service or benefit rendered to the petitioner by Stages in connection with petitioner's business. 130 F. 2d 136, 139.

In view of these conclusions, it is unnecessary to characterize the payment by petitioner as a capital expenditure or otherwise, or to decide whether if the record were complete petitioner and Stages should be treated as a [595] taxable entity for the claimed purpose. Cf. Moline Properties v. Commissioner, ante, p. 436.*

MR. JUSTICE JACKSON, dissenting:

Affirmed.

This taxpayer operated a bus system between Chicago and Los Angeles. It could not pick up intrastate passengers in California, as it did elsewhere, because the State denied foreign corporations permission to do so. In order to obtain local traffic to help carry the cost of operating the interstate buses, taxpayer organized a wholly-owned and dominated California subsidiary. This contented the local authorities, and it was granted permission to carry local business. It took over buses arriving at the state line, operated them in California, thus performing a part of the taxpayer's agreements of through carriage and benefiting from local traffic to reduce the cost. It was a common-sense business arrangement, for the purpose of making its business profitable.

The taxpayer made a contract with the subsidiary, by which the subsidiary undertook the service; the parent company became entitled to the profits and assumed the losses. The taxpayer agreed to reimburse the subsidiary for any operating deficit. This, too, was a common-sense business arrangement. To pay its wholly-owned subsidiary more would be pointless, for it would only come back. To pay it less would result in its bankruptcy to the injury of creditors. So the taxpayer agreed that the operating deficits should be the measure of its contractual obligation to the subsidiary.

There is no suggestion that this arrangement was for tax avoidance, or for that matter that it did not actually reduce taxpayer's costs and thus increase its tax liability. The Commissioner ruled, however, that the amount of operating deficit paid by the taxpayer was not a business expense..

[596] To require the Commissioner in all cases to allow a deduction so fixed might be turned by the unscrupulous to tax-evasion ends. It could then, through its controlled subsidiary, make expenditures not properly allowable as business expense, but get them allowed as part of the deficit assumed by contract. Of course the Commissioner is not obliged to allow this, or any other arrangement, when it is used as a cover for tax skullduggery. Examination of the items is open to the Commissioner. But this deduction has been denied, not for such reasons, but upon a legal theory which I think is erroneous.

The taxpayer took inconsistent positions: first, that the corporate entity of the subsidiary should be disregarded and the two companies taxed on a consolidated basis; second, that the amount was a proper deduction under the contract, which of course implies existence of two parties to contract. The Government, not to be outdone in the matter of inconsistency, denied the separate entity theory and also disregarded the contract, and argues to us "the contract of the tax

*Page 192 herein.

payer to make good Stages' operating deficits is one pervaded by the stockholder-corporation iela.ion. Any contribution to Stages under this contract must therefore be regarded as incident to the taxpayer's stockholder status." So the Government says the payment was not a compensation for services which the contract provides that it was, but was a “capital contribution” which the contract says it was not.

I think there is no merit in the taxpayer's theory that the Commissioner must disregard the corporate entity of the subsidiary. If a taxpayer itself creates and uses a corporation, he cannot require the Commissioner to say it isn't there.

But on the other hand, if the Commissioner says there are two entities, it would seem that they would be able to contract with each other, one to perform a service and the other to pay a price. The service may be, and often is, [597] one that the taxpayer could not perform for itself, but if it is hired to build up its business, I see no reason why its proper cost is not a business expense deduction. The price need not be a fixed one, but may be determinable by costs or other contingencies; but when fixed, its amount (barring use as a device to evade) is the amount of the deduction. Cost or "cost plus" is one of the Government's own methods of contracting. It is not an illicit method for a taxpayer to employ.

But it is urged that since the taxpayer could not itself pick up local business under California law, it cannot be the business of the taxpayer in a legal sense to have a subsidiary do so, and disbursements to have local business brought in are legally foreign to its business, although for its benefit. I do not suppose the taxpayer corporation can itself legally practice law or medicine, but I would suppose if it needed legal service for its business or thought it good business to supply medical attention to injured or ailing employees, the cost would be a business deduction, even though the agent was doing what the taxpayer could not legally do for itself. The taxpayer may not be authorized to run a newspaper or put up billboards, but if it contracted for services of those who are, in order to fill vacant seats in its buses, I do not suppose its cost would be disallowed for that reason.

This company has not violated the law, even of California. Indeed, it went to this trouble to comply with it. The fact that it used a subsidiary to benefit its business in areas where its own competence was lacking can hardly invalidate the arrangement, particularly since it is insisted that the subsidiary had separate legal and tax existence. If states create dummies, business men may utilize them so long as they keep within the law, and the function of the revenue laws is not to tell them how they shall manage business, but to see that what they do has proper tax consequences.

