Court Opinion

ID: 4608883
Source: CourtListenerOpinion
Date Created: 2020-11-20 19:43:36.290953+00
Date Added: 2024-06-11T07:53:46.793431
License: Public Domain

CORONADO OIL & GAS CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Coronado Oil & Gas Co. v. CommissionerDocket No. 10503.United States Board of Tax Appeals14 B.T.A. 1214; 1929 BTA LEXIS 2964; January 14, 1929, Promulgated *2964  1.  INCOME - LEASE - EXEMPTION - GOVERNMENT INSTRUMENTALITY. - Petitioner's income derived from the sale of oil and gas produced by it from school lands owned by the State of Oklahoma and leased by petitioner for oil and gas purposes, held, not exempt from Federal income and profits taxes as, under the facts proven, petitioner is not shown to be such an instrumentality of the State of Oklahoma in its performance of a governmental function, that a tax upon its income constitutes an interference with the exercise by that State of a sovereign power.  2.  INVESTED CAPITAL. - Upon the evidence, held, petitioner is entitled to include in invested capital $58,538 as a paid-in surplus, and further, that it is entitled to depletion upon that additional capital asset.  3.  Id. - Held, that respondent erred in reducing invested capital by a tentative tax.  T. P. Gore, Esq., Hubert L. Bolen, Esq., D. A. Richardson, Esq., and S. W. Hayes, Esq., for the petitioner.  Dwight H. Green, Esq., and Maxwell E. McDowell, Esq., for the respondent.  TRUSSELL *1214  In this proceeding the petitioner seeks a redetermination of its income and excess-profits*2965  taxes for the calendar years 1917, 1918, and 1919, for which years the respondent has determined deficiencies in the following amounts: $6,556.86, $8,637.08, and $3,040.25, respectively, making a total deficiency of $18,234.19.  The petitioner alleges that respondent erred (1) in determining that its entire net income for the calendar years under consideration was not exempt from Federal income and profits taxes, such income having been derived from the production and sale of oil and gas *1215  from school land owned by the State of Oklahoma and leased by petitioner for oil and gas purposes; and, further, if its income be subject to Federal taxation, that respondent erred (2) in not including in invested capital for the said years the amount of $58,538 as a paid-in surplus; (3) in computing the amount of depletion, allowable as a deduction, upon the basis of cost of development of the lease subsequent to the acquisition of the same by the petitioner, it being alleged that the fair market value of the development on the lease, amounting to $58,538 when acquired by the petitioner, was a part of the assets received and is subject to depletion; (4) in reducing the petitioner's*2966  invested capital in each of said years by the amount of income and excess-profits taxes payable within the taxable years upon the income of preceding taxable years; and (5) in reducing invested capital at the beginning of the year 1918 on account of a tentative tax computed and deducted from available earnings to date of dividend payment in that year.  FINDINGS OF FACT.  The petitioner is a corporation organized under the laws of the State of Oklahoma, with its principal office in Cleveland in that State, for the purpose of leasing, holding and operating oil, gas, coal, and other mineral lands and to engage in any line of business connected therewith.  The petitioner's entire income is derived from the sale of oil and gas produced by it from certain school land owned by the State of Oklahoma and duly leased to petitioner.  As a preliminary to the admission of Oklahoma to statehood an act of Congress was passed enabling the people of Oklahoma to form a constitution, etc., which was approved June 16, 1906.  Ch. 3335, vol. 34, pt. 1, U.S. Stat. p. 267.  The Enabling Act contains the following provisions: SEC. 3, Par. 5.  That provisions shall be made for the establishment*2967  and maintenance of a system of public schools which shall be open to all the children of said State * * *.  SEC. 7.  That upon the admission of the State into the Union, sections numbered sixteen and thirty-six, in every township in Oklahoma territory, and all indemnity lands heretofore selected in lieu thereof, are hereby granted to the State for the use and benefit of the common schools * * *.  SEC. 8.  * * * (Grant of other lands for university, certain educational institutions and public institutions and buildings.) Where any part of the lands granted by this Act to the State of Oklahoma are valuable for minerals, gas and oil, such lands shall not be sold by the said State prior to January first, nineteen hundred and fifteen; but the same may be leased for periods not exceeding five years by the State officers duly authorized for that purpose, such leasing to be made by public competition after not less than thirty days advertisement in the manner to be prescribed by law, *1216  and all such leasing shall be done under sealed bids and awarded to the highest responsible bidder.  The leasing shall require and the advertisement shall specify in each case a fixed royalty*2968  to be paid by the successful bidder, in addition to any bonus offered for the lease, and all proceeds from leases shall be covered into the fund to which they shall properly belong, and no transfer or assignment of any lease shall be valid or confer any right in the assignee without the consent of the proper State authorities in writing: Provided, however, That agricultural lessees in possession of such lands shall be reimbursed by the mining lessees for all damage done to said agricultural lessees' interest therein by reason of such mining operations.  The Legislature of the State may prescribe additional legislation governing such leases not in conflict herewith.  SEC. 9.  That said sections sixteen and thirty-six, and lands taken in lieu thereof, herein granted for the support of the public schools, if sold, may be appraised and sold at public sale * * * the proceeds to constitute a permanent school fund, the interest of which only shall be expended in the support of such schools.  But said lands may, under such regulations as the Legislature may prescribe, be leased for periods not to exceed ten years; * * *.  The State of Oklahoma accepted the terms and the conditions of the*2969  Enabling Act.  The Constitution of Oklahoma, art. 11, sec. 1, reads as follows: The State hereby accepts all grants of land and donations of money made by the United States under the provisions of the Enabling Act, and any other Acts of Congress, for the uses and purposes and upon the conditions, and under the limitations for which the same are granted or donated; and the faith of the State is hereby pledged to preserve such lands and moneys and all money derived from the sale of any of said lands as a sacred trust, and to keep the same for the uses and purposes for which they are granted.  Article VI, section 32 provides as follows: The Governor, Secretary of State, State Auditor, Superintendent of Public Instruction, and the President of the Board of Agriculture, shall constitute the Commissioners of Land Office, who shall have charge of the sale, rental, disposing, and managing of the school lands and other public lands of the State, and of the funds and proceeds derived therefrom, under rules and regulations prescribed by the Legislature.  The legislature of the State of Oklahoma enacted a law authorizing and providing for the disposition, by sale and lease, of the state*2970  public lands in conformity with the provisions of the Enabling Act, together with other regulations pertaining thereto, and also authorizing the Commissioners of the Land Office to adopt and promulgate rules and regulations for carrying into effect the provisions of the Act.  On December 4, 1913, pursuant to a resolution adopted by the Commissioners of the Land Office of Oklahoma, notice was given that the Commissioners of the Land Office would receive on the 9th day of January, 1914, bids for releasing for oil and gas purposes certain described public lands belonging to the State of Oklahoma.  The said notice stated that the lease would be for a term of five years, with privilege to release for an additional five years as prescribed by *1217  law and regulation; that each bidder should deposit the sum of $55,800, the appraised value of the equipment placed upon said land and used by the South western Oil Fields Co.; that the said lands contained 15 producing wells; and that the total oil production from said land from January 1 to November 1, 1913, was 81,138 barrels, or an average of 8,113 barrels per month for 10 months.  The said notice also contained other information, *2971  which is included in the following notice sent out by the Commissioners of the Land Office: Rules and Regulations for Leasing Public Lands for Oil and Gas Purposes.  Bids to be received on the following described lands: N.E. 1/4 and S. 1/2 of N.W. 1/4, and S.W. 1/4, and S. 1/2 of S.E. 1/4, all in Section 16, Twp. 21 N., Range 8 E., Indian Meridian, containing 480 acres.  Rule 1.  All bids must be on forms furnished by the Commissioners of the Land Office, and must be filed with the Secretary, at four o'clock P.M., on the 9th day of January, 1914, to be opened immediately thereafter.  Rule 2.  All bidders will be required to deposit a certified check or bank draft on some bank within the State, for the sum of Three Thousand Dollars ($3,000), payable to the Commissioners of the Land Office to be held as earnest money as outlined in the advertisement.  Rule 3.  The highest responsible bidder will be required to give bond, to be approved by the Commissioners of the Land Office for the faithful performance of this contract, and to develop the lands sufficiently to extract all the oil and gas thereunder with the least possible delay.  Rule 4.  The royalty shall be fifty per centum*2972  (50%) of the total output of oil and gas from said lands, and all bonuses must be offered in addition to the fixed royalty.  Should bonus be offered in cash, the same must be paid to the Commissioners at the time of the execution of the lease, and if in oil, the bidder must offer a definite and specific percentage of the gross production in addition to the fixed royalty of fifty per centum (50%) above set out.  Rule 5.  All producing wells that are now or may hereafter be drilled on adjoining properties to be offset by corresponding wells on the lands to be leased under these rules.  Rule 6.  Certified copies of pipe line runs, and all sales and shipments to be furnished monthly, or on demand.  Rule 7.  