title to oil in place. Since the intangible drilling and development costs here involved arose in connection with the drilling of the first well on each tract, it is apparent from the foregoing discussion that they form a part of the consideration for and constitute capital expenditures in the acquisition of the First National Bank, Standard of Kansas, Dodge, M. K. Carter, A. W. Johnson, Burkitt, and BetzRobinson tracts. Accordingly, such costs may not be deducted but can be recovered only through depletion allowances. Hardesty v. Commissioner, supra; Hunt v. Commissioner, supra; Walsh v. Commissioner, supra; Hugh Hodges Drilling Co., 43 B. T. A. 1045; NunnStubblefield Oil Co., 31 B. T. A. 180.

We next consider the question in relation to the drilling of the dry hole on the Monnig tract. In each instance the assignment to petitioners was not executed until after they had drilled on the property. Petitioners drilled to enjoy the avails of a contract whereby the first parties agreed to assign their leasehold interest in the tract provided petitioners performed a positive undertaking to drill. Performance was required in order to obtain any interest in the tract which was the subject of the contract. In the final analysis the position of the parties was practically identical to that existing in respect to the "unless" type instruments. Under the latter, leasehold interests automatically became vested in petitioners when the drilling requirement was performed, while here the passing of title was contingent upon the execution of a further instrument, the assignment itself. However, in both cases, petitioners were entitled to no interest in oil in place until a well was drilled. Clearly, the drilling of the well on the Monnig tract also was a consideration for the interests acquired. See Nunn-Stubblefield Oil Co., supra, wherein the material facts are undistinguishable from those here giving rise to the Monnig leasehold.

Petitioners contend that the rule of the Hardesty case does not apply where the well turns out to be as here a dry hole. There is no merit to this contention. United States v. Sentinel Oil Co., supra. Regardless of the outcome, the drilling operation was undertaken as a part of the consideration for the assignment of the lease. The option accorded by the regulations to expense the cost of nonproductive wells extends only to situations in which such a well is drilled by the taxpayer on land in which he has a fee interest.

The instruments in evidence to sustain the deduction claimed respecting the McKinzie tract present a different picture. By the agreement dated November 4, 1938, petitioners specifically agreed to commence and continue a well as part of the consideration for the assignment of interests in 11.25 acres. Petitioners were released from the obligation as to two acres three days later. Drilling was likewise expressly made a consideration for the assignment of H. F. Cheatham's interest in 6.1875 acres of the McKinzie tract. Hence, in respect of

15.4375 acres in this tract petitioners clearly drilled the well as a consideration for the acquisition of a capital asset and petitioners concede as much. None of the other instruments in evidence, however, contain any reference whatever to drilling. Accordingly, petitioners contend that they need capitalize only so much of the intangible drilling costs of the McKinzie well as 15.4375 bears to 67.5. This contention is based upon the theory that their interests in the McKinzie tract embraced a total of 671⁄2 acres and is made in reliance on Hunt v. Commissioner, supra.

The difficulty in following petitioners lies not with their general proposition, but in the state of the record. It is elementary that the burden of showing the respondent's determination to be erroneous falls upon the petitioners. Among other facts, petitioners here were each obliged to establish that they had an interest in each tract upon which they drilled; that the drilling was not consideration for the interests acquired; and, with respect to the McKinzie tract which raises the apportionment issue, the numerator and denominator of the ratio to be applied. To establish these matters in connection with the McKinzie tract petitioners offered in evidence 11 instruments, all of which were received. One was an oil lease covering a seven-sixteenths interest in a 672-acre tract. However, this interest was granted to Carter & Gragg Oil Co., a partnership. There is nothing in the record which purports to show that petitioners acquired any interest whatever in this portion of the 672-acre tract from Carter & Gragg, or anyone else. We can not indulge in an assumption that they did. Of the remaining 10 instruments, 3 were assignments of a one-tenth interest in a certain lease by which Alice McKinzie leased her undivided interest in the 671/2-acre tract. Two instruments were assignments of a one-third interest in a certain lease by which other parties leased their undivided interest in the 672-acre tract. We do not know the extent of the original lessors' interests in the tract, however, since the leases themselves were not offered in evidence and no testimony was given on this point. Consequently, we are unable to determine what interests petitioners obtained. Moreover, a one-sixteenth interest in the 672-acre tract is altogether unaccounted for. It is obvious that proof of the denominator of the apportionment ratio is lacking to such a degree as to make any figure a mere guess. In these circumstances we must sustain respondent.

