*30 Decisions will be entered under Rule 50.
1. Where, in an oil payment contract, the oil payment covered a greater interest in the lease than that sold and where a lien was reserved covering such larger interest, held, following Anderson v. Helvering, 310 U.S. 404">310 U.S. 404, the seller retained additional security beside the oil payment and income arising from the production and sale of oil is taxable to the petitioners, the purchasers at the sale.
2. In consideration of services rendered and to be rendered, petitioners and Myles agreed that he would receive a one-sixteenth interest in a certain oil and gas lease and a one-fifth interest in all oil and gas leases thereafter acquired by the partnership, when its financial position would permit. It was further agreed that if sale of any oil or gas lease of the partnership were made before the said one-fifth interest had been conveyed to him, Myles would receive his proportionate share of the sale price. Myles continued to render services to the petitioners. On January 23, 1940, petitioners conveyed such one-sixteenth interest to Myles. On the same day they and he conveyed their respective interests*31 to the Texas Co. Texas paid $ 17,187.50 to Myles as the full purchase price of his interest. Held, the amount so received by Myles was includible in his gross income and not in that of the petitioners.
*1167 The respondent determined deficiencies of $ 3,081.94 and $ 1,818.97 in the the income tax of petitioner Charles Burke for the years 1939 and 1940, respectively, and deficiencies of $ 3,252.33 and $ 1,691.02 in the income tax of petitioner Sylvia Burke for the same respective years.
The issues are:
(1) Whether or not the petitioners, assignees of fractional interests in oil properties, are taxable on proceeds of sales of oil extracted therefrom *1168 and distributed in 1939 pursuant to the terms of a written contract.
(2) Whether or not the petitioners may report on the installment basis gain derived from the sale of an oil lease. The answer to this question in turn rests on whether or not the petitioner must add to the cash payment therefor the amount paid to Harry S. Myles for a one-sixteenth interest in the lease.
Certain other issues*32 were abandoned by the petitioners.
FINDINGS OF FACT.
The facts were stipulated. The portions thereof material to the issues are as follows:
The petitioners reside in St. Louis, Missouri. They filed their income tax returns for the taxable years with the collector of internal revenue for the first district of Missouri. Charles Burke will be referred to hereinafter as the petitioner.
On or about August 1, 1938, the petitioner and his wife formed a partnership under the name of "Charles & Sylvia Burke," for the purpose of buying, selling, and developing oil and gas properties. The partnership was dissolved on January 4, 1941, pursuant to a written dissolution agreement. The petitioner was the active manager of the partnership and, for convenience, he handled various partnership matters in his own name rather than in the name and style of the partnership.
On or about April 11, 1939, the petitioner, on behalf of the partnership, entered into an oral agreement with Signal Hill Oil Corporation of Illinois, hereinafter referred to as Signal Hill, for the acquisition of all of the latter's undivided interests in and to two certain oil and gas leases, one known as the Nathan Lee lease *33 and the other known as the Fred Lee lease, both in Marion County, Illinois, and in and to 6,250 shares of stock of Haynes-Thomas Drilling Corporation, for the total consideration of $ 5,000 in cash and the execution by the petitioner, on behalf of the partnership, of a written contract, the execution of which had been authorized by a resolution of the board of directors of Signal Hill adopted at a meeting held April 10, 1939.
At the date of such oral agreement Signal Hill and the partnership owned undivided one-eighth and three-sixteenths interests, respectively, in the Nathan Lee lease, record ownership of the partnership's interest being in the name of the petitioner. Signal Hill owned an undivided sixteen ninety-sixths interest in the Fred Lee lease, but record title to such undivided interest was held in the name of the petitioner, who then held of record an undivided seventy-eight ninety-sixths interest in said lease, of which a sixteen ninety-sixths interest *1169 was held for the benefit of Signal Hill and the balance of sixty-two ninety-sixths was held for the benefit of the partnership.
