by the corporation to the persons with whom it does business. Merchandising or trading either directly or indirectly in commodities or the services of others is not rendering personal service. Conducting an auction, agency, brokerage, or commission business strictly on the basis of a fee or commission is rendering personal service. If, however, the corporation assumes any such risks as those of market fluctuation, bad debts, failure to accept shipments, etc., or if it guarantees the accounts of the purchaser, or is in any way responsible to the seller for the payment of the purchase price, the transaction is one of merchandising or trading, and this is true even though the goods are shipped directly from the producer to the consumer and are never actually in the possession of the corporation. The fact that earnings of the corporation are termed commissions or fees is not controlling. The fact that a commission or fee is based on a difference in the prices at which the seller sells and the buyer buys raises a presumption that the transaction is one of merchandising or trading, and it will be so considered in the absence of satisfactory evidence to the contrary.

Article 1528, Regulations 45, provides in part as follows:

* * * If employees contribute substantially to the services rendered by a corporation, it is not a personal service corporation unless in every case in which services are so rendered the value of and the compensation charged for such services are to be attributed primarily to the experience or skill of the principal owners or stockholders, and such fact is evidenced in some definite manner in the normal course of the profession or business.

*

In reading the above-quoted provisions of the Revenue Act of 1918 defining a personal service corporation and the quoted articles of the regulations thereunder, it is noted that the word "primarily" is used and that the word "principally" is used in article 1525. The words primarily" as used in the Revenue Act of 1918 and "principally" as used in Regulation 45, do not mean that 100 per cent of the earnings of the corporation must be derived from commissions before the corporation can be classified as a personal service corporation. If all the earnings of a corporation must be derived from rendering personal service before such corporation can be classified as a personal service corporation under the Revenue Act of 1918, the word primarily" as used in the Act and the word "principally" as used in the regulations are meaningless.

The corporation contends that no part of its business is trading and submits that no part of the net earnings of the corporation is derived from trading in the services of others. It is also submitted that the capital used in the business for 1918 is not a material incomeproducing factor and that the income may be ascribed primarily to the activities of the sole stockholders.

It appears that this corporation meets every test laid down by the regulations and that it is entitled to personal service classification for 1918. It is obvious to the Committee, after careful analysis of all the facts submitted and a study of the law and regulations, that the income may be ascribed primarily to the activity of the sole stockholders, and that capital, whether invested or borrowed, is not a material income-producing factor.

In view of the foregoing the Committee recommends that the action of the Income Tax Unit be reversed and that personal service classification be allowed for 1918.

Committee Recommendation 235 holding that this corporation was not entitled to personal service classification for 1918 and that the tax be determined and assessed under the provisions of sections 327 and 328 of the Revenue Act of 1918 is hereby revoked.

SECTION 201.-DIVIDENDS.

SECTION 201, ARTICLE 1541: Dividends:

(See 34-21-1786; sec. 325, art. 813.) Informal agreement among all stockholders to credit their accounts.

SECTION 201, ARTICLE 1541: Dividends. (See 41-21-1861; sec. 221, art. 364.) bentures. Debentures defined.

Payments to holders of de

SECTION 201, ARTICLE 1541: Dividends.

43-21-1878 L. O. 1073

INCOME TAX-SECTIONS 213, 201(a) AND 202(b), REVENUE ACT OF 1918.

Profit made by a corporation in 1918 or subsequent years from the realization of appreciation of corporate assets accrued before March 1, 1913, is taxable income to the stockholder when distributed as a dividend in 1918 or subsequent years.

The following question is raised: Is the profit made by a corporation in 1918 or subsequent years, from the realization of the appreciation of the March 1st value of property (that is, the profit realized between cost and March 1st value of property sold in 1918 or subsequent years), taxable as income, when distributed as a dividend to a stockholder in 1918 or subsequent years?

To illustrate the point, the M corporation purchased capital assets in 1910 for $10,000. On March 1, 1913, these assets had a value of $20,000. In the year 1918 or a subsequent year the M corporation sells these assets for $20,000 and distributes the $10,000 realized gain to its stockholders as dividends. The question asked is whether the $10,000 thus distributed is taxable as income to the stockholders.

