*624 1. The petitioner, under his agreement of employment, was granted in 1927 an option to purchase 20,000 shares of stock of corporation A, his employer company, and was also granted, as an inducement to enter into such employment agreement, an option to purchase 20,000 shares of stock of corporation B, which controlled corporation A, in the event corporation A did not make available to petitioner 20,000 shares of its stock as provided in the employment agreement. In January 1928 the petitioner, through his New York attorneys, caused to be organized corporation C and corporation D and assigned his two options to corporation C for all its common no par value stock and purchased 10,800 shares of its preferred stock at $100 per share. Corporation C, under the option, purchased 20,000 shares of corporation B stock and paid therefor with proceeds received from petitioner in payment for 10,800 shares of its preferred stock. Petitioner transferred the common stock of corporation C to corporation D in exchange for all of its common no par stock. Corporation C was dissolved in February 1928 and petitioner, as holder of 10,800 shares of its preferred stock, received the stock of corporation*625 B, and corporation D, as holder of its common stock, received the proceeds paid by petitioner to corporation C for its 10,800 shares of preferred stock remaining after payment of the purchase price of the 20,000 shares of corporation B stock and certain expenses. Corporation C transacted no other business except such as pertained to the acquisition of the stock of corporation B. Corporation D continued its existence and purchased and sold securities other than those involved herein. Thereafter, petitioner sold 15,000 shares of corporation B stock to corporation E, which corporation had prior to 1928 negotiated for the purchase of, and early in 1928 had offered to purchase, such stock, and exchanged the remaining 5,000 shares for 3,750 shares of class A common stock of corporation E, which petitioner, in March 1928, sold to corporation D. Held:
(1) Corporation C was a mere contrivance, conduit, or transfer agent for petitioner and not a separate and distinct entity, from the standpoint of tax significance, within the purview of and as contemplated by the applicable provisions of the revenue act, since, although such corporation was legally organized, it was immediately dissolved*626 after it had served its single limited purpose, it being apparent that it was not intended at the outset to organize an enduring corporation to function as a separate entity engaged in the business for which it was supposedly organized.
(2) The basis for computation of gain or loss on the disposition of the stock of corporation B is the amount paid therefor upon the exercise of the option to purchase, the same having been paid by the petitioner through corporation C.
(3) The respondent has not sustained the burden of proving fraud placed upon him by statute (sec. 907(a), as amended by sec. 601, 1928 Act) where the record merely discloses a sequence of transactions carried out in the acquisition and disposition of certain stock, each transaction being legal in itself, although planned and carried out with the purpose of avoiding taxes and there is no other evidence of fraudulent intent on the part of the petitioner to evade tax.
(4) No part of the deficiencies resulting from the above transactions and the negligent failure of petitioner to include an item of $42,500 of income in gross community income for the taxable year is due to fraud on the part of the petitioner or his*627 wife with intent to evade income taxes.
2. The petitioner, due to pressure of business affairs, did not check over his return prepared wholly by his secretary, who failed to include therein $42,500 of income actually received by petitioner within the year involved. Held, that the part of the increased deficiency resulting from the omission of such income in his return for 1928 was due to his negligence.
3. The petitioner's wife did not participate in any of the foregoing transactions. She filed a separate return on a community basis, which was prepared by the secretary of petitioner from data furnished by petitioner and was, as to the community property, in substance a duplicate of his return. Held, that the signing and filing of a separate return by a wife reporting her share of the community income is not sufficient evidence to justify the imposition of a fraud penalty or a negligence penalty, in the absence of knowledge of the receipt by her husband of the $42,500 or other evidence showing fraud with intent to evade taxes or negligence on her part and in the presence of evidence that different examinations of petitioner's records, all of which were available, *628 by revenue agents, failed to discover petitioner's receipt of such $42,500, the burden of proving both fraud and negligence being upon the respondent.
*928 These proceedings, duly consolidated, are for the redetermination of deficiencies in income taxes for the year 1928. In Docket No. 66716 the respondent determined a deficiency in income tax in the amount of $52,176.29, and in Docket No. 66717 in the amount of $49,860.09. In his amended answers he made claim to any increase in such deficiencies resulting from the changes of certain amounts, and to a fraud penalty, or, in the alternative, to a negligence penalty, as hereinafter more particularly set forth.
In each proceeding it is alleged that the respondent erred in increasing the net income of each petitioner by adding thereto the amount of $209,432.27 as representing one-half of an alleged additional community profit of $418,864.74 from the sale in 1928 of stock of the Wesco Corporation.
