*1052 1. Losses allowable on account of the abandonment or other disposition of oil leases determined.
2. A net loss sustained by a member of an affiliated group in 1923 may not be carried forward under the provisions of section 206 of the Revenue Act of 1926 and allowed as a deduction in computing consolidated net income in 1925 where the corporation which sustained the net loss in 1923 had no net income in 1925.
3. A liquidation in kind held not to have occurred through an agreement between a majority of the stockholders of a corporation and a purchaser of such stock wherein it ws agreed that any income later realized from a certain contrct then held by the corporation would be paid to the stockholders who were then disposing of their stock.
4. After corporation A had acquired 91.1 percent of the stock of corporation B, corporation A transferred the stock so acquired to corporation C, its wholly owned subsidiary, which immediately effected a liquidation of corporation B by taking over its assets and assuming its liabilities. None of the stockholders in coirporation A were stockholders in B. Held, that the proper basis for depreciatioin for corporation C on account*1053 of the assets received in liquidation of corporation B is the fair market value of the assets at the date received.
5. Amounts expended during 1926 for drilling productive oil wells held to be recoverable through depletion rather then by depreciation allowances. Petroleum Exploration v. Commissioiner,288 U.S. 467">288 U.S. 467.
*1108 These proceedings, which were consolidated for hearing, involve deficiencies as determined by the Commissioner as follows:
| 1925 | 1926 | |
| Simms Petroleum Co | None | None |
| Simms Oil Co | $251,456.17 | $52,906.98 |
| Trinity Drilling Co | 10,123.12 | 5,605.49 |
| 261,579.29 | 58,512.47 |
The deficiencies are determined upon the basis of an affiliated group of the three corporations, of which the Simms Petroleum Co. is the parent company and the other two companies are subsidiaries. The various questions presented may be summarized as follows:
(1) What loss, if any, did the Simms Oil Co. sustain*1054 upon the abandonment or other disposition during 1922, 1923, 1924 and 1925 of certain oil leases which were acquired by it in 1919, at the time of its organization?
(2) What deductible loss, if any, was sustained by the Simms Oil Co. during 1923 upon the dissolution of the Rowe Oil Corporation?
(3) Whether the Commissioner properly included in the income of the Simms Oil Co. for 1925 and 1926 certain sums received by said company on account of the assignment of certain rights by the Clayton Oil & Refining Co. to the Atlantic Refining Co.
(4) The proper basis for computing depreciation on the assets of the Clayton Oil & Refining Co. which were acquired by the Simms Oil Co. upon dissolution of the former corporation in 1925.
(5) Is the cost of drilling oil wells under so-called turnkey contracts recoverable in its entirety through depreciation deductions, or is the portion thereof which the Commissioner allocated to intangible costs recoverable through depletion deductions?
*1109 (6) Where the Simms Petroleum Co. sustained a net loss for 1925, is a net loss of such company for 1923 deductible in determining the consolidated net income of the affiliated group here*1055 involved for 1925?
In addition to certain stipulated facts and the evidence submitted at the hearing in these proceedings, the entire record in the case of , in so far as material and relevant, was submitted as evidence in these proceedings.
FINDINGS OF FACT.
Issue No. 1.
1. During 1917, 1918, and the early part of 1919, E. F. Simms acquired leases on approximately 421,000 acres of oil lands in various counties of west central Texas at a cost to him and his associate of $972,012.94. On June 19, 1919, the Simms Oil Co., petitioner, was organized under the laws of Texas, with an authorized capital stock of $10,000,000, and on the same day all of its authorized capital stock (except qualifying shares) was issued to Simms or his nominee for the lease on the 421,000 acres of land referred to above. On June 27, 1919, the Simms Petroleum Co., petitioner, was organized under the laws of Delaware, with an authorized capital stock of 500,000 share os no par value. On June 30, 1919, Simms transferred the entire capital stock of the Simms Oil Co. to the Simms Petroleum Co. in exchange for 280,990 shares of the latter corporation's stock. *1056 At the same time the Simms Petroleum Co. accepted the offer of Knauth, Nachod & Kuhne, brokers and investment bankers, for the purchase of 144,000 of its remaining shares at $25 per share. The brokers immediately sold the stock received by them and duly paid $3,600,000 in cash therefor to the simms Petroleum Co. Of the $280,990 shares received by Simms, 56,000 shares were transferred to Harry Bronner in connection with the transactions referred to above, thus leaving as the consideration received by Simms for the entire capital stock of the Simms Oil Co. 224,990 shares of the Simms Petroleum Co. stock. The entire capital stock of the Simms Oil Co. had a fair market value on June 19, 1919, of $972,012.94. (A more detailed reference to the circumstances surrounding the transactions referred to above will be found in the findings of fact set out by us in the case of , which findings are incorporated herein by reference and made a part of these findings.)
2. During 1922, 1923, 1924, and 1925 certain of the leases involved in the foregoing transaction were abandoned, forfeited, lost by expiration, sold, or otherwise disposed of. The parties have*1057 stipulated that the appropriate portion of the total cost of all of the leases which *1110 were acquired by the Simms Oil Co. as indicated above shall be allocated to the leases lost or disposed of in the years 1922, 1923, 1924, and 1925 in accordance with the following percentages:
| Percent | |
| 1922 | 46.136 |
| 1923 | 34.954 |
| 1924 | 7.497 |
| 1925 | .209 |
The Commissioner, in determining the taxable income of the Simms Oil Co. for 1922, 1923, 1924, and 1925, did not allow any cost basis for the leases disposed of in those years, and included in taxable income the entire proceeds, if any, arising from their disposition.
Issue No. 2.
3. Prior to December 18, 1919, the Simms Petroleum Co. had extended its activities into Louisiana, where it had acquired additional acreage and was producing oil. At or about December 18, 1919, there was a recapitalization of the Simms Oil Co. and an increase in its capital stock. At that time the Rowe Oil Corporation owned oil and mineral leases on certain lands near Homer, Louisiana, and had outstanding 700,000 shares of capital stock. On December 18, 1919, the Simms Petroleum Co. entered into a contract with W. H. Rowe by*1058 which it acquired 379,880 shares of stock of the Rowe Oil Corporation through payment to the said Rowe of $548,137.49 in cash and 17,000 shares of the Simms Petroleum Co. stock. On December 22, 1920, the Simms Petroleum Co. acquired the remaining shares of stock of the Rowe Oil Corporation (except qualifying shares), namely, 320,100, for a cash consideration of $50,000.
