Opinion ID: 508452
Heading Depth: 1
Heading Rank: 1

Heading: The Indictment and Proof

Text: 4 The indictments of Duncan and Downing grew out of an extensive investigation into the collapse of the so-called Butcher banking empire in East Tennessee in the early 1980's. C.H. Butcher, Jr., a principal figure in the Butcher banks, was the third person named in the indictment with appellants. The indictment charged Butcher, Duncan, and Downing with conspiring to defraud the United States by impeding the ascertainment and collection of income taxes in violation of 18 U.S.C. Sec. 371 (Count One); charged Duncan with violating 26 U.S.C. Sec. 7206(1) by making false returns for the years 1981 (Count Two) and 1982 (Count Three); and charged Downing with violating 26 U.S.C. Sec. 7206(2) by aiding in the preparation of false returns for the years 1981 (Count Four) and 1982 (Count Five). The jury acquitted Duncan and Downing on all counts except for counts for the year 1982. The 1982 tax return contained two allegedly false statements--that $115,000 of income received was a capital gain rather than ordinary income, and that Duncan had paid $8,800 in interest when he had not. 5 Butcher, who had earlier pleaded guilty to Count One, testified for the Government. His testimony, and the Government's theory, described a scheme whereby Butcher sought to gain control of the Knox Federal Savings & Loan, a mutual S & L over which Duncan's family exercised partial control. In return for the assistance of the Duncans and of the other controlling family, named Curtis, Butcher agreed to undertake separate financial transactions favorable to each family. David Crabtree, a close associate of Butcher, testified that, acting as a nominee for Butcher, he bought the building that housed Knox Federal from the Curtises for a significantly inflated price of $525,000 as an aspect of buying the [S & L] Board seats. Defendant Duncan, meanwhile, had about $310,000 in indebtedness to the United American Bank (UAB) of Knoxville, which Butcher's family controlled. Some $90,000 of this debt was guaranteed by Duncan's brother Jim. Butcher testified that to enlist the Duncans' support, 1 he and Crabtree, with Downing as a middleman, devised an arrangement to write off defendant Duncan's debt. 6 On October 30, 1981, the Knox Federal board of directors, which to that point was majority-controlled by the Duncans and Curtises, was expanded to include a number of Butcher associates. On November 6, 1981, at Downing's insistence, Butcher wrote a letter confirming the arrangement that would relieve defendant Duncan's debt and Jim Duncan's guarantee. Addressed to defendant Duncan, it said: 7 The purpose of this letter is to confirm my commitments to you to provide sources of income during 1981 and/or 1982 in a manner which can hopefully be to your best advantage for income tax purposes in the aggregate of approximately $311,500, which in turn will be utilized by you to discharge existing indebtedness to UAB of Knoxville, which is represented by promissory notes dated August 25th, 1980 and June 30th, 1981. 8 Tr. 367. 9 Butcher testified that the $311,500 represented a fee to Duncan for being my conduit to a smooth transition at the S & L. Crabtree testified that at Butcher's request, he studied Duncan's financial situation and determined that the best way to avoid taxability was to turn the $300,000 payment into a short term capital gain that could be offset against Duncan's existing short term capital losses. The creation of a capital gain, however, would involve a sham transaction that would involve some papering of transactions, backdating of documents. Crabtree said that he told Butcher the arrangement would be technically correct but in reality a sham. Crabtree said Butcher replied that this wasn't his problem, that it solved his side of the deal, that was the Duncans' problem. Tr. 478. 10 The capital asset ultimately used was a right of first refusal to buy a 40 percent interest in a Knoxville motel. Downing, who had been engaged in negotiations to buy other motel properties from the same seller, Clyde Blalock, persuaded Blalock to convey this first refusal to Duncan for nominal consideration. The first refusal was then assigned by Duncan to Downing. 2 Both the agreement granting the first refusal and the assignment were dated September 21, 1981, although Blalock testified that he believed the agreement actually had been drawn in October or November. Blalock also testified that on the day the agreement was signed Downing took him to Duncan's office, which was in the same office building as Downing's separate office, and the three discussed and signed the agreement. Blalock said he did not know of the assignment until he was told by federal agents a couple of years later. 