In his amended answers the respondent denied that he erred as above stated*629 and affirmatively alleged that he erred in his computation *929 of the tax shown in the notices of deficiency by crediting the amount of $33,600 profit reported on the sale of Fox Film Corporation stock; and that the amount of $42,500 should be added to income of petitioners as unreported commissions of Harold B. Franklin; and alleged fraud with intent to evade income taxes and made claim for such increase in each deficiency as may result from the above adjustments and corrections of error, plus the 50 percent fraud penalty, or, in the alternative, the 5 percent negligence penalty for failure to report the item of $42,500. Each petitioner replied denying such allegations of error on the part of respondent and of fraud with intent to evade income taxes, or negligence on the part of petitioners, and alleged that disclosure of the item of $42,500 was voluntarily made and the omission thereof was due to mistake.
FINDINGS OF FACT.
The petitioners are husband and wife and in 1928 resided in Los Angeles, California. Anna May Franklin did not participate in the following described transactions and whenever the term "petitioner" is used herein Harold B. Franklin is referred*630 to.
The petitioner, under written agreement dated March 1, 1927, with the West Coast Theatres, Inc., hereinafter referred to as West Coast, was employed to serve such corporation as president, director, and general manager for a period of five years. In addition to compensation of a fixed annual salary and a certain percentage of the consolidated net earnings computed as provided in the agreement, the petitioner was granted an option to acquire, at any time within five years from date of such agreement, 20,000 shares of the common capital stock of West Coast at a price of $30 per share, which price was subject to certain adjustments as provided in the agreement. West Coast had over a hundred subsidiary corporations, which owned and operated approximately five hundred theatres and the real estate in connection therewith. The theatres were located principally in the western part of the United States. The petitioner's principal office was in Los Angeles, California. He traveled about one-third of the time visiting the above theatres and made a trip to New York about every sixty days.
As an inducement to enter into such agreement with West Coast, the Wesco Corporation, hereinafter*631 referred to as Wesco, agreed in writing under date of February 2, 1927, that in the event West Coast did not make available to the petitioner the 20,000 shares of its stock under its agreement with him, he was granted the option to subscribe for 20,000 shares of the common capital stock of Wesco, at $30 per share, which price was subject to adjustment as provided in such agreement. He paid no cash for such option.
*930 Wesco was formed to acquire shares of West Coast and other corporations in Wisconsin and the Pacific Northwest. To retain voting control of Wesco a voting trust was created, consisting of five trustees. In lieu of stock certificates, voting trust certificates were issued by such trustees. Wesco controlled West Coast.
William Fox, president of the Fox Film Corporation and owner of approximately 33 1/3 percent of the stock of West Coast, in about 1926 commenced negotiations in behalf of the Fox Film Corporation for the purchase of the controlling stock of Wesco. On January 21, 1928, in a letter addressed to the Haystone Securities Corporation, New York, hereinafter referred to as Haystone, the Fox Film Corporation offered and agreed to purchase voting*632 trust certificates representing at least 112,000 shares of stock of Wesco at a price of $54 per share and $1 per share commission to Haystone, subject to the terms and conditions contained therein and subject to the provisions of an agreement entered into between the same corporations on the same date wherein Haystone undertook to find purchasers or to purchase on February 27, 1928, 125,000 shares of class A common stock of the Fox Film Corporation at $75 per share, the proceeds of such shares to be applied by the Fox Film Corporation to the purchase of the Wesco stock. The failure of Haystone to purchase such Fox Film Corporation stock as provided in the agreement would release the Fox Film Corporation from its obligation to purchase the Wesco stock at the time of the closing of the agreements seven days after February 27, 1928.
The profit-participating members of the partnership of Hayden, Stone & Co., stockbrokers, were the owners of the common stock of Haystone, which had its office at the offices of such partnership. The officers of Haystone in 1927 and 1928 were partners or employees of Hayden, Stone & Co. In 1928 the petitioner was a client of Hayden, Stone & Co.
In*633 a communication under date of February 1, 1928, addressed to the holders of voting trust certificates representing shares of the capital stock of Wesco, Haystone outlined the plan of reorganization with Fox Film Corporation under which each share of Wesco stock could be (a) exchanged for three-fourths of a share of class A common stock of the Fox Film Corporation, Haystone to receive $1 per share of Wesco stock as compensation, or (b) $55 in cash, less $1 per share to be retained by Haystone as compensation. This offer and plan of reorganization was, among other things, conditioned upon its being accepted on or before February 15, 1928, by the holders of a majority of the shares of Wesco stock. Acceptance of either offer was required to be made under such plan by written notice accompanied by the voting trust certificates duly endorsed.