4. Between December 18, 1919, the date on which the Simms Petroleum Co. entered into the contract for the acquisition of a majority of the outstanding stock of the Rowe Oil Corporation, as shown above, and December 31, 1923, the date on which the Rowe Oil Corportion was liquidated as hereinafter shown, the Simms Petroleum Co. advanced to or for the account of the Rowe Oil Corporation $511,259.69, of which amount $132,015.25 was advanced prior to the date the two corporations became affiliated for purposes of filing consolidated income tax returns. Of the foregoing advances, $356,767.77 was forgiven and canceled by the Simms Petroleum Co. on or before December 31, 1923, without compensation except as the value of the stock of the Rowe Oil Corporation, held by it, was increased. Advances to the extent of $145,158.59*1059 were unliquidated and outstanding as an indebtedness of the Rowe Oil Corporation at December 31, 1923.
*1111 5. On December 31, 1923, the Simms Petroleum Co. entered into a contract with the Simms Oil Co. by which the latter corporation became the owner of the entire capital stock of the Rowe Oil Corporation. The material parts of the contract read as follows:
Simms Petroleum Company, Incorporated, is the beneficial owner of all the outstanding shares of the capital stock of Rowe Oil Corporation, and it hereby undertakes immediately to surrender or cause to be surrendered for cancellation, all such outstanding shares of the capital stock of Rowe Oil Corporation.
In consideration of the performance of the above undertaking, Simms Oil Company hereby promises on demand to pay to Simms Petroleum Company, Incorporated, the sum of $1,182,053.24.
On the same day (December 31, 1923), the Simms Oil Co. entered into a contract with the Rowe Oil Corporation whereby the Simms Oil Co. acquired all of the assets and assumed all of the liabilities of the Rowe Oil Corporation. The material parts of the contract read as follows:
That Rowe Oil Corporation, a corporation, has bargained, *1060 sold, transferred, conveyed and delivered, and by these presents does bargain, sell, transfer, convey and deliver all of its properties whatsoever, alike real estate and personal property and wheresoever situated, unto Simms Oil Company, a corporation, its successors and assigns.
TO HAVE AND TO HOLD unto Simms Oil Company, its successors and assigns forever.
In consideration of this sale and assignment, Simms Oil Company hereby assumes all obbligations whatsoever of Rowe Oil Corporation and in further consideration thereof, Simms Oil Company hereby undertakes to cause all outstanding shares of the capital stock of Rowe Oil Corporation to be surrendered for cancellation.
The Rowe Oil Corporation was thereupon dissolved.
6. The fair market value of the assets of Rowe Oil Corporation distributed on its liquidation at December 31, 1923, less the liabilities of Rowe Oil Corporation assumed or canceled by Simms Oil Co., other than the indebtedness of Rowe Oil Corporation to Simms Petroleum Co., was $99,669.38.
7. The Simms Petroleum Co. and the Simms Oil Co. filed consolidated returns for the years 1920 to 1925, inclusive. The Rowe Oil Corporation was included in the same*1061 returns for December 1920, and the years 1921, 1922, and 1923. The Trinity Drilling Co. was also a member of the same group for 1924, 1925, and 1926. The following stipulation was submitted as to the years involved:
The net income or net loss of the petitioners and other corporations included in the same affiliated group, respectively, during the years in question, before deducting the net loss for previous years, as determined by the Respondent and before giving effect to adjustments which the petitioners claim are proper, were as follows:
| SIMMS PETROLEUM | ||||
| COMPANY | 1922 | 1923 | 1924 | 1925 |
| Net loss | $18,158.27 | $75,343.16 | $58,806.20 | $86,012.62 |
| SIMMS OIL COMPANY | ||||
| Net loss | 89,307.48 | |||
| Net income | * 558,271.62 | 1,048,306.86 | 2,016,874.06 | |
| ROWE OIL | ||||
| CORPORATION | ||||
| Net loss | 90,413.86 | 64,165.08 | ||
| TRINITY DRILLING | ||||
| COMPANY | ||||
| Net income | 16,164.55 | 81,286.92 |
*1112 The losses from operations of the Rowe Oil Corporation for December 1920, were $48,968.88 and for the year 1921, $64,994.28.
Issues No.*1062 3 and No. 4.
On October 19, 1922, the Gasoline Products Co. (hereinafter sometimes referred to as the Gasoline Co.), as licensor, and the Clayton Oil & Refining Co. (a Delaware corporation and hereinafter sometimes referred to as the Clayton Co.), as licensee, entered into an agreement whereby the Clayton Co. was granted a license to install and operate units for the cracking of petroleum under the so-called "Cross process." This license extended to apparatus having a daily throughput capacity of 30,000 barrels. On October 9, 1924, the Clayton Co., the Gasoline Co. and the Atlantic Refining Co. (hereinafter sometimes referred to as the Atlantic Co.) entered into certain agreements under which the Clayton Co. assigned to the Atlantic Co. rights under its agreement with the Gasoline Co., dated October 19, 1922, to the extent of apparatus with a daily throughput capacity of 20,000 barrels. The Atlantic Co. thereby agreed to pay royalties to the Gasoline Co. respecting such apparatus and the Gasoline Co. in turn agreed to pay or cvasue to be paid to the Clayton Co. the sum of $8,000 in respect of each 1,000 barrels daily capacity thereof within ten days following the payment of royalties*1063 to the Gasoline Co. by the Atlantic Co. The assignment provided that the rights granted thereunder would lapse unless execrcised within certain stated periods and/or also upon the failure of the Atlantic Co. to pay the royalties when due.
