Court Opinion

ID: 4626268
Source: CourtListenerOpinion
Date Created: 2020-11-21 02:58:52.68251+00
Date Added: 2024-06-11T07:56:50.387521
License: Public Domain

SAN MARTINEZ OIL COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.San Martinez Oil Co. v. CommissionerDocket Nos. 37447, 43121.United States Board of Tax Appeals25 B.T.A. 218; 1932 BTA LEXIS 1558; January 18, 1932, Promulgated *1558  1.  DEPLETION.  Fair market value of petitioner's property at date of discovery of oil held to be basis for depletion allowance.  2.  Id. Equitable owner of leases on date of discovery held entitled to depletion on basis of discovery value.  D. Webster Egan, Esq., for the petitioner.  Philip M. Clark, Esq., for the respondent.  ARUNDELL*219  The respondent has determined deficiencies in the amounts of $14,201.11 and $5,922.80 in this petitioner's income taxes for the years 1923 and 1924, respectively.  The two proceedings have been consolidated and the issues involved are (1) whether petitioner owned certain oil and gas leases on the date of discovery of oil on such leased property, and (2) whether petitioner is entitled to a depletion allowance for each of said years based on an alleged discovery value by reason of the discovery of oil on said leased property on November 20, 1921.  FINDINGS OF FACT.  The petitioner is a California corporation having its principal place of business in the city of Los Angeles.  It was organized in December, 1920, as a drilling company and primarily for the purpose of producing oil for the Vernon*1559  Oil Refining Company, a California corporation having its principal place of business in the city of Los Angeles, and engaged only in the business of refining oil.  The president of the latter company, J. A. Bower, was also president of the petitioner.  R. E. Bering, vice president of petitioner, endeavored to secure leases in the Signal Hill district, but he was unsuccessful, due to the fact that several well known and established oil companies were making the same endeavor and that the petitioner was a new company without an established reputation.  Thereupon the petitioner and the Vernon Oil Refining Company agreed that the oil leases which petitioner desired to acquire should be obtained in the name of the Vernon Oil Refining Company as lessee and assigned by it to petitioner.  That agreement was entirely for the benefit of petitioner, who agreed to pay the cost of obtaining the leases, and also it was agreed that the Vernon Oil Refining Company would hold such leases in trust for the petitioner without consideration until assigned to petitioner.  R. E. Bering obtained the following indentures of lease, which named the Vernon Oil Refining Company as lessee; the Fry Lease on December 21, 1920; *1560  the Freeman Lease on January 7, 1921; the Greene Community Lease on February 10, 1921; and the Booth Community Lease on April 11, 1921.  The Vernon Oil Refining Company, without the receipt of any consideration, assigned the said leases to the petitioner, and such assignments were executed on September 15, 1921, as to the first two leases, and on November 28, 1921, as to the last two leases.  All of the said leases were for a period of 20 years and gave the lessee the exclusive right of exploiting and drilling for, developing, producing and extracting, storing and removing oil and gas and other hydrocarbon substances from the approximately 40 adjoining acres of land included in the said leases.  *220  The lessee obtained a five-sixths interest in all the oil and gas produced and saved from said land.  The Vernon Oil Refining Company never claimed ownership of the said leases nor any interest therein adverse to the petitioner.  The said leases cost the petitioner a total of $4,608.80 as bonuses and other amounts paid to the numerous lessors by the end of the year 1921.  That amount was paid by checks issued by the Vernon Oil Refining Company during the period the leases were*1561  being obtained and charged on its books directly to the petitioner.  The said amount was entered on petitioner's books as a credit to the Vernon Oil Refining Company's subscription to petitioner's capital stock.  At the time the said leases were obtained, no oil or gas had been discovered within 10 miles of the land embraced therein and said leases were not obtained as a result of the purchase of a proven tract or lease.  On June 28, 1921, the petitioner began drilling on the land included in the Booth Lease at a point about the center of the whole 40-acre tract.  That drilling operation consisted of the sinking of an exploratory well, known as Booth Well No. 1, and petitioner had no knowledge of the depth of oil sands, if any.  When the well had been drilled to a depth of about 3,500 feet, the casing became logy, that is, the friction on the outside became great, and it could not be easily pulled up and lowered.  It was necessary to work or move the casing every so often to keep it free, but in doing so, the casing parted at a depth of about 2,600 feet.  The parted casing was then fitted together, the water baled out and the casing cemented.  The drilling operations then ceased*1562  for 15 days, after which the well was drilled to a depth of about 3,600 feet during which time further casing difficulties were encountered.  In drilling oil wells it is necessary to cement the casing just before or immediately upon entering the oil-bearing sands in order to prevent the seepage of water into the casing or down its sides to the oil sands.  The Booth Well No. 1 was a wildcat well, that is, a test well, and before it had been properly cemented off, oil was encountered unexpectedly on November 20, 1921, in the sands known as the Alametoz Zone.  The well came in with a gusher shooting an 8-inch stream of oil over 100 feet in the air.  As no tanks had been placed on the property, the oil was turned into a sump hole.  Booth Well No. 1 flowed clean oil at the rate of 1,500 to 2,000 barrels for three days and then sand and water broke into the casing because of its poor mechanical condition and shut off the flow of oil.  A total of 3,153 barrels of oil was salvaged from the sump hole and sold.  Every effort was made to properly cement the well so as to shut out the sand and water, but all attempts were only partially successful.  *221  The well produced 170 barrels*1563  in December, 1921; 756 barrels in January, 1922; 3,057 barrels in February, 1922; 1,639 barrels in March, 1922; 2,324 barrels in August, 1923; and 2,539 barrels in September, 1923.  The trouble encountered with Booth Well No. 1 was purely a mechanical defect.  The said discovery of oil on November 20, 1921, demonstrated the value on that date of petitioner's leases and of its interest in the estimated oil reserves, amounting to 2,337,049 barrels.  The fair market value of the petitioner's interest in the oil reserves discovered on November 20, 1921, was $859,474.30, without consideration of the casing head gas contained in the land.  On January 19, 1922, petitioner began drilling Fry Well No. 1 as an offset well.  It was drilled to the Alametoz Zone of oil-bearing sands which the Booth Well had tapped and oil was brought in in May, 1922.  From that time until June, 1927, when the well was sold, it produced 193,129 barrels of oil.  In October, 1923, petitioner gave up the attempt to cement the casing in Booth Well No. 1, pulled as much of the casing as could be reclaimed and practically sunk a new well at the same location, but drilled to a depth of about 4,886 feet and brought*1564  in a well in the Brown Zone which produced approximately 248,577 barrels of oil from November, 1923, to June, 1927.  The petitioner drilled 12 producing wells on the said 40 acres and had one well drilled under contract, and during the period from November 20, 1921, the date of discovery of oil, to December 31, 1926, the petitioner produced and saved from the Alametoz and Brown Zones approximately 2,393,667 barrels of oil, which were sold for $2,665,830 and in which petitioner had a five-sixths interest.  During the years in question petitioner's gross production in barrels and gross sales were as follows: YearBarrels producedSales1923424,422.34$288,506.281924704,411.04739,201.2919241 15,791.7020,591.47On its tax return for 1923 petitioner deducted $166,459.09 as depletion, based on a discovery value of $859,474.30, which was materially disproportionate to the cost.  The respondent has allowed a deduction in the amount of $44,956.90 as depletion, based on cost.  On its tax return for the year 1924 petitioner deducted $193,394.34 as depletion, based on the said*1565  discovery value, and respondent *222  allowed a deduction in the amount of $146,011.93 as depletion, based on cost.  OPINION.  ARUNDELL: The oil leases involved in this proceeding were obtained in the latter part of 1920 and the early part of 1921, in the name of the Vernon Oil Refining Company, but they were so obtained for and on behalf of the petitioner.  That procedure was necessary for business reasons and the Vernon Oil Refining Company never claimed any interest in the leases except to hold them in trust for petitioner until assigned to the latter.  The petitioner paid the cost of obtaining the leases and carried on all drilling operations which resulted in the discovery of oil on November 20, 1921, on the Booth Lease.  It was at all times then material the equitable owner of the property, and the delay in conveying the bare legal title until after the discovery is not important.  Cf. . The only remaining issue is whether the petitioner is entitled to a depletion allowance based upon the fair market value of the property at the date of discovery of oil on November 20, 1921, as provided by section 234(a)(9) of the Revenue*1566  Act of 1921 and sections 234(a)(8) and 204(c) of the Revenue Act of 1924.  The facts of record clearly establish that the petitioner, by its own drilling operations, discovered oil on its Booth Lease on November 20, 1921, and that the well was not acquired as the result of the purchase of a proven tract or lease.  When the leases in question were obtained from the owners of the land, oil had not been discovered within 10 miles thereof.  We have already pointed out in our findings that the failure of the well to continue to flow after the third day was due solely to the presence of certain mechanical defects in the equipment and that with the coming in of the well a valuable discovery had been made.  Our real problem is to determine its value in dollars.  The record contains the uncontradicted testimony of several experts who have been engaged in the oil business for years, and, in particular, the testimony of a mining engineer and geologist who had been employed by the Federal Government as a valuation engineer, examining and appraising mineral and oil lands in California for a period of 10 years, and who has been continuously engaged in private practice in his profession since*1567  1921.  This witness was not only the best qualified of the several who testified, but he also exercised greater care and gave more attention to recognized valuation factors in reaching his valuation than did the others.  The discovery value he arrived at, namely, $859,474.30, impresses us, after consideration of all the evidence, as being the most nearly correct figure.  *223  We have accordingly found as a fact that that sum represents discovery value.  The value so found is clearly disproportionate to cost and depletion should be based on it.  The parties agreed and stipulated that all of the statements and data contained in "Form 0" filed with petitioner's return for 1923 are true and correct except as to the dates of acquisition of the leases, the amount of the fair market value of the property on November 20, 1921, and the estimated recoverable oil reserves.  Petitioner has proved those three items to be true and correct as set forth in the said "Form 0" and therefore the amount of depletion as computed by petitioner and deducted on its return for 1923 in the sum of $166,459.09 is the amount to which it is entitled as a deduction.  The "Form 0" filed with petitioner's*1568  return for 1924 refers to "Form 0" filed with the 1923 return and is based thereon.  The deduction for depletion in the amount of $193,394.34, taken by petitioner on its 1924 return is the amount to which it is entitled as a deduction.  Judgment will be entered for the petitioner.Footnotes1. 30 per cent of oil produced from Monrovia Well under contract. ↩