*1115 Payments made by petitioner to an employee of a company for which it was laying pipe lines under contract, for the purpose of securing relief from arbitrary and impeding demands of the company's inspectors and the prompt delivery of materials, held not an ordinary and necessary business expense.
*351 This proceeding is for the redetermination of a deficiency of $3,785.37 in income tax for 1929. Petitioner alleges that respondent erroneously disallowed the deduction from gross income, as an ordinary and necessary business expense, of $34,412.39, the amount it paid in 1929 to J.T. Van Hook, an engineer employed by the Cities Service Gas Co.
FINDINGS OF FACT.
Petitioner is an Oklahoma corporation, maintaining its office at Tulsa, and is engaged in the business of constructing, under contract, pumping stations and pipe lines for the transportation of oil and gas.
*352 Petitioner, and its predecessor partnership, had from time to time entered into construction contracts with a number of concerns, including the Cities Service Gas*1116 Co. (hereinafter called the gas company). Its contracts with the gas company provided, among other things, that materials be furnished on the ground by the gas company as needed; that all progress of construction, including ditching, pipe-laying, welding, painting, and ground clean-up, be subject to the conclusive acceptance or rejection of inspectors and engineers employed by the gas company; and that damages to property be compensated for by the gas company if on the right of way, and by the contractor if off it. The contracts demanded that the projects covered be completed within a specified time, asserting a per diem penalty for overtime, and allowing a per diem bonus for completion sooner than required.
During 1929 (and perhaps prior thereto) the greater part of petitioner's operations were carried on under contracts with the gas company. Clay Briggs was then the gas company's chief engineer; it was one of his duties to employ and discharge the gas company's inspectors, assigned to its various construction jobs. His assistant was J.T. Van Hook, who, generally, was in charge of construction activities in the field, and who also tabulated bids on contracts. The resident*1117 engineer was P.S. Gaston, who was also in the field and there in charge of the inspectors.
Beginning in 1928, petitioner experienced difficulties with failure to receive materials on time and with the gas company's inspectors. Their supervision became arbitrary and harassing, chiely in that they would permit pipe to be laid without objection, and later order it uncovered and relaid, even though the job was properly done in the first place. This practice occasioned petitioner considerable expense in moving its heavy machinery, and caused it loss of time, interfering with the progress of its work and putting it behind schedule. Under this regime of arbitrary faultfinding, petitioner was falling behind in the performance of its contracts and was unable to operate profitably.
This condition was continued until petitioner's president, Dempsey, was approached and told these practices would be stopped upon payment of a sum of money. Dempsey complained to Briggs who told him to put on his (petitioner's) pay roll one of the gas company's employees, an inspector named Evanoff. Petitioner took on Evanoff as a pipelayer at $10 a day and kept him about six months and on two different*1118 jobs. Evanoff continued to draw pay from the gas company meanwhile. After petitioner put Evanoff on its pay roll, it suffered no more delays in the delivery of materials or because of inspections, was able to make rapid progress on its contract and to complete it at a profit.
*353 Meantime, petitioner had obtained another contract with the gas company for construction of a pipe line. Before the work was started, Gaston approached Dempsey, represented himself as a relative of the secretary-treasurer of the gas company in New York, asked Dempsey whether he had had enough of the conditions encountered on the previous job, and said that he (Gaston) would relieve them and assure fair inspection on the work next to be started upon payment to him of a sum of money.
Petitioner had never before (except in the Evanoff case) made payments of the sort demanded. Dempsey was reluctant to do it. He consulted one Straight, who was a director of the gas company and vice president of the bank of which petitioner was a customer, but Straight had no suggestions for relief. Dempsey then consulted with petitioner's directors, who, after discussion, agreed to pay Gaston at the rate of*1119 2 1/2 cents a lineal foot of line for fair inspection of the construction work. In 1929 petitioner paid Gaston $1,075 under this agreement.
Thereafter Gaston and Van Hook came several times to see Dempsey at his home. They represented that Van Hook was helping petitioner from the gas company's office in the matter of supplying materials promptly, settling right of way damages unjustly charged against petitioner, and keeping the inspectors in line; and that he would continue so to do if paid. After considerable discussion petitioner's directors finally agreed to pay Van Hook also at the same rate as Gaston. Later, on one job, this rate was doubled. In 1929 petitioner paid Van Hook $34,412.39 under this arrangement.
Dempsey knew these payments were "not in the form of business" but deemed them unavoidable. He asked for no favors, or to be permitted to slight the construction work, but only for fair inspections and cooperation. After making the arrangements with Gaston and Van Hook, petitioner's work progressed without further harrassment, and so satisfactorily it was able to earn substantial bonuses on every contract and its profits generally greatly increased.
During*1120 this time petitioner was bidding on other contracts with the gas company, and in making its estimates included a sum sufficient to cover its future payments to Gaston and Van Hook under any further contracts it might obtain.
Upon its return for 1929 petitioner deducted as an item of business expense the amount paid to Van Hook. Respondent's disallowance of that deduction gives rise to the deficiency here in controversy.
OPINION.
