*3318 Personal service classification allowed.
*75 This proceeding was instituted for the purpose of obtaining a redetermination by the Board of deficiencies in income and profits taxes of $3,513.90, $3,945.03, and $2,552.07 for the years 1919, 1920, and 1921, respectively. The question presented for decision is whether the petitioner is entitled to be classified as a personal service corporation.
FINDINGS OF FACT.
The petitioner, a New York corporation, with principal offices in New York City, is an advertising agency, and a member of the American Association of Advertising Agencies. It was incorporated December 21, 1912, under the name of Cheltenham Advertising Service, Inc. In 1916, the corporate name was changed to "Corman-Cheltenham Company," and on or about September 5, 1918, when S. W. Corman acquired the interest of the principal stockholder, Corman changed the corporation's name to "The Corman Company."
During the years 1919, 1920, and 1921, the petitioner had a capital stock of $50,000, divided equally between common and preferred. *3319 Corman held all of the preferred stock and never had less than 240 of the 250 shares of common stock. The remainder of the common stock was held by Anna M. Corman, wife of S. W. Corman, and E. N. Wilkinson, treasurer and office manager of the petitioner.
At the time of the organization of the corporation, $15,000 was paid in for stock. The balance of the stock was issued for alleged good will. No additional money has been invested in the business.
From 1895 until the summer of 1916, Corman was engaged in various branches of advertising work, including eight years as "superintendent of business getting," and general manager of N. W. Ayer & Son, an advertising agency, Philadelphia.
Corman has been president and general manager of the petitioner since October, 1918. During the taxable years Corman was the principal stockholder of the petitioner and devoted all of his time to the affairs of the corporation.
The clients of the petitioner, particularly during the years 1919, 1920, and 1921, were intentionally limited in number to carry out *76 Corman's policy of giving his personal attention to the business of each client.
Corman solicited all of the business of*3320 the petitioner requiring solicitation; obtained all of the clients who spent in excess of $25,000 annually for advertising placed through the petitioner; kept in contact with clients; discussed merchandising problems with clients and with their assistance determined their advertising policies; dictated to his assistants the kind and character of advertising required for each client and personally directed and supervised the preparation of advertisements. Corman also made, or directed, trade investigations for clients in order to obtain first-hand information about their merchandising problems, and selected, with the approval of the advertiser, the publications to be used for advertising.
Wilkinson took care of the financial affairs of the petitioner, including the collection of bills rendered clients, and managed its office.
The objective of the petitioner was to form business connections with commercial concerns as a counselor of merchandising, and as the merchandising counsel of a firm, to study its peculiar marketing problems and assist it in developing a selling plan for its product. The petitioner styled itself "Merchandising Counsel-Advertising Service," on its business*3321 cards, letterheads and other official paper.
An example of the petitioner's manner of conducting its business is shown in the case of a varnish company, which, when Corman solicited its advertising business, was selling its product in bulk without satisfactory results. After a thorough investigation by the petitioner of the client's advertising expenditures, the Company decided to sell its product in packages rather than bulk. As a result of this decision, Corman prepared a new selling system for the company; traveled throughout the country collecting data for his client; made a study of competitors' products; addressed jobbers' conventions; attended salesmen's conventions; organized and attended a sales convention of the company, and selected labels for the tin cans in which the product was marketed. Corman also selected, with the approval of the varnish company, a list of publications for advertisements, and directed negotiations with publishers for advertising space.
Advertisements were drafted by employees of the petitioner under the constant supervision of Corman. After a proof of the advertisement to be run had been approved by the client, the necessary drawings were*3322 completed, and the petitioner had the required electrotypes, zinc etchings or half tones manufactured by outside concerns. Upon the approval by the client of a proof of the finished advertisement, the petitioner had a plate made and forwarded it to the publisher to be run in the space reserved for the advertisement.
*77 The petitioner did not produce any of the illustrations, art work, engravings, electrotypes, stereotypes, and matrices used in connection with its business. All of such work and material was, however, procured under the direction of the petitioner.
