Armstrong v. Commissioner , 25 B.T.A. 928 ( 1932 )

WILLIAM M. ARMSTRONG, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Armstrong v. Commissioner

Docket No. 40419.

United States Board of Tax Appeals

25 B.T.A. 928; 1932 BTA LEXIS 1452;

March 21, 1932, Promulgated

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Where the taxpayer and a corporation entered into agreements for the development and operation of certain oil and gas leases of the corporation, and the taxpayer's interest was charged with a proportionate amount of the expenses and credited with a proportionate amount of the gross receipts from the sale of the oil and gas produced, held, only the distributive share of net earnings constitute taxable income to him.

Geo. E. H. Goodner, Esq., and Frederick C. Rohwerder, C.P.A., for the petitioner.

Chester A. Gwinn, Esq., and John R. Gaskins, Esq., for the respondent.

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SMITH

The Commissioner determined deficiencies in petitioner's income tax as follows:

1919	$21,855.16
1920	196,216.48
1921	2,708.78
Total	220,780.42

The parties have agreed to certain adjustments to be made upon final settlement. The only issue for our determination is the amount of income received by the petitioner in the taxable years under certain agreements for the operation of certain oil and gas leases. The facts were stipulated.

FINDINGS OF FACT.

The petitioner is a resident of Los Angeles, California.

Prior to December 7, 1917, petitioner acquired, without cost, certain oil and gas leases and on that date entered into an agreement (hereinafter referred to as the Blanket Agreement) with the Ohio Oil Company, an Ohio corporation, whereby he sold to said corporation an undivided 60 per cent interest in said leases, and acquired an undivided 40 per cent interest in certain oil and gas leases then owned by the corporation, and wherein certain agreements were made by the corporation for the development and operation of the leases. The agreement contained, inter alia, the following:

FIRST: The party of the second part [Ohio Oil Company] shall have the management and control of the said leases and the development and operation thereof.

SECOND: The party of the second part agrees to commence a well at some point on the above described premises immediately following the execution hereof, which well shall be completed at its own expense to such depth as will thoroughly test the sands underlying said premises.

THIRD: After said well as is provided by paragraph two has been completed, the party of the second part shall continue to develop the property as fully and as rapidly as is consistent with good business management. It will pay all costs and expense incurred in said development and operation, and also the protection of said leases by payment of rentals or otherwise, and shall charge the undivided forty per cent interest of the first party [petitioner] its proportion of the actual and necessary expenses of said development and operation, including the protection of leases as aforesaid of all leases and also the payment of all taxes both State and Federal. Said party of the second part shall market all the oil and gas produced from said premises and account to party of the first part for his proportion of the same at the prevailing market price at the wells for said oil and gas. Party of the second part shall be reimbursed by the party of the first part from the first party's proportion of the oil and gas produced and sold from said premises, application of the proceeds from sale of said oil and gas to be made to the credit of first party's account on the first day of the month following that in which the oil or gas is sold. The party of the second part shall be entitled to and shall charge the party of the first part six per cent (6%) interest on the money so advanced for the costs and expenses aforesaid for the account of the first party's interest until the same is paid out of the proceeds of first party's proportion of the oil and gas.

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FIFTH: The second party agrees that it will transmit to the party of the first part monthly statements showing the cost and necessary expense of developing and operating the wells and property on said premises and will remit to the party of the first part, monthly, for any proceeds of the oil and gas sold from the interest of the first party over and above the amount necessary to reimburse the party of the second part for the expenditures made by it on account of the first party's interest.

Prior to March 28, 1918, petitioner acquired without cost, a certain oil and gas lease, which, on that date, he owned jointly with Will McMurray. On March 28, 1918, petitioner and McMurray entered into an agreement (hereinafter referred to as the Section 34 Agreement) with the Ohio Oil Company, whereby they sold to the corporation an undivided 60 per cent interest in the lease, and wherein certain agreements were made by the corporation for the development and operation of the lease. Similar provisions to those quoted above from the Blanket Agreement were contained in the Section 34 Agreement for the payment of petitioner's share of the development and operating expenses out of the proceeds from the sale of oil and gas, and the remittance of the balance to him.

Pursuant to the terms of the agreements, the Ohio Oil Company entered upon the lands covered by the leases and proceeded to develop and operate same. The operations resulted in the production of oil, which was marketed by the corporation as provided in the agreements.

