1933 BTA LEXIS 1105">*1105 During the taxable years the petitioner operated oil wells on several separate properties. Some of these properties were owned and some were leased. In computing the reasonable allowance for depletion under section 204 of the Revenue Act of 1926, and section 114 of the Revenue Act of 1928, held, the computation should be made with respect to each property separately.
28 B.T.A. 549">*549 The Commissioner determined deficiencies in the petitioner's income tax as follows:
| Docket No. | Year | Deficiency |
| 46744 | 1927 | $2,144.41 |
| 54650 | 1928 | 8,393.03 |
| 64156 | 1929 | 6,156.12 |
28 B.T.A. 549">*550 The issues presented are:
(1) Whether the allowance for depletion of oil wells should be computed upon the combined gross income from several such properties or upon each property separately; and
(2) The proper allowance for the depreciation or depletion of intangible well costs, which the petitioner has consistently capitalized.
In the alternative, the petitioner alleges that, in the event that it should be determined that1933 BTA LEXIS 1105">*1106 it is not entitled to a depreciation deduction for intangible well costs, it is entitled to deduct such costs as were incurred during the taxable years in computing its net income for those years. The respondent affirmatively alleges that he erred in allowing, in computing the deficiency for 1927, the deduction of $31,363.09 representing the depreciation of intangible well costs, and duly asserts claim to an increased deficiency for that year. The facts were stipulated.
FINDINGS OF FACT.
The petitioner is a corporation organized and existing under the laws of the State of Texas, with its principal office at Orange, Texas. Since the date of its organization in 1914, and including the years here involved, the petitioner has been engaged in the oil-producing business in the Ged (Vinton) oil pool in Calcasieu Parish, Louisiana, and in connection with that business, in owning, drilling, and operating oil wells, and in owning necessary machinery and equipment for carrying on such business.
During the taxable years before us the petitioner conducted its operations upon several separate tracts of land, some of which were owned in fee and some of which were leased.
The following1933 BTA LEXIS 1105">*1107 schedule shows the number of producing wells drilled by petitioner upon its reserves previous to 1927, and the number drilled and producing during each of the years involved:
| Tract | Number of | New | New | New | Total | Total | Total |
| wells | wells | wells | wells | wells | wells | wells | |
| drilled | drilled | drilled | drilled | prod. in | prod. | prod. | |
| previous | in 1927 | in 1928 | in 1929 | 1927 | in 1928 | in 1929 | |
| to 1927 | |||||||
| Gordon Fee | 7 | 1 | 1 | None | 1 | 1 | 1 |
| Gardiner | None | None | None | None | None | None | None |
| Fee | |||||||
| Gray | 58 | 2 | 2 | None | 37 | 35 | 31 |
| Harmony | 15 | None | 1 | None | 4 | 4 | 4 |
| Vincent or | 17 | 3 | None | 1 | None | 1 | 2 |
| Gulf | |||||||
| Coast | |||||||
| Rescue 40 | 22 | None | None | None | 8 | 7 | 8 |
| Rescue | 4 | 3 | 1 | 1 | 1 | 1 | 3 |
| 13 2/3 | |||||||
| Matilda | None | None | None | 4 | None | None | 4 |
| Gray |
28 B.T.A. 549">*551 In carrying on its development and producing operations, the labor employed by petitioner and its general drilling machinery, tools, and equipment and well-pulling machinery and equipment are at all times used upon its lands and leaseholds as such operations or circumstances may require, the costs of such operations being charged to the particular tract or1933 BTA LEXIS 1105">*1108 leasehold upon which such work is done. The oil produced is measured and an account thereof made to the owners of the land or mineral interest therein for their proportionate shares or royalties, all of which are payable in kind. Thereafter, petitioner's share is run to common storage where it commingles and is withdrawn as sold.
In addition to the royalties which petitioner is obligated to pay to the lessors of its Rescue and Vincent leases and others owning mineral interests therein, petitioner is obligated, under the terms of the contracts by which these leases were acquired, to pay to the Rescue Oil Co. and the C. H. Benckenstein Syndicate, former lessees, 25 percent and 50 percent, respectively, of the net profits derived from their operation after first being reimbursed for all capital expenditures incurred in their development.
