                         T.C. Memo. 1998-271



                       UNITED STATES TAX COURT



    SAMSON INVESTMENT COMPANY AND SUBSIDIARIES, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 20424-96.              Filed July 27, 1998.



     C.F. Allison, Jr., Michael V. Powell, and Alex D. Madrazo,

for petitioner.

     Avery Cousins III, Thomas R. Lamons, Donna Mayfield Palmer,

and Sandra K. Robertson, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION

     VASQUEZ, Judge:    Respondent determined the following

deficiencies in and penalties on petitioner's Federal income

taxes:

         Tax Year                          Penalty
          Ended           Deficiency     Sec. 6662(a)

     June 30, 1990        $2,473,392         $98,935
     June 30, 1991        12,772,856       1,018,275
                               - 2 -


     June 30, 1992       11,493,555        911,504
     June 30, 1993       10,717,851      1,401,649

     Unless otherwise indicated, section references are to the

Internal Revenue Code in effect for the years in issue.    All Rule

references are to the Tax Court Rules of Practice and Procedure.

     After concessions, the issues for decision are:

     1.   Whether sections 3821 and 383 bar the use of Continental

Drilling Co.'s (CDC) net operating loss (NOL) and investment tax

credit (ITC) carryforwards by Samson Investment Co. and its

subsidiaries (Samson, the Samson group, or petitioner) in

petitioner's taxable years ending June 30, 1990 through 1993;

     2.   whether drilling rigs and related equipment owned by CDC

and Eason Drilling Co. (Eason) were subject to depreciation under

section 167 in petitioner's taxable years ending June 30, 1990

through 1993; and

     3.   whether petitioner is liable for penalties for

substantial understatements of its tax liability for the taxable

years ending June 30, 1990 through 1993.2



                         FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

The stipulation of facts and the attached exhibits are



     1
        References to secs. 382 and 383 and the regulations
thereunder are to the Internal Revenue Code and applicable
regulations in effect on Dec. 31, 1986.
     2
        Respondent has determined penalties only with respect to
the sec. 382 and sec. 383 issues.
                                - 3 -


incorporated herein by this reference.    At the time the petition

was filed, Samson's principal place of business was located in

Tulsa, Oklahoma.

     On December 31, 1986, Samson acquired all the stock of CDC

(the change of ownership).   From 1981 through 1986, CDC had

generated NOL's from its contract drilling business.    On its

consolidated Federal income tax returns for the taxable years

ended June 30, 1990 through 1993, Samson deducted the NOL

carryforwards generated by CDC prior to the change of ownership

against other income of the Samson group.

Definitions and Industry Conditions

     The operator of an oil or natural gas well has the right to

drill the well.    It is generally an owner of a working interest

in the well and thus has an economic interest in the well.     A

drilling contractor usually owns one or more drilling rigs, and

it contracts with an operator to drill a well.    It drills a hole

at a particular location to a depth specified under an agreement

with the operator and typically prepares a daily drilling report

of its progress in drilling the well.    Often a drilling

contractor acquires working interests in oil and natural gas

wells in payment, or partial payment, for its drilling services

or in order to generate an additional source of cash-flow to

supplement its income from drilling operations.

     Operators are reluctant to hire drilling contractors whose

rigs have not been adequately maintained because such rigs might

require extensive, costly, and time-consuming repairs during
                               - 4 -


rig-up and drilling operations.    A well-maintained rig also has a

higher resale value.   A rig crew of 16 to 18 people is required

to operate a deep well rig.

     The oil and gas industry historically has ups and downs,

with periods of favorable market conditions (boom periods) and

unfavorable market conditions (bust periods).   One boom period

began in 1973 when OPEC cut oil production, increased crude oil

prices approximately 70 percent, and established an embargo on

oil sales to the United States.    Spurred on by rising oil prices,

the U.S. domestic oil and natural gas exploration and production

industry achieved several years of unprecedented levels of

drilling activity.   As a result of rising oil and natural gas

prices, Congress' authorization of the construction and filling

of the Strategic Petroleum Reserve, harsh winter conditions in

1976-77, deregulation of certain deep natural gas, and record

demand for oil and natural gas, oil and gas drilling activities

continued to expand through the late 1970's and into the 1980's.

CDC's Organization, Business Plan, and Financing

     J.D. Allen and Carl W. Swan organized CDC as an Oklahoma

corporation on October 27, 1980.   Messrs. Allen and Swan have a

history of involvement in oil and gas activities.   Edwin D.

Arnold joined CDC as president at the time of its incorporation.

Mr. Arnold had worked over 25 years in the oil and gas drilling

business before joining CDC.

     CDC engaged in the contract drilling of oil and gas wells.

Initially, CDC planned to design and construct a standardized
                                - 5 -


fleet of 42 deep well drilling rigs, utilizing the most modern

equipment in the industry.   In 1981, CDC placed orders for the

components needed to fabricate 42 rigs, at a total purchase price

of $263 million.   During 1981 and 1982, CDC completed fabrication

of 22 drilling rigs.   Drilling rigs are highly complex pieces of

equipment that require extensive and frequent maintenance to

remain operational.    At its peak in 1981 and 1982, CDC had more

than 500 employees.

     To fund the construction of its new rig fleet, CDC secured

purchase money financing from sellers of rig components, obtained

standard bank financing, and entered into sale-leaseback

arrangements.   In 1981, CDC entered into transactions with

Metromedia, Inc. (Metromedia), and Atlantic Richfield Co. (ARCO).

CDC sold 10 of its new drilling rigs to Metromedia and ARCO and

then leased the rigs from the purchasers.   These lease agreements

(safe harbor leases) were supported by letters of credit.     Under

the terms of the safe harbor leases, CDC was required to maintain

its corporate existence and maintain insurance against

customarily insured losses and could not dispose of substantially

all of its assets.

     In December 1981, CDC established a deposit account with

First National Bank of Seattle (Seattle-First), as required by

the letter of credit agreement related to the ARCO safe harbor

lease.   As the tax benefits accrued to ARCO, the amount required

to secure the tax benefits declined, and funds were released to

CDC (or later placed in a cash collateral account).
                               - 6 -


     On August 17, 1981, CDC entered into a sale and leaseback

financing transaction (the equipment lease agreement) with

Greyhound Leasing & Financial Corp. (Greyhound).   Pursuant to

this transaction, CDC sold two rigs to Greyhound and then leased

the rigs from Greyhound under capital leases which expired in

1988.

     During the first quarter of 1982, CDC entered into a safe

harbor lease agreement with Texas Oilfield Supply (TOS) for the

sale of tax benefits on three rigs.    TOS was an equipment supply

company with which CDC contracted for the purchase of major

components used in the fabrication of its rig fleet.

     On January 26, 1982, CDC entered into a new $90 million loan

agreement ($70 million term and $20 million revolving credit

agreement) with Penn Square Bank, N.A., Chase Manhattan Bank,

N.A., Continental-Illinois, Seattle-First, and other banks (the

bank group).   Pursuant to the loan agreement, CDC granted the

bank group liens on and security interests in (1) 13 drilling

rigs; (2) drilling equipment, drill pipe, machines and equipment;

(3) CDC's inventory of parts and supplies; (4) CDC's accounts

receivable from its drilling rigs; and (5) CDC's contract rights.

