Cosmopolitan Credit Corp. v. Commissioner

Cosmopolitan Credit Corporation v. Commissioner.

Cosmopolitan Credit Corp. v. Commissioner

Docket No. 3628-69.

United States Tax Court

T.C. Memo 1972-103; 1972 Tax Ct. Memo LEXIS 154; 31 T.C.M. (CCH) 404; T.C.M. (RIA) 72103;

May 3, 1972, Filed

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Dougal C. Pope, Houston 1st Savings Bldg., Houston, Tex., for the petitioner. R. James Curphy, William T. Overton, and Robert Liken, for the respondent.

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FAY

Memorandum Findings of Fact and Opinion

FAY, Judge: Respondent determined deficiencies in petitioner's income taxes as follows:

Year Ended		Addition to Tax	Deficiency
May 31	Income Tax	§6653(a)	§6653(b)
1959	$1,941.57		$ 970.79
1960	4,598.55		2,932.36
1961	1,568.57		784.29
1962	2,351.78	$117.59
1963	3,071.85	153.59
1964	575.84	28.79
1965	122.21

The issues to be decided are:

(1) Whether deductions taken in each of the years in question were ordinary and necessary expenses of petitioner's business.

(2) Whether petitioner is entitled to a deduction for an accrued salary expense for compensation payable to its president but not actually paid within two and one-half months after the close of petitioner's taxable year ending May 31, 1960.

(3) Whether petitioner received additional income in taxable years ending May 31, 1960, 1961, 1962, and 1963 attributable to the understatements of bad debt recoveries.

(4) Whether any part of the deficiencies in each of the taxable years ended May 31, 1959, through May 31, 1961, inclusive, is due to fraud with intent to evade tax within the meaning of section 6653(b). ¹

(5) Are the deficiencies due from petitioner for taxable years ending May 31, 1962, through May 31, 1964, attributable to negligence or intentional disregard of rules and regulations within the meaning of section 6653(a).

Findings of Fact

Some of the facts have been stipulated and are, together with the exhibits attached to the stipulation, incorporated herein by this reference.

Cosmopolitan Credit Corporation (hereinafter sometimes referred to as C.C.C.), formerly known as Carr Investment Corporation, was incorporated under the laws of the State of Louisiana in May of 1955 and at all relevant times maintained its principal place of business in Shreveport, Louisiana. C.C.C. filed corporate income tax returns for each of the years in question with the district director of internal revenue at New Orleans, Louisiana. C.C.C. employed a fiscal year ending May 31 and maintained its books and records on the accrual basis of accounting.

C.C.C. is engaged in the business of making loans in excess of $300. The business is owned and operated by Claude C. Carr (hereinafter sometimes referred to as Carr). Carr was both president and chairman of the board of directors during the years in issue. He personally maintained close control over the business and dominated every phase of the operation of C.C.C. from its inception until at least taxable year ended May 31, 1965. Carr was the only corporate officer with authority to issue checks on C.C.C.'s checking account, and he alone issued and signed all checks involved herein. He owned 99 percent of the outstanding shares of C.C.C. stock outright and the remaining one percent was held by Elizabeth Erholm, an employee of C.C.C., in trust for Carr.

In addition to Elizabeth Erholm, who served as secretary, treasurer, member of the board of directors and office manager, C.C.C. employed Doris O. Saucier as the office secretary.

During the course of each of the years in question C.C.C. issued numerous checks payable to third parties, petty cash, or to Carr. The expenditures were recorded on petitioner's books as being made for various business purposes, the majority being charged to advertising and travel accounts with occasional entries to office supplies, auto expense, entertainment, and miscellaneous. The checks referred to, on a year-by-year basis, are as follows:

