Court Opinion

ID: 9636696
Source: CourtListenerOpinion
Date Created: 2023-08-22 14:39:45.482746+00
Date Added: 2024-06-11T18:09:48.181170
License: Public Domain

WILBUR, Circuit Judge (dissenting).
In the case at bar three items involved aggregating $91,832.28 have been claimed by the petitioner as its expenditures in the ordinary course of its business to be deducted from gross income in determining its net income, estimated without the depletion allowance. This deduction has been allowed. The law also authorizes a further deduction from the net income so determined of a depletion allowance, but provides that it shall not exceed one-half of thfe net “income from the property” estimated without the depletion allowance. The Commissioner has determined the “net income from the property” in the same way that he has determined the “net income of the taxpayer” (without depletion),” that is by deducting the operating expense claimed by the taxpayer which includes the so-called “development expense” to determine the net income from its property. The taxpayer contends that a current expense of the business of operating an oil company’s oil property is not a true operating expense of operating such property where the expense of operation may be, but is not capitalized at the election of the taxpayer. To state the proposition in the language of the petitioner’s brief, we quote as follows :
“The latter article (Arts. 223 and 201 [h] of Regs. 62) requires the deduction of ‘operating expenses’ in arriving at ‘net income * * * from the property.’ But ‘development expenses,’ which are of such a nature and character that they may properly be capitalized, as recognized in Art. 223, are, and since Regs. 62 always have been, regarded as different and distinct from true ‘operating expenses,’ which are of such a nature as not properly to permit of their being capitalized.”
I find no difficulty in concurring with my brethren upon the subject of the deduction of operating expenses only in ascertaining the net income “from the property.” I differ from them in the idea that the expenditures upon oil property have a fixed status as an operating expense on the one hand, or a development expense, a capital investment, on the other. In my opinion, it is in any case money out of pocket in the current year which may be treated as an expense, or a capital investment as the taxpayer elects, according to the rule of the Internal Revenue Department.
When he does elect, he should be held to his election. This is in accordance with the Treasury regulations (Reg. 69, art. 223) adopted in pursuance of the statute (Revenue Act 1926, § 234 (a) (8) requiring the Commissioner to adopt such rules for fixing “ * * * a reasonable allowance for depletion.” The regulations provide that “such incidental expenses as are paid for wages, fuel, repairs, hauling, etc., in connection with the exploration of the property, drilling of wells, building of pipe lines, and development of the property may at the option of the taxpayer be deducted as a development expense or charged to capital account returnable through depletion. * * An election once made under the provisions of this article will control the taxpayer’s returns for all subsequent years.” Treasury Regulations 69, adopted under the Revenue Act of 1926, art. 223. As the Supreme Court stated in U. S. v. Dakota-Montana Oil Co., 288 U.S. 459, 53 S.Ct. 435, 436, 77 L.Ed. 893, “Article 223 purports to permit the taxpayer to choose whether to deduct costs of development and drilling as a development expense in the year in which they occur or else to charge them ‘to capital account returnable through depletion.’ ” Aside from the question of the effect of an election by the taxpayer to treat development expense as a current expense it is clear that the expense of drilling a well may be treated either as a capital investment, or as an expense, depending in part upon whether or not the - income of the property is sufficient to justify the expenditure of that sum from the current income. *484Whether or not a developing expense should be treated as a current or operating expense and as'such deductible from current income in estimating the income tax or whether it should be treated as an investment of capital not deductible from current income, and when so considered, to be added to the capital, to be recovered by subsequent deductions from gross income by either a depreciation or a depletion allowance, is one which cannot be settled by the application of an arbitrary legal rule. It must depend upon the situation of the party and also upon his election as to whether he will treat the expenditure as an operative expense or as a capital investment as manifested by his bookkeeping system or by his return for income tax purposes. This is a factual question. It is somewhat analogous to the question of overhead expenses in the development of a public utility property. Many items of overhead may be treated as current expenditures on the one hand, or as á capital investment on the other. See discussion in my concurring opinion in the Los Angeles Gas & Electric Corp. v. Railroad Comm. (D.C.) 58 F.(2d) 256, 267, a rate case. See, also, the majority opinion by Judge James in that case, 58 F.(2d) 256, 260, 261. We there held that the public utility company should not be permitted to shift its ground and claim that amounts apportioned to current expense and thus paid by the consumers, should be subsequently treated as a capital investment upon which compensatory rates should be allowed to the company. This principle was recognized and apparently approved by the Supreme Court speaking through Chief Justice Hughes in that case, 289 U.S. 287, 293, 294, 309, 310 311, 317, 53 S.Ct. 637, 77 L. Ed. 1180. See, also, discussion as to going concern value, 289 U.S. 316, 317, 53 S.Ct. 648, 77 L.Ed. 1180, and dissent of Justice Butler, 289 U.S. 323, 53 S.Ct. 650, 77 L.Ed. 1180.
In dealing with the question of the allowance for depletion of’mineral properties in income tax matters, it should be remembered that the allowance for depletion is made as a deduction for capital returned by the sale of the minerals or oil recovered. That is to say, depletion is capital extracted from the property. This capital has been commingled with the income or profit derived from the property and must be deducted from the gross returns in ascertaining the profit or income from the property. See discussion in Murphy Oil Co. v. Burnet (C.C.A.) 55 F.(2d) 17; Id., 287 U.S. 299, 306, 53 S.Ct. 161, 77 L.Ed. 318. (If, therefore, the taxpayer treats the development expense as a capital investment, his depletion allowance should be correspondingly increased (see U. S. v. Dakota-Montana Oil Co., supra) whereas if he treats the expenditure as an operating expense to be deducted from current income, it should not be also added to the capital investment and again recovered in the form of a depletion allowance deducted from gross income.
It should be observed here, that under the statutory formula for ascertaining the depletion allowance, it is increased by treating the development expenditure as a capital investment, as it should be, because such capital must be recovered through the depletion allowance. On the other hand its deduction as an operating expense correspondingly decreased the depletion allowance which is given for the recovery of capital. It is true that in the arbitrary legislative formulae the allowance of 27% per cent, of the gross income from the property as a return of capital, allows no flexibility as to return of capital investment from the property, but the qualifying clause for fixing the depletion allowance now under consideration does respond in a measure to this principle of an allowance for return of capital as illustrated in the case at bar; for if the taxpayer treats the development expense as capital investment it at once receives a return by way of depletion allowance of about 50 per cent, thereof as a capital return, whereas if it treats it as a current expense or operating expense it gets it all as a deduction to be at once subtracted from his gross income and not as a depletion allowance. ' This is as it should be for having been returned to the taxpayer as an allowable deduction from the gross income it represents no investment of capital and consequently should not figure in the depletion allowance of that year or any other. If development expense is treated as a capital investment for the purpose of fixing the depletion allowance, it should be treated as a capital investment in determining the taxable net income, and vice versa. If treated as a capital investment, 50 per cent, is deducted at once in the form of a depletion allowance; if treated as a current expense, 100 per cent, is at once deducted, but in no event should the taxpayer have a 150 per cent, deduction. The taxpayer should not be permitted to blow hot and cold in the matter but should be held to his election.
The order should be affirmed.