Worcester v. CIR, 6715.

• Decision Date: 07 December 1966
• Docket Number: No. 6715.,6715.
• Citation: 370 F.2d 713
• Parties: Thomas WORCESTER et al., Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — First Circuit

370 F.2d 713 (1966)

Thomas WORCESTER et al., Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 6715.

United States Court of Appeals First Circuit.

Heard October 3, 1966.

Decided December 7, 1966.

John L. Saltonstall, Jr., Boston, Mass., with whom Gerald T. O'Hara, Joseph D. Steinfield and Hill & Barlow, Boston, Mass., were on brief, for petitioners.

Burton Berkley, Atty., Dept. of Justice, with whom Mitchell Rogovin, Asst. Atty. Gen., and Lee A. Jackson and David O. Walter, Attys., Dept. of Justice, were on brief, for respondent.

Before ALDRICH, Chief Judge, WOODBURY,^* Senior Circuit Judge, and COFFIN, Circuit Judge.

OPINION OF THE COURT.

ALDRICH, Chief Judge.

This is a series of consolidated petitions to review decisions of the Tax Court which determined deficiencies in the 1947 individual tax return of petitioner Thomas Worcester, and in the 1948-52 joint returns of Thomas Worcester and wife, and upheld the Commissioner's impositions of fraud penalties and interest. A number of sources of income were involved, all of which relate essentially to the husband, and the asserted fraud was wholly his.

The facts are these. Thomas Worcester, Inc. (TWI) was incorporated in Massachusetts in 1946 to engage in the business of performing architectural and engineering services and construction work. During the years in question Worcester and his wife owned a majority of the voting stock. Worcester was the principal officer, and one Murphy was comptroller. Ross Turner & Company (RT) was a partnership, formed in 1949, of which Worcester and Murphy held themselves out as the active partners, and the income of which was divided equally between them on the partnership tax returns. Allegedly it was a sales agency. State Street Sales, Inc. (SSS) was a Massachusetts corporation formed in 1950, authorized to perform architectural, engineering and construction work, and to operate a restaurant. During 1950 Worcester acquired all of its stock.

Four categories of payments are involved, all, initially, from TWI: (1) Payments to Worcester allegedly for travel and entertainment expenses; (2) Payments to RT and SSS that were retained by them; (3) Payments made to RT and SSS which were subsequently turned over by them to Worcester; (4) Payments made to various individuals and allegedly passed on to Worcester. No accounting questions are involved,¹ but matters of more general substance.

(1) With respect to the expense allowances not reported in petitioners' returns as income, TWI had a general account for employee expenses, which may, or may not, have included Worcester. In addition, it made $100 weekly payments to Worcester, commencing in 1947, allegedly for travel and entertainment expenses, that were increased to $150 weekly in February 1949 and thereafter. The first nine weeks were in varying amounts, but averaged out to exactly $100. There were no written records or vouchers of any sort, and in oral testimony Worcester could describe only a relatively small amount of alleged actual expenses. While this is understandable, particularly in the days when taxpayers often kept few such records, we cannot say as matter of law that petitioners sustained their burden of showing the Commissioner's assessment erroneous. Welch v. Helvering, 1933, 290 U.S. 111, 54 S.Ct. 8, 78 L.Ed. 212. Indeed, such regular and sizeable expense allowances so consistently maintained, and so unpersuasively explained, would seem a possible badge of fraud.

(2) Some $100,000 was paid by TWI to SSS in the years following its formation, allegedly for services although it rendered none, which was retained by it.² Since Worcester was the controlling stockholder of both corporations, this was income to him. Biltmore Homes, Inc. v. Commissioner of Internal Revenue, 4 Cir., 1961, 288 F.2d 336, 340-341, cert. den. 368 U.S. 825, 82 S.Ct. 46, 7 L.Ed.2d 30; Helvering v. Gordon, 8 Cir., 1937, 87 F.2d 663. Cf. Commissioner of Internal Revenue v. Makransky, 3 Cir., 1963, 321 F.2d 598. Any other rule would permit a stockholder to convert income into capital gains by transferring funds from one business to another then selling the latter company at a profit; or, if that were not permitted, at least to escape the strictures placed on accumulation of income by sections 531-537 of the Internal Revenue Code, 26 U.S.C. §§ 531-537, and thereby postpone at will the realization of taxable income. In the case at bar SSS operated its restaurant at a substantial loss. It was able to use this loss to avoid paying a tax on most of the "income" received from TWI. No error appears in charging Worcester with this income.

