AUERBACH SHOE COMPANY v. Commissioner of Int. Rev., 4837.

• Decision Date: 12 November 1954
• Docket Number: No. 4837.,4837.
• Parties: AUERBACH SHOE COMPANY, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — First Circuit

216 F.2d 693 (1954)

AUERBACH SHOE COMPANY, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 4837.

United States Court of Appeals First Circuit.

November 12, 1954

Harry Bergson, Boston, Mass., for petitioner.

Dudley J. Godfrey, Jr., Sp. Asst. to Atty. Gen., with whom H. Brian Holland, Asst. Atty. Gen., and Ellis N. Slack and Lee A. Jackson, Sp. Asst. to Atty. Gen., were on brief, for respondent.

Before MAGRUDER, Chief Judge, and WOODBURY and HARTIGAN, Circuit Judges.

WOODBURY, Circuit Judge.

This is a petition for review of a decision of the Tax Court of the United States affirming an assessment by the Commissioner of Internal Revenue of 50% fraud penalties computed on deficiencies in the petitioner-taxpayer's excess profits taxes for its fiscal years ending October 31, 1944, and October 31, 1945, and on a deficiency in its disclosed value excess profits tax for the later year. The stipulated facts as found by the Tax Court can be briefly stated.

The taxpayer is a Massachusetts corporation which at the times involved was engaged in the business of manufacturing shoes. It kept its books and filed with the local Collector of Internal Revenue its federal tax returns on the accrual basis covering fiscal years ending on October 31.

During the fiscal years 1944 and 1945 one Hyman Auerbach owned all the issued and outstanding stock of the corporation, and as its president, treasurer, and principal managing officer he devoted his full time to its affairs for which he drew a sizable salary.¹ In the course of those years he made sales of substantial quantities of goods belonging to the corporation, chiefly shoes, the proceeds of which he diverted from the corporation to his own personal pocket. His method of operation was to intercept bills of lading before they reached the petitioner's bookkeeper, to make out invoices for the sales himself, and then personally to collect the amounts of the sales from the customers. He did not report the amounts thus appropriated in his individual income tax returns, nor did he report those amounts in the petitioner's federal tax returns which he executed under oath and filed on its behalf. Nevertheless, he included in the petitioner's returns the cost to it of the goods sold as described above. There is no evidence that any of the other officers or directors of the corporation, or any employee, had any knowledge of Hyman Auerbach's diversion of the proceeds of sales of corporate property to his own account, or of the petitioner's failure to disclose the amounts of those sales in its tax returns.

In May 1947, the petitioner voluntarily disclosed to the Commissioner that it had unreported income for its fiscal years 1943, 1944, 1945, and 1946. Thereupon the Commissioner ordered an examination of the petitioner's books which disclosed substantial deficiencies in its federal taxes for its fiscal years 1944 and 1945. But the examination also disclosed that the petitioner had suffered a net operating loss in its fiscal year 1947. In May 1948 the petitioner filed an application for tentative carry-back adjustment by reason of that net operating loss, and because of that loss and an unused excess profits credit, the petitioner's tax liability for the fiscal years involved (1944 and 1945) was modified to the extent of showing an overassessment for the later year and a reduced deficiency for the earlier one. The Commissioner added a 50% fraud penalty to the net deficiency of the earlier year but the overassessment for the later year was still great enough to show the petitioner entitled to a refund. The petitioner executed a "Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment" (Form 874) setting forth the Commissioner's computation of its taxes as described above and in due course thereafter the petitioner received a refund in the net amount of overassessment.

In making his computation of tax in 1948 the Commissioner followed the long-established practice of the Bureau of Internal Revenue which was first set out in a Treasury Ruling in 1923, the relevant portion of which provided:

"Where a return contains a fraudulent understatement of tax and there is therefore a deficiency in the tax, but the deficiency is wiped out by applying a deduction allowable under section 204 of the Revenue Act of 1918, the ad valorum fraud penalty provided in section 250(b) is not applicable, since upon the redetermination under section 204 there is no deficiency within the meaning of section 250(b)."²

But early in 1950 the Supreme Court of the United States decided Manning v. Seeley Tube & Box Co., 338 U.S. 561, 70 S.Ct. 386, 94 L.Ed. 346, and later that year, in the light of that decision, the above Ruling was revoked and a new one promulgated reading:

"Interest and penalties assessed and collected in connection with a Federal income tax liability should not be credited or refunded even though such tax liability is reduced or eliminated by net operating loss carry-backs."³

In September 1951, the Commissioner mailed notice of the deficiencies in the additions to basic taxes for fraud with which we are here concerned, which were obviously determined in accordance with the Ruling of the year before quoted last above, for the penalties were computed on the basis of the original deficiencies in excess profits taxes and declared value excess profits tax for the fiscal years 1944 and 1945 before application of the excess profits credit and net operating loss carry-back.

The petitioner does not question the validity in general of the last quoted Ruling, but advances three arguments in support of the proposition that it is inapplicable here. Its first and principal one is that the Commissioner, having ascertained, assessed, and collected a fraud penalty in 1948, had no statutory authority to come back some two years later and, using a different method of calculation, assess a balance of penalty for the same fraud determined on the basis of his recomputation. That is to say, the argument is that the Commissioner, having once made a determination of fraud and assessed and collected a penalty therefor, exhausted his statutory power, with the result that, although he still had power to impose an additional fraud penalty calculated on additional income should any subsequently be found to have accrued to the taxpayer, he had no power to assess any balance of penalty for the old fraud based on another method of computation. We do not agree.

Section 293 of the Internal Revenue Code, 26 U.S.C.A., under the heading "Additions to the tax in case of deficiency", provides, with an exception irrelevant here, in its paragraph (a) headed "Negligence":

"If any part of any deficiency is due to negligence, or intentional disregard of rules and regulations but without intent to defraud, 5 per centum of the total amount of the deficiency (in addition to such deficiency) shall be assessed, collected, and paid in the same manner as if it were a deficiency, * * *."

And paragraph (b) of the section, under which the penalty with which we are concerned was assessed, provides under the heading "Fraud":

"If any part of any deficiency is due to fraud with intent to evade tax, then 50 per centum of the total amount of the deficiency (in addition to such deficiency) shall be so assessed, collected, and paid, in lieu of the 50 per centum addition to the tax provided in section

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