The Colony, Inc. v. Commissioner

PETITIONER:The Colony, Inc.
RESPONDENT:Commissioner
LOCATION:Wolverine Tube, Inc.

DOCKET NO.: 306
DECIDED BY: Warren Court (1957-1958)
LOWER COURT: United States Court of Appeals for the Sixth Circuit

CITATION: 357 US 28 (1958)
ARGUED: Apr 03, 1958
DECIDED: Jun 09, 1958

Facts of the case

Question

Audio Transcription for Oral Argument – April 03, 1958 in The Colony, Inc. v. Commissioner

Earl Warren:

Number 306, The Colony, Incorporated, Petitioner, versus Commissioner of Internal Revenue.

Mr. Doll, you may proceed.

A. Robert Doll:

Mr. Chief Justice, may it please the Court.

This is an income tax case rising under the Internal Revenue Code of 1939.

Specifically, the question in this case involves the statutory construction of Section 275 (c) of the 1939 Code.

Generally speaking, the Internal Revenue Service must assess tax deficiencies or taxes within three years after a tax return is filed.

There are certain exceptions including fraudulent returns and where no return is filed, where there’s no statute.

There’s the so-called five-year statute which is the one we’re dealing with.

That section provides that if a taxpayer omits from gross income, amounts properly includable therein in excess of 25% of the gross income stated in the return then the Commissioner has five years instead of three to make the assessment.

The taxpayer’s construction of that statute is that omits from gross income means leaving out items of receipt.

The Government on the other hand contends that where — wherever a taxpayer’s gross income is understated in a statutory amount regardless of the cause of the understatement, the five-year statute applies.

In terms of volume, I think perhaps the petitioner has a better side of the case.

This issue of course has been up in the lower courts and the Courts of Appeal for the Third, Fifth, Ninth and Eighth Circuits have construed the statute the way that the taxpayer here is contending.

On the other hand, the Tax Court and the Court of Appeals for the Sixth Circuit are construed as the respondent without having construed.

I think that the facts in this case point up the issue, the material facts and they are the — this taxpayer was in the subdivision business subdividing the land.

He did not build but he subdivide it.

During the years in question, he reported all of his gross receipts from a sale of his lots but he over reported the cost of his lot sold.

He overstated them.

The principal item of overstatement was the cost of a water supply system which he had allocated certain amounts to that cost to each lot that was sold.

The Tax Court held on the merits that he’d overstated the cost and I might point out that they went at some length, I think, they had to distinguish a earlier decision of theirs to decide against the taxpayer on the merits.

As you can see —

Delivered — delivered overstated (Inaudible)

A. Robert Doll:

No, sir.

It was not.

It was — as I pointed out in my brief and the Government made reference to it, this was an innocent overstatement that had a reasonable basis.

Now, the Tax Court held as a — has held in the past that in this case where the overstatement of the cost to good sold resulted in an understated gross income and — that overstated offset item resulting in an understated gross income that there was no omission.

The Court of Appeals for the Sixth Circuit affirm citing an earlier decision of this it — of its own.

I think, however, at least we feel that in its opinion, which is very short, the Sixth Circuit perhaps indicated that it had misgivings because it eluded favorably, we think, to the contrary decisions in the Courts of Appeal for the Third, Fifth, Ninth and Eighth Circuits.

The reasons why the petitioner thinks that it is right are as follows.

As I’ve said, our position is that omits from gross income means leaves out items of receipt.

A. Robert Doll:

First of all, the statutory language itself, the verb in the statute is the word “omits.”

The ordinary and normal meaning of that verb according to the dictionary is to leave out to — not to mention the fail to include or insert.

Secondly, going to the legislative history, we feel that that — that that also supports this.

I might, if I may, take you back to when this was put in to the — the code.

It was in the Revenue Act of 1934.

In the Revenue Act of 1932, the — the statute of limitations, they’re set out with a normal three-year statute and then they switched over to no statutes of — no statute of limitations in the case of fraudulent returns and no returns.

In the Revenue Act of 1934, when this Section 275 (c) was first proposed, there was an unlimited statute of limitations.

We feel that the legislative history shows that what Congress had in mind was to catch situations that were, to certain extent, similar to a fraudulent return or filing no return at all.

They — there was no statute of limitations.

But going to the committee reports themselves, if I may just briefly and I’m looking at page 14 of the petitioner’s brief.

In the — the first pertinent bit of legislative history was a House subcommittee report starting in the — at the second paragraph.

“Your subcommittee is of the opinion that the limitation period on assessment should also not apply to certain cases where the taxpayer has understated his gross income on his return by a large amount, even though fraud with intent to evade tax cannot be established.

It is, therefore, recommended that the statute of limitations shall not apply where the taxpayer has failed to disclose in his return an amount of gross income in excess of 25% of the amount of gross income stated in the return.

The Government should not be penalized where a taxpayer is so negligent as to leave out items of such magnitude from his return.”

