Thompson & Black v. Commissioner

*729 This proceeding is for the redetermination of a deficiency of $5,212.40 in excess-profits taxes for the year 1917. As error the petitioner alleges the refusal of the respondent to allow as deduction from gross income the sum of $65,155.04, representing losses resulting from prospecting for, and the development of, oil and gas properties.

FINDINGS OF FACT.

The petitioner, a copartnership with its principal office in 1917 in New York City and a branch office in Tulsa, Okla., was formed in New York, N.Y., July 1, 1916, by M. W. Thompson and David Friday, under an oral agreement to engage in the business of making engineering and accounting examinations and reports primarily for bondholders, stockholders, general businesses, bankers and lawyers, and with the*3734 expectation of also doing mining and engineering work. By the terms of the agreement, Thompson and Friday were to have drawing accounts, respectively, of $18,000 and $9,000 per year, and the profits and losses were to be divided and assumed on the basis of 85 per cent and 15 per cent, respectively.

Early in the year 1917 the undivided profits of the petitioner were greatly in excess of the yearly drawing accounts of the members thereof and during that year the petitioner made a number of examinations and reports on large business interests, including companies engaged in the business of producing oil and gas.

Sometime in 1917 the members of the copartnership orally agreed to extend the scope of the business to the locating, buying and selling *730 of oil and gas producing land, and that any losses sustained in connection therewith would be borne by Thompson, individually, and charged to his share of partnership profits, and any profits realized from the venture would be distributed on the basis of 95 per cent to Thompson and 5 per cent to Friday, instead of 85 per cent and 15 per cent, respectively, as was the case with other profits and losses of the firm. The petitioner*3735 then had undivided profits of around $40,000.

After this modification of the partnership agreement was entered into, a geologist in the employ of the firm opened a partnership branch office in Tulsa, Okla., from which the field operations of the oil and gas phase of petitioner's business were conducted and the petitioner entered into an understanding with the Ramona Oil Co. whereby the latter was to supply the leases for oil and gas property and profits and losses resulting from joint transactions were to be shared equally. Pursuant to this arrangement, approximately 20 leases, comprising more than 2,000 acres of land, were bought. Under an agreement between Thompson and Friday the petitioner's share of the cost of the leases, as well as other expenses incurred in connection with this branch of its business, was paid from undivided profits in bank to the credit of the partnership. In 1917 the petitioner invested between $75,000 and $80,000, and lost $65,155.04 in this branch of its business.

For the year 1917 the petitioner returned gross income of $176,884.52, and net income of $20,444.71 after deducting excess profits tax of $1,256.06 and deductions of $155,183.75. The*3736 latter figure included the aforementioned loss of $65,155.04 and a salary of $6,000 to each member of the firm. Thompson's share of net income, after giving effect to his agreement with Friday to bear all losses incident to the oil venture, was shown to be $10,874.80, and Friday's $9,569.91. The latter figure is equivalent to 15 per cent of the profits of the partnership for the year from the rendition of professional services.

The respondent allowed as a loss the sum of $65,155.04 in computing the individual tax liability of Thompson for the year 1917.

On an examination of petitioner's return for the year 1917 the respondent declined to allow the amount expended in prospecting for and the development of oil and gas properties as a deduction, on the ground that the amount was a proper deduction from the income of M. W. Thompson.

OPINION.

ARUNDELL: At the time Thompson proposed to Friday, the other member of the partnership, that the firm extend its activities by entering into the business of leasing, buying and selling oil and gas *731 property, the latter was not disposed to assume the risk involved. Thompson, however, was of the belief that the partnership could*3737 engage in the proposed business without great risk of financial failure, and in consideration of a right to receive 95 per cent of any profits realized from the venture instead of 85 per cent, the proportion he was entitled to receive of other earnings of the firm, agreed with Friday to indemnify him against any loss resulting from the new business, the loss, if any, to be deducted from the former's share of partnership profits. Pursuant to this verbal understanding the partnership invested between $75,000 and $80,000 in the venture and during the taxable year suffered a loss in connection therewith in the amount of $65,155.04. All business was transacted in the name of the petitioner, all expenses were paid from partnership funds, representing undivided profits, and the net loss incurred in the transaction was claimed as a business expense by the firm in its return for 1917. These as well as other facts in the record convince us that the business was not that of Thompson, as contended by the respondent at the time of his disallowance of the amount here claimed as a deduction, but that of the petitioner.

The respondent argues in the alternative that, even conceding that the transactions*3738 were engaged in by the partnership, there was no loss suffered by it as Thompson had agreed to individually stand any losses. The agreement as we understand it, however, was one between Thompson and Friday to the effect that the former would indemnify the latter to the extent that Friday would in any event receive not less than 15 per cent of the partnership earnings derived from the rendition of professional services. The loss was suffered in a transaction in which the partnership was engaged and the fact that one partner agreed with the other that any losses sustained therein should be charged to the former's share of the partnership profits makes this loss none the less a loss of the partnership.

Judgment will be entered on 10 days' notice, under Rule 50.