*157 Decision will be entered under Rule 155.
Petitioner, which was discharging sewage waste from its premises into an underground waterway, entered into an agreement with the Commonwealth of Pennsylvania, under its Clean Streams Law, to make monthly payments to the Clean Water Fund until a central municipal sewer system became available and to connect to, and discharge its waste into, that system. The State would have sought to prevent petitioner from constructing its own treatment facility. Held, the monthly payments were not a "fine or similar penalty" within the meaning of
*1226 Respondent determined deficiencies in petitioner's income tax as follows:
| FYE June 30 -- | Deficiency |
| 1974 | $ 7,464 |
| 1975 | 2,019 |
All other adjustments having been conceded by petitioner, the *1227 sole issue for decision is whether petitioner is entitled to deduct certain payments made to the Clean Water Fund of the State of Pennsylvania.
FINDINGS OF FACT
Petitioner had its principal place of business in Wilkes-Barre, Pa., at the time it filed its petition herein. It filed its Federal income tax returns for the taxable years in question on the accrual basis with the Internal Revenue Service Center, Philadelphia, *159 Pa.
At all times relevant herein, petitioner was engaged in the business of owning and operating a motel and restaurant under the name of the Treadway Inn.
During the periods involved herein, a Clean Streams Law was in effect in Pennsylvania, as set forth in
(a) sets forth a sharply defined policy with respect to the essentiality of clean and unpolluted streams and water, and the prevention and elimination of water pollution, including a comprehensive program of watershed management and control.
(b) prescribes fines for violations (ranging from $ 100 to $ 50,000 for each offense) and/or imprisonment (ranging from 60 days to 2 years);
(c) prescribes civil penalties of up to $ 10,000 per day for each violation,
(d) provides that a violation shall constitute a nuisance and shall be abatable by restraining order; and
(e) establishes a Clean Water Fund to which all fines and civil penalties shall be paid and provides that the fund is to be administered by the Sanitary Water Board for use in the elimination of pollution.
The Department of Environmental Resources of the Commonwealth of Pennsylvania (hereinafter*160 the department) was charged with responsibility for enforcing the Clean Streams Law during the taxable periods in question. That department was vested with authority to:
pursuant to the rules and regulations adopted by the board, in the case of a discharge which is authorized only if pursuant to a permit issued by the department, accept payments which would be paid into The Clean Water Fund in lieu of requiring the permittee to construct or operate a treatment facility. Such rules and regulations allowing such payments shall include the following:
*1228 (1) That the department finds that the use of the funds so received would provide greater benefit to citizens of the Commonwealth and would more appropriately conform to the declarations of policy of this act than would the construction and operation of a treatment facility.
(2) That in determining the amounts of such payments, the department shall consider the cost of construction and operation of a treatment facility, the quantity and quality of the discharge, the effect of the discharge on waters of the Commonwealth, the period of time for which the discharge will continue and other relevant factors.
(3) That the permit*161 authorizing the discharge be subject to such conditions as the department might impose, including conditions relating to procedures for the effective cessation of any pollutional discharge upon closing of the operation.
(4) That allowing the discharge will not adversely affect any treatment program which is being conducted or is contemplated in the watershed in which the discharge is located.
(5) That any such payments accepted in lieu of requiring the permittee to construct or operate a treatment facility shall be used for abatement programs or the construction of consolidated treatment facilities which would be more effective than a larger number of smaller programs or facilities, and further, that such funds shall be used only for such projects, including gathering and collection systems, on the watershed or on the body of water into which such permittee is discharging. [
No such rules and regulations have ever been adopted.
At some time prior to June 30, 1973, the Bureau of Water Quality Management of the Department learned that petitioner was discharging raw sewage directly into an underground waterway.
Pennsylvania created*162 an Environmental Strike Force, comprised of special assistant attorneys general to enforce the Clean Streams Law, including litigation. One Ralph Kates (hereinafter Kates) was a special assistant attorney general assigned to that task force.
