Court Opinion

ID: 9685364
Source: CourtListenerOpinion
Date Created: 2023-08-24 14:34:41.924162+00
Date Added: 2024-06-11T18:18:05.185683
License: Public Domain

Shepherd, J.
(dissenting). I respectfully dissent. In this case the majority concludes that certain payments, called leasehold bonuses, constitute royalties for purposes of the Michigan Single Business Tax and must be "added back” to petitioner’s *429federal taxable income to arrive at petitioner’s "tax base” under the sbta. MCL 208.9(4)(g); MSA 7.558(9)(4)(g).
Petitioner is in the business of exploring and developing oil and gas reserves. Petitioner researches and investigates properties with potential oil and gas reserves. Petitioner then enters into leases with the owners of property with reserve potential for the purpose of exploring and developing the potential oil and gas reserve. Included in the lease is a royalty provision which grants the landowner a certain percentage share of the profit if, and only if, the leased property proves to be productive. The landowner also receives a "leasehold bonus” as consideration for signing the lease agreement. The amount of this one-time, unconditional bonus payment depends on a number of factors but it is not dependent on the productivity of the well. In other words, the bonus differs from a royalty in that the bonus is unconditional, given as consideration for signing the lease and the productivity of the leased property is not a factor in its payment.
Moreover, authoritative oil and gas law treatises apparently agree that there is a distinction between "royalties” and a "leasehold bonus” in the industry:
Bonus may be defined as a payment made for the execution of an oil and gas lease. It represents market value for a "sale” of the minerals to the lessee. The amount of bonus paid, usually referred to as a per acre amount, may fluctuate widely between properties, depending upon the nature of the development activity in the vicinity. If the land is located in a semi-proven area, or in a logical extension of a proven field the bonus paid may be substantial. On the other hand, if located in a wildcat area, i.e., a new area of development, *430or one which has been partially condemned by the drilling of dry holes, the sum may be quite small. Where a lease is abandoned before the end of the first year of the primary term, bonus may constitute the entire return to the landowner.
Although bonus is usually paid in cash, when the amount of bonus is large, a portion may be paid on a deferred basis, out of future production. This may be advantageous to the landowner as it will prevent bunching of income into any particular taxable year.
As stated above, bonus may be defined as a sum paid for the execution of an oil and gas lease, whereas royalty represents the landowner’s share in the fruits of any oil and gas development activity. [Hemingway, The Law of Oil and Gas (2d ed), §§ 2.4, 2.6, pp 50-51, 61.]
See also 8 Williams & Meyers, Oil & Gas Law, Manual of Terms (1987), pp 87-89, 856-858.
Even more significant is the treatment the two types of payments receive under federal tax law. Treas Reg 1.612-3(a)(3) (1987) provides in pertinent part:
In the case of the payor, payment of the bonus constitutes a capital investment made for the acquisition of an economic interest in a mineral deposit or standing timber recoverable through the depletion allowance.
Consistent with the treasury regulation, petitioner expenses royalties in the year in which they are paid, but leasehold bonuses are considered lease costs and are capitalized. Petitioner initially enters all leasehold bonus costs on its books in a capital account established for undeveloped properties. If a particular leased property proves productive, the applicable leasehold bonus costs are *431transferred to a productive properties account, amortized and depleted over the life of the lease term. Depletion deductions are allowed under the sbta, and thus leasehold bonuses paid on productive properties are not subject to taxation.
If a property proves unproductive, i.e., either it is uneconomical or dry, the lease is viewed as valueless and the costs associated with the lease, including any undepleted bonus costs, are deducted as losses, consistent with federal tax rules and regulations, during the year of expiration or release of such lease. In other words, petitioner, as lessee, has acquired a capital asset, i.e., the lease, whose value is unknown at the time of purchase. Federal regulations allow for the loss in value of this asset.
Although leasehold bonuses and royalties are treated differently both in the oil and gas industry and by the federal tax laws, respondent claims that the bonus is a royalty for sbta purposes. Royalty is undefined in the sbta. The majority relies on the following statutory provision in its decision:
(2) A term used in this act and not defined differently shall have the same meaning as when used in comparable context in the laws of the United States relating to federal income taxes in effect for the tax year unless a different meaning is clearly required. A reference in this act to the internal revenue code includes other provisions of the laws of the United States relating to federal income taxes. [MCL 208.2(2); MSA 7.558(2X2).]
I emphasize "in comparable context” because the majority ignores this key phrase when it points to two federal decisions which hold that cash bonuses and royalties in the hands of the lessor should be treated alike for federal income *432tax purposes. See Anderson v Helvering, 310 US 404; 60 S Ct 952; 84 L Ed 1277 (1940); Comm’r of Internal Revenue v Clarion Oil Co, 80 US App DC 41; 148 F2d 671 (1945), cert den 325 US 881 (1945). I cannot concur in the view that this is a "comparable context.” Federal tax regulations require the bonus to be capitalized. Under the federal scheme such investment costs are covered by a depletion allowance, presumably designed to encourage exploration and development of natural resources, including oil and gas. Given the substantive distinction between the two payments, I do not believe that leasehold bonuses fit within the definition of royalty under the sbta. Therefore, I would conclude that petitioner is not required to add back its leasehold bonus costs for Michigan tax assessment purposes.