Cooper Foundation v. Commissioner , 13 T.C. 209 ( 1949 )

Cooper Foundation, a Charitable Corporation of Lincoln, Nebraska, Petitioner, v. Commissioner of Internal Revenue, Respondent

Cooper Foundation v. Commissioner

Docket No. 18509

United States Tax Court

13 T.C. 209; 1949 U.S. Tax Ct. LEXIS 108;

August 16, 1949, Promulgated

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Decision will be entered under Rule 50.

1. Amount expended by corporation in successful effort to defeat jurisdiction over it and related corporations as parties defendant in suit against principal shareholder, held, deductible as reasonable and necessary business expense.

2. Corporation which paid total amount of litigation expense, arising from litigation involving it and related corporations, held, entitled to deduct amount paid in full as business expense.

J. Lee Rankin, Esq., for the petitioner.

George E. Gibson, Esq., for the respondent.

LeMire, Judge.

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LeMIRE

This proceeding involves deficiencies in income and excess profits taxes in the amounts of $ 65.39 and $ 19,405.26, respectively, for the year 1943 of J. H. Cooper Enterprises, Inc., a dissolved corporation. Petitioner is the sole transferee of the assets of J. H. Cooper Enterprises, Inc., and admits transferee liability for any deficiencies found to be due from that company.

The errors alleged by the petitioner are respondent's disallowance of a deduction for capital stock tax on the ground that it was not paid; respondent's disallowance of a deduction for repair expense on the ground that the expenditures were capital expense; respondent's determination of the amount of the deductible depreciation on certain equipment; and the respondent's disallowance of a deduction of $ 21,166.46 for legal expense on the ground that it was not a necessary or ordinary expense in the operation of the corporation's business. The petitioner waived the first three issues above at the hearing. The only issue remaining for adjudication is the correctness of respondent's disallowance of the claimed deduction for legal expenses.

Some of the facts were stipulated and are so found. The stipulation filed is incorporated herein by reference.

FINDINGS OF FACT.

On December 29, 1943, the petitioner herein, Cooper Foundation, a charitable corporation of Lincoln, Nebraska, acquired, as a liquidating dividend, all the assets of J. H. Cooper Enterprises, Inc., a Colorado corporation, hereinafter referred to as Enterprises, which was then dissolved. The tax returns of Enterprises for 1943 were filed with the collector of internal revenue for the district of Nebraska.

On March 23, 1933, Joseph H. Cooper entered into an agreement with the trustee in bankruptcy of Publix Enterprises, Inc., by which he took over and reorganized the Colorado theatre properties of the Mountain States Theatre Corporation. Publix Enterprises, Inc., at that time owned all the stock of Mountain States Theatre Corporation and had a claim against it of approximately $ 538,537.75. Cooper agreed to organize a corporation to hold and operate the Colorado theatres of Mountain States Theatre Corporation. The stock of the holding company was to be transferred to Regal Theatres, Inc., a Delaware corporation, in which Publix Enterprises, Inc., and Cooper each held 50 per cent of the stock. Publix Enterprises, Inc., was to assign its claim against Mountain States Theatre Corporation to Regal Theatres, Inc., and was to pay half of the acquisition costs of the Colorado theatre properties on demand.

Cooper later organized Enterprises, instead of Regal Theatres, Inc., to hold the Colorado theatres, pursuant to later agreement between him and Paramount Pictures, Inc., hereinafter called Paramount, successor to Publix Enterprises, Inc. Enterprises was the principal operating company, but Cooper also organized Interstate Theatres, Inc., a Colorado corporation, hereinafter called Interstate, to operate three theatres in Colorado Springs, Colorado, and Rialto, Inc., a Colorado corporation, hereinafter called Rialto, to hold title to real estate only.

During the ensuing seven years Cooper, through the corporations organized by him, developed the business successfully, but Paramount did not pay or assume any of the acquisition costs and did not assign the claim against Mountain States Theatre Corporation, as provided in the agreement of March 23, 1933. Paramount later demanded that Cooper transfer to it one-half of his stock in Enterprises, Interstate, and Rialto. By July 9, 1943, Cooper had assigned all of the stock of Enterprises and all of the stock of Rialto to Cooper Foundation. He retained ownership of one-half of the stock of Interstate, the remaining stock in that corporation being held by parties not here involved.

On August 18, 1943, Paramount filed a suit in the Supreme Court of New York County, New York, against Cooper, Enterprises, Interstate, and Rialto, demanding judgment determining its rights and directing the transfer to Paramount of one-half of the stock held by Cooper in the three corporations. Although all three corporations were Colorado corporations, with their entire business in Colorado, Paramount contended that they were doing business in New York and were amenable to process there. Cooper did not object to the jurisdiction of the New York court over his person, but the three corporate defendants removed the case to the United States District Court for the Southern District of New York. There they moved for dismissal of the case for lack of jurisdiction in New York. On both the motion for removal to the Federal court and the motion for dismissal, extensive oral arguments and briefs were submitted. Finally, after approximately fourteen months of litigation, the Federal District Court dismissed the proceeding and dismissed the appeal. No other action was ever brought against any of the three corporations by Paramount in any jurisdiction.

The entire expense of the litigation on behalf of the three corporate defendants on the jurisdictional question amounted to $ 21,166.46, all of which was paid by Enterprises and deducted as a business expense in its 1943 tax return. Cooper, personally and through his estate, paid a total of $ 23,610.47 for legal expenses incurred in defense of the suit against him by Paramount. No part of Cooper's personal expense was connected with the jurisdictional matter and no part of the expense paid by Enterprises was in connection with the personal suit against Cooper.

