Ostrow v. Commissioner

*870 This is a proceeding in which petitioner asks redetermination of deficiencies asseted by the respondent for the years 1919 to 1922, both inclusive, amounting to $133,180.52, to which were added fraud penalties amounting to $66,590.27. The deficiencies were computed by treating as income for the taxable years the difference in the alleged net worth of petitioner between the beginning and end of the period and prorating the result so arrived at equally to the several years.

FINDINGS OF FACT.

Petitioner is a native of Russia who emigrated to the United States in 1902 and became a naturalized citizen as soon as permitted under the law. Upon arrival he settled in Pittsburgh, Pa., where he worked for an uncle, Sol. Rosenblum, who was engaged in the *871 wholesale*3440 liquor business. Petitioner had accumulated in Russia and brought with him to the United States the sum of $15,000, which was turned over to Rosenblum for use, he paying interest at the rate of 6 per cent.

Petitioner remained in Pittsburgh three years, during which time he saved approximately $3,000. In 1905 he went to Dillonvale, Ohio, and there engaged in the wholesale and retail liquor business on his own behalf. The town of Dillonvale was located in a mining community where the population was 90 per cent foreign-born and was the only town within a radius of 20 miles where liquor could be legally sold. There were from 22 to 28 saloons in the town, of which petitioner's was much the largest, doing a business of over $600,000 in four years. At the end of 1909 the county was voted dry and petitioner was obliged to seek a new location. In the four-year period he had saved out of profits $220,000 in addition to his former savings.

In 1910 petitioner went to Toledo where he engaged in similar business until sometime in 1911, when he sold his lease and closed out his stock of goods. In Toledo he added $15,000 to his savings. The Ohio Valley district centering around Steubenville*3441 and East Liverpool was voted wet in 1911 and thereupon petitioner opened a chain of liquor stores located in Steubenville, East Liverpool, Wellsville, Toronto, and Dillonvale. The Steubenville store was closed by a local option election in 1913, and, due to a new Ohio law forbidding one person to own more than one saloon or liquor store, petitioner was obliged to dispose of all but one of those remaining. During the period 1911 to 1913 he had added $150,000 to his savings.

In 1914 petitioner went to Erie, Pa., and there bought out the established wholesale liquor business of Joseph A. Stern & Bro., paying $60,000 cash. He continued in the business until June 30, 1919, when war-time prohibition became effective. During this time the business was financially profitable and petitioner added $85,000 to his savings.

In Erie petitioner also became engaged in the wholesale tobacco business, which he continued up to 1923. This business was not profitable. He also became interested in a theatre and after 1923 in real estate and wholesale lumber.

During all of the time 1902 to 1918 petitioner invested but small amounts in real estate and securities. His profits were almost exclusively*3442 invested in whiskey certificates. (A whiskey certificate is a receipt of a 5-barrel denomination for whiskey stored in a bonded warehouse on which storage and tax are unpaid.) Rosenblum, the uncle, was a very large dealer in whiskey certificates and, following his example, petitioner began investing therein in 1902. Thereafter, he purchased and sold large quantities of these certificates. At the *872 end of December, 1918, petitioner owned whiskey certificates calling for 6,125 barrels of whiskey and representing an aggregate cost of $367,500. These certificates formed a bundle 6 or 7 inches high, each being for 5 barrels, and there being approximately 200 certificates to the inch. The whiskey certificates, which petitioner kept in his office safe, were used as a medium of investment of profits and not as capital in the liquor business. When a certificate was sold it was passed through the books of the liquor store, being charged to the store at cost to petitioner and "Merchandise Sales" credited with the sales price. All of the profit made by petitioner in the purchase and sale of whiskey certificates was thus reflected in petitioner's books and returned for taxation. *3443 The certificates did not otherwise appear in the books of the business but petitioner kept a certificate book, or register, giving full data as to purchase and sale.

Beginning in 1919 and continuing down to the present year, petitioner has been engaged in converting the whiskey certificates into cash. The largest number were sold in 1919 and the last three in 1927.

