148 F.2d 80 | 5th Cir. | 1945
Lead Opinion
This appeal involves income taxes of the Kirby Petroleum Company for the year 1940. The question presented for review is whether the taxpayer is entitled, under Sections 23(m) and 114(b) (3) of the Internal Revenue Code, 26 U.S.C.A. Int.Rev. Code, §§ 23(m), 114(b) (3), to a depletion deduction of 27% per cent on the amount received by it as its share of the net profits realized by its lessees from operations under an oil and gas lease.
The taxpayer owned a tract of land in Texas upon which a % mineral interest had been retained by a former owner. It leased the tract to an oil company for exploration and production, reserving a % toyaltv in the minerals, (which included the % held by the former owner) and receiving a bonus. It was stipulated that all obligations of the lessees were to be understood as covenants and not as conditions or limitations. Contemporaneously with the execution of the lease, the parties executed an agreement under which the taxpayer was to receive 20 per cent of the net profits realized by the lessees from their operations under said lease.
During the year 1940, the taxpayer received $26,223.70 as its share of the net profits. In its income tax return for that year, it deducted 27% per cent depletion on this amount. There was no dispute as to the depiction allowances on the cash bonus and royalty payments. The Commissioner allowed these items, but disallowed the depletion deduction on the amount of the net profits. The Tax Court ruled that depletion on the profits should have been allowed since the lessor had an economic interest in the oil in place.
Gross income from the property, as used in Section 114(b) (3), means gross income from the oil and gas.
The percentage depiction cannot exceed 27% per cent of the gross value of the captured minerals. The nature of the interest in the deposit does not turn upon the form of the conveyance, but upon the particular consequences of the provisions for payments.
Prior to the execution of the lease and the agreement here involved, the taxpayer (with exception of the % interest mentioned) had .the entire capital investment in the underlying oil and gas. To the extent of the cash bonus and the right to royalty payments, it retained a proportionate economic interest in the oil and gas in place, and to that extent the lessees did not acquire a depletable interest;
In Helvering v. Elbe Oil Land Co., 303 U.S. 372, 58 S.Ct. 621, 82 L.Ed. 904, the reservation of the right to share in net profits by the former owner of the mineral deposits was ruled not to constitute a retention of a capital investment in the oil in place. In Anderson v. Helvering, 310 U.S. 404, 60 S.Ct. 952, 84 L.Ed. 1277, the reservation of the right to share in net profits was held not to entitle the holder of such interest to a depletion allowance even though continued production was essential to the realization of such profits. There are good reasons for the rule; the depletion deduction is granted in recognition of the fact that the person having the requisite economic interest received a partial return of his capital investment when production took place.
A taxpayer who leases solely for net profits no longer has a direct interest in the production of mineral deposits; his interest is in the ability of the operators to earn profits. It is true that there would be no net profits if there were no production; but since production could take place without there being any net profits, the taxpayer’s income accrues after, no.t at the time of, the extraction of the oil and gas from the deposits. These principles have been given concrete application by this court.
The instant case cannot be distinguished from the O’Donnell, Anderson, and Elbe Oil Co. cases on the ground that in those the right to share in the net profits was not accompanied by an interest in the minerals. Here the retention of an oil royalty in addition to a share of the net profits operated to reserve an interest in the oil in place, but it was a partial interest that was not enhanced by the personal covenant to pay a percentage of net profits. Here at the instant of production, % of the oil belonged to ¡the former owner, (plus an amount sufficient to pay the cash bonus)
The respondent claims, and the Tax Court held, that its gross income from the property was “clearly the proceeds from the % [should be ]4t] royalty interest which petitioner retained in the lease and the 20 per cent annual profits which it received from the operator of .the lease under the contemporaneous agreement amounting in 1940 to $26,223.70.” In other words, the claim is that a net profit is gross income if paid by the lessee to the lessor of oil property. This would not he so, it is admitted, if the lessor had not reserved in the lease a royalty interest that entitles it to some percentage depletion. The argument is that this reservation converts a net profit into a bonus and distinguishes this case from the O’Donnell and similar cases above cited; but there is no difference in the controlling legal principle that underlies them all. The payment of net profits to the lessor is not the payment in kind of royalty oil or its equivalent.
