*674 1. In 1930 petitioner was indemnified against any loss resulting from payment to the indemnitor of the proceeds of production of an oil well in accordance with existing agreements. The indemnitor died in 1934, leaving no estate. In 1936 the courts decided that an assignee of the indemnitor was entitled to the amount that had been paid to the indemnitor. Held, that the debt was ascertained to be worthless and charged off in 1936.
2. In 1936 petitioner canceled and credited to surplus the amount of $7,000 representing salary accrued on its books in 1931 in favor of one of its officers. Petitioner sustained a net loss of about $90,000 in 1931. Held, that the amount of salary canceled in 1936 does not constitute taxable income to petitioner in that year.
3. Petitioner was in receivership during a portion of 1936. Held, that petitioner has failed to prove that it was insolvent at any time during that period within the meaning of section 14:d):2) of the Revenue Act of 1936.
4. Petitioner's oil and gas wells were in possession of and being operated by receivers and/or trustees from 1931 until November 1936, during which time the proceeds of production, less*675 operating expenses chargeable to petitioner, were impounded pending judicial determination of the parties entitled thereto. Expenses of operation were deducted in determining the net amount pavable to petitioner, part of which net amount was paid in 1936. Held, that the amount paid to petitioner in 1936, plus the amount of income which had been expended for operating expenses, constitutes gross income received from the property by petitioner in 1936 for depletion purposes.
5. In 1937 one of petitioner's wells ceased to produce and was transferred by quitclaim deed to one of its stockholders. Held, that petitioner may not deduct any amount as a loss, on account of failure to prove the cost of the property.
*591 This proceeding involves the redetermination of deficiencies in income tax for the years 1936 and 1937 in the respective amounts of $32,767.96 and $15,816.89. The issues are :1) whether respondent erred in disallowing a bad debt deduction of $16,500.10, :2) whether salary in the amount of $7,000 accrued*676 in 1931 and canceled in 1936 constitutes taxable income; :3) whether respondent erred in determining that petitioner was not insolvent during a period of receivership and therefore was subject to surtax on undistributed profits; :4) whether respondent erred in not allowing a greater amount as a deduction for depletion; and :5) whether petitioner sustained a deductible loss upon the abandonment of an oil well known as Well No. 16, and, if so, whether it was a capital loss or an ordinary loss. Other issues reised by the petitioner were abandoned at the hearing. The stipulation of facts filed in the proceeding is incorporated herein by reference as part of our findings of fact. Material portions thereof will be set forth in the findings of fact made from other evidence.
FINDINGS OF FACT.
Petitioner was organized in 1926 under the laws of California. It kept its books and filed its returns on the accrual basis. Petitioner's *592 returns for the taxable years were filed with the collector for the sixth district of California.
In 1922 and 1923 C. C. Julian acquired several oil leases covering property in the Santa Fe Springs, California, field. The leases were assigned*677 to the Citizens Trust & Savings Bank, Los Angeles, California, in trust, with direction to pay expenses of the trust and any balance to the trustor or such person as he designated. The trustor had exclusive control of the leases as agent of any assignee of any interest therein. Pursuant to this plan C. C. Julian sold to the public fractional interests in wells to be drilled under the leases. Five oil and gas wells, known as Julian Wells Nos. 1, 2, 3, 11, and 12, were drilled with the proceeds of such sales.
In 1925 C. C. Julian entered into an agreement with D. R. Morrow and W. J. Barnhart by the terms of which the latter agreed to operate the wells for 50 percent of the production of the wells, exclusive of royalties. In 1927 the operating agreement was assigned to petitioner. In 1929 petitioner's compensation for operating the property was increased to 65 percent of the gross production, exclusive of royalties, out of which it was required to pay all operating expenses.
On March 9, 1928, the United Oil Well Supply Co. and others entered into an agreement, hereinafter referred to as the United lease, leasing certain property to W. J. Barnhart. On September 28, 1928, W. *678 J. Barnhart assigned to C. C. Julian such portion of the lease as related to certain property described in the lease, and another portion to petitioner. On the same day petitioner agreed in writing with W. J. Barnhart to drill at its own expense a well on the property to productive sands below 5,000 feet. After payment of landowners' royalty of 16 2/3 percent, if a well was drilled less than 5,000 feet, and 20 percent if drilled more than 5,000 feet, petitioner was entitled to receive $100,000 out of the remaining production. Thereafter the 83 1/3 percent interest of the lessee was to be divided equally between petitioner and W. J. Barnhart after paying operating expenses, except that Barnhart's interest was not chargeable with more than $250 per month while the well was flowing and $500 per month while the well was being pumped. Petitioner also agreed on September 28, 1928, in another instrument, to pay C. C. Julian the sum of $2,500 to be relieved of its obligation to drill a well deeper than 5,000 feet and to accept $80,000, instead of $100,000, for the drilling of such a well. Thereafter petitioner drilled a productive well on the property, known as Julian Well No. 16, to*679 a depth of less than 5,000 feet.
