*4256 The evidence fails to show that the petitioner should be classified as a personal service corporation.
*1264 This is a proceeding for the redetermination of deficiencies in income, excess-profits and war-profits taxes for the years 1918, 1919 *1265 and 1920 only, in the respective amounts of $6,731.46, $7,017.25, and $1,501.08. The cases were consolidated for hearing and decision. The errors alleged are (1) the failure of the Commissioner to allow personal service classification in each year, and (2) refusal of the Commissioner to compute the tax liability for the years 1918 and 1919 in accordance with the provisions of sections 327 and 328 of the Revenue Act of 1918.
FINDINGS OF FACT.
The petitioner is a corporation organized under the laws of the State of Illinois, with its principal office in St. Louis. It also had offices at Chicage, Ill., Milwaukee, Wis., and Indianapolis, Ind. It sold groceries wholesale on commission for manufacturers, producers, and canners, and also sold some groceries wholesale as a principal. Its "territory" included*4257 eastern Missouri, Illinois, part of Indiana, southern Michigan and southern Wisconsin.
The outstanding capital stock consisted of 250 shares each having a par value of $100 and each having been issued for cash at par. During the years 1918, 1919, and 1920, H. C. Struss was treasurer and bookkeeper, devoted his entire time to the business and held 5 shares of stock; W. Helfensteller was secretary and had charge of salesmen at St. Louis, devoted his entire time to the business and held 20 shares of stock; R. L. Koenig was vice president and general manager of the Chicago office, devoted his entire time to the business and held 71 1/4 shares of stock; Louis Hilfer was president and general manager of the St. Louis office, devoted his entire time to the business and held 153 3/4 shares of stock, except that on January 2, 1920, he transferred 50 of these shares to his son, Louis Hilfer, Jr., who thereafter held these 50 shares of stock and devoted his entire time to the business. Nonstockholders had charge of the petitioner's offices in Milwaukee and in Indianapolis.
The petitioner took orders for groceries from wholesale jobbers and others and submitted these orders to its principals*4258 for confirmation. In some cases the principal would then send a contract to be signed by the purchaser and returned. The principal would then ship the goods to the purchaser and send him a bill. The petitioner received a copy of the invoice and entered a charge on its books against the principal for the commission due. The petitioner was not responsible for the collection of bills due from the purchasers, although if the purchasers failed to make payment the petitioner usually lost its commission. The petitioner never advanced money to its principals.
*1266 Its gain and loss account shows the following:
| Year | Gain | Loss |
| 1907 | $8,850.67 | |
| 1908 | 10,038.69 | |
| 1909 | $4,025.59 | |
| 1910 | 2,477.18 | |
| 1911 | 165.76 | |
| 1912 | 2,357.05 | |
| 1913 | 9,163.84 | |
| 1914 | $7,036.07 | |
| 1915 | 12,514.63 | |
| 1916 | 24,459.98 | |
| 1917 | 22,813.50 | |
| 1918 | 22,599.59 | |
| 1919 | 25,317.91 | |
| 1920 | 5,791.83 |
During this time dividends were declared and credited to the stockholders' accounts in the following total amounts:
| 1907 | $8,673.66 |
| 1908 | 10,038.69 |
| 1915 | 7,500.00 |
| 1916 | 35,000.00 |
| 1917 | $22,500.00 |
| 1918 (Dec. 26) | 22,500.00 |
| 1919 (Dec. 27) | 25,000.00 |
A considerable portion of the*4259 dividends credited to the stockholders was not drawn. Instead, the stockholders allowed this money to remain with and to be used by the corporation upon payment of interest at 5 per cent. In 1918, this interest amounted to $1,907.51, in 1919 to $2,741.31, and in 1920 to $2,532.89.
