
USCA1 Opinion

	




                            UNITED STATES COURT OF APPEALS                                FOR THE FIRST CIRCUIT                                 ____________________        No. 93-1365                         ALAN E. LEWIS AND HARRIET R. LEWIS,                               Petitioners, Appellants,                                          v.                          COMMISSIONER OF INTERNAL REVENUE,                                Respondent, Appellee.                                 ____________________                              ON APPEAL FROM A DECISION                            OF THE UNITED STATES TAX COURT                                 ____________________                                        Before                                 Breyer, Chief Judge,                                         ___________                           Rosenn,* Senior Circuit Judge,                                     ____________________                               and Cyr, Circuit Judge.                                        _____________                                 ____________________            David  R. Andelman with whom  Edward F. Fay, Colleen  A. Brady and            __________________            _____________  _________________        Lourie & Cutler, P.C. were on brief for appellants.        _____________________            Kenneth  L. Greene,  Attorney, Tax  Division, U.S.  Department  of            __________________        Justice, with whom Michael L. Paup, Acting Assistant Attorney General,                           _______________        Gary  R. Allen  and  Curtis C.  Pett,  Attorneys, Tax  Division,  U.S.        ______________       _______________        Department of Justice, were on brief for appellee.                                 ____________________                                    March 17, 1994                                 ____________________        _____________________        *Of the Third Circuit, sitting by designation.                       BREYER, Chief  Judge.    Alan  and  Harriet  Lewis                               ____________             appeal  from  a  Tax  Court decision  assessing  taxes  upon             $1,062,500,  which  a  Lewis-controlled  corporation  called             "ILT"  distributed to  the  Lewises in  1984.   In  the  Tax             Court's view, that money represented an ILT "dividend," paid             to  the Lewises at that time.   See I.R.C.   301(a), (c)(1)-                                             ___             (3)  (1986).  The  Lewises disagree.  They  point out that a             "dividend"  must  come from  a  corporation's "earnings  and             profits."   See id.   316(a).   And, they argue,  ILT had no                         ___ __             "earnings and profits," either in or before 1984, from which             it might  have paid a "dividend"  in 1984.   The Tax Court's             contrary conclusion, they believe,  rests upon a simple, and             clear, factual error.                    _______                       The  Lewises   further   argue  that,   if   ILT's             distribution of the $1,062,500 is not a dividend, neither is             it any  other kind of 1984  taxable "income."  See  id.   61                                                            ___  __             (defining "gross income" as "all income from whatever source             derived").   Rather,  in their  view, the  1984 distribution             represents income that they constructively  received in, and             accumulated from, earlier years,  namely from the years 1974             through 1980.   The  Lewises concede  that they  should have                                                              ___________             paid (but never have paid) income tax on this money sometime             ____      _______________             between 1974 and  1981.   But, as all  parties concede,  the                                               ___                                         -2-                                          2             statute  of  limitations  now  bars  the  Commissioner  from             assessing  taxes  for those  earlier  years.    And, in  the             Lewises's view, the Commissioner  cannot subvert the letter,             and  the spirit, of that  statute by taxing  now income that                                                          ___             the  government  should  have  taxed then.      The  Lewises                                                  ____             conclude that  we should, therefore, simply  reverse the Tax             Court's determination.                       In our view, the Lewises are correct about the Tax             Court's factual error.  The record makes clear that the 1984             distribution did not come from ILT's "earnings and profits."             It is, as the  Lewises say, some form of  accumulated income             that  the  Lewises "constructively  received" in  prior, and             now-closed, tax years.  But, whether or not the Lewises must             pay  taxes on that distribution  is a different  matter.  In             adjudicating tax cases, the courts have developed a  type of             estoppel  known   as  "quasi  estoppel"  or   the  "duty  of             consistency," whereby a taxpayer may not take  a position in             one year to  his advantage,  and then at  some later  point,             after correction for that  year is barred by the  statute of             limitations, adopt a contrary  position touching on the same             facts  or  transaction.   Jacob  Mertens,  Jr., The  Law  of                                                             ____________             Federal  Income  Taxation     60.05 (1992).    