Opinion
Docket Nos. 15154 15162.
1948-09-28
R. T. MYERS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.EVA L. MYERS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Thomas Y. Banks, Esq., for the petitioners. John P. Higgins, Esq., for the respondent.
1. X and Y partnership was engaged in the business of drilling oil wells. It agreed to drill wells for Z in return for an oil payment of $52,000. The cost of X and Y of performing the contract was $27,000, including an item of ‘material and equipment‘ of $14,000. In the contract between the partnership and Z, it was agreed that the material and equipment furnished in the performance of the contract should remain the property of the partnership ‘until same has been paid for in full.‘ Held, partnership held a depletable interest in oil in place. T. W. Lee, 42 B.T.A. 1217;affd., 126 Fed.(2d) 825.
2. Other issues disposed of on facts. Thomas Y. Banks, Esq., for the petitioners. John P. Higgins, Esq., for the respondent.
In these cases, consolidated for hearing and opinion, the respondent determined deficiencies in income tax for the year 1941 against each petitioner in the amount of $1,701.20. These deficiencies resulted from respondent's adding to the community income, as shown by the returns, the amount of $21,104.78 as ‘Unallowable deductions and additional income: (a) Partnership income increased.‘ This is explained by respondent in an attached ‘Explanation of Adjustment.‘ These explanations may be summarized as follows: (1) Respondent disallowed certain deductions claimed on the 1941 returns of partnerships in which R. T. Myers was a partner, and of one alleged partnership in which both petitioners purported to be partners, those deductions being those taken in the return of the partnership of Richards, Holloway & Myers for interest in the sum of $80.71, and for material and supplies in the sum of $6,895.53; those deductions taken in the return of the partnership of Myers & Holloway for depreciation in the sum of $463.91, and for ‘Boguss lease judgment‘ in the sum of $349.19; and those deductions taken in the return of the alleged partnership of R. T. Myers, Sr., Eva L. Myers, R. T. Myers, Jr., and Evelyn Myers Lake, for repairs and supplies in the sum of $6,642.69, and for labor in the sum of $4,917.39; (2) respondent determined that the correct amount of profit from contracts reported in the return of the partnership of Richards, Holloway & Myers is $11,138.86; (3) respondent disallowed a deduction claimed in the partnership return of Richards, Holloway & Myers for an auditing fee of $1,000 upon his determination that this was ‘paid as a volunteer for the partnership composed of C. C. Richards and C. O. Holloway, and not as a cost or expense of the partnership of Richards, Holloway & Myers * * * ‘; and (4) respondent determined that the alleged partnership of R. T. Myers sr.,., Eva L. Myers, R. T. Myers, Jr., and Evelyn Myers Lake, was not to be recognized for tax purposes, and therefore, included the total income of the alleged partnership in the community income of petitioners.
In the amended petitions filed herein petitioners alleged error on the part of respondent as to the increase of the partnership income in the sum of $21,104.78, and as to all of the adjustments outlined in respondent's ‘Explanation of Adjustment,‘ with the exception of the disallowance of the depreciation deduction taken by Myers and Holloway, and the further exception of the disallowance of the auditing fee. In addition, petitioners allege error on the part of respondent ‘in determining the income of the partnership of Richards, Holloway and Myers, upon a 'completed-contract’ basis,‘ in determining the income of the family partnership ‘by treating the disbursements for 1941 on a completed-contract basis, while treating the receipts for said year on a basis of cash receipts,‘ and ‘in treating the $22,500 received on the Beulah Emmett sale and contract, as cash receipts, in 1941, while treating expenditures for account of the contracts of the partnership on a completed-contract basis.‘
At the hearing herein petitioners conceded the correctness of respondent's disallowance of the deduction taken in the return of the partnership of Holloway & Myers for ‘Boguss lease judgment,‘ and that only $50.34 was deductible as interest paid by Richards, Holloway & Myers during the taxable year. Petitioners also conceded that respondent did not err in his determination that the income of the alleged family partnership should be included in the community income of petitioners. With regard to the amount of the net income of the alleged family partnership, petitioners now contend, as alleged in the amended petition, that the amount of the deduction for repairs and supplies should be $3,607.50 instead of $6,642.69, and that the amount of the deduction for labor should be $3,586.52 instead of $4,917.39.
