FA Gillespie & Sons Co. v. Commissioner of Int. Rev.

• Decision Date: 23 May 1946
• Docket Number: No. 3180,3181.,3180
• Parties: F. A. GILLESPIE & SONS CO. v. COMMISSIONER OF INTERNAL REVENUE (two cases).
• Court: U.S. Court of Appeals — Tenth Circuit

154 F.2d 913 (1946)

F. A. GILLESPIE & SONS CO. v. COMMISSIONER OF INTERNAL REVENUE (two cases).

Nos. 3180, 3181.

Circuit Court of Appeals, Tenth Circuit.

March 12, 1946.

Rehearing Denied May 23, 1946.

Harold E. Rorschach, of Tulsa, Okl. (Jack L. Rorschach, of Vinita, Okl., on the briefs), for petitioner.

Hilbert P. Zarky, Sp. Asst. to Atty. Gen. (Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key and J. Louis Monarch, Sp. Assts. to Atty. Gen., on the brief), for respondent.

Before PHILLIPS, BRATTON, and HUXMAN, Circuit Judges.

PHILLIPS, Circuit Judge.

These are petitions to review two decisions of the Tax Court of the United States. They involve deficiencies in income tax for the years 1937 and 1939.

F. A. Gillespie and Sons Company¹ is an Oklahoma corporation organized in 1920.

1. The Placedo Leases.

In 1937, the taxpayer owned one-half of a 7/8ths working interest in 11 oil and gas leases,² covering approximately 1400 acres of land, situated in the Placedo Oil Field, in Victoria County, Texas. The remaining one-half of the 7/8ths working interest was owned by the Superior Oil Corporation.³

On June 15, 1937, for a cash consideration of $200,000, the taxpayer transferred its interest in the Placedo leases to Superior, reserving 1/8th of 7/8ths of the oil and gas to be produced from the leases until it received the sum of $275,000 from the retained interest. No reservation was made with respect to equipment. The discovery well in the Placedo Field was completed by the taxpayer on April 10, 1935, on a lease covering approximately 170 acres. That well ceased to produce on October 21, 1936. At the date of the sale there were 15 wells on the Placedo leases, all of which were producing. Production was from the Greta sand. The thickness of that sand varied. It averaged nine feet. A deeper sand, known as the Frio, was productive in the Placedo Field at the time of the sale. There were also other deeper, known producing sands in the area, but they had not been tested in the Placedo Field. The greater part of the oil produced from the Placedo leases had a gravity of 23 degrees. At the time of the hearing before the Tax Court, only two of the leases, covering 211 acres, were producing. From the date of the sale through March, 1944, the taxpayer received a total of $111,190.19 from the retained interest.

The taxpayer and Superior had each paid one-half of the intangible drilling and development costs. The taxpayer's share of such cost amounted to $142,467.80, which it had capitalized. The original cost of the leases was nominal and had not been capitalized by the taxpayer. The taxpayer claimed and was allowed depletion of $5,441.51 for the year 1935 and $10,104.98 for the year 1936 in its respective tax returns for those years. In its tax return for 1937, the taxpayer claimed a depletion allowance of $4,126.80. The Commissioner determined it was entitled to $5,717.12, making aggregate depletion allowances to the date of sale of $21,263.61. The taxpayer's interest in leasehold equipment had cost $120,403.46. It claimed and was allowed depreciation thereon in its returns for 1935, 1936, and 1937, aggregating $10,278.74. In its return for 1937, the taxpayer reported a loss of $37,181.64 on the sale of its interest in the Placedo leases and in the leasehold equipment.

The Commissioner determined that the value of the retained interest was $100,000. He deducted from the development cost the depletion allowances and from the leasehold equipment costs the depreciation claimed and allowed, and fixed the adjusted basis at $231,328.91. Of that amount, he allocated 100/300, or $77,109.64, to the retained interest and determined the taxable gain on the sale to be $45,780.73.

At the hearing before the Tax Court, the Commissioner conceded that the taxpayer was entitled to recover the full depreciated cost of the leasehold equipment, and that he erred in allocating any part thereof to the retained interest.⁴

2. The Shear Lease.

In 1939, the taxpayer was the owner of a lease, known as the Shear lease, which had been acquired for a nominal consideration. During 1939, the taxpayer transferred that lease, with the leasehold equipment thereon, for $49,950, reserving 1/8th of 7/8ths of the production therefrom until it received the sum of $100,000 from the retained interest. Intangible drilling and development costs to the date of the sale amounted to $26,937.98. Of that amount, $22,439.71 had been capitalized. Depletion deductions taken by the taxpayer, and allowed by the Commissioner, with respect to the lease amounted to $1,345.85. The cost of the leasehold equipment up to the date of sale was $9,665.92, and the depreciation claimed and allowed with respect thereto was $483.30. In its income tax return for 1939, the taxpayer reported a gain of $19,449.66 from the sale of that lease.

