less than face value as determined by respondent. This holding, if correct, would dispose of the question but only if the constructive receipt theory were abandoned and the decision premised on actual receipt of the notes by petitioner and its voluntary delivery of them to Kellogg. The record, I think, amply proves that the notes were without fair market value in 1939. I doubt their negotiability. Each of them on its face was subject to the terms of a deed of trust on the properties, executed by Davis, and that deed of trust was expressly made subject to the contract under which Davis & Co. could return the properties and recover the consideration paid therefor, together with interest thereon. And, at the close of 1939, Davis & Co. was seriously considering doing just that. But more important, petitioner did not voluntarily deliver the notes to Kellogg as "collateral" and therefore can not be held to have received them in fact. It can no more be said that petitioner received the notes absolutely than did Kellogg. They were all drawn to Kellogg. They could not have been sold by petitioner. They could have been used by petitioner in no other way than they were used-by the delivery to Kellogg as "collateral" to petitioner's obligation. I do not think petitioner is taxable as having received the face value of the unpaid notes in 1939. See Nunnally Investment Co. v. United States, 36 Fed. (2d) 332; affd., 316 U. S. 258; Dudley T. Humphrey, 32 B. T. A. 280. F. H. E. OIL COMPANY (A DISSOLVED CORPORATION), PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. FLEMING-KIMBELL CORPORATION, PETITIONER, V. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Docket Nos. 111575, 548. Promulgated January 13, 1944. 1. During the taxable years involved petitioners were engaged in the oil business in Texas. They acquired certain oil and gas leases and as part of the consideration therefor expressly agreed to drill oil wells upon the leased property. Held, the cost of drilling these wells represented a part of the cost of the leases and must be recovered by way of depletion, and the provisions of article 23 (m)-16, Regulations 101, granting petitioners an option to either capitalize intangible drilling costs or deduct them as ordinary and necessary business expenses, are not applicable. 2. Petitioners also were lessees in other leases in which there were provisions that unless petitioners commenced the drilling of a well within an agreed length of time the leases would terminate. Held, that the costs of the wells drilled upon the properties covered by these leases were incurred as a part of the consideration for a leasehold interest in the properties and oil in place and such costs are not deductible as intangible drilling costs. 3. In one of the taxable years involved petitioner Fleming-Kimbell Corporation made certain charitable contributions for which it took a deduction under section 23 (q) of the Revenue Act of 1938. Held, these charitable contributions were not "deductions attributable to the mineral property upon which the depletion is claimed" within the meaning of article 23 (m)-1 (h), Regulations 101, and in computing the limitation on percentage depletion under section 114 (b) (3) of the Revenue Act of 1938 such charitable contributions need not be deducted from "gross income from the property" in determining the petitioner's "net income from the property." Harry C. Weeks, Esq., for the petitioners. Frank B. Appleman, Esq., for the respondent. This is a consolidated proceeding involving income tax deficiencies determined against F. H. E. Oil Co. for its taxable years ended January 31, 1939 and 1940, in the respective amounts of $7,103.40 and $10,353.06, and against Fleming-Kimbell Corporation for its taxable years ended April 30, 1939 and 1940, in the respective amounts of $8,717.18 and $5,677.44. Certain assignments of error have been abandoned and others have been withdrawn from consideration by agreement. As to the latter, it was stipulated at the hearing that dues and membership fees paid by petitioners to the Independent Petroleum Association may be deducted from income. These dues and fees amount to $375 and $500 for the two taxable years in the case of F. H. E. Oil Co. and $500 and $625 in the case of FlemingKimbell Corporation. It was further stipulated that the overhead expenses fixed by respondent in computing depletion allowances should be increased, in both proceedings, by the amounts of such dues and fees; that with respect to F. H. E. Oil Co. such overhead expenses for its taxable years ended January 31, 1939 and 1940, should be reduced by $16,121.26 and $14,312.18, respectively; that in the case of F. H. E. Oil Co. such adjusted overhead expenses should be allocated in full to oil activities with 60 percent thereof allocated to operations and the balance to development; that the 60 percent so allocated to operations should be further apportioned among the producing properties upon the basis of receipts from production; and that the 40 percent so allocated to development should be apportioned among the properties upon which development occurred upon the basis of the amount expended on the respective properties. Respondent has also conceded his error in disallowing deductions of $68.59 in 1939 and $5,587.97 in 1940 claimed by F. H. E. Oil Co. as deductible intangible drilling and development costs with respect to wells drilled upon its Airport lease. Effect will be given to the stipulation and concession in the recomputation under Rule 50. Remaining for consideration are two questions, but one of which is common to both petitioners, namely, whether petitioners are entitled to deduct from their income for the taxable years in question "intangible drilling and development costs" incurred in the drilling of nine oil wells on leased property. The second question, affecting Fleming-Kimbell Corporation's tax for its year ended April 30, 1939, is whether charitable contributions are to be deducted from gross income from the property in computing the limitation on percentage depletion. Both parties kept their books and made their returns on the basis of cash receipts and disbursements. F. H. E. Oil Co.'s fiscal year ended on January 31 and Fleming-Kimbell's ended on April 30. Returns were filed with the collector of internal revenue for the second ́ collection district of Texas at Dallas. The proceedings were submitted upon oral testimony and documentary evidence, from which we make the following findings of fact. FINDINGS OF FACT. During all times here pertinent F. H. E. Oil Co., hereinafter called "F. H. E.,” and Fleming-Kimbell Corporation, hereinafter called "Fleming-Kimbell" were Texas corporations engaged in producing oil, with principal offices in Fort