Schermerhorn Oil Corporation v. COMMISSIONER OF INTERNAL REVENUE

• Decision Date: 23 January 1942
• Docket Number: Docket No. 103049,100663.,104204
• Citation: 46 BTA 151
• Parties: SCHERMERHORN OIL CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. SCHERMERHORN-WINTON COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. CHARLES WELDON TOMLINSON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Board of Tax Appeals

46 B.T.A. 151 (1942)

SCHERMERHORN OIL CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

SCHERMERHORN-WINTON COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

CHARLES WELDON TOMLINSON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket Nos. 103049, 104204, 100663.

Board of Tax Appeals.

Promulgated January 23, 1942.

George H. Abbott, C. P. A., and L. Karlton Mosteller, Esq., for the Schermerhorn Oil Corporation and Schermerhorn-Winton Co., petitioners.

Ezra Dyer, Esq., for Charles Weldon Tomlinson, petitioner.

John E. Marshall, Esq., for the respondent.

The respondent determined deficiencies in income tax of the petitioners as follows:

                ----------------------------------------------------------------------------------
                     Docket No.    |              Petitioner                 |    Year |  Amount
                -------------------|-----------------------------------------|---------|----------
                                   |                                         |  | 1935 |   $633.76
                103049 ___________ | Schermerhorn Oil Corporation __________ | 
 The issues involve payments made by the corporations to a geologist — Tomlinson — or to his assigns. The payments were 10 percent of the net profits realized from the sale of gas or oil produced from property acquired upon Tomlinson's recommendation. The Commissioner determined that the payments were capital expenditures. The corporations contend: (a) They were not capital expenditures; (b) in the alternative, they were merely transferred by the companies to Tomlinson and never became either income or expenses to the corporations; (c) further in the alternative, they were either: (1) ordinary and necessary business expenses in the nature of depletion and separately deductible as such; (2) general overhead expenses, allocable to all of the corporations' oil producing properties and deductible from gross income; or (3) direct overhead expenses, allocable to each particular oil property and deductible in computing the income produced by such property. The aggregate of the payments made in 1937 by the corporations to Tomlinson's wife, as assignee, was included by the Commissioner in his gross income. Tomlinson contends that this was erroneous.
                
 The proceedings were consolidated for hearing. Most of the basic facts were stipulated, included in documents received in evidence without objection, or admitted in the pleadings. We find the facts to be as stipulated whether set out in our findings or not.
                
 FINDINGS OF FACT.
                
 The Schermerhorn Oil Corporation is a corporation organized under the laws of the State of Minnesota, with principal office at Minneapolis, Minnesota. Its income tax returns for the years 1935, 1936, and 1937 were filed with the collector of internal revenue for the district of Minnesota.
                
 The Schermerhorn-Winton Co. is also a Minnesota corporation, its principal office being located at Tulsa, Oklahoma. Its income tax returns for the years 1936 and 1937 were filed with the collector of internal revenue for the district of Oklahoma.
                
 Charles Weldon Tomlinson, hereinafter referred to as Tomlinson, is a resident of Ardmore, Oklahoma. His individual income tax  return for 1937 — his wife filing a separate return and claiming the personal exemptions and credits — was filed with the collector of internal revenue for the district of Oklahoma and the tax shown to be due thereon was paid.
                
 On May 25, 1921, a written agreement was entered into between J. B. Schermerhorn, oil producer, and Tomlinson, commercial geologist. The agreement was for a period of one year, renewable at the option of either party and automatically renewable in the absence of a written notice to discontinue. It provided that Schermerhorn should pay Tomlinson an annual salary of $7,500 for a period of one year beginning June 1, 1921, payable in equal monthly installments; that in addition to this salary Tomlinson should be paid all expenses prudently incurred by him in and about the performance of services for Schermerhorn while traveling and away from home; and that whenever any property was acquired by Schermerhorn upon Tomlinson's recommendation, the latter should receive 10 percent of the net profits derived by Schermerhorn and his associates from the sale of such property at a profit, after deducting the original cost and all other expenses incident to the purchase and sale, and the same percentage of the net profits resulting from the sale of oil produced on any such property held and developed by Schermerhorn, after the latter had reimbursed himself from profits on the first oil sold for all expenses incurred in acquiring and developing such property, and after the deduction of royalties and operating expenses. The agreement further provided that all operations should be under the exclusive control of Schermerhorn and subject only to his honest judgment and discretion. Tomlinson agreed to devote his entire time and all of his expert knowledge and skill as a geologist to the exclusive service of Schermerhorn, and that the latter should be the sole judge as to the acquisition of any properties. Schermerhorn in his discretion, could refuse to accept, acquire, or develop any property recommended by Tomlinson. In the agreement Tomlinson also agreed as follows:
                