Whether  that             _________________________             doctrine  requires  the  Lewises   to  treat  the  1984  ILT                                         -3-                                          3             distribution as taxable income is a  matter so far addressed             only superficially by the parties and upon which we wish the             Tax  Court's  views.   We  therefore  decline the  Lewises's             invitation  to hold  that the $1,062,500  is not  taxable to             them in 1984, and we  remand this case to the Tax  Court for             further proceedings.                                          I                                   Background Facts                                   ________________                       To understand the Tax  Court's factual error,  one             must have in mind a rather complex (and here undisputed) set             of events,  some  of which  took  place before,  and  others             after, December 1980, when ILT's  bank account showed a zero             balance.                                          A                                 Before December 1980                                 ____________________                       This  case arises out of  an effort by Alan Lewis,             and Steven  Belkin, his business associate,  to avoid paying             federal  income  taxes  on revenue  generated  primarily  in             Europe  by  their  travel  business, Trans  National  Travel             ("TNT").   Two key sets of events took place before December             1980.   First, between 1974  and 1980, Lewis  and Belkin had             TNT employees  send TNT  revenue  generated by  the sale  of             local (e.g.,  European city) tours  in Europe to  the Cayman                                         -4-                                          4             Island bank account of ILT, a  foreign corporation that they             owned and  controlled.   ILT transferred some  of the  money                                                      ____             received  from  TNT to  two  Cayman  Island trusts.    Those             trusts, it later turned out, were "grantor" trusts of  Lewis             and Belkin (meaning, basically, that Lewis and Belkin should             have paid income tax on the money those trusts received when             the trusts received it.)                       Second,  and more important  for present purposes,             between 1977 and  1980 ILT  "loaned" the rest  of the  money                                                      ____             received  from TNT  to two  limited partnerships  formed and             controlled by Lewis and  Belkin.  In effect, this  was money             "loaned" by Lewis and Belkin  to themselves, for the purpose             of making some  personal investments.   The total amount  of             these "loans" was approximately  $2.075 million.  There were             three  such  "loans,"  each  of which  involved  money  that             travelled  a circuitous  path,  reaching  Lewis  and  Belkin             through paper intermediaries:                       a)   In 1977, ILT loaned $800,000 to Gran Compania                            De  Comercio,  which  reloaned  the  money to                            Windikip    Financieringsmaatschappij   B.V.,                            which   in  turn   reloaned   the  money   to                            Charlesgate West Associates.  We  assume that                            Gran Compania and Windikip were Lewis/Belkin-                            controlled  entities  that  existed  only  on                            paper (though their use  may have avoided the                            need  to  withhold  U.S.  taxes  on  interest                            payments).    Charlesgate was  a Lewis/Belkin                            real estate partnership, which used the money                            for the benefit of Lewis and Belkin.                                         -5-                                          5                                         b)   In   1978,   ILT   loaned  Charlesgate   West                            Associates an additional $600,000,  using the                            same intermediaries.                                         c)   In   1980,   ILT   loaned   $675,000   to   a                            Lewis/Belkin-controlled      real      estate                            partnership    named     Taunton    Boulevard                            Associates,  which used  the money  for their                            benefit.    This   time  the   intermediaries                            consisted of two  different foreign  entities                            called  "Mido  Capital  Venture,   N.V."  and                            "Bristol Realty Trust."                       In each  instance, the lending entity  and all the             borrowing  entities created  all the  necessary loan-related             documentation.  Thus, on paper, it  seemed as if Charlesgate             owed  Windikip (which  owed Gran  Compania, which  owed ILT)             regular payments of  interest plus  repayment of  principal.             Similarly, it  seemed, on paper, as if  Taunton owed Bristol             (which  owed  Mido,  which  owed ILT)  regular  payments  of             interest plus repayment of principal.  The Tax  Court found,             however,  that  neither Lewis  nor  Belkin,  the persons  in             control of Charlesgate and Taunton Associates, ever intended             to  pay back the  $2.075 million in "loans"  to ILT.  Hence,             for tax purposes, they were not loans at all.                       By  the end of  1980, ILT apparently  had paid out             all  the  TNT  money  it  had  received  either  1)  to  the             Lewis/Belkin "grantor"  trusts, or  2)  to the  Lewis/Belkin             real  estate  partnerships  by  way of  the  $2.075  million                                         -6-                                          6             Charlesgate and Taunton  loans.   