Petition for Writ of Certiorari — Davis v. United States

Page

Opinions Below ............-.+eeeeeeeeeeeseeeeees 1

ci ns vanscbns ae nnesceesnseeseeeeeaan 1

Question Presented ...........-++eeeeeeeeeeeeereee 2

Statutes Involved .......... cece ccc ccccecsecccces 2

Ne acaccceasee eaunonnFNeneicseantpaee 4

Reasons for Granting the Writ .............++++++- 9

RR gc ook cas cans vnc cesnccesineessonceseses 33

Appendix ........ ee cece cece eee eee e eet e eee eens la

CITATIONS

CasEs:

Alison v. United States, 344 U.S. 167 ............. 25

Anderson v. United States, 11 F. 2d 938 .......... 14

Anktell Lumber & Coal Co. v. United States, 1 F.

Supp. 724 ........ cece cece este eee e tee eeeses 29

Beretta v. Commissioner, 141 F. 2d 452, cert. denied

Es Srey ere ee 15

M. E. Blatt Co. v. United States, 305 U.S. 267...... 28

Byers v. Commissioner, 199 F. 2d 273 ............ 29

Capital Estates v. Commissioner, 138 F. 2d 156.... 12

Chettanooga Sav. Bank v. Brewer, 17 F. 2d 79, cert.

denied, 274 U.S. 751 ....... 2... sees eee eee eee 29

Jack M. Chesbro, 21 T.C. 123, aff’d, 225 F. 2d 674.. 26

Choate v. Commissioner, 129 F. 2d 684 ........... 12

Christopher v. Burnet, 55 F. 2d 527 ..........---. 29

Clark v. United States, 211 F. 2d 100 ............ 14, 20

Commissioner v. Estate of Bedford, 325 U.S. 283... 13

Commissioner v. Court Holding Co., 324 U.S. 331... 14

Commissioner v. Glenshaw Glass Co., 348 U.S. 426 12

Commissioner v. Goldwyn, 175 F. 2d 641 .......... 12

Commissioner. v. Jacobson, 336 U.S. 28 ........... 12

Commissioner v. Munter, 331 U.S. 210 ........... 13, 28

Commissioner v. Wheeler, 324 U.S. 542 ........... 13

Commissioner v. Wilcox, 327 U.S. 404........ 17, 18, 24

ii

Index Continued

Page

Currier v. United States, 166 F. 2d 346

11, 23, 24, 25, 26, 27

Davis v. United States, 160 U.S. 469 ............ a Ww

D. W. Dawkins, 14 T.C.M. 684 ...............45. 30, 31

Doyle v. Mitchell Brothers Co., 247 U.S. 179 ....... 14

Edwards v. Douglas, 269 U.S. 204 ................ 15

Faris v. Helvering, 71 F. 2d 610, cert. denied, 293

ee ea ca beh ses hadscavenctescinass 15

Faweus Machine Co. v. United States, 282 U.S. 375 14

Freuler v. Helvering, 291 U.S. 35 .............45. 19

P. Garvan, Ine. v. Eaton, 20 F. 2d 422 ............ 29

Gleckman v. United States, 80 F. 2d 394 .......... 11, 20

Hadley v. Commissioner, 36 F. 2d 543 ............ 29

Healy v. Commissioner, 345 U.S. 278 ............. 17

Helvering v. Canfield, 291 U.S. 163 ............... 15

Helvering v. Griffiths, 318 U.S. 371 ............... 12

Helvering v. Horst, 311 U.S. 112 ..............45. 18

Helvering v. Mitchell, 303 U.S. 391 ............... 10

Holland v. United States, 348 U.S. 121 ......... 6, 10, 32

Jackson v. Commissioner, 172 F. 2d 605.......... 12, 15

Jones v. Dawson, 148 F. 2d 87 .............0008. 13, 15

Jordan v. DeGeorge, 341 U.S. 223 ................ 33

Kasper v. United States, 225 F. 2d 275............ 32

Klein v. Board of Supervisors, 282 U.S. 19........ 22

Lawrence v. Commissioner, 143 F. 2d 456......... 15

Leland v. Commissioner, 50 F. 2d 523, cert. denied

EE Ce inc kin beck ukee wae bbandeceacesn

Lincoln Nat. Bank v. Burnet, 63 F. 2d 131 ......... 23

Lynch v. Hornby, 247 U.S. 339 ..... 6... ee eee eee es 23

McCaughn v. MeCahan, 39 F. 2d 3 ............... 15

Bennett E. Meyers, 21 T.C. 331 .................- 30

Moline Properties v. Commissioner, 319 U.S. 436

11, 14, 21, 23

National Carbide Corp. v. Commissioner, 336 U.S.

SR cia iwahanns hea deahestesce nus 11, 14, 21, 22, 23

National Investors Corp. v. Hoey, 144 F. 2d 466.... 22

Palmer v. Commissioner, 302 U.S. 63 ............ 12, 13

Paramount-Richards Theatres v. Commissioner,

8 RRS Serer eer eee ree

Michael Potson, 22 T.C. 912 ................00055 30

Estate of Putnam v. Commissioner, 324 U.S. 393. .13, 23

Index Continued iii

Page

Regensburg v. Commissioner, 144 F. 2d 41, cert.

denied, 323 U.S. 783 ........... ee esses eee eeees

Estgte of Rogers v. Commissioner, 320 U.S. 410.... 18

Rutkin v. United States, 343 U.S. 130

11, 12, 15, 16, 18, 20, 21

13

Mbield Co., 3 TC. TER .n.n cn cancccccencscscessess

Smith v. United States, 348 U.S. 147 ...........-- 10

Spies v. United States, 317 Se ca 04 tA cease A 10, 27

Texas v. Florida, 306 U.S. 398 ...........-0. ee ee 31

United Mercantile Agencies, Inc., 23 T.C. No. 139. .30, 31

United States v. Augustine, 185 F. 2d 407

11, 23, 25, 26, 27

10

United States v. Augustine, 189 F. 2d 587 .........

United States v. Bruswitz, 219 F. 2d 59, cert. denied,

Re TE, GES ok kan ckcnenn6Gs ser abineessases exe

United States v. Iozia, 104 F. Supp. 846 .......... 26

United States v. Johnson, 319 U.S. 503 ........... 10

United States v. Joliet & Chicago R. Co., 315 U.S.

BR. Sle Ces OME EL A A KASS Kise pea 14, 22

United States v. Lewis, 340 U.S. 590 ............ 17, 19

United States v. E. Regensburg & Sons, 221 F. 2d

336, cert. denied, October 10, 1955 ............-: 29

United States v. Schenck, 126 F. 2d 702, cert. denied

sub. nom. Moskowitz v. United States, 316 U.S.

ON 6 os a FONG CAG AN hawt AOE ES ARR ONS R EO KERDND 11

United States v. Smith, 206 F. 2d 905............ 11, 27

Wiese v. Commissioner, 93 F. 2d 921, cert. denied,

be ag reer eer yer tery ers Tt 29

F. A. Wilson, 5 T. C. M. 647, aff’d on another issue,

163 F. 2d 680, cert. denied, 332 U.S. 842......... 31

SratutsEs:

Internal Revenue Code of 1939:

iv Index Continued

Page

Internal Revenue Code of 1954:

Sec. 316(a) ..... 2. cece eee cece eee tener ee eees 12

ie I in Ken kone ba sends ee et nnues oo cegge 10

MISCELLANEOUS:

Rothwacks, Taxability of Corporate Receipts Di-

verted by Officer-Stockholders, 7 N.Y.U. Ann.

Tax Inst. 577 (1949) ......-- eee e eee eee eens 27

Rudick, ‘‘Dividends’’ and ‘‘Earnings or Profits”’

Unaer the Income Tax Law: Corporate Non-

Liquidating Distributions, 89 U. of Pa. L. Rev.

