*2699 1. Deduction for obsolescence of intangibles disallowed.
2. Deduction for compensation of an attorney for services rendered allowed in the taxable year.
3. Invested capital should not be reduced on account of a tentative tax in determining current earnings available for the payment of dividends within the year.
*1231 The Commissioner determined a deficiency in income and profits tax of $63,968.85 for the calendar year 1919.
It is claimed that the Commissioner erred in disallowing a deduction of $41,702.07 for obsolescence of intangible assets consisting of good will, trade-brands, etc.; a deduction of $6,035, being the amount of a fine paid in the United States District Court for New Mexico on account of a technical violation of the Federal prohibition law; disallowance of a deduction of $21,526.08, representing attorney's fee accrued on the books as an expense during 1919; reduction of invested capital for the taxable year 1919 in the amount of $22,131.79, through computation of a tentative tax in determining current earnings available*2700 for the payment of a dividend of $170,400 on June 16, 1919, and reduction of invested capital in the amount of $159,090.13 on account of income and profits taxes for the year 1918 prorated.
A deduction of $182,787.65 was claimed in the return filed for the year 1919 for obsolescence of intangible assets, but only the amount above set forth is claimed in this proceeding.
FINDINGS OF FACT.
Petitioner is a Kentucky corporation with principal office in Louisville. It was engaged in the distilling, warehousing, and sale of intoxicating liquors.
The net income derived by the petitioner from the regular operation and conduct of its business, exclusive of income from stocks and securities, for the period July 1, 1907, to December 31, 1912, was as follows:
| To June 30, 1908 | $97,979.34 |
| June 30, 1909 | 79,860.50 |
| June 30, 1910 | 91,917.19 |
| June 30, 1911 | 73,925.07 |
| June 30, 1912 | 95,066.43 |
| Six months ending Dec. 31, 1912 | 66,173.55 |
| Average annual net income | 91,804.01 |
*1232 The capital employed by the petitioner in the regular operation of its business and invested in tangible assets, exclusive of stocks and securities, for the same period, was as follows: *2701
| To June 30, 1908 | $314,859.99 |
| June 30, 1909 | 321,307.11 |
| June 30, 1910 | 328,240.33 |
| June 30, 1911 | 334,494.37 |
| June 30, 1912 | 365,177.70 |
| Dec. 31, 1912 | 395,348.87 |
| Average annual investment in tangible assets | 338,500.68 |
The fair market value on March 1, 1913, of the intangible assets, consisting of good will and trade-brands, owned by the petitioner was $287,115.95. These intangible assets were rendered worthless by prohibition legislation during the period January 31, 1918, to January 16, 1920. Because of such legislation petitioner ceased distilling in May, 1917. On December 31, 1919, petitioner owned no whiskey, having prior thereto declared a liquidating dividend of its stock of whiskeys. The several thousand barrels of whiskey then remaining in the warehouse were owned by others, who held warehouse receipts for the same. In view of that fact, the corporation was not dissolved nor did all business cease.
In May, 1921, one Edward E. Kirwan, formerly manager and later treasurer of petitioner, made a proposition to the stockholders to assume certain liabilities and to continue the business with W. O. Bonnie, Jr., as a partner; that he would purchase whiskeys*2702 that were made by Bonnie Brothers then in storage in the warehouse and put them in cases and sell them in compliance with the Prohibition Act, the purpose being to get the whiskey out of the warehouse and complete the liquidation of the corporation. The proposition was accepted and the book assets with those exceptions were turned over to R. P. Bonnie as trustee for the old stockholders. It was understood that when the last barrel was taken out the business would cease and the corporation would be dissolved. The sales of such whiskey were made to hospitals, retail and wholesale druggists, and to doctors. In the sale of the whiskey some labels or brands which were on hand were used.
In 1919 petitioner was forced to pay a fine in the United States District Court for New Mexico in the amount of $6,035 for the violation of Federal laws regulating interstate shipment of intoxicating liquors. For many years prior to 1919 petitioner's practice had been to ship whiskey into the State of New Mexico. In November, 1918, petitioner inquired of the Attorney General of the State of New Mexico and was advised that there was no state law against the shipment of whiskey, but that the matter*2703 would probably be governed by the Federal laws. The petitioner then inquired of carriers and, *1233 from information thus obtained, made several shipments of whiskey into New Mexico in the spring of 1919 in the belief that such shipments were not unlawful. The shipments were plainly marked and there was no effort or intention to deceive. Subsequently, indictments were returned against the petitioner in the United States District Court at Albuquerque, N. Mex., as a result of which fines totaling $6,035 were paid on August 24, 1919. The petitioner deducted the amount of fines as an ordinary and necessary business expense for 1919 and the Commissioner disallowed the same.
