[393]*393OPINION.
Littleton :
The deficiencies in this case arose as the result of the disallowance by the Commissioner of a part of the depletion claimed in the partnership return filed by the Fern Hollow Gas & Oil Co. for the calendar year 1920, which resulted in an increase in the partnership income and correspondingly an increase in the taxable income of the petitioners, who were two of the partners in the enterprise.
The action of the Commissioner, however, in disallowing depletion is not the issue raised before the Board, it apparently being conceded by petitioners that the foregoing was correct. The error here assigned is, broadly, that the Commissioner has determined the income of the partnership for 1920 to be in excess of what it really was when effect is given to all proper items of income and all allowable deductions.
The problem then is to determine the correct income of the partnership. The parties are, in effect, in accord as to the amounts which were received and disbursed by the partnership during the year 1920, the question being how the various items should be treated for tax purposes.
In order to determine taxable income, it is necessary in any given case to decide first the basis on which income is to be computed, [394]*394since very different results follow when a receipts and disbursements basis is being used as compared with the use of the accrual basis. Section 212(b), Eevenue Act of 1918, provides:
The net income shall be computed upon the basis of the taxpayer’s annual accounting period (fiscal year or calendar year, as the case may he) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made upon such basis and in such manner as in the opinion of the Commissioner does clearly reflect the income. If the taxpayer’s annual accounting period is other than a fiscal year as defined in section 200 or if the taxpayer has no annual accounting period or does not keep books, the net income shall be computed on the basis of the calendar year.
In this case, no books of account (as the term is ordinarily understood) were kept by the partnership, the information for its 1920 return being compiled from check books, canceled checks, pass books, memoranda, etc. This return reflected income on the basis of cash received and disbursed, and also included deductions from gross income on account of depreciation and depletion, the former being allowed in total by the Commissioner and the latter being almost entirely disallowed by him. Similarly, the petitioners’ amended statement of income of the partnership is prepared on the basis of cash received and disbursed, capital items such as purchase of land being taken as a deduction and no depreciation or depletion being claimed.
The petitioners contend in the first instance that income of the partnership should be computed on the receipts and disbursements basis which they have used, wherein capital expenditures are taken as deductions from gross income or, in the alternative, that an accrual method should be followed and the income of the partnership determined upon the basis of the operation of the partnership from the date of its organization in 1920 to the end of its existence in 1924.
Considering, first, the situation with respect to the alternative method. It is not argued by the petitioners that there was sufficient information available in 1920, or any books kept, on which a return could have been prepared on an accrual basis which would have reflected even an approximation of the income which the partnership ultimately produced over its period of operation. It is readily apparent that such a method does show what ultimately resulted from the venture into which the petitioners and the other partners embarked in 1920, in a similar manner that would be true in considering the entire life of any business undertaking. It is, however, peculiar to our Federal revenue laws that the accounting period generally recognized is one year and the income and deductions must be [395]*395determined upon an annual basis. In effect, what the petitioners ask is stated in these words by one of the petitioners in his testimony that “ Our maintenance is now, that we are taking it on the whole to show the amount of profit made in the entire deal.” In other words, the petitioners contend that the Board should consider the operations of the partnership over the period from 1920 to 1924 in determining whether any income was derived in the year 1920 and defer as income of the partnership amounts received in 1920 from the sale of the rights to share in prospective earnings.
Not only are we of the opinion that no statutory authority exists for following this proposal, but also that the accrual method on an annual basis would not result in an allowance of the petitioners’ contention. The principal item which gives rise to the income in question is $51,800 received from the sale of certificates entitling the holders thereof to an interest in the future net earnings, if any, of the partnership. These holders were unlike stockholders in a corporation in that they were merely entitled to share in anticipated net earnings and beyond this they had no voice in the business or right or interest in the property of the partnership prior to or upon dissolution, every obligation of payment to them being discharged when payment was made to them of their share of the net profits when earned and if none were earned they lost entirely. Whatever net earnings may have been derived and distributed in years subsequent to 1920 were deductible from the earnings of the partnership in determining the partners’ distributable shares in such years. It is difficult to conceive of a basis upon which the amount of $57,800 might be deferred over the succeeding years. There was no investment by the partners of the amount of $57,800 nor was there any obligation that they should return this amount or any part of it to the purchasers of the certificates.
