Docket No. 26971.
Sam G. Winstead, Esq., for the petitioner. D. Louis Bergeron, Esq., for the respondent.
Amounts expended by petitioner in consideration for option to buy property held, upon failure to exercise option, deductible only as short term capital loss under section 117(g)(2), Internal Revenue Code. Sam G. Winstead, Esq., for the petitioner. D. Louis Bergeron, Esq., for the respondent.
Respondent determined deficiencies in petitioner's income tax for the calendar years 1944 and 1945 in the respective amounts of $2,295.44 and $1,160.28.
The question presented is whether certain expenditures of petitioner's in 1944 were deductible as ordinary business expenses, as claimed by petitioner, or whether same constituted a short term capital loss attributable to petitioner's failure to exercise an option within the meaning of section 117(g)(2) of the Internal Revenue Code, as determined by respondent. Dependent on our holding on this question is the subsidiary question of whether petitioner is entitled to carry over a net operating loss from 1944 to 1945, and if so, in what amount. Other issues raised have been abandoned by petitioner.
FINDINGS OF FACT.
Petitioner is a corporation organized under the laws of the State of Texas in 1938, with its principal office and place of business in Corpus Christi, Texas. It filed its tax returns for the calendar years 1944 and 1945 with the collector of internal revenue for the first district of Texas.
Petitioner is a public gas utility company and is engaged in the sale and distribution of natural gas. Its customers are industries such as refineries and other plants and do not include private residences and small consumers. It does not own any leases, but purchases from producers the gas sold by it.
In January 1944, petitioner's board of directors adopted a resolution authorizing its president to enter into a contract with the Southern Community Gas Corporation, herein called the ‘Gas Company,‘ which resolution is as follows:
WHEREAS, this company has jointly made and entered into a contract with the Nueces Corporation of Nueces County, Texas, whereby it purchased the 4-inch gas transmission line extending from Clarkwood area in Nueces County, Texas, to Robstown in said county, including among other things certain customers to either be served by the Southern Community Gas Company and/or the Southern Coast Corporation, and whereas there are pending negotiations by which this company has every expectation of consummating whereby it will purchase the remainder of the transmission gas lines, customers and contracts of the Nueces Corporation, being more particularly located between Clarkwood and the city of Corpus Christi, including the contracts of the Southwestern Oil and Refining Company and the American Mineral Spirits Company, located on or near Port Avenue within the city limits of the City of Corpus Christi; and whereas if such purchase is consummated this company will probably need additional supply of natural gas for the fulfillment thereof in view of the restriction in its existing contract with the Lockhart Oil Company of Texas for the purchase of gas, unless such restriction is waived by the Lockhart Oil Company of Texas.
And WHEREAS negotiations are also pending and being discussed with respect to this company supplying to the affiliated companies of the Nueces Corporation to-wit, the Gulf Plains Corporation and/or the Chicago Corporation about twelve million cubic feet of gas per day for the requirement of it and their contract with the Central Power and Light Company of this city, and which said gas under the terms of the aforesaid contract between the Gulf Plains Corporation, the Chicago Corporation and the Central Power and Light Company is now being transported through the gas system of this company for the account of the Gulf Plains Corporation and/or the Chicago Corporation, the gas being supplied at the initial point by the Gulf Plains Corporation.
And WHEREAS to enable the Southern Coast Corporation to not only acquire, if it can, the Nueces Corporation's gas lines, but to bid on a contract to supply the requirements of the Central Power and Light Company contract for the account of the Gulf Plains Corporation, it is vitally necessary that the Southern Coast Corporation acquire sources and reserves of gas other than that which is provided for in its existing contracts for the purchase of gas.
Now therefore the president of this corporation is hereby authorized, directed and instructed to make and enter into a contract or contracts with owners and/or operators of properties in particular companies owning oil wells in the Saxet-Clarkwood Field or who may acquire oil wells in said area in which the oil has been exhausted and which are prospective gas properties that might become available to this company, and to enter into contracts to advance monies for the re-working, re-conditioning and re-drilling of such wells and to actually advance money, to extend credit, to assume obligations, and to assist in any practical way that would be to the interests of this company according to the judgment of said president of said corporation, such advancements shall be in consideration of an option for the purchase of the entire output of such well, or wells as may come within the scope of this authorization. Such option to be executed only in the event this company is successful in the purchase of the remainder of the lines and the customers of the Nueces Corporation and/or the contract to supply the gas, or a substantial part thereof to the Gulf Plains Corporation and the Chicago Corporation for the requirements of the Central Power and Light Company. The contract between the Gulf Plains Corporation, the Chicago Corporation and the Central Power and Light Company having approximately fifteen years or thereabouts to run. The option to purchase gas from well or wells or from persons, companies or corporations to whom this company may advance money, credit, equipment or things of value shall be exercised only in the event such gas covered by such option shall have been actually sold or contracted to sell by this company. And such contract if executed, shall in no way conflict with the existing contracts of the Southern Coast Corporation for the purchase of gas with other companies.
WHEREAS the above and foregoing is hereby authorized in view of the fixed and settled policy of this company not to own leases or develop for gas, or produce gas of its own, but instead the policy is one of purchasing gas from producers, pipe line companies, and recycling plants and not to engage in the actual production of gas properties.
The president of this corporation is specifically authorized to make and enter into an optional contract such as authorized above with the Southern Community Gas Company, a public utility, the ownership of the latter company being vested in different stockholders from those of the Southern Coast Corporation, and this can be done notwithstanding the fact that the president of this company is also an official and director of the Southern Community Gas Company, whose policy with respect to developing for gas is different from that of the policy of this company.
Pursuant to above resolution petitioner and the Gas Company, on January 10, 1944, entered into the following contract:
WHEREAS the Southern Community Gas Company has under negotiations an option to purchase certain leases on which abandoned oil wells are located, which are excellent prospects for gas in the upper sands, and is desirous of obtaining from the Southern Coast Corporation advancement of cash and credit and to have the Southern Coast Corporation under its direction, re-work, re-complete and re-drill such well or wells as it may acquire in the year, 1944, and same to be done at the expense of the Southern Coast Corporation.
And WHEREAS in consideration of such performance by the Southern Coast Corporation, the Southern Community Gas Company does hereby give to the Southern Coast Corporation an option to purchase all gas from any well or wells which either the Southern Community Gas Company and/or the Southern Coast Corporation re-complete and develop into gas wells of which leases may be owned by the Southern Community Gas Company. The price of said gas to be two cents per thousand cubic feet and to run for the life of the wells, or such respective wells or leases that are now owned by the Southern Community Gas Company, or that will be acquired during the year, 1944.
The option to purchase said gas by the Southern Coast Corporation shall be exercised before December 31, 1944 and failure to make and enter into a contract in pursuance to this option on or before December 31, 1944 shall ipso facto terminate said option and shall be null and void and the Southern Coast Corporation shall have no claim, demand or cause of action against the Southern Community Gas Company for any money, funds, or credit extended or work performed on well or wells of the Southern Community Gas Company during the year 1944. Any unpaid obligation against said well or wells as of December 31, 1944, either incurred in the name of the Southern Coast Corporation or the Southern Community Gas Company, shall be paid by the Southern Coast Corporation even though it does not exercise its option to purchase said gas.
Pursuant to the above contract petitioner expended in 1944 the sum of $27,994.12 in re-working, re-completing and re-drilling wells on properties of the Gas Company, and thereafter petitioner's negotiations for the acquirement of the new outlet failed, the Houston Natural Gas Company having acquired the contract to supply same, and at a meeting of the petitioner's board of directors, held in 1945, a resolution was adopted reading in part as follows:
WHEREAS the officers of this corporation having advised the Board of Directors that Mr. Fred Fues, Vice president of the Chicago Corporation and managing director of the Nueces Corporation and the Gulf Plains Corporation, from whom the gas transmission line from Clarkwood to Robstown was purchased in December, 1943 has advised the company that the remainder of their gas system has been sold to the Houston Natural Gas Company and that the Houston Natural Gas Company has contracted to supply the gas requirements of the Central Power and Light Company for the account of the the Gulf Plains Corporation under the terms of the original contract between the Gulf Plains Corporation, the Chicago Corporation and the Central Power and Light Company and that all negotiations with this company have and are now terminated.
And WHEREAS this company has heretofore had an option to the purchase of certain gas from the Southern Community Gas Company in anticipation of the successful consummation of the purchase of the Nueces Corporation's line and its customers and for securing a contract to supply gas for the Central Power and Light Company's requirements for the account of the Gulf Plains Corporation, and which option this company has not exercised due to the fact that it has no outlet for the gas controlled under said option.
THEREFORE BE IT RESOLVED that the consideration for such option shall be charged as an operating loss for the year 1944 and the auditors of said company are instructed to so change same. * * *
In petitioner's income tax return for 1944 it claimed a deduction of $17,994.12 as ‘Loss on Wells Developed for Southern Community Gas Co. on which option was not exercised,‘ which was disallowed by respondent on the ground that it constituted a short term capital loss within the meaning of section 117(g)(2). In its 1945 return petitioner claimed a net operating loss deduction of $7,891.84, due to a net loss carry-over from the preceding year. Petitioner had no capital gains during the taxable year 1944. The price of gas named in the option was the ordinary market price in that field.
The expenditure by petitioner of $27,994.12 resulted in a loss attributable to petitioner's failure to exercise its option to buy the gas from the Gas Company.
The question is whether amounts concededly expended by petitioner are deductible only as a short term capital loss by reason of the provisions of section 117(g)(2), Internal Revenue Code. This in turn depends, as the case is presented, on whether it can be said that within the meaning of that section the expenditures in question were ‘losses attributable to the failure to exercise‘ an option ‘to buy * * * property.‘
SEC. 117. CAPITAL GAINS AND LOSSES.(g) GAINS AND LOSSES FROM SHORT SALES, ETC.— For the purpose of this chapter—(2) gains or losses attributable to the failure to exercise privileges or options to buy or sell property shall be considered as short-term capital gains or losses.
Petitioner does not question that the natural gas it hoped to acquire was property, but urges that the section in dispute applies only to losses attributable ‘solely‘ to a failure to exercise an option and further, in what is perhaps different language for saying the same thing, that the loss was attributable not to the failure to exercise the option but to the failure to obtain the customer to whom it was intended that the gas would be sold.
In presenting its position petitioner notes that the section pertains to gains or losses attributable to the failure to exercise options and not to ‘all gains or losses attributable to‘ such options. With that statement as a premise, there can of course be no quarrel. But we cannot follow petitioner to its conclusion. There is no suggestion in the legislation or its history that the failure to exercise the option must be the ‘sole‘ cause of the loss, and, indeed, it might be difficult to find any human situation in which a result follows solely from a single cause. See Estate of George E. Howe, 16 T.C. 1493, 1495. What petitioner would have us do is determine not so much the cause of the loss as the anterior reason leading to its decision to allow the option to lapse; and in this case to attribute the loss not to petitioner's failure to take up its option but to its lack of success in obtaining the customer who would make the option profitable. Such philosophic speculation would go far to make the section impossible of practical administration.
‘Finally, under the amendment it is the gains or losses attributable to 'the failure to exercise’ privileges or options to buy or sell property and not all gains or losses attributable to such privileges or options which are to be treated, as a matter of law and without regard to varying circumstances, as gains or losses from sales or exchanges of capital assets held for 1 year or less.‘ Conference Report, 73rd Cong., 2nd Sess., H. Rept. 1385, p. 23.
The sums expended by petitioner were treated by the parties at the time as the consideration for the option. Not once but three times did petitioner itself view them as consideration; first, in the enabling resolution; second, in the option contract; and third, in the resolution dealing with the unsuccessful consequences of the venture where petitioner's own officials directed that ‘the consideration for such option shall be charged as an operating loss for the year 1944.‘ The consideration so paid for the option was lost naturally enough when the option expired without being exercised. It is difficult to conceive of a loss more directly attributable not alone to the option, but in accordance with the legislative intent to ‘the failure to exercise‘ it, Cf. Seth M. Milliken, 15 T.C. 243. ‘We have reviewed carefully the legislative history of that section and can not find there any indication that Congress did not intend that * * * corporation which lost the money paid for an option which it purchased but did not exercise should be exempted from its provisions.‘ Nordblom Associates, Inc., 15 T.C. 220, 224.
