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Allied-Signal, Inc. v. Commissioner of Internal Revenue Serv.

ELR Citation: 25 ELR 21182
Nos. No. 94-7336, 54 F.3d 767/40 ERC 1660/(3d Cir., 02/23/1995)

The court holds that a 1977 contribution a chemical company made to the Virginia Environmental Endowment Fund, which was created in response to litigation over environmental contamination at the company's former plant in Hopewell, Virginia, was in substance an environmental penalty that the company could not deduct as an ordinary and necessary business expense under Internal Revenue Code (IRC) §162(a). After the company pleaded nolo contendere, the district court assessed a fine of $13,240,000 against the company for violating the Refuse Act, 33 U.S.C. §411, and the Federal Water Pollution Control Act, by unlawfully discharging and depositing toxic chemicals into waters of the United States. The district court later reduced the fine to $5 million when the company agreed to contribute $8 million to creating the endowment. On its 1977 federal income tax return, the company treated the $ 8million it transferred to the endowment as an ordinary and necessary business expense deductible under IRC §162(a) because it contributed to restoring the company's business reputation in the community. The Tax Court affirmed the Internal Revenue Service (IRS) decision disallowing the deduction under IRC §162(f), which provides that no deduction shall be allowed under §162(a) for any fine or similar penalty paid to a government for the violation of any law.

The court first holds that the company did not voluntarily contribute $8 million to the endowment. The payment was a quid pro quo for the district court's reduction of the criminal fine, and a voluntary payment must be one made without expecting a quid pro quo from a court. The district court presented the company with only two choices: Either pay the $13,240,000 million fine or contribute to the endowment. The company expected some mitigation of the fine but ended up getting a dollar for dollar reduction in exchange for its contribution.

The court holds that an $8 million payment does not fall under the IRS regulation defining "compensatory damages" as an amount paid to a government that does not constitute a fine or penalty. The $8 million payment is punitive rather than remedial in nature, because the endowment the company created did not compensate aggrieved parties for the specific losses attributable to the company's misconduct. The endowment served general public purposes, and to hold that punitive exactions used for general public purposes fall outside the ambit of §162(f) would effectively nullify the statute, since all exactions of this nature are ultimately used for general public purposes. While the district court judge may have been motivated by both punitive and compensatory purposes, the court finds that the payment was merely a criminal fine diverted from the U.S. Treasury to the endowment.

The court holds that the "paid to a government" requirement of §162(f) can be satisfied when the payments are made under a court's direction. The district judge was an official of the government, and the payment to the endowment was at his direction and made in lieu of the criminal fine. The court finds no practical difference between a situation when a fine is paid to the Treasury and the government then expends the money for a public purpose, and a situation when the fine is paid directly into a fund to benefit the public at the government's direction.

Counsel for Appellee
Edward Perelmuter
Teich, Groh & Frost
691 State Hwy. 33, Trenton NJ 08619
(609) 890-1500

Counsel for Appellant
Jerome B. Libin
Sutherland, Asbill & Brennan
1275 Pennsylvania Ave. NW, Washington DC 20004
(202) 383-0100