That an obligation rested upon the partners to pay out a part of the net profits as earned and that this obligation arose on account of the receipt of the amount of $57,800 from the sale of certificates, is certainly true, but it certainly is not of such a definite character that a reserve could be set up to provide for its amortization over future operation. Concerning the setting up of reserves for contingencies, the Board in the Appeal of Consolidated Asphalt Co., 1 B. T. A. 79, said:
It is quite true that not all amounts received constitute income; but when a taxable corporation in the course of its business of making profits receives contractual compensation for work done and material furnished; it can not contend that a part of the amount received is not income because the taxpayer is subject to a collateral obligation the fulfillment of which may require it to spend some of the amount. This is in substance what we said in the Appeal of William J. Ostheimer, 1 B. T. A. 18, and as we there said, this result is not [396]*396changed because in the light of general experience the taxpayer feels reasonably certain of the necessity to expend the amount and is impelled by business prudence to set up a reserve therefor.
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[393]*393OPINION.
Littleton :
The deficiencies in this case arose as the result of the disallowance by the Commissioner of a part of the depletion claimed in the partnership return filed by the Fern Hollow Gas & Oil Co. for the calendar year 1920, which resulted in an increase in the partnership income and correspondingly an increase in the taxable income of the petitioners, who were two of the partners in the enterprise.
The action of the Commissioner, however, in disallowing depletion is not the issue raised before the Board, it apparently being conceded by petitioners that the foregoing was correct. The error here assigned is, broadly, that the Commissioner has determined the income of the partnership for 1920 to be in excess of what it really was when effect is given to all proper items of income and all allowable deductions.
The problem then is to determine the correct income of the partnership. The parties are, in effect, in accord as to the amounts which were received and disbursed by the partnership during the year 1920, the question being how the various items should be treated for tax purposes.
In order to determine taxable income, it is necessary in any given case to decide first the basis on which income is to be computed, [394]*394since very different results follow when a receipts and disbursements basis is being used as compared with the use of the accrual basis. Section 212(b), Eevenue Act of 1918, provides:
The net income shall be computed upon the basis of the taxpayer’s annual accounting period (fiscal year or calendar year, as the case may he) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made upon such basis and in such manner as in the opinion of the Commissioner does clearly reflect the income. If the taxpayer’s annual accounting period is other than a fiscal year as defined in section 200 or if the taxpayer has no annual accounting period or does not keep books, the net income shall be computed on the basis of the calendar year.
In this case, no books of account (as the term is ordinarily understood) were kept by the partnership, the information for its 1920 return being compiled from check books, canceled checks, pass books, memoranda, etc. This return reflected income on the basis of cash received and disbursed, and also included deductions from gross income on account of depreciation and depletion, the former being allowed in total by the Commissioner and the latter being almost entirely disallowed by him. Similarly, the petitioners’ amended statement of income of the partnership is prepared on the basis of cash received and disbursed, capital items such as purchase of land being taken as a deduction and no depreciation or depletion being claimed.
The petitioners contend in the first instance that income of the partnership should be computed on the receipts and disbursements basis which they have used, wherein capital expenditures are taken as deductions from gross income or, in the alternative, that an accrual method should be followed and the income of the partnership determined upon the basis of the operation of the partnership from the date of its organization in 1920 to the end of its existence in 1924.
Considering, first, the situation with respect to the alternative method. It is not argued by the petitioners that there was sufficient information available in 1920, or any books kept, on which a return could have been prepared on an accrual basis which would have reflected even an approximation of the income which the partnership ultimately produced over its period of operation. It is readily apparent that such a method does show what ultimately resulted from the venture into which the petitioners and the other partners embarked in 1920, in a similar manner that would be true in considering the entire life of any business undertaking. It is, however, peculiar to our Federal revenue laws that the accounting period generally recognized is one year and the income and deductions must be [395]*395determined upon an annual basis. In effect, what the petitioners ask is stated in these words by one of the petitioners in his testimony that “ Our maintenance is now, that we are taking it on the whole to show the amount of profit made in the entire deal.” In other words, the petitioners contend that the Board should consider the operations of the partnership over the period from 1920 to 1924 in determining whether any income was derived in the year 1920 and defer as income of the partnership amounts received in 1920 from the sale of the rights to share in prospective earnings.