Petitioner's books were kept and its returns were made on the accrual basis.
Within the time required by law, the petitioner filed an income and profits-tax return for the calendar year 1918 showing a total tax of $576,899.12.
Thereafter, petitioner consulted an attorney with reference to his tax matters, as a result of which on March 31, 1919, a written contract was entered into between the petitioner and the attorney, as evidenced by a letter from the petitioner to such attorney and his reply, whereby*2704 the attorney undertook to handle the matter of petitioner's 1918 Federal income and profits-tax liability upon the basis of a contingent fee to be computed on the "saving" to petitioner in the matter of its taxes for that year. The contract of employment was as follows:
MARCH 29, 1919.
Mr. GEO. A. GREVEMEYER,
111 South 7th Street,
City.
Dear Sir:
Your proposition of the 28th inst. in reference to securing recovery on our income and excessive profit tax for the year 1918 has been received and carefully perused.
We are of the belief that compensation on the scaling basis as made by you is a little extreme and make the following counter-proposition, which if accepted by you and acknowledged will be considered as a contract.
We are willing to pay you
10% commission on the first $100,000 saving to us
7 1/2% commission on the next 50,000 saving to us
5% commission on the next 50,000 saving to us
2 1/2% commission on any amount over and above the foregoing.
We further desire to say that in the event of failure to recover we are willing to allow you for your services in preparing brief $250.00 in addition to other incidental expenses necessary to present the*2705 case.
Now if this proposition meets with your approval kindly acknowledge same and at the same time advise us when you will be prepared to begin work.
Yours truly,
BONNIE BROS.
*1234 Grevemeyer replied March 31, 1919, accepting employment under the terms stated, as follows:
I am in receipt of your favor of the 29th amending my proposition for the handling of your 1918 income and excess profits tax matter to the extent of making the commissions as follows:
10% on the amount saved up to $100,000.00
7 1/2% on the amount saved from $100,000.00 to $150,000.00
5% on the amount saved from $150,000 to $200,000.00
2 1/2% on any amount saved over and above $200,000.00.
* * *
I am willing to accept the proposition as amended by you and thank you for placing the matter in my hands.
If it is agreeable to Mr. Kirwan, I shall be pleased to meet him at your office tomorrow (Tuesday) evening at 7:30 P.M. and we will then commence securing the necessary data to properly prepare and present your claims to the Government.
From that time forward the attorney was engaged in preparing and compiling information considered necessary for submission to the Federal taxing*2706 authorities in connection with the claim of the petitioner for reduction of its tax liability. The attorney prepared an amended return claiming obsolescence and assessment of profits taxes under sections 327 and 328 of the Revenue Act of 1918 and prosecuted the claims on behalf of petitioner before the Treasury Department with the result that the Commissioner rendered a decision in connection with petitioner's tax liability for 1918 wherein it was decided that petitioner was entitled to a refund of a portion of the tax shown upon the return which it had already paid.
Prior to the filing of the amended return the petitioner had paid in 1919, on account of its 1918 tax, $220,009.88. On September 26, 1919, petitioner received from the Treasury Department a refund check in the amount of $54,153.86 representing an amount overpaid on its tax for 1918. As the corporation had paid $220,009.88 on its tax for 1918, the refund check of $54,153.86 indicated a total tax liability of $165,856.02.
Having received the refund check in September, 1919, and no further demand having been made on its 1918 tax during that year, the petitioner entered on its books of account on December 30, 1919, as*2707 an accrued liability for the fee of George A. Grevemeyer, an item of $21,526.08, the entry being as follows:
Journal, page 70, December 30, 1919, expense charged, $21,526.08. George A. Grevemeyer credited on agreement for saving on 1918 tax
| $100,000.00, 10 per cent | $10,000.00 |
| 50,000.00, 7 1/2 per cent | 3,750.00 |
| 50,000.00, 5 per cent | 2,500.00 |
| 211,043.10, 2 1/2 per cent | 5,276.08 |
| Total | 21,526.08 |
*1235 This fee to the attorney was computed on a "saving" of $411,043.10 on the 1918 tax arrived at as follows:
| Amount of tax on tentative return | $576,899.12 | |
| Amount paid in 1919 | $220,009.88 | |
| Less refund | 54,153.86 | |
| 165,856.02 | ||
| Net saving | 411,043.10 |
On January 27, 1923, the Commissioner advised the petitioner, in connection with the issuance of a certificate of overassessment in respect of the tax for 1918, that the total tax liability for that year had been determined to be $234,166.70. On the basis of this letter from the Commissioner the petitioner recomputed Grevemeyer's fee for 1918 and paid the same, as follows:
| Tax shown on tentative return | $576,899.12 |
| Tax under letter of January 27, 1923 | 234,166.70 |
| Total saving | 342,732.42 |
| $100,000.00 at 10 per cent | 10,000.00 |
| 50,000.00 at 7 1/2 per cent | 3,750.00 |
| 50,000.00 at 5 per cent | 2,500.00 |
| 142,732.42 at 2 1/2 per cent | 3,568.31 |
| Total fee earned | 19,818.31 |
*2708 Subsequently, on March 10, 1923, the petitioner paid Grevemeyer a bonus of $10,000 which is not involved in the deduction here claimed, but which was paid by the petitioner for the reason that it considered the services rendered by Grevemeyer in connection with the 1918 tax liability would result in a saving to the taxpayer on its 1919 taxes.
