Court Opinion

ID: 4497159
Source: CourtListenerOpinion
Date Created: 2020-01-23 18:15:17.298331+00
Date Added: 2024-06-11T08:00:17.382403
License: Public Domain

Smith,
dissenting: The Revenue Act of 1934 provides in part as follows:
8EC. 23. DEDUCTIONS FROM GROSS INCOME.
In computing net income there shall be allowed as deductions: *******
(m) DEEjusiaoN. — In the case of mines, oil and gas wells, other natural deposits, and timber, a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case; such reasonable allowance in ail cases to be made under rules and regulations to be prescribed by the Commissioner, with the approval of the Secretary. * * *
(n) Basis for Depreciation and Depletion. — The basis upon which depletion, exhaustion, wear and tear, and obsolescence are to be allowed in respect of any property shall be as provided in section 114.
SEC. 114. BASIS FOR DEPRECIATION AND DEPLETION.
* * * * # ❖ ♦
(b) Basis for Depletion.—
*******
(3) Percentage depletion fob oil and gas wells.' — In the case of oil and gas wells the allowance for depletion under section 23 (m) shall be 27% per centum of the gross income from the property during the taxable year, excluding from such gross income an amount equal to any rents or royalties paid or incurred by the taxpayer in respect of the property. Such allowance shall not exceed 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property, except that in no case shall the depletion allowance under section 23 (m) be less than it would be if computed without reference to this paragraph.
Article 23 (m)-10 of Regulations 86, promulgated under the provisions of the Revenue Act of 1934, provides as follows:
Art. 23 (m)-10. Depletion — Adjustments of accounts based on bonus or advanced royalty. — (a) If a lessor receives a bonus in addition to royalties, there shall be allowed as a depletion deduction in respect of the bonus an amount equal to that proportion of the basis for depletion as provided in section 114 (b) (1) or (2) which the amount of the bonus bears to the sum of the bonus and the royalties expected to be received. Such allowance shall be deducted from the lessor’s basis for depletion, and the remainder is recoverable through depletion deductions on the basis of royalties thereafter received.
(b) If the owner has leased a mineral property for a term of years with a requirement in the lease that the lessee shall extract and pay for, annually, a specified number of tons, or other agreed units of measurement, of such mineral, or shall pay, annually, a specified sum of money which shall be applied in *869payment of the purchase price or royalty per unit of such mineral whenever the same shall thereafter be extracted and removed from the leased premises, an amount equal to that part of the basis for depletion allocable to the number of units so paid for in advance of extraction will constitute an allowable deduction from the gross income of the year in which such payment or payments shall be made; but no deduction for depletion by the lessor shall be claimed or allowed in any subsequent year on account of the extraction or removal in such year of any mineral so paid for in advance and for which deduction has once been made.
(e) If for any reason any such mineral lease expires or terminates or is abandoned before the mineral which has been paid for in advance has been extracted and removed, the lessor shall adjust his capital account by restoring thereto the depletion deductions made in prior years on account of royalties on mineral paid for but not removed, and a corresponding amount must be returned as income for the year in which the lease expires, terminates, or is abandoned.
(d) In lieu of the treatment provided for in the above paragraphs the lessor of oil and gas wells may take as a depletion deduction in respect of any bonus or advanced royalty from the property for the taxable year 27% per cent of the amount thereof; and the lessors of sulphur mines, metal mines, and coal mines may take as a depletion deduction in respect of any bonus or advanced royalty from the property for the taxable year beginning after December 31, 1933, for which he first makes return in respect of the property (and for subsequent taxable years in case an election to have depletion computed on a percentage basis has been exercised in the proper return) 23 per cent, 15 per cent, and 5 per cent, respectively, of the amount thereof; but the deduction shall not in any case exceed 50 per cent of the net income of the taxpayer (computed without allowance for depletion) from the property.
This regulation is consonant with similar provisions promulgated under the Revenue Act of 1926, the Revenue Act of 1928, and the Revenue Act of 1932. See Regulations 67, art. 216; Regulations 74, art. 236; Regulations 77, art. 230.
