CTA Case No. 42

DECISION

This is a petition for review of the decision of the Collector of Internal Revenue dated Oct- ober 13, 1954 wherein the sum of #641 ,470.04 was assessed against petitioner as deficiency income tax for the calendar years 1946 to 1950, ine clusive, together with the corresponding penal- ties.

The petitioner 18 # businessman, engaged in the optical, office equipment end haberdashery business. During the aforesaid years, petitioner filed his income tax returns reporting income on the basis of the “cash receipts and disburse. ment method" and paid the correspending taxes thereon as follows!

Near NetJInceme Amount of tax paid 1946 no record ® 10,594.06 1947 919,160.98 1,332. 37 1948 20,115. 87 1,494. 70 LgagQ 18,559. 64 1,230.14 1950 22,198.07 2,274. 82 After an investigation previeusly conducted 369 a DECISION.

C. Te Ae CASE NO. 42 «2e by internal revenue examiners, respondent Col« lector of Internal Revenue, on October 13, 1954, determined the income tax deficiencies of peti« tioner by means of the net worth method, come puted in the following manner? 4246 "a as of December 31, e i e ® e * e e e s e Lesss Net worth as of January 1, 1946. .

Increase in net worth Tax due thereon...

Less: Amount of tax assessed » «6 « » « Deficiency tax due .

50% surcharge . .. « Total amount due ..

4247 Net worth as of December 31, 194 ee # Lesss Net worth as of January 1, 1947. .

Increase in net worth Tax due thereon...

Less Amount of tax assessed . . « « « Deficiency tax due .

50% surcharge... .

Total amount due. . .

4248 Net worth as of December 31, 194 Less: Net worth as of January 1, 1948. .

Increase in net worth Tax due thereon...

Less Amount assessed Deficiency income tax surcharge « « « » Total amount due . .

due o @&ee8 @ 6 @ BG ee ¢ ees @ eo @eeeess® .187,677.98 -®_53,08 .F 11,104, 29 - 10,594.08 . 510. 21 » B386 ,009. 45 » 187,677.98 -#198,331.47 0? 67,479. 22 ‘Gender seogz0. 38 o®583, 706,07

DECISION-

C.T.A. CASE NO. 42 ade 1949 —— as of December 31, a Ae a a ne a oe # 769,757.15 Lesst Net worth as of J 1, 1949 ..- Saenenee ie BO Weuth .

Net worth as of December 31, 190. eo ee woe seeve #7,080,401.78 Lesg! Net worth as of 1, 1990 «2s. 169,752.15 Increase in net worth... 2 310,644.63 Tax due thereon . *ecocee B 153,694.00 Less: Tax already assessed a gp tax still due . ® 151,397. eo ¢e¢e#ee 8 @ oennneneeg hte OD, Amount sti due = 2 *# @ ® erence

Summary

ee a a ee 765.32 1947 e e e e » s e 99 ,220. 28 1948 sc @ & © 4 © 98,576. 82 1949 ~ de ec eee 91,510. 97 1950 e eo ¢ e@ @ e 5% surcharge... 25,858. 47 1% monthly inter- est from March 31, 1953 to Octe ober 31, 1954. . 98,262.18 Administrative pen- alty fer lete pay- = Amount due as of October 31, .s@ 2464 seeseoeset:t#8 ss €s# ¥'?

The foregoing deficiency income tax assess~ ment was arrived et after determining petitioner's taxable income on the basis of the net-worth methed (alse known as the inventery method), 371 era ee Ne. 42 abe the legality of the use ef which has been reised es one of the iseues in this case. The assete and liabilities considered by respondent in the assessment under zeview are shown in the report ef the inceme tex examiner whe investigated the case (Exhibit ©, petitioners Exhibit 9, respon- dent }o On the same day that the deficiency tex assessment was issued, respondent iesued a war- Fant of distreint and levy by virtue of which the properties of the petitioner were ordered to be seized end sold st public auction sheujd the petitioner fail to psy the totel emount demanded on or before November 1©, 1964, Feile ing te secure «a revision of the essesement, petitioner filed s petition with this Court on November 15, 1954 te set aaide respondent's decision. The following day, he filed an urgent petition te restrain respondent from executing the warrant ef distraint and levy ieeued te ene force collection of the assessment, it appear ing that respendent issued instructions te the City Treasurer of Manila te preceed with the execution ef seid werrant. After preliminery hearing on this incident, this Court granted the injunction in ite Resolution dated January &, 1955, which has been eppesled by recpendent

DECISION}

CeTsAs CASE NO. 42 Be .

to the Supreme Court in G. R. 1~8685, and is Still pending consideration by said Court. The case now befere us concerns the legality and correctness of the assesement.

The findings of respondent in regard te the net worth of petitioner being disputed by peti- tioner, the parties presented evidence te show ‘the assets and liabilities ef petitioner on the first and last days of each year beginning 1946 wp to 1950. After trial, the following assets and liabilities ef petitioner on January 1, 1946 have been admitted and their values recognized or conceded by the partiess

Assets : Cost

Admitted assets (real estate holdings weenie Re See Summary, age payanle a Let «~ Felix Huertax cvceosese Exh. PP 22,000.00 .

Lot «- Laong Laan-Dos Castillas

Exhibit GQ cesccecseve . 56,000.00 Let ~ K06.002 Cavite St..... Exh. RR Lot » Lardizabal ccssecese.« Exhe SS Let +» Raon Corner Sales «+... Exhe XX 35 ,C0O. 00 Let «= 1004 Magdalena ecosscee Exh. COCO eal mpeg Sagdnhe TTeecsscecve 3,000.00 iding ena, Schedule D of Exhe TT cesvsesece 8,060, 00 Lot - pe 3 a9 Avee, Schedule D of Ex TT cecccvovesensvecss 12,000.00 Building att A tS00 Rizal Avee Schedul e D of Exhe Tt esssessvs 27,570.00 Let in Sen Juan, Rizal «© Exhs. GG a at CPR RR SRA ERERERE REE} iF aon ob apteeecMuaye etden~ Mike Miy-s2::: $20808-88 Building at 312 Cavite - Exhs. JJJ ...

and JoJo] ssesevevccsccsecccce mtelO.09 ae ed 373 DECISION.

C. T. A. CASE NO. 42 J..isbiliti cs Admitted liabilities of J nuary 1 , 946 (See ortg g ayable on Lot at Rizal Av nu and Soler, se above ) •• •••••••••••••• ••• •• • • ••• • · 30, • 00 The net rorth of p tit'oner

of January

1 , 1946 , which was originally · dopted by re .... pondent as the opening net worth for puxposes of the as ssment was •134,597. 00. It i a - parent from respondent's memorandum (se page 86 and Ann x l of emor ndum for espondent) that he is willing to cone d that petitione •s opening net o:rth ' On s id date was 3 0 .,630. 00, thus paving the way for the edification of the assessment.

Respondent also admits th follow- i ng assets and liabilities of petitioner as of t he end of t he calend r years in qu stion: !:!!te mb,er 31,., 194,6 .

, dJai.tted assets ' Merchandise inventory - Miscel- laneous • • • • • • • • • • ~ Mer~handise inventory - laberdashery - Local • • • • erchandise inventory •

Haberdashery - Imported • • •

Merchandise inv ntory ...

Office equipment - Imported • erchandise inventory - o tic l goods - Local • • • • • • • • erchandise inventory •• tical goods ... lfl'l)orted • • • • • • Building fixtures • • • • • - • • Optical equipment and apparatus Auto & delivery trucks ••• • • Phi lippin Racing Club • • • • • anila Sur ty & Fidelity Company Real est ate holdings • • • • • 374 5 ,079. 72 20,053. 28 70 ,699. 16 47 ,925.29 8,072. 33 21 ,414. 12 4,500. 00 14,140. 03 18,050. 40 27,5 .oo 10,000. 00 5 1 , 20a •. oo —_—_ —— a ns

DECISION «

C. T. &. CASE NO, 42 Admitted liabilities Loans payable ? 405000499 Acceptances payable 58,506 Hotes payable (banks) 25000 400 Overérafts with banks ieee 88 Accounts payable Mortgage Sayahis (see Annex "A* and Annex 1 of rospective meno- rande of parties) 160,000,00 . December 31. 1947 Adulited assets Merchandise inventory - Maber- psL 5 oe dashery ~- Local 26,315.62 Merchandise inventory - Office . oust epost - Local 635979221 Merc ise inventory - Optical goods ~ 18437257 Merchandise inventory - Optical goods = Imported 239 Lelh Auto & delivery trucks Sven

Philippine Racing Club 677600

Manila Fidelity & Surety Co. 10"000200 Merchandise in transit:

Haberdashery 26 519-37

Office equipment ’ .

Optical goods 92,061.74

Admitted Jiabilities

Loans Payable 4.9, 500,00 Notes payable (banks) 65,500.00 Mortgage payable 270,931.00 Overdrafts with banks ws ben 2304 regres Jockey Ciub ase 200 ppine | eee Club aube payable Ww? 1.52 .

deemenenses payable 1035156 .39 oe

December 315 1945

Admitted assets | Petty cash 1,000.06 ) aa se inventory - Haber- en | shery - Local *.

ig ems = ge ple ol - Office ‘ pole | pment <- 355 Korein tse inventory - Optical al ) 19,5632?

prefeia’ taxes 55 3 Demand deposit (Pe B, Ce) oF, Philippine Racing Club 26,726.00 : f 375

DECISION~

C.T.A. CASE NO. 42 -8- Philippine Ready~itix Concrete

Corperation

Manila Surety 4 Fidelity

Company

Admitted Jiabilities

Loans peyable Aeceptenses payable Notes payable « banks Overdrafts with banks

Manila Jockey Club

Philippine Racing Club

Accounts payable Mortgage payable December 3). 1949 Admitted assets Petty cash Accounts receivable Merchandise inventory » Haber- dashery ~ Local Merchandise inventory - Office equipment - Local Merchandise inventory ~- Optical s « Lecal Prepaid taxes esit - P.B.C.

te | veg Racing Club Manila ine hoody & dey td Ce.