Following this subcommittee report, there was a hearing that was held before the full House committee and at that time, Mr. Roswell Magill was with the Treasury Department and he had a — a discussion which is set out on page 15 of the petitioner’s brief with — with Congressman Jerry Cooper of Tennessee.

Now if I may just prefer to the first question and answer, “Mr. Cooper, what we really had in mind was just this kind of a situation.

Assume that a taxpayer left out, say, a million dollars, he just forgot it.

We felt that whenever we found that he did that we ought to get the money on it, the tax on it.”

Following the — this hearing, the House Committee adopted a report also providing for an unlimited period for assessment and their report which is similar to the one I read, the — the subcommittee report is on page — well, 16 and also the Senate Finance Committee report.

Now, we feel that when you take the — the ordinary meaning of the statute and when you go to the legislative history that is clear that — that what Congress was really concerned with was leaving out items of receipt.

After all that — that is what you put in the tax return.

Now, in this case where we have an understatement of gross income that results from — from an inflated item, there’s nothing left out of this return, there’s too much put in.

And from a logical standpoint, I don’t think Congress was — was aiming at that.

For example, when you take your gross income, there is — there are deductions from gross income.

In other words, Section 23 of the 1939 Code permits rent and so forth to be deducted from gross income to get your net income.

Well, quite obviously, the statute would not apply regardless of how far overstated these rent items or salary or what have you, these deductible items.

Now, we feel that those items, those overstated items where there are errors resulting from a — from an overstatement below the gross income line that are clearly not — will not bring a statute into play.

The Congress didn’t — didn’t have in mind that an error above the gross income line and the cost of good sold that — that they weren’t really concerned with that type of an error.

They — they were concerned with left out items.

And I — I think that perhaps the reason for that — there’s a reason for that.

A. Robert Doll:

In the case of overstated deductions, as well as overstated cost of good sold, that figures on the tax return.

To get the benefit from that figure, you’ve got to claim it on the tax return.

Well, the revenue agents, they don’t have the same problems of trying to discover where the error is.

It’s on the return and they can just verify it from — from what’s already there.

You say this is sort of a mathematical error.

A. Robert Doll:

That’s right.

That’s — that’s what the — the Court of Appeals for the Third Circuit in the Uptegrove case found that that was a mathematical error that Congress was not concerned with that type of an error.

They were concerned with leaving out.

Charles E. Whittaker:

Wasn’t that what was held in the Goodenow case also?

A. Robert Doll:

I beg your pardon, sir.

Charles E. Whittaker:

Is not that the same as was held in the Goodenow case in the Eighth Circuit?

A. Robert Doll:

That is correct.

Yes, sir.

The opinions that have construed the statute as we’re now urging or — it’s — the — there’s the Uptegrove case in the Third Circuit, which was the first case decided and that is exactly the same on the facts to this case.

That was a cost of good sold case.

The Court, the Third Circuit then decided the Deakman-Wells case where a taxpayer showed his gross receipts on a schedule attached to his return but then subtracted items from it to convert itself to a — a cash basis.

The — the next decision was — I think was the Goodenow case in the Eighth Circuit and Slaff versus the Commissioner, which was the Ninth Circuit case and Davis v. Hightower, a Fifth Circuit case.

All those cases adopt this construction.

There’s one further point that I would like to mention — mention the — the statutory language, the legislative history and what we think is the logic of the interpretation.

In 1954, Congress enacted Section 6501 — 6501(e) (1) (A), which is the successor to Section 275 (c) of the 1939 Code.

In — and I’m looking at page 23 of the petitioner’s brief, the footnote sets forth the new — the new law.

Under A, the general rule, Congress adopted precisely the same language that was contained in Section 275 (c).

It made two changes, which aren’t — which are not material, but they adopted substantially the same language.

If the taxpayer omits from gross income an amount properly includible therein, then for purposes of this subparagraph, they go down to subsection (i).

In the case of a trade or business, the term “gross income” means the total of the amounts received from sale of goods or services prior to diminution by the cost of such sales.

In other words, in that subsection (i), Congress is essentially adopting the — the construction we urge in this case.

The Government has contended that Congress changed the law in 1954.

We admit that the law was changed to the extent that they started out with the old law and then they added new language.

The purpose of that new language, we think, was obviously to approve the prior construction.

They agreed with it and we think it was to explain it and to clarify and to say what the proper construction of the predecessor section was.

A. Robert Doll:

In the committee reports that I referred to, there are in each of those reports, statements of a general nature to the effect and they start out the reports on that thing and I’m looking at page 14, the House Subcommittee report.

“Your subcommittee is of the opinion that the limitation period on assessment should — should also not apply to certain cases where the taxpayer has understated his gross income on his return.”

The respondent attaches great significance to the use of the word “understatement” there.

The Court of Appeals for the Third Circuit held and we think quite correctly that that was of a general introductory nature that after that language in each of the committee reports, Congress wants a specific example of — of what they were thinking about.