On September 28, 1928, W. J. Barnhart assigned his interest in the operating agreement to Wm. M. Cady. On July 25, 1929, Wm. M. Cady assigned his interest to James B. Boyle as security. In acquiring *593 the United lease and making the assignment to Wm. M. Cady, W. J. Barnhart was acting for C. C. Julian.
Well No. 16 produced prior to May 1930 sufficient oil and gas to pay petitioner out of 83 1/3 percent of the production the consideration of $80,000 for drilling the well.
On May 15, 1930, C. C. Julian directed petitioner to pay to H. B. Flesher his one-half share of the proceeds of production of Well No. 16, this being the same interest W. J. Barnhart, acting for C. C. Julian, had assigned in writing to Wm. M. Cady on September 28, 1928.
On July 18, 1930, petitioner advised C. C. Julian by letter that on August 20, 1929, it had received a communication from James B. Boyle in which he claimed ownership of his interest in production of Well No. 16. On July 25, 1930, C. C. Julian advised petitioner that James B. Boyle had no interest in production of the well above 5,000 feet. The letter also contained the following:
The undersigned*680 hereby agrees to fully protect and indemnify your company against any and all action or actions that may be brought against you by reason of you paying to me, or to my properly authorized agent, such sums of money to which I am entitled in accordance with existing agreements.
At various times thereafter in 1930 petitioner paid to H. B. Flesher the sum of $16,500.10 out of 83 1/3 percent of the proceeds of production of Well No. 16.
On November 30, 1931, Wm. M. Cady assigned his interest in Well No. 16 to J. A. Smith.
On September 28, 1928, W. J. Barnhart assigned to C. C. Julian the remainder of the United lease not involved in Well No. 16. Thereafter Well No. 17 was drilled on the premises. In 1930 petitioner undertook to place the well incondition to produce from the Meyer sand and if successful petitioner was to receive $78,000, payable out of 41 2/3 percent of the production. Thereafter interests in the production of the well were: C. C. Julian, 41 2/3 percent; petitioner, 38 percent; and Santa Fe Springs Oil Co., 3 2/3 percent. As of January 1931 petitioner was in possession of and operating the well.
All of the wells hereinbefore described were purchased by R. *681 L. Mack in an execution sale held to satisfy a judgment in the amount of $10,925.98 obtained by one Garliepp against C. C. Julian in 1929. The purchaser conveyed his interest by deed to W. A. Schwartz, who thereupon claimed to be the owner of the wells except for the royalty interests.
In about January 1931 C. C. Julian instituted suit in the Superior Court of California to restrain Schwartz from taking possession of the wells. The holders of participating oil agreements in Wells Nos. 1, 2, 3, and 11 filed a cross-complaint in the action, wherein they claimed to be the owners of the interests assigned to them and also claimed that *594 Wells Nos. 16 and 17 were wrongfully producing oil from Wells Nos. 1, 2, 3, and 11. On March 19, 1931, the court appointed two individuals as receivers to operate the wells under existing leases, sell the production of the property, paying therefrom royalties and expenses incident to the receivership and the operation of the wells, and retain other funds until further order of the court. In April 1931 the court discharged one of the receivers. On March 23, 1932, pursuant to a stipulation of all of the parties to the action, the court appointed*682 two trustees to operate the wells, but continued the receivership for the purpose of carrying on the litigation. Judgment was entered in the case on September 7, 1933. The court held that petitioner and J. A. Smith were each entitled to an undivided one-half interest in Well No. 16, subject to the terms of the lease entered into on March 9, 1928. The judgment was affirmed by the District Court of Appeal, August 28, 1936, 16 Cal.App.:2d) 310; 60 Pac.:2d) 887. The case was finally determined on October 28, 1936, upon the denial of a hearing by the Supreme Court of California. While the proceeding was pending the wells were in possession of and being operated by receivers and/or trustees, hereinafter referred to as trustees, under the direction of the court.
