Opinion
Docket No. 110566.
1944-08-4
BURTON-SUTTON OIL COMPANY, INCORPORATED, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Wright Matthews, Esq., for the petitioner. Frank B. Schlosser, Esq., and L. R. Van Burgh, Esq., for the respondent.
1. Petitioner acquired an oil and gas lease by assignment and contracted with the assignor, among other things, that ‘After Grantee has met the underlying and overriding royalty obligations referred to in paragraph 2 hereof and has been reimbursed out of the proceeds of the oil and gas produced from all such costs and expenses of operating upon said property as defined below, Grantee shall account to and pay Grantor 50% of the remaining portion of said proceeds * * * .‘ During the taxable years 1936, 1937, and 1938 it paid the grantor of the contract certain amounts representing the ‘50% of the remaining portion of said proceeds‘ called for in the contract. Held, the amounts so paid to the grantor are capital expenditures and represent a part of the cost of the lease to petitioner and are not to be excluded from petitioner's income except through deductions for depletion or as a part of the cost basis in case of a sale or other disposition of the property. Quintana Petroleum Co., 44 B.T.A. 624;affd., 143 Fed.(2d) 588, followed.
2. In 1940 the State of Louisiana asserted against petitioner additional corporation franchise taxes for the taxable years 1937 and 1938, which petitioner paid in 1940. Petitioner kept its books upon the accrual basis. Held, the amounts asserted and paid in 1940 represented taxes accrued in 1937 and 1938, respectively, and as such were allowable deductions from gross income for the years 1937 and 1938 under section 23(c) of the Revenue Act of 1936.
3. In 1941 the State of Louisiana asserted against petitioner additional income taxes for the taxable years 1937 and 1938, together with interest thereon, all of which petitioner is contesting before the board of tax appeals of that state. Held, petitioner is not entitled to deduct any of these contested items from its gross income for the taxable years 1937 and 1938, respectively. Dixie Pine Products Co. v. Commissioner, 320 U.S. 516.
4. During the taxable year 1938 petitioner expended a sum of money in resisting certain condemnation proceedings instituted by the United States which involved, among other things, a dispute over the boundaries of petitioner's property. The dispute was settled in petitioner's favor. Held, the expenditures in question are deductible as ordinary and necessary business expenses. L. B. Reakirt, 29 -.T.A. 1296; affd. per curiam, 84 Fed.(2d) 996, followed. Wright Matthews, Esq., for the petitioner. Frank B. Schlosser, Esq., and L. R. Van Burgh, Esq., for the respondent.
This proceeding involves the determination by the respondent against petitioner of deficiencies in income and excess profits taxes for the taxable years 1936, 1937, and 1938 in amounts as follows:
+--------------------------------------------+ ¦Fiscal year ended-¦Income tax¦Excess profits¦ +------------------+----------+--------------¦ ¦ ¦ ¦tax ¦ +------------------+----------+--------------¦ ¦Feb. 29, 1936 ¦$10,799.01¦$667.42 ¦ +------------------+----------+--------------¦ ¦Feb. 28, 1937 ¦66,341.26 ¦27,899.87 ¦ +------------------+----------+--------------¦ ¦Feb. 28, 1938 ¦82,655.94 ¦32,157.86 ¦ +--------------------------------------------+
The above deficiencies result from several adjustments to the net income as reported by petitioner. Not all of these adjustments are contested. Some of the adjustments that were contested by appropriate assignments of error were abandoned at the hearing, without prejudice to petitioner's right to raise similar issues in future years. These abandoned issues relate to claimed deductions for depreciation for 1936 and 1938, and claimed deductions for timber used for construction purposes in 1937 and 1938. Additional errors were assigned by petitioner relating to certain claimed deductions for state franchise and state income taxes, together with interest on the income taxes, concerning which no adjustments were made by the respondent. The issues which have thus been raised by appropriate assignments of error and remain for our determination and decision are as follows:
1. Is petitioner entitled to exclude from taxable income in each of the taxable years the amount paid to the Gulf Refining Co. of Louisiana under the terms of a contract whereby petitioner acquired an oil and gas lease?
2. Is petitioner entitled to deduct in the taxable years 1937 and 1938 the amounts of additional franchise taxes for those years which were asserted by the State of Louisiana in the year 1940 and paid by petitioner in 1940?