Philippine Concrete

auecontden Admitted liabilities Loans payable Acceptances payable Senna rirefts wi s with banks Tine loan = PNB Cabanatuan branch

Manila Jockey Club

Philippine Racing Club

Accounts payable December 31, 1950 Admitted assets Petty cash Merchandise inventory « Habere dashery « Lecal Merchandise yy > le Office equipment - =e 376 25 ,000.00 10,000.00 44,800.00 164,203. 54 60,500.00 328,567.94 1,341. 20 18,655. 30 220,931.00 1,000.00 123,744.07 36,775.98 63,346. 23 7,161.20 4,647.53 367.93 264 , 726.00 10,000.00 28,000.00 25 ,O00. OO a eae as 101 , 730.00 327 ,815. 28 14,000.00 1,700.00 26,713.33 28 ,068. 89 2,000.00 39,041.92 65,126.47

DECISIONe

GeTeoAe CASE NO. 42 wha Merchandise inventory « Optical goods « » 6,732.9 Demand deposit eo PeeCe 243. 33 taxes femeee

Rosine Club 376 9925-00

Manile Surety 4 Fidelity Co. 40,000.00 ddpitted Jisbilitios Loans payable 90, pay. isl os Notes payable « 9383, 3 pe me payable « C.B.C. 30,000, 00 ts with 290 185.63 Time loan « PNB - Manile Jockey Club — _ g680.00 Club 71,288.81 Accounts payable 23, In view of the stipulstion of facts of the parties dated August 1, 1955 and the evidence edduced during the hearing a8 te the assets and liabilities of petitioner es of the end of the celender years from 1946 te 1950, to which res- pondent himself has substantially ecquiesced (see ppe 4, 8-9, 12615 and Annex “8° of respone dent's memorandum), the deficiency income tax assessment of petitioner is now open for revision after consideration first being teken of the foctuael and legel issues raised by petitioner.

The issues raised by the parties aret le The correctness of the net worth of peti- tioner st the beginning of 1946 and eat the end of each of the calendar years 1946 to 1950 es found by respondents (2_ The legality of the net worth method of determining texeble income under cur Income Tax

Laws |

3 The propriety of the imposition of the = 377

DECISION]

GeTeAe CASE NO. 42 #10.

fraud penalty (50% surcharge provided in Section 72, Natienel Internal Revenue Code)3 snd

4. The etetute of limitations upon assess- ment and collection properly appliceble te the case of petitioner.

Counsel for both parties gave prier consi-~ . dexation to the disputed assets and liabilities affecting the net worth of petitioner befere dise cussing the legal issue releting to the validity ef the use of the net worth method. Fer cone venience, we shall consider the issues raised in the order presented by counsel fer both : perties.

The disputed sssets end liabilities inveived in the firet issue are itemized as follows: As.of January 1. 1946 A. Building et Raon corner * "Sales P45 000.00’ 942,780.00 .

3. Depreciation of assets oon (4,370.00) &s..0f Decombex 3). 1946 4 Ii Race horses ems 36 5135.00 . | Asef December 3h. 1947 | 6 Merchandise inventory «= 21,777.73 107,758.17

Haberdashery

Te Merchandise inventery effice equipment G7 056.83 122,969.03

Saag

378

DECISION}

C.T.Ae CASE NO. 42 9 10.

ll.

12.

13.

14, 15.

16.

17.

18, 19.

20, 22.

236 28.

27.

28.

elle Optical equipment ® 12,763.58 Furniture and fix- . tures 17,267.18 Depreciation of .

assets (negative ) Real estate holdings 72 ,448.00 Race horses As of Dec, 31, 1948 Merchandise inventory

Haberdashery - Ime

ported 46,498.15 Merchandise inventory Office equipment «- Imported 78,621 ,11 Merchandise inventory Building fixtures 3,500.00 Optical equipment 11,170. 83 Furniture & fixtures 17,072.91 Auto & delivery trucks 68,028.00 Depreciation of assets (negative ) Real estate holdings 762,708.00 Race horses As. of Dec, 31, 1949 Merchandise inventory «

Haberdashery «- Ime

ported 75,643.94 Merchandise inventory-

Equipment - Ime

ported 72,765.59 Merchandise inventory - Optical ~- Imported 104,327.22 Building fixtures 3,045.00 Optical equipment 9,578.08 Furniture & fixtures 14,984.01 379 14,140.03 18,050.00 (21 ,632. 28) 738,698.00 39 ,420.00 138,985.09 216 ,409/87 155,719.08 4,500.00 14,140.63 18,0580. 40 11,842.00 (39,256.02) 767 , 208.00 39,420.00 173,538.61 271 , 209.16 224,343.92 44,500.00 14,140.03 18,050. 40

DECISIONe

CoTeAe CASE NOe 42

os 3).

32.

33.

MM.

35.

3%.

37, ».

4.

43.

standing et of the end of the texable years el Qe Auto 4 delivery trucks 5! of sssets negative ) Reel estate holdings Race horses Merchandise inventery «

Imported

Merchandise inventory « Optical goods «

Imported

Building fixtures Optical equipment & apparatus Purniture 6 fixtures Auto 4 delivery trucks owrinegstive) Real estate holdings

Philippine

lippine Ready-Mix ® 8,217.04 270 4458.00 67,025. 48 $8,148.06 116,246.59 2,540, 00 7,985.33 13,234. 26 10,291.%6 217,558.00 40,000.90 P 13,842.00 (40,078. 76} 977,208.00 69,700.00 1754799267 175,338, 39 244,069.32 314,522.81 4,300.00 14,140,093 18,050.60 11,842.00 (45,737.00) 100 gOOo, OO Petitioner cloims te heve incurred certain Mabilities all, or portions of which, were tute 1946, 1947, 1948, 1949 snd 1950, Respondent, however, did not consider seid liabilities in the determination of petitioner's net worth Claiming thet the alleged loans are fictiticus. The liabilities claimed by petitioner are item = 380

DECISIONe

CoTeAe CASE NG. 42 wl3e ized es follows:

Disoubed Linbilities

Date Dd. 1946 | Praneci e evece 9200, 00 Pablo pects ne sezeecs OF 000.00 Bulogie Rodriquez, Jre 2,000.00

DeSie Dhs 1947

renciseco * Reyes asene 200 Penis ee eescres $5 1000.00 Bulegioc Rodriquez, Jr. 30,000, oo Dets.ahsI24R Pable pustaments Sigh ay ype es Bulogio Rodriquez good.

Juan Ge So Vide oesee_ 206000,00 DeSe.3h2.1949 Franci Pe Reyes seeee 25,000.00 Pablo fos eeeseee 25,000.00 Rulegio Rodriquez, Jre _JOsDO.00 Dette. 2s 19D Hee pay we De Reyes PYTyy) 23,000.00 ablo Bustamante = SS ase ae Bbleste Rodriguez, Jz. eae eooes 25,000.00 ag Meneses aoece P 70,000.00 60,000.00 85,000. 00 60,000.00 325,000.00 Te shell consider esch Stem of the disputed assets and liabilities listed above to determine whether or not the same should be properly taken inte account in the determination of peti- tioner’s net worth.

~Dudlding et comer of Reon end Sales Sts. {ikem Hoe 3), © Thet this building is owned by petitioner is admitted by respondent, but 14¢ wes taken up by respondent at 942,750.00 for the = 381

DECISION-

C.T. A. CASE 0. 42 -14- opening n t orth.

P·eti tion r, ho ever, claim that the correct valu of aid property as of January 1 , 1946 should be 5,000. 00.

agre ith p titioner that th v lue of th building hich hould b t k n into ccount i P45 ,ooo.oo. , This is cl rly ho n by th fact that th con- tract pric for t h construction of th building also pp .ar in th p rformance bond (Exh. ).

That this building was completed in Dec mb r, 1945 i shown in petition r's real property tax d claration (Exhibit BBBB).

Th

cost is corrobo- r at d by etition r's i ncome tax r turn for 1947 hich i a docum nt antft litis motam (Exhibit 00- titioner; Exhibit 33 * R spondent on page 3 thereof , Sch dul of Depreciation) , whi ch sho that th cost of the building i 45,000.00, so that of c mber 31, 947 , it had a n t book v lu of 40.500.00 after a y arly depreciation allowanc of •2,250. 00 for 194 an 1947, or a total depreciation of 4,500.00 or two years. Land at 312 Cavite St. (It pondent claim that the sum of 2,008. 00 (install- ment p id in 1945 and prior year on account of a lot at Cavit St. in tv anila) should not b c considered as part of the as ets of petitioner in 1945, or a of January 1, 1946, becaus t he lot was purchased by in tallment , and th l ast pay- 3 82

DECI

c •• 42 - 15- ent was m d in 1946.

In oth r ~ord , amounts paid by w y of installment re not ass t of th purchas r i n th ye r of payment; only the total amount , or the purchas price wh n paid in full , becomes an asset of the purchas r in th year the final inst~lment is paid. e c n not accept this vie • / we bell. ve that in · acquisitions of property by installment, all pay- ments made during a year are art of the pur-- chaser ' s ssets in the year of payment , not in the year the final inst l lment is paid.:fthat petitioner acquired this land in 1932 by inst all- ment and not in lu~ sum is ·further corroborat d by the fact that in 1933 he const ructed a build- ing thereqn hich was declared for tax purposes in th na 1e of petitioner (Exhibits JJJ and JJJ-1), hich building r spond nt admits a forming part of petitioner's opening net orth. Ra&e horses (I t ems Nos. 4 , 3, 23 , and 33 ) • • According to respondent, the p tit ioner had 11 race horses a of December 31, 1946, valued each t 3, 285. 00, or 36,135. 00, "hich petitioner . d nied at first becaus. it as not in respondent ' findings (E_ h.

, Net orth Summary for 1946 to 1950) or in the p1e dings.

