Reich v. Comm'r of Internal Revenue , Docket Nos. 2065-65— 2069-65
| Decision Date | 31 July 1969 |
| Docket Number | 2088-65— 2091-65,3152-65,3214-66,3818-66.,3353-65,Docket Nos. 2065-65— 2069-65 |
| Citation | 52 T.C. 700 |
| Parties | ARTHUR E. REICH AND CAROLYN G. REICH, ET AL,1 PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Mark Townsend and John D. Clark, Jr., for the petitioners.
J. Carl Gardner and Richard W. Janes, for the respondent.
The petitioners participated in ventures to drill for and exploit geothermal steam. One of these ventures were successful and the resulting wells produced sufficient steam to supply electrical generating plants. One of the petitioners claimed percentage depletion against the gross income it received from steam production in the successful venture. All the petitioners expensed the intangible costs of drilling and developing geothermal steam wells. Held, the petitioner which participated in the successful venture is entitled to deduct percentage depletion at the rate of 27 1/2 percent against gross income it received from steam production. Held, further, all petitioners are entitled to expense the intangible costs of drilling and developing geothermal steam wells.
Respondent determined deficiencies in the petitioners' income taxes as follows:
By the actions of the parties, several issues were dropped from the case by the time the original briefs were filed. The issues remaining for decision are:
Primary Issues:
With respect to Thermal Power Co.—
With respect to all petitioners—
Alternative Issues:
Alternative issues with respect to drilling and development costs, in the event the Court determines that such costs are not deductible under section 263(c):
With respect to Thermal Power Co.—
With respect to all petitioners—
Some of the facts were stipulated. The stipulations of facts, together with the exhibits attached thereto, are incorporated herein by this reference.
Petitioner Thermal Power Co. (hereinafter referred to as Thermal) has a fiscal taxable year ending on November 30. It filed its Federal corporate income tax returns for the taxable years involved herein with the district director of internal revenue, San Francisco, Calif. Its principal place of business was San Francisco, Calif., when it filed its petition in this case.
Thermal was incorporated under the laws of California. It is engaged in the business of drilling for and exploiting geothermal steam.
The remaining petitioners are individuals. All of them are calendar year taxpayers. During the years involved herein, they filed their Federal income tax returns with the district director of internal revenue, Los Angeles, Calif. Their legal residences were in or near Los Angeles, Calif., when they filed their petitions in this case.
The individual petitioners herein are partners in four partnerships which engaged in the business of drilling for geothermal steam. The names of these partnerships are Endogenous Power Co., Vulcan Thermal Power Co., Geothermal Resources Co., and Casa Diablo Exploration Co.
In 1847 a bear hunter in California discovered a canyon with steam pouring out along a quarter-mile of its length. The steam was coming from natural fumaroles in the ground. The area came to be known as The Geysers. During the 1860's, it was developed into a tourist attraction.
The Geysers area is located about 75 miles north of San Francisco. The area contains four subareas commonly known as Big Geysers, Little Geysers, Sulphur Bank, and Happy Jack.
In 1921 there was an attempt to develop The Geysers' power potential by drilling wells to obtain steam. By 1925 eight wells were completed. However, the project was not commercially successful and it was abandoned.
On February 9, 1955, the Magma Power Co. (hereinafter referred to as Magma), a Nevada corporation, obtained a steam lease covering approximately 3,200 acres in The Geysers. The lessor was The Geysers Development Co., a California corporation. The Geysers Development Co. was the fee owner of the land subject to the lease. The purpose of the lease was to drill for and exploit the natural steam in the area.
Pursuant to this lease, Magma drilled a well in The Geysers area. After completing the well, Magma entered into an agreement with Thermal to form a partnership (hereinafter referred to as Magma-Thermal) to conduct drilling and development operations in The Geysers. The agreement was dated December 17, 1956. Pursuant to the agreement, Magma assigned to Thermal an undivided one-half interest in its steam lease in The Geysers.
