Commissioner of Internal Rev. v. Textile Mills S. Corp.

MARIS, Circuit Judge

(dissenting in part).

I fully concur in the opinion of my brethren that this court consists of all five circuit judges in active service and that the court may lawfully sit en banc, as it did in this case. I find myself, however, unable to agree with the conclusion which the majority have reached as to the merits of the case for reasons which I shall state.

The taxpayer entered upon the business of seeking to bring about the return of its principals’ seized property through the passage of Congressional legislation authorizing such return. Its compensation was to be contingent upon and measured by its success in securing the return of the property and it was to bear all the expenses of its effort. Among these expenses were substantial sums paid to Ivy Lee for publicity work, including the making of arrangements for speeches and speakers around the country and cooperating with the press in editorial comments, as well as news items, and to W. F. Martin and J. Reuben Clark for preparation of propaganda concerning international relations, treaty rights, and the historical policy of the United States relative to enemy-owned property in times of war. It is these sums which the taxpayer seeks to deduct from its gross income as ordinary and necessary expenses of its business in computing its net income subject to income tax. The majority of this court deny the right to the deductions upon grounds, none of which, in my opinion, is valid.

Three of my brethren conclude that the Board of Tax Appeals erred in holding the deductions to be “ordinary” business expenses and therefore within the category of deductions permitted by the Revenue Act. As I understand it, they take the view that the expenses were not “ordinary” because they were paid in execution of a contract which was void as against public policy and because they were paid in an enterprise which was against public policy and which in any event did not meet the standard of morality in public affairs set by students of political science.

Their conclusion that the contract between the taxpayer and its principals is against public policy is rested upon the decisions of the Court of Appeals of the District of Columbia in Gesellschaft Fur Drahtlose Telegraphie M. B. H. v. Brown, 64 App.D.C. 357 , 78 F.2d 410 , and Brown v. Gesellschaft Fur Drahtlose Telegraphie M. B. H. 70 App.D.C. 94 , 104 F.2d 227 , holding void the provisions of a similar contract between alien claimants and an American agent which provided for the payment of compensation to the agent on a contingent basis. Those decisions were placed upon the ground that the Settlement of War Claims Act was “favor legislation” as distinguished from “debt legislation” and that a contract to procure “favor legislation” for a contingent fee is against public policy and, therefore, void. It was accordingly held that the agent might not recover the contingent fee stipulated for in the contract. I have grave doubt of the soundness of the distinction thus drawn between “favor legislation” and “debt legislation” 1 and I am clear that in any event the *76 validity of the contract has no bearing on the question before us, for reasons which will be discussed later. But even if its bearing be conceded it seems to me that the Settlement of War Claims Act was in fact “debt legislation.”

Section 7 of the Trading with the Enemy Act, 50 U.S.C.A. Appendix § 7, authorized the seizure by the alien property custodian of enemy-owned property such as the textile properties here involved, but it did not purport to confiscate these properties without return or compensation. On the contrary it clearly contemplated that the former owners had claims which would have to be dealt with after the war, for by Section 12, 50 U.S.C.A. Appendix § 12, the act provided that “After the end of the war any claim of any enemy or of an ally of enemy to any money or other property received and held by the alien property custodian or deposited in the United States Treasury, shall be settled as Congress shall direct.” Here was not only the recognition of the existence of claims on the part of the former owners of seized property but also a clearly implied invitation to them to solicit from Congress legislation providing for the settlement of their claims. That the Settlement of War Claims Act which finally provided for these claims was “debt legislation” seems to me quite clear in the light of these circumstances. 2

As I have already suggested, however, I think that even though the taxpayer’s contract was void because in violation of a public policy which frowns upon the offering of a contingent compensation for procuring legislation, it does not follow that the expenses paid in carrying out the agency constituted by the contract were not ordinary business expenses. The illegality suggested is as-to the manner of compensation and not as to the result sought to be accomplished. It, therefore, seems to me to be wholly immaterial to the decision of the case before us whether the contract between the taxpayer and its principals was void because of the contingent fee for procuring what the majority describe as “favor legislation.” The fact remains that the business contemplated by the contract was carried through, the contingent compensation was paid and is now being taxed, and the expenditures here sought to be deducted were expended in carrying on that business and earning that compensation. The alleged invalidity of the contract obviously does not affect the taxability of the income and I see no basis for holding that it affects the deductibility of the expenses. -

