*2214 1. Where a taxpayer entered into an agreement with a corporation relative to an oil lease upon lands in the State of Louisiana, by which the corporation was placed in possession of the lease, and agreed to operate it at its own expense so long as oil might be produced in paying quantities, and where, under the agreement, the corporation was entitled to all gas and casing-head gas and to 40 per cent of all the oil produced subject to certain deductions, and where the corporation paid to the taxpayer a large cash payment and agreed to pay him a further sum up to 60 per cent of the oil produced, and where at the date of the agreement a deed of assignment was executed by the taxpayer to the corporation and placed in escrow and it was agreed that the deed should be delivered when the taxpayer had received in all a certain amount, part of which was payable out of oil, held that the contract was a contract of sale.
2. Where a taxpayer in the year 1919 entered into a contract for the sale of an oil and gas lease whereby he received a certain sum of money, and whereby he was to remain in possession of and operate the lease until a further payment had been made, and where no such further*2215 payment was made, and where the contract was by decree of court rescinded as of the date of its execution, and where the taxpayer was adjudged entitled to retain all the proceeds of oil and gas produced during said period, but was ordered to refund to the purchaser the said initial payment, held that the amount refunded was balanced by the amount previously received and added nothing to the cost of the lease.
*934 These proceedings were by order duly entered, consolidated for hearing and decision, and involve the redetermination of the following deficiencies and overassessment in income tax:
| Deficiencies | |||
| 1921 | 1922 | Overassessment, 1922 | |
| S. L. Herold | $16,183.37 | $11,479.72 | |
| Estate of J. A. Thigpen | 17,890.67 | 5,998.74 | |
| Estate of Mrs. George O. Baird | 4,803.46 | $69.35 | |
| George O. Baird | 4,803.46 | 5,324.34 | |
| Mrs. S. L. Herold | 16,247.37 | 11,479.72 | |
| Mrs. J. A. Thigpen | 17,890.67 | 5,999.74 |
The errors alleged are that respondent determined that the contract between George O. Baird and the Gulf Refining Co. of Louisiana evidenced*2216 a sale by Baird and his associates to said company, and therefore erred in determining (1) that the sum of $350,000, which the written contract states was borrowed by the taxpayers from the Gulf Refining Co. of Louisiana, was taxable income in 1921; (2) that, despite the recitals of said written contract, the Gulf Refining Co. of Louisiana acquired the ownership of the lease on November 1, 1921, and, accordingly, that taxpayers lost their right to depletion on the oil subsequently produced for their account, and (3) that no account was taken of the return by the taxpayers in 1921 to Flannery's assignee, of the sum of $350,000 received by them from Flannery in 1919, and which necessarily had to be returned to clear their title to the lease.
The facts were stipulated and from the stipulation and from the pleadings we make the following findings of fact.
FINDINGS OF FACT.
All of the matters giving rise to these controversies grow out of interests owned by the petitioners in what is known as the George O. Baird-Langston Lease in Claiborne Parish, Louisiana, as here set out:
In the year 1919 George O. Baird, acting for himself and associates, as hereinafter set out, acquired*2217 a certain oil and gas lease on a then unproven area consisting of about 51 acres and known as the "Langston Lease" in said Claiborne Parish. The lease was taken for the use and benefit of the following named persons in the proportions here set out, to wit:
*935 The George O. Baird partnership, composed of George O. Baird, E. G. Palmer, R. T. Layne, J. A. Thigpen, and S. L. Herold, equally, an undivided one-half interest or an undivided one-tenth interest each.
Mrs. Elias Goldstein and Mrs. H. C. Walker, Jr., an undivided one-fourth interest or an undivided one-eighth interest each.
Mrs. J. A. Thigpen and Mrs. S. L. Herold, an undivided one-fourth interest or an undivided one-eighth interest each.
All of the parties above named were at the time of their acquisition of their respective interests in said lease and throughout the years in controversy, to wit, 1919, 1920, 1921, and 1922, citizens of and domiciled in the State of Louisiana and were married, so that each such interest was community property vesting title in one-half of the interest so acquired in the husband and one-half in the wife.
Baird and his associates above named drilled a well on the said unproven*2218 tract which resulted in the discovery of oil on August 23, 1919. Their rights, as discoverer, to a revaluation, based on discovery under the provisions of the revenue act were duly asserted, and have been formally recognized by the Commissioner - the discovery revaluation having been fixed by the Commissioner at $1,011,397.67 and the unit for depletion purposes having been definitely found and adjudged by the Commissioner to be $1.3859 per barrel.
On December 10, 1919, George O. Baird with the consent of and representing all of his associates, as well as himself, entered into a contract with J. Rogers Flannery, the material parts of which read:
THIS AGREEMENT, made and executed this 10th day of December, A.D. 1919, by and between GEORGE O. BAIRD, a resident of Caddo Parish, Louisiana, and J. ROGERS FLANNERY, of Pittsburgh, Pennsylvania, WITNESSETH:
1. - The said Baird has agreed to sell with full warranty of title, and the said Flannery has agreed to buy, on the terms, conditions and consideration hereinafter set out, the following described property situated in the Parish of Claiborne, State of Louisiana, to-wit: [Here follows description of George O. Baird-Langston Lease].
