source: Caselaw Access Project

author: Phillips:

license: Public Domain

text:
    Appeal of Hedwall-Sundberg Co.
    Docket No. 459.
    Promulgated February 19, 1927.
    Corporation conducting business as general agents ior fire and hail insurance companies and performing a substantial portion of its functions through others than the principal stockholders, held, not to be entitled to personal service classification.

      W. Tale Smiley, Esq., Monte Affel, Esq., and Carl A. Heister-man, Esq., for the petitioner.

      J. Arthur Adams, Esq., for the Commissioner.
    The taxpayer appeals from the determination by the Commissioner of a deficiency of $9,794.63 in income tax for 1918. It alleges that error was committed in denying it classification as a personal service corporation.
    FINDINGS OF FACT.
    On January 1, 1914, Charles J. Hedwall and Harry A. Sundberg entered into an agreement of partnership to do business under the name and style of the Hedwall-Sundberg Co. The purpose of the partnership was the conduct of a general insurance agency in Minneapolis, Minn.
    At the time of the formation of the partnership, both Hedwall and Sundberg were experienced insurance men. They had been continuously engaged in the insurance business in Minnesota and adjacent States for twenty-six years and fifteen years, respectively, and knew the business and the territory intimately.
    On January 15, 1914, Hedwall and Sundberg signed a contract with Svea Fire & Life Insurance Co. to represent that company as its general agents for the State of Minnesota. This was superseded by a contract dated January 1, 1917, the material portions of which are as follows:
    This Agreement made and entered into this 1st day of January 1917, by and between the Svea Eire and Lute Insurance Company, Limited, of Goth-enburg, Sweden, party of the first part, and Charles J. Hedwall and Harry A. Sundberg, of Minneapolis, Minn., (doing business under the name of The Hedwall-Sundberg Company) party of the Second Part, Witnesseth :
    First:' — That in consideration of the fulfillment of the mutual agreements herein made, the party of the first part appoints the party of the second part its Generad Agents for the States of Minnesota, Wisconsin, Iowa, North Dakota, South Dakota and Kansas, with full power and authority to appoint and remove agents in said State, to accept service of process for the Svea Fire and Life Insurance Company, Limited, to adjust losses under the policies of said Company, to receive and acknowledge service of Proofs of Loss, to issue, countersign and cancel its policies and to receive and receipt for premiums thereon and generally to conduct the business of said Company in the territory above-mentioned in accordance with such instructions and directions as they may from time to time receive from the said Company.
    Second : — That the local agents in the said territory shall report their business to the said General Agents, and the party of the second part hereby agrees to forward promptly to the Home Office of the party of the first part, copies of reports of risks written and of endorsements made as may be received by them from the agents in said territory, also to promptly report all policies written in the office of the party of the second part and endorsements made on such policies by them; also to report promptly to the party of the first part all appointments, removals and changes of agents, and to furnish other information which said party of the first part may desire in connection with said business. The party of the first part reserves the right to reject and cancel any business sent in that is not entirely satisfactory to it.
    Third: — That the said party of the second part shall forward not later than the Fifteenth (15th) of each month a monthly report or statement of account for the preceding month, of all business done for the party of the first part by said party of the second part, as well as through all the authorized agents in the territory named, and shall forward to said party of the first part the balances shown by such statements within seventy-five (75) days after the close of the month for which said account was made up, and the said party of the second part does hereby agree to assume and does assume the responsibility to said party of the first part for the premiums written by them or by the agents in said territory. It is agreed that policies cancelled for non-payment of premiums are to be returned to the party of the first part as uncollectible within Ninety (90) days after the month in which they are issued. Otherwise the said party of the first part is to be credited with the earned premiums for the full period from the date of issue to the date of cancellation. It is understood that on all cancellations and reinsurance effected on business written under this Agreement there shall be returned to the said Company the same percentage of commission, inclusive of overriding commission, as was allowed on the original transactions.
    Fourth: — The said party of the second part shall forward to said party- of the first part a satisfactory Bond in the sum of Ten Thousand ($10,000) Dollars conditioned upon the satisfactory discharge of their indebtedness to the said party of the first part and the faithful performance of their obligations under this contract.

      Fifth :• — The party of tlie second part stall advise the party of the first part of all losses immediately after they have received advices of same, and the party of the second part is hereby authorized to provide for the adjustment of the losses, the losses when adjusted to be paid in the manner directed by the party of the first part. It is, however, understood and agreed that in event of differences arising in the adjustment of any .loss, or in ease of threatened litigation arising in connection with any claim, the party of the second part jvill immediately and fully communicate all the facts to the party of the first part, so that the party of the first part may have full information and advise the party of the second part of its wishes in the matter.
    Sixth : — Said party of the first part agrees to pay the party of the second part an overriding commission of Ten (10%) per cent, on the net premiums written, meaning thereby the gross premiums less return premiums and reinsurances placed through the said General Agents, or effected in the office of the party of the first part. The said commission of Ten (10%) per cent, shall be in full for all costs of the business to the party of the first part, excepting commissions paid to local agents, taxes, fees and licenses — both State and Municipal, adjustment expenses paid by the party of the second part to parties not connected with their office, (except such losses as in their judgment the Company’s interest will be best served by their personal adjustment), legal expenses in resisting losses, expressage and legal advertising, local board and fire patrol assessments, and the party of the first part further agrees to furnish, for the use of the agents in said territory, policy blanks, policy registers, daily reports, endorsement blanks and the usual and necessary agency supplies.
    Seventh: — It is understood and agreed that on the business ceded to the Treaty Company and to the Reinsurance Bureau the party of the second part shall only be allowed a commission of Twenty-five (25%) per’ cent, flat, inclusive of local agents commissions and overriding commissions.
    Eighth : — The said party of the first part further agrees to pay said party of the second part a further compensation of Ten (10%) per cent., on the net profits earned on the business transacted, the net profits to be determined by a calculation on the following basis: * * *.
    Ninth : — This contract may be terminated at any time by either party giving sixty (60) days’ notice in writing to the other, at the expiration of which time this Contract shall cease and terminate, and in case of either so doing neither shall have any claim upon the other for loss of prospective profits, commissions, or damage to business arising therefrom, and the duties of each party to the other shall continue in full force and effect until the termination of said sixty (60) days, unless otherwise mutually agreed.
    It Is Further Understood and Agreed that upon the termination of this Contract no charges shall be made by the said party of the second part for services in the settlement of their account or winding up the affairs of the business of the said party of the first part and said party of the second part.
    In Witness Whereof, the said Svea Fire and Life Insurance Company, Limited, of Gothenburg, Sweden, and Charles J. Hedwall and Harry A. Sundberg, of Minneapolis, Minn., (doing business as The Hedwall-Sundberg Company) have affixed their signatures to this Agreement the day and year first above written. •
    Svea Fire & Life Insurance Co., Ltd.
    (Signed) J. M. Wennstrom, Manager.

    The Hedwall-Sunbeeg Co., Genl. Agents.
    (Signed) Chas. J. Hedwall.
    (Signed) Harry A. Sundberg.
    Witness: George C. Hale.
    Witness: F. Harlin.

      In April, 1914, Hedwall and Sundberg formed the Hedwall-Sund-berg Co., a Minnesota corporation, the appellant before us. All the authorized stock was issued to Hedwall and Sundberg in the same proportion as their interests in the partnership, i. e., two-thirds to Hedwall and one-third to Sundberg.
    Subsequently, in the years prior to 1918, Hedwall and Sundberg signed other contracts with other insurance companies to represent such companies as general agents in Minnesota and adjacent States, the material portions of which are as follows :
    This Memorandum of Agreement, made and entered into this ninth day of December, A. D. 1915, by and between the Providence Washington Insurance Company, a corporation duly chartered by the General Assembly of the State of Rhode Island, and located and doing business in Providence in said State, hereinafter called the Company, and Charles J. Hedwall and Harry A. Sundberg, of Minneapolis, Minnesota, doing business as the Hedwall-Sund-berg Company, hereinafter called the General Agents.
    Witnesseth, That whereas the said Company is desirous of appointing the Hedwall-Sundberg Company, and hereby does appoint them, its General Agents for the management of its 1-Iail Insurance Business in the States of Minnesota, North Dakota, South Dakota, Nebraska, Montana, Kansas, Iowa, Colorado, Texas and Wyoming, in accordance with its Rules, Regulations and Instructions, and
    Whereas, said General Agents are desirous of accepting, and hereby do accept said position, subject to said Rules, Regulations and Instructions of the Company.
    Now, Therefore, in consideration of the premises, of the mutual covenants and agreements hereinafter contained, and of One Dollar paid by each party hereto to the other (the receipt whereof is hereby acknowledged), it is mutually agreed by and between the parties hereto, as follows, namely:
    First — Company’s Obligations. The said Company hereby agrees to provide all necessary Hail policy blanks and to pay for the printing of applications, loss notices, proofs of loss and other Company supplies necessary to the conduct of the Hail Insurance Business, and authorizes the said General Agents to have said printing done in Minneapolis, Minnesota, and to charge the bills therefor in their monthly accounts, furnishing proper vouchers therefor.
    It also agrees to pay all taxes, agency licenses and Insurance Department fees, postage at a rate of not exceeding four cents (40) per policy, express and Parcel Post charges incurred in shipping supplies to agents.
    It will also furnish drafts for the payment of all losses incurred under this contract, and it hereby authorizes the General Agents to issue drafts in payment of such losses upon the Home Office of the Company at Providence, R. I.
    It hereby agrees to allow the General Agents Thirty-Two and one-half per cent. (32%%) on the net premiums on the Hail business written through them; and in addition thereto it will pay a contingent commission of ten per cent. (10%) on the net profits of the business covered by this contract, which net profit shall be determined as follows:
    * # * # H* * ' *
    The term “ Net Premiums,” wherever used in this contract, means the gross premiums written by and through the General Agents, less all return premiums, rebates, and premiums paid or charged on reinsurance policies.

      Second — General Agents’ Duties. The General Agents hereby agree upon the foregoing terms to supervise the Hail business of the Company in the territory named after this date, and to devote their time, skill and energies thereto, and to establish agencies in said territory; to adjust, or cause to be adjusted, all losses that may occur, and to faithfully perform all other duties of General Agents under the direction of the Executive Officers of the Company, subject in all cases to such instructions as may be given to them from time to time; that they will compensate their local agents out of their commissions which the Company has hereinbefore agreed to pay them, and that they will pay for all necessary, special and adjusting work, in order that the business may be handled properly and the best results obtained; that they shall appoint the now duly authorized fire agents of the Company as their agents to accept applications for Hail insurance, with the proviso, however, that, should the General Agents desire to appoint additional agents for said purpose, they are authorized to do so.
    They agree to forward to the Home Office of the Company a weekly statement of all agents appointed and policies issued, showing policy numbers, names of assured, amount of liability, amount of premiums, locations of agency and of risk, and a similar record of all policies cancelled, returned and not taken.
    The said General Agents agree to be personally responsible to the Company for the payments of all premiums on policies issued by or through them, and to remit the balance due the Company as shown by their final account, made in accordance with the provisions of this contract each season not later than November 15th of each year, said final account to be forwarded on or before November 1st of each year.
    All other expenses connected with the business not specifically enumerated herein as chargeable to the Company, shall be borne by the General Agents ; but nothing herein shall render them liable for any losses incurred under the policies issued by them, or for any litigation expenses incurred in contesting losses, all of which are to be paid by the Company, but no such expenses of litigation are to be incurred without the approval of the Company.
    The General Agents agree to comply with all State Laws in conducting the business, so as not to render the Company liable for any penalty.
    They also agree to furnish original notice of loss attached to each proof of loss, together with advice of issuance of loss draft in payment of claim not later than the date on which the draft is issued.
    On the 15th day of each month they shall forward a statement to the Company showing the actual cash remittances received in payment of premiums during the preceding calendar month, and the proceeds of notes and certificates of deposit maturing and collected during the preceding month, and shall accompany same by a remittance of the net amount due the Company.
    Should the Company at any time request it, the General Agents agree to send to its Home Office any portion of or all certificates of deposit and notes received in payment of premiums for Hail insurance in their possession, properly endorsed to the Company, it being understood that said certificates of deposit and notes are at all times the property of the Company until the General Agents settle the balance due the Company at the end of each season, when they become the property of said General Agents.
    The General Agents agree to give the Company a fidelity bond in the sum of Ten Thousand Dollars ($10,000) guaranteeing the just and prompt payment of all moneys due to the Company upon any business done in said territory by the General Agents, in the usual form.

      This Agreement shall continue in force, from year to year, until cancelled by either party giving the other sixty (60) days’ written notice of its intention to discontinue same, but no such notice shall take effect until the end of any season and until all the obligations under the contract pertaining to said season have been fulfilled.
    In testimony whereoe, the said Company and Charles J. Hedwall and Harry A. Sundberg, the members of the firm of General Agents, have hereunto set their names, and caused their seals to be affixed, this tenth day of December, A. D. 1015.
    Providence Washington Insurance Company.
    (Signed) O. D. Dunlap,

      Vice President.

    Signed, Sealed and Delivered in presence of:
    (Signed) Chas. J. Hedwall.
    (Signed) Harry A. Sundberg.
    (Signed) L. N. Davis.
    This Agreement made by and between the Westchester Fire Insurance Company of New York on the one part, hereinafter referred to as the “ Company ”, and Charles J. Hedwall and Harry A. Sundberg, doing business as The Hedwall-Sundberg Company, of Minneapolis, Minn., on the other part, hereinafter called the “ General Agents ”.
    Witnesseth: That the Westchester Fire Insurance Company appoints and constitutes the Hedwall-Sundberg Company as its sole General Agents for the conduct of its Hail Insurance business in the States of Minnesota, North Dakota, South Dakota, Nebraska, Montana, Kansas, Oklahoma, Iowa, Colorado, Texas and Wyoming, with full power and authority to issue policies of Hail Insurance, and, as to this department only, to appoint and remove agents, to fix rates of premiums subject to the approval of the Company, to collect premiums, adjust losses, and, as General Agents, to act within said States as its representatives subject to the following conditions:
    1. The General Agents specifically assume all responsibility for full compliance with the laws of the various States in which they operate; and, for the faithful performance of their duties and the execution of this contract, agree to. furnish for the benefit of the Company a Fidelity Bond in a Surety Company satisfactory to the latter in the amount of $50,000.
    2. The General Agents agree that in appointing agents to accept applications for hail insurance, they will give preference to the duly authorized fire agents of the Company, to the end that the Hail Department may be conducted as a supporting adjunct to the Company’s fire insurance business and not to the detriment thereof. It is, however, understood and agreed that the General Agents shall, if they so desire, be permitted, and they are hereby authorized to appoint other and additional agents for hail business.
    3. The General Agents shall, during the hail writing season, forward to the office of the Western Department of the Company at Chicago, Ill., a weekly statement of all policies issued by them or by agents appointed by them, showing policy numbers, names of assureds, amount of liability, amount of premiums, location of agency, location of risk, and a similar record of all policies cancelled, returned and not taken.

      4. The General Agents shall be personally responsible to the Company for the payment of all premiums on policies issued by them or by their agents, and in consideration of the compensation hereinafter mentioned, to assume and pay all expenses of supervision and inspection, office rent, office salaries, advertising, and all oilier expenses connected with the operation of the General Agency, including special agents’ salaries and traveling expenses, and loss and adjustment expenses, except that no loss expenses for litigation are to he paid by the General Agents, and no such expenses of litigation are to be incurred by them except with the approval of the Company.
    5. The Company agrees to furnish policy blanks and to pay for the printing of applications, loss notices, proofs of loss, and other Company supplies necessary to the conduct of hail insurance, said printing to be left in the hands of the General Agents but proper vouchers for these expenses shall be furnished to the Company.
    6. The Company also agrees to pay for all taxes, agency licenses and Insurance Department fees, and postage, not to exceed 4†, per policy, and express and parcel post charges incidental to shipping supplies to agents.
    7. The Company agrees to furnish the General Agents with drafts for payment of all hail losses, and authorizes the General Agents to issue drafts in payment of losses upon its Western Department Office at Chicago, HI.
    8. The General Agents agree to forward the original notice of loss attached to proof of loss, together with advice of issuance of loss draft in payment of claim not later than the date on which the draft is issued.
    9. The General Agents shall forward to the Western Department Office of the Company at Chicago, Ill. on the 15th day of each month, a statement showing the actual cash remittances received in payment of premiums during the preceding calendar month and the proceeds of notes and certificates of deposits maturing and collected during the preceding calendar month, and shall at the same time remit to said Company the amount of such premiums and proceeds received, less commission as hereafter established and such other expenses incurred during the said month as are chargeable to the Company under this contract.
    10. The General Agents agree to forward at the request of the Company such certificates of deposit received in payment of premiums for hail insurance in their possession under the operations of this contract as are available and not necessary to further the production of business by the General Agents.
    11. A final account on which the contingent of the business of the current year is to be figured, shall bo rendered not later than November 1st of each year, and the final balance due the Company shall be paid not later than November 15th of each year.
    12. The Company shall make an allowance to the General Agents of Twentj'-seven and one-lialf Percent (27%%) commission on the net premiums on the business coming within the scope of this agreement, (i. e., gross premiums loss cancellations and returns, and less also all reinsurance effected), and a further allowance of Ten Percent (10%) contingent commission on the annual net profits which shall be calculated as follows:
    * * * * * * * *
    14. This agreement is made for one year from December 1st 1917 but in consideration of compliance with the terms thereof by both contracting parties, shall thereafter continue in force from year to year by mutual consent. It is especially provided, however, that this agreement may be terminated in its entirety as of December 1st, in any year or modified as to the territory included within its scope by either party upon notice in writing to the other party, provided such written notice is given on or before December 1st of the same year.