Furthermore, it is at once apparent that petitioners have failed to prove a right to expense the intangible cost of the McKinzie well upon a totally different ground. As we have stated, several of the assignments contained no drilling provision. Upon this fact alone is based petitioners' contention that drilling could constitute no part of the consideration for the interests thus acquired. But as assignees of a lease petitioners acquired no greater rights than those of their assignor

thereunder and were subject to all the obligations, conditions, and considerations imposed by the lease upon the assignor. None of the leases in relation to the McKinzie tract, except the lease to CarterGragg Oil Co., were offered in evidence and no evidence was offered as to the provisions thereof. Not having the information which such evidence would afford for consideration in connection with the provisions of the intervening assignments of the leases, we have no factual basis upon which to determine whether it is permissible under the regulations in question to expense the intangible drilling costs of the well drilled on such leased premises. We can not, therefore, hold that respondent erred in denying the applicability of such regulations in respect of the drilling of such well.

This observation applies also to the state of the proof respecting petitioners' acquisition of interests in the A. W. Johnson, M. K. Carter, Burkitt, Betz-Robinson, and Monnig tracts. In each instance the assignments covering these properties themselves contained drilling provisions which, as we have held, required drilling as a part of the consideration for the capital assets which petitioners acquired. This suffices to support our conclusion as to the drilling expenses on these tracts. However, had these assignments been silent regarding drilling or had drilling provisions therein been of a character not bringing them within the rule of the Hardesty case, we would still be obliged to approve the respondent's determination disallowing deductions for the intangible costs of the wells on these tracts, since neither the underlying leases nor their provisions are before us.

F. H. E. was not a lessee under the lease conveying interests in the First National Bank tract. Fleming-Kimbell was not mentioned in the assignment of the leasehold interest in the Betz-Robinson tract. No evidence was offered to supply the missing links. Nevertheless, F. H. E. claimed a deduction for intangible drilling expenses in connection with the First National Bank well and Fleming-Kimbell claimed one for similar expenses in connection with the Betz-Robinson well. It can not be said, and in fact is not contended, that such expenses are deductible on the theory that petitioners, in the named instances, were merely acting as contractors drilling for others and so entitled to a business expense deduction, for petitioners did not actually do the drilling. The drilling was contracted by them, not to them. Such expenses are not deductible by F. H. E. in respect of the well on the First National Bank tract nor by Fleming-Kimbell in respect of the well on the Betz-Robinson tract, because of failure to prove an interest, respectively, in such tracts.

For the reasons discussed above we hold that petitioners are not entitled to expense the intangible drilling and development costs connected with any of the nine wells.

The second question in this proceeding is whether charitable contributions made by Fleming-Kimbell during the taxable year ended April 30, 1939, are to be deducted from gross income from the property in computing the limitation on percentage depletion pursuant to section 114 (b) (3) of the Revenue Act of 1938. Respondent claims that they are, while petitioners contend to the contrary.

The statute provides that the allowance for percentage depletion shall not exceed 50 per cent of the net income of the taxpayer from the property (computed without allowance for depletion). The Commissioner has issued a regulation 2 defining the term "net income of the taxpayer from the property" for the purposes of this limitation. It requires that "gross income from the property" be reduced by the allowable deductions attributable to the mineral property upon which the depletion is claimed. Montreal Mining Co., 2 T. C. 688. It does not provide that gross income must be reduced by all the deductions which may be allowed the taxpayer by statute. The answer here turns upon whether the charitable deductions in question are attributable to Fleming-Kimbell's oil properties.