GOODRICH: The testimony tells a tale of graft. Petitioner was held up and had to pay. Until it did, the work under its contracts *354 was impeded through harrassing tactics by gas company employees who demanded subsidies before they would honestly discharge their duties; it lost money. After it "greased some palms", its work was accepted, promptly and without question; its contracts were completed within the allotted time or before; it made profits.
Payments made in 1929 to Evanoff and Gaston for so-called cooperation are not here in issue - why not, we are not told. The question presented for our determination is, whether payments, totaling $34,412.39, made in 1929 to Van Hook in consideration of his promise to see "that we got our*1121 materials on the job promptly", that "the inspectors on the particular jobs were kept in line and would not be arbitrary but would cooperate", are deductible from petitioner's income as a part of the expenses of its business. Our answer to that question is - no.
Assuming (but not deciding) that these payments are "expenses" of petitioner's business, clearly, they are not deductible 1 for they are not ordinary expenses. Said Mr. Justice Cardozo in considering the meaning of the word "ordinary" as applied to expenses of a business ():
Now, what is ordinary, though there must always be a strain of constancy within it, is none the less a variable affected by time and place and circumstance. Ordinary in this context does not mean that the payments must be habitual or normal in the sense that the same taxpayer will have to make them often. A lawsuit affecting the safety of a business may happen once in a lifetime. The counsel fees may be so heavy that repetition in unlikely. None the less, the expense is an ordinary one because we know from experience that payments for such a purpose, whether the amount is large or small, *1122 are common and accepted means of defense against attack. Cf. . The situation is unique in the life of the individual affected, but not in the life of the group, the community, of which he is a part. At such times there are norms of conduct that help to stabilize our judgment, and make it certain and objective. The instance is not erratic, but is brought within a known type.
* * *
Unless we can say from facts within our knowledge that these are ordinary and necessary expenses according to the ways of conduct and the forms of speech prevailing in the business world, the tax must be confirmed. But nothing told us by this record or within the sphere of our judicial notice permits us to give that extension to what is ordinary and necessary.
The question here comes down to this: Is it an ordinary thing to pay out money to induce the acceptance and approval of work well done, to induce the employees of another*1123 to promptly and honestly perform the duties for which they were hired? We believe that it is not. And petitioner's witness, its president, indicated clearly in his testimony that such was his opinion; that he regarded the demands *355 as most unusual and unjust. The record does not tell us that such expenditures were common to the operation of a business such as petitioner's in the Mid-Continent oil field. We know that petitioner made them during three years - never before - but as to the practice of other enterprises in the field we are not told. Rumors are prevalent concerning extortions, "rackets", "shakedowns" in all lines of business, but veiled hints and "understandings" cannot serve as a ground for judicial notice that dishonesty, such as here disclosed, is a normal practice. Measured then by the norms of conduct of which we have notice (and this record fails to convince us that they have been changed), we must conclude that the payments made by petitioner to Van Hook were not ordinary, but, to the contrary, extraordinary.
Nor does it appear that they were necessary. Petitioner proves beyond dispute that its business was being ruined by groundless faultfinding*1124 and unjust practices until it acceded to the demands of those persons whose approval was necessary to the acceptance of work done under its contract. It shows that appeal to the chief engineer and to one of the directors of the company with which it had contracted and which had the troublemakers in its employ brought no relief; indeed brought only advice to pay up and avoid difficulty. And it shows that after it agreed to contribute as demanded, its impediments vanished; that it completed its contracts profitably and promptly, and obtained more, upon bids which included a spread sufficient to supply funds to be passed on.
No doubt, that was the easiest and quickest way out of its difficulties, but it was not necessary for petitioner to adopt that course. The courts were open to it, wherein it could have proved the substantial performance of its contracts and demanded payment therefor. Moreover, the laws of Oklahoma afforded it protection against extortion - if the threats and solicitations of Van Hook and the others amounted to that - by the punishment provided for those attempting it. To be sure, the prosecution of proceedings against the gas company for the enforcement*1125 of petitioner's rights under its contract would have been expensive, perhaps tedious, and probably would have resulted in the loss of any future business with that company. And the instigation of criminal prosecution of the gas company employees for such of their acts (if any) as were unlawful would be troublesome and disagreeable. But, for all this record tells us, the normal business conduct of the group, the community, would have made the doing of these things necessary, and not the adoption of the course chosen by petitioner - the "paying of tribute" as it is described on the record.
Moreover, to encourage the accession to demands of this sort, both morally and legally wrongful, by straining the common meaning of *356 the words of the statute to permit such payments to be deducted as ordinary and necessary expenses of operating a business would be poor public policy. This Board and the courts have consistently refused to do so with respect to expenditures occasioned by somewhat comparable causes. 2
*1126 Reviewed by the Board.
Judgment will be entered for the respondent.
SMITH concurs in the result.
Footnotes
1. The statute (sec. 23(a), Revenue Act, 1928) provides for the deduction from gross income of "ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business." ↩
2. As to illegal expenses such as bribery, see ; as to expense incurred in defending an indictment for perjury, see ; as to fines, court costs, and attorney fees incurred in connection with an indictment for violation of antitrust laws, see ; ; affd., ; as to fines for violation of Federal statutes see ; affd., ; certiorari denied, ; ; affirmed on this issue, ; certiorari denied, ; ; affirmed on this issue, ; certiorari denied, ; . ↩