3. Is petitioner entitled to deduct in the taxable years 1937 and 1938 amounts representing additional state income taxes, together with interest thereon, which were asserted for those years by the State of Louisiana on December 31, 1941, where an appeal has been taken to the Board of Tax Appeals of the State of Louisiana and the additional taxes and interest have not been paid?
4. Is the sum of $27,564.61 paid in the taxable year 1938 for legal services rendered in connection with a condemnation suit brought against petitioner and others by the United States, which involved the boundary lines of petitioner's property, deductible as an ordinary and necessary expense?
FINDINGS OF FACT.
Petitioner is a corporation organized in February 1933 and doing business under the laws of the State of Louisiana, with its principal office in Lake Charles, Louisiana. The returns for the taxable years here involved were filed with the collector of internal revenue for the district of Louisiana at New Orleans. Petitioner kept its books and prepared its returns on the accrual basis.
Issue No. 1.— The adjustments to petitioner's net income for the years 1936, 1937, and 1938 which resulted in assignments of error raising issue No. 1 were explained by the respondent in the statement attached to the deficiency notice as follows:
It is held that payments made to Gulf Refining Company of Louisiana in each of the years 1936, 1937 and 1938 in accordance with the contract whereby you acquired the lease to a section of State school land in Cameron Parish, Louisiana, represent a part of the cost of that lease, and are therefore not to be deducted or excluded from taxable income, except as they are recovered through depletion. Since in each of the years under consideration percentage depletion is greater than depletion based on cost of the lease, adjusted for depletion previously allowed, percentage depletion has been allowed in each year.
On or about February 27, 1933, petitioner acquired from J. G. Sutton a contract which had been entered into on February 18, 1933, between Sutton as ‘grantee‘ and the Gulf Refining Co. of Louisiana, hereinafter sometimes referred to as Gulf or as grantor. This contract recited that Gulf, for and in consideration of $10 and other valuable considerations, ‘has sold, conveyed and transferred, and does hereby sell, convey and transfer‘ unto the said grantee ‘all oil and gas rights, titles, interests or privileges given, conveyed and transferred by virtue of that certain mineral lease executed by Cameron Parish School Board to S. W. Sweeney, dated April 4, 1927, covering all of the whole of Section Sixteen (16), Township Fourteen (14) South, Range Thirteen (13) West, Louisiana Meridian, in Cameron Parish, Louisiana.‘ The contract further recited that:
This assignment is made subject to the following terms and conditions:
1. Grantee binds and obligates himself to begin on or before thirty days from date, operations for the drilling of a well on said land and to continue his operations thereon with reasonable diligence to completion or abandonment in an honest, bona fide effort to find oil or gas in paying quantities on said land. After the completion of said well, Grantee shall continue such operations on said land as may be necessary to continue said lease in full force and effect. If, after completing said well, Grantee shall desire to cease operations on said land, he shall, upon demand, reassign said lease to Grantor not less than thirty days prior to the maturity date of any obligation accruing after the date of the cessation of his operations on said land.
2. All oil and gas royalties which are due and payable under the terms of said lease herein referred to, as well as the overriding oil royalty provided for in the contract executed by Gulf Refining Company of Louisiana to S. W. Sweeney, on April 7, 1927, together with all the costs and expenses incurred by Grantee in his operations on said land, shall be borne and paid by Grantee, out of the remainder of the proceeds of the sale of any oil and/or gas produced from the land, after payment of the royalties hereinabove provided for, Grantee shall reimburse himself for the costs and expenses incurred and allowed by reason of his operations under said lease.
3. After Grantee has met the underlying and overriding royalty obligations referred to in paragraph 2 hereof and has been reimbursed out of the proceeds of the oil and gas produced from all such costs and expenses of operating upon said property as defined below, Grantee shall account to and pay Grantor 50% of the remaining portion of said proceeds of the oil and/or gas produced and sold from the said land. Accounting hereunder shall be at the price which Grantee received for the oil and/or gas produced from said land.
