Old Farmers Oil Co. v. Commissioner ( 1928 )

OIL FARMERS OIL CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Old Farmers Oil Co. v. Commissioner

Docket No. 2824.

United States Board of Tax Appeals

12 B.T.A. 203; 1928 BTA LEXIS 3579;

May 29, 1928, Promulgated

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(1) Section 277(b) of the Revenue Act of 1924 applied.

(2) An erroneous decision of a question of law made by an officer of the Government is not binding on his successor in office.

(3) Where a vendor executes a contract of sale and a deed and where the vendee is immediately placed in possession of the property sold, and where the contract and deed are placed in escrow the deed to be delivered when he has paid the purchase price, held that such transaction was completed in the year in which the contract and deed were executed.

(4) Certain obligations payable to petitioner held not to have a realizable market value and petitioner to be entitled to recover cost of the property sold before taxable gain arises.

(5) Where petitioner contracted with third person to bore oil wells, the wells to be completed and turned over to it for a stipulated price, held that the cost of such wells was a capital item, even though erroneously deducted by petitioner from the income for the previous year as an ordinary business expense.

Luke B. Garvin, C.P.A., and George S. Atkinson, Esq., for the petitioner.

Bruce A. Low, Esq., for the respondent.

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MILLIKEN

This proceeding involves a deficiency in income and profits taxes for the calendar year 1919 in the amount of $108,059.25. Petitioner asserts (a) the assessment and collection of the deficiency herein asserted is barred by the statute of limitations, and the following errors: (b) that respondent has reopened and reconsidered questions of fact which were properly considered and determined by his predecessor in office; (c) respondent has determined that a certain contract and deed of sale and assignment resulted in a closed transaction for the year 1919; (d) respondent has not allowed sufficient deductions for depletion and depreciation; (e) respondent has not allowed as a credit taxes paid on income returned for the calendar year 1920, which return included the profits and gains resulting from the contract and assignment aforesaid; (f) respondent has not allowed as a deduction from the alleged sale price the cost of the properties alleged to have been sold by petitioner as above set forth; (g) respondent has added to petitioner's gross income for the year 1919, $100,000 in excess of the amount actually received by him on account of the above sale and assignment; (h) respondent refused to permit the deduction of certain losses and bad debts; (i) respondent failed to correctly compute petitioner's invested capital; (j) respondent has refused to grant petitioner the benefits of section 337 of the Revenue Act of 1918; (k) respondent has denied petitioner the right to report its income from said sale and assignment on the basis of an installment sale.

Petitioner introduced no evidence with respect to contentions (h) and (i) and by an amended petition filed at the hearing has withdrawn contention (k).

Respondent filed an amended answer in which he alleged that he erred in computing the profit arising from the sale and assignment above set forth on the forfeiture basis; that he should have determined a profit on a deferred payment and not on an installment plan basis, and that the notes received as a part consideration for the sale of such properties were worth their face value of $350,000.

FINDINGS OF FACT.

Petitioner was a corporation organized under the laws of Louisiana in December, 1917. During the calendar year 1918 petitioner was the owner of certain oil and gas leases in the State of Louisiana, on which it had made a discovery by prospecting and exploration and discovery work of oil and gas and on which it had producing oil and gas wells and on which said leases it had in progress of drilling certain other oil and gas wells, all of which development and exploration began prior to the calendar year 1919. During the calendar year 1918 petitioner entered into negotiations with one J. M. Burk, a duly authorized agent of Globe Oil Co., a corporation, for the sale of said oil and gas leases on which discovery of oil and gas had been made by petitioner, as aforesaid, and which said oil and gas leases were producing oil and gas, and on which leases certain wells were in process of completion by petitioner. These negotiations resulted in a written contract between petitioner and Burk which was entered into on or about December 16, 1918, and which reads:

This instrument in writing witnesseth:

That The Old Farmers Oil Company, Inc., a Louisiana Corporation, domiciled in Shreveport, Louisiana, herein represented by H. G. Freedman, its President, acting herein by virtue of a resolution of the Board of Directors of said corporation, a certified copy of this resolution is attached hereto, agrees to sell, transfer, assign and set over and deliver to

J. M. Burk, a resident of the City of Tulsa, State of Oklahoma, and the said J. M. Burk agrees to buy the following described property, to-wit:

All and singular the right, title and interest of the said corporation under certain oil, gas and mineral leases as shown by the conveyance records of the Parish of Caddo, State of Louisiana, affecting the following described property, to-wit: -

West half of the North East Quarter of Section twenty-five, township twenty-one, range fifteen; the South West quarter of the South East Quarter of section nineteen, township twenty-one, range fourteen; North East Quarter of the North East quarter of section four, township twenty-one, range fourteen; and the North West quarter of the North West quarter of Section three, township twenty-one, range fourteen; all in Caddo Parish, Louisiana, including all buildings, storage tanks, boilers and all material and equipment located on the said property belonging to the Old Farmers Oil Company, and all pipe and gas line belonging to said company and heretofore used by them in connection with operations for developing the said property for oil and gas; The Old Farmers Oil Company, Inc., agree to furnish abstracts covering said described property to J. M. Burk, which shall show title to be good in said Corporation and property free from all encumbrances said abstract to be furnished on or before December 21st Nineteen Hundred and Eighteen. At the time of signing thereof the said J. M. Burk has paid to the said corporation the sum of Five Thousand Dollars in cash, the same being the amount of two certificates of Two Thousand and Three Thousand Dollars, certificates of deposit issued by the Guaranty State Bank of Okmulgee, Okla.

