Court Opinion

ID: 4616946
Source: CourtListenerOpinion
Date Created: 2020-11-21 02:35:32.662778+00
Date Added: 2024-06-11T07:55:12.636945
License: Public Domain

WILLIAM C. NEWMAN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Newman v. CommissionerDocket No. 6530.United States Board of Tax Appeals10 B.T.A. 158; 1928 BTA LEXIS 4180; January 24, 1928, Promulgated *4180  1.  Right to and amount of amortization of cost of leaseholds determined.  2.  Rate of depreciation determined.  3.  Petitioner exchanged property for stock in a corporation and at the same time all of the stockholders entered into an agreement restricting the sale of the stock.  Held, that the transaction gave rise to taxable income.  Charles H. Garnett, Esq., for the petitioner.  John D. Foley, Esq., for the respondent.  GREEN *159  In this proceeding the petitioner seeks a redetermination of his income tax for the years 1919 and 1920, for which years the respondent has asserted deficiencies in the amounts of $407.87 and $148,609.65, respectively.  The amended petition alleges errors as follows: (1) The disallowance as a deduction from income in the year 1919 of the sum of $4,680.07 for the amortization of the cost or bonus money paid for unoperated leases owned by the petitioner, or as an aliquot part of such cost or bonus money allotted to that year.  (2) The disallowance of an adequate deduction from income for the year 1919 for depreciation on drilling tools of the Mack Drilling Company, a partnership, of which the petitioner*4181  owned a three-fourths interest, and on the truck and trailer of the Richardson Truck Company, a partnership, of which the petitioner owned a one-third interest, and on drilling tools of the whaley Drilling Company, a partnership, of which the petitioner owned a one-half interest.  The total of this additional depreciation deduction to which the petitioner is entitled on account of the foregoing items is $687.86.  (3) The disallowance as a deduction from income in the year 1920 of the sum of $5,068.42 for the amortization of the cost or bonus money paid for unoperated leases owned by the petitioner, or as an aliquot part of such costs or bonus money allotted to that year.  (4) The disallowance of an adequate deduction from income for the year 1920 for depreciation on drilling tools of the Mach Drilling Company, a partnership, of which the petitioner owned a three-fourths interest, and on the truck and trailer of the Richardson Truck Company, a partnership, of which the petitioner owned a one-third interest, and on drilling tools of the Whaley Drilling Company, a partnership, of which the petitioner owned a one-half interest.  The total of this additional depreciation deduction to*4182  which the petitioner is entitled on account of the foregoing items is $1,470.84.  (5) The erroneous addition to income for the year 1920 of $986.98 of notes and accounts ascertained to be worthless and charged off on the books of the petitioner for that year, and the equally erroneous failure to deduct this item from income.  This error, therefore, makes income for the year $1,973.96 too large.  (6) The erroneous inclusion in income for the year 1920 of the sum of $426,252.14 representing an alleged net profit as fixed by the Commissioner resulting to the petitioner from the exchange of certain oil and gas leases for 252,500 shares of the corporate stock of the Kingwood Oil Company.  (7) The determination of the petitioner's surtax for the year 1920 under section 211(b) of the Revenue Act of 1918 by first computing such surtax on his entire net income, then taking the portion of such surtax indicated by the ratio which his net income from the sale of oil and gas properties bore to the whole of his net income as the portion of the surtax attributable to such sale, and reducing this amount to 20% of the selling price of such properties, instead of determining his surtax for said*4183  year by first computing it in the ordinary way upon his net income derived from sources other that such sale and then adding thereto 20% of the selling price in such sale.  FINDINGS OF FACT.  The petitioner herein is a resident of Okmulgee, Okla, and is engaged principally in the oil and gas business.  During the years *160  1916 to 1920, inclusive, he acquired numerous oil and gas leases, among which there were 25 that, during the years in question, may be described as nonproducing properties, due to the fact that no wells had been drilled thereon, or that such wells as had been drilled thereon had not resulted in commercial production.  As to all of these leases, the petitioner was a sublessee, having in each instance acquired his rights from the original lessee by the payment of a bonus, which bonuses ranged in amount from $40 to $11,500.  The terms of the original leases ranged from two to ten years and in practically every instance some portion of the term had lapsed prior to the acquisition of the lease by the petitioner.  The total of the amounts paid as bonuses in the acquisition of these leases is $36,776.62.  Prorating the cost or bonus on each lease to the unexpired*4184  term and adding the amounts thus obtained, we find that to the year 1919 there should be allocated the amount of $4,008.05 as the proportionate cost of leases for that year.  Following the same procedure for the year 1920, we find that the proportionate cost of leases for that year is $5,029.22.  In 1919 the petitioner owned a three-fourths interest in a set of drilling tools used in the vicinity of his residence and operated under the name of Mack Drilling Co.  The parties have stipulated that the cost of these tools in 1917 and 1918 was $4,829.37, and in 1919 additions were made in the amount of $746.98.  The Commissioner determined that the life of this set of tools was 10 years and allowed a composite rate of 10 per cent.  The life of the set of tools was 5 years.  