# Rosenbaum v. Commissioner

> United States Tax Court · February 24, 1983 · 45 T.C.M. 825

URL: https://www.frixlaw.com/law-library/cases/4618446

## Case

- **Full name:** JANE C. ROSENBAUM, <sup id="fnr_fnote1"><a href="fn_fnote1" id="">1</a></sup> v. COMMISSIONER OF INTERNAL REVENUE
- **Court:** United States Tax Court
- **Decided:** February 24, 1983
- **Citations:** 45 T.C.M. 825; 1983 T.C. Memo. 113; 1983 Tax Ct. Memo LEXIS 674
- **Precedential status:** Unpublished
- **Opinion:** Opinion
- **Cited by:** 0 later opinions in the Frix Law Library

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## Opinion text

JANE C. ROSENBAUM, ET AL, 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Rosenbaum v. Commissioner
Docket Nos. 5199-72, 5200-72, 5311-72, 5312-72, 2460-75
United States Tax Court
T.C. Memo 1983-113 ; 1983 Tax Ct. Memo LEXIS 674 ; 45 T.C.M. (CCH) 825 ; T.C.M. (RIA) 83113 ;
February 24, 1983 ; Reversed and Remanded January 10, 1989
Austin J. Doyle , for petitioner in Dkt. No. 5199-72.
Francis N. Rosenbaum, pro se in Dkt. No. 5200-72.
Sidney Gelfand, Wallace Musoff , and Barry Gordon, for petitioners in Dkt. Nos. 5311-72, 5312-72, and 2460-75.
Marlene Gross and Thomas F. Kelly, for respondent. 2
WILBUR
MEMORANDUM FINDINGS OF FACT AND OPINION
*677 WILBUR , Judge: These consolidated cases were tried before a Special Trial Judge pursuant to Rule 180, Tax Court Rules of Practice and Procedure. His report was filed with the Clerk of the Court on February 29, 1980, and was served on the parties. Respondent and petitioner Francis N. Rosenbaum filed exceptions to the report, and the cases were assigned to this Division pursuant to Rule 182(d), Tax Court Rules of Practice and Procedure.
In particular, respondent has objected to the findings and conclusions of the Special Trial Judge that:
(1) Petitioners Andrew L. Stone and/or Francis N. Rosenbaum did not receive constructive dividends and unreported income, respectively, arising from deductions claimed by Chromcraft Corporation and/or Alsco, Inc. with respect to payments to Scientific Electronics, Ltd., Bregman Electronics, Ltd., Republic Electronic Industries, Inc., Western Molded Fibre Products, Inc., Establissement Velo International, Establissement Orma-Commerce, CEPAB, Finax A.G., and Dr. Jorg Haemmerli.
(2) Petitioner Andrew L. Stone had legitimate interest expense for his transactions with Finanz Gesellschaft and Peralta Shipping.
(3) Neither petitioner Andrew *678 L. Stone nor Francis N. Rosenbaum is liable for civil fraud for the taxable years 1963 through 1967.
(4) The assessment and collection of deficiencies and additions to tax for the taxable year 1963 of petitioners Stone, and for the taxable years 1963 and 1964 of petitioner Francis N. Rosenbaum, are barred by the statute of limitations.
(5) Petitioner M. Jeanne Stone is not liable as a transferee under section 6901 3 for the deficiencies in tax of Andrew L. Stone, additions to tax, and interest with respect thereto for the taxable years 1963 through 1967.
Respondent also contends that petitioner M. Jeanne Stone does not qualify for innocent spouse status under section 6013(e). Since under the determination of the Special Trial Judge the requisite omissions from gross income were absent, this issue was not presented in all its aspects.
Petitioner Francis N. Rosenbaum has objected to the finding and conclusion of the Special Trial Judge that *679 he has failed to carry the burden of proving he is entitled to interest deductions claimed for the taxable years 1963 through 1967.
We have given due regard to the circumstance that the Special Trial Judge had the opportunity to see and evaluate the credibility of the witnesses. Nevertheless, the presumptive correctness of the Special Trial Judge's report does not impair nor dilute our duty of bearing the ultimate responsibility for determining matters before us. Rule 182(d), Tax Court Rules of Practice and Procedure and note thereto. See 60 T.C. 1150 . Montgomery Coca-Cola Bottling Co., Inc. v. United States, 222 Ct. Cl. 356 , 615 F.2d 1318 , 1322 (1980) . After careful consideration of the evidence presented and the exceptions noted above, we hold for respondent on all issues excepted to, other than those concerning Republic Electronics Industries, Inc. and a portion of Stone's interest expenses. We also decide that M. Jeanne Stone qualifies as an innocent spouse during the years in issue. In reaching these holdings, we have to a very large degree, adopted the findings of fact of the Special Trial Judge; to the extent that we disagree with the *680 Special Trial Judge, our disagreement relates to certain inferences he drew and the conclusions which he reached based on those findings.
Respondent determined deficiencies in income tax and additions to tax for fraud under section 6653(b) and transferee liability for deficiencies and additions to tax against petitioners in amounts and for years as follows: Deficiency Addition
Petitioner Docket No. Year (or Liability) to Tax
Jane C. Rosenbaum 5199-72 1963 $174,021.32
1964 1,559,931.25
1965 1,923,724.85
1966 1,578,936.91
1967 332,576.27
Francis N. Rosenbaum 5200-72 1963 174,021.32 87,010.66
1964 1,559,931.25 779,965.63
1965 1,923,724.85 961,862.43
1966 1,578,936.91 789,468.46
1967 332,576.27 166,288.47
Andrew L. Stone 5311-72 1963 171,488.03 85,744.02
1964 1,347,174.97 673,587.49
1965 1,945,630.33 972,815.17
1966 992,449.38 496,224.69
1967 282,498.43 141,249.22
M. Jeanne Stone 5312-72 1963 171,488.03 85,744.02
1964 1,347,174.97 673,587.49
1965 1,945,630.33 972,815.17
1966 992,449.38 496,224.69
1967 282,498.43 141,249.22
M. Jeanne Stone, 2460-75 1963)
Transferee 1964)
1965) 1,460,098.00
1966)
1967)
*681 By amendments to his answers, respondent claimed increased deficiencies and additions to tax for fraud for 1966 and 1967, as follows: Increased Increased
Docket No. Year Deficiency Addition to Tax
5199-72 1966 $574,706.31
1967 532,709.55
5200-72 1966 574,706.31 $287,353.16
1967 532,709.55 266,354.78
5311-72 1966 565,440.53 282,720.27
1967 532,709.54 266,354.77
5312-72 1966 565,440.53
1967 * 532,709.54
The principal area of dispute concerns respondent's determination that certain items, which respondent determined to be unallowable deductions of Chromcraft Corporation (Chromcraft) or its successor corporation, Alsco, Inc. (Alsco), or unreported income of Chromcraft or Alsco, constituted constructive distributions 4 to Andrew L. Stone (Stone), and "unreported income" to Francis N. Rosenbaum (Rosenbaum) "representing funds accruing to your benefit from your manipulation of transactions to divert monies arising from contracts between Chromcraft Corp. [and Alsco, Inc.] and the United States Government." 5 Identical amounts were determined *682 to be the income of each of those individuals. There is also a group of items which respondent disallowed as deductions to Chromcraft or Alsco which were determined to be constructive dividends to Stone alone.
Numerous issues raised by the pleadings have been settled or stipulated by *683 the parties. The issues thus remaining for our decision are:
1. Whether Stone and/or Rosenbaum are properly chargeable with constructive dividends and "unreported income," respectively, arising from respondent's disallowance of:
a. Deductions claimed by Chromcraft with respect to payments to Scientific Electrics Ltd., of $108,175 for 1963, $1,051,766 for 1964, and $1,161,178 for 1965, which were charged to purchases of materials;
b. Deductions claimed by Chromcraft with respect to payments to Bregman Electronics, Inc., of $812,386 for 1965 and $380,774 for 1966, which were charged to purchases of materials;
c. (1) Deductions claimed by Chromcraft and Alsco with respect to payments to Republic Electronics Industries, Inc., of $255,000 for 1966, representing the purchase of rights to the Zuni rocket launcher, which were charged to purchases and factory office expenses;
(2) Deductions claimed by Chromcraft and Alsco with respect to payments to Republic Electronic Industries, Inc., of $821,009 for 1966 and $761,013 for 1967, which were charged to purchases of materials (this sub-issue was raised by respondent in his amended pleadings);
d. Deductions claimed by Chromcraft *684 with respect to payments to Western Molded Fibre Products, Inc., of $8,983 for 1963, $136,034 for 1964, $221,084 for 1965, and $318,406 for 1966, which were charged to purchases of materials;
2. Whether Stone and/or Rosenbaum are properly chargeable with constructive dividends and "unreported income" respectively, arising from respondent's disallowance of:
a. Deductions claimed by Chromcraft and Alsco with respect to payments to Establissement Velo International of $571,328 for 1966 and $250 for 1967, which were variously charged to purchases of materials, factory expenses, and sundry expenses;
b. A deduction claimed by Chromcraft with respect to a payment to Establissement Orma-Commerce of $22,768 for 1963, which was charged to purchases of materials;
c. A deduction claimed by Chromcraft with respect to a payment to CEPAB of $52,172 for 1965, which was charged to purchases of materials;
d. A deduction claimed by Alsco with respect to a payment to Finax Aktiengesselschaft of $8,000 for 1967, which was charged to factory office expense;
e. A deduction claimed by Alsco with respect to payments to Dr. Jorg Haemmerli of $16,000 for 1967, which were charged to sundry expense;
*685 f. Deductions claimed by Chromcraft with respect to payments to Scientific Electronics, Ltd., of $50,400 in 1964 and $38,500 in 1965, which were charged to purchases of dies and jigs.
3. Whether Stone and/or Rosenbaum are properly chargeable with constructive dividends and "unreported income," respectively, arising from respondent's disallowance of:
a. Deductions claimed by Chromcraft and Alsco with respect to payments to Scientific Industrial Developments, Ltd., of $18,000 for 1963, $48,000 for 1966, and $18,500 for 1967, which were variously charged to purchases of materials, factory office expense, and sundry expense;
b. A deduction claimed by Chromcraft with respect to a payment to GEAG Aktiengesselschaft of $15,000 for 1963, which was charged to sundry expense;
c. Deductions claimed by Chromcraft and Alsco with respect to payments to Pacific Enterprises, Inc., of $70,500 for 1967 and $40,000 for 1966, which were charged to sundry expense;
d. A deduction claimed by Chromcraft with respect to payments to Harold E. Schendell totaling $33,000 for 1967, which were charged to sundry expense.
4. Whether Stone and/or Rosenbaum are properly chargeable with constructive *686 dividends and "unreported income" arising from:
a. Allegedly understated sales by Chromcraft and Alsco to Les Forges de Zeebrugge of $158,059 in 1965, $21,529 in 1966, and $13,428 in 1967; and
b. Royalty income alleged to have been received by Chromcraft and Alsco of $13,793 for 1963, $13,700 in 1964, $101,321 in 1965, and $69,201 in 1966.
5. Whether Stone is properly chargeable with constructive dividends arising from respondent's disallowance of:
a. Deductions claimed by Chromcraft with respect to payments to Goodwin, Rosenbaum, Meacham & White of $5,000 for 1963, $22,000 for 1964, and $5,750 for 1965, which were variously charged to legal fees and sundry rocket launcher expense;
b. Deductions claimed by Chromcraft with respect to payments to Fred French of $1,265 for 1963, $1,265 for 1964, $959 for 1965, and $633 for 1966, which were charged to rent expense;
c. Deductions claimed by Chromcraft and Alsco with respect to payments to L. M. Stone of $3,000 for each of the years 1963 through 1966, which were charged to professional fees;
d. Deductions claimed by Chromcraft and Alsco with respect to payments to Vivian Smith of $2,400 in 1963, $2,550 in 1964, $2,500 *687 in 1965, $2,950 in 1966, and $2,500 in 1967;
e. A deduction claimed by Chromcraft with respect to payment to Southwest Furniture, Inc. of $15,402 for 1966, which was charged to sundry expense.
6. Whether Stone is entitled to interest expense deductions, as set forth in adjustment (c) of the deficiency notice to him and M. Jeanne Stone, as follows: Year Amount
1963 $2,089.55
1964 17,000.00
1965 34,000.00
1966 30,407.43
1967 199,740.65
7. Whether, if it is determined that Stone is not entitled to interest expense deductions with respect to claimed interest payments to Finanz Gesellschaft, he erroneously reported on his 1967 return certain long-term capital gain upon the transfer of Alsco shares to Finanz Gesellschaft.
8. Whether Rosenbaum is entitled to interest expense deductions, as set forth in adjustment (c) of the deficiency notice to him and Jane C. Rosenbaum, as follows: Year Amount
1963 $5,250.00
1964 5,825.00
1965 7,593.75
1966 8,427.78
1967 12,878.42
9. Whether Stone is liable for additions to tax for fraud for each of the years 1963 through 1967.
10. Whether Rosenbaum is liable for additions to tax *688 for fraud for each of the years 1963 through 1967.
11. Whether petitioners Jane C. Rosenbaum and M. Jeanne Stone qualify for innocent spouse status under section 6013(e) for the years 1963 through 1967.