Pursuant to the oral agreement, on April 11, 1939, Signal Hill executed an absolute*34 assignment to the petitioner (acting for the partnership) of all of its right, title, and interest in the Nathan Lee lease. No instrument of conveyance was executed by Signal Hill with reference to its undivided sixteen ninety-sixths interest in the Fred Lee lease, inasmuch as record title thereto was already held in the name of the petitioner. On the same date the petitioner (acting on behalf of the partnership) paid Signal Hill the sum of $ 5,000 in cash, which was treated by the parties as the purchase price of the 6,250 shares of Haynes-Thomas Drilling Corporation stock. In further pursuance of the oral agreement, the petitioner and Sylvia Burke executed a written contract dated April 11, 1939. The contract was corrected by a contract dated April 19, 1939, in order to eliminate certain errors in the statement of fractional interests in the applicable leaseholds. The contract of April 19, 1939, entitled "Oil Payment," provides, among other things, as follows:
That we, Charles Burke and wife, Sylvia Burke, of the City of St. Louis, and State of Missouri, being the undersigned present owners of the aforementioned interests, in consideration of the sum of Ten Dollars ($ 10.00) *35 and other good and valuable considerations to us in hand paid by the Signal Hill Oil Corporation of Illinois, receipt whereof being hereby acknowledged, do hereby sell, assign, set over and convey unto the said Signal Hill Oil Corporation, its successors or assigns, an undivided one-third (1/3) of seven-eighths (7/8) of the oil saved, produced, sold and marketed from said leased premises described as Tract One; together with an undivided one-fourth (1/4) of the seven-eighths (7/8) of the oil saved, produced, sold and marketed from the said leased premises described as Tract Two, until the Assignee, the said Signal Hill Oil Corporation of Illinois, its successors or assigns, have received from the proceeds of the sale of the proportionate part of the oil sold from the two tracts, the sum of Fifty Thousand Dollars ($ 50,000.00); and any individual, company, refiner, pipe line company, or other purchaser of the oil, is hereby authorized and directed to make payment for the proportionate part of the oil herein conveyed unto the said Signal Hill Oil Corporation of Illinois, its successors or assigns, until it, or its assigns, have received the sum of money aforesaid.
It is understood and*36 agreed, however, by and between the parties hereto, that when Assignee, its successors or assigns, have received the sum of Fifty Thousand Dollars ($ 50,000.00) from the proceeds of the sale of that proportionate part of the oil herein conveyed, then this assignment to be and become null and void, and of no further force or effect.
It is understood by and between the parties hereto that this Assignment of oil payment, regardless of its execution date, is to be effective as of the date of April 1, 1939, and that proportionate part of the oil runs conveyed by these presents from such date shall be paid direct to Assignee, its successors or assigns, and charged against said oil payment.
It is contemplated by the parties that this payment will be discharged in a period of two (2) years from the effective date hereof; and in this connection it is agreed that Assignor shall have the right, privilege and option, at any time, *1170 on or before said two year period, to pay off and discharge the same by paying any unpaid portion thereof due Assignee or its successors or assigns.
Assignee shall have a lien on the undivided one-third interest in and to said lease covering Tract One, and*37 a lien on the undivided one-fourth interest in the lease covering Tract Two, to secure the payment, payable out of oil, herein provided for.
The assignment of the interest herein provided for shall in no wise be construed by the parties as an agreement to become mining partners, it being understood that Assignor, his heirs or assigns, shall have the entire control and operation of said leases and shall be charged with all covenants running with the original leases.
[The leased premises described as tract one and tract two were the Fred Lee and Nathan Lee leases, respectively.]
The sum of $ 50,000, which the written contract of April 11, 1939, provided shall be paid to Signal Hill, was completely paid by September 25, 1939, $ 43,445 thereof being paid out of oil runs from the Nathan Lee lease, and $ 6,555 being paid out of oil runs from the Fred Lee lease. The payments were made directly to Signal Hill by the pipe line company, pursuant to transfer orders directing that such sums be paid, which transfer orders were executed pursuant to the written contract of April 11, 1939.