Taxable Year
Ended May 31, 1959
Date of		Check	Amount of	Account Charged
Check	Payee	Number	Check	Name	Amount
7/25/58	Skaggs Drug	2807	$ 20.21	Advertising	$ 20.21
	Co.
9/27/58	Skaggs Drug	2907	54.88	Advertising	54.88
	Co.
1/20/59	Skaggs Drug	3292	26.98	advertising	26.98
	Center
	Total Year				$ 102.07
	Ended May 31,
	1959
Taxable Year Ended
May 31, 1960
7/29/59	Skaggs Drug	3878	$ 34.12	Advertising	$ 34.12
	Center
9/21/59	United	4077	41.93	Advertising	41.93
	Wholesale
	Jewelers
12/22/59	B. F. Goodrich	4445	26.42	Auto expense	26.42
	Stores
2/27/60	Hudson Vitamin	4627	34.70	Advertising	34.70
	Products
3/8/60	Business	4652	13.77	Office supplies	13.77
	Record Service
	Total Year				$ 150.94
	Ended May 31,
	1960
Taxable Year Ended
May 31, 1961
12/9/60	C. C. Carr	5681	$ 89.64	Travel	$ 89.64
12/30/60	C. C. Carr	5785	300.00	Travel	300.00
11/19/60	Diners Club	5613	254.64	Travel	254.64
11/8/60	American	5557	20.88	Travel	20.88
	Express
3/9/61	American	6048	42.86	Travel	42.86
	Express
12/17/60	C. C. Carr	5729	300.00	Entertainment &	300.00
				Donation
11/17/60	Sears Roebuck	5559	$ 19.72	Auto expense	$ 19.72
	& Co.
4/28/61	Browns Floral	6237	8.37	Miscellaneous	8.37
	Shop
4/28/61	Holiday In	6238	25.00	Advertising	25.00
	Drive
	Total Year				$1,061.11
	Ended May 31,
	1961
Taxable Year Ended
May 31, 1962
7/6/61	Hardy O'Neal	6557	$168.36	Travel	$ 168.36
	Arns Travel
	Agcy.
10/2/61	Diners Club	6808	228.59	Travel	228.59
12/5/61	LePetit Motel	7051	92.70	Travel	92.70
12/30/61	Roosevelt	7183	50.00	Travel	50.00
	Hotel
2/28/62	Diners Club	7422	16.40	Travel	16.40
8/29/61	Diners Club	6672	115.04	Entertainment &	115.04
				donation
	Total Year				$ 671.09
	Ended May 31,
	1962
Taxable Year Ended
May 31, 1963
12/18/62	Monteleone	8546	$ 25.00	travel	$ 25.00
	Hotel
12/18/62	Hilton Inne	8547	95.82	Travel	95.82
2/8/63	Flournay	8781	155.75	Entertainment &	155.75
	Jewelers			donation
	Total Year				$ 276.57
	Ended May 31,
	1963
Taxable Year Ended
May 31, 1964
Unknown	Petty cash	1-338	$102.60	Travel	$ 75.81
				Office supplies	24.90
				Recording -	1.89
				filing fees
Unknown	Petty cash	1-340	134.39	Advertising	66.00
				Office supplies	16.80
				Entertainment &	29.99
				promotion
				Recording -	21.60
				filing fees
Unknown	Petty cash	1-350	75.00	Advertising	30.00
				Miscellaneous	42.00
				Recording -	3.00
				filing fees
Unknown	Petty cash	1-368	124.40	Office supplies	55.25
				Travel	31.80
				Entertainment &	24.60
				promotion
				Miscellaneous	12.75
Unknown	Kidd Ruso	Unknown	86.80	Advertising	86.80
Unknown	Rubenstein	Unknown	33.05	Advertising	33.05
	Dept. Store
Unknown	United	Unknown	26.08	Advertising	26.08
	Jewelers
12/19/63	Lester Carr	9684	60.00	Entertainment &	60.00
				promotion
11/19/63	Diners Club	9537	64.03	Entertainment &	64.03
				promotion
1/22/64	Plaza Hotel	9846	51.56	Entertainment &	51.56
				promotion
12/18/63	American	9657	112.45	Travel	112.45
	Express
1/31/64	American	9899	53.92	Travel	53.92
	Express
12/19/63	Lester Carr	9684	90.00	Travel	90.00
	Total Year				$1,014.28
	Ended May 31,
	1964
Taxable Year Ended
May 31, 1965
12/17/64	Lester Carr	10976	$163.50	Travel	$163.50
12/21/64	Delta Airlines	10999	164.75	Travel	164.75
	Total Year				$328.25
	Ended May 31,
	1965

Carr personally negotiated many of the checks set forth above at the Commercial National Bank of Shreveport, Louisiana, the bank upon which the checks were drawn. The checks made to petty cash were simply presented for payment and those made to third party payees were endorsed by Carr in the name of the payee and presented for payment. The proceeds received from the checks were either deposited in C.C.C.'s bank account as a contribution to capital or unaccounted for. C.C.C. claimed a deduction on its income tax returns for taxable years May 31, 1959, through May 31, 1965, for each specific category of expenses set out above. The checks not handled in this fashion were in payment for Carr's personal expenses.

In addition to the above transactions which occurred throughout the taxable years in question, C.C.C. ostensibly made a flurry of disbursements at or very near the close of each year.

