Summary
In Rudco Oil Gas Co. v. United States, 82 F. Supp. 746, 113 Ct.Cl. 206, decided by this court in 1949, an accrual method corporation was the lessee in a number of oil and gas leases under which it was producing and selling oil.
Summary of this case from Williamson v. United StatesOpinion
No. 47808.
March 7, 1949.
Maxwell M. Mahany, of Tulsa, Okla., for plaintiff.
J.H. Sheppard, of Washington, D.C., and H.G. Morison, Asst. Atty. Gen., for defendant.
Before JONES, Chief Justice, and LITTLETON, WHITAKER, MADDEN, and HOWELL, Judges.
Action by Rudco Oil Gas Company against the United States to recover income and declared value excess profit taxes with interest paid with respect to calendar year 1943.
Petition dismissed.
This case having been heard by the Court of Claims, the court upon the evidence and the report of a commissioner, makes the following special findings of fact:
1. The plaintiff is a corporation organized December 19, 1933, under the laws of the State of Delaware, with its principal office in Tyler, Texas. Plaintiff brought this action to recover Federal income and declared value excess profits taxes, with interest thereon, paid with respect to the calendar year 1943.
2. Except for the ownership of two qualifying shares, plaintiff's sole stockholders from the time of its organization through December 1, 1943, were Ike Rudman and his wife, Rose Rudman. From the shares owned by Rose Rudman, one share was assigned in 1935 to Y. Scrinopskie, a daughter of Ike Rudman and Rose Rudman, and in 1941, one share was assigned to C.C. Cook, the secretary of the company. In 1943 Ike Rudman owned 475 shares of the 500 total shares of stock outstanding, Rose Rudman owned 23 shares, and their daughter and the secretary of the corporation owned one share each.
During 1943 the directors of plaintiff were I. Rudman, Rose Rudman, and Y. Scrinopskie.
3. For the calendar year 1943, the plaintiff kept its books and made and filed its Federal tax returns upon the accrual basis. On March 13, 1944, plaintiff filed with the Collector of Internal Revenue at Dallas, Texas, its corporation income, declared value excess profits and excess profits tax returns for the calendar year 1943, and plaintiff paid the taxes shown to be due on such returns as follows: Income tax $65,212.50, declared value excess profits tax $3,237.74, excess profits tax $6,630.99, a total of $75,081.23.
4. On May 2, 1945, the Internal Revenue Agent In Charge sent plaintiff a ninety-day determination letter regarding the tax returns for the year 1943, which letter stated that there was a deficiency of income tax of $12,315.06, a deficiency of declared value excess profits taxes of $4,769.33, an overassessment of excess profits tax in the amount of $6,630.99, or a net total deficiency of $10,453.40. The determined deficiency with interest thereon of $862.27, a total of $11,315.67, was paid by plaintiff on July 27, 1945. Additional interest of $613.20 on the 1943 deficiency was paid by plaintiff on December 7, 1945.
The following is a summary of the total taxes and interest assessed and paid by plaintiff for the calendar year 1943:
Income tax .......... $65,212.50 12,315.06 __________ $77,527.56 Declared value excess profits tax ........ 3,237.74 4,769.33 __________ 8,007.07 Interest ............ 862.27 613.20 __________ 1,475.47 __________ Net Total Tax and Interest paid for 1943 .......... 87,010.10
5. In arriving at the deficiency set forth in the letter of May 2, 1945, the Commissioner of Internal Revenue added to income theretofore reported by plaintiff an item designated as "Gain on Distribution of Dividend in Kind." In explanation of this determination, the nintey-day letter stated:
"It is held that you realized taxable gain of $56,022.89 in taxable year upon payment in kind to your sole stockholders of an ordinary dividend. The dividend consisted of an oil payment in the total face sum of $60,200.00. The fair market value of the oil payments which, under the conditions existing at date of distribution should pay out in about three months, was $59,297.00, which represents a discount of 1½%. The cost basis of the oil payments was $3,274.11. Therefore the taxable gain realized amounts to $56,022.89 as follows:
Total fair market value of oil payments ................... $59,297.00 Cost of oil payments ......... 3,274.11 __________ Profit (long-term capital gain) .................. 56,022.89"
6. On September 30, 1943, there was a specially called meeting of plaintiff's Board of Directors, which adopted a resolution authorizing payment of a dividend in kind to the stockholders by the transfer of plaintiff's interest in certain oil and gas leases. This action was reflected in the minutes of the meeting which read in part as follows:
"The President thereupon stated that one of the purposes of the meeting was to consider the question of payment of dividend to the stockholders of the company. He stated that there had been no dividend paid during the preceding year because, while the company had earned a profit, the funds had been reinvested in new properties acquired and new development done, but that he felt a dividend should be paid out of the earnings of the current year.