865, 887 (1941) ...... cece cece rece eee eet eees 14

IN THE

Supreme Court of the United States

OctToBER TERM, 1955

Poncet Davis, Petitioner,

-

Unirep States oF AMERICA, Respondent.

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE SIXTH CIRCUIT

Petitioner prays that a writ of certiorari issue to

review the judgment of the United States Court of

Appeals for the Sixth Circuit.

OPINIONS BELOW

The memorandum opinion of the District Court

(Appendix, infra, pp. 10a-13a) is not officially re-

ported. The opinion of the Court of Appeals (Appen-

dix, infra, pp. 1a-9a) is not yet officially reported.

JURISDICTION

The judgment of the Court of Appeals was entered

on October 13, 1955. The time to petition for certio-

rari was extended to December 12, 1955, by an order of

Mr. Justice Reed dated November 5, 1955. The juris-

diction of this Court is invoked under 28 U.S.C.,

Section 1254.

2

QUESTION PRESENTED

Whether petitioner could be convicted of attempted

evasion of income tax on distributions from his wholly

owned corporation where the Government offered no

evidence that the corporation had any current or accu-

mulated earnings or profits in the years when the

distributions occurred.

STATUTES INVOLVED

Internal Revenue Code of 1939:

Sec. 22. Gross INCOME.

(a) General Definition. —‘‘Gross income”’

includes gains, profits, and income derived

from salaries, wages, or compensation for per-

sonal service * * * of whatever kind and in what-

ever form paid, or from professions, vocations,

trades, businesses, commerce, or sales, or deal-

ings in property, whether real or personal, grow-

ing out of the ownership or use of or interest in

such property; also from interest, rent, dividends,

securities, or the transaction of any business car-

ried on for gain or profit, or gains or profits and

ineome derived from any source whatever. * * *

* * * * *

(e) Distributions by Corporations.—Distribu-

tions by corporations shall be taxable to the share-

holders as provided in section 115.

* * * * *

(26 U.S.C. 1946 ed., Sec. 22.)

Sec. 115. DisTRIBUTIONS BY CORPORATIONS.

(a) Definition of Dividend—The term **divi-

dend’’ when used in this chapter * * * means any

3

distribution made by a corporation to its share-

holders, whether in money or in other property,

(1) out of its earnings or profits accumulated

after February 28, 1913, or (2) out of the earnings

or profits of the taxable year (computed as of the

close of the taxable year without diminution by

reason of any distributions made during the tax-

able year), without regard to the amount of the

earnings and profits at the time the distribution

was made. * * *

(b) Source of Distributions.—For the purposes

of this chapter every distribution is made out of

earnings or profits to the extent thereof, and from

the most recently accumulated earnings or

profits. * * *

* * * * 7

(d) Other Distributions from Capital—If any

distribution made by a corporation to its share-

holders is not out of increase in value of property

accrued before March 1, 1913, and is not a divi-

dend, then the amount of such distribution shall

be applied against and reduce the adjusted basis

of the stock provided in section 113, and if in ex-

cess of such basis, such excess shall be taxable in

the same manner as a gain from the sale or ex-

change of property. * * *

*”

* * > *

(26 U.S.C. 1946 ed., See. 115.)

Src. 145. PENALTIES.

* * * * *

(b) Failure to Collect and Pay Over Tax, or

Attempt to Defeat or Evade Tax.—Any person

required under this chapter to collect, account for,

and pay over any tax imposed by this chapter, who

willfully fails to collect or truthfully account for

4

and pay over such tax, and any person who will-

fully attempts in any manner to evade or defeat

any tax imposed by this chapter or the payment

thereof, shall, in addition to other penalties pro-

vided by law, be guilty of a felony and, upon con-

viction thereof, be fined not more than $10,000, or

imprisoned for not more than five years, or both,

together with costs of prosecution.

* * * * *

(26 U.S.C, 1946 ed., See. 145.)

STATEMENT

On April 23, 1952, petitioner was indicted in four

counts in the Northern District of Ohio for willfully

attempting to evade his income taxes for the years 1945

through 1948. He was charged with having omitted

an aggregate income of $867,864.26 on which taxes of

$738,249.16 were allegedly due. The net income and

resulting taxes, as reported by petitioner and as re-

vised by respondent, were as follows:

Reported Revised

Year Net Income Tax Net Income Tax

1945 $53,037.58 $29,549.29 $240,601.72 $199,605.62

1946 53,312.63 26,770.50 665,194.62 549,842.99

1947 46,211.66 21,861.78 93,704.03 57,510.63

1948 10,403.85 1,885.47 31,329.61 11,356.96

After a jury trial petitioner was found guilty on all

four counts. He was sentenced to imprisonment for

five years on each count, the terms to run concurrently,

and he was fined $10,000 on each count, or a total of

$40,000. (R. 5a-Ta, 9a, 13a-14a, 223a-226a; 4b-9b,

222b-228b. )"

—-—

1‘*R’? designates references to the Appendix filed in the court

below by petitioner or respondent, as the case may be.

oO

The relevant evidence may be summarized as fol-

lows:

Robbins Tire & Rubber Company, Ine., is an Ala-

bama corporation engaged in producing and selling

rubber products. It files its returns on the accrual

basis. During the years involved petitioner was presi-

dent, treasurer, and sole stockholder of the corporation.

Its plant was located in Tuscumbia, Alabama, and its

head office in Akron, Ohio. That office was occupied

by petitioner and several clerical employees, including

a bookkeeper. The plant usually sent copies of in-

voices and remittance statements to the Akron office,

where sales and collections were entered on the books.

In the years 1945 through 1948 six customers of the

corporation sent their checks directly to the Akron

office in accordance with instructions from that office.

Neither the sales to these customers nor their checks

were reflected in the corporate books. The checks

totalled $187,564.14 in 1945, $611,881.99 in 1946,

$47,492.37 in 1947, and $20,925.76 in 1948. They were

all payable to the corporation and endorsed in the

name of the corporation. Practically all these checks

were cashed by employees of the corporation at two

banks in Akron. The cash was either delivered to pe-

titioner or placed in the office safe. Petitioner never

instructed the employees to conceal any sales or re-

ceipts. (R. 15a-16a, 21a-24a, 26a-27a, 29a-3la, 35a,

38a-39a, 49a-50a, 61a-68a, 72a-73a, 76a, 78a-79a, 81a-87a,

91a-92a, 95a-98a, 104a-105a, 120a, 123a-126a, 132a-134a,

136a-142a, 146a; 10b, 15b-16b, 19b-22b, 39b-63b, 69b-

124b, 129b-132b, 136b-138b, 142b-145b, 147b-149b, 151b-

154b, 156b-163b, 167b-169b, 176b-181b, 185b-207b,

214b-216b.)

6

Of the unrecorded checks aggregating $867,864.26,

one check for $467.14 was deposited on May 16, 1945,

in the bank account of petitioner’s wife. (R. 24b-25b.)°

Two other checks, making a total of $1,142.10, were

deposited in petitioner’s personal account on January

24, 1945. (R. 64b-66b, 213b-214b.)* On March 31, 1945,

petitioner made a gift of $100,000 to his wife. He duly

filed a gift tax return on March 15, 1946, and paid a

vift tax of $8,595. (R. 99a-100a; 154b-155b, 235b-

236b.)* On February 12, 1945, petitioner purchased

a treasurer’s check in the amount of $40,000. On Sep-

2In its summary of the evidence the Court of Appeals broadly

declared that ‘‘proceeds from the customers’’ of the corporation

‘‘were deposited’? in her account. (Appendix, infra, p. 3a.)

This generality suggests much more than the evidence reveals.

