*1144 1. A business conducted by a husband alone, to which his wife contributed funds which she was willing to loss if the business were not successful, held, upon the evidence, not to be the business of a partnership with distributable income, but the business of the husband alone, the income being entirely taxable to him.
2. The transfer in 1920 by a taxpayer of the assets of his business, including an oil lease which was the subject of an action by the taxpayer to quiet his title, in exchange for shares of a newly organized corporation, held, upon the evidence, to result in taxable gain, and the shares received were not without fair market value.
*264 Respondent disallowed a claim in abatement of $26,474.21 income and excess profits taxes for 1917. He determined deficiencies of $57,576.10, $182,457.44 and $400,564.64 in income taxes for 1918, 1919 and 1920, respectively. Petitioner contends that respondent improperly taxed to him the entire income of an oil business which he alleges was owned by a partnership*1145 composed of himself and wife, and that respondent improperly computed gain upon an exchange in 1920 of the oil business and properties for corporate stock alleged to have had less fair market value than determined. Respondent prays that in the event the latter issue is decided in petitioner's favor the deductions allowed for depletion of petitioner's oil wells be reduced to reflect the lower value of said wells resulting from a could on petitioner's title.
FINDINGS OF FACT.
Petitioner and his wife reside at Enid, Oklahoma. On August 30, 1916, petitioner leased from George Beggs and wife 160 acres of land in Garfield County, Oklahoma, for the purpose of mining and operating for oil and gas for a period of five years and as long thereafter as production continued. The lessors agreed "to warrant and defend the premises against all former leases." Petitioner paid them $12,000 in cash for the lease. Of this amount he borrowed $10,000 from a bank upon a note signed by him and his wife.
The same land had been the subject of a prior lease entered into February 23, 1916, between the Beggs and the Chanute Refining Co. This lease provided that if no well was completed on the land*1146 by August 23, 1916, it should terminate as to both parties unless on or before that date the lessee paid or deposited to the lessors' credit $80 which was to operate as a rental and extend the lessee's time for completing the well by six months. The Chanute Refining Co. immediately transferred the lease to the Garfield Oil Co. On August *265 23, 1916, no well had been commenced on the property and the $80 was not paid or deposited to the lessors' credit, but was later tendered by the Garfield Oil Co. and refused.
On November 4, 1916, Beggs, his wife, and petitioner instituted an action in the District Court of Garfield County, Oklahoma, against the Garfield Oil Co., to quiet petitioner's title to the second lease. After eight years of litigation, during which the case was twice reviewed by the Supreme Court of the State, petitioner's title was held sound by decision rendered October 14, 1924. Throughout these proceedings petitioner represented himself to be, and was, the sole owner of the lease. The cloud on his title was constant from acquisition until termination of the litigation.
Shortly after August 1916, petitioner began development of the property. He found*1147 that the cost of the lease and the drilling of the first well would require about $25,000. In October he mentioned to his wife that the venture was new for him, that he expected to put in so much and no more, and that if the well were dry, the whole investment would be a loss. His wife proposed that she put in money of her own which she had received as gifts from her parents, and that if he lost what he put in, she would lose what she put in. Nothing was said about her sharing in the profits or losses in excess of the amount that she contributed. On December 21, 1916, her contributions totaled $13,495.33. None of this amount has been repaid to her, nor has she received any distribution of the profits or assets of the business. During the first six or eight months petitioner borrowed additional funds for development upon notes signed by himself and wife.
Petitioner operated the business under his own name, and deposited proceeds from it in his personal bank account until August 1917, when he purchased a small refinery at Enid which he operated thereafter under the name of Champlin Refining Co., depositing the proceeds to an account in that name. The operations became very*1148 profitable, many producing wells having been discovered by April 1920.
