*1 Decisions will be entered under Rule 50.
1. Petitioner drilled oil-gas wells for the usual contract price, under a contract providing for immediate payment of its out-of-pocket expense, and for deferment of the balance until the owner had recovered all other costs, after which petitioner would receive monthly an amount not less than 50 per cent of the owner's net income from the four leases on which the drilling was done, until the owner's obligation was fully discharged. Held, the petitioner acquired no economic interest in the oil, and an amount received in the taxable year in settlement of a controversy over the matter was ordinary income, not capital gain as claimed by petitioner.
2. Petitioner's fiscal year ended June 30, 1946. On February 28, 1946, the stockholders resolved to liquidate, and to wind up its affairs at the earliest possible date, not later than October 1, 1946; about 80 per cent of the assets were distributed in redemption of 90 per cent of the stock, but three oil-gas wells were drilled thereafter before June 30, 1946, for about $ 31,000 paid March 31, 1946. About $ 11,500 wages were paid for March, April, May, and June, and $ 172,000 was collected. *2 On June 30, 1946, about $ 28,000 claims against the Commissioner of Internal Revenue were unsettled. Cash of $ 30,000 was distributed on July 20, 1946, and $ 12,951.62 on October 16, 1947. The corporation was dissolved on October 31, 1947. Held, the Commissioner erred in annualizing the period from June 30, 1945, to February 28, 1946, for purpose of excess profits credit under
*966 OPINION.
This case involves excess profits taxes of M-B-K Drilling Co. for its fiscal year*3 ending June 30, 1945, in the amount of $ 37,120.21 and income tax for its fiscal year ending June 30, 1946, in the amount of $ 5,192.03. After concessions made, and admission of transferee liability by Roeser & Pendleton, Inc., Kerr-McGee Oil Industries, Inc., and Big Chief Drilling Co., there remain for our *967 consideration only two questions: (a) Whether $ 31,060.43 received by M-B-K Drilling Co., in a compromise on June 17, 1945, is long term capital gain as contended by petitioner or ordinary income as determined by the respondent; and (b) whether M-B-K Drilling Co. was a taxable corporate entity from February 28, 1946, to June 30, 1946 (period between date of a resolution to liquidate and dissolve, and the end of the fiscal year), so as to get the benefit of the full amount of unused excess profits credit for the year ended June 30, 1946, in arriving at its excess profits tax for the previous fiscal year ending June 30, 1945. All facts have been stipulated and are found as so stipulated. Only such portions thereof as it is considered necessary to state for purposes of discussion will be set forth herein.
For purposes of clarity the two questions will be taken up separately*4 and the facts as to each set forth, followed by opinion thereon, except for brief statement of general facts applying to both questions.
The petitioner M-B-K Drilling Co. (hereinafter sometimes called petitioner) was until dissolution on October 31, 1947, a corporation organized under the laws of Delaware with its principal place of business now in Oklahoma City and was engaged in oil well drilling operations and crude oil production. It kept its books and filed its income tax returns on the accrual basis and on the basis of fiscal years ending June 30 of each year. It filed its corporation income and excess profits tax returns for the taxable years here involved with the collector of internal revenue for the collection district of Oklahoma.
