Opinion
Docket No. 9028.
1947-07-31
R. O. H. HILL, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Charles A. Roberts, Esq., and Robert O. Muller, Esq., for the petitioner. Henry C. Clark, Esq., for the respondent.
1. The two owners of all the stock of the petitioner formed a partnership with a capital of $150 and, as such partners, executed a contract with petitioner under which it was agreed that petitioner would do certain manufacturing for the partnership at cost plus 10 per cent and would turn over to the partnership the balance of the sale price it collected. Petitioner's own employees solicited all orders, carried out these orders in its own name, and collected the sales price. The partnership did nothing but maintain a record of the payments made to it by petitioner and its distribution or payment of these funds. Held, that respondent did not err in disregarding the partnership in including in petitioner's income the total amount paid over by it to the partnership.
2. The alleged partnership, upon receipt of funds from petitioner under the contract, expended certain of these in paying additional compensation to certain of petitioner's employees for exceptionally efficient service in obtaining and executing orders. Held, that in disregarding the partnership such payments must be considered as made by petitioner and as reasonable additional compensation for services rendered; the deduction of such amount should be allowed petitioner under section 23(a), I.R.C.
3. On the facts it is held that respondent erred in his disallowance of a portion of the amount paid by petitioner in reimbursing employees for travel and entertainment expenses incurred by them for petitioner and paid for from their personal funds. Charles A. Roberts, Esq., and Robert O. Muller, Esq., for the petitioner. Henry C. Clark, Esq., for the respondent.
Respondent has determined deficiencies in income, declared value excess profits, and excess profits taxes for the taxable year ended May 31, 1943, in the respective amounts of $152.16, $6,254.48, and $38,379.75. The issue presented is the correctness of respondent's action in including in income of petitioner the sum of $47,770.40 representing (1) the major portion of the profit derived from certain work done by petitioner and turned over to a partnership composed of the owners of all of its stock, and (2) the portion of the sum deducted by petitioner as travel and entertainment expenses and disallowed by respondent.
FINDINGS OF FACT.
Petitioner is a New York corporation. Its place of business is in New York City. It operated a printing and engraving plant specializing in business cards and letterheads. Its returns for the fiscal year ended May 31, 1943, were filed with the collector of internal revenue for the second district of New York.
The officers of petitioner for the year 1943 were R. O. H. Hill, president and treasurer; Henry R. Jacquerod, vice president and secretary; and Richard Townley, director and acting secretary. Hill took over active management of petitioner about 1923, upon the death of his father. Jacquerod has been with the corporation more than 40 years, and Townley, 20 years. Jacquerod had charge of production and ordering. Townley was advertising manager and had charge of the selling department. There were 50 or 60 employees. Petitioner had outstanding 150 shares of no par value common stock, all owned by Hill, and 87 shares of $100 par value preferred stock, owned 40 shares by Hill and 47 shares by Jacquerod.
In 1942 petitioner's business had fallen off materially. The bulk of its business was the printing of business cards for salesmen, and, due to war conditions, few companies were employing salesmen. It was realized by Hill and his associates that, if the business was to continue, it would have to find some new line of business other than letterheads and business cards. The manufacture and sale of several articles of a different character from those formerly handled by petitioner were attempted, but proved unsuccessful. In the spring or early summer of 1942, Townley noted the award of Army ‘A‘ flags to certain war contractors for meritorious service. The presentation of these awards in nearly all cases was made the occasion for a celebration in which the employees participated. There were public speakers and in many instances elaborate entertainments, with many invited guests. For such an occasion a quite elaborate program would be printed and enclosed in an ornamental cover with patriotic designs and colors. There would also be necessary in many cases invitations to guests, admission cards, place cards, badges, et cetera. An order covering the necessary printing, engraving, and binding required by such an occasion amounted to a substantial piece of business of a character with which the petitioner was familiar and in a position to execute with its own facilities and those of certain of its suppliers with whom it was familiar and in constant contact.
Townley urged Hill to have petitioner attempt to get some of this business. The latter was at first dubious as to this line of business being profitable, but Jacquerod was enthusiastic about the promise of a substantial return.
Shortly after this, the Army and Navy combined in awarding a joint ‘E‘ banner to meritorious contractors, and it became possible to ascertain some 30 days prior to the formal announcement of the award the companies to whom the awards were to be made. This information would make it possible to contact the particular company and solicit the printing and engraving business incident to the celebration. After the first order was obtained, it was merely a question of developing a sales method to secure this business quickly and easily. After the first two orders had been obtained, orders ‘began to snowball.‘ Thirty-seven orders were obtained and filled prior to November 30, 1942. The first order was obtained not long after the August 1, 1942, list of awards appeared.
