CIR v. Welch

• Decision Date: 01 June 1965
• Docket Number: No. 20819.,20819.
• Citation: 345 F.2d 939
• Parties: COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. Thompson I. WELCH, Individually, et al., Respondents. Thompson I. WELCH, Individually, et al., Respondents v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Fifth Circuit

345 F.2d 939 (1965)

COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. Thompson I. WELCH, Individually, et al., Respondents.

Thompson I. WELCH, Individually, et al., Respondents v. COMMISSIONER OF INTERNAL REVENUE.

No. 20819.

United States Court of Appeals Fifth Circuit.

June 1, 1965.

COPYRIGHT MATERIAL OMITTED

Carolyn R. Just, Atty., Dept. of Justice, Louis F. Oberdorfer, Asst. Atty. Gen., Lee A. Jackson, Gilbert E. Andrews, Attys., Dept. of Justice, R. P. Hertzog, Act. Asst. Chief Counsel, I.R.S., Robert B. Alexander, Jr., Atty., I.R.S., Washington, D. C., for petitioner.

Robert E. Davis, Wentworth T. Durant, Ronald M. Mankoff, Dallas, Tex., for respondents.

Before BROWN and WISDOM, Circuit Judges, and ESTES, District Judge.

JOHN R. BROWN, Circuit Judge.

This case is not so much the problem of who did what to whom. Rather, it is who really did the act and when. This simplification is beguiling, however, for specifically involved is the right of the Commissioner to make pre-1954 adjustments occasioned by 1957-1958 changes in the Taxpayer's method of accounting pursuant to § 481,¹ a statutory structure with a laudable aim but with inescapably built-in difficulties.² Cf. Graff Chevrolet Co. v. Campbell, 5 Cir., 1965, 343 F.2d 568 No. 21178, March 29, 1965.

The Tax Court held that the change was initiated by the Taxpayers³ through the instrumentality of their 1957 returns, timely filed in 1958. Finding also that the change was made without consent of the Commissioner,⁴ the Court approved the Commissioner's conclusion that adjustments were required to avoid exclusion of income. At issue here is the correctness of including in the adjustments those relating to pre-1954 inventories and accounts receivable. On Taxpayer's appeal we reverse this holding and remand the case for further consistent proceedings including consideration of the proper post-1954 adjustments sought by the Government's protective inconsistent deficiency notice and appeal.⁵

A capsulated discussion of the statutory-decisional background simplifies consideration of the facts.

It starts with the principle that taxable income is to be computed under the method of accounting on the basis of which a taxpayer regularly computes his income in keeping his books.⁶ Prior to the enactment of the 1954 Code, the Commissioner was left to administrative practices to compel adjustments to prevent the omission of income or duplication of deductions occasioned by change in the method of accounting by a taxpayer. The problem could arise in at least three situations, (a) where a taxpayer sought consent to change a method of accounting, (b) where the Commissioner compelled a change, and (c) where a taxpayer made change without the Commissioner's consent. Not surprisingly there was neither consistency nor uniformity in court treatment of these administrative practices.⁷ After considerable tergiversations, uniformity did emerge that when the Commissioner compelled the change in the method of accounting, adjustments could not be required as to prior years. By § 481 the 1954 Code expressed the legislative policy that no item should be omitted and no item should be duplicated as a result of a change in a method of accounting or reporting income for taxation. The provisions were to apply both in the case where the taxpayer voluntarily changes his accounting method with the consent of the Commissioner and also in the case where a change in method is required by the Commissioner. 2 Mertens, § 12.21. But as originally enacted, § 481 literally forbade adjustments with respect to a taxable year to which the 1954 Code did not apply without regard to who initiated the change.⁸ The Code had scarcely been engrossed and the ceremonial pens passed out when the taxing authorities recognized the likely existence of a large, not a loop, hole.⁹ To avoid such unintended and irrational windfalls, Congress enacted the Technical Amendments Act of 1958 (see note 1, supra). To the exception in § 481(a) (2), see note 8, supra, the italicized words were added to read as follows:

"Except there shall not be taken into account any adjustment in respect of any taxable year to which this section does not apply unless the adjustment is attributable to a change in the method of accounting initiated by the taxpayer."

