*3672 1. GAIN OR LOSS. - Petitioners sold oil stock for $500,000 cash and 200 oil and gas income certificates which had a fair market value. Held, that such certificates should be treated as the equivalent of cash to the extent of their fair market value and the profit returned on a "closed transaction" basis rather than a "return of capital" basis.
2. VALUATIONS. - Petitioners on the same day sold the certificates for a fixed consideration of $2,500,000 payable in five years without interest unless 20 per cent of the gross production equaled that amount in less than that time. Testimony of petitioners' witnesses that the fair market value of the certificates on date of sale was $2,500,000 was rejected, and since respondent had made no determination as to such value further evidence will be taken unless parties can agree before settlement date.
3. DEPLETION. - Where individuals own oil leases and transfer such leases to a corporation in exchange for stock they are no longer entitled to a depletion deduction with respect to such leases.
4. HUSBAND AND WIFE. - Ownership of stock in a corporation as between husbands and wives determined from the evidence.
*979 In these proceedings which were consolidated for trial, the petitioners seek redeterminations of their income tax liabilities for the years set forth below for which the respondent has determined deficiencies as follows:
| Petitioner. | Docket No. | Year. | Deficiency. |
| M. C. Garber | 3710 | 1919 | $76,187.39 |
| Do | 13909 | 1920 | 129.845.11 |
| Do | 13909 | 1921 | 22,962.54 |
| Do | 13909 | 1922 | 104,702.39 |
| Do | 13909 | 1923 | 53,742.97 |
| Estate of Wm. F. Kistler | 3707 | 1920 | 1,997.30 |
| Do | 11986 | 1922 | 716.17 |
| Do | 11986 | 1923 | 411.80 |
| Do | 18061 | 1919 | 4,314.98 |
| B. A. Garber | 3708 | 1919 | 76,696.78 |
| Do | 14097 | 1920 | 131,753.09 |
| Do | 14097 | 1921 | 23,413.46 |
| Do | 14097 | 1922 | 113,922.66 |
| Do | 14097 | 1923 | 81,534.07 |
| L. C. Moore | 3709 | 1919 | 31,110.20 |
| Do | 13907 | 1920 | 58,036.93 |
| Do | 13907 | 1921 | 9,301.61 |
| Do | 13907 | 1922 | 46,563.66 |
| Do | 13907 | 1923 | 21,029.16 |
| James Tait | 13908 | 1920 | 1,560.55 |
| Do | 13908 | 1921 | 1,015.45 |
| Do | 13908 | 1922 | 663.52 |
| Do | 13908 | 1923 | 392.36 |
*980 The petitioners allege error on the part of the respondent in*3674 holding that the profit from the sale on December 14, 1918, of certain shares of stock in the Garfield Oil Co. should be spread over a period of approximately 5 years and taxed accordingly rather than treating, as the petitioners contend, the entire profit as income for the year 1918 only. Failing in this the petitioners allege as an alternative that the respondent erred in refusing to allow depletion in connection with the 200 oil and gas certificates which were received as a part of the consideration for the sale of the above mentioned Garfield Oil Co. stock, and as a further alternative the petitioners, M. C. Garber, B. A. Garber and L. C. Moore, allege that the respondent erred in not finding that one-half of the profit from the sale of said Garfield Oil Co. stock apportioned to them was the income of their respective wives.
FINDINGS OF FACT.
The petitioners, in 1916, were the owners of oil and gas leases in Garfield and Noble Counties, Oklahoma, aggregating approximately 11,000 acres, which in the same year they sold to the Garfield Oil Co., a corporation, for and in consideration of 200 shares of the latter's stock of the par and actual cash value of $100 per share issued*3675 as follows:
| Shares. | |
| M. C. Garber | 75 |
| B. A. Garber | 75 |
| L. C. Moore | 40 |
| W. F. Kistler | 5 |
| James Tait | 5 |
| Total | 200 |
*981 The above 200 shares represented one-half of the issued and out standing capital stock of the Garfield Oil Co., the other one-half being then owned by a corporation known as the Chanute Refining Co. Later in the year 1916, the Exchange Oil Co., a corporation, acquired from the Chanute Refining Co. the 200 shares held by the latter in the Garfield Oil Co.
