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statute would seem to be broad enough to include as personal service corporations those which trade in the services of others.

(b) THE BUSINESS MUST BE CONDUCTED PRINCIPALLY BY THE STOCKHOLDERS. —

REGULATION. In determining whether a corporation is a personal service corporation, no weight can be given to the fact that it renders personal services unless (a) the principal owners or stockholders are regularly engaged in the active conduct of its affairs and are engaged in such a manner that the earnings are to be ascribed primarily to their activities, and (b) its affairs are conducted principally by such owners or stockholders. (Art. 1527.)

2. To what extent must the earnings be derived from services rendered by the stockholders?—

(a) A NON-PERSONAL SERVICE ELEMENT MAY BE PRESENT IF IT IS NEGLIGIBLE.—

REGULATION. It frequently happens that corporations are engaged in two or more professions or businesses which are more or less related, one of which does not consist of rendering personal service. Thus an engineering concern may also engage in contracting, which amounts to trading in materials and labor, a brokerage concern may guarantee some of its accounts, a photographer may sell pictures, frames, art goods and supplies, or a dealer in a commodity may furnish expert advice or services with respect to its installation, use, etc. In such case the corporation is not a personal service corporation unless the non-personal service element is negligible or merely incidental and no appreciable part of its earnings are to be ascribed to such sources. .... (Art. 1526.)

An advertising agency which is incorporated, the principal owners of which are personally engaged in the business, although capital is employed to carry the accounts of customers, would probably be classed as a personal service corporation. In such a case capital would be no more than incidental and would not be a material income-producing factor.

(b) EARNINGS ARE NOT DERIVED FROM PERSONAL SERVICES IF THE PRINCIPAL DUTIES OF THE STOCKHOLDERS ARE TO SUPERVISE A FORCE OF EMPLOYEES.—

REGULATION. Where the principal owners or stockholders do not render the principal part of the services, but merely supervise or direct a force of employees, the corporation is not a personal service corporation. If employees contribute substantially to the services rendered by a corporation, it is not a personal service corporation unless in every case in which services are so rendered the value of and the compensation charged for such services are to be attributed primarily to the experience or skill of the principal owners or stockholders and such fact is evidenced in some definite manner in the normal course of the profession or business. The fact that the principal owners or stockholders give personal attention or render valuable services to the corporation as a result of which its earnings are greater than those of a corporation engaged in a like or similar business, the principal owners or stockholders of which do not devote personal attention to the management or supervision of its affairs, does not of itself constitute the corporation a personal service corporation. (Art. 1528.)

3. To what extent may capital be used to conduct the business?

(a) CAPITAL MUST NOT BE A MATERIAL INCOME-PRODUCING FACTOR.

REGULATION. In determining whether a corporation is a personal service corporation, no weight can be given to the fact that the invested capital of the corporation for the purpose of the war profits and excess profits tax or the actual investment of the principal owners or stockholders is comparatively small. The test established by the statute with respect to capital is entirely different. That test is the nature of the profession or business as indicated (a) by the kind of services it renders and (b) the extent to which capital is required to carry on such profession or business. If the use of capital is necessary or more than incidental, capital is a material income-producing factor and the corporation is not a personal service corporation. No corporation is a personal service corporation if it carries on business of a kind which ordinarily requires the use of capital, irrespective of whether the owners or stockholders have actually invested a substantial amount of capital. (Art. 1531.)

(b) THERE MUST NOT BE A SUBSTANTIAL AMOUNT OF CAPITAL EMPLOYED, WHETHER SECURED DIRECTLY OR INDIRECTLY.

REGULATION. The term “capital" as used in section 200 of the statute . ... means not only capital actually invested by the owners or stockholders, but also capital secured in other ways. Thus if capital is borrowed either directly as shown by bonds, debentures, certificates of indebtedness, notes, bills payable or other paper, or indirectly as shown by accounts payable or other forms of credit, or if the business of the corporation is in any way financed by or through any of the owners or stockholders, these facts will be deemed evidence that the use of capital is necessary. If a substantial amount of capital is used to finance or carry the accounts of clients or customers, it will be inferred that because of competition or other reasons such practice is necessary in order to secure or hold business which otherwise would be lost, and that the corporation is not a personal service corporation. If a corporation engaged in an agency, brokerage or commission business regularly employs a substantial amount of capital to lend to principals, to buy and carry goods on its own account, or to buy and carry odd lots in order that it may render more satisfactory service to its principals or customers, it is not a personal service corporation. In general the larger the amount of the capital actually used the stronger is the evidence that capital is necessary and is a material income-producing factor and that the corporation is not a personal service corporation. (Art. 1532.)