However, evidence showing th~ number of horses at later dates in- die tes that som of the horses o ned in 1948, 1949 or 195 . ver alr ady o ned by petitioner in 1946.

Considering tha the evidenc of respond nt 383

DECISION-

C. T. A. CASE NO. 42 i one to prove the increase of petitioner's net worth for each of t he years involved , and that respondent has admitted certain asset . but n ver• theless contends that th invr ase in net worth is much ore than what petitioner is willing to admit, believe that evidence in t hi r pect is admissible if only to sustain t he increase in net worth for each year as found by re pendent in the d cision subject of this appeal. espondent determine the value of each hor on the basis of the average cost of the dead horses claimed as losses by p titioner in his 1948 income tax r turn (Exh. YY • e note that this valuation appears to be the 1o est of valuations placed upon horses claimed to have died in 1947• 1948 and 1950.

We also not that petitioner has. not been vocal about the correct- ness of the number and valu of his horse during th period involved.

It b comes necessary for us to re iew all the evidence ,on thi point. fro petitioner's summary of horses di posed of in 1950 (Exh. TTT) he sold n n

(9) horses ith nam s listed ther in (see also Exh. LL for dates of certificates of ownership) , which accor- ding to his income tax return for the same year (p. 2. Exh. TT) had a cost of 27 ,400. 00, or an 384 DECISION ...

C.T.A. CASE O. 42 average of 3,044. 44 each.

From the s me sum- mary (Exh. TTT) , he claims to hav lost three horses, two of ich, •Night e n · and 11Blaek Chief•, were ' alued at 9,200;00, or 4,600.00 each., as shown in his incom tax r tum for 1950 (Exh. TT).

From the same summary (Exh. TTT). · w note that he gave away cert in ho:r;ses to his f ther-in-la , each having a co t of 3, .00.

Prom the testimony of Jose arren, an official of th M nila Jock y club, it appears that ther were eleven (11) ho~s s register din th nam of p titioner during 1946.

This is admitted by petition r.

d petit1on r like is pres nted ....

a list of horses registered in his nam or in that of his wif sine 1949 , and thos in peti· tioner' s son and father-in-la • From the foregoing , w find the followings

(1) that p titioner owned hor es named B tt r B t • , Buha i • , and 11 Requ sted• sinc·e 19.46 until sold to illiam Li Yao in 1950, which hors s wer acquir d by petitioner at a cost of 3,044. 44 ch; (2) that the horse "Black Chief was first listed in the name of the p tition r or of his ir in 1946 and •Night Queen in 1947, and that both wer owned until the hors died in 1950, each having a cost of 4 ,600. 00; (3) that p ti- tion r acquired fonr Freedoms

and Pearl Diver•

in 1947, " ram • in 1948 and •s1u E gle and 385

DECISION-

C.T •• CASE NO. 42 \ .18- •slack ight• in 1949 , each at a co t of P3,044.44, which continu d to b owned by p ti• tioner until sold to 'illiam Li Yao in 1950;

(4) that petitioner in 1949 acquired horses •Royal Beauty•, •rhe Boss• and •Gilded Kntght" at cost of 3,000.00 each, hich horses cont• inued to be regist red in the name of petitioner' s wife in 195 , and wer in f ct re-registered in her name in 1951, and transf r of tit to the fir t two named ho~es was mad in favor tif p ti- tioner.'s father-in~law only in 1952 (Exh. S).

e find that "Gilded Knight• could not have died · ·n 1950 but prob b1y thereafter since it as in fact regi tered as alive in 1951 (Exh. SSS). Hence , the total number and valuation of horses owned by petit·on r during th period under r • vi are as follows s ~ No. of HorSi!

Valua;t~ on December 31, 1946 4 13,733. 32 December 31 , 1947 7 24 ,422. 20 Dec mber 31 t 1948 8 27,466. 64 Dec mber 31 , 1949, 13 42, 55 . 52 Dee mber 31 , 1950 3 9,000. 00 il the res ondent did not consid r that petition r had a balance of thr ee (3 ) racf horses still on hand as of December 31 , 1950, w beli ve that this must have been due to oversight and since it is dtsclosed in petitioner' s own evidence {Exhs. S S and W ), we have to consider this fact by petitioner's admission. 386 'CIS! ON ..

• T.A. CASE NO. 42 ~rchandise Inv9ntories (Items.No.s, 6 and 7Ll247Z ; No •. 14, , 1? and 16 Ll94SL; Nos. !4, 25 and 26 Ll249h and No•• 35 and 37 /19507). - P titioner sub- •tt d evidence to prove that ~rrors were committed in the prepar tion of his m rchandise inventoriee for t he year 1947, 1948, · 1949 and 1950 in that, i nstead of .reflecting the cost of acquisition of imported goods, the dealers ' prices wer sed, and the inventories contain d duplication and sometimes triplications of various item of merchandise.

If this is correct , t e net worth of petiti ner during those year ld be reduc d and the taxabl e income would also be cor espondingly r duced. ecti n 36 of the Revenu. Code , requiring the t aking oi inventories, p rovide~~ EC, 36.

nventorie§. -- Whenever in the judgment of the Collector of Internal Revenue, the use of inve tories is necessary in order to determine clear- ly th income of any ta ayer, inven. tor~es shall be taken by such taxpay r upon such basis as the Seer tary of Finance may, by regulations , prescribe, as conforming as nearly a mcy b to the best accounting practice in th trade o:t business and as most clearly reflecting the i l}come. • The l aw "· eq ires the taking of inventories if they are necessary "to det rmin clearly t h i ncome of any taxpayer, • such inventories to be tak n •upon such b~sis as the S cr tary of Fi- nance may, by regulations, prescrib , as c nform ... ing as nearly as may be to the best accounting 387 .D CISIO - C. T.

• C E O. 42 - 20 - pr ctic in the t rad or busin ss and as ost clearly r fl cting th inco

I •

Th

r egul tion pro 1 a d by the Seer tary of Finane r quir s the us of inventor! s "in v ry cas in which th ~ production, purchas , or sale of erchandis is an 1nco producing f ctor. u (S ction 144, ev nu R gulation No. 2, 39 o. a. 325. ) I n ord r that an i nv ntory ay satisfy th r quire nts of th law and r gulations , (1) it ust confer s n arly as possible to th best ccounting practic~ in the trad or busin s , and (2) it st clearly r fleet the inco of th taxpay r .

An d in order that an inventory y clearly r fl ct the inco of th . taxpay r, th merchandis t be valued (l)at cost or (2) at cost or mark t price, which v r is lower. (S c. 145, Rev nue egulations Nos. 2)

Th

t r ttcost" ans, in th cas of rchandis purchased sine the b ginning of th taxable ye r - "x x x th invoic price 1 s trad or other discounts, xcept strict- ly c sh discounts approx1 ating a fair interest rate, which y be deduct d or not at the option of th taxpayer, provided a consistent cours is fol- lowed.

To this net invoic price should be added transportation or other n cessary charges incurred in acquir- ing poss ssion ot th goods. ' Sec.

146, Rev nue Regulations o. 2. ) That th cost should be the proper b sis of th valuation of the inventories of p titian r is not disputed by respond nt. Howev r, it is 388

DECISIO

• C. T. A. C SE NO. ~2 alleged on behalf of r spondent that the valuation use in the inventories o:r petitioner is the cost and not the dealers' prioe as claimed by petitioner.

The question to be decided• there- fore, is wh ther or not t he actual cost or the rchandis in question was used in said inv n- tories • .t>ati tioner presented avid nee during the trial to rove that the d alers' pric . was used as basis in the valuation of his erchandi'se i ventori s .

Evid nee was also adduced as to ,· th actual cost of the merchandise. o evidence was presented by r spond•nt to rebut the evidence for the petitioner. Respondent relies on the certifications made by petitioner contained in the audit reports to th effect that the invento- ries were taken und r his personal supervision and priced at cost.

He also sought to impugn the credibility and compet ncy of the witnesses £.or petitioner who testified to the fact that the valuation used was the dealers' price and not the cost.

Likewise , it is alleged that having certified to the correctness of' the inventories, petitioner is estopped from claiming th incor- rectness of such inventories. Finally, it is argued that the correction of t he inv ntor1es as desir d by petitioner would r sult in pet1- ti.oner having sustained huge losses, which is incredible consid ring the increase in his n t 389

MECN

GofeAe CASE MO. 42 - 22 « worth, ;

To prove that @ mustake was committed in the pricing of merchandise inventories, withnesses were presented to show that the priging was based on the dealer's prices appearing in price — lists supplied by Purim Javier, chief clerk of the A. P. Reyes Optical Co. Javier appears to have been the source of the error because when- ever he ordered the taking ef an tiventory he supplied the persons doing the inventory work with a price list containing the dealers’ and retailers‘ prices. That the dealers’ prices were used and not the actual cost has been sufficiently established by the decuxents pre-~ sented as evidence, Duplications end triplications in the list- ing of various items of merchandise have also been clearly established by the testimony of witnesses and the documents presented as exhibits.

Bat respondent insists that petitioner having “admitted and certified under oath both in his letter to his own auditors and in his income tax returns that the inventories declared therein were valued at cost, petitioner must be bound by his own admission. Sec. 7, “ules 123, Rules of Court; 62 Moran Yol. 3.)° We can not agree with his line of reasoning, Respondent

DECISIO

C. T.

• CASE O.

