Rev. Rul. 60-19

Advice has been requested as to the effect of the decision in Earl V. Whitwell el al. , v. Commissioner , 257 Fed.(2d) 548 on the position of the Service regarding equalization payments for unitized oil and gas properties.

In the case of Earl V. Whitwell et al. , the taxpayers, originally the owners of undivided oil and gas lease interests, owned interests in three separate unitized production units. These units were incorporated into a larger unitized production unit on April 15, 1950, by order of the Louisiana Commissioner of Conservation, and the taxpayers were given a participating share in the larger unit. In order to equalize the development costs of the entire unitized property, a determination was made of the total costs of the wells. According to their percentage participation, each participant was charged with his share of the costs. As an offset, each of those participants who had wells upon his acreage was credited with the costs related to that acreage. This computation resulted in some participants being creditors and others debtors. The taxpayers, who had made substantial developments on their acreage, were ascertained to be creditors. Instead of receiving cash as an equalizer from the debtor participants, the taxpayers received the right to net oil payments.

The Tax Court of the United States held that such payments received during the year 1950 were taxable as ordinary income subject to depletion. 28 T.C. 372. The Court of Appeals for the Fifty Circuit reversed the Tax Court by holding that the taxpayers received a return of their capital investment and not taxable income. The court stated, `the payment to petitioners of the equalization money by the purchaser of the oil and gas, as agent and paymaster for the owners, petitioners' debtors, was merely a convenient arrangement to all concerned for the payment to them of their debt and the return to them of their capital investment.' This position seems to turn upon the question of whether the equalization payments made to the taxpayers were in fact oil payments.

In order to be an oil payment there must be no liability to make any payment other than the income realized from the oil production. This is ordinarily made plain by a statement that the payment is to be made only out of oil. However, there is nothing in the record to indicate that the debtor participants in the unitization were relieved of personal liability to the taxpayers if the oil production has been insufficient for payment. This silence of the record indicates that the payment out of oil was merely a method of payment and not a complete satisfaction of the debt by the assignment of a property right. Hence, the equalization payments were not true oil payments.

In view of the above, the decision of the Court of Appeals, insofar as it refused to characterize the right to receive income from oil production as an oil payment, will be followed in all similar cases in which the recipient does not have to look solely to the income from production of the oil to satisfy the obligation or debt.