Lightning Creek Oil & Gas Co. v. Commissioner

LIGHTNING CREEK OIL & GAS CO. AND CONSOLIDATED COMPANY, CAREY OIL & GAS CO., PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Lightning Creek Oil & Gas Co. v. Commissioner Docket Nos. 8584, 23204. United States Board of Tax Appeals 9 B.T.A. 1150; 1928 BTA LEXIS 4285; January 11, 1928, Promulgated *4285 1. The action of the respondent in reducing invested capital to an amount determined by him to represent the actual cash value of assets at the time paid in for stock approved because of insufficient evidence. 2. The reduction of invested capital on account of the use of a "tentative tax" in determining the amount of earnings evailable for distribution as dividends held to be erroneous. 3. Where invested capital had been impaired by the payment of dividends in excess of earnings, held that the respondent in computing the amount of the liquidating deficit committed no error by including as a part of such deficit the amount by which the depletion sustained exceeded the depletion provided for in the books of the petitioner. E. C. Gruen, C.P.A., for the petitioners. P. M. Clark, Esq., and C. C. Holmes, Esq., for the respondent. TRAMMELL *1150 These proceedings, which were consolidated for hearing and decision, are for the redetermination of deficiencies in income and profits taxes of the Lightning Creek Oil & Gas Co. of $1,010.46 for 1919, in Docket No. 8584, and $1,099.94 for 1920, in Docket No. 23204. The deficiencies*4286 result from reductions made by the respondent in invested capital and which are set out more particularly hereinafter. FINDINGS OF FACT. The petitioners are consolidated corporations with their principal office at Wellsville, N.Y. The Lightning Creek Oil & Gas Co. was incorporated on July 13, 1904, under the law of the then Territory of Arizona, with an authorized capital stock of $100,000 divided into 1,000 shares of a par value of $100 each. The original stockholders were as follows: James T. Hall, Walter E. Carr, Fred H. Hamlin, John Martin, and Walter J. Hamlin. The Carey Oil & Gas Co. was incorporated on October 1, 1904, under the laws of the then Indian Territory, with an authorized capital stock of $300,000 divided into 12,000 shares of a part value of $25 each. At the time of incorporation $200,000 of the stock had been subscribed by the incorporators. The original stockholders and the number of shares owned by each were as follows: Shares Chas. H. Hammett 7,940 James T. Hall [10] William F. Hammett [10] J. Wood Glass [10] Emma M. Carey [10] Arthur J. Hoover [10] Charles H. Mehlin [10] *1151 At the time of the first meeting of the*4287 incorporators $1,000 of the capital stock had been paid in by the subscribers. On September 6, 1904, the Lightning Creek Oil & Gas Co. authorized the issuance to Charles H. Hammett or his assigns 995 shares of its capital stock fully paid and nonassessable for oil and gas mining leases on the NW. 1/4 sec. 19, T. 25, R. 17 E., located in the then Indian Territory. The Carey Oil & Gas Co. on October 31, 1904, authorized the issuance to Walter E. Carr or his assigns of 7,840 shares of the capital stock fully paid and nonassessable for oil and gas mining leases on 268.13 acres of land, lying in T. 25, R. 17 E., Cherokee Nation, Indian Territory. The company on January 3, 1905, authorized the issuance of 5.600 shares of its capital stock fully paid and nonassessable to Clement E. B. Burton and Marcus Simpson, under a percentage basis contract by which Burton and Simpson were to drill a number of wells and contruct a pumping plant on the holdings of the company. On or about June 9, 1906, the ownership of the entire 1000 shares of the capital stock of the Lightning Creek Oil & Gas Co. of a total par value of $100,000 passed to H. H. Thornton, T. F. Higgins, C. A. Farnum, Joseph*4288 P. Coyle, James P. Coyle, Helen A. Anderson, and Mary E. Coyle Estate, who constituted a different group from the original stockholders. The consideration for the transfer was the payment of $62,000 in cash. At this time the company authorized the establishment of branch office at Wellsville, N.Y. Some time prior to or on January 11, 1916, the outstanding capital stock of the Carey Oil & Gas Co. was reduced to $12,000 and the number of shares reduced to 480. On or about March 20, 1916, the ownership of the 480 shares was transferred to the following, who constituted a different group from the original stockholders: C. A. Farnum, D. H. Anderson, T. F. Higgins, L. H. Thornton, Jos. P. Coyle, Jas. P. Coyle, Mary E. Coyle Estate. A cash payment of $10,000 was the consideration for the transfer. After March 20, 1916, the persons owning the stock of the two companies and hereinafter referred to as the Wellsville group were practically the same. The two corporations continued operations without any change in their respective corporate