*234 Decision will be entered under Rule 50.
Petitioner corporation, which included in its activities the giving of instructive courses in gemmology, held, not exempt from tax under section 101 (6), I. R. C., because part of its net earnings inured to the benefit of an individual.
*1605 The Commissioner determined against petitioner the following tax deficiencies and penalties:
| 25 per cent | |||
| Tax | Year | Deficiency | penalty |
| 1944 | $ 1,009,98 | $ 252.50 | |
| Declared value excess profits | 1945 | 1,562.52 | 390.63 |
| 1944 | 1,693.18 | 423.30 | |
| Income | 1945 | 2,674.19 | 668.55 |
| 1946 | 3,854.02 | 963.51 |
Two issues were raised by the petition; one of these, the*235 question of liability for delinquency penalties, was disposed of in petitioner's favor by stipulation of the parties that failure to file corporation income and declared value excess-profits tax returns was due to reasonable cause and not to willful neglect. The sole issue remaining is whether petitioner was exempt from Federal income and declared value excess-profits tax under the provisions of section 101 (6) of the Internal Revenue Code. A supplemental stipulation agreed to by the parties establishes the deficiencies for declared value excess-profits tax for the years before us.
FINDINGS OF FACT.
Some of the facts were stipulated, and are so found.
Petitioner is an Ohio corporation organized October 8, 1942, with its principal place of business located in Los Angeles, California.
In the spring of 1931, a venture, known as the Gemological Institute of America, was formed by Robert M. Shipley and Beatrice Shipley, his wife, for the purpose of offering courses of instruction in the science of gemmology 1 and related subjects. This venture was the outgrowth of Robert M. Shipley's prior business activity, which included work in the retail jewelry business and retail jewelry trade*236 associations. Shipley also spent 2 years in Europe. During this time abroad he studied and lectured on gemmology. The venture was organized and operated under the sponsorship of jewelers located throughout the United States. The policies of the venture were directed by a board of governors, elected by and from the sponsoring jewelers.
During the venture's existence the amount of income withdrawn by the Shipleys for their personal use was controlled by the board of *1606 governors. From 1931 to 1943, Shipley's salary from the venture averaged $ 275 per month, and his wife's average salary was $ 165 per month. Shortly after the formation of the venture a distinct and separate organization known as the American Gem Society was formed. As originally planned, the membership*237 of the Gem Society was to be composed of jewelers and others interested in gems. Many of its members were graduates and students of the Gemological Institute of America but its membership was not limited to such graduates and students. Because of a decrease in enrollment during the war years, the American Gem Society started a movement to raise an endowment fund for the Institute. As a result of this movement a fund of $ 60,000 to $ 70,000 was raised by contributions from jewelers, manufacturers, suppliers, and others interested in the perpetuation of the Institute. With the raising of the endowment fund, it was deemed proper "to form a corporation, not for profit," and the petitioner was thus formed. The Gemological Institute of America, Inc., was not a stock corporation but was composed of five classes of members.
On June 30, 1943, the petitioner entered into a written agreement with Robert M. Shipley and his wife for the purchase of the venture. The material provisions of this agreement are in part as follows:
1. Party of the first part [Gemological Institute of America] hereby agrees to, and does hereby, sell to the party of the second part [Gemological Institute of America, *238 Inc.], the good will and business * * * for the sum of Four Thousand Dollars ($ 4,000.00), * * *.
* * * *
4. It is contemplated that contemporaneous with the execution of this agreement the said Robert M. Shipley will become the executive director of the business of the party of the second part for a term of years. It is understood and agreed that the party of the first part and its members individually and as partners thereof hereby agree that they nor either of them will become associated or employed directly in any business, enterprise or association which is directly competitive with the business of the party of the second part so long as said party of the first part or the members thereof, or any of them, shall be in the employ of said party of the second part and for a period of five (5) years after termination of such employment. Such restriction shall be effective in all areas wherein, at the time of the termination of said employment, the party of the second part shall then be transacting its business. It is understood, however, that if the party of the first part shall engage in any activity indirectly competitive with that of the party of the second part, the said party*239 of the first part, or its members, may do so only after having obtained the express approval of the Board of Governors of the party of the second part.
