Opinion
Docket Nos. 110805 111028.
1949-10-21
HUGH B. MONJAR, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Paul F. Myers, Esq., and James Craig Peacock, Esq., for the petitioner. James C. Maddox, Esq., for the respondent.
1. The petitioner organized and controlled a club on a nation-wide scale and obtained from members a large amount of money through transactions called ‘PLs.‘ Because thereof he and associates were convicted in a Federal court of having employed a scheme to obtain money under false pretenses in the sale of securities by the use of the mails and interstate communication. Held, that the verdict of conviction estops the petitioner to deny that the amounts received were income.
2. Golden Braid, a corporation which sold costumes only to members of the club, was formed in 1936. Petitioner's sister and a Mrs. Drew, his secretary whom he married in December 1940, were, with a minor exception the stockholders and were, with his sister's two daughters, the officers of the corporation and received salaries and dividends therefrom. Petitioner advanced from ‘PL‘ funds the purchase price of their original stock and somer later stock. The club purchased from the corporation many more costumes than were purchased by members from the club. Four thousand dollars, being one-half of one dividend received by Mrs. Drew in 1936, was paid to petitioner. Mrs. Drew received, from 1938 through 1940, $17,250 to $18,750 annually for salary, but her successor in December 1940 received only $150 a month. Petitioner supplied from ‘PL‘ funds the purchase price of the stock when she transferred it to her successor in December 1940. Held, on the facts, that the income of petitioner included the dividends and disallowed salaries paid by Golden Braid.
3. For lack of evidence, held that the Commissioner is not shown to have erred in including in petitioner's gross income $20,375 income from Key Publishing Co.
4. Held, on the facts, that a part of the deficiency for each taxable year was due to fraud, with intent to evade tax, within the intent of section 293(b) of the Internal Revenue Code, and that assessment and collection of deficiencies were not barred by statutes of limitation. Paul F. Myers, Esq., and James Craig Peacock, Esq., for the petitioner. James C. Maddox, Esq., for the respondent.
These cases, consolidated for hearing and disposition, involve petitioner's income tax liability as follows:
+-----------------------------------------------------------------+ ¦Deficiency ¦ ¦50 per cent penalty¦ ¦ ¦ +------------+----------+-------------------+----------+----------¦ ¦ ¦Jeopardy ¦Not ¦Jeopardy ¦Not ¦ +------------+----------+-------------------+----------+----------¦ ¦Taxable year¦assessment¦assessed ¦assessment¦assessed ¦ +------------+----------+-------------------+----------+----------¦ ¦1936 ¦$5,881.28 ¦$38,743.54 ¦$2,940.64 ¦$19,371.77¦ +------------+----------+-------------------+----------+----------¦ ¦1937 ¦27,292.34 ¦82,788.86 ¦13,646.17 ¦41,394.43 ¦ +------------+----------+-------------------+----------+----------¦ ¦1938 ¦30,941.55 ¦97,905.32 ¦15,470.78 ¦48,952.66 ¦ +------------+----------+-------------------+----------+----------¦ ¦1939 ¦60,966.21 ¦12,032.05 ¦30,483.11 ¦6,016.03 ¦ +------------+----------+-------------------+----------+----------¦ ¦1940 ¦16,518.56 ¦53,314.96 ¦8,259.28 ¦26,657.48 ¦ +------------+----------+-------------------+----------+----------¦ ¦Total ¦141,599.94¦284,784.73 ¦70,799.98 ¦142,392.37¦ +-----------------------------------------------------------------+
The above jeopardy assessments were made on February 21, 1942. The additional deficiencies in tax and penalties appearing under the headings above entitled ‘Not assessed‘ were determined on April 21, 1942. A notice of deficiency was mailed to petitioner on March 13, 1942, in regard to a deficiency of $30,941.55 in income tax and a 50 per cent penalty of $15,470.78 determined for the year 1938. On April 28, 1942, petitioner filed his petition with this Court, Docket No. 110805 (consolidated herein), asking for a redetermination of the deficiency for 1938. The petition involved in Docket No. 111028 (consolidated herein) was filed on May 13, 1942. The latter case stems from the Commissioner's notice of deficiency dated April 21, 1942, above mentioned. This petition alleges overpayments for the years 1939 and 1940 in the amounts of $715.28 and $1,930.51, respectively.
The issues for our determination are: (1) Whether the amounts received by petitioner from Mantle Club members in each of the taxable years constituted taxable income; (2) whether petitioner exercised such power and control over the stock and operations of the Golden Braid Costume Co. (hereinafter sometimes referred to as Golden Braid) that its dividends and disallowed salaries were taxable to him; (3) whether respondent erred in adding to petitioner's income for 1940 any part of the $20,375 described in the deficiency notice as ‘income from Key Publishing Company‘; and (4) whether any part of the deficiency for each of the taxable years was due to fraud with intent to evade tax, within section 293(b) of the Internal Revenue Code. In the alternative, petitioner asks that the following issues be decided: (5) Whether the deficiencies asserted for 1936 and 1937 on February 21, 1942, were at that time already barred by the statute of limitations; (6) whether the assessment and collection of the additional deficiencies for the years 1936, 1937, and 1938, proposed for the first time in the deficiency notice dated April 21, 1942, are barred by the statute of limitations; (7) whether as to 1938 taxes the respondent had and sustained the burden of proof, where two deficiency notices were sent, and the respondent covered the matters in affirmative averments in his answer.
A stipulation of facts was filed. We adopt same by reference and find the facts therein set forth. Such parts thereof as it is considered necessary to set forth are included with other facts found from evidence, both documentary and oral, in our findings of fact.
FINDINGS OF FACT.
Petitioner, a resident of Pennsylvania, was formerly a resident of New York. His income tax returns for 1936, 1937, 1938, and 1939 were filed with the collector of internal revenue for the third district of New York, and his income tax return for 1940 was filed with the collector of internal revenue for the first district of Pennsylvania. All returns were filed on a cash basis. They were filed on March 13, 1937, March 10, 1938, March 13, 1939, March 15, 1940, and March 15, 1941, respectively, and reported, respectively, the following amounts of gross income:
+----------------+ ¦1936¦$13,000.00 ¦ +----+-----------¦ ¦1937¦19,500.00 ¦ +----+-----------¦ ¦1938¦29,656.00 ¦ +----+-----------¦ ¦1939¦14,963.00 ¦ +----+-----------¦ ¦1940¦17,669.80 ¦ +----------------+
In 1924 petitioner founded a fraternal corporation known as the Decimo Club, and until the latter part of 1927 was chairman of its national board of governors. The Decimo Club had a slow beginning, but increased its membership from about 7,000 members at the end of 1926 to 62,702 members by the time of its annual convention in the latter part of 1927. In 1927 petitioner received from the Decimo Club $394,930 as commissions for obtaining new members during that year. Meanwhile, he had organized the Apasco Purchase & Sales Corporation, in which he held all the stock, and Drew Tailoring Corporation, two very successful business activities which were separate from the Decimo Club but participation in the benefits of which was limited to its members. At the 1927 annual convention of the Decimo Club petitioner and his national board of governors were unseated by another faction, and both the club and the two corporations soon ceased functioning.
In 1929 petitioner founded the Mantle Club, and until 1945 was chairman of its national board of governors. During the years 1936— 1940, inclusive, (hereinafter sometimes referred to as the taxable years) he was also editor and principal author of a monthly magazine and two books, all published by the Key Publishing Co. and during those years sold primarily to members of the Mantle Club. The Mantle Club remained small, with less than 100 members until late in 1933, when it began expanding on a nation-wide scale.
By January 1, 1936, 13 district units had been organized in large cities throughout the country, and by December 31, 1940, 30 such districts had been organized. The following table shows under ‘Gross‘ the total cumulative number of men received into membership up to the end of each year, and under ‘Net‘ the actual membership on each such date:
+----------------------------+ ¦ ¦Gross ¦Net ¦ +--------------+------+------¦ ¦August 1933 ¦96 ¦96 ¦ +--------------+------+------¦ ¦December 1933 ¦397 ¦382 ¦ +--------------+------+------¦ ¦December 1934 ¦3,092 ¦2,539 ¦ +--------------+------+------¦ ¦December 1935 ¦12,381¦10,082¦ +--------------+------+------¦ ¦December 1936 ¦24,337¦17,692¦ +--------------+------+------¦ ¦December 1937 ¦33,121¦20,594¦ +--------------+------+------¦ ¦December 1938 ¦45,515¦26,243¦ +--------------+------+------¦ ¦December 1939 ¦60,282¦31,697¦ +--------------+------+------¦ ¦December 1940 ¦73,237¦34,218¦ +----------------------------+
The following table, for all districts, shows under ‘Gross‘ the total cumulative number of men received into full membership up to each date, and under ‘Net‘ the actual net number of full members on such date:
+------------------------------------------------+ ¦Full membership, all districts * ¦Gross ¦Net ¦ +----------------------------------+------+------¦ ¦Dec. 31, 1936 ¦3,169 ¦3,088 ¦ +----------------------------------+------+------¦ ¦Dec. 31, 1937 ¦6,956 ¦6,612 ¦ +----------------------------------+------+------¦ ¦Dec. 31, 1938 ¦9,942 ¦8,897 ¦ +----------------------------------+------+------¦ ¦Dec. 31, 1939 ¦13,181¦10,690¦ +----------------------------------+------+------¦ ¦Dec. 31, 1940 ¦14,895¦10,772¦ +----------------------------------+------+------¦ ¦Dec. 31, 1941 ¦16,822¦10,470¦ +------------------------------------------------+
During the years 1934 to 1941, inclusive, petitioner's receipts from ‘PLs‘ and repayments were as follows:
+----------------------------------------+ ¦Year ¦Receipts ¦Repayments¦Net ¦ +-----+------------+----------+----------¦ ¦1934 ¦$26,181.75 ¦$423.25 ¦$25,758.50¦ +-----+------------+----------+----------¦ ¦1935 ¦55,651.75 ¦829.25 ¦54,822.50 ¦ +-----+------------+----------+----------¦ ¦1936 ¦106,838.50 ¦3,252.50 ¦103,586.00¦ +-----+------------+----------+----------¦ ¦1937 ¦191,225.00 ¦10,200.00 ¦181,025.00¦ +-----+------------+----------+----------¦ ¦1938 ¦215,779.00 ¦29,344.00 ¦186,435.00¦ +-----+------------+----------+----------¦ ¦1939 ¦207,345.00 ¦54,668.00 ¦152,677.00¦ +-----+------------+----------+----------¦ ¦1940 ¦208,709.00 ¦53,935.50 ¦154,773.50¦ +-----+------------+----------+----------¦ ¦1941 ¦122,448.50 ¦63,720.50 ¦58,728.00 ¦ +-----+------------+----------+----------¦ ¦Total¦1,134,178.50¦216,373.00¦917,805.50¦ +----------------------------------------+
In petitioner's office at Wilmington, Delaware, a complete set of accounts and files of all these transactions with each individual was kept under the supervision of Abraham J. Cook (referred to hereinafter sometimes as Cook), one of petitioner's close associates.
In each city which had such a ‘PL‘ group petitioner also employed one of the members of the group as his ‘PL‘ agent, who handled and remitted the monthly installment payments from subscribers and petitioner's own repayments to them, and kept a local set of accounts and records. On receiving each installment payment the ‘PL‘ agent would ordinarily give a conventional 3 inches by 5 inches receipt form, reading, in substance, ‘Received from John Doe * * * Dollars, Acct. PERSONAL LOAN H. B. MONJAR,‘ or ‘Received of John Doe the sum of $ . . .,a/c of HBM-PL No. . . . .‘ Under date of December 18, 1940, Cook addressed a letter to an agent, in which he suggested that if a smaller type had been used on the rubber stamp, ‘HBM— CD GRP,‘ it would have served the purpose and would have been less conspicuous.
