Bow HERBERT and Nancy Herbert, Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Appellee, 377 F.2d 65

JERTBERG, Circuit Judge: Before us is a petition for review of a decision of the Tax Court involving asserted deficiencies in income tax against petitioners for the fiscal years ending September 30, 1958, September 30, 1959, and September 30, 1960, in the aggregate amount of $54,476.61. The petitioners, husband and wife, filed joint income tax returns for the fiscal years in question. The Commissioner asserted that petitioners understated their income in their income tax returns for each of said years.

On petition for redetermination by the Tax Court, that Court upheld the deficiency determination made by the Commissioner. Hereafter for convenience, petitioner, Bow Herbert, will be referred to as the taxpayer, and only incidental reference will hereafter be made to petitioner, Nancy Herbert. It appears from the record that during the tax years under review, and for several years prior thereto, there were two limited partnerships composed of the petitioners, as general partners, and in the case of the Gardena Club, Adam S. Campbell, Michael M.

Wind, Murray Klein and taxpayer as limited partners, and in the case of the Horseshoe Club, Ben Cohen, Michael M. Wind, and A. S. Campbell and taxpayer as limited partners. Each partnership owned and operated a draw poker parlor located in the City of Gardena, the operation of which was legal under the laws of the State of California and the ordinances of the City of Gardena, and each was duly licensed to so operate by the City of Gardena.

The taxpayer was the managing partner of both partnerships, which derived their income from the rental of seats to the general public at poker tables where legalized gambling was permitted. The partnership did not participate in the losses or winnings of the players. Additional income to each partnership was derived from the operation of restaurants and news stands on the premises, and from the sale of miscellaneous items. The limited partnership known as the Horseshoe Club was acquired by taxpayer and associates in 1951 and a successor limited partnership was formed in 1956.

The limited partnership known as the Gardena Club was acquired by taxpayer and associates in 1952, and a successor limited partnership was formed in 1955. Amended certificates of the formation of the two limited partnerships were signed, filed and recorded as required by the Uniform Limited Partnership Act of the State of California,

Section 15501 et seq., of the Corporations Code of the State of California.

Pertinent parts of the certificates of limited partnership reveal: That petitioners held 53% and that the other limited partners held 47% interest in the Horseshoe Club, and that each partner was entitled to receive profits of the partnership in accordance with his respective interest in the partnership; That petitioners held 62% and that the other limited partners held 38% interest in the Gardena Club, and that each partner was entitled to receive profits of the partnership in accordance with his respective interest in the partnership; That books of account be kept of all transactions of each partnership at the principal place of business of the partnership, and be at all times open for the inspection and examination of each partner; That monies of the Gardena Club were to be deposited in a bank account and that withdrawals from said account were to be made by check signed by one general partner and either one of two specified limited partners.

Taxpayer received salary from each club in the following amounts: Year Ended Horseshoe Gardena 9-30-58 $23,850.00 $20,605.00 9-30-59 $23,400.00 $20,280.00 9-30-60 $26,000.00 $10,920.00 During the tax years under review, and prior years, it was the practice of each partnership to deposit, periodically, partnership funds into an account designated “Bow Herbert, Personal Account”, maintained in the United California Bank, Crenshaw Branch.

Checks deposited to said account were drawn on the partnership bank account, and in the case of the Gardena Club were signed either by the taxpayer or an employee of the partnership and one of the designated limited partners; and in the case of the Horseshoe Club were signed by the taxpayer or an employee of the partnership. Such deposits were charged in the books of each partnership to the following accounts: The Horseshoe Club Other Expense Account Public Relations Account #418 The Gardena Club Other Expense Account Public Relations Account #674.