For Federal income tax purposes Signal Hill treated the $ 50,000 as the proceeds of the sale of its undivided*38 interests in the Nathan Lee and the Fred Lee leases. Neither the petitioner nor Sylvia Burke had any interest in Signal Hill as a stockholder, creditor, or otherwise, and neither the petitioner nor Sylvia Burke had any part in determining how Signal Hill should report the transaction for income tax purposes.
In 1938 Harry S. Myles came to Illinois at the request of the petitioner and Sylvia Burke and became the general manager of the properties of the partnership in the oil fields in Illinois and Indiana. On December 5, 1938, he became general manager of Haynes-Thomas Drilling Corporation, all of the stock of which was at that time owned in equal shares by the petitioner (acting for the partnership), J. C. Haynes, A. C. Thomas, and George Anderson. These same parties were at that time owners of fractional interests in the Nathan Lee and Fred Lee leases. This employment continued pursuant to an oral agreement made on or about April 11, 1939, between the petitioner (acting for the partnership) and Myles that, in consideration of the services rendered and to be rendered by Myles to the partnership, Myles would be entitled to receive, when the financial position of the partnership*39 permitted, a one-half interest in the partnership's one-eighth interest in the Nathan Lee lease which was to be purchased from Signal Hill, and would be entitled to receive a one-fifth interest in all oil and gas leases and interests therein thereafter acquired by the partnership. It was further agreed that if any such lease had not prior *1171 thereto produced sufficient oil and gas to pay all development costs Myles would, upon the conveyance to him of such interest, pay his proportionate share of all such costs.
It was further agreed that after such conveyance Myles would pay his proportionate share of all development and operating expenses subsequently incurred. It was also agreed that in the event of the sale of any interest in any oil and gas lease owned by the partnership before such one-fifth interest in the interest owned by the partnership therein had been conveyed to him, Myles should receive his proportionate share of the sale price. No present conveyance of any interest in the Nathan Lee lease was then made. Record title to the five-sixteenths working interest in the Nathan Lee lease (subject to the rights of Signal Hill) remained in the petitioner until record*40 title to a one-sixteenth interest in the Nathan Lee lease was conveyed by the petitioner and Sylvia Burke to Myles, as hereinafter stated.
On or about January 23, 1940, the Texas Co., hereinafter called Texas, agreed by an oral arrangement to purchase the Nathan Lee leasehold and the equipment thereon for a total consideration of $ 275,000, to be allocated among the interest holders in proportion to the size of their respective interests. On January 23, 1940, the petitioner and Sylvia Burke executed an instrument styled "Assignment of Oil and Gas Lease," which recited that, for a consideration of one dollar and "other good and valuable considerations," the petitioner and Sylvia Burke "do hereby bargain, sell, transfer, assign, and convey" an undivided one-sixteenth interest in the Nathan Lee lease and in the equipment thereon to Myles. On the same date the petitioner and Sylvia Burke executed a contract of sale and an assignment to Texas, conveying to it their four-sixteenths interest in the Nathan Lee lease and equipment. On that date Harry S. Myles and Inez Myles executed a separate instrument of assignment to Texas, transferring their one-sixteenth interest in that lease and*41 equipment.
The assignment by the petitioner and Sylvia Burke of an undivided one-sixteenth interest in the Nathan Lee lease and equipment thereon to Myles on January 23, 1940, was executed in contemplation of the sale by the petitioner and Sylvia Burke and all other parties interested in the Nathan Lee lease of all of their undivided interests in the leasehold and the equipment thereon to Texas. The assignment to Myles by the petitioner and Sylvia Burke was executed at the request of Texas.
