Gray v. Comm'r of Internal Revenue

• Decision Date: 26 August 1949
• Docket Number: 17955.,17954,17953,Docket Nos. 17952
• Citation: 13 T.C. 265
• Parties: WILLIAM D. GRAY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE RESPONDENT.FANNIE M. GRAY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.R. J. WOLFE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.NONA HOBBS WOLFE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

13 T.C. 265

WILLIAM D. GRAY, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE RESPONDENT.FANNIE M. GRAY, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.R. J. WOLFE, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.NONA HOBBS WOLFE, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket Nos. 17952

17953

17954

17955.

Tax Court of the United States.

Promulgated August 26, 1949.

The taxpayers, owners of gas and oil leases, assigned the leases to a corporation under a contract whereby they received a cash payment and the right to a fifth of the oil produced and to a fifth of the profits from the gas produced. If the assignee should organize a corporation to process the gas, 20 per cent of the stock was to be issued to the taxpayers. On the evidence, held, that under the terms of the assignment contracts the taxpayers retained an economic interest in the minerals in place and that payments received by them under the contracts are taxable as ordinary income, subject to depletion allowances. Russell Scott, Esq., and Thad T. Hutcheson, Esq., for the petitioners.

L. R. Van Burgh, Esq., and D. Louis Bergeron, Esq., for the respondent.

In these consolidated proceedings the Commissioner determined deficiencies in individual income taxes as follows:

+-------------------------------------------------------+
                ¦                ¦          ¦Deficiency                 ¦
                +----------------+----------+---------------------------¦
                ¦Petitioner      ¦Docket No.¦                           ¦
                +----------------+----------+---------------------------¦
                ¦                ¦          ¦Cal. yr. 1943¦Cal. yr. 1944¦
                +----------------+----------+-------------+-------------¦
                ¦William D. Gray ¦17952     ¦$5,298.16    ¦$1,049.42    ¦
                +----------------+----------+-------------+-------------¦
                ¦Fannie M. Gray  ¦17953     ¦5,298.16     ¦1,049.42     ¦
                +----------------+----------+-------------+-------------¦
                ¦                ¦          ¦Fiscal yr.   ¦Fiscal yr.   ¦
                +----------------+----------+-------------+-------------¦
                ¦                ¦          ¦7/31/42      ¦7/31/44      ¦
                +----------------+----------+-------------+-------------¦
                ¦R. J. Wolfe     ¦17954     ¦$4,585.76    ¦$997.41      ¦
                +----------------+----------+-------------+-------------¦
                ¦Nona Hobbs Wolfe¦17955     ¦4,585.76     ¦860.64       ¦
                +-------------------------------------------------------+
                

The basic question is whether the respondent erred in holding that the amounts received by a partnership, of which the petitioner husbands were members, from the assignee of oil and gas leases are taxable as ordinary income. Some of the facts were stipulated.

FINDINGS OF FACT.

The stipulated facts we adopt and by this reference include herein. Petitioners are individuals and throughout the period here involved resided in Houston, Texas. During said period William D. Gray and Fannie M. Gray were living together as husband and wife, and R. J. Wolfe and Nona Hobbs Wolfe were likewise husband and wife, and each of them filed separate income tax returns with the collector of internal revenue for the first district of Texas. Gray and wife filed same for each of the calendar years 1943 and 1944 upon a cash receipts basis, as their books were kept. Wolfe and wife kept their books and filed their returns on the accrual basis of accounting, and filed same for each of the fiscal years ended July 31, 1942, to July 31, 1944, inclusive.

During the period involved and continuously after 1932, William D. Gray and R. J. Wolfe were equal copartners in a firm known as Gray & Wolfe, sometimes herein called the partnership, whose office and principal place of business was in Houston, its business being drilling operations and oil and gas production. The transactions involved herein are treated generally as those of the partnership rather than those of the individual partners. The partnership kept its books and filed its returns on the accrual basis of accounting, and for each of the fiscal years ended July 31, 1942, to July 31, 1944, inclusive, filed partnership returns with the collector of internal revenue for the first district of Texas.

In the fall of 1941 and the spring of 1942 and within the fiscal year ended July 31, 1942, Gray & Wolfe, after geophysical work, acquired certain oil and gas leases covering approximately 1,800 acres located in the Pinehurst field, ¹ Montgomery County, Texas, at a cost of $45,000, plus a drilling obligation as to certain of said leases. Most of the leases were on standard commercial lease forms, Producers 88, providing the usual one-eighth royalty to the landowner, but the leases from Grogan-Cochran Lumber Co. were in special form. One of the Grogan-Cochran Lumber Co. leases contained a well-drilling obligation and both of the Grogan-Cochran leases, over and above landowner's royalty, called for an oil payment of $100 per acre, payable out of one-sixteenth of the oil and gas production, which burdened more than half of the leasehold acreage involved in the purchase agreement.

