William E. Peck & Co. v. Commissioner

WILLIAM E. PECK & CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

William E. Peck & Co. v. Commissioner

Docket No. 15825.

United States Board of Tax Appeals

17 B.T.A. 898; 1929 BTA LEXIS 2218;

October 14, 1929, Promulgated

---

Personal service classification denied.

Donald Horne, Esq., for petitioner.

James O'Callaghan, Esq., for the respondent.

---

MURDOCK

The Commissioner determined a deficiency of $24,472.13 in the petitioner's income and profits tax for the calendar year 1919. The petitioner alleges as error the Commissioner's failure to classify it as a personal service corporation and also his failure to assess its profits tax under the provisions of sections 327 and 328 of the Revenue Act of 1918. On the latter question the hearing was limited to proof of abnormalities.

FINDINGS OF FACT.

The petitioner was a West Virginina corporation which had its principal office in New York City. It was not a foreign corporation and it had no Government contracts during the year 1919. It owned all of the stock of the Consolidated Chemical Co.

The petitioner had a number of contracts to represent American manufacturers. A typical contract was as follows:

JAN. 24, 1919.

Mr. CHARLES SCHINDLER,

1401 West Delaware Ave., Toledo, Ohio.

- To -

Messrs. WILLIAM E. PPCK & CO.,

New York City.

DEAR SIRS, In consideration of your agreeing to push the sale of the YOYS manufactured by us, to the best of your ability and to the exclusion of any competing line, we hereby appoint you as our exclusive selling agents for the territory of BRITISH ISLES, CONTINENTAL EUROPE, AUSTRALIA, NEW ZEALAND, SOUTH AFRICA, BRAZIL AND THE ARGENTINE REPUBLIC both of us hereby pledging a hearty co-operation to the advancement of our mutual interests.

We will supply you free of charge with the necessary samples, advertising matter and electrotypes, enabling you to properly place our line before the Trade in the specified territory; all forwarding charges from New York, duties and every other selling expense to be borne by you.

We will refer to you for such action as you may deem best, all inquiries and orders coming to us directly from the territory above named, or pertaining to said territory when received through American Exporters or merchants; and it is agreed that no shipments or quotations shall be made to or for said territory except through you or with your consent.

We agree to execute all orders coming within the scope of this agreement with reasonable promptness, and goods furnished by us need not be examined by you, but are warranted by us to be of the same kind and quality as called for by you and represented by us, or as samples submitted by us to you.

For the services rendered by you (and entirely independent of our lowest export prices and best discounts, which we agree to give you), we will allow you a commission of 10% upon all goods shipped to said territory through whatever channel; and in the event of any advance in prices we will protect at the old price all orders which may have been taken by your foreign representatives previous to their having received notice of such advance, which notice you hereby agree to forward promptly on receipt.

This Agreement shall remain binding until December 31, 1919, with the understanding that it shall continue in force thereafter from year to year, unless notice of cancellation be given by either of us to the other three months previous to the expiration of this or any future calendar year.

Yours very truly,

(Signed) CHARLES SCHINDLER

Accepted as a contract

WILLIAM E. PECK & CO.

(Signed) WM. C. WULP

Secretary.

The petitioner had branch offices in London and in Buenos Aires and had a subsidiary company in Rio de Janeiro. It also had numerous representatives at other places in foreign contries and particularly in Australasia. Most of its representatives were selected by a stockholders.

In most instances the petitioner had written contracts with its subagents or representatives in foreign countries. The following is a typical contract of this kind:

AGREEMENT

This agreement entered into this eleventh day of November 1913 between

Wm. E. Peck & Co., Inc., of NEW YORK

and

G. M. & A. PETITJEAN of SANTIAGO,

witnesseth:

1 - Said Peck & Co. hereby appoint said Petitjean their sole agents for the territory of Chile and said Petitjean hereby accept said appointment and agree not to represent any other North American interests. However, business in electrical and other machinery and appliances, as supplied to electric light and power companies and nitrate works, are hereby excepted from present agreement.

