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Commissioner of Internal Revenue v. Textile Mills Securities Corporation.

December 7, 1940


On Petition for Review of Decision of the United States Board of Tax Appeals.

Author: Biggs

Before BIGGS, MARIS, CLARK, JONES, and GOODRICH, Circuit Judges.

BIGGS, Circuit Judge.


Textile Mills Securities Corporation, the respondent taxpayer, is a Delaware corporation. Its charter is not in evidence, but it is stipulated that the taxpayer's business activities included trading in securities, investing in properties and acting as an agent for foreign and domestic principals. It also appears that all of the taxpayer's officers had connections either by way of official position or stock ownership in one or more textile manufacturing corporations. These officers were in touch with german textile corporations whose properties had been seized by the Alien Property Custodian during the first World War under the provisions of the Trading with the Enemy Act, 50 U.S.C.A. Appendix. In 1924 the taxpayer was employed by these German interests to represent them in the United States with the object of presenting their cause to Congress, and the ultimate recovery by the claimants, under anticipated legislative enactments, of their properties or compensation therefor. The properties had an estimated aggregate value of $60,000,000. Under the terms of the contracts under which the taxpayer was employed, in the event of success, the taxpayer was to receive as compensation ten per centum of the amount or value of the properties recovered. The expenses and costs incident to the undertaking were to be borne by the taxpayer. The obligations created by these contracts of retainer were to cease at the close of the Second Session of the Sixty-Ninth Congress unless the legislation sought had been enacted prior to adjournment.

The taxpayer worked vigorously to procure the desired legislation. It employed various persons and organizations, including the Ivy Lee organization, Warren F. Martin, J. Reuben Clark and F. W. Mondell. The Lee organization took charge of publicity, made arrangements for speeches and kept in touch with the press to the end that there might be editorial comment and news items. We think that it may be assumed with fairness that these news stories and editorials were to be favorable to the proposed legislation. Mr. Martin, who had been a former Special Assistant to the Attorney General, and Mr. Clark, who had been a former solicitor in the State Department, prepared brochures entitled, respectively, "Status of Ex-Enemy Property, Interpretation of Treaties and Constitution" and "American Policy Relative to Alien Enemy Property". The last is a comprehensive study of the history of the treatment of persons and property in war. Mr. Mondell, who is an attorney and a former member of Congress, was employed by the taxpayer to make proposals and suggestions to members of Congress to promote the speedy passage of the desired legislation. Mr. Mondell also appeared as counsel in hearings before the Alien Property Custodian and certain tribunals on behalf of the taxpayer's clients.

A bill for the settlement of war claims was introduced into and passed by the House of Representatives during the Second Session of the Sixty-Ninth Congress, but did not pass the Senate prior to adjournment. Before the beginning of the First Session of the Seventieth congress, the taxpayer negotiated new contracs with its clients substantially similar in terms to those which had terminated except for the fact that these new contracts provided for the payment of 3% of the amount or value of property recovered by the claimant and for an additional 2% of the money or property paid over by the United States within one year after the enactment of favorable legislation. In short, the contingent compensation was reduced from 10% of the recovery to a maximum of 5% of the recovery. The new contracts provided that the taxpayer should pay the costs and expenses incurred by it in the performance of its obligations under the contracts. Messrs. Lee, Martin, Clark and Mondell continued their efforts on behalf of the taxpayer. The Seventieth Congress passed the "Settlement of War Claims Act of 1928", 45 Stat. 254, 50 U.S.C.A. Appendix, §§ 9, 10, 20 et seq. At this time the services of all the persons named except Mr. Mondell terminated. Mr. Mondell continued to render services during the remainder of the year 1928 and thereafter. His services may be characterized as purely legal and consisted of appearances and arguments before the Alien Property Custodian and certain tribunals.

