25 T.C. 43">*44 The respondent determined deficiencies in the income tax of petitioner in the amount of $ 11,821.77 for the year 1948 and $ 20,675.89 for the year 1949.

The questions are:

1. Is petitioner entitled to exclude from its gross income that portion of insurance commissions actually received by it which was equal to amounts that it subsequently paid to unlicensed automobile dealers and others for soliciting insurance?

2. If such amounts are not excludible from gross income, is the petitioner entitled to deduct these amounts as ordinary and necessary business expenses under section 23 (a) (1) (A) of the Internal Revenue Code of 1939?

3. Are amounts paid by petitioner during taxable years to absorb certain premium differences and to take care of errors made in advising customers of the cost of policies deductible as ordinary and necessary business expenses?

FINDINGS OF FACT.

A stipulation of facts filed by the parties is hereby adopted as part of the findings and is incorporated herein1955 U.S. Tax Ct. LEXIS 77">*79 by reference.

The petitioner is an Illinois corporation. Its principal office is located at 166 West Jackson Boulevard, Chicago, Illinois. Its income tax returns for the calendar years 1948 and 1949, and an amended return for 1948, were filed with the collector of internal revenue for the first district of Illinois.

Petitioner is engaged in the insurance brokerage business and operates an insurance agency. A substantial amount of its business during the taxable years was transacted with automobile dealers.

Under licenses granted by the State of Illinois, the automobile dealers or their representatives provided the purchasers of automobiles with fire, theft, and collision insurance which was acquired through nonresident underwriting insurance companies licensed to sell such insurance. Neither the dealers nor their representatives were licensed insurance agents, brokers, or solicitors for personal liability and property damage insurance under the laws and regulations of the State of Illinois.

In the latter part of 1947, officers of the petitioner met with various automobile dealers at the Lake Shore Club in Chicago and entered into 25 T.C. 43">*45 oral agreements pertaining to personal1955 U.S. Tax Ct. LEXIS 77">*80 liability and property damage insurance. The substance of each agreement was that in consideration for each dealer soliciting and sending applications for such insurance to the petitioner, it would pay to him, or his representative, a specific percentage of the gross premiums, varying to some extent as between dealers. Pursuant to these agreements the automobile dealers or their representatives, during the years 1948 and 1949, were paid by petitioner 15 per cent, 17 1/2 per cent, or 20 per cent of gross premiums on personal liability and property damage insurance business sent by them to the petitioner, and petitioner retained 10 per cent, 7 1/2 per cent, or 5 per cent, respectively, of the gross premiums.

Under written agreements between petitioner and insurance companies issuing policies for personal liability and property damage insurance, petitioner was required to remit to the companies 75 per cent of the gross premium on each policy and permitted to retain 25 per cent as its commission.

Each automobile dealer or his representative filled out a Boyle, Flagg and Seaman, Inc., application for personal liability and property damage insurance when an automobile was sold and sent1955 U.S. Tax Ct. LEXIS 77">*81 the application for such insurance, which was signed by the dealer and by the purchaser-applicant, to the petitioner. It in turn obtained the policies of insurance covering personal liability and property damage from an underwriting insurance company. In more than 99 per cent of the transactions the premiums were received by the petitioner from the dealers and not from the applicants. The dealers remitted the full gross premiums collected by them to the petitioner, and it paid the underwriting companies 75 per cent of these premiums. The percentage of gross premiums which the dealers were to receive pursuant to the oral agreements was deposited by petitioner each month in a special bank account which was carried in the name of an employee of the petitioner. The dealers were paid from this account. The petitioner also maintained a record in a separate book showing the percentage of the premium on each policy for personal liability and property damage insurance which each dealer was to receive. At the end of each month petitioner sent each dealer a statement showing the names of the insured, the gross premiums on policies solicited by them and placed with petitioner, and the 1955 U.S. Tax Ct. LEXIS 77">*82 portion of these premiums due it. A check was sent with each statement. Information returns on Form 1099 were filed by the petitioner with the Internal Revenue Service showing amounts paid to each dealer during each of the taxable years. The underwriting insurance companies knew that these amounts were being paid by petitioner.

