Petition — Ocean Sands Holding Corp. v. Commissioner

ih eee ye Court, 6

892 - 2081 ELLE D

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ALEXANDER L. STEVM&S,

CLERK

No.

IN THE SUPREME COURT

OF THE UNITED STATES

October Term, 1982

OCEAN SANDS HOLDING CORPORATION,

a Virginia Corporation, et al.,

Petitioners,

Vv.

COMMISSIONER OF INTERNAL REVENUE,

Respondent.

PETITION FOR A WRIT OF CERTIORARI

FROM THE UNITED STATES COURT OF APPEALS

FOR THE FOURTH CIRCUIT

Carter R. Anderson, Jr.

Counsel for Petitioners

2240 N. Great Neck Road

Virginia Beach, Virginia

23451

Carter R. Anderson, Jr.

Counsel of Record

2240 N. Great Neck Road

Virginia Beach, Virginia

23451

(804) 481-4646

June 17, 1983

zeegt®

The other petitioners are as

follows in these consolidated cases:

(1)Sea Fin Holding Corporation v.

Commissioner, (2) Chattel Corporation

v. Commissioner, (3) Sea Star

Corporation v. Commissioner, (4) Colony

Holding Corporation v. Commissioner,

(5) Russell W. Chaplain, Jr. and Mary

H. Chaplain v. Commissioner, (6)

William G. Chaplain and Sandra B.

Chaplain v. Commissioner, (7) Russell

W. Chaplain, Sr. and Elsie B. Chaplain

v. Commissioner, (8) William J. Newton,

III and Linda G. Thornton, nee Linda G.

Chaplain, formerly Linda G. Newton v.

Commissioner.

he

QUESTIONS PRESENTED

I

Did the Commissioner of Internal

Revenue violate the Seventh Amendment

rights of the petitioners in assessing

duplicate and unjustifiably prohibitive

notices of deficiency against them

which precluded the payment of taxes

and suit for refund, with trial by

jury, in the United States District

Court.

II

Should the separate tax cases of

the petitioners been consolidated and

tried by the United States Tax Court

over their objections.

II!

Did the United States Tax Court

err in finding that the gross receipts

of the corporate taxpayers were

understated.

IV

Did the United States Tax Court

err in finding that the deductions for

depreciation and expenses of the

corporate taxpayers were overstated.

Vv

Did the United States Tax Court

err in finding that the statute of

limitations did not bar assessment and

collection of alleged deficiencies for

Ocean Sands Holding Corporation for

1967.

vi

Did the United States Tax Court

err in assessing fraud penalties

against two of the corporate

petitioners when it held the individual

taxpayers did not commit fraud based

upon identical conduct and evidence.

TABLE OF CONTENTS

Questions Presented

Table of Authorities

Opinions Below

Jurisdiction

Statutes Involved

Statement of the Case

Reasons for the Granting

of this Writ

Conclusion

3

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24

65

TABLE OF CONTENTS (APPENDIX)

Appendix A:

Memorandum Findings of Facts

and Opinion of the United

States Tax Court

Opinion of the United States

Court of Appeals for the

Fourth Circuit (Unpublished)

A-197

TABLE OF AUTHORITIES

CASES: Page

CANDELA v. UNITED STATES 60

635 F. 2a l2?72 (7th Cir. 1980)

CARTER v. CAMPBELL 61

264 F. 2d 930 (5th Cir. 1959)

COHEN v. COMMISSIONER 38

266 F. 2d 5 (9th Cir. 1959)

DARTMOUTH COLLEGE v. WOODWARD 29

4 Wheat (17 US) 518 (1819)

FOSTER v. COMMISSIONER 59

487 F. 2a 902 (6th Cir. 1973)

HALLE v. COMMISSIONER 42

7 T.C. 245 (1946)

HOLLAND v. UNITED STATES 33,59

348 U.S. 121 (1954)

JUD PLUMBING & HEATING v. 29

COMMISSIONER

153 F. 2d 681 (5th Cir. 1946)

KAHR v. COMMISSIONER 55

414 F. 2a 621 (nd Cir. 1969)

LOFTIN AND WOODARD, INC. v. 54,58

577 F. 2d 1206 (5th Cir. 1978)60,62

MEAD CORP. v. COMMISSIONER 29

F. (3rd Cir, 40)

MILLS v. COMMISSIONER 44

399 F. 24 744 (4th Cir. 1968)

-6-

Pave

POTTS, DAVIS & COMPAN* v.

COMMISSIONER

43 F. 2d 1222 (1970)

REVELL, INC. v. RIDDELL

273 F. 24 649 (9th Cir. 1959)

RUIDOSO RACING ASSOCIATION, INC.

v. COMMISSIONER

476 F. 2d 502 (10th Cir. 1973)

SAMMONS v. UNITED STATES

433 F. 2d 728 (5th Cir. 1970)

STONE v. COMMISSIONER

22 T.C. 8893 (1954)

STONE v. COMMISSIONER

56 7.C. 213 (i971)

WEIMENSKIRCH v. COMMISSIONER

596 F. 2d 358 (9th Cir. 1979)

WEIR v. COMMISSIONER

283 F. 2d 675 (6th Cir, 1960)

CONSTITUTIONAL PROVISIONS:

U.S. CONST. AMEND. VII

44

37

55

46

33

56

38

36

1l

OPINIONS BELOW

The Memorandum Findings of Fact

and Opinion of the United States Tax

Court, Tax Court Memorandum 1980-423 is

printed in Appendix A hereto, infra ,

page A-l.

