Sweeney & James Co. v. Commissioner

SWEENEY & JAMES CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Sweeney & James Co. v. Commissioner

Docket Nos. 10266, 19783.

United States Board of Tax Appeals

10 B.T.A. 966; 1928 BTA LEXIS 3996;

February 23, 1928, Promulgated

---

Petitioner, an advertising agency, held to be a personal service corporation.

Everet L. Bono, Esq., and Challen B. Ellis, Esq., for the petitioner.

John F. Greaney, Esq., for the respondent.

---

SIEFKIN

This is a proceeding brought for a redetermination of a deficiency in income and profits taxes for the year 1920 in the amount of $11,575.12 and for 1921 in the amount of $9,631.77. It is alleged that the Commissioner erred in holding that this corporation is not a personal service corporation. It is alleged also that the Commissioner should have calculated a deficiency in tax for the year 1920 under sections 327 and 328 of the Revenue Act of 1918, instead of section 302, if this corporation be held not to be a personal service corporation.

FINDINGS OF FACT.

The petitioner is a corporation organized December 19, 1919, under the laws of Ohio, with its principal office located at 1632 Euclid Avenue, Cleveland, Ohio. At the time it was organized, 1,200 shares of stock at a par value of $25 each were issued. Practically all this stock was divided equally between John F. Sweeney and Frank G. James, three shares each being given to the attorney to the corporation and his two assistants, in order to qualify the number of directors required by the laws of Ohio. James and Sweeney held the same amount of stock through the years 1920 and 1921.

Petitioner was an advertising agency, and soliciting of clients was done by James and Sweeney. After a client was obtained, petitioner made surveys of the market for products of the client, the salability, the price, the distribution and other elements, and thereafter made recommendations to the client as to the proper method of advertising, which would include advertising in newspapers, magazines, trade papers, folders, direct literature, printed literature, hangers, outdoor signs, painted signs and bulletins. If the client approved the plans of petitioner, definite authority would be given petitioner as advertising agent and petitioner would proceed to make layouts, including art and typography, and have the necessary plates and time mats made for publications. The schedule submitted to the client would include the names of publications to be used, the dates on which the advertisement would be inserted and the number of lines comprising such advertisement.

Orders would then be sent by petitioner to those publishing, or other concerns, for such advertisements, on behalf of the client. These concerns would then render bills to the petitioner, but such bills would state that they were for the client.

Petitioner received nearly all its income from commissions generally allowed by the publishers and others from whom they secured service or material for the clients. Petitioner's custom was to collect from the clients in advance of the time the bill to the publisher came due, in order that money would be on hand to pay such bills. On one occasion the Sunbeam Chemical Co. failed to pay petitioner, and this company was immediately dropped as a client. The net income of petitioner was $34,731.41 for 1920, and $28,468.71 for 1921. The following are combined income and expense statements for the years 1920 and 1921:

	1920		1921
EXPENSE
Loss and gain (Sumbeam account)	$8,082.25
Administration expenses	21,622.09		$20,072.46
Commissions for buying and selling bonds			36.25
Office expenses	20,510.08		16,573.70
Legal fees to American Indemnity	226.00
Traveling expenses, James	2,280.53		2,140.61
Traveling expenses, Lilyeblade	55.09		577.59
Traveling expenses, Sweeney	1,997.50		2,034.69
Traveling expenses, Smith	94.15
Traveling expenses, Montgomery	39.74
Traveling expenses, Spencer	535.90
Office supplies	762.31		384.28
Printing and stationery	1,540.38		401.86
Rent	1,800.00		2,200.00
Telephone	425.76		522.04
Telegraph	66.81		36.84
Magazine subscriptions	11.50		7.00
Depreciation on furniture and fixtures	287.07		684.21
Insurance	2,623.85		17.87
Taxes	120.65		591.12
General expenses	1,925.73		1,698.67
Postage	214.73		179.11
Total expense		$65,222.12		$48,158.30
Total gain		34,731.41		28,468.71

 

INCOME
Commissions on space	$96,331.39		$62,759.68
Commissions on material	1,895.08
Commissions on art, cuts, etc			3,171.70
Paper sales	20.55		3.74
Interest on United States certificates	608.70		1,447.83
Interest on Liberty bonds			424.33
Interest on bank balance	198.52		371.61
Interest on checks			.54
Interest	352.03
Discount	547.26		153.16
Service charges			7,931.91
Commissions earned in advertising			362.51
Total income		$99,953.53		$76,627.01

All responsible work, such as interviewing clients and making decisions as to advertising, was done by Sweeney or James. During the years 1920 and 1921, petitioner employed in all some twelve or thirteen persons. In 1920 there were only five employees part of the time and the number never exceeded eight at any time. Throughout 1921, there were six employees who were engaged in stenographic, clerical or other detail work only.

When the corporation was organized $30,000 in cash was invested therein, but within a few days after starting it was found that this money was not being used and it was invested in United States Treasury certificates. It remained so invested until the Treasury certificates were called and it was then transferred into either certificates or bonds. Capital used in the business was expended only for items necessary to the conduct of the business of an advertising agency.

