*1206 1. During 1926 and 1927 a corporation bought stock on order for its president, who paid for the stock that was issued in his name. The books and records of the corporation carried these purchases in an account named for the stock itself, and at the end of 1927 the corporation closed out the stock account into the personal account of its president. Held, that no constructive dividend from the corporation to its president resulted, because the stock was purchased for and belonged to the president.
2. The basis for computing gain or loss on subsequent sales of stock acquired under a contract to buy 600,000 shares at varying prices for the first, second, and third blocks of 200,000 shares each is the contract price for each 200,000-share block and not the average price for the whole 600,000 shares.
3. Respondent's accrual of a $5,000 commission item as income for 1928 disapproved.
4. Evidence held insufficient to justify respondent's determination that part of the deficiencies asserted was due to fraud with intent to evade tax.
5. Evidence held sufficient to justify imposition of negligence penalty.
*1198 The above entitled proceedings, together with the proceeding in Watson-Moore Co., Docket No. 42506, were consolidated for hearing. Docket No. 42506 has been disposed of by order of the Board, pursuant to a stipulation of the deficiencies involved. In Docket No. 68218 the respondent's motion, acquiesced in by the petitioner, was granted, dismissing the proceeding in so far as it related to the calendar year 1930 for the reason that no deficiency had been determined for that year. This leaves for consideration the following deficiencies:
| Petitioner | Docket No. | Year | Tax | Fraud penalty |
| Watson-Moore Co | 62179 | 1927 | $12,320.34 | $6,160.17 |
| Do | 62179 | 1928 | 5,801.84 | 2,900.92 |
| John R. Moore | 64791 | 1925 | 16.98 | 8.49 |
| Do | 64791 | 1926 | 239.69 | 119.85 |
| Do | 64791 | 1927 | 6,132.75 | 3,066.37 |
| Do | 68218 | 1929 | 2,670.26 | |
| Alma V. Moore | 64790 | 1927 | 6,112.50 | 3,056.25 |
| Do | 64790 | 1928 | 63.99 | 1 16.00 |
| Do | 68219 | 1929 | 2,669.04 |
The above deficiencies were determined by the respondent as a result*1208 of numerous adjustments and radical changes made by revenue agents in petitioners' items of income and deduction. Various concessions were made and agreements reached prior to, during, and after trial, and on some of the adjustments made by respondent and put in issue no evidence was offered.
The particular concessions and stipulations which dispose of many of the allegations are as follows: The parties stipulated that the deficiencies for 1925 and 1926 in the appeal of John R. Moore, Docket No. 64791, are $16.98 and $239.69, respectively, but the fraud penalty asserted remains in dispute. Petitioner concedes that the deficiency for 1928 in the Alma V. Moore appeal, Docket No. 64790, is $125.98, but disputes the negligence penalty. In their reply brief petitioners' counsel concedes the correctness of the deficiencies determined by respondent for the year 1929 in John R. Moore, Docket No. 68218, and Alma V. Moore, Docket No. 68219. Petitioner concedes that items of interest on mortgages, insurance, taxes, and some upkeep on certain houses known as Laurelhurst constituted the property of John R. Moore, and not the property of the Watson-Moore Co. For 1928 the Watson-Moore Co. *1209 concedes that the value of Borden Line Transportation Co. stock should be $6,000 instead of $1,500 as *1199 originally claimed. Respondent agreed in view of the last two concessions not to attribute any direct fraud to these items.
The above concessions and agreements leave the following major questions for determination: (1) Whether 110,939 shares of Sunshine Mining Co. stock, purchased in 1926 and 1927, were acquired by the Watson-Moore Co. for itself or as an agent of John R. Moore; (2) whether John R. Moore and his wife received a constructive dividend of 110,939 shares of Sunshine Mining Co. stock in 1927, which stock has been valued by respondent at December 31, 1927, at $122,032.90; (3) whether average cost, or cost per 200,000-share block, should be the basis for determining profit on sales of the Little Sunshine Mining Co. stock purchased under a contract to buy 600,000 shares; (4) whether the Watson-Moore Co. should accrue $5,000 in 1928 as income, representing a commission for promotion services rendered to the Little Sunshine Mining Co.; and (5) whether petitioners, or any of them, were guilty of fraud, or, in the alternative, of negligence.
