Attorney-at-Law

NO INVENTORY? NO FRAUD

In Uncategorized on 09/14/2015 at 20:27

IRS can’t muster clear and convincing proof that la famille Foote, hawkers of “…aircraft engines and engine parts for use in military vehicles, including helicopters, airplanes, and tanks,” were actual fraudsters.

The Footes ran an outfit called Transsuport, which “… primarily purchased surplus parts from the Government in bulk lots that contained parts having little value as well as parts that petitioner wanted for its business. Petitioner bought the lots to acquire items that it expected to sell but ended up with items that would not be sold. The costs of particular items were not specified as part of the purchase transactions.” 2015 T. C. Memo. 179, at p. 4.

Judge Cohen’s opinion may be found in Transupport, 2015 T. C. Memo. 179, filed 9/14/15.

A lot of what the Footes bought couldn’t be sold because obsolete or banged-up.

The Footes never bothered with inventory. IRS nailed the Footes for 10 years’ worth of deficiencies, but seven (count ‘em, seven) of those would be off the table because of SOL, unless fraud.

The Footes had their returns prepared by Elaine Thompson. “Thompson was a certified public accountant (C.P.A.), was a name partner in her firm, and was the first female president of the Connecticut Society of Certified Public Accountants.” 2015 T. C. Memo. 179, at p. 5.

Interesting that Ms. Thompson was a CT CPA when the Footes’ operations were in New Hampshire.

Anyway, her firm worked off the Footes’ handwritten summaries, audited nothing, and advised the Footes that inventory creates income. The Footes apparently took that to mean they shouldn’t do it.

And when the Footes wanted to flog their cash cow, they put out a private placement memo boasting of their huge profits, even when some of what they bought was unsaleable.

Nothing like buying stuff from the government at scrap prices and reselling it for a ton of money.

One of the flogees, apparently disgusted by this, dropped a Form 211 Whistleblower on the Ogden Sunseteers, and IRS descended upon the Footes.

IRS clearly and convincingly proves that the Footes overstated their cost of goods sold and understated their income and thus their taxes.

But where are the other badges of fraud, beloved the judges?

IRS responds with the Sierra Madre defense: “We don’t need no stinkin’ badges!”

“Respondent argues that fraud has been proven directly in this case and that, therefore, the Court need not rely upon the badges of fraud typically used to determine intent where direct proof of fraudulent intent is unavailable. See, e.g., Bradford v. Commissioner, 796 F.2d 303, 307 (9th Cir. 1986) (setting forth factors or “badges” of fraud), aff’g T.C. Memo. 1984-601. Respondent’s argument, however, rests on the assertion that petitioner realized a 75% gross profit on sales of surplus parts, as claimed by Foote who knowingly represented to petitioner’s tax preparer that the gross profit percentage was substantially less. Respondent relies heavily on the sales materials attributable to petitioner that boasted about the favorable tax results from writing off ‘the majority of inventory as purchased’. The Recast Financial Summary presented on petitioner’s behalf to prospective purchasers assumed a 75% profit on ‘general part sales’ and a nonobsolete inventory on hand exceeding $100 million cost.” 2015 T. C. Memo. 179, at pp. 18-19.

“The statements made orally and in writing to prospective purchasers of petitioner’s business by petitioner’s representatives are admissions of the taxpayer that may be considered as evidence. Such admissions are not conclusive, and they are not more likely to be truthful than any other uncorroborated statements of interested persons. In the context in which they were made, those boastful statements have no more guarantees of truthfulness than the tax return reporting. The attitude of petitioner’s officers was best expressed by W. Foote during his testimony about the Honeywell list: ‘Accuracy was not important. It’s a sales document. They can choose to accept it or not accept it, but it’s on them to come and actually verify what they think we have versus what we actually have.’” 2015 T. C. Memo. 179, at pp. 19-20.

“Although petitioner was required to and failed to keep inventory records, the nature of its business of acquiring surplus parts through bulk purchases and keeping them for years in the hope that many would ultimately be sold provides a plausible nonfraudulent explanation of those failures. Petitioner’s employees did not think that the effort to keep reliable inventories was worth the trouble. They were wrong, and this case should convince them otherwise. However, so far as the record reflects, neither the IRS agents conducting earlier exams nor petitioner’s accountant made clear the consequences of failing to do what they should have been doing. No adjustments were made or suggested during the early audits or the annual review by the accountant. So far as the record reflects, petitioner was not clearly advised to find a method to write off obsolete parts as a means of legitimately reducing the inventory value.” 2015 T. C. Memo. 179, at p. 21.

Besides, the Footes didn’t hide anything from IRS, contrary to what IRS’s counsel claims. They did come up with a lot of self-serving testimony. While the Court can kick self-serving testimony, to prove fraud, the testimony must be demonstrably false. And this wasn’t.

Not to forget there was their highly-credentialed accountant, who seems to have snowed the IRS examination team.

“Acquiescence in petitioner’s methodology by its well-credentialed C.P.A., which apparently satisfied successive IRS examiners, may well have lulled petitioner’s principals into thinking that what they were doing would pass muster for tax reporting purposes even if the economics of the business were better than reported. In this context, their open and puffing statements to prospective purchasers are reconcilable with their current explanations. There is no clear and convincing evidence to the contrary.” 2015 T. C. Memo. 179, at p. 23.

Though the evidence falls short of clear and convincing proof of fraud, the Footes are not exonerated thereby.

And IRS’s examination team gets a slap from Judge Cohen.

“The actions or inactions of petitioner’s accountants and the IRS auditors, however, included no clear warnings to petitioner that its conduct was illegal or fraudulent. To the extent that none of these professionals undertook the task of determining petitioner’s correct income, they were complicit in the duration of the improper reporting. This case is before the Court only because the IRS’ acquiescence in petitioner’s methodology ended when a whistleblower saw an opportunity for an informant’s reward.” 2015 T. C. Memo. 179, at p. 25.

Wanna bet what said whistleblower gets when the Ogden Sunseteers get through with him?

Anyway, the Footes are off the hook for the first seven years, but the next three are up for grabs.

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