Apart from the one check for $467.14, the Government at most

tried to establish that between August 13, 1945, and January 12,

1946, four other checks totalling $5,989.09 were deposited to the

wife’s credit. The attempted proof turned out to be rather

inadequate. (R. 25b-30b, 36b-38b.)

3The Court of Appeals erroneously intimated that large sums

found their way into petitioner's personal account. (Appendix,

infra, p. 3a.)

‘The Court of Appeals stated : ‘‘It appears also that during the

tax years in question, appellant made a gift to his wife of

$100,000 in cash, although at that time he had less than $1,200

in his bank account.’’ (Appendix, infra, p. 3a.) The gift was

made in early 1945—at the outset of the four-year period for

which petitioner was indicted. It does not shed the slightest light

on petitioner’s income for nine months in 1945 or on his income

for the years 1946-1948. Moreover, in so far as the first three

months of 1945 are concerned, the Government made no effort

to fix petitioner’s net worth as of the beginning of that period.

In fact, no phase of the prosecution was based on the so-called |

net worth method. Cf. Holland v. United States, 348 U. S. 121

(1954).

7

tember 8, 1945, he sent the check to one Charles U.

Bay. The Government called an executive assistant

of Bay to testify about the transaction to which the

check related. The witness indicated that he knew

nothing about it. (R. 67b-69b, 112b, 125b-127b, 229b-

230b.) On March 11, 1946, petitioner purchased a

treasurer’s check in the amount of $70,000. On the

following day he sent the check to American Trust

Company in connection with a purchase of stock in

Pacific Rubber & Tire Manufacturing Company. (R.

117b, 231b-235b.)°

The Government treated all the unrecorded pro-

ceeds of the corporation as unreported income of peti-

tioner. In its bill of particulars the Government

stated that the ‘‘additional income’”’ attributed to peti-

tioner ‘‘represents proceeds of sales’’ by the corpora-

tion ‘personally appropriated by him.’’ It did not

offer any proof that the corporation had any current

or accumulated earnings or profits during the vears

1945-1948. The Government also treated the same

proceeds as additional gross receipts of the corpora-

tion. Petitioner was indicted, as officer of the cor-

’ With respect to this transaction the Court of Appeals ex-

pansively indicated that large amounts of customers’ checks ‘‘were

used’? by petitioner ‘‘to purchase stock in his own name.”’

(Appendix, infra, p. 3a.) As noted above, petitioner made

only one payment on such stock. It consisted of a check obtained

toward the beginning of the second year involved in the ‘ndict-

ment. There was no proof of stock purchases in 1945, 1947, and

1948. Nor was there any proof that petitioner’s net worth at the

start of 1945 was insufficient to cover the one check obtained in

early 1946.

®In the case of the corporation the Government reduced the

unrecorded proceeds by amounts representing reimbursements for

excise taxes paid by the corporation.

8

poration, in the Northern District of Alabama with

respect to taxes of the corporation for its fiscal year

1945. The trial court, over the objection of petitioner,

instructed the jury to disregard the testimony relating

to the Alabama indictment and the Government’s in-

clusion of the proceeds in the corporation’s receipts.

(R. 9a, 122a-131a, 135a-142a, 146a, 169a-170a, 177a-

178a, 198a.)

The trial court charged the jury that the proceeds

in question were ‘‘received, in the first instance,”’’ by

the corporation. ‘‘Money received by a corporation is

not income to an individual unless the corporate funds

are in some way transferred or diverted to an indi-

vidual and become property over which he exercises

dominion and control and treats as his own to the ex-

clusion of any interest therein by the corporation.”

The court further charged, ‘If you find that the De-

fendant, as the sole owner of the Robbins Tire & Rub-

ber Company, diverted funds of that corporation to

himself personally and exercised control and dominion

over the funds and treated them as his own, that would

constitute taxable income that he was required by law

to include in his tax return.’”’ The trial court then

stated, ‘‘Income received from any source constitutes

taxable income when its recipient has such control over

it that, as a practical matter, he derives readily realiz-

able economic value from it. That occurs when cash is

received by an individual in a manner which allows

him freedom to dispose of it or use it at will. Such in-

come is taxable in the yearly period during which it

is received.’’ (R. 208a-209a.)

Petitioner urged that he ‘‘could not have taxable

income as an individual unless and until the Govern-

9

ment proved that there were profits of the corpora-

tion.’’? He requested the trial court to charge that the

Government was obliged to establish ‘‘an earned sur-

plus or profits available for distribution”’ to him; and

that there had ‘‘been a failure of proof’’ in this respect.

The trial court refused to so charge. Petitioner moved

for a judgment of acquittal and for a new trial because

of this failure of proof. The trial court denied both

motions on the ground that such proof was unneces-

sary. It ruled that under section 115(b) of the Inter-

nal Revenue Code of 1939 the funds received by peti-

tioner were presumed to derive from corporate earn-

ings or profits, and hence they ‘‘eonstituted a con-

structive dividend as a matter of law.”” “If proper

entries,’’ the court said, ‘‘had been made upon the cor-

poration’s books showing the sales to customers, the

receipt of payments for those sales and the distribu-

tion of $850,000 to the defendant, the court would be

required to hold as a matter of law that the distribu-

tions were from earnings and therefore taxable in-

come.’’ The applicable principle is the same, the court

concluded, ‘‘where the sole owner of the corporation

conceals the distribution of corporate profits to him-

self.” (R. 214a-216a, 219a-220a, 238a-247a; Appen-

dix, infra, pp. 10a-13a.) The Court of Appeals disap-

proved this ruling as a ‘“‘misconstruction of law,”’ but

affirmed the judgment as nevertheless ‘‘sound.’’ (Ap-

pendix, infra, p. 9a.)

REASONS FOR GRANTING THE WRIT

Petitioner was tried and convicted under section

145(b) of the Internal Revenue Code of 1939. Sec-

‘ tion 145(b) provides that ‘“‘any person who willfully

attempts in any manner to evade or defeat’’ his income

10

tax is “guilty of a felony.’” Needless to say, this penal

sanction is ‘“‘enforced by the criminal process in the

familiar manner.’’ Spies v. United States, 317 U. S.

492, 495 (1943). The ‘‘settled standards of the erimi-

nal law’ apply no less to prosecutions for attempted

tax evasion than to “‘prosecutions for other crimes.”

Holland v. United States, supra, at 138. ‘‘Unlike civil

actions for the recovery of deficiencies, where the de-

terminations of the Commissioner have prima facie

validity, the prosecution must always prove the crimi-

nal charge beyond a reasonable doubt.’” Id. at 126.

And from beginning to end that burden of proof ex-

tends to ‘‘every element of the offense’’ without ex-

ception. Jd. at 138. See also Helvering v. Mitchell,

303 U. S. 391, 397 (1938) ; Davis v. United States, 160

U. S. 469, 487 (1895).

As this Court has succinctly stated, the crime con-

demned and punished in section 145(b) ‘‘is the wilful

attempt to evade the payment of what was due to the

revenue.”’ United States v. Johnson, 319 U_ 8S. 503,

515 (1943). In other words, ‘‘an underste ement of

taxable income” is ‘‘one of the elements co« the crime

of tax evasion.’’ Smith v. United States, 348 U.S. 147,

154 (1954). See also Holland v. United States, supra,

at 137. The Government, therefore, ‘‘has the burden

of proving that income tax was due from the accused

for the year involved.’’? United States v. Augustine,

189 F. 2d 587, 589 (3d Cir. 1951). If it fails or refuses

to carry this burden, it has not established the alleged

erime. And so the Government must prove not only a

T'The same criminal sanction is imposed by section 7201 of the |

Internal Revenue Code of 1954. Hence the significant problem

presented here involves the 1954 Code as well as the 1939 Code.

