Opinion
Docket No. 44932.
1957-04-5
W. A. SHAW AND GRACE SHAW, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
John J. Hooker, Esq., K. Harlan Dodson, Jr., Esq. and Sewell R. Creel, C.P.A., for the petitioners. J. Elton Mitchiner, Esq., for the respondent.
Respondent determined deficiencies in income tax and additions to tax for fraud for the years 1941 to 1947, inclusive, and 1949.
1. Held, respondent has filed to prove fraud for the years 1941 to 1944, inclusive, and the assessment and collection of the deficiencies and additions to tax for such years are barred by the statute of limitations.
2. Held, further, part of the deficiencies for each of the years 1945, 1946, 1947, and 1949 was due to fraud, and the deficiencies and additions to tax for fraud determined by respondent are sustained. John J. Hooker, Esq., K. Harlan Dodson, Jr., Esq. and Sewell R. Creel, C.P.A., for the petitioners. J. Elton Mitchiner, Esq., for the respondent.
Respondent determined the following deficiencies in income tax and additions to tax against petitioners:
None.
The amounts stated are those determined by respondent as at December 31 of the preceding year.
Although the deficiency notice was addressed to both W. A. Shaw and Grace Shaw, it is clear that petitioner Grace Shaw has no liability other than for the year 1949 since she had no separate income during the years 1941 to 1947, inclusive, filed no returns for such years, and filed a return jointly with her husband only for the year 1949.
+--------------------------------------------------+ ¦ ¦ ¦Additions to tax ¦ +------------+----------+--------------------------¦ ¦Taxable year¦Income tax¦ ¦ ¦ +------------+----------+-----------+--------------¦ ¦ ¦deficiency¦ ¦ ¦ +------------+----------+-----------+--------------¦ ¦ ¦ ¦Sec. 293(b)¦Sec. 291 ¦ +------------+----------+-----------+--------------¦ ¦1941 ¦$692.75 ¦$346.38 ¦$173.19 ¦ +------------+----------+-----------+--------------¦ ¦1942 ¦2,951.14 ¦1,475.57 ¦--------------¦ +------------+----------+-----------+--------------¦ ¦1943 ¦5,262.33 ¦2,631.17 ¦--------------¦ +------------+----------+-----------+--------------¦ ¦1944 ¦4,543.58 ¦2,271.79 ¦--------------¦ +------------+----------+-----------+--------------¦ ¦1945 ¦3,036.57 ¦1,518.29 ¦--------------¦ +------------+----------+-----------+--------------¦ ¦1946 ¦19,663.45 ¦9,831.73 ¦--------------¦ +------------+----------+-----------+--------------¦ ¦1947 ¦5,388.60 ¦2,694.30 ¦--------------¦ +------------+----------+-----------+--------------¦ ¦1949 ¦9,401.18 ¦4,700.59 ¦--------------¦ +--------------------------------------------------+
By amended answer, respondent claims the following additional deficiencies and additions to tax:
+------------------------------------+ ¦ ¦ ¦Additions to¦ +------------+----------+------------¦ ¦Taxable year¦Income tax¦tax sec. ¦ +------------+----------+------------¦ ¦ ¦ ¦293(b) ¦ +------------+----------+------------¦ ¦1941 ¦$195.99 ¦$97.99 ¦ +------------+----------+------------¦ ¦1944 ¦22.25 ¦11.13 ¦ +------------+----------+------------¦ ¦1945 ¦3,437.36 ¦1,718.68 ¦ +------------+----------+------------¦ ¦1949 ¦361.94 ¦180.97 ¦ +------------------------------------+
The issues to be decided are: (1) Whether petitioner W. A. Shaw understated his net taxable income on his individual income tax returns for the taxable years 1941 to 1947, inclusive, and whether he and his wife, Grace Shaw, understated their net taxable income on their joint income tax return for the taxable year 1949, in the amounts as determined by respondent; (2) whether any part of the deficiencies were due to fraud with intent to evade the payment of taxes; (3) whether the assessment and collection of the deficiencies for the years here in issue are barred by the statute of limitations; and (4) if the statute of limitations bars the assessment and collection of the deficiency determined for 1942, whether respondent is entitled to have petitioner's tax liability for 1943 recomputed pursuant to the provisions of section 6 of the Current Tax Payment Act of 1943.
Respondent has conceded that petitioner W. A. Shaw is not liable for the delinquency penalty determined pursuant to section 291 for the taxable year 1941. This concession will be taken into account under a Rule 50 computation.
Some of the facts were stipulated.
FINDINGS OF FACT.
The stipulated facts are so found and are incorporated herein by this reference.