C.C.C.'s books and records reflect the following schedule of expenditures and their purpose: 408

Taxable Year Ended May 31, 1959
Date of		Check	Amount of
Check	Payee	Number	Check
5/30/59	Giddens-Lane Building	3664	$1,200.00
5/28/59	Petty cash	3665	1,638.39
5/28/59	E. J. Coen	3666	510.00
5/29/59	Petty cash	3667	1,221.45
5/28/59	B. M. Carr	3668	900.00
5/30/59	Lester M. Carr	3669	900.00
	Total Taxable Year
	May 31, 1959
Taxable Year Ended May 31, 1960
5/27/60	Giddens-Lane Building	4955	$1,200.00
5/27/60	B. M. Carr	4956	1,000.00
5/27/60	Lester Carr	4957	1,000.00
5/27/60	Petty cash	4959	1,197.00
5/31/60	Petty cash	4961	1,416.00
5/30/60	E. J. Coen	4962	345.00
5/30/60	Petty cash	4963	1,065.00
5/31/60	Petty cash	4966	360.00
5/31/60	Petty cash	4967	1,022.00
	Total Taxable Year
	May 31, 1960
Taxable Year Ended May 31, 1961
5/31/61	Petty cash	6398	$1,146.00
5/30/61	Petty cash	6399	342.00
5/30/61	Petty cash	6400	210.00
5/31/61	Postmaster	6402	450.00
5/31/61	Giddens-Lane Building	6403	1,200.00
5/31/61	Petty cash	6404	399.24
	Total Taxable Year
	May 31, 1961
Taxable Year Ended May 31, 1962
5/31/62	C. C. Carr Ins. Agcy.	Unknown	$1,500.00
5/31/62	Petty cash	7744	1,441.10
5/31/62	Petty cash	7745	1,122.00
5/31/62	Petty cash	7746	1,143.90
5/31/62	Petty cash	7751	457.00
	Total Taxable Year
	May 31, 1962
Taxable Year Ended May 31, 1963
5/27/63	J. B. Handcock	9053	$ 660.00
5/27/63	Postmaster	9055	276.00
5/28/63	Petty cash	9058	771.63
5/30/63	Paul Johnson	9059	270.00
5/30/63	J. B. Handcock	9060	612.00
5/30/63	Albert Gaston	9061	456.00
5/30/63	Postmaster	9062	300.00
5/30/63	Petty cash	9063	675.93
5/30/63	James Lewis	9064	324.75
5/31/63	Petty cash	9065	849.72
5/31/63	Giddens-Lane Building	9066	1,500.00
5/24/63	L. Robinson	9052	276.42
	Total Taxable Year
	May 31, 1963
Taxable Year Ended May 31, 1964
5/27/63 1	Martha Ayers	9054	$ 672.00
5/28/63 1	James Leasis	9057	171.00
	Total Taxable Year
	May 31, 1964

Taxable Year Ended May 31, 1959
Date of	Date Paid	Account Charged
Check	or Cashed	Name	Amount
5/30/59	8/20/60	Rent	$1,200.00
5/28/59	8/17/60	Advertising	540.30
		Auto expense	720.90
		Collection	324.75
		Telephone & telegraph	52.44
5/28/59	1/15/60	Legal	510.00
5/29/59	8/20/60	Office supplies	150.45
		Entertainment and
		promotion	525.00
		Insurance - general	51.00
		Postage	445.00
		Miscellaneous	50.00
5/28/59	8/20/60	Director's fees	900.00
5/30/59	8/17/60	Director's fees	900.00
			$6,369.84
Taxable Year Ended May 31, 1960
5/27/60	9/1/60	Rent	$1,200.00
5/27/60	9/1/60	Director's fees	1,000.00
5/27/60	9/1/60	Director's fees	1,000.00
5/27/60	9/1/60	Advertising	1,020.00
		Donations	177.00
5/31/60	9/1/60	Office supplies	126.00
		Entertainment and
		promotion	600.00
		Postage	690.00
5/30/60	9/1/60	Legal	345.00
5/30/60	9/1/60	Telephone & telegraph	120.00
		Travel	945.00
5/31/60	9/1/60	Automobile	240.00
		Filing & recording	120.00
5/31/60	9/1/60	Collection	902.00
		Miscellaneous	120.00
			$8,605.00
Taxable Year Ended May 31, 1961
5/31/61	6/28/61	Advertising	$1,146.00
5/30/61	6/28/61	Collection	246.00
		Entertainment and
		promotion	81.00
		Donations	15.00
5/30/61	6/28/61	Office supplies	210.00
5/31/61	6/29/61	Postage	450.00
5/31/61	6/29/61	Rent	1,200.00
5/31/61	6/29/61	Office supplies	3.24
		Miscellaneous	384.00
		Dues & subscriptions	7.50
		Clerk of Court	4.50
			$3,747.24
Taxable Year Ended May 31, 1962
5/31/62	6/8/62	Rent	$1,500.00
5/31/62	6/5/62	Advertising	1,441.10
5/31/62	6/8/62	Collection	996.00
		Miscellaneous	126.00
5/31/62	6/5/62	Office supplies	90.00
		Entertainment and
		promotion	150.00
		Insurance - general	108.00
		Postage	795.90
5/31/62	6/5/62	Miscelllaneous	152.00
		Travel expenses	305.00
			$5,664.00
Taxable Year Ended May 31, 1963
5/27/63	9/ /63	Advertising	$ 660.00
5/27/63	Missing	Postage	276.00
5/28/63	9/4/63	Travel expense	597.63
		Miscellaneous	174.00
5/30/63	9/6/63	Office supplies
		270.00
5/30/63	9/6/ 3	Advertising	612.00
5/30/63	9/6/63	Collection	456.00
5/30/63	Missing	Postage	300.00
5/30/63	8/27/63	Entertainment and
		promotion	675.93
5/30/63	9/6/63	Collection	324.75
5/31/63	9/4/63	Auto expense	621.00
		Miscellaneous	159.72
		Various others	69.00
5/31/63	Missing	Rent	1,500.00
5/24/63	9/6/63	Miscellaneous	276.42
			$6,972.45
Taxable Year Ended May 31, 1964
5/27/63 1	9/6/63	Collection	$ 672.00
5/28/63 1	9/6/63	Collection	171.00
			$ 843.00