After the termination of the litigation, J. A. Smith, successor to Wm. M. Cady of the one-half interest in Well No. 16 originally held by C. C. Julian, presented a claim to petitioner for one-half of the funds accruing from production of Well No. 16 after the receipt by petitioner of $80,000 for drilling the well. The sum of $16,500.10 was included in the amount paid by petitioner to H. B. Flesher upon the order of C. C. *683 Julian. Petitioner conceded that the payments theretofore made to H. B. Flesher had been made in error and in 1936 paid the sum of $16,500.10 to J. A. Smith in accordance with his demand. C. C. Julian died a suicide in China in 1934, leaving no estate.
Petitioner quitclaimed Well No. 16 to J. A. Smith on December 20, 1937, in accordance with a resolution of its board of directors held on that date.
The amount of $16,500.10 was ascertained to be worthless and charged off in 1936.
On or about July 29, 1931, D. R. Morrow brought an action in the Superior Court of California against petitioner, Guy L. Hardison, and W. J. Barnhart for an accounting of the affairs of petitioner; for an accounting to petitioner by W. J. Barnhart, general manager, and Guy L. Hardison, president of petitioner, for any and all profits, including secret profits, and for unlawful payments set forth in the complaint; contesting unlawful and excessive salaries paid to W. J. Barnhart and Guy L. Hardison, and for their removal as officers of petitioner; and for the appointment of a receiver to take charge of the *595 affairs and assets of petitioner pendente lite. It was alleged in the complaint*684 that W. J. Barnhart and Guy L. Hardison had caused to be paid to themselves and/or credited to them excessive salaries from about September 1928 in the amount of $1,000 each per month. On the same day the court appointed Ralph S. Armour receiver for petitioner.
On July 29, 1931, there had been accrued on petitioner's books at the rate of $1,000 per month to July 31, 1931, as payable to Guy L. Hardison, the sum of $14,000. There was also recorded on petitioner's records as due to Guy L. Hardison on July 31, 1931, the sum of $8,500, represented by two notes payable. This liability arose out of a purported sale by Guy L. Hardison to petitioner of certain oil well equipment in connection with Well No. 17.
The questions relating to the salary of $14,000 accrued in favor of Guy L. Hardison and the notes in the amount of $8,500 were not settled until December 11, 1936, when the board of directors of petitioner authorized the payment of $7,000 to him for salary to December 30, 1930. At that time Guy L. Hardison admitted that the salary accrued in his favor was excessive. The remainder of the salary, being for the first seven months of 1931 during which petitioner's affairs were*685 in the hands of a receiver appointed in connection with the Julian v. Schwartz litigation, was not recognized or paid. Such salary was written off in 1936 as of 1931 and credited to surplus.
The net income or net loss of petitioner each year from 1930 to 1935 was as follows:
| Net income | Net loss | |
| 1930 | $3,175.54 | |
| 1931 | $90,116.67 | |
| 1932 | 5,213.85 | |
| 1933 | 666.27 | |
| 1934 | 2,516.00 | |
| 1935 | 6,063.64 |
In accordance with instructions of the court, the trustees kept a record of the income and operating expenses of each well. On July 23, 1934, the court issued an order directing the trustees to pay from funds in their possession certain amounts, including $102,885.93 to petitioner. The court order was ineffective during the pendency of the appeal in the Julian v. Schwartz litigation. It became effective on October 28, 1936, when the case was finally determined and adjudicated. The amount of cash distributed to petitioner in 1936 pursuant to the order was $112,000. In 1937 petitioner received the additional sum of $121,037.94 from the trustees pursuant to a court order entered in February 1937. The trustees paid the sum of $17,852.13 to the*686 receiver in 1936 for the account of petitioner.
In or about February 1937 the trustees made a report to the court of their records and accounts for the period December 1, 1930, to *596 November 30, 1936. The accounting was approved by the court on October 19, 1937.
Ralph S. Armour, receiver, was never in complete charge or control of the assets of petitioner, as the oil wells at Santa Fe Springs were in control of and being operated by the trustees.