On or about March 1973, as a result of negotiations in which Kates played a leading role, the department entered into the following agreement with petitioner: 1
AGREEMENT
The Commonwealth of Pennsylvania and The Treadway Inn, Inc.
Whereas, The Treadway Inn, Inc. is a commercial establishment operating *1229 motel, eating and drinking facilities on Pennsylvania Route 315 in Plains Township, Luzerne County; and
Whereas, The Treadway Inn, Inc. is currently discharging approximately four hundred thousand (400,000) gallons of raw sewage per month directly to the underground; and
Whereas, The Treadway Inn, Inc. is in the process of constructing forty (40) additional motel units at the same site as Treadway Inn, Inc. and
Whereas, the sewage wastes from said additional motel units will also be discharged directly to the underground; and
Whereas, Plains Township is currently under order from the Department of Environmental Resources for the construction*163 and operation of a sanitary sewer system;
And Now, on this 21st day of February 1973, upon the mutual exchange of the covenants contained herein, and both parties intending to be legally bound by this Agreement;
It is Hereby Agreed by and between Treadway Inn, Inc. ("Treadway") by its owner and duly authorized representative, Mr. Mark Kornfold and the Commonwealth of Pennsylvania ("Commonwealth"), Department of Environmental Resources ("Department") by its attorney that;
1. Treadway shall connect to and discharge into the sanitary sewer system of Plains Township when said sanitary sewer system becomes available.
2. Treadway shall donate one thousand dollars ($ 1,000.) per month to the Clean Water Fund of the Commonwealth ("Clean Water Fund") beginning March 1, 1973 until such time as Paragraph #1 of this Agreement is complied with and payments to be made on the first day of each month.
3. Treadway shall donate One Thousand Two Hundred Fifty ($ 1,250.) Dollars per month to the Clean Water Fund from the time the construction on the aforesaid forty (40) additional motel units is completed until such time as Paragraph #1 of this Agreement is complied with.
4. Treadway shall notify Department*164 immediately upon the completion of said additional motel units. Notice to Department shall be by certified mail, return receipt requested, addressed to "Mr. Lawrence A. Pawlush, Regional Water Quality Manager, Department of Environmental Resources, 383 Wyoming Avenue, Kingston, Pennsylvania 18704."
5. Department agrees not to prosecute Treadway for any violations of the Clean Streams Law or the Rules and Regulations enacted pursuant thereto which are contained in this Agreement; Provided that the quality and quantity of sewage discharges from Treadway do not exceed those existing at the time of this Agreement.
6. Department reserves the right to enforce this Agreement, any permits issued or to be issued to Treadway, and all laws, rules and regulations, except those specifically waived in this Agreement.
7. This Agreement may be altered, in writing, by mutual Agreement of the parties hereto, their successors or assigns.
8. This Agreement shall bind the parties hereto, their successors and assigns.
*165 Kates negotiated and completed the agreement on the basis of his understanding that: (a) There was no practical environmental *1230 harm being caused by petitioner's discharge of sewage waste; (b) a central municipal sewage system was under construction and, as a matter of governmental policy, it was desirable that petitioner connect to that system rather than build its own treatment facility; and (c) the amount of the payments required to be made by petitioner under the agreement approximated what petitioner would have been required to pay the municipality if that central system had been in operation.
Kates believed he had authority, and in fact he had at least apparent authority, to negotiate and execute the agreement.
Petitioner paid into the Clean Water Fund $ 14,000 and $ 15,000 during its 1974 and 1975 taxable years, respectively.
After entering into the agreement, petitioner continued to discharge raw sewage directly into the underground. Neither Pennsylvania nor any municipality provided any treatment of the raw sewage discharged by petitioner, but the State would have sought to prevent petitioner from constructing its own treatment facility.