On April 17, 1920, the Champlin Refining Co. was organized as a corporation under the laws of Maine, with an authorized capital stock of $10,000,000, divided into 5,000 common shares of the par value of $1,000, and 50,000 preferred shares of the par value of $100. On the following day petitioner assigned to the corporation the Beggs lease, together with all right, title and interest in and to the refining and marketing business owned by him. The assignment recites, inter alia:
WHEREAS, the said lease and all rights thereunder or incident thereto are now owned by H. H. Champlin,
* * *
*266 And for the same consideration, the undersigned for himself and his heirs, successors and representatives, do covenant with the said assignee its heirs, successors or assigns that he is the lawful owner of the said lease and rights and interests thereunder and of the personal property thereon or used in connection therewith; that the undersigned has good right and authority to sell and convey the same, and that said rights, interest and property are free and clear from all liens and incumbrances and that*1149 all rentals and royalties due and payable thereunder have been duly paid.
The corporation issued 1,351 of its common shares to petitioner, 1,345 to his wife, and four qualifying shares to others. The total par value of the shares issued was $2,700,000. The assets and liabilities transferred were entered on the corporate books, April 17, 1920, as follows:
| ASSETS | ||||
| Current Assets: | ||||
| Cash | $196,701.82 | |||
| Accounts Receivable | 150,195.75 | |||
| Notes Receivable | 23,947.26 | |||
| Inventory | 75,877.53 | |||
| H. H. Champlin | 306,685.37 | |||
| Total Current Assets | $753,407.73 | |||
| Fixed Assets: | ||||
| Real Estate | 11,446.50 | |||
| Refinery | $319,452.58 | |||
| Construction | 24,010.00 | |||
| Pipe Line | 54,253.84 | |||
| Stations | 50,109.29 | |||
| Tank Cars | 447,951.28 | |||
| Drums & Barrels | 433.31 | |||
| Refinery Tools | 1,820.41 | |||
| Autos & Trucks | 14,043.98 | |||
| Furniture & Fixtures | 4,284.41 | |||
| $916,359.10 | ||||
| Less Reserve for Deprec. | 87,726.86 | |||
| 828,632.24 | ||||
| Beggs Lease: | ||||
| Depleted Cost | $6,578.27 | |||
| Appreciation | 869,198.05 | |||
| Total lease | 875,776.32 | |||
| Casing & Pipe | 194,205.20 | |||
| Rigs, Mchy. & Boilers | 40,600.00 | |||
| Tanks | 28,721.85 | |||
| Building | 8,196.63 | |||
| Total Value Beggs Lease | 1,147,500.00 | |||
| Total Fixed Assets | 1,987,578.74 | |||
| $2,740,986.47 | ||||
| LIABILITIES | ||||
| Current Liabilities: | ||||
| Bills Payable | $5,000.00 | |||
| Accounts Payable | 94,937.85 | |||
| Total Current | $99,937.85 | |||
| Liabilities | ||||
| Net Worth | 2,641,048.62 | |||
| $2,740,986.47 |
*1150 *267 The values assigned to the assets other than the Beggs lease correctly reflect their cost or depreciated cost and their fair market values as of April 1, 1920. The liabilities of the business are fully set forth in the schedule.
Petitioner and his wife have never disposed of any of the shares issued to them at incorporation.
The fair market value of an unclouded title to the Beggs lease on April 1, 1920, was, as stipulated by the parties, $1,530,000. By reason of the cloud on petitioner's title, respondent determined that the value of his title on that date was 25 percent less than that of a sound title, or $1,147,500, which amount he included in the fair market value of the corporate stock exchanged therefor. He computed a gain on the exchange of the business assets and liabilities for the stock by deducting from the determined value of the title, $278,301.95, the agreed cost of the lease, buildings and operating equipment as reduced by depletion or depreciation to the date of exchange, and taxed petitioner for 1920 on the entire resulting gain of $869,198.05.
The fair market value of the Beggs lease on April 17, 1920, was $1,147,500.