*2219 2. - The price of the said sale is the sum of Two Million Five Hundred Thousand Dollars ($2,500,000.00), which the said Flannery binds and obligates himself to pay in the manner and on the terms here set out, to-wit:
3. - With the signing of this act the said Flannery has paid to the said Baird the sum of Five Hundred Thousand Dollars ($500,000.00), the receipt whereof is hereby acknowledged, and further binds and obligates himself to pay on or before the eighth day of February, 1920, to the said Baird the further sum of Three Hundred Thousand Dollars ($300,000.00).
Upon the failure of the said Flannery to make the said payment on or before the date above specified, the said Baird shall have the right and option after giving to the said Flannery fifteen days' notice in writing of his intention so to do, to declare the forfeiture of this contract and to retain the sums already paid, and any retention of said sums shall be in full liquidation and settlement of damages and in lieu of any other or further damages whatsoever which the said Baird, his heirs or assigns, might claim, and operate as a release and *936 discharge of said Flannery, his heirs and assigns, of and*2220 from any and all liability whatsoever incurred under or by virtue hereof.
4. - When the said Flannery shall have paid to the said Baird under the aforesaid terms the sum of Eight Hundred Thousand Dollars ($800,000.00), then the said Baird shall execute to the said Flannery a good and sufficient deed to the property herein sold, taking the notes of the said Flannery for the remainder of the purchase price, five (5) of the said notes to be in the sum of Three Hundred Thousand Dollars ($300,000.00) each, due on or before thirty (30), sixty (60), ninety (90), one hundred twenty (120) and one hundred fifty (150) days, respectively, after date of said deed, and one (1) note for the sum of Two Hundred Thousand Dollars ($200,000.00), due on or before one hundred eighty (180) days after date of execution of the said deed, said notes bearing five (5) per centum per annum interest from date; said notes to be secured by said property and the production thereof, subject, however, to a provision that, so long as the said notes are being promptly paid at maturity, no part of production from said wells shall be withheld from the purchaser on account of the said security. Said notes also to be*2221 subject to the right of payment before maturity, with interest to date of payment, as hereinafter provided.
5. - At any time after January 1, 1920, the said Flannery shall have the right to make payment of the entire unpaid balance of the said purchase price, with such interest only as may have accrued to such date of payment, and contemporaneously with such payment to receive from the said Baird, and the said Baird shall deliver, a good and sufficient deed for the property herein sold, or, if said deed has already been delivered under the provisions of the preceding paragraph, then the said Baird shall forthwith deliver and return to the said Flannery any and all promissory notes given under the said preceding paragraph for any part of the said purchase price.
6. - Upon payment of the said sum of Eight Hundred Thousand Dollars ($800,000.00) and the execution of the deed and notes as aforesaid, as provided in paragraph 4, or upon payment of the entire unpaid balance of the said purchase price as provided in paragraph 5, the said Flannery shall be entitled to credit for the proceeds of all the oil run and sold from the property from and after 7:00 A.M. November 8, 1919, and shall*2222 pay to the said Baird all sums expended by him for or on account of the development of the said properties from and after said date.
Under this contract Flannery paid, on December 10, 1919, as recited in the above contract, the sum of $500,000. Part of said sum was used by Baird to pay certain obligations of Flannery; the balance after such payments, amounting to $350,000, being the net sum paid on that date by Flannery under the terms of the contract. As authorized by the agreement, Baird retained for his security the possession of the property and continued its operations. The sums received from Flannery were returned in previous years and the tax due thereon paid.
On December 30, 1920, George O. Baird, E. G. Palmer, J. A. Thigpen and S. L. Herold, purchased from Mrs. Elias Goldstein and Mrs. H. C. Walker, Jr., the whole of their interest in the aforesaid Langston Lease, which interest (like that of all the other parties named except Baird) had been represented by written instruments signed by Baird but not recorded. Flannery failed to make any payments other than his original cash payment or to otherwise comply *937 with his obligations under the contract above*2223 set forth. Accordingly, on January 11, 1921, Baird instituted a suit in the Third Judicial District Court of Louisiana, in and for the Parish of Claiborne, demanding a resolution of the contract for nonperformance of its conditions. The material parts of the petition in said suit read:
The petition of George O. Baird, a resident of the Parish of Caddo, with respect represents:
I
That it is now, and was on the 10th day of December, 1919, the owner of a valid oil and gas lease covering and affecting the South half of Northeast quarter (S 1/2 of NE 1/4) of Section Twenty four (24), Township Twenty-one (21) North, Range Eight (8) West, less thirty (30) acres off the west end thereof, subject to a drilling contract with Robert Lynn relative to a tract 280 feet square out of the Southwest corner thereof, together with the wells, tanks and all other equipment forming part of the said lease as a producing property.
II
That on the 10th day of December, 1919, he entered into a contract with one J. Rogers Flannery, a resident of Pittsburgh, Pennsylvania, which said contract is hereto annexed and made part hereof, wherein and whereby petitioner agreed to sell the said property on*2224 certain conditions therein set out to the said Flannery.
III
That the price of the sale, the executory contract affecting which is embraced in the said agreement made part hereof, was Two Million, Five Hundred Thousand Dollars ($2,500,000.00), which the said Flannery bound and obligated himself to pay on the terms and in the manner as here set out, to-wit:
(a) With the signing of the act, Flannery paid to your petitioner the sum of Five Hundred Thousand Dollars ($500,000.00), and bound himself to pay to your petitioner on or before the 8th day of February, 1920, the further sum of Three Hundred Thousand Dollars ($300,000.00).
