Vestal v. United States, 73-1588

• Decision Date: 01 May 1974
• Docket Number: No. 73-1588,73-1589.,73-1588
• Citation: 498 F.2d 487
• Parties: Jack H. VESTAL and Mary S. Vestal, Plaintiffs-Appellees, v. UNITED STATES of America, Defendant-Appellant. John T. DANIEL and Thase F. Daniel, Plaintiffs-Appellees, v. UNITED STATES of America, Defendant-Appellant.
• Court: U.S. Court of Appeals — Eighth Circuit

498 F.2d 487 (1974)

Jack H. VESTAL and Mary S. Vestal, Plaintiffs-Appellees, v. UNITED STATES of America, Defendant-Appellant.

John T. DANIEL and Thase F. Daniel, Plaintiffs-Appellees, v. UNITED STATES of America, Defendant-Appellant.

Nos. 73-1588, 73-1589.

United States Court of Appeals, Eighth Circuit.

Submitted December 12, 1973.

Decided May 1, 1974.

Rehearing and Rehearing Denied June 12, 1974.

Louis A. Bradbury, Atty., Tax Div., Dept. of Justice, Washington, D. C., for defendant-appellant.

Jerry T. Light, Little Rock, Ark., for plaintiffs-appellees.

Before BRIGHT and STEPHENSON, Circuit Judges, and STUART, District Judge.^*

Rehearing and Rehearing En Banc Denied June 12, 1974.

BRIGHT, Circuit Judge.

In 1962, cash basis-taxpayer Jack H. Vestal¹ obtained contract rights to receive in the future a fractional share of a partnership in a Canadian oil and gas field development in return for services rendered to certain of the limited partners in an oil development partnership, Olds, Ltd. The oil and gas rights were subsequently sold, and Vestal received installments of $8,143.81 in 1964, $129,984.39 in 1965, and $1,602.15 in 1966 in satisfaction of his contract rights to obtain a partnership share of the oil and gas field. On his income tax returns for each of those years, Vestal seeks to treat these sums as capital gains rather than as ordinary income. The Commissioner of Internal Revenue denied these claims. Vestal paid the tax and sued for a refund in the United States District Court for the Western District of Arkansas. That court granted Vestal relief. We reverse, holding the payments taxable as ordinary income.

In a related case, taxpayer John T. Daniel,² an investor in the same Canadian oil field, sought to deduct as an income expense the sum of $25,422.54, paid to Vestal in 1964 and 1965 in satisfaction of Vestal's contract right to receive a share of Daniel's limited partnership interest in the oil and gas field. Daniel claimed he paid this money in the taxable years in question as compensation for investment advice which he had received from Vestal relating to the Canadian oil field. The Commissioner disallowed the claimed deduction as an expense, ruling that the questioned payment should be accounted for as a capital expenditure, i. e., a commission or finder's fee to be added to the basis of the property obtained by Daniel through Vestal's efforts. On Daniel's refund suit, the district court sustained the taxpayer and the Government brings this appeal. We also reverse this decision.³

The present tax questions arise out of investments made in the Olds Gas Field located in south central Alberta, Canada. According to the record, Robert M. Leibrock and four associates had formed Olds Holdings, Ltd. in 1961 to purchase a leasehold interest from Shell Oil Company in six shut-in wells and 60,000 acres of the Olds Gas Field for $50,000 in cash plus 15 percent of the gross income from the fields up to $700,000. In addition, Shell retained a ten percent overriding royalty.

Thereafter, Olds Holdings, Ltd. undertook a two-step plan for developing this oil and gas acreage for commercial purposes. The plan initially envisioned the formation of a limited partnership known as Olds, Ltd. composed of Leibrock and his associates from Olds Holdings, Ltd., who would serve as general partners and contribute their oil and gas interests in the Olds Field. They would then seek other investors who would subscribe one million dollars to Olds, Ltd. and own 50 percent of the venture as limited partners. The second stage of the plan called for the drilling of additional wells to establish the adequacy of reserves in order to satisfy the needs of any potential purchaser of gas. After obtaining a satisfactory gas sales contract, Olds, Ltd. planned to construct and operate a gas purification plant to remove excess hydrogen sulfide and carbon dioxide from the "sour" gas and market the resultant "sweet" gas and other by-products produced by this plant.

