AH Pah Redwood Co. v. Comm'r of Internal Revenue

• Decision Date: 28 September 1956
• Docket Number: Docket No. 50695.
• Citation: 26 T.C. 1197
• Parties: AH PAH REDWOOD CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

26 T.C. 1197

AH PAH REDWOOD CO., PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 50695.

Tax Court of the United States.

Filed September 28, 1956.

James C. Dezendorf, Esq., for the petitioner.

Wendell M. Basye, Esq., for the respondent.

1. Held, the amounts received by petitioner in 1948 and 1949 from Coast Redwood Co. for timber cut by the latter in those years from the property of petitioner are properly taxable as ordinary income.

2. Where petitioner did not in fact ascertain at any time during 1948 and 1949 a discrepancy between its actual timber resources and prior estimates, even though such fact was at all times readily ascertainable, a revision of petitioner's depletion allowance effective for the years 1948 and 1949 is not warranted under section 23(m), I.R.C. 1939.

The respondent determined deficiencies in income tax of petitioner, and additions thereto, pursuant to section 291(a) of the Internal Revenue Code of 1939, for failure to file timely returns, for years and in amounts as follows:

+-------------------------------------+
                ¦Year  ¦Deficiency  ¦Addition to tax  ¦
                +------+------------+-----------------¦
                ¦1948  ¦$2,654.84   ¦$663.71          ¦
                +------+------------+-----------------¦
                ¦1949  ¦35,649.37   ¦8,912.35         ¦
                +-------------------------------------+
                

Respondent's imposition of the additions to tax is not contested. Nor is error assigned with respect to various adjustments made by respondent in his determination. The issues framed by the pleadings and here to be resolved are:

(1) Whether the amounts received by petitioner in 1948 and 1949 from Coast Redwood Co. for timber cut by the latter from the property of petitioner are properly taxable as long-term capital gains.

(2) Whether petitioner's depletion allowance for the taxable years 1948 and 1949 is properly to be adjusted subsequent to the close thereof by revision of the estimated amount of units of timber standing on petitioner's property during such years.

FINDINGS OF FACT.

The stipulation of facts filed by the parties, with exhibits attached, is adopted and, by this reference, made a part hereof.

The petitioner, Ah Pah Redwood Co., is a corporation organized under the laws of California, with its main office at Portland, Oregon. The returns for the periods here involved were filed with the then collector¹ of internal revenue for the district of Oregon. Such returns were filed on a calendar year basis.

Upon its organization in October 1947, petitioner purchased all the right, title, and interest of ‘the buyer’ in a certain purchase agreement (hereinafter called the Sage Agreement), and all the timber and land covered thereby, dated December 13, 1946, between Sage Land & Lumber Company, Inc. (hereinafter called Sage), as seller, and Union Bond & Trust Company (hereinafter called Union), as buyer. The timber and land involved are located in Humboldt County, California, and the purchase price paid by petitioner was $1,443,838.99. Shortly after the purchase of this tract (hereinafter called Coast), allowed the latter to begin cutting timber from the Sage Tract and pay therefor $5 per thousand feet as removed. On January 9, 1950, petitioner entered into a formal written agreement with Coast, pursuant to which petitioner agreed to sell all of the timber and land covered by the Sage Agreement to Coast.

In the years 1948 and 1949, petitioner reported its income on the sales of timber to Coast as long-term capital gains. In so reporting its income on the timber thus sold to Coast, petitioner used the basis for depletion of $3,941566 per thousand board feet. Respondent also used such basis in computing a portion of the deficiencies here in question. This basis for depletion was computed by both parties by dividing the amount of timber on the Sage Tract, as was shown on schedule A of the Sage Agreement per the French cruise, which amount petitioner assumed to be the correct quantity thereof, into the total purchase price paid by petitioner for such agreement. In 1952, petitioner first became aware of the fact that schedule A of the Sage Agreement erroneously overstated the quantity of timber on the Sage Tract by a substantial amount. Upon an actual cruise made shortly after logging operations ceased in November 1954, it was ascertained that such overstatement was approximately double the actual amount and that there was a ‘fall-down’ of approximately 48 percent.

In addition to other sales, petitioner sold 33,883,000 board feet of timber covered by the Sage Agreement to A. K. Wilson Lumber Company in 1950. This quantity of timber was assumed to be the above amount on the basis of the quantities shown in schedule A to the Sage Agreement. Prior to petitioner's acquisition of the Sage Agreement, International Pacific Pulp and Paper Co. sold 16,022,060 board feet of the timber covered thereby to Coast in the years 1946 and 1947.

OPINION.

VAN FOSSAN, Judge:

The first issue is whether the amounts received by petitioner in 1948 and 1949 from Coast for timber cut in those years by the latter from the Sage Tract are properly taxable as capital gains, as urged by petitioner, or as ordinary income, as determined by respondent. The statutes involved are sections 117(j) (1) and 117(k)(2) of the Internal Revenue Code of 1939, as amended, the pertinent provisions of both of which are set forth below. ² It is petitioner's position that the only question to be resolved under this issue is whether or not its oral arrangement with Coast, whereby Coast commenced logging operations on the Sage Tract, as indicated in our findings above, in October 1947, shortly after petitioner's acquisition thereof, from which logging operations the amounts in dispute were received, constituted a ‘disposal’ by petitioner of all of the timber standing thereon within the meaning of section 117(k)(2).

In line with this view, petitioner makes the argument on brief that such oral arrangement was ineffective to pass title to all of the standing timber in question in October 1947, the date the oral agreement was made, because of the California Statute of Frauds (Cal. Civ. Code Ann. sec. 1091 (West)); Anderson v. Palladine, 178 P. 553; see, also, a ‘disposal’ of such timber within the ambit of the cited statute at any time prior to the execution of the written agreement in 1950. Further, petitioner advances the theory that while its oral agreement with Coast was not effective as a contract to sell standing timber, it did constitute a license to cut, which license ripened into a contract for the sale of logs upon the severance of each individual tree.

Whether or not petitioner's theory be valid, its application will not constitute a disposition of the issue framed in the pleadings. Thus to narrow the issue is to make the unwarranted assumption that the timber involved in the transaction at issue constituted a capital asset to petitioner at the time of such transaction, within the definition contained in section 117(a)(1) of the Internal Revenue Code of 1939,³ or property used in petitioner's trade or business within the meaning of section 117(j)(1), supra. In this connection, respondent makes the point, which we feel to be well taken, that petitioner at no time engaged in any logging activities, but, rather, merely sold the Sage timber to others under arrangements whereby the vendees would do the logging; that these sales of timber were the only business activity entered into by petitioner; that it is thus to be considered as having been engaged in the trade or business of selling timber; and that the timber in dispute, whether or not it was standing, was held for sale to customers in the ordinary course of such business.

The facts found on this record lead to the conclusion that petitioner was engaged in the trade or business of selling timber and that the timber in controversy was held for sale to customers in the ordinary course thereof. Petitioner does not deny the nature of its business activity and the purpose for which the Sage timber was held. Nor does it claim that the timber comes within the definition of section 117(a)(1), supra. In fact, petitioner bases its entire case upon the applicability of section 117(j). In this connection, petitioner's position is summed up in its statement on brief that section 117(j) ‘includes timber to which Section 117(k)(2) is applicable and allows capital gain treatment of income therefrom without regard to the nature of the taxpayer's business or the purpose for which the timber is held.’

The view thus expressed is in direct conflict with the plain wording of the statute relied upon. Section117(j), by its own language, specifically excludes from its operation all property held for sale to customers in the ordinary course of business. This being true, the gains derived from the sale of the Sage timber, regardless of the time of such sale, would not qualify for capital gains treatment under either section 117(a)(1) or section 117(j).

While there is no direct evidence of the precise terms of the oral cutting contract entered into between petitioner and Coast, such contract, for aught that is shown, looked immediately to the severance and removal of all timber standing upon the Sage Tract. Under the provisions of the Uniform Sales Act which was enacted in California in 1931 (See title 1, Sales of Goods, Stats. 1931, ch. 1070, p. 2234, sec. 1; Cal. Civ. Code Ann. secs. 1721-1800 (West)), the sale of ‘things attached to or forming a part of the land,‘ which category includes fructus naturales, or standing timber, pursuant to a contract according to the terms of which the trees are to be severed and removed as soon as possible, as a sale of goods, i.e., personality, and not of an interest in land. See sec. 1796, supra; Brown, Personal...