1956 U.S. Tax Ct. LEXIS 107">*107
The United States, under
26 T.C. 948">*948 OPINION.
The Commissioner determined a deficiency in petitioners' income tax for 1952 in the amount of $ 14,876.67.
The issues for decision are whether petitioners are entitled to a deduction, as ordinary and necessary business expenses, of the following: (a) $ 28,638.72 paid by petitioners to the United States as double damages on a judgment rendered against petitioner David R. Faulk, arising out of a civil action brought by the Government for knowingly presenting false claims to the Government; (b) in the alternative, for one-half of the sum paid in satisfaction of such judgment; and (c) $ 3,442.52 1 paid by petitioners for attorneys' fees and other expenses incurred in said litigation.
1956 U.S. Tax Ct. LEXIS 107">*109 The petitioners, husband and wife, filed their joint return for 1952 with the director of internal revenue for the first Texas district, and therein claimed deduction of $ 28,638.72 as "Damages paid to U. S. Govt. July 23, 1952, as per Judgment in Civil Action No. 1372, U. S. Dist. Court, Western Dist. of Texas," and also $ 3,442.52 1 attorneys' fees and other expenses incurred in said civil action. All of these claimed deductions were disallowed by the Commissioner in his notice of deficiency.
Substantially all facts herein have been stipulated and same are hereby so found. From the stipulation of facts we quote in part as follows:
4. Petitioners have owned and operated a business known as Faulk Creamery located at San Antonio, Texas, for several years, and continued to operate such business during the year before the Court.
5. Prior to the institution of the civil action giving rise to the claimed deductions1956 U.S. Tax Ct. LEXIS 107">*110 in issue before the Court, a criminal action involving the identical 26 T.C. 948">*949 matters and issues later presented to the Federal District Court, was filed against petitioner David R. Faulk under Title 18, Section 80 (now Section 1001) of the United States Code in the United States District Court for the Western District of Texas, alleging the presentment of false claims against the Government and in the trial of that criminal case, said David R. Faulk was acquitted by instructed verdict.
6. Thereafter, a civil action under
7. At the close of the evidence the cause was submitted to the jury (the charge of the court and the verdict of the jury being attached hereto as Exhibit 3-C and incorporated herein by reference), and the court1956 U.S. Tax Ct. LEXIS 107">*111 rendered judgment on said verdict awarding to the United States a judgment for: A. $ 28,638.72 as "double the amount of damage sustained by it as determined by the jury." B. "forfeiture in the sum of $ 2,000 for each of the false vouchers presented * * * or a total of $ 10,000." C. "All costs in this behalf incurred."
8. On appeal to the United States Court of Appeals for the Fifth Circuit said judgment was affirmed. [
9. All of the claimed deductions in dispute were paid by petitioners solely in respect of the trial judgment and appeal of the civil action referred to. The $ 10,000 forfeiture was not claimed as a deduction.
10. The attorneys' fees and expenses were all reasonable in amount.
Paragraph 5 of the stipulation was received in evidence over respondent's objection as to its materiality, and a transcript of the record on appeal, including the evidence adduced therein, of the civil action in question was admitted over petitioners' objection. Both were admitted on the ground that they might shed some1956 U.S. Tax Ct. LEXIS 107">*112 light on the nature of the proceeding in which the judgment in question was recovered, for payment of which deduction is claimed.
shall forfeit and pay to the United States the sum of $ 2,000, and, in addition, double the amount of damages which the United States may have sustained by reason of the doing or committing such act, together with the costs of suit;
Petitioner had a contract with the Government for the delivery of fresh milk to Lackland Air Base near San Antonio, Texas, but delivered reconditioned and recombined milk. The jury found that of the 6 invoices submitted by petitioner to the Government, 5 were 26 T.C. 948">*950 knowingly false; hence the judgment for $ 10,000 as a "forfeiture." They also found that 70 per cent of the milk delivered by petitioner under his contract was recombined or reconditioned milk; and that 15 per cent of the milk delivered by petitioner1956 U.S. Tax Ct. LEXIS 107">*113 was not consumed by the troops because it was recombined or reconditioned milk. The District Court found that double the amount of damage sustained by the United States, as determined by the jury, totaled $ 28,638.72, and rendered judgment accordingly.