Accurate and reliable information concerning wells and their operation and management to be furnished on demand to the Commissioners of the Land Office, or any one authorized to act for them.  Rule 8.  The lease to conform to and be interpreted and construed by the laws of the State of Oklahoma, and the rules of the Commissioners of the Land Office.  Rule 9.  The Southwestern Oil Fields Company, a corporation, by virtue of its lease heretofore held upon said lands, under the*2973  law, is entitled to the preference right to re-lease said lands at the maximum rate of rentals, royalties and bonuses that may be obtained therefor, said preference right to take at the highest and best bid to be exercised within five (5) days after the award by the Commissioners of the Land Office.  (Signed) LEE CRUCE, Governor and Chairman.Attest: (Signed) JNO. R. WILLIAMS, Secretary.*1218  Under the rules of the Commissioners of the Land Office governing bids received the lease on the above described land was awarded to G. W. Sutton, who deposited with his bid the amount of $55,800, to be paid to the former lessees for the physical equipment located thereon and used in connection with the operation of the 15 producing wells thereon.  The amount of $55,800 was the fair market value of the physical equipment as appraised by Frank Orr, duly appointed by the Commissioners on September 13, 1913, to appraise such equipment, and was accepted by the prior lessees as full compensation at the time of the surrender of their prior lease.  That amount did not include any value for the development of the leased property, consisting of the drilling of 17 wells.  *2974  Under the rules and regulations of the Commissioners governing the bidding for oil and gas leases on state school lands and the awarding of such leases which were in effect at the time this lease was awarded, there was no provision for appraising the cost of drilling the producing wells on leases to be advertised for re-leasing and including such appraised value in the amount to be paid by the successful bidder to the preceding lessee.  The reproduction cost of the producing wells, having an aggregate depth of 29,269 feet at the date of acquisition, was $2 per foot, or $58,538, and the estimated amount of oil to be produced from these wells over a 5-year period or the duration of the lease was 76,000 barrels of oil for the lessee's 50 per cent share during the five years.  The prevailing price of oil at the date of acquisition of the lease was $1.03 per barrel, representing an expected gross return of $78,280 and a present net worth to the lessee of $58,710 after deducting lifting cost and deferment in the amount of 25 per cent.  At the time that G. W. Sutton's successful bid was accepted on January 19, 1914, by the Commissioners of the Land Office, the petitioner was not in existence. *2975  At the request of G. W. Sutton, the Commissioners of the Land Office voted that the lease awarded to Sutton be issued to the Coronado Oil & Gas. Co., whose charter was issued on January 21, 1914.  The lease was duly executed, naming petitioner as lessee and being effective from January 17, 1914.  G. W. Sutton and his associates, in exchange for their rights in the lease and the physical equipment on the land, received from the petitioner its note for $5,800, bonds of the petitioner in the amount of $25,000, and 250 shares of the petitioner's stock, par value $100 each.  The lease entered into by the Commissioners of the Land Office and the petitioner reads as follows: THIS INDENTURE OF LEASE, made and entered into in duplicate on this the 17th day of January, 1914, by and between the Commissioners of the Land Office of the State of Oklahoma, hereinafter styled the lessors, parties of the first *1219  part, and Coronado Oil & Gas Company, hereinafter styled the lessee, party of the second part, WITNESSETH: That under and in pursuance of the constitution and laws of the State of Oklahoma, the said lessors, for and in consideration of the royalty, covenants and stipulations*2976  and conditions herein expressed and hereby agreed to be paid, observed and performed by the said lessee, its successors and assigns, do hereby lease and let unto the said lessee and its successors and assigns for a term of five (5) years from and after the date hereof all oil deposits and natural gas in or under the following described tract of land lying in the County of Pawnee, in the State of Oklahoma, to-wit: The South Half of the Northwest Quarter, the Southwest quarter, the Northeast quarter and the South half of the Southeast quarter of Section Sixteen (16), Township Twenty-one (21) North, Range Eight (8) East I.M.  Which said lands are public lands belonging to the State, and were by the said Commissioners of the Land Office declared to be valuable for oil and gas purposes, and the said oil and gas deposits therein contained were by the said Commissioners of the Land Office segregated from the surface use and interest therein, with the right to prospect for, extract, pipe, store, refine and remove such oil and natural gas, with the right to use and keep so much of the said surface of said premises as may be necessary to prospect for, extract, pipe, store, refine and remove*2977  such oil and natural gas, including still further the right to use a sufficient amount of such oil and natural gas as fuel, light and power so far as may be necessary to the prosecution of said operations, and with the further right to use any water on said premises that may be necessary to carry on said operations, in consideration whereof the lessee hereby agrees to pay a royalty of fifty (50%) per centum of all the oil and gas produced and sold from the fifteen wells now in operation upon the said premises, and to operate the same to their full capacity, and not to abandon or plug any well now upon the said lands without written consent of the Commissioners of the Land Office first obtained in writing.  All oil and gas due to the State under this contract shall be delivered by the lessee herein or his assigns free of cost to the State into pipe lines, tanks, or cars, or settled for before removing the same from the premises if sold in any other way.  Certified copies of gauge tickets, sales, and shipments to be furnished at the request of the Commissioners or any one authorized to act for them; gas to be metered on the premises under high pressure unless some other method of gauging*2978  and measuring same shall be hereafter agreed upon in writing.  The lessee further covenants and agrees to exercise diligence in the sinking of wells for oil and gas purposes on the lands covered by this lease, and to drill a sufficient number of wells on said premises to offset each and every well drilled upon adjoining premises, and the said lessee is hereby required and binds itself to develop said premises as is required by the laws of the State of Oklahoma and the rules and regulations adopted by the Commissioners of the Land Office.  Whenever any well shall hereafter be drilled adjoining said premises and such well shall produce oil or gas in paying quantities, then within fifteen days thereafter the lessee herein shall begin the drilling of offset wells as above provided and development of oil and gas on such land herein shall be sufficient to extract all oil and gas therefrom with the least possible delay.  The said lessee shall operate the leased premises for oil and gas to as full an extent as individual and corporate premises are being operated within the *1220  general oil and gas field where such lands are located, and the failure to do so shall forfeit this*2979  lease to the State, and thereupon the Commissioners of the Land Office shall be entitled to take immediate possession of said lands and all improvements thereon.  Accurate and reliable information concerning all wells and their operation and management to be furnished on demand of the Commissioners of the Land Office.  The said party of the second part further agrees to carry on operations in a workmanlike manner to the fullest possible extent; to commit no avoidable waste on the said land, and to suffer no avoidable waste to be committed upon the portion of its occupancy or use; to take good care of the same, and to promptly surrender and return the premises upon the termination of this lease.  The tools, boilers, power houses, lines, pumping and drilling outfits, tanks, engines and machinery (and casing of all dry and exhausted wells) shall remain the property of the party of the second part, and may be removed by them at any time before or at the expiration of this lease.  The casing, derricks, boilers, power houses, power plants, lines, tanks, tubing, rods, pumping and drilling outfits, engines and machinery, tools and all other appliances necessary to be used in the operation*2980  of any producing well on the lease, shall be appraised six months prior to the expiration of this lease contract, in order to ascertain the fair and reasonable value thereof by appraisers, one to be appointed by the Commissioners of the Land Office, and one by the lessee herein named or its assignee holding said lease at the time, and if said appraisers be unable to agree upon the fair and reasonable value of all such property of the lessee or its assigns on said premises the two appraisers so appointed shall have the right and authority to appoint a third person, and the appraisement of a majority of said three appraisers shall be binding upon both parties hereto.  It being expressly understood that the actual sale value of the materials and improvements mentioned at the time of appraisement shall alone be considered and no expense incurred in drilling, except materials permanently used in the operation of the well, shall be considered as improvements.  In advertising said land for re-lease for a second term of five years, the appraised value of said property of the lessee on the lease shall be stated in said advertisement, and any bidder other than the lessee herein named or its*2981  assignee shall be required to deposit the appraised value thereof with the Commissioners of the Land Office at the time the bid for the second term of five years is made, and if the lessee herein named or its assignee does not succeed in leasing said premises for a second period of five years, then in that event said amount shall be paid over to the lessee herein named or its assignee, provided, however, that all royalties, rentals, charges and claims have been paid; that it will not permit any nuisance to be maintained on the premises under its control; that it will not use such premises for any other purpose than those authorized in this lease.  