*1078 1. Petitioner lessee sold production certificates which entitled the holders to a percentage interest in the proceeds to be derived from the production of designated oil wells. Held:
(a) Where such sales were made respecting completed wells, proceeds realized therefrom constituted income to petitioner.
(b) Where the petitioner has failed to show the state of the drilling operations at the time of selling the production assignments, or that the production assignments were sold to procure funds for the drilling of a particular well, or that any of the funds so received were intended or required to be used or were actually used in drilling the well in respect of which the certificates were sold, the proceeds from the sale of such certificates must be included in petitioner's income. Rogan v. Blue Ridge Oil Co., Ltd., 83 Fed.(2d) 420.
(c) Where the petitioner agreed to use the funds so received in drilling a particular well and to furnish proof of such use, and the total cost of the well was in excess of the sums so received, the proceeds from the sale of production assignments, subject to those conditions, did not constitute income to the petitioner. *1079 Transcalifornia Oil Co., Ltd.,37 B.T.A. 119">37 B.T.A. 119.
2. Held, that proceeds realized by petitioner from its sales of production interests in oil wells do not constitute "gross income from the property" for the purpose of computing its depletion allowance.
3. Under the facts shown, held, the transaction whereby petitioner transferred part of its assets to a corporation in exchange for a majority of its capital stock was made pursuant to a plan of reorganization and under the provisions of section 112 of the Revenue Act of 1928 no gain is to be recognized.
4. Held, that petitioner is not entitled to a bad debt deduction where the evidence fails to establish that the debt was properly ascertained to be worthless during the taxable year.
*128 These proceedings were brought to redetermine deficiencies in income tax for the years 1929 and 1930, in the amounts of $6,067.29 and $17,038.54, respectively. One issue common to both years is whether or not proceeds received*1080 by petitioner from its sales of production interests in oil wells constitute income. In the alternative, if those proceeds constitute income, then it will be necessary to determine whether the respondent erred in excluding such proceeds from the "gross income from the property" for the purpose of computing petitioner's depletion allowance. Two other issues to be determined for the year 1930 are: (a) Whether the transaction whereby petitioner transferred part of its assets to the Government Petroleum *129 Corporation, Ltd., in exchange for capital stock in that corporation constituted a reorganization in which no gain or loss is recognized under the statute, and (b) whether the respondent erred in disallowing a claimed bad debt deduction.
FINDINGS OF FACT.
The petitioner is a California corporation, with its principal office and place of business in Los Angeles, California. It is engaged in the operation and exploitation of oil and gas properties.
In order partly to finance its operations, the petitioner sold percentage interests, sometimes referred to as production assignments, which entitled the purchasers to a certain percentage of the proceeds to be realized from*1081 the production of designated wells. During 1929 it sold production assignments covering two wells known as "Rawco Well #2" and "Lewis Well #1", and during 1930 it sold production assignments covering two wells known as "Noll Well #1" and "Colter Well #1." The facts concerning the drilling of these wells have been stipulated.
Rawco Well #2.
On May 13, 1929, the petitioner completed the drilling of a well known as Rawco Well #2 on the Butler Lease at Richfield, California. The lease provided for landowner's royalty amounting to 17.67 percent of production. During 1929 the petitioner sold production assignments in Rawco Well #2 to various persons for a total consideration of $39,600. These production assignments entitled the purchasers to receive in the aggregate 35.20 percent of the proceeds to be derived from the well's production. One production assignment, covering 10 percent of the well's production, was sold on May 10, 1929, but the record does not disclose when the other sales were made. The form of the certificates issued by petitioner to purchasers of production assignments reads as follows:
Receipt is acknowledged from you of the sum of $ . In consideration*1082 of said sum, Rawco Incorporated hereby covenants and agrees to hold for your benefit ( %) per cent of the gross proceeds (after deducting 20% leasehold interest) realized from the sale of all oil and ( %) per cent of the net proceeds received from the purchasers or marketers of the gas, produced and saved from that certain oil well known as Rawco #2 located on real property described as follows:
* * * But upon the condition and with the express understanding that each one (1%) per cent interest hereby transferred and assigned shall bear one-eightieth (1/80) share of all costs and expenses incurred in the operation of said Rawco Well #2.