4. Accounting and settlement under this agreement shall be made at the end of each calendar month, and losses and arrears sustained by Grantee in his operations may be brought forward from month to month until extinguished. * * *
Paragraph 5 of the contract specified what ‘costs and expenses allowed in this agreement and that may be deducted by Grantee from the proceeds of the Gross production of oil and gas from said land before a payment shall be made to Grantor.‘ Paragraph 6 provided that the grantee shall keep accurate accounts and furnish the grantor with a complete statement at the end of each month. Paragraph 7 provided that in no event shall the grantor be obligated to pay any of the costs or expenses incurred by the grantee in his operations under the agreement. Under paragraph 8 ‘It is understood and agreed that all sulphur rights and all rights to produce sulphur under and by virtue of the said lease herein referred to have been and are still reserved to Grantor * * * .‘ The final paragraph was numbered 9, and it provided for the manner in which the oil produced from the land was to be sold, the grantor being given the right to purchase such oil at the average posted price if it so desired.
Shortly after acquisition of the contract petitioner, pursuant to the terms thereof, proceeded to the development and operation of the property and obtained oil and/or gas in paying quantities. In accordance with the above provisions of paragraph 3 of the contract, the following sums were paid to Gulf during the taxable years indicated:
+----------------+ ¦1936¦$17,406.19 ¦ +----+-----------¦ ¦1937¦232,498.94 ¦ +----+-----------¦ ¦1938¦286,128.28 ¦ +----------------+
The foregoing amounts were claimed as deductions in the returns filed for the respective years and they were disallowed by the respondent in his notice of deficiency on the ground that the amounts paid Gulf represented additional costs of the property covered by the contract, recoverable through depletion allowances. The parties have stipulated that, depending upon our final decision as to this issue, ‘the allowable depletion will be determined under Rule 50.‘
Issue No. 2.— Under date of November 27, 1940, the Department of Revenue of the State of Louisiana asserted against petitioner additional corporation franchise taxes in the amounts of $814.11 and $1,237.83 for the taxable years 1937 and 1938, respectively. These taxes were paid on November 30, 1940. The respondent has refused to allow these amounts as deductions in the computation of petitioner's income and excess profits tax liabilities for the taxable years in question.
Issue No. 3.— Under date of December 31, 1941, the Office of the Department of Revenue for the State of Louisiana asserted against petitioner additional income taxes for the taxable years 1937 and 1938 in the amounts of $15,025.42 and $15,750, respectively, and interest thereon in the amounts of $3,305.59 and $2,520, respectively. Petitioner contested these assertions and filed an appeal with the Board of Tax Appeals of the State of Louisiana. At the time of the hearing in the present proceeding that appeal was still pending and had not been decided. The respondent has failed and refused to allow any of the above amounts as deductions from gross income for the taxable years 1937 and 1938, respectively.
Issue No. 4.— The adjustment to petitioner's net income for the fiscal year ending February 28, 1938, which resulted in the assignment of error raising issue No. 4 was explained in the statement attached to the deficiency notice as follows:
(a) The legal expenses incurred by you in connection with litigation covering a large tract of land within which is included the land on which you were conducting oil operations, are held to have been expended in defending and perfecting your title to the property, and as such, are specifically excluded from allowable deductions by article 24-2 of Regulations 94.
On July 19, 1937, the United States of America filed at Law No. 2841 a petition for condemnation in the District Court of the United States for the Western District of Louisiana, Lake Charles Division, against ‘139,248.68 acres, more or less, of land in Cameron Parish, Louisiana; Orange Cameron Land Company, Inc., a Texas corporation, et al., Defendants.‘ Petitioner was made a defendant in this suit under paragraph 11 of the petition, which was as follows:
11. The said defendants generally and all and singular the heirs, executors, administrators, representatives of each and every of the above named persons; and all unknown owners, lienors, and claimants having or claiming any right, title, estate, equity, interest or lien; and all occupants, lessees, licensees and users and holders and owners of and claimants to easements in, on, over or through said lands; and all persons, firms and corporations claiming any title or interest to or in any of said tracts of land; are made parties defendant to the end that they may come into Court and by proper pleadings make claim to said lands, or to the proceeds arising therefrom.
Petitioner's interest in this suit as a party defendant came about in the following manner. The land being condemned was to be used as a Federal bird preserve under the jurisdiction of the United States Department of Agriculture, and it took in several townships (except section 16 in each township, which was owned by the state) in Cameron Parish, Louisiana, between Sabine Lake on the west and Calcasieu Lake on the east, and from about five miles north of the Gulf of Mexico to about 14 miles north thereof. The lease which was acquired by petitioner on or about February 27, 1933, and is involved in issue No. 1 herein was in this territory, and, being a lease covering all of the whole of ‘Section Sixteen,‘ township 14 south, range 13 west of the Louisiana meridian, would have been exempt from the condemnation if there had been no dispute as to the location of said section 16, which dispute is more fully explained below. From the time petitioner acquired this lease in 1933 up to the time the condemnation suit was filed in 1937, petitioner had drilled about 19 producing wells on the land, and petitioner's gross income therefrom was something over $1,000,000 a year for the fiscal years 1937 and 1938.
The Bureau of Biological Survey of the Department of Agriculture made a survey of the 139,000 acres preparatory to acquiring the land. Early in 1936 petitioner learned that the survey made by the Bureau of Biological Survey had the effect of moving all north and south section lines in township 14 south, range 13 west, about three miles to the west. This would have had the effect of leaving the oil field which petitioner had developed in what it contended was section 16 in a section three miles to the east.
Petitioner then employed the law firm of Cline, Thompson & Lawes to represent it in connection with this controversy. Protests and arguments were made as to the correctness of the Bureau's survey which resulted in a resurvey, and on the second survey it was proposed to move the lines about three-fourths of a mile to the west, which still had the effect of placing the land on which petitioner's oil field had been developed in section 15 of that township rather than section 16. The State of Louisiana owns section 16, subject to the right of the Cameron Parish School Board to lease it for oil and receive the revenue from it. The school board, under its lease with petitioner which is described in issue No. 1 herein, received a one-eighth royalty.
During the early part of 1936 and until the case was concluded in December 1937, W. W. Thompson of the law firm of Cline, Thompson & Lawes did practically no work except that in connection with this condemnation proceeding. This work consisted of writing briefs, holding many conferences in Washington, Dallas, Galveston, Orange, New Orleans, Shreveport, Baton Rouge, and Lake Charles in efforts to convince the Orange Cameron Land Co., principally, and the Government that the Bureau's survey was wrong and that a survey made by F. Shutts Sons in 1924 and 1925 was correct, and that the lines of section 16 of township 14 south, range 13 west, as established by the Shutts survey, formed the correct boundary lines between that section and the lands of the Orange Cameron Land Co. that were being taken by the Government. Finally, a few days before the trial, which was fixed for December 13, 1937, at a conference in Washington in the office of the Attorney General, at which conference were present representatives of the Bureau of Biological Survey, the State of Louisiana through its Attorney General, the Orange Cameron Land Co. and others, Thompson was successful in convincing all the interested parties that the section lines as contended for by petitioner were correct and, based upon that agreement, judgment was entered in the case in so far as petitioner was concerned on December 14, 1937.
In the above mentioned suit there was no question as to the validity of petitioner's lease with the Cameron Parish School Board. The only question involved in so far as petitioner was concerned was the location of section 16, township 14 south, range 13 west, and the boundaries thereof. If section 16 were located on the ground where the Bureau of Biological Survey contended it was, petitioner would have a lease on barren prairie land with no production, whereas if it were where petitioner contended it was the lease would be on land with 19 producing wells. If petitioner had lost, it would have lost its entire oil field and the income therefrom. The final judgment placed the boundary of said section 16 just as petitioner had contended it should be placed, namely, in accordance with the survey made by Shutts in 1924 and 1925.
During the taxable year ended February 28, 1938, petitioner expended $27,564.61 in legal expenses (including a $25,000 fee to Cline, Thompson & Lawes) in resisting the above mentioned condemnation proceedings instituted by the United States. On its return for that taxable year it deducted this amount as an ordinary and necessary business expense. The respondent disallowed the item, for the reasons given above.
Any part of the stipulated facts not included in the foregoing findings of fact are incorporated herein by reference.
OPINION.
BLACK, Judge:
We shall consider the issues in the order previously stated.
Issue No. 1.— Should the amounts of $17,406.19, $232,498.94, and $286,128.28 paid by petitioner to Gulf during the taxable years 1936, 1937, and 1938, respectively, be excluded from petitioner's income? These amounts were paid pursuant to paragraph 3 of the February 18, 1933, contract between Sutton and Gulf, which contract petitioner acquired from Sutton on or about February 27, 1933. In Anderson v. Helvering, 310 U.S. 404, the Supreme Court said:
It is settled that the same basic issue determines both to whom income derived from the production of oil and gas is taxable and to whom a deduction for depletion is allowable. That issue is, who has a capital investment in the oil and gas in place and what is the extent of his interest.
The respondent determined and contends that under the contract of February 18, 1933, Gulf sold all of its ‘oil and gas rights, titles, interests or privileges ‘ in the lease ‘in consideration of Ten Dollars ($10.00) and other valuable considerations‘ part of which consisted of the ‘50% of the remaining portion of said proceeds of the oil and/or gas produced and sold from the said land ‘ provided for in paragraph z of the contract. In other words, the respondent determined and contends that the above amounts paid to Gulf represent a part of petitioner's ‘capital investment in the oil and gas in place‘ and as such should be added to petitioner's cost basis of the lease. On that theory the respondent has included in petitioner's gross income all the income derived by it from the production and sale of oil and gas from the lease, exclusive of the original oil royalty and the overriding oil royalty concerning which there is no dispute, and has allowed petitioner deductions for depletion of $27 1/2 per centum of the gross income from the property‘ under section 114(b)(3) of the Revenue Acts of 1934 and 1936.
The above amounts paid to Gulf, which were determined by the respondent to represent capital expenditures and a part of the cost of the lease, were therefore included as a part of petitioner's ‘gross income‘ under section 22(a) of the Revenue Acts of 1934 and 1936, and as a part of petitioner's ‘gross income from the property‘ under section 114(b)(3) for depletion purposes. Cf. Helvering v. Twin Bell Oil Syndicate, 293 U.S. 312; Sunray Oil Co., 3 T.C. 251, 254. The above mentioned deductions for depletion of ‘27 1/2 per centum of the gross income from the property ‘ were allowed by the respondent for each of the taxable years before us on the ground that the respondent had also determined that such percentage depletion was greater than depletion based on cost under section 114(b)(1) of the Revenue Acts of 1934 and 1936. The respondent now concedes that if he is correct in his contention that the amounts paid to Gulf represents a part of the cost to petitioner of the lease, then for the year 1938, the depletion based on cost under section 114(b)(1) is greater than the percentage allowance under section 114(b)(3), and as a result thereof the parties have stipulated relative to the year 1938 that ‘If this Court does not permit the petitioner to eliminate from its taxable income the payment of $286,128.23, then the petitioner is entitled to an additional deduction for depletion in the fiscal year ended February 28, 1938, in the amount of $45,754.36.‘ Cf. North American Oil Consolidated, 12 B.T.A. 68 (bottom of p. 94 to middle of p. 95), appealed and reversed on other issues, 286 U.S. 417. On the other hand, if we agree with petitioner that the amounts paid to Gulf should be excluded from petitioner's taxable income, then petitioner's allowance for depletion would have to be redetermined and the parties have stipulated that this may be done under Rule 50.
Petitioner contends that the contract of February 18, 1933, was a sublease rather than a sale; that Gulf retained an ‘economic interest‘ in the oil and gas in place to the extent of the payments required under paragraph 3 of the contract; and that, therefore, the amounts paid to Gulf under paragraph 3 should be excluded from its income. Among the cases cited by petitioner in support of these contentions are Thomas v. Perkins, 301 U.S. 655; Holly Development Co. v. Commissioner, 93 Fed.(2d) 146; and Marrs McLean, 41 B.T.A. 565, 573-575 (Gray lease under issue No. 2), affirmed on other issues, 120 Fed.(2d) 942.
Respondent relies upon Helvering v. O'Donnell, 303 U.S. 370; Helvering v. Elbe Oil Land Development Co., 303 U.S. 372; Blankenship v. United States, 95 Fed.(2d) 507; Anderson v. Helvering, supra; and Quintana Petroleum Co., 44 B.T.A. 624.
We think the facts in the instant proceeding are practically on all fours with those in Quintana Petroleum Co., supra, on this issue. In that case respondent relied upon the same authorities as he relies upon here, and we sustained him. In that case the pertinent agreement between the parties provided, among other things, as follows:
* * * If as a result of Trinity's operations on said land, oil and gas should be produced therefrom in paying quantities, then, after paying all of the costs and expenses incurred in drilling, equipping, and operating said well, Trinity shall account to Gulf monthly for one-fourth (1/4th) of the net proceeds of such operations.
The agreement then specified the costs and expenses deductible by Trinity in computing the amount of the payments to be made to Gulf Production Co.
In the instant case paragraph 3 of the agreement, by which petitioner was obligated to pay Gulf 50 percent of the net proceeds after deduction of expenses, is in our judgment to all intents and purposes the same as the agreement in the Quintana Petroleum Co. case, supra. As in that case, the agreement here was followed by a detailed enumeration of the expenses which were to be deducted by petitioner before there was to be a 50 percent division of the net proceeds with Gulf. Thus, as we have already indicated, we see no distinction in substance between the facts of the two cases. On June 27, 1944, since the filing of briefs in this proceeding, the Fifth Circuit affirmed us in the Quintana Petroleum Co. case. See Quintana Petroleum Co. v. Commissioner, 143 Fed.(2d) 588. Therefore, upon the authority of Quintana Petroleum Co. v. Commissioner, we sustain the respondent's determination upon this issue, and in accordance with the stipulation the petitioner is ‘entitled to an additional deduction for depletion in the fiscal year ended February 28, 1938, in the amount of $45,754.36.‘ Cf. Estate of Dan A. Japhet, 3 T.C. 86.
Issue No. 2.— Petitioner contends that the additional corporation franchise taxes for the taxable years 1937 and 1938 asserted by the state in 1940 and paid by petitioner in 1940 actually ‘accrued‘ as a liability during the respective taxable years in question and that, since petitioner kept its books on the accrual basis, the taxes so asserted and paid are deductible for the taxable years 1937 and 1938, respectively.
Section 23(c) of the Revenue Act of 1936 provides that in computing net income there shall be allowed as deductions ‘Taxes paid or accrued within the taxable year,‘ with certain exceptions, none of which are material here. Section 48(c) of the same act provides that when used in this title ‘The terms 'paid or incurred’ and 'paid or accrued' shall be construed according to the method of accounting upon the basis of which the net income is computed under this Part. ‘ Petitioner's method of accounting was the accrual method.
The respondent concedes that the rule is well established that taxes accrue when all events have occurred that fix the amount of the tax and determine the taxpayer's liability to pay it, citing Oregon Pulp & Paper Co., 47 B.T.A. 772, 780, and the cases therein cited. The respondent contends, however, that petitioner has failed to show that all the events fixing the additional franchise tax liabilities here involved transpired during the years 1937 and 1938, and that, therefore, ‘there is no basis upon which this Court can permit the accrual and deduction of the taxes in the years 1937 and 1938.‘ We think this contention by respondent can not be sustained.
In Oregon Pulp & Paper Co., supra, we held that the taxpayer there could not deduct in 1936, the year of payment, the amount of an additional excise tax demanded from the taxpayer by the State of Oregon for the year 1934. We said there that all events had transpired prior to 1936 which fixed the amount of the liability; that the taxpayer had erroneously computed the amount of its tax to the state; and that the subsequent discovery of the error in 1936 ‘related back to the taxable year in which the mistake occurred.‘ This is all the petitioner in the instant proceeding is claiming.
The liability for the franchise taxes in question was fixed by laws of the State of Louisiana. Those laws were in force during the taxable years 1937 and 1938. Petitioner had erroneously computed the amount of the liability. The subsequent discovery of the error and the correction thereof in 1940 related back to the taxable years 1937 and 1938, in which years the mistake occurred. Oregon Pulp & Paper Co., supra, p. 780. We hold that the amounts of $814.11 and $1,237.83 are allowable deductions for the taxable years 1937 and 1938, respectively, under section 23(c), supra.
Issue No. 3.— The question involved in this issue is substantially the same as the one that was recently decided by the Supreme Court in Dixie Pine Products Co. v. Commissioner, 320 U.S. 516. Both parties in their briefs seem to agree that the Supreme Court's decision in that case is controlling. In its brief petitioner concedes that ‘The income taxes therefore will be deducted under this decision of the Supreme Court when the litigation is finally adjudicated.‘ We hold that the same rule applies also to the interest items in question. Section 23(b) of the Revenue Act of 1936 provides for the allowance as deductions of ‘All interest paid or accrued within the taxable year on indebtedness * * * .‘ Here the taxpayer is contending before the Board of Tax Appeals of the State of Louisiana that it is not indebted to the state for the amounts on which the interest is based. We hold that petitioner is not entitled to any deductions for the taxable years 1937 and 1938 on account of either the contested additional income taxes or the interest thereon, the amounts of which are set out in our findings of fact. Dixie Pine Products Co. v. Commissioner, supra.