The taxpayer paid to the four men named various sums for their services and reported a net loss for the year 1929 of $101,405.56 and a net loss of $134,797.93 for the year 1930. We are concerned only with the year 1931 for the taxpayer pursuant to statutory authority carried forward to that year its net loss for 1929 and 1930, resulting in a net loss for 1931 of $7,615.15. The Commissioner refused to accept the losses claimed, disallowing as deductions the sums paid or credited by the taxpayer to Messrs. Lee, Mondell, Martin and Clark for the services performed by them. The Commissioner now concedes that the amounts credited to Mr. Mondell in 1929 were for services rendered "in connection with particular claims of petitioner's principal, after the enactment of the 'Settlement of War Claims Act of 1928'", in other words was compensation for legal services, not for procuring legislation, and therefore were properly deductible. The taxpayer claimed that the sums paid or credited to Messrs. Lee, Martin and Clark were deductible as ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business as provided by Section 23(a) of the Revenue Act of 1928, c. 852, 45 Stat. 791, 26 U.S.C.A. Int. Rev. Acts, page 356, and were not prohibited by Article 262 of Treasury Regulations 74 as promulgated under that act. The Commissioner contended to the contrary. The Board held in favor of the taxpayer*fn1 and the petition at bar followed.

The Law.

It should be observed that a contract for allegedly procuring the very legislation here involved was twice passed upon by the Court of Appeals for the District of Columbia in two cases, viz., 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, certiorari denied 307 U.S. 640, 59 S. Ct. 1038, 83 L. Ed. 1521, the court having before it a suit brought by an attorney to collect a contingent fee for services rendered by him in part in promoting the remedial legislation. In the first case cited the court held the contract to be void as against public policy, stating, page 412 of 78 F.2d, that there is " * * * a general condemnation of contracts for the procuring of legislation, especially where the legislation is remedial and provides for the assertion of claims against the government, and the contract is for a contingent portion of a claim that may be given legal status through success in securing the legislation. Such contracts are illegal as tending to corrupt by improper influnce the integrity of our political institutions. It is incumbent, therefore, upon the courts to pronounce void any such contract in which the ultimate or probable tendency would be to corrupt or mislead the judgments of legislators in the performance of their duties", citing Marshall v. B. & O.R. Co., 16 How. 314, 14 L. Ed. 953.While the decision in Marshall v. Baltimore & Ohio Railroad Company was based in part upon the concealment of the lobby and the lobbyist, the general principles there enunciated are applicable to the case at bar for in our opinion those principles have not been modified by the decision in Steele v. Drummond, 275 U.S. 199, 48 S. Ct. 53, 72 L. Ed. 238. In the case last cited the Supreme Court pointed out that Drummond was not employed by Steele or the railroad company to secure the passage of the desired ordinance, but was himself interested in that very end as an owner of property.

The contracts between the taxpayer and its clients were to procure "favor legislation" as distinguished from "debt legislation".See the cases cited, page 229 of 78 F.2d, note 7 to Brown v. Gesellschaft Fur Drahtlose Telegraphie M. B. H., supra. Compensation for procuring the legislation was upon a contingent basis. In the light of both of these considerations, the contracts were null and void. The services performed by the taxpayer and its agents were rendered without suggestion of corruption and, with the exception hereinafter referred to, were not unethical, but as was stated in Haxelton v. Sheckells, 202 U.S. 71, 79, 26 S. Ct. 567, 568, 50 L. Ed. 939, 6 Ann.Cas. 217, "The objection to them rests in their tendency, not in what was done in the particular case." Such contracts as were here made possess a tendency unduly to influence legislative action and to destroy the integrity of legislative institutions. The function of Congress in passing the War Claims Act was purely legislative. It was enacting a remedial statute and providing a method for the adjudication of claims thus created before another tribunal. A distinction is properly made between contracts for contingent compensation for the prosecution of a debt or contract claim even though such a debt or claim may require legislation and appropriation, and "favor legislation" which creates a debt or claim. The second is prohibited; the first is permissible provided the interest is disclosed and the methods employed are legitimate.

As found by the Board of Tax Appeals, the Lee organization was employed to handle matters of publicity, "including the making of arrangements for speeches, contacting the press, in respect of editorial comments, and news items." Obviously these news items and editorial comments did not appear under the stated sponsorship of the taxpayer or its clients. The reader of such news comments and editorials including members of Congress could not have known that they emanated from a source inspired by self-interest. Such practices tend to poison public opinion and should be condemned. See Marshall v. B. & O.R. Co., supra; Providence Tool Company v. Norris, 2 Wall. 45, 17 L. Ed. 868; 6 Williston on Contracts, p. 4879; 17 C.J. Contracts § 213. The services rendered by the Lee organization were in and of themselves not otherwise than contrary to public policy.