*130 Rawco Well #2 was drilled to completion on May 13, 1929, with a total drilling cost of $53,991.36, of which sum $29,751.03 represented intangible expenditures and $24,240.33 represented cost of tangible equipment. The latter sum was capitalized by petitioner and depreciation thereon has been allowed by respondent. Subsequent to the completion of the well petitioner assigned to the Government Petroleum Corporation, Ltd., hereinafter referred to as the G. P. Corporation, rights to receive 16 percent of the proceeds to be derived from*1083 the well's production, and received in consideration therefor capital stock of that corporation.
Lewis Well #1.
During 1929 petitioner drilled on the Lewis Lease at Signal Hill, California, a well known as Lewis Well #1. The lease provided for landowner's royalty of 16.67 percent of production. On August 23, 1929, petitioner entered into a written contract with the G. P. Corporation wherein the former represented that the Lewis well was drilled to a depth of approximately 6,285 feet, that it was unable to entirely finance the drilling of the well, and that it desired to obtain a portion of such finances from the latter. Pertinent provisions of this agreement read as follows:
1. First party [petitioner] agrees within five days after the date hereof to begin the further drilling upon said lease and that it will furnish for the drilling, complete drilling equipment necessary and proper to drill the well.
2. First party agrees at its own expense to furnish in connection with said drilling operations, all necessary and proper equipment for use in producing and marketing oil, gas and other hydrocarbon substances, including all boilers, tanks, rigs, gas traps and other*1084 usual equipment.
3. In connection with said drilling operations, first party agrees to fully comply with each and all of the requirements of the lease and of the laws and/or ordinances and/or regulations of the city of Signal Hill, County of Los Angeles, State of California, and/or the United States of America.
4. First party agrees to pay for all labor and/or materials used on said property either in connection with said drilling operations or otherwise, as well as all other charges which may accrue in connection with the use of said property and all such charges shall be promptly paid when due.
5. Second party [G. P. Corporation], agrees, provided that the first party shall fully perform each and all of the Agreements, to pay to first party the following sums of money.
$5,000.00 upon the signing of this Agreement
$5,000.00 on August 24, 1929
$5,000.00 on September 9, 1929
$5,000.00 on September 24, 1929
$5,000.00 on October 9, 1929
6. First party agrees that said moneys so to be paid by second party shall be used for the purpose of paying for labor and materials used in drilling the well and shall, if the second party requires it, produce satisfactory*1085 evidence *131 showing that the moneys so paid have been used, or are available, to pay for labor and/or materials used in connection with drilling of said well.
7. First party agrees that at all times during the drilling and operation of said well that it will keep and hold the second party harmless of and from any and all claims of every kind and character whatsoever that could or might arise by reason of the use, disuse or misuse of the said operations, and furthermore that it will carry adequate public liability insurance and full workmen's compensation insurance.
8. As part of the consideration moving the second party to make the payments to be made by the second party, first party agrees to pay to the second party out of twenty-five (25%) per cent of the gross production of oil and out of twenty-five (25%) per cent of the net production of gas and gasoline products, and not otherwise, the sum of Twenty-five Thousand ($25,000.00) Dollars advanced by second party under this Agreement and after said sum of money has been so repaid, the first party agrees to transfer and assign to the second party, twelve and one-half (12 1/2%) per cent interest of the proceeds received*1086 from the sale of all oil and hydrocarbon substances and twelve and one-half (12 1/2%) per cent of the net proceeds received from the sale of all the gas and gasoline produced from that certain oil well known as Lewis #1. The said Assignment shall be delivered and placed in escrow immediately on the signing of these presents but shall only be delivered to the second party after the said well shall have been brot on production in commercial quantities, which means at least 100 barrels per day.