Petitioners W. A. Shaw and Grace Shaw are husband and wife and since prior to the year 1934 have been residing at Pittsburg Landing, Tennessee. W. A. Shaw did not file an income tax return or pay income tax for any taxable year prior to 1941. He filed individual income tax returns for the calendar years 1941 to 1947, inclusive, and he and his wife filed a joint income tax return for the calendar year 1949 with the former collector of internal revenue for the district of Tennessee. Grace Shaw had no separate income or assets during the calendar years 1940 to 1949, inclusive. Since the deficiencies here in issue relate solely to the income of her husband, he will hereinafter be referred to as the petitioner.
During the years 1941 to 1949, inclusive, petitioner was engaged in the operation of a general merchandise store and various farming, mussel fishing, and cotton ginning interests in the vicinity of Pittsburg Landing, Tennessee. The assets of the store were acquired by him in November 1937 and he thereafter operated it as a sole proprietorship. In addition, he also conducted a dining room in the store building and rented rooms on the second floor of the premises. On January 1, 1946, petitioner sold a one-half interest in all the assets of the store, with the exception of the accounts and notes receivable outstanding as of December 31, 1945, to his brother, R. D. Shaw, for $25,000. The store was operated as a partnership by petitioner and his brother during the years 1946 to 1949, inclusive, each having a one-half interest therein.
In 1951, petitioner's income tax returns were audited by a revenue agent. This investigation covered the returns filed by petitioner for the years 1945 to 1949, inclusive, as well as petitioner's income tax liabilities for the years 1941 to 1944, inclusive, although the returns for these earlier years were no longer in respondent's possession. No books and records for the period prior to or during the taxable years 1941 to 1949, inclusive, were made available to the revenue agent by petitioner, his explanation being that these records were destroyed after each of the income tax returns was filed. The revenue agent resorted to the increase in net worth method in order to determine petitioner's taxable income during those years. Set forth below are the amounts of net income reported by petitioner on his individual income tax returns for the calendar years 1941 to 1947, inclusive, and on the joint return filed by him and his wife for 1949; the amounts of net income as determined by respondent by the net worth method for such years; and the resulting understatement of income as determined by respondent for each of such years:
+-----------------------------------------------------+ ¦ ¦Net income¦Net income ¦Understatement¦ +-------------+----------+-------------+--------------¦ ¦Calendar year¦reported ¦determined by¦of income de- ¦ +-------------+----------+-------------+--------------¦ ¦ ¦on returns¦respondent ¦termined by ¦ +-------------+----------+-------------+--------------¦ ¦ ¦ ¦ ¦respondent ¦ +-------------+----------+-------------+--------------¦ ¦1941 ¦$2,049.11 ¦$6,939.70 ¦$4,890.59 ¦ +-------------+----------+-------------+--------------¦ ¦1942 ¦2,769.51 ¦12,684.81 ¦9,915.30 ¦ +-------------+----------+-------------+--------------¦ ¦1943 ¦2,742.68 ¦16,700.76 ¦13,958.08 ¦ +-------------+----------+-------------+--------------¦ ¦1944 ¦3,884.00 ¦15,869.16 ¦11,985.16 ¦ +-------------+----------+-------------+--------------¦ ¦1945 ¦2,665.33 ¦12,237.98 ¦9,572.65 ¦ +-------------+----------+-------------+--------------¦ ¦1946 ¦3,963.64 ¦43,493.06 ¦39,529.42 ¦ +-------------+----------+-------------+--------------¦ ¦1947 ¦4,605.52 ¦19,532.97 ¦14,927.45 ¦ +-------------+----------+-------------+--------------¦ ¦1949 ¦3,474.88 ¦34,957.24 ¦31,482.36 ¦ +-----------------------------------------------------+
In his petitioner, petitioner alleged that on December 31, 1940, the beginning of the net worth period, he was the owner and operator of an automobile service station and a farm seed business. He further alleged that respondent had omitted the assets of these businesses, with a total estimated value of $35,000 as of December 31, 1940, from the net worth computation. No evidence with respect to these purported businesses or these assets was introduced at the hearing.
The sole items in the net worth computation which are in dispute are the amount of the store's merchandise inventories at the end of each of the calendar years 1940 to 1943, inclusive; the total amount of the store's accounts and notes receivable
at the end of each of the calendar years 1940 to 1945, inclusive; the total amount of the notes receivable held by petitioner personally at the end of each of the calendar years 1943, and 1945 to 1949, inclusive; and the amount of notes payable by petitioner at December 31, 1948, and December 31, 1949.
In order to distinguish the accounts and notes receivable acquired by petitioner in the conduct of his store from those notes receivable acquired by him as the result of personal loans which he made, the former will hereinafter be referred to simply as accounts receivable, and the latter, as notes receivable.
