De Masters v. Arend

Decision Date26 February 1963
Docket NumberNo. 17796.,17796.
Citation313 F.2d 79
PartiesPerry A. De MASTERS, Internal Revenue Agent, Internal Revenue Service, Arthur G. Erickson, District Director of Internal Revenue, Mortimer M. Caplin, Commissioner of Internal Revenue and The United States National Bank of Portland (Oregon), Appellants, v. Egon D. AREND and Mela K. Arend, Appellees.
CourtU.S. Court of Appeals — Ninth Circuit

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Louis F. Oberdorfer, Asst. Atty. Gen., Meyer Rothwacks, Joseph M. Howard, Norman Sepenuk and Burton Berkley, Attys., Dept. of Justice, Washington, D. C., and Sidney I. Lezak, Acting U. S. Atty., Portland, Or., for appellants.

Morris J. Galen, Portland, Or., for appellees.

Before MERRILL, BROWNING and DUNIWAY, Circuit Judges.

BROWNING, Circuit Judge.

The District Court permanently enjoined appellants (employees of the Internal Revenue Service) from investigating possible income tax liability of appellee taxpayers for years as to which recovery would be barred by the statute of limitations in the absence of fraud. The Court also permanently enjoined the United States National Bank of Portland from disclosing to appellants any information regarding transactions by or with the taxpayers during such years. We reject appellants' contention that a District Court has no power to issue such a restraining order in any circumstances, but we conclude that the Court lacked power to do so in the circumstances of this case.

The taxpayers'1 1946 and 1948 income tax returns were audited and their records for those years examined during 1948 and 1950. In 1957 appellant De Masters, an Internal Revenue agent, began a new investigation of the taxpayers' returns. It is stipulated that the period during which additional income tax could be assessed against taxpayers for any year prior to 1955 had expired, unless fraud were involved.2 The taxpayers furnished De Masters with the information which he requested until he sought access to taxpayers' records without limitation as to date. Appellees' counsel then advised De Masters that in view of the prior audits and because the taxpayers were not charged with fraud they would not cooperate further in the investigation.

De Masters prepared tentative computations from various sources which indicated that the increase in the taxpayers' net worth, plus their estimated living expenses, during the period 1940 through 1956 totaled approximately $170,000. This increase, after appropriate adjustments, exceeded the income which the taxpayers reported during the same period for tax purposes by more than $90,000. He then examined records of a branch of the First National Bank of Portland reflecting deposits during 1948 to the account of taxpayers' shoe store, and found that they totaled some $17,000 more than the gross receipts reported on taxpayers' income tax return for that year.

De Masters concluded that further investigation was justified, and caused a summons to issue directing the United States National Bank of Portland to produce records pertaining to the taxpayers' transactions with the bank during the years 1940 to 1957. The taxpayers were advised that the bank would comply with the summons. They then filed the present suit for an injunction, naming the bank, the Commissioner of Internal Revenue, the District Director, and De Masters as defendants.

The District Court held a hearing at which De Masters testified as to his computations and the results of his analysis of the taxpayers' 1948 deposits with the First National Bank of Portland. The Court concluded that the appellants had "failed to establish by competent evidence that there exists any reasonable grounds or other probable cause to find or suspect that any fraud existed with respect to any of the returns filed by the plaintiffs for the years that are now closed by the statute of limitations," and that the taxpayers were therefore entitled to an injunction. The Court permanently enjoined the appellants from examining the taxpayers or their records, or any third party as to transactions with the taxpayers, with respect to any year prior to 1955; and permanently enjoined the United States National Bank of Portland from disclosing any information as to transactions with the taxpayers prior to that year.

Appellants contend that (1) the District Court lacked jurisdiction of the action, (2) the suit was one against the United States to which consent had not been given and was therefore barred by the doctrine of sovereign immunity, and (3) the District Court's decision on the merits was erroneous.

