Court Opinion

ID: 4489328
Source: CourtListenerOpinion
Date Created: 2020-01-17 22:01:47.498149+00
Date Added: 2024-06-11T15:03:54.203714
License: Public Domain

Teammell,
dissenting: The deduction allowed for depletion in the case of mines is a special application of the general rule of the statute allowing a deduction for exhaustion of property. Lynch v. Alworth-Stephens Co., 267 U. S. 364. The end sought in an exhaustion allowancé is to have the capital sum invested in a wasting asset returned to the taxpayer as a charge against receipts annually realized from the asset and in this way avoid taxing a return of capital. The entire amount of such receipts is not taxable, but only so much thereof as does not represent a return of capital. Edith Andrews Logan, 12 B. T. A. 586. In essence, the deduction for depletion does not differ from the deduction for depreciation, and the proviso limiting the amount of such deductions to the amount of the capital invested shows that such deductions are to be regarded as a return of capital. United States v. Ludey, 274 U. S. 295.
In the case of oil wells operated by a lessee, the value of the lease contract is at all times in proportion to the recoverable oil content. As the oil is pumped out, the value of the lease is correspondingly diminished, so that when the oil reserve is fully exhausted, the value of the lease is likewise exhausted, and no part of the capital asset remains. The process is comparable to the gradual sale of the lease in units measured by the barrels of oil recovered and sold. The proceeds from the sale of the oil represent in part a return of capital and in part taxable income.
In United States v. Ludey, supra, the court in the course of its opinion said:
The depreciation charge permitted as a deduction from the gross income in determining the taxable income of a business for any year represents the reduction, during the year, of the capital assets through wear and tear of the *1000plant, used. The amount of the allowance for depreciation is the sum which should be set aside for the taxable year, in order that, at the end of the useful life of the plant in the business, the aggregate of the sums set aside will (with the salvage value) suffice to provide an amount equal to the original cost. The theory underlying this allowance for depreciation is that by using up the plant a gradual sale is made of it. The depreciation charged is the measure of the cost of the part which has been sold. When the plant is disposed of after years of use, the thing then sold is not the whole thing originally acquired. The amount of the depreciation must be deducted from the original cost of the whole in order to determine the cost of that disposed of in the final sale of properties. Any other construction would permit a double deduction for the loss of the same capital assets.
* $ Sfc ⅜5 # ⅜
The depletion charge permitted as a deduction from the gross income in determining the taxable income of mines for any year represents the reduction in the mineral contents of the reserves from which the product is taken. The reserves are recognized as wasting assets. The depletion effected by operation is likened to the using up of raw material in making the product of a manufacturing establishment. As the cost of the raw material must be deducted firom the gross income before the net income can be determined, so the estimated cost of the part of the reserve used up is allowed.
In tlie Ludey case, the court had before it the question of whether a gain was realized or a loss sustained upon the sale in 1917 of oil mining properties and the solution of the question depended primarily on whether deductions for depletion and depreciation were to be made from the original cost. The property consisted, besides mining equipment, in part of oil land held in fee, and in part of oil mining leases, which Had been owned and operated by Ludey for several years. The tax in controversy was computed on the basis of cost reduced by the full amount of depreciation and depletion sustained, whether or not allowable by law as a deduction from gross income in past years, and the Government contended that this was the correct basis for the computation. On the other hand, Ludey contended that the correct basis for determining gain or loss on the sale of his property was original cost reduced by an amount not in excess of the deductions actually claimed by and allowed to him during the years from 1913 to 1916 on account of depletion and depreciation, without regard to the amount he Avas entitled to deduct under the law. The court declined to accept either contention, saying:
Congress doubtless intended that the deduction to be made from the original cost should be the aggregate amount which the taxpayer was entitled to deduct in the several years.
In accordance with the foregoing rule, if the petitioner in this proceeding had sold its oil mining lease in 1918, the basis for determining gain or loss on such sale would have been the March 1, 1913, Avalué, less the aggregate amount which it was entitled to deduct in the preceding years on account of depletion, without regard to either *1001the amount of the depletion actually sustained or the amount of the deductions actually claimed and allowed.
This being the sound rule for determining gain or loss on the sale of the whole property, I am unable to perceive any fundamental distinction in the case of a gradual sale of the property through depletion.
I am further impelled to this view by the fact that the application of this rule will provide an equitable method by which the entire amount of the petitioner’s capital investment may be returned to it through depletion allowances, tax free, which, as pointed out above, is the manifest purpose of the statutory provisions for all exhaustion allowances. This, in my opinion, will provide, as required by the statute, a reasonable allowance for depletion according to the peculiar conditions in this case.
The aggregate amount which the petitioner herein was entitled to deduct from gross income for the years 1913, 1914, and 1915 as depletion allowances was $8,322.02. It is my opinion, therefore, that the correct depletion unit to be used in computing the petitioner’s depletion allowance for 1918 should be determined by reducing the agreed March 1, 1913, value (which, under the statute, must be taken in this case in lieu of original cost) by the amount of $6,322.02, the amount of depletion which the petitioner was entitled to deduct, instead of the amount of $91,686.15.
Lansdon and SriarJsiN agree with this dissent.