[598] Since the decision of this case the Tax Court has held in a very similar case that where a wholly-owned subsidiary exclusively performs services essential to the business of the parent corporation, advances made by the parent to meet the subsidiary's operating deficit are deductible as a business expense. Texas & Pacific Ry. Co. v. Commissioner, No. 105730, March 25, 1943. I think this is a correct rule. Judge Harron there avoids the force of this case only upon the ground that the parent corporation here could not itself engage in the business done in its behalf by the subsidiary. That distinc

tion is good enough to get the Tax Court away from a bad rule, but I see no reason why such a deduction should be available in case of an unnecessary subsidiary and be refused in the case of one needed to comply with state laws in making a profitable enterprise. I would

reverse.

The CHIEF JUSTICE and MR. JUSTICE MURPHY join in this dissent.

2. COMMISSIONER OF INTERNAL REVENUE v.

HEININGER

(320 U. S. 467. No. 63-Decided December 20, 1943)

1. Attorney's fees and other legal expenses, reasonable in amount, incurred by a taxpayer (a licensed dentist engaged in selling artificial dentures by mail) in resisting issuance by the Postmaster General of a "fraud order" which would destroy his business, and in connection with subsequent proceedings on judicial review, the final result of which was unsuccessful for the taxpayer, held, in computing income tax under the Revenue Acts of 1936 and 1938, deductible under § 23 (a) as "ordinary and necessary" expenses of the business. P. 472.

2. The policy of 39 U. S. C. §§ 259 and 732, which authorize the Postmaster General to issue fraud orders, will not be frustrated by allowance of the deduction. P. 474.

[468] 3. The Board of Tax Appeals was not required to regard an administrative finding of guilt under 39 U. S. C. §§ 259 and 732 as barring the deduction. P. 475.

4. Whether an expenditure is directly related to a business and whether it is ordinary and necessary are in most instances questions of fact, the decision of which by the Board of Tax Appeals is binding on the courts; but here the Board denied the claimed deduction not by an independent exercise of judgment but upon the erroneous view that denial was required as a matter of law. P. 475.

133 F.2d 567, affirmed.

CERTIORARI, 319 U. S. 740, to review the reversal of a decision of the Board of Tax Appeals, 47 B. T. A. 95, which affirmed the Commissioner's determination of a deficiency in income tax.

MR. JUSTICE BLACK delivered the opinion of the Court.

The question here is whether lawyer's fees and related legal expenses paid by respondent are deductible from his gross income under § 23 (a) of the Revenue Acts of 1936 and 1938 as ordinary and necessary expenses incurred in carrying on his business.1

[469] The fees and expenses were incurred under the following circumstances. From 1926 through 1938 respondent, a licensed dentist of Chicago, Illinois, made and sold false teeth. During the tax years 1937 and 1938 this was his principal business activity. His was a mail-order business. His products were ordered, delivered, and paid for by mail. Circulars and advertisements sent through the mail proclaimed the virtues of his goods in lavish terms. At hearings held before the Solicitor of the Post Office Department pursuant to U. S. C., Title 39, §§ 259 and 732, respondent strongly defended the quality of his workmanship and the truthfulness of every statement made in

1 Revenue Act of 1936, c. 690, 49 Stat. 1658.

"Sec. 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 on any trade or business,

Section 23 (a) of the Revenue Act of 1938, c. 289, 52 Stat. 460, is identical with § 23 (a) of the Revenue Act of 1936.

his advertisements, but the Postmaster General found that some of the statements were misleading and some claimed virtues for his goods which did not exist. Thereupon, on February 19, 1938, a fraud order was issued forbidding the Postmaster of Chicago to pay any money orders drawn to respondent and directing that all letters addressed to him be stamped "Fraudulent" and returned to the senders. Such a sweeping deprivation of access to the mails meant destruction of respondent's business. He therefore promptly sought an injunction in a United States District Court contending that there was no proper evidential basis for the fraud order. On review of the record that Court agreed with him and enjoined its enforcement. The Court of Appeals drew different inferences from the record, held that the evidence did support the order, and remanded with instructions to dissolve the injunction and dismiss the bill. Farley v. Heininger, 105 F. 2d 79. Respondent's petition for certiorari was denied by this Court on October 9, 1939. Heininger v. Farley, 308 U. S. 587.

During the course of the litigation in the Post Office Department and the courts respondent incurred lawyer's fees and other legal expenses in the amount of $36,600, admitted to be reasonable. In filing his tax returns for the years [470] 1937 and 1938 he claimed these litigation expenses as proper deductions from his gross receipts of $287,000 and $150,000. The Commissioner denied them on the ground that they did not constitute ordinary and necessary expenses of respondent's business. The Board of Tax Appeals 2 affirmed the Commissioner, 47 B. T. A. 95, and the Circuit Court of Appeals reversed and remanded. 133 F.2d 567. We granted certiorari because of an alleged conflict with the decisions of other circuits."