I

The taxpayers assert that their suit falls in the category of actions "arising under any Act of Congress providing for internal revenue" over which district courts are granted original jurisdiction by Section 1340 of the Judicial Code.3 Concededly, appellants purported to act under the authority of Section 7602 of the Internal Revenue Code4 in issuing the summons to the bank. The taxpayers challenged appellants' authority under that section on the ground that the inquiry was prohibited by Section 7605(b) of the Internal Revenue Code5 as well as by the Fourth Amendment. Since the taxpayers' suit involved a substantial controversy as to the construction and effect of these sections of the Code, we agree with the District Court that if otherwise maintainable the action fell within the jurisdictional grant of Section 1340.6

II

Section 1340 is not a consent by the United States to suits against it.7 However, if appellants were indeed prohibited by Section 7605(b) or the Fourth Amendment from initiating this inquiry, a suit to restrain their unlawful conduct would not be barred by the doctrine of sovereign immunity.8

A. The Fourth Amendment

Appellants' conduct did not violate the Fourth Amendment. They did not seek to compel production of the taxpayers' books and records, and if they had the Fourth Amendment would offer no basis for resisting that demand.9 Assuming that an administrative subpoena directed to a corporation may constitute an "unreasonable search and seizure,"10 the right violated would be that of the bank whose papers were demanded; but the bank waived any right it might have had to resist production, and the taxpayers could not in any event assert the right on the bank's behalf.11

B. Section 7605(b)

Section 7605(b) contains two distinct prohibitions. The first is that "no taxpayer shall be subjected to unnecessary examination or investigations"; the second that "only one inspection of a taxpayer's books of account shall be made for each taxable year unless the taxpayer requests otherwise or unless the Secretary or his delegate, after investigation, notifies the taxpayer in writing that an additional inspection is necessary."

1. Appellants neither violated the second prohibition nor, at the time of suit, threatened to do so.

This prohibition applies by its express terms only to the taxpayers' records; it did not prevent the appellants from seeking information from other sources, such as the bank, regarding the taxpayers' possible liability.12 Indeed, the section anticipates that such inquiries will be made; as we read it, the section intends that the Commissioner of Internal Revenue (the Secretary's delegate) shall notify the taxpayer of an additional inspection of the taxpayer's books only "after investigation" from which the Commissioner concludes that "an additional inspection is necessary," and the preliminary investigation referred to must necessarily be an inquiry of sources other than the taxpayer.

There is nothing to indicate that appellants intended to seek a second inspection of the taxpayers' records for the years 1946 and 1948 unless, and until, the investigation of other sources required by Section 7605(b) had been completed, and had disclosed that an additional inspection of taxpayers' records was necessary. De Masters testified that the reason the taxpayers had not been notified of a second examination of their own records was that he had not completed the preliminary investigation required to sustain the notice. The threat that appellants would attempt a second examination of taxpayers' records without first satisfying the prerequisites of Section 7605(b) was at best remote and speculative.13

2. We turn finally to the provision of Section 7605(b) that "no taxpayer shall be subjected to unnecessary examinations or investigations."

The command is unequivocal. We have held that it constitutes "a limitation on the power" of the tax collecting authorities; appellants, in consequence, had "no power to make an unnecessary examination or investigation."14 As we have said, if appellants violated this statutory limitation upon their power, the present suit is maintainable.15 The difficult problem, of course, is that of determining the scope of the limitation: what is meant by an "unnecessary" investigation?

The Commissioner's statutory duty and power to inquire are stated in broad terms. He is directed to "cause officers or employees of the Treasury Department to proceed, from time to time, through each internal revenue district and inquire after and concerning all persons therein who may be liable to pay any internal revenue tax."16 He is authorized to examine records and data and to require persons liable for tax and others to appear, give testimony, and produce records and data, relevant or material to an inquiry "for the purpose of ascertaining the correctness of any return, making a return where none has been made, determining the liability of any person for any internal revenue tax * * * or collecting any such liability."17

These grants of power are to be liberally construed in recognition of the vital public purposes which they serve;18 the exception stated in Section 7605(b) is not to be read so broadly as to defeat them.19 A limited construction of Section 7605(b) is also supported by the...

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