Although Paramount's suit was primarily against Cooper, personally, to compel transfer of title and possession of the stock interests which Paramount claimed, the three corporations were made parties defendant to the suit in order to subject them to the Federal Rules of Civil Procedure as parties to the action for the purpose of producing evidence in connection with the accounting matters of the suit, to subject them to the judgment of the court, and to compel them to recognize Paramount as the rightful owner of the stock on their record books.

The three corporate defendants resisted jurisdiction of the suit by Paramount in both the state court and the Federal District Court located in New York to avoid anticipated difficulty and expense of defending a suit outside the State of Colorado. Since Rialto held real estate only and took no part in theatre operations, it kept no records and had no employees with knowledge of the subject matter of the suit. Interstate was an operating company, operating three theatres in Colorado Springs, but paid Enterprises $ 103 per week for supervision and management services. It had only one employee who had any direct knowledge of the subject matter of the suit and maintained no substantial records material to the suit. As the principal operating company of its own theatres and those of Interstate, Enterprises maintained voluminous records which were material to the subject matter of the suit and most of its executive employees and managers had direct knowledge of the matters involved in the suit. Had it been necessary for corporate employees to testify in New York and to produce corporate records there, considerable expense and interference with the highly competitive business of the corporations would have resulted. After the suit was dismissed as to the three corporations, they were not parties to any further legal action by Paramount in any jurisdiction.

OPINION.

The only question for our determination is whether or not the legal expenses paid by Enterprises in 1943, in connection with resisting jurisdiction over itself, Interstate, and Rialto by New York courts of the suit by Paramount, were ordinary and necessary business expenses of the corporation. Respondent contends that the amount was expended as part of the defense of a suit over title to stock in the three corporations for the benefit of a stockholder, and consequently does not constitute business expense.

Generally, expenditures incurred in defense or protection of title to property are required to be treated as capital expenditures. See Safety Tube Corporation, 8 T.C. 757">8 T.C. 757; affd., 168 F.2d 787">168 F.2d 787. It is clear from the evidence in this proceeding, however that the corporations had no title or interest to defend or protect in the stock involved in the suit, since it all belonged to Cooper personally, and that they were only nominal parties defendant to the suit. Cooper undoubtedly benefited from the corporate litigation on the jurisdiction issue in the suit, but the course taken by the corporations in successfully resisting the jurisdiction of the New York courts was primarily for their own benefit to avoid further involvement in the suit, with its anticipated attendant difficulties and expense. There was no litigation over the title to the stock up to the point where the suit was dismissed as to the corporations. It was only over the jurisdictional question. Legal expenditures incurred in the removal and jurisdictional proceeding by the corporations can not be said to have been incurred either for the defense or protection of title to the stock or for Cooper's benefit, except in that it was of some incidental benefit to him. It is true that the corporations themselves had no direct interest in the outcome of the suit between Cooper and Paramount as to ownership of the stock, but they did have an interest in avoiding the consequences that might arise from their position as defendants in that suit.

The fact that this litigation was unusual in the affairs of the corporation does not prevent it from having a direct effect upon their business. Ordinary and necessary expenses incurred or paid during the taxable year in carrying on any trade or business are deductible under section 23 (a) (1) (A) of the Internal Revenue Code. Legal expenses in defense of suits attacking a taxpayer do not have to be habitual or normal in the sense that the same taxpayer would have to make them often, but may be unique in the life of the taxpayer, since they are accepted as the ordinary and necessary means of defense against attack. Welch v. Helvering, 290 U.S. 111">290 U.S. 111, 78 L. Ed. 212">78 L. Ed. 212, 54 S. Ct. 8">54 S. Ct. 8. Here, the corporations took a reasonable course of action in resisting jurisdiction of the suit in courts outside Colorado. In so doing they avoided possible serious interference with their business. Estimates of the expense and difficulties which might otherwise have resulted were necessarily speculative, but Enterprises' view that they might have been considerable was a reasonable one to take. We conclude that the legal expenses incurred and paid by Enterprises in connection with the Paramount suit are ordinary and necessary business expenses of the corporation. Kornhauser v. United States, 276 U.S. 145">276 U.S. 145, 72 L. Ed. 505">72 L. Ed. 505, 48 S. Ct. 219">48 S. Ct. 219.

Respondent contends in the alternative that if the legal expenses in question are held to be deductible as ordinary and necessary business expenses, not more than one-third of the total expenses of the litigation is deductible by Enterprises. Respondent argues that Interstate and Rialto were equally involved in the litigation with Enterprises and that the expenses should be apportioned equally between the three corporations instead of being borne entirely by Enterprises.

There is no evidence of any agreement among the three corporations which obligated Enterprises to pay the entire amount. However, the entire record shows that Enterprises was the principal operating company of the Colorado theatres and that the employees and records which might have become involved in the litigation if it were pursued further in New York were employees and records of Enterprises. Rialto was not an operating company and had neither employees nor records which might have been involved in the litigation. Interstate was an operating company, but it paid management fees to Enterprises for supervision and management services by it and had only one employee and no appreciable amount of records which would have been involved in the litigation. Enterprises alone had a sound basis for anticipating that a full trial of the case in New York would result in considerable expense and interference in its business. The principal benefit from the result of the litigation was to Enterprises. Benefits to Rialto from the litigation, if any, were negligible. Benefits to Interstate were slight and were compensated for by the weekly payments to Enterprises for management. Although some share of the expenditures could have been paid by the other corporations, the evidence is that payment of the entire amount by Enterprises was reasonable in view of the interrelationship of the corporations. We conclude that the entire amount of legal expenses, $ 21,166.46, was incurred and paid by Enterprises and was properly deductible by Enterprises as a business expense of 1943.

Decision will be entered under Rule 50.