(a) The pertinent facts with reference to the first question, whether M-B-K Drilling Co. (hereinafter called M-B-K) had ordinary income or capital gain from receipt of the $ 31,060.43 on June 17, 1945, are as follows:
On June 20, 1939, M-B-K as "Contractor" and York & Harper, Inc., as "Operator" entered into a contract in writing providing so far as considered material here that M-B-K would drill wells upon a lease belonging to York & Harper, *5 Inc., and would be paid at the completion of each well "at the prevailing rate in the field at the date of such completion for similar work performed by independent contractor," in the following manner: At the completion of each well M-B-K would be paid for its actual cash outlay, all items of actual cash expense incurred in the drilling of the well; the difference between the contract price of each well, that is, at the prevailing rate for similar work performed by independent contractors, and the actual cash outlay would be "set up on the books of Operator as a Deferred Account Payable to be paid by Operator to Contractor after the properties above have been fully developed * * *" and when the *968 properties had been fully paid out the difference between the contract price and the actual cash cost to contractor of all wells then drilled would be paid to M-B-K "in a series of monthly payments, each such payment to be in an amount not less than fifty percent of Operator's net income from the four leases above described, the first of such payments to be made the 20th day of the first month following the complete payout of the properties and a similar payment to be made the 20th*6 day of each month thereafter until Operator's account payable to Contractor is fully discharged." About June 30, 1940, M-B-K had completed its obligations under the contract and had set up on its books an item of $ 124,241.72 upon a ledger sheet bearing the heading "York and Harper, Inc., Bagley, Foster 'B' and Foster 'D' Leases Drilling Contracts Receivable Out of Oil." Seven journal vouchers of M-B-K, under date of December 31, 1939, credit accounts receivable with various amounts as to the York and Harper, Foster "B" and "D" leases, or Bagley, Foster "B" and "D" leases with corresponding entries under "debit." Three credit items use the expression "Receivable Out of Oil" and four make no reference to oil. Three debit items refer to "Receivable Out of Oil" and four make no reference to oil. Journal vouchers referring to York and Harper, dated January 31, 1940, April 30, 1940, and April 30, 1940, make no reference to payment from oil. A journal voucher dated June 30, 1943, recites a debit item as to York and Harper "Accounts payable solely out of oil" and another journal entry dated July 31, 1945, under credit accounts payable, recites "Accounts Payable Solely Out of Oil -- York*7 & Harper, Inc." The $ 124,241.72 was not included in taxable income for the fiscal year ending June 30, 1940. M-B-K's return for that period made reference to $ 109,157.65 as "Deferred Profit on drilling contracts." 1 Prior to May 17, 1945, controversies had arisen between M-B-K and York and Harper, Inc., over the rights to M-B-K to sums due not only under the contract of June 20, 1939, but also under other drilling and operating contracts between the two parties. On May 17, 1945, an agreement was entered into between them referring to several contracts, including the one of June 20, 1939, between York and Harper and M-B-K. The contract refers to certain controversies and differences of opinion and states that the memorandum is entered into for the purpose of evidencing the agreements of the parties "relative to those matters of construction and interpretation heretofore in issue." After disposing under separate headings of various matters, the contract under the heading "Deferred Account" recites that "in order to settle the controversy and dispute that has heretofore arisen with reference to the time of payment and the amount of moneys due M-B-K * * *" [under the contract of*8 June 20, 1939] it is agreed *969 that on or about July 20, 1945, "all the terms as to time when M-B-K * * * would be entitled to the deferred account will have been met, and York & Harper, Inc., will on July 20, 1945, pay to M-B-K * * * $ 31,060.43 in full settlement of all rights, claims or demands of M-B-K * * *" under that portion of the contract of June 20, 1939, referring to drilling the wells.
On or about July 20, 1945, the $ 31,060.43 was paid.
Under the above facts the Commissioner in the deficiency notice for the year ending June 30, 1945, added the $ 31,060.43 to income explaining that the amount, received in settlement of the balance due under the drilling contract of June 20, 1939, though reported as long term capital gain was determined to be ordinary income, inasmuch as the payment was not restricted to the income derived from oil and gas production.
Under the above facts, we must decide whether the $ 31,060.43 was ordinary income or capital*9 gain. The petitioner contends, in substance, that the issue will be answered by the determination whether M-B-K under the contract of June 20, 1939, acquired an economic interest in oil, and argues that the contract of June 20, 1939, having provided for monthly payments in an amount not less than 50 per cent of York and Harper's "net income from the four leases above described," there would be no payments due if there was no production, and that M-B-K had an economic interest in the oil. 2 It is said that if the contract is ambiguous, the treatment accorded to it on the records of M-B-K is indicative in that the ledger sheet and the several journal vouchers, also the return for 1940, referred to payment from oil, and that the Commissioner in his deficiency notice for the fiscal year ending June 30, 1940, refers to the taxpayer's elimination of "Deferred Oil Payments" from taxable income in the amount of $ 109,157.65, and determined that the amount was understated and should have been $ 111,214.97, resulting in an adjustment. M-B-K cites and quotes at length from