A bonus is subject to percentage depletion upon the theory that it is an advance royalty; but net profits are not paid in advance, and cannot be paid until they are earned and ascertained. Gross income, under .the statute, is exclusive of any rents or royalties paid or incurred by the taxpayer. If, therefore, net profits are held to he rents or royalties within the meaning of Section 114(b) (3), the depletable gross income thereunder cannot be ascertained until we determine the amount of the net income. Under the present state of the law, tile depletion allowance of 27% per cent is granted upon the gross income from every barrel of oil captured, which allowance is apportioned pro rata among those who own the oil itself.
If net profits, which cannot be computed or paid until they are earned, are rents and royalties within the meaning of Section 114(b) (3), the depletion allowances on the working interest cannot be ascertained until the amount of net income is determined. This poses an abstruse problem instead of the rule of thumb that the arbitrary percentage-depletion allowance was intended to be.
In addition, it would be a departure from the theory upon which bonus payments are depletable, since no economic interest in the oil in place was reserved by the lessor to represent the contingency of net profits that might be earned. On the contrary, the lessor accepted the personal covenant of the lessees to pay whatever ■amount of net profits became due by the lessees. This entailed upon the lessor the financial risk of the lessees’ personal ability to earn profits and to account for them. For these reasons we conclude that the doctrine of advance royalty payments cannoi be extended to net profits.
The decision of the Tax Court is reversed, and the cause remanded for further proceedings not inconsistent with this opinion.
Helvering v. Mountain Producers Corporation, 303 U.S. 376, 382, 58 S.Ct. 623, 82 L.Ed. 907.
Helvering v. Bankline Oil Co., 303 U.S. 362, 367, 58 S.Ct. 616, 82 L.Ed. 897.
United States v. Dakota-Montana Oil Co., 288 U.S. 459, 467, 53 S.Ct. 435, 77 L.Ed. 893.
Helvering v. Bankline Oil Co., supra, 303 U.S. p. 368, 58 S.Ct. 616, 82 L.Ed. 897.
Anderson v. Helvering, 310 U.S. 404, 411, 60 S.Ct. 952, 84 L.Ed. 1277.
Palmer v. Bender, 287 U.S. 551, 558, 53 S.Ct. 225, 77 L.Ed. 489; Murphy Oil Co. v. Burnet, 287 U.S. 299, 53 S.Ct. 161, 77 L.Ed. 318; Burnet v. Harmel, 287 U.S. 103, 53 S.Ct. 74, 77 L.Ed. 199; Bankers’ Coal Co. v. Burnet, 287 U.S. 308, 53 S.Ct. 150, 77 L.Ed. 325; Anderson v. Helvering, supra, 310 U.S. p. 408, 60 S.Ct. 954, 84 L.Ed. 1277.
Helvering v. O’Donnell, 303 U.S. 370, 58 S.Ct. 619, 82 L.Ed. 903; Helvering v. Elbe Oil Land Co., 303 U.S. 372, 58 S.Ct. 621, 82 L.Ed. 904; Anderson v. Helvering, supra.
Helvering v. Bankline Oil Co., supra, 303 U.S. 362, at pages 366, 367, 58 S.Ct. 616, 82 L.Ed. 897.
Helvering v. Bankline Oil Co., supra, 303 U.S. 362 at pages 366, 367, 58 S.Ct. 616, 82 L.Ed. 897.
Blankenship v. United States, 5 Cir., 95 F.2d 507; Sneed v. Commissioner of Internal Revenue, 5 Cir., 119 F.2d 767, 770; Commissioner of Internal Revenue v. Caldwell Oil Corporation, 5 Cir., 141 F.2d 559, 561; Quintana Petroleum Co. v. Commissioner of Internal Revenue, 5 Cir., 143 F.2d 588.
Helvering v. Twin Bell Syndicate, 293 U.S. 312, 321, 55 S.Ct. 174, 79 L.Ed. 383.
Helvering v. Twin Bell Syndicate, 293 U.S, 312, 55 S.Ct. 174, 79 L.Ed. 383; Thomas v. Perkins, 301 U.S. 655, 57 S.Ct. 911, 81 L.Ed. 1324.
