Lilly v. Commissioner of Internal Revenue, 6204.

• Decision Date: 02 April 1951
• Docket Number: No. 6204.,6204.
• Citation: 188 F.2d 269
• Parties: LILLY et al. v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Fourth Circuit

188 F.2d 269 (1951)

LILLY et al. v. COMMISSIONER OF INTERNAL REVENUE.

No. 6204.

United States Court of Appeals Fourth Circuit.

Argued March 12, 1951.

Decided April 2, 1951.

Richard E. Thigpen, Charlotte, N. C. (Arthur M. Jenkins, Charlotte, N. C., on the brief), for petitioner.

I. Henry Kutz, Sp. Asst. to the Atty. Gen. (Theron Lamar Caudle, Asst. Atty. Gen., Ellis N. Slack and Lee A. Jackson, Sp. Assts. to the Atty. Gen., on the brief), for respondent.

Lehrich & Lehrich, New York City, on the brief for Association of Independent Optical Wholesalers as amicus curiae.

Before PARKER, Chief Judge, DOBIE, Circuit Judge, and WATKINS, District Judge.

DOBIE, Circuit Judge.

This is an appeal from a decision of the Tax Court of the United States sustaining the disallowance by the Commissioner of Internal Revenue of certain alleged "trade discounts" claimed by Thomas B. Lilly and Helen W. Lilly (hereinafter referred to as taxpayers), trading as the City Optical Company of Wilmington, North Carolina, totaling $61,601.95 and $60,021.65 for the years 1943 and 1944 respectively, and against Helen W. Lilly, trading as the Duke Optical Company, in the amounts of $6,568.87 and $4,798.35 for the years 1943 and 1944 respectively.

The facts are not disputed. Taxpayers, who are engaged in the business of grinding, fitting and selling eye glasses and spectacles, entered into oral contracts with various oculists whereby taxpayers agreed to pay the oculists one-third of the retail price of all eye glasses and spectacles purchased by patients sent to them by the oculists. The evidence shows that the oculists did not inform their patients of this rebate arrangement but such a disclosure was made only when it was specifically requested by individual patients.

The sole issue in this case is whether these rebates paid by taxpayers to the doctors were deductible under § 23(a) (1) (A) of the Internal Revenue Code, 26 U.S.C.A. § 23 (a) (1) (A), as "ordinary and necessary" business expenses.

We feel that the answer to this must be in the negative. As the courts have frequently said, the allowance of a deduction is a matter of legislative grace and not a matter of right. Deputy v. DuPont, 308 U.S. 488, 60 S.Ct. 363, 84 L.Ed. 416; White v. United States, 305 U.S. 281, 59 S.Ct. 179, 83 L.Ed. 172; City Ice Delivery Co. v. United States, 4 Cir., 176 F.2d 347. Once, therefore, the Commissioner has made a determination against deductibility, the burden is upon the taxpayer to prove the Commissioner wrong. Welch v. Helvering, 290 U.S. 111, 54 S.Ct. 8, 78 L. Ed. 212.

The wording of the statute that in order to be deductible, an expense must be "ordinary and necessary" is sufficiently broad to require interpretation by the courts. As we said in City Ice Delivery Co. v. United States, 4 Cir., 176 F.2d 347, 350, 351: "These be rather strong adjectives which the courts have often been called upon to define and apply." Through this process of judicial interpretation has been evolved the rule that no deduction should be allowed as "ordinary and necessary" which violates sharply defined public policy. Commissioner of Internal Revenue v. Heininger, 320 U.S. 467, 64 S.Ct. 249, 88 L.Ed. 171; National Brass Works v. Commissioner, 9 Cir., 182 F.2d 526; Commissioner of Internal Revenue v. Longhorn Portland Cement Co., 5 Cir., 148 F.2d 276; Rugel v. Commissioner, 8 Cir., 127 F.2d 393. We must examine these kickbacks in the light of this rule.

This court is not at all impressed with the argument that such an inquiry amounts to judicial legislation, for we are only interpreting what Congress meant by the use of the words "ordinary and necessary." As Mr. Justice Black said in Commissioner of Internal Revenue v. Heininger, 320 U.S. at page 473, 64 S.Ct. at page 253, 88 L.Ed. 171: "The Bureau of Internal Revenue, the Board of Tax Appeals, and 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."

In Winfield, Public Policy in The English Common Law, 42 Harv.L.Rev. 76 (1928), the author states (p. 97): "But the better view seems to be that the difficulty of discovering what public policy is at any given moment certainly does not absolve the bench from the duty of doing so. The judges are bound to take notice of it and of the changes which it undergoes, and it is immaterial that the question may be one of ethics rather than of law. The basis for their decision is `the opinions of men of the world, as distinguished from opinions based on legal learning.' Of course it is not to be expected that men of the world are to be subpoenaed as expert witnesses in the trial of every action raising a question of public policy. It is the judges themselves assisted by the bar, who here represent the highest common factor of public sentiment and intelligence."

"The relationship of patient and physician is to the highest possible degree a fiduciary one, involving every element of trust and confidence" Stryker, Courts and Doctors, (1932) p. 9.

To such a relationship, one uberrimae fidei, the oft-quoted words of Chief Judge (afterwards Mr. Justice) Cardozo, in Meinhard v. Salmon, 249 N.Y. 458, 464, 164 N.E. 545, 546, 62 A.L.R. 1, are peculiarly applicable: "Many forms of conduct permissible in a workaday world for those acting at arm's length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior. As to this there has developed a tradition that is unbending and inveterate." Quite germane, too, is the statement in 6 Williston on Contracts, (Rev.Ed.), 4907: "Clearly an agreement, for a secret consideration, to influence one with whom the promisor stands in a confidential relation is...