FINDINGS OF FACT.
*1210 During the taxable years in question the Watson-Moore Co., a corporation organized under the laws of the State of Washington, was engaged in a general brokerage business, buying and selling stocks and bonds on its own account and for the account of others, and the promotion of certain corporations. John R. Moore was president of the corporation, its manager, a director, and the principal stockholder thereof, owning approximately 60 to 65 percent of its capital stock in 1927 and 1928. Alma V. Moore, the wife of John R. Moore, was also a stockholder of the Watson-Moore Co.
Prior to May 3, 1926, Moore became interested in accumulating the stock of the Sunshine Mining Co., and submitted to that company a proposition to purchase 40,000 shares of its stock. On or before May 3, 1926, a contract was entered into whereby the Sunshine Mining Co. agreed to sell to the Watson-Moore Co. 40,000 shares of its stock at 30 cents a share, the stock to be delivered when and as paid for to the Watson-Moore Co., or its order, in denominations of not less than 1,000 share certificates. The contract acknowledged the receipt of $600 with the execution thereof and provided for weekly payments until*1211 June 17, 1926, when the purchase price would be paid. The contract was executed "Sunshine Mining Co. by John Sawbridge its President, party of the First Part," and "Watson-Moore Co., by J. R. Moore, Party of the Second Part."
The stock purchased under this contract was issued to the Watson-Moore Co. in the amount of 33,335 shares and to John R. Moore in the amount of 6,665 shares. In addition to the above purchase the *1200 Watson-Moore Co. purchased thousands of shares of Sunshine Mining Co. stock on the open market during 1926 and 1927. A large proportion of the stock so purchased was bought for and on order of John R. Moore. The Watson-Moore Co. gave its check in payment for the shares purchased, but used funds furnished by Moore or was reimbursed by Moore for the Sunshine shares acquired for him. A part of the purchases by the Watson-Moore Co. represented trading operations in Sunshine stock for its own account, from which it realized a profit, which is not here in controversy.
All transactions by the Watson-Moore Co. in Sunshine stock were entered on its stock ledger in an account entitled "Sunshine Mining Company." This treatment was similar to that accorded*1212 purchases of other securities which were in the name of John R. Moore but were reflected on the books of the Watson-Moore Co. in stock accounts carried in the name of the stock itself. The Sunshine Mining Co. account makes no segregation of purchases and sales for the company's account from purchases and sales for the account of John R. Moore, individually. At the end of 1927 this account showed a debit money balance of $18,379.75 and a credit balance of approximately 111,000 shares of Sunshine stock (inventoried at 110,939 shares by revenue agent). Under date of December 31, 1927, the Watson-Moore Co. closed out this account by charging the cash balance to the personal account of John R. Moore, but made no entry respecting the 110,939 shares.
The books and records of the Sunshine Mining Co. show a different treatment of the purchases of its stock by the Watson-Moore Co. during 1926 and 1927. In an account entitled "Watson-Moore Company" it records the transfer of 33,335 shares to that company by June 17, 1926, the last certificate for 667 shares being issued on that date and being the last certificate issued to the Watson-Moore Co. according to that account. Beginning with*1213 June 17, 1926, this account shows transfers of 10,000 shares to certain individuals and a transfer on July 14, 1926, of 20,000 shares to John R. Moore. Thereafter, the account was gradually closed out until on June 3, 1927, there was a balance of only 1,000 shares, which were transferred to John R. Moore on June 9, 1928, thereby completely closing the account. An analysis of the various certificates in this account, together with the account of John R. Moore with the Sunshine Mining Co., reveals that practically all the 33,335 shares were eventually acquired by Moore.
