*3065 PERSONAL SERVICE. - Petitioner did not buy and sell merchandise nor trade as a principal; it rendered the purely personal service of soliciting orders for textiles; its income was derived from commissions earned from such personal service, except for interest incidentally earned upon accumulated profits of the business; it did not use capital in its business as a selling agent; and its stockholders were regularly and actively engaged in the conduct of its affairs. Held, that petitioner is entitled to personal service classification.
*1342 This proceeding is from respondent's determination of deficiencies in income and profits taxes in the amount of $30,984.44 for the calendar year 1919, and $49,687.14 for the period from January 1, 1920, to May 31, 1920.
The petitioner alleges that respondent erred as follows:
1. That he denied petitioner personal service classification as defined by section 200 of the Revenue Act of 1918.
*1343 2. That upon the failure to allow personal service classification, he*3066 denied petitioner a determination of its tax liability under the provisions of sections 327 and 328 of the Revenue Act of 1918, it being alleged that petitioner's invested capital can not be determined pursuant to section 326 of the said Act; and
3. That he reduced petitioner's invested capital by prorating prior years' taxes.
FINDINGS OF FACT.
Weill-Jamison Co., Inc., the petitioner herein, was organized under the laws of the State of New York, in July, 1917, with an authorized capital stock of 1,000 shares, being of the par value of $100 each. and it was dissolved in August, 1920. From the time of its organization to and including May 31, 1920, upon which latter date it ceased to engage actively in any business, it was engaged in the business of selling textiles under contract as a mill agent on a commission basis. The outstanding capital stock during petitioner's existence was $20,000 issued to Isaac Weill, Emmanuel Weill, William D. Jamison and B. H. Bristow Draper, in equal proportions, for which each paid $5,000 in cash. Isaac Weill, Emmanuel Weill, and William Jamison were the officers and directors of petitioner, but Jamison, secretary and treasurer, was the only*3067 officer who received a fixed salary, which amounted to about $15,000 per annum. All four stockholders shared equally in dividends.
Prior to the organization of petitioner, I. Weill and E. Weill, as copartners under the firm name of I. and E. Weill, conducted a business of selling textiles on a commission basis under contracts with certain mills for the sale of their entire output, and William D. Jamison was a representative of the firm. At or about the time of incorporation, I. and E. Weill assigned to petitioner their contract with the Pilgrim Mills, a corporation of Fall River, Mass., giving I. and E. Weill an exclusive sales agency of the mill's entire output, and they also assigned to petitioner the lease for offices at 320 Broadway, New York City, for which petitioner agreed to pay I. and E. Weill $90,000 in equal monthly installments of $1,500 each. The said contract was entered into on January 28, 1915, effective on June 2, 1915, and to be terminated on June 2, 1918, provided that notice be given prior to February 1, 1918, by either party to so terminate the contract, and provided further, that, in the event no such notice be given, the contract be continued thereafter*3068 from year to year Under date of September 15, 1917, the petitioner, the Pilgrim Mills and I. and E. Weill as copartners entered into an agreement whereby petitioner was substituted for I. and E. Weill as party to said contract of January 28, 1915. Subsequently the contract of January 28, 1915, was canceled by a new contract entered into on January 2, 1918, *1344 between petitioner and the Pilgrim Mills, which new contract was similar in all respects to the canceled contract except that it be terminated on December 31, 1920, if notice be given, and if not, that it be continued thereafter from year to year.
Under date of September 1, 1917, petitioner entered into a contract with the Queen City Cotton Co. of Burlington, Vt., for the exclusive sales agency of that mill's entire output for a period from the date of the contract and terminating on September 1, 1920, if proper notice be given, and if not, continuing thereafter from year to year.
The two contracts of January 2, 1918, and September 1, 1917, which were in effect during the periods in question, were similar in material respects except as to one matter hereafter set forth, and provided, briefly, that petitioner sell*3069 the entire output of the mills at prices fixed by the mills; that petitioner give the mills the benefit of its knowledge of the condition of the market and styles and also its advice as to the nature of the textiles to be produced; that petitioner continue to furnish the services of William D. Jamison its secretary and treasurer; that the mills pay expenses of collection of accounts where goods do not meet requirements of the agreement of sales; that petitioner guarantee all accounts and that petitioner receive a specified commission. The Pilgrim Mills contract provides that petitioner "render accounts current semi-annually, and account sales monthly as near the first of the month as possible, and to make remittances * * * (to the mill) on or before the fifteenth of each month, in such amounts as may be found due" the mill. The Queen City Cotton Co. contract provides that the mill "do all billing and collecting and will render to * * * (petitioner) a detailed statement daily of all goods charged and also overdue accounts," and further, "to render a monthly statement of sales and to render to * * * (petitioner) all commissions due for preceding month."