Members of the Mantle Club were taught certain ideas, including ‘confidence.‘ The arrangements under which petitioner procured money known as ‘PLs‘ were designated as transactions that were strictly confidential and were under no circumstances to be divulged to outsiders and not to be discussed with other participants. At times it was represented to a particular ‘PL‘ group that the ‘PL‘ activity was limited to a very few districts. The members of the Mantle Club were taught all through the steps of the organization that the way to realize the fruits or the rewards that were to be gained was to stick with the organization and take part in all its activities. The members were constantly being tested and were told that the best way to test a man was through his money. The ‘PL‘ group was the segment of the Mantle Club closest to petitioner.
Various reasons were given for ‘soliciting‘ the ‘PLs,‘ the main one being that it was a test by which the members of the Mantle Club could establish a further record of dependability. The members were often told that petitioner did not need the money. Invariably, it was represented that petitioner could use the money as he saw fit. One of the series was ‘solicited‘ on the basis that the funds would be used to pay petitioner's income tax liability which he claimed would be later refunded by reason of its invalidity. Petitioner had encountered difficulty in this regard in that many of the men were astonished to hear that he had any old obligations. Drew suggested that Monjar refrain from mentioning anything about what he was going to do with the money in the future. At the time of obtaining signature on some of the ‘PLs,‘ promises were made to the effect that the person ‘contributing‘ his money could expect to receive in return, per month, four times the amount of his yearly contribution, beginning in 1939. Often it was represented that petitioner planned to organize large corporations which would give worthy Mantle Club members good positions. Petitioner did not wish the records to indicate any connection between the Mantle Club and the series of ‘PL's‘ unless it was ‘absolutely certain‘ that such records would be kept ‘strictly confidential.‘ Those in authority made no effort to keep the records of ‘PLs‘ and Mantle Club separate. Drew's idea was that the local agent, only, should know the details of the ‘pl‘ group, to prevent the local board from voting men into full membership before they demonstrated their fitness by a sufficient record in the Mantle Club, for he thought the board members had a tendency to want to promote men because they advanced money and not because their records justified it. He also thought some of the members of the Mantle Club developed a feeling of security because they had advanced money on the ‘PLs.‘ Drew was of the opinion that the local agents did not know how to conduct an intelligent program in a ‘PL‘ meeting.
It was represented to the select group that petitioner was receiving no salary from the Mantle Club and that he needed income for the time he devoted to the club's activities. In petitioner's official capacity with the Mantle Club, he was allowed an expense account that varied from $20 to $50 per diem. Drew addressed a letter to one of petitioner's agents, wherein a refund check was enclosed and the following statement made: ‘Please return this money to above-mentioned individuals AS SOON AS POSSIBLE, so that Mr. Monjar will KNOW that he has no outstanding obligations.‘
Under date of November 21, 1936, Drew addressed a letter to an agent in which he stated that the three main purposes of the local agent were, first, to locate for Monjar a certain definite number of dependable men that Monjar could test, and that when a man was recommended the agent was guaranteeing to Monjar that there was no question about the man's sincerity and loyalty; second, to raise for Monjar a certain amount of revenue that he could use and control without any restrictions or interference; and, third, ‘ALWAYS‘ to protect Monjar and his interest against any individual or group within or without his activities.
Petitioner and his associates controlled the financial side of the Mantle Club and the ‘PLs.‘ Repayment of ‘PLs‘ were made, but only after extreme measures were taken to block such refunds. Drew addressed a letter to Cook under date of January 10, 1935, in which he suggested that the agents tighten up on all delinquents, as there was absolutely no necessity for the records as they stood. Drew thought that the agents were afraid of hurting someone's feelings instead of realizing that they were Monjar's trusted agents and should make men cooperate.
In another letter, under date of July 28, 1935, Drew stated that petitioner controlled the extension of time on payments of ‘PLs.‘ Further, that the men came into the ‘PL‘ proposition on a group basis of cooperation and he thought it an important test of each man for him to ‘break his neck‘ to make a good record. He also suggested that petitioner wanted ‘STRONG‘ men as agents, and no ‘softies.‘
The members of a ‘PL‘ group that did not sign up for the following series of ‘PL‘ group that did not sign up for the following series of ‘PLs‘ or decided to withdraw from ‘PL‘ activities became a very real problem to petitioner and his associates. When a member failed to sign up for the following series of ‘PLs,‘ the agent was to determine whether such a member was skeptical, disloyal, distrustful, or lacked confidence or belief in Monjar or the ‘PL‘ proposition, and if he (the agent) thought that the member was negative in any of these, then the proper action should be taken to disassociate the member from the group. If a member was not in arrears on his ‘PLs,‘ the only way he could be disassociated from the group was to have him eliminated from the organization itself, as his removal from the ‘PL‘ group then would be automatic. When it was determined that a member was skeptical of the ‘PL‘ group and began to cause trouble within the groups, petitioner wasted no time in eliminating such a member from the organization. It was realized that a member with a skeptical attitude toward ‘PLs‘ could do considerable damage within the ranks of the organization and especially among the full members. The Mantle Club agent at Portland was advised by Cook on March 26, 1941, that Monjar had placed a maximum limit of $2,000 monthly to be allowed for all Portland refunds.
The ‘PL‘ agents were instructed to show the ‘PL‘ participant that it was a privilege to belong to that group and that unless he could arrange to meet his obligations promptly he was not wanted in the group. Hypothetically, a ‘PL‘ member could retrieve the amount he had paid into the ‘PL‘ fund by showing that he had suffered financial reverses. However, great pressure was brought to bear on the ‘PL‘ participant when he attempted to withdraw his money under this condition. One ‘PL‘ participant attempted to withdraw on this basis, stating that he could not raise the money to continue payment on his ‘PL.‘ After some discussion, the agent made the following statement to him: ‘If your wife had to go to the hospital you would raise the money, wouldn't you? * * * Go borrow the money.‘
Petitioner and his associates were very emphatic that petitioner could ‘refund‘ the money he received through ‘PL's‘ at any time he saw fit. The men within the ‘PL‘ groups were to understand distinctly that Monjar did not need the money, but could use it as he saw fit; that as far as the members were concerned he could throw the money into the Pacific Ocean if he was so minded. Petitioner implied that the real purpose of this activity was the supreme test for each man. However, the money was to be used, not banked. Among other things, petitioner wanted to use the ‘PL‘ money he received to take care of his sister, Mrs. B. M. Mason, and her family and wanted to ‘save‘ Josephine T. Drew and to put her in an ‘independent position.‘ Cook stated in a letter to an agent that if the money were to be saved, or banked, there would be no need for it and would be contrary to the purposes outlined. Drew, in writing a ‘PL‘ agent, was emphatic that petitioner owed no duty to return the money to the ‘PL‘ participants until he got ‘good and ready‘ to do so, if at all.
An agent, in a letter to Cook, mentioned, among other matters, that certain ‘PL‘ money had been ‘invested,‘ and Cook was prompt to reply that the agent should be extremely careful to refrain from using the word ‘invested‘ in the manner in which it was used. For, said Cook, ‘it is NOT TRUE and even if you inadvertently happen to use it, others will also repeat it and the first thing you know there will be * * * endless misunderstandings and misconstruction placed upon it. So please be careful in the use of words.‘
A committee of ‘PL‘ participants from Detroit came to Wilmington to investigate what use petitioner had made of ‘PL‘ funds, and it was denied an audience on the grounds that it was none of their business.
Extreme care was taken to keep correct and exact records. When a ‘PL‘ participant wanted to increase his subscription, the agent in charge would write to Cook to secure permission. In one case remittance was received by Cook in excess of the amount of the subscription of the participant. Cook, in a letter, indicated that he assumed that the participant had increased his subscription in that amount.
On February 27, 1942, the Securities and Exchange Commission filed an action in the United States District Court for the District of Massachusetts against petitioner, Cook, Drew, and several others of petitioner's associates, as Civil Action No. 1805. The bill of complaint, which alleged that:
Since on or about January 19, 1934, the defendants have been and are now selling to several thousand members of the Mantle Club residing in California, Colorado, Illinois, Maryland, Massachusetts, Michigan, Minnesota, Missouri, New Jersey, New York, Ohio, Oregon, Pennsylvania, Rhode Island, Washington, and Wisconsin, securities aggregating in excess of $1,340,000 in connection with transactions described by the defendants as ‘personal loans‘ to Hugh B. Monjar, and in the sale of such securities the defendants have been and are now directly and indirectly using the mails and the means and instruments of transportation and communication in interstate commerce * * *
also alleged that such securities had not been registered in accordance with Securities Act and prayed for an injunction enjoining the use of the facilities of interstate commerce or of the United States mails in connection with such transactions unless duly registered.
In response to a demand for a bill of particulars as allowed by a court order of March 23, 1942, the plaintiff Commission supplemented its complaint by further alleging:
That the securities which the defendants have been and are now selling are not evidenced by, described in, or set forth in any one document or instrument but consist of and are evidenced by: (1) ‘receipts‘ issued to the members of the Mantle Club by the defendants in connection with transactions described by the defendants as ‘personal loans‘ to Hugh B. Monjar; (2) ‘subscription cards‘ and other instruments solicited from members of the Mantle Club by the defendants in connection with such ‘personal loans‘, and (3) various other oral and written evidences of the indebtedness arising out of such ‘personal loans.‘
On September 18, 1946, the above action was, on the agreement of the parties in open court, ordered dismissed.
On May 26, 1942, petitioner and 4 associates were indicated in the United States District Court for the District of Delaware, and on September 22, 1942, 12 others of his associates were indicted in the same court. Both indictments related in large part to the ‘PL‘ transactions. The first indictment had 25 counts. Counts 1-15 and 23-24 charged violations of the Mail Fraud Act (Title 18, USCA, sec. 338).
In substance, each count charged the defendants with obtaining money under false pretenses, through the mails. Counts 16-22 charged violations of the Securities Act (Title 15, USCA, sec. 77q(a)(1)).
In substance, counts 16-22 charged the defendants with having employed a scheme to defraud and obtain money by false pretenses ‘in the sale of a security, to wit, a certain evidence of indebtedness‘ by the use of the mails (or interstate communication by telegraph). Count 25 charged conspiracy to violate both acts. The second indictment contained only a single count, charging conspiracy. Petitioner filed a demurrer to all counts of the first indictment. The District Court sustained the demurrer as to count 1 and overruled it as to the other counts. United States v. Monjar, 47 Fed.Supp. 421.
In a joint trial of the defendants in both indictments, which began February 8, 1943, and continued for more than 60 days over a period of 4 months, petitioner was convicted on 5 of the Securities Act counts, viz., counts 16, 17, 18, 20, and 21; also on counts 2-3, 5-8, 10-15, and 23.25.
In the indictment by the grand jury, the order overruling demurrer, briefs by counsel for the Government, both in the trial court and the Court of Appeals, and in the charge to the jury, the words ‘loan‘ and ‘personal loan‘ are used, a total of many times. On June 25, 1943, petitioner was sentenced to one year imprisonment and a fine of $5,000 on each of counts 16, 17, 18, 20, and 21, said sentences of imprisonment to run concurrently with sentences imposed under other counts.