The following is a list of clients of petitioner for the year 1920 and 1921 and billing for each:

	1920	1921
Jordan Motor Car Co. (Inc.)	$594,341.43	$275,154.97
Sunbeam Chemical Co	102,663.77
Burdette Murray Co	942.90	572.24
Forbes Chocolate Co	267.56
Sterling Motor Co	21.56	1,149.92
Brown Hoist Machinery Co		8,994.30
Cleveland Garment Manufacturers' Association		13,572.03
Ferry Cap & Set Screw Co		8,400.21
General Fireproofing Co		13,026.29
Mason Tire & Rubber Co		94,979.28
Plain Dealer Publishing Co		39,337.77
Perfection Heater & Manufacturing Co		25,416.20
W. J. Bailey Co		$88.00
Simplex Products Co		2,911.09
Corday & Gross Co		103.60
Elyria Steel Co		51.80
Van Sicklen Speedometer Co		36.27
Detroit Gear Co		51.80
Michigan Stamping Co		50.32
Crouse-Tremaine Co		55.00
The Glessner Co		152.67
Owen Tire & Rubber Co	3,651.92
Davis & Farley Co		922.71
The Jordan Ohio Co		183.15
H. B. Snyder		.99
	$698,237.31	488,862.53

The principal client of the petitioner in 1920 and 1921 was the Jordan Motor Car Co. This company hired the petitioner because of the knowledge of advertising possessed by Sweeney and James and its confidence in them as individuals, and petitioner was allowed to handle all the advertising of this concern.

OPINION.

SIEFKIN: The question arising in this case is whether the petitioner was a personal service corporation in 1920 and 1921. Petitioner contends that if it was not a personal service corporation, a deficiency in tax should have been calculated for the year 1920 under sections 327 and 328 of the Revenue Act of 1918 instead of under section 302 of the said Act. The sections of the Revenue Acts of 1918 and 1921 pertinent to the case are 200, 231(14), 218(e), and 304(a).

The evidence in the case discloses that in 1920 and 1921 John F. Sweeney and Frank G. James, who did all the responsible work, owned all of the stock in the corporation except three shares which were issued to qualify a sufficient number of directors. Capital in the amount of $30,000 was invested in the business at its inception, but this was later invested in certificates and bonds. The capital used in the business was spent for office equipment, help, and in other ways incidental to the conduct of the business. The petitioner acted as advertising agent for its clients, reserving space in publications for advertisements in the name of the client and in other similar ways attended to the advertising of its clients' products. Bills for advertising were rendered to petitioner for the clients and petitioner paid such bills after receiving payment from the clients of the amount the publisher or other concern charged. Petitioner's income was derived from the commissions allowed by publishers and other concerns who rendered service to petitioner's clients. The principal client of petitioner, the Jordan Motor Co., did business with the petitioner because of the qualifications of James and Sweeney, and its confidence in them as individuals.

The net profits were $34,731.41 for 1920, and $28,468.71 for 1921, which were derived almost entirely from commissions on advertising. Most of the capital paid in was found to be unnecessary in the business and was invested in certificates and bonds. We, therefore, find that capital was not a material income-producing factor in petitioner's business.

The facts in this case closely parallel those in . In that case the plaintiff was a general advertising agency. Services rendered consisted in counseling and advising clients in connection with advertising their services and products. Such counsel was given only after diligent and thorough study of the production and services its clients have to sell. The study was directed to an investigation of the market, an analysis of all factors of distribution, a survey of all advertising media, and costs of such advertising, a retainer fee was usually agreed upon in advance, some of the principal stockholders of the plaintiff were employed elsewhere, but gave their services to the plaintiff. The plaintiff had capital stock outstanding of the value of $115,000 in 1919, but did not need and did not actually use in its business more than a third of this amount. Its earnings from personal services rendered account for 99.24 per cent of its total income and only .76 per cent is attributable to invested capital and other sources. Nor did the plaintiff buy and sell or otherwise trade in advertising space. The discount allowed by the publisher to the advertising agent, and the discount for cash payment made up substantially the plaintiff's entire income. In practice the plaintiff arranged its due dates with its clients in time to get in their money before the publisher's bills had to be paid. In only one instance during the period in question did any of the plaintiff's clients fail to pay on time. The plaintiff's business success was not due to the presence of capital or to its financial rating, but to its standing in the advertising world on which its business success was based due to the prestige of Smith and other principal stockholders. The plaintiff had many employees and small stockholders to whom were paid large salaries, but all but one of them were engaged in purely clerical or minor duties.

The court said:

The question is, I think, not one of exemption from taxation, or even of exemption from the general provisions of law otherwise applicable, but is, within which set of taxing provisions a taxpayer falls.

It was held in the case cited that the principal stockholders were regularly engaged in the conduct of its affairs of the corporation; that the plaintiff's capital was not a material income-producing factor; that the plaintiff's income was to be ascribed primarily to the activities of its principal owners or stockholders, and that, therefore, the corporation was entitled to be classified as a personal service corporation.

We have also held to the same effect in . In that case the petitioner was a corporation engaged in the advertising business. Conover held practically all the stock although 60 shares were issued to others and all the stockholders were actively engaged in the business. The only employee of the company was a stenographer-bookkeeper. Its business was obtained mainly because of Conover's familiarity with the advertising business. Petitioner made studies of the market, salability and other factors in the sale of the product of its clients and made recommendations as to the best method to employ. A service fee of $100 per month was charged and 15 per cent of the gross charges which were billed to the client. Petitioner paid the publishers and others rendering services for the clients usually after clients had paid petitioner but frequently payment was made by petitioner before clients paid. Petitioner paid an average of $5,000 per month to publishers prior to payment to petitioner by client. Other expenses incurred and paid on behalf of clients would increase the above figure considerably.

In holding the Conover Company to be a personal service corporation, we said:

The only thing that the corporation had to sell was the service and advice of its stockholders and under the circumstances there can be no doubt that the income is to be ascribed primarily to their activities. * * * It is not sufficient to defeat personal service classification that capital be used in the business or that capital be incidental to the production of the income.

In , on facts substantially the same as in the case at bar, the corporation was held to be a personal service corporation. See also .

In view of the facts sets forth above, we must find that the petitioner is a personal service corporation within the meaning of the Revenue Acts of 1918 and 1921.

Reviewed by the Board.

Judgment will be entered for the petitioner.