As we have  said, the  Tax             Court  found  that, as  of  December  31,  1980, ILT's  bank             balance was zero.                                         -7-                                          7                                          B                                      After 1980                                      __________                       Three  significant  events  occurred  after  1980.             First,  in  1983,  Belkin  and Lewis  ended  their  business             association.  As part of  their consequent efforts to divide             property jointly owned or  controlled, they decided to repay             the three  "loans" from  ILT.   They therefore reversed  the             "money flow," having (in the  one case) Gran Compania  (paid             by Windikip,  paid by Charlesgate) pay ILT $1.4 million, and             (in the other  case) Mido Capital  (paid by Bristol  Realty,             paid by Taunton) pay ILT $708,658.                       Second,  ILT,  having  received this  money  (plus             related interest) from Gran Compania and Mido, divided it in             half,  distributing $1,079,329  to Belkin's  "grantor" trust             and  $1,079,329 to  Lewis's "grantor"  trust.   The adjusted             amount   ($1,062,500)  of   this  distribution   to  Lewis's             "grantor" trust in 1984 (which, as noted  above, amounts for             tax purposes  to a  distribution to  Lewis  himself) is  the             money at issue here.                                          II                                The Tax Court's Error                                _____________________                       The  factual record,  as just  described, suggests             that  the underlying,  and possibly  difficult,  question in                                         -8-                                          8             this case is  not one of finding the facts,  but rather, one             of characterizing facts that are essentially beyond dispute.                ______________             Is ILT's 1984 distribution of roughly $2.159 million taxable             "income"  to its recipients in  light of the  fact that that             distribution originated in the repayment of sham loans (made                          __________             in years now closed to review), the funds for which "loans,"             in  turn, originally  took the  form of  what may  have been             taxable  (but  untaxed)  income  to  those  same  recipients             (again, in  years now  closed to  review)?    The  Tax Court             avoided this question, however, by finding  as fact that ILT             had other  "earnings  and profits"  out  of which  its  1984                 _____             distribution could have been made.  The Tax Court found that                       between  1981   and  1984,  unidentified                       amounts   were  deposited   into  and/or                       credited  to  ILT's Cayman  Islands bank                       account  in  the  approximate amount  of                       $4.5 million.             Since the  law presumes that a  corporate distribution comes             from "earnings  and profits,"  leaving the taxpayer  to show             the contrary, see Hagaman v. Commissioner, 958 F.2d 684, 695                           ___ _______    ____________             n.16  (6th Cir. 1992) (citing cases), were it true that $4.5             million  in "unidentified  amounts"  were (between  1981 and             1984)  "deposited  into  and/or  credited  to  ILT's  Cayman             Islands bank account," the law would simply presume that the                                         -9-                                          9             $2.159 million payment in  1984 was a "dividend."   (This is             so  because  $4.5  million  minus the  $2.159  million  loan             repayment would still  have left ILT with  $2.341 million in             "earnings and profits" -- enough to support a $2.159 million             dividend.)   And, the Lewises  would have to  pay taxes upon             that dividend income.                         Unfortunately  for  the  Commissioner, the  record             makes  clear that  it is  not true that  ILT had  some other                                       ___                          _____             significant  source  of  income.   The  1981-1984  ILT  bank             account deposits are fully explained; and,  ILT did not have             $4.5  million  in  "earnings and  profits,"  accumulated  or             otherwise.   The  Tax  Court's finding  to  the contrary  is             "clearly erroneous."   See, e.g., Hagaman,  958 F.2d at  690                                    ___  ____  _______             (Tax  Court's findings  accepted  on appeal  unless "clearly             erroneous").                       We  reach  this conclusion  because  Lewis himself             testified,  without contradiction,  that  ILT  had no  other                         _______ _____________             income.   He said  that ILT  was formed to  serve as  a tax-             saving entity for TNT's "local tour"  money (in other words,             that ILT was a sham corporation), that the transfers of that             "local tour" money constituted ILT's sole significant source                                                  ____             of "income,"  and that TNT did not transfer any money to ILT                                                         ___             after  1980.   