Carr admittedly forged the payee's endorsement on a number of the checks allegedly written in payment of the above expenses. The forgeries were often deceptively executed in a style of handwriting different from Carr's usual style.

Checks numbered 3666 and 4962 above were written to one E. J. Coen, an attorney, allegedly for legal expenses. During the fiscal years ending May 31, 1959, and May 31, 1960, Coen performed no legal services either for C.C.C. or Carr. In addition Coen never received the checks or the proceeds therefrom. Carr, without authorization, endorsed Coen's name on the checks, cashed them, and either retained the funds or deposited them in C.C.C.'s account.

Lester V. Carr and B. M. Carr are the brothers of Claude C. Carr. Lester was vice president and a member of the board of directors of C.C.C. during the taxable years in question. During the taxable years ended May 31, 1959, and May 31, 1960, however, he performed no services for C.C.C. Neither check number 3669 nor check number 4957, written to Lester Carr 410 and charged to an account for director's fees, was received by Lester. In fact, both checks were falsely endorsed by Claude C. Carr in the name of the payee, negotiated at the Commercial National Bank and the proceeds either retained or deposited in C.C.C.'s account.

B. M. Carr was neither a director nor officer during any of the years in question and performed no services for C.C.C. Checks numbered 3668 and 4956, written to B. M. Carr and charged to a director's fees account, were never received by B. M. Carr. They too were falsely endorsed by Claude C. Carr, presented for payment at the bank on which they were drawn and the proceeds were then either retained by Carr or deposited in C.C.C.'s account.

Check number 6402 is a $450 check written to the postmaster on May 31, 1961, and charged to an account labeled "postage." The postmaster never received the check or payment in lieu thereof and it too was falsely endorsed by Claude C. Carr, presented for payment at the bank on which it was drawn and the proceeds deposited in C.C.C.'s account.

As set out above, during the last week of May 1959 through 1963 C.C.C. issued a series of petty cash checks in amounts varying from $210 to $1,638.39 and charged the items to various expense accounts. C.C.C. has no receipts or other comparable documentation substantiating the legitimacy or business purpose of any of the expenses. Moreover, many, if not all, of the checks to petty cash were presented for payment to the Commercial National Bank by Claude C. Carr and deposited in C.C.C.'s account.

In each instance where Carr made the deposits set forth above in C.C.C.'s checking account a corresponding increase was made to Carr's capital account. C.C.C.'s books and records relative to Carr's capital account for taxable years 1959 through 1962 were as follows:

May 31, 1959
Date	Source of Capital Increases or	Amount
	Decreases
5/31/58	Opening balance per 1959 return	$ 60,250.00
Unknown	Unknown	6,500.00
5/31/59	Balance per books and return	$ 66,750.00
	May 31, 1960
12/11/59	Cash received from Carr	$ 2,000.00
12/16/59	Cash received from Carr	3,000.00
12/22/59	Cash received from Carr	1,000.00
1/11/60	Cash received from Carr	1,000.00
5/31/60	Adjustment	(2,500.00)
5/31/60	*13Balance per books and return	$ 71,250.00	May 31, 1961
7/ 5/60	Cash received from Carr	$ 3,000.00
7/ 9/60	Cash received from Carr	2,000.00
8/13/60	Cash received from Carr	2,500.00
8/16/60	Various corporate checks deposited	2,400.00
	to corporation account
8/19/60	Cash received from Carr	6,000.00
8/25/60	Cash received from Carr	5,000.00
8/31/60	Cash received from Carr	2,000.00
9/ 1/60	Various corporate checks deposited	9,605.00
	to corporate account
1/28/61	Cash received from Carr	2,000.00
2/10/61	Cash received from Carr	2,000.00
2/18/61	Cash received from Carr	2,500.00
5/31/61	Balance per books and return	$110,255.00
	May 31, 1962
6/ 5/61	Cash received from Carr	$ 3,000.00
6/ 8/61	Cash received from Carr	1,974.00
6/28/61	Various corporate checks deposited	2,097.24
	to corporate account
6/29/61	Various corporate checks deposited	1,652.76
	to corporate account
7/ 7/61	Cash received from Carr	6,150.00
9/18/61	Cash received from Carr	1,500.00
9/30/61	Corporate check issued to Carr as	6,000.00
	salary and deposited
4/25/62	Cash received from Carr	2,250.90
5/31/62	Balance per books and return	$134,879.90

