Hales-Mullaly v. Commissioner of Internal Revenue

• Decision Date: 06 November 1942
• Docket Number: No. 2565.,2565.
• Citation: 131 F.2d 509
• Parties: HALES-MULLALY, Inc., v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Tenth Circuit

131 F.2d 509 (1942)

HALES-MULLALY, Inc., v. COMMISSIONER OF INTERNAL REVENUE.

No. 2565.

Circuit Court of Appeals, Tenth Circuit.

November 6, 1942.

Chas. H. Garnett, of Oklahoma City, Okl., for petitioner.

L. W. Post, of Washington, D. C. (Samuel O. Clark, Jr., Asst. Atty. Gen., Sewall Key, J. Louis Monarch, and Arthur Manella, Sp. Assts. to Atty. Gen., on the brief), for respondent.

Before PHILLIPS, BRATTON, and HUXMAN, Circuit Judges.

BRATTON, Circuit Judge.

The question is whether Hales-Mullaly, Inc., herein called petitioner, was authorized in computing its net income to deduct as expenses or losses amounts paid in settlement of pending litigation and for attorneys fees and other expenses incurred in connection with the litigation.

Harbour-Longmire Company, a corporation, was engaged in the mercantile business in Oklahoma City, and dealt at wholesale and retail in furniture, furnishings, equipment and appliances of various kinds. W. T. Hales was a large stockholder in the corporation and was its president prior to 1935. J. R. McBrayer entered its employ in 1917, later became a stockholder, and was its secretary from January, 1923, to September, 1935. George A. Hales and Carter Mullaly were employees until August, 1935. George A. Hales was the son and Carter Mullaly the son-in-law of W. T. Hales. In 1934, W. T. Hales and McBrayer became dissatisfied with the conduct of the business; and in May or June, 1935, Hales sold all of his stock and McBrayer part of his to the company. By letter dated September 5 or 6, 1935, the company agreed to sell to George A. Hales and Mullaly its entire stock of household appliances in the wholesale division, such as refrigerators, radios, and ranges, together with parts and accessories. Three or four days later, on September 9, petitioner was incorporated. W. T. Hales, George A. Hales, W. T. Hales, Jr., Mullaly and McBrayer were its incorporators and constituted its first board of directors. On September 12, three days after petitioner was organized, Harbour-Longmire and George A. Hales and Mullaly entered into a formal contract for the sale of the entire stock of household appliances in the wholesale division, certain franchises, and the good will of the company, as outlined in the letter. The purchase price of $47,566.51 was paid with checks of petitioner, and the merchandise was conveyed to George A. Hales and Mullaly but they later transferred it to petitioner. From the time petitioner was organized, George A. Hales and Mullaly merely acted for it in connection with the transaction.

In December, 1935, five former employees of Harbour-Longmire filed separate suits against that company for the recovery of alleged unpaid commissions. The total amount claimed in the several suits was in excess of $27,500. At the time of the institution of the suits, these individuals were employees of petitioner. In March, 1936, Harbour-Longmire instituted in the state court an action against W. T. Hales, George A. Hales, Mullaly, McBrayer, the five former salesmen, and petitioner. It was alleged that sometime between the middle of the year 1934 and 1935, W. T. Hales, George A. Hales, Mullaly and McBrayer formed a conspiracy to injure the wholesale business of plaintiff including its good will, and procure for themselves such business and good will, together with the franchises which plaintiff had in connection therewith; that the five former employees later joined the conspiracy; that certain overt acts were committed in furtherance of it; that petitioner was organized for the purpose of taking over such business and good will and franchises when they should be procured by the conspirators, and that it did so; and that plaintiff had suffered damages in the sum of $1,096,739.53. Judgment was sought in that amount. The parties to all six of the cases agreed upon a settlement. The consideration for the settlement was the satisfaction by petitioner of the amounts claimed by the former employees on the basis of sixty per cent of the amount claimed. Petitioner paid the former employees $16,585.33, paid its attorneys in the damage suit $35,000 as compensation for their services, and paid other expenses in the sum of $202.75, aggregating $51,788.08.

In making its income tax return for the fiscal year ended August 31, 1937, petitioner claimed deductions for these expenditures as ordinary and necessary expenses in carrying on its business; the Commissioner of Internal Revenue ruled that such expenditures were not thus deductible; on redetermination, the Board of Tax Appeals sustained the Commissioner; and petitioner brought the proceeding here on review.

Section 22(a) of the Revenue Act of 1936, 49 Stat. 1648, 1657, 26 U.S.C.A. Int.Rev.Acts, page 825, provides that "gross income" shall include "gains, profits, and income derived from * * * businesses, commerce, or sales, or dealings in property, whether real or personal * * *; also * * * the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever." The broad language of the provision clearly indicates a purpose on the part of Congress to exert the full measure of its taxing power within the categories enunciated. Helvering v. Clifford, 309 U.S. 331, 60 S.Ct. 554, 84 L.Ed. 788. And deductions from gross income are not a matter of right. They are a matter of legislative grace, and a taxpayer claiming a deduction must bring himself squarely within the terms of a statute expressly authorizing it. New Colonial Ice Co. v. Helvering, 292 U.S. 435, 54 S.Ct. 788, 78 L.Ed. 1348; White v. United States, 305 U.S. 281, 59 S.Ct. 179, 83 L.Ed. 172; Deputy v. Du Pont, 308 U.S. 488, 60 S.Ct. 363, 84 L.Ed. 416.

Petitioner relies on section 23(a) of the Revenue Act, 26 U.S.C.A. Int.Rev. Acts, page 827, supra, for the deductions as expenses. The pertinent part of the section provides that "In computing net income there shall be allowed as deductions: * * * All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, * * *." The statute does not authorize a deduction for every expense paid or incurred. It expressly limits the taking of deductions to expenses which are ordinary and necessary in carrying on the trade or business. An expense may be...