The method followed by the petitioner in getting out booklets was to first write a description of the booklet and present it to a prospective client with a statement of the maximum cost to him. If the client authorized the petitioner to proceed with the work, the latter would make up a dummy and have a printing establishment produce a rough copy. The petitioner then roughed up the pages, sketched the proposed illustrations, and wrote the text, and if the proposed booklet was approved by the client, the petitioner gave the client an estimate of the cost.
The petitioner's clients during the taxable years*3323 were, and the amount billed each, were, with some exceptions, as follows:
| 1919 | 1920 | 1921 | |
| Mennen Co | $252,468.42 | $203,844.03 | $256,001.17 |
| Wallach Bros | 178,807.97 | 309,722.02 | 290,936.48 |
| Torbensen Axle Co | 96,722.39 | 34,494.48 | |
| National Bank of Commerce in New York | 62,270.19 | 161,427.85 | 149,849.55 |
| Murphy Varnish Co | 52,637.43 | 70,891.87 | 70,409.96 |
| Gordon Tire & Rubber Co | 43,551.26 | 207.83 | |
| Hardman, Peck & Co | 33,152.91 | 34,189.97 | 41,622.31 |
| L. A. Young Industries, Inc | 19,407.04 | 745.20 | |
| Allen Corporation | 9,840.28 | 16,361.10 | |
| Haviland China Co., Inc | 10,308.21 | 3,605.10 | 5,475.52 |
| Phenix Cheese Co | 9,568.92 | 38,529.39 | 24,053.75 |
| Pictorial Review | 861.70 | ||
| Powrlok Co | 9,554.72 | 1.50 | |
| Brooks Brothers | 7,000.51 | 7,987.21 | 12,906.74 |
| Lincoln Trust Co | 5,204.39 | 3,911.66 | 2,836.31 |
| Dominick & Dominick | 4,319.69 | 3,674.38 | 6,270.32 |
| Sexton Manufacturing Co | 4,015.05 | 41,716.46 | 34,246.89 |
| Alex D. Shaw Co | 3,561.15 | 707.48 | |
| W.J.B. Motor Truck Co., Inc | 2,907.35 | ||
| Triangle Film Corporation | 2,721.91 | ||
| A. J. Coccaro & Co | 2,034.48 | 30.00 | |
| National Thrift Bond Corporation | 1,539.90 | 185.33 | |
| Leslie-Judge Co | 1,007.44 | 3,105.99 | |
| George D. Sykes Co | 1,248.33 | ||
| Astoria Mahogany Co | 946.58 | 8,413.71 | 858.42 |
| Lionel Corporation | 685.80 | 1,283.08 | |
| Central Talking Machine Co | 1,560.69 | ||
| American Hard Rubber Co | 262.76 | ||
| Total | 816,606.78 | 945,035.64 | 897,028.11 |
*3324 The total billings each year were: 1919, $820,632.55; 1920, $1,012,820.71; 1921, $954,791.73.
The contracts entered into between the petitioner and its clients for the services of the former, read as follows:
The CORMAN COMPANY, INC.,
New York City.
We hereby appoint you to act as our advertising agent with the understanding that you will not lend your services to another organization to advertise a product competitive with the product you are advertising for us without our consent and that all your books, bills, papers and orders pertaining to our business are subject to our inspection at any time.
*78 Upon our specific authorization you are to contract for advertising space for us in magazines, newspapers, street cars, on bill boards or elsewhere, such space to be billed to us at the gross rates charged you, the differential allowed you as a recognized advertising agent to be retained by you as compensation for your service to us. Where no differential is allowed you are to charge us 15%.
We agree to pay bills for space within the period specified on such bills with the understanding that you will allow us the full amount of all cash discounts allowed*3325 you.
In the preparation of advertisements you are to make no charge for the writing of copy; composition is to be charged at cost to you; illustrations, engravings, electrotypes, stereotypes and matrices are to be charged at net cost to you, plus 15%.
