Martin v. Chandis Securities Co., 9735.

Decision Date29 May 1942
Docket NumberNo. 9735.,9735.
Citation128 F.2d 731
PartiesMARTIN, Internal Revenue Agent, v. CHANDIS SECURITIES CO. et al.
CourtU.S. Court of Appeals — Ninth Circuit

Samuel O. Clark, Jr., Asst. Atty. Gen., Helen R. Carloss and Frank J. Ready, Sp. Assts. to the Atty. Gen., all of Washington, D. C., William Fleet Palmer, U. S. Atty., E. H. Mitchell, Asst. U. S. Atty., Eugene Harpole and Samuel Taylor, Sp. Attys., Bureau of Internal Revenue, all of Los Angeles, Cal., for appellant.

A. Calder Mackay, T. B. Cosgrove, F. J. O'Neil, and F. B. Yoakum, Jr., all of Los Angeles, Cal., for appellees.

Before GARRECHT, MATHEWS, and HANEY, Circuit Judges.

HANEY, Circuit Judge.

The court below, by order, quashed an order it had previously issued requiring appellee Downing to appear on a specified date and produce certain records of appellee Chandis Securities Company. Appeal was taken from the first mentioned order.

In 1916, Mrs. Chandler's husband organized appellee Chandis Securities Company, hereafter called the company, with an authorized capital stock of 500 shares each having a par value of $1,000. The husband then transferred real and personal property to the company in exchange for all its stock. The husband then transferred 200 shares of the stock to Mrs. Chandler, hereafter called the wife, and 280 shares to the eight children. Thereafter the husband transferred other property to the company and received in payment therefor notes bearing interest at the rate of 5% per annum. The husband then assigned the notes to his wife and children in approximately the same proportion as their stockholdings in the company.

The company kept its books on the accrual basis, but accrued no interest on the notes until December 31, 1923. On that day it executed renewal notes to the wife and children covering principal and all accrued interest. The wife and children, who reported income in their income tax returns on the cash basis, did not report receipt of any interest in their returns for 1923 or previous years. The Commissioner of Internal Revenue assessed deficiencies in taxes for such years on the ground that the wife and children had constructively received the accrued interest. On petition for redetermination, the Board of Tax Appeals decided to the contrary. Marian Otis Chandler v. Commissioner, 16 B.T.A. 1248, decided June 29, 1929.

The company increased its stock to 50,000 shares and changed the par value thereof to $100 per share about October 14, 1929.

On December 18, 1929, the wife and children expressed their willingness to exchange their notes for stock in the company. On the same date, the company passed a resolution authorizing its officers to apply to the California Corporation Commissioner for permission to issue 40,000 shares of its stock to liquidate its outstanding notes. The application was filed on December 20, 1929 and granted on December 26, 1929.

The wife and children surrendered the notes to the company on January 2, 1930, and such notes were cancelled on that day. The stock certificates were not actually delivered until May, 1930.

In their income tax returns for the year 1929, the wife and children, who reported their income on the cash basis, reported none of the interest on the notes as income. The Commissioner assessed deficiencies on the ground that the wife and children had received interest in 1929. On petitions for redeterminations, the Board stated that two issues were presented: "(1) Was the transaction by which petitioners exchanged certain notes and interest for stock consummated in 1929 or 1930? (2) Did the petitioners realize taxable income by reason of such exchange?" The Board found "that the exchange was made in 1930" and did not pass on the second issue, the contentions made with respect to that issue not being stated by the Board. Marian Otis Chandler v. Commissioner, 32 B.T.A. 720. On petition to review, this court sustained the Board, saying among other things: "From no conceivable viewpoint does it appear to us that the involved transaction was consummated prior to 1930". Commissioner v. Chandler, 9 Cir., 89 F.2d 332, 333.

After having given notice to the company, appellant issued a summons to the company and to appellee Downing as Assistant Secretary thereof, to appear before appellant at a designated place on December 11, 1939, and to produce a great many records of the company "for the years 1916 to 1930, inclusive". Appellees declined to obey the summons.

On March 5, 1940, appellant filed in the court below a "Petition For Production Of Records". The petition alleged that the wife's income tax return for the year 1930 was then under investigation by appellant; that appellees had under their control and in their custody certain records bearing upon the matters required to be included in said return; that a summons was served on appellees but appellees refused to obey it; and that appellant prayed for an order requiring appellees to appear before appellant at a designated time and place and produce the records. Other than the allegation to the effect that the wife's return was being investigated, the petition stated no reason for examination of the requested records.

Attached to the petition was an affidavit of one Williams an agent of the Bureau of Internal Revenue, in which he deposed:

"That it is necessary that representatives of the Bureau of Internal Revenue examine the books and records of the Chandis Securities Company for the years 1916 to 1930, inclusive, and question said H. E. Downing, in order to determine whether Marian Otis Chandler committed a fraud against the Revenue by failing to report upon the income tax return filed by her for the calendar year 1930 a large sum of asserted interest income received by her from the said Chandis Securities Company in the year 1930."

On the same day the court issued the ex parte order prayed for.

On March 19, 1940, appellees moved to quash and vacate the order of March 5, 1940, on the following grounds among others: (1) that the time for further assessment and collection of taxes for the year 1930 had expired prior to the issuance of the order, unless the return was false or fraudulent with intent to evade the tax, and there was no proof or prima facie showing that the return was false or fraudulent with intent to evade the tax; (2) that examination and investigation of such records were unnecessary and in violation of § 3631, Int.Rev.Code, 26 U.S.C.A. Int. Rev.Code § 3631; and (3) that all records requested had already been examined by the Commissioner and his agents in connection with the so-called "interest income".

Attached to the motion was an affidavit of Downing in which he deposed: the facts concerning the previous cases; that on October 3, 1935, the Board decided that the issuance of stock for notes and accrued interest was a tax-free reorganization within the meaning of Section 112(b) (3) of the Revenue Act of 1928, 26 U.S.C.A. Int.Rev. Code § 112(b) (3), and that the note holder did not derive taxable income when he received the stock in Daniel H. Burnham v. Commissioner, 33 B.T.A. 147, affirmed 7 Cir., 86 F.2d 776, certiorari denied 300 U.S. 683, 57 S.Ct. 753, 81 L.Ed. 886; that prior to the exchange of notes for stock, Downing consulted with income tax advisors, of recognized professional standing and ability with respect to the proposed transaction; that he was advised and believed that such transaction would be one by which neither the company nor the wife would have a gain or loss; and that the 1930 return of the wife was prepared under his supervision and was full, true and correct, was made in good faith and was in no sense false or fraudulent.

On April 6, 1940, there were filed two affidavits, one made by Donnally, an agent of the Bureau of Internal Revenue, and the other made by Williams. Donnally stated that in 1931, Downing told him that the notes were cancelled in 1929, and that the notes had been misplaced; and that he relied on Downing's statement in recommending to his superiors that the exchange was taxable in 1929. Williams stated that the reasons why it was necessary to examine the records in question were: (a) to determine how much interest was included in the notes exchanged; and (b) to determine the value of the stock. He attached exhibits to his affidavit.

One of the exhibits was the wife's protest to the deficiency assessment in connection with her return for 1929, in which she stated that the exchange of the stock for the notes was in 1929 and was "an exempt exchange in connection with a reorganization".

Downing then filed an affidavit denying the statements attributed to him by Donnally. Donnally then filed an affidavit containing a portion of the testimony of Downing before the Board in 1933. The testimony was that Downing had no recollection of the alleged statements he was supposed to have made to Donnally in 1931.

Williams then...

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