Section 591 of chapter 73 of the Illinois Revised Statutes (in effect during 1948 and prior to August 12, 1949) provided that an agent or broker may pay money, commission, or brokerage, or give or allow 25 T.C. 43">*46 anything of value for or on account of solicitation of insurance only to licensed parties, and section 609 thereof provided that any person or corporation violating section 591 shall "in addition to any other penalty provided herein, upon conviction, be fined not less than fifty dollars ($ 50.00) nor more than one thousand dollars ($ 1,000.00) for each offense." The above-quoted penalty provisions were incorporated in section 1065.59 of chapter 73 of the Illinois Revised Statutes (in effect from August 12 to December 31, 1949, inclusive) and there were added thereto the words "or imprisoned in the county jail for not more than one (1) year or both."

1955 U.S. Tax Ct. LEXIS 77">*83 The petitioner knew that the payments made pursuant to its oral agreements with the automobile dealers violated the insurance code of the State of Illinois. However, such payments were a common practice in the insurance business in that State during 1948 and 1949 and the percentages of gross premium paid by petitioner were those generally used and were what the automobile dealers indicated would have to be paid for obtaining applications for personal liability and property damage insurance from their customers and sending such applications to petitioner. Petitioner believed that if it did not make such payments, the dealers would send their business to other agents or brokers.

In August of 1950 the petitioner discontinued its payments to the automobile dealers. In June of 1951 officers of petitioner were interrogated by officials of the State of Illinois about the payments. A hearing was held and petitioner received a reprimand. Its license has never been revoked.

In petitioner's income tax return for the year 1948 it claimed "Other Deductions" in the amount of $ 93,240.80, and in its return for the year 1949 it claimed "Other Deductions" in the amount of $ 109,361.78. Of the1955 U.S. Tax Ct. LEXIS 77">*84 amount of $ 93,240.80, $ 27,654.88 was claimed as a deduction for "Promotion Expenses," and of the amount of $ 109,361.78, $ 50,029.81 was claimed as a "Promotion Expense." In determining the deficiencies for the years 1948 and 1949, the respondent disallowed the amounts claimed in petitioner's returns for these years for promotion expenses.

$ 23,908.90 of the $ 27,654.88 claimed as promotion expense for 1948 and $ 46,085.28 of the $ 50,029.81 claimed as promotion expense for 1949 represented amounts paid to automobile dealers or their representatives pursuant to the oral agreements pertaining to personal liability and property damage insurance.

$ 2,428.79 of the $ 27,654.88 and $ 2,232.86 of the $ 50,029.81 represented amounts which the petitioner felt it was necessary to pay in the years 1948 and 1949 as small commissions to employees and individuals who directed customers to it for insurance. This was a common practice in the State of Illinois. The employees and individuals to 25 T.C. 43">*47 whom these payments were made were not licensed insurance agents, brokers, representatives, or solicitors during the years 1948 and 1949.

The remaining $ 1,317.19 of the $ 27,654.88 and $ 1,711.671955 U.S. Tax Ct. LEXIS 77">*85 of the $ 50,029.81 were expended by the petitioner to absorb certain premium differences and to take care of errors made in advising customers of the cost of policies. Occasionally the petitioner found it to be good business to absorb certain premium differences when writing a policy for a new customer and canceling an already existing policy with some other company. Also occasionally the cost of an insurance policy was erroneously quoted to a customer and the petitioner was thereafter advised of the mistake by the underwriting insurance company. It was then too late to go back to the customer and tell him a mistake had been made and that he should make a further premium payment. In such cases the petitioner forwarded the correct amount to the insurance company and charged the under-collection off as a promotion expense. Expenditures of the kind mentioned above were a common and usual practice in the State of Illinois during the years 1948 and 1949.

OPINION.

The petitioner contends that the portion of the premiums on personal liability and property damage insurance paid to the automobile dealers during the taxable years was at all times the property of the dealers and was excludible1955 U.S. Tax Ct. LEXIS 77">*86 from and not a part of its gross income for those years. In the alternative it contends that, if the payments to the dealers are includible in its gross income, they constituted proper deductions as ordinary and necessary business expenses under section 23 (a) (1) (A) of the Internal Revenue Code of 1939. ¹

