*140 Decision will be entered under Rule 50.
Petitioner entered into several partnership or joint ventures for drilling and developing oil and gas wells. The partnerships contracted to pay the promoter-operators, as drilling contractors, a fixed price for drilling the wells, and petitioner paid his proportionate share. The promoter-operators subcontracted the work of actually cutting the holes in the ground and paid the subcontractors less than the fixed prices received from the joint ventures. Held, petitioner may deduct as intangible drilling and development expenses the amounts he paid the promoter-operators.
*695 Respondent determined a deficiency in petitioners' income tax for the year 1958 in the amount of $ 721.27.
The only issue for decision is whether petitioners are entitled to deduct as intangible drilling expense, incurred in various oil and gas well ventures in which they participated, an amount in excess of that determined and allowed by respondent.
FINDINGS OF FACT
Petitioners are husband and wife residing in Spencer, W. Va. They filed a joint Federal income tax return for the year 1958 with the district director of internal revenue, Parkersburg, W. Va.
G. F. Hedges, Jr., who will be referred to as petitioner herein, is a lawyer practicing in Spencer who also had interests in many oil and gas wells and other business ventures.
A. G. Anderson and Tom G. Garretson (hereafter referred to, respectively, as Anderson and Garretson) were*142 engaged in the oil and gas business in the area of Spencer, doing business as Garretson & Anderson. In 1958 they acquired interests in oil and gas leases, known as the Lindsay Palmer lease and the Henry Smith lease, by assignment from Delbert Goff, the lessee, who retained a three thirty-second working interest in all the oil and gas produced and saved *696 under each lease free and clear of all drilling, equipment, etc., costs. Anderson and Garretson paid no consideration for assignment of the twenty-nine thirty-second interests transferred by the lessee, but the assignments required them to drill test wells within 6 months on each property.
In 1956 Anderson and N. M. Jackson (hereinafter called Jackson), who were also in the oil and gas business together, entered into an oil and gas lease as lessees, with the landowner, known as the A. M. Wilkinson lease. The lease provided that it was to be null and void if the lessees did not begin drilling a well within a period of 6 months and further provided for a royalty of one-eighth of all oil and gas produced and saved, and for a rental of $ 1 per acre to be paid to the lessor. Except for the rental of $ 1 per acre, Jackson and*143 Anderson paid no consideration for the lease.
In 1958 petitioner acquired from Garretson and Anderson a one thirty-second working interest in the Lindsay Palmer and the Henry Smith leases, and he acquired from Jackson and Anderson a one-sixteenth working interest in the A. M. Wilkinson lease. He dealt on an informal basis with Anderson, whom he had known for many years, and he agreed to pay one twenty-ninth of the costs of drilling wells under the Lindsay Palmer and Henry Smith leases, and one-sixteenth of the costs of drilling wells under the A. M. Wilkinson lease. Petitioner did not receive any written instrument evidencing either his one thirty-second working interest in the Lindsay Palmer and the Henry Smith leases or his one-sixteenth working interest in the A. M. Wilkinson lease. He deemed such a written instrument unnecessary because Anderson was dependable and because he considered a working interest in a lease to be personal property under West Virginia law, transferable without deed. It was not unusual for working interests in oil and gas wells to be transferred or acquired in this manner in the Spencer area. Petitioner paid Garretson & Anderson the sum of $ 650, which*144 petitioner considered to be his share -- one twenty-ninth -- of the costs of drilling and preparing a well for production under the Lindsay Palmer lease. He also paid Garretson & Anderson the sum of $ 650 which he considered to be his share of the costs of drilling and preparing a well for production under the Henry Smith lease. These payments were made by petitioner on September 6, 1958.
Petitioner also paid Jackson & Anderson $ 1,000 on December 21, 1957, on February 26, 1958, and on September 6, 1958. He considered each of these $ 1,000 payments to be his share -- one-sixteenth -- of the costs of drilling and preparing for production each of three wells under the A. M. Wilkinson lease, known as A. M. Wilkinson No. 2, No. 3, and No. 4.
*697 Petitioner considered all these drilling and preparation costs reasonable, and he was acquainted with such costs in the Spencer area.
