REYNOLDS v. McMURRAY, 60 F.2d 843

PHILLIPS, Circuit Judge. Donald McMurray brought this action to reeover alleged over-payments of income taxes, with interest, for the years 1920, 1922, and 1924. The stipulated facts aro as follows: On December 7, 1917, W. M. Armstrong and the Ohio Oil Company owned oil leases on certain lands in Wyoming in the proportion of 40% and 60% respectively.

On that date they entered into agreements with respect thereto which provided that the Ohio Company should manage, control, develop, and operate such leases, and should immediately drill a well thereon at its own expense; that after the completion of the first well the Ohio Company should continue to manage, control, develop, and operate the leases and pay all costs incident thereto, and should charge Armstrong’s undivided interest with its proportionate part thereof; that it should market the oil and gas produced and account to Armstrong for his proportionate part thereof; that it should he reimbursed by Armstrong from the proceeds derived from the sale of his proportionate part of the oil and gas, to be effected by crediting Armstrong’s account with the Ohio Company, on the first of each month, with the proceeds derived from the sales during the month preceding of his proportionate part of the oil and gas; and that it should make monthly remittances to him of his proportionate share of any proceeds remaining after deducting the amounts duo it for expenditures made by it for him.

On December 21, 1917, Armstrong assigned an undivided portion of his interest in the leases to Will McMurray. Thereafter the Ohio Company carried an account on its books, in accordance with such agreements, covering Will McMurray’s share in the expense of the development and operation of such leases and the revenue therefrom. The latter died intestate on February 3, 1925, and plaintiff is his sole heir at law. The Commissioner made deficiency assessments against Will McMurray for 1920,1922, and 1924.

His administrator paid such deficiencies under protest, and duly filed claims for refund thereof, which were rejected. Such deficiencies were based wholly upon the income of Will McMurray arising out of the production of oil and gas by the Ohio Company on such leases. The Commissioner, in recomputing the taxes for the years in question, included the entire amount credited to Will McMurray on the books of the Ohio Company in his gross income and allowed deductions for business expense, depletion, and depreciation.

The question presented by this appeal is whether that portion of Will MeMurray’s share of the receipts from such leases applied to reimburse the Ohio Company for expense of development and' operation, less proper deductions, was income to Will McMurray for the years involved, and therefore subject to the tax. Counsel for plaintiff contend that such amounts were not income to Will McMurray because profits to him were contingent upon the leases producing revenue in excess of the cost of development and operation.

Where one co-owner makes advances for the benefit of the other, to be repaid from earnings from the property before any division of profits is to be made but without personal obligation on the part of the other to repay such advances, thus making them subject to the risks of the business, the co-owners are joint adventurers in the operation of the property. Nelson v. Lindsey, 179 Iowa, 862, 162 N. W. 3.

If the agreements in the instant ease could be construed to be a relinquishment of the rights which Armstrong had in such leases in return for a percentage in the net profit, then plaintiff’s contention would have merit. But such was not the effect of the agreements.

They provided that the Ohio Company should account to Armstrong not for net proceeds but for his proportionate part of the oil and gas produced and sold; that it -should charge Armstrong’s undivided interest with its proportionate part of the expenses; and that it should be reimbursed out of the proceeds derived from the sale of his proportionate part of the oil and gas. The purpose of the agreements was to facilitate development; not to transfer title. The title of the respective owners remained as before.

It follows that Armstrong, the Ohio Company, and Will McMurray were co-owners of the leases and joint adventurers in the operation of such leases, and the income produced therefrom was the income of all. Ferry Market, Inc., v. Commissioner, 5 B. T. A. 167; Dickey v. Commissioner, 14 B. T. A. 1295; Glenmore Securities Corp. v. Commissioner, 24 B. T. A. 697.

While the obligations of Armstrong and Will McMurray, as his assignee, to reimburse the Ohio Company were contingent and limited to payment from a particular source, they became certain and fixed to the extent of the full amounts charged against them when the receipts from the leases equaled the expenses incurred by the Ohio Company. • A part of the advances made and expended by the Ohio Company under the agreements was business expenses and a part was capital expenditures.

It is true that, had development of the leases -not resulted in commercial wells, there would have been no capital improvements in fact, no obligation on the part of Will McMurray to pay therefor, and no income to him (Bliss v. Commissioner (C. C. A. 5) 57 F.(2d) 984); but, when such development did result in commercial wells, there was a capital improvement, forty per cent, of which accrued to Armstrong and Will McMurray, and they derived income from the leases as a result thereof. The agreements did not constitute a present transfer of an interest in the leases.

They authorized the Ohio Company to receive and apply to its claim moneys accruing to Armstrong and Will McMurray. They were: agreements to pay in the future from a particular source. Under each of the several applicable Revenue Acts the tax is imposed by force of the statute itself (United States v. Nashville, C. & St. L. Ry. (C. C. A. 6) 249 F. 678) immediately when the income is derived, actually or constructively, and the tax attaches before such income passes from the recipient by a transfer to take effect in the future. Rensselaer & S. R. Co. v. Irwin (C. C. A. 2) 249 F. 726; Northern R.

Co. of New Jersey v. Lowe (C. C. A. 2) 250 F. 856; Hamilton v. Kentucky & I. T. R. Co. (C. C. A. 6) 289 F. 20; Leydig v. Commissioner (C. C. A. 10) 43 F.(2d) 494; Lucas v. Earl, 281 U. S. 111, 50 S. Ct. 241, 74 L. Ed. 731. See, also, Corliss v. Bowers, 281 U. S. 376, 50 S. Ct. 336; 74 L. Ed. 916. Counsel for plaintiff further contend that- the amounts of Will MeMurray’s share applied to reimburse the Ohio Company were not income to him because they were not received by bim or placed at his disposal. But it was not necessary that his share of the proceeds he paid to him personally to render it subject to the tax.

Profits which would constitute income if paid directly to a person are also income to him if paid, pursuant to his agreement, to a third person to discharge his obligation to such third person. Old Colony Trust Co. v. Commissioner, 279 U. S. 716, 49 S. Ct. 499, 73 L. Ed. 918; United States v. Boston & Maine R. Co., 279 U. S. 732, 49 S. Ct. 505, 73 L. Ed. 929; Blalock v. Georgia R. & E. Co. (C. C. A.) 246 F. 387; Rensselaer & S. R. Co. v. Irwin, supra; Washington Market Co. v. Commissioner, 25 B. T. A. 576.

The Ohio Company acted as Will MeMurray’s agent in applying to his account the proceeds from the sales of his share of the oil and gas produced (Ferry Market, Inc., v. Commissioner, supra), and thereby discharged, in accordance with such agreements, his obligations to it. Will McMurray and Armstrong derived benefits therefrom in that the amounts credited on their accounts paid in part for capital expenditures, which resulted in the development of such leases and increased the value of their interests therein.

We therefore conclude that the method used by the Commissioner in arriving at the tax liability was correct. We do not however undertake to pass on the correctness of the items. The issues as to them will have to be determined by the trial court. The decree is reversed and remanded with instructions to grant tho Collector a new trial.