9. It is agreed that when and after said well provided for herein, is placed upon production, each one (1%) per cent interest in the oil, gas and other hydrocarbon substances produced and saved, shall bear one-eightieth (1/80th) share of all costs and expenses incurred in the operation of said well and in saving the oil, gas and other hydrocarbon substances produced, which expense shall also include any mineral rights taxes that may be levied against the production of said well.
10. This Agreement is not intended and shall not be construed to create a partnership between the parties.
11. In connection with drilling operations on said well, first party agrees to exercise proper skill*1087 and diligence in accordance with the custom existing among skilled operators.
12. First party agrees to pay promptly when due, all taxes and assessments of any kind and character whatsoever that are or could or might become a lien upon said real property or the leasehold estate created by the lease hereinbefore referred to and the first party agrees further to make all payments and to do all things that are required by said lease.
13. It is mutually agreed between the parties hereto that anything herein to the contrary notwithstanding, that in the event the well provided for herein shall be placed on production and shall thereafter cease to produce and shall require redrilling or reconditioning, then and in that event the interest of the second party herein shall be available for the repayment of its proportionate part of the expense of said reconditioning or redrilling. [Acknowledged by both parties on October 31, 1929.]
Pursuant to the terms and conditions of the above agreement, the G. P. Corporation paid the petitioner the sum of $25,000, and petitioner executed and delivered an assignment for 12 1/2 percent of the proceeds to be derived from the production of Lewise*1088 Well #1.
*132 On October 18, 1929, petitioner entered into another written agreement with the G. P. Corporation reciting that the above well was then being drilled and that the petitioner desired to obtain $6,000 from the G. P. Corporation for the purpose of completing the well. The terms and conditions of the contract were substantially similar to those contained in the contract of August 23, 1929, except that the clause wherein the petitioner agreed to use the money acquired in sinking the well and to stand ready to account to the G. P. Corporation for such expenditures was omitted. In consideration for the payment of the $6,000 by the G. P. Corporation, the petitioner agreed to pay to the former $6,000 out of 6 percent of the well's production, "and not otherwise", and after payment of that sum to transfer and assign to the G. P. Corporation a 3 percent interest in such production. The 3 percent production assignment was executed and delivered to the G. P. Corporation on the date of the agreement.
In conformity with the agreement of August 23, 1929, the petitioner paid to the G. P. Corporation out of 25 percent of the well's production the $25,000 specified; $16,271.87*1089 was paid during the month of December 1929 and the balance, or $8,728.13, was paid during January 1930. Also during the month of January 1930 the petitioner paid to the G. P. Corporation the sum of $6,000 out of 6 percent of the well's production, in conformity with the terms of the contract of October 18, 1929.
Lewis Well #1 was drilled to completion on October 30, 1929, with a total drilling cost of $51,070.39, of which sum $23,617.10 represented intangible expenditures and $27,453.29 represented cost of tangible equipment. The latter sum was capitalized by petitioner and depreciation thereon has been allowed by the respondent.
Subsequent to the completion of the well, petitioner sold production assignments to various persons which entitled them to receive in the aggregate 24 percent of the proceeds to be derived from the well's production, and received in consideration therefor the total sum of $38,972.50.
Noll Well #1.
In 1930 petitioner drilled on the Noll Lease at Signal Hill, California, a well known as Noll Well #1. The lease provided for landowner's royalty of 25 percent of production. On January 2, 1930, petitioner entered into a written contract with the*1090 G. P. Corporation, the terms and conditions of which were substantially similar to those contained in the contract of August 23, 1929, with respect to Lewis Well #1. The contract recited that the petitioner had spudded in and was then drilling on the said lease, and had applied to the G. P. Corporation for $40,000 to assist in the drilling of the said well. *133 In consideration for the payment of the $40,000 applied for, the petitioner agreed to deliver and pay over 25 percent of the proceeds to be derived from the gross production of oil and 25 percent of the net production of gas and gasoline products until the full amount of $40,000 should be repaid, it being understood that the payments were to be made from the oil and gas only from the said well. As a further consideration for paying the said money, the petitioner agreed to assign and transfer to the G.P. Corporation, by an assignment to be delivered only after the well should be brought on production, 25 percent of the proceeds from the said gross oil and 25 percent of the net gas and gasoline products. On April 22, 1930, petitioner received an additional sum of $40,000 from the G. P. Corporation. On the same date*1091 it executed and delivered to the G. P. Corporation an assignment of 50 percent of the proceeds to be derived from the sale of oil and gas from Noll Well #1.