Said second party further obligates itself and agrees not to plug, abandon or pull the casing from any well, productive or otherwise, without first securing the written consent of the first party, or its duly authorized agent, and it is further mutually agreed that a violation of this provision shall work a forfeiture of this lease at the option of the first party, and that before abandoning any well under said written consent it will securely plug the same so as to effectually shut off all water above and below the oil bearing horizons according*2982  to law.  And the said party of the second part further covenants and agrees that it will keep an accurate account of all oil and gas mining operations, showing the sales, prices, dates of purchase, and the whole amount of oil and gas mined and removed; and all sums due as royalties shall be a lien on all implements, tools, movable machinery and all other personal chattels used in said prospecting *1221  and mining operations and upon all the unsold oil obtained from the land herein leased as security for the payment of said royalty.  And it is mutually understood and agreed that this indenture of lease shall in all respects be subject to the rules and regulations heretofore or that may hereafter be lawfully prescribed and not in conflict with the lawful terms of this lease by said Commissioners relative to oil and gas leases of public lands, and that this lease or any interest therein shall not be sublet, assigned or transferred without the consent of the Commissioners of the Land Office first obtained in writing.  And it is further mutually understood and agreed that this lease is not executed to or in the interest of any pipe line or transportation company, or any company*2983  allied to or confederated therewith or any subsidiary company thereof, nor any other company, corporation, person or association under the control of either or all of them, nor to any stockholder, officer, director, agent, representative or employee, acting singly or as a firm, or corporation of such companies or either of them, and that should the second party or its assigns violate any of the covenants, stipulations or provisions of this lease, or any of the regulations, or fail for a period of sixty days to pay the stipulated royalties provided herein, then the Commissioners, after ten days' notice to the parties hereto, shall have the right to avoid this indenture of lease and cancel the same.  If the lessee makes reasonable and bona fide efforts to find and produce oil in paying quantities as herein required of it, and such effort is unsuccessful, it may at any time thereafter surrender and wholly terminate this lease upon the full payment and performance of all its then accrued and payable obligations hereunder.  It is agreed that for any refinery of crude oil and its products and by-products owned and controlled by the State of Oklahoma the State shall have the preference*2984  right to purchase and receive the output from said premises at the market prices therefor; providing that the lessee may sell the said output to any firm, corporation or person whatsoever until notice in writing from the Commissioners of the Land Office has been served upon the lessee that the State of Oklahoma is ready to take such oil or gas or either of them.  The lessee, its successors or assigns, shall have the preference right to release said premises for a second term of five years at the expiration of this lease, at the maximum rate of rentals, royalties and bonuses that may be obtained therefor at the time of such renewal.  Said maximum rate shall be determined by such reasonable and lawful regulations as are now or may hereafter be prescribed by the Commissioners of the Land Office or other person or persons authorized thereto by the State of Oklahoma.  The term "Commissioners of the Land Office of the State" as used in this lease shall include any board, person, or persons who are or may hereafter be authorized by law to act in behalf of the State in the matters relating to the leasing of the public lands of the State of Oklahoma for oil and gas purposes.  It is further*2985  agreed and understood that the approval of this lease by the Commissioners shall be of no force nor effect unless the party of the second part furnish a bond in the sum of Ten Thousand Dollars ($10,000.00) to the satisfaction of said Commissioners, in accordance with the regulations of said Commissioners, which shall be deposited and remain on file in the office of the Commissioners of the Land Office of Oklahoma.  And it is agreed that the lessee shall, at the expiration of each quarter after the premises produce oil and gas, or either of them, make and file with said Commissioners a production report showing the full amount of the production of oil and gas, or either of them, for the quarter prior to the said report, and *1222  whenever said production reports, computed together or singly vary from the sales report, the lessee, upon the proper showing and proof shall be given credit on the production report or reports for the amount of shrinkage.  The said lessee binds and obligates itself to do and perform all of the conditions imposed on it by law and this lease and obligates itself to protect the State of Oklahoma from all damage, loss, charges, and claims of every kind*2986  or nature, by reason of a failure to comply in whole or in part with the terms of this lease, and in the event that lessee fails, neglects or refuses to comply with the terms of this lease as herein imposed, this lease and all rights and privileges inuring to the benefit of the said lessee may be forfeited and cancelled, and the said Commissioners for and on behalf of the State of Oklahoma shall be entitled to recover from the lessee's bondsmen all rents, royalties, charges, and claims of every kind and nature due and owing and accruing and arising out of and by reason of this lease.  In Witness Whereof, the said parties have hereunto subscribed their signatures, the day and year first above written.  THE COMMISSIONERS OF THE LAND OFFICE OF THE STATE OF OKLAHOMA.  By (Signed) LEE CRUCE, [SEAL.] Governor of the State of Oklahoma and Chairman of said Commissioners.Attest: JOHN R. WILLIAMS, SecretaryCORONADO OIL AND GAS COMPANYBy (Signed) G. W. SUTTON President.Attest: GEORGE REYNOLDS Under date of January 17, 1917, the Commissioners of the Land Office and the petitioner entered into a supplemental agreement permitting petitioner to drill*2987  additional wells and to pay a royalty of 12 1/2 per cent on oil and gas produced from such additional wells, but in nowise affecting the 50 per cent royalty on the oil from wells already drilled and producing.  The primary purpose of that supplemental agreement was to enable petitioner to drill offset wells to prevent drainage of oil from the leased school land.  Upon the expiration of petitioner's lease in January, 1910, the lands covered by said lease were duly advertised for re-lease subject to the preference right of petitioner.  At that time the regulation governing the determination of the sum to be paid the prior lessee by the succeeding lessee had been changed so that the appraisal of property to be surrendered by the prior lessee included not only the fair value of the physical equipment on the land, but also the fair value of the improvements, namely, the drilled and producing wells.  On March 18, 1919, the Commissioners of the Land Office received all bids and awarded the lease to petitioner, effective as of the date of the expiration of its prior lease in January, 1919.  The lease reads as follows: *1223  THIS INDENTURE OF LEASE, Made and entered into in duplicate, *2988  on this Jan. day of 17th A.D., 1919, by and between The Commissioners of the Land Office of the State of Oklahoma, acting for and in behalf of the State of Oklahoma, parties of the first part, hereinafter designated as lessor, and Coronado Oil & Gas Company, of Cleveland, Oklahoma, party of the second part, hereinafter designated as lessee, under and in pursuance of the provisions of the Constitution and Laws of the State of Oklahoma, relating to the segregation of the oil and gas deposits and the leasing thereof on school and other public lands belonging to the State of Oklahoma, WITNESSETH: 1.  The lessor, for and in consideration of Four Hundred & Eighty No/100 ($480.00) Dollars, the receipt whereof is hereby acknowledged, and of the royalties, covenants, stipulations and conditions hereinafter contained and hereby agreed to be paid, observed and performed by the lessee, and his lawful assigns, does hereby demise, grant, lease and let unto the lessee for the term of five years from the date hereof, and as long thereafter as oil or gas or either of them is produced in paying quantities, all the oil deposits and natural gas in or under the following described tract of land lying*2989  and being within the County of Pawnee, in the State of Oklahoma, to-wit: Northeast (NE 1/4) Quarter; South-half of Northwest (NW 1/4) Quarter, South-half (S 1/2) of the Southeast (SE 1/4) Quarter and the Southwest (SW 1/4) Quarter of Section Sixteen (16) Township Twenty-one (21) North Range Eight (8) E.I.M.  and containing 480 acres, more or less, with the exclusive right to prospect for, extract, pipe, store and remove oil and natural gas, and to occupy and use so much only of the surface of said land as may reasonably be necessary to carry on the work of prospecting for, extracting, piping, storing and removing such oil and natural gas.  Also the right to obtain from wells or other sources on said land by means of pipe lines or otherwise, a sufficient supply of water to carry on said operations, except the private wells or ponds of the surface owner or lessee, and also the right to use, free of cost, oil and natural gas as fuel so far as necessary to the development and operation of said property.  2.  The lessee hereby agrees to deliver or cause to be delivered to The Commissioners of the Land Office of the State of Oklahoma, or their successors, a royalty, of one-eighth part*2990  of the oil or gas produced from the leased premises or in lieu thereof pay to the State the market value of said royalty interest, as the Commissioners may elect.  All oil and gas due to the State under this contract, shall be delivered by the lessee herein, free of cost, into pipe lines, tanks or cars, or settled or paid for before removing same from the premises if handled in any other way.  The lessee shall furnish to the lessor certified copies of gauge tickets, sales, shipments and amount of gross production, at their office in Oklahoma City.  