*2481 1. Held, the petitioner was not a personal service corporation during the taxable year.
2. Where compensation for personal services of stockholders was neither authorized, paid nor accrued, no amount therefor can be allowed as a deduction from income.
*939 This is a proceeding for the redetermination of a deficiency of $8,956.14 in income and profits taxes for the fiscal year ended July 31, 1920. The matters in controversy are the respondent's action in denying personal service classification and in refusing to allow a deduction for officers' salaries.
*940 FINDINGS OF FACT.
The petitioner is a New York corporation organized in 1912 and having its principal office in New York City.
The petitioner corporation was formed to conduct a general theatrical business, produce plays, exploit them in New York and on tours, and to operate the 48th Street Theatre when completed in New York City. The authorized capital stock of $10,000 par value was issued at the time of organization for cash and has*2482 never been increased. During the taxable year ended July 31, 1920, the petitioner's capital stock was held by William A. Brady, George Broadhurst, Lawrence Weber and Felix Isman, each of whom held 25 per cent.
The petitioner did not own the 48th Street Theatre, but operated it under a five-year lease at an annual rental of $32,500, plus the taxes on it which in the taxable year amounted to $12,641.75. The four stockholders had an agreement among themselves whereby they were to stand together and keep the theatre in operation. In pursuance of such agreement, three plays were put on during the taxable year. The first and third, produced by Brady, were failures, and the second, produced by Broadhurst, was fairly successful and ran for the greater part of the year.
The arrangement between the petitioner and the stockholders under which the plays were presented provided that the petitioner furnish the house lighted and heated, the box office staff, ushers, and theatre mechanics, and pay part of the advertising and other small items of expense. The stockholder producing the play hired and paid the actors, furnished the costumes, any extra stage hands that were required, any extra*2483 electricity that was required, and paid the royalties and part of the advertising. Under the arrangement the petitioner and the producer each received from a play 50 per cent of the gross receipts up to 5,000. Of the receipts in excess of that amount, the petitioner received 40 per cent and the producer 60 per cent.
For the taxable year, the petitioner's share of the proceeds from the sale of tickets amounted to $154,867.80. Interest on bank deposits amounted to $389.24. Receipts from "privileges" amounted to $2,008.33. The foregoing amounting to $157,265.37, constituted the petitioner's gross income for the taxable period. Expenses, including an amount of $43,307.25 for salaries, totaled $123,130.01, leaving a net income of $34,135.36. The item for salaries represented the amount paid by the petitioner to its employees which included a stenographer, a box office force of three persons, night watchman, day watchman, man to open carriages, four or five cleaners, six or eight ushers, dressing-room attendants, stage hands, and stage mechanics.
*941 The following are the petitioner's balance sheets on the dates indicated:
| July 31, 1919 | July 31, 1920 | |
| Assets: | ||
| Cash in bank | $ 32,409.61 | $ 58,419.97 |
| Prepaid accounts | 8,125.00 | |
| 32,409.61 | 66,544.97 | |
| Liabilities: | ||
| Capital stock | 10,000.00 | 10,000.00 |
| Surplus | 22,409.61 | 56,544.97 |
| 32,409.61 | 66,544.97 |
*2484 The leasehold on the 48th Street Theatre was not shown as an asset on the balance sheet. The petitioner's surplus of $56,544.97 on July 31, 1920, consisted of its surplus of $22,409.61 at the end of the preceding year plus its profits of $34,135.36 for the taxable year.
Brady started in the theatrical producing business about 1877 as a property man and worked up through all the departments of the theatre. He has been in the theatrical producing business for himself since 1889, and since that date has picked and chosen plays, written and rewritten them, chosen the casts, directed them, put them on the stage, looked after the advertising and everything else that goes to produce a play. Broadhurst was one of the premier dramatists of the country. He had written many successful plays, and in some of them he and Brady had been partners. Broadhurst was also a stage director and competent in all lines of theatrical work. He had also been engaged in directing and managing his own plays. Weber also had long experience in managing and producing plays. He also took considerable part in rewriting plays. However, he was more of a "fixer" or "play doctor."
