Union Inv. Co. v. Commissioner

Union Investment Company, Petitioner, v. Commissioner of Internal Revenue, Respondent Union Inv. Co. v. Commissioner Docket No. 40969 United States Tax Court 21 T.C. 659; 1954 U.S. Tax Ct. LEXIS 306; January 29, 1954, Promulgated *306 Decision will be entered under Rule 50. Payments required by corporate bylaw and made by petitioner to indemnify its vice president for costs incurred in his defense against a criminal charge resulting from an act in his official capacity held deductible by petitioner as an ordinary and necessary business expense. Edward D. Quint, Esq., and Henry H. Sills, Esq., for the petitioner. Roy E. Graham, Esq., for the respondent. Opper, Judge. Bruce, J., dissents. Withey, J., dissenting. Raum, J., agrees with this dissent. OPPER *659 The Commissioner determined deficiencies of $ 15,580.91 and $ 9,880.78 in the petitioner's income tax for 1943 and 1944, respectively. The issue for our determination is whether the Commissioner erred in disallowing litigation expenses and attorney fees paid by*307 petitioner for the defense of a corporate officer in a criminal suit. Another issue raised by the petition has been settled by the parties. *660 FINDINGS OF FACT. The facts have been stipulated by the parties and are found accordingly. Union Investment Company, the petitioner, is a corporation organized under the laws of the State of Michigan, with its principal office and place of business in the city of Detroit. Petitioner filed its corporate income tax returns for the taxable years ended December 31, 1943 and 1944, with the collector of internal revenue for the district of Michigan at Detroit, Michigan. Petitioner's business is that of a finance company, consisting of the purchase of retail installment paper, loans to finance real estate purchases, loans to commercial and industrial enterprises, the financing of accounts receivable, real estate mortgage loans, and related activities. In the operation of its business petitioner borrows a portion of its operating funds from banks and other financial institutions widely scattered throughout the United States. During the years here involved upwards of 25 banks extended credits and made loans to petitioner. The following tabulation*308 shows the volume of business transacted by petitioner and its borrowings from banks and others from the years 1942 through and including the year 1952: Outstanding Year Gross receivables Mortgages borrowings at acquired closed and sold close of year — 1942 — $ 14,474,400 $ 5,904,330 $ 3,979,500 — 1943 — 12,247,900 9,183,660 2,911,400 — 1944 — 7,727,480 8,821,460 322,000 — 1945 — 7,232,930 1,391,880 1,050,000 — 1946 — 9,082,230 4,275,860 4,050,000 — 1947 — 10,563,100 8,411,500 5,250,000 — 1948 — 14,133,680 7,356,350 5,550,000 — 1949 — 11,748,500 7,141,000 5,700,000 — 1950 — 18,057,450 18,439,250 9,700,000 — 1951 — 23,404,300 4,885,550 9,800,000 — 1952 — 33,830,370 2,047,350 14,050,000 The stock of petitioner is publicly held, is listed on the American Stock Exchange and Detroit Stock Exchange, and was so listed in 1944. Samuel M. Hopkins became the vice president of petitioner in 1937 and has continued in that capacity. In January of 1944 a warrant was issued by the Circuit Court for Ingham County, State of Michigan, charging Hopkins and Abraham Cooper, president of petitioner, together with officers of two other finance companies doing business in the State of Michigan, *309 and a number of members and former members of the Michigan Legislature, with having conspired to corrupt legislators in connection with legislation introduced at the 1939 session of the Michigan Legislature. Wide publicity attended the issuance of the warrant, in which Hopkins was *661 identified as an officer of petitioner. This publicity came to the attention of the banks and other lending institutions which extended credit to petitioner. The case was tried before a jury from June 12, 1944, continuously through August 12, 1944, and Hopkins was acquitted. Upon trial Hopkins was represented by two attorneys, one of whom was a member of the law firm which was general counsel for petitioner. The attorney fees, expenses, and other costs incurred in the defense of Hopkins aggregated $ 21,221.97, which was paid by petitioner. Such costs and expenses were reasonable in amount. In its income tax return for the year 1944 petitioner deducted the litigation expenses under section 23 of the Internal Revenue Code. In the case against Hopkins it was the claim of the prosecution that the alleged conspiracy was formed at meetings of a group of finance company executives held in Detroit, *310 Michigan, at which they decided to engage, and did engage, legislative counsel to represent them at the 1939 session of the Michigan Legislature. It was not claimed that Hopkins had participated in