The next sentence, for example, “It is, therefore, recommended that — that statute of limitations shall not apply where the taxpayer has failed to disclose in his return an amount of gross income in excess of 25% of the gross income stated in the return.

The Government should not be penalized where a taxpayer is so negligent as to leave out items.”

In conclusion, we think that the common sense reading the statute is confirmed by the legislative history and the logical approach is to show that that — that the only way — what Congress really intended was to give the taxpayer two extra years.

He’s already — the — the Commissioner already has three years, that he was to have two more years where a — items of receipt were left out of the return, the computation of gross income.

Thank you.

Earl Warren:

Mr. Goetten, you may proceed.

Joseph F. Goetten:

Mr. Chief Justice, may it please the Court.

We agree that the single issue in this case is whether the general three-year statute of limitations bars assessment and collection of tax deficiencies admittedly due, as the taxpayer contends or whether if the courts below held the five-year statute of limitations applies.

The important facts are not disputed.

The taxpayer corporation in this case understated its gain from sales of property by more than 25% of the amount reported as gross income in its return.

Could you explain what the — without too much technicality, what the understatement was of the basis or —

Joseph F. Goetten:

Yes.

— or your statement of the basis.

Joseph F. Goetten:

In the main part, it consisted of allocating to the various lots sold a portion of the cost of a waterworks that the taxpayer had constructed to furnish water to these various residential lots it was selling.

The difficulty with the taxpayer adding that to the cost basis of the lots was that the taxpayer did not transfer that to the purchasers of the lots or to a — a nonprofit corporation to hold it for them.

The taxpayer retained title to the waterworks and sold the water to the lots that was there were not included.

Charles E. Whittaker:

But he had spent the money for the waterworks, which he did a portion in this return among the several lots.

Joseph F. Goetten:

That’s right, Your Honor.

He did a portion wrongfully because he kept title that was still his waterworks.

Charles E. Whittaker:

Were there any facts concealed?

He just allocated a certain portion of the waterworks, the title to which he kept to these lots used erroneously as the information there.

Joseph F. Goetten:

Well, I think it’s conceded for purposes of this case, erroneously.

Charles E. Whittaker:

It was erroneous.

Joseph F. Goetten:

Yes, Your Honor.

Charles E. Whittaker:

Yes.

He committed all the lots.

Joseph F. Goetten:

Well, he sold the lots in three different years, Your Honor.

Two years —

(Inaudible)

Joseph F. Goetten:

Yes, he allocated — he sold some of the lots in the two years before the Court at this time, 19 fiscal years ending at 1946 and 1947, and then he sold some in 1950.

He allocated the total cost of the waterworks to the various lots as sold, a proportionate part.

Now this understatement of gain here resulted from overstating the cost or adjusted basis of the lot sold.

And accordingly, part of the gain from the sales of the lots was not correctly shown as gain, but was erroneously shown as a return of capital investment in the property.

Now the statute to be construed in this case is set forth at pages 3 to 4 of the Government’s brief.

It’s very short and very simple, Section 275 (c) of the Internal Revenue Code of 1939.

It provides that the Commissioner will have five years after a return is filed within which to assess or collect deficiencies.

“If the taxpayer omits from gross income an amount properly includible therein which is in excess of 25 per centum of the amount of gross income stated in the return.”

Now, taxpayer would emphasize the world “omits” in that statute, but the word “omits” standing alone is meaningless.

It immediately suggest the questions “omits what from what?”

And the statute supplies the answer.

It says omits from gross income an amount properly includible therein.

Now, gross income is a term of art.

It’s defined by statute.

So defined, it expressly includes gains from the sales of property.

Gain from the sale of property in turn is also defined by statute as the excess of the sales proceeds or amount realized over the cost or adjusted basis of the property sold.

Applying these statutory definitions here gain from the sale of property is “properly includible” and “gross income.”

Total sales proceeds or total receipts are not properly includible.

Accordingly on the plain language of the statute, an omission from gross income of a part of the gain from the sales of property is an omission of an amount properly includible therein.

William O. Douglas:

Well, how far does that take — take us suppose that I properly report my — my salary?

But I improperly claim exemptions and deductions so that the — that the taxable income is reported inaccurately by more than 25%.

Joseph F. Goetten:

That would not be an understatement of gross income within the meaning of the statute.

William O. Douglas:

Would not.

Joseph F. Goetten:

It would not, Your Honor.

William O. Douglas:

And how do you distinguish that through this case?

Joseph F. Goetten:

Well, Congress could have used the terms “omission of net income” or omissions from the tax itself, more than 25%.

It did not use that language.

Joseph F. Goetten:

It has not — there is no indication in the legislative history, the hearings or anything, why they chose the term “gross income.”

But I think there’s a very good obvious reason.

Gross income is the basic figure.

There are very few computations in arriving at gross income.

Once you get to net income, there are a whole series of computations involved.

There are even more when you get to the tax itself.

