text:
    Appeal of R. M. Waggoner. Appeal of Ada Waggoner.
    Docket Nos. 5880, 5881.
    Promulgated January 26, 1927.
    1. A taxpayer lessor who keeps his books and renders liis returns upon a cash receipts and disbursements basis, which method in the. circumstances of this proceeding is held clearly to reflect income, is entitled to a reasonable allowance for depletion only upon the amount of royalties received.
    2. In the circumstances of this proceeding it is held that a sale of an oil and gas royalty interest was consummated in the calendar year 1919, and the Commissioner’s determination that the profit resulting therefrom was taxable in that year is approved.

      Harry G. Weeks, Esq., for the petitioners.

      Bruce A. Low, Esq., for the Commissioner.

      The Commissioner determined deficiencies in income tax of $57,-075.22 against each of the taxpayers for the calendar year 1919. Separate appeals were filed and were consolidated for hearing and decision. The issues in both cases are the same.
    The taxpayers, lessors of certain oil rights, claimed that for 1919 they were entitled to a deduction for depletion under section 214 (a) (10) of the Revenue Act of 1918 upon the basis of a total of 485,535.84 barrels of oil. The unit of depletion fixed by the Commissioner was so much per barrel of oil. Taxpayers employed the cash receipts and disbursements method of accounting in keeping their books and in reporting their income. The depletion unit of $1.50 per barrel of oil is not in controversy. In the deficiency notices the ‘Commissioner computed the allowance for depletion upon 435,429.10 barrels, being the total amount stated in the returns. At the hearing the Commissioner repudiated his determination in this regard and claimed that, upon the basis of cash received and disbursed, taxpayers were entitled to an allowance for depletion upon only 280,523.71 barrels of oil, since they received income as royalties from this number of barrels; that if depletion is to be allowed tvpon 485,535.34 barrels, taxpayers’ income, in order to be clearly reflected, must be computed upon the accrual basis.
    The next question is whether a profit of $222,607.15 upon the sale of a three-eighths overriding royalty interest in an oil lease was realized in 1919 or 1920. The Commissioner held that the sale was consummated in 1919 and taxpayers claim that it was not completed until January 2, 1920.
    BINDINGS OR FACT.
    Taxpayers are residents of Wichita Falls, Tex. During 1919 they kept their books and rendered their returns upon a cash receipts and disbursements basis. In 1919 and for some years prior thereto they owned the fee simple title to a stock farm of 521 acres near Burkburnette, Blocks 84, 85, 86 and 87, Red River Valley Lands Subdivision, in Wichita County, Texas.
    Prior to and during the year 1919 certain persons held oil leases on this property from taxpayers, under which taxpayers had what is termed in the record a “ one-eighth royalty interest.” The lessees discovered oil on the property and the removal of oil began on April 22, 1919. Other oil leases, under which taxpayers’ interests were the same as above mentioned, were given by taxpayers so that before the end of 1919 there were fifty lessees operating on the 521 acres. The lessees had tanks upon their leaseholds into which oil removed by them was run. Various oil-purchasing companies, designated in the record as pipe-line companies, had pipe lines connected with these storage tanks through which the oil, as purchased by them, was run into their tanks. The various leases given by the taxpayers, in which their interests were fixed, are not before the Board. The oil was not measured as it was removed from the ground by the lessees and pumped into their storage tanks. Occasionally the lessees, after their tanks had been “ strapped ” to prevent leakage, determined the quantity of oil therein by the measurements of the tanks. During the year 1919, 3,884,272.70 barrels of the oil extracted by the lessees were sold as it was run from lessees’ tanks through pipe lines of the purchasing companies into their tanks. As this oil was run through the pipe lines the purchasing company was given a document signed by the lessor and lessee, called a “ division order,” showing what proportion of the purchase price per barrel of the oil it should pay to the lessor and what proportion to the lessee. In this instance one-eighth of the purchase price was due the lessor, the taxpayers herein, and seven-eighths to the particular lessee. As the oil was run through the pipe lines of the purchasing company it was carefully measured. The lessee was required to furnish the purchasing company with an abstract of the property from which the oil had been extracted before it purchased the same. The purchasing companies paid or credited the lessor or the lessee with the respective amounts due them. The average sale price of the oil sold in 1919 was $2.25 a barrel. Under the “ division order ” given a purchasing company by the lessors and the various lessees, the taxpayers were due payment from the purchaser of one-eighth of the purchase price of the 3,884,272.70 barrels, which amount represented the sales price of 485,535.34 barrels of oil. The lessors had no information of the amount of oil extracted by the various lessees, other than as shown by the statements furnished them by the purchasing companies. The lessors made no eifort at the end of 1919 to determine the quantity of unsold oil, if any, in the tanks of the lessees.
    During the year 1919 taxpayers received payments on account of the amounts due them by the purchasers of the oil above mentioned, totaling $631,178.35 and representing the average selling price of $2.25 a barrel for the 280,523.71 barrels, which amount they entered upon their books and reported in their income-tax returns as income from royalties received within the year. The amount of income during the taxable year from royalties was not made an issue in the pleadings, nor was any question concerning this raised at the hearing. At the time of making the returns, the computation of the bookkeeper for the taxpayers, based upon statements which he then found had been received from the purchasing companies, showed that the taxpayers’ “ one-eighth royalty interest ” in the oil sold represented 435,429.10 barrels, and this number of barrels was shown in the returns as the basis for the depletion allowance under section 214 (a) (10) of the Be venue Act of 1918. The Commissioner in determining the depletion allowance of these taxpayers for 1919 used a depletion rate of $1.50 a barrel, which was the unit measurement for the purpose of determining the depletion allowance. Neither the basis nor the unit rate for depletion is in controversy in these appeals. In his deficiency notices the Commissioner computed the allowance for depletion upon the 435,429.10 barrels shown in the returns, but in his answer to the petitions and at the hearing he contended that his determination in this regard was erroneous because (1) the taxpayers employed the cash receipts and disbursements method of accounting and in reporting income, and they were therefore only entitled to an allowance for depletion for 1919 computed at $1.50 per barrel upon 280,523.71 barrels of oil for which they received income during 1919 and not, upon 435,429.10 barrels, and (2) that if the Board should conclude that the taxpayers were entitled to depletion computed upon the basis of the number of barrels of oil for which the purchaser was indebted to them, but for which they had not received payment, their income should be computed upon the accrual basis and the accounts receivable reflected in income.
    Some of the purchasing pipe-line companies followed the practice of paying for oil run into their tanks from the 1st to the 15th of the month, on the 25th of the same month, and for all oil run from the 15th to the end of any month, on.the 10th of the month following. Other purchasers followed the practice of paying for all oil run during any month on the 10th of the following month.
    Prior to November 26, 1919, these taxpayers, together with Clois L. Greene, owned a three-eighths overriding royalty interest in an oil and gas lease on 20 acres of land in Block 86, Bed Biver Lands Subdivision, in Wichita County, Texas. At that time B. M. Wag-goner and his wife owned the fee simple title to the property. They had previously made an oil and gas lease by virtue of which the lessee became entitled to seven-eighths and the taxpayers to one-eighth of the oil produced. Waggoner and Greene acquired the title to this lease, selling thereafter in July, 1919, an interest to David Livingston, by which Livingston became obligated to operate and develop the property at his own cost and expense, and entitled to receive therefrom four-eighths of all the oil produced, the remaining three-eighths being delivered to Waggoner and Greene without cost or expense to them. This three-eighths interest of Waggoner and Greene in the oil produced without expense to them was termed an “overriding royalty.” Between July and November 26, 1919, Livingston sold to the Charles F. Noble Oil & Gas Co. an interest in and to the four-eighths interest which he had acquired, this interest being commonly referred to as the “ working interest,” and on and prior to November 26, 1919, the Charles F. Noble Oil & Gas Co. was in possession of these 20 acres, developing the same and producing oil .therefrom. This company had a pipe line through which it transported all the oil produced from these 20 acres to a refinery owned and operated by it. It was the established custom in sales of this kind for the seller to furnish the purchaser with an abstract of title to the property involved in the interest sold. The sale to Livingston above referred to had been made for a consideration of $125,000 — $50,000 in cash and $75,000 to be paid from one-half of the proceeds of the four-eighths of the oil going to Livingston and produced from said property, so that on November 26, 1919, Noble & Company was in possession and operating the property and was also receiving into its pipe lines all of the oil produced therefrom. They were crediting one-eighth of this oil to B. M. Waggoner as his royalty; three-eighths to Waggoner and Greene as their overriding royalty; two-eighths to Waggoner and Greene upon their deferred payment, and the remainder of the working interest to Livingston and Noble & Company. Noble & Company did not make payment to Waggoner and Greene or E. M. Waggoner in 1919 for any of the oil produced from the property either before or after November 26, 1919. This included the deferred payment due them upon the Livingston sale, as well as Waggoner’s one-eighth royalty and the three-eighths overriding royalty.
    As a result of a conference between Waggoner, Greene, their attorney, and Charles F. Noble, president of Noble & Company and the attorney for the company, held on November 26, 1919, at Tulsa, Oída., a written agreement was entered into between Waggoner and Greene, as parties of the first part, and Charles F. Noble Oil & Gas Co., as party of the second part, and Charles F. Noble, party of the third part. (Charles F. Noble was a party to the agreement because he was a guarantor of the obligation hereinafter referred to, and for the further reason that at that time the company had not been domesticated in Texas and did not desire to appear as doing business in that State.)
    Waggoner and Greene contracted to sell to Noble & Company the three-eighths royalty interest in the property above referred to for $500,000, and the .following contract was executed:
    This Agreement entered into this 26th day of November A. D. 1919, by and between K. M. Waggoner and Olois L. Greene, both of Wichita County, Texas, hereinafter styled parties of the first part and Charles IT. Noble Oil & Gas Company, a corporation hereinafter styled party of the second part and Charles F. Noble of Tulsa County, Oklahoma, hereinafter styled party of the third part.
    Witnesseth: that for the considerations hereinafter shown, parties of the first part have sold and agreed to transfer, assign, and deliver, under the terms and conditions hereinafter specified, and party of the second part has purchased and agrees to accept and pay for, under said terms and conditions, the following described property to-wit:
    A tlirce-eighths royalty interest in all the oil produced from the following described land to-wit: the south 20 acres of the North 35 Acres of Block No. 86 Bed River Yalley Lands Subdivision in Wichita County, Texas and being the same royalty interest retained by parties of the first part in an assignment made by them to David Livingston on May 29th, 1919, which assignment is duly recorded in Volume 133, pages 415 and 416 Deed records of Wichita County, Texas, to which records reference is hereby expz-essly made for all purposes.
    The consideration to be paid for said assignment and for said property is $500,000.00, which shall be paid as follows: $150,000.00 in cash upon approval of the abstract, as hereinafter provided and the balance in three deferred payments, one for $150,000.00 due on or before March 1st, 1920, one for $100,000.00 due on or before June 1st, 1820, and the last for $100,000.00 due on or before September 1st, 1920, said deferred payments shall be evidenced by note in the amount and due as above stated, said notes to bear even date herewith, and to draw interest from date until paid at the rate of 7% per annum and to contain the usual optional maturity and attorney’s fee clauses and to be secured by vendor’s lien upon the property conveyed.
    The assignment to said property shall be in the form and shall contain the terms, stipulations and conditions set forth in a copy of an assignment this day executed by parties of the first part to party of the third part, a copy of which is attached hereto, marked “ Exhibit A” and made a part hereof for all purposes.
    Within fifteen days from the date thereof, parties of the first part shall furnish to party of the second part, a complete abstract of title to the real estate above described and party of the second part shall have one week within which to examine said abstract, if at the end of said one week period, said abstract does not show good and merchantable title to the interest in said property to be conveyed hereunder in parties of the first part, then party of the second part shall furnish parties of the first part, at Wichita Falls, Texas, with a written statement of the defects in said title and all defects not therein pointed out, shall be deemed waived. If defects are pointed out, parties of the first part shall have two weeks from the end of said one week period, within which to cure said defects and they hereby bind and obligate themselves to use every reasonable effort so to do, it being understood and agreed that if said defects are cured, at the end of the two weeks period above allowed for curing defects in title, then the purchase and sale herein provided for, shall at once be eonsummatedj otherwise, this agreement shall be of no force and effect and all moneys posted hereunder, shall be forthwith returned to the party posting the same and all liabilities hereunder shall cease and terminate.
    It is understood and agreed in this connection, that the assignment above provided for is made to party of the third part; that this is done for convenience and that party of the third part is to hold said property for the use and benefit of party of the second part and that party of the second part is the real purchaser and is primarily obligated by reason of this contract and that the notes herein provided for are the primary obligation of party of the second part and that the liability of party of the third part thereon and hereby is as endorser and surety.
    A copy of this contract together with an assignment properly executed and acknowledged by parties of the first part in the form herein provided for covering the property above described and .said three notes executed by parties of the second and third part to parties of the first part and the sum of «$150,000.00 in cash shall be at once placed in escrow in the Wichita State Bank and Trust Company in Wichita Falls, Texas and be held by them subject to the following: If the conditions herein contained as to title are complied with, then said sum of money and said notes, shall be delivered forthwith to parties of the first part and said assignment to party of the second part, otherwise, said notes and said money shall be returned to party of the second part, the assignment to parties of the first part, and all obligations hereunder shall cease and terminate.
    And for the sum of $10.00 and other considerations to him in cash paid, receipt of which is hereby acknowledged and confessed party of the third part hereby guarantees unto parties of the first part, the prompt and faithful performance of this agreement and the prompt payment of said notes by party of the second part.
    This agreement shall extend to and be binding upon the respective heirs, successors and assigns of the parties hereto.
    Witness the hands of the parties hereto in triplicate this day and year above written.
    (Signed) E. M. Waggoner,
    Clois L. Greene,

