and i'm pleased to represent the appellant's in this case jerry and son son we believe that the central issue although we have brief several issues in this case is whether or not the s should pay tax on money their quired from mr chung that was subject to an agreement to repay me ask what's the source of all this money mr chong was sending here from china he testified at trial that he was worth a hundred million and that he had twenty million dollars of investable funds beyond that there's no indication of sources in the shipping business he brokers ships he hires the ships and mr sun would paint him to transport goods overseas and there was testimony about that because they were searching for some reason it would be income or that did they have a business relationship that was the government's position that it was too good to be true that this money would just come over and be to be invested so they were searching to find a business relationship not finding any because  if you find something to do with my money invested somewhere instead he goes to vegas and loses it all is that taxable for the investment advisor there was a case very similar to that it was the walters case and the holding was that there was no consensual agreement to repay the funds and that is that in that case it was income but here the court found credible testimony that when at the time that those funds were exchanged there was an obligation and an intent to have a consensual agreement to repay but i'm if i give money to my broker or a financial advisor he's obligated to repay maybe not exactly what i gave in that whatever the investments lose i get my money back if i want to write well not necessarily i don't know any financial planner that will give a money back guarantee you know with with gain or loss that's all i'm saying or whatever whatever turns out with my money if i double my money  if i lose seventy percent of that eventually it has to be repaid to me whatever profits there are losses i get right think that is different that that is different from a hard and fast agreement to repay this court in more versus commissioner said that and this is quoted in our briefs said that it had to be a hard in fast agreement to repay and almost gore in an obligation and that is different from a financial planner who simply either loses the money because it is a poor investment advisor that's not income to the financial planner or because he didn't take he didn't invest money but in your case if he took it and cited in our briefs and it's a fist circuit case and in that case the court drew the line between a false promise and a real promise and here the tax court found credible testimony that this gentleman had an agreement to repay the fines and that's that's different from false promises mean work and the record would indicate there was a credible genuine problem the court's holding a what in record the fact that mr chung gave instructions to mr sam that he could do whatever he wanted with the money spend or invest it all he cared about of your clients said your client says i was going to give him ten percent back and then above that we'd split any profits and so according to that your client would have had to account for whether the money was was earning you know was profiting or lose losing investment income and there was no evidence that any of that was done so how how was what happened consistent with your client's characterization of the of the arrangement i think that profit sharing after that mr chung never said there was a fifty fifty split that was only mr sun's testimony what mr chung did say is that there was a guaranteed ten percent per annum the tax court's opinion casts some doubt on that because it says it wasn't clear whether it was ten percent per year or a cumulative ten percent at the end of the ten year period mr chang cleared that up at trial on testimony and that's the trial transcript page one ninety three through one ninety nine he was asked several times to clarify that issue and i even gave him an example if if you have one hundred dollars invested and you get it do you get back one hundred  ten every the ten every year or do you get one hundred ten at the end of ten years and he said no not that that wasn't there was absolutely no question it was ten percent annually if you're right that it's not misappropriation what is it i mean it's got to be something it's got to be categorized somehow i would you categorize you try to say it was a loan is that are you still standing by the well the chance or the first question the court never defined misappropriation the way that it's defined in texas rather than what are you saying it is i know you're saying not but all right what i'm saying it is is using money or property that you have that is contrary to the agreement under which you hold it and we're saying under don't want to be a gift is a gift taxable even though a lot of what chuang saying i don't care what he did with that he could go gamble it away i mean a lot of that seems consistent with the gift but that is tax consequences so what are you saying you're actually on the give the court held it was not a gift arrangement between two men and bell business partners and friends who trusted each other and mr chung respected mr sun's investment abilities and unfortunately they had an oral does not necessarily imply trust in the case of indianapolis versus commissioner the supreme court in one nine hundred ninety held that the light company's customers and trusted their funds to the light company these were deposits against their utility bills and despite that word interested the supreme court said that despite the utility companies unfettered use in control and that's an exact quote unfettered use  control they put the money in their general account paid their bills with it but the the reason it was not taxable to indianapolis power and light is because they had and a consensual agreement to repay the customer either when they asked for the money back on terminations of service or they applied it to future utility bills and i'm saying that is what mr sun and mr chang had in terms of used as sort of a conduit that mr chang's money came in and then it went out to mr sun and some of those were transfers directly to win which is a gambling house there were transfers back from when the net effect was about two million dollars and mr chang knew about it he said it was a small amount of money and frankly mr turner was financially in different