On December 14, 1918, the petitioners entered into a written agreement with the Exchange Oil Co. by which they sold or exchanged all of their stock in the Garfield Oil Co. to the Exchange Oil Co. for $500,000 cash, payable that day, plus 200 oil and gas income certificates calling for 20 per cent of the total gross receipts from the sale of all the oil produced from the leases then owned by the Garfield Oil Co. Among other things the agreement provided that the Exchange Oil Co. would take over all of the assets and assume all of the liabilities of the Garfield Oil Co.; that in case of default in the payment of any part of the 20 per cent of gross receipts to a trustee named for the*3676 petitioners, the unpaid portion was to be a lien upon all of the leases taken over from the Garfield Oil Co.; that no oil and/or gas income certificates were to be issued except those issued to the petitioners; and that the Exchange Oil Co. was prohibited from selling to anyone, except the Sinclair Oil & Gas Co. (a corporation which owned 100 per cent of the stock of the Exchange Oil Co.), any of the leases previously owned by the Garfield Oil Co. without having first offered the same to the petitioners upon the same terms as offered by any one else, and if the petitioners declined to purchase and any such leases were sold to third parties then the petitioners were to receive such a percentage of the sale price as, when added to the income previously paid to them on their certificates, would not exceed $2,500,000.
On the same day, to wit, December 14, 1918, the petitioners entered into a second agreement with the Sinclair Oil & Gas Co. in which they in substance sold to the Sinclair Co. all of their oil and gas income certificates received from the Exchange Oil Co. for a total consideration of $2,500,000. This second agreement took the form of an "option" in which it was agreed*3677 that the Sinclair Co. had the exclusive right to purchase the said certificates on December 14, 1923, for $2,500,000 unless purchased at an earlier date. As part of the consideration for the so-called "option" the Sinclair Co. agreed that if, in any one or more years prior to the exercise of the so-called option to purchase the said certificates by the Sinclair Co., the petitioners received less than $500,000 out of 20 per cent of the gross production as provided in the certificates, the Sinclair Co. would loan without interest to the petitioners a sufficient amount to bring the total receipts within the year up to $500,000. As an additional consideration for the so-called option the agreement provided that the *982 petitioners "shall have the right and privilege on the 14th day of December, A.D. 1923, to require the 'Sinclair Company' to purchase the said certificates upon the terms and conditions hereinbefore set forth."
As a result of the above agreements the following amounts were paid to the following persons during the years 1918 to 1923, inclusive:
| Dec. 14, 1918. | Apr. 16,1919. | July 16, 1919. | Oct. 16, 1919. | |
| M. C. Garber | $187,500.00 | $43,283.60 | $21,004.39 | $28,403.58 |
| Lucy M. Garber | None. | None. | 21,004.38 | 28,403.59 |
| B. A. Garber | 187,500.00 | 43,283.60 | 21,004.39 | 28,403.58 |
| Vida R. Garber | None. | None. | 21,004.38 | 28,403.59 |
| L. C. Moore | 100,000.00 | 11,542.30 | 11,202.34 | 15,148.58 |
| Louisa Moore | None. | 11,542.29 | 11,202.34 | 15,148.58 |
| W. F. Kistler | 12,500.00 | 2,885.57 | 2,800.59 | 3,787.14 |
| James Tait | 12,500.00 | 2,885.57 | 2,800.59 | 3,787.14 |
| 500,000.00 | 115,422.93 | 112,023.40 | 151,485.78 |
| 1920. | 1921. | 1922. | 1923. | Totals. | |
| M. C. Garber | $136,215.57 | $49,845.77 | $121,524.49 | $90,114.28 | $677,891.68 |
| Lucy M. Garber | 136,215.57 | 49,845.77 | 121,524.49 | 90,114.29 | 447,108.09 |
| B. A. Garber | 136,215.57 | 49,845.77 | 121,524.49 | 90,114.29 | 677,891.69 |
| Vida R. Garber | 136,215.57 | 49,845.77 | 121,524.47 | 90,114.28 | 447,108.06 |
| L. C. Moore | 72,648.30 | 26,584.42 | 64,813.26 | 48,060.98 | 350,000.18 |
| Louisa Moore | 72,648.30 | 26,584.42 | 64,813.27 | 48,060.96 | 250,000.16 |
| W. F. Kistler | 18,162.08 | 40,135.38 | |||
| W. F. Kistler estate | 13,947.12 | 11,395.38 | 9,522.18 | 34,864.68 | |
| James Tait | 18,162.09 | 13,947.13 | 11,395.38 | 9,522.18 | 75,000.08 |
| Totals | 726,483.05 | 280,446.17 | 638,515.23 | 475,623.44 | 3,000,000.00 |
With the exception of the First payment of $500,000 on December 14, 1918, the balance of $2,500,000 was paid out of receipts from 20 per cent of the gross production. None of the above amounts represented any loans from the Sinclair Oil & Gas Co.