Petitioner appealed to the United States Circuit Court of Appeals for the Third Circuit. The judgment of the District Court was affirmed. United States v. Mojar, 147 Fed.(2d) 916;certiorari denied, 325 U.S. 859. Petitioner has since served the sentences and paid the fines.
On May 21, 1942, petitioner established a liquidating trust which recited that its purpose was ‘to put into effect an orderly plan for the gradual liquidation of his obligations under all the aforesaid 'personal loan’ agreements.‘ Under ‘Exhibit A,‘ which was to be property transferred, assigned and delivered to the trustees by the grantor (petitioner herein), no property was scheduled or delivered to the trustees. Under ‘Schedule B,‘ which was to be properly executed and delivered to the trustees by the grantor and his wife, Josephine T. Monjar, there were scheduled and delivered to the trustees 3 mortgages for an aggregate face value of $115,000 on real estate. Under ‘Exhibit C,‘ which was to be property assigned and delivered to the trustees by various friends of the grantor, there was scheduled and delivered to the trustees contributions by some 45 Mantle Club members of certificates for a total of 1,423 shares of stock in a number of different corporations organized by Mantle Club members.
When the liquidating trustees took over on May 21, 1942, the total net outstanding receipts by petitioner had been reduced by repayments to $1,056,922. Between that date and November 28, 1942, the trustees under the procedure set up under the trust distributed $815,746.80 to ‘PL‘ subscribers whose payments to petitioner were included in the $1,056,922, and since November 28, 1942, they have similarly distributed an additional $125,891.70. After the aforesaid distributions there remained on petitioner's records a balance of $115,283.50 in the accounts of 715 ‘PL‘ subscribers. The trustees, who now hold $26,684.40 in cash and some additional unliquidated assets, estimate that they will eventually realize and have available for further distribution a total of between $30,000 and $40,000. No distributions are being currently made because the collector of internal revenue has served a notice of levy on all the trust assets in connection with the jeopardy assessments against petitioner which are at issue in the instant case. Substantially all of the distributions by the liquidating trustees as described in the preceding paragraph were made out of funds contributed to the trustees by individual ‘PL‘ subscribers. In the case of a number of such individuals, such contributions exceeded the amount of the respective distributions to them.
The contributions received by the liquidating trustees were secured in much the same manner as petitioner had previously secured ‘PL‘ funds. Agents were appointed in strategic areas, with detailed instructions to contact ‘PL‘ participants, purportedly to pay the amount included in the member's ‘PL‘ account. The agent was instructed to interview the ‘PL‘ participants and was given the following instructions:
1. Test the man's understanding of principles and his loyalty by giving him information mentioned in ‘Outline of Personal Interviews‘ and secure his reactions to questions as outlined in Ques. Nos. 3-4-5-6.
(If reaction not favorable terminate interview at this point in friendly manner.)
(If satisfactory emphasize confidential nature of interview— at conclusion of interview explain reason we want him to keep same confidential is because we do not want him, in his elation or enthusiasm, to inadvertantly (sic) mention subject matter of interview to other men and thereby possibly offend him by he thinking he was overlooked— before we get around to giving him the opportunity to help too.)
2. If reaction OK then proceed with balance of ‘Outline‘.
3. Obtain largest contribution possible— get largest possible payment at time of interview.
4. Complete Contribution Form.
5. Tell contributor NO RECEIPTS will be given and reason therefor. (Reason: SEC is trying to show that PL etc. receipts already issued constitute a security etc.)
6. Tell contributor that acknowledgments will be sent each contributor direct from Trustees covering each contribution.
7. Re: War Bonds— Defense Bonds: We do not want men to cash these in or disturb any purchase arrangements with regard to same.
8. Agent is authorized to make immediate payment of PL etc. amounts where advisable.
* * *
Detailed weekly reports were to be rendered to one W. H. Mattox, of Wilmington, Delaware, on contributions and disbursements. The ‘Outline of Personal Interviews‘ referred to in the above instructions covered reading to the member a legal report on the situation, and an explanation of the grand jury system and of the trust set up, inquiring as to confidence in Monjar and willingness to protect him, and the securing of contributions in the largest possible amounts in the shortest possible time. The legal report was a memorandum pertaining to such situations as where petitioner and other members had been indicted on charges of conspiracy, violation of Blue Sky laws, etc., in Pittsburgh, and advising that an action in the Federal District Court in Boston had been brought to enjoin petitioner and others from continuing ‘PL‘ activities; that a grand jury investigation was being conducted in Wilmington concerning ‘PL‘ and other activities; and that a jeopardy assessment of income taxes had been made against petitioner and others connected with the Mantle Club. The U.S.A. Grand Jury System memorandum gave a short resume of someone's opinion of the grand jury system of the United States, with emphasis on the thought that only one side of the story had been revealed and that even though one had been indicted the accused person is presumed to be innocent until he has been proved to be guilty in a fair and impartial trial.
Various methods were used to complete the program outlined for the agents. Some ‘PL‘ participants were desirous of securing the money they had ‘contributed‘ to the ‘PL‘ fund and upon contacting the agent these were told of the indictment of petitioner and that the best way to insure getting the money back was to make a contribution of that amount (the amount of their ‘PLs‘) to petitioner, which they often did and signed all receipts requested. They were led to believe that such contributions would relieve petitioner of his obligations and that he (petitioner) could go into court and say that he owed no man. Further, that the ‘PL‘ participant could, in due time, expect repayment from the liquidating trustees of the amount of their ‘PLs.‘ Such extreme care was taken that at the end of one interview the agent handed the ‘PL‘ participant his money and remarked as follows: ‘To make this legal I have to give you this money because you are signing a form saying that you received the money from Mr. Monjar.‘ The ‘PL‘ participant was handed the money and the agent said: ‘Now, you have signed the form. Give it to me back.‘ So the ‘PL‘ participant gave him back the money. One ‘PL‘ participant was asked to make a gift to petitioner of the amount he had in the ‘PL‘ fund. One of the agents of the liquidating trustees ‘paid out‘ about $54,000 and received contributions of $65,000.
The Key Publishing Co. published a monthly magazine entitled ‘The American Key‘ and two books entitled ‘Code of Ethics‘ and ‘Code of Ethics Supplement,‘ all of which were during the taxable years here in question sold primarily to members of Mantle Club. Petitioner, as editor, received in the years 1935 to 1937 a salary; in the year 1938, a salary and royalties; and in the years 1939 and 1940, royalties. The magazine was sold to distributors wholesale at 15 cents a copy and retailed only by sale of single copies at 25 cents a copy. The books were sold at retail at $2 each. A royalty of $1 a copy on the books was paid to petitioner up to July 1940, and thereafter 20 cents a copy was paid.
At the time of the organization of the Key Publishing Co. in 1933, 360 shares of $1 par value were issued, 10 shares each to J. F. Jones, Cook, and A. F. Muller, and 330 shares to 90 other individuals of the group at that time composing the membership of the Mantle Club. On January 1, 1937, 411 shares were outstanding. In November of 1937 Jones and Cook each transferred 100 shares of the Key Publishing Co. stock owned by them to the American Business Management Corporation at $1 per share.
At or about the same time 589 shares, being the unissued stock of the Key Publishing Co., were issued at $1 a share to employees and members of the Mantle Club, making 1,000 shares in all outstanding. In April 1940 Cook, Jones, and Drew transferred, respectively, 37, 38, and 25 shares of stock of the Key Publishing Co. to the American Business Research Corporation.
This is stipulated. The record does not explain how they acquired the additional stock.
The president of the Key Publishing Co. was J. F. Jones from March 10, 1933, to August 19, 1938; Drew from August 19, 1938, to May 22, 1940; J. F. Jones from May 22, 1940, to February 18, 1941; and Cook for several years thereafter. The salary paid to these individuals as president was $400 a month. Salaries of $400 and $300 a month were paid to the secretary and the treasurer, respectively, of the corporation.
The Key Publishing Co's. stock was transferred at $1 a share at various times, regardless of the value of the stock as reflected on its books or as reflected by its financial statements.
On January 1, 1935, Key Publishing Co.'s capital and surplus were as follows:
+-----------------+ ¦Capital¦$395.00 ¦ +-------+---------¦ ¦Surplus¦1,451.34 ¦ +-------+---------¦ ¦Total ¦1,846.34 ¦ +-----------------+
For the years 1935-1940, inclusive, the total net income of the Key Publishing Co., the dividends paid by it, and the salary and royalties paid to petitioner, were as follows:
+-----------------------------------------------------------------------------+ ¦Paid to ¦ ¦ ¦ ¦ ¦ ¦petitioner ¦ ¦ ¦ ¦ ¦ +-------------+-----------+-------------------------------+--------+----------¦ ¦Year ¦Net income ¦Total dividends for all ¦Salary ¦Royalties ¦ ¦ ¦ ¦outstanding stock ¦paid ¦ ¦ +-------------+-----------+-------------------------------+--------+----------¦ ¦1935-1940, ¦$184,451.82¦$65,220 ¦$56,300 ¦$42,788.80¦ ¦incl ¦ ¦ ¦ ¦ ¦ +-----------------------------------------------------------------------------+
A dividend of $35,000 in 1940 paid by the Key Publishing Co. was eventually received by the following:
+-----------------------------------------------------------------------+ ¦American Business Management Corporation, as stockholder¦ ¦$7,000¦ +--------------------------------------------------------+-------+------¦ ¦American Business Research Corporation, as stockholder ¦ ¦3,500 ¦ +--------------------------------------------------------+-------+------¦ ¦84 individual stockholders (paid to petitioner) ¦$20,375¦ ¦ +--------------------------------------------------------+-------+------¦ ¦Retained for income tax ¦660 ¦ ¦ +--------------------------------------------------------+-------+------¦ ¦ ¦ ¦21,035¦ +--------------------------------------------------------+-------+------¦ ¦42 individual stockholders ¦ ¦3,465 ¦ +--------------------------------------------------------+-------+------¦ ¦Total ¦ ¦35,000¦ +-----------------------------------------------------------------------+
In the deficiency letter of April 21, 1942, respondent added the above mentioned $20,375 to petitioner's reported income for 1940 as ‘(c) income from Key Publishing Company.‘ When the liquidating trustees took over on May 21, 1942, $11,460 of this amount had been repaid by petitioner. The balance of $8,915 is included as part of the $1,056,922, supra, to which, on that date, the petitioner's receipts had been reduced by repayments. The entire $20,375 was included as a part of the $1,316,813, supra, the total amount received by petitioner from the members. The subsequent distribution by the trustees included distributions of an additional $8,705 on account of the above mentioned $8,915.
The Mantle Club on December 31, 1938, had on hand copies of the American Key Magazine for which it had paid 15 cents a copy, the total cost being $142,000. On December 31, 1940, the Mantle Club had in its inventory 918,347 copies of the American Key Magazine at a cost of $137,752.05, of which 828,914 were current issues when purchased. On December 31, 1941, the Mantle Club had on hand 797,926 copies which cost 15 cents each, or a total cost of $119,688.90. Between 1934 and 1940 the Mantle Club purchased at a cost of 15 cents a copy 1,154,245 American Key Magazines which included 325,331 copies which were back issues when purchased. Of these back issues, 235,898 were resold to the Key Publishing Co., leaving 89,433 back issues in the Mantle Club's inventory as at December 31, 1940.