The following are the balance sheets of the petitioner as of the beginning and end of the various years in question:
| Beginning of 1918 | End of 1918 | End of 1919 | End of 1920 | |
| ASSETS | ||||
| Furniture and fixtures | $1,877.11 | $2,735.82 | $2,875.26 | $3,133.11 |
| Investments: | ||||
| Gay Ola Sales Co | 10,000.00 | 10,000.00 | 10,000.00 | 15,010.00 |
| Cleveland Macaroni Co | 7,500.00 | 7,500.00 | ||
| Merchandise inventory | 7,901.47 | 26,426.84 | 13,723.91 | 12,134.23 |
| Supply inventory | 663.78 | 266.70 | ||
| Accounts and notes receivable | 58,019.68 | 57,455.03 | 68,538.89 | 43,773.45 |
| Advances to salesmen and managers | 291.45 | 1,081.67 | 1,674.22 | |
| Sundry debtors | 7,153.30 | |||
| Liberty loan and war savings stamps | 5,000.00 | 10,252.20 | 10,252.20 | 252.20 |
| Cash in bank and on hand | 14,553.36 | 4,872.66 | 28,096.79 | 4,797.26 |
| Total | 97,643.07 | 120,988.00 | 142,927.97 | 86,253.55 |
| LIABILITIES | ||||
| Capital stock | 25,000.00 | 25,000.00 | 25,000.00 | 25,000.00 |
| Accounts and notes payable | 10,607.10 | 12,864.11 | ||
| Accounts payable | 6,754.53 | 7,147.26 | ||
| Unpaid Liberty loan subscription | 2,500.00 | |||
| Notes payable | 2,500.00 | |||
| Sundry creditors: | ||||
| Stockholders | 51,813.10 | 65,090.71 | 88,763.49 | 37,280.53 |
| Managers and salesmen | 6,132.93 | 11,995.74 | 8,491.17 | |
| Credit balances, accounts and notes receivable | 390.78 | 2,049.57 | ||
| Accrued pay roll | 1,204.92 | |||
| Reserve for Federal taxes | 3,305.71 | |||
| Reserve for expenses | 275.43 | 2,730.62 | 531.06 | |
| Special reserve | 4,636.80 | 4,883.16 | 5,286.02 | 10,577.85 |
| Total | 97,643.07 | 120,988.00 | 142,927.97 | 86,253.55 |
*4260 The petitioner owned all of the stock of Gay Ola Sales Co., which it had organized for the purpose of selling a fountain syrup.
*1267 The petitioner owned 75 shares of the stock of the Cleveland Macaroni Co., for which it acted as agent.
The petitioner's gross income for the years 1918, 1919, and 1920, as shown by the credit side of its loss and gain account, was as follows:
| 1918 | 1919 | 1920 | |
| Commissions | $77,035.31 | $93,551.56 | $103,440.01 |
| Brokerage | 56,450.58 | 62,088.87 | 49,191.50 |
| Brokerage merchandise | 5,346.86 | 7,692.38 | |
| Merchandise (Milwaukee, St. Louis, and Chicago) | 4,949.15 | 4,131.13 | 3,588.09 |
| Railway claims | 526.96 | 733.26 | 234.55 |
| Interest on United States Government securities | 200.00 | 407.30 | 351.28 |
| Recoveries on bad accounts | 800.00 | 76.63 | 1,610.73 |
| Interest on acceptances taken for brokerage due | 80.97 | ||
| Dividends (Cleveland Macaroni Co.) | 450.00 | 225.00 | |
| Unexplained | 50.38 | 193.10 | |
| Total | 146,359.24 | 169,131.13 | 158,915.23 |
The item designated "Commissions" represents compensation received based upon a percentage of gross sales made during the year for principals whom the petitioner represented to the exclusion of all*4261 others who had a similar or competing product or line of goods.
The item designated "Brokerage" is similar except that it includes only compensation from principals who were not given this exclusive representation.
