Docket No. 20090.
Samuel A. Boorstin, Esq., and Arthur E. Rubin, Esq., for the petitioner. John P. Higgins, Esq., and W. B. Riley, Esq., for the respondent.
DEDUCTION— EXPENSE OR CAPITAL EXPENDITURE— DEFENSE OF TITLE— ATTORNEY'S FEES.— Attorney's fees and related expenditures paid to defend against an action attacking the petitioner's title to stock and claiming dividends and interest while stock was held by petitioner are capital expenditures and no part is deductible as an ordinary and necessary expense. Safety Tube Corporation, 8 T.C. 757,affd. 168 F.2d 787, followed. Samuel A. Boorstin, Esq., and Arthur E. Rubin, Esq., for the petitioner. John P. Higgins, Esq., and W. B. Riley, Esq., for the respondent.
The Commissioner determined income tax deficiencies of $2,192.93 for 1943 and $6,836.49 for 1944 against the petitioner. The only issue for decision is whether all or some part of the amounts paid in each year as attorney's fees is deductible as an ordinary and necessary expense and is not a capital expenditure.
FINDINGS OF FACT.
The petitioner filed its tax returns for 1943 and 1944 with the collector of internal revenue for the district of Oklahoma.
The petitioner purchased 2,000 shares of its own stock in 1937 for $67,000. It retained the stock in its treasury. It purchased the stock from or through Hoagland & Allum Company, Inc.
The trustee in bankruptcy of Hoagland & Allum Company, Inc., filed a supplemental complaint in 1943 for the discovery of assets of the bankrupt, which was in part as follows:
This supplemental complaint against Midco Oil Corporation is founded on the fact that within one year prior to the bankruptcy, Hoagland & Allum Company, Inc., (a corporation), the bankrupt, who had been engaged in the stock brokerage business sold, transferred, and delivered to Midco Oil Corporation, without any right, title or authority, 2,000 shares of the capital stock of said Midco Oil Corporation, which stock had theretofore been deposited with the bankrupt by various of its customers for the specific and limited purpose as hereinafter set out. The said bankrupt thereafter fraudulently hypothecated and converted said shares of its stock to its own use, and it thereafter sold said shares of stock to Midco Oil Corporation, and converted and hypothecated the proceeds of such sale to its own use. * * *
The trustee alleged that the bankrupt began negotiations for the purchase at $43 a share of a majority of petitioner's outstanding stock about August 1937; stockholders were circularized and those interested were requested to deposit their stock with a bank of Tulsa, Oklahoma, to facilitate execution of the proposed sale; some deposited their stock as directed with the bank; others, for convenience, delivered a total of 2,000 shares to the bankrupt for transmittal to the bank; the total shares ultimately deposited did not constitute a majority of outstanding Midco stock; the stock held by the bank was returned to the depositing stockholders but the bankrupt fraudulently sold the 2,000 shares in its possession to the petitioner on September 3, 1937, at $33.50 a share; $2,000 of the $67,000 total sales price was paid to an intermediary in the transaction; and no part of this sales money was paid over to the owners who had deposited the stock.
Other allegations and the plaintiff-trustee's concluding prayer to the court were:
10. By such purported purchase, the said defendant acquired no right, title, or interest in and to said shares of said stock; the sale thereof was and is in all respects void, fraudulent and illegal, and the right to rescind such sale and to claim and receive from said Midco Oil Corporation the actual value of said 2,000 shares of stock is in plaintiff, as such Trustee in bankruptcy of Hoagland & Allum Company, Inc.
11. At the time of the sale of said 2,000 shares of stock on to=wit: September 3, 1937, the actual value thereof was in excess of $50.00 per share, or in excess of the total sum of $100,000.00, for which actual value said Midco Oil Corporation is liable and obligated to pay over to plaintiff as such Trustee in bankruptcy as an asset of said bankruptcy estate.
12. Prior to the date of said fraudulent sale, and every year subsequent thereto, the defendant, Midco Oil Corporation, declared and (paid) dividends on all of its shares of stock, at the rate of $1.00 per share, each year. The dividends thus declared, paid or accumulated on said 2,000 shares of stock, to the date of judgment herein likewise belongs to plaintiff; the sums thus accumulated as dividends on said stock should therefore be ordered paid over to plaintiff. In addition to the foregoing, plaintiff is entitled to have and receive from the defendant legal interest on the total amount thus found to be due from said defendant, at the statutory rate of five (5) per cent per annum, to date of judgement.