2 ... 23 ..

has ought to establish that the bookS and rec• ords or p titioner are not correct and do not reflect his tru ineo e , ·d, eons quently 9 he has resort d t o th n t orth tho to et r - ne petitioner's taxabl inco e. C rtainJ.y., petitioner is also entitl o prov if he can, errors in the sa books a s whic ould tend to r educe his liabilit , : . prov .· a tak s in a taxpayer • s ook and r cords can not b . a one-sided af'fa r . A~y ass ss ent at a deficiency tax based on th . incorr ctness of a taxpay r •s books and records would be un- just if the taxpay r can not be permitted to prov rrors in th sa e books and records to show a 1 ss r tax.

l·foreov r, if the position tak n by counsel for the Government in · a cas is corr ct 1 ections 306 and ~of the . Revenue Cod , Which authorize refunds or credits ot i nt rnal r venue taxes rroneously or ill g 1- ly paid., would be but an empty gesture on the part of th Government, for taxpayers can not be per tt to prove stakes in their r cords to sp~rw . the erroneous payment of such taxes . ~ ,,f~"t,.'1i 4 spond nt ha argu d that if th actu 1 cost of petit1oner 1 s :rchandise inventor! s · were as elai d by the latt r, he would hav suf£ered hu losses during th period in question, 'Which is quite incredible. Respondent pos d this qu stion: "If · petition r sustained 391 •

D CI IO

c. • • C 'E O. • 42 - 24 - sueh loss , wh r did h get th on y to ae uir thos ss ts whieh he piled p during those y ars?' It would r lly be difficult to answer this qu t1on if th 1nco e tax returns of p titian r r to b con der • t res- pond nt has shown t t p titionar•s 1neome t r turns ar not corr et, nd after giving p t1- t1on r cr i t for th di crepanei s f ound n hi inv ntor s, p titian r ~till pe rs o have d ri d con id r 1 profits aft r b hown.

will h r - ar , ther for , con trained to susu in t st nd of p tit on ~ r s r · rds the ct ual co t of h1 entori s r...ich . ust be t k n int o ccount in the d t r n~ tion of his net wort •

(S

pag s 1- o this d cision) On oth r point hich ght b stated in f vor of tition r is t e f ct that the original mnv ntori e submitt d to respond nt.

s id ori in 1 inv ntori st hav b en 3 b t- t d t r spondent at the nd of ach year, pur- su nt t ection 1 of nu

R

u1 tion No.

V-1, or the oo 5'63).

e invoi pin R gul tions .43 o. G.

which wo~ld prov b yond doubt t act 1 cost of the import d rc ndise in question wer also submitted by petitioner to r spend nt wh n th cas was being i nv s- tigat b x n r of th Bur nu of Int rn 1

Revenu •

Th

or~inal inv ntori s coul not b 392 DECISIO ..

C. T. A. CAo.E NO . 42 ... 25 ...

submitted by respondent at the trial, whil only a por tion of the invoices was produced. This do s not sp ak w 11 of the stand taken b respond nt in this o s • ~· J.QJ.ng :t: .xture s 1 9R furniture and fixtures, nd 1 9l;t8s I tau lips . 22 . t o 31 . for 191±2 and

OSt J8

t o >+2 for 122 ·'·- P titioner in ~his case -appaars \ t o have agr d wit ·th ltams and mounts r ... gar ding building fixt ures, opt· cal quip furnitur and fixt es and a to deliv ry nt, ' ) uc s ' appea~1ng in the report of ' a ner osi co \ (Exh. W) , which was mad the basis of respondent;•\s ·

I'

..

. .

..

.

~I I

'I'

decision.

Since no evi nee h,a$ been sub ·~-~ i \ t o contr vert the s .aid i t em , " must sustain .I the items a th y app ar in the said Exhibit , and therefore sustain p titioner1 s vien on ' such items.

t any rate , respondent appear tt> have

I'

' agr ed t the computat ion , but he ha separ t ed th port ion in :regard to epreciation nd tr~a-ted the s e as a liabilit y.

inc i t is gen r lly accepted accounting procedure to d duct depre- ciat i on directly from the val u of the asset involved, r at her t ha n car ry the depr eciatior. a a liability in t he stat ment of assets and lia-- bilities (Fi nley & Miller, PriD 1 l s of ccou t- ing .. Intermediate .• 1953 ed. PP• 126, 415 ), t he 393

OECISION-

C. T.A. C SE N • 42 separ ate items for depreciation of depreciable assets should be disregarded. ) Rt.ta! estate hoJ.dings . (Item No • 12. ~Z....

· 32 and 43 ). - The difference in the i tan s of real st ate holdings for each of the years 1947, 1948. 1949 and 1950 is attributable to th fact that petition r deducted the accumulated depreciation at he :rate of 2,250.00 a y ar on the building at the corn . r of Raon and ales ts., Whereas the same amount is carried as a liability and includ d in the iter, tmder d reciation or de- preciable a set • Since the question is similar to the one involved in the p c ding items (Items ....

Nos. 8-11 for 1947; Items Nos. 17-21 for 1948; ,etc. ) , suffic·e it to say that the petition r's presentation is more in line with regular account- ing proc dure; and since there would be no dif• erence in the final analysis, we believe that th f'gures presented by p titioner on this point , for clarity and consistency, must have to be sustained.

Accounts receivable (Ite No. 34 ..... Th petitioner did not disput the report of Exam. ine~ Cosico as to the balanc of 148,435. 97 r lating to accounts receivable as of December 31 , 1900 (s e Exh.

).

How ver, respondent presented the Balanc Sheet of petition r as of December 31 , 1950, prepared by petitioner' s accountant (Exh. 12, p. 28, Vol. 3 , B. I.R.

DEC! ION- C. T.A. C SE NO. 42 -27- ..

records) which shows the amount of accounts re- ceivable t 17 ,799. 67.

e consider and hold the 1 tter amount as correct , because it ap ears to conform it petitioner' s o n books o.f account as prepared by an ind pend nt certified account- · ant , the sta em nt having been made ante liti mo~sm • Philipping Ready .. ~x Concrete Corpo,ration s ares of stock ( tern No. 44) •• Petitioner appears to have acquired in March, 1950, 100 .ooo •, • .. shares of stock for 100,000.00. This amount of -100. 000. 00 was treated by re~pondent as part of the assets f p titioner as of December 31 , 1950. On the ther and , it is contended by petitioner that he sold 90,000 shares to tty. E. A. Pica2o sometime in Sept .ember, 1950 with the right to repurchase reserved by petitioner until December 20, 1950.

Petitioner having failed to xercise t e option to repurchase ,. Atty. Picazo became the absolute owner of th said share of stock aft r December 20, 195 • Therefore , petitioner claims that he owned only .10,000. 00 worth of the shares of stock of the Fhilippin R ady-Mix Con- crete Corporation as of December 31 , 1950, instead of 100?000.00 as claimed by r spondent/ Att y. Picazo, who as pr sented as a it- ness , testified that he bought the 90. 0 shares of stock in question from petitioner, as evident d by a document of ale (Exh. E • Th pr.ice paid 1 according to the document of sale , as 35 ,000. 00, 395

DECISTON=

CeTeAe CASE NO. 42 ~28~ much below the par value of #90,000.00. The cer- tificates of stock were delivered te him on September 1, 1950 endorsed i blamk. The witness also testified that he instructed his secretary to send the deed cf sale to the Philippine Ready- Mix Conerete Corporation for notification or registration. fut the secretary of the corporas tion testified that the alleged transfer of the shares of stock in question had never been regis- tered in the books of the corporetion up to the date when he testified in August, 1955.

Respondent mainteine that “the alleged sole of the shares was fictitious and that witness Picazo was biased because of his business rela-~ tionship and friendship with petitioner (p. 7, t.8.ne, August 3, 1955 hearing)*, Pieazo being “the secretary of the Philippine Racing Club of which petitioner is the president."

While friendship and business relationship do not necessarily make @ person a biased wite ness for his friend and business associate, the evidence of record in this case in support of the sale or transfer of the said sheree of stock is not very convincing. Considering thet the buyer is a well known lawyer, it seems incredible that he would not take proper steps te heve his shares of stock registered in his name. The allegetion thet he merely entrusted the duty of 396

DECISION·

.t.A. C E NO. 42 registering the sal to his secretary may b accepted as correct; but not having received the ne certificates ~f stock in his name after a con. siderable length of time , h should have taken personal interest in the matter to hav th sale or transf r duly registered in the book of th corporation.

Petitioner would just1.fy Atty. Picazo's lack of interest 'in said shares of stock , . fter purchasing the same a few month ~efore , to the precarious financial situation of the cor- poration.

But Atty. Picazo bought the said shares of stock for 35 ,000.00, and 35 ,000. 00, by any standard, is not an insignificant amount which may be lightly disregarded.

• Moreover, nowhere in the books and records of petitioner does the alleged sale of th said shares of stock appear; neither was the loss of 55,000. 00 1·esultibg from the sale of said shares of stock re orted by petitioner in his 1950 inco~e tax ret urn. We are , therefore , of the opi.nion that the pr ponderance of th evidence in this case leans h vily in favor of the stand . f respond nt. Accordingly, the sum of tlOO .• ·ooo.oo representi~g th cost of acquisition of said shares of stock by petitioner, has been properly treated by respondent as part of the orm r's assets as of Dee mber 31 , 1950.

J]ispu.t§d. liaW.l!l;i,e,s. - Respond nt disalll:lwed the deducti on from the assets of pet itioner of certain liabilities amounting to tl70'j000. 00 as 397 DECISION.

CeTeote CASE NO, 42 De Of December 31, 1946; 960,000,900, es of December 3), 19473 #85,000.00, a6 of December 31, 19483960,000.00, as of Becember 31, 19493 and ®125,0009.00, a8 of December 321, 1950, These amounts were allegedly personal leans secured from francisco P. Heyes, Pable Bustamante, Congressman Bulogio Redriquesz, _Jte, Juan G. Se Viado, Simeon Reyes, and Remon HENCLOS.

The elleged lean secured from Francisco Po Reyes in 1946 is not evidenced by any promissory note, but it is cleiwed that it was paid in 1952, presumably after the case of petitioner hed been oxdered investigated, by means of 6 check drawn on the China Banking Corporation (fxh. Gj). But the records of petitioner do not shew clearly thet such a loan was secured from his brothex.