Also on January 2, 1930, petitioner entered into a contract with P. G. Cumming, wherein the latter agreed to do all the welding and bit dressing required in connection with the drilling of the Noll Well, and to accept in payment therefor a 2 percent overriding royalty in the well's gross production, "and not otherwise", up to $3,500. Assignment of 1 percent was to be made when $1,750 had been earned, and the remaining 1 percent was to be assigned after the second $1,750 had been earned. These two assignments were made on January 21, 1930, and March 17, 1930, respectively.
On April 3, 1930, petitioner received the sum of $900 from one David H. Cannon, and under date of April 11, 1930, assigned to him one-half of 1 percent interest in the proceeds to be derived from the production of Noll Well #1.
On or about April 16, 1930, petitioner received the sum of $10,000 from the Signal Royalties Co., and under date of May 6, 1930, assigned to it a 5 percent royalty interest in the production from the Noll lease. This assignment, *1092 and the above mentioned assignment to the G. P. Corporation, were made under permits secured from the Commissioner of Corporations of the State of California.
Noll Well #1 was drilled to completion on April 30, 1930, with a total drilling cost of $62,714.01, of which sum $39,025.85 represented intangible expenditures and $23,688.16 represented cost of tangible equipment. The latter sum was capitalized by petitioner and depreciation thereon was allowed by respondent.
Subsequent to the completion of the Noll Well, and on September 24, 1930, petitioner assigned to one G. P. Christensen a 1 percent interest in the proceeds to be derived from the well's production, and received in consideration the sum of $10.
*134 Colter Well #1
In December 1929 petitioner started the drilling of a well on the Colter Lease at Signal Hill, California. The lease provided for landowner's royalty of 22 percent of production.
On January 15, 1930, petitioner entered into a written agreement with the G. P. Corporation, the terms and conditions of which were substantially similar to those contained in the contract of August 23, 1929, with respect to Lewis Well #1. The contract recited*1093 that the petitioner had installed drilling machinery and equipment on a well to be drilled on the leasehold premises and had applied to the G. P. Corporation for $24,000 to assist in drilling the well. Petitioner agreed upon receipt of the $24,000 specified to assign to the G. P. Corporation, by good and sufficient assignment, a 15 percent interest in the proceeds to be derived from the production of the said well. The petitioner also granted an option to the G. P. Corporation to purchase an additional 15 percent interest in the proceeds from said well for the sum of $24,000, or any lesser interest at the rate of $1,600 for each 1 percent interest; provided, however, that the option should be exercised before drilling operations reached 5,000 feet; and provided further, that any assignment that might be made in pursuance of the option should be subject to the conditions set out in connection with the subject matter of the present contract. On April 22, 1930, petitioner received an additional sum of $56,000 from the G. P. Corporation. On the same date it executed and delivered to that corporation an assignment of 50 percent of the proceeds to be derived from the sale of oil and*1094 gas from Colter Well #1. This assignment was made under a permit issued by the Commissioner of Corporations of the State of California.
On February 21, 1930, petitioner entered into an agreement with P. G. Cumming wherein the latter agreed to do all the welding and bit dressing required in connection with the drilling of the Colter Well, and to accept in payment therefor a 2 percent overriding royalty in the well's gross production up to $3,500. Pursuant to the agreement petitioner made a 1 percent assignment on March 20, 1930, and another 1 percent assignment on June 3, 1930.
Colter Well #1 was assigned to G. P. Corporation on April 30, 1930, prior to its completion. The total cost of drilling up to the time of transfer was $46,885.48, of which sum $23,442.74 represented intangible expenditures. The cost of tangible equipment was capitalized by petitioner, but, since the well was transferred prior to its completion, no depreciation was claimed by petitioner nor allowed by respondent.