Lewis's  testimony is  supported  by the  Tax                                         -10-                                          10             Court's own explanation of  the workings of the Lewis/Belkin             tax  avoidance plan, which fully accounts for the money that             ILT received.  Nothing in that explanation suggests that ILT             had some other source of income.                      _____                       Finally,  and  most  important,  the  Commissioner             introduced  into  evidence  (over the  Lewises's  objection)             ILT's 1981-1984 bank account records.  Those records confirm             that  ILT's  income  during  that  period  consisted  of  1)             interest  paid on  the Charlesgate  and Taunton  "loans," 2)             interest earned on the account balance, and 3) the return of             the  Charlesgate and Taunton "loan" principals in 1984.  (We             attach  that exhibit as an  Appendix here.)   The Lewises in             their brief go through each entry, showing how it falls into             one of  these three  categories (with  the exception  of two             bank  errors  --  a   deposit  notation  of  $1.415  million             (4/26/84), reversed the  same day, and a deposit notation of             $37,625 (5/25/84),  reversed about one month  later).  Their             explanation  is supported  by  the facts  that  1) the  bank             statement  shows large  deposits in  the very  "loan return"             amounts  that  the  Tax  Court  mentions,  2)  many  smaller             deposits refer  to "Mido"  or "Gran Compania,"  the entities             that  should have  paid ILT  interest on  the loans,  3) the             other   deposits,  totalling  roughly   $2.7  million,  bear                                         -11-                                          11             references of "from fixed [or 'call'] deposit," which is how             banks  sometimes  label  redeposits   from  interest-bearing             instruments,  and  4)  the  Lewises, in  their  amended  tax             returns for  1983 and 1984, described  the interest payments             as  "interest" and paid  taxes on them.   Not a  word in the             record, or in the Commissioner's brief, casts doubt upon the             Lewises's  explanation  of  the  record  of  ILT's   account             activity.                              To  understand the  Lewises's  explanation of  the             transfers  to, and redeposits from, certain interest-bearing             instruments  labelled "fixed" or  "call" "deposit," consider             the  following  hypothetical example.   Suppose  a depositor             instructs a bank to  take money from his account  and invest             it  in an  interest-bearing  instrument (contained,  or  not             contained, in a  separate interest-bearing account),  and to             "roll  over"  the  investment  from  time  to  time  as  the             interest-bearing instrument expires.  Suppose,  for example,             that  on January 1, John Smith deposits $10,000 in the local             bank,  along  with an  instruction  to invest  the  money in             Treasury Bills that  expire every three months and  that pay             an annual interest of 5%.  Smith's bank statement might look             something like this:                       Date      Deposit     Withdrawal      Balance                       ____      _______     __________      _______                                         -12-                                          12                       Jan 1     10,000                      10,000                       Jan 1                   10,000 (to                                                T'bills)      0                       March 31  10,125 (from                                 T'bills)                    10,125                       April 1                 10,000 (to                                                T'bills)      125                       June 30    10,125 (from                                                            T'bills)                    10,250                       July 1                  10,000 (to                                               T'bills)      250                                         -13-                                          13                       Sept 30   10,125 (from                                 T'bills)                    10,375                       Oct 1                   10,000 (to                                               T'bills)      375                       Dec 31    10,125 (from                                 T'bills)                    10,500             The Commissioner  might use this  kind of bank  statement as             evidence  that Smith had interest income of $500, or even as             evidence  that Smith had income of $10,500 (if the source of             the initial  $10,000 deposit  is  not otherwise  explained).             But, we  do not see how  the Commissioner -- or,  as in this             case, the  Tax Court --  could add up  all the  deposits and             then use this statement as evidence that Smith had income of             $50,500.  The statement shows the contrary.                         In our view, ILT's bank account, in respect to its             "fixed/call   deposit"   references,   is   that    of   our             hypothetical.  The Lewises say in their brief that the back-             and-forth  transfers of  money  between  ILT's  account  and             "fixed   [or   'call']   deposit"  represent   intra-account                                                            _____________             transfers  to  and  from  the  "checking"  and  "investment"             portions  of the  single  account.   