Opinion
Docket No. 12447.
Promulgated January 14, 1948.
For several years prior to 1943 petitioner's president served as treasurer and president of the Catholic Press Association, of which petitioner was a member. An extended controversy arose, based on a claim by the association that petitioner's president in his official capacity as treasurer of the association had failed to invest certain association funds which otherwise would have accrued considerable interest. The president stoutly denied any malfeasance or personal liability to the association and refused to pay the claim. Subsequently the controversy began to have an adverse effect on petitioner's business, and its board of directors became alarmed. After many discussions of the matter, the board concluded that to protect petitioner's business and prevent further injury to its reputation and standing, the controversy would have to be ended. They directed the president to effect an immediate settlement. Pursuant to that directive, he paid the association $2,871.24, and petitioner reimbursed him in equal amount. Held, petitioner is entitled to deduct the payment as an ordinary and necessary business expense under section 23 (a) (1) (A), Internal Revenue Code.
Richard W. Wilson, Esq., and Franklin C. Ellis, C. P. A., for the petitioner.
Rigmor O. Carlsen, Esq., for the respondent.
The respondent, for the fiscal year ended September 30, 1943, determined deficiencies in income, declared value excess profits, and excess profits taxes in the respective amounts of $84.94, $92.38, and $2,217.83.
An issue relating to the determination of petitioner's excess profits tax credit for the fiscal year involved has been conceded by respondent. The remaining question is whether petitioner is entitled to a deduction under section 23 (a) (1) (A) of the Internal Revenue Code for the sum of $2,871.24 which it paid in the taxable year under the circumstances hereinafter appearing.
FINDINGS OF FACT.
Petitioner is a New York corporation, with its principal office in New York City. It prepared its tax returns for the fiscal year ended September 30, 1943, on the accrual basis and filed them with the collector of internal revenue for the second New York district.
Petitioner has been engaged in the publication of a Catholic periodical, known as the Catholic News. During the taxable year in question, and for many years prior thereto, petitioner was a member of the Catholic Press Association of the United States, Inc., hereinafter called the association. The association membership is comprised of accredited publishers of Catholic newspapers, magazines, and reviews, located and doing business in the United States. Individuals are ineligible for active membership. The executive board of directors and officers of the association are elected from the officers of the member publishing companies. The association, an independent organization, issued no stock, but assesses annual dues among its members. It holds annual conventions to formulate general plans and policies for the mutual benefit of it members, but otherwise conducts no business.
For many years Charles H. Ridder has been an officer of the petitioner and has served as its president since 1936. During the taxable year he was also a member of petitioner's board of directors. At that time, 200 shares of petitioner's capital stock were outstanding, of which Ridder owned 10 shares, his son owned 40 shares, and his father's estate owned the remaining 150 shares. The executors thereof were Ridder, his stepmother, and petitioner's attorney.
Ridder was elected treasurer of the association solely by virtue of petitioner's membership and standing therein. He accepted the office to further the best interests of petitioner and was repeatedly reelected as treasurer from 1928 to 1936. In the latter year, he was chosen as president of the association, in which capacity he served for the two following years. When he entered the presidency, he transferred all association funds to the succeeding treasurer. He continued to exercise some control over the financial accounts, however, because of the sickness of the new official.
During Ridder's tenure as treasurer he was custodian of all funds, including dues and moneys raised from time to time for special purposes. Except for $100 per year to cover expenses, no compensation was paid for this position. During this period, but at a time undisclosed by the record, Ridder was in charge of a drive to collect money for the establishment of a literary award fund. Bonds were purchased with some of the donations. Ridder placed the remaining receipts in several bank accounts, including deposits in his own personal account at the Bank of Yorktown. No interest was paid on any of these bank deposits, and plans to invest this additional money in government bonds never materialized.
For several years prior to 1942 Ridder and succeeding treasurers had maintained the financial accounts of the association in careless and slipshod fashion. Because of a growing dissatisfaction among the membership about this matter, an accountant was employed in 1942 to revise and correct the existing records. In December 1942 a controversy developed between the association and Ridder with respect to his handling of association funds. The association took the view that he as treasurer had neglected to invest the funds in his custody, which otherwise would have earned a 6 per cent return. Ridder stoutly denied any malfeasance in office and refused to make any payment. He further countered with a claim against the association for $1,580 to cover the compensation of his secretary when he was an officer of the association. Petitioner actually paid her salary during this period.