John R. Moore's account on the stock ledger of the Sunshine Mining Co. starts with entries on July 10, 1926, reflecting the issuance of 6,665 shares, being a portion of the 40,000 shares contracted for on May 3, 1926. The next entries in Moore's account reflect the transfer *1201 to him from the Watson-Moore Co. of 20,000 shares of Sunshine stock on July 14, 1926. Subsequent entries in this account reflect the volume of operations in Sunshine stock, the balances at the following dates showing the amount of stock standing in John R. Moore's name: on December 31, 1926, 25,832 shares; on May 20, 1927, 110,189*1214 shares; and on December 31, 1927, 173,985 shares.
A summary of Sunshine stock certificates held by John R. Moore on June 26, 1931, showing the date each certificate was transferred to him, the certificate number, the number of shares in each certificate, the cost per share, and the total cost of each certificate, reveals that Moore received 111,780 shares of Sunshine stock during 1926 and 1927, at a total cost of $56,362.74. The summary shows only such certificates as were retained by Moore, without regard to trading carried on in Sunshine stock by Moore and by the Watson-Moore Co. The detail of the summary (Exhibit 1), in so far as it is pertinent hereto, is incorporated herein and made a part hereof by reference. The Watson-Moore Co.'s books show that Moore made advances to the company from time to time in an amount more than sufficient to cover the cost of the stock.
The stock certificates listed in the aforesaid summary formed a part of the stock which was reflected in the credit balance of the Sunshine Mining Co. account appearing in the stock ledger of the Watson-Moore Co. at the time the account was closed out by transferring the cash balance to John R. Moore's personal*1215 account.
No shares of Sunshine stock owned by the Watson-Moore Co. were delivered to John R. Moore during 1927 under the guise of a dividend, nor were any stocks owned by the company turned over to Moore during 1927. Sunshine stock was purchased by the Watson-Moore Co. for the personal account of John R. Moore upon his instructions and delivery thereof was made in 1927.
During 1927 John R. Moore borrowed money from different sources, using Sunshine Mining Co. stock as collateral to secure the loans. The funds thus secured were delivered to the Watson-Moore Co. for the purpose of buying additional Sunshine stock for Moore's account.
The Sunshine Mining Co. declared dividends on its stock on May 10, 1927, August 10, 1927, October 11, 1927, and November 28, 1927, and these dividends were paid to John R. Moore during 1927.
The Watson-Moore Co. owed John R. Moore $2,077.02 on January 1, 1927, and on December 31, 1927, it owed him $32,803.98. Cash advances were made in 1927 by Moore to the company in the amount of $79,891.30 and in addition there were numerous credits to his account, in all totaling $112,137.10. Cash withdrawals amounted to $67,501.70, which with other charges*1216 totaled $95,861.57.
*1202 In auditing the Watson-Moore Co.'s return for 1927 the respondent determined that the credit balance of 110,939 shares in the Sunshine Mining Co. account on its books was a constructive dividend to John R. Moore, and determined that the fair market value for a block of stock of this size on December 31, 1927, was $1.10 per share, or a total of $122,032.90.
The inventory value assigned to these 110,939 shares by respondent at December 31, 1927, was $129,760.15, which amount was included in the Watson-Moore Co.'s closing inventory for 1927 upon the theory that the shares belonged to the company until the account was closed out as of December 31, 1927, by a transfer to John R. Moore.
In 1927 the Watson-Moore Co. became interested in the Little Sunshine Mining Co. The minutes of a special meeting of the board of directors of that company, dated September 28, 1927, show that an option was given to the Watson-Moore Co. on "600,000 shares of the treasury stock of the corporation, quoted at the following mentioned prices, to wit: the first 200,000 shares at 15 cents per share net to the corporation; the second 200,000 shares at 25 cents per share*1217 net to the corporation; the third 200,000 shares at 35 cents per share net to the corporation." The minutes were signed by the acting secretary and by J. R. Moore, president.
The Little Sunshine Mining Co. charged the Watson-Moore Co. on its books with 600,000 shares at a total cost of $150,000 as one operation.
