CTA Case No. 189 (Decision)

REPUBLIC OF THE PHILIPPIN~ COURT OF TAX APPEALS MANILA ElJGENIO PEREZ, Pet iti ner, versus J . T NIO RANETA , cting Collector of Internal Revenue , Respondent . X- - - - - - - - - -X DECI S I 0 N 0n September 3 , 1952 , respondent assessed �. against petitioner the sum of ~369 , 708 . 27 as de- ficiency inc me tax and 50% surcharge fr m 1945 to 1950. Upon requ st for reconsideration of said assessment , resp ndent reduced the amount to 186 ,- ,. 170. 43 in a letter dated July 9 , 1953. Subsequently , tne said am unt vr as increased t ~ 197 , 179. 85 in a letter f respondent dated rovember 6 , 1953. Upon refusal of resp ndent ~ cdnsider furtber requests f r reinvestigati n and reexaminati n of the case, petiti ner appealed to the then B ard f Ta x ppeals . This cas e is n w bef re this Court by virtu f Se c- tion 21 f Republic ct N � 1125 , which requires that all cases pending in said B ard f Tax ppeal s n the date of approval of said ct n June 16 , 1954 shall be transferred t this Court and shall be heard and decided by the latter to all intents and purposes a s if they had Leen riginally filed therein . Bef re the hearing of the case n the merits , counsel f r petitioner filed a motion raising the questi n f t ' e propriety f t 11e use of the "net 6

DECISICN- B�T�A. CJ.S!:. N � 189 2 worth methodu applied by resp ndent in the investiga - tion of the incomes and increases in net w rth f peti - ti ner and in tne assessment f his deficiency inc me tax during the years in question. It was alleged in said mcticn that the use of the "net worth method" is invalid as the Income Tax Law do s not permit its use in pr vinq undeclared income , and since this issu is a prejudicial questi n, the same sh uld first be disp sed of before the petiti n for review is heard. In a res lu- tion dated Oct ober 4 , 1954 , this C urt ruled that - "X X X the q uesti n as t whether the ' Net ' orth l.leth d ' is arbitrary and unjust is a matt'er that c unsel f r the petitioner should prove at the trial of this case, particularly h v� it was so in the case of his client. It would be too premature for tne Court to decide the legality or the illegality of the method at this stage cf t~e proceedings without knowing fully the facts upon which an intelligent decision could be based. Piecemeal decisions are 1 oked upon with disfav Dr by the Supreme Court . (Director of Lands vs . Sanz , 45 Phil. 117. )" During tne hearing , an ther question was raised by counsel for petitioner. He asked that he be al- lowed to present additional evidence in chief after . . respondent shall have presented his evidence in chief and after the latt r shall have rested his case. This was opp sed by counsel f r resp ndent on the gr unds that it is irregular and vi lative of the procedural lawo The issue was res lved by this Court in its Reso - luti n of pril 15 , 1955; which r~ads, in part , as f llows: " cting �n the verbal motion f coun - sel f r the petition r that he be allcwed 61

DECISION - B. T�� C SEN � 189 3 t present additional evidence in chief after the respondent shall have rested his case and it appearing : 'That c unsel f r t1e petitioner has already formally presented a great p rti n of his evidence in chief during the past hearings of this case with the excepti n f his last "''itness , t1e petiti ner 1 re - in , who was n t then avai l able , he being c nfined at John Hopkins H spital in Balti- m re , ~aryland , U. S � � ; "That on moti n f c unsel for the pet itioner , Letters Rogat ry was i s sued by this Co ~ rt in order to btain the de - positi n f the petiti ner in the United States , alth ugh the same was not served upon hi because of his early return t the Phili p - ines bef re said Letters R gat ry could be served up n him; ' "That because of petitioner ' s sudden return to the Philippines , his c unsel thereby manifested that the petiti ner w uld be presented in person as a witness in his o n behalf bef re tnis C urt with- ut the need of taking his dep siti n in the Lnited States , to which suggesti n respondent ' s c unsel agreed; "That after the issuance of the Letters Rogatory and without expecting at the time the early return f petiti n- er from the United States , tne respondent was allowed after the petiti ner had rested his cas e , t pr ceed with the pre- sentati n cf his evidence in chief and at the last h aring f th i s case n ~~rch 22 , 1955 , the petitioner himself shoul d have been presented to testify in his "n be - half as per .previ us reservation and agree - ment , bvt counsel f r the petiti ner sud - denly c ange fr nt by requesting instead t~at the re spondent c ntinue presenting his evidence and after the latter shall h ve rested his case , the petiti ner sh uld be allowed to testify in his be - half as evidence in chief and n t limited merely to rebuttal ; "That t o allow counsel f r the peti - tioner t present his addit i nal evidence in chief after the respondent shall have rested his case is most irregular; it w uld create confusion in the pr ceadings ; it would indefinitely pr 1 ng t he t r ial

DECISION - B. T. � CASE NO . 189 4 f this case t the seri us detriment f the pp sing party and w uld be in utter disregard of secti n 1 , Rule 33 f the Rules of Court; �That it w uld n t prejudice the interest f petiti ner any if he were t testify n w in his behalf as agreed up n by the parties nad then recalled as a r buttal witness after the respondent is thr ugh ith the presentation f his evidence in chief; "That there exist that pr sumpti n f regularity in fav r of resp ndent ' s deficiency income tax assessment against the petiti ner and the burden f pr ving the same t be illegal and irregular lies in the latter which he may d thr ugh his evidence in chief r n rebuttal ; and 11 1\lhat while it is true that under secti n 8 f Republic ct t � 1125 , this Court is n t required f r the sake of ex ediency t f 11 v strictly t e technical rules f evidence in the trial f tax and customs cases before it , such discretion v�ill n t be exercised by the Court in fav r f either rarty if the result w uld be t pr 1 ng the case unnecessarily instead of expeditiryg its early adjudica- ti n. ''JHERE ORE , the m ti n of c unsel f r the petiti ner that he be all �ed t pre - sent additi nal evidence in chief after the resp ndent shall have rested his case must be , and the same is , hereby denied . " This case Na s there after submitted f r decisi n after the filing f an " ended greed Stipulation f Facts , " which is tncorp rated h rein by reference . The issues raised by c unsel for petitioner are stated by him in his memorandum dated N vember 15 , 1955 and filed with this Court n t' vember 29 , 1955 , t wit : (a) The legality f the s - called 'net worth meth d ' used by respondent in c mputing the net income f petiti ner. ( mended eti tion f r Review , par. (a) , page 5. ) 63 ~��

DECISHDN - B.T. A.. CiSE NO . 189 5 "(b) The legality f the imposition f the 59 per cent surcharge as fraud penalty. ( mended etiton f r Review , par . 11 , page 3; par . 13, page~) "(c) The application of the law n orescripti n f r the collecti n f tax s on resp ndent's deficiency income tax assessments against petiti ner cover- ing the tax years 1946 , 1947 and 1948. (Amended Petition for Review , par. 14 , page 4; par. (a) , page 5. ) �(d) The pr p r treatment f~D per- '� s nal exemptions and deductible expenses allowed by law. (Amended Petiti n f r Re - view , par. 15 , page 4; par. 17 , oage 5 . )" The The s - called "net w rth meth d" in the field f inc me taxation is an indirect method f pr ving unreported inc me . There are , generally , five kn wn methods f establishing income tax deficiencies f taxpayers , t it : "1 . The def ndant ' s own b oks and rec rds , if made available by lawful means . 'Then truthful , the defendant's own b ks and records \ ill usually establish the nature and source f the unrep rted income; if false, they will aff rd at least a starting p int fr m which matters f inc me may be verified fr m other sources. x x x �2. B ks and rec rds and b rative statements f third pers ns wh have dealt with the taxpayer , ften establishing payment cf moneys vhich rculd c nstitute taxable income to the taxpayer. � "3 . Bank dep sits and barlkc r ecords � "4. Increase in net worth; including investments , purchases f pr per~y and other business transactions by the tax - payer. "5. nalysis f expenditures , t sh w that expenditures were in excess of .. 6 !l

DECISI N- B. T. A. e ,SE N . 1 89 6 declared or available inc r e r t hat ex - pe ndi tures f r clained items of deducti cn s were fictituous or verstated. 'The: purp se of each f these met h ds is t o establish taxable but unrep Fted in- c ll1e ; any ccmbinatic n f the rneth ds may b res rted t by the g vernment t supp rt its case . ' (Harry Graham Balt er , raud Under ederal Tax Law , 2nd ed . , pp . 414 - 415. ) The net worth technique f r dete r mining inc me may be expressed in the f 11 wing f rmula : Increase in Ne t V rth N n - deductible -xpe nditures - Jon - Taxable Receipts = Taxable Ue t In c ome . ( Samuel Bye r , "The Ne t �~orth Technique f r Determining In - c me , ' ~roc . YU 13th nn . Inst . on Fed ~ Taxati n 1 58 L-1952J. ) "The net w rt h expenditures meth od is based n the accounting formula that an increase in net vc rth , plu s n n- deductible disbursements , minus non -taxable receipts equals taxable net in- c me . " (Pviakan , "The l~et ~~ rth l~ethod f Establ ish - ing Fraud , 11 Fro c . NYU 11 th nn . Inst . n Fed . Tax - ati n 707 L-195~. ) The p r cedure for determi ning tax able net income under th1 s f rmula ha s been des - cribed a s f 11 ws : "The net ~ rth at the beginning and end f the taxa~le year is comp uted by subtracting liabilities fr m assets and t he increase in net w r th i s , f course , determined by c ompa ri ng t he beginning and ending net w rth . N n- deductible expenditures (except capital expenditures whi ch appear as assets) like living ex- penses , gifts , x x x inccme tax payments and like are added t the increase in net w rth ~ Fr m this s um is subtracted t he t tal of non -tax able receipts l ike gifts , i nhe rit ances , n n- t axab l e intetett , ~i etc . These non - taxable receipts must be subtracted oecause they are either included in the ending assets r 65

DECISIOtJ - B. T. � C SE N � 189 7 ay have been used t pay f r so .1e n n- deductible expense." (Samuel Byer , "!Jet ' rth Technique f r Determining Income,'' supra. ) The Supreme Curt f the United States , in a recent case , has given a sh rt exp sition f the net worth f rmula thus: rtin a typical net worth pr secuti n the Government , having c nclud ed _that ' the taxpayer's records are inadequate as ' a basis for determining incorre tax liability , attempts t establish an 'opening net w rth' r t tal net value f the taxpayer's assets at the beginning of a given year. It then proves increases in the taxpaye�r ~ s net w rth f r each succeeding year during t he peri d under examinati n and calculates the difference between the adjusted net values f the taxpayer's assets at the beginning and end f each f the years involved. The taxpayer's n n-deductible expenditures , including living expenses , are added t these increases , and if the resulting figure f r any year is substan- tially greater than the taxable inc me reported by the taxpayer for that year , the overnment claims the excess represents unreoc rted taxable income . In addition , it asks the ~ury to infer villful ness fr m this und e rstatement , when taken in c nnecti n with direct evidente f 'c n- duct , the lik ly result of which w uld be t mislead r c nceal. ' Spies v. united States , 317 T S 492 , 499 , 87 L. ed . 418 , 423 , 63 S. Ct . 364. 11 (Holland v . U. S . , 348 l:IS 121. ) This method of p r ving umrep rted inc me , ace r- ding t resp ndent in a decisi n rendered in an ther case , "is based up n the general theory that m ney and other assets in excess f liabilities, after an accurate and pr per adjustment of non-deductible and ncn - taxable items f a taxpayer n t ace unted f r by his inc me tax returns , leads to the inference that part f his inccme has n t been rep rted." (See letter f Collect r of Internal Revenue t 66