2 - Said Petitjean pledge their best efforts to the development of the business contemplated by both parties, consisting in the sale of American goods of every description, and said Peck & Co. pledge their full support of the same end. It is further understood that said agents will endeavour to secure buying accounts of large importing firms and pay special attention to the sale of such lines of goods which said Peck & Co. control for this territory and, for the purpose of enabling said Peck & Co. to obtain other agencies, said Petitjean will, in the course of their work, recommend such other lines of goods as they may consider suitable for these markets.

3 - All orders shall be taken by said Petitjean subject to draft terms, i.e. said Peck & Co. shall draw directly on the customers through a bank at sight, 30, 60 or 90 days sight, shipping documents attached to drafts and to be delivered against payment or acceptance, as the case may be. A buying commission is to be charged in all cases, except in lines on which a commission is paid by the manufacturers, when the charging of a buying commission shall be left to the judgment of said Petitjean. Interest is to be charged in every case, at the rate of 6% (six per cent) p.a., to cover the time from date of draft until receipt of funds in New York.

4 - It is understood and agreed that the delcredere on the business transacted shall be entirely for account of said Peck & Co., but said Petitjean agree to use extreme care and judgment in the granting of credits, and to forward confidential reports on all customers with the first transaction and also at any time, later on, as may be requested by said Peck & Co. In case of any difficulties in the collection of outstanding drafts, said Petitjean agree to use their best efforts to fully protect the interests of said Peck & Co., as they would their own. The orders booked by said Petitjean are subject to the approval of said Peck & Co., who agree, however, to give their reason in case of refusal to execute.

5 - Samples without value and all catalogues required for the proper conduct of the business shall be supplied by said Peck & Co. free of charge. All samples of value shall be invoiced to said Petitjean at lowest export prices, with such additional sample allowances as said Peck & Co. may be able to obtain from the manufacturers without remuneration to said Peck & Co., the final disposal of such samples, after proper use, being entirely for account of said Petitjean. Samples of value shall be charged to in a special samples account and shall be transferred to current account twelve months after date of respective invoices. No samples of value will be sent without agreement of said Petitjean.

6 - It is hereby agreed that, as their remuneration, said Petitjean shall receive one third of the profit of each transaction when said profit does not exceed a total of five per cent and when the total profit on any one transaction shall exceed five per cent, said Petitjean shall receive one third of the profit up to five per cent and half of any profit in excess of 5% (five per cent). All discounts including those for cash payment, special rebates, premiums given by certain manufacturers at end of the year and the primage reimbursed by the steamships Companies will be taken in account in the calculation of the profits. It is also agreed that said Petitjean shall not be entitled to any remuneration on any business the liquidation of which will show no profit. All travelling expenses are to be borne by Messrs. Petitjean, all cable charges by said Peck & Co. unless paid by customers. The cables will only be made use of when necessary and will be drawn up with the code Lieber.

7 - On or about January 1st and July 1st of each year, said Peck & Co. shall prepare and forward to said Petitjean a statement of the profits earned by said Petitjean, on all shipments made during the previous period of six months, a sight draft for balance to their credit at the time of making up the statement to be sent to Credit Lyonnais, Boulevard des Italiens, Paris, for their account.

8 - It is hereby agreed that the present agreement shall remain in full force and effect from its date until December 31, 1914, and that it shall continue thereafter from year to year, unless notice of cancellation, to take effect six months later, be given by either party to the other on the 31st day of December 1914, or on the same date of any succeeding year.

9 - Said Peck & Co. agree to send regularly to said Petitjean all duplicates of invoices and correspondence with customers.

(Signed) WM. E. PECK & CO.,

WM. C. WULP, Secretary.

