Kreps v. CIR

• Decision Date: 21 September 1965
• Docket Number: Docket 29304.,No. 431,431
• Citation: 351 F.2d 1
• Parties: Sidney KREPS, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Second Circuit

351 F.2d 1 (1965)

Sidney KREPS, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 431, Docket 29304.

United States Court of Appeals Second Circuit.

Argued May 19, 1965.

Decided September 21, 1965.

Rehearing Denied October 26, 1965.

COPYRIGHT MATERIAL OMITTED

Martin D. Cohen, Morris A. Kaplan, New York City, for petitioner.

Mark S. Rothman, Atty., Dept. of Justice, Louis F. Oberdorfer, Asst. Atty. Gen., Lee A. Jackson, David O. Walter, Attys., Dept. of Justice, for respondent.

Before WATERMAN, MARSHALL^* and ANDERSON, Circuit Judges.

WATERMAN, Circuit Judge:

Sidney Kreps petitions to review a decision of the Tax Court holding him liable under the transferee provisions of the 1939 Internal Revenue Code for unpaid income taxes of Metropolitan Air Freight Depot, Inc.

Metropolitan was organized in March 1949, pursuant to the laws of New York. Its business was air freight forwarding. It received shipments from various manufacturers, consolidated them, and shipped them by air to various customers. One Bernard J. Kurtin was President of Metropolitan, petitioner Sidney H. Kreps was both Secretary and Treasurer, and they were its principal stockholders. The corporate books and records were maintained and the tax returns filed on a cash receipts and disbursements method of accounting.

Metropolitan apparently ceased operating in 1953. Since that time its affairs have been the subject of several tax controversies. At some point all the original books and records of the company disappeared.¹ The documentary evidence that remains are certain loose leaf ledger sheets that the lower court termed both "confusing and inadequate," a few check stubs, and the corporate income tax returns that were filed during the years in question. The absence of the original books and records complicates several of the issues in the case, but this absence does not make it impossible fairly to decide the questions petitioner raises, for we wish to stress that on this record neither party can be blamed for the disappearance.

On June 27, 1958, a notice of deficiency was mailed to Metropolitan showing deficiencies in income tax for its fiscal years ending February 28, 1951, February 29, 1952, and February 28, 1953. These totaled $24,393.98. Additions to tax amounted to another $12,083.10. No petition was filed in the Tax Court, and on the 28th of November 1958, the deficiencies, additions to tax, and interest were assessed against Metropolitan. Except for one payment of $467.66, paid to reduce the amount due from Metropolitan for the fiscal year ending February 28, 1951, the liability of Metropolitan remained unsatisfied. The Commissioner finally concluded that Metropolitan was unable to satisfy its liability and notified petitioner that the Commissioner considered him a transferee of property once owned by Metropolitan and considered him liable for a certain portion — $7,357.54 to be exact — of the deficiency due and owing from Metropolitan.² The petitioner then contested this determination of his liability in the Tax Court.

Petitioner's first contention is that the applicable statute of limitations barred the assessment of the tax against Metropolitan. Section 275(a) of the 1939 Internal Revenue Code³ states that the income taxes imposed by chapter one of the Code must be assessed within three years after the required return is filed. If section 275(a) applies here petitioner would prevail for the Commissioner mailed the notice of the deficiency to Metropolitan on June 27, 1958, more than three years after Metropolitan filed its returns for the fiscal years ending February 28, 1951 and February 29, 1952.⁴ But section 275(a) is qualified by section 276(a) of the 1939 Internal Revenue Code.⁵ which allows the Commissioner to assess the tax "at any time" if the return for the year in question is "false or fraudulent" and filed "with intent to evade tax." So if Metropolitan filed false and fraudulent returns with intent to evade taxes due for those fiscal years the Commissioner's assessment of the tax in 1958 was timely.