In November of 1961, taxpayer Vestal, a consulting engineer and geologist, first learned of the plan of Leibrock and his associates to develop the Olds Gas Field. At this time certain individuals had contributed about three-fourths of the needed capital of one million dollars to Olds, Ltd. and had joined the venture as limited partners. Vestal proposed to raise the remainder of the needed capital from his own clientele who resided in his home town of El Dorado, Arkansas. Accordingly, Vestal interested four El Dorado residents, including Daniels, in investing a total of $235,000 in the venture. Each of these four persons (hereinafter the El Dorado investors) subsequently became a limited partner in Olds, Ltd. For his efforts in presenting the investment opportunity to the El Dorado investors, Vestal received a separate contract agreement from each of them. These agreements provided that each investor would deliver to Vestal a proper conveyance of one-eighth of his interest in the Olds, Ltd. partnership:

From and after the time the El Dorado investor has received from the proceeds of the sale of oil, gas, distillate, sulphur and other minerals from the interests acquired in said limited partnership, the entire costs incurred by the investor in drilling, developing, producing and operating the properties acquired by said limited partnership * * *.

However, these agreements stipulated that Vestal must obtain the consent of the general partners in order to become a participating limited partner in Olds, Ltd., and, as noted above, any El Dorado investor would not convey any part of his limited partnership interest to Vestal until such investor had recovered his initial investment and any future investment in Olds, Ltd., plus six percent interest compounded semi-annually.

The respective limited partnership agreements of the El Dorado investors in Olds, Ltd. and their contracts with Vestal were executed in 1962. Olds, Ltd. undertook some development in the Olds Field, drilling additional wells in 1962 and 1963, but capped them for want of a purchaser of any gas production. In June of 1964, the general partners pursuant to authority vested in them under the Olds, Ltd. partnership agreement, sold the partnership interests in the Olds Gas Field to Amarada Petroleum Company for approximately eleven million dollars. The purchase price was to be paid in three yearly installments from 1964 to 1966 and the proceeds divided equally between the general partners as a group and the limited partners as a group.

I. VESTAL'S CLAIM

Each of the El Dorado investors, after receiving his share of the purchase price from the sale to Amarada and then deducting the amount of his investment plus compounded interest, issued a check to Vestal for one-eighth of the remaining balance. Vestal reported these sums as long term capital gain income on his individual income tax returns for each year.

The trial court judge, after hearing testimony and examining the written contracts and other documentary evidence, found that at the time the contracts were executed in June of 1962 the fair market value of the collective interest obtained by Vestal from the contracts with each El Dorado investor amounted to $29,375. He also found that the interests derived from these agreements constituted capital assets which were sold or exchanged in 1964. Accordingly, the court directed that his gains from this transaction be taxed at long term capital gain rates, using the $29,375 value in 1962 as the basis for the property exchange in computing the gain.

On this appeal, both parties concede that amounts received as compensation for personal services, whether paid in cash or kind, constitute ordinary income in the year which they are actually received. See Treas.Reg. § 1.61-2(d).⁴ The dispute between the parties, however, depends on whether Vestal's contention that receipts from the contracts with the El Dorado investors relating to the Olds Gas Field constituted income and a capital asset when received in 1962, although he did not report the value of these contract rights as income on his 1962 return, or whether, as contended by the Government, the contract rights obtained by Vestal in 1962 constituted neither income in 1962 nor a capital asset.

The trial court's finding that the fair market value of Vestal's contract with the El Dorado investors amounted to $29,375 was based on Vestal's own testimony and the opinion of Mr. Leibrock of Olds, Ltd., who testified as an expert on oil and gas matters. The Government's position is that the rights obtained by Vestal in 1962 by virtue of his contract with the El Dorado investors were contingent, conditional, and speculative, and as a matter of law, did not constitute income taxable to Vestal in 1962.

The Treasury Regulations on Income Tax define gross income as including "income realized in any form, whether in money, property, or services," Treas. Reg. § 1.61-1(a), and, as we have already noted, Treas.Reg. § 1.61-2(d) provides that where services are paid for with something other than money, the "fair market value" of the property or services taken in payment must be included in income. The term "fair market value" as used by this circuit in conjunction with the tax statutes has been broadly defined as the established market value of property, the sum resulting from fair negotiations between buyer and seller, Whitlow v. Commissioner of Internal Revenue 82 F.2d 569, 572 (8th Cir. 1936), or the fair or reasonable value of the property, North American Telegraph Co. v. Northern Pac. Ry., 254 F. 417, 418 (8th Cir. 1918).

Where a contract calls for future payments of compensation based on unmet conditions, contingencies, or speculation, the courts have been loath to assess any present tax consequences to the transaction and thus to require the beneficiary of the contract to pay an income tax upon a potential, as distinguished from a guaranteed receipt of those funds. Deshotels...