During the taxable year*2485 Brady was also associated with another theatre, The Play House, which was near the 48th Street Theatre. He devoted to it such an amount of his time as was necessary properly to attend to the business there. He was also associated with the British Recruiting Association to conduct a play that was sent to this country. In addition, he had an interest in 2 pictures which were not made by him and an interest in 11 plays, some of which were owned by him. With respect to three others, he had made payment of advance royalties or of amounts preliminary to later production. The petitioner had no interest in any of these productions, some of which required a part of Brady's attention during the year. On account of Broadhurst's play being successful, he devoted more time to the operation of the petitioner during the taxable year than Brady did.
*942 During the taxable year none of the stockholders acted in any of the plays produced by Brady and Broadhurst, nor did they participate in the actual staging of the plays except in directing, conducting and carrying them on. The duties of the stockholders were to cooperate actively for the successful conduct of the theatre. They would*2486 meet once or twice a week or daily if necessary. If things went well, they would not be at the theatre so often. Otherwise, they would be there constantly, depending on how much their services were needed. The stockholders devoted all the time that was required for the successful promotion of the theatre whenever called upon.
For the taxable year, petitioner filed a return as a personal service corporation, showing each stockholder's share of the net income of $34,135.36 to be one-fourth or $8,533.84. The net income, however, was not paid to the stockholders as the petitioner "was short of funds" and it was agreed that the money be left with the petitioner. No salary or compensation was paid to the stockholders during the year, and no deduction was taken on the petitioner's return for salaries or compensation to them for their services. In an audit of the return, the respondent disallowed personal service classification and determined the profits-tax liability under section 328 of the Revenue Act of 1918.
The minutes of the meeting of the board of directors of the petitioner corporation on December 12, 1923, are in part as follows:
The meeting was called to order by the*2487 President who thereupon submitted orally the following report as a committee of one, covering the steps he had taken to conserve the interests of the company under the ruling of the Internal Revenue Department that this company was not a Personal Service Corporation. The President stated that he had prepared and forwarded to the Commissioner of Internal Revenue, notice of an appeal from the Commissioner's decision and further had asked for a conference.
The President made the further statement that as in his opinion the company had the right to ask permission to amend the Income Tax Return of the company for the years ending July 31, 1919 and July 31, 1920, and for all other years following those years, he had also asked of the Internal Revenue Department leave to so amend the said Income Tax Returns, that, said returns as amended should include salaries for the said Directors and also for the said President. The President explained that in his judgment the Directors and himself were clearly entitled to salaries for the large amount of work that they were constantly performing for the company. On motion of Mr. Weber the report of the President as a committee of one was received*2488 and approved.
On motion of Mr. Felix Isman, seconded by Mr. Lawrence Weber the salaries of each of the Directors Messrs Isman and Weber were fixed at $7,500 per annum for the year ending July 31, 1919 and for all subsequent years to date and the salary of the President [Brady] was fixed at $15,000 for the year ending July 31, 1919 and for all subsequent years to date, said salaries however to remain in the treasury of the company subject to such disposal of the same as might later be determined upon by the Board of Directors.
*943 Prior to the above, the last recorded action of the board of directors with respect to salaries or compensation to stockholders for services is contained in the minutes of a directors' meeting held on January 25, 1917, when an amount of $2,500 was voted to each of the four stockholders for his services during the five-year period ending August 1, 1917.
The petitioner was not a personal service corporation during the taxable year.
OPINION.
TRAMMELL: The petitioner contends that it met all of the requirements for classification as a personal service corporation, during the taxable year. It also contends that, in event it is held not*2489 to be entitled to such classification, it should be allowed a deduction representing $7,500 to each of the four stockholders as salary or compensation for services rendered by them.
With respect to the question as to whether the petitioner was a personal service corporation, the respondent concedes in his brief that the stockholders were regularly engaged in the active conduct of the affairs of the corporation, but denies that the income of the petitioner is to be ascribed primarily to the activities of the stockholders or that capital was not a material income-producing factor.