to h so why did he tell them to invest it and as long as he got his money back with ten percent that would be the end of the why does he care if invested what is what is sense they had to give a prof split profits above ten percent which is the stories aren't consistent no doubt if they just said i'm loaning you money and pay me back ten percent per annum that's a lot but there's this investment component to it i don't just cast i think it makes sense that if mr sun is getting twenty million dollars and he's got the monkey on his back to pay it all back plus ten percent per annum it makes him very good sense that he will invest it that's that's a heck of a monkey to have and he did in fact but keep in mind that mr son's testimony was that he viewed it as a joint investment and because of the fifty fifty profit split this is just like the facts in nahr versus commissioner which we also cited in our brief our reply br the work was a consensual agreement to repay it they were partners in this it in one sense you asked me how i would characterize it i might characterize it if i didn't characterize it as a contract or characterize it as a general i don't i don't think jurisdiction is why a ball my for my general understanding is as a tax lawyer jurisdiction it can be raise it any time and if it's if the tax court does not have jurisdiction it will not take the case we've had cases like that where we raised jurisdiction at the last minute and it's at the end all of the briefing and the tax court relied on web versus commissioner this was a court of appeals in the first circuit and the reason i think this case is important it's not only because it's one of the main cases that the tax court relied on to find income here in keep in mind what the tax court found it found that sun's personal unrestricted use of the funds constituted misappropriation which constituted income so that was their logic i restricted use equal misappropriation it's all income and i believe if you read the web pages you will find it remarkable similarity to the tax court logic and the court of appeals rationale with one critical difference and that is the outcome of to case and i think it also explains why we have a trust in the middle of this relationship may please the court just climate for the commissioner of internal revenue the primary issue raised in this appeal is whether the factual record below in the tax court supported the finding a misappropriation supreme court in james this court rochelle has have indicated that  mr sun took funds belong to mr chung and used them for gambling use them to give the money away use it to pay his mortgage or to buy a car for his personal use he used the funds to secure a loan for his closely held business he held the funds in his own funds and reported either the earnings on those funds or in some cases the funds themselves as his funds on tax returns or associated filings the taxpayers ultimately cont either that a miss finding the missive misappropriation was inappropriate because on one hand they argue that mr sun was never obligated to invest a single penny of mr chung's funds that he had complete discretion to do whatever he wanted with those  on the other hand they argue that mr sun always intended to restore or pay the fines and recognize my obligation to do so but neither of those arguments are available here with respect to the former obligation there is adequate factual support in the record that these funds were earmarked for the specific purpose of investment mr sun testified that he was intrusted with his friends funds for investment in trust that's mr son's word in the taxpayer post trial brief it doc at thirty three the taxpayers argued that mr son was intrusted with funds belonging to another for the purpose of an investment much like a custodian mr chang for his part was questioned to trial a bout whether c asked mr sun to invest all the funds that he provided he answered in the affirmative to the extent that there's any contrary indications in the record in terms of mr sun having broad discretion about how to use the funds certainly the tax court was well positioned and uniquely qualified to draw the inferences and turman what actually carried the day and here it found that the testimony that these funds were intrusted for the specific purpose of investment was credible and made in that case the court this court held that attacks cares intend to repay fines even a sincere intent did not preclude a finding of misappropriation when the taxpayer acted inconsistently with the thing that he entered into or prejudice to the party who provided the funds and more the situation was the taxpayer went to a series of lenders and attempted to secure loans conditioned on the promise that he would use the local loan proceeds  purchase industrial tanks to store ammonia those tanks within service collateral to secure the loans the taxpayer adamantly testified that he intended to repay the loans even though he had not purchased that tanks that would serve as collateral he testified that he intended to repay those loans and in fact had taken steps to begin doing so he had made all de payments of principal interest all the bonus payments that were due under the loan this court nonetheless found that it was appropriate to find misappropriation because a sincere intent contradicted by evidence showing that there was not an intent that the mere expression of intent is not sufficient to carry the day to the court here make those findings though the tax court found that the funds were interested for a specific purpose and then made the findings that you intend interested for investment and used for other purposes that it make a finding that there was a lack of sincerity as to the obligation to repay the tax were made findings that the funds were used for a purpose inconsistent with repaying the funds inconsistent with the the agreement that the funds would be invested  that the taxpayer was worth that the mr chung was prejudiced by virtue of the fact that the funds were not being used to create any kind of a return that that was the entire purpose of the agreement was to try to secure a return to mr chung's return on investment depended on the use the funds he was certainly precious when those funds were not invested in some cases completely eliminated they were spent or gambled away similarly that the seventh circuit how does that do with the obligation to repay a requirement that james  dispositive so it's fine that mr sloan