The following issues are therefore pending for our decision in these cases: (1) Whether a deduction taken by Richards, Holloway & Myers on account of interest is allowable in the sum of $50.34; (2) whether the same partnership properly took a deduction in the sum of $6,895.53 on account of materials and supplies; (3) the correct amount of profits realized by this partnership from a certain drilling contract; (4) whether petitioners may be allowed as a deduction the sum of $3,607.50 now claimed to have been expended by the family partnership for repairs and supplies; (5) whether petitioners may be allowed a deduction in the sum of $3,586.52 now claimed to have been expended by the family partnership for labor and services; and (6) whether respondent erred in treating certain items of income and expense incident to several drilling contracts of the several partnerships on a ‘completed-contract basis.‘
FINDINGS OF FACT.
Petitioners are husband and wife. They lived during the taxable year in Tyler, Texas. They filed separate tax returns for 1941 with the collector of internal revenue for the second district of Texas, in which they reported their income on a community basis and on a cash basis. The tax returns of the several partnerships hereinafter referred to were filed in the same collector's office and state that they were prepared on the cash basis. R. T. Myers will hereinafter be called the petitioner.
The partnership of Richards, Holloway & Myers was formed in 1939 for the purpose of carrying on the business of drilling oil wells. Richards and Holloway were experienced drillers. Petitioner furnished money and credit to the partnership venture. This partnership ceased doing business in April 1941. Holloway and petitioner continued the business until the latter part of 1941 as a new partnership, called Holloway & Myers. The bank account of each partnership was carried in the name of ‘R. T. Myers, Trustee.‘
The books and records of these partnerships were missing at the time of the hearing herein.
Sometime during 1941 a partnership was purportedly formed consisting of petitioner, Eva L. Myers, R. T. Myers, Jr., and Evelyn Myers Lake. The last two named individuals were the son and daughter, respectively, of petitioner and Eva L. Myers. During the latter part of 1941 petitioner, purportedly acting on behalf of the alleged family partnership, began the drilling of two wells. After the dissolution of the partnership of Holloway & Myers, petitioner took over from this partnership a drilling rig and other equipment, including two trucks and miscellaneous tools. The bank account of this alleged partnership was kept in the names of all of the purported partners. Its only records consisted of this bank account, which was used for personal as well as business purposes, and upon which each of the four individuals could draw checks. After the dissolution of the other two partnerships, petitioner frequently drew checks upon this account in payment of obligations still owing from the partnerships of Richards, Holloway & Myers and Holloway & Myers.
ISSUE NO. 1.
At some time prior to 1941, the partnership of Richards, Holloway & Myers purchased supplies from the Frontenac Pipe Line Co. To evidence the resulting debt owed to that company, the partnership executed a note in the principal sum of $2,000. The partnership paid the principal amount of the note at the rate of $125 per month. It also made periodic payments of interest thereon. During 1941 the partnership paid interest upon the indebtedness evidenced by this note in the total amount of $50.25.
ISSUE NO. 2.
The partnership of Richards, Holloway & Myers purchased pipe, tubing, casing, and other supplies needed in its business from the National Supply Co. On November 15, 1940, the partnership was indebted to that company on account of such purchases in the sum of $6,099.38, and executed to it a note in that amount bearing interest at 6 per cent. On April 1, 1941 (the approximate date of the dissolution of the partnership) it was indebted to the same company on account of a balance due on additional purchases made by it in the sum of $950.13, and executed a note in this amount with interest at 6 per cent. On October 17, 1941, the National Supply Co. drew a draft upon petitioner, Richards, and Holloway for $6,403.36, representing the unpaid principal due upon these notes in the sum of $6,375.97, plus unpaid interest. Since the partnership had ceased doing business, and its bank account was closed, each of the former partners upon whom the draft was drawn paid the draft and the notes by his own personal check for one-third of the amount due thereon.
The sum of $6,375.97 was properly deducted by the partnership of Richards, Holloway & Myers in its income tax return for the year 1941 as payments made by it in that year for materials and supplies.
ISSUE NO. 3.
