Southwestern Oil & Gas Co. v. Comm'r of Internal Revenue
| Decision Date | 23 May 1946 |
| Docket Number | Docket No. 1244. |
| Parties | SOUTHWESTERN OIL & GAS COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
1. EXCESS PROFITS TAX—NET ABNORMAL INCOME ATTRIBUTABLE TO PRIOR YEARS.—In determining the amount of net abnormal income of the petitioner attributable to prior years under section 721(b), Internal Revenue Code, all of it which resulted from sales of crude oil at higher prices in the taxable year than in prior years should be allocated to the taxable year.
2. Id.—In determining the amount of the net abnormal income attributable to prior years no diminution thereof is necessitated by the fact that the unit cost per barrel of crude oil produced was lower in the taxable year than in prior years, where such reduction in cost, as here, was due solely to increased production from newly discovered wells and not to any reduction in wages or cost of materials, supplies, etc. Robert A. Rundle, Esq., and J. Stanton Carson, Esq., for the petitioner.
Richard L. Shook, Esq., for the respondent.
This proceeding is for the redetermination of a deficiency in excess profits tax for the calendar year 1940 in the amount of $29,707.82. The question in issue is the measure of relief to which petitioner is entitled under section 721, Internal Revenue Code, on account of the realization in 1940 of net abnormal income attributable to other taxable years.
Most of the essential facts are contained in a stipulation filed by the parties, which is incorporated in our findings by reference. The following numbered paragraphs of our findings of fact are substantially as set forth in the stipulation. The stipulation authorizes two minor adjustments in petitioner's 1940 tax liability which are not related to the matter in controversy.
1. The petitioner is a corporation, organized in 1909 under the laws of the State of Delaware. Its principal office is located in Pittsburgh, Pennsylvania. Its business is that of producing crude petroleum, with its oil fields located in the State of Illinois. At all times pertinent hereto its operations were confined to leases on properties located in or near Sandoval, Illinois.
2. The amount of the deficiency asserted in the deficiency notice is $29,707.82.
3.Petitioner filed its corporation income, declared value excess profits, and defense tax return (Form 1120) and its corporation excess profits tax return (Form 1121) for the calendar year 1940 with the collector of internal revenue for the twenty-third district of Pennsylvania, at Pittsburgh. Such returns, as well as petitioner's Federal income tax returns for the years 1936 to 1939, inclusive, were filed on the accrual basis.
4. In its excess profits tax return so filed for the calendar year 1940 petitioner claimed a deduction of $98,080.50 abnormal income attributable to other years and, as a result, the return showed no income subject to excess profits tax. A statement was attached to the return showing that the item of $98,080.50 was computed on the basis of production from prior years' development. In the Commissioner's notice of deficiency the deduction of the $98,080.50 was disallowed as abnormal income attributable to other years.
5. During the years 1936, 1937, and 1938 petitioner's entire income was derived from the sale of crude petroleum produced by wells that had been drilled many years prior to 1936. The wells were drilled by petitioner upon leases designated as the Benoist, Warfield, and Stein leases, all located in Marion County, Illinois. The last of these wells was drilled in 1926. Each of the three leases was obtained from a different lessor, but they covered contiguous land. The petitioner's income from the operation of the wells for the years 1936, 1937, and 1938 was as follows:
+------------------------------+
¦Year¦Gross income ¦Net income ¦
+----+-------------+-----------¦
¦1936¦$17,371.09 ¦$851.77 ¦
+----+-------------+-----------¦
¦1937¦16,371.15 ¦1,726.17 ¦
+----+-------------+-----------¦
¦1938¦12,352.29 ¦(-1,928.57)¦
+------------------------------+
6. In 1938 petitioner decided to drill a well to a greater depth than any well on the Benoist, Warfield, and Stein leases in the hope of finding a hitherto unknown oil-bearing stratum. Such drilling operations were started on the Benoist lease in September 1938, and late in December 1938 oil was found in large quantities in what is known as the Devonian lime. Expenses of the drilling operation of this well were not billed until 1939. In 1939 four additional wells were completed to the Devonian lime on the Benoist lease and one on the Warfield lease. In 1940 one additional well to the Devonian lime was completed on the Benoist lease, two on the Stein lease, and one on the Warfield lease. In the income tax returns filed by petitioner the drilling costs of these wells for the appropriate years were claimed and allowed as deductions from gross income.
7. In 1939 the first crude petroleum produced by these new wells drilled to the Devonian lime was sold and sales continued throughout 1939 and 1940. Over 98 percent of the income received by petitioner in 1940 resulted from the sale of crude petroleum produced by these wells drilled to the Devonian lime.
