Court Opinion

ID: 4633060
Source: CourtListenerOpinion
Date Created: 2020-11-21 03:13:08.806704+00
Date Added: 2024-06-11T07:59:15.069850
License: Public Domain

CALDWELL OIL CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Caldwell Oil Corp. v. CommissionerDocket No. 104240.United States Board of Tax Appeals47 B.T.A. 707; 1942 BTA LEXIS 655; September 22, 1942, Promulgated *655  1.  Petitioner executed an oil payment contract to its chief stockholder, X, in consideration for his paying the costs of drilling certain wells.  Under the contract petitioner assigned to X the proceeds of a full seven-eighths working interest in each well after deducting actual operating expense, until the proceeds paid a stipulated sum to X.  Petitioner was to operate the wells.  Held, that X acquired through his investment in the wells an economic interest in the oil in place and the amounts received therefrom by him in the taxable years constituted income to him and was not petitioner's income.  Question controlled by Thomas v. Perkins,301 U.S. 655">301 U.S. 655, Anderson v. Helvering,310 U.S. 404">310 U.S. 404, does not apply.  2.  Under a mistake of law the oil payments were included in petitioner's income in its returns.  Likewise, under mistake of law, they were not reported by X in his returns.  Petitioner denied liability for tax on the income in an amendment to the petition to the Board filed prior to expiration of the period within which respondent could assess tax on the income against X.  Respondent knew the facts.  Held, that petitioner is*656  not estopped to deny liability on the income.  R. B. Cannon, Esq., and Benjamin L. Bird, Esq., for the petitioner.  Frank B. Appleman, Esq., for the respondent.  HARRON *708  Respondent determined deficiencies in petitioner's income tax and excess profits tax liability for the year 1937 in the respective amounts of $2,836.56 and $1,116.96.  For the year 1938 respondent originally determined deficiencies in income tax and excess profits tax liability in the respective amounts of $678.80 and $355.29.  At the hearing, by amended answer, respondent made claim for increases in the deficiencies in income tax and excess profits tax in the respective amounts of $1,130.05 and $968.62, so that the respondent now claims that for the year 1938 there is a total deficiency in income tax in the amount of $1,808.85 (see statement attached to the amended answer to explain typographical error of 10 cents), and a total deficiency in excess profits tax of $1,323.91.  Respondent also determined a deficiency in income tax for the year 1936 in the amount of $42.85, which petitioner concedes and about which no issue is raised.  The main issue is whether or not there*657  should be included in petitioner's income for each of the years 1937 and 1938 the amounts of the net proceeds from sales of oil produced by certain wells which were paid to an individual under an assignment to him of the proceeds of a full seven-eighths working interest in the wells.  Petitioner denies liability for tax on such income.  Other issues raised by respondent are whether petitioner is estopped from raising the first issue, and whether petitioner realized income from the forgiveness of interest by a creditor on a note of petitioner.  Petitioner claims that it has overpaid income and excess profits tax for each year.  FINDINGS OF FACT.  Petitioner is a Texas corporation, incorporated in June of 1936.  Petitioner's 1937 and 1938 income and excess profits tax returns were filed on the cash basis with the collector for the second district of Texas.  Petitioner's principal place of business is located in Tyler, Texas.  Petitioner's president is D. K. Caldwell, who owned 998 of its 1,000 shares of outstanding stock.  Petitioner purchased from Caldwell on June 12, 1936, an oil lease called the Beatrice Fox lease, acquiring a full seven-eighths working interest in all wells*658  which might be drilled on the lease.  Part of the consideration was $7,000, for which petitioner gave Caldwell its 6 percent note, due June 12, 1938.  Petitioner paid the principal part of the note in 1938.  Caldwell waived the entire accrued interest, gratuitously, receiving no consideration for the waiver.  Petitioner did not deduct any amount for accrued interest, being on the cash basis.  There were no wells on the Fox lease.  Petitioner was without funds to defray the costs of drilling wells.  At the time petitioner *709  acquired the lease, it was recognized that the drilling of wells would require the outlay of considerable money, and Caldwell agreed that he would individually advance the funds required for the drilling and equipping of wells, with the understanding that he would be repaid only out of oil, if and when produced.  He did not take any security by way of a lien or otherwise to secure repayment of his advances.  during 1936 Caldwell procured the drilling and equipping of four wells at a total cost of $44,024.03, for materials and labor.  Caldwell paid out that total amount in cash, from his own funds, during 1936.  On November 2, 1936, petitioner executed*659  an assignment to Caldwell, which was recorded in the deed records of Rush County, and which provided, inter alia, as follows: * * * THAT the Caldwell Oil Corporation acting pursuant to a Resolution of the Board of Directors this day adopted, and in consideration of the payment of all costs of drilling and equipping said above mentioned wells by the said D. K. Caldwell does hereby Bargain, Sell, Assign, and Deliver unto the said D. K. Caldwell his heirs and assigns, the proceeds of the full seven-eighths :7/8ths) Working Interest in all of the wells upon the above described oil and gas lease, after deducting the actual and necessary operation expense, until the proceeds of said interest shall pay to the said D. K. Caldwell, his heirs and assigns, the full sum of Forty Four Thousand, Twenty-four ($44,024.03) and 03/100 Dollars, plus Six (6%) per cent interest, per annum, from the respective dates that said monies were actuall [sic] paid out by said D. K. Caldwell, according to the statement of costs hereinabove set forth.  