During the taxable years the petitioner owned a one-half interest in a set of drilling tools operated under the name of the Whaley Drilling Co.  The parties have stipulated that the cost of these tools as of September 1, 1919, was $12,509.72.  The Commissioner determined that these tools had a life of 6 1/4 years and allowed a composite rate of 16 per cent.  The tools in question had a life of 5 years.  The petitioner*4185  owned a one-third interest in a certain truck and trailer, the cost of which the parties have stipulated to be $7,424.62, as of September 1, 1919.  The Commissioner determined the life of these assets to be 5 years and allowed depreciation at the rate of 20 per cent per annum.  The life of these assets is not to exceed 3 years.  The petitioner continued to own the same proportionate interest in the assets above enumerated during the year 1920, and there was no change in the conditions surrounding their use which would vary the useful life of each group as above found.  In the year 1920 the petitioner entered into an oral contract with Bingham Brothers, by the terms of which it was agreed that jointly *161  they should advance the cost of constructing an addition to a farmhouse which was to be used jointly as a boarding house for the men employed by petitioner and Bingham Brothers.  The cost of this construction was to be borne, two-thirds by the petitioner and one-third by Bingham Brothers.  By reason of the failure of the oil wells in that community, neither of the parties to the contract ever used the building, and Bingham Brothers refused to pay their one-third of the cost*4186  and denied their liability therefor.  The petitioner, being doubtful of the validity and justice of his claim against Bingham Brothers, charged off his books the amount of $547.48 as a worthless debt.  The remainder of the cost of construction had been charged to expense.  In the year 1920 the Western Rope & Manufacturing Co. was indebted to the petitioner in the amount of $439.50.  The debtors refused to pay and did all that they could to prevent collection.  During the year (some time in 1919 or 1920) they became bankrupt.  The petitioner was informed in 1920 that they were insolvent and charged off his books as worthless the amount of the indebtedness.  The two items for bad debts, above referred to, total $986.98.  In the preparation of the return the petitioner sought to charge off these amounts as bad debts, but by error the total of the two items was added to, instead of deducted from, income, with the result that the income as reported exceeded by the amount of $1,973,96 the amount which the petitioner intended to return.  The petitioner and the Kingwood Oil Co. (a corporation of Okmulgee, Okla.) owned as tenants in common certain producing oil and gas properties in the*4187  vicinity of Okmulgee.  The Kingwood Oil Co. had outstanding approximately 1,100,000 shares of its stock of a par value of $1 per share.  Of this stock, T. J. King, president of the company, owned approximately 240,000 shares and W. E. Wood, secretary and treasurer, owned approximately 219,000 shares.  The remainder of the stock was distributed in small amounts among a large number of stockholders, many of whom were employees of the company or relatives or close friends of King and Wood.  In August of 1920, negotiations were commenced between the petitioner, on the one hand, and the Kingwood Oil Co., on the other hand, for the acquisition by the Kingwood Oil Co. of the petitioner's interest in the properties owned as tenants in common, together with certain small interests held by some associates of the petitioner.  The purpose of the acquisition by the corporation of the title to the remainder of the property was to enable it to readily dispose of the property either by a sale of the majority of the shares of stock or a sale of the properties themselves.  It was proposed that the outstanding *162  interest in the property be conveyed to the corporation in exchange for 275,000*4188  shares of stock and $23,500 in cash.  Of this amount, 252,500 shares were to be the property of the petitioner and the cash and the remainder of the stock to be the property of the holders of the small interests, above referred to.  One of the conditions insisted upon by King and Wood, and agreed to by the petitioner, was that the stock of all of the three was to be pooled and that neither would sell his stock without the consent of the others.  The transaction was consummated in August of 1920 in accordance with the arrangements above detailed.  The life of the pooling agreement was not agreed upon, it being the expectation of all that a sale of the assets or a majority of the stock would be consummated within a reasonable time thereafter.  The petitioner concedes the fair market value of the stock received by him on this exchange to be $2 per share.  The pooling agreement was faithfully observed by all the parties thereto.  In 1921 the petitioner secured the consent of King and Wood to his sale of 50,000 shares; the remainder of his stock was sold until 1925.  OPINION.  GREEN: The first and third allegations of error relate to the disallowance as a deduction from income of an*4189  amount representing an aliquot part of cost of certain unproductive leases.  This Board has held in the , that the cost of, or bonus paid for, a lease may be amortized and an aliquot part thereof deducted annually over the life of the lease.  We have not thought it necessary to set out in detail all of the data with reference to each lease and have contented ourselves with setting forth the total cost thereof and an amount which represents the sum of the amounts properly allocable to each year in the case of each lease, the total of which is, for the year 1919, $4,008.05, and for the year 1920, $5,029.22.  The petitioner is entitled to deduct these amounts in the computation of his income for such years.  