The unpublished opinion of the

United States Court of Appeals for the

Fourth Circuit concerning the

consolidated cases of Ocean Sands

Holding Corporation, et al is printed

in Appendix A hereto, infra , page A-

197.

,

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7

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JURISDICTION

The judgment of the United States

Court of Appeals for the Fourth Circuit

(Appendix A, infra , page A-l) was

entered on February 11, 1983. The

jurisdiction of the Court is invoked

under 26 U.S.C. Section 7482(a) and 28

U.S.C. Section 1254(1).

CONSTITUTIONAL PROVISIONS

AND STATUTES INVOLVED

U.S. CONST. AMEND. VII

In Suits at common law, where the

value in controversy shall exceed

twenty dollars, the right of trial by

jury shall be preserved, and no fact

tried by a jury shall be otherwise re-

examined in any Court of the United

States, than according to the rules of

the common law.

26 U.S.C. Section 6501(e)(1)(A)

General rule. If the taxpayer

omits from gross income an amount

properly includible therein which is in

excess of 25 percent of the amount of

gross income stated in the return, the

tax may be assessed, or a proceeding in

court for the collection of such tax

may be begun without assessment, at any

time within 6 years after the return

was filed.

26 U.S.C. Section 7454(a)

Fraud. In any proceeding involving

the issue whether the petitioner has

been guilty of fraud with intent to

evade tax, the burden of proof in

respect of such issue shall be upon the

Secretary.

-ll-

sf

STATEMENT OF THE CASE

These cases originated in 1967

when, after reading newspaper accounts

concerning various individual members

of the Chaplain family being embroiled

in non-tax controversies with local

authorities, Internal Revenue Service

agents , who had been assigned cases on

individual taxpayers Russell Wilson

Chaplain, Sr. and his wife, Elsie B.

Chaplain, began investigations of

corporations owned by members of the

Chaplain family. the matters were

referred to the Criminal Investigation

Division of the Internal Revenue

Service for investigation of criminal

fraud and investigations of both

individual and corporate taxpayers were

begun.

As stated by the Tax Court “some

understanding of the, family history of

the Chaplains and their financial

transactions is essential to a fair and

proper evaluation of the merits of

these cases"; that family history

includes the following facts which are

not in dispute.

Russell Wilson Chaplain, Sr.

married his wife, Elsie B. Chaplain, in

1941 and together they raised eight

children, several of which have become

parties, as individual taxpayers to the

consolidated cases.

In 1950 the senior Chaplain was

found to have sugar diabetes and,

because of this, and other health

problems, he withdrew from active

involvement in the family businesses.

From 1950 on the senior Chaplain did

not participate in the family

businesses other than to occasionally

consult with those _penbers of the

family who were responsible for the

operation of the various businesses on

methods of building construction and

design and discuss generally how the

family interests might be advanced.

Russell Wilson Chaplain, Sr. never

owned stock in any of the corporations,

and was never a director, officer or

employee of any of the corporations.

Although the Tax Court

characterized Russell Wilson Chaplain,

Sr. as “the patriarch and the brain of

the Chaplain family" it was always

Elsie B. Chaplain who directed the

family in its various enterprises.

Elsie B. Chaplain was the sole

stockholder of any stock that had been

issued by any of the corporations. At

no point in time has Russell Wilson

Chaplain, Sr. ever claimed ownership or

involvement, Legh. oF beneficial, in

the corporations operated by his wife

and children.

Elsie B. Chaplain directed the

operation of the corporations; the

eldest son, Russell W."“Chappy"

Chaplain, Jr., and his brother, William

G. “Jerry” Chaplain, were in charge of

construction and maintenance of the

corporate properties and the eldest

daughter, Suzanne Chaplain Goldsticker,

was responsible for the maintenance of

all corporate records and the majority

of banking and bookkeeping for the

corporations.

The Commissioner determined

deficiencies in tax and additions to

tax against the petitioners for years

between 1967 through 1973.

Duplicate notices of deficiency,

by the admissions of the Internal

ines

Revenue Service, were assessed against

both individual and corporate taxpayers

in the cases. Due to the prohibitive

amounts alleged in the notices of

deficiency and the fact that these were

duplicated, the petitioners were unable

to pay the tax and then sue for a

refund in the United States District

Court.

Accordingly, the taxpayers filed

petitions for redeterminations of the

asserted taxes and additions to tax in

the United States Tax Court.

Separate cases were instituted bv

these petitioners in the Tax Court. By

order of the Tax Court, these cases

were consolidated for trial, briefing

and opinion over the objection of the

petitioners. Among these cases was the

case of Ocean Sands Holding Corporation

v. Commissioner of Internal Revenue

(Record No. 81-1467) in which the Tax

Court held that the 6 year statute of

limitations as set forth in 26 U.S.C.

