*4091 Personal service classification denied.
*460 In this proceeding the petitioner seeks a redetermination of its income and excess-profits tax liability for the calendar years 1920 and 1921, for which the respondent in his deficiency letters dated November 4, 1925, and March 23, 1926, determined deficiencies of $1,753.77 and $425.84, respectively. The proceedings were consolidated for hearing. The only question is whether the petitioner is entitled to personal service classification for the years involved.
FINDINGS OF FACT.
The petitioner was incorporated under the laws of the State of Ohio on November 4, 1918, for the purpose of acting as financial correspondent for the Union Central Life Insurance Co. of Cincinnati and engaging in the insurance business. Its principal office is in Toledo.
The authorized, issued and outstanding capital stock of the petitioner is $10,000 divided into 100 shares having a par value of $100 each. The only assets turned over to the petitioner in consideration for all of its capital stock were two contracts, one which*4092 C. F. Medaris had with the Union Central Life Insurance Co. to act as *461 financial correspondent for that company, and one which William R. Medaris (brother of C. F. Medaris) had with the New Amsterdam Casualty Co. to act as general agent for the latter. The capital stock was originally issued to the two Medaris brothers, their wives, and a son of C. F. Medaris, as follows:
| Shares | |
| C. F. Medaris | 35 |
| Lida S. Medaris (wife of C. F.) | 20 |
| Charles L. Medaris (son) | 5 |
| William R. Medaris (brother of C. F.) | 20 |
| Evelyn H. Medaris (wife of W. R.) | 20 |
| Total | 100 |
The material part of the minutes of the first meeting of the directors of the petitioner, held on November 4, 1918, is as follows:
Pursuant to the Waiver of Notice of all the Incorporators of The C. F. Medaris Company books of subscriptions as required by law were today duly opened and subscriptions to the capital stock made by the following individuals in the number and amount as follows:
| C. F. Medaris | 35 shares - $3500.00 |
| Wm. R. Medaris | 20 shares - 200.00 |
| Chas. L. Medaris | 5 shares - 500.00 |
| Lida S. Medaris | 20 shares - 2000.00 |
| Evelyn H. Medaris | 20 shares - 2000.00 |
and thereupon*4093 all of the stock having been subscribed the books of subscriptions were closed and the subscribers to the capital stock above set forth convened for the election of the Board of Directors of the said C. F. Medaris Company.
C. F. Medaris, Chairman of the meeting - Wm. R. Medaris, Secretary.It being necessary under the laws of Ohio for the Board of Directors to be constituted by at least five persons and there being five subscribers to the capital stock it was thereupon determined that the Board of Directors of The C. F. Medaris Company, subject to the action of the stockholders at the first annual election in January 1920 should be the above named subscribers to-wit:
C. F. MedarisWm. R. Medaris
Chas. L. Medaris
Lida S. Medaris
Evelyn H. Medaris
and that the holdings and stock of the said Lida S. Medaris and Evelyn H. Medaris should be nominal for the purpose of qualifications, and certificates of stock issued to them should be endorsed by them and the certificates of stock issued to Lida S. Medaris should be delivered to C. F. Medaris and the certificates of stock subscribed and issued to Evelyn H. Medaris should be endorsed by her and delivered to Wm. R. Medaris*4094 and that there should be no stockholders of the said C. F. Medaris Company not directly engaged in the business of said Company.
Within a day or two after the stock was issued both of the wives endorsed their shares in blank and handed them back to their husbands. *462 The stock originally issued to Lida S. Medaris is now in the safe deposit box of C. F. Medaris and that issued to Evelyn H. Medaris is now on deposit with the Commerce Trust & Savings Bank as collateral on a personal loan to William R. Medaris. During the years 1920 and 1921, Lida S. and Evelyn H. Medaris were the actual owners of all the stock originally issued to them as a gift from their respective husbands.