This explanation  makes             sense  given  what  we  understand  about  standard  banking             activity  (i.e., "fixed  deposit"  may denote  a fixed-term,                        ____             interest-bearing  certificate of deposit, and "call deposit"             may denote an interest-bearing instrument, say an investment                                         -14-                                          14             in a money  market fund, which can be recalled  on demand of             the depositor).  Moreover,  nowhere does the government deny                                         _______             that these transfers of money were short-term investments of             the  kind  just  described.    In  essence,  the  government             concedes the point.                        The  government  argues  that the  Lewises  should             lose, even  if their  bank deposit explanation  is believed,             because  they did not  advance that  explanation at  the Tax             Court's initial  proceeding.   The Lewises did  advance that                                                        ___             explanation,  however,  in  a  motion  for  reconsideration,             immediately after they  saw what the Tax Court  had written.             One  can  meet a  burden  of  proof without  disproving,  in             advance,  all logical alternative  possibilities.   It seems             reasonable for them  not to have made an issue of the matter             earlier, and to have assumed that the government and the Tax             Court would read a bank deposit statement in accordance with             ordinary commercial banking practices.                       Of  course, one  might  wonder how  we  can be  so             certain  that the Lewises are right about the meaning of the             bank  deposit statement.   The  truthful  answer is  that we             cannot  be completely  certain, for  we are  not experts  in                        __________             banking  practices.    But,  the  Lewises's  explanation  is             plausible;  it  is  consistent  with what  we  know  of  the                                         -15-                                          15             commercial  world;  and, the  government  could easily  have             provided  a counter-explanation,  grounded in  accounting or             banking  principles, were  the Lewises's  explanation wrong.             The government failed even to advance a contrary argument.                         If  we put  the  matter in  terms  of "burdens  of             proof," the Lewises satisfied that burden, initially through             testimony that would have proved sufficient had  the IRS and             the Tax  Court read the bank deposit statement as reflecting             ordinary banking  activity; and,  then, through  a rehearing             motion with  a full, and uncontroverted,  explanation of the             statement.   If  we put  the matter  in practical  terms, we             recall Abraham Lincoln's famous question and reply.  Lincoln             asked his cabinet members, "How many legs would a sheep have             if you call a tail a leg?"  "Five," they answered.  "Wrong,"             said Lincoln, "the answer is four; calling a tail a leg does             not make it one."                        In sum, the record here shows that Lewis explained             the sources and amounts  of ILT's income at trial.   Nothing             in  the record  suggests that  his unrebutted  testimony was             "improbable,  unreasonable,  or  [even] questionable,"  such             that the Tax Court could choose to disregard it.  See Estate                                                               ___ ______             of DeNiro v. Commissioner, 746 F.2d 327, 331 (6th Cir. 1984)             _________    ____________                                         -16-                                          16             (citing Commissioner v.  Smith, 285  F.2d 91,  96 (5th  Cir.                     ____________     _____             1960)).  And, ILT's  bank statement supports that testimony.             ILT  did not  have  "unexplained  deposits  .  .  .  in  the                      ___             approximate amount of  $4.5 million."   Insofar as it  rests             upon this  factual error, the  Tax Court's finding  that ILT             had  "earnings and profits" in 1984  sufficient to support a             $2.159   million   "dividend"   distribution   is   "clearly             erroneous."                                          III                                Proceedings on Remand                                _____________________                       Our  conclusion  about  the  facts  of  this  case             returns it  to where we believe it  should have begun.  How,             for  tax purposes,  should one  characterize the  funds that             flowed to, and then through, ILT in 1984?                       Some  of those funds represent "interest" payments             to ILT.   The Lewises agree that they must pay income tax on             the 1984  distribution to the  extent that ILT  received any             such interest.   But, those  sums account for  only a  small             part  of the distribution.  The more important part consists             of ILT's receipt  and subsequent return to  Lewis and Belkin             (through their  "grantor" trusts)  of the $2.159  million in             sham loan proceeds.                                           -17-                                          17                       The Tax Court seemed  to find that this undisputed             transfer of  funds to  ILT reflected possible  ILT "earnings             and profits," for it said that                        Petitioners have  failed to  show .  . .                       