The controversy became more heated in early 1943, to the point where petitioner became vitally concerned about the situation. As a result, the matter was discussed "all the time" by petitioner's board of directors and its counsel. There was strong feeling that "the business was practically being attacked through its president," which could only result in detrimental effects on future business. Ridder refused, however, to make any payment to the association, expressing his willingness to "fight it out." Finally, to prevent further criticism injurious to petitioner's reputation and standing, and to prevent consequent injury to its business, its board of directors flatly instructed Ridder to effect an immediate settlement of the dispute. He would have prolonged the dispute indefinitely, except for the directive of the board; but he acquiesced in the board's decision and delivered his personal certified check for $2,871.24 to the association on May 28, 1943, in full payment of the association's claims. Petitioner then reimbursed Ridder in the same amount, pursuant to the following resolution of the board of directors adopted on July 12, 1943:
RESOLVED, that this Board of Directors hereby authorizes and directs the repayment to Charles H. Ridder of $2,871.24 for expenses incurred by him during his tenure of the offices of Treasurer and/or President of The Catholic Press Association; such expenses having been incurred by him as a result of his office as President of this Corporation and publisher of its newspaper, and for the purpose of furthering the best interests of this Corporation and its said newspaper.
Ridder did not report the reimbursement from petitioner as compensation or other form of income in his tax return. Petitioner claimed a business expense deduction in the amount of $2,871.24 in its 1943 return. Respondent disallowed the deduction on the theory that the liquidation by the petitioner of a claim against its president under the circumstances here involved did not constitute an ordinary and necessary business expense.
OPINION.
To look upon the petitioner's expenditure of the $2,871.24 simply as a payment to its president, as does the respondent, is to isolate a small part of an entire transaction and obscure the real question in this case. That question, as we see it, is whether the expense incurred in settling a controversy injurious to petitioner's business and damaging to its reputation and standing can qualify as an ordinary and necessary business expense.
The facts are that Ridder became an officer of the association solely because of the petitioner's membership in it and to further the petitioner's interests. Whether the discharge of his duties as an officer of the association was praiseworthy or blameworthy is beside the point. In any event, he stoutly denied malfeasance or dereliction, denied any liability to the association for interest which might have been earned had the funds in his charge been otherwise invested, refused to make payment, and was willing to fight the thing out. But the matter did not remain a purely private dispute between Ridder and the association. It was used as a weapon to attack the petitioner and its business. The petitioner's board of directors became alarmed and after much discussion finally concluded that to protect petitioner's business an end would have to be put to the controversy. They ordered Ridder to effect a settlement. From that point on Ridder was not acting as a mere individual to settle a personal claim against himself. Rather, he was acting as an agent of the petitioner to bring about the settlement of a controversy which, in the opinion of its directors, materially and adversely affected its business. We have no doubt it was so understood by both Ridder and the petitioner's directors.
The manner of effecting settlement appears to us to be a matter of complete indifference. That is to say, the fact that Ridder first used his own funds to pay the association and was reimbursed by the petitioner in equal amount calls for no different result than if petitioner had made direct payment to the association or, in the first instance, had given Ridder the money to turn over to the association. And, even if there was no express understanding, petitioner was certainly obligated in equity and good conscience to reimburse Ridder, cf. Gilt Edge Textile Corporation, 9 T.C. 543, in view of the fact that it had directed him to settle a claim for which he denied all personal liability and which he would not otherwise have paid.
Disregarding form, the substance of the matter is that petitioner's expenditure here in issue was for the purpose of settling the controversy. Was it then an ordinary and necessary expense in the petitioner's business? It is obvious that petitioner's board of directors believed it a necessary one, and not without reasonable grounds for that belief. They concluded that it was in the best interests of the petitioner to terminate the dispute before growing adverse publicity did irreparable damage to its business standing and repute. While it may have been an unique and unusual event in petitioner's own experience, that alone would not make the payment extraordinary. We think other corporations would be impelled to make a similar outlay under similar circumstances. Cf. Dunn McCarthy v. Commissioner, 139 F.2d 242; Levitt Sons v. Nunan, 142 F.2d 795. As the payment in question was proximately related to the conduct of the petitioner's business, Kornhauser v. United States, 276 U.S. 145, and was made to protect and promote that business, Scruggs-Vandervoort-Barney, Inc., 7 T.C. 779, it is our opinion that it constitutes an ordinary and necessary business expense within the meaning of section 23 (a) (1) (A) of the code. The deduction should therefore be allowed.
Decision will be entered under Rule 50.