Accordingly, if Congress had talked about a 25% omission from net income as stated on the return, it would be perhaps embodying many mathematical errors of the taxpayer in computing his tax.

By picking gross income stated in the return, it picked a figure which does not include many computations.

It does include a few.

I think that is perhaps the — the real answer to why the statute is drafted the way it is.

(Inaudible)

Joseph F. Goetten:

No.

Your Honor, Form 1040 —

Or whatever the form is.

Joseph F. Goetten:

— or whatever the form is, contains no specific item labeled “gross income” and it’s not our position as the taxpayer maintains that if gross income is correctly stated in the various schedules set up for various types of gross income such as dividends, interests, hence received and so forth, if there’s any error in carrying that over to the phase of the return or any error adding the figure up, we do not contend that’s an omission from gross income.

The statute talks about gross income stated in the return.

It’s our position that means stated in the schedules of various types of gross income and to get back to concealment if an item is not stated as gross income or if it’s stated as a — an excess of cost basis.

The Commissioner is not familiar entirely with the facts that took place.

He — it is concealed.

It is not disclose.

The important factor is that it must be disclosed as gross income.

Now, it — it’s also clear from the legislative history of this statutory provision that a taxpayer omits within the meaning of the Section when he understates his gross income on his return.

Now, the Committee reports are set forth at pages 19 to 20 of the Government’s brief and they both refer to this law in the following language, the change enlarges the scope of this provision to include cases wherein the taxpayer understates gross income on its return by an amount which is an excess of 25% of the gross income stated in the return.

They clearly meant “omits” to include the word “understates.”

Now it is true as taxpayer has pointed out that the committee reports giving examples also go on to describe omissions as a leaving out or a failure to disclose.

But when this language is read in the full context of the committee reports, it’s clear that it refers to a failure to disclose as gross income or a leaving out of items of gross income.

None of the examples given refers to a failure to disclose or leaving out of gross receipts, gross proceeds of sale or anything other than gross income.

Now there are some cases such as salary, dividends where gross income and gross receipts may be synonymous, but none of the examples given is an example of a gross receipt that is not gross income.

And the statute proceeds to provide when the omission from gross income of an amount properly includible therein shall be crucial, and I think this is the really important part of the statute.

It is crucial only if the omitted amount is in excess of 25% of the amount of gross income stated in the return, and is thus apparent that Congress was primarily concerned with a relative size of the omission.

Joseph F. Goetten:

And I should point out here that this very provision makes it clear that Congress was not thinking in terms of how long will the Commissioner need to catch up with the particular error here because it obviously takes him just as long to find an omission of a smaller amount from gross income as it does to find an omission of a larger amount from gross income.

The Committee reports make it clear that Congress merely decided that taxpayers failing to state as gross income, relatively large amounts which should be included therein should run the risk of the longer statute of limitations.

Congress was concerned with results, not causes, with relatively large omissions and not that those may have been honest omissions.

In fact, the Committee reports show that Congress intended to cover honest mistakes in this Section.

Dishonest mistakes are covered somewhere else.

And it meant to require taxpayers to run the risk of the longer limitations even if they omitted the doubtful item from gross income.

In other words, it’s all — it’s frequently a difficult question is to whether a particular item of gross income should be reported in one year or another year.

And if you leave it out, you don’t report it as gross income for a particular year, it’s an omission within the meaning of this Section and the committee reports give that specific example.

In fact, it was because of this that the House Bill was amended by the Senate.

The House Bill would have provided no statute of limitations where it was the 25 — an omission in excess to 25%.

The Senate thought that that was too harsh where the error was an honest error and that applied your — limitations should be provided.

This last part of the statute also provides the measure for the amount omitted.

It speaks of 20 — in excess of 25% of the amount of gross income stated in the return, and as I have pointed out, the only place where gross income is fully stated in the return is in the schedules.

And our position has been misconceived by taxpayer.

It was misconceived by the Third Circuit in the Uptegrove case where they say that the Commissioner’s position is that if the final figure in the gross income computation is understated then there has been an omission from gross income within the meaning of the statute.

That is not the Commissioner’s position and has never been.

If there is an error in transposing an amount of gross income from a schedule to the phase of the return, but the amount is fully disclosed and is disclosed as gross income in the schedule, there’s been no omission.

If there’s a mathematical error, that is an error in adding up the figures on the phase of the return, that is not on omission from gross incomes.

We don’t look at the last figure.

We look at each figure which describes a particular type of gross income either — either received or approved by a particular taxpayer.

And that that is clearly the Commissioner’s position is made clear by two factors.

First of all, the Commissioner has an old statute of limitations problem with respect to mathematical errors on the phase of the return.

There is a 100% mathematical verification of returns.

There are so many returns filed.

The Commissioner cannot audit all of them, a relatively small number, perhaps 10% are audited.

But there is a mathematical verification of returns and the Commissioner needs not — not even three years to accomplish that objective.

And that brings me to the fact that there is — even in the court a special treatment for mathematical errors.