For many years, including the years in question, the petitioner sold some merchandise as a principal, mainly for the purpose of taking advantage of the lower freight rates on carload lots as compared with the freight rates on less than carload lots. If the petitioner did not have sufficient orders for a certain commodity to require the shipment of a carload of that commodity, it sometimes ordered on its own account a sufficient amount of the commodity to complete a carload. The car would then be shipped directly to the petitioner for distribution. The petitioner would bill the various jobbers for the goods ordered by them and for a proportionate share of the freight. The petitioner took title to the remainder of the shipment and sold the goods as a principal, charging only the equivalent of a commission. On its books such items as brokerage merchandise, Milwaukee, Chicago, and St. Louis merchandise, represent goods which it had sold as a principal.
The loss*4262 and gain account in the petitioner's books shows, Inter alia, debits described either as salaries or bonuses in the following total amounts:
| 1918 | 1919 | 1920 |
| $81,060.56 | $99,429.07 | $98,706.89 |
During these years the total compensation paid to the stockholders was as follows:
| 1918 | 1919 | 1920 |
| $27,619.98 | $28,619.96 | $27,010.00 |
*1268 The income-tax returns filed by the petitioner show, Inter alia, the following:
| 1918 | 1919 | 1920 | |
| Gross income | $142,717.67 | $168,783.27 | $154,900.22 |
| Total deductions | 120,118.08 | 143,465.36 | 142,417.09 |
| Deductions for ordinary and necessary expenses (exclusive of compensation of members): | |||
| Salaries and commissions | 1 51,059.66 | 1 70,809.11 | 72,617.45 |
| Traveling expense | 6,312.55 | 10,504.29 | 5,688.68 |
| Freight, drayage, and storage | 2,301.72 | 2,305.47 | 3,092.11 |
| Rent | 3,212.50 | 3,838.00 | 5,803.50 |
| Postage | 3,431.85 | 3,992.47 | 3,727.40 |
| Telephone and telegraph | 4,793.14 | 6,153.90 | 5,704.39 |
| Printing, advertising, stationery, and supplies | 5,141.98 | 4,185.67 | 3,809.70 |
| Brokerage paid out | 342.02 | 423.32 | 2,752.46 |
| Credit investigation | 147.00 | 160.00 | 150.00 |
| Legal expense | 89.63 | 103.90 | |
| Light and fuel | 35.65 | 58.80 | 62.71 |
| Insurance: Fire sprinkler and liability | 344.03 | 328.95 | 384.52 |
| Discount allowed | 641.61 | ||
| Cartons | 1,698.37 | ||
| Miscellaneous | 5,467.55 | 6,280.08 | 5,853.05 |
| 82,679.28 | 109,785.57 | 111,344.34 |
Louis Hilfer has been president and general manager of the petitioner since 1903, the date of its incorporation. He once worked as a grocery clerk and later became associated with B. T. Babbitt Co., soap manufacturers of New York City, for whom he worked as an advertiser and salesman. In 1888, this firm sent him from Chicago to St. Louis, as a branch manager, advertising and selling soap. In 1900, he severed his connection with this firm to represent it and others on a commission basis. A short time thereafter he formed a partnership with Koenig, which lasted until the petitioner was incorporated in 1903. The original stockholders were Hilfer, Koenig, Schinner, and Rosenbloom. In 1909, Louis Hilfer went to New York, as sales and advertising manager of B. T. Babbitt Co., where he remained until some time in 1911. His salary was $25,000 a year, plus a share of the profits. In 1911, he returned to his duties with the petitioner at St. Louis.
About 1904, the petitioner put on an intensive campaign in its territory for the introduction and sale of Carnation*4264 Milk. Louis Hilfer planned and supervised the work and the manufacturers of the milk paid the expenses of the campaign. The campaign was very successful. In 1914, and in other years, other similar campaigns were put on in the same way. The Carnation Milk Products Co. and other canners and manufacturers sometimes called upon Louis Hilfer for advice in connection with the advertisement or sale of their product.
