Burton-Sutton Oil Co. v. Comm'r of Internal Revenue

• Decision Date: 04 August 1944
• Docket Number: Docket No. 110566.
• Citation: 3 T.C. 1187
• Parties: BURTON-SUTTON OIL COMPANY, INCORPORATED, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

3 T.C. 1187

BURTON-SUTTON OIL COMPANY, INCORPORATED, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 110566.

Tax Court of the United States.

Promulgated August 4, 1944.

1. Petitioner acquired an oil and gas lease by assignment and contracted with the assignor, among other things, that ‘After Grantee has met the underlying and overriding royalty obligations referred to in paragraph 2 hereof and has been reimbursed out of the proceeds of the oil and gas produced from all such costs and expenses of operating upon said property as defined below, Grantee shall account to and pay Grantor 50% of the remaining portion of said proceeds * * * .‘ During the taxable years 1936, 1937, and 1938 it paid the grantor of the contract certain amounts representing the ‘50% of the remaining portion of said proceeds‘ called for in the contract. Held, the amounts so paid to the grantor are capital expenditures and represent a part of the cost of the lease to petitioner and are not to be excluded from petitioner's income except through deductions for depletion or as a part of the cost basis in case of a sale or other disposition of the property. Quintana Petroleum Co., 44 B.T.A. 624;affd., 143 Fed.(2d) 588, followed.

2. In 1940 the State of Louisiana asserted against petitioner additional corporation franchise taxes for the taxable years 1937 and 1938, which petitioner paid in 1940. Petitioner kept its books upon the accrual basis. Held, the amounts asserted and paid in 1940 represented taxes accrued in 1937 and 1938, respectively, and as such were allowable deductions from gross income for the years 1937 and 1938 under section 23(c) of the Revenue Act of 1936.

3. In 1941 the State of Louisiana asserted against petitioner additional income taxes for the taxable years 1937 and 1938, together with interest thereon, all of which petitioner is contesting before the board of tax appeals of that state. Held, petitioner is not entitled to deduct any of these contested items from its gross income for the taxable years 1937 and 1938, respectively. Dixie Pine Products Co. v. Commissioner, 320 U.S. 516.

4. During the taxable year 1938 petitioner expended a sum of money in resisting certain condemnation proceedings instituted by the United States which involved, among other things, a dispute over the boundaries of petitioner's property. The dispute was settled in petitioner's favor. Held, the expenditures in question are deductible as ordinary and necessary business expenses. L. B. Reakirt, 29 -.T.A. 1296; affd. per curiam, 84 Fed.(2d) 996, followed. Wright Matthews, Esq., for the petitioner.

Frank B. Schlosser, Esq., and L. R. Van Burgh, Esq., for the respondent.

This proceeding involves the determination by the respondent against petitioner of deficiencies in income and excess profits taxes for the taxable years 1936, 1937, and 1938 in amounts as follows:

+--------------------------------------------+
                ¦Fiscal year ended-¦Income tax¦Excess profits¦
                +------------------+----------+--------------¦
                ¦                  ¦          ¦tax           ¦
                +------------------+----------+--------------¦
                ¦Feb. 29, 1936     ¦$10,799.01¦$667.42       ¦
                +------------------+----------+--------------¦
                ¦Feb. 28, 1937     ¦66,341.26 ¦27,899.87     ¦
                +------------------+----------+--------------¦
                ¦Feb. 28, 1938     ¦82,655.94 ¦32,157.86     ¦
                +--------------------------------------------+
                

The above deficiencies result from several adjustments to the net income as reported by petitioner. Not all of these adjustments are contested. Some of the adjustments that were contested by appropriate assignments of error were abandoned at the hearing, without prejudice to petitioner's right to raise similar issues in future years. These abandoned issues relate to claimed deductions for depreciation for 1936 and 1938, and claimed deductions for timber used for construction purposes in 1937 and 1938. Additional errors were assigned by petitioner relating to certain claimed deductions for state franchise and state income taxes, together with interest on the income taxes, concerning which no adjustments were made by the respondent. The issues which have thus been raised by appropriate assignments of error and remain for our determination and decision are as follows:

1. Is petitioner entitled to exclude from taxable income in each of the taxable years the amount paid to the Gulf Refining Co. of Louisiana under the terms of a contract whereby petitioner acquired an oil and gas lease?