The balance sheet of the petitioner at the close of the years 1930 to 1934, inclusive, shows deficits as follows:
| 1930 | $70,486.41 |
| 1931 | 160,603.08 |
| 1932 | 165,816.93 |
| 1933 | 163,582.01 |
| 1934 | 166,098.01 |
The balance sheet of petitioner at the close of 1935 was as follows:
| ASSETS | ||
| Supplies | $594.09 | |
| Captial assets: | ||
| Leasehold interests | $224,251.92 | |
| Oil well machinery and equipment | 60,568.15 | |
| Intangible oil well costs | 60,908.31 | |
| Automobiles and trucks | 443.73 | |
| Office furniture and fixtures | $811.50 | |
| 346,983.61 | ||
| Less reserve for depreciation and depletion | 99,979.87 | |
| $247,003.74 | ||
| Patents | 1,000.00 | |
| Good will | 26,224.21 | |
| Capital stock issued for services and leases | 219,120.50 | |
| Organization expense | 42,488.53 | |
| Accounts receivable | 35,507.19 | |
| Total | 571,938.26 | |
| LIABILITIES | ||
| Notes payable | $3,000.00 | |
| Accounts payable | 17,267.70 | |
| Accrued expenses: | ||
| Interest | 1,396.67 | |
| Taxes | 1,051.66 | |
| Pay roll | 14,078.00 | |
| Due to stockholders | 6,995.63 | |
| Total liabilities | 43,789.66 | |
| Deferred credits | 5,333.25 | |
| Capital stock | 694,977.00 | |
| Surplus (deficit) | (172,161.65) | |
| Grand total | 571,938.26 |
*687 *597 The assets shown in the balance sheet as capital assets, except a well known as the Hartley Well :not carried as an asset after 1930), and office furniture and fixtures shown in the books after 1931 at a value of $811.50, were not in the possession of petitioner from the time of the appointment of the receiver in 1931 until the final determinaton of the Julian v. Schwartz litigation in 1936, but were in the possession of the receiver in that litigation and were being claimed by Schwartz and the holders of participating oil agreements as asserted in the proceeding. The financial condition of petitioner remained about the same from january 1, 1936, until the receipt in November 1936 of funds from the trustees.
The income and expenses of petitioner for 1936 were as follows:
| INCOME | ||
| Oil and gas sales after November 1, less expenses | $3,218.15 | |
| Rental on drilling equipment | 5,000.00 | |
| Distributions from trustees | 142,989.99 | |
| Claim for interest relinquished | 391.67 | |
| 151,599.81 | ||
| EXPENSES | ||
| Interest paid | $1,409.36 | |
| Loss, erroneous payments to J. A. Smith | 16,500.10 | |
| Receivership expenses | 17,574.68 | |
| $35,484.14 | ||
| Net income | 116,115.67 |
*688 None of the income impounded by the trustees in the Julian v. Schwartz litigation was considered as income to petitioner until released to it. In and after 1933, pursuant to a stipulation filed with the court in 1933, there was released to J. A. Smith for the account of petitioner proceeds of gas production of Wells Nos. 1, 2, 3, and 11 accruing to petitioner. At a hearing held in Washington, D.C., on August 13, 1937, these amounts were determined to have been constructively received by petitioner in 1933 and years subsequent thereto. There was deducted from such income depreciation on the tangible equipment of the wells and other tangible lease equipment which was then being used by the trustees. In addition to the depreciation so deducted, there was deducted and allowed business expenses paid and accrued, including legal fees and receivership expenses. The receivership ship expenses so allowed were allowed as deductions in and for the years for which they were definitely determined and approved by the court.
On November 12, 1936, Ralph S. Armour, receiver, filed with the court a final account and report showing that during the period *598 of the receivership*689 he had incurred expenses, aggregating $17,852.12, as follows:
| 1931 Auditors' services | $125.00 | |
| Appraisers' fees | 300.00 | |
| Stationery | 13.00 | |
| Notarial fee | .85 | |
| Advertising sale of equipment | 12.00 | |
| $450.85 | ||
| 1932 Telephone | 73.57 | |
| Rent | 302.50 | |
| Towel service | 5.50 | |
| Auditors' services | 1,750.00 | |
| Typewriter repairs | 2.90 | |
| Loan by receiver to pay telephone bill | 27.45 | |
| Insurance, Wells Nos. 16 and 17 | 108.53 | |
| Attorneys' fees | 480.00 | |
| 2,750.45 | ||
| 1933 Bond, Hartley Well No. 1 | 100.00 | |
| 100.00 | ||
| 1934 Typewriter repairs | 12.50 | |
| 12.50 | ||
| 1936 Attorneys' fees | $6,920.00 | |
| Receiver's bond | 125.00 | |
| Office rent, phone, etc., pro rata | 1,100.00 | |
| Receiver's fees | 6,393.32 | |
| $14,538.32 | ||
| Total | 17,852.12 |
The court approved the account the day it was filed. In its order approving the account, the court said:
* * * it appearing to the court that defendant, Barnhart-Morrow Consolidated, a corporation, is no longer insolvent by reason of its success in the litigation entitled: Julian v. Schwartz, No. 315-345, in this court, now finally determined on appeal, and that by reason of the termination of said litigation and the present solvency of said corporation, there*690 is no longer any reason for the continuance of said receivership herein. * * *
and directed that the receiver's expenses be paid out of the first moneys accruing and paid to petitioner.