Petitioner never entered into a written partnership agreement with the owners of other working interests in the Lindsay Palmer, the Henry Smith, or the A. M. Wilkinson leases. This was not unusual in the Spencer area.
Garretson and Anderson, acting as drilling contractors, agreed to drill and prepare for*145 production the wells under the Lindsay Palmer and the Henry Smith leases for a fixed price of $ 18,850 per well. There was no written agreement for Garretson and Anderson to do the drilling. Garretson and Anderson subcontracted the actual drilling of the wells and paid the subcontractors $ 11,974.50 for drilling the Lindsay Palmer well and $ 11,466 for drilling the Henry Smith well. Garretson and Anderson treated the $ 18,850 received from the holders of the working interests in each well as ordinary income from drilling. They anticipated there would be a profit from the drilling operation. Garretson and Anderson had a one-sixteenth working interest in each well, which interests were chargeable with their proportionate share of the drilling and preparation charges paid to them as drilling contractors.
Jackson and Anderson, acting as drilling contractors, agreed to drill and prepare for production the wells on the A. M. Wilkinson lease for a fixed price of $ 16,000 per well. There was no written agreement for Jackson and Anderson to do the drilling. Jackson and Anderson subcontracted the actual drilling of the wells. The amounts paid the subcontractor for drilling the A. M. *146 Wilkinson wells No. 2 and No. 3 totaled $ 24,313.50; the amount paid the subcontractor for drilling the A. M. Wilkinson well No. 4 was $ 12,454.52. Jackson and Anderson treated the $ 16,000 received for each well as ordinary income from drilling.
Partnership returns, Form 1065, for the year 1958 were filed in the name of "Lindsay Palmer No. 1 and Henry Smith No. 1," with the district director of internal revenue, Parkersburg, W. Va. Lindsay Palmer No. 1 reported drilling costs as a deduction in the amount of $ 18,850 and a loss in the amount of $ 22,939.41, of which one twenty-ninth was $ 791.01. Henry Smith No. 1 also reported drilling costs as a deduction in the amount of $ 18,850 and a loss in the amount of $ 21,956.67, of which one twenty-ninth was $ 757.13. Information reports under section 761 1 were filed in the name of A. M. Wilkinson Nos. 1, 2, 3, and 4.
On their return for 1958, petitioners reported income or loss*147 from 81 oil and gas partnerships. They reported a loss from "Lindsay *698 Palmer No. 1," in the amount of $ 791.01; a loss from "Henry Smith No. 1" in the amount of $ 757.13; a loss from "A. M. Wilkinson" in the amount of $ 743; and a loss from "Wilkinson #4" in the amount of $ 1,461.18. Petitioner's share of oil and gas partnership losses was computed by deducting as drilling costs of the partnerships or joint ventures the amounts of $ 18,850 for each of the Lindsay Palmer No. 1 and the Henry Smith No. 1 wells and the amounts of $ 16,000 for each of the Wilkinson wells.
Respondent determined that the drilling costs of the Lindsay Palmer No. 1 well and the Henry Smith No. 1 well did not exceed $ 11,974.50 and $ 11,466, respectively; that the drilling costs of the A. M. Wilkinson No. 2 and No. 3 wells did not exceed $ 24,313.50; and that the drilling costs of the A. M. Wilkinson No. 4 well did not exceed $ 12,454.52. Respondent adjusted the losses reported by the partnerships or joint ventures accordingly and these determinations resulted in decreasing the losses reported by petitioners for 1958 from these partnerships or joint ventures.
The amounts petitioner paid Garretson*148 & Anderson and Jackson & Anderson under the fixed price agreements were paid for drilling and preparing the wells for production of oil and gas.
The stipulated facts are so found.
OPINION
Petitioners claim that the entire amounts they paid Garretson & Anderson as their share of the drilling and preparation costs on the Lindsay Palmer and Henry Smith leases, being one twenty-ninth ($ 650) of the total amounts paid by the partnerships or joint ventures to Garretson & Anderson ($ 18,850) for drilling a well on each of the above leases, and the entire amounts they paid Jackson & Anderson as their share of the drilling and preparation costs on the A. M. Wilkinson lease, being one-sixteenth ($ 1,000) of the total amounts paid by the partnerships or joint ventures to Jackson & Anderson ($ 16,000) for drilling each of the wells on that lease, are deductible as intangible drilling expenses under section 263(c) of the 1954 Code.