On May 14, 1925, while the arrangements contemplated by the foregoing agreements were in effect, but before any sums had become payable thereunder, G. M. P. Murphy & Co. (hereinafter sometimes *1113 referred to as Murphy & Co.), as the owner or in control of at least two thirds of each class of stock of the Clayton Co., entered into an agreement with the Simms Petroleum Co. for sale to the latter company of the outstanding stock, preferred nd common, of the Clayton Co. Among the recitations set out in the agreement was the following:
That, annexed hereto, made part hereof, and marked "Exhibit E", is a true copy of the contract between the company [Clayton Co.] and Gasoline Products Company, Inc., of date 19th day of October, A.D. 1922, under which the Company acquired an assignable license for the use of the Cross Process under letters patent of the United States, which contract permits the Company a through-put volume of 30,000 barrels*1064 per day. That on or about October, 1924, the Company entered into an arrangement with the Gasoline Products Company, Inc., whereby the Company agreed to assign 20,000 barrels per day of its 30,000 barrels per day through-put volume, to the Atlantic Refining Company, under an agreement whereby the Company is to be paid for such assigned rights certain specified sums of money at later dates, fixed by such agreement. All sums to be paid for such assignment and such rights and the right to receive same, are to become the property of those persons who are stockholders of the Company just prior to the delivery of shares to be made by Vendors to Purchaser hereunder, through some legal arrangement which shall be formulated by, and acceptable to, the Vendors, and at such time as the Vendors may designate, nd to these ends the Purchaser, if necessary, shall co-operate. * * *
The consideration to be paid by the Simms Petroleum Co. for the Clayton Co. stock was fixed as follows:
Thereupon, the vendors agree to transfer and deliver to the Purchaser, and the Purchaser agrees to accept and pay for, upon the basis fixed herein, not less than 5,000 nor more than 7,400 shares of preferred stock*1065 of the Company and not less than 13,000 nor more than 19,075 shares of the common stock of the Company, the Purchaser agreeing to accept and pay for not less than the minimum quantity stated and as much more as may be tendered up to the maximum quantities stated, and the Vendors undertaking and agreeing to deliver at least the minimum quantities states and as much more, up to the maximum quantities stated, as they may be able to tender after reasonably diligent, good faith efforts to obtain the largest practicable quantities of each class of such stock.
The price to be paid by the Purchaser for all stock delivered to it hereunder shall be fixed and arrived at as follows: On the basis of 7,400 shares of preferred stock and 19,075 shares of common stock, the total price to be paid shall be $1,026,000.00, as follows: (a) for each share of preferred stock, its par value, plus all unpaid dividends stipulated for in such shares to accrue to July 1, 1925; (b) for ech share of common stock its pro rata part of the sum which will remain apportionable to common stock out of the said sum of $1,026,000.00, after deducting from such sum the total amount apportionable to and payable upon 7,400*1066 shares of preferred stock, on the basis set out in subdivision (a) of this section.
If approved by counsel of Company, it will declare and pay to holders of its preferred stock all dividends to accrue to July 1, 1925, on its outstanding preferred stock, not, however, to exceed $135,000.00. In case of any such declaration *1114 and payment of dividends on preferred stock between the date of this contract and the delivery of shares by Purchaser under this contract, the purchase price to be paid for all shares shall be diminished by the amount of such dividend so paid, and the sum to be apportioned to each share of preferred stock shall also be correspondingly reduced, leaving undisturbed the sum to be apportioned to common stock. In case the Company shall conclude to pay such dividends, or any portion thereof, and shall deem it to be to its interest to borrow money for the purpose, the Purchaser, at the time of taking delivery of the major blocks of stock to be sold it by the Vendors agrees either to loan money to, or arrange credit for funds for, the Company for such purpose.
The Company shall have the right to provide for and pay additional or back compensation to certain*1067 of its officers and employees, not in excess, in the aggregate, of $35,000.00, but if any such compensation be paid between the date of this contract and the date of delivery of the major blocks of shares sold hereunder, the basis price to be paid by Purchaser for shares hereunder shall be diminished by such sum as may be so paid by the Company, and in such case the amounts payable upon, and apportionable to, common stock shall be correspondingly and proportionately reduced.
On June 10, 1925, in contemplation of the "legal arrangement" referred to in the first quotation set out above, the following proposal was made by the Simms Petroleum Co. and accepted by Murphy & Co.:
1. Any of the rights not exercised and paid for by Atlantic Refining Company and reverting to the Clayton Company may be exercised by Clayton Company, or may be sold by it to Simmis Petroleum Company or any company in which the Simms Petroleum Company owns at least forty-nine per cent. of the outstanding voting capital stock. As to any rights so reverted and so exercised or sold, Clayton Company shall, for the purposes of this agreement, be deemed to have received eight dollars for each one barrel of rated*1068 daily capacity of such rights so exercised or sold.
2. Upon receipt by Clayton Company from Atlantic Refining Company or Gasoline Products Company, Inc. of the proceeds of sale of any such rights and upon the exercise by Clayton Company (by installation of apparatus) and the sale of any such reverted rights to Simms Petroleum Company or any such company in which it has a stock interest, Simms Petroleum Company agrees forthwith to pay over to Murphy and Company for the account of holders of the shares of common stock of Clayton Company actually delivered by Murphy and Company to Simms pursuant to the provisions of said agreement of May 14, 1925, a proportionate part of the net proceeds realized by Clayton Company from such sales, after deducting the amount of any federal income taxes payable by Clayton Company in respect thereto, equal to the same percentage of such net proceeds as the percentage of the number of shares of common stock of the Clayton Company actually delivered by Murphy and Company to Simms bears to the 19,075 shares of such common stock now outstanding.
3. Murphy and Company agrees that it will provide for the immediate distribution of all sums so paid to it*1069 by Simms Petroleum Company to and among the holders of common stock of the Clayton Company delivered by Murphy and Company to Simms Petroleum Company pursuant to said contract of May 14, 1925. Murphy and Company agrees that all sums received by Clayton Company as the proceeds of the rights above mentioned may be retained by the Clayton Company.
*1115 Under and pursuant to the provisions of the contract referred to above as having been entered into on May 14, 1925, between the Simms Petroleum Co. and Murphy & Co., all the outstanding stock, preferred and common, of the Clayton Co. was received by and transferred to the Simms Petroleum Co. between May 14, 1925 and December 28, 1925.
On July 1, 1925, the following resolution was adopted by the executive committee of the Simms Petroleum Co.:
WHEREAS, This Company has acquired, or has received advice that there will be tendered to it for acquisition, a total of 7,395 shares of preferred stock and 18,983 shares of common stock of Clayton Oil & Refining Company, being 99.9% and 99.5% of the respective outstanding issues, and
WHEREAS, it seems advisable for Simms Oil Company, the operating subsidiary of this Company, to conduct*1070 the refining and distributing operations taken over in the acquisition of Clayton Oil & Refining Company centering at Dallas, Texas, it is
RESOLVED, that the officers of this Company, and of its subsidiary, Simms Oil Company, be and they hereby are authorized to take whatever steps may be necessary or advisable to dissolve Clayton Oil & Refining Company and to transfer its assets to Simms Oil Company.