During the taxable years the petitioner conducted a food show at the Canners' Convention in Cleveland, to show the canners and wholesale *1269 grocers there assembled how to display and demonstrate their product to the public. Louis Hilfer has taken wholesale grocers of his territory on trips to the plant of the Carnation Milk Products Co. in Wisconsin. The petitioner sends circulars and sales bulletins to the jobbers and jobbers' salesmen in its territory telling the salesmen how to sell the various products of the manufacturers whom the petitioner represents exclusively.
The petitioner employs salesmen. Each man is given a drawing account and is paid a commission, and some are paid a salary in addition.
The stockholders of the petitioner were all regularly*4265 engaged in the active conduct of the affairs of the corporation. The gains, profits, and income which this petitioner derived from trading as a principal did not amount 50 per cent or more of its gross income. The petitioner had no 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.
OPINION.
MURDOCK: Apparently the claim for special assessment has been abandoned. No evidence was introduced with respect to it and no mention was made of it either in the petitioner's oral argument or in its brief. So far as this feature of the case is concerned our judgment must be for the respondent.
The petitioner's remaining claim is that for the three years in question it was entitled to be classified for taxation purposes as a personal service corporation. In section 200 of the Revenue Act of 1918, the following definition appears:
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 regularly engaged in the active conduct of the affairs of the corporation*4266 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. * * *
As we have already said in -
These qualifying words, Primarily, regularly and Actively, and material, preclude any definitive classification. They make necessary the application of a flexible judgment * * * which must be applied to the facts of each case which comes before us. No intensive rule can be laid down, and it is not *1270 surprising that the Commissioner's administration of this section of the statute has been an extremely difficult task. The very statement of a rule, if rigidly adhered to, would defeat the letter and intendment of the Act.
It is quite apparent from the evidence that this petitioner*4267 meets several of the requirements of the statute. But as to two of the requirements the evidence is not so clear and the respondent contends, and always has contended (as appears from his deficiency notice and answers), that the income of the petitioner is not to be ascribed primarily to the activity of the principal owners or stockholders, but that employees who were not stockholders contributed substantially to the services rendered by the petitioner, and that capital, invested or borrowed, was a material income-producing factor. It was therefore incumbent upon the petitioner to produce evidence to overcome the presumption against it, to present facts to which we could apply our judgment and from which we could intelligently decide whether or not the respondent was in error in denying personal service classification to this petitioner.
On direct examination of its witnesses the petitioner showed that although profits had been made they had been distributed promptly by way of dividends to the stockholders. Cross-examination by the respondent brought out the fact that these dividends had merely been credited to the accounts of the stockholders and that to a large extent they*4268 had been left undrawn and at interest with the corporation. A glance at the balance sheets will show that the petitioner had the use of a considerable amount of capital, invested or borrowed, in a addition to that carried in the stockholders' accounts.
The largest part of the petitioner's income was derived by way of commissions and brokerage for selling merchandise as an agent. The earning of this kind of income would not ordinarily require the use of much capital. Moreover, the sales of merchandise as a principal made by this petitioner would require but a very small amount of capital. Yet we see that the petitioner was borrowing money from its stockholders and from others and that it was paying interest thereon, and that it had invested capital in excess of $25,000. The witness, Louis Hilfer, attempted to explain the use of this capital by saying that it was only a normal amount for such a large business, that principals were sometimes slow in paying commission, and that in order to pay labor and clerical help and to pay the operating expenses of the business this amount of money was necessary. Of course, the mere fact that this capital was available to the petitioner is*4269 not determinative of the question of whether or not capital was a material income-producing factor, but the presence of such a large amount of borrowed and invested capital in the petitioner's balance sheets demands more of an explanation on the part of the petitioner than has been given in this case.