It is further agreed that on the 27th day of December, Nineteen Hundred and Eighteen, or before that date the said Burk shall pay an additional sum of thirty thousand dollars in certificates of deposit on some State Bank of Oklahoma on account of this agreement.

It is further agreed that in the event of the failure on the part of the said Burk to pay the said sum of Thirty Thousand Dollars in certificates of deposits as aforesaid on or before the 27th day of December, Nineteen Hundred and Eighteen, then and in that event, without the necessity for any demand or putting in default whatsoever this contract shall be ipso facto null, void and forfeited and the said corporation shall be entitled to retain the Five Thousand Dollars in cash and the certificate of deposit for Five Thousand Dollars presently received by them as earnest money.

It is further agreed that on the 10th day of January Nineteen Hundred and Nineteen the said Burk shall pay to the said corporation for and on account hereof the additional sum of One Hundred Thousand Dollars.

It is further agreed that in the event of the failure on the part of the said Burk to pay such additional sum of One Hundred Thousand Dollars on the 10th day of January, Nineteen Hundred and Nineteen, after having complied with his other obligations herein above recited, then in that event, without the necessity for any demand and without any putting in default whatsoever, this contract shall be ipso facto null, void, and forfeited and the said corporation shall be entitled to retain the sums of money theretofore paid as well as the certificates of deposit herein above mentioned.

Upon the payment of the said One Hundred Thousand Dollars the said corporation hereby agrees and obligates itself to return to the said Burk the sum of Thirty-Five Thousand Dollars in certificates of deposit and the Five Thousand Dollars cash heretofore mentioned.

It is further agreed and understood that on the 10th day of January, Nineteen Hundred and Nineteen, upon the compliance by the said Burk with his obligations hereunder, the said corporation shall make proper assignment to the said Burk covering the within described property, which shall recite a cash consideration of One Hundred Thousand Dollars and a credit portion of Three Hundred and Fifty Thousand Dollars in addition to the said One Hundred Thousand Dollars, which said credit portion shall be divided into five installments, represented by five notes of the said proposed purchaser and endorsed in blank and endorsed either by the Crescent Oil Company of Delaware or The Globe Oil Company of Delaware, each of which companies now have offices in the City of Tulsa, State of Oklahoma, which said notes shall bear interest at the rate of six per cent per annum from January 10th, Nineteen Hundred and Nineteen until paid.

Four of said notes shall be for the sum of Seventy-Five Thousand Dollars each and shall be due and payable respectively, March 15th, Nineteen Hundred and Nineteen, May 15th, Nineteen Hundred and Nineteen, July 15th, Nineteen Hundred and Nineteen and September 15th, Nineteen Hundred and Nineteen, and the fifth of said notes shall be for the sum of Fifty Thousand Dollars and shall be due and payable on November 15th, Nineteen Hundred and Nineteen.

The said purchaser agrees to apply all net proceeds from (H.G.F.) production in excess of One Thousand barrels per day produced from the within described property on outstanding unmatured notes designated by said corporation.

The said deed shall provide that failure to pay any one of the said notes promptly and punctually at its maturity shall render all the remaining notes immediately due and exigible at the option of the holder thereof.

The said deed shall contain all the usual security clauses including stipulation for special mortgage and vendor's lien.

Upon the payment of One Hundred Thousand Dollars on January 10th, Nineteen Hundred and Nineteen and the passing of the deed herein contemplated the said J. M. Burk shall be entitled to receive possession of the within described property including all oil, gas and other minerals produced from the within described property from and including the 16th day of December, Nineteen Hundred and Eighteen; the said purchaser assuming as a part of the consideration hereof all obligations from and after the 15th day of December, Nineteen Hundred and Eighteen and to unpaid balances on wells now drilling not to exceed the sum of Twenty-Four Thousand Dollars on four unfinished wells.

Taxes for the year of Nineteen Hundred and Eighteen to be paid by the said corporation.

Petitioner received in 1918 the $5,000 initial payment mentioned in the above contract.

On January 10, 1919, petitioner and Globe Oil Co. entered into the following contract:

STATE OF LOUISIANA

PARISH OF CADDO.

BE IT REMEMBERED: That this contract and agreement made and entered into by and between the Old Farmers Oil Company, Inc., a corporation organized under the laws of Louisiana and domiciled in the City of Shreveport, Caddo Parish, hereafter designated as 'Vendor', and Globe Oil Company, a Delaware corporation with its principal offices in the City of Tulsa, Oklahoma, as party of the second part, hereafter designated as 'Vendee.'