Prior to the sale in 1918, considerable development had been made of the leases held by the Garfield Oil Co. On December 14, 1918, the company had approximately 60 producing wells with development still*3679 going on. The gross production at that time was about 1,500 barrels per day. The majority of the wells were producing from what was known as the 1,100-foot sand.
The financial condition of the Sinclair Oil & Gas Co. on December 14, 1918, was such that it could easily assume an obligation to pay $2,500,000 as was provided for in the so-called "option agreement." The petitioners in addition to the $500,000 received on December 14, 1918, were assured of receiving the full amount of $2,500,000 within at least the next five years.
In filing their returns for 1918 the petitioners reported as income from the sale of stocks the entire amount received by them during 1918 as a result of the sale of the Garfield Oil Co. stock and deducted *983 therefrom an amount in excess of the cost to them of such stock, on the theory that such excess amount represented an allowable deduction from income in the nature of depletion based upon discovery value. In filing their returns for the years 1919 to 1923, inclusive, the petitioners reported as income from the sale in 1918 of the said Garfield Oil Co. stock the amounts paid directly to them, and the wives of M. C. Garber, B. A. Garber, and*3680 L. C. Moore reported the amounts paid directly to them. All parties in those years deducted from the income reported amounts which they claimed were allowable deductions from income in the nature of depletion based upon discovery value. The respondent for 1918 disallowed all deductions for depletion taken in connection with the sale of the Garfield Oil Co. stock in 1918, but did allow the petitioners the entire return of their capital, namely, the cost of the Garfield Oil Co. stock in the amount of $20,000, before computing any taxable profit on the sale. For the years 1919 to 1923, the respondent also disallowed all the depletion taken by the petitioners and added to the income reported by the petitioners, M. C. Garber, B. A. Garber and L. C. Moore, the amounts paid to and reported by their respective wives. The profit resulting from the sale of the Garfield Oil Co. stock attributable to the year 1919, as determined by the respondent, was greater than the combined amounts actually received by the petitioners and their wives during that year and was as follows:
| Respondent's determination. | Combined receipts | Overstatement. | |
| M. C. Garber | $187,500.00 | $142,099.54 | $45,400.46 |
| B. A. Garber | 187,500.00 | 142,099.54 | 45,400.46 |
| L. C. Moore | 100,000.00 | 75,786.43 | 24,213.57 |
| W. F. Kistler | 12,500.00 | 9,473.30 | 3,026.70 |
| James Tait | 12,500.00 | 9,473.30 | 3,026.70 |
*3681 For the year 1920 the same was true with respect to W. F. Kistler, the respondent's determination being $18,554.02 as compared with actual receipts of $18,162.08, an overstatement of $391.94.
M. C. Garber and Lucy M. Garber was married in 1900. At the time of their marriage M. C. Garber owned a quarter section of unimproved land in Oklahoma and an undivided interest with his brother in a small country store. He was engaged in the practice of law with his father in the town of Garber. Lucy M. Garber possessed a few earnings which she had saved from teaching school. After their marriage she took care of the stenographic and office work in her husband's office. She also personally represented a number of fire insurance companies. Both husband and wife deposited their earnings in a joint bank account against which either one could draw *984 upon using his or her individual signature. After Garber's father's death, Lucy M. Garber was appointed United States Commissioner. Later in 1902, M. C. Garber became probate judge for about five years. They acquired a residence property, first in Garber and then in Enid, the title to the latter being taken in both of their names. *3682 Upon receiving the first payment of $187,500 on December 14, 1918, M. C. Garber first deposited the money in the same joint checking account. He later invested the money in real estate which in turn was transferred to The Garber Brothers, incorporated, in which he, his wife, his brother and his brother's wife each received one-fourth of the capital stock. In 1919, M. C. Garber and his wife engaged a bookkeeper and informed him that they "had always been 50-50"; he thereupon recommended that a division be made of the property of each. On July 14, 1919, M. C. Garber assigned to his wife, Lucy M. Garber, 37 1/2 of the 75 oil and gas income certificates received by him as a part of the consideration for the sale of the 75 shares of Garfield Oil Co. stock on December 14, 1918. Lucy M. Garber then opened a separate bank account of her own.