On July 2, 1925, the board of directors of the Clayton Co. adopted the following resolution:
WHEREAS, Clayton Oil & Refining Company is the owner of refineries and other properties and it is desired that the ownership and operation of such properties shall rest in Simms Oil Company, in order that the operations of production and refining be brought together, and in order that Clayton Oil & Refining Company may be liquidated, and
WHEREAS, Simms Petroleum Company is the owner of 7,245 shares of Preferred Stock (out of a total outstanding issue of 7,400 shares) and 16,864 shares of Common Stock (out of a total outstanding issue of 19,075 shares) of Clayton Oil & Refining Company; the remaining outstanding shares of that company being owned by divers other persons, and
WHEREAS, *1071 Simms Petroleum Company has consented to the transfer of such properties for liquidation, etc., and the eventual dissolution of Clayton Oil & Refining Company,
THEREFORE, IT IS RESOLVED:
(1) That Clayton Oil & Refining Company make legal transfer of all of its assets of every description to Simms Oil Company - the latter company assuming all outstanding obligations of Clayton Oil & Refining Company, except its obligations of liquidation to its stockholders.
(2) That Simms Oil Company, in consideration of the transfer to it of such properties, shall acknowledge itself indebted to Simms Petroleum Company in the sum of $861,872.71, plus whatever sums may be received by Simms Oil Company from time to time representing proceeds of assignment of rights to 20,000 barrels cracking capacity, as set forth in contract between Simms Petroleum Company and G. M. P. Murphy and Company, dated June 10, 1925, and that it shall execute to Simms Petroleum Company such evidences of such indebtedness as may be agreed upon between such companies; Simms Petroleum Company to undertake to liquidate the outstanding shares of Clayton Oil & Refining *1116 Company held by persons other than Simms*1072 Petroleum Company, at the rate of $100.00 per share for each share of Preferred Stock; and $6.389132 per share for each share of Common Stock, plus (to holders of Common Stock only) a proportionate amount of such sums so received on account of assignment of rights, less Federal income taxes payable with respect thereto, and to acknowledge itself to have received in liquidation of its interests and shares in Clayton Oil & Refining Company full satisfaction for the same in the aforesaid obligation to it of Simms Oil Company.
(3) That, upon compliance with the foregoing, the officers of Clayton Oil & Refining Company be, and hereby are, authorized to execute and deliver to Simms Oil Company conveyances of title to all singular, the assets, real, personal and mixed, of Clayton Oil & Refining Company upon recital of a consideration of $1.00 and other valuable considerations.
(4) That Clayton Oil & Refining Company be dissolved upon the filing in the office of the Secretary of State, of the State of Delaware, of such certificates, etc., as the law requires.
Pursuant to the foregoing resolution the Clayton Co. thereupon executed and delivered an instrument conveying all its assets*1073 to the Simms Oil Co., and at the same time or shortly thereafter the Simms Petroleum Co., the Simms Oil Co., and the Clayton Co. entered into an agreement which provided in part as follows:
THIS AGREEMENT WITNESSETH that Simms Petroleum Company agrees to and acquiesces in said sale of assets of Clayton Oil & Refining Co. to Simms Oil Company in consideration for an open account receivable from Simms Oil Company in the amount of $861,872.71, plus certain additional sums as set forth above and Simms Petroleum Co. agrees and undertakes to liquidate the interests of the other stockholders in Clayton Oil & Refining Co. by paying to holders of preferred stock $100 per share for such stock and to holders of common stock $6.389132 per share, plus a proportionate share of sums received on account of assignment of rights to 20,000 barrels cracking capacity, less Federal income taxes, payable in respect thereto.
A certificate of dissolution of the Clayton Co. was issued on December 28, 1925.
Pursuant to the contracts, assignments, etc., as referred to above, the following amounts were paid by the Atlantic Co. to the Gasoline Co. on the dates indicated:
| Oct. 16, 1925 | $390,000 |
| Nov. 6, 1925 | 130,000 |
| Nov. 19, 1925 | 130,000 |
| Dec. 7, 1925 | 130,000 |
| Dec. 21, 1925 | $130,000 |
| Dec. 31, 1925 | 130,000 |
| Jan. 7, 1926 | 130,000 |
| Oct. 1, 1926 | 130,000 |
*1074 Thereafter, and on the dates set forth, checks for the following amounts were drawn by the Gasoline Co. to the order of the Clayton Co.:
| Oct. 16, 1925 | $48,000 |
| Nov. 6, 1925 | 16,000 |
| Nov. 20, 1925 | 16,000 |
| Dec. 7, 1925 | 16,000 |
| Jan. 2, 1926 | $16,000 |
| Jan. 2, 1926 | 16,000 |
| Jan. 7, 1926 | 16,000 |
| Oct. 1, 1926 | 16,000 |
*1117 The foregoing amounts, for which checks were so drawn, had been credited to the Clayton Co. on the books of the Gasoline Co. as follows:
| Oct. 1925 | $48,000 |
| Nov. 1925 | 32,000 |
| Dec. 7, 1925 | 16,000 |
| Dec. 21, 1925 | 16,000 |
| Dec. 31, 1925 | $16,000 |
| Jan. 7, 1926 | 16,000 |
| Oct. 1, 1926 | 16,000 |
Each of the aforementioned checks was endorsed by Alfred J. Williams as assistant treasurer of the Clayton Co. to the order of the Simms Petroleum Co. The checks were thereafter deposited in the bank account of the Simms Petroleum Co. and the said company in turn paid to Murphy & Co. the following amounts on the dates set forth:
| Oct. 19, 1925 | $41,988.99 |
| Nov. 9, 1925 | 13,996.33 |
| Nov. 21, 1925 | 13,996.33 |
| Dec. 8, 1925 | 13,996.33 |
| Jan. 4, 1926 | $27,992.66 |
| Jan. 7, 1926 | 13,996.33 |
| Oct. 1, 1926 | 13,920.00 |
Murphy returned*1075 $1,043.38 on October 7, 1926, to complete a reserve for taxes.