A loan of #25,000.00 was also allegedly secured from Pablo Bustamante in 1946. It is claimed that = promissory note was issued evidencing the loan, but that it wae destroyed or lost when the losn was peid in 1952. Payment is alleged — to have been made by means of 2 check drqmn on tae Prudencial Bank and Trust Co., dated Deceme ber 15, 1952, which check was kept in the wallet of the payee for about 30 to 45 days, after which it wet indorsed to the Philippine Asecing Club and paid by the letter in Jenuery, 1953.

In further evidence of the payment of the loan, s 398 ae DEC SION.

c.r.A. c se o. 42 voucher of the Aur lio P. Reyes Department Store (Exh. C). 'las pres nted.

No similar voucher was .ad or issued in the CpS of the lean secur d from Francisco P. Reyes. No record or ntry regarding this loan app ars in th books of petitioner.

The circumstance surrounding the all ged loans secur d from Congressman Eulogio odriguez , Jr. are described in sufficient d tail in th memorandum of couns 1 for petition r , from which .

• ... Eulogio Rodriguez , Jr. Loan of 20,000. 00 - Th de osition of Congres - man Eulogio Rodriguez, Jr. was submit- ted and adMitted in evidence s Ex.

ibit •v • During the deposition, counsel for re . ond nt ho r pre- sent subjected the itness to cross ... examination.

The testimony of Cong~ ressman Eulogio Rodriguez, Jr. ras cl ar that in 1946 he accommodated th petitioner ith a loa of 20,000.00, which he gave in cash and for which the p titioner executed a •val ' (D - position t . s. n. , p . 3 ). That loan of 20,000.00 was reduced to only 10,000. 00 in 1947, because of a payment of 10,- 000.00 (Affidavit of Congressman Rod- riguez , Jr., par. 2, Exh. S). In 1948, the loan was again increased to the original amount of 20,000.00 (Affidavit , Par. 3, Exh. S).

Again , in 1949, th petitioner made a partial payment of 10 ,000.00, reducing the loan to 10,- 000.00 (Affidavit , par. 4, Esh. S) , and in 1950, the petitioner once more borrowed an additional mount of 20,.

rooo.oo, increasing the totil outstand- ing loan to 30,000. 0Q---. s of .,December 31 , 1950 (Affidavit , Par~--5 , Ex!!. S ).

Th

contents of his affidavit , w ich vas admitted as Exh. S, were all con- firmed by him during the dep sition (Deposition , t.s. n., ~ · 3). Con ress- man Rodriguez, Jr. testified that he 399

DECISION-

C.T.A. CASE NO. 42 had been paid by the petitioner in the sum of 25,000.00, hich he acknowledg d by signing a voucher present d to him (Exh. T ).

The voucher, dated in 1952,.

indicates that the payment was made ith Prudential Bank & Trust Co. Ch ck No. B0-3938, dated in 1952, in the sum of 25 ,000.00 (Exh. U).

H testified , how ver, that he asked the petition r to have the check cashed for him, after hich th cash as delivered to him by Mr. Aurelio • Reyes (Deposition, t.s. n. , p. 4).

The testimony of Cong- re man Rodriguez confirms the expla- nation of the pet1tioner for the app ar. anee of his indorsement at the back of the check (Exh. U).

The petitioner previously testified that he indor ed the check because he cashed the check ith the Bank ~on request of Congress- man Rodriguez (t. s. n. , f>· 235 ). (pp. 11-12.)

' Congressman Rodriguez testified tha th loan of 20,000. 00 m de by him to petitioner in 1946 was taken into account by the Bur-eau of Internal Revenue hen · an assessment for d fici n- cy incom tax was issued against him. This is not d nied by respondent.

Juan c. s. Viado , bookkeeper of petitioner, allegedly loaned to p titioner the sum of 20,000. - 00 in cash ~ sometime in 1948, which wa videnced by a promissory note.

Th note was paid in .

1949 , also in cash, and the promissory note was l.

returned to p tition r. Viado claims that th sum of 20,000.00 is part of hi share of the pro- ce ds of the sale of a property owned in common by him nd his brother , which property was sold in 1948.

Th

examiner of th Bureau of Internal R.venue, who investigated the case of petitioner, 400 DEC! I c.r.A. c se ~o . 42 t stified , ho ever, that when he interviewed Viado befor his report was submitted , th lat ter told him that the said 20,000. 00 as part of his s ving o t of his sal ri es.

H was receiving a salary of 125. 00 month f r om petitioner.

o ouch r was m d or issu d by petitioner hen p yment we mad , and no entry about the loan appears in his records.

~meon eyes also allegedly loaned to peti- tional' the sum of 25 ,000.00 in 1950,. evidenced by a romis ory note , which s aid y means of a check dra '0 on the rudent ial Bank and Trust Co., dated October 13, 1952.

No voucher is alleged to have been made or i ssued and th account is not recorded in etitioner' s books r records.

The loan of 2 ,.oco.oo secured from R mon r.eneses in 1950 was given by the lender to Mrs. A relio • R yes.

The circumstances surrounding the loan are r lated in the memorandum of coun- sel for petitioner, as foll o s $ ~~s . Aurelio P. Reyes testified th. t she borrowed 20,000.00 from r . Ramon Meneses sometime in the early P.ar t of .950, round arch or April (t. s.n. j p. 58).

In acknow edgment of th loan , she g ve him a promissory note , ·1hich she has failed to locate, s i n e~ i t was r et urned to her upon partial payment of the original loan. parti al paym nt o 7,()(X).00 was ade ometime in 1951 (t •• n., P• 59) and th b&lance of 13,000. 00 s e id ced by a promissory note , dated Ap:ril 4 , 1951 , which has been admi tt d in evidence s xhibit ' J ' .

~~s .

ureli 401

DECISION-

C.T.A. CASE NO. 42 -34- P. Reyes was able, however, to pro- du e the receipt issued by Mr. Ramon Menes s on October 3, 1950, acknowledging payment of •1,200.00 as interest for the loan of 20,000.00 (Exh. 'H').

We respectfully submit that the in- terest of 1,200.00 computed at the original rate of interest of 12% per annum (t.s.n., P• 66) corresponds to interest for six months and did suf- ficiently establish that the loan was originally incurred sometime in April of 1950 which is just six months be- fore October 3, 1950.

Stated other- wise, 6% interest on 20,000.00 is 1,200.00t which was paid as per Exh. 'H'. Besides the receipt, Exhibit 'H', the bank statement of the petitioner showing the debit of a check in a si- ilar amount of 1,200.00 on October 5, 1950 was introduced in evidence as Exhibit 'K' 'and the particular entry in the bank statement referring to Check No. 382520 for 1,200.00 which was debited by the bank on October 5, 1950 was marked in r ed pencil as Exhi- bit 'K-1 '• •That the original loan was t20,- 000.00 and that the promissory note of 13,000.00 executed on April 4, 1951 (Exh. 'J') was merely a renewal for · the balance is further proven by ano- ther bank statement of the petitioner produced by the •itness showing the debit of •1,000.00 October 5, 1951 (Exh. '1' ).

The particular check show- int the debit of 7,000.00 on April 5, 1951 has been e closed in red pencil and marked as Exh. '1-1'.

Various

other checks which had been ed by the petitioner on his ife to make pa ial payments on account of the principal and interest on the loan were produced before this Honorable Court and admitted as Exhibits L, M, N, O, P.Q, and R.

These checks have all been properly endorsed by Mr. Ramon Meneses.

The witness further testified that at ·the time she was under cross- examination, there was still an out- standing liability in favor of Mr. Meneses in the sum of f7,000.00, more or less (t.s.n., PP• 66-67)f 402 DECISION.

ColeoAe CASE HO, 42

#3Se

We have gone cver ¢erefully the evidence pre end con cencerning the contested liabilities, and we egree with respondent thet the existence of the seid leans, extept those secured by peti« tiener from Congressman Eulogic Rodriguez, Jr. and Ramon Meneses, heve not been cleezly estebe Aished. While it is true that in most cases promissory notes or “vales” were issued covering the loans, end sometimes payments were allegedly evidenced by means ef checke and vouchers, there is nething in the recerds of petitioner te ine dicate thet the loans were actually secured from the persons already mentioned. Petitioner admittedly has verted business interests. He has beeks and records. Fer his om pretection, even hie private leens should be recorded to prove that the loans sre pons fide transactione.

It may be argued that personel transect ions net connected with the requier business of the tampeyer are not required te be recorded, This is the theory relied uwpen by counsel for petitioner in justifying the feilure ef their client to record said leanne. This is net exect~ dy correct a8 we shall presently show.

Section 334 of tne National internal Ree venue Cede provides:

or persons required by _q- se pay sy ternal revenue texes "Yael & 403 Same.

oat LONe CeTeAe CASE NO, 42 ~-%e eurnel end « ledger, or their equivee s? Provided, however, That those wnose gress querterly seles, earnings, receipts, or ut do not exceed fise thousand pesoe shall keep and use a simplified set of Bookkeeping Records duly suthorized rf the Secrerery of Finance wherein all trensactions and results of operetions gre show and fzom which all taxes due the Govern. ment oe readily and securetely be ascertained and determined anytize of the yeer!

Theat in the cease of corporations, come panies, pertinerships of persone whose gross cGuerterly ee. earnings, re- ceints or cutput exceed twent yefive theusand pesos, siall have their Beoks of Accounts audited and examined yearl by endent Cestified Public Account. ants and their income tax returns accom- penied with certified balance sheets, prorat. ye loss ni te 9 tS, a es ome-producing properties and a es incores there- rom and oumieet te elevent statements. As e 2, Republic Act ie ioe: ea sec. mas Republic Act No. 656, )*

Sect

ion 334 ef the Revenue Code, in clear and unmistekable languege, provides thet ell ‘persons required By law te pay internal revenue taxes, end this obviously includes income tax, must keep a journal and a ledger, or theix equivalents. However, where the gross quarterly sales, earnings, receiv ts, or output do net exceed fime thousand pesos, such persons are required to keep and use a sinplified set of bookkeeping records wherein ai) teopsections and Eesults of omerations must be show, The reason for these requirements is stated in the law ite self - jn oxder that al) texes due ihe Sovern- . 14) tely be 4 tained 404 DECISION.