Section 6501(e)(1) did not prohibit the

Commissioner from attempting to collect

an amount alleged in his notice of

deficiency to be in excess of 25

percent of the gross income stated in

the return of the petitioner even

though the only evidence presented by

the Commissioner was unsubstantiated ,

hearsay to which timely objection was

made by the petitioner.

During the years in question there

were five corporations owned and

operated by Elsie B. Chaplain and her

children:

1. Ocean Sands Holding

Corporation.

2. Colony Holding

Corporati.on.

3. Sea Yin Holding

Corporation.

4. Chattel Corporation.

5. Sea Star Corporation.

-17-

eos

Ocean Sands Holding Corporation

owned and operated the Kona Kai motel,

which consists of the land and

improvements located at 18th Street

between Atlantic Avenue and the

oceanfront in Virginia Beach, Virginia.

Colony Holding Corporation owned

and operated the Kona Kai East motel ,

which consists of the land and

improvements located at 16th Street

between Atlantic Avenue and the

oceanfront in Virginia Beach, Virginia.

Sea Fin Holding Corporation owned

and operated the Colony Motel and

Trailer Park and a Phillips 66 service

station, all of which consist of the

land and improvements located in the

900 block of Virginia Beach Boulevard

in Virginia Beach, Virginia.

-18-

Chattel Corporation and Sea Star

Corporation each owned one unimproved

let between 18th and 19th Streets on

the oceanfront in Virginia Beach,

Virginia.

The investigations by the

Commissioner as well as the proceedings

before the Tax Court were saturated

with hostility between the Commissioner

and his agents and individual members

of the Chaplain family; the Tax Court

recognized that there existed

“emotionalism and ... venom among the

parties". The Tax Court determined that

"Petitioners ... failed to preserve

diligently those business records that

were made" and assigned responsibility

for this failure to statements made by

the senior Chaplain. The

interpretations of the Tax Court of the

personalities and circumstances

-19-

revealed through the evidence became

its findings of fact. These findings of

fact were drawn from proceedings

typically marred by confusion,

invective, innuendo and in a pervasive

atmosphere of hostility.

The Tax Court filed its Memorandum

Findings of Fact and Opinion on

September 23, 1980 , and entered its

decisions on April 27, 1981. The Tax

Court entered its decisions in favor of

the Commissioner in three of the 22

consolidated proceedings, and in the 19

other cases, it determined amounts

owing somewhere between the amounts

asserted by the Commissioner and those

claimed by the taxpayers.

The Tax Court determined that the

conduct of the individual taxpayers did

not constitute fraud but that the

identical conduct Of, the same

individuals, in their capacity as

corporate officers, did constitute

fraud on the part of the corporate

taxpayers.

Taxpayers filed timely notices of

appeal and the cases were consolidated

for appeal in the United States Court

of Appeals for the Fourth Circuit by

its order dated July 16, 1981.

On February ll, 1983, in an

unpublished opinion, the United States

Court of Appeals for the Fourth Circuit

affirmed the decision of the United

States Tax Court.

The petitioners filed a timely

Petition for Rehearing with the United

States Court of Appeals for the Fourth

Circuit, which petition was denied by

that court on March 21, 1983.

-21-

REASONS FOR GRANTING THIS WRIT

The Commissioner initially filed

grossly inflated notices of deficiency

against these petitioners alleging huge

deficiencies and additions to tax due

becuase of alleged fraud. These figures

were in excess of $3,600,000.00.

The deliberate, gross

overstatement of deficiencies and

additions to the tax by the

Commissioner economically prohibited

the petitioners from paying the tax and

then suing for a refund in the United

States District Court and exercising

their Constitutional right to a trial

by jury.

The petitioners contend that the

record clearly shows that the huge

-22-

notices of deficiency and additions to

the tax were deliberately filed by the

Commissioner and that, based upon the

findings of the Tax Court these notices

of deficiency and additions to the tax

claimed by the Commissioner were,

without exception, greatly in error.

The petitioners contend that they

owe no tax; however had the

Commissioner utilized an accurate and

sensible method of estimation of income

the petitioners would have been well

able to pay the alleged tax and then

sue for a refund before a jury.

The Tax Court recognized the

hostility that existed between the

Commissioner and the petitioners. The

hostility was not one sided and the

petitioners submit that, as a result of

their hostile feelings towards the

petitioners agents of the Commissioner

-23-

intentionally inflated all of the

figures in the notices of deficiency

and additions to the tax to such an

incredible level for the purpose of

ensuring that the petitioners could not

pay the tax and thus sue for a refund

before a jury in the United States

District Court.

The petitioners submit that this

constant course of conduct by agents of

the Commissioner was in derogatiion of

their civil rights and was intended to,

and did, effectively prevent them from

exercising their Constitutional rights

under the Seventh Amendment to the

United States Constitution.

It

The petitioners involved in these

consolidated cases noted their

separate, distinct. Apa independent

appeals. Unfortunately, the findings of

fact and determinations of the United

States Tax Court, and thus the fates of

the corporations, became inextricably

enmeshed with the cases of the

individuals, most notably that of

Russell Wilson Chaplain, Sr..