Pursuant to the terms of the contract of sale dated January 23, 1940, Texas made cash payments, in 1940, to the petitioner and Sylvia Burke in the amounts of $ 10,000 and $ 9,937.50, respectively, or a total of $ 19,937.50. In the 1940 return filed by the partnership of Charles & Sylvia Burke there is reported a profit of $ 19,937.50 from the sale *1172 of its interest in the Nathan Lee lease. The sale was treated by the partnership as reportable on the installment basis, and the amount reported in the 1940 return was treated as the initial cash payment on the purchase price.
Upon executing the instrument of assignment dated January 23, 1940, Myles received the cash sum of $ 17,187.50 from*42 Texas as the full purchase price for the one-sixteenth interest in the Nathan Lee lease covered by such assignment.
In the partnership return for 1939 income from the Nathan Lee lease in the amount of $ 28,168.74 was reported by the partnership on the basis that the partnership was entitled to a three-sixteenths interest prior to April 11, 1939, and a five-sixteenths interest after April 11, 1939, in the lease after deducting $ 43,445, which was reported by the petitioner in a fiduciary return for the Nathan Lee lease as not being taxable income of the partnership, but as being taxable income of Signal Hill. In the partnership return for 1940 income from the Nathan Lee lease in the amount of $ 1,739.59 for the period from January 1 to January 22, 1940, was reported on the basis of a five-sixteenths interest in the property.
It was further stipulated that should this Court determine that the $ 43,445 paid to Signal Hill in the year 1939 out of oil runs from the Nathan Lee lease constituted taxable income during such year of the partnership of Charles & Sylvia Burke, then the net cost basis of the partnership's interest in the leasehold and equipment, for the purpose of determining*43 the gain on the conveyance of the interest to Texas on January 23, 1940, was $ 19,539.29.
Should this Court determine that the sum of $ 43,445 paid to Signal Hill in 1939 did not constitute taxable income of the partnership, then the net cost basis of the partnership's interest in the leasehold and equipment, for the purpose of determining gain on the 1940 transaction, was $ 7,884.92.
OPINION.
The first issue involves the taxability of the $ 50,000 paid to Signal Hill under the terms of the contract of April 19, 1939 (correcting the original contract of April 11, 1939). The respondent states that the decisive test as to such taxability is "whether Signal Hill, in making the assignments of fractional interests in the two leaseholds, reserved or withheld a certain amount of the oil in place and was solely dependent upon such oil reserves and the production therefrom for the recovery of the stipulated sum, or whether it made an outright sale without reservation of an economic interest and looked to the personal covenant of the petitioners for payment of the purchase price."
*1173 The respondent asserts that the terms of the contract imposed a personal covenant upon the petitioners*44 to pay the contractual sum and relies on . The petitioners contend that the $ 50,000 is taxable to Signal Hill as the owner of the oil payment and not to the petitioners, the owners of the interest out of which such payment had been carved. They rely on , and kindred cases. See .
We have here two contracts -- one an oral contract of sale by Signal Hill of all its undivided interest in two leases, the interests sold being a sixteen ninety-sixths interest in the Fred Lee lease and a one-eighth interest in the Nathan Lee lease, plus 6,250 shares of the Haynes-Thomas Drilling Corporation, the consideration being $ 5,000 cash (allocated by the parties to the payment for the stock) and the execution of a written contract denominated on execution "Oil Payment." Absolute assignment with respect to the Nathan Lee lease was executed by Signal Hill, but the same was not done as to the Fred Lee lease, petitioner already holding a record title to the same.
By the written contract petitioner and his *45 wife, owners of thirteen-sixteenths interest in the Fred Lee lease and five-sixteenths of a seven-eighths interest in the Nathan Lee lease, sold and assigned to Signal Hill an undivided one-third of seven-eighths (seven twenty-fourths) of the oil saved, produced, sold, and marketed from tract one (the Fred Lee lease) and one-fourth of seven-eighths (seven thirty-seconds) of the oil saved, produced, sold, and marketed from tract two (the Nathan Lee lease) until the assignee (Signal Hill) should receive from the proceeds from the sale of the proportionate part of the oil sold from the two tracts the sum of $ 50,000. Any oil purchaser was authorized to pay direct to Signal Hill. Upon receipt by Signal Hill of $ 50,000 the assignment became void. It was contemplated that the payment would be discharged in two years and assignor (the petitioner) had the right at any time to pay off any balance due. The assignee was given a lien covering the one-third interest in the Fred Lee lease and the one-fourth interest in the Nathan Lee lease to secure the payment.