      Party of the first part.

    Chakles F. Noble Oil & Gas Company,
    By Chas. F. Noble, Pres.,

      Party of the second part.

    Chakles F. Noble,

      Party of the third part.

    The foregoing contract consummated agreeably to all parties concerned this 2nd day of January, A. D. 1920.
    (Signed) Waggoner & Greene,
    By Hakky G. Weeks.
    Chas. F. Noble.
    On the date the contract was executed an assignment, referred to therein as Exhibit A, from Waggoner and Greene was also executed by Waggoner and Greene. This assignment, dated and acknowledged November 26, 1919, was as follows:
    Whereas, heretofore, on the 27th day of January, 1919, R. M. Waggoner and his wife, Ada Waggoner, executed and delivered to J. P. Cantrell & Wm. M. Marseilles an oil and gas lease and leasehold estate covering the North 25 acres of Block 86, Bed River Valley Land Subdivision in Wichita County, Texas, as fully «appears from said lease contract, which is of record in the deed records of Wichita County, Texas, reference to which is here made and
    Whereas, on the 27th day of January, A. D. 1919, R. M. Waggoner and,his wife, Ada Waggoner, executed and delivered to Clois 1. Greene and C. F. Wilson, an oil and gas lease and leasehold estate in and to the South 25 Acres of the North 50 Acres of Block 86, Red River Valley Land Subdivisions in Wichita County, Texas, as fully appears from said lease contract of record in the deed records of Wichita County, Texas, reference to which is here made; and
    Whekeas, both of said oil and gas leases above described in so far as same pertains to the following described land to-wit: the South 20 Acres, of the North 35 Acres of Block 86 Red River Valley Land Subdivision in Wichita County, Texas, were transferred and assigned .to Clois L. Greene and R. M. Waggoner and whereas afterward to-wit: On the 29th day of May, A. D. 1919, the said Clois L. Greene and R. M. Waggoner, sold, transferred and assigned said oil and gas leases insofar as same pertains to the 20 acre tract above described, to David Livingston and did in same transfer and assignment, retain unto themselves an over-riding royalty of three-eighths of all of the oil produced from said 20 Acre tract, which assignment is duly recorded in Volume 133, Pages 415 and 416, deed records of Wichita County, Texas to which record reference is expressly made for all purposes.
    Now therefore know all men by these presents, that we the said Clois L. Greene and R. M. Waggoner both of Wichita County, Texas, the present legal and equitable holders and owners of said royalty interest above referred to, for and in consideration of the sum of $500,000.00 to us paid and secured to be paid by Charles F. Noble of Tulsa, Oklahoma, as follows: $150,000.00 in cash paid receipt of which is hereby acknowledged and confessed and the balance in three deferred payments due as follows: to-wit: $150,000.00 on or before March 1st, 1920, $100,000.00 on or before June 1st, 1920, $100,000.00 on or before September 1st, 1920, for which deferred payments the said Charles F. Noble has executed his three promissory notes all of same bearing even date herewith, in the amounts and due as above set forth, all of said notes bearing interest from date until paid at the rate of 7% per annum and all of said notes containing the usual optional maturity and attorney’s fee clauses, and being secured by vendor’s lien upon the property conveyed hereby.
    Have bargained, granted sold and conveyed and by these presents do bargain, grant, sell and convey unto the said Charles F. Noble of Tulsa, Oklahoma, all of the three-eighths royalty retained by grantors in the assignment to David Livingston above referred to.
    To have and to hold the property and estates above conveyed together with all and singular the rights and appurtenances thereto in any wise belonging to the said Charles F. Noble, his heirs and assigns forever, subject however, to all of the terms and conditions in the original leases contained, and to the further terms and conditions hereof.
    It is understood and agreed between the parties to this conveyance, that all of the oil produced from the 20 Acre tract above described, which would otherwise go to grantors by virtue of said three-eighths royalty interest from and including November 27th, 1919, shall go to grantee herein, but this conveyance shall not affect the rights of grantors to their portion of the oil in storage on said lease up to November 27th, 1919, or the oil run from said property prior to that date, and it is further agreed and understood that this conveyance shall not in any manner affect the one-eighth royalty going to the said R. M. Wag-goner, by reason of his ownership of the land covered by the leases above referred to, nor any of his rights by virtue of such ownership.
    And it is further agreed and understood between the parties hereto that this conveyance shall not in any manner affect the payment of the $75,000.00 deferred payment described in the conveyance from grantors herein to David Livingston above referred to and that regardless of this assignment, said payment shall be due in the same way and grantors shall have the same security and the same right to enforce payment as if this conveyance had not been made.
    And it is expressly. agreed and stipulated that the vendor’s lien Is retained against the property premises, and estates conveyed hereby until the above described notes together with all interest thereon due, are fully paid according to their face, tenor, effect and reading, whereupon this conveyance shall become absolute.
    Witness the hands of the grantors herein this 26th day of November, A. D. 1919.
    R. M. Waggoner.
    Clois L. Greene.
    The profit resulting to R. M. Waggoner from this sale was $222,607.15.
    The contract of conveyance, the three notes, the check for $150,000, which was endorsed by Waggoner and Greene, and an agreement for the optional maturity of the notes in the event of failure of the maker to pay any one at maturity were, on November 26, 1919, delivered by the respective parties to the attorney for Waggoner and Greene, to be by him placed in escrow in the Wichita State Bank & Trust Co. at Wichita Falls in accordance with the terms of the contract. The instruments mentioned were delivered to the said bank on November 28,1919, and the president of the bank executed his receipt therefor. The check for $150,000 was cashed by him and the proceeds held.
    On and after November 27, 1919, Noble & Company continued to extract oil “ from the ” property, retaining the three-eighths interest specified in the contract and assignment which had theretofore been credited to Waggoner and Greene. No portion thereof was credited to Waggoner and Greene after November 26.
    An abstract of title to the property was furnished Noble & Company at some time prior to December 20, 1919, the exact date not being disclosed by the record. This abstract, consisting of approximately 150 pages, was not brought down to November 26, 1919, but showed all conveyances prior to September 4, 1919. On December 20, 1919, the attorney for Noble & Company advised the attorneys for Waggoner and Greene by letter as follows:
    I have received and examined the abstract of title covering among other lands the south 20 acres of the north 35 acres of Block 86, Red River Valley Lands Subdivision in Wichita County, Texas, and find that this abstarct is continued down to the fourth day of September — 1919.
    We request that a supplement of this abstract continued down to the twenty-sixth day of November, 1919, be furnished us that we may examine the records of transfer made subsequent to September 4th, 1919.
    The supplemental abstract showing all conveyances to December 26, 1919, was furnished Noble & Company on or about December 27, 1919. The completed abstract so furnished showed good and merchantable title in and to the property conveyed. On January 2, 1920, Charles F. Noble appeared at the office of the attorney of Waggoner and Greene and announced his willingness to release the escrow agreement and deliver the purchase price to Waggoner and Greene. The attorney for Waggoner and Greene went with him to the bank where the papers and money had been placed in escrow and the following notation was made upon the sales contract signed by Waggoner and Greene by their attorney and Charles F. Noble:
    The foregoing contract consummated agreeable to all parties concerned, this 2nd day of January, 1920.
    The contract of conveyance was delivered to Noble and the $150,-000 cash was deposited to the credit of Waggoner and Greene in the Wichita State Bank & Trust Co., and the notes for $350,000 were held by the bank for Waggoner and Greene.
   OPINION.