The petitioner's share of the gross proceeds of production of Julian Wells Nos. 1, 2, 3, 11, 16, and 17 for the period December 1, 1930, to November 14, 1936, during which time the wells were in possession of and being operated by the trustees, was $488,903.65. The total charges made against petitioner by the trustees for the operation of the wells during that period were $223,352.83, leaving a balance of $265,550.82 payable to petitioner. Of the net amount of impounded funds due petitioner, $142,989.99 was paid to it in 1936, $122,371.37 in 1937, and the balance of $189.46 in subsequent years. The payment made in 1936 consisted of the following items: cash paid to Ralph S. Armour, receiver, *599 for receivership expenses, $17,852.13; cash to petitioner, $112,000; depreciated cost of well equipment acquired by trustees and delivered to petitioner on November 14, 1936, $7,992.90; compensation insurance, $300; liabilities of petitioner paid by trustees, $4,844.96.
The petitioner sustained*691 an operating loss of $3,258.78 in the operation of Well No. 16 in 1937 up to the time it ceased producing because of unknown damage to the well. Work of an undescribed nature on the well was necessary to ascertain the kind and extent of the damage and the cost of making repairs. J. A. Smith, the owner of the other one-half interest in the well, including its equipment, was not liable for more than $250 per month for operating expenses of the well.
The terms of the United lease required petitioner to operate Well No. 16 even though in doing so it sustained a loss, and in the event that petitioner abandoned the well the lessor had the right to take posession thereof, including its equipment, and hold or operate the property at its own expense, free from any claim of the petitioner, subject, however, to a royalty of 8 1/3 percent to petitioner. In case the lessor did not exercise the right to take over any abandoned well, petitioner was obligated to restore the promises to their original condition, including the plugging of the well in accordance with the laws of California. The cost of plugging a well is from $5,000 to $10,000. The well had some salvage value, probably $2,000.
*692 In December 1937 Harold G. Morton, an experienced oil operator and counsel, and a director and stockholder of petitioner, suggested to the board of directors of petitioner that the well be abandoned. At that time J. A. Smith held about 35 percent of petitioner's stock and Harold G. Morton and another individual each held about 9 percent. The remainder of the stock was widely distributed. On December 20, 1937, the board of directors of petitioner adopted a resolution to surrender the well, and the premises pertaining thereto, to J. A. Smith and executed a quitclaim deed for the property in his favor.
Work done on the well immediately thereafter by J. A. Smith reyealed that the liner thereof had crumpled. The damage was repaired at a cost of about $800. The well sustained similar damage in 1936 and was repaired at a cost of about $18,000.
The well was placed on production in January 1938, in which month it produced oil and gas of a value of about $1,500. The gross production of the well was increased to $2,550 in April 1938, and thereafter it decreased to $700 or $800 in October 1941.
OPINION.
Bad Debt Issue.
DISNEY: The respondent disallowed the item of $16,500.10*693 as a bad debt deduction upon the ground that the debt was not ascertained *600 to be worthless and charged off during the taxable year. The substance of respondent's argument upon brief is that the promise of C. C. Julian ceased to have any value in 1934, when he died leaving no estate, and that the
It was stipulated that the amount was charged off in 1936, leaving for decision only the question of whether the debt was ascertained to be worthless in the same year. Both parties refer to the undertaking of C. C. Julian as a contract of indemnity and we will assume that it was such an agreement. Under it the indemnitor obligated himself to reimburse petitioner in the event petitioner was compelled to pay to another any amount paid to him or his agent under his claim of right to receive a portion of the proceeds of production of Well No. 16. This promise did not ripen into a claim against the indemnitor until 1936, when the courts of California decided that J. A. Smith was the owner of the interest under which C. C. Julian's nominee had received the sum in question. Howell v. Commissioner, 69 Fed.:2d) 447. Thus there was not at any time prior to 1936 a debt against*694 C. C. Julian to ascertain to be worthless. When it did come into existence, it was worthless and petitioner so ascertained it. Then, for the first time, there was a debt to collect, and if ascertained to be worthless, to charge off as uncollectible.
Respondent cites no authority for his statement that the obligation of C. C. Julian was discharged by his death. We find none. It was not a personal covenant, incapable of being performed by any other person. On the contrary, his obligation was one which survived him and for which his estate was liable. ; ; . His estate was insolvent when the debt came into existence. We hold that the petitioner is entitled to deduct the amount in controversy as a debt ascertained to be worthless and charged off in 1936.
Salary Issue.
