*1209 Value of certain maineral deposits determined for depletion purposes.
*1191 This proceeding involves a deficiency in income tax of $24,540.25 for the calendar year 1929. The only question to be determined is the basis for computing the depletion allowances on the petitioner's mineral deposits for the years 1927, 1928, and 1929. The years 1927 and 1928 are involved only for the purpose of determining the amount of the net losses for those years which are deductible in determining the net income of 1929. It is alleged that the respondent erred in holding that the petitioner acquired the assets in question by a statutory reorganization, and in computing the depletion allowances upon a basis of $1,495,577.66, and not at $4,250,000, the alleged cost to the petitioner on November 30, 1925.
FINDINGS OF FACT.
Prior to November 30, 1925, the Pecos Corporation, a Delaware corporation, was the owner of certain mining property in San Miguel County, New Mexico, known as the Pecos Mine. All the stock of the Pecos Corporation was*1210 owned by the Goodrich-Lockhart Co., a Delaware corporation. The mine contained zinc, lead, copper, silver, and gold. It was in process of development, but no ore had been mined. The American Metal Co., Ltd., hereinafter called the Metal Co., was a New York corporation with wide and varied interests in mines and their operation in this country and other parts of the world.
For the purpose of putting the Pecos Mine upon a profitable and producing basis on a large scale the Goodrich-Lockhart Co. entered into an agreement with the Metal Co. on or about September 24, 1925, by which it was agreed that the former would cause the Pecos Corporation to convey all of its property free of lien to a new corporation, the petitioner, which was to be organized by the Metal Co. The petitioner was to be organized under the laws of Delaware, with 10,000 shares of no par value, and was to be authorized to issue $4,000,000 of 8 percent 10-year redeemable gold bonds, to be secured by first lien on all of its property, and further empowered to issue $500,000 noninterest-bearing 10-year redeemable bonds to be secured by a second lien. Upon conveyance of the property of the Pecos Corporation to the*1211 petitioner the latter was to transfer to the *1192 Goodrich-Lockhart Co. $1,000,000 of the first mortgage bonds, all of the $500,000 second mortgage bonds, and the entire 10,000 shares of its stock.
Contemporaneously with these transfers the Metal Co. agreed to purchase from the Goodrich-Lockhart Co. for the sum of $1,000,000 cash the $1,000,000 of first mortgage bonds and 52 percent of the capital stock of the petitioner, and to purchase at par from the petitioner from time to time as needed an additional $2,000,000 of the first mortgage bonds, the proceeds thereof to be used for opening and equipping the mining property. It was agreed that the remaining $1,000,000 first mortgage bonds should remain in the treasury of the new company, to be sold by it if and when additional funds were needed. Upon receipt of the 52 percent of the stock of the new company the Metal Co. was to transfer 100 shares to the Mining & Development Corporation for services rendered in negotiating the contract.
It was further provided that the deeds of trust securing the first and second mortgage bonds should provide that the first mortgage bonds and interest thereon should first be paid from*1212 the net profits of the new company, that when so paid 50 percent of the net profits thereafter should be applied to the payment of the second mortgage bonds, and that the remaining 50 percent should go to the stockholders. Pursuant to the foregoing contract, the petitioner was organized under the laws of Delaware on November 30, 1925, and the contract was consummated by an additional agreement between the Pecos Corporation, the Goodrich-Lockhart Co., and the petitioner. Under this latter agreement the Goodrich-Lockhart Co. conveyed certain property it owned in San Miguel County, New Mexico, to the petitioner and the petitioner issued directly to the Metal Co. $1,000,000 first mortgage bonds and 5,100 shares of fully paid and nonassessable stock; to the Goodrich-Lockhart Co. $500,000 second mortgage bonds and 4,800 shares fully paid and nonassessable stock; and to the Mining & Development Corporation 100 shares fully paid and nonassessable stock. The 5,100 shares of stock going to the Metal Co. were issued in the names of Ludwig Vogelstein and Otto Sussman, as trustees; that of the Goodrich-Lockhart Co. in the name of Alex R. Bergen; and that of the Mining & Development Corporation*1213 to it.
Since November 30, 1925, there have been no recorded transfers of the securities thus issued.
In addition to the 100 shares of stock in petitioner, the Metal Co. paid the Mining & Development Corporation $50,000 as additional compensation for its services.
From time to time during the year 1926 the Metal Co. purchased from the petitioner the $2,000,000 of first mortgage bonds, with *1193 accrued interest, for which it paid $2,124,111.09. This money was used by petitioner in constructing a plant and equipping its mine for operation.