Worth, Texas. F. H. E. has since been dissolved. Wm. Fleming was president and general manager of both companies. They operated most of their properties jointly. Petitioners have consistently followed the practice of expensing their so-called "intangible drilling and development costs" incurred in the drilling of oil wells and of expensing the cost of dry holes. From 1936 through 1940 petitioners acquired rights under various leases, assignments, and agreements. They treated such acquisitions as constituting nine named "leases," hereinafter called "tracts," upon each of which a well was drilled. The nine tracts and the amounts expended by each petitioner in the respective taxable years for so-called "intangible drilling and development costs" in connection with the drilling of the well on each tract follow: Petitioners deducted the above amounts expended by them in com puting their taxable income for the periods in question. Respondent disallowed such deductions. The parts of each lease, assignment, or agreement in evidence which are pertinent to the principal issue are summarized or quoted in the following paragraphs. (a) First National Bank tract.-Rights in this tract were acquired under an oil lease dated June 21, 1939, and running from C. L. Mahaney and First National Bank of Palestine, Texas, to FlemingKimbell, Carter-Gragg Oil Co., and Wm. Fleming, trustee. It does not appear that F. H. E. obtained any interest in this tract. printed granting clause recites: * * The That the said lessor, for and in consideration of Ten and no/100 ($10.00) Dollars cash in hand paid * and other covenants and agreements hereinafter contained on the part of the lessee to be paid, kept and performed has granted, demised, leased and let, and by these presents does grant, lease and let unto the said lessee for the purpose and with the exclusive right of exploring, drilling, mining, and operating for, producing, and owning oil, gas, sulphur and all other minerals all that certain tract of land * as follows, to-wit: described Twenty acres, more or less, in the James Madden League [here follows legal description]. Typed in as a part of the first paragraph is the following: "If no well be commenced on said land on or before August 15, 1939, this lease shall terminate as to both parties." Paragraph 3 provides for a primary term of five years, paragraph 4 provides for royalties, and paragraph 5 provides that the lease shall terminate if operations for drilling of a well be not commenced by June 21, 1940, unless lessee pay delay rentals. (b) Standard of Kansas tract.-Rights in this tract were acquired under two oil leases, the printed portions of which are identical to the analogous parts of the lease mentioned in (a) above, except as hereinafter noted. One of the leases is dated December 8, 1939, and runs from Elizabeth B. Crane to petitioners and Carter-Gragg Oil Co. and covers 2,032 acres. The following quotation is typed in as part of the granting clause: If operations for the drilling of a well are not commenced by lessee on some part of the land covered by this lease within sixty (60) days from date hereof, and thereafter drilled with due diligence to a depth sufficient to test the known producing horizons in the woodbine sands, this lease shall terminate as to both parties. Clause 5 pertaining to delay rentals does not fix a date on or before which a well must be commenced. After the printed portion of this clause is typed the following: "This clause is subordinate to the provision hereof regarding commencing a well within 60 days hereinabove set out." The second lease is dated September 15, 1939, and runs from the Standard Oil Co. of Kansas to petitioners and Carter-Gragg Oil Co. and covers 199.98 acres. Added to the printed granting clause of this lease is the following: If operations for the drilling of a well are not commenced by Lessee on the A. W. Johnson tract of 425.81 acres * and thereafter drilled with due diligence * * within 25 days from date hereof this lease shall terminate as to both parties; and if said well is drilled by lessee on the A. W. Johnson tract as aforesaid, then if operations for the drilling of a well be not commenced on the tract covered by this lease within ninety days after the well on said Johnson tract shall have been completed (either as a producer or a dry hole), and if said well on this tract be not thereafter drilled with due diligence to a depth sufficient to test the known producing horizons in the Woodbine sand, this lease shall terminate as to both parties. The printed paragraph 5 pertaining to delay rentals is deleted in its entirety from this lease. (c) Dodge tract.-Petitioners acquired rights in this tract under an oil lease dated January 10, 1940, and running from Percy Jones and wife to petitioners. The granting clause of the lease is as follows: WITNESSETH: That the said lessor, for and in consideration of Ten and No/100 Dollars and of the covenants and agreements hereinafter contained on the part of lessee to be paid, kept and performed, have granted, demised, leased and let and for these presents do grant, lease and let unto the said lessee for the sole and only purpose of mining and operating for oil and gas save and take care of said products, all that certain tract of land [description of tract containing 200 acres]. The lease is for a primary term of one year and provides for the payment of the usual royalty. Typed into the instrument is the following: If no well be commenced at some location on the land covered by this lease, and not more than two locations from the center of said section 15 within sixty (60) days from date of this lease and the drilling thereof continued with due diligence to a depth sufficient to test the formation from which the wells now on said section are producing, unless oil or gas in paying quantities is found at a lesser depth, this lease shall terminate as to both parties and be of no further force or effect. (d) A. W. Johnson tract.-Petitioners' rights in this tract were acquired under an assignment of a lease to which reference is made in the assignment. The lease is not in evidence. The assignment is dated September 11, 1939, and the granting clause is as follows: For the considerations and on the terms and conditions and subject to the provisions and reservations hereinafter set out, TIDE WATER ASSOCIATED OIL COMPANY, a corporation, and SEABOARD OIL COMPANY OF DELAWARE, a corporation, hereinafter called Assignors, * * do hereby assign unto CARTERand FLEMING GRAGG OIL COMPANY * * *, F. H. E. OIL COMPANY, all of the right, title and interest of Assignors in and to said oil and gas lease, as amended, ratified and confirmed, insofar as it covers [a described tract of 425.81 acres, excepting a tract of 160 acres]. |