CDC entered into a restated loan agreement with the bank group on

February 1, 1983.   The restated loan agreement between CDC and

the bank group required CDC to maintain a cash collateral

account, referred to as a special collateral account (SCA).    CDC

was required to deposit 75 percent of its monthly cash-flow into
                               - 7 -


this account.   The SCA also served as additional security for

CDC's notes payable to the bank group.

     In July 1982, CDC hired William J. West, Jr., to assist with

the financial operations of CDC.    CDC authorized Mr. West to

execute contracts and other instruments on behalf of CDC as

necessary to conduct the business affairs of the corporation.      On

October 19, 1982, Mr. West was elected financial vice president

and assistant secretary of CDC.    On September 7, 1983, CDC and

Mr. West entered into the first of a series of employment

agreements.

CDC's Operations

     Before petitioner's acquisition of CDC on December 31, 1986,

CDC's main financial and accounting office was located in

Oklahoma City, Oklahoma.   CDC owned and operated three rig yards

located at Owentown, Texas, Victoria, Texas, and Elk City,

Oklahoma.   The Owentown rig yard was the main field operations

office of CDC, where Mr. Arnold maintained an office until

sometime in 1986.

     CDC acquired working interests in oil and natural gas

properties.   CDC reported income from these working interests in

the amounts of $183,408 in 1982, $68,495 in 1983, $130,900 in

1984, $60,991 in 1985, and $30,692 in 1986.

Drilling Activities

     From its incorporation through July 1984, CDC drilled 48

deep wells.   CDC drilled these wells primarily in Oklahoma,

Texas, and Louisiana; the wells ranged in depth from 10,000 feet
                                - 8 -


to over 20,000 feet.    CDC used each of its rigs to drill at least

one well.

     On April 26, 1982, CDC settled a lawsuit with Conoco, Inc.,

for trademark/tradename infringement.   Under the settlement, CDC

agreed to engage in no business other than contract drilling for

a period of 10 years.

     The rigs owned by CDC at the time of the Samson acquisition

were "deep well rigs", which were intended to drill wells deeper

than 12,000 feet.   During drilling operations, CDC required its

drilling rig crews to perform periodic maintenance on their

operating rigs consistent with industry practice.

Economic Downturn

     Oil and natural gas production is a high-risk business that

is driven by the price that can be obtained for the oil or

natural gas being produced.   The boom period of the late 1970's

and early 1980's saw prices for deep natural gas soar from $1.20

per MCF (thousand cubic feet) to over $11 per MCF.   As the

difference between deep gas and other gas increased, there was

increased exploration for deep natural gas that resulted in a

dramatically increased demand for rigs capable of drilling deep

wells.

     In 1982, the drilling market entered a bust period.   The

price for deep natural gas produced from new wells began to drop.

Deeper wells are more expensive to drill, and with the fall in

the prices of oil and natural gas, operators had difficulty in

paying the higher drilling rates necessary to make it economical
                                - 9 -


to drill with deep rigs.    As a result of the decrease in the

price of deep natural gas, the amount of exploration and drilling

for deep natural gas declined sharply.    The number of deep

drilling contracts entered into throughout the oil and gas

industry dropped rapidly.    Deep well drilling activities led this

decline as the price difference between deep gas and other gas

narrowed.

     Although there were relatively few deep wells drilled during

1986 and 1987, some operators were willing to enter into new

contracts to drill deep wells, but generally only on terms that

required drilling contractors to bid at rates below their actual

cost or on a turnkey basis, which placed the economic risk of the

drilling operation on the drilling contractors.

     On November 3, 1983, CDC began drilling a well that it had

taken over from another company.    Due to problems encountered in

drilling the well, it lost money on the job.    After it completed

drilling this well in July 1984, the rig was released.    After

July 1984, CDC drilled no wells before the Samson acquisition.

     After July 1984, CDC employed no rig crews.    It was standard

practice in the contract drilling business to lay off rig crews

when a rig was not on a contract and to rehire them when the rig

returned to drilling operations.    Experienced rig hands would

have been readily available had CDC obtained a profitable

drilling contract.   CDC hired its former toolpushers and rig

supervisors to provide security for its rigs in order to keep

quality drilling personnel readily available to operate the rigs
                                - 10 -


when the drilling market became more favorable.    All of CDC's

original drilling rigs were stacked after July 1984.    After the

boom period of the early 1980's ended, it was industry practice

for drilling companies to stack their deep rigs for long periods

before they were able to use those rigs again.

     Companies owning smaller rigs for use in drilling shallow

wells were better suited than CDC to the demands of the market in

the mid-1980's.    In fact, industrywide, only 7 percent of deep

rigs were working in 1986.    From 1984 through 1987, there were

very few drilling contracts available.    During this time, wells

were drilled by contractors pursuant to long-term contracts

entered into before the decline or by contractors willing to

drill at a loss in order to generate cash-flow and keep rigs

together.

     In 1982, due to industry conditions, equipment manufacturers

reduced their production of new rig components.    A main source

for components became "used" rigs and rig equipment.    Rig buyers

could, and some did, generate profits by purchasing a complete

rig and then reselling the components.    CDC never cannibalized

its rigs or sold them piecemeal; to do so would have required a

large startup time before a rig could be used for drilling.

There were no sales of CDC's rigs from January 1, 1986, through

June 30, 1987.

Effect of Economic Downturn on CDC

     On December 31, 1981, CDC had a working capital deficit of

$19,207,000.     As of December 31, 1981, CDC had total liabilities
                              - 11 -


of $100,357,000, including $43,859,000 owed to the bank group.

Beginning in 1982, CDC was unable to meet its scheduled principal

and interest payments to the bank group.    On December 31, 1982,

CDC was highly leveraged with a debt-equity ratio in excess of 9

to 1.

     CDC's financial difficulties increased in 1982 as the demand

for drilling dropped.   During 1982 and 1983, CDC canceled

purchases, ceased construction of additional drilling rigs, and

commenced negotiations with its lenders.    The decrease in CDC's

cash-flow from drilling operations impeded its ability to service

or refinance its bank loans, which in July 1982 totaled

approximately $85 million in principal.    CDC found it necessary

to restructure its financing arrangements with the bank group and

executed a restated loan agreement dated February 1, 1983.

     In April 1983, due to cash-flow difficulties, CDC stopped

making the monthly payments required under its sale and leaseback

financing arrangement with Greyhound.    It then attempted to

restructure the terms of the Greyhound agreement.    On August 30,

1983, after these attempts failed, CDC agreed to a voluntary

repossession of two rigs by Greyhound.

     On August 1, 1983, CIT Corp. (CIT), one of CDC's equipment

lenders, foreclosed on certain equipment.    CDC had defaulted on

its notes to CIT in the total amount of $381,096.