The interaction of sections 275 (a) and 276(a) represents a compromise between conflicting public policies. On the one hand, of course, there is good reason to provide that after a determinate period of time citizens can rest assured that their tax returns will not be reopened by zealous tax officials. On the other hand, the skillful deception of some taxpayers and the limited investigative resources of the government make it certain that some fraud will go undetected for more than three years after a return is filed. The Code therefore states that the tax may be assessed at any time if a taxpayer files a false or fraudulent return with intent to evade tax. But in order to insure that this provision does not eviscerate the policy of repose embodied in section 275(a) special rules concerning the burden of proof have been adopted. Section 1112 of the 1939 Internal Revenue Code⁶ states that in a proceeding involving the issue of fraud with intent to evade tax, the burden of proof with respect to the issue of fraud is on the Commissioner. And many courts have added the further requirement that this burden is not satisfied unless the Commissioner proves fraud by "clear and convincing evidence." See, e. g., Bryan v. Commissioner of Internal Revenue, 209 F.2d 822 (5 Cir. 1954), cert. denied, 348 U.S. 912, 75 S.Ct. 289, 99 L.Ed. 715 (1955).

The Tax Court decided that the returns filed by Metropolitan for the fiscal years here in question were false and fraudulent with intent to evade tax, and that the tax payable for these years could be assessed at any time. Central to this decision was the Tax Court's treatment of certain undisputed facts. The parties stipulated that during its fiscal years 1951 and 1952 Metropolitan made purchases of airline passenger tickets amounting to $26,395.37, and that, although the ticket cost was charged to "Air Freight," one of Metropolitan's ledger expense accounts, the tickets were never used for air travel. Instead, the tickets were redeemed shortly after they were purchased and the refund checks were deposited in either the personal bank account of the petitioner, or the joint account of the petitioner and his wife, or the personal account of Kurtin. It is undisputed that at least $7,357.54 of the amount funneled out of Metropolitan by means of this ticket redemption ruse was received and retained by the petitioner during the fiscal years ending February 28, 1951 and February 29, 1952. In the Tax Court the petitioner offered evidence to show that the funds so received by him were additional compensation to him, or were used by him to make gifts to employees of various trucking and airline companies in order to "generate business" for Metropolitan. The charge to the "Air Freight" account, the petitioner argued, was simply a camouflage designed to circumvent the prohibitions of the Civil Aeronautics Board relating to rebates and unfair competition. Petitioner argued before the Tax Court that Metropolitan's returns for its fiscal years 1951 and 1952 were not false or fraudulent with intent to evade tax because the charges to the "Air Freight" expense account were properly deductible as ordinary and necessary expenses of an air freight forwarding business, cf. Lilly v. Commissioner of Internal Revenue, 343 U.S. 90, 72 S.Ct. 497, 96 L.Ed. 769 (1952), and that Metropolitan's tactics, while devious, did not constitute fraud because the deduction taken by Metropolitan for the sums transferred to petitioner was allowable and simply misnamed.

The Tax Court concluded that "charging . . . the airline passenger tickets to `Air Freight,' in itself a false representation, plus the failure to credit the amounts received in redemption of such tickets back to the corporation" was "sufficient of itself to render the returns, filed by or on behalf of Metropolitan for these two years, false or fraudulent with intent to evade tax." 42 T.C. 666. The Tax Court went on to say that inasmuch as this evidence established a prima facie case of fraud, the burden of going forward shifted to the petitioner to show that the money received by petitioner when the airline tickets were redeemed was, as claimed, used to generate Metropolitan's business, or to pay petitioner additional compensation, and that the petitioner had failed to meet this burden.

Having failed below to show that the funds channeled into his hands through the ruse of purchasing and redeeming airline tickets were either additional compensation or were spent by him in the course of Metropolitan's business, the petitioner has changed the posture of his case before this court. He now urges that the Commissioner failed to prove "the returns filed by Metropolitan reflected the cost of these tickets as a deduction from income or that any under-payment (deficiency) of income tax on the part of Metropolitan for the taxable years involved was attributable to the cost of the airline tickets." This confusing language boils down to either one of two claims: The petitioner may be arguing that Metropolitan cannot be said to have filed a fraudulent return with intent to evade tax because the company took no deductions for the amounts charged to "Air Freight," or, alternatively, petitioner may be arguing that, even though Metropolitan did take the deductions, the Commissioner did not establish that the deductions proximately caused the deficiencies asserted. Neither of these possible interpretations of petitioner's argument have merit.

In arguing that the Commissioner did not show that Metropolitan deducted the amounts charged to "Air Freight," petitioner benefits from the fact that the corporate tax returns filed by Metropolitan are not sufficiently detailed to permit this issue to be resolved by an examination of the returns, and he also benefits from the fact that Metropolitan's original books and records have vanished. It is also true that the...