DOUGLAS v. COMMISSIONER OF INTERNAL REVENUE
NOS. 130 AND 131
Supreme Court of the United States
May 15, 1944
322 U.S. 275
Mr. Kimball B. DeVoy, with whom Messrs. James E. O‘Brien and Thomas P. Helmey were on the brief, for petitioners.
Messrs. F. G. Davidson, Jr., Theodore L. Harrison, J. Donald Rawlings, and W. A. Sutherland filed a brief on behalf of the Virginian Hotel and other taxpayers, as amici curiae.
MR. JUSTICE REED delivered the opinion of the Court.
The Commissioner of Internal Revenue assessed income tax deficiencies against the petitioners for the year 1937, because of their failure to include in income for that year sums required to be reported by the terms of Article 23 (m)-10 (c) of Treasury Regulations 94, issued pursuant to
The
“SEC. 23. Deductions from Gross Income.
“In computing net income there shall be allowed as deductions:
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“(m) Depletion.-In the case of mines, oil and gas wells, other natural deposits, and timber, a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case; such reasonable allowance in all cases to be made under rules and regulations to be prescribed by the Commissioner, with the approval of the Secretary. In any case in which it is ascertained as a result of operations or of development work that the recoverable units are greater or less than the prior estimate thereof, then such prior estimate (but not the basis for depletion) shall be revised and the allowance under this subsection for subsequent taxable years shall be based upon such revised estimate....”
Revenue Act of 1936, c. 690, 49 Stat. 1648, 1658-60 .
From the beginning of income taxation, as now, the regulations covered the conventional situations of payments for ores as mined and made provision for depletion measured by the volume actually extracted. The 1918 Act permitted the new regulations, Regulations 45, Article 215 (c), to provide for the first time a deduction in the year of receipt of advance royalties of a depletion allowance calculated on the unit value of the mineral in place. This met a frequently recurring variation from the normal lease. As a corollary the regulations required that in case a lease was surrendered before the lessee had extracted all the ore for which advance royalties had been
“ART. 23 (m)-10. Depletion-Adjustments of accounts based on bonus or advanced royalty
“(b) If the owner has leased a mineral property for a term of years with a requirement in the lease that the lessee shall extract and pay for, annually, a specified number of tons, or other agreed units of measurement, of such mineral, or shall pay, annually, a specified sum of money which shall be applied in payment of the purchase price or royalty per unit of such mineral whenever the same shall thereafter be extracted and removed from the leased premises, an amount equal to that part of the basis for depletion allocable to the number of units so paid for in advance of extraction will constitute an allowable deduction from the gross income of the year in which such payment or payments shall be made; but no deduction for depletion by the lessor shall be claimed or allowed in any subsequent year on account of the extraction or removal in such year of any mineral so paid for in advance and for which deduction has once been made.
“(c) If for any reason any such mineral lease expires or terminates or is abandoned before the mineral which
The deficiency here assessed falls squarely under the subsections. Their validity is therefore the decisive issue. In our opinion the regulations are valid.
Since the revenue acts have not forbidden recognition of bonus or advanced royalties as a basis for the calculation of appropriate depletion, the provision of the regulations for a depletion offset against their receipt is within the broad rule-making delegation of
By the 1919 Regulations, the plan of restoring the sum of depletion deductions to capital and carrying a corresponding amount to income in the year of the termination of a lease without production was adopted instead of a permanent reduction of basis or a restoration of the depletion deductions to income for the years in which they were deducted. The
As no depletion of the ore mass occurred or can occur under the lease which produced the gross income, the issue is not whether the regulation gives a reasonable allowance for depletion when prepaid royalties are involved. That issue has been decided in favor of the validity of such allowances in other cases. Herring v. Commissioner, 293 U.S. 322; Murphy Oil Co. v. Burnet, 287 U.S. 299. The problem here is the validity of Article 23 (m)-10 (c) when the depletion for which a deduction has been previously allowed fails in the manner anticipated as a possibility at the time of deduction.
A. Petitioners attack the validity of the regulation on the ground that the restoration of the accumulated deductions to capital, i. e., the depletion basis, with a corresponding increase of the taxpayers’ annual income for the year of the restoration, is contrary to the requirements of certain sections of the 1936 Act. §§ 23 (m), 114 (b) (1) and 113 (b) (1) (B). It is unnecessary to appraise the effect in other years of the antecedents of these sections. Petitioners urge that the depletion deductions which were the untaxed portion of the royalties paid in prior years were capital recoveries in those prior years which resulted in a statutory, permanent reduction of basis which cannot be restored to basis and hence cannot be treated as income for 1937. Petitioners point to § 23 (m), supra, p. 278, as providing for the deduction for depletion on payment of advance royalties. It is contended that §§ 114 (b) (1) and 113 (b) (1) (B)3 supplement the statutory direction
To accept these arguments as a sound interpretation of the meaning of these provisions, however, would put into
B. Petitioners vigorously press another argument against the validity of the regulations. This is that the separate annual instalments of untaxed royalties (prior depletion deductions), since these untaxed portions of the royalties were income for the prior years, may not be accumulated and taxed for 1937 because such treatment is fictional, distorts the 1937 income to petitioners’ detriment, is unreasonable and violates §§ 23 (m), 41 and 42 of the Act. The latter two sections require the computation of income, net and gross, upon the basis of an annual accounting period and the inclusion of gross income in the year received by the taxpayer. The applicability of all three sections depends upon whether a sum equal to depletion deductions allowed in prior years may be treated as income for 1937. Petitioners deny that this may be done and rely for the soundness of their position upon the familiar principle of annual computation of income, “as the net result of all transactions within the year.” Burnet v. Sanford & Brooks Co., 282 U.S. 359, 365.