In determining the amounts to be included in the net worth computation with respect to the store's merchandise inventories, respondent accepted the amounts reported by petitioner on his return for 1945, and by the partnership on its returns for 1946, 1947, and 1949. The only earlier amount known to respondent was the fair market value of the store's inventory at the time the store was acquired by petitioner in November 1937, such value being $2,168.82. In the absence of books and records, or petitioner's income tax returns for the years 1941 through 1944, respondent estimated the store's inventories for these years by assuming that they had increased by an equal amount during each of the years from 1937 to 1944. In this computation, respondent used the amount of $2,168.82 as the store's inventory on December 31, 1937, and assumed that it had increased by $2,455.01 at the end of each of the intervening years between 1937 and 1945. Set forth below are the merchandise inventories of the store for the years ended December 31, 1944, through December 31, 1949, as they were reported by petitioner and the partnership on their returns and as included by respondent in his net worth computation, and also the inventories, as estimated by respondent, for the years ended December 31, 1940, to December 31, 1943, inclusive:
+----------------------------------------------------------+ ¦ ¦Merchandise¦Merchandise ¦ +-------------------------------+-----------+--------------¦ ¦Calendar year ended December 31¦inventory ¦inventory as ¦ +-------------------------------+-----------+--------------¦ ¦ ¦reported ¦estimated ¦ +-------------------------------+-----------+--------------¦ ¦1940 ¦ ¦$9,533.85 ¦ +-------------------------------+-----------+--------------¦ ¦1941 ¦ ¦11,988.86 ¦ +-------------------------------+-----------+--------------¦ ¦1942 ¦ ¦14,443.87 ¦ +-------------------------------+-----------+--------------¦ ¦1943 ¦ ¦16,898.88 ¦ +-------------------------------+-----------+--------------¦ ¦1944 ¦$19,353.91 ¦--------------¦ +-------------------------------+-----------+--------------¦ ¦1945 ¦20,114.89 ¦--------------¦ +-------------------------------+-----------+--------------¦ ¦1946 ¦21,356.37 ¦--------------¦ +-------------------------------+-----------+--------------¦ ¦1947 ¦23,736.34 ¦--------------¦ +-------------------------------+-----------+--------------¦ ¦1948 ¦25,893.21 ¦--------------¦ +-------------------------------+-----------+--------------¦ ¦1949 ¦26,756.38 ¦--------------¦ +----------------------------------------------------------+
The inventory of the store consisted of a general line of merchandise composed of staple groceries and farmers' working dry goods and supplies. General merchandise prices remained more or less constant during the years 1938, 1939, and 1940 and not until after 1942 did a period of inflation begin.
In applications for loans from the Jackson Production Credit Association, Jackson, Tennessee, dated March 11, 1940, and March 28, 1941, petitioner represented that his accounts and notes receivable as of those dates were $3,000 and $2,000, respectively. The accounts receivable reported on the partnership's returns as of December 31, 1946, 1947, 1948, and 1949, were as follows:
+-------------------------------------------------+ ¦Calendar year ended¦ ¦ +-------------------+-----------------------------¦ ¦December 31 ¦Accounts and notes receivable¦ +-------------------+-----------------------------¦ ¦1946 ¦$12,047.69 ¦ +-------------------+-----------------------------¦ ¦1947 ¦11,412.82 ¦ +-------------------+-----------------------------¦ ¦1948 ¦13,601.10 ¦ +-------------------+-----------------------------¦ ¦1949 ¦12,477.25 ¦ +-------------------------------------------------+
In his net worth computation, respondent adopted the accounts receivable as reported on the partnership's returns. He determined that petitioner owned the following amounts of accounts receivable, as a result of the store's business, at the ends of the years 1940 to 1945, inclusive, by assuming that petitioner's accounts receivable aggregated $2,000 on December 31, 1940, and that such assets increased from that amount to the $12,047.69 reported on the partnership return for 1946 by an equal amount during each of the intervening years:
+---------------------------------------+ ¦Calendar year ended¦ ¦ +-------------------+-------------------¦ ¦December 31 ¦Accounts receivable¦ +-------------------+-------------------¦ ¦1940 ¦$2,000.00 ¦ +-------------------+-------------------¦ ¦1941 ¦3,674.61 ¦ +-------------------+-------------------¦ ¦1942 ¦5,349.22 ¦ +-------------------+-------------------¦ ¦1943 ¦7,023.83 ¦ +-------------------+-------------------¦ ¦1944 ¦8,698.44 ¦ +-------------------+-------------------¦ ¦1945 ¦10,373.05 ¦ +---------------------------------------+