411

The entry of September 1, 1960, set forth above, consists of the following checks which were deposited in C.C.C.'s checking account on September 1, 1960:

Check Number &		Amount
Voucher Number	Payee	of Check
4955	Giddens-Lane Co.	$1,200.00
4959	Petty cash	1,197.00
4962	E. J. Coen	345.00
4956	B. M. Carr	1,000.00
4957	Lester V. Carr	1,000.00
4961	Petty cash	1,416.00
4963	Petty cash	1,065.00
4966	Petty cash	360.00
4967	Petty cash	1,022.00
4958	Claude C. Carr	1,000.00
		$9,605.00

The capital account entry of June 28, 1961, set forth above, consists of the following checks negotiated by Carr and deposited in C.C.C.'s checking account on that same date:

Check Number &		Amount
Voucher Number	Payee	of Check
6398	Petty cash	$1,146.00
6399	Petty cash	342.00
6400	Petty cash	210.00
6404	Petty cash	399.24
		$2,097.24

It has been stipulated that Carr entered a plea of guilty and was sentenced on one count of making and subscribing to, under the provisions of section 7206(1), a false corporate income tax return filed for C.C.C. for the taxable year ended May 31, 1959.

In addition to all of the items discussed above, in each of the years before us petitioner occupied a portion of the office space which was leased by Carr or Claude C. Carr Insurance Agency from Giddens-Lane Company, Inc. The reasonable annual rental value of petitioner's office space was $1,200 for each of the first three taxable years in question and $1,500 for taxable years ending May 31, 1962, and 1963. Checks made in payment for rent were written to Giddens-Lane Building. Giddens-Lane did not receive the checks. The checks in fact were falsely endorsed by Carr, negotiated at the Commercial National Bank, and deposited in C.C.C.'s checking account. Rent for the entire premises was, however, paid to Giddens-Lane Company, Inc., by Carr.

C.C.C. claimed on its income tax return for the taxable year ended May 31, 1960, a deduction for accrued compensation payable to Carr in the amount of $6,000. In December 1960 petitioner made an entry on its books and records for accrued compensation payable to Carr, and the amount was eventually paid September 30, 1961. Carr computes his taxes on the cash method of accounting.

During the taxable years ended May 31, 1960, through May 31, 1965, C. C.C. utilized the reserve method of accounting for bad debts. Recoveries of bad debts were recorded as gross income. For each of the taxable years ending May 31, 1960, through May 31, 1963, petitioner had bad debt recoveries in excess of those reported for income tax purposes. For each year the figures are as follows:

	Amount of
Year Ending	Recoveries on	Amount
May 31	Bad Debts	Reported
1960	$ 356.39	$ 79.00
1961	535.35	447.00
1962	1,675.51	534.36
1963	2,544.64	None

Opinion

The first issue to be decided is whether the various alleged disbursements made by petitioner are properly deductible. With respect to this determination petitioner asserts that the deficiencies involved were reached in an arbitrary and capricious fashion, hence shifting the burden of proof to respondent. This assertion, however, is wholly lacking in merit. The two bases on which petitioner relies are both fallacious. Petitioner relies first on the disallowance of a rental expense and secondly, on a rather wholesale disallowance of items charged to petty cash. As will be set out in detail below, the rental expense, while perhaps presenting an issue decidable in petitioner's favor, in no way forms the basis for a charge of arbitrary and capricious. The facts indicate that the transaction by which petitioner paid rent was highly unusual, deceptive, and deserving of suspicion. The question of whether a rental expense should be allowed was exceedingly close and under no definition can respondent's disallowance be classified as arbitrary or capricious.

Petitioner's reliance on the wholesale disallowance of the petty cash expenditures as an arbitrary and capricious determination is likewise erroneous. Respondent was not arbitrary and capricious, but on the contrary quite reasonable and, in fact, correct. No other reasons having been pressed as indicating an arbitrary determination on respondent's behalf, we conclude that petitioner's allegations must be spurned.