12. Whether as regards Stone, M. Jeanne Stone, and Rosenbaum, assessment and collection of deficiencies and additions to tax for each of the years 1963 through 1967 is barred by the statute of limitations. Jane C. Rosenbaum did not plead the bar of the statute in her petition at Docket No. 5199-72.
13. Whether petitioner M. Jeanne Stone is liable as a transferee under section 6901 for the deficiencies in tax of Andrew L. Stone, additions to tax, and interest with respect thereto for the taxable years 1963 through 1967, to the extent of $1,460,097.75.
Petitioners Stone did not allege error or present any evidence with respect to a partial disallowance, for lack of substantiation, of $200 of the deduction for charitable contributions for 1963. No issue is deemed to be presented with respect to that disallowance.
GENERAL FINDINGS OF FACT
Many of the facts have been stipulated. The several stipulations, together with the exhibits identified therein, are incorporated *689 herein by reference.
The legal residence of petitioners Stone and M. Jeanne Stone (Jeanne) on July 3, 1972, the date of the filing of the petitions in Docket Nos. 5311-72 and 5312-72, was St. Louis, Missouri. The Stones filed joint income tax returns for 1963 through 1967 with the District Director of Internal Revenue, Manhattan District, New York, New York. Jeanne's residence was St. Louis, Missouri, when she filed the petition in Docket No. 2460-75.
The legal residence of petitioners Rosenbaum and Jane C. Rosenbaum (Jane) on June 30, 1972, the date of the filing of the petitions in Docket Nos. 5199-72 and 5200-72, was Washington, D.C. The Rosenbaums filed joint income tax returns for 1963 through 1966 with the District Director of Internal Revenue, Baltimore, Maryland, and a joint income tax return for 1967 with the Mid-Atlantic Service Center, Philadelphia, Pennsylvania.
During 1963 and continuing through May 31, 1966, Chromcraft was a Missouri corporation engaged primarily in the manufacture and sale of rocket launchers for use on fixed and rotary winged aircraft under contracts from the United States Government. Chromcraft kept its books and records on the accrual *690 method of accounting and filed its income tax returns on a calendar year basis through 1965. In 1966, it filed its income tax return for the period January 1, 1966 through April 9, 1966.
During 1963, 1964, and up to March 2, 1965, Stone owned 75 percent of the stock of Chromcraft, and his basis therefor was $269,376. He was a director and president of Chromcraft.The remaining 25 percent of Chromcraft's stock was owned by Irwin C. Keefer (Keefer). On March 2, 1965, Chromcraft acquired Keefer's stock in Chromcraft, leaving Stone as the sole shareholder.
During the taxable years at issue, Alsco, a Delaware corporation, was a publicly-held corporation whose outstanding shares were traded on the American Stock Exchange. Prior to May 31, 1966, its principal operations consisted of the manufacture and sale of aluminum siding, aluminum storm windows and doors, and related products. Alsco kept its books and records on the accrual method of accounting and filed its income tax returns on the basis of a fiscal year ending May 31. On April 9, 1966, Stone and Alsco entered into a contract for the acquisition by Alsco of Stone's shares in Chromcraft. As of May 31, 1966, Chromcraft was merged *691 into Alsco and its operations involving the manufacture and sale of rocket launchers continued as the Techfab Division of Alsco. Upon the merger of Chromcraft into Alsco, Stone became a director and president of Alsco and the owner of approximately 56 percent of the outstanding shares of Alsco stock. Effective November 21, 1969, Alsco was merged into Harvard Industries, Inc. (Harvard), a Delaware corporation.
During the taxable years involved, Rosenbaum was an attorney and a partner in the Washington, D.C. law firm of Good-win, Rosenbaum, Meacham and White (GRM&W). The firm was tax counsel to Chromcraft, and Rosenbaum was the member of the firm generally responsible for Chromcraft matters. During 1965, Rosenbaum became a director of Chromcraft, and after its merger into Alsco he became a director of Alsco. The firm became tax counsel to Alsco and Rosenbaum was the member of the firm generally responsible for Alsco matters. The firm also acted as financial advisor to and represented Chromcraft and later Alsco in promotional activities with respect to rocket launchers.
For convenience, the designation "Chromcraft" will be used herein for periods both prior and subsequent to *692 the merger of Chromcraft into Alsco. Thus, a reference to "Chromcraft" in a transaction or occurrence after its merger into Alsco on May 31, 1966, will be understood to refer in fact to the Techfab Division of Alsco.
Chromcraft was a prime contractor for the United States military services in the manufacture of rocket launchers. It used several full-service sub-contractors, such as Engineered Instruments, Insul-8, and Republic Electronics Industries Corp. (Republic), for electronic parts; Western Molded Fibre Products, Inc. (Western) for fairings; Container Corporation for paper tubes; Cincinnati Die Casting for die cast parts; and Elliot Tool for stock parts. As full-service sub-contractors, these businesses had engineering, purchasing and production departments. Each purchased its own supplies, had its own program for quality control, and had a Navy inspector on the premises approving parts shipped to Chromcraft.
The contracts for rocket Launchers received by Chromcraft from the United States military services were all fixed-fee contracts, except for the last two received in 1967 and 1968.
On August 30, 1968, a Federal grand jury returned an indictment in the United States *693 District Court for the District of Columbia against Stone, Rosenbaum, Chromcraft, its successor Alsco, and others. Alsco pled guilty to one count of the indictment. On October 13, 1969, Stone and Rosenbaum each entered pleas of guilty to counts 1, 3, 7, 8, 9, 10, 11, 15 and 16 of the indictment. On February 10, 1970, Stone and Rosenbaum were sentenced on the charges to which they had pled guilty and the remaining counts of the indictment were dismissed as to Stone and Rosenbaum. Stone was incarcerated on February 24, 1970, to begin serving a 15-year sentence.
Count 1 of the indictment, in short, charged Stone and Rosenbaum with being part of a conspiracy to defraud the United States Government on defense contracts through overbillings based upon false and fictitious invoices to Chromcraft. Pertinent portions of Count 1 read as follows:
18) From on or about January 1, 1963 and continuously thereafter through February 1, 1967, the exact dates being unknown, in the District of Columbia and elsewhere, ANDREW L. STONE, FRANCIS N. ROSENBAUM, EVELYN R. PRICE, ROBERT B. BREGMAN and CHROMCRAFT who are the defendants herein, and HANS SENN, WALTER A. LIPS and THE BANK FUR HANDEL, [sic] *694 and EFFEKTEN who are named herein as co-conspirators but not as defendants, unlawfully, willfully and knowingly did agree, combine, conspire and confederate among themselves and each with the other, and with other persons whose names are presently to the Grand Jury unknown, to defraud the United States of America, that is to say the said defendants and co-conspirators did agree, combine, confederate and conspire:
(a) To hamper, hinder, frustrate, defeat, impair and impede by craft, trickery, deceit and dishonest means including false, fictitious and fraudulent statements and representations, concealments of material facts and kickbacks, the lawful and legitimate functions, operations and purpose of
(1) the Department of the Navy in all phases of its negotiation for and the administration of contracts awarded to CHROMCRAFT for the procurement of rocket launchers under the hereinabove mentioned contracts and;
(2) the Renegotiation Board to ascertain, determine, recoup and eliminate excessive profits derived under the hereinabove specified contracts.
25) It was further a part of said conspiracy that the DEFENDANTS would and did divert and cause to be diverted to the prsonal use, *695 gain and benefit of the DEFENDANTS money paid by the Department of the Navy under the hereinabove described contracts contrary to and in derogation of the purposes and intent of the national defense program and the Renegotiation Act of 1951, as amended, as follows:
a) It was further a part of said conspiracy that the DEFENDANTS would and did pay and cause to be paid the above described false, fictitious and fraudulent invoices purportedly received from Scientific Electronics, Limited and Bregman Electronics, Inc.
b) It was further a part of said conspiracy that the DEFENDANTS would and did prepare and cause to be prepared false and fictitious invoices bearing the following foreign names and addresses: NAME ADDRESS
a) Geag Chur, Switzerland
b) Elpag, A.G. Chur, Switzerland
c) Alwatra, A.G. Zurich, Switzerland
d) Establissement, Macoba Vaduz, Lichtenstein
e) Infina, A.G. Zurich, Switzerland
which false and fictitious invoices would be and were paid from funds received by Scientific Electronics, Limited and Bregman Electronics, Inc. in payment of the false and fictitious invoices described in subparagraph (a) of this paragraph.
c) It was *696 further a part of said conspiracy that the DEFENDANTS well knowing that their interest in accounts in Swiss banks could and would be disguised and concealed by the co-conspirators HANS SENN, THE BANK FUR HANDEL and EFFEKTEN and WALTER A. LIPS would and did cause to be paid the foreign invoices described in the preceding paragraph and did transmit and caused to be transmitted checks in payment of same to the aforesaid WALTER A. LIPS at the Union Bank of Switzerland and HANS SENN at THE BANK FUR HANDEL and EFFEKTEN who would and did cause the said checks to be negotiated for the personal use, gain, and benefit of the defendants.
In January 1969, the United States of America filed two essentially similar actions in the United States District Court, Eastern District of Missouri and the United States District Court, District of Columbia, seeking recovery of damages under the False Claims Act, 31 U.S.C. sections 231 , et seq. (1976) , from Stone, Rosenbaum, Chromcraft and Alsco as a result of an alleged multimillion dollar fraud on the United States perpetrated by Stone and Rosenbaum through Chromcraft and Alsco from 1963 through 1967. Various other actions *697 seeking damages in connection with the alleged fraud were brought by other parties in different jurisdictions.
On March 7, 1969, a Federal grand jury returned an indictment in the United States District Court for the Eastern District of Missouri against Stone, Chromcraft, its successor Alsco, and others. Alsco pled guilty to one count of the indictment. Stone entered a plea of guilty to count 1 of said indictment. This court was a criminal charge of shipping munitions out of the country without first obtaining an export license or written approval of the Department of State, in violation of 22 U.S.C. section 1934 . On April 3, 1970, Stone was sentenced and the remaining counts of the indictment were dismissed as to him.
Issue 1. Constructive Dividends and Unreported Income-- Scientific, Bregman, Republic, Western Molded.
FINDINGS OF FACT
(a) Scientific Electronics, Ltd.
As stated earlier, Chromcraft was a prime contractor for the United States military services in the manufacture of rocket launchers, and as such, utilized several subcontractors. A company known as Engineered Instruments was the subcontractor for electrical assemblies *698 up to 1960, when it failed. Chromcraft thereupon turned to a company by the name of Insul-8 as a subcontractor for electrical assemblies. Both Engineered Instruments and Insul-8 were full-service contractors, i.e., they had engineering, purchasing, and production departments, and there were United States Navy inspectors on their premises certifying to quality control.
Toward the end of 1962, Chromcraft experienced difficulty in obtaining deliveries from Insul-8, which claimed it was losing money on Chromcraft orders. Chromcraft agreed to increase the price it was paying, and Insul-8 finished out its contract in 1963. Insul-8 was not interested in continuing to work on what it considered to be the low profit items required by Chromcraft, and Chromcraft refused to continue paying the increased prices. Labor costs at union rates and union jurisdictional conflicts precluded Chromcraft from making electrical assemblies at its own plant. Chromcraft was therefore compelled to look for a supplier to take the place of Insul-8, and John Nash, its chief engineer, obtained a list of possible suppliers from the Small Business Administration. Chromcraft ultimately selected a sole proprietorship, *699 Robert L. Wolf and Associates (Wolf), in Granite City, Illinois, across the Mississippi River from St. Louis.
Wolf operated at the time in a quonset hut in the proprietor's backyard, in which the proprietor, his wife, his son, and two women assembled battery chargers. Wolf furnished only the labor.The raw materials were purchased by Chromcraft and were picked up by Wolf and taken to Granite City. Wolf would assemble the electrical components into finished products according to Chromcraft's specifications, and deliver them to Chromcraft. This method of picking up the raw materials from Chromcraft, assembling them, and shipping the completed assemblies back to Chromcraft continued even through 1968.
Wolf did not have any research and development capabilities; quality control at Wolf was handled by Nash and Frank Best, Chromcraft's purchasing director.
Among the clients of GRM&W was an individual named Mario Simonson (Simonson), a Brazilian active in banking, newspapers, coffee, real estate, communications, television stations, and other enterprises. Simonson's communication business, Wasim, at that time was involved in the Intel project, an effort aimed at expanding Brazil's *700 communication system. The New York office of Wasim was managed by Leon Schwartz (Schwartz), a director and vice-president of Wasim. 6 Sometime in 1963, Schwartz moved from New York to California to set up an office for Ladevco, Inc. (Ladevco), a California corporation formed by Simonson. Ladevco was engaged primarily in promoting relations between United States communication companies and the Brazilian Government.Its offices were located at 144 South Beverly Hills Drive, Beverly Hills, California. Ladevco's sole stockholder was Simonson and Schwartz was its president.
Another of GRM&W's clients was an Englishman named Fred Charnock (Charnock) who headed a firm in England known as Scientific Industrial Developments, Ltd. (SID). Charnock wanted to form a California subsidiary of his English firm, to be known as Scientific and Industrial Development, Ltd. That name was not available for use in California so, at Charnock's request, Rosenbaum caused the formation of a California corporation *701 by the name of Scientific Electronics, Ltd. (Scientific) in March 1963. Further complications arose when the British Treasury would not authorize the transfer of funds from SID to pay for Scientific's stock. As a result, neither Charnock nor SID put any capital into Scientific.