The said Flannery further agreed in said contract that upon his failure to make the said additional payment of Three Hundred Thousand Dollars ($300,000.00), your petitioner should have the right, on giving him fifteen days' notice in writing of intention so to do, to declare the forfeiture of the contract and to retain the sum so paid as liquidated damages for the violation of the contract.
(b) Said Flannery agreed in said contract, after the payment of the said Eight Hundred Thousand Dollars ($800,000.00), to execute his notes for the remainder of*2225 the purchase price, five of the said notes to be in the sum of Three Hundred Thousand Dollars ($300,000.00) each and one note in the sum of Two Hundred Thousand Dollars ($200,000.00), all in the manner as set out in paragraph 4 of the contract hereto annexed, with the proviso that Flannery should have the right at any time after January 1, 1920, to pay all of the said notes with interest to the date of payment, upon which payment or upon payment in full of all of the said notes at their maturity, Flannery was to become the owner of the property and a deed therefor to be delivered to him.
*938 IV.
Petitioner shows that Flannery paid the sum of Five Hundred Thousand Dollars ($500,000.00), as set out in paragraph 3 of the contract, but never paid the sum of Three Hundred Thousand Dollars ($300,000.00) which he obligated himself to pay on or before the 8th day of February, 1920, nor has Flannery ever paid unto your petitioner any further sum whatsoever.
V.Petitioner shows that he has remained in charge of the property and has operated the same and has received large quantities of oil therefrom, which he has sold, the proceeds of which such sale he has credited to Flannery.
*2226 VI.Petitioner shows that the failure of Flannery to pay the said sum of Three Hundred Thousand Dollars and his failure to pay the other notes has accomplished the resolutory condition of such contract, and that petitioner is entitled to have the same resolved and set aside and treated as if it never existed.
VII.Petitioner shows that such sums as have been realized from the proceeds of the sale of oil produced from the said property were never the property of Flannery, and that on the resolution of the contract Flannery is entitled to no credit therefor, as the same by the resolution of the said contract was due to your petitioner.
VIII.Petitioner shows, as aforesaid, that Flannery has paid to him the sum of Five Hundred Thousand Dollars ($500,000.00) only, and further shows that out of the said sum of Five Hundred Thousand Dollars ($500,000.00) he has advanced to Flannery or paid for said Flannery's personal account the sum of Three Hundred Eighty-five Thousand, One Hundred Twenty-five and 78/100 Dollars ($385,125.78), as will be fully shown on the trial hereof, making a total paid him by Flannery in cash for the said property of One Hundred Fourteen Thousand, *2227 Eight Hundred Seventy-four and 22/100 Dollars ($114,874.22).
IX.Petitioner shows that he herewith tenders to said Flannery and offers to pay into the registry of the court the said sum of One Hundred Fourteen Thousand, eight Hundred Seventy-four and 22/100 Dollars ($114,874.22), or any further sum that might be found due on final liquidation by the court, and also tenders to Flannery the notes of the said Flannery now held by petitioner, and that he is entitled to and does hereby demand the resolution of the said contract.
X.Petitioner shows that he has made repeated amicable demands on the said Flannery for the payment of the sums due him on account of the said contract, and, as will be shown on the trial hereof, has on numerous occasions made written demands therefor, and that during the month of December, 1920, made such demand in person, and also made demand for the resolution of the contract and the annulment thereof.
*939 XI.
Petitioner shows that the said described property is located in Claiborne Parish, Louisiana, and that your petitioner is entitled to have the said contract annulled, resolved and set aside.
WHEREFORE, he prays that an attorney*2228 at law be appointed to represent the said absent defendant and that process be duly served on the said Flannery through the attorney so appointed, and that after all legal delays and due proceedings had there by judgment resolving and setting aside the aforesaid contract, hereto annexed as part hereof, and that the said judgment carry with it the legal effect of a judgment of resolution, that is to say, treating said contract as if it never existed and declaring petitioner to have always been the owner of said property, and cancelling and annulling all indebtedness of said Flannery, including the notes aforesaid, and ordering the said Flannery to accept the amount due by your petitioner to the said Flannery, to-wit, One Hundred Fourteen Thousand, Eight Hundred Seventy-four and 22/100 Dollars ($114,874.22).
Petitioner further prays for all necessary orders and general relief.
The suit was contested by Flannery; the case was put as issue; trial was had and there finally was a judgment entered on the 9th day of November, 1921, which reads:
In this cause, by reason of the law and evidence being in favor thereof, it is ordered, adjudged and decreed:
1. That the contract of date*2229 December 10th, 1919, attached to plaintiff's petition, be, and the same is hereby resolved for noncompliance by defendant with the stipulations therein.
2. That, accordingly, plaintiff, George O. Baird, be and he is hereby, declared to be the owner of the property described in said contract, to-wit: [Here follows description of George O. Baird-Langston lease] subject to the claim of John Munhall, Jr., substituted defendant or assigns, in the sum of Three Hundred and Fifty Thousand ($350,000.00) Dollars, with interest from November 9, 1921.