B. A. Garber and Vida R. Garber were married in 1907. At the time of their marriage B. A. Garber owned an unimproved farm, an interest in a mercantile business, and a little bank stock. Vida R. Garber had a small amount of personal property. After their marriage Vida R. Garber took charge of a country store and post office, doing most of the*3683 book work and the buying and selling of merchandise. The first property acquired after marriage by either of them was a home in Garber, the title to which was taken in Vida R. Garber's name. They maintained but one bank account in the husband's name against which either one could draw upon using his or her individual signature. Three-eighths of the expense of acquiring the leases which were turned over to the Garfield Oil Co. for stock in 1916 came out of the joint bank account. Upon receiving the first payment of $187,500 in 1918, B. A. Garber invested part of it in real estate, which in turn was transferred to The Garber Brothers, Incorporated, in which he, his wife, M. C. Garber and his wife each received one-fourth of the capital stock. On July 14, 1919, B. A. Garber assigned to his wife, Vida R. Garber, 37 1/2 of the 75 oil and gas income certificates received by him as a part of the consideration for the sale of the 75 shares of Garfield Oil Co. stock on December 14, 1918. Vida R. Garber then opened a separate bank account of her own.
L. C. Moore and Louisa Moore were married in 1893. At the time of their marriage neither had any property. L. C. Moore was a traveling*3684 salesman, which position he held until sometime in 1917. They first lived at Newton, Kans., for about a year, after which they *985 moved to Blackwell, Okla., where they purchased a residential property at a cost of approximately $3,700. Title was taken in Louisa Moore's name. At some time prior to 1918 Moore inherited about $1,000 from his brother and applied $800 of such inheritance against a mortgage which they still owed on the residential property of $1,500. The balance of the mortgage of $700 was not paid off until after the sale of the Garfield Oil Co. stock. At the time Moore became interested in the Garfield Oil Co. he owned some oil stock and a little mining stock having a total value of approximately his wife's equity in the home. At all times they maintained a double checking account at the bank. Upon receiving the first payment of $100,000 on December 14, 1918, Moore first deposited the money in the bank and immediately purchased several lots for $3,500, erected a house costing $35,000, with furnishings costing approximately $15,000. Title to this property was also taken in his wife's name. During 1916, L. C. Moore gave his wife, Louisa Moore, one-half*3685 of the stock he then held in the Garfield Oil Co. Prior to 1918 Moore told third parties that he considered his wife as owner of 20 of the 40 shares of the Garfield Oil Co. stock. At the time of the sale on December 14, 1918, 40 temporary oil and gas income certificates were made out in Moore's name. In less than a week thereafter Moore personally called at the offices of the Exchange Trust Co. and told them that one-half of the certificates belonged to his wife, and, when the permanent certificates were issued, 20 were issued to Moore and 20 to his wife. The first payment on April 16, 1919, and all payments thereafter, as set out in the above schedule, were equally divided between Moore and his wife.
None of the wives signed any of the contracts with the Exchange or Sinclair companies.
W. F. Kistler died during March, 1921.OPINION.
GREEN: The respondent treated the sale or exchange of the Garfield stock for $500,000 and the 200 certificates and the subsequent sale of the 200 certificates for $2,500,000 as if both were one single transaction. He determined that the taxable income should be ascertained by applying the consideration from the first and second transactions*3686 to the cost of the Garfield stock which was sold or exchanged in the first transaction. This application was made on the "return of capital" theory, which contemplates the receipt by the taxpayer of his entire cost before there can be taxable income. All receipts after the cost was returned are regarded as income. The petitioners contend that the first of the transactions is complete in itself and that the income therefrom should be determined in accordance with the provisions *986 of section 202(b) of the Revenue Act of 1918, the applicable part of which reads as follows:
When property is exchanged for other property, the property received in exchange shall for the purpose of determining gain or loss be treated as the equivalent of cash to the amount of its fair market value, if any;
We think that the petitioners' contention is correct. There were two transactions, each separate and distinct from the other and each giving rise to income. When, in 1918, the petitioners sold or exchanged their Garfield stock for $500,000 in cash and the 200 certificates, they received cash and property having a fair market value and derived income therefrom, the amount of which is immaterial*3687 here since the year 1918 is not before us. They derived no income from that transaction in the subsequent years.