In computing the profit on sales of Little Sunshine stock by the Watson-Moore Co. in 1927, the respondent used the cost price of 15 cents a share on the first 200,000 shares, and determined a profit of $14,900, while petitioner used an average cost of 25 cents a share in computing the profit realized, which would entirely eliminate the $14,900 item.
In 1928 the Little Sunshine Mining Co. set up a $5,000 credit on its books in favor of the Watson-Moore Co. as a commission for promotion services. No instructions were given to the bookkeeper to set up such commission on the Little Sunshine Mining Co.'s books, and the commission was never paid. No entry respecting the commission item appears on the books of the Watson-Moore Co., although its books were kept on the accrual basis.
For 1928 the respondent determined the net income of the Watson-Moore Moore Co., as adjusted, *1218 to be $48,348.63, whereas the company's return showed a net loss of $61.17. In arriving at this taxable income the deficiency letter shows numerous changes by way of additions to and deductions from the Watson-Moore Co.'s taxable income without itemization of each change. One of the items included therein consisted of a profit of $3,000 determined by respondent *1203 from transactions in Little Sunshine Mining stock. This increase in profit resulted from granting a claim of petitioner that certain transactions with one Molly Fisher were actual and not fictitious, as a result of which respondent determined that petitioner had sold stock from the first 200,000-share block of purchases in its contract with the Little Sunshine Mining Co., instead of from the second 200,000 block of purchases, which had a higher cost price.
In checking petitioners' returns with the books and records for the taxable years the respondent found that numerous transactions had not been properly recorded in the books of the Watson-Moore Co., particularly with respect to stock dividends and stocks shown as on hand which could not be found, and failure of the Watson-Moore Co.'s accountants to properly*1219 determine the long and short positions of that company as to its stock transactions. A check on correspondence files, bank records, and other sources of information enabled the revenue agent to adjust certain errors which were reflected in the deficiency letter. No cross or concealing entries appeared on the books relating to the transactions that were questioned.
Information obtained from the banks disclosed certain items of income and at least one deduction of approximately $4,500 for John R. Moore, personally. The respondent further found that throughout the years 1924 to 1928, inclusive, the Watson-Moore Co. had erroneously reported that company's short position in such a way as to overstate its income for the five years in a total amount of $98,331.50.
For 1927 the respondent's auditor determined a profit in the Watson-Moore Co.'s transactions in General Motors stock of $3,585.77, whereas petitioner's auditor determined a loss of $1,836.75. This difference was subsequently reconciled by petitioners' auditor agreeing with the respondent's position. The auditors agreed that the transactions in General Motors during 1928 resulted in a profit of $53.22. Various adjusting*1220 entries were made to the account by both auditors in arriving at the amount of profit.
OPINION.
ARUNDELL: The first and second questions raised by these proceedings will be considered in one discussion, since both questions involve the ownership of the 110,939 shares of Sunshine Mining Co. stock. Respondent determined that this stock was purchased by the Watson-Moore Co. during 1926 and 1927 and that it was carried on its books in the "Sunshine Mining Company" stock account as the property of the Watson-Moore Co. until December 31, 1927, when the account was closed out to John R. Moore, who thereby received a constructive dividend in the amount of the fair market value of the *1204 stock, which respondent says is $122,032.90. The petitioners contend that the stock appearing in the above mentioned account belonged to and was purchased for John R. Moore, pursuant to his instructions to the Watson-Moore Co.
It has been fully established that the Sunshine stock in question was purchased and paid for by the Watson-Moore Co., and that the stock was carried in its books in a stock account entitled "Sunshine Mining Company." However, John R. Moore has testified that these*1221 purchases were made pursuant to his order and in his behalf; that the stock was issued in his name, except for the first few thousand shares; that the account was known to be his personal account; that the purchases were paid for by him from time to time as deliveries were made, either by cash, credit on the books, or assets turned over to the company; that no Sunshine stock was ever given to him that belonged to the Watson-Moore Co.; and that the latter company purchased the stock as his agent.