*931 The petitioner, with the advice and assistance of counsel, and with the purpose of avoiding income taxes payable upon the prospective sale of 20,000 shares of either West Coast or Wesco stock, caused two corporations to be organized under the laws of the State of Delaware - the Harbrook Corporation, hereinafter referred to as Harbrook, *634 incorporated January 24, 1928, with an authorized capital stock of 11,000 shares of nonvoting preferred stock and 1,000 shares of common stock of no par value, and the Brookin Corporation, hereinafter referred to as Brookin, incorporated on January 30, 1928, with an authorized capital stock of 1,000 shares no par value. The petitioner was elected president and treasurer of both corporations. In consideration of the assignment of the above mentioned options by the petitioner, Harbrook, under date of January 30, 1928, issued to him its 1,000 shares of common stock. For the purpose of paying for 10,800 shares of the preferred stock of Harbrook subscribed for by him on or about January 30, 1928, the petitioner borrowed $1,080,000 from Haystone upon his collateral demand notes, one for $656,733, with interest at 6 percent, dated January 30, 1928, and another for $423,267 without interest, dated February 3, 1928. Harbrook, on or about January 30, 1928, exercised the option assigned to it by the petitioner by purchasing the 20,000 shares of Wesco stock at a cost of $656,733 and authorized and directed the delivery of such shares of Wesco stock to Haystone. Voting trust certificates representing*635 20,000 shares of Wesco stock were issued to Harbrook under date of January 30, 1928, and delivered to Haystone. The petitioner paid Harbrook for 6,567 shares of its preferred stock with a check endorsed by him received from Haystone on his loan in the amount of $656,733, which check was in turn endorsed to Wesco by Harbrook in payment of the cost of the 20,000 shares of Wesco purchased by Harbrook under the option. Harbrook, under date of January 30, 1928 notified Haystone that it had notified Wesco to deliver to it 20,000 shares of its shares to be placed under the proposed offer of the Fox Film Corporation to purchase such stock at $55 per share less $1 commission to Haystone, which agreement was canceled by Harbrook on or about February 3, 1928, with directions to hold such stock subject to the order of Harbrook. The petitioner, on or about February 4, 1928, acquired the remaining 4,233 shares of the 10,800 shares of preferred stock of Harbrook subscribed for by him, and paid for them with a check of Haystone, endorsed by him, in the amount of $423,267, being the proceeds of his second note.
The petitioner, about February 8, 1928, acquired all of the capital stock of Brookin*636 in exchange for all of the common stock of Harbrook, all pursuant to a written offer and acceptance.
*932 On February 10, 1928, Harbrook was dissolved. In liquidation Harbrook assigned to the petitioner, as holder of 10,800 shares of preferred stock, the 20,000 shares of Wesco stock purchased under the option, and authorized Hayden, Stone & Co. to transfer to the credit of Brookin, as holder of all the common stock of Harbrook, the amount of $423,267 on deposit with it to the credit of Harbrook, less $3,952.26 drawn therefrom by Harbrook.
The petitioner, through Haystone, accepted the offer of the Fox Film Corporation and thereunder sold 15,000 shares of Wesco at $55 per share, less $1 commission, and exchanged 5,000 shares for 3,750 shares of class A common stock of the Fox Film Corporation. On or about March 6, 1928, the petitioner sold the 3,750 shares of Fox Film Corporation to Brookin for $303,750, which was paid by a transfer of that amount on deposit with Hayden, Stone & Co., to the credit of the petitioner. He received $809,400 in payment for the 5,000 shares of Wesco stock by a credit theerof to his loan account at Haystone. Such account was also charged with*637 $200 transfer tax on 5,000 shares of Wesco stock and interest in the amount of $3,830.94. The balance in such loan account of $273,830.94 was authorized by the petitioner to be paid by Hayden, Stone & Co. and charged to his account with that company. The two collateral notes of $656,733 and $423,267 were marked "Cancelled" and returned.
The collateral deposited with such notes consisted of the common stock of Harbrook, later released and replaced by the 1,000 shares of Brookin stock, the 10,800 shares of preferred stock of Harbrook and all the equity of the petitioner in all securities held in his account with Hayden, Stone & Co. He further agreed in writing and guaranteed that in consideration of the loan in the sum of $423,267 such amount would be deposited with Hayden, Stone & Co. and left there intact until the completion of the sale of the 20,000 shares of Wesco stock, the proceeds of which were to be applied by Haystone to the payment of his obligations to Haystone.
Brookin is still in existence, and during 1928 it purchased and sold securities and loaned money on call through New York banks.
Harbrook, until dissolved, engaged in no other business transactions except*638 as heretofore stated; and the only funds ever acquired by it were obtained through the issuance of its preferred stock to the petitioner and a preliminary advance by him for organization expenses, which was repaid.
All corporate actions hereinabove set forth were duly authorized.
The petitioner and his wife filed separate returns for 1928 on a community basis. These returns were prepared by J. F. Kingman, who was employed by the petitioner in February 1929 as confidential secretary and accountant. At that time the petitioner had no complete set of books of account, and in preparing the returns J. F. *933 Kingman used the check and bank books and the brokerage and bank statements of the petitioner, and information returns of employer showing salary paid. The only assistance given by the petitioner in the preparation of the returns was in respect to his personal business expenses. The petitioner had a number of brokerage accounts and his tax return for 1928 discloses that he maintained stock and bond trading accounts with Hayden, Stone & Co., New York City; Marine Trust Co., Buffalo; E. F. Hutton & Co., Los Angeles; E. A. Pierce & Co., Los Angeles; and Bank of Italy, *639 Los Angeles. To the 1928 tax return of the petitioner is attached a schedule listing over 200 sales of securities during the year 1928. In such return or schedule no reference is made pertaining to the transactions in the Wesco, Harbrook, or Brookin stocks, except that such schedule showed the sale of 3,750 shares of Fox Film A at 81 at a profit of $33,600.
