VALUE OF PROPERTY RECEIVED FOR SERVICES TO JOINT VENTURE IS TAXABLE INCOME.

             UNITED STATES COURT OF APPEALS FIFTH CIRCUIT

The arrangement proved successful, and it was evident in the early part of 1955 that Wheless and Woolf would fully recover their costs and expenses by the end of November of that year. In April 1955, the 1951 contract was terminated, and by contract dated April 20, 1955, all the properties acquired under the earlier arrangement were transferred to the W.W.F. Corporation, a Delaware corporation formed specifically to acquire these properties in return for the issuance of debentures to Wheless and Woolf and of stock to Wheless, Woolf, and Frazell. Frazell received 6,500 shares of W.W.F. stock (13% Of the total issued), having a fair market value of $ 91,000.00, but he included no part of this amount in his 1955 income tax return. The Commissioner ruled that the $ 91,000.00 should have been included in income and assessed a deficiency, which Frazell paid under protest and seeks to recover here.

Frazell contends that he received the W.W.F. stock in a tax-free exchange within the terms of section 351(a), Internal Revenue Code of 1954. That section provides:

     'No gain or loss shall be recognized if property is transferred

It is fundamental that 'compensation for services' is taxable as ordinary income under the Internal Revenue Code of 1954. I.R.C.1954 Section 61(a)(1). This principle applies whether the one compensated for his services is an employee receiving a salary, fees, or commission (ibid.), one receiving corporate securities ( I.R.C.1954 Section 351(a)), or a 'service partner' receiving an interest in the partnership. ( I.R.C.1954 Section 721; Treas.Reg. Section 1.271-1(b) (1)).

The regulation pertaining to partnerships provides that

     'the value of an interest in such partnership capital so

The applicable rule is in no way changed by Frazell's contention that his interest in the enterprise was a 'carried interest.' There are three recognized varieties of 'carried interest,' and each 'may be created under varied circumstances, e.g., * * * as compensation for services rendered, e.g., by a geologist. * * *' Williams & Meyers, Oil and Gas Law, vol. 2, Section 424 (1959). The interest created by the 1951 contract most nearly fits into the 'Menahan' category of 'carried interests;' that is, 'a springing executory interest * * * conveyed by the carrying party (Wheless and Woolf) to the carried party (Frazell), such interest to become possessory upon the satisfaction of * * * (the carrying party's) costs.' Williams & Meyers, op. cit. supra Section 424.1, p. 423. Even if Frazell is taken to have had some sort of interest in the properties in question from their first acquisition, his interest would not have become possessory until November 1955. Under Treasury Regulation Section 1.721-1(b)(1), the value of that interest would have been taxable to him at that time. See also Anderson & Coffee, 'Proposed Revision of Partner and Partnership Taxation: Analysis of the Report of the Advisory Group on Subchapter K,' 15 Tax L.Rev. 285, 318 (1960).

The fact that the contract was terminated prior to November 1955 should have no effect on the tax consequences of Frazell's arrangements. The transactions of April 1955 may be viewed in either of two ways: (1) If Frazell's partnership interest became possessory immediately upon the termination of the 1951 contract, so much of that interest received as compensation for services was taxable to him under the rule of Treasury Regulation Section 1.721(b)(1). Thereafter, the transfer of his interest for W.W.F. stock was tax-free under section 351(a). (2) If the $ 91,000.00 of W.W.F. stock was given in substitution for the partnership interest originally contemplated, so much of that stock received in compensation for services was taxable to Frazell under section 351(a). As either view of the 1955 transactions results in ordinary income to Frazell there is noreason for us to split hairs and choose between them.

This is not to say that the full $ 91,000.00 is ordinary income. The trial court found that, just as Wheless and Woolf contributed large amounts of capital, 'Frazell supplied to the venture a very valuable oil map which was his private property.' 213 F.Supp. at 461. Indeed the record shows that prior to entering into the 1951 contract Frazell had acquired several maps which apparently proved very helpful to the work of the venture. Among the reasons given by Mr. Wheless for desiring to employ Frazell was that 'he had accumulated maps, geological data and various information that was valuable to the arrangement that it would have taken a long time for someone else just moving into the territory to accumulate.' And Frazell himself testified that he 'had contributed considerable information and maps which resulted in the discovery and production of oil. * * *' Although it is clear that the greater part of the 13% Interest received by Frazell was received as compensation for services, the court's finding and the cited testimony suggest that some part of that interest might have been received in return for 'property;' namely, the maps. That part of the property Frazell received in 1955 attributable to his contribution of maps is not taxable in 1955 no matter whether we view the interest received as a partnership interest vesting on the termination of the 1951 contract ( I.R.C.1954 Section 721) or as shares of W.W.F. stock given in substitution therefor. ( I.R.C.1954 Section 315(a)). See Treas.Reg. Section 1.351-1(2), example 3; Mertens, The Law of Federal Income Taxation, vol. 6, Section 35.37, pp. 108-09.

Before the nonrecognition rule can be applied to the maps in this case, however, two factual determinations must be made: (1) Did Frazell contribute the maps in question to the oil venture or did he keep them as his own personal property? (2) If he contributed them to the venture, what was their value at the time they were contributed? As the burden of proof on both of these issues lies with the taxpayer, it might be argued that he is foreclosed in these issues because of the silence of the record on these points. However, we prefer to remand the case to the district court to permit it to make findings on these two issues. This disposition is in accord with the action of this court in a number of recent cases. E.g., Bisbee-Baldwin Corp. v. Tomlinson, 5 Cir. 1963, 320 F.2d 929.

The judgment is therefore reversed and the case remanded to the district court to determine whether the maps introduced at the original trial were contributed by Frazell to the oil venture created by the 1951 contract. If the court finds that the maps were so contributed, it shall determine their value as of the time of their contribution. Such part of $ 91,000.00 as exceeds the value of the maps as determined by the trial court is properly taxable to Frazell as ordinary income. ²

Reversed and remanded.

² The parties have stipulated that the initial computation of any refund that may be due will be made by the Internal Revenue Service. It is expected that such computation will be made in light of all relevant Code provisions, including section 1301.

HUTCHESON, Circuit Judge (dissenting).

This is an appeal from a judgment of Judge Dawkins in a taxpayer's suit for refund. The judgment is based upon a careful opinion by Judge Dawkins, reported in 213 F.Supp. 457. I was, and am, of the opinion that we should affirm per curiam on that opinion.

The district court's determination was that the transaction which gave rise to the litigation was a tax free exchange of property for stock within the meaning of Sec. 351(a) 1954 Code, and the attack of the appellant on the opinion and judgment largely turns on Louisiana law.

It seems to me that the district judge's opinion is incontrovertible, that the contentions of the appellant are technical and unsubstantial, and that the majority opinion is not a correct statement of the law. I, therefore, dissent from it.