Mantle Club was not a distributor of the American Key Magazine, nor did it sell such magazines. Its purchase of the magazines from the Key Publishing Co. was for the purpose of holding the copies purchased until there was a demand therefor. When the demand occurred the Mantle Club sold the copies required to meet the demand occurred the Mantle Club sold the copies required to meet the demand to the Key Publishing Co. at 15 cents a copy. The copies required to meet the demand were then sold by the Key Publishing Co. at 25 cents a copy, less a discount to individual distributors.
The number of American Key Magazines printed, the number of copies purchased by the Mantle Club, the number of copies sold back by the Mantle Club to the Key Publishing Co., and the number of copies on hand in the inventory of the Mantle Club, were as follows:
+-----------------------------------------------------------------------------+ ¦ ¦1935 ¦1936 ¦1937 ¦1938 ¦ +---------------------------------------------+-------+-------+-------+-------¦ ¦Current copies of American Key Magazine ¦151,000¦320,000¦480,000¦480,000¦ ¦printed ¦ ¦ ¦ ¦ ¦ +---------------------------------------------+-------+-------+-------+-------¦ ¦“Back” copies printed ¦48,500 ¦70,000 ¦360,000¦ ¦ +---------------------------------------------+-------+-------+-------+-------¦ ¦Total copies printed ¦199,500¦390,000¦840,000¦480,000¦ +---------------------------------------------+-------+-------+-------+-------¦ ¦Current copies purchased by Mantle Club from ¦132,200¦194,000¦240,000¦240,000¦ ¦Key Pub. Co ¦ ¦ ¦ ¦ ¦ +---------------------------------------------+-------+-------+-------+-------¦ ¦1935 copies purchased by Mantle Club in 1937 ¦ ¦ ¦140,168¦ ¦ +---------------------------------------------+-------+-------+-------+-------¦ ¦Total of current copies and 1935 back copies ¦132,200¦194,000¦380,168¦240,000¦ ¦purchased by Mantle Club ¦ ¦ ¦ ¦ ¦ +---------------------------------------------+-------+-------+-------+-------¦ ¦Repurchases by Key Publ. Co. from Mantle Club¦71,585 ¦44,357 ¦ ¦32,300 ¦ +---------------------------------------------+-------+-------+-------+-------¦ ¦Magazines of 1935-1938 issues held by Mantle ¦60,615 ¦149,643¦380,168¦207,700¦ ¦Club ¦ ¦ ¦ ¦ ¦ +-----------------------------------------------------------------------------+
The American Business Management Corporation was a corporation the stock of which was owned by officers and employees of the national board of governors of the Mantle Club, among whom were Cook and J. E. Lindh, the latter an officer of the American Business Management Corporation, and Drew, the general manager of the American Business Corporation. The paid-in capital was advanced by petitioner out of ‘PL‘ funds
The American Business Research Corporation, organized on January 18, 1937, was a corporation the stock of which was owned by officers and employees of the national board of governors of the Mantle Club, among whom was out of ‘PL‘ funds. It received fees of $1,000 per years each from the Key Publishing Co., Golden Braid Costume Co., and petitioner. In 1937 it secured through the Portland Research Corporation a survey of residents of the city of Portland, Oregon. The Portland Research Corporation was organized by officers and members of the Portland district of the Mantle Club; its capital was advanced out of ‘PL‘ funds; and the survey which it conducted was financed by advances from the American Business Research Corporation. The records resulting from such survey were turned over to petitioner by the American Business Research Corporation upon payment by petitioner of $24,750.
In the fall of 1940 the Independence Club of America was organized, the board of governors of which were all Mantle Club members and some of whom were members of the board of governors and officers of the Mantle Club. Its membership in 1940 was 21,000. For his initiation fee and monthly dues a member of the Independence Club of America was given a copy of the Code of Ethics and a copy of each monthly issue of the American Key published by the Key Publishing Co.
The Golden Braid Costume Co. (hereinafter referred to as Golden Braid) was incorporated in Delaware on June 13, 1936. From then until December 1940 Josephine T. Drew (petitioner's former secretary) was its president, and, with a minor exception, was also the record holder of 80 per cent of its stock. She had been, some time prior to December 1936, divorced from Clement O. Drew. During the years 1936 to 1940 Mrs. B. M. Mason, sister of petitioner, was its vice president and, with a similar exception, was record holder of 20 per cent of its stock.
Golden Braid issued 100 shares of $100 par value, 80 to Josephine T. Drew and 20 to Mrs. B. M. Mason. On November 20, 1937, 92 additional shares were issued by the company, 80 to Josephine T. Drew, 10 to Mrs. B. M. Mason, and two to R. W. Talt, brother of Josephine T. Drew. On February 2, 1938, 8 additional shares were issued to Mrs. B. M. Mason. During February 1938 the 2 shares held by R. W. Talt were transferred to Mrs. B. M. Mason. Cash was paid into issues in 1936 and for the 2 shares to Talt in 1937 being advanced to the individual stockholders by petitioner out of ‘PL‘ funds.
Golden Braid paid salary and dividend to Josephine T. Drew and Mrs. B. M. Mason as follows:
+----------------------------------------------------------+ ¦Josephine T. Drew¦ ¦Mrs. B. M. Mason¦ ¦ ¦ +-----------------+------+----------------+------+---------¦ ¦Year ¦Salary¦Dividends ¦Salary¦Dividends¦ +-----------------+------+----------------+------+---------¦ ¦1936 ¦$3,875¦$8,000 ¦$300 ¦$2,000 ¦ +-----------------+------+----------------+------+---------¦ ¦1937 ¦11,000¦24,000 ¦1,300 ¦6,000 ¦ +-----------------+------+----------------+------+---------¦ ¦1938 ¦17,250¦32,000 ¦1,800 ¦6,800 ¦ +-----------------+------+----------------+------+---------¦ ¦1939 ¦18,000¦1,600 ¦1,800 ¦400 ¦ +-----------------+------+----------------+------+---------¦ ¦1940 ¦18,750¦12,000 ¦1,800 ¦3,000 ¦ +-----------------+------+----------------+------+---------¦ ¦Total ¦68,875¦77,600 ¦7,000 ¦18,200 ¦ +----------------------------------------------------------+
The salary of Josephine T. Drew was at the rate of $500 a month from June 15, 1936, to January 1, 1937; at the rate of $750 per month from January 1, 1937, to September 1, 1937; at the rate of $1,000 from September 1, 1937, to April 1, 1938; and at the rate of $1,500 a month from April 1, 1938, to December 31, 1940. A bonus of $750 was paid in December of 1940.
Out of the first dividend, paid on December 12, 1936, received by Josephine T. Drew in the amount of $8,000, she paid over $4,000 to petitioner. Out of the dividend for the year 1937 paid on November 29, 1937, received by Josephine T. Drew and Mrs. B. M. Mason in the respective amounts of $24,000 and $6,000, Josephine T. Drew paid into the Golden Braid $8,000 and Mrs. B. M. Mason paid $2,000 for the additional new stock issued to them, which doubled their holding in that stock and increased the capital stock of Golden Braid from $10,000 to $20,000.
Josephine T. Drew and Mrs. B. M. Mason reported the above respective salaries and dividends in their individual Federal income tax returns for 1936 to 1940, inclusive, and paid the taxes shown on the returns.
The sales and net income of Golden Braid for the years 1936 to 1940 were as follows:
+-------------------------+ ¦Year ¦Sales ¦Net income ¦ +-----+-------+-----------¦ ¦1936 ¦$42,060¦$17,167.97 ¦ +-----+-------+-----------¦ ¦1937 ¦162,761¦66,727.79 ¦ +-----+-------+-----------¦ ¦1938 ¦168,122¦38,161.01 ¦ +-----+-------+-----------¦ ¦1939 ¦93,720 ¦5,322.49 ¦ +-----+-------+-----------¦ ¦1940 ¦183,114¦55,057.28 ¦ +-----+-------+-----------¦ ¦Total¦649,777¦182,436.54 ¦ +-------------------------+
In the early audits of the income tax returns of Golden Braid, salaries allowed and disallowed as a deduction were as follows:
+-------------------------------------------------------------+ ¦Josephine T. Drew¦ ¦Mrs. B. M. Mason¦ ¦ ¦ +-----------------+-------+----------------+-------+----------¦ ¦Year ¦Salary ¦Salary ¦Salary ¦Salary ¦ +-----------------+-------+----------------+-------+----------¦ ¦ ¦allowed¦disallowed ¦allowed¦disallowed¦ +-----------------+-------+----------------+-------+----------¦ ¦1936 ¦$3,000 ¦$875 ¦$300 ¦ ¦ +-----------------+-------+----------------+-------+----------¦ ¦1937 ¦6,000 ¦5,000 ¦600 ¦$700 ¦ +-----------------+-------+----------------+-------+----------¦ ¦1938 ¦6,000 ¦11,250 ¦600 ¦1,200 ¦ +-----------------+-------+----------------+-------+----------¦ ¦1939 ¦6,000 ¦12,000 ¦600 ¦1,200 ¦ +-----------------+-------+----------------+-------+----------¦ ¦1940 ¦6,000 ¦12,750 ¦600 ¦1,200 ¦ +-----------------+-------+----------------+-------+----------¦ ¦Total ¦27,000 ¦41,875 ¦2,700 ¦4,300 ¦ +-------------------------------------------------------------+
In the deficiency letter of April 21, 1942, the following amounts, added to petitioner's income for the respective years, in each instance as described as income from Golden Braid Costume Co.:
+-------------+ ¦1936¦$10,875 ¦ +----+--------¦ ¦1937¦35,700 ¦ +----+--------¦ ¦1938¦51,250 ¦ +----+--------¦ ¦1939¦15,200 ¦ +----+--------¦ ¦1940¦28,950 ¦ +-------------+
These amounts were computed by adding together the disallowed portions of salaries paid to Josephine T. Drew and Mrs. B. M. Mason and all dividends paid to them.
Under date of January 13, 1944, the internal revenue agent in charge at Baltimore sent Golden Braid 30-day letters transmitting revenue agents' reports dated May 15, 1942, for 1938, 1939, and 1940, proposing salary allowances and disallowances for those years in the amounts stated above. Under date of February 7, 1944, Golden Braid filed a sworn protest. A conference was held with the revenue agent's office, and under date of March 17, 1944, a final audit letter allowed salary deductions for each of the three years of $9,000 for Josephine T. Drew and $1,200 for Mrs. B. M. Mason.
On December 23, 1940, Josephine T. Drew transferred 160 shares of Golden Braid stock (worth $85,000) to E. T. Elkin (at one time a member of the national board of governors of the Mantle Club and active in the ‘PL‘ campaigns) for $16,000. The $16,000 was supplied by petitioner out of ‘PL‘ funds. Elkin endorsed this stock in blank and placed it in an envelope in a safe in the office of Golden Braid and Cook was informed thereof. Up to the year 1942, Elkin had not made any payment on the $16,000 supplied by petitioner.
Josephine T. Drew, upon the transfer of her stock to Elkin, resigned as president of Golden Braid. Upon becoming a stockholder, Elkin was elected president. Elkin's salary as president was $150 a month.
Josephine T. Drew and petitioner married on December 29, 1940.
In October 1941 Elkin resigned as president of Golden Braid to become the president of the American Distributing Corporation at a salary of $150 a month. The American Distributing Corporation, after its organization in the latter part of 1941, distributed the costumes made by Golden Braid and the magazines and books published by the Key Publishing Co. Upon resigning as president of Golden Braid, Elkin sold half of his Golden Braid stock to M. S. Apgar at par; Apgar thereupon became president of Golden Braid. Apgar was an employee of Mantle Club.