Petitioner, via its primary officer and controlling shareholder, Claude C. Carr, has seen fit to conduct a substantial portion of its business activity in a highly questionable manner. Numerous disbursements were 412 purportedly made and fictitiously entered as expense items on petitioner's books and records. The records were then employed in completing petitioner's tax returns resulting in erroneous deductions. Many such disbursements were made during the entire course of the taxable years before us, with an uncommon acceleration occurring at or near the end of each year. Most of the checks involved were negotiated by Carr, and either diverted for his own use or deposited in C.C.C.'s checking account. With the exception of the checks that the parties agree were written in payment for Carr's personal expenses, none of the checks have been received by the designated payee. Petitioner does not seriously contend otherwise. Petitioner does contend that the amounts in question, while disguised as various and sundry expenses, were really compensation to Carr and so disguised by him in order to evade personal income tax. Petitioner therefore concludes that the expenditures, while not deductible in the form taken, should be lumped together and allowed as a deduction for compensation. This is an interesting and novel approach - however, it is derived from hindsight and contains little substance. The entire plan, as is evidenced by the record, reveals no suggestion that petitioner intended the various disbursements to constitute compensation. On the contrary, we think that the cyclical nature of the route taken by the checks here involved is convincing evidence that compensation was not their purpose. The checks were written and signed by Carr, deductible entries were made in the corporate books, the checks were then taken by Carr to the bank on which they were drawn, negotiated, and, for the most part, returned to petitioner's checking account. Neither Carr, nor anyone else, received any direct, material benefit from this merry-go-round method of generating deductions. The corresponding entries made to Carr's capital account are not, in this context, sufficient to warrant a conclusion that he received compensation or, more importantly, that petitioner so intended.

The burden of disproving respondent's determination is on petitioner. Rule 32, Tax Court Rules. He has produced not one shred of credible evidence indicating the legitimacy of the expenditures in question. Such a barren record necessarily dictates a conclusion in respondent's favor. We likewise find the record inadequate to support an application of the doctrine set forth in Cohan v. Commissioner, 39 F. 2d 540 (C.A. 2, 1930). Application of that rule is only proper where we are otherwise convinced that a portion of claimed and unsubstantiated deductions were in fact legitimate. This is not the case here.

The second and yet more serious question is whether any portion of the deficiencies for taxable years ending May 31, 1959, through May 31, 1961, was due to fraud, thus justifying imposition of the 50 percent fraud penalty. ²

The burden of proof in establishing fraud rests with respondent and requires a showing of clear and convincing evidence. See section 7454; Mitchell v. Commissioner, 118 F. 2d 308 (C.A. 5, 1941); and Frank Imburgia, 22 T.C. 1002">22 T.C. 1002 (1954). Fraudulent conduct on the part of corporate officers is imputed to the corporation and will justify a holding of fraud. Elmer J. Benes, 42 T.C. 358">42 T.C. 358 (1964), affd. 355 F. 2d 929 (C.A. 6, 1966), certiorari denied 384 U.S. 961">384 U.S. 961 (1966); Auerbach Shoe Co., 21 T.C. 191">21 T.C. 191 (1953), affd. 216 F. 2d 693 (C.A. 1, 1954). That Carr possessed the requisite fraudulent intent has been made abundantly clear. We are persuaded by ineluctable evidence that the transactions occurring herein were part of a fraudulent scheme to generate false deductions. Only the most obvious and noteworthy examples will be dealt with in particular.

Two checks, one in 1959 and one in 1960, were written to one E. J. Coen for legal services never performed. The checks, issued and signed by Carr, were then falsely endorsed in the name of the payee and eventually redeposited in petitioner's checking account. Similar circumstances surround the four checks written to Lester Carr and B. M. Carr, Claude's two brothers. Checks payable to them for director's services never performed, were issued and signed by Carr, falsely endorsed and redeposited in petitioner's account. Lastly, a check written 413 to the postmaster, for postage never purchased, followed the same cycle.

These are but several of the numerous instances that constitute a fraudulent scheme by petitioner's president to generate illegitimate deductions.

Respondent need only show that a part of the deficiency is attributable to fraud and the penalty will apply to the entire deficiency. Arlette Coat Co., 14 T.C. 751">14 T.C. 751 (1950). The above instances alone are sufficient to establish the fraudulent conduct of petitioner.

