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if possible what may be the errors, if any, which have been made in the case, whatever those errors may be. The examination of the case for the purpose of discovery of such errors as there may be, particularly such errors as may result unfavorably to the Government, is of great importance and is the initial procedure in each case which is undertaken. After the case has been so examined for the purpose of discovery of any errors which there might be, such issues as may have been raised by the taxpayer or the unit, or such new issues as may have been discovered, must then be considered, first with regard to the facts which have been established and, second, with regard to the provisions of the law relating to the facts and the decisions of the bureau and the decisions of the courts and the Board of Tax Appeals relating to such facts or issues. The evidence presented and accumulated in the progress of the audit of the case of the nature of those which are involved is usually very voluminous and requires considerable time for examination for the purposes which are above indicated.

PENAL DIVISION

The work of this division may be described as follows:

(1) Preparation of opinions advising the commissioner and the heads of the various units of the bureau as to liability for fraud, negligence, or delinquency penalties in cases where protests have been filed by taxpayers against proposed assessment of penalties by one of the accounting units or where an opinion as to assertion of penalties has been requested by any officer or unit of the bureau; (2) preparation for reference to United States attorneys for the purpose of prosecution of criminal cases arising under the internalrevenue laws or applicable provisions of the criminal laws of the United States; (3) assisting in such criminal prosecutions by furnishing evidence for grand jury and court proceedings, preparing indictments and briefs, and participating in arguments, trials, and appeals at the request of the Department of Justice or the United States attorneys; (4) preparation of opinions, letters of instructions, and answers to inquiries from local and field officers of the bureau regarding conduct of tax examinations, special investigations, and general matters relating to violations by taxpayers of Federal penal statutes; (5) recommending acceptance or rejection by the commissioner of offers in compromise made by taxpayers charged with civil penalties or violations of Federal penal statutes; and (6) consideration of claims for reward under section 3463 of the Revised Statutes.

When taxpayers protest against the proposed assertion of penalties, of whatever nature, it is the practice of the division to grant the taxpayers and their qualified representatives hearings, at which they are entitled to present evidence and arguments with briefs in support thereof. Written opinions are then prepared, in which are stated the pertinent facts, the law involved, and the conclusions reached, with the reasons therefor. These opinions, over the general counsel's signature, are sent to the appropriate bureau officer. If no hearing is requested or desired, cases are considered and decided upon the evidence in the respective files.

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There were 679 cases (without regard to tax years) pending in the division on June 30, 1927. These cases are classified for reference as (1) “interpretative cases" and (2) " law cases.

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These classifications are in turn grouped as (1) "income-tax cases" and

) (2) “miscellaneous tax cases.” The “interpretative cases” are those referred to the office of the general counsel by the unit for recommendation as to percentage penalties, for consideration as to whether criminal proceedings should be instituted, and for rulings on questions of law. “ Law cases” are those pending for consideration of compromise offers where penalties are involved, and cases in suit—that is, pending in the courts on indictments or otherwise. The “miscellaneous tax cases” are those involving special taxes, other than income taxes, such as estate taxes, gift taxes, tobacco taxes, admission and excise taxes. The following table shows the "interpretative incometax cases” for the years 1917 to 1926, inclusive, pending in the penal division June 30, 1927, classified by tax years, amounts,

and questions involved:

"Interpretative" income-tax cases pending in penal division on June 30, 1927

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The larger part of the “interpretative income-tax cases ” pending in the penal division were referred by the unit under the provisions of T. D. 3867 for recommendation as to whether 60-day letters should notify taxpayers the percentage penalty for fraud, negligence, or delinquency had been incurred. The rest of the cases, under the caption “Questions other than penalties," consist chiefly of cases referred for consideration of pure questions of law, or as to whether criminal proceedings should be instituted.