     By September 6, 1983, CDC realized that, because of cash-

flow problems, it could not meet its October 1983 interest

payment to the bank group under the restated loan agreement.
                               - 12 -


Therefore, CDC began negotiations with the bank group again to

restructure and refinance its debt.     On April 13, 1984, the bank

group applied $3,126,316.96 of funds in the SCA to CDC's debt.

CDC's Activities After July 1984

     On June 15, 1984, CDC entered into an equipment maintenance

and security agreement with Mr. Arnold.    Under this agreement,

Mr. Arnold was responsible for the care and maintenance of CDC's

17 remaining drilling rigs and related rig equipment.    The

agreement required him to provide 24-hour security for CDC's

drilling rigs and equipment in its Elk City and Owentown rig

yards.   In consideration for those services, Mr. Arnold received

$19,850 per month (plus travel costs).    CDC also incurred

expenses for rig watch and land rent for rigs not at the Owentown

and Elk City rig yards.    All work under the equipment maintenance

and security agreement was personally supervised by Mr. Arnold

and/or his two employees, Edwin L. Arnold (Mr. Arnold's son) and

Daniel Webber.   The equipment maintenance and security agreement

remained in effect from June 1984 through December 31, 1986.

     After July 1984, CDC moved most of its rigs to the rig yards

it owned.   Due to the high cost of moving a rig, CDC stacked four

rigs in other locations.   CDC continued to provide security for

its rig yards and for the rigs it did not move.    Beginning on

December 1, 1984, maintenance, security, and insurance

expenditures on CDC's rig fleet were paid out of the SCA.

     In order to reach settlements with certain creditor groups

and help pay down its bank group debt, CDC needed to sell some of
                                - 13 -


its equipment and rigs.     On January 28, 1985, CDC entered into a

settlement agreement with Dresser Industries, Inc. (Dresser), one

of CDC' principal rig fabricators.       Pursuant to the settlement

agreement, CDC and the bank group agreed to release their claims

and security interests in specific equipment associated with

uncompleted drilling rigs and to return the equipment to Dresser.

In exchange, Dresser agreed to release its security interest in

equipment that it had supplied to CDC and that had been

incorporated into CDC's drilling rigs.       In addition, Dresser

agreed to release CDC from all claims by Dresser against CDC's

rigs.

     During May 1985, CDC sold two drilling rigs to Superior

Equipment and Supply Co. for $1,450,000 and $1,500,000 and

transferred the sales proceeds to its creditors to reduce their

claims.     These rigs were surplus to CDC's needs.    It is customary

for drilling contractors to sell surplus rigs.

CDC's Bankruptcy Proceeding

        On July 12, 1984, Crocker National Bank and TOS, trade

creditors of CDC, filed an involuntary petition under chapter 11

of the Bankruptcy Code against CDC.       CDC converted the case into

a voluntary chapter 11 proceeding (bankruptcy proceeding).

        On May 30, 1986, CDC filed an amended plan of reorganization

(amended plan) and an amended disclosure statement with the U.S.

Bankruptcy Court for the Western District of Oklahoma (the

bankruptcy court).     As a fallback provision, section 6.12 of the

amended plan required that, if at the end of 5 years from the
                               - 14 -


consummation date CDC's stock had not been sold, CDC would (1)

transfer any rigs that it continued to own to Chase Manhattan

Bank, N.A., as agent for the bank group, in satisfaction of the

bank group's secured claims, (2) liquidate its other remaining

assets, and (3) distribute the proceeds of the liquidation pro

rata to all creditors holding unsecured claims.    Less than 6

months after the bankruptcy court entered a confirmation order,

Samson purchased all of CDC's stock; therefore, no liquidation

was necessary.

     The amended plan provided for the issuance of stock in CDC

to a trust (the shareholder trust) for the benefit of unsecured

creditors.    The five-member board of directors of CDC included

three representatives of the bank group and one unsecured

creditor.    During CDC's reorganization, CDC managed its own

affairs through the efforts of its own officers, Messrs. Arnold

and West.    The role of the bank group in the business affairs of

CDC did not increase during the period of CDC's chapter 11

reorganization.    The bank group would have made cash from the SCA

available to CDC for drilling operations if CDC had presented

them with a profitable contract.    Richard D. Barton, a vice

president at Seattle-First, and John F. Jerow, a vice president

at Chase, agreed that the bank group would have allowed CDC to

use funds in the SCA to conduct drilling operations if CDC could

have obtained a profitable drilling contract.

     The bankruptcy proceeding discharged CDC's debts other than

the debt to the bank group.    The discharge eliminated CDC's
                                - 15 -


retained earnings deficit of $55,279,302 and reduced paid-in

capital by $6,404,957.

     The purpose of CDC's amended plan was to ensure that its

creditors received as much as possible in the ultimate sale of

CDC's assets or stock.

The Samson Acquisition

     Samson was created and incorporated on June 26, 1986.3    At

the time it acquired CDC, Samson, together with its affiliated

subsidiaries, was a privately held diversified group of

corporations.   While some members of the Samson group had been

involved in the oil and natural gas industry as working interest

owners and operators of oil and natural gas properties, the

historical businesses of the Samson group did not include

contract drilling.   The Samson group's practice had been to hire

drilling contractors to supply the drilling rigs, drilling rig

equipment, and rig crews necessary to drill the wells it operated

or jointly owned.

     By late 1985 or early 1986, the Samson group determined that

market conditions made it an economically attractive time to

examine the prospect of acquiring drilling rigs or contract

drilling businesses.     In 1986, rigs and rig equipment could be

acquired through negotiated asset purchases, auctions, and

acquisitions of drilling companies.


     3
        On June 26, 1986, the Samson group formed Samson
Investment Co. as a holding company. However, members of the
Samson group had been engaged in the oil and gas business since
1971.
                               - 16 -


       In early 1986, the Samson group established a consulting

arrangement with Suits Drilling Co. (Suits), a drilling

contractor and rig fabricator.    Over a period of years prior to

the Samson acquisition, members of the Samson group, as operators

of oil and gas leases, contracted with Suits for drilling

services many times.    Suits was owned by Jerry Suits, Tom

Dillingham, and Dan Dillingham.

       In July 1986, Jerry Suits brought the possibility of

purchasing CDC to Samson's attention.    Jerry Suits was familiar

with CDC and CDC's business because Dillingham Insurance Agency,

which was owned by Tom and Dan Dillingham, provided insurance for

CDC.

       Alan W. Carlton, senior vice president in charge of

acquisitions and operations, led Samson's negotiations for the

purchase of CDC.    Mr. West, who became CDC's president and CEO in

September 1986, represented CDC in the negotiations.

       At the time of the Samson acquisition, the bank group wanted

to convert their CDC stock into cash as soon as possible.

       On December 31, 1986, Samson purchased CDC pursuant to a

stock purchase agreement and an agreement relating to assignment

and partial release of security interests between the bank group

and Samson.    Samson acquired 100 percent of CDC's stock for a

payment of $5,201,184 to the shareholder trust.    In exchange for

obtaining the release of the bank group's security interests in

CDC's rigs and related equipment, Samson paid $3,098,854.40 to

the bank group, other than Continental Illinois National Bank
                              - 17 -


(CINB), and agreed to transfer 5 of CDC's 15 remaining drilling

rigs to CINB.

