On Appeal from the United States District Court for the District of New Jersey (D.C. No. 82-0154).
Seitz, Hutchinson, and Garth, Circuit Judges.
Appellant Resyn Corporation appeals (at 87-5134) from an order of the United States District Court for the District of New Jersey, essentially affirming an order of the United States Bankruptcy Court. The district court's order awarded the government judgment for income tax deficiencies for the years 1963 through 1969 in the net amount (after payment of $452,346) of $180,789, plus pre-petition interest on the tax deficiencies in the amount of $278,018. The district court's order also awarded judgment for post-petition fraud penalties of $571,574. The district court, however, denied the government post-petition interest on the fraud penalties in the amount of $420,546. Resyn appeals from the order affirming the tax deficiencies awarded to the government; the government appeals (at 87-5162) from the denial of post-petition interest on the fraud penalties.
We have reviewed Resyn's arguments with respect to its appeal and are satisfied that the district court properly affirmed the bankruptcy court in upholding the government's position with respect to Resyn's tax deficiencies. However, we have determined that the district court erred in denying the government post-petition interest on the fraud penalties from the date of assessment, notice and demand.
We will thus affirm the district court's order with respect to Resyn's appeal but will reverse and remand with respect to the government's cross-appeal.
This case arises out of bankruptcy proceedings initiated by Resyn, a New Jersey Corporation engaged in the purchase, manufacture, and sale of resins and other chemicals and oils used to manufacture paint supplies. From 1963 until the filing of its Chapter XI petition on September 3, 1970, Resyn was owned and operated by its president, and sole shareholder, Leo Levitt ("Levitt").
Between November 1971 and February 1973, the Internal Revenue Service filed proofs of claim against Resyn for corporate income tax deficiencies and assessed Resyn for 50% penalties for tax fraud that occurred during the six year period from 1963 to 1969. In 1977, Resyn and the IRS entered into an agreement whereby taxes of $416,409.04, exclusive of penalties, for the years 1968 through 1970, would become payable when Resyn's plan of arrangement was confirmed by the bankruptcy court. The agreement also placed a cap of $1,183,590.96 on Resyn's potential tax liability for the years 1963 through 1970. The agreement also provided that Resyn could contest this latter assessment for unpaid taxes and penalties.
In November 1981, following a six-day trial, the bankruptcy court allowed the deficiencies claimed by the government and held that Resyn had committed tax fraud during the years 1963 through 1970. The fraud was perpetrated by Levitt, Resyn's president, and was designed to shield and conceal income that would otherwise have been subjected to corporate income taxes.
In its November 22, 1982 opinion, the district court described Levitt's scheme as follows:
Levitt's scheme involved the establishment of two fictitious companies: Polymer Chemicals and Chemical Traders. Bank accounts were opened for both companies. Harry Levenson, a public accountant employed by Resyn, was the authorized signatory for the Polymer Chemicals account. Leo Levitt was the signatory for the Chemical Traders account. Chemical Traders was supposedly established to buy, sell and trade chemicals. Its actual function, however, was to ultimately divert income belonging to Resyn into the possession of Leo Levitt. Under the scheme, Resyn's customers would be billed on Chemical Trader's invoices. On the invoices, instructions were given to customers to remit payment to the home of Leo Levitt. Through this facet of the scheme, a substantial amount of revenue earned by Resyn went unreported.
Another facet of the scheme involved the diversion of rebates. In the chemical industry, discounts are often given to bulk purchasers. Resyn often purchased large volumes of chemicals and thereby earned substantial discounts. Instead of forwarding the rebate check directly to Resyn, companies were instructed to make checks payable to Chemical Traders and to send the checks to Levitt's home. These checks were deposited by Levitt in the Chemical Traders account, over which Levitt had control. Through this facet of the scheme, Levitt was again able to unlawfully divert monies owed to Resyn away from the company.
There was yet a third facet to Levitt's scheme. Polymer Chemicals was purportedly established as a chemical supply company. In fact, however, the company was non-existent. Invoices were printed with Polymer's name and were submitted to Resyn for payment. Resyn paid the bills to Polymer and the monies were deposited in Polymer's account. Levitt then had Resyn's accountant, Harry Levenson, who was the signatory of the account, draw checks in blank. These checks were completed by Levitt and the funds were withdrawn by him from the account. Through this device Resyn artificially increased its costs of goods sold and thereby reduced reported income.