WITNESSETH:

Whereas vendor is the owner of the following described properties in Caddo Parish, Louisiana, to-wit:

[Here follows description of leases which are the same as in contract between petitioner and J. M. Burk.]

Also all buildings, storage tanks, boilers, and all material and equipment located on the said described property belonging to the Old Farmers Oil Company, Inc., and all pipe and gas lines belonging to the said Company and heretofore used by them in connection with operations for developing said properties for oil and gas, and,

Whereas, the Vendor desires to sell and assign said property and leases for the consideration of Four Hundred Fifty Thousand ($450,000.00) Dollars, upon the terms and conditions hereinafter specified, and vendee desires to purchase said property and leases for said price and upon said terms and conditions hereinafter specified.

Now, therefore, vendor hereby covenants and agrees to sell, transfer, set-over, and deliver said leases and property unto vendee for the said sum of Four Hundred Fifty Thousand ($450,000.00) Dollars, paid and to be paid as follows, to-wit: r by

One Hundred Thousand ($100,000.00) Dollars cash in hand paid vendor by discharge granted therefor. The balance of Three Hundred Fifty Thousand ($350,000.00) Dollars shall be divided into seven equal payments, payable as follows: Fifty Thousand Dollars ($50,000.00) on the 15th day of April, 1919; Fifty Thousand ($50,000.00) Dollars on the 15th day of July, 1919; Fifty Thousand ($50,000.00) Dollars on the 15th day of October, 1919; Fifty Thousand Dollars ($50,000.00) on the 15th day of January, 1920; Fifty Thousand Dollars ($50,000.00) on the 15th day of April, 1920; Fifth Thousand Dollars ($50,000.00) on the 15th of July, 1920; and Fifty Thousand Dollars ($50,000.00) on the 15th day of October, 1920.

Said deferred payments to bear six per cent (6%) per annum interest from date hereof, the interest on all deferred payments is to be paid on each due date of the payment under this contract, and vendee upon its part hereby covenants and agrees to purchase said leases and property from vendor for the consideration above specified, and to pay, and make payments as said payments mature and become due under the terms of this contract. All payments to be made under the terms of this contract shall be paid by the vendee to the vendor by placing the amounts thereof to the credit of vendor in the First National Bank of Shreveport, Louisiana.

It is further agreed that vendee is to apply on deferred payments next due all proceeds from the oil produced and sold in excess of one thousand (1000) barrels per day average over a period of ninety (90) days, intervening between the payments.

It is especially agreed and understood between both vendor and vendee, and it is of the essence of this contract, that when each deferred payment under this contract falls due vendee shall have the right to extend the same if it has not marketed the oil produced from the above described property, until such time as it does market said oil, provided vendee shall pay promptly all interests due upon all of the deferred payments as it matures under this contract, and provided further the said oil is stored and insured in favor of vendor for the maximum amount obtainable thereon, and provided further that vendee, on each maturity date, will pay, as a credit on the payment then due, the proceeds from all such oil sold up to that time; and provided further that should the oil produced from said property be marketable to the pipe lines in the immediate field for One ($1.00) Dollar per barrel or better, then vendee shall have no right to any extension of time for meeting the deferred payments in principal, the payment of the interest being otherwise provided for.

It is further agreed and understood by and between vendor and vendee that vendee shall take immediate possession of said leases and properties, and hereby assumes all the drilling obligations, as well as royalty obligations resting upon vendor under the terms of the leases under which it holds said properties, and in addition vendee obligates itself to further develop said property with due diligence.

It is further agreed and understood that vendor shall now turn over and deliver unto vendee, and vendee shall thereupon immediately become the unqualified owner of all the oil and gas which has been produced from the said properties from and including the 16th day of December, 1918.

It is further agreed and understood by and between vendor and vendee that vendor shall complete, with due diligence, the four (4) wells now in process of drilling, to-wit: No. 1 Keoun and Nos. 3, 4 and 6 on the J. S. Noel lease, but vendee shall pay toward the expense of the completion of said wells a sum not to exceed twenty-four thousand ($24,000.00) Dollars.

It is further agreed and understood by and between both vendor and vendee, that vendee hereby assumes all the obligations of vendor for material purchased and labor performed in operating said leases and other operating expenses, since December 15th, 1918.

It is further agreed and understood that vendor, as a part of this transaction, has this day executed unto vendee a warranty deed, or assignment, covering the property and leases hereinabove set forth for the consideration stipulated in this contract, which warranty deed shall be placed with First National Bank of Shreveport, Louisiana, upon the signing of this contract, to be by said Bank held in escrow pending the carrying out of the terms of this contract, and which said deed is to be delivered to vendee by said Bank when vendee has paid all the payments specified in this contract.

It is further agreed and understood that vendor shall pay all taxes that may be due, or may become due upon said properties up to and including the year 1918.