There can be no doubt that the legal expenses of respondent were directly connected with "carrying on" his business. Kornhauser v. United States, 276 U. S. 145, 153; cf. Appeal of Backer, 1 B. T. A. 214; Pantages Theatre Co. v. Welch, 71 F. 2d 68. Our enquiry therefore is limited to the narrow issue of whether these expenses were "ordinary and necessary" within the meaning of § 23 (a). In determining this issue we do not have the benefit of an interpretative departmental regulation defining the application of the words "ordinary and necessary" to the particular expenses here involved. Cf. Textile Mills Securities Corp. v. Commissioner, 314 U. S. 326, 338. Nor do we have the benefit of the independent judgment of the Board of Tax Appeals. It did not deny the deductions claimed by respondent upon its own interpretation of the words "ordinary and necessary" as applied to its findings of fact. Cf. Hormel v. Helvering, 312 U. S. 552, 555, 556. The interpretation it adopted was declared to be required by the Second Circuit Court's reversal of the Board's view in National [471] Outdoor Advertising Bureau v. Commissioner, 32 B. T. A. 1025.4

2 Section 504 (a) of the Revenue Act of 1942, c. 619, 56 Stat. 798, 957, U. S. C., Title 26, § 1100 changes the name of the Board of Tax Appeals to "The Tax Court of the United States."

3 Helvering v. National Outdoor Advertising Bureau, 89 F. 2d 878 (C. C. A. 2); Helvering V. Superior Wines & Liquors, 134 F. 2d 373 (C. C. A. 8).

Helvering v. National Outdoor Advertisement Bureau, supra, note 3. In that case the taxpayer had incurred legal expenses defending a suit begun by the United States to enjoin violations of the Sherman Act. It had successfully defended part of the charges against it, but had agreed to the entry of a consent decree of injunction as to the balance. The Board held that all of the legal expenses were ordinary and were proximately connected with the taxpayer's business, and that to allow them as deductions would not be

We

It is plain that respondent's legal expenses were both "ordinary and necessary" if those words be given their commonly accepted meaning. For respondent to employ a lawyer to defend his business from threatened destruction was "normal"; it was the response ordinarily to be expected. Cf. Deputy v. du Pont, 308 U. S. 488, 495; Welch v. Helvering, 290 U. S. 111, 114; Kornhauser v. United States, supra. Since the record contains no suggestion that the defense was in bad faith or that the attorney's fees were unreasonable, the expenses incurred in defending the business can also be assumed appropriate and helpful, and therefore "necessary." Cf. Welch v. Helvering, supra, 113; Kornhauser v. United States, supra, 152. The government does not deny that the litigation expenses would have been ordinary and necessary had the proceeding failed to convince the Postmaster General that respondent's representations were fraudulent. Its argument is that dentists in the mail order business do not ordinarily and necessarily attempt to sell false teeth by [472] fraudulent representations as to their quality; that respondent was found by the Postmaster General to have attempted to sell his products in this manner; and that therefore the litigation expenses, which he would not have incurred but for this attempt, cannot themselves be deemed ordinary and necessary. think that this reasoning, though plausible, is unsound in that it fails to take into account the circumstances under which respondent incurred the litigation expenses. Cf. Welch v. Helvering, supra, 113, 114. Upon being served with notice of the proposed fraud order respondent was confronted with a new business problem which involved far more than the right to continue using his old advertisements. He was placed in a position in which not only his selling methods but also the continued existence of his lawful business were threatened with complete destruction. So far as appears from the record respondent did not believe, nor under our system of jurisprudence was he bound to believe, that a fraud order destroying his business was justified by the facts or the law. Therefore he did not voluntarily abandon the business but defended it by all available legal means. To say that this course of conduct and the expenses which it involved were extraordinary or unnecessary would be to ignore the ways of conduct and the forms of speech prevailing in the business world. Cf. Welch v. Helvering, supra, 115. Surely the expenses were no less ordinary or necessary than expenses resulting from the defense of a damage suit based on malpractice, or fraud, or breach of fiduciary duty. Yet, in these latter cases legal expenses have been held deductible without regard to the success of the defense."

[473] 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 § 23 (a) in order that tax deduction consequences might not frustrate sharply defined national or state policies proscribing particular types of conduct. A

against public policy. The Circuit Court reversed as to that portion of the expenses attributable to the consent decree. See also Helvering v. Superior Wines & Liquors, supra, Note 3. where the Board was reversed for allowing a taxpayer in the liquor business to deduct lawver's fees incurred in connection with a compromise of liability for civil penal. ties assessed for improper bookkeeping under U. S. C., Title 26, §§ 2857 et seq. 5 See Note 8, infra.

Malpractice: C. B. V.-1. 226: Fraud: Helvering v. Hampton, 79 F. 2d 358: Breach of fiduciary duty: Keeler v. Commissioner, 23 B. T. A. 467. See also the examples of deductible expenses set forth in Kornhauser v. United States, 276 U. S. 145.