In preparing the returns I. F. Kingman did not include in taxable income an item of income of $42,500 shown as a credit to the account of the petitioner, in 1928, in one of the statements of Hayden, Stone & Co. This amount was received for petitioner by Hayden, Stone & Co., while the petitioner was in Portland, Oregon, from Gore Brothers, who were owners of a large number of Wesco shares, and credited to the account of the petitioner on March 8, 1928.
No part of the deficiencies resulting from the transactions relating to the option to purchase 20,000 shares of Wesco stock or the failure to include the amount of $42,500 in the gross income of the petitioners or otherwise, is due to fraud on the part of the petitioners, or either of them, with intent to evade tax.
That part of the deficiencies resulting from the omission*640 of the $42,500 from marital community income is due to the negligence of the petitioner Harold B. Franklin.
The respondent computed the profit resulting from the transactions pertaining to the option to purchase the 20,000 shares of Wesco stock as follows:
| 15,000 shares Wesco stock sold for | $809,400.00 |
| 5,000 shares Wesco stock exchanged for 3,750 shares Fox Film Corporation stock sold for | 303,750.00 |
| Value of Brookin Corporation stock | 419,314.74 |
| Total | $1,532,464.74 |
| Less: Cost of Harbrook Corporation stock | 1,080,000.00 |
| Profit | $452,464.74 |
| Less: Profit on sale of Fox stock | 33,600.00 |
| Balance | $418,864.74 |
| One-half community | $209,432.37 |
*934 OPINION.
MCMAHON: The first question to consider is whether the transactions relating to the acquisition and disposition of the Wesco stock accomplished the purpose intended of avoiding or reducing taxes on the purchase and sale of 20,000 shares of Wesco stock.
The petitioner had an option to purchase Wesco stock. He organized two corporations. To one of them he assigned such option in exchange for its common stock and with funds paid by the petitioner for some of its preferred stock such company purchased*641 the Wesco stock under the option. The petitioner turned over the common stock of the first corporation to the second corporation for its common stock. The first corporation dissolved and the petitioner, as preferred stockholder, received in liquidation the Wesco stock, which he thereafter disposed of.
The factual situation in Chisholm v. Commissioner, 79 Fed.(2d) 14, wherein no fraud issue was raised, is distinguishable from the factual situation herein. In the Chisholm case the taxpayer, his brother, and three others owned all the stock of the Houde Engineering Corporation. On September 26, 1928, all five gave a 30-day option upon their shares to Krauss & Co. which that company on October 11 agreed to take up. The Houde shares had increased in value very much and, upon the advice of their attorney, for the purpose of avoiding income tax on the prospective sale of the Houde stock the Chisholm brothers, on October 22, formed a partnership and transferred to it their Houde stock, and notified Krauss & Co. that the partnership would perform their contract. Krauss & Co. took up the option on October 24 and the partnership received the money therefor. The*642 firm was not then nor has it since been dissolved. The court, in holding therein that the situation presented was not analogous to the situation presented in Gregory v. Helvering,293 U.S. 465, stated that the purpose of the Chisholm brothers was certainly "to form an enduring firm which should continue to hold the joint principal and to invest and reinvest it" (emphasis supplied), whereas:
* * * In Gregory v. Helvering, supra, (293 U.S. 465) the incorporators adopted the usual form for creating business corporations; but their intent, or purpose, was merely to draught the papers, in fact not to create corporations as the court understood that word. That was the purpose which defeated their exemption, not the accompanying purpose to escape taxation; that purpose was legally neutral. Had they really meant to conduct a business by means of the two reorganized companies, they would have escaped whatever other aim they might have had, whether to avoid taxes, or to regenerate the world. [Emphasis supplied.]