In the latter part of 1941, Mrs. B. M. Mason transferred the 40 shares of Golden Braid stock issued to her to George Baird, as employee of the Mantle Club. Baird, up to the beginning of 1942, and not paid for this stock, nor had he given a note therefor. He endorsed the stock in blank and delivered it to Apgar.
The officers of Golden Braid were as follows:
President, Josephine T. Drew (replaced by Elkin and later by Apgar).
Vice president, Mrs. B. M. Mason.
Secretary, Miss H. B. Mason (daughter of Mrs. B. M. Mason).
Treasurer, Miss V. F. Mason (daughter of Mrs. B. M. Mason).
The two daughters of Mrs. B. M. Mason each received $200 a month from Golden Braid.
The Mantle Club was the sole customer of Golden Braid. The costumes made by Golden Braid were those which could be worn only by full members of the Mantle Club.
Through the years 1936 to 1940, inclusive, the total number of costumes purchased by the national board of governors from Golden Braid was 43,318, at $15 each; the number of such costumes shipped to the local units of the Mantle Club at the same price was 33,518; and the number of costumes purchased by full members from the club at the same price was 12,413. Of the 12,413 costumes purchased by members of the Mantle Club up to December 31, 1940, 2,672 were repurchased by the Mantle Club from members upon their resignation.
The disposition made by petitioner of his receipts from salaries, royalties, and net ‘PLs‘ during the years 1934 to 1941, inclusive, was substantially as follows:
+-----------------------------------------------------------------------------+ ¦Checks to his former wife, Mary A. Monjar, for support and alimony ¦ ¦ ¦from January 1937 on, at the rate of $1,500 a month, plus the first¦$100,000 ¦ ¦of four annual payments of $10,000 each representing a divorce ¦ ¦ ¦settlement ¦ ¦ +-------------------------------------------------------------------+---------¦ ¦Advances, mostly in currency, to Josephine T. Drew ¦100,600 ¦ +-------------------------------------------------------------------+---------¦ ¦Withdrawals of currency deposited in bank accounts of Josephine T. ¦88,300 ¦ ¦Monjar in 1941 ¦ ¦ +-------------------------------------------------------------------+---------¦ ¦Checks to his sister, Mrs. B. M. Mason ¦33,000 ¦ +-------------------------------------------------------------------+---------¦ ¦Payment of Federal Income Tax and interest, of which approximately ¦200,000 ¦ ¦$195,000 represented the old liability on years 1926 and 1927 ¦ ¦ +-------------------------------------------------------------------+---------¦ ¦Loans to officers and employees of Mantle Club to purchase stock in¦ ¦ ¦following allied corporations: ¦ ¦ +-------------------------------------------------------------------+---------¦ ¦American Business Management Corp ¦$20,000 ¦ ¦ +------------------------------------------------------+------------+---------¦ ¦American Business Research Corp ¦8,000 ¦ ¦ +------------------------------------------------------+------------+---------¦ ¦American Distributing Corp ¦6,000 ¦ ¦ +------------------------------------------------------+------------+---------¦ ¦American Tailoring Corp ¦15,000 ¦ ¦ +------------------------------------------------------+------------+---------¦ ¦Golden Braid Costume Co. (E. T. Elkin) ¦16,000 ¦ ¦ +------------------------------------------------------+------------+---------¦ ¦ ¦ ¦$65,000 ¦ +-------------------------------------------------------------------+---------¦ ¦Loans to PL agents in Portland, Seattle, and Denver to purchase ¦ ¦ ¦stock in local corporations allied with Mantle Club from retiring ¦36,850 ¦ ¦members ¦ ¦ +-------------------------------------------------------------------+---------¦ ¦Purchase of statistics from American Business Research Corporation ¦24,750 ¦ +-------------------------------------------------------------------+---------¦ ¦Loans in 1938 and 1939 through J. Fenton Jones to Daniel O. ¦31,000 ¦ ¦Hastings, General Counsel for Mantle Club ¦ ¦ +-------------------------------------------------------------------+---------¦ ¦Repayment of money borrowed from Mantle Club ¦14,200 ¦ +-------------------------------------------------------------------+---------¦ ¦Salaries and expenses paid to “PL” agents ¦50,500 ¦ +-------------------------------------------------------------------+---------¦ ¦Checks drawn to cash not included in above and miscellaneous checks¦433,500 ¦ ¦for personal expenses, etc ¦ ¦ +-------------------------------------------------------------------+---------¦ ¦Total ¦ ¦1,177,700¦ +-----------------------------------------------------------------------------+
Petitioner was, during the taxable years, conscious of the tax consequences of his financial undertakings. He had pending, about 1936-1937, a tax case for 1927 and testified therein that because of such case pending he handled his transactions on a cash basis; that if he had funds in his name the collector might distrain. He (through his employees) had various conferences with representatives of the Bureau of Internal Revenue. He maintained, from not later than 1937, an accountant on his staff to keep him informed on tax matters. The accountant rendered opinions on tax matters, and in 1937 developed a library on various subjects including tax matters. In the course of collecting ‘PL‘ funds petitioner gave as a reason for not organizing large corporations that smaller ones would pay less tax.
The tax returns filed by petitioner for the taxable years were false and fraudulent, with intent to evade tax, and a part of the deficiency was due to fraud with intent to evade tax.
OPINION.
DISNEY, Judge:
(1) The petitioner contends that all matters here involved are barred by the statutes of limitation. We note this matter at this time because, of course, if statutes of limitation apply, consideration on the merits is not in order. It is clear, however, that if we should find that petitioner had income as charged by the respondent, he omitted from his returns more than 25 per cent of the amounts of gross income stated therein, in which case the 5-year period of limitation would apply under section 275(c) of the Internal Revenue Code, at least as to all years except 1936, since the jeopardy assessments were made on February 21, 1942, less than 5 years from the filing of returns for all taxable years, the deficiency notice issued on April 21, 1942, within 60 days thereafter (in Docket 111028), and the deficiency notice issued on March 13, 1942, for the year 1938. Moreover, if, as the respondent urges, the returns were false or fraudulent, with intent to evade tax, no statute of limitation applies. Sec. 276(a), I.R.C. We, therefore, for the present, pass the question of statutes of limitation until we have determined whether or not there was income to the petitioner, and whether the returns were false and fraudulent, with intent to evade tax; after which we shall state our conclusions as to the statutes of limitations.
(2) The petitioner urges, first, so far as the case on the merits is concerned, that the Government of the United States having, through the Securities and Exchange Commission, in an injunction case at Boston, and the Department of Justice, in the criminal case, having elected to treat the ‘PLs‘ as loans, the respondent here is concluded from treating them otherwise. This if, of course, not a plea of res adjudicata or estoppel by judgment. Reliance is placed in the main upon Hoe & Co. v. Commissioner, 30 Fed.(2d) 630, and Brown v. Commissioner, 54 Fed.(2d) 563.
The facts relied on in this particular were those involved in the injunction suit filed at Boston by the Securities and Exchange Commission against petitioner and others, and those in the criminal prosecution. Examination of the injunction suit reveals that, instead of electing to treat the PLs‘ as loans, the bill of complaint and supplement to the complaint both say: ‘transaction described by the defendants as 'personal loans.’‘ The supplement also refers to various other oral and written evidence of the indebtedness arising out of such ‘personal loans.‘ It is clear that the facts as to the injunction suit, negative, rather than bear out, the petitioner's contention on this point. The Securities and Exchange Commission did not elect to treat the ‘PLs‘ as loans, but only observed and followed defendants' designation of them as such.
With reference to the election urged, as based on the procedure in the criminal case, it is true that the facts disclose many references to loans. They are found in the indictment by the grand jury, opinion of the court on demurrer to indictment, briefs by Government counsel, charge to the jury, and opinion affirming conviction. Such references in the indictment by the grand jury, charge to the jury, and opinion by the courts appear to us no basis of election by the United States. They are not statements by its representatives. (We hereinafter discuss them as indicia of estoppel by judgment.) The reference and expressions in briefs by Government counsel are, of course, of a different nature and do express a view by counsel for the United States. But examination of the brief of Government counsel on petitioner's demurrer to the indictment reveals that reference to loans are references to the language of the indictment where that term was used, in almost all cases. Obviously, such references do not constitute an election to treat the ‘loan‘ as such. A letter-brief by Government counsel does refer to loans, but only after initially referring to them as ‘so called PL or CD loans,‘ so that it is apparent that no unequivocal stand on the matter was therein taken. A supplemental brief again refers to the ‘so called PL and CD loans,‘ though other references are made to loans, particularly in connection with recitation of what the indictment charges. Considering these briefs on the demurrer to indictment as a whole, they clearly constitute no election by Government counsel to recognize the ‘loans‘ as such. A brief filed in the Circuit Court on appeal is likewise relied on for the election. Though therein there are references to loans, again we find that they are in fact largely references to terms used in the indictment, charge to the jury, and evidence. Though some of the references are not so limited, in our opinion, the United States can not fairly be charged, in that brief, with having made the election urged. They are descriptive and narrative of what had occurred, and had been referred to by the grand jury, rather than admissions or position taken on the nature of the transaction. It would appear very difficult for counsel to refer to or discuss the transactions previously referred to by grand jury and court as loans, and to discuss the facts and distinguish between transactions referred to as loans by grand jury or court and the transactions themselves, without calling them loans. We do not think the appellations constitute election. The questions there were whether there was a security sold in violation of the act, and whether money was obtained by false pretenses through interstate communication, in which latter case loan would have been immaterial. The Hoe case and Brown case, supra, also Ernest Strong, 7 T.C. 953, do not, in our view, parallel the situation here. There the Government sought to take diametrically opposite views at different times, but in this matter, in the criminal case, the question was not the same as the question of loan or income here involved; but the question was one where loan was immaterial (under counts 2-15) and, secondly, one whether there was sale of a security. We conclude that the respondent's position is not precluded by election.
We next consider the contention, made by both parties, that the judgment of conviction of petitioner is basis for estoppel by judgment. The petitioner says it determines for us that the ‘PLs‘ were loans, therefore did not represent income; the respondent says that the conviction for violation of the Securities Act, on counts 16, 17, 18, and 21, estops the petitioner from denying that the money was obtained under false and fraudulent pretenses, in the sale of securities, through interstate commerce or the mails, that though in form loans, they were not such, and that it was thereby determined that the receipt of such money by petitioner was income to him, and not loans.