Moore's testimony is corroborated, in part at least, by the books of the Sunshine Mining Co., which show that its account with the Watson-Moore Co. was closed out shortly after transferring 33,335 shares to it, while John R. Moore's account with that company has continued to date, and practically all the shares originally in the Watson-Moore account can be traced by certificate numbers into the account of John R. Moore.
Furthermore, a summary of certificates by serial numbers, which shows the date each certificate was transferred to Moore, discloses that prior to November 26, 1927, at least 111,780 shares stood in Moore's name. The evidence shows that these same certificates still stood*1222 in his name in June 1931, and the books of the Sunshine Mining Co. show that at the end of 1927 the balance of John R. Moore's account was 173,985 shares.
Respondent has vigorously assailed the weight to be given the testimony of John R. Moore, basing his attack upon discrepancies between Moore's testimony and affidavits submitted to the respondent which were received in evidence. Such discrepancies, however, have been either explained or the mistake admitted, and petitioners are no longer relying thereon. Respondent stresses particularly Moore's attempt to convince the Government that the transactions in Sunshine stock were personal rather than company transactions. We do not understand that petitioners have receded from this position; they merely admit that the record shows that some stock originally was issued to Watson-Moore Co., but was later transferred to Moore.
Moore's unrefuted testimony is that he ordered the stock bought for his account, that it was bought for his account by the company, and that he paid for each purchase. The only contradictory evidence *1205 in the record is the manner in which the Sunshine Mining Co. stock transactions were handled on*1223 the books of the Watson-Moore Co. Book entries, however, must give way before the true facts. .
It is our opinion, therefore, that respondent erred in determining that John R. Moore and his wife received a constructive dividend on December 31, 1927, in the amount of the fair market value of 110,939 shares of Sunshine Mining Co. stock, since the record shows that the stock was purchased for John R. Moore personally and was not the property of the Watson-Moore Co. In view of the conclusion here reached it follows that so much of the deficiency found by the respondent against the Watson-Moore Co. as is attributable to treating the stock as the property of that company at any time is disallowed.
The next issue is the cost basis to be used in determining the profit realized by the Watson-Moore Co. on sales of Little Sunshine Mining Co. stock in 1927. Respondent has computed the gain according to the contract and has thereby determined that the first shares sold were from the first 200,000-share block purchased. Petitioner has taken the average cost for the full 600,000-share purchase.
The petitioner submits this question*1224 to the Board upon the theory that as a matter of law the contract called for the purchase of 600,000 shares at a total cost of $150,000, or an average cost of 25 cents per share. This theory completely ignores the plain wording of the agreement, which fixes the cost of the first 200,000 shares at 15 cents a share, the cost of the second block at 25 cents a share, and the third, at 35 cents a share. If the shares purchased could not be identified with respect to their sales, petitioner would still be unable to prevail because in that event the "first in, first out" rule would apply, which is the rule followed by respondent. Upon this issue, therefore, respondent's determination must be approved.
The third question relates to a commission of $5,000 which respondent has added to 1928 income of the Watson-Moore Co. as an item due to it by the Little Sunshine Mining Co. The evidence is that the item never appeared on the books of the Watson-Moore Co. and no such commission was ever earned by or paid to petitioner. Respondent discovered an item on the books of the Little Sunshine Mining Co. of $5,000 as being due to the Watson-Moore Co. and by reason thereof added that sum to the*1225 income of the petitioner. There is no suggestion of any services having been performed by petitioner for the Sunshine Mining Co. which would call for the payment of the commission, and Moore testified he did not understand the reason for the entry in the books of the Little Sunshine Mining Co. In the face of direct evidence that the sum was neither *1206 earned by nor paid to the petitioner, the presumption of correctness attaching to respondent's determination has been overcome. The action of the respondent in this particular is reversed.
The remaining issue is whether any part of the deficiencies asserted against the Watson-Moore Co. for 1927 and 1928 is due to fraud with intent to evade tax. Since the burden of proving fraud is placed by statute upon the respondent, he has affirmatively alleged in his answers the grounds upon which he has determined that petitioners acted fraudulently.