Hill and Jacquerod executed an agreement bearing the date of August 14, 1942, agreeing that they would, as partners, under the partnership name of ‘R. Hill & Company,‘ engage in and conduct a business of selling and preparing programs and certificates relating to the granting of ‘E‘ certificates by the Federal Government. The capital of the partnership was provided by the agreement to be the sum of $150, of which Hill would contribute $100 and Jacquerod $50, and the profits of the partnership were to be divided between the two in proportion to their capital contribution. A second contract was executed, bearing the date of September 10, 1942, between the petitioner, R. O. H. Hill, Inc., as a domestic corporation, represented by R. O. H. Hill, president, and the alleged partnership of R. Hill & Co., represented by R. O. H. Hill and Henry R. Jacquerod as partners. This agreement witnessed the fact that the partnership was in the business of selling and preparing programs and certificates relating to the granting of ‘E‘ certificates, and that petitioner was willing to undertake the completion of such work for the partnership. The agreement then provided that petitioner was granted the exclusive right to perform all services, including the printing and assembling of any orders obtained by the partnership for this type of work, and was entitled to receive all of the profits from this work completed prior to November 30, 1942, and that subsequent to that date, petitioner was to be entitled to retain from the payments for such work its cost for performing the work, plus 10 per cent of that amount. It was further provided that orders obtained by the partnership might be placed in the name of the petitioner and that the contract should cover not only orders contained by the partnership, but orders obtained by petitioner as well. The two aforementioned documents were prepared by an attorney, who was paid on January 25, 1943, the sum of $250 for this service. A ‘Notice of Partners Doing Business as R. Hill & Company‘ was recorded in the office of the county court clerk of New York County on November 10, 1942. The contributions of Hill and Jacquerod to the alleged partnership in the respective amounts of $100 and $50 were made on December 14, 1942.
The alleged partnership of R. Hill & Co. paid no rent and had no telephone or listing in any telephone directory, nor did its name appear upon any office door. It did not obtain an order for ‘E‘ celebration work. The petitioner, through its own employees, obtained all of the orders received, executed them in its own name, and received payment for the work. All the advertising for ‘E‘ award printing and engraving was by petitioner in its own name. The alleged partnership had no employees other than an accounting firm which furnished an accountant one day each month to enter on its books the items of receipts and disbursements of the funds received from petitioner. The accounting firm was paid $25 a month for its services. The partnership performed no service whatsoever in connection with the work for which it received payments from petitioner under the aforementioned contract. Its sole activity was in maintaining a book record of its receipts of these payments and the disbursements thereof.
Beginning with December 31, 1942, up through May 31, 1943, the close of petitioner's fiscal year, payments were made to the partnership by petitioner totaling $47,770.40, as representing that portion of the profits on the work performed by petitioner to which the partnership was entitled under its contract. Of this total amount, Hill withdrew from the partnership during that period the sum of $19,600, and Jacquerod the sum of $9,800.
In addition to the disbursements made by the partnership to Hill and Jacquerod, a total of $8,073.65 was disbursed by the partnership in what was characterized on its books as expenses. Of this total, $7,370.51 was represented by payments voluntarily made by the partnership to various employees of petitioner other than Hill and Jacquerod. These payments represented additional compensation to these individuals for their industry and interest in the work and in recognition of the large part played by them in making the performance of this work a success. The balance of the amount expended as expense was represented by fees for legal services in the setting up of the partnership, and the accounting service in maintaining its journal and cash book. A small amount was represented by items the character of which is not possible to determine accurately from the record.
Petitioner's return for the fiscal year 1943 claimed deductions from traveling and entertainment in a total of $6,773.17. Its deduction of such expenses for the prior year had been approximately the same figure. In that year it had sustained a loss and in the fiscal year 1943 took credit for a net loss carry-over in excess of $1,500. Respondent, in determining the deficiency, disallowed for each of these years the flat sum of $1,500 of the amount claimed. This action decreased petitioner's computed net loss carry-over from the prior year by $1,500 and increased its net reported income for the taxable year by a similar amount. The deductions by petitioner for travel and entertainment expense for the two years represented amounts actually paid by the petitioner in reimbursement of its employees for amounts reported by them to have been expended for this purpose. The practice was that such expenditures were made by the employees from their own funds and reimbursement secured by them from petitioner.
OPINION.