[Name illegible]

(SEAL)

After the petitioner had made a contract with a manufacturer to represent it in a foreign market, the petitioner would submit to that market, through its foreign representatives, samples, prices and all particulars of the manufacturer's goods. Thereafter, the petitioner's representatives would usually sell the manufacturer's goods to the trade in his territory and would usually send orders to the petitioner for execution, although in some instances he might sell goods from stock which he had on hand. Upon receipt of an order from one of its foreign representatives, the petitioner would place the order with the manufacturer. The petitioner made itself responsible to the manufacturer for the order. When the goods were ready for shipment they would be sent to an American port where the petitioner, without opening the goods, would load them on a steamer, take out ocean bill of lading, insurance certificate and all other necessary shipping documents, which it sent to its bank in New York with a draft on the customer for the amount of the order, and ship the goods to its customer in the foreign country. The draft usually included freight, insurance and the cost of negotiating the draft. The bank would discount the draft. Thereupon, the petitioner, from the proceeds of the draft, would pay the manufacturer after first deducting its commission. In some instances the petitioner paid the manufacturer for goods before it discounted the draft. These drafts were usually payable 30, 60 or 90 days after sight. In case a draft was not honored by a customer, the bank which had discounted the draft called upon the petitioner to return the amount advanced.

In some instances those who represented the petitioner in foreign countries purchased goods from the petitioner to be carried in stock in the foreign country.

The petitioner also received orders from foreign buyers for goods of American manufacturers with whom the petitioner did not have any contract. In such cases the petitioner added its commission to the manufacturer's price and collected the same from the buyer.

In case a purchaser refused to receive goods, the petitioner's representative in the foreign country would take over the goods and sell them for the petitioner. Sometimes the petitioner rented warehouse space at New York and elsewhere in which to store goods which it could not ship or dispose of immediately.

The petitioner had from eight to twelve employes at Buenos Aires and about the same number at Rio de Janeiro and at London. At Buenos Aires the petitioner had a manager, a bookkeeper, two stenographers, an office boy, a reporter and several salesmen. It leased office space and warehouse space.

The following table shows the names of the various stockholders and the number of shares of preferred and common stock held by each on the first and last days of the year 1919:

	Preferred		Common
Stockholders	Jan. 1, 1919	Dec. 31, 1919	Jan. 1, 1919	Dec. 31, 1919
Bertha T. Peck	5	5	225	215
William E. Peck	10	10	150	150
Elena M. Peck	5	5	15	25
H. R. Hillard	135	135	120	125
Sarah F. Wing	25	25
Adeline F. Wing	20	20
Ethel T. Sullivan	2	2
Caroline R. Wing	20	20
Wilson D. Wing	150	150	60	60
Geo. D. Harrison	50	50
Anna Drake		10
Noah Cornwell Rogers	40	40	10	10
Wm. C. Wulp	15	15	70	75
Emma G. Welch	150	150
F. L. Upjohn	108	108
Edward F. Peck	8	8
Arthur Groves	100	100
Mrs. M. J. Potter	3	3
J. F. Messinger	7	7
Emma Twinning	12	12
W. H. Woodward	20	20
Lillian S. Hillard	25	25
H. R. Hillard, trustee	5	5
Mrs. Ann Stevens Knight	20	20
Mercy Stevens Ingalls	50	50
J. K. Robinson	35	0
Mrs. S. A. K. Robinson	25	25
Edmund L. Dow	5	5
D. C. K. Robinson		18
Carmela R. Robinson		17
Leopold Buhler	50	50
Investment Trust Cassels	45	45
Byron A. Pierce	13	13
Ernest W. Pierce	6	6
Wm. Drake	10
Anita T. Van Lennep	60	60
H. J. S. Hall	30	30
Anne M. Upjohn	30	30
Carolyn P. Boardman	15	15
Wm. Boyd Hunter	10	10
Ernest P. Armstrong	5	10
Augusta M. Wulp	10	10
Mary A. Cushing	20	20
Anna P. Stevens	20	20
John J. Phelps	50	50
Anna N. Rogers	20	20
Florence M. Peterson	5	5
P. W. Gilbert	5		10
Minnie S. Pierce	10	10
Robert W. McNeal	20	20	10	10
Robert Upjohn Redpath	5
John Redpath	10	15
Lucy Madeira Wing	25	25
Morris B. Bogart			10	10
	1,524	1,524	680	680

William E. Peck was president of the petitioner and he was regularly engaged in the active conduct of its affairs.

W. D. Wing was vice president of the petitioner, but received no salary from the petitioner. He was interested in many other enterprises. He visited the petitioner's office occasionally. Peck sometimes consulted him in regard to the business of the petitioner.

H. R. Hillard was treasurer of the petitioner. He was regularly engaged in the active conduct of the affairs of the petitioner. He had no other business.

W. C. Wulp was secretary of the petitioner and general assistant to Peck. He was regularly engaged in the active conduct of the affairs of the petitioner.

N. C. Rogers had formerly been an employee of the petitioner, but during the taxable year he acted as its legal counsel and otherwise advised the officers of the petitioner.

Arthur Groves was head of the petitioner's London office. He was a director of the petitioner and was regularly engaged in the active conduct of its affairs. Groves and Buhler each held a power of attorney from the petitioner and acted in legal matters for it.

J. K. Robinson was the petitioner's representative in Chile and was regularly engaged in the active conduct of its affairs.

Leopold Buhler had full charge of the petitioner's affairs in Buenos Aires. He was regularly engaged in these affairs.

William Drake was the petitioner's cashier. He paid the employees, tendered the drafts and invoices, and was regularly engaged in these duties.

Ernest P. Armstrong was head of the Brazilian department. He was regularly engaged in the active conduct of its affairs.

Robert W. McNeal was the petitioner's accountant and was regularly engaged in the active conduct of its affairs.

Morris B. Bogart was head of the River Plate department. His office was in New York.

Carmela R. Robinson was the daughter of J. K. Robinson. Bertha T. Peck was the wife of William E. Peck. Elena M. Peck was the daughter of William E. Peck. Anna Drake was the sister of William Drake. Lillian S. Hillard was the wife of H. S. Hillard. Mrs. S. A. K. Robinson was the mother of J. K. Robinson. Augusta M. Wulp was the wife of William C. Wulp.

George D. Harrison was not employed by the petitioner and received no salary from it, but he frequently came to the petitioner's office and advised its officers in regard to insurance.

Upjohn had other business, but acted as a director of the petitioner and advised its officers.

In 1893 William E. Peck organized the petitioner to take over his individual business. At that time he received a check in the amount of $50,000 from the petitioner for his old business. He immediately purchased $50,000 par value of the petitioner's stock, one-half of which he gave to his wife. She still held this stock in the taxable year.

The petitioner filed an original return for the year 1919 and later filed an amended return for the year 1919. Attached to these returns were balance sheets which for the beginning of the year 1919 were respectively as follows:

	Original	Amended
ASSETS
Cash	$9,942.75	$9,942.75
Accounts receivable	831,115.26	831,115.26
Drafts for collection	30,977.48	30,977.48
Finished products	791,350.79	2,197,895.86
Investments:
3 1/2 per cent, first Liberty	5,300.00	5,300.00
4 per cent, second Liberty	18,500.00	18,500.00
4 1/4 per cent, third Liberty	10,252.48	10,252.48
4 1/4 per cent, fourth Liberty	8,700.00	8,700.00
Stocks of corporations:
Domestic	$20,350.00	$20,350.00
Bonds (other)	53,189.52	53,189.52
Rio de Janeiro branch	134,511.68	134,511.68
London branch	10,110.08	10,110.08
Buenos Aires branch	511,066.57	511,066.57
Australia branch	81,566.31	81,566.31
Furniture and fixtures	8,700.21	8,700.21
Good will	50,000.00	50,000.00
	2,575,633.13	3,982,178.20
LIABILITIES
Notes payable (others)	443,000.00	443,000.00
Accounts payable	1,144,981.75	1,144,981.75
Uncompleted contracts		1,476,709.76
Accrued expenses	13,325.21	13,325.21
Reserve for taxes	83,000.00	83,000.00
Capital stock:
Common	77,800.00	68,000.00
Preferred	152,400.00	162,200.00
Surplus	661,126.17	590,961.48
	2,575,633.13	3,982,178.20

The petitioner kept its books and made its returns on an accrual basis.

An order became an account receivable on the petitioner's books when an invoice was made up and posted from the book of original entry to the customer's account in the ledger. This was done when the shipment was made. When money was received from the bank on a draft the account was credited and closed.

The amount of merchandise or finished products shown on the balance sheet attached to the original return corresponds to the amount shown by the petitioner's books and represents goods ordered from the manufacturers but not invoiced to customers at the date of the balance. The difference of $1,476,709.76 between this amount and the amount shown on the balance sheet attached to the amended return represents goods afloat or undelivered appearing also as "Uncompleted Contracts."

Upon the receipt of an order from a customer, the petitioner made no book entry until it received a bill from the manufacturer, then it entered the amount of the bill, less discounts, in a book showing the date the petitioner expected to pay the bill. From this book the item was posted as a credit to accounts payable and a debit to purchases at the end of each month. Then, when goods were shipped, the customer's account was charged with the amount of the bill plus all charges, and when money was received on the draft, the customer's account was credited.

The item of "Rio de Janeiro Branch" consisted of:

Cash	$3,272.35
Accounts receivable	40,142.16
Furniture and fixtures	3,424.92
Merchandise	87,672.25

This branch had accounts payable of $94,105.13, which were included in the petitioner's accounts payable on the above balance sheet.

The item "Buenos Aires Branch" was made up of:

Cash	$27,675.85
Furniture and fixtures	1,659.15
Investments	78,944.64
Accounts receivable	204,654.57
Merchandise	198,134.58

It had accounts payable in the amount of $202,621.37, which were included in the accounts payable of the petitioner in the balance sheet.

The item "Australian Branch" consisted of two accounts with Ayers & James Proprietary, who represented the petitioner in Australasia. These were:

Account current	$76,125.41
Cons gnment account	5,440.90

The item "London Branch" consisted of:

Cash	$1,859.12
Accounts receivable	1,537.34
Merchandise	5,044.14
Furniture and fixtures	1,689.48

It had accounts payable in the amount of $850.86, which were included in the petitioner's accounts payable on the above balance sheet.

In the latter part of 1918 boats were scarce and the petitioner could not discount all of its drafts, so it borrowed money on its notes to make good its checks to the manufacturers.

Accounts payable represented mostly current merchandise received from manufacturers but not paid for at the date of the statement, and also freight, insurance, cartage, and the amount owed agents unpaid at the date of the statement. The petitioner's credit with the steamship companies was such that it did not have to pay freight in advance of the date it discounted its drafts for the merchandise shipped.

Of the common stock, $68,000 par value had been fully paid and the additional amount of common stock outstanding as shown on the balance sheet represented installments which had been paid on additional stock of the par value of $98,000.

Accounts receivable and inventory vary with the petitioner's current business and the date of sailing of steamships. The following table shows the amount of these items on three different dates during the year 1919:

	Jan. 1	July 1	Dec. 31
Accounts receivable	$831,065.26	$672,239.38	$339,210.23
Inventory	791,350.79	238,199.62	235,969.96

Cash and accounts payable on these three dates were as follows:

	Jan. 1	July 1	Dec. 31
Cash	$9,942.75	$1,406,956.52	$101,683.43
Accounts payable	840,204.39	690,305.35	517,554.31

The petitioner's earnings for the first six months were $226,669.64, after deducting reserves for bad debts and taxes of $68,399.78. For the last six months its earnings were $36,294.79, after deducting reserves of $26,772.31. For the taxable year the petitioner claimed a deduction for bad debts of $82,073.43.

Fifty per cent or more of the petitioner's gross income consisted either of gains, profits or income derived from trading as a principal.

The petitioner was not a personal service corporation.

OPINION.

MURDOCK: On October 16, 1928, the petitioner's motion, that the hearing in this case be limited in the first instance to the establishment of abnormalities and the trial of issues which do not involve sections 327 and 328 of the Revenue Act of 1918, was granted. It was then the duty of the petitioner, if it desired any further hearing on the question of special assessment, to offer at the hearing, in the first instance, satisfactory proof of abnormalities within the meaning of section 327(d) of the Revenue Act of 1918, which was the section, judging from its pleadings, under which it claimed it was entitled to special assessment.