DECISION - B. T. . C SE NO. 189 8 Senator C. N. Rect , Lay 6 , 1954 , XX Lawyers Jour- nal , p . 101 , Feb. 28 , 1955; see als Balter , Fraud Under J:"ederal Tax Law , 2nd ed . 1953 , p . 421.) In H lland v . U. S., supra , the Supreme Court of the United States made a brief hist rical sketch of the net w rth method , its early application and recent devel pments. It appears that the net wo;th meth d was first utilized in the cases f Capons v . United States , 51 � 2d . 609 , 76 ALR 1534 (1931 , C! 7th 111) and Guzik v . United States , 54 F 2d 618 (1932, Cr 7th 111) , to corr borate direct proof f undeclared inc me . ,. nd in u. S. v . J hnson , 319 U. S. 5 3, 67 L ed 1546, 63 S Ct 1233 , the U. S. Supreme Co urt approved the use cf the method t supp rt the inference that the taxpayer , v~o was knC\''n as an operator f various gambling h uses upon which no income was declared , "had indeed re- ceived unrep rted in c Le in a 's ubstantial amount .' " "It was ,� according t the Court , "a potent weapon in establis ing taxable inc me fr m undisclcsed sources when all ther efforts failed . " Si nc e the decision in the Johns n Case , the use cf the method has been extended t "run- �-the-mine cases regard- less f the tax deficiency involved. " s its use in ordinary incor..e - bracket cases greatly increases the chances f r error , the C urt issued the warning that the dangers inherent in this reth d "must be c onsci usly kept in mind in rder t assure adequate ap praisal of the specific facts in individual cases . " ,:� 67

DECISI IJ - B. T. , . C SE U � 189 9 Having explained in sor.�e detail t e meaning cf the net \'' rth meth d and the procedure generally follo ed in the investigati n Gf net worth cases, we ��ill n c nsider tne issue raised - whetner the net vt rth meth d f pr ving unrep rted inc me , as used and applied in the Lnited States , may be utilized here under existing law. It is the conten- ti n of c unsel for the G vernment that the net rth ---- technique is permitted under Secti n 15 of the Nation- al Internal Revenue C de , which provides 'that- hen a r eport required by law as a basis for the assessment f any nati n- al internal-revenue tax shall not be forth- c ming within the ti me fixed by law r regulation , r when there is reas n t believe that any such report is false , in - completer�� or errone us , the Collector of Internal Revenue shall assess the proper tax on the best evidence obtainable. x x x" - - and also under Section 38 of the same Code, ,.,rutch provides : "The net income shall be c m uted up n t e Lasis f the taxpayer's annual ac� unting period (fiscal year or calendar year , as the case may be in ace rdance with the meth d of accounting regularly emol yed in keeping the b ks of such taxpayer; but if n such meth d of ac - counting has been s empl yed , or if the method emplcyed d es n t clearly reflect the income , the c mputation shall be made in a ce rdance vith sue method as in t1e opini n f the Collector f Internal Revenue does clearly reflect the inc me . If the taxpayer's annual ace unting period is other than a fiscal year , as defined in section 84 , or if the taxpayer has no annual accounting period , r des not keep bo ks , or if the taxoay - er is an individual , th net inc me shall be c mputed on the ba sws of the calendar year. ' 6

DECISIC�J - B. T. . CASE NO . 189 10 Both parties agree that Section 38 f ur Re- venue Cede is a copy of Section 41 of the U. S. Internal Revenue C de of 1939. It is c ntended on behalf of respondent that the use of the net w rth method by the Commissioner f Internal Revenue f the United States was authorized under Section 41 of the 1939 U. S. Internal Revenue Code ~ On the other hand , counsel for petitioner contends that ncne f the cases decided by merican c urts which recognized the power f tne u. S . Commissioner to emplcy the net worbh metj:l d ever de c lared that such power was derived from Section 41 . He claims , in- come tax returns and "to determine the correct amount . f the tax . " Since no similar provision appears in ur la\M , it is alleged that the use of the method is unauth rized and illegal . The case of Holland v . L. S. , Supra , has been cited in support f this view . (Se pages 6&9 , >1emorandum of Counsel for Petiti ner , November 15 , 1955 . ) This being a case f first impressi n in hhi s jurisdiction , we have s studied with care the question raised by petitioner. The consensus of opinion among well - known auth rities en rederal income taxation in the United States is that the power f the Commissioner f In- ternal Revenue to use the net worth method springs ? 69

DECISION - B. T. I � Cl SE NO . 189 11 or is derived mainly from Section 41 of the Internal Revenue Code of 1939 (Section 446 f the 1954 Code) . Samuel Byer , a !lew York att rney and f rmerly Agent , C nferee , Technical dvisor in p ellate Division , U. s . Internal Revenue Service , in an arti cl e 'The Net vJ rth Technique f r Determining Inc me ,� (Pr c . NYU 13th Ann . Inst . on Fed . Taxation ' :. 1055 Ll952/ , while expressing the opini n that Section 41 'd s n t represent the auth rity f r use f the net w rth r any ther indirec.t metho.d" because he believes that it proceeds fr m the broad general investigat ry p~ovisi ns f the Code , has this t says "The propositi n th~t the Commissi n- er's auth rity to use the net w rth meth d r any other indirect method in determining income , is r oted in r stems from Secti n 41 of the Internal evenue Code of 1939 has been supported by the c urts s frequently that the mere mention of the indirect technique f r determining inc me calls forth a recitati n f the pr visi ns of that secti n. Supp rt for the prop siti n is not lacking in dis - cussion by able tax men . " In an addendum t the same article , pr mpted by the decisi ns f the u. S. Supreme Court on December 9 , m954 in fo mr net worth cases , ne of which isH lland v . U. s ., supra , Mr . Byer made a searching analysis f the decisions in s aid cases and his pinion is t at Secti n 41 d es not preclude the use f the net worhh meth d . !'Je qu te:

DECISION- B. T. . C SE N � 189 12 "That first pressing question de- cided is whether the dangets and sh rt- c mings of the net w rth technique sh uld ' f reel se is use . ' The Supreme Curt ' s answer is a flat NO. ~The second is whether it is re- levant to refer to Section 41 f r the purpose f denying the g vernment the right t use the net w rth technique. The Court again said N � Its opinion explains that Secti n 41 'refers t meth ds such as the cash receipts or accrual method which all cate inccme and expenses between years ' and that 'Congress never intended to make Section 41 a set f blinders which prevents the government from 1 oking beyond the self - serving� declarati ns in a taxpayer ' s books . The United States has relied f t the collect- i on of income tax largely up n the tax - payer ' s ~n discl sures the g vernment must be free to use all leg~l evidence available t it in determining whether the st ory t ld by the taxpayer ' s ooks accurately reflects his financial ist ry . ' 11 ; It appears to us to be well established that the prevailing view in t he United States is that the use of the net N rth or any indirect method f pr ving unreported inc n:e is permitted under Secti n 41 f the U. s. Internal Revenue Code of 1939 (Secti n 446 of the 1954 Code). Section 38 of ur Revenue C de having been patterned after Secti n 41 of the U. S. Code , t he c nstructi n placed upon t hat section by the U. S. c urts has a str ng per- suas' ive f rce in this jurisdicti n. We have n d ubt, the ref re , t hat Section 38 f ur evenue c de as it is w rded permits the use f the net ~ w r,1eth d by the C llect r f Internal Revenue where direct pr f of under - declarati n of income is net available by any other means . j "Je have s me across an opinion of c unsel f r petiti oner t the !'' 71

DECISION- B. T�� GSE N . 189 13 same effect , ~hich we qu te: 11 It has been bserved that in many instances the amount of inc me taxes paid by individuals is grossly disproporti nate to the yearly increase in their vealth. In view cf the dif - ficulty encountered in the determina - tion f the true net income of such individuals by the crdinary process of considerati n of taxable inc ffie and de- ducti ns , the Bureau f Internal Revenue has adopted the 'inventory metn d' (net w rth method) f determining net inc me . XXX f deter- The opinion f counsel for petitioner quoted above Yas made in 1949 (his b k was published in t at year) . It was an impartial and an unbiased opinion , c ning as it did fr ne wh had then n n t w rth case t defend cr pr secute and at a time when he c uld speak \ith a certain degree of auth rity on the subject . He was at that tim a supervising inc me tax examiner cf the Bureau f Internal Revenue . We have als taken n te f the fact tnat Se cti ns 15 and 38 f the evenue Code have nlt undergone any change r amendment from the time said C de was enacted in 1939 t the present . 72

DECISION - BoT�� C SEN � 189 14 There app~ars to be net reas n f r a c ange in the interpretation f the la , specially s because the path charted by c urt decisions has remained unchanged . 1e are , therefore , of th pini n that the Col - l l ect r of Internal hevenue is empowered under Sec - ti n 38 f the evenue Code t utilize the net w rth or any ther indirect meth d f determining unreported inc me in cases where direct proof f unde r - declarati n is unavailable . However , we agree with the U. S. Supreme Court that the method "is s fraught ~ith danger for the inh cent that the courts must cl sely scrutinize its use . " We will heed that w~rning . Counsel for petitioner maintains that 1 assuming that tlie net worth meth d is applicable to this case , his cltent is not liable t pay any deficiency income tax n the basis of the amended stipulati n of facts . (Page 14 , .\emorandum of Counsel for Pet i- tioner , Nov . 15 , 1955. ) 'pparently , counsel for petiti ner admits that the requirements f r the use f the net w rth meth d have been fully satisfied9 no question having Leen raised in regard thereto . In the amended stipulation of facts , viliich was signed by the incumbent Collector f Internal Rev- enue , the parties agreed t eliminate the bank with- dr~wals as part of the assets d petiti ner . nd in the mem randum of c unsel f r the G vernment , the deficiency I a x f r 1946 has been eleminated , an~ .. 7 3

DECISI0tJ - B. T. � C SE NO . 189 15 admissi n that there was no tax defficiency f r that year. Ve shall, theref re, c nsider cnly the alleged inc me tax deficiencies of petitioner f r the years 1947 , 1948 , 1949 and 1950. Up n the evidence submitted and the amended stipulation of facts , c unsel for resp ndent have ; c mputed the income tax deficiencies f petitioner from 1947 to 1950 at 41 , 511 . 77, including the sur- charge of 50%o On the other hand , c unsel f r peti - tioner, after applying the net worth meth d , claims hhat his client d es n ,�t ha ve any income tax deficiency during the years in question , except during the year 1947 when petiti ner incurred a deficiency tax f 1,196. 02. In fact, it is alleged that petitioner made an verpayment of -44 , 74 in 1948, 113.77 in 1949, and ~28 . 00 in 1950. f he difference in the results between the tw c mputations lies mainly in the inclusi n by c un - sel f r the G vernment and the exclusi n by coun- sel for petitioner, of certain pr perties and in- vestmenta of petitioner in arriving at his net worth at the end of the taxable years . Counsel f r petiti ner maintains that whil said properties and investments vere acquired by petitioner , resp ndent failed t pr duce evidence that they were held by petiti ner at the end of the c rresponding taxable year . (Se pp . 18- 21 , �emorandum f C unsel f r Petiti ner , N v. 15 , 1955. ) .J.t having been admitted that said properties and investment were acquired

D..!.CI I B � T. � C. �~ 0 � 1 9 16 by petitioner, the presumption i that his ownership thereof continues unles th contrary is hown . letitiuner, therefore, ha the burden of proof to contradict the U�8.:~ tion o owner hi , and certainly it was ea~y for him to have reduced such evidence , if he had any, that he had tran ferred owner hip of said propetie � Havin,. failed to do o, it i to be pre umed that he continued to be the owner of said ro ertie , and hi claim to the contrary !olely on the round that re pondent failed to prove that he continued to �own the to the end of the tax- pble years in ue~ ti o,n mu t be di mi sed a untenable o nother ite~ which produced different result in the co putations of coun el for both partie is the alle ed inJebtedne. of petitioner to .tty. Ja an T. David in the amount of 30,000. ~ie have examined carefully the evidence adduced in up ort of the alle ed indebtednes , and we a.ree with coun el for the Cov rnnent thet the exi tenca of said loan ha not been sat i dactorily proven . The said arount is not , therefore , a proper deduction in the conputa- tion of petitioner ~ net worth . ccordin:ly, we find the claim of coun el for petitL.)ner that hi coient id not incur a defi- ciency income tax, e}~pt durin: the year 1947 , and that petitioner made overpayment durin� the years 1948 , 1949 and 1950, is not worthy of con- iderationo 75