Prior to the exchange, *1151 petitioner discovered eight oil wells on the lease, for which respondent determined the following discovery values:
| Well #1, Dec. 23, 1916 | $386,942.40 |
| Well #10, Aug. 1, 1917 | 339,025.70 |
| Well #14, Apr. 17, 1918 | 476,521.99 |
| Well #15, June 21, 1918 | 298,774.56 |
| Well #19, Aug. 13, 1918 | 181,788.80 |
| Well #22, Dec. 15, 1918 | 343,493.85 |
| Well #24, Jan. 15, 1919 | 177,781.20 |
| Well #27, Apr. 4, 1919 | 91,269.10 |
| 2,295,597.60 |
In computing petitioner's net income, respondent allowed the following deductions for depletion:
| 1918 | $266,275.74 |
| 1919 | 369,809.26 |
| Jan. 1 to Mar. 31, 1920 | 67,841.89 |
| Total | 703,926.89 |
*268 Of the total, $700,243.75 represents depletion of the wells; $3,683.14, depletion of the lease. The discovery values determined correctly reflect the values of a sound title to the wells; the depletion deductions were allowed without diminution because of the cloud on petitioner's title. The net value of the production obtained from the lease during 1917 was $95,420.41.
Petitioner and his wife filed joint returns for 1917 and 1918; separate returns for 1919 and 1920. Partnership returns were filed by Mrs. Champlin for 1919 and*1152 1920, showing profits of $98,423.79 and $27,821.18, respectively, from the business of the Champlin Refining Co. These amounts were assessed and paid, and no claim for refund has been filed. Taxes on the same profits were assessed against and paid by petitioner. The Commissioner tendered a refund, with interest, of the tax paid by Mrs. Champlin for 1920; this was refused by her. No partnership returns were filed for 1917 and 1918.
OPINION.
STERNHAGEN: 1. The first issue has been settled by the parties. The Commissioner had allowed the petitioner a deduction of $10,000 for salary, which petitioner claimed was inadequate and should be increased to $25,000. This the Commissioner now concedes, and thus removes the issue from consideration.
2. The petitioner contends that during all of the period in question the income from the oil and refining business inured to a partnership which existed by agreement between him and his wife. The respondent denies the partnership. In our opinion, the evidence fails to establish that such a partnership existed.
It has been held that in tax cases a claim of partnership between husband and wife must be carefully scrutinized, and is*1153 not to be lightly allowed. ; ; ; cf. ; ; ; (); ; . While, in Oklahoma it may be, as the petitioner contends, that a husband and wife may properly form a partnership, and that such state law would be controlling (but see ; ), the question here is whether the evidence is sufficient to establish such a partnership in fact. We are unable to find that it does. The wife merely contributed some of her own funds to the petitioner to be used in the acquisition and operation of the lease, being at the same time aware that the venture might prove unsuccessful and that her contribution might thus be lost. Nothing more was understood as to a partnership*1154 relation, either *269 between themselves or by anyone else who did business with the petitioner. The wife had no authority to participate either in the management or the responsibilities of the business, and she never attempted to exercise any. The business was conducted entirely by the petitioner and in his own name. No distribution of profits was ever made to the wife. Under these circumstances the petitioner properly omitted to file partnership returns for 1917 and 1918, and the fact that such returns were improperly filed for 1919 and 1920 and the resulting tax was distributively paid by both, adds nothing to demonstrate the existence of a partnership.
3. The petitioner contends that for 1920 the Commissioner erroneously charged him with gain resulting from the exchange by him of the assets of his business, including the Beggs lease, for shares of the newly organized Champlin Refining Co. He contends that the transaction was within section 202(b), Revenue Act of 1918, 1 and that the shares received had no fair market value and thus the transaction involved no gain. The evidence offered to support this point is misconceived. *1155 It is directed not so much to the actual fair market value of the shares received as it is to the effect of the title litigation upon the scope of the market for the Beggs lease. Since the opening balance sheet shows that the corporation's shares were backed not alone by the Beggs lease, but also by the substantial value of various other apparently unrelated assets, there would still be value in the shares even if it could be said that the Beggs lease was itself without fair market value. . The balance sheet indicates that such assets included cash $196,000, accounts receivable $150,000, refinery $319,000, tank cars $447,000, and other items, all aggregating over $1,500,000. Nothing in the record indicates that this valuation was inflated. There is therefore no basis for a finding that the shares had no substantial fair market value.