The Tax Court's interest in the

personality of Russell Wilson Chaplain,

Sr. led it to anthropomorphize the

petitioner corporations and attribute

to them his motivations, passions,

emotions and thought processes. This

line of association eventually led the

Tax Court to refer to the senior

Chaplain as a corporate officer when

there is no evidence upon which to base

this deduction.

It is important to keep in mind

the magnitude of the cases against

petitioners. The Commissioner asserted

over $3,600,000 in deficiencies and

additons to tax which covered sixty

separate matters to be considered by

the Tax Court. There were thirteen

separate individual and corporate

petitioners.

Yet, at the hearing held January

17, 1979, the Tax Court ordered the

cases of the individual and corporate

petitioners consolidated for trial,

briefing and opinion.

The petitioners desired, and were

entitled to, separate consideration of

each of their cases on the merits.

There can be no question that a

corporation is a separate legal entity.

This was first established by the

decision of this Court in the case of

Dartmouth College v. Woodward , 4 Wheat

(17 US) 518, 635 (1819). It is also

equally clear that she corporate entity

"is not to be disregarded merely

because the corporation is controlled

by a single family" Mead Corporation v.

Commissioner , 116 F2d 187 (3rd Cir.

1940); Jud Plumbing & Heating, Inc. v.

Commissioner , 153 F2d 681 (5th Cir.

1946).

In denying the petitioners

separate trials the Tax Court ruled to

the prejudice of the petitioners.

III

The Tax Court determined that

Ocean Sands Holding Corporation (Kona

Kai), Colony Holding Corporation (Kona

Kai East) and Sea Fin Holding

Corporation (Colony Trailer Park and

Motel) gross receipts were understated

by petitioners for various tax years

from 1967 to 1973.

-27-

or

These findings were reached after

presentation at trial, by the

Commissioner, of multiple, often

conflicting, methods of reconstruction

of the income of petitioners.

The Commissioner utilized three

basic methods of reconstruction of

income of the petitioners and altered

his approach towards reconstruction in

an effort to maximize the liability of

the petitioners as opposed to trying to

ascertain the actual liability, if any,

actually existing. These methods were:

1. Direct Method: This method

consisted of reconstruction

of gross income based upon

the records of petitioners,

such as motel registration

cards.

2. Linen Expense Method: This

method was initially employed

-28-

by state tax investigators in

investigating alleged sales

tax deficiencies. The method

consisted of estimating the

occupancy of motels by

interpolation of linen

expense for that motel.

3. Income from Comparable

Motels: This approach was

"based upon the assumption

that gross receipts per room

per month must have been

equal to the average receipts

per room per month of a group

of comparable motels in

Virginia Beach."

A fourth, ancillary method

employed by the Commissioner to

increase his determination of

petitioners' alleged income was the

reconstruction of alleged income from

-29-

telephone charges. Evidence was

introduced at trial which showed that

during the years in question C&P

Telephone Company charged five cents

($.05) per message unit to petitioners

for telephone service. IRS agents

assumed, without substantiation, that

| appellants charged motel guests twenty-

five cents ($.25) per call and

therefore charged petitioners with

twenty-cents ($.20) income for each

telephone message unit. This unfounded

assumption remained unproven at trial.

A fifth, ancillary method employed

by the Commissioner in reconstructing

income for Sea Fin Holding Corporation

(Colony Trailer Park and Motel)

consisted of a review of the records of

Virginia Electric and Power Company

(Vepco) which purported to accurately

ascertain the number of paying tenants

staying at the park at any given time.

The record continually reflects that

the estimates of spaces available at

the park during any given tax year were

a source of continuing controversy.

Citing Holland v. United States ,

348 US 121 (1954). The Tax Court held

that where the taxpayer's records were

inadequate or nonexistent, the

Commissioner would be allowed to

reconstruct income by the use of any

method which would, in the opinion of

the Commissioner, clearly reflect

income.

The only restriction on this rule

is that the method adopted must be

reasonable. Stone v. Commissioner , 22

T.C. 893, 905 (1954).

After finding the Commissioner to

have inflated his determinations by an

-3l-

average of 50%, the Tax Court further

reduced those determinations by

arbitrary percentages to reflect the

existence of special factors affecting

the various petitioners. It would seem

that if the methodology of the

Commissioner was reasonable then it

would have reached reasonable

determination of reconstructed income

and the equitable intervention of the

Tax Court would not be have been

necessary to protect the taxpayers.

The decision of the Tax Court

reflects the following margins of error

by the Commissioner.

1. Ocean Sands Holding Corporation

(1967, 1968 and 1969):

The Court determined that the

Commissioner had inflated

determinations approaching an average

—

margin of error of 50% for the years in

question

V4

Ocean Sands Holding Corporation

(1971, 1972 and 1973): The Tax Court

determined that the Commissioner

overstated his determinations of

deficiency, on the average, by a margin

of error of 50%.

3. Colony Holding Corporation

(1972 and 1973): based upon the same

methods and evidence the Tax Court

found that the Commissioner overstated

his determinations of deficiency

against this petitioner, on the

average, by a margin of error of 72%.