The taxpayer expended the sums paid to the three individuals named, and now sought to be deducted, in the execution of a void contract. In our opinion such expenditures cannot be deemed to be ordinary. They are outside the norm of ordinary business conduct.A proper construction of Section 23(a) requires its words to be given their "popular or received import". See Deputy v. DuPont, 308 U.S. 488, 493, 60 S. Ct. 363, 366, 84 L. Ed. 416, and Welch v. Helvering, 290 U.S. 111, 54 S. Ct. 8, 78 L. Ed. 212.Moreover, even if this were not so, the payment of moneys for carrying out a purpose contrary to public policy is by no means ordinary. The great weight of authority supports this view. See Burroughs Bldg. Material Co. v. Commissioner, 2 Cir., 47 F.2d 178; Chicago, R.I. & P. Ry. Co. v. Commissioner, 7 Cir., 47 F.2d 990, certiorari denied, 284 U.S. 618, 52 S. Ct. 7, 76 L. Ed. 527; Great Northern Ry. Co. v. Commissioner, 8 Cir., 40 F.2d 372, certiorari denied, 282 U.S. 855, 51 S. Ct. 31, 75 L. Ed. 757, and United States v. Sullivan, 274 U.S. 259, 47 S. Ct. 607, 71 L. Ed. 1037, 51 A.L.R. 1020.

Quite apart from the foregoing, however, we cannot perceive how the taxpayer's lobbying expenses under the circumstances of the case at bar can be deemed to be necessary expenses in the light of the principles enunciated by the Supreme Court in its decision in Kornhauser v. United States, 276 U.S. 145, 48 S. Ct. 219, 72 L. Ed. 505, and Deputy v. DuPont, supra, 308 U.S. page 494, 60 S. Ct. 363, 84 L. Ed. 416, for there is nothing contained in the stipulation of facts nor any finding by the Board that the services performed by the taxpayer or its agents were the moving or a contributing cause of the passage of the War Claims Act. We cannot perceive how proximate causation can be established between the efforts of lobbyists and the passage of desired legislation except where the efforts extend to actual corruption of individual members of a legislative body for, if the methods employed by the lobbyist be those of permissible persuasion, the legislative body still exercises its freedom of mind and independence of action. As that is the situation ordinarily to be presumed in the absence of a showing to the contrary, there is then interposed between the lobbyist and the law which he desires enacted an independent legislature. The business of the legislature remains the passage of legislation for the public good. It follows that the payments here sought to be deducted could not proximately have served the taxpayer's business and were, therefore, unnecessary as a matter of law. In a far truer sense they resulted proximately from the business of the United States.*fn2 Where the law thus determines the want of necessity for expenditures in the operation of a business, it is neither appropriate nor allowable for the Board of Tax Appeals or the courts to find otherwise in fact because of asserted special purposes or needs of the particular business.

The conclusion, that money spent for lobbying purposes is not deductible as an ordinary and necessary business expense within the intent of the Revenue Acts, is further confirmed by the implication to be derived from recurrent Treasury Regulations denying to corporations the right to deduct such expenditures as donations for business purposes. Thus, Article 262 of Regulations 74, promulgated under Sec. 23(n) of the presently applicable Revenue Act (1928), provides in part, that "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". A similar provision was contained in T.D. 2137, 17 Treasury Decisions, Internal Revenue (1915) (pp. 48, 57-58), later appearing as Article 562 of Regulations 45, promulgated under the Revenue Act of 1918. The same provision has appeared without change in regulations promulgated under the Revenue Acts of 1921, 1924, 1926, 1928, 1932, 1934, 1936 and 1938. See Article 562 of Regulations 62, 65 and 69, Article 262 of Regulations 74 and 77, Article 23 (o)-2 of Regulations 86 and Article 23 (q)-1 of Regulations 94 and 101. It may be argued that Article 262 of Regulations 74 is in excess of the Treasury's power to promulgate interpretive regulations for the more efficient administration of the Revenue Acts, in that, this particular regulation, which purports to interpret a statutory provision having to do with charitable contributions made by individuals, applies to corporations. Nevertheless, the regulation conforms in purpose with the congressional intent as restricted by the allowance of deduction for business expenses to such as are ordinary and necessary in law as well as in fact. This may not only be reasonably inferred from the legislative history of the repeated enactments of the particular statutory provision without congressional disapproval or rejection of the regulation but that such was and is the congressional intent has more lately been impliedly confirmed by express statutory enactment.

