*1444 Where taxpayer sold certain stock and options for a proportionate interest in future income of certain property and previous to the taxable year received under the sale agreement a sum in excess of the basic fair market value of such stock and the cost of the options, all sums received in the taxable year constituted income.
*956 This proceeding was brought to redetermine a deficiency in the income taxes of the petitioner for the year 1923 in the sum of $2,201.69.
The petitioner alleged that the respondent erroneously increased his income by $16,023.51. The respondent conceded his error in this respect, but by his second amended answer affirmatively raised the issue that the petitioner was taxable on the income from Trusts numbered 5106 and 5549 received during the year 1923 in the sum of $164,509.12, and requested that the deficiency in his income tax be increased to $45,616.67. The petitioner entered a general denial of all affirmative allegations of the answer.
FINDINGS OF FACT.
The facts were stipulated*1445 and are substantially as follows.
During March, 1917, Thomas A. O'Donnell, M. L. McCray and L. A. McCray acquired for a nominal consideration certain oil and gas leases, more particularly described as:
(a) A certain lease dated March 27, 1917, wherein G. Piuma, et al., are designated as lessors and M. L. McCray as lessee, which lease runs for 15 years.
(b) A certain lease dated March 15, 1917, wherein Barton Darlington is designated as lessor and M. L. McCray as lessee, which lease runs for the period of 20 years.
(c) A certain lease dated March 15, 1917, wherein B. F. Taylor is designated as lessor and M. L. McCray as lessee, which lease runs for a period of 20 years.
(d) A certain lease dated March 15, 1917, wherein Andres Irwin is lessor and M. L. McCray is lessee, which lease runs for a period of 20 years.
*957 (e) A certain lease dated March 12, 1917, wherein William S. Prugh is designated as lessor and M. L. McCray as lessee, which lease runs for a period of 20 years.
On June 28, 1917, the said leases were transferred and assigned to the San Gabriel Petroleum Company in exchange for its outstanding capital stock, Thomas A. O'Donnell, M. L. McCray and*1446 L. A. McCray each receiving one-third of such stock.
On December 24, 1917, and December 31, 1917, respectively, Thomas A. O'Donnell acquired certain options to purchase all of the said capital stock in the San Gabriel Petroleum Company owned by M. L. McCray and L. A. McCray.
The option dated December 24, 1917, and executed by M. L. McCray provided for the purchase of 235 shares of the capital stock of the San Gabriel Petroleum Company for $75,000, payable $25,000 on January 6, 1918, and the remainder in 10 equal annual installments. The option also contained the following condition:
This price is to be net to me [McCray] over and above all stockholders and other liabilities for which I may be responsible at the date of sale, including note at Farmers & Merchants National Bank. At the time of sale I will want this note cancelled and returned to me, together with a letter from the bank releasing me from stockholders' liability. I will also want your guarantee to hold me from of all stockholders and other liability.
The option dated December 31, 1917, and executed by L. A. McCray covered the purchase of all of his stock in the San Gabriel Petroleum Company for $75,000, *1447 payable $25,000 upon the exercise of the option and the remainder in five annual installments of $10,000 each on January 6, 1919 to 1923, inclusive. The option also contained the following provisions:
The foregoing option is given with the understanding that said San Gabriel Petroleum Company is indebted to the bank to the extent of $45,000.00.
It is also understood that if this option is exercised you [O'Donnell] will assume all responsibility in connection with said indebtedness and relieve me [McCray] as guarantor of any existing notes at the time transfer is made.
Thereafter Thomas A. O'Donnell assigned all of his right, title, and interest in and to the options heretofore mentioned and also all his right, title and interest in and to the stock then owned by him in the San Gabriel Petroleum Company, being one-third of the outstanding stock thereof, to the Petroleum Midway Company, Ltd., in consideration of the contract of January 9, 1918, wherein Thomas A. O'Donnell is designated first party, and Petroleum Midway Company, Ltd., second party. By the terms of that contract the Petroleum Midway Company, Ltd., purchased all of the petitioner's stock in the San Gabriel*1448 Petroleum Company for one-third of the net profits to be received by it from the development and operation of the properties described in the leases and contracts owned by *958 the San Gabriel Petroleum Company. The Petroleum Midway Company, Ltd., also agreed to pay all debts of the San Gabriel Petroleum Company, to acquire all the assets owned by that company, and to dissolve and "disincorporate" it.