Prior to 1925 it was not feasible or profitable to operate the Pecos Mine because of the difficulty of separating the various metals from the ore, but in that year, because of improvements in what is known as the flotation process, successful operation became possible. Before entering into the contracts referred to above, the Metal Co. had its chief engineer and mining expert, Otto Sussman, confer with representatives of the Pecos Corporation, and after such conferences its chief engineer and two assistants visited the property in July and August 1925 and made a thorough and scientific physical examination of the property.
*1214 They submitted a report dated December 4, 1925, reading as follows:
Valuation of Pecos Mine
The Pecos Mine which you own has an ore reserve of 1,000,000 tons running approximately 17% zinc, 5% lead, 1% copper, 3.5 ozs. silver, and .13 ozs. gold.
Based on these values, metallurgical tests carried out by the Minerals Separation Company at San Francisco, New York lead and St. Louis spelter prices of 7.5?? each, and smelting and freight schedules which have been submitted by the smelters and railroad concerned, this ore has a net value per ton f.o.b. cars at proposed concentrator near Glorieta, New Mexico, as follows:
| Account of lead concentrate | $5.29 |
| Account of zinc concentrate | 9,60 |
| Total value concentrates per ton of ore | $14.89 |
| It is estimated that it will cost to mine and concentrate the ore, per ton | 6.00 |
| Leaving a net value or operating profit per ton | $8.89 |
It is proposed to exhaust this ore reserve at the rate of 200,000 tons annually, indicating an operating life of five years. The amount of annual profit would therefore be 200,000 X $8.89 or $1,778,000. The present value of an annual dividend of $1,778,000. for five years at 8% interest and*1215 4% replacement of capital is
| $1,778,000. X $3.78 | = $6,720,840. |
| Deducting Equipment cost | = 2,000,000. |
| Leaving the value of the mine two years hence at | $4,720,840. |
or a present value, deducting two years' interest at 5%, of $4,281,943. or say $4,250,000.
On the above reasonable assumptions the present value of the Pecos Mine, therefore, is $4,250,000.
The above information is based on a physical examination of the property made by me in July and August of this year.
Very truly yours,
[Signed] OTTO SUSSMAN,
Mining Engineer.
*1194 The mine began operations early in 1927, about 14 months after November 30, 1925, and is still operating. About 1,250,000 tons of ore have been recovered and it is estimated that an excess of over 500,000 tons is in reserve.
On November 30, 1925, the mine contained 1,000,000 tons of ore and its fair market value on that date was $1,500,000.
The petitioner filed an income tax return for 1929 in which it reported a net loss of $454,158.09. In his audit of the return the respondent computed a net income of $223,093.23 and a tax liability of $24,540.25, the amount of the deficiency herein. He disallowed*1216 claimed deductions in the amount of $677,642.30, of which amount $392,685.41 represented excessive depletion allowances on mineral deposit and $284,251.89 represented excessive statutory net losses for the prior years 1927 and 1928. The adjustments on account of the net losses were due principally to the disallowance of depletion deductions claimed in the prior years. The deficiency notice states with respect to the computation of the depletion allowances that:
Depletion Schedule
The basis for computing depletion is on actual cost. This basis is computed as follows:
| Total assets as at December 31, 1924 | $3,746,690.80 | |
| Less: | ||
| Organization expense | $1,113.14 | |
| Appreciation, not recognized or realized | 2,250,000.00 | |
| 2,251,113.14 | ||
| Actual cost of assets | $1,495,577.66 |
OPINION.
SMITH: The petitioner contends that the respondent erred in computing its depletion allowances for 1927, 1928, and 1929 upon a cost basis of $1,495,577.66 as of December 31, 1924, and that the correct basis is the actual cost of the assets to the petitioner on November 30, 1925, which it claims was $4,250,000.
The respondent's determination is based upon the theory that*1217 the petitioner acquired the assets in question by a statutory reorganization in 1925; that is, that the petitioner is a reorganization of the Pecos Corporation, and that the basis for depletion allowances to the petitioner is the same as it would have been in the hands of the transferor, the Pecos Corporation. On the other hand, the petitioner contends that it acquired the assets by purchase from the Goodrich-Lockhart Co. upon its organization on November 30, 1925, and that the basis is therefore the cost to it of the assets, which, since it paid only its own stock and securities, is the fair market value of the property at the date of acquisition.
*1195 The Revenue Acts of 1926 and 1928 provide that the basis upon which depletion is to be allowed is the same as is provided for the purpose of determining gain or loss upon the sale or other disposition of property, which, with certain exceptions, is the cost thereof with respect to property acquired after February 28, 1913. See section 204 of the Revenue Act of 1926, and sections 113(a) and 114(b)(1) of the Revenue Act of 1928. The only exception to this rule with which we are concerned in this proceeding is that where*1218 the property was acquired by a nontaxable reorganization the basis remains the same as it would have been in the hands of the previous owner or transferor. See provisions relating to reorganizations contained in section 204(a)(7) of the Revenue Act of 1926, and section 113(a) of the Revenue Act of 1928.