In the second transaction, also in 1918, they sold the 200 certificates received by them in the first transaction. The sales price was $2,500,000, payable, however, at the rate of $500,000 or more per year without interest. Again we have a transaction which results in gain or loss. The petitioners never have sought to pay tax on this on the installment theory. The tax thereon must be computed on the gain derived therefrom in the year 1918. The first essential element of the computation is the value of the certificates sold. There can be no better evidence of their value than their sales price on the day they were received. This sales price was $2,500,000 to be paid at the rate of $500,000 or more per year without interest. Quite obviously this price was not the equivalent of $2,500,000 in cash. It must be discounted to its present worth. In any event the certificates were sold for their value, and no income resulted from this transaction. The evidence of the petitioners' witness was to the effect that these certificates were worth $2,500,000 but their sale*3688 for that amount to be paid in annual installments of $500,000 or more over a period of five years seems to us to establish conclusively that the then fair market value was not equal to $2,500,000 in cash. The sales price and consequently the value of the certificates was the value on the date of the sale for $2,500,000 payable over the five year period.
The situation here is quite analogous to the situation in the case of . There the Circuit Court of Appeals for the Seventh Circuit, in affirming , said:
And so with respect to the notes themselves, which by their terms, matured up to 40 years from their date, without interest. That the notes were good is quite beyond dispute - good, however, only for their face value at maturity, but surely not good for their face value when made. That a note, however absolutely good the security, due 40 years from its date, without interest, is not*987 worth its face at time of making, is apparent from the mere statement. And so with the notes in question, paid in 1921 and 1922, eight and nine*3689 years from their date. Conceding these notes to have been capital assets of the taxpayer on their date, they were capital assets not for their face value but for the materially less amount which the notes were then actually worth; and in their payment at maturity there was plainly gain, profit or income to the extent of the difference. (Italics supplied.)
The value of the right to receive the $2,500,000 in accordance with the terms of the contract can not be determined from the record and the respondent has made no determination with reference thereto. The purchase price was paid as follows:
| 1919 | $378,932.11 |
| 1920 | 726,483.05 |
| 1921 | 280,446.17 |
| 1922 | 638,515.23 |
| 1923 | 475,623.44 |
| Total | 2,500,000.00 |
As these payments were made the petitioners derived income to the extent that each exceeded its proportionate part of the value of the $2,500,000 payable over the period. This value must be determined either by agreement or by the Board upon evidence. If the parties can not agree, evidence will be taken and the value determined therefrom.
The petitioners herein reported their income upon the "return of capital" theory now contended for by the respondent, and*3690 for this reason the respondent urges that they should not be permitted to depart from that theory to the end that a part of the income received by them in 1918 escape taxation. If the certificates received on the sale or exchange had a fair market value at the time of their receipt - and we hold that they did in an amount equal to the present worth of the right to receive $2,500,000 over the period of five years in accordance with the terms of the contract - then there is no justification for the application of such a theory. Other than the excess of the payments over the present worth of the $2,500,000, all income from both transactions was derived in 1918, a year not before us, and can be subjected to tax in no other year.