*1271 By this same witness, Louis Hilfer, the petitioner tried to show that its income in the taxable years is to be ascribed primarily to the activities of the principal owners or stockholders, and that there were no other elements materially contributing to the income of the petitioner, and particularly that only a small percentage of the petitioner's income could properly be ascribed to the activities of persons other than the petitioner's stockholders, in short, that the activities of salesmen did not prevent the stockholders from being primarily responsible for the income of the petitioner. He testified at some length in regard to the manner in which he at St. Louis and Koenig at Chicago, supervised the activities of salesmen under them. He stated that in his opinion the stockholders of the petitioner were responsible for at least 80 per cent of its gross income and that*4270 although it might appear that salesmen were responsible for 20 per cent of the gross income, they were, in fact, not responsible for even this percentage. However, there was no showing of any facts on which he based this opinion. From his testimony it was argued that the salesmen were mere messengers and that they were probably misnamed salesmen, that they had no authority or discretion in making sales, and that they only carried out the expressed will of one of the stockholders.
The petitioner has not disclosed the number of salesmen employed by it and the total amounts of salaries and commissions paid to nonstockholders during these years were shown only on cross-examination of the petitioner's witnesses. From this evidence it appears that during the taxable years the petitioner paid in salaries, commissions, bonuses, and other forms of compensation to nonstockholders over 2.35 times the amount which it paid during the same period as compensation to its stockholders. Some of the nonstockholding employees were no doubt neither managers nor salesmen but we have not been told how many such employees there were or how much they received. We have no reason to assume that their*4271 salaries accounted for any particular portion of the total compensation paid employees. From the figures in evidence it would seem that if less than 20 per cent of the gross income of the petitioner is to be ascribed to the activities of the nonstockholders, the petitioner could have more than tripled its income for the period before us by simply dismissing its nonstockholding salesmen and managers. In short, the contention of the petitioner that less than 20 per cent of its income is to be ascribed to the activities of its salesmen is apparently contradicted by figures in evidence relating to salaries and commissions. No attempt was made to explain this apparent contradiction.
*1272 In addition, we know that the petitioner had offices at Milwaukee, Wis., and at Indianapolis, Ind., which were in charge of nonstockholders. The supervision which Louis Hilfer claimed he exercised over the activities of the salesmen at St. Louis could hardly have been exercised, and, so far as we know, was not exercised by any stockholder over the activities of the salesmen at Milwaukee and at Indianapolis. We do not know the amounts of either gross income or net income to be allocated to*4272 the different offices. It may well be that a large part of the income of the petitioner must be ascribed to the Milwaukee andIndianapolis offices and to the activities of nonstockholders there employed, and, as we have previously stated, the evidence is contradictory in regard to the importance of salesmen at the St. Louis and Chicago offices. So that under all the facts in this case we are in doubt and we can not say that the income of the petitioner in the taxable years is to be ascribed primarily to the activities of the principal owners or stockholders.
In reaching this conclusion we have not been unmindful of the evidence favorable to the petitioner's contention. The sale of the product of the Carnation Milk Products Co. on commission was one of the important sources of income to the petitioner, probably the most important. A witness, who was vice president of this company at the time, stated that during the taxable years the petitioner's offices at Milwaukee and at Indianapolis had not been handling this account in a manner satisfactory to the Carnation Milk Products Co., that as a result the account was taken away from the Milwaukee office later, and some complaint was*4273 made to Hilfer in regard to the Indianapolis office, although the account was not taken away, The witness further stated that in his opinion the unsatisfactory handling of the account at these two offices was due to the fact that Hilfer was not able to give his personal attention to the conduct of the business at these offices. It also appears that when Hilfer left the petitioner to take a position in New York, the petitioner's business showed a loss, where formerly it had shown a profit, and that when Hilfer resigned his position in New York, and returned to the petitioner, it no longer had losses, but was shortly made to pay substantial profits. This testimony has a certain evidential value tending to prove that Hilfer was largely responsible for the petitioner's income, but with the other testimony favorable to the petitioner's contention, it fails in connection with all of the evidence to show that petitioner meets with all the requirements of the statute and that it should be classified as a personal service corporation.
Judgment will be entered for the respondent.
Footnotes
1. This item does not include $5,850 paid to John A. Lee, vice president and salesman, who was not a stockholder. ↩