how a transfer between  separate taxable                       entities,   i.e.,    a   transfer   from                       petitioner  and Belkin to ILT, would not                       be includable in ILT's taxable income or                       in ILT's earnings and profits.             But, the question at issue here is not factual; it is legal.                                                                   _____             The   Lewises  did   show,   and  indeed,   the  Tax   Court             acknowledged, what the transfer consisted of, as a matter of             fact.  It consisted of an effort by Lewis and Belkin to send             ____             themselves some money in  the manner described in Part  I of             this opinion, namely, by  repaying "loans" obtained from ILT             several years before, and  flowing the repayment through ILT             to  themselves (in the form of their "grantor" trusts).  The             Lewises  themselves  now concede  that the  original "loans"             were  shams.   They now dispute,  not the facts,  but how to             characterize them as a legal matter.  That is, they deny the             Commissioner's legal right to tax  in 1984 money that should             have been taxed earlier, in now-closed years.                         The  law  either does,  or  does  not, permit  the             government  to  tax this  money now.    The taxpayer  has no             greater  burden   of  "proving"   the  law  than   does  the             Commissioner, or, for that matter, the  courts.  Our problem                                         -18-                                          18             is that neither the  Tax Court, nor the  Commissioner, seems             thoroughly  to have considered a portion of the law that may             answer the legal question.  Our  own research has led us  to             conclude that  a type of estoppel known  as "quasi estoppel"             or the "duty of  consistency" might operate  in a way as  to                                           _____             prevent the Lewises from denying the taxability, in 1984, of             the  $1,062,500 distribution.    This "duty  of consistency"             prevents a taxpayer who  has already had the advantage  of a             past  misrepresentation -- in a year now closed to review by             the  government  --  from  changing  his  position  and,  by             claiming he should  have paid more tax before,  avoiding the             present  tax.  See Beltzer  v. United States,  495 F.2d 211,                            ___ _______     _____________             212-13 (8th Cir. 1974).                         The "duty of consistency"  seems to apply when the             earlier taxpayer position amounts to a misstatement of fact,             not of law.  See, e.g., Herrington v. Commissioner, 854 F.2d                          ___  ____  __________    ____________             755,  758  (5th  Cir.  1988), cert.  denied,  490  U.S. 1065                                           _____________             (1989); Beltzer,  495 F.2d at 213; Mayfair Minerals, Inc. v.                     _______                    ______________________             Commissioner,  456 F.2d  622, 623  (5th Cir.  1972); Crosley             ____________                                         _______             Corp. v. United States,  229 F.2d 376, 380 (6th  Cir. 1956);             _____    _____________             Ross  v. Commissioner,  169 F.2d  483, 496  (1st Cir.  1948)             _____________________             (simple failure  to report  income "is not  a representation             that such income  has in  fact not been  received" and  does                                         -19-                                          19             not, without more,  furnish grounds for  estoppel); Mertens,                                                                 _______             supra,    60.05  ("Where there is  a mistake  of law  and no             _____             factual misrepresentations, the doctrine of consistency does             not  apply.").   Moreover, the misstatement  must be  one on             which the government reasonably relied, in the sense that it             neither  knew, nor ought to  have known, the  true nature of             the  transaction  mischaracterized  by  the  taxpayer.   See                                                                      ___             Herrington, 854 F.2d at 758;  Mayfair Minerals, 456 F.2d  at             __________                    ________________             623; Ross, 169 F.2d at 495-96.                  ____                       In this  case, it  seems possible that  Lewis made             representations of key facts  regarding the genuine business             activities  of ILT  throughout  the 1970's  and the  genuine             intent  on his and Belkin's  part to repay  the ILT "loans."             If  such representations  of  fact were  made, then  holding             Lewis to them now might generate a 1984 tax liability.                       We stress,  however, that  we are uncertain  about             this  matter.  Since it has not  been argued here, and since             factual  history  is  at issue,  both  the  Lewises  and the             Commissioner  should have  a full  opportunity to  argue the             issue before the  Tax Court.   We therefore  vacate the  Tax             Court's  judgment insofar  as it  is inconsistent  with this             opinion.   And,  we remand  the case  to  the Tax  Court for             further proceedings.                                         -20-                                          20                       So ordered.                       __________             NOTE:  See Slip Opinion for Appendix.                                         -21-                                          21