Helvering v. Twin Bell Syndicate, 293 U.S. 312, 321, 55 S.Ct. 174, 79 L.Ed. 383; Helvering v. Mountain Producers Corporation, 303 U.S. 376, 381, 58 S.Ct. 623, 82 L.Ed. 907.
Helvering v. Mountain Producers Corporation, supra.
Dissenting Opinion
(dissenting)-
Believing that the Tax Court is clearly right and that the opinion of the majority completely misconceives both the facts and the law, I think it well, in order to point this out, to fully state -the facts which control' the decision of this case and restate the controlling principles.
Taxpayer, the fee owner of two tracts of oil bearing land, leased them in 1927 for a cash bonus, an oil royalty of one-sixth, and oil payments of 20 percent to be paid out of the net profits from production. Oil was discovered in 1932, and in 1935, 1936, 1937, 1938, 1939 and 1940, taxpayer received out of production its royalty and also payments on account of the 20 percent it had reserved. Of the opinion that all of the payments made to it out of production were a return of its capital interest in the oil in place, taxpayer, on the authority of W. S. Green, 26 B. T. A., 1017, a precisely similar case, claimed, and for 1935 -through 1939 was allowed, depletion on them all. For 1940, the tax year in question here, the Commissioner allowed the depletion on the one-sixth royalty, but denied it on the oil payments on the ground that these were not payments out of an interest ,in oil reserved by taxpayer but were mere cash payments on an outright sale of -the minerals it owned.
.The Tax Court took a different view. It found,
The Commissioner, pointing with unwavering finger at the words, “net profits” realized by lessees from their operation of the lease, used by the parties as the measure of the payments out of production, is here insisting that the cases he cites
Taxpayer is here insisting that this is just another of the all too many cases in which a too intense preoccupation by the Commissioner with words as formulas, here “net profits”, coupled with a complete disregard of the controlling facts existing and found by the Tax Court as to what the parties intended to do and did do, has led the Commissioner astray. He points out that the ci-ted cases, except Commissioner of Internal Revenue v. Caldwell Oil Corporation, 5 Cir., 141 F.2d 559, which taxpayer insists supports it and not the Commissioner, dealt with situations in which it was clear that the taxpayer, reserving no economic interest in the minerals in place, but, by outright sale, parting with all of them, had made provisions, sometimes in one way and sometimes in another, merely for payments in cash of the consideration for -the sale. He insists that the situation here is quite different in fact, and the controlling cases are: Thomas v. Perkins, 301 U.S. 655, 57 S.Ct. 911, 81 L.Ed. 1324;
I think it clear that the Tax Court was right. The most cursory examination of
That the parties intended by the leasing ■contracts, not an outright sale of the properties but to provide for the retention by taxpayer of an interest in the oil in place, is suggested by even the most superficial view of the contracts and the circumstances attending their making and carrying out. The assembling and analysis of the significant facts found by the Tax Court leaves me in no doubt that taxpayer is entitled to the depletion. Taxpayer was the owner in fee of the property, and it did not sell it outright for a price to be paid in cash, but, on the contrary, leased it for a royalty and a bonus to be paid, part in cash and part from future production. It neither received nor contracted to receive any cash as the purchase price, but only as bonus, that is, as advance royalty, as royalty and as oil payments. It carefully guarded the ascertainment of the net profits through the receipt of which it was to recover part of its reserved capital by specifying what charges should be made and how they were to be made. To remove
It will serve no useful purpose for me to analyze each of the cases cited by the Commissioner. The Tax Court has sufficiently distinguished them. It is sufficient to say that some of them are not depletion cases at all. In most 'the issue was who owned the production, that is to whom it was taxable as ordinary income. The Commissioner does not contend that the 20 percent payments are taxable as ordinary income to the lessees and not to the taxpayer, as was successfully contended in some of the cases Commissioner cites, and as would be the case here if .the Commissioner is right. Quite to the contrary, he accepts them as ordinary income as they were returned by Kirby, and insists on taxing them as such. As Anderson v. Helvering [310 U.S. 404, 60 S.Ct. 954]
Helvering v. Anderson makes it plain that there is no difficulty about the principle to be applied. The difficulty comes only in its attempted application. All agree
Helvering v. O’Donnell, 303 U.S. 370, 58 S.Ct. 619, 82 L.Ed. 903; Helvering v. Elbe, 303 U.S. 372, 58 S.Ct. 621, 82 L.Ed. 904; Anderson v. Helvering, 310 U.S. 404, 60 S.Ct. 952, 84 L.Ed. 1277; Blankenship v. U. S., 5 Cir., 95 F.2d 507; Quintana Petroleum Co. v. Commissioner of Internal Revenue, 5 Cir., 143 F.2d 588; and Commissioner of Internal Revenue v. Caldwell Oil Corporation, 5 Cir., 141 F.2d 559.