"Statements of the earnings of the company through the months (sic) of August 1943, were presented and also statement of the estimated earnings for the remainder of the year, which statements had been prepared by the accounting department of the company.
"After examination of these statements and discussion, it was decided by the Directors that a dividend payment was proper but that such payment should be made as a dividend in kind, to be paid by the transfer of certain properties of the company to the stockholders.
"The following resolution was made by Rose Rudman and after being duly seconded, was unanimously adopted:
"`Be it resolved by the Directors of Rudco Oil Gas Company that a dividend payable in kind by the transfer of interests in certain properties of the company, be paid to the stockholders of record as of the date of this meeting, and that the officers of the company be directed to prepare the necessary and proper instruments conveying such interests, and further execute any and all transfer orders and other required instruments to effect such transfers, the same to be done as soon hereafter as is possible, and to be effective as of October 1, 1943.'"
7. Pursuant to the resolution adopted by the board of directors, plaintiff, on October 1, 1943, executed several instruments conveying its interest in eighteen producing oil and gas leases to I. Rudman and Rose Rudman in proportion to their stock ownership, namely 19/20ths to Ike Rudman and 1/20th to Rose Rudman, for such length of time as would be required to pay the transferees a stated sum of money out of the production of each lease, the total to be paid from all leases amounting to $60,200.
Copies of such instruments executed by plaintiff are in evidence as plaintiff's exhibits 2 to 8, inclusive, and are made a part hereof. Exhibit 2, which is typical of all of the others, reads in part as follows:
"Rudco Oil Gas Company does hereby Sell, Assign, Transfer and Convey to I. Rudman and Rose Rudman, their heirs, representatives and assigns, in the proportions hereinafter shown, all of the interest of the said Rudco Oil Gas Company in and to the oil and gas lease on the above described lands, until said assignees shall have received the sum of Twelve Hundred and No/100 ($1200.00) Dollars from the proceeds of the sale of the oil and/or gas, as, if and when produced from the above described oil and gas lease. The division of interest hereby assigned to the assignees shall be as follows:
To I. Rudman, 19/20 To Rose Rudman, 1/20
"It is hereby agreed that all costs and expenses of development and operation, including all taxes of whatever nature, shall be borne by the assignor, and that the said interest conveyed shall be wholly free and clear of all costs and expenses.
"Any pipe line company or other purchaser connected to said lease and purchasing therefrom the oil and/or gas is hereby authorized and directed to make payment to the assignees herein in the respective proportions set out above.
"The effective date of this instrument is as of 7:00 o'clock A.M. October 1, 1943."
8. In the instruments executed by it, plaintiff transferred to the Rudmans its entire interest in each of such oil and gas leases, although in some instances plaintiff owned only a fraction of the working interest in the lease, while in others it owned 100 percent of such interest. The plaintiff had acquired the leases at different times between 1931 and 1942. A few of such leases were acquired after the land was producing oil, but most of the leases were obtained before there was any production of oil or gas and plaintiff subsequently drilled wells on the land.
9. At the time plaintiff transferred the leases to the Rudmans, plaintiff was operating each lease and was producing oil therefrom. The grades of oil produced on each lease were fairly consistent and the field prices for the oil were known at the time the transfers were executed. The production of oil from the transferred leases throughout the year 1943 was quite consistent, the allowable production being regulated by the Railroad Commission of the State of Texas.