the alleged conspiracy except that in the performance of his duties as vice president of petitioner he authorized and approved the issuance of a company check in the amount of $ 200 to another finance company executive, who was acting as treasurer of the group, on account of petitioner's share of the compensation and expense of the legislative counsel. Similar contributions were made by a number of other finance companies. At the annual meeting of stockholders of petitioner held in February 1943 its bylaws were amended by adding thereto the following: Article XI. The Corporation shall indemnify each director and officer of the Corporation (and his heirs, executors and administrators) against all expenses and liabilities reasonably incurred by him in connection with or arising out of any action, suit or proceeding in which he may be involved by reason of his being or having been a director or officer of the Corporation (whether or not he continues to be a director or officer at the time*311 of incurring such expenses and liabilities), such expenses and liabilities to include, but not to be limited to, judgments, court costs, and attorney's fees, and the cost of reasonable settlements. The Corporation shall not, however, indemnify such director or officer with respect to matters as to which he shall be finally adjudged in any such action, suit or proceeding to have been liable for willful misconduct in the performance of his duties as such director or officer. If a settlement or compromise is effected, indemnification may be had only if the Board of Directors shall adopt a resolution determining that such settlement or compromise is reasonable, and approving the same. The foregoing right of indemnification shall be in addition to any other right to which any director or officer may be entitled as a matter of law. Such bylaw provisions are, and were at that time, lawful in Michigan. A number of the companies subject to the statutes administered by the United States Securities and Exchange Commission have corporate indemnification provisions in their bylaws. Of the approximately *662 1,500 companies which file proxy statements with the Securities and Exchange*312 Commission, 137 companies noted indemnification proposals in statements filed with the Commission during 1943, and 292 companies noted such proposals in statements filed during the years 1943 to 1950, inclusive. In the warrant issued January 22, 1944, wherein Hopkins and Cooper were charged with having committed a criminal conspiracy, 26 defendants were named; 20 were legislators, or former legislators, and 6 were representatives of finance companies. Prior to the trial of the conspiracy case, 1 defendant was dropped and 2 pleaded guilty. One defendant was granted a separate trial. Twenty-two defendants, of whom five were finance company executives and seventeen were legislators or former legislators, stood trial. The jury's verdict resulted in the acquittal of two of the finance company defendants, one of whom was Hopkins, and the conviction of three finance company defendants, one of whom was Cooper; all of the legislator-defendants were convicted. The three convicted finance company defendants and many of the legislator-defendants were granted leave to appeal to the Michigan Supreme Court. That court on January 9, 1950, in a 3 to 2 opinion, affirmed the conviction of the 3*313 finance company defendants, including Cooper, and all the appellant legislator-defendants, except one. In February of 1950, Cooper and the other convicted finance company defendants, together with a number of the legislator-defendants, were granted a rehearing and reargument before the Michigan Supreme Court. That court again affirmed the convictions as it had on the original appeal. Cooper and the other convicted finance company defendants thereupon filed petitions for appeal to the United States Supreme Court, which Court allowed their appeals by an order entered on September 20, 1950. Before prosecuting their appeals to the United States Supreme Court, the three convicted finance company defendants applied to the Ingham County Circuit Court for leave to move for a new trial, and for a new trial on the grounds of newly discovered evidence. These motions were granted and a new trial was ordered, the order being entered on November 29, 1950. The prosecution thereupon applied to the Michigan Supreme Court for leave to appeal from the orders granting a new trial. Its application was denied April 12, 1951. The appeals to the United States Supreme Court were thereupon withdrawn. *314 On September 14, 1951, orders nolle prosequi were entered in the cases of all the convicted finance company defendants, including Cooper, and all the legislators who were granted new trials, and thereupon the matter terminated and was concluded. The payments