*3051 Held that capital was a material income-producing factor in the business of the petitioner and petitioner was not a personal service corporation in 1920 and 1921, within the meaning of section 200 of the Revenue Acts of 1918 and 1921.
*1367 This is a proceeding for the redetermination of deficiencies in income and excess-profits taxes for the calendar years 1920 and 1921, in the amounts of $6,153.57 and $4,117.55, respectively.
*1368 The error alleged is the holding of the respondent that the petitioner, during the years in question, was not entitled to personal service classification.
FINDINGS OF FACT.
James M. Franciscus and Charles C. Kunz had been engaged in the real estate business, as a partnership, in St. Louis, Mo., since about 1901. In February, 1920, the business was incorporated under the laws of Missouri and the petitioner was formed. Capital stock of the par value of $50,000 was issued for the good will of the partnership business. No cash or tangible assets were paid in. The original stockholders and directors were*3052 Franciscus, Kunz, and Albert J. Hummel. The stockholdings during the years 1920 and 1921 were as follows:
| 1921 | |||
| Owner | 1920 | First 6 months | Last 6 months |
| Shares | Shares | Shares | |
| James M. Franciscus | 273 | 273 | 388 |
| Charles C. Kunz | 223 | 223 | 50 |
| Loretta C. Dooling | 2 | 2 | 20 |
| Albert J. Hummel | 2 | 2 | 20 |
| August C. Beckemeier | 20 | ||
| K. G. Franciscus | 2 |
All of these stockholders were actively engaged in the business of the petitioner, devoting all their time to it, except K. G. Franciscus, to whom two qualifying shares were issued. In 1921, Kunz' health was impaired and he was only able to devote about 3 or 4 days per week to the business. His work was performed by Miss Dooling, Hummel, and Beckemeier.
The business of the petitioner consisted generally in renting, leasing and selling real estate for other persons in St. Louis and vicinity, and in making and selling loans. The business was conducted in the same manner after incorporation as before. The petitioner did not buy or sell any real estate for itself, nor did it deal in merchandise, stocks, or bonds. The business was obtained, to a large extent, by Franciscus and Kunz. *3053 Franciscus usually negotiaged and closed the deals, and Hummel and Miss Dooling did the important office work. In the latter part of 1921 Beckemeier also assisted in the office.
In 1920 petitioner also employed 11 persons who did not hold stock of petitioner. They consisted of a janitor, an errand boy, two stenographers, three collectors, a statement maker, an assistant bookkeeper and a repair man. In 1921 it employed 12 nonstockholders. These employees obtained no new business for petitioner but were engaged only in routine work. The salaries paid to the stockholders and nonstockholders were as follows:
| 1920 | |
| To nonstockholders | $7,255.35 |
| To stockholders | 15,320.00 |
| 1921 | |
| To nonstockholders | 6,851.60 |
| To stockholders | 15,435.00 |
*1369 There was also distributed to stockholders from earnings, $24,961.56 in 1920 and $17,137.39 in 1921. The petitioner also, from time to time, employed salesmen.
The gross income of the petitioner for the year 1920 was made up as follows:
| Commissions on rents | $12,892.86 | |
| Commissions on loans and sales | 35,192.03 | |
| Commissions on insurance | 1,530.93 | |
| Commissions on miscellaneous | 7,743.93 | |
| Interest received | $4,722.12 | |
| Less interest paid | 2,173.22 | |
| 2,548.90 | ||
| 59,908.65 |
*3054 The net income for the year 1920 was $24,961.56.
The gross income for the year 1921 was made up as follows:
| Commission on rents | $14,846.29 | |
| Commission on loans and sales | 28,532.78 | |
| Commission on insurance | 1,413.60 | |
| Commission on miscellaneous | 6,131.70 | |
| Interest received | $3,689.89 | |
| Less interest paid | 2,491.40 | |
| 1,198.49 | ||
| 52,122.86 |
The net income for the year 1921 was $17,137.39.
The item "commissions on rents" covered 2 1/2 per cent or 3 per cent of the total rents the petitioner collected for others.
"Commissions on loans and sales." The petitioner charged a commission upon the sale of property for others. Petitioner also charged a commission on loans which it made.
"Commission on insurance" was received by petitioner also. Petitioner would place insurance with some company for its clients and would receive a commission for so doing from the client and often the insurance company would pay petitioner a certain amount of the premium for placing it with such insurance company
The item "Miscellaneous" includes amounts received by petitioner for services which could not be classified under the preceding heads. Sometimes petitioner*3055 would have to carry a loan for a while and the interest accumulated thereon was included in this item. This also includes fees for superintending repairs to property of its clients and fees received for drawing up a number of wills and 99-year leases.
*1370 The rental business of the petitioner was large in comparison to its other business.