Littleton:

Taxpayers claim (1) that they together, as lessors, are entitled to an allowance for depletion for 1919 of $728,303.01, computed at $1.50 a barrel on 485,535.34 barrels of oil, and (2) that the sale of certain oil and gas interests to Noble & Company was not consummated and completed until 1920 and there was therefore no taxable gain from that source in 1919.

During the taxable years taxpayers kept their books and rendered their returns upon the cash receipts and disbursements basis, and they had large income from various sources other than from royalties and from the alleged sale to Noble & Company.

The Commissioner contends (1) that the reasonable allowance for depletion to which these taxpayers were entitled for 1919 should be computed upon the basis of $1.50 on 280,523.71 barrels of oil, if their income is to be determined upon the cash receipts and disbursements basis; (2) that if they are to be allowed depletion upon the basis of the 485,535.34 barrels, or on any amount in excess of the 280,523.71 barrels, their income, in order to be clearly reflected, should be determined upon the accrual basis; and (3) that upon either the accrual or the cash receipts and disbursements basis his determination that the profit of $222,607.15 on the transaction was realized in 1919 should be approved.

Section 214 (a) (10) of the Revenue Act of 1918 provides:

(a) That in computing net income there shall be allowed as deductions:
* * * * * * *
(10) In the case of mines, oil and gas wells, other natural deposits, and timber, a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case, based upon cost including cost of development not otherwise deducted: Provided, That in the case of such properties acquired prior to March 1, 1913, the fair market value of the property (or the taxpayer’s interest therein) on that date shall be taken in lieu of cost up to that date: Provided further, That in the case of mines, oil and gas wells, discovered by the taxpayer, on or after March 1, 1913, and not acquired as the result of purchase of a proven tract or lease, where the fair market value of the property is materially disproportionate to the cost, the depletion allowance shall be based upon the fair market value of the property at the date of the discovery, or within thirty days thereafter; such reasonable allowance in all the above cases to be made under rules and regulations to be prescribed by the Commissioner with the approval of the Secretary. In the case of leases the deductions allowed by this paragraph shall be equitably apportioned between the lessor and lessee.

The purpose of the depletion provision of the statute is to return to the taxpayers having an interest in oil properties through the aggregate of annual depletion allowances, the basis of the depletion allowances, that is, the cost or the value on March 1, 1913, or the value of the oil in place at the date of discovery or within thirty days thereafter, before any income therefrom during the year shall be subjected to tax. These taxpayers employed the cash receipts and disbursements method of accounting, and in view of this and other facts disclosed by the record, we are of the opinion that the reasonable allowance to which these taxpayers were entitled for the year 1919 should be computed upon the basis of the royalty income received within the year. It is only in this manner that taxpayers employing the cash receipts and disbursements method of reporting income can get the full benefit of the provision of section 214 (a) (10) for, if a taxpayer employing such a method of accounting should for any reason receive no royalties from such source and had no other income from which to take the deduction of the allowance for depletion, he would receive no benefit from the statute; and if he should receive in a subsequent year his royalties, as the facts show was true in the case of these taxpayers, he would be required to pay a tax upon the entire amount thereof. The tax is an annual tax and the deductions are annual deductions and it is the intent and purpose of the statute that income and deductions shall be treated consistently. United States v. Anderson, 269 U. S. 422; United States v. Mitchell, 271 U. S. 9; Appeal of Consolidated Asphalt Co., 1 B. T. A. 79; Appeal of Henry Reubel, 1 B. T. A. 676. Royalties are income. Sargent Land Co. v. Von Baumbach, 207 Fed. 423; 219 Fed. 31; 242 U. S. 503; Alworth-Stephens Co. v. Lynch, 278 Fed. 959; 294 Fed. 190; 267 U. S. 364. In the last mentioned case depletion was allowed the lessor under the provisions of the Revenue Act of 1916 upon the basis of the value of its interest in the mineral rights and the royalties received within the year.

The leases under which these taxpayers were entitled to royalties are not before the Board, and the facts contained in the record show that those taxpayers received royalties amounting to $631,178.85. The taxpayers claimed that because the lessees removed from the leased premises and sold during the year 3,884,272.70 barrels of oil and that under the terms of the leases and the “ division order ” they had a “ one-eighth royalty interest,” (whatever that may mean), they -were entitled to an allowance for depletion computed upon one-eighth of this number of barrels, or 485,535.34 barrels, notwithstanding they only received royalties to the extent of $631,178.35, the equivalent of the sales price of 280,523.71 barrels of oil. The only basis for their contention is that the Commissioner’s regulation provides that depletion in the case of oil shall be computed by applying the depletion unit, in this case $1.50 a barrel, to all oil produced within the year, and that such regulation is binding upon the Commissioner and the Board. These taxpayers were not engaged in producing oil. They only received royalties. It is apparent from the argument of the Commissioner in this case that the allowance for depletion to lessors should be upon the basis of the royalty income received, that he does not construe his regulation as taxpayers contend. The Board does not construe the regulation in the manner contended for by the taxpayers and therefore fails to find merit in their contention. Article 210, Regulations 45, provides as follows:

(a) Depletion attaches to the annual production ‘‘according to the peculiar conditions of each case ” and when the depletion actually sustained, whether legally allowable or not, from the basic date, equals the cost or value on the basic date plus subsequent allowable capital additions, no further deductions for depletion will be allowed except in consequence of added value arising through discovery or purchase. * * *
(b) When the value of the property at the basic date has been determined, depletion for the taxable year shall be determined by dividing the value remaining for depletion by the number of units of mineral to which this value is applicable, and by multiplying the unit value for depletion, so determined, by the number of units sold within the taxable year. In the selection of a unit for depletion preference shall be given to the principal or customary unit or units paid for in the product sold.

These Regulations further provide, in article 215 (b), that—

* ⅜ * where the owner has leased a mineral property for a term of years with a requirement in the lease that the lessee shall extract and pay for, annually, a specified number of tons, or other agreed units of measurement, of such mineral, or shall pay, annually, a specified sum of money which shall be applied in payment of the purchase price or royalty per unit of such mineral whenever the same shall thereafter be extracted and removed from the leased premises, the vaiue in the ground to the lessor, for purposes of depletion, of the number of units so paid for in advance of extraction will constitute an allowable deduction from the gross income of the year in which such payment or payments shall be made; but no deduction for depletion by the lessor shall be claimed or allowed in any subsequent year on account of the extraction or removal in sucli year of any mineral so paid for in advance and for which deduction has once been made.

