Laird v. Commissioner

ROY H. LAIRD, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Laird v. Commissioner Docket No. 79760. United States Board of Tax Appeals 35 B.T.A. 75; 1936 BTA LEXIS 568; November 13, 1936, Promulgated *568 1. Petitioner, the owner of certain oil and gas leases, in 1931 sold his entire interest therein for a cash consideration, retaining no interest in the production of oil from the property or the proceeds thereof. Held, that the transaction constituted a sale of property upon which petitioner is entitled to compute his profit upon the basis of the cost to thim of the leases sold, but is not entitled to percentage depletion upon the cash consideration under section 114(b)(3) of the Revenue Act of 1928. 2. Upon sale of Texas oil leases for cash and certain deferred payments to be made out of oil if and when produced from the property covered by the leases assigned, the vendor is not entitled to percentage depletion as to the cash received, as such payment, unconnected with production of oil, is to be dealt with as representing a conversion of capital by sale; but the vendor is entitled to the percentage depletion deduction on the deferred payments thus received. 3. Petitioner, owning certain oil and gas lands in fee, executed leases thereon for which he received cash bonuses and reserved a one-eighth royalty interest, together with a further right to receive a sum certain*569 out of oil, if and when produced. Held, that petitioner is entitled to percentage depletion upon the bonus and deferred oil payments received, as well as upon the proceeds of the one-eighth royalty interest reserved. Robert Ash, Esq., and H. I. Wilhelm, C.P.A., for the petitioner. Eugene Smith, Esq., for the respondent. BLACK *75 This proceeding involves a deficiency in income taxes for the calendar year 1931 determined against petitioner in the amount of $1,937.70. We find the facts as stipulated, as follows: FINDINGS OF FACT. I. The Petitioner is an individual, who resides in Kilgore, Texas, and who during the year 1931 was unmarried. II. The Petitioner kept his books on a cash receipts and disbursements basis and his income tax return was filed on that basis. III. The Petitioner owned certain oil and gas leases, in the usual Texas form on land in the Tom O'Bar, Sevier and John A. Snow Surveys, which were acquired at an aggregate cost of $3,101.85. During the calendar year 1931, thePetitioner assigned his entire interests in the said leases for cash bonuses aggregating *76 $35,420.00. The assignments*570 of these leases contained no reservation of interest to this Petitioner either in the form of royalties or otherwise. ThePetitioner claimed a credit for statutory depletion on these cash bonuses. The Respondent denied the said depletion deduction. IV. During the calendar year 1931, the Petitioner owned certain oil and gas leases in the usual Texas form on land in the Sevier and John A. Snow Surveys, which has an aggregate cost of $2,325.08. During the calendar year 1931, the Petitioner executed assignments of these leases for which he received cash bonuses aggregating $18,472.50, together with the right to receive $29,472.50 payable out of oil, if and when produced. Other than the right to receive $29,472.50 payable out of oil, if and when produced, the assignments of these leases contained no reservation of interest to this Petitioner either in the form of royalties or otherwise. During the year 1931, the Petitioner received $3,166.55 on account of the oil payments above referred to. Petitioner claimed statutory depletion on the said cash honuses and on the amount received on account of the oil payment. The Respondent denied the said depletion deduction. V. During*571 the year 1931, the Petitioner executed certain oil and gas leases in the usual Texas form, reserving unto himself the usual 1/8 royalty interest, on lands owned in fee in Gregg and Rusk Counties, Texas, and received therefor cash bonuses aggregating $33,802.50 and the right to receive $136,926.25 out of oil, if and when produced. During the calendar year 1931, Petitioner received $15,677.45 on account of the oil payments. The Petitioner claimed depletion on the cash bonuses and on the $15,677.45 received on account of the oil payments. The Respondent allowed depletion on the cash bonuses, but disallowed depletion on the oil payments. OPINION. BLACK: Petitioner in his brief succinctly states the issues raised in the petition as follows: The issues involved in this case have to do with allowable depletion on three kinds of lease transactions; first, the assignment of the entire interest in a lease for cash; second, the assignment of a lease-interest for cash and the right to receive certain stipulated amounts from the oil, if, as and when produced; and, third, the granting of a lease on fee land for a cash consideration plus the right to receive certain stipulated amounts*572 from the oil, if, as and when produced. The stipulation of facts with respect to the first issue involving petitioner's right to depletion upon an amount of $35,420, received as a cash consideration for the conveyance of all of his interest in certain leases, refers to this payment as a "bonus." That stipulation, however, shows that this payment is in no sense a bonus for the execution of a lease or other conveyance of interests in oil properties, but is the entire consideration paid. The transaction was merely a sale of property for cash consideration and the issue is controlled *77 by our decision in . See also ; ; certiorari denied, . Petitioner is not entitled to depletion upon the consideration received. The second issue is whether petitioner has a right to depletion on certain amounts received under contracts by which he assigned certain oil leases owned by him for a consideration, including a cash payment in a stipulated amount, and deferred payments to be made from the proceeds*573 of oil, if and when produced from the properties. No percentage oil royalty was reserved by petitioner on the assignment of these leases. Respondent has disallowed depletion deductions on both the cash payment received and the payments realized under the contract from the proceeds of oil produced. The Revenue Act of 1928, section 114(b)(1) and (b)(3), is controlling. 