Petitioner's tax returns were checked up by Revenue Agent R. T. Griswold, as to years 1914 to 1923, and except for minor adjustments found correct. The examination of petitioner's returns for the latter years was made at petitioner's repeated request on orders from Washington. All of petitioner's books were put at the agent's disposal. In December, 1924, petitioner learned that an investigation of his tax liability was being conducted by two other agents. He notified the agents that he would furnish them all information desired and ordered his secretary to go to the place where the records were stored and bring all of them to the office. This storage room was in the basement of the theatre building where petitioner had formerly had his office. On investigation it was found that the janitor of the building had*3444 thought the records and boxes of papers useless, and, on peremptory orders of the fire marshal that they be removed from the theatre building and on further orders of the manager of the building, had given them to the Volunteers of America, who had sold them to a paper mill. Inquiry at the paper mill revealed that they had been destroyed. Among other records thus lost or destroyed was the certificate book. This book was practically obsolete as by this time petitioner had disposed of nearly all his whiskey certificates and his secretary had made a separate memorandum transcript from the book of the small number remaining on hand, which memorandum petitioner carried and used in making any sales.

On December 31, 1922, petitioner had a personal loan from the First National Bank of Erie, not connected with his business, of $20,000, which loan was not reflected in his balance sheet or books of *873 account. This item was not deducted by respondent in computing petitioner's net worth.

OPINION.

VAN FOSSAN: At the hearing petitioner related in great detail the story of the accumulation of his fortune and established the amount of his earnings in each business location. He*3445 established further that his net worth in 1918 was understated by at least $367,500, which he had invested in whiskey certificates. This medium of investment was adopted shortly after he came to the United States in 1902 and was constantly followed until 1919. These certificates were solely a medium of a personal investment and were no more a part of the invested capital of his liquor business than had he invested in bank stocks or railway bonds. Being no part of his liquor business, petitioner was under no obligation to make disclosure of these personal holdings except in so far as necessary to account for profit made on sale thereof. This petitioner did by charging the certificates as sold on the books of the liquor business and crediting "Merchandise Sold" with the sales price. All profits so made on sale of whiskey certificates were thus accounted for and returned for taxation. There is no claim that petitioner failed to return the profit on sales of certificates. The deficiencies are based on the theory that petitioner apparently had accumulated unaccounted for wealth and presumptively had not paid taxes thereon. This charge is fully disproved by the evidence in the case. *3446 Petitioner has demonstrated conclusively, and in this he is corroborated by many witnesses and circumstances, that he had accumulated the larger part of his wealth through the years from 1902 to 1918 and at December 31, 1918, was possessed of at least $367,500 which did not appear in the statement of resources of the liquor business. When he disposed of these large holdings of whiskey certificates he converted the proceeds into other investments and accounted for the profit realized. Except for the profit his net worth was not thereby increased.

The misconception of the respondent arose from the fact that the net worth statement of 1918 related to the liquor business and did not reflect the large personal investment in whiskey certificates, while the personal statement of 1922, after disposition of the certificates and conversion into other property, did reflect this accumulation.

The evidence clearly establishes that the returns filed by petitioner were substantially accurate. It also proves that if the net worth basis were to be applied there should be added to the December 31, 1918, statement the sum of $367,500 represented by petitioner's personal investment in whiskey*3447 certificates. It further shows that respondent should have included in petitioner's "Bills payable" in *874 the 1922 statement the sum of $20,000 owed by him to the First National Bank of Erie as the result of a personal loan.

The above facts being in evidence, it follows that section 3176, Rev. Stats., as amended by section 1003 of the Revenue Act of 1924, was not applicable. This section is applicable only if and when a person, corporation or association fails to make and file a return or list or makes "wilfully or otherwise a false or fraudulent return or list * * *." The evidence clearly negatives any charge of fraud. Petitioner accounted for the profit made in day to day sales of whiskey certificates and returned the same for taxation. There is no word or circumstance of any consequence leading to a contrary conclusion. Petitioner, by the testimony of the person who destroyed certain old records, proved his innocence of any knowledge of the destruction or of any intention to prevent a full investigation of his business dealings. So far as proof of fraud is concerned petitioner's record is clear.

The testimony of the Revenue Agent is that with certain relatively*3448 minor adjustments, of which petitioner does not complain, the tax returns for the years in question were accurate and correctly reflected income. With this we agree. The taxes should be computed on the basis of the returns as adjusted.

Judgment will be entered under Rule 50.