4. Sea Fin Holding Corporation

(1971, 1972 and 1973):

The Tax Court found that the

Commissioner overstated his

determinations of Sot Set pacr against

this petitioner on the average, by a

margin of error of 18%; this is

contrasted with the average of 5.5%

error of understatement attributed to

the petitioner.

These petitioners were constantly

required by the Tax Court to prove that

they did not receive income as

determined by the Commissioner. The

case of Weir v. Commissioner of

Internal Revenue , 283 F.2d 675 (6th

Cir. 1960) states,

"The law imposes much less of

a burden upon a taxpayer who

is called upon to prove a

negative - that he did not

receive the income which the

Commissioner claims ..."

The Sixth Circuit, in the above

case, goes on to state,

"The Commissioner's

determination is presumed

correct, but if error is

shown, the presumption

disappears and the

Commissioner then has the

burden ~. roving the

correctness of his

determination, or at least

the correct amount actually

due."

In these cases the Commissioner made

conflicting determinations against

these petitioners. In Revell, Inc. v.

Riddell , 273 F.2d 649 (9th Cir. 1959)

the Court observes that,

"Conceivably the Commissioner

may lose the benefit of such

presumption if it should be

made to appear to the Tax

Court that the Commissioner

has made conflicting

determinations against the

same person in respect to the

same income. In such event

the burden of proof would be

upon the Commissioner to

establish the correctness of

his determination."

A deficiency determination which

is not supported by the proper

foundation of substantive evidence is

clearly arbitrary and erroneous.

Weimenskirch v. Commissioner , 596 F.2d

358 (9th Cir. 1979).

-3$-

The core flaw running throughout

all of these consolidated cases is the

consistent arbitrary determination, by

the Commissioner, of huge amounts of

income deficiencies asserted against

the petitioners, both individual and

corporate. The Commissioner blatantly

duplicated huge determinations of

deficiency. Coupled with this is the

consistent holding of the Tax Court

that the Commissioner repeatedly

overstated deficiencies by an average

margin of error of 50%.

The Ninth Circuit states the law,

and petitioners' argument, eloquently

in the case of Cohen v. Commissioner of

Internal Revenue , 266 F.2d 5 (9th Cir.

1959) in the following opinion,

"When the Commissioner's

determination has been shown

to be invalid, the Tax Court

must redetermine the

deficiency. The presumption

as to the correctness of the

Commissioner's determination

is then out of the case. The

Commissioner and not the

taxpayer then has the burden

of proving whether any

deficiency exists and, if so,

the amount. It is not

incumbent upon the taxpayer

under these circumstances to

prove that he owed no tax or

the amount of the tax which

he did owe.

The Commissioner's

determination is invalid when

it is arbitrary or erroneous.

Whether or not the

Commissioner's determination

in this case was arbitrary,

it was at least erroneous in

substantial respects, Cohen

accordingly met his burden of

proof of proving that the

Commissiner's determination

was invalid.

The question is not whether

the determination was invalid

after the Tax Court had

reduced it by 85%. The

pertinent inquiry is whether

it was invalid as originally

computed by the Commissioner.

Cohen, having met his burden

of proving the Commissioner's

determination invalid, and

thus taking the presumption

of the correctness of that

determination out of the

case, was not chargeable with

failure to make a further

showing. fgnee it was

improper for the Tax Court in

making its redetermination to

accept its maximum possible

gross income figure as the

actual figure only because

Cohen failed to show a lesser

amount."

In the cases before this Court the

above opinion applies with equal force.

The holdings of the Tax Court clearly

show the Commissoner's initial

determinations of deficiency against

these petitioners to have been

arbitrary, or at the very least,

grossly erroneous. This being the case,

the Tax Court should have held that the

Commissioner had forfeited the

presumption of correctness that

normally attaches to his determinations

and the Tax Court should have ensured

that the burden of proof was shifted

upon the Commissioner instead of

allowing it to remain, wrongly, upon

these petitioners to combat the

-38-

incredible allegations levied by the

Commissioner.

IV

The Tax Court determined that

depreciation and business expense

deductions were overstated by the

corporate petitioners in these

consolidated cases.

Ocean Sands Holding Corporation's

basis for depreciation of the Kona Kai

was $301,000. Colony Holding

Corporation's basis for depreciation of

the Kona Kai East was $473,622. In the

notices of deficiency the Commissioner

adjusted the Kona Kai's basis to

$204,600 and did not allow the Kona Kai

East any depreciation expense.

The Commissioner also disallowed

numerous expense deductions in addition

to depreciation for, Ocean Sands Holding

Corporation, for Colony Holding

Corporation and for Sea Fin Holding

Corporation.

Although the Commissioner touted

the validity of the comparable method

for reconstruction of the income of

petitioners, he refused to even

consider comparable expenses of the

other motels.

In looking at these obvious

inconsistencies it is apparent that the

Court erred in allowing the

Commissioner to retain the presumption

of correctness while it invoked Halle

v. Commissioner 7 T.C. 245 (1946) to

claim that the evidence of the

petitioner's amounted to mere

reaffirmance of return data which was

unworthy of consideration.