It will be noted that paragraphs (a), (5) and (c) of article 23 (m)-10 of Regulations 86 deal with “cost” depletion. They do not deal with “percentage” depletion. Paragraph (d) deals with “percentage” depletion. It states that “In lieu of the treatment provided for in the above paragraphs” etc. Nothing is said in paragraph (d) about restoring to “capital account” any portion of the depletion claimed for earlier years.
Apparently the respondent so construed his regulations until after the decision of the Supreme Court in Herring v. Commissioner, 293 U. S. 322. He then issued General Counsel Memorandum 14448 contained in Cumulative Bulletin XIV-1 (1935), page 98. In that memorandum it is stated:
In its opinion in William E. Herring v. Commissioner, supra, the Supreme Court made the statement that it expresses no opinion as to whether the amount allowed as a depletion deduction from the bonus payment in the year of the execution of the lease may be taxed as income to the lessor in the year of the termination of the lease where there has been no extraction of mineral from the leased premises. * * *
*870It then states:
* * * Since the “nature and purpose of the allowance is the same,” as the Supreme Court has pointed out, whether the deduction he computed on the cost basis or on a per cent of the gross income from the property it follows that the taxpayer must be deemed to have taken the bonus depletion deduction on the percentage of income basis on the condition that he will restore the amount of such deduction to income as of the year of the termination of the lease where there has been no production from the leased premises.
It was not until 1935 that the respondent construed article 23 (m)-10 of Regulations 86 as it has been construed in the proceeding at bar. In other words, the respondent has accepted the decision in Herring v. Commissioner, supra, as deciding what it expressly says it does not decide.
In the majority opinion the decision of the Supreme Court in Murphy Oil Co. v. Burnet, 287 U. S. 299, is relied upon as warranting the inclusion in the gross income of the lessor of an oil lease, in the year of the termination of the lease, of a part of the depletion allowance which the petitioner was permitted to take in a prior year. I do not think that the opinion of the Supreme Court in the Murphy Oil Go. case supports such view. In that case the Court stated:
* * * The question to be decided is whether the Commissioner correctly calculated the deduction for depletion for the years in question, by treating the bonus previously received by the petitioner, as a return of capital and by reducing pro tanto the depletion allowed on the royalties received in later taxable years. [Italics supplied.]
The Court was dealing there with “cost” depletion and not with “percentage” depletion. Manifestly, “cost” depletion is to be determined on a different basis from “percentage” depletion. In the one case the depletion deduction is to be limited by the cost or value of the depletable property. In the other it is not. This is recognized by the Commissioner’s regulations; for, in article 23(m)-l of Regulations 86 it is stated: “(1) In the case of * * * oil and gas wells the aggregate annual allowable deductions may, because of percentage depletion, ultimately exceed the cost or other basis.”
The depletion allowance under the Revenue Act of 1934 is an amount not exceeding 27yz percent of the gross income from the property during the taxable year and not exceeding 50 percent of the net income. Since it is apparent from the decision of the Supreme Court in Herring v. Commissioner, supra, that the petitioner was entitled to deduct from the gross income of 1934 an allowance for depletion, why should the benefit of that deduction be taken away in part by requiring her to include in her gross income for 1935 a part of the depletion allowance to which she was entitled for 1934? Did the petitioner receive any income in 1935? If the lessee had drilled for oil upon the demised property and found that there was *871none in it and abandoned the lease in 1935, would the lessor have received income in 1935 from the abandonment of the lease? I do not think so.
The Revenue Act of 1934 permits the deduction of a depletion allowance in the case of oil and gas wells equal to a percentage of the income from the property. It is not limited by cost or value. The right to that deduction is not abridged by the Commissioner’s regulations, as I read them. If there is doubt upon this point I think it should be resolved in favor of the taxpayer.
I do not think there is any merit in the statement in the majority opinion that the regulations of the Commissioner promulgated under the Revenue Acts of 1926 to 1934, inclusive, have the force of law by reason of the successive enactments without change of the revenue acts permitting the deduction from gross income of percentage depletion, since the regulations do not require the adjustment of the capital account in case no oil is found in the land. There is no capital account to be adjusted. The regulations provide for an adjustment of capital accounts only where depletion is taken upon a cost or value basis. No adjustment is provided for where depletion is taken on the percentage basis.
Arundell agrees with this dissent.