Atlanta-Southern Dental College v. Commissioner

*1325 The respondent has asserted a deficiency in income and profits taxes for the fiscal year ended June 30, 1922, in the amount of $2,100.72. The deficiency arises from the disallowance by the respondent of petitioner's claim for classification as a personal service corporation.

FINDINGS OF FACT.

The petitioner is a Georgia corporation with its principal office at Atlanta, where during the taxable year it owned and operated a school of dentistry. It was incorporated in 1917, being a consolidation of the Atlanta Dental College and the Southern Dental College.

In connection with its school petitioner opened an infirmary and held clinics, where dental services were rendered for nominal fees. The infirmary has continually been operated at a loss, its purpose*2683 being to afford students of the dental school an opportunity to gain practical experience. Text books were handled by petitioner as a matter of convenience to its students. On the consigned books petitioner received from the publishers a commission of 20 per cent of the selling price. The supply of caps and gowns for rent in Atlanta *1326 was limited and in order to supply its graduating classes the petitioner purchased a quantity of caps and gowns, which it rented to students at a slight charge.

Petitioner's authorized capital stock is $50,000, divided into 500 shares of a par value of $100 each. During the period June 30, 1921, to December 31, 1921, the stockholders, their activities, and compensation were as follows:

The professors listed above as "full time" were regularly employed in a detailed program of recitations and examinations, which does not necessarily mean in a business of this kind that every moment of their time was devoted to school affairs. They were regular as distinguished from occasional instructors. The "part time" professors conducted certain classes only, devoting in most instances two or three hours a week. The balance of the time was given to their professional practice.

*1327 Barnwell was one of the professors in the Atlanta Dental College prior to the merger with the Southern Dental College. During the taxable period here involved he was vice president, attended petitioner's business meetings, and was subject to call as a special lecturer. He was not actively engaged in teaching and during the period herein involved was not called upon to lecture.

Crenshaw was one of the founders of the Atlanta Dental College and was actively engaged in teaching until the petitioner was organized. He was not active*2685 in the conduct of petitioner's affairs during the taxable year.

Nicholson was subject to call as a special lecturer, but he was not actively engaged in teaching during the taxable year. He was one of the founders of the Southern Dental College and prior to the petitioner's organization he had lectured on anatomy and surgery for about 30 years.

Smith was one of the professors in the Atlanta Dental College and he continued to teach with petitioner for two or three years after its organization, but was retired and inactive during 1921 and 1922.

Wallace and White were formerly professors with the Atlanta Dental College and the Southern Dental College and they continued with petitioner for a few years after its organization. They were retired from active teaching prior to the taxable year.

Seventeen professors who were not stockholders were employed on the faculty. Petitioner also employed eight clerks, two janitors and six maids. Nurses were temporarily employed when needed in the infirmary. The salaries of the nonstockholder employees amounted to $26,600.60 during the taxable year, of which $19,209.49 was paid to professors.

The balance sheet of the petitioner at the*2686 end of the taxable year follows:

*1328 Petitioner owned a three-fourths interest in the land, buildings and equipment occupied solely by its dental school. The land and buildings were acquired by petitioner from two individuals who are stockholders. *2687 Petitioner's interest in the land and buildings was carried on the books at a value of $75,000, less the reserve for depreciation. At the end of the taxable year the book value of the equipment used by petitioner amounted to $34,612.78 after deducting from the original cost of $57,664.84 the amount of the reserve for depreciation. In addition there was office equipment of a depreciated value of $489.63. "Notes payable for real estate" and "real estate loan payable" represent petitioner's liability for unpaid portions of the purchase price of the real estate.

During the fiscal year ended June 30, 1922, there was no income from sources other than school. Income from students' tuition and miscellaneous fees amounted to $86,912.74; commissions received for the sale of books and supplies were insufficient in amount to pay the clerk who attended to the matter; interest received on promissory notes given for unpaid subscriptions to capital stock of petitioner amounted to $273; income from rental of caps and gowns amounted to $179.75; money was borrowed for operations and repaid out of income in the respective amounts of $6,000 and $10,000; an amount of $885.13 was expended for advertising, *2688 of which approximately $593 represented the cost of catalogues; salaries to stockholder-professors amounted to $21,476.68; salaries to employees other than stockholders amounted to $26,600.60; interest on money borrowed from the bank and on mortgage and notes payable amounted to $4,404.33.

The full-time salaries paid by petitioner continued during the summer vacation period and during the taxable year it became necessary for petitioner to borrow money during this short interval for the payment of salaries.