The “Bow Herbert, Personal Account” was segregated from the taxpayer’s other accounts and other personal financial affairs of the taxpayer. During the tax years in question there was deposited in the “Bow Herbert, Personal Account” the following amounts: Year Ended Horseshoe Club Gardena Club 9-30-58 $19,500.00 $13,000.00 9-30-59 $19,500.00 $13,000.00 9-30-60 $19,500.00 $ 5,000.00 Withdrawals from said account were made by checks prepared by club employees, signed by taxpayer, and drawn to cash in all except five instances.

Audit reports and periodic financial statements of both partnerships, reflecting deposits made by the pártnershipsto the “Bow Herbert, Personal Account”,, were distributed to the limited partners. The partnerships did not claim deductions in their tax returns for the deposits made by the partnerships into the-“Bow Herbert, Personal Account.” The amounts of said deposits were reported as income on the individual tax returns of the members of the partnerships.

During the years in question, and prior years, taxpayer made no accounting to the partnerships or to the limited partners with respect to the disbursement of funds from the “Bow Herbert, Personal Account.” The limited partnerships continued in existence until December 31, 1961, at which time an Amended Certificate of each limited partnership was signed, filed and recorded as required by law. Under the Amended Certificate of each limited partnership: 1. The limited partners became also general partners along with petitioners, who also remained limited partners; 2.

The new general partners acquired co-signing authority on all checks drawn against the partnership bank accounts; and 3. The taxpayer remained as the managing partner at a salary of $65.00 per day, seven days a week, in the Gardena Club, and $75.00 per day, seven days a week, from the Horseshoe Club.

Contemporaneously with the signing, filing and recording of the Amended Certificates, each of the limited partnerships entered into a written agreement with taxpayer whereby taxpayer was employed as managing general partner, to manage and conduct the business of the limited partnership, at the salaries specified in the certificates.

The agreement respecting the Gardena Club provides in paragraph 7 as follows: “7. (Public Relations Funds) Managing General Partner shall receive from the Limited Partnership the sum of SEVEN HUNDRED FIFTY DOLLARS ($750.00) per accounting period for public relations expenses of the Limited Partnership. (An accounting period shall be of not less than four (4) weeks’ duration). Such amount shall be a charge to the Limited Partnership as a cost of doing business and shall not be considered compensation to Managing General Partner.

Managing General Partner shall receive said public relations funds from the Limited Partnership for the purpose of disbursing said funds for and on behalf of the Limited Partnership for public relation purposes of the Limited Partnership, provided that, nothing to the contrary herein withstanding, Managing General Partner shall not be required by the Limited Partnership or any member thereof to account for the expenditure of such fund or funds.” Paragraph 7 of the 'Management Agreement relating to the Horseshoe Club is identical except that the amount specified therein is the sum of $1500.00 per accounting period.

The provisions of paragraph 7, except with respect to the amount of public relations expenses for each accounting period, are in conformity with the practices which prevailed during the years in question and prior years. The Amended Certificates of the limited partnerships of December 1961, and the Managing General Partner Agreements of that year were the products of a settlement of litigation instituted in 1959 in the state court by the limited partners against the taxpayer.

The litigation arose because of taxpayer’s refusal during the years in question, and prior years, to disclose to the limited! partners the identity of the recipients of money disbursed by taxpayer from the “Bow Herbert, Personal Account.” As-stated in the findings of the Tax Court: “The limited partners wanted to know where the money was spent.

Petitioner would not tell them and refused' to disclose the identity of the recipients.” Notwithstanding such disputes the record establishes that during the years in question and prior years the “public relations” accounts were maintained and disbursements therefrom were made solely by taxpayer without accounting to the limited partners as to the disposition thereof. In the deficiency assessment the Commissioner determined: “It has been determined that you [Mr.

Herbert and his wife] received income of $19,500 from the Horseshoe Chib, and $13,000 from the Gardena Club, partnerships, in each of the taxable years ended September 30, 1958, September 30, 1959, and September 30, 1960, purportedly for use as partnership promotional expenses. The total amount of $32,500 represents income under the provisions of

section 61 of the Internal Revenue Code, and no part of it is deductible since you have failed to establish that any of the amounts were expended and are deductible under the provisions of the Code.” By stipulation filed in the Tax Court proceedings, it was stipulated that the amount deposited by the Gardena Club to the “Bow Herbert, Personal Account” for the year ended September 30, 1960, was the sum of $5,000 instead of the sum of $13,000, as set forth in the Commissioner’s determination.