D.8Cloi ' !:~ . T . � C. JE O. 189 17 of re ondent that t o the deficiency income ta of petitioner a _ tab- li hed by the net worth . ethod there should be added the ~urchar.e of 5e 1 � This urchar.e ii provid d in Section 7 of the hevenue Code, and it i i po~ed in case of "willfull ne,lect to file the return or li t within the time prescribed by law, or in ca e a false or fraudulent r~turn or li t is willfully made ." The ir1po �tion of a'id wurcharr;e i .,ou to be iju tifivd on the followin., rounds: ,' (1) 11 n analp.sis of tie facts inv l~ed in hi ca e indicate tLat the ba i"' of a es ments wa du~ to the con istent dispatity betv en tne inco e decla~ed in the return x x and that founo in the inve.,ti at ion , which is clearly in- dicatibe of fra1ild;" and ( ) "While it is true that fraud, bein., a ~tat of ind , i ~eldom e tabli hed by dir3ct evidence , nevertheles , the saae may be rea~onably inferre from the ubstantial differance in peti- titiJner ' increa e in net wott h each year and the n9t inco e declared in hi returns . 11 Counsel for etitionsr vi:orou ly in0i t that hi client filed inco~e tax raturn for the yars in question under oath; that aia r~tyrn " efleet .., truly and accurately all the income e had earned;" and that he ;;'aid inco. e taxes a ori:inally a ~es ed

c o. D"""CI IO 18~ B. l � .1.:.. ~� 18 a ainst hir , to show that the irhpo i tion of the 50% aurchar e i~ not in order . That the a sse srnent un- derwent various chan e3 ( 369 , 7 8. 7 on September 3, 195; -186,170.43 on July 9 , 1953; 197, 1'19 . 85 on oba b r 6, 1953 has also been advanced as an a~:u.nent that 11 these asve ments lave lo. t the force and strn th of their resu. ed accuracy and that what3 er dil'f~rence ' now berwaen the amounts o 1 1co e tax-:; aid or. the returns a:pd the amounts of de iciency inco 18 taxe that "'D.Y be found due under the nethod used by re"'_r;undent would lart:=ly be due to un::ju.,tifi~P- a u ption of un:r.-voven feet an to d:ver.anca in the treat ent of fi urcs ari in� fro the ~ arent defect of the ethod as an n- me dl.um . II 1 ati tioner filed inco~e tax return~ ll!'de:p oath feD the years lS47 to 195~ . 'he fro s income~ q.r;o 3Xp~n e"' hown ;_n the r3turn , nnd the aJotmt"' of tax pai re as _o1lo~: YE" ... �16, OoOO _6 , ~.. 7 . 9u 361 . 57 16 , ),0/3 . 99 11. 5 . 26 1947 o.oo 1948 19LJ9 lo,ouo.o 9 JL 3 . 76 113 . /7 195 16 , l) � (; e ,J;6 .49 16t . 0 ~he ro s inco e of l6 , JU . 00 re ~ o~t?d fsr each of the re r'3 involved ~as derived by petitioner exc1usivel} :r u 1 '"!l1ary o o other inco 1~ fro.I any other source vla included in hi.:, .ross inco e roqu�r db law to be hfuwn in hi~ incu1e ta. re - turn _or said years . Ln~ yot after the app1ic~ti0n o~ the net worth m2th d, oL the basis of the a ended ,. 7 7

D.uCI _8 .;j � � , 19 ti .1 tion off&~ s, it ha~ be3n shown th t in / 7 , a 1 n1 a et inco .e o .t~+3v�:.1-v.lOn3r � �n 19L-5 , -39 , -./?; .26; in 191 ? , .-17,t) 7. 27; and in 195 , xo1, vOo4b . If tw~ e fi ure., are to be be - 1ieved , there were ub~t ntial under - ~ec1ar~tion of inco.e in the inco e ta ~eturns of petitio~mr or <.l.:_ ye::tr � deduction f r '1oss:J �' i!."l his inco 9 ta:: r 1rn � The de uction. c1ai ed, �nclu~in. alle� ed losses , in hi returns are ite1iz1d below: 1947 �.� Inco~e d~cl�red , alary- lv , OvU . ' ~xes �.�...�.�. 15 . 0 Interert �..�.� ::.-::.7 . 9 Los as ��..���. 6,00 . Contr buti n )7 � Total deauctions .. 6 , 9g7. 9 194u .�... Inco ,e declqred , ~alary - �1 , 000 . 00 ':'axes o ������ � 1 1.50 :nter9st ���� 517.1 ~ :oswa~ . . . . . . . 7 , 5JOQ 0 Co'l.tribution ~ o l . � u ':'ot..11 deductio ) , 078 . 99 19 9 Inco~e dec1 red , alary - 16 , 0 . 0 Te~es ���.�� 1,723~80 Intere~t ��� 71 . 66 Lo as � � . � � � 7 , c::..J . 00 Contribution~s_____L~u~3~�~3~u ':'otal ded1ction J. } , b 3 . 16 195u 0 A o ... nco 1e decl::~red, alany - 16, 0 � 0 L Tax9 �.����� . 49 Los 9 .����� 6..95 � 0 Contributio~~ 4Ju � Total d~duction � . 3,356 . 49 ;�' 78

-�DEC-I,,-� IO � 189 20 on~ the circu.~tances enerally reco nize~ as ju ti yin the inpo~ition of the fraud penalty re: (1) 'ntebtional undJrstate ent of inco1e, sub tantial in a mount per ~.or ub tantial in relati on to the total reported income; (2J inten- tional OV3r tat~ 3nt 0- deductions, aubstantial in a1ount per ~e or substantial in relat:on t. the total re or~ed incore; and (3J recu~rence of the undersyate ent of inco e or overs~ate 1ent of d - daction for more than one tax year . "(Lal ter, rraud Under Federal Eax ~aw, nd ed , (1953), p. 226 . ) ,� Fro an annual inco e of ;~:l6,00v derived olely fro salary, petitioner con.:.;istently dedacted substantially bi a 10unts of "los es," the nature and -xtent of which have not been explained. In 191.7, petitioner claimed adduction for "losses" in the a. ount of 6,0 0; in 191.8, r7,500; in 1949, .7,20 ; and in 1950, 7,2u , considerabl~ reducin hi ta able n_t inco e . Fran ly, we have been un?ble to divide the nature ~ said losses, peti- tioner clai in: he had never been ~n busine s . The lo s_s ~1ich are allowable as deductions fro ros income under ection 3 (d) o the Revenue Code are, in the ca e of individuals: lo Los es actu lly su~tained durin the taxable year and not compensated for by insurance or otherwis~- (. ) If incurred in trade or busines ; or (3 If incurred in any trans ction entered into for profit, thou:h not connected� vii th the traa, o bu ines"; or ;; 79