Drilling operations by or on behalf of Magma-Thermal began in 1957. The following table indicates the number of wells, both commercially productive and not commercially productive, which were completed and the year of completion: 4
Magma-Thermal made the following expenditures in drilling geothermal wells at The Geysers during the fiscal years indicated:
+-------------------------+
¦F.Y.E. ¦ ¦
+-------------+-----------¦
¦June 30— ¦Amount ¦
+-------------+-----------¦
¦1958 ¦$114,551.00¦
+-------------+-----------¦
¦1959 ¦49,974.93 ¦
+-------------+-----------¦
¦1960 ¦269,557.16 ¦
+-------------+-----------¦
¦1061 ¦0 ¦
+-------------+-----------¦
¦1962 ¦242,132.67 ¦
+-------------+-----------¦
¦1963 ¦128,148.80 ¦
+-------------+-----------¦
¦1964 ¦431,102.50 ¦
+-------------------------+
In October 1958 Pacific Gas & Electric Co. (hereinafter referred to as P.G. & E.) entered into a contract with Magma-Thermal to build an electric generating plant which would utilize the steam from certain of the wells in The Geysers. The first generator unit, unit No. 1, began operation in 1960. It had a capacity of 12,500 kilowatts. In 1963 a second generating unit, unit No. 2, was added to the plant. The second unit had a capacity of 14,000 kilowatts. In 1967 a second generating plant was put into operation. It contained a generator unit, unit No. 3, which had a capacity of 27,500 watts. At the time of the trial herein, another generator unit, unit No. 4, was being added to the second plant. The new unit was to have a capacity of 27,500 kilowatts.
The generator units used by P.G. & e. at The Geysers are turbine generators. These generators are rotary engines which are activated by the impulse of steam against a series of curved blades on a central rotating spindle. The impulse of the steam is in its pressure. While heat is the source of the pressure-energy in steam, heat alone will not drive the generators.
The steam which drives the generators comes directly from the wells. The wells are connected by a pipeline to the inlets of the generator units.
P.G. & E. makes monthly payments to Magma-Thermal for the steam delivered to the generating plants. The amount of the payments is based on the amount of electricity which the plants deliver to the transmission lines.
Magma-Thermal received gross income from P.G. & E. for the fiscal years 1961, 1963, and 1964, less amounts paid to The Geysers Development Co., as follows:
+----------------------+
¦F.Y.E. ¦Gross ¦
+-------------+--------¦
¦June 30— ¦income ¦
+-------------+--------¦
¦1961 ¦$176,985¦
+-------------+--------¦
¦1963 ¦843,780 ¦...To continue reading
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...turning generators. United States v. Union Oil Co. of Cal., 549 F.2d 1271, 1272 (9th Cir.1977). (citing Reich v. Comm'r, of Internal Revenue, 52 T.C. 700, 704-05, 1969 WL 1674 (1969), aff'd, 454 F.2d 1157 (9th Cir.1972); H.R.Rep. No. 91-1544, reprinted in 3 U.S.C.C.A.N. 5113, 5114 (1970); B......
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U.S. v. Union Oil Co. of California
...Howard B. Turrentine, United States District Judge, Southern District of California, sitting by designation.1 Reich v. Commissioner, of Internal Revenue, 52 T.C. 700, 704-05 (1969), aff'd, 454 F.2d 1157 (9th Cir. 1972); H.R.Rep. No. 91-1544, 91st Cong., 2d Sess., reprinted at 3 U.S.Code Con......
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Pariani v. State of California
...was rejected by the Tax Court as "a mere play on words" when it argued that heat, not gas, was being produced at The Geysers (Reich v. C. I. R., 52 T.C. 700, aff'd. (9th Cir. 1972) 454 F.2d Alternatively, the owners focus on one of the components of the complex Geysers geothermal system, th......
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County of Sonoma v. State Bd. of Equalization
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