In addition to the accounts receivable which were acquired in connection with the conduct of the general merchandise store, petitioner held numerous notes receivable as the result of various personal loans which he made. The records in the offices of the Registers of Deeds of McNairy and Hardin Counties, Tennessee, for the period covering the calendar years 1930 to 1949, inclusive, disclose 93 notes for amounts ranging from $42.10 to $2,295.33 secured by chattel mortgages executed to petitioner as grantee. None of these notes had been released or canceled of record, and the aggregate yearly amounts of such notes were as follows:
+---------------------------------------------------------------------------+ ¦ ¦McNairy ¦Hardin ¦Combined ¦ +------------------------------+--------------+--------------+--------------¦ ¦Taxable year ended December 31¦County total ¦County total ¦totals ¦ +------------------------------+--------------+--------------+--------------¦ ¦ ¦amounts ¦amounts ¦ ¦ +------------------------------+--------------+--------------+--------------¦ ¦1930-1939 ¦--------------¦--------------¦--------------¦ +------------------------------+--------------+--------------+--------------¦ ¦1940 ¦$75.00 ¦--------------¦$75.00 ¦ +------------------------------+--------------+--------------+--------------¦ ¦1941 ¦100.00 ¦--------------¦100.00 ¦ +------------------------------+--------------+--------------+--------------¦ ¦1942 ¦500.00 ¦$874.49 ¦1,374.49 ¦ +------------------------------+--------------+--------------+--------------¦ ¦1943 ¦1,809.00 ¦1,274.15 ¦3,083.15 ¦ +------------------------------+--------------+--------------+--------------¦ ¦1944 ¦5,226.14 ¦375.00 ¦5,601.14 ¦ +------------------------------+--------------+--------------+--------------¦ ¦1945 ¦2,675.00 ¦1,392.10 ¦4,067.10 ¦ +------------------------------+--------------+--------------+--------------¦ ¦1946 ¦4,499.33 ¦556.90 ¦5,056.23 ¦ +------------------------------+--------------+--------------+--------------¦ ¦1947 ¦7,131.20 ¦--------------¦7,131.20 ¦ +------------------------------+--------------+--------------+--------------¦ ¦1948 ¦3,699.91 ¦380.00 ¦4,079.91 ¦ +------------------------------+--------------+--------------+--------------¦ ¦1949 ¦1,197.42 ¦1,890.22 ¦3,087.64 ¦ +---------------------------------------------------------------------------+
Respondent's agent discussed each of the aforementioned notes with petitioner to determine whether they arose from personal loans or from credit furnished to customers at the store. In addition, the parties have stipulated the amounts of certain other notes owned by petitioner and the amounts of certain trust deeds which were recorded in the offices of the Registers of Deeds of McNairy and Hardin Counties, Tennessee, in the name of either E. L. Shaw or R. D. Shaw, as trustee for petitioner. Upon the basis of the foregoing, respondent determined that petitioner owned the following aggregate amounts of notes receivable at the end of each of the years 1940 to 1949, inclusive, such notes being separate and distinct from those acquired in the conduct of his general merchandise store:
+-------------------------------------+ ¦Calendar year ended¦ ¦ +-------------------+-----------------¦ ¦December 31 ¦Total notes owned¦ +-------------------+-----------------¦ ¦1940 ¦( 1 ) ¦ +-------------------+-----------------¦ ¦1941 ¦( 1 ) ¦ +-------------------+-----------------¦ ¦1942 ¦( 1 ) ¦ +-------------------+-----------------¦ ¦1943 ¦$2,928.00 ¦ +-------------------+-----------------¦ ¦1944 ¦( 1 ) ¦ +-------------------+-----------------¦ ¦1945 ¦4,008.00 ¦ +-------------------+-----------------¦ ¦1946 ¦37,785.00 ¦ +-------------------+-----------------¦ ¦1947 ¦35,455.00 ¦ +-------------------+-----------------¦ ¦1948 ¦34,588.00 ¦ +-------------------+-----------------¦ ¦1949 ¦36,673.24 ¦ +-------------------------------------+
Petitioner reported no interest income on his income tax returns for 1945, 1946, 1947, and 1949. Among the specific items of income which he failed to report on his returns for the years here in issue were a long-term capital gain of $4,543.59 which he realized in 1946 upon the sale of a one-half interest in his store to his brother, and a long-term capital gain of $1,117.19 which he also realized in that year upon the sale of his interest in the ‘B. W. Forsythe’ partnership. Petitioner did not claim a deduction on his 1949 return for a loss of $876.57 which he realized in that year upon the sale of a tract of land he had previously operated as a farm.
