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In the instant case capital (patents) is employed in the business. Royalties are the result of the employment of this capital, and it can not be denied that the volume of the business rests practically upon the individual efforts of the stockholders of this corporation. This is true, more or less, in every corporation, and the distinction must be noted between personal service and commercial service.

The company has paid-in capital, but its true invested capital for the taxable year can not be actually determined. At any rate, the income for the taxable year justifies the consideration given the case under section 210 of the Revenue Act by the Income Tax Unit.

The Committee accordingly recommends that the action of the Income Tax Unit in denying assessment of taxes against this corporation under section 209 of the Revenue Act be sustained, and that its action in assessing the tax under section 210 be approved.

SECTION 200, ARTICLE 1523: Personal service

corporation. (Also Section 327, Article 901.)

3-21-1395 A. R. R. 364

REVENUE ACT OF 1917.

The Committee has had under consideration the appeal of M Company, a partnership, from a decision of the Income Tax Unit rejecting the excess profits tax return filed for the calendar year ended December 31, 1917, under the provisions of section 209, and making an assessment of excess profits tax under the provisions of section 210.

It appears from the records in the case that the partnership was formed in 190– for the purpose of conducting a wholesale merchandise brokerage business, the firm acting as local brokers of foreign principals in negotiating sales on a commission basis. In addition to its regular business of negotiating sales of merchandise as brokers the firm purchased merchandise from time to time in “pooled cars" which it sold at a profit. The sales negotiated on a commission basis luring the year 1917 aggregated 100x dollars and yielded gross brokerage charges of x dollars, while the amount of merchandise purchased aggregated 22x dollars, which merchandise was sold at a gross profit of 4/5x dollars. A, in an affidavit, states that it is his opinion that the expense of conducting the business could be fairly apportioned so as to charge brokerage sales with 40 per cent and merchandise sales with 60 per cent of the total expense. An allocation of expense on the basis stated by A to each line of business conducted shows that approximately 30 per cent of the firm's net income was derived from sales of merchandise. In reply to inquiries made by the Income Tax Unit the firm stated that it had no branches during the year 1917, employed only one salesman, and that it was not responsible in any event for losses in shipments, bad debts, etc.; that such responsibility rested upon its foreign principals or was a matter of adjustment between foreign sellers and local buyers, and that it did not either directly or indirectly make loans or advances to customers, but did extend short-time credits on merchandise.

The partnership in rendering its returns for the year 1917 computed excess profits tax under the provisions of section 209 based on the contention that its principal net income was due primarily to the personal activities of the two partners. The balance sheets accompanying the returns show as of January 1 and December 31, 1917, moneys borrowed in considerable amounts and accounts receivable and payable, indicating the use of capital more than nominal in amount in the business.

Because of the volume of business transacted by the partnership during the year 1917 through direct buying and selling of merchandise, and the numerous accounts receivable and payable shown on the firm's balance sheets, both at the beginning and close of the taxable year, the Unit denied assessment under section 209, but, holding that a statutory invested capital of 1/3x dollars was negligible in comparison with the volume of business transacted and seriously disproportionate to the invested capital of other taxpayers doing a like or similar business, assessed tax under the provisions of section 210, basing such assessment upon comparative data compiled in the Unit. The comparatives used appear to be representative and give a tax which is both fair to the Government and to the taxpayer.

In view of the foregoing, the Committee is of the opinion that classification under the provisions of section 209 was properly denied, and that the assessment of the tax as made by the Unit under the provisions of section 210 should be sustained.

17-21-1588 A. R. R. 464

SECTION 200, ARTICLE 1523: Personal service

corporation. (Also Section 212, Article 23; Section 327, Article 901.)

REVENUE ACT OF 1917.

Recommended, in the appeal of the M Company that the action of the Income Tax Unit in denying assessment under section 209 of the Revenue Act of 1917 be sustained, and that the said corporation's excess profits tax liability be determined under the pro

visions of section 210 of that statute. The Committee has had under consideration the appeal of the M Company, from the action of the Income Tax Unit in denying assessment under section 209 of the Revenue Act of 1917 and assessing excess profits tax under the provisions of section 201 for the fiscal year ended March 31, 1917.