The respondent, in substance, argues that the $ 124,241.72 was a mere deferred account payable and not an economic interest in oil, that the petitioner did not report it as income in its return for the fiscal year ending June 30, 1940, that the settlement for $ 31,060.43 in May 1945, paid about July 20, 1945, resulted in no sale or exchange under section 117 (j), and that there was no economic interest on the part of M-B-K which had no capital interest in the lease upon which the drilling was done but was merely entitled to collect on its open *970 account as any other creditor of York and Harper, Inc.; that therefore the agreement of May*11 17, 1945, was merely a commutation of the liability, for 25 per cent, of $ 124,241.72. Respondent cites, among other cases,
Neither party has cited a case on all fours with this one. We consider here a contract which provides that M-B-K should drill wells and be paid therefor at the prevailing rate for similar work done by independent contractors, that certain out-of-pocket expenses should be paid upon completion of each well, and that the difference between that amount and M-B-K's actual cost should be set up on the operator's books "as a Deferred Account Payable" to be paid after all other expenses of the property had been recovered by the operator, in a series of monthly payments each "in an amount not less than fifty per cent of Operator's net income" from the leases involved. It is obvious that these provisions do not in words provide for payment solely out of oil or the proceeds thereof or even out of oil or oil proceeds, without "solely"; but that each monthly payment is merely to be in an amount not less than 50 per cent of operator's net income from the four leases described. Though M-B-K *12 argues that the amount was set up on its ledger, and referred to in some but not all of its journal vouchers referring to that account, as payable from oil, and that it so referred in its return, we note that this is in the nature of self-serving evidence, not to be given much weight as interpretation of contract by parties. Self-serving statements in corporate books have been held to be inadmissible in support of corporate claims. Jones on Evidence, 2nd Ed., Vol. 4, Par. 1735. The fact that the Commissioner did not in determining the deficiency for the fiscal year ending June 30, 1940, discover the contention he now raises is evidential but of little weight. Passing to the authorities cited, the Burton-Sutton case does not by any means, in our opinion, indicate that the petitioner here acquired an economic interest. The petitioner there had had an interest in the land and made a contract which the Court considered as a reservation of an interest therein so far as the oil and gas is concerned. The petitioner here had had no interest prior to June 20, 1939, therefore nothing to reserve. In the Burton-Sutton case, moreover, the contract involved required the grantee, the*13 taxpayer, to pay the grantor "50% of the proceeds of the oil produced and sold from the land." The Court concludes that: "Through retention of certain rights to payments from oil or its proceeds in himself, each of these assignors of partial exploitation rights in oil lands has maintained a capital investment or economic interest in the oil or its proceeds." Here M-B-K had a mere right to be paid monthly an amount not less than 50 per cent of the net income from the leases. Moreover, M-B-K had drilled wells for which it was to be paid the prevailing rate in the field and the monthly payments were to be continued *971 "until Operator's account payable to Contractor is fully discharged." We do not see in this situation that the petitioner was limited to payment solely from oil or its proceeds. It is not reasonable to believe that the petitioner would have drilled for the usual rate prevailing in the field and at the same time have taken a chance on oil production for its payment. We have no doubt that had there been intent to take such a chance, the drilling price would have been more than the usual rate. Though there were to be monthly payments deferred until the "payout" *14 of the properties of the operator, there was provision for continuation of payments until the "account payable" was "fully discharged," from which we believe that the principal thought involved was the deferment of liability until the operator's other costs were fully paid out and that in the absence of any provision that payment should be limited to the oil or proceeds, M-B-K would have had a right to a reasonable monthly payment even after oil production had ceased, until the account was paid up.
The Court refers to the provision "for payment to assignors in oil only" and to the "absence of any obligation of the assignee to pay in oil or in money." It is clear, we think, that the case is no basis here for M-B-K's contentions. In
It is noteworthy also that there is no indication in the record that the petitioners returned payments as they were received and claimed depletion based thereon, consistent with the present contention of economic interest; and since all facts were stipulated it is apparent, and we assume, that such return of income and claim of depletion was not made. We conclude and hold that the petitioner did not acquire an economic interest in the oil involved. Since the $ 31,060.43*20 received on compromise in May 1945 is to be considered as the same nature as the right compromised,
(b) We next consider whether M-B-K was a taxable corporate entity from February 28, 1946, to June 30, 1946, and therefore entitled to benefit of the full amount of unused excess profits credit for its fiscal year ending June 30, 1946, in arriving at excess profits credit for the fiscal year ending June 30, 1945.