The respondent makes the general contention under the second issue that, where salary is accrued and deducted from income and the liability is satisfied in a subsequent year for less than its face amount, the difference between the liability and the amount for which it was satisfied*695 constitutes taxable income. The rule laid down by the Board in and since , has been that such an amount is not income unless the deduction made in a prior year served to offset taxable income. ; ; .
Here the petitioner had a net loss in 1931 of $90,116.67 and no contention is made that the compensation canceled in 1936 was not deducted *601 in arriving at the net loss. Accordingly we sustain the petitioner on this issue.
Insolvency Issue.
In his determination of the deficiency for 1936 respondent held that petitioner was not insolvent at any time during the period of its receivership in that year and therefore was not exempt from surtax on $89,476.51 of undistributed net profits under the provisions of section 14:d):2) of the Revenue Act of 1936 1
*696 The difference between the parties is whether petitioner was insolvent in 1936 during the period of receivership. They agree that if it was insolvent at any time during that period the statute exempts petitioner from surtax.
In , we said that the word to carry the meaning used . In that case the Court said that "Insolvency, in the sense of the Bankrupt Act, means that the party whose business affairs are in question is unable to pay his debts as they become due, in the ordinary course of his daily transactions. this was evidenced by the Senate Finance Committee Report on the provision, in which the committee said:
The Finance Committee Bill also avoids the possibility of tax avoidance by collusive Receiverships by limiting the provision to cases in which the corporation is in bankruptcy under the Federal bankruptcy laws, and to cases in which it is insolvent, i.e., its liabilities are in excess of its assets or it is unable to pay the claims of creditors as they mature - and in receivership in Federal or State Courts.
In holding that the petitioner did not come within the exemption provided*697 by the statute, we referred to proof that during the taxable year its assets were about ten times its liabilities, exclusive of capital stock and surplus, and that it had made payments on some of its obligations.
Regulations 94, promulgated for the Revenue Act of 1936, does not define the meaning of insolvent. See art. 14-1. Article 13-4 of Regulations 101, Revenue Act of 1938, defines the term insolvent as meaning and in the sense of inability to meet obligations as they mature."
Regulations 103, applicable to the Internal Revenue Code, defines the term insolvent as meaning *602 of liabilities over assets or in the sense of inability to meet obligations as they mature. is established if liabilities exceed assets or if the debtor corporation is unable to meet its obligations United Statesv. Anderson, 119 Fed:2d) 343. In that case the court said that in determining insolvency use of the debtor's credit."
The United States Circuit Court of Appeals, in reversing artesian , said that as the taxpayer's assets exceeded its liabilities and it was not, therefore, insolvent in a bankrupt sense, solvency or insolvency turned upon*698 whether "the taxpayer was able to meet its obligations as they matured, in the usual course of trade or business. 125Fed.:2d) 17. It decided that the taxpayer was unable to meet its obligations, of the debtor's dredit' :United Statesv. Anderson Co., supra.)
We think a corporation is insolvent within the meaning of section 14:d):2), supra, if at any time during receivership it is unable to meet its obligations as they mature in the ordinary course of business, with a reasonable use of its credit.
All of petitioner's oil and gas property was in the possession and control of trustees appointed by the court in the Julian v. Schwartz litigation. The remaining assets were in the possession and control of a receiver appointed in the litigation instituted by D. R. Morrow in 1931. The balance sheets of petitioner at the close of the years 1932, 1933, 1934, and 1935 reflect, exclusive of the oil and gas properties, no cash on hand. Other assets on which something might have been realized consisted of supplies in the amount of $594.09, patents $1,000, stock issued for service and leases $219,120.50, and accounts receivable of $35,507.19. Its liabilities, consisting*699 of notes and accounts payable, accrued expenses and amounts due stockholders, were $55,611.12, $43,580.75, $43,111.14, and $43,789.66, respectively, at the close of 1932, 1933, 1934, and 1935. The balance sheets of petitioner as of the termination of the receivership and at the close of 1936 were not introduced in evidence. Testimony, however, established that there were no substantial changes before the termination of the receivership in 1936.
Though the final accounting of the receiver disclosed obligations incurred as early as 1931, the record does not disclose whether any of the debts shown by the balance sheets, except salary accrued in 1931 in favor of Guy L. Hardison in the amount of $14,000, but which was involved in the litigation instituted by D. R. Morrow in 1931, matured during the receivership. No evidence was offered as to the arrangements made, if any, with the creditors for payment of these debts.