Rosenbaum and Schwartz became acquainted in 1959; Schwartz met Stone about a year later. In 1963, Rosenbaum requested that Schwartz allow Scientific to use as its corporate address the 144 South Beverly address which was the office of Schwartz and Ladevco. In addition, shortly after Scientific was formed, Rosenbaum asked Schwartz to become president of Scientific and Schwartz agreed. Schwartz was aware that the foregoing was being done for a client of Rosenbaum's, namely Stone.
The Ladevco offices at 144 South Beverly had 2,000 square feet of office space and no manufacturing facilities. Besides Schwartz, the only employees in the offices were a secretary and a part-time salesman. Schwartz had no experience in procuring electronic parts. His background was in real estate and his promotional activities for Simonson.
When Schwartz agreed to become president of Scientific, Rosenbaum turned over to *702 him its charter, minute book and stock book. Ladevco subscribed for 5,000 shares of Scientific's stock but it never paid for the shares and no shares in the corporation were ever issued.
From the beginning, Schwartz believed Rosenbaum and Stone to have complete authority to give directions and instructions with respect to Scientific. At Rosenbaum's direction, Schwartz opened a bank account in Scientific's name, upon which Schwartz was the sole signatory. As early as April 1963, Schwartz began receiving correspondence from either or both of them with instructions to write letters and/or checks to various businesses. (The first letter was from Stone, dated April 29, 1963, with a copy to Rosenbaum. Stone requested Schwartz to pay the two invoices enclosed--invoices from a St. Louis printer for letterhead stationery for Scientific and SID ordered March 15, 1963.)
In September, 1963, Chromcraft began issuing purchase orders to Scientific for completed electrical assemblies. Stone's secretary, Evelyn Price (Price), prepared purchase orders on behalf of Scientific to Wolf for labor on the assemblies which Chromcraft had ordered from Scientific. Chromcraft obtained the raw materials *703 for the assemblies which were delivered to Chromcraft and then picked up by Wolf. For the first couple of months, the suppliers' bills were sent to Scientific and were paid by it. Scientific also paid Wolf for the labor performed. Scientific invoices for the completed assemblies were submitted to Chromcraft and they were paid by Chromcraft checks which were deposited in Scientific's account. The prices that Scientific charged Chromcraft for the completed assemblies were fixed by Stone, and these prices were set at figures from 5 to 10 cents less than those that had been charged by Insul-8.
Toward the end of 1963, Stone and Rosenbaum decided to change the Chromcraft-Scientific relationship in the following respect. Instead of sending the suppliers' bills to Scientific for payment, Chromcraft paid the suppliers itself. Chromcraft deducted the amounts so paid on its tax returns as part of cost of goods sold, and never billed Scientific for the raw materials. Scientific continued to invoice Chromcraft for the entire cost of the completed assemblies, labor and materials, and continued to pay Wolf for its assembly charges. Chromcraft was thus paying for the raw materials twice, *704 thereby overstating its cost of goods sold, while Scientific was receiving payment for labor and materials, but only making payments for labor.
At the same time, Stone, Rosenbaum and Schwartz agreed that Rosenbaum would obtain invoices for raw materials from what can best be described as "dummy" Swiss entities, which invoices would be submitted to Scientific and which Scientific would pay. Stone furnished to Rosenbaum the nomenclature that was used on the Swiss invoices. When Scientific made payment on such an invoice, it would send its check to Chromcraft, which would forward the check to the Swiss entity. The Swiss "vendor" would deposit the check in its own Swiss bank account and, after deducting a small percentage as a service fee for its participation in the endeavor, transfer the remainder to one of several Swiss bank accounts under the control of Rosenbaum.
At Stone's direction, Price did all the paperwork involved, including preparing the purchase orders from Scientific to Wolf on blank Scientific forms in her possession; preparing the Scientific invoices to Chromcraft on blank Scientific forms in her possession; typing cover letters for Schwartz's signature, on blank *705 Scientific letterhead stationery in her possession, to accompany Scientific payments to Wolf and others; typing letters for Schwartz's signature, on Scientific stationery and addressed to Chromcraft, giving quotations and pricing information; receiving checks from Scientific to the foreign "vendors"; and, after making lists of the payments for Stone and Rosenbaum, forwarding the checks to the Swiss entities. For these services beyond her Chromcraft duties, Price was paid by checks from Scientific to her father, L. T. O'Connell.
As indicated above, Scientific had a bank account, on which Schwartz was the sole signatory. In that account, Scientific deposited receipts of $123,518.33 in 1963, $1,312,621.93 in 1964, and $1,370,910.04 in 1965. In 1963, Scientific issued 19 checks to Wolf, 16 checks to recognized suppliers of materials and services, 1 check to Chromcraft, 3 checks for printing and stationery, 3 checks as loans to Schwartz or a corporation he owned (Sea Range Properties, Inc. (Sea Range)), 1 check to Ladevco as rent, 1 check to L. T. O'Connell, and 5 checks to SID. In 1964, Scientific issued 46 checks to Wolf, 25 checks to recognized suppliers of materials and services, *706 1 check to L. T. O'Connell, 1 check to Andrew Smith (Stone's nephew), 3 checks as loans to Ladevco, 2 checks as loans to Schwartz, 8 checks to Sea Range charged to Schwartz, 3 checks to the Union Bank of California charged as loans to Schwartz, 30 checks for rent, taxes, stationery, legal and accounting services, and promotion and travel expense, 38 checks to Alwatra, A.G. (Alwatra), 5 checks to Infina, A.G. (Infina), 3 checks to Albert Schelling (Schelling), and 34 checks to GEAG. In 1965, Scientific issued 19 checks to Wolf, 12 checks to recognized suppliers of materials and services, 3 checks to L. T. O'Connell, 3 checks to Andrew Smith, 1 check as a loan to Schwartz, 24 checks for rent, taxes, contributions, legal and accounting services, organization expense, and promotion and travel expense, 24 checks to Alwatra, 23 checks to Macoba Establissement (Macoba), and 1 check to Mario W. Simonson & Sons Trust Co. (the Simonson Trust). In connection with the rent, Schwartz determined whether payment should be made to Ladevco or to Sea Range. In 1964, Schwartz charged Ladevco expenses to Scientific and drew Scientific checks in payment therefor.
The checks reflecting payments to *707 SID, Alwatra, Infina, Schelling, GEAG, Macoba, and the Simonson Trust were those mailed to Switzerland for deposit. The total amounts of the checks were as follows: 1963 SID $50,688.58 $50,688.58
1964 Alwatra 372,409.00
Infina 43,686.50
Schelling 52,514.90
GEAG 406,660.49 875,270.89
1965 Alwatra 327,695.80
Macoba 972,913.34
Simonson Trust 5,873.73 1,306,482.87
Checks to SID, GEAG, and Schelling were sent for deposit at the Union Bank of Switzerland at Aarau, Switzerland (the Union Bank). 7 Rosenbaum's contact at the Union Bank was Dr. Walter Lips. Rosenbaum would tell Dr. Lips that he needed an invoice sent to Scientific for a certain amount, and Dr. Lips would pick the company and arrange to have the invoice sent. Rosenbaum had the same arrangement with Dr. Hans Senn at the Bank fur Handel und Effekten in Zurich, Switzerland (the Handel Bank), where the checks reflecting payments to Alwatra, Infina, Macoba, the Simonson Trust, and one check to GEAG were sent for deposit. Rosenbaum used the two different banks and their respective "contacts" because Lips and Senn were involved with different groups of companies and also *708 because Rosenbaum believed it would make the invoice scheme look more authentic.
The Chromcraft-Scientific relationship came to a close in 1965 because Schwartz was found to have been using Scientific funds to his own advantage. During the period from late 1963 to late 1965 Schwartz had withdrawn in excess of $255,000 from Scientific's bank account without the knowledge of Stone or Rosenbaum. Portions of these withdrawals had been repaid by Schwartz, but when the withdrawals came to light in the latter part of 1964, there remained $118,000 which had not been repaid.Schwartz then repaid an additional $40,000, leaving a balance due of $78,000. By agreement between Schwartz, Rosenbaum, and Stone, Schwartz was credited with salary of $48,000 and gave Pacific Enterprises, Inc. (Pacific), as nominee for Chromcraft, three notes of $10,000 each. (See Issues 1(c)(2) and 3(c) infra, with regard *709 to Rosenbaum's relationship with Pacific). In December 1966, after the notes had not been paid, Pacific sued Schwartz on the notes. The moneys ultimately collected by Pacific on the notes were paid to Alsco, as successor to Chromcraft, the nominee for which Pacific had acted.
The Scientific account was losed in July 1965, by a final check written to the order of the Simonson Trust. The check was drawn by Schwartz at the instructions of Rosenbaum and Rosenbaum deposited the check into an account under his control at the Handel Bank.
Schwartz was again contacted by Rosenbaum in February 1968. At that time Schwartz was engaged in seeking a company to buy an electronics firm manufacturing microfilm readers. A grand jury investigation was then taking place and was inquiring into the affairs of Rosenbaum with respect to his activities with Scientific. Rosenbaum indicated that he might know of a company interested in Schwartz's microfilm readers, and suggested that he (Schwartz) take a trip to Europe at Rosenbaum's expense. The trip was 2 weeks in duration and the expenses were paid by Rosenbaum, using moneys from the Swiss accounts.
Operations of Scientific were included *710 in the consolidated Federal income tax returns of Ladevco for the taxable years ended February 29, 1964, and February 28, 1965. Those returns were signed y Schwartz. Form 1122, with Ladevco's return for the fiscal year ended February 29, 1964, states under penalties of perjury that Ladevco owned 100 percent of the stock of Scientific, but that such stock had not yet been issued. Schwartz suggested the filing of consolidated returns to save money and to bolster the appearance of Scientific as a valid corporation doing subcontracting for Chromcraft.
On October 19, 1971, respondent issued a statutory notice of deficiency to Ladevco pertaining to the consolidated income tax returns of Ladevco and Scientific for the fiscal years ended February 29, 1964, February 28, 1965, and a consolidated income tax return constructed by respondent for the fiscal year ended February 28, 1966. In that notice, respondent determined deficiencies and additions to tax for fraud, as follows: Additions
Year Ended Deficiency to Tax
February 29, 1964 $79,660.90 $39,830.45
February 28, 1965 642,683.66 321,341.83
February 28, 1966 420,162.15 210,081.08
That notice of deficiency *711 accepted the sales and deductions reported in the tax returns, except for $2,300 of rent in fiscal 1964, and $151,777.02 and $1,316,381.51 of purchases for fiscal 1964 and 1965, respectively. For fiscal 1966, respondent determined sales by Scientific to Chromcraft of $873,058.67, purchases of $13,993.49 and deductions for Scientific of $4,583.70, consisting of rent, accounting and legal fees, franchise tax, business promotion and travel, and sundry other items.
A petition contesting the deficiency was filed with this Court on November 24, 1971, Docket No. 7926-71, executed by Schwartz, wherein it was alleged that the petitioner had acted as agent for Chromcraft with respect to the transactions of Scientific.
In his answer at Docket No. 7926-71, respondent affirmatively alleged that Scientific was a wholly-owned subsidiary of Ladevco and that Scientific had income from sales of $873,058.67 in fiscal 1966 and had failed to file a consolidated income tax return for that year.
On January 5, 1973, this Court entered a decision in Docket No. 7926-71, pursuant to stipulation of the parties, reflecting income tax deficiencies and additions to tax for fraud, as follows: Additions
Year Ended Deficiency to Tax
February 29, 1964 $79,117.61 $39,558.81
February 28, 1965 617,542.63 308,771.32
February 28, 1966 403,095.66 201,547.83
*712 Schwartz agreed on behalf of the corporation to pay the amount of the deficiency. He paid nothing on the deficiency personally but rather was protected from doing so by an agreement with Rosenbaum, whereby Rosenbaum agreed to hold Schwartz harmless from any payment on the deficiency or with respect to the activities of Scientific.
On October 19, 1971, respondent issued a notice of transferee liability to Rosenbaum, as transferee of Ladevco, for the deficiencies and additions to tax of Ladevco for its fiscal years 1964, 1965, and 1966 set out above. A petition based upon such notice was filed with this Court on January 17, 1972, at Docket No. 459-72. In an amended answer filed in Docket No. 459-72 on July 23, 1974, respondent affirmatively referred to the Tax Court's entry of decision in Docket No. 7926-71 and pleaded the doctrine of res judicata as conclusive of Ladevco's liability for the deficiencies and additions to tax and that the petitioner, as transferee, was accordingly barred from litigating the amounts of such deficiencies and additions to tax.
Respondent has determined all the moneys paid by Chromcraft to Scientific in each of the years 1963, 1964, and *713 1965, less Scientific's payment to Chromcraft suppliers, are income to Stone, as constructive dividends from Chromcraft, and to Rosenbaum, as "unreported income," in those years and at the times when Chromcraft made the several payments. Respondent has also disallowed such payments as deductions to Chromcraft, but its liabilities are not before the Court in the present proceedings.
(b) Bregman Electronics, Inc.