The stipulated facts considered necessary of statements here, on this question, are as follows: On February 28, 1946, the stockholders of M-B-K, that is, Big Chief Drilling Co., Kerr-McGee Oil Industries, Inc., and Roeser & Pendleton, Inc., adopted a plan of liquidation, in a special meeting of stockholders. It was resolved that in order to place the corporation in a financial position to retire forthwith all of its outstanding debts and obligations now due, or shortly to mature, the stockholders should contribute and pay over as a contribution to capital*21 a total of $ 500,000, ratably as stock was held, whereupon the officers and directors should be authorized and directed to pay said debts forthwith; that M-B-K should "forthwith cease the transaction *974 of all its business, other than that incident to the winding up of its affairs" and should "in no event enter into any new or additional contracts for the drillings of wells, or make contracts with respect to any new ventures; provided, however, that incident to the winding up of the affairs of such company, such corporation shall proceed with diligence to complete the drilling contracts which it now has in progress"; that a liquidating dividend in cancellation and redemption of 90 per cent of the capital stock should be distributed in kind to the stockholders, covering certain described assets (comprising approximately 80 per cent of the corporate assets); that M-B-K should at the earliest possible date and in any event by October 1, 1946, completely wind up its affairs and distribute all of the balance of its assets ratably; that in connection therewith the corporation should at the earliest possible time complete the drilling of the wells in progress, collect and realize *22 upon all of its assets, pay all of its liabilities, and forthwith distribute ratably to its stockholders all the remaining assets "whereupon all of the stockholders shall, and they do hereby, consent, in writing, to a dissolution of the corporation, and hereby direct that such steps shall thereupon be taken as may be required to file such consent in the office of the Secretary of State" and cause M-B-K to be dissolved. Pursuant to such resolution, liquidating distributions were made in amounts and on dates as follows: On February 28, 1946, $ 1,048,488.80 (in miscellaneous assets); on May 31, 1946, cash $ 45,000; on July 20, 1946, cash $ 30,000; on October 16, 1947, cash and miscellaneous assets $ 12,951.62. After March 1, 1946, and before March 15, 1946, M-B-K completed three drilling contracts, receiving thereon a total of $ 31,103.05 on March 31, 1946, based on billings made on or after March 1, 1946. After February 28, 1946, M-B-K paid $ 7,935.19 wages to drilling crews for March, and during April and May paid $ 1,750 to a drilling superintendent; it also paid a total of $ 1,522.50 for other wages during March and April. Drilling operations had, however, already ceased on March*23 15, 1946. During March, April, May, and June 1946 M-B-K collected a total of $ 172,025.12, which amount with the exception of the $ 31,103.05 (from the three drilling contracts above) in large measure represented charges made prior to February 28, 1946. On June 30, 1946, there was due M-B-K, as shown by its balance sheet, $ 22,710.47 from the collector of internal revenue representing a tentative allowance of an unused excess profits credit carry-back to the fiscal year ending June 30, 1945. Of such amount $ 3,370.60 was refunded and the balance, $ 19,339.87, was an abatement of a portion of the original excess profits tax assessment for the fiscal year ended June 30, 1945. There was also on June 30, 1946, due to M-B-K, as shown by its balance sheet, $ 5,204.15 from the collector of internal revenue representing net overassessment of taxes for *975 the fiscal years ending June 30, 1942, to June 30, 1945. The balance sheet of M-B-K at June 30, 1946, also showed cash of $ 40,188.18 and accounts receivable of $ 15,625.26, with liabilities (aside from net worth) as follows: Accounts payable $ 7,856.33; due to collector of internal revenue $ 29,283.15; and on June 30, 1947, the*24 balance sheet showed assets of cash $ 12,345.42 and accounts receivable $ 3,714.22, with no liabilities. After the distribution on October 16, 1947, the only asset on hand was cash in the sum of $ 2,952.50. The corporation was dissolved on October 31, 1947.
Under the above facts, the respondent in the deficiency notice determined that substantially all assets of M-B-K were distributed on February 28, 1946, that for the remainder of the taxable year ended June 30, 1946, the principal corporate activity was liquidation of other assets, and that, therefore, for excess profits tax purposes the income, $ 36,502.66, was applicable to the period from July 1, 1945, to February 28, 1946, or 243 days, and that the amount should be annualized in the computation of allowable excess profits credit carry-back to the year ended June 30, 1945.
Upon brief, in support of such determination, the respondent cites only
Decisions will be entered under Rule 50.
Footnotes
1. The deficiency notice increased the amount to $ 111,214.97.↩
2. M-B-K also points to a provision of the contract of June 20, 1939, which states that M-B-K is to handle the operation of the wells "free of all cost to operate," but this provision refers to the operation of the wells and not to the cost of drilling. The contract elsewhere provides for payment for operation. We find in this provision nothing to support M-B-K's contention.↩