11

willful effort to defraud, but also an obligation to pay

more tax than the tax returned. See further Gleckman

v. United States, 80 F. 2d 394, 399 (8th Cir. 1935) ;

United States v. Schenck, 126 F. 2d 702, 705 (2d Cir.

1942), cert. denied sub nom. Moskowitz v. United

States, 316 U. S. 705 (1942) ; United States v. Smith,

206 F. 2d 905, 911 (3d Cir. 1953).

Here the Court of Appeals plainly departed from

this hornbook principle which governs prosecutions

for attempted tax evasion. While the court agreed

that the Government must show ‘‘the existence of a

tax liability in excess of that reported’? (Appendix,

infra, p. 5a), it proceeded to sustain the convic-

tion though no such liability was shown. This

grave and startling error warrants expeditious

review by this Court for several reasons. The

decision below derives from a serious misapplica-

tion of this Court’s opinion in Rutkin v. United States,

343 U. S. 130 (1952). It is in conflict with this Court’s

decisions in Moline Properties v. Commissioner, 319

U. S. 436 (1943), and National Carbide Corp. v. Com-

missioner, 336 U. S. 422 (1949). It is equally at odds

with the decisions of other Courts of Appeals in Cur-

rier v. United States, 166 F. 2d 346 (1st Cir. 1948), and

United States v. Augustine, 185 F. 2d 407 (3d Cir.

1950). And it raises a significant question in the en-

forcement of section 145(b) which radiates far beyond

this immediate case.

1. Section 22(a) of the 1939 Code defines ‘‘gross in-

come” as including income from “dividends.” Sec-

tion 22(e) significantly adds that ‘‘Distributions by

corporations shall be taxable to the shareholders as

provided in section 115.’’ As the courts have repeat-

edly recognized, section 115 ‘‘qualifies the generality

12

of §22(a).’’ It defines the tax status of ‘‘distributions

by corporations.’” Cf. Helvering v. Griffiths, 318 U. 8.

371, 394 (1943). See further Palmer v. Commissioner,

302 U. S. 63, 69 (1937) ; Choate v. Commissioner, 129

F. 2d 684, 689 (2d Cir. 1942) ; Capital Estates v. Com-

missioner, 138 F. 2d 156, 157 (3d Cir. 1943). In short,

while section 22(a) generally embraces ‘‘income de-

rived from any source whatever,’” a distribution from

a corporation to its shareholders is not income except

as section 115 so provides. A corporate distribution is

includible in gross income under section 22(a) only if

it is income under section 115. See Commissioner V.

Goldwyn, 175 F. 2d 641, 643 (9th Cir. 1949) ; Jackson

v. Commissioner, 172 F. 2d 605, 606 (7th Cir. 1949).

For present purposes we need only consider sub-

sections (a), (b), and (d) of section 115.° Subsection

(a) defines a dividend as ‘‘any distribution made by a

corporation to its shareholders, whether in money or

in other property, (1) out of its earnings or profits

accumulated after February 28, 1913, or (2) out of

the earnings or profits of the taxable year.’’ Subsec-

tion (b) states that ‘‘every distribution is made out of

earnings or profits to the extent thereof, and from

the most recently accumulated earnings or profits.”’

Subsection (d) provides that if a distribution ‘‘is not

a dividend,”’ then the amount of the distribution ‘‘shall

be applied against and reduce the adjusted basis of

the stock’’; and if the amount of the distribution ex-

8 See Commissioner v. Jacobson, 336 U. S. 28 (1949) ; Rutkin

v. United States, supra; Commissioner v. Glenshaw Glass Co., 348

U. S. 426 (1955).

® These provisions are now contained in sections 301(c) (1) (2)

(3) and 316(a) of the 1954 Code.

13

ceeds that basis, the excess is ‘‘taxable in the same

manner as a gain from the sale or exchange of prop-

erty.’”°

Obviously, under section 115 a distribution from cor-

poration to stockholder is a dividend, taxable as ordi-

nary income, only if the distribution is out of earnings

or profits. That is why the term ‘‘earnings or profits”’

has ‘‘long been in the revenue acts.”’ Commissioner

v. Wheeler, 324 U. S. 542, 545 (1945). In the words

of Mr. Justice Reed, dividend income is ‘‘the earnings

of a corporation’’ which “‘pass into the earnings of its

stockholder.”’ Estate of Putnam v. Commissioner,

324 U. S. 393, 400 (1945). See also Commissioner v.

Estate of Bedford, 325 U. S. 283, 290-291 (1945) ;

Commissioner v. Munter, 331 U. S. 210, 211, 214-215

(1947). If the corporation has no earned surplus, the

stockholder has no dividend income. To borrow the

apt language of Mr. Justice Stone, the “bare fact”’

that a transaction ‘‘has resulted in a distribution of

some of the corporate assets to stockholders, gives rise

to no inference that the distribution is a dividend

within the meaning of § 115.’’ At the very least it

must appear that ‘‘the transaction is in purpose or

effect used as an implement for the distribution of

corporate earnings to stockholders.”’ Palmer v. Com-

missioner, supra, at 69-70. See further Jones v. Daw-

son, 148 F. 2d 87, 91 (10th Cir. 1945). By the same

token, if the Government seeks a conviction on the

10 Ag section 115(d) indicates, if there are no earnings or profits,

a distribution is at most a capital gain after the stockholder re-

covers the basis of his shares. See, e.g., Shield Co., 2 T.C. 763

(1943). Here the Government treated the distributions as ordinary

income.

14

basis of an unreported distribution, it must prove be-

yond a reasonable doubt that the corporation had

earnings or profits in the year of distribution. For

otherwise it fails to establish that the stockholder

understated any income obtained from the corpora-

tion.

Here the Government made no effort to show that

the corporation had an earned surplus for the years

1945-1948. It merely set out to prove that distribu-

tions were made, and then it chose to rest. Hence the

Government conspicuously failed to confirm its charge

that the distributions were income to petitioner. Since

the unrecorded proceeds derived from sales by the cor-

poration, they were, of course, includible in its gross

receipts. United States v. Joliet & Chicago R. Co.,

315 U. S. 44 (1942); Moline Properties v. Commis-

sioner, supra; Commissioner v. Court Holding Co., 324

U. S. 331 (1945) ; National Carbide Corp. v. Commis-

sioner, supra. But it scarcely follows that the corpora-

tion had earnings or profits in each of the years in-

volved. Proof of gross receipts is quite different from

proof of an earned surplus. See Doyle v. Mitchell

Brothers Co., 247 U. S. 179, 184 (1918); Anderson v.

United States, 11 F. 2d 938, 940 (7th Cir. 1926) ; Clark

v. United States, 211 F. 2d 100, 102 (8th Cir. 1954).”

11 Even net income is considerably different from an earned

surplus. For example, in computing the surplus for any year

allowance must be made for income taxes, excess profits taxes, and

other liabilities which are not deductible in computing net income.

See, e.g., Faweus Machine Co. v. United States, 282 U.S. 375, 378

(1931); and see generally Rudick, ‘‘Dividends’’ and ‘‘ Earnings

or Profits’? Under the Income Tax Law: Corporate Non-Liqui-

dating Distributions, 89 U. of Pa. L. Rev. 865, 887 (1941).

15

In so far as the present record is concerned, the cor-

poration may well have had a deficit in one or more

years. The record reveals no more than certain gross

receipts from certain customers.

The trial court was not unaware of the Government’s

complete lack of proof of earnings or profits. It

bravely sought to pardon the deficiency on the basis of

section 115(b) of the Code. (Appendix, infra, p.

