RAWCO, INCORPORATED, LTD. v. COMMISSIONER OF INTERNAL REVENUE

Decision Date21 January 1938
Docket NumberDocket No. 77034.
Citation37 BTA 128
PartiesRAWCO, INCORPORATED, LTD., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
CourtU.S. Board of Tax Appeals

Raymond R. Hails, Esq., and A. L. Moreton, Esq., for the petitioner.

E. C. Algire, Esq., and Lloyd B. Harrison, Esq., for the respondent.

These proceedings were brought to redetermine deficiencies in income tax for the years 1929 and 1930, in the amounts of $6,067.29 and $17,038.54, respectively. One issue common to both years is whether or not proceeds received by petitioner from its sales of production interests in oil wells constitute income. In the alternative, if those proceeds constitute income, then it will be necessary to determine whether the respondent erred in excluding such proceeds from the "gross income from the property" for the purpose of computing petitioner's depletion allowance. Two other issues to be determined for the year 1930 are: (a) Whether the transaction whereby petitioner transferred part of its assets to the Government Petroleum Corporation, Ltd., in exchange for capital stock in that corporation constituted a reorganization in which no gain or loss is recognized under the statute, and (b) whether the respondent erred in disallowing a claimed bad debt deduction.

FINDINGS OF FACT.

The petitioner is a California corporation, with its principal office and place of business in Los Angeles, California. It is engaged in the operation and exploitation of oil and gas properties.

In order partly to finance its operations, the petitioner sold percentage interests, sometimes referred to as production assignments, which entitled the purchasers to a certain percentage of the proceeds to be realized from the production of designated wells. During 1929 it sold production assignments covering two wells known as "Rawco Well #2" and "Lewis Well #1", and during 1930 it sold production assignments covering two wells known as "Noll Well #1" and "Colter Well #1." The facts concerning the drilling of these wells have been stipulated.

Rawco Well #2.

On May 13, 1929, the petitioner completed the drilling of a well known as Rawco Well #2 on the Butler Lease at Richfield, California. The lease provided for landowner's royalty amounting to 17.67 percent of production. During 1929 the petitioner sold production assignments in Rawco Well #2 to various persons for a total consideration of $39,600. These production assignments entitled the purchasers to receive in the aggregate 35.20 percent of the proceeds to be derived from the well's production. One production assignment, covering 10 percent of the well's production, was sold on May 10, 1929, but the record does not disclose when the other sales were made. The form of the certificates issued by petitioner to purchasers of production assignments reads as follows:

Receipt is acknowledged from you of the sum of $____. In consideration of said sum, Rawco Incorporated hereby covenants and agrees to hold for your benefit ___ (—%) per cent of the gross proceeds (after deducting 20% leasehold interest) realized from the sale of all oil and ___ (—%) per cent of the net proceeds received from the purchasers or marketers of the gas, produced and saved from that certain oil well known as Rawco #2 located on real property described as follows:

* * * * * * *

but upon the condition and with the express understanding that each one (1%) per cent interest hereby transferred and assigned shall bear one-eightieth (1/80) share of all costs and expenses incurred in the operation of said Rawco Well #2.

Rawco Well #2 was drilled to completion on May 13, 1929, with a total drilling cost of $53,991.36, of which sum $29,751.03 represented intangible expenditures and $24,240.33 represented cost of tangible equipment. The latter sum was capitalized by petitioner and depreciation thereon has been allowed by respondent. Subsequent to the completion of the well petitioner assigned to the Government Petroleum Corporation, Ltd., hereinafter referred to as the G. P. Corporation, rights to receive 16 percent of the proceeds to be derived from the well's production, and received in consideration therefor capital stock of that corporation.

Lewis Well #1.

During 1929 petitioner drilled on the Lewis Lease at Signal Hill, California, a well known as Lewis Well #1. The lease provided for landowner's royalty of 16.67 percent of production. On August 23, 1929, petitioner entered into a written contract with the G. P. Corporation wherein the former represented that the Lewis well was drilled to a depth of approximately 6,285 feet, that it was unable to entirely finance the drilling of the well, and that it desired to obtain a portion of such finances from the latter. Pertinent provisions of this agreement read as follows:

1. First party petitioner agrees within five days after the date hereof to begin the further drilling upon said lease and that it will furnish for the drilling, complete drilling equipment necessary and proper to drill the well.