      15. This agreement supersedes and replaces all previous agreements or addenda between the contracting parties and relating to the subject hereof.
    Westchester Fire Insurance Company oe New York. By (Signed) Sigeried Schwarz, Manager.

    (Signed) Chas. J. Hedwall.
    (Signed) Harry A. Sundberg.
    Witnesses :
    (Signed) Edwin Werner.
    Julia Carlson.
    F. Harlin.
    GENERAL AGENCY AGREEMENT.

      Thib Agreement, made this - day of - A. 30. 1917, by and
    between the Columbian National Fire Insurance Company, of Detroit, Michigan, party of the first part, and Charles J. Hedwall and Harry A. Sundberg, doing business as The Hedwall-Sundberg Company, of Minneapolis, Minnesota, party of the second part.
    Witnesseth : that the said parties, in consideration of the mutual covenants and agreements hereinafter mentioned, hereby mutually agree with each other as follows:—
    That the said party of the first part does hereby appoint said party of the second part as representative, with the title of General Agent, for the purpose of appointing agents, collecting premiums, making inspections, attending to settlement of losses, if any, and performing such other duties as are usually required of a General Agent. This appointment being made on the following terms and conditions:—
    First: The territory allotted to the said The Hedwall-Sundberg Company is the States of Minnesota and Kansas, and such other States as may from time to time be allotted to them.
    Second : The compensation for such services as General Agent shall be as follows: Thirty (30%) percent commission upon the net premiums written by all the agents in the States of Minnesota and Kansas and other States, if any, covered by this contract (net premiums being the gross premiums written, less return premiums, rebates and premiums on re-insurance, if any, effected by the said The Hedwall-Sundberg Company, General Agent.)
    Third: In addition to the said Thirty (30%) per cent commission, a Contingent Commission of Ten (10%) percent to be determined as follows:
    $$$$$$ *
    Fourth : The first Contingent year shall date from the time this Agreement takes effect, viz: April First, 1917.
    Fifth : The party of the first part to pay all adjustment expenses, state and other taxes, if any, a fire insurance company is subject to in the territory mentioned; postage, agents’ licenses, furnish all agency supplies and such advertising matter as shall be determined by said party of the first part. Also rating bureau and patrol expense.
    Sixth: The party of the second part shall fix and pay commissions to all agents licensed and commissioned by said party of the first part in territory covered by this contract.
    Seventh : All agents of record to mail Daily Reports of policies written or binders issued, direct to the party of the second part at Minneapolis, Minnesota, who will make copy of same for their record, forwarding the original Daily Report or binder (as issued by agent) promptly to the party of the first part at Detroit, Michigan, with notation as to acceptance or declination.
    Also monthly accounts current, endorsements and cancellations to be mailed direct to party of the second part, who after making copy or record, will promptly forward to party of the first part.
    Eighth: The party of the first part reserves the right to accept or cancel any risks so reported.
    Cancellations, if any, by the party of the first part to be made through the party of the second part, who hereby agrees to use due diligence in securing prompt return of such cancelled policies.
    Ninth : All losses sustained shall be paid by draft from the office of the party of the second part. Such loss drafts having been preceded by a satisfactory proof of loss and notice to said party of the first part of the making of such drafts.
    Tenth: Monthly accounts current to be rendered promptly at the close of each month’s business, and remittances to be made in payment of same to the party of the first part within Seventy-five (75) days from the close of each month’s business.
    Eleventh : All re-insurance of Liability accepted by party of the first part to be determined and effected by said party of the first part. Except when party of second part may be specifically authorized to effect re-insurance, in which case the premium on such re-insurance will be treated in computing Contingent Commission as a return premium. Commission on re-insurance effected by the party of the second part to be Thirty (30%) percent.
    Twelfth : The party of the second part hereby guarantees the payment of all premiums upon policies issued by them or other agents in the States of Minnesota and Kansas, or other states covered by this contract, if any, and further agrees to furnish the party of the first part with a good and sufficient personal Bond in the sum of Ten Thousand ($10,000) Dollars, guaranteeing the faithful performance of each and every provision and stipulation of this Agreement, and the payment of all premiums on accounts due or to become due, and the satisfactory accounting for all property sent to the said party of the second part during the life of this Agreement.
    Thirteenth : This Agreement may be terminated at any time by either party giving Thirty (30) days notice of such intention. Such notice to be delivered either in person or by registered mail.
    Fourteenth : In case the termination of this Agreement by either party before the completion of a year’s business, the above Contingent Commission shall become void and of no effect.
    In Witness Whereof, The parties to this Agreement have' hereunto subscribed the same.
    The Columbian National Fire Insurance Company.
    (Signed) H. P. Orr,

      Secretary-Treasurer.

    Detroit, Michigan.
    Dated: -, 1917.
    (Signed) Chas. J. Hedwall,
    (Signed) Harry A. Sundberg,

      Doing business as The Hedwall-Sundberg Oo.,

      General Agents.

