Wegener v. COMMISSIONER OF INTERNAL REVENUE
| Decision Date | 16 April 1940 |
| Docket Number | Docket No. 92333. |
| Citation | 41 BTA 857 |
| Parties | H. H. WEGENER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. |
| Court | U.S. Board of Tax Appeals |
Charles H. Garnett, Esq., and C. F. Miller, C. P. A., for the petitioner.
John E. Marshall, Esq., for the respondent.
The respondent determined a deficiency in petitioner's income tax for the year ended December 31, 1935, in the amount of $13,347.99. The petitioner alleges that the respondent erred (a) in including in income the amount of $23,592.08 as "additional income from drilling", and (b) in understating allowable depletion on certain oil and gas leases in the amount of $2,040.05. This assignment of error was, however, abandoned at the hearing. The case was submitted on oral testimony and documentary evidence.
FINDINGS OF FACT.
The petitioner is an individual, residing at Dallas, Texas. His principal place of business for the taxable year 1935 was Oklahoma City, Oklahoma.
By written agreement dated February 23, 1932, Walter H. Gant and Knox L. Garvin acquired from the Reliance Oil & Royalty Corporation et al., an interest in certain oil and gas leases covering acreage in Rusk County, Texas, for certain oil considerations. Under the terms of the agreement the assignees were obligated to begin drilling operations at once and to develop the acreage in order to prevent drainage of the field.
The petitioner was engaged, among other things, in the business of drilling oil wells and owned drilling machinery and equipment. It was agreed, in February or March 1932, between Gant and Garvin and petitioner that petitioner would take a one-third interest in the Rusk County leases and would drill wells on the property at an agreed price. During the negotiations petitioner expressed himself as being unwilling to enter into a partnership deal and no partnership agreement was entered into between the parties. By written agreement dated October 31, 1932, which is included herein by reference, Gant and Garvin assigned to him an undivided one-third of the interest acquired by them in the Rusk County leases, all personal property used or obtained in connection therewith, and all rights, options, and privileges granted under the agreement of February 23, 1932, and the supplemental modification dated July 7, 1932, subject to the terms and conditions thereof.
According to the terms of the assignment petitioner assumed one-third of all the duties, obligations, and liabilities imposed upon Gant and Garvin by their agreement with their assignors, and the undivided one-third interest assigned to him was chargeable with one-third of all oil considerations payable by them under the terms of that agreement. It was further specifically provided that, in so far as the Reliance Oil & Royalty Corporation, et al., were concerned, petitioner "shall be liable jointly and severally with the said Walter H. Gant and Knox L. Garvin for the full performance of all the duties, obligations, and liabilities imposed" upon Gant and Garvin by the original contract and modifying agreement, and the one-third interest assigned to him "shall be and remain jointly and severally liable with the 2/3 interest" for the payment of all oil and money considerations payable to the Reliance Oil & Royalty Corporation, et al.
Gant, Garvin, and Wegener developed the leases. Drilling operations were started by petitioner in March 1932 and continued thereafter. In order to finance the development and operation of the leases it was necessary to borrow money from time to time and oil runs were pledged to repay the loans.
In October 1932 a loan of $80,000 was obtained from the First National Bank & Trust Co. of Oklahoma City and a deed of trust was executed by petitioner and Gant and Garvin, "as individuals and as partners", conveying the Rusk County leases to A. J. Peters, as trustee, to secure the loan. A separate bank account was opened at the First National Bank & Trust Co. of Oklahoma City by Gant, Garvin & Wegener, and checks were issued on this account.
According to the terms of the trust instrument, checks in payment of oil runs were sent direct to the bank until the loan was liquidated. Such checks were made out to the individual owner of an interest in the lease and not to Gant, Garvin & Wegener.
Petitioner made financial statements to the Liberty National Bank, Oklahoma City, Oklahoma, at the close of the years 1932, 1933, and 1934. In answer to the question, "Have you any partners in your business?", he said: "No — Rusk County, Texas, operations are a joint venture."
Petitioner's books were kept in the office of his attorneys, Miller & Homan. They kept books on an accrual basis. For the first wells drilled on the Rusk County leases, he charged Gant and Garvin with two-thirds of the price and his own capital account with one-third. In the latter part of 1932, books in the name of Gant, Garvin & Wegener, were set up for the joint enterprise. Thereafter petitioner charged Gant, Garvin & Wegener with the entire amount due him for drilling done on the leases at the agreed price. It was understood that he would receive the full amount of the footage rate for drilling wells, which, including the agreed rental for tools, was $130,594.50 in the taxable year. He billed Gant, Garvin & Wegener with this amount and received payment in full from them.
Letterheads bearing the name "Gant, Garvin & Wegener", were printed and used after the fall of 1932. Petitioner, Gant, and Garvin shared equally in the profits and losses from the enterprise.
In 1935 Gant, Garvin, and Wegener, as a copartnership and as individuals, secured loans from the National Bank of Tulsa, Tulsa, Oklahoma, in the amount of $300,000, and assigned to F. M. Sowle, as trustee, the Rusk County leases as security for the loan. Other loans were made during the year. The money in payment of the oil runs went to the bank to liquidate the loans and the bank turned over to the joint account enough money to pay the current operating expenses. Petitioner was paid for drilling from the money borrowed from time to time. It was understood that he would receive the full amount of the footage rate for drilling wells.
Partnership returns on form 1065 were filed by Gant, Garvin & Wegener, on the advice of tax counsel (who thought the revenue law required such a return), for the taxable years 1932, 1933, 1934, and 1935. These returns showed a loss of $4,449.74 for 1932 and net income of $6,445.63 for 1933, $15,635.84 for 1934, and $55,680.67 for 1935. The gross profits from operations in 1935 were $174,609.15. These returns stated that Gant, Garvin & Wegener is a partnership organized in 1932 and engaged in the oil and gas business. No deduction was taken on these returns for the cost of drilling oil wells, or for any amount paid out for such drilling.
In his individual income tax return for 1935 petitioner reported, as income from Gant, Garvin & Wegener, his pro rata share of the net income shown on the partnership return, or $18,560.22. He also reported net income from drilling and rental of tools, "Gant, Garvin & Wegener", $47,184.15. The latter amount represented two-thirds of the net profit from the drilling operations in 1935 and was computed by petitioner as follows:
Amount received from drilling, rental tools ___________________ $130,594.50
Drilling expense ______________________________________________ 59,818.27
____________
Net profit _____________________________________________ $70,776.23
1/3 Net profit allocated to petitioner's interest _____________ 23,592.08
____________
2/3 Net profit...To continue reading
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