In the instant proceedings, Harbrook was incorporated on January 24, 1928. As soon as the options had been transferred*643 by the *935 petitioner to Harbrook and the Wesco stock acquired by it with funds provided by the petitioner through purchase by him of its preferred stock, Harbrook on February 10, 1928, was dissolved. The activity and the life of Harbrook were limited to the purpose of acquiring the Wesco stock and transferring it to the petitioner in exchange for its preferred stock to establish a cost basis that would reduce or eliminate all taxable gain. The evidence adduced here does not disclose, as in the Chisholm case, an intention to form an "enduring firm" to engage in the business for which it was organized. While a valid corporation was created, its existence and purpose of existence was limited at the outset to that of acting as a contrivance, conduit, or transfer agent for Franklin for his own purpose. No real, subsisting, and enduring corporation was intended in the incorporation of Harbrook. The language of the United States Supreme Court in Gregory v. Helvering, supra, is equally applicable here:
* * * Putting aside, then, the question of motive in respect of taxation altogether, and fixing the character of the proceeding by what actually occurred, *644 what do we find? Simply an operation having no business or corporate purpose - a mere device which put on the form of a corporate reorganization as a disguise for concealing its real character, and the sole object and accomplishment of which was the consummation of a preconceived plan, not to reorganize a business or any part of a business, but to transfer a parcel of corporate shares to the petitioner. No doubt, a new and valid corporation was created. But that corporation was nothing more than a contrivance to the end last described. It was brought into existence for no other purpose; it performed, as it was intended from the beginning it should perform, no other function. When that limited function had been exercised, it immediately was put to death. [Emphasis supplied.]
See, also, Sydney M. Shoenberg,30 B.T.A. 659; affirmed in Shoenberg v. Commissioner, 77 Fed.(2d) 446; certiorari denied, 296 U.S. 586. 1
*645 The case of Commissioner v. Eldridge, 79 Fed.(2d) 629, affirming A. S. Eldridge,30 B.T.A. 1322, is distinguishable on the facts. That case involved sales of stock to a corporation, the stock of which was all owned by taxpayers. The Circuit Court and the Board held that generally a corporation and its stockholders must be treated as separate entities and that the facts presented did not warrant disregarding such rule. Therein, the corporation was a going concern and had been engaged in business prior to the sales involved and continued in business thereafter. Herein, on the other hand, the corporation *936 was organized not to transact business as a going concern, but for one purpose only, and, having performed such function, it was dissolved.
In the instant proceedings, Harbrook should, from the standpoint of Federal income taxation, be disregarded as a separate entity.
The purchase price of the 20,000 shares of Wesco stock was $656,733. While it appears that, under plan (a) of the Fox Film Corporation offer, $54 per share was to be paid for the stock, or $810,000 for 15,000 shares, the account of the petitioner with Haystone*646 was credited with $809,400, representing a price of $53.96 for each share. It was testified that a transfer tax of $800 was paid on the 20,000 shares of Wesco stock. The difference in the price of $54 per share and $53.96 per share for 15,000 shares amounts to $600, which would indicate that the price of $53.96 reflects the purchase price less transfer tax of a total of $600. The account shows that the petitioner was charged with $200 for transfer tax on 5,000 shares of Wesco exchanged for Fox Film stock. Thus a transfer tax of $800 was paid by the petitioner. The petitioner further received $303,750 from Brookin for the 3,750 shares of Fox Film exchanged for the remaining 5,000 shares of Wesco. Hence he actually received $810,000 plus $303,750 for the 20,000 shares of Wesco, less $800 for transfer tax, or $1,112,950. The community profit is the difference between $1,112,950 and $656,733, or $456,217. From this amount there should be deducted the amount of $33,600, representing the community profit reported by petitioners upon the sale to Brookin of the 3,750 shares of Fox Film stock exchanged for 5,000 shares of Wesco stock, leaving a taxable community gain of $422,617, one-half*647 of which is to be added to the reported taxable income of each petitioner for 1928. Since Brookin issued its 1,000 shares for 1,000 shares of the common stock of Harbrook and received $423,267 less $3,952.26, or $419,314.74, for the Harbrook stock, such amount represents the amount which the petitioner paid for the 1,000 shares of Brookin stock. Looking through form to substance, the petitioner in effect borrowed $1,080,000 from Haystone, of which $656,733 was used to purchase the 20,000 shares of Wesco stock under the option, for which he had not paid anything, and of which $423,267, less $3,952.26, or $419,314.74 was used to purchase 1,000 shares of Brookin stock. The Wesco stock was disposed of and the petitioner received $809,400 for 15,000 shares thereof and $303,550 for 5,000 shares thereof which had been exchanged for 3,750 shares of Fox Film.
The respondent at the opening of the hearing requested leave to file amended answers, stating that it was his intention, as to a possible fraud issue, to see what the evidence amounted to, and then at the close of the hearing to ask for leave to amend his amended answers to conform to proof. The presiding Member ruled that the burden*648 *937 of pleading and proving fraud rested upon the respondent and that no proof of fraud would be received over objection unless fraud was pleaded by the respondent before the taking of testimony. The respondent thereupon requested leave to amend his amended answers to allege fraud, which request was granted over the objection of the petitioners based upon the ground that to do so at the opening of the hearing was an abuse of discretion on the part of the Board. Opportunity was extended therefor and the petitioners could have then requested a postponement of the hearing to prepare their defense, but counsel stated that unless counsel for respondent alleged something not covered in his opening statement he would prefer to proceed immediately with the hearing. W. S. Gilman,18 B.T.A. 1277; affirmed in Gilman v. Commissioner, 53 Fed.(2d) 47, is not applicable here. Therein the respondent, after the hearing, moved to amend his answer by adding thereto an affirmative allegation of fraud. The Board denied the motion, stating in part:
* * * Under the law the respondent has the burden of proof to sustain an allegation of fraud. We think*649 the petitioner must be put on notice that such a charge is to be made and permitted to prepare his defense thereto in advance of hearing.