    Dated: Apr. 1st, 1917.
    The contract with the Providence Washington Insurance Co. was modified on November 4, 1917, to reduce the allowance of 32% per cent on the net premiums on hail business to 2ly2 per cent and to increase the bond to $25,000. The contract with the Westchester Fire Insurance Co. of New York superseded and replaced a similar agreement dated October 7, 1915.
    All such contracts were signed by Hedwall and Sundberg, individually. Pursuant to the provisions of these contracts, fidelity bonds were secured and delivered by Hedwall and Siindberg to the insurance companies, guaranteeing the fidelity of Hedwall and Sund-berg, individually.
    None of the contracts entered into with insurance companies by Hedwall and Sundberg, individually, was ever assigned to the corporation. The corporation had no license to act as an insurance agent. The State of Minnesota did not issue such certificates to corporations. Licenses were issued by the proper state authorities to Hedwall and Sundberg, individually.
    Sundberg devoted all his time to the business of the. companies represented and Hedwall devoted the greater portion of his time to such business. The companies represented by them as general agents wrote fire, cyclone and tornado insurance, and hail insurance on growing crops. Neither Hedwall nor Sundberg, individually, nor the corporation, ever wrote any insurance policies. All policies were written by local agents of the companies.
    A part of the duties of the general agents was to secure local agents to write business. When Hedwall and Sundberg became general agents for the insurance companies, these companies had local agents. They continued as local agents of the insurance companies after Hedwall and Sundberg became general agents for the territory in which they operated. Pledwall and Sundberg recommended others to the insurance companies for appointment as local agents. Applications to the proper state authorities for the issuance of licenses to the local agents were made in the name of the insurance companies, who paid the requisite license fees. The insurance companies issued to the local agents certificates of authority which required the countersignature of the general agents. They also furnished all supplies to the local agents. Hedwall and Sundberg had no authority to revoke the licenses of local agents; such authority was vested exclusively in the insurance companies. Part of the territory within their jurisdiction was later taken away from Hedwall and Sundberg in 1917 or 1918, and the local agents in such territory continued as the agents of the insurance companies, making their reports direct to the companies and no longer reporting to Hedwall and Sundberg.
    The general agents had four principal duties. The first of these was to secure satisfactory local agents to write insurance in the companies they represented; the second was to pass upon the risk involved, either accepting or rejecting the insurance and securing reinsurance when deemed advisable; the third was to attend to collections from the local agents and the remittances to the insurance companies, and the fourth was to adjust hail losses. It was the duty of the local agent to forward each day to Hedwall and Sundberg a report of all policies written by him, giving the details of the insurance written and the property covered. It was the duty of Hedwall and Sundberg either to accept or reject the risk. In case of rejection, the local agent was notified by telegraph to cancel the policy, which notification was subsequently confirmed by letter. They accepted some risks and rejected others.' The decisions of the general agents on acceptance or rejection of risks are generally final, although occasionally they are reviewed by the insurance companies. In passing upon the risk for fire business they investigated the moral hazard and the financial responsibility of the assured, using avenues of information which it was their duty to open up and maintain. In passing upon the physical hazard they mapped the business, taking into account such factors as the area of the building, its construction, its occupancy, the exposure, the public fire protection provided by the municipality in which the building was located, other similar risks in the same territory, etc. In passing upon the risk in hail business, which is a very hazardous business and which furnishes about 80 per cent of their income, they passed upon the moral hazard and the financial responsibility of the assured, using avenues of information which it was their duty to open up and maintain. In passing upon the physical risk in the hail business they took into account the susceptibility to hail of the particular locality, the character of the crops to be insured, and other similar factors necessitating a wide experience in the business and an accurate knowledge of the territory. It was their duty to use their judgment and discretion to see that the risk as to all classes of business was properly diversified as to character and locality. It was also their duty, when the risk was acceptable but the amount of insurance written by the local agent was too large in a certain territory or on a certain building or crops, to secure reinsurance of all or a part of such risk, according to their judgment. Neither Hedwall nor Sundberg ever wrote any insurance or performed any of the duties of the local agents.
    In considering the appointment of general agents, the insurance companies consider the personal abilities, integrity and knowledge of the prospects. They make no requirement as to the financial standing of such an agent. They require satisfactory bond for the faithful performance of the duties of the agents, including remittance to the company of all premiums collected.
    The premiums paid to local agents of different insurance companies are in all cases the same. It was the duty of the general agents to call upon the local agents for the purpose of retaining their good will and endeavoring to influence these agents to write policies in the companies which the general agents represented. Both Hed-wall and Sundberg were known to many of the local agents and during the taxable year a portion of this duty was performed by Hedwall and Sundberg. There were also employed several men, known as special agents, whose duty it was to call upon the local agents for this purpose and also to instruct them as to the correct methods of completing applications and the correct forms of remittance. Only one such agent gave all of his time to the work and the rest worked only a portion of each year. In some instances these special agents were sent to interview prospective local agents.
    In addition to making daily reports of the insurance written, it was the duty of the local agents at the end of each month to prepare and forward an account current, which showed, among other things, the amount to be remitted by the local agent after deducting his commissions. The local agents were required to make remittances within forty-five days after the end of each month for the insurance written during such month. At the end of each month it was the duty of the general agents to prepare and forward to the insurance companies a similar account current, showing the business written in the territory by all of the local agents. The general agents were allowed seventy-five days within which to remit the net premiums to the insurance company. In the case of applications for hail insurance, however, the apx>lication for insurance was required to be accompanied by a remittance of the premium, which remittance might take either of three forms: (1) check or draft for the premium, (2) notes signed by the assured and endorsed by the local agent, which were made payable to the insurance company, or (3) bank certificates of deposit. In the case of payment by note or certificate of deposit, the payment was retained by the general agent until the due date, generally October 1 of each year, when they would be collected by the general agent and remitted to the insurance companies.
    Remittances were due from the local agents, as set out above, thirty days prior to the date when remittances were required to be made to the insurance companies. Because of this the general agents usually had on hand during the taxable year from $8,000 to $10,000 per month of fire insurance premiums received from the local agents but not yet remitted to the insurance companies, and during eight or nine months of the year from $50,000 to $100,000 of such premiums upon hail insurance received but not yet remitted.
    The premiums upon hail insurance were required to be remitted with the application for insurance. In the case of fire insurance, if payment was not made within from forty-five to seventy-five days after the close of the month in which the insurance was written, it was customary to cancel tlie policy. In such circumstances, if the premium could not be collected, the facts were reported to the insurance company which usually allowed a cancellation of the policy with full credit to the local and general agents of the premium.
    The business was started in 1914 without capital and no capital was ever contributed to the business by anyone. It was the policy to distribute all the earnings at the end of each year.
    During the taxable year the Charles J. Hedwall Co., a corporation in which Hedwall owned practically all of the stock, was indebted to the taxpayer in sums ranging from $40,000 at the beginning of the year to $72,000 at the close of the year. Hedwall was at all times indebted to the Charles J. Hedwall Co. for sums in excess of the indebtedness of that company to the taxpayer. To make such loans, the taxpayer borrowed money at its bank, ranging from $33,000 at the beginning of the year to $48,000 at the close of the year. These loans were evidenced by promissory notes of the taxpayer endorsed by Hedwall and secured by collateral furnished by him. Hedwall was a director in the bank and for that reason was unable to borrow money in person, and the arrangement outlined above was primarily for the purpose of permitting Hedwall to secure money for investment in various real estate projects.
    The gross premiums during 1918 payable by the several assureds amounted to $1,063,922.54. The gross commissions paid by the hail insurance companies were $239,303.99, and the commissions paid by the fire insurance companies were $55,054.37. The total gross commissions paid for insurance were $294,358.54, of which $166,751.99 was the amount payable to local agents and $127,606.35 was retained and reported by the taxpayer.
    The expenses of the year were as follows:
    Office salaries-$11, 385.29
    Field salaries_ 6,193.46
    Office expense_ 3, 027.07
    Field expense- 29, 414. 52
    General expense- 4, 691. 98
    Hail adjustment expense_ 19, 509.71
    Total_ 74, 222. 03
    The office salaries represent payments to clerical employees, including bookkeepers and an auditor. The item of field salaries represents the amount paid to the special agents referred to above. The item of field expense represents the expenses of such special agents and expenses of the officers of the corporation while traveling. The item of hail adjustment expense represents the cost of 2,787 adjustments of claims for loss under hail insurance policies at $7 each. During the taxable year all such losses were adjusted by the Western Adjustment & Inspection Co. upon the basis of a flat rate of $7 for each claim so adjusted. Under the terms of the contracts this expense was borne by the general agents.
    During the taxable year the corporation had no income from any source other than as general agents. For the taxable year the corporation filed an income-tax return as a personal service corporation. The Commissioner denied the corporation classification as such and determined the deficiency in issue.
   OITNION.

Phillips:

Counsel for the taxpayer point out that the contracts appointing the general agents were with Hedwall and Sundberg individually, that there was no assignment thereof to the corporation, and that the corporation could not lawfully transact business as insurance agents. It is not clear whether it is the contention of counsel that because of this situation the corporation never had any income, or whether it is urged as showing that the income is to be attributed to these individuals.

It is not unusual for a corporation, for one reason or another, to enter into a contract in the name of one of its officers, employees or stockholders. Such is the case here. Although for some purposes the individuals were the general agents, the benefits of the contracts made in their names inured to the corporation, and the contracts were in fact performed through the corporation. All of the expenses of the business, including the salaries of the officers, were paid by the corporation. All of the profits went into its treasury. We can not doubt that, although the individuals still remained personally responsible, there had been such a transfer to the corporation of their interest in "these contracts and such an acceptance thereof that the corporation ivas also a party thereto and is liable for payment of taxes upon any gains arising therefrom so long as the corporation continues to perform these contracts as its own.

Section 200 of the Revenue Act of 1918, so far as here material, defines a personal service corporation as “a corporation whose 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 in which capital (whether invested or borrowed) is not a material income-producing factor.”

There was some contention that premiums were paid by the taxpayer to the insurance companies in advance of receipt of such payments from the local agent and that capital was a material income-producing factor for that reason. Although the oral testimony was to the effect that no payments were forwarded to the insurance company prior to remittance from the local agents, the Commissioner relied upon a material difference which existed between the accounts receivable and the accounts payable, as shown by trial balance sheets. It appears, however, that the commissions which taxpayer was entitled to receive were not segregated from these separate accounts until the close of each year, and that the difference between the accounts receivable and payable represents taxpayer’s commissions, to a considerable degree.

It appears that remittances were due from the local agents forty-five days after the close of each month, while taxpayer had seventy-five days in which to make its remittance to the insurance company. The testimony is to the effect that because of this interim period the taxpayer always had on hand from $8,000 to $10,000 which was due to the fire insurance companies, and for about nine months of each year had from $50,000 to $100,000 due to the hail insurance companies. Considering all of the testimony, we are satisfied that taxpayer was not required or accustomed to make payments of premiums to the insurance companies prior to receipt from the local agents.