2. Is petitioner entitled to deduct in the taxable years 1937 and 1938 the amounts of additional franchise taxes for those years which were asserted by the State of Louisiana in the year 1940 and paid by petitioner in 1940?

3. Is petitioner entitled to deduct in the taxable years 1937 and 1938 amounts representing additional state income taxes, together with interest thereon, which were asserted for those years by the State of Louisiana on December 31, 1941, where an appeal has been taken to the Board of Tax Appeals of the State of Louisiana and the additional taxes and interest have not been paid?

4. Is the sum of $27,564.61 paid in the taxable year 1938 for legal services rendered in connection with a condemnation suit brought against petitioner and others by the United States, which involved the boundary lines of petitioner's property, deductible as an ordinary and necessary expense?

FINDINGS OF FACT.

Petitioner is a corporation organized in February 1933 and doing business under the laws of the State of Louisiana, with its principal office in Lake Charles, Louisiana. The returns for the taxable years here involved were filed with the collector of internal revenue for the district of Louisiana at New Orleans. Petitioner kept its books and prepared its returns on the accrual basis.

Issue No. 1.— The adjustments to petitioner's net income for the years 1936, 1937, and 1938 which resulted in assignments of error raising issue No. 1 were explained by the respondent in the statement attached to the deficiency notice as follows:

It is held that payments made to Gulf Refining Company of Louisiana in each of the years 1936, 1937 and 1938 in accordance with the contract whereby you acquired the lease to a section of State school land in Cameron Parish, Louisiana, represent a part of the cost of that lease, and are therefore not to be deducted or excluded from taxable income, except as they are recovered through depletion. Since in each of the years under consideration percentage depletion is greater than depletion based on cost of the lease, adjusted for depletion previously allowed, percentage depletion has been allowed in each year.

On or about February 27, 1933, petitioner acquired from J. G. Sutton a contract which had been entered into on February 18, 1933, between Sutton as ‘grantee‘ and the Gulf Refining Co. of Louisiana, hereinafter sometimes referred to as Gulf or as grantor. This contract recited that Gulf, for and in consideration of $10 and other valuable considerations, ‘has sold, conveyed and transferred, and does hereby sell, convey and transfer‘ unto the said grantee ‘all oil and gas rights, titles, interests or privileges given, conveyed and transferred by virtue of that certain mineral lease executed by Cameron Parish School Board to S. W. Sweeney, dated April 4, 1927, covering all of the whole of Section Sixteen (16), Township Fourteen (14) South, Range Thirteen (13) West, Louisiana Meridian, in Cameron Parish, Louisiana.‘ The contract further recited that:

This assignment is made subject to the following terms and conditions:

1. Grantee binds and obligates himself to begin on or before thirty days from date, operations for the drilling of a well on said land and to continue his operations thereon with reasonable diligence to completion or abandonment in an honest, bona fide effort to find oil or gas in paying quantities on said land. After the completion of said well, Grantee shall continue such operations on said land as may be necessary to continue said lease in full force and effect. If, after completing said well, Grantee shall desire to cease operations on said land, he shall, upon demand, reassign said lease to Grantor not less than thirty days prior to the maturity date of any obligation accruing after the date of the cessation of his operations on said land.

2. All oil and gas royalties which are due and payable under the terms of said lease herein referred to, as well as the overriding oil royalty provided for in the contract executed by Gulf Refining Company of Louisiana to S. W. Sweeney, on April 7, 1927, together with all the costs and expenses incurred by Grantee in his operations on said land, shall be borne and paid by Grantee, out of the remainder of the proceeds of the sale of any oil and/or gas produced from the land, after payment of the royalties hereinabove provided for, Grantee shall reimburse himself for the costs and expenses incurred and allowed by reason of his operations under said lease.

3. After Grantee has met the underlying and overriding royalty obligations referred to in paragraph 2 hereof and has been reimbursed out of the proceeds of the oil and gas produced from all such costs and expenses of operating upon said property as defined below, Grantee shall account to and pay Grantor 50% of the remaining portion of said proceeds of the oil and/or gas produced and sold from the said land. Accounting hereunder shall be at the price which Grantee received for the oil and/or gas produced from said land.

4. Accounting and settlement under this agreement shall be made at the end of each calendar month, and losses and arrears sustained by Grantee in his operations may be brought forward from month to month until extinguished. * * *

Paragraph 5 of the contract specified what ‘costs and expenses allowed in this agreement and that may be deducted by Grantee from the proceeds of the Gross production of oil and gas from said...