11 Duncan's indebtedness to UAB was discharged in the following manner, with consequences for both the 1981 tax return for which the defendants were acquitted and the 1982 return for which they were convicted. By check dated November 25, 1981, Downing paid Duncan $200,000. The check was drawn on the account of Downing's firm, but apparently was funded by a $200,000 loan from UAB made November 27, 1981. The loan went to Desh Investment Corporation, a separate Downing enterprise with which Butcher and Crabtree also were involved. Duncan endorsed the $200,000 check to UAB to apply to his indebtedness. 12 In April or May 1982, UAB advanced a second loan to Desh totaling $115,704.28. As the loan application stated, the funds were used to pay off Duncan's loan. At approximately the same time, Downing wrote a check on a Desh account paying UAB $8,817.59 owed in interest on Duncan's loans. Neither loan to Desh ever was repaid; the loans, totaling about $315,000, eventually were written off by another bank that assumed them after UAB failed. 13 Indictment Counts Two and Four charged that Duncan 3 and Downing had willfully filed and prepared a false return for 1981 which reflected the $200,000 as a short term capital gain rather than as ordinary income. The 1981 return had identified the transaction as Inv., Howard Johnson, the cost as zero, the gross sales price as $200,000, and therefore the gain as $200,000. Counts Three and Five charged that the 1982 return was false because it reflected (1) $115,704.28 as a short term capital gain rather than as ordinary income, and (2) an interest expense deduction of $8,817.59 to which Duncan was not entitled. The 1982 return had listed a gain of $115,704.28 without any further identification or detail of cost or sale price. 14 At trial, the Government's case included the testimony of Butcher, Crabtree, Blalock, some employees of Downing, and several bank officials and government agents. A Downing employee, Mark Lund, testified that he had prepared Duncan's 1982 return and that Downing had told him to get the interest figure on Duncan's loans by calling UAB. Neither Downing nor UAB told Lund that Desh, not Duncan, had paid the interest, and Lund did not ask. An IRS expert testified at the close of the Government's case-in-chief that, based on all the evidence presented, the right of first refusal was valueless, the asset transaction was a sham, and both the $200,000 payment in 1981 and the $115,000 payoff in 1982 should have been classified as ordinary income. On cross-examination, the Government expert acknowledged that the right of first refusal transaction could have been reported properly as a capital gain [i]f there had been substance to the transaction, and it was, in fact, a viable option. Tr. 1266. 15 Neither defendant testified. Both offered expert testimony from law school professors that the Blalock transaction could reasonably have been treated as a capital gain. The defense had presented testimony from William Hitson, an Atlanta investor and founder of Days Inns, that he often traded in rights of first refusal for motel properties, that he had negotiated a possible purchase earlier in 1981 of the Knoxville motel in question, and that in his opinion the Blalock document had a value of at least $500,000. Downing's expert also said that Duncan should have reported the $8,800 interest payment as income and then would have been entitled to deduct it. 16 The Government theory presented to the jury, thus, was that the entire Blalock transaction was a phony scheme concocted to disguise as a capital gain what was really a flat fee paid by Butcher to Duncan, that the scheme was accomplished by backdating documents from November to September, that both Downing and Duncan were aware of its sham nature, and that any real difference of opinion about how it should have been reported did not exist at the time but was being created by the defense experts after the fact. The defense theory presented was that the right of first refusal was genuine and valuable, that the documents were not back dated, that it was proper to classify the income in both years either as a capital gain or as a forgiveness of debt while the taxpayer was insolvent--which would have resulted in no tax due--and that any errors made were honest and nonwillful mistakes occasioned by Duncan's reliance upon Downing and by Downing's carelessness, ill health, and misplaced reliance upon his own employees. Downing's counsel acknowledged that the interest deduction was a mistake, but called it an honest one.