Two other agreements were also entered into on June 30, 1943, between the petitioner and Robert M. Shipley. In one agreement the petitioner agreed to employ Shipley as its executive director for a period of 3 years from July 1, 1943, at a salary of approximately $ 375 per month. As a part of this agreement, Shipley agreed not *1607 to become "associated, employed, or interested financially or otherwise in any business or enterprise or association which is directly competitive with the business of the petitioner." The second or supplemental agreement is in part as follows:
It is mutually understood and agreed by the parties hereto that commencing on January 1st, 1944, the party of the first part shall pay to the party of the second part, in addition to the salaries agreed to be paid in that certain agreement of employment heretofore entered into, a sum equal to fifty per cent (50%) of the net amount received from the operation of said business, to be computed in accordance with accepted business accounting practices and after*240 allowance for depreciation, amortization, reserves for emergencies, insurance contingent liabilities, replacement of inventories at cost price, deduction of fixed overhead, including salaries, taxes, rents, public service utility charges and all other similar charges usually considered in computing the amount of net income for Federal income tax purposes. Said percentage will be paid annually on or before three months after the close of the fiscal year adopted by the corporation and shall be based on the business for the annual accounting period adopted by the corporation. Said percentage shall not be cumulative and shall only be for the period during which said party of the second part shall continue in the employ of said party of the first part.
If it shall be concluded that payment of said sum of 50% shall be in contravention of the regulations of the Internal Revenue Code of the United States or any regulation of any governmental authority pursuant thereto so as to prevent said party of the first part from receiving the benefits of a tax-free enterprise as a non-profit corporation, then and in that event it is understood and agreed that in lieu of said 50% the said party of *241 the first part will pay or cause to be paid to the party of the second part a royalty or commission upon the business transacted by said party of the second part in an amount which will approximate a sum equal to 50% of the net amount received from the operation of said business as hereinabove provided.
On March 15, 1944, petitioner filed with the collector of internal revenue at Los Angeles, California, its application for exemption under section 101 (6) of the Code. By letter dated April 21, 1944, respondent held that the petitioner was not entitled to the exemption. However, at petitioner's request, respondent reconsidered his action. In a letter dated February 2, 1945, respondent held that petitioner was entitled to exemption under the provisions of section 101 (6). Later, on December 13, 1948, respondent modified his prior determination that petitioner was exempt. Respondent said, in part, in his letter notifying petitioner of his action:
Based upon the evidence on file and the facts outlined above, it is the opinion of this office that inasmuch as you are bound by the terms of the above-mentioned supplemental agreement to pay Mr. Shipley fifty percent of your net income, *242 in addition to the amount agreed upon as compensation for his services, it cannot be said that no part of your net earnings inures to the benefit of a private shareholder or individual.
Shipley rendered valuable services to the petitioner during each of the years 1944, 1945, and 1946. He was paid an annual salary *1608 of $ 4,500 in each of these years and in addition received, under the 50 per cent clause of the supplemental agreement, the amounts shown in the following table:
| Taxable year ended December 31 | |||
| 1944 | 1945 | 1946 | |
| Gross income: (Tuition, books sold, dues, | |||
| sales of equipment, etc.) | $ 50,429.29 | $ 72,771.95 | $ 185,972.17 |
| Less: | |||
| Expenses (Books, insurance, legal | |||
| depreciation, taxes, etc.) | 30,626.55 | 43,597.38 | 146,152.61 |
| Salary: Shipley | 4,500.00 | 4,500.00 | 4,500.00 |
| Shipley's share of profit | 7,651.37 | 11,837.30 | 18,128.18 |
| Total expense | $ 42,777.92 | $ 60,934.68 | $ 168,780.79 |
| Net income | $ 7,651.37 | $ 11,837.27 | $ 17,191.38 |
During 1944, 1945, and 1946 petitioner gave its regular courses of instruction in gemmology. There were four correspondence courses and two residence courses. The correspondence courses covered the subjects *243 from the fundamentals of gemmology to an intensive study of diamonds. The residence courses consisted primarily of laboratory work and the study of instruments used by jewelers in evaluating gems and precious stones. Each of the correspondence courses required about 9 months for completion. The normal procedure was to study the correspondence courses for 9 months of the year, and to take 4 years to complete all the correspondence courses. The residence courses were taken during the vacation periods or at the end of the 4 years.
