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Kehoe v. Commissioner of Internal Revenue.

June 27, 1939


Petition for Review from the United States Board of Tax Appeals.

Author: Buffington

Before DAVIS, BIGGS, and BUFFINGTON, Circuit Judges.

BUFFINGTON, Circuit Judge.

This is a petition to review the decision of the United States Board of Tax Appeals. The Commissioner of Internal Revenue has assessed the petitioner, John Kehoe, with a deficiency in tax for 1925 of $208,043.36, plus a penalty of $108,803.61. The Board of Tax Appeals confirmed the Commissioner and dismissed Kehoe's appeal.

The fact situation presents no dispute. The petitioner's income tax for 1925 is involved. Twice he paid, without apparently any protest. His first return filed March 15, 1926, showed gross income of $27,865.61 and a net taxable income of $19,198.33 on which a tax of $194.56 was computed and paid. In September 1927 agents of the Commissioner made an examination and investigation of the petitioner's income for 1925. As a result he was notified of an additional tax due of $9,563.86, based on an increase in taxable income of $53,990.46. At this point it is significant to note there is no evidence to indicate the basis for these figures, how they were arrived at, what was the source of income heretofore not was the source of income heretofore not reached or reported; nor is there evidence disbursements or gross or net income. Moreover, the agent of the Revenue Department who made the examination was not called by the government. The petitioner, however, appeared satisfied with this additional assessment thus made which reached him October 20, 1927, and was by him paid. He also executed a waiver of appeal to the United States Board of Tax Appeals. Following this an agreement in writing under Section 1106(b) of the Revenue Act of 1926 was executed. It was approved by the Acting Secretary of the Treasury on January 27, 1928 and became final and conclusive on both taxpayer and Commissioner under the terms of the Act.*fn1

Several years later, however, the Commissioner notified the petitioner that his return for 1925 would be re-examined. This was followed by a letter dated February 24, 1932, determining the deficiency tax for 1925 at $208.043.36, plus a fraud penalty of $108,803.61, based on an alleged income of $890,000. The appeal of Kehoe, the petitioner, to the United States Board of Tax Appeals, and the subsequent hearing developed the circumstances and facts responsible for this additional deficiency assessment.

We here note that the Board was warranted in finding that Kehoe, the petitioner, had illegally operated a brewery known as Bartels, during the year 1925, through a permit obtained by one P. F. McGowan, who now informed against Kehoe. McGowan was merely a straw-man for the illegal manipulatoins of Kehoe, and during the year 1925, he sold "high powered" beer, exceeding the limitation of alcoholic content, amounting to $890,000, concealing his own identity as the real operator. Proof by railroad records was produced to show illegal activity in sales of beer not covered by the permit of P. F. McGowan.

Were the issue here involved the revocation of the permit to operate the brewery on ground of illegal activity, there could be no hesitation in saying that a case had been made out. Were the issue one of conspiracy between Kehoe and McGowan to violate the National Prohibition Act, the answer again would be that the case against them was established. But the issue here involved is altogether different. It is whether or not the closing agreement executed by the Commissioner and the taxpayer and approved by the Acting Secretary of the Treasury on January 27, 1928 was procured by fraud or malfeasance or misrepresentation of fact.

The Revenue Act of 1926, c. 27, 44 Stat. 113, provides that a closing agreement shall be "final and conclusive" in the absence of fraud. The purpose of the statute is the commendable one of terminating disputes and settling controversy. Judge Woodrough in Wolverine Petroleum Corporation v. Commissioner of Internal Revenue, 8 Cir., 75 F.2d 593, 595, says: "The purpose of the statute authorizing closing agreements is to enable the taxpayer and the government finally and completely to settle all controversies in respect of the tax liability for any previous taxable period, and to protect the taxpayer against the reopening of the matter at a later date * * * to facilitate the settlement of many items affecting a taxpayer's liability, the policy has been to broaden, rather than limit, the scope of these settlements."

Congress reenacted the provision of this section in subsequent revenue acts (See: 26 U.S.C.A. § 1660(b), realizing the wisdom of allowing and encouraging final compromises and settlements. This enactment should not lightly be disregarded by the courts since it has always been the policy of the law to encourage compromises and settlements. In Miller v. Pyrites Co., 4 Cir., 71 F.2d 804, 810 (certiorari denied, 293 U.S. 604, 55 S. Ct. 121, 79 L. Ed. 696), the court said: "Compromises of disputed claims are favored by the court and, when fairly entered into, are final." Hennessy v. Bacon, 137 U.S. 78, 11 S. Ct. 17, 34 L. Ed. 605; Williams v. First National Bank, 216 U.S. 582, 595, 30 S. Ct. 441, 54 L. Ed. 625.

The Commissioner, therefore, had the burden of proof to show that the closing agreement was entered into either through fraud, malfeasance or misrepresentation of fact. This burden was affirmatively placed on the Commissioner by the Revenue Act of 1928, c. 852, § 601, 45 Stat. 872, 26 U.S.C.A. § 612, which reads: "In any proceeding involving the issue whether the petitioner has been guilty of fraud with intent to evade tax, where no hearing had been held before May 29, 1928, the burden of proof in respect of such issue shall be upon the Commissioner."

The Commissioner at the hearing on the appeal before the Tax Board assumed the burden. As stated above, the proofs showed that the taxpayer, Kehoe, was part and parcel of a scheme to evade the National Prohibition Act in 1925. He showed that Kehoe was the actual operator of the brewery and large sums of money came into his hands through the sale of high-powered beer. But how does that prove that the closing agreement was entered into through the fraud of the taxpayer, Kehoe? The Commissioner took no steps to show that when the settlement was made the income from the illegal operation of the brewery was not taken into consideration.It was clearly within the power of the Commissioner to introduce evidence of the closing agreement and the nature of the income on which the additional tax was based. The failure to produce such testimony would clearly warrant the inference that if such testimony were produced it would be unfavorable to the Commissioner. Runkle v. Burnham, 153 U.S. 216, 14 S. Ct. 837, 38 L. Ed. 694; Chicago & N.W.R. Co. v. Kelly, 8 Cir., 84 F.2d 569, 572; The Marsodak, 4 Cir., 94 F.2d 339, 343. In Mammoth Oil Co. v. U.S., 275 U.S. 13, 48 S. Ct. 1, 9, 72 L. Ed. 137, Mr. Justice Butler quotes Lord Mansfield in Blatch v. Archer, (Cowper, 63, 65): "It is certainly a maxim that all evidence is to be weighed according to the proof which it was in the power of one side to have produced, and in the power of the other to have contradicted." And our Supreme Court has held, Runkle v. Burnham, 153 U.S. 216, 14 S. Ct. 837, 841, 38 L. Ed. 694:

"The doctrine that the production of weaker evidence, when stronger might have been produced, lays the producer open to the suspicion that the stronger evidence would have been to his prejudice was expressly adopted in the case of Clifton v. United States, 4 How. 242 [11 L. Ed. 957]."

Considering the policy of the law to favor compromises and settlements, it was incumbent on the Commissioner to show that the income from the operation of the brewery was not considered when the additional assessment was made. That an investigation of Kehoe's liability was made, is the fact. That a written, statutory settlement was made, is also the fact. It follows, therefore, that the presumption is that all his tax liability was settled. That additional tax liability of some $53,000 was ascertained and settled, is a fact. There is no proof that other than the brewery, any other liability existed or was claimed. If this increased liability of $53,000 was not brewery liability, what was it? Moreover, there is nothing in the record to show that the income of which McGowan informed the government in 1930 was not considered in 1927, and paid for, and closed by agreement ...

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