After Schwartz's use of Scientific funds had come to light, Stone and Rosenbaum decided to terminate the relationship between Chromcraft and Scientific. Rosenbaum had known Robert Bregman (Robert) since 1949. He introduced him to Stone in 1965 with the intention of having Robert organize a corporation to take the place of Scientific. Rosenbaum told Robert he needed a company to run paperwork through.
Bregman Electronics, Inc. (Bregman) was incorporated in New York on June 1, 1965, and had a corporate address at 25 West 43rd Street, New York, New York. Its president was Robert Bregman and its treasurer and secretary was Edward Friedland (Friedland). Friedland, Robert's lawyer, formed the corporation and allowed Robert to use his law offices as the corporate *714 address. Robert was the corporation's sole stockholder and the signatory on its bank account.
Shortly after the formation of Bregman, Chromcraft began to issue purchase orders for completed electrical assemblies to Bregman, for use in Chromcraft's manufacture of rocket launchers. As in Chromcraft's relationship with Scientific, Chromcraft purchased the raw materials for the assemblies and the materials were delivered to Chromcraft's plant. From there, they were either picked up by or shipped to Wolf. As before, Price did all the paperwork involved, and was paid for her services by checks to L. T. O'Connell from Bregman. She prepared the Bregman purchase orders to Wolf for the latter's labor in producing the assemblies. Wolf delivered the completed assemblies to Chromcraft's plant, along with its invoices for labor. Price then sent the labor invoices to Bregman for payment. Price prepared the Bregman invoices to Chromcraft for the completed assemblies -- labor and materials -- and Chromcraft paid those invoices by checks which Bregman deposited in its account. Chromcraft, which had paid the suppliers of the raw materials going into the assemblies, never billed Bregman for the *715 cost of these raw materials, with the result that Chromcraft took a double deduction for raw materials and overstated its cost of goods sold on its tax returns.
The prices charged to Chromcraft by Bregman for the electrical assemblies were set by Chromcraft and were arrived at by taking the lowest prices quoted by other firms and reducing them by 5 to 10 cents.
Again, as in the Chromcraft-Scientific relationship, Rosenbaum arranged for invoices to be submitted by a "dummy" Swiss entity to Bregman for raw materials which were never shipped to or received by Bregman. Bregman issued its checks in payment of those invoices to the foreign entity. That entity deposited such checks in its own bank account in Switzerland and, after deducting a small percentage as an accommodation fee for supplying the invoices, transferred the remainder to a bank account in Switzerland controlled by Rosenbaum. Stone created correspondence relating to Bregman which purports to discuss actual transactions regarding the receipt of materials by Bregman from this foreign vendor. The correspondence was prepared to give the appearance of authenticity to these transactions.
Bregman deposited in its bank *716 account receipts of $892,078 in 1965 and $432,251 in 1966. In 1965, Bregman issued 21 checks to Wolf, 2 checks to Friedland for rent, 2 checks to an independent accountant, 8 checks for Robert's personal purposes, 19 checks for office expenses, telephone, taxes, travel, stationery and supplies, and other expenses, as well as 13 checks to Macoba. In 1966, Bregman issued 3 checks to Wolf, 3 checks to Robert for personal purposes, 9 checks to Friedland, 1 check to L. T. O'Connell, 1 check to Andrew Smith, 36 checks for rent, office expenses, taxes, travel, and salaries, and 5 checks to Macoba.
The 18 checks of Bregman to Macoba reflect deposits at the Handel Bank. The total amounts of those checks were: 1965 Macoba $657,839.50
1966 Macoba 522,852.60
Rosenbaum and Stone decided to terminate the Chromcraft-Bregman arrangement in 1966 because Robert's performance was less than satisfactory and because he had very expensive personal habits. After Bregman ceased operations, Rosenbaum found Robert a job with a friend and Rosenbaum agreed to finance Robert in going to Europe and trying to do business there. Rosenbaum arranged for certain funds to be made available *717 to Robert at the Handel Bank. During the pendency of the criminal investigation against Stone and Rosenbaum, Rosenbaum made payments to Robert from a Swiss bank account to secure Robert's cooperation and to have him confirm Rosenbaum's version of the events.
Again, as he did with respect to the Chromcraft-Scientific relationship, respondent disallowed Chromcraft's payments to Bregman and determined deficiencies against Chromcraft. He also determined those payments in their entirety (less Bregman's payments to Wolf) were income to Stone and Rosenbaum, as constructive dividends and unreported income, respectively, at the times and in the years when Chromcraft made the payments to Bregman.
Bregman filed tax returns, one of which was a Federal income tax return for its fiscal year ended May 31, 1966. On that return it reported sales of $1,319,257.55, which represented the amounts it received from Chromcraft. Bregman showed as cost of goods sold $1,304,851.77, which is 99.7 percent composed of the amounts it paid to Wolf and to the "dummy" Swiss entity. So far as the record herein shows, respondent did not make any adjustments with respect to that return.
(c)(1) Republic *718 Electronics Industries Corp. -- Zuni Rocket Launcher
Prior to November 1, 1965, Republic Electronics Industries Corp. (Republic) was a subsidiary of Belock Instrument Corporation (Belock), which owned 62 percent of Republic's common stock, its only class of stock. The remaining 38 percent was owned by a large number of individuals and was traded over the counter. An individual named Jeremy Taylor (Taylor) was Republic's executive vice-president and responsible for its operations. Taylor held the degree of Master of Science in Physics and had done further graduate work in physics and science. He had been employed by Bell Telephone Laboratories as a research physicist on semiconductors for two years, by Lockheed Corporation in telemetry and space recognizance for six years, and by Belock as executive assistant to the president for two years before moving to Republic.
On November 1, 1965, Belock's 62 percent interest in Republic was acquired by Falrock Corporation (Falrock). The stockholders of Falrock were John W. Seabrook, (Seabrook) (60 percent), William Witmer (Witmer) (30 percent), and Rosenbaum (10 percent).More background with regard to the organization of Falrock *719 will be given in the next section of these findings dealing with the disallowed purchases of materials from Republic.
In the late summer of 1965, Taylor received a telephone call from Stone, in which Stone expressed his interest in having Chromcraft acquire the rights in the seven-round Zuni rocket launcher, which Republic was developing for Belock, and in having Chromcraft acquire Republic as a supplier of electronic parts utilized in Chromcraft's manufacture of rocket launchers. Thereafter Taylor went to St. Louis to meet with Stone.
Stone, acting for Chromcraft, expressed the desire to acquire the rights to the Zuni and agreed to buy them if Republic could arrange to acquire the rights from Belock. Stone and Taylor discussed the potential profitability of the Zuni.
Republic purchased from Belock the latter's rights in the Zuni, effective November 1, 1965. The purchase of Belock's interest by Republic occurred simultaneously with the purchase of the Republic stock by Falrock.
At the end of 1965 or early 1966, Stone asked to buy the Zuni and inquired of Taylor as to a price. Earlier, in 1964, Taylor had written an extended memorandum to the cognizant officer of Belock *720 wherein he projected Zuni sales of $3,000,000 if the launcher were developed and marketed and that a 10 percent rate of profit, or $300,000, could be expected. Based upon that projection, Taylor initially stated to Stone that Republic would sell its rights to the Zuni for $300,000. Stone countered with an offer for Chromcraft to purchase such rights for $225,000, to which Taylor agreed.
Taylor, at Stone's request, prepared invoices for engineering development and testing charges ($77,000), fabrication (labor) charges ($103,000), and material charges ($45,000). The foregoing allocations were made by Taylor. Chromcraft issued its checks in payment on January 31, 1966, and charged the $225,000 to rocket launcher inventory.
Later, in April and May 1966, further amounts totalling $30,000 were paid by Chromcraft to Republic to enable it to continue development of the Zuni, based upon estimates by Republic's engineers. Zuni prototypes, ready to fire, were stocked in a section of the Chromcraft plant.
The Zuni ultimately passed all test-firing requirements, and Chromcraft endeavored to promote sales of the Zuni.Republic was also aggressive in trying to sell Zuni launchers to *721 the United States Government, but was not successful.Proposals to the Government were submitted under Republic's name, since Republic was to be the producer under arrangement with Chromcraft.
Republic realized a profit of approximately $189,000 on the sale of its rights in the Zuni to Chromcraft.
The $225,000 paid by Chromcraft to Republic was reported by the latter in its tax return. None of that amount was remitted to Stone or to Rosenbaum.
Respondent has disallowed deductions to Chromcraft for the $225,000 which it paid in January 1966 to Republic and for the $30,000 paid later in April and May of that year, and in his notices of deficiency he has determined that the total amount of $255,000 was income to Stone as a constructive distribution from Chromcraft, and to Rosenbaum, as "unreported income", for 1966, the year Chromcraft made the payments to Republic.
Rosenbaum was a director of Republic from November 1965 to the fall of 1968; he was never an officer or stockholder. As found above he was a 10 percent stockholder in Falrock which owned 62 percent of Republic's common stock. Stone was never an officer, director, or stockholder of Republic.
(c)(2) Republic *722 Electronics Industries Corp. -- Purchases of Materials
In October 1964, Belock had acquired 62 percent of the stock of Republic, the operations of which were in a facility in Melville, Long Island, New York. At that time Republic was in a Chapter XI bankruptcy proceeding.
Subsequent to the acquisition by Belock of its interest in Republic and Republic's thereby becoming a subsidiary of Belock, the two companies entered into two joint venture contracts with the United States Government covering the manufacture and sale of navigation equipment. Republic could not have entered into these Government contracts alone because of its poor financial condition. Belock's financial assistance was required so that the Government could award contracts to Republic. Belock undertook to furnish such assistance by providing raw materials under Belock purchase orders. During 1965, Belock's ability to assist Republic financially changed significantly, due to the indictment by the Government of two of Belock's officers for fraud. This caused consternation among suppliers who had been providing Republic with materials based on Belock's credit. Because of the dire situation which Republic *723 faced, Taylor approached the president of Belock and requested permission to put Republic on the market with a view to obtaining an outside infusion of capital.
As mentioned in the preceding section of these findings, in the late summer of 1965, Taylor received a telephone call from Stone wherein the latter expressed his interest in having Chromcraft acquire Republic's rights to the Zuni and having Chromcraft acquire Republic as a supplier of electronic parts.
Negotiations for the acquisition proceeded between Chromcraft and Republic and it was planned that Chromcraft would organize a wholly-owned subsidiary, Falrock Corporation (Falrock), to acquire Republic. Chromcraft's counsel caused the formation of Falrock on or about October 20, 1965.
Chromcraft eventually decided, on the advice of its counsel, not to have Falrock make the acquisition, due to the pendency of a lawsuit against a bank and Belock by a former shareholder of Republic, Thomas F. Lo Giudice, alleging duress by Belock in Lo Giudice's sale of his Republic stock to Belock. Rosenbaum, who had been following the negotiations between Chromcraft and Republic and who along with Stone was aware that Republic had *724 a net operating loss of $1,600,000, viewed Chromcraft's withdrawal as unwise. He informed Stone that he (Rosenbaum) was going to follow through with the acquisition of Belock's 62 percent interest in Republic, using therefor moneys in Switzerland that had their origin in Chromcraft-related transactions, such as those involving Scientific and Bregman hereinbefore described. Such funds in banks in Switzerland, in the aggregate, will be referred to hereinafter as "the Chromcraft Swiss Fund." Rosenbaum informed Stone that he (Rosenbaum) would repay the Chromcraft Swiss Fund the full amount withdrawn, plus interest, in any event; and if the investment proved to be a profitable one, the Chromcraft Swiss Fund would not only receive repayment with interest, but also an unspecified share of the profit ultimately realized upon disposition of the investment. Chromcraft's counsel suggested that Rosenbaum might utilize the Falrock corporate entity which had been formed by Chromcraft and which had not yet issued any stock.
Rosenbaum decided to use Falrock and proceeded to obtain a release from Lo Giudice of his claims against Belock and the bank. Rosenbaum also prevailed upon Seabrook and *725 Witmer to become stockholders with him in Falrock, which would be utilized for the making of investments, using moneys which Rosenbaum represented that a client of his in Europe had available. The only basis on which Rosenbaum could induce Seabrook and Witmer to go into Falrock was on the guarantee that they would not be personally liable for any losses of the funds. At that time Seabrook was executive vice-president of International Utilities Corporation and Witmer was executive vice-president of Tennessee Gas Transmission Corporation (now called Tenneco, Inc.) The officers of Falrock were Seabrook (president) and Rosenbaum (vice-president and treasurer). Rosenbaum, Seabrook, and Witmer were its directors. Its principal office was in the law offices of GRM&W, the firm in which Rosenbaum was a partner. Falrock engaged in the making of investments, and it had no inventories of any kind. It kept its books and records on the accrual method of accounting and filed its income tax returns on the basis of a fiscal year ending September 30.
Pacific Enterprises, Inc. (Pacific), which figured in the Falrock acquisition in a manner presently to be described, was incorporated on June 4, 1957. *726 Its place of business was located at the law offices of GRM&W. It kept its books and records on the accrual method of accounting and filed its income tax returns on a calendar-year basis. Prior to March 4, 1965, Rosenbaum and his brother, Joseph H. Rosenbaum, each owned of record 20 percent of the 250 shares of Pacific's outstanding stock. The remaining 60 percent of Pacific's shares were held of record in equal portions by three other persons as nominees for Rosenbaum. On March 4, 1965, Finanz A.G. (Finanz), a Liechtenstein corporation, acquired of record 375 newly issued shares of Pacific stock as a nominee for Rosenbaum.