It appears from the records in the case that during the taxable year in question the four officers of the company owned all of the stock and gave their entire time and attention to the business, that of obtaining exclusive selling contracts covering lots, tracts, and other parcels of land and the disposal of such lands on a commission basis. It does not appear that the company made any purchases and sales of lands on its own account nor that it assisted in the financing of real estate operations, except that in a very few cases where the purchasers of lands were unable to continue their pay. ments under the terms of their contracts and the company would lose its commission should such contracts lapse, and in one or two instances where such losses and lapse of contracts would result in a

61360°—21-2

serious hardship to the purchaser of the lands the company assumed such contracts and resold them.

It further appears that the company was organized with an authorized capital of $3,000, of which amount $2,000 was subscribed for and paid in prior to January 1, 1917, and that no addition to capital has been made since the organization from any source other than from earned income, funds, however, being borrowed oceasionally to meet pay rolls and expenses at times when the collection of commissions earned has been deferred. The taxpayer contends that it requires and employs no more than a nominal capital in the conduct of its business, that the character of its business is such that capital is not required, and that its success is due to and its net income is derived solely from the activities of its officers, all of whom are stockholders. To this contention the Committee does not agree for the reason that it is shown that in the conduct of its business the corporation does require capital and that its income is derived in a large part from services rendered by others.

Under its usual form of contract the company, in taking over a subdivision for sale, obligates itself to bear all selling expenses such as newspaper advertisements, printed matter, signs, and the cost of erecting branch offices on the property offered for sale. During the year in question advertising, auto expenses, miscellaneous expenses, and supplies, as shown by taxpayer's original return, amounted to 4.0 dollars. It also obligates itself to render various forms of service, such as planning and supervising the placing of properties on the market, the making of sales and collections, and the accounting for and remitting of collections made, to furnish surety bonds for the faithful performance of its contracts, to supervise the entire work of preparing the property for market, including the negotiation and letting of contracts, subject to the approval of the owners of the land, with all engineers and contractors, and the laying out and construction of improvements by such engineers and contractors, to negotiate with all public and private corporations and public authorities for permission to construct and connect improvements in conformity with private rights and public law, and to prepare and publish such advertising matter as is deemed necessary. These duties are discharged in part by the four officers of the corporation and in a large part by its superintendents and salesmen working on a commission basis and its salaried office force. The compensation of the corporation for the rendition of such services is received in the form of commissions based on the amount of sales made by its salesmen, an average of twenty-five being employed, each of whom receives a stated percentage of the commissions received on the sales made by him. The superintendents who direct and supervise the activities of the salesmen and perform other duties receive a commission of 2 per cent on all sales made. The balance of the commissions received accrues to the corporation.

In view of these facts it is the opinion of the Committee that the business of the corporation is such as that ordinarily requiring the use of capital, and inasmuch as a substantial part of the income received is derived from services rendered by the company's superintendents and salesmen, the Committee holds that the Unit was correct in denying assessment under section 209 and recommends that such action be sustained.

The corporation in preparing its return for the fiscal year 1917, reported on the accrual basis, showed a net income of 35x dollars, and computed the excess profits tax thereon under the provisions of section 209. It is shown that the corporation is entitled, under its usual form of contract, to a commission of from 10 per cent to 30 per cent on the gross sales price of each property sold, that it usually deducts 5 per cent of such sales price from the initial, or “ down” payment, in part payment of its commission, and a portion of each subsequent installment payment until its entire commission is satisfied. Under this plan of realizing its commissions the company must wait from two and one-half to five years, and in some instances a much longer period, before it finally receives payment in full for its services. It is stated that the company attempted to make a return on the actual receipt and disbursement basis but was forced by the Collector of its district to report on the accrual basis.