The respondent in his brief filed in this proceeding has conceded that petitioner did not acquire the property in question, that is, the Pecos Mine, by a statutory reorganization, citing ; affirming . He admits that the basis for computing depletion allowance is the fair market value of the property as of November 30, 1925, the date of its acquisition by the petitioner. We therefore limit our inquiry to that question only, namely, the value of the Pecos Mine at November 30, 1925.
As above indicated, the petitioner claims that the fair market value of the Pecos Mine on the basic date was $4,250,000. Such valuation is predicated upon the report made upon the mine by Otto Sussman, an eminent mining engineer who submitted the report dated December 4, 1925, incorporated*1219 in our findings. To sustain that valuation the petitioner has adduced before the Board the testimony of Sussman and a number of other witnesses. The respondent, on the other hand, contends that the fair market value of the mine on the basic date was not in excess of $1,500,000. In support of such contention the respondent introduced the evidence of one John Alden Grimes, a mining engineer in the service of the Bureau of Internal Revenue, engaged in valuing mines for tax purposes. In arriving at his value of approximately $1,500,000 Grimes used the data adduced in evidence by Sussman.
Sussman's estimate is based upon the proposition that it would take approximately two years to complete a smelting plant and to prepare the mine for operation; that the mine had an ore reserve of approximately 1,000,000 tons; that the ore reserve would require the operation of the mine for a period of five years; that the estimated profits from operation over such period would be $8,890,000, or an annual profit of $1,778,000. By the method of valuation used by Grimes the fair market value of the mine on November 30, 1925, is computed to be $1,428,570.
*1196 The assumptions of the Government's*1220 witness as to rates of interest to be used in reducing the estimated earnings over the period of operations to a present worth value on November 30, 1925, is strongly opposed by petitioner's witnesses, who contend that the fair market value on the basic date was $4,250,000.
We are of the opinion that it is not necessary to analyze exhaustively the various contentions of the petitioner's witnesses as opposed to those of the Government's witness. We are of opinion that there is other evidence which more nearly establishes the fair market value of the Pecos Mine on November 30, 1925.
Prior to the sale of the Pecos Mine to the petitioner in November 1925, all of the capital stock of the company owning the mine was owned by the Goodrich-Lockhart Co. That company parted with its ownership in the mine for a cash consideration of $1,000,000 plus $500,000 noninterest-bearing, 10-year, second mortgage bonds and a 48 percent interest in the stock of the petitioner corporation. The $1,000,000 cash was paid to it by the American Metal Co., Ltd., a New York corporation, for which that company was given $1,000,000 of the 8 percent first mortgage bonds of the petitioner company. The American*1221 Metal Co., Ltd., was to advance an additional amount of approximately $2,000,000 to the petitioner company, secured by an additional issue of first mortgage bonds, the first mortgage bonds to be redeemed in their entirety out of the first profits of operations of the petitioner. It was only after the first mortgage bonds should be redeemed in their entirety, together with interest, that any of the profits were to be utilized in the redemption of the second mortgage bonds and in payment of dividends upon the stock. Whether these bonds or the shares of stock had any fair market value either on November 30, 1925, or at any subsequent date is not shown by the evidence. The evidence does show, however, that there was never any transaction in them.
The respondent has determined that the Goodrich-Lockhart Co. parted with 70 percent of the estimated profits from the enterprise for a cash payment of $1,000,000 for the mine; that on this basis the mine was worth not more than $1,500,000 cash on November 30, 1925; and that this is a sale of controlling interest for cash by a willing seller to a willing buyer and should be "absolutely conclusive evidence of the value of the mine."
*1222 Although the opinion of experts in a question of this character is entitled to weight, those opinions are not conclusive upon the Board. . Where the testimony of experts varies so widely as the testimony of the several experts in this proceeding, the Board is not measurably enlightened thereby
*1197 It is at once apparent that the American Metal Co., Ltd., acquired a 51 percent interest in the stock of the petitioner corporation at a cash outlay of very little, if any, for the stock. Indeed, it seems that the stock was given to that company as an inducement to it to advance money to the petitioner, to be secured by first mortgage bonds which were all to be retired before any profits would accrue to the second mortgage bondholder or to the stockholders.
The computation of the respondent, that the Goodrich-Lockhart Co. parted with a 70 percent interest in the estimated profits to be realized from the operation of the Pecos Mine for a cash consideration of $1,000,000, appears to be substantially correct. In the light of all of the evidence we sustain the respondent's contention that the cost of the*1223 Pecos Mine to the petitioner was not in excess of $1,500,000, which we have found as its fair market value on November 30, 1925.
Reviewed by the Board.
Judgment will be entered under Rule 50.
LEECH dissents.