A plan was devised by Rosenbaum, under which Pacific would advance the money for the Republic acquisition to Seabrook who was then to advance a portion of such money as a capital contribution to Falrock and the remainder as a loan to that corporation. This method would enable Seabrook to act as agent for Witmer and Rosenbaum. When and if Falrock had profits and paid dividends, those dividends would be used to pay the subscription price for Falrock's shares, which theretofore had not been paid. Thus, in order for Falrock to purchase Belock's interest in *727 Republic, it borrowed the necessary funds from Seabrook who in turn borrowed the funds from Pacific.
In 1965, the books and records of Pacific reflect total loans from Finanz of $575,000. During 1966, the books and records of Pacific also reflect certain loans received from Finanz and from the Handel Bank. These loans totalled $2,060,000. There were, in fact, no loans or advances by Finanz to Pacific. Pacific had received such funds from drafts drawn on the Agencia account at the Handel Bank.The Agencia account was controlled by Rosenbaum and was the principal depository of the Chromcraft Swiss Fund. Finanz was owned by an individual named Fidel Gotz, who was told by Rosenbaum that Finanz would be compensated for its participation and that by accommodating Rosenbaum in this matter he (Gotz) would come into contact with important business executives in the United States.
Under the final purported loan agreement between Pacific and Seabrook, Pacific was to receive two-thirds of any profits realized by Falrock on its investments. Falrock in effect would retain one-third of the profits it realized after returning to Pacific all principal.
The closing date for the sale of *728 Belock's shares in Republic was November 1, 1965, at which time Falrock bought 334,105 shares of Republic, approximately 62 percent of the outstanding shares. The remainder, as mentioned above, was publicly held and traded over the counter. The initial investment was $400,000. One thousand dollars was allocated to the shares, $150,000 went to Belock for repayment of various payables due Belock from Republic, and the remainder stayed in Republic for working capital.
Rosenbaum did not discuss with Stone the mechanics of the transfer of funds from the Chromcraft Swiss Fund in Switzerland, what rate of interest would be paid by Rosenbaum on those funds, or what was meant by the participation in profits to which the Chromcraft Swiss Fund would be entitled in the event the Republic investment proved to be profitable. At all times, however, Stone was aware of Rosenbaum's decision to use the money in the Agencia account for Falrock's investment in Republic.
Additional moneys were invested in Republic by Falrock subsequent to its initial acquisition. As stated earlier, the source of these additional funds was also the Chromcraft Swiss Fund.
Immediately after the acquisition of *729 Republic by Falrock, Stone approached Taylor with respect to doing subcontract work for Chromcraft. At that time, Republic was so heavily committed on its above-mentioned Government contracts for nvaigation equipment that Taylor did not want the Chromcraft business. Rosenbaum prevailed upon Taylor to take the Chromcraft work, and Republic and Chromcraft agreed that Republic was to be Chromcraft's sole subcontractor for electronic parts, receive all orders, and supervise the fulfillment of such orders. Chromcraft agreed to pay Republic prices competitive with quotations Chromcraft was receiving and assured Republic that it would realize a 15 percent profit on its business with Chromcraft. The price per part Chromcraft paid Republic was the lowest obtainable. The assured 15 percent profit was to be obtained by adjusting the cost of raw materials which Chromcraft furnished to Republic and for which Chromcraft charged Republic.
The first two purchase orders received from Chromcraft by Republic, in November 1965, were for 20,000 intervalometers and 20,000 harness assebmlies. Republic had previously received drawings and samples of those parts so that it could become acquainted *730 with them. It had previously manufactured harness assemblies for Belock, and had the required knowledge. Republic sent one of its engineers to Wolf to study how that proprietorship was assembling the parts ordered by Chromcraft. As indicated above, Chromcraft was to procure the materials. Prices on Chromcraft's second group of purchase orders dated December 20, 1965, as were those on the first two, were set by Chromcraft, but were reviewed by Taylor and Republic's operating personnel.
Republic had serious production problems on its first two orders from Chromcraft. Someone had used a solvent instead of water in which to wash the completed parts, with the result that the reject rate on the parts was unusually high and Chromcraft's rocket launcher delivery schedule was adversely affected.
Republic, which was heavily committed to the performance of its Government contracts for the navigation equipment, did not have enough trained personnel to work on those contracts and on Chromcraft's orders in its own plant. It would have been hard pressed to do any major work for Chromcraft after the first two orders. At Stone's suggestion, Republic turned to Wolf to do the labor on the *731 parts ordered by Chromcraft from Republic. Taylor had Republic's purchasing department send to Chromcraft approximately 20 blank Republic purchase order forms with control numbers. In order to eliminate the time lag in the beginning that would be incurred in Chromcraft sent its purchase orders to Republic and Republic then issued its own purchse orders to Wolf, Chromcraft completed the Republic forms and sent them directly to Wolf. After the first four to six Republic purchase orders to Wolf, Republic prepared its own purchase orders, signed by its own purchasing agent, to Wolf. Republic paid Wolf for its labor on all Chromcraft parts assembled by it.
Up until July 1, 1967, Republic continued to subcontract labor on Chromcraft purchase orders to Wolf. Chromcraft purchased the raw materials which were delivered to its own plant, where they were picked up by or sent to Wolf. Wolf delivered the completed parts directly to Chromcraft. This practice, called "drop-shipping," is not unusual in the business world. In contradistinction to what had prevailed in the Chromcraft-Scientific and Chromcraft-Bregman transactions, Chromcraft billed Republic for the cost of such raw materials. *732 Republic, in its turn, billed Chromcraft for the completed parts, material and labor included.
In November and December 1965, Republic was hard pressed for cash, and Stone and Rosenbaum were aware of this condition. As a consequence, Chromcraft transmitted advances to Republic against the purchase orders of $60,000 on November 10, $100,000 on November 19, and $40,000 on December 3. Before the end of the year 1965, Stone asked Taylor to send Chromcraft invoices for the entire amount of those purchase orders, $230,000; and on January 8, 1966, after deducting the $200,000 previously advanced, Chromcraft transmitted its check to Republic for the $30,000 balance due thereon. At that time, only 6 of the 20,000 units ordered had been completed; however, in 1966, Republic completed its performance under the purchase orders and delivered the quantities called for thereon in full. Chromcraft made other advances from time to time to Republic against purchase orders. Republic had received other advance payments on Government contracts in excess of expenditures. It was not unusual to receive advance payment for the total amount of such a contract.
Every payment made by Chromcraft to Republic *733 was for goods delivered by Republic at invoice prices which were fair and reasonable. All such payments received by Republic were taken into income. Its income tax returns were thoroughly examined and investigated for its fiscal years 1966 and 1967, and there was no dollar adjustment to its income.
Republic made no payments on false invoices from "dummy" Swiss entities, nor did it send any funds overseas in the manner that Scientific and Bregman had done.
Republic's facility on Long Island was inadequate to handle both its contracts from the Government work for Chromcraft and consequently, Republic began a search for a facility in which to do the work for Chromcraft. It contacted the Federal Office of Economic Opportunity, and considered possible sites in Brooklyn, Queens, and Jamaica in the New York area, as well as a site in Pennsylvania. Republic finally located a plant in Arnold, Missouri, near St. Louis, where labor rates and productivity were satisfactory. With advice and assistance from Chromcraft personnel, Republic commenced operations at this plant, called the Tenbrook Division, on or about July 1, 1967, with Chromcraft as its sole source of business. Even after *734 Tenbrook was established, Republic continued to subcontract some of its Chromcraft work to Wolf, which provided a second source of labor in case of interruption at the Tenbrook division.
The prices paid by Chromcraft to Tenbrook for electrical assemblies were in line with prices paid in prior years.
Prior to July 1, 1967, Republic engaged in research and development of two types of intervalometers for Chromcraft. Republic resumed intervalometer development when the Tenbrook facility was set up. Later, Republic developed an electromechanical intervalometer, which was less expensive to manufacture and more reliable than the dropped-wire type used in the beginning, and Republic manufacturered the new intervalometer.
In his notices of deficiency, respondent determined Stone and Rosenbaum had income from the Republic transactions only as a result of the purchase of Republic's rights to the Zuni, described in the preceding section of these findings.In his amended answers in the Stone deficiency cases, and in his amendments to amended answers in the Rosenbaum cases, all filed on May 16, 1975, respondent alleged Stone had received constructive dividends from Chromcraft as a result *735 of causing the payment of inflated invoices of Republic to be paid by Chromcraft in the amounts of $821,009.01 and $761,013.63 in 1966 and 1967, respectively; and Rosenbaum had "unreported income" in the same amounts for the same years. Respondent sought increased deficiencies and additions to tax for fraud as a result of the foregoing allegations in his amended pleadings. None of the additional income is related to Chromcraft's purchases from Rpublic after July 1, 1967, when the Tenbrook division operations commenced.
(d) Western Molded Fibre Products, Inc.
Rocket launchers manufactured by Chromcraft were fitted with fairings. Each launcher was fitted with a set, composed of one front fairing and one rear fairing. Up until 1963, these fairings were plastic, made of fibre material bonded together with a chemical known as phenolic formaldehyde. The purpose of the fairings was to give a streamlining effect to the launcher, thereby reducing aerodynamic drag. These plastic fairings were frangible, that is, the fairings were broken up by the rockets when fired and the pieces fell away to the ground.
During the taxable years at issue, Western Molded Fibre Products, Inc. (Western) *736 was a California corporation which manufactured and sold fairings to Chromcraft and Alsco. Western was a subsidiary of Hawley Products (Hawley), which was publicly owned and which manufactured civilian products. Hawley's principal office and plant were in St. Charles, Illinois, near Chicago; Western's office and plant were in Gardena, California. The president of Western was Peter De Luca (De Luca) who, until July 1966, was stationed at Hawley's office in St. Charles. The person in charge of operations at Gardena was Thomas Austin (Austin). In July 1966, Austin was transferred to St. Charles, and De Luca replaced him in Gardena. Approximately 70 percent of Western's business was with Chromcraft, and fairings were Western's principal, if not sole, products.Sales of fairings were inextricably bound up with the sale of rocket launchers, and consequently, unless there were sales of launchers there would be no sales of fairings.
Launchers purchased by the Armed Services of the United States were principally for use in Vietnam. As the launchers themselves were normally jettisoned to reduce weight and drag on the return from a mission, only frangible plastic fairings were specified. *737 However, rocket launchers purchased by NATO and other countries were chiefly used for training purposes, and were not jettisoned. A reusable launcher which could be fired 100 times would consequently use 100 sets of the disposable plastic fairings; and, while the cost of a set of fairings did not constitute a major portion of the cost of a fully-equipped launcher, if 100 sets of fairings were required, the result was that the fairings cost as much as the launcher itself.in these circumstances, foreign countries using rocket launchers wanted reusable fairings which could be used over and over again for the life of the launcher.
At about the same time that the need for the development of reusable fairings arose, in the early part of 1963, a new development was taking place with respect to the frangible plastic fairing. The regular frangible fairing would, after firing, break into relatively large pieces which often caused problems both for the aircraft from which it dropped and for other aircraft flying in the same formation. To meet these problems a grenade-type fairing was developed, with a pineapple configuration on the inside surface of the fairing. Upon firing, the grenade-type *738 fairing would break into very small fragments, which posed much less of a hazard both to the aircraft on which the firing took place and to the other aircraft in the same formation.
Chromcraft, the launcher manufacturer, had borne the cost of developing launchers, which entailed expenses of designing, engineering, manufacturing prototypes, and testing. It also was required, in its arrangements with Western, to buy the tools, dies and molds for the development by Western of the grenade-type fairings. Chromcraft also had promotional expenses in obtaining contracts from the United States Government for the purchase of launchers as well as in obtaining sales to NATO and other countries through the United States Military Assistance Program. Chromcraft paid the roughly $2 million of costs incurred out of its corporate treasury. Under Armed Services Procurement Regulations, Chromcraft was unable to recover these costs; the only way to recover such expenditures was to have a specific arrangement allowing expenditures for these types of expenses, to incur the expenses within the contract, and to have the expenses approved.
Western, at this time, was the only supplier of fairings qualified *739 under military regulations to submit bids, although another company, General Molding, could have become qualified with Chromcraft's assistance. The necessary tools were owned by Chromcraft, and Chromcraft had a license from Hawley to use Western's patents.
In early 1963, Stone approached DeLuca purportedly seeking to have Western reimburse Chromcraft for a portion of the latter's costs in research, development, and promotion, from which Western was deriving significant benefits. Stone and DeLuca orally agreed that Chromcraft and Western would share such costs in the ratio of two-thirds/one-third, although Stone never intended any portion of the reimbursement to go to Chromcraft. The "reimbursement" agreement was for an ongoing program covering costs previously incurred by Chromcraft as well as those to be incurred in the future, both in the United States and abroad. No price for fairings was fixed at the time the agreement for sharing costs was reached, nor were the mechanics for Western's payment of its share determined. Stone subsequently suggested increasing the price on fairings by approximately $2.50 per set to cover Western's share of the costs. The price was eventually *740 increased another 50 cents, making the total increase approximately $3 per set.
