Louisiana Iron & Supply Co. v. Commissioner

*1244 The Commissioner determined a deficiency of $533.81 in income tax for 1935 and a deficiency of $27.69 in excess profits tax for the same year. The only issue for decision is whether the petitioner is entitled to deduct percentage depletion on 1935 receipts from oil payments.

FINDINGS OF FACT.

The petitioner is a corporation, organized in 1933. It succeeded to the business of a partnership selling oil well supplies. All of the assets of the partnership were turned in to the petitioner for its stock.

Among the assets received were six oil payments, fixed amounts to be paid from oil as produced. The partnership had acquired these oil payments in 1932 and 1933, either directly for materials furnished or as payments on a previously existing account receivable. The partnership in 1932 and 1933 had charged off as a loss its cost of these oil payments when the drilling produced a dry hole. It had claimed*1210 and been allowed deductions for those losses. The oil payments had no cost or other basis in the hands of the petitioner.

Later, producing wells came in on the leases and payments were received by the petitioner. The following table shows the name of *1245 the oil payments, the cost to the partnership, the amount assigned, and the amounts received on the payments through 1935:

The petitioner reported the entire income received from the payments, but the amount previously deducted by the partnership was never otherwise included in income subsequent to the charge-off.

The petitioner claimed deductions for depletion on these oil payments on its return for 1935, and the Commissioner disallowed*1211 the deductions. He explained that the cost of the assignments of oil payments had been charged off in previous years.

OPINION.

MURDOCK: The owner of an oil payment has a depletable interest in the oil. T. W. Lee,42 B.T.A. 1217. The respondent does not argue to the contrary. He confuses the receipts from the oil payments with collections on debts which he says were previously charged off. He is in error in stating that these receipts represent collections on bad debts and that the oil payments lost their bases by reason of deductions taken in prior years for bad debts. The partnership took the assignments of the oil payments in discharge of amounts due it for material furnished. The partnership later deducted the cost of the oil payments as losses, not as bad debts. Thenceforth, the oil payments had no cost basis in the hands of the partnership. The oil payments were transferred to the petitioner corporation in exchange for its stock and took the same basis in the hands of the petitioner as they had had in the hands of the partnership. See sec. 112(b)(5) and sec. 113(a)(8), Revenue Act of 1934. Thus, the oil payments had no cost basis in the hands of*1212 the petitioner. But the petitioner had never taken a deduction in relation to the payments and was merely obliged to report as gross income any receipts which it had thereafter as owner of those oil payments. It has done that and, indeed, it could have done no more. The Board is not confronted with the question of whether some adjustment should be made because these oil payments were once charged off by a previous owner. The only question before the Board is the right of the petitioner to percentage depletion under section 114(b)(3). See, also, sec. 23(m).

*1246 The substance of the argument of the respondent is that percentage depletion may not be taken on property which has no basis for gain or loss and for cost depletion in the hands of the taxpayer. He says that the whole purpose of the depletion deductions is to return the cost of the property tax free to the owner and when cost has been returned by any method, no further deductions for depletion are proper. Percentage depletion, however, as provided under section 114(b)(3), is not based upon cost. It is an arbitrary allowance fixed at "27 1/2 percentum of the gross income from the property during the taxable*1213 year." The words of the statute and the legislative history do not justify the contention of the respondent that percentage depletion is no longer allowable after the cost of the property has been recovered tax free. He has cited no case in point. His rulings are to the contrary. I.T. 2327, C.B. VI-1, p. 18 G.C.M. 14448, C.B.XIV-1, pp. 98, 100. It is possible, and not unusual, for a taxpayer to recover tax free, through percentage depletion, an amount greater than the cost of the property. Commissioner v. Elliott Petroleum Corporation, 82 Fed.(2d) 193. Cf. Thomas v. Perkins,301 U.S. 655; F. H. E. Oil Co.,41 B.T.A. 130, 134; Cook Drilling Co.,38 B.T.A. 291. It follows that a taxpayer may recover a larger amount tax free through depletion than he could through a sale or other disposition of the property. The statute ignores all such inequalities and allows the deduction regardless of whether or not cost has been recovered. Cf. Second Carey Trust,41 B.T.A. 800, 807, 808, where no cost was proven. This petitioner had gross income from these properties during the taxable*1214 year and had a depletable interest in them. Therefore, it is entitled to the deduction of percentage depletion provided under section 114(b)(3).

Decision will be entered under Rule 50.