It was held in Lynch v. Hornby, 247 U. S. 339 (T. D. 2731), that such increase in the value of corporate assets accrued prior to March 1, 1913, was taxable income under the Income Tax Act of 1913 when distributed as a dividend in the ordinary course of business. The court stated:

* *

Hence we construe the provision of the Act that “the net income of a taxable person shall include gains, profits, and income derived from interest, rent, dividends, or gains or profits and income derived from any source whatever" as including (for the purposes of the additional tax) all dividends declared and paid in the ordinary course of business by a corporation to its stockholders after the taking effect of the Act (March 1, 1913), whether from current earnings or from the accumulated surplus made up of past earnings or increase in value of corporate assets, notwithstanding it accrued to the corporation in whole or in part prior to March 1, 1913. (Italics mine.)

The definition of income contained in section 213, Revenue Act of 1918, is, in its essentials, the same as the definition in the Act of 1913, and it follows, therefore, that unless Congress has by other statutory provisions exempted such income it is taxable.

Pertinent provisions in the Revenue Act of 1918 bearing on this point are section 201(a) and (b) which provide as follows:

(a) That the term "dividend when used in this title (except in paragraph (10) of subdivision (a) of section 234) means (1) any distribution made by

*

* *

* *

out of its

a corporation, to its shareholders or members, earnings or profits accumulated since February 28, 1913 (b) any distribution made in the year 1918 or any year thereafter shall be deemed to have been made from earnings or profits accumulated since February 28, 1913, or, in the case of a personal service corporation, from the most recently accumulated earnings or profits; but any earnings or profits accumulated prior to March 1, 1913, may be distributed in stock dividends or otherwise, exempt from the tax, after the earnings and profits accumulated since February 28, 1913, have been distributed.

* **

out of

It seems clear that the distribution here in question is a "dividend" within the meaning of section 201(a), which defines a dividend as "any distribution made by a corporation, its earnings or profits accumulated since February 28, 1913." Mere increase of capital assets unrealized is not, in our judgment, "earnings or profits." Obviously it is not an earning. Is it a "profit," as that term has come to be understood in income tax parlance? In Lynch v. Turrish, 247 U. S. 221, the Supreme Court quoted with approval the following from Gray v. Darlington, 15 Wall. 63:

Mere advance in value in no sense constitutes the gains, profits, or income specified by the statute.

In Eisner v. Macomber, 252 U. S. 189, the court in commenting on the meaning of income states:

Here we have the essential matter: Not a gain accruing to capital, not a growth or increment of value in the investment, but a gain, a profit, something of exchangeable value proceeding from the property, severed from the capital however invested or employed,

Here profit is made synonymous with income, and income is held not to include mere appreciation of capital. Hence the word "profit" can not include mere appreciation of capital. The statute, section 213, defines income as including "profits." Surely a part can not be said to be greater than the whole as that whole has been defined by the Supreme Court. See also article 23, Regulations 45, holding appreciation of capital is not income.

Such appreciation becomes income, or profit, however, when realized through sale of such assets (Merchants Loan & Trust Co. v. Smietanka, decided by the Supreme Court, Mar. 28, 1921; T. D. 3173, C. B. 4, p. 34). It is clear, therefore, that this increase did not become "earnings and profits" to the corporation until after February 28, 1913. Therefore any distribution out of it must have been a distribution out of the earnings and profits accumulated after February 28, 1913. That such increase when realized is not taxable to the corporation because accrued prior to March 1, 1913, is immaterial. The definition of a dividend does not confine itself to taxable or nontaxable earnings or profits. It is concluded, therefore, that the distribution is a dividend within the meaning of section 201 (a).

It remains to be determined whether this distribution falls within the express exemption of section 201 (b), which provides in part :

Any distribution made in the year 1918 or any year thereafter shall be deemed to have been made from earnings or profits accumulated since February 28, 1913 * *; but any earnings or profits accumulated prior to March 1, 1913, may be distributed in stock dividends or otherwise, exempt from the tax, after earnings and profits accumulated since February 28, 1913, have been distributed.

This section, read in connection with the definition of a dividend, makes manifest the intention of Congress to exempt "earnings and

profits" which would otherwise be taxable under the doctrine of the Hornby case. It will be noted, however, that the statute is peculiarly silent as to the increase of capital assets accrued prior to March 1, 1913. At the time the Revenue Act of 1918 was passed by Congress the case of Lynch v. Hornby had been decided and it must be assumed. that Congress knew that under that decision increase of corporate assets as well as earnings and profits accumulated prior to March 1, 1913, but distributed later in the ordinary course, were taxable as income. Whatever may be conjectured as to the intention of Congress to reverse by statute the entire ruling laid down in the Hornby case, the fact remains that it did not use language which in our judgment is sufficient to accomplish that result, and it can not be assumed by an executive department that Congress intended to extend the exemption beyond the clear import of the words used. The express exemption applies to "earnings and profits" accumulated prior to March 1, 1913, and as has already been demonstrated, these terms do not include unearned increment. A distribution like that under consideration in this case is not, therefore, within the exemption.

