Opinion
Docket Nos. 109301 109491.
1944-02-21
LONGHORN PORTLAND CEMENT COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.SAN ANTONIO PORTLAND CEMENT COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
James H. Yeatman, Esq., H. I. Wilhelm, C.P.A., and A. N. Moursund, Esq., for the petitioners. Frank B. Appleman, Esq., for the respondent.
Petitioners were sued by the State ofTexas for alleged violations of the antitrust statutes of that state. Although convinced they had a valid defense, petitioners, for business reasons, consented to the entry of judgment against them in compromise and settlement of the action. The judgment specifically stated that the entry thereof should not constitute or be construed as an admission in any degree of the truth or correctness of the alleged violations in whole or in part. Under the judgment each of the petitioners paid $50,000 to the state and paid attorney fees and legal expenses incident thereto. Held, the compromise payments and the attorney fees and legal expenses were ordinary and necessary expenses paid or incurred in carrying on a trade or business. Commissioner v. Heininger, 320 U.S. 467, followed. James H. Yeatman, Esq., H. I. Wilhelm, C.P.A., and A. N. Moursund, Esq., for the petitioners. Frank B. Appleman, Esq., for the respondent.
These consolidated proceedings involve deficiencies in income and excess profits taxes for 1939 as follows:
+------------------------------------+ ¦Docket No.¦Income tax¦Excess profits¦ +----------+----------+--------------¦ ¦ ¦ ¦tax ¦ +----------+----------+--------------¦ ¦109301 ¦$10,389.43¦$2,023.43 ¦ +----------+----------+--------------¦ ¦109491 ¦10,126.74 ¦None ¦ +------------------------------------+
The issue is whether amountspaid the State of Texasin compromise of a suit brought by the state, and attorneys' fees and expenses paid in connection therewith, are deductible as ordinary and necessary expenses paid or incurred in carrying on a trade or business under section 23(a)(1)(A) of the Internal Revenue Code, as amended by section 121, Revenue Act of 1942.
FINDINGS OF FACT.
The petitioners are corporations organized under the laws of Texas. Prior, subsequent to, and during the taxable year they were engaged in the manufacture and sale of cement, each having gross sales for 1939 of approximately $2,000,000. Their income and excess profits tax returns for the taxable year were filed with the collector of internal revenue for the first district of Texas at Austin.
During the taxable year each of the petitioners paid the State of Texas $50,000 in compromise of a suit by the state in which petitioners were defendants. The suit, numbered 62,298 on the docket of the District Court of Travis County, Texas, was captioned State of Texas v. San Antonio Portland Cement Company, et al. In connection with this suit the Longhorn Portland Cement Co. paid attorneys' fees during the taxable year of $15,010.40 and the other petitioner paid attorneys' fees of $3,410.40.
The suit referred to was one in which the state alleged that the defendants had violated the antitrust laws of the State of Texas in various respects set out in great detail in the petition filed September 21, 1939. By this suit the state sought to recover statutory penalties provided by articles 7426 to 7447, inclusive, Revised Civil Statutes of Texas, 1925, of from $50 to $1,500 per day from January 1, 1930, to the date of filing suit, a judgment canceling and forfeiting the charters of the defendants, a judgment establishing and foreclosing the lien given by the above articles against the property of the defendants, and a judgment against each defendant enjoining and restraining each from carrying out alleged agreements, conspiracies, trusts, and combinations, and for other general and special relief.
The answer of each of the petitioners herein to said suit consisted of a general demurrer, a general denial, and a special denial that any acts, methods, or practices used in its business were used as a result of, or pursuant to, any agreement or for any unlawful purpose.
No evidence was ever taken in said suit numbered 62,298.
The officers and directors of the petitioners were advised by their respective counsel that they had a good defense, but they were induced to and did compromise the suit and paid the sum of $50,000 each to the state because of the following considerations:
(a) From the advice and information given them by their attorneys they became convinced that it would cost less to so settle than the expense of carrying the litigation to its end, even though successful.
(b) Disruption of their respective businesses would result from the attendance of officers at hearings for the taking of evidence and a long trial of the case.
(c) Unfavorable publicity would result from the newspaper reports of the trial, which would have a damaging effect upon their businesses.
(d) The injunctive relief sought by the state would not prevent them from carrying on business according to the prices charged and practices pursued so long as they did not act pursuant to any agreement with one another, or with any other competitor, and they contended that they had not made or joined in any agreement as to the conduct of their businesses.