The petitioners here were put on notice as to the issue of fraud at the opening of the hearing and waived their right to further time in which to prepare their defense by proceeding to hearing.
The burden of proving fraud on the part of the petitioners rests upon the respondent. Sec. 907(a), as amended by sec. 601, Revenue Act of 1928. Such burden is discharged only by clear and convincing evidence. In Henry S. Kerbaugh,29 B.T.A. 1014; affirmed in Commissioner v. Kerbaugh, 74 Fed.(2d) 749, the Board stated:
* * * A charge of fraud has always been regarded as a serious matter in the law. Not only is it never presumed, but the ordinary preponderance of evidence is not sufficient to establish such a charge. It must be proved by clear and convincing evidence. * * *
* * * If not admitted it must be proved. * * *
That Harbrook and Brookin were legally organized and that all the transactions set forth in our findings involved in the acquisition and disposition of the Wesco stock and the Fox Film*650 Corporation stock were duly and actually carried out by the respective parties, is not questioned. That such transactions were carried out for the purpose of avoiding or reducing income tax does not invalidate such transactions. Transactions, legal in themselves, carried out with an intent to avoid income taxes, do not constitute a fraud upon the Government merely because of such underlying purpose. In Helvering v. Gregory, 69 Fed.(2d) 809, the court stated:
We agree with the Board and the taxpayer that a transaction, otherwise within an exception of the tax law, does not lose its immunity, because it is *938 actuated by a desire to avoid, or, if one choose, to evade, taxation. Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose the pattern which will best pay the Treasury; there is not even a patriotic duty to increase one's taxes. U.S. v. Isham,17 Wall. 496, 506 * * *; Bullen v. Wisconsin,240 U.S. 625, 630. * * *
To the same effect see *651 Gregory v. Helvering,293 U.S. 465, affirming Helvering v. Gregory, supra;Chisholm v. Commissioner, 79 Fed.(2d) 14; and Joseph E. Uihlein,30 B.T.A. 399; affirmed in Commissioner v. Brumder, 82 Fed.(2d) 944.
There are two issues involved herein, i.e., the question whether the transactions were such as to avoid taxes, which we have answered in the negative, and the question of fraud. To negative the first does not necessarily prove the second. The fact that the respondent determined a greater tax liability than reported and his determination is sustained does not of itself establish fraud. James Nicholson,32 B.T.A. 977.
As to fraud with intent to evade taxes, the record herein does not disclose that petitioners, or either of them, "attempted to obtain unallowable deductions by falsely representing the character of the same" or the "swearing to the truth of divergent statements of facts", or other facts clearly establishing fraud, as in *652 M. Rea Gano,19 B.T.A. 518, 533, cited by respondent. Nor does the record disclose any concealment of income by fictitious means as in Garden City Feeder Co.,27 B.T.A. 1132, cited by respondent, or in John Kehoe,34 B.T.A. 59. Fred Ascher,2 B.T.A. 1257; I. J. Adelson,7 B.T.A. 110; Bert M. Wuliger,16 B.T.A. 1220; 19 B.T.A. 462; and L. Schepp Co.,25 B.T.A. 419, also cited by the respondent, are distinguishable on the facts from the instant proceedings.
Two field examinations and investigations were made by different revenue agents, one in Los Angeles, California, in July 1931, and another in New York later in 1931. In making his recomputation and in his notices of deficiency, dated April 27, 1932, the respondent did not take the position that the transactions herein were fraudulent with intent to evade taxes. No affirmative allegations of fraud were made in the original answers filed nor in the first amended answers presented at the hearing, counsel for respondent stating that he intended to withhold alleging fraud until the close of the hearing, *653 and his so doing depended upon the evidence adduced at the hearing. In his computation of the deficiency the respondent allowed the cost basis of $1,080,000 as claimed by the petitioners, and in his original answer admitted that the 10,800 shares of preferred stock of Harbrook were acquired at a cost of $1,080,000. At the time respondent pleaded fraud affirmatively, at the hearing, he had no newly discovered evidence upon which to base his plea of *939 fraud except the voluntary admission of the petitioner that it had been discovered a few days prior to the hearing that the item of $42,500 had been inadvertently omitted from the gross community income for 1928. Although he attempted to show, upon cross-examination of petitioners' witness, that the petitioners refused to permit the revenue agents to examine petitioners' records, which was emphatically denied by such witness, he failed to call the revenue agent to rebut the testimony of petitioners' witness in this respect. All the papers, statements and other data relating to the transactions here involved or used in the preparation of the returns of petitioners were submitted to the revenue agents. It would appear that*654 up to the time of the hearing respondent had found no evidence of fraud and that at that time he was uncertain what position to take and intended to permit the evidence adduced at the hearing to shape his course. The attitude of the respondent throughout indicates that the results of his examinations and investigations up to the time of the hearing negatived fraud or, at least, were insufficient to justify the determination of a fraud penalty.