The balance of the sums so deposited in the account of the Simms Petroleum Co., and which was withheld as a reserve for the possible payment of Federal taxes, was credited on its books to the account of the Simms Oil Co.
Pursuant to the contracts referred to above, as executed May 14, 1925, and June 10, 1925, by and between Murphy & Co. and the Simms Petroleum Co., the sums paid to Murphy & Co. were disdistributed by Murphy & Co. to the persons who were the holders of record of the common stock of the Clayton Co. immediately prior to the transfer of said shares to the Simms Petroleum Co.
The registered holders of stock of the Clayton Co., from whom the stock was transferred to the Simms Petroleum Co., were not at any time during the calendar year 1925 registered holders of stock of the Simms Petroleum Co.
The depreciated cost to the Clayton Co. of its refinery and marketing plant and equipment at the date of its liquidation to the Simms Oil Co. was $667,581.45. The fair market value of those assets at that date was $726,375.35. The parties have stipulated that if the latter amount is used as a basis for determining*1076 the depreciation allowable to the Simms Oil Co. on those assets, such corporation is entitled to an allowance of additional depreciation for 1925 of $4,418.94 and of additional depreciation for 1926 of $8,837.90.
The amounts set out above as having been paid by the Gasoline Co. to the Clayton Co. and later transferred as indicated were not included in the consolidated returns as filed by the Simms Petroleum *1118 Co., the Simms Oil Co., and the Trinty Drilling Co. for the calendar years 1925 and 1926, though the Commissioner in his determination included the entire amount as taxable to the Simms Oil Co. as follows: $96,000 in 1925, and $64,000 in 1926.
Issue No. 5.
The Simms Oil Co. was the owner of an oil lease known as the Palacios lease on which 19 wells were drilled during 1926 at a cost of at least $114,400. The drilling was carried out under what is termed "turnkey contracts." The contracts for drilling the wells were of a standard type, similar to those previously considered by the Board on issues of this character, and they are incorporated herein by reference and made a part of these findings. When completed the wells became producing wells.
When the*1077 foregoing expenditures were made, the Simms Oil Co. followed a practice, which had been followed since the beginning of the company, of capitalizing the items which referred to physical equipment, such as the derrick and casings, and charging to expense the remaining items such as labor, fuel oil, services for hauling equipment, and geological and engineering advice. Subsequent to an examination by a revenue agent and subsequent to 1926, the company changed its practice and capitalized the entire amount for 1926. No part of the expenditures has been allowed as a deduction in computing the taxable income of the Simms Oil Co. The following stipulation was submitted by the parties as to the portion of the above mentioned expenditures on which the petitioners contend they are entitled to a depreciation allowance:
The Respondent has not allowed any depreciation for 1926 against $82,827.60 expended in connection with the wells on said Palacios lease under a form of contract to be introduced in evidence, but has determined $17,144.30 as the depletion for 1926 against such cost. Gross income from said lease for said year was $176,412.87. The Respondent determined that the net*1078 income of said lease for said year, before deducting allowance for depletion, was $101,403.79. The Respondent allowed depletion of $48,513.54, which includes the allowance for depletion against the cost of the wells.
OPINION.
Issue No. 1.
SEAWELL: The first issue involved is entirely one of fact, namely, the amount of losses to which the Simms Oil Co. is entitled on account of the abandonment or other disposition of certain oil leases in 1922, 1923, 1924, and 1925. The parties have stipulated that the Commissioner did not allow any cost basis on account of the acquisition of the leases in question on June 20, 1919, and accordingly *1119 included in taxable income the entire proceeds, if any, arising from their disposition. We have found as a fact that the cost of the leases to the Simms Oil Co. was $972,012.94 and the parties have stipulated the percentage of such cost which is applicable to the leases abandoned in the several years referred to above. The losses allowable (to the extent material in these proceedings) will accordingly be determined on the basis of the cost as determined herein and the percentage of such cost as stipulated by the parties as applying*1079 to the several years referred to.
Issue No. 2.
On this issue the error assigned in the petition is, first, that the Commissioner erred in failing to recognize a loss of $673,852.02 sustained by the Simms Petroleum Co. in 1923 through the disposal on December 31, 1923, of the stock owned by it in the Rowe Oil Corporation to the Simms Oil Co. The computation of the loss was set out in the petition as follows:
| Cost of the Rowe Oil Corporation stock | |
| Cash | $598,137.49 |
| 17,000 shares of Simms Petroleum Co. at | 901,000.00 |
| an alleged value of $53 per share | |
| Total | $1,499,137.49 |
| Capital contribution of Simms Petroleum | 356,767.77 |
| Co. to Rowe Oil Corporation resulting from | |
| forgiveness of indebtedness | |
| $1,855,905.26 | |
| Less: Consideration named in the contract | 1,182,053.24 |
| of Simms Petroleum Co. with Simms Oil Co. | |
| for the sale of the Rowe Oil Corporation | |
| stock | |
| Alleged loss sustained | $673,852.02 |
It is further contended that the Simms Oil Co. sustained a loss on the same day of $1,227,542.45 as a result of the liquidation and dissolution of the Rowe Oil Corporation, computed as follows:
| Cost of Rowe Oil Corporation stock | $1,182,053.24 |
| Indebtedness of Rowe Oil Corporation to Simms | 145,158.59 |
| Petroleum Co. assumed by Simms Oil Co. | |
| $1,327,211.83 | |
| Less: Net fair market value (exclusive of above | 99,669.38 |
| indebtedness) of assets of Rowe Oil Corporation | |
| distributed in complete liquidation of Rowe Oil | |
| Corporation on December 31, 1923 | |
| Alleged loss sustained | $1,227,542.45 |
*1080 In considering this issue it should be observed at the outset that the year in which the alleged losses occurred is not before the Board, but what the petitioners desire is to use such losses in increasing or *1120 creating net losses in 1923 which may be carried forward and allowed as deductions in computing net income for 1925. Further, it should be kept in mind that at the time the transactions in question took place the Simms Petroleum Co. owned all the capital stock of the Simms Oil Co. and the Rowe Oil Corporation, and the three corporations filed a consolidated return for 1923. While a loss was claimed in the petition for the Simms Petroleum Co., as set out above, no mention is made of such loss in their brief, but the entire argument advanced is on account of the loss to the Simms Oil Co. In any event, we think it clear that whatever net loss may have been sustained by the Simms Petroleum Co., either as a result of the transactions here referred to or otherwise, may not be availed of by it in 1925 under the provisions of section 206 of the Revenue Act of 1926, since the Simms Petroleum Co. had no income in that year against which such net loss might be applied. *1081 In other words, a net loss sustained by a member of an affiliated group may not be availed of in a subsequent year for an amount greater than its own income in such subsequent year. ; ; ; affd., ; ; affd., ; and .