10a.) However, as the Court of Appeals frankly

confessed, this excuse is no excuse at all. (Appendix,

infra, p. 9a.) Section 115(b) does not come into play

unless a corporation has earnings or profits to dis-

tribute. If earnings or profits are available, then sec-

tion 115(b) attributes the distribution to that source

“to the extent thereof.’’ See Helvering v. Canfield, 291

U. S. 163 (1934) ; McCaughn v. McCahan, 39 F. 2d 3

(3d Cir. 1930) ; Leland v. Commissioner, 50 F. 2d 523

(Ist Cir. 1931), cert. denied, 284 U. S. 656 (1931);

Faris v. Helvering, 71 F. 2d 610 (9th Cir. 1934), cert.

denied, 293 U. S. 544 (1934) ; Beretta v. Commissioner,

141 F. 2d 452 (5th Cir. 1944), cert. denied,323 U.S. 720

(1944) ; Lawrence Vv. Commissioner, 143 F. 2d 456 (9th

Cir. 1944); Jones v. Dawson, supra; Jackson v. Com-

missioner, supra. Cf. Edwards v. Douglas, 269 U.S.

204 (1925). Here, however, there was not the barest

proof of earnings or profits to which section 115(b)

might apply. Not even the corporate income tax re-

turns were offered in evidence.

9. Aside from its erroneous theory of a ‘‘construc-

tive dividend’”’ under section 115(b), the trial court re-

lied on this Court’s decision in Rutkin v. United States,

supra. Indeed, its charge to the jury on the alleged

omission of income was essentially a mere echo of this

16

Court’s language in that case. Compare 343 U.S. at

137, with R. 208a-209a." See also R. 168a-169a. The

Court of Appeals regarded section 115 as irrelevant

and fully relied on the Rutkin decision. It held that,

whether or not the corporation ‘‘had sufficient surplus

to cover a dividend distribution,” the withdrawn cash

was taxable to petitioner under section 22(a). In be-

half of this conclusion the court quoted the Rutkin

opinion and borrowed a good deal of its language.

The cash was income to petitioner, said the court, be-

cause “he exercised command, control, and dominion”’

over it. He obtained the cash ‘‘as his own”’ and treated

it “‘as his own.” (Appendix, supra, pp. 5a-Ta.) This

conclusion, we submit, reflects an egregious misconcep-

tion of the Rutkin case.

The Rutkin opinion dealt with a prosecution for

attempted evasion of income tax on $250,000. At the

trial the defendant contended that he had been one of

several stockholders of a corporation; that the stock-

holders had sold their shares; that the $250,000 repre-

sented his portion of the sales proceeds; and that the

capital gains tax had been paid. The jury, however,

found that the defendant ‘‘was neither a stockholder

of record nor a beneficial owner of any of the stock

of the company at any time.’’ His alleged claim to the

eash was ‘‘false and fraudulent”, and it was illegally

gotten ‘‘by extortion.”? 343 U. S. at 132-136. In the

context of these findings the issue before the Court

was whether money unlawfully obtained by extortion

was taxable income within section 22(a) of the 1939

Code.

12 See p. 8, supra.

17

This question inevitably focused on Commissioner V.

Wilcox, 327 U. S. 404 (1946), where the Court decided

that embezzled money was not a taxable gain. On that

oceasion the Court declared that ‘‘a taxable gain’’ re-

quires the co-existence of two factors: (1) ‘the pres-

ence of a claim of right to the alleged gain,’’ and (2)

“the absence of a definite, unconditional obligation to

repay or return that which would otherwise constitute

a gain.”? Unless there is ‘‘some bona fide legal or

equitable claim,’’ the Court stated, ‘‘even though it be

contingent or contested in nature, the taxpayer cannot

be said to have received any gain or profit within the

reach of (22(a).’’ Hence the embezzled funds were

not income, for an embezzler obtains possession ‘‘with-

out any semblance of a bona fide claim of right.”’ In

terms of tax liability, the Court particularly indicated,

it is unimportant that the embezzler controls and en-

joys his loot. Id. at 408-409. Cf. United States v.

Lewis, 340 U. S. 590 (1951); Healy v. Commissioner,

345 U. S. 278 (1953).

In the Rutkin case the Court took a different ap-

proach to the same problem. While it apparently re-

garded embezzlers and extortioners as birds of a

feather, it held that proceeds of extortion, unlike pro-

ceeds of embezzlement, are taxable gain. Under the

Rutkin decision the governing consideration in apply-

ing section 22(a) is not whether the taxpayer asserts

a bona fide claim of right to what he receives, but

whether he exercises beneficial dominion and control

over what he receives as if he had a claim of right. In

the words of Mr. Justice Burton, ‘‘An unlawful gain,

as well as a lawful one, constitutes taxable income

when its recipient has such control over it that, as a

18

practical matter, he derives readily realizable economic

value from it.’”’ ‘‘That occurs when cash, as here, is

delivered by its owner to the taxpayer in a manner

which allows the recipient freedom to dispose of it at

will, even though it may have been obtained by fraud

and his freedom to use it may be assailable by someone

with a better title to it.” 343 U. S. at 187. See further

Mr. Justice Burton’s dissenting opinion in Commis-

sioner v. Wilcox, supra, at 413.

We need not pause to consider whether the Wilcox

and Rutkin decisions are adequately reconcilable. Cf.

United States v. Bruswitz, 219 F. 2d 59, 61 (2d Cir.

1955), cert. denied, 349 U.S. 9138 (1955). The core of

the matter is that nothing in the Ruthin opinion justi-

fies the decision below. To apply it here is to misapply

it. The essence of the Rutkin opinion is that it equates

dominion and control with a claim of right if what

is received is otherwise a gain. Just as a gain may be

realized under a claim of right, so may it be realized

by exercising dominion and control without a claim

of right. See generally Helvering v. Horst, 311 U.S.

112, 115 (1940). But this is not to say that whenever

eash is received—with or without a claim of right—it

necessarily constitutes a gain, regardless of the source

from which it derives and the context of its acquisition.

“Tn law also the right answer usually depends on

putting the rigat question.’’ Estate of Rogers v. Com-

missioner, 320 U. 8. 410, 413 (1943). Here the ques-

tion is not whether the taxpayer exercised dominion

and control over cash which was otherwise income

under section 22(a). The question, rather, is whether

the Government has shown that the withdrawals from

19

the corporation were income to begin with. And ‘‘the

right answer’’ to ‘‘the right question’’ is given by

section 115, which the Court of Appeals wholly ig-

nored," and not by section 22(a), which it erroneously

invoked." Any distribution of cash from a corporation

to a stockholder affords him ‘‘ecommand, control, and

dominion’? over the cash. But under section 115(a)

the distribution is ordinary income to him only if the

corporation has commensurate earnings or profits.

Or to put the matter somewhat differently, section

115(a) excludes from ordinary income under section

22(a) any corporate distribution which is not covered

by earnings or profits. See p. 12, supra. Otherwise

section 115(a) is quite meaningless; and so is section

92(e), which declares that ‘distributions by corpora-

tions” are ‘‘taxable to the shareholders as provided in

section 115.’ Here, of course, the Government meticu-

lously refrained from showing any earnings or profits.”

13 Tn its charge to the jury the trial court did pretty much the

same. It quoted section 22(a), but omitted to mention the word

‘‘dividends”’ contained in that provision. (R. 208a.)

14 Compare Freuler v. Helvering, 291 U.S. 35 (1934), where the

Government similarly tried to tax receipts, acquired under a

mistaken claim of right, as income under section 22(a), though

the status of the receipts was governed by other provisions. See

United States v. Lewis, supra, at 591.

13 At one point the Court of Appeals utterly misconceives the

nature of our-.contention, We are arguing, the court says, that

‘‘sinee there is no proof’’ of an earned surplus, petitioner ‘‘is only

a holder of the cash for the benefit of the corporation.”’ (Appendix,

infra, p. 5a.) It is difficult for us to understand how the court

arrived at this view of our position. We are saying, rather, that

even if distributions were made for petitioner ’s own benefit, they

were not shown to be income because there was no evidence of an

earned surplus.