in question were proximately and directly related to the conduct of petitioner's business. *663 OPINION. The salient facts of this claimed deduction are: Petitioner's vice president, as such, signed a check on behalf of petitioner. By reason of this act, the vice president was indicted and required to stand trial. A bylaw of petitioner obligated it to indemnify officers for the consequence of their official acts. Pursuant thereto petitioner defrayed the cost of the vice president's defense, the amount of which was concededly reasonable. The vice president was acquitted. Petitioner claimed, and respondent disallowed, the deduction of the fees paid by petitioner for the vice president's defense. On these facts the questions are whether the payments were deductible as ordinary and necessary business expenses, Kornhauser v.United States, 1 or whether, on the contrary, their deduction should be denied as tending*315 to frustrate a well-defined public policy. See Commissioner v. Heininger. 2 See also Lilly v. Commissioner, 343 U.S. 90. We think that the payments were ordinary in that one accused of a crime would ordinarily be expected to defend himself and to pay the expenses so incurred, Commissioner v. People's-Pittsburgh Trust Co., (C. A. 3) 60 F. 2d 187; and if the act involved and the disbursements made were proximately and directly connected with a taxpayer's business, as they were here, it would be logical for the payments to be considered as ordinary business expenses. *316 Citron-Byer Co., 21 B. T. A. 308; Hal Price Headley, 37 B. T. A. 738; Kornhauser v.United States, supra; cf. Appeal of Backer, 1 B. T. A. 214. We think that the payments were necessarily made by petitioner both because of the general circumstances, and more particularly by reason of its indemnity agreement, an undertaking which is itself shown to have been far from extraordinary. 3 And see Louis E. Wakelee, 17 T. C. 745. Whatever might otherwise have been the case, we think the vice president's acquittal adequately disproves the*317 charge that the payments for his defense frustrated any well-defined public policy. *664 It has never been thought * * * that the mere fact that an expenditure bears a remote relation to an illegal act makes it non-deductible. [Commissioner v. Heininger, supra.] At another point in the same opinion (footnote 8) the Supreme Court comments: A taxpayer who has been prosecuted under a federal or state statute and convicted of a crime has not been permitted a tax deduction for his attorney's fee. Estate of Thompson v. Commissioner, 21 B. T. A. 568; Burroughs Bldg. Material Co. v. Commissioner, supra. But if he has been acquitted, a deduction has been allowed. Commissioner v. People's-Pittsburgh Trust Co., 60 F. 2d 187; cf. Citron-Byer Co. v. Commissioner, 21 B. T. A. 308; Headley v. Commissioner, 37 B. T. A. 738. Cf. Helvering v. Superior Wines & Liquors, supra, Note 3. For the reasons stated we take the view that the deductions were improperly disallowed. See Jerry Rossman Corp. v. Commissioner, (C. A. 2) 175 F. 2d 711;*318 Pacific Mills, 17 T. C. 705. Decision will be entered under Rule 50. WITHEY Withey, J., dissenting: Deductions from gross income are not a matter of right but are a matter of legislative grace and a taxpayer claiming a deduction must bring himself squarely within the terms of a statute granting it. New Colonial Ice Co. v. Helvering, 292 U.S. 435, affirming 24 B. T. A. 886. Deductions for expenditures incurred for lobbying activities and for the promotion or defeat of legislation are outside the statutory grant relied on by the petitioner. Textile Mills Securities Corp. v. Commissioner, 314 U.S. 326. Where, as here, the taxpayer acting through its vice president makes an expenditure not shown to have been for other than lobbying activities or for the promotion or defeat of legislation and as a result incurs an additional expenditure for the defense of the vice president, the latter expenditure is so directly related to the former as to partake of its character. In the absence of a showing as to what the character of the former expenditure was, I*319 would sustain the respondent in disallowing the latter. Footnotes 1. 276 U.S. 145↩. 2. 320 U.S. 467, 473: the federal courts have from time to time, however, narrowed the generally accepted meaning of the language used in Section 23 (a)↩ in order that tax deduction consequences might not frustrate sharply defined national or state policies proscribing particular types of conduct. * * * 3. The purpose of indemnification provisions "is to encourage capable men to serve as corporate directors, secure in the knowledge that expenses incurred by them in upholding their honesty and integrity as directors will be borne by the corporation they serve." Mooney v. Willys-Overland Motors, Inc., (C. A. 3) 204 F. 2d 888↩.