Nor can we agree with the petitioners that the loss which occurred on account of the liquidation of the Rowe Oil Corporation is one which was sustained by the Simms Oil Co. In short, what occurred was that the Simms Petroleum Co. acquired the entire capital stock of the Rowe Oil Corporation in 1919 and 1920 and held such stock until December 31, 1923, when it determined to liquidate the Rowe Oil Corporation. At the same time the Simms Petroleum Co. owned the entire capital stock of the Simms Oil Co. On December 31, 1923, the net value of the assets of the Rowe Oil Corporation was $99,669.38, exclusive of an indebtedness to the Simms*1082 Petroleum Co. of $145,767.77, which, if taken into consideration, would show liabilities in excess of assets of approximately $46,000. Regardless of the lack of value attaching to the assets of the Rowe Oil Corporation, the Simms Petroleum Co. entered into a contract with its other wholly owned subsidiary, the Simms Oil Co., whereby the latter would pay to the parent $1,182,053.24 for the assets of the Rowe Oil Corporation in addition to assuming the liability of the Rowe Oil Corporation to the Simms Petroleum Co. On the same day the Rowe Oil Corporation liquidated to the Simms Oil Co. and thereupon dissolved. Of course, if we would view the situation as the petitioners would have us view it, namely, *1121 in its separate aspect as an acquisition of the stock of the Rowe Oil Corporation by the Simms Oil Co. and the liquidation of the former corporation to the latter, a loss on the part of the Simms Oil Co. would be said to have occurred in the amount of the difference between the cost of the stock to the Simms Oil Co. and the net value of assets received (*1083 ; affd., ), but we are convinced that what occurred can not be looked at in that manner. Prior to December 31, 1923, there was no apparent corporate connection between the Rowe Oil Corporation and the Simms Oil Co. other than might be said to exist because of a common parentage in the form of the Simms Petroleum Co., but such a relationship does not alter the fact that each of the corporations is separate and distinct and each corporation in an affiliated group must be looked at as a separate taxpayer. Cf. , and In short, what may be carried forward in the form of a net loss by each member of an affiliated group (after appropriate use of such net loss in determining the consolidated net income for the year in which the loss occurred) is its own net loss and not the loss either of the group or of some other member.
When considered in the foregoing manner we fail to see how it can be said that the Simms Oil Co. sustained a net loss through the liquidation of the Rowe Oil Corporation in 1923 which*1084 may be carried forward and allowed as a deduction in computing its net income for 1925. Certainly a situation here exists for an application of the well recognized principle in tax cases that substance should prevail over form, since in the merest form only can it be said that the Simms Oil Co. sustained a loss through the transaction in question. Obviously, the Simms Oil Co. was acting merely as the nominee of the Simms Petroleum Co. in effecting the liquidation and dissolution of the Rowe Oil Corporation, and the transfer of the Rowe Oil Corporation stock from the Simms Petroleum Co. to the Simms Oil Co. was in no sense an arm's length transaction. To recognize such a loss as the loss of the Simms Oil Co. would be tantamount to the recognition of a loss created without regard to the realities of the situation. How the consideration named in the contract between the Simms Petroleum Co. and the Simms Oil Co. was arrived at does not appear, but apparently it might well have been any other amount, large or small, which the exigencies of the occasion or the desires of the parties might have dictated. But even if we should overlook the evident fact of nominee relationship existing*1085 on the part of the Simms Oil Co., would it not be a most unusual situation for a deductible loss to arise on account of the acquisition of a negative quantity? We think so. On the whole, we are of the opinion that whatever *1122 deductible loss arose on account of the transactions in question was that of the Simms Petroleum Co. and, as we pointed out under a discussion of another phase of this issue, since that corporation had no net income in 1925, any net loss which arose in 1923 may not be availed of either by itself or the other members of the group in 1925.
Issue No. 3.
The errors assigned on this issue are that the Commissioner erroneously included certain amounts in the income of the Simms Oil Co. which were paid to the former stockholders of the Clayton Co. as set out in our findings. A brief recital of the facts, which are somewhat complicated by the various corporations and contracts involved, should make the issue clear. In 1922 the Clayton Co. secured certain rights from the Gasoline Co. to crack gasoline under patents owned by the latter corporation. Shortly thereafter the Clayton Co. assigned some of the rights so received to the Atlantic Co. under*1086 a contract which provided that the Clayton Co. would receive some of the royalties to be paid by the Atlantic Co. to the Gasoline Co. On May 14, 1922, and before any amount had become payable under the foregoing arrangements, the Simms Petroleum Co. entered into an agreement with Murphy & Co., owners or in control of some two thirds of the stock of the Clayton Co., for the acquisition of stock of the Clayton Co. In addition to the amount stated in the agreement to be paid for the stock, it was provided that all sums to be paid the Clayton Co. under its royalty arrangements with the Gasoline Co. and the Atlantic Co. would become the property of the stockholders of the Clayton Co. who were stockholders of record of such company immediately prior to the transfer of the stock to the Simms Petroleum Co. By July 2, 1925, the Simms Petroleum Co. had acquired 91.1 percent of the Clayton Co. stock under the agreement with Murphy & Co. and at that time the Simms Petroleum Co. owned the entire capital stock of the Simms Oil Co. On July 2, 1925, the Clayton Co. authorized the sale and transfer of its assets to the Simms Oil Co. as of June 30, 1925, and such authorization was carried out. In*1087 such sale the Simms Oil Co. took over the assets and assumed the liabilities of the Clayton Co. and also obligated itself to pay $861,872.71 to the Simms Petroleum Co. In addition the Simms Oil Co. accepted or acquiesced in the arrangement by which any payments to be made on account of the assignment of rights to the Atlantic Co. would be paid to the former stockholders of the Clayton Co. Between May 14 and December 28, 1925, all the outstanding stock of the Clayton Co. was acquired by the Simms Petroleum Co. pursuant to its contract with Murphy & Co., and on December 28, 1925, the Clayton Co. was formally dissolved. *1123 As payments became due and payable under the assignment of rights by the Clayton Co. to the Atlantic Co. they were made to the parties who it was agreed should receive them, namely, they were eventually lodged in the hands of the former stockholders of the Clayton Co.