Thus done and signed in triplicate, in the presence of R. B. Dalrymple and A. D. Keeney, competent witnesses on this the 10th day of January, A.D., 1919.

No notes were executed for the deferred payments set forth in the above contract.

On the same day, to wit, January 10, 1919, petitioner executed a deed of conveyance to Globe Oil Co. which in all respects conformed to the above contract. The deed and a copy of the contract were deposited with the First National Bank of Shreveport, La., to be held and delivered by said Bank in accordance with the terms of the contract. Said deed was never delivered to Globe Oil Co. The total amount of payment made in cash during the year 1919 by the Globe Oil Co. to petitioner on the principal amount of the price contracted to be paid by Globe Oil Co. to petitioner for petitioner's properties was $133,451.26 paid as follows:

Initial payment, January 10, 1919	$100,000.00
Installment payment, Apr. 16, 1919	8,707.84
Installment payment, July 15, 1919	8,387.34
Installment payment, Oct. 16, 1919	16,356.08
	133,451.26

In the fall of 1919 petitioner instructed its attorneys to recover from the Globe Oil Co. possession of properties. The sheriff operated the property and in the year 1920 paid petitioner from oil runs therefrom while in his hands the sum of $14,736.13. The total amount received by petitioner in 1919 and in 1920 by reason of said contract was $148,187.39. Petitioner repossessed the properties in 1920 by purchasing them at the sheriff's sale for the sum of $100,000, which was applied against the purchase price. The cost to petitioner of the leases, material and equipment, and of drilling wells, which it contracted to sell or sold to Globe Oil Co., less adjustments for allowable depreciation and depletion, was $71,214.68, all of which was expended in the year 1918. All said wells were drilled for petitioner by contractors under "turnkey" contracts - that is, the contractors furnished all casing, fuel, and materials, and turned over the completed wells to petitioner for a stipulated price.

Petitioner kept its accounts and made its tax returns on a cash receipts and disbursements basis and for calendar years. In its return for 1918, petitioner reported oil runs for the months of November and December, as follows:

November, 1918	72,665.50 barrels
December, 1918	26,259.62 barrels

Petitioner sought a depletion allowance of $206,753.50, this allowance being at the rate of $2.09 per barrel. Respondent allowed depletion at the rate of 55.2 cents per barrel. Petitioner sought in said return the following amounts as deductions for ordinary and necessary expenses:

Cost of drilling wells, exclusive of pipe:
Noel No. 1	$9,895.20
Noel No. 2	10,971.60
Noel No. 3	10,382.70
Noel No. 4	9,682.81
Noel No. 6	6,520.00
Koen No. 1	7,039.40
Total	54,491.71

Petitioner filed with the collector its tax return for the calendar year 1919 on March 10, 1920, and in it did not report the sale to Globe Oil Co. or any of the amounts received by it on account of said transaction. It therein reported oil production to the extent of 15,655.25 barrels, and sought a depletion deduction in the amount of $32,619.47, or at the rate of $2.09 per barrel. Respondent allowed depletion on the number of barrels reported at the rate of $55.2 cents per barrel, which is the proper depletion rate.

J. B. Maguire was a member of the firm of Winston, Maguire and Pearson, Accountants. This firm was petitioner's representative in Federal tax matters and prepared its tax returns for the calendar years 1918, 1919, and 1920. On January 5, 1921, the then Acting Deputy Commissioner wrote to Winston, Maguire and Pearson, stating that petitioner had submitted, in connection with a certain claim, a copy of a contract of sale to Globe Oil Co., but had not reported in its 1919 return any profit from such sale and requested full explanation. To this Winston, Maguire and Pearson replied with the explanation that the agreement was a contract to sell and not a contract of sale; that there was no closed transaction; that petitioner was holding the payments in suspension until the ultimate culmination of the contract when the proper basis would be ascertained and the net income computed and reported. To this the then Deputy Commissioner responded:

JANUARY 27, 1921.

IT:SA:NR:RWW

4490

WINSTON, MAGUIRE & PEARSON,

404 Merchants Building, Shreveport, Louisiana.

In re: Old Farmers Oil Company.

SIRS:

Reference is made to your letter dated January 8, 1921.

The terms of the contract set out that an initial payment of $100,000.00 was made on the signing of the contract and that the deferred payments "shall be paid by the vendee to the vendor by placing the amounts thereof to the credit of vendor in the First National Bank of Shreveport, Louisiana."

Articles 44, (2) and 46 of Regulations 45 are applicable to the case.

From the contingency attached to the deferred payments it is assumed that these payments could not be discounted, in which event, the articles above referred to will be modified by the following ruling:

"Section 213(a), Article 44: Sale of real estate involving deferred payments.

8-19-314

O.D. 181.

In the case of real estate sales involving deferred payments, even though substantial first payment is made, if the notes given by buyers of real estate cannot be discounted nor sold on account of lack of credit of the buyers, such notes need not be regarded as the equivalent of cash, and the vendors may report as their income from the proposed transaction for each year only the proportion of each payment actually received in that year which the gross profit to be realized when the property is paid for bears to the gross contract price."