The following table shows the volume of work handled in the division during the past four fiscal years. The number of cases given are without regard to tax years or classification:

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ATTORNEY A

At this time I have on hand 34 cases, involving $13,766,101.14, which may be classified as follows: Criminal cases awaiting trial---Criminal case awaiting hearing on defendant's plea of immunity

1 Case pending court's decision---

1 Cases for presentation to court for order to produce books for examination. 2 Cases for consideration of criminal prosecution.--

4 For collection of taxes and penalties after conviction in a criminal prosecution--

1 Offers in compromise (four)

1 For consideration of fraud penalties.

16 Miscellaneous.

4

Number

Number

12

34 Amount involved. --'

$13, 766, 101, 14 The years and the number of case-years involved are as follows: Years

Years 1915 1 1922

21 19179 1923_

18 1918.

12 1924. 1919. 15 1925_

4 1920

29 1921. 21

142 The questions involved in the foregoing classification of cases, and the nature of the work in connection therewith, may be stated generally as follows:

Criminal cases awaiting trial (4).-In the four cases under this classification consideration was originally given to the advisability of instituting criminal proceedings. This involved a consideration of all the facts and circumstances in each case, the weight and admissibility of evidence available to the Government, the probability of successful prosecution, whether or not conviction of the taxpayers would have a salutary effect in their respective communities, and the general preliminary questions to be determined in connection with any criminal prosecution. Indictments were prepared and forwarded to the respective United States atttorneys, with letters outlining the issues, the law, and such further information as was deemed necessary to bring to the special attention of the United States attorney. The examining agents were instructed to submit to the United States attorneys the evidence they had developed and to cooperate in the preparation of the cases for trial by interviewing such additional witnesses as the United States attorneys deemed necessary, securing additional evidence, and to hold themselves in readiness to testify at the trial. Certified photostat copies of all documentary evidence were prepared and forwarded to the United States attorneys for use before the grand jury and at the trial. Since the indictments were returned, offers in compromise of both civil and criminal liabilities have been submitted by the defendants in each of the four cases. One of such offers has been considered and rejected, while the other three are still pending. Consideration of the acceptance or rejection of offers in compromise in this class of cases usually involves a reconsideration of the advisability of proceeding with the prosecution in

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· Three offers pending in criminal cases awaiting trial not included here.

the light of such additional information as may have been subse. quently developed by the agents, or submitted by defendant's counsel, The pending offers are awaiting results of further investigation by the field agents. In one of the cases the indictments as returned by the grand jury were found to be defective, and it was found necessary to obtain new indictments.

After cases are referred to the l'nited States attorner for prosecution and indictments have been returned, the attorney handling the case in this office must be in readiness to assist at the trial when called upon and to prepare the necessary briefs on preliminary motions and pleas and, in case of appeal, to prepare the appeal brief. It frequently happens that a criminal case is taken to the Supreme Court by writ of certiorari, in which case the brief in support of the application for the writ, and, when granted, the brief in support of the Government's case are prepared in this office in cooperation with the Department of Justice.

Criminal case awaiting further hearing on defendant's plea of immunity (1).-In this case the defendant has been indicted for filing a false and fraudulent income tax return and for perjury in connection therewith. The case involved all the preliminary consideration mentioned in the foregoing paragraph. The defendant filed demurrers and motions to quash the indictments, which were overruled and denied by the court. The defendant has now filed a “plea of immunity,” in which he claims immunity from prosecution on the ground that the evidence which enabled the Government to obtain the indictments was secured through the examination of his books and records, in violation of his rights with respect to unreasonable searches and seizures and compulsory self-incrimination under the fourth and fifth amendments to the Constitution. The United States attorney has moved the court to strike defendant's plea. Briefs were requested by the court and this office was called upon by the United States attorney to prepare the brief in support of the motion to strike. The issue raised by the plea involves the right of the Government to prosecute taxpayers for fraud where the evidence of such fraud has been discovered incidental to an examination of the taxpayer's books and records made for the purpose of verifying a return filed, or to discover his correct tax liability: The case is awaiting hearing on the plea and motion. The United States attorney has requested that the attorney handling the case in this office attend at such hearing and present the Government's case on the motion, and, if defendant's plea is dismissed, to assist at the trial of the case.