charters. The accounting records kept were inaccurate and incomplete. *1152 In determining the deductions allowable for depletion*4289 the respondent used $62,000 as a basis for recoverable costs for the properties of the Lightning Creek Oil & Gas Co. and $10,000 for the properties of the Carey Oil & Gas Co. In determining invested capital for 1919, the respondent found that at January 1 of that year the Lightning Creek Oil & Gas Co. had a deficit of $54,547.49 resulting from dividends having been paid in excess of earnings. A portion of the deficit, which petitioner contends was incorrectly determined, was computed as follows: The respondent determined that to January 1, 1919, the company had sustained depletion of $55,160.30 for which a depletion reserve of only $11,880.50 had been set up, leaving an amount of $43,279.80 depletion sustained in excess of the depletion reserve. This was included by the respondent in computing the deficit existing on January 1, 1919. In determining invested capital for 1920, the respondent found that at January 1 of that year the company had a deficit of $51,977.60 which resulted from the same cause as the deficit existing on January 1, 1919. The respondent determined also that depletion and depreciation sustained by the company to January 1, 1920, amounted to $57,606 for which*4290 there was a reserve of $13,895.85, leaving an amount of $43,710.15 which had not been set up in the reserve. The respondent included this amount in computing the amount of the deficit existing at the beginning of the year. The respondent reduced invested capital for 1919 by $696.79 representing 1918 taxes of $1,648.82 prorated for the year. Invested capital for 1920 was reduced by $573.40, representing 1919 taxes of $1,360.71 prorated over the year, and by additional taxes of $1,045.90 and $605.25 for 1917 and 1918 respectively. In his determination of the taxes for 1917, 1918, 1919, and 1920 the respondent reduced invested capital for each year by computing tentative taxes of $2,769.21, $1,648.82, $1,400.95, and $1,499.90, respectively, in determining the amount of earnings available for distribution as dividends during the respective years. OPINION. TRAMMELL: The petition filed for the year 1919 alleges that the respondent erred in eliminating from invested capital as appreciation an amount of $40,000, which is the difference between the total par value of the stock of the Lightning Creek Oil & Gas Co. and the Carey Oil & Gas Co., or $112,000, and the amount paid therefor, *4291 $72,000, when the stock was purchased in 1906 and 1916. The petition for 1920 in addition to alleging the same error as for 1919 also alleges that the respondent erred in eliminating from invested *1153 capital (1) an amount of $1,231.99 as "1917 tax adjustment" of which $186.09 is outlawed and uncollectible and the remainder based on an erroneous determination of income and profits taxes payable for that year; (2) $51,977.60 as "Liquidating deficit" which is largely depletion computed by respondent for the years 1906-1919 inclusive and not deducted from income in determining tax due; (3) $573.40 "1919 tax prorated," which is an erroneous determination based upon a tax the correctness of which is now pending before this Board; (4) $1,750.61 as a "Dividend adjustment" which was computed by the use of a "tentative tax" to determine income available for distribution; (5) $605.25 as "1918 income taxes" based upon an erroneous determination of the tax due for that year. The respondent denies the commission of any error. With respect to the elimination from invested capital of $40,000 as appreciation, the respondent determined that the assets of the two companies at the time*4292 acquired had an actual cash value of $72,000. The evidence offered in support of the contention that the respondent's valuation was erroneous consists of copies of the articles of incorporation of the two companies, copies of the minutes of certain meetings of the boards of directors and stockholders and various letters from the respondent as to the action taken by him on the returns of the Lightning Creek Oil & Gas Co. from 1913 to 1921 and the Carey Oil & Gas Co. from 1916 to 1921. We have found that on September 6, 1904, the Lightning Creek Oil & Gas Co. authorized the issuance of 995 shares, or $99,500 par value of its stock, in exchange for oil and gas mining leases. On October 31, 1904, the Carey Oil & Gas Co. authorized the issuance of 7,840 shares or $196,000 par value of its capital stock for oil and gas mining leases and on January 3, 1905, authorized the issuance of 5,600 shares or $140,000 par value of its stock under contract for the drilling of wells and the constructing of a pumping station. It is not clear from the record how this $336,000 par value of stock could be issued by the corporation after it had already issued $200,000 par value, when