The only issue presented to the Tax Court for redetermination under the pleadings filed by the parties was whether petitioners received income in the amounts deposited by the partnerships in the “Bow Herbert, Personal Account” in the years in question. The taxpayer made no claim in the petition filed with the Tax Court that he was entitled to an offsetting deduction in respect to any part of the partnership’s funds deposited in said account.

The Tax Court sustained the Commissioner’s determination “that the ‘Public Relations’ money received by petitioner was taxable income to petitioner in the years of the controversy, and that no part thereof is deductible as an ordinary and necessary business expense.” The “ultimate findings” made by the Tax Court are: “1. Petitioner failed to prove that the amounts he received in the form of cash, denominated as ‘public relations’ money, was not an item of taxable income during the fiscal years ended September 30, 1958, 1959, and 1960. “2.

Petitioner failed to prove that the ‘public relations’ money he received during the years in issue was expended for tax deductible purposes.” The general rule is that the burden of proof is on the Commissioner to establish that the taxpayer received income. However, the Commissioner’s determination of a deficiency satisfies such burden since the determination made by the Commissioner is presumptively correct. The taxpayer then has the burden of overcoming this presumption by a preponderance of the evidence. American Pipe and Steel Corp. v.

Commissioner of Internal Revenue, 243 F.2d 125 (9th Cir.), cert. denied, 355 U.S. 906, 78 S.Ct. 333, 2 L.Ed.2d 261 (1957). When the taxpayer has overcome the presumption by competent and relevant evidence, the presumption disappears and drops out of the case. J. M. Perry & Co., Inc. v. Commissioner of Internal Revenue, 120 F.2d 123, 124 (9th Cir. 1941); Clark v. Commissioner of Internal Revenue, 266 F.2d 698, 706 (9th Cir. 1959); Cohen v. Commissioner of Internal Revenue, 266 F.2d 5 (9th Cir. 1959); Hemphill Schools, Inc. v. Commissioner of Internal Revenue, 137 F.2d 961 (9th Cir. 1943).

The above authorities and the cases therein cited support the rule that the Commissioner and not the taxpayer then has the burden of proving whether any deficiency exists, and if so, the amount. It is not incumbent upon the taxpayer under these circumstances to prove that he owed no tax, or the amount of the tax which he did owe.

In the instant case relevant and competent evidence received on behalf of ( petitioners establishes that the checks deposited in the “Bow Herbert, Personal Account” were drawn on bank accounts belonging to and standing in the names of the partnerships, and, as found by the Tax Court, were paid to taxpayer “as general managing partner”.

There is not a scintilla of evidence in the record which tends to prove, or from which it may be reasonably inferred, that taxpayer was to receive as income from either partnership any amounts other than his salary and the amount of his percentage interest in the profits of the partnership. The evidence is clear and uncontradicted that the funds of the partnerships, deposited in said account, were partnership funds and that withdrawals from said account by taxpayer remained partnership funds in his hands.

In our view such testimony on behalf of the taxpayer overcame the presumption arising from the Commissioner’s determination that the taxpayer received income from the two clubs during the years in question in the amounts specified in the deficiency assessment made by the Commissioner. . Any use of said funds by taxpayer for other than partnership purposes would constitute the crime of embezzlement by taxpayer of funds belonging to the partnerships, and would be contrary to the terms of the certificates of partnership.

The Commissioner made no contention in the Tax Court, and makes no contention before us, that the partnerships were sham and used by taxpayer for the purpose of defrauding the government of taxes to which it is entitled. In other words, the bona fides of the partnerships is not questioned by the Commissioner or by the Tax Court.