     On December 31, 1986, CDC's drilling rigs had an estimated

fair market value of $4,508,816, and its equipment had a fair

market value of $300,000.   Total liabilities of $4,508,816 were

characterized as nonrecourse bank debt.   The value of the

property and equipment had been written down to estimated cash

liquidation value.   CDC had no liabilities, except the

nonrecourse bank debt.   CDC's liabilities, with the exception of

the nonrecourse note payable to the banks, had been discharged as

a result of the bankruptcy.

     By purchasing CDC's stock, petitioner acquired CDC's assets

and hoped to acquire CDC's "tax attributes" (primarily CDC's

accompanying NOL carryforwards totaling $104,867,066).

     At the time of the Samson acquisition, CDC owned:    (1) Ten

drilling rigs with accessories, components, parts, supplies, and

tools (including drill pipe and drill collars) related thereto;

(2) three rig yards (located in Elk City, Oklahoma, Owentown,

Texas, and Victoria, Texas); (3) accounts receivable, including

those of Good Hope Refining and Martin Exploration; (4) the ARCO

deposit account with a balance of approximately $4,700,000 and

interests in the ARCO safe harbor lease and related collateral

account; (5) all contract rights of CDC; (6) working interests in

oil and gas producing properties; and (7) miscellaneous

equipment.
                              - 18 -


     Immediately before the Samson acquisition, CDC had four

employees:   Mr. Arnold, Mr. West, and two secretaries who

provided office administration and clerical services at its

Oklahoma City office.   After the Samson acquisition, H. John

Rogers became the president of CDC, and Mr. Carlton served as the

chairman of CDC's board of directors.

     CDC and Suits entered into a service and management

agreement (Suits agreement) effective December 31, 1986.     On

March 29, 1989, CDC and Suits Rig Corp. (an affiliate of Suits)

entered into a first amended and restated service and management

agreement which retroactively amended and restated the Suits

agreement, effective to December 31, 1986.    The Suits agreement

provided for Suits to maintain CDC's rigs.    The Suits agreement

also required Suits to use its best efforts and devote such time

as might be necessary to promote utilization of CDC rigs,

including marketing the rigs for contract drilling.   Suits was an

independent contractor.   Suits was also a drilling contractor

with significant experience in the contract drilling business.

Suits also drilled wells for the Samson group after the Samson

acquisition.   From 1992 through 1996, 26 wells were drilled under

a lease agreement between CDC and Suits.

Collection of Old CDC Receivables

     For the first 11 months following the Samson acquisition,

CDC collected $16,085 a month from Good Hope Refinery for

drilling services performed by CDC in 1982.
                                - 19 -


     At the time of the Samson acquisition, CDC owned a

$2,600,000 account receivable from Martin Exploration for

drilling done by CDC in 1982.    This account receivable was

ultimately settled for $37,000.

CDC's Historic Assets

     After the Samson acquisition, CDC owned three rig yards

located in Owentown, Texas, Victoria, Texas, and Elk City,

Oklahoma.   These were the same rig yards owned by CDC before the

change of ownership.    In May 1987, CDC sold the Victoria rig yard

for $25,309.

     In November 1987, CDC sold three of its rigs to Petroleum

Supply Co. for a total of $2,700,000 (approximately $900,000 per

rig).

Working Interests in Oil and Gas Properties

     CDC had income from its oil and gas working interests of

$11,122 and $19,014 for its taxable years ending June 30, 1987

and 1988, respectively.   CDC's income from its oil and gas

working interests increased to $53,803,784, $64,003,383,

$32,157,221, $61,659,750, and $102,317,645 for its taxable years

ending June 30, 1989, 1990, 1991, 1992, and 1993, respectively.

Rig and Related Equipment Activities

     Within 4 months after the Samson acquisition, CDC began

purchasing additional rigs and drill pipe.    In the first 12

months after the Samson acquisition, CDC more than doubled the

size of its rig fleet by purchasing 15 rigs.    CDC purchased an

additional 17 rigs in 1988 and 2 more rigs in 1989.
                               - 20 -


     In April 1987, CDC purchased rig No. 40, a rig constructed

by Suits.    CDC used rig No. 40 from July 1987 to 1989 to drill 14

wells on properties for which Sam Resource Co., a member of the

Samson group, was the operator.    After the change of ownership,

this was the only drilling performed by CDC as the drilling

contractor.    Officers and employees of CDC supervised CDC's rig

No. 40 drilling performed by Suits.     After the change of

ownership, CDC was selective in its rig acquisitions, inspecting

approximately 10 rigs for every one that it purchased.

     In early 1989, CDC purchased a 21-acre rig yard in Enid,

Oklahoma.    The Enid yard provided storage, maintenance, and

security for rigs.

     None of CDC's employees before the Samson acquisition

remained employees of CDC after the Samson acquisition.       CDC did

not ask Mr. Arnold or Mr. West to continue his employment with

CDC because CDC had other employees performing the work

previously performed by Mr. Arnold and had access to the

financial and accounting staff of Samson (so it no longer needed

Mr. West).    None of the former employees were necessary to

continue CDC's contract drilling business.

     After the Samson acquisition, CDC never obtained any

drilling contracts for the deep well rigs which it had fabricated

in 1981 and 1982.    After CDC stacked its original deep well rigs

between 1982 and July 1984, neither CDC nor any member of the

Samson group used them for contract drilling.
                              - 21 -


CDC's Earnings and Petitioner's Use of CDC's Carryforwards

     For the 6 months ending June 30, 1987, CDC, for financial

purposes, reported total assets of $22,890,735, gross income of

$2,963,940, and expenses of $3,688,840.   For the fiscal year

ending June 30, 1988, CDC, for financial purposes, reported total

assets of $39,069,154, gross income of $11,257,000, and expenses

of $17,622,666.   For the fiscal year ending June 30, 1989, CDC,

for financial purposes, reported total assets of $106,898,766,

gross income of $64,731,731, and expenses of $51,828,789.    For

the fiscal year ending June 30, 1990, CDC, for financial

purposes, reported total assets of $138,294,807, gross income of

$81,335,142, and expenses of $63,627,979.   For the fiscal year

ending June 30, 1991, CDC, for financial purposes, reported total

assets of $266,127,001, gross income of $140,899,602, and

expenses of $106,195,409.   For the fiscal year ending June 30,

1992, CDC, for financial purposes, reported total assets of

$256,382,000, gross income of $216,888,000, and expenses of

$182,773,000.   For the fiscal year ending June 30, 1993, CDC, for

financial purposes, reported total assets of $340,757,000, gross

income of $344,612,000, and expenses of $276,147,000.

     For its taxable years ending June 30, 1989, 1990, 1991,

1992, and 1993, petitioner used CDC's preacquisition NOL

carryforwards to reduce its income by $6,106,243, $11,570,311,

$38,001,412, $37,584,020, and $12,054,360, respectively.    The

Samson group reported no taxable income for its taxable years
                                - 22 -


ending June 30, 1989 through 1992, and reduced its taxable income

for its taxable year ending June 30, 1993, from $67,529,801 to

$55,475,411 by using the remaining CDC preacquisition NOL

carryforwards.