Thereafter, on April 22, 1942, La Gloria Corporation, in a letter to Gray & Wolfe, made the following offer to purchase these leases:

We wish to submit to you the following offer for the purchase of your block of Oil and Gas Leases on approximately 1,800 acres of land located in, or in the vicinity of the Charles Frazier and A. Prather Surveys in Montgomery County, Texas, said Surveys being about three miles east of Magnolia and said leases being those indicated on the map you have heretofore furnished us.

We propose to acquire these leases on the following terms and conditions, to-wit:

1. We will pay you $45,000.00 in cash on the delivery of proper assignments of the leases.

2. You will reserve the following:

(1) On oil produced from the first well to be drilled on said leases, you will retain an overriding royalty of 1/16 until we have recovered the drilling cost of said well from our working interest therein. After the drilling cost of the first will is recovered, your overriding royalty on oil will be increased from 1/16th to 1/5th. On oil produced from all wells except the first well, you will reserve to yourselves an overriding royalty of 1/5th without regard to drilling cost, provided, however, that when any well on said leases ceases to flow oil naturally, the overriding royalty will be reduced to 1/10th unless you pay your pro-rata share of the lifting cost.

(2) On gas, casinghead gas, natural gasoline, distillate and all other products that may be separated or extracted from gas produced from said leases, you will reserve a carried interest of 20%. If we elect to organize a corporation to erect and operate a processing and cycling plant to process the gas produced from said leases, you will have 20% of the common stock of the said corporation without cost to you. If La Gloria Corporation elects to erect and operate the processing plant, you will have a carried interest of 20% in said products, or in the value thereof, subject, of course, to the cost of the plant and the operating and managerial expense and subject to interest charges at the rate paid by La Gloria which shall not exceed 5%.

4. We understand that the leases above mentioned are written on the Revised 88 Form and that the rentals are $1.00 per acre. We also understand that the Grogan-Cochran leases are encumbered with an oil payment of $100.00 per acre, payable out of 1/16th of the oil and gas production.

* * * * *

On this letter Gray & Wolfe noted acceptance of the offer the same day.

This letter formed the basis of the contract between the parties, and in furtherance thereof, on May 25, 1942, four written instruments were executed, viz:

(1) Gray & Wolfe's assignment to La Gloria Corporation covering 1,640 acres of the oil and gas leases referred to in the letter.

(2) Gray & Wolfe's assignment to La Gloria of the oil and gas leases on the remaining 156.6 acres.

(3) Supplemental agreement (hereinafter called gas production contract) elaborating upon La Gloria's obligation to transfer to Gray & Wolfe 20 per cent of the stock in a corporation contemplated to be formed to erect, own, maintain and operate a gas-processing and cycling plant, etc.

(4) Drilling contract.

Further description or such portions of each of said instruments as are deemed pertinent are set out below:

(1) The 1,640-acre assignment provides:

This writing evidences an assignment and contract by and between W. D. Gray and R. J. Wolfe of Harris County, Texas, hereinafter called SELLERS and La Gloria Corporation, a Texas Corporation, hereafter called PURCHASER, as follows:

Sellers for and in consideration of the sum of $33,828.25 cash to it in hand paid by Purchaser, the receipt of which is hereby acknowledged, and in further consideration of the faithful performance by Purchaser of the agreements and (which shall be covenants running with the land), and upon the terms and conditions and subject to the acceptances and reservations hereinafter set out have granted, bargained, sold, conveyed and assigned, and by these presents do grant, bargain, sell, convey and assign to Purchaser those certain oil and gas mining leases a full list and description of which is attached hereto marked ‘Exhibit A‘² and made a part hereof.

TO HAVE AND TO HOLD, subject to the terms, agreements, covenants, conditions, acceptances and reservations set out, such oil and gas mining leases, together with all and singular the rights and appurtenances thereto and anywise belonging unto the said Purchaser, its successors and assigns in accordance with the terms and provisions of said leases and in so far as the said leases cover the lands described therein; and subject to the terms, agreements, covenants and reservations hereinafter set out, Sellers do hereby bind themselves, their heirs and assigns to warrant and forever defend all and singular the said oil and gas leases unto said Purchaser, its successors and assigns, against every person whomsoever...