The judgment rendered on December 15, 1939, after specifically reciting in detail the agreement of the parties in compromise of said suit, provided in part as follows:
And it appearing to the Court that said agreement is proper and in keeping with the law in such cases made and provided, and that same should be approved, and that final judgment should be entered in keeping therewith, it is:
FIRST
THEREFORE, ORDERED, ADJUDGED AND DECREED that the agreement heretofore entered into between the parties to this cause be and the same is hereby in all things approved.
SECOND
IT IS FURTHER ORDERED, ADJUDGED AND DECREED that plaintiff, the State of Texas, have and recover of and from the defendants, San Antonio Portland Cement Company and Longhorn Portland Cement Company, jointly and severally, the sum of One Hundred Thousand ($100,000.00) Dollars in full satisfaction of all claims of the State of Texas for penalties for the alleged violations of law set out in Plaintiff's Original Petition, and in full satisfaction of all expenses of the Attorney General in investigating, instituting and preparing this cause for trial; and all costs of suit are hereby adjudged against the defendants, San Antonio Portland Cement Company and Longhorn Portland Cement Company, jointly and severally, but plaintiff shall not recover of and from the Gulf Portland Cement Company any sum of money whatsoever, nor shall any costs of suit be adjudged against defendant Gulf Portland Cement Company.
THIRD
IT IS FURTHER ORDERED, ADJUDGED AND DECREED that the Clerk of this Court shall issue to each of the defendants in this cause, including the Gulf Portland Cement Company, a writ of injunction in full conformity with the provisions of said agreement, and that no bond shall be required of plaintiff.
In January 1940, pursuant to said judgment, the District Court of Travis County permanently enjoined these petitioners, and the Gulf Portland Cement Co., defendants in that cause, from creating or becoming a part of any combination of capital, skill, or acts for the purpose of doing any of the things enumerated in the statutes as interdicted (said things being specifically enumerated). Petitioners were further enjoined from following by agreement various acts and practices enumerated in the judgment and writ of injunction, which acts and practices at least in part were alleged in the state's petition to have been committed, it being stipulated, however, that these petitioners were not enjoined from so doing, each acting independently of the other, except that the injunction applied to any acts ‘(E) Controlling or attempting to control the use of cement after title has passed from the shipper.‘
The judgment rendered in suit numbered 62,298 contains no express finding that petitioners and Gulf Portland Cement Co., or any of them, had violated the antitrust laws of the State of Texas or any provision thereof. The judgment embracing the compromise agreement, Exhibit E attached to the stipulation of facts, sets forth the denial of these petitioners that the practices used by them in carrying on their businesses were the result of any agreement, express or implied, or were followed for any unlawful purpose; and section III thereof reads as follows:
III
This agreement is made by the parties hereto solely and only for the purpose of comprising and settling the matters involved in this suit, by and between the State of Texas, as plaintiff, and the defendants herein named, and it is expressly understood and agreed as a condition hereof, that neither this agreement nor the judgment to be entered thereon, nor any clause or provision of said agreement or judgment, shall constitute or be construed to be an admission or estoppel as against the various defendants herein as evidencing or indicating in any degree an admission of truth or correctness of the allegations in plaintiff's petitions contained in whole or in part.
Prior to the filing of suit numbered 62,298, the State of Texas had filed on March 7, 1938, a suit numbered 59,685, captioned State of Texas v. Lone Star Cement Corporation, et al., in which the six cement companies then operating in Texas were made defendants, namely, Lone Star Cement Corporation, Longhorn Portland Cement Co., San Antonio Portland Cement Co., Southwestern Portland Cement Co., Trinity Portland Cement Co., and Universal Atlas Cement Co., alleging violations of the antitrust laws of Texas, seeking recovery of penalties, forfeiture of charters or rights to do business in Texas, as the case might be, establishment and foreclosure of alleged liens, and injunctive relief against alleged conspiracies and agreements.
On November 12, 1938, the state filed an amended petition in suit numbered 59,685, continuing the suit against the four major companies but omitting petitioners therefrom.
After the filing of such amended petition in suit numbered 59,685, evidence was taken therein at Los Angeles, New York, and Chicago, the record being voluminous, to wit, over 6,000 pages of stenographic record and over 3,000 pages of exhibits.
