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A5

1924

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INVESTIGATION OF BUREAU OF INTERNAL REVENUE

MONDAY, FEBRUARY 23, 1925.

UNITED STATES SENATE,

SELECT COMMITTEE TO INVESTIGATE
THE BUREAU OF INTERNAL REVENUE,

Washington, D. C.

The committee met at 10 o'clock a. m., pursuant to call of the chairman.

Present: Senators Couzens (presiding), Ernst, and Jones of New; Mexico.

Present also: Mr. L. C. Manson, of counsel for the committee; Mr. L. H. Parker, chief engineer for the committee; and Mr. A. H. Fay, consulting engineer for the committee.

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Present on behalf of the Bureau of Internal Revenue: Mr. A. W. Gregg, special assistant to the Secretary of the Treasury; Mr. C. R. Nash, assistant to the Commissioner of Internal Revenue; Mr. S. M. Greenidge, head engineering division, Bureau of Internal Revenue; and Mr. W. N. Thayer, chief oil and gas section, Bureau of Internal Revenue.

The CHAIRMAN. You may proceed, Mr. Manson.

Mr. MANSON. The matter to be presented this morning deals with discovery values allowed to the Gypsy Oil Co., one of the subsidiaries of the Gulf Oil Corporation.

The principal feature brought out is the market price of oil used. as the basis for these valuations. The regulations do not specify what price of oil should be taken to determine valuations for discov ery. The customary practice, however, in the department, has been to utilize the posted price of oil at or within 30 days after discovery, although there are instances, as in this case, where discovery. prices have been used. In the instance cited herein the taxpayer made discoveries when the price of oil was low, and in order to obtain a higher oil-depletion unit he has assumed that the price depression. can not last long, and has therefore taken what he calls an average price of the preceding months and utilizes this in setting up his valuation. Whenever peak prices prevail, he takes advantage of these prices, as will be shown in this discussion.

I will now ask Mr. Fay to present the details.

STATEMENT (RESUMED) OF MR. A. H. FAY, CONSULTING
ENGINEER FOR THE COMMITTEE

Mr. FAY. Mr. Chairman, I have listed here 10 or 12 leases in the Oklahoma field, wherein the taxpayer has actually used what he considered the average price of oil in the previous few months.

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The CHAIRMAN. How many months?

Mr. FAY. He does not specify.

The CHAIRMAN. Has there been any check up on the part of the bureau to ascertain what months were taken?

Mr. FAY. No; not so far as this case was concerned, Mr. Chairman. I have written one lease up here pretty much in detail, and then as to the rest of them I have simply added them more or less as exhibits, so that there would not be a repetition of the details. first one covers two pages of detail, and I will give that.

The taxpayer, in making his claim for discovery, states-
Mr. MANSON. You might state what this is.

This

Mr. FAY. This is the A. Focht lease, No. 682, well No. 5, Chandler, Battlesville sand, Cushing and Shamrock districts, Oklahoma. The CHAIRMAN. Who was the lessee in that case?

Mr. MANSON. The Gypsy Oil Co.

Mr. FAY. The Gypsy Oil Co.

The CHAIRMAN. You did not state that, and I thought we ought to have it in.

Mr. FAY. Yes; the Gypsy Oil Co., a subsidiary of the Gulf Oil Co. The taxpayer, in making his claim for discovery, states that the well was completed on June 30, 1916. The log record of this well, filed by the taxpayer, states that drilling commenced on May 19, 1916; that drilling was finished on August 4, 1916, and that the well began producing on August 4, 1916. Notwithstanding this, the date of discovery is placed as of June 30, 1916.

The CHAIRMAN. Will you state right there what is the date of discovery of an oil well?

Mr. FAY. I should say that is when it shows a production sufficient to be of commercial importance.

Mr. MANSON. Is not that so defined under the regulations?

Mr. FAY. The regulations define a discovery valuation as one that shows a disproportionate value as between cost and a value estimated on the basis of the production.

Mr. MANSON. So, until that is shown, there is no discovery within the meaning of the regulations?

Mr. FAY. There would not be; no.

The CHAIRMAN. I would like to ask Mr. Gregg, as he is familiar with the oil situation, what his interpretation is of when an oil well is discovered.

Mr. GREGG. I should say when oil is brought in in such quantities as to make its value as of that date materially disproportionate to its cost. I think the act makes that interpretation necessary. It describes the discovery of an oil well as increasing its value to such an extent that the discovery value is disproportionate to the cost. That is the date of discovery.

Mr. FAY. I think that is fairly well brought out in the regulations and in the case just cited.

Mr. MANSON. As I understand it, in this case the well began producing on August 4, yet the date of discovery is fixed as of June 30. Mr. FAY. Yes.

Mr. MANSON. Go ahead.

Mr. FAY. The price of oil on June 30, 1916, was $1.55 per barrel. On July 30, $1.50 per barrel; on August 4, the date of first production, $1.15 per barrel; and on September 4, 30 days later, 90 cents

per barrel. In setting up this discovery valuation, as well as a number of others at about this time, the taxpayer explained why he uses what he calls the average price of oil as a basis for discovery valuation. The CHAIRMAN. What was the price they used in arriving at the average?

Mr. FAY. $1.49.

Mr. GREGG. May I ask a question there so as to keep it straight as we go along?

The CHAIRMAN. Yes, Mr. Gregg.

Mr. GREGG. You say they used $1.49.

Mr. FAY. Wait a minute.

Mr. GREGG. I did not get the values as of the different dates.

Mr. FAY. The price of oil on June 30, 1916, was $1.55 per barrel; on July 30, $1.50 per barrel; on August 4, the date of first production, it was $1.15 per barrel, and on September 4, 30 days later, 90 cents per barrel. In setting up this discovery valuation, as well as a number of others at about this time, the taxpayer explains why he uses what he calls the average price of oil as a basis for discovery valuation, Exhibit 1. Apparently the only time that the taxpayer uses the average price of oil is when the price of oil is exceedingly low. Then the average price for a period of months is considerably above the market price. No cases have been found as yet where the taxpayer considered using the average price of oil when a discovery well came in at a peak price. He very carefully utilizes the peak prices when there is a possibility of a drop and he uses the average price of oil after the drop has occurred. In this way he secures the advantage of the peak prices for discovery valuations, but is not willing to accept the low prices for the same purpose. In order to be consistent, he should either use the average price for all valuations, or in the event that he uses the market price of oil for valuation purposes, he should use the market price as of that date and no other price.

Mr. MANSON. Let me interrupt you at this point. You refer here to what the taxpayer does. I believe you have already stated that in all of the Gulf Oil Co. valuations the taxpayer's figures were accepted by the bureau.

Mr. FAY. They were.

In the present case of Focht lease, well No. 5, Chandler, the average price for oil for six months prior to August 4, 1916, was $1.4912 per barrel, and for nine years previous to December, 1915, the price had ranged from 26 cents to $1.03, with only eight months in the nine years, when the price was $1 or more per barrel. For five months after the discovery, or until December 31, the price varied from 90 cents to $1.15 per barrel, which is above the average nineyear price. Beginning with January, 1917, the price was $1.62 and gradually increased until it reached $3.50 in December, 1920, and in March, 1921, it again dropped to $1.75. The taxpayer has used in this instance $1.50, which is approximately the average for six months and the actual quotation as of July 30, 1916. He has dated his discovery back to June 30, 1916, when, as a matter of fact, the well was completed and production began on August 4, 1916, at which time the price was $1.15.

Cost of discovery well: Another point to take into consideration in connection with this well is the matter of cost of the discovery well. The taxpayer considers that one more well will have to be drilled to

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