Cf. the thoughtful analysis and application of that case in Anderson v. Helvering, 310 U.S. 404 at pages 409-13, 60 S.Ct. 952, 84 L.Ed. 1277.
These arrangements provided for the royalty and made the ordinary provisions carried in oil loase contracts. In addition, after providing that the lessees ■should have exclusive charge of all operations to be conducted on the land as well as the payment of rentals, royalties. taxes and other charges which may become due, the contract went into most •careful detail as to the costs and expenses which were to be charged to the joint account. Providing “no home office or other overhead charge shall be made to the joint account, in connection with the operation of premises”, it provided: for a fixed bookkeeping and expense charge; that material should be charged at cost; and otherwise made it clear that though lessee was to he the operator of the premises and was to make payments to lessor equivalent to 20 percent of the net profits therefrom, the operation was for joint account.
Olause IV provided: “First Party shall have exclusive charge and control of Ihe marketing of all oil, gas and other minerals produced from said premises, and in which the parties hereto m,aaj be interested”, (emphasis supplied). “Upon the sale of any such minerals', the accounts covering the lease referred to above, shall be credited with the proceeds of such sales. * * * ”,
Clause V provided: “The total net profits (or total net loss as the case may be) shall be determined by deducting the total charges made against the lease as authorized herein from the itotal credits at,lowed the lease as authorized herein Second Party shall participate in the profits dei-ived from the sale of the oil and gas and other mineral production of the lease embraced in this agreement only after all charges and debits and costs of producing profits shall have been paid and provided for. It is expressly agreed that First Party shall have the right to carry forward any loss from operations as a charge against the net profit account for the next and succeeding months until such loss has been wiped out and paid.” (Emphasis supplied.)
Clause VI provided that First Party should keep an accurate record of all accounts, which record should be available at all times for examination and inspection by second party, and “Second Party shall also have access at all reasonable times to the well and production records and reports relating to said premises.” First party was required within one month after the close of each calendar month to furnish Second Party with statement of authorized expenses incurred and charges made and authorized credits made. It provided finally that within one month after the close of each calendar month Second Party shall be paid its 20 percent of the net money profits derived from the operation of the lease as calculated and determined under the terms hereof.
Clause IX provided: “THIS CONTRACT SHALL BE BINDING UPON THE PARTIES HERETO AND THEIR RESPECTIVE SUCCESSORS IN INTEREST”. (Emphasis supplied.)
“It is settled that the same basic issue determines both to whom income derived from the production of oil and gas is taxable and to whom a deduction for depletion is allowable. That issue is, who has a capital investment in the oil and gas in place and what is the extent of his interest. Helvering v. Bankline Oil Co., 303 U.S. 362, 367, 58 S.Ct. 616, 618, 82 L.Ed. 897; Helvering v. O’Donnell, 303 U.S. 370, 58 S.Ct. 619, 82 L.Ed. 903; Helvering v. Elbe Oil Co., 303 U.S. 372, 58 S.Ct. 621, 82 L.Ed. 904; Thomas v. Perkins, 301 U.S. 655, 661, 663, 57 S.Ct. 911, 913, 914, 81 L.Ed. 1324; Helvering v. Twin Bell Oil Syndicate, 293 U.S. 312, 321, 55 S.Ct. 174, 178, 79 L.Ed. 383; Palmer v. Bender, 287 U.S. 551, 53 S.Ct. 225, 77 L.Ed. 489. Compare Helvering v. Clifford, 300 US. 331, 60 S.Ct. 554, 84 L.Ed. 788.”