect and it is certain that he personally supervised the service to the Southern Stevedoring Co. Notwithstanding this fact, the records show that this business was handled by petitioner in much the same manner as it handled all its other business. The gross receipts from the Southern Stevedoring Co. were treated in petitioner's books of account the same as any other income. "Advances" from Lykes Brothers for pay-roll purposes were received and blended with petitioner's funds. The expenses incident to the service of the Southern Stevedoring Co. were treated by petitioner in the same manner as its other business expenses, and there is nothing in the record that will enable us to segregate them from petitioner's other expenses. Nor is there anything before us from which we can determine what the net profits from the Southern *1180 Stevedoring Co. were. In its income-tax returns for 1920 and 1921*1980 petitioner made no segregation of the income or expenses of the Southern Stevedoring Co., but included these items in its gross income and expenses. In this condition of the record the determination of the respondent is sustained as to this issue.
Reviewed by the Board.
Decision will be entered under Rule 62(c).
SMITH, TRUSSELL, and SEAWELL dissent.
Footnotes
1. Net, after deducting credit balances, aggregatinc $21,887.44, of accounts of 2 clients. ↩