The parties agree that estoppel by judgment applies in this civil case, though from a verdict in a criminal case, and such is the law. Local 167, International Brotherhood of Teamsters v. United States, 291 U.S. 293 (injunction suit under Sherman Act involving facts as to which there was former conviction); Austin v. United States, 125 Fed.(2d) 816 (former conviction proved in civil case); Diamond v. New York Life Ins. Co., 50 Fed.(2d) 884(same); Frank v. Mangum, 237 U.S. 309, where the court (in a case of facts in connection with former conviction shown in habeas corpus procedure) said:
* * * It is a fundamental principle of jurisprudence, arising from the very nature of courts of justice and the objects for which they are established, that a question of fact or of law distinctly put in issue and directly determined by a court of competent jurisdiction cannot afterwards be disputed between the same parties. Southern Pacific Railroad v. United States, 168 U.S. 1, 48. The principle is as applicable in the decisions of criminal courts as to those of civil jurisdiction. * * *
The petitioner's view has as basis the repeated use of the words ‘loans‘ or ‘personal loans‘ in the trial of the criminal case, in indictment, evidence, instructions, charge, opinion on demurrer to indictments, and opinion on appeal. We have carefully reviewed the use of these expressions, and considered them in the light of the statutes the violation of which was charged, and we conclude that the use of ‘loan‘ or ‘personal loan‘ is not determinative that there was estoppel against the respondent to deny that there was not loan, but income. ‘Personal loan‘ was the term often used on the ‘PLs‘ and ‘loan‘ was variously used in the history of the case, so that the terms appear to us as descriptive and as vehicles of thought to express what had occurred, or had been referred to, and not as determinative of a fact binding in this adjudication of a different cause of action. The question involved in the criminal prosecution was first (counts 2-15) whether the petitioner through the mails obtained money by false pretenses, and second (counts 16, 17, 18, 20, 21) whether in the sale of securities through such interstate commerce or mails he employed a scheme, device, or artifice to defraud. As to the first, the petitioner could be guilty, because of use of false pretenses, even though he was only procuring a loan, Commonwealth v. Schwartz, 18 S.W. 775, but could be guilty even though there was no loan, so that conviction on counts 2-15 throws no light, and affords no estoppel, as to whether petitioner made loans, and respondent, on brief, bases his position only on conviction under the Securities Act. Counts 16, 17, 18, 20, and 21. As to these counts, the question was merely whether the terms of the act were violated. It could be, if fraud was employed in the sale of a ‘security‘ through use of the mails or interstate commerce, to paraphrase the statute. ‘Security‘ by statutory definition included, inter alia, ‘evidence of indebtedness‘ and ‘investment contract.‘ The definition did not include ‘loan.‘ It did include ‘note,‘ of which more hereinafter. It is obvious, we think, that ‘evidence of indebtedness‘ is not limited to ‘loan‘ so that the words ‘security, to wit, a certain evidence of indebtedness‘ in the indictment does not require a conclusion of loan. Estoppel by judgment requires an issue ‘necessarily involved‘ in the judgment, and that means that ‘without the determination thereof the action could not have been determined.‘ Knutson v. Ekron, 5 N.W.(2d) 74; 50 C.J.S. 209-212. Certainly, considering the breadth of the statutory definition of securities, the verdict against petitioner could have been rendered without determination that there were loans. Therefore, considering the text and the plain objective of the statute, we come to the conclusion that the mere use of the word ‘loan‘ or ‘personal loan‘ in the course of the criminal procedure in describing what had occurred does not demonstrate determination that the ‘PLs‘ were loans and, therefore, did not represent income. To so hold would be to make descriptive terms more important than the statutory requisites of the indictment and conviction. Plainly the jury could convict on the ground that an ‘investment contract‘ or some other instrument included in the statutory definition of ‘security‘ had been, through fraud and through the mails, the subject of ‘sale‘ without concluding that the ‘PLs‘ were loans.
Turning now to the respondent's contention: Does the conviction of employing fraud in selling securities through interstate commerce or the mails carry a determination, binding here, that the ‘PLs‘ were not loans? The problem has entailed much study. It seems patent that one may not be convicted merely of obtaining a loan (except by false pretenses, covered by counts 2-15, not just here being considered). Petitioner was, however, also convicted on the later counts, under the charge of use of fraud in sale of securities through interstate commerce or mails. Therefore, petitioner was convicted of something more than or different from merely obtaining loans through false pretenses through the mails. So far as that charge is concerned, counts 16, 17, 18, 20, and 21 were superfluous, for petitioner had already been so charged in counts 2-15. As concerns inclusion of ‘note‘ in the definition of security, even if we assume that a PL‘ was a ‘note,‘ we consider it clear that the Securities Act was never intended to require prosecution of one for merely giving his own note, though fraudulently and through the mails; not only because the Mail Fraud Statute (counts 2-15) covers such actions (as is shown by the conviction on those counts), but because of the essential meaning of ‘sale.‘ To be convicted under the later counts the petitioner must have employed fraud ‘in the sale of securities.‘ But the ordinary meaning of sale is transfer of property for money. Williamson v. Berry, 49 U.S. 495. Petitioner, if he merely borrowed money, as he contends, received money, but he did not transfer property. He would in such case only promise to repay the borrow.
In Commissioner v. Spreckles, 120 Fed.(2d) 517, it was held that, where the holder of a promissory note and mortgage on realty surrendered it, there was no sale or exchange of a capital asset. In Bingham v. Commissioner, 105 Fed. (2d) 971, it is essentially the same. Again, in Hale v. Helvering, 85 Fed. (2d) 819, the court, quoting Words and Phrases that a sale is a transfer of property for money, held that the compromise of a suit to collect on a mortgage note and turning over of the note to the maker were not a sale or exchange to the maker. If one receiving back his note in consideration of surrender of property or settlement is not making a sale, surely, in borrowing money the mere giving of a note, or a receipt such as here involved, is not a sale. The jury, however, found petitioner guilty of fraud in the sale of a security; therefore, found that he did not merely borrow on his note, or receipt, or whatever the ‘PLs‘ may be regarded, but in selling securities used fraudulent device or scheme. We conclude that the Securities Act may not be considered to include one's own ‘note,‘ or the ‘PLs‘ here involved, in securities, or the giving thereof in securing a loan as a ‘sale‘ of such security. In short, petitioner was not convicted, on counts 16, 17, 18, 20, and 21, of securing a loan through fraud and the mails.
In overruling the demurrer to the indictments, the trial judge, discussing the Securities Act counts, quoted Securities and Exchange Commission v. Universal Service Assn., 106 Fed.(2d) 232:
* * * But decisions uniformly hold that in determining whether a particular instrument is a security within the meaning of the act the substance of the transaction and of the relationship between the alleged issuer and alleged security holder will control as against the form of the alleged security. * * *
Later, the trial court observes that, ‘we must recognize that the Congressional intention is to give effect to substance and not to form.‘ This means, in our view, that, in overruling the demurrer and later letting the matter go to the jury, the trial court recognize that whatever the form of the transaction— in form of loan or something else— the jury was to decide whether in reality and fact there was fraud in the sale of securities. By convicting, the jury held that in truth, considering ‘the substance of the transaction and of the relationship‘ between the parties, there was not mere innocent borrowing of moneys, but fraud in a selling of securities. Even assuming that the jury considered the matter to have the form of loan, it concluded that there was not a loan in fact, but a prohibited fraudulent sale of securities. The petitioner here is in the position of urging that, despite the jury's verdict, there was loan— in short, that, despite verdict deciding that there was no loan in reality, nevertheless the form of the loan controls here.
In tax cases it has been held, in cases so numerous as not to require citation, that taxation is a realistic matter, and that we look through form to substance to ascertain the true rather than the seeming situation, in application of the internal revenue law. That there may have been loan in form is, therefore, not conclusive; and the jury, having under instructions viewed the facts and having necessarily found that regardless of form of transaction there was in reality a sale of a security described in the statute, that fact has been determined for us.
The verdict, that there was fraud in the sale of securities, is wholly inconsistent with petitioner's view that the money was only borrowed. If there was a sale the petitioner received, as his own, the proceeds thereof, and comes within those cases which held there is taxable income if money is received under claim of right. North American Oil Consolidated v. Burnet, 286 U.S. 417; National City Bank v. Helvering, 98 Fed.(2d) 93. That those parting with their money might recover is not decisive. Akers v. Scofield, 167 Fed. (2d) 718. Moreover, the verdict means that the pieces of paper handled, called ‘PLs‘ or receipts, were not, in effect, notes as petitioner's view would have it, but merely means or artifices to defraud. Had they been found to be promises to pay representing loans, conviction on counts 16, 17, 18, 20, and 21 (as distinguished from conviction under counts 2-3, 5-8, 10-15) would not have been sustainable. We conclude and hold that the petitioner is estopped by the verdict on counts 16, 17, 18, 20, and 21 in the criminal case to assert that the ‘PLs‘ were loans. This contention being the gist of the petitioner's contention, on the merits, that the ‘PLs‘ did not result in income, we hold because of the estoppel that they did produce income to him. Moreover, we hold, on all the facts, that petitioner had income from the ‘PLs‘ and ‘CDs‘ and not mere proceeds of loans.
Though we sustain the plea of estoppel of judgment by the respondent and hold that the moneys collected were income, we do not consider that it follows that we should sustain objection to the evidence along that line adduced by the petitioner, because such evidence is so tied in with and necessary to consideration of the issue as to fraud and penalties, and to some extent the Golden Braid Co., that it should not be stricken. The whole record requires examination on the question of fraud and penalties. The verdict is not conclusive as to liability for the penalities. Helvering v. Mitchell, 303 U.S. 391. We have, moreover, considered the matter on the facts adduced by such evidence.
(3) We are convinced, from all the evidence before us, that petitioner exercised such power and control over Golden Braid's stock and operations that its dividends and disallowed salaries were taxable to him. The organization and operation of the company was merely one of the many ways designed by petitioner to relieve his followers of their money. We are convinced that he had the utmost confidence in his sister, Mrs. B. M. Mason, and his then secretary and, later, wife, Josephine T. Drew. Mrs. Drew was the divorced wife of Clement O. Drew, one of petitioner's key workers in the ‘PL‘ work. The original investment in the company are purported loans to these two of ‘PL‘ funds. The record contains no indication that the loans were repaid. Other than the fact that Josephine T. Drew was its president and Mrs. B. M. Mason was its vice president, there are no facts to indicate what duties were performed by them, or Mrs. Mason's daughters, each of whom drew salaries of $200 per month. The fact that Josephine T. Drew was allocated a salary of from $17,250 for 1938 to $18,750 for the year 1940 and her successor (Elkin), who was elected president at the end of 1940, assumed the same position at a salary of $150 a month, is strong indication that the large salary paid her was not paid for services rendered to the corporation, particularly in view of the fact there was no indication in the record that the change in presidents caused a change in the duties for the office. The fact that the salary of this office was cut from $18,750 a year to $1,800 a year is of great significance, since Elkin, as far as the record is concerned, acquired the complete interest of his predecessor, Josephine T. Drew. If actually he succeeded to all her rights, title, and interest in the stock and the same duties as president, it would seem logical that he would also succeed to her salary, if the matter was in good faith under his control. We are also confronted with the facts that the 160 shares of stock held by Josephine T. Drew (worth ($85,000) passed to Elkin for $16,000, the $16,000 being supplied by petitioner out of ‘PL‘ funds; further that the stock was endorsed in blank, placed in a safe in the office of Golden Braid, and Cook (one of petitioner's close associates) was informed. Elkin had been a member of the national board of governors of the Mantle Club and was active in the ‘PL‘ campaigns. These facts indicate that the control of the company was in someone other than the stockholders; and they fail to show the amount of services performed by the petitioner's sister, nieces, and wife-to-be.
A clearer insight as to who controlled Golden Braid is gained by considering the facts in regard to sales of the costumes it produced. Petitioner had complete control of the Mantle Club. Golden Braid's only customer was the Mantle Club (through its national board of governors), and the only costume it made was the one worn by full members of the Mantle Club. The total cumulative number of full members December 31, 1940, was 14,895, the actual net number at the date was 10,772. The number of costumes purchased by the Mantle Club through its national board of governors at that date was 43,318; while the number of costumes purchased by the Mantle Club members from the club at that same date was 12,413. From all this, we conclude that through the influence of petitioner money from the Mantle Club was channeled into Golden Braid and thereby made available for distribution. We are of the opinion that Golden Braid was merely another element in petitioner's scheme to divert the funds out of the hands of his followers into his own or to those of his choice. The fact that he was taking care of his sister and her family and that he wanted to ‘save‘ Josephine T. Drew and to put her in an ‘independent position‘ convinces us that it was his choice that they received the money from Golden Braid in the manner aforementioned. We note that petitioner married Josephine T. Drew December 29, 1940.
