Abatti v. C. I. R.
| Decision Date | 29 July 1981 |
| Docket Number | No. 79-7139,79-7139 |
| Citation | 644 F.2d 1385 |
| Parties | 81-1 USTC P 9442, 8 Fed. R. Evid. Serv. 550 Tony ABATTI and Sheila Gruis, formerly known as Sheila Abatti, Petitioners- Appellees, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant. Tony ABATTI, Petitioner-Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant. Ben ABATTI and Margaret L. Abatti, Petitioners-Appellees, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant. Tony ABATTI and Ninfa Abatti, Petitioners-Appellees, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant. Ben ABATTI and Margaret L. Abatti, Petitioners-Appellees, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant. |
| Court | U.S. Court of Appeals — Ninth Circuit |
David I. Pincus, Washington, D. C., for respondent-appellant; Gilbert E. Andrews, Dept. of Justice, Tax Div., Washington, D. C., on brief.
James O. Hewitt, San Diego, Cal., for petitioners-appellees.
Appeal from the United States Tax Court.
Before CHAMBERS and NORRIS, Circuit Judges, and SOLOMON, * District Judge.
The tax court disallowed $2,356,381 in deficiencies assessed against Ben and Tony Abatti and their wives for the tax years 1971, 1972, and 1973. The Commissioner of Internal Revenue (the Commissioner) appeals. We reverse.
Ben and Tony Abatti are farmers. They conduct their farming operations through three entities. Abatti Brothers (B&T) is a partnership which owns or leases land. It has a calendar year. Abatti Farms (Farms) is a subchapter S corporation which grows crops for B&T and others. It has a May 31 fiscal year end. Abatti Produce (Produce) is a subchapter S corporation which harvests, packages and markets crops for B&T and others. It has a January 31 fiscal year end. All these entities use the cash method of accounting.
There were many intercompany transfers of funds for services rendered, disbursements of sales proceeds and intercompany loans. They kept no records to reflect the reasons for these transfers and there were no billings or invoices. At each entity's year end, the intercompany accounts were closed by payments to the other entities for amounts due. These intercompany transactions were the subject of the Commissioner's audit.
The 1971-1972 year end transactions illustrate the transactions which the Commissioner examined. On December 31, 1971, B&T obtained a one month loan of $861,127.36 from Security Pacific National Bank. On the same day B&T distributed $660,000 of the loan proceeds to Produce and the other $201,127.36 to Farms. These entities bought Time Certificates of Deposit (TCD's) in those amounts which they pledged to the bank as collateral for B&T's loan. On January 31, 1972, the certificates matured and the bank deposited the proceeds in B&T's account. On the same day B&T repaid the loan.
Frank Hatfield, an Internal Revenue Agent, was assigned to conduct an audit of Produce for its fiscal year ending January 31, 1971. He called Produce and asked to speak with Ben Abatti. Hatfield gave his name and told Ben that he was going to conduct an examination of Produce's 1971 tax return but Ben testified that Hatfield did not identify himself as an IRS agent. Ben told Hatfield to contact his accountant, Mickey Macklin, to make arrangements for the audit. Macklin had been the Abattis' accountant since 1959 and was responsible for making the entities' accounting decisions.
Because of the many intercompany transfers, Hatfield expanded the audit to all three entities for 1971, 1972, and 1973. Hatfield questioned Ben about these transactions and Ben referred him to Macklin, because as Ben later testified, he knew nothing about the record keeping and he relied on Macklin to do all the accounting work. Thereafter, Hatfield made his requests for information to Macklin. Macklin was not enrolled to practice before the IRS. In July, 1974, Macklin told Hatfield that the Abattis had retained Charles A. Pinney, Jr. as their attorney in this matter. Pinney was enrolled to practice before the IRS.
On October 9, 1974, Pinney, Macklin, and Hatfield met at Pinney's office. A ring binder prepared by Macklin, which contained accounting schedules and other data principally prepared by Macklin and by Mrs. Poloni, the Abattis' sister and bookkeeper, was delivered to Hatfield. The binder showed how the intercompany transactions were reported and how they should have been reported.