In June 1963, Western furnished Chromcraft with a price of $16.60 for a set of grenade-type fairings for a 19-round launcher ("round" refers to the number of rockets a launcher will hold and fire), which amount was utilized in a bid submitted to the Government by Chromcraft and on which it was subsequently awarded a contract. The price that had been previously charged by Western for non-grenade-type fairings for a 19-round launcher was $13.64 per set. In the early fall of 1963, Western quoted a price of $13.027 per set for the grenade-type fairings for a 7-round launcher, which amount was utilized by Chromcraft in its bids to the Government on which it was subsequently awarded contracts. The price previously charged by Western for non-grenade-type fairings for a 7-round launcher was $10.21 per set.
Western did not have detailed cost data records regarding fairings. In essence, the cost figures were decided upon and then backed into. At the same time that Western furnished the above-mentioned prices to Chromcraft, a letter was drafted by De Luca containing a phony explanation for the increase in *741 price costs of the fairings contained in the new price quotations. The letters were drafted at the suggestion of and the contents dictated by Stone.
Pursuant to the arrangements between Stone and De Luca, Stone initially asked Rosenbaum to have Scientific Industrial Developments, Ltd. (the same Scientific Industrial Developments, Ltd., or SID, mentioned previously in connection with Scientific Electronics), a London-based firm which handled promotional efforts for sales of Chromcraft's launchers to England and the British Commonwealth nations, submit a bill to Western. SID submitted such a bill for $9,000 to Western on May 20, 1963, for services and expenses of a market investigation of the potential use of the 2.75 inch rocket launcher in the United Kingdom and the Commonwealth countries. Upon receipt of this bill, De Luca returned it unpaid to SID and informed Stone he could not pay a bill for services but only for materials.
De Luca gave Stone the name and specifications for phenolic formaldehyde, the chemical used to bind the fibre in fairings, and the unit price therefor.
The method thereafter pursued to effect the reimbursement was as follows. Stone from time to *742 time would tell Rosenbaum an amount that was to be billed to Western for its share in reimbursing Chromcraft for the latter's research, development, and promotional costs. Rosenbaum then would have a "dummy" Swiss entity issue its invoice for phenolic formaldehyde to Western in a quantity which, when multiplied by the unit price, equaled the amount which Stone had given to Rosenbaum. When Western accumulated a number of these foreign source invoices, De Luca would cause a purchase order to be issued by Western to the "dummy" Swiss entity for the phenolic formaldehyde thus invoiced to Western.
Austin, having been told by De Luca how the mechanics of payment were to be worked out, caused an accrued liability of $2.96 per set of fairings for 19-round launchers, and $2.82 per set of fairings for 7-round launchers to be set up on Western's books when Western billed Chromcraft for fairings shipped to it. Then, when Chromcraft paid such an invoice from Western, Western drew its check to the "dummy" Swiss entity in an amount computed by multiplying the number of sets of fairings paid for by Chromcraft times the appropriate per-set reserved or accrued figure ($2.96 or $2.82). In its *743 internal record keeping Western would charge the amounts of such checks against a foreign source invoice until the full amount had been paid.When the amount of a particular Western check exceeded the balance due on a particular foreign source invoice, Western would simply apply the excess to a different invoice and thereafter continue charging its payments against that second invoice, and so on and on.
Western checks to the "dummy" Swiss entities were sent to Rosenbaum who in turn transmitted them to the entities in Switzerland, which deposited them in their Swiss bank accounts. Then, after deducting a fee for services, the Swiss entities would forward the balance, about 98 percent, to Swiss bank accounts on which Rosenbaum was the signatory. Rosenbaum was not an officer, director, or shareholder of any of the Swiss entities.
All foreign source invoices were paid by Western. The last foreign source invoice to Western for materials was dated September 21, 1966, for $30,225. The last Western payment of a foreign source invoice was made by its check dated January 3, 1967, in the amount of $21,454.08. Western related that payment to Chromcraft's purchase orders and Western invoices *744 to Chromcraft of August 1966. De Luca did not seek more foreign invoices in 1966, although Western had continued to reserve or accrue a substantial amount of money to pay such, based upon Chromcraft's payments to Western.
Stone did not ask De Luca to set aside a specific amount of money on each set of fairings for reimbursement to Chromcraft for its costs of research, development, and promotion of sales of rocket launchers, which totaled approximately $2,000,000 over the years. Stone did not learn the details of what Western had been doing in regard to reserving or accruing amounts for payment until 1971, although he was aware of the practice by January 1967. The system of reserving or accruing amounts was a Western decision by Austin, and was not one made by Stone. Stone did not furnish the accrual figures. The foreign source invoices which Rosenbaum caused to be sent to Western were sent at irregular intervals, and were not based upon the number of sets of fairings sold by Western to Chromcraft.
In January 1967, officials of Hawley learned of the payments made by Western to the "dummy" Swiss entities. In an effort to establish that the payments were not kickbacks, Rosenbaum *745 arranged for a number of foreign persons and organizations to send letters to Hawley stating that they had been paid for services. These letters were to a large extent fabrications, although, as found above, Chromcraft had actually incurred expenses of approximately $2,000,000 for research, development, and promotion of sales of rocket launchers.
Western sent $663,481 to the "dimmy" Swiss entities, of which $31,269.38 was returned to Western after Hawley learned of the payments by Western. These payments were in the years and amounts as follows: 1963 Orma-Commerce $8,612.20 $8,612.20
1964 Orma-Commerce 36,371.80
Geag 32,100.00
Alwatra 65,167.06 133,638.86
1965 Alwatra 55,152.94
Macoba 120,319.96
Export Technik 8,721.78 184,194.68
1966 Export Technik 315,581.23 315,581.23
1967 Export Technik 21,454.08 21,454.08
The checks of Western to Geag and Orma-Commerce reflect deposit at the Union Bank; the checks to Alwatra, Macoba, and Export Technik reflect deposit at the Handel Bank.
Respondent disallowed Chromcraft's purchase expenses on its purchases of fairings from Western in the following amounts for the years and *746 periods indicated: 1963 $ 8,983
1964 136,034
1965 221,084
1/1 - 4/9/66 142,494
4/10 - 5/31/66 61,512
6/1 - 12/31/66 114,400
Total $684,507
The foregoing disallowances were apparently based upon a disallowance of $2.96 for each set of 19-round launcher fairings and $2.82 for each set of 7-round launcher fairings purchased by Chromcraft from Western.
Respondent determined the foregoing amounts disallowed were constructive dividends to Stone from Chromcraft and "unreported income" to Rosenbaum.
Issue 1
ADDITIONAL FINDINGS OF FACT
(e) Funds in Switzerland and the Swiss Bank Accounts.
As appears from preceding findings under this Issue 1 and as will appear from the findings under Issues 2, 3, and 4, substantial amounts of money originating from Chromcraft, Scientific, Bregman, Western and Zeebrugge were remitted overseas to Switzerland where they were deposited in Swiss banks. These may be summarized as follows: Chromcraft to Establissement Velo $571,577.50
Chromcraft to Establissement Orma-Commerce 22,768.00
Chromcraft to CEPAB 52,172.00
Chromcraft to Finax 8,000.00
Chromcraft to Haemmerli 16,000.00
Chromcraft to Scientific 88,900.00
Chromcraft to SID 51,000.00
From Scientific 2,232,442.34
From Bregman 1,180.692.10
From Western 663,481.05
From Zeebrugge 193,016.00
*747 In addition, Stone, as will be shown in the interest expense deduction issue, remitted $102,000 in cash as interest to Finanz GmbH and $6,227 in cash as interest to Peralta, substantially all of which ultimately ended up in a Swiss bank account.
There were several bank accounts utilized in the transactions in these cases. Principal among them was an account in the name of Agencia Industriale C por A (the Agencia account) in the Handel Bank in Zurich. Other accounts included the Chromcraft account at the Union Bank in Aarau, the Inversiones Petroleras Internationales S.A. account (the IPI account) in the Union Bank, and the Scientific Industrial Development account (the SID account) and the Establissement Velo account (the Velo account) at the Handel Bank. Neither the Chromcraft ledgers nor its financial statements showed the existence of the Chromcraft account, and neither Chromcraft's directors nor its shareholders knew of its existence. Although the foregoing accounts (with the exception of the Chromcraft account) bore names indicating that they were accounts of business enterprises, none was such during the taxable years involved. Stone was a signatory on the Velo account, *748 and became a signatory on the Chromcraft account in 1964 and on the St. Louis sub-account (but not the U.S. dollar or Swiss franc sub-accounts) of the Agencia account in 1965. Rosenbaum was a signatory on all the accounts.
Not only Chromcraft funds were deposited in the Swiss accounts. Very large amounts of deposits, probably amounting to millions of dollars, were made by Rosenbaum from sources wholly unrelated to Chromcraft or to Stone.
The accounts were managed by and totally under the control of Rosenbaum. He received the statements from the banks and the debit and credit advices which showed deposits and withdrawals from the accounts. He freely commingled the funds coming into the accounts from various sources, transferring money in his discretion from one account to another. Rosenbaum kept no written records of the funds and their sources, but kept only a mental tally of the funds and their whereabouts. Rosenbaum regarded himself as having an interest, which has never been specified as to amount, in all of such funds except those coming over to Switzerland from Zeebrugge and Western, with the balance belonging to Chromcraft or Stone to do with as either told him. That *749 undefined interest of Rosenbaum's he regarded to be his for his services in arranging for foreign invoices, making and managing investments, and generally managing the funds. Neither he nor his law firm billed Chromcraft or Stone or received payment for such services.
Besides making payment to individuals such as Schwartz, Robert Bregman, Czarnecki (Issue 4), Schendell (Issue 3) and others, Rosenbaum from time to time would invest funds in certificates of deposit and in marketable securities. These investments were made to avoid having the funds lie idle and unused. Rosenbaum on occasion would discuss the investments with Stone; however, he generally did what he wanted to with the funds as regards investments. Stone trusted Rosenbaum completely because of their close personal relationship. 8 Rosenbaum never reported to Stone or to Chromcraft the income or gain or loss on any of the investments made with the Swiss funds, so neither Stone nor Chromcraft reported any such income or gains or losses on their Federal income tax returns, and neither did Rosenbaum.
*750 Rosenbaum also made many investments on his own behalf from the aggregate of funds under his control in the Swiss banks.
While Stone did not have the detailed knowledge that Rosenbaum had of the Swiss accounts and their contents, he was aware of the plan to send funds overseas from its inception. He handled the Chromcraft end and was aware of the various transactions, e.g. supplying the raw materials without billing the companies therefor while purchasing completed assemblies at full price. Moreover, in many instances, payments could not have been made to the Swiss accounts without Stone's knowledge and cooperation, as it was he who approved the invoices and signed the checks. In addition, Stone had at least a rough idea of the amount of money in the Swiss accounts. As stated in the findings of fact, the checks on foreign invoices from Scientific, Bregman and Western were sent first to Chromcraft or Rosenbaum, then forwarded overseas. Lists of the payments were routinely kept by the secretaries involved (Price at Chromcraft, and Shirley Sorenson and Elinor Harmon at Western) and given to Stone and Rosenbaum.
According to Stone and Rosenbaum the moneys were accumulated in *751 Switzerland to build a fund for corporate (Chromcraft) investments and, particularly with those moneys coming from Western, for rocket launcher promotion in Europe. However, Stone and Rosenbaum had no specific purpose or corporate acquisition in mind when they started accumulating the funds. Also, of the $663,481 sent to Switzerland via Western for "rocket launcher promotion," only approximately $50,000 was disbursed, nd that to such people as Schendell, Vollmer and Charnock for their participation in the plan.
Stone never sought to have Rosenbaum disburse any of the money in the Chromcraft Swiss fund directly to him or a member of his family, although Rosenbaum would have acceded to such a request if Stone had made one. There were, however, instances disclosed by the record of a disbursement for the personal benefit of Stone or a member of his family. One such instance occurred in 1965, in the following circumstances. On March 24, 1965, Rosenbaum withdrew $20,000 from the Agencia account to make a personal loan to Mme. de Ora Trujillo, a client of GRM&W, Rosenbaum's law firm. Rosenbaum was aware of a trip that Jeanne Stone and her children were planning to make to Europe *752 and he told Stone that Mme. Trujillo owed him money and that he would have Mme. Trujillo pay for the American Express tour when the Stone party arrived in Paris, as a means of her partially repaying Rosenbaum. When Jeanne and the children arrived in Paris, Mme. Trujillo did not make the payment which she had agreed to make.Rather than cause Jeanne embarrassment, Rosenbaum had the Union Bank wire $6,689.25 from the Chromcraft account in the Union Bank to Amexco Tours on May 18, 1965. When Mme. Trujillo subsequently repaid Rosenbaum, she did so by a payment to one of the Swiss accounts which he controlled. Rosenbaum never told Stone what had been done, and Stone did not learn until the taking of depositions in 1971 in the Alsco-Harvard Fraud Litigation that Rosenbaum had sent the money for Jeanne Stone's tour from the Chromcraft account in the Union Bank.
Also, in 1966, Stone asked Rosenbaum to accumulate several parcels of land for him in St. Louis, on one of which was situated the Stones' present home. Stone asked Rosenbaum to act, since Stone feared that the price would escalate if the identity of the real purchaser were known. Stone did not know what the cost of the properties *753 would be; whatever the price, Stone agreed to pay.