For mail, express or telegraph charges in connection with the placing of our advertising, you are to charge us the cost to you.
For the writing of booklets, catalogues, circulars, and follow-up letters or the production of store advertising such as countertrims, window cutouts, etc., you are to charge us a reasonable price for the services rendered and materials supplied and are, upon request, to furnish us in advance an estimate of the cost of such work before incurring any expense chargeable to our account.
When in our mutual judgment extended market or trade investigations are essential, specific provision will be made as to the basis upon which they are to be undertaken and an estimate of the maximum cost approved by us before proceeding with the work.
This engagement of your services may be terminated by you or us upon ninety days' written notice.
The petitioner never bought space in publications for sale to clients. *3326 After the client had ordered the reservation of space, the petitioner arranged for the space, using the following form of order blank:
Publisher (Name of publication)
Please enter our order for space to be used for the advertising of (Name of advertiser)
For this service you are to charge us (amount)
Less Commission Cash Discount.
Space reserved in the name of a particular advertiser was not transferable by the petitioner to another advertiser. It was a common practice for publishers to communicate directly with advertisers concerning their accounts and advertising.
The gross income and expenses of the petitioner during each taxable year, were as follows:
| 1919 Business | ||
| GROSS INCOME: | Per cent | |
| Commissions earned | 90.72 | $94,237.09 |
| Production profits | 7.28 | 7,560.19 |
| Art and copy | .48 | 502.48 |
| Interest on bank deposits and discounts earned | 1.42 | 1,475.14 |
| Interest on Liberty bonds | .10 | 103.65 |
| Total | 100 | 103,878.55 |
| EXPENSES: | ||
| Advertising | $136.87 | |
| General office expense | 5,182.88 | |
| Insurance | 151.74 | |
| Postage | 498.87 | |
| Rent | 4,330.03 | |
| Salary | 71,974.04 | |
| Stationery and office supplies | 1,341.21 | |
| Telegraph | 104.89 | |
| Telephone | 732.42 | |
| Traveling expenses | 2,223.32 | |
| Depreciation on F. & O.E | 365.00 | |
| Depreciation on improvement | 745.87 | |
| Bad debts | 742.26 | |
| Taxes | 187.13 | |
| Total | $88,716.53 | |
| Net income | 15,162,02 |
| 1920 Business | ||
| GROSS INCOME: | Per cent | |
| Commissions earned | 91.87 | $119,884.54 |
| Production profits | 6.40 | 8,356.64 |
| Art and copy | .29 | 373.11 |
| Interest on bank deposits and discounts earned | 1.23 | 1,601.76 |
| Interest on Liberty bonds | .21 | 273.44 |
| Total | 100 | 130,489.49 |
| EXPENSES: | ||
| Advertising | $237.09 | |
| General office expense | 4,232.33 | |
| Insurance | 147.01 | |
| Postage | 445.20 | |
| Rent | 4,439.99 | |
| Salary | 95,409.82 | |
| Stationery and office supplies | 1,933.60 | |
| Telegraph | 93.03 | |
| Telephone | 1,084.87 | |
| Traveling expense | 2,758.88 | |
| Depreciation on improvement | 663.33 | |
| Taxes - New York State | 738.32 | |
| Taxes - Federal | 32.00 | |
| Bad debts | 1,069.45 | |
| Total expenses | 113,284.92 | |
| Net income | 17,204.57 |
| 1921 Business | ||
| GROSS INCOME: | Per cent | |
| Commissions earned | 93.09 | $116,517.51 |
| Production profits | 4.31 | 5,399.33 |
| Art and copy | .53 | 660.72 |
| Interest on bank deposits and discounts earned | 1.73 | 2,165.65 |
| Interest on Liberty bonds | .34 | 427.85 |
| 100 | 125,171.06 | |
| EXPENSES: | ||
| General office expense | $4,204.88 | |
| Insurance | 118.88 | |
| Postage | 370.43 | |
| Rent | 4,440.00 | |
| Salary | 94,661.51 | |
| Stationery and office supplies | 915.91 | |
| Telegraph | 52.90 | |
| Telephone | 872.31 | |
| Traveling expense | 5,065.13 | |
| Depreciation on F. & O.E | 855.25 | |
| Depreciation on improvement | 663.32 | |
| Taxes - New York State | 765.27 | |
| Total expenses | $112,985.79 | |
| Net income | 12,185.27 |
*3328 *80 The account "Commissions Earned" represents fees charged advertisers on the basis of 15 per cent of the cost of the space used and the differential allowed the petitioner by publishers as a recognized advertising agent. The totals shown in the account "Production Profits" represent the 15 per cent allowed the petitioner on the cost of engravings, electrotypes, stereotypes, and matrices. The account "Art and Copy" covers charges made for small jobs performed by members of the petitioner's staff.