It will be necessary for the Old Farmers Oil Company to file amended returns for the year 1919 setting out its income in accordance with the provisions of the above regulations.

Respectfully,

(Signed) G. V. NEWTON,

Deputy Commissioner.

RVA

Winston, Maguire and Pearson under date of February 1, 1921, replied to the above and after again insisting that the contract between petitioner and Globe Oil Co. did not result in a closed transaction requested that the Commissioner reconsider the matter. On February 8, 1921, the then Deputy Commissioner answered the above and adhered to his ruling. He requested that the matter of filing amended returns for 1919 be given immediate consideration. Winston, Maguire and Pearson replied that no amended returns were necessary because the statute of limitations had some time to run; that the Commissioner could make any adjustments he saw fit and then requested immediate advice so that they could carry the matter to the then existing Committee on Appeals and Review. Petitioner filed no amended returns for the year 1919. On April 28, 1921, the following letter was mailed and was received by petitioner in due course of mail:

APRIL 28, 1921.

IT:SA:NR-a

FAR

OLD FARMERS' OIL COMPANY,

Shrevesport, Louisiana.

SIRS:

An examination of the information submitted in connection with your income tax return for the year 1919, on file in this office, has resulted in certain changes.

Gross income reported			$38,057.11
Less:
Deduction claimed		$62,519.78
Less:
Depletion disallowed		32,619.47
			29,900.31
Net income corrected			$8,156.80
Invested capital as reported	22,200.00
8% of $22,200.00			1,776.00
Specific exemption			3,000.00
Excess profits credit			$4,776.00

As the tax computed under Section 301 exceeds the limitations provided under Section 302, the tax is computed under the latter Section as follows:

Net income reported			$8,156.80
Less:
Exemption under Section 302			3,000.00
Amount subject to tax at 20%			$5,156.80
20% of $5,156.80			$1,031.36
Net income corrected		$8,156.80
Less:
Excess profits tax	$1,031.36
Exemption	2,000.00
		3,031.36
Amount subject to tax at 10%		$5,125.44	512.54
Total tax			$1,543.90
Tax previously assessed			None
Tax due			$1,543.90

In the contract of sale of leaseholds dated January 10, 1919, a copy of which is on file in this office, the following paragraph is found:

"It is further agreed and understood that the vendor shall turn over and deliver unto the vendee, and vendee shall thereupon immediately become the unqualified owner of all the oil and gas which has been produced from the said properties from and including the 16th day of December, 1918."

Inasmuch as the depletion attaches upon production and not upon sale, you, having no production in the year 1919, are not entitled to any deduction on account of depletion.

The tax as noted above will be assessed at an early date, and notice as to place and time of payment will be sent you by the Collector of Internal Revenue for your district.

Respectfully,

E. H. BATSON,

Acting Deputy Commissioner.

By (Signed) S. A. ALEXANDER,

Head of Division.

The present Commissioner of Internal Revenue and respondent herein, D. H. Blair, took oath of office on May 27, 1921.

On July 13, 1921, respondent signed an assessment certificate for the District of Louisiana for June, 1921. In this assessment certificate petitioner was assessed $1,543.90. On July 22, 1921, petitioner filed a claim in abatement for the whole of said assessment, to wit, $1,543.90. Petitioner filed no waiver extending the time for the assessment or collection of the taxes for 1919. On February 6, 1925, respondent mailed to petitioner the deficiency letter which is the basis of this proceeding. This letter contains the following statement:

1919
Deficiency in tax		$108,059.25
Net income reported (loss)			$24,462.67
Add:
Payments on contract forfeited by Globe Oil
Company:
Initial payment		100,000.00
Subsequent installments		148,187.39
Depletion claimed	$32,619.47
Depletion allowed	8,641.70
		23,977.77
			272,165.16
Revised net income			$247,702.49

In treating the transaction with the Globe Oil Co. as a sale in 1919, this office is governed by what appears to have been the intention of the contracting parties as expressed in paragraph 3, on sheet number 3, of the contract. It was agreed therein that the "vendee shall take immediate possession of said leases and properties", and in the next paragraph it is, "further agreed and understood that vendor shall now turn over and deliver unto vendee, and vendee shall thereupon immediately become the unqualified owner" of certain oil and gas produced from properties which were the subject of this sale.

In O.D. 988 C.B. June 1920, page 84, it was held that a sale occurs "at the time a deed passed or at the time possession and the burdens and benefits of ownership are from a practical standpoint transferred to the buyer, whichever occurs first."

It appears, therefore, that the sale occurred in 1919 and the payments received are treated as income for that year.

Since the excess profits tax computed under Section 301 exceeds the limitation provided for in Section 302, the tax is computed under the latter section.