The officers of plaintiff arrived at the amount of dividend to be paid to I. Rudman and Rose Rudman by taking into account the cash position of the company and its anticipated revenues and operating expenses for 1943. It was decided that the sum of $60,200 would be available out of current revenues for payment of the dividend and this figure was apportioned to the various transferred leases. The transfers provided and plaintiff intended that the leasehold interests would revert to plaintiff as soon as production from the transferred leases was sufficient to pay I. Rudman and Rose Rudman the $60,200.
10. Promptly after the plaintiff executed the conveyance of such leasehold interests to the stockholders, the instruments were recorded in the respective counties wherein the leaseholds were located. A certified copy of each conveyance was then transmitted to the pipeline company receiving the production of oil from each lease, as authority for discontinuing payments to plaintiff and for making payments to the Rudmans. The pipeline company also prepared and furnished to plaintiff and the Rudmans a transfer order, one copy of which was signed by plaintiff for each leasehold conveyed and which authorized the pipeline company to make payments to the Rudmans for all oil received by it from October 1, 1943, until the market value of the oil purchased by the pipe-line company aggregated a specified sum.
In connection with the majority of contracts between plaintiff and the pipeline companies, the parties executed a division order, which could be terminated by either the lessee or the pipe-line company on short notice, but no such division order was executed with respect to the 18 leaseholds transferred to the Rudmans.
11. The pipe-line companies paid plaintiff for all oil production from the 18 leaseholds hereinabove referred to during the months from January to September, inclusive, 1943. During the months of October, November and December, 1943, however, the Rudmans received payment for all production from the transferred leaseholds, except for a small amount of production on one lease during the last days in December after the specified payments to the Rudmans from that lease had already been completed.
12. As of December 31, 1943, Ike Rudman and Rose Rudman had received payments aggregating $59,461.80 for the oil produced from the transferred leases during the months of October, November and December 1943. After the receipt by the Rudmans of $59,461.80, which was approximately the amount specified in the leasehold transfers, Ike Rudman and Rose Rudman executed releases or re-transfers of such leasehold interests to plaintiff, the releases being recorded in the counties where the property was located. The Rudmans also signed transfer orders, directing the pipe-line companies to make payments to plaintiff for oil subsequently received. The reversion of such leasehold interests to plaintiff had been contemplated, planned and provided for at the time plaintiff conveyed such interests to the Rudmans.
13. During the time the Rudmans were receiving production payments from the pipe-line companies, plaintiff continued to pay all costs of management and operation of the leases, including the cost of producing oil therefrom. The production expenses included the labor for either flowing or pumping the wells and some miscellaneous supplies, the cost of which was negligible. On its books and in its Federal tax returns for 1943, plaintiff took deductions from its income for the entire year's depreciation of the equipment and structures on the 18 leases which had been transferred to Ike and Rose Rudman.
14. The Rudmans reported the $59,461.80, received from the pipe-line companies, in their respective individual 1943 Federal income tax returns as dividends received from plaintiff, and tax liability was computed thereon as provided by the Internal Revenue Code. Neither the Rudmans nor plaintiff claimed depletion deductions in connection with the $59,461.80 income received from oil production by the Rudmans, but on plaintiff's Federal tax returns for 1943, a deduction for depletion was made with respect to the income from the 18 leaseholds which plaintiff received during the period from January through September 1943.
15. During the year 1943, plaintiff made no distributions by way of dividends or otherwise to its stockholders except for the dividend authorized on September 30, 1943, and effected by the transfer of the leaseholds to Ike Rudman and Rose Rudman, as shown in plaintiff's exhibits 2 to 8 inclusive.
At no time during the year 1943 was plaintiff's earned surplus account, available for dividends, less than $60,200.
16. The figure of $59,297, which the Commissioner of Internal Revenue determined as the fair market value of the oil payments made to Ike Rudman and Rose Rudman, was arrived at by discounting the proposed dividend of $60,200 by 1½ percent. This was considered a fair discount, because under the conditions existing at the time the leaseholds were transferred, it was thought that the production from the leaseholds would be sufficient to pay the dividend in about three months.
17. On January 15, 1946, plaintiff filed a claim for refund of $18,616.84, on the ground that the Commissioner of Internal Revenue erred in including the item of $56,022.89 in plaintiff's income for 1943, for the reason that that amount never became income or gain to plaintiff. In the claim for refund, plaintiff conceded that all adjustments reflected in the ninety-day deficiency letter of May 2, 1945, were correct with the exception of the item relating to the dividends paid to the Rudmans. As so conceded and adjusted, the plaintiff's 1943 tax liability was asserted to be:
Income tax .................. $65,612.24 Declared value excess-profits tax ....................... 2,781.02 __________ Total ................... 68,393.26
Based upon such tax liability for the year 1943, the refund claimed to be due was arrived at as follows:
Tax and interest paid ........ $87,010.10 Tax correctly payable ........ 68,393.26 __________ Amount to be refunded, plus interest ................. 18,616.84
18. By letter of December 16, 1946, the Commissioner of Internal Revenue rejected plaintiff's claim for refund.
The plaintiff is a corporation whose 500 shares were, at the times here pertinent, owned, except for two qualifying shares, by Ike Rudman and his wife Rose Rudman, the husband owning 475 and the wife 23. The corporation was the lessee in a number of oil and gas leases which it was operating and from which it was producing and selling oil. On September 30, 1943, the plaintiff's board of directors, consisting of Mr. and Mrs. Rudman and their daughter, who held a qualifying share, determined that a dividend should be paid out of the current years' earnings, but that it should be a dividend in kind, made by transferring certain property of the company to the stockholders. It was determined that the cash position of the corporation justified paying $60,200 in dividends in 1943. A resolution was adopted pursuant to which on October 1, 1943, the plaintiff executed instruments conveying its interests in eighteen producing oil and gas leases to Mr. and Mrs. Rudman in proportion to their ownership of the shares of the plaintiff, for such length of time as would be required to pay the grantees a stated sum of money out of the production of each lease. The several sums named in the different conveyances when added together made $60,200.
The several conveyances were recorded in the counties where the leased lands lay, and the pipe-line companies which were purchasing the oil from the leases were properly notified of the transfers. The pipe-line companies thereupon paid Mr. and Mrs. Rudman for all oil received by them from these leases after October 1, for the rest of the year 1943, with one unimportant exception. By December 31, the Rudmans had received $59,461.80, and without waiting to receive the balance of the $60,200 to which the conveyances entitled them, they executed reconveyances or releases to the plaintiff of the interests which had been transferred to them. These releases were recorded, the pipe-line companies were notified, and their payments to the plaintiff were resumed as of January 1, 1944.
During the period that the conveyances to the Rudmans were in effect, the plaintiff continued to pay all costs of management and operation of the leases, as it had agreed to do in the instruments of conveyance. On its corporate books, and in its tax returns for 1943, the plaintiff took deductions for the entire year's depreciation on its equipment and structures on the leases in question.
The Rudmans reported the $59,461.80 received by them as dividends from the plaintiff and paid their Federal income tax accordingly. The plaintiff did not report these payments as income to it in its tax return for 1943. The Commissioner of Internal Revenue assessed a tax against the plaintiff on the money which had been paid to the Rudmans on the theory that the dividend in kind declared by the plaintiff distributed to its stockholders an asset which had cost it only $3,274.11 when it acquired it, but which when distributed was worth $59,297. This appreciation in value in the hands of the corporation was treated as income. The parties are agreed that the commissioner's determination of the cost basis of the asset was correct, but they are also agreed that appreciation in value of assets held by a corporation which distributes those assets in kind does not constitute taxable gain to the corporation. General Utilities Operating Co. v. Helvering, 296 U.S. 200, 56 S.Ct. 185, 80 L.Ed. 154; Benjamin Guinness v. United States, 73 F. Supp. 119, 109 C.Cl. 84, certiorari denied 334 U.S. 819, 68 S.Ct. 1083. The plaintiff paid the assessed tax, filed a claim for refund, which was rejected, and brought this suit.