And the officers of said Caldwell Oil Corporation are hereby authorized and directed to pay over to said D. K. Caldwell the proceeds of said interest, *660  as received, deducting only actual and necessary operating expenses.  TO HAVE AND TO HOLD, the above described interests unto the said D. K. Caldwell, his heirs and assigns forever, subject only to the terms and provisions of this assignment.  During 1937 Caldwell procured the drilling of a fifth well known as equipping the additional well, and petitioner agreed to reimburse him from the lease. payment held by D. K. Caldwell for the drilling and equipping of the other wells until the cost of drilling and equipping Well #4 is paid in full petitioner on November 2, 1936).  Caldwell paid amounts in excess of $3,750 during 1937 in connection with the drilling and equipping of the fifth well.  During 1937 there were produced and sold from the Beatrice Fox lease, exclusive of the landowners' royalty, oil and gas of the gross value of $36,036.87.  Of this amount petitioner retained $7,867.98 for operating expenses.  The balance, $28,168.89 was paid to Caldwell.  During 1938 the oil and gas produced and sold from the lease had a gross *710  value of $33,335.94.  Of this amount, petitioner retained $13,141.40 for operating expenses.  The balance of $20,194.54 was paid to Caldwell. *661  Petitioner included in its income tax returns for 1937 and 1938 the total gross income from the Fox lease.  Caldwell did not include in income in his individual returns for 1937 and 1938 any of the sums which he received from the proceeds of oil produced on the Fox lease.  In an amended petition filed with the Board on February 28, 1941, petitioner alleged that there should be excluded from its gross income for 1937 and 1938 the proceeds of oil and gas sold from the Fox lease and paid over to Caldwell pursuant to the terms of an assignment Caldwell filed his returns for 1937 and 1938 on the dates the returns were due, March 15, 1938, and March 15, 1939.  The secretary of petitioner, a certified public accountant, prepared the income tax returns for 1937 and 1938 of both petitioner and Caldwell.  Petitioner's returns were made up from its books.  Caldwell's returns were made up from a detailed statement of his receipts and disbursements compiled by him.  Caldwell did not instruct the accountant on how the returns should be compiled.  The accountant prepared all the returns in accordance with his understanding of the pertinent provisions of the revenue acts.  At the time the accountant*662  prepared the returns of petitioner and Caldwell for 1937 and 1938 it was his understanding that, under existing rulings of the Bureau of Internal Revenue, the assignor of an "oil payment" was required to include the proceeds therefrom in his own return.  Caldwell's books were checked by a revenue agent in 1938 in connection with his individual return for 1937, and he requested the agent to check petitioner's books as well.  At that time there was put at the agent's disposal every record of petitioner and of Caldwell.  The first four wells were drilled by Joe Long during 1936.  The cost of materials was $26,303.83, and the labor costs were $17,720.20.  The intangible drilling costs in 1936 were $17,720.20, for which payment was made in 1936.  Under the contract between Caldwell and Long, as originally made, Long was to receive agreed amounts for his labor in drilling the wells and Caldwell was to pay him the actual cost for the materials which he purchased.  This original agreement was modified by an oral agreement to the effect that either Long could purchase the materials and bill Caldwell for them at actual cost, or Caldwell could purchase the materials himself.  All the work done*663  by Long was done in accordance with the terms of the original agreement, that is, he purchased the materials and billed Caldwell for the cost and he was paid agreed amounts for his labor.  *711  The fifth well was drilled by John F. Merrick.  Caldwell executed a contract with him on May 24, 1937, under which, inter alia, Caldwell was to pay $3,750 to Merrick for furnishing slush pits and all labor, repairs, costs of cementing, and equipment and tools necessary to drill and complete the well.  This part of the agreement remained unchanged, but other parts of the agreement were modified to the effect that Caldwell himself agreed to and did furnish the rest of the material.  During 1937 Caldwell purchased material, which included casings, tubings, cement, plugs, and valves, from various supply companies, and paid them with checks drawn against his individual account.  Also during 1937 he paid $3,750, as above, to Merrick.  That amount and other amounts advanced for materials were to be repaid only out of the proceeds of the sale of oil, if and when produced.  Petitioner deducted in its returns for 1937 and 1938 the respective amounts of $11,260.70 and $8,128.31 as "intangible*664  drilling and development costs paid." Respondent disallowed the deductions in each year for the reason, inter alia, drilling expenses represents expenditures which were made in 1936 and are not deductible in the year claimed. amounts which were paid by Caldwell in 1937, $7,510.70 for various items, none of which were intangible drilling costs, and the $3,750 paid to Merrick.  