Petitioner argues that no evidence has been offered to justify including the salaries disallowed as a part of petitioner's taxable income in accordance with article 23(a)-7 of Regulations 94 and 101, which provides:
* * * In the absence of evidence to justify other treatment, excessive payments for salaries or other compensation for personal services will be included in gross income of the recipient and subjected to both normal and surtax.
The error of petitioner's argument is that the regulation cited is to control when the ‘recipient‘ is considering what will be included in his gross income. Such an overpayment might be classified as a dividend payment; it might be shown that it constitutes payment for property or the like. Such a provision is not controlling here, where respondent is contending that petitioner exercised such control over these payments that such payments constitute income on his part.
‘* * * it is the power which the taxpayer has over property which determines his taxability on income therefrom.‘ Leonard Mark, 47 B.T.A. 204. Perhaps in the usual case of this type the control is by a stockholder or one exercising power through a trust instrument. Even though there was no control exercised in the instant case through actual stock ownership or through a trust instrument, there was a means of control exercised by petitioner as effective as if he actually had title to the stock. With such control exercised by petitioner, we think it proper that he be taxed on the dividends and certain portions of the salaries of Golden Braid under the broad general provisions of section 22(a) of the Internal Revenue Code.
In this matter, though the facts are different from those of H. S. Richardson, 42 B.T.A. 830; affd., 121 Fed.(2d) 1, the same principle applies as there expressed:
Under the facts in the instant case we are not so much concerned with the refinements of title to the property which has been ostensibly passed around the immediate family circle as with the actual dominion and control over the property. Here, the property and the income therefrom is so clearly subject to the petitioner's unfettered command that they are, in substance, his and, even though he did not see fit to use the property or the income during the taxable year, the latter may be taxed to petitioner as his income under the broad general tax provisions of section 22(a) * * *.
The authority cited for the above quotation in the Richardson case included, among others, Helvering v. Clifford, 309 U.S. 331. The fact of family group there involved is present here, as is the dominion and control there considered. Here, as there, ‘legal paraphernalia which inventive genius may construct as a refuge from surtaxes should not obscure the basic issue. ‘ See also Robert E. Werner, 7 T.C. 39; Anthony Cornero Stralla, 9 T.C. 801. Considering, as by the Clifford case required, all of the ‘circumstances attendant,‘ we hold that petitioner had in this case gross income from Golden Braid within the broad definition and view there taken.
Even though the general theory of respondent is approved, we consider that he erred as to the years 1938, 1939, and 1940 in that he based the taxable amount for salaries disallowed on the figures in ‘the early audits of the income tax returns of Golden Braid,‘ while in a final audit letter under date of March 17, 1944, Josephine T. Drew was allowed an amount of $3,000 more a year for 1938, 1939, and 1940 than shows in the early audit; in like manner the final audit letter shows salary allowed Mrs. B. M. Mason at $1,200 a year for these three years instead of $600 as shown in the early audit. We are of the opinion that, since respondent allowed these additional amounts as salaries in the final audit, such amounts, totaling $3,600 in each year, should be deducted from the amounts included in petitioner's taxable income under salaries disallowed.
(4) Respondent added $20,375 to petitioner's 1940 income and described it in the deficiency notice as ‘income from Key Publishing Company.‘ The question of whether this amount was income to petitioner in 1940 must be determined on the basis that respondent's determination carries with it the presumption of correctness. This presumption, we do not think petitioner has overcome.
There is convincing evidence that the Key Publishing Co. paid a dividend of $35 per share in October 1940. The amount of $20,375, representing part of the interest of 84 individual stockholders, was eventually received by (or paid to) petitioner. As to whether the amount was received by or paid to him in 1940 as loans, we have no evidence on which we can base a conclusion. The same is true of the circumstances attending receipt of the money. We merely know it was eventually received by him. Petitioner has not proved that the amount received constituted loans to him by the individual stockholders, as contended in his petition. The burden rests upon petitioner. In the absence of proof we must sustain the respondent on this item.
(5) We come now to the question whether the deficiencies were due, in whole or part, to fraud with intent to evade tax, so that petitioner is liable for the 50 per cent penalty imposed by section 293(b) of the Internal Revenue Code.
The burden is on the respondent. It must be shown that the petitioner meant to evade tax, and a conclusion that fraud was practiced by petitioner on members of the Mantle Club does not of itself satisfy that burden. To decide this issue, we are required to determine petitioner's intentions concerning this matter during the taxable years from the evidence of record.
(b) FRAUD.— If any part of any deficiency is sue to fraud with intent to evade tax, then 50 per centum of the total amount of the deficiency (in addition to such deficiency) shall be assessed, collected, and paid, in lieu of the 50 per centum addition to the tax provided in section 3612(d)(2).
The record shows, and we hold therefrom on the facts, that petitioner committed fraud on members of the Mantle Club. It shows the fraud to be continuing during all the years here involved, and during the times when the returns were filed. It shows the large amounts of money received by the petitioner, and that they were not reported. It shows that petitioner was tax-conscious, in that he (through his employees) had conferences with tax officials; that he had tax cases in court; and that he employed people to advise him on tax matters. At one point in his drive for ‘PL‘ funds he gave as an excuse for not organizing large corporations that small ones would pay less tax. One of the ‘PL‘ series was solicited on the basis that it would be used to pay petitioner's income tax liability, as to which he claimed there would later be a refund.
It is our opinion that the facts of this case present such a sequence of events that we must conclude that petitioner omitted from his income tax returns the amounts received from the ‘PLs‘ due to fraud with intent to evade tax and that a large part of the deficiencies is due to fraud with intent to evade tax. In making this conclusion, we are conscious that, to find fraud, it must be proved by clear and convincing evidence. A. W. Mellon, 36 B.T.A. 977. We are of the opinion that such clear and convincing evidence is present in this case.
(6) We having concluded that the deficiencies involved were in part due to fraud with intent to evade tax, and that the returns were fraudulent with intent to evade tax, it follows that none of the statutes of limitation relied upon by the petitioner apply. Sec. 276(a), I.R.C.
(7) The petitioner raises the question, as to 1938, as to the burden of proof where two deficiency notices were sent, but the respondent, by affirmative plea in his answer, raised the issues involved. Assuming that the respondent had the burden, we consider that the evidence before us sustains the holding that there was, under the facts so involved for 1938, income to the petitioner.
The petition alleges error of the respondent in failing to determine overpayments of $715.28 and $1,930.51 for the years 1939 and 1940, respectively. Under our conclusion above, there was no overpayment. Also, there is no satisfactory proof from which we could find as fact that such payments were made.
Reviewed by the Court.
Decisions will be entered under Rule 50.
VAN FOSSAN, J., dissents.
BLACK, J., dissenting: I agree with the holding of the majority that a part of the deficiency for each taxable year was due to fraud, with intent to evade tax, that fraud penalties should be assessed, and that none of the deficiencies are barred by the statute of limitations. I do not agree with the majority opinion where it holds that, because petitioner was convicted in a United States District Court of having employed a scheme to obtain money by false pretenses in the sale of securities by the use of the mails and interstate communications, he is estopped to claim that the money which he received from the so-called ‘PLs‘ represented loans and was not taxable income. It does not seem to me that the facts detailed by the majority represent a proper situation for the application of the doctrine of estoppel by judgment— a doctrine which I think should be sparingly applied in tax cases. See Commissioner v. Sunnen, 333 U.S. 591. However, the majority opinion, after holding that estoppel by judgment is applicable, says: ‘Moreover, we hold on all the facts that petitioner had income from the 'PLs' and 'CDs' and not mere proceeds of loans.‘ With this latter conclusion I am in agreement, though not agreeing to the estoppel by judgment holding of the majority.
I dissent from the majority opinion wherein it holds that petitioner is taxable on certain portions of the salaries paid by the Golden Braid Costume Co. to Josephine T. Drew and Mrs. B. M. Mason and disallowed by the Commissioner as deductions in computing the net taxable income of the corporation. We do not have the corporation before us as a taxpayer, but I am assuming that the Commissioner was entirely correct in disallowing as deductions substantial parts of these salaries to the corporation. But that still leaves me unable to see why the disallowed parts of these salaries should be taxed to petitioner. Josephine T. Drew and Mrs. B. M. Mason appear to have been, during the periods in question, the principal stockholders of the corporation. Whatever salaries it paid them, even though very much in excess of the value of the services which they actually rendered the corporation, were taxable to them. Indeed, the findings of fact of the majority inform us that these two women did include the entire amount of the salaries paid them in their own income tax returns and paid taxes thereon. Under the facts stated, I think this was proper.
The Commissioner has not determined that the corporate entity of Golden Braid should be disregarded and that it should be regarded as merely the alter ego of petitioner. He apparently has taxed it in each of the taxable years in question as any other corporation would be taxed. I, therefore, an unable to understand the logic of the majority which holds that petitioner is taxable on all the salaries paid by the corporation to these two women, except that portion of their salaries which was allowed to the corporation as a deduction in determining its net income. From this holding of the majority opinion on this issue, I respectfully dissent.
KERN and ARUNDELL, J. J., agree with this dissent.
FN* The difference between associate membership and full membership is explained later.
The Mantle Club is and at all times material was an unincorporated association of persons which was organized in 1929, and at the time of trial it comprised some 30 district units in large cities throughout the United States. It is an unusual organization, largely the creation of the petitioner, whose ideas, concepts, and purposes permeate and control the entire organization. It is managed in an autocratic manner by insistence on implicit obedience to rules. Membership is limited to men between the ages of 21 to 45, and is limited to 100,000 members. The constitution provides that the club was organized to cultivate the social, educational, and business requirements of its members, to improve their standards of honor, ethics, efficiency, and productivity, to broaden their interests in the pursuit of their occupations, and to encourage a true feeling of friendship and a friendly spirit of mutual cooperation. The prospectus of the club expressed a dictatorial attitude. It emphasized the fact that anyone wanting to become a member of the club must be willing to work diligently for success in his chosen line and have a desire to have other members reach the same objective. The prospectus was very definite that the dues were to be paid at the monthly meetings of the organization. It provided that every member was to receive for his money the usual benefits and privileges of a fraternal organization, supplemented by a larger, broader contact with fellow members, due to each member attending the regular monthly meetings. It emphasized also that the real basis of power of the organization was the ability to stick together and work together. It suggested that if a prospective member was the type who would desire to change his mind after giving his word, he was not wanted in the organization, but, rather, that the organization wanted real men with a sense of business honor, men whose words really meant something and who would keep their agreements and their promises of their own volition, without the necessity of reminding them of their obligations.
In order to accomplish the purposes of the organization, the Mantle Club held numerous meetings, practically all of which were devoted to lectures or readings about and discussion and study of ideals and principles of honor, loyalty, common sense, courage, justice, ambition, pride, self-control, confidence, energy, responsibility, self-respect, and other desirable qualities, and the importance of the application of these virtues to the everyday lives of individual members.