3. That the resolution of the said contract hereby decreed is ordered and adjudged effective as of date of said contract, so that no right, title, claim or interest therein has ever vested in the said Flannery or his assigns.
4. That the plaintiff, George O. Baird, be, and he is hereby ordered to pay unto John Munhall, Jr., the vendee of the said Flannery, and substituted defendant herein, the sum of Three Hundred and Fifty Thousand ($350,000.00) Dollars, being the net sum heretofore paid by the said Flannery to the said Baird, under the said contract, and that this judgment shall become operative and in full force and effect upon the*2230 restitution of the said sum of Three Hundred and Fifty Thousand ($350,000.00) Dollars, by its payment either to the said John Munhall, Jr., or his representatives; and that upon such payment of the sum of Three Hundred and Fifty Thousand ($350,000.00) Dollars, the said contract shall be as if it had never existed.
It is further ordered, adjudged, and decreed that defendant pay all costs.
As shown by the judgment above set forth Flannery had, subsequent to the suit but prior to the judgment, assigned all his rights under his contract with George O. Baird to one John Munhall, Jr., so *940 that the judgment, as finally rendered, was against Munhall, as assignee of Flannery.
On November 16, 1921, George O. Baird, acting for himself and his then coowners, made the following agreement with the Gulf Refining Co. of Louisiana:
This agreement between George O. Baird, husband of Estella Mitchell, a resident of Caddo Parish, Louisiana; and the Gulf Refining Company of Louisiana, a corporation under the laws of the State of Louisiana, and domiciled at Orleans Parish, witnesseth:
1. That said Baird is the owner of an oil and gas lease covering all of the S 1/2 of the NE 1/4 of*2231 Section 24, Township 21 North, Range 8 West, less the West 30 acres thereof; and less also about one (1) acres in a square in the southwest corner of said described property, as to which one acre, however, the said Baird is the owner of an undivided one-half (1/2) interest, the Gulf Refining Company of Louisiana being the owner of the other undivided one-half interest in the lease covering the said one acre; the lease above referred to including the eleven (11) oil wells on the said property, all the equipment thereto annexed and attached, together with the interest of the said Baird in the one well located on said one acre tract hereinabove referred to.
2. For and in consideration of the obligations and agreements hereinafter set out, the Gulf Refining Company of Louisiana has obligated itself and does hereby agree to take possession of the said lease, to equip same properly at its own expense, and to operate such wells diligently for the production of oil, and to maintain the said production as long as oil may be produced therefrom in paying quantities; all such equipment and operation to be at the entire expense of the Gulf Refining Company of Louisiana and free from any expense*2232 whatsoever to the said Baird. And all taxes of every character legally assessed and charged against said lease, including all severance tax on the production therefrom, except as to the royalty interests, shall be paid by the Gulf Refining Company of Louisiana.
3. For and in consideration of the obligation of the Gulf Refining Company of Louisiana to equip and to operate said property free of expense to him, the said George O. Baird agrees that the Gulf Refining Company of Louisiana may retain from the production of the said property, forty per cent (40%) of the oil produced therefrom, the agreement between the parties being that out of the said 40 per cent so retained by the Gulf Refining Company of Louisiana, that Company shall deliver the royalty of one-eighth (1/8th) of the oil, as provided for in the lease covering said property, and shall in addition deliver to the said Baird for a term of three (3) years, beginning the 1st day of November, 1921, one-twenty-fourth (1/24th) of all the oil that may be saved from that produced from the said property, the said delivery to be made in the same manner in which the royalty is to be delivered to the lessors, under the provisions*2233 of the original lease.
4. In consideration of this obligation and agreement, as hereinabove set out, the Gulf Refining Company of Louisiana shall have, however, the right to all of the gas, including casing-head gas, extracted from the wells on the said property, and all profits therefrom accruing, subject to such contracts as it may be able to secure from the lessors of the said property, and free from any obligation to account to the said Baird for any of the said gas or any of the profits derived from its manufacture or sale.
5. The Gulf Refining Company of Louisiana has this day loaned to the said George O. Baird, the sum of THREE HUNDRED AND FIFTY THOUSAND ($350,000.00) *941 DOLLARS, on the sole security of the said lease, without any personal liability. And, in order to secure the repayment of the said sum within thirty (30) months from this date, the said Baird has, and does by these presents, mortgage and hypothecate unto the said Gulf Refining Company of Louisiana all of his right, title and interest thereto, and, in addition to further secure said obligation, pledges unto the said Gulf Refining Company of Louisiana, all of the oil that may be saved from that*2234 produced from the said leased lands, after the delivery of the royalty of one-eighth (/8th) to the lessors, and the one-twenty-fourth (1/24th) to the said Baird, as hereinabove provided.
It is distinctly agreed and understood, however, that the Gulf Refining Company of Louisiana will as hereinabove set out deliver to the said Baird sixty per cent (60%) of the oil produced from the said property, notwithstanding the said mortgage and pledge and free from any claim thereunder, until the said Baird shall have received from the said production sufficient oil to yield him, at the market price prevailing on the date of delivery, and at which price he will be able to sell said oil, the sum of THREE HUNDRED AND TWENTY-FIVE THOUSAND ($325,000.00) DOLLARS, from the 60 per cent (60%) of the oil produced from the said property, which the said Gulf Refining Company of Louisiana has under this agreement obligated itself to deliver.