c v 189 1 (C f ro etyy not connected with the trade or bu iness, if the los ari e ~rom fires, tor 1S, whipwrec , or other C<.Slalty, ot fro. fobbery, theft, or e bezzl3 ent; � C pital los e , to the e tent ~rovi ded in ~action 34; 3. a ses on warh sales of ~toe~, or securi- tie ; and 4. ~ erin lossa � � bviously, the lo S �3 clained by peti ti'on'3r in his return could not have been incurr~d or suf- fered in th_ cour e of trade or bus-ne , his only inco.1e declared bein his alary . It is possible that the lo e could have been brou ht abihut by ,� 11 fir"' , tor s, shi wrec' or other casualty, or 'ron robbery, theft or ';; bezzler.aent, 11 but thi po si - bility i ._diately fibJs way to serio~s doubt be - causa the alle ~d losse ware .~re or l ss constant durin all the yearf in question . It is quite im- probable that petitioner could have been the victi of the a e casualties durin all those ~eats . either could the alle ed losses be attrib~table to ca ital lo sas ot losse on wash sales of sto or securitmes , beca e as clnarly etatJd hi~ only inco.e re~orted was hi salary . :he aid los.es could be 1wa', L G vSE , 11 b~t these losses are deductible only to the ertent of the ains or winnin� . In any of the cases entioned above, it is our opinion that th3 alle_.._d losses constitute "intentionel overstate- ent of deductions, su stantial in relation to the total re orted inco e" or 11 overstate�1ent o dedactions 0

DECI.... I � 189 B � T. � C SE 22 for more than one tax )tear" which justify the i po- it~on of tha fraud panalty o (See Balter, ~raud Under .~.<'ederal ':'��x Law, upra . ) ~Jith respect to the alle ati n that "as .. ess - ment~ have lo t the force and stren of their pre - su ed accuracy" in vie\v of the vario'�IS alterations in the anounts of deficiency incoTie tax dater ined by respondent, it is enou h to state that in 't~e us of the net worth ethod of pro in unreported inco, e errors are ~Pfund to be co�w.i tted a the real facts are either unav~ilnlle to the Collector or are withheld by the ~axp yer . In auch c ses, 9Trors or is takes, vlhich the Collector mu t have to cor - rect, cannot a feet the in osition of the raud penalty, unless it is shown that, after correction of the errors, nothin � is left fro. \.Jhich any infer- ence .1ay be dr:..wn that th_ r_turns 8 filed re not t int~d with fraud . The in istence of etitioner that the r~turns a. � iled by him are tr'�Ie and accurate can not be vie �-d in a different li ht . We i t ol o st te that in the f"nal co . uta - tion o the da iciency inco e tax in this case as sub- . i tted by counsel for the overnr1ent, and a arently s nctioned by the Collector as he i J ed the mended a reed stipulation of � cts, the chan es or eltera - tions . ade in the co '1 utation which br01..t�ht down the s~es_ed d3ficiency fro 197,179 . 85 to � 1,511 . 77 (which should bv l 1, 547 . 771 w~re ro pted ore by tne ense S~ liberality of the ~ollector ;" 81

D CI 0 - B. T. � C S l 0 . 1 9 23 th n anythin el. e . Ve lw to cite but one inst nee to prove th's ~oint . alre dy stat-d, the or ula for dete inin unre orted lnco e by th~ net worth ethod i : (1) incr a ~:~n net worth , plus (2) non- deductible dis- bur e ents , inus (3) non-t a able receipt~ , ~qu ls .e . ( t ble net inco Ite (2) referrin., to nonae - e.ctible disburse cnts r .efcr mainly to r.onal, livin , or family ex ~n e of the t payer which u t be added to the increa e in net worth'to at~ive at the ro s lnco1e . In thecae of petitioner , re~pon dent reduced tne est~ atad er onal ,~'vin , or fa il expen e~ from 6,1 19 . ~2 to 3, for th _ year 1947 ; fro 12 J , 1 1 . 50 to 3 , 500 in 1948; fro 12 ' 773 . 8 to 4 , 800 in 1950 . o ~vidence has b2en adduced as to th2 roximate p~rsonal, livin , or f � ily ex en~e of herein etitioner, Lnd for this reason wa are forced to acce t the a ra.:.sal by re ondent for t 3 ur 0~3 o_ arrivin� at petitioner ' t,J: ble net in o, le . 'vJe are, ho ever , ver cert in that petitioner hi !elf would not ad it that he s ent for hi ersonal, livin , or fa ily e .en~e les than 5,000 durin each o~ the ye~rs in questiono Petition r can not, ther-fore, validly clai~ that in view f pr viop~ chan es in the asse s ents, fuD- th _r reduction of the ~inal co . utation o~ hi income t x de~iciencie~ \ould till b justified , unless he h rea on to believe that ~he liber lity !' 82