The item of $742.26 charged to bad debts in 1919 represents the total of small sums loaned to employees of the petitioner prior to the time Corman acquired an interest in the business. The bad debt item of $1,069.45 in the statement for 1920 covers an account against an advertiser charged off as worthless.
Between 90 and 95 per cent of petitioner's gross income was earned through services performed in connection with advertisements, and the remainder, with the exception of interest earned on bank deposits and liberty bonds, and cash discount taken on bills payable, was derived from the preparation and production of booklets, store trims, and engravings and the like. Of*3329 the latter per cent, less than one per cent was earned through the writing of booklets.
The balance sheets of the petitioner on the first day of the years 1919 to 1922, inclusive, were:
| Jan. 1, 1919 | Jan. 1, 1920 | Jan. 1, 1921 | Jan. 1, 1922 | |
| ASSETS | ||||
| Cash | $23,493.58 | $33,481.72 | $39,892.53 | $54,885.29 |
| Accounts receivable | 25,079.82 | 42,777.29 | 36,718.93 | 24,334.73 |
| Bills receivable | 2,142.87 | 4,200.00 | ||
| Art and engraving | 305.23 | 2,158.85 | 1,223.79 | 1,320.06 |
| Liberty loan employees | ||||
| account | 538.60 | 224.84 | ||
| Furniture and office | ||||
| equipment | 2,025.00 | 2,428.60 | 2,393.35 | 3,454.85 |
| Improvements | 2,302.33 | 1,824.46 | 1,161.13 | 497.81 |
| Insurance unexpired | 74.58 | |||
| Good will | $35,000.00 | $35,000.00 | $35,000.00 | $35,000.00 |
| Loss and gain | 1,015.92 | 4,699.09 | 9,205.19 | 9,214.39 |
| Liberty loan investment | ||||
| Total | 91,995.93 | 126,794.85 | 125,594.92 | 128,707.13 |
| LIABILITIES | ||||
| Accounts payable | 40,495.93 | 63,566.03 | 56,286.53 | 53,921.17 |
| Surplus | 3,603.82 | 12,808.39 | 24,744.96 | |
| Capital stock | 50,000.00 | 50,000.00 | 50,000.00 | 50,000.00 |
| Reserve for dividends | 1,500.00 | 9,625.00 | 6,500.00 | |
| Total | 91,995.93 | 126,794.85 | 125,594.92 | 128,707.13 |
*81 The item "Accounts*3330 Receivable" represents the unpaid amount of bills rendered clients for advertising space. The account "Bills Receivable" represents money loaned to employees of the petitioner. The amounts set up in the account "Art and Engraving," represent charges for art work and engravings which had not been allocated to a particular job. The figures in the account "Liberty Loan Investment" represent the amount of money invested in Liberty bonds. The item "Accounts Payable" represents the amount owing to, but not due, publishers for advertising space.