The Government's defense is not based upon the theory on which the tax was assessed and collected. It is based rather upon the theory that the dividend in kind declared by the plaintiff was an assignment of anticipated income made for the purpose of keeping the income out of its hands so that it would not have to pay taxes on it. The receipt by the plaintiff of approximately $60,200 from the sale of the oil from the 18 leases during the remainder of the year 1943 was anticipated. That income would have come to the plaintiff at least as certainly as expected salary would come to an employed person, or expected dividends or interest would come to the holder of stocks or bonds. The question then is whether it is tolerable, when an income tax is being imposed upon citizens generally, to permit particular persons to rid themselves of their income and their share of the income tax by assignment of the expected income in advance of its receipt to avoid the tax. Lucas v. Earl, 281 U.S. 111, 50 S.Ct. 241, 74 L.Ed. 731, held that one could not achieve that result by assigning his salary before it was paid. Harrison v. Schaffner, 312 U.S. 579, 61 S.Ct. 759, 85 L.Ed. 1055, held that one entitled to the income from a trust could not escape income taxes by assigning a part of the future income to his children. Helvering v. Horst, 311 U.S. 112, 61 S.Ct. 144, 85 L.Ed. 75, 131 A.L.R. 655, held that an owner of an interest-bearing bond could not, by detaching interest coupons before they were due and giving them to his son, avoid paying an income tax on the interest, when collected, as if it had been paid to him. Helvering v. Clifford, 309 U.S. 331, 60 S.Ct. 554, 84 L.Ed. 788, is instructive on the question of transactions which, without resulting in important economic changes, are engaged in for the purpose of affecting tax liabilities.
In the instant case the plaintiff corporation foresaw that its operations for 1943 would justify it in distributing a dividend to its stockholders. Its stockholders had a right to have that question considered. The corporation did consider it, and decided that it could produce the same economic benefits for the stockholders by having its prospective debtors, the pipe-line companies which were purchasing its oil and paying for it, make their payments to the stockholders instead for so long as was necessary to put the determined amount of money in the hands of the stockholders. In all reality, it was a plain case of the assignment of future income to satisfy a moral and near-legal obligation of the assignor, a transaction without purpose or intended consequences except in relation to income tax liability.
The plaintiff urges that "oil payments" such as were transferred by the plaintiff to its stockholders are property interests. They are, no doubt, valuable rights, and susceptible of ownership, just as the right, after proper assignment, to receive salary to be earned by another was assumed to be in Lucas v. Earl, supra, and as the interest coupons clipped from the bond were in Helvering v. Horst, supra. The property interests conveyed by the plaintiff to its stockholders were unusual, in that the plaintiff, without consideration, expressly relieved the stockholders of the normal burdens of such ownership, the expense of operating and managing the leases. This arrangement would hardly have been made, of course, except for the expectation of the stockholders that they should be paid dividends, or the family and stock ownership situation which made it immaterial except for tax purposes how the proceeds of the soil should be put into the hands of the stockholders.
Payments received from the production and sale of oil are income, and taxable as such. Burnet v. Harmel, 287 U.S. 103, 53 S.Ct. 74, 77 L.Ed. 199; Helvering v. Twin Bell Oil Syndicate, 293 U.S. 312, 55 S.Ct. 174, 79 L.Ed. 383. These cases also show that the wasting nature of the subject matter is compensated for by the allowance of a statutory percentage depletion as a deduction from such income. The anticipated receipt by the plaintiff, then, from the production and sale of the oil being the anticipated receipt of taxable income, its assignment before receipt was in all respects comparable to the assignment of salary, or income from a trust, or interest on a bond, considered in the cases cited above.
The plaintiff urges that there was something advantageous to it in a memorandum opinion of the General Counsel of the Bureau of Internal Revenue, G.C.M. 22, 730, 1941 — 1 Cum.Bull. 214 issued in 1941, which was changed by a later opinion 24, 849, 1946 — 1 Cum.Bull. 66 issued in 1946, which change, however, was expressly made nonretroactive by specific Bureau Ruling, I.T. 3895, 1948 — 1 Cum.Bull. 39, and hence, should not have been applied to the plaintiff's 1943 transactions. We have studied these opinions and do not find anything in the analyses made there which would indicate that the taxing authorities intended to permit the owner of income-producing property to escape paying taxes by assigning the right to receive the income. Such a view would have contradicted all the decisions of the Supreme Court of the United States which had ever dealt with the problem.
Our conclusion is that the plaintiff's petition should be dismissed. It is so ordered.