     On its consolidated return for the taxable year ended June

30, 1993, the Samson group used CDC's preacquisition ITC

carryforwards of $2,849,987.

Section 167 Depreciation

     The rigs owned by CDC at the time of the Samson acquisition

had been substantially depreciated before the taxable year ending

June 30, 1987, and were fully depreciated before the taxable year

ending June 30, 1990.    On its Federal income tax returns for 1987

through 1993, CDC claimed depreciation deductions under section

167 on 34 drilling rigs and related equipment acquired by CDC

after the Samson acquisition.

     CDC acquired rig No. 40 in April 1987 and 33 additional rigs

beginning in May 1987.     CDC acquired 15 drilling rigs in 1987, 17

in 1988, and 2 in 1989.

     After the change of ownership, CDC did no drilling with

either the CDC rigs acquired before the Samson acquisition or

with the 34 rigs acquired after the Samson acquisition, with the

exception of rig No. 40, which was used to drill 14 wells from

1987 through 1989.

     On August 31, 1988, Samson acquired 100 percent of Eason for

$6,654,000.   Through the acquisition of Eason's stock, Samson
                              - 23 -


also acquired Eason Drilling Division (Eason Division) and

Crescent (Crescent Division), both operating divisions of Eason,

and Crescent Pipe & Supply Co. (Crescent), a wholly owned

subsidiary of Eason.   Samson depreciated rigs and related

equipment that it acquired through the purchase of Eason and

Crescent.

     Eason was organized in the 1950's and was based in Oklahoma

City, Oklahoma.   Eason was an independent oil and gas company

that operated as a drilling contractor and had ownership

interests in oil and natural gas properties.    In 1977, Eason

became a wholly owned subsidiary of ITT Corp.    As of August 31,

1988, Eason owned:   (1) Ten drilling rigs with related equipment;

(2) one rig yard located in Oklahoma City, Oklahoma; (3) the

inventory of Crescent Division; (4) assets, equipment, and

improvements to real property relating to the operations of

Eason, Eason Drilling, Crescent Division, and Crescent; (5)

contract rights, including those arising from certain safe harbor

leases; (6) trade receivables from unaffiliated third parties;

(7) capital stock and security interests; and (8) a note

receivable from Speller Oil Corp. to Crescent Division dated

November 27, 1985, due and payable on December 1, 1988.    Eason's

10 rigs had been used by an Eason company in drilling operations

before Samson acquired Eason's stock.   At the time of its

acquisition, Eason had only one rig drilling a well.    After it

completed that well in October 1988, none of the Eason rigs were
                              - 24 -


used for drilling by petitioner.   All of the Eason rigs were

subject to the Suits agreement.

     In 1993, CDC was audited by the State of Texas.   Gary

Golden, an auditor for sales and use tax for the State of Texas,

audited CDC for its fourth quarter of 1987 and its first quarter

of 1988, relative to a possible use tax liability.

     Jennifer Leigh Nance audited CDC for the State of Texas

Comptroller's office for the 4-year period from April 1, 1988,

through March 31, 1992.   Ms. Nance proposed a sales and use tax

liability against CDC because the rigs were being depreciated on

petitioner's Federal income tax returns and were not in an

inventory account of CDC.

     In audit questionnaires in the Texas use tax proceeding, CDC

described its business operations as “oil and gas drilling” in

1988 and “oil and gas operations” in 1991.

                     ULTIMATE FINDING OF FACT

     CDC was engaged in the conduct of an active trade or

business at all relevant times prior to its acquisition by

Samson.

     CDC continued to carry on, after December 31, 1986,

substantially the same trade or business it had conducted before

December 31, 1986.
                              - 25 -


                              OPINION

1.   Sections 382 and 3834

     Section 382 provides for the elimination of NOL carryovers

of a corporation if a qualifying change in the ownership of the

stock of the corporation is accompanied by the failure of that

corporation to continue carrying on substantially the same trade

or business as it conducted before the change of ownership.

Neither party contests that there was the required change of

ownership.   The only question to be resolved, therefore, is

whether CDC carried on substantially the same trade or business

under section 382(a)(1)(C).

     Respondent claims that section 382 applies because

petitioner's drilling business was dormant for 2 years before the

acquisition.5   Alternatively, if CDC was in an active business


     4
        The parties agree that our resolution of the sec. 382
issue will also resolve the sec. 383 issue.
     5
         Sec. 1.382(a)-1(h)(6), Income Tax Regs., provides in
part:

          (6) A corporation has not continued to carry on a
     trade or business substantially the same as that
     conducted before any increase in the ownership of its
     stock if the corporation is not carrying on an active
     trade or business at the time of such increase in
     ownership. Thus, if the corporation is inactive at the
     time of such an increase and subsequently is
     reactivated in the same line of business as that
                                                   (continued...)
                              - 26 -


before the acquisition, respondent contends that CDC did not

carry on substantially the same trade or business after the

change of ownership.   See sec. 382(a)(1)(C).   Petitioner claims

that CDC was, at all relevant times, in the contract drilling

business.   In support thereof, petitioner claims that CDC was in

a state of readiness and that any inability to obtain profitable

drilling contracts was temporary and due to the severe downturn

in the contract drilling economy.   The resolution of this issue

therefore turns on whether there has been a change in CDC's

business or a break in the continuity of business activity.

     A.   Continuity of Business Activity

     Section 382(a)(1)(C) precludes the carryforward of NOL's of

an acquired loss corporation where the loss corporation has not

“continued to carry on a trade or business” substantially the

same as that conducted before the acquisition.   (Emphasis added.)

Respondent argues that implicit in this section is the

requirement that the acquired corporation must have been engaged

in an active trade or business at the time of the acquisition.




     5
      (...continued)
     originally conducted, the corporation has not continued
     to carry on a trade or business substantially the same
     as that conducted before such increase in stock
     ownership. * * *
                               - 27 -


In support thereof, respondent cites section 1.382(a)-1(h)(6),

Example (1), Income Tax Regs., which provides:

          Example (1). X Corporation is engaged in the
     business of manufacturing and selling machinery. On
     January 1, 1958, the corporation suspends its
     manufacturing activities and begins to reduce its
     inventory of finished products because of general
     adverse business conditions and lack of profits.
     During the period between January 1 and September 1,
     1958, the business of the corporation remains dormant.
     On September 1, 1958, A, an individual, purchases at
     least 50 percent in value of X Corporation's
     outstanding stock. On October 1, 1958, the corporation
     begins to manufacture the same type of machinery it
     manufactured before January 1, 1958. The reactivation
     of the corporation in the same line of business as that
     conducted before January 1, 1958, does not constitute
     the carrying on of a trade or business substantially
     the same as that conducted before the increase in stock
     ownership.

This Court, however, has recognized that in some situations, a

company may be temporarily inactive and still satisfy the

requirements of section 382.   See Clarksdale Rubber Co. v.