 To make his home and place of abode during the continuance of this Agreement in Ardmore, Oklahoma, or elsewhere in the United States or Canada as requested by the First Party; in addition to his other duties hereinabove specified, to act as said First Party's representative there when and as requested in any matter connected with said First Party's oil business, and particularly in watching new developments in oil production at places pointed out (from time to time) by said First Party, and in promptly examining areas adjacent to or in such fields when there are favorable developments, and in acquiring options for said First Party upon desirable acreage therein or thereabouts; it being agreed and understood that the words, "adjacent to or in such fields" and "therein or thereabout" refer to areas or acreage within three miles only of producing oil and gas wells; it being understood that the salary (and  expenses) hereinabove provided for shall constitute the principal compensation of said Second Party for said last mentioned services. * * *
                
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 PROVIDED also that in acting as such representative, the said Second Party shall have no general power to bind or obligate said First Party under contracts or agreements with third parties, but only as specifically authorized from time to time in each case.
                
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 2. That each property hereafter acquired by said First Party, under the conditions (as provided in this Agreement) entitling said Second Party to participation in the net profits of sale or development thereof, shall be taken and considered as entirely separate, distinct and apart from any other property whatsoever; and shall not be involved or drawn into any controversy or dispute which may arise between the parties hereto in reference to any other property.
                
 3. That this Agreement shall not be specifically enforceable in equity by either party; nor shall any injunction be applied for or issued at the instigation of either party in case of dispute or alleged breach of this Agreement, but the injured party shall have only his right of action for full damages at law.
                
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 That this Agreement shall not be assignable without the consent of both parties thereto; but this provision shall not prevent either party from selling, assigning or transferring his pecuniary interest in any specific property acquired pursuant to this Agreement.
                
 Oil and gas leases known as the Holman, Watkins, Palmer, Dickerson, and McGill leases, all located in Carter County, Oklahoma, were acquired upon the recommendation of Tomlinson under the agreement of May 25, 1921.
                
 On May 14, 1925, Schermerhorn-Ardmore Co. and Tomlinson entered into an agreement under the terms of which the latter was to devote his entire time to the interests of the corporation, for which he was to receive a salary of $8,400 per year and 10 percent of the net profits derived by the corporation from any property recommended by Tomlinson and thereafter developed by the company into oil producing properties or thereafter sold at a profit. The provisions contained in this agreement differed in no material respect from the provisions of the 1921 contract. The services which petitioner was to render to the corporation were similar to those which he had previously agreed to render to Schermerhorn and the corporation assumed the obligation of Schermerhorn to make payment of the proportion of the net profits which Tomlinson was entitled to receive under the 1921 contract. Either party could terminate the agreement on the 31st day of May, in any year, by giving 30 days' notice in writing to the other, and in the event no such notice was given within 30 days before the termination of any annual period, the parties agreed that it should be deemed to be renewed for an additional period of one year.
                
 Oil and gas leases located in Carter County, Oklahoma, known as the Cruce, Calvery, Lyles, Lyles-Roxana, Morris-Luster, Crockett,  and Smith leases, and one located in Stephens County, Oklahoma, known as the Shields lease, were acquired upon the recommendation of Tomlinson under the agreement of May 14, 1925.
                
 In 1930 Tomlinson relinquished three-tenths of his interest in the profits of the Smith lease to S. W. Hamner, the superintendent in charge, as a stimulus to his efficient operation of the property.
                
 Supplemental agreements dated January 25, 1927, June 9, 1928, and February 3, 1930, were executed between the Schermerhorn-Ardmore Co. and Tomlinson, in which the former acknowledged its liability to pay Tomlinson a percentage of the net profits from the operation or sale, or operation and sale, of the oil and gas leases heretofore...