Petitioner argues that the conduct of its president, Carr, was part of his personal scheme to deceive the government as to his individual income and hence should not be attributed to the corporation. We disagree. The facts do not indicate that Carr was so motivated. Moreover, we think the language used by the Circuit Court in Auerbach Shoe Company v. Commissioner, 216 F. 2d 693, 697 (C.A. 1, 1954), affirming 21 T.C. 191">21 T.C. 191 (1953), is particularly appropriate here:

In the first place it is hardly conceivable that Auerbach was acting solely for his direct personal benefit and account when he filed fraudulent returns for the petitioner. No doubt he hoped by filing those returns to conceal his wrongful diversion of corporate property and his fraudulent understatement of income in his personal returns. But when creditors' rights are not involved, and so far as the record discloses creditors' rights were not involved here, there is as little point in a sole stockholder cheating his corporation as there is in cheating at solitaire unless, of course, tax consequences result. Thus, while no doubt Auerbach had a purely personal motive in falsifying the petitioner's returns, we think it an inescapable inference that he must also have had a motive to benefit the petitioner by reducing its taxes, whereby he would also stand to gain substantially, although indirectly as its stockholder.

The fraud penalty imposed above covers only three of the years before us; to wit, taxable years ending May 31, 1959, through May 31, 1961. Respondent has asserted a penalty under section 6653(a)³ for taxable years ending May 31, 1962, through May 31, 1964. It is well settled that respondent's determination of negligence or intentional disregard of rules and regulations is presumptively correct, and the burden of disproving the allegation rests with petitioner. David Courtney, 28 T.C. 658">28 T.C. 658 (1957).

Petitioner has placed nothing in evidence to contradict the allegation of negligence. In addition, the record is replete with ample evidence warranting the conclusion that petitioner, at the very least, failed to exercise reasonable care in maintaining accurate books and in computing its tax liability. We find little, if any, difficulty in sustaining respondent's imposition of the negligence penalty.

Three remaining items must be singled out and dealt with separately. The first relates to the checks made out to Gidden-Lane Building and charged to rent. C.C.C. occupied a portion of the office space leased by Carr or his insurance company. The rent for the entire premises was paid and deducted by Carr. The rental payments ostensibly made by petitioner to Giddens-Lane never reached the payee and were diverted by Carr. The rental payments, however, were reasonable and in fact were in payment for the use of office space. That Carr chose to have them made payable to a third party payee - for whatever reason - causes them to be no less payments of rent. We therefore conclude that petitioner is entitled to a deduction for the rental payments made, deducted, and disallowed by respondent.

There is also in issue the deductibility of $6,000 in accrued but unpaid compensation for the taxable year ending May 31, 1960. Determination of this issue is governed by section 267. The requirements of this section are clearly set out within the statute and are as follows:

SEC. 267. LOSSES, EXPENSES, AND INTEREST WITH RESPECT TO TRANSACTIONS BETWEEN RELATED TAXPAYERS.

(a) Deductions Disallowed. - No deduction shall be allowed - * * *

(2) Unpaid Expenses and Interest. - In respect of expenses, otherwise deductible under section 162 or 212, or of interest, otherwise deductible under section 163, -

(A) If within the period consisting of the taxable year of the taxpayer and 2 1/2 months after the close thereof (i) such expenses or interest are not paid, and 414 (ii) the amount thereof is not includible in the gross income of the person to whom the payment is to be made; and

(B) If, by reason of the method of accounting of the person to whom the payment is to be made, the amount thereof is not, unless paid, includible in the gross income of such person for the taxable year in which or with which the taxable year of the taxpayer ends; and

(C) If, at the close of the taxable year of the taxpayer or at any time within 2 1/2 months thereafter, both the taxpayer and the person to whom the payment is to be made are persons specified within any one of the paragraphs of subsection (b).

(b) Relationships. - The persons referred to in subsection (a) are: * * *

(2) An individual and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual;

In the case now before us petitioner, an accrual basis taxpayer, seeks to deduct $6,000 of compensation actually paid to Carr some 16 months after the close of the taxable year in question. Carr, a cash basis taxpayer, was not required to include the payment in his income until payment was made. In addition, at all relevant times Carr effectively owned or controlled 100 percent of petitioner's stock. This case is a model for application of section 267.

Petitioner argues that Carr, the recipient of the compensation, constructively received the payment within 2 1/2 months of the close of petitioner's tax year. While constructive receipt may provide an escape hatch under proper circumstances, it has not been proven to exist here. There was no corporate action taken in this regard within the 2 1/2 month period: no corporate resolutions, no entry on the books, and no effort of any kind to set the funds aside and/or put them at Carr's unfettered disposal. There is nothing indicating he had any right to the money whatsover until the first entry was made in petitioner's records in December of 1960, well after the passing of the 2 1/2 months.