Commissioner, 45 T.C. 234 (1965); H.F. Ramsey Co. v.

Commissioner, 43 T.C. 500 (1965).   Thus, the question becomes

what degree of activity is necessary to sustain the

characterization of “active trade or business.”

     Our issue is therefore factual.    If we conclude that

petitioner permanently ceased all business operations before the

change of ownership, then it was engaged in no business at the

time of the change, and therefore CDC could not “continue” to
                                - 28 -


carry on substantially the same “trade or business”.    See Glover

Packing Co. v. United States, 164 Ct. Cl. 572, 328 F.2d 342, 349

(1964).    If, however, we conclude that CDC was merely temporarily

inactive or simply maintaining a low profile with the intent to

resume contract drilling when economically possible, then CDC

would be able to “continue” to carry on substantially the same

trade or business.     See Six Seam Co. v. United States, 524 F.2d

347 (6th Cir. 1975).

     We have considered a break in operations of a corporation

for reasons that indicated the resumption of operations was

reasonably to be anticipated to be a “temporary” ceasing of

operations and not a cessation of the conduct of the

corporation's regular trade or business.    See Clarksdale Rubber

Co. v. Commissioner, supra; H.F. Ramsey Co. v. Commissioner,

supra.    In H.F. Ramsey Co. v. Commissioner, supra at 504, we

found:

          As jobs were completed by * * * [the taxpayer],
     its equipment, when not needed on other jobs, was
     brought to * * * [taxpayer's] equipment yard where it
     was reconditioned. Many pieces of equipment were sold
     for the best price available without sacrifice and the
     proceeds from the sale were used to discharge the loan
     from Wachovia Bank & Trust Co. Ramsey's primary aim at
     this time was to complete contracts in progress and to
     do everything necessary and possible to discharge all
     of * * * [taxpayer's] debts and liabilities.
                              - 29 -


Although the acquired company in H.F. Ramsey “was pretty much of

a shell corporation, [it] was not a shell immediately prior to

the negotiations for sale.   It was a viable corporation which had

been actively engaged in the road construction business but which

was temporarily inactive.”    Id. at 516.    Although the Court

found that the taxpayer in H.F. Ramsey was acquired with the

principal purpose of avoiding Federal income taxes in violation

of section 269, we also found that the taxpayer continued to

carry on, after the acquisition, substantially the same trade or

business conducted before the acquisition.    The U.S. Court of

Appeals for the Sixth Circuit stated in Six Seam Co. v. United

States, supra at 353:

     the correct standard in determining whether such
     limited activity amounts to continuing a trade or
     business under the statute is whether it evidences only
     an intent to wind up corporate affairs, or whether
     instead the company is simply maintaining a low profile
     with an intention to resume operations should the
     business climate improve.

     The regulations support the construction that a temporary

break in operations which is not intended to be permanent is not

to be considered as “not carrying on an active trade or

business.”   See sec. 1.382(a)-1(h)(6), Example (2), Income Tax

Regs.
                               - 30 -


     Mr. Arnold and Mr. West both testified that in 1986 CDC

maintained its rigs in a state of readiness for immediate return

to active drilling when the contract drilling market turned

around.   Maintenance was performed at a cost of approximately

$20,000 per month.   Maintenance was performed to keep CDC's rigs

in condition to return to active drilling in a matter of days if

the market for deep drilling improved.

     In 1986 and through the time of the change of ownership, CDC

owned all assets necessary for a contract drilling business.     CDC

had 15 rigs and related equipment, drill pipe, three rig yards,

and working interests in oil and gas properties.   This is in

marked contrast to the taxpayer in United States v. Fenix and

Scisson, Inc., 360 F.2d 260, 268 (10th Cir. 1966), in which the

court stated that the “attempt to sell nearly all of * * *

[Oronogo's] equipment is incompatible with the idea that it was

merely standing by intending to resume operations should business

factors improve.”    In Fenix and Scisson, Inc., the acquired

company (Oronogo) had attempted to sell between 80 and 90 percent

of its assets more than 3 years before the acquisition.   The

court found that “Had they been completely successful in selling

equipment, they would have been unable to resume operations short

of repurchasing necessary equipment.    We hardly believe Congress
                                - 31 -


intended [section] 382(a) to turn on such a fortuitous

circumstance.”   Id.    Additionally, in that case, Oronogo filed

articles of dissolution more than 2 years before the acquisition.

The attempted sale of nearly all of Oronogo's assets along with

the filing of articles of dissolution evidenced an intent to

conduct no further business operations that is not present in the

instant case.

     At all relevant times, CDC was trying to reorganize and

resume its contract drilling business.     CDC made no attempt to

liquidate its assets.    In 1986, CDC was operating its rig yards,

maintaining administrative offices, managing its working

interests in gas wells, maintaining insurance, and complying with

the terms of its safe harbor leases.     CDC employed experienced

management employees:    Mr. Arnold, who was in charge of the

operations of CDC, and Mr. West, who handled CDC's finances.     Mr.

Jerow and Mr. West testified that officers of CDC--rather than

the bank group--were managing CDC's business affairs in 1986.

     At all times prior to the change of ownership, CDC filed its

Federal and State income tax returns and Oklahoma franchise tax

returns, which reported that CDC was in the contract drilling

business.   Cf. Utah Bit & Steel, Inc. v. Commissioner, T.C. Memo.

1970-50 (“A further indication of lack of intent to continue
                               - 32 -


business operations is the fact that petitioner did not even pay

its franchise tax.”).

     CDC's lack of business in 1984 resulted from adverse

business conditions.    William Glass, the former president of Big

Chief Drilling Co., a competitor of CDC, testified that as long

as a drilling contractor owned rigs, it could be in the drilling

business.   Jerry Suits, president of Suits, and Charles Hinton,

the former president of W.B. Hinton Drilling Co., both testified

that there were instances when their own deep drilling rigs were

not drilling, but their companies remained in the drilling

business.   Additionally, Dr. Preston L. Moore, one of

petitioner's expert witnesses, testified that, during the years

leading up to the change of ownership, “These rigs were being

maintained in a state of readiness to drill.    People were out

trying to get contracts.    The contracting business goes on.   The

fact that the rigs aren't working does not mean the business is

not an ongoing business.”    CDC always intended to remain in the

contract drilling business.    Mr. Arnold testified that CDC always

intended to be in the contract drilling business and never

intended to get out of that business.

     Furthermore, under the facts here present, the filing of a

petition in bankruptcy does not indicate that CDC meant to cease
                              - 33 -


business operations.   When CDC entered bankruptcy, the record

indicates that there was every intention to continue its

operations.   Cf. Utah Bit & Steel, Inc. v. Commissioner, supra.

Throughout CDC's chapter 11 reorganization, Mr. West actively

worked on behalf of CDC trying to collect receivables,

negotiating with CDC's creditors, and managing CDC's litigation.