Even if the Regulations could be construed as permitting the deduction of an allowance for depletion to a lessor receiving royalties and employing the cash receipts and disbursements basis of accounting on units of measurement in excess of that on which such lessors received income from royalties, it might be seriously doubted if such a method would be a proper interpretation of the statute. The Commissioner has held that a lessor of mining property who waived his rights to royalties for several years and received all of the royalties in 1917 was entitled, since he submitted his returns for those years on the cash receipts and disbursements basis, to deduct from income received in 1917 such depletion allowance as appertained to that income. See A. R. M. 17, C. B. No. 2, p. 144. We think this holding applied the correct principle and followed the intendment of the statute. All that the statute provides is that in computing net income there shall be allowed as a deduction a reasonable allowance for depletion “ according to the peculiar conditions in each case,” and this reasonable allowance must be determined in the light of the provisions of sections 212 and 213 of the Act defining gross and net income.

As stated hereinbefore, the leases are not before us and we do not know just what they provided regarding the payment of royalties. The evidence shows that the oil was extracted by the lessees and run into their tanks located upon the leased premises; that they had possession of the oil until it was run through the pipe lines and sold to others. At the time of the sale the purchaser was given some kind of a written document signed by the lessor and the lessee to the effect that the taxpayers, lessors, were to be paid one-eighth of the purchase price of the oil. The purchaser thereupon paid or credited taxpayers with that amount and they reported as royalties received that portion of the one-eighth of the selling price received by them during the year 1919. The number of barrels of oil upon which taxpayers claim an allowance for depletion, to wit, 485,535.84, represented one-eightli of the total number of barrels of oil sold to the pipe-line companies during the year.

We are not deciding the question whether if a lessor under the terms of a lease receives instead of cash a certain proportion of the oil produced by the lessees he thereupon receives taxable income. That question is not before us, and, if it were, the evidence in this case is insufficient to enable us to decide it. All that we decide in connection with the issues presented is that upon the facts in this case these taxpayers received royalties to the extent of $631,178.85 and that upon the unit of measurement for the purpose of computing the depletion deduction they were entitled to depletion from 280,-523.71 barrels of oil.

In view of our conclusions in respect of the depletion allowance, it may not be said that the cash receipts and disbursements method of accounting employed by these taxpayers did not clearly reflect their income.

Waggoner and Greene unconditionally sold their three-eighths interest in a certain oil and gas well on November 26, 1919. All that remained to be done before they became unconditionally entitled to receive the $500,000 placed in escrow was for them to furnish an abstract showing good and merchantable title to the property sold. Beyond this provision the transaction was in all other respects a completed sale on November 26, 1919. Waggoner and Greene were given fifteen days from November 26 within which to furnish abstract of title to the property. This period expired on December 11, 1919. Noble & Company were given one week thereafter, or until December 18, within which to examine the abstract and point out any defects therein. Waggoner and Greene were then given an additional two weeks, or until January 1, 1920, within which to cure any defects pointed out. At some date prior to December 20, 1919, an abstract was furnished in which, so far as the period which it covered is concerned, the attorney for Noble & Company found no defect. On December 20, 1919, he requested that a supplemental abstract covering the period from September 4, the last date covered by the first abstract furnished, to November 26, 1919, be furnished him. This supplemental abstract was furnished on or about December 27, 1919, and showed good and merchantable title. The conveyance specifically provided that Waggoner and Greene should furnish the abstract within fifteen days; that Noble <& Company should have one week thereafter in which to point out any defects in the title; that, if any defects were pointed out, Waggoner and Greene should then have two weeks from the end of the said one-week period to cure such defects in the title as might have been pointed out, and that upon such defects being cured the purchase and sale should at once be consummated. The effect of this provision was that since Waggoner and Greene had furnished an abstract showing good and merchantable title the sale should become absolute. The completed abstract of title was not furnished within the fifteen days, nor were any defects pointed out by Noble & Company within one week after the expiration of the fifteen days specified or at any time thereafter. The first abstract furnished by Waggoner and Greene was satisfactory to Noble & Company as far as it went. The only defect pointed out was that the abstract was not complete and a supplemental abstract was asked for, which was furnished on or about December 27, 1919, showing a good and merchantable title to the interest in the property conveyed. This was after the expiration of the fifteen days allowed Waggoner and Greene for furnishing the abstract and also beyond the period of one week allowed Noble & Company within which to examine the abstract. The time for furnishing and for the examination of the abstract was never extended, and in our opinion the sale became completed and consummated on December 27, 1919, when the complete abstract showing good and merchantable title in Waggoner and Greene was furnished to Noble & Company. Under the provisions of the conveyance Noble & Company did not have a period of one week from December 27, 1919, within which to examine the contract before the sale should become consummated. On that date-Wag-goner and Greene, having furnished an abstract showing good and merchantable title as required by the conveyance, could have demanded and enforced the delivery of the $500,000 purchase price, and it would have been incumbent upon Noble & Company to show that their title to the property conveyed was imperfect. This, according to the evidence, it could not have done. After the time specified in the conveyance within which the abstract should be furnished and examined had expired, no modification of the provision having been made by the parties, the furnishing of the abstract showing good and merchantable title in the sellers consummated the sale, and the taking effect of the sale so as to postpone the realization by the sellers of the profit thereon could not be postponed by the delay of Noble <& Company in notifying the escrow agents that the escrow agreement had been complied with.

The purpose of Waggoner and Greene from the beginning was to postpone the realization of the profit on the sale of their three-eighths interest until the year 1920. We think that they have failed in their attempt to accomplish this. In the opinion of the Board the sale became a completed one on December 27, 1919.

The consideration received for the property consisted of $150,000 in cash and three interest-bearing promissory notes executed by the Charles F. Noble Oil & Gas Co., one for $150,000 due March 1, 1920, one for $100,000 due June 1,1920, and one for $100,000 due September 1, 1920.

The Commissioner held that the profit on the sale was realized in the year 1919, that the promissory notes were the equivalent of cash, and that Waggoner’s profit on the transaction was $222,607.15. The taxpayer stated “the agreed consideration was $500,000, of which one-half was to go to Waggoner. The profit of these taxpayers in this transaction is admittedly $222,607.15, The question at issue is the year in which the profit is to be reported.” In the opinion of the Board the Commissioner’s determination that the profit was realized in 1019 was correct and is approved.

Judgment will ~be entered on SO days’ notice, under Rule 50.

Milliken not participating.

Akundell, Phillips and Teammell dissent from the decision reached on the last issue discussed.


source: Caselaw Access Project

author: Lansdon:

license: Public Domain

text:
    Appeal of Lenox Land Co.
    Docket No. 1083.
    Promulgated January 26, 1927.
    Value of a leasehold at date paid in to a corporation for stock and of the same property at March 1, 1913, determined for invested capital and exhaustion purposes.

      W. H. Cloud, Esq., and Eugene M. Lynn, C. P. A., for the petitioner.

      Arthur J. Seaton, Esq., for the Commissioner.
    This is an appeal from the determination of a deficiency in income and profits taxes for the year 1920, in the amount of $8,278.65. The questions involved are the value at the date of acquisition of a certain leasehold for invested capital and its value at March 1, 1913, as the basis for a deduction for exhaustion.
    FINDINGS OE FACT.
    The petitioner is a Missouri corporation with its principal place of business in Kansas City. It was incorporated on December 15, 1904, with a paid-up capital in the amount of $50,000.
    On February 5, 1895, R. C. and Hannah T. Walpole leased the land in question to Willard Carl Feld for a term of 99 years, beginning August 12, 1895, and ending August 12, 1994. This lease reserved a rental of $6,000 per year for the first ten years, and provided for an appraisal at the expiration of such term, and of each succeeding ten-year period, and that the annual rental to be reserved for each term should be 6 per cent of the appraised value. The lessee was empowered to improve the property as he might desire, and it was provided that he should own all improvements, conditioned upon his payment of all rents due, and taxes and assessments. If he surrendered the lease or defaulted in any payment to which he was obligated thereunder between any valuation dates, all improvements were to become the property of the lessor. The lease contained the following provision for cancellation and surrender at the end of any revaluation period:
    Said Feld, Ms heirs, representatives or assigns, shall have the right and privilege of improving said property as he or they may desire, and he or they shall have the right and privilege of surrendering this lease and terminating this tenancy at the expiration of any period of ten years for which said real estate may have been appraised, as above provided, and upon the payment of any and all rent which may be due upon said premises and of any and all taxes and assessments, general and special, which may he assessed or levied upon said property, he or they shall own all improvements which may have been placed upon said lot and shall have the right and privilege of removing the same therefrom.
    On August 17, 1899, Jeremiah S. Lillis, representing the Lillis family, purchased the leasehold for a consideration of $53,000. Prior to 1905, title to the fee was acquired from the Walpoles by Ada M. Pulliam. On April 28, 1905, an agreement was entered into by Pulliam and Lillis, the then parties in interest, which modified the original lease as follows: Rental from August 12, 1905, to August 12, 1915, was fixed at $10,000 per year, and from the latter date to August 12, 1925, at $12,000 per year; within two years from date the lessee was to begin the construction of a building on the leased lot at a cost of not less than $30,000. Pursuant to this condition, Lillis erected a building, which was completed early in 1908, at a cost of $105,091.80.
    On March 17, 1908, the petitioner acquired the leasehold and building, and in payment therefor issued all of its capital stock of the par value of $50,000 for distribution among the members of the Lillis family. On March 20, 1916, the petitioner and the owner of the fee agreed to the cancellation of the provisions for tenth-year appraisals and substituted therefor an agreement that the rental for the remainder of the term of the lease subsequent to August 13, 1925, should be $20,000 per year, payable in equal monthly installments. As consideration for the abrogation of the reappraisal provisions of the lease, the petitioner paid the owner of the fee the amount of $30,000, which the parties to this appeal agree is to be regarded as a part of the cost of the leasehold. On October 3, 1919, the petitioner sold the building for $100,000, under a contract to retain possession and the receipt of all rentals from subleases until July 31, 1925, on terms and conditions that are not material to the issues involved in this appeal.
    From 1908 until January 1, 1913, the petitioner operated the property in its own interest and received gross rentals as follows: 1908, $48,499.65; 1909, $53,087.89; 1910, $56,713.21; 1911, $59,077.42; 1912, $56,253.42. From 1913 until 1918, inclusive, the rentals varied from $41,083.31 to $48,610.39, and from 1919 to 1924, the gross average annual rental was $45,000. From 1908 to 1912, inclusive, the average net income from the property was $31,659.20 per annum.
    The leasehold covers a lot located at the southwest corner of the intersection of Eleventh and Walnut Streets in Kansas City, Mo., and is within what real estate men call the “ 100 per cent ” downtown business district of that city, in which land values are rapidly increasing. At the time of the acquisition of the leasehold by the petitioner, the city had a population of 230,000, which was rapidly increasing. The lot is one of the best business locations in the city.
    In its income and profits-tax return for 1920, the petitioner claimed a value for the leasehold in the computation of its statutory invested capital in the amount of $400,000 as of the date of its acquisition. Upon the audit of such return, the Commissioner reduced the value of the leasehold to $191,364.80 at March 17, 1908, and determined the deficiency for 1920, and from such determination this appeal is taken.
    The depreciated cost of the improvements on the leasehold at March 1, 1913, was $94,582.60.
    The actual cash value of the leasehold acquired by the petitioner on March 17, 1908, was, on that date $225,000, and at March 1, 1913, it had a fair market value of $160,000.
   OPINION.