Case pending court's decision (1).- This case is a somewhat different phase of the same question raised by the defendant's plea in the preceding case. In this case the revenue agents were instructed to examine the taxpayer's books and records to verify returns filed by him. He refused to permit such examination on the ground that it might incriminate him. Revenue agents' subpænas were disregarded and application was thereafter made to the Federal district court for an order directing the defendant to produce his books and records for examination. The defendant moved the court to deny the Government's application and on argument the court's decision was withheld and briefs requested. Prior to the hearing, the United States attorney called upon this office for a memorandum brief, the

1

Reorganization.-Taxpayers were majority stockholders of a large corporation, some of their stock having been acquired prior to March 1, 1913, by purchase and by gift, and some acquired subsequent to that date by gift, purchase, and stock dividends. In a reorganization a second new corporation was created. Taxpayers sold their stock in the first corporation, receiving in exchange cash and stock of the new corporation. Complicated questions are presented involving the reorganization and computation of profits realized on the sale of stock, and as to what part of such profits may properly be ascribed to the period prior to March 1, 1913.

Dividends.-Five individuals are sole stockholders of corporation A. Corporation A owns all the stock of corporation B, and corporation B owns all the stock of corporation C. A and C sold coal lands for cash. After the sale, the assets of the corporations were almost wholly liquid. No dividends were declared. The five stockholders of corporation A, who were also directors, held the necessary meetings at which resolutions were adopted authorizing corporations A and C to loan a large amount of cash to the five individuals on demand notes. The loans were treated as dividends by the Income Tax Unit and additional taxes assessed accordingly. Taxpayers contend the transactions were bona fide loans, made with full legal formality. Whether or not the transactions were bona fide loans or taxable dividends is the question presented. If the transactions are held to be loans and not dividends, the case presents the further question whether or not corporation A should be assessed under section 220.

Liquidating dividends. -Whether or not the March 1, 1913, value of corporate assets distributed upon liquidation in 1919 was greater or less than the value at date of distribution. Whether the March 1, 1913, value is the correct basis for computing profit realized from the liquidation, or whether cost basis measured by original investment should be used.

Losses.-Whether or not a taxpayer may take a loss in the amount of the original purchase price of an oil royalty where dry holes were drilled around the property, condemning it for oil purposes, but where the taxpayer has not abandoned the lease or royalty contract.

Allowance of losses claimed on notes of two individuals who were insolvent at the close of 1920, the notes not being written off and no steps taken to enforce collection, and where the individuals voluntarily transferred to the taxpayer a lease or royalty interest considered by them to be worthless, but which subsequently became valuable and has not been abandoned by taxpayer,

Whether or not taxpayer operated a farm for profit or as a hobby and for pleasure; deductibility of losses sustained on the farm.

Income.-Whether or not an agent realizes taxable income, where he receives secret commissions on contracts let for his principal, it being conceded that the agent has only the bare legal title thereto and is subject to the contingent liability of reimbursing his principal if discovered.

Taxpayer and wife, in partnership, as tax consultants, owned contracts for services to clients. A new corporation was created and the contracts assigned to the corporation in exchange for paid-up stock. Aș, the fees became due they were paid to the corporation. The taxpayer and his wife reported no taxable income therefrom, nor did the corporation. The case presents the question of the taxability of this transaction and who is liable therefor.

Taxpayer as president of a corporation, and practically sole owner, made continued withdrawals therefrom over a period of years, no dividends ever being declared. His withdrawals were carried as accounts receivable by the corporation. A stock dividend was declared by which the president received stock approximately equal to his withdrawals. He returned this stock to the corporation in cancellation of his indebtedness and the stock was then retired by the corporation. The effect of the transaction was that the taxpayer received funds from the corporation which he failed to report. Taxpayer contends the return by him of stock to the corporation was a sale and that his profits therefrom, if any, should be measured by the value of the stock at the date of sale and the amount received therefor. Question, taxability of the transaction.

À TYPICAL MONTH'S WORK

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The month of April, 1927, was selected as the month to be used by each of the attorneys submitting this report in outlining the nature

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