The two brothers and Charles L. Medaris were regularly engaged in the active conduct of the affairs of the petitioner. Their wives devoted no time to the business with the exception of attending the directors' meeting about once a year. C. F. Medaris did practically all the work which was performed in the placing of loans for the Union Central Life Insurance Co., which work consisted of examining the property on which the loans were made, giving his personal approval thereof, making personal appraisals*4095 of such property, and other work necessary in connection with the placing of the loans. William R. Medaris had general charge of the accounting for the petitioner and was office manager and had entire charge of the insurance branch of the business. Charles L. Medaris was largely engaged in the insurance end of the books and had been educated in both the insurance and loaning branch.
The petitioner filed its returns for the years 1920 and 1921 on Form 1065 as a personal service corporation and reported gross income and expenses as follows:
| 1920 | 1921 | |
| INCOME | ||
| Commissions received | $72,485.92 | $77,778.14 |
| Miscellaneous receipts | 1,187.43 | 1,874.73 |
| Total income | 73,673.35 | 79,652.87 |
| EXPENSES | ||
| Brokerage paid to agents | 32,058.63 | 34,203.57 |
| Advertising | 694.18 | 802.32 |
| Interest expense | 2,063,76 | 763.61 |
| Office expense and office salaries | 5,206.63 | 6,749.55 |
| Postage and express | 624.33 | 557.93 |
| Telephone and telegraph | 464.72 | 726.78 |
| Traveling expenses | 1,302.46 | 1,574.15 |
| Insurance and taxes | 208.07 | 497.87 |
| Salaries (A. M. Ducy) | 2,500.08 | |
| Bonus (A. M. Ducy) | 1,118.87 | 462.63 |
| Bad debts | 500.00 | |
| Depreciation furn. & fixt | 461.82 | |
| Automobile expenses | 1,677.01 | |
| Columbus Branch expense | 2,523.78 | |
| Attorneys' fees | 3,500.00 | |
| Salaries | 3,849.96 | |
| Total expenses | 47,203.55 | 57,889.16 |
| Profit reported | 26,469.80 | 21,763,71 |
*4096 *463 Attached to the returns were statements of assets and liabilities as follows:
| Dec. 31, 1920 | Dec. 31, 1921 | |
| ASSETS | ||
| Contracts | $10,000.00 | $10,000.00 |
| Cash | 2,661.59 | 793.66 |
| Accounts receivable: | ||
| Customers' accounts | 11,309.58 | 19,751.52 |
| Union Central - commissions earned and unpaid | 16,619.80 | 5,237.75 |
| Investments: | ||
| Bonds - Inverness Club | 2,000.00 | 2,000.00 |
| Stock - New Amsterdam Co | 1,000.00 | 2,600.00 |
| Stock - Motor Finance Corp | 2,500.00 | |
| Stock - Fifty Associates Co | 150.00 | |
| Stock - Ohio Recharger co | 3,116.38 | |
| Loans and advances: | ||
| Members | 5,707.16 | 9,597.49 |
| Others | 1,316.75 | |
| Furniture and fixtures: | ||
| Toledo Office | 1,500.00 | 1,769.00 |
| Columbus Branch | 804.16 | |
| Automobile account | 1,000.00 | |
| Total assets | 50,798.13 | 60,636.71 |
| LIABILITIES | ||
| Capital stock | 10,000.00 | 10,000.00 |
| Loans and notes payable: | ||
| Members | 787.60 | 1,813.07 |
| Others | 13,914.81 | 20,501.24 |
| Accounts payable: | ||
| Insurance Companies | 13,774.55 | 18,978.98 |
| Subagents | 1,132.50 | 1,703.50 |
| Surplus and undivided profits | 3,013.62 | 7,639.92 |
| Total liabilities and capital | 50,798.13 | 60,636.71 |
The loan business for the Union Central Life Insurance Co. was secured largely*4097 from country banks and local men who were engaged in the farm loan business in their respective communities. The petitioner had no contracts with subagents in the loan business but did accept applications and pay commissions to whoever submitted an application for a loan. The greater portion (75 or 80 per cent) of the loan business came by way of invitation from different banks to look over their loans to farmers in their respective territory. The banks did this in order to keep their money moving faster. During the years in question only farm loans were made. The method followed in making a loan generally took the following course. The farmer desiring a loan would first make an application, C. F. Medaris would examine the property of the applicant and appraise it, and if approved by him would forward the application to the home office of the Union Central Life Insurance Co. After approval of the application by the home