Lansdon:

Each party insists that the only problem presented is the determination of the cash value of the leasehold in question when it was acquired by the petitioner in exchange for shares of stock at March 17, 1908. At the same time the parties agree that such valuation must be the basis for the computation of the petitioner’s invested capital, and also for the determination of the annual exhaustion of the capital value of the leasehold. In the light of the statutory provision for excess-profits credits and of the rule established by the Board in the Appeal of Grosvenor Atterbury, 1 B. T. A. 169, and the Appeal of Hotel de France Co., 1 B. T. A. 28, it is obvious that we must find the value at March 17, 1908, as an element of invested capital, and at March 1, 1913, as a basis for annual exhaustion for years subsequent thereto.

The petitioner contends that at March 17, 1908, the leasehold had a value of not less than $400,000. In our judgment the facts adduced are not sufficient to establish such value. The leasehold cost the petitioner $53,000 in 1895. Early in 1908, the property was improved by the completion of a six-story steel and brick building at a cost of $105,991.80. At March 17, 1908, little, if any, income had been received from the improved property, but space in the building had been leased on terms that yielded an average annual net income for the years 1908 to 1912, inclusive, in the amount of $31,659.20. All such income accrued subsequent to the date with which we are concerned, and, while it may have some weight as corroborative evidence of value ascertained by appraisement or otherwise, it is clear that it can not be used as the basis for our determination. It is necessary, therefore, to resort to collateral evidence, and to consider the opinion of a witness reputed to be an expert in the valuation of real property in Kansas City.

In support of its contention the petitioner called three witnesses— a real estate operator and two certified public accountants. The real estate man testified that the entire property, made up of the fee, the leasehold, and the building, had a value of $800,000 at March 17, 1908. He was unable to show that any sales of similar property in the same locality at about the same time supported his estimate. With $800,000 as the basis of his computation, and, taking into consideration the rentals reserved and also the peak rental which was not established until 1919, the witness estimated the value of the fee to have been $280,000. He arrived at this figure by capitalizing its earnings at 5 per cent. Subtracting the amount so obtained and the cost of the building from the assumed basic value of $800,000, he reached the conclusion that the leasehold had a value of $115,000 at the date of acquisition.

The first accountant corroborated the testimony of the real estate operator. By applying Hoskold’s formula for finding the present worth of future income to the average net annual receipts from subleases for the five years from 1908 to 1912, inclusive, and subtracting the cost of the building from the result, he arrived at a value of $415,000. The second accountant testified that a 99-year lease is in effect a title to the fee, and that annual reductions from reserved rentals for the purpose of extinguishing capital value are so small that for all practical purposes they may be ignored.

The Commissioner contends that the leasehold had a value of only $191,364.80 at the date of its acquisition. To support his estimate he proved that a leasehold on an equally desirable property just across the street, on which ground rentals in the amount of $20,000 were reserved, was sold for $100,000 at about the time the petitioner acquired the property in question, but offered no other evidence to sustain his position.

We are unable to accept either the petitioner’s or the Commissioner’s estimates of value. The methods used by witnesses for the petitioner are empirical and involve so many doubtful and unknown factors that they can not safely be used as the basis for our determination. The Commissioner’s argument that the value should be measured by the selling price of a 99-year lease on a similar property just across the street is of slight weight, since cross examination of witnesses disclosed that such sale was made in conditions that prevented the owner from realizing full market value for the property.

We are convinced that the leasehold in question had a fair market value at March 17, 1908, in excess of the amount found by the Commissioner, but substantially less than that asserted by the petitioner, and we have fixed such value at $225,000, which should be included in the petitioner’s invested capital for the taxable year. It is in evidence that at March 20, 1916, the petitioner paid the owner of the fee $30,000 in consideration for certain modifications in the terms of the lease. The payment was made from surplus or from additional amounts paid in to the petitioner by its stockholders, and, in either event, should be included in the computation of the petitioner’s statutory invested capital for the taxable year.

Having determined the value of the leasehold in question for invested capital purposes at March 17, 1908, and at January 1, 1919, it now becomes necessary to ascertain its value at March 1, 1913, as a basis for annual deductions for exhaustion.

Before we proceed with a computation of value we must first determine the term of years to be used as the time factor of our calculations. In the light of all the conditions contained therein, is the lease for a term of 81½ years or 12½ years from March 1, 1913 ? Do the recapture clauses constitute a practical termination of the lease at the end of each revaluation period ? A careful study of the terms of the instrument here in question indicates that it is no more than a lease for ten years, in which the lessor grants the lessee an option of renewal on certain conditions that are specifically set forth. The lessee is under no obligation to renew his tenancy at any rental fixed in the lease or in advance of the reappraisal provided. Without action and acceptance on its part of new terms that never can be known in advance of ten-year appraisals, the lessee is free to retire and remove his property from the ground. So far as it relates to any term beyond which a revaluation of the ground has been made and a new rental rate accepted by the lessee, the instrument is a unilateral contract unenforceable against the lessee, who has perfect liberty to exercise his option and continue his tenancy under the new terms fixed by appraisal or to withdraw if his interests or inclinations prompt such action.

We can not know that the net differential between ground rental and income from subleases will continue beyond the first recapture date. By that time it is fair to assume that 6 per cent on the increasing value of the fee will absorb most of the differential. During the same period the building will have depreciated physically and will have become more and more unsuitable for profitable business uses, and, by 1925, it will be necessary to expend large amounts in modem-izing the original structure or in its demolition and the construction of a new building in keeping with the economic possibilities of the location. It is impossible to forecast the effect of these factors on the differential in rentals which may be entirely absorbed or greatly increased, but it is so indefinite and uncertain that it can not be used as a factor in computing value for the leasehold beyond the recapture date at which the lessee has the privilege of cancellation and surrender. We are of the opinion, on the evidence, that the value of the leasehold at March 1, 1913, should be computed on the basis of the 12½ years to elapse before another revaluation is due to be made.

In arriving at the value at March 1, 1913, of the leasehold here in question, which we have set forth in our findings of fact, we have considered ground rentals, gross income for the five years preceding that date, the differential between ground rentals and gross income, the capital value of the improvements, and the remaining effective term of the lease. The petitioner is entitled to annual deduction from its gross income of aliquot parts of $160,000 from March 1, 1913, to July 28, 1925.

Judgment will be entered on 15 days' notice, under Rule 50.


author: Love:

text:
    Appeal of Lucas E. Moore Stave Co.
    Docket No. 5146.
    Promulgated January 26, 1927.
    On tlie facts stated, held, tliat the petitioner and the Irvington Cooperage Co., were affiliated during the year 1920.

      Samuel V. Marhley, Esq., for the petitioner.

