Oil City National Bank v. United States

JoNES, Judge-,

delivered the opinion of the court:

The sole question in this case is what part of a dividend received by Harry Heasley in the year 1934 from thé Devonian Oil Company is taxable and what part is not taxable.

During the years 1920 to 1934, inclusive, the Devonian Oil Company was engaged in the buying and selling of oil and gas leases and in the production and sale of crude oil. Between the years 1925 and 1934 it disposed of a great many of its capital assets. There were gains and losses in the sales of the various properties. The total operations showed a net gain for some years and a net loss for others.

The issue in this case grows out of a transaction during the year 1934, the taxes for that year being paid in the year 1935, with additional special assessments for 1934 paid in 1936 and 1937.

During the year 1934 the Company made 34 different sales of assets. Sales were made in every month of the year except June and August. Among the 34 transactions was the sale of the Alford, Ingram and Milstead leases, which will be referred to as the three leases. Total sales for the year amounted to $1,479,858.48. Of this amount $1,419,311.61 was received from the sale of the three leases. The profit from the sale of the three leases was $1,270,998.57. Due to losses on some of the sales the profit from all the sales during 1984, including the sale of the three leases, was $1,249,749.49.

During 1934 the Company paid four regular quarterly dividends of -25 cents per share, thus making a distribution of .$80,451.25.

On April 1, 1934, the Company sold the three leases, receiving payment May 15, 1934. On June 11, 1934, it made distribution to its stockholders of $5.00 per share, or a total of $1,609,025.

On June 11, 1934, Harry Heasley owned 20,780 shares out of a total of 321,805 outstanding in the hands of stockholders. He received dividends thereon in the total amount of $124,505 during 1934.

•In arriving at the amount of earnings available for dividend payments in each of the years 1920 to 1933, inclusive, the Commissioner of Internal Revenue averaged the Devonian Oil Company’s total income from all sources for the year, treating the income as. accruing ratably throughout the year. For the year 1934 he used the same method as to the four regular quarterly dividends, but applied a different method for determining the operating income for the profit from the sale of the three leases. The profits from the sale of these three leases he did not treat as having accrued ratably.

The defendant contends that the profits from the sale of the major capital asset need not be prorated over the year as ordinary income, but as profits available for. a special dividend distribution.

In the light of the peculiar facts of this case, we do not think that the Commissioner of Internal Revenue was justified in departing from the method which he had used during the previous years. During the previous years as well as during the year 1934 there had been numerous, sales of leases and other assets. Some of these showed gains,, some of them showed Tosses. It was practically impossible to tell until the end of the year whether there would be a gain of a loss for the year. In treating this particular transaction separately and in arriving at his determination the Commissioner of Internal Revenue did not take into consideration overhead and other operating costs. He did not take into consideration either depreciation or depletion for the year 1934, though these- had been taken into account in previous years. 1

True, this was a large transaction and undoubtedly showed a profit, but with all these factors present, we do not see how the Commissioner could know just- what that profit would be until the end of the year when the various factors and the amount' involved in such factors could be known and until the further losses and profits for the year had been ascertained. In the sale -of numerous assets in the oil business it is always possible that profits will be almost if. not completely absorbed by other losses during the operating year.

Practically the same question was considered by the Board of Tax Appeals in the case of Gardner Governor Co. v. Commissioner, 5 B. T. A. 70, except in that case the position of the parties was reversed, the Government contending for and securing a decision to the effect that the losses should be prorated through the year in order to determine whether there was a net gain or a loss. The Board in that case commented upon the endless confusion and disputes that would arise if an arbitrary method were to be used as to isolated transactions. In a memorandum opinion by the Board of Tax Appeals entered November 6, 1941, in Boylston Market Association C. C. H. (1941, par. 7769-B), it was held that a method used consistently over a period of years should be continued.

The Government having taken one position in the Gardner case, supra, and having prevailed, it does not seem just that it' should now be permitted to take a directly opposite position and prevail again merely because it would mean more money in the individual case, especially in view of the confused consequences that would necessarily follow. We do not think the cases of Mason v. Routzahn, 275 U. S. 175 or Edwards v. Douglas, 269 U. S. 204, applicable to the facts of this case. Entirely different questions were presented in those cases.

In the instant case the special dividend distribution was considerably more than the profits from the sale of the three leases and considerably more than the total profits from the entire year. In the many sales that were being made involving both profits and losses, it was impossible to determine at the time of the special distribution or at the time of the sale of the property or at any period during the operating year just what the profits, if any, would be during that year. If a separate method is to be used in reference to a transaction simply because it is large, then there is no logical dividing line and there would be nó sure method by which the taxpayer could know in advance' into just what classification any individual item would fall. Numerous lawsuits and consequent uncertainty would inevitably result.

In the facts of this case the taxpayer was entitled to the usual method of prorating the profits over the year and to have the tax levied on the basis of the net earnings for the year in accordance with the method used by the Commissioner of Internal Revenue in calculating the tax of the same company for the previous several years.

Plaintiffs are entitled to recover the sum of $18,525.92, with interest thereon at the rate of 6 percent per annum from March 24, 1937.

It is so ordered.

Whitakee, Judge; LittletoN, Judge; and Whaley, Chief Justice, concur.