*135 On June 2, 1930, petitioner sold one-half of 1 percent interest in the well's production to S. E. Goldstein and received in consideration therefor the sum of $800.
In its income*1095 tax returns filed with the collector of internal revenue at Los Angeles, California, the petitioner excluded from gross income the sums of $109,572.50 and $178,710 received by it during 1929 and 1930, respectively, from its sales of production assignment in the four wells. The respondent has determined that such sums constituted income for the year received. In computing petitioner's depletion allowance for the two years, the respondent excluded those sums from the "gross income from the property."
On April 28, 1930, the petitioner entered into a written contract with the G. P. Corporation under the provisions of which petitioner agreed to transfer to that corporation certain assets consisting of leases and oil well equipment, in consideration of its issuance to the petitioner of "an amount of stock equivalent to the amount of stock outstanding as of April 24, 1930" in the G. P. Corporation. The assets of the G. P. Corporation were appraised by the American Appraisal Co. as of April 24, 1930. Its total number of shares of all classes of stock issued and outstanding on that date was 243,408, of which petitioner owned 37,300 shares.
On May 19, 1930, the parties entered into*1096 a supplemental agreement, amending the agreement of April 28, 1930, and providing that petitioner would receive 243,409 shares of stock of the G. P. Corporation instead of 243,408 shares as provided in the original agreement. Petitioner transferred to the G. P. Corporation on April 30, 1930, the assets covered by the original agreement together with other leases and the equipment thereon, and on June 6, 1930, the G. P. Corporation in consideration for such transfer issued to petitioner certificates evidencing 243,409 shares of its common capital stock. Immediately after such issue the total outstanding capital stock of the G. P. Corporation was 486,817 shares, there being no stock outstanding other than the common stock.
The depreciated and amortized cost of the assets transferred by petitioner to the G. P. Corporation was $210,815.19. The value of the stock of the G. P. Corporation received by petitioner in consideration for such transfer was $243,409. In its income tax return for 1930 petitioner treated the above transaction as a reorganization in which no gain or loss is recognized under the statute. The respondent has determined that petitioner's gain of $32,593.81 resulting*1097 from that transaction constitutes taxable income for 1930.
During 1929 petitioner advanced certain sums to the Biltmore Petroleum Corporation on open account. The total assets of that corporation consisted of the Lewis lease, a partially drilled oil well, *136 and certain tools and equipment located thereon. The corporation lost that lease on August 29, 1929, by reason of its inability to comply with the terms thereof. Petitioner thereupon obtained the lease from the landowners, and entered into a written contract with the Biltmore Petroleum Corporation whereby the latter agreed to assign to the petitioner all its right, title, and interest in the equipment and tools on the lease, and petitioner agreed to complete the well and to set aside an amount equivalent to 12 1/2 percent of the net proceeds to be derived from the well's production for the purpose of paying the creditors of that corporation. It was agreed that petitioner should first reimburse itself out of such proceeds and then make pro rata payments to the other creditors. After all the creditors had been paid, then petitioner was to assign the 12 1/2 percent interest to the Biltmore Petroleum Corporation.
*1098 Petitioner brought the well (Lewis Well #1) on production in October 1929, with an initial daily production of 2,300 barrels. This lease was among those transferred to the G. P. Corporation pursuant to the agreement of April 28, 1930, and thereafter the well was operated by that corporation. Petitioner retained the right to receive 21 1/2 percent of the proceeds from the well's production, 12 1/2 percent of which was to be applied in accordance with its agreement with the Biltmore Petroleum Corporation. The application of such proceeds reduced that corporation's debt from $29,591.24 on December 31, 1929, to $15,855.57 on December 31, 1930. The well's production declined rapidly and in November 1930 production of oil ceased entirely. During December 1930 sales of gas amounted to $118.55 while operating expenses totaled $907.43. The G. P. Corporation made various efforts to bring the well back on production, but its operating expenses continued to exceed revenues until June of 1931 and for the entire year 1931 expenses of operation exceeded income from production.