On April 15, 1976, the Commissioner sent revenue agent's reports for 1971 and 1972 to the three Abatti entities and to Pinney. The reports proposed adjustments to each entity's income and deductions on the ground that under Section 482 of the Internal Revenue Code, as amended, 26 U.S.C. § 482 (Section 482), 1 the intercompany It is determined from the books and records of the partnership (or subchapter S corporation) that you have income of * * * dollars for the taxable year * * * in lieu of * * * dollars reported on your return.
transactions did not clearly reflect income. On the same day, the Commissioner mailed statutory notices of deficiency to the taxpayers. These notices contained the same explanation of the adjustments to income and deductions:
The taxpayers petitioned the United States Tax Court for a redetermination of the deficiencies. The Commissioner, in his answer, admitted or denied the various allegations and affirmatively alleged fraud.
On June 29, 1976, Pinney, Macklin, Hatfield, and Revenue Agents Kellogg and Herstedt met at Pinney's office. A second binder containing additional schedules relating to 1974 and new summaries and other information was delivered to Hatfield. Herstedt reconciled the books and records of each of the entities with its tax return.
On March 30, 1977, the Commissioner issued notices of deficiency for 1973 to the taxpayers with the same explanation as those sent in 1976 but no revenue agent's report was mailed.
On March 27, 1978, at a tax court calender call, Pinney made a settlement offer but these was no settlement. The tax court set the trial for June 26, 1978.
On June 1, 1978, the court was informed that the taxpayers had discharged Pinney and had retained James O. Hewitt, an experienced tax attorney. The Commissioner moved to postpone the trial because Hewitt refused to stipulate to the deficiencies. The court denied the postponement and advanced the trial from June 26 to June 21.
On June 7, 1978, Hewitt asked the Commissioner's counsel what legal theories he planned to use. Counsel told him that he would be unable to answer until the following week. On June 16, 1978, counsel informed Hewitt that the Commissioner would rely on Section 482.
At the beginning of the trial Hewitt moved:
(1) to exclude reliance on Section 482 and evidence related thereto;
(2) to shift the burden of proof to respondent;
(3) to limit reliance of respondent to issues properly raised.
The tax court granted all three of these motions.
The tax court, because it found that the deficiency notices contained no valid grounds, permitted the Commissioner to amend his answers to allege that the deficiencies were based on fraud. This required the Commissioner to assume the burden of proof under Rule 142(a) of the Rules of Practice and Procedure of the United States Tax Court (Rule 142(a)). 2
The Commissioner's counsel called Ben Abatti; four bank officials; Mrs. Poloni; Pinney; Macklin, who refused to testify on the ground of self-incrimination; and Hatfield. During direct examination of Hatfield, counsel sought to introduce the binders. The court held that the binders were inadmissible. The Commissioner's counsel stated that he was precluded from presenting his case based on fraud and rested. The tax court then announced from the bench that it would hold for the taxpayers.
In this appeal, the Commissioner contends that the tax court erred when it precluded him from relying on Section 482, when it shifted the burden of proof, and when it held that the binders were not admissible in evidence.
The Commissioner does not appeal the tax court's disallowance of the fraud penalties.
The tax court held that the taxpayers did not have fair warning that the Commissioner intended to invoke Section 482 when the statutory deficiency notices and the pleadings did not expressly mention that section.
The Commissioner may not rely on Section 482 when its use would surprise the taxpayer at the trial. CIR v. Chelsea Products, 197 F.2d 620 (3d Cir. 1952); Richard R. Riss, Sr., 56 T.C. 388 (1971). The Commissioner may, however, use Section 482 when the taxpayer has reason to believe that the Commissioner intends to invoke that section. In Rubin v. CIR, 56 T.C. 1155 (1971), aff'd per curiam, 460 F.2d 1216 (2d Cir. 1972), the court allowed the Commissioner to rely on Section 482 because the taxpayers conceded that the Commissioner had informed them of his intent to use that section during a conference well before trial.
In CIR v. Stewart, 186 F.2d 239 (6th Cir. 1951), the court rejected the taxpayer's contention that the deficiency notices were invalid because they contained no explanation of the method by which the Commissioner made the assessments. The court stated that "the taxpayer was fully advised, as shown by his petition filed with the Tax Court, of the reasons forming the basis for the Commissioner's actions." Id. at 242. Similarly, in Olsen v. Helvering, 88 F.2d 650 (2d Cir. 1937), the court stated, "(t)he taxpayer's petition ... makes it perfectly plain that he was not mislead ..." Id. at 651.
The agent's reports contained a full statement on Section 482. The taxpayers and Pinney, who was their attorney at that time and who had represented them in these cases for three years, received them. Pinney thereafter filed petitions for the taxpayers that contained numbers and other information showing that he referred to the revenue agent's report. It appears incredible...
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