20

The reason for the Court of Appeals’ confusion is

not obscure. The court misread the Rutkin opinion as

holding that any receipt of cash is ipso facto taxable

income if the recipient controls the cash as his own. In

this connection we cannot do better than quote what

the Court of Appeals itself said. ‘If appellant had

been doing business as an individual,” the court stated,

‘and retained a million dollars of receipts from his

customers, as his own, using the cash for personal

investments and expenditures, and concealing from

the government, through false bookkeeping entries and

fraudulent income tax returns, the fact that he had

received and kept as his personal property such a huge

sum, there is no doubt that he would be accountable

for that money as income which is required to be

reflected in his income tax return.’ (Appendix, infra,

pp. 6a-Ta.)

According to the Court of Appeals, then, even where

a business is individually owned, the withdrawal of

proceeds creates taxable income if the proprietor as-

sumes dominion over them. The question whether the

business has produced a profit is deemed entirely

immaterial. We need not labor the point that this

doctrine is as erroneous as it is novel. “Of course.

gross income and not gross receipts is the foundation

of income-tax liability, for it is only earnings, profits

and gains which the statute subjects to tax.” Clark

v. United States, supra, at 102. The mere acquisition

of cash does not ‘‘in and of itself, suffice to establish

that income tax was due on account of it.’ Gleckman

v. United States, supra, at 399. Since the Court of

Appeals was so seriously confused with resnect to with-

drawals from an individual business, it easily erred

a

21

with respect to withdrawals from a corporate enter-

prise. In holding that the existence of earnings or

profits was immaterial, the Court of Appeals plainly

misapplied the Rutkin opinion.

3. The Court of Appeals sought to bolster its strange

understanding of the Rutkin case by ignoring the cor-

porate entity of Robbins Tire & Rubber Company,

Ine. And so one error quickly led to another. ‘*What

appellant did,’”’ the court said, ‘twas to take funds,

individually, from his wholly owned corporation, which

he completely dominated and controlled. In other

words, he merely took the funds from himself under

a different name.’’ (Appendix, infra, p. Ta.) In

short, the court viewed the tax consequences as if the

amounts withdrawn were proceeds of sales made by

petitioner rather than distributions from the co pora-

tion which made the sales. As a result, the decision

below ineseapably conflicts with this Court’s decisions

in Moline Properties v. Commissioner, supra, and

National Carbide Corp. v. Commissioner, supra,

In these familiar cases the Court held that ‘‘a cor-

poration formed or operated for business purposes”’

is a taxpayer separate and apart from its stockholders.

‘‘“Complete ownership of the corporation, and the con-

trol primarily dependent upon such ownership,’’ the

Court emphasized, are irrelevant ‘“‘in determining

taxabilitv.”’ 336 U.S. at 429. As long as the corpora-

tion ‘‘earries on business activity,’’ it makes ‘‘no dif-

ference taxwise’’ that ‘‘the owner retains direction of

16 Tmmediately before these observations the Court of Appeals

appraised the case as if petitioner had been doing business as an

individual. See quotation at p. 20, supra.

an eS a oes Se

22

its affairs down to the minutest detail, provides all of its

assets and takes all of its profits.’’ Jd. at 431-432. ‘‘Un-

doubtedly the great majority of corporations owned

by sole stockholders are ‘dummies’ in the sense that

their policies and day-to-day activities are determined

not as decisions of the corporation but by their owners

acting individually.’”’ Nevertheless a wholly owned

corporation which serves a business purpose must be

recognized as a tax entity. Jd. at 433. Whatever

interest the stockholder has in the assets of the corpora-

tion is ‘‘strictly derivative in origin.’’ United States

v. Joliet & Chicago R. Co., supra, at 48. As Mr. Justice

Holmes so felicitously stated, ‘‘The corporation is a

person and its ownership is a nonconductor that makes

it impossible to attribute an interest in its propertv

to its members.’’ Klein v. Board of Supervisors, 282

U. S. 19, 24 (1930). See also Learned Hand. J.. in

National Investors Corp. v. Hoey, 144 F. 2d 466, 467-

468 (2d Cir. 1944).

Here, needless to add, the corporation was ‘‘formed”’

and ‘‘operated for business purposes.’’ And, as even

the trial judge conceded, the ‘‘income’’ represented by

the checks ‘‘was received in the first instance’’ by the

corporation. (R. 208a.) Nor does the Government

contend otherwise, for it has included the proceeds in

the gross receipts of the corporation. See p. 7, supra;

and decisions cited at p. 14, supra. Of course, the

Government had no choice in the matter, in view of

the many decisions ‘‘requiring that income be taxed

to those who earn it.’? National Carbide Corp. v.

Commissioner, supra, at 436. Since the corporation

was the taxpayer in regard to the proceeds, it is no

less true that the amounts withdrawn by petitioner

23

him by reason of his status-as.stockholder.. See Lynch

v. Hornby, 247 U. S. 339, 343 (1918) ; Estate of Put-

nam v. Commissioner, supra, at 399-400. Hence once

more they cannot be attributed to him as dividend in-

come because there is no evidence that the corporation

had earnings or profits. Unless the withdrawn amounts

are treated as distributions from the corporation, this

Court’s decisions in the Moline Properties and National

Carbide cases are being quietly ignored.

4. In holding that proof of earnings or profits was

unnecessary, the Court of Appeals came into further

conflict with decisions of the First and Third Circuits

in Currier v. United States, supra, and United States

v. Augustine, supra.

The Currier ease similarly involved a defendant who

was sole stockholder, president, and treasurer of a

corporation engaged in business.” The corporation

received numerous checks which were not recorded

on its books. All were endorsed in the name of the

corporation and deposited in the stockholder’s per-

sonal account. They totalled $83,496.11 in 1943 and

$21,095.88 in 1944. The Government carefully estab-

lished that the corporate earnings and profits were

$26,017.00 in 1943 and $10,404.45 in 1944. Both the

corporation and the stockholder were indicted for

attempted income tax evasion with respect to the two

vears. However, while the corporation was charged

with deliberately excluding income equal to the unre-

corded receipts, the stockholder was charged with

17 The defendant’s wife was record owner of 25 percent of the

stock, but the District Court found that he was beneficial owner

of all the shares. See 166 F. 2d at 348.

24

willfully omitting income equal to the earned surplus

available for distribution." The indictment expressly

described the lesser amounts imputed to the stock-

holder as ‘‘ Dividends.’””

In its brief the Government carefully explained that

the ‘‘diverted funds were properly treated as taxable

dividends’’ to the stockholder ‘‘under Section 115 of

the Code.’? The amounts designated as ‘‘ Dividends”’

were ‘‘arrived at by treating the diverted corporate

sales receipts as constructive dividends to Currier, to

the extent permitted by the amount of corporate sur-

plus available for distribution as dividends.’’ This

treatment, the Government stated, ‘‘is in accord with

well recognized civil tax procedure, controlling here

insofar as the determination of income is concerned.’””

The First Circuit approved the Government’s analysis,

which was precisely the same as our own. It upheld

the conviction on the ground that the stockholder

‘*received a constructive dividend which he was under

no obligation to repay.’™ The court found ‘‘no incon-

sistency’’ in treating the entire sales proceeds as in-

come of the corporation and treating ‘‘only part of the

money”’ as ‘‘a taxable dividend’’ to the stockholder,

‘*since dividends are only taxable if paid out of earn-

ings and profits. Any further amounts he received

18 See Brief for the United States, pp. 2-6, Currier v. United

States, supra.

19 Jd. at 5, 11-12.

20 Td. at 7, 12.

21 The stockholder argued that the withdrawals were not taxable

because they were embezzled funds within the holding of Commis-

sioner Vv. Wilcox, supra. The District Court rejected this argument

(70 F. Supp. 219, 220-221 (D. Mass. 1947)), and the First Circuit

briefly agreed. 166 F. 2d at 348.