Wherefore plaintiff respectfully prays this Honorable Court for judgment against the defendant Midco Oil Corporation, as follows:
a) That said defendant shall make full, true and complete answer hereto, and shall set out, and disclose the manner of the negotiation, and of its acquisition of said 2,000 shares of stock, and the disposition it made of said respective shares of stock.
b) That the court should find that the acts and conduct of said defendant and of said bankrupt, in relation to their dealings and transactions concerning said 2,000 shares of stock, was and is fraudulent and illegal.
c) That the Court should find, determine and adjudicate that the defendant Midco Oil Corporation acquired no right, title or interest in and to the said 2,000 shares of stock, or any part thereof, and that that (sic) said shares of stock were wrongfully and fraudulently converted and hypothecated from the true owners thereof, in consequence of which, the possession of said shares of stock by said defendant, is wrongful, fraudulent, tortious and illegal.
d) That said defendant should be ordered, directed and adjudged to pay over to plaintiff as such Trustee in bankruptcy, the actual value of said 2,000 shares of stock, as of the date of said fraudulent purchase, on to-wit: September 3, 1937, at the rate of the $50.00 each share, or such other and additional amounts as shall correspond to or represent the actual value thereof, as of the date of such fraudulent and illegal purchase.
e) In addition to judgment for the actual value of such shares of stock, the plaintiff should have judgment against said defendant for the dividends which were declared, have accrued, or which were payable on said respective shares of stock, to the date of judgment herein.
f) Plaintiff should also have judgment for legal interest on the total sums which shall be found to be due and owing from said defendant, at the statutory rate of five (5) percent per annum, on the respective amounts so accruing from time to time, to the date of judgment herein.
g) That plaintiff may have such other and further relief against said supplemental defendant (petitioner), as justice may require.
The total amount at issue under the above complaint was $144,277.78, the breakdown of which was 2,000 shares of stock at $50 per share, $100,000; interest at 5 per cent from September 3, 1937, date of purchase, $30,694.44; dividends which would have been paid on the shares for 6 years, $12,000; interest at 5 per cent per annum on each dividend declared, $1,583.34.
The petitioner answered denying each allegation except the asserted mechanics of sale, and alleged that it purchased the certificates of stock ‘in good negotiable form‘ so as to constitute it a ‘purchaser for value in good faith without notice * * * , and without notice of any wrongful transfer, if such there was.‘
A judge of the United States District Court for the Northern District of Illinois, Eastern Division, on April 3, 1944, made conclusions of law, in part, as follows:
2. The only question for decision is whether good faith was exercised and honesty of purpose displayed by the purchaser in the acquisition of the 2,000 shares.
4. Unless something were shown by the evidence to bring home to * * * Midco Oil Corporation actual knowledge, or unless a situation were shown which would, by the exercise of ordinary care put * * * the corporation * * * upon notice that there was something corrupt in the affairs of Hoagland & Allum, Midco Oil Corporation cannot be held liable.
5. The purchaser was a bona fide purchaser for value and without notice of certificates of stock endorsed in blank with signatures of endorsement properly and duly guaranteed.
6. Midco received and acquired good title to the certificates of stock so purchased.
7. The complaint impleading Midco Oil Corporation as a party defendant shall be and is dismissed on the merits and the defendant shall have and recover from the plaintiff its cost in this action.
The United States Court of Appeals for the Seventh Circuit affirmed that judgment and the petition for certiorari to the Supreme Court of the United States was denied.
The petitioner had employed Samuel A. Boorstin to represent it in the action. A statement of account submitted to the petitioner by Boorstin on April 20, 1944, contained the following paragraph descriptive of the proceeding:
SUIT BROUGHT FOR: A plenary action by the Trustee in Bankruptcy claiming priority rights under the Amendment to the Bankruptcy Act known as the Chandler Act, and claiming under Sections 60-e and 70-e the fraudulent acquisition of stock, preference against the Trustee under the Chandler Act, and fraudulent acts on the part of defendant corporation through its officials, under both the State and Bankruptcy laws, and seeking restoration to the Trustee of 2,000 shares of MIDCO OIL CORPORATION stock, or judgment for the recovery of the value of the stock at $50.00 per share, plus all dividends declared thereon from 1937 to date, with interest on the respective sums until paid at 5% from 1937 to date, aggregating, under the prayer contained in the Motion for Summary Judgment, the total sum of $144,277.78, plus costs of action.
The petitioner in its returns claimed a deduction of $5,470.74 for 1943 and one of $12,967.81 for 1944, representing attorney and related fees incurred in connection with the bankruptcy proceeding.
The Commissioner, in determining the deficiencies, disallowed both claimed deductions, with this explanation:
It has been determined that such expenditures were made in defense of your title or right to 2,000 shares of your own capital stock acquired by you in September 1937 and held as treasury stock since that date. Accordingly, it is held that the * * * legal expenses mentioned above ($5,470.74 for 1943; $12,967.81 for 1944) constitute additional cost of the treasury stock, and the deduction claimed therefor is disallowed. In no event does such amount represent ordinary and necessary business expense.
The major objective and primary purpose of the action, in defense of which the petitioner expended the amounts claimed as deductions, was to dispute the petitioner's title to the 2,000 shares of its stock purchased on September 3, 1937.
No part of the expenditures was an ordinary and necessary expense of the business of the petitioner.
All facts stipulated by the parties are incorporated herein by this reference.