Assuming that the parties might agree that a discount of 5 per cent with a provision for payments into a sinking-fund at 4 per cent compounded annually represented under the circumstances a reasonable discount, the total discount would amount to $368,960 which would be returned as income by the petitioners and Louisa Moore (the reason for including Louisa Moore will appear later in the opinion), in the following years:
| 1919. | 1920 | 1921. | 1922. | 1923. | Totals. | |
| M. C. Garber | $20,971.62 | $40,206.48 | $14,712.88 | $35,870.14 | $26,598.85 | $138,359.97 |
| B. A. Garber | 20,971.62 | 40,206.48 | 14,712.88 | 35,870.14 | 26,598.85 | 138,359.97 |
| L. C. Moore | 5,592.43 | 10,721.73 | 3,923.43 | 8,565.40 | 7,093.03 | 36,896.02 |
| Louisa Moore | 5,592.43 | 10,721.73 | 3,923.43 | 9,565.40 | 7,093.03 | 36,896.02 |
| W. F. Kistler | 1,398.11 | 2,680.43 | 4,078.54 | |||
| W. F. Kistler estate | 2,058.37 | 1,681.78 | 1,405.32 | 5,145.47 | ||
| James Tait | 1,398.11 | 2,680.43 | 2,058.37 | 1,681.78 | 1,405.32 | 9,224.01 |
| 55,924.32 | 107,217.28 | 41,389.36 | 94,234.64 | 70,194.40 | 368,960.00 |
*3691 *988 The respondent in his brief contends that:
The only possible ground on which the petitioners can rely to establish the stock sale transaction as closed on December 14, 1918, is to show that the remainder of the consideration over and above cash, which was in the form of oil and gas income certificates, called for 20 per cent of the gross income to Exchange from the operation of the Garfield leases was liquidated as of December 14, 1918, under the option contract with Sinclair.
He then continues his argument to the effect that the so-called "option agreement" was an option rather than a sale, and that under the most favorable interpretation possible it would appear to be only "a contract to sell in the future and not a contract of sale on which a closed transaction can be predicated."
We regard the contract with the Exchange Oil Co. and the contract with the Sinclair Oil & Gas Co. as two separate transactions. As previously expressed, it is our opinion that the first contract was a completed sale coming squarely within the provisions of section 202(b), supra. The certificates, in our opinion, clearly had a fair market value which value should, according*3692 to the statute, be treated as the equivalent of cash. But even under the respondent's theory we can see no semblance of an option in the second agreement. The Sinclair Co. had no election in the matter. Under paragraph III of the contract it was bound to pay on December 14, 1923, any portion of the full $2,500,000 purchase price which had not been received by the petitioners up to that time. In our opinion the second agreement was a sale and not an option. We also regard it as immaterial that 100 per cent of the stock of the Exchange Oil Co. was owned by the Sinclair Oil & Gas Co.
Since we are not accepting the value put on the certificates by the petitioners with the result that the petitioners will have a certain amount of income for the years 1919 to 1923, inclusive, it becomes necessary to decide their two so-called alternative contentions.
Regarding the depletion question, we fail to see where the petitioners retained any depletable interest in the oil leases after they were turned in to the Garfield Oil Co. for stock in 1916. In our opinion it is not necessary to cite authorities for the proposition that corporations and individuals are separate entitles. After the*3693 leases became the property of the Garfield Oil Co., the petitioners *989 lost all right to depletion therein. We sustain the respondent's determination on this point.
The last alternative is whether the respondent erred in not finding that one-half of the income resulting from the sale of the Garfield stock apportioned to M. C. Garber, B. A. Garber and L. C. Moore belonged in fact and in law to their respective wives.
In the cases of M. C. Garber and B. A. Garber we are not satisfied from the evidence that the respondent erred in determining that the wives did not own any of the Garfield Oil Co. stock which was sold on December 14, 1918. Lucy M. and Vida R. Garber were never stockholders of record in the Garfield Oil Co. They were never owners of record of the Garber leases that were transferred to and became the assets of the Garfield Oil Co. They were not signatories to either of the contracts of December 14, 1918. In the case of M. C. Garber the evidence is not clear out of what funds or as to how he acquired his interest in the Garber leases. After the sale had been made and after consulting an accountant, both parties decided to assign one-half of the oil and*3694 gas certificates to their wives, which was done on July 14, 1919. We believe the situation is analogous to the situation in the cases of , , and , and therefore affirm the respondent's determination on this point.
The case of L. C. Moore, however, is different. In his case he actually gave one-half of his stock in the Garfield Oil Co. to his wife in 1916. The gift was not made a matter of record but we have the testimony of a third party to the effect that Mr. Moore had prior to December 14, 1918, frequently referred to his stockholdings in the Garfield Oil Co. as being owned one-half by his wife. On these premises we conclude that L. C. Moore should be taxed only on the income received from the sale of 20 shares of Garfield Oil Co. stock instead of 40 shares as determined by the respondent.
Judgment will be entered on 15 days' notice, under Rule 50.