25

in excess of the corporation’s earnings and profits can

either be considered as return of capital or money

wrongfully taken, and th *s not taxable as dividends.”’

166 F. 2d at 348.”

In United States v. Augustine, supra, withdrawals

from a closely held corporation were again involved.

The Government treated as omitted income not the

full amount of the withdrawals, but a smaller sum

covered by earnings and profits. In the Government ’s

own words, ‘‘the theory”? of the prosecution was

‘‘hased on Section 115 of the Internal Revenue Code.”

The smaller amount ‘‘constituted taxable income to

the defendant on the basis that the defendant received

these moneys in the form of an undeclared or con-

structive dividend’’ from the corporation.* The con-

viction was again sustained under section 115(a) in

the light of the Government’s proof of an earned sur-

plus. ‘There was evidence from which the jury was

entitled to infer that the money received by the appel-

lant was a dividend.” 185 F. 2d at 407. Although

on rehearing the Third Circuit ‘‘reluctantly”’ reversed

the conviction because of ‘‘an undue restriction” in

eross-examination (189 F. 2d 587, 590-591), it spe-

cifically noted the Government’s claim that the with-

22'The First Cirenit also applied its analysis to the corporate

indictment and conviction. The corporation argued that the

withdrawal of the corporate funds constituted an embezzlement

loss deductible under section 23(f) of the 1939 Code. Cf. Alison

v. United States, 344 U.S. 167 (1952). The court answered, inter

alia, that ‘‘part of the money taken by Currier was a constructive

dividend. Certainly the corporation is entitled to no deduction

for dividends paid.’’ 166 F. 2d at 348.

28 Brief for the United States, pp. 2-3, 5-8, United States v.

Augustine, supra.

26

drawals were ‘“a constructive dividend.’’ At the same

time it approved the admission of testimony by a

revenue agent on the corporation’s earnings and profits

for the year off indictment. Jd. at 589-590. See also

United States v. Iozia, 104 F. Supp. 846 (S.D. N.Y.

1952).**

We respectfully submit that the decision below can-

not be reconciled with the decisions in the Currier and

Augustine cases. Unlike the Sixth Circuit in this case,

the First and Third Circuits considered it critically

significant ‘‘whether the corporation had sufficient

surplus to cover a dividend distribution.’’ See p. 16,

supra. In each case the conviction was sustained

because a surplus was shown to be available. If, how-

ever, the decision below is correct, then the First and

Third Cireuits. were sensitively concerned with irrele-

vancies. In pointing to the Currier and Augustine

decisions we are doing what the Government has al-

ready done. At the trial it stoutly maintained that

this case was akin to both those cases, ‘‘where you had

similar facts.’” (R. 165a.) The trial court agreed.

It referred approvingly to the Currier decision as

involving ‘‘momney received under circumstances similar

to those presented here,’’ which was deemed ‘‘in the

nature of a constructive dividend and taxable.”’ (R.

169a.)” The Government and trial court, however,

24 Cf. Jack M. Chesbro, 21 T.C. 123 (1953), aff’d, 225 F. 2d 674

(2d Cir. 1955), involving civil fraud under section 293(b) of the

1939 Code. There, also, unrecorded amounts withdrawn from a

closely held corporation were treated as dividends to the stock-

holders. See further cases cited at p. 30, infra.

25 In the Court of Appeals the Government conceded that in the

Currier ease the First Circuit was ‘‘concerned with the earnings,

profits or deductions’’ of the corporation from which withdrawals

were made. Brief of Appellee, pp. 44-45.

27

overlooked one vital detail. In the Currier case, as in

the Augustine case, the Government diligently showed

that the corporation had an earned surplus and the

withdrawn amounts were regarded as income only to

the extent that an earned surplus was proven. See

further Rothwacks, Taxability of Corporate Receipts

Diverted by Officer-Stockholders, 7 N.Y.U. Ann. Tax

Inst. 577 (1949).

5. The decision below presents an extremely im-

portant question in the administration of criminal

sanctions against taxpayers. Section 145(b) is the

most thorough coercive measure designed to assure

payment of the income tax. The ‘‘serious and inclu-

sive felony’’ which it defines is ‘‘the climax” of the

‘‘variety of sanctions” imposed by Congress. Spies

v. United States, supra, at 496-497. If the decision

below is permitted to stand, it will inevitably under-

mine basic principles of the criminal law which this

Court has painstakingly guarded and preserved in

prosecutions for tax evasion. Indeed, unless the deci-

sion below is reversed, it will similarly upset established

rules of tax law where only civil liabilities are involved.

For as we shall shortly indicate, the grave implications

with which this case is laden do not tolerate nice dis-

tinctions between criminal tax cases and civil tax cases.

As we have pointed out, before a defendant can be

convicted of tax evasion, the Government must prove

‘Can understatement of taxable income.’’** Apart from

the element of willful concealment, the crux of the

crime is omitted ‘‘income within the legal sense of that

term.’’ United States v. Smith, supra, at 910. Obviously,

‘‘the legal sense’? of income is exactly the same for

26 See p. 10, supra.

28

criminal purposes as for civil purposes. Unless a

receipt is income when a deficiency is asserted, it can-

not be income when evasion is charged. In criminal

cases, too, the Treasury ‘‘can add nothing to income

as defined by Congress,’’ though it may firmly feel

that the definition could be improved. Cf. M. E. Blatt

Co. v. United States, 305 U. S. 267, 279 (1938). The

one critical distinction between a charge of evasion

and an assertion of deficiency is that the Government

has the burden of proving that income was realized.

And in carrying that burden the Government must pro-

duce evidence which adequately spells out the receipt

of income as Congress has defined it. Undoubtedly,

not even the Government would candidly quarrel with

the elementary principles which we have just stated.

Yet in the present prosecution the Government has

blandly proceeded to do what these principles prohibit,

and the Court of Appeals has approved.

This case involves distributions from a corporation

to its sole stockholder. It has long been settled that

distributions to stockholders are not taxable as ordinary

income except as they are covered by an earned sur-

plus.” As tersely stated in Commissioner v. Munter,

supra, at 211, ‘‘dividends are taxable as income”’ to

the recipients ‘‘if the corporation paid them out of

its earnings and profits.’’ It is equally settled that

the same rule applies where corporate funds are in-

formally withdrawn by stockholders of a close corpo-

ration. <A corporate distribution to stockholders is no

more than a transfer of corporate assets to them,

and hence it makes no difference that a formal declara-

27 See p. 13, supra.

29

tion of dividend is lacking.* ‘‘The character of the

distribution”’ is ‘‘not changed by the manner in which

it was accomplished’’ or ‘‘by the personal motives’’

which prompted the distribution. Lincoln Nat. Bank

v. Burnet, 63 F. 2d 131, 133 (D. C. Cir. 1933).

Whether the distribution is formal or informal, its

taxability as ordinary income hinges on the presence

of an earned surplus.

In the present case the Government merely proved

that distributions were made to the sole stockholder.”

The conviction rests on the bare premise that corporate

distributions are necessarily ordinary income though

there is no proof of earnings or profits. This premise

was admirably summarized by the trial court. As he

so well phrased it, ‘“‘I think I understand what the

Government is required to prove. They must prove

28 See Chattanooga Sav. Bank v. Brewer, 17 F. 2d 79 (6th Cir.

1927), cert. denied, 274 U. S. 751 (1927); Hadley v. Commis-

sioner, 36 F. 2d 543 (D. C. Cir. 1929); Christopher v. Burnet,

55 F. 24 527 (D. C. Cir. 1931) ; Wiese v. Commissioner, 93 F. 2d

921 (8th Cir. 1938), cert. denied, 304 U.S. 562 (1938); Regens-

burg v. Commissioner, 144 F. 2d 41 (2d Cir. 1944), cert. denied,

393 U. S. 783 (1944); Paramount-Richards Theatres v. Commis-

sioner, 153 F. 2d 602 (5th Cir. 1946) ; Byers v. Commissioner, 199

F. 2d 273 (8th Cir. 1952); United States v. E. Regensburg &

Sons, 221 F. 2d 336 (2d Cir. 1955), cert. denied, October 10, 1955;

Anktell Lumber & Coal Co. v. United States, 1 F. Supp. 724

(Ct. Cls. 1932); P. Garvan, Inc. v. Eaton, 20 F. 2d 422 (D.

