Davis v. Commissioner of Internal Revenue, 11606.

• Citation: 239 F.2d 187
• Decision Date: 13 December 1956
• Docket Number: No. 11606.,11606.
• Parties: Howard DAVIS, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: United States Courts of Appeals. United States Court of Appeals (7th Circuit)

239 F.2d 187 (1956)

Howard DAVIS, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 11606.

United States Court of Appeals Seventh Circuit.

December 13, 1956.

Bradford S. Magill, New York City, Nelson Bohannan, Bohannan & Burton, Anderson, Ind., Naylon, Foster, Dean, Shepard & Aronson, New York City, for petitioner.

Charles K. Rice, Asst. Atty. Gen., Marvin W. Weinstein, Lee A. Jackson, A. F. Prescott, Attys., Department of Justice, Washington, D. C., for respondent.

Before FINNEGAN, SWAIM and SCHNACKENBERG, Circuit Judges.

SWAIM, Circuit Judge.

Petitioner-taxpayer seeks review of a decision of the Tax Court of the United States, 14 T.C.M. 294, which determined that there were deficiencies in his income tax for the years 1942 through 1945, inclusive, and found that at least part of the deficiency in each year was due to fraud with intent to evade tax. In determining that the taxpayer had understated his taxable income for the years in question, the Commissioner utilized the net worth method.

Taxpayer complains that the Commissioner was not warranted in resorting to the net worth method of proving taxable income under the circumstances in this case; that certain net worth computations were clearly erroneous; and that the Tax Court erred in holding that the Commissioner had sustained the burden of proving fraud.

As to the first question, it is taxpayer's contention that the net worth method may be used notwithstanding the presence of records only where evidence of concealment or falsity exists. The Supreme Court has expressly held, however, that the net worth method is not confined to situations where the taxpayer has no books or where his books are inadequate. Holland v. United States, 348 U.S. 121, 130-132, 75 S.Ct. 127, 99 L.Ed. 150. Taxpayer's argument is the same argument rejected by the Court in the Holland case for concealment and falsity necessarily impugn the adequacy of a taxpayer's books. Although the Holland case was a criminal case, there is no reason why the analysis therein should not apply with equal force to a civil case or why the use of the net worth method should be more circumscribed in the case of a deficiency determination. See Thomas v. Commissioner of Internal Revenue, 6 Cir., 223 F.2d 83, 86.

Taxpayer obviously overlooks the fact that the net worth technique of computing income is not a method of accounting. It is no more than proof of income by circumstantial or indirect evidence. If a taxpayer's net worth has increased over a period of time and the increase is not due to nontaxable receipts or nontaxable appreciation of assets, the conclusion is inescapable that taxable income has been received. The fact that the taxpayer's books and other records are consistent with his income tax returns or are internally consistent proves nothing more than that they are consistent; it does not establish that they are truthful or accurate. See Holland v. United States, 348 U.S. at pages 131-132, 75 S.Ct. at page 133. In short, the apparent adequacy of the taxpayer's books is the very thing that the net worth method attacks by independently demonstrating the receipt of unrecorded and unreported taxable income. The Holland decision makes it clear that there are no conditions precedent to the utilization of the net worth technique. The Court stated, 348 U.S. at pages 131-132, 75 S. Ct. at page 133:

"Petitioners\' accounting system was appropriate for their business purposes; and, admittedly, the Government did not detect any specific false entries therein. Nevertheless, if we believe the Government\'s evidence, as the jury did, we must conclude that the defendants\' books were more consistent than truthful, and that many items of income had disappeared before they had even reached the recording stage. Certainly Congress never intended to make § 41 a set of blinders which prevents the Government from looking beyond the self-serving declarations in a taxpayer\'s books. * * To protect the revenue from those who do not `render true accounts,\' the Government must be free to use all legal evidence available to it in determining whether the story told by the taxpayer\'s books accurately reflects his financial history." (Emphasis added.)

See also Canton v. United States, 8 Cir., 226 F.2d 313, 322-323.

Furthermore, the Tax Court found that taxpayer's records were not adequate and this finding is well supported by the evidence. Taxpayer was engaged in the business of growing, buying, processing and selling popcorn. Records of purchases of popcorn and all records in connection with his farm and the processing of popcorn were maintained personally by taxpayer prior to and during the taxable years. These records, consisting of a day book kept on a cash basis, were destroyed by fire subsequent to the start of an investigation of his income tax returns. From 1940 until the middle of 1944, records of taxpayer's popping operations were maintained by his plant manager. Thereafter, these records were maintained by another employee in accordance with instructions from taxpayer's accountant. The record indicates, and the Tax Court so found, that taxpayer did not keep an accurate record of inventory and purchases which were undoubtedly important in determining his net income. And the parties had stipulated that there was unreported income, in substantial amounts, from the farm owned by petitioner and his mother in the years 1942, 1943 and 1944. This fact alone contradicts taxpayer's contention that his farm records were accurately maintained. The taxpayer himself admitted the inadequacy of his books and records in a letter written to a bank stating that "Until January 1945 I did not have an adequate set of books for the volume of business I was doing." Taxpayer's attempt to explain away this admission is not convincing.

No useful purpose would be served by repeating the history and ramifications of taxpayer's business activities and we shall limit ourselves to such detail as is necessary to the particular questions raised. Apart from the propriety of using the net worth method, taxpayer attacks the accuracy of the Commissioner's determination of opening net worth on January 1,...