Gas to be metered on the premises under high pressure, unless some other method of gauging and metering same shall be hereafter agreed upon by the parties hereto in writing.  3.  The lessee shall exercise diligence in sinking wells for oil and natural gas on the land covered by this lease, and shall drill a sufficient number of wells to offset the wells upon adjoining contiguous premises, said offset wells to be commenced within ten days after completion of any producing well upon such adjoining contiguous premises, unless a different time is prescribed by notice in writing from the lessor, and be prosecuted diligently and continuously*2991  until completed; and the said lessee shall operate the leased premises for oil and gas to same extent as individual and corporate premises are being operated within the general oil and gas fields where such land is located, and failure to faithfully comply with this provision shall be cause for forfeiture of this lease to the State.  *1224  At least one well producing oil or gas in paying quantities shall be drilled and completed within one year from the date hereof, or failing so to do the lessee shall pay to the lessor for each whole year the completion of such well is delayed, for not to exceed five years from the date hereof, in addition to the other consideration named herein, a rental of One ($1.00) Dollar per acre, payable annually, in advance, and if the lessee shall fail to drill at least one such well within any such yearly period, and shall fail to surrender this lease on or before the end of any such year during which the completion of such well is delayed, such failure shall be taken as conclusively evidencing the election and covenant of the lessee to pay the rental of One ($1.00) Dollar per acre for such year, and thereupon the lessee shall be absolutely obligated*2992  to pay such rental.  The failure of the lessee to pay such rental before the expiration of fifteen (15) days after it becomes due at the end of any yearly period during which a well has not been completed as herein provided shall be a violation of one of the material and substantial terms and conditions of this lease, and be cause for cancellation thereof, but such cancellation shall not in any wise operate to release or relieve the lessee from the covenants and obligations to pay such rental or any other accrued obligation.  It being understood that the completion of one well producing oil or gas in paying quantities during the life of this lease, shall relieve the lessee of all future liability for said $1.00 per acre hereunder, but the lessee shall nevertheless remain obligated to drill an offset, or necessary offsets, and other wells necessary to the proper development and operation of said lease as herein otherwise provided; and provided further that unless a producing well of oil or gas is completed on the above described premises within five years from date hereof this lease shall be void.  4.  The lessee shall carry on the development and operation in a workman-like manner; *2993  commit no waste on said land, and suffer none to be committed upon the portion in his occupancy or use; take good care of the same, and promptly surrender and return the premises upon the termination of this lease to the lessor, or to whomsoever shall be lawfully entitled thereto, unavoidable casualty only excepted.  All tools, derricks, boilers, boiler houses, pipe lines, pumping and drilling outfits, tanks, engines and machinery, and the casing of all dry or exhausted wells, shall remain the property of the lessee, and may be removed at any time prior to or at the termination of the lease by forfeiture or otherwise; and the lessee shall not permit any nuisance to be maintained on the premises; and shall not use said premises for any purposes than those authorized in the lease; and before abandoning any well, shall securely plug the same so as to effectually shut off all water from the oil bearing stratum, or in the manner required by the laws of the State of Oklahoma.  5.  The lessee shall keep an accurate account of all oil and gas mining operations, including a log of each well drilled, duly sworn to by the contractor or driller, which shall be filed with the Secretary to The*2994 Commissioners of the Land Office within thirty days after said well is completed.  Accurate and reliable information concerning all wells and their operation and management shall be furnished to The Commissioners of the Land Office or their representatives upon demand.  The said lessee shall also keep an accurate account showing the sales, prices, dates, purchases, and the whole amount of oil and gas mined or removed, and all sums due as royalities shall be a lien on the implements, tools and movable machinery or personal chattels used in operating said property, and also upon all the unsold oil and gas obtained from the land herein leased as security for the payment of said royalties.  *1225  6.  The lessee shall be liable to the surface owner or surface lessee for all damages or loss accruing to the surface interests in said land, and to all crops and improvements thereupon and appurtenances and hereditaments thereunto belonging by reason of the oil or gas mining operations hereunder, and in the event the amount of such damage can not be agreed upon by the lessee hereof and such surface owner or lessee, then the amount of such damage shall be determined as is or may be provided*2995  by law.  The lessee hereof further agrees to pay all such damages within ten days after the amount thereof is determined, and the amount of such damages may be recovered from the lessee hereof and his sureties upon the bond given to secure the faithful performance of this lease.  7.  This lease shall be subject to the Constitution and laws of the State of Oklahoma and the rules and regulations of The Commissioners of the Land Office now or hereafter in force relative to such leases; all of which are made a part and condition of this lease; Provided, That no regulations made after the execution of this lease affecting either the length of the term hereof, the rate of royalty, or payment hereunder or the assignment hereof, shall operate to affect the terms and conditions of this lease.  8.  No transfer or assignment of this lease or any part thereof, shall be valid, or convey any right in the assignee without the consent in writing of The Commissioners of the Land Office; and such assignee shall furnish a bond to the satisfaction of The Commissioners of the Land Office, conditioned for the faithful performance of the covenants and conditions of this lease, and pay an assignment fee*2996  of Five Dollars.  9.  Before this lease should be in force and affect the lessee shall give a good and sufficient bond in the sum of Two thousand & No/100 ($2,000.00) Dollars, to be approved by the Commissioners of the Land Office, for the faithful performance of this lease.  10.  Upon the violation of any of the substantial terms or conditions of this lease, The Commissioners of the Land Office shall have the right at any time after hearing upon ten days' notice, given by registered mail to the last known address of such lessee, or by posting notice in writing in a conspicuous place upon the said premises, specifying the terms or conditions violated, to declare this lease null and void; and the said Commissioners for and on behalf of the State of Oklahoma, shall be entitled to recover from the Lessee's bondsmen, all rents, royalties, charges, claims of every kind and nature due and owing and accruing and arising out of and by reason of this lease, on failure to comply with the provisions thereof, and the lessors shall be entitled and authorized to take immediate possession of the land.  11.  It is further agreed that for any refinery of crude oil and its products and by-products, *2997  owned and controlled by the State of Oklahoma, the State shall have the preference right to purchase and receive the output from said premises at the market price thereof; Provided, that this clause shall not prevent the lessee from selling the output of said leases to any person, firm or corporation whatsoever until notice in writing from The Commissioners of the Land Office shall be served on the lessee that the State is ready to take such oil and gas or either of them, and all sales of oil and gas or either of them under this proviso shall be valid and binding.  12.  The lessee may at any time hereafter surrender and wholly terminate this lease upon payment of the rentals and other liabilities then accrued and due hereunder, and may exercise such right by filing a formal relinquishment and release of the said lease with the Secretary to The Commissioners of the Land Office: Provided, that if such lease has been recorded, by causing the *1226  release thereof to be filed and recorded in the proper recording office, and upon a compliance with these requirements such lessee shall thereby be relieved from liability for rental thereafter accruing.  13.  The surface owner of*2998  lessee of the said premises shall have gas free of cost from any well on said premises for domestic use thereon by making his own connection with the well.  IN WITNESS WHEREOF, the parties hereunto subscribed their signatures on the day and year first above written.  THE COMMISSIONERS OF THE LAND OFFICE OF THE STATE OF OKLAHOMABy (Signed) J. B. A. ROBERTSON Governor and ChairmanATTEST: (Signed) A. S. J. SHAW Secretary to the Commissioners of the Land OfficeCORONADO OIL & GAS COMPANY LesseeBy (Signed) R. L. LUNSFORD, PresidentATTEST: (Signed) J. B. MYERS, Treas.Petitioner's only source of income during the years under consideration was from the sale of oil and gas produced from the lands leased as aforesaid and respondent determined such income to be taxable.  Respondent excluded from petitioner's invested capital the amount of $58,538, which petitioner claims should be included therein as a paid-in surplus representing the value of the improvements and producing wells on the leased lands at the date of acquisition and respondent also excluded the said amount from the basis upon which he computed the allowed deductions for depletion. *2999  In computing petitioner's invested capital for the year 1918, respondent reduced the same by the amount of $1,336.99 on account of a dividend of $20,000 paid November 4, 1918, prorated out of invested capital after applying thereto the available earnings to date of payment less tentative tax.  OPINION.  