-40-

When faced with these cases the

taxpayers were faced with substantial

difficulty in reconstructing events due

to the length of time that had passed

and the sheer volume of research

necessary.

The one person who could

adequately bring all of this

information together was Russell W.

"Chappy” Chaplain, Jr. and he did so by

painstakingly itemizing and

reconstructing the costs of the motels.

The Tax Court recognized that the

cost basis for the Kona Kai and the

Kona Kai East was considerably less

than the appraised value of the

structures when they were completed.

The Court correctly indicated that the

tax basis for depreciation was the

actual cost of the buildings. Again,

the only person with any knowledge of

the cost basis was "Chappy”™ and yet the

Court largely ignored his evidence.

In Potts, Davis & Company v.

Commissioner ,43l1 F.2d 1222 (1970) the

Court stated "the Tax Court is not ...

free to ignore the uncontroverted

testimony of the taxpayer". It is

clearly error for the court to have

ignored the testimony of the witness

most knowledgeable in these matters on

the basis that he was a party to the

proceedings.

An arbitrary assessment by the

Commissioner may destroy the

presumption that his determination of

deficiency is correct. Mills v.

Commissioner , 399 F.2d 744 (4th Cir.

1968).

It logically follows that, with

the articulated cognizance of the Court

-42-

of the distrust, hate and disharmony

between the parties, to allow the

Commissioner to retain his presumption

of correctness in the disallowance of

petitioner's proper depreciation and

business expense deductions after such

obviously arbitrary exercise of this

presumption that the Court clearly

erred.

The Tax Court, basing its opinion

on Section 6501(E) of the Internal

Revenue Code determined that the

Commissioner was not barred by the

Statute of Limitations in assessing tax

for the year 1967 against Ocean Sands

Holding Corporation.

The deficiency notice for 1967 was

dated March 10, 1972. Where the

Commissioner aotre oe the above

cited section in the assessment or

collection of tax he has the burden of

proving facts and circumstances

entitling him to the application of the

section. Sammons v. United States , 433

F.2d 728 (5th Cir. 1970).

The Tax Court determined that the

Commissioner had met his burden based

on the Court's findings that the

corporation had gross income of $62,010

in 1967 and had reported gross income

of $29,106.51 on its 1967 corporate

return.

The gross receipts in the subject

year, as found by the Tax Court, were

based upon Ocean Sands reconstructed

income as determined from the use of

spread sheets showing alleged laundry

expenses and telephone charges.

-44-

The Tax Court also held that

during at least a portion of 1967,

construction on all the motel rooms was

not completed; the elevator was not

completed and that for varying periods

between 1967 and 1973 as many as four

rooms were used by Suzanne Chaplain

Goldsticker as a manager's apartment.

It was uncontradicted that, during

1967, there were only 24 rooms

available for rent in the motel

operated by the corporation.

The laundry expenses were based

solely upon work papers prepared by

Virginia State Tax authorities.

During the course of trial, a

subpoena duces tecum was served on

National Linen Service demanding the

production at trial of records

pertaining to Ocean Sands Holding

Corporation to inclyde invoices,

delivery tickets, books of entry and

journal ledger entries through which

the Commissioner intended to attempt to

justify the figures contained in the

spread sheets prepared by the state tax

investigator, subsequently obtained by

the Commissioner and upon which the

Commissioner relied for his proof in

establishing deficiencies against the

petitioner for the year 1967.

However, at the time of trial, the

records were not available, having been

routinely destroyed by National Linen

Service pursuant to their usual

administrative procedure in purging old

records. The only documentary evidence

available through the linen service was

the National Linen Service Price List

in effect in 1967 . The delivery

invoices and other records had only

been maintained for a period of three

-46-

years and then were destroyed as

outlined above.

Statutes of limitation are enacted

for the very purpose of preventing what

happened in this case. The Commissioner

has utilized a state revenue agent's

schedule based upon records which no

longer exist because of the passing of

time.

Despite the continuing objection

of the petitioners, the Tax Court

admitted this hearsay and the

Commissioner accordingly argued, that

based upon this hearsay, he had met his

burden of proof in proving that facts

in this case merited the exception to

the three year statute of limitations.

Since the issue in controversy was

the amount of gross income received by

the corporation in 1967, and since the

-47-

resolution of this controversy turned

on proof of laundry expenses, it was

therefore, exceedingly prejudicial to

the corporation for the Tax Court to.

admit this tainted information that was

so clearly rank hearsay.

The Tax Court reduced the gross

receipts claimed by the Commissioner by

a straight fifteen per cent, and giving

as its reason the facts that 1967 was

the first year of operation for the

motel, that the elevator was missing

and that the building was still under

construction, reduced the gross

receipts by yet another ten per cent,

all for a total 25% reduction in the

Commissioner's proof by the comparable

method. The overall reduction from the

original deficiency determination by

the Commissioner was in the amount of

$32,181; this Sigesy means that the Tax

Court found that there was a 52% error

between the Commissioner's

determination of deficiency as stated

in the notice of deficiency and the

evidence the Commissioner presented at

trial. It is clear from the decision of

the Tax Court that the Commissioner

failed to meet his burden.

