Du Pont v. Deputy

• Decision Date: 21 February 1938
• Citation: 22 F. Supp. 589
• Parties: DU PONT v. DEPUTY, Collector of Internal Revenue.
• Court: U.S. District Court — District of Delaware

22 F. Supp. 589

DU PONT v. DEPUTY, Collector of Internal Revenue.

District Court, D. Delaware.

February 21, 1938.

COPYRIGHT MATERIAL OMITTED

Aaron Finger (of Richards, Layton & Finger) of Wilmington, Del., James S. Y. Ivins, Percy W. Phillips, and Laurence Graves (of Ivins, Phillips, Graves & Barker), all of Washington, D. C., for plaintiff.

John J. Morris, Jr., U. S. Atty., of Wilmington, Del., Mason B. Leming, E. J. Dowd, and T. H. Lewis, Jr., Sp. Attys., Bureau of Internal Revenue, all of Washington, D. C., James W. Morris, Asst. to Atty. Gen., Department of Justice, and Andrew D. Sharpe and Lester L. Gibson, Sp. Assts. to Atty. Gen., Department of Justice, for defendant.

BIGGS, Circuit Judge.

The plaintiff, Pierre S. Du Pont, has sued Willard F. Deputy, Collector of Internal Revenue for the District of Delaware, pursuant to the provisions of section 3226 of the Revised Statutes, as amended by Act June 6, 1932, c. 209, § 1103(a), 47 Stat. 286, 26 U.S.C.A. §§ 1672-1673, to recover income taxes assessed against the plaintiff for the year 1931, in the amount of $142,466.79, together with interest thereon in the amount of $29,884.85, comprising a total of $172,351.64.

At the time of the trial a stipulation, duly entered into by the parties, was filed with this court, whereby it was agreed by the defendant that the plaintiff was entitled to a judgment of $54,439.52 upon one of the issues involved herein and would be entitled to a judgment in the sum of $172,351.64 if he was held to be successful upon the questions presented by the remaining issue.

That issue can be stated broadly as follows: Is the plaintiff entitled to certain deductions claimed by him in computing his net income for the taxable year in question, viz., 1931? To understand the question presented it is necessary to give a brief statement of the facts involved.

Following the end of the World War, the plaintiff, as an individual the largest beneficial owner¹ of the stock of the E. I. Du Pont De Nemours & Company, aware that the company would be compelled by changing circumstances to engage in business other than the manufacture of explosives, felt, as did other responsible heads of the company, that a new management should be put in charge of its peace-time affairs. As a result, a new executive committee, comprising nine members, was created. The responsible officers of the Du Pont Company, including the plaintiff, felt it to be essential that these nine men should be compensated not only by way of salaries and bonuses, but also that each of them should have that interest in the future success of the company best achieved by stock ownership. It was first proposed that the nine executives should receive each 1,000 shares of the stock of the company as compensation for future services, but since the law of Delaware forbade such a course, another plan was worked out, as follows: After discussion and the agreement of all concerned, the plaintiff undertook to sell to the nine committeemen each 1,000 shares of the common stock of the Du Pont Company, at an agreed price just under book value, viz., at a price of $320 per share.² It should be noted that the transaction referred to occurred before the listing of the stock of the Du Pont Company under the New York Stock Exchange. Testimony was given at the trial of this cause indicating that the market for the common stock of the Du Pont Company was very thin and the purchase of the 9,000 shares would have augmented substantially the price per share. The Du Pont Company loaned to each of the committeemen the necessary funds to purchase his aliquot portion of the stock, and the plaintiff received the purchase price stipulated by him. In short, the plaintiff sold 9,000 shares of the common stock of the Du Pont Company to the nine committeemen at a price of $320 a share and received the proceeds therefrom.