The Petroleum Midway Company, Ltd., determined to exercise the O'Donnell option and on the 7th day of January, 1918, a certain agreement was entered into between M. L. McCray and L. A. McCray, parties of the first part, and Petroleum Midway Company, Ltd., party of the second part, whereby the second party agreed to purchase and the first party agreed to sell the stock held by them in the San Gabriel Petroleum Company. The Petroleum Midway Company, Ltd., paid to L. A. McCray and M. L. McCray, on the dates indicated, the following amounts:
| Date of payment | Amount paid L. A. McCray | Amount paid M. L. McCray |
| January 4, 1918 | $25,000.00 | $25,000.00 |
| January 4, 1919 | 10,000.00 | 25,000.00 |
| January 5, 1920 | 40,000.00 | 25,000.00 |
| Total amount paid | 75,000.00 | 75,000.00 |
*1449 After January 9, 1918, and prior to May 1, 1918, the Petroleum Midway Company, Ltd., acquired all of the assets of the San Gabriel Petroleum Company, which consisted of the leases heretofore referred to, and assumed the latter's liabilities, and thereupon the latter company was dissolved.
During the period from January 9, 1918, to July 25, 1919, the Petroleum Midway Company, Ltd., paid the petitioner the total sum of $64,775.48, under and pursuant to the terms of that certain contract dated January 9, 1918, heretofore referred to, which proceeds were derived by the Petroleum Midway Company, Ltd., from the operations of the leases heretofore referred to.
On or about the 25th day of July, 1919, the petitioner created by a written instrument, a declaration of trust, called No. 5106, wherein he appointed the Security Trust & Savings Bank as trustee, and conveyed to it all his right, title and interest in and all claims under the contract of January 9, 1918, with the Petroleum Midway Company, Ltd. He also transferred to the trust $5,000 in cash. The petitioner's wife and relatives were made the beneficiaries under conditions not material to this case. The trust contains the following*1450 provisions:
It is an express term and condition of this trust that said Trustor has reserved, and said Trustee does hereby assent to, the express right, power, option and privilege in said Trustor, by notice in writing addressed and delivered to said Trustee at any time or times during the term of this trust, *959 without any payment or other consideration therefor, to withdraw, and have duly paid, transferred, assigned, conveyed and delivered to him the whole or any part of the trust estate, or to substitute for the whole or any part of the above described trust estate any other property, real and/or personal which said Trustor may tender for the purpose, and upon the receipt of such written directions or request from said Trustor, said Trustee shall forthwith and without consideration or any investigation or appraisal of the value of the same, convey, transfer or deliver to the Trustor any portion or the whole of the Trust Estate which may be designated in such written request, or shall accept in exchange and substitution for the whole or any portion of the trust estate, such property, real and/or personal, as the Trustor shall tender to the Trustee for such exchange or*1451 substitution.
In acting in conformity and compliance with said Trustor's written request, said Trustee shall be and hereby is fully and absolutely released and discharged from all liability to any person whomsoever on account of the property affected by such written request, or by reason of anything it may do in accordance therewith; anything to the contrary herein contained notwithstanding.
* * *
It is a further provision of this trust that said Trustor has reserved, and he is hereby given, the express rights and power to revoke in whole or in part this trust at any time after two years from the date hereof by a notice of revocation in writing addressed and delivered to said Trustee at least five (5) days prior to the taking effect of such revocation. Between the time of receipt of such notice of revocation and its taking effect, said Trustee shall have every power, right and privilege herein given to it in reference to the trust estate, except that no sales, incumbrance or other disposition of the principal or income of any trust estate shall be made by said Trustee during such period; provided, however, that on such revocation taking effect said Trustee shall convey, transfer, *1452 assign, and deliver it to said Trustor, or his nominees, such rights, titles, interests and estates as said Trustee shall then have or possess in and to all of the property then subject to this trust, and said Trustor or his nominees shall take and accept the trust estate affected thereby subject to, and shall assume all of the existing contracts, agreements and incumbrances or other obligations incurred in reference thereto by said Trustee under the terms of this trust; and provided further that in no event shall any shall notice of or attempted revocation be of any effect or validity unless and until all sums then be due the Trustee under the terms hereof, or which it may be obligated to then or thereafter pay, shall first be fully paid, and said Trustee shall be fully released and discharged from all liabilities and obligations of every kind and nature affecting such property or the Trustee in relation thereto, or the claims of any other beneficiaries under this trust, anything to the contrary herein contained notwithstanding.
* * *
This trust shall continue in full force and effect for a period of ten (10) years from and after the date hereof, unless the whole trust be sooner*1453 revoked, or unless the subject matter or corpus of the trust be sooner extinguished, lost, or exhausted, and the whole of the trust estate at the termination hereof shall be transferred absolutely to said O'Donnell Oil & Securities Company. Upon the expiration of said ten (10) years from the date hereof and the payment in full to the Trustee or all sums then due it under the terms hereof, said Trustee shall interest, (sic.) assign and deliver the whole of the property then subject to this trust to said O'Donnell Oil & Securities Company.