The Commissioner deducted the depletion allowed from the capitalized intangible drilling and development costs and the depreciation claimed and allowed from the leasehold equipment costs and fixed the adjusted cost basis at $34,774.75. He determined the value of the retained interest at $60,000, arriving at a total value of $109,950. Of the adjusted cost as determined by him, he allocated 45.43 per cent, or $15,798.17, to the interest sold, and the balance, or $18,976.58, to the interest retained, and thus determined a net taxable gain of $34,151.83 from the interest sold.

At the hearing before the Tax Court, the parties stipulated that the value of the interest retained was $5,000; and the Commissioner conceded that the taxpayer was entitled to recover the full depreciated cost of the leasehold equipment, and that he erred in allocating any part thereof to the retained interest.

3. The Annuities.

By a contract entered into on May 15, 1929, between the taxpayer and F. A. Gillespie and Maud Gillespie, husband and wife, the Gillespies transferred to the taxpayer certain properties of the value of $1,464,240.22. The cost of these properties to the Gillespies equalled or exceeded the fair market value at the date of transfer. Under the terms of the contract, the taxpayer agreed to pay F. A. Gillespie $15,000 per year for life, and to pay Maud Gillespie $15,000 per year for life. In addition, the taxpayer agreed that Maud Gillespie should receive during her life, $10,000 annually, as dividends, and if in any year funds should not be available for the declaration of dividends in that amount, the taxpayer would pay her such amount.

F. A. Gillespie was born on August 22, 1868, and Maud Gillespie on June 9, 1872. An annuity upon the life of a male individual born in the United States on August 22, 1868, which would have paid him $15,000 per annum for life, could have been purchased on May 15, 1929, from a reputable life insurance company, doing business in the United States, for the sum of $153,750. An annuity upon the life of a female individual born in the United States on June 9, 1872, which would have paid her $15,000 per annum for life, could have been purchased on May 15, 1929, from a reputable life insurance company, doing business in the United States, for the sum of $196,537.50.

Under the terms of the contract of May 15, 1929, the taxpayer paid F. A. Gillespie a total of $54,375 for the years 1929 to 1932, inclusive, and for the years 1933 through 1942 the amount of $15,000 per annum. The taxpayer paid Maud Gillespie, for 1932, and for certain settlements to that time, $34,891.01. For 1933, she was paid $25,000 and in November of that year she agreed that the taxpayer might discontinue paying her the additional $10,000 per annum. However, in 1934, she was paid $20,000, and for the years 1935 to 1940, inclusive, she was paid $15,000 per annum. She died in 1941, and for the portion of that year ending with September, she was paid $12,250.

The taxpayer claimed the right to deduct, as interest, 3 per cent of what it would have cost to purchase such annuities from its gross income in each of the years 1937 to 1939, inclusive.

The Tax Court held that, in computing gain on the sale of the leases, proper adjustment should be made for the prior deductions taken for depletion and depreciation, without regard to whether any tax benefit had been received; that an aliquot portion of the capitalized intangible drilling and development costs should be allocated to the taxpayer's retained interest in the leases; that the claimed deductions for interest were not allowable; and that on recomputation the amount of depletion allowed for 1937 and 1939 should be adjusted in accordance with its decisions.

The pertinent statutory provisions are set forth in the margin.⁵

The Revenue Act of 1938, 52 Stat. 490, 460, 26 U.S.C.A. Int.Rev.Acts, pages 1048, 1053, 1011, 1012, contained corresponding provisions in identical language.

The petitioner contends that, although it claimed depreciation allowances in its tax returns, which were allowed by the Commissioner, such depreciation should not be considered in arriving at the adjusted cost basis of the property under § 113, because it received no tax benefit from such depreciation. This contention is foreclosed by the decision of the Supreme Court in Virginian Hotel Corp. v. Helvering, 319 U.S. 523, 526, 63 S.Ct. 1260, 1262, 87 L.Ed. 1561, 152 A.L.R. 871. The court there said:

"But it is said that `allowed' unlike `allowable', connotes the receipt of a tax benefit. The argument is that though depreciation in excess of an `allowable' amount is claimed by the taxpayer and not disallowed by the Commissioner, it is nevertheless not `allowed' if the deductions other than depreciation are sufficient to produce a loss for the year in question. `Allowed' in this setting plainly has the effect of requiring a reduction of the depreciation basis by an amount which is in excess of depreciation properly deductible. We do not agree, however, with the contention that such a reduction must be made only to the extent that...