Profits tax under Section 302			$94,481.00
Net income		$247,702.49
Less:
Profits tax	$94,481.00
Exemption	2,000.00
		96,481.00
Balance taxable at 10%		$151,221.49
Tax at 10%			15,122.15
Total tax assessable			$109,603.15
Previously assessed			1,543.90
Deficiency in tax			$108,059.25

Due to the fact that the statute of limitations will presently bar any assessment of additional tax against you for the year 1919, the Bureau will be unable to afford yor an opportunity under the provisions of Treasury Decision 3616 to discuss your case before mailing formal notice of its termination as provided in Section 274(a) of the Revenue Act of 1924. It is necessary at this time, in order to protect the interests of the Government, either to make an immediate assessment under the provisions of Section 274(d) of the Revenue Act of 1924 or to issue a formal notice of deficiency.

In view of the above adjustment your claim for the abatement of $1,543.90, income and profits tax for the year 1919, will be rejected in the next Schedule to be approved by the Commissioner.

Petitioner filed its petition with the Board on March 26, 1925.

In its return for the calendar year 1920, petitioner reported as income the forfeit from Globe Oil Co. and from oil runs on the escrow agreement $148,187.39, and paid the tax due thereon. Said tax has not been refunded and no claim for refund has been filed by petitioner.

OPINION.

MILLIKEN: There is no merit in the plea of the statute of limitations. Petitioner filed its return for 1919 on March 10, 1920; respondent mailed the deficiency letter involved in this proceeding on February 6, 1925, and petitioner filed its petition with the Board on March 26, 1925. The five year period within which assessment can be made, provided in section 277(a)(2) of the Revenue Act of 1924, is extended by subdivision (b) of the same section. This subdivision provides:

(b) The period within which an assessment is required to be made by subdivision (a) of this section in respect of any deficiency shall be extended (1) by 60 days if a notice of such deficiency has been mailed to the taxpayer under subdivision (a) of section 274 and no appeal has been filed with the Board of Tax Appeals, or, (2) if an appeal has been filed, then by the number of days between the date of the mailing of such notice and the date of the final decision by the Board.

This proceeding falls within the above provision. See also section 277(b) of the Revenue Act of 1926. Since assessment is not barred, neither is collection barred. Art Metal Works,9 B.T.A. 491">9 B.T.A. 491, section 278(d) Revenue Act of 1926.

Petitioner insists that respondent's predecessor in office, with all the facts before him, determined the tax due; that this determination was final and that respondent does not possess the authority to review the act of his predecessor and again determine the tax. It is by no means clear that respondent's predecessor had all the facts before him when he wrote the letter of April 28, 1921; neither is it certain that such predecessor determined the tax, since the assessment list of June, 1921, was signed by respondent, who took the oath of office and assumed his duties prior to that date. Petitioner also filed a claim in abatement on July 22, 1921, for the whole of the assessment made by the respondent on July 13, 1921, thus reopening the entire matter. Waiving these considerations, it appears that all such predecessor did was to determine whether the contract of January 10, 1919, between petitioner and Globe Oil Co. constituted a closed transaction; that is, whether the amounts received under that contract by petitioner during the year 1919 were taxable as income received during that year. This was a pure question of law. Since an erroneous decision on a question of law by an officer of the Government is not binding on his successor in office (Yokohama Ki-Ito Kwaisha, Ltd.,5 B.T.A. 1248">5 B.T.A. 1248, Estate of W. S. Tyler,9 B.T.A. 255">9 B.T.A. 255), this issue must be resolved in favor of respondent.

This brings us to the vital issue in this case, which is, whether the contract of January 10, 1919, the execution of the deed, the filing of these papers in escrow and what was done under this contract and this deed, constituted a closed transaction in the year 1919. Under the contract, Globe Oil Co. was not only at once placed in possession of the property, but it acquired the ownership of all oil which had been produced from and including the 16th day of the preceding December. The purchaser paid the cash installment of $100,000 and promised to pay the remaining installments when due. This promise was qualified by but one limitation and that was the provision with reference to the marketing of the oil. Subject to this limitation, petitioner had the right on each due date to enforce payment of each installment. Cf. Loud v. Pomona Land & Water Co.,153 U.S. 564">153 U.S. 564. The provision as to the marketing of the oil can have no more effect on the nature of this transaction than if it had been contained in a deed which had been duly delivered. This right to enforce the collection of each installment when due differentiates this proceeding from North Texas Lumber Co.,7 B.T.A. 1193">7 B.T.A. 1193, and R. M. Waggoner,9 B.T.A. 629">9 B.T.A. 629. After the execution and delivery of the contract and the execution and delivery of the deed to the bank in escrow, petitioner had nothing further to do except receive the payments when due. If all payments had been made as provided in the contract, the deed would have been delivered to the purchaser by the bank and not by petitioner. Petitioner's assent to the delivery of the deed was not required. Under these facts, we are clearly of opinion that the income from this transaction was taxable when received by petitioner. See D. M. Stevenson,9 B.T.A. 552">9 B.T.A. 552.