      Percy S. Crewe, Esq., for the Commissioner.
    This is an appeal from the determination of a deficiency in income and profits tax in the amount of $11,755.44 for the year 1920. The only question involved is whether the petitioner was affiliated with the Irvington Cooperage Co. (hereinafter referred to as the Irvington Company).
    FINDINGS OF FACT.
    The petitioner is a Louisiana corporation with principal place of business in New York City.
    The Irvington Company was incorporated in March, 1920. On July 9, 1920, this corporation issued capital stock as follows:
    Shares.
    Lucas E. Moore Stave Co-185½
    Charles Ossner- 62½
    A. T. Knox (in trust for petitioner)- 1
    Frank J. Davidson_ 1
    Total_250
    57694° — 27-80

      W. K. Knox was president of the Lucas E. Moore Stave Co.
    Charles Ossner was president and also foreman of the Irvington Company. The stock issued to him was issued in exchange for machinery valued at $6,250 which he had installed. On the same date as the issuance of stock, July 9, 1920, Ossner indorsed in blank his certificate for 62½ shares and delivered it to A. T. Knox, who was vice president and treasurer of the petitioner and vice president of the Irvington Company. On the same date Ossner executed an option reading as follows:
    Eor and in consideration of the sum of $1.00 receipt of which is hereby acknowledged, I agree to sell to the Lucas E. Moore Stave Company, at any time prior to January 1, 1927, the 62½ shares of stock in the Irvington Cooperage Company which I now own, for and in consideration of not less than the sum of $6,250.00 or the book value of said stock, provided the book value be in excess of the cost thereof.
    (Signed) C. Ossner.
    No transfers of stock were recorded on the stock book of the Irvington Company in 1920.
    The petitioner purchased, j>aid for, and delivered to the Irvington Company all materials and supplies used by the latter. These materials and supplies were charged by the petitioner at cost to the Irvington Company on its books, which were kept at the office of the petitioner in New York. The Irvington Company maintained no office of its own.
    With the exception of a few small cash sales, the petitioner made all sales of the product of the Irvington Company. In making-sales the petitioner in its own name billed the goods to the purchaser and collected the payments and credited the receipts to the Irving-ton Company, which service was performed without charge to the Irvington Company.
    During the year 1920 the petitioner advanced to the Irvington Company the sum of $98,038.98, upon which it neither charged nor received interest.
    The meetings of the directors of the Irvington Company were usually attended by A. T. Knox, Davidson, and Ossner.
   OPINION.

Love:

We are of opinion from the evidence that the stock of the Irvington Cooperage Co. was owned or controlled by the petitioner and that it was affiliated within the meaning of section 240 of the Revenue Act of 1918.

Judgment will he entered on days’ notice, under Rule SO.


author: Trussell:

text:
    Appeal of Stevens & Thompson Paper Co. (and Stevens & Thompson Co.).
    Docket No. 3501.
    Promulgated January 26, 1927.
    1. Invested capital. — The taxpayer’s surplus at the beginning of each of the years under consideration was properly reduced by the prorated amount of the prior year’s income and profits taxes computed according to existing regulations, and under the provisions of section 1207 of the Revenue Act of 1926.
    2. Invested capital. — The taxpayer’s surplus at the beginning of each taxable period was properly reduced by the amount of additional income taxes found to be due for the years 1913 to 1915, inclusive. Appeal of Harriet Ootton Mills, 5 B. T. A. 734, followed.
    3. Invested capital. — Invested capital at the beginning of a fiscal year may not be reduced in determining the extent to which a dividend is paid from current earnings by a tentative tax theoretically set aside out of such earnings pro rata over the year. Appeal of L. 8. Ayers & Go., 1 B. T. A. 1135, followed.

      J. R. Little, Esq., for the petitioner.

      M. N. Fisher, Esq., for the Commissioner.
    The original petition in this case raised the issue as to whether the petitioner was, during the taxable years mentioned, affiliated with the Walloomsac Paper Co., which affiliation the Commissioner had denied. Shortly before the trial the petitioner filed an amended petition as a complete substitute for the original, abandoned its issue respecting affiliation, and set up only the contentions—
    (1) That the Commissioner had erroneously reduced invested capital by the elimination of income and profits taxes due to be paid during the current year.
    (2) That the Commissioner had erroneously reduced invested capital by reducing the amount of current earnings applicable to the payment of dividends by a so-called tentative tax computation.
    The amended petition filed prior to the passage of the Revenue Act of 1926 was drawn with the apparent purpose of raising these two issues in respect both to the computation of deficiencies and the computation of overassessments covering the years and taxable periods from 1917 to a fiscal year ended June 30, 1920. In view of the provisions of the Revenue Act of 1926 limiting the jurisdiction of the Board only to those taxable years or periods in which deficiencies are asserted, the findings of fact hereinafter set forth, are made to include only the essential facts relating to the computation of deficiencies for the fiscal year ended March 31,1917, and the fiscal year ended June 30, 1919, and in respect to the issues as disclosed by amended petition. The amounts of the deficiencies asserted are for the fiscal year ended March 31, 1917, $2,345.45, and for the fiscal year ended June 30, 1919, $34,266.26.
    FINDINGS OF FACT.
    The Stevens & Thompson Paper Co. and the Stevens & Thompson Co. are corporations engaged in the manufacture of paper at North Hoosick, N. Y., both having been in business since prior to the year 1909. The deficiency letters, which are the basis of this proceeding, were dated February 20, 1925, and show the results of an audit of all the corporation excise, and income and profits-tax returns made by the petitioner and the Stevens & Thompson Co. for all the years and taxable periods from January 1, 1909, to June 30, 1920, and show various readjustments of invested capital for all or nearly all of said years and periods, resulting in additional corporation excise taxes against each of the companies for the years 1909 to 1912, inclusive, and additional income taxes for the years 1913 to 1916, inclusive. The total of such additional income taxes asserted against the two companies for those years are as follows:
    1913-$183.73
    1914- 303. 91
    1915- 187.86
    1916- 8.73
    Total- 684.23
    The total of the corporation excise taxes asserted for the years from 1909 to 1912, inclusive, against the two companies is $1,853.83.
    In computing the deficiency for the fiscal year ended March 31, 1917, the Commissioner reduced invested capital by the sum of the amounts of additional and prorated taxes as follows:
    1913 Additional income tax_$183. 73
    1914 Additional income tax_ 303.91
    1915 Total income tax prorated_ 956.70
    The Commissioner further reduced the invested capital for that period by eliminating $30,030.12 on account of a dividend paid April 30, 1916, arriving at the deduction by use of a tentative tax computation as follows:
    Invested capital (tentative)-$906,203.03
    Net income for year (books)- 206, 710. 36
    Tentative tax- 13, 629.23
    Available for dividends- 193, 081.13
    Dividend paid April 30, 1916_ 41, 876.47
    Amount of current earnings reduced by tentative tax available for dividends- 10,190.39
    Paid out of surplus- 31, 686.08
    Prorated for 11 months_ 30,013.75

      In computing the deficiency for the fiscal year ended June 30,1919, the Commissioner reduced invested capital on account of income taxes as follows:
    Additional income tax for the year 1913_ $183.73
    Additional income tax for the year 1914_ 303. 91
    Additional income tax for the year 1915_ 187. 86
    Prorated tax for the year 1918_ 3, 728. 58
   OPINION.

Trussell:

The Commissioner’s action in reducing taxpayers’ surplus at the beginning of the several periods here under consideration by the amount of the prior year’s income and profits taxes appears to have been made in accordance with existing regulations, and under the provision of section 1207 of the Revenue Act of 1926 such reduction of invested capital must be approved.

The computations of additional income taxes for the years 1913 to 1915, inclusive, as made by the Commissioner, do not appear to be questioned or to be in any way in issue in this proceeding. We must therefore conclude that the amounts of such taxes were due and owing to the United States prior to the beginning of the taxable year ended March 31, 1917, and, following the rule laid down in the Appeal of Harriet Cotton Mills, 5 B. T. A. 734, we must hold that they were for that and each subsequent period here under consideration properly eliminated from invested capital.

We have heretofore held in the Appeal of L. S. Ayers & Co., 1 B. T. A. 1135, that in the computation of invested capital for any period the amount of current earnings applicable to dividends paid during such period may not be reduced by a tentative tax computation. In the instant case it appears that the consolidated net income for the period ended March 31, 1917, was $206,710.36; that under the rule-of the Ayers case, supra, one-twelfth of that amount was current earnings applicable to the payment of dividends on April 30, 1916; that the total tax liability of these taxpayers for that period was found by the Commissioner to be $13,636.74. It is thus seen that the taxpayers’ profits and income for the fiscal year were much more than sufficient to cover the amount of current earnings distributed in dividends on April 30, 1916, and the total tax liability for the full year. And, therefore, without discussing when income and profits taxes may be said to accrue, we are convinced that the rule in the Ayers case, supra, must govern in the instant case.

Order of redetermination will be made upon 15 days' notice, pwrsuant to Rule 50, and judgment entered m due course.


text:
    Gopher Granite Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 6631.
    Promulgated January 26, 1927.

      Samuel Lipsehultz, Esq., for the petitioner.

      A. H. Fast, Esq., for the respondent.
   Trussell:

This is a proceeding for the redetermination of a deficiency in income and profits taxes for the fiscal year ended October 31, 1920, in the amount of $1,386.80.

The petitioner claims that the Commissioner erred in disallowing a deduction of $3,144.97, the same being the cost of exploring a certain tract of land for the purpose of developing a granite quarry, and in disallowing a deduction of $425, paid in settlement of petitioner’s liability on certain corporate stock.

At the hearing counsel for the petitioner and counsel for the Commissioner,- by agreement, read into the record a stipulation that the amount expended during the fiscal year in question in the development work was $3,144.97.

FINDINGS OF FACT.

The petitioner is a corporation having its principal place of business at St. Cloud, Minn. It was organized in the year 1917 and has since that time been engaged in the business of making monuments.