For the reasons above stated it is concluded that profit made by a corporation in 1918 or subsequent years from the realization of appreciation of corporate assets accrued before March 1, 1913, is taxable income to the stockholder when distributed as a dividend in 1918 or subsequent years.

CARL A. MAPES,

Solicitor of Internal Revenue.

SECTION 201, ARTICLE 1542: Presumption as to source of distribution.

REVENUE ACT OF 1917.

38-21-1824 A. R. R. 577

Recommended, in the appeal of A against the assessment of 4x dollars, additional tax for the year 1917, that the action of the Income Tax Unit in reallocating dividends reported in the taxpayer's original return as paid out of 1916 accumulated earnings of the M Company as having been paid out of most recently accumulated earnings of the corporation to the extent of such earnings to date of payment, and taxable at the 1917 rates in accordance with the provisions of article 107, Regulations 33, revised, Revenue Act of 1917, be sustained, and the appeal of the taxpayer accordingly be denied.

The Committee has had under consideration the appeal of A from the action of the Income Tax Unit in assessing an additional tax for the year 1917 by the reallocation of dividends which were reported on the original return of the taxpayer as paid out of accumulated earnings of 1916 of the M Company showing such dividends as being paid out of most recently accumulated earnings of the corporation and taxable at the 1917 rates under the provisions of article 107, Regulations 33, revised, Revenue Act of 1917.

A, president of the M Company, received dividends from the company during the year 1917 in the following amounts:

The taxpayer states in his affidavit that the M Company has a fiscal year commencing July 1 and ending June 30 of the following year; that said corporation has consistently closed its books on March 31, June 30, September 30, and December 31 of each year, and that the books of said corporation as balanced on the 31st day of December, 1916, showed a surplus and undivided profits balance of 70x dollars; that said corporation declared dividends on January 1917, of which he received 16x dollars; that said corporation also declared dividends March —, 1917, of which he received 9x dollars; that said corporation did not have any method of bookkeeping, nor has any balance of its books been made prior to March 30, 1917, by which it could be determined whether said corporation had made any profits during the year 1917, up to the time it declared said dividend's in January and March, 1917.

* * *

Article 107, Regulations 33, revised, Revenue Act of 1917, provides: Any distribution made to shareholders in the year 1917 or subsequent years shall be deemed to have been made from the most recently accumulated undivided surplus or profits, and shall constitute income of the distributee for the year in which received, and shall be taxed to such distributee at the rates prescribed by law for the years in which such surplus or profits were earned by the distributing corporation. Thus if a corporation distributed dividends in 1917, such dividends will be deemed to have been paid from the earnings of 1917, and the recipient, if an individual, will be liable to additional tax, if any, and if a corporation, to income tax, at the rates for the year 1917, unless it is shown to the satisfaction of the Commissioner of Internal Revenue that at the time such dividends were paid the earnings up to that time were not sufficient to cover the distribution, in which case the excess over the earnings of the taxable year will be deemed to have been paid from the most recently accumulated surplus of prior years, and will be taxed at the rate or rates for the year or years in which earned.

The Committee has examined the computation of the revenue agent and concurs in the opinion of the Income Tax Unit that the allocation has been made in accordance with the provisions of article 107, Regulations 33, revised, and with the consistent practice of the Bureau.

The Committee therefore recommends in the appeal of A against the assessment of 4r dollars additional tax for the year 1917 that the action of the Income Tax Unit in reallocating dividends reported in the taxpayer's original return as paid out of 1916 accumulated earnings of the M Company, as being paid out of most recently accumulated earnings of the corporation to the extent of such earnings to date of payment, and taxable at the 1917 rates in accordance with the provisions of article 107, Regulations 33, revised, Revenue Act of 1917, be sustained, and the appeal of the taxpayer accordingly be denied.

ART. 1543. Distributions which are not dividends.—A distribution by a corporation out of earnings or profits accumulated prior to March 1, 1913, or out of any assets except earnings or profits accumulated since February 28, 1913, is not a dividend within the meaning of the statute. A distribution by a personal service corporation out of earnings or profits accumulated since December 31, 1917, is not a dividend. A distribution out of earnings or profits accumulated