*603 The burden was on petitioner to establish its insolvency and any deficiency of proof must operate against it. No attempt was made to show inability to meet maturing debts by a reasonable use of credit. It is true that the oil and gas properties were*700 in the possession and control of the trustees and for that reason could not have been used by the receiver as collateral for a loan, but he had under his control stock of a book value of about $220,000. Nothing of record is opposed to the idea that this stock could have been used as security for a loan or sold to pay debts. Neither does it appear that an application was ever made to the court for permission to sell receiver's certificates of otherwise raise funds to meet matured obligations.
We do not regard as helpful to petitioner the statement appearing in the court order of November 12, 1936, that petitioner was no longer insolvent by reason of the litigation. It does not appear that the court ever had before it the question of solvency or insolvency of petitioner. Neither does it appear that any of the parties in interest ever alleged such a fact in pleadings before the court. On the contrary, the complaint filed by D. R. Morrow, which resulted in the appointment of the receiver, alleged, among other things, that the corporation had been in a prosperous condition and was then operating at a profit, but that the profits were being diverted from the stockholders and petitioner. *701 The receiver does not appear to have received any funds until the latter part of 1936, when his expenses were paid out of receipts from the trustees, but inability to pay due to impounding of assets in a receivership, not based upon grounds of insolvency, is not proof of insolvency in the sense of inability to meet maturing debts. The receivership of itself does not prove insolvency.
The petitioner has failed to prove that it was insolvent at any time during the period of receivership in 1936. Accordingly we sustain the respondent on this issue.
Depletion Issue.
In his determination of the deficiency for 1936 respondent allowed depletion on $142,989.99, representing the amount received by petitioner in cash and credits in that year our of the funds impounded by the trustees in the Julian v. Schwartz litigation. He contends here that that amount constitutes petitioner's gross income and net income during the taxable year from the operation of the wells by the trustees. Petitioner contends that it is entitled to depletion on not only the $142,989.99 thus received, but on the additional amount of $223,352.83, representing expenses incurred by the trustees in the*702 operation of the properties, all of which was chargeable to and charged to petitioner. Thus petitioner seeks depletion on $366,342.82 and respondent asks us to restrict it to the net amount. The facts are *604 not in dispute. Depletion on the production of the wells in 1936 after petitioner acquired possession of the wells and in 1937 is not in controversy.
Petitioner insists that its economic interest in the production of all of the wells was $488,903.65 and that it could not actually or constructively receive the net economic interest of $265,550.82 ($488,903.65 less operating expenses of $223,352.83) without constructively receiving the $223,352.83 charged to it for operating expenses.
The parties agree that under the rule of , no part of the proceeds of production constituted taxable income to petitioner until received by it. They also reached an agreement in 1937 that no income tax liability would be assessed against the trustees for the years 1931 to 1936, but that the recipients of the proceeds of production would be liable for income taxes in the year or years in which the funds were*703 distributed.
We think the question is controlled by Crews v. Commissioner, 89 Fed.:2d) 412, affirming, on the point involved herein, . 2 In that case in 1922, while certain litigation relating to failure to drill offset wells was pending, the lessors of oil property entered the undeveloped section of the leased land and began development thereof. The Sinclair Oil & Gas Co., operator of the developed portion of the property as assignee of the lease, served notice that it claimed a right to such production as might be obtained by the lessors. To provide an outlet for their production, the lessors entered into an escrow agreement under the terms of which seven-eighths of the proceeds of production was to be deposited in escrow in a bank, subject to payment to the proper parties in interest when the litigation was settled, the escrow agent to pay to the lessors in the meantime such sums out of the escrow funds as were necessary for them to use in further developing the land. The litigation was settled in October 1930. Prior thereto there was expended out of the escrow funds the sum of $849,544.37 for drilling, equipping and operating wells and*704 for miscellaneous purposes incident to the production of oil and gas. While this arrangement was in effect the lessors produced from the property entered by them oil and gas in the amount of $1,462,504.02. Aside from the moneys expended for development and operating purposes, no part of the escrow funds was actually paid to the lessors, due, among other things, to misappropriation of funds by officials of the bank and worthlessness of an indemnity agreement executed in connection with the matter and the giving of a release by the lessors in favor of the bank.
The question involved in the proceeding was the amount of depletion to which the lessors were entitled, in connection with which it *605 was necessary to determine the amount of gross income from the property. We held that gross income from the property was $1,462,504.02 less $514,000 representing bonds purchased with escrow funds by the bank, no part of which, however, was ever received*705 by the lessors, plus $355,000 received from Sinclair in 1930, the taxable year, in settlement of the litigation, a total of $1,303,504.02. Upon appeal the court held that the gross income from the property was $1,204,544.37, being $849,544.37 plus $355,000. Subsequent consideration of the proceeding by this Board and the Circuit Court of Appeals did not in any wise alter the conclusion thus reached that upon settlement of the litigation and the termination of the escrow agreement in 1930, the taxable year, the amount of $849,544.37 paid out of production for development and operating purposes constituted gross income.