After the said Baird shall have received from the 60 per cent of the oil so delivered to him the sum of $325,000.00, or after the expiration of the 30 months from this date, if the said Baird shall not have received such amount from the said production within that*2235 time, then the Gulf Refining Company of Louisiana shall have the right to apply such 60 per cent of the oil, or the proceeds thereof, to the repayment of the said loan until same shall have been paid in full, without interest.
6. In consideration of the obligations and agreements hereinabove entered into on the part of the Gulf Refining Company of Louisiana, the said Baird now agrees and obligates himself that whenever there shall have been produced from the said property by the Gulf Refining Company of Louisiana such quantity of oil that the 60 per cent which the said Gulf Refining Company of Louisiana has agreed herein to deliver to him, shall have produced the sum of SIX HUNDRED AND SEVENTY-FIVE THOUSAND ($675,000.00) DOLLARS (the first $325,000.00) of the proceeds of the sale of such oil to be retained by Baird as above provided, and the remaining $350,000.00 to be retained by the said Company, to be applied by it to the liquidation of the indebtedness above set out, that he will then sell, assign, convey, and deliver to the said Gulf Refining Company of Louisiana the entirety of the said mineral lease hereinabove referred to and forming the subject matter of this contract, *2236 for the consideration of the obligation upon the part of the Gulf Refining Company of Louisiana to continue to operate said property for the production of oil for such length of time as it may be able to produce oil therefrom in paying quantities, and to deliver to him, or his transferees, the one-twenty-fourth (1/24th) royalty out of the oil, as hereinabove provided, until the expiration of three (3) years from this date, and a royalty of one-thirty-second (1/32nd) of all the oil that may be saved from that produced, after said date, and as long thereafter as oil may be produced from the said property in paying quantities.
7. As further security to the Gulf Refining Company of Louisiana for the performance of the obligation to sell as set out in the last preceding paragraph, the said Baird has this day executed an assignment in favor of said Company of his entire interest in the said lease, which said assignment he agrees to deposit in escrow with such depositary as may be mutually agreed upon by the parties, to be retained by said trustee and to be delivered to the Gulf Refining *942 Company of Louisiana, when it shall have complied with the obligations above set out and*2237 made a consideration of said assignment; said assignment so delivered in escrow shall moreover be considered between the parties thereto as a further security for the pledge and mortgage hereinabove stipulated.
In witness of which, this agreement has been this day executed in duplicate, the said Gulf Refining Company of Louisiana being represented therein by its Third Vice-President, C. R. Minor, being herein authorized, and this agreement being executed as of and effective from seven-thirty o'clock A.M., November 1, 1921. Shreveport, La., Nov. 16th, 1921.
The sum of $350,000 therein mentioned was not paid to Baird and/or his coowners, but at their direction was paid by the Gulf Refining Co. of Louisiana, to John Munhall, Jr., through the Mellon National Bank of Pittsburgh, Pa., in compliance with the terms of the judgment.
As provided in the contract between George O. Baird and the Gulf Refining Co. of Louisiana, above set forth, said company took physical possession of the property, as therein provided, and a deed was executed by Baird and deposited in escrow with an escrow agent agreed upon by both parties, to be delivered under the conditions decided in said contract. *2238 This deed remained in the hands of the escrow agent under the terms of the escrow agreement throughout the remainder of the year 1921 and through all of 1922 and until some time in 1927 when same was delivered by the escrow agent to the Gulf Refining Co. of Louisiana.
Each petitioner returned as income in 1921 his proper proportion of 60 per cent of seven-eighths of production, as heretofore set forth, deducting therefrom depletion based upon discovery revaluation previously allowed by the respondent. The assessment giving rise to this appeal was the result of a disallowance of such depletion and of respondent's holding that the $350,000 referred to in the contract with the Gulf Refining Co. of Louisiana was income to the petitioners in the year 1921 and that no account was to be taken of the repayment of the same sum of $350,000, made a condition, by the judgment above set forth, of the repossession of the property.
Each of the petitioners in 1922 correctly reported his proportion of 60 per cent of seven-eighths of the oil production and its value, deducting therefrom discovery depletion as theretofore determined and adjudged by the respondent. The assessment giving rise*2239 to this appeal rejected the depletion so claimed.
The books of the petitioners show the transaction between them and the Gulf Refining Co. of Louisiana as a loan by the Gulf Refining Co. of Louisiana under the terms and conditions of the said written escrow and a retention by them of the ownership of the lease. The petitioners' books and records, kept on a receipts basis, as do their returns, show the receipt by them of the 60 per cent of seven-eighths of the oil and its sale by them.
*943 OPINION.
MILLIKEN: 1 Since the overassessment as to the estate of Mrs. George O. Baird for the year 1922 does not result, so far as the record discloses, from the rejection of a claim in abatement, the Board is without jurisdiction as to such petitioner for said year and the petition, in so far as it involves that year, is dismissed. Cornelius Cotton Mills, 4. B.T.A. 255.