*960 By an independent instrument dated February 25, 1919, the petitioner assigned to the trustee all his rights under the contract with the Petroleum Midway Company, Ltd., dated January 9, 1918.
From the 25th day of July, 1919, to and including December 31, 1922, the Petroleum Midway Company, Ltd., paid to the said Security Trust & Savings Bank, as trustee under the declaration of trust No. 5106, the total sum of $348,896.66, by virtue of the contract of January 9, 1918, and the assignment thereof. During the year 1923 the Security Trust & Savings Bank, as trustee in that certain trust No. 5106, received the sum of $32,080.85 from the*1454 Petroleum Midway Company, Ltd., by virtue of the contract of January 9, 1918, and the assignment thereof referred to above. The bank paid to itself as trustee during said year as commission and fees the sum of $320.81, and distributed during the said year to the following persons the amounts set opposite their respective names:
| Lillie O'Donnell | $3,000.00 |
| Ruth O'Donnell Tompkins | 750.00 |
| Doris O'Donnell | 750.00 |
| Mamie Litster | 900.00 |
| O'Donnell Oil & Securities Co. | 26,360.15 |
| Total | 31,760.15 |
On April 9, 1923, the said trust No. 5106 was revoked.
The petitioner, by a written instrument dated April 16, 1923, created a declaration of trust, called No. 5549, wherein the Security Trust & Savings Bank was appointed trustee. All terms and conditions of trust No. 5549 were practically identical with those contained in declaration of trust No. 5106, the beneficiaries and their respective shares therein being different. During the year 1923 the Security Trust & Savings Bank, as trustee in that certain trust No. 5549, received the sum of $83,988.04 from the Petroleum Midway Company, Ltd., by virtue of the contract of January 9, 1918, and the assignment thereof to the*1455 trustee as referred to in this paragraph. The bank paid to itself as trustee during the said year as commissions and fees the sum of $839.88, and distributed during said year to the following persons the amounts set opposite their respective names:
| Lillie O'Donnell | $9,000.00 |
| Ruth O'Donnell Tompkins | 2,250.00 |
| Doris O'Donnell | 2,250.00 |
| Mrs. Myra O'Donnell | 900.00 |
| Mrs. Winnie Tucker | 900.00 |
| Tompkins Investment Co | 67,848.16 |
| Total | 83,148.16 |
*961 The petitioner kept his accounts and reported his income for the taxable year 1923 on the cash receipts and disbursements basis.
The following phrase preceded the signed stipulation:
IT IS HEREBY STIPULATED AND AGREED by and between the parties hereto, through their attorneys, subject to such objections as to relevancy, materiality or competency as either party may have hereto.
In the respondent's second amended answer appears the following:
Respondent alleges that the fair market value, if any, of the rights acquired by the petitioner by virtue of the contract entered into between the Petroleum Midway Company, Ltd. and the petitioner herein, on January 9, 1918 * * * did not exceed the sum of $75,000.00*1456 on the last-named date; that the net proceeds and profits paid over to the petitioner or his assignees under the terms and provisions of said contract of January 9, 1918, with the Petroleum Midway Company, Ltd., between said last-named date and December 31, 1922, is the sum of $413,672.14.
We make the following additional finding of fact:
The fair market value of the stock in San Gabriel Petroleum Company acquired by petitioner June 28, 1917, in exchange for his interest in the several leases, together with the cost on the dates acquired of the options on the remaining two-thirds of the stock of said company, was not in excess of $413,672.14.
OPINION.
VAN FOSSAN: Respondent admitted error in his original determination of a deficiency, but by second amended answer raised an issue as to the taxability to petitioner of payments made to the trustee of the two trusts created by him. Both trusts were expressly subject to revocation by the settlor and petitioner apparently does not seriously contend that the income, if any was earned in 1923, was not income to him, but maintains that the respondent has failed to prove the payments constituted income.
Respondent's allegation*1457 is that the fair market value of the rights acquired by the petitioner by virtue of the contract of January 9, 1918, with Midway, i.e., the right to receive one-third of the future profits of Midway from the property in question, did not exceed $75,000 on the date of acquisition and that he or his nominees had received the sum of $413,672.14 under such contract prior to 1923.
