INTRODUCTION:

With the discovery of the Brady violation and the government’s intentional and egregious attempts to hide CommunityOne Bank’s (COB) enablement of the Black Diamond (BD) Ponzi scheme conspiracy, the basis for the conspiracy charges has been proven false. Subsequently, the government’s supporting arguments for tax evasion have become moot. Simply put, without being a member of the BD conspiracy, there can be no tax evasion.
COB’s testimony would have supported Davey’s claim that he did not receive any benefit from the BD conspiracy. Therefore, all of the government’s arguments about Davey’s “bad intentions and acts” as a profiteer of the Ponzi scheme would have been irrelevant because there was no tax deficiency. Tax evasion requires meeting three elements: 1) an intent to evade, 2) an affirmative act toward evading, and 3) a tax deficiency. Since there was no tax deficiency, there can be no tax evasion. In Boulware v US, 552 US 421, 128 SCT 1168 (March 2008), the Supreme Court held that “the determination [of tax evasion] is computational and not dependent upon intent.” Id 431.

The court further clarified its position by stating, “Without the deficiency there is nothing but some act expressing the will to evade and, under Sec. 7201, acting on bad intentions alone is not punishable.” Id 433. The Fourth Circuit has ruled accordingly that “in order to prove a tax deficiency, the government must first show that the taxpayer had unreported income, and second that the income was taxable.” US v Moore, 998 Fed Appx 195,202 (4th CA, 2012). As will be shown, Davey’s innocence is predicated upon the longstanding IRS rule of “no earnings and profits, no income.” This reasoning is further supported by the Second Circuit which stated, “If congress intended this showing [i.e., willfulness] to suffice to establish a violation of Sec. 7201, it would not have included a tax deficit as a requisite element.” US v D’Agostine, 145 F.3d 69,73 (2nd CA, 1998).

THE TAX EVASION CHARGE (COUNT #4):
The government charged Davey with tax evasion for the year 2008 for not paying taxes on $810,000 that was transferred as a loan from his hedge fund, Divine Circulation Services LTD, to Shiloh Estate, an LLC owned by Davey.

INNOCENCE CLAIM:
In order to answer and diffuse the government’s arguments presented at trial and on appeal, it is imperative to address the three aspects of funds from which a tax deficiency can be created: 1) the source of funds, 2) the use of funds, and 3) the transmission of funds. As will be shown, all 3 aspects support Davey’s claim of innocence.

1) Source of Funds:
Contrary to the Government’s fundamental position, the $810,000 was not taxable income. Both Davey and the Government agree that there were no actual earnings in 2008 for either DCS or Black Diamond. Although Davey and every other victim of the Black Diamond Ponzi scheme believed that there were significant profits in 2008, the stark reality – not realized until December 2009 – was that that were never any profits. BD never invested any of the funds it received from victims and therefore had zero earnings. Accordingly, every dollar DCS received from BD was a return of its own capital. As an example, if a person opens a bank account today and deposits $10 into the new account and tomorrow withdraws $5 from his new account, the $5 is not income but rather a return of his principal. DCS’s total receipts from BD were LESS than its total deposits into BD. Since DCS did not receive any funds in excess of its basis, DCS received no earnings or profits from BD.

Therefore the $810,000 represents DCS’s investor capital and NOT income from BD. Whether DCS decided to use this $810,000 for another investment purpose or simply allow the $810,000 to sit in its bank account, this amount could not be considered taxable income in 2008.

The Supreme Court held that “the established tax principle [is] that a transaction is to be given its tax effect in accord with what actually occurred and not in accord with what might have occurred.” Commissioner v Nat. Alfalfa Dehydrating, 417 US 134,148, 94 SCT 2129 (May 1974). Thus, the Government’s argument about Davey’s intentions with what he believed were profits from BD in 2008 is moot in light of the fact that there were no actual profits. Davey cannot be convicted for a tax deficiency on DCS’s receipt of $810,000 from BD because the actual source of these funds was a non-taxable return of principle.