On March 4, 1924, the Commissioner modified his decision in respect of petitioner's tax liability for the year 1918 and notified the petitioner that he proposed to assess against it additional tax of $142,288.88 for that year. This proposed additional tax resulted from changes in various items of gross income and deductions on petitioner's books and not from any decision in respect of the items urged by the petitioner in regard to which the tax liability was reduced and the refund made.
On June 16, 1919, petitioner paid a dividend of $170,400, pursuant to a resolution of the directors passed June 14, 1919. The Commissioner computed a tentative tax of $105,382.85 upon the income for the year 1919 and prorated the same to the date of the dividend, thereby reducing invested capital for 1919 in the amount of $22,131.79. The actual current*2709 earnings of petitioner for the year 1919 prior to the payment of the dividend of $170,400 were in excess of the amount of the dividend.
*1236 OPINION.
LITTLETON: The first issue as to the claimed deduction for obsolescence of good will, trade-brands, etc., is decided in favor of the Commissioner on the authority of ; ; ; affd., .
During the taxable year petitioner paid a fine of $6,035 for violation of Federal laws regulating the interstate shipment of intoxicating liquors, and it is insisted on behalf of petitioner that such fine represented an inherent hazard of the business and constituted an ordinary and necessary expense incident to the carrying on of it business and is, therefore, a proper deduction from gross income. The claim is without merit. Payments of fines and penalties do not result from ordinary and necessary acts incident to the lawful conduct of the business, but from violations of the law, and are not deductible as an ordinary and necessary business*2710 expense. The action of the Commissioner in disallowing the amount claimed as a deduction is approved. ; ; .
As to the attorney's fee of $21,526.08, we are of the opinion that the petitioner is entitled to a deduction on account thereof. The Commissioner disallowed the deduction of any portion of this fee upon the ground that the fee provided in the contract was a contingent one and that it was not definitely determinable within the taxable year 1919. No question is raised as to the propriety of the deduction as a proper business expense. The attorney was employed after the taxpayer had made its return for 1918 showing a large tax for that year, in the belief that by proper presentation and prosecution of certain claims in respect of its 1918 tax liability a reduction in the tax shown on the return could be obtained and that a considerable saving to the petitioner would thereby be effected. In September, 1919, petitioner received advice from the Treasury Department of its determination in respect of its 1918 tax and*2711 actually received a check for refund of a portion of the total tax which had already been paid. When this occurred all the events necessary under the terms of the contract had happened so as to fix the amount of the attorney's fee and to enable the computation thereof. This was done and the amount of the fee determined in accordance with the contract, totaling $21,526.08, was accrued on petitioner's books as an expense for the year 1919. Petitioner paid a portion of this fee to the attorney at various times subsequent to the receipt of the refund check, but before the fee had been entirely paid the Commissioner, subsequent *1237 to his determination and the making of the refund, reconsidered the case and made adjustments in petitioner's income for the year 1918 and notified it of an additional tax. The first notice of this adjustment was given the petitioner by the Commissioner on March 4, 1924, and, since petitioner had not fully paid the fee to its attorney, made an adjustment thereof as indicated in the findings of fact which reduced the same to $19,818.31, which it paid.
Although petitioner was justified in entering upon its books as a liability the total amount of*2712 the fee computed upon the basis of the Commissioner's determination of its tax liability at that time for the year 1919, in view of the fact that petitioner's tax liability for the year 1919 is now before us for determination and in view of the fact that petitioner adjusted the accrued item for attorney's fee upon its books and has finally settled the same by payment of a lesser amount than that originally entered upon the books, the amount of $19,818.31 finally determined should be allowed as a deduction from income for the year 1919. Cf. ; .
The invested capital of petitioner should not be reduced on account of a tentative tax computed in determining earnings available for the payment of dividends on June 14, 1919. . In any event, the evidence in this proceeding shows that the current earnings to the dividend date were more than sufficient to pay the same.
Petitioner abandons the last assignment of error with reference to the reduction of invested capital on account of income and profits tax for prior years.
Judgment*2713 will be entered under Rule 50.