The magic word is, of course, "initiated". The legislative history illumines the amendatory clause and reflects a congressional purpose to treat the word both broadly and specifically. Thus, the House Report, taking cognizance of the change wrought by § 481 as originally enacted that, without regard to the party setting them in motion "no adjustments are required which are attributable to years before the application of the 1954 Code," declared that the Committee could see "no reason why the pre-1954 Code year adjustments should not be made, when taxpayers, of their own volition, have changed their method of accounting * * * this being generally the practice under the 1939 Code."¹⁰ The same idea was put forward in the Senate Committee Report which concluded that "pre-1954 Code year adjustments should be made where taxpayers of their own accord changed their method of accounting."¹¹ (Emphasis supplied) The report then pinpoints it in terms of action occasioned by examination by a Revenue Agent: "A change in the taxpayer's method of accounting required by a revenue agent upon examination of the taxpayer's return would not, however, be considered as initiated by the taxpayer."¹² And the regulations purport to paraphrase these approaches.¹³

Several things bear emphasis. Foremost, § 481(a) (2) still imposes a condition on pre-1954 adjustments. The condition is that the change in the method of accounting giving rise to the necessity for the adjustment be "initiated by the taxpayer." If, therefore, the change is not initiated by the taxpayer, it matters little who else might have done it or the governmental authority of such person for such act. In other words, as a logical-legal matter generally, demonstration of the negative is not proof of the positive. Thus the mere showing (or finding) that the examining Revenue Agent affirmatively lacked the power to bind the Commissioner, i. e., lacked power to "initiate", is not a sufficient basis for concluding the opposite — that it was the Taxpayer who "initiated" the change. Metaphysics cannot be carried that far that fast. Formidable as is the presumptive correctness of the Commissioner's implied finding, the record must finally show a factual basis for it. See Phillip's Estate v. Commissioner of Internal Revenue, 5 Cir., 1957, 246 F.2d 209, 214.¹⁴ Next, whether the change was taxpayer initiated is essentially a question of fact with § 7482(a) bringing into play the clearly erroneous concept of F.R.Civ.P. 52(a) which includes countervailing inferences from uncontradicted facts, Commissioner of Internal Revenue v. Duberstein, 1960, 363 U.S. 278, 80 S.Ct. 1190, 4 L.Ed.2d 1218. But United States v. United States Gypsum Co., 1947, 333 U.S. 364, 395, 68 S.Ct. 525, 92 L.Ed. 746, 766, and our many cases following it¹⁵ leave the Court with the responsibility of reversing such findings upon judicially determining that the result is contrary to the truth and right of the case. Finally, for our present purpose, reviewing a fact finding of the Tax Court, reviewing courts recognize that the fact finder may distinguish between a positive "requirement" and a mere "suggestion" made by a revenue agent to a taxpayer whose return is being examined. Falk v. Commissioner of Internal Revenue, 37 T.C. 1078, affirmed 5 Cir., 1964, 332 F.2d 922; Brookshire v. Commissioner of Internal Revenue, 1959, 31 T.C. 1157, affirmed, 4 Cir., 1960, 273 F.2d 638, cert. denied, 363 U.S. 827, 80 S.Ct. 1597, 4 L.Ed.2d 1523.

This brings us to the facts which, although largely uncontradicted, are hardly simple in revealing the undulating process through which the Commissioner, personifying the whole Revenue Service establishment, finally arrives at the determination carrying presumptive correctness.

Welch Grain Company, the partnership, up to 1957 maintained its books and records and reported its income on the cash method. It reported its cash receipts as income and its expenses as deductible when paid. Although it had records showing the precise status of inventories of grain on hand in determining or reporting income for tax purposes, inventories¹⁶ were not used nor was account taken of accounts receivable.

In 1956 began a series of revenue agent examinations which did not terminate until 1959. The first was by Agent Martin who examined returns for 1953 and 1954 of one of the Taxpayers. He advised Taxpayers that the books of the partnership were in good shape and no adjustments were proposed.

Next came the examination of Agent Black in 1957. This examination covered the returns, books and records of the Taxpayers and the partnership for the years 1954, 1955 and 1956. The testimony was uncontradicted that Agent Black arrived from the Dallas office with the announced purpose of changing the Company from a cash to an accrual or inventory method. And he did just that. During his examination, Agent Black was preoccupied with inventory problems, records and data. At the conclusion of his examination, he filed a Revenue Agent's Report, corroborated completely by his later court testimony, in which he computed income for the Grain Company on the basis of inventories. In reconstructing the income statement, Agent Black allowed no opening inventory for 1954 and estimated closing inventories for 1954, 1955 and 1956 by spreading back the 1956 closing inventory over each of those years in approximately equal thirds. On the basis of these inventory adjustments and without inclusion of any amount for accounts receivable (or increases therein),¹⁷ Agent Black's report resulted in an increase in Grain Company income of $66,137.22. Despite some likely internal errors in the adjustments (see...