They are treated separately, Section 272 (f), which was added to the code at the same in 1934.

At the same time, this statute was added provide its — provides that the Commissioner does not have to send the 90-day notice of his determination of a deficiency in the case of a mathematical error.

If it’s in the taxpayer’s favor, he merely sends him a letter with a check.

Joseph F. Goetten:

If it’s in the Commissioner’s favor.

He sends a letter and tells him to remit.

And accordingly, our position is that there is an omission from gross income under the terms and legislative history of the statute.

Whenever the gross income stated in the various schedules of the return is deflated by more than 25%.

Now we submit that that would be the logical construction of this statute even if the proposition were coming up way back in 1934.

William O. Douglas:

This would be — your rule would be applicable to excess the claims for depreciation?

Joseph F. Goetten:

No, Your Honor, not if they’re in the deduction, if they’re treated as a deduction.

There are certain instances where by rulings, the Commissioner allows depreciation to be taken out in arriving at a certain item that goes in the gross income schedule.

But ordinarily, depreciation is a deduction item and as such, an overstated deduction item would not be an understatement of gross.

William O. Douglas:

How do you — why do you draw that distinction in this case and —

Joseph F. Goetten:

Between a deduction item and — and a —

William O. Douglas:

Between depreciation case and your — this instant case.

Joseph F. Goetten:

Because Congress has used the term gross income, it’s written the statute in such a way that it — it expresses concern with omissions from gross income of amounts properly includible therein.

It could have said net income and caught overstated deductions.

It didn’t say so.

It could have — it could have said omissions from the tax itself and even brought more than understated items of gross and overstated items of deduction.

But I think the logical reason why they’re not doing it is that then, if they talked about net income stated in the return or the tax reported in the return and there are frequently errors, mathematical errors, it would have encompassed that within the statute and I don’t think Congress intended to do that.

William J. Brennan, Jr.:

Well, maybe this is the same question that the cost of lot sold is of course not a deduction.

Joseph F. Goetten:

No, Your Honor.

It is not.

William J. Brennan, Jr.:

Is that by reason of the definition of gross income?

Joseph F. Goetten:

By reason of the statutory definition —

William J. Brennan, Jr.:

Of gross income.

Joseph F. Goetten:

Of gross income and a gain from sale.

There are two definitions (Voice Overlap) —

William J. Brennan, Jr.:

Well, that’s in fact the statute had made cost of lot sold a deduction.

The argument you’re making here is not —

Joseph F. Goetten:

That is true.

William J. Brennan, Jr.:

Could not remain

Joseph F. Goetten:

That is correct.

(Inaudible)

Joseph F. Goetten:

If, Your Honor — if I understand Your Honor correctly that you included the cost of the trailer in your cost basis of the property and subtracted that in the writing that you gained from sell, my answer is yes.

And I think that Congress intended to cover mistakes by that and the five-year statute has made crystal clear by the Committee reports, which I previously referred to on pages 19 to 20 of our — our brief.

In changing the Senate Bill, which would have provided an unlimited period for assessment in this type of case, the House said — or I mean, the House bill, the Senate said, “Your committee is in general accord with the policy expressed in this Section of the House bill.

However, it is believed that in the case of a taxpayer who makes an honest mistake, it would be unfair to keep the statute open indefinitely.

For instance, a case might arise where a taxpayer failed to report a dividend because he was erroneously advised by the officers of the corporation that it was paid out of capital or he might report his income for one year, an item of income which properly belonged in another year, which is often a very difficult question.

Accordingly, your committee has provided for a five-year statute in such cases.”

In other words, they intended to cover honest mistakes here, Your Honor.

Close questions like in what year does the income go and you put it in a wrong year, it amounts to a 25% omission, the five-year statute applies.

It’s not because it takes the Commissioner longer to catch the error.

It’s just that they felt because of the adverse effect on the revenue, a person making a mistake, an honest mistake that large, should run the risk of a longer period.

(Inaudible)

Joseph F. Goetten:

Yes, Your Honor, even though it is because the — it’s often a very — not only a legal conclusion but a very difficult legal conclusion as to — to determine in which year an item of income should go.

Even all the facts.

Joseph F. Goetten:

Even all — all the facts have been revealed.

(Inaudible)

Joseph F. Goetten:

Exactly, Your Honor.

We’re — we’re trying to collect something that’s actually due here and we’re dealing with something technical as statute of limitations and whether it bars and accordingly, any statute of limitations as to a certain extent arbitrary.

Congress has set one here.

We submit it issues, plain language in setting that statute, the legislative history is crystal clear and you would reach this conclusion even if you didn’t have a long history of an administrative and judicial construction, but you do have that.

This statute was enacted in 1934 and the Treasury Regulations which were issued at that time under the 1934 Act provided that if they are submitted from the gross income stated in the return, they say nothing about any computation or disclosure or anything else, if they’re submitted from the gross income stated in the return, an — an amount — excuse me —

(Inaudible)

Joseph F. Goetten:

Omits, I — I say it means leaves out an item of gross income, fails to disclose an item as gross income or understates gross income.