The fraud here perpetrated by petitioner against the Government was in aggravated form. The Court of Appeals for the Fifth Circuit, in affirming the judgment of the District Court, said:
There is further testimony to the effect that appellant deliberately engaged in deception and a series of fraudulent practices in order to escape being detected in his fraud; that such practices consisted in mislabeling the milk bottles so as to show that they contained "Grade A" milk when in fact he knew they contained "recombined milk", placing a few bottles of fresh milk in the rear of his delivery truck each day in order to deceive the Army veterinarian officer whose duty it was to inspect the milk before consumption by the troops; preparing the recombined milk at night in order to deceive an inspector for the Air Force sent to the plant for inspection purposes, threatening some of his employees with physical violence if they exposed him, and1956 U.S. Tax Ct. LEXIS 107">*114 finally delivering the recombined milk rather than the fresh milk called for by the contract and certifying in his claims that delivery was in accordance with specifications. * * * [See
Are petitioners entitled to deduct all, or, as alleged in their alternative plea, one-half of the $ 28,638.72 paid as double damages on the ground that such payment constituted "ordinary and necessary expenses paid in carrying on a trade or business" within the meaning of
Petitioners concede that the $ 10,000 is not deductible, alleging it to be a "penalty," but contend that the "double damages" are deductible, on the ground that they are "compensatory in nature." We do not agree.
Under the law and the facts here, as affecting the pending issue, we do not think the two payments are divisible. Both payments were based upon the violation of a Federal statute contained in the same section of the Code, both were embraced in the same suit, as the law required, and both payments resulted from and were attributable to1956 U.S. Tax Ct. LEXIS 107">*115 the same act of fraud perpetrated by the same taxpayer against his Government. We cannot believe that payment of damages for fraud committed by a taxpayer against his Government where, as here, the fraud was knowingly, deliberately, and personally perpetrated by the taxpayer, can be claimed by him in a tax proceeding as either ordinary or necessary business expense.
26 T.C. 948">*951 Sound public policy would forbid such a deduction. The allowance of the instant deduction would frustrate the sharply defined national policy proscribing the conduct of knowingly presenting false claims to the Government. Furthermore, on a factual basis we do not think that such expenses incurred under the circumstances and the facts of this case can be deemed either ordinary or necessary. Perpetration of fraud in the conduct of a business is neither ordinary nor necessary, and neither are the expenses resulting therefrom. "* * * the law will not recognize the necessity of engaging in illegal courses in the conduct of a business * * *."
Under the facts here we think it immaterial whether the expenditures in question1956 U.S. Tax Ct. LEXIS 107">*116 were "compensatory in nature" or not. Petitioners have cited no case sustaining their contention, while respondent quotes the following pertinent statement from
we have found no case which permits a taxpayer to successfully claim a deduction based on a sum which said taxpayer has paid the Government by way of damages which arose from a fraud which the said taxpayer perpetrated upon the Government.
Evidently petitioners also "have found no case" so holding, since none is cited.
The two cases in their brief, which petitioners stress as supporting their contention on this issue, are distinguishable, differing from the instant case both as to issues and facts.
In the first,
In striking contrast are the facts in the instant case, where the acts of the taxpayer were knowingly, deliberately, and willfully perpetrated with fraudulent intent. This is not an ordinary suit for failure to comply with a contract and resultant damages in breach of such contract. The statute in question, unlike the O.P.A. law, is concerned only with those claims whose genesis is fraudulent and where such fraud is practiced against the Federal Government.
26 T.C. 948">*952 It is well established that payment of a judgment for willful violation of the O. P. A. law is not deductible.
Petitioners' second case,
In reply to this case respondent cites a later case,
Under the law and the facts of this case we hold that the attorneys' fees and other costs paid by petitioners in defense of the suit brought by the Government, wherein the judgment in question was obtained, are not deductible. The same reasons given by us in denying the deductibility of the $ 28,638.72 also apply to the attorneys' fees and expenses incident to the litigation incurred by petitioners.
On this issue petitioners rely on
Furthermore, the Supreme Court, in the
We agree with respondent that the facts of this case are sufficiently strong to invoke the doctrine announced in
It is true that neither the tax statute nor the treasury regulations condition deductibility upon the lawful character, either directly or remotely, of the expenditure made. * * * But, in the nature of things, public policy must narrow the field of allowable deductions which rest as they do upon legislative indulgence.