TRUSSELL: The taxes here involved are for the calendar years 1917, 1918, and 1919, and the deficiencies appealed from have been determined under the Revenue Acts of 1916, 1917, and 1918.  By section 10 of the first mentioned Act, which is carried into the two subsequent Acts, a tax is imposed upon the net income of "every corporation, joint stock company or association, or insurance company, organized in the United States, no matter how created or organized", with the exception of corporations operated for certain *1227  specified purposes, which need not be here detailed, as it is not claimed that petitioner falls within one of these excepted classes.  It is not questioned that petitioner is a private domestic corporation, created and operated for the personal and private gain of its individual stockholders, and that the property from which the income in question was*3000  derived, consisting of a lease of oil lands and physical assets represented by the operating equipment on those lands, belonged to it and represented the personal investment of its stockholders.  It will thus be seen that petitioner is subject to tax upon its income unless entitled to some exemption, and that such exemption, if it exists, is not granted by the taxing statute.  Petitioner claims that its income during the taxable years in question is exempt from Federal taxation for the reason that it was all derived from the sale of oil and gas produced from public school lands leased from the State of Oklahoma; that by its lease of such lands from the State it became the instrumentality through which the latter derived part of its public school fund and that to tax its income is to burden the State in the performance of its governmental function of maintaining public schools.  In approaching the question we must bear in mind that exemption from tax is never presumed, but, on the other hand, the presumption is in favor of the taxing power and the burden is upon the claimant to establish clearly and beyond doubt its right to exemption.  It is well recognized that "taxation is the*3001  rule and exemption the exception".  Cooley on Taxation, vol. 1, p. 356.  The mere fact that the property of the State of Oklahoma is exempt from Federal taxation does not grant such immunity to a lessee of that property, as it is well recognized that the right to use property is distinct from the fee and that a tax upon the interest of the lessee is not a tax upon that of the lessor.  In Heiner v. Colonial Trust Co.,275 U.S. 232">275 U.S. 232, the court held the lessee of tax exempt Indian lands liable to Federal income tax upon the ground that the exemption of the lessor by Congress could not be presumed to extend to those doing business with him.  In Jetton v. University of the South,208 U.S. 489">208 U.S. 489, there was involved the right of the State to lay a tax upon the interest of a lessee in property belonging to a lessor who was specifically exempted from taxation by statute, it being claimed that the tax violated the legislative contract of the statute as it lessened to that extent the value of the leasehold interest to the lessor and thus indirectly burdened him with the tax.  In denying exemption to taxation to the lessee the court said: *3002  As long as different interests may exist in the same land, we think it plain that an exemption granted to the owner of the land in fee does not extend to an exemption from taxation of an interest in the same land, granted by an owner *1228  of the fee to another person as a lessee for a term of years.  The two interests are totally distinct, and the exemption of the one from taxation plainly does not thereby exempt the other.  In Elder v. Wood,208 U.S. 226">208 U.S. 226, the right of the State of Colorado to tax a mining claim belonging to an individual was questioned, the fee in the land upon which the claim was located being in the United States.  The court in sustaining the right to tax held that the property taxed was "the right of possession of the land for mining purposes," which belonged to the individual, saying: Such an interest from early times has been held to be property, distinct from the land itself, vendible, inheritable and taxable.  That the State may not impose a tax which interferes with the free exercise by the Federal Government of the powers granted it by the Constitution, and that a privilege or occupation tax upon an instrumentality which*3003  represents in its creation or use a direct exercise of such powers, is an interference therewith, can not be questioned.  In McCullough v. Maryland,4 Wheat. 316">4 Wheat. 316, the right of the State was denied to impose a privilege or occupation tax upon the Bank of the United States, a corporation created by Congress, upon the ground that Congress possessed the power to create such a corporation and the grant of such power by the Constitution implied such immunity as necessary to maintain the free exercise thereof and accordingly the taxation by the State of the thing created, the corporate body, was an interference with the exercise of such power.  Following this decision the courts in many decisions have affirmed and applied this rule.  Osborn v. Bank,9 Wheat. 738">9 Wheat. 738; Weston v. City Council of Charleston,2 Pet. 449; Dobbins v. Commissioners of Erie County,16 Pet 436; Van Allen v. Assessors,3 Wall. 573">3 Wall. 573; Bradley v. People,4 Wall. 459">4 Wall. 459; *3004 National Bank v. Commonwealth,9 Wall. 353">9 Wall. 353; Van Brocklin v. State of Tennessee,117 U.S. 151">117 U.S. 151; Northern Pacific R.R. Co. v. Smith,171 U.S. 261">171 U.S. 261; Grether v. Wright,75 Fed. 742; Home Savings Bank v. Des Moines,205 U.S. 503">205 U.S. 503; Farmers' Bank v. Minnesota,232 U.S. 516">232 U.S. 516; Johnson v. Maryland,254 U.S. 51">254 U.S. 51. The converse of this rule, a corresponding limitation upon the power of the Federal Government to interfere with the exercise by the States of the powers reserved to them, is equally well established.  In Collector v. Day,11 Wall. 113">11 Wall. 113, it was held that the Federal Government had no right to impose a tax upon the salary of an executive officer of a State, the court saying: And if the means and instrumentalities employed by that government to carry into operation the powers granted to it are, necessarily, and, for the sake of self-preservation, exempt from taxation by the States, why are not those of the States depending upon their reserved powers, for like reasons, equally exempt from Federal taxation?  Their unimpaired*3005  existence in the one case is as essential as in the other.  It is admitted that there is no express provision in the Constitution that prohibits the general government from *1229  taxing the means and instrumentalities of the States, nor is there any prohibiting the States from taxing the means and instrumentalities of that government.  In both cases the exemption rests upon necessary implication, and is upheld by the great law of self-preservation; as any government, whose means employed in conducting its operations, if subject to the control of another and distinct government, can exist only at the mercy of that government.  In Pollock v. Farmers Loan & Trust Co.,157 U.S. 584">157 U.S. 584, the court said: As the States cannot tax the powers, the operations, or the property of the United States, nor the means which they employ to carry their powers into execution, so it has been held that the United States have no power under the Constitution to tax either the instrumentalities or the property of a State.  In *3006 Ambrosini v. United States,187 U.S. 1">187 U.S. 1, the power of the Federal Government was denied to levy a stamp tax on bonds given a State under a requirement of its law.  The court said: The general principle is that as the means and instrumentalities employed by the general government to carry into operation the powers granted to it are exempt from taxation by the States, so are those of the States exempt from taxation by the general government.  The application of these rules has, however, been limited to those cases where the Federal Government or the State in its employment and use of an instrumentality was performing some definite governmental function peculiar to its sovereign character.  It is held not to apply to the case where a private individual or corporation merely deals with the Federal Government, or with the State for private gain under a contract executed by the latter as an incident of the exercise of one of its governmental powers.  In Baltimore Shipbuilding Co. v. Baltimore,195 U.S. 375">195 U.S. 375, the Supreme Court, speaking through Justice Holmes, said: But, furthermore, it seems to us extravagant to say that an independent private*3007  corporation for gain, created by the State, is exempt from State taxation, either in its corporate person, or its property, because it is employed by the United States, even if the work for which it is employed is important and takes much of its time.  In Fidelity & Deposit Co. v. Pennsylvania,240 U.S. 319">240 U.S. 319, the corporation claimed immunity from taxation by the State on premiums collected by it on bonds executed under authority of an act of Congress allowing it to be accepted as surety on bonds required by laws of the United States, charging that its transactions with the Federal Government thereunder constituted it a governmental instrumentality.  In holding that it was subject to taxation by the State on such business the court said: But mere contracts between private corporations and the United States do not necessarily render the former essential governmental agencies and confer freedom from taxation.  *1230  In Osborn v. The Bank, supra, where it was held that the Bank of the United States was not a private corporation but a public one, created for national purposes and accordingly not subject to taxation by the State, Chief*3008  Justice Marshall, for the court, conceded that had it been a private corporation, with private trade and profit its purpose, it would be subject to State taxation.  The learned Chief Justice said that had this been the case - This mere private corporation engaged in its own business, with its own views, would certainly be subject to the taxing power of the State, as any individual would be; and the casual circumstance of its being employed by the government in the transaction of its fiscal affairs would no more exempt its private business from the operation of that power than it would the private business of any individual employed in the same manner.  