In addition to collecting and remitting premiums from local agents, taxpayer performed three other principal functions in the conduct of its business. It secured agents and took steps to retain their business, it accepted or rejected the insurance risk and rein-sured whenever it seemed advisable so to do, and it adjusted losses. Each was an integral part in the transaction of the business, and each played its part in the production of the income. Only one of these functions was performed entirely by the stockholders. The adjustment of losses, certainly an important matter, appears to have been intrusted entirely to a company specializing in such matters. Relations with the local agents were maintained in part through the stockholders and in part through special agents in the employ of the taxpayer. In such circumstances as are disclosed by this record, after giving full credit for the important functions performed by the stockholders, their experience and standing in the business and the undisputed fact that the contracts as general agents were secured because of this experience and standing and were made with them as individuals, it nevertheless appears that the taxpayer has failed to establish the first requirement of a personal service corporation, namely, that the income shall be ascribed primarily to the activities of the principal stockholders.

Decision mil be entered for the Commissioner.

Tiros sell not participating.


author: Smith:

text:
    Fellows Medical Manufacturing Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 5592, 8980.
    Promulgated February 19, 1927.
    1. Slaares of stock authorized to be issued by a corporation on March 9, 1917, were not “ outstanding ” on March 3, 1917.
    2. In 1916 the petitioner acquired the assets of a Canadian corporation having a fair market value of $7,000,000 for $200,000 pax-value capital stock, with an understanding on the part of all concerned that additional shares would be issued to its stockholders as soon as the fair value of such assets had been determined and authority had been obtained for the issuance of them. Held,, that the $200,000 capital stock was issued “ at a nominal value ” within the meaning of section 325(b) of the Revenue Act of 1918.

      Paul F. Myers, Esq., for the petitioner.

      A. B. Ma/rrs, Esq., for the respondent.
    This proceeding is for the redetermination of deficiencies in income and profits tax for the calendar years 1918 and 1919 in the amounts of $144,611.19 and $90,457.94, respectively. Separate petitions were filed for each year. The cases were consolidated for the purpose of the hearing and decision. The issues are (1) whether capital stock of a par value of $10,000,000 was “ outstanding ” on March 3, 1917, within the meaning of section 326(a)(4) of the Revenue Act of 1918, and (2) in the event that it is held that capital stock of $10,000,000 was not “ outstanding ” on March 3,1917, whether the stock of the petitioner was issued at a “ nominal value ” within the meaning of section 325 (b) of the Revenue Act of 1918, and the par value of the stock for the purposes of section 326(a) (4) of the same Act should be deemed to be the fair market value of said stock on May 1,1916, the date of its issuance.
    FINDINGS OF FACT.
    1. The Fellows Medical Manufacturing Co., Ltd., (hereafter called the Canadian corporation), was incorporated in the year 1876, under the laws of the Dominion of Canada, with a capital stock of $100,000, consisting of 100 shares of a par value of $1,000 each. It was organized for the purpose of engaging in the business of manufacturing and selling “Fellows Compound Syrup of Hypophosphites,” a drug product, under a formula transferred to it which had been invented by James I. Fellows in about 1866. The Canadian corporation conducted the business from the year 1876 until May 1,1916, when it was succeeded by the petitioner corporation.
    2. In 1901 the Canadian corporation reduced the par value of its shares of stock from $1,000 to $100 each and increased the number of its shares from 100 to 1,000. In 1907 the par value of its shares was further reduced to $50 each and the number of shares was increased from 1,000 to 2,000. The par value was reduced only to facilitate the distribution of the stock among the heirs of owners who died.
    3. The business of the Canadian corporation in countries engaged in the European War fell off during the years 1914, 1915, and 1916. As about four-fifths of the stockholders were American citizens and the principal business of the corporation was in the United States, it was decided in 1916 to reincorporate under the laws of the United States. Accordingly, the stockholders of the Canadian corporation caused the petitioner to be incorporated under the laws of the State of New York on April 15, 1916, for the purpose of taking over all of the assets and continuing the business of the Canadian corporation. No intangible value was carried on the books of the Canadian corporation. It was recognized, however, by its stockholders and directors that the Canadian corporation possessed intangible assets of great value that were not capitalized and discussions had taken place among them as to such values. Frederick A. H. Anger, general manager and secretary-treasurer of the corporation, and Tracy H. Harris, a director and representative of one group of stockholders, had formed their opinions prior to 1916 that the intangible property had a value of approximately $10,000,000. The directors discussed tlie amount of capitalizátion of the new corporation and decided that, pending the determination of the actual value of the assets, the new corporation should be formed with the same number of shares, namely, 2,000, as the Canadian corporation had, except that the par value of each share should be $100 instead of $50. It was understood that later the stock would be increased to correspond with the value of the assets as then determined.
    4. The petitioner is a corporation organized and existing under and by virtue of the laws of the State of New York. It was organized, as above indicated, on April 15, 1916, with an authorized capital stock of $200,000, divided into 2,000 shares of $100 par value each. The first meeting of the incorporators and subscribers to the capital stock was held April 17, 1916. At this meeting the written offer by the Canadian corporation to transfer its assets to the American company in exchange for the capital stock of the latter was considered and accepted. This letter provided in part:
    It hereby offers to sell, assign, and convey to your Company by a good and sufficient bill of sale and warranty, the above-mentioned business, including all its right, title, and interest in and to the same and the good will thereof and the stock on hand at home and abroad, and in the process of manufacture, raw materials, tools, machines, trademarks, tradenames, brands, formulae, books, bills and accounts receivable, contracts and personal property of every name and description used in the conduct of said business and owned by the said corporation, and to accept in consideration and full payment for the said sale, transfer, and conveyance, two thousand (2,000) shares of the par value of $100. each of the capital stock of your company, being its entire issue, and also the assumption by your Company of its outstanding indebtedness.
    If this proposition is accepted, the said shares of stock are to be issued to the Stockholders of The Fellows Medical Manufacturing Company, Limited, of Canada, in proportion to the number of shares held by them in this Company.
    The resolution accepting the offer contained the following provision carrying forward the understanding that later stock would be issued to correspond to the value of the assets which were being exchanged for stock:
    Further Resolved, That in the judgment of the Incorporators of this Company, the said assets transferred by said Fellows Medical Manufacturing Company, Limited, and mentioned in the said bill of sale, being of much greater value than represented by the present capital stock this Company reserves the right to increase its capital stock from the present amount to the amount of the actual value of the said assets.
    5. On the same day, April 17, 1916, a meeting of the directors of the petitioner was held and the last above quoted resolution was contained in the resolution accepting the said offer.
    6. Pursuant to the offer on the part of the Canadian corporation and the acceptance on the part of the petitioner, there Avas transferred on May 1, 1916, to the petitioner by the Canadian corporation all of its assets, both tangible and intangible, and at the same time the petitioner, in exchange for such assets, issued 2,000 shares, its entire capital stock, to the stockholders of the Canadian corporation in proportion to their stock holdings in the Canadian corporation. The assets transferred to the petitionei; included tangible assets worth approximately $345,000. The remaining assets consisted of intangible property.
    7. Various discussions concerning the Avalué of the assets acquired by the petitioner were held by individual directors and stockholders of the corporation between May, 1916, and January, 1917. On January 18, 1917, the directors of the petitioner held a meeting at which they passed the following resolution:
    Further Resolved, that in the judgment of the Incorporators of this Company, the said assets transferred by said Fellows Medical Manufacturing Company, Limited, and mentioned in the said bill of sale, being of much greater value than represented by the present capital stock, this Company reserves the right to increase its capital stock from the present amount to the amount of the actual value of the said assets.
    Now be it Resolved, that in the judgment of the Board of Directors the actual value of the said assets of said Company did then and do now amount to the sum of $10,000,000; further
    Resolved, that the capital stock of this company be increased from $200,000, consisting of 2,000 shares of the par value of $100. each to $10,000,000, to consist of 100,000 shares of the par value of $100. each; further