It is said by the majority that since the expenditures in question were made in execution of a void contract they “cannot be deemed to be ordinary. They are outside the norm of ordinary business conduct.” It is also said that the solicitation of legislation, commonly known as “lobbying”, is against public policy and has been condemned by judges and political scientists and that “the payment of moneys for carrying out a purpose contrary to public policy is by no means ordinary.” As my colleague Judge CLARK puts it in his concurring opinion the public policy, which he suggests prohibits “lobbying,” must be read as a mandatory gloss upon the adjective “ordinary” in the statute. To me this is not interpretation but amendment of the legislative language. Section 23(a) of the Revenue Act of 1928 authorizes the deduction in computing net income of “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” The majority I think lose sight of the fact that the reference *77 is to any trade or business. It seems obvious to me that the act contemplates that taxpayers will engage in all sorts of trades and businesses including businesses which are against public policy or even criminal in character, and that those expenses which are ordinary and necessary in each particular type of trade or business may be deducted from the income derived therefrom. The determination of the character of the expenses as ordinary and necessary is, therefore, not to be based, as the majority suggest, upon “the norm of ordinary business conduct” in general but is to be made in the light of the relation of the expenses to the particular trade or business. As Mr. Justice Cardozo said in Welch v. Helvering, 290 U.S. 111, 113 , 54 S.Ct. 8, 9 , 78 L.Ed. 212 , “Now, what is ordinary, though there must always be a strain of constancy within it, is none the less a variable affected by time and place and circumstance.”

It seems to me that the majority by their decision are converting into a penal statute what was intended by Congress to be solely a revenue measure. The revenue laws, as Judge Sibley aptly said in Alexandria Gravel Co. v. Commissioner, 5 Cir., 95 F.2d 615, 616 , “are not over-squeamish. By the broad definition of gross income, income arising from an illegal business is taxed even though the illegality be one declared by the Constitution itself. United States v. Sullivan, 274 U.S. 259 , 47 S.Ct. 607 , 71 L.Ed. 1037 , 51 A.L.R. 1020 . The provisions of the statute fixing the deductions to be regarded in arriving at the net income which alone is taxed, 26 U.S.C.A. § 23 [26 U.S.C.A. Int.Rev.Code § 23], are as broad and unqualified as those defining the taxable gross income.” There is no suggestion in these provisions that the word “ordinary” is to be restricted in meaning to those expenditures only which are not against public policy or which meet a moral standard laid down by textwriters and courts. On the contrary it has been held that business expenses are deductible even though by reason of the nature of the busiiness they involve payments so clearly criminal as bribes for “protection.” Steinberg v. United States, 2 Cir., 14 F.2d 564 . As Judge Hough demonstrated in the case cited the income tax law is not a penal statute but a revenue measure. It taxes income derived from criminal enterprises as well as those which the law countenances and its purpose is to tax the net income derived therefrom not the gross receipts.

In the present case the business upon which the taxpayer entered was that of soliciting through propaganda the passage of legislation, commonly known as “lobbying.” This is an activity which Congress has never seen fit to prohibit and which has always been freely indulged in without restraint. The facts stipulated in the record before us do not show that the taxpayer indulged in any questionable practices or that its activities in respect of which the expenses were incurred were against public policy. It was encumbent upon the government to show that the taxpayer’s activities were illegal or against public policy if such was the case. It failed to do so. Certainly this court may not indulge the presumption, as I think the majority do, that the petitioner was guilty of improper conduct not disclosed by the record merely because it did not produce affirmative evidence of its innocence.

The question which we are called upon to determine is whether the Board of Tax Appeals was in error in finding as a fact that the activities for the cost of which the taxpayer seeks deduction were ordinary in the particular business in which it was engaged. As we have seen, the taxpayer engaged Ivy Lee to arrange publicity and Martín and Clark to prepare propaganda. I think it must be conceded that publicity and propaganda are methods of procuring legislative action which have been universally employed in this and every other democratic nation. Since the business in which the taxpayer was employed was that of soliciting legislation by Congress it seems to me to be entirely clear that expenditures for publicity and propaganda wére “ordinary” in its particular line of business within the meaning of the Revenue Act. It is wholly beside the point to consider whether such expenditures would be ordinary in business generally. It is doubtless true that expenditures for lobbying activities are not ordinary in the case of persons engaged in-mining, manufacturing or commercial businesses, but here lobbying was not merely incidental to the taxpayer’s business but itself constituted the business. I do not understand that it is suggested that the taxpayer’s expenses were not of the kind ordinarily incurred in the business of lobbying. To hold that these expenditures are not “ordinary” within the meaning of the Revenue Act because we think that they contravene that undefinable concept of the judicial mind which the courts have called *78 “public policy”, or because they are deemed to be unwise or improper by political scientists and judges seems to me to be reading into the Revenue Act what is not there. In doing so the majority have placed the stamp of illegality upon conduct which Congress has never declared to be criminal. I think that in thus restricting the plain language of the act .this court is exercising a legislative and'not a judicial function. I cannot agree that we have such power.