Those are the terms the Committee used, I think, in the same context, Your Honor.

(Inaudible) understated.

Joseph F. Goetten:

Both in the sense of understate — yes, the — the Committee reports used it as understates and when they also go on to use synonymous terms such as leave out or fail to — fail to disclose, they say leave out items of gross income, fail to disclose as gross income.

I’d like to see (Inaudible)

Joseph F. Goetten:

Subtraction.

Subtraction (Inaudible)

Joseph F. Goetten:

It’s the alleged cost in this case, but it’s an erroneous cost basis.

(Inaudible)

Joseph F. Goetten:

That’s right, Your Honor.

(Inaudible)

Joseph F. Goetten:

Which is labeled gross revenue, yes, Your Honor.

(Inaudible)

Joseph F. Goetten:

The statute requires it.

I — I think you have to distort the statute to come to any other conclusion.

And as I would like to point out, the regulations interpreted, the 1934 Code provision as applying to an omission from gross income stated in the return, it had to be stated as such, those regulations were adopted under the 1934 Act.

The statute was enacted in 1936, 1938 and 1939.

The same regulations were repeated under each of those statutes.

I think if Congress had disagreed with that construction, they would have said so.

Moreover, the judicial construction of this statute was entirely consistent for 19 years after the statute was enacted.

From 1934 to 1953, 19 years, this legislation was unanimously construed by the courts as applying to omissions from gross income as defined by statute.

The Tax Court in the Malloy case, the Second Circuit in the Ketcham case, the Fifth Circuit in the Foster’s Estate case, the Sixth Circuit in Ewald and Reis, and the Ninth in the O’Bryan case so held.

We think if there was any doubt initially, it should have been put to rest by these 19 years of consistent administrative and judicial construction, and this brings us to our final point —

(Inaudible)

Joseph F. Goetten:

In 1953, the First Circuit decided Uptegrove and I’ll tell you what the basis of their conclusion was.

First, they misstated the Commissioner’s position.

They said that the Commissioner’s position is that income is omitted if the ultimate figure in the computation of gross income is understated.

That has never been the Commissioner’s position.

Then they got into the word “computation” and they wrote that into the statute.

They wrote the statute as if it read and an omission from the computation of gross income.

It doesn’t say that.

They had to go further and write in something else because if you talk nearly about an omission from the computation, you might have been omitting a negative item rather than a plus item.

So they have to write in an omission from the computation of gross income of a plus item such as a receipt item or a taxable receipt, for instance, if it’s a dividend, taxable or taxable dividend rather than nontaxable dividend.

William O. Douglas:

But your definition of gross income includes gains and profits derived from any sort, and that requires a competition that — at a retail store.

It has gross — gross receipts and he has expenses.

You have to figure your deductions for this (Inaudible) —

Joseph F. Goetten:

Yes, Your Honor.

And that is also defined by regulation that gross income in the case of a merchandising or manufacturing concern means gross receipts less the direct cost of good sold.

William O. Douglas:

That — — that’s — that’s what I thought Hastie was worrying about in the Third Circuit.

Joseph F. Goetten:

Well, I don’t read the opinion.

I — if that was a cost of receipts case, Your Honor, it was exactly like this one and —

William O. Douglas:

That’s right.

Joseph F. Goetten:

— and he was worried about —

William O. Douglas:

You told me that the problem of deduction isn’t here, but I would think that — that you get to the profits or the gains or profits of a retail store and that you get into deduction necessarily.

Joseph F. Goetten:

Well, it’s gain from sale, if Your Honor please, gain from the sale of property and that itself is —

William O. Douglas:

Or from any source, what — whatever —

Joseph F. Goetten:

Yes, but this is a specific source.

It is from sale property that’s undisputed in Section 111 —

William O. Douglas:

I’m was just trying to see how far your theory would be applied.

It seems to me that — that Hastie was not exaggerating, that he has — I mean I — I don’t understand.

Joseph F. Goetten:

Well, Your Honor, I — I think Judge Hastie with all due respect, pulled many of the statements from the legislative history out of context.

He relied on the words leave out and fail to disclose, but if those are read in the full context to the Committee reports, it’s clear that they may leave out items of gross income or failed to disclose as gross income.

And — and we think therefore, that since the statute says what gained from sales shall comprised, you follow the statutory language and these are omissions from gross income.

Hugo L. Black:

Is gross income anonymous to gross taxable income?

Joseph F. Goetten:

I think it is, Your Honor, because for instance, gross income does not include a nontaxable dividend and that’s one — if Your Honor please, that’s one of the beauties of this statute, by talking about omissions from gross income.

They avoid all these many detailed computations and they also avoid the problem of — in the case for instance of a dividend, whether it’s taxable or not.