At the hearing herein, a stipulation of facts was introduced by the parties which was inconsistent, in certain respects, with respondent's net worth computation. Respondent corrected such computation to conform to the stipulation and, as a result, there was a shift in petitioner's taxable income from one year to another. Respondent claimed additional deficiencies and additions to tax upon the basis of the increased taxable income shown by the adjusted net worth computation. Set forth below is a schedule of the understatements of income shown by the net worth computation as adjusted to conform to the stipulation of facts and, also, a schedule of the various disputed items for each of the years in issue:
+----------------------------------------------------------------+ ¦ ¦Understatement¦Disputed ¦Disputed ¦Disputed ¦ +----+--------------+--------------+--------------+--------------¦ ¦Year¦per adjusted ¦merchandise ¦accounts re- ¦notes re- ¦ +----+--------------+--------------+--------------+--------------¦ ¦ ¦net worth ¦inventory ¦eivable ¦ceivable ¦ +----+--------------+--------------+--------------+--------------¦ ¦ ¦computation ¦(store) 1 ¦(store) 1 ¦(personal) 1 ¦ +----+--------------+--------------+--------------+--------------¦ ¦1941¦$6,192.09 ¦$9,533.85 ¦$2,000.00 ¦--------------¦ +----+--------------+--------------+--------------+--------------¦ ¦1942¦8,750.21 ¦11,988.86 ¦3,674.61 ¦--------------¦ +----+--------------+--------------+--------------+--------------¦ ¦1943¦13,707.59 ¦14,443.87 ¦5,349.22 ¦--------------¦ +----+--------------+--------------+--------------+--------------¦ ¦1944¦12,029.65 ¦16,898.88 ¦7,023.83 ¦$2,928.00 ¦ +----+--------------+--------------+--------------+--------------¦ ¦1945¦16,721.32 ¦--------------¦8,698.44 ¦--------------¦ +----+--------------+--------------+--------------+--------------¦ ¦1946¦29,399.32 ¦--------------¦10,373.05 ¦4,008.00 ¦ +----+--------------+--------------+--------------+--------------¦ ¦1947¦8,826.62 ¦--------------¦--------------¦37,785.50 ¦ +----+--------------+--------------+--------------+--------------¦ ¦1949¦32,304.94 ¦--------------¦--------------¦34,588.00 ¦ +----------------------------------------------------------------+
Part of the deficiencies for each of the years 1945, 1946, 1947, and 1949 was due to fraud with intent to evade the payment of taxes, and the returns for said years were false and fraudulent with intent to evade taxes.
OPINION.
FISHER, Judge:
We must decide whether respondent is correct in his determination of deficiencies in petitioners' income taxes and, further, whether such deficiencies are due to fraud. During the years here in issue petitioner was engaged in a variety of business activities, the principal one of which appears to have been the conduct of a general merchandise store. In addition, he operated several farms, engaged in a mussel fishing business, and had an interest in the operation of a cotton gin. When respondent's agent attempted to audit petitioner's income tax returns, he was informed by petitioner that all books and records were destroyed immediately after each of the returns was prepared. Respondent, accordingly, resorted to the net worth method to determine petitioners' income, and as a result of such computations, he determined that petitioner had understated his income for the years in issue by amounts ranging from 300 per cent to 1,000 per cent.
As this case comes before us, we find that petitioner has agreed to most of the items in respondent's net worth computation. Petitioner attacks the validity of the net worth computation by contending that the amounts of various assets were incorrectly determined, certain liabilities omitted, and that, accordingly, the computation is completely erroneous. Only four categories of items appear to be in dispute. The first two relate to petitioner's conduct of his general merchandise store, namely, the store's inventories at the end of the years 1940 through 1943, and its accounts receivable at the end of the years 1940 through 1945. The remaining two items in issue are the amounts of notes receivable held by petitioner, personally, at the end of the years 1943 through 1949, and whether he owed any notes payable on December 31, 1948, and December 31, 1949. As stated in Holland v. United States, 348 U.S. 121 (1954):
an essential condition in cases of this type is the establishment, with reasonable certainty, of an opening net worth, to serve as a starting point from which to calculate future increases in the taxpayer's assets. The importance of accuracy in this figure is immediately apparent, as the correctness of the result depends entirely upon the inclusion in this sum of all assets on hand at the outset. * * *
After careful consideration of the record herein, we are convinced that, with respect to the taxable years 1941 to 1944, inclusive, respondent has failed to satisfy this ‘essential condition.’