Our question is whether the Commissioner erred in including the foregoing payments in the taxable income of the Simms Oil Co., the successor in interest of the Clayton Co. If the payments had been made to the Clayton Co. in the ordinary course of events the amounts so paid would have constituted*1088 income; in other words, the Clayton Co. had an income-producing asset in the form of a contract, the income from which would have been taxable to it. Further, no question is raised that the income would not have likewise been taxable to the Simms Oil Co., the successor in interest of the Clayton Co., had it not been for the contract which was entered into for the benefit of the old stockholders of the Clayton Co. Our question is whether as a result of the agreement between Murphy & Co. (representing the old stockholders) and the Simms Petroleum Co. there was such a change in the status of the income to be received that it would be taxable to the old stockholders without first having become the income of the Simms Oil Co.
The major contention advanced by the petitioners is that the contracts of the Clayton Co. with the Gasoline Co. and the Atlantic Co. were a contingent claim which was distributed as a dividend in kind to the stockholders of the Clayton Co. and the proceeds thereof were not, in any event, income of the Simms Oil Co. Admittedly, there is much that may be said in support of such a proposition, but we think such a conclusion overlooks certain basic corporate principles*1089 and certain important facts which are present in the case at bar. In the first place, the contracts of May 14 and June 10, 1925, did not have the Clayton Co. as a party; they were between Murphy & Co., which either owned a majority of the stock of the Clayton Co. or represented a majority of its stockholders, and the Simms Petroleum Co., which was buying the Clayton stock. That a corporation is separate and distinct from its stockholders and that a corporation owns the corporate assets rather than its stockholders are too well established to require citation of authority in support thereof. Accordingly, we fail to see why the position of the Clayton Co. as a separate taxable corporate entity was in any manner changed as a result of contracts to which it was not a party; the royalty contract remained as its asset and any income to be derived therefrom would have been taxable to it.
So far we do not think the petitioners seriously question that a distribution in kind had not taken place, but they say that the action of the Clayton Co. in connection with the transfer of its assets to the *1124 Simms Oil Co. and its liquidation and dissolution amounted to a ratification of*1090 the stockholders' contracts with the Simms Petroleum Co. and thus completed the action necessary for an effective distribution in kind of the royalty contract to the old Clayton stockholders. We are constrained to disagree. It is true that the trilateral agreement of the Simms Petroleum Co., the Simms Oil Co., and the Clayton Co. specifically recognizes the contract as to the payments to the old stockholders and the same is true of the resolution adopted by the board of directors of the Clayton Co. for the transfer of its assets to the Simms Oil Co., but the fact remains that the asset itself was transferred to, and became the property of, the Simms Oil Co. At that time no income had accrued or become payable under the royalty contract in question. Even, therefore, if we agree that the contract between Murphy & Co. and the Simms Petroleum Co. had been acquiesced in and accepted by the Clayton Co. and the Simms Oil Co., we have nothing more than an assignment of income to arise in the future, which has long been recognized as taxable to the assignor when it arises. *1091 , and ; affd., ; certiorari denied, . Certainly, if a dividend in kind had been intended, we see no reason why it could not have been accomplished through the assignment of the asset itself instead of retaining what seems like a most cumbersome way of having the income pass through the several hands before reaching the old Clayton stockholders. Under the petitioners' theory, the Simms Oil Co. became a mere stakeholder with no interest whatsoever in the contract or its proceeds other than to turn the proceeds over to the old stockholders. The extent to which that proposition is true we shall not attempt to determine, though the more reasonable view would seem to be that for some reason the Simms interest desired to retain a measure of control over the royalty contract. Whether the retention of the contract meant some possible benefit to the Simms interest does not appear, though it is difficult to conceive that any other reason would have prompted the action taken. Further, the parties to the contracts seemed to have recognized at*1092 least the possibility that the income under the royalty contract would be taxable to the Simms Oil Co., since it was provided that the amount to be distributed to the old stockholders was the amount paid by the Atlantic Co. "less Federal income taxes, payable in respect thereto." The course pursued was in accordance with that understanding, namely, the Simms Oil Co. retained an amount estimated as sufficient to cover the Federal taxes and the balance was distributed. In any event, it is clear that the royalty contract passed to the Simms Oil Co. and we can see no basis under our scheme of taxation by which the income derived therefrom would *1125 not be taxable to it even though it distributed such income in accordance with a preexisting contract to persons who were not its stockholders at the date of distribution.
The further contention is made that even if it should be held that the amounts in question are taxable to the Simms Oil Co., in any event two amounts which were shown in our findings as having been credited on the books of the Gasoline Co. to the Clayton Co. on December 21 and December 31, 1925, but were not paid by the Gasoline Co. until January 2, 1926, were*1093 erroneously included by the Commissioner in taxable income for 1926, when they should have been included in taxable income for 1925. The Commissioner maintains that the position as set out in the deficiency notice is correct, though he pleads affirmatively that in the event the two amounts should be taxed in 1925 instead of 1926, the deficiency for 1925 should be increased accordingly. The answer to the question rests upon a determination whether the amounts were constructively received in 1925 when the credits to the Clayton Co. were placed upon the books of the Gasoline Co. The Commissioner's various regulations which have been promulgated under the several revenue acts (including art. 51 of Regulations 69), as well as numerous court and Board decisions, have applied the principle that the doctrine of constructive receipt is inapplicable unless the amount in question is unqualifiedly subject to the demand of the party who would receive the same. Certainly, we can not say, because the amounts were credited to the Clayton Co. by the Gasoline Co., that they therefore became unqualifiedly subject to the demands of the Clayton Co. prior to their payment. The most that can be said*1094 is that the crediting was evidence that the Gasoline Co. was living up to its contract and the same might be said of the payments by the Atlantic Co. to the Gasoline Co., but we are unwilling to say from such evidence that the amounts thereby became unqualifiedly subject to the demand of the party to whom credited.
Issue No. 4.