Pacific Enterprises, Inc., formed a subsidiary corporation, Blackacre (whose name was subsequently changed to Whiteacre, and later to Realacre), to accumulate the parcels. Pacific "borrowed" somewhat over $300,000 from the Agencia account, which was advanced to the subsidiary and used by it to acquire the parcels of land.Stone ultimately purchased the parcels from the subsidiary using funds which he had borrowed from domestic sources, and the "borrowed" funds, plus interest, were returned to the Agencia account. As will be shown in the interest expense deduction issue, Stone utilized the Swiss funds as loans on other occasions as well.
Falrock Corporation, mentioned previously in the findings relating to the disallowed Chromcraft purchases from Republic, in which Rosenbaum was a shareholder, officer, and director, but in which Stone was none of these, in October 1965 acquired 334,105 shares, approximately 62 percent, of the outstanding shares of Republic from Belock Instrument Corporation. In December 1965 Falrock acquired all the outstanding stock of Concord Control, Inc., (Concord) from Computer Systems, Inc. On January 14, 1966, Falrock *754 purchased 386,952 shares of Alsco, Inc., from Kaiser Aluminum & Chemical Sales, Inc., for a cash consideration of $4.25 per share; 25,000 of the shares purchased were for Irwin C. Keefer, an associate of Stone in Chromcraft.Falrock became the record holder of approximately 44 percent of the outstanding shares of Alsco, and the other 56 percent was widely held. The investment in Alsco was an investment of funds emanating from the Chromcraft Swiss Fund in which investment Rosenbaum and the Chromcraft Swiss Fund were to share equally in both profits and losses.
To effect the purchases of Republic, Concord, and Alsco stocks, Falrock borrowed from John Seabrook, Falrock's president, who in turn borrowed from Pacific Enterprises, Inc. Pacific received funds from drafts drawn on the Agencia account.
The amount of $245,745.81 was loaned by Pacific to Seabrook in December 1965 for the acquisition of Concord. Two hundred twenty-five thousand dollars of Pacific's funds were obtained from the Agencia account and reflected on its books as a loan from Finanz A.G.
Rosenbaum, in arranging to use money from the Chromcraft Swiss Fund for the investments in Republic and Concord, informed *755 Stone that he intended to borrow from the Chromcraft Swiss Fund and would repay it. If there were a loss, Rosenbaum agreed that he would see that the money was returned with interest. The money used to purchase Concord was ultimately returned to the Chromcraft Swiss Fund, together with a portion of the profit.
The amount of $400,000 was loaned by Pacific to Seabrook in October 1965 for the acquisition of Republic stock and for loans to Republic. Three hundred fifty thousand dollars of Pacific's money for the loan to Seabrook was obtained from the Agencia account, and reflected on Pacific's books as a loan payable.
In December 1966, Falrock purchased 5,283 units of Republic's subordinated income debentures and warrants for an aggregate cost of $264,150. In January 1969, Falrock exercised the warrants and acquired an additional 158,490 shares of Republic common stock at a total cost of $293,206, which increased its holdings in Republic to approximately 90 percent of the total common stock outstanding.
Proceeds of $322,125 realized by Falrock on the sale of Alsco stock and of Concord stock, after paying income tax on the gains realized, were either loaned to Republic, or *756 returned to Pacific in repayment of loans and then returned by Pacific to the Agencia account.
In January 1969, the United States filed essentially similar actions in the United States District Court for the Eastern District of Missouri and the United States District Court for the District of Columbia, seeking recovery of damages from Stone, Rosenbaum, Chromcraft, and Alsco as the result of an alleged multi-million dollar fraud on the United States perpetrated by Stone and Rosenbaum through Chromcraft and Alsco from 1963 to 1967. Various other actions seeking damages were brought by other parties in different jurisdictions.
Upon motion of Stone and Rosenbaum for consolidated pre-trial proceedings in the various actions brought in connection with the alleged fraud, the judicial panel on multidistrict litigation concluded that all related actions should be transferred to the District of Columbia for coordinated or consolidated proceedings. For purposes of the consolidated proceedings, the said consolidated actions were referred to by the United States District Court for the District of Columbia as "In the Matter of Alsco-Harvard Fraud Litigation, Docket No. 54."
The Alsco-Harvard *757 Fraud Litigation was the subject of a "Stipulation of Compromise and Settlement" on August 16, 1976. The defendants waived all rights in the 113,000 shares of Alsco stock registered in the name of Finanz and the 253,452 shares of Alsco registered in the name of Falrock, and Harvard and its shareholders dismissed on the merits and with prejudice all their claims against each of the settling defendants. Stone also dismissed certain claims he had asserted against Harvard. Such settlement was subject to the prior rights and claims of the United States.
The 113,000 Alsco shares in the Agencia account registered in the name of Finanz and the 253,452 shares of Alsco registered in the name of Falrock were recovered by Harvard but surrendered to the United States with the understanding that Harvard may reacquire those shares from the United States.
Harvard has subordinated in favor of the United States its claim to the money in the Agencia account and any shares of Alsco stock in the Agencia account which had become Harvard preferred shares. Harvard has also agreed to subordinate to the United States its claims against the assets of Falrock, including shares held by Falrock in Heath-Techna *758 corporation (into which Republic was merged in April 1969) and in Concord. The United States, to whom Harvard subordinated its claims, has a continuing trust action against the assets of Falrock.
Issue 1
OPINION
The question presented in this first issue is whether Stone and Rosenbaum are properly chargeable with income for certain amounts disallowed as deductions to Chromcraft. Respondent has determined (or claimed in his amended pleadings) that Stone received constructive dividends from Chromcraft to the extent of the amounts disallowed as deductions. As to Rosenbaum, respondent's position is that identical amounts are "unreported income * * * representing funds accruing to [his] benefit from [his] manipulation of transactions to divert monies arising from contracts between Chromcraft [and Alsco] and the United States Government."
The case of Stone will be considered first. Section 316(a) defines "dividend" in language requiring the satisfaction of four criteria: There must be (1) a "distribution" of property (2) "made by a corporation" (3) "to its shareholders" (4) *759 "out of its earnings and profits." There is no requirement that the distribution be made pursuant to a formal declaration. Informal withdrawals and distributions, although characterized by the parties as other than dividends, must be taxed as such if the statutory criteria are met. Commissioner v. Makransky, 321 F.2d 598 (3d Cir. 1963) , affg. 36 T.C. 446 (1961) . The motive, or expressed intent of the corporation is not determinative, and constructive dividends have been found contrary to the expressed intent of the corporation. Loftin and Woodward, Inc. v. United States, 577 F.2d 1206 (5th Cir. 1978) revg. and remanding an unreported District Court decision; Sachs v. Commissioner, 277 F.2d 879 (8th Cir. 1960) , affg. 32 T.C. 815 (1959) . There is also no requirement that the distribution be pro rata among the shareholders or even that all shareholders participate in receiving a distribution. Crosby v. United States, 496 F.2d 1384 (5th Cir. 1974) , revg. on other grounds an unreported District Court decision; Simon v. Commissioner, 248 F.2d 869 (8th Cir. 1957) , revg. *760 a Memorandum Opinion of this Court.
Where controlling shareholders divert corporate income to themselves, the courts have held it is proper to regard such diverted funds as constructive dividends for tax purposes. 9 Sachs v. Commissioner, supra ; Dawkins v. Commissioner, 238 F.2d 174 (8th Cir. 1956) , affg. a Memorandum Opinion of this Court; Currier v. United States, 166 F.2d 346 (1st Cir. 1948) , affg. 70 F. Supp. 219 (D. Mass. 1947) ; United Mercantile Agencies, Inc. v. Commissioner, 23 T.C. 1105 (1955) , revd. on another issue sub nom. Drybrough v. Commissioner, 238 F.2d 735 (6th Cir. 1956) ; Chesbro v. Commissioner, 21 T.C. 123 (1953) , affd. 225 F.2d 674 (2d Cir. 1955) . Neither does the dividend escape taxation simply because it fails to pass through the hands of the particular taxpayer when, as in the instant case, the dividend is diverted at the behest of the taxpayer into the hands of others. Sammons v. United States, 433 F.2d 728 (5th Cir. 1970) , *761 affg. an unreported District Court decision; Biltmore Homes, Inc. v. Commissioner, 288 F.2d 336 (4th Cir. 1961) , affg. a Memorandum Opinion of this Court. The shareholder is taxable on the distribution of corporate earnings made at his demand or request to a third person for some purpose or obligation which he wished to fulfill, even though he, himself, received no direct economic gain. Sachs v. Commissioner, supra ; Greenspon v. Commissioner, 229 F.2d 947 (8th Cir. 1956) , revg. on another issue 23 T.C. 138 (1954) ; Byers v. Commissioner, 199 F.2d 273 (8th Cir. 1952) , affg. a Memorandum Opinion of this Court; Commissioner v. Makransky, supra.
The courts, in determining the existence of constructive dividends, have consistently used a two-pronged test. First, the corporation must have conferred an economic benefit on the shareholder *762 without expectation of repayment. United States v. Smith, 418 F.2d 589 (5th Cir. 1969) , revg. and remanding 266 F. Supp. 814 , (S.D.Tex. 1967). This part of the test is based upon the assignment of income principle enunciated in Helvering v. Horst, 311 U.S. 112 , 116-117 (1940) , wherein it was explained that income is realized by the assignor when he "who owns or controls the source of the income, also controls the disposition of that which he could have received himself and diverts the payment from himself to others as the means of procuring the satisfaction of his wants." 10 Second, the corporation-provided benefits must primarily advance the shareholder's personal interest as opposed to the business of the corporation. Ireland v. United States, 621 F.2d 731 (5th Cir. 1980) , affg. on this point an unpublished District Court opinion; Sammons v. Commissioner, 472 F.2d 449 (5th Cir. 1972) , affg. on this point a Memorandum Opinion of this Court; United States v. Gotcher, 401 F.2d 118 (5th Cir. 1968) , affg. on this point 259 F. Supp. 340 (E.D. Texas 1966) .
*763
The determination of a constructive dividend is a question of fact to be determined in each case. Hardin v. United States, 461 F.2d 865 (5th Cir. 1972) , affg. on this point an unpublished District Court opinion; Lengsfield v. Commissioner, 241 F.2d 508 (5th Cir. 1957) , affg. a Memorandum Opinion of this Court.On the facts before us, and for the following reasons, we cannot find either that the payments made to Scientific, Bregman, and Western were without economic benefit to Stone, or that they advanced the corporation's interest. Consequently, a portion of such payments resulted in constructive dividends to Stone.
Turning next to the case of Rosenbaum, who was not a Chromcraft stockholder, respondent's determination is that Chromcraft's payments to Scientific, Bregman, Republic, and Western were Rosenbaum's "unreported income * * * representing funds accruing to your benefit * * *, etc." The impact of the holding just made in regard to Stone is that a portion of such payments (with the exception of those made to Republic, see infra ) were Rosenbaum's *764 income and that they were properly included in his income by respondent.
(a) Scientific Electronics, Ltd. --Stripped of details, the facts are appallingly simple. Chromcraft purchased raw materials and sent them to Wolf for assembly; it then paid Scientific the full cost of labor and materials, with Scientific, at Stone's direction, forwarding the labor costs to Wolf. Scientific, headed by Schwartz, then transferred portions of the surplus payments from Chromcraft to Swiss bank accounts controlled by Rosenbaum and, at times, Stone as well.
We note at the outset that petitioners 11 have conceded the existence of the above transactions. However, they contend the plan to accumulate funds in Switzerland was effectuated for corporate, not personal, purposes, e.g. rocket launcher promotion, investments, and corporate acquisitions, and that they therefore had no personal interest in the Swiss funds. As proof of this they argue, as they did many times at trial, that they never used the Swiss funds for personal purposes and that any withdrawals of those funds were viewed by them as "borrowings" and repaid with interest. They contend, moreover, that the moneys paid by Chromcraft *765 to Scientific cannot possibly be attributed to them as income in the amounts and at the times the moneys left Chromcraft because they had no control over Scientific or its president, Schwartz. If Schwartz had refused to pay the foreign invoices, they argue, their only recourse would have been for Chromcraft to bill Scientific for the moneys owed it for the raw materials.
It is well settled that the burden is on the taxpayer to prove by a preponderance of the evidence that the specific transfer of funds determined by the Commissioner to be dividend income was in fact a bona fide payment for a corporate business purpose. Welch v. Helvering, 290 U.S. 111 (1933) ; Gurtman v. United States, 237 F. Supp. 533 (D.N.J. 1965) . The primary factual determination is recognized to be the intention of the shareholder-officer of the corporation at the time the transfer is made. Commissioner v. Makransky, 321 F.2d 598 (3d Cir. 1963) ; Wiese v. Commissioner, 93 F.2d 921 (8th Cir. 1938) , *766 affg. 35 B.T.A. 701 (1937) . To carry the burden imposed upon him the taxpayer must prove that he had a state of mind at the time of withdrawal which included a specific plan to use the money solely for the corporation's business.A vague, uncertain or indefinite intention as to use for corporate purposes at some time in the future is insufficient where the withdrawal places the money in the taxpayer's absolute control and subject to his absolute discretion as to its use. Nasser v. United States, 257 F. Supp. 443 (N.D. Cal. 1966) ; Gurtman v. United States, supra.