In December 1931 the G. P. Corporation negotiated a sale of the lease, together with tools and equipment thereon. *1099 In order to consummate that sale, it was necessary that petitioner surrender the 21 1/2 percent interest in production then held by it. For such surrender petitioner received the sum of $5,160. By journal entry of December 12, 1931, petitioner credited $3,686.40 of that sum to recovery of capital, and the remaining $1,473.60 to income.
On December 31, 1930, petitioner charged off its books as a bad debt the sum of $16,260.57, which represented $15,855.57 appearing on the Biltmore Petroleum Corporation's open account and also a balance of $405 due on a note of that corporation. The total amount so charged off was claimed as a bad debt deduction on petitioner's *137 income tax return for 1930. The deduction claimed has been disallowed by the respondent.
OPINION.
TURNER: The first issue presented for our determination is whether or not the proceeds received by the petitioner from its sales of production assignments in the four wells constitute income. In the alternative, if that question is decided in the affirmative, then it will be necessary to determine whether the respondent erred in excluding such sums from the "gross income from the property" for the purpose*1100 of computing petitioner's depletion allowance.
The petitioner contends that the amounts received by it from such sales constitute contributions of capital, and not income. . The respondent contends that the transactions constitute sales of property interests and that the gain realized therefrom is income to the petitioner.
In ; certiorari denied, , the court held that where certificates sold cover the production or net income of a completed well specifically described in the certificates, the proceeds from the sale of such certificates constitute income to the lessee and, further, that where the well the production of which is sold is to be drilled or is only partially drilled and there is no obligation on the part of the lessee to return to the certificate holders the excess of moneys received over and above the cost of the well, such excess is income to the lessee. In that case the entire proceeds from the sale of certificates were included in income by reason of the taxpayer's failure to show how much, if any, of such*1101 proceeds were actually used in drilling the well designated.
In the instant case the proof is more complete and definite as to certain of the sums received by the petitioner from production assignments. As to the $25,000 received under the contract of August 23, 1929, in respect of the production of Lewis Well #1, the $40,000 received under the contract of January 2, 1930, in respect of the production of Noll Well #1, and the sum of $24,000 received under the contract of January 15, 1930, for the assignment of production in Colter Well #1, the contract in each instance specifically provided that, the money so paid by the G. P. Corporation to the petitioner was to be used in either drilling or completing the particular well in question. In the first two contracts mentioned it was also provided that the G. P. Corporation could require a showing that the money so paid was actually used in drilling the well or was available to cover the cost of drilling. These contracts fixed the rights and obligations of the parties and under none of them did the petitioner have the right *138 to convert the funds so received to its unrestricted use. Furthermore, we have no reason to assume*1102 that the contracts were not carried out and that the money was not expended by the petitioner in accordance with its obligations thereunder. In the case of each of the three wells the cost of drilling was in excess of the respective sums above mentioned. None of the sums here dealt with constituted income to the petitioner. .
Similarly the sum of $6,000 received from the G. P. Corporation on October 18, 1929, for use in drilling Lewis Well #1, should be excluded from income. The contract there recited that the well was being drilled and the sum of $6,000 was desired for the purpose of its completion. While the contract did not contain a provision for an accounting, it does appear that the petitioner did proceed with the drilling of the well after the receipt of the $6,000 mentioned, bringing it to completion eighteen days later. Furthermore the sum of $25,000 already received and the $6,000 here considered were well within the total cost of the well and it may not be said that upon completion of the well there was any excess of the amounts so received over the cost of the well.
The same ruling applies to the compensation*1103 of P. G. Cumming for services rendered in connection with the drilling of Noll Well #1 and Colter Well #1, for which he received production assignments in each well. The amounts here unquestionably represented the measure of the labor of Cumming which was completely applied to the drilling of the wells and for which he received his interests in the wells. Clearly the petitioner received nothing that might be classified as income.