The second and fourth allegations of error relate to the deductions for depreciation to be allowed upon two sets of drilling tools and a certain truck and trailer for both of the years in question.  Our findings of fact dispose of these issues.  The fifth allegation of error relates to the disallowance of certain deductions for bad debts and a mathematical error, the result of which was to increase the net income by $986.98*4190  instead of reducing it by that amount.  In any event, the petitioner's net income should be reduced by the amount of $986.98.  With reference to the account against Bingham Brothers, the facts are that the petitioner in 1920 determined that there was grave doubt *163  as to the legality and justice of this item and charged it off as a bad debt and totally abandoned his claim against Bingham Brothers.  He regarded his action in this respect as equivalent to treating this as an expense item.  We think that the petitioner, having expended the amount of money which he seeks to deduct (having totally abandoned his claim against Bingham Brothers), and having also, by reason of the change in conditions, entirely lost the use of the property for which the money was expended, is entitled to deduct the amount thereof.  With reference to the account against the Western Rope & Manufacturing Co. the evidence is far from clear and we can not determine therefrom that this debt became worthless in 1920, and we therefore approve the action of the Commissioner in disallowing it as a deduction in that year.  The sixth allegation of error relates to the inclusion in income of the amount of*4191  $426,252.14 which the Commissioner determined to be the net profit realized by the petitioner upon the exchange of assets for stock, which stock the parties agree had a fair market value of $2 per share.  The petitioner's contention is that the realization of profit was delayed and deferred by reason of the pooling agreement and that in 1920 he derived no income from this transaction.  The respondent's contention is, first, that such a contract is void as against public policy, and second, that in any event there was an exchange of property for property, that the property received had a fair market value, and that consequently the amount of the gain must be measured and included in income.  The Commissioner's first position requires us to assume that the contract, void as against public policy, may not be considered in determining actual income.  Assuming, but not deciding, that such is the law, we are still unable to agree with the respondent in his contention as to this case.  There are many cases in which the effect of a pooling agreement similar to the one here under consideration has been passed upon by the courts, and their conclusions with respect to the validity thereof are*4192  far from harmonious.  One group of cases, of which , is an example, holds that an agreement between the stockholders of a corporation not to sell or transfer their shares without the consent of all the parties thereto, is in restraint of trade and contrary to public policy and is therefore void if there is no other consideration than the mutual promises of the stockholders.  See Fletcher's Encyclopedia of Corporations, vol. 6, sec. 3761, p. 6264.  That group of cases is best distinguished from the one here under consideration by the fact that the pooling agreement, which the respondent seeks to have us hold void as against public policy, was a condition *164  precedent to the exchange of property for stock and does not arise out of mutual promises made after the acquisition of stock.  Another group of cases takes the opposite view.  Notable examples of these cases are, ; ; *4193 ; ; ; ; ; ; and ; . A careful examination of these authorities leads us to the conclution that this pooling agreement is not void as against public policy.  Having disposed of the respondent's contention that the pooling agreement was void, we come next to the question of its effect upon taxable income.  The petitioner contends that thereby the realization of income is deferred and the respondent contends that, viewing the transaction as a whole, it was an exchange of property for property which had a fair market value and that income was realized therefrom.  The parties, by their stipulation that at the time of its receipt by the petitioner the stock had a fair market value of $2 per share, have eliminated the most difficult part of the question.  Section 202(b) of the Revenue Act of 1918, in so far as it is here material, reads as follows: *4194  When property is exchanged for other property, the property received in exchange shall for the purpose of determining gain or loss be treated as the equivalent of cash to the amount of its fair market value, if any; * * * Clearly there was an exchange of property for property the value of which the parties have stipulated was $2 per share, and income was realized to the extent that the fair market value of the property received exceeded the cost or other basis of the property exchanged.  See . It should also be noted that the exchange was between the corporation and the petitioner and that the pooling agreement was between stockholders and that they were entirely separate agreements. The last allegation of error relates to the computation of the tax upon the income derived from several sources.  The respondent has denied all of the allegations relating to this assignment of error.  The petitioner offered no proof in support of his assignment, and we, accordingly, confirm the Commissioner's actions in this regard.  Apparently the Commissioner's action is in accord with article 13 of Regulations 45; the decision of the*4195 District Court of the Northern District of Texas in ; and the decision of this Board in . Judgment will be entered after 20 days' notice, under Rule 50.