The $8,128.31 does not represent payment in 1938 for any drilling costs in 1938.  OPINION.  HARRON: Issue 1. - The question in this issue is whether the net proceeds in 1937 and 1938 from the sale of oil produced on the Fox lease is income of petitioner or of Caldwell.  Under the assignments of November 2, 1936, and the agreement made by petitioner in 1937, Caldwell was to receive all of the net proceeds from oil and gas sold from the lease.  The parties argue the question under the terms of the assignment of November 2, 1936, and it will be considered with respect to the terms thereof.  The facts are that Caldwell acquired an oil payment right, that is, the right to receive a specified sum out of the oil production, if, as, and when oil was produced, saved, and sold as the consideration for his*665  payment for the costs of drilling and equipping the wells.  The instrument in clear terms gave Caldwell an interest in the proceeds of a full seven-eights working interest bin all the wells, after deducting the necessary and actual expenses of operation, until the of the interest Caldwell.  While it is true that petitioner was to pay Caldwell proceeds up to a specified amount, such payments were to be made only *712  out of oil, if, as, and when produced.  Caldwell so testified.  There was no personal obligation in petitioner to make repayment to Caldwell, and there was no obligation in petitioner to make repayment from any other source.  Further, the repayments were not to be made from petitioner's example, there were certain outstanding liens against the Fox lease when petitioner acquired it, but the assignment did not provide that Coldwell was to receive proceeds from the sale of oil after deducting amounts necessary to take care of existing liens as well as operating expenses.  Nor were any other items, such as developmental expense, to be deducted from the proceeds from the oil such as enter into the calculation of bring this case within the rule of *666 ; ; and . The determination of the issue turns on whether or not Caldwell acquired an economic interest in the oil under the instrument relied on.  It appears that respondent could not seriously contend that Caldwell did not obtain an economic interest, in the face of such authorities as , and , and see also , but for the provision that actual operating expenses were to be deducted from proceeds from the sale of oil.  The weight of authority leaves little doubt, if any, that such provision is immaterial.  First, the rule is now clear, as stated in the O'Shaughnessy case, supra, that: * * * One who acquires by contract, in whatever form, a right to the production from an oil and gas well, or the proceeds thereof until a stipulated amount has been paid, without any other or further security except the contingency*667  of the production, thereby becomes the owner of an economic interest in oil in place * * *.  [Italics supplied.] See also, : * * * the owner of oil payment rights, who is required by the terms of the contract to look solely to the oil and gas or the proceeds from production for the agreed payments, has an economic interest in the oil and gas in place, is taxable upon the gross income derived from his interest, and is entitled to an allowance for depletion thereon.  In , affd., 102 Fed.:2d) 508; certiorari denied, , among the facts, most of which have a close similarity to the facts here, Ortiz, which executed an oil payment contract with persons who advanced money for the acquisition of property, and the drilling of wells, was to manage, develop, and operate the properties and pay all expenses.  The Board found as a fact, p. 660, that "They [Westbrook and Thompson] had an 'overriding' interest, all expenses of development and operation being paid by *713  petitioner." The board held (p. 664), that, in substance, the money furnished by*668  Westbrook and Thompson was a cash consideration for the purchase of certain specified portions of the oil production, the extent of $359,333.34 in value, if, as, and when same should be produced, constituted property of Westbrook and Thompson.  The Board recognized that their portions of the oil runs was Ortiz paying all expenses.  The Board and the court held that Westbrook and Thompson acquired an economic interest in the oil in place and that their right to share in the oil produced constituted an economic interest in the properties to the extent me amount agreed upon.  It is not necessary to set forty all of the facts of the Ortiz case, other than to point out that Westbrook and Thompson were entitled to receive certain portions of the proceeds of sales.  The determining factor there was, and here is, that the persons who received rights to the proceeds of production from oil wells in consideration for advances, stood to be reimbursed only if oil was produced; otherwise, their money was lost.  See also, . While we believe it is immaterial that petitioner was to retain out of proceeds from the sale of oil enough*669  to pay actual operating expenses, it is pointed out that under the assignment to Caldwell his right was not limited to a share in the proceeds of oil produced and sold, but was a right in the entire seven-eighths working interest in all of the wells.  Petitioner was no more than an operator.  In order to realize anything from the oil payment right, expenses had to be entailed to lift the oil and deliver it to pipe lines.  In reality, petitioner retained no interest in the oil in place, but had only a reversionary interest to come back to it when and after Caldwell's right was exhausted.  