In attempting to ascertain Stone's intention at the time of the transfer, we must consider three types of evidence. Nasser v. United States, supra, at 447 . First, the testimony of Stone himself which to the extent it is inconsistent with the conclusion we reach, is flatly contradicted by the course of conduct he engaged in. Second, objective evidence contemporaneous with the transfer of funds which is weighed to determine whether it corroborates or contradicts the petitioners' asserted intention. Kaplan v. Commissioner, 43 T.C. 580 (1965) . *767 Third and last, evidence as to acts subsequent to the date of the transfer which may be considered in light of its consistency or inconsistency with the testimony as to original intent. Baird v. Commissioner, 25 T.C. 387 (1955) .
After consideration of all the evidence, we conclude that the payments from Chromcraft to Scientific were not intended to be nor were they made for a legitimate corporate purpose. Stone's testimony at best showed only sketchy and hypothetical plans for the accumulated funds. Although Stone's testimony was corroborated by that of Rosenbaum, under the circumstances before us Rosenbaum's testimony was no more detailed than Stone's and was equally inconsistent with the course of conduct he engaged in.
The contemporaneous objective evidence conveys a contrary intention to that asserted by Stone and Rosenbaum. Stone argues that he was initially hopeful that Scientific would become a full-service supplier of electrical assemblies, thereby taking the place of Insul-8. He asserts that only after it became apparent that Schwartz could not do the job, did he decide to use Scientific to send money overseas for Chromcraft. But it is what he *768 did that decides this case even if it is different from his original plan. And in any event, it is clear that neither Stone nor Rosenbaum ever intended Scientific to be anything other than a conduit for the funds from Chromcraft to Swiss accounts controlled by Stone and Rosenbaum. 12 Scientific had no manufacturing facilities, no production staff, and no purchasing agents. Schwartz was its president by virtue of being Rosenbaum's friend; he had no knowledge of or experience with electrical components. Scientific's paperwork was done by a Chromcraft secretary on Scientific stationery ordered by Stone.
Moreover, the funds channeled through Scientific were placed in Swiss bank accounts under Rosenbaum's control, and none of these *769 accounts--not even the one in Chromcraft's name--were listed on any of Chromcraft's ledgers or financial statements. The moneys in these accounts were used for investments by Rosenbaum and "loans" by Stone. No corporations were acquired by Chromcraft, and no amounts were expended for rocket launcher promotion. The $2,000,000 spent on rocket launcher promotion and development was paid from the Chromcraft corporate treasury.
Subsequent events likewise convince us the transfers were made to advance the personal interests of Stone and Rosenbaum. When the grand jury investigation was taking place, inquiring into Rosenbaum's affairs concerning Scientific and the Chromcraft Swiss Fund, Rosenbaum paid Schwartz's expenses for a two-week trip to Europe; the payment was made from the Fund. Also, Rosenbaum executed an agreement for Schwartz whereby Schwartz would be held harmless for any taxes or claims arising out of Schwartz's connection with Scientific.
Even were we to find as a reason for the transfers the corporate purpose alleged by Stone and Rosenbaum, such purpose would be too vague and indefinite to negate constructive dividend treatment to Stone where "the withdrawal places *770 the money in * * * [his] absolute control and subject to his absolute discretion as to its use." Nasser v. United States, supra at 447 . This leads us back to the test of economic benefit outlined earlier. The crucial question here is whether Stone obtained sufficient power and control over the diverted funds or even receipt of the diverted funds to make it reasonable to treat him as the recipient of the income for tax purposes. See Commissioner v. Sunnen, 333 U.S. 591 (1948) . Such power and control exist where the taxpayer has "freedom to dispose of it at will, even though * * * it may be assailable by someone with a better title to it." Rutkin v. United States, 343 U.S. 130 , 137 (1952) . As the Supreme Court stated in Corliss v. Bowers, 281 U.S. 376 , 378 (1930) , "The income that is subject to a man's unfettered command and that he is free to enjoy at his own option may be taxed to him as his income, whether he sees fit to enjoy it or not." See also Burnet v. Wells, 289 U.S. 670 (1933) ; Helvering v. Horst, 311 U.S. 112 , 118-119 (1940) . *771
We believe the question must be answered in the affirmative. The payments from Chromcraft to Scientific were made and transferred at the direction and control of Stone (in conjunction with Rosenbaum). Some of the money so transferred was used to pay Stone's obligation to Price for services (by Scientific checks to her father, L. T. O'Connell), and some were disbursed to Stone's nephew, Andrew Smith. Additional sums were used to pay the expenses of Scientific and Schwartz. By far the largest amounts (about 80 percent) were transferred to Switzerland and deposited in bank accounts over which Rosenbaum (and at times, Stone) had complete dominion and control. The funds were remitted by Schwartz by checks written as payment on foreign invoices furnished by Stone and Rosenbaum, i.e., the funds were transferred in the amounts and at the times directed by Stone and Rosenbaum. Although Rosenbaum, whom Stone trusted like a brother, was more directly involved with the funds, both men were in the entire elaborate scheme together. Indeed, Rosenbaum kept Stone informed of the important personal applications of the Swiss funds, most particularly the acquisitions by Falrock.
We are unpersuaded *772 by petitioners' contention that they had no control over the persona of Schwartz. 13 We must look at what actually happened, not what could have, in determining petitioners' control over Schwartz's actions. Schwartz obviously believed, and so testified, that he was to take orders from Stone and/or Rosenbaum. Schwartz paid the invoices sent to him, and wrote the checks to Wolf, O'Connell, Smith and others as directed.
We are likewise unpersuaded by petitioners' attempts to distinguish the many cases cited as the basis for our decision 14 on the grounds that petitioners personally received no money or economic benefit from such money. As we have already found, Stone did use the funds in the Swiss accounts for his personal purposes, and derived economic benefit therefrom. In any event, it is not the enjoyment of income but the power to dispose of income and the exercise of that power that determines whether taxable income has been received. Helvering v. Horst, supra ; *773 Sammons v. Commissioner, 472 F.2d 449 (5th Cir. 1972) .
Our finding that the payments from Chromcraft to Scientific were constructive dividends to Stone poses no problem with regard to our stipulated decision entered January 5, 1973, in docket No. 7926-71, pertaining to consolidated returns of Ladevco and Scientific, wherein the receipts by Scientific from Chromcraft were determined to be income to Scientific in fiscal years 1964 through 1966. We have found that the consolidated returns there at issue were filed at Schwartz's suggestion to save tax money and to support the appearance of Scientific as a viable and separate subcontractor to Chromcraft. The stipulated decision does not preclude a determination that the same funds, siphoned through those "corporations," are income to Stone and Rosenbaum. Certainly there can be no bar of res judicata, as the same parties are not before us, nor is there any privity between Scientific or Ladevco *774 and Stone or Rosenbaum. Moreover, there can be no collateral estoppel, as a stipulated decision is "only a pro forma acceptance by the Tax Court of an agreement between the parties to settle their controversy for reasons undisclosed." Unless we can say that the decision reflected an adjudication on the merits, it has no greater effect than a compromise of the parties. United States v. International Bldg. Co., 345 U.S. 502 , 505 (1953) . Finally, it is clear that respondent was unaware when these settlements were reached that the corporations were simply conduits for Stone and Rosenbaum. Indeed, an essential part of the fraudulent scheme was keeping this knowledge from the Government.
As our analysis of the facts before us reveals that Stone did receive constructive dividends from Chromcraft during the years in issue, it remains for us to determine the amount. Stone and Rosenbaum had each an undefined, percentage interest in the Swiss funds, which has never been specified in amount. We believe the two were equally involved in the diversion and transfer of funds; they therefore should share equally in the amounts diverted and transferred. We conclude, *775 then, that Stone is chargeable with having received as constructive dividends 50 percent, or one half of the payments from Chromcraft to Scientific in the years and amounts as determined by respondent.
We have just stated that Stone and Rosenbaum were equally involved in the "scheme" to divert money to Swiss bank accounts, as described earlier. Respondent's determination that such moneys were "unreported income" to Rosenbaum "representing funds accruing to [his] benefit, etc." must be upheld in view of our decision with regard to Stone. Rosenbaum, therefore, received unreported income equal to 50 percent or one-half of the payments from Chromcraft to Scientific in the amount and years determined by respondent.
(b) Bregman Electronics, Inc. --The situation with respect to Bregman closely parallels, if it is not identical with, the situation regarding Scientific. Chromcraft continued to purchase raw materials for assembly by Wolf; Bregman now was the repository of the difference between the amounts paid by Chromcraft for the completed units and the labor costs of Wolf. Bregman, through its president Robert Bregman, made payments on fictitious foreign invoices and issued *776 various checks at the direction and control of Stone and Rosenbaum. The payments overseas were deposited in a Swiss bank account over which Rosenbaum at all times had control.
The payments to Bregman were for the purpose of accumulating funds in Switzerland for use by Stone and Rosenbaum. Bregman was merely a conduit for the funds from Chromcraft to the Swiss account, or in the words of Rosenbaum, a "company to run paperwork through." Bregman had no manufacturing facilities, no production staff, and no purchasing personnel. Robert agreed to be the president of Bregman as a favor to Rosenbaum; he had no knowledge of or experience with electrical components. Stone's secretary continued to do the paperwork involved. After the Chromcraft-Bregman phase was ended, Rosenbaum staked Robert in a business in Europe, and made additional funds available to him from the Swiss accounts. During the pendency of the criminal investigation against Stone and Rosenbaum, Rosenbaum made payments to Robert to ensure his cooperation.
The payments by Chromcraft to Bregmen were made under the same circumstances and for the same purposes as set forth in the discussion regarding Scientific. Accordingly, *777 50 percent or one-half of such payments disallowed by respondent, in the amounts and years determined, are constructive dividends to Stone. 15 The other 50 percent or one-half of the payments are "unreported income" to Rosenbaum.
(c)(1) Republic Electronics Industries, Inc.--Zuni Rocket Launcher --The findings of fact on this issue reveal that in January 1977, Chromcraft paid Republic $225,000 for the latter's rights to the Zuni rocket launcher, which Republic had acquired from its former controlling stockholder (Belock Instruments Corporation), and $30,000 later in the year to enable Republic to continue work on the development of the Zuni. After considering the evidence, we believe the price paid for the rights to the Zuni was a fair and reasonable one. The $30,000 payment for further development costs was based upon estimates by Republic's engineers. There is, and can be, no question that *778 Republic was a viable corporate entity, separate and distinct from Chromcraft. Stone was not an officer, director, or shareholder of Republic, although Rosenbaum had an indirect ownership interest in Republic through Falrock.
In our opinion, the payments by Chromcraft to Republic for the rights to the Zuni and to enable Republic to continue development of the Zuni were proper disbursements by Chromcraft and advanced Chromcraft's corporate purposes. The amounts so paid to Republic were deposited in its bank account, and were reported as income on its Federal income tax return. None of the moneys were ever transmitted to the Swiss bank accounts, and none were remitted to Stone or to Rosenbaum.
We conclude the Chromcraft payments did not confer an economic benefit upon Stone and do not constitute constructive dividends to him. Inasmuch as those payments were the income of Republic, they were not the "unreported income" of Rosenbaum.
(c)(2) Republic Electronic Industries, Inc.--Purchases of Materials --This issue was raised by respondent in his amended pleadings. Accordingly, respondent has the burden of proof on this issue. Rule 142(a) .
From the evidence, it is established *779 to our satisfaction that Republic was from the beginning envisioned as a functioning full-service supplier of electrical assemblies to Chromcraft. Shortly after Belock's 62 percent interest in Republic was acquired by Falrock, Chromcraft, in November 1965, issued two purchase orders to Republic for electrical assemblies. These were followed by two more in December 1965. Due to its commitments under Government contracts for navigation equipment, Republic was unable to fulfill its orders from Chromcraft with the requisite promptness, and, at Stone's suggestion, turned to Wolf to perform the necessary labor. Republic itself did ultimately fully perform on the two November purchase orders. The Wolf arrangement continued until July 1967 when the Tenbrook division became operational. From and after July 1, 1967, respondent has made no claim for increased deficiencies from Stone and Rosenbaum, presumably because he considers the Chromcraft-Republic relationship after that date to be entirely regular. The evidence is that Republic on occasions even after Tenbrook became operational continued to utilize Wolf when necessity required.
The payments which Chromcraft made to Republic represented *780 the cost of completed electrical assemblies which Chromcraft used in the manufacture of rocket launchers. All of such payments were deposited in Republic's own bank account and included in its own tax returns. Respondent has made no dollar adjustment to Republic's income. None of those payments were transmitted to Switzerland and none were kicked back to Stone or to Rosenbaum.
Respondent's assertions to the contrary notwithstanding, our conclusion is that Chromcraft did not pay inflated invoices from Republic. The prices charged by Republic for electrical assemblies were competitive with quotations Chromcraft had received from other companies. The prices charged after Tenbrook, about which respondent has evinced no concern, were in line with Republic's prices to Chromcraft prior thereto.
We conclude the Chromcraft pay

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Source: Frix Law Library, https://www.frixlaw.com/law-library/cases/4618446. Public record. Not legal advice.