In computing taxable net income for the years here involved petitioner claimed an allowance for depletion of its oil wells in the pool representing 27 1/2 percent of the combined gross income received from its oil wells, calculated by it as being less than 50 percent of the combined net income from the wells, as follows:
| 1927 | 1928 | 1929 | |
| Total gross income from wells | $858,133.34 | $844,335.73 | $806,150.70 |
| Depletion at 27 1/2 percent | 235,986.67 | 232,192.32 | 221,691.44 |
1933 BTA LEXIS 1105">*1109 As shown by the following schedule, respondent computed the petitioner's allowance for depletion of its wells in the pool for said years by first computing the depletion allowance for each separate tract or lease, and then combining the amount so computed as representing the total amount of depletion sustained by the petitioner during each year:
| 1927 | ||||||
| Prop- | Gross | Net | 50% | 27 | Depletion | Depletion |
| erty | income | income | net | 1/2% | on cost | allowed |
| from | income | gross | ||||
| oil | income | |||||
| Gray | $755,292.52 | $486,942.57 | $234,471.28 | $207,705.45 | $64,011.28 | $207,705.44 |
| Harm- | 25,584.81 | 3,680.11 | 1,840.05 | 7,035.82 | None | 1,840.05 |
| ony | ||||||
| Res | 75,181.53 | None | None | 20,674.92 | 287.06 | 287.06 |
| -cue | ||||||
| 40 | ||||||
| Rescue | None | 361.93 | 361.93 | |||
| Gulf | 2,074.48 | None | None | 570.48 | 72.03 | 72.03 |
| Coast | ||||||
| 858,133.34 | 490,622.68 | 245,311.33 | 210,266.51 | |||
| 1928 | ||||||
| Gray | $663,148.69 | $414,304.33 | $207,152.16 | $182,365.89 | $62,668.55 | $182,395.89 |
| Harm- | 18,601.82 | 998.20 | 499.10 | 5,115.50 | 1,087.60 | 1,087.60 |
| ony | ||||||
| Gulf | 21,996.07 | (21,759.92) | 6,048.93 | 618.66 | 618.66 | |
| Coast | ||||||
| Rescue | 104,301.31 | 21,474.41 | 10,737.20 | 28,682.86 | 5,212.33 | 10,737.20 |
| Gordon | 36,287.84 | 24,345.52 | 12,172.76 | 9,979.15 | 2,074.05 | 9,979.15 |
| 844,335.73 | 439,362.54 | 230,561.22 | 204,788.50 | |||
| 1 | ||||||
| 1929 | ||||||
| Gray | $538,250.24 | $315,458.94 | $157,729.47 | $148,018.82 | $57,069.07 | $148,018.82 |
| Harm- | 16,633.34 | 0 | 0 | 0 | 937.62 | 937.62 |
| ony | ||||||
| Res- | 96,171.46 | 14,352.14 | 7,176.07 | 26,147.07 | 5,884.58 | 7,176.07 |
| cue 13 | ||||||
| and 40 | ||||||
| Gulf | 4,213.10 | 0 | 0 | 0 | 1,026.47 | 1,026.47 |
| Coast | ||||||
| Gor | 16,747.47 | 6,660.72 | 3,330.36 | 4,605.55 | 1,016.65 | 3,330.36 |
| don 2A | ||||||
| Matil- | 134,135.09 | 96,999.82 | 48,499.91 | 36,887.55 | 4,615.89 | 36,887.55 |
| da | ||||||
| Gray | ||||||
| 806,150.70 | 433,471.62 | 216,735.81 | 197,376.89 |
28 B.T.A. 549">*552 The petitioner has at all times since the date of its organization maintained on its books and records separate accounts for its respective lands and leaseholds. It has at all times consistently capitalized all costs of drilling and equipping its wells and in computing its net taxable income consistently deducted from gross income depreciation of these capitalized well costs at 20 percent a year.
In computing petitioner's allowable depletion based on cost of its oil reserves for all years previous to 1928, the respondent did not include in the cost of the oil reserves the intangible well costs which the petitioner had capitalized. In computing petitioner's allowable depletion, based on cost for the years 1928 and 1929, the respondent included such capitalized intangible well costs as a part of the cost of the reserves.