8. In 1939 the gross income received by petitioner from wells drilled in the Benoist, Warfield, and Stein leases, segregated as to old and new wells, was as follows:
+------------------------------------------+
¦Leases ¦Old wells¦New wells ¦Total ¦
+--------+---------+-----------+-----------¦
¦Benoist ¦$9,532.10¦$145,754.28¦$155,286.38¦
+--------+---------+-----------+-----------¦
¦Warfield¦729.00 ¦18,832.78 ¦19,561.78 ¦
+--------+---------+-----------+-----------¦
¦Stein ¦3,721.43 ¦ ¦3,721.43 ¦
+--------+---------+-----------+-----------¦
¦Total ¦13,982.53¦164,587.06 ¦178,569.59 ¦
+------------------------------------------+
9. In 1940 the gross income received by petitioner from wells drilled in the Benoist, Warfield, and Stein leases, segregated as to old and new wells, was as follows:
+------------------------------------------+
¦Leases ¦Old wells¦New wells ¦Total ¦
+--------+---------+-----------+-----------¦
¦Benoist ¦$2,597.95¦$266,855.53¦$269,453.48¦
+--------+---------+-----------+-----------¦
¦Warfield¦328.65 ¦77,246.74 ¦77,575.39 ¦
+--------+---------+-----------+-----------¦
¦Stein ¦3,117.40 ¦17,526.54 ¦20,643.94 ¦
+--------+---------+-----------+-----------¦
¦Total ¦6,044.00 ¦361,628.81 ¦367,672.81 ¦
+------------------------------------------+
10. the income and expenses of petitioner for the years 1936 to 1940, as taken from the income tax returns filed by the petitioner for those years, were as follows:
+---------------------------------------+
¦Years¦Income ¦Expenses ¦Net income ¦
+-----+----------+----------+-----------¦
¦ ¦ ¦ ¦per return ¦
+-----+----------+----------+-----------¦
¦1936 ¦$17,371.09¦$16,519.32¦$851.77 ¦
+-----+----------+----------+-----------¦
¦1937 ¦16,371.15 ¦14,644.98 ¦1,726.17 ¦
+-----+----------+----------+-----------¦
¦1938 ¦12,352.29 ¦14,280.86 ¦(-1,928.57)¦
+-----+----------+----------+-----------¦
¦1939 ¦178,921.61¦134,137.73¦44,788.88 ¦
+-----+----------+----------+-----------¦
¦1940 ¦368,258.61¦205,997.07¦162,261.54 ¦
+---------------------------------------+
The expenses of petitioner for the year 1939, in the amount of $134,137.73, as shown on the income tax return filed, were properly adjusted to $137,913.
11. No new well to the Devonian lime had been completed on the Stein lease in 1939 and there was no production from such a well on the Stein lease for a period of twelve months prior to December 31, 1940.
12. The development costs, both tangible and intangible, incurred during the respective years 1939 and 1940, of the new wells to the Devonian lime drilled on the Benoist and Warfield leases and the percentages of the total allocable to the two years are as follows:
+----------------------------------------------------+
¦ ¦Benoist ¦Warfield ¦
+-----+-----------------------+----------------------¦
¦Year ¦ ¦ ¦ ¦ ¦
+-----+----------+------------+----------+-----------¦
¦ ¦Amount ¦Percentage ¦Amount ¦Percentage ¦
+-----+----------+------------+----------+-----------¦
¦ ¦ ¦of total ¦ ¦of total ¦
+-----+----------+------------+----------+-----------¦
¦1939 ¦$98,070.51¦81.80663854 ¦$20,254.09¦57.9523462 ¦
+-----+----------+------------+----------+-----------¦
¦1940 ¦21,810.36 ¦18.19336146 ¦14,695.47 ¦42.0476538 ¦
+-----+----------+------------+----------+-----------¦
¦Total¦119,880.87¦100.00000000¦34,949.36 ¦100.0000000¦
+----------------------------------------------------+
13. The net income for declared value excess profits computation of petitioner for the year 1940 was $162,472.79.
14. The base period excess profits credit of petitioner for the year 1940, based on income, is $21,054.
15. The following table sets forth a complete computation of petitioner's net abnormal income for the year 1940, computed in accordance with section 721 of the Internal Revenue Code:
+-----------------------------------------------------------------------------+
¦ ¦Total ¦Benoist ¦Warfield ¦Other ¦
+------------------------------+-----------+-----------+----------+-----------¦
¦Income resulting from ¦ ¦ ¦ ¦ ¦
¦exploration, discovery, ¦ ¦ ¦ ¦ ¦
+------------------------------+-----------+-----------+----------+-----------¦
¦and development of tangible ¦$368,258.61¦$270,039.28¦$77,575.39¦$20,643.94 ¦
¦property ¦ ¦ ¦ ¦ ¦
+------------------------------+-----------+-----------+----------+-----------¦
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