Issue No. 4.— Section 23(a) of the Revenue Act of 1936, as amended by section 121 of the Revenue Act of 1942, provides that in computing net income there shall be allowed as deductions ‘All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business * * * . ‘ Petitioner contends that the item of $27,564.61 here in question is deductible under this provision of the statute, and cites Welch v. Helvering, 290 U.S. 111; L. B. Reakirt, 29 B.T.A. 1296; affd. per curiam, 84 Fed.(2d) 996; Commissioner v. Chicago Dock & Canal Co., 84 Fed.(2d) 288; and Commissioner v. Heininger, 320 U.S. 467.
Section 24(a)(2) of the Revenue Act of 1936 provides that in computing net income no deduction shall in any case be allowed in respect of ‘Any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate.‘ Pursuant to section 62 of the Revenue Act of 1936, the respondent prescribed and published, as a needful regulation for the enforcement of section 24(a)(2), article 24-2 of Regulations 94, which among other things provides that ‘The cost of defending or perfecting title to property constitutes a part of the cost of the property and is not a deductible expense.‘ In referring to an identical provision of Regulations 86, the Tenth Circuit, in Farmer v. Commissioner, 126 Fed.(2d) 542, affirming on this point Central Material & Supply Co., 44 B.T.A. 282, said:
This regulation finds general support in the decisions of the courts. The authorities quite generally hold that expenditures made in defense of a title upon which depends the right to receive oil and gas royalty payments are capital expenditures and not deductible as ordinary business expenses. Croker v. Helvering, 67 App.D.C. 226, 91 F.2d. 299; Murphy Oil Co. v. Burnet, 9 Cir., 55 F.2d 17, 26; Blackwell Oil & Gas Co. v. Commissioner, 10 Cir. 60 F.2d 257. Petitioners did more than litigate the right to receive oil royalty payments. The title to the oil and gas lease under which they received these payments depended upon the title to the land. Without title to the land they had nothing. It was therefore necessary for them to defend and establish the title to the land in order to retain their interest in the oil and gas. The decision of the Commissioner and of the Board in this respect is approved.
To the same effect are Jones' Estate v. Commissioner, 127 Fed.(2d) 231, and Moynier v. Welch, 97 Fed.(2d) 471. We think it is true, as stated by the court in Farmer v. Commissioner, supra, that ‘The authorities quite generally hold that expenditures made in defense of title upon which depends the right to receive oil and gas royalty payments are capital expenditures and not deductible as ordinary business expenses.‘
While the general rule is as above stated, the Board held in L. B. Reakirt, supra, that attorney fees paid by a taxpayer engaged in the real estate and investment business in resisting an illegal attempt by a city to condemn and acquire certain of his property are deductible as ordinary and necessary expenses of such business. Our decision in that case was affirmed by the Sixth Circuit, per curiam, supra. We do not believe that the Reakirt case has been overruled by the later decisions which we have cited above. There can be no doubt that suit at law No. 2841 filed by the United States of America in the District Court of the United States for the Western District of Louisiana, described in our findings of fact, was a condemnation suit. If the United States had prevailed against petitioner, who became a party to that suit, all of petitioner's 19 producing oil wells would have been taken. Petitioner employed counsel and defended against the Government's effort to condemn its property upon the ground that its properties were not included in the proper boundaries of the lands which the Government was seeking to condemn. Petitioner prevailed in this contention and judgment was entered by the United States District Court in petitioner's favor. While it is unquestionably true that the principal question involved in the condemnation suit, in so far as the Government and petitioner were concerned, was the correct location of boundary lines, it is also true that the suit was a condemnation suit and that as a result of the judgment petitioner's property upon which its 19 producing oil wells were located was not taken by the United States Government. We think the amounts aggregating $27,564.61 which petitioner expended to prevent its property being taken should be allowed as ordinary and necessary business expenses incurred in resisting condemnation proceedings, under authority of the Reakirt case.
The fact that the taxpayer in the Reakirt case was engaged in the real estate and investment business, whereas the taxpayer in the instant case is engaged in the production and sale of oil, is, we think, without any important significance. The important factor in each case is that the expenditures in question were made in preventing the taxpayer's property from being taken in a condemnation proceeding. Article 24-2 of Regulations 94 is not applicable to such a state of facts.
On issue No. 4, petitioner is sustained.
Reviewed by the Court.
Decision will be entered under Rule 50.