While respondent has set forth numerous allegations of fraud with respect to each deficiency, he has failed to offer proof on each allegation, preferring to rely only upon certain specific allegations of fraud to support his determination. Thus, the allegation of fraud relied on*1226 by respondent in so far as John R. and Alma V. Moore are concerned, relates to their failure to report as income in 1927 the fair market value of 110,939 shares of Sunshine Mining Co. stock which respondent claimed was a dividend from the Watson-Moore Co. Our findings that these shares were at all times John R. Moore's and not the Watson-Moore Co.'s eliminates this item from consideration as an element of fraud. No proof of fraud as to 1925 and 1926 having been offered, respondent's determination as to these years must likewise be disapproved.
The allegations of fraud as to the Watson-Moore Co. upon which proof was offered by respondent were the concealment of facts relating to the purchase and ownership of Sunshine Mining Co. stock, the manner in which the General Motors account was handled on the Watson-Moore Co.'s books, and the overstatement of petitioner's stock purchases for 1926 by $60,000.
The principal proof offered in support of the fraud allegations was the testimony of the revenue agent who audited the books of the Watson-Moore Co. The agent testified in detail regarding numerous adjustments that were necessary from the Government's point of view in order to reflect*1227 correctly taxpayer's income for 1927 and 1928. Some of these adjustments were brought to his attention by the Watson-Moore Co.'s representative, and some were made upon his own determination. Some of the agent's adjustments petitioner conceded as obviously correct, while others were vigorously objected to as incorrect. The deficiency letter shows that taxpayer's income for 1927 was increased by virtue of these adjustments in the amount of $359,618.47, and at the same time adjustments by way of deductions amounted to $270,356.67. Adjustments for 1928 amounted to additions to income in the amount of $169,350.93, and additional deductions of $120,941.13.
Our discussion of the constructive dividend of Sunshine Mining Co. stock as an element of fraud as to John R. and Alma V. Moore *1207 and our decision that no element of fraud was involved disposes of this allegation as to the Watson-Moore Co. for 1927. We have carefully considered the proof offered by respondent upon his other allegations, but we are not convinced that it established fraudulent intent on the part of this petitioner for 1927 and 1928. The fact that numerous adjustments were necessary and that some were*1228 complicated in nature, due to the method of bookkeeping used by petitioner, is insufficient to establish fraud.
The remaining question is the alternative issue raised by respondent's answers in Dockets 62179, 64790, and 64791 that petitioners were negligent and the 5 percent negligence penalties provided by section 275(a) of the Revenue Acts of 1924 and 1926, and section 293(a) of the Revenue Act of 1928, should be imposed. In the appeal of John R. Moore, Docket 64791, the parties stipulated the deficiencies for 1925 and 1926, but left the fraud question for decision. The respondent, however, failed to offer proof to support his alternative allegation of negligence as to these years, and, therefore, for lack of evidence, we must deny his contention that the negligence penalty be imposed. In the appeal of Alma V. Moore, Docket 64790, respondent has determined a negligence penalty for 1928, which petitioner has failed to overcome, and the penalty for that year is therefore approved. The affirmative allegation of negligence against all of the petitioners for 1927 and against the Watson-Moore Co. for 1928 is in our opinion supported by the evidence. The record shows that numerous*1229 adjustments to income and deductions, totaling large sums, were necessary in order to reflect correctly the taxable income of these petitioners. We are satisfied from the evidence that these changes and corrections were necessary primarily because the taxpayers were negligent in keeping their accounts and rendering their returns, and that the deficiencies, at least in part, resulted from their negligence.
The deficiencies should be recomputed, giving effect to the concessions and stipulations of the parties and to the determination herein of the controverted issues. As to those errors alleged in the petitions that have been entirely ignored by the petitioners, the determination of the respondent is approved and should be so reflected in the recomputation.
Decision will be entered under Rule 50.
Footnotes
1. Negligence penalty. ↩