The facts upon which we base our determination that the evidence offered by the taxpayer overcame the presumption of correctness arising from the Commissioner’s determination is made without any reference to any testimony of the taxpayer which the Tax Court characterized as “incredible.” The presumption of correctness having disappeared from the case, the burden of proof that taxpayer received income from the two clubs in the years in question was upon the Commissioner and the ultimate redetermination by the Tax Court was required to be made on all of the evidence in the record, unaided by the presumption, and be supported by substantial evidence.

See cases cited supra, and Kaufman v. Commissioner of Internal Revenue, 372 F.2d 789 (4th Cir. 1966). Our final task is to determine whether or not the Commissioner sustained the burden of proof which was upon him to establish that the taxpayer received as income from either of the two clubs, in the years in question, any part of the amounts deposited in the “Bow Herbert, Personal Account”, and whether or not the redetermination by the Tax Court is supported by substantial evidence.

Such determination by us must be based solely upon the relevant and competent evidence produced by the taxpayer and the Commissioner. We have carefully examined all of the evidence appearing in the record. We believe it is unnecessary to further review the same here because our examination compels us to agree with the statement appearing in the opinion of the Tax Court that “the record contains no evidence that petitioner personally profited by an increase in assets or a decrease in liabilities, * * It is further stated in the Tax Court opinion: “The money came into petitioner’s hands.

Once it got there the only way he could avoid paying income tax on it was to prove that he was entitled to an offsetting deduction by substantiating his expenditure of the money as an ordinary and necessary business expense. This he has failed to do.” And “The failure to trace cash into assets, a burden which the respondent does not have here, does not show that the petitioner had no income. For all we know he may have spent the cash for his personal benefit.” The burden of proof was not upon the taxpayer to show that he had no income.

The burden was upon the Commissioner to establish that the taxpayer received the money as income. It appears to us that the Tax Court has confused the burden of establishing receipt of income with the burden of supporting allowable deductions from income. In the former case the burden is on the Commissioner, and in the latter case the burden is upon the taxpayer. As previously noted, the taxpayer made no claim before the Tax Court that he was entitled to an offsetting deduction in respect to any part of the partnership funds deposited in said account. Such was not an issue in the Tax Court proceedings.

The injudicious statement of the Tax Court that: “For all we know he may have spent the money for his personal benefit” cannot be substituted for competent and relevant evidence. Such statement cannot be based upon other than sheer suspicion, conjecture and speculation.

The same vice appears in the “ultimate findings” made by the Tax Court, quoted supra, in which it is stated that the petitioner failed to prove that the amounts he received in cash, denominated as “public relations” money was not an item of taxable income and that petitioner failed to prove that the “public relations” money he received during the years in issue was expended for tax-deductible purposes.

In our view the Tax Court erred in placing the burden of proof on the taxpayer to establish that he had no income instead of placing upon the Commissioner, where it belonged, the burden of establishing that petitioner realized income. We entertain the definite and firm conviction that a mistake has been made and the Court’s findings of ultimate fact are clearly erroneous. United States v. United States Gypsum Co., 333 U.S. 364, 395, 68 S.Ct. 525, 92 L.Ed. 746 (1948). The decision of the Tax Court is reversed. .

The facts of this case are significantly distinguishable from the facts in cases relied upon by the Commissioner, which he states support the proposition that when funds are subject to taxpayer’s sole use, dominion and control, such amounts ' must be attributed as income to the person receiving them. The cases cited are Helvering v. Horst, 311 U.S. 112, 119, 61 S. Ct. 144, 85 L.Ed. 75; Helvering v. Clifford, 309 U.S. 331, 60 S.Ct. 554, 84 L.Ed. 788; Shaw Construction Co. v. Commissioner of Internal Revenue, 323 F.2d 316 (9th Cir. 1963) ; Kuney v. Frank, 308 F.2d 719 (9th Cir. 1962).