1 *574 Petitioner's right to deductions for depletion at the rate of 27 1/2 percent on $3,166.55 received by him under the contract which gave him the right to receive $29,472.50 payable out of oil if and when produced, seems clear. ; ; affd., ; ; ; ; ; affd., . We hold that petitioner is entitled to percentage depletion on this payment of $3,166.55 out of oil produced. Petitioner also claims the right to a 27 1/2 percent deduction on the so-called cash bonus aggregating $18,472.50 received in the transaction involved in paragraph IV of the findings of fact. The $18,472.50 in question was not paid as a true bonus or advanced royalty in anticipation of future oil production such as was present in *575 ; , where a percentage oil royalty was reserved by the assignor or sublessor. It was received as a cash payment for the assignment of leases. These leases had an aggregate cost of $2,325.08 and we assume the Commissioner in computing the gain in this transaction *78 has allowed a recovery of the entire cost basis of the leases assigned. There is no contention to the contrary. In , we denied to the taxpayer percentage depletion under section 114(b)(3) of the Revenue Act of 1928 of a cash payment of the character here presented. Our decision was affirmed by the United States Circuit Court of Appeals, Fifth Circuit. See . In the Fleming case the court held that upon the sale of Texas oil leases for cash and a share of the oil when produced, the vendor is not entitled to percentage depletion as to the cash received, as such money payment, unconnected with production of oil, is to be dealt with as representing a conversion of capital by sale. The court further held*576 that the vendor is entitled to the percentage depletion deduction as to his income from the sale of oil produced. We are unable to distinguish the cash payment of $18,472.50 here in question from the cash payment involved in the Fleming case and therefore, following the Fleming case, we affirm the Commissioner in his disallowance of percentage depletion on the cash payment in question. The third issue involves the correctness of respondent's action in disallowing petitioner's claim for depletion upon payments received from oil production under leases granted by him on lands owned by him in fee, where a percentage oil royalty was reserved. As to these leases it is stipulated: The petitioner executed certain oil and gas leases in the usual Texas form, reserving unto himself the usual 1/8 royalty interest * * * and received therefor cash bonuses aggregating $33,802.50 and the right to receive $136,926.25 out of oil, if and when produced. During the calendar year 1931, petitioner received $15,677.45 on account of the oil payments. The petitioner claimed depletion on the cash bonuses and on the $15,677.45 received on account of the oil payments. The respondent allowed*577 depletion on the cash bonuses, but disallowed depletion on the oil payments. We reverse the action of respondent in disallowing percentage depletion on the $15,677.45 received by petitioner on account of the oil payments. ; Reviewed by the Board. Decision will be entered under Rule 50. LEECH LEECH, dissenting: I dissent on the second point. The majority opinion relies upon Fleming v. Commissioner, 82 Fed.(2d) 324, which affirmed the result but discarded the Board's reasoning in 31 B.T.A. 623, on the present issue. Both cases involve identical facts on this issue. Both opinions decided that, in the lease transaction, the taxpayer retained an economic interest in the oil in place. That *79 transaction is then segregated, and the deferred payments from the oil production are held to be income from the economic interest retained, and therefore depletable. But the court and the majority opinion of the Board then refused depletion on the bonus or cash payment, on the ground that such payment was consideration for the absolute*578 sale of something. In my judgment, this is exactly what the Supreme Court refused to do in , arising under section 214(a)(10) of the Revenue Act of 1921, and again in , involving section 214(a)(9) of the Revenue Act of 1926, which is similar to the depletion provisions in the Revenue Act of 1928. The tax-free recovery, by the taxpayer, of his statutory investment in the property is the basis of all these provisions. The method of computation, only, was changed. . In the Herring case, the Supreme Court held that, in such a transaction, where the taxpayer retained an economic interest in the oil in place, the bonus or cash consideration was income from that economic interest, and subject to depletion, even though no production at all occurred on the lease during the year when the taxpayer received the bonus. Certainly, neither the actual source of the funds with which the bonus was paid to the taxpayer, nor the legal relationship existing between the parties, was considered controlling in either*579 the Palmer or Herring cases. I think the rule in such cases is that when the taxpayer retains an economic interest in the oil in place, the bonus or cash consideration, from whatever the payor's source, as well as the deferred payments from the oil, are gross income to the owner from that retained economic interest, and are, therefore, subject to the depletion allowance. ;;; ; ; . Here the retention of any "economic interest in the oil in place" may be debatable. However, I agree with the Fleming case and the majority opinion of the Board here that the taxpayer did retain such an interest. ; ; affd., *580 ; ; . But, since he did retain such an economic interest, I think that the bonus, as well as the deferred payments, were income from that economic interest, and both are, therefore, depletable. ; SMITH, MORRIS, VAN FOSSAN, and TYSON agree with this dissent. Footnotes 1. SEC. 114. BASIS FOR DEPRECIATION AND DEPLETION. (b) Basis for depletion. - (1) GENERAL RULE. - The basis upon which depletion is to be allowed in respect of any property shall be the same as is provided in section 113 for the purpose of determining the gain or loss upon the sale or other disposition of such property, except as provided in paragraphs (2) and (3) of this subsection. * * * (3) PERCENTAGE DEPLETION FOR OIL AND GAS WELLS. - In the case of oil and gas wells the allowance for depletion shall be 27 1/2 per centum of the gross income from the property during the taxable year. Such allowance shall not exceed 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property, except that in no case shall the depletion allowance be less than it would be if computed without reference to this paragraph. ↩