If it goes in gross income, it’s a taxable dividend, so if you’ll omit something, it is not a taxable dividend such as a declaration of a common stock dividend and uncommon stock, then you have no problem on the statute.

It’s not an omission.

Hugo L. Black:

Can the tax form set out when you get — get down to a point where you have income, where do you get the — what — what is in the line that says gross income in connection with the sale of property.

Joseph F. Goetten:

Your Honor, unfortunately, that has not been printed.

There is no sharp dividing line.

The — the returns in this case are in the record and the first one is on page 27.

And the first general heading is gross income and then item 15 is a figure called total income, but I would like to point out to the Court that that is not either total gross income or total net income.

It’s a hybrid figure and I can show by example, item 10, rents received.

That is gross income, but turned down to 12 (b) net gain from sale or exchange of property other than capital assets.

That is not a gross income figure.

It’s a net income figure and there’s a good reason why they put it up here and take it out this way.

Ordinarily, a person who is not in the business of selling property can’t take a general deduction for property, expenses of selling property.

Joseph F. Goetten:

This net gain figure that goes on the face of the return as subtracted from it, not only the cost of good sold but the expenses of sale.

And unless they’re grouped together, the sale itself and the expenses of sale as they are in the schedule called for, schedule B, which unfortunately was on the back of this form and hasn’t been printed.

Unless they’re put together, a person checking the form has no idea whether the expenses of sale are deductible or not.

It’s unfortunate that this form is drafted so as to help the — the people that have to go over and check it.

It would be better for the lawyer to broke —

It helps the taxpayer?

Joseph F. Goetten:

Well, it helps the taxpayer in the sense, Your Honor, that it makes this computation as easy — easily — as easy as possible but it doesn’t break it down for the lawyer in terms of gross income, adjusted gross income, net income tax.

That is not done on the form.

Earl Warren:

Mr. Doll.

A. Robert Doll:

May it please the Court.

I submit that the respondent’s argument is based on hindsight.

Mr. Justice Brennan asked the question of whether in defining gross income, you — this cost a good sold item in there.

Now here is what — as I understand it, what the respondent — his argument is.

Under Section 22 (a), that is the general definition of gross income.

It — they set out certain specific items if dividends are includible in gross income and gains or profits — from any source, whatsoever.

Now, the respondent takes that word “gains” and he goes over — over to Section 111 of the Code.

Now, that section provides that in determining the gain from a sale of property, there’s a difference between the gross proceeds from a sale and the cost of the property.

Now, he takes two sections of the Code, 22 and 111 and says they that in enacting Section 275 (c), Congress was intending to cover this situation.

Now, I submit to you that when Congress enacted 275 (c), they weren’t concerned about Section 22 (a) or Section 111, they were concerned with omits from.

Now, the reason they use gross income is because as a matter of fact, it is generally synonymous with gross receipts.

And the majority of tax returns, the income and the receipts are the same.

That’s what’s includible.

That’s — and from that, you take off figures.

Now, it so happens that in the case of a manufacturing concern that you take your gross receipts and you subtract from that, your cost to good sold and from an accounting standpoint, you come up with gross income but the only thing includible in gross income are the receipts.

The cost are offset items.

You subtract from that.

William J. Brennan, Jr.:

Well, why — why is the — why is the schedule prepared the way it is?

A. Robert Doll:

Sir?

William J. Brennan, Jr.:

Why is your schedule prepared as it is?

You have made — according to this, you have a schedule of income.

William J. Brennan, Jr.:

You have subheading revenue.

A. Robert Doll:

That’s correct.

William J. Brennan, Jr.:

Gross — gross receipts of sale.

A. Robert Doll:

That’s right.

William J. Brennan, Jr.:

Then you take off the cost of lot sold.

Now, down below that, you have a brand new category called “deduction.”

A. Robert Doll:

Well, that — that is correct, sir.

This —

William J. Brennan, Jr.:

Why don’t they enter into — what I’m trying to get to is why don’t go to deduction equally under any (Inaudible)?

A. Robert Doll:

Well, that is what we consider one of the — the strongest — the things we rely on for our construction.

In other words, under the tax laws or accounting laws, we start off with gross receipts.

You subtract from that in the case of a manufacturing concern, the cost of the property being sold and then you come up with gross income.

Now, under our tax laws, your advertising, your rent, and so forth are specifically authorized as deductions by law.

You subtract those from your gross income to get your net income.

Now, we feel because the statute obviously doesn’t cover those items.

They can be overstated.

It doesn’t matter how far they’re overstated.

The deductions authorized by Section 23 —

William J. Brennan, Jr.:

Well, I gather the Government conceded.

A. Robert Doll:

They conceded as a must, and we say that the cost item, which is similar in nature to those items, they’re both expenditures that you report on a return and to get your benefits, you’ve got to report them.

We — we don’t think that Congress intended — just because it was a cost item, for the statute to apply.

It — it’s inconsistent.

If they were worried about that type of an error, they would have gone under — include the deductions that you take from gross income.

