Manahan Oil Co. v. Comm'r of Internal Revenue, Docket Nos. 9669

• Citation: 8 T.C. 1159
• Decision Date: 29 May 1947
• Docket Number: 9664,9666,Docket Nos. 9669,9668.
• Parties: MANAHAN OIL COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.G. A. MANAHAN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.R. D. CREIGHTON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.PEARL V. MANAHAN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: United States Tax Court

8 T.C. 1159

MANAHAN OIL COMPANY, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.G. A. MANAHAN, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.R. D. CREIGHTON, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.PEARL V. MANAHAN, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket Nos. 9669

9664

9666

9668.

Tax Court of the United States.

Promulgated May 29, 1947.

1. DEDUCTIONS FROM INCOME— INTANGIBLE DRILLING AND DEVELOPMENT COSTS.—Petitioner acquired an interest in leases by drilling and developing and was not entitled to deduct those costs as expenses. F.H.E. Oil Co., 3 T.C. 13;affd., 147 Fed.(2d) 1002, followed.

2. INCOME— Amounts received from production from fractional interests in leases temporarily assigned to the petitioner until from those interests and others the petitioner received the equivalent of the development costs, were income to the petitioner. C. H. Rosenstein, Esq., for the petitioners.

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

OPINION.

MURDOCK, Judge:

The Commissioner determined deficiencies of $6,316.80 and $1,459.21 in the income tax of the Manahan Oil Co. for the fiscal years ended June 30, 1940 and 1941. He also determined liabilities against the other three petitioners as transferees. The three individual petitioners concede that they are liable as transferees for any amounts due from the corporation. The latter will be referred to hereinafter as the petitioner.

The issues for decision are whether the Commissioner erred, first in disallowing deductions taken by the petitioner for intangible drilling and development costs of oil wells and, second, in adding to the income of the petitioner amounts received for oil from fractional interests in leases assigned to the petitioner only until it was reimbursed for its drilling and development costs. The facts have been stipulated and the stipulation is adopted as the findings of fact.

The petitioner filed returns for the periods here involved with the collector of internal revenue for the district of Oklahoma.

The Shasta Oil Co. owned a seven-eights working interest in an oil and gas lease, called the Carlock lease, covering about 120 acres of land in Texas. The petitioner acquired an interest in the Carlock lease under a written contract with Shasta dated April 21, 1939. Shasta was described in the agreement as the vendor and the petitioner as the vendee. The agreement recited that the vendor desired to have the property developed for oil and gas and the vendee was in a position and desired to develop the property. The vendor conveyed to the vendee an undivided one-half of its seven-eighths interest in the leases and the vendee paid the vendor $37,639.25. The vendee agreed to commence the drilling of a well within 30 days and to complete the drilling of the well to a sufficient depth to test the present producing horizon. The agreement contained the following provision:

Time is of the essence of this agreement, and failure of Vendee for any reason to spud in said well as and within the time above provided shall entitle vendor at its option to terminate this contract forthwith and absolutely.

The vendee, after completion of the first well, was to drill such additional wells as might be required to develop and protect the property. The vendor agreed to assign to the vendee portions (hereinafter for convenience referred to as one-fourth of seven-eighths) of the vendor's retained interest in the leases until the vendee should receive, from the proceeds of that one-fourth plus the proceeds of the vendee's one-half of the seven-eighths interest, an amount equivalent to the total expended by the vendee in the development of the property, plus the $37,639.25 paid to the vendor. Thereafter, the vendee's interests in the one-fourth of seven-eighths should terminate and the full one-half of seven-eighths should remain the sole property of the vendor, so that the vendor and vendee would each own one-half of the seven-eighths interest and each should henceforth bear its one-half of the operating expenses in the jointly owned property. The vendee was to have exclusive control and sole management of the development and operation of the property. The agreement was carried out.

The petitioner received $16,815.16 during the fiscal year ended June 30, 1940, and $13,919.62 in the fiscal year ended June 30, 1941, from the one-fourth of seven-eighths temporarily assigned to it by Shasta. It credited those amounts to the larger development costs previously incurred. The petitioner did not report the two amounts above mentioned in income, but the respondent included them in income in determining the deficiencies.

The petitioner acquired some interests in other oil leases, under contracts requiring it to drill wells, similar to the agreement already described, except for the absence of a cash payment, and it received payments which were treated similarly. The only distinction made by either party between these agreements and the Carlock agreement is one made by the petitioner in which it points to the payment of cash in the Carlock agreement as giving the petitioner a basis for its alternative argument on the first issue.

The petitioner's first contention is that it is entitled to deduct the intangible drilling and development costs on all of the leases as expenses. The Commissioner has held that it may not deduct those...