So far as the record discloses the remaining sums received from the sale of production assignments were received either after completion of the particular well, at or within a very few days of its completion, or the record is silent as to the state of drilling operations at the time of receipt. Further, there is nothing in the record to show that any of the production assignments for which the said sums were received were sold for the purpose of procuring money to drill the particular well or any well. Neither does it appear that there was any understanding or intention on the part of the parties that the moneys so paid to the petitioner should be so used and no proof has been offered by the petitioner to show that any of the sums so received were actually*1104 expended in sinking the well in respect of which the said certificates were sold. On this state of the record the sums so received should be included in petitioner's income for the year in which they were received.
The petitioner contends in the alternative that if the proceeds from *139 the sale of production assignments constitute income the sums so received should be included in "gross income from the property" in computing its depletion allowance under section 114(b)(3) of the Revenue Act of 1928. 1 The respondent contends that the disposition of production assignments by the petitioner were sales of property interests and that the proceeds from such sales were not "gross income from the property" within the meaning of the statute.
*1105 On this issue the respondent must be sustained. The allowance for depletion is permitted where the income in question is derived from an economic interest owned and retained by the taxpayer and which economic interest is subject to exhaustion by reason of the production of oil and gas therefrom. ; ; . On the other hand, a taxpayer is not entitled to a depletion allowance in respect of money received from the sale or disposition of the economic interest itself. In such a case the proceeds from the sales are not derived from property owned and retained by the taxpayer, which property so owned and retained is susceptible of depletion by reason of the production of oil and gas thereon and in respect of which production the payments so received are made. ; ; *1106 ; and . See also . In this case the petitioner parted specifically and finally and for a definite sum of money paid in cash with the production assignments in question. The transactions were sales of the economic interests themselves and not the receipt of income in respect of economic interests in the property owned and retained, and the petitioner is not entitled to the depletion allowance claimed.
On the next issue the petitioner contends that the transaction of April 28, 1930, whereby it transferred certain assets to the G.P. Corporation in exchange for capital stock of that corporation, comes within the meaning of section 112(b)(4) and (i)(1)(A) of the Revenue Act of 1928, hence was a reorganization, and its gain is not *140 recognized for tax purposes. The pertinent provisions of the Revenue Act of 1928 are shown in the footnote. 2
*1107 The respondent contends that the exchange was not made pursuant to a plan of reorganization. He argues that it constituted an outright sale and that the difference between the cost of the assets sold and the value of the stock received, or $32,593.81, constituted taxable income to petitioner.
When the petitioner entered into the contract of April 28, 1930, it already owned 37,300 shares of capital stock of the G. P. Corporation. Under the terms of that contract and the supplemental agreement of May 19, 1930, petitioner acquired 243,409 additional shares, making a total of 280,709 shares, or approximately 59 percent of the total outstanding stock of the G. P. Corporation. That petitioner acquired "at least a majority of the voting stock and at least a majority of the total number of shares of all classes of stock" of the G. P. Corporation, is not denied by the respondent, and we think that such acquisition was made within the meaning of the parenthetical clause of section 112(i)(1)(A), supra. . The respondent's position is that such acquisition was not made pursuant to a plan of reorganization as required by section 112(b)(4), *1108 supra.
We think that the provisions of the contract of April 28, 1930, show that the parties entered into the agreement in pursuance of a *141 plan. The agreement constituted a plan of reorganization if the acts to be performed fall within the meaning of the term reorganization as defined by section 112(i)(1), supra.The respondent places a great deal of importance upon the fact that the parties referred to the transaction as a sale in their supplemental agreement of May 19, 1930. We do not think the fact that they referred to it as a sale would change its nature or effect, nor operate to exclude it from the meaning of the statute if it would otherwise fall therein. . The important fact is that the transaction amounted to a reorganization within the meaning of the statute, and that it was entered into in pursuance of a plan. "The plan of reorganization was the contract made and performed." ; affd., .
The respondent argues in his brief that there is no proof of a continuity of interest on the part of the petitioner in the properties*1109 transferred to the G. P. Corporation. We do not see how it could be otherwise. The petitioner owned certain leases and oil drilling equipment. It transferred these assets to the G. P. Corporation in exchange for capital stock in that corporation. No cash or other securities were involved in the transaction. After the transfer petitioner owned a substantial majority of all the outstanding stock of the G. P. Corporation, which would give it absolute control over the assets transferred as well as all the other assets owned by the G. P. Corporation.