Did I make myself clear on that?

(Inaudible)

A. Robert Doll:

We think that when you stand back and look at this statute, what Congress really meant omits from gross income.

Now, omits means to leave out items of receipt.

That’s actually what they had in mind.

Now, and there are examples I submit in the Committee reports are exactly that kind of a situation.

Take for example in the Senate report, on page 16 in the petitioner’s brief.

A. Robert Doll:

For instance, a case might arise where a taxpayer failed to report a dividend because he was erroneously advised by the officers of the corporation that it was paid out of capital or he might report his income for one year, an item of income which properly belonged in another year.

Now, a dividend is a receipt.

That’s exactly what Congress was aiming at.

Now —

Hugo L. Black:

Why — why is that (Inaudible)

A. Robert Doll:

Sir?

Hugo L. Black:

How can you go from the fact if they mentioned dividend in the report and make the next step to say that’s what they were aiming at this implication (Inaudible).

A. Robert Doll:

That is our position, sir, that they were aiming at left out receipts.

That’s what this statute was intended to — to give the Commissioner a longer period when the taxpayer left out items of receipt from his income.

Hugo L. Black:

Gross income?

A. Robert Doll:

From his — from his gross income.

That’s correct.

Now —

Hugo L. Black:

When you’ve made this report for gross income, you first took all — you talk what (Inaudible)

A. Robert Doll:

That is correct.

Hugo L. Black:

That’s down and your report (Inaudible)

A. Robert Doll:

That is correct.

Hugo L. Black:

And the receipts that you put down there so far as the gross income was concerned, was there.

A. Robert Doll:

That is correct.

Hugo L. Black:

That’s — what’s the difference in that and the dividend.

Either one of them has to put in as a part of your gross income.

A. Robert Doll:

Yes, sir.

But we think is that — in — in the latter situation, the non-dividend situation, the receipts as you say are in there and you subtracted some cost from those receipts to come up from the gain of the sale of the property.

Now, we feel that Congress didn’t intend to — was not concerned about errors resulting from the overstated cost items.

Hugo L. Black:

Why not?

If — if it’s gross income, and that’s probably the gross income, the gross income whether up or down, according to the amounts you put, you (Inaudible) we use to compute the gross income (Inaudible)

A. Robert Doll:

That’s correct, sir.

Hugo L. Black:

Why wouldn’t it wanted that as much as anything else?

You may have 25% error.

A. Robert Doll:

Because they were only concerned with omissions from the left out we feel.

A. Robert Doll:

They — they weren’t concerned — in other words —

Hugo L. Black:

It has error.(Voice Overlap)

A. Robert Doll:

That’s — they weren’t concerned with all errors.

It was simply from left out items of receipt.

Now —

Hugo L. Black:

But — but if you leave it out by figuring it, instead of just by not figuring it, what’s the difference?

A. Robert Doll:

Well, that’s the respondent’s case.

That’s his argument.

We think there’s a big difference.

We think it — that when you read these Committee reports and when you take the normal statutory language that — that the case that you mentioned there was no omission there.

It — the income was understated.

We will admit that in this case, gross income was understated but we deny that there was anything omitted from gross income.

Hugo L. Black:

When you entered — when you entered the list on this report as I just read it, it’s made up very wrong.

You entered a list provided that you had received as your gross income.

A. Robert Doll:

Yes, sir.

Hugo L. Black:

You entered a certain figure reached by calculations on a basis which was not right.

A. Robert Doll:

That’s correct.

Hugo L. Black:

And you put that in there and the Government lost a tax on it by then.

A. Robert Doll:

That —

Hugo L. Black:

Because it was not included, that the right figure was not included in the list of gross item, the gross income you received.

A. Robert Doll:

That is correct, sir.

Our cost were overstated and our — our gross income was understated but we —

Hugo L. Black:

The deduction comes in quite a different way.

That comes after you figured up all your gross income.

A. Robert Doll:

That’s correct.

But we — we don’t think because our gross income was understated.

There was no omission from gross income.

Hugo L. Black:

Whether you call it understated or not is what — as much as it was.

A. Robert Doll:

That’s correct.

Hugo L. Black:

— as much as it was.

A. Robert Doll:

We — we admit that.

That’s true.

One further point, if I may, that the respondent has stated that there is a long — that there is quite a bit of judicial history that there’ve been in a long period of time where the cases adopted one view.

We — we don’t think that is true in this particular case, this type of situation.

The cases by and large that the respondent relies on, the real issue in that case was where there were on a schedule attached to a return, statements to the effect that certain alleged receipts were nontaxable.

The courts in the early cases held that that was not a sufficient disclosure and that therefore, that was an omission.

I think the — that type of situation would then — cured by the 1954 law in the second subsection.

We think it actually — the — the issue didn’t come to our head, really, until the Uptegrove case, which was the first conflicting case with the Reis case as far as the Circuit Court of Appeals go.

Thank you.

Earl Warren:

Thank you.