Certainly Carr, by virtue of his control of the corporation, had the power to draw a corporate check in payment of the accrued compensation. However, it is well established that the application of the doctrine of constructive receipt is controlled by the right, as distinguished from the power, to receive funds. Hyland v. Commissioner, 175 F. 2d 422 (C.A. 2, 1949), affirming a Memorandum Opinion of this Court. In Hyland the court said, in part:

* * * No doubt it is true that the taxpayer by reason of his very large stock ownership, could have effectively directed the various agents having charge of the corporation's bookkeeping and financial affairs to take action to make available to him the necessary cash and to draw a check in his favor for the amount claimed by him for 1942 services. But he did not do so; indeed, there is no evidence that he even knew of the directors' resolution authorizing his compensation before he received it. The argument that the rule of constructive receipt becomes applicable with the mere possession of such power, without any indication of an intent to exercise it, proves too much. It would mean that in every close corporation the corporate earnings are immediately constructively received by the controlling stockholder provided their withdrawal would not make the corporation insolvent. * * * We think that where, as here, the controlling stockholder treats himself as a creditor and the corporation as his debtor, he must, if he invokes the doctrine of constructive receipt, prove that the requirements of the Regulations have been satisfied. He does not make such proof merely by showing that he owns more than 50% of the corporation's outstanding stock. * * *

Petitioner's final contention is that if the amount in issue cannot be deducted in the taxable year ended May 31, 1960, then it is allowable in the year ended May 31, 1962, when actual payment was subsequently made. This position is contrary to sec. 1.267(a)-1 (b)(2), Income Tax Regs., which provides in part:

* * * if the accrued expenses or interest are paid after the deduction has been disallowed under section 267(a)(2), no deduction would be allowable for the taxable year in which payment is made, since an accrual item is deductible only in the taxable year in which it is properly accruable.

We have no quarrel with the regulations and on one occasion have given approval to its import; see North American Service Co., 33 T.C. 677">33 T.C. 677 (1960). ⁴

415

We do have serious reservations as to whether the item of compensation was properly accruable as a deduction in taxable year ended May 31, 1960, and may in fact be properly accruable in taxable year ended May 31, 1961, or even for that matter, 1962. This speculation is meaningless, however, since petitioner has not presented evidence at trial, nor pressed by way of argument on brief, that the compensation is accruable in any year other than 1960.

We therefore conclude, as respondent urges, that the item is properly accruable and deductible only in 1960 and that section 267 precludes its deduction in that year.

The last question to be considered is whether petitioner had additional income attributable to the unreported recovery of bad debts. In the statutory notice of deficiency respondent determined that during the taxable years ended May 31, 1960, through May 31, 1963, petitioner received bad debt recoveries in excess of the amounts reported on its income tax returns as follows:

	Bad Debt	Reported on	Amount
Year Ended	Recoveries	Return	Understated
5/31/60	$ 356.39	$ 79.00	$ 277.39
5/31/61	535.35	447.00	88.35
5/31/62	1,675.51	534.36	1,141.15
5/31/63	2,544.64	None	2,544.64

The amount of bad debt recoveries received by petitioner in each taxable year has been stipulated by the parties, and there is no dispute as to the amount shown on petitioner's Federal income tax returns as "recoveries on bad debts." Thus, respondent contends it is obvious that petitioner has understated bad debt recoveries in his computation of taxable income in each taxable year at issue.

Petitioner, nevertheless, contends that the actual bad debt recoveries in excess of that reported on the income tax return as "recoveries on bad debts" have in fact been reported somewhere in gross income. Such a vague and ambiguous contention is obviously insufficient to even approach carrying petitioner's burden of proof. On the basis of the record before us we must conclude in favor of respondent.

Decision will be entered under Rule 50.

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Footnotes

• 1. All section references are to the Internal Revenue Code of 1954, unless otherwise indicated.↩

• 1. Charged to expense 10/31/63↩

• 2. SEC. 6653. FAILURE TO PAY TAX.

  (b) Fraud. - If any part of any underpayment (as defined in subsection (c)) of tax required to be shown on a return is due to fraud, there shall be added to the tax an amount equal to 50 percent of the underpayment. In the case of income taxes and gift taxes, this amount shall be in lieu of any amount determined under subsection (a). In the case of a joint return under section 6013, this subsection shall not apply with respect to the tax of a spouse unless some part of the underpayment is due to the fraud of such spouse.↩

• 3. SEC. 6653. FAILURE TO PAY TAX.

  (a) Negligence or Intentional Disregard of Rules and Regulations With Respect to Income or Gift Taxes. - If any part of any underpayment (as defined in subsection (c)(1)) of any tax imposed by subtitle A or by chapter 12 of subtitle B (relating to income taxes and gift taxes) is due to negligence or intentional disregard of rules and regulations (but without intent to defraud), there shall be added to the tax an amount equal to 5 percent of the under-payment.↩

• 4. The Seventh Circuit in North American Service Co. v. Commissioner ordered that this case be remanded and disposed of in accordance with a stipulated settlement. This, however, does not affect the vitality of the opinion as an expression of the Tax Court's views on the issue involved.↩