Since none of the books or records of petitioner's business were available, respondent had a particularly difficult task in computing the amounts of the aforementioned assets held by petitioner on December 31, 1940, the beginning of the net worth period. One of the disputed items, merchandise inventories, was presumably reported by petitioner on each of his returns for the years 1941 through 1944, but unfortunately it appears that respondent no longer had these returns in his possession. The earliest return available to respondent was that for 1945 which reported the opening and closing inventories for that year. As for accounts receivable, they were not required to be reported on Schedule C of a taxpayer's individual return, and the earliest reported amount was that for December 31, 1946, which was reported on the partnership's return for 1946.
However, there was some evidence as to the value of the inventory in 1937 and the accounts receivable in 1940, and respondent has attempted to reconstruct the amounts of these disputed assets for the earlier years in issue by assuming that each of these assets increased annually, by an equal amount, from those dates until the dates disclosed by the returns. Thus, respondent has started with evidence as to the inventories existing at December 31, 1937, and December 31, 1945, and the accounts receivable existing at December 31, 1940, and December 31, 1946, and has attempted to fill in the details for the intervening years by adopting a purely mathematical approach. Obviously, this procedure results in estimates which are, at best, crude approximations. If this case involved only deficiencies, and the burden of proof were entirely upon petitioner, we would have to sustain such estimates, for petitioner has done nothing to rebut them. It is obvious that the job must, in some fashion, be done, for a taxpayer cannot be permitted to evade the audit, proper computation, and assessment and collection of taxes by his failure to maintain the records required by law. But the burden of proof rests upon respondent in the instant case since the deficiencies for the years 1941 through 1946 are barred by the statute of limitations if fraud is not proved for such years. It is axiomatic that fraud must be shown by clear and convincing proof. Arlett Coat Co., 14 T.C. 751 (1950); M. Rea Gano. 19 B.T.A. 518 (1930). Although our suspicions may be aroused because of petitioner's destruction of his records, by his failure to testify or to introduce evidence regarding any of the controverted items, and by respondent's computation of substantial deficiencies based upon what, at first glance, appears to be a reasonable reconstruction of petitioner's assets for certain vital years, this is not sufficient to sustain respondent's burden of proof. Petitioner's failure to overcome the presumptive correctness of the deficiencies extending over a period of years cannot be regarded as, in and of itself, sufficient proof that the deficiencies, or any part thereof, were due to fraud on the part of the taxpayers. Drieborg v. Commissioner, 225 F.2d 216 (C.A. 6, 1955). Respondent must affirmatively show that there were deficiencies for the years barred by the statute of limitations, and that such deficiencies were due to fraud. This is not to say that respondent must prove the precise amount of the deficiencies, for that is not part of the burden of proving fraud. But respondent must at least prove that some part of the deficiency for each year in question was due to fraud with intent to evade taxes. If he carries this burden by clear and convincing evidence, and eliminates the bar of the statute of limitations by proof that the returns for such years were false and fraudulent with intent to evade taxes, the correctness of the deficiencies determined by him will be presumed. Leonard B. Willits, 36 B.T.A. 294 (1937).
Since the partnership did not acquire any interest in the store's outstanding accounts receivable upon its organization on January 1, 1946, the amount of petitioner's accounts receivable as of that date is not obtainable from the partnership's 1946 return.
The basic fallacy in respondent's approach to the merchandise inventories and accounts receivable is that there are no grounds for assuming that they increased in the rigid, precise fashion of an arithmetical progression. The increase in these assets may have occurred entirely in one year and the fraud might have been consummated solely in that year. In such a situation, there is no justification for spreading the deficiencies and fraud penalties over a period of years. One of the fundamentals of our income tax system is the annual accounting concept and, although the net worth method of determining an individual's taxable income may result in some slight deviation from this because of the approximations inherent in a net worth computation, there is no authority in the Code for a complete disregard of the principle that each year is a separate taxable unit. Where the issue is fraud, we cannot assume that such fraud occurred in each of the years in issue rather than solely in one.
As the schedule at the end of our Findings of Fact shows, in each of the years 1941 to 1944, inclusive, the aggregate of the disputed inventories and accounts receivable is in excess of the total understatements in issue. Obviously the store had some inventory and some accounts receivable at the end of each of these years. But we are unable to determine whether these assets increased ratably over this 4-year period, or whether the increases occurred prior to, during one, or during several of the years. Although the aggregate annual increase determined by respondent for these two assets is only $4,129.62, the amounts of the understatements for the years 1941 to 1944, inclusive, are not sufficient to assure us that fluctuations in these assets, if known to us, might not show that there were actually no deficiencies for certain of these years. Accordingly, we hold that respondent has failed to prove the existence of deficiencies, and, therefore, of fraud for any of such years.