CeTsAe CASE NO. 42 aJ37e and. determined anytime of the yeag. Undoubtedly, if petitioner's private er personal transactions are not recorded in his beoks, the income tax due the Government from him con 263 Se readily and accurately ascertained end determined any- time of the year. That the personal leans in question effect the determination ef petitioner's income tax is attested by his attemt te prove the existence of such leans te minimize or reo duce the deficiency income tex essessed against we ' In expressing the opinion thet even pere sone] transactions of = person regulerly engaged in business must be recorded, in order te reflect his true income and his tex liebilities, and thet in the absence ef appropriate entries in his books ez records, such personal trensactions may be disregarded fer tax purpeses, we do net mean to imply thet ell such transaction must be dis- | regarded irrespective ef the weight of evidence presented in suppert thereef. Ve believe that in the case of persenal leans, it is not enough te prove the existence ef such leens by the pree . sentation ef promissory notes or Svales* signed by the borrower, or ef checks or vouchers evidencing peyment. By the very nature of loan traensections between individuels such transactions ere easily concected, specially between friends and relatives, and promissory notes, “veles", checks, oxother 409 om •

DECISION-

c .r . A. CASE NO. 42 -38- similar ritten documents~ in the bsene of other r•l vant evidenc ., dese,rv cant con ider tion.

This is speci 11 'ti:ru h r the /'posed borrow- er bas a pend ng tax as essment. In order that such transactions a.y pr r y consid red , it i essenti l that the · xist nee the of u t b . proven y cl and convinci g evidenc pendent of promi _sory notes, •val •. ch cks or _,....

other i ila d cuments. ~ In the in tant case. only th loan secur d by petition r f Congr s an Rodrigu z and Ramon neses app a.r t b v b en satisf orily proven by corroborativ vidence independent of t prom! so.ry notes or vales• signed by tb borrow- er, p tition· r h rein.

The loan given by Congres.s an Ro rigu z to petitione.r wa·s pro en not <~nly b eans of the •val ·executed by peti- tioner. It was shown that the loan as taken into consideration· by respondent i self in th a &essment of the deficiency inco tax against Congress an Rodrigu z. It would be· inconsistent for respondent to r ject the same loan a a liability_ of petitioner.

With .respe1:t. t ·o the 1 n ecured from mon Meneses . it has ben s · n that interest was paid and a receipt cov ring pay- nt of interest as sub t ted in evidenc-e. -- The ree i:pt appears to have een xecut ed and deliv red to the wif . of petitioner on October 3., 1'950., 406

DECISION~}

C.T.Ae CASE NO. 42 -39- before the case of petitioner was investigated by an examiner of the Bureau of Internal Revenue. The existence of the other alleged leans not having been satisfactorily proven, we are , constrained to sustain the stend of respondent in rejecting the same. Accordingly, only the leans secured from Congressman Redriquez and Ramon Meneses may be admitted es part of the liabilities of petitioner in the years in which they appear te have been outstanding.

The foregoing disposes of the first issue in regard to the correctness of the net worth of petitioner at the beginning of 1946 and at the end ef each ef the taxable years 1946 and 1950 as determined by respondent. Ina accordance with the agreement of the parties as regards certain assets and liabilities and the foregoing opinion on the disputed items, the determination by res- pondent of the net worth of petitioner during the period under review and the corresponding defi« ciency income tax and surcharge due mist have te be revised in line with the following computae ‘tien:

(Centinued to page 40)

DECISION-

C. I . A. CASE NO. 42 - 40- Begipning Net · rth of Petitioner

QQ January 1 1 1946

Assets -

Assets dmitted by parties Plus assets roven at trial~

(1 ) Building

(2) Installments paid on a l ot Total assets

Liabilities -

Liabilities admitted by parties Net worth as of Jan. 1 , 1946 ss ts

Increase in Net Worth

and Def iciency Tax ue ' in 124~ Assets admitted by ~arties Plus assets proven at trial:

Race horses Total assets

Liabilities -

Liabilities admitted by par ties Plus liabilities proven at trial Tot 1 liabilities Net worth as of Dec. 31 , 1946 Less net worth as of Jan. 1, 1946 Increase in net worth in 1946 Pl us non- deductible expenditures: Personal, living and family xp nses Gross income L ss person l exempti ons Net Taxable income in 1946 Tax due Less tax already paid efici .ncy Tax Add 50% surcharge Deficiency tax and surchar e 408 302 , 250. 00 45 ,000. 00 2 ,003 .. 00 349 ,258. 00 30 000. 00 . 319 , 258.00 ~814 , 642.33 13,733. 32 828 , 375. 65 6,500. 00 112,279.30 6 500. 00 105 ,779.30 29 ,491.72 10 ,594. 08 .

18, 897. 64 9 , 448. 8,2 346. 46 .t DECISION.

GeTeAe CASE NO. 42

Assets -

Aesets admitted by parties . 9420 ,408. 45 Plus assets proven at trials

(1) Merchandise inventories < : eager me = ~~ 4 pidge:

{2 } oui ides fixtures 4,000.00 3 “oo equipment and apo eratus 12,763. 56 purndtuse & fixtures 417,267.18 ms Real estate holdings T3H9448.00 ©) Race horses Total assets Pl, elJdle

Liabilities - 7

Liabilities admitted parties TSO 416-96 Pius liabilities preonth | at trial 10,000.00 Tetal liabilities 2760 ,416. 96 Net worth as of Dec. 31, 1947 2963,721.01 Less net werth as of Jane 1, 1947 Increase in net worth in 1947 3 yi Plus non-deductible expenditures’ on living & family ex- —— re @) pense Income tax paid in 1946 2 Gress income pi85s777- 79 Less personal exemtions Net taxable income in 1947 Tax due 91-1) Less tax already paid Deficiency tax » 455 Add 5O® surcharge Deficiency tax and surcharge pee P< {continued to page 42) 409

DECISION «

CeTeAe CASE NO. 42

Assets «

Assets admitted by parties Plus assets proven ot trial:

(2) Merchandise inventories «

Haberdasheries «= Imported

Office equipment Optical equipment * {3} Building fixtures 3) Optical equipment and apparatus |

4) Furniture & Fixtures

5) Aute and delivery trucks 6) Real estate holdings 7) Race horses ~ Total assets

Liabilities «

Liabilities admitted by parties Plus liabilities preven at trial Total liabilities Net worth a6 of Dec. 31, 1948 Less net worth as of Jan. 1, 1948 increase in net worth in 19468 Plus nenedeductible exe penditures!

Personal, living and family expenses Income tax paid in 1947 Gross income Less deductible items} Personal exemptions SO% of capital gain Net taxeble income in 1948 Tax due Less tax elready paid Defi tax aia x surcharge Deficiency tax and surcharge P429 , 763267 46,498.15 76,621.11 93—861.293 3,500.00 11,170.83 17 ,CT2.91 8,078.00 162, 702%.00 27 1466264 PLGTE 691. 24 941 ,O78. 98 617,612. 26

DECISION=

C.Teie CASE NO. 42

Assets -

Assets admitted by parties 9539 768.96 Plus assets proven at trial:

(1) Merchandise inventories = Haberdesheries - imported 73,643.94 Gpthenl equi: * 104°397.22 Optica pmer: "

2 building fixtures | : 3.04500 Optical equipment { apparetus 4} Furniture @ fixtures 14,964.02 §) Auto & deliv trucks 8,271.04 6) Real estete heidings 270,458.00 7) Reee horses Total assets

Liabilities -

~ liabilities admitted by parties " 736,771.53 Plus liabilities preven at trial 105000 Totel liabilities Net worth as of Dee. 31, 1949 Less net worth es of Jame 1, 1949 Decrease in net worth in 1949 al e 3 Less non-deductible expendituress Persom], living and family expenses 6,500.00 Income tax raid in 1948 19494,79 Gross loss & 24,991¢73 Add deductible itenss Personal exemptions 6,500.00 Wax damage compensation uw aes 26 Net loss in 1949 eee PELTON] No deficiency tax due.

(continued te page 44) 411 =»

DECISION}

CeTeAe CASE NO. 42

Assets «

Assets admitted by parties » $23,361.73 Plus assets proven at trials 1) Accounts receivable 173, 799e67 2) Merchandise inventories ~ Naberdasheries «- Imorted 67 ,0O23.48 Office equipment * 58,148.66 Optiesl equipment * 116 , 246,59 3) fullding fixtures 2,340.00 Opticel ye ee and apparatus 7,985.33 5S) Furniture & fixtures 13,234. 28 6) Auto & delive ae 10, 2901636 7) Real estate holdi 217 , 558.00

6) Philippine Ready-i :

Concrete Cexporation stecks 300,060, 00

(9) Rece horses Tetal assets Bl, oA Dle

Liabilities -

Liebilities admitted by parties 673,669. 37 Plus liebilities preven at trial me Total liabilities 2 Net worth as of Dec. 31, 1959 i sr2le Less net worth as of Jan. i, 1950 So Increrse in net worth in 198° > ’ Plus non-deductible exnenditures Personal, living and family expenses 7,806.00 Income tax paid in 1949 Gress income ba 1, Less deductible itenss Personal exewntions 7,800.00 SO® of capitel gain 17,725.00 War damege compensation.

Net texable income in 1950 f Tax due y Less tax i Sonaney paid mee >

SO% a

Deficiency tax and surcherge 1946 P 28,346.46 1947 68,338. i1 1948 12,649. 36 1949 none - 1950 2 {

DECISION~ H|

C.T.As CASE NO. 42

~A5~ )

The second issue relates to the legality ef the net worth method of determining thxeble income under our Income Tax Law (Title 1 of the National Internal Revenue Code).