     We are convinced that at all relevant times, CDC was ready,

willing, and able to drill wells if profitable drilling contracts

became available.   CDC's drilling rigs were maintained in a state

of readiness for drilling.   Unemployed rig hands were readily

available for employment on the rigs.    CDC also had working

capital for conducting drilling operations.    The funds in CDC's

SCA were available for these operations.    As of June 30, 1986,

the balance in the SCA was $6,279,000.    Mr. Barton testified that

the bank group would have allowed CDC to use these funds if a

profitable contract had been obtained.

     Considering all the facts of record, we find that there was

a continuation of business by CDC at the time of the change of

ownership.6   Having concluded that section 1.382(a)-1(h)(6),


     6
        We note that petitioner contends that respondent is
collaterally estopped from arguing that CDC was not engaged in an
active trade or business because the bankruptcy court confirmed
CDC's plan of reorganization. Respondent contends that the
                                                   (continued...)
                              - 34 -


Income Tax Regs., does not apply here, we look to the factors

mentioned in section 1.382(a)-1(h)(5), Income Tax Regs., to

determine whether CDC continued to conduct substantially the same

trade or business after its acquisition by petitioner.7

     B.   Substantially the Same Trade or Business

     Section 382 by its terms does not require a corporation to

continue exactly the same trade or business.   “[I]t would seem

there could be some changes in the manner of conducting * * *

[the] trade or business and yet the business could remain

'substantially the same.'”   Goodwyn Crockery Co. v. Commissioner,

37 T.C. 355, 362 (1961), affd. 315 F.2d 110 (6th Cir. 1963).     On

the other hand, the regulations and the legislative history state

that the discontinuance of any except a minor portion of the


     6
      (...continued)
principles of collateral estoppel do not apply in this situation
and that petitioner did not plead collateral estoppel, and
therefore petitioner cannot raise the issue on brief. Petitioner
counters that the issue of collateral estoppel has been tried by
consent within the meaning of Rule 41(b)(1) and, in the
alternative, has filed a Motion for Leave to File Amendment to
Petition to include the issue of collateral estoppel. We have
found that petitioner continued to carry on a trade or business
prior to the change of ownership, and therefore the issue is
moot. Petitioner's motion for leave to amend the petition will
be denied.
     7
        The relevant periods for making this determination are
the taxable year of the acquisition and the following taxable
year. Sec. 382(a); Princeton Aviation Corp. v. Commissioner,
T.C. Memo. 1983-735; sec. 1.382(a)-1(a)(1), Income Tax Regs.
                                - 35 -


taxpayer's business may constitute the necessary change in a

trade or business.   S. Rept. 1622, 83d Cong., 2d Sess. 285

(1954); sec. 1.382(a)-1(h)(7), Income Tax Regs.

     The test under section 382(a) is an objective one with

specific factors to be considered along with any other relevant

item in determining whether a corporation has continued to carry

on a trade or business substantially the same as that conducted

before a change of ownership.    Section 1.382(a)-1(h)(5), Income

Tax Regs., provides as follows:

          (5) In determining whether a corporation has not
     continued to carry on a trade or business substantially
     the same as that conducted before any increase in the
     ownership of its stock, all the facts and circumstances
     of the particular case shall be taken into account.
     Among the relevant factors to be taken into account are
     changes in the corporation's employees, plant,
     equipment, product, location, customers, and other
     items which are significant in determining whether
     there is, or is not, a continuity of the same business
     enterprise. These factors shall be evaluated in the
     light of the general objective of section 382(a) to
     disallow net operating loss carryovers where there is a
     purchase of the stock of a corporation and its loss
     carryovers are used to offset gains of a business
     unrelated to that which produced the losses. However,
     the prohibited utilization of net operating loss
     carryovers to offset gains of a business unrelated to
     that which produced the losses is not dependent upon
     considerations of purpose, motive, or intent, but
     rather is established by the objective facts of the
     particular case. The principles set forth in this
     subparagraph shall be applied in accordance with the
     rules set forth in the following subparagraphs of this
     paragraph.
                               - 36 -


     Respondent contends that, if CDC was in an active business

prior to the change of ownership, the trade or business of CDC

after the change was not substantially the same as that conducted

prior to the acquisition.    Respondent's primary argument in

support thereof is that CDC was not in the contract drilling

business but rather acquired assets at depressed prices to be

resold at a profit.

     Respondent points to Clare Co. v. Commissioner, T.C. Memo.

1969-264, in which the taxpayer contended that it was “a viable

corporation, ready, willing and able and attempting to conduct

the same type of business it was engaged in prior to the change

in stock ownership.”   The facts of Clare Co. are distinguishable

from those of the instant case.    In Clare Co., the taxpayer,

prior to the change of ownership, was in the construction

business.   After the change of ownership, the taxpayer sold all

of its construction equipment and bought river barges.    The

taxpayer then rented out these river barges with the resulting

rental income accounting for 89 percent of its gross income for

the year after the change.    CDC on the other hand maintained the

necessary equipment, including drilling rigs, rig yards, and

related rig equipment, so that at all times during the relevant
                               - 37 -


periods, had the contract drilling economy improved, it could

have used its rigs as a contract driller.

     We have determined that CDC was in the contract drilling

business prior to the change of ownership.   Therefore, to be

entitled to deduct the NOL's, it follows that CDC must have

continued in the contract drilling business after the change of

ownership.   In H.F. Ramsey Co. v. Commissioner, 43 T.C. at 514,

we reviewed the legislative history of section 382 and concluded

that “it would appear that there has to be a real change in the

type of business conducted to come within * * * [the] statute.”

Accord Clarksdale Rubber Co. v. Commissioner, 45 T.C. 234 (1965);

Goodwyn Crockery Co. v. Commissioner, supra.   Both before and

after the acquisition, CDC's operations are best described as a

contract drilling operation.

     The facts in the record indicate that had CDC been in the

business of buying and selling rigs, as respondent contends, CDC

would have operated in a substantially different manner.   After

the change of ownership, CDC continued to maintain its rigs to

keep them in a state of readiness for drilling.   Had CDC been

trying to sell its rigs, the maintenance would have been lower

cost and more cosmetic in order to enhance the visual appeal of
                               - 38 -


the rigs.8   Additionally, companies in the rig selling business

used manufacturers' representatives to do the maintenance so the

representative could provide certificates to a prospective

purchaser with independent verification that the equipment was

operational.    CDC did not hire equipment manufacturers'

representatives but rather performed its own maintenance work.

     Companies that were in the business of selling drilling rigs

maintained offices in Houston because buyers from around the

world came to Houston to shop for drilling rigs.    CDC never

opened an office in Houston.    CDC located its rigs in remote

areas in Oklahoma and Texas where the demand for drilling would

occur.

     CDC would have advertised the sale of its rigs in trade

publications.    CDC never advertised in any trade publication that

specialized in advertising rig sales in order to sell any of its

rigs.

     CDC would not have acquired trucks and forklifts because it

would have been cheaper to hire a trucking company to move the

rigs and equipment only one time before they were sold.




     8
        It was more expensive to maintain rigs in a state of
readiness than it was to maintain them for resale.
                                - 39 -


     The Suits agreement would not have been entered into because

Suits' personnel were primarily experts in drilling operations

and not in marketing drilling rigs and equipment for resale.