2. First party agrees at its own expense to furnish in connection with said drilling operations, all necessary and proper equipment for use in producing and marketing oil, gas and other hydrocarbon substances, including all boilers, tanks, rigs, gas traps and other usual equipment.

3. In connection with said drilling operations, first party agrees to fully comply with each and all of the requirements of the lease and of the laws and/or ordinances and/or regulations of the city of Signal Hill, County of Los Angeles, State of California, and/or the United States of America.

4. First party agrees to pay for all labor and/or materials used on said property either in connection with said drilling operations or otherwise, as well as all other charges which may accrue in connection with the use of said property and all such charges shall be promptly paid when due.

5. Second party G. P. Corporation, agrees, provided that the first party shall fully perform each and all of the Agreements, to pay to first party the following sums of money.

                       $5,000.00 upon the signing of this Agreement
                       $5,000.00 on August 24, 1929
                       $5,000.00 on September 9, 1929
                       $5,000.00 on September 24, 1929
                       $5,000.00 on October 9, 1929
                

6. First party agrees that said moneys so to be paid by second party shall be used for the purpose of paying for labor and materials used in drilling the well and shall, if the second party requires it, produce satisfactory evidence showing that the moneys so paid have been used, or are available, to pay for labor and/or materials used in connection with drilling of said well.

7. First party agrees that at all times during the drilling and operation of said well that it will keep and hold the second party harmless of and from any and all claims of every kind and character whatsoever that could or might arise by reason of the use, disuse or misuse of the said operations, and furthermore that it will carry adequate public liability insurance and full workmen's compensation insurance.

8. As part of the consideration moving the second party to make the payments to be made by the second party, first party agrees to pay to the second party out of twenty-five (25%) per cent of the gross production of oil and out of twenty-five (25%) per cent of the net production of gas and gasoline products, and not otherwise, the sum of Twenty-five Thousand ($25,000.00) Dollars advanced by second party under this Agreement and after said sum of money has been so repaid, the first party agrees to transfer and assign to the second party, twelve and one-half (12½%) per cent interest of the proceeds received from the sale of all oil and hydrocarbon substances and twelve and one-half (12½%) per cent of the net proceeds received from the sale of all the gas and gasoline produced from that certain oil well known as Lewis #1. The said Assignment shall be delivered and placed in escrow immediately on the signing of these presents but shall only be delivered to the second party after the said well shall have been brot on production in commercial quantities, which means at least 100 barrels per day.

9. It is agreed that when and after said well provided for herein, is placed upon production, each one (1%) per cent interest in the oil, gas and other hydrocarbon substances produced and saved, shall bear one-eightieth (1/80th) share of all costs and expenses incurred in the operation of said well and in saving the oil, gas and other hydrocarbon substances produced, which expense shall also include any mineral rights taxes that may be levied against the production of said well.

10. This Agreement is not intended and shall not be construed to create a partnership between the parties.

11. In connection with drilling operations on said well, first party agrees to exercise proper skill and diligence in accordance with the custom existing among skilled operators.

12. First party agrees to pay promptly when due, all taxes and assessments of any kind and character whatsoever that are or could or might become a lien upon said real property or the leasehold estate created by the lease hereinbefore referred to and the first party agrees further to make all payments and to do all things that are required by said lease.

13. It is mutually agreed between the parties hereto that anything herein to the contrary notwithstanding, that in the event the well provided for herein shall be placed on production and shall thereafter cease to produce and shall require redrilling or reconditioning, then and in that event the interest of the second party herein shall be available for the repayment of its proportionate part of the expense of said reconditioning or redrilling. Acknowledged by both parties on October 31, 1929.

Pursuant to the terms and conditions of the above agreement, the G. P. Corporation paid the petitioner the sum of $25,000, and petitioner executed and delivered an...

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT