Source: https://supreme.justia.com/cases/federal/us/288/459/
Timestamp: 2019-04-22 18:42:33+00:00

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Justia › US Law › US Case Law › US Supreme Court › Volume 288 › United States v. Dakota-Montana Oil Co.
Section 234(a)(8) of the Revenue Act of 1926, provides that, in the case of oil wells, the taxpayer shall have, as a deduction from gross income, "a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions of each case," to be made under departmental rules and regulations. Section 204 permits the taxpayer to calculate depletion on the basis of cost alone, or else to deduct an arbitrary allowance, fixed by the statute, without reference to cost or discovery value at 27% of gross income from the well. Held, construing these in the light of earlier provisions and administrative construction, that the capitalized cost of drilling, as distinguished from cost of physical property such as machinery, tools, equipment, pipes, etc., is subject to depletion allowance, and not to depreciation allowance. Pp. 288 U. S. 460, 288 U. S. 466.
Certiorari, 287 U.S. 591, to review a judgment against the United States on a claim for money collected as income taxes.
Respondent, a North Dakota corporation, in making its tax return of income derived from its operation of oil wells in 1926, claimed a deduction from gross income of a depreciation allowance on account of the capitalized costs of preliminary development and drilling. The Commissioner refused to allow the deduction claimed, ruling that it was for depletion, not depreciation, and was therefore included in the statutory depletion allowance of 27 1/2 percent of the gross income, which the respondent had also deducted. §§ 204(c), 234(a)(8), Revenue Act of 1926, c. 27, 44 Stat. 9, 14, 16, 41. Having paid the correspondingly increased tax, respondent brought this suit in the Court of Claims to recover the excess. The court gave judgment for respondent, holding that the development and drilling costs were the proper subjects of a depreciation allowance which should have been made in addition to that for depletion. 59 F.2d 853. This Court granted certiorari to resolve a conflict of the decision below with that of the Circuit Court of Appeals for the Fourth Circuit in Burnet v. Petroleum Exploration, 61 F.2d 273.
latter event, which is the case here, "insofar as such expense is represented by physical property, it may be taken into account in determining a reasonable allowance for depreciation," which, if the arbitrary deduction for depletion were claimed, would constitute an additional allowance. Article 225 limits the depreciation for which an allowance may be made to that of "physical property, such as machinery, tools, equipment, pipes," etc. We do not doubt that the effect of this language is to require the taxpayer to look to the depletion allowance, in this case 27 1/2 percent of gross income, for a return of the costs of developing and drilling the well, which are involved here.
Respondent challenges the validity of the regulations thus applied as in conflict with § 234(a)(8), which allows the deduction of a reasonable allowance "for depreciation of improvements" in addition to the deduction for depletion. It is urged that the drill hole is an "improvement" of the taxpayer's oil land, and that no logical distinction in accounting practice can be made between the cost of this improvement and the cost of buildings and machinery placed on the property for the operation of the well, for which depreciation should admittedly be allowed.
The government argues that the well itself is not tangible physical property which wears out with use so as properly to be the subject of depreciation, and that, in any event, the regulations are based upon the practices of the oil industry, and are within the requirements of § 234(a)(8) that a reasonable allowance for depletion and depreciation of improvements be made in all cases under rules and regulations to be prescribed by the Treasury Department.
used in production, or whether an allowance for the former serves a purpose logically distinguishable from one for the latter. For the issue before us, whether the statute requires the former to be treated as depletion, is resolved by the history of the legislation and the administrative practice under it.
The Revenue Act of 1916 permitted the deduction of a reasonable allowance for the "exhaustion, wear and tear of property" used in a business or trade, and, in the case of oil and gas wells, "a reasonable allowance for actual reduction in flow and production." § 12(b) Second. The regulations authorized the deduction of an annual allowance for "depreciation," and, in the case of oil and gas wells, for "depletion" (Treasury Regulations 33, Arts. 159, 160, 162, 170), but ruled that no annual deduction for "obsolescence" was authorized by the statute in any case; such a loss, it was provided, might only be deducted in the year when it became complete by abandonment of the property as no longer useful. See Arts. 162, 178, 179 of Treasury Regulations 33; Gambrinus Brewery Co. v. Anderson, 282 U. S. 638, 282 U. S. 643. In defining these terms, therefore, the Department was apparently faced with the practical consequence that no annual deduction could be made in anticipation of those losses which it regarded as attributable to obsolescence, while such a deduction might be made for those which it attributed to depreciation or depletion. Depreciation was defined generally to include the wear and tear and exhaustion of property by use, and obsolescence the loss in value of property due to the fact that, because of changing conditions, it has ceased to be useful.