The income of the petitioner was derived primarily from the presentation of plays produced by its stockholders. The stockholder producing a play hired and paid the actors, paid the royalties and part of the advertising, furnished the necessary costumes, any extra stage hands that were necessary and any extra electricity that was required. The petitioner furnished, among other things, the house lighted, heated and provided with a certain personnel.
From the standpoint of the petitioner, the successful presentation of plays required, among other things, a suitable place for their presentation. *2490 No matter how good the plays might be, they could not prove income-producing successes without a proper place to present them. Such a place was just as necessary and essential in the production of the petitioner's income as were the plays presented. Under such circumstances, a place for presenting the plays is a material income-producing factor, and under the conditions present here, constituted capital. In considering this question in , we said:
The corporation was enabled to provide the place (the theatre), which, as we have observed, was a material factor in producing its income, by its possession of a leasehold of the theatre premises. Such a leasehold was a capital asset of the corporation and entered into its capital account. This leasehold was especially valuable to the corporation because it made possible the presentation of the plays selected by its stockholders and in that very material manner helped to produce the income of the corporation. The business in which the *944 corporation was engaged makes this reasoning particularly applicable and constitutes a cogent factor in our determination. There are*2491 businesses which are so conducted that the places in which they are conducted do not matter much or contribute materially to the income, but a theatre for the presentation of plays to large bodies of the discriminating public does not come within such class. The theatre which taxpayer held under leasehold was capital to the corporation and was a material income-producing factor.
See also ; ; .
We are confirmed in our opinion that capital was a material income-producing factor by the fact that at the beginning of the taxable year petitioner's capital of $10,000 and surplus of $22,409.61 consisted entirely of cash in bank; that no part of the surplus was distributed during the taxable year, and that no part of this surplus or of the earnings of the year, amounting to $34,135.36, was paid out to the stockholders for the reason that petitioner "was shy of money" when at that time its capital and surplus were represented by cash in bank amounting to $58,419.97 and prepaid accounts amounting to $8,125. We can only*2492 conclude that no distribution was made because the money was needed in the business.
Since capital was a material income-producing factor, the petitioner does not meet one of the requirements prescribed by the statute. The petitioner, therefore, does not come within the meaning of a personal service corporation as defined by statute. Its contention as to personal service classification is accordingly denied.
With respect to the second issue, the petitioner contends that it should be allowed a deduction representing salary or compensation of $7,500 to each of its four stockholders.
No deduction for stockholders' salaries was taken on the petitioner's return nor was any allowed by the respondent. No salaries were paid during the taxable year, nor were any authorized for that year until in December, 1923. While Brady, a witness in behalf of the petitioner, testified that the stockholders before distributing the profits informally agreed among themselves that each stockholder's distributive share, or one-fourth of the profits, would be considered as compensation for his services, the minutes of the directors' meeting of December 12, 1923, disclose that the authorized compensation*2493 of Isman and Weber for the taxable year was $7,500 each, whereas Brady's compensation was fixed at $15,000. These amounts are much at variance with each member's distributive share of $8,533.84.
In , a question similar to the one here involved was considered. There we said:
Petitioner, the G. Angelo Co., claims the right to the deduction of a reasonable allowance for salaries or other compensation for personal services actually rendered by the stockholders, as provided in section 234(a)(1) of the Revenue *945 Act of 1918. It appears that the stockholders, all of whom were active in the conduct of the affairs of the corporation, believed this close corporation to be a personal service corporation, and they failed to authorize or to pay or accrue, compensation as such for their services. However, dividends were declared and paid, and petitioner proposes that we allocate in each year so much of the dividends as appears reasonable for salaries and permit the deduction of such allowances from income for the purpose of computing net income. Inasmuch as the statutory provision for the deduction of the salaries is coupled*2494 with the requirement that they shall have been paid or accrued during the taxable year the proposed allowance is unwarranted. Cf. ; When .
We think our decision in the foregoing is applicable and controlling here.
Judgment will be entered for the respondent.