LEECH, Judge:
Petitioner contends that the $47,770.40 paid over by it to the alleged partnership of R. Hill & Co. constituted earnings of the partnership. It is argued that the partnership was in all respects an actual bona fide entity, created to serve a definite legitimate business purpose. Petitioner insists that its contract with the partnership was a real and genuine transaction entered into at arm's length and that the arrangement was made for the corporate benefit. It claims that under the contract it acted merely as agent for the partnership and that its only income from the ‘E‘ award business was 10 per cent upon cost, the balance of the earnings being the income of its undisclosed principal. Respondent contends that the partnership was a mere sham and device by which petitioner sought to avoid payment of taxes upon its income.
We agree with respondent. The record shows clearly that the partnership contributed absolutely nothing either in services or capital to the production of the income arising from the executing of orders for ‘E‘ award printing. Its capital was $150, which was little more than half of the amount expended in attorney fees for the work incident to the technical creation of a partnership and its contract arrangement with petitioner. It obtained no business, bought no supplies, and did no work. It is clear to us that its function and purpose were merely to siphon off the greater portion of the earnings derived by the petitioner. The contract between the alleged partnership and petitioner certainly was not an ‘arm's length‘ transaction. Viewing it wholly from petitioner's standpoint, it was one in which petitioner voluntarily released to another the greater part of its earnings for no consideration whatsoever. The argument of petitioner's president that the partnership was protecting petitioner by guaranteeing to it a 10 per cent profit, the partnership assuming the liability for any loss in the carrying out of the work, is not supported by the record. The orders were solicited from prosperous companies who were able to pay generously for work properly done. The work was of such character that its cost could be definitely estimated by petitioner. The latter took no chance of loss with respect to this business. Obtaining the orders was all that was necessary. By far the greater part of the work was not even done in petitioner's place of business, but was contracted from other concerns with whom petitioner was in contact and who had long been serving petitioner in that type of its work requiring color printing, binding, and other items.
We think that we could say appropriately here, as we did in Jud Plumbing & Heating, Inc., 5 T.C. 127; affd., 153 Fed.(2d) 681, that ‘The fundamental concept of taxation is that income is taxable to him who earns it and that concept, we think, is correctly applied by the respondent here.‘ There appears to be no question that all of the income here involved flowed directly from the efforts of petitioner and its employees in obtaining and executing these orders. We approve the action of respondent in disregarding the alleged partnership and treating the $47,770.40 paid over to that partnership as income earned by and taxable to petitioner. Forcum-James Co., 7 T.C. 1195; Louis Adler Realty Co., 6 T.C. 778; Harrison v. Schaffner, 312 U.S. 579; Burnet v. Leininger, 235 U.S. 136.
Petitioner asks that, if the partnership be disregarded, the result is that it must be given credit for the expenditures made from the $47,770.40 by petitioner as expenses of carrying on business. It argues that the amounts withdrawn from that fund by Hill and Jacquerod were only reasonable commissions for services performed by these men. This contention requires little discussion. The withdrawals by these two men were not made as compensation for services rendered, but as a distribution of profits. They are the owners of all of petitioner's outstanding stock. Aside from this, there is nothing in the record to indicate the value of the services rendered by these two individuals or to show that these amounts, it treated as compensation, represented reasonable amounts.
However, the record does disclose that the partnership paid from the funds received by it from petitioner a total of $7,370.51 as additional compensation to various employees of petitioner whose excellent service had contributed largely to the success of the work. Respondent argues that this is not allowable as an expense, since the recipients of these payments were not employees of the partnership which made the payments. We think this argument is inconsistent with respondent's position that the partnership should be disregarded. We have held that the partnership was really the petitioner and that its income was that of the petitioner. It necessarily follows that its disbursements were those of the petitioner and these payments of additional compensation to employees, which are indicated by the record to be reasonable in amount, should be allowed as deductions to petitioner. The other items of expenditure by the partnership as expenses, composed of legal expenditures in its creation and the cost of keeping of its accounts, are manifestly items not allowable to petitioner, since they are not ordinary and necessary expenses. The service there rendered contributed in no respect to the earning of income by petitioner.
This leaves for consideration the question of respondent's disallowance of the flat sum of $1,500 of the amount deducted by petitioner in the present and prior fiscal years here as representing travel and entertainment expense. The disallowance appears to be of a purely arbitrary amount. It is not a disallowance of any particular items making up the total on petitioner's books for each of those years. The ground for the disallowance is merely the general one that the expenditures have not been supported by the necessary evidence. Petitioner's officers have testified that these payments were actually made by petitioner to its employees in reimbursement of those employees for expenditures made by those employees for petitioner's account in travel and entertainment of customers. There is no question but that petitioner actually expended these amounts and for these purposes. Respondent's action in disallowing the flat sum of $1,500 in the prior fiscal year and reducing the net carry-over in consequence and in disallowing the same amount in the present fiscal year is disapproved.
Decision will be entered under Rule 50.