*2006 1. Where the taxpayer and others transferred their interests in certain oil royalties to a common law trust and received in payment therefor beneficial units in the common law trust, and subsequently the common law trust conveyed the oil and gas royalties to a corporation in exchange for its capital stock, to be distributed to holders of beneficial units in the same proportion as they were holders of beneficial units in the common law trust, and the taxpayer subsequently exchanged his shares of stock in the corporation for certain oil royalties, the latter is a taxable transaction. The measure of the gain or loss is the difference between the cost of the stock exchanged and the fair market value of the property received in exchange.
2. Where the cost of the shares of stock exchanged by the petitioner is not shown the determination of profit by the respondent must be approved.
*1140 This proceeding is for a redetermination of a deficiency of $1,441.09 for the year 1922 in which the petitioner alleges that the respondent erred in determining that*2007 he received income in the year 1922 in the sum of $12,644.68, resulting from an exchange of shares of *1141 stock in a corporation owning royalties, for oil and gas royalty rights transferred to him by an individual. Petitioner contends that there was no taxable profit in the transaction and if there was, it was only $678.45. By amended answer the respondent alleges that in addition to the deficiency set up in the deficiency notice, the petitioner had received dividends of $5,799.75 during the taxable year, which should be added to his net income and taxed at surtax rates and the deficiency should be increased accordingly.
FINDINGS OF FACT.
The petitioner is an individual and resides at Lewistown, Mont. In March, 1917, he filed a homestead claim in Fergus County, Montana, and subsequently entered into an arrangement with Frank Frantz to develop the lands for oil and gas purposes upon a basis of 5 per cent royalty to the petitioner.
In March, 1921, petitioner, Harrison Green, and L. W. Robinson, Jr., adjoining landowners, organized a common law trust similar to a Massachusetts trust, by which they conveyed to themselves as trustees certain royalty interests owned*2008 by them. The interests of the parties were represented by unit certificates in the sum of $100,000 to Harrison Green, $25,000 to L. W. Robinson, Jr., and $50,000 to the petitioner, which was in the proportion of four-sevenths to Green, one-seventh to Robinson and two-sevenths to the petitioner. The powers and duties of the trustees were limited strictly to the collection and distribution of the royalties, and the payment of necessary expenses. The trust agreement was subsequently amended to include the Lewistown State Bank as a trustee and as the custodian and depository of the receipts from royalties. This trust was known as the Wildschutz-Harrison Green Royalty Association. In September, 1921, petitioner, Green, and Robinson organized a corporation under the laws of Montana by the name of Green-Wildschutz Royalty Company. The objects and purposes of the corporation are stated as follows in the articles:
To purchase with the said Units of stock the Royalty of oil holdings of the WILDSCHUTZ-HARRISON GREEN ROYALTY ASSOCIATION, in the Cat Creek Field in Fergus County, Montana, and to manage, control, operate and hold the said royalty of oil holdings for the purpose of receiving*2009 the money derived from the sale of oil from the said holdings and paying all of the same out in quarterly dividends after office and incidental expenses have been paid, but in no case shall it be necessary to pay out fractional percents in dividends and also in no case shall a salary or incidental expense be paid to an officer, employee or other person greater than would be paid for similar services or expenses in any ordinary commercial business according to the time actually devoted to said business or expense actually incurred in said business, it being the purpose and intention that this shall be an absolute oil royalty company and that no money *1142 received from the sale of oil can be used in drilling or for any other purposes than the ones herein named.
The capital stock was fixed at $70,000, divided into 2,800 units of the par value of $25 each. It was subscribed as follows: Harrison Green, 1,380 units, $34,500; Matthias W. Wildschutz, 776 units, $19,370; L. W. Robinson, Jr., 345 units, $9,625; and 299 units, $9,625, were retained in the treasury to exchange for units in the trust sold to other persons.
On October 1, 1921, the trustees of the Wildschutz-Harrison*2010 Green Royalty Association, the common law trust, conveyed all the royalties owned by it to the new corporation, Green-Wildschutz Royalty Company. The corporation thus became the owner of the royalties originally owned by petitioner, Green and Robinson, which had been assigned by them to the common law trust. Seven hundred and eighty-four shares in the corporation were issued to petitioner, although the charter of the corporation only recorded him as subscriber for 776 shares. The royalties originally conveyed by Harrison Green to the common law trust were 3 per cent on all oil and gas produced from the lands described in his assignment.