Petitioner next contends that if it be held that this was a closed transaction in 1919, it was also a closed transaction in 1918. This contention, in our opinion, is not tenable. Burk was not placed in possession. Petitioner had no right to enforce the collection of the deferred payments. Further, it does not appear that Burk paid the $30,000 which was due December 27, 1918, the failure to pay which operated as a forfeiture of the contract. Besides, the contract of January 10, 1919, differed in many particulars from the contract with Burk. The Burk contract called for notes and the second contract did not. The deferred payments differed in amount. The Burk contract called for the delivery of a deed which was to contain a provision for a vendor's lien. The deed executed January 10, 1919, did not provide for such a lien but the contract of that date did provide that the deed should be placed in escrow. The first contract was an agreement to sell and to vest possession on date of sale. The second was a contract of sale which vested immediate possession in the vendee. Cf. Sophia M. Garretson,10 B.T.A. 1381">10 B.T.A. 1381.

The next issue is what amount of taxable income petitioner received during the calendar year 1919 on account of the sale of January 10 of that year. Petitioner admits, and it is true, that the sale was not made on the installment plan, and, therefore, is not taxable under the provisions of sections 212(d) and 1208 of the Revenue Act of 1926.

Respondent, in his amended answer, alleged that the deferred payments were worth their face value of $350,000 and the burden rests upon him to sustain this affirmative allegation. This burden he has failed to meet, since he introduced no evidence whatever on this issue. The question remains, Were the deferred payments the equivalent of cash? If so, petitioner is taxable thereon to the extent of their cash value even though such payments were not represented by notes. See C. L. Starr,9 B.T.A. 886">9 B.T.A. 886. Respondent, in the brief filed in his behalf, states:

"Accordingly, it is submitted that respondent's determination that the obligations of the vendee had a fair market value of $148,187.39 at the time they were received by petitioner, must be approved."

We find nothing in the record which bears out this statement. Respondent's deficiency letter expressly states that so much of the income included in the deficiency as arose from the sale to Globe Oil Co. consisted of "Payments on contract forfeited by Globe Oil Company" and "It appears, therefore, that the sale occurred in 1919 and the payments received are treated as income for that year." It was only "payments" that respondent included in gross income. By no stretch of the imagination can the inclusion of payments be twisted into a valuation of unpaid installments. Although it is evident that respondent included in gross income only payments, it is apparent that he erred in determining the amount of such payments and also in determining the year in which a part of these payments should be taxed. Petitioner was on a cash receipts and disbursements basis and was taxable in the year 1919 only on the amount of such payments as it received in that year. The facts with reference to the amounts received by petitioner by reason of a sale to Globe Oil Co. and the dates of such receipt were stipulated and the stipulation shows that petitioner received in the year 1919 the cash payment of $100,000, and partial payments on the installments amounting to $33,451.26, making the whole amount received by petitioner in 1919, $133,451.26. In the succeeding year, 1920, it received from the sheriff $14,736.13. The total amount received by petitioner in both years was $148,187.39. The deficiency letter shows that respondent computed the amount of payments received as $248,187.39 and included in gross income as forfeited payments the cash payment of $100,000 and the further sum of $148,187.39, which latter amount is precisely the equivalent of what petitioner received in both 1919 and 1920, and which was all that it received by reason of the sale. In other words, respondent has included the cash payment of $100,000 twice and has added to the payments received in 1919, the payment of $14,736.13 which was received in 1920. If respondent's theory in conformity with the deficiency letter had been correctly applied the gross income which petitioner received in 1919 would amount to $133,451.26.

Respondent has computed the deficiency on the basis of payments received and now attempts to change his position by asserting that all unpaid installments were worth their face value. This as we have pointed out he has failed to prove. Neither has he attempted to prove that such installments had a cash value of any amount. It is evident that the unpaid installments were not the equivalent of cash. The fact that instead of delivering the deed as required by the Burk contract it was placed in escrow, evidences a fear that the vendee might be unable to meet its obligations when due and further evidence of this fear is shown by the provision which extended the time of payments of the installments if the oil was not marketed. The unpaid installments were not secured by a lien on the property sold, the only security being that the deed was in escrow. The deed could not be withdrawn by petitioner so long as the vendee complied with its agreement. The result of this is that a sale of the contract would carry with it no legal title to the security. The security could be transferred only by the execution of another and conditional deed to the assignee of the installments. The record shows that the vendee paid in 1919 only $33,451.26 on installments falling due in that year, which totaled $150,000, and that petitioner in the latter part of that year instructed its attorneys to proceed to recover possession. Neither the contract nor the deed contained forfeiture or precipitating conditions. We are of opinion that the unpaid installments were not the equivalent of cash. We therefore find that the total amount of gross income received by petitioner in 1919 from the vendee was $133,451.26 instead of $248,187.39 as found by respondent.

