Deputy, Administratrix, et al. v. du Pont
308 U.S. 488 (1940)
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Rule of Law:
For a payment to be deductible as an "ordinary and necessary" business expense, the transaction giving rise to the expense must be common or frequent in the taxpayer's particular type of business and must proximately result from the taxpayer's business, not the business of another entity. Furthermore, a payment is deductible as "interest on indebtedness" only if it is compensation for the use or forbearance of money, not other property.
Facts:
- In 1919, E. I. du Pont de Nemours and Company (the du Pont Company) wanted its nine top executives to acquire a financial interest in the company by purchasing 9,000 shares of its stock.
- Due to legal difficulties, the du Pont Company could not sell the shares directly to the executives.
- The respondent, a beneficial owner of about 16% of the du Pont Company's stock, agreed to facilitate the transaction.
- The respondent borrowed 9,000 shares from Christiana Securities Company under a ten-year agreement, obligating him to return the shares in kind and pay the lender an amount equal to any dividends declared on the borrowed shares.
- The respondent then sold the 9,000 borrowed shares to the nine du Pont Company executives.
- In 1929, when the ten-year loan was expiring, the respondent did not have enough shares to repay Christiana Securities Company.
- To satisfy his obligation, the respondent borrowed the necessary number of shares from the Delaware Realty and Investment Co. (Delaware Company) under a new ten-year agreement.
- Under the new agreement with the Delaware Company, the respondent was obligated to pay the lender an amount equivalent to all dividends declared on the borrowed shares until they were returned. In 1931, he made payments totaling $647,711.56 pursuant to this agreement.
Procedural Posture:
- The Commissioner of Internal Revenue disallowed the respondent's claimed deductions for the payments and determined a tax deficiency.
- The respondent paid the deficiency and sued for a refund in the U.S. District Court.
- The District Court, as the court of first instance, entered a judgment against the respondent.
- The respondent, as appellant, appealed to the U.S. Circuit Court of Appeals.
- The Circuit Court of Appeals reversed the District Court's judgment, ruling in favor of the respondent (now appellee).
- The Commissioner, as petitioner, was granted a writ of certiorari by the U.S. Supreme Court to review the decision of the Circuit Court of Appeals.
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Issue:
Do payments made by a major stockholder to a lender, equivalent to dividends on borrowed stock that the stockholder used to facilitate his corporation's executive stock purchase plan, qualify as deductible 'ordinary and necessary' business expenses or as 'interest on indebtedness' under the Revenue Act of 1928?
Opinions:
Majority - Mr. Justice Douglas
No, the payments are not deductible either as ordinary and necessary business expenses or as interest on indebtedness. First, the expenses were not proximately related to the respondent's alleged business of conserving his estate; rather, they originated from the business of the du Pont Company, which sought to incentivize its executives. The Court's precedents do not permit blending a corporation's business with that of its stockholders for deduction purposes. Second, the payments were not 'ordinary' because the underlying transaction was not common, normal, or customary for a stockholder or investor engaged in conserving and enhancing an estate. The transaction was described as extraordinary and beyond the norm of accepted business practice. Finally, the payments do not qualify as 'interest on indebtedness' because that term, in the context of a revenue act, means compensation for the use of money, not for the use of property like borrowed stock.
Concurring - Mr. Justice Frankfurter
No, the payments are not deductible because the taxpayer's activities did not constitute a 'trade or business' in the first place. The opinion states that to be engaged in a 'trade or business' under § 23(a), a taxpayer must hold themselves out to others as offering goods or services. The respondent's activities, which involved managing his personal investments, did not meet this standard. Therefore, since there was no 'trade or business,' the payments could not be deducted as expenses related to one, making it unnecessary to decide if they were ordinary and necessary.
Analysis:
This decision significantly narrowed the scope of deductible business expenses by reinforcing a strict interpretation of the term 'ordinary.' It established that the normalcy of an expense must be judged relative to the specific type of business involved, not just whether it was a logical expenditure for the taxpayer. The ruling also created a clear distinction between the business of a corporation and the investment activities of its shareholders, preventing shareholders from deducting expenses incurred to benefit the corporation. Finally, the case solidified a narrow definition of 'interest' for tax purposes, limiting it strictly to compensation for the use of money, which has had a lasting impact on the tax treatment of transactions involving borrowed property.