1. Petitioner's argument in support of its first contention is that it engaged in a series of joint ventures with the automobile dealers, and that the portions of the gross premiums on personal liability and property damage insurance which the dealers received during the taxable years belonged to1955 U.S. Tax Ct. LEXIS 77">*87 them as members of these joint ventures and were not properly includible in its gross income. We do not agree. The petitioner had written contracts with underwriting insurance companies under the terms of which it was obligated to pay them 75 per cent of the gross premiums on policies placed with them 25 T.C. 43">*48 for personal liability and property damage insurance and was entitled to retain as its commission the remaining 25 per cent. In oral agreements with the dealers it promised to pay them a specified percentage of its commission in consideration for their services in soliciting personal liability and property damage insurance from automobile buyers and sending applications therefor to it. They acted as agents of the petitioner and paid to it the entire premium collected from the applicant for a policy. They were working for an agreed compensation measured by a percentage of gross premiums. They received this compensation regardless of whether the business operated at a profit, and were not entitled to a share in the profits as such. They acquired no proprietary interest in the business. They were not joint venturers with petitioner and there is no convincing evidence that1955 U.S. Tax Ct. LEXIS 77">*88 the dealers and the petitioner ever intended that the relationship between them should be that of a joint venture. Cf. Wm. J. Lemp Brewing Co., 18 T.C. 586, 597. The petitioner in its income tax returns correctly treated the premiums received from the dealers, as well as those received from its licensed agents, as part of its gross income. If petitioner is to be entitled to a tax benefit with respect to the amounts paid to the dealers, such benefit must be in the form of a deduction from gross income, which is considered hereinafter as the second issue.

Cases relied upon by the petitioner are distinguishable. We do not have here an instance where several persons agreed to participate in a business and to divide its income among themselves ( Horace Mill, 5 T.C. 691), or where a taxpayer acted as a mere conduit for receiving and passing on to another certain amounts in which he was thought to have no claim of right ( Lashells' Estate v. Commissioner, 208 F.2d 430 (C. A. 6)).

2. We now consider petitioner's alternative contention that the amounts paid by it to the automobile dealers for1955 U.S. Tax Ct. LEXIS 77">*89 soliciting and sending to it applications for personal liability and property damage insurance were deductible from gross income as ordinary and necessary business expenses.

There is no serious dispute between the parties as to the basic facts. The payments were made to the dealers by petitioner in the regular course of its business. During the years 1948 and 1949 it was a common practice for licensed agents and brokers doing business in Illinois to pay automobile dealers a percentage of their commission for sending them applications for personal liability and property damage insurance. By reason of their contacts with purchasers of new automobiles the dealers were in a position to solicit this insurance and send applications therefor to agents or brokers who would pay them the usual compensation.

25 T.C. 43">*49 The insurance code of Illinois forbids an agent or broker to pay money, commission, or brokerage, or give or allow anything of value, for or on account of the solicitation of contracts on property or risks in that State to anyone other than a duly licensed person. Violation of these provisions was punishable by fine, and, during the tax period here involved, the statute was 1955 U.S. Tax Ct. LEXIS 77">*90 made more severe by providing for fine or imprisonment or both. It is undisputed that the automobile dealers to whom petitioner made the payments here involved were not duly licensed agents or brokers within the meaning of the Illinois statute. The payments made to them, therefore, violated the insurance laws of Illinois, and the evidence discloses that petitioner was aware of this at the time they were made. ²

The petitioner contends that the1955 U.S. Tax Ct. LEXIS 77">*91 legality or illegality of the payments which it made to the dealers is not decisive of their deductibility as ordinary and necessary business expenses under section 23 (a) (1) (A), supra.

The respondent contends that the allowance of the payments as deductions under section 23(a)(1)(A) must be denied because they violated State law and because their allowance would "frustrate sharply defined national or state policies proscribing particular types of conduct." The quoted words, used by the Supreme Court in Commissioner v. Heininger, 320 U.S. 467">320 U.S. 467, 320 U.S. 467">473, 320 U.S. 467">474, and Lilly v. Commissioner, 343 U.S. 90">343 U.S. 90, are now recognized as a restriction upon the deduction of business expenses. Jerry Rossman Corporation v. Commissioner, 175 F.2d 711, 713 (C. A. 2); American Brewery, Inc. v. United States, 223 F.2d 43, 46 (C. A. 4); National Brass Works, Inc., 16 T.C. 1051, 182 F.2d 526, 530, 205 F.2d 104 (C. A. 9); Pacific Mills, 17 T.C. 705, 719, affirmed 207 F.2d 177, 181, 1821955 U.S. Tax Ct. LEXIS 77">*92 (C. A. 1). To the same effect as to losses, see Fuller v. Commissioner, 213 F.2d 102, 105 (C. A. 10).