The petitioner would loan money for clients and sometimes when a party wanted to borrow, petitioner would loan the money and carry it for a number of days or a number of weeks and would then sell the loan. Petitioner, in such a case, would sometimes borrow money from banks. Personal notes for the borrowed money were given the banks by Franciscus and Kunz. The item of income "interest received, less interest paid" refers to the difference in interest the petitioner received from borrowers and the interest which the petitioner paid the bank. Sometimes a client for whom petitioner had placed a loan would return and want to obtain cash. Petitioner would then, in order to satisfy the client, buy the loan and carry it until it could be disposed of. In making loans the petitioner also used accumulated profits, money left by clients*3056 after a sale, funds of trust estates which were left with the petitioner to be invested, and maturities from mortgages left for the petitioner to collect and reinvest.
The following is a tabulation of money borrowed by petitioner in 1920:
| Amount borrowed | Paid off | Balance | |
| Balance from December 31, 1919 | $20,000.00 | ||
| January | $12,000.00 | 32,000.00 | |
| February | $12,000.00 | 20,000.00 | |
| March | 8,000.00 | 28,000.00 | |
| April | 28,000.00 | ||
| May | 17,000.00 | 17,000.00 | |
| June | 17,000.00 | ||
| July | 17,000.00 | ||
| August | 17,000.00 | ||
| September | 17,000.00 | 17,000.00 | 17,000.00 |
| October | 10,000.00 | 27,000.00 | |
| November | 27,000.00 | ||
| December | 27,000.00 | ||
| 64,000.00 | 57,000.00 | 27,000.00 |
The following shows loans paid off and sold in 1920:
| Loans made | Paid off or sold | Balance | |
| January | $8,700.00 | $25,365.12 | $26,013.61 |
| February | 23,800.00 | 9,699.15 | 40,114.46 |
| March | 35,000.00 | 21,866.19 | 53,248.27 |
| April | 45,650.00 | 47,724.02 | 51,174.25 |
| May | 34,500.00 | 27,964.28 | 57,710.06 |
| June | 26,050.00 | 21,387.11 | 62,372.95 |
| July | 18,250.00 | 40,032.99 | 40,589.66 |
| August | 10,900.00 | 23,105.08 | 28,385.48 |
| September | 20,950.00 | 9,419.22 | 39,916.26 |
| October | 27,100.00 | 20,700.00 | 46,316.26 |
| November | 16,800.00 | 37,335.50 | 25,780.76 |
| December | 14,315.00 | 21,141.50 | 18,953.57 |
| 282,015.00 | 305,740.16 | 18,953.57 |
*3057 *1371 The following shows the money borrowed by petitioner in 1921:
| Amount borrowed | Paid off | Balance | |
| Balance from Dec. 31, 1920 | $17,000.00 | ||
| January | $10,000.00 | $10,000.00 | 17,000.00 |
| February | 17,000.00 | ||
| March | 10,000.00 | 17,000.00 | 10,000.00 |
| April | 10,000.00 | ||
| May | 10,000.00 | ||
| June | 15,000.00 | 15,000.00 | |
| July | 15,000.00 | ||
| August | 10,000.00 | 25,000.00 | |
| September | 10,000.00 | 15,000.00 | |
| October | 15,000.00 | ||
| November | |||
| December | 20,000.00 | 20,000.00 | |
| 65,000.00 | 62,000.00 | 20,000.00 |
The following shows the loans paid off and sold in 1921:
| Loans made | Paid off or sold | Balance | |
| January | $18,953.57 | $14,520.83 | $6,744.74 |
| February | 20,262.00 | 11,175.00 | 13,519.74 |
| March | 15,500.00 | 8,530.67 | 20,489.07 |
| April | 11,000.00 | 13,547.00 | 17,942.07 |
| May | 26,025.00 | 11,271.32 | 32,695.74 |
| June | 12,500.00 | 21,333.22 | 23,862.53 |
| July | 23,750.00 | 2,880.00 | 44,732.53 |
| August | 3,100.00 | 8,468.92 | 39,363.61 |
| September | 12,100.00 | 17,338.66 | 34,124.95 |
| October | 42,650.00 | 38,935.79 | 37,839.16 |
| November | 13,300.00 | 18,394.16 | 27,545.00 |
| December | 9,200.00 | 17,375.00 | 24,570.00 |
| 208,340.57 | 183,770.57 | 24,570.00 |
*3058 The assets and liabilities of petitioner were as follows:
| Feb. 4, 1920 | Dec. 31, 1920 | Dec. 31, 1921 | |
| ASSETS | |||
| Cash | $19,467.95 | $3,754.61 | |
| Expense | 2,628.26 | ||
| Fixtures | 1,645.00 | $2,200.00 | 1,900.00 |
| Bills receivable | 18,953.57 | ||
| Notes on deeds of trust | 26,013.61 | 24,570.00 | |
| Joint venture 52 acres | 11,792.13 | 4,195.39 | |
| J. M. Franciscus personal | 999.27 | ||
| Clients accounts receivable | 19,300.49 | 22,271.69 | 49,107.90 |
| Good will | 50,000.00 | 50,000.00 | 50,000.00 |
| 119,055.31 | 105,217.39 | 134,527.17 | |
| LIABILITIES | |||
| Commissions | 2,767.56 | ||
| Miscellaneous | 561.70 | ||
| Interest | 341.62 | ||
| Bills payable (bank) | 32,000.00 | 27,000.00 | 20,000.00 |
| Cash overdrawn | 465.84 | ||
| J. N. Franciscus, personal | 4,029.42 | 3,540.11 | |
| C. C. Kunz, personal | 3,405.33 | 2,360.01 | 810.87 |
| Clients accounts payable | 25,949.68 | 21,851.43 | 63,716.30 |
| Capital stock | 50,000.00 | 50,000.00 | 50,000.00 |
| 119,055.31 | 105.217.39 | 134,527.17 |
The item "bills receivable" refers to notes on deeds of trust covering loans which petitioner held for disposition.