The controlling question in these proceedings is whether the agreement of November 16, 1921, between Baird and the Gulf Refining Co. of Louisiana, hereinafter referred to as the Gulf Company, was a contract of mortgage or pledge, *2240 or was a contract of sale. At the outset it is proper to state what actually was done and agreed to be done under the agreement. Flannery's assignee, Munhall, had recovered judgment against Baird for the sum of $350,000, which had to be paid before the judgment became effective. The sum of $350,000, which the agreement recites was loaned to Baird, was in fact paid by the Gulf Company directly to Munhall and Baird was not to be personally liable for this amount or any part thereof, nor was any interest to be paid thereon. The Gulf Company was placed in possession of the lease and agreed to operate it at its own expense "as long as oil may be produced therefrom in paying quantities." Baird was to receive 60 per cent of the oil until he had received the sum of $325,000 or for the term of 30 months from the date of the agreement, whichever occurred first. When Baird had received oil to the extent of $325,000 or if he had not received that amount at the end of 30 months, then the Gulf Company was to recoup out of Baird's 60 per cent of the oil the amount of $350,000 which it had paid to Munhall. When the proceeds of the said 60 per cent of the oil had produced the sum of $675,000*2241 (the said sum being composed of $350,000 paid to Munhall and $325,000 payable to Baird) then the escrow agent was to deliver to the Gulf Company the deed of assignment which Baird had executed contemporaneously with the execution of the agreement and had then deposited in escrow. On the other hand, the Gulf Company was to own all the gas and casing-head gas produced from the lease and, further, subject to the payment of the royalty of one-eighth to the lessor and the delivery by it to Baird for three years of one twenty-fourth of all the oil produced, was to own the remaining 40 per cent of the oil. By the deed deposited in escrow, it was provided that Baird was to receive one twenty-fourth of the oil produced for the period of three years from the date of the contract and one thirty-second of the oil thereafter produced.
Was the above contract a contract of pledge with an option in the Gulf Company to purchase or was it a contract of sale?
*944 In this connection petitioners urge that parol evidence should not be admitted to vary the terms of the written agreement and, further, that the Board is bound by its recitals to the effect that the agreement was an hypothecation*2242 and that the Gulf Company had "loaned" to Baird the sum of $350,000. While it is true that every word of a written agreement must be given effect, we are not bound by any one separate provision or recital. The paper should be construed as a whole. The fact that a paper terms itself a mortgage, pledge or lease is not controlling when the instrument taken by its four corners discloses that it is something else. Thus, in the leading case of , the court, in holding that what purported to be a lease was in fact a contract of sale, said:
What, then, is the true construction of the contract? The answer to this question is not to be found in any name which the parties may have given to the instrument, and not alone in any particular provisions it contains, disconnected from all others, but in the ruling intention of the parties, gathered from all the language they have used. It is the legal effect of the whole which is to be sought for. The form of the instrument is of little account.
Though the contract industriously and repeatedly spoke of loaning the cars to the railroad company for hire, for four months, and delivering*2243 them for use for hire, it is manifest that no mere bailment for hire was intended. * * *
It is also pertinent to point out that we are applying a Federal income-tax act which taxes, or at least attempts to tax, alike, the income of all persons, it matters not in what particular State they reside. Cf. ; , and .
It is clear that the agreement, although it recites that Baird "does by these presents mortgage and hypothecate," was not a mortgage under the laws of Louisiana, since the Gulf Company was placed in possession. See Gates v. Gaither, 46 L.Ann. 286; . It is petitioner's contention that the agreement was in the nature of that character of pledge known to the civil law as an antichresis, to secure the payment of what the agreement terms a loan by the Gulf Company to Baird of the sum of $350,000. The following provisions of Merrick's Revised Civil Code of Louisiana are pertinent:
ART. 3133 [3100]. THE PLEDGE is a contract by which one debtor gives something*2244 to his creditor as a security for his debt.
* * *
ART. 3134 [3101]. KINDS OF. There are two kinds of pledge: The pawn. The antichresis.
* * *
ART. 3135 [3102]. PAWN; ANTICHRESIS. A thing is said to be pawned when a movable thing is given as security; and the antichresis, when the security given consists in immovables.
* * *
*945 ART. 3141 [3108]. PLEDGE FOR DEBT OF ANOTHER. A person may give a pledge, not only for his own debt, but for that of another also.
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ART. 3152 [3119]. ACTUAL DELIVERY AND POSSESSION OF THING PLEDGED. It is essential to the contract of pledge that the creditor be put in possession of the thing given to him in pledge, and consequently that actual delivery of it be made to him, unless he has possession of it already by some other right.
* * *
ART. 3176 [3143]. CREDITOR'S RIGHTS. The antichresis shall be reduced to writing
The creditor acquires by this contract the right of reaping the fruits or other revenues of the immovables to him given in pledge, on condition of deducting annually their proceeds from the interest, if any be due him, and afterwards from the principal of his debt.
* * *
ART. 3177*2245 [3144]. TAXES AND REPAIRS. The creditor is bound, unless the contrary be agreed on, to pay the taxes, as well as the annual charges of the property which have been given to him in pledge.
He is likewise bound, under penalty of damages, to provide for the keeping and useful and necessary repairs of the pledged estate, saving himself the right of levying on their fruits and revenues all the expenses respecting such charges.
* * *
ART. 3178 [3145]. RECLAMATION BY DEBTOR: ABANDONMENT BY CREDITOR. The debtor can not, before the full payment of the debt, claim the enjoyment of the immovables which he has given in pledge.
