Reservoir Hill Gasoline Co. v. Commissioner

*210 This appeal seeks a redetermination of the petitioner's income-tax liability for the fiscal years ended February 28, 1925 and 1926. For the first taxable period the respondent has asserted a deficiency in tax of $3,134.66 and for the latter a deficiency of $926.97. In respect to both determinations the petitioner alleges that the respondent committed error in reducing its allowable deductions from gross income on account of depreciation sustained on depreciable assets in the years involved.

FINDINGS OF FACT.

The petitioner is a California corporation, with its main office and place of business at Los Angeles. It was organized and began business in May, 1924, and ever since that time has been engaged in the operation of a casinghead gasoline plant in what is known as the Reservoir Hill oil district at Long Beach, California.

Prior to the incorporation of the petitioner, its*1347 organizer, W. R. Ramsey, acquired a small group of oil leases in the Long Beach field, ranging in size from a city lot to twenty-nine acres. At the date the petitioner was incorporated this territory was well occupied by responsible oil companies, but development had been directed mostly to shallow drillings and its main resources, which lay in the deeper oil sands, were little known. Prior to the organization Remsey had drilled a number of wells on the leases subsequently acquired by the petitioner and was still engaged in drilling, and, in some cases deepening wells already drilled.

Two of Ramsey's leases were acquired from the city of Long Beach and its officials were pressing him to put in a plant for converting the casinghead gas from its wells into gasoline. Ramsey was uncertain as to whether or not the available supply of casinghead gas recoverable from his own leases and others in that territory would be sufficient to justify the expense of building a plant; more particularly in view of the fact that the Shell Company had a similar plant in operation in the field and largely controlled the available supply of raw material. After some investigation and negotiations he*1348 concluded a contract with the Pan-American Petroleum Company, whereby it agreed to purchase all of the casinghead *211 gasoline he produced at a highly attractive price, in virtue of which he condluded that if he could obtain a sufficient supply to enable him to operate for two or three years, a plant would prove profitable. He then built a casinghead gas plant on the city property, which, together with a group of leases, he conveyed to the petitioner in payment for its capital stock, all of which was issued to him.

The petitioner began business on May 1, 1924, and thereafter continued the work of drilling and developing the leases taken over from Ramsey and the operation of the casinghead gas plant continuously through the years involved. In the first taxable period under review, which was the first of petitioner's operation, it treated 2,111,212 cubic feet of casinghead gas recovered from its own leases. In the second period, it treated 1,711,110 cubic feet, 175,807 of which it procured from outside leases. The plant continued in operation from May 1, 1924, through each succeeding year to and including 1928, and, in said years, treated a grand total of 10,551,682 cubic*1349 feet of casinghead gas, 1,943,942 of which it procured from leases other than its own. Of the years shown the greatest, from the standpoint of volume of casinghead gas treated at petitioner's plant, was 1928.

In its income-tax returns for the periods in review, the petitioner sought to compute depreciation sustained in each period on its operating plant by the unit-of-production method in which it estimated that its reserve of available gas, which it placed at 5,489,932 M cubic feet on its own leases, would be exhausted in three years, thus rendering its plant obsolete at the end of that period. The respondent rejected the petitioner's method of computing depreciation on the unit-of-production method, holding that the same was not applicable, inasmuch as the leases owned by it did not constitute the plant's whole source of supply. In lieu of the petitioner's method, which attributed a three-year useful life to the gas plant, based upon predicted exhaustion of available raw material, the respondent has substituted the straight-line method for computing depreciation, fixed the useful life of the plant at six years, and allowed depreciation at the rate of 16 2/3 per cent of cost*1350 for each year.

OPINION.

LANSDON: We think the holdings of the respondent must be sustained. Whatever may be said in favor of the unit-of-production method urged by the petitioner, it is obvious that some reasonable estimate of the mineral reserve must be shown in order to determine that portion of the cost of the plant borne by each unit of production. A further showing that the established reserve is reasonably certain to be exhausted within the estimated time must also be made. In neither of these essentials has the petitioner sustained the burden of proof incumbent upon him. Respecting the productive *212 life of petitioner's reserve, we have only the statement of Ramsey who says that at the time he decided to build the plant the known gas supply was very small, with insufficient flow to supply fuel for the boilers. He further stated no one could know how long the wells would last and that he was largely influenced in building the plant through politics and pressure brought to bear upon by the city.

The record, on the whole, indicates that it was the whole Long Beach gas field that Ramsey looked to for future supply of raw material for his plant and that the*1351 recovery from his own leases was but one of the several factors that entered into his scheme of operation when he decided to build. In this connection he testified: "We scoured the country thoroughly and got all of the gas we could get at that particular time and figured if we could run the plant a year and a half or two years we might get out of it." With a picture of the field as the record shows it to be at the time Ramsey built his plant, in its primitive stage of development, it is clear that the project was largely speculative and that no reliable basis existed for determining its productive life. In view of these uncertainties and of the fact that the petitioner's plant was still operating in 1928, with increased production, we are of opinion that the determination of the respondent should be approved.

Decision will be entered for the respondent.