testified in testified repeatedly oh i intend to pay the fines but that does not constitute a consensual obligation to repay when he acts inconsistently with those statements it's similar to you know when he wouldn't he believe that the taxpayer did not make a specific finding to say he intended or did not intend but he did say that his use of the funds was inconsistent with using them for investment was inconsistent with using them for the purpose of investment  return on the funds but that does nothing to eliminate mr chung's prejudice by having the funds not invested at all or not being invested on his behalf there's no way for him to unwind the clock and say five years from now well you got your money back but in the in the intervening five years there was no one but there was no return on your investment or maybe a negative one hundred percent return on your investment he was prejudiced by the fact that mr sun did not honor his end of the agreement and did the district c well your honor as a threshold issue we think that the taxpayers chose the wrong vehicle to challenge the increase in they claim that the challenging the increase in the deficiency what they're really trying to do is to argue no one sixty one motion to reconsider or for  new or for the trial that they never actually submitted they're really trying to use their opposition to the commissioner's motion to amend not to challenge the calculations not to increase the deficiencies but they're really use it to challenge the now complain that they were somehow prejudiced by not being able to introduce additional evidence or arguments because they didn't ask for correct because they didn't ask for it furthermore we would submit that the adjusted calculations and again these are only adjusted funds that were transferred from mr chung to mr sun were his ordinary income the questions primary theory was that these were first ordinary income to mention mr son's closely held corporation and then were considered to be dividend income sun but the commissioners notice of deficiencies that was an alternative theory which of that was that we should ignore the transfer to make them and treat these as the direct ordinary income of mr sawyer it's also consistent with the position that the taxpayers took in their post trial brief at docket thirty three where they repeatedly argued that mention i'm certain merely as a conduit that it should not have any tax consequences on its own for receipt of these funds that mention was merely a conduit for passing the funds to mr sun and they should be taxable to mr sun directly or not at all we would know just for clarification this was this case was tried on a consolidated basis with mr sun's close the whole corporation mention as well as with the individual taxpayers mr sun his wife although the amount increased for her with her son and his wife by a little over a million dollars if you look at the total tax and penalties it should be noted that the tax consequences of that the and the penalties owed by mention decreased dramatically as a result of the court's opinion because they were no longer being taxed for receiving ordinary income so it ended up being a net seven million dollar decrease when considering this on an a we would submit that the evidence fully supported the court's finding misappropriation and that the tax payers have not put forth any credible arguments as to what evidence they were precluded from introducing what evidence or arguments they should have been allowed to to submit expert testimony regarding the law of of trusts that they might have called mr chung's business associates as witnesses and here in the reply brief on appeal there are going maybe they would call mr sons friends or or associates character witnesses maybe they would have brought in financial experts to offer expert testimony perhaps they would have brought in this your sons bankers or investment advisers or business colleagues to testify but none of those facts that they're that they're saying that they were precluded from introducing or should have been allowed to introduce go to the core issue in this case which is what was the agreement between mr sun mr chung and what did mr sonner ultimately do with the funds that he got from mr chang and was that consistent or inconsistent with the terms under which he acquire earmarked for investment but that mr sun was loud broad latitude in discretion in how he invested the funds that was the way that it resolved any inconsistency between the testimony that these funds were trusted for the purpose of investment and the fact that there weren't any restrictions or additional restrictions placed on the funds do you agree that if if it were a consensual agreement sincere to repay the phone then the money that the day that would not constitute misappropriation distinguishing factor is that that was a commitment to make investment so you're saying that's correct that that there was an agreement that the money would actually be used for one particular purpose and mr sun decided to use it for a different purpose that was inconsistent with the truth according to the factual findings of the tax on the jurisdictional issue this section sixty two fourteen that the increased efficiency has to be before at the hearing can you point to any cases where the deficiency was increased at at this juncture re court there was a similar situation where there was a consolidated talks were proceeding involving a corporate tax payer as well as individual tax payers there were just months there were factual findings that the tax court made during the course of the trial that ended up adjusting the treatment of certain items reported by the corporation those had a flow through effect to how those transactions were treated on the returns of the individual taxpayers who are also parties to the case after the and did so and this court affirmed that decision so we think that in terms of the statute sixty two fourteen it's a purely temporal test whether or not the request for an increase is made at or before the hearing or has held that hearing should be accorded a broader meaning consistent with not only the trial but also the computations phase and the entry of the decision and that's consistent with the well established principle that a hearing in equity embraces the decision as ponting unilaterally increasing deficiencies and so this was meant to force the commissioner to actually request such an increased efficiency so that the taxpayer