Hubbard-Ragsdale Co. v. Dean

• Decision Date: 22 May 1926
• Docket Number: No. 3562.,3562.
• Citation: 15 F.2d 410
• Parties: HUBBARD-RAGSDALE CO. v. DEAN, Internal Revenue Collector.
• Court: U.S. District Court — Southern District of Ohio

15 F.2d 410 (1926)

HUBBARD-RAGSDALE CO. v. DEAN, Internal Revenue Collector.

No. 3562.

District Court, S. D., Ohio, W. D.

May 22, 1926.

Hunt, Bennett & Utter, of Cincinnati, Ohio, for plaintiff.

Haveth E. Mau, U. S. Atty., and Simon Ross, Asst. U. S. Atty., both of Cincinnati, Ohio, and T. H. Lewis, Jr., Sp. Atty. Bureau of Internal Revenue, of Washington, D. C., for defendant.

HICKENLOOPER, District Judge.

The only question raised in this action is whether the plaintiff corporation is entitled to classification as a personal service corporation under the Internal Revenue Act of 1918 (40 Stat. 1057). Section 200 of this act (Comp. St. § 6336 1/8a) provides:

"The term `personal service corporation' means 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; but does not include * * * any corporation 50 per centum or more of whose gross income consists either (1) of gains, profits or income derived from trading as a principal. * * *"

The plaintiff corporation was engaged in buying and selling live stock upon commission. It engaged in no trading upon its own account, and all of its stockholders, with one partial exception, devoted their entire time to the business as salaried officers or employés.

The corporation enjoyed an extensive and valuable good will, which was originally created because of the long experience of its officers in this business. Sales of live stock for consignors were made only through other dealers, and immediately upon the making of such sales the plaintiff's check was given to the consignor for the amount of the sale price, less commissions. In making purchases for customers, the plaintiff bought only through other dealers, and, upon such purchases being made, gave their check for the purchase price. In the case of sales, the bank account of the plaintiff, upon which its check had been drawn, was reimbursed almost immediately with the check of the dealer representing the purchaser. In the case of purchases through the plaintiff, if for an outside market, the stock was shipped and a draft drawn upon the purchaser with bill of lading attached. Having paid for the stock so purchased from its own bank account, it was likewise then and there necessary to reimburse such bank account through discount of the drafts so drawn. To cover these transactions of continuous draft upon and reimbursement of its bank account, it was expedient, if not absolutely necessary, that a liquid balance of approximately $25,000 be kept on deposit, and this was in fact the average deposit balance kept by plaintiff for the transaction of its business.

The first element of the definition of a personal service corporation is directed toward the elimination of inequality of taxation of partnerships, on the one hand, and corporations in which the income is due primarily to the personal activities of the principal stockholders (whether professional, clerical, executive, or manual), on the other hand. In the latter class of corporations the situation of the stockholder is closely analogous to that of an active partner in an unincorporated business. This analogy is further emphasized by the fact that under section 218(e) of the act (Comp. St. § 6336 1/8i) personal service corporations are exempted from taxation as such, but the individual stockholders are taxed "in the same manner as the members of partnerships."

In a corporation such as is the plaintiff in this case, where all or substantially all of the officers and employés are stockholders, and where practically all stockholders devote their entire time to the business, this first element would seem to be fully met. This is, in fact, virtually conceded by the government.

We come then to the second element of the definition; that is, whether capital (invested or borrowed) is a material income producing factor. Here the test is not exclusively whether the corporation bought and sold on its own account, or did a strictly commission business; it is whether it necessarily requires capital for, and in fact uses it in, the conduct of the business. If the nature of the business is such that it cannot be carried on at all without the constant use of capital, and such use of capital plays a vital part in the successful conduct of the business, it cannot be said that its use in the business is merely incidental.

Under section 209 of the Revenue Act of 1917 (Comp. St. § 6336 3/8j), a different, though somewhat analogous, question was repeatedly presented in determining whether a trade or business had "more than a nominal capital." Under that law the invested capital was considered as merely nominal, if it was used solely as a fund from which to advance salaries, wages, etc., and to provide office furniture, accommodations, and equipment. Under such circumstances it played no integral part in the actual production of income. It was incidental to the earning power of the corporation, which functioned...