Two of my colleagues suggest that the Board of Tax Appeals erred in finding that the expenditures in question were “necessary” business expenses because the activities which they represent cannot be shown to have been the proximate cause of the legislation enacted by Congress. Their view is, that only those expenses áre necessary which result in achieving the object sought by the taxpayer for which the expenditures were incurred and that in this case the taxpayer’s expenditures could not have been the proximate cause of the passage of the legislation sought since Congress must be presumed to have acted independently in the public interest. I cannot agree that the Revenue Act contemplates any such restriction upon the de-ductibility of business expenses. Certainly it has never heretofore been suggested that the deductibility of a business expense is contingent upon the success of the business enterprise in which it is incurred. So to hold would impose an intolerable burden upon taxpayer and Commissioner alike. Nor do I see any merit in the suggestion that the expense was not necessary because Congress must have acted independently and not as a result of the taxpayer’s activities. Mercantile advertising seems to me a perfect analogy. I do not think that my colleagues would go so far as to suggest that a merchant must be disallowed his trade advertising expenses because he cannot show that those expenses brought in customers or because he cannot show that the customers who did arrive came in under the hypnotic influence of, his advertising and not in the exercise of an independent judgment in the light of their own self-interest. I entirely agree with Judge CLARK that the word “necessary” as used in the act must be read as “helpful” and must be considered in the light of the enterprise in which the taxpayer is engaged rather than the result which it is seeking to a,chieve.

Finally two judges of the court take the ground that Article 262 of Regulations 74 prohibits the deduction of expenses of the character involved in this case. I agree with the conclusion of the Board of Tax Appeals that this article of the regulations does not prohibit the deduction of these expenditures if they may fairly be classed as ordinary and necessary business expenses. The article in question is as follows:

“Art. 262. Donations by corporations.— Corporations are not entitled to deduct from gross income contributions or gifts which individuals may deduct under section 23 (n). Donations made by a corporation for purposes connected with the operation of its business, however, when limited to charitable institutions, hospitals, or educational institutions conducted for the benefit of its employees or their dependents are a proper deduction as ordinary and necessary expenses. Donations which legitimately represent a consideration for a benefit flowing directly to the-corporation as an incident of its business are allowable deductions from gross income. For example, a street railway corporation may donate a sum of money to an organization intending to hold a convention in the city in which it operates, with the reasonable expectation that the holding of such convention will augment its income through a greater number of people using the cars. Sums of money expended for lobbying purposes, the promotion or defeat of legislation, the exploitation of propaganda, including ’advertising other than trade advertising, and contributions for campaign expenses, are not deductible from gross income.”

The article is arranged in the Regulations under Section 23 (n) of the Revenue Act. That section is entitled “Charitable and Other Contributions”. It authorizes the deduction of such contributions in the case of an individual. By restricting deductions of this character to individuals the act denies ' them to corporations. I think that Article 262 was intended merely to be interpretive of Section 23 (n) by making clear what that sectiop leayes to inference, namely, that charitable and similar donations are not deductible as such by corporations and that lobbying and legislative expenses are likewise not deductible as such or in the guise of donations. The article was not intended to be interpretive of business expenses or to restrict the deduction of any *79 expenditures which may fairly be deemed ordinary and necessary expenses of business under Section 23 (a) of the act. That this is so is borne out by the fact that Article 262 does not contain a cross-reference to Article 121 which does define business expense, while the latter, which states “As to items not deductible, see Section 24 and Article 281-284,” does not contain a similar cross-reference to Article 262. Furthermore, Article 262 itself points out that donations to charities may be deducted by a corporation as business expenses when made for purposes connected with the operation of its business.