The petitioner claims that the entire amount of the attorney's fees and related expenditures for each year is deductible as an ordinary and necessary expense of that year because the suit was for a money judgment and, as an alternative, if all is not deductible, at least a substantial part allocable to the defense against the claim for dividends and interest, is deductible. The Commissioner contends, on the other hand, that no part of the expenditures for either year is deductible as an ordinary and necessary expense since the primary purpose of the action defended against was to protect the title of the petitioner to the 2,000 shares of its stock purchased on September 3, 1937. The petitioner recognizes many cases holding that expenses of establishing or protecting title are capital expenditures not deductible as ordinary and necessary expenses.
One of those cases is Safety Tube Corporation, 8 T.C. 757, affd. 168 F.2d 787. The present case is not distinguishable from that case. There, the petitioner was defending its title to a patent and other property. That particular phase of the litigation was terminated favorably to the petitioner in 1940, but the proceeding went to trial to see whether funds such as royalties received from the use of the patent were to be taken away from the petitioner. The jury failed to agree and a decree dismissing the complaint was entered by consent of the parties in 1942. This Court, after a discussion of the subject and the authorities thereon held that none of the legal expenses was deductible as an ordinary and necessary expense but all were capital expenditures. The Circuit Court of Appeals for the Sixth Circuit affirmed, rejecting the argument of the petitioner that after the questions of title to the patent were removed the gist of the action became the right to the income which had been earned from the manufacture of the patent device. The Court said:
The suit clearly involved the title to the Bradley patent as the principal issue and the accounting for royalties as held by the Tax Court was only a corollary to the determination of rights under the patent. The gist of the controversy is the right to the asset which produced the income. If the Bradley patent belonged to Seaton, then obviously the petitioner was not entitled to royalties.
The Court distinguished Kornhauser v. United States, 276 U.S. 145, and Rassenfoss v. Commissioner, 158 F.2d 764. The present case is not distinguishable in principle from the Safety Tube Corporation case and, following that authority, the holding must be that none of the amounts in controversy is deductible as an ordinary and necessary expense.
This Court held in Harold K. Hochschild, 7 T.C. 81, that a portion of the attorney's fees involved therein was expended in defense of title, was a capital expenditure, and was not deductible as an ordinary and necessary expense, but the remaining portion was allocable to the defense against the claim to interim dividends and was deductible as an expenditure connected with the collection of income. The petitioner's title to stock was involved in that litigation but, nevertheless, the Circuit Court of Appeals for the Second Circuit reversed the Tax Court, 161 F.2d 817, and held that the entire expenditure was deductible as an ordinary and necessary expense of the business of the petitioner in acting as a director and officer of a corporation. The Court felt that, even though in a sense Hochschild's title to the stock was defended, nevertheless, in the suit he ‘but fended off an abortive attack upon the conduct of his business as a fiduciary * * * .‘ The present case is distinguishable since here it clearly appears that the major objective and primary purpose of the suit against the petitioner was to dispute its title to the 2,000 shares of stock purchased on September 3, 1937, and the other phases of the litigation were only corollary.
Reviewed by the Court.
Decision will be entered for the respondent.
OPPER, J., dissenting: As I understand it, the present opinion holds in effect that where the principal purpose of a proceeding deals with the title to property no part of the expenses of litigation may be deducted, but all must be capitalized notwithstanding that the litigation also involves income items and that the attorneys' fees could be allocated on some basis between the latter and the capital expenditure.
The sole authority for this conclusion appears to be Safety Tube Corporation, 8 T.C. 757, affd. (C.A. 6) 168 F.2d 787. Although Harold K. Hochschild, 7 T.C. 81, reversed other grounds (C.A. 2) 161 F.2d 817, had already been decided, holding that under circumstances similar to those here an allocation was proper and should be made, the case is not referred to in Safety Tube Corporation, supra, as being overruled. It seems reasonable to assume that it was thought to be distinguishable.
On the other hand, as recently as a year ago, the allocation rule of the Hochschild case was followed. Virginia Hansen Vinsent, 18 T.C. 339. We there said (p. 349):
The respondent's determination involves recognition that the claims of the petitioner included claims which could be satisfied only by a money judgment as, for example, the earnings of the stock while it was held by the defendants, as well as interest, and he has allowed deduction of part of the expenses * * * . The expenditures which are ‘at least comparable to those required for the collection of income‘ are deductible under section 23(a)(2). Harold K. Hochschild, * * * supra.
See also Adam, Meldrum & Anderson Co., 19 T.C. 1130.
Neither of these cases is mentioned in the present opinion. Yet I am unable to understand how they or the Hochschild case are distinguishable from the present facts. It seems to me highly unfortunate that two lines of cases apparently remain in existence, neither of them expressly repudiated but reaching opposite results as to the permissibility of allocation between income and capital items in such cases as this.
I would find that a portion of the attorney's fees was paid for the protection of petitioner's right to income, as opposed to the defense of title, and that as to this portion the amount is currently deductible.
KERN, ARUNDELL, JOHNSON, and TIETJENS, JJ., agree with this dissent.