C. C. Harris Oil Co. v. Commissioner

C. C. HARRIS OIL CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

C. C. Harris Oil Co. v. Commissioner

Docket No. 8011.

United States Board of Tax Appeals

13 B.T.A. 937; 1928 BTA LEXIS 3148;

October 11, 1928, Promulgated

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Where petitioner's books are kept on the accrual plan, income produced but held in abeyance by litigation is taxable for the years when produced and not for the year when actually received.

Dudley Robinson, Esq., for the petitioner.

LeRoy Hight, Esq., for the respondent.

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MARQUETTE

The respondent determined a deficiency in petitioner's tax return for the year 1921 with respect to money received by the petitioner during that year but which became due to petitioner under a contract during the years 1915 to 1917, inclusive. A redetermination of this deficiency is sought on the ground that the income in question should be treated as accruals for 1915, 1916, and 1917, rather than receipts for 1921.

FINDINGS OF FACT.

In June, 1914, a contract was entered into by the Pentland Union Petroleum Co., and the Trojan Oil Co., first party, and the petitioner, second party. The first party represented that it owned a certain leasehold in probable oil lands in California, and by the contract the petitioner agreed to complete the drilling of a well on said leasehold. If oil was found in paying quantities petitioner was to receive from the first party the cost of such drilling operation and also a sum equal to three times the amount of such costs. All of these payments were to be made out of 25 per cent of the net production of the well, except that the Trojan Oil Co. guaranteed the payment of the drilling expense, but the bonus, or profit to the petitioner was to be paid only out of the said net production. It was further provided that:

* * * Said 25% of said net production shall be and become the sole property of said party of the second part to such extent as shall be necessary to fully discharge and repay all obligations due the said party of the second part as hereinbefore fully defined and that said oil shall be sold by said parties of the first part acting as agent for said party of the second part - and payment shall be made to said party of the second part for its portion of oil so produced as aforesaid not later than the 20th day of each calendar month for such oil produced during the preceding calendar month.

The well was completed and accepted in June, 1915.

In April, 1915, the leasehold was taken over by a receiver pending litigation between the Government and the Trojan Oil Co. to determine the title and rights of the Oil Company in and to the land on which the well was located. The contention of the Government was upheld in the Federal District Court. While an appeal was pending the Leasing Act of 1920 was passed and a compromise was effected; the Trojan Oil Co. was given a lease in the land embracing the well and the receiver paid over to the Government one-eighth royalty on the production during the receivership, the balance going to the Trojan Oil Co. Thereupon, in 1921, the Trojan Oil Co. paid to the petitioner the sum of $76,924.68, the balance due under the drilling contract of June, 1914.

The petitioner's drilling expense was $21,641.56, its bonus, three times that amount, was $64,924.68. From July, 1915, to February 2, 1917, there was paid on account to petitioner various sums, aggregating $9,641.56. The net production of the well, expressed in dollars, was for November and December, 1915, $18,635.29; for the year 1916, $178,067.21; for January to April (inclusive), 1917, $68,665 - an aggregate of $265,367.50.

The petitioner kept its books on the accrual basis. It did not, however, take up on its books as accrual the total amount due under its drilling contract. Its tax returns for 1915, 1916, and 1917 did not include income from this drilling contract, but amended returns for those years were filed in 1922, in which said income was reported on the basis of 25 per cent of the production of those years. The respondent has rejected this method of treating the income on the ground that:

* * * Inasmuch as the additional income of $63,660.51 could not be determined until after the United States Government's case was finally adjudicated, and until which time it appears that there was no assurance of any additional income, the Bureau has ruled that the additional income is, therefore, taxable in the year in which received.

The additional tax assessed for 1921 amounts to $7,876.66; the additional income involved is $63,660.51.

OPINION.

MARQUETTE: The question in this proceeding is whether income received by the petitioner in 1921, after settlement of litigation which involved the source of such income and held it in abeyance, shall be taxed as of that year or whether it should be treated as accruals for the years 1915, 1916, and 1917 - when the income was really produced.

In 1915 the petitioner fully completed its contract to do certain work and thereby became entitled to receive from the Trojan Oil Co. $21,641.56, expense of doing the work, and a further sum of $64,924.68. Payment of the first sum, the expense money, was guaranteed by the Trojan Oil Co.; the second and larger sum was to be paid out of 25 per cent of the net production of the oil well petitioner drilled, "and not otherwise." Just about the time the petitioner completed drilling the well the Government brought suit against the Trojan Oil Co. and attacked the validity of its leasehold rights in and to the land on which the well was drilled. The well was operated for about 22 months thereafter, its proceeds being impounded to await the outcome of the litigation. During such operations the net production of the well amounted to $265,367.50. The law suit was finally compromised and the Trojan Oil Co. received the impounded money, less a royalty to the Government. Upon such receipt of the money the petitioner was paid, in 1921, the total balance due it, namely, $76,924.68 - something less than half the expense money having been paid by Trojan Oil Co. in 1915 and 1916. The respondent has ruled that the amount so received by the petitioner in 1921 is taxable income for that year; the petitioner has allocated it to 1915, 1916, and 1917, on the accrual plan.

The petitioner kept its books on the accrual method but the income in question was not taken up on its books as an accrual. Such omission, however, would not have the effect of placing the petitioner upon a nonaccrual basis. ; .

Whether petitioner's income received in 1921 can be properly accredited to prior years, depends upon when the liability for payment of such income accrued. Such liability became fixed, accrued, by the terms of petitioner's contract with Trojan Oil Co., at the time the petitioner completed its work, and that was in June, 1915. In , it was held that inspection fees, which by statute were made payable at the time of inspection, accrued as liabilities at the times of inspection, although payment was withheld pending the outcome of litigation to test the validity of the inspection law. The same reasoning applies in the instant case.

By the terms of its contract the petitioner became entitled to receive a determinable sum of money when a certain oil well was completed. The fact that payment of three-fourths of that sum was contingent upon continued profitable production to the obligor under the contract makes no difference. As soon as the petitioner completed its work it had a valid claim for compensation, maintainable in the courts and enforceable for what it might be worth. Under its contract petitioner could, and should, have entered on its books accruals of such compensation when and as the oil well produced. We think that under the principles laid down in , and in the decisions of this Board already cited, the petitioner should accrue the income here in question for the taxable years 1915, 1916, and 1917.

Reviewed by the Board.

Judgment will be entered under Rule 50.