But the creditor who wishes to free himself from the obligations mentioned in the preceding articles, may always, unless he has renounced this right, compel the debtor to retake the enjoyment of his immovable.
* * *
The first essential of a pledge, whether a pawn or an antichresis, is a debt or an obligation of someone. It may be the debt or obligation of another. Here neither Baird nor anyone else was personally liable for the repayment of the sum of $350,000 or any part thereof. We are asked to hold that the Gulf Company, a corporation, loaned*2246 this sum to Baird without personal liability, without any fixed date of maturity and without interest. Indeed, we may look in vain to find any provision in the agreement of November 16, 1921, whereby the Gulf Company was to be repaid the $350,000 in case oil in sufficient quantities could not be extracted to meet the advance payment to Baird of $350,000. We do not say that such an agreement would not be valid under the laws of Louisiana but we do say that this part of the transaction more nearly corresponds with the concept of an advance payment on a sale than with that of a loan. There is, however, an essential to a pledge without which a pledge can not exist, and that is the right of redemption or, as termed in the Louisiana Code, of reclamation. *946 This right is not only absent from the agreement but could not have been exercised by Baird at any time. When the sum of $675,000 had been produced from the oil, the deed held in escrow was to be delivered. We are unable to find that the agreement constituted a pledge in the nature of an antichresis.
The next question is whether the agreement between Baird and the Gulf Company was in the nature of a sublease and, if*2247 so, whether the payments received by Baird were in the nature of rentals. The question as to what is a sublease or an assignment of a lease under the laws of Louisiana is discussed at length in . As pointed out in that case, an essential element of a sublease is a reversionary interest remaining in the grantor. Here no such interest was reserved to Baird. The Gulf Company was placed in possession under a contract to operate the lease so long as oil in paying quantities was produced, with the corresponding agreement on the part of Baird that the deed placed in escrow should be delivered when the sum of $675,000 had been raised from 60 per cent of the oil. No right of reentry was reserved. No penalty of forfeiture was imposed. There is nothing in the wording of the agreement which indicates that a subleasing was intended. Neither are there any provisions therein which have any relation to such tenure. Baird's contract was to sell "the entirety of the said mineral lease" and the sum of $675,000 was a part of the purchase price. Nor is our conclusion affected by the fact that, in addition to said sum of $675,000, Baird was to*2248 receive for the first 36 months one twenty-fourth of the oil, and one thirty-second thereof thereafter. He was to receive these amounts both under the agreement and under the deed. After the delivery of the deed they could not be rentals. The same is true of them before such delivery. Under both they were a part of the purchase price. The agreement, as we will now proceed to show, was in fact a contract not of subleasing or a contract to sell, but was a contract of sale.
Subject to the liability of making the deferred payments out of oil, every right of ownership was vested in the Gulf Company. It had the right of possession so long as oil was in practical existence. The Gulf Company was the owner of all gas and casing-head gas produced after the date of the agreement. It agreed to pay all taxes assessed against the lease. It paid for the use of Baird his judgment obligation to Munhall. This payment was, for income-tax purposes, in effect a payment to Baird. See Old Colony Trust Co. v. Commissioner of Internal Revenue, and United Statesv. Boston & Maine Railroad, both decided by the Supreme Court of the United States on June 3, 1929. This payment at*2249 once became the absolute property of Baird. For the term of 30 months from the date of *947 the agreement Baird was to receive 60 per cent of all oil produced, or until he had received the sum of $325,000, whichever event occurred first. After the happening of the event, no further payments were to be made to Baird out of this 60 per cent until the Gulf Company had recouped, out of the said 60 per cent of the oil, the amount paid by it to Munhall. In all events Baird, subject to certain conditions, was to receive in addition to the sum paid to Munhall, the benefit of 60 per cent of the oil until the additional sum of $325,000 was paid to him. The fact that this amount of $325,000 was to be paid out of oil does not militate against the operation of the agreement as a contract of sale. See . The provisions of the agreement as to time and conditions of payment out of oil are only limitations on the method of payment of the purchase price. Looking through the form to the substance (See *2250 , and reducing the contract to its essence, the agreement was to sell the lease for the sum of $675,000, of which $325,000 was, subject to certain conditions, payable out of oil, and the payment of the further amount of one twenty-fourth of the oil for the first 36 months and one thirty-second thereof thereafter, and when Baird had directly or indirectly received in all the sum of $675,000 the deed already executed was to be delivered by the escrow agent to the Gulf Company.
At this point it is argued that the agreement contained no express obligation on the part of the Gulf Company to accept the deed and therefore it was optional with the Gulf Company whether it would or would not purchase. This contention overlooks the fact that in the clause 2 of the agreement the Gulf Company obligated itself to operate the lease so long as oil may be produced in paying quantities. It overlooks the further fact that the only apparent way in which the Gulf Company could terminate its liability to turn over to Baird 60 per cent of the oil and to reduce its liability to one twenty-fourth and then to one thirty-second*2251 thereof, was by the acceptance of the deed. We cannot disregard this obvious fact and hold that the Gulf Company was under no obligation to purchase. The exercise of the so-called option operated not to impose upon the Gulf Company a further obligation, but to relieve it of a greater liability. Viewed in this aspect the provision for the option was a mere form.