In view of the foregoing we are of the opinion that the transaction in question constituted a reorganization within the meaning of section 112(b)(4) and (i)(1)(A), supra, and petitioner's gain is not recognized for tax purposes. ; ; certiorari denied, ; ; and *1110
The respondent has disallowed the deduction claimed by the petitioner for the year 1930 in respect of the indebtedness of the Biltmore Petroleum Corporation on the ground that there were definite possibilities of collecting the account as at December 31, 1930. The petitioner claims that the debt was worthless in 1930 and that he is entitled to the deduction claimed. In our opinion, however, the facts of record are not sufficient to sustain taht claim. It is true that the only prospect of payment was from the Lewis lease and the production therefrom. It is also true that production of oil from Lewis Well #1 had ceased in November of 1930 and that operating costs in December of that year exceeded the proceeds from the sale of gas, and, further, that operating costs continued to exceed revenues from production until June 1931. It appears, however, that the G. P. Corporation was striving to put the well back on production on a paying basis and the only *142 reasonable inference that may be drawn from the facts stipulated is that it did succeed in accomplishing that purpose by June of 1931, even though the production so obtained may*1111 have been light. It is also a fact that the condition of the well and lease was such that in December 1931 the G. P. Corporation was able to find a purchaser for the property for a reasonably substantial sum and that the petitioner at that time, for the surrender of the 21 1/2 percent interest in production held by it, received cash in the amount of $5,160. While all of the amount so received may not be attributed to the 12 1/2 percent interest looked to for repayment of the indebtedness of the Biltmore Petroleum Corporation, the amount attributable to that interest did further reduce in a substantial way that corporation's indebtedness to the petitioner.
In the light of these facts and in the absence of a more definite showing by the petitioner that it could not reasonably be expected that the well would be brought back on production on a paying basis, we conclude and hold that the petitioner has failed to show that the debt of the Biltmore Petroleum Corporation was worthless at December 3 , 1930, the date on which it was charged off.
Decision will be entered under Rule 50.
Footnotes
1. SEC. 114. BASIS FOR DEPRECIATION AND DEPLETION.
* * *
(b) Basis for depletion. -
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(3) PERCENTAGE DEPLETION FOR OIL AND GAS WELLS. - In the case of oil and gas wells the allowance for depletion shall be 27 1/2 per centum of the gross income from the property during the taxable year. Such allowance shall not exceed 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property, except that in no case shall the depletion allowance be less than it would be if computed without reference to this paragraph. ↩
2. SEC. 111. DETERMINATION OF AMOUNT OF AMOUNT OF GAIN OR LOSS.
(a) Computation of gain or loss -Except as hereinafter provided in this section, the gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the basis provided in section 113, and the loss shall be the excess of such basis over the amount realized. SEC. 112. RECOGNITION OF GAIN OR LOSS. (a) General rule. - Upon the sale or exchange of property the entire amount of the gain or loss, determined under section 111, shall be recognized, except as hereinafter provided in this section.
(b) Exchanges solely in kind. -
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(4) SAME. - GAIN OF CORPORATION. - No gain or loss shall be recognized if a corporation a party to a reorganization exchanges property, in pursuance of the plan of reorganization, solely for stock or securities in another corporation a party to the reorganization.
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(i) Definition of reorganization - As used in this section and sections 113 and 115 -
(1) The term "reorganization" means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or substantially all the properties of another corporation), or (B) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred, or (C) a recapitalization, or (D) a mere change in identity, form, or place of organization, however, effected.
(2) The term "a party to a reorganization" includes a corporation resulting from a reorganization and includes both corporations in the case of an acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation.
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SEC. 113. BASIS FOR DETERMINING GAIN OR LOSS.
(a) Property acquired after February 28, 1913.↩ - The basis for determining the gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall be the cost of such property; * * *