D ';ISI B . 'l'. � C ..!. .. � 189 4 of respondent could be ~tretchJ~ fnrth3r . Th ~ ar f u ent has been adv, need th t the ri.ht oft~ Governlent to collect the deficiency inco~e ta as~~ -sed a ainst petitioner, at lea t w1,th res - ect to the tr..J-. blc ~re""r 19L6, 19 7 nd 1}~3 , has res ribed, ur~uant to Section 33 1 'or the He'Tenue Code . n t~e oth~r ijand, res ondent�b~lieves that Section 3~ i the law ap~lic ble to the caue . 'ections 33 1 ,�3nd 33 f the Rav3nue od~ ro - vide - ' e � 331. Period of li itation collection .-- ~ce t as ~rovided in the .ucceodin sectio ., intnrnal- revenb.e to.xes hall be as<"esscct within five :> e r s r'ter the return v' s filed, and no procecdin in court without ,s r-.ment for the colle tion of ~uch t~~~s h~ll be be un ft r the e:z:pir tion of such eriod. ~o the ur~oses of thi~ action a ret1rn filed ba_ore the lact day re cribed by law :or the ilin thereof uh 11 De consi0ered as fil_d on VCh 1 t OGy ; ro ~i ded , t ct this li itution shall not~ J~ly to c�.e al - ready i~ve~ti at~d pi er to the a rov 1 of this Code . "ue � 332 ~~~~ ao' -)~-~~~~~~~~~: li itat i-o-nT or taxes . .'raud1Jlent r""turll with intent to evade t x or of failure to file a return, the tax 1ay be as.cssed , or a proceedin in court for the colle tion o_ such t x ay be be un Tilt.llwut D ~e~sr1ent , at any ti e o. the fal itj, raud , or o1irsion. 11 (b) \'Jher'e bafore the 3Y ira tion 0~ the ti e rescribed il the precedin se tion for the _s~3. ent o the tv, both t .e Collector of Internal Leve.1ue end the ta �payer have co~.ented in writin to itc

D.:t..""IoiO - B . �; . � C E 0. 189 5 uUCh ti e, the taX ay be � e. ad at any ti e prior to tl1e ex - pir tion of the period a reed u~on . The period o a reed upon may be eytended by ub equent a~re~ ent in writin .ade before the ex iration of the eriod previol ly a reed upon. '' (c) WhJre the asse s ent of any intern 1- revenue tax ha been ade with- in the period o li itation above pres- cribed such tax ay be collected by ~ distraint or levy or by a proceedin in court, b~t only if be:un (1) within five ye r~ a~ter th~ a sess ent of the tax , or (~J prior to the e iration of any period ~or coll~ction ~ reed upon in writinw by the ollector of Internal h3venue ann the taxp1yer before the expiration of such five - year ~eriod . ~he period o a reed ~~qn ay be ext~nd ed by subsequent a~ree ents i 1 writin� ade before the ex iration of the eriod reviously a reed upon . 11 nder Section 331 , the ollector of Int3rnal 1, ~venue ha 5 years after th; r~turn w fil9d with- in which to assess an internal revenue t;n, and no pro- C9edin in court without assess. ent oan be be un after e~ iration of said eriod . However , un er o~ction 33 {a), it is provided that in the ca~e of a fal~~ or fraudulent return with intent to evade tax or of a failure to file a r~turn , the tax ray be a s~~~ed , or a proceediu in court or the collection of uch ta ay be be un witho~t a ess en , at any ti a within ten years after the discovery of the falsity , fraud , or o is fun~. In connactioh with the issue as to the 1 ality of the i posi- tion o the fraud penalty, we ~Jpressed the opinion that t e fraud penalty is applicable . ~.ccordin ly, it i~ al~o our o inion that the 10- year eriod provided ;;. 84 '

ECISIO. - B . ~� . � C1 S.!.. L- � H39 6 in ecti on a3 2 ( a ~ within which a deficiency income t~x ay be asses~ed appl ie s o ~ here is no question ttat the as~ess.ents in thi ca e were all ade within 10 ye~rs fran the date of discovery of the fraud . It follows that said assesf ents were valid- ly ade . 'nd since un�e r the l a\.v, the vollector of Internal Reven ~ ha 5 years after asse . st ent ' wi t hin which to collect the ta:Y , it is ob'viou'�s t at the rifht of the Govern ent to collect the deficiency inca e tax assessed a ains~ petitioner for the years � 1947 to 19; hac not re cribed . The fourth issue raised by petiti .ner ~ to " the pro er treat ent for ersonal e:xe tions and deductible expenses allowed by law" d es not a ~ar clear to us . Coun el for petitioner , on pa.e 25 of his e erandu o' ~ave b3r 15, 1955 , say : "Respond ... nt :airht raise the pro - prist' of the allowance of _arsenal and additional e:xe ptlons because they ija ve not be n previou ly added to the increase in net worth or to the net i n col1le . The reason why tne a aunts .!."'i:Yed for perso - nal abd additional exeraption are not a ded to the incr~c..se in the net w-Jrth or to the net in o e is that hhey are include in the _tJersonal , llvin nd fa ily expenses d3fr~ ad :ro the a~ount s wi thdra-vm fro ban 6 (bC"ln wi t hdrawals) whicl-: , by stipulation of th3 parties , .re eli- ina t'3d as art of the ner inca :'18 . C, ended rreed 0tipulati n of Facts , par . I ,pa e 1 ). The l aw does not prohibit rnxpayers fror clai in personal and additional e~e p- ;t 85

D CISI B . f . .. 0 189 � \I'JT . l t 7 27 tion!S \orhether pent or not . ~ide, thsrof~re, fro th3 sti ulaticn, it i s11b itted that petition~r ha~ t ...e ri .t to d~duct p:;rson l and additional ex- e pti n fro his t been previously dd_d thereto . " T a "'tatement th9t the law ''r'lcec:o nvt robibit tazpayer frot clai in ersonal and ~dditivnal 2 tions, hGther spent or not' has artie lGrly drawn our attent:u... . Grantin this to bo true, we do not beli-ve it ha aby applic tion to t e csra cf p~ itioner 9 ~t is unbelievaThfue th t )etitioner did not actually spend any. a ount fc:o .ersonal , livi . , ~r fa ily eipa~ses. w~ have ~de a a .in re rr 0~ this ~tter elre �ere in th:s decision, an the least said ab ut it the bette1 for all coL C SIDEBATIO. S , the decision appealed fro is hereby edified, as prayed for b y respondent, and petitioner is, accordin_, , ~~reby orJered to ay the su o~ 41 , 547.77, as deficiencr inco e tLx 2ni rurchar:~ corre~pondin to tho ~ears 194 7 , 191 , 1:'49 r1nd. 195' , ore parti ularly i te - ized as follov!S: one _otal as ets durin. th:; ~re:1r . � o -66,53 . 93 Los ort of residential hou-~ nd une oor.,.ried bolan ; of tac 1r.tJ3.Y �� 'otal adju t:;d 2ssa ,s �����..��..� :osQ liabilitiJs durin th :car �� .et worth at the end of the ye r �� :� 8 6