In that case, as already indicated, there was nothing in the escrow fund in 1930 to pay over to the lessors. Hence none of the proceeds of production were actually received, except for the $849,544.37 expended for development and operating purposes. Here the proceeds of production during the pendency of the Julian v. Schwartz litigation were in excess of operating expenses paid by the trustees out of production and upon the final termination of the litigation in 1936 only a part of the net proceeds was paid to petitioner. *706 We do not think this point of difference in the facts of the two proceedings requires a different conclusion. The expenditures were made out of production of oil and gas for the benefit of petitioner. Under , we must consider the petitioner as having received no income until its right thereto was determined and receivership terminated, which was in 1936, and that the fact that the money was earned in previous years does not control; and the Crews case applies the principle there enunciated squarely to gross income, arising from oil production in years earlier than the year of receipt, for the purpose of computing depletion. This is consistent with the agreement of the parties that taxation would fall in the years when the funds were distributed. We hold the item of $223,352.83 to be gross income in 1936 from the property and that the Commissioner erred in refusing to allow petitioner depletion thereon. Depletion will accordingly be recomputed on the basis of $488,903.65 as the gross income from the property, the amount of depletion on the entire property for the year 1936 not to exceed, however, 50*707 percent of the net income from the property. There appears to be no difference of opinion between the parties on the facts necessary to compute the net income from the property.
*606 Loss, Well No. 16, Issue.
The respondent is contesting the allowance of petitioner's claim for a loss of $43,151.96 upon the relinquishment in 1937 to J. A. Smith of its one-half interest in Well No. 16 upon the ground that the petitioner has failed to prove the cost or other basis of the property. Petitioner relies upon its Exhibit No. 57 to establish the amount of its loss. This exhibit is a statement prepared from petitioner's books showing entries made therein for the cost of tangible well equipment, less depreciation, and intangible drilling cost, less depletion and depreciation on drilling equipment.
In his determination of the deficiency the respondent disallowed a loss of $38,984.02 claimed by petitioner in its return upon the ground that the alleged loss did not fall within the provisions of section 23 of the Revenue Act of 1936. During the course of the hearing in this proceeding respondent's counsel announced that the amount of the loss was in dispute. Exhibit No. 57*708 was offered by the petitioner manner in which petitioner arrived at the figure of $43,151.96 * * * and not for the purpose of showing that it is evidence of the fact that they did sustain that, but to show how we arrived at that figure, to show our method of computing. objected to the introduction of the document in evidence offered as being immaterial." The objection was overruled and the exhibit was admitted in evidence
The method employed in determining the amount of a loss is not in every instance proof of cost or other basis. It does not prove the cost in this proceeding. Respondent never agreed that petitioner's books reflected actual cost of the well. Petitioner deducted from the book costs of tangible equipment a total of $17,889.48 for depreciation. Whether this amount represents the :but not less than the amount allowable) section 113:b):1):B) of the Revenue Act of 1936 does not appear. Depreciation in the amount of $3,604.26 on drilling equipment was included in a total of $74,167.31 for intangible drilling costs. No evidence was offered to prove whether the item of $3,604.26 represents the correct figure for depreciation and the record is devoid of any evidence*709 to show that these intangible drillings costs were not deducted as ordinary and necessary business expense in the year in which they were incurred, as permitted by article 243, Regulations 74. The balance sheet as of the close of 1935 has an item of $60,908.31 for intangible drilling costs of the well, but that does not, without more, prove that petitioner has not had tax benefit from *607 the expenditure. No allowance was made by petitioner in the computation for the salvage value of the well.
The evidence of record fails to prove the amount of any loss sustained by petitioner in connection with the transfer of its interest in Well No. 16. Accordingly we sustain the respondent on this issue.
Decision will be entered under Rule 50.
Footnotes
1. SEC. 14. SURTAX ON UNDISTRIBUTED PROFITS.
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:d) EXEMPTION FROM SURTAX. - The following corporations shall not be subject to the surtax imposed by this section:
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:2) Domestic corporations which for any portion of the taxable year are in bankruptcy under the laws of the United States, or are insolvent and in receivership in any court of the United States or of any State, Territory, or the District of Columbia. ↩
2. For a complete history of the proceeding see also ; ; ; ; ; . ↩