In determining how much income had been unlawfully diverted by Levitt, the government did not have available to it the records of the Resyn Corporation. These records had disappeared without explanation. Therefore, to compute the amount of income which had not been reported, all deposits made to the Chemical Traders account were added together and were treated as unreported income on which taxes were owed. In addition, the negotiated checks of the Polymer Chemicals were added together to reduce the cost of goods sold and to increase the amount of unreported income.
On appeal, the district court affirmed the bankruptcy court's findings of fact on the basis that they were not clearly erroneous.*fn1
In October 1986, the district court entered an order awarding the government tax deficiencies, pre- and post-petition interest on those deficiencies, fraud penalties and interest on those penalties running from the date of the bankruptcy court's judgment. The district court, however, denied interest on the fraud penalties from the date of assessment, notice and demand. On a motion for reconsideration of its order, the government moved to have the district court modify its order so that the interest on the fraud penalty would begin to run as of the date of assessment, notice and demand. This motion was denied by the district court's order of January 25, 1987. Both parties now appeal aspects of the district court's orders of October 16, 1986 and January 25, 1987.
We turn first to Resyn's appeal. The government's deficiency assessment ordinarily is afforded a presumption of correctness, thus placing the burden of producing evidence to rebut that presumption squarely on the taxpayer. Helvering v. Taylor, 293 U.S. 507, 79 L. Ed. 623, 55 S. Ct. 287 (1935); Anastasato v. Commissioner, 794 F.2d 884, 886 (3d Cir. 1986). Resyn first argues that the method of computation adopted by the I.R.S. in determining Resyn's tax deficiencies was arbitrary and clearly erroneous. The burden of proving that an assessment is arbitrary and excessive rests on the taxpayer; if the taxpayer cannot prove that the assessment was arbitrary, it retains the burden of overcoming the presumption in favor of the government that the assessment was not erroneous. Demkowicz v. Commissioner, 551 F.2d 929 (3d Cir. 1977); Gerardo v. C.I.R., 552 F.2d 549, 552-53 (3d Cir. 1977).
However, once the taxpayer has sustained its burden of proving that the assessment is arbitrary and excessive, i.e., that it lacks a rational foundation in fact and is based upon unsupported assertions, the ultimate burden of proving that the assessment is indeed correct is placed on the government. Baird v. Commissioner, 438 F.2d 490, 492 (3d Cir. 1971). Thus in this case Resyn, claiming that the assessment was arbitrary and excessive, argues that it is the government that bears the burden of proving that its assessment was correct.
A. Was the Assessment Arbitrary?
Resyn contends that the deficiencies assessed in this case were arbitrary and excessive because the I.R.S. agent who computed the deficiency utilized the wrong computational method. Thus, Resyn maintains that no presumption arises in favor of the Commissioner. The government responds by arguing that Resyn failed to make any showing that the assessment was arbitrary and excessive and that therefore, the burden was properly placed on Resyn to prove that the assessment was inaccurate. We agree.
Resyn did not dispute that it was involved in a scheme to create an impression of lower revenue earning during the years 1963 through 1969. See App. at 731. Moreover, the checks that were deposited in Chemical Trader's account and the Resyn checks that were deposited in the Polymer account provide a means of calculating the amount of money illegally diverted from Resyn's gross income. The government thus contends that the burden was properly placed on Resyn to prove that the assessment was inaccurate and that Resyn failed to meet its burden, which could only be met by Resyn demonstrating the correct amount of tax actually owed.
The district court found that Resyn had failed to show that the government's assessment was arbitrary and excessive. In so finding, the district court relied heavily on the fact that Levitt, who was the only person in a position to disclose the true nature and purpose of the various inter-company transactions, did not testify. On the basis of our review of the evidence, this finding is not clearly erroneous.
B. Has Resyn Met Its Burden of Showing that the Deficiency was Erroneous?
Given Resyn's failure to demonstrate that the government's assessment was arbitrary, Resyn retains the burden of demonstrating that the deficiency was incorrect. In order to have made such a showing in the district court, Resyn would have had to produce "credible and relevant evidence sufficient to establish that the determination was erroneous." Anastasato, 794 F.2d at 887. Resyn did not do so. In particular, Resyn, in order to sustain its contention, sought to prove that: (a) the method used to compute the deficiency was flawed because it did not account for certain "redeposits" from the Chemical Traders' account into Resyn's account; (b) the accounting was not conducted on an accrual basis; (c) the government failed to credit ...