During the taxable years under consideration the petitioner expended for the labor costs of drilling its oil wells the following amounts, which it capitalized as intangible well costs:
| Property | 1927 | 1928 | 1929 |
| Gordon Fee | $2,793.85 | $6,460.95 | $0.00 |
| Gray | 12,259.90 | 4,656.85 | 0.00 |
| Harmony | None | 5,733.70 | 67.00 |
| Rescue 40 | 6,382.35 | 4,394.56 | 4,560.85 |
| Rescue 13 | 13,201.65 | 5,155.95 | 5,215.81 |
| Vincent or Gulf Coast | 10,267.05 | 2,888.40 | 7,452.25 |
| Matilda Gray | None | 754.95 | 11,810.60 |
| Total | 1 34,637.75 | $30,045.36 | 29,106.51 |
The parties have agreed that if the petitioner is entitled to depreciation of intangible well costs incurred in drilling the wells and capitalized on its books, then in such event the petitioner is 28 B.T.A. 549">*553 entitled to the following deductions from gross income for the years involved:
| 1927 | $31,363.09 |
| 1928 | 37,164.37 |
| 1929 | 31,652.15 |
OPINION.
SMITH: The principal issue is whether depletion allowance to be deducted by this taxpayer should be 27 1/2 per centum of the combined gross income from the several properties (as the petitioner contends), or whether the depletion allowance should be computed separately for each property (as the respondent contends). Section 204(c)(2) of the Revenue Act of 1926, and section 114(b)(3) of the Revenue Act of 1928 are the same, and are as follows:
In the case of oil and gas wells the allowance for depletion shall be 27 1/2 per centum of the gross income from the property during the taxable year. Such allowance shall not exceed 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property, except that in no case shall the depletion allowance be less than1933 BTA LEXIS 1105">*1112 it would be if computed without reference to this paragraph.
By section 234(a)(8) of the Revenue Act of 1926, "the Commissioner with the approval of the Secretary" is authorized to prescribe rules and regulations under which the depletion allowance is to be made. Article 221 of Regulations 69 reads as follows:
ART. 221. Depletion in the case of oil and gas wells. - Under section 204(c)(2), in the case of oil and gas wells, a taxpayer may deduct for depletion an amount equal to 27 1/2 per cent of the gross income from the property during the taxable year, but such deduction shall not exceed 50 per cent of the net income of the taxpayer (computed without allowance for depletion) from the property. In no case shall the deduction computed under this paragraph be less than it would be if computed upon the basis of the cost of the property or its value at the basic date, as the case may be. In general, "the property," as the term is used in section 204(c)(2) and this article, refers to the separate tracts or leases of the taxpayer. [Italics supplied.]
On brief the respondent points out that:
The Commissioner's interpretation of the word "property" is first set1933 BTA LEXIS 1105">*1113 forth in Article 221 of Regulations 69, supra, and is repeated in Article 241 of Regulations 74, supra, promulgated under the Revenue Act of 1928. If his interpretation in the first instance had not been expressive of the intent of Congress, it would seem that an appropriate change would have been made in the Revenue Act of 1928. None having been made, it must follow that Congress placed its stamp of approval on the Commissioner's interpretation of the statute. National Lead Companyv.United States,40 Sup.Ct. 237; 252 U.S. 140">252 U.S. 140.
The petitioner argues that the respondent interpreted the provisions of the Revenur Act of 1924 with respect to depletion and depreciation 28 B.T.A. 549">*554 as embracing all the properties of the taxpayer, calling attention specifically to article 201 of Regulations 65. It is to be noted, however, that throughout this article the term "property" is used in the singular, and from a reading of that and subsequent articles of Regulations 65, interpreting the statute, the Board construes the article as treating each property separately. This construction is fully supported by article 219, which begins:
To each return made by1933 BTA LEXIS 1105">*1114 a person owning or operating oil or gas properties there should be attached a statement showing for each property the following information, which may be given in the form of a table, if desired, by taxpayers owning more than one property: * * *
Then follows an enumeration of the information required for each property.