Conn. 1927). See also cases cited at p. 30, infra.

2° In its bill of particulars the Government referred to the dis-

tributions as moneys ‘‘appropriated’’ by him. See p. 7,

supra. Of course, any distribution to stockholders is an ‘‘appro-

priation’’ of corporate assets for their own purposes. The sole

objective of a distribution is to transfer dominion from the cor-

poration to the stockholders.

30

he got the money.’’ (R. 27a.)*° To the trial court, as

to the Court of Appeals, proof of earnings and profits

was entirely immaterial. And so the Government has

successfully devised a special definition of taxable

income for the purpose of criminal prosecution. Any

distribution from a close corporation to its stockholders

is regarded as taxable income, regardless of whether

the corporation has an earned surplus. Under cover

of this special definition the Government has conven-

iently killed two birds with one stone. The concept

of taxable income for criminal purposes is no longer

the same as for civil purposes. And the Government

no longer has the burden of proving that the defendant

realized income as Congress has defined it for civil

purposes.

We may put the same consequences a little differ-

ently. If the Government asserted a civil liability |

here, the withdrawals would not be taxable dividends

in the absence of earnings and profits. Again, if the

Government sought to impose a civil penalty for

‘fraud with intent to evade tax,’’ the answer would

again turn on the presence of earnings or profits. For

the penalty is 50 percent of the tax due on the allegedly

omitted income. Int. Rev. Code, § 293(b). See, e.9.,

Bennett E. Meyers, 21 T.C. 331 (1953); Michael Pot-

son, 22 T.C. 912 (1954); United Mercantile Agencies,

Inc., 23 T.C. No. 139 (1955); D. W. Dawkins, 14

T.C.M. 684 (1955). ‘‘We have held time and again,”’

the Tax Court has only recently said, that ‘the

diverted funds are taxable as income to the corpora-

%° Later the trial court stated along the same lines: ‘‘So we have

a situation here where the sole owner’’ of a corporation ‘‘received

very substantial sums of money.’’ (R. 167a.)

31

tion and are taxable as dividends to the extent of earn-

ings and profits to the officer-stockholders receiving

them.’’ United Mercantile Agencies, Inc., supra.

(Italics supplied.)*' Yet here the Government has done

criminally what presumably it cannot do civilly. The

withdrawals have been treated as income to the stock-

holder without any evidence of earnings in the cor-

poration.” The determinative consideration is the

stockholder’s exercise of ‘‘complete control’’ over what

he receives—no matter what its source may be. (Ap-

pendix, infra, p. 6a.) On the other hand, if this test

of taxability is correct, we fail to see how it can be

closely confined to criminal prosecutions. Certainly,

if it provides an adequate basis for sending a taxpayer

to jail, it is also a sufficient ground for sustaining a

deficiency against him. Hence—unless we are to have

diverse concepts of income for civil and criminal pur-

poses—the decision below inevitably imperils the

established rule that the taxability of a dividend rests

on corporate earnings or profits.

The threatening consequences of the decision below

hardly pause at this point. As Mr. Justice Frankfurter

once observed, ‘‘legal doctrines have, in an odd kind of

way, the faculty of self-generating extension.’’ Texas

vy. Florida, 306 U. S. 398, 434 (1939). Decisions do

31 Therefore, in D. W. Dawkins, supra, the Commissioner treated

withdrawals by the sole stockholder as dividend income to the

extent of available earnings, ‘‘and the excess as a return of

capital, taxable as long-term capital gain.’’ 14 T.C.M. at 689, 691.

82 In those civil cases where the burden of proof is on the Gov-

ernment, it must prove the existence of earnings or profits if it

seeks to tax corporate distributions as dividends. See, ¢.g., F. A.

Wilson, 5 T.C.M. 647 (1946), aff’d on another issue, 163 F. 2d

680 (9th Cir. 1947), cert. denied, 332 U. S. 842 (1947).

32

not linger very long in their original environment.

Here we need not be too imaginative in contemplating

the shape of things to come. Already the Court of

Appeals has indicated that even proceeds withdrawn

from an individually owned business constitute income,

though there is no proof that the business has earned

any income. Such large words as ‘“‘dominion’’ and

‘control’? are regarded as some magical incantation

which unerringly reveals income where none is proven

according to the criteria established by Congress.

The short of the matter is that the income tax

becomes a levy on receipts as distinguished from in-

come.” And since receipts customarily exceed profits,

the chance of conviction is appreciably increased. As

this Court has perceptively warned in an opinion by

Mr. Justice Clark, ‘‘bare figures have a way of acquir-

ing an existence of their own, independent of the

evidence which gave rise to them.’’ Holland v. United

States, supra, at 128. Judges, too, are not insusceptible

to persuasion when astronomical receipts are skillfully

33 In line with our analysis of its opinion the Court of Appeals

states: ‘‘Thus, evidence of unexplained funds or property in the

hands of a taxpayer establishes a prima facie case of understate-

ment of income, and it is then incumbent on him to overcome the

logical inferences to be drawn from such proof.’’ (Appendix,

infra, pp. Ta-8a.) We had supposed that in Holland v. United

States, supra, this Court had clearly settled the law differently.

‘‘Inereases in net worth standing alone,’’ the Court declared,

‘feanrot be assumed to be attributable to currently taxable

incorse.”’ The Government must produce ‘‘evidence supporting

the inference that the defendant’s net worth increases are

attributable to currently taxable income.’’ 348 U. S. at 137, 138.

It is not incumbent upon the defendant to explain the bulge in his

net worth, for ‘‘such a rule would tend to shift the burden of

proof.’’ Jd. at 128. See also Kasper v. United States, 225 F. 2d

275, 278 (9th Cir. 1955).

33

confused with taxable income. This very case provides

an illuminating example. The trial judge was con-

fronted by gross receipts of $867,864.26. He promptly

assumed that this formidable sum was taxable income

of ‘approximately $1,000,000.’ Next he easily in-

ferred that ‘“‘never in the history of this court has

there been a case where the evidence showed such

colossal fraud”? upon the revenue. In the light of this

emotional response he immediately imposed a sentence

of five years as fit punishment for the alleged crime.

(R. 226a.) Yet there was no evidence that the receipts

were income to petitioner, since there was no evidence

that there were earnings or profits in the corporation.

We have no desire to condone tax evasion or the

fraud which is ‘‘a contaminating component”’ of the

crime. Cf. Jordan v. DeGeorge, 341 U. 8. 223, 229

(1951). We do say, however, that before a taxpayer

can be pronounced guilty of this felony, the Govern-

ment must carry its burden of proof; and in carrying

its burden the Government must at least prove that the

taxpayer realized income which he failed to report.

The Court of Appeals has forsaken these basic prin-

ciples under the erroneous impression that it was

faithfully applying this Court’s decision in the Rutkin

ease. Only this Court can assure a prompt return to

the principles which the decision below would erode.

CONCLUSION

It is respectfully urged that this petition for a writ

of certiorari should be granted.

Respectfully submitted,

RanpDoLPpH FE. Patt,

Counsel for Petitioner.

Louis EISENSTEIN,

Of Counsel.