The petitioner offered no proof and made no argument in support of its allegation that the Commissioner erred in failing to assess its profits tax under the provisions of sections 327 and 328 of the Revenue Act of 1918. We see nothing in the facts which would indicate that the Commissioner erred in this regard and we therefore affirm his action and deny the petitioner the right to any further hearing on this question.

The petitioner claims that it is a personal service corporation within the meaning of that term as set forth in section 200 of the Revenue Act of 1918. We must determine whether its 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 whether capital, either invested or borrowed, is a material income-producing factor, and also whether 50 per cent or more of its gross income consists of gains, profits, or income derived from trading as a principal. If our decision on any one of these points should be unfavorable to the petitioner, then our judgment on this point must be for the respondent. ; .

The petitioner's counsel and one of its witnesses were free to admit that in doing 11 or 12 per cent of its business, the petitioner traded as a principal, and that 7 1/2 per cent of its gross income was from this source, but they contended that this business resulted in a loss. It is immaterial on the "trading as a principal" question whether or not the business resulted in a loss, because gross income is the determining factor. The only witness who testified in regard to these percentages stated that where the petitioner bought goods before it had orders for them and subsequently sold those goods, it was trading as a principal, and where it had orders first and then bought the goods from a manufacturer for delivery to its customer, it was not trading as a principal but was only acting as an agent and collecting a commission for its services. We can not agree with this witness' classification, for in our opinion the petitioner in all of its business was selling its own goods and thus trading as a principal. It is true that it had contracts with manufacturers to represent those manufacturers in foreign markets, and in the two such contracts offered in evidence as typical examples, the petitioner is called a selling agent for the manufacturer and the contracts provide that the manufacturer pay the petitioner a so-called commission. However, these two typical contracts do not indicate whether or not the petitioner was to take title to the goods which it ordered. The testimony and other evidence is clear on this point and shows that the petitioner did take title to the goods, that it was responsible to the manufacturer for the goods, and that it paid the manufacturer for the goods before they reached their destination and before the purchaser had accepted the draft attached to the bill of lading. In case the purchaser refused to accept the goods, the manufacturer lost nothing, because in that case the petitioner, being responsible for the goods, and having paid the manufacturer, sold them on what it "called its "own account."

The petitioner has not shown that capital was not a material income-producing factor. It had a substantial amount of capital of its own, borrowed money on its notes, had a large amount of accounts payable and accounts receivable and also claimed that it had a substantial amount of bad debts each year. Furthermore, its credit must have been good with its New York bank; otherwise, the latter would not have discounted the drafts in the way it did. Its good credit seems to have been an important factor in its business and we do not know that this good credit was not due to the large amount of capital retained by the petitioner. All these things indicate that capital was used in the petitioner's business and that its use was important in the earning of income. Whether the petitioner might have successfully conducted its business in some other way we do not know, but in any event, having been shown the manner in which the petitioner carried on its business, we can not say from the evidence that capital was not a material income-producing factor. Cf. .

Only a few of those holding the petitioner's preferred stock were regularly engaged in the active conduct of the affairs of the corporation and these few held only a small part of the total amount of preferred stock outstanding. Of the holders of the common stock, only Peck, Hillard, Wulp, McNeal, and Bogart were regularly engaged in the active conduct of the affairs of the corporation, while four or five other persons holding at least 45 per cent of this class of stock were not so engaged. Cf. ; ; . We do not know exactly how many employees the petitioner had nor do we know how important they were as income-producing factors. One witness stated that the petitioner had probably several hundred salesmen in South America. We know that the petitioner had representatives at a number of the principal cities in Australasia and that it had additional employees in London and in a number of other places. The petitioner's business was the kind that ordinarily requires the use of salesmen and we know that the petitioner had salesmen. The petitioner does not meet the requirement of the statute that 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. Cf. .

Judgment will be entered for the respondent.