Respondent in this case assessed against petitioner deficiency income tax for the years from 1946 to 1950. Although petitioner filed income tax returns for those years and paid income tax on his net incomes es reflected in his ree turns, respondent found, after investigation by an income tax exeminer of the Bureau of Internal Revenue, thet the former hed considerable amounts of wnreported income net resorded in his beoks nor reflected in his income tax returns. For this reason: » respondent determined petitioner's taxable income for those years by means of the net method.

The formula for determining the taxable net inceme of a taxpayer by means of the net worth method is as follows increase in net worth, plus non-deductible disbursements, mfinus non- taxable receipts equals taxable net ineone. | (See Perez v. Araneta, B.T.A. No. 189, decided by this Court on February 13, 1956, and authorities cited therein.) The procedure for determining taxable net income under this formula has been described in a recent decision of the U.S. Supreme Court, vizs 413 ™ DECISION.

C.T.A. CASH NO. 42 ~46= s *in'sotypiteat ned worth prosecu.e tion the Government, having concluded that the taxpayer’s records are ine adequate as a basis for determining income tax liability attemts to establish an ‘opening net worth’ or total net value of the taxpeyer's assets at the beginning of a given year. It then proves increases in the, xpayer's net worth for each succeed~ ing year during the peried under exam- ination and calculates the dafference sereen the adjusted net values of — axpa s assets at the beginning end of uth of the years involved. The taxpayer's aen-deductible expenditures, including living exmenses, are added te these increases, and if the result. ing fiqure for any year is substan- tially ter than the taxable income Teperted by the taxpayer for that year, the Government claims the excess re- presents unreported taxable income. In addition, it asks the j to infer willfulness from this understatement, when taken in connection with direct evidence ef ‘conduct, the likely re- ' sult ef which would be to mislead or conceal.* Spies v. United States, 317 US 492, 499» 87 Le. ed. 418, 423, 63 US 4, cited in Perez v. Araneta, Respondent claims that his authority te use the net worth method is sanctioned by Sections 15 and 38 ef the Revenue Code. Section 15 em- powers the Collector of Internal Revenue to “assess the proper tax on the best evidence obtainable when @ report required by law as a basis for the assessment of any national internal~revenue tax shall not be forthcoming within the ‘time fixed by law or regulation, or when there is reason to believed that any such report is false, incom. plete, or erroneous. Section 38 provides that the net income of a taxpaper shall be comuted on .. 444

DECISION-

c. T . A. CASE O. 42 .. 47- the· bas.is of ~his annual .aecountinq p·&r.i'Od in accordance it the met od of accounting r gular- ly empl .yed by hi ink ing his books, but .if no such met .od of ccounting 1 s b n mploy d ., or if t h method employ d does not e~arlv refl;ee~ the. income,. the comwuta:ti.on in method as in of the Cg.J.l ec;tor of In,t1rnal Revenu does cleaa::lv Section 15 of the Revenue Code app ars in Title 1 under the heading Organization of Bu- reau and is . th refore.

9 n ral pr ovision which is applicable to all internal revenue tax&s • while ' .

ection 38 is em o ie ·n Tit!

under the heading · !nco ~ax solely to inco taxes.

But g neral provision and ac ..

ll and i.le 8 s of t e Cod i applicabl ction 15 i pecially pplicable to inco e taxes ., there is nothin-g in th t o ection from which any implication m y / / be drawn that S ction 15 has no application to income taxes.

Tl

tw sections are complement ry --.._ to 4!!nd not ineon istent . ith aeh other.j Section 3B is a c py of Section 41 of th

u. S. Int mal Rev nue .od of 1939 (Se-c .. 446 of the u. s. eode of 1954).

hile e g:ree with counsel for petit ioner that decisions of th

u. s. Supreme Court in net orth cas s are not binding in this jurisdiction, such d cisions h ve a strong persuasive force and are generally ?

' 415 DECISION= , C.T-Ae CASEW NO. 42 ~48< f6llowed and applied by our courts. (See Perez ve. Araneta, supra.) iIn fact the memoranda abe mitted by counsel few petitioner are replete with citations of American decisions which have been cited in support of the stand taken by them The legality of the use of the net werth method is being assailed on three main grounds, viz:

(1) “Increase in Net Worth® is not synonymous to "Net Income";

(2) The taxpayer's method of accounting should be follewed; and |

(3) The inventery (or net worth) methed is grossly inaccurate and arbitrary.

We agree that “increase in net werth" is not Synonymous to “net income" as the letter term is defined in Section 28 of the Revenue Code. Where, however, the net income of a taxpayer can net be determined from the income tax returns which he is required te file, or from his books and rece owds, experience beth here and in the United States has shown that the use of the net worth meBhod is a reasonable means of determining net income.

That the taxpayer's method of accounting / should be followed generally may also be admitted. ‘But Section 38 is very clear and explicit that where the method employed by a taxpayex does not clearly reflect his income, the Collector of In- !

416 @m-

DECISION]

C.TeAe CASE NO. 42

~A9~

ternal Revenue may employ any other method which in his opinion would clearly reflect the income, "or he may make use of “the best evidence obtain- able* under Sec. 15. The power or authority of the Collector to chcose the method of determining taxable income is quite comprehensive, and the @nly limitation to the exercise of such power or authority is that the method chosen or adopted must “clearly reflect the incoze.* The govern- ment, in the wor€s of the U. S. Supreme Court, “has relied for the collection of income tax largely upon the tazpayer's own disclosures. « « the government must be free to ute all legal evidence available to it in determining «hether the story told by the texpeyer's books accurately . Beflects his financial history. * (Holland ye UsS-supra, ) . That the nét worth methed may in some ins tances be greasly inaccurate and arbitrary, may also be accepted? but the fact that the use of such method may be arbitrary in isclated instances is not a valid defense against its legality. By the very nature of the net worth method, exrors or mistakes are apt to be committed in arriving at the net worth of the taxpsyer in any given period, specially where the necessary data are withheld by the taxpeyer himself ,or are sinply unavailable because of the absence of adequate records. fhe walidity or efficacy of the net worth method can not, under such circumstances, t 4 ges d to th b olute c.c r ey of rrived t by th u of sweb ·v-emm nt ·d b at th rcy of taxpayers.

er it cle rly ap e ~ • •r., that an . bus or i jusUe h r bown to exi in th us of tb m th d • thi Court ill t he it t t ·o le . lts assist nc to lf unju t or incorrect ass ·. s. nt.. of th ev In~ernal .

ini • t r for • i that Section 38 nu to uthoriz s the Coll ctor of loy th n t orth th r a taxp y r ke s no bo ks or ~ cords or her• such ooks or reeoaa do not cl arly re-· fl et hi tb 1 ex r s d on_our cl i io in Perez v.

418 ~---------------------------------------------------------~------ •.

ECIS1 1-

. T.A!I CAS . ys Th proposition tha~ th C ..

stonn 's uthor1 ty to li$ th n th or n othe·r in. 1r ct thod in d t rmining inc:o • 1 rooted in o:r · t ms fro Section 41 of b In- t mal R v· u Cod of 1939 ha~ b n upported th . C s . fr . qu ntly th t the • re ment ion cf the indir ct teehniq f o d t ing inc .

lls forth a reeitation of th . provision f t at s etion.

Support foJ: the pro- position is not la~king in discua-sion b 1 tx n.

X

X

.

lt p ars to us to b ll established that the p.r vailing vi in tb nit States is that the us of th n to orth or any indirect t o o pr ing ur .ported in~ome i p r- mitted under ~Section 41 of the· u. s •.

Intern 1

ven

Co

of 1939 (S etion 44 of th 1954 Cod ).

Section 3 of

our e nue Cod · having be n patterned after S ction 4 of the u.s. Code. the constr ction plac po t s ctio by t e U. S. court ha · strong p r- s asive fore i t is j ri di .ction.

e hav n do bt, there or , that S c- tion 38 of our u

Cod

i i worded perudts the use cf the net tb eth by h Coll etor of lo- t rnal Revenue wher Biz ct proof Qf d r-deela ation of income- is not v ilable by any other na. x x x 11 lt i th n t o 9 d, v r , t at a od • r.' p · ' i t e n ·ng- th-t t .la ~tis n t app li~a 1 to the case o . h r in petiti th.

tdi r it u r ot pr nt.

Th foll ing ondition • aecor.

l.ng cou s 1 f pe·ti on r, . r indi p nsable 1:tt i ites for t . e. 1J~r~er use f th ethods "{1) r ta ks. or i ooks r that t ey do not i me.

419 t .ortb

DECISION}

CeTeAe CASE NO. 42 a5 20 *(2) There must be an net worth, established with reasensa- ble certaint » to Serve as a starting peint from which to ecslculete future increases in the taxpayer's assets. The importance of accuracy in this figure is immediately arent, es the correctness of the result depends en- tirely upen the inclusion in this sun of ali assets on hand at the outset.

"(3) The Government must track down all relevant leads furnished by the gn amt reasonably susceptible of being ked.

*(4) There is le evidence of source income of taxpayer, which eccounts for the increase in networth.

The government must do more the® show an increase in networth; it must preve in some way that the source ef the in- crease was taxable income.

*(5) Proper adjustment must be made for personal and other non- deductible expenditure® as well as for none-texable receipts and for depre~ ciation.* (pe. 104, ) The question has been askedt Do these cone ditions obtain, or have they been complied wita, in the case at bar? Te which counsel for peti- tioner refliedt “Our answer is emphatically in the negative. This is especially true with res~ less to state, are amongt the most important ones.* Apparently, Condition Ne. l- that the books of the petitioner sere sco inadequate thet they de not reflect his copreet income - has been met, counsel for petitioner not having bothered te prove the adequacy of their client's beoks and records. That the books and records of peti- tioner do not reflect his correct income is \

420 Po

DECISION

C.T.A» CASE NO. 42 ~53~ clearly shown in our discussio& of the first issue (referring to the correctness of the in- creases in net worth of petitioner), and also in Annex*A® attached to the memorandum for petitioner dated Feb. 27, 1956. In said Annex *aA®, it is admitted that petitioner incurred ine come tax deficiencies during the years 1947, 1948 and 1950, wven without considering the items disputed by respoddent. .