Previous to October 4, 1939, an agreement to compromise suit numbered 59,685 was negotiated between the four major companies and the attorney general, but the major companies insisted that they should not be bound by injunctions unless their competitors were also bound on account of the adverse effect it would have on their business unless this was done. Suit numbered 62,298 was thereupon filed by the state against these petitioners, but they refused to agree to any compromise. Thereupon and on October 4, 1939, an interlocutory decree was entered in suit numbered 59,685 which provided for injunctive relief against the four major companies as well as the payment of $400,000 to the state, but said interlocutory decree also provided that no final decree should be entered awarding injunctive relief unless similar relief in part was obtained by the state against petitioners and the Gulf Portland Cement Co.
Suit numbered 62,298 was first filed only against these petitioners. Subsequently, the Gulf Portland Cement Co. was made a party defendant and included in the judgment as hereinbefore mentioned.
The petition filed in suit numbered 59,685 charged the four major companies, all nonresident corporations, with being members of the Cement Institute for the entire period of time involved, and the injunction granted in such cause contained a provision enjoining them from participating in any activities of the Cement Institute relating to their respective intrastate operations and sales within the State of Texas, and from putting into effect in Texas any agreement, plan, device, or practice adopted, approved, recommended, or promulgated by the Cement Institute.
The Texas companies, namely, the petitioners herein and the Gulf Portland Cement Co., were not charged in suit numbered 62,298 with violating the antitrust laws by belonging to or following any code of ethics of the Cement Institute, and the judgment in suit numbered 62,298 did not contain the provisions found in subdivision 3(a) of paragraph II of Exhibit D of the stipulation, which is a part of the compromise agreement and judgment in suit numbered 59,685, or any provisions of like import.
The petitioners herein had been members of the Cement Institute during the existence of the National Recovery Administration, but resigned when N.R.A. was declared unconstitutional. A copy of the Code of Fair Competition for the cement industry was duly filed in the office of the Attorney General of Texas on December 27, 1933, after being approved by President Roosevelt on November 27, 1933. The Cement Institute had been designated by the code as the official representative of the cement manufacturers.
The omitted portions of the stipulated facts are incorporated herein by reference.
The amounts paid the State of Texas in compromise of the suit brought by the state against these petitioners, and the attorney fees and expenses paid in connection therewith, were ordinary and necessary expenses paid or incurred in carrying on a trade or business.
OPINION.
ARNOLD, Judge:
The question here is whether certain payments in compromise of a suit brought by the State of Texas against these petitioners for alleged violations of its antitrust laws, and attorney fees paid in connection therewith, constitute ordinary and necessary expenses of their business under section 23(a)(1)(A) of the Internal Revenue Code, as amended by section 121 of the Revenue Act of 1942.
Consideration of these proceedings was postponed pending decision by the Supreme Court in Commissioner v. Heininger, 320 U.S. 467, certiorari having been granted therein because of an alleged conflict in the decisions of the Circuit Court of Appeals. The question there presented was whether attorney fees and related legal expenses of the taxpayer were deductible as ordinary and necessary expenses. Our question is broader, because petitioners seek to deduct compromise payments and attorney fees.
SECTION 23. DEDUCTIONS FROM GROSS INCOME.In computing net income there shall be allowed as deductions:(a) EXPENSES.—(1) TRADE OR BUSINESS EXPENSES.—(A) In General.— All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. * * *
In Kornhauser v. United States, 276 U.S. 145, the taxpayer sought to deduct attorney fees for defending an accounting action brought by a former partner. The Supreme Court allowed the deduction because the suit or action against the taxpayer was directly connected with, or proximately resulted from, his business. Applying this test to the present circumstances, we find that petitioners were charged by the State of Texas with business practices and conduct that violated the antitrust laws of that state. We further find that petitioners denied these charges, generally and specifically, and that the charges were never proven. In our opinion the suit and the expenses in connection therewith were directly connected with the business carried on by each petitioner.