its authorized*4293 capital stock was $300,000. Nor does the record show more than the authorization contained in the minutes for the issuance of such stock for the drilling of wells and the leases. There is no evidence that any wells were drilled pursuant to the contract. We are urged to find from these facts that the respondent erred in his determination of the amount of $72,000. It is also insisted that "under the conditions here prevailing the assumption of the legality, validity and value back of this stock issue should prevail" and the determination of the respondent be overruled. We have heretofore considered the question as to the weight to be given the presumption that assets acquired for stock have a value equal to that of the par value of the stock issued therefor and have *1154 held that such presumption unsupported by any evidence is insufficient to sustain the burden of proof. . In the absence of any other evidence we must approve the action of the respondent in reducing the invested capital by $40,000 for each of the years 1919 and 1920. With reference to the allegation that invested capital for 1920 was reduced*4294 by $1,231.99 representing "1917 tax adjustment" of which $186.09 is barred by the statute of limitations and uncollectible and the remainder based on an erroneous determination of tax for that year, we find upon examination of the respondent's notice of the deficiency for 1920 which was put in evidence by the petitioner, that the respondent reduced the invested capital by only $1,045.90. Invested capital, therefore, was not reduced by the $186.09 which it is claimed is uncollectible. We have found that in determining the tax liability for 1917 the respondent reduced invested capital for that year by computing a "tentative tax" in determining the amount of earnings available for distribution as dividends. This was erroneous. . The amount of earnings available for dividends should not be so reduced. With reference to the contention that there was eliminated from invested capital for 1920 an amount of $51,977.60 as a "Liquidating Deficit" composed largely of depletion computed by the respondent for the years 1906 to 1919, inclusive and not deducted from income in determining tax due, we have found that the respondent determined that*4295 to January 1, 1920, the Lightning Creek Oil & Gas Co. had sustained depletion of $43,710.15 for which provision had not been made in its depletion reserve. There is no evidence that the computation of the respondent of the amount of depletion sustained was erroneous. The respondent included this amount in his computation of the deficit arising from the declaration of dividends in excess of earnings. The evidence discloses that for the years 1913 through 1918 the company in the determination of its tax liability was given the benefit of the depletion deductions as determined by the respondent subsequent to the filing of the returns. The amount of the depletion actually sustained in excess of the amount shown by the petitioner's books should be considered in determining the earnings available for dividends. If the dividends paid are in excess of earnings after allowance for sustained depletion, to the extent of the excess they amount in effect to a distribution of capital. . The respondent in his determination of the earnings available for dividends correctly followed this principle which we think is correct. The same*4296 principle is applicable to the depletion sustained in years prior to 1913 for invested capital purposes. The invested capital *1155 should be reduced to the extent that the distributions made to stockholders exceeded earnings available therefor considering in determining the amount thereof the depletion actually sustained. This appears to have been done by the respondent in determining the deficiency. It is contended that the respondent's determination that invested capital for 1920 should be reduced by $573.40 representing "1919 tax prorated" is erroneous since it is based upon a tax the correctness of which is pending before this Board. It is sufficient to say that in the recomputation of the tax to be submitted in connection with notice of settlement the amount of this item should be computed upon the basis of the tax finally determined for the year 1919 in accordance with our findings of fact and this opinion. With respect to the remaining contentions that invested capital for 1920 was erroneously reduced by $1,750.61 representing "Dividend adjustment" and $605.25 representing "1918 income taxes," we have found that for the years 1917, 1919, and 1920 the respondent*4297 made use of a "tentative tax" in determining the amount of earnings available during these years for distribution as dividends. As heretofore pointed out, such action is erroneous. Reviewed by the Board. Judgment will be entered on 15 days' notice, under Rule 50.