Court Opinion

ID: 4484452
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:16:45.880883+00
Date Added: 2024-06-11T11:42:06.711355
License: Public Domain

Fay, J., dissenting: I respectfully dissent. In my opinion, lease bonuses do in fact represent “production” for purposes of section blSAic).1 As most of the reasons for my disagreement with the majority position are set forth at length in my dissenting opinion in Engle v. Commissioner, 76 T.C. 915, 940 (1981), my comments will be brief. It seems that the majority opinion denies percentage depletion deductions based on the lease bonuses in this case because those lease bonuses were not income directly traceable to extraction occurring in the same taxable year as the lease bonuses were received. In other words, the majority opinion seems to require both extraction and that extraction’s income to occur in the same taxable year for a percentage depletion deduction to be allowable.2 Such reasoning would, in effect, disallow percentage depletion with respect to any oil sold in a taxable year other than the taxable year that oil is actually extracted. As I noted in Engle v. Commissioner, supra at 941 (Fay, J., dissenting), that is obviously not what Congress intended.3  I am also troubled by the implication in the majority opinion that lease bonuses are not payments for oil or gas. It is well settled that lease bonuses are considered payments for oil or gas for depletion purposes. As the United States Supreme Court said in Anderson v. Helvering, 310 U.S. 404, 409 (1940), “Cash bonus payments, when included in a royalty lease, are regarded as advance royalties, and are given the same tax consequences.” See Herring v. Commissioner, 293 U.S. 322 (1934); Burnet v. Harmel, 287 U.S. 103, 112 (1932) (bonus and royalties are both consideration for the lease, neither are capital gains); Palmer v. Bender, 287 U.S. 551, 557-558 (1933) (lessor entitled to depletion on bonus and royalties). See also Shamrock Oil & Gas Corp. v. Commissioner, 35 T.C. 979 (1961), affd. 346 F.2d 377 (5th Cir. 1965), cert. denied 382 U.S. 892 (1965). The majority opinion discounts the above line of authority as, in effect, having been overruled by section 613A. Majority, supra at 956. I disagree. In the first place, “gross income from the property” always has been necessarily related to extraction (sec. 1.613-3(a), Income Tax Regs.); and, second, “gross income from the property” is still the percentage depletion calculation base for purposes of applying sec. 613A(c)(l) (“the allowance for depletion * * * shall be computed in accordance with section 613”). I emphasize that I am not maintaining that “production” does not mean extraction. Upon that point, the majority and I agree.4 I do maintain that “production” is not limited to current extraction but includes past or future extraction as well. In my view, “production during the taxable year” means the extraction (past, current, or future) properly attributable to that year. The number of barrels of extraction properly attributable to a year is easily measured by income. Indeed, such always has been the case under section 613, which explicitly ties percentage depletion to income. The logical bases for my position are fully elucidated in my dissenting opinion in Engle v. Commissioner, supra.5  In this case, I would allow petitioners a percentage depletion deduction calculated on all the lease bonuses received by them in 1975. Those bonuses represent extraction, albeit future extraction, for depletion purposes; that extraction is properly attributable to 1975, the taxable year in which the petitioners received income from that extraction; and, as stipulated by the parties, inclusion of the extraction represented by the lease bonuses in petitioners’ 1975 “production” would not cause petitioners to exceed their 1975 “depletable oil quantity.” Accordingly, I would hold for petitioners.  Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954 as amended and in effect during the year in issue.   However, the majority, supra at 957, also seems to say that only future extraction is tainted. That may imply that extraction occurring in a year previous to that extraction’s income could serve as a basis for percentage depletion. See sec. 1.613A(c)-3(aX4), example (JO, Proposed Regs., 42 Fed. Reg. 24281 (May 13, 1977). See also Engle v. Commissioner, 76 T.C. 915, 940 (1981) (Fay, J., dissenting).   The majority opinion states that its conclusion “is consistent with the views of text writers” (majority, supra at note 8), and cites two authorities. In F. Burke & R. Bowhay, Income Taxation of Natural Resources, sec. 8132 (1980), the authors do in fact state that lease bonuses do not qualify for percentage depletion. However, they do not analyze the issue and rely only on the proposed regulations promulgated under sec. 613A(c). Proposed regulations, of course, represent no more than respondent’s litigating position. F. W. Woolworth Co. v. Commissioner, 54 T.C. 1233,1265-1266 (1970). In Miller’s Oil & Gas Federal Income Taxation, sec. 31-3, p. 580 (J. Houghton ed. 1980), the authors reach the same conclusion as Burke & Bowhay. But they do point out the incongruity of distinguishing between pre-extraction income and post-extraction income. J. Houghton, supra at 580-581. Furthermore, they point out that the proposed regulations have been severely criticized on the very grounds which form the basis for my dissent. J. Houghton, supra at 581 n. 15. The majority opinion completely omits any mention of those writers reaching a result opposite its own. See Linden, “Oil and Gas Depletion Regulations: Complexity Compounded,” 24 Oil & Gas Tax Q. 351, 380 (1976) (excluding future extraction from “production” for purposes of sec. 613A(c) overrules prior case law without a clear statutory mandate); Bravenee, “Continued Availability of Percentage Depletion on Oil and Gas,” 23 Oil & Gas Tax Q. 204, 212 (1975) (“the construction of ‘production’ as sales for all purposes under Section 613A(c) is highly desirable”). In fact, I have been unable to locate any author to date who has analyzed the issue involved in this case in depth and agrees with the proposed regulations.    note that in defining “production” to mean extraction, the majority cites Texas cases in which “production” was held to mean current extraction. However, none of those cases dealt with either depletion or Federal taxation. Rather, they were contract cases involving construction of oil and gas leases with the courts’ inquiry being what the parties to the various contracts meant by “production.” Accordingly, those cases should have no bearing on the interpretation of “production” as that term is used in sec. 613A(c). As the United States Supreme Court said in Burnet v. Harmel, 287 U.S. 103, 110 (1932), “State law may control only when the operation of the federal taxing act, by express act or necessary implication, makes its own operation dependent on state law.”   Additionally, a number of the points made by the majority opinion in this case have been fully addressed in my dissenting opinion in Engle v. Commissioner, 76 T.C. 915, 940-948 (1981). The majority’s conclusion that there is no helpful legislative history(majority, supra at 954')isa vast overstatement. See Engle v. Commissioner, supra at 946 n. 13 (Fay, J., dissenting). The majority’s reliance on the parties’ stipulation of no “production” (majority, supra at note 12), ignores the obvious meaning of that stipulation. See Engle v. Commissioner, supra at 940 n. 2 (Fay, J., dissenting). Finally, the practical problems which the majority envisages flowing from my interpretation (majority, supra at 958) are addressed in Engle v. Commissioner, supra at 948 n. 15 (Fay, J., dissenting).