The income tax return of the partnership of Richards, Holloway & Myers filed for the year 1941, on Form 1065, showed only a loss of $8,734.97. There was attached to the return a ‘Profit & Loss statement for the year,‘ which reads as follows:
+-----------------------------------------------------------------------+ ¦Income Drilling Contract: ¦ ¦ ¦ +--------------------------------------------------+---------+----------¦ ¦H. L. Swindler, et al ¦ ¦$29,302.48¦ +--------------------------------------------------+---------+----------¦ ¦Miller Production Co ¦ ¦8,323.50 ¦ +--------------------------------------------------+---------+----------¦ ¦Mudge Oil Co ¦ ¦23,231.45 ¦ +--------------------------------------------------+---------+----------¦ ¦Gross ¦ ¦60,867.43 ¦ +--------------------------------------------------+---------+----------¦ ¦Deductions: ¦ ¦ ¦ +--------------------------------------------------+---------+----------¦ ¦Cost of drilling—see schedule ¦ ¦54,474.33 ¦ +--------------------------------------------------+---------+----------¦ ¦ ¦ ¦6,393.10 ¦ +--------------------------------------------------+---------+----------¦ ¦Labor and supplies—not in above ¦$5,688.49¦ ¦ +--------------------------------------------------+---------+----------¦ ¦Interest ¦80.71 ¦ ¦ +--------------------------------------------------+---------+----------¦ ¦National Supply Co. for materials used in drilling¦6,895.53 ¦ ¦ +--------------------------------------------------+---------+----------¦ ¦Unemployment and social security tax ¦1,463.34 ¦ ¦ +--------------------------------------------------+---------+----------¦ ¦Auditing ¦1,000.00 ¦ ¦ +--------------------------------------------------+---------+----------¦ ¦ ¦ ¦15,128.07 ¦ +--------------------------------------------------+---------+----------¦ ¦Loss ¦ ¦8,734.97 ¦ +--------------------------------------------------+---------+----------¦ ¦ ¦ ¦ ¦ +-----------------------------------------------------------------------+
Division C .C. Richards, 1/3 $2,911.65 C .O. Holloway, 1/3 2,911.65 R .T. Myers, 1/3 2,911.65
The schedule referred to in this statement breaks down the drilling cost among the three drilling operations, showing the costs allocable to the so-called Swindler contract to be $26,362.06, the costs allocable to the Mudge Oil Co. contract to be $20,295.84, and the costs allocable to the Miller Production Co. contract to be $7,816.34.
The respondent, in his determinations of deficiency, made no adjustment with regard to the Miller Production Co. operation, and with regard to the Mudge Oil Co. operation, he increased by $601 the partnership's cost of drilling. However, with regard to the so-called Swindler contract, the respondent made the following adjustments:
+--------------------+ ¦Drilling Operations ¦ +--------------------¦ ¦ ¦ ¦ ¦ +--------------------+
Computation of Realized Profit as Corrected Swindler Contract Contract price (oil payment) $52,000.00 Cost of contract: Labor—pay roll $2,445.32 Labor—contract 956.21 Gas and oil 725.63 Trucking 896.67 Supplies and equipment 14,930.79 Derricks 2,550.00 Water 1,200.00 Cementing and drilling 2,000.00 Miscellaneous 1,472.44 Pits 185.00 Total Cost 27,362.06 Gross profit 24,637.94 Percentage of profit: $24,637.94/52,000.00, equals 47.38% Collections: Received direct $4,302.48 Credited on bank note 13,209.50 Total 17,511.98 Taxable profit, $17,511.98 X 47.38% 8,297.18
Petitioners do not now contest the accuracy of the figures used above by respondent as the costs under this contract, as the total receipts by the partnership in 1941, and as the ‘contract price (oil payment).‘ Petitioners contend that respondent's method of arriving at the amount of taxable profit under this contract is erroneous, in view of the provisions of the contract which is incorporated herein by reference.
The pertinent parts of that contract (in which the Swindlers were named as parties of the first part and Richards, Holloway, and petitioner were named as parties of the second part), are as follows:
WHEREAS, the parties of the first part desire to have drilled and the parties of the second part desire to drill the four oil and/or gas wells to be known as wells 8, 9, 10, 11, for the parties of the first part, and being on the following described property:
The parties of the second part contract and agree to drill the four oil and/or gas wells and to be known as wells Nos. 8, 9, 10 and 11 on the terms of which is known as ‘Turnkey Basis‘ furnishing all labor, material and equipment necessary to complete the said four wells into the tanks, provided they flow of their own accord, and after services shall include in part as follows: labor, superintendent, water, fuel, cement, and the cost of cementing, trucking and team work, compensation and public liability insurance, old age benefit tax, all materials and equipment, which equipment is hereinafter set out in part and incident to drilling and completing said four oil and/or gas wells on the above described property.