In the deficiency notice, respondent disallowed as a deduction petitioner's aliquot share of the difference between the amounts paid by the partnerships or joint ventures (hereinafter referred to as partnerships) to Garretson & Anderson and to Jackson & Anderson (both*149 being referred to hereinafter as promoter-operators), as above set out, and the amounts actually paid by the latter to the drilling subcontractors for drilling the wells; and on brief respondent argues that the difference in each instance was paid to the promoter-operators for an interest in the lease, which must be capitalized.
*699 Section 263(c) provides as follows:
Intangible Drilling and Development Costs in the Case of Oil and Gas Wells. -- Notwithstanding subsection (a), regulations shall be prescribed by the Secretary or his delegate under this subtitle corresponding to the regulations which granted the option to deduct as expenses intangible drilling and development costs in the case of oil and gas wells and which were recognized and approved by the Congress in House Concurrent Resolution 50, Seventy-ninth Congress.
The regulations required by section 263(c) have not yet been finalized. Under section 7807(a) the applicable regulations are therefore section 39.23(m)-16, Regs. 118, promulgated under the Internal Revenue Code of 1939, which provide:
Charges to capital and to expense in case of oil and gas wells. (a) Items chargeable to capital or to expense at taxpayer's*150 option:
(1) Option with respect to intangible drilling and development costs incurred by an operator (one who holds a working or operating interest in any tract or parcel of land either as a fee owner or under a lease or any other form of contract granting working or operating rights) in the development of oil and gas properties: All expenditures made by an operator for wages, fuel, repairs, hauling, supplies, etc., incident to and necessary for the drilling of wells and the preparation of wells for the production of oil or gas, may, at the option of the operator, be deducted from gross income as an expense or charged to capital account. Such expenditures have for convenience been termed intangible drilling and development costs. They include the cost to operators of any drilling or development work (excluding amounts payable only out of production or the gross proceeds from production, and amounts properly allocable to cost of depreciable property) done for them by contractors under any form of contract, including turnkey contracts. * * * Included in this option are all costs of drilling and development undertaken (directly or through a contract) by an operator of an oil and gas*151 property whether incurred by him prior or subsequent to the formal grant or assignment to him of operating rights (a leasehold interest, or other form of operating rights, or working interest); except that in any case where any drilling or development project is undertaken for the grant or assignment of a fraction of the operating rights, only that part of the costs thereof which is attributable to such fractional interest is within this option. In the excepted cases, costs of the project undertaken, including depreciable equipment furnished, to the extend allocable to fractions of the operating rights held by others, must be capitalized as the depletable capital costs of the fractional interest thus acquired.
It will be noted that it is expressly provided that drilling costs within the option to deduct intangible drilling expenditures include those which are undertaken by the operator directly or through a contract. Cf. Commissioner v. Ambrose, 127 F. 2d 47 (C.A. 5, 1942), affirming 42 B.T.A. 1405">42 B.T.A. 1405 (1940); Retsal Drilling Co., 42 B.T.A. 1057">42 B.T.A. 1057 (1940), revd. 127 F. 2d 355*152 (C.A. 5, 1942). The operator is defined as the holder of a working or operating interest, and respondent in this case does not dispute that the partnerships of which petitioner was a member are entitled to deduct intangible drilling expenses. Only the amount of these expenses is in controversy.
*700 Respondent does not contend that any part of the amounts paid by petitioner are allocable to the interests which the promoter-operators acquired in the partnerships so as to fall within the exception provided in the regulation. In other words it is not argued that the promoter-operators acquired their interests in the partnerships in exchange for their undertaking to drill the wells; indeed it is evident from the computations that petitioner was charged only with the proportionate share of the total cost that was attributable to his own interest in the wells, 2 and respondent would allow him to deduct his proportionate share of the total drilling costs. The dispute lies in what constituted the intangible drilling and development costs within the meaning of the statute and the regulations -- whether it was the total of the amounts paid by the holders of the working interests to*153 the promoter-operators, or the amounts paid by the promoter-operators to the subcontractors for drilling the wells.