On October 9, 1919, it entered into a lease with the wife of the president of the petitioner corporation, under which it undertook to explore and, if found practicable, to develop a granite quarry upon the leased premises.

Retween November 1, 1919, and June, 1920, the petitioner expended for labor and equipment in the prospecting and exploring of the leased premises the amount of $3,144.97, to determine whether said premises contained granite of such commercial quality and quantity as would warrant the operation of a quarry and the production of granite of the character required by the petitioner in its business. Six hundred dollars of this amount was paid for the purchase of such equipment as was deemed necessary for use in the opening up of a granite quarry. Two thousand five hundred and forty-four dollars and ninety-seven cents was paid for labor and services for removing forest growth and uncovering the surface of the granite and placing two test holes. The result of the work up to this time demonstrated that the granite rock uncovered was of a character wholly unfitted for use in the petitioner’s business, and the attempted development of a granite quarry was then, in June, 1920, abandoned. The equipment was moved to the yards of the petitioner’s manufacturing plant and was sold piecemeal during the years 1920 and 1921, and the last of it was disposed of as junk in the year 1922.

At the time the petitioner corporation was organized it acquired $6,800 par value of the capital stock of the Sauk Rapids Granite Co., which latter company became bankrupt in 1919, and its receiver brought a suit against the petitioner to enforce the stockholders’ liability. This suit was settled by the petitioner in 1922 by the payment of $425.

The sum of $2,544.97 is an allowable deduction from gross income for the fiscal year ended October 31, 1920.

The $600 paid for quarry equipment was a capital item in the year ended October 31, 1920, and no part of it is deductible for that year.

The $425 paid in settlement of a lawsuit in 1922 is not a deduction for the year 1920.

A redetermination- m accordance with the foregoing findings of fact will be made on 15 days' notice,. pursuant to Buie 50, amd judgment entered accordingly.


author: Trammell:

text:
    A. M. Robinson Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 5652.
    Promulgated January 27, 1927.
    1. Invested capital may not be reduced in determining the extent to which a dividend is paid from current earnings of a year by a “tentative tax” theoretically set aside out of such earnings pro rata over such year.
    2. In the absence of evidence that the action of the respondent in reducing invested capital on account of depreciation sustained was erroneous, his action is approved.

      Sidney J. Sayles, G. P. A., for the petitioner.

      Ward Loveless, Esq., for the respondent.
    This is a'proceeding for the redetermination of a deficiency in income and profits tax for the fiscal year ended October 31, 1920, in the amount of $883.47. The deficiency results from the action of the respondent in (1) deducting from invested capital a tentative tax computed in connection with a dividend paid during the year; (2) in disallowing a portion of the deduction claimed for depreciation on machinery, equipment, furniture and fixtures; (3) in reducing invested capital by the amount of a rejected claim for the abatement of additional income and profits taxes for 1918; (4) in reducing invested capital by the amount of adjusted income and profits taxes for the year 1919, prorated; and (5) in excluding from invested capital the amount of a reserve for depreciation which had been written ofi by the petitioner but restored by it to the books.

      FINDINGS OF FACT.
    The petitioner is a Georgia corporation with its principal office at Atlanta. During the period involved in the appeal it operated two plants, one known as the manufacturing plant and the other as the Robinson Shirt Co. On January 5, 1920, the petitioner paid a cash dividend of $51,250. Its books were not closed on that date nor was its net income otherwise determined for the expired portion of the taxable year.
    The respondent determined the taxpayer’s net income, including dividends, to be $166,868.53 for the entire year ended October 31, 1920. A tentative tax of $33,121.64 was determined by the respondent upon the income for the entire year. He deducted the amount of the tentative tax from the total income and found that there was a balance of $133,146.89 available for dividend distribution. Since the taxpayer did not close its books at January 5, 1920, this income was divided by 365 days and a daily average income of $365.42 found. Since 65 days had elapsed at the time of the payment of the dividend, the respondent determined that there were earnings available for distribution up to that date of $23,752.30. The dividend paid exceeded this amount by $27,497.70. The respondent prorated the $27,497.70 over a period of 301 days. The resulting amount was $22,614.23, by which petitioner’s invested capital was reduced. The petitioner made its return on the accrual basis. It had a reserve account for Federal income and profits taxes in which it had set up an amount of $9,993.53 on October 31, 1920.
    The assets of the two plants were carried on petitioner’s books at $18,127.56 on October 31, 1912. To that date there had been set up as a reserve for depreciation $9,745.42. On October 31, 1918, an entry was made charging the reserve for depreciation account with $9,745.42 and crediting the undivided profits account with the same amount. No appraisal had been made of the assets as of March 1, 1913. Sales and inventories for the Manufacturing Plant and the Robinson Shirt Co. were as follows:

      The petitioner in its return claimed depreciation in the amount of $2,187.64 on its plants, equipment, furniture, and fixtures. This amount was reduced to $977.12 by the respondent.
    The respondent reduced the invested capital by $9,993.53, representing the amount of a rejected claim for the abatement of additional income and profits taxes for the year 1918. He also reduced the invested capital by $48,483.54, representing the prorated amount of the adjusted income and profits taxes for the year 1919.
    The respondent reduced the invested capital by increasing the amount of a reserve for depreciation by $10,614.83, of which $9,845.42 represented depreciation written off prior to March 1, 1913, but which was restored by the petitioner to its books by an entry made on October 31,1918.
    On October 31, 1916, the total amount of the reserve for depreciation that had been set up on petitioner’s books was $16,350.76. The assets against which this reserve had been set up were carried on the books at $19,835.38. In determining petitioner’s surplus as of October 31,1916, which surplus was carried forward in the computation of petitioner’s invested capital for the year under consideration, the respondent allowed in the asset account an amount of $5,042.89, or $1,558.27 in excess of the undepreciated amount of the assets as shown by the books.
   OPINION.

Trammell:

The petitioner contends that the income should not be reduced by a tentative tax in determining the amount available for distribution from the earnings for the expired portion of the taxable year.

We considered this question in the Appeal of L. S. Ayers & Co., 1 B. T. A. 1135. There we held that the respondent’s action in reducing the invested capital of a corporation in determining the extent to which a dividend is paid from current earnings of a year by a tentative tax theoretically set aside out of such earnings prorated over the year was erroneous.

Since our decision in the Ayers appeal, the Supreme Court in the case of United States v. Anderson, 269 U. S. 422, has held that the munitions tax for 1916 accrued and was deductible in that year by a corporation which reported on the accrual basis.

In reaching that decision the court said:

Only a word need tie said with reference to the contention that the tax upon munitions manufactured and sold in 1916 did not accrue until 1917. In a technical legal sense it may be argued that a tax does not accrue until it has been assessed and becomes due; but it is also true that in advance of the assessment of a-tax, all the events may occur which fix the amount of the tax and determine the liability of the taxpayer to pay it. In this respect, for purposes of accounting and of ascertaining true income for a given accounting period, the munitions tax here in question did not stand on any different footing than other accrued expenses appearing on appellee’s books. In the economic and bookkeeping sense with which the statute and Treasury decision were concerned, the taxes had accrued.

Subsequent to the decision of the Supreme Court in the above case, we have affirmed the decision in the Appeal of L. S. Ayers & Co. as not being in conflict therewith. Appeals of Washington Motel Co., 4 B. T. A. 441; Amalgamated Sugar Co., 4 B. T. A. 568.

In attempting to show that its depreciable assets had a fair market value on March 1, 1913, equal to the cost price at which they were carried on the books without any allowance for depreciation, the petitioner introduced evidence showing the sales made by each plant and its inventories from 1912 to 1921. The only witness offered by the petitioner testified entirely from the books. He stated that he was not employed by the petitioner on March 1, 1913, that he had no personal knowledge as to the fair market value of the petitioner’s assets on that date, and that he did not know how long the assets had been in use prior to that date. The books show that on October 31, 1912, the depreciable assets were carried at $18,127.56. Against this a reserve for depreciation, amounting to $9,745.42, had been set up leaving a book value of $8,382.14 on October 31, 1912.

Ten thousand six hundred and fourteen dollars and eighty-three cents was eliminated from the invested capital by the respondent and restored to the reserve for depreciation account; $9,745.42 of that amount represented depreciation written off prior to March 1, 1913, but restored to the books on October 31, 1918. Wo are unable to find from the evidence that the depreciation written off prior to March 1, 1913, was not sustained prior to that date, nor can we find from the evidence that the fair market value of the assets on that date was greater than their undepreciated value as shown by the books. There is no evidence that the reduction of invested capital on account of depreciation sustained subsequent to March 1,1913, was erroneous. The adjustment made by the respondent is, therefore, sustained. Nor is there any competent evidence that the action of the respondent with respect to the deduction on account of depreciation in determining taxable income was erroneous.

No error is shown to have been committed by the respondent in reducing invested capital by the amount of a disallowed claim for abatement. If there was a liability for unpaid taxes for prior years, earned surplus should be reduced by such amount. In the absence of evidence showing error in this respect, we affirm the respondent’s determination.

The action of the respondent in reducing invested capital on account of income and profits taxes for the prior years is in accordance with section 1207 of the Revenue Act of 1926.