The interpretation adopted by my colleagues would, it seems to me, render the article invalid as an invasion of the legislative power. Section 23(a) of the Revenue Act authorizes the deduction of business expenses provided only that they are ordinary and necessary. Nowhere in the act is there any further qualification that they must not have been incurred for lobbying or the promotion of legislation. Consequently, the effect given to Article 262 of the Regulations, by my colleagues is, not to construe, interpret or implement an ambiguous, doubtful or general provision of the act, but rather to amend the unambiguous language of Section 23 (a) by adding to it a proviso to the effect that lobbying expenses shall not be deducted by a taxpayer even though they are ordinary and necessary in its business. It is settled that the law cannot thus be amended by regulation. Koshland v. Helvering, 298 U.S. 441 , 56 S.Ct. 767 , 80 L.Ed. 1268 , 105 A.L.R. 756 ; Manhattan General Equipment Co. v. Commissioner, 297 U.S. 129 , 56 S.Ct. 397 , 80 L.Ed. 528 . In Koshland v. Helvering, supra, Mr. Justice Roberts said (298 U.S. pages 446, 447, 56 S.Ct. page 770, 80 L.Ed. 1268 , 105 A.L.R. 756 ):

“Where the act uses ambiguous terms, or is of doubtful construction, a clarifying regulation or one indicating the method of its application to specific cases not only is permissible but is to be given great weight by the courts. And the same principle governs where the statute merely expresses a general rule and invests the Secretary of the Treasury with authority to promulgate regulations appropriate to its enforcement. But where, as in this case, the provisions of the act are unambiguous, and its directions specific, there is no power to amend it by regulation. Congress having clearly and specifically declared that in taxing income arising from capital gain the cost of the asset disposed of shall be the measure of the income, the Secretary of the Treasury is without power by regulatory amendment to add a provision that income derived from the capital asset shall be used to reduce cost.”

In Sunset Scavenger Co. v. Commissioner, 84 F.2d 453, 457 , the Circuit Court of Appeals for the Ninth Circuit had under consideration the effect to be given to Article 262 of the Regulations. It held that this Regulation limited the sweeping terms of the statute by entirely prohibiting the deduction of lobbying expenses. This holding was based upon its conclusion that “the statute is ambiguous because it makes no determination of what is or is not an ‘ordinary and necessary’ expense.” But what is “ordinary” or “necessary” as a business expense is clearly a question of fact to be determined in the light of the particular business in which the taxpayer is engaged. The words do not create an ambiguity but merely call for the exercise of the fact finding function. To permit the Commissioner of Internal Revenue to limit the scope of these words must necessarily involve authorizing him “to convert what in the view of the statute is a question of fact requiring proof into a conclusive presumption which dispenses with proof and precludes dispute,” to use the words of Mr. Justice Sutherland in Miller v. United States, 294 U.S. 435, 440 , 55 S.Ct. 440, 442 , 79 L.Ed. 977 . To continue in his words: “This is beyond administrative power. The only authority conferred, or which could be conferred, by the statute is to make regulations to carry out the purposes of the act — not to amend it.” I am, therefore, not persuaded by the opinion of the court in the Sunset Scavenger Co. case that Article 262 should be given the broad construction which my colleagues have placed upon it.

I am authorized to say that Judge GOODRICH concurs in this dissent.

The distinction sought to be drawn, as I understand it, is between legislation designed to provide for or facilitate the set *76 tlement of existing claims against the government and legislation which confers benefits upon individuals who had no claims against the government prior to its passage. This distinction seems to have been first expressed by the Court of Appeals of the District of Columbia in the first Brown case, supra. _ I. do not find the distinction referred to in any decision -of the Supreme Court of the United States. On the contrary the rule of that court seems to be to strike down such contracts as against public policy if it appears to the court that they are likely to facilitate and encourage the corruption of the legislative body. Trist v. Child, 88 U.S. 441 , 21 Wall. 441 , 22 L.Ed. 623 . If this is the test, as I think it is, it would seem to follow that “debt legislation,” since it is ordinarily devoid of general public interest and, therefore, not subject to public scrutiny during the process of enactment, would provide a much greater opportunity for legislative corruption than "favor legislation” which ordinarily affec.ts a larger section of the public and is, therefore, subject to much greater public attention while being considered by the legislative body.

For eases in which contingent fee contracts have been uphold under similar circumstances see Spalding v. Mason, 161 U.S. 375 , 16 S.Ct. 592 , 40 L.Ed. 738 ; Winton v. Amos, 255 U.S. 373, 41 ,S.Ct 342, 65 L.Ed. 684 , and Hollister v. Ulvi, 199 Minn. 269 , 271 N.W. 493 .