      Resolved, that the above increase of 98,000 shares of stock (fully paid and non-assessable) be issued to stockholders of record at the close of business on February 23rd, 1917, in proportion to their holdings, being the amount of their share of the capital assets (represented by the said shares of stock) to which they were entitled when the said assets were transferred to the Company, in addition to the shares they now hold; further
    Resolved, that the total amount of assets transferred to the corporation when it was organized amounting in value to the sum of ,$10,000,000. represents assets accrued prior to March 1st, 1913; further
    Resolved, that the Treasurer of the Company be authorized to make the following entry in the books of the Company:—
    “ Surplus assets not heretofore capitalized, being cash value of secret formulae, goodwill, trade-mark, process of manufacture etc., acquired from Fellows Medical Manufacturing Co., Limited, $9,800,000.” further
    Resolved, that a Special Meeting of the Stockholders of this Company be held on the 23rd day of February, 1917, at 3 o’clock in the afternoon at the office of the Company, No. 26 Christopher Street, in the Borough of Manhattan, City of New York, far the purpose of voting on a proposition to increase its capital stock from $200,000, consisting of 2,000 shares of the par value of $100. each to $10,000,000. to consist of 100,000 shares of the par value of $100. each.
    The members of the board of directors represented about four-fifths of the stockholders of the corporation. ■
    8. On February 23, 1917, the stockholders of the petitioner held a special meeting for the purpose of passing upon said increase and the matter was discussed. All those present were ready to vote in favor of the increase but, at the request of one of the members representing an estate in Connecticut, the meeting was adjourned for two weeks until he could see his co-trustee in Connecticut. At this meeting more than a majority of the shares of the stock of the corporation were represented by proxies, which contained specific authorization to vote in favor of the increase of the capital stock to $10,000,000 par value. Later these proxies were turned over to the tellers of said meeting and counted.
    9. On March 9, 1917, the stockholders of the petitioner met again and approved an increase of its capital stock from the par value of $200,000 to the par value of $10,000,000 and said increase was then made pursuant to law.
    10. The shares of stock of the Canadian corporation and of the petitioner were owned by the members of about five different families. There were no sales of the stock of either corporation around the year 1916. The net earnings of the business gradually increased from 1876 to 1916, inclusive, with the exception of a small decline in the years 1914, 1915, and 1916, due to the difficulties of delivering orders to foreign countries engaged in the war. For the ten years prior to and including the year 1916 the net earnings ranged from $711,088 to $841,482.50, and the dividends paid during those years ranged from $715,000 to $840,000 per year.

      11. The product of the petitioner and of its predecessor, the Canadian corporation, namely, “ Fellows Compound Syrup of Hypophos-phites,” has never been advertised before the public but was only advertised in medical journals and was sold only to medical, nursing, and dental professions.
    12. The actual cash value of the assets acquired by the petitioner in exchange for its entire capital stock was $7,000,000, of which more than $6,500,000 was the value of intangibles, and the fair market value of the petitioner’s stock outstanding on March 3, 1917, was $7,000,000.
    13. In its income-tax returns for the years 1918 and 1919 the petitioner included in the statutory invested capital 25 per cent of $10,-000,000 for intangibles paid in for shares of stock. The Commissioner held that the petitioner was entitled to include in its statutory invested capital for intangibles 25 per cent of $200,000, the amount of stock that was actually issued and outstanding as a matter of record on March 3, 1917. The excess-profits tax liability for each year has been determined by the Commissioner under the provisions of section 328 of the Revenue Act of 1918, and the deficiencies are based upon such determinations.
   OPINION.

Smith:

The petitioner alleges error on the part of the Commissioner in determining deficiencies for the years 1918 and 1919 upon the ground (1) that the Commissioner erred in finding that the amount which may be included in the invested capital for the purpose of determining profits tax for the years 1918 and 1919, on account of intangible property transferred to the corporation at the time of its organization in 1916, is limited to 25 per cent of $200,000 par value of its capital stock, and that there may not be included in the invested capital on account of such intangible property any portion of the remaining capital stock of the corporation of a par value of $9,800,000; and (2) that the Commissioner erred in selecting as comparatives, in applying the provisions of sections 327 and 328 of the Revenue Act of 1918 for the purpose of determining profits tax liability, corporations which the petitioner believes are not truly representative of the situation of the petitioner and which the petitioner believes paid a higher rate of profits tax for the year 1918 than that paid by truly representative corporations.

The petitioner has adduced no evidence with respect to the second allegation of error in its petition and therefore it will not be further considered.

With respect to the first allegation of error the petitioner makes two'contentions, first, that $10,000,000 capital stock was outstanding on March 3, 1917, within the purview of section 326(a) (4) of th§ Revenue Act of 1918, and, second, that, if it should be held that only $200,000 was outstanding on that date, then the stock of the petitioner was issued at a “ nominal value ” within the meaning of subdivision (b) of section 325 of the Revenue Act of 1918, and that the par value of the stock for the purposes of section 326 (a) (4) of the taxing statute should be deemed to be the fair market value of said stock on May 1,1916, the date of its issuance.

Section 326(a) (4) of the Revenue Act of 1918 permits the inclusion in invested capital of:

Intangible property bona fide paid in for stock or shares prior to March 3, 1917, in an amount not exceeding (a) the actual cash value of such property at the time paid in, (b) the par value of the stock or shares issued therefor, or (c) in the aggregate 25 per centum of the par value of the total stock or shares of the corporation outstanding on March 3, 1917, whichever is lowest.

Under the agreed statement of facts filed by the parties to the proceeding, the stockholders voted for an increase in the capital stock from $200,000 to $10,000,000 on March 9,1917. A certificate evidencing the vote of the stockholders for an increase in capital stock was not filed with the Secretary of State of New York until after the meeting of the stockholders on March 9, 1917. The filing of such a certificate was a prerequisite to an increase of the capital stock; We can see no merit in the argument that shares of stock of the petitioner corporation were “outstanding” on March 3, 1917, in excess of the amount authorized by its charter on that date. In the opinion of the Board, the “ outstanding ” capital stock of the petitioner corporation on March 3, 1917, was the $200,000 capital stock issued in 1916, and no more.

On behalf of the petitioner it is argued that if it be held that stock of the corporation of the par value of $10,000,000 was not outstanding on March 3, 1917, but that stock of a par value of $200,000 only was. outstanding on that date, then the case comes within the provisions of section 325(b) of the Act and that the 25 per cent limitation on the inclusion of intangible values in invested capital should be applied to the fair market value of the stock at the time of its issuance on May 1, 1916.

Section 325(b) of the taxing act above referred to provides:

For the purposes of this title, the par value of stock or shares shall, in the ease of stock or shares issued at a nominal value or having no par value, be deemed to be the fair market value as of the date or dates of issue of such stock or shares.

This provision is new to the Revenue Act of 1918. It has no counterpart in the Revenue Acts of March 3, 1917, and October 3, 1917. Those Acts fail to state how the limitation upon the inclusion of intangibles in invested capital shall be computed in the case of a corporation with shares of stock having no par value. The defect of the Act of October 3, 1917, was attempted to be cured by a regulation of the Commissioner'. In article 58 of Regulations 41, it was provided:

Intangible property bona fide purchased prior to March 3, 1917, with stock having no par value may be included in invested capital at a value not exceeding the actual cash value of such intangible property at time of the purchase and in an amount not exceeding 20 per cent of the total shares of stock outstanding on March 3, 1917, measured by their value as at the date or dates of issue.

Section 325(b) of the Revenue Act of 1918 was undoubtedly intended to remedy the defects of the earlier law. In doing so it not only provided for the case of stock or shares having no par value, but also for the case of those issued “ at a nominal value.” This phrase appears never to have been judicially construed.

Section 209 of the Revenue Act of 1917 provides:

That in the case of a trade or business having no invested capital or not more than a nominal capital, there shall be levied * * * a tax equivalent to eight per centum of the net income of such trade or business * * *. (Italics ours.)

The term “ nominal capital ” contained in the above section was defined by tlTe Commissioner in his regulations as meaning, “ in general a small or negligible capital whose use in a particular trade or business is incidental.” (Article 74, Regulations 41.) A number of corporations claimed that they had “no invested capital, or not more than a nominal capital,” within the-meaning of section 209, and when their claims were denied by the Commissioner, they brought suit for the recovery of taxes alleged to have been illegally exacted. The courts held this section applicable to many corporations which had no invested capital or only a small invested capital. Porter v. Lederer, 267 Fed. 739; Cartier v. Doyle, 277 Fed. 150; R. H. Martin, Inc. v. Edwards, 293 Fed. 258; De Laski & Thropp Co. v. Iredell, 268 Fed. 377; Empire Fuel Co. v. Hayes, 295 Fed. 704. They denied the application of the section to a corporation which sold stock for cash, Alworth-Stephens Co. v. Lynch, 278 Fed. 959, and to one which issued stock for a secret process and machinery, Lincoln Chemical Co. v. Edwards, 272 Fed. 142; (C. C. A.) 289 Fed. 458. In the last named case the higher court said:

It must, be admitted that, if the corporation can show that on January 1, 1917, it had no “ invested capital,” * * * within the meaning of section 209, it was entitled to be assessed under that section. We think it clearly appears that at the time above mentioned the company had some invested capital, and therefore was not entitled to be assessed under the section referred to.

In all of the above decisions it is apparent that the term “ nominal capital ” was construed with reference to the language with which it was associated. The decisions are not particularly persuasive as to the meaning of the word “nominal,” contained in section 325(b) of the Revenue Act of 1918.