In Flint v. Stone Tracy Co.,220 U.S. 108">220 U.S. 108, the court, after citing the authorities holding that the State can not tax agencies or corporations which are created for the purpose of carrying out governmental functions of the United States, said: An examination of these cases will show that in each case where the tax was held invalid the decision rested upon the proposition that the corporation was created to carry into effect powers conferred upon the Federal Government in its sovereign capacity, and the attempted*3009  taxation was an interference with the effectual exercise of such powers.  In this case the court in its discussion of the right of the Federal Government to tax instrumentalities of the State said: The true distinction is between the attempted taxation of those operations of the States essential to the execution of its Governmental functions, and which the State can only do itself, and those activities which are of a private character.  The former, the United States may not interfere with by taxing the agencies of the State in carrying out its purposes; the latter, although regulated by the State and exercising delegated authority, such as the right of eminent domain, are not removed from the field of legitimate Federal taxation.  And so in Grover v. Standard Dredging Co.,224 U.S. 362">224 U.S. 362, it was held that the property of a contractor employed by the United States was not exempt from taxation even though exclusively used for the carrying out of the contract.  The Supreme Court has also drawn a definite distinction between those cases in which the State was exercising a purely governmental power and one merely incident, and equivalent to the carrying on of*3010  a private business, although the agency employed was one representing the interest of the State alone.  In South Carolina v. United States,199 U.S. 437">199 U.S. 437, there was presented the right of the Federal Government to lay an excise tax upon the agents employed by the State of South Carolina to operate the State liquor dispensary under the provisions of a statute of that State under which it took over the exclusive sale of liquor, this statute having been held constitutional by the Supreme Court as a proper *1231  exercise of its sovereign police power.  In this case the business carried on by the agents was wholly an activity of the State itself, all of the net profits were revenue to the State and any burden by way of tax on the business was directly reflected in a lessening of the revenue it ultimately received.  The court, after reviewing the authorities, in sustaining the right of the Federal Government to tax this instrumentality of the State said: So here the charge is not upon the property of the State, but upon the means by which that property is acquired, and before it is acquired.  It is also worthy of remark that the cases in which the invalidity*3011  of a Federal tax has been affirmed were those in which the tax was attempted to be levied upon property belonging to the State, or one of its municipalities, or was a charge upon the means and instrumentalities employed by the State, in the discharge of its ordinary functions as a government.  Many cases have arisen calling for the application of the general rules discussed and the courts have recognized that the question is not one in which a hard and fast rule may be laid down which may be applied to every case of attempted taxation of a State or Federal agency.  The reason for this is that the question in each case is whether or not, under the particular facts involved, the tax constitutes an interference with the exercise of a sovereign power.  The objection to it, in any case, rests not upon the fact that it is a tax but that it is an interference with the exercise of a power which is immune from interference.  Even where the levying of the tax interferes with the exercise of a right possessed by the State, it may not constitute an interference with its necessary governmental powers.  This is illustrated by the case of *3012 Veazie Bank v. Fenno,8 Wall. 533">8 Wall. 533. In this case the Federal Government levied a tax upon the circulation of a State bank, the qeustion being practically the converse of that involved in McCullough v. Maryland, supra.In sustaining the validity of the tax the Supreme Court admitted that the right to create such a bank was not surrendered by the State in the grant of power to the Federal Government by the Constitution, but such a power was not one of these necessary to be kept free from interference to maintain the sovereignty of the State.  The court in that case points out those functions of the State which are sovereign in the following words: It may be admitted that the reserved rights of the States, such as the right to pass laws, to give effect to laws through executive action, to administer justice through the courts, and to employ all necessary agencies for legitimate purposes of State government, are not proper subjects of the taxing power of Congress.  But it can not be admitted that franchises granted by a State are necessarily exempt from taxation; for franchises are property, often very valuable and productive property; and when*3013  not conferred for the purpose of giving effect to some reserved power of a State, seem to be as properly objects of taxation as any other property.  *1232  And so it has been held that where the effect of the tax was merely to cause the Federal Government or the State to receive less income than it would had the tax not been imposed, it is not an interference with its sovereignty as a tax upon its property.  In this connection it is noted that the courts have held proper a succession tax levied upon legacies of property to the Federal Government or the State, the effect of which tax was to lessen the amount ultimately received under the legacy.  Thus, in United States v. Perkins,163 U.S. 625">163 U.S. 625, a succession tax of the State of New York was sustained, although the property charged was bequeathed by will to the United States, and in Snyder v. Bettman,190 U.S. 249">190 U.S. 249, a Federal succession tax was sustained although the bequest in question was to the City of Springfield, Ohio.  In Railroad v. Peniston,18 Wall. 5">18 Wall. 5, the court in holding that a tax upon the property of a government instrumentality was not an interference*3014  with the exercise of the governmental power to do those things which it is carrying into effect through the agent, said: It is therefore manifest that exemption of Federal agencies from State taxation is dependent not upon the nature of the agents or upon the mode of their constitution or upon the fact that they are agents, but upon the effect of the tax; that is, upon the question whether the tax does in truth deprive them of power to serve the government as they were intended to serve it, or does it hinder the efficient exercise of their power.  In Metcalf & Eddy v. Mitchell,269 U.S. 515">269 U.S. 515, the right of the United States was questioned to tax such portion of the incomes of two partners in an engineering firm as represented payments made the partnership by certain States and municipalities for services rendered as consulting engineers, it being claimed that as to the employment for which they were paid they were agents of the State Governments and as such exempt from taxation.  The court, after reviewing the authorities, in restating the rule as announced in *3015 Railroad v. Peniston, supra, that the fact of whether or not the tax constituted an interference was one for determination under the facts of each case as submitted, said: As cases arise, lying between the two extremes, it becomes necessary to draw the line which separates those activities having some relation to government, which are nevertheless subject to taxation, from those which are immune.  Experience has shown that there is no formula by which that line may be plotted with precision in advance.  But recourse may be had to the reason upon which the rule rests, and which must be the guiding principle to control its operation.  Its origin was due to the essential requirement of our constitutional system that the Federal government must exercise its authority within the territorial limits of the states; and it rests on the conviction that each government, in order that it may administer its affairs within its own sphere, must be left free from undue interference by the other.  McCulloch v.Maryland supra; Collector v. Day; Dobbins v. Commissioner of Erie County, supra.*1233  In a broad sense, the taxing power of either government, *3016  even when exercised in a manner admittedly necessary and proper, unavoidably has some effect upon the other.  The burden of Federal taxation necessarily sets an economic limit to the practical operation of the taxing power of the states, and vice versa.  Taxation by either the state or the Federal government affects in some measure the cost of operation of the other.  But neither government may destroy the other nor curtail in any substantial manner the exercise of its powers.  Hence the limitation upon the taxing power of each, so far as it affects the other, must receive a practical construction which permits both to function with the minimum of interference each with the other; and that limitation cannot be so varied or extended as seriously to impair either the taxing power of the government imposing the tax (South Carolina v. United States,199 U.S. 437">199 U.S. 437, 461; Flint v. Stone Tracy Co., supra, at 172) or the appropriate exercise of the functions of the government affected by it.  Railroad Co. v. Peniston, supra, 18 Wall, 31. We think it clear under the decisions that had the lands in question been merely State lands*3017  burdened with no special trust and held for general State purposes, there would be no question but what petitioner, as an individual lessee for private gain, would not be entitled to exemption from Federal taxation.  It could not be claimed that it was an instrumentality of the State when the lease of the land would be no more than an exercise of a right of ownership by the State, a right possessed by any individual and in no sense requiring an exercise of the power peculiar to sovereignty, or in the language of the court in Flint v. Stone Tracy Co., supra, "an act essential to the execution of its governmental function and which the state can only do itself." However, in the present case, it is claimed that the lands leased are a part of those ceded by the National Government to the State of Oklahoma, by the Enabling Act, for the definite and specific purpose of creating a permanent school fund to be administered in trust by the State for the maintenance of its public schools; that the acceptance of the grant created a trust in respect to such lands, undertaken by the State in its sovereign capacity, and that its every act toward performance of the trust and obtaining*3018  a school fund was one in carrying out a sovereign obligation; that in maintaining its public schools it is exercising a governmental function and that the lessees of school lands are its instrumentalities employed in the exercise of such function and accordingly exempt from Federal taxation.  