As to the item of $42,500, the secretary of the petitioner testified in substance that although he had seen the item on the Hayden, Stone & Co. statement, he had not included it in income because he thought it represented a capital transaction; that about two days before the hearing of these proceedings, in examining correspondence of the petitioner for possible use thereat, he came across a telegram sent by the Gore Brothers referring to this item; that he called it to the attention of the petitioner, who asked him whether he had included it in his reported income; that upon his reply in the negative, the petitioner stated that he should have done so; and that he thereafter mentioned the matter to petitioners' counsel on the day before the*655 hearing while traveling to Washington.
Harold B. Franklin testified that he recalled receiving the amount of $42,500 from Gore Brothers in March 1928; that he did not receive it personally, but that it was sent to Hayden, Stone & Co. and deposited to his credit while he was in Portland, Oregon; that the amount represented "an expression of appreciation for a job well done" in developing West Coast Theatres, Inc., of which Gore Brothers owned considerable stock, from a losing to a profitable enterprise.
There is no showing of any attempt to conceal the item of $42,500, or any other item or transaction involved herein, so as to prevent the discovery thereof. As stated in Drawoh, Inc.,28 B.T.A. 666;
* * * While it is of course lawful for taxpayers to use means and methods which are legal and not tainted with fraud to avoid taxes, Brillen v. State of Wisconsin,240 U.S. 625, Isham v. United States, 17 Wall, 496, it is *940 never lawful for taxpayers to use methods of concealment and deception to evade taxes. It is in the use of the latter methods that taxpayers run afoul of the fraud penalties. * * *
*656 The evidence presented as to the transactions relating to the Wesco stock does not justify a finding of fraud and the imposition of a fraud penalty, nor does the evidence presented justify a finding that the omission of the income item of $42,500 was due to fraud with intent to evade income tax. Ned Wayburn,32 B.T.A. 813; Oscar G. Joseph32 B.T.A. 1192. On the contrary the evidence, in our opinion, shows that the transactions here involved and the failure to report the income item were not due to fraud with intent on the part of the petitioners, or either of them, to evade income taxes, and we have so found.
Consideration of the testimony as it was adduced at the hearing, together with a consideration of the entire record thereafter, leads to the conclusion that the conduct of the petitioners is reconcilable with good faith on their part and establishes that they are not guilty of fraud as charged by the respondent in his amended answer. There is no basis in the record adequate to sustain a finding or holding that they, or either of them, are guilty of fraud. On the other hand the record does sustain the finding and holding, which we have made, *657 that neither is guilty of fraud.
The petitioner, Harold B. Franklin, who was present throughout the hearing, was not called as a witness in his own behalf, but he was called as a witness by the respondent and examined touching various aspects of the affirmative allegations of fraud of the respondent. After direct examination he was cross-examined by his counsel, and his counsel apparently considered that there was no occasion for further examination of the petitioner as a witness. Petitioner's attorney at law, who at the times in question handled all of the transactions pertaining to the Wesco stock for him, his confidential secretary and accountant employed by him in about February 1929, who made the 1928 separate income tax returns for him and his wife, and others were called as witnesses by the petitioner, and other witnesses were called by the respondent. In the testimony of all of these witnesses all of the transactions in question and all of the details and corporate minutes and records and book entries touching the issues presented here were gone into extensively. This petitioner at that time was president and manager of West Coast, which operated approximately five hundred*658 theatres, and he filed returns of about one hundred corporations. He traveled extensively and obviously, of necessity, he was obliged to leave most details, and some things that were more than details, to others, and more particularly to his attorneys and his secretary, and even to *941 those acting for the corporations. There is no justification in the record for an inference that this petitioner or his wife attempted to withhold from the Board any evidence necessary to a proper disposition by it of the issues raised. In any event, in the light of the whole record, the failure of this petitioner to testify further is not an adequate basis for reaching results, other than those reached herein.