OPINION
Before dealing with*166 the basic question as to whether petitioner's payments to the Clean Water Fund were fines or penalties within the meaning of
We turn to the impact of
Respondent counters with the assertion that the payments represent nothing more than the price paid by petitioner for an agreement by the Commonwealth of Pennsylvania not to prosecute or otherwise proceed legally against petitioner for its admitted violation of the Clean Streams Law and that, in this context, the payments clearly fall within the ambit of
Clearly, the Clean Streams Law has its punitive aspects; it imposes criminal and civil penalties. But, it is also clear that the law has as one of its purposes the orderly development of pollution control through the construction and*170 operation of "consolidated treatment facilities" -- rather than "a larger number of smaller programs or facilities." See
Based upon the record herein, we are satisfied that the payments in question were in furtherance of the purpose of the Clean Streams Law to control pollution through consolidated, rather than individual, facilities, and that they were made by petitioner in consideration of being allowed to continue to discharge its sewage waste, rather than as a fine or similar penalty imposed by the law or "settlement of the taxpayer's [petitioner's] actual or potential liability for a fine or penalty." See
We recognize, of course, that the*172 March 1973 agreement provided that the department would not prosecute petitioner for any violations of the Clean Streams Law, but we view this as merely incidental to the main purpose of the agreement, which was to ensure that petitioner would join the municipal disposal system and not go off on a frolic of its own. Moreover, we note that the agreement not to prosecute was conditioned upon the continuation of the quality and quantity of the sewage discharges not exceeding those contemplated by the agreement. See par. 5 of the agreement, p. 1229 supra. In the foregoing context, respondent's reliance on
The agreement was based upon Kates' understanding that the impact of petitioner's then-existing discharges (as well as those expected to result from the additional motel units) would not be harmful to the environment. There is no inkling in the record that the underlying facts with regard to the situation of the petitioner herein belied Kates' understanding, nor was any such evidence in this regard offered or suggested. 6 Under these circumstances, we think it immaterial whether Kates' understanding was or was not technically supported in fact. The point is that his understanding of the underlying basis for the agreement gave direction to its objective and thereby to the purpose of the payment.
*174 *1234 Nor are we impressed with respondent's argument that
Our analysis makes it unnecessary to deal with an alternative contention by petitioner that, in any event, the institution of a legal proceeding (which did not occur herein) is a necessary precondition to the application of
*176 On the basis of the circumstances revealed by the record herein, we hold that petitioner's payments into the Pennsylvania Clean Water Fund in 1974 and 1975 are deductible under
Decision will be entered under Rule 155.
Footnotes
1. As appears, the agreement is between the department and the Treadway Inn, Inc., which would seem to be a separate corporation. There is nothing in the record to explain the discrepancy except the stipulation that petitioner transacted its business under the name of "Treadway Inn." The parties, however, have treated petitioner and Treadway Inn, Inc., as one and the same, and we accord them similar treatment for the purposes of this case.↩
2. All section references, unless otherwise indicated, are to the Internal Revenue Code of 1954 as amended and in effect during the taxable years in question.↩
3. There is a passing reference to the general application of
sec. 162(a)↩ in the opening statement of respondent's counsel at trial, but it is made in the context of the issue of "fines or similar penalties" and is so vague that we do not consider it sufficient to put petitioner on notice of the existence of the issue, assuming that a clear statement at such late date would have been sufficient properly to raise the issue.4. See also
Commissioner v. Lincoln Savings & Loan Assn., 403 U.S. 345, 353↩ (1971) .5. Thus, if the municipal facility had become available prior to the end of March 1973, petitioner presumably would have forthwith implemented its obligation to connect thereto and, consequently, would have had to make only one monthly payment of $ 1,000.↩
6. The evidentiary disputes at the trial related solely to the scope and interpretation of the Clean Streams Law.↩
7. See
Adolf Meller Co. v. United States, 220 Ct. Cl. , 600 F.2d 1360, 1364↩ (1979) (regulation held valid).8. The issue of the necessity of a legal proceeding was apparently not raised in
Tucker v. Commissioner, 69 T.C. 675↩ (1978) , in view of the automatic application of the particular statutory provision involved therein.