2) Use of Funds:
In 2008, DCS took the $810,000 and loaned it to an affiliate corporation, Shiloh Estate LLC. Both DCS and Shiloh duly recorded the loan on their books. Shiloh used 100% of the loan proceeds to purchase investment-grade capital assets (i.e., $550,000 for 3 parcels of land comprising 50 acres with the remainder used for architectural design and initial development toward building a house that Davey intended to lease from Shiloh when completed in 2010). The assets were recorded on Shiloh’s books and filed in Shiloh’s name with the County Records Office. The purchase of these assets by Shiloh was consistent with the purpose of DCS providing the investment loan. While DCS could have purchased these capital assets on its own, it was more economically feasible to loan the funds to Shiloh and put Shiloh in charge of developing the assets and earning a return on this capital.
Throughout all of 2008, there were no emails or other correspondence about any concerns with BD’s viability. Everyone was extremely pleased with BD’s perceived performance. Concerns about BD did not arise until later in 2009. The Government argued at trial that Davey intended to default on the loan in 2009. The Government then successfully moved to prevent Davey from presenting his 2009 tax return to the jury because the 2009 tax return was irrelevant to the 2008 tax evasion charge. Davey was unable to present to the jury that a loan default by Shiloh would have potentially created a negative taxable consequence for him. The Government further argued to the Appellate Court that the lack of a stated interest rate invalidated the loan from DCS to Shiloh. The appellate court’s focus on the absence of an explicit interest rate typifies the proverbial “straining at gnats while swallowing camels.” The court overlooked the very real and obvious fact that if Davey’s intention was to avoid an interest payment, he could have directed DCS to purchase the assets on its own and proceed WITHOUT any loan or involvement with Shiloh. Nitpicking minor technicalities of a loan between related corporations ignores the economic substance of the transaction. See Boulware, at 1176.

Nevertheless, the Supreme Court already ruled in Commissioner v Nat. Alfalfa Dehydrating that a tax evasion charge is based on what ACTUALLY transpired in that tax year and not what MIGHT have occurred. The Government should have been hoisted with its own petard at trial. The Government’s accusations concerning Davey’s intentions in 2009 are – as the trial court previously ruled against Davey – irrelevant for determining a tax deficiency in 2008. But the trial court allowed the Government to argue it anyway.

A corporation using non-taxable corporate funds to purchase corporate assets does not create a taxable event, nor does it create corporate income, nor does it create a tax deficiency for the business owner. Similarly, a corporation loaning to another corporation to finance a capital purchase is not deemed to constitute constructive dividends. The mere fact that a shareholder may derive benefit does not give rise to constructive dividends. This is supported by Schnallinger v Commissioner (T.C. January 6, 1987). The Tax Court held that “Advances by a corporation to another corporation owned by the same stockholder constitute loans for tax purposes and are not dividends to common stockholders where advances were intended to serve a valid business purpose of both corporations and were consistently treated as loans by both.

Therefore, Shiloh’s use of the $810,000 did not create a tax deficiency in 2008. Arguments about Davey’s intentions beyond 2008 are irrelevant according to the Supreme Court’s reasoning in Boulware that the determination of a tax deficiency is a computational exercise.

3) Transmission of Funds:
The movement of the $810,000 always remained at the corporate level. The funds went straight from DCS’s corporate bank account to Shiloh’s corporate bank account. The funds never went to Davey nor passed through his personal bank accounts. The purchase of the land and related development costs were solely paid out of Shiloh’s corporate account. Further, a forestry management plan for the land was developed and paid for with Shiloh funds. At no time did ownership, development, or vendor agreements ever fall under any other entity than Shiloh in 2008. The Government’s accusation that this transaction created a tax deficiency ignores the simple fact that all activity in 2008 took place at the corporate level with no liability to Davey personally. Additionally, all funds Davey received personally were processed through his accounting firm’s payroll system and properly taxed. In fact, Davey was never charged with tax evasion for any funds he personally received.

CONCLUSION:
DCS expected a return on capital from the investment loan to Shiloh and was fully collateralized with the capital assets. Shiloh benefited from developing the land and the prospect of future rental income. DCS moved non-taxable corporate funds to Shiloh’s corporate account in order to purchase investment-grade appreciable assets. The Government’s position that this transaction resulted in taxable income and a tax deficiency to Davey in 2008 is inconsistent with generally accepted accounting principles, unsupported in the tax code, and without precedent in case law. The jury and appellate court focused on the government’s narrative of Davey’s bad acts as a member of the Black Diamond Ponzi scheme conspiracy. Without the conspiracy, the facts show that none of the $810,000 was the proceeds of the conspiracy. It is without question that these funds represented a return of principle for DCS. Further, the loan from DCS to Shiloh did not cause a tax event. Thus, neither the source, the use, nor the transmission of the $810,000 created a tax deficiency, and Davey is innocent of tax evasion.