Respondent on brief contends, in the alternative, that if we do not accept the inventories which he has determined for the years 1941 to 1944, inclusive, we should use the amount ($12,489.76) which petitioner alleged, in his petition, ‘could be reasonably expected on December 31, 1940.’ Respondent, in his answer, denied the allegation, and did not offer it at the trial as an admission. We do not think the language used in the petition may be taken as an admission of a precise amount of inventory as of any of the years in question, or that it is of itself sufficient to supply the clear and convincing evidence which is respondent's burden.
In each of the remaining years in issue, 1945, 1946, 1947, and 1949, we feel that respondent has convincingly shown that at least some part of the deficiency was due to fraud. We will first discuss the deficiencies for each of these years, reserving the discussion of the fraud issue for later in the Opinion. We note at this point, however, that since we have found that part of the deficiencies for each of such years was due to fraud, the burden was upon petitioner to disprove the correctness of such deficiencies.
Turning our attention first to the years 1945 and 1946, the schedule at the end of our Findings of Fact discloses that the understatements shown by the adjusted net worth computation for each of these years is approximately twice the aggregate amount of the disputed items. The disputed items during these years are the accounts receivable and petitioner's notes receivable. Petitioner did not testify or introduce evidence as to either of these items. On the other hand, respondent has proved to our satisfaction that the amounts included by him in the net worth computation with respect to petitioner's notes receivable for the years 1944 to 1949, inclusive, were reasonably correct. Each of the notes included by respondent in his net worth computation was evidenced by actual trust deed records in two countries in which petitioner did business.
Although petitioner objects that some of these notes represent duplications of notes also included among the store's accounts and notes receivable, he has made no effort to clarify this matter. However, respondent's agent testified that he had discussed the various notes with petitioner in order to determine which arose from personal loans made by petitioner and which arose from credit furnished to customers at the store. We were impressed with the honesty and directness of this revenue agent's testimony and believe that he made a sincere and thorough effort to accurately determine this item. Even though there may have been some small inaccuracies, since mortgage records do not conclusively establish the date of payment, we are convinced they are relatively minor and insufficient to radically affect the deficiencies for these years. As for the accounts receivable for these years, although they were determined by respondent by the same mathematical approach used during the previous years, we are convinced that even though there may be some error in the determination of this item, such error would not be sufficient to eliminate the understatements shown by the net worth statement. Thus, the adjusted net worth statement shows an understatement of $16,721.32 for 1945 and $29,399.32 for 1946, and respondent determined an increase in accounts receivable for each of these years amounting to but $1,674.64. In order to eliminate the understatement disclosed by the net worth computation for 1945, petitioner would have to show that his accounts receivable, the only item in issue for that year, had declined by $18,395.96 during that year. As for 1946, accepting the notes receivable as correct (which we do), it would be necessary for petitioner to show that the accounts receivable, the only other disputed item for that year, had declined by still another $31,073.96 in order to eliminate the understatement for that year. Merely to state such hypothetical declines in petitioner's accounts receivable is to show the impossibility of such violent fluctuations in this asset when we consider the volume of sales done by petitioner and the subsequent accounts receivable reported by the partnership. These accounts receivable, as reported on the partnership's returns for 1946 through 1949, amounted to but $12,047.69 on December 31, 1946, and they did not decline or increase by more than $2,500 during any of the succeeding 3 years. We accordingly hold that petitioner has failed to overcome the presumptive correctness of the deficiencies determined for the years 1945 and 1946.
These country records indicated no personal notes receivable owned by petitioner during 1940, 1941, 1942, and 1944.
As for the remaining 2 years in issue, 1947 and 1949, here, also, petitioners have failed to overcome the presumptive correctness of respondent's determination. The preceding discussion of the notes receivable for the years 1945 and 1946 is equally appropriate for these last 2 years and need not be repeated.
One more argument regarding the net worth computation must be discussed, namely, petitioner's contention that respondent omitted various notes payable by petitioner, as of December 31, 1948, and December 31, 1949. Respondent's agent testified that he discussed this matter with petitioner prior to preparing the net worth schedule, but the only notes payable which he was shown were drawn after the period in issue. Since petitioner has failed to introduce any evidence as to the nature or amounts of these notes, we must assume that petitioner had no such liability as of these dates and respondent's action on this point is sustained.