On review, the Commissioner should

be barred by the three year statute of

limitations from further attempts to

assess or collect alleged deficiencies

from this taxpayer for the year 1967.

VI

The Tax Court's findings of fraud

on the part of the corporate

petitioners, Ocean Sands Holding

Corporation and Colony Holding

Corporation, are illogical and

inconsistent with its other findings of

lack of fraud in these consolidated

cases.

In the cases of the eight

individual taxpayers the Tax Court

held, correctly, that the Commissioner

had “not carried that burden in proving

fraud in the cases of any of the

individual petitioners". This holding

was based upon " the conduct of the

individuals involved and the

surrounding circumstances". The case of

Stone v. Commissioner , 56 T.C. 213,

223-224 (1971) was referenced by the

Tax Court as authoritative in adopting

this viewpoint. With this the corporate

petitioners agree.

Similarly, in the cases involving

Sea Fin Holding Corporation, the Tax

Court correctly found that the

Commissioner had “failed to carry his

burden of proof of clear and

convincing'. proof with respect to the

fraud penalties against Sea Fin".

Therefore, the holdings of the Tax

Court that these two corporate

petitioners should be singled out held

to have committed fraud does not

logically follow.

That these findings are illogical

is only accentuated by the Tax Court's

own observations that it recognized the

" inherent imprecision in the method of

reconstruction". used by that Court in

determining income to the corporations.

and that the weakness of the

Commissioner's case was underscored by

the huge discrepancies between cash

dividends asserted for fraud purposes

and figures asserted for deficiency

purposes.

~$l<

The Tax Court correctly held that

“the burden of establishing fraud, by

clear and convincing evidence, is upon

the Commissioner. Foster v.

Commissioner , 487 F.2d 902, 903 (6th

Cir. 1973), 26 U.S.C. Section 7454(a).

In the case of Loftin and Woodard,

Inc. v. United States , 577 F.2d 1206

(Sth Cir. 1978), Court warned,

"Fraud is not easily shown.

It implies bad faith,

intentional wrongdoing, and a

sinister motive ...

negligence, whether slight or

great, is not equivalent to

the fraud with intent to

evade tax named in the

statute. The fraud meant is

actual, intentional wrong-

doing, and the intent

required is the specific

purpose to evade a tax

believed to be owing ...

added to this is the burden

placed upon the

Commissioner."

The specific intent referred to by

the Court was addressed in the case of

Kahr v. Commissioner , 414 F.2d 62l,

=S30

627 (2d Cir. 1969) where it was clearly

stated that,

",.. the requirements that

specific intent be proved

before either the civil fraud

addition may be assessed or

the criminal sanction may be

imposed are identical."

Keeping well in mind the holding

of the 10th Circuit that,

"The Commissioner has the

burden to prove fraud for

each year by clear and

convincing evidence" Ruidoso

Racing Association, Inc. v.

Commissioner , 476 F. 2d 502

(10th Cir. 1973).

Based upon the record in the Tax

Court it is clear that, as regards the

five tax years for which it is asserted

that these two corporations understated

income, that the Commissioner inflated

determinations in the total amount of

$263,250 and averaged over a 51% margin

of error. These gross inaccuracies on

the part of the Commissioner were part

-53-

LS Lae

of a continuing course of conduct

against these petitioners. For the

taxable years 1967, 1968 and 1969 the

Commissioner inflated determinations

against Ocean Sands Holding Corporation

in a total amount of $135,025 at an

average margin of error of 49%.

The Commissioner “alleged as his

basis for fraud that gross receipts

were understated and that adequate

records were not maintained".

If the findings of the Tax Court

are contrasted with its findings as to

the errors in deficiences determined

and asserted by the Commissioner the

results are extremely instructive.

According to the Tax Courts own

findings, during the years 1971, 1972

and 1973 Ocean Sands Holding

Corporation understated income by an

average of 19%; in Page the same

years the Tax Court found the

Commissioner's determinations to have

been inflated by an average of over

37%. Remembering that the Tax Court's

reconstruction of income was based upon

an “inherently imprecise method" Ocean

Sands Holding Corporation was still

almost 20% more correct than the

Commissioner on the average. For the

years 1972 and 1973 the Tax Court found

Colony Holding Corporation to have

understated income by an average of

33%; yet during these same years the

Commissioner's determinations were

found to have been inflated by an

average of 72%. Both corporate

petitioners, averaged together, were

found to have understated income by an

average of approximately 26% for the

taxable years in question. For the same

taxable years the Commissioner was

found to have ee his assertions

‘

of deficiency by an average of more

than 54%. Simple arithmetic shows that,

based upon the Tax Court's own

findings, that the corporate

petitioners were more than 100% more

accurate than the Commissioner in their

reported income for the taxable years

in question.

In finding that these two

corporate petitioners committed fraud,

the Tax Court relied upon its finding

of a pattern of substantial

understatement of gross receipts as the

basic factor for its holding. In the

case of Loftin and Woodard, Inc. v.

United States , supra, the Court held

that “case law does not indicate that

consistent and substantial

understatement of income is sufficient,

by itself, to support a finding of

fraud". The Tax Court found the

-56-

Commissioner to have consistently made

grossly inflated determinations and to

have consistently overstated the

determinations without substantiation.