On its books, the Ohio Oil Company charged petitioner with his proportion of the total costs and expenses incurred in developing and operating the leases covered by the two agreements and credited him with his proportion of the gross receipts therefrom as his interests appeared under the agreements. From the beginning of operations to December 31, 1921, the gross receipts from the leases credited and the costs of operations and development charged to petitioner were as follows:

	Under blanket agreement		Under section 34 agreement
Year		Costs of		Costs of
	Gross receipts	operations and	Gross receipts	operations and
		developments		developments
1918	$1,025.56	$17,849.37	None.	None.
1919	36,083.74	148,075.27	$4,492.35	$4,908.00
1920	344,079.24	387,536.73	83,637.81	33,293.99
1921	206,176.75	235,759.66	62,973.61	9,722.82
Total	587,365.29	789,221.03	151,103.77	47,924.81

During the taxable years, petitioner received no cash payments from the Ohio Oil Company in respect of its operations under the Blanket Agreement, but during the taxable years 1920 and 1921 received cash payments in the respective amounts of $23,179.17 and $75,348.81 in respect of its operations under the Section 34 Agreement.

During the years 1919, 1920, and 1921, the Ohio Oil Company rendered to petitioner monthly statements showing the charges and credits made to his account on its books, with respect to its development and operations under the Blanket Agreement and the Section 34 Agreement.

Petitioner kept books and rendered income-tax returns for all of the years here in question on the cash receipts and disbursements basis.

In computing the net income of petitioner for each of the years, as set out in the deficiency letter, the Commissioner has included therein the portion of the gross receipts from the leases covered by the Blanket Agreement and Section 34 Agreement which was credited to petitioner on the books of the Ohio Oil Company during each of the respective years, and has allowed him as deductions therefrom the charges made against him on the books of the corporation for operating costs and has also allowed him deductions for depreciation on the charges covering depreciable tangible property.

OPINION.

SMITH: The respondent contends that petitioner, who kept his accounts and filed his income-tax returns upon the basis of cash receipts and disbursements, realized income in the amount of the gross receipts from the sale of oil and gas credited to him upon the books of the Ohio Oil Company during the taxable years before us. Pursuant to the two agreements, the Ohio Oil Company developed and operated the oil leases, charged petitioner with his proportionate part of the expenses therefor, and, upon the sale of the oil and gas produced, credited him with his proportionate part of the receipts therefrom. In support of his contention, respondent argues, first, that petitioner and the Ohio Oil Company were joint adventurers and that the gross receipts in the hands of the latter constituted income to petitioner; and, second, that petitioner constructively received the amounts in question, since they "were set apart and dedicated to his use" and that "he became enriched by the gradual reduction of his liability and that enrichment represents income" to him. The first argument is predicated upon the assumption that in a joint adventure the adventurers individually account for their respective shares of the gross income from and the gross expenses of the enterprise. The cases cited by the respondent on this point correctly hold that members of syndicates are taxable upon their distributive shares of the net earnings of the syndicate, even though a portion of such earnings is retained for future contingencies. See ; ; . The second argument is based upon cited decisions holding that (a) money paid for the benefit of the taxpayer constitutes income to him (; ; ); (b) the incidence of tax upon income can not be escaped by anticipatory arrangements (; ; ); and (c) a taxpayer's share of partnership earnings is income to him although the amount is applied to the payment of his note given for his interest in the partnership (). Such arguments are inapplicable to the facts of record, which show that petitioner incurred no liability to the corporation and that he received, and was entitled to receive, only his proportionate share of the net earnings from the enterprise.

Petitioner contends that "the gross receipts entered on the Ohio Oil Company's books were not subject to the demand of petitioner and could not be reduced to possession by him until such time as all of the costs and expenses of the Ohio Oil Company had been paid." This contention is consistent with the agreements of the parties and their conduct in carrying out their agreements. Petitioner was entitled to a monthly remittance of his percentage of the proceeds from the sale of the oil and gas produced under the leases "over and above the amount necessary to reimburse" the Ohio Oil Company "for the expenditures made by it on account of" the petitioner's interest. In other words, the petitioner had no right to receive anything from these operations until there were net earnings. The facts show that there were no net earnings upon petitioner's interest from the operations under the Blanket Agreement during the taxable years, but that the operations under the Section 34 Agreement produced net earnings of $49,928.17 (after absorbing the loss of $415.65 for 1919) in 1920 and $53,250.79 in 1921 upon his interest. The difference between these amounts and the amount of cash received by petitioner in the respective years is not explained, and neither does it appear that any portion of the net earnings upon his interest in the operations under the Section 34 Agreement were applied against the charges incident to the operations under the Blanket Agreement. It does not appear of record, and petitioner apparently does not contend, that he was not entitled to receive upon demand payment of the net earnings under the Section 34 Agreement during the taxable years 1920 and 1921. In the circumstances, we hold that these amounts, representing his distributive share of net earnings under that agreement, constituted taxable income to him in those years. ;;;. See also . In thus determining the amount of income that petitioner realized under the agreements with the Ohio Oil Company, it is not necessary to discuss further either the respondent's or the petitioner's arguments regarding the constructive receipt of income, except to state that the instant decision is in accord with the Board's decisions on that question. Cf. ; ; ; ; .

Judgment will be entered under Rule 50.