In September, 1922, the petitioner exchanged his 784 shares of stock in the Green-Wildschutz Royalty Company, the corporation, with Harrison Green and wife for a royalty of nine-tenths of 1 per cent of all oil and gas produced from certain described property, which was part of the same property originally owned by Green, from which the 3 per cent royalty of the corporation was derived. This assignment was as follows:
KNOW ALL MEN BY THESE PRESENTS: that we, Harrison Green and Gladys Pearl Green, his wife, of Lewistown, Montana, for and in consideration*2011 of the sum of One Dollar and other good and valuable considerations in hand paid by Matthias W. Wildschutz of Lewistown, Fergus County, Montana, the receipt of which is hereby acknowledged and confessed, do hereby sell, assign, transfer and set over unto the said Matthias W. Wildschutz, all of our right, title and interest in and to nine-tenths (9/10ths of 1%) of one per cent royalty of all the oil and gas saved and marketed from the hereinafter described lands and premises, as assigned and contracted to me, said lands being located and situated in the County of Fergus, State of Montana, and more particularly described as follows: [Here follows description of the land.]
To have and to hold unto the said Matthias W. Wildschutz, his heirs, executors, administrators and assigns all of our right, title and interest in and to the said nine-tenths of one per cent (9/10ths of 1%) royalty of all the oil and gas produced and saved from the above described lands as assigned and contracted to me, together with the rights, privileges and benefits to be derived therefrom, and subject to the conditions and covenants contained in said assignments or contracts.
It is agreed that this assignment*2012 shall be effective as of date of August 1st, 1922, and that the said Matthias W. Wildschutz shall be entitled to collect and receive all monies accruing on the above described royalty from and after said 1st day of August, A.D., 1922.
*1143 Petitioner did not report any profit from this transaction, acting on the theory that it was merely an exchange of property for property of a like kind or use, to wit, oil royalties, and disregarding the corporate entity and treating his ownership of shares in the corporation as ownership of an interest in oil royalties approximately equal in amount to that for which he traded his shares. The respondent determined it to be a taxable transaction, and valued the nine-tenths of one per cent royalty received by petitioner at $12,664.68 and added that amount to petitioner's income. Respondent allowed nothing for the cost or value of the units of corporate stock exchanged on the ground that no information had been furnished thereon. On the hearing there was no evidence introduced by petitioner as to either the market value or the original cost of the petitioner's royalties conveyed by him to the common law trust, or of his units or shares*2013 of stock in the common law trust or of his units or shares of stock in the corporation.
OPINION.
BLACK: The respondent filed an amended answer in which it was alleged that the petitioner had received during the year 1922 dividends to the amount of $5,799.75, which had not been reported and that petitioner's net income should be increased by that amount for surtax purposes. At the hearing the petitioner admitted this was correct and upon recomputation the amount of the dividends will be added to petitioner's income. The contention of the petitioner is that the exchange of his stock in the corporation of Green-Wild-schutz Royalty Company for the nine-tenths of one per cent royalty in the Green property was merely an exchange of royalty interests for other royalty interests and that the petitioner is only chargeable with the difference in the amount and value of the royalties as income, which he estimates to be three-fiftieths of one per cent, or $678.45.
It is further contended by the petitioner that the Board should disregard and look through the corporate entity and that in so doing, it would be apparent that there is no taxable profit from the transaction, except as to*2014 the excess in value of the oil royalty which he received in exchange over the value of the oil royalty represented by the stock which he gave in exchange. Petitioner claims that his interest was practically the same before and after the exchange, viz., the right to take oil in form of royalty from the same wells on the same property, the only difference being in the evidence of his ownership or interest. He contends that ownership was evidenced before the exchange by units or shares of stock and after the exchange by an assignment of royalty. In making this contention, petitioner argues that he was the owner of 784 shares out of *1144 2,800 shares of the corporation and that therefore he was the owner of 784/2800 of 3 per cent royalty on the Green property. This is equivalent to 7/25 of 3 per cent or 21/25 of one per cent of the oil produced from the Green property. After the exchange he was the owner of 9/10 of one per cent of the oil from the Green property, which is the equivalent of 45/50, which is only 3/50 more than the 21/25 or 42/50 of one per cent which he owned before the exchange, which he concedes to be of the value of $678.45.
In the first place, this argument*2015 overlooks the fact that the corporation was not only the owner of 3 per cent of the Green royalties, but it was also the owner of a 2 per cent royalty, a 1 per cent royalty, and a one-fifth of 1 per cent royalty from all the oil and gas produced and saved on certain other lands not necessary to be described here in detail, but fully described in the assignment of royalties made by the Wildschutz-Harrison Green Royalty Association to Green-Wildschutz Royalty Company October 1, 1921; but, even if the corporation had only owned the Green royalties, the argument would not be valid.
