Walls v. Commissioner of Internal Revenue, 547.

• Decision Date: 05 July 1932
• Docket Number: No. 547.,547.
• Citation: 60 F.2d 347
• Parties: WALLS v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Tenth Circuit

60 F.2d 347 (1932)

WALLS v. COMMISSIONER OF INTERNAL REVENUE.

No. 547.

Circuit Court of Appeals, Tenth Circuit.

July 5, 1932.

C. R. Ellery, of Cheyenne, Wyo., for petitioner.

Helen R. Carloss, of Washington, D. C., for respondent.

Before LEWIS and McDERMOTT, Circuit Judges, and POLLOCK, District Judge.

POLLOCK, District Judge.

The facts material on this appeal are: One T. Joe Cahill and the Midwest Refining Company got into a controversy in 1923 between themselves and with the state board of land commissioners of Wyoming over the right to lease and operate upon certain land belonging to said state. Their differences were adjusted by a contract April 19, 1925, by which it was agreed that, if a lease should be granted to the Midwest Company, said company would pay to Cahill and his assigns one-third of the net profits from the operations. It was further provided that the total expense of production, exclusive of taxes and drilling new wells, would not exceed in any one year an average of $1500 per month, and that no more than $500 per month would be charged against Cahill's interest, but, if one-third of the actual expense did exceed $500, the amount over could be charged against Cahill's interest the next month, provided the total yearly charge against his interest should not exceed $6,000.

There were other provisions in the contract, but this is sufficient to illustrate the nature of the agreement. It was a working interest, as distinguished from a royalty interest, because Cahill would get no income unless the operations were profitable.

Soon after the contract was executed, Cahill assigned one-eighth of his one-third interest under the contract to the petitioner, Walls, who was a lawyer, for professional services. Petitioner did not resell his interest thus acquired, but held it with the intention of taking his proportion of the net profits over the term of the lease. During 1923 the Midwest Company paid petitioner $4,470.87 in monthly payments as his share of the profits, and continued to do so to the time of the hearing herein.

Petitioner did not prepare an income tax return for 1923. A deputy collector prepared a return for him, and determined that petitioner's interest under the contract had a fair market value of $16,500, which, included with other income, made his net taxable income total $32,741.51. Petitioner was also assessed 25 per cent. of the tax as a penalty.

Petitioner thereupon took an appeal to the Board of Tax Appeals, which held that petitioner's one-eighth interest in the working agreement had a fair market value of $16,500, and should be included in the petitioner's income for 1923. The Board held that petitioner was entitled to deduct from his income a pro rata part representing exhaustion of the value of the agreement spread over its term. Also petitioner was assessed with a 25 per cent. penalty for failure to file a return. The petitioner thereupon filed this petition for review.

The statutes and regulations relied upon by the parties and applicable in this case are:

Revenue Act of 1921, c. 136, 42 Stat. 227:

"Sec. 212. (a) That in the case of an individual the term `net income' means the gross income as defined in section 213, less the deductions allowed by section 214. * * *

"Sec. 213. That for the purposes of this title (except as otherwise provided in section 233) the term `gross income' —

"(a) Includes gains, profits, and income derived from salaries, wages, or compensation for personal service * * * of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, * * * or gains or profits and income derived from any source whatever. The amount of all such items (except as provided in subdivision (e) of section 201) shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under methods of accounting permitted under subdivision (b) of section 212, any such amounts are to be properly accounted for as of a different period; but * * *"

"Treasury Regulations 62:

"Art. 33. Compensation paid other than in cash. — Where services are paid for with something other than money, the fair market value, if readily realizable, of the thing taken in payment is the amount to be included as income. If the services were rendered at a stipulated price, in the absence of evidence to the contrary such price will be presumed to be the fair value of the compensation received. Compensation paid an employee of a corporation in its stock is to be treated as if the corporation sold the stock for its market value and paid the employee in cash. * * *"

The question or questions argued are:

Did petitioner's interest in the working agreement received as compensation for petitioner's services in 1923 have a fair market value, so that that value should be included in his gross income for that year?

If so, is the Board's determination that that interest had a fair market value of $16,500 supported by the evidence?

Petitioner testified as to the acquisition of his interest for professional services. He testified as to a verified letter that he filed with the Income Tax Unit:

"Q. In such statement, I note the following: `This 1/8 of 1/3 interest had an estimated value of $16,500 and I have no doubt of my being able to sell it for such sum but I do not choose to sell my interest. I prefer to hold it and take my proportion of the net results of the operating under the lease over the period of five years, the time for which the lease runs.' State whether or not it was your intention in making that statement, to advise the Tax Unit that the interest at the time you acquired it had a fair market value of $16,500? A. It was not. May I add — it was an estimate placed upon the value of the interest, which sum I would ask for the interest if I offered it for sale.

"Q. Upon what premise did you make the statement: `I have no doubt of my being able to sell it for such sum'? A. Well, I had heard that a like interest had been sold by Mr. Ridgely for a sum approximating $16,000, and I predicated that statement upon the inference that I might be able to sell it for a like sum if I desired to sell it. His interest was sold, as I understood it, to the Midwest Company. I thought I might be able to sell mine to that company, too."

Petitioner went on to explain that the interest had no market value, but was speculative for several reasons. The Midwest Company controlled the field, fixed the price of oil, and controlled the output. The company was able to charge petitioner's interest with operation expenses and diminish the return, and no one other than that company had sufficient knowledge of the field by which they could approximate the value of the interest here involved. The petitioner said that interests in oil leases are bought and sold frequently in Wyoming, but that each interest has a speculative value peculiar to itself. The witness said his interest was identical to that of Mr. Ridgely who sold to the Midwest for $16,500, and he thought he might have sold for that. However, he thought there was a relationship between Ridgely and that company which entered into their negotiations.

Mr. Ridgely testified for petitioner that he made the sale of his interest to the Midwest Company for $16,500; that the Midwest Company was the only possible purchaser of interests in that field; that there is no general market for oil leases or interests therein; that Mr. Bretschneider of the Midwest said they were buying his interest as an accommodation.

Mr. Connaghan testified for petitioner that there was no general market for royalty interests; that there is no market price, but the seller would have to find a buyer willing to buy, and the price would depend on how much he was willing to pay. "The value would depend on the structural conditions and the grade or quality of oil and its locations to the market, and the nature of the contract covering the royalty." The witness considered royalty interests extremely speculative.

For respondent, Mr. Rath, a geologist and appraiser employed by the Midwest Company, testified that by considering production, price of oil, geological conditions, money invested, and the nature of the agreement a value can be arrived at for royalty interests. There is more or less speculation about it. The witness said, "It is possible that a royalty interest might produce an income whereas a working interest on the same lease might never prove profitable." He said the Grass Creek...