Concurrently with the completion of arrangements for advertising space, book entries were made charging the advertiser and crediting the publisher for the cost of the space. Bills rendered by the petitioner to clients for advertising space had to be paid not less than five days in advance of the last cash discount day of the publisher's bill in order to entitle the advertiser to the discount allowed by the publisher for prompt payment of bills. The petitioner did not allow a cash discount on its own account and passed on to its clients any discount allowed it. Every invoice sent out by the petitioner indicated the time within which the debtor*3331 would have to pay the account in order to obtain the cash discount allowed by the publisher. During a period of twelve years, including the taxable years in question, all of petitioner's bills, with a few exceptions, were paid by the client sufficiently in advance of the due date of the publisher's bill to enable the petitioner to pay the publisher with funds paid in by the advertiser.
The bank balance of the petitioner on the first day of each month of the years 1919, 1920, and 1921, was:
| 1919 | 1920 | 1921 | |
| January | $28,573 | $43,876 | $46,768 |
| February | 31,127 | 36,260 | 64,206 |
| March | 31,224 | 33,688 | 49,383 |
| April | 48,325 | 36,836 | 69,276 |
| May | 65,550 | 38,637 | 61,064 |
| June | 64,822 | 61,527 | 84,059 |
| July | $64,316 | $65,341 | $75,441 |
| August | 69,110 | 61,304 | 78,625 |
| September | 46,040 | 55,973 | 69,394 |
| October | 41,384 | 51,745 | 75,862 |
| November | 40,886 | 54,562 | 67,782 |
| December | 52,015 | 47,342 | 66,919 |
*82 Most of the money in bank represented funds paid in by clients and being held for the payment of publisher's bills. None of it was borrowed money.
The officers and employees of the petitioner during the years in question, were, together with the compensation*3332 paid them, as follows:
| 1919 | 1920 | 1921 | |
| GROUP 1 | |||
| S. W. Corman, president | $29,000.00 | $36,000.00 | $36,000.00 |
| Adams, writer | 6,536,11 | 9,840.47 | 10,888.51 |
| Milne, writer | 2,573,34 | 4,660.00 | 4,580.00 |
| Benet, writer | 1,300.16 | ||
| Jones, writer | 3,528.96 | 4,556.00 | 4,801.83 |
| Palmer, artist | 4,080.00 | 4,923.06 | 5,004.97 |
| Goldman, assistant | 1,061.83 | ||
| Coffrain, media | 3,581.31 | 4,506.00 | 4,629.59 |
| Roth | 1,040.49 | 1,409.67 | |
| Crowe, writer | 4,550.00 | ||
| GROUP 2 | |||
| E. H. Wilkinson, treasurer | 4,812.50 | 5,987.66 | 6,674.76 |
| Cummings | 1,295.93 | 3,356.80 | 3,965.00 |
| Knapp | 842.00 | 1,086.67 | 1,036.40 |
| Ganz | 631.00 | 959.00 | 1,130.22 |
| Fagan | 1,287.51 | 1,421.25 | 1,480.05 |
| Fleming | 1,809.46 | 2,073.10 |
In addition, the petitioner had a total of nine, six, and eight stenographers, telephone operators, lobby attendants, file clerks, and messengers in the respective years. All of the employees in group one assisted Corman in so-called "plans work," conducting investigations and writing, and otherwise preparing, advertisements. Adams was the petitioner's head writer and wrote or finished writing most of the text in advertisements handled by the petitioner. Palmer was proficient*3333 in making visuals or layouts for use by outside artists in producing a completed picture. His chief value to the petitioner was his ability to purchase art from outside artists, and the purchase of art was his principal duty. Goldman was an assistant to Palmer. The employees in group two were engaged in accounting work and checked advertisements in publications. Cummings had charge of "media work," assisted the bookkeeper and Wilkinson and conferred with clients concerning business matters. Knapp kept the petitioner's books and Ganz and Fagan assisted others in accounting work. None of the employees did executive work or took any part in the management of the business. All of the employees were selected by Corman.
OPINION.
ARUNDELL: It is clear from the evidence that the petitioner was not engaged in trading as a principal. It is equally evident, and we have so found as a fact, that Corman, who never held less than 96 per cent of the petitioner's capital stock, was the principal stockholder *83 and was regularly engaged in the active conduct of the affairs of the corporation. The elimination of these requirements of the statute in favor of the petitioner leaves*3334 for our consideration and determination the two remaining questions of (1) whether capital, invested or borrowed, is a material income-producing factor, and (2) whether the income of the petitioner is to be ascribed primarily to the activities of its principal stockholders.
Although the respondent appears to have disallowed personal service classification on the ground that capital was a material income-producing factor, we have found no difficulty in reaching a contrary conclusion from the evidence submitted.
The only cash paid in for stock was $15,000, the balance of the capital stock of $35,000 having been issued for alleged good will. In 1920 the petitioner had a surplus of $3,603.82, and in 1921, $12,808.39. Of the total of these amounts, there was invested in furniture and office equipment, improvements and Liberty bonds, the sum of $4,327.33 in 1919, $8,952.15 in 1920, and $12,768.87 in 1921, leaving the amounts of $10,672.67, $9,651.67, and $15,039.52 in the corporation during the the respective years available for transacting business.
Notwithstanding the small cash capital investment and the large amount of advertising handled each year, and the other business*3335 transacted, which in 1920 exceeded a million dollars, the petitioner was able to conduct its affairs without the use of borrowed money. This was possible because of its ability to collect amounts due from clients before the cash discount maturity date of the publisher's bill, thereby enabling it to pay these bills with funds provided by the client. The record does not show whether the petitioner was legally liable to the publisher for his advertising charges, but the question is immaterial here since all of such bills, with a few possible exceptions, were paid by the client before the due date of the publisher's invoice. As we said in , "The actual method of operation and not the theoretical or legal liability is what controls." See , and .
As to the other requirement of the statute, that of whether the corporation's income is to be ascribed primarily to the activities of the principal stockholder, we find an abundance of evidence to sustain the claim of the petitioner. *3336 After a client had contracted to place his advertising through the petitioner, Corman, the principal stockholder, with the assistance of a few employees of his selection, proceeded to make an investigation into the particular marketing problems of the client, and after a plan of operation had been *84 agreed to, to prepare the necessary advertisements and arrange, in the name of the advertiser, for space in publications acceptable to the client for the running of advertisements. For the completion of art work necessary in connection with the manufacture by others of a plate for the advertisement, the petitioner employed outside artists and charged the advertiser 15 per cent of the cost to it. A similar situation existed in other proceedings wherein we held that that fact was not fatal to the claim being made if the petitioner met the other requirements of the statute. See ;, and . The commissions received on art work never exceeded about 7 per cent of the petitioner's gross income and in 1921 were approximately*3337 4 per cent. Substantially all of the petitioner's gross revenue was derived by way of commissions and fees for preparing and placing advertisements and work incidental thereto. The percentage to gross income approximated 90 per cent in 1919, 92 per cent in 1920, and 93 per cent 1921. The interest received on Liberty bonds never amounted to one-half of 1 per cent of gross income.
Corman was the only solicitor of the petitioner and actually obtained all of its clients excepting those whose billings each year were less than $25,000. The balance of the clients were obtained by employees or came to the petitioner unsolicited. The petitioner did not trade in the sale of advertising space and did not reserve space until after a particular publication had been approved by the advertiser. The only thing it had for sale, and did sell, was its services. Corman was the only person connected with the corporation who had had experience in all branches of advertising work and it was due to his qualifications to successfully carry out a publicity campaign that the petitioner obtained its business in the first instance and it was to him, rather than petitioner's employees, that clients looked*3338 for results. The employees merely carried out ideas formulated by and under the direction of Corman. While they may have produced some of the petitioner's income the statute did not require that all the income be traceable to the principal stockholders. It is sufficient if the income is primarily due to their activities. We are satisfied from all the evidence before us in this proceeding that the income of the petitioner is to be ascribed primarily to the activities of Corman, the principal stockholder.
Judgment will be entered for the petitioner.