During the hearing the respondent asked and was granted leave to amend his answer to the petition by setting up an averment that the petitioner’s invested capital for the year in question should be further reduced by an amount of $1,558.2?, representing the difference between the value of petitioner’s assets as shown by its books and that allowed by the respondent in determining surplus at October 31, 1916. The testimony is not sufficient to sustain the respondent’s affirmative allegations. Therefore, the invested capital for the year ended October 31, 1920, should not be further reduced by $1,558.2?.

Judgment will be entered after 15 days' notice, under Bule 50.


text:
    Standard Gas Products Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 9843.
    Promulgated January 27, 1927.

      Sidney J. Sayles, G. A. P., for petitioner.

      M. N. Fisher, Fsq., for the respondeht.
   Trammell:

This is a proceeding for the redetermination of deficiencies in income and profits taxes for 1920 and 1921, in the amounts of $95.22 and $1,427.13, respectively. The deficiencies result from the refusal of the Commissioner to permit the petitioner and the Southern Oil Treating & Hardening Co. to file a consolidated return as affiliated corporations under section 240 (b) of the Revenue Act of 1918.

FINDINGS OF FACT.

The petitioner, sometimes hereinafter referred to as the Standard Company, is a Georgia corporation organized in 1913 with its principal place of business at Atlanta. It was engaged in selling and distributing oxygen gas and supplies, such as welding and cutting apparatus and fluxes. The Southern Oil Treating & Hardening Co., sometimes hereinafter referred to as the Southern Company, is a Georgia corporation organized in 1919 with its principal office and place of business at Atlanta, and during the years involved was operated in connection with the Standard Company. It was organized for the purpose of furnishing oxygen gas to the Standard Company at a lower cost than that company was required to pay to other companies and because the company from which it had been buying it had had an explosion. In producing oxygen it simultaneously produced hydrogen, which was used in the process of hardening cotton seed oil.. The Southern Company charged the Standard Company a fixed price of $1 per cylinder or 50 cents a cubic foot. That price, which was less than the market price, was fixed by Bawling and Wilcox, the owners of the stock of the Standard Company and the officers of both companies. Wilcox and Bawling borrowed from a bank $135,000 with which to establish the plant of the Southern Company, and the Standard Company also loaned that company money to complete the plant and pay off obligations. For some of the money advanced by the Standard Company to the Southern Company, Wilcox and Bawling gave their notes and put up some of their own stock as security with Mrs.'Bawling and Mrs. Wilcox, who sold real estate to raise the money. The Southern Company gave no security for any money borrowed from the Standard Company.

The two companies occupied the same offices and had the same directors, officers, accountants and bookkeeper. Expenses were allocated between the two companies. The following is a statement of the stock holdings of the two companies during 1920 and 1921:

Clementine B. Bawling, who was the record owner of 50 shares of stock in the Southern Company during 1920, was the wife of Bawling, majority stockholder of the Standard Company, and Katharine B. Wilcox, who owned of record 150 shares in the same company, was the daughter of Bawling and the wife of Wilcox, a stockholder of the Standard Company. This stock belonged to Wilcox and Bawling but was transferred to and held by Mrs. Wilcox and Mrs. Rawling as security for money borrowed by the Standard Company for the Southern Company.

George Trippe was an employee of both the Standard Company and the Southern Company.

Shepard Bryan was attorney of both the Standard Company and the Southern Company and assisted in the organization of the latter company and in shaping its policies. He was the personal attorney of Wilcox and Rawling. T. C. Law, a chemist, acted in an advisory capacity in the Southern Company. He acquired his stock for services rendered.

J. T. Carson acquired his stock as a means of inducing the company to grant him favors in the placing of insurance.

The stock owned by H. B. Darling during 1921 was acquired for services rendered.

All of the stockholders of both companies are close business associates. Substantially all the stock of the Southern Company was owned by the Standard Company or controlled through closely affiliated interests. The two companies were affiliated within the meaning of section 240 (b) of the Revenue Act of 1918.

Judgment will be entered on 15 days’ notice, under Rule 50.


author: Marquette:

text:
    Appeal of Pacific Realty Corporation.
    Docket No. 4526.
    Promulgated January 27, 1927.
    1. The March 1, 1913, value of certain real estate, acquired by the petitioner prior to that date, determined.
    2. The petitioner in computing its net income for the year 1919 is not entitled to deduct, as a debt ascertained to be worthless and charged off within the taxable year, the amount of the promissory note involved herein.

      Edwin G. Dutton, Esq., and Don R. Hutchinson, Esq., for the petitioner.

      Thomas P. Dudley, Jr., Esq., for the Commissioner.
    This appeal is from the determination of a deficiency in income and profits taxes for the year 1919 in the amount of $16,214.02.
    FINDINGS OF FACT.
    The petitioner was, during the year 1919, a corporation organized and existing under the laws of the State of Washington, and was engaged in the business of selling real estate at Tacoma, Wash. The outstanding capital stock of the corporation was, during the year 1919, of the par value of $183,960, of which all but one share was owned by James B. Thompson, president of the corporation. The corporation was dissolved in the year 1924.
    During the years 1918 and 1919, the petitioner sold certain real estate, which it had acquired prior to March 1, 1918. The Commissioner, in computing the profits and losses from the sales, used as a basis therefor the cost of the real estate. The description of the real estate in question and the March 1, 1918, value thereof are as follows:

    Some time in the year 1909, James It. Thompson met one Frank H. Pilling, whom he had formerly known in Montana. Pilling informed Thompson that he was purchasing real estate in Tacoma and asked Thompson to endorse a check for him in the amount of $18,000. Thompson endorsed the check and Pilling obtained the money thereon. Subsequently, the check was returned, marked “ no funds,” and Thompson had to pay the amount thereof. Pilling thereupon turned over to Thompson certain real estate worth $800 and gave him his, Pilling’s, note for $17,200, dated December 27, 1909, due in five years and bearing interest at the rate of 6 per cent from date, the interest being payable at the maturity of the note. From December 27, 1909, until the date the note matured, Thompson did not know where Pilling was and never saw him again until subsequent to June 24, 1919, although a short time prior to June 24, 1919, he had heard from some source that Pilling was cashier of a bank at Everett, Wash. Thompson held the note in question until June 24, 1919, at which time no part of the principal or the interest due thereon had been paid. On that date, Thompson was indebted to the petitioner in the amount of about $39,000. The manager of the petitioner corporation, one Gamer, who owned the one share of the capital stock not owned by Thompson, suggested to Thompson that he should reduce his indebtedness. Thompson thereupon endorsed the note in question to the petitioner, without recourse, and in consideration thereof, his indebtedness to the corporation was canceled to the extent of $17,200, the face value of the note. Shortly thereafter Thompson met Pilling at Everett, Wash., and stated to him that he, Thompson, had transferred the note in question to the petitioner herein and that the petitioner would make trouble for him, Pilling, unless the note was paid. Pilling, who in fact was not the cashier of a bank, but was an employee of the Merchant’s Association of Everett, said that he could not pay anything on the note at that time, but would try to pay it eventually. The petitioner, on November 17,1919, brought suit against Pilling to collect the amount of the note and the interest due thereon. On November 29, 1919, Pilling filed a voluntary petition in bankruptcy and was adjudicated a bankrupt on December 1, 1919. The petitioner did not further prosecute its action against Pilling on the note, but on December 5, 1919, filed a claim in the bankruptcy proceedings for the amount of the note and interest. Pilling was discharged from bankruptcy on March 18, 1920, and the petitioner received nothing on its claim. On December 31, 1919, the note in question was charged off as worthless on the petitioner’s books, and in its income and profits-tax return for the year 1919 it deducted from gross income the amount of the note, $17,200, as a debt ascertained to be worthless and charged off within the taxable year. The Commissioner disallowed the deduction.
   OPINION.

Marquette:

The petitioner alleges that the Commissioner erred in computing the profits and losses from the sale of the several parcels of real estate involved in this appeal, in that he used as a basis therefor the cost of the real estate rather than the March 1, 1913, value thereof. The Commissioner admits, in his answer, that such profits and losses were computed on the basis of cost.

The evidence herein establishes to our satisfaction that the several parcels of real estate were acquired by the petitioner prior to March 1, 1913, and that they had, on that date, the values set forth in the findings of fact. There appears to be no dispute between the petitioner and the Commissioner as to the cost of the real estate or the amounts for which it was sold. On the sale of property acquired prior to March 1, 1913, profits should be computed by taking as a basis therefor the cost or March 1, 1913 value, whichever is higher, Goodrich v. Edwards, 255 U. S. 527; Walsh v. Brewster, 255 U. S. 536, and losses should be computed by taking as the basis therefor the cost or March 1, 1913, value, whichever is lower. United States v. Flannery, 268 U. S. 98; McCaughn v. Ludington, 268 U. S. 106. The profits or losses arising from the sale of the real estate in question should be computed on that basis.

The only other question for determination is whether or not the petitioner, in computing its net income for the year 1919, should be allowed to deduct, as a debt ascertained to be worthless and charged off within the taxable year, the amount of the Pilling note. We are of the opinion, upon consideration of the evidence presented, that we would not be justified in allowing the deduction. The testimony as to this point is conflicting and we are not satisfied that the note had any value whatever when it was assigned by Thompson to the corporation, or that the transaction between Thompson and the corporation was a bona fide transaction between parties dealing at arm’s length.

Judgment will be entered on 15 days' notice, under Rule 50.