The respondent alleges and claims, in the alternative, that the 5 percent negligence penalty should be imposed for failure to report the item of $42,500 as community income. The petitioner testified that he did not audit or check his return prepared by his secretary to see whether any particular transactions were included; that he did not have the item of $42,500 in mind at the time, although he had knowledge of receiving it; that he did not have time to check over his return; that*659 it was impossible for him with his various duties to have done so; that he filed returns of perhaps one hundred corporations; that he traveled a lot; that he had to rely on some one in this respect; and that he had confidence in his secretary and depended upon him entirely to prepare his return. As stated in Irving Fisher,30 B.T.A. 433, 443, "Petitioner can not escape liability for a correct return by committing its preparation entirely to his secretary." See also cases cited therein, and Milton A. Machay,11 B.T.A. 569. Section 51(a) of the Revenue Act of 1928 provided that he "shall make under oath a return stating specifically the items of his gross income." (Emphasis supplied.) We conclude, therefore, and we have so found, that the omission of this item of $42,500 from the reported community income was due to the negligence of Harold B. Franklin and the negligence penalty of 5 percent should therefore be imposed as to him upon the whole of his deficiency. Sec. 293(a), Revenue Act of 1928.
As to Anna May Franklin, the secretary of her husband testified that she did not provide him with any books or statements for the preparation of*660 her return; that the return was submitted to her to sign; and that he did not know how complete an examination of it she made. Franklin testified that he discussed casually with Mrs. Franklin the transaction relating to the Wesco stock; that she had some knowledge of this transaction, but not as to details. The returns for 1928 of the petitioners disclose that Anna May Franklin had no other income than that derived from the earnings of her husband, dividends from securities bought after July 29, 1927, and the profits resulting from her husband's dealings in securities, in which she acquired a community interest because of their residence in California and their relationship as husband and wife, the basic relationship as between them. From the evidence *942 it appears that the transactions herein were all carried out by the direction of her husband, and that he managed and controlled the community property as his own. In 1928, so far as we know, Anna May Franklin resided in California. Harold B. Franklin traveled a good part of the time and transacted a large part of his business in New York. The community interest of Anna May Franklin in the earnings and property of her*661 husband and the fact that her return was substantially a duplicate of her husband's return is not sufficient proof of fraud or negligence on her part. The evidence adduced as to her is wholly insufficient to prove fraud with intent to evade taxes or negligence on her part, the burden of proving which rests upon the respondent, Henry S. Kerbaugh, supra, and American Ideal Cleaning Co.,30 B.T.A. 529. There is no evidence disclosing that she had knowledge of the receipt by her husband of the $42,500; that she could have with due diligence discovered the receipt of such income, or that she did not use due diligence and care in the preparation of her return. Although two revenue agents examined her husband's records upon two different occasions, they failed to discover this item and no claim was made for the tax thereon until her husband voluntarily, at the hearing, admitted receiving the same.
Reviewed by the Board.
Decision will be entered under Rule 50.
BLACK, MURDOCK, and MELLOTT dissent because they do not think the separate entity and the acts of the Harbrook corporation can be ignored.
TYSON, dissenting: The opinion*662 as adopted by the Board finds that there is negligence on the part of Harold B. Franklin, the husband of Anna May Franklin, both being petitioners in these consolidated proceedings, in omitting from his return his share in the item of $42,500 received as community income, and imposes upon him as a result the statutory penalty of 5 percent, but absolves Anna May Franklin from the imposition of a like penalty for an identical omission. I disagree with the opinion in so far as it fails to impose a negligence penalty on Anna May Franklin.
In the preparation of the returns in which the omissions occurred both petitioners acted through an agent, who knew of the item, but did not include it in income because he thought it a capital transaction, and each petitioner filed his or her respective return as so prepared. At the time of the preparation of these returns the only difference between the relative positions of the husband and wife *943 with regard to this item was that the husband had actual knowledge of having received it, while it does not appear from the opinion that the wife did have such actual knowledge. However, in the opinion it is said:
From the evidence it appears*663 that the transactions herein were all carried out by the direction of her husband and that he managed and controlled the community property as his own.
It thus appears that it managing and controlling the community property the husband was acting as the agent of the wife, and his knowledge of the receipt of this $42,500 as well as any negligence on his part in thereafter failing to see that this item was included in her return is imputable to her.
Mrs. Franklin's return having been prepared by her husband's secretary as her agent for that purpose, the negligence of such agent, if any, in its preparation is also imputable to her. So, regardless of whether the negligence in ommiting the item from her return was attributable to either her husband or his secretary, or to the joint negligence of both, such negligence was hers under the familiar rule that the negligence of an agent when acting within the scope of his authority is the negligence of the principal.
I dissent from the opinion in so far as it failed to assess the statutory penalty of 5 percent against Anna May Franklin.
Footnotes
1. In North Jersey Title Insurance Co. v. Commissioner, 84 Fed.(2d) 898, the court stated:
"The principle that substance and not form should control in the application of income tax law is fundamental. Fictional corporate camouflage cannot be made the device to escape taxation."
See also 112 West 59th St. Corp. v. Helvering, 68 Fed.(2d) 397. Cf. Edward Securities Corporation,30 B.T.A. 918; affd., 83 Fed.(2d) 1007↩.