
    CHARLES L. HUISKING v. THE UNITED STATES
    [No. E-471.
    Decided April 2, 1928]
    
      On the Proofs
    
    
      In-come and excess-profits taxes; secs. 201 and 209, revenue act of .1917; separation of brokerage and, merchandizing businesses.— Where the business of a taxpayer was primarily that of a broker, requiring no capital or only a nominal capital, and due to the war he found it advantageous to and did engage in the additional business of buying and selling commodities, in which he employed an invested capital, but kept the two branches of his business separate, he was entitled to return his income and excess profits for tax purposes in accordance with the separation of his activities, and to' an assessment, under sections 201 and 209' of the revenue act of 1917, on that basis.
    
      The Reporters statement of the case:
    
      Mr. Levi Goohe for the plaintiff. Goohe c% Beneman wore on the brief.
    
      Mr. George H. ■Foster, with whom was Mr. Assistant Attorney General Herman J. Galloway, for the defendant. Mr. Thaddeus G. Benton was on the brief.
    The court made special findings of fact, as follows:
    I. The plaintiff at all times material herein was and now is a citizen of the United States and a citizen and resident of the State of New York.
    II. This action is based upon a claim for the refund of $17,770.88 additional income and excess-profits taxes for 1917, alleged , to have been erroneously collected from the plaintiff by the collector of internal revenue for the second district of New York.
    III. On March 25,1918, plaintiff made and filed with said collector of internal revenue on the form provided by said collector his Federal income and excess-profits tax return for the calendar year 1917, and in accordance with the computation made on that return plaintiff on or about June 4, 1918, paid to said collector income and excess-profits taxes for the said year in the sum of $72,531.50.
    
      IV. Within the time prescribed by law the Commissioner of Internal Revenue assessed against the plaintiff additional income and profits taxes for the taxable year 1917 in the amount of $17,770.88, which amount upon notice and demand was paid by the plaintiff to said collector of internal revenue on or about June 14, 1924, under protest.
    V. On July 15, 1924, plaintiff made and filed with the said collector of internal revenue a claim for refund of the said $17,770.88 so paid as additional income and excess-profits taxes for the year 1917. Thereafter, on December 15, 1924, said claim for refund was rejected by the Commissioner of Internal Revenue.
    VI. The computation upon which the Commissioner of Internal Revenue determined the plaintiff’s tax liability for 1917 to be $17,770.88 in excess of the amount of the tax liability as computed by the plaintiff is set forth in Exhibit D, as amended by Exhibit E, attached to plaintiff’s petition and made a part hereof by reference.
    VII. Exhibits A, B, C, D, and E attached to plaintiff’s petition are genuine copies of the originals.
    VIII. Plaintiff began the business of a drug broker in the year 1910 and continued solely as such until within a short time he was one of the larger brokers in the drug business. Upon the outbreak of hostilities in 1914 it became difficult to secure drugs immediately upon order therefor, or in sufficient quantities to satisfy the trade, and plaintiff found it advantageous to buy drugs on his own account whenever and wherever he could, later selling them to his customers. During all the time that he so engaged in trading he kept his books of account, showing separately his brokerage and his trading business. During the year 1917 plaintiff had by far the largest brokerage business in drugs in the United States, was the foremost commercial authority in the United States on drugs and allied products, and was so considered by the trade.
    From January 1 to October 31, 1917, plaintiff was so engaged in business as a drug broker and in the business pf ' buying and selling drugs on his own account.
    IX. Plaintiff’s income from carrying on business as a broker during the said period in 1917 was $69,511.74, all derived from commissions in which the plaintiff operated as agent for and received his commission from the seller and employed in the earning of the said income no capital or only a nominal capital.
    X. During the said period in 1917 the plaintiff earned net income from buying and selling drugs and other products on his own account the sum of $128,689.80, employing in the said business an invested capital of $310,852.99.
    XI. Plaintiff in his excess-profits tax return for the year 1917 returned as taxable at the graduated rates under section 201 of the revenue act of 1917 the total sum of $90,478.93 made up of $128,015.03, less $50,000 as hereinafter set forth, reported net profit from carrying on the trade of buying and selling drugs, and a further sum of $12,463.90. In returning the said income plaintiff deducted $50,000 as personal compensation in connection with the said business of buying and selling drugs, representing his personal services and personal contribution to the earning of said income, and erroneously omitted from income an amount of $674.77. Plaintiff also reported in his income-tax return as taxable at 8 per cent under the provisions of section 209 of the said revenue act of 1917 the said amount of $50,000, and the further sum of $69,511.74 above stated as earned from carrying on the business of a broker in drugs and allied products.
    XII. The commissioner determined plaintiff’s income subject to the graduated rates under the provisions of section 201 of the revenue act of 1917 to be $140,665.44. He arrived at this determination by adding to plaintiff’s income as reported for taxation at the said graduated rates in the amount of $90,478.93 the amount of $674.77, erroneously omitted as above set forth, and the amount of $69,511.74 earned by plaintiff as commissions and reported by him as taxable at 8 per cent under section 209 of the revenue act of 1917, and deducting from the total so determined of $160,665.44 a further amount of $20,000.00 as representing plaintiff’s personal contribution to the earning of the said income.
    XIII. During the period in 1917, as above set forth, in which plaintiff operated his individual business of buying and selling drugs and allied products, his value to the said business through his individual earning capacity was not less than $70,000, exclusive of his earnings as a broker on commissions.
    The court decided that plaintiff was entitled to recover $17,770.88, with interest from June 14, 1924, to date of judgment.
   Moss, Judge,