The transaction of January 9, 1918, by the terms of which the petitioner transferred to Midway his one-third stock interest in San Gabriel and options on the remaining two-thirds of such stock in consideration of receiving one-third of the future profits of Midway was not a closed transaction on which gain arose on the contract date. It was a sale of property which might or might not give rise to income, dependent on the inscrutable factor of future oil production. *962 If and when petitioner had received back his capital cost or basis, income would begin to accrue. If such cost were never recovered no income would ever arise. . Petitioner reported his income on a cash basis and is required to return income for taxation only when the profit*1458 is realized. The promise to pay one-third of future profits was not equivalent to cash nor did it have, on January 9, 1918, an ascertainable fair market value. .
Nor do we deem it proper to find a fair market value as of January 9, 1918, by employing as a basis the subsequent profits. Such profits might serve as corroborative of the reasonableness of a figure of value if such were ascertainable as of the basic date. But no value of the right being ascertainable on that date, the subsequent returns will not be looked to to determine the same.
This is not, however, an end of the matter. Though respondent may have been mistaken in assuming that a fair market value could be determined as of January 9, 1918, we have the further problem of determining whether petitioner had recovered the cost or value of the stock and options prior to the close of the taxable year. It is stipulated that petitioner, or the trustee of the revocable trusts created by him, received from the Midway Company between January 9, 1918, and December 31, 1922, the sum of $413,672.14 on account of the contract of January 9, 1918, and that in 1923 the further*1459 sum of $114,908.31 was so received. As we have indicated, if he had recovered the cost or basis of the property sold, the payments received in 1923 constituted income. To solve this further problem it is necessary to look back of the transaction of January 9, 1918, to the date of acquisition of the stock and options and, if possible, determine their cost or value, whichever is the appropriate base.
Under date of June 28, 1917, petitioner acquired one-third of the stock of San Gabriel Company by transferring to that company his undivided one-third interest in certain oil leases. At the same time the two McCrays received one-third each of the stock for their interests in the leases. These leases had been acquired for a nominal consideration.
Under the revenue act then in force the transaction of June 28, 1917, was a taxable transaction and thereafter the basis for determining gain on disposition of the stock was the fair market value of the same when received. Since all of the stock was exchanged for the leases, and there being no evidence of any other assets, we believe it reasonably inferable that the stock had no greater value than the leases. These leases had been acquired*1460 during March of the same year. The facts do not indicate that any development had been undertaken or production achieved prior to June 28, 1917, when the leases were transferred to San Gabriel Company.
*963 Six months later, on January 7, 1918, the two McCrays sold their stock for a net price of $75,000 to each, the Midway Company assuming all obligations of San Gabriel Company and undertaking to save the sellers harmless therefrom. In the option given petitioner on M. L. McCray's stock mention is made of a note due the Farmers & Merchants National Bank, while in the option from L. A. McCray specific mention of a note for $45,000 due "the bank" is made. That these references are to the same note seems clear to us. There is no other evidence from which we are led to believe that the liabilities assumed by Midway were in a large amount and in any event it seems apparent that all of these liabilities, including the note for $45,000, were incurred by the San Gabriel Company subsequent to June 28, 1917, the date when petitioner acquired his stock. If, however, they were in existence at the last mentioned date they would not serve to increase the value of the stock then acquired*1461 by petitioner.
In addition to his one-third stock interest petitioner sold on January 9, 1918, the two options on the remaining two-thirds of such stock held by the McCrays. One of these options recites no consideration while the other states one dollar as consideration. The first of these options was acquired on December 24, 1917, and the other on December 31, 1917. They were sold and transferred a few days later - on January 9, 1918. Since the options were so acquired, their cost is the basis for determining gain on disposition. Having been acquired at nominal cost, they add nothing to the aggregate amount to be used as a base on their subsequent sale with the stock. We are thus thrown back on the fair market value of the stock on June 28, 1917, as the ultimate base for determining profit.
The record in this case is incomplete in many respects. The facts were stipulated, and we have no opinion evidence such as is usually presented in valuation cases. On such facts as we have before us, and making such reasonable inferences of fact therefrom as seem justified, does it appear that by the end of 1922, when petitioner or his nominees had received $413,672.14, he had recovered*1462 the fair market value of the stock and cost of the options sold January 9, 1918? Though it is impossible on the record to determine exactly the fair market value of petitioner's stock on June 28, 1917, we are satisfied that it, together with the cost of the options, was less than $413,672.14, the amount paid on account thereof by Midway Company prior to January 1, 1923, and we do so find. It follows that previous to the taxable year petitioner had received the fair market value or cost of the property sold by him on January 9, 1918, and that all sums received in 1923 constituted taxable income.
Decision will be entered under Rule 50.