The making of so-called "leases" in which "rentals" were in fact payments on the purchase price, with an option at the end of the "term" to purchase for a small sum, is not new. Here, as above pointed out, there was in fact a relief from a large liability. The courts, looking through the form to the substance, have held *948 such contracts to evidence conditional sales. Thus, in , the facts were that Corbett who did business in Pennsylvania "leased" to Keefe & Son a steam shovel and shipped it to the firm in Virginia. The "term" of the "lease" was six months and the total "rental" was the sum of $5,600. The firm had the right within 10 days after the expiration of the "term" to purchase the shovel for the sum of $10 or else to return it to Corbett*2252 in Pennsylvania. The court disregarded the fact that the instrument termed itself a "lease" and the payments "rentals" and held that the paper evidenced a conditional sale. With respect to the optional right to purchase, the court said:
The requirement that if they should elect to purchase they should pay an additional $10 was obviously a mere form. If the notes had been paid, of course the $10 would have been. The shovel would have been worth more than that to sell as old iron. Moreover, if they did not pay the $10 they bound themselves to return the shovel to Pennsylvania. That would have cost many times $10.
In , the Adding Machine Co. had "leased" to Munger Fish Co. an adding machine for the "term" of nine months, for which the Fish Company paid $75 cash and agreed to pay a monthly "rental" of $47.22, making the total payments due under the "lease" of the sum of $499.97. The Fish Company had the right to "purchase" the machine for an additional amount of $47.22 over and above the cash payment and the so-called rental. The court, in holding that this was a conditional sale, said:
*2253 The final payment, which is nominally the purchase price, is so small in comparison with the entire purchase price as to leave no real choice to the "lessee". The obvious purpose was to dispose of the machine under such conditions that when the "lessee" had paid the "rental" he could not afford to fail the relatively small final payment to obtain it. This would have been the obvious and natural, if not the inevitable, result. Evidently it was what the parties desired and intended to accomplish.
See, also .
The agreement between Baird and the Gulf Company was skillfully drawn, and its true effect is often submerged under a cloud of legal verbiage, but when we look at it as a whole, at its purposes and results, and when we consider it in connection with the provisions of the deed contemporaneously executed and placed in escrow, the fact stands out that the agreement was neither a pledge nor a sublease. What petitioners have realized was a capital gain arising from the conversion into cash or its equivalent of their capital asset. *2254 . Under these circumstances petitioners are not entitled to the right of deduction for depletion. See
*949 Petitioners contend that if we determine that the contract between Baird and the Gulf Company was a contract of sale, then they are entitled to add to the cost of the lease the sum of $350,000, which was paid to Flannery's assignee, for the purpose of clearing the title to the lease; and that, if this is not true, then the payment was taxable income in the year 1919, when received from Flannery, and since, as contended, no part of this amount was paid to petitioners in the deal with the Gulf Company, they should not be taxed upon it a second time.
As we have shown, the payment by the Gulf Company to Flannery's assignee was, for income-tax purposes, a payment to petitioners. The sale to Flannery in 1919 and its rescission in 1921 constitute a series of transactions distinct and separate from the sale to the Gulf Company in the latter year. The fact that the rescission and subsequent sale occurred in the same year does not change the situation from what it would have*2255 been had they occurred in separate years. It is at once evident that the payment to Flannery's assignee constituted no part of the cost of the lease to petitioner. During the period from the date of the contract of sale to Flannery down to the effective date of the sale to the Gulf Company, Baird operated the lease and collected all the proceeds arising therefrom. It is true that in his petition in the state court he alleged that such proceeds had been credited to Flannery but he further alleged that Flannery was not entitled to such proceeds or any part thereof and such was the effect of the judgment, which contains the following:
That the resolution of the said contract hereby decreed is ordered and adjudged effective as of date of said contract, so that no right, title, claim or interest therein has ever vested in the said Flannery or his assigns.
That the plaintiff, George O. Baird, be, and he is hereby ordered to pay unto John Munhall, Jr., the vendee of the said Flannery, and substituted defendant herein, the sum of Three Hundred and Fifty Thousand ($350,000.00) Dollars, being the net sum heretofore paid by the said Flannery to the said Baird, under the said contract, *2256 and that this judgment shall become operative and in full force and effect upon the restitut on of the said sum of Three Hundred and Fifty Thousand ($350,000.00) Dollars, by its payment either to the said John Munhall, Jr., or his representatives; and that upon such payment of the sum of Three Hundred and Fifty Thousand ($350,000.00) Dollars, the said contract shall be as if it had never existed.
There is presented no question of repossession. Baird was never out of possession. The contract was rescinded as of the date of its execution. Baird was adjudged entitled to all the proceeds of the lease and, as a matter of equity, the judgment became effective only upon payment to Flannery's assignee, but when it did become effective the contract was "as if it had never existed." The amount due Flannery's assignee under the judgment was precisely the net amount *950 received from Flannery. The payment represented an amount which Baird had no right to retain, since he received all the proceeds of the lease during the period. The amount refunded precisely balances the amount received. The slate was wiped clean and Baird was where he had been when the contract was made. The*2257 cost of the lease was neither enhanced nor diminished by the receipt and payment of precisely the same amount of money.
Reviewed by the Board.
Judgment will be entered for the respondent.
Footnotes
1. This decision was prepared during Mr. Milliken's term of office. ↩