It is agreed that the following equipment be used in and on said well, or wells, and such other material and equipment as is necessary to make a complete ‘Turnkey Job.‘
4— 87' x 20' Stell Derricks, set on concrete corners and left set-up over said well, or wells, when completed, and must be either new or A-1 second-hand.
4— Strings of Surface Casing, footage enough to fulfill all requirements in that area.
4— Slush Pits.
4— Complete Strings of 5 1/2‘ OD Casing and must be A-1 tested and inspected second-hand and being approximately 3800’ per well.
Float shoes, Braden heads, Flow lines, Xmas trees, and all well fittings and connections complete.
Now, for and in consideration of the sum of Thirteen Thousand ($13,000.00) Dollars for each well drilled, or a total sum for the entire four oil and/or gas wells drilled to be Fifty-Two Thousand ($52,000.00) Dollars, payable out of 765625% (sic) of the gross production from the four oil and/or gas wells drilled under this contract and known as wells Nos. 8, 9, 10 and 11, * * *
It is further distinctly understood and agreed that the title to material and equipment furnished by the second parties in the performance of this contract shall remain the property of the second parties and shall not pass to or become vested in the first parties until same has been paid for in full. This provision, however, is applicable to each well separately so that in the event one or more wells are drilled under the terms of this contract and the considerations, therefor are fully paid as to such well, or wells, then at the time of the payment of said considerations in full for the drilling and equipping of said particular well, title shall then and there vest in and become absolute in the parties of the first part, their successors and assigns, and the second parties will not be entitled to any lien of any kind or character upon said material, equipment, or wells so drilled and paid for, which secured the payment for the operation created incident to the drilling and completing either of the wells or any additional wells to be drilled under this contract, and for a further consideration to the parties of the first part and the parties of the second part the overriding royalty owners herein namely, viz.; the Mayfield Company, having an interest of 15624905% (sic throughout), and the Continental Royalty Company having an interest of 11718754%, and Troy Smith, having an interest of 01562491%, for which each agrees to release it or their interest to the first and second parties until each of the interests have paid the respective amounts: Mayfield Company, $1,714.28; Continental Royalty Company, $1,285.72; and Troy Smith, $171.43 per well, which consideration the Mayfield Company, Continental Royalty Company and Troy Smith are giving for the drilling of each well, aggregating $3,171.43, and this amount is to go to the parties of the second part until the second parties have received the sum of $3,171.43 for each well out of the overriding royalty interest. * * *
ISSUE NO. 4.
In its income tax return for the year 1941, the family partnership took as a deduction the sum of $6,642.69 for ‘repairs and supplies,‘ with the explanatory note that this represented ‘Repairs & Supplies to drilling rig and supplies on well drilled by Myers & Holloway, paid by the partnership and belonging to same.‘ Petitioners now contend that this deduction should be allowed in the sum of $3,607.50, representing the sum of $3,028.73 expended for materials used by the family partnership in its own drilling operations and $578.77 representing one-half of the bills and accounts paid by it for the partnership of Holloway & Myers.
During the year 1941 petitioner made payments on behalf of the alleged family partnership on account of materials and supplies used by it in the total sum of $2,007.53.
During the year 1941 petitioner made payments from the bank account of the alleged family partnership on account of unpaid bills for materials and supplies of the partnership Holloway & Myers in the total sum of $1,182.35.
ISSUE NO. 5.
In its income tax return for 1941, the family partnership took a deduction in the sum of $4,917.39 for ‘labor,‘ with the explanatory note that this represented ‘Labor paid on Florida deal, watching time, truck driver and on well drilled by Myers & Holloway, paid by partnership and belonging to same. ‘ Petitioners now contend that this deduction should be allowed in the sum of $3,586.52, representing the sum of $3,225.15 paid on account of labor and services rendered to the family partnership during the taxable year and $361.37 representing one-half of the amounts paid by petitioner from the bank account of the family partnership in payment of bills for labor and services rendered to the partnership of Holloway & Myers.
During the year 1941 petitioner made payments on behalf of the alleged family partnership on account of labor and services rendered to it in the sum of $2,902.74; and made payments from the bank account of the family partnership on account of unpaid bills for labor and services rendered to the partnership of Holloway & Myers in the sum of $519.20.
The total amount of the deduction allowable under this issue is $3,162.34.