We need not consider the allegations in the petition that petitioner owned an automobile service station and a seed business at the beginning of and during the net worth period and that the purported inventories of such businesses were excluded from the net worth computation. Though the petition indicates that the service station business was discontinued at some unidentified time prior to December 31, 1945, and that the seed business was discontinued during the calendar year 1945, not one scintilla of evidence was introduced by petitioner at the hearing with respect to these businesses. Accordingly, respondent was under no obligation to rebut these allegations. Wichita Terminal Elevator Co., 6 T.C. 1158, 1165 (1946), affd. 162 F.2d 513 (C.A. 10, 1947). The failure of petitioner to introduce evidence solely within his possession, which, if true, would be favorable to him, gives rise to a presumption that if produced it would be unfavorable and becomes, itself, ‘evidence of the most convincing character.’ Stoumen v. Commissioner, 208 F.2d 903 (C.A. 3, 1953); William G. Lias, 24 T.C. 280 (1955), affd. 235 F.2d 879 (C.A. 4, 1956); Wichita Terminal Elevator Co., supra.
Our study of the record in this case convinces us that the deficiencies for the years 1945, 1946, 1947, and 1949 were due to fraud with the intent to evade the payment of taxes. Petitioner reported a net income on his returns for these years varying from $2,665.33 to $4,605.52, whereas his income as computed by the net worth method, which took into account the stipulation of facts submitted at the hearing, shows a net income ranging from $13,432.14 to $35,779.82. Although there may be some minor inaccuracies in the net worth computation, our analysis of the various disputed items clearly shows that it is substantially correct for each of the years 1945, 1946, 1947, and 1949. The understatements for these years ranged from $8,826.82 to $32,304.94. Whatever inaccuracies there may have been in the determination of the disputed items in the net worth statement would be too minor to affect our finding that such understatements were substantial. The consistent understatement of substantial amounts of income is persuasive evidence of fraud. United States v. Calderon, 348 U.S. 160 (1954); Rogers v. Commissioner, 111 F.2d 987 (C.A. 6, 1940); Arlette Coat Co., 14 T.C. 751 (1950). Moreover, petitioner failed to report any income from interest on his returns for these years although the evidence indicates that he owned notes receivable aggregating approximately $4,000 at the end of 1945 and substantially in excess of $30,000 at the end of each of the remaining years.
He also failed to report a long-term capital gain of $4,543.59 which he realized upon the sale of a one-half interest in his store to his brother, and a long-term capital gain of $1,117.19 which he realized from the sale of his interest in the ‘B. W. Forsythe’ partnership. These gains were both realized in 1946. It should be noted, in petitioner's favor, however, that he did not claim a deduction on his 1949 return for a loss of $876.57 which he realized in that year upon the sale of a tract of land which he had previously operated as a farm.
The circumstances surrounding the unavailability of petitioner's books and records contribute to the inference of fraud. When the revenue agent requested petitioner's books and records he was advised that they could not be located, and when he and petitioner jointly searched the store, they were unable to find any of the books or records. Not until a subsequent meeting did petitioner inform the revenue agent that his brother had maintained the records for many years and that, after discussing the matter with his brother, they had decided that the records had been destroyed after the returns were filed. Moreover, when petitioner did produce a copy of his return for 1941 for the purpose of showing that he had filed a return for that year (in order to avoid the delinquency penalty), pages 3 and 4 of that return were missing. These pages presumably contained material information as to petitioner's inventory at the beginning of the net worth period, and their absence under the circumstances is significant.
We add that while we draw no affirmative inference of fraud from the fact that neither petitioner nor his brother testified in the case, by the same token we cannot assume affirmatively that petitioner had a reasonable explanation which would have refuted the otherwise clear inference of fraud when no such explanation, if it existed, was presented to us by available witnesses.
Since we have found as a fact that the returns for 1945, 1946, 1947, and 1949 were false and fraudulent with intent to evade taxes, the statute of limitations does not apply for any of such years. Sec. 276(a), I.R.C. 1939.
At the hearing herein, the parties introduced a stipulation of facts which, when applied to the net worth computation, caused a shift in petitioner's income from one taxable year to another. On the basis of these modifications in the net worth computation, respondent claimed additional deficiencies and additions to tax for the taxable years 1941, 1944, 1945, and 1949. Fraud not having been proved for the years 1941 and 1944, they are barred by the statute of limitations. But, for the years 1945 and 1949, the additional deficiencies and additions to tax are sustained since petitioner has stipulated to the correctness of the facts on which they are based, and no claim has been made that respondent erred in the application of such stipulated facts to the net worth computation.
The last issue herein relates to respondent's alternative claim that, in the event the assessment and collection of the deficiency and addition to tax for 1942 are barred by the statute of limitations, he should be permitted to recompute petitioner's tax liability for 1943 under the provisions of section 6 of the Current Tax Payment Act of 1943. However, since respondent has also failed to prove fraud for the year 1943, it is clear that the assessment and collection of any additional tax and additions to tax which might be determined pursuant to such recomputation are also barred by the statute of limitations.
Decision will be entered under Rule 50.