Petitioner's school terms combined extended from October 1 to June 1. The school day extended from 8.30 a.m. to 5.30 p.m. Student fees were payable in advance at the beginning of each semester.

In securing new students petitioner relied largely upon the activities of its 2,600 alumni, who advised prospects of petitioner's school and reported to petitioner data relative to those prospects. Catalogues were prepared by petitioner and distributed to the prospective students. A form announcement, usually referred to as "cards," was inserted in a number of professional journals. In the local press small advertisements were inserted advising the public of the privilege of attending*2689 the clinics at the infirmary and of the hours for attendance. There was no other school of dentistry in Atlanta or in any of the nearby States, from which petitioner drew a majority of its students.

*1329 For the taxable year petitioner filed a personal service return, Form 1065B, which included the following:

*2690 In determining the deficiency the respondent has computed the following:

*1330 During the years 1918, 1919, and 1920 petitioner operated substantially the same kind of a business under similar conditions. For all of those years the respondent allowed petitioner classification as a personal service corporation.

The excess-profits tax for the period subject to the rates for 1921 has been computed by the respondent under the provisions of section 202 of the Revenue Act of 1921.

OPINION.

LANSDON: The single issue to be determined in this proceeding is whether the petitioner was a personal service corporation during the first six months of its fiscal year ended June 30, 1922, the benefit of that classification having been specifically denied after December 31, 1921, by section 218(d) of the Revenue Act of 1921. The*2691 statutory definition of a personal service corporation is contained in section 200(5) of the Revenue Act of 1921, which reads in part as follows:

(5) 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; * * *

In order to bring itself within the definition, petitioner must establish (1) that it is engaged in rendering personal service as distinguished from trading, merchandising or manufacturing; (2) that capital, whether invested or borrowed, is not a material income-producing factor; (3) that the principal stockholders are regularly engaged in the active conduct of the business; and (4) that the income may be ascribed primarily to the activities of the principal stockholders. Failure to meet any one of these qualifications is fatal to the claim for personal service classification.

The petitioner operates a school of dentistry, where students seek and are afforded instruction from an experienced*2692 and capable faculty. Only an insignificant amount of income is derived from the sale of books and supplies, the rental of caps and gowns, and interest paid by stockholders on notes for the balance of their subscriptions to stock.

*1331 During the period June 30, 1921, to December 31, 1921, the petitioner had 22 stockholders who held its 500 shares of outstanding stock. We have found that six of such stockholders, who held 33.2 per cent of the stock, were inactive in petitioner's affairs. The petitioner contends that one of such number, Barnwell, who held 75 shares of stock, was actively engaged in petitioner's affairs during the taxable period inasmuch as he was vice president, was influential in securing new students and attended the regular business meetings. We have heretofore held that a principal stockholder who renders no service to the corporation other than social in character, such as the cultivation of acquaintances for the purpose of inducing them to have business transactions with the corporation, is not regularly engaged in the active conduct of the affairs of the corporation. *2693 ; ; .

We are of the opinion that the remaining 16 of petitioner's stockholders, who held 68.8 per cent of the stock, do not constitute "the principal owners or stockholders" within the meaning of the Revenue Act, and that petitioner's principal stockholders were not regularly engaged in the active conduct of its affairs.

We think petitioner fails to come within the fourth condition listed above, namely, that its income may be ascribed primarily to the activities of its principal stockholders. It employed 17 professors and instructors who were not stockholders, paying them salaries in the aggregate amount of $19,209.49 as compared with aggregate salaries paid to the 16 stockholder professors of $21,476.68. Petitioner's other employees, who received salaries totaling $7,391.11, were clerks and stenographers and were incidental to the management. The 17 nonstockholder professors and instructors, however, were skilled employees and were responsible for the production of a large portion of petitioner's income. They*2694 may not be described as incidental to petitioner's management and their efforts in producing income may not be ascribed to the management. Cf. , affirming ; ; ; ; .

The petitioner contends that, having been granted personal service classification for the preceding taxable years 1918, 1919, and 1920, when it operated substantially the same kind of a business under similar conditions, including the employment of substantially the same professors, it should be granted personal service classification in this proceeding. We do not agree with such contention. The *1332 granting of a special classification for one year does not of itself warrant the granting of that classification for a succeeding year. *2695 ; .

Reviewed by the Board.

Decision will be entered for the respondent.

TRUSSELL dissents.