In order to ascertain the net income from this sale, the cost of the properties sold to petitioner should be deducted from the gross sale price. It was stipulated at the hearing that the total cost of such properties less proper allowances for depletion and depreciation was $71,214.68, all of which was expended in the year 1918. Respondent urges that since this amount includes $54,491.71, which was the cost of drilling oil wells, and since petitioner deducted this latter amount as ordinary and necessary expenses from its gross income for the year 1918, it is now precluded from asserting that this amount was part of the cost of the property sold in 1919 and cites article 223 of Regulations 45. This article in part provides:

Such incidental expenses as are paid for wages, fuel, repairs, hauling, etc., in connection with the exploration of the property, drilling of wells, building of pipe lines, and development of the property may at the option of the taxpayer be deducted as an operating expense or charged to the capital account returnable through depletion. If in exercising this option the taxpayer charges these incidental expenses to capital account, in so far as such expense is represented by physical property it may be taken into account in determining a reasonable allowance for depreciation. * * * An election once made under this option will control the taxpayer's returns for all subsequent years. * * *

Before discussing this regulation, it is expedient to point out that what is properly a capital investment is not and can not be an ordinary and necessary expense and that the reverse is equally true. The Revenue Act of 1918 conferred no authority on the Commissioner to arbitrarily determine by regulation or otherwise that a purely capital item was a business expense. Compare Union Metal Manufacturing Co.,1 B.T.A. 395">1 B.T.A. 395; Union Collieries Co.,3 B.T.A. 540">3 B.T.A. 540; Boyne City Lumber Co.,7 B.T.A. 36">7 B.T.A. 36. Much less could he authorize a taxpayer to elect whether he will deduct from gross income an expenditure made for a purely capital purpose as an ordinary and necessary expense. Whether the provision of the regulation which permits a taxpayer to elect whether he will deduct or charge to capital account, "Such incidental expenses as are paid for wages, fuel, repairs, hauling, etc., in connection with * * * drilling of wells * * *" is a proper exercise by the Commissioner of his authority to make regulations is not before us. Petitioner made no such expenditures. What he did was to contract with third persons for completed wells and pay such persons the stipulated price therefor. By these contracts, petitioner received assets which were just as much capital assets as structures erected above ground. The payment for wells when completed bears no resemblance to payments for wages, fuel, repairs, hauling, etc. Payments for such items may be in the nature of ordinary and necessary expenses, but payments for completed wells are payments for capital assets. This is the construction which respondent has placed on his own regulation. (A.R.R. 1147, Cumulative Bulletin I-2, p. 140.) Such wells had useful lives and their value may be returned to the taxpayer through deductions for wear and tear and exhaustion. See Consolidated Mutual Oil Co.,2 B.T.A. 1067">2 B.T.A. 1067. We are of opinion that the moneys expended by petitioner in 1918 for the acquisition of oil wells was a capital investment which should be included in the cost of the property sold. See Seletha O. Thompson,9 B.T.A. 1342">9 B.T.A. 1342, and Consolidated Mutual Oil Co., supra.

The fact that petitioner sought to deduct in his return for 1918 these expenditures as business expenses does not preclude it from asserting that the cost of these wells was a part of the cost of the property sold in 1919 any more than his return of the profit arising from this transaction as income for the year 1920 precludes him from being taxed on part of that income for the year 1919. The only question for our decision is whether under the provisions of the Revenue Act of 1918 the amounts thus expended were deductible in 1918 or constituted a part of the cost of the property sold. We are of opinion that they constituted a part of the cost of the property sold.

Petitioner is entitled to recover its capital investment of $71,214.68 before it can be said to be in receipt of income. Anton M. Meyer,3 B.T.A. 1329">3 B.T.A. 1329; C. L. Starr, supra.

Respondent in the brief filed in his behalf vigorously contends that petitioner is not entitled to the benefit of section 337 of the Revenue Act of 1918 because the evidence is not sufficient to prove that the principal value of the property sold had been demonstrated by exploration and discovery work. In making this contention, he overlooks the obvious fact that in his answer he admits all the facts alleged in the petition with respect to this contention. We are of the opinion that the facts of this case bring this transaction within the provisions of section 337 and that petitioner is entitled to the benefits of that section.

Petitioner's contention that it should be allowed as a credit on its taxes for 1919, so much of its taxes paid on its income for 1920, as pertained to the profits on the sale made in 1919 must be denied. The credit, if any, in such a contingency is not a matter over which the Board has jurisdiction. Petitioner's remedy is to secure a refund.

Petitioner averred that the respondent had not allowed a deduction for depletion. We have carefully considered the evidence and from the same are unable to conclude that the respondent erred in this respect. We have found as a fact the correct unit rate for depletion, the amount claimed for the year 1918 and allowed for the year 1919. Petitioner's contention is based on the proposition as we understand it that oil was produced in 1918 and sold in 1919 on which no allowance for depletion has been granted. We do not doubt that petitioner, being on a cash receipts and disbursements basis, is entitled to an allowance in 1919 for all oil sold in that year, but we are unable to determine that such allowance has not been granted by the respondent. We have no positive proof upon which to base a decision concerning this assignment of error.

Judgment will be entered under Rule 50.