The error assigned under this issue relates to the same transaction as the previous issue and has for its ultimate question the basis for depreciation by the Simms Oil Co. of the assets received by it through the liquidation of the Clayton Co. on July 2, 1925. More specifically, the question is whether the cost to the Clayton Co. or the cost to the Simms Oil Co. as represented by the fair market value of the depreciable assets at the date of liquidation of the Clayton Co. is to be used as the basis for depreciation by the Simms Oil Co.
The position of the Commissioner is that there was here a reorganization (a merger) within the meaning of that part of section *1126 203(h)(1) of the Revenue Act of 1926 which defines a reorganization as "a merger or consolidation (including the acquisition by one corporation of * * * substantially all the*1095 properties of another corporation)" and that accordingly the case is governed by section 204(a)(7) and (c), which provides for the use of cost to the transferor corporation as the basis for depreciation to the corporation to which depreciable assets are transferred. The particular type of reorganization which he contends occurred was a merger, and in support of this position he relies on a statement in ; affd., , where it is stated that "In a merger one corporation absorbs the other and remains in existence while the other is dissolved."
It is of course true that when two corporations merge one corporation absorbs the other and remains in existence while the other is dissolved, and in this case the assets of one corporation were taken over by another, its liabilities were assumed and thereafter it was dissolved, while the transferee corporation remained in existence, but we do not understand that such a transaction constitutes the character of absorption and continuation necessary for a merger within the meaning of the statute. *1096 For example, if after the Simms Petroleum Co. had acquired 91.1 percent of the Clayton Co., the Simms Petroleum Co. had liquidated the Clayton Co., taking over its assets and assuming its liabilities, we do not understand that a merger would have arisen any more than there occurred in the case of , where one corporation which owned all the stock of a second corporation caused the second corporation to be dissolved and took over its assets. In that case the reasoning here advanced by the Commissioner would result in a merger being held to have occurred, but the Board held that the liquidation of the subsidiary gave rise to a deductible loss on the part of the parent. Cf. (reversing ); affd., . In the case at bar the Simms Petroleum Co. was not even affiliated with the Clayton Co. since it owned less than 95 percent of its stock, and with all the more reasoning it would be said that a basis for gain or loss would arise on account of such liquidation. There was also no continuation of stock*1097 interest between the Clayton Co. and the Simms Petroleum Co., that is, none of the old stockholders of the Clayton Co. were or became stockholders of the Simms Petroleum Co.
The liquidation here, however, was not of the Clayton Co. to the Simms Petroleum Co., but instead it was one step removed therefrom, namely, to the Simms Oil Co., whose entire capital stock was owned by the Simms Petroleum Co., and from the common ownership *1127 it is urged that there was a merger in which more than an 80 percent interest remained in the same hands, namely, the Simms Petroleum Co. We disagree and can see no more reason for saying that a merger occurred than in the suppositious case which we set out above. The most that can be said is that the resolution of the Simms Petroleum Co., dated July 1, 1925, and providing for the transfer of assets in question, stated that it seemed advisable to have the Simms Oil Co., its operating subsidiary which was engaged in a line of business similar to that of the Clayton Co., take over the assets of the Clayton Co. and carry on refining and distributing operations such as that corporation previously carried on. But we do not understand that such*1098 action contemplated any merger of the corporate life of the Clayton Co., a Delaware corporation, with that of the Simms Oil Co., a Texas corporation, other than might appear in any case of an outright acquisition of the assets of one corporation by another. The ownership of the assets of the Clayton Co. passed completely to the Simms Oil Co. and the Clayton Co. was thereafter dissolved. There is not even the common contention as to whether what occurred constituted an intercompany transaction, since the Clayton Co. and the Simms Oil Co. were not affiliated when the transfer of assets occurred. Between July 2 and December 28, 1925, the Simms Petroleum Co. or the Simms Oil Co. acquired the minority interest under the same contract by which the other stock had been acquired, but such acquisition would not alter the affiliated status which existed on July 2, 1925. On the whole, we are of the opinion that what here occurred amounted to a liquidation of the Clayton Co. to the Simms Oil Co. and that the basis for depreciation for the Simms Oil Co. on account of the depreciable assets received is the fair market value of such assets at the time received. It accordingly follows that the*1099 additional depreciation stipulated by the parties on such basis should be allowed. See ; ; certiorari denied, .
Issue No. 5.
While our evidence on this issue is not of the most satisfactory character in all of its details, we do not understand that there is any disagreement between the parties other than as to the amount of $82,827.60 on which the Commissioner has not allowed depreciation as shown in the stipulation set out in our findings on this issue. The Commissioner, while not agreeing to the correctness of our decisions, conceded in his brief that issues of this character have been decided on several occasions by the Board against his position and that accordingly, if the Board adheres to its prior rulings, the Simms Oil Co. is entitled to depreciation on the item in question. *1128 ; (reversed by the circuit court of appeals, *1100 , and certiorari granted, November 14, 1932); ; and . Since our decisions in the above cited cases, however, the Supreme Court of the United States definitely and authoritatively settled the issue now being discussed in favor of the contention of the Commissioner by affirming the decision of the United States Circuit Court of Appeals of the Fourth Circuit in , referred to above. See also , and , in which latter case the Court said:
It is true that the Board of Tax Appeals in construing the 1924 and 1926 Acts has held that capitalized drilling costs are subject to a depreciation rather than a depletion allowance. ; *1101 ; . But these cases were all decided after the enactment of the 1926 Act and did not consider the administrative and legislative history, which we think decisive.
The decisions of the Supreme Court above cited are controlling and are determinative of this fifth issue in favor of the contention of the Commissioner that the amounts expended during 1926 for drilling productive oil wells are recoverable through depletion rather than by depreciation allowances.
Issue No. 6.
The final issue, as to whether a net loss sustained by the Simms Petroleum Co. for the year 1923 may be carried forward and allowed as a deduction in computing consolidated net income of the several petitioners for 1925, when the Simms Petroleum Co. sustained a loss for 1925, is fully covered, and decided adversely to the carrying forward of such a net loss, in our discussion of issue No. 2. It accordingly follows that the Commissioner is sustained on this issue.
Reviewed by the Board.
Judgment will be entered under Rule 50.
Footnotes
*. Before deducting depletion allowable in excess of depletion on cost, which cannot be used as a deduction in arriving at a net loss. ↩