ISSUE NO. 6.
The income tax returns of the several partnerships for the year 1941 were prepared and filed on the cash basis.
No action taken or adjustment made by respondent incident to the determinations of deficiency here involved were inconsistent with such basis.
OPINION.
KERN, Judge:
The questions for decision involved in issues 1, 2, 4, 5 and 6, have been decided in our findings of fact stated under each issue.
Any discussion of the long and tedious record made at the hearing upon these issues would be unnecessary and unprofitable. We content ourselves with three observations. First, as to the issues which we have decided in favor of petitioners, and the amounts thereof, petitioners have borne the burden of proof by the narrowest of margins. Second, as to issue No. 6, we have been unable to discover any basis whatsoever to petitioners' contention. Third, for this tribunal to spend many hours refereeing, in effect, an impromptu audit of three partnerships is a waste of its time and is to be deprecated.
Upon issue No. 3, involving the computation of income derived by the partnership of Richards, Holloway & Myers from the so-called Swindler contract, petitioners argue that, while the figures used by respondent are correct, the method used by the partnership in its return for the computation of taxable income is correct in that the amounts expended by it as the cost of drilling and equipping the wells called for under this contract should be deducted as ordinary and necessary business expenses from any moneys actually received on account of the contract during the taxable years, and the remainder, if any, would constitute the taxable income for the year resulting from this contract. Respondent contends, in line with his determination, that the partnership obtained by virtue of this contract an oil payment of $52,000 at a cost of $27,362.06, representing the cost of drilling the wells; that the partnership thereby obtained a depletable interest in oil in place; that the cost of this oil payment should be capitalized; and that, after allowing cost depletion, the partnership realized taxable income to the extent of 47.38 per cent of the receipts under this contract.
In answer to respondent's contention, petitioners argue that under the contract there was no assignment to the partnership of an interest in the oil and gas leasehold estate or in the oil in place, and, therefore pursuant to our decision in F. H. E. Oil Co., 41 B.T.A. 130, there was not an acquisition of a capital asset, and the taxable income should be computed by including in gross income the actual receipts, and allowing as deductions the disbursements on account of drilling costs. See F.H.E. Oil Co., supra, p. 134.
While petitioners are correct in their statement as to the holding in the F.H.E. Oil Co. case, this question was reconsidered by us in T. W. Lee, 42 B.T.A. 1217, which was decided after the opinion was handed down by the Supreme Court in Anderson v. Helvering, 310 U.S. 404, and we decided that the F.H.E. Oil Co. case (and other cases relied upon therein) would be no longer followed on this point. In the Lee case we held that an interest held under an oil payment contract was a depletable interest in oil in place, ‘regardless of the absence of formal words of assignment of such an interest. ‘ This decision was affirmed on appeal, 126 Fed.(2d) 825.
Petitioners also answer respondent's contention by arguing that the provision in the Swindler contract reserving to the partnership title to the material and equipment placed in the wells until the oil payment was made as to each well, constituted ‘additional security guaranteeing payment of the sum specified, ‘ and thus rendered the oil payment ‘merely a money obligation.‘ See T. W. Lee, supra, p. 1227.
The record does not show with exactness the cost of material and equipment furnished by the partnership in performance of the contract by which it obtained the oil payment of $52,000, but, from the statement attached to the determination of deficiency, conceded to be accurate as to the figures, it is obvious that the cost of the material and equipment installed was less than $14,930.79, which is the cost of all the ‘supplies and equipment‘ used on the job. There is no evidence as to their fair market value. Since there is no evidence in the record as to the value of this material and equipment, and since petitioner has the burden of proof, we are unable to make any finding as to this value, or to conclude that it was of any substance.
The retention of an interest in certain material and equipment furnished under the contract, which had an unknown, and, so far as the record discloses, an unsubstantial value, and a cost considerably less than the cost of the contract, might assure the partnership of a recoupment of an unknown part of its cost if the operation proved unsuccessful, or might have served to reduce in an unknown amount its loss; but it could, in no realistic sense, be considered as ‘additional security guaranteeing the payment of the sum specified,‘ i.e., the oil payment of $52,000, to the extent that it was thereby rendered a money obligation in that amount.
On this issue, pursuant to the authority of T. W. Lee, supra, we decide in favor of respondent.
Reviewed by the Court.
Decisions will be entered under Rule 50.