About 95 per cent of petitioner's students were correspondence students. Because of the war in 1944, there were no residence courses. The number of new enrollments during the taxable years was approximately as follows:
| 1944 | 200 |
| 1945 | 350 |
| 1946 | 900 |
Petitioner was approved by the Veterans Administration to give correspondence courses under the "G. I. Bill."
During the years 1944 through 1946 petitioner had from 7 to 25 employees of which 2 to 5 were faculty members. Similar courses of instruction were conducted by the mineralogical departments of Columbia University, University of Michigan, and the University of Colorado.
Petitioner's other activities*244 also included the development and the distribution of instruments used in gemmology. Petitioner published books, including text books and a quarterly. These were sold to students and others seeking a knowledge on the subject of gemmology. Petitioner's students were not limited to its members or employees of members. Anyone interested in taking the courses could enroll upon the payment of the tuition.
*1609 OPINION.
Petitioner, claiming exemptions from tax on corporations under section 101 (6), asserts that it was organized and operated exclusively for scientific and educational purposes, and that no part of its net earnings inures to the benefit of any private shareholder or individual.
In presenting the issues, respondent alleges, inter alia, that part of the petitioner's net earnings inured to the benefit of an individual, and, therefore, petitioner is precluded from the benefits of the section.
In order to be exempt, under this section, petitioner must meet each of three tests:
(1) It must be organized and operated exclusively for one or more of the specific purposes;
(2) Its net income must not inure in whole or in part to the benefit of private shareholders or individuals; *245 and
(3) It must not by any substantial part of its activities attempt to influence legislation by propaganda or otherwise.
"The words 'private shareholder or individual' in section 101 refers to persons having a personal and private interest in the activities of the organization." Regulations 111, section 29.101-2 (d). The facts prove that Shipley was a "person with a personal and private interest" in the petitioner. Actually, Shipley was the dominant individual in the corporation. While technically he did not create the corporation, he was the founder of the original venture, and upon transferring his activities to the petitioner, he became the most valuable and the most essential individual in the corporation.
Petitioner argues, because of Shipley's ability and past services, that he "was entitled to receive much more than the nominal amount set up as flat salary." This is not disputed. However, when petitioner further says that Shipley's compensation was not part of its net earnings but was only measured by the amount of its net earnings, we can not accept this argument as it is unsupported by the facts. In 1944 Shipley's compensation over and above his $ 4,500 salary was *246 $ 7,651.37. The petitioner's net earnings for that same year, after deducting this amount as a business expense, was the same amount, $ 7,651.37. In 1945 Shipley's compensation, not including salary, was $ 11,837.30 and the petitioner's net income was $ 11,837.27. In 1946 Shipley's compensation, again not including salary, was $ 18,128.18 and petitioner's net income was $ 17,191.38.
Regardless of what these amounts are called, salary or compensation based on earnings, it is obvious that half of the net earnings of petitioner inured to the benefit of an individual, viz., Shipley. These earnings are too material to be ignored. Roger L. Putnam, 6 T. C. 702. Cf. Edward Orton, Jr. Ceramic Foundation, 9 T. C. 533, affd. 173 F.2d 483">173 F. 2d 483. Such a distribution of net earnings is unequivocally *1610 prohibited by the statute. The petitioner has failed to meet one of the essential tests of section 101 (6). Therefore, it does not qualify for the exemptions because all requirements of the section must coexist. This holding renders it unnecessary to consider respondent's other contentions.
Because*247 the parties agreed to a stipulation of facts concerning the deficiencies for the declared value excess-profits tax, and for the penalties, a redetermination of the deficiencies must be made.
Decision will be entered under Rule 50.
Footnotes
1. Gemmology as defined by the petitioner is the science of gemmological stones having to do with identification, evaluation and classification of gems. Webster's New International Dictionary defines "gemmology" as: "The study of precious stones."↩