By Sec. 23(q) of the Revenue Act of 1936, c. 690, 49 Stat. 1648, 26 U.S.C.A. Int. Rev. Acts, pages 830, 831, Congress for the first time permitted corporations to deduct, within prescribed limits, donations for charitable uses if "no substantial part of the activities of [the donee] is carrying on propaganda, or otherwise attempting, to influence legislation" etc.*fn3 If money paid to lobbyists were an ordinary and necessary business expense to a corporation, within the intent and understanding of Congress, then the denial by Sec. 23(q) of the right to deduct a contribution when used by the donee for such inhibited purpose could serve no effective end, for, as a business expense, the expenditure would none the less be deductible under Sec. 23(a) of the Act of 1936, 26 U.S.C.A. Int. Rev. Acts, p. 827.Furthermore, the allowance of deduction for business expenses under Sec. 23(a) of the Act of 1936 is specified in the very same words used in Sec. 23(a) of the Act of 1928. Consequently, moneys spent for lobbying not being ordinary and necessary business expenses under Sec. 23(a) of the Revenue Act of 1936, as Sec. 23(q) clearly implies, such expenditures are likewise not ordinary and necessary business expenses under Sec. 23(a) of the Act of 1928. In expressly denying by Sec. 23(q) of the Act of 1936 any right to a corporate taxpayer to deduct contributions for lobbying, it was the evident intent of Congress to make sure by positive legislative direction that the privilege there granted to corporations of making deductible contributions for charitable uses should not be laid hold of by a taxpayer to gain a credit against tax liability for expenditures which were not, and never had been, deductible as business expense.

For the reasons stated, we conclude that the sums paid by the taxpayer to the three individuals referred to are not ordinary and necessary expenses paid or incurred in carrying on any trade or business. Accordingly, the Commissioner was right in disallowing the credits claimed for the sums so expended.

The Right of the Court to Sit En Banc.

This case was originally heard by three circuit judges but before its decision this court, by special order, directed that it be reheard by the court en banc, consisting of the five circuit judges of the circuit in active service. The case has now been heard and considered by the court en banc. The order for rehearing was entered pursuant to Rules 4 and 5 of this court, effective March 1, 1940, which are set out in a footnote.*fn4 The authority of a circuit court of appeals thus to provide for sittings to be held by all the circuit judges has been questioned in the Ninth Circuit.*fn5 We therefore, deem it important to consider this question. We begin its consideration with a brief reference to the history of the federal judicial system.

The Judiciary Act of September 24, 1789, 1 Stat. 73, set up three categories of federal courts, the Supreme Court, the circuit courts and the district courts, and these courts continued to exist as thus set up (except as to the circuit courts for the period from February 13, 1801, to July 1, 1802) until the effective date of the Judicial Code, January 1, 1912, 28 U.S.C.A. § 1 et seq., when the circuit courts went out of existence. The original scheme was for the Supreme Court to be held by justices appointed to it, the district courts to be held by district judges appointed to them, and the circuit courts to be held by supreme court justices and district judges sitting together. In 1802 provision was made for the definite assignment of the Supreme Court justices to the several judicial circuits. When thus assigned and holding circuit court they became known as circuit justices. See Sec. 605, Rev. St. 28 U.S.C.A. § 217. The law was that the circuit justice of the circuit and the district judge of the district in which a circuit court was held might hold the court together or either of them might hold it separately.

The burden upon the Supreme Court justices at circuit became too heavy and by the Act of April 10, 1869, c. 22, § 2, 16 Stat. 44, it was enacted "That for each of the nine existing judicial circuits there shall be appointed a circuit judge, who shall reside in his circuit, and shall possess the same power and jurisdiction therein as the justice of the Supreme Court allotted to the circuit." This provision was carried into Sec. 607 of the Revised Statutes. The circuit judges thus appointed soon became primarily responsible for holding the circuit courts, largely relieving the circuit justices of this work.

The business of the circuit courts continued to increase, particularly in the Second Circuit, and by the Act of March 3, 1887, c. 347, 24 Stat. 492, the President was directed to appoint for the Second Circuit "another circuit judge, who shall have the same qualifications and shall have the same power and jurisdiction therein that the present circuit judge, has under existing laws." By the Act of March 3, 1891, c. 517, § 1, 26 Stat, 826, the President was directed to appoint "in each circuit an additional circuit judge, who shall have the same qualifications, and shall have the same power and jurisdiction therein that the circuit judges of the United States, within their respective circuits, now have under existing laws." Thus after ...

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