Unlike the earlier case law which did not recognize amounts paid under turnkey drilling contracts as deductible intangible drilling costs, see Old Farmers Oil Co., 12 B.T.A. 203">12 B.T.A. 203 (1928); Retsal Drilling Co. v. Commissioner, 127 F. 2d 355 (C.A. 5, 1942), the presently effective regulations specifically include the cost to operators of any drilling work done for them by contractors under any form of contract, including turnkey contracts. Thus, the issue here is narrowed to a question of fact, whether the payments made by petitioner to the promoter-operators were actually paid for the costs of drilling and developing the wells, or were paid partially for drilling and development costs and partially for an interest in the wells. Respondent, citing Sidney Platt, 18 T.C. 1229 (1952),*154 affd. 207 F. 2d 697 (C.A. 7, 1953); Berkshire Oil Co., 903">9 T.C. 903 (1947); and Manahan Oil Co., 8 T.C. 1159 (1947), argues that only those expenses "undertaken" or "incurred" by the petitioner are subject to the option to deduct, and that petitioner undertook or incurred only those expenses incurred in the actual cost of cutting the wells. The balance, claims respondent, must have been paid for interests in the leases or wells. We do not agree.
While it would be much preferable as a matter of proof to have the agreements of the parties in ventures such as these reduced to writing, we are convinced from the oral testimony of the witnesses, which included both petitioner and Anderson, and other evidence that the agreements between the promoter-operators and the various partnerships was that the partnerships would pay the promoter-operators a fixed sum for drilling the wells and completing whatever other work was necessary to bring the wells in. The fact that the promoter-operators *701 were able to subcontract the work of actually cutting the hole in the ground for less than the amounts they*155 received from the working interests does not limit the drilling and development costs undertaken by the partnership to the amounts paid to the subcontractors. If they contracted to pay independent contractors a fixed amount for drilling the wells and preparing them for production, and paid that amount under the contracts, the amounts so paid were drilling and development expenses to them. The fact that the drilling contractors made a profit on the contracts would not change the situation. Commissioner v. Ambrose, supra.
The promoter-operators paid nothing for the assignment of the leases to them. The only consideration given by them for the assignments were the overriding royalties and the obligation to drill wells within specified times. The partners, together with the promoter-operators whose partnership or working interests were also chargeable with a part of the cost, put up the money to meet these obligations. There was no reason for the promoter-operators to charge the partnership for an interest in the leases or in the wells. The leases were not assigned to the partnerships and the latter helped pay for the wells. The promoter-operators*156 looked to their own working interests or participations in the partnerships for their income if the leases proved productive and to whatever profit they might make by agreeing to drill the wells for a fixed price. They also ran the risk of losing if the drilling and other costs exceeded the contract price and the well was a dry hole.
Respondent relies heavily on the absence of any written agreement between the partners themselves and between the partnerships and the promoter-operators to support his position that petitioner "undertook" or "incurred," as intangible drilling and development costs, only his proportionate part of the actual cost of cutting the holes in the ground. While, as heretofore noted, the absense of written agreements makes the task of determining the true agreements between the parties more difficult, nevertheless, this method of doing business appears to have been customary in the Spencer area at this time, and the evidence presented here all supports petitioner's claim that the entire amounts he paid to the promoter-operators were for intangible drilling and development costs. They are therefore deductible by petitioners under section 263(c) and the effective*157 regulations.
The cases cited by respondent do not require a contrary conclusion. In Sidney Platt, supra, the Court found that under the contract between the taxpayer, who acquired "operating rights" in a well that had already been drilled to a depth of 11,200 feet, and the operator, who was obligated to continue the drilling, the drilling was done by the operator in discharge of his own obligation and not as agent for *702 the taxpayer. Here we find that petitioner and his coadventurers or partners undertook to drill or at least to finance the drilling of the wells and entered into agreements with the promoter-operators to do this work for them at a fixed price. Manahan Oil Co., supra, and Berkshire Oil Co., supra, wherein the taxpayers incurred the drilling expenses in exchange for interests in the leases, are distinguishable on their facts, and also involved years prior to the effective date of T.D. 5276, 1943 C.B. 151">1943 C.B. 151, which amended the pertinent regulations.
Because of other adjustments agreed to by the parties,
Decision will be entered*158 under Rule 50.