Condition No. 5, referring to edjustment for persoae! and other non-deductible expendétures as well as for non-taxable receipts and for depreciation, is also admitted as having been complied with. This wes made possible largely by agreement of the parties.

Condition Ne. 2, relating te the opening not worth, which must be established with reasen- able cetainty, is alleged not to have been cleqrly established. While it is true that the @pening net worth cf petitioner as of Jan. 1, 1946, which was used by respondent in detere mining petitioner’s yearly increases in net worth from 1946 to 1950, has been shown to be erroneous, yet upon the evidence submitted hy the parties, the opening net worth hzs been established with reasonable certainty. (See page 40, supra, ) 1¢ may be stated in favor of petitioner and his counsel that they cooperated willingly during the trial of this case in bringing to light peti- tioner's opening net worth, which happily

DECISION •

C. T.

• CASE NO. 42 - 54 - facilitat ed t he early termination of the tx• 1 ' and hel ped the C urt in great measure in the proper determi nation of the i s sue. Condition No. 3, which requi res , accordi ng to counsel for petitioner, that the Government must track down al l relevant le ds furnished by the taxpayer reasonably suscepti ble of being checked ," has been in our opinion, adequately met.

Leads furnished by petitioner i n regard to his assets and liabilities ere investigated a checked , and , where found t o have been clearly established,' were admit ted by r espon- , dent.

The same is true lit h petitioner 's non- t axable receipts and income. I t may be true that there were certain flaws in th findings of respondent , but the fla s that we have ob- serv d operated mor e to the advantage of peti- tion r tha of the Government.

Note, for in-a.:

tance , the subject of non-deductible expenditure.s , among which are the personal , living and family expenses of the f"axpayer (Sec. 31, Revenue Code ), .

which expenditures are required t o be added t o his increase in net worth to arrive at his gross income. 1 Respondent, without consider:fng 11r ela- ' vant leads• . simply estimated petitioner's per- sonal expenses as the equivalent of his personal exemptions deductible under Section 23 of the Revenue Code.

In effect , respondent did n-ot find any non-deductible expenditure of p titioner f or personal , living & family expenses duri ng ·.?;

' 422 Lie he DAD C. T. Ae CASE NO. 42 oe 35 = all the years under review. Ye de not believe that petitioner would assail the propriety of the net worth methed as applied to his case merely because of the failure of respondent to appraise reasonably his non-deductible expen- ditures for personal, Living and family expenses.

Cendition No. 4, requiring evidence of ine come of the taxpayer, which accounts for the increase in his net worth, has likewise been complied with. The evidence of record shows thet petitioner has, or had during the period under review, a flourishing business in optical geods, office equipment, and haberdashery. He maintained expensive race horses of which he kept no records. He had considerable real ese tate transactions, which were alse not recorded, the only record wi which is what appears in the income tax returns. 4e alleges to have con~ tracted personal leans, no record of which was also kept, which personal loans do net sppear te have been spent for personal, living and family expenses and mist presumably have been invested in income-producing ventures. He is also the president of the Philippine Recing Club. Considering the admittedly inaderuate records of petitioner, we find no aaffieulty in expreste ing the opinion that these are ‘some \of the pre- bable sources of petitioner Vd ‘undeclared income.

It is net required e net, worth cases f / 1 4

Js

423 yg •

I

DECISION •

,, C .. T. A. CASE. NO. 42 ... 56 - that the Government prove flfith absolut~ ~ 'Certainty the sour~e s from w&ich petitioner der~" ~~d his unreported income.

It is sufficient if· 'evidence is adduced of the likely source or sourc •s of such income.

In this case, there is amp'l? evidence of the probable sources from which peti- . tioner could have derived his undeclared income •in quantity sufficient to account for the net worth increases•.

(Holland v. U.

• supra. )

The third issue refers to the propriety of the imposition of the 50$ fraud enalty provided ,.

in Section 72 of the Revenue Code. The pertinent portion of said sec~ion relating to the fraud penalty readst " x x x In case of willful neglect to file the return or list ~ it h in the time prescribed by -law , or in case a false or fraudulent return "" or list is willfully made , the Col- ~ lector of Internal Revenue shall add to the tax or to the deficiency tax . in case any payment has been made on the basis of such return before the discoYery of the falsity or ~raud, a surcharge of fifty p..ar cent pm of the amount of such tax or deficiency tax." Among the circumstances generally recognized as justifying the imposition of th fraud penalty ares (l } int1e~tional understatement of income, substantial 'in a~ount ~ . sa ox substantial in relation to tne ·total reported income; (2) i!'- tentional overstatement of deductions. substan-

I

tial in amount p.e.r s.e. or substantial ih relation / to the total reported income; and {3) recurrenEe of the understatement of income or overstatement

DECIS-0 -

C. T. A. CASE NO. 42 - 57 - of deductions for more than one tax year. (Balter, Fraud Under Federal Tax Law, 2nd ed. Ll953/ , p . 226, cited in Perez v. Araneta, supra. )

In the case at bar, the understatements of petitioner's income are -substantial in amount ~ ~ or substantial in r~lation to the total reported income~ Such substantial understatements of income have been clearly estab~ished in 1946, which recurred in the following yea up to 19~ , xcept in 1949.

In fact, petition r admits that understatements were made in his returns, although in amounts less than tho ." "

stablished during the trial~ as shewn in Annex ' •A attached to the memorandum for petitioner dated February 27 ,, 1966.

The following is a com- parative statement of the net incomes declared in his returns and the net inco~es established by the net worth method , together with the under-declarations .

..

Net Income Declared Net Income

fstibl:ished

Net Income

l.Jndecl a red 1946 -1947 1948 1950 51 , 380~ 26 12,660.98 13, 615.8?

14·, 395. 07 ill05 .. 779. 30 149 , 277. 79 49,098. 62 161 , 583.70 ' 54 ,399. 04 136 ,616.81 35,482.75 147,177.63 The net inco e undeclared in 1946 is more than 100% of the net income declared. In 1947 , the undeclared net income is more than 1,079% of the net income decla;ea • . In -1948; the -un .. \ declared net income is mor than 260% of the net income declared.

In 1950, the undeclared net 425 /

DECISION -

C. T. A. C SE NO. 42 income is more than - 58 - 1,000

I

I

of the declare d net income.

Ve have no hesitancy in expressing the opinion that , under the cirscumstances, such ug~ underdeclarations could not have been the re- sult of honest mistakes .

In pes v. .s. 317

u. S. 492 , it was held that affirmative willful · att rrpt . may b inferred from any conduct , the likely effect of hich would be to mi~ead or t o conceal.

iaving arrived at the conclusion that •the fraud ~enal ty has been pre erly i mposed in this cas , the l ast issue as regards the stat ute of limitations upon asses ment and collection properly applicable to the case is easy of solu- , / tion.

The arne question as fully discussed by us in Perex v.

raneta, supza from which we quote:

Under Section 331 , th Collect- or of Internal Revenue has 5 years after the return as filed within which to ass ss an internal revenue t ax, and no procee ing in court without assess- ment can be begun after expiration of sai eriod.

HoNever, under ction 332 {a), it is provided that in the case of a false or fraudulent return th intent to evade tax or f a failur t fil a return, the tax may be as- ssss d, or a proceeding in court fox the collection of uch tax may be begun ithout assessment, at any tim within ten years after th discovery of the falsity, fraud, or omission.

In con- nection ith the issue as to the legal- ity of the impositi n of the f raud penalty, e expressed th opinion that th fraud penalty is applicable. Accordingly, it is also our opinion t at the 10-year period provided in Section 332 {a) wit hin w ich a deficiency income tax may be assessed applies.

I • '

VE LILUN]

C.T.Ae CASE NO. 42 F iad =59- There is no question that the assess~ ments in this case were all wade withe in 10 years from the date of discovery of the fraud. It follows that said assessments were validly made. And since under the law, the Collector of Internal Revenue has 5 years after assessment within which to collect a tax, it is obvious that the ry Fp the Government to collect the eticionny income tax assessed against petitioner ' for the yecrs 1947 to 1950 has not prescribed. * In this case, the assessment was made within 10 years from the discovery of the fraud. Cone sequently, the right of the Government to assess the deficiency income tax in question has not prescribed. The sight to collect by judicial action has not also prescribed, judicial preceed- ings having been instituted by petitioner hime self within 5 years aftex the assessment. Of céyrse, we Still maintein the view that efter the lapse of three years after the returns were due, or were filed, the Collector cof Internal Revenue is not autherized to collect any deficiency income tax by werrant cf distraint and levy.

For the foregoing considerations, we are of the opinion that -

(1) The undeclared taxable incomes of peti« tioner for the years 1946, 1947, 1948 and 1950 have been clearly established by the use of the net werth method;

(2) The use of the net worth method, or any ether method, to prove umreported income is clearly authorized under Sections 15 and 38 of the Ree / venue Code3

427 Game

i ae our 7 + “a ¥

DECISION-

C.T.Ae CASE NC. 42 =60- | (3) The SO® surcharge prescribed in Section 72 of the Revenue Code has been properly imposed$ and .

(4) The right of the Government to assess the deficiency income tax against petitioner for the years 1946, 1947, 1948 and 1950 and the right to eollect such deficiency tax by judicial action have not prescribed.

Accordingly, the decision appealed from is - hereby modified, and petitioner is hereby ordered to pay the aggregate amount of #210,758.%, representing deficiency income tax and 50% sure charge corresponding to taxable years 1946, 1947, 1948 and 1950, enianinait and itemized on pages 40.244 of this decisicn, such payment to be made within a reasonable period to be fixed by res- pondent. With costs against petitioner.

Associate Judge

We Concur:

MARLANO NABLE

Presiding Judge -

AUGUSTO M. LUCIANO

Associate Judge

428 — ro wr .