Under date of January 2, 1919, petitioner*3070 and I. Weill, E. Weill, B. H. Bristow Draper and William D. Jamison entered into an agreement canceling the agreement of 1917 between petitioner and I. and E. Weill in so far as it made petitioner liable for the payment of $90,000 for the assignment of the Pilgrim Mills contract of January 28, 1915. Petitioner did not purchase and sell any merchandise on its own account, but merely solicited and obtained orders for the products of the Pilgrim Mills and Queen City Cotton Co. under contract and, also, during the latter part of its existence petitioner obtained a small amount of orders for the products of the Alta Vista Mills, with which mill it had no contract. Petitioner received a commission of 3 per cent on sales which was its only income except interest derived on its bank balance and from United States Liberty bonds in which it invested a portion of its surplus *1345 earnings. Petitioner obtained orders with complete specifications, prices, customer's name, etc., which orders were numbered consecutively and sent to the respective mills for filling. The mills either consigned the merchandise to petitioner, who in turn invoiced it to the customers, or the mills consigned*3071 it direct to the customers. Some collections were made by the mills and some by petitioner who made regular remittances to the mills. Between the fifteenth and twentieth of each month a settlement was made by petitioner with the mills of all moneys due for the previous month's sales, but petitioner's collections were always in excess of amounts due the mills for any one month. Petitioner did not remit to the mills in advance of making collections.
Petitioner employed in its office a combined stenographer and bookkeeper, a telephone operator, and a clerk. It never employed brokers, although sales were made through brokers, who represented purchasers.
Petitioner's gross sales for 1919 amounted to $4,122,526.83 and the total brokerage paid during 1919 amounted to $24,527.01, which latter figure represents 1 per cent of the gross sales on which brokers received commissions. For the period of 1920, here involved, petitioner's gross sales amounted to $2,903,821.82 and the total brokerage paid amounted to $17,699.55. Some of the petitioner's customers employed brokers regularly to keep them posted with the market and to make purchases, and it was the custom of the trade for such*3072 brokers to receive the regular commission on purchases made by such customers, although the brokers had no part in the sales made by petitioner. In instances where a prospective purchaser's broker came to petitioner and a sale was made, petitioner paid the broker a commission in accordance with the custom of the trade. Whenever brokers or customers went to the mills direct for quotations or the purchase of merchandise they were always referred to petitioner, due to the exclusive sales contracts.
During the periods here in question William D. Jamison devoted his entire time and attention to the business of petitioner and was in charge of the office. He made sales and also called on prospects and closed prospective deals given him by the other stockholders. I. Weill and E. Weill continued their partnership business of selling textiles of the Waypoyset Manufacturing Co. under contract, but also kept in constant touch with the affairs of petitioner, made sales for petitioner, and gave Jamison leads as to prospective customers. B. H. Bristow Draper was sales manager for the Draper Corporation, a large machinery concern, which position kept him on the road visiting cotton mills a*3073 great part of the time, and he also had several other business activities. Draper gave petitioner the benefit of his experience and knowledge as to styles, etc., of textiles that other mills *1346 were producing, which enabled petitioner to properly advise the mills as to the kinds of textiles to be produced. Petitioner declared dividends in proportion to stockholding but a surplus was maintained in cash in the bank on which interest was derived. When petitioner had sold textiles in a quantity equal to the year's production capacity of the mills it represented, its work for those mills was completed for that particular year.
Petitioner's books of account have not been submitted in evidence, but its return for the year 1919 contains the following statements:
| Ordinary and necessary expenses | |
| Rent | $1,870.00 |
| Telephone and telegraph | 659.88 |
| Traveling expenses | 2,275.00 |
| Advertising | 400.00 |
| Salaries | 4,073.00 |
| Miscellaneous | 1,100.19 |
| Brokerage | 24,527.01 |
| Total | 34,905.08 |
| Compensation of officers | |
| W. D. Jamison, treasurer, complete time devoted. Shares owned, 50. Total salary | $15,000.00 |
| Exhaustion, wear, and tear | ||||
| Character | Estimated life | Value | Depreciation | Previous years |
| for this year | ||||
| Furniture and fixtures | 10 years | $1,397.35 | $139.74 | $107.89 |
| Comparative balance sheets as at January 1, 1919, and January 1, 1920 | ||
| Jan. 1, 1920 | Jan. 1, 1919 | |
| ASSETS | ||
| Cash | $35,671.80 | $40,391.60 |
| Anticipated collections paid to | ||
| mills * | 53,908.42 | 26,966.67 |
| Liberty bonds | 75,000.00 | 35,000.00 |
| Furniture and fixtures | 1,397.35 | 1,078.85 |
| Good will | 6,000.00 | 6,000.00 |
| Total assets | 171,977.57 | 109,437.12 |
| LIABILITIES | ||
| Capital stock outstanding | 20,000.00 | 20,000.00 |
| Members' capital accounts: | ||
| I. Weill | 37,932.48 | 22,332.31 |
| E. Weill | 37,932.49 | 22,332.31 |
| B. H. Draper | 37,932.49 | 22,332.30 |
| W. D. Jamison | 37,932.48 | 22,332.31 |
| Reserve for depreciation, | ||
| furniture, and fixtures | 247.63 | 107.89 |
| Total liabilities | 171,977.57 | 109,437.12 |
| Analysis of members' net worth accounts | ||
| Members' net worth, January 1, 1919 | $89,329.23 | |
| Net profit for year 1919 | 84,400.71 | |
| Total | 173,729.94 | |
| Dividends paid April 30, 1919 | $6,000.00 | |
| Dividends paid July 31, 1919 | 8,000.00 | |
| Dividends paid Sept. 30, 1919 | 8,000.00 | |
| 22,000.00 | ||
| Members' net worth, January 1, 1920 | 151,729.94 |
*3075 *1347 Petitioner's net income as adjusted by respondent amounted to $85,040.52 for the calendar year 1919, and $117,674.95 for the fiscal period January 1, 1920, to May 31, 1920.