This argument disregards the corporate entity Green-Wildschutz Royalty Company. A similar question was before us in , where the owners of undivided interests in oil leases transferred them to a corporation in exchange for the capital stock of the corporation. It was held to be a taxable transaction, and although that was a case where the taxpayer exchanged an interest in oil royalties for corporate stock, whereas in the instant case the taxpayer exchanged corporate stock for an interest in oil royalties, the reasoning and decision in that case apply with equal*2016 force to the facts in the instant case. The Board there said:
The taxpayers contend that they realized no taxable gain upon the transfer to the corporation of their undivided interests in the leases in exchange for capital stock of the corporation, the transfer being such as affected the form of ownership only and was not one of substance.
* * *
There might be some grounds for saying that the stock certificates held by the stockholders represent the same amount of interest in the leases as they had owned before the transfer, but to say that they represent the "same undivided interests" is not accurate nor in accordance with the settled law. Prior to the exchange the taxpayers held title to their interests in the leases with all the incidents of complete ownership; after the exchange the corporation had title, legal and equitable, to the whole property. .
The taxpayers further urge that the change of ownership of the leases was a change in form and not in substance; the tenants in common created the corporation to serve them, controlled the corporation entirely, and in substance had nothing more than they had*2017 before the transfer. We think it immaterial that the former tenants in common controlled the corporation, as the fact remains that they and the corporation were separate entities. This fact *1145 is one that can not be ignored and the distinction between a corporation and its stockholders for income-tax purposes is a legal distinction of substance and not merely of form. ; . And whether the stockholders had anything more after receiving the corporate stock than they had before is not the test. ; . The true test is laid down in , where the court says, at page 254, that, if a stockholder is to be taxed on an exchange of property the transaction must be "something which gives the stockholder something really different from what he theretofore had." This test, when applied here, gives the real solution to the question. The taxpayers, prior to the exchange, had the direct ownership, *2018 hence complete and full control, over their interests in the leases; after the exchange they were at most beneficial owners of the assets of the corporation, their shares therein being evidenced by stock certificates which carried with them no direct right of ownership in the assets. , and cases therein cited. In other words, by this transaction the taxpayers received shares of stock which were property of a distinctly different kind from, and having entirely different attributes than, the property paid in by them.
See also ; ; ; .
Under these decisions and many others we have held that the corporate entity can not be disregarded and that shares of stock in a corporation and rights under oil leases are distinct and different things although both were related to or based on the same leases. Manifestly, the same rule applies here, although in this case the final exchange was the reverse of that in the Burge case. In fact there were more points*2019 of difference, for in this case the shares of stock represented interests in all of the royalties originally held by petitioner, Green and Robinson, while the royalty he received was derived only from that of Green, while in the Burge case they were the same. We conclude that the exchange of petitioner's stock in the Green-Wildschutz Royalty Company for the nine-tenths of one per cent royalty in the Green lease was a taxable transaction. We have examined the cases cited by petitioner relative to disregarding the corporate entity and do not think they apply here. They are not tax cases, but involve questions of fraud or claims against bankrupt estates.
In making his determination of the deficiency the respondent did not fix the cost or market value of the stock in the corporation. The stock which petitioner owned in Green-Wildschutz Royalty Company was received in exchange for royalty units which he owned in Wildschutz-Harrison Green Royalty Association, a common law trust, and which latter transaction was not taxable under section 202(c), Revenue Act of 1921. Under section 202(d)(1), of the Revenue Act of 1921, the stock which petitioner received in the corporation took*2020 the same basis of cost as the certificates of interest *1146 which he owned in the Wildschutz-Harrison Green Royalty Association. Said section 202(d)(1) reads: "Where property is exchanged for other property and no gain or loss is recognized under the provisions of subdivision (c), the property received shall, for the purposes of this section, be treated as taking the place of the property exchanged therefor, except as provided in subdivision (e)." In this proceeding the burden of proof is upon the petitioner to show error on the part of the respondent. Respondent has found the value of the nine-tenths of one per cent royalty received by petitioner in the exchange to be $12,644.68 and petitioner has not contested that valuation. No evidence has been introduced to show either the cost of the original royalty interests to the petitioner, or the cost or market value of the certificates of interest in the common law trust, or the cost or market value of the shares of stock exchanged by petitioner to Green. Under these circumstances, we must approve the action of the respondent. *2021 .
Decision will be entered under Rule 50.