The manner in which the Commissioner exercised that power by attributing the sums restored to basis to the 1937 income, rather than to the years 1929 to 1936, is not invalid as an arbitrary penalty or an improper attribution under the theory of an annual period for determination of income taxes. On the termination of the lease, the
C. The last contention of petitioners for our consideration is that where depletion deductions were taken in years when no equivalent tax benefit resulted, the amount of the deduction which resulted in no tax benefit should not be attributed to the year of the surrender of the lease. This question arises only in No. 131. The Board of Tax Appeals refused to allow the addition to the 1937 income of the taxpayer of sums which represented the amount of deductions for depletion beyond amounts of deductions which offset income. The Circuit Court of Appeals reversed.
Upon this last point, the decision below in No. 131 is affirmed by an equally divided court. The members of this Court who join in the dissent do not reach this question but their position on other issues results in their voting for a reversal of the entire judgment of the Circuit Court of Appeals. Two other members of this Court are of the view that in No. 131 the judgment of the Circuit Court of Appeals should be reversed and that the decision of the Board of Tax Appeals should be affirmed.
In Nos. 130, 132 and 133, the foregoing leads us to the conclusion that the regulations are valid and the judgments of the Circuit Court of Appeals are
Affirmed.
MR. JUSTICE JACKSON took no part in the consideration or decision of this case.
MR. JUSTICE RUTLEDGE, dissenting:
In my opinion Article 23 (m)-10 (c) is not a reasonable exercise of the rule-making authority conferred by § 23.
In requiring that “a corresponding amount must be returned as income for the year in which the lease expires, terminates, or is abandoned,” the regulation piles up as “income” for a single year the sum of all the deductions taken in the previous ones. Wholly apart from whether in theory or in fact “income” can be said to be realized by thus piling up the deductions,1 this requirement imposes risks and burdens upon taking the deduction heavier than any advantage to be gained from it and therefore prohibitive.
The consequences hardly could be illustrated better than by the case of Bessie P. Douglas. By taking the deduction during the eight years when she received advance royalties, 1929 to 1936 inclusive, she saved a total in taxes of about $7,000. Then her lease was canceled by the lessee. And in 1937, a year in which she received no cash return from the lease, her tax liability was increased by
The regulation‘s destructive effect bears on all who receive advance royalties, not merely on those who actually must return accumulated prior deductions as “income” in a single year. The taxpayer must take the deduction, if at all, as his royalties accrue, not later as the ore is removed. The system of annual accounting is said to require this. Cf. Burnet v. Thompson Oil & Gas Co., 283 U.S. 301, 306; Burnet v. Sanford & Brooks Co., 282 U.S. 359. Yet it is said also to require that the deductions be telescoped into “income” for a single year in which the returns they represent are not received, and with an effect in tax burden, by the mere fact of the aggregation, far beyond any which would be imposed if the deductions never had been authorized or taken. Hence all who receive advance royalties are faced with the choice of taking the deductions and thus risking this pyramiding of “income,” against the chance the lessee will some day deplete the property, or of foregoing the deductions altogether.
It is true the taxpayer may receive an economic benefit in the release of his ore from the right of another to remove it. And by the regulation‘s requirement that he restore to his capital account an amount equal to the sum of the accumulated deductions, he also receives a possible future tax benefit in larger deductions allowable if and when he sells or leases the minerals again. But these benefits are wholly uncertain. In fact, release of his ore from the right of removal gives him not income then realized in cash to the amount of accumulated deductions, but unsold ore in the ground which the lessee has found it unprofitable to remove although he has paid for it. The only contingency on which the taxpayer really benefits by the deductions is in the event the lessee ultimately does deplete the property. But it is difficult to
Nor is the regulation reasonably adapted to recoupment of the losses in revenue, wholly proper when incurred but which later events require to be made up. On the contrary, it perverts recoupment by pyramiding income spread in receipt over many years into “income” received in a single, entirely different one. And in a day when the tax rate mounts more often than yearly the skyrocketing effect of the process operates with wholly incalculable effect on the taxpayer, who it will be noted has no control over the contingency which brings it into play.
A regulation which would require the taxpayer to pay the taxes deducted for the prior years together with the usual interest and penalties would be harsh enough in discouragement of taking the deduction. In effect it would penalize one who rightfully takes an allowance as much as one who wrongfully does so. But, even so, this would bear some semblance of reasonable relation to recouping the losses sustained by the revenue and to allocating income to the year in which it is received. However, to amalgamate the deductions into “income” for a single year, in which none of it is actually received, is an entirely different thing. It is to make of the so-called scheme of deductions a snare for the unwary who violate no law
The regulation, therefore, both effectively nullifies a privilege which Congress provided the taxpayer shall have and reaches farther than any reasonable recouping provision should go. It is no answer to say deduction is a privilege which Congress need not have extended, or having extended can qualify out of existence. The question is whether Congress did, or authorized the Commissioner to do, the latter. Its language, its prior treatment of the problem3 and its treatment of a related problem in the identical section of the Revenue Act all point to the conclusion it did neither.
Other questions are raised on the record. It is unnecessary to consider them. In my opinion Congress would not have nullified its grant of the privilege to take “a reasonable allowance for depletion” by enacting Article 23 (m)-10 (c) to make exercising it so hazardous, capricious, and unjust in consequence.4 That being true, I do not think authority was delegated to the Commissioner to adopt or to the Secretary to approve it. I would reverse the judgment.
MR. JUSTICE MURPHY joins in this opinion.