ruled that it was not to be treated as obsolescence by declaring that the purpose of the statutory provision relative to oil wells was to return, through the aggregate of annual depletion deductions, the taxpayer's capital investment in the oil, including "the cost of development (other than the cost of physical property incident to such development)." Article 170 thus contemplated that an annual deduction should be made for costs of development by including them in the cost of the oil in the ground for which a depletion allowance was authorized by § 12(b), Second, "for actual reduction in flow and production."
was discovery value, rather than cost. [Footnote 6] In answering these questions, the Department adhered to and made explicit the position taken by it under the 1916 Act that development costs other than the cost of physical property incident to the development must be returned through the depletion allowance, but the regulations also provided expressly that the cost of "physical property such as machinery, tools, equipment, pipes, etc.," should be returned by an annual allowance for depreciation. Articles 223, 225 of Treasury Regulations 45 under the Revenue Act of 1918. The distinction thus taken was continued in the regulations under the Revenue Acts of 1921, 1924, and 1926, [Footnote 7] although, beginning with that of 1924, the express declaration of the statute, already noted, that the cost basis for depletion and depreciation of improvements should include costs of development was eliminated, leaving the broad provision that a reasonable allowance should in all cases be made under rules and regulations to be prescribed by the Commissioner, with the approval of the Secretary.
drilling and operation of the well, the oil or gas content of the particular sand, zone or reservoir . . . in which the discovery was made by the drilling, and from which the production is drawn."
Thus, the Acts of 1918, 1921, and 1924 were consistently construed by the regulations to permit a depletion, but not a depreciation allowance for the costs of development work and drilling, which were treated for this purpose either as a part of the cost or an addition to the discovery value of the oil in the ground. The administrative construction must be deemed to have received legislative approval by the reenactment of the statutory provision, without material change. Murphy Oil Co. v. Burnet, 287 U. S. 299; Brewster v. Gage, 280 U. S. 327, 280 U. S. 337.
It is true that the Board of Tax Appeals, in construing the 1924 and 1926 Acts, has held that capitalized drilling costs are subject to a depreciation, rather than a depletion allowance. Jergins Trust v. Commissioner, 22 B.T.A. 551; Ziegler v. Commissioner, 23 B.T.A. 1091; P-M-K Petroleum Co. v. Commissioner, 24 B.T.A. 360. But these cases were all decided after the enactment of the 1926 Act, and did not consider the administrative and legislative history, which we think decisive.
§ 234(a)(9), Revenue Act of 1918; § 234(a)(9), Revenue Act of 1921; § 234(a)(8), Revenue Act of 1924.
§ 234(a)(9), Revenue Act of 1918; § 234(a)(3), Revenue Act of 1921; § 204(c), Revenue Act of 1924.
§ 234(a)(7) of the Revenue Acts of 1918, 1921, 1924 and 1926.
The discoverer of an oil well upon an unproven tract was permitted for the first time by § 234(a)(9) of the Revenue Act of 1918 to calculate the allowance for depletion upon the basis of the value of the "property" at the time of the discovery or within thirty days thereafter. See note 2 supra. The statute was silent as to the inclusion of development costs.
Arts. 223, 225, of Treasury Regulations 62, 69; Arts. 225, 227, of Treasury Regulations 65.
Articles 220(a)(3) of Treasury Regulations 62 and 222(3) of Treasury Regulations 65.
See Senate Report No. 52, 69th Congress, 1st Session, pp. 17, 18.
Compare also Treasury Decision 4333, Internal Revenue Bulletin XI, April 11, 1932, No. 15, pp. 2, 3.

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