The sale just described was a short sale, for at this time the plaintiff was not the legal owner of sufficient stock to consummate the transaction. He was, however, the president and a director of Christiana Securities Company and the holder of a very substantial block of the stock of that company. Pursuant to contract entered into between the plaintiff and the Christiana Company upon December 23, 1919, this company loaned to the plaintiff 9,000 shares of the common stock of the Du Pont Company, which were in fact the shares sold by him to the members of the executive committee. By the agreement just referred to the Christiana Company required that the 9,000 shares of stock so loaned by it to the plaintiff should be paid back to it in kind within ten years and, further, that the plaintiff pay to the Christiana Company sums equivalent to all dividends which might be paid by the Du Pont Company upon the 9,000 shares of stock so loaned until the loan was repaid. It should be here noted that the directors of the Christiana Company in the resolution authorizing the loan of the stock to the plaintiff recited that Christiana Securities Company was the principal stockholder of the Du Pont Company and as such was deeply interested in the success of that company. The contract of December 23, 1919, was modified subsequently to the extent that the plaintiff was required to reimburse and did in fact reimburse the Christiana Company for federal income taxes imposed upon that company by reason of the receipt of the dividends upon the 9,000 shares of stock paid to it by the plaintiff in accordance with the contract.³

By March 9, 1921, the stock of the Du Pont Company had declined largely in value. The bargain made by the nine committeemen had become a disadvantageous one and was the subject of considerable discussion. In a memorandum from Irenee Du Pont to the plaintiff, written about March 10, 1921, the following appears: "From the Committeemen's point of view, each has made a bad bargain. From the Company's point of view, the bargain was a bad one, because certainly a majority of the Committeemen are more or less disturbed over their financial condition * * *." The plaintiff thereupon, by letters written by him to each of the committeemen, made plain that he had no intention of making any profit upon the sale of the 9,000 shares of Du Pont Company stock to them and proposed to assign to each of the committeemen 400 shares of stock of the Christiana Company, possessing value of $160,000, but with an option reserved in the plaintiff to enable him to redeem these shares by payment of the sum of $160,000 to the committeemen at the time of the maturity of the loans made to them by the Du Pont Company and heretofore referred to. This offer was accepted by the committeemen, and the stock of the Christiana Company was assigned to them by the plaintiff in accordance with the terms of the letters.

As the ten-year period, dating from December 23, 1919, drew to a close, the plaintiff, upon October 25, 1929, entered into an agreement with Delaware Realty & Investment Company whereby that company undertook to loan to the plaintiff the necessary shares of Du Pont common required by him to repay his loan of stock to the Christiana Company. It should be here noted that the contract of October 25, 1929, between the plaintiff and the Delaware Company, recited that the plaintiff was not "at this time contemplating the closing of the short sale transaction of December, 1919. * * *"

The terms of the plaintiff's contract with the Delaware Company provided that he would return the Du Pont Company stock borrowed from it in kind within ten years after October 25, 1929, would pay to it an amount equivalent to all dividends declared by the Du Pont Company upon the shares borrowed, and would reimburse the Delaware Company for all taxes paid by it by reason of the receipt by it from the plaintiff of the sums equivalent to the dividends declared upon the stock borrowed. In 1931, the taxable year in question, the plaintiff paid to the Delaware Company the sum of $567,648, being the amount equivalent to the dividends paid by the Du Pont Company upon the shares for which he was then indebted.⁴ In addition thereto, the plaintiff paid to the Delaware Company the sum of $80,063.56, which was in fact the amount of federal income tax imposed upon the Delaware Company by reason of the payments equivalent to the sum of declared dividends which it had received from the plaintiff. The total of these two items, $647,711.56, is the amount of the deduction to which the plaintiff claims he is entitled in the suit at bar. Whether the plaintiff is or is not entitled to such deduction is the precise issue here presented.

The facts in the case at bar have been largely stipulated and no pertinent facts, other than what may be described as the intent or purpose of the plaintiff in embarking upon the course of conduct and the transactions here involved, are in controversy.

The Questions of Law Presented.

The plaintiff makes five contentions. They may be summed up as follows: The sums claimed by way of deduction are deductible because there were (1) ordinary and necessary business expenses; (2) losses sustained during the taxable year, 1931, incurred in the plaintiff's business; (3) payments required to be made by the plaintiff as a condition to the continued use of property in which the plaintiff had no equity; (4) interest on the indebtedness of the plaintiff; or (5) if not losses sustained in the plaintiff's business, were losses in a transaction entered into by the plaintiff for profit. If any one of these five contentions is deemed to be valid by the court, the plaintiff must prevail.

The pertinent statutory provisions are contained in section 23 of the Revenue Act of 1928, 45 Stat. 799, 26 U.S.C.A. § 23 and note, and are set out hereafter:

"§ 23. Deductions from gross income.

"In computing net income there shall be allowed as deductions:

"(a) Expenses. All the ordinary and necessary expenses paid or incurred during the taxable year in carrying...