It will be noted that while Signal Hill orally sold the petitioner a sixteen-ninety-sixths, or a one-sixth interest in the Fred Lee*46 lease and a one-eighth interest in the Nathan Lee lease, by the terms of the written contract petitioner assigned and sold to Signal Hill a seven-twenty-fourths interest in the oil produced and sold from the Fred Lee lease and seven-thirty-seconds of the oil sold from the Nathan Lee lease, payable in oil payments to the total amount of $ 50,000. That is to say, the interests in the leases sold by Signal Hill to petitioner do not coincide in amount with the percentage of oil sold under the oil payment contract. By virtue of this difference, Signal Hill *1174 received from the petitioner a greater interest from which the oil payment was to come than the property sold by it to the petitioner. A similar situation exists as to the property covered by the lien. The question raised by this fact is whether the additional interest was such a reservation of an additional type of security for the deferred payment as served to distinguish the case from , as did the reservation of an interest in the fee in
The decided cases have laid down certain basic principles*47 here pertinent:
1. The same basic issue determines both to whom income derived from the production of oil is taxable and to whom depletion is allowable, that issue being who has a capital investment in the oil in place and what is the extent of that interest.
2. The sole owner of oil properties is taxable on gross proceeds of production and is granted a deduction for depletion as compensation for consumption of his capital.
3. The reasons for depletion deductions do not apply where there is an outright sale of an interest in oil property for cash.
4. Where a sale of oil property is made, the seller reserving the right to receive oil payments up to an agreed amount in payment and seller reserving no security or personal obligation, the seller is deemed to have reserved from the sale such proportionate part of the oil and is entitled to depletion and is chargeable with income arising from the oil so reserved.
5. Where a seller reserves other security in addition to the oil payments, he is deemed to have made an outright sale and the proceeds from oil production paid to the seller under the oil payment contract are includible in the gross income of the purchaser.
In Anderson v.*48 Helvering the Supreme Court had for consideration a situation involving the same fundamental question presented by the instant case. The Court there stated:
* * * this Court in Thomas v. Perkins decided that the provision in the lease for payments solely out of oil production should be regarded as a reservation from the granting clause of an amount of oil sufficient to make the agreed payments, and should be given the same tax consequences as a provision for oil royalties. The decision did not turn upon the particular instrument involved, or upon the formalities of the conveyancer's art, but rested upon the practical consequences of the provision for payments of that type.
Relying on the last quoted statement, although the facts are thereby confused, we see no obstacle in the fact that the oil payment was provided for in a written contract while the two lease interests which were sold were conveyed by oral agreement, followed by written assignment as to one lease. Treating both contracts as one and thus placing the parties in the same relative position as in the cited cases, *1175 we may consider Signal Hill as assignor and petitioner as assignee. The questions*49 thus posed are, what are the nature and extent of the interests in oil sold, and what was reserved?
In the Anderson case the decision was adverse to petitioner's position because the transfer included the reservation of an interest in the fee, in addition to the interest in the oil produced. While in the instant case the interest in oil produced was the sole resort for payment, there is a barrier, erected by the parties to the contract, which precludes a decision favorable to petitioner. In the Anderson case the Court observed:
* * * But our decision in Thomas v. Perkins does not require that payments reserved to the transferor of oil properties shall for tax purposes be treated distributively, and not as a whole, depending upon the source from which each dollar is derived. An extension of that decision to cover the case at bar would create additional, and in our opinion, unnecessary, difficulties to the allocation for income tax purposes of such payments and of the allowance for depletion between transferor and transferee.