DECISION - B. T. � C SE NO . 189 28 I' Net w rth at the end of the year o �� P 26 , 339. 26 Deduct net worth at the beginning of the year . � � . . . � . � � . . 936. 74 Increase in net worth � � � � � . 25 , 402. 52 Add living and family expenses � � � 3 ,000. 00 Net in c ome as per investigation � � . ~ 28 , 402. 52 Dedu ct net incre ase as per return � � 9 ,012. 10 Net income under- declared o � � � � � s 19 , 390. 42 Ne t increase as per investigation � � 28 ~ 4 2 . 52 Deduct personal exemption � . . . � . 3 ,000. 00 rmount subject t tax . � � � . � P 25 ~ 402 . 52 Tax due thereon � o � � ����� 3 ~ 768 . 55 Less amount already paid o � � � � � 361 . 57 Deficiency income tax � � � � � � � � 3 ~ 406 . 98 50% surcharge � � � � � � � � � � � . � 1 ,703. 49 T tal amount due ��� o �� � � 5 ,110.47 1948 Total assets during the year � � 100 , 52. 48 Less cost f resid~ntial h use & unexpended balance f backpay � . � 37 , 537. 96 Total adjusted assets ������ � 62 , 514.52 Less liabilities during the year � � ---- Net worth at th end of the year � � ~� 62 , 514 ... 52 Deduct net worth at beginning of the year � � � � � � � . . � � � Increasd in net worth � . � � � � . o 26 ,339. 26 ,dd : Living and family expenses ��� ~ 36 , 175. 26 Net wcrth as per investigati n � � � 3 ,5 0. 00 Dedu ct net increase as per return � � 39 , 675. 26 Net income undeclared � � � � � � 6 t 921.01 32 , 754. 25 Net increase as per investigation � � Deduct : Personal exemptions � � � � p 39 , 675. 26 Am unt subject t tax � . . . . . � . 3 ,500.00 Tax due there n . . . . � � � . � � � 36 ,175. 26 Less : mount already paid � � � � � 'l, 6 , 385. 56 Deficiency inc n. tax � � � � � � . . 145 . 26 50% surcharge � � � . � . � . . � . f?; 6 , 240. 30 Total am unt due ���o � � � � 3 ,120. 15 fL 9 , 360. 45; :o:::PS+:C 1949 Tot~l assets during the year � � � � 147 , 147. 85 Less : C st of residential house 62 ,514. 52 unexpended balance f backpay � . � 13 , 547. 27 T tal adjusted assets � � � � . � � � 3 , 500. 00 17 ,047. 27 Less: Liabilities during t e year 6 , 396. 24 Net worth at the end f the year � � ~ 10, 651.03 Deduct : Net w rth at the beginning of year � . ��� . ������ Increase in net worth � � � � � dd : Living and family expenses �� Net increase per investigati n ��� Deduct : Net incf ease as per return � Net inc me undeclared . � � � � 87

D.... l iJ B . 't . � C.i J; u � 1 9 9 ~ ount c<,:D:Ci'3d forwar�d �.. � ��� 1 ,6~1 . 03 .�e t lnco ~ a., per inves tira tion l!,O 7. 27 educt: ersonal e.a1.l:Jtiuns ��� 3, 5\HNOO .oL 0Ullt SUbject to ta;._ o o o o o o o o 't" 13,547 . 22 Tax due thereon �������� � ����� l , l� 33 . 00 Less: . ount already paid ���� 113 . 72 efi laney tax due ����������� � 1 , 369 . 23 5 'surchur,a ���������������� 6 4 . 62 l.'otal a o�tnt ue �� � ���������� 2 , o53 . e5 ; 1950 ~ot al as et~ durin~ the year � 204 , 22�'0 . 31 LesJ: co~t of residential hous and ~nexpanded balance of buc~pay 0 37 , 5~'7 . 96 o O oooooooOo O OOOo ~otal uaju~ted assats ������� 166 , 6 2 . 36 Lass: Liabilities durin, the. year . ........ . ............ . � et ~;.ortn at t e end of year . educt nat worth Ht be i ain� of year . .:'. ....�.��....... I ncre se ia net worth ��� � �� ~ du: Livin <�nd fa .ily ex- t1 , doo . oo pe11.. es �� �� ��� ������������ et increase af par invEstl- a t i f)J ... . . . . . . . . . . . o � � � � � � o 61 ,060 . 46 educt net incrdr e s per !5 :464163 .. ~1 1"''etur11 ������������������� \i ��et inc-rease undeclared ��� � 1et ~ncre ase a~ per inves - ti a tion ... . ... .. .. . .. . . . 61,ooo . 46 .,;educt: )er'"'Oll._l axe ptJ.on �� 4, :300 o QlJ ot nt ..Jubject to tu.Jo. ...... . 56,26o . 46 Ta) aue thereon � �.� �� ������� � lo, J4 1 . JU educt ; ~� ou.nt alre1.dy paid �� 162. 00 Deficiency tay due . l � ���.��� 16,o J2 . 0u 5o; surch~r e ���.�����.������ J , 3~ 1 � 0 Toatl n ount aue ������������ 25 , 023 . 00 1946 . . . . . . . . . . . . . . . . . . . . . . . . 1 one 1947 ��.�����.��..����������� 5 , 110 . ~/ 1948 . . . . . . . . . . . . . . . . . . . . . . . . 9 , 360 .45 194-9 . . . . . . . . . . . . . . . . . . . . . . . . 2 , 053 . l"55 1950 ������������.���..������ 25 , 023 . 00 :a ,�.� D '.LO 1 ���� � h1 , 542 . 22 th costs a a ius t po ti t~oner ;fanila , hilip.,ine[" , li'ebruary 13 , 1956 . ve con- 0. � U-IALI ssocinte ~ua ,e :. 8 8

DECISION - B. T. � CASE N � 189 30 CUR : l. RI JO N BLE Presiding Judge AUGuST r.~ . LUCI tJO Associate Judge 89