*1156 The parties have stipulated that, except for the effect of the litigation upon the petitioner's rights under the Beggs lease, the lease *270 was worth $1,530,000. This figure is substantially less than the aggregate discovery values of the eight wells which were brought in on the property prior to the incorporation, upon which substantial depletion deductions had been claimed and allowed. Throughout the litigation the petitioner and the corporation were successively in possession of and actually engaged in operating the property, and during this period the petitioner's right to operate and retain the proceeds was never sufficiently in doubt to impel the court by the appointment of a receiver or otherwise to restrict his use of either the property or the proceeds. One witness thought that the petitioner's chance of ultimate success in the litigation was one out of three. The witness translated this and other facts into a value for the lease while under the cloud amounting to "$400,000 or $500,000." Another witness thought that the major oil companies would not be interested in buying either the petitioner's shares or the leasehold, and this he translated into an opinion*1157 that the leasehold and shares were unmarketable and without fair market value. His opinion of the value of the sound right under the lease was $750,000, which is one half of the value stipulated. As a matter of fact, no attempt was made by the petitioner or the corporation at any time to sell either the lease or the shares, and evidence of actual effect upon the market is not available. The opinions of the witnesses are conjectural estimates, cf. , and, as we have said, relate primarily not to the corporate shares but to the controverted lease.
The corporation which the petitioner organized accounted for the leasehold at a total depleted value of $1,147,500. The respondent, having agreed with the petitioner that the sound, unclouded title to the lease was worth $1,530,000, recognized that the pendency of the title litigation served to diminish such market value and he determined the value thus diminished to be 25 percent less, or $1,147,500, which is the same figure appearing as the opening entry upon the corporation's books. We are unable, after a full consideration of the evidence, to say that*1158 this determination overstates the fair market value of the lease or that the fair market value of the corporation's shares was less than the Commissioner's figure, which reflected the inclusion among the corporation's assets of the Beggs lease at $1,147,500.
4. The respondent raises an alternative issue as to the depletion allowance if his valuation be overruled. Since the valuation is sustained, there is no occasion to consider this alternative issue, there being no claim for an increase in the deficiency.
Reviewed by the Board.
Judgment will be entered under Rule 50.
*271 SMITH, dissenting: I do not agree with the majority holding that the taxpayer realized a gain upon the incorporation of his oil business. Section 202(b) of the Revenue Act of 1918 provides that upon an exchange of property "the property received * * * shall * * * be treated as the equivalent of cash to the amount of its fair market value, if any." There is no warrant in the statute for resorting to the intrinsic value of the assets of the new corporation in determining the "fair market value, if any," of its stock. The statute uses terms connoting a concourse of*1159 willing buyers and willing sellers. The evidence of record discloses that there were neither sales nor offers to buy or sell; that there was a cloud upon the title of the petitioner to the Beggs lease; and that there was no market for the stock in 1920. In these circumstances I do not see how it can be said that the shares of stock had a fair market value. In my opinion there was no realized gain taxable as income to Champlin. See O'Meara v. Commissioner (C.C.A., 10th Cir.), 34 Fed.(2d) 390; Schoenheit v. Lucas (C.C.A., 4th Cir.), 44 Fed.(2d) 476; Mount v. Commissioner (C.C.A., 2d Cir.), 48 Fed.(2d) 550, wherein similar transactions have been held to result in no taxable gain.
Footnotes
1. SEC. 202. (b) When property is exchanged for other property, the property received in exchange shall for the purpose of determining gain or loss be treated as the equivalent of cash to the amount of its fair market value, if any; but when in connection with the reorganization, merger, or consolidation of a corporation a person receives in place of stock or securities owned by him new stock or securities of no greater aggregate par or face value, no gain or loss shall be deemed to occur from the exchange, and the new stock or securities received shall be treated as taking the place of the stock, securities, or property exchanged.
When in the case of any such reorganization, merger or consolidation the aggregate par or face value of the new stock or securities received is in excess of the aggregate par or face value of the stock or securities exchanged, a like amount in par or face value of the new stock or securities received shall be treated as taking the place of the stock or securities exchanged, and the amount of the excess in par or face value shall be treated as a gain to the extent that the fair market value of the new stock or securities is greater than the cost (or if acquired prior to March 1, 1913, the fair market value as of that date) of the stock or securities exchanged. ↩