Great importance was attached to attendance on monthly and other meetings, prompt payment of dues, the contact of prospective members, and obtaining new members, as well as zeal in promoting the other activities of the club. Records were kept, and a member was advanced in the club according to the marks which he merited and received. The larges of the meetings was an official monthly meeting which the entire membership was required to attend. The meeting was opened with patriotic ceremonies, presentation of the flag, and musical numbers or other form of entertainment. At each meeting the monthly message of petitioner was read, relating to some ethical trait, such as honor or loyalty. Addresses were delivered on such subjects and the application of the relevant ethical principles to the daily lives of the members. The principal method of impressing these ideas on the members was repetition of them, which became boring to some members and caused them to drop out of the club. On the other hand, many members found the meetings beneficial.
Other meetings of the club were held, sometimes in ‘sections‘ of 1,000, and regularly in ‘divisions‘ of approximately 100, and also in ‘captains' groups ‘ of 10 members. The nature of these meetings and the subjects discussed were similar to those of the official monthly meetings, except that in the smaller divisions and group meetings the individual members had more opportunity for expression. The use of liquor was not permitted at any meeting or activity of the club, or on the way thereto or therefrom. No smoking was permitted at the meetings.
Full minutes were regularly kept of the official monthly meetings, division meetings, and meetings of the local board of governors, in which were recorded the nature of discussions and activities of the club. The minutes contain many references to announcements of the social and athletic activities of the club.
There were also assimilation meetings for the purpose of familiarizing members with the purposes of the order, especially as set forth in the prospectus, and to explain the prospectus so as to attract new members. Attraction of new members was a feature of the club work greatly emphasized and efficiency in which to a large extent measured a member's marks of merit and entitled him to advancement. The large membership of the club was built up in this manner.
Membership consisted of two classes— ‘associate‘ and ‘full.‘ All members were originally associate members and advanced by merit, as determined by record marks as evidence of their zeal in the activities of club work, until they were admitted into full membership, when they were carried through an elaborate and serious initiation ceremony and became entitled to vote. The fee for initiation as associate members was $20. The monthly dues were $2. The entire initiation fee and one-half of the dues went to the national organization.
The local board of governors, together with section and division heads and captains, constituted the ‘contact structure,‘ which held many meetings. Through this contact structure information was conveyed from local board to section head, to division head, to captain, to members, and vice versa through the same line. This system was actively used not only for transmitting information in both directions, but for questions and answers pertinent to the obligations and duties of members.
The Mantle Club also fostered certain business plans which were frequently referred to in the various meetings held by the membership. In connection with these plans, the following is an excerpt from a set of questions and answers used in the early days in training captains and other officers:
The Mantle Club has a definite fraternal set-up, concerning the handling of the group that will set up an efficient machinery of MEN. The details of this plan will gradually be revealed to the members as they earn the right to this information. In addition to this, the founder of the Mantle Club has a definite set of business plans that will produce business results for every man in the organization if he will prove up, through the set-up of the Mantle Club. These plans, of course, must be worked through regular business channels, because they have to do with profit making and are the personal property of the founder and not of the club or its membership. They are based on the cooperation of the group. It will require a national membership to put these plans into operation. The member is not buying a place in these plans with his $20. His record in the Mantle Club will entitle him to the opportunity to participate in these plans.
The club had a ‘welfare committee‘ appointed by the local board of governors, whose function, among others, was to control and stimulate so-called ‘unofficial activities‘ of the club. Subdivisions of the welfare committee were the employment, sick, recreation, and entertainment committees. The local board of governors warned against the overemphasizing of the unofficial activities in relation to the serious work of the club. No credit points for advancement in the club were given for such activities. However, at the regular monthly meetings of the division meetings and group meetings, announcement was made about these activities, and their support was emphasized, discussed, and urged upon the membership by those interested in the activities. They were sponsored by the Mantle Club, and without that sponsorship could not have been held.
The promotion and development of friendship among the membership was particularly stressed. The dinners for members preceding the division meetings of the club provided companionship and sociability. The picnics and other social activities afforded members and their wives opportunities for pleasure and also tended to mitigate such opposition as there may have been on the part of wives to frequent attendance at meetings as required of their husbands. Practically all the social activities participated in were limited strictly to members and their families, and were for the purpose of creating a closer relation between the members in the various activities of the Mantle Club.
An informal and intimate group of petitioner's closest associates met regularly on Friday nights to discuss both business plans and ethical principles. This group, known as the Friday Night Group, started about August 1933, with 25 or 30 men within the New York City area; it later included some 30 other men located in various cities in the United States.
The Mantle Club had a goal of 100,000 members. The Independence Club of America (explained in more detail later), with less rigid requirements and lower fees and dues, had a membership goal of 1,000,000. Members of these two organizations were to be the customers for certain business corporations to be formed. These corporations fell into two groups— local and national. In each city a local mercantile corporation for the sale of groceries and a local distributing corporation to distribute the publications of the Key Publishing Co. were to be first organized, and corporations to sell shoes, clothing, and haberdashery, and to provide housing were to follow. In addition to the Key Publishing Co., national corporations in such fields as management, research, purchasing, importing, and distribution were to be set up to service the local corporations. Local members of the Mantle Club or the Independence Club would benefit financially both through savings in purchases and through investment in their own local corporations. Petitioner and his immediate associates expected to become wealthy through rendering services to or investing in the national corporations, or both.
The Key Publishing Co. was organized in 1933, and it paid substantial dividends in 1936, 1937, and 1940. A national management corporation and a national research corporation were organized in 1937, a national tailoring corporation in 1938, and a national distributing corporation in 1940. Local mercantile corporations were organized at Portland, Oregon, in 1936, at Seattle in 1937, and at Denver in 1938. A local research corporation was also organized at Portland in 1937. Local distributing corporations were organized at Portland, Seattle, Denver, Los Angeles, San Francisco, and Oakland in 1940, and at Kansas City, Boston, Providence, and Detroit in 1941. Substantially all of the stock of the national corporations was owned by the original Mantle Club group, but the stock of each local corporation was owned entirely by local Mantle Club members in the particular city.
During the taxable years petitioner devoted about one-fourth of his time to the Key Publishing Co. and about three-fourths to the Mantle Club. He received during that period total salary and royalties of $94,788.80 from the Key Publishing Co., but no salary or other compensation from the Mantle Club.
Advancement in the Mantle Club depended not only on what the member did in the club, but also what he did in activities outside of, but associated with, the club, such as the purchasing of the Key Magazine, the Code of Ethics, and the costume, holding membership, and working in the Independence Club of America, patronizing the local mercantile and distributing corporation, if one was available, and subscribing to ‘PLs‘ (described and explained later) of petitioner. Advancement to the higher levels in the Mantle Club was not the ultimate goal of all the members of the Mantle Club. For many, the primary purpose of membership in the Mantle Club was to secure financial gain promised them by petitioner and his associates.
Over a period from January 19, 1934, to February 28, 1942, petitioner received largely from ‘PLs‘ from a large number of Mantle Club members in 20 different cities a total of $1,316,813 for his personal use.
Shortly before the first presentation of plans for ‘PLs,‘ Clement O. Drew (one of petitioner's key men) received the following instructions from petitioner:
Information for Men Selected From Charter Membership
As you doubtless realize I have given considerable thought to the question of salary or income for my own personal use and I have arrived at the conclusion that such salary or income must come from men who are putting up the money for that particular purpose.
It is not my intention to draw any salary or income from the Mantle Club either now or later. Such expenses money as has to be advanced to me will be repaid by me at a later date.
As for business activities, I do not want to draw any considerable amount for purpose of salary or compensation, until long after the demonstration of my ability to make large profits which would justify such income or salary.
I intend, therefore, to form a corporation, extremely limited, and the stockholders of this corporation would put up the money for the specific purpose of paying my salary and office expenses. As you no doubt understand, my income has to be rather large, as a large part of it would be used for the repayment of money that has been loaned to me. In addition, it is necessary for me to have my own funds to use for purposes of experiment on business matters, for filing necessary corporation papers, and many other matters of a kindred nature.
The contemplated amount is $3,000.00 per month, of which $2,500 would be for salary and $500 for other office expenses including rent, furniture, office help, etc.
The minimum amount would have to be $3.00 per month for ten months, and the maximum amount $20.00 per month for ten months, each man to profit, naturally, from the extent of the money that he advances. You recognize that it is impossible for me to form a corporation and issue stock at the present time, therefore all such amounts would have to be advanced to me as a personal loan until approximately April, at which time the necessary arrangements would be made to put this in corporate form. * * *
Therefore, at the present time I can only offer the opportunity to these individual men that have been approved by you and Gene to lend me these particular amounts according to their abilities and you can select Bob Burns temporarily to take care of these payments if you are absent, unless you know of a better selection.
I want no urging or persuasion used on these men, but I do want them to understand that I will do all in my power to see that eventually they will receive great benefits from their assistance financially at this time. The record is to be kept of all monies advanced and personal receipts may be issued by either yourself or Bob in my name, signed with your initials.
There is to be no urging or persuasion— it is an opportunity and I do not really care what advantage is taken of it by the men to whom the privilege is given. It is important, however, that I know promptly what is to be done. Would suggest that you call a meeting of these particular men the night of the 5th, read them this letter and secure their schedules, making sure that they all understand this is confidential and is available only to certain restricted men.
Those who do want to help, I would ask that they do as much as possible, but won't allow advance payments made. In other words, if a man desires to limit himself to $30.00— then I want this paid in ten monthly installments, preferably on meeting night, to my personal agent and not given in a lump sum. The same thing applies to large schedules.
I want to know that I have a definite income coming in each month and I do not want it paid in advance with a possibility that later months would show a decrease in income. Would prefer that these payments start as of February, so as to have uniform records, but the first payment may be extended to March the 5th, or event later, where the individual is worthy of special consideration. The limit, however, is from March to December and there is to be no expectation of an absolute date on the formation of the corporation.
I have my plans laid to handle this in April and to attend to these matters personally if I should come out to the Coast in April.
I want each man concerned to know the amount of salary and the amount for other office expenses, so that there can be no misunderstanding later. It is only fair, however, that you explain why such a large salary is necessary and that I have borrowed money and advanced it to keep things going for three or four years. I am merely trying to get back on a sound basis, where no one could conceivably criticize the source of my income and where I would have the means of making it extremely profitable for those who helped in this particular manner.
* * *
You are merely giving certain selected men this message for me and you record what they want to do. This same thing is applicable to Portland after its Charter is granted. The number of men will probably necessarily be smaller, but I want them given the opportunity. I presume that both yourself and Gene will want to go down for the maximum amount of $20.00 per month. If so, it can be deducted from pay checks.
* * *
Under date of February 6, 1934, Drew wrote petitioner, in part, as follows:
After the M. C. meeting, I called a Special Meeting for the approved men in the Charter group and covered the situation on Loans for you. I did not read that part of your letter stating amount of salary for you as I felt it was away over their heads and Gene and Bob agreed that it would probably be dynamite as these men cannot understand such figures. I put it up to them hard-boiled and told them they were never to question the expenditure of the money and also told them if they passed the information on, we would find it out and I would see that they were expelled from M.C. and they liked it. 66 men out of 75 (including myself) were present and every man signed a card— only one unable to determine amount at the time. I got a wonderful reaction from the group as far as spirit is concerned and believe we didn't make any mistakes on the men selected. Time can alone answer this, of course.
At a certain stage in the advancement of a member he was told he had reached a point where he was qualified for participation as a member of one of petitioner's select groups of men outside of the club. Either Drew or some other of petitioner's associates would visit a district unit and attend a meeting of this selected group of members and then outline to them the terms of the proposed ‘PL‘ and solicit their participation. This procedure was repeated in many of the district units each year from 1934 through 1941. Sometimes petitioner himself also met with such groups.
The transactions known as ‘PLs‘ and ‘CDs‘