The next question is whether the attorney fees and related expenses were both ‘ordinary‘ and ‘necessary‘ expenses paid or incurred in carrying on the business. In testing the present facts by these statutory requirements we give both words their commonly accepted meaning, as the Court did in the Heininger case, supra. Our findings show that the suit brought by the State of Texas threatened to destroy the business of each of these petitioners because the suit sought to recover statutory penalties, forfeiture of their charters, a statutory lien for the amount of the penalties against their property, an injunction to restrain them from carrying out alleged agreements, conspiracies, trusts, and combinations, and other general and specific relief. The seriousness of the threat becomes more apparent when the penalties are reduced to dollars, i.e., penalties of $50 to $1,500 per day for a period of 3,549 days would aggregate total penalties of $177,450 to $5,323,500 each. Serious as the imposition of the penalties would be, the forfeiture of their charter would be even more effective in destroying petitioners and the cement business conducted by each.
Under these circumstances we think the following language contained in the Heininger case is particularly apt, even though the facts are distinguishable:
It is plain that respondent's (taxpayer's) legal expenses were both ‘ordinary and necessary‘ if those words be given their commonly accepted meaning. For respondent to employ a lawyer to defend his business from threatened destruction was ‘normal‘; it was the response ordinarily to be expected. Cf. Deputy v. DuPont, 308 U.S. 488, 495 * * * ; Welch v. Helvering, 290 U.S. 111, 114 * * * ; Kornhauser v. United States, supra. Since the record contains no suggestion that the defense was in bad faith or that the attorney's fees were unreasonable, the expenses incurred in defending the business can also be assumed appropriate and helpful, and therefore ‘necessary‘. Cf. Welch v. Helvering, supra, 290 U.S. at page 113 * * * ; Kornhauser v. United States, supra, 276 U.S. at page 152 * * * .
Respondent argues against allowance of the deductions because the record fails to show that petitioners' expenditures were normal in their business of manufacturing cement. But this argument ignores the fact that similar litigation expenses and compromise payments were incurred at or about the same time by four other large cement manufacturers operating in Texas because of antitrust suits instituted against them by the State of Texas. Their response to the threatened destruction of their business was the same as that of petitioners and was the response ordinarily to be expected, Commissioner v. Heininger, supra, namely, they defended themselves by all available legal means. In the light of these and the other facts of record, it is our opinion that the attorney fees incurred by petitioners were ordinary and necessary expenses of carrying on a trade or business.
Our previous discussion has been directed primarily to the deductibility of the attorney fees and related expenses. The remaining question involves the deductibility of the compromise payments made in settlement of the antitrust suits. Petitioners cite International Shoe Co. 38 B.T.A. 81, and H. M. Howard, 22 B.T.A. 375, as authorizing the deduction of compromise payments. Respondent distinguished these authorities on the ground the payments there were made to individuals to settle damage suits between private parties. He contends that a different rule prevails where the alleged offense is against the Government, and relies upon Helvering V. Hampton (C.C.A., 9th Cir.), 79 Fed.(2d) 358; National Outdoor Advertising Bureau v. Helvering (C.C.A., 2d Cir.), 89 Fed.(2d) 878; General Outdoor Advertising Co. v. Helvering (C.C.A., 2d Cir.), 89 Fed.(2d) 882; Standard Oil Co., 43 B.T.A. 973; affd. (C.C.A., 7th Cir.), 129 Fed.(2d) 363; certiorari denied, 317 U.S. 688.
The rule, however, is not as broad as respondent contends. Even before the decision in the Heininger case the deduction of expenses incurred in defending suits brought under Federal and state statutes had been allowed where the taxpayer successfully defended himself against the charges; National Outdoor Advertising Co., supra, which involved alleged violations of the Sherman Act; Commissioner v. People's-Pittsburgh Trust Co. (C.C.A., 3d Cir.), 60 Fed.(2d) 187, which involved charge of fraud in making Federal income and excess profits tax returns for a corporation of which taxpayer was president; Commissioner v. Continental Screen Co. (C.C.A., 6th Cir.), 58 Fed.(2d) 625, which involved alleged violations of the Sherman Act; Hal Price Headley, 37 B.T.A. 738, which involved alleged violations of the Federal narcotic acts; Citron-Byer Co., 21 B.T.A. 308, which involved an indictment for conspiracy to defraud the Federal Government; and H. E. Bullock, 16 B.T.A. 451, which involved a proposed penalty for filing false and fraudulent excess profits tax return. But where the taxpayer was convicted or pleaded guilty to the violations charged, the deductions for fines, penalties, and legal expenses have been denied, Columbus Bread Co., 4 B.T.A. 1126; Bonnie Bros. Inc., 15 B.T.A. 1231; Great Northern Railway Co., 8 B.T.A. 225; affd., 40 Fed.(2d) 372; certiorari denied, 282 U.S. 855; Burroughs Bldg. Material Co. v. Commissioner (C.C.A., 2d Cir.) 47 Fed.(2d) 178; Estate of John W. Thompson, 21 B.T.A. 568; Tunnel R.R. of St. Louis v. Commissioner (C.C.A., 8th Cir.), 61 Fed.(2d) 166; certiorari denied, 288 U.S. 604; Helvering v. Superior Wines & Liquors, Inc. (C.C.A., 8th Cir.), 134 Fed.(2d) 373.