In support of its contention petitioner cites certain decisions by the Supreme Court upon questions arising in connection with leases of tax-exempt Indian lands. In Choctaw O. & G.R. Co. v. Harrison,235 U.S. 292">235 U.S. 292, the right of the State of Oklahoma was disputed to levy upon a railroad company an occupation tax computed upon the gross sales of coal mined by it under leases to it by the Federal Government of tax-exempt Choctaw and Chicksaw Indian lands.  The court held that the treaty between *1234  these Indian tribes and the Federal Government imposed upon the latter a definite duty in respect to opening and operating these mines in their interest, and that the railroad company was the instrumentality through which this obligation was carried into effect, and as such could not be subjected to an occupation or privilege tax by the State.  *3019 In Indian Territory Illuminating Oil Co. v. Oklahoma,240 U.S. 522">240 U.S. 522, there was questioned the right of the State of Oklahoma to subject an oil and gas lease on tax-exempt Osage Indian lands to general taxation.  The court held that the property in question was under the protection of the Federal Government and that the leases "have the immunity of such protection." The court further said that "it follows from these views that the assessment against the oil company, so far as it included the leases, whether as separate objects of taxation or as represented or valued by the stock of the company, is invalid." The same principal was applied in Howard v. Gypsy Oil Co.,247 U.S. 503">247 U.S. 503, and Large Oil Co. v. Howard,248 U.S. 549">248 U.S. 549, involving gross-production taxes.  In Gillespie v. Oklahoma,257 U.S. 501">257 U.S. 501, a lessee of tax exempt Indian lands, from the Federal Government, disputed the right of the State of Oklahoma to exact a tax based upon the net income derived from operations under the lease.  In holding such taxes invalid the Court said: The same considerations that invalidate a tax upon the leases invalidate*3020  a tax upon the profits of the leases, and, stopping short of theoretical possibilities, a tax upon such profits is a direct hamper upon the effort of the United States to make the best terms that it can for its wards.  It is insisted that the condition presented in this proceeding is substantially similar to the one involved in the last cited case and that upon this and the other cases cited petitioner must be considered an instrumentality employed by the State of Oklahoma in the exercise of one of its sovereign powers and that to tax its income is to interfere with the exercise of that power.  In the cases cited the lands were held by the Federal Government in trust for Indian tribes.  The beneficiaries of the trust were dependent wards in respect to whom a duty rested upon the Government to exact a maximum income from the trust property.  The obligation of the trust was one assumed by treaty ratified by Congress and for that reason peculiarly sacred and inviolate as involving the national honor.  These treaties are obligations of sovereignty and have the same effect as treaties with foreign nations.  *3021 United States v. New York Indians,173 U.S. 464">173 U.S. 464; Turner v. American Baptist Missionary Foundation, 24 Fed. Cases 14251. An obligation to develop these Indian lands and to extract their mineral resources for *1235  these wards are ones specifically assumed by the Federal Government under the treaties, and the court has held that this laid upon the latter, as a sovereign, an obligation to obtain the best terms possible for its wards, and that to impose a tax upon the instrumentality through which it performs its duty interferes with the carrying out of its obligation.  In the execution of the leases involved in the cases cited the Federal Government was not merely leasing its public lands in securing revenue, but carrying out a sovereign treaty obligation.  We do not see in the facts presented in the proceeding before us a condition similar to that involved in leases of Indian lands.  In the language of the court in Metcalf & Eddy v. Mitchell, supra; in referring to the Gillespie case, the condition there involved was one of taxation by one government of "an agency created and controlled by the other, exclusively*3022  to enable it to perform a governmental function." We have no such condition here.  Petitioner is merely one of many lessees of school lands and if an instrumentality of the State in its furnishing of public education it is only one of many agencies of various kinds and characters, made use of as an incident of the performance of its governmental function.  In this connection see Choctaw O. & G.R. Co. v. Mackay,256 U.S. 531">256 U.S. 531, holding that a tax upon merely one of several agencies employed by the United States in discharging its obligations toward its Indian wards can not be considered as an interference with its exercise of its governmental power to carry out that obligation.  It is not controlled or directed by the State to any further extent than any other lessee of public lands.  We can not see in the two cases a similarity controlling the conclusion to be arrived at in the present case.  It is true that these lands were received by the State of Oklahoma from the Federal Government to be used for the creation of a school fund but can it be said that the act of the State in leasing them is, in view of that fact, of a different and more sovereign character than*3023  the leasing of its other public lands to obtain revenue for general State purposes.  We can see in the trust arising from the ceding of these lands to the State of Oklahoma for the creating of a school fund nothing more than a designating or setting aside of this property for this purpose.  The authority of the State in respect to these lands was, in so far as control and disposition of them was concerned, substantially the same as in respect of its other public lands, except that the proceeds from sale or lease should not go into its general revenues but into a permanent school fund, which was to be maintained intact, and the income therefrom used for its public schools.  Can it be said that one who leases such lands from the Commissioners of the Land Office, the instrumentality through which the State of Oklahoma controls and disposes of all of its public lands, *1236  is thereby constituted an instrumentality of the State in the performance of its governmental function of maintaining public schools, or an instrumentality of that State in the performance of a trust in respect to such lands assumed by it in its sovereign capacity, and therefore exempt from income tax upon the*3024  ground that the denial of such exemption would interfere with the securing of a more generous rental from the lessee and would lessen to that extent the amount derived for the school fund and ultimately affect a lessening of the income to be derived in the future from that fund for school maintenance, and that this would interfere with the performance by the State of its governmental function?  Can it be said that such a lessee is an instrumentality necessary to the performance of the governmental function and that a tax upon its income incapacitates it to perform properly the service for which it is employed?  Let us consider for the moment the extent to which the rule insisted upon by petitioner would lead.  It can not be questioned that the administration by the State of the permanent school fund secured from the sale or lease of the ceded lands is of no less sovereign character than its administration of the lands themselves in the obtaining of that fund.  Under the statutes of Oklahoma this fund is administered by the Commissioners of the Land Office and the income therefrom, which the Enabling Act provides shall be used for the maintenance of the public schools, is obtained*3025  by loaning it on first mortgages on land and by investment in certain specified classes of public bonds.  If an individual who obtains the use of school lands from the Commissioners of the Land Office for a rental is an instrumentality of the State in the carrying out of its governmental power to maintain public schools, as is claimed, so is the individual who obtains the use of a portion of the school fund for the payment of an interest charge.  If the first is exempt from taxation by the Federal Government, we see no reason why the second could not claim the same immunity, thus putting it in the power of any individual or corporation to become a tax exempt governmental instrumentality of the State of Oklahoma by merely securing a loan from the school fund.  Can it be said that the lessee of school lands stands upon a different footing from others with whom the State deals in carrying out its function of providing public education?  His connection with public education is more remote than one who builds a public school under contract with the State and whose total income from the work is paid him directly from school funds, and yet it could not be argued in the light of the decisions*3026  cited that the latter was a tax-exempt instrumentality of the State?  New York Trust Co. v. United States,63 Ct.Cls. 100; James A. Sackley Co. v.United States, 65 Ct.Cls. Cls. 304.  In American Book Co. v. Shelton,117 Tenn. 745">117 Tenn. 745; 100 S.W. 725">100 S.W.  725, *1237  a statute of Tennessee had provided for the use of uniform text books in the public schools and for the creation of a State text book commission which should determine the books to be used and provide for their being supplied to the schools, the commission being empowered to contract with some publishing house, through public bid, for the maintaining of a depot in the State of the books selected from which they would be supplied and fixing the prices at which they might be sold.  The plaintiff, as the successful bidder with whom the State contracted through the commission, claimed immunity from State ad valorem or privilege taxation, upon the ground that it was an instrumentality through which the State performed its sovereign function of providing public education.  