*1372 "Joint venture, 52 acres," has reference to a personal transaction by the individuals, Franciscus and Kunz for which the petitioner*3059 advanced part of the capital.
Sometimes petitioner made repairs on clients' property and the cost thereof was carried by petitioner until enough rent was collected to repay it.
The collection of rents was accomplished mainly through the mail, although it was necessary in a great many cases to solicit payment by means of collectors.
The petitioner advertised in newspapers and by signboards. The expense of this item in 1920 was $6,790.27, and in 1921 it was $6,089.47.
OPINION.
SIEFKIN: The petitioner alleges error on the part of the respondent in holding that the petitioner, during the years 1920 and 1921, was not entitled to personal service classification.
Section 200 of the Revenue Acts of 1918 and 1921 provides in part:
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 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*3060 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.
The petitioner obtained its income from various sources, among which were commissions on rents collected, sales of property, placing of insurance, making repairs on clients' property, making loans, and from interest on loans.
The petitioner owned no real estate and had no paid-in cash or tangible property. When money was needed in the business, the petitioner borrowed it from the banks on the personal notes of Franciscus and Kunz, or used the accumulated profits of the business which were distributed semiannually.
The testimony shows that money left by clients after a sale of property, funds of trust estates which were left with the petitioner to be invested, and maturities from mortgages which were left for the petitioner to collect and invest, were used in the business, but it does not appear clearly whether these funds were used by the petitioner as principal or as agent for the clients.
The petitioner*3061 loaned money for its clients and charged the borrower thereof a commission. Sometimes a client for whom petitioner *1373 had placed a loan wished to obtain cash for it and petitioner would buy the loan and hold it until it could be disposed of. Sometimes a borrower would apply to petitioner for a loan and petitioner would advance the money and carry the loan until it could be sold.
The amount of interest which the petitioner received from such loans over the amount of interest which petitioner had to pay upon money borrowed for that purpose in 1920 was $2,548.90, or about 4.25 per cent of $59,908.65, the gross income for that year. During 1921 this item amounted to $1,098.49, or about 2.29 per cent of $52,122.86, the gross income for that year. The amount of commissions received by the petitioner on loans and sales in 1920 was $35,192.08 and in 1921 the amount was $28,532.78. The amount received as commissions on loans is not segregated. The total of loans made by the petitioner in 1920 was $282,015 and in 1921, was $208,340.57. It is not shown how much of these amounts were loans made by petitioner on behalf of clients and how much constituted loans which the petitioner*3062 itself made and carried.
In 1920 the petitioner borrowed $64,000 and the average monthly balance of such borrowed money throughout the year was about $22,000. In 1921 petitioner borrowed a total of $65,000 and the average throughout the year was about $16,000.
The petitioner made advances for clients for repairs on the clients' property and carried such amounts until they were paid by the rent from such property.
The testimony and the statement of assets and liabilities indicate that the petitioner borrowed this money and that the amount the petitioner owed in this connection was $25,949.68 on February 4, 1920, $21,951.43 on December 31, 1920, and $63,716.30 on December 31, 1921. This is an addition to the other money which the petitioner owed the bank, which amounted to $32,000 on February 4, 1920, $27,000 on December 31, 1920, and $20,000 on December 31, 1921. Thus the average borrowed capital which petitioner employed to earn $59,908.85 gross income in 1920 was about $53,000.
In 1921 it employed an average of about $66,000 of borrowed money to earn a gross income of $52,122.86.
In *3063 , the court said:
We come then to the second element of the definition; that is, whether capital (invested or borrowed) is a material income producing factor. Here the test is not exclusively whether the corporation bought and sold on its own account, or did a strictly commission business; it is whether it necessarily requires capital for, and the fact uses it in the conduct of its business. If the nature of the business is such that it cannot be carried on at all without the constant use of capital, and such use of capital plays a vital part in the successful conduct of the business, it cannot be said that its use in the business is merely incidental.
*1374 Irrespective of the amount of income directly received by petitioner from the use of capital, it is our opinion that capital was a necessary factor in the conduct of the business.
The petitioner is not entitled to personal service classification during the years in controversy, since it has not met one of the requirements of section 200 of the Revenue Acts of 1918 and 1921.
Judgment will be entered for the respondent.