In United States v. Dakota-Montana Oil Co.,288 U.S. 459">288 U.S. 459, the Supreme Court said:
* * * The earlier acts provided that depletion should be allowed on the basis of cost unless the taxpayer was the discoverer of the well upon an unproven tract, in which case the basis was the "value of the property" at the time of the discovery or within 30 days thereafter. See No. 215, Palmer v. Bender, decided January 9, 1933. But the "discovery value" provision was eliminated from the Act of 1926, which is applicable here, and the taxpayer was permitted to calculate depletion on the basis of cost alone [§ 204(c)] or else to deduct an arbitrary allowance, fixed by the statute, without reference to cost or discovery value, at 27 1/2% of gross income from the well.
After reviewing the earlier statutes and the interpretative regulations, the Court1933 BTA LEXIS 1105">*1115 said:
* * * The administrative construction must be deemed to have received legislative approval by the reenactment of the statutory provision, without material change. No. 80, Murphy Oil Co. v. Burnet, decided December 5, 1932; Brewster v. Gage,280 U.S. 327">280 U.S. 327, 280 U.S. 327">337.
The facts show that the petitioner has consistently treated the several properties involved as separate and independent of each other in accounting for its operations on each property. The respondent computes the depletion allowance in accordance with the petitioner's bookkeeping and his own regulations. We believe an analysis of the respondent's computation for 1927 will show that he has properly applied the statute. The gross income from the 37 wells on the Gray leasehold was $755,292.52 and the respondent allowed depletion of $207,705.44, which is less than 50 percent of the net income from "the property" and greater than the allowance would have been upon the basis of cost. The gross income from the four producing wells on the Harmony leasehold was $25,584.81, but 27 1/2 percent of the gross income ($7,035.82) from that property being more than 50 percent of the net income of the1933 BTA LEXIS 1105">*1116 taxpayer from the property, the allowance was restricted to 50 percent of the net income 28 B.T.A. 549">*555 or $1,840.05. The gross income from the eight producing wells on the "Rescue 40" leasehold was $75,181.53, but since there was no net income from that property the 27 1/2 percent rate cannot apply, however, "in no case shall the depletion allowance be less than it would be if computed without reference to" section 204(c)(2), therefore the respondent has allowed depletion on the basis of cost (section 204(c) and (a)). The allowances with respect to the Rescue and Gulf Coast properties were similarly computed. We believe the respondent has computed a reasonable allowance for depletion and his determination in sustained.
On brief the petitioner states that:
In view of the decision of the Supreme Court of the United States in the case of United States v. Dakota-Montana Oil Co.,77 L. Ed. 585, decided March 13, 1933, the petitioner waives its second alternative contention, viz, that respondent erred in refusing to allow it depreciation of intangible well costs originally capitalized under its system of bookkeeping and for which it annually claimed and was allowed1933 BTA LEXIS 1105">*1117 by respondent a deduction for all years previous to 1928.
That decision is dispositive of the question of depreciation of intangible well costs, where there has been an arbitrary allowance at the rate of 27 1/2 percent of the gross income from the property. But, as shown above, that arbitrary allowance cannot apply to some of the properties operated by this taxpayer. The petitioner has failed, however, to segregate the claimed depreciation of such intangible well costs, and we cannot determine what portion, if any, is not comprehended by the 27 1/2 percent depletion allowance with respect to some properties. In these circumstances, no allowance should be made for the depreciation of intangible well costs.
The remaining issue, in the alternative, is the petitioner's claim to the deduction of the expenditures in the respective taxable years for the labor cost of drilling wells. Such expenditures have been consistently capitalized by the petitioner. We have held that such expenditures are capital expenditures and not deductible as ordinary and necessary business expenses. See 1933 BTA LEXIS 1105">*1118 Charles Christy,23 B.T.A. 300">23 B.T.A. 300; P-M-K Petroleum Co.,24 B.T.A. 360">24 B.T.A. 360; California Cost Oil Co.,25 B.T.A. 902">25 B.T.A. 902. That being the case, and in view of the fact that such capital expenditures are returnable through depletion, the petitioner's alternative contention must fail.
Since the respondent erred in allowing the deduction, from gross income of 1927, of $31,363.09 representing the depreciation of intangible well costs (288 U.S. 459">United States v. Dakota-Montana Oil Co., supra), the respondent's motion for an increased deficiency for 1927 is granted, provided any such increase results on the redetermination of the deficiency.
Reviewed by the Board.
Judgment will be entered under Rule 50.