Much might be said in support of the proposition that by the phrase “ at a nominal value ” Congress intended to reach only those cases where stock or shares were issued at a nominal par value, as, for instance, where the shares were issued with the minimum par value allowed by statute, and that it was never the intention of Congress that stock issued with a par value of $100 per share should be regarded as having been issued “ at a nominal value.” It is to be noted, however, that Congress did not use the phrase “ at a nominal par value ” but “ at a nominal value.” It must be presumed that Congress used this language advisedly, and that if it had meant to cover only the case of shares of stock issued at a nominal par value it would have used language which would clearly have expressed that thought.

The term “ nominal ” is defined in Webster’s Dietionary as follows :

Existing in name only; not real or actual; merely named, stated, or given, without reference to actual conditions; — often with the implication that the thing named is so small, slight, or the like, in comparison to what might properly be expected, as scarcely to be entitled to the name; as, a nominal difference; a nominal price.

In our opinion stock or shares are issued “ at a nominal value ” when issued at an insignificant or negligible value, as compared with their true value. The term “ nominal ” is the opposite of “ substantial.” The question before us is whether the $200,000 par value of capital stock issued by the petitioner was an insignificant or negligible amount in comparison with the value of the assets acquired or with the true market value of the shares that were issued. We think that it was. All of the evidence goes to show that the incorporators were not concerned with issuing an amount of capital stock which at all corresponded with the value of the assets acquired. The Canadian corporation, the petitioner’s predecessor, had 2,000 shares of stock outstanding, and for convenience the petitioner corporation was organized with the same number of shares, although the par value of each share was double that of each share of the Canadian corporation. The value was, however, purely “ nominal.” This is shown by the fact that the incorporators expressly reserved the right to issue additional shares of stock as soon as it could be determined just what the fair value of the assets acquired was. In the light of the entire record we think that the stock was issued at a nominal value within the meaning of section 325(b) of the Revenue Act of 1918, and that the fair market value of the 2,000 shares of stock issued was $7,000,000.

Judgment will 5e entered on 15 days’ notice, under Bule 50.


author: ARttndell:

text:
    George E. Hamilton, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7140.
    Promulgated February 19, 1927.
    Under Title IX of the Revenue Act of 1918, the tax imposed on sales by manufacturers of automobiles and accessories is not deductible by individual purchasers of such products.

      John F. McCarron, Esq., and George E. Hamilton, Jr., Esq., for the petitioner.

      J. Harry Byrne, Esq., for the respondent.
    The Commissioner has determined additional income taxes for the years 1919, 1920, and 1921 in the amounts of $143.35, $714.90, and $1,048.97, respectively. So much of the deficiency as is in dispute arises /from the refusal of the Commissioner to permit the taxpayer to deduct the amount of certain excise taxes alleged to have been paid in connection with the purchase of automobiles in the years 1919 to 1921, inclusive.
    FINDINGS OF FACT.
    In the year 1919 petitioner purchased from the Loccfrnobile Company of America an automobile and paid as a part of the purchase price thereof $405, which was designated as “5% TJ. S. excise tax.” In 1920 petitioner purchased an automobile from the Chevrolet Motor Co., the receipt for the purchase showing a tax of $39.75 and containing a further notation “war excise tax paid by us.” The petitioner made a further purchase during the year 1920 of a chassis and commercial body for an automobile from Hill & Tibbitts, of Washington, D. C. The tax incident to the sale of the chassis amounted to $21.66 and the receipt contains a notation that the tax on the automobile body was $4.50. In 1921 the petitioner purchased an automobile from the Semmes Motor Co., of Washington, L>. C., and the receipted bill introduced in evidence carries a notation that the tax was $25.23. Petitioner made a further purchase during the year 1921 of an automobile from Stanley II. Horner, Washington, D. C. The receipted bill carries a notation that the tax amounted to $99.84. Homer paid the amount of $99.84 to the Buick Motor Co., the manufacturer of the automobile purchased by the petitioner, and the Buick Company in turn paid the amount of $99.84 to the collector of internal revenue.
    The petitioner deducted in his 1919 income-tax return the amount of $405, in his 1920 income-tax return the sums of $39.75 and $26.16 were deducted, and in his return for the year 1921 petitioner deducted the sums of $25.23 and $99.84.
   OPINION.

ARttndell:

Tlie evidence in this case was stipulated by the parties. It indicates that the excise tax was passed on to petitioner as a part of the purchase price of the car in the case of the Locomobile purchased by him in 1919 and in the case of the chassis purchased in 1920. It can not be determined that the excise taxes were passed on to the purchaser in the case of the other transactions, as this information is neither disclosed by the signed stipulation nor by the receipted bills attached thereto.

The matter of the deductibility by the purchasers of automobiles of the taxes imposed on the sale by manufacturers of automobiles and accessories was before us in the Appeal of R. C. Musser, 3 B. T. A. 498. In that appeal, which arose under the Revenue Act of 1921, we held that the war tax on automobiles sold by manufacturers is a tax imposed upon sales by manufacturers and is not an allowable deduction in computing the net income of the purchaser. The Revenue Act of 1918, which was in effect during the years 1919 and 1920, uses the identical language used in the 1921 Act, and the decision reached in the Musser case would be equally determinative of the deductibility of such tax under the earlier Act. We see no reason to depart from the conclusion reached by us in the Appeal of R. C. Musser.

Judgment will he entered for the Commissioner.


author: Lansdon:

text:
    Lassen Lumber & Box Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 3431.
    Promulgated February 19, 1927.
    1. Petitioner bad a ten-year contract for cutting timber on a Federal forest reserve. There was a substantial supply of privately owned logs and timber available. The contract with the Government contained a provision for extension should conditions warrant such a change in its condition. There was a large supply of Federal forest reserve timber available for the petitioner’s purposes on the usual terms for the sale of such timber to private operators. Held, that in these conditions the petitioner was not entitled to depreciate its plant assets with a normal useful life in excess of ten years on the basis of the ten-year term of the timber sale agreement with the Government.
    2. Basis of depreciation for plant assets determined from the evidence adduced at the hearing.

      Walter Slack, Esq., O. K., Gushing, Esq., and G. V. Rowe, G. P. A., for the petitioner.

      A. Gadder Mackay, Esq., for the respondent.

      This is a proceeding for the redetermination of deficiencies in income and profits taxes for the years 1919 and 1920, in the respective amounts of $10,881.68 and $29,525.93, which arise from a controversy over the proper basis for depreciating certain tangible assets, to ascertain the annual deductions for exhaustion, wear and tear to which the petitioner is entitled for the taxable years. All the issues raised in a supplementary petition were abandoned at the hearing. The whole amount in controversy is $40,407.61.
    FINDINGS OF FACT.
    The petitioner is a California corporation with its principal office at San Francisco. During the taxable years it was engaged in logging, in converting logs into lumber, in manufacturing boxes, and in the marketing of the various products resulting from its operations. Its manufacturing plant is located at Susanville, in the northeastern section of California, on the eastern slope of the Sierra Nevada Mountains.
    On May 13, 1918, the petitioner entered into a timber sale agreement with the Forest Service of the United States Department of Agriculture, whereby it agreed to purchase all the saw logs and lodge-pole pine' ties in 26,000 acres of the forest reserve of the Government of the United States in two tracts designated as the Norval Flat Logging Chance and the McCoy Logging Chance. The tracts so acquired were estimated in the agreement to include 233,200 thousand board feet of saw timber, and 35,000 lodge-pole pine railroad ties. This agreement contained many provisions, of which only the following are material to the issues to be determined:
    The cutting and removal of timber under this agreement shall begin not later than July 1, 1918, and unless extension of time is granted shall be completed not later than July 1, 1929. Unless such amounts are reduced in writing by the Forester at least 10,000,000 feet B. M. will be cut prior to July 1, 1919; at least 76,000,000 feét B. M. will be cut prior to July 1, 1922; at least 145,000,-000 feet B. M. will be cut prior to July 1, 1925; at least 213,000,000 feet B. M. prior to July 1, 1928, and the remainder of the timber during the remaining period.
    Hs % * * * Hi sH
    Saw mills, camps, buildings, roads, and other necessary structures will be located and operated subject to such regulation by the forest officer in charge as may be necessary for the protection of National Forest interests. Except as hereinafter provided, all improvements will be removed from National Forest lands within six months after the termination of this agreement, unless permits or easements are secured from the officer of the United States having jurisdiction and in accordance with Federal laws for their future occupancy and use. If not removed within such time or further occupancy and use under such permits or easements authorized, they will become the property of the United States.
    $$$$$$$
    (f) It is further agreed that the Secretary of Agriculture will, upon written application from the purchaser showing good and sufficient reasons therefor and specifically tRe existence of a serious emergency arising from changes in market conditions since the readjustment, at his option, when action of either character is necessary to relieve the purchaser from hardship, either—
    (1) Redetermine and establish the stumpage rates and designate a date when the rates as redetermined shall be effective, which date shall be within six months of the date of application; or
    (2) Grant an extension of time, within which the respective amounts of timber specified in Section 3 shall be removed, not to exceed the total period allowed for cutting all the timber.
    Included in the agreement were the rules, regulations, and restrictions under which the operations of the petitioner were to be conducted, and provisions that it should make, deliver, and maintain a bond in the amount of $40,000, to guarantee satisfactory compliance with all the terms and conditions of such agreement.
    Upon the execution of the timber sale agreement, the petitioner at once began the erection of buildings, the installation of all the necessary machinery and equipment and material for logging.and manufacturing and marketing lumber and boxes. In its income and profits-tax return for the year ended December 81, 1919, the petitioner, under “ Schedule A-18 Exhaustion, Wear and Tear,” included the following statement and deducted the depreciation thereon indicated from if§ gross income for such year:

      In its income and profits-tax return for the year ended December 31, 1920, the petitioner, under “ Schedule A-18 Exhaustion, Wear and Tear,” included the following statement, and deducted the depreciation thereon indicated from its gross income for such year:

    The total aggregate cost of all plant assets to December 31, 1918, the cost of additions to such assets during the year 1919, and the total aggregate cost at December 31,1919, were as follows:

    The total aggregate cost of all plant assets of the petitioner at December 31,1919, the cost of additions thereto during the year 1920, and the total aggregate cost at December 31, 1920, were as follows:

    Upon audit of the petitioner’s income and profits tax returns for the years 1919 and 1920, the Commissioner disallowed deductions from gross income for each of such years on account of depreciation in the respective amounts of $25,640.97 and $66,701.90, and added such amounts to the taxable income of the petitioner for the respective taxable years.
    The petitioner began the erection of its plant and the assembly of its logging and manufacturing equipment in the latter half of the year 1918, while the World War was still in progress. At that time, and for many months thereafter, it was very difficult, and, as to many necessary items, wholly impossible, to purchase new machinery and equipment. The plant assets acquired in 1918 and 1919 were largely secondhand, and, in many instances, were too light for economic use in logging and manufacturing the heavy timber owned by the petitioner. During the taxable years, all completed sections of the manufacturing plant were operated two shifts a day for eight and one-half months of each year. The water supply of the petitioner was impregnated with alkali, and the useful life of boilers, fire extinguishing equipment and water mains was thereby greatly reduced.
    The useful life of plant assets is as follows: 20 years — box factory, cottages, cabins, dormitories, water tank, hotel buildings, lath mill, machine shop, office building, pond construction, planing mill, warehouses and trackage spurs; 15 years — except in mill No. 1, machinery of all types, the buildings of mill No. 1 and mill No. 2, power plant and warehouse equipment; 10 years — camp construction, electrical installation, gas supply stand, hose house, office equipment and furniture, oil house, pond equipment, track equipment, water lines, garage, and stables; 7 years — hotel equipment and machinery and equipment of mill No. 1; 5 years — live stock and logging equipment; 4 years— automobiles, fire equipment, tent house; 2 years — Duck Lake Spur and discarded machinery.
   OPINION.

Lansdon:

The sole issue for consideration here is the correct deduction from gross income to which the petitioner is entitled in its income and profits-tax returns for each of the taxable years on account of exhaustion, wear and tear of tangible assets used in its business. In the computation of the amounts to be so deducted, the petitioner and the respondent differ — (1) as to the proper method of depreciating assets added by purchase during each of the years in question; (2) on the value and term of usefulness of plant assets that have a normal, useful life of less than ten years; and (3) on the method of computing depreciation of plant assets with a normal useful life in excess of ten years. The petitioner now admits that the average value of plant additions made during any given year, or one-half the total cost thereof for such year, is the proper basis for computing depreciation on annual additions to plant assets. This admission leaves only two phases of the controversy for our consideration.

The petitioner constructed its plant and assembled its logging equipment during and immediately subsequent to the World War. At the time it was difficult, and, as to many items, impossible to secure new machinery. Consequently, a large amount of secondhand equipment, much of it unsuitable for the heavy duty required by the nature of the timber to be logged and manufactured, was purchased and installed. Much of the equipment acquired in 1918 and 1919 had a useful life of less than ten years. We are also convinced by the evidence adduced by the petitioner that its lists of assets with a useful life of less than ten years and its computations of depreciation thereon, as reported in its income and profits-tax returns for the years 1918 and 1919, are substantially correct, and, on this point, we sustain the contention of the petitioner.

The most important question for our consideration is whether the plant assets owned by the petitioner during the taxable years should be depreciated for income and profits-tax purposes on the basis of their normal useful life or on that of their alleged economic usefulness which the petitioner contends is, by the terms of its timber sale agreement with the Department of Agriculture, limited to eleven years from July 1, 1918.

It appears from the evidence that the timber sale agreement contained a provision for extension of time for cutting the timber thereby acquired if conditions warranted such change; that there was a considerable supply of logs and timber privately owned that was available for the operations of the petitioner and that in the taxable years it purchased substantial quantities of such raw materials; that there was much privately owned timberland within a profitable operating radius of the petitioner’s plant; and that there were also large supplies of Government-owned timber within profitable operating distance of the plant, and that the petitioner was advised that such timber was available on the conditions imposed by the Department of Agriculture. The petitioner installed mills and equipment at a cost of more than one million dollars. It is fair to assume that men experienced in logging and manufacturing lumber must have believed that there was a reasonable prospect for securing timber during the normal life of a plant of such cost. To be entitled to recover the entire cost of its plant during the term of its contract with the Government, the petitioner must show that there was a practical certainty that it could not use its assets for the purposes of its business after the expiration of such contract. Appeal of Eimer & Amend, 2 B. T. A. 603. We are of the opinion that it has not sustained the burden of proof necessary to show that there would be no raw material available for its purpose at the termination of its original contract with the Government.

Having decided that the allowances for depreciation of its plant assets should not include obsolescence determined by the terms of the timber sale agreement, it follows that whatever allowances the petitioner is entitled to take on account of depreciation are matters of fact to be established by evidence. We have made a careful study of the testimony adduced at the hearing and we are of the opinion that the assets had a normal, useful life as set forth in our findings of fact.

Depreciation should be recomputed on the basis of our findings in conformity with this opinion.

Judgment will be entered on %0 days’ notice, under Rule 50.


author: KoRner, Chairman:

text:
    W. H. Combs, Sr., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 10182.
    Promulgated February 19, 1927.

      W. E. Combs, Sr., pro se.

      A. R. Marrs, Esq., for the respondent.
    Proceeding involving additional income tax liability for the calendar years 1920 and 1921, determined by the respondent in the amount of $1,910.23.
    FINDINGS OF FACT.
    Petitioner is an individual engaged in the undertaking business in Miami, Fla. On the birthday of one of his sons, on January 5, 1921, the petitioner presented the son with a one-sixth interest in the undertaking business. The gift was made as of January 1, 1921. In giving this interest to his son the petitioner retained and reserved to himself all accounts receivable as of December 31, 1920.
    During the calendar year 1921 the petitioner collected, on account of the receivables above mentioned, an amount of $9,202.58. The respondent held that the petitioner accounted on the accrual basis and not on the basis of cash receipts and disbursements. Accordingly, the respondent treated the receivables in the sum of $9,202.58 as income for the calendar year 1920, and determined a deficiency in consequence. In his notice of the deficiency, the respondent advised the petitioner of a deficiency in tax for the years 1920 and 1921, amounting to $1,910.23. The statement accompanying the deficiency notice showed this amount of $1,910.23 to have been ascribed in its entirety to the year 1920.
    The petitioner kept his accounts and reported his income on the basis of cash receipts and disbursements. The amount of $9,202.58 collected by the petitioner in 1921 on the receivables set out above, was not reported by the petitioner as taxable income either for the year 1920 or for the year 1921.
   OPINION.

KoRner, Chairman:

As a result of the findings of fact set out above, the tax should be recomputed by the respondent, and in such recomputation the amount of $9,202.58 collected by the petitioner in the year 1921 should be eliminated from income of the year 1920 and added to petitioner’s income for the year 1921. Since the petitioner accounted on a basis of cash receipts and disbursements, the respondent was in error in ascribing the $9,202.58 to the income for the year 1920.

Judgment will ~be entered on 15 days’ notice, under Bule 50.