It is the opinion of the Committee that the alleged action of the collector in refusing to permit the corporation to report on an actual receipt and disbursement basis was not justified. It is shown that the responsibilities and duties of the company under its usual form of contract with the owners of the properties to be sold, in consideration for the assumption of which responsibilities and the discharge of such duties, commissions are to be received, are not fully discharged and the commissions fully earned until the last installment payment is received from the purchaser, and therefore to report the fuil amount of commissions called for under sales contracts as income for the year during which such contracts are entered into is to report as income for that year commissions which have not been fully earned and which, in case of default, will never be received.

The revenue agent reported a net income of 14x dollars, computed on the actual receipt and disbursement basis, and an invested capital of 10x dollars for the fiscal year 1917, and stated that the company and its accountant agreed with this report except in respect to his decision that the company was not entitled to classification as a personal service corporation.

After a careful consideration of all the facts presented the Committee is of the opinion that the M Company is not entitled, for the fiscal year 1917, to assessment under the provisions of section 209 as a personal service corporation or one employing only a nominal capital. In connection with this case, however, the Unit has prepared a comparative data sheet, using a number of comparatives.

From these comparatives it is apparent that the amount of statutory invested capital allowable to the M Company for the taxable year 1917 is small when compared with that of other taxpayers engaged in a like or similar business, which fact would, through the operation of section 207, place that corporation at a serious disadvantage in comparison with such other taxpayers, and that the percentage of excess profits tax to net income assessed against it for the said taxable year is grossly disproportionate to such percentage in the case of other corporations engaged in a like or similar business. In comparison with the amount of business done the appellant does not appear to have a normal amount of capital invested in its business, owing to which fact it found itself obliged from time to time to borrow funds with which to meet its pay rolls and current expenses. It does not appear to have enjoyed any particular advantage over other corporations doing a similar business.

Article 52 of Regulations 41 provides, in part, as follows:

Section 210 provides for exceptional cases in which the invested capital can not be satisfactorily determined. In such cases the taxpayer may submit to the Commissioner of Internal Revenue evidence in support of a claim for assessment under the provisions of section 210. (See articles 18 and 24.) Such exceptional cases may consist, among others, of the following:

*

*

* *

&

(3) Long-established business concerns which by reason of ultraconservative accounting or the form and manner of their organization would, through the operation of section 207, be placed at a serious disadvantage in competing with representative concerns in a like or similar trade or business.

Section 327(d) of the Revenue Act of 1918 provides, in part, that

Where upon application by the corporation the Commissioner finds and so declares of record that the tax if determined without benefit of this section would, owing to abnormal conditions affecting the capital or income of the corporation, work upon the corporation an exceptional hardship evidenced by gross disproportion between the tax computed without benefit of this section and the tax computed by reference to the representative corporations specified in section 328.

While the above-quoted provision of the Revenue Act of 1918 will not be applied in any case in which the tax computed without its benefit is high merely because the corporation earned in the taxable year a high rate of profits upon a normal invested capital, in the opinion of the Committee it confirms the interpretation which has been placed upon section 210 of the Revenue Act of 1917 and articles 18, 24, and 52 of Regulations 41.

It having been shown that the M Company employed more than a nominal amount of capital in its business during the taxable year ended March 31, 1917, and derived a considerable part of its net income from services rendered by others than its four stockholders, the Committee recommends that the action of the Unit in denying assessment under the provisions of section 209 be sustained. And further, in view of the fact that the said corporation was ultraconservative in its capitalization and the further fact that the amount of capital it had invested in the business was insufficient at times to meet the needs of that business and was less than normal as compared with the amount of business transacted and as compared with the amount of capital employed by other concerns doing a similar business, the Committee recommends that the case be returned to the Unit for adjustment and assessment of excess profits tax under the provisions of section 210 on the basis of the average percentages shown on the data sheet submitted to the Committee.

SECTION 200, ARTICLE 1523: Personal service

21-21-1645 corporation.

A. R. R. 500 (Also Section 327, Article 901.)

REVENCE ACT OF 1917.
Recommended, in the appeal of the M Company that the action
of the Income Tax Unit be reversed and that assessment of the
excess profits tax of this corporation be made in accordance with

the provisions of section 209 of the Revenue Act. The Committee has had under consideration the appeal of the M Company from the action of the Income Tax Unit in denying

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