     CDC continued to market its rigs for drilling and to

maintain them in a state of readiness so that CDC could drill

with them profitably if the market improved.

     CDC continued to own two of the three rig yards that it

owned prior to the change of ownership.    CDC continued to use the

same name and logo that were used prior to the change of

ownership.   CDC continued to own and maintain all of its working

interests in producing wells.

     Respondent emphasizes the fact that CDC had over 500

employees at its peak and only four employees just prior to the

change of ownership.   The relevant comparison, however, is the

number of CDC employees just before the change compared with the

number of employees after the change of ownership.    Due to the

economic conditions at the time, CDC was able to run the business

with only four employees just prior to the change of ownership.

Petitioner established that had CDC been able to acquire

profitable contracts, CDC easily could have hired experienced rig

crews at that time.    When CDC drilled 14 wells after the

acquisition, it was able to contract with Suits to provide the
                                - 40 -


necessary rig crews.     After considering the record as a whole, we

find that CDC continued substantially the same trade or business

after the change of ownership as that conducted prior to the

change of ownership.

     C.   Conclusion

     Based on all the facts and circumstances, we find that

during the relevant periods CDC was engaged in the contract

drilling business.     Thus, the limitations of sections 382 and 383

are not triggered.

2.   Section 167

     Respondent argues that petitioner improperly claimed

depreciation deductions for assets of CDC and Eason held as

inventory for resale.9    Petitioner contends that it devoted all

of the assets it depreciated to the contract drilling business.

     Section 167(a) allows as a depreciation deduction a

reasonable allowance for the exhaustion, wear and tear of

property used in a trade or business, or property held for the

production of income.    Section 1.167(a)-2, Income Tax Regs.,




     9
        The depreciation issue relates only to rigs and equipment
that CDC purchased after the change of ownership and to the Eason
rigs and equipment. The parties do not contest the bases of the
assets.
                              - 41 -


provides that the depreciation allowance “does not apply to

inventories or stock in trade".

     The period for depreciation begins "when the asset is placed

in service".   Sec. 1.167(a)-10(b), Income Tax Regs.   Section

1.167(a)-11(e)(1)(i), Income Tax Regs., provides in relevant

part:

     The term “first placed in service” refers to the time
     the property is first placed in service by the
     taxpayer, not to the first time the property is placed
     in service. Property is first placed in service when
     first placed in a condition or state of readiness and
     availability for a specifically assigned function
     * * *

     This and other courts have recognized that taxpayers may

claim depreciation deductions under the so-called idle asset rule

in situations where the asset involved, while not in actual use

during the year in issue, nevertheless was devoted to the

business of the taxpayer and ready for use should the occasion

arise.   See P. Dougherty Co. v. Commissioner, 159 F.2d 269 (4th

Cir. 1946) (for purposes of determining whether depreciation was

allowable for years when barges lay idle for protracted periods

during a 20-year period, it was sufficient that they were kept in

usable condition and were ready for use should the occasion

arise), affg. 5 T.C. 791 (1945); Kittredge v. Commissioner, 88

F.2d 632 (2d Cir. 1937); Piggly Wiggly Southern, Inc. v.
                               - 42 -


Commissioner, 84 T.C. 739, 745-746 (1985), affd. 803 F.2d 1572

(11th Cir. 1986); Clemente, Inc. v. Commissioner, T.C. Memo.

1985-367.   In Kittredge v. Commissioner, supra at 634, the court

said:

     To read the phrase "used in the trade or business" as
     meaning only active employment of property devoted to
     the business would lead to results which we cannot
     believe Congress intended. For example, one factory of
     a large industrial plant may lie idle for a year, and
     in fact suffer depreciation as great, or greater, than
     that sustained by the factories in operation. To allow
     no depreciation for the idle factory would be most
     unfair to the taxpayer, for he must claim the deduction
     in his tax return for the year when the depreciation
     occurs, and may not take it in a later year. * * *
     Hence we think the phrase should be read as equivalent
     to "devoted to the trade or business"; that is to say,
     that property once used in the business remains in such
     use until it is shown to have been withdrawn from
     business purposes. * * *

     In Piggly Wiggly Southern, Inc. v. Commissioner, supra, we

set forth the requirements for application of the “idle asset

rule” (i.e., that assets may be “placed in service” when not yet

in actual use but in a state of readiness and available for a

specifically assigned function).   We identified two necessary

factors:    (1) The taxpayers already were engaged in the business

for which they purchased the equipment, and (2) the taxpayers did

all that was in their power to place the equipment into service.

     We have already found that CDC was in the contract drilling

business.   Furthermore, Eason was in the contract drilling

business and used each of its rigs to drill wells prior to the

years at issue.   Thus, the first factor is satisfied.   We must
                               - 43 -


therefore decide whether petitioner did all that was in its power

to place the rigs at issue into service.

     All of the CDC and Eason rigs were subject to the Suits

agreement.   Both John Rogers and Jerry Suits testified that

during the taxable years at issue, both CDC and Eason owned

fleets of drilling rigs that they held as part of their drilling

business.

     Respondent points to a Texas sales and use tax audit of 12

of the rigs in question, in which Samson argued that the rigs

were not subject to Texas use tax because it purchased them for

resale.   This, however, was merely one of several alternative

arguments asserted by petitioner in the use tax audit.   In audit

questionnaires in the Texas use tax proceeding, CDC described its

business operations as “oil and gas drilling” in 1988 and “oil

and gas operations” in 1991.   Additionally, petitioner and the

State of Texas have agreed to defer to this Court for resolution

of this issue.   If we determine that CDC is allowed depreciation

deductions, then it will be liable for Texas use tax.

     In Sears Oil Co. v. Commissioner, 359 F.2d 191 (2d Cir.

1966), affg. in part, revg. in part and remanding T.C. Memo.

1965-39, the taxpayer purchased a canal barge that it was unable

to use until the following year because the canal froze.   The

court found that the taxpayer was entitled to depreciation in the

year of purchase because (1) the barge was gradually

deteriorating as it was “subject to the weather elements”, (2)
                               - 44 -


the freezing of the canal was “not a condition which the taxpayer

desired to bring about”, and (3) “depreciation may be taken when

depreciable property is available for use 'should the occasion

arise,' even if the property is not in fact in use.”    Id. at 198.

In arriving at this finding, the court noted that the taxpayer

was already in the business for which the depreciable asset had

been purchased.

       Property, once used in business, remains in such use until

it is shown to have been withdrawn from business purposes.      P.

Dougherty Co. v. Commissioner, supra.    Petitioner's rigs were

available for drilling, though it was unable to obtain profitable

contracts.    Petitioner did not withdraw the rigs from business

use.    On this evidence, we hold that petitioner's use of the rigs

was such that depreciation deductions are allowable.

       Petitioner has prevailed on the sections 382 and 383 issues;

therefore, the issue of whether petitioner is liable for

substantial understatement penalties is moot.

       To reflect the foregoing,

                                                An appropriate order

                                          will be issued, and

                                          decision will be entered

                                          under Rule 155.