We do not think that they are so attributable. To be deductible as ordinary and necessary expenses under section 23 (a) of the Revenue Act of 1938, charitable contributions must have in a direct sense a reasonable relation to the business of the taxpayer corporation. However, the respondent makes no contention that the charitable contributions involved here were so closely related to Fleming-Kimbell's business as to make them deductible under section 23 (a). On the contrary, the parties seem to assume that the instant charitable contributions are of the character deductible only by virtue of section 23 (g) of the Revenue Act of 1938, which permits the deduction of certain contributions up to a limited amount regardless of their connection with a corporate taxpayer's business. Charitable contributions thus deductible do not appear to constitute deductions attributable to the mineral property upon which depletion is claimed within the meaning of the quoted regulations. On this issue, we sustain the petitioner.

Reviewed by the Court.

DISNEY, J., dissents.

Decisions will be entered under Rule 50.

2 ART. 23 (m)-1. Depletion of mines, oil and gas wells, other natural deposits, and timber; depreciation of improvements.

(h) "Net income of the taxpayer (computed without allowance for depletion) from the property," as used in section 114 (b) (2), (3), and (4) and articles 23 (m)-1 to 23 (m)-28, inclusive, means the "gross income from the property" as defined in paragraph (g) less the allowable deductions attributable to the mineral property upon which the depletion is claimed • including overhead and operating expenses, development costs properly charged to expense, depreciation, taxes, losses sustained, etc., but excluding any allowance for depletion. Deductions not directly attributable to particular properties or processes shall be fairly allocated.

BLACK, J., dissenting: The majority opinion, after discussing the legal effect of oil leases which contain the "unless" clauses and the oil wells which have been drilled thereunder, concludes: "It is apparent from the foregoing discussion that they form a part of the consideration for and constitute capital expenditures in the acquisition of tracts. Accordingly, such costs may not be deducted but can be recovered only through depletion allowances." (Citing cases.)

the

*

I agree that such expenditures are capital expenditures but the very purpose of article 23(m)-16 of Treasury regulations printed in the margin is to give the taxpayer the option of either deducting as a business expense the intangible drilling costs incurred in drilling a producing oil well which he owns, or to capitalize such intangible drilling costs to be recovered through depletion.

I think a producing oil well is a capital asset to a taxpayer who brings it in and owns it, whether he does it on land which he owns in fee simple, or on land which he has leased for development with an affirmative obligation to drill one or more wells in his program of development, or on land which he has leased with a mere option to drill within a given time and the lease to be forfeited unless he does drill, or on land where the lease contains no specific provisions at all as to when development shall begin. A producing oil well in all the cases which I have enumerated is a capital asset in the hands of the owner, I think, and just as much so in the one case as in the other. It seems to me that article 23 (m)-16 is broad enough to include within its provisions all the cases I have mentioned above and I dissent from the view that it should be denied application to wells drilled under the circumstances which exist in the instant case.

I further dissent from that part of the majority opinion which would deny the right to deduct intangible drilling costs to F. H. E. in respect of the well on the First National Bank tract and to FlemingKimbell in respect of the well on the Betz-Robinson tract, on the further ground of failure to prove an interest, respectively, in such tracts. I do not understand that the Commissioner either in his deficiency notice or at the hearing of these proceedings made any contention that petitioners were not the joint owners of the wells which they drilled on the two leases thus mentioned, in the drilling of which they incurred the intangible drilling costs which they here seek to deduct. The Commissioner makes no such contention in his brief. The issue as presented by the parties was whether under the drilling clauses of the leases-not only the First National Bank lease and the Betz-Robinson lease, but the other leases in evidence-petitioners were entitled to deduct their intangible drilling costs as business expenses, they having elected so to do in prior years, or whether they must