If petitioner had assigned to Caldwell a right to participate in only a share of the production, it is conceivable that the parties might have executed an operating contract under which operating and supervisory costs would be borne in proportion to their interests.  Cf.  (reversed on a point not involved here).  Under the facts it appears that petitioner was no more than an agent of Caldwell, its chief stockholder, to operate the lease.  Whatever other questions this suggests we do not consider, because no other questions are in issue.  *670  It is held that Caldwell's right to the oil payments constituted an economic interest in the oil in place and that the amounts which he received therefrom during the taxable years constituted gross income to him, not to petitioner.  ;;;*714 Issue 2. - Respondent contends that petitioner is estopped from raising the above issue.  Petitioner included in gross income in its returns for each taxable year the amounts of the oil payments paid to Caldwell.  After the respondent determined the deficiencies, petitioner, by an amendment to its petition, alleged that the oil payments should be excluded from its income in each year.  Caldwell did not report the oil payments in income in his returns.  Petitioner contends that, even though the oil payments constituted Caldwell's income, nevertheless, he is not taxable upon the oil payments because they equaled his capital investment in the wells.  That question, which is not in issue, is not considered, but see *671 ; affd., 126 Fed.:2d) 825, on the point of recoupment of cost out of production prior to reporting income from production. Respondent raises the estoppel issue because he can not make any assessment against Caldwell for the years 1937 and 1938, more than three years having elapsed since the returns for those years were filed.  Sec. 275:a), Internal Revenue Code.  The facts are that Caldwell's returns were filed when due, on March 15, 1938, and March 15, 1939.  Petitioner filed the amendment to the petition on February 28, 1941, which was prior to the expiration of the period within which respondent could have made assessment of an income tax deficiency against Caldwell for both years.  Also, the date of the hearing in this proceeding, October 8, 1941, was prior to the expiration of the assessment period for the year 1938.  There is nothing in the facts to show that Caldwell, as president of petitioner and as an individual taxpayer, concealed any of the facts regarding the oil payments in question, from the respondent's agents, or misrepre sented them.  He put at the disposal of the agents the records of petitioner and himself.  In petitioner's*672  returns it is stated that its books are in the care of D. K. Caldwell.  Also, Caldwell signed petitioner's returns as its president.  Caldwell's returns bear the stamps of respondent's auditor, the return for 1937 having been audited April 28, 1939, and the return for 1938 having been audited January 26, 1940.  The 1938 return of petitioner bears the stamp Audit Division - " under date of April 17, 1939.  The record shows (Tr. 145) that the agent asked Caldwell for figures pertaining to his income and the corporation's income.  Caldwell testified that, when respondent's agent come to his office to audit his return for 1937, he asked the agent to check petitioner's books, related and had [sic] books all there in the office together." The question is whether petitioner's mistaken course of conduct in including the oil payments in gross income in its returns, under a mistake of law, has estopped it from raising the question here.  The respondent contends that he lost his right to assert a deficiency against *715  Caldwell because he relied upon the returns as filed.  But this respondent must prove, "for estoppel is an affirmative defence." *673 . It does appear now that some income may escape tax under the holding made in the main issue, but this is not because respondent was misled by petitioner's returns.  The respondent was advised of petitioner's position in season to assess tax upon the income in question in the hands of Caldwell.  Respondent, apparently with full knowledge of the facts, relied upon an erroneous theory of the law, to wit, that the oil payments constituted petitioner's income.  His predicament is not due to reliance upon any misconduct or misrepresentation by petitioner, but to his own misconception of the law.  Under the facts, respondent should have made his determination on the matter of whether the oil payments constituted income to Caldwell when he learned of petitioner's claim, and he should have assessed tax against Caldwell during the period allowed by the statute.  As has been stated succinctly by the Circuit Court of Appeals for the Second Circuit, "if he wished to avoid the running of the statute, he must make up his mind for himself." *674 ; Respondent makes no claim that petitioner concealed facts or made misleading statements.  Respondent's plea of estoppel can not be sustained, because he had knowledge of all the facts, as far as the record before us shows.  He offered no proof to the contrary.  See . Petitioner's failure to exclude the income in question from its return was due to a mistake of law and not to misrepresentation of fact.  There is no basis here for estoppel.  ; affd., ; . By an affirmative pleading respondent alleged that petitioner's income for 1938 should be increased by the amount of $1,071.84 accrued interest on its note to Caldwell which was forgiven by Caldwell in 1938.  Respondent has abandoned this issue, conceding it.  Other issues raised by the pleadings are no longer issues to be considered in view of the holding under issue 1.  Decision will be entered under*675  Rule 50.