office, the applicant was required to secure and deliver to the petitioner an abstract of title brought down to date which the petitioner, after examination, forwarded to the home office. As soon as notice was received from the Union Central that the abstract*4098 *464 was satisfactory the petitioner would give the Commerce Guardian Trust & Savings Bank in Toledo its own individual note for the amount of the loan and would then give the borrower its check on the bank for a like amount in return for notes and a mortgage signed by the borrower. The borrower's notes were made payable to the Union Central but were first given to the petitioner, who placed them as collateral for the loan which it had made with the bank prior to issuing its check to the borrower. The mortgage, after being recorded in the local county recorder's office, was forwarded to the Union Central, who, after their approval thereof, which took from one to three weeks, would take up the petitioner's note at the bank or issue what was called their "dating," but would only pay interest from the date of the farmer's signature on his note and mortgage. Since the petitioner's note most generally bore an earlier date, the petitioner was forced to pay a part of the interest, which amounted to $2,063.76 in 1920 and $763.61 in 1921. The petitioner's loans at the bank ran as high at $200,000 to $300,000 at one time and during each of the years in question it borrowed in the*4099 manner described above approximately one million dollars. The Union Central kept on deposit a substantial amount for services of that bank in assisting the petitioner to close the loans approved by the former. The bank examiners regarded all loans made by the petitioner as described above as being loans made by the Union Central rather than loans made by the petitioner. The gross commissions received by the petitioner and brokerage paid to others as a result of the loan business were as follows:
| 1920 | 1921 | |
| Gross commissions (loan business) | $44,037.72 | $28,039.12 |
| Brokerage paid (loan business) | 18,395.56 | 9,092.83 |
| Net commissions (loan business) | 25,642.16 | 18,946.29 |
The insurance part of the business consisted of acting as both local and general insurance agents for various companies, handling all kinds of insurance except life insurance. Ninety per cent of the insurance business was done under the general agency contract with the New Amsterdam Casualty Co. The business originated largely through personal solicitation of William R. Medaris and 35 to 40 subagents. As a general proposition the acquaintance and standing of the local agent was the predominating*4100 factor in getting business. At the time the petitioner was incorporated one of the big problems was to find efficient local agents. The subagents' contracts were made direct with the insurance companies and not with the petitioner. The applications for insurance secured by the subagents were supervised by the petitioner and accepted or declined by it on *465 behalf of the insurance company. The policies were all written in the petitioner's office. The gross commissions received by the petitioner and brokerage paid to others as a result of the insurance branch of its business were as follows:
| 1920 | 1921 | |
| Gross Commissions (insurance) | $28,448.20 | $49,739.02 |
| Brokerage paid (insurance) | 13,663.07 | 25,110.74 |
| Net Commissions (insurance) | 14.785.13 | 24,628.28 |
The petitioner extended its customers a credit of 30 days in which to pay the premiums. Its contracts with the insurance companies provided for payment in 60 days. The petitioner endeavored to collect the premium from the insured before it was required to forward it to the home office. Under its contract with the casualty company it guaranteed the collection of all premiums.
The petitioner*4101 was not engaged in trading as a principal.
OPINION.
GREEN: The question is whether the petitioner was a "personal service corporation" during the calendar years 1920 and 1921. That term is defined in section 200 of the Revenue Acts of 1918 and 1921 as "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 and in which capital (whether invested or borrowed) is not a material income-producing factor; * * *."