could respond and determine whether there was any prejudice and making arguments that they wanted to make and that is consistent with what happened here where the commissioner moved to increase the deficiency to conform to the facts and findings made by the tax court d text i was given the opportunity to respond and then the court ruled  for the trial of a row one sixty one the the motion to amend was merely a matter of computations and calculations which the taxpayers concede are correct based on the opinion that was issued by the tax court the issue of additional could have challenged the new granted the parties agreed that the calculations as it were that were submitted by the commissioner were correct they jointly said these are the correct computations based on the tie sports opinion so there wasn't any issue as far as them needing to use introduce additional evidence in terms of the calculations or computations which was what that motion dealt with and again if they wanted to introduce additional evidence they were certainly free to do so at a little one sixty one they could have done that and the only following the court's opinion or if they wanted to they caught could have sought leave from the tax court to file funds for example mr chung said i don't think that i'm he said that in terms of funds that were not used for the purpose of investment he said that wasn't much money in fact it was one hundred percent of the money that was not used to invest  he likewise said i know the mr some gambled but i thought he was gambling his own money or maybe my money so without the opportunity for full and contemporaneous disclosure which is what the taxpayers have pointed to in the north case we don't do that as as being consents nor was there any evidence that there was a modification to the agreement that said ok we understand that you know you you didn't invest some some out of funds but you're not going to be you're required to go into going forward there's no renegotiation of prerequisite to finding a misappropriation in fact in the more case this court made a finding of misappropriation without any preliminary finding that a trust existed we do think that there is special support for the existence of a trust but is not a legal prerequisite to finding this appropriation fourteen and fifteen and mr sun testified that that as he would sell assets he would repay portions of the money and he's done so but again that's not in the record i just know  that to be able to deduct that if the misappropriation perry stacks and he ends up paying it all back you can deduct that and the years he pays it back that that is what james held and i think part of the problem is that we are getting away from the fundamental principle of law that james set out which is that there is a two prong test for income and you have to meet both punks before there is income what the government is asking you to do is to hold that the unrestricted use alone whether it constitutes misappropriation are not is is is the only prong that's important they're asking you to ignore the agreement to repay which the tax court found that both men credibly testified that there was an agreement to repay and that is contrary directly contrary to the james case in fact james says misappropriation is the beginning of the inquiry not the end because it says that whether earnings are acquired lawfully or unlawfully there is a two prong test that we have to me are who have acquired funds a law fully from those who are law abiding citizens i mean from the words law abiding citizens versus criminals should we let the criminals off the hook because they had an illegal op legation to repay and the gist of the supreme court thought the entire holding is about we're not going to treat them any differently we're going to treat them the same if they pass the two prong test and i mean holy war because  your honor it's been cited over and over and over the three cases that the tax court cited in support of its opinion referred to james the four cases that the government cited in its briefs all transferred to james james is quoted over and over and over over four hundred times it is it is the be fundamental principle i think it squarely controls the outcome of this argument and then your argument that they should have been given leave to amend the answer all your arguments about that seem to say we should throw out the whole case because your client didn't know about this misappropriation theory didn't have notice you say we were a party fails to raise a theory and a notice of deficiency a court should not consider that there is a why are you only challenging the increase in the deficiency and not saying because the misappropriation which you're saying is and that's why the deficient right in on the why aren't you asking after up the whole trial because it was that the whole decision was based on a theory that was never alleged and you never had notice of it just longer your argument unprejudiced doesn't seem to go so much to that increased efficiency as to saying the whole thing was unfair and improper as it turns out you know i think we had ample evidence to prove that there is no income because of the obligation to repair a under the two prong test in james if and obviously the tax court did not subscribe to the james theory it didn't even cite james i think if we had known misappropriation recent issue we could have put on more evidence as it turns out i think we had ample evidence but if this court does believe that james controls the outcome of this case then i think i would like an opportunity to try that issue that way our appeal that were appealing what seems odd to me if you just let's say we affirm on the liability of the tax code but then we agree with you that there was no jurisdiction increase that efficiency so your clients left with a tax bill that said in his argument is that the government motion to a man was not based on their alternative theory as they say it was because if you look at the tax difference between the tax on the misappropriation and their alternative theory there are different numbers than the one we agreed on the computation because under rule one fifty five you can't challenge it you're supposed to agree on the court found so in other words if you have found that james did not apply and that misappropriation is allowed to constitute taxable income and many a misunderstanding your question  for this event so exciting we're going to take a ten minute break