‘ * * * such advancements shall be in consideration of an option for the purchase of the entire output of such well, or wells * * * .‘
‘WHEREAS the Southern Community Gas Company * * * is desirous of obtaining from the Southern Coast Corporation (petitioner) advancement of cash and credit and to have the Southern Coast Corporation under its direction, re-work, re-complete and re-drill such well or wells as it may acquire * * * .‘‘And WHEREAS in consideration of such performance by the Southern Coast Corporation, the Southern Community Gas Company does hereby give to the Southern Gas Corporation an option to purchase all gas * * * .‘
Reviewed by the Court.
Decision will be entered for the respondent.
JOHNSON, J., dissenting: As the trier of the facts I cannot agree with the majority opinion. It give undue emphasis to the so called option and the part that it played in the transaction. This appears to be due to a failure to consider the entire record upon which the transaction is based. Its premise that ‘amounts expended by petitioner‘ were ‘in consideration of an option to buy property‘ apparently rests alone upon sentences quoted from the documentary evidence, and no consideration appears to have been given to the other facts and circumstances surrounding and causing the execution of the instruments and the results flowing therefrom. In determining tax liability, the record as a whole should be considered.
Undoubtedly the basis of the option contract and the overall consideration which prompted its execution and the resultant expenditures by petitioner were due solely to petitioner's preparation to secure a supply of gas to enable it to fill its anticipated contract with the Chicago corporation and its affiliates.
That the option contract was secondary and subject to obtaining the Chicago contract is evidenced by recitals in the enabling resolution that the option was ‘to be executed only in the event this company is successful in the purchase‘ of the lines and customers, etc., of the Nueces corporation, etc., (affiliates of Chicago corporation) and furthermore, that the option ‘shall be exercised only in the event such gas covered by such option shall have been actually sold or contracted to sell by this company.‘ While this provision does not appear in the option contract, petitioner and the Gas Company were closely affiliated corporations, having largely the same officers, and it is reasonable to infer that both parties knew, when the option contract was executed, that the option to purchase would be exercised only if the Chicago contract were secured. Petitioner and the Gas Company were both engaged in the sale of gas, and it would have been to their mutual benefit to procure the Chicago contract.
That the Gas Company did not regard the improvement of the wells by petitioner as the paramount or inducing cause of its contract with petitioner is evidenced by the fact that the contract did not obligate petitioner to expend any sum whatever; it was solely within the discretion of petitioner as to what sum, if any, it would expend for this purpose. Furthermore, under the evidence the Gas Company would have given petitioner the option to buy gas at the price stipulated in the contract without any obligation on the part of petitioner to do anything with reference to the wells.
Considering the record as a whole, we question the soundness of the premise upon which the majority opinion rests.
But regardless of the part the expenditures may have played, if any, in the purchase of the option, we unequivocally differ with the majority's conclusion that petitioner's loss was ‘attributable‘ to its ‘failure to exercise its option to buy.‘
The option was merely the right to buy gas at a price shown to be the market price in that field, and hence petitioner could not have sold the option at a profit. And furthermore, it was without dispute that petitioner's only market for the gas was in the event of its acquirement of the Chicago contract. Hence, if petitioner had exercised its option and bought the gas, it would not have averted or diminished, but rather increased its loss. The fact that an option to buy or sell property is involved in a transaction will not make the loss resulting therefrom a short term capital loss within the meaning of section 117(g)(2), unless such loss is directly attributable to the failure to exercise the option. Alvin J. Spring, 4 T.C. 248. Cf. Seth M. Milliken, 15 T.C. 243.
We agree with the majority that it would be too narrow an interpretation of the section in dispute to say that it ‘applies only to losses attributable 'solely’ to a failure to exercise an option,‘ but we do think a reasonable interpretation would require that the ‘proximate‘ cause of the loss was attributable to the failure to exercise the option, which is not the case here.