delivered the opinion of the court:

Since 1910 plaintiff, Charles L. Huisking, has been continuously engaged in business as a drug broker. For a number of years prior to 1917, in addition to the brokerage business, plaintiff from time to time made incidental purchases and sales of drugs, chemicals, and allied articles as a merchant. After the beginning of the World War, plaintiff, realizing that the sources of available supply were insufficienf to meet the world demand, began to give particular attention to methods of acquiring such articles as a merchant, by purchasing same outright. This branch of plaintiff’s business grew rapidly during the war period, reaching its peak in 1917 when his net income from this source for the first ten months of that year amounted to $128,689.80, with an invested capital for the same period of approximately $800,000. During the same period plaintiff’s net income from the brokerage business amounted to $69,511.74, with no invested capital except the necessary expense of maintaining an office with a force ranging from five to twenty employees. On November 1, 1917, plaintiff incorporated under the name “ Charles L. Huisking, Inc.,” and thereafter continued both the brokerage business and the merchandizing business.

In his income and excess-profits tax return for the period from January 1, 1917, to October 31, 1917, plaintiff stated a taxable income derived from his commissions as a broker amounting to $69,511.74, and also a taxable income derived from the business of buying and selling drugs on his own account in the sum of $128,689.80.

The question here involved is controlled primarily by sections 201 and 209 of the revenue act of 1917, 40 Stat. 303-307.

The applicable portion of section 201 provides:

“That in addition to the taxes under existing law and under this act there shall be levied, assessed, collected, and paid for each taxable year upon the income of every corporation, partnership, or individual a tax (hereinafter in this title referred to as the tax) equal to the following percentages of net income.”

Here follows the schedule of percentages. Section 209 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, assessed, collected, and paid, in addition to the taxes under existing law and under this act, in lieu of the tax imposed by section two hundred and one, a tax equivalent to eight per centum of the net income of such trade or business in excess of the following deductions: In the case of a domestic corporation $3,000, and in the case of a domestic partnership or a citizen or resident of the United States $6,000; in the case of all other trades or business, no deduction.”

Article 39 of Regulations 41, promulgated by the Commissioner of Internal Revenue with the approval of the Secretary of the Treasury, so far as applicable to this proceeding, reads as follows:

“An individual carrying on a trade or business having an invested capital may, in computing th’e net income of the trade or business, for purposes of the excess-profits tax, deduct a reasonable amount designated by him as salary or compensation for personal service actually rendered by him in the conduct of such trade or business. In no case shall the amount so designated be in excess of the salaries or compensation customarily paid for similar service under like responsibilities by corporations or partnerships engaged in like or similar trades or business.”

In his return for 1917 plaintiff computed his excess-profits tax on the taxable income derived from the business of buying and selling drugs, by applying the graduated rates under section 201 above quoted according to the following process: He deducted from the net income of $128,689.80 the sum of $50,000, which he claimed as compensation for his personal services in connection therewith, and arrived at the tax due by applying to the remainder, $90,478.93, the appropriate percentage under section 201. He also reported in his return for excess-profits tax purposes as income taxable at 8 per cent under the provisions of section 209 of said act the sum of $69,511.74 derived from the brokerage business, together with the $50,000 which had been deducted from the $128,689.80 earned from the merchandizing business. There was a further sum, not important in the consideration of this case, which was returned by plaintiff. Plaintiff’s total tax as thus computed amounted to $72,531.50, which was duly paid. Thereafter the Commissioner of Internal Revenue assessed against plaintiff for the same period an additional tax of $17,770.88, which was paid under protest. Plaintiff filed a claim for the refund of said sum and same was rejected. This suit is for the recovery of said additional tax.