The respondent contends that a large portion of the income was ascribed primarily to the activities of "sub-agents"; that 40 per cent of he capital stock was owned by stockholders, namely, the wives, who were not regularly engaged in the active conduct of the petitioner's affairs; that due to the large amount of money borrowed in connection with the loan business, namely, $200,000 to $300,000 at a time, capital was a material income-producing factor; and that for those reasons alone personal service classification should be denied.
The points relied upon by the petitioner are stated in its brief as follows:
1. That*4102 all the capital stock of the petitioner is actually owned by C. F. Medaris, C. L. Medaris and W. R. Medaris who are actively engaged in carrying on the business of the petitioner.
2. That the income earned by the petitioner is commissions received from the writing of insurance, supervising the applications of subagents for insurance, writing the policies, settling the claims of the insured, and from the placing of loans for other parties.
*466 3. That the business carried on by this petitioner requires the personal supervision and efforts of the stockholders of the said corporation.
4. That the income of the petitioner is not due to trading.
5. That the income produced by the petitioner is due primarily to the activities of the stockholders who are actively engaged in furthering the interest of the petitioner's business.
6. That the income is not produced by capital either borrowed or invested.
In connection with the first point the petitioner cites the , in which case personal service classification was allowed and in which we said, "It is well settled that the endorsement of a certificate of stock*4103 in blank and the delivery thereof passes both the legal and equitable title as between the parties." In that case the evidence showed that two of the principal stockholders had given their wives a substantial amount of stock and on the same day the wives endorsed the stock in blank and delivered it to their husbands "with intent to pass the title thereto." The latter fact is not present in the instant case. All of the evidence on this point consists of the minutes of the board of directors set out in the findings, the tax returns, the affidavits executed by William R. Medaris, and the testimony of the same affiant. In our opinion the minutes are not conclusive evidence that the ownership of the 40 shares of stock issued to the wives was vested in their husbands during the years 1920 and 1921. The returns for those years list each wife as the owner of 20 shares. The affidavits executed by William R. Medaris contain statements that -
The stock ownership of the company, as pointed out in our letter of June 5, 1924, is held as follows:
| C. F. Medaris | 35 shares |
| William R. Medaris | 20 shares |
| Charles L. Medaris, son of C. F. Medaris | 5 shares |
| Lida S. Medaris, wife of C. F. Medaris | 20 shares |
| Evelyn H. Medaris, wife of Wm. R. Medaris | 20 shares |
*4104 Neither Lida S. Medaris nor Evelyn H. Medaris, the wives of C. F. Medaris and William R. Medaris, respectively, are engaged in the business of this company; nor did they pay anything for the capital stock of the company. Such stock was given to them by their respective husbands. The evidence on this point convinces us that the stock of the petitioner, during the years 1920 and 1921, was actually owned by the individuals to whom it was originally issued in 1918.
The facts in connection with the second, third and fifth points relied upon by the petitioner are very similar to the facts in the ; ; ; ; and ,Conklin-Zonne-Harrison*467 , in which appeals personal service classification was denied.
We have found as a fact the contention stated in the petitioner's fourth point but this alone does not entitle the petitioner to be classed as a personal service corporation.
Regarding the last point*4105 relied upon by the petitioner, we believe the evidence shows that borrowed capital was a very material income-producing factor. During each of the years 1920 and 1921 the petitioner borrowed in connection with its loan business approximately $1,000,000 and at times was owing the bank as high as $200,000 to $300,000. It is true the loans were of short duration and were considered by the bank examiners as being the loans of the Union Central Life Insurance Co., but nevertheless the party primarily liable on the notes was the petitioner itself, as it was the sole maker and only gave as collateral the farmers' notes made payable to the Union Central.
Under all the circumstances, we are of the opinion that the petitioner is not entitled to be classed as a personal service corporation.
Judgment will be entered for the respondent.