J.S. Abercrombie Co. v. Comm'r of Internal Revenue, Docket No. 6168.

• Decision Date: 12 June 1946
• Docket Number: Docket No. 6168.
• Citation: 7 T.C. 120
• Parties: J. S. ABERCROMBIE CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

7 T.C. 120

J. S. ABERCROMBIE CO., PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 6168.

Tax Court of the United States.

Promulgated June 12, 1946.

Petitioner and H corporation were the operators of certain oil and gas properties under an agreement with A and C corporations. At one time the four corporations owned equal interests in the leases. In 1937 A and C corporations transferred to petitioner and H corporation a portion of their interests in consideration of a cash bonus and a reserved oil payment, but reserved to themselves as a ‘carried working interest‘ an undivided one-sixteenth of the working interest in all minerals. Under the agreement one-sixteenth of the proceeds of all oil and gas sales was to be credited to the carried interest and one-sixteenth of all expenditures, including capital expenditures, was to be charged to it. Petitioner and H corporation were to have the management of the properties and the right and obligation to sell, together with their own, the oil and gas accruing to the carried interest. When the proceeds should exceed the chargeable expenditures, regular distributions of the excess were to be made to A and C corporations. Not until after the taxable year did the proceeds exceed the chargeable expenditures. Held, A and C corporations retained a capital investment to the extent of a one-sixteenth interest in the oil and gas in place. Under the agreement the income and expenditures attributable to the carried working interest belonged to A and C corporations and petitioner is not taxable on that income. G. Kibby Munson, Esq., for the petitioner.

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

Respondent has determined a deficiency of $43,097.44 in petitioner's income tax liability for the calendar year 1941. In that year petitioner was engaged in developing and operating oil and gas leases known as the Old Ocean Field Prospect, and the only question for decision is whether it is entitled to eliminate, in computing its tax liability, a share of income and corresponding deductions attributable to a ‘carried working interest‘ of two other oil companies. If it is held that the income and expenditures attributable to the said ‘carried working interest‘ belonged to the other companies, then the parties have agreed that the proper deficiency is $36,640.04; otherwise, that the deficiency asserted by the Commissioner is correct.

All the facts have been stipulated and will be summarized herein.

FINDINGS OF FACT.

Petitioner is a corporation, organized and existing under the laws of Texas, with its principal place of business at Houston, Texas. Its income tax return for the year 1941 was filed with the collector for the first district of Texas.

Prior to November 1, 1937, petitioner and three other corporations, Harrison Oil Corporation, Atlatl Royalty Corporation, and Coronado Exploration Corporation (hereinafter referred to as Harrison, Atlatl, and Coronado, respectively) jointly owned and operated a number of oil and gas leases covering lands in Brazoria County, Texas, known as the Old Ocean Field Prospect, the four sharing equally in all expenses and profits.

During November of that year the four corporations were negotiating for a transfer of a portion of Atlatl's and Coronado's interests to Harrison and petitioner. The negotiations culminated in an agreement, effective as of November 1, 1937, which recited that in a contemporaneously executed instrument, incorporated by reference, Atlatl and Coronado, as assignors, were assigning their interests in the oil and gas leases to Harrison and petitioner, as assignees, subject to the reservations and conditions stated in the agreement. The instrument of assignment provided that ‘subject to the reservations, and on the terms and conditions stated in (the) agreement * * * Atlatl * * * and Coronado * * * do * * * hereby grant, bargain, sell, convey, transfer and assign unto Harrison * * * and J. S. Abercrombie Company (petitioner) * * * all of the undivided one-half (1/2) interest of assignors in and to the oil and gas leases * * * and in and to certain personal property * * * .‘

Item I of the agreement provided for the payment of $600,000 in cash by petitioner and Harrison to Atlatl and Coronado.

In item II of the agreement the assignors reserved to themselves, as a limited overriding royalty, an oil payment of $2,250,000, payable out of one-fourth of the first oil, gas, etc., produced, saved, and marketed.

Item III of the agreement reads in part as follows:

In addition to, and independently of, the interest hereinabove reserved, Assignors do also hereby reserve unto themselves, their heirs, successors, representatives and assigns as a carried working interest that shall be and remain the property of Assignors, one-eighth (1/8) of the present interest of Assignors, being one-sixteenth (1/16) interest, and to all of the oil and gas leases, during their lives or during the life of any extension or reacquisition thereof, in their entirety described in Exhibit ‘A‘ (the assignment) hereto attached, together with a like one-sixteenth (1/16) interest in personal property now or hereafter placed on the lands covered thereby. In consequence of this reservation, Assignees shall account to Assignors from time to time for one-sixteenth (1/16) of the operating profits as hereinafter defined (if any) that are realized from the development and operation of said oil and gas leases, if, as and when realized and collected.

Assignees, their successors and assigns, shall have and are hereby granted, the sole and exclusive superintendence, direction and management of said properties, * * * it being the understanding and intention of the parties hereto that Assignees shall have unrestricted freedom in the development and operation of said...