The quoted language perfectly describes the situation in the present case. By reason of the fact that Signal Hill sold petitioner only a one-sixth*50 interest in the Fred Lee lease and a one-eighth interest in the Nathan Lee lease, whereas the oil payment contract sold and conveyed all of the oil saved and produced from seven-twenty-fourths of the Fred Lee lease and seven-thirty-seconds of the Nathan Lee lease, some sort of allocation of depletion between Signal Hill and petitioner would be necessary. Whether such an apportionment based on the relative fractional interests can be made we do not feel called on to determine. It is clear that such a computation presents, and well illustrates, the very difficulties of which the Supreme Court spoke and which it refused to encourage in the Anderson case. Thus it is that decision must be for the respondent on this issue.
A further obstacle in petitioner's path is the lien reserved in the contract. The contract gave Signal Hill a lien on the undivided one-third interest in the Fred Lee lease and on the undivided one-fourth interest in the Nathan Lee lease. Thus the lien covered a greater interest than that sold by petitioner. The right to resort to the excess interest in the leases to protect the payment constituted an additional security reserved. The lien here given was not*51 limited as was the lien in the Anderson case, which was solely on oil and gas produced.
The second issue challenges the respondent's right to tax the petitioners on the one-sixteenth interest in the Nathan Lee lease purported to be owned by Myles and, together with the petitioners' one-fourth interest therein, sold to Texas in 1940. As the respondent has well said, this issue is purely factual. He interpreted the stipulated facts as showing that the petitioners, in substance, assigned a five-sixteenths interest in the lease to Texas. He argues that petitioner Burke at all times (except immediately before the sale to Texas) held and exercised *1176 the ownership rights to the five-sixteenths interest and, prior to the sale, treated the so-called one-sixteenth interest of Myles as belonging to the partnership.
The stipulated facts recite that, in consideration of services rendered and to be rendered by Myles to the partnership as its general manager, he would receive a one-sixteenth interest in the Nathan Lee lease and a one-fifth interest in future oil and gas leases acquired by the partnership. The only condition mentioned was that the financial position of the partnership*52 must permit its transfer. Myles agreed to pay his share of the development and operating expenses of the enterprise after such conveyance to him. The partnership and Myles agreed that, upon the sale of any partnership interest in any oil lease before the transfer to him of the one-fifth interest in the partnership leases, Myles would receive his proportionate share of the sale price.
On January 23, 1940, Texas orally agreed to purchase the Nathan Lee leasehold for $ 275,000, to be allocated proportionately among the interest holders. The petitioner had retained the record title to the entire five-sixteenths interest in the Nathan Lee lease in his own name until, at the suggestion of Texas, he and his wife conveyed the one-sixteenth interest therein to Myles. Thus the petitioner, Myles, and Texas all recognized Myles as the owner of an interest in the lease. Formal assignments to Texas were duly executed by the partnership and Myles for their respective interests.
In Illinois oral contracts for the transfer of real estate in consideration of services to be rendered have been held valid. ; ,*53 and cases there cited. In , the United States District Court for the Eastern District of Illinois held that when one party has knowingly aided or permitted the other to do acts in partial performance of an oral agreement, and the other has relied thereon and thereby the relationship between the parties has been changed, as would not have occurred but for the contract, the courts will enforce such a contract even if the statutes of fraud would otherwise bar the completion of the contract (see cases there cited).
Myles continued to serve as manager of the partnership properties, thus establishing himself as the equitable owner of the one-sixteenth interest in the Nathan Lee lease. The partnership, through the petitioner as its owner of record, held the Myles' interest in the lease in trust for his benefit. ; . Myles' ownership of the one-sixteenth interest in the Nathan Lee lease is fully supported by the record, and the $ 17,187.50 received by him from Texas upon the sale of that interest is includible*54 in his gross income and not in the gross income of the petitioners.
In the recomputation of the tax, due consideration will be given to the figures stipulated by the parties.
Decisions will be entered under Rule 50.