(3) More substantial questions arise with respect to payments which TWI made to RT and SSS, again for services not performed, and which, in turn, were shown to have been paid over to Worcester. We need not trace the course which such funds thereafter allegedly followed in and out of Worcester's safe deposit box. Worcester's position is that they were not income to him because he was a mere "conduit" through whom, by way of Murphy and a deceased individual named Norton, payments were made to public officials to advance TWI's business interests. We are not unimpressed by some of the evidence which petitioners marshal to support this position. However, we cannot rule as matter of law that the evidence favorable to Worcester went further than the recognition which the Tax Court in fact afforded it. The burden was upon petitioners. Perhaps not surprisingly, even the testimony favorable to them was not always consistent and above criticism. Wherever the line may be at which the Tax Court is required to accept a taxpayer's evidence, it is not here. Having wet his feet by, at least impliedly, confessing to bribery, it was to Worcester's advantage to claim that everything he took was thus paid out. The court was not obliged to believe him, particularly where he had shown himself not to have been entirely honest with the government in other respects.

Petitioners seek to claim that the government is collaterally estopped from disputing Worcester's testimony that he paid out these receipts to or through Murphy and Norton. This claim is based upon the following circumstances. Before the tax case was initiated the government brought a criminal proceeding against Worcester, charging the filing of false joint income tax returns for the years 1950, 1951 and 1952 with the intent to evade taxes. The factual assertions made by Worcester in defense of that case are essentially the ones made here in this. Worcester was convicted on all counts. Thereafter, as a result of a deal proposed by the district court and accepted, discussed infra in another connection, Worcester was sentenced to jail, but the execution of the sentence was suspended and he was placed on probation upon the condition that he should give "full, candid testimony" if requested by any proper investigative body. See United States v. Worcester, D.Mass. 1961, 190 F.Supp. 548, 552-553. Subsequently Worcester testified before a federal grand jury, continuing his position that he delivered the money to Norton, and that he had no inkling, with one exception, to whom it ultimately went. The United States Attorney took the position that Worcester knew more than this, and a lengthy hearing was held before the district court as to whether Worcester's probation should be revoked. The court refused to revoke, stating expressly that Worcester's testimony had been "candid, credible, complete." Petitioners now argue that the criminal conviction is no longer pertinent, and that it is res judicata against the government that Worcester was nothing but a conduit for all of the sums paid to him from RT and SSS.

Worcester assumes that the district court probation revocation findings went to the extent of endorsing the correctness of all of his prior testimony, even as to dollar amounts. We do not think so.³ The revocation issue was in much broader focus. The court was not trying over again the issue of whether there had been any willful understatements in the returns, but was considering simply the overall truthfulness of Worcester's grand jury testimony.

However, even if we consider that the court had duly found, in terms, that it believed that Worcester had not retained a penny of what he received from RT and SSS, we note two things. In the first place, the burden was on the government in the probation proceedings to prove Worcester wrong. The decision in Worcester's favor meant only that the government had failed to persuade the court to disbelieve him. In the case at bar, the burden was on Worcester to show error on the part of the Commissioner. The difference in burden of proof is important. See Developments in the Law — Res Judicata, 65 Harv.L.Rev. 820, 878 (1952). Cf. Helvering v. Mitchell, 1938, 303 U.S. 391, 397, 58 S.Ct. 630, 82 L.Ed. 917. But of perhaps even greater importance, a probation revocation proceeding under 18 U.S.C. § 3653 is an informal matter — however protracted this one may have been — not restricted by many of the ordinary rules of evidence. Burns v. United States, 1932, 287 U.S. 216, 53 S.Ct. 154, 77 L.Ed. 266; United States v. Register, 4 Cir., 1966, 360 F.2d 689, cert. den. 87 S.Ct. 37. It should not lead to a judgment binding in other, more judicial, that is to say, more formal proceedings, as we suspect Worcester would be the first to contend had this particular probation proceeding gone against him.

(4) No question can arise with regard to some relatively small payments which the government traced from TWI to employees of TWI, notably Murphy and one Bullock, and from them to Worcester. This was a straight question of fact, and the Tax Court's resolution was not plainly wrong.

We turn to the question which underlies the government's entire case, namely, the issue of fraud. The burden was upon the government to prove by clear and convincing evidence, Drieborg v. Commissioner of Internal...