Similar examples of payments, the allowance of which as deductions would "frustrate" Federal or State laws, are fines or penalties paid for violating them. ³Commissioner v. Longhorn Portland Cement Co., 148 F.2d 276 (C. A. 5), certiorari denied 326 U.S. 728">326 U.S. 728; Burroughs Building Material Co. v. Commissioner, 47 F.2d 178 (C. A. 2); Great Northern Ry. Co. v. Commissioner, 40 F.2d 372, 373 (C. A. 8); William F. Davis, Jr., 17 T.C. 549; Davenshire, Inc., 12 T.C. 958; 25 T.C. 43">*50 Bonnie Bros., Inc., 15 B. T. A. 1231, 1236. And in the same category, because they are either penalties or in the nature of penalties, are payments made because of willful violations of the Emergency Price Control Act of 1942. George Schaefer & Sons v. Commissioner, 209 F.2d 440 (C. A. 2); National Brass Works, Inc., supra;1955 U.S. Tax Ct. LEXIS 77">*93 Henry Watterson Hotel Co., 15 T.C. 902, affirmed 194 F.2d 539 (C. A. 6); Joseph Salzman, 21 T.C. 777; Julian Lentin, 23 T.C. 112. Cf. Bowles v. Farmers National Bank of Lebanon, Ky., 147 F.2d 425 (C. A. 6).

Had petitioner paid any fines or penalties for the violations in question, they plainly would not have been deductible by reason of the foregoing line of cases. However, we need not decide whether the deduction of the payments themselves to the automobile dealers must similarly be disallowed under those cases, for the1955 U.S. Tax Ct. LEXIS 77">*94 allowance of the deduction is in any event precluded by a different, although related, line of decisions.

Even though the payments were "ordinary" in the sense that it was the common practice of Illinois insurance brokers to make such payments, and even though they may have been thought to be "necessary" in the sense that the automobile dealers might not have referred their business to petitioner unless it made such payments, ⁴ the deduction must nevertheless be disallowed by reason of the decisions which construe the words "ordinary and necessary" so as to imply a condition that the payments themselves must not be illegal. Thus, it has often been held that expenditures which are wrong in themselves or which violate Federal or State law do not qualify as ordinary and necessary business expenses under the statute. See Gallatin Farmers Co. v. Commissioner, 132 F.2d 706 (C. A. 9); Rugel v. Commissioner, 127 F.2d 393 (C. A. 8); Raymond F. Flanagan, 47 B. T. A. 782; T. C. Nicholson, 38 B. T. A. 190, 199; Easton Tractor & Equipment Co., 35 B. T. A. 189;1955 U.S. Tax Ct. LEXIS 77">*95 The Lorraine Corporation, 33 B. T. A. 1158, 1166; Israel Silberman, 44 B. T. A. 600. It has been said that the basis for these holdings is that "the law will not recognize the necessity of engaging in illegal courses in the conduct of a business." National Outdoor Advertising Bureau, Inc. v. Helvering, 89 F.2d 878, 881 (C. A. 2). While the question of the deductibility of expenditures which violate a Federal or State law was not at issue in the Lilly case, the Supreme Court recognized (343 U.S. 90">343 U.S. at pp. 94-95) that such expenditures "by virtue of their illegality" might not be "ordinary and necessary" business expenses within the meaning of the statute. Petitioner has referred us to no authority to the contrary, and we therefore hold that the payments it made to unlicensed automobile dealers, and others, for 25 T.C. 43">*51 soliciting insurance for it in contravention of the insurance laws of the State of Illinois, are not deductible under section 23 (a) (1) (A).

1955 U.S. Tax Ct. LEXIS 77">*96 3. The amounts expended by petitioner during the taxable years to absorb certain premium differences and to take care of errors made in advising customers of the cost of policies qualify, we think, as ordinary and necessary business expenses. The respondent erred in disallowing their deduction as such.

Decision will be entered under Rule 50.