The Commissioner of Internal Revenue determined plaintiff’s tax liability by adding to the $90,478.73, which was the income from the merchandizing business, less $50,000 deducted by plaintiff as compensation for personal services, the amount of $69,511.74 earned by plaintiff as brokerage commissions. To this was added the sum of $674.77, being an item erroneously omitted by plaintiff in his original return, making a total of $160,665.44. In addition to the $50,000 claimed and deducted by plaintiff in his tax return as compensation for personal sendees in connection with the merchandizing business, the commissioner allowed the further sum of $20,000. The total of these two sums, $70,000, was then deducted from the total income, and the amount of tax due was determined by applying to the remainder the appropriate graduated rate under section 201. By this process it will be seen that plaintiff’s income from the brokerage business, taxable at a flat rate of 8 per cent, is subjected to taxation measured by capital employed, not in the brokerage business, but in the collateral business of buying and selling. It results in this case in imposing an excess-profits tax of 60 per cent upon the greater portion of plaintiff’s income as a broker, whereas the statute provides that such income should be taxed at 8 per cent.

The tax imposed by section 201 was a tax on capital. The rates were graduated to meet the varying conditions as to amount of invested capital, ranging from 20 per cent to 60 per cent of the amount of the net income. The tax imposed by section 209 was a tax on income produced solely, or almost-solety, from personal services, and an arbitrary rate was fixed as representing what Congress regarded as a fair measure for computing such tax. If the method adopted by the commissioner in the present case is sound in principle, the inevitable result would be the occasional imposition of the higher-rates under the graduated scale of percentages on both classes of income, regardless of their relative importance. For example, a taxpayer in plaintiff’s situation might produce an income, negligible in amount, from the business of a merchant and an abnormally large income from the brokerage business, and yet he would be required to pay the tax on the aggregate income from both sources at the disproportionately high rates. While plaintiff’s income for 1911 derived from the trading business exceeded the income from the brokerage business, it was the result of accidental business conditions due to the exigencies of the war. Plaintiff’s chief business throughout his entire career was that of broker. His activities in buying and selling, at first incidental and unimportant in volume, were a later development, which grew in importance after the outbreak of the World War, reaching its high point in 1917, and thereafter declined. The wide variance between the two classes of tax, one of which imposed a tax of 8 per cent and the other, as in this case, of 60 per cent, would seem to refute the idea that Congress could have intended that the latter percentages should, under any circumstances, be applied in determining the amount of tax in the former class, provided,.of course, the two incomes were susceptible of definite separation. In this case that question presents no difficulties. The brokerage business and the merchandizing business were maintained separately on plaintiff’s books, which clearly differentiated the two incomes.

The Government’s theory does not seem to be in accord with the spirit and purpose of Congress as expressed in the statutes under consideration.

Defendant cited the case of J. H. Lane & Company v. United States, 62 C. Cls. 721, as decisive of this case. The statute applicable to the question involved in the Lome case was section 303 of the revenue act of 1918, by which Congress specifically provided relief from high rates of the excess-profits tax to that portion of the income of a corporation which, if constituting the sole trade or business, would bring it wdthin ths class of personal-service corporations in which capital must not be a material income-producing factor. The relief sought in the Lane case was denied in an opinion by Judge Booth. The facts in the two cases differ materially. It is stated in the opinion, “ The plaintiff’s system of accounting, reflected in bookkeeping, disclosed the income received from its various sources but did not disclose an allocation of invested capital to any one or more of its alleged branches,” and further, “ In keeping its books it never occurred to plaintiff that its business embraced five distinct and separate branches, for its accounts were not so kept, and it required the services of an expert to make an allocation of income thereto.” The evidence in the instant case shows quite the reverse of this situation. There was no invested capital in plaintiff’s brokerage business, except the mere expense of maintaining an office and a force of clerks and other employees ranging in number from five to twenty persons. Furthermore, plaintiff’s books were kept in such a manner as to determine with unerring accuracy the separate incomes from the two branches of plaintiff’s business. The reasoning of the court in the opinion in the Lane ease tends to sustain the theory of plaintiff in this case.

The court is of the opinion that the method employed by plaintiff in computing his tax liability for the period in question was correct and that he is entitled to recover. It is so ordered.

Gbaham, Judge; Booth, Judge; and Camebell, Chief Justice, concur.  