Penn-Ohio Steel Corp. v. C.I.R., 050564 FEDTAX, 84058

Docket Nº:84058, 84059, 84060.[1]
Opinion Judge:HARRON, Judge:
Attorney:David Brady, for the petitioners. Ira L. Tilzer, for the respondent.
Case Date:May 05, 1964
Court:United States Tax Court

23 T.C.M. (CCH) 719 (1964)

T.C. Memo. 1964-124




Nos. 84058, 84059, 84060. [1]

United States Tax Court.

May 5, 1964

Held: Respondent failed to prove by clear and convincing evidence that each petitioner filed a false or fraudulent return with intent to evade tax. Therefore, assessments of deficiencies are barred by the statute of limitations. Secs. 276(a), 1112,1939 Code.

David Brady, for the petitioners.

Ira L. Tilzer, for the respondent.


HARRON, Judge:

The respondent determined income tax deficiencies for the calendar year 1949, and 50 percent additions thereto for traud with intent to evade tax under section 293(b), 1939 Code, as follows:


Numbers Taxpayer Deficiency Sec. 293(b) Total

84058 Penn-Ohio Steel $264,493.56 $133,640.21 $398,133.77

84059 J. B. Montgomery 43,139.60 21,569.95 64,709.85

84060 S.E. Magid 95,471.16 47,735.58 143,206.74

Totals $403,104.62 $202,945.74 $606,050.36

The main question is whether each of the petitioners filed a false or fraudulent return for 1949 with intent to evade tax. In each case, assessment and collection of deficiencies for 1949 are barred by the statute of limitations unless, under his burden of proof, the respondent established by clear and convincing evidence that the taxpayer filed a false or fraudulent return. Section 276(a), 1939 Code. Montgomery and Magid were stockholders of Penn-Ohio Steel Corporation. The corporation had a contract with Allis-Chalmers Manufacturing Company to furnish steel to the latter. Allis-Chalmers cancelled the contract in 1949 and made a demand for damages on Penn-Ohio. The resulting dispute was settled in 1949. Respondent determined that the settlement agreements constituted a tax evasion scheme. Whether or not each petitioner filed a false return involves the settlement agreements. FINDINGS OF FACT. The stipulated facts are incorporated herein by this reference and are found as stipulated. The returns for 1949 were filed in 1950, as set forth hereinafter. Each statutory notice of deficiency was mailed by the respondent on September 2, 1959. None of the petitioners, prior to the expiration of the 3-year period of limitation upon the assessment and collection of tax prescribed by section 275(a), 1939 Code, executed a waiver consenting to the assessment of the tax after the expiration of such period of limitation. The returns for 1949 were filed on the following dates: The return of Penn-Ohio Steel Corporation was filed on April 14, 1950, with the collector of internal revenue for the first district of Pennsylvania. The joint return of Joseph B. Montgomery, Jr., and his wife, was filed on January 16, 1950, with the collector of internal revenue for the eighteenth district of Ohio. The joint return of Samuel E. Magid and his wife was filed on May 15, 1950, with the collector of internal revenue for the third district of New York. In the cases of the individual taxpayers, since the wives are not involved, Joseph B. Montgomery, Jr., and Samuel E. Magid are referred to hereinafter as the individual petitioners. Penn-Ohio Steel Corporation, hereinafter called Penn, is a Delaware corporation which was incorporated in January 1948 for the purpose of manufacturing and selling steel ingots. Joseph B. Montgomery, Jr., was its president; Samuel E. Magid was treasurer and chairman of the board of directors; and John G. Baker, hereinafter called Baker, was assistant to Montgomery. In 1948, there was a shortage of steel ingots, and there was a great demand for them among those who used them in manufacturing steel products. Manufacturers were willing to pay premium prices for steel ingots. Montgomery has had a great deal of experience in the manufacture of steel. In May 1948, he and Magid located an idle open-hearth foundry at Birdsboro, Pennsylvania, formerly operated by the Birdsboro Steel Foundry & Machine Company, which was then controlled by the United States Navy Department as a national defense plant and industrial reserve facility. They made a proposal to the Navy Department to lease this Naval Industrial Reserve Plant at Birdsboro for the purpose of producing steel ingots. In June 1948, the Navy Department and Penn-Ohio Steel Corporation entered into a 5-year lease agreement under a Letter of Intent of the Navy Department which gave Penn the option to extend the term of the lease for two additional terms of 5 years, each. The Navy Department required, as a condition of the Lease, that Penn must have control of working capital of at least $700,000 within 60 days after accepting the Letter of Intent. In 1948, the authorized capital of Penn consisted of 7,500 shares of no par value common stock, and 5,000 shares of 5 percent cumulative preferred stock of a par value of $100 per share. As of June 30, 1948, none of the preferred stock had been issued. , the records of Penn indicate that the 7,500 shares of common stock were issued in equal amounts to three stockholders for the total paid-in amount of $205,000; i.e., 2,500 shares, each, were issued to Montgomery, Magid, and P. T. Baker. At some time in 1948 or 1949, the 2,500 shares owned by P. T. Baker were acquired by John G. Baker, referred to above. In the spring and early summer of 1948, Allis-Chalmers Manufacturing Company in Milwaukee, Wisconsin, hereinafter called Allis, was desperately in need of obtaining steel ingots. It entered into negotiations to obtain them from Penn under a supply contract. In the negotiations, Magid represented Penn, and Walter E. Hawkinson, who was then the secretary and treasurer of Allis, represented Allis. During the negotiations, Magid and Montgomery represented that Penn had just taken possession of the steel plant at Birdsboro under a lease from the Navy and that with proper fioancing Penn could increase its capital and construct an additional furnace, and that Penn could negotiate a contract with other companies. Magid also stated that he and the other stockholders of Penn had an opportunity at that time of selling part of their common stock for an immediate profit or $500,000. During the negotiations, the Executive Committee of Allis was aware of the then deficit in the supply of steel ingots which was available to Allis. Representatives of Allis urged Magid to agree to a supply contract between Penn and Allis and assured him that Allis would assist Penn in obtaining an additional furnace, which would increase Penn's production of steel, provided Allis received a priority in such increased production. On August 26, 1948, the Executive Committee of Allis adopted resolutions authorizing the officers of Allis to enter into a purchase agreement with Penn for 50,000 gross tons of steel ingots, and authorizing the purchase by Allis of all of the authorized preferred stock of Penn, 5,000 shares, at the par value of $100 per share, or $500,000 as part of the consideration for the proposed steel purchase agreement. The agreement of Allis to purchase the preferred stock of Penn for $500,000 assured Penn of working capital of $700,000, as required by the Navy Department. On August 26, 1948, a supply contract was entered into by Penn and Allis, and on August 27, 1948, Allis purchased 5,000 shares of Penn preferred stock for $500,000. Under a supplemental agreement the holders of the common stock of Penn agreed jointly and severally to guarantee the payment of dividends on the preferred stock and the maintenance of a sinking fund to retire the preferred stock; and they agreed that a nominee of Allis would be elected to the board of directors of Penn and would serve as long as any of the preferred stock was held by Allis. The supply contract of August 26, 1948, provided in material part as follows:

As a result of our several discussions on the subject of producing basic open hearth steel ingots for you, it is agreed that we will produce and ship 50,000 gross tons at the rate 3,000 G.T. in September, 1948 and 4,000 G.T. each month thereafter from ingot molds of the following sizes: 21" ‘ x 48" ‘ x 76" ‘ ; 22" ‘ x 25- 1/2 " ‘ x 78; 22" ‘ x 24" ‘ x 70" ‘ ; or other sizes to be agreed upon at a later date. Our present estimated capacity is 7,500 G.T. per month and it is agreed that your orders shall be given priority over all other contracts for delivery of steel ingots.

During the life of this contract for the production for you of ingots, we will give you the first refusal of any additional capacity created by installation of new furnaces which we may develop on terms mutually satisfactory. It is further agreed that the cost to you for this steel will be arrived at on a conversion basis substantially as follows: the average cost at Birdsboro, Pennsylvania of steel scrap, iron scrap and/or pig iron shall be determined each month from our records, subject to your audit, to which is added 10% plus $41.00 per G.T. For example, the iron and steel average may be $53.50; add 10%, or $5.35, plus $41.00, equals $99.85 per G.T. at Birdsboro. Should you elect to supply direct scrap, steel or iron, of suitable quality at prices lower than our buying prices for your account, we will, of course, process such scrap and reflect the reduced cost in the price you pay for conversion into ingots. Furthermore, if you should supply pig iron it would likewise assist in reducing the ingot cost since the current market pig iron price is lower than the price for best grades of iron scrap. The $41.00 figure...

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