Petitioner did not use capital, either invested or borrowed, in the conduct of its sales agency business. Each year's profits were partially distributed to the stockholders, partially invested in Liberty bonds and the balance kept in banks for the purpose of drawing interest, but such cash surplus was not used in the business.
The respondent has disallowed petitioner personal service classification, has computed its invested capital under section 326 of the Revenue Act of 1918, and in so doing has allowed a paid-in surplus of $64,800 apparently for the value of the contract acquired by petitioner from I. and E. Weill, but the consideration for which was canceled as of January 1, 1919. The respondent has also prorated prior years' taxes as provided by regulations, thus reducing invested capital.
OPINION.
TRUSSELL: In order to classify petitioner as a personal service corporation, it must meet all the requirements of section 200 of the Revenue Act of 1918, which defines a personal service*3076 corporation as one whose income is to be ascribed primarily to the activities of the principal owners or stockholders who are themselves 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.
The business of petitioner consisted of soliciting orders for the textiles produced by the mills it represented as selling agent. Its income is to be ascribed primarily to commissions earned upon sales of textiles for the mills and those sales were due to the activities of the four stockholders. Jamison was in charge of the office and attended to all the details of the business, for which services he received a salary. I. Weill and E. Weill, although engaged in other business activities, kept in close touch with the affairs of petitioner, made sales and gave Jamison leads as to prospective customers. Draper was engaged in other business activities, but such activities enabled him to *1348 keep petitioner posted at all times as to market conditions, change in styles, etc., of textiles which was a service as valuable as the making of sales for it was necessary for petitioner*3077 to advise the mills as to the best and most marketable style, color, etc., of textiles to produce. It was not necessary for I. and E. Weill and Draper to devote their entire time to the business of petitioner for as soon as petitioner had secured orders for a quantity of textiles equal to the year's production capacity of the mills, the petitioner's work for those mills was completed for that year. The activities of all four stockholders resulted in the sale of the entire output of certain mills, which was the only business of petitioner, and all four stockholders were actively and regularly engaged in the particular business of petitioner.
Capital was not a material income-producing factor. Neither the cash paid in for stock nor the accumulated surplus was used in petitioner's business of selling textiles for the mills. Petitioner did not remit to the mills in advance of making collections from customers. Its collections exceeded the amounts due the mills on regular monthly settlements, which were made between the fifteenth and twentieth of each month for the preceding month's sales. The profits which were not distributed as dividends were either invested in Liberty bonds*3078 or kept in banks and the surplus was considered as the members' (stockholders') net worth.
I. and E. Weill's assignment of the Pilgrim Mills contract to petitioner for $90,000 to be paid in monthly installments of $1,500 each was merely a method by which I. and E. Weill were to secure a larger portion of profits from the business, but shortly after the assignment the contract so assigned was canceled and I. and E. Weill entered into an agreement with petitioner relieving it of its obligation to pay the said $90,000.
The courts have held that the language used in section 200 is "regularly engaged" not "exclusively engaged" and may not be so narrowly construed as to exclude all outside activities, that the presence of capital does not affect personal service classification if it is not a material factor in the production of the corporation's income and that the distinction between personal service corporations and those which are not, is income earned by personal effort and income earned by capital through trading as a principal, respectively. See *3079 ; ; ; ; .
Petitioner did not buy and sell merchandise nor trade as a principal; it rendered the purely personal service of soliciting orders for *1349 textiles; its income was derived from commissions earned from such personal service, except for interest incidentally earned upon the accumulated profits of the business; it did not use capital in its business as a selling agent; and its stockholders were regularly and actively engaged in the conduct of its affairs. We are of the opinion that petitioner is entitled to be classified as a personal service corporation for the periods here in question, and having so decided, it is not necessary to discuss the other two issues relative to invested capital.
Reviewed by the Board.
Judgment will be entered for the petitioner.
TRAMMELL, MORRIS, GREEN, *3080 and MURDOCK dissent.
Footnotes
*. In the comparative balance sheets the item termed "Anticipated collections paid to mills" should be "Commissions receivable," on sales made but on which petitioner had not made collection. Accounts receivable and accounts payable are not shown on the above balance sheets for the reason that accounts receivable from customers less commissions, offset accounts payable to the mills. ↩