The court in denying it the immunity claimed, said: If the fact that the book company has a contract*3027  with the State gave it immunity from taxation, the same rule would likewise exempt a manufacturer who might sell clothes for the convicts, the stationer who furnishes supplies to the State officers, and the printer who publishes the proceedings of the Legislature or the Supreme Court Reports, and apply to the ice dealer, who purchases his stock from the Board of Prison Commissioners, to the coal dealer who procures his coal from the State Commission, and to the dealer in hosiery who buys the output of the prison factory.  We do not think that petitioner under the facts here proven, as a lessee of public school lands in Oklahoma, for private and individual profit, stands in a position different, in so far as liability for Federal income tax is concerned, from a lessee of other property of the State or property of a private individual.  We can not see in the taxing by the Federal Government of its income therefrom an interference with the exercise by that State of one of its governmental powers.  The second issue involves the question of whether petitioner is entitled to a paid-in surplus in the amount of $58,538, the alleged value of the improvements on the lease on the date of*3028  its acquisition in January, 1914.  In advertising for bids for releasing the land in question the Commissioners of the Land Office notified prospective bidders that the equipment on the land had been appraised at a value of $55,800, that the land contained 15 producing wells and that the oil production from said wells averaged 8,113 barrels per month from January 1 to November 1, 1913.  The testimony establishes that the wells drilled had an aggregate depth of 29,269 feet, the reproductive cost of which amounted to $58,538 in January, 1914.  The testimony further establishes that, based upon the estimated production of oil from those wells over the five-year period of the lease and upon the then prevailing price of oil, the present net worth of those improvements in January, 1914, amounted to $58,710.  Upon all the facts of record, we are of the opinion that in January, 1914, the improvements, consisting of 15 producing wells, had an actual *1238  cash value of $58,538 which attached to the lease awarded to Sutton, for the lessee acquired a 5-year interest in those wells, together with a preference right to release the land for an additional five years.  Sutton and his associate*3029  paid in to petitioner the physical equipment on the leased land, having an actual cash value of $55,800, and in addition the lease, having an actual cash value of $58,538, for $25,000 par value of petitioner's stock, $25,000 of its bonds, and its note for $5,800.  No evidence has been submitted as to the payment of the said bonds and note, but respondent raised no question with respect thereto and has included in petitioner's invested capital the amount of $55,800, representing the cost of the physical equipment to petitioner as aforesaid.  The only question presented to the Board is whether petitioner is entitled to additional invested capital in the amount of $58,538 as a paid-in surplus.  The lease, of the actual cash value of $58,538, having been paid in for stock in addition to other property paid in for the stock issued and of a value equal to the par value thereof, we are of the opinion that petitioner is entitled to include in invested capital the amount of $58,538 as a paid-in surplus under the provisions of section 207 of the Revenue Act of 1917, and section 326 of the Revenue Act of 1918.  With reference to the third issue, the value of $58,538 in January, 1914, of the*3030  improvements on the lease should be included in the basis upon which respondent computed the allowable deduction for depletion.  The fourth issue is relative to the proration of prior years' taxes out of invested capital for each of the years involved.  Such proration should be made upon the basis of the correct amount of taxes due as computed pursuant to this decision and in accordance with the Commissioner's regulations.  The last issue is relative to the respondent's reduction of petitioner's invested capital for the year 1918 on account of a tentative tax computed on earnings to date of a dividend paid on November 4, 1918, which action must be held erroneous under authority of L. S. Ayers & Co.,1 B.T.A. 1135">1 B.T.A. 1135. Reviewed by the Board.  Judgment will be entered pursuant to Rule 50.GREEN GREEN, dissenting: The petitioner herein has leased certain oil and gas lands from the State of Oklahoma.  The lands covered by the lease were part of the lands which were conveyed by Congress to the State of Oklahoma at the time of its admission to statehood, and the restrictions which were attached to this land by the terms of the Enabling Act were accepted*3031  by the State of Oklahoma in its constitution and subsequently the legislature of the State passed such legislation as was necessary to carry out the terms imposed by Congress.  These *1239  lands are conveniently described as school lands.  The major question in this proceeding is the right of the Federal Government to impose a tax upon the income a derived by this petitioner from its operation of its leases on these State-owned school lands.  That the lands here under consideration are the property of the State of Oklahoma is not questioned.  Likewise it appears to be conceded that the erection and maintenance of public schools is an essential governmental function of the State.  This could not be otherwise in view of the Enabling Acts and other legislation under and by virtue of which Oklahoma became a State and the United States conveyed to it the school lands, the income of which is here under consideration.  The issue has been narrowed to the sole question of the right to tax the income derived by a lessee from State-owned school lands.  The leading case on the right of a State to tax the income of a lessee of Federal lands is *3032 Gillespie v. State of Oklahoma,257 U.S. 501">257 U.S. 501. In holding that such income could not be taxed the United States Supreme Court said: A tax upon the leases is a tax upon the power to make them, and could be used to destroy the power to make them.  240 U.S. 530">240 U.S. 530. The steps from this to the invalidity of the tax upon income from the leases is not long.In cases where the principal is absolutely immune from interference, and inquiry is allowed into the sources from which net income is derived, and if a part of it comes from such a source, the tax is pro tanto void (Pollock v. Farmers Loan & Trust Co.,157 U.S. 429">157 U.S. 429), a rule lately illustrated by Evans v. Gore,253 U.S. 245">253 U.S. 245, and applied in a case somewhat like the present by the Supreme Court of Hawaii (Oahu Ry. & Land Co. v. Pratt, 14. Haw. 126.) Whether this property could be taxed in any other form or not, it cannot be reached as profits or income from leases such as those before us.  The same considerations that invalidate a tax upon the leases invalidate a tax upon the profits of the leases; and, stopping short of theoretical possibilities, *3033  a tax upon such profits is a direct hamper upon the effort of the United States to make the best terms that it can for its wards.  (Italics supplied.) This case is the converse of the Gillespie case.  There the State sought to tax income derived by the lessee of Federal lands.  Here the United States seek to tax the income derived by the lessee of State lands.  It is also the law that the United States may not tax the agencies' instrumentalities or property of the States.  In Van Brocklin v. State of Tennessee,117 U.S. 151">117 U.S. 151, the court said: In Collector v. Day,11 Wall. 113">11 Wall. 113, it was adjudged that Congress had no power, even by an act taxing all income, to levy a tax upon the salaries of judicial officers of a State, for reasons similar to those in which it had been held in Dobbins v. Erie County Commissioners,16 Peters 435">16 Pet. 435, that a State could not tax the salaries of officers of the United States.  Mr. Justice Nelson, in delivering judgment, said: "The general government, and the States, although both exist within the same territorial limits, are separate and distinct sovereignties, *1240  acting separately*3034  and independently of each other, within their respective spheres.  The former in its appropriate sphere is supreme; but the States, within the limits of their powers not granted, or, in the language of the Tenth Amendment, 'reserved', are as independent of the general government as that government within its sphere is independent of the States." 11 Wall. 124">11 Wall. 124. * * * The reasons for exempting all the property and income of a State, or of a municipal corporation, which is a political division of the State, from federal taxation, equally require the exemption of all the property and income of the national government from State taxation.  If there were any remaining doubts, the court set them at rest in Pollock v. Farmers Loan & Trust Co.,157 U.S. 584">157 U.S. 584, when it said: As the States cannot tax the powers, the operations, or the property of the United States, nor the means which they employ to carry their powers into execution, so it has been held that the United States have no power under the Constitution to tax either the instrumentalities or the property of a State.  The United States have such powers and rights as have been granted to them by*3035  the several States.  There is nothing in the Constitution which limits the right of either to tax the other.  That these limitations exist is, however, beyond question.  They grew out of the common necessity that each, within its own sphere, be free from interference from the other.  I have been unable to find any intimation that the limitations are more rigorous in the case of one than in the case of the other.  If, then, as was held in the Gillespie case, the State may not tax the income derived by the lessee from the operation of lands leased from an instrumentality of the United States, it follows inevitably that the United States may not tax the income derived by a lessee from the operations of lands leased from the State of Oklahoma or one of its instrumentalities.  The effect upon the lessor, of taxing the income of the lessee, is the same irrespective of which is the lessor and the same rule should be applied to either case.  The income derived by a lessee on public school lands of the State of Oklahoma is not, in my opinion, subject to Federal taxation.  MARQUETTE, PHILLIPS, and SIEFKIN agree with this dissent.