Not only are we of the opinion that no statutory authority exists for following this proposal, but also that the accrual method on an annual basis would not result in an allowance of the petitioners’ contention. The principal item which gives rise to the income in question is $51,800 received from the sale of certificates entitling the holders thereof to an interest in the future net earnings, if any, of the partnership. These holders were unlike stockholders in a corporation in that they were merely entitled to share in anticipated net earnings and beyond this they had no voice in the business or right or interest in the property of the partnership prior to or upon dissolution, every obligation of payment to them being discharged when payment was made to them of their share of the net profits when earned and if none were earned they lost entirely. Whatever net earnings may have been derived and distributed in years subsequent to 1920 were deductible from the earnings of the partnership in determining the partners’ distributable shares in such years. It is difficult to conceive of a basis upon which the amount of $57,800 might be deferred over the succeeding years. There was no investment by the partners of the amount of $57,800 nor was there any obligation that they should return this amount or any part of it to the purchasers of the certificates.
That an obligation rested upon the partners to pay out a part of the net profits as earned and that this obligation arose on account of the receipt of the amount of $57,800 from the sale of certificates, is certainly true, but it certainly is not of such a definite character that a reserve could be set up to provide for its amortization over future operation. Concerning the setting up of reserves for contingencies, the Board in the Appeal of Consolidated Asphalt Co., 1 B. T. A. 79, said:
It is quite true that not all amounts received constitute income; but when a taxable corporation in the course of its business of making profits receives contractual compensation for work done and material furnished; it can not contend that a part of the amount received is not income because the taxpayer is subject to a collateral obligation the fulfillment of which may require it to spend some of the amount. This is in substance what we said in the Appeal of William J. Ostheimer, 1 B. T. A. 18, and as we there said, this result is not [396]*396changed because in the light of general experience the taxpayer feels reasonably certain of the necessity to expend the amount and is impelled by business prudence to set up a reserve therefor. In this instance good accounting and the statute may not be in strict accord, since Congress may with entire fairness tax what a very conservative and prudent business man may wish to hold in reserve.
See also Appeal of Uvalde Co., 1 B. T. A. 932, and Appeal of Morrison-Ricker Mfg. Co., 2 B. T. A. 1008.
The second difficulty which arises in the use of the accrual method is that no books of account were kept by the partnership. In the Appeal of John A. Brander, 3 B. T. A. 231, the Board said:
He had no method of accounting, for he kept no books, and, except in an extraordinary case, which does not now come to mind, an accrual method without accounting records is an anomaly. Such a method is inherently an accounting system whereby one is 'enabled not merely to record receipts and payments after they take place but to keep track of his financial rights and obligations under a credit system. Even a simple practice of accruals would require systematic accounting and some sort of bookkeeping. Without records it may generally be concluded that the cash method is being used.
The Board is, therefore, of the opinion that the accrual method is not applicable in determining the income of the partnership and that the entire amount of $57,800 received from the sale of certificates was properly included by the partnership in its return filed and by the Commissioner in his determination as a part of gross income.
Our next consideration is whether the deductions from income contended for by petitioners on the receipts and disbursements basis can be sustained. Under this theory, the material difference between the parties is that the petitioners consider all items of disbursements as deductions from gross income, regardless of their nature, and whether for land, permanent improvements, or additions, whereas the Commissioner contends that capital items are not proper deductions from gross income even on a receipts and disbursements basis. The principal item in controversy here is $11,000, representing the cost of the land. That the amount paid for such an item was a capital expenditure and therefore not deductible from gross income, either on the receipts and disbursements or the accrual basis, is too well established to admit of questioning. (See section 215 (b) of the Kevenue Act of 1918.) In fact, petitioners do not specifically contend that this item and the item of $37,697.70 hereinbefore mentioned were not of a capital nature. The testimony shows that in the item of $37,697.70, the amount paid the contractor for drilling the wells and for equipment, there were certain items of a capital nature which were likewise not deductible from gross income.
In our findings of fact, there is shown an excess of receipts over disbursements of $18,329.03, exclusive of the amount paid for land. [397]*397Included, however, in the deductions which give rise to the foregoing net amount are capital items which are not allowable deductions, and no amount is shown among the deductions for depletion or depreciation to which the partnership is apparently entitled. In the original return as considered by the Commissioner certain capital items here claimed as deductions were not so included and depreciation and depletion were allowed as deductions.
The evidence is insufficient to show whether by the proper exclusion of the capital item and the allowance of the depreciation and depletion to which the partnership is entitled the income of the partnership would be more or less than that determined by the Commissioner.
Judgment will be entered for the respondent.
Arundell, GiíeeN, and Phillips dissent.