The present situation falls between these two lines of authorities. Petitioners were charged with violations of the state antitrust laws. The charges were vigorously denied. No evidence was taken in connection with the charges because the parties settled the suit out of court. The judgment that was entered specifically states that neither the agreement of the parties to settle the suit nor the judgment entered thereon, which embraced and approved the agreement, should constitute or be construed as an admission in any degree of the truth or correctness of the alleged violations in whole or in part. The judgment decreed, however, that the state should recover from petitioners, jointly and severally, $100,000 ‘in full satisfaction of all claims of the State of Texas for penalties for the alleged violations of law set out in Plaintiff's Original Petition, and in full satisfaction of all expenses of the Attorney General in investigating, instituting and preparing this cause for trial.‘
If unexplained this judgment would weigh heavily against petitioners and in favor of respondent. But the proof shows, and we have set forth in our findings, the factors that influenced petitioners to compromise rather than litigate. These factors present the practical aspects that confronted the petitioners, and this background is of importance from a tax standpoint in considering the tax effect of the money judgment entered and the writ of injunction issued. Financially, the petitioners were convinced that it would cost more to litigate the suit than to settle, even though they received a favorable verdict. Economically, the injunction would not prevent them from carrying on their business so long as they did not act under an agreement with competitors as to the conduct thereof. Actually, the disruption of their business because of the absence of their officers and key men in their organizations, plus the unfavorable publicity attendant upon the trial, might be more damaging to each of the petitioners than the amounts of the compromise payment. Since taxation is a practical matter, the practical aspects of a tax problem should be weighed and considered in determining tax liability. See Margery K. Megargel, 3 T.C. 238, and cases there cited.
Respondent's reliance in his brief upon National Outdoor Advertising Bureau and General Outdoor Advertising Co., supra, now appears to be ill-placed in view of the Heininger decision by the Supreme Court. The Board decided the Heininger case, 47 B.T.A. 95, originally in favor of the Government because of the impact of the Second Circuit's opinion in the Outdoor Advertising cases. However, the Seventh Circuit refused to follow the reasoning of the Second Circuit and reversed the Board. It was this alleged conflict between the Circuit Court decisions (and also the Eighth Circuit's decision in Helvering v. Superior Wines & Liquors, Inc., supra), which resulted in the granting of certiorari in the Heininger case. In affirming the Seventh Circuit, the Supreme Court pointed out that the generally accepted meaning of the language used in section 23(a) has been narrowed from time to time by the Bureau of Internal Revenue, the Board of Tax Appeals, and the Federal courts ‘in order that tax deduction consequences might not frustrate sharply defined national or state policies proscribing particular types of conduct. ‘ After stating that each case should depend upon its own circumstances and citing some examples to illustrate the principle involved, the Court said:
* * * It has never been thought, however, that the mere fact that an expenditure bears a remote relation to an illegal act makes it non-deductible. The language of Section 23(a) contains no express reference to the lawful or unlawful character of the business expenses which are declared to be deductible. * * *
We do not believe that the tax consequences of allowing the deductions here will in any way frustrate sharply defined policies of the State of Texas proscribing combinations or agreement sin restraint of trade. The state is in no position under the judgment entered to say that petitioners were convicted of any violations of its antitrust statutes. The judgment which the state agreed should be entered specifically refutes conviction or admission of violations in whole or in part. In this view of the compromise payments we are not impressed by respondent's arguments that they are penal in nature and the penalties are nondeductible. Our view is that under all the facts and circumstances the attorney fees, the related expenses, and the compromise payments were ordinary and necessary expenses paid in carrying on petitioners' respective businesses, and we so hold. Since other adjustments were involved in determining the deficiencies,
Decision will be entered under Rule 50.