Generally speaking, the test is not the small amount of capital employed, but the nature of the business as indicated by the kind of services rendered, rather than by the extent to which capital is required. If capital is employed, but is not needed for the conduct of the business, the size of the capital alone would not prevent a corporation from being classed as a personal service corporation.

To constitute a "personal service corporation" no definite percentage of stock need be held by those conducting the business.

REGULATION. No.definite percentage of stock or interest in the corporation which must be held by those engaged in the active conduct of its affairs in order that they may be deemed to be the principal owners or stockholders can be prescribed as a conclusive test, as other facts may affect any presumption so established. No corporation or its owners or stockholders shall, however, make a return in the first instance on the basis of its being a personal service corporation unless at least 80 per cent of its stock is held by those regiilarly engaged in the active conduct of its affairs. (Art. 1529.)

The regulations do not require that at least 80 per cent of the stock of the corporation must be held by those regularly engaged in the active conduct of its affairs, but do stipulate that unless 80 per cent of the stock is so held the corporation must first make the corporation return and subsequently make application for the privilege of being classed as a personal service corporation.

The Secretary of the Treasury in his Notes on the Revenue Act of 1918 suggests (page 7) that the fourth paragraph of section 200 be amended to read as follows:

The term "personal corporation" means a corporation (1) whose principal stockholders (a) regularly devote their chief time and attention to the active conduct of the affairs of the corporation, and (b) own not less than 85 per centum of the capital stock of the corporation and (2) in which the number of stockholders not regularly devoting their chief time and attention to the active conduct of its affairs does not exceed ten.

Change of ownership does not take a corporation out of the personal service class.

REGULATION. The fact that the owners or stockholders of the corporation may change during the course of the taxable year does not take a corporation which is normally in the personal service class out of that class. Frequent changes in the ownership of any substantial interest or number of shares are, however, evidence bearing on the question as to whether the principal owners or stockholders are actively engaged in the conduct of the affairs of the corporation. The incapacity, retirement or death of a principal owner or stockholder who has been actively engaged in the conduct of its affairs will not be deemed to make any change in the status of the corporation during a reasonable time thereafter. (Art. 1530.)

Manner of taxing stockholders of a "personal service corporation.”—

REGULATIONS. . . . . An individual stockholder of a personal service corporation is .... subject to tax much like a member of a partnership upon his distributive share of the net income of the corporation. The net income of a personal service corporation, as in the case of a partnership, shall be computed in the same manner and on the same basis as the net income of an individual, except that the deduction of contributions or gifts is not permitted. . ... A corporation which is taxable under section 303 is not a personal service corporation and its stockholders are taxed like stockholders in an ordinary corporation.31 (Art. 328.)

*See page 523.

A stockholder of a personal service corporation is required to include in his gross income for the taxable year (a) any dividends paid by the corporation in such year out of earnings or profits accumulated since February 28, 1913, and before January 1, 1918; (b) his share of any distribution made by the corporation in such year out of earnings or profits accumulated since December 31, 1917, and since the close of its taxable year ending with or during his next preceding taxable year; and (c) his distributive share of the undistributed net income of the corporation for its taxable year ending with or during his taxable year, provided he was at the close of its taxable year a stockholder in the corporation notwithstanding he might since have ceased to be a stockholder. .... In the case of personal service corporations with taxable years other than the calendar year, however, such distributive shares or distributions may be subject to different rates of tax.32 (Art. 330.)

CREDITS ALLOWED STOCKHOLDERS OF PERSONAL SERVICE CORPORATION.

REGULATION. A stockholder of a personal service corporation is entitled to credit for the purpose of the normal tax only for amounts received in distribution of earnings or profits of the corporation accumulated since February 28, 1913, and prior to January 1, 1918. .... In addition to the credits ordinarily allowed to an individual a stockholder of a personal service corporation is entitled to the following credits: (a) a credit against net income for the purpose of the normal tax only of his proportionate share of such dividends from a corporation subject to tax and of such interest not entirely exempt from tax upon obligations of the United States and bonds of the War Finance Corporation as are received by the personal service corporation, and (6) a credit against income tax of the stockholder's proportionate share of income, war profits and excess profits taxes of the personal service corporation paid or accrued during the taxable year to a foreign country upon income derived from sources therein, or to any possession of the United States, subject to the limitations of section 222 of the statute. .... (Art. 331.)

Foreign corporations cannot be classed as personal service corporations.—Even though a foreign corporation doing business in the United States derives all its income from the activities of its principal owners, it cannot be classed as a personal service corporation. The 8 per cent excess profits tax rate no longer applies, so that prima facie such foreign cor

*See Chapter VI, “Rates and Computation of tax," page 152.

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