In the case of Holland v. United States

, 348 US 121 (1954), this Court warns,

"Appellate courts should

review the cases, bearing

constantly in mind the

difficulties that arise when

circumstantial evidence as to

guilt is the chief weapon of

a method that is itself only

an approximation"

Petitioners contend that the above

admonition is especially applicable in

these cases.

Inadequacy of Records The Tax

Court found as a “badge of fraud" that

the "petitioners failed to keep

complete books and records and that

their bookkeeping system was wholly

inadequate". Again, in the case of

Loftin and Woodard, Inc. v. United

States , we are told that an indicia of

WS shot St |

eee

fraud is the “lack of adequate books

and records which one would expect of

the particular taxpayer, based upon his

business experience, education,

knowledge of books and records, etc."

The record is replete with evidence

that these are corporations operated by

family members who do not have the

benefit of sophisticated, formal

educations. Taxpayers with limited

education and training in the keeping

and maintaining of business records are

not held to the same standard of

accountability as those with extensive

background and education in the field.

Candela v. United States , 635 F. 2d

1272 (7th Cir. 1980). The record

further shows that the petitioners

maintained adequate, albeit simple,

records and that the difficulty

concerning the records results from the

fact that numerous specords have been

lost, stolen or destroyed by fire over

the past 17 years. The Tax Court holds

another “badge of fraud" to be the

"history of repeated incidents,

including a series of fires (two of

which are highly suspicious), in which

records were allegedly destroyed.” The

petitioners have consistently explained

their inability to produce certain

records; the Commissioner has

consistently hinted that this is

“suspicious”. In Carter v. Campbell ,

264 F. 2d 930 (5th Cir. 1959), the

Court states,

"Fraud implies bad faith,

intentional wrongdoing and a

sinister motive. It is never

imputed or presumed and the

courts should not sustain

findings of fraud upon

circumstances which at most

create only suspicion."

Lack of Cooperation The Tax Court

found "Petitioners' officers' refusal

to cooperate with the revenue agents in

-59-

their investigation" to be an

additional “badge of fraud". Again, in

Loftin and Woodard, Inc. v. United

States , supra, the Fifth Circuit

reminds us that,

"Where fraud is alleged

against a corporate taxpayer,

the requisite proof of

fraudulent is to be found in

the acts of its officers,

inasmuch as the corporation,

being an artificial person

created by law, can have no

separate intent of its own

apart from those who direct

its affairs."

In that same case the Court also

advises that,

"In investigating the issue

of corporate fraud, the court

must determine whether the

conduct and intentions of the

corporations and/or agents

may be imputed to the entity

itself.”

It is clear from the record that,

even after being advised that she and

her husband were personally under

criminal investigation, Elsie B.

Chaplain cooperated fully with revenue

-60-

o, Sa

agents investigating the petitioner

corporations and that Suzanne Chaplain

Goldsticker, who was a corporate

officer and is not a party to any of

these proceedings, also cooperated

fully. The Tax Court prejudices the

petitioner corporations when it

attributes the alleged non-cooperative

attitude of Russell Wilson Chaplain,

Sr. to the corporations.

Use of Cash The Tax Court finds,

as a further factor in its

determination against these

petitioners, the “extent to which the

petitioners dealt in cash" and "the

general custom of each of the

corporations of dealing substantially

in cash". Again, the Tax Court

prejudices the petitioner corporations

when it links the emotional aversion of

Russell Wilson enagnes. Sr. to dealing

peg

with banks to the corporations. Russell

Wilson Chaplain, Sr. was not an owner,

director, officer or employee of these

corporations. The personal feelings of

Russell Wilson Chaplain, Sr. about

banks, or anything else, are not proper

evidence, much less proof of fraud,

against the corporations. These

corporations operate motels. Travelers

deal in cash. Merchants and suppliers

give discounts for cash payment. The

Tax Court's findings as to the use of

cash in the business dealings of the

petitioner corporations constitute

error against them.

=-2-

CONCLUSION

For the foregoing reasons this

Petition for a Writ of Certiorari

should be granted.

Respectfully submitted,

Se Kad

Carter R. Anderson, @r.

Counsel for Petitioners

Carter R. Anderson, Jr.

Counsel of Record

2240 N. Great Neck Road

Virginia Beach, Virginia 23451

(804) 481-4646

June 17, 1983

ae

CERTIFICATE OF SERVICE

Pursuant to Rule 28.5(b) of the

United States Supreme Court I hereby

certify that on the _17th day of June,

1983, by my bt suatien, Susan S.

Williams of Lawyers Printing Company,

Suite B-115, 7th and Franklin Building,

Richmond, Virginia, mailed first class

postage prepaid, from Richmond,

Virginia, three copies of the foregoing

Petition for a Writ of Certiorari to

Glenn L. Archer, Jr., Esq., Assistant

Attorney General and Michael L. Paup,

Esq., Ann B. Durney, Esq., and Stanley

S. Shaw, Jr., Esq., Attorneys, Tax

Division, Department of Justice,

Washington, D.C. 20530.

LAV.

Carter R. Anderson, Jry